David Warshs book describes a great contradiction inherent in economi

David Warsh’s book describes a great contradiction inherent in economic theory since 1776, when Adam Smith published The Wealth of Nations. Warsh calls it the struggle between the Pin Factory and the Invisible Hand.

Using the example of a pin factory, Smith emphasized the huge increases in efficiency that could be achieved through increased size. The pin factory’s employees, by specializing on narrow tasks, produce far more than they could if each worked independently. Also, Smith was the first to recognize how a market economy can harness self-interest to the common good, leading each individual as though “by an invisible hand to promote an end which was no part of his intention.” For example, businesses sell products that people want, at reasonable prices, not because the business owners inherently want to please people but because doing so enables them to make money in a competitive marketplace.

These two concepts, however, are opposed to each other. The parable of the pin factory says that there are increasing returns to scale—the bigger the pin factory, the more specialized its workers can be, and therefore the more pins the factory can produce per worker. But increasing returns create a natural tendency toward monopoly, because a large business can achieve larger scale and hence lower costs than a small business. So given increasing returns, bigger firms tend to drive smaller firms out of business, until each industry is dominated by just a few players. But for the invisible hand to work properly, there must be many competitors in each industry, so that nobody can exert monopoly power. Therefore, the idea that free markets always get it right depends on the assumption that returns to scale are diminishing, not increasing.

For almost two centuries, the assumption of diminishing returns dominated economic theory, with the Pin Factory de-emphasized. Why? As Warsh explains, it wasn’t about ideology; it was about following the line of least mathematical resistance. Economics has always had scientific aspirations; economists have always sought the rigor and clarity that comes from representing their ideas using numbers and equations. And the economics of diminishing returns lend themselves readily to elegant formalism, while those of increasing returns—the Pin Factory— are notoriously hard to represent mathematically.

Many economists tried repeatedly to bring the Pin Factory into the mainstream of economic thought to reflect the fact that increasing returns obviously characterized many enterprises, such as railroads. Yet they repeatedly failed because they could not state their ideas rigorously enough. Only since the late 1970s has this “underground river”—a term used to describe the role of increasing returns in economic thought—surfaced into the mainstream of economic thought. By then, economists had finally found ways to describe the Pin Factory with the rigor needed to make it respectable.

1. Which one of the following most accurately expresses the main point of the passage?

(A) Mainstream economists have always assumed that returns to scale are generally increasing rather than decreasing.
(B) The functioning of the Invisible Hand is accepted primarily because diminishing returns can be described with mathematical rigor.
(C) Recent developments in mathematics have enabled the Pin Factory to be modeled even more rigorously than the Invisible Hand.
(D) Adam Smith was the first economist to understand how a market economy can enable individual self-interest to serve the common good.
(E) Economists have, until somewhat recently, failed to account for the increasing returns to scale common in many industries.


2. The author’s attitude towards the idea that the Pin Factory model should be part of the mainstream of economic thought could most accurately be described as one of

(A) hostility
(B) uncertainty
(C) curiosity
(D) indifference
(E) receptivity


3. The main purpose of the fourth paragraph is to

(A) critique a theory purporting to resolve the tensions between two economic assumptions
(B) explain a difficulty associated with modeling a particular economic assumption
(C) outline the intuitions supporting a particular economic assumption
(D) describe the tensions resulting from attempts to model two competing economic assumptions
(E) refute an argument against a particular economic assumption


4. It can be inferred from the passage that the Pin Factory model would continue to be an “underground river” (Highlighted) were it not for

(A) the fact that economics has always been a discipline with scientific aspirations
(B) David Warsh’s analysis of the work of Adam Smith
(C) economists’ success in representing the Pin Factory model with mathematical rigor
(D) a sudden increase in the tendency of some industries toward monopoly
(E) a lowering of the standards used by economists to assess economic models


5. The reference to railroads (Highlighted) serves to

(A) resolve an ambiguity inherent in the metaphor of the Invisible Hand
(B) illustrate the difficulty of stating the concept of the Pin Factory with mathematical rigor
(C) call attention to the increasing prevalence of industries that have characteristics of the Pin Factory
(D) point to an industry that illustrates the shortcomings of economists’ emphasis on the Invisible Hand
(E) present an example of the high levels of competition achieved in transportation industries


6. Which one of the following best illustrates the concept of increasing returns to scale described in the second paragraph of the passage?

(A) A publishing house is able to greatly improve the productivity of its editors by relaxing the standards to which those editors must adhere. This allows the publishing house to employ many fewer editors.
(B) A large bee colony is able to use some bees solely to guard its nectar sources. This enables the colony to collect more nectar, which can feed a larger colony that can better divide up the work of processing the nectar.
(C) A school district increases the total number of students that can be accommodated in a single building by switching to year-round operation, with a different quarter of its student body on vacation at any given time.
(D) The lobster industry as a whole is able to catch substantially more lobsters a day with the same number of traps because advances in technology make the doors to the traps easier for lobsters to get through.
(E) A large ant colony divides and produces two competing colonies that each eventually grow large and prosperous enough to divide into more colonies. These colonies together contain more ants than could have existed in one colony.


7. The passage states which one of the following?

(A) The only way that increasing returns to scale could occur is through increases in the specialization of workers.
(B) Economics fails in its quest to be scientific because its models lack mathematical rigor.
(C) The Pin Factory model’s long-standing failure to gain prominence among economists was not a problem of ideology.
(D) Under the Pin Factory model no one is in a position to exert monopoly power.
(E) Adam Smith did not recognize any tension between the Pin Factory model and the Invisible Hand model.


8. Which one of the following, if true, would most undermine the connection that the author draws between increased size and monopoly power?

(A) In some industries, there are businesses that are able to exert monopoly power in one
geographical region even though there are larger businesses in the same industry in other regions.
(B) As the tasks workers focus on become narrower, the workers are not able to command as high a salary as when they were performing a greater variety of tasks.
(C) When an industry is dominated by only a few players, these businesses often collude in order to set prices as high as a true monopoly would.
(D) The size that a business must reach in order to begin to achieve increasing returns to scale varies widely from industry to industry.
(E) If a business has very specialized workers, any gains in productivity achieved by making workers even more specialized are offset by other factors such as higher training costs and increased turnover.