1.3.2 Value

The factors that determine the value of a commodity is one of the most controversial debate in classical and neoclassical theory, see also Davide Ricardo determination of prices.

This is, incidentally, another reason why it doesn't make a lot of sense, if we disregard the Keynesian theory, to put all the classical authors in one cupboard and the neoclassical authors in another. There are different positions related to the question whether the value depends on the supply, the costs, or whether it depend on the demand, the preferences of the customers.

The final answer is given by Alfred Marshall, see equilibrium in the short run and equilibrium in the long run. The answer is quite simple. In the long run, the amount of the supply will chance, and the price is determined by costs. In the short run, the supply can't chance, and the market equilibrium will be reached through an adaptation of the prices.

However, with a little bit of common sense, anybody can get to the (almost) right answer. The price is determined by demand and supply. If here people are willing to pay 1 dollar for an apple, all the producers of apple who succed in bringing an apple for 1 dollar to the market will sell their apples. If the technology changes, for instance because the transportation costs decrease or because the apple trees are cultivated in a way that makes the harvest easier, the price of an apple can decrease for instance to 0.50 dollars. Then everybody who is willing to buy an apple for 0.50 dollars will buy one. However, if a new technology allows to conserve and transport apple juice at lower costs and if this is more profitable than selling apples, the supply of apple for direct consumption will be reduced again and prices rise.

It is, therefore, obvious that prices depends as well from supply and from demand.

[We admit that we can rarely observe phenomenon of this type in reality. Even inflation happens too slowly in order to actually observe it and even if we realise an increase of decrease of prices; we normally don't know why this happens. However, it is quite obvious that in the case of improvement in the cultivation of apples, some producers will offer their apples, to stick with our example, at lower prices and the other producers can do nothing but offer their apples at a lower price as well or abandon the market. There is no need to "observe" that. It can't be otherwise. For a short time the most efficient producer will get a producer surplus until the other producers adopted the new technologies.]

The only situation where we really reflect on the price or the value of something is in foreign countries, with a foreign currency. In this case, we actually make a little calculation in order to know how much a commodity would cost in our national currency. We do that because only in our national currency we know the relationship between the different prices and we can say if something is expensive or cheap.

Normally, we don't reflect on prices and the neoclassical approach, that people take conscious decisions based on their preferences is absurd. We don't reach the best use of our income by making consciousness decisions. We approach this optimum by trial and error during a lifetime. We will discuss this topic more in detail in the chapter about Joseph Schumpeter.

Neoclassical theory assumes that people spent their money in accordance with the marginal utility under the assumption that the utility decreases the more is consumed. (The marginal utility of the first apple is higher than the one of the second apple, the marginal utility of the second apple higher than the one of third...). People reach the maximum of utility if the marginal utility is the same in any use. (Otherwise, a substitution would be an improvement.)

This is actually a theory that sounds logical at first glance but is not based on empirical data. Presented in a mathematical model, like the one we find in any textbook, it looks very scientific, but actually it is nothing else than an "intuitively" obtained idea, see Vilfredo Pareto.

A lot arguments can be put forward against this theory; we will just mention one here and rediscuss the topic later again. In order to find the consumption optimum given a certain income, we need to know all the possible uses of our money and all the utilities of this uses. That's never the case. There is certain tendency towards a consumption optimum of this kind, there is a learning process by trial and error, but this kind of optimum is a fiction. It can be argued that this simplification can be useful because it allows in understanding some basic problems. The truth is that this model is never helpful when it comes to discussing real problems.

One can talk about that during the study of economics for five minutes, but dedicating a few hours to this is too much. There is one thing really scarce on earth, and that is time. If academic teachers don't know what to do with the time saved, then a change of the personnel is needed.

In some special contexts we are even interested in the value of an item measured in labour, although we have on intention to follow the strange ideas of Karl Marx. Labour a unit of measurement can be interesting for example if we compare different times. At the beginning of this century for intance a workman in Germany has to work two hours each month only for food. Today three days. We can deduce from that that very big changes had happened. [There is no need to mention, that this contradicts completely the pronostics of David Ricardo.]

