Labor Theory of Value

Historical Price Formation in Classical Economics and Marxism

An Article in the Compendium of Market-Based Social-Ecological Economics

Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?

Click here for the list of all articles: Compendium
Click here for the German-language version: Arbeitswertlehre

Table of Contents

  1. Overview
  2. Classification of Terms
    > 2.1 Pricing in Classical Economics
    > 2.2 Pricing in Marxism
  3. Pricing in the Market Economy

1. Overview

Although uncritical recourse to theorems of historical economic doctrines is to be warned against in principle, they can certainly sharpen the perception of the classification of modern economic findings. The historical development of ideas on economic price formation is a suitable example of this, not least because it also provides an explanation as to why the practical implementation of Marxist theories is doomed to failure.

2. Classification of Terms

The term labor theory of value refers to the historically outdated fundamentals of both the price formation in classical economics and marxism. These fundamentals demonstrate the differences between the two historical economic doctrines and the price mechanism of the modern market economy:

2.1 Pricing in Classical Economics

In classical economics – shaped by Adam Smith and David Ricardo in the 18th and 19th centuries – a distinction is made between »natural price« and »market price«. The former is calculated from the cost of labor and land rent as well as from entrepreneurial profit. The influence of the market is considered insignificant because it is assumed that each supply automatically creates its own demand and that the market price deviates only temporarily and slightly from the natural price. It follows, that goods and services that can be produced or provided in any quantity at the appropriate expenditure, i.e. goods and services that can be arbitrarily multiplied and therefore are not scarce, are attributed an objective value in exchange that is identical to their (natural) price.

Since classical economics assume that the economy is always in equilibrium with all productive factors fully employed, markets always cleared and unemployment basically being voluntary, the classical model is obviously not realistic.
For further details I recommend the article Classical and Neoclassical Economics.

2.2 Pricing in Marxism

Marx’s doctrine later draws on these elements of classical economics, but ignores the influence of the market and restricts pricing to labor. Only labor is supposed to create the added value as so-called »variable capital«, which is identical with the entrepreneurial profit (difference between the value in exchange of the produced goods and the value in exchange of labor), while the productive factors capital and land merely transfer their value to the goods as so-called »constant capital«, but do not generate added value themselves.

Since, according to Marx, only human labor is capable of creating value, the capitalists are tempted to constantly increase the labor input of the proletarians (for a contemporary critique, see the article Excesses of Capitalism). This notion serves Marx as the basis for his Theory of Exploitation. Later, he modifies his labor theory of value in relation to industrial productions with high accumulation of capital by attributing a value-creating function to the factor capital alongside labor. However, he does not succeed in developing a practical model for determining the added value because he fails to provide an answer to the evaluation of differently qualified workers and different capital intensities.

Since Marx attaches no importance to the market, he makes no contribution to the theory of price formation – which, incidentally, is a major reason why Marxist economic systems in practice lack economic dynamism and individual initiative of economic players and consequently must fail under all circumstances.

3. Pricing in the Market Economy

In today’s economics, all products are attributed a subjective value in exchange. Accordingly, the prices result not alone from the costs of the suppliers, but beyond that from the subjective evaluation of the demanders, which is subject to a multiplicity of influences and forces the suppliers to constant price adjustments. The entrepreneurial price calculation can therefore not be based on static cost calculations alone, as intended by classical economics. Rather, entrepreneurs have to estimate their costs and prices over the entire product life cycle, depending on the anticipated market and competitive situation, in order to draw up a profit and loss account, which they can then – in addition to other considerations – conscientiously take into account in their decision to enter the market.

Regardless of the subjective assessment of the demanders and regardless of the profits or losses of the suppliers, it should be noted that prices in the market economy, as well as in all other conceivable economic systems, must include all the costs caused by the production and use of products if they are not to endanger social welfare. This internalization of costs is the responsibility of economic governance and must apply to all suppliers in order not to distort competition. In other words, these costs must not be passed on to the general public (they must not be externalized). In particular, suppliers need to be encouraged by appropriate frameworks, rules and standards to avoid external costs from the outset (to internalize them in advance). As a supplement see the article Economic Externalities.

Permanent social welfare within an economic area requires an autonomous economic policy. Permanent welfare, to be complemented by international trade and competition, requires bilateral trade agreements between economic areas on exchange rates, tariffs and trade quotas.

For a more detailed description of pricing in the market economy, I recommend the articles Market and Market Economy and Economic Pricing.

Click here for the German-language version: Arbeitswertlehre.

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