We then have the opposite effect whereby the price is low and there is a large amount of excess demand, which is shown as P2. In turn, the market is brought back into equilibrium as consumers flock back at the lower price – at P1. This may mean they lose some money but would have gained from the higher prices. The producers will be unable to sell all the goods at that price, so are forced to sell at a lower price otherwise make a 100 percent loss. The high prices have driven producers to oversupply the market – driven by their own self-interest to make a profit. So at point P3, the market is in a state of excess supply. These two forces push the market towards the equilibrium point in what is known as ‘the invisible hand’.Īs seen from the graph above, the invisible hand constantly pushes the market back into equilibrium. When there is an undersupply of goods, prices rise to encourage producers to increase production and supply. To explain, when there is an oversupply of goods, prices fall so that demand increases. These are forces that constantly push supply and demand back so that a socially optimal supply is reached. In his book, Smith uses the Invisible hand as a metaphor for the constant fluctuations that occur between supply and demand in order to reach equilibrium. The invisible hand itself was originally coined by Adam Smith in his book ‘The Wealth of Nations’, published in 1776. In turn, society benefits as those goods might not otherwise have been produced. In other words, by pursuing the profit motive, people must provide goods that others want, at a price they are willing to pay. The invisible hand is a term that explains how the self-interst of the individual benefits the rest of society. WRITTEN BY PAUL BOYCE | Updated What is the Invisible Hand
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