In Chapter 6 of The Wealth of Nations (available here), Adam Smith writes: “Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these.” (WN, I.vi.17) In other words, the real price of a good or service is a function of three variables: wages, profit, and rent. Smith breaks down each one of these key variables as follows:

1. Wages (Paras. 1-4). First off, the Scottish philosopher-economist begins this chapter with wages. In brief, we can think of wages as the revenue generated by one’s labor:

“… the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity, is the only circumstance which can regulate the quantity of labour which it ought commonly to purchase, command, or exchange for.” (WN, I.vi.4)

But wages are just one component of the real price of goods and services. The other two components are rent and profit.

2. Rent (Para. 8). Rent, by contrast, is the revenue generated by one’s real property or land:

“As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part.” (WN, I.vi.8)

3. Profit (Paras. 5-7). Profit is the most fascinating of Smith’s three variables, for in the process of explaining profit, Smith describes an entirely new economic system, i.e. capitalism:

“As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials. In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials, and the wages of the workmen, something must be given for the profits of the undertaker of the work who hazards his stock in this adventure. The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him; and he could have no interest to employ a great stock rather than a small one, unless his profits were to bear some proportion to the extent of his stock.” (WN, I.vi.5)

4. Examples (Paras. 11-13). Smith also illustrates his theory of price with numerous examples. Below is Smith’s explanation of the price of one of the most essential commodities of Smith’s time — i.e. the price of “corn” or cereal grains like barley, oats, rye, and wheat:

“In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or maintenance of the labourers and labouring cattle employed in producing it, and the third pays the profit of the farmer. These three parts seem either immediately or ultimately to make up the whole price of corn. A fourth part, it may perhaps be thought, is necessary for replacing the stock of the farmer, or for compensating the wear and tear of his labouring cattle, and other instruments of husbandry. But it must be considered that the price of any instrument of husbandry, such as a labouring horse, is itself made up of the same three parts; the rent of the land upon which he is reared, the labour of tending and rearing him, and the profits of the farmer who advances both the rent of this land, and the wages of this labour. Though the price of the corn, therefore, may pay the price as well as the maintenance of the horse, the whole price still resolves itself either immediately or ultimately into the same three parts of rent, labour, and profit.” (WN, I.vi.11)