Comparison of Theory of Value: Adam Smith and David Ricardo | Free Essay Example

Comparison of Theory of Value: Adam Smith and David Ricardo

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Introduction

Economists often differ on various economic aspects, as evidenced by the opposing recommendations and views in different economic aspects that are significant to a nation’s economy. Numerous cases of controversy amongst economists on various economic elements have been documented over the years. A casual observer might develop the perception that economists do not concur on little aspects about the economy.

However, Hall and Leiberman assert that the “seemingly positive disagreement is based on hidden normative disagreements” (598). For example, the United States’ economists developed varied opinion regarding the proposed Recovery and Reinvestment Act of 2009, whose objective was to stimulate the country’s economic performance. The Act advocated an increment in government spending and reduction of taxes by $ 787 billion.

Economists engaged in extensive discussion on the impact of the policy on the US economy. Some economists were of the view that implementing the policy would affect the citizen’s living standards adversely. Conversely, other economists argued that it would stimulate the country’s economic performance. In this scenario, the controversy might have arisen from the view adopted by the two groups. For example, the opposing group focused on the long-run impact of government borrowing while the supporting group focused on the short-run effect. This aspect illustrates the existence of positive disagreements amongst economists, which is critical in the development of economic history and theory.

Sexton (18) affirms that disagreements amongst economists usually originate from differences in policy beliefs and values. Additionally, Sexton asserts that disagreements “might arise from the validity of a given economic theory for the policy in question” (18). In an attempt to illustrate the controversy amongst economists, this paper compares the theory of value between two main economists, viz. Adam Smith and David Ricardo. The paper is comprised of two main sections. The analysis section provides a comprehensive evaluation on Adam Smith and David Ricardo’s proposition regarding the theory of value. The second section outlines how the divergent views between the two economists have contributed to the development of economic theory. The last section entails a conclusion on the issues evaluated in the paper.

Analysis

The theory of value has been evaluated extensively from different classical, Keynesian, and Post-Keynesian economists’ perspectives over the years. Subsequently, the theory has been improved remarkably over the years. Some of the arguments put forward by Adam Smith and David Ricardo on the theory of value are evaluated herein.

Adam Smith’s proposition on the theory of value

As one of the renowned classical economists, Adam Smith plays a critical role in the development of the classical value theory. Smith mainly focuses on developing the theory of value based on the cost of production and the concept of scarcity, as illustrated by the diamonds and water paradox. In a bid to illustrate the difference between the value in commodities, Smith asserts that water “is valueless, but useful, while diamonds are valuable, but useless” (O’Brien 91).

Smith argues that value can be defined based on two main notions, viz. ‘value in exchange’ and ‘value in use’ (Wood 142). The concept of value in use relates to the utility associated with a commodity, while the concept of value in exchange entails the purchasing power in a commodity. Smith asserts that some commodities that are characterised by high value in use usually have minimal value in exchange. Similarly, some commodities that are characterised by high exchange value have minimal value in use. Smith mainly emphasised the definition of value based on a commodity’s purchasing power [exchange] as opposed to value in use. Subsequently, Smith’s ‘diamond and water’ paradox dismissed utility as a metric that can be used in assessing the value of a commodity.

Principles of exchange value

According to Smith’s proposition, “it is impossible to measure the purchasing power of a commodity if compared against different commodities” (O’Brien 93). Thus, Smith adopted labour as one of the core measures of value, which is evidenced by his labour command theory. Pack asserts that Smith was of the opinion that the “value of any commodity to the person who possesses it and who means not to use or consume it him/herself, but to not exchange it for other commodities, is equal to the quantity of labour, which it enables him/her to purchase or command” (50). Therefore, the amount of labour that a product can exchange [command] for is influenced by the price of labour (Pack 50).

Smith argued that labour is a real measure of value, and thus it forms the basis for a product’s value in exchange (Rima 119). The decision to adopt labour as a measure of value arose from the identification of its invariability over time. Despite the view that the “amount of labour required to produce a commodity varies geographically and from time to time, the labourers’ sacrifice is absolute” (Pack 55).

