 In the last part of this module we looked at the general analysis of the circulation of capital. Using the circuit of capital we understood various stages of the circuit, we understood various phases of the circuit, the stocks and flows that lie hidden in the circuit. Now we would like to go back to investigating some of the issues related to the question of realization of surplus value. We are going to divide this discussion about the realization of surplus value into two parts. The realization of surplus value will involve two types of questions. One question will relate to the question of aggregate demand. So, we will try to understand the issues related to the generation of aggregate demand. The other question or other sets of questions would relate to what we can call the use value basis of production. What the use value basis of production refers to is what we today call the product mix of output meaning how much consumption goods are produced and how much machinery is produced. We will see that both these issues are important to understand the question of realization of surplus value. So, let us start with the question of aggregate demand. What the question of aggregate demand really boils down to can be understood again using the circuit of capital. So, let us write the circuit of capital. So, the capital starts with the sum of money goes to the market, purchases two types of commodities means of production labor power brings them together in the production process. The finished commodity comes out and then it is sold for a sum of money. Now the question of aggregate demand really boils down to two types of issues. One is the issue of finance and the other is the issue of spending. So, let us first look at the issue of finance. Now the issue of finance can be really understood quite easily by considering the two ends of the circuit. Now we know in the process of production value has been created not only value, but surplus value. So, therefore, the value of C prime which is the finished commodities is bigger than the value of C which is the bundle of commodities that was purchased by the capitalist to start out the production process. The value of C is represented by the sum of money M. Therefore, the system if it started out with the sum of money will need some extra sum of money at this point to realize the value contained in C prime because of the simple fact that the value of C prime is bigger than the value of C which was purchased with the sum of money M. So, value of C prime will need to be met or will need to be realized in a quantity of money M prime and we know M prime is bigger than M. And therefore, the difference between the two which is the representation in monetary form of the surplus value there will need to be generation of some source of finance to purchase this additional value which has been created the surplus value. So, the question is how does the capitalist system provide this finance this additional finance to realize the extra value that has been created and embedded in the commodity bundle the finished commodities. And there are two ways in which the system can provide this extra source of extra finance to realize this surplus value. The first is the setting that Marx talked about which was the commodity money system. So, when Marx was discussing the structure of capitalism what we had was a commodity money system. So, gold or silver was used as a commodity when we are in the context of a commodity money system this extra source of finance can be found if the production of gold is kept pace with the rest of the economy. So, that period after period extra gold of the amount of delta M is produced which will then be useful to realize this extra surplus value. Now, gold being a commodity will be produced, but gold has the important feature that in a commodity money system it is the money commodity. Therefore, it does not need to be sold to realize its value when it is created it already has its value. So, therefore, if the system is able to produce gold in a commodity money system at the rate that is necessary to realize this extra value, then the capitalist system will be able to generate the extra finance to continuously keep realizing the value and surplus value produced. And this discussion is present in towards the end of volume 2, but you might say that we no longer live in a commodity money system and that is true from the early 20th century onwards especially from mid 20th century onwards we do not have a commodity money system. So, when we do not have a commodity money system what is the mechanism available to a capitalist system to make sure that the means of realizing this surplus value is available. What the capitalist system does when we are in a non commodity money system? So, we are now in a non commodity money system and here the role of the central bank becomes important. In a non commodity money system the money commodity is replaced by the provision of credit and the provision of credit in a mature capitalist economy is ultimately controlled by the central bank of the economy. The central bank makes available what economists call high powered money through the commercial banking system the high powered money provides the amount of credit that is necessary to the system to the whole capitalist system both to support its production and consumption needs. So, when we are in a non commodity money system what becomes important is the provision of high powered money by the central bank. Once the central bank is able to provide the adequate amounts of high powered money the system generates the amount of credit that is necessary to realize the commodity the extra surplus value that has been created. So, therefore, either in a commodity money system or in a non commodity money system the capitalist system does have mechanism to make available adequate amounts of finance that is necessary to purchase the commodities that have been produced and therefore to realize the value and surplus value that has been generated. Now, even if adequate finance is available there is still an additional issue of spending. So, even if the banking system is able to provide credit it might still be the case that key economic actors are not willing to take up that credit and make spending. So, therefore, the second issue is about spending there can be cases where the capitalist system has lot of credit available, but it is not used to finance actual expenditures. And we know that we have lived through a financial crisis where this has become very important. So, there are tons of cash which are lying idle with firms, but those are not being used to make investment. So, even if finance is available it is possible for capitalist economic actors important