The news says the market fell. A politician says the market will decide. Somebody at work says they are waiting for the market to pick up. Which market? Where is it, who is in it, and who decided what things cost?
A market is not a place and it is not a force. It is what happens when buyers and sellers meet, in person or through a screen, and agree on a price. That is the whole idea, and there needs to be nothing confusing about it.
This is the second piece in the Money Basics series. If you have not read the first, start with how money actually works. It explains what a payment is. This piece explains what happens when a payment gets agreed.
A price is an agreement, not a fact
Think about a bottle of water. In a supermarket it costs about a dollar. At an airport, past security, the same bottle costs three or four. Nothing about the water changed. The bottle did not become better water. What changed is who was standing there and what their alternatives were.
A price is a record of what a buyer and a seller agreed to, at a moment, given what each of them could do instead. That is why the same house is worth more with a good school down the road, why the same seat on the same plane costs different amounts depending on when you booked it, and why the same hour of work earns different amounts in different towns.
This is the single most useful thing to understand about prices: they are information about a situation, not a property of an object. When a price looks wrong to you, you have usually found a difference in the situation rather than a mistake in the arithmetic.
Where the markets are
Because we use the word for everything, it helps to see how many different shapes a market takes.
- A physical market. A farmers market, a car boot sale, a high street. Buyers and sellers in the same place, prices usually negotiable, and everybody can see what everybody else is charging.
- A market with no place at all. The job market. The housing market. The market for second-hand cars. Nobody meets anywhere, the price is discovered through adverts, offers and refusals, and it can take weeks for an agreement to be reached.
- A market you are in every week without noticing. The supermarket. You do not negotiate, because the shop has set one price for everyone and you accept it or shop elsewhere. That choice is the thing that makes it a market, even though the price is not up for discussion.
- A market that sets a number everybody watches. Shares, currencies, and the price of oil. These are the ones the news means, and they work differently, because what is being bought and sold is a claim on something in the future. We will come back to that in a later piece.
In every case the same three things are present: somebody selling, somebody buying, and a price that both of them can walk away from.
Why prices move
Prices move because the balance between buyers and sellers moves, and because both sides are guessing about the future.
If there are more people who want a thing than there are things to sell, the price tends to rise, because sellers can ask more and still find a buyer. If there are more sellers than buyers, the price tends to fall, because a seller with stock and no customers will accept less rather than go away with nothing.
Two cautions that most explanations skip. First, “demand” does not mean wanting something. It means being willing and able to pay for it. A million people wanting a house they cannot afford is not demand in the sense that moves prices. Second, prices move on expectations as well as on what is happening now. A shop raises the price of a thing when it expects a shortage, before the shortage arrives. That is why price rises can feel like they come out of nowhere, and why they so often turn out to be self-fulfilling.
Two questions that are not the same
Here is where the word causes real confusion, and it is worth being precise.
Question one: is the market working? That is about whether buyers and sellers can find each other, whether prices are responding to supply and demand, and whether the thing being traded is what it claims to be.
Question two: is the outcome fair, or even acceptable? That is a different question, and a market can pass the first test while failing the second, at least in the opinion of some people.
A housing market can be working exactly as markets work, with prices clearing, and still leave a nurse unable to rent near the hospital where she works. The mechanism is not broken in that story. The mechanism and the outcome are separate questions, and people argue past each other constantly because they answer different ones. When somebody says “the market has decided”, they have answered question one. They have not answered question two, whatever they think they have said.
That separation matters for you practically. If you are priced out of something, the useful question is not whether the market is rigged. It is which of the two problems you actually have. A broken market is a rule problem. A working market that produces an outcome you cannot live with is a political problem, and it gets solved by people deciding to solve it, not by waiting.
Markets need rules, and the rules are not the opposite of a market
It is tempting to think of markets as natural and rules as interference. The history runs the other way.
Every market depends on things that somebody has to enforce: that the thing you bought is yours, that a contract means something, that a pound of apples weighs a pound, that the money is not counterfeit, and that there is somebody to complain to when it goes wrong. Without those, you do not get a free market. You get a market where the strongest or the least scrupulous person wins, and everybody else stops trading.
That is why every serious market economy has weights and measures, contract law, food standards and a regulator for something. The argument in a healthy society is about where the rules should sit and who writes them, not about whether rules should exist.
What to do with this
- Treat a price as information. When something costs more than you expected, ask what is different about the situation - the timing, the place, the alternatives the seller has. You will usually find the reason, and sometimes you will find a better price.
- Get more than one price for anything large. A quote is an offer, not a fact. Three quotes turn a single seller into a market, and that is the cheapest negotiation technique there is.
- Know the range before you talk about pay. A salary is a price in the job market, and the person who knows the range has a completely different conversation from the person who does not.
- Separate the two questions. When you are angry about a price, work out whether you are looking at a broken market or a working market with an outcome you dislike. The first is fixed by rules, the second by decisions, and confusing them wastes your time & energy.
Next in the series: What Actually Happens to Your Money When You Put It in a Bank. You hand over cash, and the bank lends most of it to somebody else. That is not a scandal, it is the business - and it is why a bank can pay you interest at all.
If you want the next piece in this series, sign up for the free guide. We are going through the money basics one at a time - what money is, what a market is, what your bank does with your money, where interest comes from - in plain language, with no jargon and no sales pitch.