The Value of a Commodity

The Labor Theory of Value (LTV) holds that the amount of labor that goes into producing a commodity is related to its price. This is over simplistic and may raise some questions. So here, I want to expand on what this means, and how exactly value relates to price.

Despite common misconception, Karl Marx was not the first proponent of the LTV. It existed long before Marx, and is also core to Adam Smith’s analysis. We will look at Smith to understand two thought processes to understand why things may have prices related to their labor content, and why the market moves in this direction.

Let’s first have a little thought experiment. Imagine two hunters who hunt different animals. Within a day, the first, who hunts rabbits, can catch as many as eight of them. The latter, who hunts moose, only catches one every other day. Let’s say the two meet up, and the rabbit hunter really wants some moose. While it would be nice if the moose hunter gave it away for free, the real world doesn’t work like that. Most people expect an equal exchange of equivalents. They would be willing to give you something, but only you could give them something in return.

“…man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

— Adam Smith, “The Wealth of Nations”

Therefore, in order to acquire the moose, it is very likely that the moose hunter will expect something equal in return. All the rabbit hunter has is rabbits. Would a single rabbit be a fair trade? If so, then why would anyone bother hunting moose? If you could catch eight rabbits per day and simply exchange them for eight moose, then you would acquire moose at a rate fourteen times that of the moose hunter himself. The moose hunter would be getting scammed!

Therefore, it is reasonable that the moose hunter would require a sufficient number of rabbits so that going to hunt that many rabbits would be roughly the same amount of toil as hunting the moose. A trade of fourteen rabbits for a single moose, therefore, would be an equal exchange. Both the fourteen rabbits and the single moose require two days of toil to acquire.

The moose hunter trades his moose in order to save him the toil of catching the rabbits, and the rabbit hunter trades his rabbits to save himself the toil of catching the moose.

“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. What everything is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.”

— Adam Smith, “The Wealth of Nations”

While this may seem like a fair deal, why does the market need to be fair? The argument for the LTV is more than simply value being a fair exchange, but that three are actual market mechanisms that put this into motion.

If the supply of a commodity falls, its price will tend to grow. When something is rare and many people desire it, the seller can charge a premium so that only those who desire it the most will pay that premium, yet the supply is so low this does not prevent them from selling all their stock. On the other hand, if the supply of a commodity grows, the price will tend to fall. Too many commodities will make it difficult to sell them all without lowering the price.

On the other hand, the demand of a commodity works in the reverse. Demand is not the number of people who wish to own something, but the number of people who wish to own it but are also willing to pay the market price for it. If demand goes up, more people will want something in proportion to its supply. This has the same effect as supply going down, and the seller can bump the price up and charge a premium. Less people would now be willing to buy it, but that is no problem since the supply was too low to satisfy them all in the first place. This, too, works in the reverse. Demand that is very low will force the seller to drop the price to sell all his stock.

Supply and demand, however, cannot explain price alone. They adjust prices relatively. There are increases or decreases in price depending on the changes in supply and demand. But they increase price from what? They decrease price from what? There is no absolute value here, so it fundamentally cannot be used as a theory of value. It only would provide relative changes in prices, but we would have to measure the price at that given moment to actually make supply and demand useful.

The absolute price becomes clear when you integrate in the LTV. Let’s say, for example, that the moose and rabbit hunter are now running their own businesses within a competitive marketplace. In this marketplace, initially, the market subjectively values a single moose at $100 a single rabbit costs $100. Under these conditions, the moose hunter will have to expend a lot of labor, while the rabbit hunter very little, yet will have the same revenue per sale of a commodity. Since the moose hunter takes two days to hunt the moose, he will earn about $50 per day, while the rabbit hunter who can catch eight rabbits in a single day will earn about $800 per day.

Clearly the rabbit business would be far more profitable and the moose business will struggle to compete on the market. Many moose businesses will go bankrupt, unable to keep up with the rabbit business’s vast profits. Many companies will divest from the moose business and invest heavily into the rabbit business to try and get in on these extraordinarily high profits.

Since less capital will be now allocated to moose hunting but more will be allocated to rabbit hunting, the supply of moose will slowly fall while the supply for rabbits will continually grow. This would mean that the price for rabbits would begin to plummet while the price for moose would increase.

There is a fundamental limit to how far prices can fall, however. Let’s say the price falls to $50 per rabbit and the price of moose has risen to $1000. This would mean per day, the rabbit hunter would be earning an income of $400, and the moose hunter would be earning an income of $500 per day. At this point, it would be more profitable to invest into moose than rabbits, and the process we laid out prior would repeat itself.

