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Understanding The Function Of Markets Through Different Theoretical Perspectives

2439 words - 10 pages

Understanding the Function of Markets Through Different Theoretical Perspectives

The aim of this essay is to answer the 2 parts of the provided
question. In the first part I will discuss the different markets
models and how those different models describe the way markets
function. While the second part will discuss how and why markets are
limited and failure cases happens. An example case of a market failure
is to be provided to assist this part of the discussion, and for this
purpose I chose the affect of SARS in the airline and tourism markets
as an example.

How the use of different theoretical perspectives can help us in
understanding how markets function

Markets are a mechanism which allows people to trade normally,
governed by the Law of Supply and Demand. Markets have different
structures or models, all function under the view of competition.

Competition in economic terms is understood to be the situation in
market where the monopoly power is absent or very limited and no power
is influencing product price or quality. Hence a competitive market is
the one in which none of the participants possess market power. A
competitive market achieves efficiency in the allocation of scarce
resources if there are not other market failures present.

The major four known competitive market models are:

1- Dynamic Competition put forward by J. Schumpeter.

2- Perfect Competition put forward by the Neo-classical followers.

3- Competition as a process of adjustment to change, put forward by F.
Hayek; and

4- Competition as a power struggle, put forward by Sen.

The main characteristics that define a market model are:

1- The number of firms in a market.

2- The ease of entry and exit from the market; and

3- The type of products and to what degree it is differentiated.

Dynamic Competition:

Schumpeter's view of this model of competitive markets stands on the
basis of competition over innovations in products and process and not
price competition. So firms that do not move ahead faster than their
competitors will fall behind and eventually will go out of business.
This process of "innovate or go bust" is what Schumpeter calls
"creative destruction".

The result of such creative destruction would be a regular changing
structure of the economy and improving living standards over the

According to Schumpeter we should not put too much emphasis on static
efficiency related to perfect competition because this tends to kill
technological change. Instead we should recognize that some degree of
monopoly power is a necessity to keep going the process of
infrastructure growth and development.

The main features of this model are:

- Short term monopolies are useful to enable firms to accumulate the
required resources.

- Large firms are important in...

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