Adam Smith Economic Theory

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Table of Contents

The Invisible Hand Theory
Division of Labour Theory
International Trade Theory
Importance Adam Smith Theories
Benefits of the theory to the U.S. Economy
References

The Invisible Hand Theory

According to this theory, Adam Smith points out his feeling about the operation of the economic society. He felt that each individual aimed at becoming rich with an intention of personal gain. However there must be sharing and exchange of commodities that one owns or what he produces.

This leads to advancement of the public interest through free market and public interest. Adam Smith is recognized as the father of economics and came up with all sorts of phenomenon for instance: environmental degradation, scientific progress and the game theory (Joyce, 2001).

Adam Smith linked the invisible hand theory to God’s creation of the universe that made human beings happy. Basing on this, he stated that the property rights must be very strong and people must respect and put into practice the social norms to minimize representations and theft.

According to smith theft was the worst crime to be committed although the poor can steal from the rich and they feel happy. According to him, the role of the government is to protect the rich from the poor.

He further states that the social norms are very important for any system to work to enable continuation of the exchange and enforcement of the contracts. This would enable people to get information about the availability of goods and services hence the rule of law must hold

He also explained how the theory works in the modern world. Adam explained a process that occurs through what he calls the invisible hand, which leads to the outcome of decentralized institutions with business contracts acting as agencies to economic transactions.

The entire process is not mandatory but is intentional with each party having some interests. However, the interests of the agents involved in the process are not similar and therefore not coordinated by the outcome of the process, which the exchange of goods and services. He said that the process is called invisible because it should be in progress even without the knowledge of the agents.

The free market, which other scholars call the market economy is mainly characterized by Adam Smith’s invisible hand given that market operators interact freely given their interests. Adam Smith assumed that consumers go in for lower prices but entrepreneurs venture into businesses of high profits.

He said that the demand of the consumers is identified by entrepreneurs through the market prices which give them a direction and an opportunity to invest in the production of various goods in a profitable industry. Put in mind that this is an industry that will produce high quality goods and services hence increasing the overall economic well being.

The most important part of the market based economy is that it put into consideration demands for other people. According to Smith, this was the good part of the invisible hand mechanism. He came up with two ways that can enable one to interact freely with others.

The first way is that they should always show the goodwill of others. Smith found out that to do this one must be repulsive which has limited success. The second way is to plea to the interest of other people

For Smith, his intention of proposing an exchange is to serve as an example to other people that what you can do is of benefit to other people. This is because when one carry out an exchange it shows that he value what other people have. This explains why the self esteem of a job is reflected in a person’s pay for instance a good pay is an indicator of how others value your contribution

Division of Labour Theory

According to Adam Smith, the riches of a nation depend on its economic growth. He further states that growth is engrained in specialization of labour which simply refers to breaking down of the production process into various stages.

Specialization is significant because repetition of the same task improves on the workers efficiency. It also saves time because labourers do not move from one task to the other. Specialization enabled the Victorian industries to expand during the nineteenth century.

They used the assembly line production to enable workers concentrate on a specific stage of the production process. However, Smith came up with various problems that were associated with this development. He found out doing the same task repeatedly makes labourers to be ignorant. Basing on this belief¸ he urged the government to take the role of educating workers.

International Trade Theory

The major objective of Adam Smith on international trade theory was to analyze various ideas called mercantilism. Some mercantilists were of the view that government regulation was a necessary requirement of international trade for a nation to have favourable balance of trade meaning that exports should be more than the imports.

The term favourable balance of trade is used to explain a situation where a country exports more goods than what it receives where the difference between these situations is solved by making payments by use of gold (Smith, 2012).

A favourable balance of trade can only be favourable if one wrongly believes that the riches of a nation depend upon it having metals like gold. However, Smith argued that if a country can produce more goods than another country at a lower cost than it would be beneficial for the two countries to exchange their goods.

Each country would exchange the good that it produces at a lower cost for the good it produces at a relatively expensive cost. In economics, this is referred to as absolute advantage against foreign trade. This argument is not restricted to foreign trade. It can also be used in national trade.

In modern economics, as labour concentrates on the production of a particular commodity there is always a reduction in costs. He argued that the merits of international trade were based on increasing returns.

