Saturday, March 16, 2013

A thought about markets

Commodity markets seem fairly clear to me. Pork bellies and barrels of crude oil are purchased as raw materials by firms that will process them into products that they will in turn sell. I presume that buyers seek to purchase at a low price, but will not pay more than that price which will allow a profit when the elaborated product to be sold on at a suitable value to pay for processing and provide profit. Indeed, farmers may participate in a futures market for pork bellies to reduce risks in the feeding of pigs, and packing plants to reduce risks of future price rises. The economics of the market seem clear.

The market in stamps for collectors seems much less clear to me. New stamps are like paper money in that they can be exchanged for a service; stamps valued by collectors are valued only because of their rarity and the desires of collectors to own them. There may be some speculators, but at the higher values of stamps people presumably buy them to possess them.

I think also of ticket scalpers at the Super Bowl. Brokers who buy tickets and resell them make $800 to $1200 per ticket bought and sold. It seems clear to me that there is a kind of mania here with the ultimate buyers paying thousands of dollars to a ticket to a game that they will watch for a few hours; a game that they could watch for free on television.

Which brings me to the stock market. Economists suggest that the value of a stock is the discounted current value of its future earnings. That seems clear. Yet we know that there are occasional bubbles when buyers bid up stock prices beyond any reasonable guess as to the present value of future earnings. There is of course an entertainment value of playing the market. There are speculators who buy stocks during the rising part of a bubble not expecting to hold them for future income, but rather to sell them to "the greater fool" in the (very) short term; speculators may also sell stocks short during the falling part of a bubble planning to quickly profit from a different "greater fool". The behavior of the people who fuel bubbles, those who suffer from "irrational exuberance" or "animal spirits" seems better explained by psychologists than traditional economists.

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