Monday, 3 August 2009

What is a market? Who solves the three fundamental questions?

A market is a mechanism through which buyers and sellers interact to set prices and exchange goods and services à in a market system, there are gains from trade! Through trade, one attains a good because he imposes a higher value on the good!

Prices coordinate the decisions of producers and consumers in a market. Higher prices tend to reduce consumer purchases and encourage production. Lower prices encourage consumption and discourage production. Prices are the balance wheel of the market mechanism.

Market equilibrium: At market equilibrium everybody who was willing to exchange goods has done so. Markets are steadily solving the three fundamental questions! 
--> they balance all the forces operating on the economy, markets are finding a market equilibrium of supply and demand.

How are the fundamental questions solved?
  • What
    - Through the daily consumption decisions, the kind of goods and services, that will be produced is determined
    - Firms are motivated by the desire to maximize profits by producing the desired goods
  • How
    - determined by the competition among the producers; best way for producers to meet price competition and maximize profits is to keep costs at a minimum by adopting the most efficient methods of production
  • For whom (who is consuming and how much)
    - depends in large part on the supply and demand for the factors of production à they determine the wage rates, land rents, interest rates and profits; by adding up the all revenues a individual receives for his factors of production, one attains the persons market income

Core determinants of the shape of our economy are the dual monarchs of tastes and technology

  • Tastes determine to a large extent the point on the PPF
  • Technology limits the choices of the consumers to the points within and on the PPF
Adam Smiths discovery
  • „by pursuing his own interest, he frequently promotes that of soceity more effectually than when he really intends to promote it“
  • under limited conditions, a perfectly competitive economy is efficient
  • however, there are market failures
    - Monopolies and other forms of imperfect competition
    - spillovers and externalities outside the marketplace

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