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The invisible hand principle can be difficult to grasp because there is a natural tendency to associate order with central direction and control. Surely some central authority must be in charge. But this is not the case. The pricing system, reflecting the choices of literally millions of consumers, producers, and resource owners, provides the direction. The market process works so automatically that most of us give little thought to it. We simply take it for granted.
Perhaps one example from your everyday life will help you better understand the invisible hand principle. Visualize a busy retail store with ten checkout lanes. No individual assigns shoppers to checkout lanes. Shoppers are left to choose for themselves. Nonetheless, they do not all try to get in the same lane. Why? Individuals are always alert for adjustment opportunities that offer personal gain. When one lane gets long or is held up by a price check, some shoppers will shift to other lanes and thereby smooth out the flow among the lanes. Even though central planning is absent, this process of mutual adjustment by self-interested individuals results in order and social cooperation. In fact, the degree of social cooperation is generally well beyond what could be achieved if central coordination were attempted – if, for example, stores hired someone to assign shoppers to checkout lanes in the interest of getting everyone out as quickly as possible. Shoppers acting in their own interests promote the most orderly and quickest flow for everyone. A similar phenomenon occurs on busy interstate highways as drivers switch between lanes for
personal gain, with the end result being the quickest flow of traffic for everyone.
Market participation is a lot like checking out at a retail store or driving on the free- way. Like the number of people in a lane, profits and losses provide market participants with information about the advantages and disadvantages of different economic activities. Losses indicate that an economic activity is congested, and, as a result, producers are unable to cover their costs. In such a case, successful market participants will shift their re- sources away from such activities toward other, more valuable uses. Conversely, profits are indicative of an open lane, the opportunity to experience gain if one shifts into an activity where the price is high relative to the per-unit cost. As producers and resource suppliers shift away from activities characterized by congestion and into those characterized by the opportunity for profit, they smooth out economic activity and enhance its flow. Remarkably, even though individuals are motivated by self-interest, market prices direct their actions toward activities that promote both order and economic progress. This is precisely the message of Smith’s “invisible hand.”
all without the central direction of any government official. How do markets bring the interests of individuals into harmony with economic progress? Consider the following three vitally important functions performed by market prices.