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A PART OF THE INVISIBLE HAND. Do you see it?. There is a story in economics that competitive market outcomes are efficient. Efficiency means two things really. What we make we have to make it as cheaply as possible. Plus we should make the things that people want the most.
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A PART OF THE INVISIBLE HAND Do you see it?
There is a story in economics that competitive market outcomes are efficient. Efficiency means two things really. What we make we have to make it as cheaply as possible. Plus we should make the things that people want the most. What are some things we know? The market supply is the supply from all firms in the market added up. The market demand curve is the demand from each consumer added up. The price and quantity traded are determined in the market. Individual firms and individual buyers have no control over the price. The firms and individuals are price takers.
P S A B C P1 D Q Q1
On the previous slide we see that consumer surplus plus producer surplus equals the area A + B, and this is the result of the market equilibrium P1 and Q1. Inside your own head can you tell if you are willing to pay more for good x over good y? I would say you can because you can determine what you like! As you compare two people can you tell who is willing to pay more for good x? This is harder, but we think the demand curve orders units in such a way that the first unit is demanded by the person who values it most in terms of their willingness to pay for it. The market price cuts off people who value the good less than those who value it more and thus the units of the good produced go to the people who value it most.
Think about sellers in the market. They want to make profit, where profit equals revenue minus cost. Can you tell between producers which can make units cheaper? It is hard but we think the supply curve orders units so that the first unit supplied comes from the lowest cost producer. The market cuts off suppliers who produce the good at too high a cost compared to those who produce at lower cost. So, the market is efficient because goods go to those who value them most and are produced by the producers who can do it cheapest.
P S A B C e h P1 g D Q qless Q1 quamore
Another way to think about efficiency is the total amount of consumer and producer surplus together. The total surplus is less when output is less than the market outcome at Q1, like at qless. Here we would see surplus fall by area e + h. If output is higher than Q1, like at quamore, then we force on the market units of the good that costs more to make than people are willing to pay to get. This is not good. Summary A competitive market is most efficient because we get the most total surplus out of it.
