One of the enduring questions of economics is “Where do profits come from” One of the ways in which economic philosophers have tried to answer it is by first answering the question of value. At the center of most economic paradigms is a Theory of Value. The classical political economists found value to be determined in production; since most of the cost of production could be reduced to labour, this approach was refined into The labour theory of Value. Neoclassical economists looked for value in the market act of exchange and developed the Marginal Theory of Value. Both of these theories are currently under challenge by the post-Keynesian’s with their Sraffian Theory of Value, which, like the labour theory of value, is based on production rather than exchange.
Any theory of value in economics is an extremely abstract formulation: in fact, value theory is the major intersection between economics and philosophy. For millennia, literally, scholars and theorists have tried to deduce how items attained their ‘value’. From pre-Christian to pre-Keynesian times, various strands of thought have proposed (often divergent) explanations for this phenomenon. For instance, economists sometimes use the term “theory of value” to mean quite different things. Here, the term is used to denote a theory that attempts to explain long-run prices in a capitalist economy.
... . , finance, marketing, personal production, etc. , managerial economics serves as an integrating agent by coordinating ... Responsibilities of a Managerial Economist A managerial economist can play a very important ... apply Profit Theory, which forms part of Distribution Theories in Economics. Managerial Economics is pragmatic. ... resources such as capital, land, labour and management are limited and can ...
But there are also theories of value which attempt to explain what prices should be. Medieval scholars used the concept of just price, which was the price that would allow the producer to earn a living appropriate to his social position. Some Institutional ists have introduced similar concepts – such as normative value or reasonable value. Whatever their explanations, theories of value are at the heart o two of the major themes: i-) the distribution of wealth and income; and ii-) the maintenance of microeconomic order. A Brief History of Value Theory The debate on the theory of value, which was initiated in Ancient Greece and which became inactive during the Middle Ages, later re-emerged at the close of the seventeenth century to dominate economic thought for the next 200 years. Even today its primary importance is such that Schumpeter claimed that “the problem of value must always hold the pivotal position, as the chief tool of analysis in any pure theory that works with a rational schema.” Similar hypothetical solutions varied from time to time.
Considering that this piece is hyperbolic in scope, shall, I would narrow down the analysis to the following structure. Firstly, I would try to overview sketching Aristotelian, Scholastic and Mercantilistic views on value. Secondly, I will follow an analysis of the contribution of pre-classica list writers like Petty, Cantillon, Galiani and Law to the debate. Thirdly, the supply oriented theory of value put forward by classical economists like Smith, Ricardo, Marx and Mill shall be examined. Fourthly, Jevons and Mengers’ neo-classical attempt to replace the classica lists with their demand-oriented theory of value will be considered. Finally, both Walras’ and Marshall’s respective resolution to the conflict shall be investigated by individually accommodating the interactions of both supply and demand as determinants of value within their overall economic framework.
Early Economic Thought The first great landmark in the long and tortuous intellectual struggle with the riddle of value, was laid by the philosophers of the Athenian Academy in the 4 th century BC. It was Aristotle (384-322) who held that the source of value was based on need, without which exchange would not take place. Originally, it was he who distinguished between value in use and value in exchange- “Of everything which we possess, there are two uses; For example a shoe is used for wear and it is used for exchange.” While the Scholastics later adopted and accommodated these views to Christian thought, like the Aristotelian philosophers before them, economics was not regarded as an independent discipline but merely as an integral part of ethical and moral philosophy. As a result, the debate on value was centred and henceforth retarded by a normative approach – what value should ‘justly’ be, instead of what actually is. During this period, utility was widely held as the determinant of value with only a minority of theorists such as St. Thomas Aquinas (1225-1274) and John Duns Scotus (1265-1308) taking note of the cost of the production side.
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The search concerning value was continued in the direction of utility by early mercantilists during the 16 th and the first half of the 17 th century. The supremacy of this argument was highlighted in 1588 when Bernardo Davanzati unsuccessfully attempted to construct a utility theory of value in Lecture On Money. It is not surprising that they concentrated on the determinants of the demand for goods (utility), since the merchants’ profits depended on the exploiting of the difference between the market buying and the selling prices rather than controlling the production process. For medieval theorists, value depended not on any intrinsic value but on utility and scarcity. Shakespeare’s Richard III battle plea “A horse, a horse, my kingdom for a horse” epitomizes the subjective approach to value of this era. Yet despite the failings and limitation of this one-sided method, this period is viewed as embryonic with regard to value theories, and one which would issue subsequent economic developments.
