Adam Smith The Classical Shool

Adam Smith and the Classical School

All of these men were laying foundations for the first major statement concerning price. The main points emphasized by Adam Smith differed but little from those of Cantillon; but it: was in the greater detail, the completeness of analysis, and the abundance of interrelationship described, that Smith's work was outstanding. "The real price of everything, what everything; really costs to the man who wants to acquire it, is the toil and trouble of acquiring it." Thus Adam Smith stated his theory of value. He continued to show that while the amount of labor necessary to produce them was the real value of all commodities, their value in exchange was seldom estimated by it, because of the difficulties of equating two different quantities of labor. Thus the process of exchange was carried on by the "higgling and bar­gaining of the market," in which money was the common unit of measurement.

In discussing the subject of price, Smith indicated that a num­ber of factors influenced the formation of nominal or money price. The value of money itself fluctuated, since the amount of labor necessary to produce a given quantity of metal varied. This in turn depended upon the productivity of mines. To illustrate, Smith used the increased production of gold from the mines in America, showing how this additional supply of gold caused a tremendous increase in prices throughout Europe. Likewise de­basement of currency caused an increase in prices, because values were normally equivalent to a quantity of gold, and if coins in­cluded less gold at one time than at another, they would purchase less goods, or in other words, cause an increase in price.

In continuing his discussion of price, Smith said, the true price of any commodity included the true price of all the factors mak­ing the commodity. "In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or main­tenance of labourers, and labouring cattle employed in producing it, and a third part pays the profit of the farmer." "When the price of any commodity is neither more nor less than what is sufficient to pay the rent of land, the wages of labour, and the profits of stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price. The com­modity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market . . ." However, "the actual price at which any commodity is commonly sold is called the market price. It may either be above, or below, or exactly the same with its natural price."

How then is the market price determined? Smith went on to explain. The market price is regulated by the quantity which is actually brought to the market and the demand of those who are willing to pay the whole of the natural price. Smith was careful to point out that the effectual demand is the important considera­tion and not the absolute demand. The former is the expressed desire for goods plus the ability and willingness to buy them, while the latter is the desire of all persons for an article whether they have the ability to buy or not.

When a quantity less than the effectual demand is brought to the market, rather than do without, some of the prospective buyers will offer to pay more than the natural price. Competition among buyers tends to increase the price. Where buyers of some wealth exist, a shortage results in exceedingly high prices if the acquisition of the commodity is of more or less importance to the prospective buyers. On the other hand, when the quantity of a good brought to the market exceeds the demand, it cannot all be sold to those who are willing to pay the natural price covering the true cost incurred in producing the good and bringing it to the market. "Some part must be sold to those who are willing to pay less, and the low price which they give for it must reduce the price of the whole." The degree to which the price sinks below the natural price is dependent upon the amount the excess supply increases the competition of the sellers. The perishable nature of the commodity will also affect the price since the sellers will be more anxious to get rid of perishable goods increasing competi­tion among them.

It is to the interests of all that the supply and demand balance one another. The natural price is then paid covering all costs, all those exercising an effectual demand are satisfied, and there is no excess of supply to lower the market price. The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually gravitating. Different acci­dents may sometimes keep them suspended a good deal above it, and sometimes force them down even somewhat below it. "But whatever may be the obstacles which hinder them from settling in this center of repose and continuance, they are constantly tending towards it."

Smith was quite well aware that sellers might seek to maintain a high price by artificial means. He knew that when a market price was established far above the natural price the producers tended to keep the matter a secret in order not to attract addi­tional competitors. Processes which tend to cut costs, if retained secretly by a small group of producers, may keep prices from fall­ing to the natural level. When the effectual demand exceeds the total productive capacity of the country, to use Smith's illustra­tion, as in the case of some vineyards in France, the price may be sustained indefinitely above the natural price. Monopolies, too, exert the same influence as a trade secret or a commodity natu­rally limited. Monopoly prices differ from freely competitive or natural prices in that the former are "the highest which can be got" while the latter are "the lowest which can be taken." All kinds of monopolistic conditions prevent the free interplay of supply and demand, and may for years maintain a price more or less higher than the natural price. While prices might be kept above a normal level almost indefinitely, it would be impossible to keep prices below the natural price for more than a very short period, for those persons who suffered loss would reduce the amount of produce which they brought to the market, or with­draw from production altogether.

