Invisible Hand Theory in Economics by Adam Smith

There is a hidden force that drives the economy of any country and strengthens the process of buying and selling that ultimately benefits society. Buyers and sellers are interrelated with their own self-interest. Let’s see this metaphor of the Invisible hand theory in economics. The concept of the Invisible hand theory was introduced by Adam Smith, the Father of Laissez-faire economics/capitalism.

• In his book “An Inquiry into the Nature & Causes of Wealth of Nations“, Scottish economist Adam Smith coined the term invisible hands in the economy. He was basically referring to the hidden economic forces.
• This concept refers to the indirect or unintended benefits for society that result from the operation of a free market economy (capitalism). A free market is a market where government interventions are minimum. If the government is not imposing any restrictions on any businesses, it can benefit society.
• This theory constitutes the belief that large-scale government interference and regulation of the economy are neither necessary nor beneficial. Businesses will take self-interested actions if there are no government interventions.

How Free markets can benefit society?

Let’s take an example of shop A selling leather jackets for $10 and that is the only shop in your locality, buyers don’t have any option and sellers don’t have any competition. In that situation, shop A can increase the jacket price to increase its profit but if buyers can borrow the same jacket for $8 in some other shop B, then shop A will lose their customers. Now to acquire the lost customers shop A can sell the same jackets for $5. So, ultimately it benefits the customers as they are getting the same quality at a lower cost. Now think what if in the same locality, customers are having four shops for leather jackets?

Businesses don’t want to lose their customers so they keep changing their product prices as per the market competition. So, that they can have a significant growth in their sales.

Additionally, if there are many businesses, they will require a lot of labor, resulting in a lot of jobs, and when companies make a profit, they will be able to pay higher taxes. As a result, these taxes generate revenue that attracts new technologies and increases investment. The country/society is benefiting from this whole process.

So, Jobs, Taxes, Technology, and investments are the invisible hands of any society’s economy. This whole process will benefit society only if the government intervention is very less and there are no restrictions on the market regarding product prices. Business owners are happy with their sales & customer acquisition and customers are happy with good quality& cheap products.

There is a quote by Adam Smith from his own book “Wealth of Nations”:-

It is not from the benevolence of the butcher, the brewer, or the baker that we get our dinner, but from their regard for their own self-interest.

–Adam Smith, An inquiry into the Nature & causes of Wealth of Nations, 1776.

The Bottom Line

The invisible hand illustrates the concept of supply and demand. If there is a monopoly in the market, prices will rise leading to an increase in supply but a fall in demand. Conversely, as the price falls, the supply is restrained when the demand increases. Businesses care about revenue which is possible only due to customer acquisition also customers want better-cheaper products which are possible only due to market competition.

Hence, both buyer and seller are concerned with their own self-interests which are beneficial to the society, state, or nation.