An Economic Theory, Second Edition
Chapter 10: Organizing the Supply of Market-making Services
10. Organizing the supply of marketmaking services 10.1 THE PACKAGING OF MARKET-MAKING SERVICES In Chapter 6, six main market-making activities were distinguished. To these can now be added two more, which were identiﬁed in Chapter 9: inventory holding (to provide on-demand service) and the provision of personal attention, as demanded by social convention. This chapter considers why a single market maker would wish to undertake all of these activities himself. Why do different market makers not operate in the same market, each specializing in one of these particular activities? Why does a single market maker emerge who packages all of the services together? The simplest answer is that a single entrepreneur has the initial idea of creating the market, and to protect his secret idea he will not want to involve other ﬁrms in any of the related activities. However, this only explains why one ﬁrm will package together all the activities at the outset. As the market expands, and competitors enter, the advantages of specialization may begin to reveal themselves. Some entrants may specialize in one market-making activity and others in another, allowing buyers to ‘customize’ their procurement of market-making services. The obvious explanation of why market-making services are packaged on a recurrent basis is that packaging substantially reduces overall transaction costs. If the separate services were not packaged together, then each buyer and seller would have to negotiate individually for each of the specialist services. Without a packager, each buyer and seller would need to be paired...
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