Principle 6 – Markets & the Invisible Hand

Principle 6 – Markets Organize Economic Activity

• \textbf{Market economy:} resource allocation determined by prices & self-interest of firms/households, not central planners.
• Decentralized choices ➔ efficient coordination ➔ higher prosperity (contrast with Soviet-style central planning).
• Collapse of communism illustrates failure of planners to process vast, changing information that prices convey.

Adam Smith & the Invisible Hand

• 1776 “Wealth of Nations”: competitive markets act as if guided by an \textit{invisible\ hand}.
• Prices transmit \text{costs} (sellers) and \text{values} (buyers) ➔ adjust until supply = demand.
• Resulting equilibrium often \max society’s well-being without anyone intending it.

Government Intervention

• Taxes & price controls distort prices ⇒ impede invisible hand ⇒ misallocation of resources.
• Examples: rent control, taxi medallions, centrally fixed prices in communist economies.

Motivation in Markets

• Participants pursue self-interest, not benevolence.
• Trade: “Give me what I want, and you get what you want” ⇒ mutual gain.

Case Study – Uber vs. Regulated Taxis

• Traditional taxis: entry limits, fixed fares enforced by government policing powers.
• Uber (2009 on): app-based matching; bypasses many taxi regulations.
• Surge pricing: fares \uparrow when demand \uparrow ➔ incentivizes extra drivers, allocates rides to those who value them most.
• 2014 economist survey: 100% say ride-sharing ↑ consumer welfare; 85% say surge pricing ↑ consumer welfare.
• Illustrates invisible hand: flexible prices & competition improve efficiency.