Theories of Value (at least 5,000). Prices have been around as …

[Pages:3]Theories of Value

...a brief jaunt through the history of price theory.

A theory of value is an explanation of what determines the prices of commodities and services. People have been buying and selling and trading things for thousands of years (at least 5,000). Prices have been around as long as people have been trading. KEY POINT - you don't need to have currency in order to have prices. E.g., when people trade wheat for apples in a barter system, a relative price is determined (e.g., 1 bushel wheat for 15 apples).

Ideas about prices have been around almost as long as people have been trading with one another.

Aristotle - Greek philosopher; he distinguished between value in exchange - basically a market (i.e., exchange) price value in use - the "true worth" of a good This distinction carried with it the idea that some goods might be "worth" more or less than their market price.

Medieval Europe Most important philosophers and scholars of Medieval Europe were officials of Catholic Church E.g., Thomas Acquinas developed the idea of a just price. A just price was a divinely determined price - reflected the "true worth" or the "intrinsic value" of a good. And, of course, an unjust price was any price that did not equal the just price.

Labor Theory of Value - late 18th century Adam Smith, David Ricardo This theory focused on value in exchange - that is, on relative market prices of goods.

Differences in market prices of goods can be traced to differences in amounts (and qualities) of labor used in production. In the long run, prices are determined by the sum of direct and indirect labor costs.

Marx's labor theory of value: Labor is the ultimate source of all value. Therefore, labor ought to receive all the rewards of the productive process. Capitalists and landowners exploit workers to the extent that they keep profits generated by their labor.

Modern (Marginalist) Theory of Value - late 19th/early 20th century - Alfred Marshall The labor theory of value is a cost-based theory of pricing. Marshall developed an analysis in which values (utilities) of buyers and costs of suppliers both play a role in determining prices. In particular, it is the marginal value and the marginal cost of the last unit traded that jointly determine a price. This is basically supply and demand analysis.

"Economists are people who know the price of everything and the value of nothing." George Bernard Shaw

Supply and Demand Model

This model indicates how the competitive interaction of buyers and sellers determines a good's market price and quantity. This is one of the most simple of all economic models; it is also one of the most important and useful economic models. A wide variety of business and government policy issues can be addressed with the help of this model.

Demand Curve - Buyer side of market ? The demand curve for a good specifies the relationship between

the quantity demanded by buyers and the price of the good. ? Law of Demand ? Illustration - Market demand for avocados ? Demand shifters?

Supply Curve - Seller side of market ? The supply curve for a good specifies the relationship between

the quantity supplied by sellers and the price of the good. ? Law of Supply ? Illustration - Market supply for avocados ? Supply shifters?

Market Equilibrium ? Outcome predicted by Supply and Demand model: equilibrium

price and quantity in the market. At this price, the quantity demanded equals the quantity supplied (that is, the market clears). ? Disequilibrium: When the market is not in equilibrium, there will be a shortage or a surplus. In either case, the price will be "pushed" toward its equilibrium level.

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