Adam Smith is often referred to as the father of economics. He believed that one of the most powerful forces promoting economic progress is self-interest directed by market prices. His theory of economics became known as the invisible hand principle. It suggested that market prices coordinate the actions of self-interested individuals and direct them toward activities that promote the general welfare. An excerpt from Smith’s book An Inquiry into the Nature and Causes of the Wealth of Nations states:
“Every individual is continually exerting himself to find out the most advantageous employment for whatever income he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society…He intends only his own gain, and he is in this, as in many other places, led by an invisible hand to promote an end which was not part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”
Smith’s philosophy makes a lot of sense. The market works automatically as if an invisible hand were guiding it. With people pursuing what they thin, will benefit them the most, they actually end up benefiting not only their own interests but society as well. And it all occurs of free will of the economic players, consumers and producers. There is not central direction or control. It all happens naturally. For instance, when shoppers line up to check out, there is no authority telling them which lane they are assigned. They naturally just proceed to the lane that they believe will help them check out most quickly, and if one lane gets congested or held up for whatever reason, shoppers will relocate to other lanes, smoothing the flow of traffic. So shoppers working toward their own self-interests result in working in the interest of everyone through social cooperation and, thereby, promoting the most efficient method for everyone.
Although people are initially motivated by self-interest, market prices direct their interests toward activities that promote economic progress and order. Primary indicators of favorable and unfavorable activities are profits and losses. Losses indicate that an economic activity is congested, whereas profits indicate that an activity offers potential and opportunity. As producers pursue those activities that offer an opportunity for profit, they smooth out the flow of economic activities, promoting more efficient economic progress.
The invisible hand principle illustrates how self-interest of the individual and market prices work together to promote economic progress. Adam Smith’s invisible hand principle is considered the basic principle of economics. As Lawarence Summers, an economist and former Secretary of the Treasury states: “What’s the single most important thing to learn from an economics course today? What I tried to leave my students with is the view that the invisible hand is more powerful than the hidden hand. Things will happen in well-organized efforts without direction, controls, or plans. That’s the consensus among economists.” And I find that I quite agree.