Markets are essential in any well functioning economy.
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They are necessary because they serve a variety of functions that no other object in an economy can serve. Markets are meeting places, either literally or figuratively, where buyers and sellers can exchange goods, currencies, commodities or securities in just about any fashion at all. It makes for a more level playing ground when these markets are efficient.
This is important to businesses large and small because of the role that these markets play in everyday business transactions. In addition to providing a meeting place for buyers and sellers, there are three main functions that markets provide that support a well functioning economy.
In order for people to engage in trading and investing, they need to know that they are paying a price that reflects the value of the underlying security. Dealing with hot shots from New York or a broker may be intimidating to some regular investors. They may feel as if they are drowning in a sea of information as their advisor spouts facts and statistics about the securities in which they are investing.
Knowing that there is an underlying system that facilitates mostly efficient pricing will encourage investors to pour their funds into the market.
This creates opportunities for businesses to expand and grow with new access to capital. Pricing securities efficiently is one of the single most important things a functioning market can accomplish. Of course, there have been crashes and slides that prevent people from holding 100% confidence in the way the market works. With all return, there are risks. This doesn't mean that the market didn't function, just that some neglected to perform due diligence.
In actuality, there are always going to be highs and lows in a market just as any other cyclical function. The important thing is that there is a consistent way to price the securities at all times.
Some assets are inherently illiquid. Real estate and antiques are two of the most popular examples. These assets can be liquid at times, such as real estate booms.
However, for the most part they are considered relatively illiquid when compared with short term securities and cash. The markets provide liquidity for securities in ways that weren't possible only a few years ago.
Most of the markets are now electronic and can match buyer and seller with incredible efficiency. This provides quick match making services for investors wishing to trade. Without the ability to quickly sell an investment, an investor will be more apprehensive to invest. Liquidity provides the exit strategy should an investment become unappealing to an investor.
Reduce Transaction Costs
Search costs can sometimes be very high for illiquid objects. Searching for a certain year and make of car can sometimes be an adventure. While this may be part of the fun for bargain shoppers or antique hunters, in terms of financial markets, people usually want to take the adventure out of it. That is why markets function so well in taking out transaction costs.
Since the securities are standardized, liquid and priced by the market, the transactions are easy to make. Electronic markets take out the middlemen and reduce the costs there as well. All of these things point to a cheaper, more efficient way to trade securities.