C.1 What determines price within capitalism?

Supporters of capitalism usually agree with what is called the Subjective Theory of Value (STV), as explained by most mainstream economic textbooks. This system of economics is usually termed "marginalist" economics, for reasons which will become clear.

In a nutshell, the STV states that the price of a commodity is determined by its marginal utility to the consumer and producer. Marginal utility is the point, on an individual's scale of satisfaction, at which his/her desire for a good is satisfied. Hence price is the result of individual, subjective evaluations within the marketplace. One can easily see why this theory could be appealing to those interested in individual freedom.

However, the STV is a myth. Like most myths, it does have a grain of truth in it. But as an explanation of how to determine the price of a commodity, it has serious flaws.

The kernel of truth is that individuals, groups, companies, etc. do indeed value goods and consume/produce them. The rate of consumption, for example, is based on the use-value of goods to the users (although whether some one buys a product is affected by price and income considerations, as we will see). Similarly, production is determined by the utility to the producer of supplying more goods. The use-value of a good is a highly subjective evaluation, and so varies from case to case, depending on the individual's taste and needs. As such it has an effect on the price, as will be shown, but as the means to determine a product's price it ignores the dynamics of a capitalist economy and the production relations that underlie the market. In effect, the STV treats all commodities like works of art, and such products of human activity (due to their uniqueness) are not a capitalistic commodity in the usual sense of the word (i.e. they cannot be reproduced and so labour cannot increase their quantity). Therefore the STV ignores the nature of production under capitalism. This is what will be discussed in the following sections.

Of course, modern economists try and portray economics as a "value-free science." Of course, it rarely dawns on them that they are usually just taking existing social structures and the economic dogmas build round them for granted and so justifying them. As Kropotkin pointed out:

"[A]ll the so-called laws and theories of political economy are in reality no more than statements of the following nature:

'Granting that there are always in a country a considerable number of people who cannot subsist a month, or even a fortnight, without accepting the conditions of work imposed upon them by the State, or offered to them by those whom the State recognises as owners of land, factories, railways, etc., then the results will be so and so.'

"So far middle-class political economy has been only an enumeration of what happens under the just-mentioned conditions -- without distinctly stating the conditions themselves. And then, having described the facts which arise in our society under these conditions, they represent to us these facts as rigid, inevitable economic laws." [Kropotkin's Revolutionary Pamphlets, p. 179]

In other words, economists usually take the political and economic aspects of capitalist society (such as property rights, inequality and so on) as given and construct their theories around it. Marginalism, in effect, took the "political" out of "political economy" by taking capitalist society for granted along with its class system, its hierarchies and its inequalities. By concentrating on individual choices they abstracted from the social system within which such choices are made and what influences them. Indeed, the STV was built upon abstracting individuals from their social surroundings and generating economic "laws" applicable for all individuals, in all societies, for all times This results in all concrete instances, no matter how historically different, being treated as expressions of the same universal concept. Thus, in neo-classical economics, wage-labour becomes labour, capital becomes the means of production, the labour process becomes a production function, acquisitive behaviour becomes human nature. In this way the uniqueness of contemporary society, namely its basis in wage labour, is ignored ("The period through which we are passing . . . is distinguished by a special characteristic -- WAGES." [Proudhon, System of Economical Contradictions, p. 199]) and what is specific to capitalism is universalised and made applicable for all time. Such a perspective cannot help being ideological rather than scientific. By trying to create a theory applicable for all time (and so, apparently, value free) they just hide the fact their theory justifies the inequalities of capitalism. As Edward Herman points out:

"Back in 1849, the British economist Nassau Senior chided those defending trade unions and minimum wage regulations for expounding an 'economics of the poor.' The idea that he and his establishment confreres were putting forth an 'economics of the rich' never occurred to him; he thought of himself as a scientist and spokesperson of true principles. This self-deception pervaded mainstream economics up to the time of the Keynesian Revolution of the 1930s. Keynesian economics, though quickly tamed into an instrument of service to the capitalist state, was disturbing in its stress on the inherent instability of capitalism, the tendency toward chronic unemployment, and the need for substantial government intervention to maintain viability. With the resurgent capitalism of the past 50 years, Keynesian ideas, and their implicit call for intervention, have been under incessant attack, and, in the intellectual counterrevolution led by the Chicago School, the traditional laissez-faire ('let-the-fur-fly') economics of the rich has been reestablished as the core of mainstream economics." [The Economics of the Rich]

Herman goes on to ask "[w]hy do the economists serve the rich?" and argues that "[f]or one thing, the leading economists are among the rich, and others seek advancement to similar heights. Chicago School economist Gary Becker was on to something when he argued that economic motives explain a lot of actions frequently attributed to other forces. He of course never applied this idea to economics as a profession . . ." [Ibid.] There are a great many well paying think tanks, research posts, consultancies and so on that create an "'effective demand' that should elicit an appropriate supply resource." [Ibid.]

The introduction of marginalism and its acceptance as "orthodoxy" served, and serves in the present, to divert serious attention from the most critical questions facing working people (for example, what goes on in production, how authority relations impact on society and in the workplace). Rather than looking to how things are produced, the conflicts generated in the production process and the generation/division of surplus, marginalism took what was produced as given, as well as the capitalist workplace, the division of labour and authority relations and so on.

Theories can pursue truth or serve vested interests. In the later capacity they will incorporate only concepts suited to attaining the results desired. An economic theory, for example, may highlight profits, quantities of output, amount of investment, and prices, and leave out class struggle, alienation, hierarchy and bargaining power. Then the theory will serve capitalists, and, since capitalists pay economists' wages and endow their universities, economists and their students who comply, will benefit as well.

