Market Organization
with Price-Setting Agents

Last Updated: 28 March 2015

Leigh Tesfatsion
Professor of Econ, Math, and ECpE
Department of Economics
Iowa State University
Ames, Iowa 50011-1070
http://www2.econ.iastate.edu/tesfatsi/
tesfatsi AT iastate.edu

Home Page for EE/Econ 458

A. What is Market Organization?

In modern usage, a commodity is anything of use that can by bought or sold in standardized form.

A market is any context in which the buying and selling of a commodity takes place.

Market Organization is the manner in which exchange in a market takes place. It is determined over time by a combination of factors, including:

B. Two Key Market Player Types: Brokers and Dealers

Key defining aspects of a BROKER:

Broker Examples:

Real estate brokers, stock brokers,...

Diagrammatic Illustration of a Broker:

                   
                   -----------------
     Payment for Q|                 |Payment for Q
     ------------>|                 |--------->
                  |                 |
         Bid      |     BROKER      |    Ask
     (Buy Offer)  |                 |(Sell Offer)
                  |                 |   
    <-------------|<----------------|<---------
      Units of Q  |  (Passed Thru)  | Units of Q
                  |                 | 
                   -----------------  


Key defining aspects of a DEALER:

Dealer Examples:

Retail store owners, new and used car dealers, NASDAQ stock dealers,...

Diagrammatic Illustration of a Dealer:





      Payment     -----------------  Payment
    ------------>|Dealer     Dealer|--------->
                 |Ask           Bid|
  Buyer          |     DEALER      |     Seller
                 |                 |
   <-------------|  Q Inventory    |<---------
     Units of Q  |                 |  Units of Q
                  -----------------


C. Four Basic Types of Market Organization

  1. Bilateral Trade (self-organized)

  2. Over-the Counter (OTC) (managed by dealers)

  3. Auction (managed by brokers)

  4. Organized Exchanges (managed by combination broker/dealers)


TYPE 1: BILATERAL TRADE

Key aspect of Bilateral Trade:

Buyers and sellers self-search for trade partners -- there is no intermediary (go-between).

Examples of Bilateral Trades:

A power purchase agreement (PPA) between a buyer and seller of electric energy; a loan you arrange with a family member; the self-sale of a home, the self-sale of a used car.


TYPE 2: OVER-THE COUNTER (OTC)

Key Aspects of OTC Markets:

OTC Market Examples:

Markets for corporate bonds; markets for U.S. Treasury bonds and notes; the NASDAQ stock market; used car dealerships; the Foreign Exchange Market


TYPE 3: AUCTION MARKETS

Key Aspects of Auction Markets:

Two Basic Types of Auctions:

1. One-Sided Posted-Offer Auction

  • The protocols (rules) governing the auction are public knowledge.

  • If the auction is a SELLER posted-offer auction, one or more SELLERS publicly post their asks (offers to sell) in advance.

  • If the auction is a BUYER posted-offer auction, one or more BUYERS publicly post their bids (offers to buy) in advance.

  • Each participant on the OTHER side of the market then tries to secure the best possible posted offer for themselves, following auction protocols.

Examples of Single-Sided Auctions:

Retail stores, eBay, Priceline,...

2. Call Double Auction

  • The rules (protocols) governing the auction are public knowledge.

  • The auction is conducted through a centralized facility that can take various forms (e.g., a human auction manager, or a web screen that automatically processes data input)

  • Sellers submit asks (offers to sell) to the centralized facility.

  • Buyers submit bids (offers to buy) to the centralized facility.

  • The centralized facility matches these asks and bids in accordance with the auction protocols.

Examples of Call Double Auctions:

Day-ahead energy markets, various business-to-business (B2B) Internet markets


TYPE 4: ORGANIZED EXCHANGE MARKETS

Key Aspect of Organized Exchange Markets:

  • Organized exchanges combine auction and OTC market features. They are centralized facilities managed in part by specialist traders who combine broker and dealer functions. For example, stock trades in the NYSE-EuroNext are managed by specialists who typically act as brokers (matching buy orders with sell orders) but who sometimes also act as dealers (buying and selling on their own account) in order to facilitate trades.

Examples of Organized Exchanges:

Electric power market exchanges, New York Stock Exchange (NYSE) EuroNext, real estate markets


Copyright © 2011 by Leigh Tesfatsion. All rights reserved.