Adam Smith • Adam Smith (1723 - 90) • 1759 - "The Theory of Moral Sentiments" • 1776 - "An Inquiry into the Nature and Causes of the Wealth of Nations” • First systematic attempt to describe of the political economy of the world. • Stresses the economic liberty of the individual
Adam Smith • Centrepiece - analysis of "the invisible hand," the mechanism by which the economic activities of profit- seeking individuals result in the greatest good for society as a whole.
Adam Smith • “Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily leads him to prefer that employment which is most advantageous to the society.” • (Book 4, Chapter 2, Wealth of Nations)
The operation of the Free Market Economy • "The statesman who should attempt to direct people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it." • Adam Smith, The Wealth of Nations
The operation of the Free Market Economy • Market allocates resources by the free interplay of demand and supply: goods are only produced if they are thought to be profitable • In this context, it is inefficient for the state to take an active economic role.
The operation of the Free Market Economy • Market price of a given commodity is the result of: • a combination of: • amount of that commodity available for sale and • the level of demand of those willing to pay the "natural price" of the commodity
The operation of the Free Market Economy • Notion of the invisible hand at the root of the 19th C. argument for laissez-faire • Political Corollary: state is absolved from any responsibility for directing the economic affairs of private individuals
The operation of the Free Market Economy • Government intervention in human affairs is generally harmful. • Exceptions: “those exertions of the natural liberty of a few individuals which might endanger the security of the whole society are, and ought to be, restrained by the laws of all governments.”
The operation of the Free Market Economy • Smith's argument that the economy was a self-regulating mechanism made it possible to conceptualise the economy as something distinct from political power • Undermines “mercantilism”.
The Division of Labour • Two aspects: • a) the division of labour between different trades • b) the division of labour within the manufacture of a single good.
The Division of Labour • Increased output through: • a) increased dexterity thru repetition of simple tasks • b) saving of time lost in passing from one task to another • c) invention of specialised machines encouraged by division of work
The Division of Labour • Caveat: • Extent of division of labour limited by extent of the market. • Thus - Smith’s argued for the opening/freeing up of markets on both a regional and international scale
Self-interest • Smith's thinking was based in a fundamental belief in an inherent naturally occurring order. • Human behaviour is driven by six elements: • a) self-love, • b) sympathy • c) the desire to be free • d) a sense of propriety • e) a habit of labour and • f) the propensity to trade.
Self-interest • Self-interest the key driver. • In pursuing his own advantage each individual was "lead by an invisible hand to promote an end which was no part of his intention". • How does individual pursuit of personal goals lead to a common good?
Self-interest • Short Answer: An individual is part of society and as such his/her search for profits can only lead along paths ordained by the natural social order.
Self-interest • Long Answer: Division of labour makes individuals dependent on the labour of others. • But “others” will not provide help out of sympathy. Therefore it must result from their self-love. • Exchange or trade makes possible the desire to "satiate" self-love on the part of two parties to a transaction: trade facilitates a mutually beneficial transaction.
Smith’s market model in brief • 1) It fixes a price • 2) it encourages producers to reduce their costs • 3) it has allocated resources • Land, labour and capital go where the profit indicators in the market are signalling.