Invisible Hand Property 2

The Balance of Industries

• This ensures that the right amount of corn is produced

• Invisible hand property 2: profit rate in all competitive industries tends toward the same level

• Situation:

  • A car industry and a computer industry both use labor and capital to produce goods

    • Labor and capital are limited

  • How do we allocate the limited labor and capital across the computer and car industry to satisfy as many of our wants as possible?

    • Profit in computer industry is total revenue - total cost

    • Total revenue measures the value of the output of the computer industry, the computers

    • Total cost measures value of the inputs to computer industry, labor and capital

    • High profits mean that outputs of high value are being created from inputs of low value

    • Profit is a signal that limited labor and capital are being used productively in satisfying our wants

  • What is the computer industry is more profitable than the car industry

    • A unit of labor and capital in computer industry is creating more value than in the car industry

    • So, we want labor and capital to move from car industry to computer industry (we want resources to flow from low-profit industries to high-profit industries)

• In a competitive market, the incentives that entrepreneurs have to seek profit and avoid losses align with the social incentive to move labor and capital out of low-value industries and into high-value industries

• Profits encourage entry

• What happens to price and profits when firms enter an industry?

  • Supply increases and price declines, which reduces profits

• Losses encourage exits

• What happens to price and profits when firms exit an industry?

  • Supply decreases and price increases, which increases profit (reduces losses)

• There is a tendency for a profit rate in all competitive industries to go to zero (normal profits)

• Profit rate tends to the same level in the car and the computer and all other industries

  • Marginal value of resources in all industries is the same (total value of production is maximized)

    • If profit rate in one industry were greater than in another, total value would increase if resources were to move from the less profitable to the more profitable industry