What is the 'Labor Theory Of Value '

The labor theory of value was an early attempt by economists to explain why goods were exchanged for certain prices on the market. It suggested the value of a commodity could be measured objectively by the average number of labor hours necessary to produce it. The best-known advocates of the labor theory were Adam Smith, David Ricardo and Karl Marx.

BREAKING DOWN 'Labor Theory Of Value '

Exchange values were a serious puzzle for early economic thinkers. If a horse cart traded for 20 ounces of gold but a pair of shoes only traded for 2 ounces, what made the horse cart 10 times as valuable as the shoes? The answer, according to the labor theory, is the horse cart took 10 times as much average labor to produce as the shoes.

Advocates of the labor theory believed that if two goods are exchanged for the same price, they must therefore have the same value. Value was determined by inputs, chiefly labor. The theory could not explain, among other things, profits, losses and land values.

Labor Theory and Marxism

The labor theory of value interlaced nearly every aspect of the Marxian analysis. Marx's pinnacle economic work, “Das Kapital,” was almost entirely predicated on the tension between capitalist owners of the means of production and the labor power of the working class.

Marx was drawn to the labor theory because he believed human labor was the only common characteristic shared by all goods and services exchanged on the market. For Marx, however, it was not enough for two goods to have an equivalent amount of labor; instead, the two goods must have the same amount of “socially necessary” labor.

Marx used the labor theory to launch a devastating critique against free market classical economists in the tradition of Adam Smith. If, he asked, all goods and services in a capitalist system are sold at prices that reflect their true value, and all values are measured in labor hours, how can capitalists ever enjoy profits unless they pay their workers less than the real value of their labor?

It was on this basis that Marx developed the exploitation theory of capitalism. Classical economists had no answer until the Subjectivist Revolution.

The Subjectivist Theory Takes Over

The labor theory’s problems were finally resolved by the subjective theory of value. This theory stipulates exchange value is not absolute but relative and based on individual subject evaluations. Value emerges from human perceptions of usefulness. Voluntary economic exchanges take place only when each trading partner subjectively values the other’s good more than his own.

This discovery also reversed the relationship between input costs and market prices. While the labor theory argued input costs determined final prices, the subjectivist theory showed the value of inputs was based on the potential market price of final goods.

Three economists independently and almost simultaneously discovered and wrote about the subjective theory of value in the 1870s: William Stanley Jevons, Leon Walras and Carl Menger. This watershed discovery for economics is known as the Subjectivist Revolution.

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