General equilibrium analysis and marginalism is made to order for the ruling class. Marginalism ignores the question of production and concentrates on exchange. It argues that any attempt by working people to improve their position in society (by, for example, unions) is counter-productive, it preaches that "in the long run" everyone will be better off and so present day problems are irrelevant (and any attempt to fix them counterproductive) and, of course, the capitalists are entitled to their profits, interest payments and rent. The utility of such a theory is obvious. An economic theory that justifies inequality, "proves" that profits, rent and interest are not exploitative and argues that the economically powerful be given free reign will have more use-value ("utility") to the ruling class than those that do not. In the market place of ideas, it is these which will satisfy the demand and become intellectually "respectable."

Of course, not all supporters of capitalist economics are rich (although most desire to become so). Many do believe its claims that capitalism is based upon freedom and that the profits, interest and rent represent "rewards" for services provided rather than resulting from the exploitation generated by hierarchical workplaces and social inequality. However, before tackling the question of profits, interest and rent we must first discuss why the STV is wrong.

C.1.1 So what is wrong with this theory?

The first problem in using marginal utility to determine price is that it leads to circular reasoning. Prices are supposed to measure the "marginal utility" of the commodity, yet consumers need to know the price first in order to evaluate how best to maximise their satisfaction. Hence subjective value theory "obviously rest[s] on circular reasoning. Although it tries to explain prices, prices [are] necessary to explain marginal utility." [Paul Mattick, Economics, Politics and the Age of Inflation, p.58] In the end, as Jevons (one of the founders of marginalism) acknowledged, the price of a commodity is the only test we have of the utility of the commodity to the producer. Given that marginality utility was meant to explain those prices, the failure of the theory could not be more striking.

Secondly, consider the definition of equilibrium price. Equilibrium price is the price for which the quantity demanded is precisely equal to the quantity supplied. At such a price there is no incentive for either demanders or suppliers to alter their behaviour.

Why does this happen? The subjective theory cannot really explain why this price is the equilibrium price, as opposed to any other. This is because the STV ignores that an objective measure is required upon which to base "subjective" evaluations within the market. The consumer, when shopping, requires prices in order to allocate their money to best maximise their "utility" (and, of course, the consumer faces prices on the market, the very thing marginal utility theory was meant to explain!). And how does a company know it is making a profit unless it compares the market price with the production costs of the commodity it produces? As Proudhon put it, "[i]f supply and demand alone determine value, how can we tell what is an excess and what is a sufficiency? If neither cost, nor market price, nor wages can be mathematically determined, how is it possible to conceive of a surplus, a profit?" [System of Economical Contradictions, p. 114] This objective measure can only be the actual processes of production within capitalism, production which is for profit. The implications of this are important when discovering what determines price within capitalism, as will be discussed in the next section (C.1.2 - So what does determine price?).

The early marginalists were aware of this problem and argued that price reflected the utility at the "margin" (Jevons, one of the founders of the marginalist school, argued that the "final degree of utility determines value"); but what determined the position of the margin itself? This is fixed by the available supply ("Supply determines final degree of utility" -- Jevons); but what determines the level of supply? ("Cost of production determines supply" -- Jevons). In other words, price is dependent on marginal utility, which is dependent on supply, which is dependent on the cost of production. In other words, ultimately on an objective measure (supply or cost of production) rather than subjective evaluations! This is unsurprising because before you can consume ("subjectively value") something on the market, it has to be produced. It is the process of production that rearranges matter and energy from less useful to more useful (to us) forms. Which brings us straight back to production and the social relations which exist within a given society -- and the political dangers of defining (exchange) value in terms of labour (see next section). Afterall, the individual does not just face a given supply on the market, they also face prices, including the costs associated with production and profit taking.

As the whole aim of marginalism was to abstract away from production (where power relations are clear) and concentrate on exchange (where power works indirectly), it is unsurprising that early marginal utility value theory was quickly abandoned. The continued discussion of "utility" in economics textbooks is primarily heuristic. First the neo-classical economists used measurable (cardinal) "utility" (i.e. that utility was the same for all) but that caused political problems (as cardinal utility implied that the "utility" of an extra dollar to a poor person was clearly greater than the loss of one dollar to a rich man and this obviously justified redistribution polities). When this was recognised (along with the obvious fact that cardinal utility was impossible in practice) utility became "ordinal" (i.e. utility was an individual thing and so could not be measured). Then even ordinal utility was abandoned as cross-personal utilities were not comparable and so objective prices could be derived from it (which was Adam Smith's argument and which lead him to develop a labour theory of value rather than one based on utility, or use value). With the abandonment of "ordinal" utility, mainstream economics gave up even thinking about individual preferences in those terms. This means that modern economics does not have a value theory at all -- and without a value theory, the claim that the workings of capitalism will benefit all or its outcome will realise individual preferences has no rational foundation.

Thus utility theory was gradually deprived of all its bite and reduced from cardinal to ordinal utility and from ordinal utility to 'revealed preference.' This retreat from cardinal utility (patently dreamland) to ordinal utility (distinction without a difference) to "revealed preferences" (the naked tautology -- consumers maximise total utility as "revealed" in the structures of spending or, consumers maximise what they maximise) was but one of the many retreats made among the marginalists as their contrived core assumptions were exposed to simple but penetrating questions.

While ignoring "utility" theory of value, most mainstream economics accept the notions of "perfect competition" and (Walrasian) "general equilibrium" which were part and parcel of it. Marginalism attempted to show, in the words of Paul Ormerod, "that under certain assumptions the free market system would lead to an allocation of a given set of resources which was in a very particular and restricted sense optimal from the point of view of every individual and company in the economy." [The Death of Economics, p. 45] This was what Walrasian general equilibrium proved. However, the assumptions required prove to be somewhat unrealistic (to understate the point). As Ormerod points out:

"[i]t cannot be emphasised too strongly that . . . the competitive model is far removed from being a reasonable representation of Western economies in practice. . . [It is] a travesty of reality. The world does not consist, for example, of an enormous number of small firms, none of which has any degree of control over the market . . . The theory introduced by the marginal revolution was based upon a series of postulates about human behaviour and the workings of the economy. It was very much an experiment in pure thought, with little empirical rationalisation of the assumptions."

