‘COST OF PRODUCTION’ AND THE THEORY OF THE RATE OF PROFIT

Adam Smith set economists and examination question: what determines long-run normal prices and the associated rate of profit. The fundamental difficulty is that the long-run equilibrium prices of reproducible means of production (Smith’s “natural” prices) must satisfy two conditions at the same time: they must clear the markets for the endowment of reproducible goods, and must be equal to the long-run prices associated with the reproduction of those goods. In the determination of normal prices in an economy with reproducible means of production, the term “cost of production” has no meaning since prices of reproducible goods enter their own “cost”. The concept of cost production is valid in an economy in which goods are defined by their physical essence and their location in time, when by definition no good is reproduced and “discounted” prices are determined without reference to a rate of interest (i.e. rate of profit). But the interpretation of such prices as “embodying” a general rate of interest lacks any coherent foundation, as was made clear by Malinvaud (1965, p.233): ….. the relationships studied here are meaningful only under precise normalisation rules for undiscounted prices. Only discounted prices are determined by competitive equilibrium, or by the price system associated with an optimum. In the absence of a normalisation rule the interest rates are not defined and can assume any value greater than -1. There is no neo-classical theory of the rate of profit.