WEBVTT 00:00:00.000 --> 00:00:05.620 âŞ[music]⪠00:00:09.090 --> 00:00:13.210 - We turn now to the second of our invisible hand properties, the balance of 00:00:13.390 --> 00:00:22.980 industries. We're also going to look at the gales of creative destruction. 00:00:23.160 --> 00:00:27.400 Invisible hand property number one says that the production of any given quantity 00:00:27.580 --> 00:00:32.479 of a good will be allocated across the firms in that industry in a way that 00:00:32.659 --> 00:00:38.570 minimizes total costs. But the question is how much should be produced in each 00:00:38.750 --> 00:00:42.240 industry? So invisible hand property number one says if we're going to be 00:00:42.420 --> 00:00:46.490 producing 200 bushels of wheat that we could be rest assured that if we have a 00:00:46.670 --> 00:00:51.830 competitive market, those 200 bushels will be allocated across the different firms in 00:00:52.010 --> 00:00:57.800 a way that minimizes total industry cost. But should we be producing 200 bushels of 00:00:57.980 --> 00:01:04.110 wheat or 500 or 1000? How should wheat be compared with corn or automobiles or 00:01:04.290 --> 00:01:10.770 books? It's the second question about how the production of goods are balanced 00:01:10.950 --> 00:01:17.230 across industries that invisible hand property number two is all about. In order 00:01:17.410 --> 00:01:22.160 to maximize the value of resources, we want each industry to produce the right 00:01:22.340 --> 00:01:28.490 quantity, not too much wheat and not too little wheat, but just the right amount. 00:01:28.670 --> 00:01:35.790 And entry or exit is what ensures that labor and capital move across industries 00:01:35.970 --> 00:01:40.360 so the production is optimally balanced and the greatest use is made of our 00:01:40.540 --> 00:01:45.870 limited resources. And here to show this we actually don't read the news anymore 00:01:46.050 --> 00:01:50.060 techniques, we just need to sort of reinterpret some of the things which we've 00:01:50.240 --> 00:01:55.910 already done. Let's take a look. Profit is the signal that allocates capital and 00:01:56.090 --> 00:02:03.440 labor across industries in just such a way that maximizes total value. So remember, 00:02:03.620 --> 00:02:07.750 if price is bigger than average cost that means that profits are above normal. Now 00:02:07.930 --> 00:02:13.400 what does above normal profit mean? It means that the output of this industry 00:02:13.400 --> 00:02:18.362 is worth more than the inputs. The profit signal is saying 00:02:18.362 --> 00:02:22.312 we want more of this good. This good is worth more 00:02:22.312 --> 00:02:26.441 than the labor and capital being used to create this good, 00:02:26.441 --> 00:02:32.120 therefore produce more of it. So the profit signals and incentivizes capital 00:02:32.300 --> 00:02:38.860 and labor to enter this industry, that is to move from a low value industry to a 00:02:39.040 --> 00:02:44.420 high value industry. Similarly if price is less than average cost, that means 00:02:44.600 --> 00:02:49.390 profits are below normal. That means that output in this industry is worth less than 00:02:49.570 --> 00:02:57.780 the inputs. So the loss signal is saying we want less of this good. Loss signals 00:02:57.960 --> 00:03:04.390 and incentivizes capital and labor to exit the industry, that is to move from a low 00:03:04.570 --> 00:03:12.280 value industry where there are losses to a high or a higher value industry. Because 00:03:12.460 --> 00:03:18.620 of this entering and exiting, the profit rate in all competitive industries tends 00:03:18.800 --> 00:03:25.180 towards the same level and that is what balances production across all industries 00:03:25.360 --> 00:03:31.410 to maximize the total value of production. If profit were higher in one industry than 00:03:31.590 --> 00:03:36.020 in another, that says that the output of that industry is worth more, therefore we 00:03:36.200 --> 00:03:41.950 should have more of that good. And that's exactly what the entry signal does and the 00:03:42.130 --> 00:03:47.830 same thing is true for exit. Let's discuss some implications of following these 00:03:48.010 --> 00:03:52.400 profit and loss signals. First, the elimination principle. 