Here is how Adam Smith explains this process. Keep in mind that he uses the term “effectual demand” to refer to those at least willing to bear minimum cost needed to produce it. He also uses the term “natural rate” and “natural price” to refer to value.

Supply < Demand → Price > ValueSupply↑

“If…the quantity brought to market should at any time fall short of the effectual demand, some of the component parts of its price must rise above their natural rate. If it is rent, the interest of all other landlords will naturally prompt them to prepare more land for the raising of this commodity; if it is wages or profit, the interest of all other labourers and dealers will soon prompt them to employ more labour and stock in preparing and bringing it to market. The quantity brought thither will soon be sufficient to supply the effectual demand. All the different parts of its price will soon sink to their natural rate, and the whole price to its natural price.”

— Adam Smith, “The Wealth of Nations”

Supply > Demand → Price < ValueSupply↓

“If at any time it exceeds the effectual demand, some of the component parts of its price must be paid below their natural rate. If it is rent, the interest of the landlords will immediately prompt them to withdraw a part of their land; and if it is wages or profit, the interest of the labourers in the one case, and of their employers in the other, will prompt them to withdraw a part of their labour or stock from this employment. The quantity brought to market will soon be no more than sufficient to supply the effectual demand. All the different parts of its price will rise to their natural rate, and the whole price to its natural price.”

— Adam Smith, “The Wealth of Nations”

Supply = Demand → Price = ValueSupply unchanged

When the quantity brought to market is just sufficient to supply the effectual demand, and no more, the market price naturally comes to be either exactly, or as nearly as can be judged of, the same with the natural price. The whole quantity upon hand can be disposed of for this price, and cannot be disposed of for more. The competition of the different dealers obliges them all to accept of this price, but does not oblige them to accept of less.

— Adam Smith, “The Wealth of Nations”

The price therefore never actual equals its value, only when supply and demand meet exactly does it equal its value. Rather, the price is constantly gravitating around its value. If it goes too high above it, market forces will pull it back down. If it goes too far below it, market forces will push it back up.

“The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually gravitating. Different accidents may sometimes keep them suspended a good deal above it, and sometimes force them down even somewhat below it. But whatever may be the obstacles which hinder them from settling in this centre of repose and continuance, they are constantly tending towards it.”

— Adam Smith, “The Wealth of Nations”

As we can see, within a competitive marketplace, the market will continually try to adjust prices around its value. This specifically applies to competitive industries. Of course, not all industries are competitive. If there is a monopoly, then the price may be much higher than its actual value. There would be no way for the supply to ever increase to meet the demand, because new businesses cannot enter the marketplace and invest into this highly profitable sector.

Commodities which are monopolized, either by an individual, or by a company, vary according to the law which Lord Lauderdale has laid down: they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production.

— David Ricardo, “On The Principles of Political Economy and Taxation”

Within a competitive marketplace, each business must at least be capable of, at the bear minimum, to cover its cost of production. If the income from the sale of the commodities is so low that they would save their toil by supplying producing something else and then exchanging it for that commodity, then businesses will pull out of the industry and its supply will fall and prices rise until the price again covers the cost of production.

As a side note, this would seem to suggest the profits would try to equalize across an entire economy. However, this is, in practice, not so. It would tend towards this equalization within a specific industry, but not across industries. As I may show in another post in the future, the ratio of constant capital to variable capital, which varies across industries, also affects profit rates, which is a Marxian prediction that has also been shown empirically. This prevents profits from equalizing across industries. This would also lead into a conversation about the transformation problem, that the two assumptions of profit equalization and values matching labor content can’t both hold. The empirical data seems to suggest that the former assumption is just false while the latter is verifiable.

The price of the commodity can be split up into three components. These three components are the costs the capitalist needs to cover when he sells his commodities.

  1. He must purchase certain items off of the market for his business. If his machines need oil and he cannot produce the oil himself, he will to purchase it from someone else. This has a definite minimum, the business cannot physically run without these things, they therefore must be purchased out of necessity.
  2. He must purchase the “labor” of workers. You can buy all the factories and machines you want, but without workers, they will simply idle. The workers need at minimum enough to cover their standard of living. If they are paid too low, they will no longer be physically or mentally capable of working. This, again, has a definite minimum. The business cannot physically function if the workers are all dead.
  3. Money set aside for profits, expansion, savings, etc. Some money will need to be set aside for profits, or else there will be no benefit for the capitalist to run the business in the first place. There may be other reasons to set aside money, such as for expanding the enterprise, or for saving in case of a rainy day. None of these things are necessary to keep the business running. Theoretically, all three could be neglected and it could still continue to produce commodities.

