3.1.4 Uses and limitations of markets
Helpful prior knowledge and learning objectives
Helpful prior learning:
Section 1.1.1 The economy and you, which explains what an economy is and how it is relevant to students’ lives
Section 1.1.2 The embedded economy, which explains the relationship between the economy and society and Earth’s systems
Section 1.3.6 Households, markets, state and commons, which explains four provisioning institutions in the economy and their interconnection
Section 3.1.1 The market as a system, which describes market parts and their relationships, and the connection between the household and the rest of the economy.
Section 3.1.2 Demand and supply, which explains the factors affecting supply and demand and the dynamic relationships and feedback between supply, demand and prices.
Section 3.1.3 Elasticity, which explains the concept of elasticity generally, and focuses on the factors affecting price elasticity of demand and its link to market power.
Section S.1 Systems thinking, which explains what a system is and why systems thinking is useful. (coming soon)
Learning objectives:
discuss the uses and limitations of markets as a provisioning institution
Markets haven't always been around. In the past, people lived in small communal societies, either as hunter-gatherers or farmers, and met their needs within those groups. Over time, people started trading with each other, and the first markets emerged about five thousand years ago. Early trade was based on barter—exchanging goods directly with people they knew and trusted. Today, markets have evolved to become incredibly diverse, involving both local and global exchanges, different types of relationships, and various forms of money.
Figure 1. Scandinavian and Russian traders bartering, from A Description of the Northern Peoples, 1555 (Public domain)
What are the uses/benefits of markets?
Markets have become central to many of our lives because they are powerful provisioning institutions and often effective at providing goods and services. The key benefits of markets include speed, adaptability, and the monetary incentives they offer. Markets and the businesses within them can be:
modular and scalable: markets can support both large and small businesses, allowing them to specialise and adapt to meet human needs. Under certain conditions, businesses can quickly scale up to address demands, like the rapid production of face masks during the Covid-19 pandemic (Figure 2);
personalised: businesses in markets have an incentive to meet diverse needs and wants. While many products are mass-produced by larger firms, the many small and local businesses can often provide personalised goods and services tailored to different people (Figure 3);
Figure 2. Businesses scaled up production of face masks very quickly during the Covid-19 pandemic
(Credit: Taiwan Presidential Office, CC BY 2.0)
Figure 3. Businesses in markets can offer personalised services, like this unusual hair colouring
(Credit: Jacob Ehnmark, CC BY 2.0)
innovative: competition among businesses can lead to innovations that improve the quality and efficiency of products and services, benefiting consumers and the economy;
responsive: businesses in markets can be quick to adapt to changes in human needs, wants, and technology. Prices in markets can help them stay responsive by providing signals and incentives, a form of balancing feedback, guiding consumers and producers to adjust their buying or production of goods and services (Section S.x coming soon! and Section 3.1.2).
What are the limitations/downsides of markets?
While markets offer some benefits, we must also understand their limitations and downsides so we can make informed decisions about when and where to use them (nor not):
markets value only what is priced, harming ecological and social systems: unregulated markets tend to damage ecosystems because they often don't account for the value of natural resources, treating them as free and overusing them. This leads to overextraction of renewable resources like fish and nonrenewable resources like fossil fuels (Figure 4, Section 1.2.4). Likewise, markets rely on unpaid household care and domestic work, which businesses need, but often ignore. Workplace practices such as low wages, long hours, and unsafe conditions can undermine this essential care work, making it harder for people to support other household members and the rest of society;
Figure 4. Markets value only what is priced, and tend to take too much from Earth’s systems. The Jharia coal mine (India)
(Credit: TripodStories- AB, CC BY-SA 4.0)
markets provide products only to those who can pay: Economists claim markets are efficient because they allocate products to those willing to pay the price. However, to get the product people also need to be able to pay. When markets are used to distribute essential goods, like food, water and housing some people may be left out, worsening economic inequality. Markets might not be suitable for meeting fundamental human needs unless strong government regulation or financial support is in place. In addition, profit maximising businesses may focus more on serving the wants of high-income groups, neglecting the needs of poorer people because it is easier and more profitable.
