Question

The second proposition of the Invisible Hand Theorem says that competition ensures the mix of output across industries that maximizes economic efficiency, meaning best satisfies consumer wants. Using both a graph and a verbal argument, demonstrate this proposition.

Answer 1

The unkown market force that helps the demand and supply of goods in a free market to which equilibrium automatically is the invisible hand. This was explained by Adam Smith in his book "The Wealth of Nations" and it was known as the theory of Invisible hand. He explained that an economy will work and function well, if the government leave the people to buy and sell freely among themselves. If people were allowed to trade freely, selfish traders in the market would compete with each other leading market towards the positive output with the help of an invisible hand or the automatic works of the market forces demand and supply. If someone charges less , the customer will buy from him. So, the producer has to lower his price better than his competetor. Whenever enough people demand something, it will be supplied by the market and everyone will be happy. The seller ends up getting the price and he buyer will get better goods at the desired price.In the figure the quantity demanded and supplied are shown on the X axis. Price of the RPoduct is shown on Y axis. When the price= Rs3, supply equals the demand at E. Excess of supply can be noticed when price is Rs4. Since the price increased , the producer produced more. Then the consumer will demand automatically less till it comes to Rs3. At this point, equilibrium quantity is 6000kg. Excess demand can be seen when the price is Rs2. Then the excess demand automatically brings shortage in supply, till the price comes to Rs3. Thus at Rs3, both the producer and consumer will be satisfied. The invisible hand of automatic price mechanism of the forces f supply and demand has brought this equilibrium.