Ricardo`s Theory Of Value Essay, Research Paper
One of the enduring questions
of economics is "Where do profits come from?" One of the ways in which
economic philosophers have tried to answer it is by first answering the question
of value. At the center of most economic paradigms is a Theory of Value. The
classical political economists found value to be determined in production; since
most of the cost of production could be reduced to labour, this approach was
refined into The Labour Theory of Value. Neoclassical economists looked for
value in the market act of exchange and developed the Marginal Theory of Value.
Both of these theories are currently under challenge by the post-Keynesians with
their Sraffian Theory of Value, which, like the labour theory of value, is based
on production rather than exchange. Any theory of value in economics is an
extremely abstract formulation: in fact, value theory is the major intersection
between economics and philosophy. For millennia, literally, scholars and
theorists have tried to deduce how items attained their ‘value’. From
pre-Christian to pre-Keynesian times, various strands of thought have proposed
(often divergent) explanations for this phenomenon. For instance, economists
sometimes use the term "theory of value" to mean quite different
things. Here, the term is used to denote a theory that attempts to explain
long-run prices in a capitalist economy. But there are also theories of value
which attempt to explain what prices should be. Medieval scholars used the
concept of just price, which was the price that would allow the producer to earn
a living appropriate to his social position. Some Institutionalists have
introduced similar concepts – such as normative value or reasonable value.
Whatever their explanations, theories of value are at the heart of two of the
major themes: i-) the distribution of wealth and income; and ii-)the maintenance
of microeconomic order. A Brief History of Value Theory The debate on the theory
of value, which was initiated in Ancient Greece and which became inactive during
the Middle Ages, later re-emerged at the close of the seventeenth century to
dominate economic thought for the next 200 years. Even today its primary
importance is such that Schumpeter claimed that "the problem of value must
always hold the pivotal position, as the chief tool of analysis in any pure
theory that works with a rational schema." Similar hypothetical solutions
varied from time to time. Considering that this piece is hyperbolic in scope,
shall, I would narrow down the analysis to the following structure. Firstly, I
would try to overview sketching Aristotelian, Scholastic and Mercantilistic
views on value. Secondly, I will follow an analysis of the contribution of
pre-classicalist writers like Petty, Cantillon, Galiani and Law to the debate.
Thirdly, the supply oriented theory of value put forward by classical economists
like Smith, Ricardo, Marx and Mill shall be examined. Fourthly, Jevons and
Mengers’ neo-classical attempt to replace the classicalists with their
demand-oriented theory of value will be considered. Finally, both Walras’ and
Marshall’s respective resolution to the conflict shall be investigated by
individually accommodating the interactions of both supply and demand as
determinants of value within their overall economic framework. Early Economic
Thought The first great landmark in the long and tortuous intellectual struggle
with the riddle of value, was laid by the philosophers of the Athenian Academy
in the 4th century BC. It was Aristotle (384-322) who held that the source of
value was based on need, without which exchange would not take place.
Originally, it was he who distinguished between value in use and value in
exchange- "Of everything which we possess, there are two uses; For example
a shoe is used for wear and it is used for exchange". While the Scholastics
later adopted and accommodated these views to Christian thought, like the
Aristotelian philosophers before them, economics was not regarded as an
independent discipline but merely as an integral part of ethical and moral
philosophy. As a result, the debate on value was centred and henceforth retarded
by a normative approach – what value should ‘justly’ be, instead of what
actually is. During this period, utility was widely held as the determinant of
value with only a minority of theorists such as St. Thomas Aquinas (1225-1274)
and John Duns Scotus (1265-1308) taking note of the cost of the production side.