markets do not provide important public goods: public goods are non-excludable, meaning everyone can use them without paying, and non-rivalrous, meaning one person's use doesn't reduce availability for others. Street lighting is an example of a public good. Private businesses won't install street lighting because these conditions make it impossible to charge people for its use. Since a business can't profit from it, a market won't form. Therefore, public goods are typically provided by the state;
markets widen inequalities and can undermine social cohesion: profits are the money that business owners keep after paying their production costs (profits = total revenue - costs of production). When profits are invested in the business and it grows, market power can increase, creating a reinforcing feedback loop (Figure 5) that further boosts profits. Wealthy business owners can also use their resources to gain political influence, shaping laws to benefit their businesses and increase profits even more. This political capture worsens economic inequality, harming social cohesion and eroding trust in the state and society.
Figure 5. Reinforcing feedback loops showing how increases in profits can lead to increased market power (right) and political power (left).
market values can crowd out other social values: When something becomes a commodity—bought and sold in a market—it changes how we perceive it. It may become valued for its use or profit, rather than valued for other important intrinsic, social or ecological reasons. For example, if young people were paid for each book they read, their love of reading might shift from enjoyment to earning money. This shift and other moral limits of markets are discussed in more detail in Section 3.2.5.
For these and other reasons discussed in Subtopic 3.2, societies must be cautious about when and where they use markets to meet human needs. In recent decades, markets have increasingly dominated our economies, but they may not be suitable in every situation.
Activity 3.1.4
Concept: Systems
Skills: Thinking skills (critical thinking, transfer)
Time: varies, depending on option
Type: Individual, pairs, and/or group
Option 1: Discussion - To what extent do markets support or undermine democracy?
Time: 40 (or more) minutes, depending on how much time students are given to develop ideas for the discussion
Milton Friedman was a famous economist from the neoliberal school of economic thought. In simple terms, neoliberal economists believe that markets are usually the best way of allocating products and resources in societies, and they favour very little state involvement in economic activities.
Friedman wrote extensively about the relationship between markets and freedom and claimed that ‘free market’ economies were a necessary, but not sufficient condition for democracy. A key part of his claim was that market “exchanges…bring about coordination without coercion”. You may have seen this argument made in the iPencil video at the start of Section 3.1.2. However, critics argue that markets undermine democracies.
Using a discussion process and format that you are familiar with, use what you have learned so far in this subtopic, including the uses and limitations of markets, to develop points for a discussion of the question:
To what extent do markets support or undermine democracy?
If you need to clarify the key characteristics of democracy as a part of your work, ask your teacher for help.
Option 2: Practising systems diagrams
Time: 25 minutes
Figure 6 illustrates the reinforcing feedback loops associated with markets, when profits are used to grow businesses larger and used to increase political power.
Sketch the illustration on a piece of paper or copy and paste it into a digital document.
The text that explained these reinforcing feedback loops mentioned that these dynamics worsen: economic inequality, trust in political systems, and social cohesion.
How could you represent these factors in the illustration? Where would they connect, and is the relationship positive or inverse?
Add your ideas to the illustration and share with another student to compare and discuss.
Ideas for longer activities and projects are listed in Subtopic 3.5 Taking action
Figure 6. Reinforcing feedback loops showing how increases in profits can lead to increased market power (right) and political power (left).
Checking for understanding
Further exploration
Wealth: what it is & how it differs from Income and Why rich people get richer - In these two short videos Gary Stevenson explains the difference between income and wealth, and the resulting dynamics of accumulation. Difficulty level: easy
The high polluting rich aren’t happier and they are costing everyone else a good life - an article by Dr Lewis Akenji, member of the Earth4All Transformational Economics Commission about how the economic activities of very high income people, including flying, housing, and investments, do not contribute much if anything to their own happiness, while at the same time are driving humanity past planetary boundaries. Difficulty level: medium
The Guardian view on water privatisation: end an experiment that has failed - an editorial from The Guardian arguing that the privatisation of previously state-owned water infrastructure and services in England has failed to meet human needs while profiting business owners greatly. In the article, the term rent-seeking, refers to profit-maximising businesses extracting as much value from other stakeholders as possible. Difficulty level: medium
Capitalism and Freedom - a famous essay by neoliberal economist Milton Friedman claiming that ‘free’ markets are a necessary condition for democracy. A highly controversial essay. Difficulty level: high
Sources
Biewen, J. and McGirt, E. (Hosts). (2024). Capitalism. Scene on Radio, Season 7. Kenan Institute for Ethics, Duke University. https://sceneonradio.org/capitalism/.
