NATIONAL LAW INSTITUTE UNIVERSITY,

BHOPAL

ECONOMICS - I
(1st TRIMESTER)

PROJECT WORK
TOPIC – ECONOMIC THEORIES OF ADAM
SMITH

SUBMITTED TO: SUBMITTED BY:

MR. RAJESH GAUTAM ARADHYA SHARMA
(ASSISTANT PROFESSOR) 2018BALLB 36

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 CERTIFICATE

This is to certify that the research paper titled ‘Economic Theories of Adam Smith’ has been
prepared and submitted by Aradhya Sharma, who is currently pursuing B.A LL.B(Hons.) at
National Law Institute University, Bhopal in fulfillment of Economics-I Course. It is also
certified that this is his original analysis of the case and this case analysis has not been
submitted to any other University, nor published in any journal.

Date:_______________

Signature of the Student :………………………………...

Signature of the Supervisor :…………………………………

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 ACKNOWLEDGEMENT

I would like to express my special thanks of gratitude to my Teacher Mr. Rajesh Gautam
who has been a great mentor and has been a constant support throughout, as well as our
Director Prof. (Dr.) V. Vijayakumar who gave me the golden opportunity to do this
wonderful project on the topic Economic Theories of Adam Smith, which also helped me
in doing a lot of research and I came to know about so many new things I am really
thankful to them.
I am also thankful to the library administration for the provision of necessary books and
texts needed for the completion of this project.
Lastly I would also like to thank my parents and friends who helped me a lot in finalizing
this project within the limited time frame.

ARADHYA SHARMA

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 REVIEW OF LITERATURE

1. “An inquiry in nature and causes of The Wealth of Nations” (1776), by Adam Smith:
One of the most acknowledged works of Sir Adam Smith. It explains all the fundamental
contributions of the economist in all eminent fields.
2. “Theory of Moral Sentiments and origin of languages” (1759), by Adam Smith:
The well known magum opus of the author, of the year 1759, talk about the theory of
psychological analysis and various other connect theories.
3. “La Problema Adam Smith”, by Gerard Jorland, Annales. Histoire, Sciences Sociales, 39e
Année, No. 4 (Jul. - Aug., 1984), pp. 831-848
4. “ADAM SMITH”, by David Smith, RSA Journal, Vol. 149, No. 5504 (December 2002), p. 66
5. “The Divison of Labour”, by Brian j. Loasby, History of Economic Ideas, Vol. 4, No. 1/2
(1996), pp. 299-323
6. Compensating Wage Differentials and Unobserved Productivity
By, Hae-shin Hwang, W. Robert Reed, Carlton Hubbard,in
Journal of Political Economy, Vol. 100, No. 4 (Aug., 1992), pp. 835-858

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 RESEARCH METHODOLOGY

The research methodology followed in making of this project is the DOCTRINAL MEATHOD.

OBJECTIVES

 To explore the various theories, concepts and contributions of Adam Smith, in the field of
Economics.
 To check the current applicability and scope of these concept in the contemporary world.
 To determine the possible future and to analyze the development of the said concept.
 To understand the working and functioning of the theories in the current economic system and
how they affect the economic conditions.

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INTRODUCTION

“Adam Smith's chief contribution was to build a coherent and logical theory of how the economy
works. The elements of Smith's theory were mostly already available in the writings of earlier
writers. However, in these writings good ideas coexisted alongside numerous other useless
theories. Somebody had to figure out which theories were useful and which were useless and
combine the useful theories into a consistent and persuasive overall theory that we can reliably
use to think about society. This is what Smith did. For this he is called the father of economics.”1

His two main works are: The Theory of Moral Sentiments and An Inquiry into the Nature and
Causes of the Wealth of Nations.

“The classical economist economics or “economics theories” proposition is largely rooted on the
work of Adam Smith who is regarded today as the father of economics. Adam Smith contained
all his ideas in his “Wealth of Nations”. The most important aspect of this book was a Theory of
Economic Development. Adam Smith’s ‘Wealth of Nations’ was scientific not because it
contained the absolute truth but because it came as a turning point, the beginning of all that came
after, as it was the end of all that came before.

