The Economics of Karl Marx

Dan Rigby

These notes are concerned with Marx’s work as an Economist, and in particular his theory of
value and crisis.

Marx, like Adam Smith and David Ricardo, was an economist in what is now known as the
Classical tradition (rather than the later Neoclassical Economics which is what is taught today in
Economics classes).

Like Smith and Ricardo, Marx was:

• interested in the distribution of wealth between social classes: mainly between

capitalists and workers;
• a believer in the labour theory of value.

Labour Theory of Value

Adam Smith (1723 – 1790) wrote on the Labour Theory of Value (LTV) and David Ricardo
(1772 – 1823) corrected and condensed this general theory.

The LTV argued that only labour can add value – raw material etc are inanimate, it takes
humans to manipulate and combine them to create additional value.

With the LTV, the price of a commodity reflected the labour embodied in it:

The meaning of “labor” here is the average amount of work needed to produce each
commodity. The different skill levels of individual workers are averaged to determine what
Marx called “the socially necessary” labor needed to produce each commodity. That
average, not each individual worker’s productivity, is what determines each commodity’s
value. (Wolff and Resnick, section 4.4.4)

This is the key concept of the Average Socially Necessary Labour Time (ASNLT).

So, the price of a good or service in the market was determined by the amount of labour
typically required to produce it. If a pair of shoes required an average of two hours of labour to
produce, it would be priced an average of twice as high as a hat that took only one hour.

Marx extended the analysis of Smith and Ricardo, to introduce the idea of surplus value and
surplus labour - and this concerned the distribution of the value that was being generated in the
production process.

1
Marxist Economics:

We will consider some key processes in the economy:

• Workers sell Labour Power (LP), as a Commodity in the labour market, receiving money
(M) in the form of wages in return;
• Capitalists buy that Labour Power (LP) and combine it with Raw Materials and
Technology/Machines;
• Capitalists thus create goods which they sell for money (M).

We can consider the values associated with these 3 commodities:

1. Raw Materials/Machinery
Their value comes from the labour it (typically) takes to extract or produce them:
Average Socially Necessary Labour Time (ASNLT).

2. Goods Produced
Their value comes from the labour it (typically) takes to produce them:
Average Socially Necessary Labour Time (ASNLT).

3. Labour Power
The value of labour power is regarded as the value of the goods and services needed to
keep that worker selling their labour.
(i.e. the value of the commodities that the worker consumes and that keeps them able to
work for a wage).

2
An Example Firm

We will consider an example firm to consider these 3 values:

Imagine workers employed by a firm to produce a simple commodity – a shovel (spade).

A worker is employed for 12 Hours (this is called Living Labour).

Their labour is combined with tools, equipment and raw materials. The labour that is typically
required to produce them is 8 Hours (called Embodied Labour).

Values:

• The value of the good (shovel) produced is 20 hours (the labour that went into its
production)
• The value of tools, equipment, and raw materials involved = 8 hours

What is value of the Labour power?

That value is whatever the employer has to pay to keep the worker functioning and returning to
work (their wage).

Remember we are still (for now) using the metric of time.

Assume that the goods and services consumed each day by the worker embodies (requires) an
average of 8 hours of labor.

That is, it takes 8 hours of socially necessary labor to produce the things required by workers to
reproduce and keep working. So, the employer must pay the worker 8 hours as their wage.

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In summary:

tools, equipment, raw materials labour Value of Output

(shovel)
8 hrs 12 hrs =20 hrs
(Embodied Labour) (Living Labour)

Marx defined the

• embodied labour of tools, equipment, raw materials etc. as constant capital (c) and,
• the amount paid to living labour as variable capital (v).

In this example, the worker is paid a sum of money, equal to the value created by 8 hours of
their labour.

tools, equipment, raw materials labour Value of Output

(shovel)
8 hrs 8 hrs 4 hrs =20
c v s
Embodied Labour (EL) Paid Living Labour Unpaid Living
(LLp) Labour (LLu)
Constant Capital Variable Capital Surplus Value

Consider the difference between the value added by the worker (12) and their daily wage (8).
The excess of the value they create over what they are paid is defined as Surplus Value, which
is the source of the profit the employer makes.

So, workers are paid a portion of the value they generate, but not paid another part of the value
they create – the surplus value.

The incentive or inducement for the capitalist to undertake shovel production now becomes
clear: the cost to the employer of the produced good is 16 while the value of the end product,
the shovel, has a value of 20 – it can be sold at this price.

The capitalist keeps the surplus value (4).

After 8 hours of work the worker has generated value equivalent to what they will be paid in
wages. For the remaining 4 hours of the day all the value thy generate is going to the employer
as surplus value.

Surplus Value arises because

• There is a labour market: the employer can buy Labour Power

• The value paid to Worker is less than the value they add.

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Exploitation

The taking or appropriation of surplus value by the employer is referred to by Marx as

Exploitation. Exploitation here is not a vague, emotive, term, it is an economic term; something
that can be defined and measured.

The rate of exploitation = s/v.

In our example the rate of exploitation is 4/8 = 0.5

This rate of exploitation could be increased by, for example:

• increasing s
• reducing v (wage).

