Business Economics

Business Case 3: The Chicago Board of Trade

Q. 1. Which market, St. Louis or Chicago, was more likely to behave like a tourist trap? Explain.

The 'tourist trap model' supposes a market in which consumers have limited information about the price, there is no single «market price» as sellers can charge different prices for the same good and transaction costs are high. Due to the case St. Louis market was likely to behave like a tourist trap, because there was no central marketplace and buyers had to search for the best deal in different locations, incuring search costs to determine the information. In this sense, the law of supply and demand and the law of a single price did not hold in a market and led to the elimination of St. Louis.

Q. 2. What was the advantage to buyers from buying their wheat in the Chicago pit instead of in St. Louis? What was the advantage to sellers?

Chicago pit represented a well-established, ongoing market with a large number of buyers and sellers, each facing a central clearing counter-party guaranteeing the settlements, which is able as a result to determine a market-clearing price, ensuring that every buyer finds a seller and vice versa. One of the Twelve Principles of Economics is that there are gains from trade and they are given by consumer and producer surpluces, therefore both sellers and buyers receive benefits from participating in the Chicago pit. Even though each buyer and seller in a market is concerned only about his own welfare, they are together led by an invisible hand to an equilibrium that maximizes the total benefits to buyers and sellers. By having an opportunity to negotiate contracts in one place buyers did not spend time and effort to check prices at various locations. Sellers provided them with guarantees (via the Board's central counter-party guaranteeing the settlements) that contracts would be fulfilled. To summarise, when consumers obtain full information, sellers charge a competitive price which...