Course Hero. "The Wealth of Nations Study Guide." Course Hero. 28 Sep. 2017. Web. 21 July 2018. <https://www.coursehero.com/lit/The-Wealth-of-Nations/>.
Course Hero. (2017, September 28). The Wealth of Nations Study Guide. In Course Hero. Retrieved July 21, 2018, from https://www.coursehero.com/lit/The-Wealth-of-Nations/
(Course Hero, 2017)
Course Hero. "The Wealth of Nations Study Guide." September 28, 2017. Accessed July 21, 2018. https://www.coursehero.com/lit/The-Wealth-of-Nations/.
Course Hero, "The Wealth of Nations Study Guide," September 28, 2017, accessed July 21, 2018, https://www.coursehero.com/lit/The-Wealth-of-Nations/.
This chapter explores why some people—including both employees and investors—make more money than others who perform the same amount of labor or provide the same amount of capital. Smith divides the discussion into two types of inequalities: those inherent to the different industries in which people (and capital) are employed, and those that arise from specific policy decisions on the part of governments.
The first type of inequality, Smith says, comes about because some jobs are naturally more hazardous or unpleasant than others—or require an expensive education. Other lines of work are held in high esteem, and will therefore be performed for less pay, or are frowned upon by society, and therefore have to pay higher wages to attract employees. Similar differences apply in what Smith calls "the employment of stock." Some industries are riskier than others, and the customs of consumption vary from market to market. Smith offers the example of rented housing: in London, tradesmen generally rent a house and let out some of the stories to lodgers to help make up the rent. Because the lodgings are not the tradesman's main source of income, they are usually rented out cheaper than they would be in Paris or Edinburgh, where independent tradesmen commonly live in apartments.
The second type of inequality comes about because of "the policy of Europe," Smith's catchall term for European laws and regulations on the international, national, and municipal levels. Some of these laws establish restrictions on specific trades (e.g., licenses and membership fees), leading to higher wages for those few who can afford to enter the trade. Others artificially encourage some trades at the expense of others, and still others, like the Statute of Apprenticeship, restrict the movement of people from one trade to another, or from place to place. At best, Smith argues, most of these trade laws are a nuisance; at worst, they do substantial harm to the British economy.
Here, Smith is unusually candid and cogent about the role of risk and uncertainty, two topics frequently brushed to the margins in The Wealth of Nations. People, he argues, are generally prone to underestimating the risk of misfortune and overestimating the likelihood of favorable events. This explains both the popularity of lotteries and the "very moderate profit of insurers"—i.e., insurers would make more money if people were sufficiently heedful of their risk of financial loss. Counterintuitively, at least for Smith, young people seem even to be drawn to risky professions such as sailing or soldiering—they see the danger as an asset to be valued in its own right, not as a drawback. His choice of a lottery as an example is revealing, since in a lottery the odds are usually known, and one might therefore decide whether the game is worth it by comparing the prize money with the number of tickets to be sold. The condition in which the likelihood of different outcomes is not known, or is merely estimated, is formally referred to as uncertainty.
This psychology of risk and uncertainty, merely hinted at here by Smith, has grown in subsequent centuries into an important part of economics. Game theory (see Context) has provided a framework for assessing and mitigating risk in complicated, but highly formalized scenarios. On a more practical plane, the core observation that people treat gains and losses differently has been tested and developed in a series of experiments, leading to the branch of economic psychology now known as prospect theory. In "Prospect Theory: An Analysis of Decision Under Risk," a March 1979 paper considered foundational in this field, researchers Daniel Kahneman and Amos Tversky note a pattern of "risk aversion in choices involving sure gains and ... risk seeking in choices involving sure losses." The article, originally published in the journal Econometrica, is fairly accessible by the standards of econometric research, containing only a modest amount of algebra to explain the researchers' quantitative results.