The Concept of Invisible Hand and General Equilibrium Theory

Answer 1:

The concept of invisible hand was initially developed by Adam Smith which explains the unintended higher social advantages and the public products brought about by persons acting in their respective self-interests. Invisible hand can be regarded as the unobservable market force which enables the supply and demand of products in the free market to attain equilibrium automatically. Adam made an assumption that the economy can operate effectively in the free market situation where each person will operate for his/her respective interest.

Answer 2:

The spontaneous order is the order that emerges as the outcome of voluntary activities of each person and not the one which is established by the government (John & Cassidy, 2013). It is found to be one of the major ideas of free market and classical liberal traditions. This idea of spontaneous order is condensed in the phrase of Adam Smith of invisible hand which recommends the orderly principle that lies behind such activities of many person purchasing and selling in the market place. Each person toils to utilize his capital to assist the domestic sector and manufacture products which has the highest value and to render annual revenue or earnings of the entire society as much as he can. Thus, by following his respective interest he commonly promotes that of society more effectively than what he actually desires to promote it.

Answer 3:

Adam Smith believed that the regulators or government had the responsibility to protect the general public from any speculative panics and financial swindles which were very common in nineteenth and eighteenth century Britain.  There was constant concern that banks in this country would issue huge promissory notes to the unworthy borrowers. It is true that the bank would give temporary help to such people by providing required amount but subsequently would lead to unfavorable situation for both the borrower and creditor.

Answer 4:

General equilibrium theory typically states that once the economy attains equilibrium, no person in the country can be made better off without making any other person worse off. It is observed that the general equilibrium theory typically supports the overall idea of invisible hand as it is considered as the direct manner of demonstrating the work of the Smith’s well-renowned invisible hand as it exhibits that the nation’s economy will efficiently distribute the resources automatically without the need for any regulatory control of the government.

Answer 2

Answer 5:

In the later 1970s, the researchers found that the existing theory is not as competent as per the prevailing situation and so they re-developed this theory. According to these economists, general equilibrium theory is regarded as the macroeconomic theory which describes how demand and supply in the economy with various market communicate dynamically and ultimately culminate in the equilibrium prices.

Answer 6:

Arrow Debreu model was developed for the walrasian equilibrium in which there are generally n number of customers and goods being sold out with their determined preferences. This framework also demonstrates intertemporal options; however many assumptions of this model is not suitable for the real economic situation. The assumptions of every individual having preliminary endowment of the favorable quantity of all that a person generally likes to consume is unrealistic. Moreover, the assumption in which each purchase occurs in the competitive market is untrue as there are non-market clearing prices at which the consumer purchase goods.

Answer 7:

Milton Friedman was given a Nobel Prize for his significant in the field of economic science in the year 1976. He is well-renowned for describing the role and importance of overall money supply in inflation and economic fluctuations. He gave the monetarism theory which refuted the essential components of the Keynesian economics. He was found to be among the greatest intellectuals of the 20^th century as of his key influence on the way in which general public determine the Fed’s stop-go monetary policy of 1970s, the capacity of the market forces and flexible exchange rates to advance the individual welfare.

Answer 8:

Normal distribution also regarded as the Gaussian distribution is mainly symmetric. The mean of a sample or the expected value is commonly observed value or price in middle of a distribution.  It is observed that if the stock returns or asset return follows the normal distribution then 99 per cent of the overall returns are generally expected to reduce within 3 standard deviations of mean. The major features of normal distribution enables the investors and analyst to make the required statistical inferences regarding the expected return as well as the risk of the stocks.

Answer 9:

Generally, changes in stock price on a particular day is not dependent on the next day’s changes in stock price. This is generally due to the market mechanisms. It can be seen that demand and supply on a particular day is not same on the next day and stock price typically depends on the demand and supply of the stock on a specific day. Moreover, stock price also depends on the geometric Brownian motion model. It is generally a model which depicts the future prices of the stock. Thus, it can be concluded that changes in such stock price on a particular day is independent from the overall changes in stock price on the next day.

