Fisheries Economics

2.4.1. Markets and prices

We will examine how markets determine the price of goods and the quantity sold and consumed. A market is a set of arrangements for the exchange of a good or a service.

Barter vs. markets

A barter system is a market system in which goods or services are traded directly for other goods or services. If you agree to repair your neighbor's computer in return for his or her assistance in painting your house, you have engaged in a barter transaction. While a barter system may be able to function effectively in a simple economy in which a limited variety of goods are produced, it cannot function well in a complex economy that produces an extensive collection of goods and services. The primary problem associated with a barter system is that any trade requires a double coincidence of wants. This means that trade can only take place if each person wants what the other person is willing to trade and is willing to give up what the other person wants. In a developed economy in which a diverse collection of goods and services are produced, locating someone willing to make the trade that you desire may be quite difficult and costly. If you repair TVs and are hungry, you must find someone with a broken TV who is willing to trade food for TV repairs. Because it is costly to arrange such a transaction, economists note that barter transactions have relatively high transactions costs.

For this reason, throughout recorded history virtually all societies have used some form of money to facilitate trade. In a monetary economy, individuals trade goods or services for money and then use this money to buy the goods or services that they wish to acquire. Since money can be traded for any good or service, the use of money eliminates the need for a double coincidence of wants and lowers the transaction costs associated with trade.

Relative and nominal prices

The opportunity cost of acquiring a good or a service under either a barter or a monetary economy may be measured by the relative price of the commodity. The relative price of a commodity is a measure of how expensive a good is in terms of units of some other good or service. Under a barter system, the relative price is nothing more than the trading ratio between any two goods or services. For example, if one laser printer is traded for 2 ink-jet printers, the relative price of the laser printer is two ink-jet printers. Alternatively, the relative price of an inkjet printer is one-half of a laser printer in this case. In a monetary economy, relative prices can also be easily computer using the ratio of the prices of the commodities. If, for example, a soccer ball costs Rs.20 and a portable CD player costs Rs.60, the relative price of a portable CD player is 3 soccer balls (and the relative price of a soccer ball is 1/3 of a CD player). Economists ague that individuals respond to changes in relative prices since these prices reflect the opportunity cost of acquiring a good or service.

In a market economy, the price of a good or service is determined through the interaction of demand and supply. To understand how market price is determined, it is important to know the determinants of both demand and supply.

Behaviour of a firm and determination of price in a market have attracted the attention of economists significantly. Enormous contributions were made on the market and marketing aspects which are central to an economy, particularly the capitalist economy. Market is the very basic foundation on which the capitalist economy rests and operates.

Market coordination

Production in modern economies is an extremely complex activity. Consider the computer that you are currently using. It consists of components and raw materials that were probably made in thousands of firms located in dozens of countries. Somehow, the glass, plastic, metal, silica, and other raw materials were all combined into the monitor, computer chips, mother board, and other components that form this computer. It is interesting to note that the computer you are using contains dramatically more computing power than the mainframe computers of 20 years or so ago. How did all of these raw materials get converted into this computer? Well, it all happened through market processes. All but the most primitive economies rely on markets to coordinate many productive decisions (yes, this was even true in the former Soviet Union -- it has been estimated that 50% or more of all output was sold in the unofficial underground market economy).

Markets and the "three fundamental questions"

All economies, no matter what their form of economic organization, must address what are known as the "three fundamental questions:"

• What?

• How?

• For Whom?

Let's examine each of these questions.

What?

The first question can be rephrased as: "What mix of goods and services will be produced?" In a market economy, the interaction of self-interested buyers and sellers determines the mix of goods and services that are produced. Adam Smith, writing in the Wealth of Nations argued that competition among self-interested producers results in an outcome that benefits all of society. Two quotes from Smith help to illustrate this argument:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self-interest. (Book I, Chapter I).

[A producer,]...by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, not very common among merchants, and very few words need be employed in dissuading them from it. (Book IV, Chapter II).

