Price Of Production

The very short definition of Price of Production is that it is Marx's definition of cost of production plus average profit. The more detailed explanation is more complex. Price of Production is the solution Marx provides to a problem faced by Ricardo and his followers in reconciling Exchange Values and Prices. It is the solution to the so called “Transformation Problem”.

The Value of a commodity is determined by the amount of Abstract Labour Time required for its production. The Exchange Value of a commodity is determined by the relation of its Value to that of some other commodity, as expressed in the Value Form. For most of the three volumes of Capital, Marx proceeds as though commodities do exchange at these Exchange Values, even though he says at the beginning that he knows that this is not the case. The market prices at which commodities actually exchange clearly diverged from Exchange Values.

He proceeds as though they do exchange at their Exchange Values for two reasons. Firstly, he wants to demonstrate that Exchange Value is the basis of these market prices. That is true both historically and logically. He wants to show that it is only by understanding the basis of Exchange Value that you can understand market prices, which is the phenomenal form, the superficial appearance of Value. By assuming that commodities exchange at their Exchange Values, he can demonstrate all of the basic relationships without the additional complexities that arise on the basis of market prices. This is particularly, important for demonstrating that Labour-Power, as a commodity, is bought and sold at its Value, and so profit is not a result of paying workers less than the Value of their labour-power. Similarly, it is important for demonstrating that profit does not arise as a result of unequal exchange, by one person in an exchange cheating the other.

But, secondly, Marx's whole approach in Capital is not just to provide a logical explanation of various categories, but to demonstrate how these categories actually developed as part of a real historical process. In fact, the logical development can only be understood in Marx's method as flowing from that historical development. This is part and parcel of his method of Historical Materialism.

So, Marx does not just analyse Capitalism, but analyses how Capitalism develops out of previous modes of production. These include non-Capitalist forms of commodity production. It is in these that commodity exchange takes place on the basis of Exchange Value, though as he describes in the Grundrisse, even Exchange Value can only assume its mature form under Capitalism, when more and more consumers are themselves wage labourers. So long as production is undertaken by individual peasant producers and artisans, and especially given that very little in the way of tools and equipment is used, commodities can exchange on the basis of the labour-time required for their production. All the individual producer is concerned with is obtaining as much labour-time back, as they have provided. He writes,

“If labourer I has greater expenses, they are made good by a greater portion of the value of his commodity, which replaces this "constant " part, and he therefore has to reconvert a larger portion of the total value of his product into the material elements of this constant part, while labourer II, though receiving less for this, has so much less to reconvert. In these circumstances, a difference in the rates of profit would therefore be immaterial, just as it is immaterial to the wage-labourer today what rate of profit may express the amount of surplus-value filched from him, and just as in international commerce the difference in the various national rates of profit is immaterial to commodity exchange.

The exchange of commodities at their values, or approximately at their values, thus requires a much lower stage than their exchange at their prices of production, which requires a definite level of capitalist development.

Whatever the manner in which the prices of various commodities are first mutually fixed or regulated, their movements are always governed by the law of value. If the labour-time required for their production happens to shrink, prices fall; if it increases, prices rise, provided other conditions remain the same.

Apart from the domination of prices and price movement by the law of value, it is quite appropriate to regard the values of commodities as not only theoretically but also historically prius to the prices of production. This applies to conditions in which the labourer owns his means of production, and this is the condition of the land-owning farmer living off his own labour and the craftsman, in the ancient as well as in the modern world. This agrees also with the view we expressed previously that the evolution of products into commodities arises through exchange between different communities, not between the members of the same community. It holds not only for this primitive condition, but also for subsequent conditions, based on slavery and serfdom, and for the guild organisation of handicrafts, so long as the means of production involved in each branch of production can be transferred from one sphere to another only with difficulty and therefore the various spheres of production are related to one another, within certain limits, as foreign countries or communist communities.”