economic actors in capitalism not to convert that finance into spending. So, the additional issue of spending becomes important when there is adequate spending in the system the system does well realizes all the surplus value that is reinvested and the circuit of capital goes on and on the flow of value increases, but for example there might be a case when capitalist do not invest. When capitalists do not invest even if finance is easily available what does that what does that imply well what that implies is that some of the surplus value that has been produced will not be realized. In other words the turnover time of capital will go down sorry the turnover time will go up meaning capital each atom of value will require a longer amount of time to traverse the circuit meaning the turnover time goes up that means what happens there is a slow down. So, the speed which with capital traverses the circuit from here to here goes down and therefore there is a slow down of the flow of value. What does that mean it means there is a slow down of the economy. So, economic economic growth falls when economic growth falls some sector of the economy has to step in and increase spending so as to revive growth. In capitalist economies there is the state with fiscal policy the state often steps in when capitalist investment has fallen and that is what revives the amount of spending back again the turnover time falls and the growth process kicks goes up. So, this is the fluctuation of the economy that we today know as the business cycles. So, the fluctuations of business cycles are created by the spending decisions which lead to fluctuations in demand and we can use the circuit of capital to understand how the fluctuations of demand lead to fluctuations of growth through an increase or decrease in the turnover time which is merely and reflection of the increase or decrease of the spending of key actors in the capitalist economy. Now, one thing that I would like to emphasize is that in a capitalist economy the key economic actor which makes all the spending decisions or which is the source of all spending decision is the capitalist. It is the capitalist who has to use the sum of money to purchase different commodities which is the beginning of all other kinds of spending because when the capitalist uses a part of his sum of money to purchase means of production what that means is that commodities produced by other capitalist have found the market. So, then that makes available finance to those capitalist in turn to make additions to their capital stock by investing. The other part of the spending goes towards purchasing labor power. Labor power when it is sold converts the commodity that is owned by workers into incomes that is their wage income. Those wage incomes in turn go towards purchasing consumption goods. So, that is another spending, but the important thing to realize is that the source of all spending is the capitalist making the investment and therefore, when we think about fluctuations of demand in a capitalist economy our analytical focus should be to try to understand why there is a fluctuation in the spending of capitalist because that is the main source of all kinds of spending in the economy and therefore, all kinds of short run fluctuations that arise because of spending and fluctuations of demand come from fluctuations in the spending decisions of capitalists. So, that is the set of issues that we need to understand when we think about the question of aggregate demand. Now, let us move on to the second aspect of the realization of surplus value which is to understand the issues related to what I have called the use value basis of production or what modern economists call the product mix of output. So, let us see what this entails. As always we can organize our discussion with reference to the circuit of capital. So, to motivate the discussion let us rewrite the circuit once again. So, the capitalist goes to the market to buy two types of commodities which are then brought to the production process, finished commodities arise and then they are sold. Now, what we want to concentrate on now is to think about the first stage of the circuit. What the capitalist is doing is purchasing two different types of commodities. Part of the money is used to purchase means of production and part of the money is used to purchase labour power. Labour power in turn needs to purchase consumption goods. So, therefore, the investment decision of the capitalist relies on the availability of the correct proportion of means of production, let us call them machines and consumption goods. Let us call them food because food will be needed by the workers whom the capitalist hires and the capitalist will need to buy the machines and the raw materials for the production process. So, therefore, there has to be some way in which the capitalist system produces the right mix of consumption goods and production goods because without the right mix when the capitalist comes to the market with the sum of money, if there is an excess or a shortage of either of these the process of production of capital will halt and there will be problems. So, the use value basis of production or the right product mix of output relates to the question of how the capitalist system is able to generate the right amount of production goods and consumption goods. So, this is the question that had been discussed by lots of economists before Marx. Some progress had been made by a group of economists, French economists known as the physiocrats. Marx borrowed some key insights from physiocrats, but then reverted to answer this question for a capitalist economy. What he did was to bring about a conceptual innovation by thinking of the economy as being divided into different departments. We will now follow his analysis which is also known as the analysis of the reproduction schemes to answer this question of how the capitalist system is able to produce the right mix of production and consumption goods that is necessary for the smooth functioning of the system. To do so, we will follow Marx and divide the total economy into two parts. So, the total economy is composed of two departments, let us call that department one and department two. What is the difference? Department one produces means of production and department two produces means of consumption. So, the question of how the economy generates the correct amount of means of production and means of consumption really boils down to the question of the correct size, the correct relative size of these two departments. One department which produces the means of consumption, another which produces the means of production. Now, to answer this or to address this question about the correct proportions, let