30 March 2010

The Labour Theory of Value

EconLog has some chatter about the Labour Theory of Value.

That's always been a problem for me - I've never understood how anyone could have believed it.

However, thinking about it now, I think I've worked it out. Try this:

Premise 1. A reasonable definition of the value of something is the price that it will fetch in a perfectly competitive ideal free market. (I think this is true).

Premise 2. In a perfectly competitive ideal free market, the price of something will approach its marginal cost of production. (this is also true).

Conclusion. The value of something is its marginal cost of production

That looks logically sound. If two things are both equal to a third thing, then they are equal to each other. An intelligent person might well be fooled by that argument.

It's not logically sound though, because the perfectly competitive ideal free market doesn't just set the "right" price for whatever randomly gets produced, it causes certain things to be produced and other things not to be produced.

Premise 2 should read, "The price of something produced in a perfectly competitive ideal free market will approach its marginal cost of production." The cost of production of something produced not in a perfectly competitive ideal free market (in the real world, for instance) does not tell you what price it would fetch if it happened to land in a PCIFM.

(I've skipped over the equating of the marginal cost of production of something with the labour needed to make it, by counting a share of the capital cost as being "dead labour", because I think that's OK, though I'm not sure it's useful).

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