The Invisible Hand

Watch this video before our next lesson and try to understand the key elements of Adam Smith’s landmark theory.

Solving the Economic Problem

Economics addresses the central issue of how scarce resources can be used in the most efficient way to produce the goods and services that consumers need and want.

Economists, like politicians, often disagree and a range of ‘solutions’ to the economic problems have been considered and attempted. A range of ‘economic systems’ exist and and no two economies are the same, but they can be boiled down to:

An economic system is a network of organisations used by a society to resolve the basic problem of what, how much, how and for whom to produce.

Free market economies:

Where households own resources and markets allocate resources through the workings of the price mechanism.  An increase in demand raises price and encourages businesses to switch additional resources into the production of that good or service.  The amount of products consumed by people depends on their income and household income depends on the market value of an individual’s work. In a free market economy there is a limited role for the government. Indeed in a pure free market system, the government limits itself to protecting the property rights of people and businesses using the legal system and it also seeks to protect the value of money or the value of a currency.

Planned or command economies:

In a planned or command system typically associated with a socialist or communist system, scarce resources are owned by the government. The state allocates resources, and sets production targets and growth rates according to its own view of people’s wants.  In such a system, market prices play little or no part in informing resource allocation decisions and queuing rations scarce goods.

Mixed economies:

In a mixed economy, some resources are owned by the public sector (government) and some resources are owned by the private sector. The public (or state) sector typically supplies public, quasi-public and merit goods and intervenes in markets to correct perceived market failure.