Smith set out to describe how production could be encouraged. Production is best served, he argued, by allowing people to feely pursue their "self interest". It is not through the spirit of charity, Smith argued, that bread gets produced and supplied to the consumer. It is, instead, the baker's pursuit of his own interests that gets the bread produced. Left to seek his fortune, the baker will try to produce an appealing loaf at an attractive price. In this way, people will choose his product in preference to others, and enhance his material well being. If the baker produces a shoddy product, or attempts to cheat his customers, the customers will desert him in favor of other bakers. It is in the baker's best interests to produce a desirable and inexpensive product.
Should a producer come up with a new product or productive technique, it will profit him for a while, but eventually others will imitatte the product or technique, and it will no longer yield extraordinary returns. Competition forces the producer to make a quality product, and prevents him from earning extraordinary returns for any extended period.
Smith believes that government should adopt a policy of letting folks do what they want, economically, and cease applying regulations to economic activity. By letting people pursue their own interests without hinderance, Smith argues that the greatest level of economic activity and productivity will ensue.
Smith, like most classical economists, relies on a "theory of value". From the classical economists' perspective, prices hover around a "natural" level for each product, and that level reflects the value of the product. Modern economists do not utilize a value theory, arguing that there is no intrinsic value, only the price at which the product sells. The classical economists felt that any given price of a product may or may not reflect the product's value. The price might be above the value were the product in short supply or particularly desired, or it might be below the value if there were an excess of the product or if it was falling from the consumers' favor. These prices, however, would merely reflect temporary phenomenon, and in the longer run, the price of the product would gravitate to it's value. For Smith, the value of a product as it's cost of production. For other economists of the period, such as David Ricardo, the value of a product lay in the labor contained in it.
David Ricardo championed free trade and argued for the free importation of food in to England. Ricardo felt that having each nation specialized in the production of those things for which it had a comparitive advantage, and trading for things in which it did not, the world's output would be maximized. It is clear, for example, that Oregon and California could each produce both timber and citrus fruit and supply themselves. However, if California were to speciallize in citrus fruit, and Oregon in lumber; and trade with each other, both states would have more citrus and more timber than they would if they had tried to make both themselves. So, too, would the world's nations were they to specialize and trade rather than try and protect their inefficient domestic producers.
Ricardo was also concerned with the theory of rent. Rent should be seen as the payment to land rather than the money we pay to rent a house. In Ricardo's eye, the interesting thing about rent is its relation to the price of food. As industrial output and production grew, more people were drawn from the country side into the towns and factories. These new factory workers needed food. Indeed, their wages would largely be spent on food. As the urban population grew, more and more food would be needed from the country side. This increased demand would drive up the price of food, which would cause less fertile land to be drawn into production. As less productive land was coaxed into crops, owners of productive land would see the return to their land (their rents) increasing. The marginal land wouldn't yield extraordiny returns, but the fertile lands would. Increasingly, land owners would become wealthy at the exense of factory owners who would see thier profits dwindling as wages rose to pay for the increasingly costly food. At İhe extreme, landowners would come to bleed away all the profit from manufacture, and the growth in industrial output would grind to a halt. The answer was an abolition of agricultural tariffs and free trade in foodstuffs.
Where Ricardo was critical of the landowners, Thomas Malthus was their champion. Malthus, a parson, is famous for the "Malthusian Doctrine" which claims that, since population increases geometriclly and food production increases arithmetically; society must eventually face a population crisis. With rapid population growth, we can expect famine, plague, pestilence and war. These "positive checks" on populaton growth will result from the pressure of popuation of limited food producing resources. The only way of avoiding these positive checks would be to convince people to delay marriange and moderate their sexual behavior--something Malthus felt would be unlikely to occur. We have, so far, managed to avoid the positive checks that Malthus predicted. Population growth has slowed in the industrialized nations, and agriculture output has inceased surprisingly through the application of science to agriculture. The "jury is still out" as to whether we have finally escaped the horrors Malthus predicted.
The other theory Malthus advanced was that, since workers cannot purchase the entire outuput of industry, there must always be a supply of products that cannot be sold. This glut of goods is disastrous for industry and business. What is needed is someone to purchase the output that the workers cannot. This can't be more workers, since they will merely produce more than they can consume, thus compounding the problem. The rescuing consumers must not be productive. They must simply consume without adding to output. The only group that can accomplish this is the landed gentry since all they do is spend their rents. They produce nothing. Thus, the landed gentry is the savior of the industrial system. Ricardo made quidk work of Malthus' argument, pointing out that there could not be a glut of goos since the incomes created in manufacturing the goods are sufficient to buy them. Remember, Ricardo would say, while the workers can't buy up all that is made, there are factory owners as well, and if their spending power is included in the equation, there will always be sufficient income to buy up the product of industry. While Malhus was wrong, he did focus on an important point which becomes central in the macroeconomics of the 20th centrury.