Scarcity, Marginal Utility and Demand
I don't think that Paul's explanation of marginalist theory is accurate either. He says,
“... if the supply of something increases, it becomes rational for people to start wanting it, and to decide what price they pay for it. Supply creates its own demand, says the theory: a freely operating market will 'clear' until demand matches supply, with prices changing in response.” (p 161)
But, the reason that marginalist/neoclassical economists believe that supply creates its own demand, so that the market clears, is essentially the same as that held by Ricardo, Mill, Say and others. It is that there can be no general overproduction of commodities. For Mill et al, if some commodities are overproduced, it is only a reflection that other commodities are not available to exchange for them, so that the former are under-consumed, as a result of the latter being under-produced. As Marx says, they arrive at this conclusion, because, rather than considering the process of commodity exchange as it actually occurs under capitalism, they apply the conditions that apply under barter. As I've set out elsewhere, some Marxist economists, by failing to take into account the actual role of demand, and of the market, also fall into this error.
Where the marginalists differed was essentially only in this: they rejected the classical notion of value, so that for them supply does not create its own demand by a process of barter, by which A exchanges an equal amount of value with B – for Ricardo money is only a means of mediating this exchange – but by the fact that the factors of production – land, labour, capital – obtain revenues from the production of A, just as similar factors obtain revenues from the production of B etc., and they use these revenues for the purchase of other commodities, thereby creating demand. For those commodities where consumer preferences are high, relative to supply, the price will rise, and that will cause factor incomes in that sphere to rise, and vice versa. Factors of production will move to where those higher incomes are available, so that capital is reallocated, at which point prices in one sphere will fall back, and in the other they rise again. Given the nature of marginalist theory and the premise of diminishing returns, prices in the former will not fall back to former levels, because of higher marginal costs and vice versa.
It's not the case, as Paul says, that the last ecstasy tablet in the nightclub has higher value/marginal utility than all the others, because it depends whether there is demand for it or not. And, nor is it the case that because the supply of something rises, marginalism says that the demand for it must appear or rise. On the contrary, the proposition is that the market will clear, because if there is no demand for it, the sellers will have to continually reduce the price of it, until a sufficient demand is created, as fruit sellers on a market stall are forced to sell off any remaining produce towards the end of the day at lower prices to clear them.
This, in fact, is the crucial point about understanding crises of overproduction, from a Marxist perspective. What the marginalists fail to account for, precisely because of their theory of subjective value, is what happens when this price at which a sufficient demand exists, to clear the market, is itself insufficient to cover the costs of production, i.e. to reproduce the capital consumed in production. So long as prices only move marginally, so as to ration out supply, or to clear some temporary excess, things are manageable. Temporary price fluctuations happen all the time, and firms factor such movements into their longer term calculation of average prices, and longer-term profits. A more sustained fall in price, reflecting a change in consumer preferences may hit a firm's profit, but, so long as it still produces a profit that is not crucial.
Such a fall in profit means it may not be able to expand, at the rate it anticipated, but, if it sees demand falling, it may decide that is no bad thing. But, if it makes a large, or sustained series of losses, unless it has reserves on its balance sheet, it will be unable to reproduce the capital consumed in its production. It will have to lay off workers, buy fewer materials, sell some machines and so on. In turn, the laid off workers have no income to buy commodities, the suppliers of materials etc. see the demand for their commodities fall, so those prices fall, and so do their profits etc.
The marginalists solution to such a situation is that, in the first company, the capital has already seen its return disappear, so the workers, to retain their jobs, have to take lower wages, the firm should negotiate lower rents with landlords, on pain of the landlord losing rent altogether and so on. But, the problem here is that the workers wages are not some arbitrary amount. As an average price, the wage is what is required to reproduce the workers' labour-power. Not only does it mean that if the workers accept lower wages they cannot buy all the wage goods they require for their reproduction, it means the suppliers of those wage goods see a fall in demand for their own output. What was a partial crisis, in one sphere, can thereby spread generally. Such falls in wages may be possible temporarily, or for longer periods where workers can utilise cheap credit, but only by deferring the problem, which is another experience seen in the last thirty years.
As Marx says in relation to the production of knives, a rise in productivity may greatly reduce the value of a knife, but this goes along with a rise in the quantity of knives produced. There is no logical reason why the demand for knives should rise proportionally to the rise in output, even at this lower unit value.
“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.” (Theories of Surplus Value, Part 3, p 118-9)
Similarly, landlords may decide to simply take their land out of circulation, rather than accept lower rents. And, again, in the last thirty years we've seen a different manifestation of that, because as central banks continually inflated asset prices, it increasingly became the case that the owners of landed property, and financial assets became less interested in yields, and more concerned with guaranteed capital gains from simply hoarding those assets.
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