ADAM SMITH: Wealth of Nations (Book I: Chapters 4-8)

    

The best things in life may be free but everything else costs money.  The main question is how much?  How much does that diamond ring in the window cost?  How much is a bottle of water?  The cost of something is what Adam Smith calls its “value.”  He says the word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods...  The utility (usefulness) of water is that we can drink it when we’re thirsty.  But what good is money?  We can’t eat it or drink it so what use is it?  The answer of course is that money can be used to buy things we do need when we need them.  If I have enough money I can buy a bottle of water.  And if I have more money I can buy a diamond ring.  This seems natural to us now but only because we’re used to it.  It’s not natural.  It’s really an odd state of affairs when you stop to think about it.  Adam Smith points out that nothing is more useful than water; but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.  Strange; I can sell a useless diamond ring for thousands of dollars but I can only sell a bottle of water for a dollar.  Why are diamonds so expensive and water so cheap?  One answer is that it takes a lot more work to gather diamonds than it does to get water.  In fact Adam Smith believes that work is the real measure of the exchangeable value of all commodities. The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. According to this formula I can calculate what everything is worth by how much work I have to do in order to pay for it.  For example, if I earn ten dollars an hour then for me buying a one dollar bottle of water is worth six minutes of work; a diamond ring that costs a thousand dollars is worth one hundred hours of work.  But if I can earn twenty dollars an hour then a bottle of water will only cost me three minutes of work.  And I can buy a thousand dollar diamond ring for only fifty hours of work.  The catch is that I have to find a job that will pay me twenty dollars an hour.  Or I can find some other way to make money that equals out to twenty dollars per hour.  Another way to make money is to start my own business.  Adam Smith shows how this works: As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials. Under this scenario I save enough money to buy some supplies to make widgets.  (Adam Smith calls this my “stock”)  Then I pay someone else ten dollars an hour to make widgets for me.  I supply the materials.  The people I hire make the widgets.  But how does this help me earn money?  Simple.  In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials, and the wages of the workmen, something must be given for the profits of the undertaker of the work who hazards his stock in this adventure. In other words, I turn around and sell widgets for twenty dollars apiece.  If supplies cost me nine dollars and wages cost me ten dollars then I have one dollar left over.  So every widget I sell earns me one dollar in profit.  This one dollar profit can then be used to replenish my stock and hire more workers.  Money from profits is the “capital” I can use to expand my business and make more widgets.  Adam Smith explains capitalism in simple terms: small profits made from selling widgets across whole countries soon add up.  The total amount of these combined profits is what Smith calls The Wealth of Nations.  One dollar profit will only buy one bottle of water.  But a bunch of dollars put together can buy battleships and interstate highways and water treatment plants and school buildings.  Some things in life are free but nations also need things that cost a lot of money.