Cost-of-production theory of value
In economics, the cost-of-production theory of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, or land) and taxation.
The theory makes the most sense under assumptions of constant returns to scale and the existence of just one non-produced factor of production. With these assumptions, minimal price theorem, a dual version of the so-called non-substitution theorem by Paul Samuelson, holds.[1]: 73, 75 Under these assumptions, the long-run price of a commodity is equal to the sum of the cost of the inputs into that commodity, including interest charges.
Historical development of the theory[edit]
Historically, the best-known proponent of such theories is probably Adam Smith. Piero Sraffa, in his introduction to the first volume of the "Collected Works of David Ricardo", referred to Smith's "adding-up" theory. Smith contrasted natural prices with market price. Smith theorized that market prices would tend toward natural prices, where outputs would stand at what he characterized as the "level of effectual demand". At this level, Smith's natural prices of commodities are the sum of the natural rates of wages, profits, and rent that must be paid for inputs into production. (Smith is ambiguous about whether rent is price determining or price determined. The latter view is the consensus of later classical economists, with the Ricardo-Malthus-West theory of rent.)
David Ricardo mixed this cost-of-production theory of prices with the labor theory of value, as that latter theory was understood by Eugen von Böhm-Bawerk and others. This is the theory that prices tend toward proportionality to the socially necessary labor embodied in a commodity. Ricardo sets this theory at the start of the first chapter of his Principles of Political Economy and Taxation, but contextualizes it as only relating to commodities with elastic supply. Taknaga advances a new interpretation that Ricardo had cost-of-production theory of value from the start and presents a more coherent interpretation based on texts of Principles of Political Economy and Taxation.[2] This alleged refutation leads to what later became known as the transformation problem. Karl Marx later takes up that theory in the first volume of Capital, while indicating that he is quite aware that the theory is untrue at lower levels of abstraction. This has led to all sorts of arguments over what both David Ricardo and Karl Marx "really meant". Nevertheless, it seems undeniable that all the major classical economics and Marx explicitly rejected the labor theory of price[3]([1]).
A somewhat different theory of cost-determined prices is provided by the "neo-Ricardian School" [2] of Piero Sraffa and his followers. Yoshnori Shiozawa presented a modern interpretation of Ricardo's cost-of-production theory of value.[4]
The Polish economist Michał Kalecki [3] distinguished between sectors with "cost-determined prices" (such as manufacturing and services) and those with "demand-determined prices" (such as agriculture and raw material extraction).