This post by Professor Steve Horwtiz originally appeared on the Foundation for Economic Education’s blog back in November of 2015. The following are excerpts.
What Menger and others argued was that value is subjective. That is, the value of a good is not determined by the physical inputs, including labor, that helped to create it. Instead, the value of a good emerges from human perceptions of its usefulness for the particular ends that people had at a particular point in time. Value is not something objective and transcendent. It is a function of the role that an object plays as a means toward the ends that are part of human purposes and plans.
But the real Copernican revolution in economics was how the subjective theory of value related to the value of labor. Rather than seeing the value of outputs being determined by the value of the inputs like labor, the subjective theory of value showed that it’s the other way around: the value of inputs like labor were determined by the value of the outputs they helped to produce.
On this view, labor gets rewarded according to its ability to produce things that others value. When you then consider the ways in which labor combining with capital enables that labor to produce goods that humans value even more, which in turn increases labor’s remuneration, Marx’s whole worldview is suddenly turned on its head. Capital does not exploit labor. Instead, it enhances labor’s value by giving labor the tools it needs to make even more of the things that humans value.
Understood correctly through the subjective theory of value, capitalism is fundamentally a communication process through which humans try to sort out how best to make use of our limited resources to satisfy our most urgent wants. Exchange and market prices are how we make our subjective perceptions of value accessible to others so they can figure out how best to provide us with the things we value most.