Adam Smith – The wealth of Nations

Book I, Chapter 1. “Of the division of labour”

 The main focus of Adam Smith of the book “The Wealth of
Nations” lies in the concept of economic growth.
 Growth, according to Smith, is rooted in the increasing division
of labour. This idea relates primarily to the specialisation of the
labour force, essentially the breaking down of large jobs into
many tiny components
 Adam Smith supports the free market and producers are free
to produce as much as they want and charge consumers the
price they want.
i.Value of price = Costs of production
he idea of Division of Labour is the specialization of each task, in other
words the breaking down of large jobs into smaller components performed
by different employees:
 “All employees from different branches must be placed under same
workhouse and must be viewed by a spectator” in bigger businesses
employees can’t be placed under same workhouse due to the total
number of employees, in these cases the work must be divided into
different parts and will be less observed.
 Number of operations performed by one employee: Dividing
operations into smaller parts performed by educated employees will
leave the business with a better result of production = Effect of
division of labor
 Improvement of dexterity of the workman necessarily increases the
quantity of the work he can perform.
 Time saving: time passing from one sort of work to another is
significantly.
 Invention of a great number of machines which facilitate and abridge
labour and one pearson to do the work of many.
 Attention on a single object rather than more: discover new methods
of performing the specific task
 Adam Smith claims that not having the switch labor during the day will
safe time and, furthermore, money for the business owner.

 - When the market is small; no person can dedicate himself
entirely to one employment. (small business)
Adam Smith – The wealth of Nations
Book I, Chapter 3. “That the division of labour is limited
by the extent of the market”
 Smith notes that some jobs which we only find in cities, he gives the
example of a porter, if you’re village there simple won’t be enough
business or enough traffic to employ a porter full-time, so thus we find
Porter’s only in cities.
 Smith draws a comparison with the highland of northern Scotland
where he notes that every family is its own baker, butcher and
brewer. They have to do so much of the work of the household
themselves.
 There is not enough market activity and not enough density of
population to support a carpenter in every small village.
 Smith draws a contrast between carrying goods by water and carrying
them over land. He knows that so many of the great cities and great
commercials regions of history have been on either navigable rivers or
on the seashore. This is because the greater ease of water transport
gives them access to larger markets (those cities can support a greater
division of labor).
Adam Smith – The wealth of Nations
Book V, Chapter 1. “On joint stock companies”
 In a joint stock company (corporation), each partner can transfer his
share to another person or introduce a new member into the
company without agreement.
 Each member is leaped to the extent of his share.
 The trade of a joint stock company is always managed by a court of
directors.
 A joint stock company consist of a small number of owners with a
average capital.
 On joint stock companies: Adam Smith had a pessimistic view on corporations. He claimed that
they would gain enough, as the managers would inevitably destroy them. Managers, the ones in
charge of other’s money, are invariably prone to waste. Even though Smith recognized the
advantages of corporations, as collecting bigger amounts of money in smaller time, he thought
the price paid was too high. Therefore, the bigger the business the bigger the waste.

- Each partner is bound for the debts contracted by the company of the whole extent of his fortune
- "The directors of such companies ... being the managers rather of other people's money rather
than of their own, it cannot well be expected that they should watch over it with the same anxious
vigilance with which [they would] watch over their own,"
Adam Smith – The wealth of Nations
Book V, Chapter I. “On education”
 Smith was a big supporter of education, and believed that everyone
should have at least the basic formation before the employment.

