What is the Labor Theory Of Value?

The Labor theory of value (LTV) was first conceived by Adam Smith, the founder of modern capitalism, before it was built upon by other economists. Using LTV, economists tried to provide an explanation for why commodities are exchanged for specific market prices. The labor theory of value claims that the basis of a commodity is measurable through the average number of (labor) hours needed for its production. The labor theory of value was developed in the 18th century, David Ricardo and Karl Marx also advocated the theory but it has gradually wane in terms of relevance in the present century. According to this theory, two different commodities can be sold for the same price if the same number of labor hours went into their production.

History of the Labor Theory Of Value

The Labor theory of value (LTV) was first conceived by Adam Smith, the founder of modern capitalism, before it was built upon by other economists. Using LTV, economists tried to provide an explanation for why commodities are exchanged for specific market prices. The labor theory of value claims that the basis of a commodity is measurable through the average number of (labor) hours needed for its production. The labor theory of value was developed in the 18th century, David Ricardo and Karl Marx also advocated the theory but it has gradually wane in terms of relevance in the present century. According to this theory, two different commodities can be sold for the same price if the same number of labor hours went into their production.

A lot of thought and work went into the development of the labor theory of value by both Smith and Ricardo who also have production companies at that time. The theory attempts to explain why goods are traded at certain values, which is in relation to the number of hours that are devoted into producing the goods. While developing this theory, the production of two commodities (beaver and deer) were sampled. With this, Smith explained that the more labor goes into the production of a commodity, the costlier the commodity would become. Hence, labor-time is an important factor in the value at which commodities will be traded. For Smith, Labor-time is an underlying principle of LTV, Ricardo on the other hand, attempted to explain the rules governing how relative prices are set for commodities. For example, if 20 labor-hours is required to produce one beaver and 10 labor-hours to produce one deer, that means two deer equal one beaver. However, while calculating the cost of production, it is crucial to know that indirect costs also matters and not just direct costs. So, a beaver might require longer labor-time because the time spent on setting a trap and catching the beaver are included. For example: If 1hr is valued at $11, the production cost for beaver will be; 12hrs (trap), 8hrs (hunt and catch) which gives a total of 20hrs. Hence, the labor-time for producing beaver is valued at $220 unlike deer that is valued at $9 per hour, so 10hrs of labor-time will realize $90. Since it is more profitable to produce beaver there will be an influx of people into beaver production to create an equilibrium.

Labor Theory and Marxism

The labor theory of value is regarded as a major pillar of traditional Marxian economics, this is because it is interwoven with almost all aspects of Marxian analysis. Karl Marx was also attributed the labor theory of value because of his contributions in its development. According to Marx, all his and services share one thing in common which is human labor. Marx however places value in socially necessary labor and not just any labor. This was however a critique of the belief of free-market economists. Marx suggested that workers be paid less than the real value of their labor, this is called the exploitation theory of capitalism.

The Subjectivist Theory Takes Over

There are a number of problems associated with the labor theory of value, these problems were resolved by the subjective theory of value. The subjective theory of value is one that maintains that value is relative and based on evaluations which can vary from one individual to another. Hence, value is not absolute, it is based on how different individuals perceive it, this means an individual can decide to value his good higher than another individual's despite that the same labor-time went into their production. William Stanley Jevons, Leon Walras and Carl Menger are economists who discovered and introduced the subjective theory of value in the 1870s. While the labor theory maintains that input costs (labor-time) determined final prices, subjectivist theory holds that the market price of produced goods determines the value of inputs.

Relate Topics

• Theory of the Firm
• Capital Formation
• Rent Seeking
• Structure Conduct Performance Model
• Integration
• Co-Insurance Effect
• Conglomerates
• Cost vs Profit Center
• Accelerator Theory
• Market Structure
• Fixed Cost vs Variable Cost
• Actual vs Implicit Costs
• Explicit Costs
• True Cost Economics
• Accounting Profit
• Economic Profit
• What are Factors of Production?
• Factor Income
• Production Function
• Fixed and Variable Inputs
• Short-Run and Long-Run Production
• Short Run
• Total Product
• Marginal Product
• Value of Marginal Product
• Law of Marginal Diminishing Product
• Production Function
• Production Possibilities Frontier
• Capital 
• Labor Theory of Value
• How the Production Function Estimates Inputs
• Factor Payment
• Economic Rent
• Cost Function
• Incremental Cost
• Marginal Input Cost  
• Fixed and Variable Costs
• Diminishing Marginal Productivity
• Costs Relate to Diminishing Marginal Productivity
• Law of Diminishing Marginal Returns
• Average Total Cost
• Average Variable Cost
• Marginal Cost
• Average Profit or Profit Margin
• Accounting Profit
• Economic Profit
• Normal Profit
• Short and Long-Run Production
• Cost Curves
• Long-Run Average Cost (LRAC)
• Production Technologies
• Economies of Scope
• Economies of Scale
• Diseconomies of Scale
• Minimum Efficient Scale
• Increasing, Constant, and Decreasing Returns to Scale
• Shape of the Average Long-Run and Short-Run Cost Curves
• Returns to Scale
• Diseconomies of Scale
• Long-Run Average Cost Curve Affect Industry Competitors
• Technology Shifts the Long-Run Average Cost Curve
• Law of Diminishing Marginal Returns