Advantages of using markets to allocate resources

What are the advantages of using markets to allocate resources? To whom do these advantages accrue? Why might these advantages not be realized?

Introduction

A market indicates to all the buying and selling activities of people that are wishing to trade a service or good. The market consists of suppliers that want to sell and demanders that want to buy the service or good. A market works to determine the price at which a good is exchanged and the quantity of it that would be bought and sold.

But, how markets are used to allocate resources? Markets work by market exchange which involves the transfer of a title to a piece of property (good/service) to another party in return for some form of payment at mutually acceptable terms (Bowles, Edwards and Roosevelt, 2005).

Competitive markets exist also where there are many actual or potential demanders and suppliers. There is a sense of competition between them.

Adam Smith’s key ideas of “invisible hand” provide a good idea about the challenge of economics and system of competitive markets. The tendency of markets to guide economy to an optimal allocation of resources. But, what exactly is an optimal allocation of resources and how it can be achieved?

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An allocation is said Pareto efficient when no further improvements can be made. If it is impossible to reallocate resources to make anyone better off without at the same time making somebody worse off, then it is called Pareto efficiency or Pareto optimum. Hence, it is a very weak judgement because it says nothing about the distribution. If all markets are in equilibrium that is demand is equal to supply in every market, then a competitive equilibrium exists. Competitive equilibrium is necessary and sufficient for Pareto efficiency (‘invisible hand’).

Advantages of Markets

The advantage of markets over government involvement is ‘efficiency’ because the forces of demand and supply that exist in every market create somewhat an automatic economic order. The amount of waste is also reduced by efficient means.

Markets are able to work together efficiently through pricing, even when there is a deficiency in supply or demand, a new equilibrium price and quantity can be reached. A market involves efficient resource distribution such that there is no shortage and surplus of products. It determines and prioritizes social goods better than a centrally planned mechanism.

In case of central planning, the direction of the economic system is according to one unified plan. The main advantage of using markets would be to introduce competition which could mean decentralized planning by many separate persons.

In case of competitive markets, there is less risk of monopoly as firms would hesitate to limit output so as to raise prices because now they would have the fear of competition. There is competition in industry and even within markets. A high competition aids in allocating resources to an efficient use through which firms and customers can benefit as economies of scale can be achieved.

Markets encourage new products, research & development and innovation of products. Customers get new products and experiment with them. A good example is of Coca Cola which introduced flavours of lemon, berry and others in its fizzy drinks to get innovation and product development.

In a capitalist economy, markets would give advantage in keeping the quantity of demand same so that the prices remain more or less the same. It would allow even a layman to buy and sell shares so that he/she can make or lose money.

Markets can be seen as transmitters of economically significant information and provide the motivation to act on the information transmitted. In most circumstances, markets can do this much more efficiently than a central planning mechanism.

The economic problem of society is not merely a problem of how to allocate “given” resources – if “given” is to taken to mean given to a single mind which deliberately solves the problem set by these data. Planning refers to complex decisions about the allocation of our available resources. There is a dispute as to whether planning is to be done centrally, by one authority for the whole economic system or to be divided among many individuals (Hayek, 1945).

Markets encourage consumers to try to meet their needs with goods that are less scarce than others and also encourage producers to produce things that are scarce with inputs that are not so scarce.

Employers intend to make profits by selling the produced goods in markets and markets must be competitive so that there are no monopolies. Even a system of competitive markets could combine greedy actions of economic actors into some results that are beneficial for society. Market can be seen as a not so authoritative structure that is an invisible hand as compared to firms.

Due to the development in technology and communication methods, even invisible markets exist in this digital world. Markets exist now over the telephones, online and even on emails. Products and goods are just now ‘one-click’ away from us. Amazon and eBay are examples of online markets enabling us one click ordering and home delivery for our bought products.

Wal-Mart, Carrefour, Tesco and Sainsbury’s are no longer grocery or retail stores but are examples of hypermarkets providing a wide variety of goods and services, almost everything a buyer needs from a seller.

There is better identification of strong and weak markets in relation to customer behaviour and potentials. There is more efficient allocations of marketing and advertising budgets (Rothman, 1964).

If care is given to the design and implementation of resource allocation by markets, targets of lower costs and better services could be easily achieved.

