MANAGERIAL ECONOMICS

ON

COST OF PRODUCTION THEORY OF VALUE

KRISHAN KAPOOR

Reg No: (S1AB2A71150A)

GREAT EASTERN MANAGEMENT SCHOOL

BANGALORE

2011

CERTIFICATE

This is to certify that the Project work of “MANAGERIAL ECONOMICS” submitted

to the College by the candidate Mr.KRISHAN KAPOOR, bearing Reg No.

(S1AB2A71150A)

Is the product of bonafide research carried out by the candidate under my

supervision in Managerial Economics.

Bangalore

July 2011 (GUIDE)

Mrs. Laxmikanan

Lecturer , Managerial economics

ACKNOWLEDGEMENT

The Project work was carried out under the remarkable guidance of

Mrs.Laxmikanan , Lecturer, Great Eastern Management School. I am grateful for

her guidance and valuable suggestions and for the constant encouragement and

co-operation.

I also express my sincere gratitude and thanks to all the teachers who helped me

to complete this project.

CONTENTS

1. INTRODUCTION2. Cost-of-production theory of value

3. Market price

4. Labor theory of value5. The theory's development6. Modern criticisms7. Effect of taxes and subsidies on price8. Economic equilibrium9. Other markets10. Abstract treatment of labour-time11. Controversies12. Cost the limit of price13. Law of value in capitalism14. Smith's hidden hand15. A comment by Marx on the law of value16. Criticism17. Excess burden of taxation18. Distortion and redistribution19. Lump-sum tax20. Economic effects21. Ethics22. Existing tax systems23. A quote from Marx on production prices24. Production prices and the transformation problem25. Value and price26. Facts and logic

Cost-of-production theory of value

INTRODUCTIONIn economics, the cost-of-production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can compose any of the factors of production (including labour, capital, or land) and taxation.

The theory makes the most sense under assumptions of constant returns to scale and the existence of just one non-produced factor of production. These are the assumptions of the so-called non-substitution theorem. Under these assumptions, the long run price of a commodity is equal to the sum of the cost of the inputs into that commodity, including interest charges.

Historical development of theory

Historically, the most well known proponent of such theories is probably Adam Smith. Piero Sraffa, in his introduction to the first volume of the "Collected Works of David Ricardo", referred to Adam Smith's adding up theory. Smith contrasted natural prices with market price. Smith theorized that market prices would tend towards natural prices, where outputs would be at what he characterized as the "level of effectual demand". At this level, Smith's natural prices of commodities are the sum of the natural rates of wages, profits, and rent that must be paid for inputs into production. (Smith is ambiguous about whether rent is price-determining or price determined. The latter view is the consensus of later classical economists, with the Ricardo-Malthus-West theory of rent.)

David Ricardo mixed such cost of production theory of prices with the labor theory of value, as that latter theory was understood by Eugen von Bohm-Bawerk and others. This is the theory that prices tend toward proportionality to the socially necessary labor embodied in a commodity. Ricardo sets this theory at the start of the first chapter of his "Principles of Political Economy and Taxation". Ricardo also refutes the labor theory of value in later sections of that chapter. This refutation leads to what later became known as the transformation problem. Karl Marx later takes up that theory in the first volume of "Capital", while indicating that he is quite aware that the theory is untrue at lower levels of abstraction. This has led to all sorts of arguments over what both David Ricardo and Karl Marx "really meant". Nevertheless, it seems

undeniable that all the major classical economics and Marx explicitly rejected the labor theory of price .

A somewhat different theory of cost-determined prices is provided by the "neo-Ricardian school" of Piero Sraffa and his followers.

The Polish economist Michał Kalecki distinguished between sectors with "cost-determined prices" (such as manufacturing and services) and those with "demand-determined prices" (such as agriculture and raw material extraction).

One might think of this theory as equivalent to modern theories of markup-pricing, full-cost pricing, or administrative pricing. Ever since Hall and Hitch, economists[citation needed] have found that the evidence gathered in surveys of businessmen support such theories.

Most contemporary economists accept neoclassical economics or mainstream economics. The non-substitution theorem is presented in graduate level microeconomics textbooks as a theorem of mainstream economics. Also many mainstream economists think they can justify theories of full-cost pricing within their theory. The majority of mainstream economists would probably then accept this theory as an element in their theory which does not give adequate attention to issues of consumer demand and marginal utility.

Market price

Market price is an economic concept with commonplace familiarity; it is the price that a good or service is offered at, or will fetch, in the marketplace; it is of interest mainly in the study of microeconomics. Market value and market price are equal only under conditions of market efficiency, equilibrium, and rational expectations.

In economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases. They are different terms and are not to be used interchangeably.

Market priceMarket price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics. Market value and market price are equal only under conditions of market efficiency, equilibrium, and rational expectations.

Measure of value

In classical economics, market pricing is primarily determined by the interaction of supply and demand. Price is interrelated with both of these measures of value. The relationship between price and supply is generally negative, meaning that the higher the price climbs, the lower amount of the supply is demanded. Conversely, the lower the price, the greater the supply is demanded. Market price is just one of the number of ways to establish the monetary value of a good or a transaction. Shifts due to changing consumer preferences will inherently influence market price.

Other measures of value include historical cost, the resource cost of the good or service, an appraised value (such as the discounted present value), economic value and intrinsic value.

Labor theory of value

The labor theories of value (LTV) are theories in economics according to which the true values of commodities are related to the labor needed to produce them.

There are many different accounts of labor value, with the common element that the "value" of an exchangeable good or service is, or ought to be, or tends to be, or can be considered as, equal or proportional to the amount of labor required to produce it (including the labor required to produce the raw materials and machinery used in production).

Different labor theories of value prevailed amongst classical economists through to the mid-19th century. It is especially associated with Adam Smith and David Ricardo. Since that time it is most often associated with Marxian economics; while among modern mainstream economists it is considered to be superseded by the marginal utility approach.

Labor theory of value

Supply and demand curves in terms of labor values

The labor theories of value (LTV) are economic theories of value according to which the values of commodities are related to the labor needed to produce them.

Various labor theories of value prevailed amongst classical economists, including Adam Smith and David Ricardo, culminating with the socialist theories of Karl Marx. Since then, the concept is most often associated with Marxian economics, while modern mainstream economics replaces it by the marginal utility approach.

Definitions of value and labor

When speaking in terms of a labor theory of value, value without any qualifying adjective should theoretically refer to the amount of labor "embodied" in a commodity. As explained by Adam Smith:

The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people.(Wealth of Nations Book 1, chapter V)

However even a person drinking water from a good stream at his doorstep must "spend" labor to gain this value, at least if this action is relevant to economics.

In terms of modern orthodox terminology it is important to note that "labor", at least in Smith's approach, is defined as the opposite of utility - "disutility", pain, toil etc. Labor which is pleasant in itself is only therefore partly labor, or perhaps not labor at all (however, see opportunity cost). Labor which is highly skilled on the other hand owes part of its produce to an "investment" made in training and is almost like capital (hence the modern concept of human capital). So many types of pleasant labor can be described as a result of an earlier and more painful investment.

In the example of a person going to a stream at his doorstep, if this is a pleasant activity, it is not labor. If it is not pleasant it could be relevant to economics because, for example, the house could be built closer to the stream, plumbing could be installed, a person could be employed to fetch water, or investment in a better path to the water might be worth considering.

But the above way of defining value is not the only one.

Value "in use" is the usefulness of this commodity, its utility. There is a classical paradox which is often expressed when considering this type of value. Here, once again in the words of Adam Smith:

The word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called 'value in use ;' the other, 'value in exchange.' The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it. (Wealth of Nations Book 1, chapter IV)

Value "in exchange" is the relative proportion with which this commodity exchanges for another commodity (in other words, its price in the case of money). It is relative to labor as explained by Adam Smith:

The value of any commodity, ... to the person who possesses 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 it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities (Wealth of Nations Book 1, chapter V; emphasis added).

Value (without qualification) as an intrinsic worth which stands without the process of exchange.

Marx defined the value of the commodity by the third definition. In his terms, value is the 'socially necessary abstract labor' embodied in a commodity. In Ricardo and other classical

economists, this definition serves as a measure of "real cost", "absolute value", or a "measure of value" invariable under changes in distribution and technology.

Ricardo, other classical economists, and Marx began their expositions with the assumption that value in exchange was equal to or proportional to this labor value. They thought this was a good assumption from which to explore the dynamics of development in capitalist societies.

Other supporters of the labor theory of value used the word "value" in the second sense, to represent "exchange value".

Conceptual model

A simple model illustrating the concepts and workings of LTV could go as follows:

In a village in Somewhereia, everyone shares a set of skills and their produce is derived from local natural resources. Through custom or inclination each person pursues a particular trade, but is capable of pursuing any other in the village. These people exchange their products on a regular basis. Each would know how long it took their fellow to produce their good, and how long it would take them to make it themself. They would also know how much of their own product they would produce in the same amount of time and how much they would be able to exchange for that product. If anyone tried to overcharge for a good, people would stop buying and make it themselves (or a competitor could enter the market and undercut them). Each person would thus be able to calculate whether it would be better for them to buy a good or make it themselves. In this scenario prices and values would be equal.

LTV and the labor process

Since the term value is understood in the LTV as denoting something created by labor, and its "magnitude" as something proportional to the quantity of labor performed, it is important to explain how the labor process both preserves value and adds new value in the commodities it creates. The value of a commodity increases in proportion to the duration and intensity of labor performed on average for its production. Part of what the LTV means by "socially necessary" is that the value only increases in proportion to this labor as it's performed with average skill and average productivity. So though workers may labor with greater skill or more productivity than others, these more skillful and more productive workers will thus produce more value through the production of greater quantities of the finished commodity: each unit still bearing the same value as all the others of the same class of commodity. By working sloppily, the unskilled workers may drag down the average skill of labor, thus increasing the average labor time

necessary for the production of each unit commodity. But these unskillful workers cannot hope to sell the result of their labor process at a higher price (as opposed to value) simply because they have spent more time than other workers producing the same kind of commodities.

However, production not only involves labor, but also certain means of labor: tools, materials, power plants and so on. These means of labor — also known as means of production — are often the product of another labor process as well. So the labor process inevitably involves these means of production that already enter the process with a certain amount of value. Labor also requires other means of production that are not produced with labor and therefore bear no value: such as sunlight, air, uncultivated land, un-extracted minerals, etc. While useful, even crucial to the production process, these bring no value to that process. In terms of means of production resulting from another labor process, LTV treats the magnitude of value of these produced means of production as constant throughout the labor process. Due to the constancy of their value, these means of production are referred to, in this light, as constant capital.

Consider for example workers who take coffee beans, use a roaster to roast them, and then use a brewer to brew and dispense a fresh cup of coffee. In performing this labor, these workers add value to the coffee beans and water that comprise the material ingredients of a cup of coffee. The worker also transfers the value of constant capital — the value of the beans; some specific depreciated value of the roaster and the brewer; and the value of the cup — to the value of the final cup of coffee. Again, on average the worker can transfer no more than the value of these means of labor previously possessed to the finished cup of coffee. So the value of coffee produced in a day equals the sum of both the value of the means of labor — this constant capital — and the value newly added by the worker in proportion to the duration and intensity of their work. Often this is expressed mathematically as:

c + L = W,where

c is the constant capital of materials used in a period plus the depreciated portion of tools and plant used in the process. (a period is typically a day, week year or a single turnover: meaning the time required to complete one batch of coffee, for example)

L is the quantity of labor time (average skill and productivity) performed in producing the finished commodities during the period

W is the value of the product of the period (w comes from the German word for value: wert)

Note: if the product resulting from the labor process is homogenous (all similar in quality and traits, for example, all cups of coffee) then the value of the period’s product can be divided by the total number of items (use-values) produced to derive the unit value of each item.

where is the total items produced.

The LTV further divides the value added during the period of production, L, into two parts. The first part is the portion of the process when the workers add value equivalent to the wages they are paid. For example, if the period in question is one week and these workers collectively are paid $1,000, then the time necessary to add $1,000 to — while preserving the value of — constant capital is considered the necessary labor portion of the period (or week): denoted NL. The remaining period is considered the surplus labor portion of the week: or SL. The value used to purchase labor-power, for example the $1,000 paid in wages to these workers for the week, is called variable capital (v). This is because in contrast to the constant capital expended on means of production, variable capital can add value in the labor process. The amount it adds depends on the duration, intensity, productivity and skill of the labor-power purchased: in this sense the buyer of labor-power has purchased a commodity of variable use. Finally, the value added during the portion of the period when surplus labor is performed is called surplus value (s). From the variables defined above, we find two other common expression for the value produced during a given period as:

c + v + s = Wand c + NL + SL = W

The first form of the equation expresses the value resulting from production, focusing on the costs c + v and the surplus value appropriated in the process of production, s. The second form of the equation focuses on the value of production in terms of the valued added by the labor performed during the process NL + SL.

The relation between values and prices

One issue facing the LTV is the relationship between value quantities on one hand and prices on the other. If a commodity's value is not the same as its price, and therefore the magnitudes of each likely differ, then what is the relation between the two, if any? Various LTV schools of thought provide different answers to this question. For example, some argue that value in the sense of the amount of labor embodied in a good acts as a center of gravity for price. As counter-intuitive as this may seem to those accustomed to neoclassical price theory, some empirical evidence suggests labor values are a better predictor of empirically recorded prices than prediction by any other means.

However, most economists would say that cases where pricing is even approximately equal to the value of the labor embodied are only special cases, and not the general case. In the standard formulation, prices also normally include a level of income for "capital" and "land". These incomes are known as "profit" and "rent" respectively. (It should be kept in mind that like the terms "labor" and "value", the terms "price, "capital", "land", "profit" and "rent" here are being used in a theoretical way which will not always correspond to everyday use, even by accountants.)

In Book 1, chapter VI, Smith explains:

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.

The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction.

In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him. Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour. 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 real value of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit.

The final sentence shows us how Smith sees value of a product as relative to labor of buyer or consumer, as opposite to Marx who sees the value of a product being proportional to labor of laborer or producer. And we value things, price them, based on how much labor we can avoid or command, and we can command labor not only in a simple way but also by trading things for a profit.

The demonstration of the relation between commodities' unit values and their respective prices is known in Marxian terminology as the transformation problem or the transformation of values into prices of production. The transformation problem has probably generated the greatest bulk of debate about the LTV. The problem with transformation is to find an algorithm where the magnitude of value added by labor, in proportion to its duration and intensity, is sufficiently accounted for after this value is distributed through prices that reflect an equal rate of return on capital advanced. If there is an additional magnitude of value or a loss of value after transformation compared with before then the relation between values (proportional to labor) and prices (proportional to total capital advanced) is incomplete. Various solutions and impossibility theorems have been offered for the transformation, but the debate has not reached any clear resolution.

LTV does not deny the role of supply and demand influencing price since the price of a commodity is something other than its value. In Value, Price and Profit (1865), Karl Marx quotes Adam Smith and sums up:

It suffices to say that if supply and demand equilibrate each other, the market prices of commodities will correspond with their natural prices, that is to say, with their values as determined by the respective quantities of labor required for their production.

It is the level of this equilibrium which the LTV seeks to explain. This could be explained by a "cost of production" argument, pointing out that all costs are ultimately labor costs, but this does not account for profit, and it is vulnerable to the charge of tautology in that it explains prices by prices. Marx later called this "Smith's adding up theory of value".

Smith argues that labor values are the natural measure of exchange for direct producers like hunters and fishermen. Marx, on the other hand, uses a measurement analogy, arguing that for commodities to be comparable they must have a common element or substance by which to measure them, and that labor is a common substance of what Marx eventually calls commodity-values.

The theory's development

The birth of the LTV

Early insights in the labor theory of value appear in Aristotle´s Politics . He deveoped a "theory of the value of labor", holding that the value of labor skills is given by the goods they command in the market. He maintained that value is not created solely by the expenditure of labor in the production process, but also the utility and labor skills are pertinent to the determination of exchange values and exchange ratios.

Scholastic philosophers like St. Thomas Aquinas, based on Aristotle´s theories, produced early labour values theories. Some writers(including Bertrand Russell and Karl Marx) think the labor theory of value can be traced back to him. In his Summa Theologiae, he expresses that "... value can, does and should be increase in relation to the amount of labor which has been expended in the improvement of commodities".

Benjamin Franklin in his 1729 essay entitled "A Modest Enquiry into the Nature and Necessity of a Paper Currency" is sometimes credited (including by Karl Marx) with originating the concept in its modern form. However, the theory has been traced back to Treatise of Taxes, written in 1662 by Sir William Petty [19] and to John Locke's notion, set out in the Second Treatise on Government (1689), that property derives from labor through the act of "mixing" one's labor with items in the common store of goods, though this has alternatively been seen as a labor theory of property.

Scottish economist Adam Smith accepted the LTV for pre-capitalist societies but saw a flaw in its application to capitalism. He pointed out that if the "labor embodied" in a product equalled the "labor commanded" (i.e. the amount of labor that could be purchased by selling it), then profit was impossible. David Ricardo (seconded by Marx) responded to this paradox by arguing that Smith had confused labor with wages. "Labor commanded", he argued, would always be more than the labor needed to sustain itself (wages). The value of labor, in this view, covered not just the value of wages (what Marx called the value of labor power), but the value of the entire product created by labor. Ricardo's theory was a predecessor of the modern theory that equilibrium prices are determined solely by production costs associated with "neo-Ricardianism".

Based on the discrepancy between the wages of labor and the value of the product, the "Ricardian socialists" — Charles Hall, Thomas Hodgskin, John Gray, and John Francis Bray — applied Ricardo's theory to develop theories of exploitation.

Marx expanded on these ideas, arguing that workers work for a part of each day adding the value required to cover their wages, while the remainder of their labor is performed for the enrichment of the capitalist. The LTV and the accompanying theory of exploitation became central to his economic thought.

19th century American individualist anarchists based their economics on the LTV, with their particular interpretation of it being called "Cost the limit of price". They, as well as contemporary individualist anarchists in that tradition, hold that it is unethical to charge a higher price for a commodity than the amount of labor required to produce it. Hence, they propose that trade should be facilitated by using notes backed by labor.

Adam Smith and David Ricardo

Adam Smith held that, in a primitive society, the amount of labor put into producing a good determined its exchange value, with exchange value meaning in this case the amount of labor a good can purchase. However, according to Smith, in a more advanced society the market price is no longer proportional to labor cost since the value of the good now includes compensation for the owner of the means of production: "The whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him." "Nevertheless, the 'real value' of such a commodity produced in advanced society is measured by the labor which that commodity will command in exchange....But [Smith] disowns what is naturally thought of as the genuine classical labor theory of value, that labor-cost regulates market-value. This theory was Ricardo’s, and really his alone." Classical economist David Ricardo's labor theory of value holds that the value of a good (how much of another good or service it exchanges for in the market) is proportional to how much labor was required to produce it, including the labor required to produce the raw materials and machinery used in the process. David Ricardo stated it as, "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, and not as the greater or less compensation which

is paid for that labour" (Ricardo 1817). In this heading Ricardo seeks to differentiate the quantity of labor necessary to produce a commodity from the wages paid to the laborers for its production. However, Ricardo was troubled with some deviations in prices from proportionality with the labor required to produce them. For example, he said "I cannot get over the difficulty of the wine which is kept in the cellar for three or four years [i.e., while constantly increasing in exchange value], or that of the oak tree, which perhaps originally had not 2 s. expended on it in the way of labour, and yet comes to be worth £100."(Quoted in Whitaker) Of course, a capitalist economy will stabilize this discrepancy until the value added to aged wine is equal to the cost of storage - if anyone can hold onto a bottle for four years and become rich, that will be done so much it is hard to find freshly-corked wine. There is also the theory that adding to the price of a luxury product increases its exchange-value by mere prestige.

The labor theory as an explanation for value contrasts with the subjective theory of value, which says that value of a good is not determined by how much labor was put into it but by its usefulness in satisfying a want and its scarcity. Ricardo's labor theory of value is not a normative theory, as are some later forms of the labor theory, such as claims that it is immoral for an individual to be paid less for his labor than the total revenue that comes from the sales of all the goods he produces.

It must be noted that it is arguable to what extent these classical theorists held the labor theory of value as it is commonly defined.[24][25][26][27] For instance, David Ricardo theorized that prices are determined by the amount of labor but found exceptions for which the labor theory could not account. In a letter, he wrote: "I am not satisfied with the explanation I have given of the principles which regulate value." Adam Smith theorized that the labor theory of value holds true only in the "early and rude state of society" but not in a modern economy where owners of capital are compensated by profit. As a result, "Smith ends up making little use of a labor theory of value."

Marx's contribution

Contrary to popular belief, Marx does not base his LTV on what he dismisses as "ascribing a supernatural creative power to labor", arguing in the Critique of the Gotha Program that:

Labor is not the source of all wealth. Nature is just as much a source of use values (and it is surely of such that material wealth consists!) as labor which is itself only the manifestation of a force of nature, human labor power.

Here Marx is drawing a distinction between exchange value (which is the subject of the LTV) and use value.

Marx uses the concept of "socially necessary abstract labor-time" to introduce a social perspective distinct from his predecessors and neoclassical economics. Whereas most

economists start with the individual's perspective, Marx starts with the perspective of society as a whole. "Social production" involves a complicated and interconnected division of labor of a wide variety of people who depend on each other for their survival and prosperity.

