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diff --git a/old/10612.txt b/old/10612.txt new file mode 100644 index 0000000..19e7614 --- /dev/null +++ b/old/10612.txt @@ -0,0 +1,5758 @@ +The Project Gutenberg EBook of Supply and Demand, by Hubert D. Henderson + +This eBook is for the use of anyone anywhere at no cost and with +almost no restrictions whatsoever. You may copy it, give it away or +re-use it under the terms of the Project Gutenberg License included +with this eBook or online at www.gutenberg.org + + +Title: Supply and Demand + +Author: Hubert D. Henderson + +Release Date: January 6, 2004 [EBook #10612] + +Language: English + +Character set encoding: ASCII + +*** START OF THIS PROJECT GUTENBERG EBOOK SUPPLY AND DEMAND *** + + + + +Produced by Josh Cogliati and PG Distributed Proofreaders + + + + +SUPPLY AND DEMAND + +By Hubert D. Henderson M.A. + +With an Introduction by J.M. Keynes M.A., C.B. + +1922. + + + + + +INTRODUCTION + +The Theory of Economics does not furnish a body of settled conclusions +immediately applicable to policy. It is a method rather than a +doctrine, an apparatus of the mind, a technique of thinking, which +helps its possessor to draw correct conclusions. It is not difficult +in the sense in which mathematical and scientific techniques are +difficult; but the fact that its modes of expression are much less +precise than these, renders decidedly difficult the task of conveying +it correctly to the minds of learners. + +Before Adam Smith this apparatus of thought scarcely existed. Between +his time and this it has been steadily enlarged and improved. Nor is +there any branch of knowledge in the formation of which Englishmen can +claim a more predominant part. It is not complete yet, but important +improvements in its elements are becoming rare. The main task of the +professional economist now consists, either in obtaining a wide +knowledge of _relevant_ facts and exercising skill in the application +of economic principles to them, or in expounding the elements of his +method in a lucid, accurate and illuminating way, so that, through his +instruction, the number of those who can think for themselves may be +increased. + +This Series is directed towards the latter aim. It is intended to +convey to the ordinary reader and to the uninitiated student some +conception of the general principles of thought which economists now +apply to economic problems. The writers are not concerned to make +original contributions to knowledge, or even to attempt a complete +summary of all the principles of the subject. They have been more +anxious to avoid obscure forms of expression than difficult ideas; and +their object has been to expound to intelligent readers, previously +unfamiliar with the subject, the most significant elements of economic +method. Most of the omissions of matter often treated in textbooks are +intentional; for as a subject develops, it is important, especially in +books meant to be introductory, to discard the marks of the chrysalid +stage before thought had wings. + +Even on matters of principle there is not yet a complete unanimity of +opinion amongst professors. Generally speaking, the writers of these +volumes believe themselves to be orthodox members of the Cambridge +School of Economics. At any rate, most of their ideas about the +subject, and even their prejudices, are traceable to the contact they +have enjoyed with the writings and lectures of the two economists who +have chiefly influenced Cambridge thought for the past fifty years, +Dr. Marshall and Professor Pigou. + +J.M. Keynes. + +CONTENTS + +CHAPTER I + +THE ECONOMIC WORLD + +Sec.1. THEORY AND FACT + +Sec.2. THE DIVISION OF LABOR + +Sec.3. THE EXISTENCE OF ORDER + +Sec.4. SOME REFLECTIONS UPON JOINT PRODUCTS + +Sec.5. SOME REFLECTIONS UPON CAPITAL + +Sec.6. THE FUNDAMENTAL CHARACTER OF MANY ECONOMIC LAWS + + + +CHAPTER II + +THE GENERAL LAWS OF SUPPLY AND DEMAND + +Sec.1. PRELIMINARY STATEMENT OF THREE LAWS + +Sec.2. DIAGRAMS AND THEIR USES + +Sec.3. AMBIGUITIES OF THE EXPRESSIONS, "INCREASE IN DEMAND," ETC. + +Sec.4. REACTIONS OF CHANGES IN DEMAND AND SUPPLY ON PRICE + +Sec.5. SOME PARADOXICAL REACTIONS OF PRICE CHANGES ON SUPPLY + +Sec.6. THE DISTURBANCES OF MONETARY CHANGES + +Sec.7. THE TRADE CYCLE + + + +CHAPTER III + +UTILITY AND THE MARGIN OF CONSUMPTION + +Sec.1. THE FORCES BEHIND SUPPLY AND DEMAND + +Sec.2. THE LAW OF DIMINISHING UTILITY + +Sec.3. THE RELATION BETWEEN PRICE AND MARGINAL UTILITY + +Sec.4. THE MARGINAL PURCHASER + +Sec.5. THE BUSINESS MAN AS PURCHASER + +Sec.6. THE DIMINISHING UTILITY OF MONEY + + + +CHAPTER IV + +COST AND THE MARGIN OF PRODUCTION + +Sec.1. AN ILLUSTRATION FROM COAL + +Sec.2. THE VARIOUS ASPECTS OF MARGINAL COST + +Sec.3. THE DANGERS OF IGNORING THE MARGIN + +Sec.4. A MISINTERPRETATION + +Sec.5. SOME CONSEQUENCES OF A HIGHER PRICE LEVEL + +Sec.6. GENERAL RELATION BETWEEN PRICE, UTILITY AND COST + + + +CHAPTER V + +JOINT DEMAND AND SUPPLY + +Sec.1. MARGINAL COST UNDER JOINT SUPPLY + +Sec.2. MARGINAL UTILITY UNDER JOINT DEMAND + +Sec.3. A CONTRAST BETWEEN COTTON AND COTTON-SEED, AND WOOL AND MUTTON + +Sec.4. THE IMPORTANCE OF BEING UNIMPORTANT + +Sec.5. CAPITAL AND LABOR + +Sec.6. CONCLUSIONS AS TO JOINT SUPPLY AND JOINT DEMAND + +Sec.7. COMPOSITE SUPPLY AND COMPOSITE DEMAND + +Sec.8. ULTIMATE REAL COSTS + + + +CHAPTER VI + +LAND + +Sec.1. THE SPECIAL CHARACTERISTICS OF LAND + +Sec.2. THE SCARCITY ASPECT + +Sec.3. THE DIFFERENTIAL ASPECT + +Sec.4. THE MARGIN OF TRANSFERENCE + +Sec.5. THE NECESSITY OF RENT + +Sec.6. THE QUESTION OF REAL COSTS + +Sec.7. RENT AND SELLING PRICE + + + +CHAPTER VII + +RISK-BEARING AND ENTERPRISE + +Sec.1. PROFITS AND EARNINGS OF MANAGEMENT + +Sec.2. THE PAYMENT FOR RISK-BEARING + +Sec.3. MONTE CARLO AND INSURANCE + +Sec.4. RISK UNDER LARGE SCALE ORGANIZATION + +Sec.5. THE ENTREPRENEUR + +Sec.6. RISK-TAKING AND CONTROL + +Sec.7. GENERAL ANALYSIS OF PROFITS + + + +CHAPTER VIII + +CAPITAL + +Sec.1. A REFERENCE TO MARX + +Sec.2. WAITING FOR PRODUCTION + +Sec.3. WAITING FOR CONSUMPTION + +Sec.4. CAPITAL NOT A STOCK OF CONSUMABLE GOODS + +Sec.5. THE ESSENCE OF WAITING + +Sec.6. INDIVIDUAL AND SOCIAL SAVING + +Sec.7. THE NECESSITY OF INTEREST + +Sec.8. THE SUPPLY OF CAPITAL + +Sec.9. INVOLUNTARY SAVING + +Sec.10. INTEREST AND DISTRIBUTION + + + +CHAPTER IX + +LABOR + +Sec.1. A RETROSPECT ON LAISSEZ-FAIRE + +Sec.2. IDEAS AND INSTITUTIONS + +Sec.3. THE GENERAL WAGE-LEVEL + +Sec.4. THE SUPPLY OF LABOR IN GENERAL + +Sec.5. THE APPORTIONMENT OF LABOR AMONG PLACES + +Sec.6. THE APPORTIONMENT OF LABOR AMONG SOCIAL GRADES + +Sec.7. THE APPORTIONMENT OF LABOR AMONG OCCUPATIONS + +Sec.8. WOMEN'S WAGES + +CHAPTER X + +THE REAL COSTS OF PRODUCTION + +Sec.1. COMPARATIVE COSTS + +Sec.2. THE ALLOCATION OF RESOURCES + +Sec.3. UTILITY AND WEALTH + +Sec.4. CRITERIA OF POLICY + + + +SUPPLY AND DEMAND + + + +CHAPTER I + +THE ECONOMIC WORLD + + +Sec.1. _Theory and Fact_. The controversy between the "Theorist" and the +"Practical Man" is common to all branches of human affairs, but it is +more than usually prevalent, and perhaps more than usually acrid in +the economic sphere. It is always a rather foolish controversy, and I +have no intention of entering into it, but its prevalence makes it +desirable to emphasize a platitude. Economic theory must be based +upon actual fact: indeed, it must be essentially an attempt, like all +theory, to _describe_ the actual facts in proper sequence, and in true +perspective; and if it does not do this it is an imposture. Moreover, +the facts which economic theory seeks to describe are primarily +economic facts, facts, that is to say, which emerge in, and are +concerned with, the ordinary business world; and it is, therefore, +mainly upon such facts that the theory must be based. People +sometimes speak as though they supposed the economist to start from a +few psychological assumptions (e. g. that a man is actuated mainly by +his own self-interest) and to build up his theories upon such +foundations by a process of pure reasoning. When, therefore, some +advance in the study of psychology throws into apparent disrepute such +ancient maxims about human nature, these people are disposed to +conclude that the old economic theory is exploded, since its +psychological premises have been shown to be untrue. Such an attitude +involves a complete misunderstanding not merely of economics, but of +the processes of human thought. It is quite true that the various +branches of knowledge are interrelated very intimately, and that an +advance in one will often suggest a development in another. By all +means let the economist and psychologist avoid a pedantic specialism +and let each stray into the other's province whenever he thinks +fit. But the fact remains that they are primarily concerned with +different things: and that each is most to be trusted when he is upon +his own ground. When, therefore, the economist indulges in a +generalization about psychology, even when he gives it as a reason for +an economic proposition, in nine cases out of ten the economics will +not depend upon the psychology; the psychology will rather be an +inference (and very possibly a crude and hasty one) from the economic +facts of which he is tolerably sure. + +But the purpose of economic theory is not merely to describe the facts +of the economic world; it is to describe them in their proper sequence +and true perspective. It must begin with those facts which are most +general and which have the widest possible significance. Those are not +likely to be the facts which our practical experience forces most +insistently upon our notice. For it is the particular and not the +general, the differences between things rather than their +resemblances, that concern us most in daily life. Nor are we likely to +find the universal facts which we require in the sphere of public +controversy. We must rather look for them in the dark recesses of our +consciousness, where are stored those truths which are so obvious that +we hardly notice them, which are so indisputable that we seldom +examine them, which seem so trite that we are apt to miss their full +significance. + + +Sec.2. _The Division of Labor_. There is one such truth in the economic +sphere which it is essential to appreciate vividly and fully, with the +widest sweep of the imagination and the sharpest clarity of +thought. Man lives by cooperating with his fellow-men. In the modern +world, that cooperation is of a boundless range and an indescribable +complexity. Yet it is essentially undesigned and uncontrolled by +man. The humblest inhabitant of the United States or Great Britain +depends for the satisfaction of his simplest needs upon the activities +of innumerable people, in every walk of life and in every corner of +the globe. The ordinary commodities which appear upon his dinner table +represent the final product of the labors of a medley of merchants, +farmers, seamen, engineers, workers of almost every craft. But there +is no human authority presiding over this great complex of labor, +organizing the various units, and directing them towards the common +ends which they subserve. Wheel upon wheel, in a ceaseless succession +of interdependent processes, the business world revolves: but no one +has planned and no one guides the intricate mechanism whose smooth +working is so vital to us all. Man, indeed, can organize and has +organized much. Within a large factory the efforts of thousands of +work-people, each engaged on the repetition of a single small process, +are fitted together so as to form an ordered whole by the conscious +direction of the management. Sometimes factory is joined with factory, +with farms, fisheries, mines, with transport and distributing +agencies, as one gigantic business unit, controlled by a common +will. These giant businesses are remarkable achievements of man's +organizing gifts. The individuals who control them wield an immense +power, which so impresses the public imagination that we dub them +"kings," "supermen," "Napoleons of industry." But how small a portion +of man's economic life is dominated by such men! Even as regards the +affairs of their own businesses, how narrow, after all, are the limits +of their influence! The prices at which they can buy their materials +and borrow their capital, the quantities of their products which the +public will consume, are factors at once vital to their prosperity and +outside their own control. + +A great business, like a nation, may cherish visions of +self-sufficiency, may stretch its tentacles forward to the consumer +and backwards to its supplies of raw material; but each fresh +extension of its activities serves only to multiply its points of +contact with the outside world. When those points are reached, the +largest business, like the smallest, is out on the open sea of an +economic system immeasurably larger and more powerful than +itself. There it must meet--the better perhaps for its inherent +strength and accumulated knowledge--the impact of rude forces, which +it is powerless to control. Beneath the blasts of a trade depression, +or some other tendency of world-wide scope, the authority of the +mightiest industrial magnate, and equally of any Government, assumes +the same essential insignificance as the pride of a man humbled by +contact with the elemental powers of nature. + + +Sec.3. _The Existence of Order_. The parallel can be pursued further with +advantage. Just as in the world of natural phenomena, which for long +seemed to man so wayward and inexplicable, we have come gradually to +perceive an all-pervading uniformity and order; so there is manifest +in the economic world, uniformity, order, of a similar if less +majestic kind. Upon the cooperation of his fellowmen, man depends for +the very means of life: yet he takes this cooperation for granted, +with a complacent confidence and often with a naive unconsciousness, +as he takes the rising of to-morrow's sun. The reliability of this +unorganized cooperation has powerfully impressed the imagination of +many observers. + +"On entering Paris which I had come to visit," exclaimed Bastiat some +seventy years ago, "I said to myself--Here are a million of human +beings who would all die in a short time if provisions of every kind +ceased to flow towards this great metropolis. Imagination is baffled +when it tries to appreciate the vast multiplicity of commodities which +must enter to-morrow through the barriers in order to preserve the +inhabitants from falling a prey to the convulsions of famine, +rebellion, and pillage. And yet all sleep at this moment, and their +peaceful slumbers are not disturbed for a single instant by the +prospect of such a frightful catastrophe. On the other hand, eighty +departments have been laboring to-day, without concert, without any +mutual understanding, for the provisioning of Paris." + +The theme may well excite wonder. But wonder should always be watched +with a wary eye; for he is apt to bring in his train a hanger-on +called worship, who can do nothing but mischief here. It is a short +step from a passage like that quoted above to a glorification of the +existing system of society, to a defence of all manner of indefensible +things; and a cross-grained attitude towards all projects of +reform. It is a short step; but it is one which it is quite +unjustifiable to take. For the evils of our economic system are too +plain to be ignored; too many people have harsh personal experience of +the wastefulness of its production, the injustice of its distribution; +of its sweating, its unemployment and slums. And when the attempt is +made to plaster over evils, such as these with obsequious rhetoric +about the majesty of economic law, it is not surprising that the +spirit of many men should revolt and that they should retort by +denying the existence of order in the business world, by declaring +that the spectacle which _they_ see is one of discord, confusion and +chaos. And then we are engulfed in a controversy as stale, flat and +unprofitable as that between the "theorist" and the "practical man." + +The truth is that the language of praise and obloquy is quite +inappropriate. In the first place, it may be well to note that the +order of which I have spoken manifests itself not merely in those +economic phenomena which are beneficial to man, but hardly less in +those which work to his hurt. Even in those alternations of good and +bad trade, which spell so much unemployment and misery, there is +discernible a rhythmic regularity like that of the process of the +seasons, or the ebb and flow of the tide. This is not an elegance to +be admired. Furthermore, in so far as the order comprises adjustments +and tendencies which are beneficial (as, indeed, is mainly true), +there is no warrant for assuming that these are either adequate to +secure a prosperous community or dependent upon the social +arrangements which happen to exist. Let us, therefore, refrain from +premature polemics and examine in a spirit of detachment some further +aspects of the elaborate, but yet unorganized, cooperation of which so +much has been already said. + + +Sec.4. _Some Reflections upon Joint Products_. A quite inadequate idea of +the complexity of this cooeperation is obtained by dwelling on the +numbers of people who participate in it, or the immense distances over +which it extends. The deficiency can be partially supplied by +referring to some of the more obvious of the many subtle +interconnections which exist between different commodities and +different trades. + +There are innumerable groups of commodities (which it is customary to +term "joint products") such that the production of one commodity +belonging to the group necessarily implies or very greatly facilitates +the production of the others. Wool and mutton; beef and hides; cotton +and cotton-seed are a few familiar illustrations. The important +feature of these "joint products" is the fairly precise relation which +must exist between the quantities in which the different products are +supplied. If you plant a certain crop of cotton, it will yield you so +much cotton lint and so much cotton-seed. You can, of course, if you +choose, throw away part of the seed, as indeed at one time planters +used to do; but unless you do this, you cannot vary the proportions of +the two things which you will have for sale. Similarly, if you keep a +flock of sheep, or a herd of cattle, you will obtain wool and mutton +in the one case, or beef and hides in the other, in proportions, which +indeed you can vary within certain limits by choosing a different +breed,[1] but which you cannot radically transform. When, however, we +turn to the uses to which these products are put, no similar relation +is to be discovered. Cotton lint is used chiefly for making articles +of clothing; cotton-seed for crushing into oil, on the one hand, and +cake for cattle fodder on the other. There is no apparent connection +of any kind between the demands for these different things, and still +less is there any obvious reason why these demands should bear to one +another the particular proportions which characterize their respective +supplies. It is very much the same with wool and mutton; with beef and +hides; with all "joint products." Why should we consume mutton on the +one hand and woolen clothing on the other, in a ratio at all +commensurate with that in which they are yielded by the sheep? + +[Footnote 1: These possibilities of small variation are of very great +importance as will be shown in Chapter V, but they do not affect the +present argument.] + +What, then, might we expect to find if order was nonexistent in the +economic world? Surely that some things such as wool would be produced +in quantities many times in excess of the demand for them, quite +possibly five, ten, or twenty times in excess; while conversely the +supplies of others such as mutton might fall far short of what was +required. But in practice we find nothing of the sort. Somehow it +comes about that an equilibrium is established between the demand for +and the supply of every commodity; and that this applies to wool and +mutton, to beef and hides, as surely as to commodities which are +produced quite independently. It is true that this equilibrium is a +rough, imperfect one; and it may happen that what is called a "glut" +of wool may co-exist for a short period with what is called a scarcity +of mutton. But qualifications of this nature are in the strictest +sense of the phrase, the exceptions which prove the rule. For the +departures from equilibrium which gluts and scarcities represent are +always transient and are usually confined within narrow limits. A +strong prevailing trend towards an adjustment of demand and supply is +unmistakably manifest amid all the vagaries of changing circumstance. +Let me carry the argument a step further for the benefit of any reader +who is restrained by a repugnance too deep and instinctive to be +readily overcome, from admitting fairly to his mind that conception of +order which I am endeavoring to emphasize. He will in all probability +be one who, cherishing ideals of a better and fairer system of +society, looks forward to a time when an organized cooeperation will be +substituted for what he regards as the existing chaos. Let us suppose +that his visions were fulfilled as completely as he could desire; and +that an immense system of Socialism were in existence, embracing