Chapter 12: Competition and the Invisible Hand

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18 Terms

1

Invisible hand property 1

the P = MC condition balances production across firms in a way that minimizes total industry costs of production

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2

Invisible Hand property 2

Entry and exit signals balance production across different industries in a way that maximizes the total value of production

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3

Minimization of total industry costs of production

to maximize profits, each firm adjusts its output until P = MC

Thus, in a competitive market with N number of firms, P = MC1 = MC2 = … = MCN

results in minimizing total costs for the industry

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4

Overview of Balance of industries

  • competitive markets ensure that the right amount of a good is produced

  • entrepreneurs seek profit and avoid losses

  • profit is a signal that labor and capital are being used productively in satisfying wants

  • profit seeking aligns with the social incentive to move labor and capital out of low value industries and into high value industries

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5

Resources flow from low profit to high profit industries

  • if P > AC, profits are above normal, causing capital and labor to enter the industry

  • If P < AC, profits are below normal, causing capital and labor to exit the industry

  • the profit rate of all competitive industries tends toward the same level

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6

Under Balance of industries

the total value of all production is maximized (allocative efficiency)

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7

Elimination Principle

above normal profits are eliminated by entry and below normal profits are eliminated by exit

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8

Implication of the elimination principle

  • above normal profits are temporary

  • to earn above normal profits, entrepreneurs must innovate

  • competition is about innovating

  • above normal profits are constantly being eliminated by competition

  • new sources of profit are constantly being created through innovation

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