Book I, Chapter VII, 1

Of the Natural and Market Price of Commodities.

In every society or neighborhood there is an ordinary or average rate of both wages and profit for each kind of employment of labor and stock. As I shall show later, this rate is governed partly by the society's general circumstances—its wealth or poverty, whether it is advancing, standing still, or declining—and partly by the particular nature of each employment.

Every society or neighborhood likewise has an ordinary or average rate of rent. This too, as I shall show later, is governed partly by the general circumstances of the society or neighborhood where the land lies, and partly by the land's natural or improved fertility.

These ordinary or average rates may be called the natural rates of wages, profit, and rent at the time and place where they prevail.

When a commodity's price is just enough to pay, at their natural rates, the rent of the land, the wages of the labor, and the profits on the stock used to raise, prepare, and bring it to market, the commodity is sold at what may be called its natural price.

It is then sold for precisely what it is worth, or what it really costs the person bringing it to market. In ordinary language, the prime cost of a commodity does not include the profit of a person who buys it for resale. Yet if that person sells for a price that does not allow the ordinary local rate of profit, the trade plainly brings a loss, since the same stock could have earned that profit elsewhere. Moreover, profit is that person's revenue, the proper fund for subsistence. Just as the seller advances wages or subsistence to workers while preparing and bringing goods to market, so too the seller advances a personal subsistence, generally suited to the profit reasonably expected on the sale. Unless the goods yield that profit, they fail to repay what may properly be called their real cost.

Thus a price that leaves this profit is not necessarily the lowest at which a dealer might ever sell goods, but it is the lowest at which they are likely to be sold for any considerable length of time, at least where there is complete freedom to change trades as often as one wishes.

The actual price at which a commodity ordinarily sells is called its market price. It may stand above, below, or exactly at its natural price.

The market price of any commodity is governed by the ratio of the quantity actually brought to market to the demand of those willing to pay its natural price: the whole value of the rent, labor, and profit necessary to bring it there. Such buyers may be called effectual demanders, and their demand effectual demand, since it may suffice to bring the commodity to market. This differs from absolute demand. In a sense a very poor person might demand a coach and six, and might like to have it. But this is not effectual demand: no such commodity can be brought to market to satisfy it.

When the quantity brought to market falls short of effectual demand, not everyone willing to pay the full value of the rent, wages, and profit necessary to bring it there can obtain as much as desired. Rather than go without entirely, some will offer more. Competition immediately arises among them, raising the market price above the natural price by an amount that depends both on the size of the shortage and on how strongly the wealth and extravagant luxury of the competitors spur their eagerness. Among competitors of equal wealth and luxury, a given shortage will provoke fiercer or weaker competition according to how important acquiring the commodity is to them. Hence the exorbitant prices of necessities during a town's blockade or a famine.

When the quantity brought to market exceeds effectual demand, it cannot all be sold to buyers willing to pay the full value of the rent, wages, and profit necessary to bring it there. Some must be sold to people willing to pay less, and the low price they pay must lower the price of all of it. The market price falls further or less far below the natural price depending on how much the excess intensifies competition among sellers, or on how urgently they need to dispose of the commodity. The same excess of perishable imports produces much fiercer competition than an excess of durable imports: oranges, for example, provoke more competition than old iron.

When the quantity brought to market is just sufficient to meet effectual demand and no more, the market price naturally equals the natural price, or comes as close to it as can be judged. All the stock on hand can be sold at this price, but not for more. Competition among dealers compels them all to accept it, but does not compel them to accept less.

The quantity of each commodity brought to market naturally adjusts to effectual demand. Everyone who uses land, labor, or stock to bring a commodity to market has an interest in keeping that quantity from exceeding effectual demand; everyone else has an interest in keeping it from falling short.

