Points of Discussion for Chapters 4-7 of the Wealth of Nations

Points of Discussion for Chapters 4-7 of the Wealth of Nations

1. What are the two meanings of the word VALUE? Here, the famous water/diamond paradox makes an appearance. How does Smith use this example?

2. At the beginning of Chapter 5, Adam Smith states the following:

“The far greater part of them [necessaries, conveniences, and amusements of human life] he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of exchangeable value of all commodities. The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. ... labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.” [underlining added]

A few pages later, after explaining why gold and silver cannot serve as the best measure of value (because their value also varies), Smith writes:

“Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer. In his ordinary state of health, strength and spirits; in the ordinary degree of his skill and dexterity, he must always lay down the same portion of his ease, his liberty, and his happiness. The price which he pays must always be the same, whatever may be the quantity of goods which he receives in return for it. Of these, indeed, it may sometimes purchase a greater and sometimes a smaller quantity; but it is their value which varies, not that of the labour which purchases them. ... Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only. ... Labour, therefore, it appears evidently, is the only universal, as well as the only accurate measure of value, or the only standard by which we can compare the values of different commodities at all times and at all places” [underling added]

Now, Smith had made the distinction between the two meanings of value at the end of Chapter 4 (value in use and value in exchange). He is obviously discussing the exchange value in Chapter 5.

First, we must be clear about the definition of value here: what is the value of a commodity? what are the units this value should be measured in?

Second, why is the nominal (money) price not a good measure of value? what about relative prices?

Third, the discussion in Chapter 5 might appear way overblown. What is Smith really trying to do and why? For example, is he

(a) simply trying to come up with a good index so that he can aggregate commodities? For example, we use a GDP deflator or the CPI in order to adjust nominal values.

(b) simply trying to come up with a way to measure welfare (hence, searching for the correct units)? For example, a simple method might be to say that I derive 10 utils of satisfaction from a cup of coffee and only 4 from a cup of tea. Or, in a slightly more sophisticated form, I am on a higher indifference curve when by consuming 8 cups of coffee and 2 cups of tea than I am when consuming 7 cups of coffee and 3 cups of tea.

(c) attempting to define a measure of exchange value which is independent of price? This would be moving towards what has come to be termed a theory of value.

3. Things seem much simpler in that “early and rude state of society” Smith keeps referring to. For example, the exchange value - or, real price - could be measured by the amount of labor (in units of hours, days, etc.) required to produce a commodity. Hence, what we would term today, a labor embodied (as opposed to commanded) theory worked in this type of society.

First, how does the ‘early and rude state of society’ differ from the society in which our poor Adam lived (or, we live for that matter)?

Second, consider the example Smith gives on the first page of Chapter 6: “If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.” Suppose the medicine man in this nation of hunters tells pregnant woman that beaver is bad to eat during pregnancy. What will happen to the exchange? Would this invalidate the simple labor embodied theory that Smith puts forth in this type of society?

Third, why doesn’t the simple labor embodied theory work in a more advanced society (i.e., with the accumulation of stock and the ‘appropriation’ of land)?

4. Early in Chapter 6 Smith gives an example that demonstrates why the simple labor embodied theory will not work in a more advanced society. Recall in the example, there are two manufactures; the profit rate is 10% for each (we see this again later); both manufacturers incur labor expenses in the amount of 300 pounds per year (20 workers at 15 pounds per year); but one incurs 700 pounds in material costs while the other incurs 7,000 pounds. Thus, Smith argues, the one will receive 100 pounds in profit (or, 10% times the total costs of production of 1,000 pounds) and the other 730 pounds (or, 10% times the total costs of production of 7,300).

First, why doesn’t the labor embodied theory explain the relative prices in this case?

Second, suppose we change the example a bit. If the second (high cost) manufacturer must employ 200 workers in order to work-up the 7,000 pounds worth of materials, could the labor embodied theory explain the relative prices?

5. It has been claimed that Smith developed an “adding-up theory of price.” In connection with this adding-up theory, Smith has been accused of using circular reasoning in Chapter 6. Smith states: “In every society the price of every commodity finally resolves itself into some one or other, or all of those three parts [i.e., wages, rent, profits] ... [now, the good part] ... A fourth part, it may perhaps be thought, is necessary for replacing the stock of the farmer [remember, he is discussing the price of corn as an example], or for compensating the wear and tear of his labouring cattle, and other instruments of husbandry. But it must be considered that the price of any instrument of husbandry, such as a labouring horse, is itself made up of the same three parts...” A few pages later Smith builds on the determination of price: “As the price of or exchangeable value of every particular commodity, taken separately, resolves itself into some one or other, or all of those three parts [i.e., wages, rent, profits]; so that of all the commodities which compose the whole annual produce of the labour of every country, taken complexly, must resolve itself into the same three parts, and be parcelled out among different inhabitants of the country, either as the wages of their labour, the profits of their stock, or the rent of their land. The whole of what is annually either collected or produced by the labour of every society, or what comes to the same thing, the whole price of it, is in this manner originally distributed among some of its different members. Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value.”

