32151974 Economics

Question:for a free market economy the value of goods is
Analyse the extent to which there are twodetermined by market forces or the supply and
distinct and inconsistent theories of value in Adamthe demand of that good. The two theories
Smith's word, one based on the `natural rates` oftherefore are inconsistent in that the value of
wages, profits and rents, the other a labour-valuegoods is determined by the amount of labour
theory.used according to the labour value theory while
Introduction:the other the value is determined by the free
The labour theory of value states that the valuemarket.
of goods will be determined by the amount ofThe labour value theory is based on only one
labour used in the production process of thatfactor of production which is labour while there
good, therefore the value of the goods accordingare other factors that are considered in the
to this theory depends on the amount of labournatural rates theory such as land, enterprise and
used, the more the amount of labour used inlabour, the labour value theory only considers one
producing a certain good the more its value willfactor of production while the second theory
be.[1]considers all other factors of production.
Adam smith advocated for the free marketThe labour value theory does not consider a free
where the government should not interfere withmarket economy but considers an open economy
the market, the free market economy wouldin which the differences in labour productivity
ensure that the optimum natural rates of labour,among countries will cause trade among countries
rent and profits which are rewards for thewhile the natural rates theory considers free
factors of production is achieved.market economies which cause the rates of
He also advocated for free trade and accordingwages and profits to be optimal.
to the factor equalisation theory which states thatThe labour value theory is based on some drastic
if factors of production cannot move from oneassumption that there exist only one factor of
country to another while the goods produced can,production, it also assumes that labour
then the free movement of goods will eventuallyproductivity is homogeneous where the
equalise factor prices when there is trade, to thisproduction function is specific and that labour
theory factor prices will be equalised across twoproductivity is always equal. The natural rate
countries if there is trade.[2]theory takes in consideration that labour
According to the natural rates of wages, rent andproductivity is different and that the market
profits theory, wages are rewards for labour,economy determines the value of goods and also
profits are rewards for enterprise while rent isthe rewards for the factors of production.
the reward for land, these rewards according toConclusion:
Adam Smith will be optimally be determined byThe labour value theory assumed that labour was
the free market economy and therefore thereis the only factor of production and that the
should be no interference of the market by thedifferences in labour productivity will cause the
government.[3]differences in the value of goods, in his natural
Inconsistence of the two theories:rate of wages and profits he considers other
According to the labour value theory the value offactors of production which include labour, capital
goods is determined by the amount of labourand land, which in a free market economy their
used in the production process of that good whilerewards will be optimally be determined by the
according to the second theory that advocatesmarket.