Definitions

# Labor theory of value

The labor theories of value (LTV) are theories in economics according to which the values of commodities are related to the labor needed to produce them.

There are many different accounts of labor value, with the common element that the "value" of an exchangeable good or service is, or tends to be, or can be considered as, or "is to be measured as equal or proportional to the amount of labor required to produce it (including the labor required to produce the raw materials and machinery used in production).

Different labor theories of value prevailed amongst classical economists through to the mid-19th century. It is especially associated with Adam Smith and David Ricardo. Since that time it is most often associated with Marxian economics; while modern mainstream economics replaces it by the marginal utility approach.

## Definitions of value and labor

When speaking in terms of a labour theory of value, value without any qualifying adjective should theoretically refer to the amount of labor "embodied" in a commodity. As explained by Adam Smith:

The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people.(Wealth of Nations Book 1, chapter V)

However even a person drinking water from a good stream at his doorstep must "spend" labor to gain this value, at least if this action is relevant to economics.

In terms of modern orthodox terminology it is important to note that "labor", at least in Smith's approach, is defined as the opposite of utility - "disutility", pain, toil etc. Labor which is pleasant in itself is only therefore partly labor, or perhaps not labor at all (however, see opportunity cost). Labor which is highly skilled on the other hand owes part of its produce to an "investment" made in training and is almost like capital (hence the modern concept of human capital). So many types of pleasant labor can be described as a result of an earlier and more painful investment.

In the example of a person going to a stream at his doorstep, if this is a pleasant activity, it is not labor. If it is not pleasant it could be relevant to economics because, for example, the house could be built closer to the stream, plumbing could be installed, a person could be employed to fetch water, or investment in a better path to the water might be worth considering.

This way of defining value can to be reconciled with the normal uses of the term:

Value "in use" is the usefulness of this commodity, its utility. There is a classical paradox which is often expressed when considering this type of value. Here, once again in the words of Adam Smith:

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; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. 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. (Wealth of Nations Book 1, chapter IV)
Value "in exchange" is the relative proportion with which this commodity exchanges for another commodity (in other words, its price in the case of money). It is relative to labor as explained by Adam Smith:
The value of any commodity, ... to the person who possesses it, and who means not to use or consume it himself, but 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 (Wealth of Nations Book 1, chapter V; emphasis added).

Value (without qualification) as an intrinsic worth which stands without the process of exchange.

Marx defined the value of the commodity by the third definition. In his terms, value is the 'socially necessary abstract labor' embodied in a commodity. In Ricardo and other classical economists, this definition serves as a measure of "real cost", "absolute value", or a "measure of value" invariable under changes in distribution and technology.

Ricardo, other classical economists, and Marx began their expositions with the assumption that value in exchange was equal to or proportional to this labor value. They thought this was a good assumption from which to explore the dynamics of development in capitalist societies.

Other supporters of the labor theory of value used the word "value" in the second sense, to represent "exchange value".

## Conceptual model

A simple model illustrating the concepts and workings of LTV could go as follows:

In a village in Somewhereia, everyone shares a set of skills and their produce is derived from local natural resources. Through custom or inclination each person pursues a particular trade, but is capable of pursuing any other in the village.

These people exchange their products on a regular basis. Each would know how long it took their fellow to produce their good, and how long it would take them to make it themself. They would also know how much of their own product they would produce in the same amount of time and how much they would be able to exchange for that product.

If anyone tried to overcharge for a good, people would stop buying and make it themselves (or a competitor could enter the market and undercut them). Each person would thus be able to calculate whether it would be better for them to buy a good or make it themselves.

In this scenario prices and values would be equal.

## LTV and the labor process

Since the term value is understood in the LTV as denoting something created by labor, and its "magnitude" as something proportional to the quantity of labor performed, it is important to explain how the labor process both preserves value and adds new value in the commodities it creates.

