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<TITLE>C.1 What determines price within capitalism?</TITLE>
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<h1>C.1 What determines price within capitalism?</h1>
<p>
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.
<p>
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.
<p>
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.
<p>
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'll 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 <b>effect</b> on the price, as will be shown, 
but as the means to <b>determine</b> 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 <b>not</b> a capitalistic commodity 
in the usual sense of the word. Therefore the STV ignores the nature of 
production under capitalism. This is what will be discussed in the following 
sections.
<p>
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: 
<p><blockquote>
<i>"[A]ll the so-called laws and theories of political economy are in reality 
no more than statements of the following nature:
<p>
'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.'
<p>
"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 <b>the facts</b> 
which arise in our society under these conditions, they represent to us 
these facts as rigid, <b>inevitable economic laws.</b>"</i> [<b>Kropotkin's 
Revolutionary Pamphlets</b>, p. 179]
</blockquote><p>
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. In other words, marginalism 
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.  Ironically enough, 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:
<p><blockquote>
     <i>"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."</i> [<b>The Economics of the Rich</b>]
</blockquote><p>
Herman goes on to ask <i>"[w]hy do the economists serve the rich?"</i> and
argues that <i>"[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 . . ."</i> 
[<b>Ibid.</b>] There are a great many well paying think tanks, research posts, 
consultancies and so on that create an <i>"'effective demand' that should 
elicit an appropriate supply resource."</i> [<b>Ibid.</b>] Obviously, 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. 
<p>
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.
<p>
<a name="secc11"><h2>C.1.1 So what is wrong with this theory?</h2>
<p>
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 <b>first</b> in
order to evaluate how best to maximise their satisfaction. Hence subjective 
value theory <i>"obviously rest[s] on circular reasoning. Although it tries to 
explain prices, prices [are] necessary to explain marginal utility."</i> [Paul 
Mattick, <b>Economics, Politics and the Age of Inflation</b>, 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.
<p>
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.
<p>
Why does this happen? The subjective theory cannot really explain why 
<b>this</b> 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? 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 
(<a href="secC1.html#secc12">C.1.2 - So what does determine price?</a>). 
<p>
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 <i>"final degree of utility determines 
value"</i>); but what determined the position of the margin itself? This is 
fixed by the available supply (<i>"Supply determines final degree of utility"</i>
 -- Jevons); but what determines the level of supply? (<i>"Cost of production
determines supply"</i> -- 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 <b>objective</b> 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 <a href="secC1.html#secc12">next section</a>). 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.
<p>
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" 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). Then even ordinal utility 
was abandoned as cross-personal utilities were not comparable (which was
Adam Smith's argument and which lead him to develop a <b>labour</b> 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.
<p>
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, <i>"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."</i> [<b>The Death
of Economics</b>, 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:
<p><blockquote>
<i>"[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."</i> 
</blockquote><p>
Indeed, <i>"the weight of evidence"</i> is <i>"against the validity of the model 
of competitive general equilibrium as a plausible representation of
reality."</i> [<b>Op. Cit.</b>, p. 48, p. 62] 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). 
<p>
In this timeless, perfect world, "free market" capitalism will prove
itself an efficient allocator of resources and all markets will clear.
And this is often termed the "high theory" of equilibrium. Obviously
most economists must treat the real world as a special case.
<p>
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. 
<p>
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.
<p>
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:
<p><blockquote>
<i>"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."</i> [<b>Rational Economic Man</b>, 
p. 34]
</blockquote><p>
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 -- <b>eventually</b> 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.
<p>
Marginalism, however, in spite of these slight problems, did serve
a valuable ideological function. It removed the appear 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, <b>with</b> the assumption of equilibrium, reality must 
be ignored. So capitalist economics is between a rock and a hard place.
<p>
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").
<p>
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) <b>away</b> 
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 <b>quality</b> 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.
<p>
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 <b>quality</b> 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 <a href="secF3.html#secf31">F.3.1</a>). 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 <a href="secB4.html#secb43">B.4.3</a>, <a href="secC7.html">C.7</a> and 
<a href="secF10.html#secf102">F.10.2</a>).
