The Wealth of Nations Chapter 6: Of the Component Part of the Price of Commodities

We read last time that when we buy something, we can think of the expense not in terms of the price tag, but in terms of our labor required to exchange (through money as an intermediary) for the good or service we desire. Here, Smith explores further what makes up the price of an item. According to Smith, there are three components of the price of something:

1. Wages

2. Profit

3. Rent

“In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or maintenance of the labourers and labouring cattle employed in producing it, and the third pays the profit of the farmer.”

Imagine you want to grow corn and sell it to others. You don’t have enough land, and you can’t do all of the labor yourself, so you have to rent some land and hire some workers. If you only made enough money to cover your rent and pay all your employees, this would not be a success financially. You take on the risk of the fixed costs of rent and labor and risk losing money (not just not making money) if you have a bad harvest due to drought or flood or other factors. Without also earning a profit, without being compensated for the risk taken, nobody would knowingly take on these entrepreneurial endeavors.

Now imagine you do have enough land. Does that mean you should sell your corn for less than the man who has to rent someone else’s land? Smith says no. Maybe you do to get a market advantage, and that’s fine, but it’s easy to forget that you or your grandfather bought the land decades ago and that you didn’t do it to lose money, but likely to make money. Similarly, if you can do all the work yourself, does that mean there should be no wages? Maybe you need to forgo a wage for yourself while you get started, but again that’s different. If you are doing the labor and not paying yourself what you’d need to pay another laborer to do the same work, this again is not a success financially.

While Smith’s main focus is not personal finance, we can still ask why this matters for us? It does for at least three reasons. Firstly, we are all consumers. When we realize that everything we buy has to cover the cost of wages of laborers, profit of owners, and rent of land or machinery, we can understand that it’s not simply us trading our labor for the labor of another. When we are an employee and not an owner or landlord (renter), we only receive one of these three for our labor, and yet need to cover the cost of all three when we are purchasing something.

Secondly, we are all investors. The companies we want to invest in are those that make a profit. Owners get the profit, and when we buy a stock, we become part owner of that company and are entitled to that portion of the profit. We want gross revenue to be high, and expenses for wages and rent to be low so that there’s money left over to compensate us for the risk we’ve taken in becoming owners (after all, the company could go bankrupt and we’d lose our investment).

Thirdly, we are all citizens and live in a society where we want to increase in wealth. The only way to do this is if individuals engage in financially advantageous activities such that they sell goods and services for an amount that covers all three of these component parts. If there are no profits left over, it’s simply an exchange of wealth. When there are profits left over, there is a creation of wealth. It was not there before, and now it’s here for us to hold and then pass to another when we use our profit to buy the goods and services (sold profitably) from other merchants. Thus the cycle of economic growth and social advantage continues from the tribes Smith first talked about who had hardly enough food and shelter to survive (though everyone worked continuously), to the great surplus of wealth that exists in our world today.

Let us know

• What is a good or service you would be happy to buy, but is typically sold for so high a price you normally do not purchase it?

• What amount of money at minimum would you want back in order to risk losing $1? $100,000?

Until next time, happy reading!