Friday, January 8, 2010

Adam Smith's Invisible Hand

Yudi said...

Hi Naveen, thanks for updating us on the current Market Levels.

It would be great if you can post something about "Adam Smith's Invisible Hand" which I am currently reading in few of newspaper articles.

Thank you,

Hey Mehra,

Its good to know that people like you are still reading economics related stuff & interested in knowing the new stuff.

Now coming to Adam Smith's Invisible Hand, first I am providing some basic definitions from various sites & then I will try to elaborate ...

According to

Term used by Adam Smith to describe the natural force that guides free market capitalism through competition for scarce resources. According to Adam Smith, in a free market each participant will try to maximize self-interest, and the interaction of market participants, leading to exchange of goods and services, enables each participant to be better of than when simply producing for himself/herself. He further said that in a free market, no regulation of any type would be needed to ensure that the mutually beneficial exchange of goods and services took place, since this "invisible hand" would guide market participants to trade in the most mutually beneficial manner.

According to

In economics, the invisible hand, also known as the invisible hand of the market, the term economists use to describe the self-regulating nature of the marketplace. For Smith, the invisible hand was created by the conjunction of the forces of self-interest, competition, and supply and demand, which he noted as being capable of allocating resources in society.

The theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a whole. The reason for this is that self-interest drives actors to beneficial behavior

My Elaboration...

According to my understanding of the above definitions (& some other sites), I can best explain the Adam Smith's Invisible Hand by taking example Telecom sector & Mobiles. You all might be aware that when Tata Indicom's DoCoMo started per second billing, due to its competition all other players in segment started per second billing. Thats exactly explains the concept of SELF INTEREST, COMPETITION and SUPPLY & DEMAND.

And this again can be elaborated by taking the initial days of telecom revolution. When there was no competition; there were charges for incoming calls also but due to entrants of new players incoming calls became charge-less. And slowly it came to today's competition level.

And you can always take our stock market & normal day-today examples for any economic explanations. For example due to monsoon failure & agricultural reasons (revision of crops in subsequent years) Sugar Cane production has reduced drastically this time, so sugar prices soared to skyrocket & due to that sugar factory stocks are roaring to new highs. This is again a supply demand & self regulating market concept.

And one more best example is present crisis in US. Bush Administration decreased the interest rates to came out of the dot com bubble burst and because of that heavy supply of cheap money & demand for real estate lead to real estate boom due to which real estate prices started soaring. And at one point due to heavy supply of real estate players & failure in secularization which lead to sudden slack of money supply, pushed into following situation which we are aware of.

So I hope I tried my level best to explain the concept. And as usual always keep reading & keep commenting as your comments encourage me to study more & more share with you all people...

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