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Research paper topic: Ricardos Theory Of Value - 3462 words
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Ricardo`s Theory Of Value One of the enduring questions of economics is "Where do profits come from?" One of the ways in which economic philosophers have tried to answer it is by first answering the question of value. At the center of most economic paradigms is a Theory of Value. The classical political economists found value to be determined in production; since most of the cost of production could be reduced to labour, this approach was refined into The Labour Theory of Value. Neoclassical economists looked for value in the market act of exchange and developed the Marginal Theory of Value. Both of these theories are currently under challenge by the post-Keynesians with their Sraffian Theory of Value, which, like the labour theory of value, is based on production rather than exchange.
Any theory of value in economics is an extremely abstract formulation: in fact, value theory is the major intersection between economics and philosophy. For millennia, literally, scholars and theorists have tried to deduce how items attained their 'value'. From pre-Christian to pre-Keynesian times, various strands of thought have proposed (often divergent) explanations for this phenomenon. For instance, economists sometimes use the term "theory of value" to mean quite different things. Here, the term is used to denote a theory that attempts to explain long-run prices in a capitalist economy.
But there are also theories of value which attempt to explain what prices should be. Medieval scholars used the concept of just price, which was the price that would allow the producer to earn a living appropriate to his social position. Some Institutionalists have introduced similar concepts - such as normative value or reasonable value. Whatever their explanations, theories of value are at the heart of two of the major themes: i-) the distribution of wealth and income; and ii-)the maintenance of microeconomic order. A Brief History of Value Theory The debate on the theory of value, which was initiated in Ancient Greece and which became inactive during the Middle Ages, later re-emerged at the close of the seventeenth century to dominate economic thought for the next 200 years. Even today its primary importance is such that Schumpeter claimed that "the problem of value must always hold the pivotal position, as the chief tool of analysis in any pure theory that works with a rational schema." Similar hypothetical solutions varied from time to time.
Considering that this piece is hyperbolic in scope, shall, I would narrow down the analysis to the following structure. Firstly, I would try to overview sketching Aristotelian, Scholastic and Mercantilistic views on value. Secondly, I will follow an analysis of the contribution of pre-classicalist writers like Petty, Cantillon, Galiani and Law to the debate. Thirdly, the supply oriented theory of value put forward by classical economists like Smith, Ricardo, Marx and Mill shall be examined. Fourthly, Jevons and Mengers' neo-classical attempt to replace the classicalists with their demand-oriented theory of value will be considered.
Finally, both Walras' and Marshall's respective resolution to the conflict shall be investigated by individually accommodating the interactions of both supply and demand as determinants of value within their overall economic framework. Early Economic Thought The first great landmark in the long and tortuous intellectual struggle with the riddle of value, was laid by the philosophers of the Athenian Academy in the 4th century BC. It was Aristotle (384-322) who held that the source of value was based on need, without which exchange would not take place. Originally, it was he who distinguished between value in use and value in exchange- "Of everything which we possess, there are two uses; For example a shoe is used for wear and it is used for exchange". While the Scholastics later adopted and accommodated these views to Christian thought, like the Aristotelian philosophers before them, economics was not regarded as an independent discipline but merely as an integral part of ethical and moral philosophy.
As a result, the debate on value was centred and henceforth retarded by a normative approach - what value should 'justly' be, instead of what actually is. During this period, utility was widely held as the determinant of value with only a minority of theorists such as St. Thomas Aquinas (1225-1274) and John Duns Scotus (1265-1308) taking note of the cost of the production side. The search concerning value was continued in the direction of utility by early mercantilists during the 16th and the first half of the 17th century. The supremacy of this argument was highlighted in 1588 when Bernardo Davanzati unsuccessfully attempted to construct a utility theory of value in Lecture On Money.
It is not surprising that they concentrated on the determinants of the demand for goods (utility), since the merchants' profits depended on the exploiting of the difference between the market buying and the selling prices rather than controlling the production process. For medieval theorists, value depended not on any intrinsic value but on utility and scarcity. Shakespeare's Richard III battle plea "A horse, a horse, my kingdom for a horse" epitomises the subjective approach to value of this era. Yet despite the failings and limitation of this one-sided method, this period is viewed as embryonic with regard to value theories, and one which would issue subsequent economic developments. Pre-Classical Thought It was only at the end of the seventeenth century when economists following a Cartesian philosophy of deduction, broke away from the dominant mercantilistic utility view and looked for a solution in the cost of production.
William Petty (1623-1687) who was influenced by the scientific advances of his era abandoned the subjective theory of value and instead objectively searched for the natural and intrinsic laws of reality - of which 'natural value' was one of them. According to Petty, the market price ('actual price') of any commodity would fluctuate perpetually around its natural value ('natural price'). The determinants of this natural value were deduced as the factors of production - land and labour. In keeping with his mathematical nature, Petty attempted to reduce his theory of value to a labour one only, by looking for a 'par' value for land in terms of labour forces. In the political Anatomy of Ireland (1691), he states that the unit of measure consisted of "The easiest-gotten food of the respective countries of the world"- average daily diet necessary to sustain a worker.
