History of Economic Thought on What Governs Value
Adam Smith
Adam Smith maintained three theories on how value or the relative prices of goods are determined (Blaug, 19855). He spoke of value in terms of the amount of labour required to produce a commodity in his labour command theory of value (labour-commanded). He explains that The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. Further, he provides a distinction between use-value and exchange-value of a commodity (Niehans, 1990). The use-value of a commodity is its utility which has little or no value in exchange. On the other hand, the exchange-value of a commodity, its price, with which this commodity exchanges for another commodity and which has no value in use. As explained by 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 (Smith, Book 1, chapter V).
However, this concept of value of Smith is somewhat ambiguous, leading to what later be known as water-diamond paradox (Ekelund Hebert, 1997). His example was a glass of water which has value in use but no value in exchange versus diamonds with no value in use but of great importance in exchange. His focus was on total utility of water which is greater than that of diamonds. It was not established then that the marginal utility is of the essence in consumption which eventually decreases as more and more of that commodity is consumed (Myint, 1946). The price or the value of a commodity depends not on its total utility but on its marginal utility. He was not able to neither solve the water-diamond paradox nor establish a relationship between use-value and exchange value.
Smiths second theory, labour cost theory of value (labour- embodied), provides that the exchange value or the price of a commodity in an economy which precedes both the accumulation of stock and the appropriation of land, the amount of labour is the only sound measure for acquiring different objects (Smith, Book 1, Chapter VI). Given this, the whole produce of the labourer belongs to himher and the amount of labour required in acquiring or producing any commodity is the only factor to consider in purchasing, commanding and exchanging it for.
Finally, Smiths cost of production theory or relative prices factor in the payments of wages, rents and profits. According to him, labour is not the only thing to consider in putting a price in a commodity but also land and capital once most land in the country has become privatized. In his own words
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 (Smith, Book 1, Chapter VI).
Karl Marx would later on call this as Smiths adding up theory of value (Myint, 1946).
David Ricardo
David Ricardo developed his theory of value mainly as a response to the controversial Corn Law (Niehans, 1990). Protectionist and many writers, chiefly Malthus, used Adam Smiths cost of production theory of value to argue that raising tariffs on the importation of grain would be beneficial to England. However, Ricardo advocated free international trade and tariff bans for English economic development. He wanted to prove that Adam Smith was wrong and that tariffs would reduce the rate of profits, implying slower rate of capital accumulation and growth. Further, he wanted to show the negative economic impact of the Corn Laws on the distribution of income and that the prevailing economic theory had nothing to say about income distribution.
Ricardo developed the Economic Value Theory by changing the focus from attempting to explain the forces that determine the relative prices of the good to the economic factors that causing the relative prices to change over time (Schumpeter, 1954). For him, only labour embodied theory of value or LTV made sense, i.e. the argument that the relative natural prices of commodities are determined by the amount of labour expended in production. Prices, per se, do not correspond with value but to the relative amount of labour required in their production. He criticized Smiths labour commanded and adding up theories of value which embodied wages and thus income distribution. Ricardo maintained that value was independent of distribution.
Unlike Smith who could not merry the use value and the exchange value of commodity, Ricardo stated that the use value is necessary for the exchange value to exist (Ekelund Hebert, 1997). In modern terminology, this means that a demand must exist to command a price. However, demandutility does not measure price but the scarcity and the amount of labour required to produce them. For scarce commodities, Ricardo maintained that his LTV would not be applicable and their value is wholly independent of the quantity of labour originally necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them (Schumpeter, 1954).
Karl Marx
Karl Marx was profoundly influenced by Ricardos ideas and theories (Blaug, 1985). His Labor Theory of Value was in fact originated from Ricardo. But in contrast, his focus on the nature of value was intended to scratch beneath the surface of modern capitalist system of production and exchange. The fact that these are social institutions means that they have social consequences. Capitalism, founded on a principle of private ownership, has the owners of the means of production (factories, raw materials) dependant on wage labor to create profits. Marxs point is that the production of commodities is a social process, dependent on exploitation and giving rise to antagonistic relationships among classes, an idea that is not addressed at all in modern economics.