us think of the total amount of value created in department one. So, the total amount of value created in department one, let us call that w one. That is the sum of the constant capital used up in production of department one, variable capital used in the production of department one and the surplus value generated in the production of department one. So, w one refers to the total value created in department one. That in turn is composed of c one which is the total constant capital used, v one the total variable capital used and s one which is the surplus value used. In a similar way the total value created in department two, let us call that w two. That is composed of c two which is the constant capital used in department two, v two which is the variable capital used in department two and s two which is the surplus value generated in department two. Now, let us think a little bit about these components c one, v one and s one and similarly c two, v two and s two. C one and c two what do they represent? Well, they represent the constant capital used up in the production in department one and department two. Therefore, c one and c two will need to be replaced because that is the means of production used up. So, therefore, c one and c two also represent the demand for new means of production. So, they are the demand for means of production. What about v one and v two? v one and v two represent variable capitals in the two department meaning they are the wage which has been used to purchase labour power. Now, the wage is the income of the worker. What will they do with it? They will use it to purchase consumption goods. Therefore, v one and v two represent the demand for consumption goods. The third component is s one and s two and that is more complicated, but also more interesting. What is s one and s two? s one and s two represent surplus value generated in the two departments. Now, the surplus value as we have seen in the circuit of capital can be used in two different ways. Part of it is used for consumption. So, it gives rise to a demand for consumption goods, but part of it can be reinvested in the production process which generates which is used to hire more workers and buy more machines. So, therefore, it can demand it can generate the demand for means of production also. So, s one and s two can represent the demand for both means of production and means of consumption. So, let me move s one and s two here because this is probably not visible. S one and s two represent the surplus values generated in the two departments. Now, we know that surplus value can be used to support the consumption of the capitalists in which case it leads to a demand for consumption goods, but part of the surplus value can also be used to reinvest in the production process in which case part of it will be used to purchase means of production. So, s one and s two leads to the demand for or can lead to the demand for means of production and means of consumption. Now, in our analysis to understand the basic issues involved, we will look at a simple case. The simple case will be where all the surplus value is used for consumption. That simple case is known by Marx is called by Marx as simple reproduction. What does that mean? Simple reproduction means that all the surplus value is used for consumption. If all the surplus value is used for consumption, then none of it is used for reinvestment. What does that mean? It means that the revenue that is generated by selling the commodities, one part of it goes towards recouping the cost. The other part is surplus value. If all of the surplus value is used for consumption, that means the scale of production remains constant over time because there is no reinvestment, there is no growth of the means of production. Therefore, the scale of production remains fixed. That is what Marx means by simple reproduction. But even in the case of simple reproduction which is unrealistic, it is useful to study simple reproduction because it allows us to understand the structure of relations that must prevail between the two departments to ensure that there is smooth reproduction over time. After having understood the simple case of simple reproduction, we can then study the case of expanded reproduction where some of the surplus value is plowed back into the production process which leads to an increase in the scale of production and growth of the capital stock. But the essential ideas remain the same and therefore, we can abstract from ignore this other complication which arises because of growth to understand the basic logic by just studying the case of simple reproduction. So, that is what we will do in this class. When you study the notes, you can look at the appendix, there is a detailed discussion of expanded reproduction. But the essential ideas can be understood even by just looking at simple reproduction. So, let us look at simple reproduction. So, we want to understand the structure of relationship thus that must prevail between the two departments to ensure smooth reproduction over time. So, to do that, let us look at both the supply and the demand sides of the market for the output of the two departments. Let us start out by looking at department one. In value terms, what is the total supply of output produced by department one? Well, the total value of output produced by department one is W 1 which in turn is the sum of C 1 plus V 1 plus S 1 that we have already seen that W 1 is C 1 plus V 1 plus S 1. So, in value terms, this sum C 1 plus V 1 plus S 1 represents the total output, the total supply of commodities produced by department one. Now, let us look at the demand side. Where does the demand for the output of department one come from? Well, department one produces means of production. Means of production will be demanded by the two departments because a part of the means of production that has been used in the production process gets used up and will need to be replaced. If we look at department one, C 1 represents the part of constant capital that is used up in the production process. Therefore, for the production process to keep going, that will need to be replaced and that is why C 1 represents the demand for means of production that arises from department one. Similarly, C 2 represents the demand for means of production that arise from department two because department two produces W 2 which itself is the sum of C 2 plus V 2 plus S 2. C 2 represents the value of constant capital used up in the production of means of consumption. So, the amount of machinery used up in producing food, well those machineries will need to be replaced if the production of food has to go on in the next period. Therefore, C 2 becomes the second source of demand for