Pre-Classical Thought It was only at the end of the seventeenth century when economists following a Cartesian philosophy of deduction, broke away from the dominant mercantilistic utility view and looked for a solution in the cost of production. William Petty (1623-1687) who was influenced by the scientific advances of his era abandoned the subjective theory of value and instead objectively searched for the natural and intrinsic laws of reality – of which ‘natural value’ was one of them. According to Petty, the market price (‘actual price’) of any commodity would fluctuate perpetually around its natural value (‘natural price’).
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The determinants of this natural value were deduced as the factors of production – land and labour.
In keeping with his mathematical nature, Petty attempted to reduce his theory of value to a labour one only, by looking for a ‘par’ value for land in terms of labour forces. In the political Anatomy of Ireland (1691), he states that the unit of measure consisted of “The easiest-gotten food of the respective countries of the world”- average daily diet necessary to sustain a worker. Although he successfully anticipated the classical-Marxian theory of subsistence wages and surplus, he also inherited the endless difficulties associated with a labour cost theory of value. Richard Cantillon (168-1734) who was another practitioner of the Cartesian approach also began with the labour-and-land theory of value.
Although, similar to Petty in that he reduces the determinants of intrinsic value in terms of one factor, unlike him, Cantillon, who was influenced by French agrarian protectionists, chose land. Cantillon finds his ‘par’ value by equating the value of a labourer with that of twice the produce of the land he consumes, while allowing for variations in the labourers’s kills and status. Once this ‘par’ value is calculated, the intrinsic values of any good can be reduced to land only. With his assumptions of constant returns to scale, Cantillon provides us with his land theory of value. He also originally shows us how resources were allocated between different markets when the market price diverge from his intrinsic ‘land’ value. Unfortunately, Cantillon’s land theory, like Petty’s labour theory, was only a true description of value in highly specific cases.
Meanwhile the medieval subjective approach to value was continued by another branch of pre-classical economists, which included people like Nicholas Barbon (1640-1698) who thought that the natural value of goods was simply represented by their market price. For him “the value of all wares arise from their use; things of no use, have no value, as the English phrase is, they are good for nothing.” Furthermore, on the continent, the Italian Ferdinando Galiani (1728-1787) borrowed the early mercantilistic writings of Davanzati and Montanari on the subjective nature of value. He devoted his time to developing a theory of utility value and even implicitly described the notion of diminishing marginal utility. His deductions just “lacked the concept of marginal utility” of the neo-classical economists, Jevons and Menger. Although Galiani vaguely accounted for the cost of production in his utility value theory, he failed to develop it into a fully-fledged supply and demand analysis.
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The Scotsman John Law (1671-1729) took up this monumental project. In his Essay on a Land Bank, Law outlined the old water / diamond paradox of value, in which comparatively ‘useless’ diamonds are more highly valued than the more ‘useful’ water and reconciled the mystery by using a supply and demand analysis. Unlike his predecessors and his immediate successors (until Walras and Marshall), Law used both demand and supply factors in determining the value of a good which has a use in society. Henceforth any changes in the value of goods were due to a change in the quantity supplied or demanded. Although John Locke (1632-1704) in, Some Considerations on the Consequences of Lowering of Interest and the Raising the Value of Money, had developed a theory of price determination earlier, it lacked the clarity, precision and understanding of Law. In Money and Trade Considered, Law corrects Locke’s unpolished value by stating that “The prices of goods are not according to the quantity in proportion to the vent, but in proportion to the demand.” Surprisingly, Law’s early solution to value theory gained little following owing probably to his failed financial operations in France.
Even more surprisingly has been the reduction of Law’s contributions in this area to mere footnotes in the mainstream economic history books. Unfortunately, for the development of value theory, this dualistic analysis was suppressed for almost 200 years, until its resurrection at the close of the 19 th century. Classical Thought The publication of Adam Smith’s (1723-1790) Wealth of Nations in 1776 heralded the rise of the classical school and swung the value debate back towards Petty’s objective labour theory of value. According to J. Nie hans, the classical emphasis on the labour cost was “a step backward” compared to the pre-classical analysis. The classical political economists shared three major points in their approach to developing a theory of value.
