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The significance of Adam Smith’s “invisible hand” concept on modern economics Research Paper


Introduction

Adam Smith, the Scottish economist, studied at the Glasgow University and the Balliol College of Oxford in England. He taught and published a number of works like “The theory of moral sentiments” in 1759. His publications gave him the motivation to conduct a study on the causes and nature of the wealth of nations in 1776. This inquiry became a significant milestone in the history of economics.

Since then, Adam Smith became a renowned global capitalist. Economic scholars remember him for his free-market ideals. Certain economic authorities regard Smith as the father of economics. He is one of the most distinguished scholars of economics in the world. Smith is also a primary advocate of the laissez-faire approach to economic policies.

Adam Smith’s research on the causes and nature of the wealth of states is similar to the philosophy of the “wealth of nations”. The theory recounts the industrial revolution in Europe. It illustrates how industrial development causes the restructuring of the economy and differences in the wealth of the nations. However, critics of the philosophy of the wealth of nations advanced that Adam Smith did not produce original ideas.

Smith is the first scholar to compile and publish thoughts about the wealth of nations. Therefore, he is responsible for popularizing the ideas that explain the classical school of economics. The concepts laid a foundation for other economists to build on Smith’s work and consolidate the classical theory of economics. They provided scholars with the framework for analyzing the Great Depression.

In his ideologies, Adam Smith created the concept of an “invisible hand” that controlled the forces of demand and supply in the market. The laissez-faire concept of reducing the interference of the state and impact of taxation in a free market affirmed the fundamental premises of Adam Smith’s ideas.

The concept of the “invisible hand” in economics postulates that each person unconsciously helps in creating the best result in a market through personal decisions. Personal choices contribute to balance in the market.

An example of the applicability of the “invisible hand” may involve the interactions among butchers, brewers, and bakers. The interactions of these experts can assist in the production of food and drinks for human consumption. The butcher engages in selling meat and its products to earn an income and fulfill peoples’ need for food.

The brewers and bakers also satisfy the needs of their clients by selling various products within their areas of occupations and subsequently procure their living. According to Adam Smith, this cooperation of the professionals creates a linked system of wealth creation for the participants.

The butcher, brewer, and baker create wealth for the nation through this system of production. Smith explains that individuals seize opportunities that have likelihoods of bringing high business prospects.

A critical analysis of Smith’s “invisible hand”

Adam Smith is a religious scholar and his invention of the “invisible hand” describes his perception of God’s management of the universe. Smith viewed the “invisible hand” as a system through which a supernatural being managed the universe by creating happiness to human beings. Smith explains in his concepts that a formal structure in the society promotes proper functionality of the theory.

For example, people need to respect moral values and property rights. Smith explains that the role of government is to defend the wealthy from the poor. His concepts illustrate an overview of how Smith understands the universe. He perceives the world as an entity that operates through several mechanisms.

He acknowledges the presence of a benevolent deity who controls the world to ensure maximum satisfaction for human beings. Smith postulates that the existence of God makes human beings behave differently. He notes that the world is a perfect entity with a balanced happiness equation for everybody. Smith observes that even the wealthy are not happier than the poor.

He suggests that human beings believe that wealth makes them happier than its absence. Smith elaborates that human beings’ mode of thought compels them to struggle and work hard to achieve a wealth status. He feels that wealth improves people’s satisfaction through the principles of trade and division of labor. Adam Smith explains that moral values are vital to the structure of wealth creation.

For instance, in order for trade to operate, appropriate contracts, access to information, availability of products and services and application of the rule of law must be available. These components provide a forum for wealth creation.

Adam Smith’s theory of “the invisible hand” has a different meaning in the contemporary society. The concept may refer to an invisible hand system where the determination of results comes from decentralized elements. In addition, the decentralized components may lack a general agreement among themselves. The agreement may not be intentional. It occurs in a subconscious manner.

The action of the components in the “invisible hand” theory lacks a central coordination. The components may not share the actual outcome as a byproduct of the objectives of the theory. In addition, the process of the invisible hand regulation may also function even without the components’ knowledge. This aspect denotes the essence of the term “invisible hand.”

The theory of the “invisible hand” works within the free market set-up. Adam Smith explains that buyers make choices on the basis of price. They most likely buy products with the lowest prices. The theory also postulates that entrepreneurs make choices on the basis of the amount of profits expected. Entrepreneurs lay down strategies that may ensure that they accrue the highest levels of financial gain.

