6.0 Representing the Power of the Invisible Hand

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6.0 Representing the Power of the Invisible Hand
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6.1.1

• Many nations of the world have switched to
  markets
• They are convinced that markets will help nations
  realize greater wealth by making production more
  efficient

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6.1.2

• Marginal cost how much it costs to make the
  next unit
• Average cost generic measure of cost, total
  cost of production divided by total units
  produced

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Unit of Output MC AC Calculating AC
1st 100 100 100/1
2nd 90 95 190/2
3rd 80 90 270/3
4th 70 85 340/4
5th 80 84 420/5
6th 90 85 510/6
7th 100 87 610/7
8th 110 90 720/8
9th 120 93 8409
10th 130 97 970/10
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6.1.3

• Average 27 goals a season
• This year you score (at the margin) 35
• What happens to average?
• It goes up
• Margin pulls average along
• If margin is higher than average, it pulls it up,
  and vice versa

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6.1.4
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• MC always intersects AC at the bottom or minimum
  of the AC curve
• Marginal always pulls average in its direction
• This relationship between MC and AC will be an
  important part of efficiency

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6.1.5

• For a firm in the product market,
• A profit is when total revenue exceeds total
  costs
• A loss is when total costs exceed total revenue
• Breaking even is when total costs and total
  revenue are the same

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Total revenue-

• Money it takes in from sale of a product
• TR p X Q
• 5 cars at 20,000 each 100,000 total revenue

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Total cost-

• Amount of money a firm spends on the process of
  producing
• TC AC X Q
• Produces 5 cars at an average of 17,000 each
  85,000 total cost

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? - Stands for profit
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In this example,

• The firm is making 15,000 profit
• 100,000 - 85,000 15,000

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6.1.6
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Market price is p1

• Firm will produce Q1 because that is where MC
  (supply) is
• The average cost at Q1 is AC1
• Total revenue p X Q
• Total cost AC X Q
• Think of each of these as rectangles
• TR gt TC
• Profit TR -TC

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6.1.7

• Profit is revenue above costs
• Costs include normal returns
• Profit is gravy, its nice,
• but not necessary to stay in business

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Profits mean

• that market is a good place to be
• Under perfect competition,
• firms have no power and all have equal access to
  information
• Profits attract competitors
• Market supply shifts out, price falls
• profits are driven to zero
• Only costs are covered

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6.1.8

• Profit is a powerful yet ephemeral signal
• It is a magnet that attracts competitors, yet the
  irony is that
• the competition drives profits away
• Firms only get normal returns under perfect
  competition

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6.1.9

• when profits have been driven to zero by
  competition
• p MC AC
• at the bottom of the average curve line
• Maximum productivity, minimal average cost
• This is the most efficient point of production

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• The self-interested behavior of seeking profits
  leads to the
• most efficient outcome

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6.1.10

• Perfect competition forces firms to adopt the
• most efficient, lowest cost technique
• If they dont, they get left in the dust, as
  customers move elsewhere,
• given our nice assumption of equal access to
  markets and info

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6.2.1

• Not only do markets encourage efficiency,
• they also encourage creativity and inventiveness

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6.2.2

• If perfect competition has a firm producing at
  the bottom of its average cost curve,
• it can go on just making normal returns
• How can you do better?
• You must innovate and become more efficient than
  your competitors

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Such innovation

• will lower your cost structure
• you could make a profit while others are breaking
  even

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6.2.3

• Another way to beat the market is to create a new
  market niche
• First firm in with a new product can make big
  profits if the market likes it
• Build a better mousetrap

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6.2.4

• Competitors will mimic you
• Market price will fall, profits will disappear
• Markets are always driving people to think of new
  products,
• or better versions of old products,
• or more efficient ways of producing
• Markets are engines for material progress, which
  can benefit all

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6.2.5

• The magic of markets
• under perfect competition, firms will be
  amazingly efficient and innovative
• A nation can get the most from its resources
• This is the power of the invisible hand

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However, efficiency doesnt necessarily mean

• a just distribution
• Markets are amoral
• They just coordinate choices given
• the distribution of social endowment among people
• individual preferences
• the state of technology