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First, all the classical economists thought it necessary to start their investigations of capitalism with the question of value. Second, all the classical economists searched for value in the conditions of production. It was in the workshop or the factory, not the marketplace, that goods acquired their particular values. Third, although they had somewhat different reasons, all the classical economists subscribed to one form or another of a subsistence theory of wages. That meant that the cost of labour was itself equal to the value of the goods and services that a working-class family needed in order to get by. Smith: Adding-Up of Costs Adam Smith found value – which he called “natural price”- by adding the costs of production.
In a society without private ownership of land and which used only the simplest of tools, labour would make up the entire cost of production: If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for, or be worth two deer. It is natural that what is usually the produce of two days’ or two hours’ labour, should be worth double of what is usually the produce of one day’s or one hour’s labour. The Wealth of Nations, Book 1, Chapter 6 But this simple measure of value is not sufficient for the more complex production processes and property ownership patterns of capitalism. When the worker is hired by a capitalist, use equipment owned by the capitalist, and works with raw materials purchased by the capitalist, there will normally be profit: In the price of commodities, therefore, the profits of stock [capital] constitute a component part altogether different from the wages of labour, and regulated by quite different principles. The Wealth of Nations, Book 1, Chapter 6 By “quite different principles,” Smith means that the worker is paid by the hour of labour while the capitalist is “paid” by the amount of capital and the length of time that the capital is engaged in that production process. Whenever a product involves the use of land, there will be a third component included in its price: 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.
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The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was 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. The Wealth of Nations, Book 1, Chapter 6 The real value, then, of any commodity, will be the sum of the labour cost and the profit plus any rent. Even though the capitalist purchase raw materials as well as labour, the raw materials – and anything else the capitalist purchases from other capitalists – can in turn be broken down into labour, profit and rent. Adding Up of Costs We can fabricate a simple example along the lines suggested by Smith.
A capitalist in the pig-raising business produces 1, 000 pigs per year. Their value can be determined by adding up the capitalist’s normal costs. There are 50 labourers at 20 per year each, for a total direct labour cost of 1, 000 per year. Raw materials run 600 per year.
Replacement of worn out tools and building repair (depreciation) comes to 50 per year. This enterprise requires 100 acres of land at 2 per acre per year, or 200 per year in land rent. The capitalist will need to have a total of 1, 500 tied up in the business. Some of this will represent investment in buildings and tools, but most of it will be operating capital – workers and suppliers have to be paid before the capitalist sells the pigs. If the normal profit rate is 10%, our capitalist will need to get 150 per year as “compensation” for having 1, 500 tied up in the business. Since the total costs, including the 150 of profit, come to 2, 000 per year, the natural price of pigs will be 2 per pig.
I think it is important to note that labour makes up most of the cost. In this example, direct labour is only half of the total cost. But if we opened the books of the businesses that supplied the raw materials and replaced the worn out tools we would find their costs can also be broken down into labour, profit, rent and supplies. Then we could look into the costs of their suppliers, and so on. About one-third (actually, 32. 5%) of the costs in this example – raw materials and replacing worn out equipment – are subject to this process.
If the costs in these supplier industries are proportional to the costs in the pig industry, (There is no reason that they should be, but assuming so makes the arithmetic easier) then half of these supply costs could be attributed to labour, then half of their supply costs, then half of those firms’s supply costs. When we add it all, we find that labour costs are close to 75% of total costs; considerably higher than the 50% figure that we get by only looking at direct labour costs. The Value of Labour The next step is to investigate the value of labour itself. According to Smith, nature sets the “minimum” wage: A man must always live by his work, and his wages must at least be sufficient to maintain him.
They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family, and the race of such workmen could not last beyond the first generation. The Wealth of Nations, Book 1, Chapter 8 It is difficult for wages to rise much above this minimum. Smith partially attributes this to inequality of bargaining power. The power of the worker to withhold his labour is far weaker than the power of the employer to withhold access to employment: A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks [capital] which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.
The Wealth of Nations, Book 1, Chapter 8 This “natural” inequality was supplemented by legal inequality. When Smith was writing The Wealth of Nations – and for another fifty years thereafter – British workers were prohibited from forming unions and bargaining collectively. There were no similar prohibitions on employers: We rarely hear, it has been said, of the combinations of masters, though frequently those of workmen. But whoever imagines, upon this account, that masters rarely combine, is as ignorant of the world as of the subject.