Indeed, "the weight of evidence" is "against the validity of the model of competitive general equilibrium as a plausible representation of reality." [Op. Cit., p. 48, p. 62] For example, oligopoly and imperfect competition have been abstracted from so that the theory does not allow one to answer interesting questions which turn on the asymmetry of information and bargaining power among economic agents, whether due to size, or organisation, or social stigmas, or whatever else. In the real world, oligopoly is common place and asymmetry of information and bargaining power the norm. To abstract from these means to present an economic vision at odds with the reality people face and, therefore, can only propose solutions which harm those with weaker bargaining positions and without information. In addition, the model is set in a timeless environment, with people and companies working in a world where they have perfect knowledge and information about the state of the market. A world without a future and so with no uncertainty (any attempt to include time, and so uncertainty, ensures that the model ceases to be of value). Thus model cannot easily or usefully account for the reality that economic agents do not actually know such things as future prices, future availability of goods, changes in production techniques or in markets to occur in the future, etc. Instead, to achieve its results -- proofs about equilibrium conditions -- the model assumes that actors have perfect knowledge at least of the probabilities of all possible outcomes for the economy. The opposite is the case in reality.

In this timeless, perfect world, "free market" capitalism will prove itself an efficient method of allocating resources and all markets will clear. In part at least, General Equilibrium Theory is an abstract answer to an abstract and important question: Can an economy relying only on price signals for market information be orderly? The answer of general equilibrium is clear and definitive -- one can describe such an economy with these properties. However, no actual economy has been described and, given the assumptions involved, no such economy could ever exist. An theoretical question has been answered involving some amount of intellectual achievement, but it is a answer which has no bearing to reality. And this is often termed the "high theory" of equilibrium. Obviously most economists must treat the real world as a special case.

Thus General Equilibrium theory analyses an economic state which there is no reason to suppose will ever, or have ever, come about. It is, therefore, an abstraction which has no discernible applicability or relevance to the world as it is. To argue that it can give insights into the real world is ridiculous. As mainstream economic theory begins with axioms and assumptions and uses a deductivist methodology to arrive at conclusions, its usefulness in discovering how the world works is limited. Firstly, as we note in section F.1.3, the deductive method is pre-scientific in nature. Secondly, the axioms and assumptions can be considered fictitious (as they have negligible empirical relevance) and the conclusions of deductivist models can only really have relevance to the structure of those models as the models themselves bear no relation to economic reality. While it is true that there are certain imaginary intellectual problems for which the general equilibrium model is well designed to provide precise answers (if anything really could), in practice this means the same as saying that if one insists on analysing a problem which has no real world equivalent or solution, it may be appropriate to use a model which has no real-world application. Models derived to provide answers to imaginary problems will be unsuitable for resolving practical, real-world economic problems or even providing a useful insight into how capitalism works and develops. In the words of noted left-wing economist Nicholas Kaldor, "equilibrium theory has reached the stage where the pure theorist has successfully (though perhaps inadvertently) demonstrated that the main implications of this theory cannot possibly hold in reality, but has not yet managed to pass his message down the line to the textbook writer and to the classroom." Little wonder, then, that his "basic objection to the theory of general equilibrium is not that it is abstract -- all theory is abstract and must necessarily be so since there can be no analysis without abstraction -- but that it starts from the wrong kind of abstraction, and therefore gives a misleading 'paradigm' . . . of the world as it is; it gives a misleading impression of the nature and the manner of operation of economic forces." [The Essential Kaldor, p. 377 and p. 399]

There is a more realistic neo-classical notion of equilibrium called "partial" equilibrium theory (developed by Alfred Marshall). "Time" is included via Alfred Marshall's notion of equilibrium existing in various runs. The most important of Marshall's concepts are "short run" and "long run" equilibrium. However, this is just comparing one static (ideal) state with another. Marshall treated markets "one at a time" (hence the expression "partial equilibrium") with "all other things being equal" -- the assumption being that the rest of the economy is unchanged! This theory confuses the comparison of possible alternative equilibrium positions with the analysis of a process taking place through time, i.e. historical events are introduced into a timeless picture. In other words, time as the real world knows it does not exist. In the real world, any adjustment takes a certain time to complete and events may occur that alter equilibrium. The very process of moving has an effect upon the destination and so there is no such thing as a position of long-run equilibrium which exists independently of the course which the economy is following. Marshall's assumptions of "one market at a time" and "all other things equal" ensure that the concept of time is as foreign to "partial" equilibrium as it is to "general" equilibrium.

So much of mainstream economics is based upon theories which have little or no relation to reality. The aim of marginality utility theory was to show that capitalism was efficient and that everyone benefits from it (it maximises utility, in the limited sense imposed by what is available on the market, of course). This was what perfect competition was said to prove. But perfect competition is impossible. And as perfect competition is itself an assumption of marginal utility, we might expect the theory to have been abandoned at this point. Instead, the contradiction was swept under the carpet.

In addition, like most religions, neo-classical economics cannot be scientifically tested. This is because the perfect competition model makes no falsifiable predictions whatsoever. As Martin Hollis and Edward Nell argue:

"Indeed the whole idea of testing the marginal analysis is absurd. For what could a test reveal? Negative results show only that the market is defective. Various interpretations can be given . . . But one interpretation is not possible -- that the marginal analysis has been refuted. . . . To generalise the point, marginalist statements to the effect that, if the assumptions of Positive micro-economics hold, then so-and-so will happen, are tautologies and their consequences are simply logical deductions from their protases. . . the model is untestable." [Rational Economic Man, p. 34]

In other words, if a prediction of marginalist economics does not hold all we can draw from the test is that perfect competition was not in existence. The theory cannot be disproven, no matter now much evidence is gathered against it. In addition, there are other useful techniques which can be used in defending the neo-classical ideology from empirical evidence. For example, neo-classical economics maintains that production is marked by diminishing returns to scale. Any empirical evidence that suggests otherwise can be dismissed simply because, obviously, the scale is not large enough -- eventually returns will decrease with size. Similarly, the term "in the long run" can work wonders for the ideology. For if the claimed good results of a given policy do not materialise for anyone bar the ruling class, then, rather than blame the ideology, the time scale can be the culprit (in the long run, things will turn out for the best -- unfortunately for the majority, the long run has not arrived yet, but it will; until then you will have to make sacrifices for your future gains...). Obviously with such an "analysis" anything can be proven.