The value of a commodity increases in proportion to the duration and intensity of labor performed on average for its production. Part of what the LTV means by "socially necessary" is that the value only increases in proportion to this labor as it's performed with average skill and average productivity. So though workers may labor with greater skill or more productivity than others, these more skillful and more productive workers will thus produce more value through the production of greater quantities of the finished commodity: each unit still bearing the same value as all the others of the same class of commodity. By working sloppily, the unskilled workers may drag down the average skill of labor, thus increasing the average labor time necessary for the production of each unit commodity. But these unskillful workers cannot hope to sell the result of their labor process at a higher price (as opposed to value) simply because they have spent more time than other workers producing the same kind of commodities.

However, production not only involves labor, but also certain means of labor: tools, materials, power plants and so on. These means of labor — also known as means of production — are often the product of another labor process as well. So the labor process inevitably involves these means of production that already enter the process with a certain amount of value. Labor also requires other means of production that are not produced with labor and therefore bear no value: such as sunlight, air, uncultivated land, un-extracted minerals, etc. While useful, even crucial to the production process, these bring no value to that process. In terms of means of production resulting from another labor process, LTV treats the magnitude of value of these produced means of production as constant throughout the labor process. Due to the constancy of their value, these means of production are referred to, in this light, as constant capital.

Consider for example workers who take coffee beans, use a roaster to roast them, and then use a brewer to brew and dispense a fresh cup of coffee. In performing this labor, these workers add value to the coffee beans and water that comprise the material ingredients of a cup of coffee. The worker also transfers the value of constant capital — the value of the beans; some specific depreciated value of the roaster and the brewer; and the value of the cup — to the value of the final cup of coffee. Again, on average the worker can transfer no more than the value of these means of labor previously possessed to the finished cup of coffee So the value of coffee produced in a day equals the sum of both the value of the means of labor — this constant capital — and the value newly added by the worker in proportion to the duration and intensity of their work. Often this is expressed mathematically as:

$c+L=W$,

where
* $c$ is the constant capital of materials used in a period plus the depreciated portion of tools and plant used in the process. (a period is typically a day, week year or a single turnover: meaning the time required to complete one batch of coffee, for example)
* $L$ is the quantity of labor time (average skill and productivity) performed in producing the finished commodities during the period
* $W$ is the value of the product of the period ($w$ comes from the German word for value: wert)

Note: if the product resulting from the labor process is homogenous (all similar in quality and traits, for example, all cups of coffee) then the value of the period’s product can be divided by the total number of items (use-values) produced to derive the unit value of each item. $begin\left\{matrix\right\}w_i= frac\left\{W\right\}\left\{sum uv\right\},end\left\{matrix\right\}$ where $sum uv$ is the total items produced.

The LTV further divides the value added during the period of production, $L$, into two parts. The first part is the portion of the process when the workers add value equivalent to the wages they are paid. For example, if the period in question is one week and these workers collectively are paid \$1,000, then the time necessary to add \$1,000 to — while preserving the value of — constant capital is considered the necessary labor portion of the period (or week): denoted $NL$. The remaining period is considered the surplus labor portion of the week: or $SL$. The value used to purchase labor-power, for example the \$1,000 paid in wages to these workers for the week, is called variable capital ($v$). This is because in contrast to the constant capital expended on means of production, variable capital can add value in the labor process. The amount it adds depends on the duration, intensity, productivity and skill of the labor-power purchased: in this sense the buyer of labor-power has purchased a commodity of variable use. Finally, the value added during the portion of the period when surplus labor is performed is called surplus value ($s$). From the variables defined above, we find two other common expression for the value produced during a given period as:

$c+v+s=W$
and
$c+NL+SL=W$

The first form of the equation expresses the value resulting from production, focussing on the costs $c+v$ and the surplus value appropriated in the process of production, $s$. The second form of the equation focusses on the value of production in terms of the valued added by the labor performed during the process $NL+SL$.

