Book contents
- Frontmatter
- Contents
- Preface and acknowledgments
- Introduction
- Part I Market microstructure and the intermediation theory of the firm
- 1 Market microstructure and intermediation
- 2 Price setting and intermediation by firms
- Part II Competition and market equilibrium
- Part III Intermediation versus decentralized trade
- Part IV Intermediation under asymmetric information
- Part V Intermediation and transaction-cost theory
- Part VI Intermediation and agency theory
- Conclusion
- References
- Index
2 - Price setting and intermediation by firms
Published online by Cambridge University Press: 18 December 2009
- Frontmatter
- Contents
- Preface and acknowledgments
- Introduction
- Part I Market microstructure and the intermediation theory of the firm
- 1 Market microstructure and intermediation
- 2 Price setting and intermediation by firms
- Part II Competition and market equilibrium
- Part III Intermediation versus decentralized trade
- Part IV Intermediation under asymmetric information
- Part V Intermediation and transaction-cost theory
- Part VI Intermediation and agency theory
- Conclusion
- References
- Index
Summary
Firms establish and operate markets by carrying out transactions and performing all the functions traditionally ascribed to market mechanisms. As intermediaries, firms engage in market making by setting prices, allocating goods and services, and holding inventories to coordinate transactions. Intermediation provides an endogenous mechanism for price setting that coordinates the activities of buyers and sellers. Firms choose two sets of prices: ask prices for consumers and bid prices for suppliers. The bid–ask spread, familiar from financial markets, provides an alternative perspective on the economic profit of firms. Economic profit reflects the returns to the market-making activities of firms.
The model of price setting by firms addresses the central question of microeconomics: how are market-equilibrium prices determined? Firms maximize profits by choosing prices such that their purchases and sales balance and such that their marginal revenues and marginal factor costs are equalized. I consider the case of monopolistic intermediaries in this chapter. I turn to oligopoly in Chapter 3 and monopolistic competition in Chapter 4. The qualitative results obtained for the monopoly case hold in a more general competitive framework.
The model of the market-making firm applies generally to most supply and demand problems. I consider two important and familiar settings: allocation under uncertainty and allocation over time. First I set out the basic insurance model with a bid–ask spread in insurance premiums. The insurance firm intermediates between a customer who is purchasing insurance and an investor.
- Type
- Chapter
- Information
- Market MicrostructureIntermediaries and the Theory of the Firm, pp. 27 - 58Publisher: Cambridge University PressPrint publication year: 1999