Monday, April 4, 2011

The Market

In our discussion on Demand and Supply, to which we would return pretty soon, we made a mention of "Market" where lemons were traded. We have used the term Market in the general understanding of common parlance, but it is interesting to see how Economics defines the term "Market".

A "market" refers to the collection of buyers and sellers that, through their actual or potential interactions, determine the price of a product or a set of products. It is interesting here to note the difference of the term "market" from that of "Industry" - An Industry is a collection of firms that sell the same or closely related products. In effect industry forms the supply side of the market.

While defining a market; economist are generally concerned with the determination of the buyers, sellers and range of products that should be included in a particular market; this is of interest since the definition of the market essentially buts a boundary on the buyers and sellers - the potential and actual ones both are important. The difference in the definition of the Maker essentially leads to a possibility of "Arbitrage". Arbitrage: Is the practice of buying at a low price at one location and selling at a higher price in another.

Let’s take an example to make it clear:

Let’s say Mr. X a resident of Hong Kong wants to purchase gold and that the price of gold is significantly lower in Chennai in India. If he intends to make use of this difference in price he would travel all the way from Hong Kong to Chennai and make the purchase at a lower price, take it back to Hong Kong and Sell it at a higher price. This is given that the transportation cost he incurs is much lower than the profit he would earn by entering into such an activity. Such activities would be detrimental on a large scale and hence the possibility of arbitrage is always checked across the globe for gold price.

The example above also highlight the “importance of Information flow in business” - about which we made brief mention while discussing Information Asymmetry.

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