Ricardos Theory Of Value Essay Research Paper

Ricardo`s Theory Of Value Essay, Research Paper

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-Keynesians 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. 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 Institutionalists have

introduced similar concepts – such as normative value or reasonable value.

Whatever their explanations, theories of value are at the heart of 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-classicalist 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 classicalists 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 4th 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.

The search concerning value was continued in the direction of utility by early

mercantilists during the 16th and the first half of the 17th 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"

epitomises 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’). 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’ skills 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. 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 19th 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. Niehans, 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. 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. 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’ 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 astringed 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

Malhus, 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. Contibutions 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 merchantilist 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 phenomene du profit se cache la realite do

surtravail." 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

Longfield 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 1870s,

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 16th 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

marginalists 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 interrelativeness 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.


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