What assumptions about the economy must be true for the...

Name: Problem 22, Chapter 2: Principles of Economics
Uploaded: 2019-08-14T03:58:27-08:00
Duration: 5 min 44 s
Channel: Mihir Nayar
Description: What assumptions about the economy must be true for the invisible hand to work? To what extent are those assumptions valid in the real world?

Key Concepts

Invisible Hand

The invisible hand is a concept in economics which posits that individuals, acting in their own self-interest, inadvertently contribute to an efficient allocation of resources within a society. It is the idea that decentralized decisions by many private actors can lead to outcomes that benefit the public, without the need for central coordination.

Perfect Competition

Perfect competition is an ideal market structure characterized by many buyers and sellers, homogeneous products, and free entry and exit. For the invisible hand to work efficiently, the market is assumed to have these features so that no single participant can manipulate prices or outcomes, ensuring that supply and demand reach an optimal equilibrium.

Rational Behavior

Rational behavior assumes that individuals are utility-maximizers who make decisions based on complete and consistent preferences. In the context of the invisible hand, it is presumed that both consumers and producers make decisions aimed at optimizing their welfare, which in aggregate results in efficient market outcomes.

Information Symmetry

Information symmetry is the assumption that all market participants have full and equal access to relevant information regarding prices, quality, and availability of goods. This transparency is essential for enabling decisions that lead to the efficient allocation of resources, as it prevents market distortions caused by information imbalances.

Well-Defined Property Rights

Well-defined property rights ensure that resources are owned and controlled by individuals or institutions with the legal authority to make decisions about their use, exchange, or sale. This clarity is crucial for the functioning of free markets, as secure property rights foster investment, trade, and innovation, all of which support the self-regulating nature of the market.

Absence of Externalities

The absence of externalities implies that the actions of individuals or firms do not impose unaccounted-for costs or benefits on others outside of the market transactions. For the invisible hand to lead to socially optimal outcomes, it is assumed that market participants internalize all the costs and benefits of their actions, thereby avoiding situations where unpriced externalities could lead to market failures.

Transcript

00:01 Hey everyone, today we're answering problem number 22 from chapter 2 of the textbook, which asks, what assumptions about the economy must be true for the invisible hand to work? to what extent are those assumptions valid in the real world? so first, we're going to define what the invisible hand is from this section in my reading.

00:20 It says third, self -interested behavior can lead to positive social results.

00:24 For example, when people work hard to make a living, they create economic output.

00:28 Consumers who are looking for the best deals when we encourage businesses to offer goods and services that need their needs.

00:35 Adam smith named this property the invisible hand.

00:39 He wrote every individual, generally indeed, neither intends to promote the public interest, nor knows how much he is promoting it.

00:46 By preferring the support of domestic to that of foreign industry, he intends only his own security.

00:52 And by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain.

00:59 And he is in this, as in many, other cases led by an invisible hand to promote an end, which is no part of his intention.

01:06 By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it.

01:15 The metaphor of the invisible hands suggest a remarkable possibility that broader social good can emerge from selfish individual actions.

01:23 So clearly there are a few assumptions made here.

01:27 The first one right after that is that a person is totally rational in the choices of selfishness.

01:37 People are rational.

01:50 Just to explain what i mean by this in a little more depth, they act in their own best interests and that they have perfect information.

02:02 Well, so they act in their own best interest.

02:05 That's basically what it means.

02:07 Pretty self -explanatory.

02:08 And then the second one, as i was getting there, is that they have perfect information.

02:25 So imperfect information essentially doesn't exist, which is obviously not true.

02:33 So that, as i said that, that answers the second part.

02:40 Well, that answers the second question for the second assumption.

02:48 Because imperfect or asymmetric information, those two always exist in the marketplace...

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