You are advised to make your work clear and well-presented; marks may be reduced for poor presentation. This includes filling your information on the cover page.
Assignment will be evaluated through BB Safe Assign tool.
Late submission will result in ZERO marks being awarded.
The work should be your own, copying from students or other resources will result in ZERO marks.
Use Times New Roman font 12 for all your answers.
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 . . . .
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 VII. http://www.adamsmith.org/
What did Smith mean by the “prime cost” of a commodity?
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?
How did Smith explain how the exit of some firms occurs in a perfectly competitive market to ensure that firms remaining in the market earn zero economic profit in the long run?