Prices of production
Encyclopedia
Prices of production refers to a concept in Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...

's critique of political economy. It is introduced in the third volume of Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...

, where Marx considers the operation of capitalist production as the unity of a production process and a circulation process involving commodities
Commodity (Marxism)
In classical political economy and especially Karl Marx's critique of political economy, a commodity is any good or service produced by human labour and offered as a product for general sale on the market. Some other priced goods are also treated as commodities, e.g...

, money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...

 and capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

. The argument is that the sales of newly produced commodities
Commodity (Marxism)
In classical political economy and especially Karl Marx's critique of political economy, a commodity is any good or service produced by human labour and offered as a product for general sale on the market. Some other priced goods are also treated as commodities, e.g...

 in the capitalist mode of production are regulated by their production prices. The regulating price of a type of product is a sort of modal average
Mode (statistics)
In statistics, the mode is the value that occurs most frequently in a data set or a probability distribution. In some fields, notably education, sample data are often called scores, and the sample mode is known as the modal score....

, above or below which people would be much less likely to trade the product. It reflects the price at which products must sell, in order to realize the average profit rate on the capital invested in producing them. So it refers basically to a "normal or dominant price level" that prevails during a longer interval of time. It presupposes that both the inputs and the outputs of production are priced goods and services, i.e. that production is fully integrated in fairly sophisticated market relations enabling a sum of capital invested into it to be transformed into a larger sum of capital. In pre-capitalist economies, that was not the case; many inputs and outputs of production were not priced.

Marx's claim is that the production prices of products themselves are fundamentally determined by their labour-values, and therefore are constrained by the law of value
Law of value
-General:The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy against Pierre-Joseph Proudhon, with reference to David Ricardo's economics...

. Since however not all goods are produced or reproducible goods, not all goods have production prices. A production price in Marx's sense can exist only in markets developed sufficiently for a "normal" rate of profit on production capital invested to become the ruling average for a group of producers.

Substantively, Marx argues that the prices of new products sold will, assuming free competition for an open market, usually tend to settle at an average level which enables at least a "normal" rate of profit on the capital invested to produce them; and as a corollary, that if such an average rate of profit cannot be reached, it is much less likely that the products will be produced (because of comparatively unfavourable profitability conditions). Thus, investment capital is likely to shift out of production activities where the rate of profit is low, and towards activities where profitability is higher; the "leading" sectors of industry are those where profitability is the highest (in modern times, these are in the production of computer facilities, healthcare, oil products, and finance). The precondition is the free mobility of capital, and thus there is a systemic tendency to remove all obstacles preventing investors from investing where profits are higher. If, for any reason, the free movement of capital is blocked or restricted, then big differences in the profit rates of enterprises are likely to occur.

According to Marx, the movements of different production prices relative to each other importantly affect how the total "cake" of new surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

 produced is shared out as profit by competing capitalist enterprises. They are the basis of the competitive position of the producers, since they fundamentally determine profit yields relative to costs.

Simple definition

For most political economists
Political economy
Political economy originally was the term for studying production, buying, and selling, and their relations with law, custom, and government, as well as with the distribution of national income and wealth, including through the budget process. Political economy originated in moral philosophy...

, the concept of production prices corresponds roughly to Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

's concept of "natural prices" and the modern neoclassical
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 concept of long-term competitive equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...

 prices under constant returns to scale
Returns to scale
In economics, returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable...

 (for an historical discussion, see Meek (1975)). However, the function of prices of production within Marxian theory is different from that of these other concepts in their own theories.

Simply put, Marx's "price of production" (P) is a price which applies to sales of new outputs produced, and it equals cost price (cp) + average profit of capital invested in production (ap). The cost price could be computed as the unit-cost of a product, the profit component being the normal mark-up. The production price is the price at which goods would have to sell in order to reach the average profit rate on capital invested into producing them. The amount ap is often assumed to have the same magnitude relative to the amount of capital invested in all sectors, seemingly representing an equilibrium of flows of capital between different parts of a capitalist economy that results in a "general rate of profit".

Thus,
P = cp + ap


The cost-price equals labour-costs incurred (or variable capital measured in price terms) in producing output, plus the monetary cost of constant capital
Constant capital
Constant capital , is a concept created by Karl Marx and used in Marxian political economy. It refers to one of the forms of capital invested in production, which contrasts with variable capital...

 inputs used up.

In the sphere of capitalist production, Marx argues, commodity values are expressed in the form of prices of production, established jointly by average input costs and by the ruling profit margins applying to outputs sold. It is a result of the establishment of regular, developed market trade; the production price averages reflect the fact that production has become totally integrated into the circuits of commodity trade
Commodity (Marxism)
In classical political economy and especially Karl Marx's critique of political economy, a commodity is any good or service produced by human labour and offered as a product for general sale on the market. Some other priced goods are also treated as commodities, e.g...

, in which capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

 has become the dominant motive. But what prices of production simultaneously hide, he argues, is the social nature of the valorisation
Valorisation
The valorisation or valorization of capital is a theoretical concept created by Karl Marx in his critique of political economy. The German original term is "Verwertung" but this is difficult to translate, and often wrongly rendered as "realisation of capital", "creation of surplus-value" or...

 process, i.e. how exactly an increase in capital-value has occurred through production. The direct connection between labour-time and value, still visible in simple commodity production
Simple commodity production
Simple commodity production is a term coined by Frederick Engels to describe productive activities under the conditions of what Marx had called the "simple exchange" of commodities, where independent producers trade their own products...