not +one country only, but the whole world. Suppose all the difficulties of +human perversity and administrative technique to have been surmounted +and a wise, disinterested executive to be in supreme control of our +business life. Let us suppose all this, and ask only the question: How +would this executive treat the humdrum case of wool and mutton? How +would it decide the number of sheep it would maintain? + +Shall we suppose that it is inspired by the ideal "to each according +to his need," and that it resolves accordingly that the commodities +which people require for a decent standard of life shall be supplied +to them as a matter of course? How, then, would it proceed? It might +estimate the amount of woolen clothing which a normal family requires, +allowing for differences in climate, and possibly indulging somewhat +the caprices of human taste. On this basis, a certain number of sheep +would be indicated. It might perform a similar calculation for mutton, +and again a certain number of sheep would be indicated. But it would +be an extraordinary coincidence if the numbers which resulted from +these independent calculations were nearly equal to one another, or +were even of the same order of magnitude; and, if they differed +widely, what number would our world executive select? Would it decide +to waste an immense quantity of either wool or mutton; or would it +decide that it could not, after all, supply the full human needs for +one or other of the commodities? + +Of course, if the executive were sensible it could solve the problem +satisfactorily enough. It could retain the monetary system we know +to-day and it could supply the commodities to the consumers, not as a +matter of right, but by selling them to them _at a price_. This price +it could then move upwards or downwards, raising, say, the price of +mutton and reducing that of wool, until it found that the consumption +of the two things was adjusted in the required ratio. But if it acted +in this manner, what essentially would it be doing? It would be +seeking by deliberate contrivance to reproduce, in respect of this +particular problem, the very conditions which occur to-day without aim +or effort on the part of anyone at all. + +The moral of this illustration must not be misinterpreted. It does +not show the folly of Socialism or the superiority of +Laissez-faire. What it does show is the existence in the economic +world of an order more profound and more permanent than any of our +social schemes, and equally applicable to them all. + + +Sec.5. _Some Reflections upon Capital_. Another aspect of the great +cooperation is of even greater significance. It embraces not only a +multitude of living men, but it links the present together with the +future and the past. The goods and services which we enjoy to-day we +owe only in part to the labors of the week, the month, or the year, +only in part even to the efforts of our contemporaries. The men, long +since dead and forgotten, who built our railways, or sunk our coal +mines, or engaged in any of a great variety of tasks, are still +contributing to the satisfaction of our daily wants. The expression is +not altogether fanciful; for, had it not been reasonable to expect +that those labors would be of use to us to-day, many of them in all +probability would never have been undertaken. It was to meet our +present wants, and even our future wants, that many men toiled on +monotonous tasks ten, twenty, thirty years ago. And yet, of course, we +should deceive ourselves if we supposed that this was the motive of +these men, that our welfare was the centre of their heart's desire. We +in our turn dedicate to the future, and often to a distant future, an +immense portion of our energies. Let any reader who doubts this, study +the statistics of the occupations of the people, and reflect on how +long a period must elapse before the labors of this trade or that can +fulfil their ultimate function. How long would the period be in the +case of a man making bricks, which will later be employed in the +erection of a factory, where machinery will be made, to equip an +electrical generating station designed to supply, over a period of +many years, light, heat, and power to people living in a remote +Continent? A longer time, it may be hazarded, than he is accustomed +to look ahead. + +Like the daily cooperation of living men, this cooperation of past, +present and future is essential to the well-being of mankind, and yet +it is undesigned and unorganized. As private individuals, men do, +indeed, deliberately provide for their own future, and for that of +their kith and kin: as the directors of businesses, they try to +forecast the trend of demand. But such conscious calculations and +deliberate acts would avail little if they stood alone. They are +hardly more than the necessary spokes in the great wheel which +regulates the relations of past, present and future. The hub of the +wheel is an elaborate system of borrowing and lending, essentially +similar to the buying and selling of commodities. The private +individual in order to provide for his family or for his old age +"saves" and "invests." But what exactly does this mean? It means that +he transfers so much purchasing power, which he might have spent on +his personal pleasures, to some one else in return for the expectation +of receiving, year by year in the future, he and his heirs after him, +a certain smaller quantity of purchasing power. The other party to the +transaction will be, we may suppose, a business man who enters into it +because he sees the opportunity of a promising industrial development, +to undertake which he requires more purchasing power than he himself +possesses. And, because this transaction is entered into, a smaller +number of us will shortly be engaged in making motorcars, or +gramaphones, and a larger number of us in making factories and +machinery, which will later enhance the world's productive power. + +Many transactions of the kind take place daily in modern communities, +and their multiplicity gives rise to a mass of phenomena with which we +are all tolerably familiar. We recognize a short-loan market, a stock +exchange, a number of "markets" where lenders and borrowers are +brought together by the aid of various intermediaries, such as banks, +bill brokers, and stock jobbers, who correspond to dealers in +commodities. Between these different specialized markets, we are +aware of an interconnection so close and strong that we speak more +generally of a Capital Market, of which the stock exchange, the +short-loan market and so forth, are the component parts. Now, "market" +is a word which was originally used to denote a place where tangible +commodities were bought and sold; and the more closely we examine the +phenomena of the Capital Market, the more closely do we perceive the +profound resemblance between the mechanism of borrowing and lending, +and that of buying and selling. Corresponding to the price of a +commodity is the rate of interest (in the short-loan market we +actually call the rate of Discount "the price of money," and speak of +money being cheap or dear); and between the rate of interest, the +demand for and the supply of capital there exist relations precisely +similar to those between price, demand, and supply in commodity +markets. Above all there is the same strong prevailing trend towards +an adjustment of demand and supply. + +This fundamental resemblance between two such apparently +incommensurable things as the buying of material commodities and the +borrowing of capital is highly significant; it is another instance of +that order in the economic world, of which the reader may now be +growing weary. But so difficult is it to see clearly and fully +something which one sees, as it were, every day of one's life, that a +few more moments of reflection on the special case of capital will be +time well spent. Let us revert then to our fantasy of a world +socialist commonwealth; and humbly submit another poser to its supreme +executive. The question this time will be whether some great +constructional work, such, let us say, as the recently mooted Severn +barrage scheme, should or should not be undertaken. Let us suppose +that the costs and future benefits of the undertaking can be estimated +accurately; and that the problem reduces itself to one of expending +now a sum, let us say, of $100,000,000, with the prospects of +obtaining in the future an income of power, or whatever it may be, +worth $5,000,000 per annum. I have assumed for the sake of simplicity +that we shall still be reckoning in terms of money, though possibly +the executive may have substituted Marxian labor units; but it is +quite immaterial to the present argument what the measuring rod may +be. The point to be observed is, that it is impossible to tackle the +problem at all without the conception of a rate of interest. For +suppose that you tried to do without it, and said, "We shall take a +long view. The interests of the future are no less our concern than +those of the present; we shall not discriminate between them. We shall +regard as an enterprise worthy to be undertaken whatever promises to +yield in the course of time a return larger than the outlay." Where +will this lead you? The particular proposal set out above would +clearly pass the test; for in twenty years the resultant benefits +would have added up to a figure equivalent to the initial cost. But +equally clearly, the cost might have been more than $100,000,000; it +might have been $250,000,000, $500,000,000, whatever figure you care +to take, and if you extend the period similarly to fifty or one +hundred years, sooner or later the gains would top the cost. Now there +is no limit to the enterprises which would pay their way on this +basis; and it would be quite impossible to undertake them all. For +they would swallow up all and more than all your labor and your +materials, and would leave you with no resources with which to meet +the recurrent daily wants of men. Clearly, then, in some way or other, +you must pick and choose, you must reject some enterprises as +_insufficiently_ worth while. But how would you proceed to choose? +Without a clear principle, a simple criterion to guide you, you would +be plunged in utter chaos. You could not say, "Let all proposals +involving capital expenditure be submitted to a central committee, who +shall compare them with one another in a sort of competitive +examination and, after deciding the number of applications they can +pass on the basis of the volume of resources which they can devote to +the future, award the places to those which head the list." Such a +prospect is a nightmare of officialism and delay. You would be driven +to formulate a simple, intelligible rule or measure, and leave that +rule to be applied by the unfettered judgment of innumerable men to +individual problems, as and when they arose. And for such a rule or +measure, you could not do better than a rate of interest; you would +have to lay it down that only those projects should be approved which +promised a return of 6 per cent, or whatever it might be. Even in +deciding what it should be, the limits of your choice would be +narrowly confined. If, for instance, you fixed on 1 or 2 per cent, +you would probably discover that you had not achieved your object, +that the undertakings for distant returns which passed this test, +still consumed far more resources than you could spare. You would be +compelled then to raise the rate until it had cut these enterprises +down within manageable limits. But, once more, what essentially would +you be doing? You would be using the instrument of the rate of +interest to adjust the demand for and supply of capital, though indeed +the interest might not be paid away as now to private individuals. You +would be reproducing by the method of deliberate trial and error, the +adjustments which occur automatically as things are, in the actual +world. Once again the most perfectly contrived Utopia would be +compelled to pay to the unorganized cooeperation of our epoch the +sincerest flattery of imitation. + + +Sec.6. _The Fundamental Character of many Economic Laws_. But again +perhaps a word of warning may be desirable. There is much controversy +in these days about something called "Capitalism" or "The capitalist +system." When these words are used with any precision, they usually +refer to the arrangement so prevalent at present, whereby the +ownership and sole ultimate control of a business rests with those who +hold its stocks and shares. There is much to be said upon the merits +and demerits of this system; something will perhaps be said upon the +matter in the fifth volume of this series; but I shall not discuss it +here. Nothing that I have said so far has any real bearing on it +whatsoever; to suppose that it has, is indeed to miss the whole point +of this chapter. + +The order, which I have sought to reveal, pervading and moving the +most diverse phenomena of the economic world, would be a far less +noteworthy and impressive thing were it merely the peculiar product of +capitalism. Merchant adventurers, companies, and trusts; Guilds, +Governments and Soviets may come and go. But under them all, and, if +need be, in spite of them all, the profound adjustments of supply and +demand will work themselves out and work themselves out again for so +long as the lot of man is darkened by the curse of Adam. + + + +CHAPTER II + +THE GENERAL LAWS OF SUPPLY AND DEMAND + + +Sec.1. _Preliminary Statement of Three Laws_. The recognition of order in +any branch of natural phenomena is but the prelude to the formulation +of a set of laws, the simpler as the order is more universal, which +describe, and as we say, explain it. Thus the perception of the even, +elliptical courses of the heavenly bodies led to the statement of the +law of gravitation and the laws of motion. + +In economics, similar laws have long since been enunciated, and have +proved themselves such valuable instruments for the understanding of +the daily problems of the workaday world, that they have been woven +into the texture of our ordinary speech and thought. I have already +touched upon them in the preceding chapter. But it is now desirable to +set them out in order, in the most concise and formal manner possible. + +LAW I. When, at the price ruling, demand exceeds supply, the price + tends to rise. Conversely when supply exceeds demand the price + tends to fall. + +LAW II. A rise in price tends, sooner or later, to decrease demand and + to increase supply. Conversely a fall in price tends, sooner or + later, to increase demand and to decrease supply. + +LAW III. Price tends to the level at which demand is equal to supply. + +These three laws are the cornerstone of economic theory. They are the +framework into which all analysis of special, detailed problems must +be fitted. Their scope is very wide. I have purposely refrained from +introducing into my statement of them any reference to commodities; +for they extend far beyond commodities. Subject to an important +qualification, they apply to capital, the price paid for the use of +capital being what we call the rate of interest. They apply hardly +less to "services," to the remuneration of labor of every kind and +grade. People sometimes protest warmly against the idea of treating +labor "like a commodity." If this indignation expresses no more than +a belief that in matters concerning conditions of work, and relations +between employees and the management, the sensibilities of human +nature should be taken into due account, it is based on elementary +decency and commonsense. But if, as sometimes appears, it is directed +against the fact that the remuneration of labor is controlled by the +laws of supply and demand, it is a mere baying at the moon, with +singularly little provocation. For these laws are in no way peculiar +to commodities, and it is no one's fault that they include commodities +too within their scope. + +But let us go back to the laws themselves, and probe them and dissect +them, and turn them this way and that, so that we may perceive their +full content, and grasp it firmly in our minds. The third law implies +a prevailing tendency for demand to be equal to supply. This +tendency, as was suggested in Chapter I, can be verified by anyone +from his experience and observation (provided he is a reasonable +person, and not the tiresome kind who would dispute the law of +gravitation because he sees that a feather falls to the ground more +slowly than a stone). But it can also be deduced as a corollary from +the two preceding laws; and to regard it in this way will help us to +appreciate its significance. Start, for instance, by supposing that +demand is in excess of supply. Then the price will tend to rise. After +the price has risen, the supply will become larger, while the demand +will fall away. The excess of demand with which we started will thus +clearly be diminished. But if there remains any portion of this +excess, the same reactions will continue; the price will rise further, +and for the same reason; demand will be further checked and supply +further stimulated. In other words, these forces must persist until +the entire excess of demand over supply is eliminated. If we start by +supposing supply to exceed demand, the converse chain of sequences +will operate. Now these very simple steps of reasoning illuminate the +nature of the normal equilibrium of demand and supply. They reveal +that the equilibrium is established and maintained by the agency of +_changes in price_, and they enable us to lay it down as perhaps the +most important thing that can be said about the price of anything that +it will tend to be such as will equate demand and supply. But that is +not all that they reveal. They reveal also the extreme dependence of +both demand and supply upon price. + +Now this is a fact which it is most important to realize vividly. It +is apt to be obscured by customary modes of speech. In ordinary times +the prices of most commodities and services do not change by very +much, unless indeed over a long period of years; the amounts demanded +and supplied may therefore seem to maintain a fairly constant level; +and we may be tempted to speak of Great Britain producing so many +million tons of coal, or America consuming so many millions of +motor-cars per annum, almost as though these quantities were +independent of price considerations. But we should never forget that +there is no service or commodity produced by man, however essential it +may seem, the demand for or the supply of which might not be reduced +to nothing, if the price were sufficiently raised on the one hand, or +lowered on the other. How easy it is sometimes to forget this simple +truth may be seen from the mistake so commonly made of supposing, +because the peoples of Central Europe were left, on the cessation of +the war, starving and destitute of the means of life and the materials +of work, that they must necessarily become heavy purchasers of +imported goods; without pausing to consider whether the prices were +such as they could afford to pay. + + +Sec.2. _Diagrams and their Uses_. It will help to prevent mistakes like +this and more generally to make sharp and clear the fundamental +relations which exist between demand, supply and price, if we exhibit +them pictorially in the form of a diagram. Such diagrams are of great +service in many parts of economic theory, not because they can prove +anything which could not be proved otherwise, but because, being +really a simpler medium of expression than words, they enable the mind +to grasp more readily and to retain more vividly the essential facts +of complex relations. + +Figure 1: + + Y + | + | S' + | * + D | ** + |* ** + | ** * + | ** * + | * * + | ** ** + | ** * + | ** * + | ** ** + | ** * + | ** Q ** + _l_|--------------*------------* R + | |*** ** + | | ** P ** + _m_|--------------------*** + | | *** |*** + _k_|--------------***----+---** _r_ + | _q_*| | *** + | *** | | **** + | *** | | **** + | *** | | *** + S |**** | | **** + | | | ** D' + | | | + | | | + | | | + | | | + 0+-------------------------------------------------------- X' + N M. + Figure 1 + +In Fig. 1 the curve DD' represents the conditions of demand. It is +supposed to be drawn in such a way that if any point, Q, be taken on +the curve, and the perpendicular QN be drawn to meet the base line, or +axis OX, then ON will represent the amount that will be demanded at a +price represented by QN (or O_l_). In other words, distances measured +along OY represent prices, and distances measured along OX represent +quantities of the commodity, or service, or whatever it may be. +Clearly, then, the demand curve, DD', must slope downwards from left +to right, since the lower the price asked, the greater will be the +amount demanded. Similarly the curve SS' represents the conditions of +supply. It is supposed to be so drawn that if any point _q_ be taken +upon it, and the perpendicular _q_N be drawn to meet OX, then ON will +represent the amount that will be supplied at a price represented by +_q_N (or O_k_). Equally clearly this supply curve must slope upwards +from left to right, since the higher the price obtainable, the greater +will be the quantity offered. Take the point P where the two curves +meet, and draw the perpendicular PM to meet OX. Then the third law +enunciated at the beginning of this chapter corresponds to the +statement that PM or O_m_ will represent the price at which the +commodity or service will be exchanged. + +It can readily be seen that no other price could be maintained. For +suppose the price to be less than O_m_, suppose it to be O_k_, then, +at this price, ON (or _kq_) will be the amount supplied, and _kr_ the +amount demanded. The demand will thus exceed the supply, and the +price will tend to rise, i.e. to move upwards towards O_m_. Similarly +if we suppose the price to be O_l_, which is larger than O_m_, the +supply (_l_R) will exceed the demand (_l_Q) and the price will fall +downwards towards O_m_. Thus, again, we have deduced Law III from Laws +I and II with the form and precision of a proposition in Euclid. Now, +when once the eye has become familiar with this diagram, it ought to +be impossible for the mind to lose even momentarily its grip on the +fact that demand and supply are both dependent upon price. For these +curves do not represent any particular amounts; they represent a +series of _relations_ between amount and price; if the price is QN the +amount demanded is ON, and so forth. The terms demand and supply in +the sense, in which I have been using them, of the respective amounts +demanded and supplied are, indeed, strictly meaningless without +reference to some particular price. The reference may sometimes be +implicit; but, whenever there is a chance of ambiguity, it should be +explicitly made. + + +Sec.3. _Ambiguities of the Expressions, "Increase in Demand," etc_. It is +the more important to be precise upon this point, in that there is a +further possible confusion which we have now to consider. Demand and +supply, as we have seen, are dependent upon price; but equally clearly +they are dependent upon other things as well. Demand depends upon the +needs, tastes and habits of the people, as well as upon the length of +their purse; supply depends upon such things as the cost of production +in the case of commodities. None of these things are constant +factors, all of them are liable to change, and it may well happen that +we shall want to consider in some concrete problem the probable +consequences of such a change. Now the most usual and natural way of +describing such changes in the medium of words is to use the +expression "increase" or "decrease in demand," and "increase" or +"decrease in supply," the same expressions, which we employed before +to describe the consequences of a change in price. This identity of +language conceals a fundamental distinction between the phenomena +described; and to make this distinction plain we cannot do better than +revert to our diagrammatic presentation of the laws. + +Figure 2: + + Y | + | + _d_| + |. + | . + | . _s'_ + | . . + D | . . + |** . . * S' + | ** .. . * + | ** . . * + | ** . .. * + | * .. . ** + | ** . . ** + | ** .. .. ** + | * . . * + | ** . . * + | ** .. . ** + | ** .. .. ** + | ** .. .. ** + | ** . .. ** + | ** p' .. ** + | **.. .. ** + | ..