Capital III, Chapter 10 - Part 16

There may be a great social need for housing in Britain today, but builders will not build houses when there are not enough people with incomes sufficient to buy them at the currently inflated prices. In fact, the house price bubble in Britain is a perfect example of what Marx is describing. Low interest rates, and easy credit, created a bubble in existing house prices. That pushed up the price of building land, which increases the price of new houses. That means new demand is choked off, as fewer and fewer people can afford to buy. So, builders naturally reduce their production, which in turn means speculation drives the prices of the existing houses higher still, until the bubble bursts.

“We must never forget that the demand for productive consumption is, under our assumption, a demand of the capitalist, whose essential purpose is the production of surplus-value, so that he produces a particular commodity to this sole end.” (p 188-9)

But, the same is true in reverse. A fall in price will cause a rise in demand. Yet, this rise in demand may be limited. Demand and social need are not at all the same thing, and yet there is here a connection. In other words, there is a limit to how much, just because the price of something is low, it will cause the demand for it to be high.

As Marx says, 

“The same value can be embodied in very different quantities [of commodities]. But the use-value—consumption—depends not on value, but on the quantity. It is quite unintelligible why I should buy six knives because I can get them for the same price that I previously paid for one.”

(TOSV 3 Chapter 20, p 119)

In other words, Marx clearly understood the principle of price and income elasticity of demand.

“The limits within which the need for commodities in the market, the demand, differs quantitatively from the actual social need, naturally vary considerably for different commodities; what I mean is the difference between the demanded quantity of commodities and the quantity which would have been in demand at other money-prices or other money or living conditions of the buyers.” (p 189)

The interaction of supply and demand cannot explain the market value of commodities, only the divergence of market prices from market values. In other words, if demand exceeds supply, what does this mean? It only means that demand is higher than supply at the market value. In that case, the market price rises above the market value. We will come back to the consequence of this later. But, if the market price is higher than the market value, because the demand was higher than the supply, it is then clear that the market value itself could not be the result of the interaction of supply and demand.

On the other hand, if demand and supply are in balance, then they cease to explain anything, because they balance each other out, so that the price moves neither up nor down. For orthodox economics, this question does not arise, because for it there is no separate market-value as opposed to market price. If demand exceeds supply, prices rise, so that on the one hand demand is reduced, whilst additional supply is encouraged.

Yet, even in this explanation, orthodox economics has to recognise the underlying role of a separate mechanism, because the question arises, why does the higher price result in additional supply? The answer is that at this higher price, above average profits can be made, because the cost of production has not changed. The additional profits result in more capital being invested, so supply increases.

The traditional supply and demand graphs of orthodox economics always show such a situation where the demand curve has shifted, as resulting in a higher price than was originally the case and with supply being higher. But, the reason for this is that it has an underlying assumption of diminishing returns. In other words, it assumes that in order to increase supply from current levels, marginal costs will rise, because it assumes that the existing production is being undertaken by the most efficient means.

Yet all experience shows this is not the case. As Marx set out, in Volume I, all experience is that as production takes place on an ever larger scale, marginal costs of production fall not rise. That is why firms do try to produce on as large a scale as possible to enjoy the economies of scale. If we look at almost any commodity, it starts life with only small amounts being demanded and supplied. Its costs of production are high, and its price is high. But, then demand and supply both increase and interact on each other. New methods of production reduce its price. Demand increases and as it rises, more is produced to meet the demand. As more is produced, economies of scale reduce the price further, which encourages yet more demand and so on.

So, if we want to understand why the higher market price results in higher supply we have to be able to understand why that additional supply only increases by a certain amount, i.e. to where the price itself is reduced to where only average profits are once more being achieved. That may be at a point where the price is higher than it was originally, if to achieve this additional supply input costs have risen, but it could just as easily be at a lower price than originally obtained, if the higher level of production means that economies of scale are obtained. In other words, the interaction of supply and demand cannot explain market value, only understanding the market value can explain the movement of supply in relation to demand.

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