Little wonder Nicholas Kaldor argued that:

"The Walrasian [i.e. general] equilibrium theory is a highly developed intellectual system, much refined and elaborated by mathematical economists since World War II -- an intellectual experiment . . . But it does not constitute a scientific hypothesis, like Einstein's theory of relativity or Newton's law of gravitation, in that its basic assumptions are axiomatic and not empirical, and no specific methods have been put forward by which the validity or relevance of its results could be tested. The assumptions make assertions about reality in their implications, but these are not founded on direct observation, and, in the opinion of practitioners of the theory at any rate, they cannot be contradicted by observation or experiment." [Op. Cit., p. 416]

Marginalism, however, in spite of these slight problems, did serve a valuable ideological function. It removed the appearance of exploitation from the system, justifies giving business leaders the "freedom" to operate as they liked and portrayed a world of harmony between the owners of factors. Hence its general acceptance within economics. In other words, it justified the mentality of "what is profitable is right" and removed politics and ethics from the field of economics. Moreover, the theory of "perfect competition" (regardless of its impossibility) allowed economists to portray capitalism as optimal, efficient and the satisfier of individual desires. And this is important, for without the assumption of equilibrium, market transactions need not benefit all. Indeed, it may lead to the tyranny of the fortunate over the unfortunate, with the majority facing a series of dismal choices between the lessor of a group of evils. Of course, with the assumption of equilibrium, reality must be ignored. So capitalist economics is between a rock and a hard place.

All in all, the world assumed by neo-classical economics is not the one we actually live in, and so applying that theory is both misleading and (usually) disastrous (at least to the "have-nots").

Some pro-"free market" capitalist economists (such as those in the right-wing "Austrian school") reject the notion of equilibrium completely and embrace a dynamic model of capitalism. While being far more realistic than mainstream neo-classical theory, this method abandons the possibility of demonstrating that the market outcome is in any sense a realisation of the individual preferences of whose interaction it is an expression. It has no way of establishing the supposedly stabilising character of entrepreneurial activity or its alleged socially beneficial character. Indeed, entrepreneurial activity tends to disrupt markets (particularly labour markets) away from equilibrium (i.e. the full use of available resources) rather than towards it. In other words, the dynamic process could lead to a divergence rather than a convergence of behaviour and so to increased unemployment, a reduction in the quality of available choices available from which to maximise your "utility" and so on. A dynamic system need not be self-correcting, particularly in the labour market, nor show any sign of self-equilibrium (i.e. be subject to the business cycle). Ironically enough, economists of this school often maintain that while equilibrium cannot be reached the labour market will experience full employment under "free market" or "pure" capitalism. That this condition is one of equilibrium does not seem to cause them much concern. Thus we find von Hayek, for example, arguing that the "cause of unemployment . . . is a deviation of prices and wages from their equilibrium position which would establish itself with a free market and stable money" and that "the deviation of existing prices from that equilibrium position . . . is the cause of the impossibility of selling part of the labour supply." [New Studies, p. 201] Therefore, we see the usual embrace of equilibrium theory to defend capitalism against the evils it creates even by those who claim to know better. Perhaps this is a case of political expediency, allowing the ideological supporters of free market capitalism to attack the notion of equilibrium when it clearly clashes with reality but being able to return to it when attacking, say, trade unions, welfare programmes and other schemes which aim to aid working class people against the ravages of the capitalist market?

These supporters of capitalism stress "freedom" -- the freedom of individuals to make their own decisions. And who can deny that individuals, when free to choose, will pick the option they consider best for themselves? However, what this praise for individual freedom ignores is that capitalism often reduces choice to picking the lesser of two (or more) evils due to the inequalities it creates (hence our reference to the quality of the decisions available to us). The worker who agrees to work in a sweatshop does "maximise" her "utility" by so doing -- afterall, this option is better than starving to death -- but only an ideologue blinded by capitalist economics will think that she is free or that her decision is made under economic compulsion. In other words, this idealisation of freedom through the market completely ignores the fact that this freedom can be, to a large number of people, very limited in scope. Moreover, the freedom associated with capitalism, as far as the labour market goes, becomes little more than the freedom to pick your master. All in all, this defence of capitalism ignores the existence of economic inequality (and so power) which infringes the freedom and opportunities of others (for a fuller discussion of this, see section F.3.1). Social inequalities can ensure that people end up "wanting what they get" rather than "getting what they want" simply because they have to adjust their expectations and behaviour to fit into the patterns determined by concentrations of economic power. This is particularly the case within the labour market, where sellers of labour power are usually at a disadvantage when compared to buyers due to the existence of unemployment (see sections B.4.3, C.7 and F.10.2).

Which brings us to another problem associated with marginalism, namely the distribution of resources within society. Market demand is usually discussed in terms of tastes, not in the distribution of purchasing power required to satisfy those tastes. So, as a method of determining price, marginal utility ignores the differences in purchasing power between individuals and assumes the legal fiction that corporations are individual persons (income distribution is taken as a given). Those who have a lot of money will be able to maximise their satisfactions far easier than those who have little. Also, of course, they can out-bid those with less money. If, as many right-"Libertarians" say, capitalism is "one dollar, one vote," it is obvious whose values are going to be reflected most strongly in the market. This is why orthodox economists make the convenient assumption of a 'given distribution of income' when they try to show the best allocation of resources is the market based one.