## The relation between values and prices

One issue facing the LTV is the relationship between value quantities on one hand and prices on the other. If a commodity's value is not the same as its price, and therefore the magnitudes of each likely differ, then what is the relation between the two, if any? Various LTV schools of thought provide different answers to this question. For example, some argue that value in the sense of the amount of labor embodied in a good acts as a center of gravity for price. As counter-intuitive as this may seem to those accustomed to neoclassical price theory, some empirical evidence suggests labor values are a better predictor of empirically recorded prices than prediction by any other means.

However, most economists would say that cases where pricing is even approximately equal to the value of the labor embodied are only special cases, and not the general case. In the standard formulation, prices also normally include a level of income for "capital" and "land". These incomes are known as "profit" and "rent" respectively. (It should be kept in mind that like the terms "labor" and "value", the terms "price, "capital", "land", "profit" and "rent" here are being used in a theoretical way which will not always correspond to everyday use, even by accountants.)

In Book 1, chapter VI, Smith explains:

As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials.
[...]
The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction.
[...]
In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him. Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour. As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce.
[...]
The real value of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit.

The final sentence shows us how Smith sees value of a produce as relative to labor of buyer or consumer, as opposite to Marx who sees the value of a product being proportional to labor of labourer or producer. And we value things, price them, based on how much labor we can avoid or command, and we can command labor not only in a simple way but also by trading things for a profit.

The demonstration of the relation between commodities' unit values and their respective prices is known in Marxian terminology as the transformation problem or the transformation of values into prices of production. The transformation problem has probably generated the greatest bulk of debate about the LTV. The problem with transformation is to find an algorithm where the magnitude of value added by labor, in proportion to its duration and intensity, is sufficiently accounted for after this value is distributed through prices that reflect an equal rate of return on capital advanced. If there is an additional magnitude of value or a loss of value after transformation compared with before then the relation between values (proportional to labor) and prices (proportional to total capital advanced) is incomplete. Various solutions and impossibility theorems have been offered for the transformation, but the debate has not reached any clear resolution.

LTV does not deny the role of supply and demand influencing price since the price of a commodity is something other than its value. In Value, Price and Profit (1865), Karl Marx quotes Adam Smith and sums up:

It suffices to say that if supply and demand equilibrate each other, the market prices of commodities will correspond with their natural prices, that is to say, with their values as determined by the respective quantities of labor required for their production.

It is the level of this equilibrium which the LTV seeks to explain. This could be explained by a "cost of production" argument, pointing out that all costs are ultimately labor costs, but this does not account for profit, and it is vulnerable to the charge of tautology in that it explains prices by prices. Marx later called this "Smith's adding up theory of value".

Smith argues that labor values are the natural measure of exchange for direct producers like hunters and fishermen. Marx, on the other hand, uses a measurement analogy, arguing that for commodities to be comparable they must have a common element or substance by which to measure them, and that labor is a common substance of what Marx eventually calls commodity-values.

Some statistical evidence for the theory has also been advanced by Shaikh.

## The theory’s development

### The birth of the LTV

Benjamin Franklin in his 1729 essay entitled "A Modest Enquiry into the Nature and Necessity of a Paper Currency" is sometimes credited (including by Karl Marx) with originating the concept. However, the theory has been traced back to Treatise of Taxes, written in 1662 by Sir William Petty and to John Locke's notion, set out in the Second Treatise on Government (1689), that property derives from labor through the act of "mixing" one's labor with items in the common store of goods, though this has alternatively been seen as a Labor Theory of Property.

Scottish economist Adam Smith accepted the LTV for pre-capitalist societies but saw a flaw in its application to capitalism. He pointed out that if the "labor embodied" in a product equalled the "labor commanded" (i.e. the amount of labor that could be purchased by selling it), then profit was impossible. David Ricardo (seconded by Marx) responded to this paradox by arguing that Smith had confused labor with wages. "Labor commanded", he argued, would always be more than the labor needed to sustain itself (wages). The value of labor, in this view, covered not just the value of wages (what Marx called the value of labor power), but the value of the entire product created by labor.

