ADAM SMITH’S ECONOMIC THEORY

THE INVISIBLE HAND

A UTILITARIAN ARGUMENT FOR THE FREE
MARKET SYSTEM
 THE FREE MARKET SYSTEM

1. Every producer (business person) hopes to earn by using his

resources to produce and sell those goods he perceives
people will want to buy.
 THE FREE MARKET SYSTEM

2. Multiplicity of such producers results in competition

for the same buyers.

 THE FREE MARKET SYSTEM

3. To attract buyers each seller must drop prices as

close as possible to the actual cost of the goods.

 THE FREE MARKET SYSTEM

4. To increase profits, each seller must reduce his costs

thereby reducing the resources he consumes
 THE FREE MARKET SYSTEM

• Competition resulting from multiplicity of private sellers and

producers (business persons) serves to:
Lower prices
Conserve resources
Make producers respond to consumer desires
 THE NATURAL PRICE

The price that just covers the cost of producing a commodity,

including the going rate of profit obtainable in other markets.
 THE PRICING MECHANISM

1. If supply of a commodity is not enough to meet demand,

buyers bid the price upward until it rises above the natural
price; producing higher profits than those of producers of
other commodities.
 THE PRICING MECHANISM

2. Producers of other commodities switch their

resources into production of the other more profitable
commodity.
 THE PRICING MECHANISM

3. Shortage of that commodity disappears and price

returns to its natural level
 CONVERSELY:
When supply of a commodity is greater than the quantity
demanded, price falls inducing producers to switch their
resources into production of other, more profitable
commodities
 COMPETITIVE MARKETS

• Producers allocate resources to those industries where they

are most in demand, and to withdraw resources from
industries where there is an oversupply of products.
• The market allocates resources so as to most efficiently meet
consumer demand – promoting social utility.
The market allocates resources so as to most efficiently
meet consumer demands – promoting social utility