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Land Theory of Value

Nick Rowe has (tongue-in-cheek) post about the land theory of value.  I know he isn’t pushing that theory but as an exercise, let me try to address his ultimate question:

Plus, the Land Theory of Value is worth considering in its own right, or simply as an exercise in studying value theory. Why is it wrong? What are we looking for in a theory of value? What counts as success?

Bound up in this question is the question “what is value anyway?”  I think what most classical, and modern mainstream economists are looking for in a theory of value is a way to explain (relative) prices.  In other words, when they say “theory of value” they mean “theory of relative prices.”  They take for granted that prices are a measurement of “value” and try to construct a theory that explains how this is true.  This seems to be what Nick is after.

On the other hand, in my opinion–and internet Marxists will probably argue with this– the Marxist version of the labor theory of value is an attempt to define “value” independently of prices and then construct a theory which says that market prices are not representative of “value.”  If this is the case, then you have a way of claiming that mutually voluntary (or, in other words, free) trade can be exploitative (someone wins and someone loses) and this is a foundational assumption underlying most Marxist rhetoric.

So if you take the latter approach and assume that all value comes from labor, then nobody can prove you wrong.  If they say “okay, but what about this diamond, it is highly valuable but it takes very little labor to produce it,” you just respond “no, it isn’t highly valuable, because it didn’t take very much labor to produce it.”  And if that makes you uneasy, then maybe you make up alternate definitions of value like “use value” and “exchange value” so that you can avoid reconciling your definition of value with the actual prices of things.

So I think most economists find the latter approach unappealing.  The standard (subjective) theory of value also defines value independently of prices.  Value means the quantity of other goods (somehow measured) which someone is willing to give up for something.  This value is subjective and there is no attempt to explain where it comes from.  We merely assume that people have some willingness to trade goods for other goods.  A nice feature of this definition of value though is that, once you use it to explain prices, you find that prices are, in fact, a measure of value (specifically marginal value).  So if, when you say “a theory of value,” you really mean “a theory of prices,” then this theory works for you, because it does explain prices.

Now what Nick seems to be describing is a theory of prices.  He (or technically, his Dutch ancestor) is basically arguing that you can explain the prices of things in reference to land.  It is not an independent theory of “value” (meaning independent of prices).  It takes for granted that price is a measure of “value” and seeks to explain these measurements.  But the theory described here does not explain these at all, it only shows that prices can be measured by a standard unit of land.  This should not be surprising if you believe in the standard (subjective value) theory.  In that model, you can measure the value of any good in terms of any other good.

Take this part.

You have to consider the marginal land, that is exactly on the margin between producing wheat and producing barley. If that marginal land could produce two tons of wheat or four tons of barley per acre, then the value of one ton of barley must be half the value of one ton of wheat. That way we can compare the value of land that only grows wheat to land that only grows barley. And the market prices will themselves tell us the relative values of all different sorts of land, so we can convert them all to standard land.

So you can observe the marginal rate of transformation between wheat and barley and that will be equal to the price.  That’s fine.  But that does nothing to determine why the margin is where it is.  If there is a concave PPF, then the marginal rate of transformation between wheat and barley depends on how much of each the society chooses to produce.  How do they determine how much wheat and how much barley to produce?  Well if you believe in subjective value, then they buy whatever they value more until, on the margin, they are indifferent between $1 worth of wheat and $1 worth of barley (or if you prefer, you can measure the market price in any other good).  This subjective value, along with the various production possibilities, determines a price.

If you wanted to, you could take some wheat land and use it to raise cockroaches.  Assuming that no land is being used for this and the market price of cockroaches is negative (you pay to get rid of them).  Do we conclude that the true “value” of cockroaches is determined by the amount of cockroaches you could raise on a “standard” unit of land?  If so, is the price wrong?  The lack of an existing margin also presents other problems but it’s not necessary to go into them.  The point is that chickens are more valuable than cockroaches not because they take more land to produce but because we subjectively are willing to give up other goods for one and not the other.

Now, of course, if things work the way the standard theory says, then the relative price of wheat and barley will be equal to the marginal rate of transformation between the two.  So if you can observe the marginal rate of transformation, you can observe the price.  But this is different from explaining the price.  In order to do that, you have to explain why the margin is where it is.  And in order to do that, you need subjective value.  Of course, Nick pointed this out to his ancestor and his ancestor made a meaningless reply.

Preferences! We cannot observe preferences. Land is real and objective. And the margin of cultivation between wheat and barley is real and objective, and we can observe it. We don’t need no stinking preferences to determine value!

But, again, the only difference between preferences and the margin of cultivation is that the latter is observable and the former isn’t.  So if all you want in your theory is a way of observing value, then this works fine.  But if you want to explain value, then you need subjective preferences.  And besides, if you just want to observe value, you can just look at prices.  So what is the point of a supposedly deeper “theory” based on land which only amounts to a more difficult way of observing the same thing?

The same argument applies to Van Rowe’s argument about crop rotation.

If there are three different crops, and three different ways of rotating them that are not linearly dependent, and all three rotations produce the same rate of profit, as they must, it is trivial matrix algebra to solve for the values of each crop.

There is no sense, independent of market prices, in which all 3 rotations must have the same profit.  They must have the same profit only if prices are such that the farmer is indifferent between them.  In a large market like those that people like me imagine, this will always be the case somewhere for someone and therefore, in theory, if you could find all of the marginal farmers and observe their production matrixes, you could back out the market prices.  But, again, you would not have explained why those margins are where they are.  In order to do that, you need a market to determine prices and that requires a demand curve, and that requires preferences.

All of this is ultimately equivalent to saying: “Supply determines the price, you don’t need demand.  See, we can always just look at the marginal cost of production and figure out the price.”  That’s nonsense, and so is this theory.

 

 

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  1. March 15, 2015 at 8:04 am

    Mike: I think you are pretty much spot on here.

    I might quibble with you a bit here: “So if, when you say “a theory of value,” you really mean “a theory of prices,” then this theory works for you, because it does explain prices.”

    I think that’s mostly correct. But there is also a normative element in competitive general equilibrium theory. The prices of goods and land and labour also reflect (given a lot of assumptions) the lamdas that come out of a central planner’s constrained maximisation problem. First and second theorems of welfare economics. Economists sometimes talk about “shadow prices” that reflect values of goods when there are externalities etc., so that observed market prices do not equal those values of goods.

    • Free Radical
      March 15, 2015 at 8:42 pm

      Nick,

      I’m not sure exactly what you mean here. If you mean that the theory implies some shadow prices which may not be directly observable (in other words, they only exist in the sense that the theory says they exist) and so the theory goes a bit farther than just explaining market prices then I agree with that. But they still fit into a coherent theory that is meant to fit with what we do observe in the real world and not just form a normative critique of what we observe in the real world.

      I don’t think the central planner is necessary. First and second welfare theorems are positive (Pareto efficiency is positive). If you make certain assumptions (basically some kind of “transaction costs”) then they won’t necessarily hold. Then, you might add in a social planner and then the social planner’s objective function will represent some normative values and, depending what they do exactly, you will get some lambdas that represent the subjective preferences of the central planner. But you can have prices (and shadow prices) without him.

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