Ricardo's theory was a predecessor of the modern theory that equilibrium prices are determined solely by production costs associated with " neo-Ricardianism".

Based on the discrepancy between the wages of labor and the value of the product, the "Ricardian socialists" — Charles Hall, Thomas Hodgskin, John Gray, and John Francis Bray — applied Ricardo's theory to develop theories of exploitation.

Marx expanded on these ideas, arguing that workers work for a part of each day adding the value required to cover their wages, while the remainder of their labor is performed for the enrichment of the capitalist. The LTV and the accompanying theory of exploitation became central to his economic thought.

19th century American individualist anarchists based their economics on the LTV, with their particular interpretation of it being called "Cost the limit of price." They, as well as contemporary individualist anarchists in that tradition, hold that it is unethical to charge a higher price for a commodity than the amount of labor required to produce it. Hence, they propose that trade should be facilitated by using notes backed by labor.

### Adam Smith and David Ricardo

Adam Smith held that in a primitive society, the amount of labor put into producing a good determined its exchange value, with exchange value meaning in this case the amount of labor a good can purchase. However, according to Smith, in a more advanced society the market price is no longer proportional to labor cost since the value of the good now includes compensation for the owner of the means of production: "The whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him. "Nevertheless, the 'real value' of such a commodity produced in advanced society is measured by the labor which that commodity will command in exchange....But [Smith] disowns what is naturally thought of as the genuine classical labor theory of value, that labor-cost regulates market-value. This theory was Ricardo’s, and really his alone.

Classical economist David Ricardo's labor theory of value holds that the value of a good (how much of another good or service it exchanges for in the market) is proportional to how much labor was required to produce it, including the labor required to produce the raw materials and machinery used in the process. David Ricardo stated it as, "The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not as the greater or less compensation which is paid for that labour" (Ricardo 1817). In this heading Ricardo seeks to differentiate the quantity of labor necessary to produce a commodity from the wages paid to the laborers for its production. However, Ricardo was troubled with some deviations in prices from proportionality with the labor required to produce them. For example, he said "I cannot get over the difficulty of the wine which is kept in the cellar for three or four years [i.e., while constantly increasing in exchange value], or that of the oak tree, which perhaps originally had not 2 s. expended on it in the way of labour, and yet comes to be worth £100."(Quoted in Whitaker) Of course, a capitalist economy will stabilize this discrepancy until the value added to aged wine is equal to the cost of storage - if anyone can hold onto a bottle for four years and become rich, that will be done so much it is hard to find freshly-corked wine. There is also the theory that adding to the price of a luxury product increases its exchange-value by mere prestige.

The labor theory as an explanation for value contrasts with the subjective theory of value, which says that value of a good is not determined by how much labor was put into it but by its usefulness in satisfying a want and its scarcity. Ricardo's labor theory of value is not a normative theory, as are some later forms of the labor theory, such as claims that it is immoral for an individual to be paid less for his labor than the total revenue that comes from the sales of all the goods he produces.

It must be noted that it is arguable to what extent these classical theorists held the labor theory of value as it is commonly defined. For instance, David Ricardo theorized that prices are determined by the amount of labor but found exceptions for which the labor theory could not account. In a letter, he wrote: "I am not satisfied with the explanation I have given of the principles which regulate value." Adam Smith theorized that the labor theory of value holds true only in the "early and rude state of society" but not in a modern economy where owners of capital are compensated by profit. As a result, "Smith ends up making little use of a labor theory of value.

### Marx's contribution

Contrary to popular belief, Marx does not base his LTV on what he dismisses as a "ascribing a supernatural creative power to labor", arguing in the Critique of the Gotha Program that:

Labor is not the source of all wealth. Nature is just as much a source of use values (and it is surely of such that material wealth consists!) as labor which is itself only the manifestation of a force of nature, human labor power.

Here Marx is drawing a distinction between exchange value (which is the subject of the LTV) and use value.