 Smith believes in the public school, he doesn’t want to see private

establishments because he wants to ensure that everyone has the
opportunity to receive a good education.
 He considers that teachers might do a better job if their salaries came
directly from students.
 Smith fears that schools are built for the need of instructors rather
than students.
 education should meet the demand of the public, in other words,
teachers should teach whatever people want to learn about.
 For Smith, one of the biggest advantages to public education is the
way it promotes social stability for example, as a way to avoid a
destroying effect from the division of labour on the worker

Conclusions
According to Adam Smith, the prosperity of a country
depends:

 Division of labour: increase of the efficiency by

assigning different and specific tasks to manufacture a
unique product.
  Limitation by the extension of the market: depending
on the size of the market (for example: city, village)
the division if labour could be possible or not.
 Pessimistic view on joint stock companies: managers
inevitably destroy the joint stock company; therefore
it results in a waste. Bigger the bussines: bigger the
waste.
 Education: basic formation before employment. only
public schools, fairshare of opportunity, salary
received from the students and finally, the most
important, education should meet the demand of the
public.
 Goal: figure out why some countries in the world are wealthier than others.
 Division of labour: main source of growth and development of the country
 Laissez faire: the best program is to let the economic process follow its own course

The Nature of the Firm

“The Nature of the Firm” (1937), is an article by Ronald Coase. It offered an economic
explanation of why individuals choose to establish partnerships, companies and other business
entities on behalf of trading bilaterally through contracts on a market.

A useful way to think about the market is as a coordination system. The price mechanism can
be used as a means of directing each resource stream to its highest value use. Assuming the
hurricane hit New Orleans, plywood prices rose. The rise in prices plays an important
coordinating role. As a resident of Virginia, when I observed the price of plywood, I was induced
to postpone my plan to build a shack in the backyard. That is, I save the plywood. This allows
more plywood to go to New Orleans, where it is most needed. The price system is non-
personal, which means that I don't even have to know or care about people in New Orleans in
order to act in ways that are beneficial to them. We will discuss the role of price more in the next
section.

Marshall introduced organization as the fourth factor of production into economic theory;
entrepreneurs had guiding functions; Professor Knight was strong. The coordinating role of
managers has been adjusted. Their unified view is that outside the enterprise, price changes
determine production, which is coordinated through a series of market transactions. Within the
enterprise, market transactions are cancelled and entrepreneurs direct production. But outside
the enterprise, price changes determine production, which is through a series of market
transactions. Easy to coordinate.

However, the market is only one of the two main ways of resource orientation. Another
mechanism is command and control. Within the enterprise, the autonomy and non-personal
coordination of the price system is replaced by a conscious interpersonal coordination
mechanism. The boss must measure or guess whether the employee is losing weight and figure
out if there is enough computer, office space and coffee. The whole purpose of the enterprise is
to engage in production without the coordination of market mechanisms. Why is this happening?
Why do someone want to avoid sending resources to their highest value use system?

There must be a case where the cost inherent in the price system is used. These “transaction
costs” include the cost of discovering the relevant price and the cost of negotiating all incidents
and eliminating opportunistic complete contracts. When an entrepreneur founded a company,
she bet she was able to channel the company's internal resources with sufficient efficiency to
produce at a lower cost than the market generated. In other words, she bet she can save on
transaction costs. Coase believes that this is the reason for the existence of the company.

Then Coase asked, “If you can eliminate certain costs and actually reduce production costs by
organizing one, are there any market transactions? Why are not all productions undertaken by a
large company?” There must be some countervailing costs along with the company. The
increase in scale has increased, which makes it uneconomical for the company to constantly
increase its "inside package". The main answer given by Coase is that as the number of
resources increases, it is more difficult for entrepreneurs to guide resources. To some extent,
the company is directing so many resources internally that the cost of one or more resources is
equal to relying solely on the market to guide its costs, transaction costs, and so on.

This theory can now be used to discuss factors that affect the size of the company. Factors
that reduce transaction costs or increase organizational costs tend to make companies smaller.
The opposite factor tends to make the company bigger. One factor that increases transaction
costs is the market exchange tax. If companies spend extra taxes to buy furniture, they may
decide to make their own furniture inside. The second factor is technology. With the
improvement of communication technology, organization in a wider space area has become
cheaper, thereby increasing the size of the company. On the other hand, technology also
reduces the cost of using the market, such as locating prices, and therefore tends to reduce the
size of the company.