In other words, under capitalism, it is not "utility" as such that is maximised, rather it is "effective" utility (usually called "effective demand") -- namely utility that is backed up with money. The capitalist market places (or rather, the owning class in such a system places) value (i.e. prices) on things according to the effective demand for them. "Effective demand" is people's desires weighted by their ability to pay. So, the market counts the desires of affluent people as more important than the desires of destitute people. And so capitalism skews consumption away from satisfying the "utility" of those most in need and into satisfying the needs of the wealthy few first. This does not mean that the needs of the many will not be meet (usually, but not always, they are to some degree), it means that for any given resource those with money can out-bid those with less -- regardless of the human cost. As the pro-free market capitalism economist Von Hayek argued the "[s]pontaneous order produced by the market does not ensure that what general opinion regards as more important needs are always met before the less important ones." [The Essential Hayek, p. 258] Which is just a polite way of referring to the process by which millionaires build a new mansion while thousands are homeless or live in slums, feed luxury food to their pets will humans go hungry or when agribusiness grow cash crops for foreign markets while the landless starve to death (see also section I.4.5). Needless to say, marginalist economics justifies this market power and its results.

In summary, neo-classical economics shows the viability of an unreal system and this is translated into assertions about the world that we live in until most people just accept that reality reflects the model (rather than vice versa, as it should but does not in neo-classical theory). Moreover, and even worse, policy decisions will be enacted based on a model which has no bearing in reality -- with disastrous results (for example, the rise and fall of Monetarism -- see section C.8). In addition, it justifies (when not ignoring) hierarchical structures and massive inequalities in wealth and bargaining power in society, which make a mockery of individual freedom. (see section F.3.1 for details). It serves the interests of those with power and wealth in modern society as well as the aims of a soul-destroying, world-polluting commercial system by deprecating the importance of aesthetic, humane and, indeed, human factors in economic decision making. Indeed, the mere suggestion that people should be placed before (never mind instead of) profits would produce a fit. Starting from a false premise, marginalism ends up negating its own stated ideals -- rather than being the economics of individual freedom it becomes the means of justifying restrictions and negations of that freedom.

So, if the STV is flawed, what does determine prices? Obviously, in the short term, prices are heavily influenced by supply and demand. If demand exceeds supply, the price rises and vice versa. This truism, however, does not answer the question. The answer lies in production and in the social relationships generated there. This is discussed in the next section.

C.1.2 So what does determine price?

The key to understanding prices lies in understanding that production under capitalism has as its "only aim . . . to increase the profits of the capitalist." [Peter Kropotkin, Kropotkin's Revolutionary Pamphlets, p. 55] In other words, profit is the driving force of capitalism. Once this fact and its implications are understood, the determination of price is simple and the dynamics of the capitalist system made clearer. The price of a capitalist commodity will tend towards its production price in a free market, production price being the sum of production costs plus average profit rates (the average profit rate, we should note, depends upon the ease of entry into the market, see below).

Consumers, when shopping, are confronted by given prices and a given supply. The price determines the demand, based on the use-value of the product to the consumer and his/her financial situation. If supply exceeds demand, supply is reduced (either by firms reducing production or by firms closing and capital moving to other, more profitable, markets) until an average rate of profit is generated (although we must stress that investment decisions are difficult to reverse and this means mobility can be reduced, causing adjustment problems -- such as unemployment -- within the economy). The rate of profit is the amount of profit divided by the total capital invested (i.e. constant capital -- means of production -- and variable capital -- wages and slavery). If the given price generates above-average profits (and so profit rate), then capital will try to move from profit-poor areas into this profit-rich area, increasing supply and competition and so reducing the price until an average rate of profit is again produced (we stress try to as many markets have extensive barriers to entry which limit the mobility of capital and so allow big business to reap higher profit rates -- see section C.4). So, if the price results in demand exceeding supply, this causes a short term price increase and these extra profits indicate to other capitalists to move into this market. The supply of the commodity will tend to stabilise at whatever level of the commodity is demanded at the price which produces average profit rates (this level being dependent on the "degree of monopoly" within a market -- see section C.5). This profit level means that suppliers have no incentive to move capital into or out of that market. Any change from this level in the long term depends on changes on the production price of the good (lower production prices meaning higher profits, indicating to other capitalists that the market could be profitable for new investment).

As can be seen, this theory (often called the Labour Theory of Value -- or LTV for short) does not deny that consumers subjectively evaluate goods and that this evaluation can have a short term effect on price (which determines supply and demand). Many right-"libertarian" and mainstream economists assert that the labour theory of value removes demand from the determination of price. A favourite example is that of the "mud pie" -- if it takes the same labour as an apple pie to make, they ask, surely it has the same value (price)? These assertions are incorrect as the LTV bases itself on supply and demand and seeks to explain the dynamics of prices and so recognises (indeed bases itself on the fact) that individuals make their own decisions based upon their subjective needs (in the words of Proudhon, "utility is the necessary condition for exchange." [System of Economical Contradictions, p. 77]). What the LTV seeks to explain is price (i.e. exchange value) -- and a good can only have an exchange value if others desire it (i.e. has a use value for them and they seek to exchange money or goods for it). Thus the example of the "mud pie" is a classic straw man argument -- the "mud pie" does not have an exchange value as it has no use value to others and is not subject to exchange. In other words, if a commodity cannot be exchanged, it cannot have an exchange value (and so price). As Proudhon argued, "nothing is exchangeable if it be not useful." [Op. Cit., p. 85]

The LTV is based upon the insight that without labour nothing would be produced and you have to produce something before you can exchange it (or you can steal it, as in the case of land). As the utility (i.e. use value) of a commodity cannot be measured, labour is the basis of (exchange) value. The LTV bases itself on the objective needs of production and recognises the key role labour plays (directly and indirectly) in the creation of commodities. However, this does not mean that value exists independently of demand. Far from it -- as noted, in order to have an exchange value, a good must be desired by someone other than its maker (or the capitalist who employs the maker), it must have a use-value for them (in other words, it is subjectively valued by them). Therefore workers produce that which has (use) value, as determined by the demand, and the costs of production involved in creating these use-values help determine the price (its exchange value) along with profit levels.