<p>
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. 
<p>
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 <i>"[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."</i> [<b>The 
Essential Hayek</b>, 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 <a href="secI4.html#seci45">section I.4.5</a>). Needless to say,
marginalist economics justifies this market power and its results. 
<p>
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 <a href="secC1.html#secc12">next section</a>.
<p>
<a name="secc12"><h2>C.1.2 So what does determine price?</h2>
<p>
The key to understanding prices lies in understanding that production
under capitalism has as its <i>"only aim . . . to increase the profits of the 
capitalist."</i> [Peter Kropotkin, <b>Kropotkin's Revolutionary Pamphlets</b>, 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 <i><b>production price</b></i> 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).
<p>
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 
average profit rates are 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). 
If the given price generates above-average profits, 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 average profits are again 
produced (we stress <b>try to</b> as many markets have extensive barriers to 
entry which limit the mobility of capital -- see <a href="secC4.html">section C.4</a>). 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 <i>"degree of 
monopoly"</i> within a market -- see <a href="secC5.html">section C.5</a>). 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).
<p>
As can be seen, this theory (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 "libertarian" capitalists and mainstream economists suggest 
that the labour theory of value removes demand from the determination of 
price. These suggestions are incorrect as this theory bases itself on supply 
and demand, recognising that individuals make their own decisions based upon
their subjective values. The LTV is based upon the insight that without 
labour nothing would be produced and so labour is the basis of (exchange)
value. However, this does not mean that value exists independently of
demand. Far from it - 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.
<p>
Therefore the LTV includes the element of truth of "subjective" theory while 
destroying its myths. For, in the end, the STV just states that <i>"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."</i> [Allan 
Engler, <b>Apostles of Greed</b>, p. 27]
<p>
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. 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.
<p>
It could be argued that this <i>"prices of production"</i> 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 <b>dynamic</b> 
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.
<p>
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). 
<p>  
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). 
<p>
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 (<a href="secC2.html">Where do profits come 
from?</a>) indicates why exploitation of labour in production is the source of 
profits, not activity in the market.
<p>
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?
<p>
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 <b>Capital</b>, 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 <b>not</b> 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 <b>The Corruption of Economics</b> by Mason 
Gaffney and Fred Harrison). 
<p>
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 <a href="secC1.html#secc11">last section</a>) 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.
<p>
<a name="secc13"><h2>C.1.3 What else affects price levels?</h2>
<p>
As indicated in the <a href="secC1.html#secc12">last section</a>, 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 changes, which of course it can and does as 
consumers' values change, this will have a short-term effect on prices,
but the average production price is the price around which a capitalist
commodity sells. In other words, <i>"market relations are governed by the
production relations."</i> [Paul Mattick, <b>Economic Crisis and Crisis Theory</b>, 
p. 51]
<p>
Therefore 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 amount of work time that it takes <b>on average</b> 
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 average profit rates. On the 
other hand, using production methods that are <b>more</b> efficient than 
average -- i.e.. which allow more commodities to be produced with <b>less 
labour</b> -- will allow the seller to 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 exchange 
value of that type of commodity. In this way, advances that reduce labour 
time translate into reduced exchange value (and so price), thus proving the 
LTV.
<p>
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 <a href="secB3.html#secb32">section B.3.2</a> -- as well as increasing
company size, market share and power -- see <a href="secC4.html">section C.4</a>).
<p>
However, to state that market price tends toward production price is <b>not</b> 
to suggest that capitalism is at equilibrium. Far from it. Capitalism is 
always unstable, since <i>"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."</i> [Paul Mattick, <b>Op. Cit.</b>, p. 51]
<p>
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 workplace (see <a href="secC7.html">section C.7</a>). 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).
<p>
As the production cost for a commodity is a given, only profit levels 
can indicate whether a given product is "valued" enough by consumers 
to warrant increased production. This means that <i>"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,"</i> so increasing supply and reducing prices,
and thus profits. [Paul Mattick, <b>Op. Cit.</b>, p. 49]
<p>
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.
<p>
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