Adam Smith

What are the advantages of the division of labor? What are the disadvantages?

Advantages: Increased efficiency, greater production, less time waste, more productivity. Disadvantages: Reduced worker mobility, if one department is hindered the entire industry is affected, causes dependence.

What does Smith mean when he writes "[t]he balance of produce and consumption may be constantly in favour of a nation, though what is called the balance of trade be generally against it"? (IV.3, p.523)

Balance of trade: the difference in value over a period of time between a country's imports and exports of goods and services. If the exports of a country exceed its imports, the country is said to have a trade surplus. If the imports exceed exports, a trade deficit exists. According to the economic theory of mercantilism, a favorable balance of trade was a necessary means of financing a country's purchase of foreign goods and maintaining its export trade. The assumptions of mercantilism were challenged by Adam Smith, who argued that free trade is more beneficial than the protectionist tendencies of mercantilism and that a country need not maintain an even exchange or, for that matter, build a surplus in its balance of trade (or in its balance of payments). A continuing surplus may, in fact, represent underutilized resources that could otherwise be contributing toward a country's wealth, were they to be directed toward the purchase or production of goods or services.

What does Smith mean by the statement "[w]hat is annually saved is as regularly consumed as what is annually spent"? (II.3, p.359)

Capital is increased through parsimony and saving, and that which is saved is consumed by productive workers. What is saved is invested rather than consumed, yet Smith implies that investment results in income payments, which in turn are used on consumption

What is Smith's concept of "effectual demand"?

Effectual Demand is the demand accompanied with at least just the right willingness to pay to bring the products or services demanded into the market.

What are profits and the profit rate? How is the profit rate determined? What are normal vs. pure profits?

For Smith, profit is primarily derived from the value which the wage-labor employed added to the original value of the raw materials. Profit depends on the amount of stock, which relates to the amount of competition in the market. Normal profit - firm said to be making profit when total revenues equal total costs Pure (Economic) profit - arises when its revenue exceeds the total opportunity cost of its inputs. [Total revenue - Economic cost (implicit + explicit cost)]

What theory is implicit in Smith's assertion that "[i]t is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour"? (I.8, p.78)

Growth has 3 main sources: (i) Growth in the labour force and stock of capital. Incentivizes division of labor, by encouraging people to specialize and larger markets encourage people to invest in new technology. Capital accumulation is necessary precursor to division of labor, as division of labor is limited only by size of the market. (ii) Improvement in the efficiency with which capital is used in labour through greater division of labour and technological progress. (iii) Promotion of foreign trade that widens the market and reinforces the other two sources of growth.

What does Smith mean when he says that trade between "distant places" is governed by money and not by real price?

He is suggesting that in different places/times, the real price (amount of labor it takes to produce commodity) and nominal price (value in terms of money) of commodities are not proportional to one another because it takes different amounts of labor to produce commodities in different places. Therefore, one needs to exchange via money (nominal price).

What are two ways of expressing the natural price of beaver in terms of deer in a labor-only economy with instantaneous production?

How many deer can you hunt in the same amount of time that you hunt a beaver... Consider that in 1 hour, you can hunt 2 deer or 1 beaver 1 deer = 1/2 beaver = 30 minutes 4 deer = 2 beaver = 2 hours This is basically an opportunity cost problem. If you decide to hunt one beaver, you give up two deer so the OC of 1 beaver is 2 deer. Twice the amount of time to kill a beaver as a deer. The economic equilibrium price will inevitably be 2 deers per beaver.

How does Smith contrast the "natural" and the historical progress of opulence?

In the natural progress of economic development, wealth is used for agriculture, second for manufacturing, and third for foreign commerce (as if investors were left alone to seek the greatest return on their investments). Historically, however, this process has been inverted. Towns have grown up much faster than their rural neighborhoods, and much more money has been devoted to manufacturing and to trade than one would expect in the "natural" scenario. People have learned to prefer these professions over the "natural" preference of the peace and stability in country living.

