PART ONE INTRODUCTION EY Adam Smith It may be only a coincidence the butcher. the brewer, or that Adam Smith's great book, he baker that we expect our and the An Inquiry into the Nature and dinner, but from their regard Invisible hand Causes of the wealth of Na to their interes tions, was published in 1776 Every individual the exact year American revolu neither intends to promote tion of Independence. But the how much he is promoting two documents do share it.. He intends only his point of view that was preva- wn gain, and he is in this, as ent at the time-that individu- in many other cases, led by als are usually best left to their an invisible hand to promote own devices, without the heay an end which was no part of ADAM SMITH hand of government guiding their actions. This political phi- his intention. Nor is it always osophy provides the intellectual basis for the market econ- the worse for the society that omy, and for free society more generally it was no part of it. By pursuing his own interest he Why do decentralized market economies work so frequently promotes that of the society more effectually well? Is it because people can be counted on to treat one han when he really intends to promote it. another with love and kindness? Not at all. here is adam Smiths description of how people interact in a market Smith is saying that participants in the economy are moth- economy. vated by self-interest and that the "invisible hand" of the marketplace guides this self-interest into promoting general Man has almost constant oc for the help of his economic well-being. brethren and it is vain for him to expect it from their Many of Smith's insights remain at the center of mod- benevolence only. He will be more likely to prevail if he ern economics. Our analysis in the coming chapters will al an interest their self-love in his favor, and show them low us to express smith,'s conclusions more precisely and that it is for their own advantage to do for him what he to analyze fully the strengths and weaknesses of the mar- requires of them .. It is not from the benevolence of ket's invisible hand this book is to understand how this invisible hand works its magic. As you study economics, you will learn that prices are the instrument with which the invisible hand directs economic activity. Prices reflect both the value of a good to society and the cost to society of making the good. Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social benefits and costs of their actions. As a result, prices guide these indi- vidual decisionmakers to reach outcomes that, in many cases, maximize the wel- sa There is an important corollary to the skill of the invisible hand in guiding eco- nomic activity: When the government prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand's ability to coordinate the mil lions of households and firms that make up the economy. This corollary explains why taxes adversely affect the allocation of resources: Taxes distort prices and thus the decisions of households and firms. It also explains the even greater harm caused by policies that directly control prices, such as rent control. And it explains the failure of communism. In communist countries, prices were not determined in the marketplace but were dictated by central planners. These planners lacked the information that gets reflected in prices when prices are free to respond to market10 PART ONE INTRODUCTION this book is to understand how this invisible hand works its magic. As you study economics, you will learn that prices are the instrument with which the invisible hand directs economic activity. Prices reflect both the value of a good to society and the cost to society of making the good. Because households and firms look at prices when deciding what to buy and sell, they unknowingly take into account the social benefits and costs of their actions. As a result, prices guide these indi￾vidual decisionmakers to reach outcomes that, in many cases, maximize the wel￾fare of society as a whole. There is an important corollary to the skill of the invisible hand in guiding eco￾nomic activity: When the government prevents prices from adjusting naturally to supply and demand, it impedes the invisible hand’s ability to coordinate the mil￾lions of households and firms that make up the economy. This corollary explains why taxes adversely affect the allocation of resources: Taxes distort prices and thus the decisions of households and firms. It also explains the even greater harm caused by policies that directly control prices, such as rent control. And it explains the failure of communism. In communist countries, prices were not determined in the marketplace but were dictated by central planners. These planners lacked the information that gets reflected in prices when prices are free to respond to market It may be only a coincidence that Adam Smith’s great book, An Inquiry into the Nature and Causes of the Wealth of Na￾tions, was published in 1776, the exact year American revolu￾tionaries signed the Declara￾tion of Independence. But the two documents do share a point of view that was preva￾lent at the time—that individu￾als are usually best left to their own devices, without the heavy hand of government guiding their actions. This political phi￾losophy provides the intellectual basis for the market econ￾omy, and for free society more generally. Why do decentralized market economies work so well? Is it because people can be counted on to treat one another with love and kindness? Not at all. Here is Adam Smith’s description of how people interact in a market economy: Man has almost constant occasion for the help of his brethren, and it is vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favor, and show them that it is for their own advantage to do for him what he requires of them. . . . It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. . . . Every individual . . . neither intends to promote the public interest, nor knows how much he is promoting it. . . . He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. Smith is saying that participants in the economy are moti￾vated by self-interest and that the “invisible hand” of the marketplace guides this self-interest into promoting general economic well-being. Many of Smith’s insights remain at the center of mod￾ern economics. Our analysis in the coming chapters will al￾low us to express Smith’s conclusions more precisely and to analyze fully the strengths and weaknesses of the mar￾ket’s invisible hand. ADAM SMITH FYI Adam Smith and the Invisible Hand