Of the Natural and Market Price of Commodities

Core idea

Every commodity has two prices that need distinguishing. The natural price is the sum of the ordinary rates of wages, profit, and rent for the trade — the price at which the commodity can be sustainably produced. The market price is what it actually sells for on any given day, set by the relation of quantity brought to market and the demand of those willing to pay the natural price.

Smith's central claim is that market price gravitates toward natural price. When market price runs above the natural rate, the excess profit attracts new producers, output expands, and the price falls back. When market price runs below the natural rate, producers exit, output contracts, and the price rises back. This is the first explicit statement of what modern economists call competitive equilibrium.

Why it matters

The topic is the analytic engine of the entire Wealth of Nations. Almost every later argument — about wages, profits, rent, trade, colonies — assumes that competition pulls prices toward natural costs, and that systematic deviations from natural price are diagnostic of obstructions to competition (monopolies, guilds, prohibitions, secrets).

The mechanism is migration of capital and labour

What pulls market price back toward natural price is not a wise hand but the self-interested decisions of producers. If hat-making is yielding 30% returns while shoe-making yields 10%, capital flows out of shoes and into hats; labourers shift trades; hat output grows; hat prices fall. The "gravity" is the aggregate movement of resources toward whatever activity is currently above-natural.

Why deviations persist

Smith catalogues the conditions under which market price stays above natural price for long stretches:

• Trade secrets — proprietary processes that competitors cannot replicate. Smith says these are the most temporary form of advantage.
• Natural monopolies — vineyards on uniquely suited soils, mines of rare ores. These are permanent because the resource cannot be replicated.
• Legal monopolies — exclusive privileges granted by the state (the East India Company, the chartered guilds). These can be lifted but historically were not.
• Corporation laws and apprenticeship rules — restrictions on how many people may enter a trade. These keep urban wages and profits above natural for whole occupations.

The implication is normative: competition is the rule, monopoly is the exception, and policy ought to remove obstructions to competition wherever it can.

The "effectual demand" definition

A subtle but important distinction: Smith does not mean "people who want the thing" by demand. He means effectual demand — people who actually have the wages, profit, or rent to pay the natural price. A starving man "wants" bread in the moral sense but contributes nothing to effectual demand. This anticipates the modern distinction between need and willingness-to-pay.

Key takeaways

Mental model

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Practical application

Smith's topic is the conceptual ancestor of every entrepreneur's pricing analysis. The diagnostic question for any market is: is the going price above, at, or below the natural cost of production? Above-natural prices are an invitation: someone, somewhere, will enter to capture the excess profit unless something blocks them. Below-natural prices are a warning: producers will exit unless cost or demand changes.

The topic is also the conceptual ancestor of every antitrust regulator's brief. If a market is showing persistent above-natural prices and no entry is occurring, the regulator's job is to ask why — and the answers will come from Smith's list of obstructions (secrets, natural monopolies, legal privileges, guild restrictions, network effects).

Example

The smartphone market in 2007: Apple's iPhone enjoyed enormous above-natural profits — a combination of trade secrets (the software, the design), patents (legal monopoly on certain methods), and a temporary natural monopoly (it was the first device of its kind). Within five years, Android entrants arrived; component costs fell; competition intensified; the average margin on mid-tier smartphones converged toward a lower natural rate. Apple maintained above-natural margins on its premium tier by preserving the brand, software, and ecosystem moat — exactly the kind of persistent advantage Smith analyses, sustained by a combination of trade secrets and network effects that competitors find genuinely difficult to copy. The system gravitates toward natural price unless something specific blocks the gravitation.

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