Smith offers alternate ways of valuing a good: by labor-commanded value, which measures how much labor ("toil and trouble") the buyer of one unit of the good can escape from; and by labor-contained value, which measures how much labor went into the production of one unit of the good. Are these measures consistent or inconsistent?

It is uncertain because it depends on whether the only input is labor or if there are any more inputs.

When was the Wealth of Nations first published?

March 9th, 1776

What is the relationship between market price and "natural" price?

Normal price is thus a permanent and stable price which has permanent equilibrium. Market price, therefore, tends to show oscillations around normal price.

How and why does Smith distinguish "pecuniary" and "non-pecuniary" returns to Labor?

Pecuniary returns to labor: the pecuniary wages paid for the labor (simply, wage) Non pecuniary returns to labor: non-pecuniary things received by worker as a result of their labor (i.e. Vacation days)

What is the relationship between population, the labor force, unemployed labor, unproductive labor, and productive labor?

Productive powers of labor - the amount of produce yielded by labor, increased by division of labor, the number of productive laborers, or the productive powers of the laborers employed.

What is Say's law? Is it implicit in Smith's thinking? (Say, writing after Smith, was his preeminent French interpreter.)

Say's law states that "Supply creates its own demand", the aggregate production necessarily precedes an equal quantity of aggregate demand. To a degree, Say's Law is just an extension of Adam Smith's insight that the division of labor is limited by the extent of the market. Smith's point was that the degree of specialization that one would see in a given market depended upon how much demand there was for the specialized product.

How does Smith understand wages, the wage rate, and the wage fund? What is meant by subsistence wage? Real wage? Nominal wage? Natural wage?

Smith thought that wages were determined in the marketplace through the law of supply and demand. The idea of a wage fund is that labor would be attracted to jobs were labor was needed most, and workers would need to be compensated by increased wages if they were to bear the cost of acquiring new skills - an assumption that still applies in contemporary human-capital theory. Subsistence wage - Smith believed that in the case of an advancing nation, the wage level would have to be higher than the subsistence level in order to spur population growth. Natural wage - while the market wage will depend on supply and demand, it tends to gravitate towards a subsistence wage which is known as the "natural wage", which is established independently of any market conditions. Nominal wage - the amount of money you earn per hour (not taking into account changes in price levels). Real wage - the nominal wage, but adjusted for inflation.

How and why does Smith distinguish demand for labor "out of stock" vs. "out of revenue"?

Smith's difference between stock and revenue: when a man possesses more than enough stock, or goods etc, he wants to derive revenue from the rest. Stock is split into two categories: the part for immediate consumption and the part which is expected to generate revenue, called his capital.

How do division of labor, pure technological progress, and accumulation contribute to economic growth?

The division of labors entails that workers will become increasingly skilled in a task that, under specialization, they must repeat continuously. This will in turn save time and promote the invention of new technologies that can once again fuel productivity. In order to acquire the large gains in productivity that result from specialization , one must first accumulate capital because productive systems of specialization require capital to thrive.

What does Smith mean by the "invisible hand"? What are the circumstances required for the invisible hand to function?

The invisible hand is an unobservable market force that helps the demand and supply of goods in a free market to reach equilibrium automatically. Smith believed that an economy will comparatively work and function well if the government will leave people alone to buy and sell freely among themselves.

What is the labor theory of value? Does it apply to all goods?

The labor theory of value holds that the economic value of a good or service is determined by the total amount of socially necessary labor that is needed to produce it. It does not apply to all goods: Not all goods can be quantified. (Value of saving a life, writing a law, any unproductive labor, etc...).

What is the water-diamond paradox? Does Smith resolve it?

The paradox: Smith noted that, even though life cannot exist without water and can easily exist without diamonds, diamonds are, pound for pound, vastly more valuable than water. He was unable to solve this paradox (he wrong for this as he should have looked at the marginal utilities instead)

Smith argues in favor of free trade both on grounds that it creates a vent, or outlet, for goods that would not otherwise be produced--thereby enabling a country to put idle labor and land to work (IV.I, pp. 468-469)--and that it makes possible the importation of goods which are absolutely cheaper to produce abroad than at home (absolute advantage). Are these arguments Contradictory?

