WHAT IS A MARKET?

In a country like the United States, most economic decisions are resolved through the market, so we begin our systematic study there. Who solves the three fundamental questions—what, how, and for whom— in a market economy? You may be surprised to learn that no one individual or organization or government is responsible for solving the economic problems in a market economy. Instead, millions of businesses and consumers engage in voluntary trade, intending to improve their own economic situations, and their actions are invisibly coordinated by a system of prices and markets. To see how remarkable this is, consider the city of New York. 

Without a constant flow of goods into and out of the city, New Yorkers would be on the verge of starvation within a week. For New York to thrive, many kinds of goods must be provided. From the surrounding counties, from 50 states, and from the far corners of the world, goods travel for days and weeks with New York as their destination. How is it that 10 million people can sleep easily at night, without living in mortal terror of a breakdown in the elaborate economic processes upon which they rely? The surprising answer is that, without coercion or centralized direction by anyone, these economic activities are coordinated through the market. Everyone in the United States notices how much the government does to control economic activity: it places tolls on bridges, polices the streets, regulates drugs, levies taxes, sends armies to Europe, and so forth. But we seldom think about how much of our ordinary economic life proceeds without government intervention. Thousands of commodities are produced by millions of people every day, willingly, without central direction or master plan.

Not Chaos, but Economic Order

The market looks like a jumble of different sellers and buyers. It seems almost a miracle that food is produced in suitable amounts, gets transported to the right place, and arrives in a palatable form at the dinner table. But a close look at New York or other economies is convincing proof that a market system is neither chaos nor miracle. It is a system with its own internal logic. And it works. A market economy is an elaborate mechanism for coordinating people, activities, and businesses through a system of prices and markets. It is a communication device for pooling the knowledge and actions of billions of diverse individuals. Without central intelligence or computation, it solves problems of production and distribution involving billions of unknown variables and relations, problems that are far beyond the reach of even today’s fastest supercomputer. Nobody designed the market, yet it functions remarkable well. In a market economy, no single individual or organization is responsible for production, consumption, distribution, and pricing. How do markets determine prices, wages, and outputs? Originally, a market was an actual place where buyers and sellers could engage in face-to-face bargaining. The marketplace—filled with slabs of butter, pyramids of cheese, layers of wet fish, and heaps of vegetables—used to be a familiar sight in many villages and towns, where farmers brought their goods to sell. In the United States today there are still important markets where many traders gather together to do business. For example, wheat and corn are traded at the Chicago Board of Trade, oil and platinum are traded at the New York Mercantile Exchange, and gems are traded at the Diamond District in New York City. In a general sense, markets are places where buyers and sellers interact to set prices and exchange goods and services. There are markets for almost everything. You can buy artwork by old masters at auction houses in New York, or pollution permits at the Chicago Board of Trade, or legal drugs from delivery serivces in many large cities. A market may be centralized, like the stock market. It may be decentralized, as in the case of labor. Or it may exist only electronically, as is increasingly the case with “e-commerce” on the Internet.