TITLE:
Adam Smith’s Perfectly Competitive Market Is Not Pareto Efficient: A Dynamic Perspective
AUTHORS:
Muhammad Ashfaq Ahmed, Nasreen Nawaz
KEYWORDS:
Dynamic Efficiency, Adjustment Path, Equilibrium, Coordination
JOURNAL NAME:
Theoretical Economics Letters,
Vol.13 No.3,
June
16,
2023
ABSTRACT: The invisible hand of a perfectly
competitive market refers to the self-regulating behavior of the market where
if each consumer and producer are allowed to freely make their own choices, the
market settles at an efficient outcome that is beneficial to all the individual
members of the society and hence to the society
as a whole. Two well-known facets of the invisible hand are generally mentioned in the economics literature—the first one is a static picture of a perfectly
competitive market, i.e. a competitive market is efficient in an equilibrium; and the second one is that if the
competitive market is disturbed from its equilibrium position, in the
absence of a market failure and frictions, the market automatically settles at
a new efficient equilibrium. Existing literature
does not consider the most important dynamic facet of the perfectly
competitive market from the perspective of Pareto efficiency, i.e. how
efficient is a perfectly competitive market on the dynamic adjustment path
after an economic shock in the absence of all kinds of frictions and price rigidities, and if all the ideal conditions are
maintained. This research models the dynamic facet of the market and
concludes that Adam Smith’s perfectly competitive market is not Pareto
efficient and coordinated actions of economic
agents can result in a level of economic efficiency on the dynamic adjustment path which is not achievable
by a free market mechanism (JEL D40, D41, D50, E32).