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Posts Tagged ‘Adam Smith

A short understanding of the Invisible Hand theory of Adam Smith

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Adam Smith
Philosopher, 1723 – 1790

Adam Smith was born in Kirkcaldy, Fife, Scotland. The exact date of his birth is unknown; however, he was baptized on June 5, 1723. Smith was the Scottish philosopher who became famous for his book, “The Wealth of Nations” written in 1776, which had a profound influence on modern economics and concepts of individual freedom.

In 1751, Smith was appointed professor of logic at Glasgow University, transferring in 1752 to the chair of moral philosophy. His lectures covered the field of ethics, rhetoric, jurisprudence and political economy, or “police and revenue.” In 1759 he published his Theory of Moral Sentiments, embodying some of his Glasgow lectures. This work was about those standards of ethical conduct that hold society together, with emphasis on the general harmony of human motives and activities under a beneficent Providence.

Smith moved to London in 1776, where he published An Inquiry into the Nature and Causes of the Wealth of Nations, which examined in detail the consequences of economic freedom. It covered such concepts as the role of self-interest, the division of labor, the function of markets, and the international implications of a laissez-faire economy. “Wealth of Nations” established economics as an autonomous subject and launched the economic doctrine of free enterprise.

Smith laid the intellectual framework that explained the free market and still holds true today. He is most often recognized for the expression “the invisible hand,” which he used to demonstrate how self-interest guides the most efficient use of resources in a nation’s economy, with public welfare coming as a by-product. To underscore his laissez-faire convictions, Smith argued that state and personal efforts, to promote social good are ineffectual compared to unbridled market forces.

In 1778, he was appointed to a post of commissioner of customs in Edinburgh, Scotland. He died there on July 17, 1790, after an illness. At the end it was discovered that Smith had devoted a considerable part of his income to numerous secret acts of charity.

Invisible hand theory of Adam Smith

One of the greatest contributions of Adam Smith was the invisible hand theory. He said that if the government doesn’t do anything, there’s a controlling factor of people themselves who can guide markets. I believe that the government should be responsible in defining the property rights, to set up honest courts, to impose minor taxes and to compensate for well defined “market failures” If I sell candies for 1 peso each and Christian sells them for 2 pesos for 3 pieces, he will get all the business making me lose mine so in order to compensate for my loss I should be forced to lower my price as to stay alive in the business. I am guided by an invisible hand which is my self interest to gain profit or as Adam Smith would say everyman for himself.

The theory of the Invisible Hand states that if each consumer is allowed to choose freely what to buy and each producer is allowed to choose freely what to sell and how to produce it, the market will settle on a product distribution and prices that are beneficial to all the individual members of a community, and hence to the community as a whole. The reason for this is that self-interest drives actors to beneficial behavior. Efficient methods of production are adopted to maximize profits. Low prices are charged to maximize revenue through gain in market share by undercutting competitors. Investors invest in those industries most urgently needed to maximize returns, and withdraw capital from those less efficient in creating value. Students prepare for the most needed (and therefore most remunerative) careers. All these effects take place dynamically and automatically.

The way I understand the said theory is by giving my own example;

Joan and Joanne are fresh graduates and are trying to open up a business to help them understand and be aware about the invisible hand. About a month they have realized that people from their hometown had to go the mountains to purchase fruits and vegetables. They conducted a survey to find the most fruits and vegetables in demand of the community. After careful consideration and months of planning they decided to open up a fruit and vegetables business naming it Twin’s fruit and vegetables where they would be the one to purchase wholesale goods and sell it to the people. The people were quite glad about it because it would save them the time and effort to go up the mountains to buy rather just go to Twin’s fruit and vegetable. Things were running smoothly for their business and they were happy about it. They offered free delivery within a certain area and maintain their low prices to satisfy their customers for they have realized that only with the continuous support of the people will they be able stay in business and also discourage other businessmen from entering the market.

It is understood that the invisible hand in this situation is the idea of being the only producer of a certain good by being considerate as to lower the price for the people to be able to afford thus making a good reputation to the said company. If the community is already satisfied with the way things are then they will continue to support the said business making it hard for other businessmen to open market

This was taken from the famous wealth of nations

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

This is as how Adam Smith explained it that being led by an invisible hand is actually profitable in the sense that it uses the will of a person’s self interest which drives him to create more and better ideas to overcome the other competitors as long as he would be doing it in a legal way.

http://www.lucidcafe.com/library/96jun/smith.html

http://en.wikipedia.org/wiki/Invisible_hand

http://plus.maths.org/issue14/features/smith/

http://answers.yahoo.com/question/index?qid=20100225123447AA1ooUA

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Written by jongart

May 25, 2010 at 11:04 PM

MONEYNESS OF “MONEY”

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What is Money?

