Posted by: erichosemann | December 27, 2009

The Wealth Of Nations, Book 1, Chapter 5, Part 1

Since this chapter is longer than the others, I’m dividing its summary into two separate posts.

Chapter 5: Of the Real and Nominal Price of Commodities, or of Their Price in Labour, and Their Price in Money

43, 1 A person’s wealth depends not on what he himself can produce but on the amount of the labor of others he can afford to purchase.  The reason a person’s wealth does not depend solely on what he produces is that, through the division of labor, what one person produces is but a small portion—if even that—of the necessities of life.

Labor is the price of everything; therefore the value of wealth is equal to the amount of labor it can purchase.

While, according to Hobbes, wealth is power, the accumulation of wealth does not automatically mean the accumulation of political power; it means the ability to purchase labor.

44, 2 Because it is difficult to find equivalence between two different types of labor, labor is not exchanged; it is exchanged indirectly through the barter of commodities.  45, 2 People better comprehend the exchange of labor in terms of goods rather than goods in terms of labor; the former involves tangible, physical goods, the latter is an “abstract notion.”

45, 2 Money facilitates exchange by serving as a common denominator.  If money was not used, awkward calculations would be necessary to determine the value of the product of labor in terms of the multiple commodities for which it is traded; e.g. one quantity of meat would equal a certain amount of beer and a different amount of bread.

46, 1 Gold and silver are themselves commodities and thus the value of a currency made of gold and silver depends in part on the difficulty of mining those metals.  When new mines were found in America in the 16th century, the prices of gold and silver were reduced by a third.  What good is money as a unit of measurement of value if it continually changes in magnitude?  Because money, as a commodity, gains and loses value, it can only be regarded as a nominal measurement of a commodity’s value; labor alone is the real measurement of value because labor always “lays down the portion of [the laborer’s] ease, his ability and his happiness” for goods.

47, 1 But labor is a commodity, too; employers purchase it as they do any other good.  Labor has a real price (the quantity of goods necessary to purchase it) and a nominal price (its price in money).  Just as a person’s wealth as a consumer depends on the quantity of labor he can purchase, a person’s wealth as a laborer depends on the quantity of goods their labor commands.

48, 1 The distinction between real and nominal prices has a practical application.  Because money’s value depends upon the amount and market price  of the metal comprising it, people dependent upon rental income are better off specifying that income be paid in a commodity instead of money.

48, 2 Sovereigns tend to debase, not augment, the amount of precious metal in their currencies, thus over time the real value of money rents is diminished.  49, 1 The discovery of new sources of gold and silver also diminishes the value of the money upon which they are based, further diminishing the value of money rent; therefore, to reduce the erosion of their real value, rents should be specified not in quantities of money but in quantities of pure metal, e.g. ounces of silver rather than number of silver coins.

49, 2 Rents paid in commodities such as corn (grain) hold their value better than rents paid in money, even when a currency is not debased.  The difference then between a rent’s value in terms of a commodity and its value in terms of money is due entirely to a lower price for precious metals.  50, 1 When debasement of a currency is combined with lower prices for the metal of which it is made, the difference between the real and nominal values of a rent is even greater.

50, 2 Over long periods the price of corn in terms of labor is relatively stable.  This is because corn is a food and is part of the laborer’s sustenance; the prices of other commodities in terms of labor suffer greater variation because they can be purchased with corn as well.

51, 1 The money price of labor varies with the average price of corn, and the average price of corn depends on the value of silver.  While the value of corn varies more from year to year than it does century to century, the value of silver changes more between centuries than years.

52, 1 Because of these discrepancies in the values of corn and silver, labor is the best, most accurate measure of value across time 52,2 while money is the best measure of value for day-to-day transactions.

53, 1 At the same time and place, the proportion between real and nominal price—the proportion between labor value and monetary value—is accurate, but only at the same time and place…

53, 2 But…money is a good measure of value between distant places, because the discrepancy between the values of labor in those places may be great.  Those who exploit this discrepancy (Smith uses as an example an importer who sells in Britain for a pound that which cost him half a pound to produce in China) care only for the nominal price and not the real price, even though the real price of an imported good would command greater amounts of labor in its exporting country. [Note: Why?  Because at the time only goods and money could be easily transported over great distances?  If so, how has increased labor mobility affected nominal prices and the role of the arbitrageur?]

54, 1 Since the nominal price determines the “prudence and imprudence of all purchases and sales,” the nominal price is what people worry about.

54, 2 In TWN, Smith will sometimes use corn as a measure of value, because, while corn prices were recorded in early times only in a few places, they are part of the historical record whereas labor prices are not.  Smith acknowledges that corn prices are only the “nearest approximation” of contemporaneous labor prices.

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