Transcript Adam Smith and The Market

Adam Smith and The Market
 Scot philosopher and originator of our concepts of
capitalism
 Self interest as an incentive in economic decisions
 The concept of the invisible hand: that self interested
decisions will, when taken together, result in a benefit
to society.
 Developed the main theoretical underpinnings of
captitalism.
Characteristics of the “pure” market
Private ownership of private property
1. Individuals and businesses own most of the private
property (land and capital)
a. right to negotiate binding contracts
b. right to use and dispose of property
2. Private property rights encourage investment,
innovation, exchange of assets, and economic
growth.
A.
Private Property cont.
3. Private property rights extend to intellectual property
as well through the use of trademarks, patents, and
copyrights.
Characteristic #2
B. Freedom of enterprise and choice exist
1. Freedom of enterprise: entrepreneurs and businesses
have freedom to use resources, produce products of
their choice, and to sell these in the markets of their
choice
#2 cont
2. Freedom of choice:
a. Owners of property and money
resources can use these as they
choose
b. Workers can choose training,
occupation and job of choice
c. Consumers may spend income as
they
choose to best satisfy wants.
This is
known as “consumer sovereignty”.
Self Interest #3
C. Self – Interest
1. Self Interest is one driving force in market economies.
Entrepreneurs attempt to maximize profit or minimize
loss, consumers attempt to maximize satisfaction, resource
suppliers attempt to maximize income.
2. As each attempts to maximize profit, satisfaction, or
income, the economy will benefit if competition exists in
the market place.
Competition #4
D.
Competition
1. Large numbers of sellers mean no one single producer
can control the price or market supply.
2. Large numbers of buyers mean no one single
consumer or employer can control price or market
demand
3. Generally, these conditions mean producers can enter
or leave the market easily. Entry and exit with ease is a
state of the pure/competitive market
Markets and Prices
E. Markets systems announce the decisions of producers
and buyers in the product and resource markets.
Supply and demand graphs illustrate this
A change in market price signals that a change of some
kind has occurred in that market
Those who respond to the signals will be rewarded
with income or profit
Necessity of Technology and Capital Goods
F. Competition, freedom of choice, self interest, and
potential for profit provide the incentives for capital
accumulation (investment).
Advanced technology and capital goods use
roundabout efficient methods of production
Specialization
G. Specialization results in efficiencies
1. People can take advantage of differences in ability
and skill
2. People with identical skills may benefit from
specializing and improving skills
3. Specialization saves time as people don’t have to
shift from one task to another
Specialization cont
4. Geographic specialization is important: Regional
and international specialization take advantage of
localized resources.
A caveat: Specialization does not necessarily mean that
everyone will be able to take advantage nor does it
imply that people will be happy to specialize. In
industrial societies specialization may, in fact, be
disincentivizing.
Use of Money as a Medium for Exchange
H. Money substitutes for barter
This requires coincidence of wants
Willingness to accept money in place of goods
allows 3 way trades ( or multiple trades)
Active but LIMITED government
I. Markets tend to underproduce goods with social
benefits and overproduce goods with social costs.
Markets also tend toward monopoly and tend to
become more unstable over time. Government can
play a role in guiding market forces to avoid these
issues.
Markets at Work
 The market is made up of billions of producers and
consumers making trillions of decisions. All of whom
are trying to maximize self interest
 It is a mechanism which provides consumers and
producers a forum to respond to each other
Markets at Work
 The four fundamental questions of any economic system.




Whether market or socialist or traditional all systems must
satisfy these questions.
1. What g/s will be produced?
2. How will the g/s be produced?
3. Who will get the g/s?
4. How will the system accommodate change?
What will be produced?
 Business responds to consumers’ wants and desires in
order to be profitable
 When business responds properly to these, profit and
allocative efficiency will occur
 Economically, profit and income are the same. Profit
must be received if a producer is going to continue to
produce in an industry
What will be produced?
 Normal profits are the return to the producer that is
necessary for him to continue to produce that product.
Any revenue beyond normal profit is called pure or
economic profit
 If an industry is producing pure or economic profit
additional producers move into that industry. Supply
will increase, prices will tend to decrease, reducing
and eliminating economic profit for some producers
What will be produced?
 When this occurs and producers experience economic
loss, some will leave the industry, contracting supply of
that product, price will increase, and economic profit
will return to that industry.
 Consumer sovereignty is also a key to determining the
types and quantities of goods and services to be
produced
What will be produced?
 Purchases will help determine which goods are wanted
or desired and eliminate those which are not. This will
determine what industries and firms are successful
and which are not.
 Business must consider and match production choices
with consumer choices or face loss and bankruptcy
How will goods and services be produced?
 The market encourages and rewards those who are
achieving productive efficiency or what is called least
cost production
 Least cost production: locating firms in optimum
locale, considering all resources costs, and considering
best technology and producing with these
How will goods and services be produced?
 The most efficient techniques will be the one that
produces a given amount of output for the smallest
input of resources when inputs and outputs are
measured in money terms
Who will get the goods and services?
 This answer is related directly to the distribution of
income in any economy
 Products will go to those able and willing to pay for
them and to no one else
 Ownership of resources, productivity of resources, and
relative supply of resources will determine income and
the distribution of it. This is linked to the resource
market as they determine income.
How will the market accommodate change?
 Markets accommodate change by using consumer
taste and the guiding function of price
 An increase in D for some products leads to higher
prices for those products
 A decrease in D for other products leads to lower
prices for those products.
Accommodating change
 Increased D leads to higher prices that induce
producers to make more of that product ( more
output=more supply)
 Higher prices also encourage other firms to enter the
industry accelerating the production of more output
(supply)
 The opposite is true for lower prices and lowered D.
Tech Change and the Market
 Markets encourage change by rewarding technological
innovation which allows lower production costs and the
accumulation of capital by certain firms who do this. The
spread of new techniques will lower pupc as well as price
 Creative Destruction: when new products and techniques
destroy the market positions of firms who are not willing
or able to adjust to the new conditions prevailing in the
market.
The “Invisible Hand”
 Competition is the controlling mechanism of any
market. It guarantees response to consumer wants and
forces firms to adopt the most efficient manner of
production
 As Smith said, this “invisible hand” promotes public
interest through a primary focus on self interest. By
attempting to maximize profit, firms will also produce
those goods and services most wanted by society.