, is largely effaced; only cost-prices and sale-prices remain, and it seems that any of the factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

 (which Marx calls the "Holy Trinity" of capitalism) can contribute new value to output, paving the way for the concept of the production function
Production function
In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs...

.

In his manuscript, Marx frequently defines a newly produced output of commodities as being equal to a newly formed "commodity capital K" where
K = c + v + s


where c = constant capital (the element of conserved value), v = variable capital, and s = surplus value (the two elements of newly created value). (Marx's standard assumption in his models is that the rate of surplus-value (s/v) is the same in all sectors. But this is just an ideal average, in reality s/v will differ in different sectors and regions; Marx seems to have thought though that assuming a uniform rate was justified, because an open market in labour and capital would tend to make working conditions increasingly similar for a whole population).

One question is then how exactly the value of K is distributed as gross revenues among producing enterprises, what determines this distribution, and what factors affect it. In the Marxian view, answers given to this question have important implications for explaining and predicting the pattern and direction of capitalist economic growth (this is the subject of Marx's theory of economic reproduction
Reproduction (economics)
In Marxian economics, economic reproduction refers to recurrent processes by which the initial conditions necessary for economic activity to occur are constantly re-created...

 and the mobilisation of capitals).

Two interpretations of production prices

Unfortunately, Marx never prepared the manuscript of the third volume of Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...

 for publication. Therefore his draft text, which sketches complicated issues in a "shorthand" way, is sometimes ambiguous and incomplete. According to Marx-scholar Michael Heinrich, "Marx was nowhere near solving all of the conceptual problems" http://www.marxists.org/archive/marx/works/1894-c3/editorial/heinrich.htm

Some writers argue that Marx's production price is similar, or performs the same theoretical function, as the "natural prices" of classical political economy found e.g. in the writings of Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

 and David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

. In that case, Marx's production price would be essentially a "centre of gravity" around which prices for outputs in a competitive market will fluctuate in the long run (cf. Fred Moseley's view http://archives.econ.utah.edu/archives/ope-l/2007m04/docP59arUyYiH.doc). This is the dominant interpretation, within the framework of equilibrium economics, which suggests that production prices are really a kind of "equilibrium prices". There is textual evidence for that, insofar as Marx sometimes defines the production price as the price which would apply if the supply and demand for products is balanced. At other times, he refers to a "longterm average price" or a "regulating price". He does not say precisely how these three different concepts are related.

Others argue that the concept of production price plays a different role in Marx's theory: the aim of the concept is to show how the distribution, as profit income, of the new surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

 produced (in the form of new outputs of goods and services) is affected by price movements and more specifically by competition between producers, and what variables and dimensions are involved here.

In that case, production prices are not necessarily equilibrium prices, but refer much more to a given price-level acting as a constraint or limit within which enterprises must operate in a developed, open market: the average or ruling costs and returns applying to their branch of activity, creating in effect a pricing regime or "regulating price". The pricing regime sets upper and lower limits for cost-prices and sale-prices. This alternative interpretation of production prices rests on four ideas:
  • in a developed market, as Marx knew, producers confront a given cost structure applying to their inputs, and a given structure of market prices for their outputs. Within this evolving but predetermined framework, in which the activity of each enterprise affects the overall outcome for all enterprises, each producer aims to manage his business in order to realise maximum surplus value
    Surplus value
    Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

    , principally by maximising surplus labour
    Surplus labour
    Surplus labour is a concept used by Karl Marx in his critique of political economy. It means labour performed in excess of the labour necessary to produce the means of livelihood of the worker . According to Marxian economics, surplus labour is usually "unpaid labour"...

     and labor productivity
    Productivity
    Productivity is a measure of the efficiency of production. Productivity is a ratio of what is produced to what is required to produce it. Usually this ratio is in the form of an average, expressing the total output divided by the total input...

     while keeping costs to the minimum. Effectively, producers aim ideally to sell as much product as fast as they can at competitive prices which are below the ruling market valuation, while still achieving a normal rate of profit on capital invested. If they sell more product faster, then even if the rate of profit on capital is not spectacular, they still make more money.

  • Marx's critics claimed to prove on the one hand that there existed no logical procedure to derive prices from values, yet on the other hand they also complained Marx's theory is not empirically verifiable or falsifiable. But the latter proposition obviously does not follow from the former. Obviously Marx's theory is verifiable and falsifiable, if we investigate whether price movements and business behaviour observably do develop in the direction that Marx predicts that they will, on the basis of his value theory. Are market prices for products really proportional to their production costs, or not? Are relative quantities of labour-time performed proportional to the long-term relative movements of output prices? Do profit rates tend to converge on a "normal" rate of return?

  • Most importantly, in a developed market, prices of production will exist regardless of whether supply and demand happen to be in balance; competition would settle an average price-level for outputs, but this did not necessarily imply any "equilibrium price" or the absence of price fluctuations. For Marx, the capitalist economy and society owed its "equilibrium" to the maintenance of its relations of production
    Relations of production
    Relations of production is a concept frequently used by Karl Marx and Friedrich Engels in their theory of historical materialism, and in Das Kapital...

