The Invisible Hand

Economy is a tricky thing to control and governments are always trying to figure out how to do it. Back in 1776 economists Adam Smith shocked everyone by saying government should back out and leave people alone to buy and sell amongst themselves. He suggested that if they just leave self-interested traders to compete with one an another markets are guided by positive outcome as if by an invisible hand. If someone charges less than you customers will buy from him instead, you will have to lower the price or offer him something better. Whenever, enough people demand something there will be supply in the market like spoilt children, only in this case everyone is happy

Adam Smith, the father of modern economics believed that there existed an “invisible hand” which ruled over the economic system. According to him the economic system, left to it, is self-regulating. The basic driving force in such a system is trying to enhance its own economic well-being. But the actions of each unit, acting according to its own self-interest, are also in the interests of the economy as a whole.

Producers are led by the profit motive to produce those goods and services which the consumers want. They try to do this at the minimum possible cost in order to maximize their profits. Moreover, if there is competition among a number of producers, they will each try to keep the price of their product low in order to attract the consumers. The goods produced are made available in the market by traders. They also act in their own self-interest. However, in a self-regulating economy, there is rarely any shortage of goods and services.

Decisions to save and invest are also taken by the individual economic units. For example, households save some of their income and deposit part of it in the banks, or invest it in shares and debentures and so on. The producers borrow from the banking system and also issue shares and debentures to finance their investments. In turn, they reinvest a part of their profits.

All the economic functions have been carried out by individuals acting in isolation. There is no government or centralized authority to determine who should produce what and in what quantity, and where it should be made available. Yet in a self-regulating economy there is seldom a shortage of goods and services. Practically everything you want to buy is available in the market. Thus according to Adam Smith, the economic system is guided by the “invisible hand”. In a more technical way we can say that the basic economic problems in a society are solved by the operation of market forces.

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