The Balance of Industries and Creative Destruction
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0:00 - 0:06♪ [music] ♪
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0:09 - 0:12- [Alex] We turn now to the second
of our invisible hand properties, -
0:12 - 0:14the balance of industries.
-
0:14 - 0:15We're also going to look
-
0:15 - 0:18at the gales
of creative destruction. -
0:23 - 0:25Invisible hand property
number one says -
0:25 - 0:28that the production
of any given quantity of a good -
0:28 - 0:32will be allocated
across the firms in that industry -
0:32 - 0:35in a way that minimizes
total costs. -
0:35 - 0:38But the question is,
how much should be produced -
0:38 - 0:39in each industry?
-
0:40 - 0:42So invisible hand property
number one says -
0:42 - 0:44if we're going to be producing
200 bushels of wheat -
0:45 - 0:46then we could be rest assured
-
0:46 - 0:48that if we have
a competitive market, -
0:48 - 0:51those 200 bushels will be allocated
across the different firms -
0:52 - 0:55in a way that minimizes
total industry costs. -
0:55 - 0:58But should we be producing
200 bushels of wheat, -
0:58 - 1:00or 500 or 1000?
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1:00 - 1:05How should wheat be compared
with corn or automobiles or books? -
1:05 - 1:07It's the second question
-
1:07 - 1:12about how the production of goods
are balanced across industries -
1:13 - 1:16that invisible hand property
number two is all about. -
1:17 - 1:20In order to maximize
the value of resources, -
1:20 - 1:23we want each industry
to produce the right quantity -- -
1:23 - 1:26not too much wheat
and not too little wheat, -
1:26 - 1:28but just the right amount.
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1:28 - 1:32And entry or exit is what ensures
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1:33 - 1:36that labor and capital
move across industries -
1:36 - 1:38so the production
is optimally balanced -
1:38 - 1:42and the greatest use
is made of our limited resources. -
1:42 - 1:45And here to show this
we actually don't need to use -
1:45 - 1:47any more techniques,
-
1:47 - 1:50we just need to sort of reinterpret
some of the things -
1:50 - 1:51which we've already done.
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1:52 - 1:53Let's take a look.
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1:53 - 1:58Profit is the signal that allocates
capital and labor across industries -
1:58 - 2:02in just such a way
that maximizes total value. -
2:03 - 2:05So remember, if price is bigger
than average cost, -
2:05 - 2:07that means that profits
are above normal. -
2:08 - 2:10Now what does
above normal profit mean? -
2:11 - 2:13It means that the output
of this industry -
2:13 - 2:16is worth more than the inputs.
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2:16 - 2:20The profit signal is saying
we want more of this good. -
2:21 - 2:24This good is worth more
than the labor and capital -
2:24 - 2:28being used to create this good,
therefore produce more of it. -
2:29 - 2:33So the profit signals
and incentivizes capital and labor -
2:33 - 2:35to enter this industry,
-
2:35 - 2:38that is to move
from a low value industry -
2:38 - 2:41to a high value industry.
-
2:41 - 2:44Similarly, if price
is less than average cost, -
2:44 - 2:46that means profits
are below normal. -
2:46 - 2:48That means that
output in this industry -
2:48 - 2:50is worth less than the inputs.
-
2:51 - 2:55So the loss signal is saying:
we want less of this good. -
2:56 - 3:00Loss signals and incentivizes
capital and labor -
3:00 - 3:02to exit the industry,
-
3:03 - 3:06that is to move
from a low value industry -
3:06 - 3:07where there are losses
-
3:07 - 3:10to a high
or a higher value industry. -
3:11 - 3:15Because of this entering
and exiting, -
3:15 - 3:18the profit rate
in all competitive industries -
3:18 - 3:20tends towards the same level.
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3:21 - 3:25And that is what balances production
across all industries -
3:25 - 3:28to maximize the total value
of production. -
3:29 - 3:32If profit were higher
in one industry than in another, -
3:33 - 3:35that says that the output
of that industry is worth more, -
3:35 - 3:38therefore we should have
more of that good. -
3:38 - 3:42And that's exactly
what the entry signal does -
3:42 - 3:44and the same thing
is true for exit. -
3:45 - 3:47Let's discuss some implications
-
3:47 - 3:49of following these
profit and loss signals. -
3:50 - 3:52First, the elimination principle.
-
3:52 - 3:55Above normal profits
are eliminated by entry -
3:56 - 4:00and below normal profits
are eliminated by exit. -
4:01 - 4:03So resources are always
tending to move -
4:03 - 4:05towards an increase
in the value of production -
4:06 - 4:08and entrepreneurs here are key.
-
4:08 - 4:11It's entrepreneurs
who move resources -
4:11 - 4:15from unprofitable industries
towards profitable industries. -
4:16 - 4:19Another implication of this
is that above normal profits -
4:19 - 4:21are always temporary.
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4:22 - 4:24To earn above normal profits,
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4:24 - 4:26you've got to do
something different. -
4:26 - 4:28You have to innovate.
