Econ 201
Lecture 20
Perfect Competition:
Leftovers
The Invisible Hand
• What do we mean?
– The basic questions
• How do we allocate goods among consumers?
• How do we get firms to produce what consumers
want?
• How do we get firms to produce goods efficiently,
i.e. at minimum costs, and use resources
efficiently?
Invisible Hand
• How could we allocate goods?
– Government could allocate
• “each according to his needs”
• Rationing/coupons
– Market
• Those whose willingness-to-pay >= market price
Invisible Hand
• How do we get firm to produce the goods
consumers want?
– Government sets firm production quotas
• E.g. Soviet 5 and 10 year programs
• China: chose where to locate firms
• => but how do you know what consumers want?
– Market
• Firms decide to produce based on whether market
demand (and WTP) are sufficient to cover their
costs
Invisible Hand
• How do we get firms to produce goods
efficiently?
– Government
• “benchmark” unit costs targets
• Mandate technology choices
– Market
• Profit incentive drives firms towards lowest cost of
production
Efficiency of Markets
• Allocative Efficiency
– Goods go to those who value them most
• Buy if MV (last unit purchased) >= market price
– Efficient, given current distribution of income
• MV of resources used to produce the good are >= to
opportunity cost of using resources to produce other goods
• Productive Efficiency
– Goods are produced at minimum costs (including
opportunity costs)
• OTW “Economic Darwinism” kills off inefficient firms