Advantages Accrued

In oligopolistic markets, where there are fewer sellers and fewer buyers, the advantages will be accrued to the major stakeholders and shareholders that would enjoy a huge profit which would normally go to a small number of large firms. The advantages are accrued to the buyer as he/she is getting the product at a good price and to the seller who is making profit out of it. These mutual benefits are healthy for competition in markets as markets compete with each other on prices. Sometimes, the advantages also go to the government when the government does not need to give subsidies, tax relaxations and intervene. The investors who had invested their money in markets have a preference for holding cash and profits. The price of share then may rise which would feed back to the economy through an upward effect on confidence. The advantage is also enjoyed by the society and customers who have better, cheaper and competitive markets. As a whole, ‘healthy’ markets help to improve the shape of the economy.Equilibrium refers to a situation; a price and a quantity exchanged in which there are no forces internal to the situation pushing it to change. In the long run, equilibrium is reached by the market where sellers and buyers know the exact price and quantity of the product. So , advantages accumulate with the buyers and sellers.

The producers and firm owners that are producing their products and supplying it to sellers will make huge profits if their product is successful in market and is competitive. These producers accumulate huge benefits and profits.

Market clearing price is the price at which buyers want to purchase exactly the quantity that sellers want to sell. If this is achieved, the advantages accumulate to marketers who are providing marketing intelligence and customer insights.

Advantages not realized

When a person goes to the market to buy something and when they have bought it, they usually do not consider in their mind that they might have got it cheap but rather always think of it in terms of money and numbers because money goes from the wallet. So, they might have got the product cheap but fail to realize this.

The advantages for third person might not be realized e.g swimming pool does not always have a pleasuring effect. The third party might be unaware of these advantages or may fail to get these benefits. In case of a market failure, the advantages will not be accrued and consequently advantages are not realized.

There is uncertainty whether the fiscal and monetary stimulus will work. Perhaps uncertainty follows the “waterbed principle”: try to flatten it in one place and it simply pops up somewhere else (The Economist, 2009).

Market Failure

Market failure occurs when the market interactions of buyers and sellers results in undesirable outcomes. This might be the case when the requirements of people are not reflected in market demands e.g my mistaken belief about the ability of a gadget. Another failure could result when markets are controlled by a small number of buyers and sellers e.g A single seller charges the price for a good that exceeds the actual cost to the firm. When governments intervene too much and impose heavy taxes or tariffs or when externalities in consumption are present. Now, the benefit or cost to the individual customer will not accurately measure the benefit or cost to society as a whole. An example of positive consumption externality is another person’s or neighbour’s enjoyment of one large beautiful swimming pool. While, an example of a negative consumption externality would be imposition of unwanted smoke by a smoker on non-smokers. Neither the prisoner’s dilemma nor the tragedy of the commons, much as they may shed light on the problems associated with self-interested market behaviour, are in themselves examples of market failure because they do not involve exchange relationships(Bowles, Edwards and Roosevelt, 2005).

But, even a market failure can be seen as a type of coordination failure because the ‘invisible hand’ will not work if prices are not appropriate and these prices do not reflect all the effects of people’s actions on one another. The prices here are not properly measuring the scarcity of goods.

Market failure occurs when there are discrepancies between costs and benefits of a decision and these divergences lead towards externalities which are also called ‘spillovers’.

Conclusion

Markets work through market exchange where goods can be transferred to a third party for payment at mutually accepted terms. The trading usually involves buyers and sellers. The advantages are accumulated with the buyers and sellers who are making profit out of it because the goal is to make profit. The investors who have invested their money into markets will also enjoy some benefits and return on investment would be expected high, though the rate of return might be low.

Using markets for allocation of resources is generally efficient, better and cheaper. It can provide quicker means of business transactions between buyers and sellers. A market tends to create and maintain somewhat a balance between demand and supply so that there is no surplus and shortage of products. There is also a competition between them for prices to attract customers and sell goods and services at a customer oriented rate. Just imagine if there would have been no markets, what would have happened? But, there has been the ‘Barter’ system, where goods are exchanged for other goods. Barter markets lacked standards for deferred payments and there was absence of common measure of value.

The market mechanism may seem cheaper but what would happen in case of a market failure. The undesirable outcomes are not pleasing as huge losses might be associated with it and reflect that prices are not right.

Then the question arises whether market or central planning mechanism? The answer to this question depends on to the extent we expect that the full use will be made of the existing knowledge. This further depends on whether the chosen mechanism would succeed in putting at the disposal of a single central authority all the knowledge which might be dispersed among many individuals (Hayek, 1945).

Hence, it depends on planning and the mechanism whether it would yield some benefits and these benefits could be either accumulated or not be realized.