1
https://www.ukessays.com/essays/economics/adam-smiths-contributions-to-economic-theory-economics-
essay.php

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Adam Smith established five fundamental, interrelated, propositions which may be taken to
characterize his ‘classical’ theory of economic growth. These are:

 Natural law of nature, supersede government laws and he advocated the philosophy of free
and independent action of the individuals.
 The most fundamental force of productivity growth is increasing division of labour.
 Increasing division of labour requires increasing scale of production and an increasing scale
of market.
 Increasing division of labour and scale of production leads historically to an increasing
percentage of investment in the economy.
 Technological progress is a product of this increasing division of labour – i.e. it is
endogenously and not exogenously determined.”2

The late British economist Kenneth E. Boulding paid this tribute to his intellectual predecessor:
“Adam Smith, who has strong claim to being both the Adam and the Smith of
systematic economics, was a professor of moral philosophy and it was at that forge that
economics was made.”

Critics of the market often seize on Smith’s “conspiracy against the public” observation cited in
the passage above. They conveniently ignore what he wrote immediately thereafter, which
indicates that he saw government as a co-conspirator whose police power was indispensable for
those conspiracies to thwart the otherwise potent forces of market competition:

It is impossible indeed to prevent such meetings, by any law which either could be executed, or
would be consistent with liberty and justice. But though the law cannot hinder people of the

2
https://educacinfo.com/adam-smith-contribution-to-economics-theories-and-developments/

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same trade from sometimes assembling together, it ought to do nothing to facilitate such
assemblies; much less to render them necessary.

Smith’s view of competition was undoubtedly shaped by the way he saw the universities of his
day, loaded as they were with coddled, tenured professors whose pay had little to do with their
service to their pupils or the public at large. While a student at Oxford in the 1740s, he observed
the lassitude of his professors, who “had given up altogether even the pretense of teaching.”

MEMOIRS OF ADAM SMITH

EARLY LIFE AND EDUCATION

Smith was born in Kirkcaldy, in the County of Fife, Scotland. His father, also Adam Smith, was
a Scottish Writer to the Signet (senior solicitor), advocate and prosecutor (judge advocate) and
also served as comptroller of the customs in Kirkcaldy.In 1720, he married Margaret Douglas,
daughter of the landed Robert Douglas of Strathendry, also in Fife. His father died two months
after he was born, leaving his mother a widow. The date of Smith's baptism into the Church of
Scotland at Kirkcaldy was 5 June 1723 and this has often been treated as if it were also his date
of birth, which is unknown. Although few events in Smith's early childhood are known, the
Scottish journalist John Rae, Smith's biographer, recorded that Smith was abducted by gypsies at
the age of three and released when others went to rescue him. Smith was close to his mother,
who probably encouraged him to pursue his scholarly ambitions. He attended the Burgh School
of Kirkcaldy—characterized by Rae as "one of the best secondary schools of Scotland at that
period"—from 1729 to 1737, he learned Latin, mathematics, history, and writing.

Smith entered the University of Glasgow when he was 14 and studied moral philosophy
under Francis Hutcheson .Here, Smith developed his passion for liberty, reason, and free speech.

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In 1740, Smith was the graduate scholar presented to undertake postgraduate studies at Balliol
College, Oxford, under the Snell Exhibition.

Smith considered the teaching at Glasgow to be far superior to that at Oxford, which he found
intellectually stifling. In Book V, Chapter II of The Wealth of Nations, Smith wrote: "In the
University of Oxford, the greater part of the public professors have, for these many years, given
up altogether even the pretence of teaching." Smith is also reported to have complained to
friends that Oxford officials once discovered him reading a copy of David Hume's A Treatise of
Human Nature, and they subsequently confiscated his book and punished him severely for
reading it. According to William Robert Scott, "The Oxford of [Smith's] time gave little if any
help towards what was to be his lifework." Nevertheless, Smith took the opportunity while at
Oxford to teach himself several subjects by reading many books from the shelves of the
large Bodleian Library. When Smith was not studying on his own, his time at Oxford was not a
happy one, according to his letters. Near the end of his time there, Smith began suffering from
shaking fits, probably the symptoms of a nervous breakdown. He left Oxford University in 1746,
before his scholarship ended.

