A great deal has been said about money and its exchange for wealth, so it is worth saying something about the mechanisms and processes that facilitate and regulate these exchanges. The most important mechanism is the market, where buyers and sellers come together to exchange goods and services, and enter into contracts to exchange goods and services, in other words to carry out transactions. Past markets were physical locations, and many still are, but increasingly they are electronic, using the power of the internet to bring people together to trade. Each market relates to a particular good, service or type of contract, so there are distinct markets for apples, steel, insurance, money, illegal drugs, labour and everything else that people want to exchange.
The behaviour of markets has been and still is a very contentious issue in economics. Indeed it is probably this issue that divides the different economic schools more than any other. The mainstream neoliberal view is that markets should be left to buyers and sellers, motivated only by money, without any external, especially government, interference - this is the 'free market' or for more emphasis the 'unfettered free market' ideology. According to this view, universal benefits flow from these markets, not only for the participants themselves but also for everyone else. Conversely, according to this view, almost any economic problem can be traced back to market interference, which if the interference hadn't happened wouldn't exist because free markets are able to solve any economic problem on their own.
The motivational power of money is immense. It's like fire. It provides tremendous benefits when properly controlled, but when uncontrolled it does great damage. Neoliberalism insists that the motivation it arouses is best left to itself in the marketplace without external restrictions. Neoliberalism has largely had its way for almost forty years and like an uncontrolled fire it has indeed done great damage.
Markets provide the exchange mechanism for private enterprise, where prices are determined by individuals concerned only with serving their own interests. Other types of exchange mechanism are possible, especially where there are wider interests at stake than those of individuals.
There are three types of markets that need to be considered separately. The first is the ideal free market, the second is the unfettered free market, and the third is the fair market.
These types of markets don't have consistent formal definitions so I have defined them in ways that seem to match those that are generally used.
This is a market in which buyers and sellers agree product prices between themselves without external interference. It reaches an equilibrium price - one that depends only on the rates of supply and demand. To be ideal requires perfect competition[112] where, amongst other things:
· sellers and buyers are free to enter and leave the market at will and can easily do so;
· there are large numbers of buyers and sellers;
· no buyer or seller is able to set prices on their own, only the activities of all buyers and sellers together can do that;
· there is perfect information - all consumers and producers know all product prices and the utilities that each person would get from owning each product;
· products of the same type from different suppliers are perfect substitutes for each other - the qualities and characteristics of a market good or service do not vary between different suppliers;
· there is perfect factor mobility - every productive factor (worker, machine, land, building etc.) can be redeployed to serve any other productive purpose at no cost;
· participants always make rational choices;
· costs and benefits don't affect third parties;
· there are no transaction costs; and
· there are no economies of scale.
None of these is ever achieved in practice of course and many lie in the land of fantasy, so an ideal free market is a complete fiction. Nevertheless it is useful to pursue the implications because where conditions fail to be met participants find opportunities for exploitation.
In an ideal free market participants are free to buy at the seller's offered price, sell at the buyer's bid price, haggle, or walk away. Sellers provide the supply of products, buyers provide the demand, and the relative strength of supply and demand determine the price that is agreed. Both supply and demand are flexible, in that new suppliers are free to enter the market if they wish without any barriers to entry, and buyers are similarly free and available in varying quantity depending on the prevailing price - generally the higher the price the fewer the buyers. I say generally because some markets behave differently, especially for things that are not for use but for later resale. Here a rise in price is often taken as a signal that further rises are likely, and demand increases as prices increase, and vice versa - see chapter 57.
The price is the mechanism that matches supply to demand. If a new product is developed that is popular, initially the supply rate is limited so there are more buyers willing to buy than there are products available for sale. If the initial price was set too low by the supplier then it rapidly rises as buyers compete between themselves by offering more in order to obtain the product or sellers recognise the high level of demand and raise the price themselves. In these circumstances supply is limited, the price is high, and buyers are limited because relatively few are prepared to pay the high price. Both supply and demand are low but matched at this high price. A high price tempts the first supplier to increase production and also tempts other sellers to enter the market, causing supply to increase. The new suppliers offer products at lower prices to attract buyers and existing suppliers are forced to follow suit. This they do until the rates of supply and demand are again matched at higher levels at this new lower price. Of course there are many more potential sellers willing to supply at a higher price and many more potential buyers willing to buy at a lower price, but there is only one price at which both supply and demand rates are equal, and this is known as the equilibrium price. At a higher price sellers make less money because there are fewer buyers and they lose more on the unsold stock than they gain on the increased price, and at a lower price sellers make less money because although there are more buyers they lose more by the reduced price than they gain by selling more stock.
