Question

Case Study No. 2 Adam Smith and the Natural Price Adam Smith explained how economic profits and losses in a competitive market cause the entry and exit of firms. Smith described what he called the natural price, or the long-run equilibrium price, in this passage from his 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations: When the price of any commodity is ... sufficient to pay the rent of land, the wages of labour. and the profits of the stock employed in ... bringing it to market, the commodity is then sold for ... its natural price www The commodity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market for though in common language what is called the prime cost of any commodity does not comprehend the profit of the person who is to sell it... The natural price ... is ... the central price, to which the prices of all commodities are continually gravitating... When by an increase in ... demand, the market price of some commodity ... (rises above the natural price... [producers of the commodity) are generally careful to conceal this change. If it were commonly known, their great profit would tempt so many rivals... the market price would soon be reduced to the natural price Secrets of this kind, however... can seldom be long kept; and the extraordinary profit can last little longer than they are kept... The market price... can seldom continue long below its natural price...the persons affected would immediately feel the loss, and some producers would immediately withdraw .. the quantity brought to the market would soon be no more than sufficient to supply the effectual demand. Its market price, therefore, would soon rise to the natural price. Source: Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations. Book One Chapter VIL http://www.adamsmith.org 1) What did Smith mean by the prime cost of a commodity? 2) How did Smith explain how the entry of firms in a perfectly competitive market ensures that firms earn zero economic profit in the long run? 3) How did Smith explain how the exit of some firms occurs in a perfectly competitive market to ensure that firms remaining in the market eam zero economie profit in the long run?
1- What did Smith mean by The "prime Cost " of commodity ?

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Answer 1

According to Adam Smith, the prime cost of the commodity is the cost that the producer has to incur in order to bring the commodity to the market (such as the wages to the labour, rent paid on the capital etc.) and sell it. Prime cost does not include any profit that the producer is expecting or aiming to make. Prime cost includes the