I always enjoy teaching the introductory economics class—we call it Econ 1 at Stanford— and I’m teaching the course again this winter. Part of the fun is trying out new teaching ideas. During the first couple of weeks I emphasize the power of the price system in competitive markets, and later we consider various market failures and, of course, government failures.
In the “free market” lectures I wear this Adam Smith tie, give a summary of Smith’s invisible hand idea, and show Milton Friedman’s famous two-minute pencil lecture on YouTube. While such stories and videos are wonderful, they do not convey the idea of how exactly competitive markets and the price system lead to a Pareto efficient allocation of resources and production. So I also dive into a technical explanation trying to keep as close as I can in a first course with no math to the spirit of the first fundamental theorem of welfare economics which we teach graduate students.
This year I tried out a short new video for this purpose. I produced it with the help of four graduate teaching assistants (who appear with me in the video) and the online course production staff at Stanford. I tried it out this past week in the free market lectures. It’s called Illustration of the Famous Invisible Hand Theorem, and it’s a little corny, but judging from the response of the students in the lecture hall, it conveys a pretty good idea of the economic reasoning behind the market efficiency theorem. Before showing the video the students learned about deriving the supply curve and demand curve for price-taking profit-maximizing firms and utility-maximizing consumers.
The video effectively illustrates or “proves” efficiency by showing that in market equilibrium the efficiency conditions hold. After a short pause (at 8.50), the video then shows the consumer and firm response to a supply shock. I also use the video in an online version of the course, but it is easier to judge its effectiveness in a live lecture because I am in the same room as the students.