    , not to some hypothetical balance between demand and supply which existed only by momentary chance. Equilibrium was less an economic, than a socio-political issue (see also law of value
    Law of value
    -General:The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy against Pierre-Joseph Proudhon, with reference to David Ricardo's economics...

    ). After all, sorts of economic fluctuations could occur while the relations of production stayed intact, and capital accumulation
    Capital accumulation
    The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

     continued unabated.

  • Marx's purpose was not really to prove a static equilibrium system with models of price distributions in which price-value deviations fully cancelled out at the aggregate level; at best that was only a simplifying assumption, to illustrate the effects of the distribution of the total new surplus value created, given that there was a minimum acceptable average profit rate on capital invested, related to the ruling rates of interest, while enterprises were constantly unequally rewarded for the production labor they performed. This central fact dominated how the production system would develop. Marx aimed to diagnose the main laws which drove the capitalist production system forward through the dynamics of competition for extra profits - the critical problem for investors was that at any time they could realize more or less money-income for the new value produced by enterprises, and that problem led to a systematic pattern of business behavior to gain competitive advantage, which in turn had definite overall effects for the whole economy. So this was more a theory of the basic parameters of business competition, rather than a theory of how the distribution of new value spontaneously evolved towards an imaginary equilibrium state.

A quote from Marx on production prices

Problems of interpretation

The first interpretative difficulty concerns the existence of various production prices. Most Marxists missed the fact that in Capital Vol. 3 Marx identified (though often not very clearly) at least four main types of production prices:
  • the private or enterprise production price which forms the starting-point of the analysis. This price equals the cost-price and profit on production capital invested which applies to the new output of a specific enterprise when this output is sold by the enterprise. This production price can be compared to the average production price that obtains for a sector or nationally.

  • the sectoral production price. This price equals the average cost-price and average profit on production capital invested which applies to the output of a commodity produced by a specific industry, sector or branch of production (at "producer's prices"). This is the average production price which applies for a particular type or class of product, reflecting the average return the producers can normally expect to obtain. In particular, Marx notes the differences between industrial and agricultural production prices.

  • the inter-sectoral production price. This price refers to the sale of output at producers' prices which reflect an average profit rate on a quantity of capital invested that applies to various sectors of industry (this is the fully formed production price Marx most often has in mind in his theoretical discussions; it reflects the product-price at which the average rate of profit on capital applying to a whole economic community is obtained).

  • the economic production price. This price equals the average cost price and average profit of an output at the point of sale to the final consumer, including labour-value contributed by all the different enterprises participating in its production (factory, storage, transport, packaging etc.). In modern times, "costing" production in order to establish the expected yield on capital invested in it often involves assessing the whole value chain
    Value chain
    The value chain, is a concept from business management that was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.-Firm Level:...

     relative to the price level at which products can be sold to the final consumer. The question then is, how can the whole production of a product - from the factory gate to the final consumer - be organized so that it can sell to the final consumer at a price that the market will bear - and still make a good profit?


These different prices are revealed when we study the composition of the cost structure of a product at different stages of its production. One source of interpretive difficulty is that Marx often assumes in his drafts that these four types of prices are all identical. But that is true only in the special case where one enterprise sells directly to the final consumer.

The reason for this conflation is probably that Marx's real analytical concern was not really with the pricing processes as such, but with the main factors influencing the realisation and distribution of new surplus-value produced, when sales occur. After all, his argument was that competition
Competition
Competition is a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources. It arises whenever two and only two strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same environment. For...

 in capitalism
Capitalism
Capitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...

 revolves around the quest of obtaining maximum surplus-value from production in the form of generic profit income (profit, interest, rent). The question was: how does a sum of capital invested in production get transformed into a larger sum of capital? What are the dynamics and overall results of that process? What are the implications for the process of economic reproduction
Reproduction (economics)
In Marxian economics, economic reproduction refers to recurrent processes by which the initial conditions necessary for economic activity to occur are constantly re-created...

?

A second source of interpretive difficulty is that in his argument Marx often conflates capital advanced (to acquire inputs necessary for production) with capital consumed (that fraction of the value of inputs used up in the production of new output). He just assumes abstractly that the output created will equal the sum of input costs incurred plus surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

, and that the sum of input costs is equal to the production capital invested, given that all output is sold. Most probably the reason was that his real interest was in the overall dynamics of capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

, competition
Competition
Competition is a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources. It arises whenever two and only two strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same environment. For...

, and the realisation of surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

 produced, assuming output would sell. He was thinking of grand averages and overall results. The simplified picture does not obtain in reality, among other things because, as Marx himself notes, capitalist competition turns on buying commodities below their value and selling them above their value (or, in the ideal competitive situation, to sell them below their value at a good profit).

