Unit 3 How Markets Work

A market is created whenever a potential seller of goods or services is brought into contact with a potential buyer and a means of exchange is available. The medium of exchange may be money or barter. Exchange agreements are reached through the operation of the laws of supply and demand. In the business view the market is a collection of selling opportunities.

It is useful to begin with a brief synoptic overview of the ba­sic market mechanism. We limit ourselves to two illustrations. These are a change in tastes and a change in costs.

A change in tastes. Assume, at the outset, "that producers find it equally profitable to produce Wensleydale or Cheddar cheese, and that consumers are prepared to buy the quantities of each that are being supplied at prevailing market prices. Now, suppose that consumers experience a greatly increased desire for Wensleydale and a diminished desire for Cheddar cheese.

What will be the effect of this change? First, consumers will buy more Wensleydale and less Cheddar. With production unchanged, a shortage of Wensleydale and a glut of Cheddar will develop. In order to unload their surplus Cheddar, merchants will reduce its price, on the principle that it is better to sell it for less than not to sell it at all. In contrast, merchants will find that they cannot keep Wensleydale on their shelves. It has become scarce. People will be prepared to pay more for it and its price will rise. As the price rises, people will buy less expensive Cheddar instead. Thus, the quantity demanded will adjust itself to the available supply.

The price changes in the shops will filter through to the cheese factories. They will re-allocate their resources from Cheddar to Wensleydale production since it will be profitable to do so.

A change in costs. For our second example, consider a change originating not with consumers, but with producers. Begin, as before, with a situation in which producers find it equally profitable to produce Wensleydale and Cheddar, and that consumers are prepared to buy, at prevailing market prices, the quantities of these two cheeses that are supplied. Now imagine that a technological change occurs; an improved Wensleydale-making process is developed and this lowers the cost of Wensleydale production. Since costs fall, Wensleydale production becomes more profitable.

Clearly, producers will begin to switch resources from Ched­dar to Wensleydale. Soon the quantities of the two cheeses coming on to the market will change. A shortage of Cheddar and a glut of Wensleydale will result. The price of Cheddar will start to rise and that of Wensleydale to fall. As the former becomes more expensive, less of it will be bought by consumers. The opposite will happen with Wensleydale. The lower price will encourage consumers to buy and eat more of it. At the same time, there will be an incentive for producers to move some resources back into Cheddar production as its price rises relative to that of Wensleydale.

The functions of price. The price mechanism operates to allocate resources in such a way as to answer the three basic questions of what is to be produced, how it will be produced, and how it will be distributed among the population. Prices do so by acting as signals to consumers and producers in two sets of markets:

• market for commodities, i.e. for goods and services (often called "goods market" for short);

• market for factors of production (often called "factor market" for short).

Prices signal to producers which goods are the most profitable to produce. Prices signal to consumers which goods give most value for the money they must pay to purchase them.

Competition is also a necessary condition of the effective market mechanism. Depending on regime of competition it is distinguished perfect and imperfect competition. Perfect competition is a model of industrial structure in which many small firms compete in the supply of a single product. There is a multitude of firms all too small to have any individual impact on market price. Perfect competition is most efficient for functioning of market mechanism.

Imperfect competition is represented by monopolies and oligopolies. Monopoly is a market situation in which there is only one supplier of a particular product in a particular market or otherwise isolated sector. The key aspect of a monopolist is that, in theory, the single supplier can charge whatever price he likes. The choice of the buyer is "buy from us or go without". There are no competitors against whom to match the company's prices. A true monopolist is consequently a price setter who enjoys the right to set prices at whichever level will maximize his profits. In practice, monopolies with such pricing power are rare, especially in developed economies. The term is still useful, though, because in some market sectors, some businesses are so large that they are virtual monopolists.

Oligopoly is a market which is dominated by a few large suppliers. Oligopolistic markets are often characterized by heavy product differentiation which is distinguishing essentially the same products from one another by real or illusory means through advertising and other marketing ploys. The most concentrated oligopoly is when just two suppliers control the market. Most industries in the UK fall more or less within the oligopoly category. Each sector will have its big players and its many smaller ones. For example, the supply of washing powder to the UK retail market is controlled almost exclusively by two very large competitors. Lever Brothers Ltd (part of Unilever pic) and the US based Proctor and Gamble group together supply in excess of 90 per cent of the total UK market. As there are two competitors, this is known as duopoly.

C o m m e n t s

synoptic -	конспективний
at the outset -	з самого початку
to adjust oneself -	пристосовуватися
multitude -	безліч
imperfect -	недосконалий
price setter -	законодавець цін
virtual -	фактичний
ploy -	трюк, хитрість.