Market Failure

In Adam Smith’s Wealth of Nations, Smith says that the best economic outcome for all comes when the individual acts in their self interest. When people act in their self interest, new goods and services are created that benefit both producers and consumers, this is the invisible hand.

The invisible hand is part of the Laissez-faire—latin for let do— approach to the market. Laissez-faire is an economic system in which transactions between private parties have no intervention from the government such as regulations, tariffs, and subsidies. The government just lets do.

Laissez-faire is an economic philosophy of free-market capitalism. But like any theory there’s flaws in practice. An example of this is pollution. If the government is laissez-faire then businesses will act within their own self interest. Perhaps dumping chemicals in the ocean or smog in the air to save money. If they refuse, then the competition can sell lower offerings and the “invisible hand” will push them out of the market.

These are what’s known as market failures. Here, the individual acts in self interest but does not benefit the whole.

And this is the issue with a laissez-faire system. In this case, perhaps it would be better for the government to act as a referee and set regulations that all businesses have to obey.