Adam Smith explores the idea that consumers control entrepreneurs’ investments by buying goods and services in the market. This fact sets the framework for establishing a market. The market produces the goods that customers need, and this aspect improves the economic standards of the nation.

The market-based economy controls the people’s manner of thinking. It makes people think and speculate about what others may desire or want. Adam Smith explains that this may be a large proportion of the positive aspects of the “invisible hand” theory. Smith explains the existence of two strategies of obtaining cooperation and help from other people in the mechanism of the theory.

The first strategy examines the attitudes and kindness of people. This aspect makes people act in a fawning and servile manner. Smith finds this strategy repulsive and limited in its chances of success. The second strategy evaluates the motives of others. This strategy appreciates that people may be dependent on one another. People do not receive assistance from God alone but diverse individuals too.

The second strategy indicates that one can offer a bargain to another person on account of goodwill. For instance, a person can procure dinner as a result of the good will of the butcher, brewer or the baker. Adam Smith observes that an individual possesses value when he or she is proposing an exchange.

In addition, when one carries out an exchange, the other party can recognize that the item of exchange is of use and offer help. This analogy explains why the level of self-esteem has a connection with someone’s job. An organization that pays its workers well does so in its recognition of their contribution and worth of their resources.

Adam Smith’s “invisible hand” theory is a simple and persuasive model of explaining unseen forces in a free market situation. The model is a demonstration of reality in the operation of a free market. Adam Smith presents a practical model that conforms to the reality of events.

A lot of skepticism “develops” regarding the theory of “invisible hand’s” connection to the improvement of human economic status. Adam Smith postulates that the theory is fundamental in providing a balance to the economic well-being of human beings. However, the theory has wide implications in the determination of economic status of any nation.

Certain economists misinterpret the notion of a “free market” in the contemporary society. Certain economic perspectives of the “free market” theory reinforce corruption and immoral economic practices in the society. However, the ancient definition of a free market entails one that upholds freedom of entry. This fact means that no barriers should prevent investors from market competition.

The significant characteristic of a free market underscores the existence of a large number of minor suppliers without lead market players that influence prices. Certain theorists negate the real meaning of the principle. Distorted perceptions dictate that a free market refers to a scenario in which the government cannot control market policies. However, this meaning assumes that the “invisible hand” theory is infallible.

Certain market players try to distort the freedom of the market in order to continue exercising monopoly of market prices. They try to eliminate competition from the market. New competitors fail to gain entry into the market. Businesses may not function efficiently without government regulation.

For instance, many businesses cannot operate properly without the structure, laws and regulations from the government. Therefore, this understanding creates a conflict concerning the definition of a free market.

The fundamental principle of classical economics refers to the freedom the government accords players in the operation of markets. Certain economic theorists refer it as the laissez-faire approach. It allows the “invisible hand” to control how everyone conducts his economic functions and also creates a proper atmosphere for doing business for many people.

The significance of the invisible hand theory

The contemporary society regards the “invisible hand” theory as a natural phenomenon that regulates the free market through demand and supply competition. The theory is essential in enhancing efficiency in capitalist economies. Competition for scarce resources creates a balance in the market and innovation in productivity to create wealth.

The “invisible hand” theory is the foundation of the classical school of economics. The theory serves as the framework for research in the field of economics. It reveals that the creation of wealth for use and production improves the status of the nation. The “invisible hand” theory examines the mechanism of action of a free market.

It illustrates that individuals may be free to process, use and trade in goods and services in a free economy. This aspect forms the basis of policy formulation in modern commerce. The concept explains that the elements of a free market are essential in promoting economic growth.

The “invisible hand” theory promotes democracy in the market. It accords people the opportunity to run their businesses liberally in the form of trade of goods and services. The invisible hand theory predicts that individuals possess the power to decide what to buy and sell in an efficient way.

The theory outlines the importance of adequate information as a principle of free market operation. It explains that inadequate information may lead to misleading prices, low quality and efficiency of supplies and inadequate competition.

The concept of the invisible hand theory explains the mode of action between the demand and supply. The interdependence between the forces of demand and supply dictates the prices of commodities in a free market.

Adam Smith’s theory of “the invisible hand” ensures that economists make sound decisions especially on policy matters. Economic policies ensure that markets do not fail to function efficiently. Market failure can occur due to a mismatch of information proportions between the producers and consumers. It can also happen as a result of market monopoly. The “invisible hand” is the most efficient method of allocation of resources.

