MARKET THEORY: WHAT IT CONSISTS OF AND EXAMPLES - ECONOMY - 2025

The theory of the market is the economic theory that relates to the determination of prices and quantities to produce goods and services, prices and uses of production factors. A market is one of the many diversities of institutions, systems, procedures, infrastructures and social relations, through which the parties participate in an exchange.

Although the parties can exchange services and goods with barter, most markets are based on suppliers who provide their goods or services, including labor, in exchange for cash from buyers.

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Markets facilitate trade and allow the distribution and allocation of resources in a society. They allow any marketable item to be evaluated and valued.

A market exists whenever individual members of a society are in close enough contact with each other to be aware of the many opportunities for exchange and, furthermore, are free to take advantage of them.

What is market theory?

The construction by economists of the set of propositions that make up the theory of the market is based on the awareness of the existence of an economic law.

What happens in the market at any moment must be attributed to what happened in the past, or as previous actions of what will happen in the future. Market phenomena do not emerge at random. They are understood to be uniquely determined by market forces.

Recognizing economic law implies the idea that, even after having used the physical and psychological sciences to the maximum to investigate the influences that have helped to determine an economic event, there are still significant elements that have not been sought.

Market system

This system allows people to exchange goods and services voluntarily, based on prices, without knowing each other.

One way to appreciate the distinctiveness of market-mediated commerce between strangers is to contrast it with other ways that people transact with each other.

Analysis of the market system will be found to reveal a remarkable feature in the operation of these constraints. It is mainly this characteristic that falls on market theory with its importance.

The true importance of the market system lies in the fact that the mutual interaction of these restrictions constitutes a unique process, by which the decisions of different people, which may be unknown to each other, tend to be progressively more consistent with each other.

Historical origin

The modern market system is considered to have emerged only in the last 300 years. Two features of the modern market system were largely absent until that time.

One was price flexibility, in response to supply and demand. Ancient and feudal trade was done at prices fixed by custom and authority.

A second characteristic is that they allow people to work for money and to trade food.

Before 1500, almost all people existed on a subsistence level, living off what they could grow. The feudal lords took any excess production and provided some goods in return.

Until 1700, the practice of obtaining a harvest with cash and buying goods and services with money was relatively unknown.

Emergence of the market system

Between 1700 and 1850 the market system emerged in Western Europe and North America. Better farming techniques allowed people to produce surplus food. Thus they had something to trade and could free up labor to work in manufacturing.

Improvements in transportation facilitated specialization and trade. Increasingly, people were moving from subsistence farming to a cash economy. In this economy they obtained money for a crop or physical work.

Adam Smith was the first philosopher to fully articulate the virtues of the market system. Smith argued that trade was more efficient than self-sufficiency.

In addition, Smith noted that the self-interest of the producers benefited the consumers.

Law of supply and demand

When consumer demand increased for some good, the price rose, attracting more producers. The fact that higher prices induce more production is known as the law of supply.

Similarly, a higher price for a good induces consumers to buy less of that product. This is known as the law of demand.

Together, the laws of supply and demand determine an equilibrium price and the level of production for each good. This impersonal and self-adjusting process is what distinguishes a market economy.

Examples

Let us consider the consequences on the price of ice from a sharp and sudden reduction in the quantity available for sale.

If the physical sciences are applied, although they can indicate why such a reduction in supply has occurred, they cannot say anything about why subsequent purchases of ice will be made at higher prices.

The explanation given that higher prices are a consequence of reduced supply invokes the concept of economic laws.

The nature and existence of economic law, and its manifestation in the interaction of market forces, must now be sought in the actions of the individual human being.

Geographic boundaries

The geographic boundaries of a market can vary considerably. For example, the food market is confined to a single building, the real estate market to a local city, the consumer market to an entire country, or the economy of an international trading bloc, to several countries.

Markets can also be global, see for example the global diamond trade.

Primary input market

The market for agricultural products is carried out by small-scale growers scattered over a large area. End buyers are also scattered. The centers of consumption are far from the regions of production.

Therefore, the merchant is in a stronger economic position than the seller. This situation is more evident when the producer is a farmer who lacks commercial and financial knowledge, being forced to sell as soon as his harvest arrives.

Under a regime of unregulated competition, such markets are overwhelmed by continual fluctuations in prices and turnover.

Although distributors can mitigate this to some extent by accumulating stocks when prices are low and releasing them when demand is high, such buying and selling often turns into speculation, which tends to exacerbate fluctuations.

References

1. Gale Thomson (2005). Market Theory. Encyclopedia. Taken from: encyclopedia.com.
2. Israel M. Kirzner (1973). Market Theory and the Price System. Mises Institute. Taken from: mises-media.s3.amazonaws.com.
3. Wikipedia, the free encyclopedia (2019). Market (economics). Taken from: en.wikipedia.org.
4. The Free Dictionary (2019). Theory of markets. Taken from: financial-dictionary.thefreedictionary.com.
5. Joan Violet Robinson (2019). Market. Encyclopaedia Britannica. Taken from: britannica.com.