Value
In a statement in which he poses the “water-diamond paradox,” Smith observed
that there are two kinds of value.
The word VALUE, it is to be observed, has two different meanings, and sometimes
expresses the utility of some particular object, and sometimes the power of purchasing
other goods which the possession of that object conveys. The one may be called
“value in use;” the other, “value in exchange.” The things which have the greatest
value in use have frequently little or no value in exchange; those which have the
greatest value in exchange have frequently little or no use value. Nothing is more useful than water: but
it will purchase scarce any thing; scarce any thing can be had in
exchange for it. A diamond, on the contrary, has scarce any value in use; but a very
great quantity of other goods may frequently be had in exchange for it.17
Smith did not solve the paradox of value. This had to await later economists who
clearly saw the distinction between a good’s total utility and its marginal utility.
Smith directed his attention toward exchange value, the power that the possession
of a commodity provides to purchase other goods—its “natural” price. The
question of what determines the exchange value of a good, or simply its relative
price, has been one of the central interests of economists since the market
economy developed. Posed differently by later economists, “Do pearls have value
because people dive for them, or do people dive for pearls because pearls have
value?”
Smith basically answered that pearls (goods) have value because people need to
dive to get them; that is, that the costs of production determine a good’s exchange
value or relative price. Smith first examined exchange value in an economy in “an
early and rude” state, which he defined as one in which labor is the only scarce
resource (capital and land are either nonexistent or are free goods). Then he developed a theory of
value for an advanced economy, in which capital had accumulated, and both it and land commanded a
positive price.
Labor theory of value in a primitive society.
Smith argued that in a society
in which labor was the only resource, the relative value of a good would be determined by the amount
of labor necessary to produce it. This is an elaboration of the
“labor cost theory of value” first presented by Petty (Chapter 2). Smith wrote:
In that early and rude state of society which precedes both the accumulation of stock
[of capital] and the appropriation of land, the proportion between the quantities of
labour necessary for acquiring different objects seems to be the only circumstance
which can afford any rule for exchanging them for one another. If among a nation of hunters, for
example, it usually costs twice the labour to kill a beaver which it does
to kill a deer, one beaver should naturally exchange for or be worth two deer.18
This can be viewed in another way, according to Smith. The value of any commodity to a person who
possesses it, if he wishes to exchange it for other commodities,
“is equal to the quantity of labour which it enables him to purchase or command.
Labour, therefore, is the real measure of the exchangeable value of all
commodities.”19 This version of Smith’s value theory sometimes is referred to as
his “labor commanded theory of value.” Using Smith’s deer-beaver example, suppose that it took two
hours to trap a beaver and one hour to hunt and shoot a
deer. What is the value in exchange of the beaver? Answer: two deer or two hours
of labor. That is, a person could either exchange the beaver for two deer (because
each deer requires only one hour of labor to harvest) or could use the beaver to command two hours of
labor services. In a primitive economy, according to Smith, labor
is both the source (labor cost theory) and the measure (labor commanded theory) of
exchange value.
Value theory in an advanced economy.
Smith realized that the growth of
capital would invalidate a simple labor cost theory of value. To understand why,
imagine two commodities made from labor of equal skill. Suppose we add up all
the time required to make each commodity, including the labor necessary to
produce the raw materials and the labor required to make capital goods used in
production, let us assume that each commodity takes two hours to produce. But
commodity A—say, potatoes grown where good land is abundant—requires virtually no capital to
produce. Commodity B—cotton yarn—on the other hand
requires intricate and expensive machinery in the production process. If one
pound of cotton yarn and ten pounds of potatoes, each containing two hours of
labor, could be exchanged for each other in the market, which would people
produce? Potatoes, of course, because they could avoid investing large amounts of
capital, and they would get the same return for their labor. This dilemma will again
come up when we discuss labor theories of value presented by Ricardo and Marx.
In a society where capital investments and land resources become important, said
Smith, goods will normally be exchanged for other goods, for money, or for labor at
a figure high enough to cover wages, rent, and profits. Moreover, profits will depend
on the whole value of the capital advanced by the employer. The real value of commodities can no
longer be measured by the labor contained in them. They still, however, can be measured by “the
quantity of labour which they can, each of them,
purchase or command.”20 The quantity of labor that a commodity can buy exceeds
the quantity of labor embodied in its production by the total profits and rents.
Demand, according to Smith, does not influence the value of commodities; the
cost of production—wages, rent, and profits—are the only determinants of value in
the long run. This is a reasonable proposition if we base it on Smith’s implicit assumption that
production will expand or shrink at constant cost per unit of output. Competition will drive prices down
to costs, including a normal profit. Any
increase in demand will not increase value because the costs of producing each
unit of the commodity remain unchanged. However, if we assume either increasing
or decreasing costs, Smith’s principle becomes untenable. If the demand for the
product rises, and if as the industry expands it produces the good at higher costs,
then the long-run price (value) of the item will rise. If rising output results in falling costs per unit, then
an increase in demand will cause the long-run price of the
good to fall.