|**p **._p_ + | .. | **** | .. + | ... |**|** | .. + | .. *| | *| .. + | ..... *** | | |** . + _s_|...... *** | | | ** .. + | *** | | | ** ... + | ***** | | | ** ... + S |***** | | | ** .. + | | | | *** .._d'_ + | | | | *** + | | | | ** + | | | | **D' + | | | | + | | | | + 0+--------------------------------------------------------- + M' M _m_ + Figure 2 + + + +In Fig. 2 we start as before with our demand curve, and supply curve, +cutting one another at the point P. We then suppose that some +alteration takes place in the conditions of demand; there has been a +growth in the general taste for the commodity or service, and the +demand, as we say, has increased accordingly. How is this fact to be +represented in the diagram? Plainly not by taking another point on +the curve, DD', at a further distance from OY. For this would merely +indicate the larger amount that would be taken, if the conditions of +demand had remained unaltered but the sellers had reduced their +prices. The correct way of representing the change we have supposed is +to construct a new demand curve (in the figure, the dotted curve +_dd'_), lying at every point above the old demand curve. For this +indicates that larger quantities will be purchased at the old prices, +which is exactly what we want to represent. Similiarly if we wish to +represent a change in the conditions of supply, such as might result, +in the case of a commodity, from a tax imposed on its production, we +must draw a new supply curve, _ss'_, which in the case supposed, must +lie everywhere above the old supply curve. On the other hand, the +decrease or increase in demand or supply, _resulting_ from a change in +price, is represented simply by a shifting of the equilibrium from one +point to another on the same curve. The striking pictorial contrast +between a movement from one curve to another, and a movement along the +same curve should help to make vivid to our minds the fundamental +distinction between a change in the _conditions_ of demand, arising +from new tastes, enhanced purchasing power, etc.; and a mere change in +the amount purchased resulting from an alteration in the price which +the sellers ask. Words, as this necessarily cumbrous sentence shows, +are a clumsy instrument for the expression of abstract relations; it +is not very easy to see which words in a sentence are the significant, +commanding ones, and which are performing, as it were, ordinary +routine duties. A diagram is not exposed to similar ambiguities of +emphasis. + +The particular distinction, to which attention has been called, is +important. The reader who has grasped it clearly will be able to +perceive many instances of the confusion arising out of its neglect in +the ordinary discussions of economic questions which take place in the +press and on the platform. It is not uncommon, for instance, for an +argument to run something like this: "The effect of a tax on this +commodity might seem at first sight to be an advance in price. But an +advance in price will diminish the demand; and a reduced demand will +send the price down again. It is not certain, therefore, after all, +that the tax will really raise the price." A glance at the diagram +will keep us out of such a bog of sophistry and muddle. For if we +suppose the amount of the tax per unit of the commodity to be +represented by S_s_, the curve _ss'_ (drawn, as it is, roughly +parallel to SS') will represent the new conditions of supply after the +tax has been imposed. The new position of equilibrium will be given by +the point P', where _ss'_ cuts DD', the demand curve. Now P' lies to +the left of P the old point of equilibrium; hence, since DD' _must_ +slope downwards from left to right, it is clear that, if, as it is +fair here to assume, the _conditions_ of demand have remained +unaltered, the new price P'M', must be greater than the old. + + +Sec.4. _Reactions of Changes in Demand and Supply on Price_. Having now +made clear the meaning that must be attached to the terms, let us +consider the question which naturally arises, whether we can lay down +any general propositions or laws as to the effect upon price, of an +increase or decrease in demand or supply. Another glance at the +diagram suggests that we can. An increase in demand is represented in +Fig. 2 by a movement from DD' to _dd'_, which cuts the supply curve, +SS', at _p_, to the right of P. Since the supply curve (drawn, as it +is best to draw it, to represent the amount which will be supplied in +response to a given price) must always slope upwards from left to +right, the new price, _pm_, must be greater than the old, PM. +Conversely a decrease in demand is represented by a movement from +_dd'_ to DD', and the new price is seen to be less than the old. We +have already seen that a decrease in supply, which is represented by a +movement from SS' to _ss'_ results in a higher price; and it is the +obvious converse that an increase in supply will have the opposite +effect. It would seem then that we might lay down quite generally that +an increase in demand or a decrease in supply will raise the price +while a decrease in demand or an increase in supply will lower it. + +But here it is necessary to be cautious. All conclusions as to the +effects of causes are necessarily based, implicitly, if not +explicitly, upon the assumption "other things being equal." This +method of reasoning, which some people appear to find so irritating in +the economic sphere, and as they say so "theoretical" and "unreal," is +one which they adopt readily enough in every other department of +life. No one, for instance, objects to the statement that the sun, +when it comes out, makes a room warmer, although it may very well +happen, if a fire is dying at the same time, that the room grows +colder in point of fact. For in our general statement we assume +implicitly that "other things" such as fires, are unchanged. But +assumptions of this kind are legitimate only when there is no reason +to suppose that the cause, the effects of which are being studied, +will itself produce a change in the "other things." If (as I have +often been told; I really do not know if it is true) the rays of the +sun help to put a fire out, the statement made above would be the +better for some qualification. + +Now we can only say that an increase in demand raises price if we +assume the conditions of supply (as represented by the supply curve) +to remain unchanged. But in practice, an increase in demand may cause +a change in the _conditions_ of supply. An increase, for instance, in +the demand for a commodity may give rise to a revolution in the +methods of production, to the introduction of labor-saving machinery +and so forth, which will eventually result in the commodity being +produced more cheaply. It will certainly take a considerable time +before reactions of this kind can exert an appreciable influence; and +we can, therefore, feel reasonably sure that over a short period an +increase in demand will raise the price. But we cannot be sure what +the ultimate effect will be. A similar alteration in the condition of +demand is less likely to result from an increase or decrease in +supply; but it may conceivably occur. We must, therefore, be careful +to qualify any general propositions which we lay down in this +connection, by explicit reference to a short period of time. We can +add the following to our body of laws:-- + +LAW IV. An increase in demand, or a decrease in supply will tend to + raise the price for a short period at least. Conversely a decrease + in demand, or an increase in supply will tend to lower the price + for a short period at least. + + +This law, like the others, applies to commodities, services, capital, +to anything which can be said, literally, or by analogy, to have a +price. "A short period" is, however, a vague expression and, since +precision is the hallmark of an important law, we must accord to this +one a status inferior to that which the preceding three can rightly +claim. + + +Sec.5. _Some paradoxical reactions of price changes on supply_. Let us +turn, though, once more to these earlier laws, and with a heightened +critical sense let us submit them to the test of the whole gamut of +our experience, and see if in any of them we can find the smallest +flaw. The first of them will pass through the ordeal--let each reader +prove it for himself--unscathed. The second will emerge with a few +hairs, as it were, singed. It tells us, for instance, that a rise in +price will tend to augment the supply. Now there are some things the +supply of which cannot possibly be augmented; these are the capital +resources of nature, of which land is the most important for our +present purpose. Land is bought and sold, it commands a price. In a +certain sense, it may be said to be possible to increase the supply of +land, in response to a rise in price, by drainage and reclamation +schemes; and it will certainly happen that a rise in the price which +land can command for any particular purpose will increase the amount +which is devoted to that purpose. But, speaking broadly, the supply +of land available for purposes of every kind is a fixed unvarying +factor, with an inertia which the cajolery of price-changes is +powerless to disturb. This is a most important fact, and it gives rise +to some peculiar features of the price and rent of land, which we +shall have to consider later as a separate problem. It constitutes a +limiting case rather than an exception to the general law. But we have +not yet done with the reactions of price upon supply. In the case of +capital, the nature of those reactions has been much discussed as a +highly controversial question. That a rise in the rate of interest +will cause some people to save more than before, is generally +admitted; but it is pointed out that the effect upon others may be the +exact opposite, because it means that they do not need to save so much +to acquire the same future annual income. It is unwise to say +dogmatically that the former tendency outweighs the latter; though +upon the whole it seems highly probable that it does. We cannot, +therefore, in this case feel confident that a change in price will +react upon supply in the manner which our law indicates. Similarly it +is possible to argue that a rise in the general level of real wages +may reduce the supply of labor, even, or some might say particularly, +if the term is used to denote not the number of workpeople, but the +quantity of work done. For there may be a tendency for workpeople, +when more comfortably off, to work less regularly or less hard. Here +again we cannot be sure. In none of these cases, however, including +that of land, is there any reason to doubt that a rise in price will +diminish _demand_, or conversely that a fall will increase it. Since, +therefore, in the reasoning by which we deduced the third law, the +conclusion will hold good, even if the effects of price-changes on +supply are of the above paradoxical kind, provided that they do not +continually outweigh the effects upon demand, there is no reason to +cast doubt on the solidity of Law III, which, indeed, as we suggested +before, commends itself directly to experience. But Law II seems now, +perhaps, somewhat the worse for wear. + +The damage, however, is not considerable. For in each case the +uncertainty arises only when we are dealing with one of the factors of +production, land, labor or capital, _regarded as a whole_. If we are +dealing with the capital available for a particular industry, a rise +in the rate of profit in that industry will certainly increase the +supply of capital available there; for it will tend to attract savings +that might otherwise have been employed elsewhere. We can even be +fairly sure that an increase in the general rate of interest +prevailing in any particular country will increase the total supply of +capital available for the businesses of that country, since capital +has in modern times acquired a considerable migratory power. In the +case of labor, we cannot go so far as this; but here, too, there is no +doubt that an increase in the remuneration offered in any particular +occupation will attract an increased labor supply (always supposing, +of course, that "other things are equal"). No similar difficulty +arises for land, labor or capital, as regards the effect of +price-changes on demand; while for ordinary commodities there is no +such difficulty on the side either of demand or of supply. Hence the +only qualification which the strictest accuracy would require us in +this connection to attach to our statement of Law II is the +postscript:-- + + + "Except that, in the case of land, the aggregate supply is + unalterable; while in the case of capital or labor we cannot be + sure how price-changes will affect the aggregate supply." + + +Much significance attaches to these exceptions, as later will appear. + + +Sec.6. _The Disturbances of Monetary Changes_. But let us still keep a +critical eye on Law II, and submit it to another flashlight from our +practical experience. The recent world war made us all acutely aware +of a remarkable rise in the price of almost everything, which yet did +not seem to diminish appreciably the demand. The explanation of this +paradox is not difficult to find. There was an immense increase in the +volume of nominal purchasing power, due to a complex set of causes, of +which "currency inflation" may be taken as the symbol. Now perhaps we +are entitled to assume the absence of such currency changes as part of +the "other things being equal" which is always understood as +implied. But it is rash to take this particular assumption for +granted, more especially in these days. Already people are too apt to +speak as though the trade depression (which as these pages are written +holds us in its grip) cannot pass away until pre-war prices are +restored, ignoring altogether the great and probably permanent +increase in nominal purchasing power which the war has left behind +it. It would be safer, therefore, to add explicitly to Law II the +reservation, "Assuming that there is no change in the general volume +of purchasing power." + +Monetary and allied questions will form the subject of the second +volume of this series. It must not be supposed that our general laws +have no bearing on them. On the contrary, Law I, which all this time +has remained serene and undisturbed by the occasional discomfitures of +Law II, is the gateway through which all questions of currency, +banking and the foreign exchanges should be approached. It is well to +note, as an inexorable corollary of Law I, that prices can rise _only_ +if demand exceeds supply, and fall _only_ if supply exceeds demand; +and hence that it is only through the agency of changes in the demand +for and supply of commodities and services that an inflation or +deflation of the currency can influence the price level. Further, +since a condition of things in which supply generally exceeds demand +spells what we know and fear as a trade depression, it may be well to +note at once that falling prices and unemployment are inseparable +bedfellows. For we are far too apt to shut our eyes to these +unpleasant truths. But we cannot pursue them further here; and in the +remainder of this volume we shall not be concerned (except, perhaps, +incidentally) with questions affecting the general level of prices or +of purchasing power; but rather with the relation which the price of +one commodity bears to that of another, with the rate of interest +(which being a rate per cent is not essentially dependent on the price +level), with "real" wages (as distinct from money wages) and the like. + + +Sec.7. _The Trade Cycle_. But our reference to trade depressions suggests +a final comment on Law II. One small qualification was embodied in our +original statement of it, namely the words "sooner or later." A rise +in price may not check the demand immediately (even if the printing +presses are standing idle in the Treasuries); it may actually +stimulate it for a time. For people may fear that the price will rise +further still, and hasten to buy what they _must_ buy before very +long. Sellers may share the same opinion, and be reluctant on their +side to part. When prices are falling the roles are reversed, and we +are likely to see the sellers tumbling over one another in a frantic +eagerness to sell, the buyers wary and aloof. Sooner or later, indeed, +these tendencies must dissolve and disappear; but they may persist for +a longer period than might seem probable at first. For the raw +material of one trade is, as we say, the finished product of +another. The demand for one thing gives rise to a demand for other +things, for the labor with which to make them, and so on in an +expanding circle. A sympathy, subtle and intense, unites the business +world, and a wave of depression or animation arising in any quarter +may spread itself far and wide, heightened by the gusts of human hope +and fear, and continue long before its influence is spent. + +Here we are upon the threshold of one of the most striking and +formidable of economic facts, the regular alternation of periods of +good and bad trade, each very widespread, if not world-wide, in its +range, each comprising certain regular phases of acceleration and +decay, and each infallibly yielding sooner or later to the other. The +details of these phenomena are highly complex, some of them obscure; +an immense literature has already been devoted to the subject, yet its +systematic study is hardly more than begun. The account given in the +preceding paragraph is incomplete and meagre. It is inserted here in +the hope that it will impress the reader with a sense both of the fact +of these alternations and of the deeply rooted nature of the causes +from which they spring. They take a heavy toll of human happiness and +wealth; and there is no object that more urgently calls for concerted +human effort than that of mitigating them, and of alleviating the +misery which they bring in their train. Still better, of eradicating +them if that is possible; but let none suppose that it can be lightly +done. Meanwhile, let us always remember that they form the atmosphere +and medium in which the enduring tendencies of the business world must +work themselves out. It is often convenient to speak of "normal +conditions" in this trade or that; but