Marx uses the concept of "socially necessary abstract labor-time" to introduce a social perspective distinct from his predecessors and neoclassical economics. Whereas most economists start with the individual's perspective, Marx starts with the perspective of society as a whole. "Social production" involves a complicated and interconnected division of labor of a wide variety of people who depend on each other for their survival and prosperity.

"Abstract" labor refers to a characteristic of commodity-producing labor that is shared by all different kinds of heterogeneous (concrete) types of labor. That is, the concept abstracts from the particular characteristics of all of the labor and is akin to average labor.

"Socially necessary" labor refers to the quantity required to produce a commodity "in a given state of society, under certain social average conditions or production, with a given social average intensity, and average skill of the labour employed. That is, the value of a product is determined more by societal standards than by individual conditions. This explains why technological breakthroughs lower the price of commodities and put less advanced producers out of business. Finally, it is not labor per se, which creates value, but labor power sold by free wage workers to capitalists. Another distinction to be made is that between productive and unproductive labour. Only wage workers of productive sectors of the economy produce value.

#### Exploitation

Marx uses his LTV to derive his theory of "exploitation" under capitalism.

Unlike Ricardo or the Ricardian socialists, Marx distinguishes between labor power and labor. "Labor-power" is the potential or ability of workers to work, given their muscles, brains, skills, and capacities. It is the promise of creating value possessed by human labour that has not yet been expended. "Labor" is the actual activity of producing value. The profit or surplus-value arises when workers do more labor than is necessary to pay the cost of hiring their labor-power.

To explain the normality of exploitation, Marx describes Capitalism as having an institutional framework in which a small minority (the capitalists) monopolize the means of production. The workers cannot survive except by working for capitalists, and the state preserves this inequality of power. In normal role of force is structural, part of the usual workings of the system. The reserve army of unemployed workers continually threatens employed workers, pushing them to work hard to produce for the capitalists.

## Modern criticisms

### Microeconomic Theory

Virtually all modern economists are supporters of marginalism, which is the view that the value of any good or service is determined by its marginal utility, the utility of the "last" bought consumption good measured by its price, in satisfying a specific consumer's wants. The utility of individuals or whole societies is to be maximized, this is in modern economics the driving force of the economy, not profit maximization, as with Marx.

Proponents of the LTV would reply that as capitalism only recognises demand backed by money - then the price of a good is not simply measured by its usefulness but by the amount of money consumers own - it depends on a pre-existing set of relations of distribution. These relations of distribution in turn rest on a set of relations of production, which determine how consumers "earn" their money, capitalists "earn" profits, workers wages, landlords rent and so on. Consequently the price of an object depends not only on its usefulness but on the amount of money different consumers have - their different effective demands. As marginal utility theory is unable to abstract from the effect of these influences on price, the usefulness of a commodity alone cannot determine its price.

This utility maximization takes place under certain constraints, these are the available amounts of factors of production, for instance, labor (as with Marx profit maximization takes place under the constraint of available production techniques and the wage rate). In fact, the ultimate restriction is time. Households divide their time (24 hours a day) into leisure time and time for work. Time for work is to make money to buy goods for consumption. The household chooses that amount of leisure time and (via working time) that amount of consumption goods which maximizes its utility level.

With Marx, working time is not based on a free decision of households, but the outcome of a class struggle between workers and capitalists, the former trying to decrease, the latter to increase working time.

Further, all this does not take account of effects of the accumulation process. With Marx, there is a tendency of equalisation of rates of profit in the accumulation process, which leads to prices of production. If the price of a commodity is above its price of production, then capitalists in that sector will earn a super profit (a rate of profit above the average rate of profit of the economy as a whole). As a result capital will be attracted to that sector, production will increase, prices fall until the super profit has been competed away. The resulting prices of production are via transformation from labor values into prices based on labor times.

According to marginalism, value is subjective (since the same item - leisure time, consumption goods - will have a different marginal utility to different consumers, or even to the same consumer under different circumstances) and therefore cannot be determined simply by measuring how much labor went into the production of an item. In the Pareto optimum, on the other hand, the exchange relations between commodities are not only determined by their marginal utility, but also by the marginal productivity of the factors of production available.