The ideas of Adam Smith, see natural price and market price, and David Ricardo, see determination of prices, are not explicitly refuted by Jean-Baptiste Say. They are silently ignored. (Although he knew the theories of both.)

However, he discussed and refuted another concept. The idea that all value derives from land.

A cet argument, les Économistes répliquaient que la valeur additionnelle répandue sur un produit par un manufacturier ou ses ouvriers, est balancée par la valeur que ce manufacturier a consommée pendant sa fabrication. Ils disaient que la concurrence des manufacturiers entre eux ne leur permet pas d'élever leur prix au-delà de ce qui est nécessaire pour les indemniser de leurs propres consommations ; et qu'ainsi leurs besoins détruisant d'un côté ce que leur travail produit de l'autre, il ne résulte de ce travail aucun accroissement de richesses pour la société.

To this argument, the physiocrats reply that the value added to a product by an industry equals the consumption during the production. They say that due to competition, it is not possible that the prices exceeds the subsistence level and therefore, their neccesities eliminate what is produced at the other side and that the wealth of nation is not increased by their work.

Jean-Baptiste SAY, Traité d’économie politique I, Des différentes sortes d'industries, et comment elles concourent à la production

What he simply wants to say is this: The workmen produce something, let's say bread, and they only receive a wage at subsistence level. They consume therefore as much bread as they produce and labour doesn't increase wealth. Only the land increases wealth.

This logic is as foolish as the theory of David Ricardo, but in comparison to the theory of David Ricardo, there is even a little improvement. In the theory of David Ricardo, it is not clear how the "capitalists" can put a price allowing them to get some added value. Competition should lower the prices until there is no added value left. (The same is valid for Karl Marx.)

The french word économiste means nowadays simply economist, but in those times, the meaning was physiocrat. The physiocrat assumed that only land creates value and they called themselves économists.

A lot of arguments could be put forward against these theory. Here are the arguments of Jean-Baptiste Say.

Il aurait fallu que les Économistes prouvassent, en premier lieu, que la production des artisans et manufacturiers est nécessairement balancée par leurs consommations. Or, ce n'est point un fait. Dans un pays anciennement civilisé et très industrieux, le nombre et l'importance des entreprises de commerce et de manufactures procurent une somme de revenus plus considérables que l'agriculture ; et les épargnes qu'on y fait annuellement excèdent probablement, au contraire, celles qui se font parmi les propriétaires des terres. En second lieu, les profits résultant de la production manufacturière, pour avoir été consommés et avoir servi à l'entretien des manufacturiers et de leurs familles, n'en ont pas moins été réels et acquis. Ils n'ont même servi à leur entretien que parce que c'étaient des richesses réelles, et tout aussi réelles que celles des propriétaires fonciers et des agriculteurs, qui se consomment de même en servant à l'entretien de ces classes. L'industrie commerciale concourt à la production de même que l'industrie manufacturière, en élevant la valeur d'un produit par son transport d'un lieu dans un autre.

First of all, the physiocrats should have proven that the production of commerce and industry always equals consumption, because that is not the case. For a long time and in already civilised countries, the quantity and the size of the companies generated more income than agriculture, and the annual savings exceeded, in opposite to what they believed was the income of the landowners. Secondly, the profits of industrial production, even if consumed and having served to maintain the producers and their families, were not less real and earned. They could have been used for their maintenance because they were real and they were as real as the ones of the landowners and farmers that serve as well for the maintenance of these classes. Trade contributes to production as does the industry by increasing the value of a product transporting it from one place to another.

Jean-Baptiste SAY, Traité d’économie politique I, Des différentes sortes d'industries, et comment elles concourent à la production

The argumentation is conclusive, although it remains unclear if there is any need to refute this theory, if we consider that agriculture contributes 2 percent, at most, to GDP in industrialised countries. He argues that the theory can't be true if the incomes of industry and trade are higher than the incomes of agriculture.

The logic of the physiocrats is somehow weird. If industry produces no value, the landowners would be better of if the sell them nothing and consume all the produce themselves.

We can draw another conclusion from that story. Sometimes it is harder to resolve inexistent problems than resolving existing ones.