Masters are always and everywhere in a sort of tacit, but constant and uniform, combination, not to raise the wages of labour above their actual rate. To violate this combination is everywhere a most unpopular action, and a sort of reproach to a master among his neighbors and equals. We seldom, indeed hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of. Masters, too, sometimes enter into particular combinations to sink the wages of labour even below this rate. The Wealth of Nations, Book 1, Chapter 8 Yet there were sometimes forces leading wages upward. Rapid economic growth can create a shortage of labour.
The reinvestment of profits will lead to ever-greater employment. However, higher wages, by improving living conditions and thus reducing infant and child mortality, quickly lead “to the great multiplication of the species.” The race between the demand for labour and the supply of labour will eventually be won by the supply of labour and wages will once again fall to the “lowest rate, which is consistent with common humanity.” Additionally, labour of greater skill or difficulty will itself take on a natural price in terms of common labour: If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour’s labour in the one way may frequently exchange for that of two hours’ labour in the other. Or if the one species of labour requires an uncommon degree of dexterity and ingenuity, the esteem which men have for such talents, will naturally give a value to their produce, superior to what would be due to the time employed about it. Such talents can seldom be acquired but in consequence of long application, and the superior value of their produce may frequently be more than a reasonable compensation for the time and labour which must be spent in acquiring them.
The Wealth of Nations, Book 1, Chapter 6 The Role of Value Value, or “natural price” is a central concept in Smith’s work. Temporary deviations of market price from natural price provide his capitalists with their production directions. When the market price is above the natural price, profits will also be above their natural rates. New capital will be drawn to such an industry until increased production brings prices and profits down to their natural rates.
When the market price is below the natural price, profits will also be below their natural rates. Capital will leave such an industry until decreased production brings prices and profits up to their natural rates. The natural price, in turn, is determined by the costs of production. The costs of production can be broken down into labour costs, rent and profit. Labour has its natural price, which is the cost of the goods and services the workers need in order to work and raise families. But how is the natural rate of profit determined Or the natural rate of rent Smith has not provided us with either an economic or sociological principle which would establish either of these rates.
He leaves us with an incomplete theory of value. Indeed, Smith who borrowed the water / diamond paradox from Law without acknowledging it, failed to resolve the riddle and the resulting relationship between use-value and use-exchange, by mistakenly focusing on total rather than marginal utility. His confusion is further shown in his experimentation with three value theories. He provided a labour cost and a labour command theory of value for a primitive society and finally a cost of production theory for an advanced one. In his “Nation of hunters” analogy, Smith’s notion of labour cost of value is determined by the quantity of labour which is measured by wages which is also extended to his labour command theory- “Value of any commodity… to the person who processes it and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which enables him to purchase or command.” However, when he perceived that if wages were not the same proportionate part of final prices of all goods, he then realised that his labour theory of value for an advanced economy would not hold.
Instead, it appears that he opted for a cost of production value theory consisting of land, labour and capital value theory. Up to this part, I have tried to give a brief history of Theory of Value before David ricardo. Now, I will try to explain Ricardian Theory of Value in detail. First of all, I would like to give some information about David Ricardo. His Life and Times David Ricardo was born 4 years before the publication The Wealth of Nations. His world was the world of the industrial revolution, his England the nexus of world trade and finance.
He was the third child of a well-to-do family of Sephardic Jews, from whom he was a stringed at the age of 21, on the occasion of his conversion and marriage to Quaker. His success as a stockbroker allowed him to devote his attention to questions of public policy, which in turn led to a successful carer as a Member of Parliament. His writings also led to a correspondence with Thomas Malthus, a correspondence into a personal friendship, although they disagreed on many of the fundamental economic issues of their they. He died in 1823 at the age of 51.
Contributions One of Ricardo’s fundamental contributions is the comparative advantage theory of trade, which explains international trade as the result of relative rather than absolute differences in productivity across countries. This implies that countries can benefit by specializing in the production of goods that they produce most efficiently, relative to the rest of world, and trading them for goods that are most efficiently produced elsewhere in the world. The theory of comparative advantage suggests that trade is beneficial to all trading partners and provides a formal rationale for free trade policy. It discredits the mercantilist view of trade, which sees the accumulation of export surpluses as the means to benefit from rate.