Marx provided a clear distinction between use value and exchange value but maintained that these two were vitally related (Schumpeter, 1954). The former means the usefulnessutilitysatisfaction which the possessor derived from utilization of the commodity. This is a subjective value, relative to use value of other things consumed. By exchange value, Marx means the power of the thing to command all other things in exchange for it. Given that Marx was analyzing value in the context of a capitalist economy characterized by specialization and complex exchange system, he saw the evidence of not only the use value but exchange value of mass produced things.
Marx redefined Ricardos theory of value by stating that the value of a commodity was the social labor that was put in its production and such value could be measured by the quantity of the labor contained in it (Blaug, 1985). According to him, a commodity has value because it is a product of social labor. The greatness of its value, or its relative value, depends on how much social substance contained in it or the relative mass of labor necessary for its production. The relative values of commodities are, therefore, determined by the respective quantities or amounts of labor, worked up, realized, fixed in them. In this sense every commodity is a symbol of human toil.
Neoclassical School of Thought
The works of the above-mentioned economists belonged to the classical economics of the 18th and 19th century, who mainly focused on value theory and distribution theory (Niehans, 1990). The value of a product was thought to depend on the costs involved in producing that product and the explanation of costs was simultaneously an explanation of distribution. However, some economists begun diverting from these emphasis and started looking at the perceived value of a good to the consumer. They proposed a theory that the value of a product was to be explained with differences in utility. Economists began to explore the way that elements such as supply and demand affected price, and neo-classical economics gradually came into being.
The Neoclassical Economics was pioneered by William Stanley Jevons, Leon Walras and Carl Menger, promulgating the marginal utility revolution (Blaug, 1985). Specifically, Walras was more interested in the interaction of markets than in explaining the individual psyche through a self-gratifying psychology. Like Menger, his conception of utility was that of usefulness in general. Jevons saw his economics as an application and development of HYPERLINK httpen.wikipedia.orgwikiJeremy_Bentham o Jeremy Bentham Jeremy Benthams utilitarianism and never had a fully developed HYPERLINK httpen.wikipedia.orgwikiGeneral_equilibrium o General equilibrium general equilibrium theory. On the other hand, Menger emphasized disequilibrium and the discrete, explaining diminishing marginal utility in terms of subjective prioritization of possible uses. He had a philosophical objection to the use of mathematics in economics, while the other two modeled their theories after 19th century mechanics.
Other worth noting Neoclassical economists were Francis Ysidro Edgeworth and Wilfrido Pareto who embraced the idea of Walras that utility was the equivalent of energy in the equations of mid-nineteenth century physics along with his conclusion that economics had become a rigorously scientific discipline (Schumpeter, 1954).
John Maynard Keynes
More recent developments in Neoclassical economics were attributed mainly to John Maynard Keynes. He reacted to Walras view of economic actors as knowledgeable individuals in economic variables and existing in a wholly abstract realm where time in all of its real or actual dimensions does not exist (Ekelund Hebert, 1997). Claiming that such was bias of Walras given his ideas borrowed from mathematical formalism of the mid-nineteenth century theory in physics. For Keynes, economic actors were motivated by animal spirits and irrational desires and inhabits an economic reality in which knowledge is always proximate and future outcomes are essentially indeterminate.
Despite this criticism, Keynes adapted Walras theory which described the whole capitalist system as a never ending cycle of production, circulation and consumption (Niehans, 1990). Looking at the big picture, for Keynes, the value of the produced (i.e. sum of costs of production and profit) was equal to the total of all income. As such, if an amount equal to the total income in society were spent on goods and services, then the value of production would be realized in sales. Money flowed from businesses to the general public in form of wages, salaries, rents, interests, and profits, then it would flow back to business as the general public bought goods and services with their earnings. If this happened (i.e. total income total value of production) profits would then remain high, flow would be circular, and equilibrium would be maintained.
The theory of value encompasses a range of approaches to understanding how, why, and to what degree humans should value things. The classical economists believed that value is derived from the amount of labour (Ricardo) or from the sum of wage, profit and rent (Smith). Ultimately, their focus was on cost of production and on distribution of the produced. The neoclassical economists, on the other hand, neoclassical economists emphasized that value is from peoples utilitysatisfaction from consuming goods and services. Keynesian economics argued that value of a commodity was equal to the total income.