The first occasion that Marx deals specifically with Smith's “absurd dogma” is in Capital II, Chapter 19. That is inevitable, because it is in Volume II that Marx first deals with the circulation of capital and commodities, as part of the reproduction process of the total social capital. In other words, its here that he first deals with the question of demand, and the creation of the funds (capital and revenue) which form the basis of this demand. Here, the question of demand, however, is still undertaken on the basis purely of exchange-value, i.e. the existence of the required funds, ignoring the question of use values, i.e. whether those in possession of the required exchange-value desire to use it to acquire the available use-values. Marx only deals with that as part of his theory of crises in Theories of Surplus Value, Chapter 17, and after.
Marx's analysis in Capital II, Chapter 20, sets out that, excluding any consideration of use-values, the process of production is also simultaneously a process of reproduction. The exchange-values created are equal to, and so able to form an adequate demand for the supply that is created by that production process. But, those exchange-values are not comprised, and could not be comprised only of the new value created this year – revenues – but also comprise the value of the constant capital (materials, wear and tear) that is preserved, and transferred into the value of current production – capital. It is able, thereby, to physically replace, on a like for like basis, all of its components that went into the production process, and so enable production to occur, on the same scale, in the following period. This is what Marx summarises in Capital III, Chapter 49.
“In so far as reproduction obtains on the same scale, every consumed element of constant capital must be replaced in kind by a new specimen of the same kind, if not in quantity and form, then at least in effectiveness. If the productiveness of labour remains the same, then this replacement in kind implies replacing the same value which the constant capital had in its old form. But should the productiveness of labour increase, so that the same material elements may be reproduced with less labour, then a smaller portion of the value of the product can completely replace the constant part in kind. The excess may then be employed to form new additional capital or a larger portion of the product may be given the form of articles of consumption, or the surplus-labour may be reduced. On the other hand, should the productiveness of labour decrease, then a larger portion of the product must be used for the replacement of the former capital, and the surplus-product decreases.”
In Capital II, Chapter 20, Marx analyses this in terms of simple reproduction, whereby the capitalist consumes all of their profit unproductively as personal consumption of necessaries and luxuries. If we assume all surplus value takes the form of profit, in order for social reproduction to occur, all of the materials consumed in production, and the worn out fixed capital, i.e. the constant capital, must be physically replaced. Secondly, all of the wage goods consumed by workers, i.e. the variable-capital, must be physically replaced, and, finally, all of the consumption goods – necessities and luxuries – consumed by capitalists must be physically replaced.
If we assume an annual cycle of production, all of these commodities, consumed during the year, have to be assumed to already physically exist, the product of previous years' production, including the production of previous modes of production. This indeed is Marx's assumption. The production that takes place, during the year, simply replaces all of these commodities, so that, in the same way, they exist as available stores, material balances, to be consumed throughout the following year.
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