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Capitalist EconomyB) Capitalist Economy
Adam Smith, , 1776.
Adam Smith was the 'forefather' of capitalist thinking. His assumption was that humans were self serving by nature but that as long as every individual were to seek the fulfillment of her/his own self interest, the material needs of the whole society would be met. Therefore, there was no need for the government or any outside force to interfere or try to regulate the market. Privately held property and making profit would be the norm and help provide incentive.
Society would only benefit, Smith believed , if there were no monopolies so that competition could operate unrestricted. So, for instance, if one baker in your neighborhood decided to charge ten dollars for a loaf of bread, he would not get away with it as long as there were another baker willing to sell his bread for a more reasonable price. You, acting in your own self interest would go to the cheaper baker (competition). If however, one person owned all of the bakeries in your neighborhood (monopoly) and he raised the price, you would have no choice and would have to pay or go without bread.
This tendency for competition to keep the prices of products in line with the needs of consumers Adam Smith called the "invisible hand." The invisible hand of the market, said Adam Smith, will allow the self interest, of each individual to provide for the overall interest of society.
Adam Smith also described the idea of division of labor. Efficiency is important in a capitalist economy and Adam Smith observed one day in a pin factory that pins could be produced more efficiently if "one man draws out the wire, another straights it, a third cuts it, a fourth points it . . ." and so on. More pins could be produced this way than if one person made the whole pin each time. This was the birth of the modern day industry.
According to Adam Smith, what is the main thing that individuals should be concerned about in order to make society run smoothly?
Do you agree that people act mainly in their own interest? Do you think this is human nature?
What are the main characteristics of a capitalist economy?
How do you think Adam Smith would view the large corporations of the modern world?
The Role of Self
This podcast describes the concepts of self-interest and competition in a market economy, and their importance as the ''invisible hand'' that guides the economy.
The Role of Self-Interest and Competition in a Market Economy - The Economic Lowdown Podcast Series
Adam Smith described self-interest and competition in a market economy as the "invisible hand" that guides the economy. This episode of the Economic Lowdown Podcast Series explains these concepts and their importance to our understanding of the economic system.
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A market economy is an economic system in which individuals own most of the resources - land, labor, and capital - and control their use through voluntary decisions made in the marketplace. It is a system in which the government plays a small role. In this type of economy, two forces - self-interest and competition - play a very important role. The role of self interest and competition was described by economist Adam Smith over 200 years ago and still serves as foundational to our understanding of how market economies function.Self Interest is the motivator of economic activity.
Why do you go to work? Why do you go to school? There may be many reasons, but at their core you probably go to work and school because you are self-interested. To be self-interested simply means that you seek your own personal gain. You go to work because you want to get paid so you can buy the things you want. You go to school so you can get a better job someday and earn more money to buy the things you want. In fact, most of the economic activity we see around us is the result of self-interested behavior. Adam Smith described it this way in his book, The Wealth of Nations:
"It is not from the benevolence (kindness) of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."
So why does the baker choose to bake? The answer is self-interest. The baker wants to earn enough money to feed his family and buy the things he wants and the most effective way he has found to do that is to bake bread for you. In fact his bread has to be good enough and the service friendly enough that you are willing to give up your money freely in exchange for his bread. The baker while serving his self-interest has produced a good that is very valuable to you. The miracle of a market system is that self-interest produces behavior that benefits others.
Is being self-interested greedy? Is it immoral? While the term self-interest has negative connotations, it does not necessarily imply greedy or immoral behavior. Self-interest just means that you seek your goals. In fact, your self-interest might lead you to study hard for your math test, give money to your favorite charity or volunteer at a local school.Competition is the regulator of economic activity.
Doesn't self-interest lead to price gouging, corruption and cheating? Sometimes it does, but most often it is held in check by competition. Because other self-interested people are competing in the marketplace, my self-interest is held in check. For example, if I were a baker, the only way I would be able to earn your dollars is to produce bread that is better, cheaper or more convenient than the bread produced by the other bakers in town. If I were to increase my price too much, you would likely buy bread from my competitors. If I were to treat you poorly when you enter my store, you would likely buy from my competitors. If my bread were moldy or inferior in any way, you will likely buy from my competitors. In order to earn your money I must provide a high quality good or service at a reasonable price. You will notice that this assumes I have competitors. If I were the only baker in 100 miles, I might be able to charge a high price, sell inferior products, or treat my customers rudely - but even in that case, another self-interested person might see an opportunity to earn a profit and open a competing bakery in town. Thus, competition is the regulator, a check on self-interest because it restrains my ability to take advantage of my customers.The Invisible Hand
Adam Smith described the opposing, but complementary forces of self-interest and competition as the invisible hand. While producers and consumers are not acting with the intent of serving the needs of others or society, they do. When you work, your goal is to earn money, but in the process you provide a valuable good or service that benefits others and society. The amazing part of this process is that there is very little government control. The bread you buy at the store arrived as the result of hundreds of self-interested people cooperating without a government bread agency managing production at each step along the way. The farmer grew the grain, the mill prepared the flour, the bakery produced the bread, the truck driver delivered the bread to the grocery store, the grocer stocked the shelves and sold the loaf to the consumer all without a Government Secretary of Bread Production telling any of them what, where, when, or how much to produce. It's as if they were being guided by an invisible hand that guided resources to their most valued use. In the words of Adam Smith:
Self-interest refers to actions that elicit personal benefit. Economist Adam Smith studied self-interest and its positive influence on the economy.
