Adam Smith's invisible hand makes the market system work.

Has the Invisible Hand Given You a Nudge Recently?

Jul 22, 2014    •    333 Views    •    EST. TIME TO READ: 3 minutes

Since this week’s posts all will relate to “invisibles,” I wanted to admit that I have an invisible hand in my classroom. Given to me by a student, it is made of paper mache.

In both of his major books, Adam Smith referred to an invisible hand. His invisible hand contradicted the seemingly haphazard nature of human behavior. Instead, Smith tells us that, pushed by an invisible hand, consumers and businesses predictably and productively interact.

Adam Smith created his image of the invisible hand just as it was just starting to touch eighteenth century Europe. For centuries, medieval England’s economy had been agricultural until, because of the Crusades, the industrial revolution, exploration, and many other large and small events, countless peasants said, “Let’s leave the farm. Let’s go to the city.” Hired by factory owners, this newly created work force could use a division of labor to mass produce.

Meanwhile, as the word spread about price and quantity, a variety of incentives started to motivate consumers and businesses. Consumers started to think, “What am I willing and able to buy?” If price is lower and quality is good, then I will purchase more.  Meanwhile, on the supply side, higher prices fueled production. With enough demand, division of labor, regional specialization and all of those ideas explained by Adam Smith were able to develop.

The result? Many buyers and sellers agree on price and quantity (although each acts independently) and you know the price of, let’s say… your cookie. On a demand and supply graph, economists call that meeting point “equilibrium.”

One contemporary called Adam Smith, “the most Absent Man that ever was. Another told how he moved his lips, talked to himself and smiled “in the midst of large Company’s…” At Edinburgh University, apparently deep in thought, he smiled at inappropriate moments during religious services. Probably pondering the fundamentals of virtue, he strolled the roads near his home attired only in his dressing gown. During tea with friends, he unconsciously placed his bread and jam in his teapot and then asked why the tea tasted fowl. Once, while walking with Charles Townshend, excitedly describing the division of labor, Smith fell into a tanning pit filled with gasses and fat. As someone who was diagnosed as having “hypochondriasis,” the event must have terrified Smith. (Once his doctor prescribed 500 miles on horseback to cure his affliction.)

Our bottom line: I liked New Yorker writer James Surowieki’s description of a market in his The Wisdom of Crowds. He said that a market “aggregates” a decentralized group of people with diverse opinions who function independently. Together, they create a network of information and produce desirable results. Why? I could add that they are nudged by an invisible hand.

 

Sources and more...The Surowiecki book, The Wisdom of Crowds was excellent while my Smith information came from several biographies including The Authentic Adam Smith: His Life and Ideas and my own book, Econ 101 1/2.

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