This question seems so elementary and self-evident.

Money is, after all, the colored pieces of papers issued by the government that we have in our pockets. But is that it? Even if one were to accept that as a satisfactory answer, what exactly are those pieces of paper for? Are they themselves the “money” or do they represent something else that is the “money?” and where do those pieces of paper come from, and are those pieces of paper considered money as opposed to anything else? We all want money, and devote our lives to getting it.


Let’s start to a textbook definition of money and from there, we proceed. Most definitions include only two parts, some add a third. According to them, money is:

Ø a medium of exchange

Ø a store of value

Ø a unit of account

If you look closely at the first two definitions, you will see that money exists in the minds of those who use it. This is partially true for the third definition as well. (note: “For all of you monetary theory geeks out there, please relax! These are deliberate simplifications designed to make the ideas accessible to a general audience and not a detailed exposition of precise financial models. Heheh”)

Ø I can exchange my money for stuff…

Ø I can exchange my money for stuff later…

Ø I can exchange my money for a predictable amount of stuff later…

Let’s think about what is happening right now. Money has value because people will exchange or give you stuff for it, both now or in the future. But why will they do that? They have to believe that they can trade it onward in turn for stuffs they want. So the utility value of money is based on a set of collective beliefs – what Carl Jung referred to as the Collective Unconscious. This is the set of beliefs that are widely held by a group of people at a deep level and upon which they will act without thinking about it. One can think of this as the unstated assumptions of a society. In the United States, the dollar has had a stable or relatively stable value for so long that few would ever consider NOT accepting it in exchange for stuff. The dollar as money is a deeply embedded part of our Collective Unconscious, both here and around the world.

Though there are many who are beginning to question the value of the dollar as money, the number is still miniscule as a percentage of society. Even if a person were to cease to believe in the dollar as money in their own mind, they would still accept it as long as they believed that others would accept it from them in exchange for goods. So externally, they would act as if the dollar was still money, even if they no longer held that belief. That is what puts the collective in unconscious. At some point, things deteriorate sufficiently that everyone KNOWS that everyone else is just pretending. That is the point of universal hypocracy just before the belief system breaks down.

Printing Dollars Destroy Money?

I agree that money, or better said “moneyness” attached to an issued currency, exist only in the minds of people, but printing dollars does not simply destroy money. Excessive printing may destroy (lower) the standard of value of dollars (inflation) while leaving the liquidity component intact. It is clear that from a purely physical point of view, a central bank can create as much currency either physical or electronic, as it wishes – subject of course to certain practical constraints such as logistics. But money exists solely in the minds of people. It is essentially a matter of faith and faith is not something a government or central bank can print or conjure from thin air. The value of the dollar is the credibility built up over two centuries of the US Treasury always meeting its obligations. The money is the widely held belief that the US government will guarantee that dollar holders will always be able to get things of value in return for their dollars, which is backed by generations of positive experience.

Now, please ask yourself, does creating more currency enhance or damage that belief system? The answer should be self-evident. The very act of creating more dollars ensures that the purchasing power of every existing dollar is diluted. There is only one scenario under which this will not damage the purchasing power of the dollar – if and only if those created dollars can be used to add a roughly comparable amount of value to the pool of available goods and services available for purchase. That is precisely the role of well-functioning credit system: to allocate capital to useful expansions of capacity and new business ventures in order to create that added value. This is why such a credit system can actually create money through credit. Because the act of printing dollars would have no such offsetting value-added, the arbitrary creation of more dollars undermines the faith which is at the root of money’s very existence.

A central bank can print currency but it cannot print belief – which is what money really is.

The great Adam Smith said it well:

“ALL MONEY IS A MATTER OF BELIEF”

(Adam Smith, Paper Money, 1981)

http://en.wikipedia.org/wiki/Money

http://www.campuscrosswalk.org/2007-spring-6.html

http://www.stenudd.com/myth/freudjung/jung-collectiveunconscious.htm

Written by lothielicious

March 24, 2009 at 4:19 PM