This means that, in marginalism, commodities exchange at the marginal amount of labor necessary to produce them. In this sense, an LTV, or, more precisely, a value theory of marginal labor inputs, holds. However, this applies to all factors of production and also to marginal utility. Labor is nothing special. That these several value theories can hold all at the same time is made possible by marginal analysis. The Pareto optimum is defined as a situation where utility is maximized and at the same time all factors of production are employed most efficiently, leading to a situation, where all commodities exchange at their marginal utilities and at their - marginal - amounts of the different factors of production necessary to produce them.

In other words, if empirically it was found out, that commodities exchange according to their marginally necessary labor inputs, this would confirm marginal theory. It would contradict Marx’s theory, because according to Marx these exchange ratios are determined by prices of production, which are generally different from the necessary labour inputs, the labor values. Implicitly, Marx is thus denying, that capitalism is in a state of Pareto optimality.

### Jevons

A close reading of Jevons' chapter on "Labor" in his "Theory of Political Economy" reveals that he considered his marginal analysis quite consistent with the labor theory of value as he established that in equilibrium marginal utility equals marginal labor value. It is indeed Jevons' revolutionary discovery that labor must be measured in terms of marginal labor value (δL/δX).

### Menger's Critique

Opponents of Marxist economics argue that the Labor Theory of Value is disproven as commodities may diverge from the average price of production. In his 1871 work Principles of Economics, Austrian Economist Carl Menger writes:

There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor and other goods of higher order were applied to its production. A non-economic good (a quantity of timber in a virgin forest, for example) does not attain value for men if large quantities of labor or other economic goods were applied to its production. Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value. In general, no one in practical life asks for the history of the origin of a good in estimating its value, but considers solely the services that the good will render him and which he would have to forgo if he did not have it at his command...The quantities of labor or of other means of production applied to its production cannot, therefore, be the determining factor in the value of a good. Comparison of the value of a good with the value of the means of production employed in its production does, of course, show whether and to what extent its production, an act of past human activity, was appropriate or economic. But the quantities of goods employed in the production of a good have neither a necessary nor a directly determining influence on its value.

LTV proponents would argue that Menger's critique rests on a confusion between production in general and capitalist production. In the capitalist mode of production, a diamond found under a rock or produced in ancient times, is worth as much as a similar diamond mined at great expense from the earth as the price of the diamond will be the average cost of production, i.e. the socially necessary labour time a diamond normally costs to produce; this average includes whatever diamonds are discovered with negligible labor cost, but such cases being rare, the average is hardly altered by them.

As Marx states in Capital: "Diamonds are of very rare occurrence on the earth's surface, and hence their discovery costs, on an average, a great deal of labour-time.....If we could succeed at a small expenditure of labour, in converting carbon into diamonds, their value might fall below that of bricks." Capital Volume 1 Part 1 Chapter 1

### Böhm-Bawerk’s criticism

The Austrian economist Eugen von Böhm-Bawerk argued against both the Ricardian labor theory of price and Marx's theory of exploitation. On the former, he contended that return on capital arises from the roundabout nature of production which necessarily involves the passage of time. A steel ladder, for example, will be produced and brought to market only if the demand supports the digging of iron ore, the smelting of steel, the machines that press that steel into ladder shape, the machines that make and help maintain those machines, etc.

Roundabout processes, Böhm-Bawerk maintained, lead to a price that pays for more than labor value and this makes it unnecessary to postulate exploitation in order to understand the return on capital.

Furthermore, Böhm-Bawerk's positive theory of interest argued that workers trade in their share of the end price for the more certain wages paid by the entrepreneur. Entrepreneurs, he claimed, have given up a safer wage-earning job to take on the role of entrepreneur. In other words, he claimed that profits compensated the entrepreneur for the willingness to bear risk and to wait to receive income.

