Supply, Demand, and Allocation
Adam Smith had argued that each good or service has a "natural price." If the price (of beer, for example), were above the natural price, then more resources would be attracted into the trade (brewing, in the example), and the price would return to its "natural" level. Conversely if the price began below its "natural" level.
The modern theory of supply and demand differs from Smith's theory in some important ways. Economists have made some progress in the last 200 years, and great economists such as John Stuart Mill and Alfred Marshall (and many others) have played their part in the growth of the modern theory of supply and demand. Nevertheless, the theory of supply and demand is the modern expression of Smith's great insight about "the natural price."
To make a long story short, before about the 1850's most economists accepted the Labor Theory of Value as the theory of the "natural price." But there were some cases it did not apply to: international trade, for example. John Stuart Mill suggested a "supply and demand" solution for prices in international trade. Other economists extended it to apply to prices in general.
Unlike the "natural price," a long-run theory only, the theory of supply and demand applies in the short run as well as the long.
Supply, Demand, and Allocation
