Several new terms are introduced here.
- VARIABLE CAPITAL is money used to purchase labor-power. This portion of capital expands in production through the addition of surplus value.
- CONSTANT CAPITAL is money used to purchase means of production (buildings, machinery, etc.) and raw materials. This portion of capital does not expand in production.
- NECESSARY LABOR is that portion of labor time that will be transformed into necessary value.
- SURPLUS LABOR is that portion of labor time that will be transformed into surplus value.
Production is initiated when one or more capitalists, perhaps in the form of a corporation, accumulate enough money to purchase the labor-power, means of production, and raw materials required for the chosen commodity. In other words, they are able to advance sufficient variable and constant capital for the selected process.
In the initial production cycle, the advanced variable capital purchases labor-power (necessary labor), and the advanced constant capital purchases means of production and raw materials.
During the production process, necessary labor creates necessary value, and surplus labor creates surplus value. Both forms of exchange-value are transferred to the commodities being produced.
Exchange-value is also transferred from the means of production and the raw materials. These elements of the process are themselves commodities from a prior production process, and therefore have exchange-values. It is these previously created exchange-values that are transferred to the new commodities.
The entire exchange-value in the raw materials is transferred. For the means of production, only the fraction used up in the process is transferred - hence the dashed lines in the drawing. For example, if the exchange-value of a machine is 1,000 units of a currency, and if it can produce 10,000 units of the commodity before being worn out, then it transfers 0.1 units of the currency to each unit of the commodity.
After the initial cycle, our capitalists possess commodities that contain necessary value, surplus value, and the exchange-value transferred from the means of production and the raw materials. The trick now is to sell these commodities in the market at the anticipated prices so that all these values can be turned back into money, including the anticipated profit.
If this is successfully accomplished, then money will be available to pay the necessary labor, means of production, and raw materials for the next production cycle. In addition, surplus-value will be available for capitalist consumption and to re-invest in production to grow the enterprise. This cycle continues until business conditions or other circumstances bring it to a halt.
In this process, capital starts as money, is transformed into productive assets and then commodities, and is finally transformed back into money - augmented by surplus value - through commodity sales in the market. This is capital - expanding exchange-value through the cycle of production and exchange.
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For capitalists, the problem with a declining ratio of variable to total capital is that the profit rate will decline, as shown in to top graph at right. This is true because variable capital is the source of surplus value. Unless the rate of surplus value increases, this declining ratio will mean that for every unit of total capital invested, less profit will result. This is acceptable only to a limited degree, beyond which the social and economic status of capitalists will be threatened.
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