Invisible Hand - Explained
What is the Invisible Hand?
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What is the Invisible Hand?
Invisible hand refers to the forces which manipulate the economic markets. The term Invisible Hand is a metaphor that is used to denote the driving forces behind the economy of a nation operating under the free market system. A societys needs, wants, and desires are usually met by the ability of individuals to freely produce goods that match the communitys interest without facing restriction. Thus, society benefits from the ability of an entity to manufacture products without interference of any sort. The invisible hand is usually the movement of supply and demand in a market, and this is caused by the production and need for products. Thus, supply and demand are the primary movers of market prices which in turn affects an economy under the free market system. As a part of the laissez-faire system (meaning to let go or to let things take their natural course), the invisible hand obeys the equilibrium hypotheses of a free market. Simply put, it states that a market will surely find an equilibrium demand, supply, and price level without interference from the government, trade unions, or any other external bodies. Thus, government, as well as other regulatory bodies, dont need to force price into an unnatural position to stable supply and demand, as the market would find a way to do that itself via the Invisible Hand. Adam Smith, a Scottish Enlightenment Thinker brought out the concept of Invisible Hand in a number of his writings during the 18th century. His 1776 work titled An Inquiry into the Nature and Causes of Wealth of Nations was the first of his several books to provide the term Invisible Hand with an economic interpretation. However, this term was not fully implemented, nor was it used in formal economics until the early 1900s (the 20th century). The invisible hand metaphor theory makes two substantial and highly visible claims. The first claim is that trades which are done in a free market system (a voluntary market) have a way of finding its equilibrium and this results in the production of widespread benefits which in most cases are unintended. The second claim states that the benefits which are derived from these voluntary trades are way bigger and tend to last longer than benefits that would have been encountered had the government or any other appropriate authority regulated the market in terms of demand, supply, or price.
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How Does the Invisible Hand Work?
Each free exchange market (free market system) generates trading signals which propels individuals to act differently, mostly opposite each other. These signals usually provide details about the value of goods and services and the difficulty of obtaining those goods (commonly called price) which are tagged valuable than others. These signals make individuals act in ways that meet the demands of others, as one is willing to sell and another is willing to buy. Individuals that are moved by these signals would include producers, distributors, and middlemen, and the actions of one works for the interest of another. A producer who makes goods to gain profit is directly fulfilling the needs and desires of a consumer who needs such goods, and the consumer is fulfilling the profit maximization dreams of the producer. Both parties are fulfilling the dreams of the middlemen, as an exchange between them means money for the intermediaries.
- Invisible Hand refers to a metaphoric system in which the actions of an individual in a free market economy benefits another individual in that market. Each partys reason for entering the market is dependent on the other.
- Adam Smith was the first person to introduce the invisible and, and he also gave it an economic interpretation in 1776.
- Instead of looking for ways to decide what good is valuable and which should be harder to obtain, the invisible hand does this as a free market economy is usually controlled by the sentiments of the parties in it. Each market system creates a signal which tells one how much a good is valuable to the society, and the difficulty involved in acquiring such product.
Each and every party in society struggle to provide himself with revenue which benefits him or her. In working to satisfy his own needs and desires, an individual will indirectly satisfy the needs of others, and this is done by the force known as the invisible hand. This individual at first doesnt have the best interest of others at heart, as he is more focused on himself and not the wants of others, just like a consumer who is making some manufacturer rich is only focused on what he or she can do with the product purchased. By chasing after his own interests, an individual in a free market system satisfies the reasons why another individual enters into that same market. This is sometimes called the counterparty scheme. In doing this, he also increases and promotes the societys best interest more than he wishes to, as he not only pays taxes and other charges but makes the society a better place by helping others without his direct consent and knowledge. Traders of public assets are said to provide more benefits to society, as they are focused on the welfare of the masses while trying to make profits.
Examples of Invisible Hand
Investors and consumers needs which are reflected by losses and profits in the market improves business productivity and profitability and this helps to boost the economic development of the society. This concept was well-defined via a famous example in Richard Cantillons An Essay on Economic Theory (1775), from which Adam Smith was able to develop his invisible hand concept. In his book, Richard Cantillon described an estate which was isolated and then later divided to create leased farms. In the farm, a number of independent entrepreneurs operated different portions in an attempt to build up and maximize profitability. Those farmers who were successful in their venture bought new equipment and adopted new farming techniques, and they also brought to the market only those goods which consumers were willing to purchase. His book described self-interest economy as a far better means of returns and profitability than a command system. He stated that the estate fared better when each farmer was left to do their own thing, rather than when their previous landlords were telling them what to do. Adam Smiths invisible hand concept became a primary justification for the creation of a free market capitalism system. His book An Inquiry into the Nature and Causes of the Wealth of Nations was published in the same year as the American Declaration of Independence, which occurred during the first Industrial Revolution of the nation. Due to the popularity of his concept, businesses in the United States later came to accept that capitalism is way better than socialism, and that the ability to enter into a market on ones own terms resulted in higher profits than if the market was to be controlled by a government body or any other authority. In some cases, governmental companies and agencies tried to incorporate the concept of the invisible hand into their operations. An example is when Former Fed Chairman Ben Bernanke explained the market-based approach is regulation by the invisible hand objectives to create a system where the aims of regulators match those of the participants
- Self Interest
- Cost-Benefit Analysis
- Enlightened Self-Interest
- Fisher's Separation Theorem
- Ratchet Effect
- Total Utility (Economics)
- Efficiency Principle
- Expected Utility
- Subjective Theory of Value
- Positional Goods
- Indifference Curve
- Time Preference Theory of Interest
- Marginal Benefit
- Diminishing Marginal Utility
- Sunk Costs
- Production Possibilities Frontier
- Law of Diminishing Returns
- Economic Efficiency
- Efficiency Theory
- Productive Efficiency
- Capacity Utilization Rate
- Allocative Efficiency
- Pareto Efficient
- Comparative Advantage
- Criticisms of the Economic Approach
- Behavioral Economics
- Normative Economics
- Positive Economics
- Invisible Hand
- Sunk cost