In Book V of The Wealth of Nations, Smith comments on the low quality of instruction and the
meager intellectual activity at English universities, when compared to their Scottish counterparts.
He attributes this both to the rich endowments of the colleges at Oxford and Cambridge, which
made the income of professors independent of their ability to attract students, and to the fact that
distinguished men of letters could make an even more comfortable living as ministers of
the Church of England.

Smith's discontent at Oxford might be in part due to the absence of his beloved teacher in
Glasgow, Francis Hutcheson, who was well regarded as one of the most prominent lecturers at
the University of Glasgow in his day and earned the approbation of students, colleagues, and
even ordinary residents with the fervor and earnestness of his orations (which he sometimes
opened to the public). His lectures endeavored not merely to teach philosophy, but also to make
his students embody that philosophy in their lives, appropriately acquiring the epithet, the
preacher of philosophy. Unlike Smith, Hutcheson was not a system builder; rather, his magnetic
personality and method of lecturing so influenced his students and caused the greatest of those to

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reverentially refer to him as "the never to be forgotten Hutcheson"—a title that Smith in all his
correspondence used to describe only two people, his good friend David Hume and influential
mentor Francis Hutcheson.

PERSONALITY AND BELIEFS

Not much is known about Smith's personal views beyond what can be deduced from his
published articles. His personal papers were destroyed after his death at his request. He never
married, and seems to have maintained a close relationship with his mother, with whom he lived
after his return from France and who died six years before him.

Smith was described by several of his contemporaries and biographers as comically absent-
minded, with peculiar habits of speech and gait, and a smile of "inexpressible benignity". He was
known to talk to himself, a habit that began during his childhood when he would smile in rapt
conversation with invisible companions. He also had occasional spells of imaginary illness, and
he is reported to have had books and papers placed in tall stacks in his study.] According to one
story, Smith took Charles Townshend on a tour of a tanning factory, and while discussing free
trade, Smith walked into a huge tanning pit from which he needed help to escape. He is also said
to have put bread and butter into a teapot, drunk the concoction, and declared it to be the worst
cup of tea he ever had. According to another account, Smith distractedly went out walking in his
nightgown and ended up 15 miles (24 km) outside of town, before nearby church bells brought
him back to reality.

James Boswell, who was a student of Smith's at Glasgow University, and later knew him at
the Literary Club, says that Smith thought that speaking about his ideas in conversation might
reduce the sale of his books, so his conversation was unimpressive. According to Boswell, he
once told Sir Joshua Reynolds, that 'he made it a rule when in company never to talk of what he
understood'.

Smith has been alternately described as someone who "had a large nose, bulging eyes, a
protruding lower lip, a nervous twitch, and a speech impediment" and one whose "countenance

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was manly and agreeable." Smith is said to have acknowledged his looks at one point, saying, "I
am a beau in nothing but my books." Smith rarely sat for portraits, so almost all depictions of
him created during his lifetime were drawn from memory. The best-known portraits of Smith are
the profile by James Tassie and two etchings by John Kay. The line engravings produced for the
covers of 19th century reprints of The Wealth of Nations were based largely on Tassie's
medallion.

Smith was passionately opposed to all laws and practices that tended to discourage production
and increase prices…. He viewed with suspicion all trade associations, both formal and
informal: as he says, “people of the same trade seldom meet together, even for merriment and
diversion, but the conversation ends in a conspiracy against the public, or in some contrivance
to raise prices.” 3

MAGNUM OPUS AND CONTRIBUTIONS

For well over a century, scholars have commented upon the various works of Adam Smith,
some of which are considered as the Magnum Opus of his career, i.e. The Wealth of the
Nations (1776) and The Theory of Moral Sentiments (1759).

THE THEORY OF MORAL SENTIMENTS

Smith continued making extensive revisions to the book until his death. Although The Wealth of
Nations is widely regarded as Smith's most influential work, Smith himself is believed to have
considered The Theory of Moral Sentiments to be a superior work.