Capital Vol III, Chapter 10

But, whilst the Law Of Value regulates the Value, and thereby Exchange Value of commodities in all of these pre-capitalist societies, once capitalist production becomes dominant, its operation becomes necessarily modified, because it is now profit which determines where capital will be allocated, and therefore, where social labour-time will be expended. The search for higher rates of profit by capital, means that profit rates tend to be averaged out, through a never ending movement, which itself means that no actual average rate of profit is ever enjoyed by all capital. The actual rates of profit enjoyed by the different capitals are always fluctuating above or below a theoretical average that itself is constantly moving.

This posed problems for Ricardo's followers. Ricardo suggested that market prices varied around the Exchange Value, fluctuating according to changes in supply and demand. In that case, if these fluctuations were discounted against each other, the central point should be the Exchange Value, but it was clear that it was not. There was a contradiction. Either commodities exchanged at their values, in which case profit rates could not be equal, or else profit rates were (at least more or less) equal, in which case commodities did not exchange at their values.

Marx demonstrates this by comparing the situation of different capitals.

Capitals	Rate of Surplus-Value	Surplus- Value	Value of Product	Rate of Profit
I. 80c + 20v	100%	20	120	20%
II. 70c + 30v	100%	30	130	30%
III. 60c + 40v	100%	40	140	40%
IV. 85c + 15v	100%	15	115	15%
V. 95c + 5v	100%	5	105	5%

Each of these Capital is equal to 100, but this 100 is divided between Constant Capital and Variable Capital in different proportions. The Rate of Surplus Value for each capital is identical at 100%. However, because the amount of labour exploited in each case is different, this produces different amounts of Surplus Value in each case. This means that the Value of the Commodity produced is also different in each case. Finally, because the Rate of Profit is defined by Marx as the amount of Surplus Value/the Total Capital laid out to produce it, the Rate of Profit is also different in each case.

Where the Organic Composition Of Capitalis high (as in V) the Rate of Profit is low, because the small amount of labour employed produces only a small amount of Surplus Value. This small amount of S is still divided by 100 (the total capital laid out). Where the Organic Composition of Capital is low (as in III) the Rate of Profit is high, because here a relatively large amount of labour is employed, creating a relatively large amount of Surplus Value. Divided by the same amount of Capital laid out (100) it necessarily results in a higher rate of profit.

Whilst, as Marx says for pre-capitalist producers this did not matter, for capitalist production it does. The capitalist only lays out capital to make a profit, and seeks the largest amount of profit they can obtain for the Capital they have laid out. It does not matter to the capitalist whether that capital is in the form of Constant or Variable Capital, Means of production or Labour-Power. For the capitalist it is not the labour that creates their profit, but their capital as a whole. Consequently, capitalists will seek to employ their capital where they can make the highest rates of profit. They will move it out of those areas where low rates are obtained, and into those where high rates obtain. As the above demonstrates, that means moving Capital out of those areas where high organic compositions of capital obtain, and into those where low rates obtain.

“Owing to the different organic compositions of capitals invested in different lines of production, and, hence, owing to the circumstance that — depending on the different percentage which the variable part makes up in a total capital of a given magnitude — capitals of equal magnitude put into motion very different quantities of labour, they also appropriate very different quantities of surplus-labour or produce very different quantities of surplus-value. Accordingly, the rates of profit prevailing in the various branches of production are originally very different. These different rates of profit are equalized by competition to a single general rate of profit, which is the average of all these different rates of profit.”

Capital Vol III, Chapter 9

It is competition in this way that tends towards an average rate of profit. But, this process whilst continuing to operate can also be seen as an historical process as described by Marx. Historically, the first areas where Capital is going to enter production – aside from any legal or other restrictions placed upon it by guild monopolies etc – are those where the highest rates of profit can be obtained, and those are the areas where the organic composition of capital is lowest. So, agriculture is one of the first areas for capital to be employed. Next come those areas of peasant production that are also labour intensive, and require little in the way of tools and equipment, such as spinning and weaving. By contrast, those kinds of production that require lots of means of production such as iron-making, for a long time remain in the hands of the so called iron masters, before they succumb to capitalist production.

