An Introduction to Product
Markets
What is a Market?
• Institution or mechanism that brings together
buyers and sellers
• Common element is goods or services are traded
• Geography, size, or familiarity doesn’t matter
– Local, national, or international
– Millions of participants or two people
– Friends or anonymous
– People you never meet
Examples of Markets
• Farmer’s roadside stand
• Retail stores like Starbucks, Blockbuster Video,
Macy’s, Home Depot, Betty’s Hair Salon and
Nike Shoes
• New York Stock Exchange
Markets Determine What Will Be
Produced by Establishing Prices
• If no one buys the shoes I’m selling, I will lower
price and not produce any more
• No one else will start producing shoes given my
lack of success in selling them
• If everyone wants my shoes, and I don’t have
enough to sell to them, I will raise the price and
start producing more shoes
• Other firms will start producing shoes given my
success in getting money for them
Markets Determine How Much Will
Be Produced by Establishing Price
• Firms will produce shoes only if they can make
a profit
• To make a profit, the price of the shoes must
cover the cost of producing them
• A firm will not produce shoes if the price is less
than what it costs to make them
• A firm will produce lots of shoes if the price is
more than what it costs to make them
Markets Determine Who Gets the
Goods by Establishing Prices
• People that can’t afford and don’t want the
shoes won’t get them
• People that can afford and want the shoes will
get them
Shoes are Bought and Sold in
Product Markets
Product markets bring together buyers and
sellers of shoes (or other goods or services)
– People want to buy shoes: they demand shoes if
they are willing and able to pay for them
– Firms want to sell shoes: they supply shoes if the
firm is able and willing to produce them (price
covers the cost of production)
Money Helps Exchange
• Shoes are traded for dollars
– Shoes have a dollar price
– Individuals pay firms dollars for shoes
• Money is a medium of exchange: it helps
consumers get goods by facilitating trade
Money Helps Markets Function
Smoothly
• Barter would exist without money
• Barter is exchanging goods for goods
• Without money individuals would have to
trade shoes for other products (like food)
– Individuals selling food might want clothes, not
shoes
– A three-way trade would have to occur
• Money makes it easier for individuals to
get the goods they want
Market Forces Operate through
Competition
• If people cannot get shoes, they will compete
against other consumers to get them by bidding up
the price
• As the price goes up, firms will start to produce
more shoes
• If firms cannot sell all the shoes it made, it will
compete with other firms for individuals to buy the
shoes by lowering the price
• As the price goes down, more people will buy the
shoes
An Introduction to Factor
Markets
Resources are Bought and Sold in
Factor Markets
• Factor markets bring together buyers and
sellers of resources
• Resources are productive (real) resources
– Land: any natural resource
– Labor: any human resource
– Capital: any product used further in production
(e.g., machines)
– Entrepreneurship (risk taking, like Holden)
Resources are Scarce
• Resources are limited
• Firms need resources to produce shoes
– They demand resources
– They will pay a price to get them because they
are scarce
• Rent for land
• Wages for labor
• Interest for capital
• Households sell their labor to firms
– They supply resources
– They receive payment for them
Money Helps Resource Markets
Operate Smoothly
• Money is a medium of exchange: it
facilitates trading for resources
• Without money, trade would be barter
– Individuals would be paid for their work with the
products they made (shoes)
– Individuals might not work (supply no resources)
because of the “pay”
• Money makes it easier for firms to get the
resources they want
Consumers Determine Resource
Use
• Resources are used only if individuals want
what is being produced
– Resources will NOT be used to produce a good if
individuals are unable or unwilling to pay for it
– Resources will be used to produce a good if
individuals are able and willing to pay it
• If firms produce shoes, they need labor and
capital that can be used in shoe production.
