Question

Adam Smith argued that markets produce wealth in which of the following ways?

Answer 1

Adam Smith who is known as the father of economics argued that wealth can be produced through free trade in the market, and this free trading system is controlled by the market forces of demand and supply or known as the force of an invisible hand in the market mechanism and wealth generation. So the way of wealth production is known as the free market mechanism as argued by Adam Smith. His ideas encompassing such argument has been depicted in his book "The Wealth of Nations."

He argued that Government intervention in the economy and restrictive trade practices give rise to inefficiency in the market mechanism and market equilibrium is not achieved due to surplus (excess production) or deficiency (inadequate production) in the economy i.e., the gap that has been generated by such intervention restrain the market from reaching the equilibrium condition, where the equilibrium price and quantity is not achieved within the market. According to him, if the Government intervention is limited with lower tax rates, and free trade practices globally, where buyers and sellers come to a general agreement regarding the price and quantity bought and sold, would contribute to the generation of more wealth and a higher level of output in the economy. The capitalistic approach was first introduced by him in his book initially when more restrictive trade practices prevailed.

In his argument, he described that division of labor, technological advancement, and free-market mechanism without any intervention or restriction can ultimately increase the overall production of the economy, with a lower cost of production and a better standard of living. When human resources will specialize in certain specified jobs, each job can be completed more efficiently and effectively due to more knowledge and training of the specialized workers. This will cut down the production cost. Whereas technological advancement will cut down the cost of production with better equipment and machinery. This reduced cost will decrease the price of the products and services with enhanced quality and increased production. So the society at large will benefit from such a free market with a better quality of life and better products.

He explained that it is always better for the people to act out of their self-interest while affecting a trade. The motive to get maximum utility of the consumers and the profit maximization motive of the producers will ultimately bring the price and quantity to an equilibrium point. So by working out of self-interest to achieve market equilibrium, the society will get benefitted with a better economy.

His theory is famous globally and in recent times we can find the most developed economies to be capitalistic ones with free-market practices and promotion of global trade between different countries. Global trade helps to curb the opportunity cost that countries incur due to higher domestic cost of production of a product due to some disadvantage. While some other country is at an added advantage to produce the same product at a lower cost. So an effective trade practice between such countries will ultimately decrease the cost of production and make the product cheap with enhanced quality of the product due to specialization.

Such practices will induce investment of the funds that are getting generated due to high production and national income facilitating from the better market mechanism, efficient labor supply, enhanced technology, and global trade. So without restriction from the Government, the economy can work efficiently and effectively as the Government intervention is a leakage in the circular flow of income, it keeps the market from flourishing and sometimes promotes unhealthy trade practices such as hoarding, black market, etc., so that the producers can raise the price of the commodity for better profit.

So from the above discussion we can conclude that the argument in favor of free-market mechanism and working of the invisible hand, where everyone is acting out of self-interest, without any Government intervention in the economy with lower tax rates and specialization of labor, with free-trade practices across the globe, can actually contribute to the development of the economy and the society at large with better standard of living, increased personal income, more production thus higher national income. It can actually promote the well-being of society and generate maximum wealth in the economy.