ECO111 Written Assignment 1
Written Assignment 1
1. What is the mechanism by which the "invisible hand" pushes markets to equilibrium?
Adam Smith pioneered the concept of the “invisible hand”, which allows households and firms to interact and compete with one another. The invisible hand is based on Smith’s belief that consumers will always want the best price, and the producers will always want to maximize profit. Basically, if the government would not interfere in what consumers could buy and what producers could produce, and both buyers and sellers were free to make their own choices, then market prices would be beneficial for both consumers and producers (Mankiw 2008). The mechanism of the invisible hand says that producers will try to maximize profits by working more efficiently to maximize production while doing so at the lowest possible price to eliminate competition- in turn other producers will do the same and the consumer is free to choose the lowest priced producer. The push of the invisible hand will result in an increase in financial gain because the consumer is getting a competitive price for high quality goods or services and the seller is increasing sales profits.
2. Explain the two main causes of market failure and give an example of each.
The two main causes of market failure are externality and market power.
Externality is defined by Markiw, 2008 as: “the impact of one person’s actions on the well-being of a bystander. An example of externality is traffic congestion. As roads become more and more congested additional roads may need to be built- thus either toll plazas are installed to collect for the project, or higher taxes to pay for additional roads. Also, employers may lose productivity time if their employers get to work late due to the traffic, and also all of the pollution emitted from the congestion, which causes health issues- which is a whole other set of medical costs.
Market power is defined by Markiw, 2008 as: “the ability of a single economic actor
1. What is the mechanism by which the "invisible hand" pushes markets to equilibrium?
Adam Smith pioneered the concept of the “invisible hand”, which allows households and firms to interact and compete with one another. The invisible hand is based on Smith’s belief that consumers will always want the best price, and the producers will always want to maximize profit. Basically, if the government would not interfere in what consumers could buy and what producers could produce, and both buyers and sellers were free to make their own choices, then market prices would be beneficial for both consumers and producers (Mankiw 2008). The mechanism of the invisible hand says that producers will try to maximize profits by working more efficiently to maximize production while doing so at the lowest possible price to eliminate competition- in turn other producers will do the same and the consumer is free to choose the lowest priced producer. The push of the invisible hand will result in an increase in financial gain because the consumer is getting a competitive price for high quality goods or services and the seller is increasing sales profits.
2. Explain the two main causes of market failure and give an example of each.
The two main causes of market failure are externality and market power.
Externality is defined by Markiw, 2008 as: “the impact of one person’s actions on the well-being of a bystander. An example of externality is traffic congestion. As roads become more and more congested additional roads may need to be built- thus either toll plazas are installed to collect for the project, or higher taxes to pay for additional roads. Also, employers may lose productivity time if their employers get to work late due to the traffic, and also all of the pollution emitted from the congestion, which causes health issues- which is a whole other set of medical costs.
Market power is defined by Markiw, 2008 as: “the ability of a single economic actor
References: Mankiw, N. G. (2008). Principals of Macroeconomics (6th ed.). Mason, OH: Cenage Learning.