The Economics Book

(Barry) #1

57


See also: Economic man 52–53 ■ The division of labor 66–67 ■ Economic equilibrium 118–23 ■ The competitive market
126–29 ■ Creative destruction 148–49 ■ Economic liberalism 172–77 ■ Markets and social outcomes 210–13


THE AGE OF REASON


... other self-interested people provide competition—
they take advantage of each other’s greed.

Businesses fail unless they pay market
wages and make products the market demands
at the price people are willing to pay.

The invisible hand of the
market brings order.

If one seller charges
too much...

If one employer pays wages
that are too low...

... another will
take his employees,
and his firm will fail.

... another will undercut
his price, and the first seller’s
products will fail to sell.

Every individual acts out
of self-interest.

This might lead to a
chaotic mix of products
and prices, but...

not a vicious one. He saw humans
as having an inclination to “truck
and barter” (bargain and exchange)
and to better themselves. Humans,
in his view, were social creatures
who act with moral restraint, using
“fair play” in competition.
Smith believed that
governments should not interfere
with commerce, a view that was
also held by other Scottish thinkers
around him, including the
philosopher David Hume (p.47).
An earlier French writer, Pierre de
Boisguilbert, used the phrase laisse
faire la nature (“leave nature alone”),
by which he meant “leave business
alone.” The term “laissez-faire” is
used in economics to advocate
minimal government. In Smith’s
view government did have an
important role, supplying defense,
justice, and certain “public goods”
(pp.46–47) that private markets
were unlikely to provide, such
as roads.
Smith’s vision was essentially
optimistic. The English philosopher
Thomas Hobbes had earlier argued
that without strong authority,
human life would be “nasty,
brutish, and short.” British
economist Thomas Malthus (p.69)
looked at the market and predicted
mass starvation as a direct result of
increased wealth. After Smith,
Karl Marx (p.105) would predict
that the market leads to revolution.
Smith, however, saw society as
perfectly functional, and the entire
economy as a successful system,
an imaginary machine that worked.
He mentioned the “invisible hand”
only once in his five volume work,
but its presence is often felt. Smith
described how his system of
“perfect liberty” could have positive
outcomes. First, it provides the


goods that people want. If demand
for a product exceeds its supply,
consumers compete with each
other to drive the price up. This
creates a profit opportunity for
producers, who compete with each
other to supply more of the product.
This argument has stood the
test of time. In an essay in 1945,
titled The Use of Knowledge in

Society, the Austrian economist
Friedrich Hayek (p.177) showed
how prices respond to individuals’
localized knowledge and desires,
leading to changes in the amounts
demanded and supplied in the
market. A central planner, Hayek
said, could not hope to gather up
so much dispersed information. It is
widely believed that communism ❯❯
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