Classical Value Theory (Part 5 of 5)

In terms of long run costs of production, Smith distinguished between the natural price as a measure of value, which is determined by the long run costs of production, and the market price that is determined by the short run interaction of forces of supply and demand. It was Ricardo who argued that the long run costs of production, with labor being the primary one, were worthy of the most interest and that short run interaction of supply and demand were too insignificant to be worthy of great concern. Malthus, however, accurately countered Ricardo by pointing out that simplifying the discussion to the point that shifts in the supply and demand schedules were not a consideration in the short run was a considerable oversight.

Ricardo borrowed from Smith but sought to simplify his theory of value as much as possible (Ekelund & Hébert, 1997). Ricardo thought that Smith’s idea of natural value when applied to a price change of one of the factors was inadequate. For Ricardo it was more important to analyze a single important variable than to consider extraneous variables that may or may not have an effect on value. In this sense, he was dead wrong in developing a theory of value that actually explained prices. Clearly, manufacturers would ask a price that would allow them to recover their costs of production, with labor being the primary component, but what about intermediaries. What about short-term excesses in the labor supply? What about differences in the quality of labor? What about the qualitative differences in skills among workers in different regions or even countries? The Ricardian system also failed to explain the demand side of price determination. Malthus noted this and pointed out many flaws, but unfortunately, Malthus did not explain his reasoning as tightly as Ricardo did.

Unlike Smith, Ricardo attempted to develop a general explanation of relative prices. On the other hand, Malthus kept trying to infuse short-term dynamics into the discussion. Ricardo’s consistency upheld the notion that labor was generally the most important factor in the determination of value. (Commodities that did not fit into this model were considered generally to not be mainstream products.) In doing so, Ricardo argued that capital was in a sense stored as embodied labor and that the more capital employed in manufacturing the product, the greater rate that value would increase. Consequently, Ricardo contributed especially in the area of how employing capital increases the value of goods. Ricardo pointed out that capital used and the time value of capital employed also adds value to a product.

Smith, Ricardo, and Malthus all shared the belief that the markets were best able to determine optimal outcomes for individuals rather than planned economies. Supply and demand theory was a chief adversary of the labor theory of value, and classical economics did not resolve this paradox. Smith, Malthus, and Ricardo all missed a point in the value analysis that was later discovered by Senior: utility value of a good and scarcity value of a good combine to produce value.

Reference

Ekelund, R. B., Jr., & Hébert, R. F. (1997). A history of economic theory and method (4th ed.). New York: McGraw Hill.