What is profit? The core of this chapter is laying the framework for what become the terms for evaluating economic situations. All revenue basically falls into three categories. Rents are what's paid to a landlord for use of land or factory space, and later I'm sure that which is paid to lease equipment. Profits are what's made in regards to maintaining and supplementing a stock of finished goods. And wages are what's paid for a persons labor.
All revenue Smith says is either one of these three or derived from one of these. And they all can play a role in a products final cost. Imagine for a moment I lease land to grow organic tomatoes. I am however lazy so I'm going to employ you dear reader as my farmer. So I will pay rent to the owner of the land. I will pay you wages to till the land. And there are various costs in figuring out farming materials. But the final price of the tomatoes at the market factor all these things in. So if it takes us $1000 total to produce 1000 tomatoes, we would charge $1 per. That does include an expected rate of return. Namely by devoting my energies into managing this operation I'd expect let's say 10% of the total revenue (so $100).
This is really just common sense really. If you think about all the things that go into making almost anything you have, and trace back to its basic most materials, there exists a long train of people doing things to get materials for someone else to manufacture into parts for yet someone else to assemble into your thing. And all those wages divided up, rents people paid, managers looking for some small measure of profit. Welcome to the supply chain baby!
Tuesday, June 30, 2009
Thursday, June 25, 2009
Wealth of Nations: Book 1: Chapter 5: Of the real and nominal Price of Commodities, or of their Price in Labour, and their Price in Money
Chapter 5 in Book 1 is a rather dense chapter in the concepts presented. Initially the theory put forth is that the true measure of value of any thing is labor. How much time would you do whatever you do to produce enough products, services or money to get what you want. Imagine for a moment you mow lawns for a living. In a barter society you might agree to mow lawn for a butcher in exchange for one steak he cuts up every week. His time of steak prep is maybe 20 minutes (I don't know much about being a butcher and am just throwing out numbers) and you know it would take one hour to mow his lawn every week. We could conclude that in real value his labor is three times more valuable than yours.
Money comes in as a necessary and convenient way to approximate value. You may not always want steak, and the value of the steak may change over time so you both would be better off if you had some impartial neutral item to trade with. Thus money is really this abstract scoring system. You can't eat money, it provides poor housing, won't keep you warm etc. Intrinsically it bears little value. But in the context of the trades it serves a useful tool towards trade. Think of monopoly money for a second. Absent a game of monopoly it is worthless, but in the course of the game you might value having a $500 monopoly bill more than one or two dollars of real money. So I guess context matters.
He then went on to talk about the real and nominal values of commodities. He spent a long time explaining how corn has been valued over time and while year to year may fluctuate wildly, over time it has retained its value quite well. Comparing college rents in Elizabethan times with the 1770s, what previously was 33% now was over 66% even though the amount of corn requested was the same. So commodities can retain value over time more than money.
He finishes showing how different commodities, namely gold, silver and copper, interplay in the formation and use as currency compared to their bullion state. While the value of the metals might not match the comparative value of the coins. So to use an American example if a nickel is 5 times a penny always, it is irrelevant to the comparative value of nickel bars to copper bars. It is important however to keep the value of the coin higher than the metal to prevent people from smelting their nickels and pennies for raw materials to sell.
Overall I think the most important things in a modern context given we use paper money and in some cases digital money, is the role that commodities have and to think of our labor as being a real measure of value. Think of your daily expenses, and think of how much you make an hour at your job, and ask yourself when you buy something, if you would be willing to work X minutes for that same thing. It is an interesting way to look at value.
Money comes in as a necessary and convenient way to approximate value. You may not always want steak, and the value of the steak may change over time so you both would be better off if you had some impartial neutral item to trade with. Thus money is really this abstract scoring system. You can't eat money, it provides poor housing, won't keep you warm etc. Intrinsically it bears little value. But in the context of the trades it serves a useful tool towards trade. Think of monopoly money for a second. Absent a game of monopoly it is worthless, but in the course of the game you might value having a $500 monopoly bill more than one or two dollars of real money. So I guess context matters.
He then went on to talk about the real and nominal values of commodities. He spent a long time explaining how corn has been valued over time and while year to year may fluctuate wildly, over time it has retained its value quite well. Comparing college rents in Elizabethan times with the 1770s, what previously was 33% now was over 66% even though the amount of corn requested was the same. So commodities can retain value over time more than money.
He finishes showing how different commodities, namely gold, silver and copper, interplay in the formation and use as currency compared to their bullion state. While the value of the metals might not match the comparative value of the coins. So to use an American example if a nickel is 5 times a penny always, it is irrelevant to the comparative value of nickel bars to copper bars. It is important however to keep the value of the coin higher than the metal to prevent people from smelting their nickels and pennies for raw materials to sell.
