Small business owners depend on a healthy and working economy in order to make their living and achieve their goals and projections. What causes people to spend money at your business versus spending it in one of a million other ways? The famous invisible hand theory could help to explain why your customers choose you and why you choose to believe they will continue to choose you in the future.

Invisible Hand: Definition

When economists refer to the invisible hand, they are referring to forces within the economy that help ensure its stability without the need for outside governmental intervention.

The idea is that when people act in their own self-interest, and businesses have freedom to produce goods and services without interference, they unintentionally promote the greater good through well-ordered allocation of resources to most people. Proponents of the invisible hand theory often argue for less governmental regulation in the marketplace because they believe this ensures the healthiest economy for all.

Invisible Hand: Theory

The invisible hand theory was originally introduced in the 18th century by father of economics Adam Smith in his famous work "An Inquiry Into the Nature and Causes of the Wealth of Nations". More than intending to argue for less government regulation, Smith was trying to show how someone exchanging money in his own best interest inevitably ends up impacting the lives of many other people.

As a small business leader, you likely experience this daily as customers give you money, which you then use to pay suppliers and employees, who then use that money to pay others or to purchase more goods. This means that your customer's one purchase has a ripple effect that positively impacts many other people and the economy as a whole.

Invisible Hand: Economics Implications

Invisible hand economics implies a predictability to how people spend money and supply demand. When you offer your goods and services as a small business owner, you are predicting that there will be consumer demand for what you offer, that your suppliers will come through for you and that services necessary to supply demand will be available to you. Your customers are predicting that you will show up for them, that their needs will be met and that they will receive a reasonable value for what they spend.

Other implications of the invisible hand theory include:

  • People contribute to the greater good whether they mean to or not.

  • Free trade works for the greater good.

  • When the wealthy get wealthier, this wealth trickles down to others.

  • Government regulation is not needed for most goods and services.

  • Business owners motivated by profit automatically make choices in favor of efficiency. 

Invisible Hand: Example

As an invisible hand example, let's say a small business owner want chips and salsa for a staff meeting at the last minute, so she heads to the grocery store two minutes away to buy those items. There's a taqueria 10 minutes away with authentic chips and salsa, but they cost more, and driving there would make the owner late for the meeting.

In spending $10 on snacks at the store close to home that predicted consumer demand for chips and salsa, both the business owner and the grocery store were acting in self-interest yet ended up positively impacting the greater good.

Invisible Hand: Objections

Researchers at Michigan State University completed a study arguing that the invisible hand is not what keeps the economy stable. Rather, they showed that it is actually a third party disrupting an existing trade relationship that contributes to economic stability.

Others argue that the invisible hand's trickle-down effect does not actually work, and some governmental intervention is needed to ensure fair working conditions for employees as well as to prevent or break up monopolies.