In the work, Smith critically examines the moral thinking of his time, and suggests that
conscience arises from dynamic and interactive social relationships through which people seek

3
As per noble laureate RICHARD STONE

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"mutual sympathy of sentiments." His goal in writing the work was to explain the source of
mankind's ability to form moral judgement, given that people begin life with no moral sentiments
at all. Smith proposes a theory of sympathy, in which the act of observing others and seeing the
judgements they form of both others and oneself makes people aware of themselves and how
others perceive their behaviour. The feedback we receive from perceiving (or imagining) others'
judgements creates an incentive to achieve "mutual sympathy of sentiments" with them and leads
people to develop habits, and then principles, of behaviour, which come to constitute one's
conscience.

THE WEALTH OF THE NATIONS

Some scholars have perceived a conflict between The Theory of Moral Sentiments and The
Wealth of Nations; the former emphasises sympathy for others, while the latter focuses on the
role of self-interest. In recent years, however, some scholars of Smith's work have argued that no
contradiction exists. They claim that in The Theory of Moral Sentiments, Smith develops a theory
of psychology in which individuals seek the approval of the "impartial spectator" as a result of a
natural desire to have outside observers sympathise with their sentiments. Rather than
viewing The Theory of Moral Sentiments and The Wealth of Nations as presenting incompatible
views of human nature, some Smith scholars regard the works as emphasising different aspects
of human nature that vary depending on the situation. Otteson argues that both books are
Newtonian in their methodology and deploy a similar "market model" for explaining the creation
and development of large-scale human social orders, including morality, economics, as well as
language. Ekelund and Hebert offer a differing view, observing that self-interest is present in
both works and that "in the former, sympathy is the moral faculty that holds self-interest in
check, whereas in the latter, competition is the economic faculty that restrains self-interest

The Wealth of Nations

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Disagreement exists between classical and neoclassical economists about the central message of
Smith's most influential work: An Inquiry into the Nature and Causes of the Wealth of
Nations (1776). Neoclassical economists emphasise Smith's invisible hand ,a concept mentioned
in the middle of his work – Book IV, Chapter II – and classical economists believe that Smith
stated his programme for promoting the "wealth of nations" in the first sentences, which
attributes the growth of wealth and prosperity to the division of labour.

Smith used the term "the invisible hand" in "History of Astronomy, referring to "the invisible
hand of Jupiter", and once in each of his The Theory of Moral Sentiments (1759) and The
Wealth of Nations (1776). This last statement about "an invisible hand" has been interpreted in
numerous ways.

As every individual, therefore, endeavors as much as he can both to employ his capital in the
support of domestic industry, and so to direct that industry that its produce may be of the greatest
value; every individual necessarily labours to render the annual revenue of the society as great as
he can. He generally, indeed, neither intends to promote the public interest, nor knows how much
he is promoting it. By preferring the support of domestic to that of foreign industry, he intends
only his own security; and by directing that industry in such a manner as its produce may be of
the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by
an invisible hand to promote an end which was no part of his intention. Nor is it always the
worse for the society that it was no part of it. By pursuing his own interest he frequently
promotes that of the society more effectually than when he really intends to promote it. I have
never known much good done by those who affected to trade for the public good. It is an
affectation, indeed, not very common among merchants, and very few words need be employed
in dissuading them from it.

Those who regard that statement as Smith's central message also quote frequently Smith's
dictum:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner,
but from their regard to their own interest. We address ourselves, not to their humanity but to
their self-love, and never talk to them of our own necessities but of their advantages.

