Definition: The invisible hand is the undetectable market force that interferes to help the demand and supply of goods to automatically reach equilibrium. More broadly, the term refers to the inadvertent social benefits of individual actions, and it is introduced by Adam Smith.
What Does Invisible Hand Mean?
What is the definition of invisible hand? In a free market, the government does not impose any restrictions, allowing the market participants to work for their own interests. However, if a producer or a seller charges a higher price than the current market price, consumers are likely to shift to a competitive company, and vice versa.
In this context, the economy works well without governmental intervention and the trade of goods and services takes place in a free market that determines the prices based on the interaction of sellers and buyers.
Let’s look at an example.
Example
John owns a retail store that sells sporting goods. John is a price taker because the market is competitive, and he cannot charge above the current market price. A year ago, another sports goods retailer opened a store three blocks away from John. During the first months, John was confident that his customers would remain loyal to his business as, before the new competitor entered the market, John was the only sports goods store in the neighborhood. However, over the past few months, John has noticed that fewer customers are shopping from his store and that the new store realizes a higher profit.
In economic terms, the demand for John’s goods has declined as the demand for the products of his competitor has increased, leading to lower profits for John and profit maximization for the competitive store. What is John supposed to do?
John cannot raise the prices because he will lose more customers. However, he can observe the demand for particular goods and raise the price for them, hoping that the change in price is accurate and enough to generate a higher profit. At the same time, he can lower the prices of his merchandise, expecting the demand for his products will be higher than the demand for the products of his competitor.
This is an example of invisible hand where the market prices adjust slowly to the new market conditions when a new competitor enters the market.
Summary Definition
Define Invisible Hand: The invisible hand means the market of suppliers and consumers that guides suppliers to produce quality goods at the lowest price and consumers to purchase these goods.
