Profits, Entry and Exit: the Basis for the 'Invisible Hand - The 'invisible hand' theory
4 important questions on Profits, Entry and Exit: the Basis for the 'Invisible Hand - The 'invisible hand' theory
In the free-enterprise system, market prices serves two important and distinct functions:
- Rationing function of price = to distribute scarce goods to those consumers who value them most highly
- Allocative function of price = to direct resources away from overcrowded markets and towards markets that are undeserved
The 'invisible hand' theory of Adam Smith is:
Two attractive features of of the invisible hand concept are:
- The market outcome is efficient in the long run (price equals marginal costs).
- The price buyers must pay is no higher than the cost incurred by suppliers.
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The allocative function of price cannot operate unless firms can enter new markets and leave existing ones at will. Barriers to entry are:
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