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- [Alex] We turn now to the second
of our invisible hand properties,

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the balance of industries.

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We're also going to look

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at the gales
of creative destruction.

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Invisible hand property
number one says

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that the production
of any given quantity of a good

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will be allocated
across the firms in that industry

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in a way that minimizes
total costs.

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But the question is,
how much should be produced

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in each industry?

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So invisible hand property
number one says,

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if we're going to be producing
200 bushels of wheat

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then we could be rest assured

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that if we have
a competitive market --

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those 200 bushels will be allocated
across the different firms

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in a way that minimizes
total industry cost.

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But should we be producing
200 bushels of wheat,

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or 500 or 1000?

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How should wheat be compared
with corn or automobiles or books?

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It's the second question

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about how the production of goods
are balanced across industries

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that invisible hand property
number two is all about.

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In order to maximize
the value of resources,

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we want each industry
to produce the right quantity,

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not too much wheat
and not too little wheat,

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but just the right amount.

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And entry or exit is what ensures

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that labor and capital
move across industries

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so the production
is optimally balanced

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and the greatest use
is made of our limited resources.

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And here to show this
we actually don't need to use

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any more techniques,

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we just need to sort of reinterpret
some of the things

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which we've already done.

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Let's take a look.

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Profit is the signal that allocates
capital and labor across industries

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in just such a way
that maximizes total value.

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So remember, if price is bigger
than average cost,

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that means that profits
are above normal.

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Now what does
above normal profit mean?

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It means that the output
of this industry

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is worth more than the inputs.

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The profit signal is saying
we want more of this good.

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This good is worth more
than the labor and capital

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being used to create this good,
therefore produce more of it.

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So the profit signals
and incentivizes capital and labor

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to enter this industry,

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that is to move
from a low value industry

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to a high value industry.

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Similarly, if price
is less than average cost,

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that means profits
are below normal.

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That means that
output in this industry

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is worth less than the inputs.

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So the loss signal is saying:
we want less of this good.

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Loss signals and incentivizes
capital and labor

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to exit the industry,

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that is to move
from a low value industry

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where there are losses

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to a high
or a higher value industry.

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Because of this entering
and exiting,

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the profit rate
in all competitive industries

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tends towards the same level.

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And that is what balances production
across all industries

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to maximize the total value
of production.

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If profit were higher
in one industry than in another,

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that says that the output
of that industry is worth more,

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therefore we should have
more of that good.

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And that's exactly
what the entry signal does

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and the same thing
is true for exit.

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Let's discuss some implications

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of following these
profit and loss signals.

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First, the elimination principle.

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Above normal profits
are eliminated by entry

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and below normal profits
are eliminated by exit.

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So resources are always
tending to move

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towards an increase
in the value of production

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and entrepreneurs here are key.

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It's entrepreneurs
who move resources

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from unprofitable industries
towards profitable industries.

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Another implication of this
is that above normal profits

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are always temporary.

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To earn above normal profits,

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you've got to do
something different.

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You have to innovate.

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Joseph Schumpeter,
the great Austrian economist,

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was very eloquent
on the importance of innovation

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in a capitalist economy.

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He said in the textbooks
we say what competition is.

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It's all about pushing prices
down to average cost

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and creating normal profits.

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But, “In capitalist reality

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as distinguished
from its textbook picture,

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the kind of competition that counts

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is competition
from the new commodity,

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the new technology,
the new source of supply,

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the new type of organization…

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[competition] which strikes
not at the margins

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of the profits and the outputs
of the existing firms

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but at their very foundations
and their very lives.

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This process of creative destruction

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is the essential fact
about capitalism.”

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Great statement
from Joseph Schumpeter.

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Now the invisible hand is marvelous
but it's not miraculous.

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The invisible hand works
when we have certain institutions.

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It doesn't always work.

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In particular,
the invisible hand will not work

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if prices do not accurately
signal cost and benefits.

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If prices don't accurately
signal cost and benefits,

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we won't get an optimal balance
between industries.

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And later on when we come
to talk about externalities,

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we'll present certain situations

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when prices aren't going
to be signaling accurately.

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Second, the invisible hand
works best

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when markets are competitive.

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When markets are not competitive,

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when we have monopoly
and oligopoly,

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this isn't going to work as well.

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And we'll be talking more
about this in future chapters

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but you can get the right idea
by thinking about the following.

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Monopolists and oligopolists
will earn above normal profits

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but entry won't
push those profits down.

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That's why they're monopolists
and oligopolists --

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because entry isn't working.

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Because those profits
aren't pushed down,

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we'll have too little
of that profitable good produced.

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We'll be talking more about this
in future chapters.

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Again this is just
a little bit of a reminder

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that the invisible hand requires
a certain set of institutions

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in order for it to work.

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So just to summarize,

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invisible hand property one says
that the P = MC condition

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results in the minimization
of total industry costs.

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Invisible hand property two
is that entry and exits result

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in the best use
of our limited resources.

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The elimination principle says that
above normal profits are temporary,

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and indeed to earn
above normal profits

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a firm must innovate.

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And this is where the importance
of creative destruction

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for a capitalist economy comes from.

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If you really want to profit a lot

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you've got to do
something different.

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You've got to bring
something new to the table.

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You have to bring in innovation.

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- [Narrator] If you want
to test yourself,

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click “Practice Questions.”

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Or, if you're ready to move on,
just click “Next Video.”

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