First, notice the possible general framework coming out here: three great classes defined by their source of income.

Second, is there circular reasoning here? If so, why would it matter? Are there any ways to get around it?

Third, is there any issue of defining cause and effect? In other words, does price resolve itself into the three revenue streams or do the revenue streams determine the price? If wages increase, then will the price of the commodity necessarily increase? If the wage rate in general rises, then will all prices go up? What does it mean to ask if prices go up: What if gold (i.e., money) is the most labor-intensive commodity produced in the society? What happens to relative prices? When answering these questions, we might establish the point a little more from a passage at the end of Chapter 7: “The natural price itself varies with the nature rate of each of its component parts, of wages, profit, and rent.”

6. Before turning to Market/Natural Price, there are certain places within these Chapters where Smith appears to be laying ground for possible confusion. On the one hand, he has certainly rejected the labor embodied theory of value for an advanced society (i.e., capitalism). On the other hand, Smith often refers to rent and profit as deductions from the produce of labour.

“The value which the workmen add to the materials [of the capitalist], therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.” [early in Chapter 6: notice also, what is Smith’s justification for profit? what about rent - remember those greedy landlords that ‘love to reap where they never sowed’?]

Jumping ahead to Chapter 8:

“As soon as land becomes private property, the landlord demands a share of almost all the produce which the labourer can either raise, or collect from it. His rent makes the first deduction from the produce of the labour which is employed upon land. ... It seldom happens that the person who tills the round has wherewithal to maintain himself till he reaps the harvest. His maintenance is generally advanced to him from the stock of a master, the farmer who employs him, and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit. This profit makes a second deduction from the produce of the labour which is employed upon land. ... The produce of almost all other labour is liable to the like deduction of profit. In all arts and manufactures the greater part of the workmen stand in need of a master to advance them the materials of their work, and their wages and maintenance till it be completed. He shares in the produce of their labour, or in the value which it adds to the materials upon which it is bestowed; and in this share consists his profit.” [beginning of Chapter 8]

So, rent and profit (along with interest) are seen as deductions from the produce of labour. How does this compare to modern theory? Is labor being exploited?

7. Let’s get some of the basics of Chapter 7 out of the way:

First, what is the distinction between market and natural price? Does modern theory of something similar?

Second, what is effectual demand?

Third, “...if he sells it at a price which does not allow him the ordinary rate of profit in his neighbourhood, he is evidently a loser by the trade; since by employing his stock in some other way he might have made that profit.” From this passage, early in Chapter 7, what ‘modern’ concept is Smith well versed in?

8. Let’s go a little deeper in the analysis:

First, what would you say is the theoretical status of Market Price? Natural Price?

Second, are price and quantity determined at the same time?

Third, Smith’s capitalists have an incentive to keep quiet if making high profits. “If it was commonly known, their great profit would tempt so many new rivals to employ their stocks in the same way, that, the effectual demand being fully supplied, the market price would soon be reduced to the natural price, and perhaps for some time even below it. If the market is at a great distance from the residence of those who supply it, they may sometimes be able to keep the secret for several years together, and may so long enjoy their extraordinary profits without any new rivals.” [middle of Chapter 7] But, wouldn’t an existing capitalist be tempted to expand production? After all, this sounds a great deal like the formation of a cartel - in fact, Smith makes a comparison to a monopoly - and we know that there is always an incentive for one firm to attempt to increase the quantity supplied. Did Smith simply overlook this possibility or does the omission indicate something more substantial?

9. Now for the theory:

Recall the modern theory of a perfectly competitive market in the short-run and long-run (assuming constant returns). Could the modern theory be said to be derived from Chapter 7? Even someone sympathetic to this view would seemingly have to admit that there is a piece of the modern theory missing in Smith’s account. What is this piece? Does this mean that Smith just wasn’t aware of it? Or, if you explained the missing piece to Smith, do you think that he would incorporate it into his theory? Finally, in order to answer the question concerning what determines the natural price (the magnitude of it), Smith refers to the natural (or, ordinary) rate of wages, profit, and rent. The determination of these natural rates are the subject of Chapters 8-11. Maybe this gets Smith out of the circular reasoning referred to earlier?