The Invisible Hand

The Invisible Hand is a theory first proposed by Adam Smith that suggests a laissez-faire, or hands off economy, is ideal. The idea is that the market and economy will self-regulate without the direct involvement of the government. People acting on their own, and with their own interest in mind, benefit the public’s interest. Those who buy and sell in a market who only think of their own gains actually drive the economy.  Competitive pricing by sellers drives buyers to find the cheapest option while encouraging other sellers to either drop their prices or offer a better service. In a supply and demand relationship, the higher the supply the lower sellers drive their prices and the more competitive businesses get; and when the supply is low, then the market for importation rises and the economy benefits. As long as business keeps rolling and individuals continue to purchase goods at lower prices, then competition in the market will continue and the economy would not stall but continue to grow.

The term was first brought up in Smith’s work The Theory of Moral Sentiments in 1759 when discussing income distribution, but the idea was expanded upon in The Wealth of Nations in 1776. After his first book was written, Adam Smith went to France and observed the country’s laissez-faire economic philosophy and neoclassical economics. Neoclassical economics is an economic approach that focuses on the factors of supply and demand. With the Invisible Hand, supply and demand play a large part in the success of the economy because theoretically that is the driving factor behind the market since the government would not have any power over businesses or any imports. By Smith’s standards after the market is left alone to regulate itself, the economy will stabilize and generate its own success. However, the time it takes for an economy to reach an equilibrium between the supply and demand, and the individual/public interest can vary greatly. This unreliable time frame and risk of an unstable economy can result in governments pulling the plug on a hands off approach to take matters into their own hands.

The success of the Invisible Hand hinges on individuals always going for the cheapest option. Competition in the market depends on businesses trying to beat each other for the better deal and more customers. However, if consumers don’t consistently go for the cheaper business, then it would take much longer for a laissez-faire style economy to balance itself out. Additionally, the variables in today’s market versus that of Smith’s time greatly affect the Invisible Hand. Today’s market is full of advertising that can sway consumers to one product or another, despite any price differences. In the Invisible Hand theory it is also important that the government stay out of all economic affairs and leave the market unregulated. The actual likelihood of a government-free market is very low. If the economy takes too long to reach an equilibrium it can cause mass unemployment and panic. Instead of riding it out, governments tend to try and quell any panic by regulating any economic affairs; similar to how the US government bailed out AIG in 2008 following the stock market crash.

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2 thoughts on “The Invisible Hand

  1. Hey Alyssa,

    I enjoyed reading your post about the invisible hand theory. I’ve been interested in this theory and actually wrote a paper on it for one of my classes. During my research I found that I don’t subscribe to the theory, as it is most commonly defined. As I was reading your definition, it made me think of how my views changed regarding the theory. The success of the invisible hand is contingent on people choosing the cheapest option, but is that usually the case? Consumers will choose EITHER the cheapest or the better quality product. I read a fascinating book entitled Predictably Irrational, and it made me rethink my initial position on this theory. The author—Dan Ariely—challenges us to “rethink what makes you and the people around you tick.” He talked about supply and demand and how people buy items based on value. Ariely stated that paying more for something actually makes us value it more. He conducted a cool experiment where he gave some people a drug valued at $2.50 and gave other people the same drug—a placebo—worth only 10 cents. Almost all of the people who used the $2.50 drug people described pain relief but only half of the 10-cent people felt relief: because they were paying more they valued the same item more. This is only one experiment, but it shows that it is not clear-cut that consumers will always choose the cheaper product, which the success of the invisible hand theory is so dependent on. There are so many variables that affect the market achieving equilibrium, and since that is the case there is no guarantee that a free market will lead to the best condition. Great thought-provoking post! (Read Ariely’s book if you get a chance; I think you’d like it.)

    Best,
    David

    Like

    • Hi David!
      I agree that people will not always buy the cheapest product available to them. Typically, the lower the price difference, the more people wonder about the quality of the product. I’ll have to check out Ariely’s book, it sounds really interesting. I think the brings up a good point with his experiment. The higher the monetary value of something is, people become more emotionally and psychologically invested in the product. The whole premise of the Invisible Hand depends on people putting a lower price in front of a better quality, which is a fairly unreliable foundation to form an economy on.

      Like

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