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Smith's statement about the benefits of "an invisible hand" may be meant to
answer Mandeville's contention that "Private Vices ... may be turned into Public Benefits". It
shows Smith's belief that when an individual pursues his self-interest under conditions of justice,
he unintentionally promotes the good of society. Self-interested competition in the free market,
he argued, would tend to benefit society as a whole by keeping prices low, while still building in
an incentive for a wide variety of goods and services. Nevertheless, he was wary of businessmen
and warned of their "conspiracy against the public or in some other contrivance to raise prices”.
Again and again, Smith warned of the collusive nature of business interests, which may form
cabals or monopolies, fixing the highest price "which can be squeezed out of the buyers". Smith
also warned that a business-dominated political system would allow a conspiracy of businesses
and industry against consumers, with the former scheming to influence politics and legislation.
Smith states that the interest of manufacturers and merchants "in any particular branch of trade or
manufactures, is always in some respects different from, and even opposite to, that of the public
... The proposal of any new law or regulation of commerce which comes from this order, ought
always to be listened to with great precaution, and ought never be adopted till after having been
long and carefully examined, not only with the most scrupulous, but with the most suspicious
attention." Thus Smith's chief worry seems to be when business is given special protections or
privileges from government; by contrast, in the absence of such special political favours, he
believed that business activities were generally beneficial to the whole society:

It is the great multiplication of the production of all the different arts, in consequence of the
division of labour, which occasions, in a well-governed society, that universal opulence which
extends itself to the lowest ranks of the people. Every workman has a great quantity of his own
work to dispose of beyond what he himself has occasion for; and every other workman being
exactly in the same situation, he is enabled to exchange a great quantity of his own goods for a
great quantity, or, what comes to the same thing, for the price of a great quantity of theirs. He
supplies them abundantly with what they have occasion for, and they accommodate him as
amply with what he has occasion for, and a general plenty diffuses itself through all the different
ranks of society. (The Wealth of Nations, I.i.10)

The neoclassical interest in Smith's statement about "an invisible hand" originates in the
possibility of seeing it as a precursor of neoclassical economics and its concept of general
equilibrium – Samuelson's "Economics" refers six times to Smith's "invisible hand". To
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emphasise this connection, Samuelson quotes Smith's "invisible hand" statement substituting
"general interest" for "public interest". Samuelson concludes: "Smith was unable to prove the
essence of his invisible-hand doctrine. Indeed, until the 1940s, no one knew how to prove, even
to state properly, the kernel of truth in this proposition about perfectly competitive market."

Very differently, classical economists see in Smith's first sentences his programme to promote
"The Wealth of Nations". Using the physiocratical concept of the economy as a circular process,
to secure growth the inputs of Period 2 must exceed the inputs of Period 1. Therefore, those
outputs of Period 1 which are not used or usable as inputs of Period 2 are regarded as
unproductive labour, as they do not contribute to growth. This is what Smith had heard in France
from, among others, Quesnay. To this French insight that unproductive labour should be reduced
to use labour more productively, Smith added his own proposal, that productive labour should be
made even more productive by deepening the division of labour. Smith argued that deepening
the division of labour under competition leads to greater productivity, which leads to lower
prices and thus an increasing standard of living—"general plenty" and "universal opulence"—for
all. Extended markets and increased production lead to the continuous re-organization of
production and the invention of new ways of producing, which in turn lead to further increased
production, lower prices, and improved standards of living. Smith's central message is, therefore,
that under dynamic competition, a growth machine secures "The Wealth of Nations". Smith's
argument predicted Britain's evolution as the workshop of the world, underselling and out
producing all its competitors. The opening sentences of the "Wealth of Nations" summaries this
policy:

The annual labour of every nation is the fund which originally supplies it with all the necessaries
and conveniences of life which it annually consumes. This produce bears a greater or smaller
proportion to the number of those who are to consume it. But this proportion must in every
nation be regulated by two different circumstances;

 first, by the skill, dexterity, and judgment with which its labour is generally applied; and,
 secondly, by the proportion between the number of those who are employed in useful labour,
and that of those who are not so employed [emphasis added].

However, Smith added that the "abundance or scantiness of this supply too seems to depend
more upon the former of those two circumstances than upon the latter."
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THEORIES AND CONCEPTS

1. THEORY OF DIVISION OF LABOUR:

The main focus of Adam Smith's The Wealth of Nations lies in the concept of economic growth.
Growth, according to Smith, is rooted in the increasing division of labor. This idea relates
primarily to the specialization of the labor force, essentially the breaking down of large jobs into
many tiny components. Under this regime each worker becomes an expert in one isolated area of
production, thus increasing his efficiency. The fact that laborers do not have to switch tasks
during the day further saves time and money. Of course, this is exactly what allowed Victorian
factories to grow throughout the nineteenth century. Assembly line technology made it necessary
for a worker to focus his or her attention on one small part of the production process.
Surprisingly, Smith recognized the potential problems of this development. He pointed out that
forcing individuals to perform mundane and repetitious tasks would lead to an ignorant,
dissatisfied work force. For this reason he advanced the revolutionary belief that governments
had an obligation to provide education to workers. This sprung from the hope that education

