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Adam Smith
Chapter 4
January 29-February 2, 2007
Smith compared to
Mercantilists
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Economic welfare is based on the flow
of goods rather than accumulation of
precious metals
Free trade v. regulated trade
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Absolute advantage
Increasing returns due to specialization
and exchange
Domestic and international trade
Smith compared to
Mercantilists

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Markets v. government allocation of
resources
Trade (internal and external) is not a
zero sum game – Smith did not favor
regulated trade
Concept of Absolute
Advantage

If a country can produce a product at a
lower cost, they should export it to
other higher cost countries
Example of Absolute
Advantage
England
France
Output of Cloth
per worker per
day
20 yds
10 yds
Output of wine per
worker per day
30 gallons
50 gallons
Absolute Advantage (continued)
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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!)
Smith compared to Physiocrats
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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)
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.'"
Smith and full employment
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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
Smith and the rate of profit
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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
Quiz
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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?