The Wealth of Nations Chapter 7: Of the Natural and Market Price of Commodities

Smith has established that the price of a commodity is composed of three parts: wages, profit, and rent. Here he makes a further distinction. These three combined form the natural price, which may or may not be what the commodity is actually sold for, the market price. “The actual price at which any commodity is commonly sold, is called its market price. It may either be above, or below, or exactly the same with its natural price. The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought to market, and the demand of those who are willing to pay the natural price of the commodity [...] The market price will rise more or less above the natural price, according as either the greatness of the deficiency, or the wealth and wanton luxury of the competitors.”

Quantity (aka supply) and demand regulate whether items are sold at, above, or below their natural price. For example, let’s say the pin factory is making each pin for 1¢ which properly accounts for wages, profits, and rent. Then the only pin factory in 100 miles burns down. Their supply is now much more limited, and people will be willing to pay more in order to get the last pins available. Alternatively, if the government says “we think everyone should always have all the pins they need so we’re offering them for free”, nobody will be willing to buy the pins from the factory anymore.

Though outside the scope of this chapter and text (but maybe to be discussed in this future book), you could understand how the government offering free pins would have some unintended consequences. Firstly, unless all the pin-workers will be working without wages, unless all the factory machine companies will be donating their machines to the pin factory without any charge, unless the electric company will be giving their electricity to the factory without charge, etc. there is actually no such thing as “free” pins. So the question is, how do we as a society allow for the most cost-effective pin making? This is another way of asking, How do we increase the wealth of the society?

Smith answers this question in a way that makes it clear why he is known as the father of capitalism. He compares the free-market price, what people willingly pay for things they desire, versus monopolies (often created or protected by government interventions): “The price of monopoly is upon every occasion the highest which can be got. The natural price, or the price of free competition, on the contrary, is the lowest which can be taken, not upon every occasion indeed, but for any considerable time together. The one is upon every occasion the highest which can be squeezed out of the buyers, or which it is supposed they will consent to give; the other is the lowest which the sellers can commonly afford to take, and at the same time continue their business.” 

So in regards to economic exchange, an exchange of labor that has different values to different people at different times and places, an exchange made by money as the intermediary, how do we continue to increase the total wealth of a nation or society? We engage in free-market exchange.

For our purposes, this applies directly to the market for financial securities, often referred to as the stock market and the bond market. There people freely buy and sell at prices that seem mutually advantageous. It is in engaging clients’ funds in this market that wealth continues to grow not only for the companies, but also for our clients and our society as a whole.

Let us know

• What good or service do you feel government intervention makes things worse?

• What good or service do you feel government intervention makes things better?

  
  

Until next time, happy reading!