Also of particular interest to industrial economists is the Ricardian notion of rent. Ricardo developed his theory of rent in his analysis of the returns to agricultural land, when such land differs in location or degrees of fertility. In the long run, the price of grain will be just sufficient to cover the cost of production (including a normal rate of return on investment, the opportunity cost of inducing the farmer to retain in the market) and transportation to market of the least productive (or most distant) farm the output of which is needed to balance supply and demand. But if the least advantaged farmer earns only a normal rate of return, then those who work more fertile farms, or farms from which the transportation cost is less, will earn an above-normal rate of return.
This excess return, an income that cannot be competed away that is a return a unique asset (fertility, location) is an example of an economic rent. Ricardo’s Labor Theory of Value In the preface of The Principles of Political Economy and Taxation (1817), David Ricardo laid out the goal of his work. He was setting out to uncover the laws that regulate the distribution of the produce of the earth – all that is derived from its surface by the united application of labour, machinery, and capital… among [the] three classes of the community, namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated. The Principles of Political Economy and Taxation [Preface]. The first step of this project was to understand the laws of value.
As the heading of Chapter 1, he gives us the foundation of what came to be called the labor theory of value: The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production… The Principles of Political Economy and Taxation, Chapter 1, Section 1 Ricardo planned to develop a rigorous theory of value. Rather than make his theory fuzzy enough to encompass the value of all goods, he would exclude goods such as “rare statues and pictures, scarce books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil,” since their value is wholly independent of the quantity of labour originally necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them. These commodities, however, form a very small part of the mass of commodities daily exchanged in the market. The Principles of Political Economy and Taxation, Chapter 1, Section 1 This theory of value would be limited to the goods and services that were typical products of competitive capitalism: In speaking, then, of commodities, of their exchangeable value, and of the laws which regulate their relative prices, we mean always such commodities only as can be increased in quantity by the exertion of human industry, and on the production of which competition operates without restraint. The Principles of Political Economy and Taxation, Chapter 1, Section 1 Ricardo was much more consistent than Smith.
Smith had identified labour as the major factor responsible for natural price. But Smith’s measure of labour itself varied from chapter to chapter. Sometimes it was the amount of labour needed to produce the product; sometimes it was the amount of labour that could be hired for an amount of money equal to the value of the product; sometimes it was the value of the goods and services that the worker could purchase with his wages. A Measure of Value But Ricardo was searching for an “invariable measure of value.” This is truly an impossible goal.
When the technology of production of a good or service changes, its value will change. All theories of value are in agreement on this. Even gold and wheat, two candidates for such a measure that were rejected by Ricardo, will alter in value as the technology of production changes. The same is true, in a more roundabout way, of labor itself.
If new farming and / or baking technology reduce the value of bread, then the value of labor will also fall since the worker’s capacity to work can be “produced” at a lower cost. (The Principles of Political Economy and Taxation, Chapter 1, Section 1. ) It might be possible, Ricardo thought, to find a measure of value which would not vary as the distribution of income changed, even thought it would certainly vary with technological change. Ricardo’s project was to discover which economic forces determined the distribution of income. The best candidate for such a measure was labour. If profits rose and wages fell, or if profits fell and rents increased, it would still require the same amount of labour to weave a bolt of cloth or to build a ship.
The Level of Wages Ricardo’s theory of wages was similar to Smith’s, but much more severe. Thomas Malthus, Ricardo’s good friend, had published his famous Essay on the Principle of Population in 1798. While Adam Smith had noted a tendency for population to increase when wages were high, Ricardo (and Malthus) turned this tendency into a ruthless certainty: The natural price of labour… depends on the price of the food, necessaries, and conveniences required for the support of the labourer and his family. With a rise in the price of food and necessaries, the natural price of labour will rise; with the fall in their price, the natural price of labour will fall… It is when the market price of labour exceeds its natural price that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family.
When, however, by the encouragement which high wages give to the increase of population, the number of labourers is increased, wages again fall to their natural price, and indeed from a reaction sometimes fall below it. When the market price of labour is below its natural price, the condition of the labourers is most wretched: then poverty deprives them of those comforts which custom renders absolute necessaries. It is only after their privations have reduced their number, or the demand for labour has increased, that the market price of labour will rise to its natural price, and that the labourer will have the moderate comforts which the natural rate of wages will afford. (The Principles of Political Economy and Taxation, Chapter 5) The Theory of Rent Agricultural products presented a particular difficulty. Smith’s solution had been to make land rent one of the components of natural price and simply add it onto labour costs and profits to get value.