00:03:52.400 --> 00:03:58.295 Above normal profits are eliminated by entry and below normal profits 00:03:58.295 --> 00:04:03.000 are eliminated by exit. So resources are always tending to move 00:04:03.000 --> 00:04:05.768 towards an increase in the value of production 00:04:05.768 --> 00:04:11.000 and entrepreneurs here are key. It's entrepreneurs who move resources from 00:04:11.180 --> 00:04:17.610 unprofitable industries towards profitable industries. Another implication of this is 00:04:17.790 --> 00:04:23.962 that above normal profits are always temporary. To earn above normal profits, 00:04:23.962 --> 00:04:28.635 you've got to do something different. You have to innovate. 00:04:28.635 --> 00:04:33.110 Joseph Schumpeter, the great Austrian economist was very eloquent 00:04:33.110 --> 00:04:36.800 on the importance of innovation in a capitalist economy. 00:04:36.800 --> 00:04:40.050 He said in the textbooks we say what competition is. It's 00:04:40.230 --> 00:04:45.240 all about pushing prices down to average cost and creating normal profits. But in 00:04:45.420 --> 00:04:50.450 capitalist reality as distinguished from its textbook picture, the kind of 00:04:50.630 --> 00:04:55.130 competition that counts is competition from the new commodity, the new 00:04:55.310 --> 00:05:00.280 technology, the new source of supply, the new type of organization. Competition 00:05:00.460 --> 00:05:05.090 which strikes not at the margins of the profits and the outputs of the existing 00:05:05.270 --> 00:05:11.720 firms but at their very foundations and their very lives. This process of creative 00:05:11.900 --> 00:05:18.030 destruction is the essential fact about capitalism. Great statement from Joseph 00:05:18.210 --> 00:05:24.830 Schumpeter. Now the invisible hand is marvelous but it's not miraculous. The 00:05:25.010 --> 00:05:30.640 invisible hand works when we have certain institutions. It doesn't always work. In 00:05:30.820 --> 00:05:36.990 particular, the invisible hand will not work if prices do not accurately signal 00:05:37.170 --> 00:05:41.570 cost and benefits. If prices don't accurately signal cost and benefits, we 00:05:41.750 --> 00:05:46.010 won't get an optimal balance between industries. And later on when we come to 00:05:46.190 --> 00:05:51.550 talk about externalities, we'll present certain situations when prices aren't 00:05:51.730 --> 00:05:57.680 going to be signaling accurately. Second, the invisible hand works best when markets 00:05:57.860 --> 00:06:02.370 are competitive. When markets are not competitive, when we have monopoly and 00:06:02.550 --> 00:06:06.540 oligopoly, this isn't going to work as well and we'll be talking more about this 00:06:06.720 --> 00:06:10.090 in future chapters but you can get the right idea by thinking about the 00:06:10.270 --> 00:06:18.090 following. Monopolists and oligopolists will earn above normal profits but entry 00:06:18.270 --> 00:06:22.780 won't push those profits down. That's why they're monopolists and oligopolists 00:06:22.960 --> 00:06:29.030 because entry isn't working. Because those profits aren't pushed down, we'll have too 00:06:29.210 --> 00:06:34.380 little of that profitable good produced. We'll be talking more about this 00:06:34.560 --> 00:06:39.500 in future chapters. Again this is just a little bit of a reminder that the 00:06:39.680 --> 00:06:44.720 invisible hand requires a certain set of institutions in order for it to work. So 00:06:44.900 --> 00:06:50.350 just to summarize, invisible hand property one says that the P equals MC condition 00:06:50.530 --> 00:06:54.720 results in the minimization of total industry costs. Invisible hand property 00:06:54.900 --> 00:07:01.370 two is that entry and exits result in the best use of our limited resources. The 00:07:01.550 --> 00:07:06.900 elimination principle says that above normal profits are temporary and indeed to 00:07:07.080 --> 00:07:11.440 earn above normal profits a firm must innovate. And this is where the importance 00:07:11.620 --> 00:07:16.460 of creative destruction for a capitalist economy comes from. If you really want to 00:07:16.640 --> 00:07:20.910 profit a lot you've got to do something different. You've got to bring something 00:07:21.090 --> 00:07:24.220 new to the table. You have to bring in innovation. 00:07:24.400 --> 00:07:29.000 - [male voice] If you want to test yourself, click Practice Questions, 00:07:29.000 --> 00:07:35.700 or if you're ready to move on, just click Next Video.