Price is the mechanism by which markets clear It is the mechanism for rationing goods Markets are created and clear when there are rational pricing mechanisms

1. Pricing
In a Market Economy

2. Price
• Price is the mechanism
by which markets clear
• It is the mechanism for
rationing goods
• Markets are created
and clear when there
are rational pricing
mechanisms

3. Pricing Mechanisms and Markets
• Junk Bonds
• Stock Options
• Auctions
• Stock Market
• Oil and Commodities
• Futures
• Derivatives
• Food
• Consumer goods

4. Junk Bonds
• In 1980s Michael
Milken figured out how
to price high risk bonds
• He created a Market in
high yield bonds
• Financing vehicle for
corporate take-overs,
LBOs
• Drexel

5. The high-yield market and the
1980s buyout boom
• Milken's network of high-
yield bond buyers enabled
him to raise large amounts
of money very quickly
• This money-raising ability
also facilitated the
activities of leveraged
buyout (LBO) firms like
Kohlberg Kravis Roberts
and of "greenmailers."

6. Drexel Burnham Lambert
• Drexel Burnham
Lambert was a major
Wall Street investment
banking firm which was
forced into bankruptcy
in February 1990 due to
its involvement in illegal
activities in the junk
bond market, driven by
Drexel employee
Michael Milken.

7. Michael Milken and Ivan Boesky

8. Stock Options
• Fisher Black
• Myron Scholes
• Black-Scholes pricing
model
• Robert Merton
• Nobel Prize in
Economics
• Long-Term Capital
Management
• Hedge Funds

9. The Black–Scholes model
• is a mathematical model of a financial market
containing certain derivative investment
instruments. From the model, one can deduce
the Black–Scholes formula, which gives the
price of options. The formula led to a boom in
options trading and the creation of the
Chicago Board Options Exchange. lt is widely
used by options market participants.

10. The Chicago Board Options
Exchange
• Located in Chicago, is the largest U.S. options
exchange with annual trading volume that
hovered around one billion contracts at the
end of 2007.
• The Chicago Board of Trade established the
Chicago Board Options Exchange in 1973. The
first exchange to list standardized, exchange-
traded stock options. The CBOE is regulated
by the Securities and Exchange Commission.

11. The Chicago Board of Trade
• Established in 1848, is
the world's oldest
futures and options
exchange. More than 50
different options and
futures contracts are
traded by over 3,600
CBOT members through
open outcry and
electronic trading.

12. Auctions
An auction is a process
of buying and selling
goods or services by
offering them up for
bid, taking bids, and
then selling the item to
the highest bidder. In
economic theory, an
auction may refer to
any mechanism or set
of trading rules for
exchange.

13. Examples of Auction Mechanism
• Stock Market
• OTC
• Merc
• Commodities
• Cattle

14. Auctions
• Ebay
• Pierre Omidyar
• Wanted to create a
“perfect market”
• Simple business model:
– Charge commission and
listing fee.

15. eBay
• 2008, the company had
expanded worldwide,
counted hundreds of
millions of registered
users, 15,000+
employees and
revenues of almost $7.7
billion

16. eBay
As eBay is a huge, publicly visible market, it
has created a great deal of interest from
economists, who have used it to analyze many
aspects of buying and selling behavior, auction
formats, etc., and compare these with
previous theoretical and empirical findings.

17. Pricing
In a Market Economy