Chapter 3.
The Invisible Hand: How Markets Work

Every individual . . . neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own gain, and he is in this . . . led by an invisible hand to promote an end which was no part of his intention.
Adam Smith, The Wealth of Nations (1776)


  • The value of a Vincent Van Gogh painting
  • How markets work
  • What it means to be in equilibrium
  • Price and value in Oscar Wilde

Scarcity breeds competition and the need to make tough choices. Opportunity cost is a way to evaluate each choice. The Production Possibility Curve exhibits opportunity cost. Some simple accounting in balance sheets and income statements helps to determine which choices have recently been possible and might be available---on the "budget line" or the Production Possibility Curve---in the near future.

Now we put choice into markets. Markets-from flea markets and thrift stores to grocery stores, employment agencies, and stock markets-bring together people who want to sell goods and services with others who want to buy them. Though no one is in charge, and everyone is focused only on profit, the competitive haggling somehow orchestrates buyers' and sellers' choices. The result is beneficial overall.

Rodney: Excuse me. Sorry to interrupt.

McCloskey: Rodney: what did I tell you about such preliminary remarks?!

Rodney: Oh, yeah, Answer Lady, "just ask the question"! You say that competition "somehow orchestrates" choices. But doesn't an orchestra, even a highly competitive orchestra, require a good conductor?

Maria: That's what I was thinking---such as the government, to conduct fair exchange, not merely profitable exchange? Just like the Chicago Symphony Orchestra needs Daniel Barenboim or someone else to do its conducting.

McCloskey: Good questions. I had a colleague at the University of Iowa who before Communism collapsed in Russia visited an agricultural region there. The Russian economists were fascinated by Jerry's account of the transport network that brought U.S. corn to market---Russia was famous then for wasting a big portion of its crop bringing it to market. One of them asked the question on everyone's minds: "But who, professor, is in charge of making the network function well? Who is the commissar," they wondered, "the boss who issues orders to get the corn harvested on time, then transported by truck to river barges and by barges to the millers and oil makers, and then to food manufacturers and animal feeders?" Jerry was startled. He replied, "Uh. . . . no one. No one is the boss. It just happens, through markets." The Russians smiled, and stopped believing him. Clearly, they all thought, the American professor was hiding a state secret. No network can work without a highly visible hand of management, backed up by firing squads and prison camps.

Like the Russians, Rodney and Maria can't see how "the invisible hand" is possible. How can socially beneficial results emerge from a crazy process driven by nothing more than profit? Stay tuned.