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could combat the deleterious effects of factory life. Division of labor also implies assigning each
worker to the job that suits him best. Productive labor, to Smith, fulfills two important
requirements. First, it must "lead to the production of tangible objects." Second, labor must
"create a surplus" which can be reinvested into production.

Another main concern for Smith involved tracing the roots of value. He identified two
different kinds of value, "use value" and "exchange value." The concept of exchange value
interested Smith considerably. The diamond-water paradox, in particular, proved puzzling to
him: Why is it that diamonds, which have very little practical use, command a higher price than
water which is indispensable to life? By discovering the true source of value Smith hoped to find
a benchmark for measuring economic growth. Eventually Smith settled on labor as the source of
value: The number of hours labor that a good can be exchanged for constitutes its inherent worth.
(Note, this is not the same as saying that a good is worth the number of hours spent in its
production.) The value of a good can also be referred to as the "natural price." The natural price
need not function as the actual cost of a good in the marketplace. Competition, however, was
expected to push the market price towards the natural price.

TYPES:

(1) Complex Division of Labor:

When a particular work is split up into different processes and sub-processes and each process is
carried out by a single person or a group of persons, the division of labor is said to be
complex. For example, in a needle manufacturing industry, no one specializes in the making of
a whole pin. The work is split up into different processes and each worker is assigned a definite
part in the whole work.

(2) Territorial Division of Labor:

When a certain locality specializes in the production of a particular commodity, the division of
labor is said to be territorial. For instance, Pakistan has specialized in the' manufacturing of
sports goods, Bangladesh in the production of Jute goods etc.

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Adam Smith in his book ‘Wealth of Nations’ pointed out three benefits of division of
labour:
1. Increase of dexterity of workers.

2. Saving time required to produce commodity.

3. Invention of better machines and equipment.4

2. THEORY OF FREE TRADE

"A policy of unrestricted international exchange of goods is known as the policy of Free
Trade".

Adam Smith like the Physocratics of France, was a staunch advocate of free trade. He was of the
view that state should not interfere in the internal economic life of the citizens of a country as it
hampers economic progress. He was against putting any kind of restrictions on the imports and
exports of commodities. In the words of Adam Smith:

"After all why the protection in needed just to save the gold from going into the other country. I
do not give much importance to it. It is a kind of commodity which is less important than other
commodities because goods can serve many other purposes besides purchasing money but
money can serve many other purposes besides purchasing goods. If protection is levied, it will
divert industries from more advantageous trade to less advantageous trade".

The other English classical economists also believed in the doctrine of laissez-faire.

4
The Wealth of the Nations, 1776

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The policy of free trade has not been carried out completely by any country of the world. Some
degree of state regulations has always been there on the international exchange of goods.
England was the only country in the world which had maintained free trade for a long period. It
was mainly due to the fact that it was more industrially advanced than the other countries and so
it suited her interest.

In the late nineteenth century, there was a reaction in favor of protection from U.S.A. and
Germany and they set up the industries by erecting, tariff walls. England abandoned her free
trade policy during the Great Depression of 1930's. In recent years, some attempts have been
made to establish free trade areas on regional basis.

In 1957, six countries of Europe comprising France, Germany, Italy, Netherlands, Belgium,
Luxembourg formed a European Common Market. A second area of regional free trade is
established by Great Britain. Norway, Sweden, Denmark, Portugal, Australia and Switzerland
and is known as E.F.T.A.

ADVANTAGES

(1) If the policy of free trade is adopted by all the countries of the world, it promotes a mutually
profitable international division of labor which leads lo specialization in the production of those
commodities in which they have the greatest relative advantage. The diversification of human
and material resources of the country into remunerative channels results in increasing the real
national product of all the countries. The standard of living of the people all over the world goes
up.