"Abstract" labor refers to a characteristic of commodity-producing labor that is shared by all different kinds of heterogeneous (concrete) types of labor. That is, the concept abstracts from the particular characteristics of all of the labor and is akin to average labor.

"Socially necessary" labor refers to the quantity required to produce a commodity "in a given state of society, under certain social average conditions or production, with a given social average intensity, and average skill of the labour employed." That is, the value of a product is determined more by societal standards than by individual conditions. This explains why technological breakthroughs lower the price of commodities and put less advanced producers out of business. Finally, it is not labor per se, which creates value, but labor power sold by free wage workers to capitalists. Another distinction to be made is that between productive and unproductive labor. Only wage workers of productive sectors of the economy produce value.

Exploitation

"The worker becomes all the poorer the more wealth he produces, the more his production increases in power and range. The worker becomes an ever cheaper commodity the more commodities he creates. With the increasing value of the world of things proceeds in direct proportion to the devaluation of the world of men. Labor produces not only commodities; it produces itself and the worker as a commodity -- and does so in the proportion in which it produces commodities generally."— Karl Marx, Economic and Philosophic Manuscripts, 1844

Marx uses his LTV to derive his theory of exploitation under capitalism.

Unlike Ricardo or the Ricardian socialists, Marx distinguishes between labor power and labor. "Labor-power" is the potential or ability of workers to work, given their muscles, brains, skills, and capacities. It is the promise of creating value possessed by human labor that has not yet been expended. "Labor" is the actual activity of producing value. The profit or surplus-value arises when workers do more labor than is necessary to pay the cost of hiring their labor-power.

To explain the normality of exploitation, Marx describes Capitalism as having an institutional framework in which a small minority (the capitalists) oligopolize the means of production. The workers cannot survive except by working for capitalists, and the state preserves this inequality of power. In normal role of force is structural, part of the usual workings of the system. The reserve army of unemployed workers continually threatens employed workers, pushing them to work hard to produce for the capitalists.

Modern criticisms

Criticisms of the labor theory of value emerge primarily from marginalist economics. Marginalism contends that discussions of value as such are irrelevant, and all effort should be placed on the consideration of price problems. Böhm-Bawerk’s criticism goes to the cyclical nature of production, and the embodiment of more than immediate labor in produced commodities, and, that profit arises from risk. Methodological individualists argue against generalized systems, and look to a general theory of equilibrium (of price) to replace theories of social construction of values.

Taxes and subsidies

A supply and demand diagram illustrating taxes' effect on prices.Taxes and subsidies change the price of goods and services. A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain equal, this will increase the price paid by the consumers (which is equal to the new market price), and decrease the price received by the sellers. Marginal subsidies on production will shift the supply curve to the right until the vertical distance between the two supply curves is equal to the per unit subsidy; when other things remain equal, this will decrease price paid by the consumers (which is equal to the new market price) and increase the price received by the producers.

Effect of taxes and subsidies on priceTaxes and subsidies change the price of goods and, as a result, the quantity consumed.

Tax impact

A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain

equal, this will increase the price paid by the consumers (which is equal to the new market price), and decrease the price received by the sellers. Alternatively, a marginal tax on consumption will shift the demand curve to the left; when other things remain equal, this will increase the price paid by consumers and decrease the price received by sellers by the same amount as if the tax had been imposed on the sellers, although in this case, the price received by the sellers would be the new market price. The end result is that no matter who is taxed, the price sellers receive will decrease and the price consumers pay will increase.

Subsidy impact

Marginal subsidies on production will shift the supply curve to the right until the vertical distance between the two supply curves is equal to the per unit subsidy; when other things remain equal, this will decrease price paid by the consumers (which is equal to the new market price) and increase the price received by the producers. Alternatively, a marginal subsidy on consumption will shift the demand curve to the right; when other things remain equal, this will decrease the price paid by consumers and increase the price received by producers by the same amount as if the subsidy had been imposed on the producers, although in this case, the new market price will be the price received by producers. The end result, again, is that no matter who is subsidized, the prices producers and consumers face will be the same.

Effect of elasticity

Depending on the price elasticities of demand and supply, who bears more of the tax or who receives more of the subsidy may differ. Where the supply curve is more inelastic than the demand curve, producers bear more of the tax and receive more of the subsidy than consumers as the difference between the price producers receive and the initial market price is greater than the difference borne by consumers. Where the demand curve is more inelastic than the supply curve, the consumers bear more of the tax and receive more of the subsidy as the difference between the price consumers pay and the initial market price is greater than the difference borne by producers.

An illustration

The effect of this type of tax can be illustrated on a standard supply and demand diagram. Without a tax, the equilibrium price will be at Pe and the equilibrium quantity will be at Qe.

After a tax is imposed, the price consumers pay will shift to Pc and the price producers receive will shift to Pp. The consumers' price will be equal to the producers' price plus the cost of the tax. Since consumers will buy less at the higher consumer price (Pc) and producers will sell less at a lower producer price (Pp), the quantity sold will fall from Qe to Qt.

Effect on investment

Taxes and subsidies also have effects on investments and share prices. Taxes embedded within supply costs (e.g. tax on labor costs) will reduce the amount of capital that can be purchased with $1 of investment, whereas a subsidy will have the opposite effect, allowing $1 of investment to purchase more capital. Embedded taxes in supply prices are bad for business because it means that they have to borrow more money to finance a project with a given expected amount of return, while the opposite is true when supply prices are reduced through subsidies (or through a competitive market).

Economic equilibrium

Price of market balance: P - price Q - quantity of good

S - supply

D - demand

P0 - price of market balance

A - surplus of demand - when P<P0

B - surplus of supply - when P>P0

In economics, economic equilibrium is simply a state of the world where economic forces are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal. Market equilibrium, for example, refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. This price is often called the equilibrium price or market clearing price and will tend not to change unless demand or supply change.

Properties of equilibrium

When the price is above the equilibrium point there is a surplus of supply; where the price is below the equilibrium point there is a shortage in supply. Different supply curves and different demand curves have different points of economic equilibrium. In most simple microeconomic stories of supply and demand in a market a static equilibrium is observed in a market; however, economic equilibrium can exist in non-market relationships and can be dynamic. Equilibrium may also be multi-market or general, as opposed to the partial equilibrium of a single market.

In economics, the term equilibrium is used to suggest a state of "balance" between supply forces and demand forces. For example, an increase in supply will disrupt the equilibrium, leading to lower prices. Eventually, a new equilibrium will be attained in most markets. Then, there will be no change in price or the amount of output bought and sold — until there is an exogenous shift in supply or demand (such as changes in technology or tastes). That is, there are no endogenous forces leading to the price or the quantity.

Not all economic equilibria are stable. For an equilibrium to be stable, a small deviation from equilibrium leads to economic forces that returns an economic sub-system toward the original equilibrium. For example, if a movement out of supply/demand equilibrium leads to an excess supply (glut) that induces price declines which return the market to a situation where the

quantity demanded equals the quantity supplied. If supply and demand curves intersect more than once, then both stable and unstable equilibria are found.

Most economists e.g., (Samuelson 1947, Chapter 3, p. 52) caution against attaching a normative meaning (value judgement) to the equilibrium price. For example, food markets may be in equilibrium at the same time that people are starving (because they cannot afford to pay the high equilibrium price). Indeed, this occurred during the Great Famine in Ireland in 1845–52, where food was exported though people were starving, due to the greater profits in selling to the English – the equilibrium price of the Irish-British market for potatoes was above the price that Irish farmers could afford, and thus (among other reasons) they starved.

Interpretations

In most interpretations, classical economists such as Adam Smith maintained that the free market would tend towards economic equilibrium through the price mechanism. That is, any excess supply (market surplus or glut) would lead to price cuts, which decrease the quantity supplied (by reducing the incentive to produce and sell the product) and increase the quantity demanded (by offering consumers bargains), automatically abolishing the glut. Similarly, in an unfettered market, any excess demand (or shortage) would lead to price increases, reducing the quantity demanded (as customers are priced out of the market) and increasing in the quantity supplied (as the incentive to produce and sell a product rises). As before, the disequilibrium (here, the shortage) disappears. This automatic abolition of non-market-clearing situations distinguishes markets from central planning schemes, which often have a difficult time getting prices right and suffer from persistent shortages of goods and services.

This view came under attack from at least two viewpoints. Modern mainstream economics points to cases where equilibrium does not correspond to market clearing (but instead to unemployment), as with the efficiency wage hypothesis in labor economics. In some ways parallel is the phenomenon of credit rationing, in which banks hold interest rates low to create an excess demand for loans, so they can pick and choose whom to lend to. Further, economic equilibrium can correspond with monopoly, where the monopolistic firm maintains an artificial shortage to prop up prices and to maximize profits. Finally, Keynesian macroeconomics points to underemployment equilibrium, where a surplus of labor (i.e., cyclical unemployment) co-exists for a long time with a shortage of aggregate demand.

On the other hand, the Austrian School and Joseph Schumpeter maintained that in the short term equilibrium is never attained as everyone was always trying to take advantage of the pricing system and so there was always some dynamism in the system. The free market's strength was not creating a static or a general equilibrium but instead in organising resources to meet individual desires and discovering the best methods to carry the economy forward.

Solving for equilibrium price

To solve for the equilibrium price, one must either plot the supply and demand curves, or solve for their equations being equal.

An example may be:

In the diagram, depicting simple set of supply and demand curves, the quantity demanded and supplied at price P are equal.

At any price above P supply exceeds demand, while at a price below P the quantity demanded exceeds that supplied. In other words, prices where demand and supply are out of balance are termed points of disequilibrium, creating shortages and oversupply. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market.

Consider the following demand and supply schedule:

Price ($) Demand Supply8.00 6,000 18,0007.00 8,000 16,0006.00 10,000 14,0005.00 12,000 12,0004.00 14,000 10,0003.00 16,000 8,0002.00 18,000 6,0001.00 20,000 4,000 The equilibrium price in the market is $5.00 where demand and supply are equal at

12,000 units

If the current market price was $3.00 – there would be excess demand for 8,000 units, creating a shortage.

If the current market price was $8.00 – there would be excess supply of 12,000 units.

When there is a shortage in the market we see that, to correct this disequilibrium, the price of the good will be increased back to a price of $5.00, thus lessening the quantity demanded and increasing the quantity supplied thus that the market is in balance.

When there is an oversupply of a good, such as when price is above $6.00, then we see that producers will decrease the price to increase the quantity demanded for the good, thus eliminating the excess and taking the market back to equilibrium.

Influences changing price

A change in equilibrium price may occur through a change in either the supply or demand schedules. For instance, an increase in demand through an increase level of disposable income may produce a new demand and supply schedule, such as the following:

Price ($) Demand Supply8.00 10,000 18,0007.00 12,000 16,0006.00 14,000 14,0005.00 16,000 12,0004.00 18,000 10,0003.00 20,000 8,0002.00 22,000 6,0001.00 24,000 4,000

Here we see that an increase in disposable income would increase the quantity demanded of the good by 4,000 units at each price. This has the effect of changing the price at which quantity supplied equals quantity demanded. In this case we see that the two equal each other at an increased price of $6.00. This increase in demand would have the effect of shifting the demand curve rightward. Note that a decrease in disposable income would have the exact opposite effect on the equilibrium market.

We will also see similar behaviour in price when there is a change in the supply schedule, occurring through technological changes, or through changes in business costs. An increase in technology or decrease in costs would have the effect of increasing the quantity supplied at each price, thus reducing the equilibrium price. On the other hand, a decrease in technology or increase in business costs will decrease the quantity supplied at each price, thus increasing equilibrium price.

Supply and demand

The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price (demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity.

The graphical representation of supply and demand

The supply-demand model is a partial equilibrium model representing the determination of the price of a particular good and the quantity of that good which is traded. Although it is normal to regard the quantity demanded and the quantity supplied as functions of the price of the good, the standard graphical representation, usually attributed to Alfred Marshall, has price on the vertical axis and quantity on the horizontal axis, the opposite of the standard convention for the representation of a mathematical function.

Determinants of supply and demand other than the price of the good in question, such as consumers' income, input prices and so on, are not explicitly represented in the supply-demand diagram. Changes in the values of these variables are represented by shifts in the supply and demand curves. By contrast, responses to changes in the price of the good are represented as movements along unchanged supply and demand curves.

Supply schedule

The supply schedule, depicted graphically as the supply curve, represents the amount of some good that producers are willing and able to sell at various prices, assuming ceteris paribus, that is, assuming all determinants of supply other than the price of the good in question, such as technology and the prices of factors of production, remain the same.

Under the assumption of perfect competition, supply is determined by marginal cost. Firms will produce additional output as long as the cost of producing an extra unit of output is less than the price they will receive.

By its very nature, conceptualizing a supply curve requires that the firm be a perfect competitor—that is, that the firm has no influence over the market price. This is because each point on the supply curve is the answer to the question "If this firm is faced with this potential price, how much output will it sell?" If a firm has market power, so its decision of how much output to provide to the market influences the market price, then the firm is not "faced with" any price, and the question is meaningless.

Economists distinguish between the supply curve of an individual firm and the market supply curve. The market supply curve is obtained by summing the quantities supplied by all suppliers at each potential price. Thus in the graph of the supply curve, individual firms' supply curves are added horizontally to obtain the market supply curve.

Economists also distinguish the short-run market supply curve from the long-run market supply curve. In this context, two things are assumed constant by definition of the short run: the availability of one or more fixed inputs (typically physical capital), and the number of firms in

the industry. In the long run, firms have a chance to adjust their holdings of physical capital, enabling them to better adjust their quantity supplied at any given price. Furthermore, in the long run potential competitors can enter or exit the industry in response to market conditions. For both of these reasons, long-run market supply curves are flatter than their short-run counterparts.

Demand schedule

The demand schedule, depicted graphically as the demand curve, represents the amount of some good that buyers are willing and able to purchase at various prices, assuming all determinants of demand other than the price of the good in question, such as income, personal tastes, the price of substitute goods, and the price of complementary goods, remain the same. Following the law of demand, the demand curve is almost always represented as downward-sloping, meaning that as price decreases, consumers will buy more of the good.

Just as the supply curves reflect marginal cost curves, demand curves are determined by marginal utility curves. Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices. The demand schedule is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time.

As described above, the demand curve is generally downward-sloping. There may be rare examples of goods that have upward-sloping demand curves. Two different hypothetical types of goods with upward-sloping demand curves are Giffen goods (an inferior but staple good) and Veblen goods (goods made more fashionable by a higher price).

By its very nature, conceptualizing a demand curve requires that the purchaser be a perfect competitor—that is, that the purchaser has no influence over the market price. This is because each point on the demand curve is the answer to the question "If this buyer is faced with this potential price, how much of the product will it purchase?" If a buyer has market power, so its decision of how much to buy influences the market price, then the buyer is not "faced with" any price, and the question is meaningless.

As with supply curves, economists distinguish between the demand curve of an individual and the market demand curve. The market demand curve is obtained by summing the quantities demanded by all consumers at each potential price. Thus in the graph of the demand curve, individuals' demand curves are added horizontally to obtain the market demand curve.

Micro Economics

Equilibrium

Equilibrium is defined to the price-quantity pair where the quantity demanded is equal to the quantity supplied, represented by the intersection of the demand and supply curves.

Changes in market equilibrium

Practical uses of supply and demand analysis often center on the different variables that change equilibrium price and quantity, represented as shifts in the respective curves. Comparative statics of such a shift traces the effects from the initial equilibrium to the new equilibrium.

Demand curve shifts

An outward (rightward) shift in demand increases both equilibrium price and quantity

When consumers increase the quantity demanded at a given price, it is referred to as an increase in demand. Increased demand can be represented on the graph as the curve being shifted to the right. At each price point, a greater quantity is demanded, as from the initial curve D1 to the new curve D2. In the diagram, this raises the equilibrium price from P1 to the higher P2. This raises the equilibrium quantity from Q1 to the higher Q2. A movement along the curve is described as a "change in the quantity demanded" to distinguish it from a "change in demand," that is, a shift of the curve. In the example above, there has been an increase in demand which has caused an increase in (equilibrium) quantity. The increase in demand could also come from changing tastes and fashions, incomes, price changes in complementary and substitute goods, market expectations, and number of buyers. This would cause the entire demand curve to shift changing the equilibrium price and quantity. Note in the diagram that the shift of the demand curve, by causing a new equilibrium price to emerge, resulted in movement along the supply curve from the point (Q1, P1) to the point Q2, P2).

If the demand decreases, then the opposite happens: a shift of the curve to the left. If the demand starts at D2, and decreases to D1, the equilibrium price will decrease, and the equilibrium quantity will also decrease. The quantity supplied at each price is the same as before the demand shift, reflecting the fact that the supply curve has not shifted; but the equilibrium quantity and price are different as a result of the change (shift) in demand.

Supply curve shifts

An outward (rightward) shift in supply reduces the equilibrium price but increases the equilibrium quantity

When the suppliers' unit input costs change, or when technological progress occurs, the supply curve shifts. For example, assume that someone invents a better way of growing wheat so that the cost of growing a given quantity of wheat decreases. Otherwise stated, producers will be willing to supply more wheat at every price and this shifts the supply curve S1 outward, to S2—an increase in supply. This increase in supply causes the equilibrium price to decrease from P1 to P2. The equilibrium quantity increases from Q1 to Q2 as consumers move along the demand curve to the new lower price. As a result of a supply curve shift, the price and the quantity move in opposite directions.

If the quantity supplied decreases, the opposite happens. If the supply curve starts at S2, and shifts leftward to S1, the equilibrium price will increase and the equilibrium quantity will decrease as consumers move along the demand curve to the new higher price and associated lower quantity demanded. The quantity demanded at each price is the same as before the supply shift, reflecting the fact that the demand curve has not shifted. But due to the change (shift) in supply, the equilibrium quantity and price have changed.

Elasticity

Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how strongly the quantities suppled and demanded respond to various factors, including price and other determinants. One way to define elasticity is the percentage change in one variable (the quantity supplied or demanded) divided by the percentage change in the causative variable. For discrete changes this is known as arc elasticity, which calculates the elasticity over a range of values. In contrast, point elasticity uses differential calculus to determine the elasticity at a specific point. Elasticity is a measure of relative changes.

Often, it is useful to know how strongly the quantity demanded or supplied will change when the price changes. This is known as the price elasticity of demand or the price elasticity of supply. If a monopolist decides to increase the price of its product, how will this affect the amount of their good that customers purchase? This knowledge helps the firm determine whether the increased unit price will offset the decrease in sales volume. Likewise, if a government imposes a tax on a good, thereby increasing the effective price, knowledge of the price elasticity will help us to predict the size of the resulting effect on the quantity demanded.

Elasticity is calculated as the percentage change in quantity divided by the associated percentage change in price. For example, if the price moves from $1.00 to $1.05, and as a result the quantity supplied goes from 100 pens to 102 pens, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2%/5% or 0.4.

Since the changes are in percentages, changing the unit of measurement or the currency will not affect the elasticity. If the quantity demanded or supplied changes by a greater percentage than the price did, then demand or supply is said to be elastic. If the quantity changes by a lesser percentage than the price did, demand or supply is said to be inelastic. If supply is perfectly inelastic—that is, has zero elasticity, then there is a vertical supply curve.

Short-run supply curves are not as elastic as long-run supply curves, because in the long run firms can respond to market conditions by varying their holdings of physical capital, and because in the long run new firms can enter or old firms can exit the market.

Elasticity in relation to variables other than price can also be considered. One of the most common to consider is income. How strongly would the demand for a good change if income increased or decreased? The relative percentage change is known as the income elasticity of demand.

Another elasticity sometimes considered is the cross elasticity of demand, which measures the responsiveness of the quantity demanded of a good to a change in the price of another good. This is often considered when looking at the relative changes in demand when studying complements and substitute goods. Complements are goods that are typically utilized together, where if one is consumed, usually the other is also. Substitute goods are those where one can be substituted for the other, and if the price of one good rises, one may purchase less of it and instead purchase its substitute.

Cross elasticity of demand is measured as the percentage change in demand for the first good divided by the causative percentage change in the price of the other good. For an example with a complement good, if, in response to a 10% increase in the price of fuel, the quantity of new cars demanded decreased by 20%, the cross elasticity of demand would be -2.0.

In a frictionless economy, the price and quantity in any market would be able to move to a new equilibrium position instantly, without spending any time away from equilibrium. Any change in market conditions would cause a jump from one equilibrium position to another at once. In real economic systems, markets don't always behave in this way, and markets take some time before they reach a new equilibrium position. This is due to asymmetric, or at least imperfect, information, where no one economic agent could ever be expected to know every relevant condition in every market. Ultimately both producers and consumers must rely on trial and error as well as prediction and calculation to find the true equilibrium of a market.

Vertical supply curve (perfectly inelastic supply)

When demand D1 is in effect, the price will be P1. When D2 is occurring, the price will be P2. The equilibrium quantity is always Q, and any shifts in demand will only affect price.

If the quantity supplied is fixed no matter what the price, the supply curve is a vertical line, and supply is called perfectly inelastic.

As a hypothetical example, consider the supply curve of land. No matter how much someone is willing to pay for additional parcels, more land cannot be created. Even if no one wanted any of the land, there would still be a supply of land. Therefore, land has a vertical supply curve, with zero elasticity.

Other markets

The model of supply and demand also applies to various specialty markets.

