Marginal pricing is a little counter-intuitive at first, but once understood is quite simple. It can deal with a much wider range of market conditions than LTV.

This migh be of interest: http://crookedtimber.org/2010/01/06/marxian-economics-mia/

One of John Quiggin’s comments in the replies to his blog entry.

As the post says, once you accept marginalist price theory, most of the questions that led people to worry about value theory, as opposed to price theory, turn out to be more or less meaningless. Austrians disagree with this and try to argue that marginalism proves that value is entirely subjective, but this is silly and ends up relying on argument by definition.

This has important consequences. Marx’s prediction of a general tendency of the rate of profit to fall was dependent on there being a direct relationship between competitive prices and value. As there is no such relationship the prediction is false, this is on the whole a good thing.

The market adjusts the price until demand equals supply i.e. S(p)=D(p). The price is such that all the supply that can be produced at that price or below is equal to all the demand that is willing to pay that price or above. The price you and other buyers are prepared to pay determines the shape of the demand curve and therefore helps determine the market clearing price.

Something that may be illuminating: http://www.marginalrevolution.com/marginalrevolution/2010/03/what-is-the-biggest-flaw-in-the-labor-theory-of-value.htm

Dan R., a loyal MR reader, poses this question:

I would be curious to know what you consider the biggest flaw in the labor theory of value to be. Also, would you say that it is disproven, unnecessarily bulky, or simply marginalized?

There is a simple model in which the labor theory of value is true. If inputs are homogeneous and constant returns to scale hold, the proportions of labor input will indeed be proportional to price. If not, labor inputs will be reallocated until this proportionality holds (Much ink has been spilled on whether this is what Smith, Ricardo, and others had in mind; it is one way of reading Smith’s deer-beaver-hunting example.)

One problem is that we need labor, capital, and land for production, not just labor. The so-called “transformation problem” tries to square this circle. The simplest response, however, is to give up the labor theory of value.

Another problem is that inputs are heterogenous. They have to be valued in dollar terms, and that requires imputation, a’la Friedrich Wieser, and that in turn requires information from the demand side. Price determines cost of production at least as much as cost of production determines price.

Compared to Marshallian supply and demand scissors, the labor theory of value is at best awkward and most of the time it is wrong. There are some economic sectors where constant returns to scale hold and thus demand has little influence over market price. But those are special cases, even if some Cambridge-U.K. linked economists promote them as the main show.

Things are worth different amounts to different people, and yet the market does not adjust its price for how much they want it. It costs what it costs, regardless if what I’m willing to pay.

The intrinsic value is contained in the commodity. It is what happens to human labor in the abstract when it expended in useful labor on a commodity–it becomes value. What is it for? It permits exchange.

You can draw a demand curve by charting the bids in a sealed bid second price commodity auction. One axis is the price and the other is the sum of the demand of all of the bidders whose maximum is above that price. Define the function of this curve as D(p).

You can draw a supply curve by charting the reserves on the offers in a commodity auction. One axis is the price and the other is the sum of supply of all of the sellers whose minimum is below that price. Define the function of this curve as S(p).

The value p such that S(p)=D(p) is the marginal price. The curves change over time and the marginal price changes.

Where is an intrinsic value and what is it for?

Those are the questions that led to the idea of intrinsic value being largely abandoned. Replaced by the idea of value as a purely local thing. Marx’s labour-value is related to supply (you need to include non-labour costs as well like rent and tax), while his use-value is related to demand. Price acts as an intermediary between them. Despite looking for it no non-local value emerged.

If you have a sealed bid commodity auction it is possible for the auctioneer to explicitly chart the demand curve. At any specific price point you can determine what the quantity that would be purchased at that price is. If you also have a range of sellers with a variety of reserve prices you can also determine that would be available for sale at that point. You can then define functions describing those curves and solve them.

Things are worth different amounts to different people. This means that things don’t have a universal value, just a local value. A market can set a price without ever needing to know an intrinsic value.