hardly ever can it be truly +said of a particular moment that conditions are normal. The normal is +rather a mean level about which oscillations to and fro, round and +about, are constantly taking place, but which itself is reached only +by accident, if at all. Whenever we say that some new factor should in +the long run lower the price of this or that commodity or service, the +picture which these words should convey to our mind is one of the +price rising less on times of boom, and falling more in times of +depression than is the case with other things. And if ever our faith +in some honored economic law is shaken by the apparent ease with +which, perhaps, in times of active trade, sellers are able to advance +their prices to whatever figure (so it almost seems) they choose to +name, let us rally our sense of economic rhythm, and reserve our +judgment until the trade cycle has run its course. + + + +CHAPTER III + +UTILITY AND THE MARGIN OF CONSUMPTION + + +Sec.1. _The Forces behind Supply and Demand_. The laws enunciated in the +preceding chapter constitute the framework and skeleton of all +economic analysis; but they do not carry us very far. It is only +through the agency of these laws that any influence can affect the +price of anything: but what influences may so affect it is a question +which we have still to consider. + +Let us begin with ordinary commodities and ask ourselves, in the light +of experience and common sense, upon what factors their price seems +mainly to depend? Two factors spring to mind at once; their cost of +production and their usefulness. As regards the former, the case seems +clear enough. We may indeed sometimes grumble that the price of this +or that commodity is unconscionably high in comparison with its cost; +but this only goes to show that we conceive a relation between price +and cost as the normal, governing rule. If one commodity cost only a +half as much to produce as another, we should think that something had +gone very wrong indeed, if the former commodity were sold for the +higher price. But, when we turn to the usefulness of commodities, the +case is not so clear. Usefulness has some connection with price, so +much is certain; for an entirely useless thing, fit only for the +dust-bin (and known to be such, it may be well to add) will fetch no +price at all, however costly it may be to produce. But it is not easy +to express the connection in quantitative terms. It seems reasonable +enough to say that the prices of commodities are roughly proportionate +to their costs of production. But directly we contemplate saying a +similar thing of their usefulness, we are pulled up short. As we look +round the world, and enumerate the commodities which by common consent +are the most useful, salt, water, bread, and so forth, the striking +paradox presents itself that these are among the cheapest of all +commodities; far cheaper than champagne, motor-cars or ball-dresses, +which we could very well get on without. As things are, of course, a +ball-dress, or a motor-car costs more to produce than a loaf of bread +or a packet of salt; and the common-sense explanation of the paradox +seems, therefore, to be that the cost of production is a more weighty +influence than the usefulness, or utility, as we will henceforth call +it (so as to include the satisfaction we derive from not strictly +useful things). We are thus tempted to conclude that, provided a +commodity possesses some utility, its price will be determined by the +cost of production, the degree of utility being unimportant. This was +exactly how the position was gummed up for many years in systematic +treatises upon Political Economy; and it was not until fully half a +century after the _Wealth of Nations_ that a discovery was made which +threw a fresh light on the whole matter. + +First of all, let it be clearly observed how very unsatisfactory is +the above account. In Chapter II where we were treading surely, with a +sense of solid ground beneath us, we drew no such invidious +distinction between supply and demand. They seemed then to possess an +equal status. But cost of production is the chief factor which, in the +case of commodities, ultimately determines the conditions of +supply. Utility, similarly, is the chief factor which ultimately +determines the conditions of demand. Must not then the symmetrical +relations between demand and supply be reflected in a corresponding +symmetry between the utility and the costs which underlie them? Demand +springs obviously from utility; the only motive for buying anything is +that it will serve some real or fancied use. Can we then accord to +demand so dignified and to utility so subordinate a place? There is +here an inconsistency which we must somehow reconcile. It will not +serve as a solution to distinguish between different periods of time, +and to say, as economists used to say not very long ago, that price is +governed over a short period by demand and supply, but in the long run +by the cost of production. This still leaves our sense of symmetry +unsatisfied. Moreover, the conception of cost of production, when we +consider it as ruling over a long period, frequently seems to lose any +precision, as an independent factor, which it may otherwise +possess. Motor-cars, we have agreed, are more costly to produce than +loaves of bread; but, as we know well, the cost of producing +motor-cars varies enormously, accordingly as they are produced on a +small or a large scale. By the methods of mass production they can be +turned out at a relatively low cost per car. But this requires that +they should be purchased in large numbers and this in turn throws us +back to the demand for motor-cars, and plainly enough, to people's +judgment as to their utility. In some cases, the opposite phenomenon +occurs. In the case of British coal, for instance, the average cost of +production would be much lower than it is if the output were reduced +to a fraction of its present volume, and if only the richer seams of +the more fertile mines were worked. Once again, therefore it is +difficult to measure the cost of production until we know the +magnitude of the demand, which in a manner, which we have still to +elucidate, clearly depends upon the utility. + +If we take the problem of joint products, the conception of cost of +production fails us still more conspicuously. For what is the cost of +producing wool, or the cost of producing mutton? We can speak of the +cost of rearing sheep: but it is hardly possible to allot this cost, +except quite arbitrarily, between the two products. How, then, can we +explain the separate prices of these things by reference to cost +alone? Instances of joint production are becoming so common in the +modern world, or at least, with the growing attention to the +utilization of by-products, are assuming so much more heightened a +significance, that an explanation of price, which does not apply to +them, is a very feeble one indeed. + + +Sec.2. _The Law of Diminishing Utility_. Let us turn back, then, to the +factor of utility, and see if we cannot put on a more satisfactory +basis the relation between utility and price. The clue to the puzzle +is to be found in a brief reflection on the implications of the second +general law propounded in Chapter II. A rise in price, it was there +stated, will sooner or later diminish the demand. This was asserted as +a matter of fact, observed from and confirmed by experience. But what +does it signify? To what causes is this familiar fact to be +attributed? The first stage of the answer is very ample. The many +individuals, whose purchases make up the demand for the commodity, +will buy smaller quantities now that the price is higher. Possibly +some of them may cease to buy it altogether; but as a rule it would be +reasonable to suppose that most people continue to buy a certain +amount though a smaller amount than hitherto. Let us turn our +attention, then, to the individual purchaser, and ask ourselves why he +(or let us say she) acts in the manner indicated. The obvious answer +is that the more she already has of anything, the less urgently does +she require a little more of it. If she buys 6 pounds of sugar every +week when the price is 7 cents a pound, but only 5 pounds when the +price is 8 cents, she shows by her action that she does not consider +that the additional utility she will derive from buying 6 pounds a +week rather then 5 pounds is worth as much as 8 cents. But she shows +at the same time that she thinks it worth 7 cents. For, when the price +is 7 cents, no one compels her to buy that sixth pound. She could +stop, if she chose, at five; and it may serve to make the point quite +plain if we suppose her actually to hesitate before she buys the +sixth. She has hitherto, let us say, been buying 5 pounds a week at 8 +cents. To-day she enters the shop and finds the price is down to 7 +cents. She asks for her customary 5 pounds; then she pauses, and a +minute later turns her order into six. What are the alternatives which +she has been weighing one against the other in that momentary pause? +Not the utility of the whole 6 pounds of sugar against the total price +of 42 cents. For she has already ordered the first 5 pounds; and the +decision to buy the sixth is taken independently and subsequently. She +has been sizing up the _increment_ of utility which a sixth pound +would yield, and she decides that this is worth the expenditure of a +further 7 cents. Again, when the price was 8 cents she need not have +bought as many as 5 pounds. She could have stopped at 4 had she +chosen, and the fact that she did buy 5 pounds shows that the +increment of utility derived from buying a fifth pound, when she might +be said already to have 4, was worth at least 8 cents in her judgment. + +This trite illustration enables us to lay down two important laws +relating to utility. To state them shortly, it is convenient to employ +one or two technical terms, which, unlike every term employed +hitherto, are not very commonly used in their present sense in +everyday life. Their adoption is desirable not merely for the sake of +convenience, but because they help to stamp clearly on the mind a most +illuminating conception, that of the "margin," which supplies the clue +to many complicated problems. The last pound of sugar which the +housewife purchased, the fifth pound when the price was 8 cents, or +the sixth pound when the price was 7 cents, we call the "marginal" +pound of sugar. And the increment of utility which she derives from +buying this marginal pound we call the "marginal utility" of sugar to +her. We are thus able to state the fact that the more a person has of +anything the less urgently does he require a little more of it, in the +following formal terms:-- + +LAW V. The marginal utility of a commodity to anyone diminishes with + every increase in the amount he has. + +The total utility will, of course, increase with an increase in the +amount, but at a diminishing rate. This law is usually called The Law +of Diminishing Utility. + + +Sec.3. _Relation between Price and Marginal Utility_ But this is not +all. We are now in a position to perceive the true relation between +utility and price. The relation is one which exists not between price +and total utility, but between price and marginal utility. If we know +only that a housewife will buy weekly 5 pounds of sugar at 8 cents per +pound, but 6 pounds at 7 cents, we know nothing of the total utility +of sugar to her. We do not know how much she might be prepared to pay +rather than go without 3 pounds, 2 pounds, or any sugar at all. But we +do know that, when she buys 6 pounds, the marginal utility of sugar is +in her judgment worth something which does not differ greatly from the +price. We can, therefore, say in general terms that the price of a +commodity measures approximately its marginal utility to the +purchaser. + +This statement is perfectly consistent with the paradox noted above +that the most useful commodities such as bread, salt and water are +very cheap. For when we say that these commodities are supremely +useful, we mean only that their total utility is very great; that, +rather than do without them altogether, we would offer for them a +large proportion of our means. But we would not value very highly a +small addition to the bread, water or salt that we habitually consume; +nor would most of us feel it as a very serious deprivation if our +consumption of these things were curtailed by a small percentage. In +other words, their _marginal_ utilities are small, and it is only the +_marginal_ utility that has any relation to price. + + +Sec.4. _The Marginal Purchaser_. A possible objection to the preceding +argument deserves to be considered. Some readers may find the picture +I have drawn of the hesitating housewife entirely unconvincing. They +may declare that her mind does not work at all in the manner I have +indicated. She will have formed certain habits in regard to her weekly +purchases of sugar, which are connected very vaguely, if at all, with +any conscious processes of thought. She will buy so many pounds of +sugar weekly without troubling her head over the specific utility of +the last pound she buys. When the price falls she may, indeed, buy +more; but it will not be because she separates out and considers by +itself the extra utility of an additional pound. She may buy more, +because she has formed the habit of spending so much money on sugar; +and now that the price has fallen, the same amount of money will +enable her to buy more pounds. Or, perhaps, she may be moved by +instinctive and irresistible attraction to buy more of a thing when it +is cheaper, similar to that which inspires so many people to face with +ardor the horrors of a bargain sale. In any case the fine calculations +I have imagined convey a fantastic picture of her state of mind. And +how much more fantastic, the critic may continue, of the state of mind +in which things of a different kind are bought by less careful +people. When, for instance, one of us happy-go-lucky males (more +liberally supplied, perhaps, than the housewife with the necessary +cash), decides to buy a motor bicycle, or to replenish his stock of +collars or ties, does the above analysis bear any resemblance to the +actual facts? In the case of the motor bicycle, the purchaser may, +indeed, weigh the price fairly carefully against the pleasure and +benefit, though contrariwise he may be a rich enough gentleman hardly +to bother about this. But, one motor bicycle is as much as he is at +all likely to buy, and what becomes, then, of the distinction between +total and marginal utility? In the case of the ties and collars, the +vagueness of many of us about the price will be extreme. We probably +have been uneasily conscious for some time of an inconvenient shortage +of these troublesome articles and eventually will go off (or perhaps +will be sent off with ignominy) to the nearest suitable shop to make +good the deficiency. How can we speak here with a straight face of the +relation between marginal utility and price? + +These are very pertinent criticisms; but they do not make nearly as +much nonsense of the notion of marginal utility as may seem at +first. The last point, indeed, serves rather to give it a fresh aspect +of much significance. Those of us who do not bother about the price we +pay for our ties and collars owe a debt of gratitude, of which we are +insufficiently conscious, to the more careful people who do; as well +as to the custom which prevails in shops in Western countries (as +distinct from the bazaars of the East) of charging as a rule a uniform +price to all customers. If _we_ were the only people who bought these +things, an enterprising salesman would be able to charge us very much +what he chose. He could put up his price, and we would hardly be aware +of it. And, as by lowering his price he could not tempt us to buy any +more, price reductions would be few and far between. But fortunately +there are always some people who do know what the price is, even when +they are buying collars and ties; and who will adjust the amount they +buy in accordance with the price. It is these worthy people who make +the laws of demand work out as we well know they do. It is they who +will curtail their consumption if the price has fallen and it is they +who constitute the seller's problem, and help to keep down prices for +the rest of us. The rest of us--it is well to be quite blunt about +it--simply do not count in this connection. We have no cause then to +plume ourselves that we have disproved the truth of economic laws when +we declare that we seldom weigh the utility of anything against its +price. All that this shows is that our actions are too insignificant +to be described by economic laws since they exert no appreciable +influence on the price of anything. And this in turn shows the extreme +importance of grasping clearly the conception of the margin. Just as +it is the marginal purchase, so it is the marginal purchaser who +matters. It is the man who, before he buys a motor bicycle, weighs the +matter up very carefully indeed and only just decides to buy it, whose +demand affects the price of motor bicycles. It is the utility which +_he_ derives that constitutes the marginal utility, which is roughly +measured by the price. + +As to the housewife, I am not prepared to concede that my picture is +in essentials very fanciful. She may be a creature of habits and +instincts like the rest of us, but most habits and instincts affecting +household expenditure are based ultimately on _some_ calculation, if +not one's own, and reason has a way of paying, as it were, periodic +visits of inspection, and pulling our habits and instincts into line, +if they have gone far astray. I am not satisfied that the housewife +does not envisage the utility of a sixth pound of sugar as something +distinct from the utility of the other five; she may buy it, for +example, with the definite object of giving the children some sugar on +their bread, and she may have a very clear idea as to the price which +sugar must not exceed before she will do any such thing. Possibly I +may exaggerate. I have the profound respect of the incorrigibly +wasteful male for the care and skill she displays in laying out her +money to the best advantage. + + +Sec.5. _The Business Man as Purchaser_. But if the reader still finds the +picture unconvincing, let us shift the scene from domestic economy to +commerce, and substitute for the careful housewife an enterprising +business man. Now, as anyone who has a business man for his father +will have often heard him say, the vagueness and caprice which +characterize our personal expenditure would be quite intolerable in +business affairs. There you must weigh and measure with the utmost +possible precision. You must be for ever watching the several channels +of your expenditure, careful to see that in none does the stream rise +higher than the level at which further expenditure ceases to be +profitable. You will not even engage typists or install a telephone in +your office without weighing up fairly carefully the number of typists +or the number of switches that it is worth your while to have. And in +deciding whether to employ say, five typists, or six, you will not +vaguely lump the services of the whole six typists together, and +consider whether as a whole they are worth to you the wages you must +give them. You will, in the most direct and literal manner, weigh up +the _additional_ benefit you would derive from a sixth typist, and if +that does not seem to you equivalent to her wage, you will not engage +her, however essential it may be to you to have one or two typists in +your office. If on the other hand, the utility of having a sixth +typist seems to you worth much more than her pay, the chances are that +you will be well advised to consider the employment of a seventh. And +so, where you stop employing further typists, the utility to you of +the last one, of the "marginal typist" as it were, is unlikely to +differ greatly from her pay. + +Now this is not a fancy picture of some remote abstraction called an +"economic man." Allowing for the over-emphasis which is necessary to +drive home the central point, it is a bald account of the aims and +methods of the actual man of business. To ascertain the margin of +profitable expenditure in each direction, to go thus and no further, +is the very essence of the business spirit, as the business man +himself conceives it. When he condemns the extravagance of Government +departments, it is their lack of just this marginal sense that he +chiefly has in mind. "The lore of nicely calculated less or more" may +be rejected by High Heaven and Whitehall, but no one can afford to +despise it in the business world. + +The transition from household to business expenditure involves an +extended use of the word utility, which is worth noting. Commodities +like bread, sugar, or privately owned motor-cars are sometimes called +"consumers' goods" in contrast to "producers' goods," which comprise +things such as raw materials, machinery, the services of typists and +so forth, which are bought by business men for business purposes. The +line of division between the two classes is not a sharp one, and we +need not trouble with fine-spun questions as to whether a particular +commodity should in certain