Overall I think the most important things in a modern context given we use paper money and in some cases digital money, is the role that commodities have and to think of our labor as being a real measure of value. Think of your daily expenses, and think of how much you make an hour at your job, and ask yourself when you buy something, if you would be willing to work X minutes for that same thing. It is an interesting way to look at value.
Tuesday, June 23, 2009
Wealth of Nations: Book 1: Chapter 4: Of the Origin and Use of Money
Book One, Chapter 4 traces the probable emergence of currency. Division of labor produces a variety of men, each with stocks of goods of their own labor which he may wish to trade for other men's goods. But how can that trade occur when any given person may not want what you wish to trade or in the innate quantities your good presents itself in? If I herd cattle does all trade have to be in relation to 1 cow? This poses any number of problems.
Societies established a center object of trade. Shells, salt, oxen or even nails in one remote Scottish village served as the currency of choice. Over time metals proved to have many characteristics which prove valuable in the establishment of currency. Metals like gold, copper or silver are durable, divisible, and lack much in the way of practical use like oxen would. But metals by themselves could prove hard to manage given dividing them from one pound bars could be trying, or subject to fraud. Maintaining accurate scales was also a barrier to trade of metal. The formulation of mints as a standard way of assuring the value of the metal became commonplace.
Then Smith describes how the Pound was originally a pound, but shrunk over time as a way to allow greedy princes and sovereigns a way to cover their debts, but the long term effect was to benefit debtors across the board at the expense of creditors. I don't know whether Smith realized it, but he basically outlined the basic concept of inflation and an expansionary money supply.
He concludes by making a few points which I assume he will expand on through future chapters. First value has two types. Value of use (like tools) which are poor instruments of exchange, and value of exchange(like coins) which have little practical use. Second he outlines a framework for what I can only assume is the foundation of price theory.
Societies established a center object of trade. Shells, salt, oxen or even nails in one remote Scottish village served as the currency of choice. Over time metals proved to have many characteristics which prove valuable in the establishment of currency. Metals like gold, copper or silver are durable, divisible, and lack much in the way of practical use like oxen would. But metals by themselves could prove hard to manage given dividing them from one pound bars could be trying, or subject to fraud. Maintaining accurate scales was also a barrier to trade of metal. The formulation of mints as a standard way of assuring the value of the metal became commonplace.
Then Smith describes how the Pound was originally a pound, but shrunk over time as a way to allow greedy princes and sovereigns a way to cover their debts, but the long term effect was to benefit debtors across the board at the expense of creditors. I don't know whether Smith realized it, but he basically outlined the basic concept of inflation and an expansionary money supply.
He concludes by making a few points which I assume he will expand on through future chapters. First value has two types. Value of use (like tools) which are poor instruments of exchange, and value of exchange(like coins) which have little practical use. Second he outlines a framework for what I can only assume is the foundation of price theory.
Monday, June 22, 2009
Wealth of Nations: Book 1: Chapter 3: That the Division of Labour is limited by the Extent of the Market
The core of this chapter is basically a two pronged descriptive analysis of how division of labor occurs.
First if you have a small village and a large town, you can expect that in the small village any given worker would be forced to cover many different trades. This is simply illustrated by the simple porter (think moving company). In a tiny village he maybe a porter maybe once a week or once a month if he was lucky. So on many of his days, he'd be doing other tasks which the small population of the village would be lacking in. "So you don't need stuff moved today, how about I mow your lawn or fix your leaky faucet?" While in a large town, he'd be a porter every day, and there would be a gardener every day, a plumber everyday. The demand for these services is large enough to support the trade in that market.
The second point is that the first can be partially negated if a healthy trade route was available. He compares how land transport at the time (some horses and a wagon) compared in cost to a ship transport. The net result was the cost of transport from one place to another is pretty cheap if you can get there by water. As examples of the benefit he compares the economies and productive nature and division of labor in great empires who either had constructed or utilized waterways to prosper, to the less civilized people who as a by product of geography had no such available option.
The points are pretty salient. You can have divided labor provided you can export the excess cheaply in exchange for stuff you can't make. The basic take away is the trade can produce greater affluence than isolation. I think it is important to review the second point in a modern context. Think for a second how much you pay for a package to be delivered by air quickly versus by ship and cargo crate. I think that as fuel prices get more expensive over time, a resurgence of rail versus highway shipping of goods could be a very likely outcome. Some wine shippers in Ireland are already toying with wind sail powered ships versus their diesel counterparts.
The notion that urbanization leads to greater societal wealth seems to have borne itself out with the grand urbanization in the last century. Think of the wealthiest countries and look at their population concentrations, you'll see large city after large city. Even looking at China's modernization over the last 20 years is a case study in the largest human migration in human history.