For a long time, Jean-Baptiste Say uses the term value without defining it. Only in the second volume of his book he gives a definition of the term value. He doesn't mention David Ricardo, but implicetely he refutes the totally the Ricardian theory about the value.

This paragraph is interesting, because it describes the other extreme. The value is determined only by the demand side.

[ We can read sometimes that all the classical authors share the idea that the value is determined by the supply side. We can learn from this paragraph that this is not the case.]

La valeur relative de deux produits se connaît par la quantité de chacun d'eux, que l'on peut obtenir pour le même prix. Si, pour une somme de 4 francs, je peux acheter 15 kilogrammes de froment et 1 kilogramme de café, je dirai que le café est 15 fois plus cher que le froment, ou que la valeur de l'un et de l'autre est en raison inverse de la quantité de chacun d'eux que l'on consent à donner et à recevoir. Mais ces deux quantités sont un effet de la valeur qu'ont les choses, et n'en sont pas la cause.

Le motif qui détermine les hommes à faire un sacrifice quelconque pour se rendre possesseurs d'un produit est le besoin que ce produit peut satisfaire, la jouissance qui peut naître de son usage.

The relative value of a product in comparison with another product is known by the quantity of the respective product that can be changed for another product. If one can obtain for 4 francs 15 kilos of bread and 1 kilo of coffee, we can say that coffee is 15 times more valuable than bread or that the value of one thing has inverse relation to the amount that must be given away to obtain it. But these two quantities are the result of the value and not the cause.

The motive that induces people to make a sacrifice in order to obtain it is the neccestity this product can satisfy, the pleasure we have when consuming it.

Jean-Baptiste SAY, Traité d’économie politique II, Des fondements de la valeur des choses

Jean-Baptiste Say defines the value of commodities in relation to other commodities and relationship of the prices is actually a relationship of amounts. If an apple costs 40 cents and a litre of milk 1.20 dollars, four apples must be given away in order to get one liter of milk.

Until here, it would be still compatible with the idea of David Ricardo that prices are accumulated labour. Following this theory, a litre of milk is requires four times the labour when compared to an apple.

However, with the sentence "...Le motif qui détermine les hommes à faire un sacrifice quelconque pour se rendre possesseurs d'un produit est le besoin que ce produit peut satisfaire, la jouissance qui peut naître de son usage..." he completely refutes the Ricardian theory.

A litre of milk does not cost four times more than an apple because four times more labour was required producing it, but because a liter of milk spent the same pleasure than four apples. This is only half of the story, the other part we have in the next paragraph.

It is often said that in the neoclassical theory happened something called "marginal revolution". The idea is, that equilibrium is reached when the last unit of something, yields the same profit, benefit or utility in any use. In this case, we reach an equilibrium because a reallocation doesn't make any sense. We have already seen that the concept of the natural price and market price already contains a marginal view. The marginal revolution never happened.

If we look at the next paragraph carefully, we see that the idea of marginality is already included. We can even say that the demand is described more precise because it fits with two different situations. The situation where only one unit is consumed and the situation where several units of the same thing are consumed. (We will return to the topic in the chapter on the law of Say.)

This is a nice example of something we can observe often. Modeling narrows the perspective. To focus on marginality impedes to take into consideration the case where only one item is used.

De là naît pour chaque produit une certaine quantité recherchée et demandée en chaque lieu, quantité qui est modifiée par le prix auquel il peut être fourni ; car plus il revient cher au producteur en raison des frais de production dont il est le résultat, et plus, dans la classification qu'en font les consommateurs, il est reculé et se voit préférer tous les produits capables de procurer une satisfaction plus grande pour le même prix.

That's why for any product, a certain amount is demanded at a certain place. This quantity is modified by the price for which it can be supplied, because the higher the price for the producer due to the cost of production of which the price is the result, the more it is, depending on the preferences of the consumer, put aside by the consumers who prefere the product that gives them a greater satisfaction for the same price.

Jean-Baptiste SAY, Traité d’économie politique II, Des fondements de la valeur des choses

This description is more precise than what we found in nowadays textbooks on microeconomics. Any commodity is competing with other commodities. The question is not, whether the price people are willing to pay corresponds to the marginal utility, that's what we found in textbooks about microeconomics, the question is whether there is an alternative commodity that yields a greater benefit for the same price.