Böhm-Bawerk's essential argument that employers are compensated for shouldering some risk in paying their employees ahead of time, however, appears unable to explain how profit can be accumulated in cases where workers are reliant on commissions, tips, etc. for their income, which are received only after they sell their services. However, Böhm-Bawerk's does provide such an explanation. In the context of a waiter earning tips, the waiter himself is not a wage-earner. The restaurant owner does not make of profit from the tips earned by the waiter. The waiter is essentially an entrepreneur, taking the risk that customers will sufficiently compensate him for the labor he provides while the customers are under no legal obligation to do so. The waiter is making an investment of services in anticipation of future return from the customers. The waiter is compensated by an aggregate amount of earnings from tips that exceeds that labor value provided to the customers, thereby including a return on the waiter's investment. If the tips were not sufficient to provide this return on investment, then the waiter would rationally seek other employment, such as a wage-earning job with similar compensation that does not include the risk element or an entrepreneurial job with similar risk that provides a better return.

Regarding other situations where the employer-entrepreneur does receive a profit from after the labor has been rendered (e.g., a salesperson who works on commission), the employer-entrepreneur may take risks other than paying a wage to the salesman, including: providing a salesperson with an office, cell phone and/or computer; paying for product training and marketing materials; paying for travel and lodging expenses; producing inventory in reliance upon future sales that may or may not be made by the salesperson. All of this comprises a potential for loss that accounts for the return on investment realized by the employer-entrepreneur.

Nikolai Bukharin argued that Böhm-Bawerk's concept of roundaboutness was untenable in the context of the continuous, simultaneous production of a modern economy.

### Methodological Individualism

The Austrian school, led by Eugen von Böhm-Bawerk, argues against the whole tradition of the LTV (see above). Neoclassical economics also follows this lead  — and that of Jevons, Menger, and Walras — from the 1870s and discards the LTV in favor of general equilibrium theory, which determines prices based on the interaction of preferences, technology and endowments through supply and demand. Some Marxists (see analytical Marxism) have adapted to this neoclassical general equilibrium theory with a new emphasis on individual exchange and markets through what they call methodological individualism.

### What is "socially necessary"?

Marx argues in Capital:

"Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production. The labour, however, that forms the substance of value, is homogeneous human labour, expenditure of one uniform labour power. The total labour power of society, which is embodied in the sum total of the values of all commodities produced by that society, counts here as one homogeneous mass of human labour power, composed though it be of innumerable individual units...The labour time socially necessary is that required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time." (Capital, Volume 1, section 1)

Thus, according to Marx, any labor power squandered during the production of a commodity, i.e. labor which is socially unnecessary, will not add value, as value is determined by the average social labor.

Robert Nozick has criticized the qualifier "socially necessary" in the labor theory of value as not well-defined and concealing a subjective judgment of necessity.

### The LTV in a socialist society

It is often assumed that the LTV would apply in a socialist (or post-capitalist) society, though (purportedly at least) without the corresponding exploitation.

However, Marx argued in his Critique of the Gotha Program:

Within the co-operative society based on common ownership of the means of production, the producers do not exchange their products; just as little does the labor employed on the products appear here as the value of these products, as a material quality possessed by them, since now, in contrast to capitalist society, individual labor no longer exists in an indrect fashion but directly as a component part of the social labor.

David Ramsay Steele expands on this:

Numerous Marxist writers, from Marx and Engels down to Charles Bettelheim, have favored employing units of labor-time for planning production under socialism. This proposal is often referred to as an application of the labor theory of value, though that usage is not in conformity with Marx's. The Marxian labor theory of value (LTV) is intended to explain the determination of prices under commodity production (this is occasionally denied, but see Steele 1986). In Marxian terminology, there can be no 'value' in post-capitalist society. Both the LTV and communist planning conceive of resource allocation being guided by quantities of labor-time. Yet the LTV as an explanation of market prices and the labor-time planning proposal are two distinct theories, which may stand or fall independently. If the LTV were the correct explanation of market prices, this in itself would not show that units of labor-time could be of any practical use in administration of communist industry. And if units of labor-time could effectively be employed for communist planning, this would not require that the LTV be the correct explanation of market prices...

