The Invisible Hand And Its Application To The Economic Market Term Paper Sample

The term “invisible hand” was first introduced by Adam Smith in 1776 through his book “An Inquiry into the Nature and Causes of the Wealth of Nations”. While it was not meant to become a theory as it is applied today, the application of it by many economists in their papers showed and proved its importance, which led to the idea into becoming a theory once and for all.

The Invisible Hand

A formal definition of the invisible hand may be taken from the Economic Times (n.d.) wherein it is known as the “unobservable market force” that brings demand and supply of goods into equilibrium.
The idea of the invisible hand banks on two main assumptions. First, the economy must be under a free market or a perfectly competitive market. Different types of market are studied in the field of economics, but a perfectly competitive one is usually used as a basis for comparison as it is most commonly associated with the “ideal” situation. This type of market is characterized by a free entry and exit of firms. Meaning, firms may opt to join the market or get out of it without any complications. At the same time, firms are price takers wherein no one firm is able to dictate on the market what the price of a certain commodity or service will be. Prices will be where demand and supply is at equilibrium. The second assumption is that the individuals or players of that market must work based on their self-interest. This is self-explanatory, individuals or firms must act in a way where the “rational” choice is to always put forth one’s own gain. Smith (1776) argues that this leads to an efficient outcome for the society since the aggregate of individuals pursuing their self –interest; there is a more efficient community.
It is best to put these two in mind as the violation of the two may lead to the inability of the invisible hand to prevail. It is also noteworthy that Smith (1776) argues that there must be minimal government intervention in a market. It is best to leave the market alone as it will bring itself into an efficient one by itself. Take for example a market where there are n number of firms selling good X. By allowing these firms to compete on their own, the one thing that will allow them to increase revenues is by increasing their sales. On the other hand, there will be consumers who will be looking for the minimum selling price of good X. These two “self-interested” players will be pulling the prices at equilibrium since one of them will be aiming for higher revenues where as to the other will be looking for the lowest price. At the same time no two suppliers will be able to control the price. Say the government places a regulation on the market where there may only be one supplier of the good, then that chosen firm will now have the option to increase the price since the competition from other suppliers is eliminated.
Given the example above, the invisible hand may be taken as a situation exhibiting “perfect competition” as well. There is therefore a need to delineate the two. Perfect competition or a market that is a perfectly competitive one, as discussed above, is one exhibiting the characteristics of a perfectly competitive market. The invisible hand is the force that pushes a perfectly competitive market into the equilibrium condition.

Applications of the Invisible Hand

The invisible hand is one of the greatest moving factors for propositions for liberalization of trade, whether international or local. A number of researchers follow the belief of Adam Smith on the idea of minimizing the hold of government in the interactions of market agents allowing perfect competition to prevail. The simplest example where the invisible hand is present is the World Wide Web where Facebook is prevailing. With the growing number of individuals working on different places and migrating, there was a demand for a medium for individuals to communicate. Thus social media was created and it still continues to be prevalent even without the aid of an authority to start it.
One interesting application of the invisible hand is to the market of prostitution as pointed out in the study made by Cunningham and Shah (2014) where they argued that prostitution must be legalized in the United States especially with the emergence of internet prostitution where it is now safer and more convenient to trade sex. While prostitution is still prohibited in most countries and is considered as an “underground market”, this same trait makes it a perfect example on the application of the invisible hand for it has limited government interference and the market is “free” in a sense that prices are dictated by the supply and demand of goods. In fact, the study made a conclusion that blondes are priced 11 percent more than the brunettes. This goes well with the classic law of demand which states that an increase in demand will increase the price to keep the market in equilibrium. The study also concluded that prostitution will prevail whether the government does something about it or not. The prostitution market, even without any government or state intervention, is able to prevail because there is a demand for its product which is dictated by the market itself.
Another example of the application of the invisible hand is that of energy markets for cutting carbon emission in Britain. The Committee on Climate Change marketed the move towards a more energy efficient production by purchasing appliances that are more environment- friendly such as solar panels. The committee left the markets to move on its own and while it did not reach the conclusion that was expected, it still points out the interesting effect of the invisible hand. For true enough, the market is still choosing fossil fuels for whatever reason that the consumers and producers deem will boost their self-interest.
Finally, you have the telecommunications market. Before, the prevailing medium of communication was through landline phones. With it however, consumers started demanding for phones that are readily available which paved the way to the creation of cellular phones. The producers answered the call of consumers when they demanded for phones provided that it was set at a price that the producers are willing to sell and consumers are willing to buy. On its own, the market was able to provide what the consumers demanded and both came to a somewhat mutual agreement when consumers started actually buying the product. This is the greatest indication that both are satisfied or at least both feel that they have benefitted with the trade.
It may be quite difficult to find a market that is governed completely by the invisible hand for it is equally difficult to identify markets under a perfectly competitive condition. Since one of the conditions is for the free entry and exit of firms proves to be a problem since there will be cost requirements that will prohibit this. Some examples of the invisible hand were taken therefore while relaxing the assumption that there is a perfectly competitive market.
Undoubtedly, the invisible hand has quite a grip on modern economics. It is still a popular theory used by many industries nowadays. Further studies on the topic however will lead to shortcomings of the theory. First of which is its inability to fully work in a fairly regulated market. While a liberalized market sounds promising, there are some considerations that one must consider before making use of it in creating a policy or guiding an economy. Take for example the concept of externalities. Answering questions as to how the gains or detrimental effects be divided among the players of the market may be difficult without having an authority aiding the market towards a “just” decision. Another will be the case of a public good. There will always be the concern for the least represented amongst the community and they must be protected. There are grey areas in certain aspects of the market that must be filled by another agent. In both these examples, it can be seen that regulation proves to have its benefits especially since it is very difficult to achieve a perfect economy.

References

Cunningham,S., Shah, M., (2014). Decriminalizing Indoor Prostitution: Implications for Sexual Health and Violence. Taken from http://www.economist.com/news/leaders/21611063-internet-making-buying-and-selling-sex-easier-and-safer-governments-should-stop on 8 March 2015
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. 434
The Economic Times. (n.d). Definition of Invisible Hand. Taken from http://economictimes.indiatimes.com/definition/invisible-hand on 8 March 2015
The Economist. (2009). Questioning the Invisible Hand. Taken from http://www.economist.com/node/14649058 on 8 March 2015