Presented By:

Natasha Farooq
Tabina Hassan
Invisible Hand of the market is a figure of speech
envisioned by Adam Smith.
One of the greatest contributions by Adam
The concept was first introduced in his book The Theory
of Moral Sentiments in 1759.
Concept was again used in his book titled The Wealth
of Nations in 1776.
An excerpt from Smith's book An Inquiry into the Nature
and Causes of the Wealth of Nations states:

Each individual intends only his own gain, and he is in this,
as in many other places, led by an invisible hand to
promote an end which was not part of his intention. By
pursuing his own interest he frequently promotes that of
the society more effectually than when he really intends
to promote it."

Adam smith believed that one of the most powerful forces
promoting economic progress is self-interest directed by
market prices.
This theory suggests that market prices coordinate the actions
of self-interested individuals and direct them toward activities
that promote the general welfare
Whenever there is excess demand of anything lets say paper
and lesser demand for pens the profits in the paper industry
would rise
Consequently the price of paper will rise as demand exceeds
supply and pushes prices up
The price of pens, on the other hand, will go down because
the supply exceeds the demand

At this point, self-interest becomes a very important factor.
Since there are higher profits in the paper industry new
producers will start producing paper
Workers also led by the profit motive, move from factories that
produce pen to paper factories.
The result is that paper production rises and pen production
falls
Before long, the market achieves a balance. As the supply of
paper grows to meet demand, paper prices decrease. As the
supply of pen falls below demand, pen prices rise. This price
increase stimulates pen production. Therefore, the opposing
forces of self-interest and competition balance the market.
Competition for these tasks prevents the individual from over-
charging society.

The key to the operation of the laws of the market is that
the market is "its own guardian." It is self-regulating if left
alone so that competition can operate freely without
government control and without monopolies.
In short, Smiths view of the workings of the market
system, any short-run deviation of the market price from
the long-run price would trigger the forces of
competitionby which Smith meant profit-seeking entry
and loss-avoiding exitwhich would eventually take the
market price to its long-run level.
However, for the existence of invisible hand, the market
needs the following preliminary conditions
An open market: no barrier to entry for producers or buyers
No seller big enough to move prices up
No buyer big enough to move prices down
Perfect (even truthful) information for everyone
Government ensures property rights.
No externalities
A free market scenario where there are no regulations or
restrictions imposed by the government, if someone
charges less, the customer will buy from him.
So prices have to be lowered or something better than
your competitor has to be offered.
Whenever enough people demand something, it will be
supplied by the market and everyone will be happy.
The seller end up getting the price and the buyer will get
better goods at the desired price.
Market failure occurs when the allocation of goods and
services by a free market is not efficient.
Market failures can result in:
mass unemployment,
pockets of poverty,
Externalities i.e pollution
and failure to generate economic growth
Example 1:
When scientists discovered that the CFCs were eroding
the ozone layer.
Chemical industry resisted demands to cease the
manufacture and distribution of chloro-fluorocarbons
(CFCs)
Once again, the US government, joined by the
governments of other industrialized nations, enforced a
ban on CFCs.

Example 2:
Reduced labor costs yield increased profits and
increased dividends to the stockholders of the
corporation.
So, if workers abroad accept wages that are a fraction of
the wages demanded in the United States, then the
corporation executives re-locate jobs abroad.
Outsourcing.
The consequences to the displaced workers, and
eventually to the national economy, are devastating.
Unless the government intervenes with tariffs, tax
incentives, regulations, and laws.

The assumptions and policy percepts of neo classical
theory will not be applicable in this case.
There is lack of competitive markets, these economies
have market imperfections, limited information is
available regarding employment, investment
opportunities and techniques of production.
The poor societies have to face externalities.
For e.g. in Pakistan producers have a great power in
determining market prices and quantities sold.
The competitiveness is hardly available in countries like
Pakistan.
Also in countries like Pakistan unlimited amount of labor
is available at the prevailing wage rate.
So wages will remain low benefiting the profit earners at
the cost of wage earners.
Thus the invisible hand in the poor countries like Pakistan
will not act to promote the general welfare but rather it
will lift up those who are already well-off by pushing down
the vast majority.

Why wont Smiths theory work today?
1. Externalities
2. Tragedy of the Commons
3. Information Asymmetry

Externalities are costs associated with something
that are not paid for by who or what is producing it.
For instance, you are in manufacturing, and one of
your by-products is a toxic sludge, you do the least
expensive thing by dumping it in a river.
But anyone who was making a living by fishing from
that river now has no job.
The most obvious externality is pollution and public
health.
Many municipalities are passing Extended Producer
Responsibility Laws to encourage companies to
design products with less toxic effects.
It occurs when no one is governing the use of a common
resource, then there is nothing to stop companies from
exploiting it to its fullest.
This kind of unsustainable harvest can lead to the
collapse of that resource.
For example the Atlantic Bluefin Tuna range across three
continents, and fishing boats can easily reach them in
international waters.
In other words, its a common resource between many
peoples and governing bodies.
Theres nothing to stop acompany from harvesting tuna
that might otherwise have migrated to Africa and been
harvested there.
In an unregulated market, the common resource is
depleted beyond its ability to replenish itself, and it
eventually collapses.
If harvested sustainably, short term profits for those
competing companies might be less, but in the long term,
jobs continue, people are fed, and future generations can
enjoy the fish as well.
Adam Smiths theories only hold if everyone
involved has equal access to information on
which to make decisions relevant to the market.
In 2008 the world economy collapsed. One of the
reasons was that rating agencies (like Moodys)
did not give a real picture of the risk of
investments
Wall Streets mortgage backed securities, gave
investors a false read on how risky the
investments were. The bankers walked away
with billions, and investors were left holding the
bag.
Although Smiths theory is very profound and insightful,
we cannot overlook the shortcomings of this theory.
When Adam Smith came up with this concept the world
was a different place.
There were not many market imperfections but in todays
economies the application of this theory is hardly
possible.
The intervention of government is necessary to avoid
disequilibrium and structural bottlenecks.

Thankyou!