Free markets are a unique economic system in that they are void of any government interventions. Each free exchange generates signals regarding which goods and services are valuable. Moreover, they illustrate the level of difficulty when it comes to bringing them to market. These signals direct competing figures – each with their own goals – to fulfill the desires of others. Probably the best way to understand free markets is by looking at a popular symbol of sorts: the invisible hand.
What is it?
The ‘invisible hand’ is a metaphor for unseen forces that are responsible for propelling the free market economy. With individual self-interest and freedom of production along with consumption, the best interests of society achieve fulfillment. The frequent interactions of individual pressures on market supply and demand trigger the natural price movement and trade flow.
The invisible hand infuses two critical concepts. One is voluntary trades in a free market creating widespread, albeit unintentional, benefits. The other is these benefits are greater than those found in a regulated economy.
Imagine a free market lacking regulations or restrictions that the government imposes. Should someone charge less, the customer will purchase from them. As a result, one must either lower their price or offer something more appealing than their competitor. When enough people demand something, the market will supply it and satisfy everyone. The seller will wind up getting the price and the buyer will receive comparatively better goods at the desired price.
The popularization of Adam Smith’s theory
Adam Smith, a Scottish Enlightenment thinker, introduced the concept of the invisible hand in several of his writings. Its initial introduction was in 1759 in Smith’s book, The Theory of Moral Sentiments. He would later use it again in his 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations. During the 1900s, the term would find use in an economical context. His propositions have been subject to many debates and reflections in the works of various revolutionary economists. These include such names as Karl Marx, Milton Friedman, David Ricardo, and John Maynard Keynes.
The theory declares that those trading in a free market out of a desire to pursue their own interests will maximize social benefits. Additionally, to reiterate, the number of free market benefits surpass those that one may find in an economy with more coordination.
According to the theory, maximizing profits is the primary motivation that drives a free economy. Furthermore, every person who acts in self-interest ends up producing a demand or supply. This compels others to buy or sell goods or services. As a result, they will either receive compensation or pay it, thus one party will generate a profit. With this exchange process in a free economy, resource allocation is done in the most efficient manner possible.
All in all, the invisible hand theory tries to convey a specific point about intervention. That being, without it, and if all individuals in the economy act in self-interest, the result will be in the best interests of the entire economy. In fact, the outcome will be better than those of a centrally organized economy.
The invisible hand theory predominantly revolves around the concept of laissez-faire. The name is a French term that translates to “leave alone,” literally meaning “let you do.” The concept itself is an economic theory whose origins date back to the 18th century. Its philosophy largely focuses on opposing government interference of any kind in business affairs. The story behind this term’s origins is an interaction between a French governmental minister and a group of businessmen. The minister asked what help the French state could provide, prompting the businessmen’s reply of “Laissez-nous faire.”
This concept adheres to the policy of allowing things to take their own course without any sort of meddling. According to laissez-faire, the less government involvement there is in making policy decisions, the better it will be for the economy. The concept’s underlying assumption is that “natural order” will prevail no matter what. Social welfare will undergo maximization if the economy is free to operate without any regulations in place.
Within a market economy, the invisible hand often describes supply and demand. Similarly, it illustrates the division of labour and labour practices. The best way to understand this is by looking at demand in the auto industry:
- The total number of people looking for a new car fluctuates wildly depending on the health of the economy.
- As the number of people purchasing cars increases, car manufacturers need to create more cars. Only by doing this can they meet the demand.
- From here, to successfully meet that demand, they have to hire more workers. If there is a short supply of workers thanks to a healthy economy, the car manufacturer needs to take another step. They must offer the workers better pay or more benefits as a way to persuade them to come to work.
The market forces influenced by the invisible hand dictate that this set of circumstances has a high chance of occurring. Why? Because if the car manufacturer fails to pay more and cannot employ more people, it cannot produce more cars. This in turn will cause the cost of cars to rise due to short supply. Consequently, consumers may not be interested in purchasing their cars and could potentially turn to a different car manufacturer.