Adam Smith is an important figure in the field of economics. Smith’s writings in economics contributed greatly to the development of capitalism as a means of economic organization in society. One aspect of the society that puzzled Smith was how it was made up of individuals acting in their own interest, yet it still held itself together. Smith theorized that an invisible hand played an important role in a society based on a market economy. According to Smith, the invisible hand leads the private interests of individuals in a direction that benefits the interests of the whole society (Heilbroner 33). This essay explains the role of the invisible hand in Smith’s analysis of natural and market prices.
Smith explained his idea of the invisible hand by examining its role in setting natural and market prices. As mentioned earlier, Smith was of the opinion that the self-interest of individuals motivated their actions. Following this logic, the pursuit of self-interests meant that individuals were expected to charge exorbitant prices for their products to derive the greatest possible profit. However, since this was not the case in society, Smith opined that an invisible hand existed, which prevented prices from spiraling out of control (Heilbroner 33). According to Smith, this invisible hand was competition. Smith explained that competition was the result of individuals in society acting in their own interest. Therefore, if individuals charged exorbitant prices for their products, their customers would go to their competitors, who would charge lower prices to attract more customers and maximize profit (Heilbroner 34). This mechanism explained how products developed natural prices, since individuals could not set arbitrary prices that were much higher than the actual costs of production.
Smith also explained that the invisible hand played a role in setting market prices by maintaining an equilibrium in the supply and demand of products. According to Smith, an increase in the demand of a certain product would cause an increase in its price. The increased price of the product would entice more individuals to start manufacturing the product because of the high profit margin associated with higher prices (Marroquin 38). This represented the point where the invisible hand took action in the market through the increased competition. However, the increase in production would eventually lead to a surplus of the product in the market. The excess supply in the market would force producers to lower their prices to sell more units of the product than their competitors. Consequently, the price of the product would drop to the equilibrium point, which would also be the market price. The equilibrium point is the point at which the supply of the product would equal the demand for it in the market (Mankiw 77).
In conclusion, the invisible hand is one of the cornerstones of a market-based economy. This is because the invisible hand takes the role of a governing body in a capitalist society, which is evident in the way it regulates the prices of products in the market. However, the invisible hand has one key advantage over an actual governing body, which is its impartiality when making corrections in the market, as opposed to a governing body, which may favor certain individuals when setting prices, leading to an imbalance in the market. Therefore, the invisible hand is the most accurate determinant of both natural and market prices.
Works Cited
Heilbroner, Robert L. The Worldly Philosophers: The Lives, Times, and Ideas of the Great Economic Thinkers. New York: Simon & Schuster, 2011. Print.
Mankiw, N. Gregory. Principles of Economics, Volume 1. Boston: Cengage Learning, 2008. Print.
Marroquin, Andres. Invisible Hand: The Wealth of Adam Smith. New York: The Minerva Group, Inc., 2002. Print.