• If firms produce cars, they need a different type
of labor and capital
Prices in Product Markets Determine
How Resources are Used
• Expensive production methods mean high prices
– Using “overly productive” resources (like producing shoes in
San Francisco or Manhattan or a MD to dig ditches)
– Wasting resources
• Cheaper production methods mean prices will be low
– Efficiently using resources
– Not wasting resources
• Fewer people buy shoes at a higher price
• Low cost production methods used since fewer
individuals buy at higher prices (if all shoes the same)
Productivity Determines How
Much Firms will Pay for Resources
• Firms can produce more if resources are
more productive
• Firms will pay more for resources that
produce more
– Firms get more out of a resource it is worth more
– Firms will bid up the price of productive resources
• Wages are higher for more productive
workers
Competition Establishes the Price
of Resources
• If firms cannot get the resources they need to
produce, they will compete against other firms to
get them by bidding up the price (e.g., wages
increase)
• As the price of resources goes up, price of product
goes up
• If firms can get lots of a resource (say labor),
unemployed workers will compete with other
individuals for a job by lowering their asking wage
• As wages go down, the price of the product goes
down
Relating Product and Factor
Markets in Market
Economies
Market-Established Prices Answer
the 4 Economic Questions
• All economic systems must address four
questions
– What will be produced?
– How much will be produced?
– How will goods and services be produced?
– Who will get the goods and services?
• In a market economy like the U.S., markets
answer these questions by determining price
What is a Market Economy?
• An economic system in which resources
are based on individual decision making
– Firms decide what they will produce
– Consumers decide what they will purchase
• In a planned economy, the government
decides what will be produced, how much
will be produced, how goods are produced,
and for whom the goods are produced
The Idea of a Market Economy is
Simple
• Individual buyers and sellers have no plans to follow
• We enter the markets we wish to trade in and
respond to prices within
• If we want to purchase a good at its price we do; if
firms want to produce it at that price they do
• If we still buy when the price goes up, we’re better
off than if we did not buy it (if we weren’t we wouldn’t
buy it)
• If a firm lowers the price of a good, it is still better off
than it would be not selling it (if it weren’t, it wouldn’t
sell it at the lower price)
To Operate Market Economies Need
• Firms
• Households/Individuals
• Property rights
• Individual decision making
Firms
• A firm is an economic unit that
– hires (demands) factors of production (productive resources)
– organizes factors to produce and sell (supplies) goods
• Form does not matter
– Corporations: infinite life, limited liability, and can raise money
for capital investment (stocks, bonds)
– Proprietorship: a single owner
– Partnership: two or more owners
• Critical element is using resources for production
Households/Individuals
• An economic unit that
– Buys (demands) goods and services
– Sells (supplies) resources to firms to use in production
• Receive payments for resources
– More productive resources have higher prices
– Payments include wages (labor), interest (capital),
rent (land)
Property Rights
• The social arrangements that say who owns, uses, and
disposes of RESOURCES
– In a market economy, individuals and firms own and use resources
how they want
– In a planned economy, the government has this right
• If individuals/firms have property rights, they use the
resources efficiently
• Other types of so-called property help market
economies function smoothly
– Financial property (examples)—medium of exchange, like money
• Stocks
• Bonds
– Intellectual property (intangible products of creativity)
• Books , music, computer programs, inventions
• Copyrights and patents establish their property rights
Individual Decision Making
• Individuals enter markets to do what will make
them happiest (act in their own self interest)
– Buy goods that they want
– Sell labor if they want to buy goods
• Firms enter markets to make profit
– Buy resources to produce goods
– Sell the goods to make a profit
• Self motivating actions in markets turn
resources into goods and services
Product and Factor Markets are
Linked
• Everyone acts in self interest, which creates
demand and supply of products and resources
• In the Factor Market:
– Individuals supply labor (or other resource) to firms for
wages (or other payment): they want $$
– Firms demand the resources from individuals: they want
to produce goods to make $$
• In the Product Market:
– Individuals demand goods and services: consuming
makes them happy
– Firms supply goods and services: selling makes them $$