The phrase “the market is broken” has been used repeatedly in recent months to describe various markets following the COVID-19 outbreak. Often it has been used by persons caught on the wrong side of market changes. The market didn’t produce the desired outcome and the blame is assessed to a broken market. When economists think of broken markets, they think differently.
Markets provide for the exchange of goods and services by buyers and sellers. The role of price is to allocate resources and serve as a measure of value to signal to both producers and consumers. Prices serve to clear the market and ration scarce goods. Higher prices tell producers to produce more and consumers to cut back. Lower prices tell producers there are too many products on the market and tells consumers that deals can be had. The interplay of supply and demand determines the price and sends the appropriate messages to producers and consumers.
In the real world a perfect market is rare. Most markets are imperfect in one way or another. Market imperfections, though, do not make market failure. Market failures are generally thought by economists to be outcomes which deviate from the optimum and are considered economically inefficient. Market failures include externalities (i.e. pollution), monopolies, rent seeking by special interest groups (i.e. tariffs), factor immobility (i.e. land), and others.
External shocks to a market, like COVID-19, can wreak havoc as buyers and sellers seek to assess the shock and determine the long-term and short-term implications and respond accordingly. When that happens, prices become volatile and irrational spikes and drops occur as buyers and sellers seek to find an equilibrium. Sometimes this can take days, sometimes it can take weeks or months. And, when shocks happen, both buyers and sellers will find themselves on the “wrong” side of a price move.
Being on the wrong side of a price move doesn’t necessarily indicate a market failure or a broken market. Sometimes it’s just the market at work. That doesn’t mean vigilance isn’t in order in monitoring markets to assure nefarious actions are not afoot. Market failures can always be lurking. It just means, to the economist, being on the wrong side of a price move isn’t necessarily evidence of a broken market.