Smith asserted that money is not an effective approach to measuring the exchange value of a commodity due to fluctuations in its value. Additionally, Smith asserted that the real price of a product can be evaluated by the ‘toil and trouble’ experienced in its acquisition. Therefore, Smith maintains that labour “is an independent method of assessing value of exchange as opposed to being a source of value” (76). Wood further asserts that Adam Smith “uses the term ‘real price’ as synonymous with value” (143).

Components of price

Smith asserts that the price of a commodity is comprised of three main components, which include rent, the wage rate, and the profit. By using the three components [rent, wage, and profit], it is possible to determine the labour-commanded by a product using the formula [w+r+p] ÷ wage per unit, where w= wage, r= rent and p= profit. According to O’Brien (92), Smith was of the opinion that every society is characterised by an average wage rate, rent, and profits of stock, which constitute the cost of production or the natural price. Therefore, Smith considered the long-term value of a commodity to be a product of the various factors of production.

Smith’s proposition of price as a component of the factors of product is an improvement of the traditional view of price. The traditional proposition of price advocated the annexation of land and the accrual of stock in order to increase the exchange value. Smith asserts that rent, profit, and wage are the core sources of exchangeable value, which constitute the natural price (74). Therefore, the natural price of different commodities depends on their profit, rent, and wage rate.

Price determination in competitive markets

Smith postulates that the price of a commodity in a competitive market is subject to three main aspects including the market price and the natural price (Hunt 73). Smith argues that the natural price refers to the lowest price of a commodity, which is offered in the market within a particular duration. However, the minimum price is set at a point that enables the producer to pay the cost of labour, wage, and rent. Thus, the natural price enables the producer to make a substantial amount of profit in order to sustain the production activities.

Smith asserts that the “market price represents the actual price at which a commodity is sold” (Sinha 38). Additionally, Smith emphasises that the market price is subject to the supply and demand forces. Thus, the market price is influenced by the quantity supplied in the market and the existing demand by consumers. The market demand refers to the number of consumers willing and in a position to pay the set natural price.

Therefore, the natural price forms the basis of the market price. However, Smith emphasises that the market price may be below, equal to, or above the natural price (Dooley 123). According to Dooley, Smith argued that the “supply curve is perfectly inelastic whereas the demand curve, whether elastic or inelastic is downward sloping” (123). If the demand is higher than the supply, the price of a commodity increases high above the natural price due to competition amongst consumers.

Conversely, if the supply of a commodity is higher than the market demand, the market price of the commodity decreases below the natural price. Therefore, the analysis on the concepts of natural and market price, as advocated by Adam Smith, illustrates the existence of a self-righting mechanism [natural equilibrium] in conditions of perfect competitive market. According to Smith, the natural price is the central point upon which a product’s actual price varies.

The determination of price in non-competitive market

Smith argues that price in a non-competitive market is within the dealers’ discretion. Thus, dealers in a particular market can increase the price of a commodity or influence the amount supplied. The dealers’ motivation to adjust the market price of a commodity depends on their profit motive. Furthermore, the dealers have the capacity to expand or narrow the market (Smith 155). Therefore, Smith accentuates that non-competitive markets may be characterised by monopolistic tendencies, hence affecting the society’s purchasing power. Moreover, the existence of monopolistic tendencies amongst dealers illustrates that the exchange value of a commodity does not depend on the factors of production.

David Ricardo proposition on the theory of value

David Ricardo is widely recognised for his contribution towards the labour theory of value. In his effort to contribute to the development of an economic theory, David Ricardo undertook a number of studies that focused on improving the ‘major errors’ made by Adam Smith in his proposition on the theory of value. In his book Wealth of Nations, Smith states, “In the early and rude state of the society, which precedes both the accumulation of stock and 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 role for exchanging them for another one” (Smith 38).