Therefore the LTV includes the element of truth of "subjective" theory while destroying its myths. For, in the end, the STV just states that "prices are determined marginal utility; marginal utility is measured by prices. Prices . . . are nothing more or less than prices. Marginalists, having begun their search in the field of subjectivity, proceeded to walk in a circle." [Allan Engler, Apostles of Greed, p. 27] The LTV, on the other hand, bases itself on the objective fact of production and the costs (ultimately expressed in labour time) ensuing in it ("The absolute value of a thing, then, is its cost in time and expense." [Proudhon, What is Property?, p. 145]). The variations in supply and demand (i.e. market prices) oscillate round this "absolute value" (i.e. production price) and so it is the cost of production of a commodity which ultimately regulates its price, not supply and demand (which only temporarily affects its market price).

While the STV is handy for describing the price of works of art (and we should note that the LTV can also provide an explanation for this), there is little point having an economic theory which ignores the nature of the vast majority of economic activity in society. What the labour theory of value explains is what is beneath supply and demand, what actually determines price under capitalism. It recognises the objectivity given price and supply which face a consumer and indicates how consumption ("subjective evaluations") affect their movements. It explains why a certain commodity sells at a certain price and not another -- something which the subjective theory cannot really do. Why should a supplier "alter their behaviour" in the market if it is based purely on "subjective evaluations"? There has to be an objective indication that guides their actions and this is found in the reality of capitalist production. To re-quote Proudhon, "[i]f supply and demand alone determine value, how can we tell what is an excess and what is a sufficiency? If neither cost, nor market price, nor wages can be mathematically determined, how is it possible to conceive of a surplus, a profit?" [System of Economical Contradictions, p. 114] Therefore, "[t]o say . . . that supply and demand is the law of exchange is to say that supply and demand is the law of supply and demand; it is not an explanation of the general practice, but a declaration of its absurdity." [Op. Cit., p. 91] Thus the labour theory of value more accurately reflects reality: namely, that for a normal commodity, prices as well as supply exist before subjective evaluations can take place and that capitalism is based on the production of profit rather than abstractly satisfying consumer needs.

It could be argued that this "prices of production" theory is close to the neo-classical "partial equilibrium" theory. In some ways this is true. Marshall basically synthesised this theory from the marginal utility theory and the older "cost of production" theory which J.S. Mill derived from the LTV. However, the differences are important. First, the LTV does not get into the circular reasoning associated with attempts to derive utility from price we have indicated above. Second, it argues that rent, profit and interest are the unpaid labour of workers rather than being the "rewards" to owners for being owners. Thirdly, it is a dynamic system in which the prices of production can and do change as economic decisions are made. Fourthly, it can easily reject the idea of "perfect competition" and give an account of an economy marked by barriers to entry and difficult to reverse investment decisions. And, lastly, labour markets need not clear in the long run. Given that modern economics has given up trying to measure utility, it means that in practice (if not in rhetoric) the neo-classical model has rejected the marginal utility theory of value part of the synthesis and returned, basically, to the classical (LTV) approach -- but with important differences which gut the earlier version of its critical edge and dynamic nature.

Needless to say, the LTV does not ignore naturally occurring objects like gems, wild foods, and water. Nature is a vast source of use-values which humanity must utilise in order to produce other, different, use-values. If you like, the earth is the mother and labour the father of wealth. Its sometimes claimed that the labour theory of value implies that naturally occurring objects should have no price, since it takes no labour to produce them. This, however, is false. For example, gemstones are valuable because it takes a huge amount of labour to find them. If they were easy to find, like sand, they would be cheap. Similarly, wild foods and water have value according to how much labour is needed to find, collect, and process them in a given area (for example water in arid places is more "valuable" than water near a lake).

The same logic applies to other naturally occurring objects. If it takes virtually no effort to obtain them -- like air -- then they will have little or no exchange value. However, the more effort it takes to find, collect, purify, or otherwise process them for use, the more exchange value they will have relative to other goods (i.e. their production prices are higher, leading to a higher market price).

The attempt to ignore production implied in the STV comes from a desire to hide the exploitative nature of capitalism. By concentrating upon the "subjective" evaluations of individuals, those individuals are abstracted away from real economic activity (i.e. production) so the source of profits and power in the economy can be ignored. Section C.2 (Where do profits come from?) indicates why exploitation of labour in production is the source of profits, not activity in the market.

Of course, the pro-capitalist will argue that the labour theory of value is not universally accepted within mainstream economics. How true; but this hardly suggests that the theory is wrong. Afterall, it would have been easy to "prove" that democratic theory was "wrong" in Nazi Germany simply because it was not universally accepted by most lecturers and political leaders at the time. Under capitalism, more and more things are turned into commodities -- including economic theories and jobs for economists. Given a choice between a theory which argues that profits, interest and rent are unpaid labour (i.e. exploitation) or one that argues they are all valid "rewards" for service, which one do you think the wealthy will back in terms of funding?

