Page 24 - Policy Economic Report - November 2024

POLICY AND ECONOMIC REPORT
OIL & GAS MARKET

Lessons from Economics

Invisible Hand Theory

The concept of the “invisible hand” was invented by the renowned economist and father of economics,
Adam Smith. It refers to the invisible market force that brings a free market to equilibrium with levels of
supply and demand by actions of self-interested individuals. The theory states that individuals that trade
in a free market pursuing their own interests will end up maximizing social benefits. Furthermore, the
benefits derived from the free market are maximum and more than those in a regulated and planned
economy.

Every individual, acting in their self-interest, generates a demand or supply which compels others to buy
or sell goods or services. In return, he either receives or pays compensation and one entity makes a profit.
In this process of exchange in a free economy, resources are allocated in the most efficient manner.

The invisible hand theory basically tries to convey that without any intervention, if all individuals in the
economy act in their best self-interest, the result is automatically in the best interests of the economy.
The results will always be better than those of a centrally planned and regulated economy.

Importance of Invisible hand in an economy

• The invisible hand is part of the laissez-faire policy concerning the market. Laissez-faire translates
to "let do/let go" and this approach holds that the market will find equilibrium without
government or other interventions forcing it into unnatural patterns.

• The invisible hand allows the market to reach equilibrium without government or other
interventions. When supply and demand find equilibrium naturally, oversupply and shortages are
avoided. The best interest of society is achieved via self-interest and freedom of production and
consumption.

Example of Invisible hand: -

• For example, if a car manufacturer produces more mini-vans than they can sell each year, their
self-interest in making a profit means they will adjust prices or produce fewer mini-vans going
forward, and perhaps manufacture more sedans if that is what consumers want. The government
does not necessarily have to tell the manufacturer how many models of different types of cars to
make, as there is a natural force driving efficiency — the invisible hand.

Criticism of Invisible hand: -

• Monopolies can set prices at a non-competitive price — even if it is high and consumers do not
want to pay that much prices. Also, with the barrier to entry to be so high that no other company
tries to compete, leaving customers with the suboptimal choice to overpay or not buy at all.

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