The theory is relevant in the contemporary society because it explains the forces of free markets. The theory reveals that individuals’ pursuance of their interests also enhances the interests of the society.

A comparison of the “invisible hand” theory with other theories Adam Smith’s work laid the framework for several economists to think, expand and elaborate on diverse economic theories. The theory prompted Karl Marx to study capitalism in a different way. Karl Marx is a German scholar on political science and economics. He studied capitalism from a pessimistic and revolutionary observation point.

Karl Marx’s theory

Adam Smith made his observations on the basis of harmony and growth. In contrast, Karl Max advanced his ideas in regard to the instability, decline and struggle of humanity. Max explained in his studies that the value of production comes from labor. He notes that a capitalist is a person who possesses the funds, wealth and organizational knowledge to sustain a processing industry.

Karl Marx suggests that the resources and profits of a capitalist come from exploiting labor. Exploitation of labor comes in the form of underpaying employees for the value of products they produce. Marx runs the theme of pessimism in his narration and explanation of capitalism in the community. He does not conform to the notion of a profit-oriented organization.

The notion of exploiting labor affirms Karl Marx’s argument of class struggle at the center of capitalism. In his studies, Adam Smith postulates that the free market competition and capitalism are good for the economic status of the society. In contrast, Karl Marx affirms that the struggle to create wealth and exploitation of labor causes class struggle in the society and tension between workers and capitalists.

Marx explains that this tension can intensify over time as business ventures expand. Karl Marx proposes that this concept may change the society towards a two tier society of rich people as capitalists and a group of lowly paid workers without benefits.

Karl Marx predicts the failure of capitalism and transformation of the community towards communism. He elaborates that in communism, “people” or “lowly remunerated workers” become the owners of the factors of production. Karl Marx’s ideas of communism had adverse effects on various countries. His economic ideas were not successful in Eastern Europe in the 20th Century.

A number of instances may affect Karl Marx’s ideas. The first instance explains that centrally planned economies are less efficient than capitalist economies in production and delivery of services and goods. These economies are not efficient in creating the highest amount of goods for the largest number of people. The second instance shows that employees’ incomes can increase over time (Yunker, 11).

This aspect undermines the theory’s explanation that the exploitation of labor may be based on the interest of financial gain. Despite widespread criticism and skepticism of Karl Marx’s theories, they retain relevance and credit in economics. They expose the weaknesses of a capitalist economic model.

For example, large business organizations enjoy comparative advantages over small companies. Big companies can absorb or reduce the activities of small companies.

John Keynes Model

Adam Smith’s work also led to an investigation on capitalism by a British economist, John Keynes. Keynes conducted a research on capitalism and developed different views from those of Adam Smith and Karl Marx.

In his publication, General Theory of Employment, Interest, and Money, John Keynes postulates that capitalism increases people’s orientation to saving as their income levels increase and this changes the spending of the economy as a whole.

Keynes interrogates the functions of state policies in free market economies. Keynes based his work on the period of the Great Depression. Millions of people lost their employment and savings during the mentioned period. Governments did not lay down effective strategies to curb the effects of the depression. People started to worry about Adam Smith’s “invisible hand” theory and its role in the depression.

John Keynes explained that there was one strategy that would overcome the depression. He explained the need for the government to start spending in order to put capital into individuals’ custody. This fact could trigger the demand for services and goods and reignite the economy again.

John Keynes advised President Franklin D. Roosevelt to initiate a big public works industry to provide work to the idle labor force. However, the emergence of World War II problems brought new economic challenges and interfered with government spending.

World War II accelerated the level of production to a high amount through the manufacture of guns, fighter jets, trucks and various types of ammunition. Keynes’ theory led to a transformation of millions of men in the labor force into the military.

John Keynesian’s economics model favors the use of government power in regulating the market. It encourages application of state policy to control spending and taxation (Wenz, 44).

The relevance, authenticity and validity of Keynesian’s idea of a “slow moving economy” may be controversial even in the modern society. In contrast to Adam Smith’s “invisible hand”, the Keynesian theory favors government interference in the market. The theory forms part of Keynesian economics.

The Austrian school of economics

The Austrian school of economics originates from Carl Menger, an Austrian economist and scholar. He wrote the book, “Principles of Economics” in the year 1871. The economic principles espoused in the book became the pillars of marginal transformation. Carl Menger evaluates in his publication that the economic principles of services and goods may be unpredictable in nature.

