AS

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