the means of production which is produced by department one. Now, let us look at department two. The total supply that is the total value of output produced by department two is C 2 plus V 2 plus S 2. What is the demand? Well, demand for means of consumption comes from two sources. All the workers involved in production in department one will earn the wage income V 1. All of the wage income will be used for making consumption, purchasing consumption goods. So, V 1 is one source of demand, V 2 is the wage income of workers in the second industry the second department that will also be used to purchase consumption goods. So, part of the demand for consumption goods comes from the wage income of the workers involved in the two departments. The second source of demand for consumption goods comes from capitalist, capitalist also need to eat. And since we are studying simple reproduction, this is the case where all of the surplus value is used for consumption. And therefore, S 1 is also the source of demand for consumption goods and so, also is S 2. So, the total demand for the output of department one comes from the consumption needs of workers and the consumption needs of capitalists. Now, let us take up any of these two equations to find the condition for equilibrium. Condition for equilibrium is when supply is equal to demand. So, when I say that the system needs to smoothly reproduce over time it means that there is neither excess supply nor excess demand nor is too much output produced nor is too little. That can happen only when the total supply and total demand are equal. Now, let us take this equation both sides of this equation have this term C 1 which we can cancel out. So, what remains of this equation is that V 1 plus S 1 is equal to C 2 or what we are saying is C 2 divided by V 1 plus S 1 is equal to 1. Now, this is precisely the condition which defines the relative size of the two departments that is necessary to ensure smooth reproduction over time. Let us understand what this is saying. This is saying that the total amount of capital constant capital used in department two that is in the department that produces means of consumption must be exactly equal to the sum of variable capital and surplus value produced in the other department. So, therefore, this condition gives us a way to find the relative size of the two departments which is necessary to ensure that there is smooth reproduction. What will happen if this reproduction condition holds? If this reproduction condition holds then there will be neither too much output produced nor too little output produced and by output we do not only mean the total amount of output, but also the right composition. Neither will too much machines be produced, neither will too much food be produced, neither will too little machines be produced, neither will too little food be produced. Just the right amount of food and machines will be produced which will be what the system needs to make sure that the process of production continues smoothly over time. So, with this analysis Marx clarified that what is essential to ensure that smooth reproduction takes place over time in a capitalist system is a key idea about proportionality. Even in this simple framework we are able to see that the system will be able to produce and reproduce itself over time smoothly without getting into problems of shortage of commodities or glut of commodities is only if the two departments are related to each other in a specific way. Now, these could be specific numbers say this could be 100, this could be 50, this could be 25 and then plugging those numbers we will get a specific ratio that must be maintained between these two departments to ensure that the system reproduces itself over time smoothly. If the system is able to generate this ratio this relative size of the two departments then it will be able to smoothly reproduce itself over time. What if it does not what if there is a shock to the system because of which the size of department one becomes too large compared to the size of department two and by too large I mean too large with reference to this condition. If that happens then the system will get into what Marx calls crisis of disproportionality because in that case too much means of production will be produced then will be necessary to for the demand of the system and therefore, that will that can very well be the beginning of a crisis. Now, since the capitalist system is a crisis prone system every 30, 40 years it gets into deep crisis. The analysis of crisis is a very important topic of of Marx's political economy. Marx never got the chance to write out a systematic account of capitalist crisis, but we do find scattered notes and scattered comments on crisis in various parts of his texts. And it is possible to reconstruct a comprehensive theory of crisis on the basis of those notes, but in this course we will not have time or occasion to get into that, but nonetheless I would like to flag this issue that a crisis of disproportionality is very much one of the important ways in which a system can get into a crisis. There are other ways in which the system can get into a crisis, but that is something that we are not going to be discussing in great detail. With that we come to the end of this module. In this module we have looked at the main argument laid out by Marx in volume 2 of Capital which relates to the question of realization of surplus value. Since surplus value is realized through the sale of commodities, what is important is the sphere of circulation. That is why in the first part of this module we began with a general analysis of the circulation of capital. We looked at the circuit of capital at its various aspects and understood very important concepts. With that then we understood and returned to the question of about the realization of surplus value. We looked at the issue of aggregate demand and we also looked at the issue of the correct product mix or the use value basis of production. With that we come to an end of the analysis that Marx laid out in volumes 1 and 2. The next module will take us into volume 3 and let me briefly say how it will be related to what we have so far studied. In volume 1 we studied the process of generation of surplus value and also its accumulation. In volume 2 we understood how the surplus value that has been generated can be realized through sale. In volume 3 we will then analyze how this surplus value that has been generated gets redistributed throughout societies and emerges as the income of different fractions of the ruling class. The capitalists who are involved in production, the merchants, the money capitalists and the resource owners. That is the main argument we will see in the next module.