The model is commonly applied to wages, in the market for labor. The typical roles of supplier and demander are reversed. The suppliers are individuals, who try to sell their labor for the highest price. The demanders of labor are businesses, which try to buy the type of labor they need at the lowest price. The equilibrium price for a certain type of labor is the wage rate.

A number of economists (for example Pierangelo Garegnani, Robert L. Vienneau, and Arrigo Opocher & Ian Steedman), building on the work of Piero Sraffa, argue that that this model of the labor market, even given all its assumptions, is logically incoherent. Michael Anyadike-Danes and Wyne Godley argue, based on simulation results, that little of the empirical work done with the textbook model constitutes a potentially falsifying test, and, consequently, empirical evidence hardly exists for that model. Graham White argues, partially on the basis of Sraffianism, that the policy of increased labor market flexibility, including the reduction of minimum wages, does not have an "intellectually coherent" argument in economic theory.

This criticism of the application of the model of supply and demand generalizes, particularly to all markets for factors of production. It also has implications for monetary theory not drawn out here.

In both classical and Keynesian economics, the money market is analyzed as a supply-and-demand system with interest rates being the price. The money supply may be a vertical supply curve, if the central bank of a country chooses to use monetary policy to fix its value regardless of the interest rate; in this case the money supply is totally inelastic. On the other hand, the money supply curve is a horizontal line if the central bank is targeting a fixed interest rate and ignoring the value of the money supply; in this case the money supply curve is perfectly elastic. The demand for money intersects with the money supply to determine the interest rate.

Empirical estimation

Demand and supply relations in a market can be statistically estimated from price, quantity, and other data with sufficient information in the model. This can be done with simultaneous-equation methods of estimation in econometrics. Such methods allow solving for the model-relevant "structural coefficients," the estimated algebraic counterparts of the theory. The Parameter identification problem is a common issue in "structural estimation." Typically, data on exogenous variables (that is, variables other than price and quantity, both of which are

endogenous variables) are needed to perform such an estimation. An alternative to "structural estimation" is reduced-form estimation, which regresses each of the endogenous variables on the respective exogenous variables.

Macroeconomic uses of demand and supply

Demand and supply have also been generalized to explain macroeconomic variables in a market economy, including the quantity of total output and the general price level. The Aggregate Demand-Aggregate Supply model may be the most direct application of supply and demand to macroeconomics, but other macroeconomic models also use supply and demand. Compared to microeconomic uses of demand and supply, different (and more controversial) theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. Demand and supply are also used in macroeconomic theory to relate money supply and money demand to interest rates, and to relate labor supply and labor demand to wage rates.

History

The power of supply and demand was understood to some extent by several early Muslim economists, such as Ibn Taymiyyah who illustrates:

"If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down."

The phrase "supply and demand" was first used by James Denham-Steuart in his Inquiry into the Principles of Political Economy, published in 1767. Adam Smith used the phrase in his 1776 book The Wealth of Nations, and David Ricardo titled one chapter of his 1817 work Principles of Political Economy and Taxation "On the Influence of Demand and Supply on Price".

In The Wealth of Nations, Smith generally assumed that the supply price was fixed but that its "merit" (value) would decrease as its "scarcity" increased, in effect what was later called the law of demand. Ricardo, in Principles of Political Economy and Taxation, more rigorously laid down the idea of the assumptions that were used to build his ideas of supply and demand. Antoine Augustin Cournot first developed a mathematical model of supply and demand in his 1838 Researches into the Mathematical Principles of Wealth, including diagrams.

During the late 19th century the marginalist school of thought emerged. This field mainly was started by Stanley Jevons, Carl Menger, and Léon Walras. The key idea was that the price was set by the most expensive price, that is, the price at the margin. This was a substantial change from Adam Smith's thoughts on determining the supply price.

In his 1870 essay "On the Graphical Representation of Supply and Demand", Fleeming Jenkin in the course of "introduc[ing] the diagrammatic method into the English economic literature" published the first drawing of supply and demand curves therein, including comparative statics

from a shift of supply or demand and application to the labor market. The model was further developed and popularized by Alfred Marshall in the 1890 textbook Principles of Economics.

Criticism

At least two assumptions are necessary for the validity of the standard model: first, that supply and demand are independent; and second, that supply is "constrained by a fixed resource"; If these conditions do not hold, then the Marshallian model cannot be sustained. Sraffa's critique focused on the inconsistency (except in implausible circumstances) of partial equilibrium analysis and the rationale for the upward-slope of the supply curve in a market for a produced consumption good. The notability of Sraffa's critique is also demonstrated by Paul A. Samuelson's comments and engagements with it over many years, for example:

"What a cleaned-up version of Sraffa (1926) establishes is how nearly empty are all of Marshall's partial equilibrium boxes. To a logical purist of Wittgenstein and Sraffa class, the Marshallian partial equilibrium box of constant cost is even more empty than the box of increasing cost.".

Aggregate excess demand in a market is the difference between the quantity demanded and the quantity supplied as a function of price. In the model with an upward-sloping supply curve and downward-sloping demand curve, the aggregate excess demand function only intersects the axis at one point, namely, at the point where the supply and demand curves intersect. The Sonnenschein-Mantel-Debreu theorem shows that the standard model cannot be rigorously derived in general from general equilibrium theory.

The model of prices being determined by supply and demand assumes perfect competition. But:

"economists have no adequate model of how individuals and firms adjust prices in a competitive model. If all participants are price-takers by definition, then the actor who adjusts prices to eliminate excess demand is not specified".

The problem is summarized in the Ackerman text: "If we mistakenly confuse precision with accuracy, then we might be misled into thinking that an explanation expressed in precise mathematical or graphical terms is somehow more rigorous or useful than one that takes into account particulars of history, institutions or business strategy. This is not the case. Therefore, it is important not to put too much confidence in the apparent precision of supply and demand graphs. Supply and demand analysis is a useful precisely formulated conceptual tool that clever people have devised to help us gain an abstract understanding of a complex world. It does not - nor should it be expected to - give us in addition an accurate and complete description of any particular real world market."

Abstract labour and concrete labour refer to a distinction made by Karl Marx in his critique of political economy. This distinction, first advanced in Marx's A Contribution to the Critique of Political Economy (1859) is discussed in more detail in chapter 1 of Capital, where Marx writes:

"On the one hand all labour is, speaking physiologically, an expenditure of human labour power, and in its character of identical abstract human labour, it creates and forms the value of commodities. On the other hand, all labour is the expenditure of human labour power in a special form and with a definite aim, and in this, its character of concrete useful labour, it produces use values. [...] At first sight a commodity presented itself to us as a complex of two things – use value and exchange value. Later on, we saw also that labour, too, possesses the same twofold nature; for, so far as it finds expression in value, it does not possess the same characteristics that belong to it as a creator of use values. I was the first to point out and to examine critically this twofold nature of the labour contained in commodities. [...] this point is the pivot on which a clear comprehension of political economy turns"

The origin of the distinction between abstract and concrete labour can be traced back to Marx's 1857 Grundrisse manuscript, in which he already distinguished between "particular labour" and "general labour", contrasting communal production with production for exchange (see Karl Marx, Grundrisse, Pelican edition 1973, pp. 171-172).

Abstract treatment of labour-time

In order to make this distinction, it must be possible to think abstractly about human work, and consider it separately from any particular worker performing it. Only on that basis, it is possible to conceive of quantities of labour (X amount of labour hours, or Y amount of workers) and work tasks (the kinds of jobs which need to be done, or functions which must be performed, irrespective of who actually does it). As soon as we ask, "how much work is necessary to produce something?", we begin to think abstractly about human labour.

In statistical reports, for example, reference is made to "the labour force" and quantities of total hours worked are calculated. This is an abstract way of viewing human work, and the workers that perform it. Or, if we take the concept of an output/labour ratio (the ratio of the value of output and the number of hours worked or the number of workers), this is again an abstract way to view labour.

Another example is the concept of unit labour costs, i.e. the cost in labour per product unit, expressible in hours or in money-prices. In time use surveys, a statistical attempt is made to quantify and average out the different types of activities people normally spend their time on.

In official economics, workers do not exist anymore; they are just an abstract "factor of production" or a "labour input" or a "consumer". Workers enter into the analysis only in management theory. Managers of course often have to estimate the number of paid working hours that a job will take to do, hire and fire workers, and keep track of the number of paid hours worked. They have to be concerned with the "human face" of the market.

Abstract labour and exchange

Marx himself considered that all economising reduced to the economical use of human labour-time; "to economise" ultimately meant saving on human energy and effort.

"The less time the society requires to produce wheat, cattle etc., the more time it wins for other production, material or mental. Just as in the case of an individual, the multiplicity of its development, its enjoyment and its activity depends on economization of time. Economy of time, to this all economy ultimately reduces itself. Society likewise has to distribute its time in a purposeful way, in order to achieve a production adequate to its overall needs; just as the individual has to distribute his time correctly in order to achieve knowledge in proper proportions or in order to satisfy the various demands on his activity." - Karl Marx, Grundrisse, Notebook 1, October 1857

However, according to Marx, the achievement of abstract thinking about human labour, and the ability to quantify it, is closely related to the historical development of economic exchange in general, and more specifically commodity trade.

The expansion of trade requires the ability to measure and compare all kinds of things, not just length, volume and weight, but also time itself. Originally, the units of measurement used were taken from everyday life - the length of a finger or limb, the volume of an ordinary container, the weight one can carry, the duration of a day or a season, the number of cattle. Socially standardized measurement units began to be used probably from circa 3000 BC onwards in ancient Egypt and Mesopotamia, and then state authorities began to supervise the use of measures, with rules to prevent cheating. Once standard measuring units existed, mathematics could begin to develop (see e.g. Dirk Jan Struik, A concise history of mathematics, 4th revised edition, 1987).

In fact, Marx argues the abstraction of labour in thought is the reflex of a real process, in which commercial trade in products not only alters the way labour is viewed, but also how it is practically treated.

If different products are exchanged in market trade according to specific trading ratios, Marx argues, the exchange process at the same time relates, values and commensurates the quantities of human labour expended to produce those products, regardless of whether the traders are consciously aware of that (see also value-form).

Therefore, Marx argues, the exchange process itself involves the making of a real abstraction, namely abstraction from the particular characteristics of concrete (specific) labour that produced the commodities whose value is equated in trade. Closely related to this, is the growth of a cash economy, and Marx makes the historical observation that:

"In proportion as exchange bursts its local bonds, and the value of commodities more and more expands into an embodiment of human labour in the abstract, in the same proportion the

character of money attaches itself to commodities that are by Nature fitted to perform the social function of a universal equivalent. Those commodities are the precious metals."

In a more complex division of labour, it becomes difficult or even impossible to equate the value of all different labour-efforts directly. But money enables us to express and compare the value of all different labour-efforts - more or less accurately - in money-units (initially, quantities of gold, silver, or bronze). This is illustrated by the popular saying, "time is money" (after Benjamin Franklin). Marx then argues that labour viewed concretely in its specifics creates useful things, but labour-in-the-abstract is value-forming labour, which conserves, transfers and/or creates economic value (see Valorisation). Quite simply, a quantity of labour can earn, or be worth, a certain amount of money. The young Marx observed in 1844 that:

"As money is not exchanged for any one specific quality, for any one specific thing, or for any particular human essential power, but for the entire objective world of man and nature, from the standpoint of its possessor it therefore serves to exchange every quality for every other, even contradictory, quality and object: it is the fraternisation of impossibilities. It makes contradictions embrace." - Karl Marx, Economic and Philosophical Manuscripts 1844, section "The Power of Money"

Abstract labour and capitalism

If the production process itself becomes organised as a specifically capitalist production process, then the abstraction process is deepened, because production labour itself becomes directly treated and organised in terms of its commercial exchange value, and in terms of its capacity to create new value for the buyer of that labour.

Quite simply, in this case, a quantity of labour-time is equal to a quantity of money, and it can be calculated that X hours of labour - regardless of who in particular performs them - create, or are worth, Y amounts of new product value. In this way, labour is practically rendered abstract.

The abstraction is completed when a labour market is established which very exactly quantifies the money-price applying to all kinds of different occupational functions, permitting equations such as:

x amount of qualified labour = y amounts of unskilled labour = z amount of workers = p amount of money = q amount of goods.

This is what Marx calls a value relationship ("Wertverhaltnis" in German). It can also be calculated that it costs a certain amount of time and money to train a worker to perform a certain task, and how much value that adds to the workers' labour, given rise to the notion of human capital.

As a corollary, in these conditions workers will increasingly treat the paid work they do as something distinct or separate from their personality, a means to an end rather than an end in

itself. Work becomes "just work", it no longer necessarily says anything at all about the identity, creativity or personality of the worker. With the development of an average skill level in the workforce, the same job can also be done by many different workers, and most workers can do many different jobs; nobody is necessarily tied to one type of work all his life anymore. Thus we can talk of "a job" as an abstract function that could be filled by anybody with the required skills. Managers can calculate that with a certain budget, a certain number of paid working hours are required or available to do the work, and then divide up the hours into different job functions to be filled by suitably qualified personnel.

Marx's theory of alienation considers the human and social implications of the abstraction and commercialization of labour. His concept of reification reflects about the inversions of object and subject, and of means and ends, which are involved in commodity trade.

Controversies

Marx regarded the distinction between abstract and concrete labour as being among the most important innovations he contributed to the theory of economic value, and subsequently Marxian scholars have debated a great deal about its theoretical significance.

For some, abstract labour is an economic category which applies only to the capitalist mode of production, i.e. it applies only, when human labour power or work-capacity is universally treated as a commodity with a certain monetary cost or earnings potential. Thus Professor John Weeks claims that

"...only under capitalism is concrete labor in general metamorphosed into abstract labor, and only under capitalism is this necessary in order to bring about the reproduction of class relations." - John Weeks, Capital and exploitation. Princeton: Princeton University Press, 1981, p. 38).

Other Marx-scholars, such as Makoto Itoh, take a more evolutionary view. They argue that the abstract treatment of human labour-time is something that evolved and developed in the course of the whole history of trade, or even precedes it, to the extent that primitive agriculture already involves attempts to economise labour, by calculating the comparative quantities of labour-time involved in producing different kinds of outputs.

In this sense, Marx argued in his book A contribution to the Critique of Political Economy (1859) that

"This abstraction, human labour in general, exists in the form of average labour which, in a given society, the average person can perform, productive expenditure of a certain amount of human muscles, nerves, brain, etc. It is simple labour [English economists call it "unskilled labour"] which any average individual can be trained to do and which in one way or another he has to perform. The characteristics of this average labour are different in different countries and different historical epochs, but in any particular society it appears as something given."

In that case, the equation of different quantities of labour-time through economic exchange is not a necessary prerequisite for the abstract treatment of labour-time; all that is required is that different labour-efforts in society are comparable, yielding averages indicating the "normal" labour-time associated with a task. In this sense, an archaeologist comments about the Sumerian economy of ancient Mesopotamia as follows:

"For example, a balanced account of the labor provided by 37 female workers in the year 2034 BC indicates the different activities in which they were involved. Milling work took up 5,986 labor-days. The time dedicated to this task was calculated on the basis of the amounts of their finished products, that is, flour of different qualities. The source tablets for the balanced account provided the total amounts of the different types of flour milled. The time needed to produce these was calculated on the basis of standardized performance expectations. The accountant knew, for example, that 860 liters of fine flour had been produced during the year. As it was expected that one woman milled 20 liters of that type of flour in one day, it was easy to calculate that 43 labor days had been involved." - Marc van de Mieroop, "Accounting in Early Mesopotamia: some remarks", in Michael Hudson and Cornelia Wunsch, Creating Economic Order: Recordkeeping, standardization and the development of accounting in the ancient Near East. Bethesda: CDL, 2004, p. 56.

On the basis of their input, output and labor accounting, the Sumerian analysts, particularly from the Ur III period, were evidently able to estimate, in quantitatively accurate terms, how much labor it took to produce a certain quantity of output, and therefore how many workers were needed for a given interval of time. They lacked a money commodity, in the sense of a universal equivalent for exchanging goods, but nevertheless "The concept of value equivalency was a secure element in Babylonian accounting by at least the time of the sales contracts of the ED IIIa (Fara) period, c. 2600 BC." (op. cit., p. 38).

In other words, it proved possible already millennia ago to express the value of a quantity of product as a quantity of many other types of products, or a quantity of labor, according to prevailing norms of exchange based on production costs. "This formation and use of grain product equivalencies ... must be considered an important step in the direction of general value equivalencies best attested for in the Ur III period for silver, but then still generally applicable for other commodities such as grain or fish, including finally also labor time." (ibid.).

What the emergence of a cash economy then adds, is a much more refined and sophisticated quantification of amounts of society's labour-time, reckoned in money-prices - a further development of the abstraction of labour, which, however, was already occurring long before the advent of capitalist industry.

Thus, on this historical interpretation, capitalism universalizes the abstract treatment of labour-time, clearly separating paid work from other activities; through the universal use of money and clocks, all forms of labour become comparable in value, and can be economised and traded on that basis. But this economising occurs in a specific pattern: its capitalistic money-making purpose is to maximise the yield of surplus value to private owners of capital.

Another controversy concerns the differences between unskilled (simple) and skilled (qualified) labour. Skilled labour costs more to produce than unskilled labour, and can be more productive. Generally Marx assumed that - irrespective of the price for which it is sold - skilled labour power had a higher value, and that skilled work could produce a product with a higher value in the same amount of time, compared to unskilled labour. This was reflected in a skill hierarchy, and a hierarchy of wage-levels. Marx believed that the capitalist mode of production would over time replace people with machines, and encourage the easy replacement of one worker by another, and thus that most labour would tend to reduce to an average skill level and standardized norms of work effort. However he provided no specific calculus by which the value of skilled work could be expressed as a multiple of unskilled work, nor a theory of what regulates the valuation of skill differences. This has led to some theoretical debate among Marxian economists, but no definitive solution has yet been given. In the first volume of Das Kapital Marx had declared his intention to write a special study of the forms of labour-compensation, but he never did so.

Criticism

"It is not money that renders the commodities commensurable. Quite the contrary. Because all commodities, as values, are objectified human labour, and therefore in themselves commensurable, their values can be communally measured in one and the same specific commodity, and this commodity can be converted into the common measure of their values, that is into money. Money as a measure of value is the necessary form of appearance of the measure of value which is immanent in commodities, namely labour-time." - Capital Vol. 1, Penguin ed., p. 188

In other words, tradeable products do not all have a value because they can all be equated with sums of money, but because they are the products of social labour; consequently, such product-value exists quite independently of the use of money, and indeed independently of whether the products at any point in time happen to be traded or not (see also value-form). It is just that what the magnitude of that value is, can become apparent and visible only via the comparisons of trading ratios, when products are being bought and sold on a regular basis. Marx did not think there was anything particularly mysterious about the fact that people valued products because they had to spend time working to produce them, or to buy them. However, academics have made many objections to his idea.

Without referring explicitly to Marx's solution of the problems of the labour theory of value of David Ricardo, the marginal utility theorist William Stanley Jevons clearly stated the main criticism of the concept of abstract labour in his 1871 treatise:

"Labour affects supply, and supply affects the degree of utility, which governs value, or the ratio of exchange. In order that there may be no possible mistake about this all-important series of relations, I will restate it in a tabular form, as follows:

Cost of production determines supply; Supply determines final degree of utility;

Final degree of utility determines value.

But it is too easy to go too far in considering labour as the regulator of value; it is equally to be remembered that labour is itself of unequal value. Ricardo, by a violent assumption, founded his theory of value on quantities of labour considered as one uniform thing. He was aware that labour differs infinitely in quality and efficiency, so that each kind is more or less scarce, and is consequently paid at a higher or lower rate of wages. He regarded these differences as disturbing circumstances which would have to be allowed for; but his theory rests on the assumed equality of labour. [My] theory rests on a wholly different ground. I hold labour to be essentially variable, so that its value must be determined by the value of the produce, not the value of the produce by that of the labour. I hold it to be impossible to compare a priori the productive powers of a navvy, a carpenter, an iron-puddler, a school master and a barrister. Accordingly, it will be found that not one of my equations represents a comparison between one man's labour and another's." - W. Stanley Jevons, The Theory of Political Economy, edited by R.D. Collison Black. Harmondsworth: Pelican Books, 1970, p. 187.

Replying to this type of criticism, the Russian Marxist Isaak Illich Rubin argued that the concept of abstract labour was really much more complex than it seemed at first sight. He distinguished between "physically equal" labour; labour which is "socially equated" by means of consensual social evaluation or comparison; and labour efforts equated via the exchange of products using money as a universal equivalent.

To these three aspects we could add at least five others which are mentioned by Marx:

the existence of normal labour-averages applying to different work tasks, which function as "labour norms" in any society;

the gradation of many different labour efforts along one general, hierarchical dimension of worth, for the purpose of compensation;

the universal exchangeability of labour efforts themselves, in a developed labour market;

the general mobility of labour from one job or worksite to another; and

the ability of the same workers to do all kinds of different jobs.

Some further aspects of the concept of abstract labour are provided by Marxian anthropologist Lawrence Krader in his works Labor and value and A treatise of social labor.