He realized that if two people were born with a particular talent and it does not change then it means that they will not benefit if they specialize and sell their goods. Smith recognized that each nation has the capability to gain absolute cost advantages in the creation of some goods and services through division of labour and specialization, and all nations could have an added advantage resulting from foreign trade.

Smith criticized policies made by the mercantilist because they evaluated the wealth of the country basing on the amount of precious metals it had instead of looking at the flow of goods. Smith hold that the government should set appropriate policies concerning foreign trade and the same should apply to domestic trade.

A laissez faire policy would improve the level of economic growth of a country. Modern economics evaluated the economic ideas and found out that there is a difference between the mercantilists and the classical that had significance on free markets against the government regulation.

In modern economics, exchange is a game in which there should be a winner and a loser. To prove that all nations can benefit from international trade, one must prove that the production of goods has increased after exchange of goods and services has taken place (Bagehot, 1915).

Smith’s insight on international trade theory was that both nationals and international countries must gain from voluntary exchanges made. Its major aim was to ensure that the US economy thrives in the long run.

Importance Adam Smith Theories

Specializations make workers to be experts in their fields of operation. As a result they become more competent in the production process which reduces the costs of production. Specialization is also very important because it leads to development of machines and tools that make workers perform their duties effectively.

According to Smith, division of labour must lead to production of valuable goods. Labour must produce more goods that can be used to produce more goods. Adam Smith identified the exchange and use value. Smith came up with a conclusion that labour is the major foundation of value.

The cost of a good is also known as its natural price. However, the natural price should not serve as a real value of the good in the market. Competition is expected to bring some changes in the market by either pushing the natural price up or down.

Benefits of the theory to the U.S. Economy

Trade liberalization is assumed to be an influencing factor to economic prosperity and growth. Free trade is important in fighting poverty and aiming at expanding economic growth of a country. The trade policy legislation made it possible for America to advocate for free trade and the benefits associated with these policies. It was mandatory that lawmakers evaluate the trade initiatives.

Free trade earned the US economy $12 trillion. The total exports in the US in 2005 totalled to $1.2 trillion. These have created manufacturing employment opportunities in the US. The jobs were directly linked with an improvement in good pay from 13% to 18%. Foreign trade has a positive impact on jobs both in the private and manufacturing g sector.

Foreign trade creates employment opportunities in Ohio’s private sector. It also supports one out of 10 private sector jobs in South Carolina. Foreign trade also promotes opportunity. International trade also accounts for 79% in the service sector of the United States economy. The service industry also contributed to generation of job opportunities. For over 20 years the service industry had created about 40 million jobs in the large America.

Currently, the international economy provides unmatched opportunities for the United States economy to enlarge trade by eliminating barriers to services and goods. Free trade has increased on the level of competition in the modern market leading to production of quality goods, introduction of new markets, increasing labourers pay and increasing saving and invest% of global consumers stay outside the US. Free trade enables the United States to join the market and improve economic growth of America.

The United States has equally benefited from the reduction of trade barriers for more than five decades. This acted as an open door to economic growth and improvement of standards of living. Free trade has improved standards of living for Americans and is optimistic to bring more improvements if trade barriers are broken down.

The institute of global economics found out that trade liberalization has a positive effect of increasing income to an American household by $9,000 annually. Other benefits resulting from free trade are the Uruguay round of the world trade organization and the free trade agreement that generate yearly benefits of 1300 dollars to 2000 dollars for an American with a family with four.

Similarly, Free trade also avails goods and services to Americans at relatively cheaper prices, enabling families to save part of their income or purchase more goods and services. Adam Smith theories have helped the economy because these theories are associated with various benefits as explained in importance of Adam Smith theories.

I think Adam Smith would suggest free trade and trade liberalization as an economic plan for our economy. This is because according to him, free trade and trade liberalization are the major pillars to economic growth and improvement of living standards of people of America.

Adams1 smith Advice to the United States would be that it opens it economy even more and remove the protectionist barriers such as “made in America” policies. The current policies in the U.S. are not beneficial to the citizens. He huge debts that the government has accumulated have put more pressure on tax payers, unemployment is still high (Finnegan, 2012).

References

Bagehot, W. (1915). Adam Smith and our modern economy. Web.

Finnegan, M. (2012). Romney pounces on Obama’s economic policies. Web.

Joyce, H. (2001). Adam Smith and the invisible hand theory. Web.

Smith, A. (2012). Free trade and international trade theory. Web.

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