ADAM SMITH and THE
INVISIBLE HAND
• Adam Smith was born in Scotland in 1723. He was a philosopher and an economist.
• He was one of the founder of classical school of economics.
• “An inquiry into the nature and causes of the wealth of nations” (1776) represents the first tried to study the economy as a separate doctrine from policy, ethics and law and a first description of what builds nations’ wealth.
ADAM SMITH ADAM SMITH
In his book Smith pointed out the power he thought dominates a market economy: THE INVISIBLE HAND.
“…Every individual neither intends to promote the public interest, nor knows how much he is promoting it… He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.
By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
• Smith is saying that participants in the economy are motivated by self-interest and in this they are guided by a supreme power - the invisible hand - which takes on the balancing role between demand and supply.
• So the invisible hand is able to make the market reach the equilibrium point (quantity demanded and quantity supplied are equal) because it has the ability to coordinate the millions of households and firms that make up the economy.
•
The price it determines is considered acceptable by both the seller and the buyer and the exchange advantageous as well.
•
The selfish behaviour of each household and
firm acting in the market will eventually
provoke the maximum general economic
well-being.
The role of the State
According to the great abilities of the invisible hand to make the market efficient the governments have very few tasks:
• The State has no say in the economy because any action would restrain the economic development and the general well-being.
• However, it should ensure its institutional functions such as national defense, safety and justice.
Does the invisible hand work?
The invisible hand has its powers in perfectly competitive markets. However, the condition for perfect competition are very strict so that there are few if any of them. In a real market economy is more probable to have other situations in which the invisible hand loses its ability.
The market failure is the situation in which the resources aren’t allocated efficiently.
This happens when there are:
• Externalities
• Market power
• Unfairly distribution of economic well-being
A market failure shows an unable invisible hand to rule the market in a efficient way.
Governments can decide to intervene in order to fill the deficiencies of the market system promoting efficiency and equity.
The actual fact
• We have a moment in the history which showed all the weakness of the liberalism and so even of the invisible hand: the Great Depression.
• It started with the Wall Street Crash in 1929 and it reveals that a market left on its own is not able to allocate its resources efficiently.
• In 1936 John Maynard Keynes will elaborate a new economic theory -the keynesian economics- in which the State has the main role.
