ECON-221 Lecture Notes - Lecture 15: Pareto Efficiency, Perfect Competition, Invisible Hand

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To demonstrate that the perfectly competitive system leads to an efficient, or parento optimal, allocation of resources, we need to show that no changes are possible that will make some people better off without making others worse off. Each individual firm needs only to make input use decisions by looking at its own labor, capital, productivity relative to their prices. But because all firms face identical input prices, the market economy achieves efficient input use between firms. Prices are the instrument of adam smith"s invisible hand, allowing for efficiency without explicit coordination or planning. We all know that people have different things in very different combinations. If you and i buy in the same markets and pay the same prices and i buy what i want and you guy what you want, we cannot possibly end up with the wrong combo of things. Free and open markets are essential to this result.

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