Cost-of-production Theory of Value - Historical Development of Theory

Historical Development of Theory

Historically, the most well 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 Adam Smith's adding up theory. Smith contrasted natural prices with market price. Smith theorized that market prices would tend towards natural prices, where outputs would be 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 such 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". Ricardo also refutes the labor theory of value in later sections of that chapter. This 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 .

A somewhat different theory of cost-determined prices is provided by the "neo-Ricardian School" of Piero Sraffa and his followers.

The Polish economist Michał Kalecki 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).

One might think of this theory as equivalent to modern theories of markup-pricing, full-cost pricing, or administrative pricing. Ever since Hall and Hitch, economists have found that the evidence gathered in surveys of businessmen support such theories.

Most contemporary economists accept neoclassical economics or mainstream economics. The non-substitution theorem is presented in graduate level microeconomics textbooks as a theorem of mainstream economics. Also many mainstream economists think they can justify theories of full-cost pricing within their theory. The majority of mainstream economists would probably then accept this theory as an element in their theory which does not give adequate attention to issues of consumer demand and marginal utility.