Marx's theory is frequently confused with input-output economics and the marginalist theory of capital, in which total inputs and total outputs are always exactly equal, an equality accomplished by treating the factor income
Factor income
Factor income is income derived from selling the services of factors of production. In the case of labour, this means wages, plus the part of the incomes of the self-employed which is a reward for their own labour. Income from land is rents, including part of the incomes of the self-employed, and...

 which is gross profit as an input. Marx did not talk about inputs and outputs in this double-entry bookkeeping sense; instead, he was concerned with how a sum of capital was transformed into a larger sum of capital through a net addition of new value created by workers in production. If indeed the value of inputs bought was exactly equal to the value of outputs sold, capitalists would not even invest in production, because they would get no profit out of it. So from Marx's point of view, input-output economics really mystified the "capital-relationship", i.e. the ability of the bourgeoisie
Bourgeoisie
In sociology and political science, bourgeoisie describes a range of groups across history. In the Western world, between the late 18th century and the present day, the bourgeoisie is a social class "characterized by their ownership of capital and their related culture." A member of the...

 to capitalize on the surplus labour
Surplus labour
Surplus labour is a concept used by Karl Marx in his critique of political economy. It means labour performed in excess of the labour necessary to produce the means of livelihood of the worker . According to Marxian economics, surplus labour is usually "unpaid labour"...

 of the workforce in virtue of its ownership of the means of production
Means of production
Means of production refers to physical, non-human inputs used in production—the factories, machines, and tools used to produce wealth — along with both infrastructural capital and natural capital. This includes the classical factors of production minus financial capital and minus human capital...

 (in Capital Vol. 3, he refers satirically to the factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

 theory as the "holy trinity" of political economy).

A third source of interpretive difficulty concerns the question of what kinds of prices production prices really are. Do these prices really exist, and if so, in what way? Or are they only theoretical or ideal
Real prices and ideal prices
Real prices and ideal prices refers to a distinction between actual prices paid for products, services, assets and labour , and computed prices which are not actually charged or paid in market trade, although they may facilitate trade...

prices? What exactly is the "average" an "average" of? What does the "cost-price" really refer to, and at what point in the process (inputs purchased, output produced before sales, output sold)? Sometimes Marx talks about production prices as theoretical prices (equilibrium prices that would exist if supply and demand are balanced), at other times as "regulating prices" or "empirical price averages", and consequently it remains somewhat ambiguous in what way such prices exist in reality. It could in principle also be argued that some types of production prices are empirical price averages, while other ones only express theoretical price-levels.

In grappling with these issues, it must also be remembered that when Marx lived there was little macro-economic statistical data available that would enable theoretical hypotheses to be tested and relativised. Marx had deduced the motion of capital essentially from an enormous amount of economic literature he read, but when, towards the end of his life, he toyed with the idea of investigating economic fluctuations econometrically, Samuel Moore
Samuel Moore
Samuel Moore may refer to:*Samuel B. Moore , sixth Governor of Alabama, U.S.A.*Sam Moore, singer from the soul duo Sam & Dave*Sammy Moore, English footballer...

 convinced him this was not possible, because relevant economic data did not exist yet. Comprehensive macro-economic data became available only half a century later.

Marx had pointed the way to solving the problems raised by the classical political economists, without however providing a complete answer. He really believed though that a "general rate of industrial profit", applying economy-wide to all industries, would be formed (in the sense of the minimally acceptable profit rate) but in truth he lacked the data to prove it. He did not discuss in any detail the difference between distributed and undistributed profit, or tax requirements, and how this might affect profit statements. His discussion was limited to physical capital and labour employed, abstracting from ancillary costs and incomes unrelated to production which enterprises usually have (including tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...

 imposts and subsidies).

Production prices and the transformation problem

The concept of production prices is one "building block" in Marx's theory of "the tendency of the rates of profit on production capital to level out through competition" (see Capital Vol. 3, chapter 10 http://www.marxists.org/archive/marx/works/1894-c3/ch10.htm) which aimed to tackle a theoretical problem left unsolved by David Ricardo
David Ricardo
David Ricardo was an English political economist, often credited with systematising economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill. He was also a member of Parliament, businessman, financier and speculator,...

. This problem concerned the question of explaining how an average or "normal" return on production capital invested (e.g. 8-16%) could become established, so that capitals of equal size reaped equal profits, even although the enterprises differed in capital compositions and amounts of labour performed (see labor theory of value
Labor theory of value
The labor theories of value are heterodox economic theories of value which argue that the value of a commodity is related to the labor needed to produce or obtain that commodity. The concept is most often associated with Marxian economics...

) and consequently generated different amounts of new value.

According to Marx, this was not simply a logical problem, a social accounting problem or theoretical problem, but a structural contradiction intrinsic to the capitalist mode of production
Capitalist mode of production
In Marx's critique of political economy, the capitalist mode of production is the production system of capitalist societies, which began in Europe in the 16th century, grew rapidly in Western Europe from the end of the 18th century, and later extended to most of the world...

, which had to be continually mediated. The fact that more or less value could be appropriated by investors from the labour-efforts of the workers employed, and thus that different labour efforts were unequally rewarded, was in his eyes central to the competitive process - in which the norms of labour effort continually clashed with the norms of profitability. On the surface, it looked to the individual observer as if profit yields on capital determine expenditures on labour, but in aggregate, it is - according to Marx - just the other way around, since the volume of labour-time worked determined how much profit could be distributed among capitalists, via the sales of products. The mass of surplus labour
Surplus labour
Surplus labour is a concept used by Karl Marx in his critique of political economy. It means labour performed in excess of the labour necessary to produce the means of livelihood of the worker . According to Marxian economics, surplus labour is usually "unpaid labour"...

 performed in the sphere of production set a limit for the mass of surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

 that could be distributed as profit in the sphere of circulation.

