Answer question. Discuss the relationship between the “invisible hand theorem” a
ID: 1154683 • Letter: A
Question
Answer question.Discuss the relationship between the “invisible hand theorem” and the “rational choice postulate”, and why, and in what way, does the way you answer impact the way economists assess alternative economic system?
Answer question.
Discuss the relationship between the “invisible hand theorem” and the “rational choice postulate”, and why, and in what way, does the way you answer impact the way economists assess alternative economic system?
Discuss the relationship between the “invisible hand theorem” and the “rational choice postulate”, and why, and in what way, does the way you answer impact the way economists assess alternative economic system?
Explanation / Answer
Adam Smith in his book 'The Wealth of Nations' introduced the term 'Invisible Hand' in which the free market of demand and supply reach the market equilibrium with the help of the market forces. In this free market, everyone works for their own self-interest and as a result of this mutual interdeopendence, the benefit of the society as a whole is large. In order to maximize their own gains, the individuals are guided by an 'invisible hand' which helps them to maximize the gains of the society as well along with maximizing their personal gains. The trade markets, if left to trade freely, where traders are interested to maximize their gains, will compete with one another leading to an ouput (as guided by the invisible hand) which will be effective for the maximization of the gains in public interest as well. According to Smith, if the consumers are allowed to choose the products of their consumption and the businesses are allowed to decide independently what they want to sell, the resultant goods will be in the right quality and also right quantity which are good for the marketplace. This happens because, the producers use an efficient method of production in which the costs are minimum and the prices are low in order to maximize revenue. Also, the consumers buy goods from these sellers at the lowest price in order to maximize their own gain. The investors, too, invest in the industries which maximize their returns. All of this is only possible when the economy is allowed to function independently and is a free market economy. There is no need of any government intervention. As a result, the gains from this free market trade will be more than the one obtained in a planned (or regulated) economy.
In economics, the rational choice postulate focuses on the fact that individuals and businessmen know how to maximize their gains from any trade done. It is assumed that each individual is intelligent and aware about all the possible alternatives present around him/her and thus, knows how to work in their self-interest and how to obtain maximum gains from all the available alternatives under given constraints. This maximizing behaviour of the individuals and businessmen complements them to maximize their utility and profits.
The invisible hand theorem can be said to be derived from the rational choice postulate. The rational choice postulate says that the prime motive of any individual/businessperson is to maximize his/her gains from all the alternatives present around him/her. The invisible hand theorem says that if all the parties of trade- producers, consumers and investors will act in their self-interest, that is, maximize their gains each time, then, an invisible hand will produce an effectual output, which will be beneficial for the society as well. Thus, it seems that the individuals/businesspeople, if follow the 'rational choice postulate', it will result in benefitting the society as a whole with the help of an 'invisible hand'. Thus, when imperfect agents focus on increasing their profits by functioning in an imperfect (unplanned) market, the result turn out to be positive for each agent.
An alternative economics system is a government owned system where the state ownership plays a major role. The economic problems of what to produce, how to produce and for whom to produce etc. are solved by the guidelines based on centralised planning of the government. The centralised planning involves the government to decide on the allocation of resources to each public enterprise, their output targets as well as the prices of the various goods and services and also determine the wages and salaries of various types of workers. The government has more control (or control on the major areas) than the free market economy.
The important fact to be taken into account is that regardless of what form of economy (free market or planned), the prime motive of every individual is to maximize his/her own profits and well-being, no matter what. This 'self-interest' oriented behaviour will give rise to the choices which will benefit individual the most, which neither harms nor benefits the society (considering both, free market and planned economies). Thus, the resultant combination of both free market as well as the planned economy will be one individual gaining at the expense of the other, the 'trade off' which might seem beneficial for the individual parties but is seen as a compensatory practice between the two parties for the economy as a whole. The economists conclude that individuals will continue to act according to their 'self-interest', which is profitable by making them 'better-off' (by exchanging goods they need), while it seems as a 'trade-off' activity to the government because one party's gain represents other party's loss, even though the two parties indulge in trade for completely selfish purposes.