Adam Smith "invisible hands"

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Adam Smith, the 18th Century economist, argued that the ‘invisible hand’ of the market is the best way of coordinating the activities of individuals within a complex economy. Using appropriate diagrams explain how markets achieve this coordination and how government price control may disrupt it.

The 18th Century economist Adam Smith indicated how the ‘invisible hand’ of the market operated through the pursuit of individual self-interest to allocate resources in society’s best interest, which remains the central view of all free-market economists (tutor2u, n.d.). The ‘invisible hand’ is ‘shorthand for the law of supply and demand and explains how the pull and push of these two factors serve to benefit society as a whole’ (Conway, 2009, p6). This essay will contain the ways of markets achieve that coordination and the ways of government price control that may disrupt it. Initially, the nature of demand and supply will be analysed, subsequently the concept of equilibrium and followed by intervention of government.

Market is the platform where buyers and sellers interact to exchange commodities. In particular, free market economy is based upon the disparate resource allocation decisions made by independent agents but not some co-ordinated control from a central authority (Bannock, 2003, p306). It emphasize on ‘Lassez- Faire’ which comprises Individualism and Liberalism. Perfectly competitive markets which comprised homogeneous commodities, perfect knowledge and lots of entrepreneurs and consumers that act as ‘price takers’, are self-regulating and flexible as they adjust to changes in market conditions in autonomous way.

Demand and supply determines prices and the allocation of resources. Demand, is the quantity of a commodity that consumers are willing and able to buy at a given price in specific time period whilst others remain constant; which would only be effective if the consumers have the desire and sufficient purchasing power. The level of demand could be influenced by several factors, such as the price level, consumers’ incomes, tastes and preferences, expectation, price of complementary and competitors’ products, and quantity of consumers. In complementary products, for instance, alteration in petrol’s price may affect the sale of private cars.

Demand curve generally is downward-sloping due to diminishing marginal utility, Mankiw’s 3rd principle: ‘Rational people think at the margin’ (Mankiw, 2008, p6). Within a specific time period, every additional units of a commodity that consumers consume, the marginal utility they gain from each unit will diminish eventually leads to the decline in the total utility and consumption of the commodity. Price changes will affect utility maximising level of consumption, hence marginal utility curve is the individual’s demand curve and market demand curve is the sum of it.

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Demand curve shows inverse relationship between the price of a commodity and quantity demanded in a specific time period. There are two types of effects regarding the alteration of commodity’s price: Substitution effect and Income effect. Substitution effect is the quantity of additional commodity the consumers would buy after price changes to achieve the same level of utility; for instance, if the price of margarine rises, the consumer may substitute it with butter. Moreover, income effect is the change in quantity demanded due to alteration in purchasing power regarding as the impact of alteration in commodity’s price; for instance, ...

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