circumstances be included under the one +head or the other. But, broadly speaking, things of the former type +yield a direct utility; they contribute directly to the satisfaction +of our pleasures or our wants. Things of the latter type yield rather +an indirect utility. Their utility to the business man who buys them +lies in the assistance they give him in making something else from +which he will derive a profit. The utility of these things is +therefore said to be _derived_ from that of the consumers' goods or +services to which they ultimately contribute. This conception of +derived utility leads to certain complications which we shall have to +notice later. + + +Sec.6. _The Diminishing Utility of Money_. But one important point must +be emphasized in this chapter. The utility which a business man +derives from the things which he buys for business purposes is the +extra receipts which he obtains thereby. Derived utility, in other +words, is expressed in terms of money, and the idea of its relation to +price presents no difficulty. But the utility of things which are +bought for personal consumption means the _satisfaction_ which they +yield, and this is clearly not a thing which is commensurable with +money. When, therefore, it is said that the prices measure their +respective marginal utilities, what exactly is meant? What was it that +the argument of Sec.3 went to show? That the utility of the marginal +pound of sugar would seem to the housewife just worth the price that +she must pay for it; in other words, that it would be roughly equal to +the utility she could obtain by spending the money in other ways. The +respective marginal utilities which _she_ obtains from the different +things she buys will thus be proportionate to their prices. But if she +were to receive a legacy which gave her a much larger income to spend, +she might buy larger quantities of practically every commodity; and, +though she would obtain a greater total utility thereby, the marginal +utility she would obtain in each direction would be smaller, in +accordance with the law of diminishing utility. The prices might not +have changed; the respective marginal utilities to her of the +different things would again be proportionate to their prices, but +they would constitute a smaller satisfaction than before. + +Thus we can only say that the prices of commodities will be +proportionate to their real marginal utilities, when we are +considering the different purchases of one and the same +individual. The amounts of money which different people are prepared +to pay for different consumers' goods are no reliable indication of +the real utilities, the amounts of human satisfaction which they +yield. Here we must take account not only of varying needs and +capacities for enjoyment, but of the very unequal manner in which +purchasing power is distributed among the people. The cigars which a +rich man may buy will yield him an immeasurably smaller satisfaction +than that which a poor family could obtain by spending the same amount +of money on boots, or clothes or milk. When, therefore, we compare +commodities which are bought by essentially different consuming +publics, their respective prices may bear no close relation to their +_real_ utility, whether marginal or otherwise. Thus the law of +diminishing utility applies to money or purchasing power, as well as +to particular commodities. The more money a man has the less is the +marginal utility which it yields him; and, where the marginal utility +of money to a man is small, so also will be the real marginal utility +he derives in each direction of his expenditure. The extreme +inequality of the distribution of wealth gives immense importance to +this consideration. Its practical implications will be discussed in +Chapter V. Meanwhile, we may express the conclusions of the present +chapter by the statement that the price of a commodity tends to equal +its marginal utility, _as measured in terms of money_, i.e. relatively +to the marginal utility of money to its purchaser. + + + +CHAPTER IV + +COST AND THE MARGIN OF PRODUCTION + +Sec.1. _An Illustration from Coal_. We have already had occasion to note +the symmetry which characterizes the relations of demand and supply to +price. This symmetry was apparent throughout the argument of Chapter +II, and it was a striking feature of the diagrams which we employed to +illustrate the argument. We shall do well to cultivate a lively sense +of this symmetry, for it will frequently save us from ignoring factors +which have a vital bearing on the problems we are considering. We +should never leave an important feature of demand without turning to +see whether it has a counterpart on the supply side, though indeed we +may not always find one. In the last chapter we examined the relation +between utility and price, and found that the true relation was +between the price and what we termed the marginal utility. +Corresponding to utility on the demand side is cost of +production on the supply side. The question should thus at once +suggest itself--"Can we speak appropriately of the marginal cost of +production, and will this serve to make clear the relation between +cost and price?" To answer these questions, let us take one of the +instances in which we found that price could not be explained +satisfactorily by the bare phrase "cost of production." + +An important feature of the coal industry, which recent events have +brought into sharp prominence, is the great diversity of conditions +between different coalfields and different collieries. We speak of +rich seams and poor seams, of fertile and unfertile mines, and we are +aware that the costs of raising coal to the surface differ very widely +in accordance with these diverse natural conditions. Nor must we +confine our attention to the cost price at the pit-head. If we wish to +speak of cost of production as a factor determining price, we must use +the term in a broad sense to include the transport and other charges +necessary to bring the coal to market. + +In this respect also one coalfield differs greatly from another. Some +are well situated close to a large market, or within easy reach of the +seaboard; others must incur very heavy transport charges to bring +their coal to any considerable centre of consumption. These varying +conditions lead, as we well know, to great variations in the financial +prosperity of different colliery concerns. In Great Britain, under the +abnormal conditions which prevailed during the war, and subsequently, +these variations were so huge as to constitute a most formidable +embarrassment and to contribute, more perhaps than any other single +factor, to the unrest and instability by which the industry has been +afflicted. But they are always with us, if usually upon a more modest +scale. + +What, then, is the normal relation between price and cost in the case +of coal? Should we direct our attention to the average costs over the +whole industry, or the costs incurred by the richer and better +situated mines, or, lastly, that of the poorer and worse situated? +Now, as things are, it is clear enough that no concern will continue +indefinitely producing at a loss. It may do so for a time, rather than +close down altogether, hoping to recoup itself later when the market +has taken a more favorable turn. But, in the long run, taking good +years with bad, it must expect to obtain receipts sufficient not only +to cover its necessary expenditure, but to provide also a reasonable +profit on the capital employed. Of course, once the capital has been +sunk and embodied in plant and buildings, which are of little use for +any other purpose, a business may continue for many years, with a rate +of profit far below what it had anticipated. But plant and buildings +gradually wear out, and need to be replaced; the course of technical +improvement calls continually for fresh capital outlay, which a +business in a bad way is reluctant to undertake. The tendency, +therefore, when profits rule low over a considerable period, is for +the plant to fall gradually into disrepair and obsolescence, and +finally for the business to disappear. We can thus include an +ordinary rate of profit under the head of cost of production, and say +with substantial accuracy that for no business can this cost for long +exceed the price if the business is to continue to exist. If then the +relatively poor and badly situated mines are to be worked, the price +of coal, taking good years together with bad, must cover the costs at +which these mines can produce. If the price rules lower than this, +sooner or later they will close down, and we will be left with a +smaller number of mines, among which great variations of conditions +will still prevail. Once more, the price must cover the cost incurred +by the least profitable of these remaining mines, unless their number +is still further to be diminished. Thus we can conceive of a "margin +of production" which will shift backwards to more profitable or +forwards to include less profitable mines, according as the demand for +coal contracts or expands. But, wherever this margin may be, there is +no escaping the conclusion that it is the cost of production of the +"marginal mines," of those that is to say which it is only just worth +while to work, to which the price of coal will approximate. + +It follows that there is no real connection between price and cost of +production throughout the industry as a whole. It follows incidentally +that those concerns which can market their coal at an appreciably +lower cost than the marginal concerns, are likely to reap more than an +ordinary rate of profit, though royalties may absorb part of the +excess. + + +Sec.2. _The Various Aspects of Marginal Cost_. This relation cuts much +deeper than the particular system under which the mines are at present +owned and worked. If, for instance, we supposed that the various +mines were amalgamated together in a few giant concerns, each of which +comprised some of the richer and some of the poorer mines, the +preceding argument would need to be recast in form, but its substance +would be unaffected. For though a great coal trust could in a sense +_afford_ to sell at a price lower than the marginal cost, setting its +losses on the poorer against its gains on the better pits, is it +likely it would do so? Why should it dissipate its profits in this +way? It is clearly more reasonable to suppose that it would close down +the poorer pits (unless it could advance the price of coal), and +thereby maintain its profits at a higher figure. If, indeed, the +mines were nationalized the deliberate policy might be pursued of +selling coal at a price which left the industry no more than +self-supporting as a whole. Some coal might thus be sold at less than +its cost price, and the selling price would conform roughly to the +_average_ cost. But such a policy, though in special circumstances it +might be justified, would represent a very dangerous principle, which +could not be applied widely without the most serious results. Nothing +could be more fatal to any enterprise, whether it be in the hands of +an individual, a joint-stock company, a State department, or a Guild, +than that the management should content themselves with results which +in the lump seem satisfactory, and regard losses here or there with an +indifferent eye. That way lies stagnation, waste, progressive +inefficiency and ultimate disaster. To inquire searchingly into every +nook and cranny of the business, to construct, as it were, for each +part a separate balance-sheet of profit and loss, to expand in those +directions where further development promises good results, and to +curtail activity where loss is already evident, is the very essence of +good management. Here, it will be observed, we are using language very +similar to that in which we described the principles which govern a +business man's expenditure. The resemblance is inevitable and +significant, for we are dealing here with what is essentially another +aspect of the same thing. The object is to secure that nowhere does +expenditure fail to yield a commensurate return. This we express, when +we consider a business in its aspect as a consumer, by saying that its +consumption of anything will not be carried beyond the point at which +the marginal utility exceeds the price it will have to pay. When we +consider it as a producer, we say that its production of anything will +not be carried beyond the point at which the marginal cost exceeds the +price it will obtain. + + +Sec.3. _The Dangers of Ignoring the Margin_. This at least is the general +rule. A business may decide deliberately to sell part of its output +below cost, because, for instance, this will serve as an +advertisement, bring it connections, and enable it to obtain a larger +profit at a later date, or immediately on other portions of its +sales. In so acting, it recognizes that the price obtained for a thing +may be an inadequate measure of the real return it yields. In the same +way, though for different reasons, a nationalized coal industry might +conceivably be justified in selling some coal below cost price, +because, let us say, it held that the price which the immediate +purchasers were willing to pay was an inadequate measure of the +utility of coal to the community as a whole. But in all such cases it +is essential to be very clear as to what exactly you are doing; so +that you may be at least moderately clear as to whether the policy is +well advised. It may be sound enough to lose on the swings and make +good this loss on the roundabouts, but only if your loss on the swings +_helps_ you to a larger profit on the roundabouts. If you would get +the same return on the roundabouts in any case, it would be better to +cut the swings out altogether. So, if you are directing the policy of +a nationalized coal industry, and decide to make a loss on a portion +of your sales, you will need to know that the indirect benefit which +the community will derive from this particular part of your coal +output is worth the loss which you incur. You will certainly come to +grief, if you pursue a vague ideal of lumping all results together, +and regarding a profit somewhere as a sufficient excuse or a positive +reason for making a loss elsewhere. + +It is quite true that in big undertakings, where there are large +standing charges, and where the organization possesses some of the +characteristics of an integral whole, it is not easy to measure +accurately the specific costs which should be assigned to any +particular portion of the output. But this difficulty is one of the +most serious weaknesses of large undertakings; precise detailed +measurement is the great prophylactic of business efficiency, and, +where it is lacking the bacilli of waste will enter in and +multiply. So clearly is this recognized, that the development of large +scale business has led to the evolution of new methods of accountancy, +designed to make detailed mensuration possible. We have most of us +heard of them vaguely under such names as "comparative costings," but +too few of us appreciate their full significance. It is hardly too +much to say that the issue as to whether the size of the typical +business unit will continue to become larger and larger, or whether it +has already overshot the point of maximum efficiency will turn largely +upon the capacity of accountancy to supply large and complex +undertakings with more accurate instruments of detailed financial +measurement. + + +Sec.4. _A Misinterpretation_. The price, then, of a commodity tends +roughly to equal its marginal cost of production; and this marginal +cost (in perfect symmetry with what we observed as regards marginal +utility), may be conceived as applying either to the marginal producer +or to the marginal output of any producer. In the former aspect it is +open to a misinterpretation, against which it will be well to guard. +Some advocates of socialism have argued, as one of the counts in their +indictment of the present industrial system, that the price of a +commodity is determined by the cost at which the least efficient +concern in the industry can produce. They say, in effect, "Under the +present competitive regime, you have to pay for everything you buy a +price which far exceeds the necessary cost to a concern which is +managed with ordinary ability. For, as economic theory has shown, it +is the cost of the _marginal_ concern, i.e. the concern managed by the +most incompetent, and half-witted fellow in the trade; it is the cost +incurred by him, together with a profit on his capital, that the price +has got to cover. The producer of no more than average capacity is +therefore making out of you a surplus profit, which would be quite +unnecessary in any well-arranged society." Such an argument is a gross +caricature of the marginal conception. The half-witted incompetent +will, as we know well enough, speedily disappear under the stress of +competition, and his place will be taken by more efficient men. There +is an essential difference between him and the "marginal coal mine" of +which we spoke above. For the probabilities are that of the coal +resources, whose existence is clearly known, the more fertile and +better situated parts will already be in process of exploitation; and +there is not likely, therefore, to be a supply of substantially better +seams which can be substituted for the worst of those in actual use. +There _is_ likely, on the other hand, to be available a supply of +decent business capacity which can be substituted for the most +inefficient of existing business men. The marginal concern, in other +words, must be conceived as that working under the least advantageous +conditions in respect of the assistance it derives from the strictly +limited resources of nature, but under average conditions as regards +managerial capacity and human qualities in general. Thus in +agriculture we can speak of a marginal farm, which we should conceive +as the least fertile and worst situated farm which it is just worth +while to cultivate (of which more will be said when we come to the +phenomenon of rent), but we must assume it to be cultivated by a +farmer of average ability. + + +Sec.5. _Some Consequences of a Higher Price Level_. The foregoing +controversy will be of service to us, if it makes clear the manner and +the spirit in which the marginal conception should be handled. It +should be regarded not as a rigid formula which we can apply to +diverse problems without considering the special features they +present, but rather as a signpost which will enable us to find our +way, a compass by which we may steer between the shoals of triviality +and sophistry to the crux of any problem with which we have to deal. +Let us illustrate its practical uses by an example which is of great +interest and far-reaching practical importance at the present day. As +has been already observed, the war has left behind it in all countries +a great and almost certainly permanent increase in nominal purchasing +power. Since the armistice prices have moved upwards and downwards +with unprecedented violence; and it would be very rash to prophesy the +precise level at which they will ultimately settle (using that word +with considerable relativity). But, for reasons for which the reader +is referred to Volume II in this series, it is safe enough to say that +the general level of post-war will greatly exceed that of pre-war +prices. Now this will apply not only to consumers' goods like milk and +clothes, or to raw materials like pig-iron and cotton, but in very +much the same degree to things like factories and machinery. Things of +this last type are sometimes called "capital goods," because it is in +them that a large part of the capital of a business is embodied. Now +the fact that it will cost much more than it did before the war to +construct fresh capital goods, has a significance which very few +people appreciate. An existing factory cost, let us say, $500,000 to +build and equip with machinery before the war. To construct a similar +factory to-day would cost, let us assume (it is probably a moderate +assumption) $1,000,000. Suppose 10 per cent to be the gross profit +that is necessary to attract capital to the particular industry. Then +it will not pay to construct this new factory unless the trade +prospects point to the probability of a profit of about $100,000 per +annum. But if the old factory is equally well managed, it too should +be able to earn this $100,000, which upon the capital actually sunk +would represent a rate of 20 per cent. The particular figures given +are, of course, purely illustrative; the conclusion to which they +point is that, if new enterprises are to be undertaken, pre-war +enterprises are likely to yield a rate of profit, on their fixed +capital at least, increased in rough proportion to the price-level. Of +course, in years when trade is bad, the factory which dates from +pre-war times will not earn a profit of this kind, it may very likely +make an actual loss. At those times it is very certain that few new +factories will be erected. But it is difficult to reconcile a +condition of trade activity, in which the constructional industries +are busily employed, with a rate of profit to pre-war businesses on +the fixed part of their capital of a lesser order of magnitude than +has been indicated. It makes no difference, it should be observed, +whether we suppose the new enterprises to take the form of starting of +new concerns or extending old ones; in neither case will they be +undertaken, unless there is reason to expect an adequate return on the +capital which they require at post-war constructional prices. High +profits (taking always good years together with bad) on capital sunk +before the war in buildings and machinery are thus a likely +consequence of an increase in the price-level. + +This fact is, indeed, the counterpart or complement of another +phenomenon with which we are more familiar. While prices are actually +rising, profits, as we have come to recognize, necessarily rule high, +because every trader or manufacturer is constantly in the position of +selling at a higher price-level, stock which he purchased, or goods +made from materials which he purchased at a lower level. He thus +acquires an abnormal profit on his circulating capital, which is +essentially similar to the profit on fixed capital, which we have just +examined. The difference is that the former profit is crowded into the +years when prices are actually on the increase, and thus is very +noticeable indeed; while the latter profit continues to accrue in +smaller instalments after prices have settled down, as it were, at the +higher level, and is not exhausted until the buildings and machinery +have become obsolete. But the two profits are essentially similar, +and in the long run should be commensurate. In the one case, stock can +be sold for a large profit, because it cannot be replaced except at a +higher price; in the other case, plant and buildings yield a higher +income because _they_ cannot be replaced except at a higher +price. Indeed, if the owners choose, the plant and building can, like +the stock, be sold at their appreciated value, as has been widely done +by the owners of cotton mills in Great Britain since the armistice. + +There is nothing in these considerations that should surprise us, or +even shock our moral sense. For what they have indicated is an +increase of money profits in rough proportion to the price-level, so +that the aggregate profits will represent about as much real income as +before.