(2) Free trade is undoubtedly the best from the point of view of the consumers, because they can
get wider range of goods and commodities at lower prices. When protection is levied, the choice
is reduced and the prices of commodities go up. The consumers then stand at a disadvantage.

(3) Free trade has the merit that it prevents the establishment of injurious monopolies.

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(4) Under free trade, the home producers try to put forth their best because they are faced with
foreign competition They quickly adopt the changes which are made in the designs of the
commodities or in methods of production.

DISADVANTAGES

(1) One of the most captivating argument put forth against free trade is that it leads to over-
dependence upon other countries. In time of war or any other emergency, the over-specialized
countries may not be able to supply the required goods to the non-specialized ones.

(2) It is pointed out that under system of free trade, the economically backward country remains
always at a disadvantage with the economically advanced country. So in order to build up
industries, the backward nations must erect tariff walls USA. and Germany in the late 19th
century abandoned free trade, because they were late in entering the industrial field. They
developed the industries behind tariff barriers. So is also the case with India.

(3) When trade is unrestricted, the import of injurious and harmful goods cannot be hindered.

(4) Under free trade, if a country resorts to dumping with a view to capturing foreign markets,
the home industries cannot be protected

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 3. THEORY OF DEVELOPMENT IN ECONOMICS

Natural Law:
Adam Smith proposes natural law in economic affairs. He advocated the philosophy of free and
independent action. If every individual member of society is left to peruse his economic activity,
he will maximize the output to the best of his ability. Freedom of action brings out the best of an
individual which increases society wealth and progress. Adam Smith opposed any government
intervention in industry and commerce.

He was a staunch free trader and advocated the policy of Laissez-Faire in economic affairs. He
opines that natural laws are superior to law of states. Statutory law or manmade law can never be
perfect and beneficial for the society, that is why Smith respects nature’s law because nature is
just and moral. Nature teaches man the lesson of morality and honesty. These exercise
favourable effects on the economic progress of society.

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Laissez Faire:
Adam Smith’s theory is based on the principle of ‘Laissez-Faire’ which requires that state should
not impose any restriction on freedom of an individual. The theory of economic development
rests on the pillars of saving, division of labour and wide extent of market. Saving or capital
accumulation is the starting point of this theory. He believed that “there is a set of rules or rights
of justice and perhaps even of morality in general which are, or may be known by all men by
hello either or reason or of a moral sense, and which possesses an authority superior to that of
such commands of human sovereigns and such customary legal and moral regulations as may
contravene them”.

The policy of laissez-faire allows the producers to produce as much they like, earn as much
income as they can and save as much they like. Adam Smith believed that it is safe to leave the
economy to be propelled, regulated and controlled by invisible hand i.e. the forces of
competition motivated by self interest be allowed to play their part in minimizing the volume of
savings for development.

4. COMPENSATING WAGE DIFFERENTIALS

The theory of compensating wage differentials, originally conceived by Adam Smith, has existed
in its original form for over 200 years. The theory suggests that jobs with disagreeable
characteristics will command higher wages, other things equal, because "the whole of the
advantages and disadvantages of the different employments of labor and stock must, in the same
neighborhood, be either perfectly equal or continually tending toward equality. 5 Like most other
predictions of microeconomic theory, those suggested by Smith's theory awaited the availability
of large data sets and high-speed computing in order to be empirically tested. This paper will
summarize the concepts of compensating wage differentials recently developed in the context of
hedonic price theory, review the relevant empirical studies, and draw inferences for public
policy. The paper will focus exclusively on the predicted trade-off between wages and
disagreeable job characteristics. Differentials arising from educational investments, race, sex, or
other individual characteristics, which could also be treated as compensating variations, will be

5
Adam Smith, The Wealth of Nations (New York: Modern Library, 1937), p. 100.

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ignored here. (They have been widely examined elsewhere.) The growing body of literature on
the trade-offs between wages and nonwage forms of compensation will also be ignored.6

When a worker is hired, employer and employee agree to a single wage rate for a job containing
numerous dimensions. These dimensions-such as pace of work, probability of injury, and
unpleasantness of tasks -are elements of both the demand and sup- ply functions relevant to the
job. Therefore, the wage rate embodies a series of implicit prices at which each of these job
characteristics is bought and sold-prices we shall call compensating wage differentials. The
nature of these differentials suggests that the theory of hedonic prices, perhaps most usefully
outlined by Rosen7, is the most appropriate framework of analysis.