If the quantity at any time exceeds effectual demand, one or more components of its price must be paid below their natural rates. If rent is reduced, landlords' interest will immediately prompt them to withdraw some land. If wages or profit are reduced, the interest of laborers or their employers, respectively, will prompt them to withdraw some labor or stock from that employment. Soon the quantity brought to market will be no more than enough to meet effectual demand. Each component of price will rise to its natural rate, and the whole price to its natural price.

If, on the other hand, the quantity brought to market falls short of effectual demand, one or more components of its price must rise above their natural rates. If rent rises, other landlords will naturally be prompted to prepare more land to grow the commodity. If wages or profit rise, other laborers and dealers will soon be prompted to employ more labor and stock in preparing and bringing it to market. Soon the quantity arriving there will be sufficient to meet effectual demand. Each component of price will fall to its natural rate, and the whole price to its natural price.

Natural price, then, is something like the center of gravity toward which the prices of all commodities continually move. Accidents may sometimes hold them far above it, and sometimes drive them somewhat below it. Yet whatever obstacles prevent them from settling at this point of rest and persistence, they always tend toward it.

In this way, all the industry annually employed to bring a commodity to market naturally adjusts to effectual demand. It naturally aims to bring just enough of the commodity to meet that demand, and no more.

But in some employments the same quantity of industry yields very different quantities of goods from year to year; in others it always yields the same quantity, or nearly so. The same number of farm laborers will produce very different quantities of corn, wine, oil, hops, etc., in different years. The same number of spinners or weavers, however, will produce the same or almost the same amount of linen and woolen cloth each year. Only the average output of the first kind of industry can be adjusted in any measure to effectual demand. Because its actual output is often much greater or much less than the average, the amount brought to market will sometimes considerably exceed and sometimes considerably fall short of effectual demand. Even if demand remains unchanged, therefore, the market price of such goods will fluctuate greatly, sometimes falling well below and sometimes rising well above their natural price. In the other kind of industry, equal amounts of labor yield the same or nearly the same output, which can therefore be matched more exactly to effectual demand. While demand remains the same, the market price of these goods is likely to remain the same too, exactly or as nearly as can be judged equal to their natural price. Everyone's experience shows that the price of linen and woolen cloth fluctuates less often and less sharply than the price of corn. The price of the former varies only as demand varies; the price of the latter varies not only with demand but with the much greater and more frequent changes in the supply brought to market to meet it.

Of the Natural and Market Price of Goods

In every society or neighborhood, each kind of work and each use of stock has a usual or average rate of wages and profit. As I will show later, this rate depends partly on the society's general condition: whether it is rich or poor, and whether it is growing, stable, or declining. It also depends partly on the particular kind of work or use of stock.

Every society or neighborhood also has a usual or average rate of rent. As I will show later, this depends partly on the general conditions in the society or neighborhood where the land lies, and partly on how fertile the land is, either naturally or after improvement.

The usual or average rates at a given time and place may be called the natural rates of wages, profit, and rent there.

A product sells at what may be called its natural price when its price is just enough to pay for the land's rent, the workers' wages, and the profits on the stock used to produce, prepare, and bring it to market, all at their natural rates.

It then sells for exactly what it is worth, or what it really costs the person bringing it to market. People do not normally include the seller's profit in what they call a product's original cost. But if he sells at a price that does not give him the usual rate of profit in his neighborhood, he clearly loses out on the deal. He could have earned that profit by putting his stock to a different use. Moreover, his profit is his revenue, the source of his living. While preparing the goods and bringing them to market, he advances wages or living expenses to his workers. In the same way, he advances his own living expenses, which generally match the profit he can reasonably expect when he sells the goods. If the goods do not yield that profit, they do not repay what can properly be called their real cost to him.

A price that allows this profit is not always the very lowest at which a dealer might occasionally sell his goods. But it is the lowest at which he is likely to sell them for any substantial length of time, at least where he is free to switch businesses as often as he likes.

The actual price for which a product is usually sold is called its market price. It can be above, below, or equal to its natural price.

