What it is:
The invisible hand refers to the self-regulating nature of the marketplace in determining how resources are allocated based on individuals acting in their own self-interest.
How it works (Example):
Coined by classical economist Adam Smith in The Wealth of Nations, the invisible hand refers to an unseen mechanism that maintains equilibrium between the supply and demand of resources. Smith states that the invisible hand functions by virtue of the innate inclination among free market participants to maximize their well-being. As market participants compete, driven by their own needs and wants, they involuntarily benefit society at large.
Smith envisioned the invisible hand as eliminating the need for market intervention on the part of government. Moreover, such regulatory action, Smith believed, would only be detrimental to market efficiency.
[InvestingAnswers Feature: Adam Smith & the Wealth of Nations: The Birth of Economics]
Why it Matters:
Adam Smith's invisible hand theory set the foundation for laissez-faire economic philosophy, which argues that government intervention in the marketplace is unnecessary. Instead, changes in demand for resources automatically result in price adjustments without the need for regulation.