Jean-Baptiste Say considers two different situations. One explicitly and the other implicitly. He assumes that with an increase in the quantity it becomes more and more difficult for a commodity to compete with other commodities. If the utility of a commodity decreases with consumption, people are willing to pay less and less for this commodity. If the supplier wants to increase the units sold, he must lower the price. Otherwise, people will buy something else. This concept includes already the idea of marginality. With any more unit consumed, the utility decreases and less the people are willing to pay.

However, the same logic can be applied if only one unit is needed. People, in general, need only one bicycle and one smartphone. If the bicycle generates the same utility than a smartphone but costs only 500 dollars and the smartphone 700 dollars, people will buy the bicycle. However, if the smartphone becomes cheaper and costs only 400 dollars, people will buy the smartphone.

We will see later on when discussing about Joseph Schumpeter that this concept doesn't explain reality. It supposes that decisions are made rationally and that the utility, even of unknown products, is known. Both is not the case. People will try to reach the optimum, that's obvious, nobody will spend his money on a commodity when he can get more utility buying something else. However, actually, people approach this optimum in a lifelong learning process without ever reaching it.

A marginal revolution never happened and besides that, the concept of marginality doesn't explain what is going on in the real world. Marginality is actually a truism, and it only looks "scientific" because it can be modelled mathematically.

However, there are some empirical data that confirms this logic. Discounts, for instance, are given because only by lowering the price people can be induced to buy more of an item.

We have already mentioned that Jean Baptiste Say describes best the dynamic of market economies, see Jean Baptiste Say. Classical authors, especially David Ricardo, and neoclassical authors, especially Léon Walras, have a mechanical conception of the economy. Economic processes depend more on "eternally valid economic laws" than any human decisions. See as well mathematical modeling.

Jean-Baptiste Say focuses on human decision making. The profit is not overall the same, labour is not homogeneous, and remuneration of a productive factor depends on demand. He doesn't mention David Ricardo, but the following paragraph is a complete refutation of the Ricardian theory.

[He refutes the idea that profits, wages, rent are kind of a compensation for capital, labour and rent. If this were the case, they must be the same everywhere. Actually, they are the result of demand and can be very different.]

On s'écarte donc des notions de l'expérience la plus commune, quand on prétend qu'au moyen des compensations les profits industriels sont les mêmes dans tous les cas. Rejeter dans les exceptions les exemples qui contrarient ce système, c'est déduite la loi qu'on veut établir ; car ces exemples démentent plus souvent la loi qu'ils ne la confirment; la règle alors devient une exception. Mais ce qui ne peut en aucune manière s'accommoder au système des compensations, ce sont les immenses disparités qu'établit dans les profits industriels et dans des carrières semblables, la différence des talents acquis. La rareté de certains talents en proportion des besoins qu'éprouve la société fait qu'on paie les services productifs qui en émanent incomparablement plus cher que d'autres. Chez un peuple nombreux, à peine y a-t-il deux ou trois personnes capables de faire un très beau tableau ou une très belle statue : aussi se font elles payer à peu près ce qu'elles veulent, si la demande est un peu forte ; et quoiqu'il y ait sans contredit une portion de leurs profits qui représente l'intérêt des avances employées à l'acquisition de leur art, cette portion de profits est petite relativement à celle qu'obtient leur talent.

By affirming that the profits in industry due to compensation are the same in all sectors, one deviates from experience. Arguing with exceptions, the examples contradicting the theory are ignored because these examples more often deny the law than confirming it. The law becomes an exception. The enormous differences of profits in industry and similar branches, due to the differences in talents, is completely incompatible with the idea of compensation. The scarcity of talents in proportion to the demand of the society leads to the result that for the products issuing from this talents much higher prices are paid than for others. In a huge population there at most two or three persons able to make a very beautiful painting or a statue and therefore they get almost any price they want, if there is any demand. It is well possible that a part of their profits is a compensation for the capital invested in the aquisition of their art, but this part is small in comparison to the profits due to their talent.

