Prices of production
Prices of production is a concept in Karl Marx's critique of political economy, defined as "cost-price + average profit". A production price can be thought of as a type of supply price for products; it refers to the price levels at which newly produced goods and services would have to be sold by the producers, in order to reach a normal, average profit rate on the capital invested to produce the products.
The importance of these price levels is, that a lot of other prices are based on them, or derived from them: in Marx's theory, they determine the cost structure of capitalist production. The market prices of products normally oscillate around their production prices, while production prices themselves oscillate around product-values.
This understanding already existed in classical political economy but, according to Marx, the political economists could not really explain adequately how production prices were formed, or how they could regulate the trade in commodities. In addition, the political economists could not theoretically reconcile their labour theory of value with value/price differentials, unequal profit/wage ratios and unequal capital compositions. Consequently, the labour theory of value of the political economists before Marx was more in the nature of a metaphysical belief, than a scientifically demonstrated proposition. If the belief persisted, that was because it made good sense of business practice - in an era where the owners of most enterprises also personally managed them, and therefore could observe the work and its results in daily life.
Basic explanation
A production price for outputs in Marx's sense always has two main components: the cost-price of producing the outputs and a gross profit margin.Marx's argument is that price-levels for products are determined by input cost-prices, turnovers and average profit rates on output, which are in turn determined principally by aggregate labour-costs, the rate of surplus value and the growth rate of final demand. These price levels determine how much of the new output value that is created in excess of its cost price can actually be realized by enterprises as their gross profit.
The suggestion is, that the differences among most producers with regard to their profit rates on capital invested will tend to "level out" as a result of business competition, so that a general norm emerges for the profitability of industries.
Profit impost
In capitalist production, a basic profit impost is the normal precondition for the supply of goods and services. When competition for product markets intensifies, the producers' margin between cost prices and sale prices, their true income, shrinks. In that case, the producers can only maintain their profits, either by reducing their costs and improving productivity, or by capturing a bigger market share and selling more product in less time, or both. In a well-established product-market, however, the fluctuations in supply and demand are usually not very large.This basic market logic was already well known by medieval merchant capitalists long before the dawn of the modern era in the 15th century. Medieval merchant houses could certainly estimate their own rate of surplus value and profit rate but they usually did not have so much knowledge about socially average profit rates; few relevant data or statistics were publicly available and a "general rate of profit" might not exist anyhow, for lack of an integrated national market for products and capital, and given the limited scope of industrialization.
Regulating prices
The regulating price of a given type of product is a sort of modal average price level, above or below which people would be much less likely to trade the product. If the price is too high, buyers cannot afford to buy it, or try to get cheaper alternatives. If the price is too low, sellers cannot cover their costs and make a profit. So normally there is a limited range of prices within which the product can be traded, with upper and lower bounds.The production price then refers basically to the "normal or dominant price level" for a type of product that prevails during a longer interval of time. It presupposes that both the inputs and the outputs of production are priced goods and services—that is, that production is fully integrated in fairly sophisticated market relations enabling a sum of capital invested into it to be transformed into a larger sum of capital. In pre-capitalist economies, this was not the case; many inputs and outputs of production were not priced.
Marx's claim is that the production prices of products themselves are fundamentally determined by the comparative labour requirements of those products, and therefore are constrained by the law of value. Since, however, not all goods are produced or reproducible goods, not all goods have production prices. A production price in Marx's sense can exist only in markets developed sufficiently for a "normal" rate of profit on production capital invested to become the ruling average for a group of producers.
Dynamics
Substantively, Marx argues that the prices of new products sold will, assuming free competition for an open market, tend to settle at an average level that enables at least a "normal" rate of profit on the capital invested to produce them, and, as a corollary, that if such a socially average rate of profit cannot be reached, it is much less likely that the products will be produced at all. Marx defines the "general rate of profit" as the average of all the average profit rates in different branches of production - it is a "grand average" profit rate on production capital. The simplest indicator of this rate is obtained by dividing an estimate of total surplus value in the economy by the estimated total production capital employed.According to Marx's theory, investment capital is likely to shift out of production activities where the rate of profit is low and toward activities where profitability is higher; the "leading" sectors of industry are those where profitability is highest. In 2024, the most dynamic growth industries were expected to be in the areas of computer hardware and software, all kinds of commercial digitalized services, pharmaceuticals, electronic machinery and electronic equipment. In these sectors, investments are proportionally the highest, there is a lot of innovation and competition, and profits are generally high.
The precondition to investment for higher profits is the mobility of capital and labour. Thus, there is a systemic tendency to remove all the obstacles that prevent investors from investing in sectors where profits are higher. If, for any reason, the free movement of capital is blocked or restricted, large differences in the profit rates of enterprises are likely to occur. In general, the trajectory of capitalist development is determined by the industries where the profits are the best, because their products are in high demand, because of special production or market advantages, etc.
According to Marx, the movements of different production prices relative to one another importantly affect how the total "cake" of new surplus value produced is distributed as profit among competing capitalist enterprises. They are the basis of the competitive position of the producers, since they fundamentally determine profit yields relative to costs.
"Natural" prices
Some writers argue that Marx's production price is similar, or performs the same theoretical function, as the "natural prices" of classical political economy found, for example, in the writings of Adam Smith and David Ricardo. This is the orthodox Marxist view, based on quotations where Marx says that his concept of production prices recalls the classical idea of natural prices. In this case, Marx's production price would be essentially a "centre of gravity" around which prices for outputs in a competitive market will fluctuate in the long run.This is an interpretation within the framework of equilibrium economics, which suggests that production prices are really a kind of "equilibrium prices". It can be supported with some textual evidence, insofar as Marx sometimes defines the production price as the price that would apply if the supply and demand for products were balanced. At other times, he refers to a "long-term average price" or a "regulating price". He does not say precisely how these three different concepts are related.
The main objection against equating production prices with natural prices is that Marx's concept of production prices is precisely a critique of the "natural prices". Support for this interpretation can be found in Capital, Volume I, where Marx criticizes and ridicules the concept of a "natural price of labour" - this concept, he argues, rests on confusions of several different economic categories.
Similarly, in Capital, Volume III, Marx rejects the concept of a "natural" interest rate, arguing that what this really refers to is just the interest rate that results out of free competition. According to this argument, there is actually nothing "natural" about the allegedly "natural" prices - they are socially determined effects of capitalist production and trade. More importantly, the existence of production prices does not logically depend on, or presuppose, an equilibrium state.
If the classical economists talked about the "naturalness" of price-levels, this was ultimately a theoretical apologism; they could not reconcile their labour theory of value with the theory of the distribution of capital. They assumed a market balance, without proving how it could exist.
The general theory behind the concept of natural prices was that the free play of markets would, through successive adjustments in the trading process, "naturally" converge on price levels at which sellers could cover their costs and make a normal profit, while buyers could afford to buy products; with the effect, that relative labour requirements would be genuinely proportional to relative prices. Yet classical political economy provided no credible theory of how this process could actually occur. Since it confused and conflated the value of labour power with the price of labour, commodity values with their production prices, and surplus value with profit, i.e. because it mixed up values and prices, it could in the end explain the normal price levels of commodities only as "natural" market phenomena.