As Capital enters one area of production after another, so the supply of commodities in each of these arenas increases, bringing their prices down below their Exchange Values, and in the process reducing the profit, and rate of profit to be made. By the same token, this means resources elsewhere are relatively undeveloped, thereby opening up the opportunity for making higher rates of profit. As each type of industry succumbs to this process, so Capital is incentivised to move on to the next, in search of higher profits. To the extent that some of these commodities also enter as inputs into the production of other commodities, so the calculation of their Price of Production rather than the Exchange Value of those inputs becomes the determining factor upon which the profit is calculated, because it is now this Price of Production, not the Exchange Value, which is passed through into the Value of the final product.

“The foregoing statements have at any rate modified the original assumption concerning the determination of the cost-price of commodities. We had originally assumed that the cost-price of a commodity equalled the value of the commodities consumed in its production. But for the buyer the price of production of a specific commodity is its cost-price, and may thus pass as cost-price into the prices of other commodities. Since the price of production may differ from the value of a commodity, it follows that the cost-price of a commodity containing this price of production of another commodity may also stand above or below that portion of its total value derived from the value of the means of production consumed by it. It is necessary to remember this modified significance of the cost-price, and to bear in mind that there is always the possibility of an error if the cost-price of a commodity in any particular sphere is identified with the value of the means of production consumed by it. Our present analysis does not necessitate a closer examination of this point.”

Capital III, Chapter 9

In other words, the process of transformation of commodity prices based on Exchange Value to prices based on Prices of Production, can be seen as an historical process. To begin with commodities exchange on the basis of Exchange Values. Capital enters agriculture, and agricultural production increases. Agricultural prices fall below Exchange Value as Supply increases, thereby reducing the rate of profit. These reduced prices also enter as cost prices of inputs, for example, lower wool prices enter as inputs into the production costs of weavers. So, the relevant price for wool as far as the weaver is concerned is not its Exchange Value, but its Price of Production. It is that price not the Exchange Value which enters into the weavers calculations. In fact, with a lower cost price for wool, the rate of profit in weaving rises, because the Surplus Value created by the labour exploited, now represents a larger proportion of the Capital laid out to produce it.. As Capital enters weaving, this increases the supply of woven cloth, reducing its price below its Exchange Value, and thereby the rate of profit in weaving.

The Price of Production of woven cloth is now the relevant cost price for the tailors etc. rather than its Exchange Value. Its lower price now raises the rate of profit for tailoring, providing an incentive for capital to enter this line of production. But, Marx then describes in Capital how this process of Capital penetrating these different spheres one after another also results in Capital necessarily raising the organic composition of capital in each area, as it revolutionises production, first rationalising the use of labour, and then via mechanisation.

The continual revolutionising of production together with the continual movement of Capital from one area to another brings about a continual shift in these costs, and prices. As Capital reduces prices in one area, so this feeds through simultaneously into a reduction in costs in another.

Once again, in order to avoid the complication involved in trying to set out all of these simultaneous interrelations between input and output prices, Marx in his solution settles for describing the basic underlying relation, which explains the solution to Ricardo's dilemma. He settles instead for pointing out that he recognises that this solution is not adequate and could lead to error unless the effects on those input prices are included.

“But for the buyer the price of production of a specific commodity is its cost-price, and may thus pass as cost-price into the prices of other commodities... It is necessary to remember this modified significance of the cost-price, and to bear in mind that there is always the possibility of an error if the cost-price of a commodity in any particular sphere is identified with the value of the means of production consumed by it. Our present analysis does not necessitate a closer examination of this point.”

Therefore, Marx restricts his solution to one in which only the output prices are transformed. He does this by calculating an average rate of profit for the whole economy, and then adding this to the value of the Constant and Variable Capital laid out by each capital. For all Capitals of equal size, irrespective of their composition, therefore, we arrive at equal prices of production, and equal rates of profit.

I) 80v + 20v + 20s. Rate of profit = 20%. 

Price of product = 120. Value = 120. 

II) 90c + 10v + 10s. Rate of profit = 20%. 

Price of product = 120. Value = 110. 

III) 70c + 30v + 30s. Rate of profit = 20%. 

Price of product = 120. Value = 130. 

It should also be remembered that this Price of Production is not the same as Market Price. Marx recognised that Market Prices fluctuate around this Price of Production as a consequence of temporary changes in demand and supply.