Question

How does the invisible hand work

Answer 1

The idea of invisible hand refers to the market forces that helps demand & supply of goods & services in a free market to reach equilibrium automatically. The phrase was first coined by Adam smith who used it to describe income distribution in the economy. According to smith wealthy people also have needs & expectations. Therefore they also need to pay for the products & services which distributes income in the economy. This idea of invisible hand describes that individuals efforts to pursue their own interests will result in higher economic benefits than if their actions were intended towards benefiting society directly.

This works well in capitalism. Since capitalist economy functions without anyone in control of it there is no visible hand telling (government in a command economy) producers what to produce & how much to produce as there is in a command economy. Consumers choose for the lowest price & producers choose for higher rate of profits. Here everyone works in their self-interests. Companies try to maximize their profits by producing what consumers demand. Consumers then decide what company’s products will survive by deciding to either buy or not to buy a company’s products. By making their excess or insufficient demand known through market prices, consumers "direct" entrepreneurs' to invest money in most profitable industry Thus it reflects an invisible hand which determines the demand & supply equilibrium in an economy.

Another example would be of a factory where owner is underpaying its employees, making them work long hours & providing substandard living. Here invisible hand will eliminate this injustice as market corrects itself & employer will be forced to provide better wages & benefits or simply exit the business by seizing production.