Adam Smith

1723-1790
 Adam Smith
Inaddition to the text, you should read the
Chapter on Adam Smith in the book the
Worldly Philosophers, by Heilbroner
This chapter will provide you with
additional background material
 Personal
Born in Kircaldy (Scotland)
Father died before he was born and his
mother lived to the age of 90
Kidnap by Gipsies when he was 4 and was
left abandon
Walked 15 miles in Nightgown until awoken by
bells
 Professorial Syndrom

Walk in a distracted fashion and fell in a Pit

Would work through academic matters out loud
Brewed himself a drink of bread and butter and
pronounced it the worst tea he had ever dranked
I am a beau in nothing but my books
 Tutoring
His book on moral theology attracted the
attention of Charles Townshend
Notorious to Americans since, as
Chancellor of the Exchequer, he
Refused to let colonist elect their own judges
Increase the duty (tariff) on American Tea
Townshend married well to the widow of a
duke
 Tutoring (continued)
He chose Adam Smith to tutor the son of the
widow
The contract was for 500 pounds per year plus
expenses and a pension of 500 pounds per year for
life after done
Smith had never collected more than 100 pounds
per year from fees collected directly from students
His students refused refund when he had to leave
saying they had more than received their return
 Tutoring (continued)
For 18 months Smith and his student went to
France
Met Voltaire in the south of France
Met Francois Quesney in Paris
He agreed with the Laissey Faire of the Physocrats
but did not agree with
Agriculture being the source of all productivity
Believed labor was an important component of
production
 Life
Smith met with Benjamin Franklin
He was impressed with Mr. Franklin and his
descriptions of the Colonies
Probably why he later wrote about the Colonies
a nation which, indeed, seemed very likely to become
one of the greatest and most formidable that ever was in
the world.
An admiration that is later also shared by Karl
Marx
 Life
Adam Smith lived with his mother until she
reached the age of 90
2 years after he published the Wealth of
Nations he was appointed
Commissioner of Customs for Edinburgh
which paid 600 pounds a year
His death went relatively unnoticed
 Professionally
Perhaps the most amazing aspect of Adam
Smiths work is the fact that in the absolute
chaos and crude conditions of the labor
markets of his time he was able to view the
beauty of the market system
He viewed the potential it had in developing
economic growth and
The difficulty it provided if unregulated
 A. Smith: First Classical
Economist
Comparison with Shaskepere
Very Careful Writer
The Theory of Moral Sentiments (London, A. Millar,
Edinburgh, A. Kincaid & J. Bell, 1759) second edition, revised 1761,
third edition, enlarged as The Theory of Moral Sentiments, To which is
added A Dissertation on the Origin of Languages (London, A. Millar,
Edinburgh, A. Kincaid, & A. Bell, 1767) fourth edition (London, W.
Strahan, J. & F. Rivington, T. Longman and T. Cadell, Edinburgh, W.
Creech, 1774) fifth edition 1781, sixth edition considerably enlarged
and corrected, 2 volumes (London, A. Strahan & A. Cadell, Edinburgh,
W. Creech & J. Bell, 1790).
 Published Works
An Inquiry into the Nature and Causes of
the Wealth of Nations, 2 volume (London,
W. Strahan & T. Cadell, 1776) second
edition, revised, 1778, third edition with
"Additions and Corrections, 3 volumes
(London, A. Strahan & T. Cadell, 1784),
fourth addition (London, A. Strahan & T.
Cadell, 1786), fifth edition, 1789
(Philadelphia, Thomas Dobson, 1789
 MAIN INTEREST
EconomicDevelopment and Policies to
Promote Economic Growth
Assumption: An economy always employs its
resources fully in production
Methodology: Deductive Theory and historical
Description
Vision:

