The distinction between market and natural price was one of the major achievements of classical economic theory. Among classical economists such as Adam Smith, natural price was taken to reflect the permanent and stable price that occurs when there is unrestrained competition. On the contrary, market prices change depending on factors that affect the supply or demand of a commodity. Smith endorsement of the natural price to be the summation of natural rates of wage, rent and profit shows various weaknesses in his assumptions which this paper will critique (Maneschi 760-762).
Smith starts this article by saying that every society has an accepted ordinary rate of wages, profits, rent, which are there irrespective of the price of commodities. He describes these average rates for the factors of production to be the natural rates. Further, he states that the natural price of a good is determined by the sum of the natural rates of rent, wages, and profit that are used in its production (Smith 99). Further, Smith points out that natural price is the true worth of a good. In this case, the real cost used to bring the commodity to the market. He also states that this price is always the least price that a trader is always willing to sell his/her commodity (Smith 100). On the description of market price, Smith notes that the market price is merely the price at which goods are sold in the market.
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 (Smith 99).
Smith further notes that individuals who are willing to pay a price equal or less than the natural price constitute the effectual demand. Noteworthy, the market price originates from the interplay between effectual demand and the actual supply.
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, or the whole value of the rent, labour, and profit, which must be paid in order to bring it thither. (Smith 99-100).
The analysis of market demand using point supply and point demand as illustrated by Smith is misleading (Shaikh. and Ertuğrul 112-132). In reality, where there is excess supply, some suppliers leave the market, while in cases of shortage there are always new entrants into the market (Fontela 9-12). Further, when there is a deficit in supply, some effective demanders leave the market (Gancia and Fabrizo 580-620). Therefore, the market demand is determined using the equilibrium of total demand and total supply.
Smith makes an elaborate and detailed description of how to determine the equilibrium demand and supply levels in the market (O’Rourke and Adam 78-92). In his argument, Smith says that a shortage in supply will lead to an increase in prices of commodities, while excess supply leads to a decrease in prices (Pack 1-7). In his interpretation, however, Smith uses the term “natural prices” as a fixed price, which is confusing.
When the quantity of any commodity which is brought to market falls short of the effectual demand, all those who are willing to pay the whole value of the rent, wages, and profit, which must be paid in order to bring it thither, cannot be supplied with the quantity which they want. Rather than want it altogether, some of them will be willing to give more. A competition will immediately begin among them, and the market price will rise more or less above the natural price… (Smith 100).
The use of the phrase “effectual demand” as used by Smith is true according to modern economics. Smith is able to distinguish between individuals who want to buy a product but cannot afford and those who want to buy and can afford. For those who can afford, he classifies them to be having “effectual demand,” which is correct. Given the significance of the use of the phrase “natural price,” it appears that the market price changes with this rate. Since the natural price originates from natural rates, it is prudent to analyze and analyze these rates. Smith defines natural rates as below:
There is in every society or neighborhood an ordinary or average rate both of wages and profit in every different employment of labour and stock….
These ordinary or average rates may be called the natural rates of wages, profit, and rent, at the time and place in which they commonly prevail (99).
Economic analysis shows that the use of natural price is faulty. To begin with, the price at which employees’ are always willing to offer services depends on their independent reservation wage. The reservation wage for individuals in a society is not always equal (Ashraf 1-25). Specifically, this issue raises concerns on the existence of a “natural rate” of wages. As illustrated by Smith, the “natural price” is in fact the normal price (Smith 29-36).
Smith’s argument that temporal changes in demand for commodities, such as colored flags during a national holiday, only lead to temporary change in price is true. He bases this argument on modern economic concepts of demand and supply, which say that an increase in demand leads to an increase in demand (Coarse 309-325). Further, his argument that monopolies and protected businesses make the market price to be higher than it should be is true (Smith 32-45). As illustrated in most economic journals, monopolistic businesses usually keep the supply of goods below the required demand levels in order to maximize profits (Buchanan 40-41). When market supply is in balance with effectual demand, the natural price will prevail in the market (Diamond 616-617).
To sum up, the article Of the Natural and Market Price of Commodities shows serious economic mistakes that Smith made in his book The Wealth of Nations. The assumption of the existence of a permanent “natural price” weakens the argument that he presents in this article. In fact, it is only through the replacement of the term “natural price” with “normal price” that his article makes economic sense. Further, an economist must acknowledge that the normal price does not have a fixed rate as assumed by Smith. Nonetheless, Smith is able to show a clear connection on how demand and supply interact to affect market prices. He shows how monopolies and protected businesses may manipulate the market price by producing below the required demand levels. As a consequence, despite the many economic misconceptions, the article is an important read on the history of economic thought.
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Smith, A. (1776) An Inquiry into the Nature and Causes of the Wealth of Nations, 2 vols., London: Strahan and Cadell; as repr. in R.H. Campbell, A.S. Skinner and W.B. Todd (eds) (1976) The Glasgow Edition of the Works and Correspondence of Adam Smith, vol. 2, 2 vols., Oxford: Clarendon, pp. 72– 81 [Book I, Ch. vii (‘Of the Natural and Market Price of Commodities’)].
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