Definition
In Adam Smith's analysis, every commodity has two prices:
- Natural price — the sum of the ordinary rates of wages, profit, and rent for the trade. It is the price at which the commodity can be sustainably produced over the long run; below it, producers do not earn enough to continue; above it, excess returns attract new producers.
- Market price — the actual price the commodity sells for on any given day, set by the immediate relation between quantity offered for sale and effectual demand (the demand of those willing to pay the natural price).
Smith's central claim is that market price gravitates toward natural price through the mobility of capital and labour between trades. This is the founding statement of what modern economists call competitive equilibrium.
Why it matters
How it works
The mechanism Smith describes is a negative-feedback loop driven by the self-interest of producers and capitalists:
- Suppose market price is above natural. The trade is yielding above-ordinary profits. Capital and labour flow in from other trades — partnerships expand, new entrants set up, workers retrain. Supply grows. Prices fall.
- Suppose market price is below natural. Producers earn below-ordinary returns or losses. Capital flows out — businesses close, owners switch trades, workers seek other employment. Supply shrinks. Prices rise.
- The system tends toward equilibrium at the natural price, where supply matches effectual demand and ordinary returns are being earned on labour, capital, and land.
The mechanism does not require any party to know what the natural price is. Each producer and worker responds only to what is happening to their own returns. The aggregate outcome is the gravitation Smith describes.
When the gravitation fails
Smith catalogues the conditions under which market price persistently stays above natural price:
- Trade secrets — proprietary processes competitors cannot replicate. Usually temporary.
- Natural monopolies — vineyards on uniquely suited soils, mines of rare ores. Permanent because the resource cannot be replicated.
- Legal monopolies — exclusive privileges granted by the state. Removable but politically sticky.
- Corporation laws and apprenticeship rules — restrictions on entry into trades. Distort the labour-mobility mechanism.
Where the gravitation fails, prices stay above natural rates and the affected sector extracts rents from the rest of the economy. The diagnostic move is to look at any persistent above-natural pricing and ask what is blocking the entry that should have closed the gap.
Modern descendants
The natural-vs-market-price framework is the conceptual ancestor of:
- Competitive equilibrium in modern economics — the price at which supply equals demand at zero economic profit.
- The theory of rents and rent-seeking — extra returns earned because of blocked competition.
- Antitrust regulation — the diagnostic discipline of finding persistent above-natural pricing and identifying the obstruction.
- Entrepreneurial price analysis — every venture's question of whether the going price is above, at, or below the natural cost of production.
The mechanism Smith identified — markets gravitate toward sustainable cost prices when competition is free — remains one of the most useful diagnostic tools in modern economics.