Market Economics: How People and Firms Interact in Producing and Allocating Resources, Goods, and Services

About Market Economics

Market Economics, sometimes referred to as microeconomics, is the study of how people and firms interact in producing and allocating resources, goods, and services. It’s not as scary as it sounds!

Market economics are important to understand because they affect how you make purchasing decisions every day, from where you buy your clothes to what you pay for groceries at the grocery store.

Since understanding them will help you get the most value out of your money, it’s crucial that you know how market economics work so that you can make smart financial decisions in the future.

What are markets?

Markets are places where goods are bought and sold. Some of those goods can be bought with currency – like when you spend money on groceries at a grocery store – but others require no monetary exchange, like when you use a straw to drink your morning coffee.

Economists think about markets through three main lenses: production markets, allocation markets, and distribution markets. Production markets allow firms to buy necessary inputs from other firms so they can produce outputs for customers. For example, if we’re going to continue using our grocery store as an example (since that seems easy), let’s say that we need some tortillas if we want to make burritos for dinner tonight.

The benefits of free markets

Economists use a variety of tools to analyze market structure. Among these are supply-and-demand curves; graphs that illustrate how consumers will react when prices increase or decrease (called elasticity); marginal analysis; and product differentiation.

In some situations, economists recommend state intervention in markets; such situations include externalities (costs or benefits to nonparticipants), public goods (goods that are impossible to exclude people from consuming), imperfect competition (such as monopolies or monopsonies), prisoner’s dilemma games, and coordination failures.

Government regulation of markets

This can range from relatively minor government involvement to complete government control. In some cases, there may be market-based incentives designed to correct for governmental failure or market distortions created by regulation.

In other cases, these incentives may simply exist without an explicit connection to correcting market failure. It is most common for governments to try to influence markets through taxation, subsidization of favored products or industries (e.g., agriculture), monopoly provision of certain goods (public utilities), legal sanctions (such as patents) against activities that would violate general rules laid down by the state for a given market.

Economic systems/models

The two broadest classes of economic systems are market economies and planned economies. A market economy is one in which prices are determined by competition (i.e., buyers and sellers) rather than by government control. Planned economies refer to those systems where the government controls prices and production levels through central planning or some other method.

In practice, most countries operate with a mix of these two models—and it’s difficult to classify them as either free-market or controlled economies because both methods rely on some level of regulation from outside forces.

Types of market failure

There are several types of market failure. Among them are adverse selection and moral hazard, which often occur together. Market power is another example of a type of market failure. Adverse selection occurs when one party to a transaction has more information than another party. For example, when an insurance company asks someone whether they engage in risky behaviors such as smoking or skydiving (and rates them accordingly), it might screen out those who have higher risk for accidents (such as those who answer yes to those questions).

This leads to people with lower risks being charged more for insurance—people with low risks get priced out of coverage because high-risk people take up too much space. Moral hazard is a similar concept but relates to businesses rather than individuals.