In some interpretations of the Marxian transformation problem
Transformation problem
In 20th century discussions of Karl Marx's economics the transformation problem is the problem of finding a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace...

, total "(production) prices" for output must equal total "values" by definition, and total profits must by definition equal total surplus value. However, Marx himself explicitly denied in chapter 49 of the third volume of Das Kapital
Das Kapital
Das Kapital, Kritik der politischen Ökonomie , by Karl Marx, is a critical analysis of capitalism as political economy, meant to reveal the economic laws of the capitalist mode of production, and how it was the precursor of the socialist mode of production.- Themes :In Capital: Critique of...

 that such an exact mathematical identity actually applies; subsequently, Frederick Engels also denied it explicitly, in a letter to Conrad Schmidt dated March 12, 1895. At best, it is an assumption used in modelling, which is justified if - as Marx believed - the divergence between total values and total production prices is quantitatively not very great, because actual labour expenditures constrain their divergence. But all this has never bothered neo-classical
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 scholars such as Paul Samuelson
Paul Samuelson
Paul Anthony Samuelson was an American economist, and the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize, that he "has done more than any other contemporary economist to raise the level of scientific analysis in...

 in their interpretation of what Marx tried to do.

The "accounting" interpretation of production prices (value/price identity at the macro-level) by economists, according to which price distributions and value distributions can be inferred from each other, would suggest that the production price is empirically obtained from a straightforward statistical averaging of aggregated cost prices and profits. In that case, the production price is a theoretical mid-point which fluctuating actual prices would match exactly only by exception.

In another interpretation, however, the production price reflects only an empirical output price-level which dominates in the market for that output (a "norm" applying to a branch of production or economic sector, which producers cannot escape from). That is, the prevailing value proportions set a range or band within which prices will move.
  • Anwar Shaikh
    Anwar Shaikh (economist)
    Anwar M. Shaikh is an American economist, and currently Professor of Economics at the Graduate Faculty of The New School in New York City. His work in political economy has focused on the economic theory and empirical patterns of developed capitalism. He has written on international trade,...

     (1977) has modelled the formation and change of production prices mathematically using iterative methods. In subsequent writings, he concretizes the concept of the production price as the "regulating price" dominating the market for a type of product.

  • Emmanuel Farjoun and Moshe Machover
    Moshé Machover
    Moshé Machover is a mathematician, philosopher, and socialist activist, noted for his writings against Zionism. Born to a Jewish family in Tel Aviv, then part of the British Mandate of Palestine, Machover moved to Britain in 1968 where he became a naturalised citizen...

     (1984) reject the whole idea that a "uniform rate of profit" would ever exist in reality, contrary to Marx's suggestion that competition would tend to establish at least a minimally "acceptable" average rate of profit on production capital invested to produce outputs, and returns proportional to capital size.


These readings of Marx imply that traditional interpretations of the transformation problem
Transformation problem
In 20th century discussions of Karl Marx's economics the transformation problem is the problem of finding a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace...

 are really rather meaningless; the apparent mathematical wizardry is based on false interpretations of the concepts involved, and the reciprocal effects of individual actions and aggregate social outcomes is overlooked. Mathematical equations cannot substitute for conceptual precision in the definition of measuring units; they can only reveal the logical and quantitative implications of concepts and measurement units.

At the beginning of Capital Vol. 3, Marx provides a clue to how he thinks the "transformation problem" is solved in reality. He implies that it can be solved only by examining capital and profit distributions as a dynamic process, rather than statically. His argument is, that what industrial competition really revolves around, is principally the difference between the value of the new commodities produced, and their cost-prices, in other words the potential surplus-value which can be realized from them. There are, in other words, constant disparities in space and time between labour-expenditures and capital returns, but also just as constant attempts to overcome or take advantage of those disparities. Thus, unrestricted economic competition has the result that the law of value
Law of value
-General:The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy against Pierre-Joseph Proudhon, with reference to David Ricardo's economics...

 regulates the trade in newly produced commodities: the ultimate limits of what products will trade for, i.e. their supply price, are set by comparative costs in labour-time.

Value and price

A lot of criticism of Marx's concept originates from the ambiguities referred to earlier. Consequently, many of the criticisms can, according to some Marxists, be dispelled simply by a more exact definition of the cost, product and revenue aggregates used, and of the timing of transactions (see e.g. Temporal Single System Interpretation).

In doing so, it must be admitted though that Marx's draft manuscript often shows sloppy use of terminology and concepts, and that Marx's purpose was often not fully explicit. At a high level of abstraction, he moves very easily and cavalierly from values to prices and back again, and restricts his discussion of "capital invested" to intermediate goods, fixed capital
Fixed capital
Fixed capital is a concept in economics and accounting, first theoretically analysed in some depth by the economist David Ricardo. It refers to any kind of real or physical capital that is not used up in the production of a product and is contrasted with circulating capital such as raw materials,...

 and labour power
Labor power
Labour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...

 only.