Chang, H. (2010). 23 Things They Don’t Tell You About Capitalism. London: London: Allen Lane.
Friedman, M. (1958). “Capitalism and Freedom”. Essays on Individuality. Philadelphia: University of Pennsylvania. https://miltonfriedman.hoover.org/internal/media/dispatcher/214956/full
Hickel, J. (2020). Less is More. London: William Heinemann.
Raworth, K. (2017). Doughnut economics: seven ways to think like a 21st century economist. London: Penguin Random House
Streeck, W. (2012). How to Study Contemporary Capitalism?. European Journal of Sociology, 53, pp 128 doi:10.1017/S000397561200001X
van Bavel, B. (2016). The Invisible Hand. Oxford: Oxford University Press.
Terminology
market: a system where people buy and sell goods and services for a price.
communal: shared by all members of a community
barter: exchanging products for other products without using money
provisioning institution: a group of people and their relationships as they try to meet human needs and wants
monetary: to do with money
scale: the size of something
demand: the quantity of a product that consumers are willing and able to purchase at various prices
incentive: something that motivates or encourages someone to do something
efficiency: the ratio of resource inputs compared to outputs
consumer: someone who buys and uses resources and products ot meet needs
economy: all the human-made systems that transfer and transform energy and matter to meet human needs and wants
price: an amount that must be paid to access a good or service; can be money or some other medium of exchange
balancing feedback: a situation where feedback produces change in the opposite direction
unregulated: not controlled by laws or rules
ecosystem: the interaction of groups of organisms with each other and their physical environment
natural resource: materials created in nature that are used by humans
overextraction: taking too much of something away from somewhere else, especially using effort or force
renewable resource: natural resources that can be regenerated in a human timescale
nonrenewable resource: natural resources that cannot be regenerated in a human timescale
fossil fuel: a non renewable energy source including coal, oil, and natural gas, formed over millions of years in the Earth's crust from decomposed plants and animals
household: a system where people living together care for each other and do domestic work, often termed the 'core economy'
care: the act of providing what is necessary for the health, welfare, upkeep, and protection of someone or something
wage: payment for work
allocate: to distribute something
economic inequality: unequal distribution of income and opportunity between different groups in society
regulation: a rule that guides individual or group behaviour and enforced by an authority
profit maximisation: the strategy where a business tries to achieve the highest profit possible
income: money received from work or investments
public good: goods that are non-excludable, meaning everyone can use them without paying, and non-rivalrous, meaning one person's use doesn't reduce availability for others; markets do not provide these goods
non-excludable: a good that everyone can use without paying, like street lighting
non-rivalrous: a good where one person's use doesn't reduce availability for others
state: a system that provides essential public services, and also governs and regulates other economic institutions
profit: total revenue minus total cost
revenue: the money earned from selling a product
investment: money spent for the enhancement of human or physical capabilities
market power: the ability of a firm to influence the price of their product in a market, as well as other market conditions
reinforcing feedback: a situation where change in a system causes further changes that amplify the original change which can lead to tipping points in a system
political capture: when the government prioritises the interests of economically powerful groups over the general interests of the public
social cohesion: the extent to which people in society feel connected to one another and share common values
commodity: something that can be bought and sold, often, though not always referring to raw materials
intrinsic: belonging to the essential nature of a thing
neoliberal: favouring policies that promote capitalism, less regulation, and reduction in government spending
rent-seeking: actions where an individual works to increase their own wealth without creating any benefits or wealth to the society
extractive: taking something from other humans or from nature without trying to replace it or avoid harm
value: ideas about what is important or good
stakeholder: a person who has an interest in or is impacted by some activity