Adam Smiths Word

Adam Smith’s Word

Question:

Analyse the extent to which there are two distinct and inconsistent theories of value in Adam Smith’s word, one based on the `natural rates` of wages, profits and rents, the other a labour-value theory.

Introduction:

The labour theory of value states that the value of goods will be determined by the amount of labour used in the production process of that good, therefore the value of the goods according to this theory depends on the amount of labour used, the more the amount of labour used in producing a certain good the more its value will be. [1]

Adam smith advocated for the free market where the government should not interfere with the market, the free market economy would ensure that the optimum natural rates of labour, rent and profits which are rewards for the factors of production is achieved.

He also advocated for free trade and according to the factor equalisation theory which states that if factors of production cannot move from one country to another while the goods produced can, then the free movement of goods will eventually equalise factor prices when there is trade,

Adam Smith’s Word

to this theory factor prices will be equalised across two countries if there is trade. [2]

According to the natural rates of wages, rent and profits theory, wages are rewards for labour, profits are rewards for enterprise while rent is the reward for land, these rewards according to Adam Smith will be optimally be determined by the free market economy and therefore there should be no interference of the market by the government that is the market should be at laissez faire. [3]

Inconsistence of the two theories:

There exist inconsistencies in the two theories by Adam Smith the labour value theory and the theory of natural rates of wages, profits and rents. According to the labour value theory the value of goods is determined by the amount of labour used in the production process of that good while according to the second theory that advocates for a free market economy the value of goods is determined by market forces or the supply and the demand of that good. The two theories therefore are inconsistent in that the value of goods is determined by the amount of labour used according to the labour value theory while the other the value is determined by the free market.

The labour value theory is based on only one factor of production which is labour while there are other factors that are considered in the natural rates theory such as land, enterprise, capital and labour, the labour value theory only considers one factor of production while the second theory considers all other factors of production.

Adam Smith’s Word

The labour value theory does not consider a free market economy but considers an open economy in which the differences in labour productivity among countries will cause trade among countries while the natural rates theory considers free market economies which cause the rates of wages and profits to be optimal.

The labour value theory is based on some drastic assumption that there exist only one factor of production, it also assumes that labour productivity is homogeneous where the production function is specific and labour productivity among countries is always equal. The natural rate theory takes in consideration that labour productivity is different across countries and that the market economy determines the value of goods and also the rewards for the factors of production.

Despite the inconsistence of the two theories the two theories are important in economics for they try and explain the factors that determine the value of goods, the labour value theory was based on labour as the only factor that determines the value of goods and in this theory Adam Smith clearly states the assumption that he considers only one factor of production, however if he had considered capital or any other factor then the results of his theory would still stand.

Conclusion:

The labour value theory assumed that labour was is the only factor of production and that the differences in labour productivity will cause the differences in the value of goods, in his natural rate of wages and profits he considers other factors of production which include labour, capital and land, which in a free market economy their rewards will be optimally be determined by the

Adam Smith’s Word

market.

Therefore the two theories are inconsistent in that they differ in their explanation on what determines the value of goods in an economy, the labour value theory assumes that labour determines the value of final goods while the other theories considers other factors of production which are capital, enterprise and land as factors that determine the value of goods.

The two theories however are important in economics in that they made a break through to explain the various economic phenomena. The two theories are useful because they give an explanation as to what determines the value of goods where they consider the value of inputs as the determining factors of the final value of goods.

Adam Smith’s Word

References:

Hadjimichalakis M. (1982) Modern Economics, Prentice Hall Publishers, New Jersey

H. Stratton (1999) Economics: A New Introduction, Pluto Press, USA

Martin U. (1976) Agricultural Production Economics and Resources Used, Oxford University Press, Oxford

Adam Smith’s Word

Paul Anthony Samuelson (1964) Economics, McGraw-Hill publishers, USA

Thomas A. and Paschal Francis (1995) Beyond Rhetoric and Realism in Economics: Towards a reformulation of economic methodology, Rout ledge, UK

Ian Livingstone (1970) Economics and Development: an introduction, Oxford University Press, Oxford

[1] Martin U. (1976)

[2] Hadjimichalakis M. (1982)

[3] Stratton (1999)