Although he successfully anticipated the classical-Marxian theory of subsistence wages and surplus, he also inherited the endless difficulties associated with a labour cost theory of value. Richard Cantillon (168?-1734) who was another practitioner of the Cartesian approach also began with the labour-and-land theory of value. Although, similar to Petty in that he reduces the determinants of intrinsic value in terms of one factor, unlike him, Cantillon, who was influenced by French agrarian protectionists, chose land. Cantillon finds his 'par' value by equating the value of a labourer with that of twice the produce of the land he consumes, while allowing for variations in the labourers' skills and status. Once this 'par' value is calculated, the intrinsic values of any good can be reduced to land only.
With his assumptions of constant returns to scale, Cantillon provides us with his land theory of value. He also originally shows us how resources were allocated between different markets when the market price diverge from his intrinsic 'land' value. Unfortunately, Cantillon's land theory, like Petty's labour theory, was only a true description of value in highly specific cases. Meanwhile the medieval subjective approach to value was continued by another branch of pre-classical economists, which included people like Nicholas Barbon (1640-1698) who thought that the natural value of goods was simply represented by their market price. For him "the value of all wares arise from their use; things of no use, have no value, as the English phrase is, they are good for nothing". Furthermore, on the continent, the Italian Ferdinando Galiani (1728-1787) borrowed the early mercantilistic writings of Davanzati and Montanari on the subjective nature of value.
He devoted his time to developing a theory of utility value and even implicitly described the notion of diminishing marginal utility. His deductions just "lacked the concept of marginal utility" of the neo-classical economists, Jevons and Menger. Although Galiani vaguely accounted for the cost of production in his utility value theory, he failed to develop it into a fully-fledged supply and demand analysis. The Scotsman John Law (1671-1729) took up this monumental project. In his Essay on a Land Bank, Law outlined the old water / diamond paradox of value, in which comparatively 'useless' diamonds are more highly valued than the more'useful' water and reconciled the mystery by using a supply and demand analysis. Unlike his predecessors and his immediate successors (until Walras and Marshall), Law used both demand and supply factors in determining the value of a good which has a use in society.
Henceforth any changes in the value of goods were due to a change in the quantity supplied or demanded. Although John Locke (1632-1704) in, Some Considerations on the Consequences of Lowering of Interest and the Raising the Value of Money, had developed a theory of price determination earlier, it lacked the clarity, precision and understanding of Law. In Money and Trade Considered, Law corrects Locke's unpolished value by stating that "The prices of goods are not according to the quantity in proportion to the vent, but in proportion to the demand" . Surprisingly, Law's early solution to value theory gained little following owing probably to his failed financial operations in France. Even more surprisingly has been the reduction of Law's contributions in this area to mere footnotes in the mainstream economic history books.
Unfortunately, for the development of value theory, this dualistic analysis was suppressed for almost 200 years, until its resurrection at the close of the 19th century. Classical Thought The publication of Adam Smith's (1723-1790) Wealth of Nations in 1776 heralded the rise of the classical school and swung the value debate back towards Petty's objective labour theory of value. According to J. Niehans, the classical emphasis on the labour cost was "a step backward" compared to the pre-classical analysis. The classical political economists shared three major points in their approach to developing a theory of value. First, all the classical economists thought it necessary to start their investigations of capitalism with the question of value. Second, all the classical economists searched for value in the conditions of production.
It was in the workshop or the factory, not the marketplace, that goods acquired their particular values. Third, although they had somewhat different reasons, all the classical economists subscribed to one form or another of a subsistence theory of wages. That meant that the cost of labour was itself equal to the value of the goods and services that a working-class family needed in order to get by. Smith: Adding-Up of Costs Adam Smith found value - which he called "natural price"- by adding the costs of production. In a society without private ownership of land and which used only the simplest of tools, labour would make up the entire cost of production: If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for, or be worth two deer. It is natural that what is usually the produce of two days' or two hours' labour, should be worth double of what is usually the produce of one day's or one hour's labour.
The Wealth of Nations, Book 1, Chapter 6 But this simple measure of value is not sufficient for the more complex production processes and property ownership patterns of capitalism. When the worker is hired by a capitalist, use equipment owned by the capitalist, and works with raw materials purchased by the capitalist, there will normally be profit: In the price of commodities, therefore, the profits of stock [capital] constitute a component part altogether different from the wages of labour, and regulated by quite different principles. The Wealth of Nations, Book 1, Chapter 6 By "quite different principles," Smith means that the worker is paid by the hour of labour while the capitalist is "paid" by the amount of capital and the length of time that the capital is engaged in that production process. Whenever a product involves the use of land, there will be a third component included in its price: As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them.