The conceptual issues associated with the concept of abstract labour have been one of the main reasons why many economists abandoned the labour theory of value. Possibly, these conceptual issues can be resolved, through a better empirical appreciation of the political

economy of education, skills and the labour market. One problem with Marx's own theory is, that he never completed a book he intended to write on the subject of wages and the labour market (see Capital Vol. 1, Penguin edition, p. 683). Nevertheless Marx made quite clear his belief that capitalism "overturns all the legal or traditional barriers that would prevent it from buying this or that kind of labour-power as it sees fit, or from appropriating this or that kind of labour" (Ibid., p. 1013). Clearly, Marx believed that capitalist development itself would establish a normal commercial value for any kind of labour, and thus that all kinds of labour would be judged socially according to the same kind of evaluative standards of effort.

Cost the limit of priceCost the limit of price was a maxim coined by Josiah Warren, indicating a (prescriptive) version of the labor theory of value. Warren maintained that the just compensation for labor (or for its product) could only be an equivalent amount of labor (or a product embodying an equivalent amount). Thus, profit, rent, and interest were considered unjust economic arrangements. As Samuel Edward Konkin III put it, "the labor theory of value recognizes no distinction between profit and plunder. In keeping with the tradition of Adam Smith's The Wealth of Nations, the "cost" of labor is considered to be the subjective cost; i.e., the amount of suffering involved in it.

The principle was set forth in Warren's Equitable Commerce (among other writings) and has been called a "mainstay of 19th century individualist anarchism." It was further advocated and popularized by Benjamin Tucker in his individualist anarchist periodical Liberty, and in his books. Tucker explained it so:

From Smith's principle that labor is the true measure of price – or, as Warren phrased it, that cost is the proper limit of price – these three men [i.e., Josiah Warren, Pierre Proudhon, and Karl Marx] made the following deductions: that the natural wage of labor is its product; that this wage, or product, is the only just source of income (leaving out, of course, gift, inheritance, etc.); that all who derive income from any other source abstract it directly or indirectly from the natural and just wage of labor; that this abstracting process generally takes one of three forms, – interest, rent, and profit; that these three constitute the trinity of usury, and are simply different methods of levying tribute for the use of capital; that, capital being simply stored-up labor which has already received its pay in full, its use ought to be gratuitous, on the principle that labor is the only basis of price; that the lender of capital is entitled to its return intact, and nothing more; that the only reason why the banker, the stockholder, the landlord, the manufacturer, and the merchant are able to exact usury from labor lies in the fact that they are backed by legal privilege...—Benjamin Tucker , "State Socialism and Anarchism," from Individual Liberty, Vanguard Press, New York, 1926

Warren put his principle into practice in 1827 by establishing an experimental "equity store," called the Cincinnati Time Store, where trade was facilitated by notes backed by a promise to

perform labor. This scheme was exactly that advocated by Pierre Proudhon some years later under the name mutuellisme; however, it is believed that Proudhon developed his ideas independently.

If a little network of self-managing workers agreed to trade among themselves respecting the principle of "the cost the limit of price", each one of them would buy and sell their commodities at lower prices (and costs, in this network) without worsening their effective purchasing power, and by that, they could persuade other self-managing workers to join (which would further reduce prices). Such a hypothetical price-of-cost network would be compelled to develop the best science about costs ever made. W. Brian Arthur's theory of increasing returns could explain how an equitable but free trade ("price-of-cost") market may compete against the always-ruling "price-of-compromise" State capitalism exploitation system. Instead of experimental "labor notes" or similar, the use of current money for "equitable commerce" by a price-of-cost network would start to change the market itself: an open universalistic utopia instead of isolated, little, weak, elite utopias with limited synergy.

"Cost the limit of price" seems more properly to indicate a (prescriptive) labor theory of price, considering seriously the distinction among whatever meaning of "cost", whatever meaning of "price", and whatever meaning of "value". "Cost the limit of price" could understate that whatever different price resulting by whatever different method of pricing acts as an non-equitable, unjust "extortion" based upon wants (upon "needs") or even upon "urgencies" ("violence upon wants" instead of freedom from wants). The alleged different prices can be legitimately named "prices of compromise". Usually competition amends almost all of that force addiction. Léon Walras, economist and mathematician, found that in a hypothetical situation of perfect competition prices would approach costs, and profits would approach zero.

To ensure fairness within a price-of-cost network, the main advantages of membership should be under the conditions of: 1. cautious deposits; 2. allowing to their customers the complete transparency of the business; 3. previous acceptance to boycott whatever violator until reparation. "Cost the limit of price" aims to establish an equitable exchange of labor. Incomes should not include profits: one's profit is always another's exploitation of the same amount ("plusprice") by pricing. In such a "transparent price-of-cost network" whatever currency would change the real meaning itself of money, it would become a sharp tool just to measure only everybody's working time, and no more measuring somebody's extortion by prices. By the generalization of the "cost the limit of price" rule, the intrinsic "surplus" from the productivity, without having any form of profit, gets the form of purchasing power per currency unit, so that among the possible consequences are: a lesser need of money to live, deflation, speculation, distributed investment power among consumers. Money should mean not merchandization in any humiliating sense.

The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy (1847) against Pierre-Joseph Proudhon,

with reference to David Ricardo's economics. Most generally, it refers to a regulative principle of the economic exchange of the products of human work: the relative exchange-values of those products in trade, usually expressed by money-prices, are proportional to the average amounts of human labour-time which are currently socially necessary to produce them.

Thus, the exchange value of commodities (exchangeable products) is regulated by their value, where the magnitude of their value is determined by the average quantity of human labour socially necessary to produce them (labor theory of value). In Das Kapital Marx normally thinks of that quantity as the ratio between the average amount of labour required to produce a reproducible good, and the corresponding average amount of labour required to produce a unit of gold (see also gold standard). His idea is effectively that the "value" of traded products is the objectified expression of the current social valuation of the human labour implicated in producing them. How any individual happens to regard a product normally cannot change that social valuation at all; it's simply a "social fact" in the same way as "the state of the market" is a social fact, even although products can at any time trade at prices above or below their value.

While Marx used the concept of the law of value in his works Grundrisse, A contribution to the critique of political economy, Theories of Surplus Value and Das Kapital, he did not explicitly formalise its full meaning in a mathematical sense, and therefore how it should be exactly defined remains to some extent a controversial topic in Marxian economics. Different economists dispute about how the proportionality between exchange-value and labour-time should be mathematically understood or modelled, and about the measures which are relevant. Marx's analysis of value was "dialectical" in the sense that he thought value phenomena could only be understood dynamically and relationally, but he did not spell out all the conceptual, quantitative and logical implications of his position with great exactitude. The scholarly debate about those implications continues even today.

Basic definition of the concept

Excess demand can raise the exchange-values of products traded, and excess supply can lower them; but if supply and demand are relatively balanced, the question arises of what regulates the settled exchange-ratios (or average price-levels) of products traded in that case, and this is what the law of value is intended to explain. According to the law of value, the trading ratios of different types of products reflect a real cost structure of production, and this cost structure ultimately reduces to the socially average amounts of human labor-time currently required to produce different goods and services.

Simply put, if product A takes 100 hours of human work to produce in total, and product B takes 5 hours to produce, the normal trading-ratio of A and B will gravitate to a rate of around 1:20 (one of A is worth 20 of B), because A is worth much more than B. The trading ratio will never be 20:1, 1:5, 1:100, or 500:1 (unless there was an exceptional shortage or oversupply of these products, or unequal exchange took place). For that reason, most market trade is regular and largely predictable, rather than chaotic and arbitrary; norms of what products are worth

relative to each other are mostly clearly known and established, even if people lack an exact knowledge of prices.

The law of value originates in the "terms of trade" established for different products. If a producer has to supply too much of his own product to get a different product, this has direct consequences for the additional time he has to work to sustain himself and the trading of his product. In practical life, producers are rarely "stupid"; they know what the consequences are for their worktime if they trade on unfavourable terms; they know fairly accurately the maximum amount of product they are willing to trade to obtain another product, and they try to get the best return for their own product. Over time, and with more market integration, relatively stable values for products are established in accordance with production norms which exist independently of the productivity of individual producers. In that situation, each producer has to adapt his own production to those socially accepted values, the average terms of trade for products vary only within fairly narrow margins, and thus producers' activities fall under the sway of the law of value, which links "the economy of labour-time" with "the economy of trade". In this way, Marx argues, production activities become dominated by the values of the products being produced and exchanged ("market forces"), often quite irrespective of what human needs might be, because these values determine whether it is "economic" or "uneconomic" to produce and trade products.

The field of application of the law of value is limited to new output by producers of traded, reproducible labour-products, although it might indirectly influence trade in other goods or assets (for example, the value of a second-hand good may be related to a newly produced good of the same type). Thus, the law does not apply to all goods or assets in an economy, and it does not "rule" the whole economy, which contains far more assets of all kinds. Rather, it limits, regulates and constrains the trade in products. Primary products are a special case, which Marx discusses in his theory of Differential and Absolute Ground Rent. World market prices for primary products can at any time be strongly influenced by the yield of harvests and mines in different countries, regardless of labour effort.

Origins of the concept

According to Marx, the knowledge that the law of value existed, expressed in one form or another, was very ancient, but different thinkers in history failed to conceptualize it with any adequacy. In part, he believed that the reason was that unrestricted trade of almost everything (including all kinds of labour) purely according to their exchange-value, was a comparatively recent phenomenon. In pre-capitalist societies, there were far more restrictions on trade, the scope of trade was much less, and trade was influenced much more strongly by local custom, religion and cultural tradition. It was therefore difficult for philosophers to reach the theoretical conclusion that only human work effort was the real substance of economic value; it seemed to contradict all kinds of other influences at work.

The basic idea of the law of value was expressed very clearly by Adam Smith in The Wealth of Nations when he wrote:

"If among a nation of hunters, for example, it usually costs twice the labor 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' labor, should be worth double of what is usually the produce of one day's or one hour's labor. If the one species of labor should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour's labor in the one way may frequently exchange for that of two hours' labor in the other..." - Adam Smith, The Wealth of Nations, Book I, chapter 6.

Utz-Peter Reich comments:

"This law of value is from Adam Smith (1776), the founding father of our economics science. As economists, however, we have been trained to reject this thesis, or more precisely to accept it only on the condition that the average cost equals the marginal cost of hunting those animals and this in turn equals the marginal utility of eating them. This value theory is firmly established in first-year economics." - Utz-Peter Reich, National Accounts and Economic Value: A Study in Concepts. London: Palgrave/Macmillan, 2001, p. 1.

In this sense, neoclassical economist Paul A. Samuelson (1971) famously argued that "the beaver-deer exchange ratio can range anywhere from 4/3 to 2/1 depending upon whether tastes are strong for deer or for beaver" and, therefore, it seems that trading ratios are regulated only by the volume and intensity of consumer demand, as expressed by consumer preferences, rather than by labour-time. According to the classical economists, however, such shifts in trading ratios would quickly cause a switch from beaver-hunting to deer-hunting or vice versa; short-term fluctuations in demand could not usually change the labour-costs of hunting as such, except if new technologies suddenly made it possible to capture more game in less labour-time, or if the herds of animals had become seriously depleted. Thus Marx writes:

"Supply and demand regulate nothing but the temporary fluctuations of market prices. They will explain to you why the market price of a commodity rises above or sinks below its value, but they can never account for that value itself. Suppose supply and demand to equilibrate, or, as the economists call it, to cover each other. Why, the very moment these opposite forces become equal they paralyze each other, and cease to work in the one or the other direction. At the moment when supply and demand equilibrate each other, and therefore cease to act, the market price of a commodity coincides with its real value, with the standard price round which its market prices oscillate. In inquiring into the nature of that value, we have, therefore, nothing at all to do with the temporary effects on market prices of supply and demand." - Karl Marx, Value, Price and Profit

The concept of the law of value was also stated by David Ricardo at the very beginning of his Principles of Political Economy and Taxation, as follows:

"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, and not on the greater or less compensation which is paid for that labour."

At the most basic level, this Ricardian law of value specified "labor-content" as the substance and measure of economic value, and it suggests that trade will - other things being equal - evolve towards the exchange of equivalents (insofar as all trading partners try to "get their money's worth"). At the basis of the trading process is the economizing of human time, and "normal" trading ratios become known to, or accepted, by economic actors. This leads naturally to the idea that the law of value will "balance out" the trading process.

However, Marx's real concern is to understand and analyze how the law of value determines or regulates exchange, i.e. how the balancing of the production of outputs and the demand for them could be accomplished, in a society based on a universal market such as capitalism, and how this was regulated by labour-time. He tries to do this by starting off with simplifying assumptions and then gradually building up a complex theoretical structure. His theory specifically aims to grasp capital in motion, i.e. how, through the circulation and competitive dynamics of capital, changing expenditures of social labor are reconciled with (or fail to be reconciled with) changing social needs. This is an enormously complex undertaking, and Marx did not get much further than to specify the main tendencies and dynamics, and "pure cases". In the third volume of Das Kapital, he aims to show how the competition for profits is constrained by the law of value, and how this shapes the development of capitalist production.

Economic value as such

Economic value exists necessarily, according to Marx, because human beings as social and moral beings must co-operatively produce and economize their means of life to survive, and in so doing they are subject to relations of production. They know that their products have a socially accepted value, even if no trade occurs yet. Human valuations originate in the ability of living organisms to prioritize behaviours according to consciously self-chosen options, but social and individual valuations begin to interact. Three main kinds of relationships are involved which are objectively and empirically verifiable, and often formalised in law:

between people (social relations). between people and their economic products (technical relations).

between products themselves (with or without trading prices; these are technical, economic or commercial relations, or, in general, value relations).

The attribution of value to labor-products, and therefore the economising of their use, occurs within these three types of relationships interacting with each other. The value of one product then depends on the value of many other products, and, in a community of independent private producers, their economic relations are then necessarily expressed through the

product-values of what they trade. Over time, most products acquire a normal exchange-value, meaning that what a product costs relative to other products remains fairly stable.

However, because these three types of relationships co-exist and interact objectively, as a given social fact, independently of particular individuals, it may appear that economic value is an intrinsic property of products, or alternately, that it is simply a characteristic that results from negotiations between market actors with different subjective preferences. Marx recognised that value has both objective and subjective aspects, but he was primarily concerned with the objectification of value through market trade, where objectified (reified) value relations rule human affairs (see value-form). Paradoxically, he argues, this phenomenon meant that human lives became ruled and dominated by the products which people themselves had produced, and more specifically by the trading values of those products.

When more and more of human requirements are marketised, and a complex division of labor develops, the link between value and labor-time becomes obscured or opaque, and economic value seems to exist only as an impersonal "market force" (a given structure of priced costs and sale-values) to which all people must adjust their behaviour. Human labor becomes dominated by the economic exchange of the products of that labor, and labor itself becomes a tradeable abstract value (see Abstract labour and concrete labour).

The result of the difficulties in explaining economic value and its sources is that value becomes something of a mystery, and that how the attribution of value really occurs is no longer clear. The three relationships mentioned become mixed up, and are confused with each other, in commercial and economic discourse, and it appears that things and assets acquire an independent power to create value, even although value is a human attribution. Marx refers to this as commodity fetishism or thingification (Verdinglichung or reification) which culminates in what he calls fictitious capital. He regards it as an inevitable effect of commercial practice, since it involves the circumstance that objects acquire a value which exists independently of the valuer, a value "set by the state of the market" which individuals normally cannot change and must adjust to.

The end result is that value theory is banished from economics as a useless metaphysics, surviving only in the form of assumptions made about price behaviour (after all, we cannot talk about price aggregates without assuming some valuation principle or value criterion - we must be able to distinguish/define value equivalence and comparability, conserved value, value transfer, value used up or lost, value increase and value newly created). Because money-prices offer convenient quantifiable and generally applicable units of economic value, no further inquiry into value is deemed necessary.

To solve the riddle of economic value, Marx argues, we must investigate the real historical origins of the conditions which give rise to the riddle in the first place, i.e. the real economic history of trade and the way that history has been reflected in human thought. Once we do this, value is no longer defined simply an attribute of products and assets, but as a relation between objects and subjects.

Is it an equilibrium theory?

Some Marxists such as Thomas T. Sekine have interpreted Marx's law of value as a purely theoretical principle of market equilibrium which has no application to empirical reality. This raises the question of how we verify that it is a "law" at all. Others such as Paul Mattick argued that Marx offered no theory of market equilibrium, only a dynamic theory of enlarged economic reproduction. In reality, markets were rarely in equilibrium anyway (that was more a hypothesis used by economists, or a euphemism for "price stability"), and what explained the market behaviour of individuals and groups was precisely the imbalances between supply and demand propelling them into action. On this interpretation, capitalist development is always imbalanced development which, typically, the state tries to mitigate or compensate for.

Under capitalist conditions, balancing output and market demand depended on capital accumulation occurring. If profits were not made, production would stop sooner or later. A capitalist economy was therefore in "equilibrium" so long as it could reproduce its social relations of production, permitting profit-making and capital accumulation to occur, but this was compatible with all sorts of market fluctuations and disequilibria. Only when shortages or oversupply began to threaten the existence of the relations of production themselves, and block the accumulation of capital in critical areas (for example, an economic depression, a political revolt against capitalist property or against mass unemployment), a genuine "disequilibrium" occurred; all the rest was just ordinary market fluctuations. Marxist economist Paul Mattick comments:

"There can be no “equilibrium” between production and consumption, at any particular time or in the long-run, because progressive capital expansion means widening the gap between the two. Market “equilibrium” can exist only in abstract value terms: it exists when the market demand is one that will assure the realization of surplus-value by way of capital expansion. The semblance of a supply-and-demand “equilibrium” exists only within the process of capital accumulation. It is only in this sense that the law of value “maintains the social equilibrium of production in the turmoil of its accidental fluctuations.” Even so, in maintaining the “social equilibrium of production,” the law of value asserts itself just “as the law of gravity does when a house falls upon our ears.” It asserts itself by way of crises, which restore, not a lost balance between supply and demand in terms of production and consumption, but a temporarily lost but necessary “equilibrium” between the material production process and the value expansion process. It is not the market mechanism which explains an apparent “equilibrium” of supply and demand but the accumulation of capital which allows the market mechanism to appear, at times, as an equilibrium mechanism." - Paul Mattick, Marx and Keynes, chapter 5

So this kind of Marxian "equilibrium" was more a condition of social stability, not a hypothetical and unverifiable perfect match between supply and demand under idealised, static conditions. In any case, real social needs and their monetary expression through market demand might be two very different things. A demand might exist without any buying power, and it might be that more could technically be supplied, but isn't (see Capacity utilization). Economic equilibrium

was not created by any perfect match of supply and demand, but by the social framework which permitted the balancing act to occur. The role of the political state was essential in this, to provide an enforced legal framework for fair trade and secure property rights (see Kay & Mott 1982). Marx himself regarded the idea that society was somehow balanced out by market trade as a typical figment of bourgeois ideology and he was a strong critic of Jean-Baptiste Say. In the real world, there was only a more or less haphazard adjustment of supply and demand through incessant price fluctuations.

The difference between the equilibrium theories of neoclassical economists and Marx's theory of the regulation of trade can be illustrated with a simple analogy. It is extraordinarily difficult to stay in balance while sitting on an ordinary bicycle, if the bicycle is stationary; but as soon as forward motion is achieved, balance is usually also achieved (give or take a few close shaves, perhaps). That balance therefore exists only as a motion involving the rider, the bike and the ground. All of these are necessary. If we just focused on the rider and the bicycle only, and ignored the ground, we would miss an important factor, to our peril.

A physicist would no doubt explain all this in terms of momentum, mass, velocity, kinetic energy, gyroscopic forces, torque and the law of gravity. The law of value performs a similar function in economic science. It tells us that the trading pattern in a society does not behave chaotically or arbitrarily, but is regulated at the very least by the relative proportions of work effort involved. Exchange-value thus expresses a necessary relationship between the demand for a good by people who need it, and the quantity of society's labour-time required to produce it. A community of private producers working independently of each other has no other way to adjust their production volume to each other, than via the trading-value of their products.

By contrast, what economists often concern themselves with is a question of this type: suppose the purpose of the bicycle is to be perfectly stationary, and the rider to sit on it while perfectly stationary. Under what conditions would the balancing act then be successful? What kind of bike would we need? What skills does the rider need? Which is interesting to speculate about. We could for example experiment with a unicycle, but most people do not ride unicyles and certainly not over long distances. A real economy has a "front wheel" (the economy of trade) and a "rear wheel" (the economy of labour-time). Because riding the bike we face forwards, we do not see the rear wheel, but that does not mean it isn't there. If it really isn't there, we can't ride.

While riding the bicycle, a potential risk exists that it will crash or collide with something; balance may be lost momentarily, yet also quickly restored. But the point is, we learn little about the possibilities or conditions for such an imbalance or crash from only examining the necessary conditions for a balancing act on a stationary bicycle - except trivia such as that if balance is not achieved, the rider must fall to the ground. We have to study the whole phenomenon interacting in motion.

More sophisticated econometric models in fact do this, by identifying the quantitative effects of the interaction of many different economic trends; this is sometimes referred to as "dynamic

equilibrium", but it is often no longer clear what exactly is being equilibrated, or what the equilibrium would consist in (since in the last instance the knowledge of equilibrium depends on the observation that "things remain constant" according to some criterion). It is more a theory of how to prevent the decline or collapse of the circulation of commodities, money and capital, or promote balanced growth on some definition. The market equilibrium concept is also frequently confused with "the stability of the economic system".