The search concerning value was continued in the direction of utility by early
mercantilists during the 16th and the first half of the 17th century. The
supremacy of this argument was highlighted in 1588 when Bernardo Davanzati
unsuccessfully attempted to construct a utility theory of value in Lecture On
Money. It is not surprising that they concentrated on the determinants of the
demand for goods (utility), since the merchants’ profits depended on the
exploiting of the difference between the market buying and the selling prices
rather than controlling the production process. For medieval theorists, value
depended not on any intrinsic value but on utility and scarcity. Shakespeare’s
Richard III battle plea "A horse, a horse, my kingdom for a horse"
epitomises the subjective approach to value of this era. Yet despite the
failings and limitation of this one-sided method, this period is viewed as
embryonic with regard to value theories, and one which would issue subsequent
economic developments. Pre-Classical Thought It was only at the end of the
seventeenth century when economists following a Cartesian philosophy of
deduction, broke away from the dominant mercantilistic utility view and looked
for a solution in the cost of production. William Petty (1623-1687) who was
influenced by the scientific advances of his era abandoned the subjective theory
of value and instead objectively searched for the natural and intrinsic laws of
reality – of which ‘natural value’ was one of them. According to Petty, the
market price (’actual price’) of any commodity would fluctuate perpetually
around its natural value (’natural price’). The determinants of this natural
value were deduced as the factors of production – land and labour. In keeping
with his mathematical nature, Petty attempted to reduce his theory of value to a
labour one only, by looking for a ‘par’ value for land in terms of labour
forces. In the political Anatomy of Ireland (1691), he states that the unit of
measure consisted of "The easiest-gotten food of the respective countries
of the world"- average daily diet necessary to sustain a worker. Although
he successfully anticipated the classical-Marxian theory of subsistence wages
and surplus, he also inherited the endless difficulties associated with a labour
cost theory of value. Richard Cantillon (168?-1734) who was another practitioner
of the Cartesian approach also began with the labour-and-land theory of value.
Although, similar to Petty in that he reduces the determinants of intrinsic
value in terms of one factor, unlike him, Cantillon, who was influenced by
French agrarian protectionists, chose land. Cantillon finds his ‘par’ value by
equating the value of a labourer with that of twice the produce of the land he
consumes, while allowing for variations in the labourers’ skills and status.
Once this ‘par’ value is calculated, the intrinsic values of any good can be
reduced to land only. With his assumptions of constant returns to scale,
Cantillon provides us with his land theory of value. He also originally shows us
how resources were allocated between different markets when the market price
diverge from his intrinsic ‘land’ value. Unfortunately, Cantillon’s land theory,
like Petty’s labour theory, was only a true description of value in highly
specific cases. Meanwhile the medieval subjective approach to value was
continued by another branch of pre-classical economists, which included people
like Nicholas Barbon (1640-1698) who thought that the natural value of goods was
simply represented by their market price. For him "the value of all wares
arise from their use; things of no use, have no value, as the English phrase is,
they are good for nothing". Furthermore, on the continent, the Italian
Ferdinando Galiani (1728-1787) borrowed the early mercantilistic writings of
Davanzati and Montanari on the subjective nature of value. He devoted his time
to developing a theory of utility value and even implicitly described the notion
of diminishing marginal utility. His deductions just "lacked the concept of
marginal utility" of the neo-classical economists, Jevons and Menger.
Although Galiani vaguely accounted for the cost of production in his utility
value theory, he failed to develop it into a fully-fledged supply and demand
analysis. The Scotsman John Law (1671-1729) took up this monumental project. In
his Essay on a Land Bank, Law outlined the old water / diamond paradox of value,
in which comparatively ‘useless’ diamonds are more highly valued than the more
‘useful’ water and reconciled the mystery by using a supply and demand analysis.
Unlike his predecessors and his immediate successors (until Walras and
Marshall), Law used both demand and supply factors in determining the value of a
good which has a use in society. Henceforth any changes in the value of goods
were due to a change in the quantity supplied or demanded. Although John Locke
(1632-1704) in, Some Considerations on the Consequences of Lowering of Interest
and the Raising the Value of Money, had developed a theory of price
determination earlier, it lacked the clarity, precision and understanding of
Law. In Money and Trade Considered, Law corrects Locke’s unpolished value by
stating that "The prices of goods are not according to the quantity in
proportion to the vent, but in proportion to the demand" . Surprisingly,
Law’s early solution to value theory gained little following owing probably to
his failed financial operations in France. Even more surprisingly has been the
reduction of Law’s contributions in this area to mere footnotes in the
mainstream economic history books. Unfortunately, for the development of value
theory, this dualistic analysis was suppressed for almost 200 years, until its
resurrection at the close of the 19th century. Classical Thought The publication
of Adam Smith’s (1723-1790) Wealth of Nations in 1776 heralded the rise of the
classical school and swung the value debate back towards Petty’s objective
labour theory of value. According to J. Niehans, the classical emphasis on the
labour cost was "a step backward" compared to the pre-classical
analysis. The classical political economists shared three major points in their
approach to developing a theory of value. First, all the classical economists
thought it necessary to start their investigations of capitalism with the
question of value. Second, all the classical economists searched for value in
the conditions of production. It was in the workshop or the factory, not the
marketplace, that goods acquired their particular values. Third, although they
had somewhat different reasons, all the classical economists subscribed to one
form or another of a subsistence theory of wages. That meant that the cost of
labour was itself equal to the value of the goods and services that a
working-class family needed in order to get by. Smith: Adding-Up of Costs Adam
Smith found value – which he called "natural price"- by adding the
costs of production. In a society without private ownership of land and which
used only the simplest of tools, labour would make up the entire cost of
production: If among a nation of hunters, for example, it usually costs twice
the labour to kill a beaver which it does to kill a deer, one beaver should
naturally exchange for, or be worth two deer. It is natural that what is usually
the produce of two days’ or two hours’ labour, should be worth double of what is
usually the produce of one day’s or one hour’s labour. The Wealth of Nations,
Book 1, Chapter 6 But this simple measure of value is not sufficient for the
more complex production processes and property ownership patterns of capitalism.