The above statement implies that Smith’s bases his arguments about value on a situation where capital is non-existent. However, Ricardo affirms that capital has always been in existence (Wood 276). Ricardo further refutes Smith’s assertion that the value in exchange is equivalent to the price. Additionally, he bases his arguments about value on the ‘value in use’ component by considering it as the utility in a commodity. In his opinion, utility is a basic, but inadequate condition in exchange relations. Ricardo further asserts that the “present or past relative value of a commodity is determined by the relative amount of commodities produced and the amount of labour consumed” (Caravale and Tosato 43). Thus, Ricardo is interested in the relative value of products as opposed to their real value.

According to Smith, a commodity’s long-run value is equivalent to its natural price and the cost incurred in its production, which relate to the cost of labour, capital, and land. Based on this assertion, an increase in the cost of one of the factors of production could trigger an increase in the price of the commodity (Wood 277). However, Ricardo argues that exchange value is not related to wage levels. Subsequently, “changes in the wage levels would not have any impact on the exchange value or the price of commodities” (Wood 277).

Ricardo suggests that changes in the level of wages could only affect prices/exchange value if the relative values of products are determined based on the ‘embodied labour’. On the contrary, adjustments in wages levels only influence the level of profitability due to the inverse relationship between wages and profit. Thus, an increase in the “level of wages leads to a decline in the level of profitability” (Wood 277). Consequently, Ricardo’s work highlights the absence of positive variation between the value of a commodity and wages.

In dissension with Smith’s argument regarding the factors of production and their influence on ‘value in exchange’, Ricardo argues that rent does not determine the price of a commodity. Subsequently, it should not be considered in determining the price or value of a product. However, Ricardo ignores the existence of differential rent and absolute rent, which implies that rent is non-existent in price determination (Wood 278). Furthermore, Ricardo criticises Adam Smith’s labour-commanded- theory of value extensively by introducing the embodied theory of value. Ricardo argues that Smith erred by only focusing on widely and easily produced products (Pack 55).

In his argument, Ricardo asserts that the Smith’s theory of labour theory of labour does not consider scarce products, which makes his labour-command theory of value ineffective. In his opinion, the value of commodities that can easily be reproduced such as foodstuffs can only be determined by assessing their embodied labour. Therefore, if producing one bed and one toy requires 30 hours and 1 hour of labour respectively, then the cost of labour incurred in producing one bed is 30 times the cost of producing a toy.

Based on Smith’s labour theory of value, if the cost of making a bed is approximately $60, then the cost of producing a toy will gravitate around $ 2. This assertion illustrates an absolute approach in the determination of value of a commodity’s price or value. However, Ricardo asserts that the cost of labour is subject to the workers’ level of skills and expertise (Foley 66).

Ricardo also argues that Smith did not take into account the non-reproducible commodities in his assessment of value. He affirms that the value of scarce products is determined by their demand. Additionally, the value of such commodities is inherent in their scarcity (O’Brien 106). Moreover, Ricardo is of the opinion that labour is not the only dimension that can be used in determining the relative value of commodities.

In his assessment, Ricardo argues that the “influence of profits on the price of a commodity varies depending on the amount of circulating and fixed capital required” (Dooley 143). Additionally, Ricardo maintains that profits “become a greater percentage of prices as fixed capital increases relative to circulating capital” (Dooley 143). Ricardo emphasises that capital-intensive products are sold at a higher price as compared to less-capital intensive products irrespective of the quantity of labour employed.

Additionally, Ricardo emphasised that the amount of duration taken to bring a commodity to the market is also a fundamental determinant of a commodity’s price irrespective of the amount of labour embodied. Therefore, a commodity’s price is determined by the compound profit and wage level (Dooley 143). This assertion implies that the value of a commodity increases as time passes. For example, the value of a well-aged wine is higher as compared to newly manufactured wine despite the amount of labour required in the production process being equal.

Implication

The above analysis underscores the existence of contentious economic aspects that have been propagated by different economists in history. The evaluation on the arguments raised by Adam Smith and David Ricardo on the theory of value illustrates the magnitude of debate on different economic aspects. The arguments proposed by various economists have played an essential role in the development of economic processes. Some of the arguments raised have obscured others, hence leading to the development of economic history.