Answer 3

Answer10:

Robert Shiller showcased his view on the main model of consumer behavior and actual behavior in real world. He stated that people or rather consumer perform immense calculations with immense databases before buying anything. However, this model states that the people are good at mathematics and they evaluate the overall impact of such purchase as well as interest rate over a period of time after they purchase them. However, this economist do not believe in this aspect of the theory and said that it is a wrong assumption since it is not possible to calculate such interest rate for the level of satisfaction.

Answer 11:

The rational economists like John Cochrane and Eugene Fame believed that consumers actually do not perform such calculations; however they have their respective defense “as if”. Eugena Fame found that the manner in which economic textbooks are generally written, these books do not claim that people behave in this manner. These books generally say that the consumers behaves “as if” they were actually doing this. Moreover, John Cochrane added that the economist do not make assumptions that consumers actually are performing such calculations rather than it is being assumed that people behave “as if” they do.

Answer 12:

It was found that Richard Thaler, the behavioral economist was not actually convinced with the theory of “as if” and he refuted it. He explained his argument with an example of billiard game.  He said that if economists are good billiard players then they would be having idea regarding trigonometry or physics because if they do not have such idea then they would not be able to be an expert in this game. Similarly people cannot do such things “as if” unless they have proper idea regarding the same.

Answer 13:

I do not agree with the explanation provided by the Eugena Fama regarding the housing decline because practically it does not make any sense. Generally, the banks were lending to the general public for their housing needs with minimal securities. Therefore, most of the people were opting for such loans and were buying the houses. This resulted in the enhanced demand for such housing which lead to increase in the price of such houses. Subsequently, most of them were not able to repay the bank when demanded and so they offered those houses to the bank instead of the money. In this way, the bank received a lot of houses from such people and hence the supply of houses enhanced. This resulted in housing decline.

Answer 4

Answer 1:

It is found that the book was quite good till the sixth chapter since a lot of crucial theories and major economists who have contributed significantly in this field and behavioral finance were being introduced. Moreover, their respective views on the existing theories as well as their own theories were also introduced to some extent.

Answer 2:

The concept of the information is observed to be in the central of the Fama and Hayek theories in which the information is the combination of each relevant data for action of the individuals. Hayek and Fama utilize the system of the prices as the manner to centralize the information while there could be no planification of the centralization by the individual. Thus, it can be said that the efficiency theory which was developed by Fama is the restatement of theory of price which was observed in the Hayek work. Moreover, both of them also defended the deregulation of market.

Answer 3:

It is seen in the given auction, after two people started many more people joined this auction even though it was rationally inappropriate. Moreover, many more people were expected to join this auction. This irrational behavior of these people was due to emotional excitement. Generally, as per the psychological theory, people envy others when more and more people join such game and thus they also want to be a part of this game irrespective of its inconsistency as per general economic theory.

Answer 4:

The economist Robert Shiller observed that the concept of interest rate for over time, pleasure after the consumer purchase something to be ridiculous and irrelevant (Turner 2017). As per him, it is quite impossible for a general human to think about calculating such interest rates since it is difficult find the rate of interest for someone’s pleasure or over time.

Answer 5:

No, generally people do not really perform all such mentioned calculations related to mortgage before opting for such mortgages. Quantitative skills are generally not present in the people or rather consumers and thus they do not think in a rational manner before opting for any kind of mortgages.

Answer 6:

Mathematical model is very essential for the economists since they forms the basis of fiscal, monetary and economic policies of a nation. These policies are very essential for the growth and development of a nation. Moreover, these policies enables the regulators to run the country in an efficient manner and maintain the economic viability of the country. It is seen that without a precise mathematical model, the regulator would not be able to develop a vibrant monetary, fiscal and economic policies for the entire nation.

References:

John, C., & Cassidy, J. (2013). How markets fail: The logic of economic calamities. Penguin UK.

Turner, G. (2017). PBS Mind Over Money. [video] Available at: <https://www.youtube.com/watch?v=tW_SNz1zNEM> [Accessed 11 February 2022].