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4:29 - 4:32Joseph Schumpeter,
the great Austrian economist, -
4:32 - 4:35was very eloquent
on the importance of innovation -
4:35 - 4:37in a capitalist economy.
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4:37 - 4:40He said in the textbooks
we say what competition is. -
4:40 - 4:43It's all about pushing prices
down to average cost -
4:43 - 4:45and creating normal profits.
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4:45 - 4:47But, “In capitalist reality
-
4:48 - 4:50as distinguished
from its textbook picture, -
4:50 - 4:52the kind of competition that counts
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4:52 - 4:55is competition
from the new commodity, -
4:55 - 4:57the new technology,
the new source of supply, -
4:57 - 5:00the new type of organization…
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5:00 - 5:02[competition] which strikes
not at the margins -
5:02 - 5:06of the profits and the outputs
of the existing firms -
5:06 - 5:10but at their very foundations
and their very lives. -
5:10 - 5:13This process of creative destruction
-
5:13 - 5:16is the essential fact
about capitalism.” -
5:17 - 5:19Great statement
from Joseph Schumpeter. -
5:20 - 5:25Now the invisible hand is marvelous
but it's not miraculous. -
5:25 - 5:28The invisible hand works
when we have certain institutions. -
5:28 - 5:30It doesn't always work.
-
5:31 - 5:34In particular,
the invisible hand will not work -
5:34 - 5:38if prices do not accurately
signal cost and benefits. -
5:39 - 5:42If prices don't accurately
signal cost and benefits, -
5:42 - 5:45we won't get an optimal balance
between industries. -
5:45 - 5:48And later on when we come
to talk about externalities, -
5:48 - 5:50we'll present certain situations
-
5:50 - 5:53when prices aren't going
to be signaling accurately. -
5:54 - 5:57Second, the invisible hand
works best -
5:57 - 5:59when markets are competitive.
-
5:59 - 6:01When markets are not competitive,
-
6:01 - 6:03when we have monopoly
and oligopoly, -
6:03 - 6:05this isn't going to work as well.
-
6:05 - 6:08And we'll be talking more
about this in future chapters -
6:08 - 6:11but you can get the right idea
by thinking about the following. -
6:12 - 6:16Monopolists and oligopolists
will earn above normal profits -
6:16 - 6:20but entry won't
push those profits down. -
6:21 - 6:23That's why they're monopolists
and oligopolists -- -
6:23 - 6:25because entry isn't working.
-
6:25 - 6:28Because those profits
aren't pushed down, -
6:28 - 6:32we'll have too little
of that profitable good produced. -
6:33 - 6:36We'll be talking more about this
in future chapters. -
6:36 - 6:39Again this is just
a little bit of a reminder -
6:39 - 6:43that the invisible hand requires
a certain set of institutions -
6:43 - 6:44in order for it to work.
-
6:45 - 6:46So just to summarize,
-
6:46 - 6:50invisible hand property one says
that the P = MC condition -
6:50 - 6:53results in the minimization
of total industry costs. -
6:54 - 6:58Invisible hand property two
is that entry and exit result -
6:58 - 7:01in the best use
of our limited resources. -
7:01 - 7:06The elimination principle says that
above normal profits are temporary, -
7:06 - 7:08and indeed to earn
above normal profits -
7:08 - 7:10a firm must innovate.
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7:10 - 7:13And this is where the importance
of creative destruction -
7:13 - 7:15for a capitalist economy comes from.
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7:15 - 7:17If you really want to profit a lot
-
7:18 - 7:20you've got to do
something different. -
7:20 - 7:22You've got to bring
something new to the table. -
7:22 - 7:24You have to bring in innovation.
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7:26 - 7:27- [Narrator] If you want
to test yourself, -
7:27 - 7:29click “Practice Questions.”
-
7:29 - 7:33Or, if you're ready to move on,
just click “Next Video.” -
7:33 - 7:37♪ [music] ♪
- Title:
- The Balance of Industries and Creative Destruction
- Description:
-
Why are price signals and market competition so important to a market economy? When prices accurately signal costs and benefits and markets are competitive, the Invisible Hand ensures that costs are minimized and production is maximized. If these conditions aren’t met, market inefficiencies arise and the Invisible Hand cannot do its work. In this video, we show how two major processes, creative destruction and the elimination principle, work with the Invisible Hand to create a competitive marketplace that works for producers and consumers.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/creative-destruction-definition-elimination-principle#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/monopoly-profit-maximization-price-aids-medication
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 07:38
Retired user edited English subtitles for The Balance of Industries and Creative Destruction | ||
Retired user edited English subtitles for The Balance of Industries and Creative Destruction | ||
Retired user edited English subtitles for The Balance of Industries and Creative Destruction | ||
MRU2 edited English subtitles for The Balance of Industries and Creative Destruction | ||
MRU2 edited English subtitles for The Balance of Industries and Creative Destruction | ||
MRU2 edited English subtitles for The Balance of Industries and Creative Destruction |