One consequence of believing that a thing has an intrinsic value is you feel justified , even perhaps obligated, to force the price to that value. This can lead to the imposition of price controls leading to either a shortage or a glut. A worse consequence can happen if the market price of labour is above what you believe to be justified, slavery. Bonded labour is a consequence of a labour shortage. A free market would see the price of labour rise until supply and demand equalise either by bringing more workers into the labour force and pricing some employers out. If you believe that there is an intrinsic value to labour than you can feel justified in using coercion to punish any worker attempting to get paid more that the value of their labour or even to force the provision of labour at that price.

Sound familiar?

“Demand is not a price, it is a quantity the demand curve describes what the how much of a good would sell at a specific price is at a specific point of time.”

Um. What say you swing around and take another pass at that one. I think it just needs a couple of words removed to become a sentence, but I’m not exactly sure which ones they are.

Iterated auctions are simply a more obvious case of a marginal price seeking mechanism. Ongoing commodity markets operate in a similar way, the spot price determines both supply and demand. If you are a supplier there is a price below which it isn’t worthwhile you selling, if you are a buyer there is a point above which it isn’t worthwhile you buying. It should be obvious that if your costs are substantially below those of the marginal supplier your profits will be substantial.

“When demand falls so low that it approaches the cost of production (I’m accepting your argument that the quality of use-value can transform itself into a quantity) does profit then approach zero? Is that your opinion?”

That doesn’t make sense. Demand is not a price, it is a quantity the demand curve describes what the how much of a good would sell at a specific price is at a specific point of time. Supply is also a quantity not a price it describes the amount which would be available at at specific price at a specific time. These can be compiled into lines on a chart which cross at a specific point.

The costs determine what the minimum acceptable price is for a specific supplier. The price will be at the point where the marginal supplier is making just enough to cover their costs and it is just worthwhile for the marginal consumer to buy. A lower cost supplier has no incentive to charge less than the marginal price as they can sell all they produce at that price and would get no additional sales by cutting the price. The profit may be substantial look at oil for example the lowest cost producer (Saudi Arabia) was profitable when oil was about $10 a barrel in the early 1990s the price is now about $80 so they may be making $70 a barrel. Alberta has a cost of about $60 a barrel so at the same price is making $20 a barrel profit.

If you are buying something you have already decided how much it is worth to you, you’ve decided that the item is worth more to you than what you are exchanging for it.

Some commodities display huge price volatility, oil and food especially. Demand for these is fairly inelastic so if supply drops the price shoots up dramatically food prices during a famine for an extreme example or the oil price spike a couple of years ago for a less extreme example. Other commodities display far less volatility.

For items produced in small quantities and traded infrequently an auction can be used to determine the marginal price. The auction price is the lowest where the number of bidders is equal to the quantity available.

Most new goods are close substitutes to existing goods that means they don’t function as entirely new products anyway and you can price by comparison to existing similar products.

Either way some goods display high volatility and others don’t. Food for example is volatile depending upon the harvest.

Now you are introducing production cost as the definition of supply, which I have no problem with. You haven’t yet reached Marx, but at least with this you’ve caught up to Ricardo and Franklin, which is good progress: they said that price was determined by production cost. They then went on to say production cost was determined by the cost of labor; maybe you’ll get there too; then you’ll at least have reached the 18th Century.

So then, you have the baseline of production cost, and demand sets an upper limit. In a certain sense, this is true, especially for new products: demand can force prices extremely high indeed. But let’s look at the other end of the curve.

When demand falls so low that it approaches the cost of production (I’m accepting your argument that the quality of use-value can transform itself into a quantity) does profit then approach zero? Is that your opinion?

(You still haven’t addressed the mechanism by which a newly introduced commodity furiously spins until it achieves the magic price that reflects user demand, but we’ll just say that’s the palm of the invisible hand of the market, and come back to it later.)