Understanding Market Structures and the Stock Market
Market Structures
Definition of a Market
A market is a set of economic relations between subjects, where they buy or sell the same goods or services regardless of location. Markets determine the price and quantity of a commodity. Examples include trade fairs, auctions, and central markets.
Types of Markets
Based on Traded Goods:
- Markets of Goods: These markets trade tangible goods like food, housing, etc.
- Markets of Services: These markets trade intangible services like telephone service, banking, etc.
- Markets of Factors of Production: These markets trade capital (banking, bags, etc.) and labor.
Based on the Number of Suppliers and Customers:
- Monopoly: A single supplier and multiple buyers.
- Monopsony: A monopoly of demand, with a single buyer and multiple sellers.
- Oligopoly: A few sellers and multiple buyers (e.g., cartels or trusts).
- Perfect Competition: Multiple buyers and sellers (a hypothetical model).
- Monopolistic Competition: Multiple suppliers and consumers, with product differentiation.
Based on State Intervention:
- Markets in Surgery: Banking, tobacco, alcohol, etc., where the state intervenes.
- Free Markets: For example, textiles, but there is always some degree of intervention.
Based on the Terms of Sale:
- Transparent Markets: All conditions are known (e.g., the stock market).
- Opaque Markets: Some conditions are not known to all involved (e.g., black markets).
Based on Access of Participants:
- Open Markets: Participation is free (e.g., stock market, general trade).
- Closed Markets: Limited participation with entry barriers (e.g., computing, oligopolies).
Perfect Competition
Definition
Perfect competition is a theoretical market model that represents an idealization and is never fully realized in practice. It serves as a reference point in economics for understanding the functioning of other market models and provides an idea of maximum efficiency in resource use.
Features:
- High Number of Buyers and Sellers: No individual can influence the price or quantities supplied and demanded. They are price-takers, meaning the price is set by free-market forces.
- Homogeneous Product: Buyers and sellers don’t care who they transact with because the product is identical with no brand differentiation.
- Transparent Market: Buyers and sellers have full knowledge of each other’s willingness to pay and exchange, including product details, quantities, and prices.
- Fully Open Market: Complete freedom of entry and exit for new firms without barriers.
Revenues of a Competitive Firm
Like any business, the goal of a firm under perfect competition is profit maximization. Since prices are fixed, the firm adjusts its production level to achieve this. The average and marginal cost curves are typically U-shaped due to the short-term nature of production, characterized by increasing and then diminishing marginal productivity of variable inputs. The competitive firm cannot set the price; it’s constant. Total Revenue (TR) = Price (P) x Quantity (Q). Average Revenue (AR) = TR / Q. Since the firm cannot influence the price, Marginal Revenue (MR) equals the price. Therefore, the individual demand curve is a horizontal line. MR = AR = Demand (D) = Q.
Output Level in the Short Term
In the short term, the number of firms is fixed. The individual firm takes the price as given and sets the output level to maximize profit. This occurs when the output level equates price to marginal cost. The maximum profit condition is: P = MC. In perfect competition, the last unit produced brings revenue equal to the price, while its production cost is the marginal cost.
Difficulties of Perfect Competition
Being an open market, long-term profits tend to disappear. If a firm manages short-term profit, it attracts competition, increasing total market supply and shifting the supply curve to the right. This leads to a decrease in the equilibrium price and profits. Under perfect competition, the equilibrium price is the same for all firms, but profits and costs may differ. Many firms may disappear in the long run if they cannot cover their total costs and will be replaced by new entrants.
Difficulties in the Functioning of the Model
- Lack of Transparency: Real markets have advertising, which can obscure competition. Buyers and sellers may not have complete information about products, purchase conditions, etc.
- Lack of Product Homogeneity: Firms strive to maximize profits by differentiating their products through branding, quality, advertising, etc.
- Lack of Free Market Access: Most free markets have entry barriers for new firms, such as technological, capital, legal, or business size restrictions, hindering the open market condition of perfect competition.
- Existence of Economies of Scale: Economies of scale occur when a firm’s production costs decrease as its production capacity increases. Larger firms can produce more at lower costs due to lower average total costs, making it difficult for smaller firms to compete on price.
The Stock Market
Definition
The stock market is a market for buying and selling securities, which can represent parts of a company’s capital (shares) or portions of large loans (bonds or debentures).
Shares
Shares are securities representing part of a company’s capital. They can be physical or electronic and grant the holder the rights and obligations of a partner or shareholder.
Types of Share Value:
- Nominal Value: The initial price of a share, representing the portion of the company’s capital corresponding to the share.
- Market Value: The price a share can achieve when traded on a stock exchange. It’s independent of the nominal value and determined by supply and demand, influenced by the company’s profits, expansion, etc.
Roles of the Stock Market
- Channeling Savings into Investment: Individuals and households with savings can invest in the stock market by buying securities, providing funds for large companies needing long-term investments.
- Acting as a Secondary Market or Exchange: The stock market allows the free exchange of securities held by individual investors, leading to:
- Setting the Trading Price: The price of each security is determined by supply and demand.
- Providing Liquidity: Savings invested in the stock market can be retrieved quickly. Investors can recover their money by selling their shares to others.
Investing in the Stock Market
- Large companies list on the stock exchange to raise capital from small savers who become shareholders or lenders.
- These companies issue securities representing either part of their capital (shares) or portions of a large loan (bonds or debentures).
- Savers and investors buy these securities, providing funds to the companies. Share buyers become part-owners of the company, while bond buyers become lenders.
- The sale of purchased shares is free. Investors can sell their shares at any time at the quoted market price, which fluctuates based on supply and demand.
Method of Recruitment
- Order to Buy or Sell: An investor gives a written order to a financial intermediary (e.g., a bank) indicating the type of security they want to buy or sell.
- Transmission: The intermediary transmits the order to a broker or dealer. Brokers are authorized to negotiate on the exchange.
- The Dealer: Can manage shares for themselves and others. No one can trade directly on the exchange.
Objectives of Stock Market Investors
- Speculative Objectives: Seeking maximum profit in a short time by exploiting price differences. Investors buy at low prices when there’s an abundance of securities and sell at high prices. Requires staying updated on the evolution of acquired shares.
- Thrifty Objective: Investors aim to preserve savings by holding securities instead of keeping money in the bank, hoping their value remains high over time. They may also receive dividends from the issuing company or collect interest from bonds.