What is the 'Invisible hand'?
It is an expression used by Adam Smith, in his 1776 book "..The Wealth of Nations", to explain how capitalism and free markets can lead to an optimum allocation of resources for the public good, while each individual company is trying to maximize its profits.
It is better explained at
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The term "Invisible hand" was coined by the 18th-century economist Adam Smith in his book "The Wealth of Nations." It refers to a concept in economics wherein the self-interested actions of individuals and businesses, motivated by the pursuit of their own gain, unintentionally contribute to the overall benefit of society as a whole.
To understand the concept of the invisible hand, one must delve into the field of economics. Economics is the study of how individuals and societies allocate scarce resources to meet their needs and wants. It recognizes that people are driven by their self-interests, seeking to maximize their own well-being and wealth.
In a free market system, the invisible hand represents the idea that when individuals and businesses act in their own self-interests, they end up promoting the greater welfare of society as a whole. This occurs through the interaction of supply and demand in the marketplace.
Here's a step-by-step explanation of how this works:
1. Self-Interest: Individuals and businesses make decisions based on their self-interest, aiming to maximize their profits, income, or utility.
2. Supply and Demand: The market consists of buyers and sellers interacting to exchange goods and services. Demand represents the needs and wants of consumers, while supply represents the goods and services produced by producers.
3. Competitive Market: In a competitive market, multiple buyers and sellers participate, leading to a marketplace where prices are determined through the forces of supply and demand.
4. Price Signals: As consumers signal their demand for certain goods or services by being willing to pay higher prices, it creates an incentive for businesses to produce more of those goods or services.
5. Profit Motive: Businesses respond to these price signals by increasing the production of goods or services that are in demand, as it presents an opportunity for profit.
6. Resource Allocation: As businesses produce more of the demanded goods, the resources and factors of production (such as labor, capital, and raw materials) are allocated to meet those needs.
7. Competitive Pressure: Competition among businesses pushes them to become more efficient, innovative, and responsive to consumer demands.
8. Overall Benefit: Through the invisible hand mechanism, the pursuit of self-interest by individuals and businesses results in the efficient allocation of resources, an increase in total output, and the satisfaction of consumer needs and wants.
It is important to note that the concept of the invisible hand assumes certain conditions, such as perfect competition, rational decision-making, and absence of externalities. In reality, market failures and government interventions can limit the effectiveness of the invisible hand. Nonetheless, the concept remains an essential pillar of classical economic theory and contributes to the understanding of how free markets operate.