Common sense can get to the same result. Profits depend on creativity, innovation, know-how, entrepreneurship and very often the capital invested is completely irrelevant. The example of Jean Baptiste Say with the painting or the sculpture is an extreme case; capital is completely irrelevant in this case and profits depend in this case solely on the talent. However, the same is true for any products and services which depend on know-how.

[[If a great part of added value depends on know-how, the logic of David Ricardo, that capital accumulates automatically, can't be true. If the added value depends on the heads and not on the capital, the "capitalist" doesn't possess the relevant, productive factor. Heads have two legs, and they go wherever they want.]

Jean-Baptiste Say argues with the "talent", in other words, something determined by nature. We actually don't believe in this thesis; it is to presume, that "talent" is more a question of chances and these chances, for many reasons, are not equally distributed. However, it is interesting because it relativises the importance of savings as a condition for investments, an idea Jean Baptiste Say as well all the other classical and neoclassical authors sticks to.

In the example given by Jean-Baptiste Say himself, painting, large profits can be obtained without capital and therefore without prior savings. That contradicts the idea that savings are needed to invest.

The point is not that this theory is wrong, on the contrary, it is very true. The point is that this contradicts his own theory.

The idea of David Ricardo that the profits are the same everywhere is incompatible with a market economy. Technological progress is only possible if the profits on capital are different. Different profits will lead to a reallocation of capital and therefore to a reallocation of resources, away from the less profitable use to the more profitable one. That way the resources adapt themselves to a change in the economic structure. However this takes a while, and until this process is not completed, profits will be different.

Sometimes it is even necessary that the adaptation takes time because any innovation or technological progress requires research and development and only in the case that the benefits from investments in research and development cover the costs, entrepreneur will invest in research and development. That's the reason why patents exist.

For David Ricardo and Karl Marx, it is important to prove that labour is a homogeneous factor, and both make a big although useless effort to prove that. Only if labour is homogeneous, it can serve as a unit of measurement and as a determinant of the prices of goods.

[We don't mention Adam Smith in this context, although he sticks to the same strange ideas concerning labour. However, Adam Smith contradicts this theory in Wealth of Nations. It is difficult therefore to name him together with David Ricardo.]

For Jean-Baptiste Say, the price is determined by supply and demand, there is, therefore, no need to prove that labour is a homogeneous factor. Know how is the driving force behind economic growth.

On doit souvent les connaissances qui servent de fondement à une foule de procédés dans les arts, aux études laborieuses, aux réflexions profondes, aux expériences ingénieuses et délicates, des chimistes, des physiciens, des mathématiciens les plus éminents. Or, ces connaissances sont contenues dans un petit nombre de pages qui, prononcées dans des leçons publiques ou répandues par la voie de l'impression, se trouvent jetées dans la circulation en quantité fort supérieure à la consommation qui peut s'en faire; ou plutôt elles s'étendent à volonté sans se consommer, sans qu'on soit obligé, pour se les procurer, d'avoir de nouveau recours à ceux de qui elles sont originairement émanées.

Very often, the knowledge upon which are based a number of processes in industry are the result of deep reflectiions, genius and complicated experiments of famous chemists, physicists, mathematicians. This knowledge is written down on a few sheets of paper which are divulgated in conferences or printed and than circulate in a quantity that exceeds very much the consumption of those who made them. Very often even they are divulgated without any consumption, without any need to pay something in order to get them or to rely on the people who initially produced them.

It clear that with Jean-Baptiste Say we have a "dynamisation" of economics. Economic is not a mechanical machine that works without the interference of human beings steered by eternally and universally valid economic laws. Economics depend on human decisions.

This can perhaps in part be explained by the fact that Jean-Baptiste Say was an entrepreneur himself, while the others, Adam Smith, David Ricardo, John Stuart Mill and, later on, Karl Marx had no real working experience

100 years later, Alfred Marshall will say the same thing: Know how is the most important productive factor, although there is still an improvement possible regarding the transformation of knowledge into concrete products.

It seems very strange, but Jean-Baptiste Say and Joseph Schumpeter are the only economists who mention the entrepreneur. Modern textbooks about economics assume that markets work without entrepreneurs.

