Economics: Invisible Hand

1. What is the mechanism by which the "invisible hand" pushes markets to equilibrium?

Prices is the tool with which the invisible hand directs economic activity. Buyers look at the prices when determining how much to demand, and sellers look at the price when deciding how much to supply. What makes market prices reflect both the value of a good to society and the cost to society of making the good, is the decisions of buyers and sellers. Economist Adam Smith made the most famous reflection of economics in his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, his understanding was that prices adjust to guide these individual buyers and sellers to reach results that, capitalize on the well-being of society as a whole.

2. Explain the two main causes of market failure and give an example of each.

A cause of market failure is externality. Externality is when the impact of one person’s actions on the well-being of a bystander. A great example of externality is pollution.

Another cause of market failure is market power, this is when a single person or group improperly influence market prices. An example is gas companies, most people need natural gas to heat and cook in their homes. There is only one Gas Company that services an entire town, therefore, they can raise their prices, since they have no competitors, and there is continued demand.

3. Use a production possibilities frontier to describe efficiency. (This question can be answered either with or without the use of a graph, depending on whether you have a graphing program on your computer. It is possible to describe the various points on the PPF without a graph.)

The above graph is a production possibilities frontier to describe efficiency in computers and car production. Points B and C are the points of efficiency inside the various combinations of output that the economy can possibly produce given the available factors of production and the available production...