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Politics & Society

What Is the Invisible Hand in Economics?

Written by MasterClass

Dec 11, 2018 • 4 min read

Eighteenth century economist Adam Smith developed the concept of the Invisible Hand, which became one of the cornerstone concepts of a free market economic system.

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Written by MasterClass

Dec 11, 2018 • 4 min read

What Is the Invisible Hand?

The Invisible Hand is a metaphor describing the unintended greater social benefits and public good brought about by individuals acting in their own self interests. The eighteenth-century economist Adam Smith is widely credited with popularizing the concept in his book The Wealth of Nations.

Who Was Adam Smith?

an image of two businesspeople shaking hands as an example of the invisible hand
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Adam Smith was an eighteenth-century Scottish economist who lived from 1723 until 1790. While his ideas were controversial and often dismissed during his day, Smith laid the foundation for free market economic theory, which is widely studied and put into use in much of the world today.

Smith’s original text from An Inquiry Into the Nature and Causes of the Wealth of Nations, Book 4, Chapter 2 read:

“(Each individual) generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it...He intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, 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.”

Smith’s concept of the Invisible Hand was likely influenced by earlier economist Richard Cantillon, who broke up a single farming estate into multiple competing leased farms, and observed that the farming techniques became more efficient, products more desired by consumers, and overall yields greater than when the estate was managed by a single farmer.

The Invisible Hand in Economics

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When Adam Smith originally described the Invisible Hand, he was describing his observance that wealth does not live in a vacuum and that people acting in their own self interest will eventually act in the best interests of the greater public good.

This concept aligns with laissez-faire economics, which comes from the French phrase “laissez-nous faire,” meaning “let us do it.” The anecdote behind the origin of this term, which describes the meaning, is that a French governmental minister asked a group of businessmen what help the French state could provide, to which the businessmen replied “laissez-nous faire.” In modern economics, some political leaders have pushed the concept further to paint a broad brush against governmental interference or regulation.

Applying Predictability to Understand the Invisible Hand

an image of a factory, a part of the market economy and division of labor
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The Invisible Hand of the market creates predictable economic systems such as supply and demand, because humans are relatively predictable in their behavior.

For example, you predict that when you go to the supermarket there will be eggs and milk for sale. The supermarket in turn predicts that the distributors will deliver eggs and milk regularly to their warehouses and lastly the distributors predict that farmers will offer eggs and milk for sale. All of this has to happen regularly—every day in fact—to ensure that fresh eggs and milk are available all across the country.

Who controls this process? No one, it turns out. It happens because each person or company is predictable enough in their behavior to make the whole system run. This is what Adam Smith was referring to as the “invisible hand” of the market.

Real World Examples of the Invisible Hand

Within markets and a market economy specifically, the Invisible Hand metaphor is used to describe supply and demand and division of labor and labor practices.

Cars, Driving, and the Automotive Industry

Consider the need for cars:

  • The amount of people in the market for a new car fluctuates depending on the overall health of the economy.
  • As more people purchase cars, car manufacturers have to produce more cars in order to meet the demand.
  • They then have to hire more workers to meet that demand. If workers are in short supply due to a healthy economy, the car manufacturer must then offer the workers better pay or benefits in order to entice them to come to work.

The market forces led by the Invisible Hand dictate that this set of circumstances is likely to happen, because if the car manufacturer refuses to pay more and cannot hire more employees, it will not be able to produce more cars, which means the cost of cars will go up due to short supply, which would dissuade consumers from purchasing their cars entirely and potentially push the consumer to a different car manufacturer.

Now, layer on the introduction of ride-sharing services.

  • When a user opts to take a ride using a ride sharing app, the Invisible Hand asserts itself in the form of surge pricing.
  • Prices on ride sharing apps remain at low levels throughout the course of the day because the demand for rides from users is at near equilibrium to the supply of drivers.
  • When the demand in a certain area becomes high, say after a concert or at the airport, prices rise, which encourages more drivers to head to that area to balance the supply.

In this interpretation of the Invisible Hand, the user’s decision to pay for a ride with a ride sharing app creates greater public benefit for the society as a whole because they are using their wealth to pay a driver, creating wealth for them to use elsewhere, further advancing the good of society.

Paul Krugman

Teaches Economics: Think like an economist

For Nobel Prize-winning economist Paul Krugman, economics is not a set of answers, it’s a way of understanding the world. In his MasterClass, Paul teaches you the economic principles that shape political and social issues—like access to health care, the tax debate, globalization, and political polarization. Heighten your ability to read between the lines and decipher the underlying economics at play.

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