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Course Hero. "The Wealth of Nations Study Guide." September 28, 2017. Accessed September 22, 2018. https://www.coursehero.com/lit/The-Wealth-of-Nations/.
Course Hero, "The Wealth of Nations Study Guide," September 28, 2017, accessed September 22, 2018, https://www.coursehero.com/lit/The-Wealth-of-Nations/.
Smith now draws a further distinction between a commodity's natural price and its market price, terms that complement the real price/money price distinction spelled out in Chapter 5. A commodity's natural price in a given time and place is the price "sufficient to pay the rent of the land, the wages of the labor, and the profits of the stock." This is not generally equal to the market price, which is the price for which the commodity is actually sold.
The remainder of the chapter is devoted to exploring those factors that raise or lower the market price. Smith begins by observing that ordinary concerns of supply and demand can affect the price. If a commodity is in short supply, it will be sold to the highest bidder, but if there is a surplus, the sellers will take a loss rather than fail to sell altogether. In explaining this, Smith sets forth the related concept of effectual demand, meaning essentially the demand for a commodity by people who can actually afford to purchase it. A poor man, Smith points out, may wish to own a fancy carriage, but his "demand" for one will not lead to any transaction.
Other industry-specific circumstances can also affect the market price of a commodity. Smith names trade secrets and monopolies as two major contributors to artificially elevated prices. Among the latter, he includes not only government-granted monopolies on specific trades, but also the various rules made up by trade associations (e.g., guilds that require apprenticeship) and even the caste system of India ("Indostan" in the English usage of the time). By restricting the manufacture of certain goods, Smith observes, monopolists can create a condition of perpetual shortage, in which there is never enough supply to meet the effectual demand.
This chapter contains Smith's first sustained argument in favor of free trade, a subject that will occupy much of his attention in later books. For Smith, any impediment to trade is an inconvenience at best, and at worst a form of economic self-sabotage. Smith's ideas on this topic have sometimes been exaggerated to paint him as an opponent of any government intervention in trade, but this is a more extreme position than is ever advanced in The Wealth of Nations. Smith, it is true, is deeply suspicious of attempts to limit the free market, but he is nonetheless willing to admit that such interventions are sometimes justified by other concerns. In Book 4, Chapter 5, for example, he suggests placing a bounty—but only a small one—on the production of those goods required to supply Great Britain's military, so as to keep the country ready for war. Likewise, in Book 5, Smith will acknowledge the necessity of levying taxes, even though, as he readily concedes, these will unavoidably disrupt the "natural" dynamics of the market.
What is truly inexcusable for Smith is an unnecessary or ill-conceived government intervention, particularly if it is motivated by the lobbying of commercial interests. Reviewing the statutes supporting England's international merchant companies, Smith finds many examples of rules enacted due to political pressure from merchant groups, not out of a sincere and well-considered belief in the beneficial effects of these laws. In Book 4, Chapters 7 and 8, he will lay out the case for abolishing those regulations that grant special favors to merchant companies. Likewise, Smith sees legally granted monopolies in the home country as not only unfair but, more damningly, counterproductive—they may benefit the monopolists, but they harm the economy as a whole.