It is obvious that Smith's ideas on price assumed a freely com­petitive market as the ideal or natural market. As a consequence lie was extremely critical of any monopolistic or regulatory force whether it came about as a result of the normal self-interest of men or the arbitrary extension of governmental power. However, he recognized the tendency for workingmen and employers to organize into combinations. Since their interests were by no means the. same, Smith said, "The workmen desire to get as much, the masters to give as little, as possible." The tendency toward combination, was less hampered among employers than among workingmen. The former were fewer in number and no acts of parliament forbade their organization as in the case of workingmen, and consequently they were always found in a sort of tacit agreement concerning wages and prices. Not only that, Smith also recognized that the employers were much more likely to call on the agencies of government for assistance in their com­petitive struggle with organized workingmen. This tendency of combination was noted in what has since become a classic quota­tion from Adam Smith. "People of the same trade seldom meet together," said he, "even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."

Not only the natural tendencies of individuals but custom itself acted to prevent freedom of competition and the unrestricted operation of the forces of the market. The law of primogeniture, Smith thought, had an adverse effect upon the economic condi­tions of the country. He compared the large increases in popula­tion in lands where inheritance of family holdings by the eldest was not a factor, as in North America, with the meager increases in Europe, indicating to his satisfaction the strongest argument against primogeniture (which gives the principal inheritance to the oldest son).

Of the general acceptance of the ideas of Adam Smith on the importance of freedom of business enterprise and the effective­ness of competition as a regulator of economic activity there can be little doubt. Smith's followers were innumerable during the next century. However, even those who openly claimed adher­ence to the classical ideas modified and pointed out inconsisten­cies in the generally accepted thought. J. B. Say in France never tired of defending the importance of supply and demand in de­termining price. He was even less tolerant than Smith of govern­ment intervention and other obstruction to the free play of eco­nomic forces. Nevertheless, in. his emphasis upon the importance of the utility of an object as a consideration in price determina­tion he unquestionably turned the emphasis away from cost of production and supply in the direction of utility and demand. This general line of development was carried forward in England by writers such as Mountifort Longfield, the first Professor of Political Economy at the University of Dublin. He accepted the idea that price was determined by supply and demand, but he followed up the general understanding of demand with the first generally accepted statement of the influence of marginal buyers on price. He pointed out that the intensity of a prospective buyer's demand was measured by the price he was willing to pay rather than do without the article. For example, he said, with each increase in price a certain number of the buyers will drop out rather than pay the additional sum. Thus the market price is measured by the least intense demand which results in a pur­chase. In later years this trend to emphasize the demand aspect of price attained great popularity, but in spite of these early hints as to the importance of demand, it was supply which received the predominant attention.


Few men reflect the character of their times as clearly as did David Ricardo. He lived in period when free competition in economic matters was nearer perfection than it had been or would ever be again. Legislation restricting foreign trade which had been passed in the full glory of mercantilism was unenforced. Only the first of the factory acts had been passed, and trade unions were stil held illegal by the courts. The market was in reality almost free. İt was Ricardo’s method to examine carefully a concrete fact of his own times, and then with unusual intellectual daring to draw general conclusions from it. Ricardo contended however that these conclusions were not directed to temporary effects, but to the long run and fundamental factors, or as he preferred to call them, the natural factors controlling economic behavior. Consequantly Ricardo’s belief in the poqer of competition to regulate production and distribution is not merely an unquestioning acceptance of an assumption made by Adam Smith, it is the result of keen observation of the economic activity of his own times.

In the long run, Ricardo believed that the poqer of competition alone would determine prices, wages, profits, and rent. Further, under a system of free trade each country would devote its labor and capital to those pursuits which were most beneficial. Likewise the abolition of taxes on the transfer of land would tend to place land in the hands of those best able to use it.

Some authors contend that Ricardo accepted so fully his postulate of free competition as the basis of his analysis that he failed to concern himself with the economic problems which arose because of the absence of competition. He did note, however, the effects of government intervention, of wars, and of the immobility of capital and labor, but these obstructions he characterized as short-run effects, which delayed but did not prevent the operation of economic forces. Moreover, he advocated the direct interference of government in the regulation of money, drugs, physicians, and the issue of credit.
In addition to his assumption of free competition Ricardo emphasized the importance of exchange value in the organization of the economic system. Briefly stated, Ricardo believed that the exchange value of any commodity was determined by the quan­tity of the commodity which a given amount of labor could produce in a given time as related to the amount of another com­modity produced by the same labor in the same time. This was different from Ricardo's concept of market price, which he be­lieved was essentially the result of the operation of the laws of supply and demand. Throughout Ricardo's work is the same confusion between natural value and exchange value on the one hand and market price on the other. This fact is noticeable in his discussions of wages and rent. However, if one could assume— as Ricardo did—a freely competitive market, natural value, ex­change value, and market price would tend to coincide.