6.0 Representing the Power of the Invisible Hand

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

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

Unit of Output MCAC Calculating AC 1 st /1 2 nd /2 3 rd /3 4 th /4 5 th /5 6 th /6 7 th /7 8 th /8 9 th th /10

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

6.1.4

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

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

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

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

 - Stands for profit

In this example, The firm is making $15,000 profit $100,000 - $85,000 = $15,000

6.1.6

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 > TC Profit = TR -TC

6.1.7 Profit is revenue above costs Costs include normal returns Profit is gravy, it ’ s nice, but not necessary to stay in business

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

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

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

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

Perfect competition forces firms to adopt the most efficient, lowest cost technique If they don ’ t, they get left in the dust, as customers move elsewhere, given our nice assumption of equal access to markets and info

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

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

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

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 ”

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

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 6.2.5

a just distribution Markets are amoral They just coordinate choices given the distribution of social endowment among people individual preferences the state of technology However, efficiency doesn’t necessarily mean