First if you have a small village and a large town, you can expect that in the small village any given worker would be forced to cover many different trades. This is simply illustrated by the simple porter (think moving company). In a tiny village he maybe a porter maybe once a week or once a month if he was lucky. So on many of his days, he'd be doing other tasks which the small population of the village would be lacking in. "So you don't need stuff moved today, how about I mow your lawn or fix your leaky faucet?" While in a large town, he'd be a porter every day, and there would be a gardener every day, a plumber everyday. The demand for these services is large enough to support the trade in that market.
The second point is that the first can be partially negated if a healthy trade route was available. He compares how land transport at the time (some horses and a wagon) compared in cost to a ship transport. The net result was the cost of transport from one place to another is pretty cheap if you can get there by water. As examples of the benefit he compares the economies and productive nature and division of labor in great empires who either had constructed or utilized waterways to prosper, to the less civilized people who as a by product of geography had no such available option.
The points are pretty salient. You can have divided labor provided you can export the excess cheaply in exchange for stuff you can't make. The basic take away is the trade can produce greater affluence than isolation. I think it is important to review the second point in a modern context. Think for a second how much you pay for a package to be delivered by air quickly versus by ship and cargo crate. I think that as fuel prices get more expensive over time, a resurgence of rail versus highway shipping of goods could be a very likely outcome. Some wine shippers in Ireland are already toying with wind sail powered ships versus their diesel counterparts.
The notion that urbanization leads to greater societal wealth seems to have borne itself out with the grand urbanization in the last century. Think of the wealthiest countries and look at their population concentrations, you'll see large city after large city. Even looking at China's modernization over the last 20 years is a case study in the largest human migration in human history.
Friday, June 19, 2009
Wealth of Nations: Book 1: Chapter 2: Of the Principle which gives Occasion to the Division of Labour
The difference of natural talents in different men is, in reality, much less than we are aware of; and the very different genius which appears to distinguish men of different professions, when grown up to maturity, is not upon many occasions so much the cause as the effect of the division of labour. The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature as from habit, custom, and education. - Adam Smith (Book 1 Chapter 2)
Even Smith jumps into the great nature versus nurture debate way back in the 1770s! The chapter in brief basically outline man as the outlier among species in that we divide labor, and have a natural interdependence. Again he shows that everyone benefits from the division of labor, and makes the claim that in a society there isn't much difference between any two men. A common street porter or a philosopher aren't so different but by "habit, custom, and education."
To prevent this blog from becoming the longest book report I've ever written, I want to riff on this premise a bit. The Enlightenment in large part felt that any man could do anything if he put his mind and grit to it. We see similar sentiments displayed by Benjamin Franklin, Thomas Jefferson, and Thomas Paine. For America I think this notion of the everyman being a well of unlimited potential is intrinsic to the national character. One common theme we see in modern conservative discussion is that if you remove government restrictions, people can pull themselves up on their boot straps. But I'd like to see how Adam Smith would view that notion. In the above quote he acknowledges that education is key to a person's success in life. Thomas Jefferson was a strong proponent of state sponsored education, and I am interested to see if Smith holds the same basic position. If that is the case, then it could be argued that a strong capitalist society and a strong democracy can only succeed if the educational foundation is strong as well.
Thursday, June 18, 2009
Wealth of Nations: Book 1: Chapter 1: Of the Division of Labor
The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour. -Adam Smith
The case for a division of labor is rather intuitive. And I imagine even in Smith's time it was just done, but giving voice to the process probably hadn't been done before. Or at least not with an eye to the greater effects it would have. Smith lays out in detail the process necessary for the creation of a simple pin, and later a nail. He contends, and rightfully so, that by division of the task at hand into its basic and simple steps, greater volume of pins and nails can be produced. The worker whose job it is to sharpen the pin gets better at sharpening them, and work time is not lost as tasks switch in the production of the pins.
He also notes that as people specialize in their tasks, they also are more prone to find more efficient ways to do these tasks. An illustration of this point is done in the description of the fire engine of the day. Young boys were asked to regulate the cylinder and boiler by opening and shutting the valve. He notes that some boy longing to play with his friends, simply tied his valve to the lever on another part of the machine, he could remove himself entirely from the process and go play with his friends. This serves as a launching point into the nature of philosophy on a given subject. The division of labor allows for people to be around who don't need to do anything, but observe and perfect the process as a whole.
He concludes with a rather long list of all the far reaching tasks and jobs needed for a simple wool coat.
The woollen coat, for example, which covers the day-labourer, as coarse and rough as it may appear, is the produce of the joint labour of a great multitude of workmen. The shepherd, the sorter of the wool, the wool-comber or carder, the dyer, the scribbler, the spinner, the weaver, the fuller, the dresser, with many others, must all join their different arts in order to complete even this homely production. How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country! How much commerce and navigation in particular, how many ship-builders, sailors, sail-makers, rope-makers, must have been employed in order to bring together the different drugs made use of by the dyer, which often come from the remotest corners of the world!