Ricardo bases his arguments on the propositions made by Adam Smith on the labour theory of value. In his criticism, Ricardo has significantly contributed to the improvement of the theory of value. Ricardo modifies the theory of value by integrating the concepts of fixed and variable capital. Moreover, his opinion regarding the theory of value has led to a significant improvement on the concepts of demand and supply, which have become prominent economic aspects in the determination of market prices in the contemporary economy.

The two economists’ studies on the theory of value have also formed the foundation for other economists. For example, Peiro Sraffa improved on David Ricardo’s labour theory of value, which led to the development of the theory of income distribution. Furthermore, the two economists’ proposition on the theory of value received extensive criticism from different economists around the world. Thus, the economists were in a position to improve their economic theories based on the positive criticism received. For example, Ricardo developed other theories such as the theory of rent.

The analysis identifies the labour theory of value as one of the areas that have received extensive studies by different economists over the years. Despite the intensive research conducted by Adam Smith and David Ricardo, their findings were characterised by numerous gaps. Hunt (45) asserts that the labour theory of value has presented economists with puzzling problems over the past decades, which explains the source of divergent views.

For example, Smith considers labour as a real metric in the determination of the exchangeable value. Conversely, Ricardo views labour as the basis of the exchangeable value in different commodities. However, these problems cannot be resolved through criticism. On the contrary, it is imperative for economists to undertake an extensive study on the relationship amongst the various economic concepts proposed by different scholars.

In an effort to improve their theory of value, the two economists were pressurised by other scholars to adjust their economic views. Ricardo improved on his view on rent as a critical determinant of the price of a commodity. Similarly, Smith improved his assumption on the non-existence of capital. Through their efforts, the two economists contributed to a mode building on the theory of value by ‘saving’ the labour theory of value. To some degree, Ricardo agreed with Smith’s proposition on labour as a fundamental measure of value in exchange. According to Rima, Ricardo maintained that the “absolute labour theory of value holds if the relative values of different commodities are proportional to the labour necessary to produce them (119).

The economic arguments on labour theory of value proposed by the classical economists such as Smith and Ricardo were extensively adopted during the 19th century. However, the emergence of neo-classical economists during the 1870s led to a significant improvement on the theory (O’Hara 649).

Conclusion

This paper cites the existence of a controversy or positive disagreement amongst economists on various theories and values as an important aspect in the development of economic history. The positive disagreements generated by economists on a particular economic aspect form the basis of additional studies, hence refining possible gaps that might have existed. Furthermore, such positive disagreements contribute to a better understanding of a broad spectrum on different economic aspects.

Despite the view that Adam Smith is considered as one of the founders of economics, the divergent views adopted by Ricardo on Smith’s proposition regarding the theory of value have enhanced the development of the theory remarkably. Thus, the propositions adopted by the two economists have led to a broad understanding on the concept of value. For example, Adam Smith has focused on diverse elements that constitute value in exchange such as the cost of production, labour, and price. On the other hand, Ricardo has emphasised on the theory of value by focusing on the concept of utility.

Furthermore, the paper illustrates the various points of divergence between the two economists regarding the theory of value with reference to labour. Ricardo advocates for embodied labour as the most effective approach in determining a commodity’s exchangeable value. On the contrary, Adam Smith emphasises the labour command theory of value. Furthermore, Ricardo’s arguments have led to the adoption of different dimensions that Smith did not consider in his argument. Therefore, none of the propositions made by the two economists can be cited as being prominent over the other.

However, the two economists have contributed positively to development of economic history. The economic views of the two economists on the theory of value have also been criticised by other economists. For example, some economists argued that Ricardo overlooked some issues in his criticism of Smith’s theory. Such criticisms have led to a remarkable improvement in their opinion regarding the theory of value. Subsequently, the two economists have converged on the theory of value, which is evidenced by the improvement of their views by the Keynesian and post-Keynesian economists.

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