NATURAL AND MARKET PRICES

 The natural and market prices of commodities is one of the hallmarks of Classical economic theory. As is well-known, the distinction refers to the sharply different nature of the forces involved: unlike their market counterparts, natural prices were taken by Classical authors to reflect the permanent and systematic forces at work whenever competition operates without restraint. In the 7th Chapter of the Wealth of Nations, all that concerns this question is most ably treated. Having fully acknowledged the temporary effects which, in particular employments of capital, may be produced on the prices of commodities, as well as on the wages of labour, and the profits of stock, by accidental causes, without influencing the general price of commodities, wages, or profits, since these effects are equally operative in all stages of society, we will leave them entirely out of our consideration, whilst we are treating of the laws which regulate natural prices, natural wages and natural profits, effects totally independent of these accidental causes. Yet, in the mature stage of thought in economics, am not a strict follower of Smith on the subject of price theory and in several places in the Principles he put emphasis on what i considered to theoretical blunders. While a thorough look at Smith’s  price theories is obviously beyond the scope of this entry, a few differences will be hinted at in what follows. As far as natural price determination is concerned, Smith endorsed what may be called an adding-up theory of natural prices since he claimed that the natural prices of the various commodities derive from the summation of the natural rates of wages, profits and rents:  In modern rational reconstructions of Classical economics natural prices are those prices that obtain in a cost- minimizing system of production, given a) the technical conditions of production of the various commodities, b) the size and composition of the social product, c) the quantities of the different qualities of land available and the known stocks of depletable resources.When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price. the latter three magnitudes to be understood as the average rates “at the time and place in which they commonly prevail” By contrast, due to its differential nature, does not enter into the cost of production of the various commodities.

 Rent is price-determined and not price-determining.The value of corn is regulated by the quantity of labour bestowed on its production on that quality of land, or with that portion of capital, which pays no rent. Corn is not high because a rent is paid, but a rent is paid because corn is high. More over a rise in wages, due to a rise in the price of corn, causes a proportional rise of all commodity prices, regardless of existing differences in the fixed to working capital ratio of each commodity: Adam Smith, have, without one exception that I know of, maintained that a rise in the price of labour would be uniformly followed by a rise in the price of all commodities. I hope I have succeeded in showing, that there are no grounds for such an opinion, and that only those commodities would rise which had less fixed capital employed upon them than the medium in which price was estimated, and that all those which had more, would positively fall in price when wages rose.  Even in that early state to which Adam Smith refers, some capital, though possibly made and accumulated by the hunter himself, would be necessary to enable him to kill his game. Without some weapon, neither the beaver nor the deer could be destroyed, and therefore the value of these animals would be regulated, not solely by the time and labour necessary 2 As emerges from an oft-quoted letter to McCulloch Adam Smith was eager to “get rid of rent” so to simplify the problem of income distribution between capitalists and workers. As is well-known,  that many of the theoretical deficiencies detected in The Wealth of Nations derive just from Smith’s imperfect comprehension of the “true doctrine of rent”.  As concerns the relationship between wages and profits Smith was not as crystal-clear. Nonetheless, It is the cost of production which must ultimately regulate the price of commodities, and not, as has been often said, the proportion between the supply and demand,  a statement which, translated into a Marshallian framework, would naturally amount to an implicit and generalized assumption of constant returns. 

A possible explanation to this theoretical puzzle is provided by the young Sraffa in his 1925 Italian contribution on Marshallian value theory. Sraffa (1925 [1998], pp. 324 – 325) stressed that Classical authors treated the phenomena of decreasing and increasing productivity in relation to the theory of rent, a chapter of distribution theory, and in relation to the process of division of labour, a chapter of production theory, When a commodity is at a monopoly price, it is at the very highest price at which the consumers are willing to purchase it. Commodities are only at a monopoly price, when by no possible device their quantity can be augmented; and when therefore, the competition is wholly on one side amongst the buyers. [...] Those peculiar wines, which are produced in very limited quantity, and those works of art, which from their excellence or rarity, have acquired a fanciful value, will be exchanged for a very different quantity of the produce of ordinary labour, according as the society is rich or poor, as it possesses an abundance or scarcity of such produce, or as it may be in a rude or polished state. 

The exchangeable value therefore of a commodity which is at a monopoly price, is nowhere regulated by the cost of production.  the proportion between supply and demand may, indeed, for a time, affect the market value of a commodity, until it is supplied in greater or less abundance, according as the demand may have increased or diminished; but this effect will be only of temporary duration.  Commodities which are monopolized, either by an individual, or by a company, vary according to the law which Lord Lauderdale has laid down: they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production. In the ordinary course of events, there is no commodity which continues for any length of time to be supplied precisely in that degree of abundance, which the wants and wishes of mankind require, and therefore there is none which is not subject to accidental and temporary variations of price.   To put it briefly, for Sraffa, no Classical economist ever thought to co-ordinate the two phenomena in one single law of non-constant productivity and to make such a law the cornerstone of the explanation of the equilibrium price of a given commodity produced under competitive conditions. 