[1] The conclusion therefore amounts to no more than this, that +you cannot alter fundamentally the distribution of wealth between +labor and capital by merely inflating the currency, or otherwise +juggling with the price-level. And this is only what we should expect, +if there are any laws of distribution of sufficient importance and +permanence to justify the many volumes which have been devoted to +them. + +[Footnote 1: Assuming that the rate of interest has remained +unaltered. In fact it has greatly increased since pre-war days, and +this points to a still further increase of money profits, and an +increase in the real income which they represent. See Chapter VIII, +Sec.10] + +But this somewhat tame conclusion does not make it any less important +to grasp clearly the significance of the appreciation in the value of +capital goods. A failure to realize it lies at the root of our +bewildered muddling of many crucial problems of the day. In the matter +of housing, for instance, we know we cannot build houses at less than +two or three times their prewar cost, and yet we cannot endure to see +the owners of pre-war houses obtaining a commensurate increase of +rent. And so, in Great Britain, we pass Rent Restriction Acts, and +Housing Acts, and then, in a fit of economy we suspend the latter, and +let the former stand, while the housing shortage becomes steadily more +acute. When we hand the railways back from State control to private +hands, our horror at the idea of the companies receiving larger money +profits than they did before the war leads us to lay down principles +for the fixing of fares and freight charges, which take no account of +post-war construction costs; and then, in alarm lest we may have +thereby made it unprofitable for the companies to spend a single penny +of fresh capital upon further development, we seek to provide for +capital expenditure by cumbrous and dubious expedients. Doubtless we +shall muddle through somehow with such policies: and, public opinion +being what it is, they may perhaps have been about the best policies +that were practicable. But the problems would have been easier to +handle, if the public generally were a little less disposed to think +in terms of averages, and a little more in terms of margins, if we all +of us instinctively realized that the cost that really matters is the +cost at which additional production is profitable under the conditions +ruling at the time, or in the immediate future. + + +Sec.6. _General Relation between Price, Utility and Cost_. Let us +conclude this chapter by summing up the conclusions which have emerged +as to the relations of utility and cost to price. + +The price of a commodity is determined by the conditions of both +supply and demand; and neither can logically be said to be the +superior influence, though it may sometimes be convenient to +concentrate our attention on one or other of them. The chief factor on +which the conditions of demand depend is the utility (as measured in +terms of money). The chief factor on which the conditions of supply +depend is the cost of production (again as measured in terms of +money). The prevailing trend towards an equilibrium of demand and +supply can thus be expressed as follows:-- + +LAW VI. A commodity tends to be produced on a scale at which its + marginal cost of production is equal to its marginal utility, as + measured in terms of money, and both are equal to its price. + + + +CHAPTER V + +JOINT DEMAND AND SUPPLY + + +Sec.1. _Marginal Cost under Joint Supply_. Several references have been +made above to joint products, a relation which it will be convenient +now to describe as that of Joint Supply. Our sense of symmetry should +make us look for a parallel relation on the side of demand; and it is +not far to seek. There is a "joint demand" for carriages and horses, +for golf clubs and golf balls, for pens and ink, for the many groups +of things which we use together in ordinary life. But the most +important instances of Joint Demand are to be found when we pass from +consumers' to producers' goods. There, indeed, Joint Demand is the +universal rule. Iron ore, coal and the services of many grades of +operatives are all jointly demanded for the production of steel; wool, +textile machinery and again the services of many operatives are +jointly demanded for the production of woollen goods (to mention in +each case only a few things out of a very extensive list). Now we have +already noted that, when commodities are jointly supplied, there is an +obvious difficulty in allocating to each of them its proper share of +the joint cost of production. There is a similar difficulty in +estimating the utility of a commodity which is demanded jointly with +others. Thus, the utility of wool is derived from that of the woollen +goods which it helps to make. But the utility of the factories, the +machinery and the operatives employed in the woollen and worsted +industries is derived from precisely the same source. How much, then, +of the utility of woollen goods should be attributed to the wool and +how much to the textile machinery? Can we make any sense of the notion +of utility as applying to one of these things, taken by itself? And, +if not, how can we explain the price of a thing like wool in terms of +utility and cost, since we cannot disentangle its cost from that of +mutton, nor its utility from that of a great variety of other things? + +Here the conception of the margin enables us to grapple with a problem +which would otherwise be insoluble. For, while it is impossible to +separate out the total utility and cost of wool, it is not impossible +to disentangle its marginal utility and its marginal cost. The +proportion in which wool and mutton are supplied cannot be radically +transformed; but it can be varied within certain limits, by rearing, +for instance, a different breed of sheep. Variations of this kind have +been an important feature of the economic history of Australasia, +where sheep farming is the leading industry. Before the days of cold +storage, Australia and New Zealand could not export their mutton to +European markets, though they could export their wool. Wool was +accordingly much the most valuable product; the mutton was sold in the +home markets, where, the supply being very plentiful, the price was +very low. In the circumstances, the Australasian farmers naturally +concentrated on breeding a variety of sheep whose wool-yielding were +superior to their mutton-yielding qualities. The development of the +arts of refrigeration led in the eighties to an important change. It +became possible to obtain relatively high prices for frozen mutton in +overseas markets. There was, therefore, a marked tendency, especially +in New Zealand, to substitute, for the merino, the crossbred sheep +which yields a larger quantity of mutton and a smaller quantity of +wool of poorer quality. Now if we calculate the cost of maintaining +the number of merino sheep which will yield a given quantity of wool, +and calculate the cost of maintaining the larger number of crossbred +sheep which will be required to yield the _same_ quantity of wool +(allowing for differences of quality) the extra cost which would be +incurred in the latter case must be attributed entirely to the extra +mutton that would be obtained. This extra cost we can regard as +constituting the marginal cost of mutton. So long as this marginal +cost falls short of the price of mutton, it will be profitable to +extend further the substitution of crossbred for merino sheep. The +process of substitution will in fact be continued until we reach the +point at which the marginal cost is about equal to the price. +Similarly by starting with the numbers of merino and crossbred +sheep which would yield the same quantity of mutton, we can calculate +the marginal cost of wool; and again the tendency will be for this +marginal cost to be equal to the price.[1] + +[Footnote 1: It may be found difficult to grasp this point when stated +in general terms. The following arithmetical example may make it +plainer:-- + +Suppose a merino sheep yields 9 units of mutton and 10 units of wool. + +Suppose a crossbred sheep yields 10 units of mutton and 8 units of +wool. + +Suppose, further, that a merino sheep and a crossbred sheep each cost +the same sum, say, for convenience, L10, to rear and maintain; and +that there are no special costs assignable to the wool and the mutton +respectively, as, of course, in fact there are. + +Then 10 merino sheep, yielding 90 units of mutton + 100 units of wool, +cost L100; while 9 crossbred sheep, yielding 90 units of mutton + 72 +units of wool, cost L90. + +Hence you could obtain an extra 28 units of wool for an extra cost of +L10, by maintaining 10 merino sheep rather than 9 crossbred sheep. The +marginal cost of wool is thus L 10/28 per unit. + +Similarly 8 merino sheep, yielding 72 units of mutton + 80 units of +wool, cost L80; while 10 crossbred sheep, yielding 100 units of mutton ++ 80 units of wool, cost L100. + +Hence you could obtain an extra 28 units of mutton for an extra cost +of L20, by maintaining 10 crossbred sheep in place of 8 merinos. The +marginal cost of mutton is thus L 20/28 per unit. + +So long as the price obtainable for wool exceeds L 10/28, and that +obtainable for mutton does not exceed L 20/28 per unit, it will pay to +substitute merino for crossbred; and conversely. If the price of wool +exceeds L 10/28 and the price of mutton also exceeds L 20/28, it will +be profitable to expand the supply of both breeds, until as the result +of the increased supply, one of the above conditions ceases to +obtain. Conversely, if the prices of both products are less than the +figures indicated, sheep farming of both kinds will be restricted. +The resultant of the processes of expansion or restriction, and +substitution, will be that, unless one of the breeds is eliminated, +the prices of mutton and wool will equal their respective marginal +costs. These marginal costs may, of course, alter as the process of +substitution extends. For the relative cost of maintaining merinos and +crossbreds will not be the same for every farmer. Here again it is the +costs at the "margin of substitution" that matter.] + + +Sec.2. _Marginal Utility under Joint Demand_. On the side of demand there +exist as a rule similar possibilities of variation. _Some_ machinery, +_some_ labor, _some_ materials of various kinds, are all indispensable +in the production of any manufactured commodity. But the proportions +in which these factors are combined together can be varied, and are +frequently varied in practice as the result of the ceaseless pursuit +of economy by business men. To produce pig-iron, you need both coal +and iron ore; but, if coal becomes more costly, it is possible to +economize its use. Machinery and labor must be used together, in some +cases in proportions which are absolutely fixed. But there is in +nearly every industry a debated question as to whether the +introduction of some further labor-saving machine would be worth +while, or some improved machine which would represent the substitution +of more capital plus less labor for less capital plus more labor. A +farmer can cultivate his land, to use a common expression, more +intensively or less intensively; in other words, he can apply larger +or smaller quantities of capital and labor (the proportion between +which he can also vary) to the same amount of land. The problem is +essentially the same as that of the substitution of the crossbred for +the merino. We can take the various possible combinations of the +factors of production, and contrast two cases in which different +quantities of one factor are employed, together with equal quantities +of the others. The extra product which will be yielded in the case in +which the larger quantity of the varying factor is employed can then +be regarded as the marginal product (or marginal utility) of the extra +quantity of that factor; and we can say that the employment of this +factor will be pushed forward to the point where this marginal product +will be roughly equal to the price that must be paid for it. We can +thus lay down the most important proposition that the relation between +marginal utility and price holds good generally of the ultimate agents +of production; that the rent of land, the wages of labor, and, we can +even add, the profits of capital tend to equal their (derived) +marginal utilities, or, as it is sometimes expressed, their marginal +net products. + +Whenever, therefore, the proportions in which two or more things are +produced or used together can be varied, the relations of joint supply +and joint demand are perfectly consistent with a specific marginal +cost and marginal utility for each commodity. + + +Sec.3. _A contrast between Cotton and Cotton-seed, and Wool and +Mutton_. But it sometimes happens that such variations cannot be +made. Thus, it has not been found possible (so far as I am aware) to +alter the proportions in which cotton lint and cotton-seed are yielded +by the cotton plant. Roughly speaking, you get about 2 pounds of +cotton-seed for every 1 pound of cotton lint (or raw cotton), and +though this proportion may vary somewhat from plantation to +plantation, it is upon the knees of the gods, and not upon the will of +the planter that the variation depends. We cannot, therefore, speak +with accuracy of the separate marginal costs of raw cotton and +cotton-seed. It is true that some plantations are so far distant from +any seed-crushing mill that it is not worth while to sell the seed as +a commercial product; and it might seem, therefore, as though we might +regard the entire costs of cotton growing on _such_ plantations as +constituting the marginal costs of raw cotton. But planters, so +situated, derive a considerable value from their cotton-seed by using +it as fodder for their live stock or as a manure. You can, of course, +argue that proper allowance is automatically made for this factor, as +a deduction from the costs of raw cotton, when you add up the expenses +of the plantation. In the same way you can deduct the price which a +planter who sells his cotton-seed obtains for it, from the total costs +of the plantation, and call the remainder the costs of the raw +cotton. But this is really to reason in a circle. For in either case +the magnitude of the deduction depends on the marginal utility of the +cotton-seed. And the notion of the cost of anything becomes blurred +and blunted if we so use it that it must be deduced from the utility +of something else, which is not an agent in the production of the +thing in question. + +This point is not merely an academic one. It means that we cannot +explain the _relative_ prices of cotton lint and cotton-seed in terms +of cost at all, whether marginal or otherwise. The influence of cost +will be confined to the _sum_ of the prices of the two things. Upon +this sum it will exert precisely the same influence as it exerts upon +price in general, by affecting the total quantities of the two things +that will be supplied. But upon the distribution of this sum between +lint and seed, cost will exert no influence whatever, because it +cannot affect the proportions in which they are supplied. It may +assist some readers if I state the matter in more concrete terms. Cost +of production will be one of the factors which will result in the +production of an annual cotton crop in the United States of, let us +say, 10 million tons of seed cotton. This crop will yield roughly +6-2/3 million tons of cotton-seed, and 3-1/3 million tons (or rather +more than 13 million bales) of lint. The combined price received by +the planter of (let us say) 14.4 cents for 1 pound of lint plus 2 +pounds of seed should correspond roughly to the marginal joint costs +of production. But the factor of cost has no influence at all in +determining that this combined price is made up of a price of 12 cents +per pound for lint, and only 1.2 cents per pound (or $24 per ton) for +cotton-seed. To account for this we must rely entirely upon demand. We +can say, shortly, that the respective prices must be such as will +enable the demand to carry off 6-2/3 million tons of seed, and 3-1/3 +million tons of raw cotton. Or we can go further and say that the +marginal utility of a pound of raw cotton, when 3-1/3 million tons are +supplied, is ten times as great as that of a pound of seed when 6-2/3 +million tons are supplied. + +If accordingly the demand for cotton-seed were to expand considerably +owing, say, to the discovery of some new use for the oil, which is its +most valuable constituent; the effect would be first a rise in the +price of cotton-seed, and, subsequently, by stimulating cotton +growing, a more plentiful supply and a lower price for raw cotton. And +so far at least as the increased supply is concerned, this must +necessarily be the effect, "other things being equal"; though, to be +sure, it might be outweighed and obscured by other influences such as +the boll-weevil. But it is _not_ the case that an increased demand for +mutton must necessarily increase the supply or lower the price of +wool; and it is most unlikely to do so in any similar degree. For, +here, the separate marginal costs of the two things exert their +influence. An increased demand for mutton will stimulate sheep +farming, but it will also stimulate the substitution of crossbred for +merino breeds; and the resultant of these two opposite tendencies upon +the supply of wool is logically indeterminate. As a matter of history +we know that the development of cold storage in the eighties (which we +may regard for the present purpose as equivalent to an increased +demand for Australian mutton) caused considerable perturbation in the +woollen and worsted industries of Yorkshire. They were faced with a +dwindling supply and a soaring price of merino wool; and the +adaptability with which they met the situation, and won prestige for +the crossbred tops, and yarns and fabrics, to which they largely +turned is a matter of just pride in the trade to-day. The fact, +however, that this alteration in the supply of wool was a matter not +only of quantity but of quality, while it takes nothing from the +substance of the preceding argument, makes it difficult to draw a +clear moral, bearing on the present issue, from this incursion into +history. + + +Sec.4. _The Importance of being Unimportant_. The above contrast between +cases in which variation is possible, and those in which it is not +possible, is reproduced with a heightened significance when we turn +back to joint demand. The cases are perhaps less common in which it is +_impossible_ to alter the proportions in which different commodities +are jointly demanded, but there are many cases in which it is not +nearly worth while to do so (and this amounts to very much the same +thing). Cases of this sort are especially likely to occur when we are +dealing with a commodity which accounts for only a tiny fraction of +the costs of the industry which is its chief consumer. Sewing cotton, +for example, is jointly demanded, with many other things, by the +tailoring and other clothing trades; but