Marx built on and critiqued the most well-known economists of his day, the British classical economists. Marx followed Adam Smith and David Ricardo in claiming that the source of profits under capitalism is value added by workers not paid out in wages. He developed this theory of exploitation of the proletariat with an exposition of the labor theory of value in the first volume of Capital, while remaining aware that the labor theory of value was not a valid theory of relative prices. He critiqued Smith and Ricardo, on the other hand, for not realizing their economic concepts reflected capitalist institutions, not innate natural properties of mankind, and could not be applied unchanged to all societies. Marx's theories of business cycles; of economic growth and development, especially in two sector models; and of the declining rate of profit are other important elements of Marxist economics.
Marx argued that this alienation of labor power (and resulting commodity fetishism) is precisely the defining feature of capitalism. Prior to capitalism, markets existed in Europe where producers and merchants bought and sold commodities. According to Marx, a capitalist mode of production developed in Europe when labor itself became a commodity -- when peasants became free to sell their own labor-power, and needed to sell their own labor because they no longer possessed their own land or tools necessary to produce. A person sells his/her labor-power when he/she accepts compensation in return for whatever work he/she does in a given period of time (in other words, he/she is not selling the product of their labor, but his/her capacity to work). In return for selling his/her labor power he/she receive money which allows them to survive. The person who must sell his/her labor power to live is a "proletarian." The person who buys the labor power, generally someone who does own the land and technology to produce, is a "capitalist" or "bourgeois." (NOTE: Marx considered this an objective description of capitalism, distinct from any one of a variety of ideological claims of or about capitalism).
Marx distinguished capitalists from merchants. Merchants buy goods in one place and sell them in another; more precisely, they buy things in one market and sell them in another. Since the laws of supply and demand operate within given markets, there is often a difference between the price of a commodity in one market and another. Merchants hope to capture the difference between these two markets. According to Marx, capitalists, on the other hand, take advantage of the difference between the labor market and the market for whatever commodity is produced by the capitalist. Marx observed that in practically every successful industry the price for labor was lower than the price of the manufactured good. Marx called this difference "surplus value" and argued that this surplus value was in fact the source of a capitalist's profit.
The capitalist mode of production is capable of tremendous growth because the capitalist can, and has an incentive to, reinvest profits in new technologies. Marx considered the capitalist class to be the most revolutionary in history, because it constantly revolutionized the means of production. But Marx believed that capitalism was prone to periodic crises. He suggested that over time, capitalists would invest more and more in new technologies, and less and less in labor. Since Marx believed that surplus value appropriated from labor is the source of profits, he concluded that the rate of profit would fall even as the economy grew. When the rate of profit falls below a certain point, the result would be a recesion or depression in which certain sectors of the economy would collapse. Marx understood that during such a crisis the price of labor would also fall, and eventually make possible the investment in new technologies and the growth of new sectors of the economy.
Marx believed that this cycle of growth, collapse, and growth would be punctuated by increasingly severe crises. Moreover, he believed that the long-term consequence of this process was necessarily the empowerment of the capitalist class and the impoverishment of the proletariat. Finally, he believed that were the proletariat to seize the means of production, they would encourage social relations that would benefit everyone equally, and a system of production less vulnerable to periodic crises.
The Austrian School were the first liberal economists to systematically challenge the Marxist school. This was partly a reaction to the Methodenstreit when they attacked the Hegelian doctrines of the Historical School. Though many Marxist authors have attempted to portray the Austrian school as a bourgeois reaction to Marx, such an interpretation is untenable: Carl Menger wrote his Principles of Economics at almost the same time as Marx was completing Das Kapital. The Austrian economists were, however, the first to clash directly with Marxism, since both dealt with such subjects as money, capital, business cycles, and economic processes. Eugen von Boehm-Bawerk wrote extensive critiques of Marx in the 1880s and 1890s, and several prominent Marxists--including Rudolf Hilferding--attended his seminar in 1905-06.
In contrast, the classical economists had shown little interest in such topics, and many of them did not even gain familiarity with Marx's ideas until well into the twentieth century.
Liberal Challenge