OK, let me clarify my position and outlook on the situation. I see a lot of people saying "well, the PCs will end up with lots of low level magical items by level X and will sell it, and if they are doing so, then so are others, thus there is a trade in magical items". My question is how high is it before PCs are willing to sell things. Most of the players I've seen like having a backup weapon, so you figure they will keep the first two, or maybe even 3, weapons they come across. Likewise, a spare suit of armor doesn't hurt to have sitting at home. Would suck for your 10th lvl PC to lose his +3 armor to a rust monster or black pudding and have to revert back to standard armor cause he sold his other magical armor for some quick cash. Also, when was the last time you saw a PC sell off a useful potion or scroll, as opposed to holding onto it "just in case". Now EVENTUALLY, I will agree that the PCs will get to a point where they will feel that selling some of their loot is worthwhile, but by this time they are usually mid level (or even higher). So my question is, how many people ever reach the point where they are willing to sell the stuff? Most of the people in the majority of the fantasy settings I've seen are peasants, merchants, laborers, nobles, etc. These are not leveled characters that are obtaining magical items to sell. Even among leveled characters, many may never be in a position to sell items. A mage who becomes very powerful through study is unlikely to be wallowing in expendable items that he can convert to ready cash, nor is the high priest who gains his powers through meditation and communion with his diety. So what I see is a VERY limited number of people who will ever be in a position where they would be willing to sell. Certainly not enough to create magical shops (although I could see some sort of auctioning being done, much like what happens today when a rare piece of art goes on sale, but this would be the exception and not the rule). The only other way for items to come into the market is if they are made to be sold. Considering the costs and time involved in making them, I doubt that many mages or clerics are willing to act as magical labor in creating the items.
Now, if the players let me know they want item X, I may throw them a bone and let them hear about someone who reportedly has said item and let them try to track the person down and barter with them for it. This can be a great platform for adventures as they follow false leads, maybe have to perform some service as part of their payment, etc. But to allow them to say at the beginning of the adventure "I'm going to sell my +2 sword and pick up a +3 sword, and a couple of cure potions and a pair of boots of speed" kinda kills the mysticism of the items, in addition to being unbelivable imho.
As for what they use their money for, most of my players find things. I've had players do anything from horde it to buying land or even (in one instance) a castle. Some have had families or even villages that they send their money back to; less savory characters have used the money to buy power or influence, and as a way of bribing others in high society when needed. Many of my players find they are consistently short of money, not that they have scads of it lying around with nothing to do with it. Adventuring is a way for them to get ahead, seek their fortunes, not an end to itself.