In Marx's view, a capitalist production process was a valorisation
Valorisation
The valorisation or valorization of capital is a theoretical concept created by Karl Marx in his critique of political economy. The German original term is "Verwertung" but this is difficult to translate, and often wrongly rendered as "realisation of capital", "creation of surplus-value" or...

 process in which new value was formed. The theoretical problem was, that this value-forming process - the process vital for capital accumulation
Capital accumulation
The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

 - took place mainly external to the market, being bracketed by the transactions M-C (purchase of inputs, C, using money, M) and C'-M' (sales of new output, C', for more money, M'). Between the successive exchanges, however, economic value was conserved, transferred and added to. Management then tried to estimate the cost and profit implications of different tasks and activities in production for the growth of capital.

But in that case, the domains of product-values and product-prices, and consequently the domains of value relations and price relations, were separate but co-existing and overlapping domains (unless one is willing to argue that goods have an economic value only at the point where they are being sold for a price). "Price management" was not really possible insofar as prices were determined by markets which individual producers could not control, but value-based management was possible.
  • Goods could sell below or above their real or socially average value, and that was precisely the critical problem for capitalists, because it affected their gross income and profit margins. The wealth of capitalist society might present itself as "a mass of commodities" (as Marx himself put it), but before and after the commodities were sold, they existed outside the market as use value
    Use value
    Use value or value in use is the utility of consuming a good; the want-satisfying power of a good or service in classical political economy. In Marx's critique of political economy, any labor-product has a value and a use-value, and if it is traded as a commodity in markets, it additionally has an...

    s. At that point, they had only a value and a use-value, but not an actual market price (though obviously one could estimate an hypothetical selling price - see also real prices and ideal prices
    Real prices and ideal prices
    Real prices and ideal prices refers to a distinction between actual prices paid for products, services, assets and labour , and computed prices which are not actually charged or paid in market trade, although they may facilitate trade...

    ).

  • Thus, at the point of production, the "factors of production" themselves had no actual market price either, only a value, because they were being used to create new products, rather than being offered for sale (indeed, what a particular business enterprise was currently "worth" in total, as a going concern, might be very difficult to say; it would depend on how much profit income it was expected to yield in the future compared to the capital assets invested in it, but even if a total price could be estimated, its individual assets might change in value continuously).

  • A quantity of value was produced by enterprises, but how much of that value would actually be realised by an enterprise as income from sales, or how gross revenues would be distributed among producers, could not be established with certainty in advance. Yet, the value of the total masses of output-values actually produced by all enterprises affected the market prices that could be obtained by each in distribution; it affected how the market would reward each of the producers, and there was a real, systematic relationship between total value produced and total sales revenue (even although these might not be equal).

  • More importantly, producers were constantly adjusting their commercial behaviour to the emerging economic reality (the "state of the market"), as far as they could. And that adjustment followed a specific pattern; Marx argued it created a specific trajectory for capitalist development, guided by the quest for realizing extra surplus value
    Surplus value
    Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

    . There is, he argues, a permanent imperative to increase productivity, and producers aim to utilize every possibility for gaining competitive advantage (which includes blocking competition from others in some way).


How could this business reality best be modelled? In contemporary "value-based management" by corporations, we can witness a continual cross-reference between past prices, current prices and future prices occurring, because there is practically no other way to do it for business purposes. In the words of group controller Gerard Ruizendaal of Royal Philips Electronics
Philips
Koninklijke Philips Electronics N.V. , more commonly known as Philips, is a multinational Dutch electronics company....

,
A partner of McKinsey & Company
McKinsey & Company
McKinsey & Company, Inc. is a global management consulting firm that focuses on solving issues of concern to senior management. McKinsey serves as an adviser to many businesses, governments, and institutions...

 comments:

.

In that case, it is impossible for the sum of input values to be exactly equal to the sum of output values. Indeed, that is exactly what, according to Marx, capitalists are in business for: to invest a sum of capital in production in order to get a larger sum of capital out of it. In bourgeois theories, value appears spontaneously out of trading activity in the sphere of circulation. Marx however regarded the prices of production as the "outward expression" of the results of a valorisation
Valorisation
The valorisation or valorization of capital is a theoretical concept created by Karl Marx in his critique of political economy. The German original term is "Verwertung" but this is difficult to translate, and often wrongly rendered as "realisation of capital", "creation of surplus-value" or...

 process in production, and in order to be able to talk about price aggregates at all, he thought reference to value relations was completely unavoidable.

Not only was a value-theoretic principle required simply to group prices, relate them and aggregate them (meaning principles of value equivalence, comparable value, value transfer, value conservation, value creation and value used up or destroyed), but most of the stock of labour-products in an economy at any time had no actual price, simply because they weren't being traded. To what extent their value could be realised through exchange in the future could be known definitely only "after the fact", i.e. after they were actually sold and paid for. In the meantime, one could only hypothesize about their price, working from previous data. But in the final analysis, the attribution of value to products implied a social relation
Social relation
In social science, a social relation or social interaction refers to a relationship between two , three or more individuals . Social relations, derived from individual agency, form the basis of the social structure. To this extent social relations are always the basic object of analysis for social...

, without which value relations could not be understood. A community of independent private producers expressed their co-existence and mutual adjustment through the trading prices of their products; how they were socially related was expressed through the forms of value
Value-form
The value-form or form of value is a concept in Karl Marx’s critique of the political economy. It refers to a socially attributed characteristic of a commodity which contrasts with its tangible use-value or utility .The concept is introduced in the first chapter of Das Kapital where Marx argues...

