The Wisdom of Perfect Competition

On Friday we looked at the model of Perfect Competition and how market particpant's behaviour is coordinated to bring about the most efficient allocation of resources even though no one is acting explicitly to achieve this. This view of Adam Smith's Invisible Hand was proven theoretically by Arrow and Debreu and shown to be true in an experimental setting by Vernon Smith. See chapter five of The Wisdom of Crowds for more on this. All of these people were awarded the Nobel Prize in Economics. The conditions necessary for a market to achieve the most efficient outcome are

• Perfect information
• All participants are perfectly rational
• Freedom of entry and exit
• No transaction costs

In these short clips from South Park we see how a lack of barriers to entry means that super-normal profits are eliminated in the long run.

First the boys come up with a great idea....

Then they realise that with freedom of entry, positive profits are only a short run phenomenon