This argument suggests that competition among self-interested producers forces them to produce goods that satisfy consumer wants. In seeking his or her own profit, each producer attempts to produce higher quality products that better serve consumer needs. This leads to a condition of consumer sovereignty in which it is ultimately the consumer who determines what mix of goods and services will be produced. Some economists, such as John Kenneth Galbraith, have questioned this argument and suggest that marketing activities by large corporations can substantially influence the pattern of consumer demand. Most economists argue, though, that while marketing methods may influence consumer demand in the short run, consumers ultimately determine what goods and services that they will buy. Effective advertising campaigns may lead to phenomena such as pet rocks and Chia Pets, but these fads are generally fairly short-lived.

If, for whatever reason, consumers want more of a good, this results in an increase in demand. In the short run, this increase in demand results in higher prices, increased output, and a higher level of profit for firms in this industry. In response to these profits, however, new firms will enter the market in the long run, resulting in an increase in market supply. This increase in supply will drive the price back down while further increasing the quantity sold. The short-run profits generated by the increase in demand gradually disappear as the price declines. Thus, the long-run response to an increase in demand is an increase in the amount produced. (Notice how this is consistent with the concept of consumer sovereignty.)

How?

The second fundamental question may be more completely stated as: "How is output produced?" This question involves the determination of the mix of resources that are to be used to produce output. In a market economy, profit-maximizing producers will be expected to select a mix of resources that result in the lowest possible level of cost (holding the quantity and quality of output constant). New production techniques will be adopted only if they reduce production costs. Sellers of resources will supply them to those activities in which they are most highly valued. Once again, Smith's "invisible hand of the market" guides resources into their most valued uses.

For whom?

This third fundamental question deals with the issue of "who gets what?" In a market economy, this is determined by the interaction of buyers and sellers in both output and resource markets. The distribution of income is ultimately determined by the wages, interest payments, rents, and profits that are determined in resource markets. Those with more highly valued land, labor, capital, and entrepreneurial ability receive higher incomes. Given this distribution of income, individuals make their own decisions concerning how much of each good to buy in output markets.

The three fundamental questions and government

Of course, in any real-world economy, markets do not make all of these decisions. In all societies, governments influence what will be produced, how output will be produced, and who receives this output. Government spending, health and safety regulations, minimum wage laws, child labor laws, environmental regulations, tax systems, and welfare programs all have a significant effect on any society's answers to these questions. We'll examine many of these topics in the next chapter. For now, we'll focus on a simple market economy. In this simple economy, there are three participants in the private sector: households, firms, and foreign countries.

Household

A household, as defined by the Census Bureau, consists of one or more individuals that share living quarters.

Types of firms

There are three possible types of firms:

• sole proprietorship,

• partnership, and

• corporation.

A sole proprietorship is a firm that has a single owner. The main advantage of this form of ownership is that it provides the owner with autonomy (the ability to be his or her own boss). There are, though, a few disadvantages. Because of the high failure rate for newly founded sole proprietorships, it is difficult to acquire funds to acquire physical capital. The owners also face unlimited liability. This means that their personal wealth is at risk if the business fails or is sued. While sole proprietorships are the most common form of firm, most are very small. Sole proprietorships account for a very small proportion of total sales in the U.S. economy.

Partnerships are firms in which two or more individuals share ownership. This form of business organization provides an advantage over sole proprietorships by allowing owners to pool their wealth, skills, and resources. The cost of this pooling of resources is some loss in autonomy for the owners. As in the case of sole proprietorships, partnerships are subject to unlimited liability.

A corporation is a business that exists as a legal entity separate from the owners. The corporation can enter contracts, own property, and borrow money as if it were a person. The stockholders of the corporation own the corporation. If the corporation declares bankruptcy, however, only the assets of the corporation are at risk. The owners' personal assets are not at risk (their only loss would be the wealth used to acquire the stock). This results in a situation in which the owners only have "limited liability." Offsetting this advantage is that corporate income is subject to double taxation. Any profits received by the corporation are subject to a corporate income tax before they are distributed as dividends to the stockholders. The dividends that are received by stockholders are taxed once again as personal income for the owners.

As your text notes, most output in the U.S. is produced in relatively large firms. Corporations account for the largest component of this output.

Multinational business has become increasingly important during the past several decades. Multinational businesses are firms that own and operate production facilities in more than one country.