AU26 Economics 2001.01 Chapter 7: Perfect Competition and The Invisible Hand

Invisible Hand

describes how self-interested individuals in a free market unintentionally benefit the wider public good

• directs consumers and producers to maximize their surplus, leading to the highest level of social welfare

Who created the metaphor “Invisible Hand”?

Adam Smith

Adam Smith

Scottish economist and philosopher
- father of modern economics

reservation value

the absolute limit—the highest a buyer will pay or the lowest a seller will accept for a good or service

social surplus

same thing as total surplus
- ecPS+CS

step curve

used to represent supply or demand when a market has a small, number of buyers or sellers rather than a smooth, continuous population

economic loss

any quantifiable financial or monetary damage suffered by an individual, business, or organization

break even

the precise level of production or sales where total revenue equals total costs, resulting in zero net profit or loss

deadweight loss

the reduction in social (total) surplus resulting from a market intervention

price control

act to restricy efficiency

market economy

prices direct flow of resources, provide incentive for participants

command economy

central agency direct resources, provides incentives

equity

ownership value in an asset or business

efficiency

occurs when an economy allocates scarce resources to maximize production and consumer satisfaction while minimizing waste

• perfectly competitive markets

pareto efficency

when no one can be better off without making someone else worse off

• close to the definition of equlbrium, but different terms

coordination problem

bringing together self-interested economic agents to form markets

• How do we bring buyers and sellers together to make transactions?

incentive problem

how to motivate agents to participlate in markets

• How do we motivate people to participate in economic activity?