15 factors counteracting the law of value

The 15 main factors counteracting the operation of the law of value, as a law governing the economic exchange of products, are:

the non-existence of regular trade or an established, stable market for products, so that a dominant social valuation and generally accepted trading norms do not rule the terms of trade for products; in this case there is no consensus on what products are worth, or it is unknown, and products will trade on all kinds of different terms which could vary greatly.

structural unequal exchange - alternative or competing sources of supply or demand are absent or blocked, distorting trading ratios in favour of those in a stronger market (or bargaining) position. In that case, the true value or cost of products may deviate greatly from actual selling prices for a prolonged time.

other restrictions on trade and what people may do with resources (legal, technical, protectionism etc.).

taxation and subsidies to producers by government

disparities in currency exchange rates.

monopoly pricing where firms drive up prices because they control the supply of most of the market demand, or temporarily lower prices to increase market share.

large-scale speculation driving up prices.

administered prices set by a state authority or a monopolist.

the large-scale use of credit economy to acquire goods and services produced, without corresponding increases in production occurring.

non-market allocation of resources, including gifts and grants

countertrade (forms of barter).

accumulation of fictitious capital (bubble economies).

dumping of surplus goods at dumping prices.

wars and disasters which create abnormal scarcities and demands for goods and services.

illegal (criminal) or "grey" transactions (including pirated and counterfeited goods).

All of these phenomena occur to some degree or other in any real economy. Hence the effect of the law of value would usually be mediated by them, and would manifest itself only as a tendency, or as a law of "grand averages". Nevertheless price-value deviations are typically quantitatively limited - whereas a fraction of goods and services will always trade for prices deviating significantly from what they are really worth, normally few people will buy an apple for $10 or sell a wellfunctioning car for $50 (unless it was part of some other deal). So although the real cost structure of production can be distorted by all kinds of extraneous factors, nevertheless the law of value places limits on the amount of the distortion.

There are many indications that Marx believed the future would see an increasingly "purified" capitalism. That is, obstructions to market expansion in every area would be cleared away through privatisation and removal of legal or technical restrictions on the expansion of trade, and that would in turn mean that the law of value would impose itself more, not less. Thus, the socially average real production costs would then influence the trading ratios in economic exchange more, not less; the allocation of goods would be determined more by private costs and private profits. Indeed, Marx felt confident about analyzing the commercial tendencies of capitalist development in their "purest form" precisely because he believed those tendencies would ultimately "win through" in the making of economic history, with "iron necessity". In other words, the "real" would in the long term increasingly approximate the theoretical "ideal", an ideal which abstracted from all kinds of contrary tendencies in local circumstances.

Law of value in capitalism

Marx argues that, as economic exchange develops and markets expand while traditional methods of production are destroyed and replaced by commercial practices, the law of value is modified in its operation.

Thus, the capitalist mode of production is a type of economy in which both inputs and outputs of production have become marketed goods and services (or commodities). In such an economy, Marx argues, what directly regulates the economic exchange of new labour-products is their prices of production, i.e. cost-price + average profits on capital invested in production. In pre-capitalist societies, where many inputs and outputs often weren't priced goods, such an expression would be meaningless. The corollary is the free movement (or at least mobility) of labour and capital among branches of industry, in other words capital and labour can be traded fairly freely.

Another way of saying the same thing, is that "sale at production prices becomes the normal precondition of supply" for new outputs produced (although in particular cases, fluctuating market prices might be above or below the production price). This means two things: the average price for which a commodity sells will typically diverge to some extent from the labour-value it represents, so that more labour exchanges for less labour and vice versa, and that the exchange values realised in trade reflect not only a physical production cost, but also a "mark-up" or surplus-value in excess of that cost. Usually this is in a range of perhaps 8-15% of capital invested (net) or about 10-40% of product unit-prices in the market, depending on the case (there is obviously a difference between the profit rate on capital invested, and the profit rate obtained from selling a single commodity). The fact that products can be traded above or below their value was for Marx the pivot of business competition in capitalist society, because it determined how much of the new surplus value produced by enterprises could be realized as profit.

Capitalist economic exchange, Marx argues, is not a simple exchange of equivalents. It aims not to trade goods and services of equivalent value, but instead to make money from the trade (this is called capital accumulation). The aim is to "buy as cheaply as possible, and sell as dear as possible", under the competitive constraint that everybody has the same objective. The effect is that the whole cost-structure of production permanently includes profit as an additional impost - which, according to medieval Christian theologians, should never be more than one-sixth (16-17%) of the value of the traded object (see Paul Bairoch, Victoires et deboires, Vol. 3, Gallimard 1997, p. 699). In an overall sense, Marx argues the substance of this impost is the unpaid surplus labour performed by the working class; part of society can live off the labour of others due to their ownership of property.

In this situation, output values produced by enterprises will typically deviate from output prices realised. Market competition for a given demand will impose a ruling price-level for a type of output, but the different competing enterprises producing it will take more or less labour to produce it, depending on productivity levels and technologies they use. Consequently, output values produced by different enterprises (in terms of labour-time) and output prices realised by them will typically diverge (within certain limits). That divergence becomes a critical factor in capitalist competition and the dynamics of the production system, under conditions where the average price-levels for products are beyond anyone's control.

If capital accumulation becomes the dominant motive for production, then producers will do everything they can to cut costs, increase sales and increase profits. Since they mostly lack control over the ruling market prices for their inputs and outputs, they try to increase productivity by every means at their disposal and maximise surplus labour. Because the lower the unit-costs of goods produced by an enterprise, the greater the margin will be between its own production costs and the ruling market prices for those goods, and the larger the profits that can be realised as result when goods are sold. Producers thus become very concerned with the value added in what they produce, which depends crucially on productivity. Marx comments:

"The fundamental law of capitalist competition, which political economy had not hitherto grasped, the law which regulates the general rate of profit and the so-called prices of production determined by it, rests... on [the] difference between the value and the cost-price of commodities, and on the resulting possibility of selling a commodity at a profit under its value." - Capital Vol. 3, chapter 1, emphasis added

In the classical competitive situation, capitalists basically aim to employ workers to produce and sell a greater volume of products more quickly, at a competitive market-price which is below the socially established "normal" valuation for that kind of product which applies in market-trade, principally by means of a better labour-exploitation rate than their competitors, which lowers the cost-price per unit of product, yet provides a superior profit rate on capital invested, even if the selling price is below the normal valuation. Such price-cutting competition is limited in scope however, because if competitors adopt the same production methods, the productivity advantage will disappear. And, obviously, if market prices for products were reduced to their most competitive cost-prices only, profits would fall to zero; the commercial rationale for producing the products would then disappear altogether.

This leads to constant attempts to improve production techniques to cut costs, improve productivity and hold down labour-costs, but ultimately also to a decline in the labor-content of commodities. Therefore, their values will also decline over time; more and more commodities are produced, for a larger and larger market, at an increasingly cheaper cost. Marx claims that this trend happens "with the necessity of a natural law"; producers had no choice about doing what they could in the battle for productivity, if they wanted to maintain or increase sales and profits. In business, if you don't go forward, you go backward. That was, in Marx's view, the "revolutionary" aspect of capitalism.

However, competition inexorably gives rise to market monopolies, which may constrain further significant advances in productivity and innovation. To be able to compete in product markets in the end requires enormous amounts of investment capital, which cuts out most would-be producers; and investors will no longer commit very large amounts of capital to investment projects if they are uncertain about whether those projects will yield an adequate return in the future. The more uncertainty there is, the more difficult it is to "securitize" (insure) their longer-term investments against losses of capital.

In a developed capitalism, the development or decline of the different branches of production occurs through the continual entry and exit of capital, basically guided by profitability criteria, and within the framework of competition. Thus, supply and demand are reconciled, however imperfectly, by the incessant movements of capital. Yet, Marx argues, this whole process is nevertheless still regulated by the law of value; ultimately, relative price movements for products are still determined by comparative expenditures of labour-time. Thus, market prices for outputs will gravitate towards prices of production which themselves are constrained by product-values expressible in quantities of labour-time.

In economic crises, Marx suggests, the structure of market prices is more or less suddenly readjusted to the evolving underlying structure of production values. Another way of saying this is, that the law of value will ultimately assert itself, by forcing a change in relative prices, in conformity with real production costs. In turn, this implies that although production values and market prices can diverge significantly from each other (in particular, because there exists no "perfect competition" - competition involves also blocking competitors), there are also limits to the possible discrepancies (because ultimately competitors will bring down artificially inflated prices, and goods sold further and further below value would eventually put producers out of business when incomes could no longer cover costs).

Smith's hidden hand

Neo-classical economics holds that, left to themselves, markets will balance supply and demand relatively quickly. If equilibrium does not exist, it will exist in the future, provided obstacles to market functioning are cleared away.

In his Bundesbank speech on January 13, 2004, US Federal Reserve chairman Alan Greenspan, stated:

"Globalization has altered the economic frameworks of both developed and developing nations in ways that are difficult to fully comprehend. Nonetheless, the largely unregulated global markets do clear, and, with rare exceptions, appear to move effortlessly from one state of equilibrium to another. It is as though an international version of Adam Smith's "invisible hand" is at work."

This was a reference to Adam Smith's Wealth of Nations (1776) where Smith wrote:

"Every individual intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his original intention. By pursuing his own interest he frequently promotes that of society more effectively than when he really intends to promote it."

Marx's theory of how the law of value operates in capitalism aims to reveal what the "hidden hand" of markets theorised by Adam Smith really consists of. It aims to explain how it comes about, that the markets get "a life of their own", by showing what drives the markets, and how the market-balancing process actually occurs.

But it can do so only by distinguishing between a domain of value-relations and a domain of price-relations, and between potential values and actual prices realised; after all, a process is involved whereby products move into markets, are sold for a price, and then move out of markets or are resold; this can be rationally understood only by assuming a temporal continuity (or conservation) of product-values through successive exchanges.

Another "take" on the law of value, from an investor's perspective, is by George Soros:

"Every market participant is faced with the task to estimate the value in the present of a future development of events, but that development is co-determined by the value which all market participants together attribute to it in the present. That is why market participants are forced to be led partly by their subjective judgement. Characteristic of that bias is that it is not purely passive: it has influence on the course of events which it should represent. This active aspect is lacking in the concept of equilibrium such as is used in economic theory." (George Soros, "The Crisis of Global Capitalism" (1998), Chapter 3, Dutch edition, p. 83).

In the real world, investors are constantly juggling between actual market prices and hypothetical (ideal) prices, based on assumptions about what the objective value of a good (its "real worth") is likely to be, now and in the future. A difficulty here is that the majority of objects of value in a society at any time don't have any actual market price, because they are not being traded. Thus, value proportions between those objects objectively exist, but at best these can only be approximated or estimated in price terms.

Marx tries to model the market outcomes macro-economically with regard to new outputs from production, assuming that values and prices will diverge, the argument being that this divergence will create a systematic pattern of economic behaviour by producers and investors. He is not interested in the circus-act of a clown balancing on a stationary bicycle, but in the bicycle ride.

Modification of the law of value in the world market

Marx believed that the operation of the law of value was not only modified by the capitalist mode of production, but also in the world market (world trade, as contrasted with the home market or national economy). The main reason for this was the existence of different levels of the intensity and productivity of labour in different countries, creating for example a very different cost structure in different countries for all kinds of products.

Products that took 1 hour of labour to make in country A might take 10 hours to make in country B, a difference in production costs which could strongly influence the exchange values realised in the trade between A and B. More labour could, in effect, exchange for less labour (an "unequal exchange" in value terms) for a prolonged time. In addition, the normal rate of surplus value could be different in different countries. Traders would try to use this differential to their advantage, with the usual motto "buy cheap, sell dear". The result, some Marxists argue, is an international transfer of value, from countries with a weaker bargaining position to those with a stronger one: products produced in country A with undervalued labour are acquired for a low price and resold in country B where labour is more highly valued, for a much higher price. The differential in labour valuations becomes a source of profit (see also Global labor arbitrage).

Among German Marxists, Marx's fragmentary remarks on the law of value in a world market setting stimulated an important theoretical debate in the 1970s and early 1980s. One aim of

this debate was to move beyond crude Ricardian interpretations of comparative advantage or comparative costs in explaining the pattern of world trade. To some extent similar debates took place in the USA (cf. Anwar Shaikh's work), France (Samir Amin) and in Japan (cf. e.g. Makoto Itoh's work available in English).

In particular, when the volume of intra-industry trade (IIT) between countries grows (i.e. the same kinds of products are both imported and exported by a country, e.g. cars, wine, beer, clothes, vegetables), and when different branches of the same multinational import and export between countries with their own internal price regime, international comparative advantage theories of the Ricardian type do not apply. Nowadays, Marxian scholars argue, comparative advantage survives mainly as an ideology justifying the benefits of international trade, not as an accurate description of that trade (some economists however draw subtle distinctions between comparative "advantages" and comparative "costs", while others switch to the concept of competitive advantage).

The operation of the law of value in the world market might however seem rather abstract, in view of the phenomena of unequal exchange, differences in accounting norms, protectionism, debt-driven capital accumulation and gigantic differences in currency exchange rates between rich and poor countries. These phenomena can create very a significant distortion in world trade between final market prices for goods, and the real production costs for those goods, resulting in superprofit for the beneficiaries of the trade.

Jayati Ghosh writes:

"While developing countries as a group more than doubled their share of world manufacturing exports from 10.6 per cent in 1980 to 26.5 per cent in 1998, their share of manufacturing value added increased by less than half, from 16.6 per cent to 23.8 per cent. By contrast, developed countries experienced a substantial decline in share of world manufacturing exports, from 82.3 per cent to 70.9 per cent. But at the same time their share of world manufacturing value added actually increased, from 64.5 per cent to 73.3 per cent."

That is, the value and physical volume of manufactured exports by developing countries increased gigantically more than the actual income obtained by the producers. Third world exporters might have got mighty rich, but the reality is that third world nations relatively speaking received less and less for what they produced for sale in the world market, even as they produced more and more; this is also reflected in the international terms of trade for manufactured products.

The postulate of the law of value does however lead to the Marxian historical prediction that global prices of production will be formed by world competition among producers in the long term. That is, the conditions for producing and selling products in different countries will be equalised in the long run through global market integration; this will be reflected also in International Financial Reporting Standards. Thus globalisation means that incipiently the "levelling out of differences in rates of profit" through competition begins to operate

internationally. Trading ratios and exchange-values for products sold globally would thus become more and more similar, in the long term. This hypothesis can be empirically tested by means of international price comparisons.

A comment by Marx on the law of value

In his letter to Louis Kugelmann of July 11, 1868, Karl Marx commented gruffly:

"As for the Centralblatt, the man is making the greatest concession possible by admitting that, if value means anything at all, then my conclusions must be conceded. The unfortunate fellow does not see that, even if there were no chapter on ‘value’ at all in my book, the analysis I give of the real relations would contain the proof and demonstration of the real value relation. The chatter about the need to prove the concept of value arises only from complete ignorance both of the subject under discussion and of the method of science. Every child knows that any nation that stopped working, not for a year, but let us say, just for a few weeks, would perish. And every child knows, too, that the amounts of products corresponding to the differing amounts of needs demand differing and quantitatively determined amounts of society’s aggregate labour. It is self-evident that this necessity of the distribution of social labour in specific proportions is certainly not abolished by the specific form of social production; it can only change its form of manifestation. Natural laws cannot be abolished at all. The only thing that can change, under historically differing conditions, is the form in which those laws assert themselves. And the form in which this proportional distribution of labour asserts itself in a state of society in which the interconnection of social labour expresses itself as the private exchange of the individual products of labour, is precisely the exchange value of these products. Where science comes in is to show how the law of value asserts itself. So, if one wanted to ‘explain’ from the outset all phenomena that apparently contradict the law, one would have to provide the science before the science. It is precisely Ricardo’s mistake that in his first chapter, on value, all sorts of categories that still have to be arrived at are assumed as given, in order to prove their harmony with the law of value. On the other hand, as you correctly believe, the history of the theory of course demonstrates that the understanding of the value relation has always been the same, clearer or less clear, hedged with illusions or scientifically more precise. Since the reasoning process itself arises from the existing conditions and is itself a natural process, really comprehending thinking can always only be the same, and can vary only gradually, in accordance with the maturity of development, hence also the maturity of the organ that does the thinking. (...) The vulgar economist has not the slightest idea that the actual, everyday exchange relations and the value magnitudes cannot be directly identical. The point of bourgeois society is precisely that, a priori, no conscious social regulation of production takes place. What is reasonable and necessary by nature asserts itself only as a blindly operating average. The vulgar economist thinks he has made a great discovery when, faced with the disclosure of the intrinsic interconnection, he insists that things look different in appearance. In fact, he prides himself in his clinging to appearances and believing them to be the ultimate. Why then have science at all? But there is also something else behind it. Once interconnection has been revealed, all theoretical belief in the perpetual necessity of the existing conditions

collapses, even before the collapse takes place in practice. Here, therefore, it is completely in the interests of the ruling classes to perpetuate the unthinking confusion. And for what other reason are the sycophantic babblers paid who have no other scientific trump to play except that, in political economy, one may not think at all!"

A comment by Frederick Engels on the law of value

"...the Marxian law of value holds generally, as far as economic laws are valid at all, for the whole period of simple commodity production — that is, up to the time when the latter suffers a modification through the appearance of the capitalist form of production. Up to that time, prices gravitate towards the values fixed according to the Marxian law and oscillate around those values, so that the more fully simple commodity production develops, the more the average prices over long periods uninterrupted by external violent disturbances coincide with values within a negligible margin. Thus, the Marxian law of value has general economic validity for a period lasting from the beginning of exchange, which transforms products into commodities, down to the 15th century of the present era. But the exchange of commodities dates from a time before all written history — which in Egypt goes back to at least 2500 B.C., and perhaps 5000 B.C., and in Babylon to 4000 B.C., perhaps to 6000 B.C.; thus, the law of value has prevailed during a period of from five to seven thousand years." (source: Supplementary Afterword to Das Kapital Volume 3).

The law of value in non-capitalist societies

There has been a long and drawn-out debate among Marxists about whether the law of value also operates in non-capitalist societies where production is directed by the state authorities.

In his famous pamphlet Economic Problems of the USSR, Joseph Stalin argued that the law of value did operate in the socialist economy of the USSR. After all, Marx had stated in Das Kapital that:

"...after the abolition of the capitalist mode of production, but still retaining social production, the determination of value continues to prevail in the sense that the regulation of labour-time and the distribution of social labour among the various production groups, ultimately the book-keeping encompassing all this, become more essential than ever."

Stalin was primarily concerned at the time with the problem of wasted labour in an economy where workers could not be easily fired and where there was often no clear relationship between salary-levels, work performance and actual output. Supporters of the theory of state capitalism in the USSR and scholars such as Andre Gunder Frank have also believed that the law of value operated in Soviet-type societies. However, it is not always clear what they mean by the law of value, beyond the vague idea that the direct producers remain dominated by their own products, or that labour costs remain important, or that Soviet-type societies remained influenced by the world market.

According to Ernest Mandel, the law of value, as a law of exchange, did influence non-capitalist societies to some extent, inasmuch as exchange and trade persisted, but because the state directed the bulk of economic resources, the law of value no longer ruled or dominated resource allocation. The best proof of that was, that there was mostly no clear relationship at all anymore between the exchange-value of goods traded, and what it really cost to produce them; accounting information, insofar as it was valid, might in fact be unable to show anything about the real nature of resource allocation. Insofar as the social priorities of state policy ensured that people got what they needed, that was a good thing; but insofar as resources were wasted because of a lack of sensible cost-economies, it was a bad thing. Cost-accounting is, of course, no more "neutral" than profit-accounting; a lot depends on what costs are included and excluded in the calculation.

Che Guevara adopted a similar view in socialist Cuba; if more resources were directly allocated to satisfy human needs, instead of commercially supplied, a better life for people would result. Guevara organised an interesting conference at which the theoretical issues were debated (see Silverman 1971). Generally, the New Left adopted the idea that true socialism would involve the abolition of the law of value, since commodity production would be abolished - goods and services would be allocated according to need, and primarily according to non-market principles.

Some Marxist authors, such as John Weeks, have argued that the law of value is unique to an economy based on the capitalist mode of production. They reject the claim by Engels that the law of value is associated with the entire history of economic exchange (trade), and modified when the vast majority of inputs and outputs of production have become marketed, priced commodities.

Other Marxists (including Ernest Mandel and the Japanese scholar Kozo Uno) followed Engels in believing that the law of value emerges and develops from simple exchange. Here, it is argued that, if the law of value was unique to capitalism, it becomes impossible to explain the development of precapitalist commodity exchange or the evolution of trading processes in a way consistent with historical materialism and Marx's theory of value. So a better approach, it is argued, is to regard the application of the law of value as being modified in the course of the expansion of trade and markets, including more and more of production in the circuit of capital. In that case, a specific society must be investigated to discover the regulating role that the law of value plays in economic exchange.

In contemporary Venezuela, the German socialist economist Heinz Dieterich has argued that the production and distribution of products should occur in accordance with their true labour costs, as shown by special macro-economic labour accounts estimating how much work-time products take to make (in Socialism of the 21st century this is called "equivalence economy"). However, this argument is very controversial. Its critics claim it is practically impossible, and some indeed point to Marx's rejection in the Grundrisse of the "time-chit" theory of allocating goods proposed by 18th and 19th century utopian socialists such as John Francis Bray and John Gray. On this view, Dieterich at most shows that the allocation of goods according to

commercial principles is only one method of allocating resources; other methods such as sharing, redistribution, barter, grants and direct allocation according to need may often serve the interest of fairness, efficiency and social justice better.

