Text 10. FOUNDATIONS OF THE MARKET ECONOMY

In his well-known work The Inquiry Into the Nature and Causes of the Wealth of Nations, Adam Smith wrote, «Every individual neither intends to promote the public interest, nor knows how much he is promoting it. He intends only his own security, 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. By pursuing his own interest he frequently promotes that of society more effectually than when he really intends to promote it».

Adam Smith's «invisible hand» underlies the importance given to individuals and individual decision-making in a free market economy. Smith contended that individuals, operating alone and without government intervention, could seek fulfillment of personal needs and, at the same time, assist in satisfying the goals of the economy. The idea that self-interest adds to the good of society is a fundamental tenet of all market driven economic systems.

In The Wealth of Nations, Adam Smith hints that of all possible economic systems, the market system has the highest potential. He knew, in the late 1700s, that the driving force behind the free market economy would be individual self-interest. To praise self-interest in 1776, as Smith did, was revolutionary. The idea that self-interest could be a noble or acceptable virtue had only recently emerged. During the Middle Ages, self-interest was considered synonymous with greed and, thus, improper and immoral. There were usury laws against charging interest because it was thought sinful for a lender to extract interest from a borrower. It was not until the late 1700s, when the economist Jeremy Bentham described his «pleasure-pain calculus», that self-interest began to be seen in a more positive light.

The theory behind the pleasure-pain calculus holds that if individuals seek their own satisfaction, society as a whole prospers. Bentham's idea is subject to the fallacy of composition: for example, a rock music fan pursuing the maximization of his or her pleasure may easily disturb the peace and tranquillity of a neighbour who prefers classical music. What is good for one is not necessarily good for all. However, on the more basic issues of self-interest and societal welfare, most free market economists agree that Bentham's pleasure-pain calculus escapes the fallacy of composition. Adam Smith refined Bentham's idea with his concept of the invisible hand. Self-fulfillment, individual motivation, or the desire for profit, if controlled by the forces of competition, could create a better world for all. This belief is the foundation of the market system.

Within the market system, individual self-interest motivates the labour force -workers «trade» their labour for money they can use to purchase food, shelter, clothing, and other consumer goods. This is hardly altruistic. Nonetheless, the products and services generated by this labour benefit other people as well. For example, an airline pilot flies a commercial plane in order to earn a salary; however, the fact that the pilot performs his or her job enables many passengers to travel on the plane. Their purposes - whether business or pleasure - are also served by the pilot's self-interest in flying the plane.

The second important principle of the market system is the idea of consumer sovereignty. Consumer sovereignty means that the individual consumer decides what is to be produced in the economy. In the United States, the executives of large corporations who decide what will be produced base their decisions on what they perceive to be the wishes of the marketplace. Thus, the sum total of individual consumer wants ultimately determines what is to be produced. A daily election of goods and services takes place in the marketplace of capitalism. That portion of a consumer's income that is available for spending in the marketplace is often referred to by economists as the consumer's «dollar votes». On a daily basis, consumers cast their ballots for those products that they believe are reliable, safe, and of good quality. Consumers reject products that do not perform well, are too highly priced, and seem to be bad bargains.

Store owners watch what is being sold on a daily basis. Items that are big sellers are reordered, while items that accumulate on store shelves are not. Such products are not in great demand: they have «failed» the market test, lost the consumer election, and soon disappear from the market.

In the market system, producers must react quickly to capitalize on consumer interest, and they stand ready to reallocate resources at a moment's notice. Some products can be created almost instantaneously in response to consumer demand. Books are written, printed, and made available to the public remarkably soon after a major event of great concern or interest occurs. A particular song becomes a hit on the radio and, almost immediately, abundant supplies of the record appear in the stores. A popular professional football player appears on national television wearing an obscure brand of sunglasses and, suddenly, every budding athlete wants a pair. Almost overnight, retailers all over town are advertising the product's availability.