the money which these trades +spend on sewing cotton is so small a part of their total expenditure, +that no ordinary variation in its price is likely to make it worth +while to study the ways and means of using it in smaller +quantities. When sewing cotton is bought by the domestic consumer, +considerations which are fundamentally the same, though somewhat +different in form, point to a similar conclusion. It is thus very +difficult to assign to sewing cotton a specific marginal utility. This +difficulty is of great importance in connection with the possibilities +of monopolistic exploitation. For it means that the demand blade of +the scissors upon which we rely to cut off excrescences of price is +blunted, and if accordingly the producers constitute a strong enough +combination to control the supply blade, they will possess an unusual +power of advancing their selling prices as they choose. I am far from +suggesting that Messrs. J. & P. Coats are to be condemned as an +extortionate monopoly. On the contrary, during 1919, when the profits +in highly competitive industries like the main branches of the cotton +and woollen trades, soared exuberantly, the record of this concern +seems to me one of distinct moderation. But the present point is that +they possess an exceptional _power_ to fix the price of sewing cotton +as they choose, and that this is attributable in no small degree to +the fact that sewing cotton constitutes an essential but relatively +trifling item in the expenses of the processes in which it is +employed. + +Perhaps the point will be made clearer if we turn from the selling +prices of commercial products, in regard to which there is a strong +and not ineffective public sentiment against "profiteering," to the +remuneration of different classes of labor. With an instinctive +disposition towards megalomania, it is often claimed in Great Britain +that the miners, being a very numerous and well-organized body of +workpeople, were in a stronger strategic position than most workpeople +for exacting the remuneration they desire. It is quite true that a +stoppage of work in the coal industry causes us a high degree of +inconvenience, and temporary concessions may thereby be obtained which +might otherwise have been refused. But this is a dubious advantage, +and we grossly exaggerate its real importance. The truth is that the +strategic position of the miners in regard to wages questions is by no +means strong. For their wages constitute a very large percentage of +the cost of coal; and the price of coal in its turn is a most +important element in the costs of many of the industries which are its +principal consumers. Great Britain, moreover, is far from possessing +a monopoly of coal. If, accordingly, the wages of the miners are +temporarily pushed up to a high point, the result will certainly be a +diminished demand for British coal, which will lead before long to +their fighting a losing battle to maintain the concessions they have +won. Contrast their position with that of the steel smelters, whose +wages (high though the wage rates are) constitute a very small +percentage of the costs of steel production, and we must agree I think +that we have in this distinction the main reason why the steel +smelters, though they hardly ever go on strike, have as a rule been +able to do so much better for themselves than the miners. + +When a commodity or service is such that an appreciable alteration in +its price has only a slight effect upon the quantity demanded, the +demand is said to be _inelastic_. Conversely, when a small change in +price greatly alters the quantity demanded, we call the demand +_elastic_. In the former case, it is worth nothing, a larger aggregate +sum of money will be spent upon the thing when its price is high than +when it is low, while the opposite is true in the latter case. This +distinction is of considerable importance in connection with many +problems (e.g. of taxation); and the terms, elastic demand and +inelastic demand, are worth remembering. We may thus express the +above conclusions by saying that the demand for sewing-cotton is +highly inelastic, and that the demand for coal miners is more elastic +than that for steel smelters. + + +Sec.5. _Capital and Labor_. Cases in which it is impracticable to make +any variation in the proportions in which different things are used +together are, however, the exception rather than the rule. Where +variation is possible, we are confronted with an uncertainty as to the +way in which an increased supply of one thing will react on the demand +for another, similar to our uncertainty as to whether an increased +demand for mutton would augment or diminish the supply of wool. It is, +for instance, of the highest importance to give a clear answer, if we +can, to the question whether an increased supply of capital will +increase the demand for labor. The chief effect of an increased +supply of capital is to facilitate the extended use of expensive +machines: to some extent these machines will increase the demand for +labor; to some extent they will be substituted for it. Which of these +two tendencies will outweigh the other we cannot be absolutely +sure. But fortunately we can be far more nearly sure than was possible +in the analogous case of wool and mutton. An increase in the supply of +capital increases the demand for the commodities, from which the +demand for labor is derived, in both the senses discussed in Chapter +II. First it makes them cheaper to buy, and thus increases the +quantity that will be bought. It is this that is parallel to the +effect of an increased demand for mutton in making it more profitable +to breed sheep. But it also serves to increase the purchasing power +with which to buy commodities, because it increases the aggregate real +wealth of the community, and it thus serves to raise the whole demand +curve. This last consideration is so important as to make it +overwhelmingly probable, apart from the evidence of history, that an +increase in the supply of capital (and the same may be said of an +increase in the supply of the other agents of production) will on +balance increase the demand for labor. The evidence of history points +to the same conclusion. The history of the last hundred years displays +an unprecedented accumulation of capital, and an unprecedented +extension of machinery, associated with an unprecedented improvement +in the standard of living throughout the whole community. This is +powerful testimony in favor of the view that an increase in the supply +of capital and the use of machinery will usually enhance on balance +the demand for labor. Moreover, though this is not conclusive, there +is little room for doubt that an obstructive attitude towards the +extension of machinery in a particular country, or a particular +district, is misguided. For its effect must be to make production +more costly there than it is elsewhere, and to lead, slowly perhaps, +but very surely, to the transference of the industry to other regions. + + +Sec.6. _Conclusions as to Joint Supply and Joint Demand_. Here, however, +we are beginning to digress. Let us sum up in a general form our +conclusions as to the way in which changes in the supply or demand of +a commodity react upon the demand or supply of the other things with +which it is jointly demanded or supplied. Everything turns, as we have +seen, on the possibility of variation in the proportions in which the +things are used or produced together; and this, it is also clear, is a +matter of degree. Our conclusions, therefore, had best take the +following form:-- + +LAW VII. When two or more things are jointly demanded, in proportions + which cannot easily be varied, the tendency will be for an increase + (or decrease) in the supply of one of them to increase (or + decrease) the demand for the others. These results will be more + certain, and more marked, the more difficult it is to vary the + proportions in which the things are used. + + Similarly, when two or more things are jointly supplied, in + proportions which cannot easily be varied, the tendency will be for + an increase (or decrease) in the demand for one of them to increase + (or decrease) the supply of the others. These results again will be + more certain and more marked, the more difficult it is to vary the + proportions in which the things are supplied. + + +Sec.7. _Composite Supply and Composite Demand_. Joint Demand and Joint +Supply do not complete the list of relations between the demand and +supply of different things. Between tea and coffee, or beef and mutton +there is a relation of a different kind. These things are in large +measure what we call "substitutes" for one another. An increased +supply, and a lower price of mutton, will probably induce us to +consume less beef. This relation it is convenient to describe as +Composite Supply. Beef and mutton make up a composite supply of meat; +tea and coffee a composite supply of a certain type of beverage. For +any group of things, between which the relation of Composite Supply +exists, we can say, with complete generality, that an increased supply +of one of them will tend to diminish the demand for the +others. Parallel to the relation of Composite Supply is that of +Composite Demand. There are frequently several alternative uses in +which a commodity or service can be employed; and these alternative +uses make up a composite demand for the thing in question. Thus +railways, gasworks, private households and a great variety of +industries contribute to a Composite Demand for coal. It is worth +noting that there is frequently an association in practice between +Joint Demand and Composite Supply on the one hand; and between Joint +Supply and Composite Demand on the other. Wool and mutton, for +instance, we have described as an instance of Joint Supply; but, in so +far as the proportions of wool and mutton can be varied, we can regard +these things as constituting a Composite Demand for sheep. And this +conception may help us to retain a clearer and more orderly picture of +the problems we have discussed above. We can regard the fact that wool +and mutton are produced together as their Joint Supply aspect, and the +fact that these proportions can be varied as their Composite Demand +aspect; and the question as to whether an increased demand for mutton +will increase the supply of wool turns upon whether the former aspect +is more important than the latter. Similarly labor and machinery, +employed together for the same purpose, form an instance of Joint +Demand; but in so far as they can be substituted for one another, they +constitute a Composite Supply of alternative agents of production. + +These four relations of Joint Demand, Joint Supply, Composite Demand +and Composite Supply are well worth remembering and distinguishing +from one another. They are of immense importance in every branch of +economic affairs. There are hardly any economic problems upon which we +are fitted to express an opinion, unless we have a lively sense of the +far-reaching ramifications of cause and consequence, of the subtle and +often unexpected interconnections between different industries and +different markets. To gape at these complexities in a confused stupor +is as foolish as it is to ignore them. But confusion and stupor are +only too likely to represent our final state of mind, if we attempt to +deal with these complications, one by one as they occur to us, in a +piecemeal and haphazard fashion. We need a clear method, a systematic +plan by which we may search them out, and fit them into place. The +four relations which we have enumerated supply us with such a plan and +method. For they represent something more than a series of pompous +names for familiar notions. They constitute a classification of the +various ways in which the demand and supply of one thing can affect +the demand and supply of others; a classification which is exhaustive +when we add the relation of derived demand, and an analogous relation +on the supply side which we must now notice. + + +Sec.8. _Ultimate Real Costs_. Just as the utility of "producers' goods" +is derived from that of the "consumers' goods" which they help to +make; so the cost of any commodity is derived from the cost of the +things which help to make it. Moreover, just as we recognize that the +utility of "consumers' goods" lies at the back of all demand, and +constitutes the ultimate end of all production; so we cannot but feel, +however obscurely, that behind the phenomena of money costs, there +must lie certain ultimate costs, of which all money costs are but the +measure. But when we try to explain what the nature of these real +costs may be, we are plunged in difficulty. Wages, it may indeed seem +at first sight, present no trouble. There is the effort and the +fatigue, the unpleasantness of human labor, to represent real +costs. But can we suppose that these things are measured with any +approach to accuracy by the wages which are paid in actual fact? Is it +true, even as a broad general rule, that the services which are most +arduous and most disagreeable command the highest price? And wages are +not the only ingredient of money costs. There are profits: to what +real costs do profits correspond? More difficult still, to what does +rent correspond? These plainly are not questions upon which he who +runs may read. It will be necessary to devote the next four chapters +to their elucidation. + + + +CHAPTER VI + +LAND + + +Sec.1. _The Special Characteristics of Land_. In the great process of +co-operation by which the wants of mankind are supplied, Nature is an +indispensable participant. She renders her assistance in an infinite +variety of ways, of which the properties of the soil which man +cultivates form only one; but the sunshine and rain which enable the +farmer to grow his crops; the coal and iron ore beneath the surface of +the earth, can be regarded for our present purpose as forming part of +the land with which they are associated. We can thus concentrate upon +land as the representative of the free gifts of nature, which are of +economic significance. Land in modern communities is for the most part +privately owned. It can be bought and sold for a price, and acquired +by inheritance. Moreover, it is a common practice, particularly in the +United Kingdom, for an owner who does not wish himself to cultivate or +otherwise use the land, not to sell it to the man who does, but to +lease it to him for a term of years for an annual payment which we +term rent. It is therefore natural and convenient to envisage the +problems, which we shall consider in this chapter, as problems +concerning the price and rent of land. But, once again, the laws and +principles which we shall state and illustrate in terms of the current +systems of ownership and tenure, possess a much deeper significance +than this terminology might suggest. + +The fact that land is a free gift of Nature distinguishes it in +various ways from commodities which are produced by man. The +peculiarities which are most important from the economic standpoint +are (1) that the supply of land is, broadly speaking, fixed and +unalterable, and (2) that its quality and value vary, from piece to +piece, with a variation which is immense in its range, but fairly +continuous in its gradation. These are thus two aspects from which +the phenomena of price and rent can be regarded; aspects which it is +usual to call, (1) the scarcity aspect, (2) the differential aspect. + + +Sec.2. _The Scarcity Aspect_. The fact that the supply of land is fixed +has the following significance. If the demand for land increases, the +price will tend to rise. This is also true, for a short period at +least, of an ordinary commodity. But, in the latter case, there would +ensue an increase in supply which would serve to check the rise in +price, and possibly, if production on a larger scale led to improved +methods of production, bring the price down eventually below its +original level. In the case of land, no such reaction is +possible. There is nothing, therefore, to restrain the price (and the +rent) of land from rising indefinitely, and without limit, if the +demand for it should continue to increase. Conversely, if the demand +for land falls off, there is nothing to check the consequent fall in +price and rent. In the case of ordinary commodities, the supply would +be diminished, because most things are either consumed by being used, +or wear out in the course of time, and a regular annual production is +therefore necessary to sustain their supply at the existing level. But +land remains, whether it is used or not; and its supply is, broadly +speaking, just as incapable of being diminished, as it is of being +increased. Changes in the demand for land in either direction are thus +likely to affect its price in a much greater degree than that in which +the price of an ordinary commodity will be affected by a corresponding +change in its demand. + +For most purposes, however, it is of more interest to compare land +with other agents of production, especially with capital and labor, +rather than with ordinary commodities. Now, as we have already noted, +there is some doubt as to the manner in which the supply of capital or +labor is likely to be affected by alterations in demand price. But the +supply of capital and the supply of labor, even if we suppose them to +be as entirely unresponsive to price changes as is the supply of land, +are at any rate not fixed. Not only _may_ they vary for many reasons, +but they are in fact likely to vary in direct proportion to the +population. An increase in population implies an increase in the +supply of labor; and it is likely to be accompanied by an increase in +the supply of capital; in other words, the supply of these agents will +expand, as the demand for them expands. But the supply of land will +remain what it was. This fact is enormously important in connection +with the broad problem of population, which will form the theme of +Volume VI. + +But it is important also in other connections. It has been the +dominating factor in many absorbing controversies upon high policy +regarding the ownership of land, or the taxation of land values, upon +which we can touch but lightly here. It has seemed to many writers a +reasonable proposition to lay down, that the ordinary course of the +progress of society, the increase of population and industry, must +mean, as a broad general rule, a constant increase in the demand for +land. And, if that be granted, it seems to follow that the price and +rent of land will tend constantly to increase. John Stuart Mill, +accordingly, in the middle of the last century, asserted that "the +ordinary progress of a society, which increases in wealth, is at all +times tending to augment the incomes of landlords; to give them both a +greater amount and a greater proportion of the wealth of the +community, independently of any trouble or outlay, incurred by +themselves,"[1] and upon the strength of this assertion, he justified +the policy of imposing a special tax upon what we have come to call +the "unearned increment" of land. But how far does actual experience +bear his assertion out? In Great Britain we have seen in the last +half-century an undoubted increase in urban rents; but over long +periods at least, there was a marked fall in both the prices and rents +of agricultural land, despite the fact that the country was +"increasing in wealth" as rapidly as ever before. This was due, of +course, in the main to the increased supplies of wheat and other +foodstuffs coming from the New World: and if, accordingly, we choose +to lump together not only our own urban and agricultural land, but the +land of other countries as well, and to speak vaguely of the demand +for land as a whole, it might seem as though we could argue that +Mill's generalization still holds good. But even this is by no means +certain and in any case such a generalization is of very little +service: what the illustration should rather suggest to us, is the +danger of speaking of land vaguely as a whole, and the importance of +turning our attention to the variations in value between different +kinds and different pieces. + +[Footnote 1: _Principles of Political Economy_, by John Stuart Mill.] + + +Sec.3. _The Differential Aspect_. Most ordinary commodities are not +produced on a single, uniform pattern. As a rule there are many +variations of grade and quality, and consequently of price. But these +variations are usually designed to meet the differences of taste among +the purchasers, and we do not expect to find that any variety of an +ordinary commodity will be produced, which is so poor in quality as to +be entirely valueless. But since it is nature which has produced the +land, without any assistance or guidance from man, there are many +pieces of land which are so unfertile, or are otherwise so unsuitable +for productive purposes, as to be quite valueless from the economic +standpoint. Even in a densely populated country like Great Britain, +there are considerable tracts of land which it is unprofitable to +employ for any economic purpose whatsoever, and which possess no +further value than what the mere pride of ownership may give +them. This fact makes it possible to apply the conception of the +margin to the case of land with particularly illuminating results. + +In the first