Markets, market prices, and market regulation

Economists often refer to “markets”. To an economist, a market is a conceptual meeting place where buyers and sellers of goods and services meet and establish a price for those goods and services. Such market places need not exist in any physical location, but in fact, exist all around us.

A job market is created by employers looking for staff and workers looking for jobs. A wholesale electricity market is created by electricity generators wanting to sell electricity and electricity retailers wishing to buy electricity, while a retail electricity market exists between electricity retailers and households.

From an economic perspective, there is a market for almost all goods.

The market serves two key purposes. The first is to allow exchanges to take place to the mutual benefit of both parties – for example, a worker sells his labour to an employer in exchange for money. The second is that a price is set for that exchange.

This price-setting behaviour of markets is a crucial part of economics because the price of resources significantly influences how that resource is used and what is produced. If a resource is mis-priced, then the ultimate allocation of the resources will be sub-optimal. If the price of a resource is too low, then society will be wasteful of it. However, if the price is too high, then the resource will be under-used and overall outcomes will be less beneficial than they could be.

Given that price is so important to economics, and that markets set prices, it is hardly surprising to find a huge body of economic work on market structures and price-setting. It is on the basis of this work that consumer legislation in most countries outlaws monopolies, collusion amongst competitors, price-fixing, misleading advertising, and any other practice that acts to prevent the free operation of a market.

The imposition of rules in a marketplace touches on one of the tensions in economics – the tension between providing sufficient structure in the market place so that market participants are treated fairly, while avoiding high administrative costs and retaining flexibility in outcomes. Economists wish markets to act freely so that their important role of price-setting is unbiased and efficient – but this does not mean there should be no regulation.

All markets have rules of operation. Simple markets may have informal rules. However, as markets become more complex and transact larger values, rules become formalised. For example, the stock exchange has a set of rules requiring disclosure of any relevant information by listed companies, their directors, and major shareholders, along with reporting of all share transactions. These rules aim to keep the market fully informed about the governance and future prospects of listed companies.

So, economists believe that rules are necessary in a marketplace to ensure efficient outcomes – but they also agree that excessive regulation hinders market operation. A key question often considered by economists is how to structure market regulation to prevent abuses of market power, without stifling the market with unnecessary rules.