En second lieu, ce genre de travail exige des qualités morales dont la réunion n'est pas commune. Il veut du jugement, de la constance, la connaissance des hommes et des choses. Il s'agit d'apprécier convenablement l'importance de tel produit, le besoin qu'on en aura, les moyens de production ; il s'agit de mettre en jeu quelquefois un grand nombre d'individus ; il faut acheter ou faire acheter des matières premières, réunir des ouvriers, chercher des consommateurs, avoir un esprit d'ordre et d'économie, en un mot, le talent d'administrer. Il faut avoir une tête habituée au calcul, qui puisse comparer les frais de production avec la valeur que le produit aura lorsqu'il sera mis en vente. Dans le cours de tant d'opérations, il y a des obstacles à surmonter, des inquiétudes à vaincre, des malheurs à réparer, des expédients à inventer. Les personnes chez qui les qualités nécessaires ne se trouvent pas réunies, font des entreprises avec peu de succès ; ces entreprises ne se soutiennent pas, et leur travail ne tarde pas à être retiré de la circulation. Il n'y reste par conséquent que celui qui peut être continué avec succès, c'est-à-dire avec capacité. C'est de cette façon que la condition de la capacité borne le nombre de gens qui offrent le travail d'un entrepreneur.

Second: This type of work (the work of an entrepreneur) requires moral qualities that we seldom find together. A clear judgement is needed, perseverance and a good knowledge of persons and things. The ability to judge correctly the importance of a product, the demand for this product and to know how to produce it. A large number of persons must be gathered. It is necessary to buy raw materials or ask someone to do it, to hire workmen, to find consumers and have a talent for administration and economy. To put it short: A talent for entrepreneurship is needed. One must be able to calculate the costs of production and to compare them to the price the respective commodity can be sold. During this process problems has to be resolved, insecurities to deas with, misfortunes have to corrected and alternatives must be found. Someone who doesn't possess these capacities can not manage a company succesfully. These companies will not survive for a long time and in a short time their work will be withdrawn from the market. Therefore, those who are able to work well will remain, in other words, those with talent. For that reason, the capacities are limited and only few people offer the work of an entrepreneur.

Jean-Baptiste SAY, Traité d’économie politique, Chapitre VII, Des revenus industriels

This sounds trivial and actually, it is trivial. However, in any textbook about microeconomics, we read the opposite. An entrepreneur is not needed in a market economy; he is not even mentioned. In textbook the economy works following universally and eternally valid "economic laws", as stable as natural laws. There is no need and no place for entrepreneurs.

We will return to the topic when talking about Joseph Schumpeter.

[This can explain in part the success of Milton Friedman. He focuses on human beings, see The Power of the Market. The message is trivial, understandable for a child of 13 years. However difficult to understand for academic teachers. The authors would say, that those who don't understand the message, should never try to run a company.]

The problem is that taking into account the work of the entrepreneur and the dynamics of markets is not possible with simple mathematical modeling and academic economics prefers to discuss irrelevant issues through mathematical modeling instead of discussing relevant issues without mathematical modeling. They focus on substitution rate, marginal utility, consumer and producer surplus, etc. that can, at least under simplifying assumptions, pressed in a mathematical model that looks quite "scientific", although it is completely trivial, see also mathematical modeling.

Los factores contingentes, espontáneos, poco previsibles y por lo tanto imposibles de modelizar matemáticamente tienen un impacto más grande sobre la economía que los parámetros presentes en los modelos. Más interesante que el tipo de interés es la pregunta como se puede propulsar la conversión de las inversiones en investigación y desarrollo en productos competitivos, vea investigación y desarrollo por el estado, como medir eficacia de las subvenciones para empresas innovadoras, el análisis de préstamos concedidos por los recaudadores de fondo, reflexión sobre el sistema educativo etc. etc.. Los problemas reales están ahí.

The misfortune of economic thinking and the beginning of the tragedy will become more obvious if we talk about Carl Menger, Vilfredo Pareto and Léon Walras. If the Menger/Pareto/Walras abracadabra is not eliminated from the academic curricula, in the long run, economics will follow the humanities way to irrelevance.

return to the top of the page ...

1.3.2 Value

What determines the value of a commodity? A phantom debatte since 200 years.