Ricardo started by examining how agriculture was different from manufacturing. When the demand for shovels increases, manufacturers can build more factories. There is no reason that these new factories cannot be as productive as the existing factories. That is, the amount of labour needed to produce a shovel will not change when we double or triple shovel production by building new shovel factories. When the factory is a farm, however, we have a different problem. Land varies greatly in its productive qualities.
It is usually the best land that is first drawn into agricultural production. Therefore, when the demand for wheat increases, it will take more than the average amount of labour to produce and transport the additional wheat. Ricardo’s example supposes that there are three grades of land. On the best land it costs 3 to produce 10 bushels of wheat and deliver it to the town market.
This cost includes the necessary amount of profit to get someone to farm the land. On the middle grade of land it costs 4 to produce the same amount of wheat and transport it to the town market. On the poorest land, it costs 5 to produce and transport 10 bushels of wheat. The differences in costs reflect differences in the amount of labour required. With a small population, the demand for wheat can be met by farming only the best land. The price of wheat will be 3 per 10 bushels.
But as population grows, some of the middle grade land will be brought into cultivation. Now the price of wheat will rise to 4 per 10 bushels. If I own some of the best land and you farm that land, I can charge you a rent of 1 per 10 bushels of wheat. If I own some of the middle grade land, I cannot collect any rent since the cost of production on that land is the same as the price of the wheat. As population continues to grow, cultivation is extended even to the poorest land and the price of wheat rises to 5 per 10 bushels. Now the owners of the best land will enjoy a rent of 2 per 10 bushels and the owners of the middle grade land can collect a rent of 1 per 10 bushels.
This rising rent has important implications. For now, we must understand how this theory of rent fits into Ricardo’s labour theory of value. Ricardo was able to show that the value of agricultural commodities, just like the value of manufactured commodities, is determined by the amount of labour it takes to produce them. The difference is that, with agricultural commodities, the value is governed by the amount of labour required under the most unfavourable circumstances – that is, by the amount of labour needed on the poorest quality land which the level of demand causes us to bring into production. Taking issue with Smith, Ricardo argued that “rent is not a component part of the price of commodities.” Smith had claimed that high land rents drove up the price of wheat. Ricardo showed that high wheat prices – which themselves were caused by a growing population – drove up rent.
Rent was the consequence, not the cause, of high food prices. A Labor Theory of Value It all fits together into a fairly complete and consistent theory of value. Value is determined by the amount of labour needed for production, including, of course, the labour used to produce the raw materials and the ‘worn out’ part of the capital equipment. For wheat and similar products, value is determined by the amount of labour needed for production on the poorest land. Wages are determined by the values of the goods and services that a working class family needs to survive and reproduce. The capitalist pays his suppliers, repairs or replaces his worn out equipment, pays the workers and sells the product for a price determined by the amount of labour it took to produce it.
Whatever is left over is profit. If the price of bread is high, wages will also be high and there will be little profit, but agricultural landowners will collect high rents. If the price of bread is low, wages will also be low and there will be high profits and little rent. Note that profit and rent are incorporated into this value theory, not added on as a cost as Smith had done. There was still one major problem with the labour theory of value. It would only work well as a theory of natural price if the ratio of labour costs to capital costs were the same in all industries.
Labor could not be an invariant standard of value when some industries used lots of labour and little capital while others used lots of capital and little labour, since a change in the distribution of income between wages and profits would alter costs in different industries by different amounts. Ricardo was still pondering this problem when he died. Nonetheless, Ricardo’s labour theory of value was something of a sensation. Thirty years after Ricardo’s Principles of Political Economy, John Stuart Mill, in his own Principles of Political Economy (1848) saw little reason to modify Ricardo’s foundation of economics: Happily, there is nothing in the laws of Value which remains for the present or any future writer to clear up; the theory of the subject is complete: the only difficulty to be overcome is that of so stating it as to solve by anticipation the chief perplexities which occur in applying it.
Mill, John Stuart. Principles of Political Economy, Book 3, Chapter 1 Karl Marx’s (1818-1883) approach to value was essentially Ricardo’s labour theory of value. According to Marx, the values of “All commodities are only definite masses of congealed labour time.” As an advocate of Ricardo’s original theory, he also followed and built on his solutions to the labour value theory’s inherent deficiencies. Although Marx used the classical concepts of value he applied his vast philosophical and sociological knowledge to reach conclusions in Capital that diverged radically from them.
