The Balance of Industries and Creative Destruction
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0:00 - 0:06♪[music]♪
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0:09 - 0:13- We turn now to the second of our
invisible hand properties, the balance of -
0:13 - 0:23industries. We're also going to look at
the gales of creative destruction. -
0:23 - 0:27Invisible hand property number one says
that the production of any given quantity -
0:28 - 0:32of a good will be allocated across the
firms in that industry in a way that -
0:33 - 0:39minimizes total costs. But the question is
how much should be produced in each -
0:39 - 0:42industry? So invisible hand property
number one says if we're going to be -
0:42 - 0:46producing 200 bushels of wheat that we
could be rest assured that if we have a -
0:47 - 0:52competitive market, those 200 bushels will
be allocated across the different firms in -
0:52 - 0:58a way that minimizes total industry cost.
But should we be producing 200 bushels of -
0:58 - 1:04wheat or 500 or 1000? How should wheat be
compared with corn or automobiles or -
1:04 - 1:11books? It's the second question about how
the production of goods are balanced -
1:11 - 1:17across industries that invisible hand
property number two is all about. In order -
1:17 - 1:22to maximize the value of resources, we
want each industry to produce the right -
1:22 - 1:28quantity, not too much wheat and not too
little wheat, but just the right amount. -
1:29 - 1:36And entry or exit is what ensures that
labor and capital move across industries -
1:36 - 1:40so the production is optimally balanced
and the greatest use is made of our -
1:41 - 1:46limited resources. And here to show this
we actually don't need to use any more -
1:46 - 1:50techniques, we just need to sort of
reinterpret some of the things which we've -
1:50 - 1:56already done. Let's take a look. Profit is
the signal that allocates capital and -
1:56 - 2:03labor across industries in just such a way
that maximizes total value. So remember, -
2:04 - 2:08if price is bigger than average cost that
means that profits are above normal. Now -
2:08 - 2:13what does above normal profit mean?
It means that the output of this industry -
2:13 - 2:18is worth more than the inputs.
The profit signal is saying -
2:18 - 2:22we want more of this good.
This good is worth more -
2:22 - 2:26than the labor and capital
being used to create this good, -
2:26 - 2:32therefore produce more of it. So the
profit signals and incentivizes capital -
2:32 - 2:39and labor to enter this industry, that is
to move from a low value industry to a -
2:39 - 2:44high value industry. Similarly if price
is less than average cost, that means -
2:45 - 2:49profits are below normal. That means that
output in this industry is worth less than -
2:50 - 2:58the inputs. So the loss signal is saying
we want less of this good. Loss signals -
2:58 - 3:04and incentivizes capital and labor to exit
the industry, that is to move from a low -
3:05 - 3:12value industry where there are losses to a
high or a higher value industry. Because -
3:12 - 3:19of this entering and exiting, the profit
rate in all competitive industries tends -
3:19 - 3:25towards the same level and that is what
balances production across all industries -
3:25 - 3:31to maximize the total value of production.
If profit were higher in one industry than -
3:32 - 3:36in another, that says that the output of
that industry is worth more, therefore we -
3:36 - 3:42should have more of that good. And that's
exactly what the entry signal does and the -
3:42 - 3:48same thing is true for exit. Let's discuss
some implications of following these -
3:48 - 3:52profit and loss signals. First,
the elimination principle. -
3:52 - 3:58Above normal profits are eliminated
by entry and below normal profits -
3:58 - 4:03are eliminated by exit. So resources
are always tending to move -
4:03 - 4:06towards an increase
in the value of production -
4:06 - 4:11and entrepreneurs here are key.
It's entrepreneurs who move resources from -
4:11 - 4:18unprofitable industries towards profitable
industries. Another implication of this is -
4:18 - 4:24that above normal profits are always
temporary. To earn above normal profits, -
4:24 - 4:29you've got to do something different.
You have to innovate. -
4:29 - 4:33Joseph Schumpeter, the great Austrian
economist was very eloquent -
4:33 - 4:37on the importance of innovation
in a capitalist economy. -
4:37 - 4:40He said in the textbooks
we say what competition is. It's -
4:40 - 4:45all about pushing prices down to average
cost and creating normal profits. But in -
4:45 - 4:50capitalist reality as distinguished from
its textbook picture, the kind of -
4:51 - 4:55competition that counts is competition
from the new commodity, the new -
4:55 - 5:00technology, the new source of supply, the
new type of organization. Competition -
5:00 - 5:05which strikes not at the margins of the
profits and the outputs of the existing -
5:05 - 5:12firms but at their very foundations and
their very lives. This process of creative -
5:12 - 5:18destruction is the essential fact about
capitalism. Great statement from Joseph -
5:18 - 5:25Schumpeter. Now the invisible hand is
marvelous but it's not miraculous. The -
5:25 - 5:31invisible hand works when we have certain
institutions. It doesn't always work. In -
5:31 - 5:37particular, the invisible hand will not
work if prices do not accurately signal -
5:37 - 5:42cost and benefits. If prices don't
accurately signal cost and benefits, we -
5:42 - 5:46won't get an optimal balance between
industries. And later on when we come to -
5:46 - 5:52talk about externalities, we'll present
certain situations when prices aren't -
5:52 - 5:58going to be signaling accurately. Second,
the invisible hand works best when markets -
5:58 - 6:02are competitive. When markets are not
competitive, when we have monopoly and -
6:03 - 6:07oligopoly, this isn't going to work as
well and we'll be talking more about this -
6:07 - 6:10in future chapters but you can get the
right idea by thinking about the -
6:10 - 6:18following. Monopolists and oligopolists
will earn above normal profits but entry -
6:18 - 6:23won't push those profits down. That's why
they're monopolists and oligopolists -
6:23 - 6:29because entry isn't working. Because those
profits aren't pushed down, we'll have too -
6:29 - 6:34little of that profitable good produced.
We'll be talking more about this -
6:35 - 6:40in future chapters. Again this is just a
little bit of a reminder that the -
6:40 - 6:45invisible hand requires a certain set of
institutions in order for it to work. So -
6:45 - 6:50just to summarize, invisible hand property
one says that the P equals MC condition -
6:51 - 6:55results in the minimization of total
industry costs. Invisible hand property -
6:55 - 7:01two is that entry and exits result in the
best use of our limited resources. The -
7:02 - 7:07elimination principle says that above
normal profits are temporary and indeed to -
7:07 - 7:11earn above normal profits a firm must
innovate. And this is where the importance -
7:12 - 7:16of creative destruction for a capitalist
economy comes from. If you really want to -
7:17 - 7:21profit a lot you've got to do something
different. You've got to bring something -
7:21 - 7:24new to the table. You have to bring in
innovation. -
7:24 - 7:29- [male voice] If you want to test
yourself, click Practice Questions, -
7:29 - 7:36or if you're ready to move on,
just click Next Video.
- 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.
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- 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 |