The model explains that what is valuable for one individual may not apply to another. Menger examines that an improvement in the production of goods may lead to the regression of the individual’s subjective nature. This fact advances the concept of diminishing marginal utility within the Austrian school of economics.

The concept of the Austrian school of economics interrogates the perspective of a verbal framework that procures protection from the challenges of central economics. The theory points to considerable deviations with other schools of thought. It provides unique illustrations of complex economic issues. The Austrian school of thought is fundamental in explaining complex economic concepts.

The school uses logic of prior thoughts to find economic laws of universal application. In similarity to other economic schools of thought, the model makes use of data and mathematical models to advance its objectives.

The theory proposes the idea that subjective factors may determine prices. The prices may include individuals’ preferences to products. This fact contradicts the classical school of economics that advances that the cost of processing may be accountable for the designing of prices.

The neo-classical school of thought also proposes that the interaction of demand and supply forms an economic equilibrium that determines the price. The Austrian school of economic thought disputes the classical and neo-classical views of price determination ( et al, 36). The classical and neo-classical perspectives reveal that subjective principles also dictate equity between demand and supply.

The Austrian school of thought and the classical concept disagree concerning the laws of supply and demand which dictate interest levels in a free market. The Austrian school of thought explains that subjective factors determine the amount of interest rates.

The thinking explains that an increase in financial supply without a proportionate increase in production of services and goods causes an increase in prices (Landsburg, 13). However, this growth is not simultaneous. The theory explains that certain goods may increase in a higher rate than others. This aspect may lead to a high deviation in the prices of goods.

Adam Smith’s “invisible hand” theory was the foundation of the formal science of economics. Karl Marx’s theory of capitalism made him a famous scholar who made a big impact in the community. John Keynes prompted new aspects of economic observation in the economic policy of the world.

His concepts were fundamental in the formulation of economic policies and institutions that regulated the economy. Keynes inspired the formation of the International Monetary Fund. This fact happened at the closure of the Second World War.

The Chicago school of economics

The school is popular for its support of monetarist and free-market concepts. It notes that stability in the market depends on a state of money availability. Milton Friedman is the principal scholar behind the theory. He supports most of the principles of Adam Smith’s model but adds modern aspects.

The model explains that aspects like modern social responsibility in business can improve the economic environment. Authorities in the economic field continue to carry out research on all the mentioned theories in order to improve and help future generations.

Conclusion

This paper confirms that Adam Smith’s “invisible hand theory” continues to influence other ideas positively. Economic authorities may conduct additional research in order to develop a concept that can integrate all the strengths of the theories discussed in this paper.

The theorists need to adopt economic policies that address dynamic financial needs of various states of the world. Countries derive their economic practices from relevant theories. They use the practices to formulate policies. States that fail to recognize the role that economic theories play in improving financial practices may suffer from stagnation in their development.

Works Cited

Landsburg, Steven. Fair Play: What Your Child Can Teach You About Economics, Values and the Meaning of Life, New York, USA: Free Press, 2010.Print.

et al.Economics: Principles in Action, New Jersey, USA: Pearson Prentice Hall, 2011.Print.
Wenz, Peter. Take Back the Center: Progressive Taxation for a New Progressive Agenda, Massachusetts, USA: Massachusetts Institute of Technology, 2012.Print.

Yunker, James. Economic Justice: The Market Socialist Vision, Maryland, United States of America: Rowman & Littlefield, 2010.Print.

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IvyPanda. (2020, January 23). The significance of Adam Smith’s “invisible hand” concept on modern economics. Retrieved from https://ivypanda.com/essays/the-significance-of-adam-smiths-invisible-hand-concept-on-modern-economics/

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"The significance of Adam Smith’s “invisible hand” concept on modern economics." IvyPanda, 23 Jan. 2020, ivypanda.com/essays/the-significance-of-adam-smiths-invisible-hand-concept-on-modern-economics/.

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IvyPanda. "The significance of Adam Smith’s “invisible hand” concept on modern economics." January 23, 2020. https://ivypanda.com/essays/the-significance-of-adam-smiths-invisible-hand-concept-on-modern-economics/.

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IvyPanda. 2020. "The significance of Adam Smith’s “invisible hand” concept on modern economics." January 23, 2020. https://ivypanda.com/essays/the-significance-of-adam-smiths-invisible-hand-concept-on-modern-economics/.

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IvyPanda. (2020) 'The significance of Adam Smith’s “invisible hand” concept on modern economics'. 23 January.

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