In his labour theory, he developed his original rate of exploitation (s’ = s / v ) and its resulting critique of capitalism-“Derriere le phenomena du profit se cache la reality do sur travail.” Like Aristotle, exchange of value or more appropriately exchange of ‘just’ value had for Marx, moral and judicial implications as well as economic ones. Despite John Stuart Mill’s (1806-1873) claim to the continuity of Ricardo’s labour theory of value, his work in retrospect was closer to Marshall and to the approaching neo-classical school. Mill gave up the classical-Ricardian search for absolute value for his belief that “The value which a commodity will bring in any market is no other than the value which, in that market, gives a demand just sufficient to carry off the existing supply.” Although lacking the tools of the supply and demand schedules, Mill clearly recognised the effects of demand on the supply in different time periods of a value theory. Although he acquired a more advanced comprehension on the subject of value than his contemporary theorists did, unfortunately it led him to prematurely and embarrassingly state in 1848 that “Happily, there is nothing in the laws of value which remains for the present or any future writer to clear up; the theory of the subject is complete.” Neo-Classical Thought Although the origins of modern utility theory can be traced back to Mountifort Long field in 1834 at Trinity College Dublin it was William Jevons (1835-1882) with his Theory of Political Economy and Carl Menger’s (1840-1921) Principles of Economics who both developed the new tool of marginal analysis in 1871 as a means of understanding value.
For the rising neo-classical school in the 1870 s, the classical cost of production theory of value seriously lacked generality – especially in determining value of goods with inelastic supply curves. Instead, Jevons and Menger separately formulated their marginal utility theory, in which it was calculated that “Value depends entirely on utility.” Like Davanzati in the 16 th century, they felt that no matter what costs were incurred in producing a good, when it arrived on a market its value would depend solely on the utility the buyer expects to receive. Menger used his marginal utility table to explain the old water / diamond paradox. The value of diamonds was greater than the value of water because it was marginal utility and not total utility that determines consumer choice and hence value. From this they also argued that value comes from the future and not past production. Henceforth, the factors of production are not price determining but price-determined, as Jevons clearly states- “Cost of production determines supply, supply determines final degree of utility, final degree of utility determines value.” Jevons and Menger like their predecessors before, erred in trying to find a simple one-way, cause and effect relationship between value, and in their case utility.
It took the intellect of Leon Walras and Alfred Marshall to see that both the cost of production (supply) and utility (demand) were interdependent and mutually determinant of each other’s values. Leon Walras (1834-1910) also independently discovered the concept of marginal utility although he went beyond Jevons and Mengers application of it to merely a utility value theory. He did not see their simple and direct causal link from subjective utility to value. Instead, he saw a complex interrelated and interactive economic system. In his Elements of Pure Economics, he created his theoretical model of General Equilibrium as a means of integrating both the effects of the demand and supply side forces in the whole economy. This mathematical model of simultaneous equations concluded that “In general equilibrium everything depends upon everything else.” Meanwhile, Alfred Marshall (1842-1924) was also amalgamating the best of classical analysis with the new tools of the marginal ists in order to explain value in terms of supply and demand.
He acknowledged that the study of any economic concept, like value, is hindered by the inter relativeness of the economy and varying time effects. As a result, Marshall who differed from Walras’ general schema, instead used a partial equilibrium framework, in which most variables are kept constant, in order to develop his analysis on the theory of value. Marshall divided his study into four time periods. Firstly, in the market period where time is so short that supply is fixed, value of a good is determined by its demand. Secondly, in the short-run period, firms can change their production but cannot vary their plant size, which allows supply as well as demand to have an effect on value. In the long-run periods where plant size can be altered, the large effects of the supply side on value depends on whether the industry of a particular good has constant, increasing or decreasing costs to scale.
Finally, in the secular period in which technology and population are allowed to vary, the supply side conditions dominate value. For Marshall a correct understanding of the influence of time and interdependence of economic variables would resolve the controversy over whether it was the cost of production or utility which determines value. In general, however he felt that it was fruitless to argue whether demand or supply determines value as “we might as reasonably dispute whether it is the upper or under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or costs of production.” Any attempt to find one single cause of value as others had unsuccessfully attempted in the past, were doomed to failure.