In the Wealth of Nations (1783) Adam Smith mentioned the term ‘invisible hand’ on two occasions. Therefore, over time, prices and supply will adjust until the market returns to equilibrium. The net effect, is that prices will rise until equilibrium is reached and the shortage is overcome. In this case, firms have an incentive to increase the price and/or firms have an incentive to increase supply – invest in production. At the current price, demand was greater than supply – leading to queues. How does invisible hand deal with shortages? We don’t need a government to set an equilibrium price – the market price will automatically occur from all the actions of firms and supplies. This competitive pressure means that the price will fall – until there is an equilibrium between supply and demand. Consumers will then switch from the high-cost bread to the low cost bread. This creates an incentive for another baker to sell at a lower price, say £2. Suppose, a firm was charging a very high price for bread – £4 a loaf. The invisible hand means that by following their self-interest – consumers and firms can create an efficient allocation of resources for the whole of society. The invisible hand is a concept that – even without any observable intervention – free markets will determine an equilibrium in the supply and demand for goods.

Invisible hand example quizlet