After completing this section, you will be able to:

● Define a market
● Differentiate between barter and monetary exchanges
● Describe the role of money in the marketplace
● Define the concept of equilibrium
● Define the concept of efficiency

As you learned in the previous section, the economy is made of a large number of
individual decision makers, acting rationally and independently. These decision makers
interact, often in markets, maximizing their happiness or profits in the face of scarcity.

Markets are where buyers and sellers engage in exchanges. It’s easy to think of a
market as a physical location, like the Chichicastenango market in Guatemala, but most
markets do not exist in one physical location. A consumer who wishes to purchase
apples may go to a supermarket to do so, but there are many locations where apples
are bought and sold. Think also about the labor market, the housing market or the used
car market. These markets have no single location, but we still refer to them as
marketplaces. In this course we will construct models of markets with the assumption
they do not need to be physical locations.

Most goods and services exchanged in market places are priced in and exchanged for
money. The alternative to a monetary exchange is barter. Barter exchanges are goods
or services in exchange for goods or services. The primary problem with barter
exchanges is that they require buyers to find sellers of goods that they want to purchase
that also happen to want the goods or services the buyers have to trade. This situation
is called the double coincidence of wants. If a monetary exchange is not possible,
buyers and sellers have to spend time and resources trying to satisfy the double
coincidence of wants. This adds a potentially huge transaction cost to every possible
exchange. Money eliminates the need for the double coincidence of wants and reduces
the cost of exchanges.

Money is an incredible invention that allows buyers and sellers to trade with no concern
about the wants of the decision-maker on the other side of the transaction. When
Celeste purchases an apple for $1, she does not concern herself with what the seller
plans to do with the $1. All she needs to consider is whether or not spending a $1 on
an apple makes her happier than spending $1 on anything else. This reminds us of
another important concept from the last section, opportunity cost. The opportunity cost
of an apple is the next best alternative to the purchase of an apple. If the apple is
priced in monetary units (be those dollars or a different currency), then the opportunity
cost of the apple is the next best alternative for the use of $1. Monetary exchanges
make relative prices and opportunity costs easier to calculate as well.
This course is not about money or “making money,” but the majority of transactions we
introduce will involve prices denominated in money.

Part of what we discuss in the class includes how prices of goods and services that are
exchanged in markets are determined. Market equilibrium is the result of all relevant
agents (buyers and sellers) in that market acting in their own self-interest
simultaneously. When markets are in equilibrium, the quantity of a good offered for sale
at the market price is equal to the quantity that consumers are willing and able to
purchase at that price. At the equilibrium price, consumers do not wish to consume any
additional units at the market price, or the marginal benefit of the last unit consumed is
equal to the marginal opportunity cost of the last unit consumed. Also at the equilibrium
price, producers do not wish to sell any additional units at the market price. Or the
marginal benefit (profit) of the last unit produced is equal to the marginal cost.

Economists refer to outcomes that maximize benefits to society less costs to society as
efficient. In this course, we will show that perfectly competitive markets often result in
an efficient outcome. In addition, we will provide examples of markets operating
inefficiently, such as markets with price controls and monopolized markets. We will also
provide scenarios where competitive markets do not result in an efficient outcome, such
as markets with externalities and the markets (or lack thereof) for public goods and
common resources.

In the next section, we provide a brief overview about the economic approach to solving
problems.