1. Interdependence of the segments of the economy

2. Policies to be followed to promote wealth of nation

 Markets
A. Contextual Economic Policy
Arguments based on observation of historical
and institutional circumstances
B.Natural Order, Harmony, and Laissez
Faire
Scientific Investigation can reveal (discover)
factual cause and effect relationship
Human beings are rational, calculating and
motivate by self interest
 Human Interest
Every man. Is first and principally
recommended to his own care; and
every man is certainly in every respect
fitter and abler to take care of himself
than of any other person (Theory of
Moral Sentiments)
 Human Interest
the desire of bettering our condition [is] a desire
which, though generally calm and dispassionate,
come with us from the womb, and never leaves us
till we to to the grave. In the whole interval which
separates those two moments, there is scarce
perhaps a single instant in which any man is so
perfectly and completely satisfied with his
situation, as to be without wish of alteration or
improvement of any kind (Wealth of Nations)
 Market (Cont.)
Competitive markets exist in which factors of
production advance economic advantage
Natural process resolves conflict better than
human arrangements (physiocratic idea)
Optimum allocation of resources occurs in
competitive markets with out intervention
 The Working of Competitive
Markets
Market vs. Natural Prices
Market Prices a Short-Run phenomenon
Natural Prices a Long-Run phenomenon
NOTE: in the LR NP will equalize rate of
profits, wages and rents among economic
sectors (landlords, capitalists, workers)
 The Working of Competitive
Markets (cont.)
In other words, given competitive market &
absence of government intervention,
resulting natural prices bring about
optimum allocation of resources because
consumers receive goods they want at
lowest prices and maximum rate of growth
occurs
THIS IS THE INVISIBLE HAND ANALOGY
 Exceptions to laissez faire
protection of infant industries by tariffs
provision of public goods (roads, schools,
vital records, justice, national defense)
ALSO, FREE ENTERPRISE SHOULD BE
CHECKED AND NOT LET GO
UNREGULATED:
 People of the same trade seldom meet together,
even for merriment and diversion, but the
conversation ends in a conspiracy against the
public, or in some contrivance to raise prices. It is
impossible indeed to prevent such meetings, by
any law which either could be executed, or would
be consistent with liberty and justice. But though
the law cannot hinder people of the same trade
from sometimes assembling together, it ought to
do nothing to facilitate such assemblies, much less
to render them necessary. Wealth of Nations, Book 1,
Chapter 10.
 Capital Accumulation (basis of
wealth of a nation)
Determines division of labor and proportion
of population engaged in production
Leads to economic development
Individual self-interest plus accumulation of
capital leads to optimum allocation of
capital among industries
 Capital Accumulation (basis of
wealth of a nation) (CONT)
Labor cannot accumulate capital because wage
level permits only satisfaction of consumption
desires (subsistence level wages)
Landholders do not accumulate capital because
they spend it on unproductive labor (servants, etc.)
Capitalists are the benefactors of society so
unequal distribution of income in their favor
benefits society by promoting economic growth
instead of immediate consumption of all
production
 An Inquiry into the Nature and
Causes of the Wealth of Nations
Book I: value theory, division of labor,
distribution of income
Book II: capital as a cause of wealth of nation
Book III: economic history of several nations
used as illustration
Book IV: history of economic thought & practice
including mercantilism & physiocracy
Book V: public finance
 Purpose of production
Purpose: for consumption and export
End purpose of economic activity is
consumption
One purpose of exports is to pay for imports
Source of wealth produced by labor (physiocrats
emphasized land as the source of wealth)
Wealth of a nation is measured in per capita
terms
One purpose of exports is to pay for imports
 Causes of the Wealth of Nations
Productivity of labor
Proportion of laborers usefully and
productively employed
Summary
 Productivity of labor
Depends on division of labor and specialization
Pin factory example - increase from 20 to 4800 pins per
worker per day when divided into 18 operations
Social disadvantage - workers dehumanized by repetitive,
monotonous tasks
Division of labor depends on extent of market and capital
accumulation
volume sold increases opportunity for division of labor
production process time consuming so stock of goods (capital)
needed to maintain labor during production
capital stock of goods comes from saving (this is the function of
the capitalist)
 Proportion of laborers usefully
and productively employed
Productive labor
employed in producing vendible commodities
Unproductive labor
employed in producing service (normative
judgment) - included sovereign, justice,
military (i.e., less govt, the better for the
economy implication: should lower taxes on
capitalists so they can accumulate more capital
to save and invest)
 Summary of the causes of the
wealth of nations
Accumulation of capital is the bottom line
Economic growth - depends on division of
total output between consumer goods and
capital accumulation (the larger capital
accumulation the greater the rate of growth)
 Summary of the causes of the
wealth of nations (cont)
Requirements for highest rate of growth:
free markets (no govt intervention)
private property
unequal distribution of income to allow
accumulation of capital
 Meaning of Value
Two Values:
value in use - the utility of an object.
Ambiguous, subjective measure
value in exchange - the purchasing power of an
object. Objective measure of price expressed in
the market.
Diamond-Water Paradox: Water has great
utility but little exchange value; a diamond
has little utility but great exchange value
 The word value, it is to be observed, has two different
meanings, and sometimes expresses the utility of some
particular object, and sometimes the power of purchasing
other goods which the possession of that object conveys.
The one may be called "value in use"; the other, "value in
exchange." The things which have the greatest value in use
have frequently little or no value in exchange; and, on the
contrary, those which have the greatest value in exchange
have frequently little or no value in use. Nothing is more
useful than water: but it will purchase scarce anything;
scarce anything can be had in exchange for it. A diamond,
on the contrary, has scarce any value in use; but a very
great quantity of other goods may frequently be had in
exchange for it.
 Wages
Smithput forth contradictory wage theories
including:
subsistence theory of wages
productivity theory
bargaining theory
residual claimant theory
wages fund theory
 Wage and Profit
Issuesthat impact on the inequalities of
wages and profits arising from the nature of
employments themselves