If it happens in an ideal free market that external effects cause an oversupply of a particular product relative to the number of buyers - perhaps another product has been produced that people prefer to the product in question - then buyers diminish because fewer are prepared to pay the current price, and sellers are forced to compete with each other by reducing the price to attract buyers so as to avoid having unsold stock, and as a result the least efficient sellers lose the most money and abandon the market. As sellers leave the market the oversupply diminishes and the fall in price levels off until it again matches the new lower supply and the new lower demand rates at the new price. If the opposite happens and there is a shortage of a particular product - perhaps the government has imposed a high tariff on similar but preferred imported products - then buyers' willingness to buy increases and the price rises as before for the new product.
Although the concept of ideal free markets is an attractive one, it isn't realisable in the real world because it relies on neither side being able to take advantage of the other side. In effect both sides have equal freedoms in the ideal free market. In the real world of course both sides don't automatically have equal freedoms. Buyers and sellers are naturally in conflict - buyers want to buy cheaply whereas sellers want to sell dearly - and in any conflict each side tries its best to use its freedom to restrict the other's freedom because that gives it the advantage. Think of almost any interactive game of skill where the actions of one player affect the actions of other players, and it is seen that skill in the game represents precisely this ability to restrict one's opponent's freedom of action. Free markets are games of this sort, though seldom played for fun, and participants use whatever freedoms they have to enhance their own position and restrict others. This is the freedom conflict discussed in the Introduction. Several examples are given in the next chapter.
A particularly unrealistic assumption in the promotion of free markets is that there are no economies of scale. In the real world there are of course, and they allow bigger companies to capture markets (which is what they all strive to do) and become monopolies by forcing smaller and less competitive suppliers out of the market. However this spoils an otherwise very elegant theory, so, in the well-established tradition of neoliberal economics it is simply assumed not to exist! Neoliberals prefer unrealistic assumptions that lead to orderly and easy-to-analyse relationships that don't work to realistic assumptions that lead to disorderly and hard-to-analyse relationships that do[113] (Schlefer 2012 pp10-15).
It is worth adding that although free markets are much praised and loved by neoliberals, they are hated by suppliers. In markets that approach this ideal most closely; where it is hard to hide relevant information and easy for new suppliers to enter, suppliers have to struggle constantly to stay afloat against fierce competition. Life for suppliers is hard in these circumstances. Many such markets are now dominated by very large companies where economies of scale have allowed them to force smaller competitors out of the market altogether.
For neoliberals this is the perfect market. It is again one where no-one other than buyers and sellers is involved in the working of the market, but the difference between this and an ideal free market is that it acknowledges the inability of a real market to achieve ideal market conditions but dismisses it as inconsequential. As a result, and by holding fast to the non-interference rule, it allows participants to pursue whatever advantage they are able to. Proponents of unfettered markets strongly favour laissez-faire - literally 'let do', meaning let people do as they choose.
Belief in the benefits of unfettered free markets is an act of faith (as indeed are many economic beliefs), in that it has never been proved, in spite of many attempts to do so, that such markets deliver the benefits that are claimed for them - see chapter 80. Claimed benefits are that they allocate resources in the most efficient manner, and in so doing bring about the best outcome for everyone - buyers, sellers and the rest of society. This is the free market utopia referred to in the Introduction.
This is a market where everyone, participants and non-participants, is treated fairly. No-one is exploited or harmed by trade, and everyone is able to exchange goods and services at prices that reflect the true value of the products. A fair market applies appropriate external regulation where necessary to ensure that no-one can unfairly exploit others. It acknowledges the need for general state intervention in the form of supporting and enforcing functions - property rules to establish ownership; courts to enforce contracts; trading regulations to protect buyers and sellers; a police force to investigate crimes and bring wrongdoers to justice; and health, safety, labour and environmental standards to comply with accepted norms; social insurance to insulate against market risk; and taxation to fund all these and many more requirements (Rodrik 2012 p22).
The main differences are between unfettered free markets and fair markets, so these are discussed at greater length.