CRITICISM OF ADAM SMITH

As Adam Smith declared economics as a Science of Wealth. Some economists of 19th Century
criticized this definition. Firstly Carlyle and Ruskin declared it a “dismal and a pig science”
which teaches selfishness. The main criticisms on the definition of Adam Smith are given in
brief as under.

1. Too Much Importance to Wealth

Definition of Economics by Adam Smith gives primary importance to wealth and secondary to
human being.

This emphasis has now shifted from wealth to human being. Man occupies primary place and
wealth a secondary one. The real fact is that man is more important than study of wealth.

2. Narrow Meaning of Wealth

In the definition the word “Wealth” means only material goods such as vehicles, industries, raw
material, Banks etc. it does not include immaterial goods like services of doctor, lawyer and
teachers. In modern economics definition the word “Wealth” includes both material and
immaterial goods.

6
Compensating wage differentials and public policy, by Robert S. Smith
7
3Sherwin Rosen, "Hedonic Prices and Implicit Markets," Journal of Political Economy, Vol. 82, No. 1
(January-February 1974), pp. 34-55.

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3. Concept of Economic Man

According to this main objective of human activities is only to earn more and more wealth. in
others words he earns only for his self interest and social interest is completely ignored. But
Alfred Marshall and his followers pointed out that economics does not study a man who works
only for his own interest, but a common man.

4. Man Welfare is Missing

The other objection by Marshall is that mans welfare has not been mentioned in Adam’s
definition of economics. He has stressed much on wealth. Wealth is a means to an end, the end
being the human welfare.

5. It Does Not Study Means

The definition lays emphasis on the earning of wealth as an end in itself. It ignores the means for
the earning of wealth.

6. Narrow and Controversial View

Since the word “wealth” did not have a clear meaning of economics by Adam Smith, therefore,
the definition became controversial. Alfred Marshall neoclassical economist gave his own
definition of economics and therein he laid emphasis on man and his welfare.

CONCLUSION

Adam Smith, one of pioneers of the field of economics and have contributed to the field in
various respects. From his book “Wealth of Nations” to many other theories and concepts, are
still considered to be as the greatest.
The theories explained above are some of the few great contribution in this field. Hereby, we can
conclude that the above mentioned theories still functions in the current economic environment.
The theories of DIVISION OF LABOUR , still plays a concrete role in deciding the labour
efficiency. And the concepts of WAGE DIFFERENTIALS still have a important place in the
economic environment. The other theory too have lasting and very crucial aspects to be played in
the current scenario.

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 BIBLIOGRAPHY

1. “An inquiry in nature and causes of The Wealth of Nations” (1776), by Adam Smith
2. “Theory of Moral Sentiments and origin of languages” (1759), by Adam Smith
3. “La Problema Adam Smith”, by Gerard Jorland, Annales. Histoire, Sciences Sociales, 39e
Année, No. 4 (Jul. - Aug., 1984), pp. 831-848
4. “ADAM SMITH”, by David Smith, RSA Journal, Vol. 149, No. 5504 (December 2002), p. 66
5. “The Divison of Labour”, by Brian j. Loasby, History of Economic Ideas, Vol. 4, No. 1/2
(1996), pp. 299-323
6. Compensating Wage Differentials and Unobserved Productivity
By, Hae-shin Hwang, W. Robert Reed, Carlton Hubbard,in
Journal of Political Economy, Vol. 100, No. 4 (Aug., 1992), pp. 835-858

INTERENT SOURCES

 https://www.investopedia.com/ask/answers/033115/how-does-law-
supply-and-demand-affect-prices.asp
 http://www.studylecturenotes.com/management-
sciences/economics/60-adam-smith-founder-of-economics-

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