We can continue to do so. The following are some of the issues that Coase has not discussed.
Another factor is bankruptcy and contract law. The fact that there is a contract default rule
reduces the cost of creating a contract (assuming the law is reasonable and effective). Need to
specify fewer incidents in advance. This reduces the cost of using the market and reduces the
size of the company. Next, consider the employment regulations. These tend to make the cost
of directing resources (at least human resources) internally higher, so when there is extensive
employment regulation, the company will become smaller. Finally, what if the law and order
completely collapse? This tends to increase transaction costs and make the market less
attractive. The size of the company will increase, in fact, humans may return to the existence of
the tribe (the tribe is the company!). Law and order and the market generally enable us to live in
a rational and individualistic way.
Coase also spent a considerable amount of space, in stark contrast to his theory and Frank
Knight's corporate theory. I won't spend a lot of time on this, but if people are interested, we can
discuss it in the comments. If you want to consider food in this area, how reasonable is Knight's
point of view if there is an insurance market and there is no transaction cost?

In the fourth part, uncertainty results in the emergence of enterprises.

Because of uncertainty, producers assume the responsibility of forecasting
consumer demand. At the same time, most of the forecasting work and the
technical guidance and control of production will be further concentrated in
a small number of producers, resulting in a leading process. The fact that
some people have good judgment and knowledge does not mean that they can only
get income from participating in production in person. They can sell advice
and knowledge. They can also get better knowledge and judgment by contracting
with those who are producing, rather than participating in production on
their own initiative.
The last part is also the last one, which is also the most important issue in
economics: to examine the explanatory power of theory to reality.

In summary, the use of the price system is not free. The fact that there is transaction cost
means that people will try to limit the number of transactions to save these costs. This means
they will seek alternative ways to guide resources, and we find these methods in the company.
Another way, command and control, never scales well. Therefore, there are natural economic
constraints on the size of the company.

The Coase Theorem describes the economic efficiency of economic allocation or outcome in
the presence of externalities. The theorem states that when an external transaction is possible
and there is no transaction cost, bargaining will produce a valid result regardless of the initial
distribution of property rights. The Coase Theorem is an important basis for most modern
economic analysis of government regulation, especially in the case of externalities.

The use of knowledge in society -

Hayek’s
 When we engage in decision-making about resource allocation (whether
collectively or individually), we are engaging in what Hayek calls “planning”.
 This raises a question which is who should do the planning? One person or how
many people? And should it be centralized or decentralized? Under what
arrangement can we make the best use of all the knowledge that is dispersed in
society?
  Most of the knowledge that exists in society is not universal, like F=ma. Instead, it
is local; in Hayek’s words, “the knowledge of the particular circumstances of time
and place.” Everyone knows at least something that no one else knows. For
instance, I need a new holder for my EZ Pass because my old one melted in the
sun. How likely is it that anyone else would know that? For society to make the
best use of its resources, it must develop a method to collect and exploit local
knowledge, not just universal knowledge.
It is essential that this method be robust in the sense of being able to withstand
constant change. The world is not static. Statistical aggregates hide the innumerable
small changes that occur. For instance, if my demand for eggs rises and my neighbor’s
demand for eggs decreases by the same amount, my neighborhood’s demand for eggs
has not changed. Nevertheless, the optimal allocation of eggs has changed; this
suggests that statistical aggregates are not an appropriate basis for allocating resources.
“[T]he economic problem of society is mainly one of rapid adaptation to changes in the
particular circumstances of time and place.” To solve the problem, we need some form
of decentralization. Decentralized actors need to be able to 1) exploit their local
knowledge while 2) making use of some sort of summary of the local knowledge
possessed by others that is relevant to their decisions. This summary can strip out a lot
of “why” questions. The actor does not need to know why some resource is more or less
scarce than before, but he does need to know if it becomes more or less scarce