Microeconomics: The Extent of a Market
In every conversation you’ll ever have about business or
economics it will always, always boil down to a certain market or collection of
markets. I always say that a market is the center of economic activity. A
market, by definition, is the collection of buyers and sells who, through their
actual and potential actions dictate the price of a good/service.
Buyers include the consumers and the firms. Consumers are
those who purchase the good or service and firms are those who buy capital,
labor and raw materials that are used to produce their good/service.
Sellers include firms and resource owners but also workers.
Firms sell their good or service. Resource owners are those who rent land or
sell mineral resources to firms. However, workers who are typically viewed as
the consumers in an economy are actually sellers too – they sell their labour service
to firms for a price i.e. a wage/salary.
You should take care in remembering that a market includes more
than an industry. Where an industry is a collection of firms that sell
homogeneous or at least very similar, closely related products. In essence, an
industry covers the supply side of a market.
Following on from this, economists are frequently concerned
with something called market definition. This is the determination of the
buyers, sellers and range of products that should be included in a particular
market.
When defining a market the potential influence of buyers and
sellers is as equally important as the actual influence. To make this point a
bit more obvious, take the market for silver. It is improbable then, that someone
who lives in London would want to travel to America to buy some silver. For this
reason, most buyers and sellers would interact in London. However, because the
transportation costs of silver are small relative to its value buyers of silver
in London could in fact purchase silver from America.
The reason that it creates a global market for a product
lies in the practice or arbitrage whereby you buy in one location at low prices
and sell at a higher price in another location. The point to be taken from this
is that this PREVENTS the prices of silver, or any commodity for that fact,
FROM DIFFERING SIGNIFICANTLY and actually creates a global market for silver.
Now that we know this we must now ask ourselves why is it
that only a few firms compete with each other in certain markets yet there are
a lot of firms competing with each other in other markets. Is the consumer better
off with fewer firms? If not should the government or market regulators
intervene? Why is it that prices rise and fall more rapidly in some markets
than in others where price is more stable?
The answer to all these questions can be answered by talking
about the level of competition - both actual and potential. Moreover, we need
to talk about market prices, too.
The level of competition in a market is significant becomes
it determines the price. In economics we compare markets to a market operating
under conditions of perfect competition – a market with many buyers and sellers
where no single buyer or seller has a significant impact on price. An example
of a market operating under perfect competition is the market for wheat. There
are thousands of farmers that produce wheat and there are thousands of
consumers that buy the stuff to produce flour and other wheat-based products. This
is typically the case in most agricultural markets and natural resource markets.
On the other hand, there are some markets that do have a
large number of firms which are described as non-competitive; where individual
firms can jointly influence the price. An obvious example of a non-competitive
market is the market for oil which has been dominated by the OPEC cartel since
the 1970’s.
It should be clear now that markets actually make
transactions between buyers and sellers possible. Products are sold at a price
which, in a perfectly competitive market, the market price prevails (determined
by levels of supply and demand). However, regarding prices in markets that don’t
operate under perfect competition, it is likely that firms will charge
different prices for a product. This occurs because firms want to win over
potential customers or because of the existence of brand loyalty that allows
firms to charge above the market price. Market prices can fluctuate over time,
some in a stable manner and others in a very rapid manner. The latter occurs
more in competitive markets i.e. the stock market.
Finally, we can now determine the extent of a market which
helps us distinguish which buyers and sellers operate in the market. The extent
of a market is the boundaries of it - both in terms of geographical boundaries and
in terms of the range of products produced/sold within it. For some products it
makes sense to only talk about it in geographical boundaries, like the housing
market. Thinking about the range of products produced helps us define the extent
of a market. Take car fuel as an example, diesel and unleaded might not be
considered part of the same market because most consumers buy one or the other.
You might now be asking why market definition is important.
Well there are 2 elements in the answer. One is that a company needs to know
who its actual or potential rivals are and that they must also know
geographical and product boundaries. This is because it helps with, for
example, advertising campaign budgets and investment decisions. The other
element is that it helps in deciding public policies. This is particularly prominent
when a government or regulator must decide whether or not to allow the
acquisition or merger of companies that produce homogeneous or at least similar
goods as this action will have an effect on future prices and levels of
competition.
Thanks for reading and if you have any queries please email me at: samandchrisshapley56@gmail.com or post a comment on the page itself and I’ll try to get back to you as soon as I can.
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