Without such exportation, a part of the productive labour of the country must cease, and the value of its annual produce diminish. Controversy has arisen over Smith's statement that international trade "gives a value to their superfluities". This has become known as the "vent-for-surplus" gain, namely: that a nation can exchange its overproduction for other goods which are demanded.

What does Smith mean by saying that, following an increase in the productive powers of labor, "though all things would have become cheaper in reality, in appearance many things might have become dearer than before"? (I.8, pp.72-73) Are there modern examples of what he has in mind?

He's suggesting that in different employments, the increases in productive powers of labor will also be different. Accordingly, products with less of an increase in productive powers will have a higher exchange value (it will be more expensive to buy/produce) compared with products that have more of an increase in productive powers (less expensive to buy and produce). In reality though, they were both easier to get than before because both had an increase in productive powers. Modern examples: Meat production was more time consuming before, but since technology has made the pace faster there is an increased demand for meat than ever before.

What is Smith's adding-up theory of price? Does it have a weakness?

Idea that "the price of a commodity is then obtained by adding up its 'component parts': wage, profit and rent. "The problem with the adding-up theory of value becomes particularly acute in the case of rent, which Smith analyzes, quite convincingly, as a residual determined by the level of prices. But if this account of rent is correct, the adding-up theory, which tries to explain the level of prices by the natural level of rents, is unacceptable because it depends on circular reasoning."

How does Smith characterize a thriving, a stationary, and a declining economy?

In a thriving economy, income level and capital stock rise and the rate of capital accumulation also tends to increase, leading to increased capital stock in successive periods as investment continues to increase. In a stationary economy, we see population remains unchanged and income remains constant. There are subsistence wages and a complete elimination of profits. In a declining economy, there are low wages and a decreasing population.

How and why does Smith distinguish "productive" and "unproductive" labor? What is their relationship to economic growth?

Smith argues that the only way an underdeveloped country can be raised out of poverty and achieve wealth is if the higher ranks of society support productive labor through the accumulation of such capital. Where productive labor (i.e. factory labor) creates a surplus and adds value to capital, unproductive labor (i.e. household service) has no long-term benefit.

What does Smith mean by national wealth? Is it equivalent to national income?

Smith challenges the ideas that money/gold is the way to measure wealth. He states that fertile soil is the source and its surplus is the measure of wealth.

What is the difference between "stock" and "capital" for Smith? Between "fixed" capital and "circulating" capital?

Smith claims that the general stock of any country divides itself in three parts, the first being assets that are subject to immediate consumption, and the other two - called fixed and circulating capital - being assets from which a revenue may be derived. Fixed capital "affords a revenue or profit without circulating or changing masters" (Smith, 367) Circulating capital, on the other hand, "affords a revenue only by circulating or changing masters" (Smith, 369).

What are rents? How are the rental rate and the price of land related? Is there a "natural" rental rate, as Smith claims?

Smith defines rent as "the price paid for the use of land" "When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the 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 rent of land, [...] considered as the price paid for the use of the land, is naturally a monopoly price. It is not at all proportioned to what the landlord may have laid out upon the improvement of the land, or to what he can afford to take; but to what the farmer can afford to give."

Who coined the term "laissez-faire" and how does it relate to the "invisible hand"?

The term was coined by François Quesney. Smith's invisible hand theory set the foundation for laissez-faire economic philosophy, which argues that government intervention in the marketplace is unnecessary. Instead, changes in demand for resources automatically result in price adjustments without the need for regulation.

How does Smith distinguish value in use from value in exchange?

Value-in-use: The satisfaction which one obtains from the use of a commodity (the want-satisfying power of a commodity). Value-in-exchange: Amount of goods and services which we may obtain in the market in exchange of a particular thing. In other words, it is the price of a particular good which can be sold and bought in the market.