How Markets Work
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How Markets Work

Supply, Demand and the ‘Real World’

Robert E. Prasch

An accessible and enjoyable look at the way the market REALLY works! How Markets Work presents a new and refreshing introduction to elementary economics. The venerable theory of supply and demand is reconstituted upon plausible and defensible assumptions concerning human nature, the law, and the facts of everyday life – in short – the ‘Real World’. The message is that markets differ in ways that matter. Starting with a brief survey of property and contract law, the lectures develop several ‘ideal types’ of markets – such as credit, assets, and labor – while illuminating the similarities and differences among them. Care has been taken to ensure that the reformulations presented are accessible to students and compatible with a variety of non-mainstream traditions in economic thought.
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Chapter: Lecture III: Credit markets: the economics of a 'relational' contract

Robert E. Prasch


LECTURE III Credit markets: the economics of a “relational” contract Considered as a market transaction, credit has several distinct properties. Collectively, these are of enough consequence that the market for credit constitutes its own “ideal type” meriting an independent examination. The place to begin is by revisiting a crucial, if often implicit, assumption underlying the analysis of the market for commodities – that these are exchanges of inspection goods in a “spot” market. To review, in a spot market the transaction is negotiated and settled during a single meeting or interaction. The previous example was a suburban yard sale. There goods are inspected, prices negotiated, and cash tendered and accepted – all in the course of single meeting. Buyers and sellers neither require nor desire the identities, backgrounds, or references for the individual or individuals with whom they conduct such exchanges. To reiterate, such “spot” transactions are the implicit model underlying the textbook theory of supply and demand. Credit transactions are, and by their nature must be, qualitatively different from the spot transactions that typify commodity markets. When a person or firm enters into a loan contract, they are committing themselves to an ongoing business relationship with another person or institution. Moreover, a loan is not an “inspection good” as one cannot know at the outset if one will be paid back. The lender, who above all wishes to see their money again, is shouldering the risk that this may not occur. For this reason they are necessarily interested in the...

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