The invisible hand indicates situations that individuals pursuing their own self-interest leads to the social interest. It is all about free-market principles in operation and how they create desired results. The invisible hand reduces to a “laissez-faire” philosophy that sees government intervention into the markets as a real problem. The market mechanism of supply and demand communicates the wants of consumers to business and through business to resource suppliers. Competition forces business and resource suppliers to make appropriate responses.
According to the invisible hand theory, each of us, acting in our own self-interests, generates a demand for goods and services that compels others to deliver those goods and services in the most efficient manner so that they may be able to receive compensation from others and make a profit in doing so. In this process, the invisible hand could be benevolent in the market because resources are allocated in the most efficient manner, in contrast to a process that relies on a centrally planned system.
The invisible hand puts more resources into producing goods for which there is a shortage, as evidenced by high profit margins, at the expense of goods for which there is a surplus, as evidenced by low or negative profit margins. And the invisible hand keeps doing these adjustments continuously without anyone planning or ordering that society should produce more of what if needs and less of what it doesn’t need. In other words, the “invisible hand” represents all the social good incidentally caused by individuals pursuing their own self-interest.
And it is true, the social benefits of the invisible hand are clearly seen in many cases. Firms are price takers in the market. So many firms that no one firm can influence price. It is also “homogeneous product”, rationality of all market actors and free entry and exit. A businessman who wants to become a millionaire must first come up with a product that is beneficial, pleasing and desired by thousand of customers. By pursuing his own greed, the millionaire also benefits society.
The basic problem with the “invisible hand of the market” is that it is a metaphor, not a concept or principles; only simpletons refer to it as such. In practice, it is still too invisible, so governments are tempted to make it more visible through political interventions. It is clear why Smith says that moral norms are necessary for such a system to work in order for exchange to proceed, contracts must be enforceable, people must have good access to information about the products nd service available, and the rule of law must hold.
Therefore, an invisible hand process is one in which the outcome to be explained is produced in a decentralized way, with no explicit agreements between the acting agents. The second essential component is that the process is not intentional. The agents’ aims are not coordinated nor identical with the acgual outcome, which is a byproduct of those aims. The process should work even without the agents having any knowledge of it. This why the process is called invisible.
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