When the worker is hired by a capitalist, use equipment owned by the capitalist,
and works with raw materials purchased by the capitalist, there will normally be
profit: In the price of commodities, therefore, the profits of stock [capital]
constitute a component part altogether different from the wages of labour, and
regulated by quite different principles. The Wealth of Nations, Book 1, Chapter
6 By "quite different principles," Smith means that the worker is paid
by the hour of labour while the capitalist is "paid" by the amount of
capital and the length of time that the capital is engaged in that production
process. Whenever a product involves the use of land, there will be a third
component included in its price: As soon as the land of any country has all
become private property, the landlords, like all other men, love to reap where
they never sowed, and demand a rent even for its natural produce. The wood of
the forest, the grass of the field, and all the natural fruits of the earth,
which, when land was common, cost the labourer only the trouble of gathering
them, come, even to him, to have an additional price fixed upon them. He must
then pay for the licence to gather them; and must give up to the landlord a
portion of what his labour either collects or produces. This portion, or, what
comes to the same thing, the price of this portion, constitutes the rent of
land, and in the price of the greater part of commodities makes a third
component part. The Wealth of Nations, Book 1, Chapter 6 The real value, then,
of any commodity, will be the sum of the labour cost and the profit plus any
rent. Even though the capitalist purchase raw materials as well as labour, the
raw materials – and anything else the capitalist purchases from other
capitalists – can in turn be broken down into labour, profit and rent. Adding Up
of Costs We can fabricate a simple example along the lines suggested by Smith. A
capitalist in the pig-raising business produces 1,000 pigs per year. Their value
can be determined by adding up the capitalist’s normal costs. There are 50
labourers at ?20 per year each, for a total direct labour cost of ?1,000 per
year. Raw materials run ?600 per year. Replacement of worn out tools and
building repair (depreciation) comes to ?50 per year. This enterprise requires
100 acres of land at ?2 per acre per year, or ?200 per year in land rent. The
capitalist will need to have a total of ?1,500 tied up in the business. Some of
this will represent investment in buildings and tools, but most of it will be
operating capital – workers and suppliers have to be paid before the capitalist
sells the pigs. If the normal profit rate is 10%, our capitalist will need to
get ?150 per year as "compensation" for having ?1,500 tied up in the
business. Since the total costs, including the ?150 of profit, come to ?2,000
per year, the natural price of pigs will be ?2 per pig. I think it is important
to note that labour makes up most of the cost. In this example, direct labour is
only half of the total cost. But if we opened the books of the businesses that
supplied the raw materials and replaced the worn out tools we would find their
costs can also be broken down into labour, profit, rent and supplies. Then we
could look into the costs of their suppliers, and so on. About one-third
(actually, 32.5%) of the costs in this example – raw materials and replacing
worn out equipment – are subject to this process. If the costs in these supplier
industries are proportional to the costs in the pig industry, (There is no
reason that they should be, but assuming so makes the arithmetic easier )then
half of these supply costs could be attributed to labour, then half of their
supply costs, then half of those firms’ supply costs. When we add it all, we
find that labour costs are close to 75% of total costs; considerably higher than
the 50% figure that we get by only looking at direct labour costs. The Value of
Labour The next step is to investigate the value of labour itself. According to
Smith, nature sets the "minimum" wage: A man must always live by his