He goes on and on speculating on all the different things that go into the process. A real long thread of economic connectivity is displayed.
If anything this is an illustration of some basic points we all know. If you divide a task among people you can get more work done, or do the work faster. If I wash dishes by myself, I wash, then dry, then put away, but if I have a second person to dry and a third to put them away, we could improve efficient, reduce wasted time, and either finish faster promoting leisure for all, or do more dishes.
But a second more important thing to remember is that in any advanced society, the specialization is what allows us to have a greater quality of life. Imagine if you had to make your own stuff. From raw materials, how much could you do? Assuming you had a sheep and knew how to sheer it, would you be able to spindle the wool, and produce the yarn to make clothes? I'm guess not. But people divide their labor, specialize in it, get better and better at it, and excess is produced so even the lowest in an advanced society can enjoy things which the chiefs of primitive tribes wouldn't dream possible.
This brings me to a quote from the Freakonomics Blog about what the purpose of economics was. Nobel Laureate Gary Becker basically said it is to understand and to alleviate poverty. And when you think about it in that context you start to see how powerful a thing like the division of labor starts to be. If by specializing in one task, I can provide for a common welfare for more people(who are specializing in their tasks), then we collectively can raise the standard for all people within our society. My work specialization allows me certain luxuries and leisure I would not enjoy if I was required to do more by myself. But it also affords people much smarter than me, the ability to work on science and art to further our progress. And in turn that progress should allow my child (I only have one right now) to enjoy a greater standard of living. I think one theme that is often forgotten in the discussion of economics is the poverty angle and its effects. I hope in some way reading Wealth of Nations here, we can glean some perspective which can help us make sense of our current situation, and keep our values in check. A future project on Pancakes in the Age of Enlightenment may be Smith's other work The Theory of Moral Sentiments to help put some moral perspective on why we do what we do.
Wealth of Nations: Introduction and Plan of Work
In the introduction to the work, Adam Smith gives one basic contention about the overall productive nature of a society, namely that how much or how little a nation can produce is directly related towards its allocation of labor. He points out quite rightly, that a nation's wealth is basically untapped and unusable if there are no people there to exploit the resources and produce goods and services. Division of labor based on skills and judgment is key to exploiting the most production within a country. He also points out that because of that division you can have people who don't work at all enjoying relatively high standards of living because of the abundance of the nation's production.
The division of the book is also outlined. Book One is largely a discussion of how labor is divided, how wages and rents are determined. How profits work etc. Book Two is about financial systems. Book Three is about the rise of industry and the decline of agriculture since the fall of the Roman Empire. Book Four is a breakdown of the political economy of trade between nations. And Book Five is about the nature of taxation and fiscal policy. Of course he doesn't use those terms for half that stuff, but we'll see how it plays out.
I will say that the introduction is interesting in a historical context. He is describing things and concepts which now have concrete and defined terms. When he talks about the produce of a nation, we'd simply say GDP. It will get further interesting, to me at least, to see how he'll grapple with concepts like supply curve, demand curve, deadweight loss, or fixed and variable costs. Unfortunately this is only an introduction, and doesn't have much impact on how we view things in a modern context.
The division of the book is also outlined. Book One is largely a discussion of how labor is divided, how wages and rents are determined. How profits work etc. Book Two is about financial systems. Book Three is about the rise of industry and the decline of agriculture since the fall of the Roman Empire. Book Four is a breakdown of the political economy of trade between nations. And Book Five is about the nature of taxation and fiscal policy. Of course he doesn't use those terms for half that stuff, but we'll see how it plays out.
I will say that the introduction is interesting in a historical context. He is describing things and concepts which now have concrete and defined terms. When he talks about the produce of a nation, we'd simply say GDP. It will get further interesting, to me at least, to see how he'll grapple with concepts like supply curve, demand curve, deadweight loss, or fixed and variable costs. Unfortunately this is only an introduction, and doesn't have much impact on how we view things in a modern context.
Embarking on an experiment..
Hello readers. This blog is an attempt to help me better myself by reading the classics that helped shape our modern world. And I hope apply their lessons to a modern context. While I am initially going to focus on works written during the Age of Enlightenment, I do reserve the right to explore other important works from other time periods. Don't be surprised if I read the Torah, Bible or Koran at some point. I will try to use Wikibooks as my source material so any readers who want to read along with me can keep up without having to rack up late fees at the library or buy copies at a great personal expense.
My first project is The Wealth of Nations by Adam Smith. This is considered one of the first major explorations into the field of economics and to be honest is something I was surprised I was not required to read in college with all the economics classes I took.
My first project is The Wealth of Nations by Adam Smith. This is considered one of the first major explorations into the field of economics and to be honest is something I was surprised I was not required to read in college with all the economics classes I took.
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