Economists build simplified descriptions to enhance their understanding of how things work
Crashes on a tabletop (photo: Franziska Kraufmann/Corbis)
The modern economy is a complex machine. Its job is to allocate limited resources and distribute output among a large number of agents—mainly individuals, firms, and governments—allowing for the possibility that each agent’s action can directly (or indirectly) affect other agents’ actions.
Adam Smith labeled the machine the “invisible hand.” In The Wealth of Nations, published in 1776, Smith, widely considered the father of economics, emphasized the economy’s self-regulating nature—that agents independently seeking their own gain may produce the best overall result for society as well. Today’s economists build models—road maps of reality, if you will—to enhance our understanding of the invisible hand.
As economies allocate goods and services, they emit measurable signals that suggest there is order driving the complexity. For example, the annual outputof advanced economies oscillates around an upward trend. There also seems to be a negative relationship between inflation and the rate of unemploymentin the short term. At the other extreme, equity prices seem to be stubbornly unpredictable.
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