In fact, the wheat farmer probably held some concept of what the 'normal' price of wheat would be, absent the fluctuations that can be attributed to war, weather or other temporary factors. It is that 'normal' price that begs for explanation, not the day-to-day price.
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So economists need a term that embodies the concept of the price that something would be if it were not for all these troublesome variations in demand, weather and so forth. A twentieth century economist might use long-run equilibrium price to express this concept.
Other terms that have been used are natural price Adam Smith , value-in-exchange , exchange value , exchangeable value and prices of production. Generally, after warning the reader that we mean value in terms of what other things the good could be exchanged for value-in-exchange and not the inherent usefulness of the good in terms of meeting our needs or desires value-in-use , or use value , we use the term "value.
One way to grasp the difference between value and market price is to think of the water level in the ocean at a particular time as a price. It goes up and down with the tides. It is also subject to the more random movement of waves and other disturbances, yet these movements will gravitate around the level determined by the tides.
The tides, then, are analogous to value , even though the actual price at any moment will be higher or lower than the value. Value lies at the core of the economic adjustment process. If the actual price of something were above the value, the extra profits to be made would attract more firms into that industry leading to a greater supply and - eventually - lower prices; conversely, if the actual price of something were below the value, the losses - or sub-normal profits - would drive firms out of that industry leading to a smaller supply and - eventually - higher prices.
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Thus value was identified as the element which organized the economic life of society, as the basis for deciding what to produce, how to produce it and who gets it. The problem, of course, was to understand how value itself was formed. The search for a theory of value is really a search for a consistent foundation for economic theory. It may have limited immediate worth in answering questions of economic policy or understanding the day-to-day or even the month-to-month movements in various prices.
In fact, we can accomplish much of this without a consistent theory of value. A house without a foundation is of more immediate use than a foundation without a house. But the classical political economists were looking at the economy over the long term and thought it important to start with a solid foundation.
Sraffa and the Theory of Prices : Alessandro Roncaglia :
Before examining different theories of value, it is useful to state our objectives. What do we want our foundation to do for us? The starting point of theories of value, at least of the theories of value we are examining here, is a capitalist economy in long-run equilibrium.
Of course this is unrealistic. In any real economy, shifts in demand and changes in technology occur before firms have fully adjusted to the last changes. But it allows us to investigate certain fundamental aspects of the economic system that are difficult to pick out from all the day-to-day movements of prices and output. The student of human anatomy can investigate human structure by examining an actual human skeleton.
Lacking cadavers, economists must hypothesize the skeletal structure of capitalism. The selection and logical analysis of appropriate stylized facts is our substitute for an X-ray photograph of the skeleton of living capitalism. We will also assume sufficient competition so that the rate of profit will be the same in all industries. Again, this is terribly unrealistic. Certainly, when there are no barriers to entry or exit, capital will flow from low profit industries to high profit industries.
Output will increase in industries which are attracting new capital, just as output will decrease in industries from which capital is fleeing. Prices in both industries will adjust until the profit rates are in the same range. But there are barriers to entry and exit in many industries. Our defense for making sufficient competition part of our set of stylized facts is twofold.
First, we are trying to understand what forces give rise to profit in general. The differences in profit rates among firms or industries is a somewhat different problem. Certainly we expect to find higher rates of profit in the industries where there is the least effective competition. Second, if we cannot understand how prices and profit rates are formed under the simplest of conditions, we cannot hope to understand them under more realistic conditions.
The anatomist must develop a concept of an ideal skeleton before being able to use skeletal remains to identify disease or malnutrition. The core of all our models is a highly simplified capitalism. It is an economy that is sufficiently competitive that all firms will have fully adjusted their outputs and use of inputs to all demand and technological conditions. 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 labor was itself equal to the value of the goods and services that a working-class family needed in order to get by. 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, labor would make up the entire cost of production:.
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, uses equipment owned by the capitalist, and works with raw materials purchased by the capitalist, there will normally be profit:. By "quite different principles," Smith means that the worker is paid by the hour of labor 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:. The real value, then, of any commodity, will be the sum of the labor cost and the profit plus any rent. Even though the capitalist purchases raw materials as well as labor, the raw materials - and anything else the capitalist purchases from other capitalists - can in turn be broken down into labor, 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, pigs per year. Their value can be determined by adding up the capitalist's normal costs. 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. Note that labor makes up most of the cost.
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In this example, direct labor 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 labor, profit, rent and supplies.
Then we could look into the costs of their suppliers, and so on. About one-third actually, If the costs in these supplier industries are proportional to the costs in the pig industry, [6: Note] then half of these supply costs could be attributed to labor, then half of their supply costs, then half of those firms' supply costs. The Value of Labor The next step is to investigate the value of labor itself. According to Smith, nature sets the "minimum" wage:. 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 labor is far weaker than the power of the employer to withhold access to employment:.
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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:. Yet there were sometimes forces leading wages upward. Rapid economic growth can create a shortage of labor. 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. Additionally, labor of greater skill or difficulty will itself take on a natural price in terms of common labor:. 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 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.
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