ECONOMICS BEHAVIORAL ECONOMICS
By WILL KENTON Updated May 28, 2021
Reviewed by ERIC ESTEVEZ
What Is Self-Interest?
Self-interest refers to actions that elicit personal benefit. Adam Smith, the father of modern economics, explains that the best economic benefit for all can usually be accomplished when individuals act in their own self-interest. His explanation of the Invisible Hand reveals that when dozens or even thousands act in their own self-interest, goods and services are created that benefit consumers and producers.
Moreover, Smith and other economists have also studied the behaviors of rational self-interest which suggest that most people will act in an economically rational way when faced with behavioral decisions affecting their own personal income and well-being which can also contribute to the positive effects of the Invisible Hand.
Self-interest refers to actions that elicit personal benefit.
Economist Adam Smith was primarily the first person to study self-interest in economics, leading to his Invisible Hand Theory.
The Invisible Hand Theory suggests that when entities make economic decisions in a free market economy based on their own self-interest and rational self-interests it manifests unintended, positive benefits for the economy at large.
Self-interest and competition dominate in capitalist economies where goods and services are exchanged freely.
Many people criticize self-interest since it can often lead to corruption and cheating if government regulations do not keep it in check.
Self-interest can be both a psychological and economic term. In general, it refers to individual actions and behaviors that provoke positive personal benefits. Throughout the years, economists have studied self-interest and the behaviors of rational self-interest to help develop theories and assumptions for the economy.
Adam Smith explored the economic effects of self-interest and rational self-interest in his popular book, An Inquiry into the Nature and Causes of the Wealth of Nations—commonly referred to simply as The Wealth of Nations. Smith found that self-interest and rational self-interest were powerful motivators of economic activity. As such, he based his theory of the Invisible Hand on these key areas.
Adam Smith and Self-Interest Considerations
In a market economy, individuals and businesses own most of the resources available (e.g. labor, land, and capital) and use voluntary decisions, made in their own self-interest, to achieve the greatest personal benefit from marketplace activities and transactions. In this type of system, the government plays a small role, and the economy is shaped by two forces: self-interest and competition.
Adam Smith argued that self-interest was of utmost importance as a motivator for economic activity. In his book The Wealth of Nations covering the subject, he describes it this way:
“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.”1
Self-interest and competition dominate in capitalist economies where goods and services are exchanged freely. These forces drive the supply and demand for goods and services as well as the value of goods and services. They can also lead to innovation.
Adam Smith was one of the first economists to explain how self-interest and rational self-interest in a free-market economy can lead to overall economic well-being. These concepts are developed in Smith’s theory of the Invisible Hand which purports that a large majority of society benefits when each entity acts in their own best interest because it also overlaps with the best interests of others manifesting unintended but powerful societal benefits at large.
Adam Smith was one of the first economists to explain how self-interest in a free-market economy can lead to overall economic well-being.
Rational self-interest is also a component of Smith’s Invisible Hand theory. With rational self-interest, Smith suggested that humans act rationally when making decisions involving their finances or monetary benefits which also have a powerful influence on the economy. This plays out in decisions on price comparisons, substitutes, expense management, and more. Overall, decisions made with rational self-interest are generally made based on financial prudence and economical satisfaction. Thus, rational self-interest can lead to important assumptions for economic projections and analysis.
In terms of a market economic system, the basic assumption is that both producers and consumers act with self-interest as well as rational self-interest to invoke not only the greatest benefits but the most prudently managed financial decisions as well. Therefore, both self-interest and rational self-interest often occur simultaneously.
The Invisible Hand
The concept of the Invisible Hand was introduced by Smith in the 18th century. It refers to the idea that when parties act or interact, making decisions based on self-interest, unintended benefits are produced for society at large. This is the basis for the underlying concept of Smith’s overriding explanation of the importance of self-interest in economics.
Economists believe that the Invisible Hand has been the driver of a number of goods and services created for the benefit of both consumers and producers. As parties interact in a market economy, voluntary exchanges occur. These voluntary exchanges are based largely on actions made in self-interest. These actions manifest societal benefits at large because actions of individual self-interest often overlap with the best interests of others creating unintended benefits for large-scale economic gains.