The market price of a particular product depends on how much of it is actually brought to market compared with the demand from people willing to pay its natural price. That price covers all the rent, labor, and profit that must be paid to bring the product there. These people can be called effective buyers, and their demand effective demand, because it can bring the product to market. This differs from demand in the broad sense. A very poor man may in some sense want a coach and six horses. He might like to have them. But his demand is not effective demand, because nobody could bring them to market to satisfy it.

When less of a product is brought to market than effective demand calls for, not all the people willing to pay the full cost of rent, wages, and profit can get as much as they want. Some will pay more rather than go without it. They will immediately compete with each other, and the market price will rise above the natural price. How far it rises depends on how large the shortage is and how strongly the buyers' wealth and taste for luxury drive their competition. Among buyers equally rich and equally fond of luxury, the same shortage leads to stronger or weaker competition depending on how much it matters to them to get the product. That is why life's necessities become extraordinarily expensive when a town is blockaded or during a famine.

When more of a product is brought to market than effective demand calls for, it cannot all be sold to people willing to pay the full cost of rent, wages, and profit. Some must go to people willing to pay less, and their lower offers pull down the price of the whole supply. The market price falls below the natural price. How far it falls depends on how much the excess supply increases competition among sellers and how urgently they need to get rid of the product. The same excess supply causes much more competition when goods spoil easily than when they last: oranges, for example, rather than old iron.

When the amount brought to market exactly meets effective demand, and does not exceed it, the market price naturally equals the natural price, or comes as close as we can judge. Sellers can dispose of the entire supply at that price but not at a higher one. Competition among dealers forces them all to accept it, but does not force them to accept less.

The amount of any product brought to market naturally adjusts to effective demand. Everyone using land, labor, or stock to bring it to market has an interest in keeping the amount from exceeding that demand. Everyone else has an interest in keeping it from falling short.

If the amount exceeds effective demand at any time, at least one part of the price must be paid at less than its natural rate. If that part is rent, landowners' interests will immediately lead them to take some of their land out of that use. If it is wages or profit, workers or their employers will have an interest in moving some of their labor or stock into other uses. Soon the amount brought to market will be only enough to meet effective demand. Every part of the price will rise to its natural rate, and the whole price will rise to its natural price.

If instead the amount brought to market falls short of effective demand at any time, at least one part of the price must rise above its natural rate. If that part is rent, other landowners will naturally have an interest in preparing more land to produce the item. If it is wages or profit, other workers and dealers will soon have an interest in using more labor and stock to prepare and bring it to market. Soon the supply there will be enough to meet effective demand. Each part of the price will fall to its natural rate, and the whole price will fall to its natural price.

Natural price is therefore a kind of central price toward which the prices of all goods are always moving. Chance events may sometimes hold prices far above it or push them somewhat below it. But whatever keeps them from settling at that stable level, they are always moving toward it.

The total amount of labor and business activity devoted each year to bringing a product to market adjusts in this way to effective demand. It naturally aims to bring in exactly enough to satisfy that demand and no more.

But the same amount of work produces very different amounts of goods from year to year in some occupations, while in others it produces the same amount, or nearly so. The same number of farmworkers produce very different amounts of grain, wine, oil, hops, and so on in different years. But the same number of spinners or weavers produce the same amount of linen and woolen cloth each year, or nearly so. In farming, only average output can be matched to effective demand to any extent. Actual output is often much higher or lower than average. So the amount brought to market will sometimes greatly exceed demand and sometimes fall far short of it. Even if demand stays the same, the market price will swing widely, sometimes dropping well below natural price and sometimes rising well above it. In the other kind of work, equal amounts of labor produce the same output, or nearly so. Output can therefore be matched much more closely to effective demand. As long as that demand stays the same, the market price is likely to stay the same too, equal to the natural price or as close as can be judged. Everyone knows from experience that the price of linen and woolen cloth varies less often and less sharply than the price of grain. Prices of the first kind of goods change only when demand changes. Prices of the second kind change both when demand changes and when the amount brought to market changes, which happens much more often and on a much larger scale.