When the capitalist purchases commodities on the market for his business, he is simply exchanging labor for labor. As Smith put it, he is saving himself the toil of having to produce that commodity himself, by providing money worth an equal amount of labor for a commodity worth a similar amount of labor. These commodities still derive their value from labor since the business they purchased it from had to labor to produce them. The more of these purchases he has to make, the more labor goes into producing the commodity, and the higher its price will be.

Of course, the wages paid to employees itself clearly come from labor, as the employees are being paid for their “labor.” The question becomes, however, where does the third set of his cost come from? None of these things need to be performed, nor do they require labor. The capitalist who received enough profits could, in fact, simply higher a manager to manage the business for him, while he pays for their labor out of the profits he collects for himself, but has so much left over he no longer even needs to do any labor but will have a perpetual revenue.

Clearly, if value comes from labor, yet it does not require labor to produce these profits, then the profits must be coming from somewhere else. They could not be coming from the purchases on the market since these are equal exchanges of equivalents. If the business did manage to cheat the other, as we have seen before, market forces would make this difficult to last in the long term.

Cheating would also simply be shifting money around, the rich could only get richer at the expense of another. Capitalist economies do not simply shift money around, they grow. This growth comes from capital investments, which again comes out of the third thing in the list, the same as profits. It, too, is not necessary to keep the business running, and must come from somewhere else.

The capitalist, in order to constantly have profits set aside for himself, and in order for there to constantly expand his enterprise, must therefore find a special commodity which adds a value greater than its market price consistently.

Here, we get to the concept of the separation between labor and labor power. It is labor that creates value, however, workers do not actually sell their labor on the market, hence why I put this in quotation markets initially. Workers instead expect a wage that is enough money to cover and maintain their quality of life. This, at minimum, is enough to keep them barely alive, but for social reasons it might be slightly higher. If a certain occupation requires a huge amount of labor beforehand to initially learn the skills, they might expect an even greater amount since they will need to pay off that debt for schooling.

Labor power is not labor itself, but the ability for the worker to labor. Labor power itself has a value, its value is the summation of all the commodities the laborer must purchase to maintain his quality of life. The food, water, housing, etc. Labor power, therefore, is a commodity which is bought and sold on the market.

Wages are simply the market price of labor power. The value of labor power is in no way connected to the actual amount of labor the worker performs. The worker may, going back to original analogy, require at least two rabbits a day in order to have enough food to be full and healthy. However, he can catch eight in a day. The capitalist can therefore hire rabbit hunters and pay them two rabbits a day, but then set aside the other six per for his profits, savings, or expanding the business.

Of course, wages are never paid in kind. These things are always sold on the market, so the worker will be paid a wage not of two rabbits but in the money’s worth of those two rabbits, while the capitalist will keep the money’s worth of the other six.

We see, then, that the fact capitalists can collect profits without laboring originates from the fact that value of labor power always fall short of the labor the worker actually performs. Labor power is a commodity which like all other commodities, its price is fluctuates around its value. The value of labor power is not tied to the actual labor performed, but to the cost of all the commodities needed to sustain the laborer’s quality of life. Profits, therefore, come from the labor of the workers, as the value they add to the commodity is split between the capitalist and the worker.

“In that early and rude state of society…the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity is the only circumstance which can regulate the quantity exchange for which it ought commonly to purchase, command, or exchange for. As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people…The value which the workmen add to the materials, therefore, resolves itself in this ease into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him; and he could have no interest to employ a great stock rather than a small one, unless his profits were to bear some proportion to the extent of his stock…In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him.”

— Adam Smith, “The Wealth of Nations”

Some may criticize this, arguing that the capitalist does himself perform labor. He performs the labor of running the business. However, this is not the case, as if a capitalist has enough profits, he can simply hire someone to run this business for him. In fact, these days, with most large corporations, this is how it works. Shareholders of very large corporations are very rarely people who actually work in it, but each share is a vote for the board of directors. Despite never having to step foot the company, they can still extract dividends from it. There is no relation to profits and how hard the capitalist works, since they do not need to work at all.

“The profits of stock, it may perhaps be thought are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. They are regulated altogether by the value of the stock employed, and are greater or smaller in proportion to the extent of this stock.”

