The Wealth of Nations · Chapter
Of the Origin and Use of Money explained
This chapter explains how the division of labor necessitates exchange, leading to the adoption of a common medium of exchange.
What happens
This chapter explains how the division of labor necessitates exchange, leading to the adoption of a common medium of exchange. It traces the evolution from barter to the use of various commodities (cattle, salt, shells, metals) and finally to coined money, highlighting the inconveniences of barter and the advantages of metals. The chapter also introduces the distinction between value in use and value in exchange, and outlines the plan for the following chapters on the principles of exchangeable value.
Themes in this chapter
Division of Labor
The division of labor creates the need for exchange, which in turn leads to the origin of money as a medium to facilitate trade.
Wealth and Money
The chapter explores the historical development of money, from commodities to metals and coined money, and its role as a universal instrument of commerce.
Historical Development of Society
Smith traces the evolution of exchange and money through different stages of society, from rude ages to commercial societies.
Characters to notice
- Adam Smith
Author and narrator, explaining the origin and use of money.
Key passages
“When the division of labour has been once thoroughly established, it is but a very small part of a man’s wants which the produce of his own labour can supply.”
Once the division of labor is fully in place, a person can satisfy only a tiny fraction of their needs with what they themselves produce.
This sets up the necessity of exchange in a commercial society.
“In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.”
To avoid the difficulties of barter, people naturally began to keep a stock of a commonly accepted commodity that they could use to trade for anything they needed.
This explains the origin of money as a solution to the double coincidence of wants problem.
“The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.”
Useful things like water often have low exchange value, while less useful items like diamonds can have high exchange value.
This introduces the famous water-diamond paradox, illustrating the distinction between value in use and value in exchange.