Adam Smith: The Foundations of Classical Economics

Adam Smith and the Foundations of Modern Economics

Adam Smith was a pioneer of political economy. His seminal works include The Theory of Moral Sentiments (1759) and An Inquiry into the Nature and Causes of the Wealth of Nations (1776), which marks the beginning of economics as a science. His theories are based on the coincidence between private and public interest in acting freely.

The Invisible Hand and State Intervention

Smith famously proposed that an "invisible hand" leads man to a purpose alien to his intentions, benefiting society through individual self-interest. Consequently, he condemned the intervention of the State in the economic life of individuals, although he admitted certain exceptions to absolute freedom, such as the gradual introduction of free trade.

Economic Development and the Division of Labour

In his work An Inquiry into the Nature and Causes of the Wealth of Nations, the main theme is economic development. The fundamental explanation is that the division of labour depends on the size of the market. Free trade leads to specialization in the goods that each country can easily produce; with the proceeds of these sales, a nation can then purchase other goods. This cycle leads to increased production and general welfare.

Market Regulation and the Theory of Value

The market acts as a regulator, which requires understanding the principles governing the exchange of goods and their value. Smith explained value through the utility they cause in the subject who acquires them. He considered that the value of a good depends primarily on the work needed to produce it.

The Natural Price and Factors of Production

Smith affirmed that land, labour, and capital are all involved in production. He established the value of a good based on the components of the "natural price", which is composed of:

• Salary: The wages paid to workers.
• Profit: The return on capital investment.
• Income from land: The rent paid to landowners.

Together, these components constitute the total cost of production.

Wages, Capital, and Land Rent

For workers, wages are determined by the supply and demand for labour. Capital is also governed by the law of supply and demand; new companies will appear in sectors with high profits, increasing the supply, which will eventually lower the price, revenue, and profit. Regarding the rent of the land, owners demand an income and the worker delivers a part of what is produced. Therefore, this rent is an effect of the price and not its cause. The amount of the rent is determined by the difference between what the workers need for their subsistence and the total production of that cultivated land.