This was the case with the labour theory of value. From the time of Adam Smith onwards, radicals had used the LTV to critique capitalism. The classical economists (Adam Smith and David Ricardo and their followers like J.S. Mill) argued that, in the long run, commodities exchanged in proportion to the labour used to produce them. Thus commodity exchange benefited all parties as they received an equivalent amount of labour as they had expended. However, this left the nature and source of capitalist profits subject to debate, debate which soon spread to the working class. Long before Karl Marx (the person most associated with the LTV) wrote his (in)famous work Capital, Ricardian Socialists like Robert Owen and William Thompson and anarchists like Proudhon were using the LTV to present a critique of capitalism, exposing it as being based upon exploitation (the worker did not, in fact, receive in wages the equivalent of the value she produced and so capitalism was not based on the exchange of equivalents). In the United States, Henry George was using it to attack the private ownership of land. When marginalist economics came along, it was quickly seized upon as a way of undercutting radical influence. Indeed, followers of Henry George argue that neo-classical economics was developed primarily to counter act his ideas and influence (see The Corruption of Economics by Mason Gaffney and Fred Harrison).

Thus, as noted above, marginalist economics was seized upon, regardless of its merits as a science, simply because it took the political out of political economy. With the rise of the socialist movement and the critiques of Owen, Thompson, Proudhon and many others, the labour theory of value was considered too political and dangerous. Capitalism could no longer be seen as being based on the exchange of equivalent labour. Rather, it should seen as being based on exchange of equivalent utility. But, as indicated (in the last section) the notion of equivalent utility was quickly dropped while the superstructure built upon it became the basis of capitalist economics. And without a theory of value, capitalist economics cannot prove that capitalism will result in harmony, the satisfaction of individual needs, justice in exchange or the efficient allocation of resources.

One last point. We must stress that not all anarchists support the LTV. Kropotkin, for example, did not agree with it. He considered socialist use of the LTV as taking "the metaphysical definitions of the academical economists" to critique capitalism using its own definitions and so, like capitalist economics, it was not scientific [Evolution and Environment, p. 92]. However, his rejection of the LTV did not imply that Kropotkin did not consider capitalism as exploitative. Far from it. Like every anarchist, Kropotkin attacked the "appropriation of the produce of human labour by the owners of capital," seeing its roots in the fact that "millions of men [and women] have literally nothing to live upon, unless they sell their labour force and their intelligence at a price that will make the net profit of the capitalist and 'surplus value' possible." [Op. Cit., p. 106] We discuss profits in more detail in section C.2 (Where do profits come from?).

Kropotkin's rejection of the LTV is based on the fact that, within capitalism, "[v]alue in exchange and the necessary labour are not proportional to each other" and so "Labour is not the measure of Value." [Op. Cit., p. 91] Which is, of course, true under capitalism. As Proudhon (and Marx) argued, under capitalism (due to existence of capitalist profit, rent and interest) prices could not be proportional to the average labour required to produce a commodity ("Wherever labour has not been socialised, -- that is, wherever value is not synthetically determined, -- there is irregularity and dishonesty in exchange." [Proudhon, Op. Cit., p. 128]) Only when the rate of profit is zero could prices directly reflect labour values (which is, of course, what Proudhon and Tucker desired -- "Socialism . . . extends its ["that llabour is the true measure of price"] function to the description of society as it should be, and the discovery of the means of making it what it should be." [Tucker, The Individualist Anarchists, p. 79]). Therefore, Kropotkin is correct to state that "[u]nder the capitalist system, value in exchange is measured no more by the amount of necessary labour." [Op. Cit., p. 91]

However, this does not mean that the LTV is irrelevant to analysing the capitalist economy. Rather, it argues that under capitalism labour is, essentially, the regulator of price, not its measure. "The idea that has been entertained hitherto of the measure of value," argued Proudhon, "then, is inexact; the object of our inquiry is not the standard of value, as has been said so often and so foolishly, but the law which regulates the proportions of the various products to the social wealth; for upon the knowledge of this law depends the rise and fall of prices." [System of Economical Contradictions, p. 94] So Kropotkin's argument does not undermine the LTV as such. Stripped of the metaphysical baggage which many (particularly Marxists) have placed on the LTV (and correctly attacked as unscientific by Kropotkin), it is essentially an methodological tool, a means of investigating the key aspects of capitalism -- namely wage labour and the conflicts associated with it at the point of production -- at a high level of abstraction. Thus it is a explanatory tool and value an explanatory category, a means of understanding the dynamics of capitalism.

Therefore, rather than being the crude idea that "exchange value" equals prices the LTV is primarily a means of analysis. This can be seen by our use of "production prices" rather than (exchange) value in our description of how the theory works. The LTV focuses analysis onto the production process and thus correctly points our investigations of how capitalism works to what goes on in production, to the relations of authority in the capitalist workplace, the struggle between the power of the boss and the liberty of the workers, the struggle over who controls the production process and how the surplus produced by workers is divided (i.e. how much remains in the hands of those who produced it and how much is appropriated by capitalists). Therefore, the claim that prices deviate from values and so the LTV is outdated indicates a confusion between the explanatory role of the LTV and the actual world of prices and profits. The LTV reminds us that production comes before and so underlies exchange and what happens at the point of production directly influences what happens in exchange. Decreasing the direct and indirect labour time required for production will decrease the cost price of a commodity and so reduce its production price. Thus the rise and fall of prices and profits is the result of changes in value relations (i.e. in the objective labour costs of production -- labour-time value) and so the use of the LTV as an explanatory tool is valid.

In other words, the labour theory of value is simply a good heuristic analysis device which gives an insight into how prices are formed rather than the prices as such. In practice, production prices are dependent on wages and these reflect labour-time values rather than are labour-time values.

Thus Kropotkin was right -- up to a point. His critique of the LTV is correct for those versions of it which state that "equilibrium" price equals the (exchange) value of a good. He was correct to note that under capitalism this rarely happens. Which means that our use of the LTV is simply that of an explanatory tool, a means of looking at the key aspect of capitalism -- namely the production process which creates things which have use value for others and are then exchanged. Production comes first and so we must first start there to understand the dynamics of capitalism. Not to do so, as the STV does, will lead your analysis into a dead end and will ignore the fundamental aspect of capitalism -- wage labour, the authority structures in production and the exploitation of labour such oppression generates.

