Perfect Competition and the Invisible Hand (Vocabulary)

Vocabulary flashcards covering key terms from the lecture notes on perfect competition, the invisible hand, reservation values, and related concepts.

Perfect competition

A market structure with many buyers and sellers; price takers; leads to efficient allocation of goods and services through the invisible hand, with efficient production within and across industries.

Invisible hand

The mechanism by which self-interested actions by buyers and sellers coordinate to allocate resources efficiently and maximize social welfare.

Pareto efficiency

A situation in which no one can be made better off without making someone else worse off.

Social surplus

The sum of consumer surplus and producer surplus.

Consumer surplus

The difference between a buyer's reservation value and the price paid (the amount the buyer would be willing to pay minus actual price).

Producer surplus

The difference between the market price and a seller's reservation value (minimum acceptable price).

Economic profit

Total revenue minus total costs (opportunity costs included); can be zero in a perfectly competitive market in the long run.

Economic loss

When total costs exceed total revenue; price is below ATC.

MR = MC

Profit-maximizing rule where marginal revenue equals marginal cost to determine optimal output.

ATC

Average total cost per unit of output.

Prices guide the invisible hand

Prices signal scarcity and direct resources to their highest valued uses, coordinating producers and consumers.

Equilibrium price and quantity

Price and quantity where quantity demanded equals quantity supplied.

Deadweight loss

The reduction in social surplus resulting from a market intervention, such as price controls.

Price controls

Government-imposed limits on prices that can cause shortages or surpluses and DWL.

Market economy

An economy where prices direct the flow of resources and incentives, coordinating production and consumption.

Command economy

An economy where a central planner directs resources and provides incentives.

Equity

Fair distribution of resources across society; often discussed alongside efficiency.

Coordination problem

Difficulty in bringing together self-interested agents to form efficient markets.

Incentive problem

Difficulty in motivating agents to participate in markets and allocate resources efficiently.

Extending the invisible hand: From the Individual to the Firm

The idea that profit-maximizing decisions at the plant level (MR = MC) guide efficient production across firms and plants.

Allocation of resources across industries

Free entry and exit redirect resources toward highest valued uses across different industries.

Reservation value

The maximum price a buyer is willing to pay or the minimum price a seller is willing to accept.

Consumer surplus (iPhone market)

The sum over buyers of reservation value minus price; measures willingness-to-pay above price.

Producer surplus (iPhone market)

The sum over sellers of price minus reservation value; measures profit above minimum acceptable price.

Evidence-Based Economics

Using real-world cases (e.g., Uber surge pricing) to test whether self-interested markets maximize social well-being.