Criticism

Traditionally, criticism of Marx's law of value has been of three kinds:

conceptual logical

empirical

(1) The conceptual criticism concerns the concept of value itself. For Marx, economic value was an objectified social characteristic of labour-products, exchanged in an economic community, given the physical reality that products took a definite amount of society's labour-time to produce, for a given demand. A product had a value, regardless of what any particular person might think about it, priced or unpriced (see value-form). Critics however argue that economic value is something purely subjective, determined by personal preferences and marginal utility; only prices are objective. One of the first Marx-critics to argue this was the Austrian Eugen von Bohm-Bawerk.

However, many prices are not objective either - they are only ideal prices used for the purpose of calculation, accounting and estimation, not actually charged or applying directly to anything real. Yet, these notional prices can nevertheless influence economic behaviour. Economists then debate about when a price can be said to be "objective". Objectivity of prices, could be taken to mean e.g. only that the prices are empirically observable, not that they are independent from subjective values. But many prices are not empirically observable either, they exist only as a numerical idea.

In almost all cases, cars will sell for more than carrots, but why? If value is subjective, all we can say is that people value cars more than carrots, or that cars are more in demand than carrots. Marx argues by contrast that cars and carrots have different objective costs of production, reducible to different amounts of labour-time. So cars will always cost more than carrots; one car will trade for, or be worth, quite a few tons of carrots, at least in the normal situation.

Against this view, one could also argue that objective amounts of comparable resources (such as energy, land, water, etc), necessary to manufacture a car, are much larger than resources necessary for growing a carrot, explaining why the cost (and, hence, minimal price) of a car is larger than the cost of a carrot. In other words, it is the total input costs (including costs of labour), not the amount of labour per se, which create the difference in costs (and, therefore minimal equilibrium prices) of the goods. Marx however argues in the first chapters of Das Kapital that most of such costs (i.e. insofar as they refer to reproducible goods) are again reducible to direct and indirect costs in human labour time. When we see a car, we do not see

the worldwide cooperation of labour-efforts that produced it at a certain cost, yet those labour efforts determine its value.

Austrian economics explicitly rejects the objectivity of the values of goods as logically and conceptually unsound. On this view, we cannot validly say that products took a certain amount of labour, energy and materials to make, and compare them on that basis. It follows that the Austrian school thinks most contemporary economic theory is invalid, as it relies in one way or another on the aggregation and comparison of actual and ideal prices. This is forcefully argued by Friedrich von Hayek who therefore was skeptical about the objectivity of macroeconomic aggregations as such. However, this raises the question of "what is the explanatory power of Austrian economics", if all we can say about a realized price is that it expresses a subjective preference, given that there are billions of subjective preferences which are all different.

(2) The logical criticism revolves around the idea that Marx is unable to reconcile the domain of value relations and the domain of price relations, showing exactly how value magnitudes correspond to price magnitudes. Various arguments are made to show that Marx's theory of value is logically incoherent. The most famous of these is the controversy about Marx's prices of production, sometimes called the transformation problem in which it is argued that total output value must equal total output prices, and total profits must equal total surplus value, so that the distributions of particular output values and output prices can then be inferred from each other, via mathematical functions and a tidy accounting sum, assuming the same rate of profit on capital invested by all sectors. Since, however, this exercise gives rise either to logical problems which have never been satisfactorily resolved, or to an unmanageably large string of assumptions and variables, it is argued that Marx's theory should be abandoned.

But although this is usually overlooked by economists, Marx himself used a uniform rate of profit for all industries in Capital Vol. 3 only for modelling purposes, to show how the ruling profit rates on capital impacted on the development of production system, and he explicitly denied that a uniform rate of profit obtained in reality; he only argued that at any time there would exist an average "minimum acceptable" profit rate on capital invested in industries, and if there was no realistic possibility at all of reaching at least that profit rate sometime in the future, capital would very likely be disinvested after a while, since the relevant business would then simply lack commercial viability; alternatively, the business would be taken over, and restructured to restore an acceptable profit rate. This minimum profit rate is closely linked to the ruling interest rates; if the interest rate is e.g. 5%, then the industrial profit rate on production capital must net at least 10% or so, otherwise investors keep their money in the bank or buy other assets. Thus Marx writes:

"The general rate of profit, however, appears only as the lowest limit of profit, not as an empirical, directly visible form of the actual rate of profit." - Karl Marx, Capital Vol. 3, chapter 22, (emphasis added)

Marx and Engels also explicitly denied that in reality total product-value would be equal to the total of product-prices (see prices of production). Such an accounting identity was ruled out in

the real world by continual variations in labour productivity and because, at any time, no competitive force existed that could exactly cancel out the difference between goods sold above value and goods sold below value. At best - Marx assumed - there was a reasonably close correspondence between total product-value and total product-prices, i.e. the deviation between total product-values and total product-prices on the whole was probably not so very large, in an open, competitive market. But that is something which is very difficult - if not impossible - to prove.

Product-values in Marx's sense cannot be directly observed, only inferred from the actual behaviour of trading relations. Product-values manifest themselves and can only be expressed as trading ratios, (ideal) prices, or quantities of labour-time, and therefore the academic "transformation controversy" is according to many modern Marxist theorists misguided; it rests simply on a false interpretation of the relationship between the value-form and the price-form. As soon as we admit that product-prices may fluctuate above or below product-values for all kinds of reasons - a central determinant of market dynamics - the quantitative relationship between values and prices is at best probabilistic, not a fixed function of some type. Marx actually made this perfectly explicit already in 1844, long before he began work on Das Kapital:

"...James Mill commits the mistake - like the school of Ricardo in general - of stating the abstract law without the change or continual supersession of this law through which alone it comes into being. If it is a constant law that, for example, the cost of production in the last instance - or rather when demand and supply are in equilibrium which occurs sporadically, fortuitously - determines the price (value), it is just as much a constant law that they are not in equilibrium, and that therefore [new] value and cost of production stand in no necessary relationship. Indeed, there is always only a momentary equilibrium of demand and supply owing to the previous fluctuation of demand and supply, [and] owing to the disproportion between cost of production and [the] exchange-value [of new products], just as this fluctuation and this disproportion likewise again follow the momentary state of equilibrium. This real movement, of which that law is only an abstract, fortuitous and one-sided factor, is made by recent political economy into something accidental and inessential. Why? Because in the acute and precise formulas to which they reduce political economy, the basic formula, if they wished to express that movement abstractly, would have to be: in political economy, law is determined by its opposite, absence of law. The true law of political economy is chance, from whose movement we, the scientific men, isolate certain factors arbitrarily in the form of laws." - Karl Marx, Comments on James Mill, Éléments D’économie Politique (1844)

.

The structure of Marx's argument in Capital Vol. 3 is that there is a constant contradiction in capitalism between the law of value which imposes inescapable labour-requirements, and the laws of price competition which creates pressure to maximize the return on capital invested - a contradiction which must constantly be mediated in practice, bringing about the "real movement" of the production system. The only way to transcend the scientific "arbitrariness" to which the young Marx already referred, was by understanding and theorizing the dynamics

of the capitalist system as a whole, integrating all the different economic forces at work into a unified, coherent theory that could withstand the test of scientific criticism. Thus, Marx's value theory offers an interpretation, generalisation or explanation concerning the "grand averages" of the relative price movements of products, and of economic behaviour in capitalist production as a social system, but it is not possible to deduce specific real product-prices from product-values according to some mathematical function. What we can verify is, to what extent production-costs and the ruling profit rates actually determine market prices for products, the relationship between hours worked and outputs produced, and whether the capitalist production system does indeed evolve historically in the way predicted by value theory. No logical proof of a concept of economic value has ever been possible; the concept proved its utility only by coherently explaining the phenomena of value, and by its ability to predict how economic behaviour would empirically evolve. It is of course also possible that Marx's bold attempt at a unified grand theory - which he did not actually finish for publication himself - is partly correct and partly incorrect.

(3) The empirical criticism is simply that there is no observable quantitative correspondence at all between changes in relative expenditures of labour-time, and changes in relative market prices of products, however measured (the measures are also contested, for example on the ground that qualitatively different kinds of labour cannot be compared and equated). This is undoubtedly the strongest criticism, but there exists as yet very little research to back it up. Most critics have tried to refute Marx's theory with an elegant mathematical model, rather than actually looking at real data to see if the capitalist economy really behaves in the way Marx claims it does. Of course, Marx is not talking about all prices, only about a theory of the formation of production prices of new output (which may deviate themselves from actual market prices, and may be observable only by comparing price aggregates during an interval of time). It is essentially an argument about the "deep structure" of product markets.

These three lines of criticism lead the critics to the conclusion that Marx's law of value is metaphysical and theoretically useless. Everything he says can be restated in terms of prices, real or ideal, so what is the point then of any theory of "value"?

Austrian economics goes a step further by attributing no special objective meaning to price levels at all, which it considers a mere "statistical outcome" of comparisons between each party's ratios between the value of money (taken to be just another kind of a good) to values of goods being sold or purchased. The prices, therefore, are knowledge, which may (or may not) influence behaviour of economic agents differently in each particular case. However, this approach is inconsistent, insofar as nothing in their theory entitles the Austrians to aggregate prices at all; because each price expresses a unique subjective preference, adding up prices is like adding up apples and pears.

Marx himself thought that the concept of value was necessary to explain the historical origins, the development and mode of functioning of capitalism as a social system, under conditions where traded, priced assets were only a subset of total assets possessing a potential exchange-value.

If the economy just consisted of prices, Marx's theory would be unnecessary, but it doesn't just consist of prices. It consists also of socially related working people creating and distributing wealth among each other, property rights enforced by the state, and a large stock of untraded assets.

Any price-accounting, calculation and aggregation could not even occur without the 7 concepts of value equivalence, value comparability, value transferred, conserved value, value used up, depreciated or destroyed (in general, reduction of value), value increase and newly created value. Any economist has to assume such basic categorical distinctions in some or other form, even if they are not made explicit in arguments about prices, or revealed by the price-form itself. By analogy, in mathematics, the validity of an equation assumes that the numbers used in it are part of a number set defined in the last instance by the categorical distinctions of number theory which imply operational rules for the use of numbers. More simply, one can say that if a price expresses a valuation, we cannot do without a concept of value. At most we can say that the price is the valuation, which is what economists typically do. But this leads to logical and explanatory problems, insofar as prices can then be explained only in terms of prices. As soon as prices cannot be explained anymore in terms of other prices, the economist is forced to resort to "extra-economic" factors outside his own science. Marx did not have that problem, because his theory is based on the social relationships between people, and the social-institutional framework within which they operate.

Marx asked questions like: if supply and demand are equal, what then explains the price-level? If goods trade at their real value, what explains the increase of value occurring in production? If competition settled a particular average profit rate, why that average level, and not any other? Price theory ended up in an infinite regress here, of explaining prices by other prices by other prices, and so on. But as soon as it was admitted that prices were the monetary expression of exchange-value in the trading process, one had to explain where that exchange-value came from, and how it was established. And that required a theory of economic value and trade.

The economists assumed all sorts of things about an economy and economic actors, in order to build models of price behaviour; Marx thought those assumptions themselves needed to be looked at and theorised consistently. However, his critics claim that his own approach has hidden assumptions as well, and that these assumptions contradict the empirically observable reality of human action. In the letter by Marx cited above, Marx anticipated this criticism, which he regarded as very shallow. For thousands of years, people believed that the sun revolved around the earth (after all, we can observe how the sun rises in the East and sets in the West) until science revealed that just the opposite was the case. It is perfectly possible not only to participate in market trade without much knowledge of markets and their overall effects, but also to participate in markets with a false or one-sided interpretation of what is really going on in the exchanges. In this sense, Marx warns that market trade can stimulate all sorts of delusions about what relationships are really involved. It is true that Marx often examined economic relationships abstractly, in the "purest" or "simplest" cases, "other things being

equal", knowing very well that in empirical reality those relationships were modified by all sorts of influences. But this is a perfectly legitimate scientific procedure in theorizing, and typically he argued that, if one couldn't explain the simplest cases of an economic phenomenon, one couldn't explain all its variations either; in fact one couldn't explain anything at all.

Steve Keen and the machine

In his book Debunking Economics, the erudite Australian economist Steve Keen has attempted to counter Marx's theory (in his view Marx's pre-1857 view, specifically) from a post-Keynesian perspective, by arguing that machines can add more product-value over their operational lifetime than the total value of depreciation charged during those asset lives. For example, the total value of sausages produced by a sausage machine over its useful life might be greater than the value of the machine. Depreciation, he implies, was the weak point in Marx's social accounting system all along. Keen argues that all factors of production can add new value to outputs.

This raises the question of how we know which part of the new value is due directly to the worker, which part is due to the pork, and which part is due directly to the machine (or indirectly to any worker involved in the production of that machine) - none of which of course can produce products without the others, unless we suppose full automation.

Marx remained insistent that only human labour could create net new value, and that machines did not create any new value by themselves; instead human beings conserved the value of machines, and transferred their value to the new products. Therefore, logically, machines could contribute no more value than was implied by the labour it took to make them, or perhaps more precisely, by their current value in society. This value should of course be distinguished from that part of the output price charged as depreciation costs, i.e. a distinction should be drawn between depreciation in value terms and depreciation in price terms. That aside, Marxist economists such as Ernest Mandel have argued that owners of new, more productive fixed equipment (which the owners may monopolize with the aid of patents) can obtain extra income from its use, representing effectively an economic rent (so-called "technological rents"). Whatever view one takes, it is clear depreciation raises complex issues, because depreciation write-offs often do not reflect the "real" loss of value of a fixed asset, but rather the maximum value permitted by governments and auditors to be written off for tax purposes (for more discussion, see the OPE-L ("Outline of Political Economy") list and Marx and Surplus Value

Excess burden of taxationIn economics, the excess burden of taxation, also known as the distortionary cost or deadweight loss of taxation, is the economic loss that society suffers as the result of a tax, over and above the revenue it collects. It is assumed that distortions occur because people or firms change their behaviour in order to reduce the amount of tax they must pay. Excess burdens can

be measured using the average cost of funds or the marginal cost of funds (MCF). Excess burdens were first discussed by Adam Smith.

An equivalent kind of inefficiency can also be caused by subsidies (that are actually taxes with negative rates).

Economic losses due to taxes were evaluated to be as low as 2.5 cents per dollar of revenue, and as high as 30 cents per dollar of revenue (on average), and even much higher at the margins. See Martin Feldstein, Tax Avoidance and the Deadweight Loss of the Income Tax, 81(4), Review of Economics and Statistics (1999), at p. 674; Charles L. Ballard, John B. Shoven and John Whalley, The Welfare Cost of Distortions in the United States Tax System: A General Equilibrium Approach, National Bureau of Economic Research Working Paper No. 1043. For a review of literature arguing that moving to a uniform taxation of investment will lead to 0.1% to 0.3% increase in GNP, see Lawrence H. Summers, Should Tax Reform Level the Playing Field?, National Bureau of Economic Research Working Paper No. 2132, Cambridge, MA, January 1987.

Measures of the excess burden

The cost of a distortion is usually measured as the amount that would have to be paid to the people affected by it, in order to make them indifferent to its presence. The excess burden of a tax depends upon two things. The first is the compensated demand or supply elasticity of the good being taxed: the more elastic the demand or supply, the greater the excess burden. The second is the tax rate: as a general rule, the excess burden of a tax increases with the square of the tax rate.

The average cost of funds is the total cost of distortions divided by the total revenue collected by a government. In contrast, the marginal cost of funds (MCF) is the size of the distortion that accompanied the last unit of revenue raised (ie, the rate of change of distortion with respect to revenue). In most cases, the MCF increases as the amount of tax collected increases.

The standard position in economics is that the costs in a cost-benefit analysis for any tax-funded project should be increased according to the marginal cost of funds, because that is close to the deadweight loss that will be experienced if the project is added to the budget, or to the deadweight loss removed if the project is removed from the budget.

Distortion and redistribution

In the case of progressive taxes, the distortionary effects of a tax may be accompanied by other benefits: the redistribution of dollars from wealthier people to poorer people who obtain more benefit from them.

In fact almost any tax measure will distort the economy from the path or process that would have prevailed in its absence (land value taxes are a notable exception). For example a sales tax

applied to all goods will tend to discourage consumption of all the taxed items, and an income tax will tend to discourage people from earning money in the category of income that is taxed (unless they can manage to avoid being taxed). Some people may move out of the work force (to avoid income tax); some may move into the cash or black economies (where incomes are not revealed to the tax authorities).

For example, in Western nations the incomes of the relatively affluent are taxed partly to provide the money used to assist the relatively poor. As a result of the taxes (and associated subsidies to the poor), incentives are changed for both groups. The relatively rich are discouraged from declaring income and from earning marginal (extra) income, because they know that any additional money that they earn and declare will be taxed at their highest marginal tax rates. At the same time the poor have an incentive to conceal their own taxable income (and usually their assets) so as to increase the likelihood of their receiving state assistance. It can be argued that the distortion of incentives (the move away from a fiscally neutral stance that does not affect incentives) does more harm than good.

One of the main distortions sometimes said to have arisen in the USA and the UK as a result of tax policy is the creation of a permanent underclass, dependent on welfare and discouraged (by the tax system) from seeking work and betterment. In some countries the tax system can be badly designed to deal with such issues, e.g. sometimes the marginal tax rate that applies to earned income (as someone takes work attempting to escape from unemployment and welfare) is so high that the person's take-home income (post-tax and after taking account of any benefits or welfare receipts) does not increase as a result of taking work. This is known as the welfare trap.

There was an example of distortion of the economy by tax policy some years ago in the UK when cars supplied by employers to their employees were taxed at advantageous rates (e.g. encouraging the growth of company car fleets). Over several years the distortion grew to the point that the majority of cars used by working families were company cars and the dealership structures, and even the types of cars used, altered to adjust to the tax regime.

Deliberate distortion

Here, the fiscal distortion is deliberate, so as to compensate for externalities. "Sin taxes" on alcohol, tobacco, pornography, etc. may be levied so as to discourage their consumption. Such an approach is often preferable to outright prohibition, since prohibition incites trafficking, often resulting in crime and other social costs, but no revenue. Similarly, taxes such as a carbon tax, may be levied on emission of pollutants, in order to encourage corporations to adopt cleaner methods of production.

Lump-sum tax

It is one of the various modes used for taxation: income, things owned (property taxes), money spent (sales taxes), miscellaneous (excise taxes).

It is a regressive tax, such that the lower income is, the higher percentage of income applicable to the tax. An example is a poll tax to vote, which is unchanged no matter what the income of the voter.

Other related examples include personal property taxes on cars or business equipment regardless of income or ability to pay; and real estate taxes where senior citizens often have to pay an extremely large percentage of their retirement income (especially when living on social security) to continue living in a home they purchased during their working years.

In economic theory, a lump-sum tax may have the advantage of not contributing to an excess burden of taxation, a loss in economic efficiency that results from taxes reducing incentives for production. In practice, lump-sum taxes are often encountered, in spite of their conflict with other criteria, such as equity or ability to pay. A lump-sum tax remains a standard for measuring the performance of other imperfect kinds of taxes (J. de V. Graaf, 1987).

Economic effects

Efficiency

A supply and demand diagram showing the effects of land value taxation. If the supply of land is fixed, the burden of the tax will fall entirely on the land owner with no deadweight loss.

Most taxes distort economic decisions. If labor, buildings or machinery and plants are taxed, people are dissuaded from constructive and beneficial activities, and enterprise and efficiency are penalized due to the excess burden of taxation. This does not apply to LVT, which is payable regardless of whether or how well the land is actually used, because the supply of land is inelastic, market land rents depend on what tenants are prepared to pay, rather than on the expenses of landlords, and so LVT cannot be passed on to tenants. The only direct effect of LVT on prices is to lower the market price of land. Put another way, LVT is often said to be justified for economic reasons because if it is implemented properly, it will not deter production, distort market mechanisms or otherwise create deadweight losses the way other taxes do. Nobel Prize winner William Vickrey believed that "removing almost all business taxes, including property taxes on improvements, excepting only taxes reflecting the marginal social cost of public services rendered to specific activities, and replacing them with taxes on site values, would substantially improve the economic efficiency of the jurisdiction." A correlation between the use of LVT at the expense of traditional property taxes and greater market efficiency is predicted by economic theory, and has been observed in practice.

Proponents, such as Fred Foldvary, state that the necessity to pay the tax encourages landowners to develop vacant and underused land properly or to make way for others who will. They state that because LVT deters speculative land holding, dilapidated inner city areas are returned to productive use, reducing the pressure to build on undeveloped sites and so reducing urban sprawl. For example Harrisburg, Pennsylvania in the United States has taxed land at a rate six times that on improvements since 1975, and this policy has been credited by its long time mayor, Stephen R. Reed with reducing the number of vacant structures in downtown Harrisburg from about 4,200 in 1982 to less than 500. LVT is an ecotax because it ostensibly discourages the waste of locations, which are a finite natural resource.

