Perfect Competition AND THE Invisible HAND PDF

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Perfect Competition AND THE Invisible HAND...

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PERFECT COMPETITION AND THE INVISIBLE HAND Adam Smith - ‘It is not from the benevolence of the butcher, the brewer, or the baker, that ew expect our dinner, but from their regard to their own interest.’ This insight has become known as the power of the “invisible hand”. It is a forceful idea in economics because it suggests that when all of the assumptions of a perfectly competitive market are in place, the pursuit of individual self-interest promotes the well-being of society as a whole, almost as if the individual is led by an invisible hand to do so. 7.1 Perfect Competition and Efficiency • Reservation value is the price at which s trading partner is indifferent between making the trade and not doing so • Both buyers and seller have reservation values (reservation values of sellers = marginal cost). • The equilibrium price and the equilibrium quantity are determined by the intersection of the market demand and market supply curves. • We find the quantity equilibrium, because the buyers are willing to pay a certain amount for a good while sellers have a reservation value less than or equal to the amount buyers are willing to pay. So we assume that if a person is indifferent to trading at that amount, they trade. Social Surplus • An important outcome from buyers and sellers optimising in perfect competitive markets is that social surplus is maximise. • Social surplus is the sum of consumer surplus and producer surplus. • Social surplus represents the total value from trade in the market. • Consumer surplus is the difference between the buyers’ reservation value and what buyers actually pay. • Producer surplus is the difference between the price and the sellers’ reservation value • For social surplus to be maximised, the highest-value buyers are making a purchase and the lowest-cost sellers are selling. Pareto Efficiency • We are also interested in allocation of surplus. • Pareto Efficiency says that in the competitive market equilibrium we cannot make an individual better off without harming someone else. • So we can say that in perfect competition, the first distinct function of the equilibrium price is that it efficiently allocates goods and services to buyers and sellers. • The theory that purely self-interested individuals are lead by the invisible hand to maximise the total well being of society represents one of the deepest insights within economics....