Market prices and natural prices

Smith’s distinction between “market prices” and “natural prices” takes up the conceptu­alization introduced by his predecessors. The market price of a commodity refers to the actual price, as it can be observed in a given time and place.

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. (WN I.vii.8)

In the usual price-quantity diagram Smith’s notions of “supply” and “effectual demand” correspond to single points (see Garegnani 1983). If the supply exceeds (falls short of) the effectual demand for the commodity, competition among sellers (buyers) will lower (raise) the market price below (above) its natural value. In both cases adjustment proc­esses are triggered by which the supply is adapted to the “effectual demand”:

If at any time it [the quantity brought to market] exceeds the effectual demand, some of the component parts of its price must be paid below their natural rate. If it is rent, the interests of the landlords will immediately prompt them to withdraw a part of their land; and if it is wages or profit, the interest of the labourers in the one case, and of their employers in the other, will prompt them to withdraw a part of their labour or stock from this employment. The quantity brought to market will soon be no more than sufficient to supply the effectual demand.

A similar reasoning applies in the converse case, so that the natural levels of the three rates of income are restored through the reactions of land-owners, workers, and capital­ists to above- or below-normal rates of remuneration. Accordingly, natural prices can be conceived as “attractors” of market prices, which according to Smith always gravitate towards or oscillate around them (WN I.vii.15).

How, then, are the natural prices determined? Smith approached this problem with reference to two different stages in the development of societies - a distinction which can be interpreted as reflecting a mere thought experiment or also a real historical sequence. In the “early and rude state of society which precedes both the accumulation of stock and the appropriation of land” (WN I.vi.1) the entire produce of labour belongs to the labourer, and the exchange ratios of commodities are determined by the ratio of the quantities of direct labour employed in their production. The amount of labour “embodied” in a commodity is then equal to the amount of labour “commanded” by it. However, in an “improved society”, where land has been privately appropriated and capital has been accumulated, the labourers have to share the produce of their labour with the owners of capital and land. Since profits and rents now enter into the prices of commodities as component parts, besides wages, the amount of labour “commanded” by a commodity must necessarily exceed the amount of labour “embodied” in it. In Smith’s view, the labour theory of value must then be dispensed with, and he suggested replac­ing it by defining the “natural prices” of commodities as the sum of three components: wages, profits, and rents, all remunerated at the corresponding “natural rates” (WN I.vi). Smith contended that the price of every commodity can always be entirely resolved into these three income components, because the means of production which have been used in the commodity’s production have themselves been produced in the preceding period by means of land, labour, and produced means of production, and the latter in turn have been produced, in the previous production period, by land, labour, and produced means of production, and so on.

It is clear that Smith’s “adding-up theory of prices” (Sraffa 1951: xxxv) involves cir­cular reasoning: it transfers the problem of price determination to that of determining the natural rates of wages, profits, and rents; and the level of the natural wage was made to depend by Smith on the prices of the workers’ means of subsistence (see Garegnani 1984). In addition, for commodity prices to be completely resolvable into the three income components there must be a production stage at which only labour and land are required as inputs, that is, the reduction series to dated quantities of labour and dated quantities of land would have to be of finite duration.