He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part. The Wealth of Nations, Book 1, Chapter 6 The real value, then, of any commodity, will be the sum of the labour cost and the profit plus any rent. Even though the capitalist purchase raw materials as well as labour, the raw materials - and anything else the capitalist purchases from other capitalists - can in turn be broken down into labour, profit and rent. Adding Up of Costs We can fabricate a simple example along the lines suggested by Smith.
A capitalist in the pig-raising business produces 1,000 pigs per year. Their value can be determined by adding up the capitalist's normal costs. There are 50 labourers at 20 per year each, for a total direct labour cost of 1,000 per year. Raw materials run 600 per year. Replacement of worn out tools and building repair (depreciation) comes to 50 per year.
This enterprise requires 100 acres of land at 2 per acre per year, or 200 per year in land rent. The capitalist will need to have a total of 1,500 tied up in the business. Some of this will represent investment in buildings and tools, but most of it will be operating capital - workers and suppliers have to be paid before the capitalist sells the pigs. If the normal profit rate is 10%, our capitalist will need to get 150 per year as "compensation" for having 1,500 tied up in the business. Since the total costs, including the 150 of profit, come to 2,000 per year, the natural price of pigs will be 2 per pig. I think it is important to note that labour makes up most of the cost.
In this example, direct labour is only half of the total cost. But if we opened the books of the businesses that supplied the raw materials and replaced the worn out tools we would find their costs can also be broken down into labour, profit, rent and supplies. Then we could look into the costs of their suppliers, and so on. About one-third (actually, 32.5%) of the costs in this example - raw materials and replacing worn out equipment - are subject to this process. If the costs in these supplier industries are proportional to the costs in the pig industry, (There is no reason that they should be, but assuming so makes the arithmetic easier )then half of these supply costs could be attributed to labour, then half of their supply costs, then half of those firms' supply costs.
When we add it all, we find that labour costs are close to 75% of total costs; considerably higher than the 50% figure that we get by only looking at direct labour costs. The Value of Labour The next step is to investigate the value of labour itself. According to Smith, nature sets the "minimum" wage: A man must always live by his work, and his wages must at least be sufficient to maintain him. They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family, and the race of such workmen could not last beyond the first generation. The Wealth of Nations, Book 1, Chapter 8 It is difficult for wages to rise much above this minimum. Smith partially attributes this to inequality of bargaining power. The power of the worker to withhold his labour is far weaker than the power of the employer to withhold access to employment: A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks [capital] which they have already acquired.
Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate. The Wealth of Nations, Book 1, Chapter 8 This "natural" inequality was supplemented by legal inequality. When Smith was writing The Wealth of Nations - and for another fifty years thereafter - British workers were prohibited from forming unions and bargaining collectively. There were no similar prohibitions on employers: We rarely hear, it has been said, of the combinations of masters, though frequently those of workmen.
But whoever imagines, upon this account, that masters rarely combine, is as ignorant of the world as of the subject. Masters are always and everywhere in a sort of tacit, but constant and uniform, combination, not to raise the wages of labour above their actual rate. To violate this combination is everywhere a most unpopular action, and a sort of reproach to a master among his neighbors and equals. We seldom, indeed hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of. Masters, too, sometimes enter into particular combinations to sink the wages of labour even below this rate.
The Wealth of Nations, Book 1, Chapter 8 Yet there were sometimes forces leading wages upward. Rapid economic growth can create a shortage of labour. The reinvestment of profits will lead to ever-greater employment. However, higher wages, by improving living conditions and thus reducing infant and child mortality, quickly lead "to the great multiplication of the species." The race between the demand for labour and the supply of labour will eventually be won by the supply of labour and wages will once again fall to the "lowest rate, which is consistent with common humanity." Additionally, labour of greater skill or difficulty will itself take on a natural price in terms of common labour: If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour's labour in the one way may frequently exchange for that of two hours' labour in the other. Or if the one species of labour requires an uncommon degree of dexterity and ingenuity, the esteem which men have for such talents, will naturally give a value to their produce, superior to what would be due to the time employed about it. Such talents can seldom be acquired but in consequence of long application, and the superior value of their produce may frequently be more than a reasonable compensation for the time and labour which must be spent in acquiring them.
The Wealth of Nations, Book 1, Chapter 6 The Role of Value Value, or "natural price" is a central concept in Smith's work. Temporary deviations of market price from natural price provide his capitalists with their production directions. When the market price is above the natural price, profits will also be above their natural rates. New capital will be drawn to such an industry until increased production brings prices and profits down to their natural rates. When the market price is below the natural price, profits will also be below their natural rates.
Capital will leave such an industry until decreased production brings prices and profits up to their natural rates. The natural price, in turn, is determined by the costs of production. The costs of production can be broken down into labour costs, rent and profit. Labour has its natural price, which is the cost of the goods and services the workers need in order to work and raise families. But how is the natural rate of profit determined? Or the natural rate of rent? Smith has not provided us with either an economic or sociological principle which would establish either of these rates.
He leaves us with an incomplete theory of value. Indeed, Smith who borrowed the water / diamond paradox from Law without acknowledging it, failed to resolve t ...
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