Indeed, Kropotkin's argument is reflected the "prices of production" perspective outlined above as we concentrate of prices rather than "values." We reject the metaphysical abstractions often associated with the LTV and rather concentrate on real phenomenon, such as prices, profits, class struggle and so on. Such a perspective helps ground our critique of capitalism in what happens in the real world rather than in the realms of abstraction. As we argue in section H.3.2, Marx's concentration on value (i.e. the abstract level of analysis) made him ignore the role of class struggle in capitalism and its affect on profits (with bad results for his theory and the movement he inspired).

C.1.3 What else affects price levels?

As indicated in the last section, the price of a capitalist commodity is, in the long term, equal to its production price, which in turn determines supply and demand. If demand or supply changes, which of course they can and do as consumers' values change and new means of production are created and old ones end, these will have a short-term effect on prices, but the average production price is the price around which a capitalist commodity sells. Thus it is the cost of production which ultimately regulates the price of commodities. In other words, "market relations are governed by the production relations." [Paul Mattick, Economic Crisis and Crisis Theory, p. 51] As Proudhon put it:

"Thus value varies, and the law of value is unchangeable, further, if value is susceptible of variation, it is because it is governed by a law whose principle is essentially inconstant, -- namely, labour measured by time." [Op. Cit., p. 100]

However, the amount of time and effort spent in producing a particular commodity is not the essential factor in determining its price in the market. What counts is the costs (including the amount of work time) that it takes on average to produce that type of commodity, when the work is performed with average intensity, with typically used tools and average skill levels. Commodity production that falls below such standards, e.g. using obsolete technology or less-than-average intensity of work, will not allow the seller to raise the price of the commodity to compensate for its inefficient production, because its price is determined in the market by average conditions (and thus average costs) of production, plus the average profit levels required to meet the average rate of profit on the invested capital. On the other hand, using production methods that are more efficient than average -- i.e.. which allow more commodities to be produced with less labour -- will allow the seller to reap more profits and/or lower the price below average, and thus capture more market share, which will eventually force other producers to adopt the same technology in order to survive, and so lower the market production price of that type of commodity. In this way, advances that reduce labour time translate into reduced exchange value (and so price), thus showing the regulating function of labour time (and indicating the usefulness of the LTV as a methodological tool).

Similarly, the LTV also provides an explanation of why common resources in one area become more valuable in others (for example, the price of water to a person in a desert would be far higher than to someone next to a river). In the short term, the owner of water in the desert can charge a vast amount to those who want it simply because it is rare and the amount of labour required to find an alternative source would be high (we will ignore the ethics of charging high prices to people in need for the moment, as does marginalist economics which portrays such situations -- which most people would intuitively class as exploitative -- as "fair exchange"). But if such excess profits could be maintained for long periods, then they would tempt others to increase competition. If a steady demand for water existed in that region then competition would drive down the price of water to around to the average price required to make it available (which explains why capitalists desire to reduce competition via the use of copyright laws, patents and so on -- see section B.3.2 -- as well as increasing company size, market share and power -- see section C.4).

To summarise, as the production cost for a commodity is a given, only can indicate whether a given product is "valued" enough by consumers to warrant increased production. This means that "capital moves from relatively stagnating into rapidly developing industries. . . . The extra profit, in excess of the average profit, won at a given price level disappears again, however, with the influx of capital from profit-poor into profit-rich industries," so increasing supply and reducing prices, and thus profits. [Paul Mattick, Op. Cit., p. 49]

This process of capital investment, and its resulting competition, is the means by which markets prices tend towards production prices in a given market. Profit and the realities of the production process are the keys to understanding prices and how they affect (and are affected by) supply and demand.

Lastly, we must stress that to state that market price tends toward production is not to suggest that capitalism is at equilibrium. Far from it. Capitalism is always unstable, since "growing out of capitalist competition, to heighten exploitation, . . . the relations of production... [are] in a state of perpetual transformation, which manifests itself in changing relative prices of goods on the market. Therefore the market is continuously in disequilibrium, although with different degrees of severity, thus giving rise, by its occasional approach to an equilibrium state, to the illusion of a tendency toward equilibrium." [Paul Mattick, Op. Cit., p. 51]

Therefore, innovation due to class struggle, competition, or the creation of new markets, has an important effect on market prices. This is because innovation changes the production costs of a commodity or creates new, profit-rich markets. While equilibrium may not be reached in practice, this does not change the fact that price determines demand, since consumers face prices as (usually) an already given objective value when they shop and make decisions based on these prices in order to satisfy their subjective needs. Thus the LTV recognises that capitalism is a system existing in time, with an uncertain future (a future influenced by many factors, including class struggle) and, by its very nature, dynamic. In addition, unlike neo-classical "long run equilibrium" prices, the LTV does not claim that labour markets will clear or that a change within one market will have no effect on others. Indeed, the labour market may see extensive unemployment as this helps maintain profit levels by maintaining discipline -- via fear of the sack -- in the workplacee (see section C.7). Neither does it maintain that capitalism will be stable. As the history of "actually existing" capitalism shows, unemployment is always with us and the business cycle exists (in neo-classical economics such things cannot happen as the theory assumes that all markets clear and that slumps are impossible).

Moreover, the LTV indicates the source of this instability -- namely the "contradictory idea of value, so clearly exhibited by the inevitable distinction between useful value and value in exchange." [Proudhon, Op. Cit., p. 84] This is particularly the case with labour, as the exchange value of labour (its cost, i.e. wages) is different than its use value (i.e. what it actually produces during a working day). As we argue in the next section, this difference between the use value of labour (its product) and its exchange value (its wage) is the source of capitalist profit (we will indicate in section C.7 how this distinction influences the business cycle -- i.e. instability in the economy).