Adam Smith

1. Adam Smith Chapter 4 January 29-February 2, 2007

2. Smith compared to Mercantilists • Economic welfare is based on the flow of goods rather than accumulation of precious metals • Free trade v. regulated trade • Absolute advantage • Increasing returns due to specialization and exchange • Domestic and international trade

3. Smith compared to Mercantilists • Markets v. government allocation of resources • Trade (internal and external) is not a zero sum game – Smith did not favor regulated trade

4. Concept of Absolute Advantage • If a country can produce a product at a lower cost, they should export it to other higher cost countries

5. Example of Absolute Advantage

6. Absolute Advantage (continued) • To Smith, all countries could gain from trade, because trade led to division of labor and specialization on a world-wide scale, thus increasing labor productivity • But, some countries may export a lot and others very little (or, theoretically, export nothing!)

7. Smith compared to Physiocrats • Both believed that wealth was measured by the goods and services that the economy produces, not stocks of gold and silver • Both believed in the power of markets – generally against government regulation • Smith did not agree with Physiocrats that wealth only came from land; to Smith, the productivity of labor determined the wealth of a country, and the productivity of labor was dependent upon the amount of capital (that is real capital, not financial capital)

8. Smith and the Physiocrats • "They [the French Économistes] delighted in proving that the whole structure of the French laws upon industry was utterly wrong; that the prohibitions ought not to be imposed on the import of foreign manufacturers; that bounties ought not to be given to native ones; that the exportation of corn ought to be free; that the whole country ought to be a fiscal unit; that there should be no duty between any province; and so on in other cases. No one could state the abstract doctrines on which they rested everything more clearly. "Acheter, c'est vendre,' said Quesnay, the founder of the school, 'vendre, c'est acheter.' You cannot better express the doctrine of modern political economy that 'trade is barter.' 'Do not attempt,' Quesnay continues, 'to fix the price of your products, goods, or services; they will escape your rules. Competition alone can regulate prices with equity; it alone restricts them to a moderation which varies little; it alone attracts with certainty provisions where they are wanted or labour where it is required.' 'That which we call dearness is the only remedy of dearness: dearness causes plenty.'"

9. Smith and full employment • Prices adjust to clear markets.  If there is excess supply of labor, wages would fall to restore equilibrium.  If there is excess demand for labor, wages would rise  • Also, competitive forces would allow for the movement of resources into their most productive use – with respect to labor, high wages in one industry will attract workers, and wages will ultimately fall until returns to labor are equalized across industries

10. Smith and the rate of profit • Competition in labor market leads to higher wages over time – does this conflict with wages fund doctrine? • Competition in the commodity market leads to higher input prices over time • Limited number of opportunities for capitalists mean eventual decline in profits

11. Quiz • In completing the flow chart on page 72 of the textbook, what items (ideas, concepts, assumptions, etc) would you include next to the arrow going from Hume to Smith? • On that same flow chart, what items would you include next to the arrow going from Quesnay to Smith?