If the employer

• halved wages from 8 to 4, then the rate of exploitation increases to 8/4.

• increased the working day from 12 to 14 hours, with no change in pay, the rate of
exploitation rises to 6/8.

Marx shared with Smith and Ricardo a belief in the labour theory of value – that runs through the
analysis above. Marx was much more formal in his analysis of value, and the distribution of value
between workers and employers.

With these basic concepts of Marxist Economics, we can set out Marx’s theory of economic crisis
– why he argued that capitalism leads to economic crises (slumps, depressions etc). This was a
novel contribution.

The additional element we need is other firms – it is competition between the (shovel) producers
that Marx regarded as leading to economic crisis – via the impact of competition on the Rate of
Profit (r).

The Rate of Profit

The Rate of Profit (r) is the ratio of surplus value to the sum of constant and variable capital.
𝑠
𝑟=
(𝑐 + 𝑣)

This is the ratio of the surplus value to the amount paid to embodied and living labour: how
much is the employer taking compared to the amount paid to capital and labour.

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Organic Composition of Capital

The Organic Composition of Capital (OCC) is a measure of the relationship between constant
capital (premises, machinery and materials) and variable capital (wage labour).

OCC = c / v

Competition and Tendency for the Rate of Profit to Fall

Marx, like others, observed the rapid and sustained developments in technology and
production that was reducing the costs of production and increasing labour productivity. These
processes required entrepreneurs to invest large proportions of surplus value into new capital
and machinery – either to get an advantage over their competitors or to keep up with their
competitors’ innovations.

It was this competitive process between firms that Marx argued led to a tendency for the rate of
profit to fall over the business cycle – eventually leading from boom to bust – to economic crisis
and depression.

tools, equipment, raw labour Value of Output

materials (shovel)
8 hrs 8 hrs 4 hrs =20
c v s
Constant Capital Variable Capital Surplus Value

The competitive pressure to invest part of s in new c leads to increase in the Organic
Composition of Capital (c / v). That is, more machines and technology per unit of labour and so
increases in labour productivity.

What does that mean for the rate of profit (r)?

𝑠
𝑟=
(𝑐 + 𝑣)

To aid understanding, we divide by v, giving:

𝑠/𝑣
𝑟=
(𝑐/𝑣 + 1)

If c/v rises faster than s/v, then the whole expression, ie the rate of profit, will fall.

If the OCC rises faster than the rate of exploitation, then the rate of profit will fall.

Competition between capitalists creates a strong pressure for investment in equipment,

machinery, new technology to survive and flourish pushing up the OCC, acting to lower the rate
of profit.

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Crisis

This tendency for the rate of profit to fall (a fall in the return on capital) acts eventually to
discourage profit-oriented capitalists and leads them to reduce their rate of expansion. Reacting
to a lower profit rate, they reduce new capital investment and other expenditures (to managers,
research and development, dividends to shareholders etc).

The reduced business expenditures flow through the economy – meaning workers lose
employment and incomes, lowering demand for goods and services. Factories close or reduce
their levels of activity, some companies go bankrupt.

This process, triggered by falls in the rate of profit, would eventually lead, Marx argued, to
recession and depression.

So, Marx concluded that capitalist competition is inherently contradictory: the interaction
between firms through competition leads to more wealth produced (more goods, at lower costs
and prices) in the expansion period, followed by downturn and economic crisis.

In this model expansion in consumption and wealth, and recession and economic crisis, are
inextricably linked (they are two sides of the same coin).

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Offsetting Effects

Note the terminology about the rate of profit - it is a tendency for the rate of profit to fall. Not
that it always falls, just that there are forces in operation that act to lower it.

There are other effects which act in the opposite direction – and the net effect is determined by
the relative magnitude of the two forces.

What are some of these effects which act to increase the rate of profit – and delay economic
crisis?

Earlier we re-wrote the rate of profit (r) as:

𝑠/𝑣
(𝑐/𝑣 + 1)

and concluded that:

• If c/v rises faster than s/v, then the whole expression, ie the rate of profit, will fall.
• If the OCC rises faster than the rate of exploitation, then the rate of profit will fall.

If employers increase the rate of exploitation (s/v) that increases r. This could be done by:

• Lowering wages (lowering v)

• Increasing the length of the working day (increasing s)
• Improvements in the productivity /technology that produce the things that workers
need to live (food, shelter etc) (lowering v).

The rate of profit can be restored during the economic crisis and recession. For example in that
crisis – firms go bust, factories and offices close – this is the destruction of constant capital (c)
and that lowers c/v, increasing the rate of profit.

In recession and depression, there is mass unemployment and wages typically fall – lowering v,
increasing the rate of profit. Wars also involve the destruction of constant capital (c).

There are other factors that can act to slow or reverse the decline in the rate of profit – including
trade and the availability of credit – but that takes us beyond the scope of Micro 1.

Summary

Marx marvelled at the productive power of capitalism, at the pace of technological innovation
and expansion of the economy’s productive power. Like many other Classical economists he
believed in the labour theory of value and the tendency off the rate of profit to fall. He
formalised the analysis of both. He argued that the forces that gave capitalism its dynamism and
scope for booms and growth, also acted to trigger downturns, recession and crisis.