— Adam Smith, “The Wealth of Nations”

The cost of a gallon of oil needed to run the machines, this is a very definite concept. It has a known market price, which may fluctuate, but is more or less predictable. The capitalist himself has very little control over this in a competitive marketplace. Only monopolies can set prices. In a competitive marketplace, he must accept the market price. To him, it is a constant that he must accept.

The laborer’s quality of life is a bit of a vague concept. The laborer will always demand his quality of life should be higher than it actually is. Wages are already far below the actual labor added, but how far below is negotiable. There may be a large difference or a small difference, the larger the distance, the greater the capitalist’s profits, and the more the lower the worker’s quality of life, and vice-versa. Naturally, there will be a struggle between these two things, and the price of labor power will be variable.

Since profits, savings, and expansions are not required, we can say this is a surplus. These things are expenditures that go above the actual necessary expenditures.

Therefore, we can divide the total cost of a commodity up into three parts: constant capital, variable capital, and surplus value. The total value of the commodity here is thus value = c + v + s.

We have said value is determined by labor time, but, at the face of it, it only appears that one of these components, v, is related to labor. But as we have shown, v is simply the price labor power and not labor. The labor added by the worker is actually v + s. We can rewrite this as value = c + L where L is the value added to the commodity by the worker.

How does c relate to labor? These are commodities purchased on the market. In order for there to a purchase, there must be another producer who is laboring to produce them. They therefore have their own value. If one business produces lamps with a value of c + L, and the glass for the lamps is purchased on the market, then the c will be the value of the glass. However, since the glass also has a value, its value too can be split up into c + L. The lamp would therefore be value[lamp] = (c[glass] + L[glass]) + L[lamp]. The c[glass] would also have its own value that could be expanded as well. In other words, if you keep on expanding down the supply chain, you can account for all the labor that went into producing the commodity, and that determines it value.

What if someone creates a mud pie? They waste a ton of labor on something useless. Since labor creates value, does this mean it must have a value? No. It is important to understand that value is a social construct. The only reason prices gravitate around their value is because of the competitive market forces I mentioned previously. This is a social process.

A television in one country may cost a lot more than in another, simply because in the former country they may lack the technology to produce televisions cheaply. If you take the television from one market to the next, from one society to the next, its value changes, because value only exist within reference to a market.

In order for labor to create value, it must be part of this social process. One must labor specifically to produce something for a market. If the labor does not produce something for the market, then it is not social labor. It is labor only for oneself, but not for society. Labor must be intended to satisfy some desire by that society, or the labor ceases to be social labor. It is social labor that produces value, not labor on its own.

“…nothing can have value, without being an object of utility. If the thing is useless, so is the labour contained in it; the labour does not count as labour, and therefore creates no value.”

— Karl Marx, “Capital”

What if someone is lazy? If they just spend longer to create the commodity, will it therefore have a greater value? No. Again, labor is social. Even though different businesses may spend more or less labor in producing a commodity, those commodities are all brought to the same markets, and therefore all sell for the same price.

“The cattle bred upon the most uncultivated moors, when brought to the same market, are, in proportion to their weight or goodness, sold at the same price as those which are reared upon the most improved land.”

— Adam Smith, “The Wealth of Nations”

This price is an average of social labor necessary to produce the commodity. Each business produces at somewhat different efficiencies, and these average out. Value is the average of all laborers. It is not the labor necessary for you to personally produce the commodity that sets it value, but the labor necessity for society, as one large unit, to produce the commodity. It is socially necessary labor time that is what creates value.

Therefore, is one produces slower than the average, they cannot raise their price, because no one will buy from them. The only way for prices to change is for a social change to occur. If most producers begin to adopt new technology that reduces labor time, then the price, at that point, will go down.

“Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production. The labour, however, that forms the substance of value, is homogeneous human labour, expenditure of one uniform labour power. The total labour power of society, which is embodied in the sum total of the values of all commodities produced by that society, counts here as one homogeneous mass of human labour power, composed though it be of innumerable individual units. Each of these units is the same as any other, so far as it has the character of the average labour power of society, and takes effect as such; that is, so far as it requires for producing a commodity, no more time than is needed on an average, no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time.”

— Karl Marx, “Capital”

This is a rather brief introduction to the LTV. I have left many components out, so there may be more questions raised. But hopefully this explains the basics.

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真理zhenli

I have a Bachelor of Science in Computer Science. Coding and Marxian economics interests me. I write code for a living.