The role of markets in allocating resources

Economics · The allocation of resources. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

A market is any arrangement that brings buyers and sellers together to trade a good or service. It does not have to be a place. A vegetable bazaar is a market, but so are online shopping sites, the market for foreign currency and the labour market, where trading takes place by phone or on a screen.

Buyers create demand. They want to pay a low price, and the way they spend their money tells firms which products are wanted. Sellers create supply. They want a high price and aim to make a profit.

Through the decisions of buyers and sellers, markets decide how scarce resources are used. Resources move towards the products people are willing to pay for.

Rules to remember

Market: any arrangement that lets buyers and sellers trade
A market needs buyers, sellers, a product and a way to agree a price; it does not need a physical place
Buyers (consumers) demand products and want low prices
Sellers (producers) supply products and want high prices and profit
Product markets trade goods and services; factor markets trade land, labour and capital
In the labour market, workers are the sellers and firms are the buyers

Common mistake

Students mix up the two sides of the labour market. Workers sell their labour and firms buy it, so the firm that hires is the buyer.

Worked example

On a phone app, passengers book motorbike rides and riders accept them at a fare shown on the screen. There is no office or stand where they meet. Is this a market, and who are the buyers and sellers?

A market only needs an arrangement that lets buyers and sellers trade; the app is that arrangement.
The passengers pay for the service, so they are the buyers.
The riders provide the service for payment, so they are the sellers.

Answer: Yes, it is a market. Passengers are the buyers and riders are the sellers.

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Cambridge Economics — Complete Theory Notes

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