.

Facts and logic

The concept of "average profit" (a general profit rate) suggested that a process of competition and market-balancing had already established a uniform (or ruling average, or normal) profit rate previously; yet, paradoxically, what profit volumes would be (and consequently profit rates) could be established only after sales, by deducting costs from gross revenues. An output was produced before it was definitively valued in markets, yet the quantity of value produced affected the total price for which it was sold, and there was a sort of "working knowledge" of normal returns on capital. This was a dynamic business reality Marx sought to model in a simple way.

But Marx's critics interpreting his models often argue he keeps assuming what he needs to explain, because rather than really "transforming values into prices" by some quantitative mapping procedure, such that prices are truly deduced from labour-values, he either (1) equates values and prices, or else (2) he combines both values and prices in one equation.

Thus, for example, either Marx infers a rate of profit from a given capital composition and a given quantity of surplus-value, or else he assumes a rate of profit in order to find the amount of surplus-value applying to a given quantity of capital invested. That might be fine if the aim is to just investigate what profit an enterprise or sector would receive on average, having produced a certain output value with a certain capital composition. But this manoeuvre of itself cannot contain any formal proof of a necessary quantitative relationship between values and prices, nor a formal proof that capitals of the same size but different compositions (and consequently different expenditures of labour-time) must obtain the same rate of profit. It remains only a theory.

Marx insists both that output prices obtained will necessarily deviate from values produced, but also that the sum of prices would equal to the sum of values in the pure case, yet, critics claim, he fails to show quantitatively how a distribution process could then occur such that price magnitudes map onto value magnitudes, and such that a uniform profit rate returns equal profits to capitals of equal sizes (a mapping relation is used here in the mathematical sense of a bijective morphism
Morphism
In mathematics, a morphism is an abstraction derived from structure-preserving mappings between two mathematical structures. The notion of morphism recurs in much of contemporary mathematics...

, involving one-to-one correspondence between value quantities and price quantities via mathematical equations). In that case, there is again no formal proof of any necessary relationship between values and prices, and Marx's manuscript really seems an endless, pointless theoretical detour leading nowhere. In modelling, simple logical paradoxes appear of the type that:
  • in a static model, it is impossible to uphold the postulate of a uniform rate of profit and the postulate of total values=total prices at the same time;
  • to find production-prices, a uniform rate of profit must be assumed, while at the same time to find a uniform rate of profit, production-prices must already be assumed;
  • a price level must be assumed, rather than be deduced from labour-values.


All these conceptual and logical issues mentioned become crucial when attempts are made to model value and price aggregates mathematically to study capitalist competition. Different kinds of theoretical assumptions or interpretations will obviously lead to very different results. In general, many modern Marxists nowadays think that Marx's idea of "transformation" was badly misinterpreted. It does not refer to a "mathematical conversion of values into prices". Rather the transformation means that the direct regulation of the exchange of commodities according to their value is, in a capitalist mode of production, transformed into the regulation of the exchange of commodities by their production prices - reflecting the fact, that the supply of commodities in capitalist society has become conditional on the accumulation of capital, and therefore on profit margins. If market trade consisted only of simple exchange (the exchange of things of the same value by the direct producers themselves), then balancing production effort, output and demand would be a fairly simple, straightforward matter. But in reality it is not so straightforward precisely because capitalist market trade is not simple exchange. Production effort, output and demand can be balanced in capitalism only if profits are made and the accumulation of capital grows. In reality, products are constantly being sold above or below their value, according to what makes the best profit.

Whatever view one takes on the theoretical issues, no one can evade the (either simultaneous or sequential) reciprocal effects of individual business behaviour and aggregate economic outcomes. Additionally, it must also be recognised that "prices" are not all of one kind; actual market prices realised are not the same as ideal prices
Real prices and ideal prices
Real prices and ideal prices refers to a distinction between actual prices paid for products, services, assets and labour , and computed prices which are not actually charged or paid in market trade, although they may facilitate trade...

 of various kinds, which may be extrapolated from real prices.

A more serious criticism of Marx is that the theory of prices of production is still pitched at a far too abstract theoretical level to be able to explain anything like specific real price movements. That is, Marx only illustrated with examples the general results towards which the competitive process would tend to move in capitalism as a social system. He tried to establish what regulates product prices in the "purest case". He believed that if one could not do that, then one could also not explain all the variations from the pure case. He had not however provided a model for accurately predicting specific price movements. In this regard, it is interesting to study the writings of Michael Porter
Michael Porter
Michael Eugene Porter is the Bishop William Lawrence University Professor at Harvard Business School. He is a leading authority on company strategy and the competitiveness of nations and regions. Michael Porter’s work is recognized in many governments, corporations and academic circles globally...

, in order to see how Marx's original intent relates to modern competitive business practice, and how it might be elaborated on (see further the important studies by Willi Semmler (1984) and Christian Bidard (2004)).

