Question

The first proposition of the Invisible Hand Theorem says that competition minimizes total costs of production in an industry. Using both a graph and verbal argument, demonstrate this proposition.

Answer 1

The first proposition of invisible hand theorem says that competition minimizes total costs of production in an industry.

Lets, look at a perfectly competitive market where the prices are same in all the firms in the industry. The main aim of a firm is to maximize its profit. Profit maximization is the point where the price is equal to marginal cost ( P = MC ). If an industry has 50 firms then the price of the product in the industry at profit maximizing point is

P = MC₁ + MC₂ + MC₃ + ....... + MC₅₀

This results in MC₁ = MC₂ = MC_{3 ............}= MC₅₀  , which means that competitive markets balance production across firms in the industry so the total industry costs are minimized (for any given quantity of production).