Marx’s theory of declining rate of profit in a capitalist economy
Marx argued that the exploitation rate (s/v) tended to be fixed, while the organic composition of capital (c/v) tended to rise over time, thus the rate of profit has a tendency to decline.
The basic logic can be as follows. For simplicity, assume a static economy (no labour supply growth). As the surplus accrues to capitalists and, necessarily, capitalists invest that surplus into expanding production, then output will rise over time while the labour supply remains constant. Thus, the labour market gets gradually “tighter” and so wages will rise.
But this decline in is temporary. There are forces at work which will restore profit rate what are these forces? Marx argued, capitalists can boost their profit rate back up by introducing labour-saving machinery into production-thereby leading to unemployment.
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Profits will be reinvested, output will grow again, labour markets will tighten once more and the whole process will repeat itself. The problem is that the second time around, there is less labour to lay off.
Recall, L was already reduced in the first round. Introducing more machinery reduces L further and, via several rounds, further and further-until there is hardly any more L that can be released.
When the system gets to the point that there are no more labourers to be fired, then there is nothing to bring s/v back up. The profit rate declines and firms will begin going bankrupt. The bankruptcy of firms means a sudden release of even more labour and capital into the market, depressing prices tremendously.
Firms that remain active will thus be able to buy the bankrupt smaller, firms and thus acquire more labour and capital at very cheap rates indeed, cheaper than their proper “value”. The unemployed, thus, act as a “reserve army of labour” and bring wages back down to a manageable level.