This point of view was further elaborated upon by Sraffa, once moved to Cambridge, in his 1928 – 1931 Lectures on the Avanced Theory of Value: see Signorino (2005, pp. 363 ff) 5 E.g. compare Ricardo’s statements quoted in the text with what Smith wrote in Chapter 7 of the Wealth of Nations about the price of commodities whose production requires specific soils and situations, and the price of commodities produced under a regime of monopoly or otherwise restricted competition. How to justify then the privileged role accorded by Ricardo to natural values within his own economic analysis? The answer is that market prices may be safely assumed as gravitating towards their natural levels. Obviously,such an assumption is warranted provided that in all markets where competition operates without restraint a very powerful mechanism is at work to adjust the quantities produced of the various commodities to their respective Smithian effectual demands.When we look to the markets of a large town, and observe how regularly they are supplied both with home and foreign commodities, in the quantity in which they are required, under all the circumstances of varying demand, arising from the caprice of taste, or a change in the amount of population, without often producing either the effects of a glut from a too abundant supply, or an enormously high price from the supply being unequal to the demand, we must confess that the principle which apportions capital to each trade in the precise amount that it is required, is more active than is generally supposed. To put it in a nutshell, for Smith unrestrained competition is very effective to dampen the variance of market prices around their average, or natural, levels. In Ricardo’s view the main actors behind such adjustment mechanism were the rich manufacturers and the financial capitalists, “the monied class” as Ricardo called them, that is, those who “live on the interest of their money, which is employed in discounting bills, or in loans to the more industrious part of the community”. Smith depicted entrepreneurs as economic agents endowed with a peculiar alertness towards the profits differentials which continually emerge out from the ebb and flow of supply and demand in the various markets. At the aggregate level, the individual choices prompted by the search of the highest available rate of return for one’s own capital are supposed to enforce (a tendency to) an uniform rate of profits:Whilst every man is free to employ his capital where he pleases, he will naturally seek for it that employment which is most advantageous; he will naturally be dissatisfied with a profit of 10 per cent, if by removing his capital he can obtain a profit of 15 per cent. This restless desire on the part of all the employers of stock, to quit a less profitable for a more advantageous business, has a strong tendency to equalize the rate of profits of all. As clarified by Smith, in his view the specific role of financial capitalists is to assist entrepreneurs in the process of reorganization of the material conditions of production to keep pace with ever-changing market opportunities: Smith  took for granted, and thus did not bother to demonstrate formally, that market and natural prices coincide on average. For a critical discussion of the literature on gravitation in Classical economics.  

The alleged long-run tendency to an uniform rate of profits and an uniform rate of wages does not imply that Classical economists ignored persistent inequalities in the rate of profits or wages due to the existence of non-pecuniary differences among sectors.When the demand for silks increases, and that for cloth diminishes, the clothier does not remove with his capital to the silk trade, but he dismisses some of his workmen, he discontinues his demand for the loan from bankers and money men; while the case of the silk manufacturer is the reverse: he wishes to employ more workmen, and thus his motive for borrowing is increased: he borrows more, and thus capital is transferred from one employment to another, without the necessity of a manufacturer discontinuing his usual occupation. The stockbroker Smith knew quite well that financial capital is endowed with a much higher inter-sectoral mobility than physical capital, particularly the fixed part of it, and thus the former, unlike the latter, may be assumed as not being tied to a given productive sector. As a consequence, fixed capital ends up to play the role of the slackening element in the adjustment process sketched above: the higher the share of fixed capital on total capital, the higher the share of sunk costs on total costs of production and thus the stronger the unwillingness of entrepreneurs to quit their sector whenever market conditions are altered by a technological breakthrough, a change of fashion, the introduction of a new tax or the repeal of an old one, the start or the end of wartime etc. The commencement of war after a long peace, or of peace after a long war, generally produces considerable distress in trade. It changes in a great degree the nature of the employments to which the respective capitals of countries were before devoted; and during the interval while they are settling in the situations which new circumstances have made the most beneficial, much fixed capital is unemployed, perhaps wholly lost, and labourers are without full employment. The duration of this distress will be longer or shorter according to the strength of that disinclination which most men feel to abandon that employment of their capital to which they have long been accustomed. (Works I.xix.3) Though the high price of agricultural products is, in Smith view, the main culprit of high wages and thus low profits and low rate of capital accumulation, Smith was aware that an abrupt removal of the obstacles to the free importation of cheap foreign corn in England, in the aftermath of Napoleonic wars, would have destroyed much of the value of the capital invested in domestic agriculture. In the circumstances, he invoked an active government policy to compensate for the negative effects of free-trade: The best policy of the State would be, to lay a tax, decreasing in amount from time to time, on the importation of foreign corn, for a limited number of years, in order to afford to the home-grower an opportunity to withdraw his capital gradually from the land.