The Theory of the Work of the Value of Exchange

Neither Smith nor Ricardo ever satisfactorily solved the paradox of water and diamonds. The concept of use value was debated by philosophers, while economists paid attention to the explanation of the determinants of exchange value (that is, to the explanation of relative prices).

A possible obvious explanation is that the exchange value of the goods is determined by what it costs to produce them. The production costs are determined, fundamentally, by labor costs, at least that were the time of Smith and Ricardoand, therefore, the labor theory of value constituted an obvious step.

For example, to paraphrase Adam Smith’s example, if a deer hunt requires twice the number of hours of work that a beaver catches, a deer should be exchanged for two beavers. In other words, the price of the deer should be double that of the beaver. Similarly, diamonds are relatively expensive because their production requires a significant amount of work.

For students with a cursory knowledge of what we now call the law of supply and demand, the explanation of Smith and Ricardo may seem a bit strange. Did they not realize the effects of demand on prices? The answer to this question is both “yes” and “no”. If they observed periods of rapid growth and reduction of prices, and attributed these variations to changes in demand.

However, they considered that these variations were abnormal issues that only generated a transitory divergence between the market price and the labor value. Since they had not really solved the paradox of use value, they did not want to assign to demand more than an ephemeral role in determining the exchange value. On the contrary, the long-term exchange values were determined solely by the labor costs of production.