Of the Real and Nominal Price of Commodities

Core idea

A thing has two prices. Its nominal price is the quantity of money it sells for. Its real price is the quantity of labour it would take to produce (or, equivalently, the quantity of labour you would have to spend to acquire it). Smith argues that the real price is the more fundamental measure — money values fluctuate as the value of money itself changes, but labour-cost is an anchor.

This is the founding statement of what economists later called the labour theory of value. Smith does not use it consistently — by Book I, Topic 6: Of the Component Parts of the Price of Commodities he qualifies it sharply — but it sets the standard against which prices are to be judged.

Why it matters

Why does a separate "real price" concept matter? Because the value of money is itself unstable. The discovery of American silver in the 16th century halved the value of European silver across a century; the harvest of a single bad year doubles the price of corn. A pound of sterling in 1500 commanded vastly more labour and goods than a pound in 1750, and unless you adjust for this, you cannot compare prices across time or across regions.

Smith's framework solves this with the proposition that labour itself, in equal exertion, is roughly invariant in real cost across time and place. "Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer." Labour can therefore be used as a numeraire — a yardstick against which all other prices can be measured.

Corn as the practical proxy

Smith concedes that "labour" is not directly observable in markets. He proposes a workable substitute: the price of corn. Corn (i.e. grain — the basic food) is the principal subsistence of the working population, and over moderately long stretches it tracks the cost of maintaining a labourer. The price of every other commodity expressed in corn is therefore a rough proxy for its labour content.

This is why Smith fills the topic with corn-price tables across centuries — to show that what looked like a vast inflation of prices in money terms was largely a fall in the value of silver, not a real rise in costs.

The diamond-water paradox, resolved

Book I, Topic 4: Of the Origin and Use of Money raised the puzzle: water is supremely useful but cheap; diamonds are nearly useless but enormously expensive. Smith's resolution is that exchange value depends on the labour required to obtain a thing, not on its utility. Water is abundant — almost zero labour acquires it. Diamonds are buried in remote mines — enormous labour acquires each one. Use-value and exchange-value, Smith concludes, are simply different concepts; the system of prices is governed by exchange-value (labour cost), not use-value.

Money is a measure, not a store of fixed worth

The deepest implication is methodological: when Smith later analyses wages or rent or profit, he is careful to ask whether he means money wages or real wages. The same applies to modern macroeconomics — "real" GDP, "real" wages, and inflation-adjusted prices all trace their conceptual ancestry to this topic.

Key takeaways

Mental model

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Practical application

The topic teaches an enduring discipline: never compare prices across long stretches of time or across different currencies without converting to a real measure. A salary of £200 in 1776 is not "small compared to today's £40,000" — it might command four loaves of bread, or four hundred, depending on the price of corn and the silver content of the pound. Historians, financial planners, and policy economists who skip this step end up making conclusions about inequality, growth, or living standards that the raw money figures simply do not support.

The modern toolkit (the consumer price index, real-wage indices, purchasing-power-parity exchange rates) implements Smith's idea more rigorously than corn-prices ever could. But the conceptual move is his.

Example

Two news headlines: "Average house in 1970 cost £5,000; in 2025 costs £290,000 — a 58-fold rise." This sounds like dramatic inflation. But if average wages over the same period rose 25-fold, and houses became larger and better insulated, the real-price change is much smaller than the nominal one. Comparing the two periods requires Smith's discipline — convert nominal money figures into a real measure (labour-equivalent hours, or purchasing power, or a basket of consumer goods) before drawing conclusions. Without that step, you confuse a change in the value of money with a change in the cost of housing.

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