Adam Smith's Theory of Value: A Reappraisal of Classical Price Discovery

The relevance of Adam Smith for understanding human morality and sociality is recognized in the growing interest in his work on moral sentiments among scholars of various academic backgrounds. But, paradoxically, Adam Smith's theory of economic value enjoys a less prominent stature today among economists, who, while they view him as the 'father of modern economics', considered him more as having had the right intuitions about a market economy than as having developed the right concepts and the technical tools for studying it. Yet the neoclassical tradition, which replaced the classical school around 1870, failed to provide a satisfactory theory of market price formation. Adam Smith's sketch of market price formation (Ch. VII, Book I, Wealth of Nations), and more generally the classical view of competition as a collective higgling and bargaining process, as this paper argues, offers a helpful foundation on which to build a modern theory of market price formation, despite any shortcomings of the original classical formulation (notably its insistence on long-run, natural value). Also, with hindsight, the experimental market findings established the remarkable stability, efficiency, and robustness of the old view of competition, suggesting a rehabilitation of classical price discovery. This paper reappraises classical price theory as Adam Smith articulated it; we explicate key propositions from his price theory and derive them from a simple model, which is an elementary sketch of the authors' more general theory of competitive market price formation.