According to Marx's theory, actual prices will virtually always diverge from 'values' defined as units of labor-time. In Marx's thinking, after 1860, the relationship between 'value' and observed market prices is somewhat analogous to the relationship between 'mass' and 'heaviness', or between 'heat' and everyday awareness of temperature. Marx's 'value' is purportedly necessary to explain price, but it does not correspond to price or equilibrium price (often not even roughly) and therefore obvious disparities between value and price are not seen by Marx as refutations of his theory, though they are seen as contradicting the simple models employed in the early stages of expounding his theory in Volumes I and II of "Capital".

### The inapplicability of the LTV

The LTV is a theory of capitalist production, or generalized commodity production. There are however, commodities bought and sold under capitalism which have a price even though they do not have a value.

"Objects that in themselves are no commodities, such as conscience, honour, &c., are capable of being offered for sale by their holders, and of thus acquiring, through their price, the form of commodities. Hence an object may have a price without having value. The price in that case is imaginary, like certain quantities in mathematics. On the other hand, the imaginary price-form may sometimes conceal either a direct or indirect real value-relation; for instance, the price of uncultivated land, which is without value, because no human labour has been incorporated in it." (Capital Volume 1, section 1)

However the socially necessary labour theory of value only becomes inapplicable for uncultivated land when that land can never be productive no matter how much commercial labour is expended on it. Desert sand, gibber plains and icy wastes have very small land values because no commercial labour can be diverted from other uses to be usefully employed. In other cases the price-form will represent the indirect socially necessary labour that could be usefully employed.

• pieces of art which could be explained as instances of monopoly
• uncultivated land which has price, even if there is no labor involved. The price of land is explained by the theory of rent. Both Ricardo and Marx developed theories of land-rent based on the LTV.
• paper money. According to Marx "The function of gold as coin becomes completely independent of the metallic value of that gold. Therefore things that are relatively without value, such as paper notes, can serve as coins in its place." (Capital, Vol 1, Part 1) Section 2
• value of shares which is explained similarly like the value of land.

### The importance of labor

Marx stated that only labor could cause an increase in value. Assuming that all labor is equal, this suggests that labor intensive industries ought to have a higher rate of profit than those which use less labor -- which is often but not always true. Marx explained discrepancies by the fact that in real economic life prices vary in a systematic way from values. The mathematics applied to the transformation problem attempt to describe this (albeit with the unwelcome side consequences described above).

Critics (following, for instance, studies of Piero Sraffa) respond that this makes the once intuitively appealing theory very complicated; and that there is no justification for asserting that only labor and not for example corn can increase value. Any commodity can be picked instead of labor for being the commodity with the unique power of creating value, and with equal justification one could set out a corn theory of value, identical to the labour theory of value. A critic of Marxism, Robert Paul Wolff says "By reproducing for corn or iron or coal, all the striking results that Marx derived concerning for labor, we have, it seems to me, raised questions about the foundations of Marx's critique of capitalism and classical political economy.

However, there may be several problems with this criticism. The starting point for Marx's argument was: "What is the common social substance of all commodities? It is labor. It is not possible to view corn, iron etc as common to all commodities, whereas the production of commodities is impossible without labor. Marx identifies the substance of value as labor, which in his view is not a commodity (though "labor power" is). This was a necessary aspect for the substance of value Marx elaborates upon in Capital and Theories of Surplus Value.

Some supporters of the LTV, however, accept the thrust of the "corn theory of value" critique, but emphasize the social aspect of what Marx calls the "common social substance", arguing that labor power is unique as it is the only commodity not sold by capitalists but rather sold by the workers themselves, whose income tends to a minimum, because they have nothing else to sell. The surplus product is appropriated by the capitalists.