Some critics conclude that because Marx fails to "transform" value magnitudes into price magnitudes in a way consistent with formal logic, he has not proved value exists, or that it influences prices; in turn, his theory of labour-exploitation must be false. But the validity of Marx's value theory or his exploitation theory
Exploitation theory
The exploitation theory is the theory, most associated with Marxists, that profit is the result of the exploitation of wage earners by their employers....

 may not depend on the validity of his specific transformation procedures, and Marxian scholars indeed often argue that critics mistake what he intended by them. In particular, since value relations - according to Marx - describe the proportionalities between average quantities of labour-time currently required to produce products, value proportions between products exist quite independently of prices.

Essentially, the advantage of distinguishing sharply between values and prices in this context is that it enables us to depict the interaction between shifts in product-values and shifts in product-prices as a dynamic process of real-world business and market behaviour, given the reality of different growth rates of supply and demand, i.e. not a study of the conditions for market balance, but a study of the actual process of market balancing occurring with a specific social framework, through successive adjustments which occur in a specific pattern.

Arguably ideal prices could substitute for values in this analysis, but Marx's argument is that product-values will, ontologically speaking, really exist irrespective of corresponding product-prices, i.e. irrespective of whether product-values are actually being traded, whereas ideal prices do not really exist other than in computations; they are only an hypothetical description. The reason is that product-values refer to empirical quantities of labour-time performed, which are not hypothetical, but an inescapable reality. This type of analysis paves the way for an important new Marxian criticism of Piero Sraffa
Piero Sraffa
Piero Sraffa was an influential Italian economist whose book Production of Commodities by Means of Commodities is taken as founding the Neo-Ricardian school of Economics.- Early life :...

's otherwise brilliant critique of capital theory. In Sraffa's theory, the value of a commodity "contains" both the average labour directly involved in making it ("direct labour") and past labour contained in the materials from which it is made ("indirect labour"). In Marx's theory, the value of the commodity represents the average labour currently required to make it, given the current state of the whole production complex - it is the current social valuation (the replacement cost) of that commodity. This is a synchronic valuation, not a diachronic one.

Some economists and computer scientists, such as Prof. Anwar Shaikh
Anwar Shaikh (economist)
Anwar M. Shaikh is an American economist, and currently Professor of Economics at the Graduate Faculty of The New School in New York City. His work in political economy has focused on the economic theory and empirical patterns of developed capitalism. He has written on international trade,...

 and Dr. Paul Cockshott, argue with statistical evidence that even just a "93% Ricardian labour theory of value" is a better empirical predictor of prices than other theories http://homepage.newschool.edu/~AShaikh/labthvalue.pdf. That is, the only real proofs of Marx theory and its applicability, beyond showing its internal logical consistency, are to be found in the evidence of experience. But whether more scholars will take up this challenge for research more comprehensively remains to be seen. Mostly, economists have preferred to build mathematical models on the basis of a bunch of assumptions, rather than comprehensively investigate available data for the purpose of creating a grounded theory
Grounded theory
Grounded theory is a systematic methodology in the social sciences involving the generation of theory from data. It is mainly used in qualitative research, but is also applicable to quantitative data....

 of economic life.

One possible solution to the "transformation problem", ignored in the literature, is that Marx tried to sketch a redistribution of value in too simplistic terms, considering the profitability of different production capitals in abstraction from the total circuit of capital. The problem that Ricardo failed to solve, was one of how capitals of equal sizes could empirically attract very similar profits, despite empirically manifest unequal expenditures of labour-time. But that problem may be solved more credibly, if we properly consider competition in the sphere of capital finance, i.e. the sphere of credit. In this sense, David Harvey
David Harvey
David Harvey is the name of:*David Harvey *David Harvey , geographer and social theorist*David Harvey , American luthier...

 for example mentions that "the growing power of the credit system in relation to industry also tends to force an equalization of the rate of profit (the connection between profit of enterprise and the interest rate is now very strong)" (cited from The Limits of Capital, Verso 2006, p. 303).

See also

  • law of value
    Law of value
    -General:The law of value is a central concept in Karl Marx's critique of political economy, first expounded in his polemic The Poverty of Philosophy against Pierre-Joseph Proudhon, with reference to David Ricardo's economics...

  • Value-form
    Value-form
    The value-form or form of value is a concept in Karl Marx’s critique of the political economy. It refers to a socially attributed characteristic of a commodity which contrasts with its tangible use-value or utility .The concept is introduced in the first chapter of Das Kapital where Marx argues...

  • Real prices and ideal prices
    Real prices and ideal prices
    Real prices and ideal prices refers to a distinction between actual prices paid for products, services, assets and labour , and computed prices which are not actually charged or paid in market trade, although they may facilitate trade...

  • capital accumulation
    Capital accumulation
    The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

  • Labour theory of value
  • transformation problem
    Transformation problem
    In 20th century discussions of Karl Marx's economics the transformation problem is the problem of finding a general rule to transform the "values" of commodities into the "competitive prices" of the marketplace...

  • capital controversy
  • Cost-of-production theory of value
    Cost-of-production theory of value
    In economics, the cost-of-production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it...

  • Temporal single-system interpretation
    Temporal single-system interpretation
    The temporal single-system interpretation of Karl Marx's value theory emerged in the early 1980s in response to renewed allegations that his theory was "riven with internal inconsistencies," and that it must therefore be rejected or corrected. The inconsistency allegations had been a prominent...

The source of this article is wikipedia, the free encyclopedia.  The text of this article is licensed under the GFDL.
 
x
OK