Marx's Theory
Marx defines value as the number of hours of labor contained in a commodity. This includes two elements: First, it includes the hours that a worker of normal skill and dedication would take to produce a commodity under average conditions and with the usual equipment (Marx terms this living labor). Second, it includes the labor embodied in raw materials, tools and machinery used up or worn away during its production (which Marx terms "dead labor"). Workers work a portion of their day reproducing the value of their means of subsistence (represented as wages), and a portion of their day producing value above and beyond that, referred to as surplus value.
Since according to Marx the source of capitalist profit is this surplus labor of the workers, and since in this theory only new, living labor produces profit, it would appear to be logical that enterprises with a low organic composition (a higher proportion of capital spent on new living labor) would have a higher rate of profit than enterprises with a high organic composition (a higher proportion of capital spent on raw materials and means of production). However, higher rates of profit are not generally found in low-organic composition enterprises or vice versa. Instead, there is a tendency toward equalization of the rate of profit in industries of different organic compositions.
Marx outlined the transformation problem as a theoretical solution to this discrepancy. The tendency of the rate of profit toward equalization means that in this theory there is no simple translation from value to money – e.g. 1 hour of value equals 20 dollars – which is the same across every sector of the economy. While such a simple translation may hold approximately true in general, Marx postulated that there is an economy-wide, systematic deviation according to the organic compositions of the different industries in society, such that 1 hour of value equals 20 dollars times T, where T represents a transformation factor which varies according to the organic composition of the industry in consideration.
In this theory, T is approximately 1 in industries where the organic composition is close to average, it is less than 1 in industries where the organic composition is lower than average, and greater than 1 in industries where the organic composition is higher than average.
Note: It should be recalled that because Marx is considering only socially necessary, simple labor, this variation from industry to industry has nothing to do with higher-paid skilled, versus lower-paid unskilled labor. This transformation factor varies only with respect to the organic compositions of different industries.
Read more about this topic: Transformation Problem
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