1. the wages of labour vary with the ease

or hardship,the cleanliness or dirtiness, the
honourableness or dishonourableness of the
employment.
 Wage and Profit
1. the wages of labour vary with the ease or
hardship,the cleanliness or dirtiness, the
honourableness or dishonourableness of the
employment.
Thus in most places, take the year round, a journeyman
tailor earns less than a journeyman weaver. His work is
much easier. A journeyman weaver earns less than a
journeyman smith. His work is not always easier, but it
is much cleanlier.
 Wage and Profit
1. Continuation
The trade of a butcher is a brutal and an odious
business; but it is in most places more
profitable than the greater part of common
trades. The most detestable of all employments,
that of public executioner, is, in proportion to
the quantity of work done,better paid than any
common trade whatever.
 Wage and Profit
Secondly, the wages of labour vary with the
easiness and cheapness, or the difficulty and
expense of learning the business.
When any expensive machine is erected, the
extraordinary work to be performed by it before it is
worn out, it must be expected, will replace the capital
laid out upon it, with at least the ordinary profits. A man
educated at the expense of much labour and time to any
of those employments which require extraordinary
dexterity and skill, may be compared to one of those
expensive machines.
 Wage and Profit
2. Continuation
Education in the ingenious arts and in the
liberal professions is still more tedious and
expensive. The pecuniary recompense,
therefore, of painters and sculptors, of lawyers
and physicians, ought to be much more liberal;
and it is so accordingly.
 Wage and Profit
Thirdly,the wages of labour in different
occupations vary with the constancy or
inconstancy of employment.
A mason or bricklayer, on the contrary, can work
neither in hard frost nor in foul weather, and his
employment at all other times depends upon the
occasional calls of his customers. He is liable, in
consequence, to be frequently without any. What he
earns, therefore, while he is employed, must not only
maintain him while he is idle, but make him some
compensation for those anxious and desponding
moments which the thought of so precarious a situation
must sometimes occasion.
 Wage and Profit
3. Continuation
When the inconstancy of employment is
combined with the hardship, disagreeableness
and dirtiness of the work, it sometimes raises
the wages of the most common labour above
those of the most skilful artificers.
 Wage and Profit
Fourthly,the wages of labour vary
accordingly to the small or great trust which
must be reposed in the workmen.
The wages of goldsmiths and jewellers are
everywhere superior to those of many other
workmen, not only of equal, but of much
superior ingenuity, on account of the precious
materials with which they are intrusted.
 Wage and Profit
4. Continuation
We trust our health to the physician: our fortune
and sometimes our life and reputation to the
lawyer and attorney. Such confidence could not
safely be reposed in people of a very mean or
low condition. Their reward must be such,
therefore, as may give them that rank in the
society which so important a trust requires. The
long time and the great expense which must be
laid out in their education, when combined with
this circumstance,necessarily enhance still
further the price of their labour.
 Wage and Profit
Fifthly, the wages of labour in different
employments vary according to the probability or
improbability of success in them.
The probability that any particular person shall ever be
qualified for the employment to which he is educated is
very different in different occupations. In the greater
part of mechanic trades, success is almost certain; but
very uncertain in the liberal professions. Put your son
apprentice to a shoemaker, there is little doubt of his
learning to make a pair of shoes; but send him to study
the law, it is at least twenty to one if ever he makes such
proficiency as will enable him to live by the business.
 Wage and Profit
Wages vary in inverse proportion to the
agreeableness of the employment.
education in the ingenious arts and in the
liberal professions, is tedious and
expensive. The pecuniary recompense,
therefore.of lawyers and physicians ought
to be much more liberal: and it is so
accordingly.
 Wages Fund Doctrine
Assumes there is a fixed capital fund for payment of wages
wages fund - the store of goods (capital) previously
produced (food, clothing, housing, etc.) for the use of
workers during the production period (time from start
to finished product)
Source of wages fund is the savings or failure to
consume of the capitalists
Wage rate = wages fund/labor force
Smith suggested that a) wages population
labor force wages (anticipated Malthus population
theory)
 Development of Society and
Property Rights
Period Property Rights
Hunting No Property Rights
Pastoral Some Private Property
(society hierarchy)
Agricultural Feudal, Property in
Landowners hands
Commercial Property of Capital