A criticism is that a land value tax forces people to devote land to its most productive use in order to be able to afford the tax, even if they want to use it for a less productive use. For example, a private park in the middle of a city may generate negligible return, and others may want to buy it to build a factory or offices on it. If a Land Value Tax was implemented, the park owner would have to be prepared to pay the costs of leaving the park undeveloped and might be unable to do so.

Real estate values

Real estate bubbles direct savings towards rent seeking activities rather than other investments, and can contribute to recessions which damage the entire economy. Advocates of the land tax claim that it reduces the speculative element in land pricing, thereby leaving more money for productive capital investment and making the economy more stable.

If the value to landowners were reduced to zero or near zero by recovering effectively all its rent, total privately held asset values could decline as the land value element was stripped out, representing a shift in apparent private sector wealth. Since landowners often possess significant political influence, this has significantly deterred the adoption of land value taxes.

Practical issues

There are several practical issues involved in the implementation of a land value tax. Most notably, it needs to be:

Calculated fairly and accurately, High enough to raise sufficient revenue without causing land abandonment, and

Billed to the correct person.

Assessments

In theory, levying a Land Value Tax is straightforward, requiring only a valuation of the land and a register of the identities of the landholders. There is no need for the tax payers to deal with complicated forms or to give up personal information as with an income tax. Because land cannot be hidden, removed to a tax haven or concealed in an electronic data system, the tax cannot be evaded.

However, critics point out that determining the value of land can be difficult in practice. In a 1796 United States Supreme Court opinion, Justice William Paterson noted that leaving the valuation process up to assessors would cause numerous bureaucratic complexities, as well as non-uniform assessments due to imperfect policies and their interpretations. Austrian School economist Murray Rothbard later raised similar concerns, stating that no government can fairly assess value, which can only be determined by a free market.

When compared to modern day property tax evaluations, valuations of land involve fewer variables and have smoother gradients than valuations that include improvements. This is due to variation of building style, quality and size between lots. Modern computerization and statistical techniques have eased the process; in the 1960s and 1970s, multivariate analysis was introduced as a method of assessing land.

Land value for LVT purposes is assessed using market evidence. Such evidence may comprise both selling prices and rentals. Where development already exists on a site, the value of the site can be discovered by various means, of which the most easily understood is the residual method: the value of the site is the total value of the property minus the depreciated value of buildings and other structures.

The valuation process commences with a measurement of the most and least valuable land within the taxation area. A few sites of intermediate value are then identified and used as "landmark" values. Other values are filled in between the landmark values. The data is then collated on a database and linked to a unique property reference number, "smoothed" and mapped using a geographical information system (GIS). The initial valuation is the most difficult; once the system is in use, successive valuations become easier.

Limited revenue

In this case, land is taxed at 100% of its value, eliminating the landowner surplus completely. Land tax revenues cannot be raised beyond this point.

In the context of land value taxation as a single tax (replacing all other taxes), some have argued that LVT alone cannot raise large enough revenues. Most modern LVT systems are alongside other taxes, and thus only reduce their impact without removing them completely. In a case or event where a jurisdiction attempted to levy a land tax that was higher than the entire landowner surplus, it would result in landowner abandonment and a sharp decline in tax revenue.

Requires clear ownership

In some countries, LVT is nearly impossible to implement because of lack of certainty regarding land titles and clearly established land ownership and tenure. For instance a parcel of grazing land may be communally owned by the inhabitants of a nearby village and administered by the village elders. If the government can not accurately define ownership boundaries and ascertain the proper owners, it cannot know from whom to collect the tax. The phenomena of lack of clear titles is found worldwide in developing countries and is in part the subject of the work of the Peruvian economist Hernando de Soto. In African countries with imperfect land registration, boundaries may be poorly surveyed, the landlord can be elusive and significantly more difficult to tax than occupants, but most governments require that tax collectors track owners down nonetheless so that the burden of the tax does not fall on the poor.

Ethics

In religious terms, it has been claimed that land is a common gift to all of mankind. For example, the Catholic Church as part of its "Universal Destination" principle asserts:

Everyone knows that the Fathers of the Church laid down the duty of the rich toward the poor in no uncertain terms. As St. Ambrose put it: "You are not making a gift of what is yours to the poor man, but you are giving him back what is his. You have been appropriating things that are meant to be for the common use of everyone. The earth belongs to everyone, not to the rich."

Land acquires a scarcity value owing to the competing needs of the community for living, working and leisure space. According to proponents, the unimproved value of land owes nothing to the individual efforts of the landowner and everything to the community at large. These supporters suggest that the value of land belongs justly and uniquely to the community.

LVT is also purported to act as value capture tax. A new public works project may make adjacent land go up considerably in value, and thus, with a tax on land values, the tax on adjacent land goes up. Thus, the new public improvements would be paid for by those most benefited by the new public improvements — those whose land value went up most.

History

Pre-modern

Land value taxation has ancient roots, tracing back to after the introduction of agriculture. One of the oldest forms of taxation, it was originally based on crop yield. This early version of the tax required simply sharing the yield at the time of the harvest, akin to paying a yearly rent.[26]

Physiocrats

Anne Robert Jacques Turgot, one of the leading physiocrats.

The physiocrats were a group of economists who believed that the wealth of nations was derived solely from the value of land agriculture or land development. Physiocracy is considered one of the "early modern" schools of economics. Physiocrats called for the abolition of all existing taxes, completely free trade, and a single tax on land; they did not distinguish, however, between intrinsic value of land and ground rent. Their theories originated in France and were most popular during the second half of the 18th century. The movement was particularly dominated by Anne Robert Jacques Turgot (1727–1781) and François Quesnay (1694–1774). It immediately preceded the first modern school, classical economics, which began with the publication of Adam Smith's The Wealth of Nations in 1776. The Physiocrats were also highly influential in the early history of land value taxation in the United States.

Thomas Paine contended in his Agrarian Justice pamphlet that all citizens should be paid 15 pounds at age 21 "as a compensation in part for the loss of his or her natural inheritance by the introduction of the system of landed property." This proposal was the origin of the citizen's dividend advocated by Geolibertarianism.

Classical economists

It was Adam Smith, in his book The Wealth of Nations, who first rigorously analyzed the effects of a land value tax, pointing out how it would not hurt economic activity, and how it would not raise land rents.

Ground-rents are a still more proper subject of taxation than the rent of houses. A tax upon ground-rents would not raise the rents of houses. It would fall altogether upon the owner of

the ground-rent, who acts always as a monopolist, and exacts the greatest rent which can be got for the use of his ground. More or less can be got for it according as the competitors happen to be richer or poorer, or can afford to gratify their fancy for a particular spot of ground at a greater or smaller expense. In every country the greatest number of rich competitors is in the capital, and it is there accordingly that the highest ground-rents are always to be found. As the wealth of those competitors would in no respect be increased by a tax upon ground-rents, they would not probably be disposed to pay more for the use of the ground. Whether the tax was to be advanced by the inhabitant, or by the owner of the ground, would be of little importance. The more the inhabitant was obliged to pay for the tax, the less he would incline to pay for the ground; so that the final payment of the tax would fall altogether upon the owner of the ground-rent.

Georgism

Henry George in 1865.Main article: Georgism

Henry George (September 2, 1839 – October 29, 1897) was perhaps the most famous advocate of recovering land rents for public purposes. An American journalist, politician and political economist, he advocated a "Single Tax" on land that would eliminate the need for all other taxes. In 1879 he authored Progress and Poverty, which significantly influenced land taxation in the United States.

Liberal and Labour Parties in the United Kingdom

In the United Kingdom, LVT was an important part of the platform of the Liberal Party during the early part of the twentieth century: David Lloyd George and H. H. Asquith proposed "to free the land that from this very hour is shackled with the chains of feudalism." It was also advocated by Winston Churchill early in his career. The modern Liberal Party (not to be confused with the Liberal Democrats, which are the larger heir to the earlier Liberal Party)

remains committed to a local form of land value taxation, as do the Green Party of England and Walesand the Scottish Green Party.

From its early years, and until just after the Second World War, there was strong support for land value taxation within the Labour Party. The Member of Parliament Andrew MacLaren was a consistent and vocal advocate. The 1931 Labour budget included a land value tax, but before it came into force it was repealed by the Conservative-dominated National Government that followed shortly after.

An attempt at introducing site value taxation in the administrative County of London was made by the local authority under the leadership of Herbert Morrison in the 1938–9 Parliament, called the London Rating (Site Values) Bill. Although it failed, it sets out detailed legislation for the implementation of a system of land value taxation using annual value assessment.

After 1945, the Labour Party adopted the policy, against the opposition of a substantial body of MPs, of attempting to collect "development value": the increase in land price arising from planning consent. This was one of the provisions of the Town and Country Planning Act 1947 and it was repealed when the Labour government lost power in 1951.

Existing tax systems

A comprehensive and detailed survey of land value taxation around the world was published in 2001.

Australia

The state of New South Wales levies a state land value tax. However unlike council rates, farmland and a person's principal place of residence are generally exempt and the state tax is only levied on value over a certain threshold. In New South Wales determination of land value, for tax purposes at a state and local level, is the responsibility of the Valuer-General. The cities of Sydney, Canberra, and others in Australia use LVT. An in-depth study under the Chairmanship of Sir Gordon Chalk issued a report in 1986 on the subject of local taxation for the city of Brisbane, Queensland. The report, which examined many alternative means of local finance, sets out comprehensive and concise arguments for LVT.

By revenue, property taxes represent 4.5% of total taxation in Australia.

Hong Kong

Hong Kong is perhaps the best modern example of the successful implementation of a high LVT. The Hong Kong government generates more than 35% of its revenue from land taxes.[39] Because of this, they can keep their other taxes rates low or non-existent and still generate a budget surplus.

United States

Land value taxes are used in various jurisdictions of the United States, particularly in the state of Pennsylvania.

Other countries

Pure LVT, apart from real estate or generic property taxation, is used in Taiwan, Singapore, and Estonia.

Several cities around the world also use LVT (e.g. see Australia, above). It has also been used in Mexicali, Mexico.

Countries with active discussion

Scotland

Since the turn of the new century, with devolution and the re-establishment of the Scottish Parliament, there has been interest and political pressure in Scotland to introduce land value taxation.

In February 1998 the pre-devolution UK government in Scotland (the Scottish Office) launched a far-reaching public consultation process on the broad question of land reform. A survey of the record of the public response found that: “excluding the responses of the lairds and their agents, reckoned as likely prejudiced against the measure, 20% of all responses favoured the land tax” (12% in grand total, without the exclusions). The government responded by announcing “a comprehensive economic evaluation of the possible impact of moving to a land value taxation basis”. However, in a welter of published Land Reform Action Plans, concrete, positive public outcomes failed to materialise.

In 2000 the Parliament’s Local Government Committee held an inquiry into local government finance. Its terms of reference explicitly included land value taxation but the Committee’s final report did not comment on the system. In 2003 the Scottish Parliament passed a resolution: “That the Parliament notes recent studies by the Scottish Executive and is interested in building on them by considering and investigating the contribution that land value taxation could make to the cultural, economic, environmental and democratic renaissance of Scotland.” In 2004 a letter of support was sent from a group of members of the Scottish Parliament to the organisers and delegates of the IU’s 24th international conference being held in Madrid—signed by members of the Scottish Green, Socialist and Nationalist parties.

The policy was considered in 2006 by banker Sir Peter Burt’s government-appointed Scottish Local Government Finance Review. The Review’s 2007 Report concludes that “although land value taxation meets a number of our criteria, we question whether the public would accept the upheaval involved in radical reform of this nature, unless they could clearly understand the nature of the change and the benefits involved…. We considered at length the many positive features of a land value tax which are consistent with our recommended local property tax [LPT], particularly its progressive nature.” However, “[h]aving considered both rateable value and land value as the basis for taxation, we concur with Layfield [UK Committee of Inquiry, 1976)] who recommended that any local property tax should be based on capital values.” In 2009, Glasgow City Council resolved that it wished to introduce a tax based on land values: “the idea could become the blueprint for Scotland’s future local taxation” The Council has agreed a “long term move to a local property tax / land value tax hybrid tax”: its Local Taxation Working Group also states that simple [non-hybrid] land value taxation should itself “not be discounted as an option for local taxation reform: it potentially holds many benefits and addresses many existing concerns”.

United Kingdom

The Liberal Democrats "Alter" (Action for land taxation and economic reform) exists

to improve the understanding of and support for Land Value Taxation amongst members of the Liberal Democrats; to encourage all Liberal Democrats to promote and campaign for this policy as part of a more sustainable and just resource based economic system in which no one is enslaved by poverty; and to cooperate with other bodies, both inside and outside the Liberal Democrat Party, who share these objectives.

Course in "Economics with Justice" with a strong foundation in LVT are offered at the School of Economic Science, which has historical links with the Henry George Foundation.

Other countries

Land value taxation is currently at some stage of being introduced in Kenya, Namibia and other countries. China's Real Rights Law contains fundamental provisions founded on a land value taxation analysis.

Policy interest elsewhere

In the Republic of Ireland the recently adopted Programme for Government includes the commitment that "we will move to introduce a Site Valuation Tax for non-agricultural land".In Zimbabwe, government coalition partners the Movement for Democratic Change has land value taxation as its policy. Since 2000, there have been political expressions of interest in the policy and analysis in Belgium, Ethiopia, Republic of South Africaand other countries. The governments of Thailand and Hungary have shown some sympathy with the policy.

There are local campaigns to introduce it in many other countries, including South Korea and the United Kingdom (where a broad assembly of independent and politically-aligned groups advocate and advance the case for land value taxation). The IU works internationally and at the United Nations in support of the policy. In 1990, several economists wroteto then President Mikhail Gorbachev suggesting that Russia use Land Value Taxation in its transition towards a free market economy: its failure to do so has been argued as causal in the rise of the Oligarchs.

Prices of production

Prices of production refers to a concept in Karl Marx's critique of political economy. It is

introduced in the third volume of Das Kapital, where Marx considers the operation of capitalist

production as the unity of a production process and a circulation process involving

commodities, money and capital. The argument is that the monetary exchange of newly

produced commodities in capitalist markets is regulated by their production prices. The

regulating price of a type of product is a sort of modal average, above or below which people

would be much less likely to trade the product. So it refers basically to a "normal or dominant

price level" that prevails during a longer interval of time. It presupposes that both the inputs

and the outputs of production are priced goods and services, i.e. that production is integrated

in fairly sophisticated market relations enabling a sum of capital invested into it to be

transformed into a larger sum of capital.

Marx's claim is that production prices of products themselves are fundamentally determined by their labour-values, and therefore are constrained by the law of value. Since however not all goods are produced or reproducible goods, not all goods have production prices. A production price in Marx's sense can exist only in markets developed sufficiently for a "normal" rate of profit on production capital invested to become the ruling average for a group of producers.

The claim is that the prices of new products sold will, assuming free competition for an open market, usually tend to settle at an average level which enables at least a "normal" rate of profit on the capital invested to produce them; and as a corollary, that if such an average rate of profit cannot be reached, it is much less likely that the products will be produced (because of comparatively unfavourable profitability conditions). Thus, investment capital is likely to shift out of production activities where the rate of profit is low, and towards activities where profitability is higher; the "leading" sectors of industry are those where profitability is the highest. The precondition is the free mobility of capital, and thus there is a systemic tendency to remove all obstacles preventing investors from investing where profits are higher. If, for any reason, the free movement of capital is blocked or restricted, then big differences in the profit rates of enterprises are likely to occur.

According to Marx, the movements of different production prices relative to each other importantly affect how the total "cake" of new surplus value produced is shared out as profit by competing capitalist enterprises. They are the basis of the competitive position of the producers, since they fundamentally determine profit yields relative to costs.

Simple definition

For most political economists, this kind of price corresponds roughly to Adam Smith's concept of "natural prices" and the modern neoclassical concept of long-term competitive equilibrium prices under constant returns to scale (for an historical discussion, see Meek (1975)). However, the function of prices of production within Marxian theory is different from that of these other concepts in their own theories.

Simply put, Marx's "price of production" (P) is a price which applies to sales of new outputs produced, and it equals cost price (cp) + average profit of capital invested in production (ap). The cost price could be computed as the unit-cost of a product, the profit component being the normal mark-up. The production price is the price at which goods would have to sell in order to reach the average profit rate on capital invested into producing them. The amount ap is often assumed to have the same magnitude relative to the amount of capital invested in all sectors, seemingly representing an equilibrium of flows of capital between different parts of a capitalist economy that results in a "general rate of profit".

Thus,

P = cp + ap

The cost-price equals labour-costs incurred (or variable capital measured in price terms) in producing output, plus the monetary cost of constant capital inputs used up.

In the sphere of capitalist production, Marx argues, commodity values are expressed in the form of prices of production, established jointly by average input costs and by the ruling profit margins applying to outputs sold. It is a result of the establishment of regular, developed market trade; the production price averages reflect the fact that production has become totally integrated into the circuits of commodity trade, in which capital accumulation has become the dominant motive. But what prices of production simultaneously hide, he argues, is the social nature of the valorisation process, i.e. how exactly an increase in capital-value has occurred through production. The direct connection between labour-time and value, still visible in simple commodity production, is largely effaced; only cost-prices and sale-prices remain, and it seems that any of the factors of production (which Marx calls the "Holy Trinity" of capitalism) can contribute new value to output, paving the way for the concept of the production function.

In his manuscript, Marx frequently defines a newly produced output of commodities as being equal to a newly formed "commodity capital K" where

K = c + v + s

where c = constant capital (the element of conserved value), v = variable capital, and s = surplus value (the two elements of newly created value). (Marx's standard assumption in his models is that the rate of surplus-value (s/v) is the same in all sectors. But this is just an ideal average, in reality s/v will differ in different sectors and regions; Marx seems to have thought though that assuming a uniform rate was justified, because an open market in labour and capital would tend to make working conditions increasingly similar for a whole population).

One question is then how exactly the value of K is distributed as gross revenues among producing enterprises, what determines this distribution, and what factors affect it. In the Marxian view, answers given to this question have important implications for explaining and predicting the pattern and direction of capitalist economic growth (this is the subject of Marx's theory of economic reproduction and the mobilisation of capitals).

Two interpretations of production prices

Unfortunately, Marx never prepared the manuscript of the third volume of Das Kapital for publication. Therefore his draft text, which sketches complicated issues in a "shorthand" way, is sometimes ambiguous and incomplete. According to Marx-scholar Michael Heinrich, "Marx was nowhere near solving all of the conceptual problems"

Some writers argue that Marx's production price is similar, or performs the same theoretical function, as the "natural prices" of classical political economy found e.g. in the writings of Adam Smith and David Ricardo. In that case, Marx's production price would be essentially a "centre of gravity" around which prices for outputs in a competitive market will fluctuate in the long run (cf. Fred Moseley's view). This is the dominant interpretation, within the framework of equilibrium economics, which suggests that production prices are really a kind of "equilibrium prices". There is textual evidence for that, insofar as Marx sometimes defines the production price as the price which would apply if the supply and demand for products is balanced. At other times, he refers to a "longterm average price" or a "regulating price". He does not say precisely how these three different concepts are related.

Others argue that the concept of production price plays a different role in Marx's theory: the aim of the concept is to show how the distribution, as profit income, of the new surplus value produced (in the form of new outputs of goods and services) is affected by price movements and more specifically by competition, and what variables and dimensions are involved here.

In that case, production prices are not necessarily equilibrium prices, but refer much more to a given price-level acting as a constraint or limit within which enterprises must operate in a developed, open market: the average or ruling costs and returns applying to their branch of activity, creating in effect a pricing regime or "regulating price". The pricing regime sets upper and lower limits for cost-prices and sale-prices. This alternative interpretation of production prices rests on four ideas:

in a developed market, as Marx knew, producers confront a given cost structure applying to their inputs, and a given structure of market prices for their outputs. Within this evolving but predetermined framework, in which the activity of each enterprise affects the overall outcome for all enterprises, each producer aims to manage his business in order to realise maximum surplus value, principally by maximising surplus labour and labor productivity while keeping costs to the minimum. Effectively, producers aim ideally to sell as much product as fast as they can at competitive prices which are below the ruling market valuation, while still making a normal profit on capital invested.

Marx's critics claimed to prove on the one hand that there existed no logical procedure to derive prices from values, yet on the other hand they also complained Marx's theory is not empirically verifiable or falsifiable. But the latter proposition obviously does not follow from the former. Obviously Marx's theory is verifiable and falsifiable, if we investigate whether price movements and business behaviour observably do develop in the direction that Marx predicts that they will, on the basis of his value theory. Are market prices for products really proportional to their production costs, or not? Are relative quantities of labour-time performed proportional to the long-term relative movements of output prices? Do profit rates tend to converge on a "normal" rate of return?

Most importantly, in a developed market, prices of production will exist regardless of whether supply and demand happen to be in balance; competition would settle an average price-level for outputs, but this did not necessarily imply any "equilibrium price" or the absence of price fluctuations. For Marx, the capitalist economy and society owed its "equilibrium" to the maintenance of its relations of production, not to some hypothetical balance between demand and supply which existed only by momentary chance. Equilibrium was less an economic, than a socio-political issue (see also law of value). After all, sorts of economic fluctuations could occur while the relations of production stayed intact, and capital accumulation continued unabated.

