Le Chatelier’s Principle and the Invisible Hand
In his prominent and august book, ‘The Theory of Moral Sentiments’, published in 1759, renowned economist Adam Smith first introduced the concept of the ‘Invisible Hand’. The invisible hand is often used as a metaphor to describe the unobservable force that facilitates the self-adjustment mechanisms of markets, allowing them to reach the stage of equilibrium. Such an equilibrium can be described in many ways- using microeconomic models of demand and supply, macroeconomic models of aggregate demand and aggregate supply et al. The philosophical model is also used to describe how individual pursuits of self-interests can result in unintended benefits accruing to the society. Several other interpretations of this model suggest different theories and thus expound several distinct explanations.
One of the common analyses of the model has manifested in the form of The First Fundamental Theorem of Welfare Economics, also known as The Invisible Hand Theorem. According to this theorem, competitive market equilibrium results in Pareto efficient outcomes. A Pareto efficient outcome is one that allocates capital among individuals in the most efficient way. In case market equilibrium gets disrupted due to changes in economic factors, the invisible hand attempts to minimize the effect of that change, bringing the market back to Pareto efficiency. This functioning of the invisible hand draws a close relationship with Le Chatelier’s principle, also known as ‘The Equilibrium Law’.
The Le Chatelier’s Principle in one of the most important principles in Chemistry. It states that ‘A change in any of the factors affecting the equilibrium conditions of a reaction (such as pressure, volume, temperature, Concentration of reactants, inert substance, etc.) will cause the chemical reaction to act in a manner to counteract the effect of change. Such a change depends on:
- Type of change
- Position of change
- Nature of chemical reaction
The same mechanism applies to the invisible hand. It moves the market to equilibrium (Pareto efficiency in economics) depending upon changes in market conditions (like no. of buyers, no. of sellers, tastes and preferences, input costs, selling costs, technology, subsidies, et al). In economics too, the functioning of the invisible hand depends upon the above three factors.
Taking the first change as an example, a change in pressure and a change in volume will both impact a chemical reaction, but in different ways. An increase in pressure would cause the reaction to move in the direction where there are lesser no. of gaseous moles, but an increase in volume will cause the reaction to move in the direction where there are more no. of gaseous moles. Likewise in economics, both cost of inputs and technology have different outcomes on market equilibrium. An increase in input cost would move the supply curve to the left and the invisible hand would raise the equilibrium price and reduce the equilibrium quantity. But an improvement in technology would move the supply curve to the right and increase the equilibrium quantity, but reduce the equilibrium price.
In the second case, when the position or the point of application of the change is different, the response to the change also differs. For eg. an increase in the concentration of any of the chemical species that constitutes the chemical reaction will cause the chemical reaction will cause the chemical reaction to move in a certain direction. If the concentration of reactants increases, the reaction moves in the forward direction. But if the same change was applied on the reactant side, the reaction would move in the reverse direction. Similarly in economics, an increase in market demand will cause the invisible hand to increase the equilibrium price, but an increase in supply will prompt the invisible hand to reduce the equilibrium price.
Finally in the third case, the change in direction of chemical reaction in response to a change depends upon the chemical reaction itself. For example, an increase in temperature causes the reaction to move in the forward direction in case of an endothermic reaction and in the backward direction if the reaction was an exothermic reaction. Even in Economics, the effect of change depends upon market conditions. For example, in a perfectly competitive market where producers are earning abnormal profits in the short run, the invisible hand causes the supply of goods sold to increase, reducing the price (or average revenue), and thus reducing the profits in the long run. However in case of monopoly, such a change will not occur because the invisible hand will not be able to raise the supply due to restrictions in market entry and exit.
The above three analogies can be used to interpret the invisible hand in a unique way. Economics and science indeed show a lot of similarities. I’ve always believed in drawing logic in economics from science. It helps to use science both as a lens to see Economics and as a tool to anatomize Economics.
