The Market System

Assessing the Importance of Markets

The importance of trade springs from the extensive degree of specialization observed in our society. Trade allows people to specialize according to their comparative advantage.

By engaging in trade, people can raise their standard of living. Trade today is much more complex and involves the decisions of billions of people around the world.

But how does an economy make trade possible, and how are the decisions of these billions of people coordinated?
In most countries trade is carried out in markets.

The Market is a system (an institution or arrangement) through which buyers and sellers come into contact to trade goods, services, commodities or financial instruments.

Markets determine the answers to the three fundamental questions: What goods and services will be produced? How will the goods and services be produced? Who will receive the goods and services that are produced? Opens in new window

Markets take several forms, such as the local fruit and vegetable market, the stock exchange or eBay. However, market doesn’t necessarily have to be a physical location.

In the modern world many trades are carried out virtually through computer and telecommunications links.

In a market the buyers are demanders of goods or services, and the sellers are suppliers of goods or services.

Household and firms interact in two types of markets:

  1. Product market, and
  2. Factor markets.
In product markets, households are demanders and firms are suppliers.

Product markets are markets for goods—such as computers—and services—such as medical treatment.


Factor markets are markets for the factors of production, such as labor, capital, natural resources and entrepreneurial ability.

Factors of production are the inputs used to make goods and services.

Factors of production are divided into four broad categories:

In factor markets, households are suppliers and firms are demanders.

Most people earn most of their income by selling their labor services to firms in the labor market.