Marx's purpose was not really to prove a static equilibrium system with models of price distributions in which price-value deviations fully cancelled out at the aggregate level; at best that was only a simplifying assumption, to illustrate the effects of the distribution of the total new surplus value created, given that there was a minimum acceptable average profit rate on capital invested, related to the ruling rates of interest, while enterprises were constantly unequally rewarded for the production labor they performed. This central fact dominated how the production system would develop. Marx aimed to diagnose the main laws which drove the capitalist production system forward through the dynamics of competition for extra profits - the critical problem for investors was that at any time they could realize more or less money-income for the new value produced by enterprises, and that problem led to a systematic pattern of business behavior to gain competitive advantage, which in turn had definite overall effects for the whole economy. So this was more a theory of the basic parameters of

business competition, rather than a theory of how the distribution of new value spontaneously evolved towards an imaginary equilibrium state.

A quote from Marx on production prices

"We have seen that the price of production of a commodity is not at all identical with its value, although the prices of production of commodities, considered in their totality, are regulated only by their total value, and although the movement of production prices of various kinds of commodities, all other circumstances being equal, is determined exclusively by the movement of their values. It has been shown that the price of production of a commodity may lie above or below its value, and coincides with its value only by way of exception. Hence, the fact that products of the land are sold above their price of production does not at all prove that they are sold above their value; just as the fact that products of industry, on the average, are sold at their price of production does not prove that they are sold at their value. It is possible for agricultural products to be sold above their price of production and below their value, while, on the other hand, many industrial products yield the price of production only because they are sold above their value. The relation of the price of production of a commodity to its value is determined solely by the ratio of the variable part of the capital with which the commodity is produced to its constant part, or by the organic composition of the capital producing it. If the composition of the capital in a given sphere of production is lower than that of the average social capital, i.e., if its variable portion, which is used for wages, is larger in its relation to the constant portion, used for the material conditions of labour, than is the case in the average social capital, then the value of its product must lie above the price of production. In other words, because such capital employs more living labour, it produces more surplus value, and therefore more profit, assuming equal exploitation of labour, than an equally large aliquot portion of the social average capital. The value of its product, therefore, is above the price of production, since this price of production is equal to capital replacement plus average profit, and the average profit is lower than the profit produced in this commodity. The surplus-value produced by the average social capital is less than the surplus-value produced by a capital of this lower composition. The opposite is the case when the capital invested in a certain sphere of production is of a bigger composition than the social average capital. The value of commodities produced by it lies below their price of production, which is generally the case with products of the most developed industries."

Problems of interpretation

The first interpretative difficulty concerns the existence of various different production prices. Most Marxists missed the fact. Marx identified (though often not very clearly) at least four main types of production prices:

the private or enterprise production price which forms the starting-point of the analysis. This price equals the cost-price and profit on production capital invested which applies to the new output of a specific enterprise when this output is sold by the enterprise.

the sectoral production price. This price equals the average cost-price and average profit on production capital invested which applies to the output of a commodity produced by a specific industry, sector or branch of production (at "producer's prices"). In particular, Marx notes the differences between industrial and agricultural production prices.

the inter-sectoral production price. This price refers to the sale of output at producers' prices which reflect an average profit rate on a quantity of capital invested that applies to various different sectors of industry (this is the fully formed production price Marx most often has in mind in his theoretical discussions; it reflects the product-price at which the average rate of profit on capital applying to a whole economic community is obtained).

the economic production price. This price equals the average cost price and average profit of an output at the point of sale to the final consumer, including labour-value contributed by all the different enterprises participating in its production (factory, storage, transport, packaging etc.). In modern times, "costing" production in order to establish the expected yield on capital invested in it often involves assessing the whole value chain relative to the price level at which products can be sold to the final consumer. The question then is, how can the whole production of a product - from the factory gate to the final consumer - be organized so that it can sell to the final consumer at a price that the market will bear?

These different prices are revealed when we study the composition of the cost structure of a product at different stages of its production. One source of interpretive difficulty is that Marx often assumes in his drafts that these four types of prices are all identical. But that is true only in the special case where one enterprise sells directly to the final consumer.

The reason for this conflation is probably that Marx's real analytical concern was not really with the pricing processes as such, but with the main factors influencing the realisation and distribution of new surplus-value produced, when sales occur. After all, his argument was that competition in capitalism revolves around the quest of obtaining maximum surplus-value from production in the form of generic profit income (profit, interest, rent). The question was: how does a sum of capital invested in production get transformed into a larger sum of capital? What are the dynamics and overall results of that process? What are the implications for the process of economic reproduction?

A second source of interpretive difficulty is that in his argument Marx often conflates capital advanced (to acquire inputs necessary for production) with capital consumed (that fraction of the value of inputs used up in the production of new output). He just assumes abstractly that the output created will equal the sum of input costs incurred plus surplus value, and that the sum of input costs is equal to the production capital invested, given that all output is sold. Most probably the reason was that his real interest was in the overall dynamics of capital accumulation, competition, and the realisation of surplus value produced, assuming output would sell. He was thinking of grand averages and overall results. The simplified picture does

not obtain in reality, among other things because, as Marx himself notes, capitalist competition turns on buying commodities below their value and selling them above their value (or, in the ideal competitive situation, to sell them below their value at a good profit).

Marx's theory is frequently confused with input-output economics and the marginalist theory of capital, in which total inputs and total outputs are always exactly equal, an equality accomplished by treating the factor income which is gross profit as an input. Marx did not talk about inputs and outputs in this double-entry bookkeeping sense; instead, he was concerned with how a sum of capital was transformed into a larger sum of capital through a net addition of new value created by workers in production. If indeed the value of inputs bought was exactly equal to the value of outputs sold, capitalists would not even invest in production, because they would get no profit out of it. So from Marx's point of view, input-output economics really mystified the "capital-relationship", i.e. the ability of the bourgeoisie to capitalize on the surplus labour of the workforce in virtue of its ownership of the means of production (in Capital Vol. 3, he refers satirically to the factors of production theory as the "holy trinity" of political economy).

A third source of interpretive difficulty concerns the question of what kinds of prices production prices really are. Do these prices really exist, and if so, in what way? Or are they only theoretical or ideal prices? What exactly is the "average" an "average" of? What does the "cost-price" really refer to, and at what point in the process (inputs purchased, output produced before sales, output sold)? Sometimes Marx talks about production prices as theoretical prices (equilibrium prices that would exist if supply and demand are balanced), at other times as "regulating prices" or "empirical price averages", and consequently it remains somewhat ambiguous in what way such prices exist in reality. It could in principle also be argued that some types of production prices are empirical price averages, while other ones only express theoretical price-levels.

In grappling with these issues, it must also be remembered that when Marx lived there was little macro-economic statistical data available that would enable theoretical hypotheses to be tested and relativised. Marx had deduced the motion of capital essentially from an enormous amount of economic literature he read, but when, towards the end of his life, he toyed with the idea of investigating economic fluctuations econometrically, Samuel Moore convinced him this was not possible, because relevant economic data did not exist yet. Comprehensive macro-economic data became available only half a century later.

Marx had pointed the way to solving the problems raised by the classical political economists, without however providing a complete answer. He really believed though that a "general rate of industrial profit", applying economy-wide to all industries, would be formed (in the sense of the minimally acceptable profit rate) but in truth he lacked the data to prove it. He did not discuss in any detail the difference between distributed and undistributed profit, and how this might affect profit statements. His discussion was limited to physical capital and labour employed, abstracting from ancillary costs and incomes unrelated to production which enterprises usually have (including tax imposts and subsidies).

Production prices and the transformation problem

The concept of production prices is one "building block" in Marx's theory of the "equalising tendency of the rate of profit on production capital through competition" (see Capital Vol. 3, chapter 10) which aimed to tackle a theoretical problem left unsolved by David Ricardo. This problem concerned the question of explaining how an average or "normal" return on production capital invested (e.g. 8-16%) could become established, so that capitals of equal size reaped equal profits, even although the enterprises differed in capital compositions and amounts of labour performed (see labor theory of value) and consequently generated different amounts of new value.

According to Marx, this was not simply a logical problem, a social accounting problem or theoretical problem, but a structural contradiction intrinsic to the capitalist mode of production, which had to be continually mediated. The fact that more or less value could be appropriated by investors from the labour-efforts of the workers employed, and thus that different labour efforts were unequally rewarded, was in his eyes central to the competitive process - in which the norms of labour effort continually clashed with the norms of profitability. On the surface, it looked to the individual observer as if profit yields on capital determine expenditures on labour, but in aggregate, it is - according to Marx - just the other way around, since the volume of labour-time worked determined how much profit could be distributed among capitalists.

In some interpretations of the Marxian transformation problem, total "(production) prices" for output must equal total "values" by definition, and total profits must by definition equal total surplus value. (However, Marx himself explicitly denied in chapter 49 of the third volume of Das Kapital that such an exact mathematical identity actually applies; subsequently, Frederick Engels also denied it explicitly, in a letter to Conrad Schmidt dated March 12, 1895. At best, it is an assumption used in modelling, which is justified if - as Marx believed - the divergence between total values and total production prices is quantitatively not very great, because actual labour expenditures constrain their divergence. But all this has never bothered neo-classical scholars such as Paul Samuelson in their interpretation of what Marx tried to do).

The "accounting" interpretation of production prices (value/price identity at the macro-level) by economists, according to which price distributions and value distributions can be inferred from each other, would suggest that the production price is empirically obtained from a straightforward statistical averaging of aggregated cost prices and profits. In that case, the production price is a theoretical mid-point which fluctuating actual prices would match exactly only by exception.

In another interpretation, however, the production price reflects only an empirical output price-level which dominates in the market for that output (a "norm" applying to a branch of production or economic sector, which producers cannot escape from). That is, the prevailing value proportions set a range or band within which prices will move.

Anwar Shaikh (1977) has modelled the formation and change of production prices mathematically using iterative methods. In subsequent writings, he concretizes the concept of the production price as the "regulating price" dominating the market for a type of product.

Emmanuel Farjoun and Moshe Machover (1984) reject the whole idea that a "uniform rate of profit" would ever exist in reality, contrary to Marx's suggestion that competition would tend to establish at least a minimum average rate of profit on production capital invested to produce outputs, and returns proportional to capital size.

These readings of Marx imply that traditional interpretations of the transformation problem are really rather meaningless; the apparent mathematical wizardry is based on false interpretations of the concepts involved, and the reciprocal effects of individual actions and aggregate social outcomes is overlooked. Mathematical equations cannot substitute for conceptual precision in the definition of measuring units; they can only reveal the logical and quantitative implications of concepts and measurement units.

At the beginning of Capital Vol. 3, Marx provides a clue to how he thinks the "transformation problem" is solved in reality. He implies that it can be solved only by examining capital and profit distributions as a dynamic process, rather than statically. His argument is, that what industrial competition really revolves around, is principally the difference between the value of the new commodities produced, and their cost-prices, in other words the potential surplus-value which can be realized from them. There are, in other words, constant disparities in space and time between labour-expenditures and capital returns, but also just as constant attempts to overcome or take advantage of those disparities. Thus, unrestricted economic competition has the result that the law of value regulates the trade in newly produced commodities: the ultimate limits of what products will trade for, i.e. their supply price, are set by comparative costs in labour-time.

Value and price

A lot of criticism of Marx's concept originates from the ambiguities referred to earlier. Consequently, many of the criticisms can, according to some Marxists, be dispelled simply by a more exact definition of the cost, product and revenue aggregates used, and of the timing of transactions (see e.g. Temporal Single System Interpretation).

In doing so, it must be admitted though that Marx's draft manuscript often shows sloppy use of terminology and concepts, and that Marx's purpose was often not fully explicit. At a high level of abstraction, he moves very easily and cavalierly from values to prices and back again, and restricts his discussion of "capital invested" to intermediate goods, fixed capital and labour power only.

In Marx's view, a capitalist production process was a valorisation process in which new value was formed. The theoretical problem was, that this value-forming process - the process vital for

capital accumulation - took place mainly external to the market, being bracketed by the transactions M-C (purchase of inputs, C, using money, M) and C'-M' (sales of new output, C', for more money, M'). Between the successive exchanges, however, economic value was conserved, transferred and added to. Management then tried to estimate the cost and profit implications of different tasks and activities in production for the growth of capital.

But in that case, the domains of product-values and product-prices, and consequently the domains of value relations and price relations, were separate but co-existing and overlapping domains (unless one is willing to argue that goods have an economic value only at the point where they are being sold for a price). "Price management" was not really possible insofar as prices were determined by markets which individual producers could not control, but value-based management was possible.

Goods could sell below or above their real or socially average value, and that was precisely the critical problem for capitalists, because it affected their gross income and profit margins. The wealth of capitalist society might present itself as "a mass of commodities" (as Marx himself put it), but before and after the commodities were sold, they existed outside the market as use values. At that point, they had only a value and a use-value, but not an actual market price (though obviously one could estimate an hypothetical selling price - see also real prices and ideal prices).

Thus, at the point of production, the "factors of production" themselves had no actual market price either, only a value, because they were being used to create new products, rather than being offered for sale (indeed, what a particular business enterprise was currently "worth" in total, as a going concern, might be very difficult to say; it would depend on how much profit income it was expected to yield in the future compared to the capital assets invested in it, but even if a total price could be estimated, its individual assets might change in value continuously).

A quantity of value was produced by enterprises, but how much of that value would actually be realised by an enterprise as income from sales, or how gross revenues would be distributed among producers, could not be established with certainty in advance. Yet, the value of the total masses of output-values actually produced by all enterprises affected the market prices that could be obtained by each in distribution; it affected how the market would reward each of the producers, and there was a real, systematic relationship between total value produced and total sales revenue (even although these might not be equal).

More importantly, producers were constantly adjusting their commercial behaviour to the emerging economic reality (the "state of the market"), as far as they could. And that adjustment followed a specific pattern; Marx argued it created a specific trajectory for capitalist development, guided by the quest for realizing extra surplus value.

How could this business reality best be modelled? In contemporary "value-based management" by corporations, we can witness a continual cross-reference between past prices, current prices and future prices occurring, because there is practically no other way to do it for business purposes. In the words of group controller Gerard Ruizendaal of Royal Philips Electronics,

"The main idea is to improve our economic value-added (EVA) every year so our return of capital is more than our cost of capital." (cited in "The value creation equation", Corporate Finance Magazine, March 2004).

A partner of McKinsey & Company comments:

"The guiding principle of value creation is that companies create value by using capital they raise from investors to generate future cash flows at rates of return exceeding the cost of capital (the rate investors require as payment). The faster companies can increase their revenues and deploy more capital at attractive rates of return, the more value they create. The combination of growth and return on invested capital (ROIC) relative to its cost is what drives value." - Timothy M. Koller, "Why value value? Defending against crises", McKinsey Quarterly, April 2010, excerpted from Tim Koller, Marc Goedhart, and David Wessels, Valuation: Measuring and Managing the Value of Companies (fifth edition, Hoboken, NJ: John Wiley & Sons, August 2010).

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In that case, it is impossible for the sum of input values to be exactly equal to the sum of output values. Indeed, that is exactly what, according to Marx, capitalists are in business for: to invest a sum of capital in production in order to get a larger sum of capital out of it. Marx however regarded the prices of production as the "outward expression" of the results of a valorisation process, and in order to be able to talk about price aggregates at all, he thought reference to value relations was completely unavoidable.

Not only was a value-theoretic principle required simply to group prices, relate them and aggregate them (meaning principles of value equivalence, comparable value, value transfer, value conservation, value creation and value used up or destroyed), but most of the stock of labour-products in an economy at any time had no actual price, simply because they weren't being traded. To what extent their value could be realised through exchange in the future could be known definitely only "after the fact", i.e. after they were actually sold and paid for. In the meantime, one could only hypothesize about their price, working from previous data. But in the final analysis, the attribution of value to products implied a social relation, without which value relations could not be understood. A community of independent private producers expressed their co-existence and mutual adjustment through the trading prices of their products; how they were socially related was expressed through the forms of value.

Facts and logic

The concept of "average profit" (a general profit rate) suggested that a process of competition and market-balancing had already established a uniform (or ruling average, or normal) profit rate previously; yet, paradoxically, what profit volumes would be (and consequently profit rates) could be established only after sales, by deducting costs from gross revenues. An output was produced before it was definitively valued in markets, yet the quantity of value produced affected the total price for which it was sold, and there was a sort of "working knowledge" of normal returns on capital. This was a dynamic business reality Marx sought to model in a simple way.

But Marx's critics interpreting his models often argue he keeps assuming what he needs to explain, because rather than really "transforming values into prices" by some quantitative mapping procedure, such that prices are truly deduced from labour-values, he either (1) equates values and prices, or else (2) he combines both values and prices in one equation.

Thus, for example, either Marx infers a rate of profit from a given capital composition and a given quantity of surplus-value, or else he assumes a rate of profit in order to find the amount of surplus-value applying to a given quantity of capital invested. That might be fine if the aim is to just investigate what profit an enterprise or sector would receive on average, having produced a certain output value with a certain capital composition. But this manoeuvre of itself cannot contain any formal proof of a necessary quantitative relationship between values and prices, nor a formal proof that capitals of the same size but different compositions (and consequently different expenditures of labour-time) must obtain the same rate of profit. It remains only a theory.

Marx insists both that output prices obtained will necessarily deviate from values produced, but also that the sum of prices would equal to the sum of values in the pure case, yet, critics claim, he fails to show quantitatively how a distribution process could then occur such that price magnitudes map onto value magnitudes, and such that a uniform profit rate returns equal profits to capitals of equal sizes (a mapping relation is used here in the mathematical sense of a bijective morphism, involving one-to-one correspondence between value quantities and price quantities via mathematical equations). In that case, there is again no formal proof of any necessary relationship between values and prices, and Marx's manuscript really seems an endless, pointless theoretical detour leading nowhere. In modelling, simple logical paradoxes appear of the type that:

in a static model, it is impossible to uphold the postulate of a uniform rate of profit and the postulate of total values=total prices at the same time;

to find production-prices, a uniform rate of profit must be assumed, while at the same time to find a uniform rate of profit, production-prices must already be assumed;

a price level must be assumed, rather than be deduced from labour-values.

All these conceptual and logical issues mentioned become crucial when attempts are made to model value and price aggregates mathematically to study capitalist competition. Different kinds of theoretical assumptions or interpretations will obviously lead to very different results.

But whatever view one takes, no one can evade the (either simultaneous or sequential) reciprocal effects of individual business behaviour and aggregate economic outcomes. Additionally, it must also be recognised that "prices" are not all of one kind; actual market prices realised are not the same as ideal prices of various kinds, which may be extrapolated from real prices.

A more serious criticism of Marx is that the theory of prices of production is still pitched at a far too abstract theoretical level to be able to explain anything like specific real price movements. That is, Marx only illustrated with examples the general results towards which the competitive process would tend to move in capitalism as a social system. He tried to establish what regulates product prices in the "purest case". He believed that if one could not do that, then one could also not explain all the variations from the pure case. He had not however provided a model for accurately predicting specific price movements. In this regard, it is interesting to study the writings of Michael Porter, in order to see how Marx's original intent relates to modern competitive business practice, and how it might be elaborated on (see further the important studies by Willi Semmler (1984) and Christian Bidard (2004)).

Some critics conclude that because Marx fails to "transform" value magnitudes into price magnitudes in a way consistent with formal logic, he has not proved value exists, or that it influences prices; in turn, his theory of labour-exploitation must be false. But the validity of Marx's value theory or his exploitation theory may not depend on the validity of his specific transformation procedures, and Marxian scholars indeed often argue that critics mistake what he intended by them. In particular, since value relations - according to Marx - describe the proportionalities between average quantities of labour-time currently required to produce products, value proportions between products exist quite independently of prices.

Essentially, the advantage of distinguishing sharply between values and prices in this context is that it enables us to depict the interaction between shifts in product-values and shifts in product-prices as a dynamic process of real-world business and market behaviour, given the reality of different growth rates of supply and demand, i.e. not a study of the conditions for market balance, but a study of the actual process of market balancing occurring with a specific social framework, through successive adjustments which occur in a specific pattern.

Arguably ideal prices could substitute for values in this analysis, but Marx's argument is that product-values will, ontologically speaking, really exist irrespective of corresponding product-prices, i.e. irrespective of whether product-values are actually being traded, whereas ideal prices do not really exist other than in computations; they are only an hypothetical description. This type of analysis paves the way for an important new Marxian criticism of Piero Sraffa's otherwise brilliant critique of capital theory.

Some economists and computer scientists, such as Prof. Anwar Shaikh and Dr. Paul Cockshott, argue with statistical evidence that even just a "93% Ricardian labour theory of value" is a better empirical predictor of prices than other theories. That is, the only real proofs of Marx theory and its applicability, beyond showing its internal logical consistency, are to be found in the evidence of experience. But whether more scholars will take up this challenge for research more comprehensively remains to be seen. Mostly, economists have preferred to build mathematical models on the basis of a bunch of assumptions, rather than comprehensively investigate available data for the purpose of creating a grounded theory of economic life.

One possible solution to the "transformation problem", ignored in the literature, is that Marx tried to sketch a redistribution of value in too simplistic terms, considering the transactions between different production capitals in abstraction from the total circuit of capital. The problem that Ricardo failed to solve, was one of how capitals of equal sizes could empirically attract very similar profits, despite empirically manifest unequal expenditures of labour-time. But that problem may be solved, if we properly consider competition in the sphere of capital finance, i.e. the sphere of credit. In this sense, David Harvey for example mentions that "the growing power of the credit system in relation to industry also tends to force an equalization of the rate of profit .