INVISIBLE HAND THEORY
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HISTORY
Adam Smith an Economist popularized the invisible hand theory in 1759, as unexpected
personal advantages that a person get by self-interest activities. Later on the concept was
linked with production.
If a company or any person work for their self-interests than they indirectly help in right
resource allocation in the community.
For example, a brand starts to sell their t-shirts for $1000 each which develops a chance
for another brand to sell their t-shirts at a less cost like $500. This price setting will
automatically make the other brand to lessen their prices and like this the equilibrium
price is maintained without the help of government regulations.
Smith says that people prioritize those things which are in their benefit such as a
businessman struggles to make more money and consumers aim at buying less costly
products. An organizations main aim is to gain profit and in order to maximize it they
indirectly develop effective economy which creates equilibrium in the market of goods.
In other way the invisible hand is interpreted by saying that the rich people’s wealth is
circulated in the society by invisible hand in form of charity or high remuneration of
employees.
CONCEPT
Karl Mark in the nineteenth century raised the point capitalist approach will lead to
rebellion as the rich will get richer and the poor will get poorer but later on it was seen
that as the capitalist grew wealthier the workers of their firms also gained wealth in form
of high pays. This benefited the capitalist as the buying power of the society increased
which helped them to sell more of their goods.
Adam Smith pointed out two opposite but important factors in this theory:
SELF-INTEREST:
Self-interest is what a person do to get advantage for himself. A person do a job in order
to earn money and fulfill his monetary desires. Here the point to be noted is that
economic activities are linked with our self-interests. Smith in his book referred to a baker,
who bake goods to earn money but indirectly he is also providing us with something of
value. In this way, self-interest in free market economy produces attitudes which are
beneficial for everyone.
COMPETITION:
Self- interest includes factors like bribery, fraud and cheating as a person seek to gain
benefit for himself. These factors of self-interest harm the society but are kept under check
by the competition in market. As there are others in the market with self-interest
intentions which keep the harmful factors under control. For example, a businessman can
only make more money if he manufacture goods which are more cheap, innovative and
efficient compared to the competitor’s products.
APPLICATION
Profit and losses make clear the objectives of marketers and consumers which lead to
better output. This idea is more explained in Richard Cantillon’s book from where Adam
Smith came up with the invisible hand theory.
Cantillon gave the example of a deserted land divided into farms which were given to
different entrepreneurs who use unique techniques and tools to provide products in the
market which were better than the competitors. By this it was observed that higher
returns were received when self-interested competitors ran the farms as compared to
government regulated farmers.
CRITICISM
Monopoly Power:
The companies in monopoly have no competition and can raise costs above the
equilibrium. With no competition the company become inactive, faulty and manipulate his
customers by receiving costs of their choice.
TRAGEDY OF THE COMMONS:
The interests of many individuals may be same and in can lead deficiency of natural
resources as all of them use it for there benefit such as over-fishing, cutting of trees.
LIMITATIONS OF SELFISH ACTIONS:
Greedy acts of a person can be defended by invisible hand theory. But it is not acceptable
by many and is considered an inappropriate concept. It is thought that inspiring others
and making them realize about the effect of their action on the whole community is a
more convenient approach.
