Adam Smith and the Invisible Hand Theory – Explained

What drives the economy? According to economic philosopher Adam Smith, it’s you! All of the individual choices we make about what we (and corporations) buy and sell are thanks to what economists call the invisible hand that guides the capitalist economy forward. Now, before we start here, I’m going to point out that here, we’re talking about how the invisible hand is supposed to work in theory. We can discuss for hours how Smith’s theories are seen in real life today, but that’s beyond the scope of this video! … Adam Smith is often considered to be the father of laissez-faire economics, or what we call capitalism. Many of these ideas came from his major work, published in 1776, titled An Inquiry into the Nature and Causes of the Wealth of Nations – often just called, the Wealth of Nations. The idea here is that the government should leave markets as free as possible and that the self-interest of individuals will ultimately grow the economy. The process by which this happens is the invisible hand. The metaphor of the invisible hand dictates that the sum of all the individual choices on the part of businesses and consumers inevitably guides economic growth. Let’s look at an example here. I love cheese, so let’s imagine two cheese shops – cheeseopolis and cheezeorama. Each of these is selling a pound of cheddar for $1. Well, if price and quality are equal, I’ll probably shop at the one most convenient. Maybe Cheeseopolis is on my way home from work, so that’s where I’ll go. Now, Cheezeorama decides to draw more customers – what can it do? Maybe have better quality? Maybe they’ll offer a larger variety of cheeses… some Brie or Roquefort to go with your cheddar… Or get some marketing out there? Hiring Kylie Jenner to Snapchat her next grilled cheese recipe with cheezorama could go a long way! …Or maybe just drop the price. 80c an lb. Now I’ll likely go a little bit out of my way for the cheaper option! Here, are the choices I make on where to shop, and the choices these stores are making to get my business – that’s the invisible hand at work. Now, what can cheesopolis do to get my business back? Lower their prices? Offer deals? Better quality or selection? This competition resulting from the invisible hand makes things cheaper and better for everyone! Woohoo! These stores don’t care about YOU – but they care about your money… but as a result, you get good, cheap stuff. Now imagine cheeseopolis is doing so well, that they decide to open up another location. Now they need to hire workers, so they’re creating jobs! Again, all due to the effect of the choices we’re making about where to shop and how to spend our money. Right? So – self-interest, competition, and the profit motive are all driving our choices, and those choices are growing the economy… and those choices are the invisible hand at work. These ideas of Adam Smith are shown through a quotation from the Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self-interest.”  Right? So these businesses don’t care about you – they care about you spending your money… but as a result, you get good, cheap food, or whatever else you’re buying – and everybody wins! Again, this is all the theory behind it, not necessarily how it works in practice.  

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