Creative Destruction

• Change is constant, so some profitable industries are always popping up and also some unprofitable industries
• In a dynamic economy, resource are always moving towards an increase in the value of production
  • Entrepreneurs listen to price signals and they move capital and labor from unprofitable industries to profitable ones
• A general feature of competitive markets is the elimination principle
  • Elimination principle: above-normal profits are eliminated by entry and below-normal profits are eliminated by exit
  • Says that above-normal profits are temporary because great ideas are adopted by other people and then they become common
  • To earn above-normal profits, an entrepreneur must innovate
• Above-normal profits are constantly being eliminated by competition, and new sources of profit are constantly being created through innovation

The Invisible Hand Works With Competitive Markets

• For competitive process to work, prices must accurately signal costs and benefits

  • Prices don’t always signal costs and benefits
  • If they don’t accurately signal costs and benefits, invisible hand property 2 won’t work perfectly and there won’t be an ideal balance between industries
  • We will get too few resources in some industries and too many resources in other

• If markets aren’t competitive, invisible hand doesn’t work

• Monopolists and oligopolists earn above-normal profits

  • When an industry earns above-normal profits, we want resources to move to that industry

  • Without the pressure of the competitive process, not enough resources will move and profits won’t be eliminated

  • Output will be too low in a monopoly or oligopoly

  • Good institutions align self-interest with social interest, but good institutions are sometimes hard to find or create

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