place, however, it should be observed that the value of +any piece of land does not depend solely on the intrinsic fertility of +the soil. The fact that land is an immobile thing makes its +_situation_ a factor of great importance. In the case of urban land, +situation is, of course, the only thing that counts. The value of a +site in Bond Street or the City is entirely unaffected by its capacity +or incapacity for potato-growing purposes. But even for agricultural +land, situation is a most important matter. A farm, which is so remote +that considerable transport charges must be incurred to bring its +produce to market, will be less sought after, and less valuable, than +one which is much better situated though somewhat less fertile. In +what follows, therefore, we must speak of the "quality" of a piece of +land in a broad sense to include advantages of situation, as well as +of fertility. Let us now, imagine the different pieces of land in +Great Britain to be arranged in order of quality, so that we have a +long series, with land of the best quality at one end, and of the +poorest quality at the other. At the latter end, we will have such +land as is found near the top of Snowden or Ben Nevis, which it +clearly does not pay to cultivate at all. Somewhere, then, between +these two extremes, we shall come to a point where the land is just, +but only just, worth cultivating, or where, to revert to a form of +words we previously employed, it is a matter of _doubt_, whether the +land is really worth using for a productive purpose. Such land we can +regard as the "marginal land"; and since the variety of nature is at +once infinite and fairly minutely graduated we shall probably find +that on one side of this margin there is much land which is only +slightly superior, and on the other, much which is only slightly +inferior, to the marginal land itself. What, then, is likely to be the +value and the rent of this marginal land, this land which is just on +the "margin of cultivation"? Some readers may find the answer +startling. The rent of the marginal land will be nil, because it will +not pay to cultivate it, if any appreciable rent is charged. A piece +of land for which it is worth a tenant's while to pay an appreciable +rent, will not be the marginal land, because there will be land just +slightly inferior to it which it will also pay to cultivate if a +somewhat lower rent is charged. And so we can pass to poorer and +poorer qualities of land, with an ever diminishing rent, until at the +margin of cultivation the derived utility of the land is negligible +and the rent vanishes. + +This certainly is a somewhat abstract conception; but it is by no +means so remote from reality as may at first sight appear. The reader +may protest that in the course of an extensive and varied acquaintance +with landowners, he has not yet run across this peculiar marginal +type, who lets his land for no rent at all. But there, if his +experience is really extensive, I think he is mistaken. It so happens +that the ordinary agricultural landowner leases out his land, not by +itself, but together with a variety of other things such as farm +buildings, which it costs him a considerable sum of money to +provide. He will not as a rule be willing to go to this expense, +unless he sees his way to obtain for the farm an annual payment, which +represents at least a fair return on this capital outlay, as big a +return as he could have got, for instance, by investing the same +amount of money in some gilt-edged security. This annual payment +will, it is true, be called rent; but the significance of this is that +what we term rent in ordinary life is usually a complex thing, made up +of two essentially distinct elements, viz. the normal return on the +capital goods supplied together with the land, and what we may call +the "net rent," or the "pure rent" attributable to the land +itself. Now will any reader make so bold as to say that there is no +land under cultivation, in respect of which this net rent is either +nil or negligible? The landowners will not agree with him. It is not +a question, it should be observed, as to whether the rent obtained +represents more than a fair return on the purchase price paid for the +land; that is quite another matter. The question is whether the rent +obtained exceeds a fair return on the capital sum spent on the +buildings, etc.; with which every farm must be equipped to let at +all. In fact there are not a few farms where there is no such excess, +and where accordingly there is no "net rent" or "pure rent" which can +be attributed to the land. + +The question whether it would be profitable to cultivate any piece of +land, turns upon whether the receipts which would be obtained by +selling the produce would exceed the costs of cultivation: and under +these costs of cultivation we must include, of course, the +remuneration of the farmer's services. Farmers, like other people, +have to live; and they would not take on the troublesome job of +farming, unless there seemed a prospect of making a living out of +it. The remuneration of the farmer takes, of course, the form not of a +salary, but of profits: and these profits vary very much from year to +year, and from place to place, and from man to man. But they are +essentially payment for work done, and an ordinary profit must be +regarded therefore as part of the necessary costs of farming. Thus it +will not be worth while to cultivate a piece of land, and the land +will in fact lie unused, upon which a careful farmer might obtain a +profit in the ordinary sense, of no more than $50 or $100 a year. The +marginal land will be land which yields a decent profit to a decent +farmer, as well as a gross rent to the landowner, sufficient to +compensate him for his capital outlay, but nothing further. + +What, then, will be the rent of a fertile and well-situated farm, +about which there is no doubt that it is well worth cultivating? Part +of the gross rent which the landowner receives must again be regarded +as merely a return for the capital expended in equipping the farm for +use; but in this case, there will be a residue left over, which +constitutes the net rent of the land. The net rent will measure the +derived utility of the land to its occupier, and will in general +represent (very roughly, of course, in practice) the differential +advantage of cultivating the land in question rather than land on the +"margin of cultivation." This differential advantage may take either, +or both, of the forms, of a larger produce per acre, or a lower cost +of production and marketing. But, in any case, the extra profit, +which, if no rent were charged, a decent farmer could obtain by +cultivating the farm in question, rather than a marginal farm, will be +roughly equal to the net rent which his landlord can exact from him, +if his landlord so chooses. The landlord may, of course, not choose to +exact a rent as high as this; and as a matter of fact, in a country +like Great Britain landlords often content themselves with less. The +traditions associated with the ownership of agricultural land, and +with the relations between landlord and tenant serve to soften the +edge of economic law, and to subject the rents which are actually +fixed to the control in no small measure of the general sense of what +is fair or customary. In such cases the landlord makes the farmer a +present, for the time being, of part of the economic rent. On the +other hand, as Irish agrarian history well illustrates, the landlord +may sometimes expropriate under the name of rent, permanent +improvements which are due to the labors or the expenditure of the +tenant. This is, of course, particularly likely to happen, whenever it +is the custom to leave to the tenant the obligation of providing the +capital equipment of the farm, which in Great Britain is, for the most +part, the recognized duty of the owner. Again, in the case of urban +land in the South of England, expropriations of this kind are an +essential and well-understood feature of the leasehold system. The +owner grants a lease for a long period of time, usually ninety-nine +years, for a ground rent, which is notoriously below the true economic +rent of the land, subject to the condition that the leaseholder must +erect upon the land and keep in good repair certain buildings, which +on expiry of the lease will become the property of the ground +owner. Here the nominal ground rent is only part of the total rent +which is really paid; the ultimate transference of the buildings +representing often the more important part. There is, in fact, a great +variety of systems of land tenure, some of which are highly complex, +the respective merits of which vary greatly, and which constitute a +most important problem for statesmen and legislators. Considerations +of this kind in no way diminish the importance of the general analysis +of rent, which we are pursuing in the present chapter. Rather they +make it the more important, because we cannot properly weigh the +merits of any system of land tenure, until we have grasped clearly the +principles governing the rent of land in the purest form. But +certainly we must never forget that the rent we are discussing may +differ very greatly from, though it will vitally influence, the money +payments which are called rent in actual life. It is the pure economic +rent, the rent which represents the _full_ annual payment which it +would be worth paying to obtain the use of the land alone, which will +measure, as we have said, the differential advantage of the land in +question over land on the margin of cultivation. + +A clear grasp of this relation helps us to perceive that an increase +in the prosperity of the community may sometimes influence rents in an +unexpected way. It all depends on the causes which have given rise to +the increased prosperity. An advance, for instance, in agricultural +science will facilitate a more abundant supply of foodstuffs; but it +will not necessarily increase the aggregate rents of agricultural +land. For if it takes the form, say, of the discovery of some new +artificial manure, it will very likely facilitate production on the +less fertile soils far more than it will on the more fertile soils +where artificial manures are not so necessary. It will thus tend to +diminish the differential advantages of working on the more fertile +farms, and their rents will accordingly fall, possibly by much more in +the aggregate than any increase in the rents of the farms near the +margin of cultivation. The point may, perhaps, be better understood if +we pass from agricultural to urban land, and ask what would be the +effect on site values of a great improvement in the facilities of +internal transport. Push the case to an extreme, and suppose passenger +transport to become so cheap and so quick that there ceases to be any +advantage in living in a town so as to be near your place of work. +Urban landlords would no longer be able to obtain the high rents they +now receive for the sites of houses in or near a town. For most people +would prefer to move out into the country where sites can be obtained +at little more than an agricultural rent. The country covers so large +an area relatively to the towns that the supply of rural sites would +be still very plentiful as compared with the demand. Their rents would +not, therefore, rise by very much, although the rents of the housing +sites in towns would fall heavily. Of course, there are other factors +to be taken into account before we could pronounce upon the effect on +aggregate rents. Central sites for shops might, for instance, fetch a +higher rental than before. The purpose of this discussion is not to +generalize but to show the danger of generalizing about rents in the +aggregate, or land as a whole. + + +Sec.4. _The Margin of Transference_. The last illustration may serve, +however, to remind us of an obvious fact which we must now take into +account. The same piece of land may be used for a variety of purposes. +It may have been used for growing corn, and later it may be devoted to +the building of houses, or, as at Slough, to a repair depot for motor +vehicles. It need hardly be said that the land will, as a general +rule, be put to the use in which its value is greatest; or to speak +more strictly, in which the biggest rent, or the biggest selling price +can be obtained. But the notion of the differential advantages which a +piece of land possesses over the marginal land becomes decidedly more +complicated when we take account of this variety of uses. Let us turn +our attention, for instance, to the sites used for shop and office +purposes, and consider what we can regard as the marginal site in this +connection. Clearly it will not be the marginal land of which we +spoke above, which it only just paid to cultivate, and which yielded +no rent at all. For this will probably be agricultural land in an +out-of-the-way district, where no one would dream of setting up an +office or a shop. Any site upon which a sane man would contemplate +setting up a shop will certainly possess value for other purposes, +such as house-building. Hence the marginal site for shopkeeping +purposes will not be like our marginal farm, a site which yields no +rent. + +As regards many pieces of land, there is no doubt as to the purposes +for which they can most profitably be used. This piece will command a +much higher rent as a shop site than in any other capacity; for that +piece house-building is the obvious employment; for another, +agriculture. But in quite a number of instances there is considerable +uncertainty. It is not clear whether upon this site it will be better +to erect a house or a shop, or if the latter, what kind of a shop. It +is not clear whether it will pay to use that farm land for a building +scheme; and, within the domain of agriculture, which of course +comprises an immense variety of really different industries, it is +often a very moot point indeed whether a certain field should be left +under grass, or brought under the plow. Cases of this sort are not +phantoms of the imagination; they emerge on every side as concrete +problems with which some one or other is dealing every day, and it is +these cases which constitute the marginal land for the purposes of a +particular occupation. The marginal sites for shops are the sites for +which it is only just worth while to pay rents sufficient to entice +them away from houses. And the rent for a site in Bond Street, or +elsewhere, which is so much more suitable for shop purposes that no +alternative use would be worth considering, will exceed the rent paid +for one of these marginal sites by, roughly speaking, the extra +advantage it possesses for shop purposes. Or will fall short of it, it +may be well to add, to the extent of its comparative disadvantage. For +there may be many such marginal sites, some of which will fetch low +rents, and others very high rents indeed; the same site being often of +great potential utility for a large variety of occupations. Between +any two occupations there will thus usually be a _margin of +transference_, which we must conceive not as a point, but as an +irregular line, upon or near to which there will be many pieces of +land, differing greatly in the rents which they fetch. These +variations of rent will correspond to the differences between the +advantages or derived utilities which the sites possess for _both_ the +occupations in question. The position of such margins of transference +will of course alter as industrial conditions change, and, when they +alter, the rents of sites which are not near any margin of +transference will be affected also. Thus an increased demand for the +products of any particular industry will make it profitable for that +industry to offer higher rents, and thus draw land away from other +occupations. This will have the effect of raising, though possibly to +a very slight extent, the rents of sites which still remain in other +uses; for there will be fewer of them available; and their derived +utilities will consequently be increased. + +But here, as everywhere, it is upon the margin that our attention +should be focussed, because it is round about the margin (wherever it +is found) that the changes are taking place which really matter for +society. When Mr. Mallaby-Deeley buys an estate in Covent Garden from +the Duke of Bedford, the transaction hardly deserves the degree of +public interest it excites. Nothing has happened which is of material +consequence to anyone except the two gentlemen concerned; the various +sites are still used for the various purposes for which they were used +before; nothing has occurred that really matters. But when houses are +pulled down for the erection of a cinema, or when a field is diverted +from tillage to pasture, something has happened which affects for good +or ill the interests of the whole community. Conversion from tillage +to pasture represents, indeed, a tendency which has been very marked +in Great Britain during the last generation, and has aroused +misgivings in many public-spirited observers. Possibly for a variety +of reasons, these misgivings may be justified; certainly the problem +is well worthy of attention. But when in this way the issue is raised +of tillage versus pasture, it is essential, if we are to discuss it +rationally, that we should envisage it clearly as applying only to a +limited portion of agricultural land, to the portion which lies +somewhere near the margin of transference, as things are now, between +the two forms of agriculture. It might be socially desirable to bring +under the plow a field which the farmer finds it only _slightly_ more +profitable to lease under grass; but this would be highly improbable +in the case of a field where the balance of argument to the farmer in +favor of pasture is overwhelming. The position of the margin of +transference between different uses may, in other words, be somewhat +out of place from the social point of view, and it may be desirable by +appeals and propaganda, even conceivably by the devices of State +subsidy and compulsion, to push it forwards or backwards in greater or +less degree. But it will be necessarily a matter of degree, and +nothing could be more foolish than to speak as though there was, or +could be, some ideal method of cultivation equally applicable to all +lands, without regard to their climatic and other conditions. Needless +to say, none of the agricultural experts who sometimes deplore the +decline of arable farming are guilty of such foolishness. But the +sense of the diversity of nature which is very vivid to them may +sometimes be lacking in people who live in towns, and a firm grasp of +the marginal notion may serve best to keep the latter from forgetting +it. + + +Sec.5. _The Necessity of Rent_. Behind all such detailed applications +there lies a more general consideration which deserves attention. The +way in which the land of a country is used, the way in which it is +apportioned between the countless alternative employments that are +possible, is a most important matter, more important perhaps than any +questions as to the size of the incomes which particular landowners +receive by virtue of their rights of ownership. How is this +apportionment effected as things are now? The answer is clear: mainly +by the agency of either rent or price. The business which finds it +worth while to offer the highest rent or the highest price for any +piece of land will, as a rule, be able to command its use. And, with +this as the governing principle, an apportionment is secured between +shops, offices, factories, agriculture, between the immense variety of +different employments covered by each of these broad headings; not a +rigid unvarying apportionment, but one which constantly changes as +economic circumstances change, and as the margin of transference +between different occupations moves hither and thither. This +apportionment takes place at present as the result of the independent +decisions and bargains of many private individuals, who are thinking +mainly of their own interests, and not of those of the community. But +this state of affairs might be altered. The land might be nationalized +and allocated to its various uses by the co-ordinated labors of a +great State department, or some other agency of the collective +will. However improbable such a change, it is perfectly conceivable. +But what is not conceivable is that any State department should handle +the job with a success even approaching that of the present system, +unless it continued to use, as its main instrument, the criterion of +either rent or price. That a piece of land would yield a higher rent +in one occupation than in any other is not conclusive evidence that it +is best to devote it to the former purpose, but it is very good +evidence, and it should be allowed to prevail unless it is +demonstrably outweighed, as it possibly might often be, by +considerations of a different kind. That it would not be well for the +community to employ land in the city of London for corn-growing +purposes, however desirable might be a revival of home agriculture, is +so obvious that it may seem to have no bearing on the present issue. +But it is only an extreme indication of the absurd and wasteful use of +our natural resources, which would grow up slowly but surely, if we +dispensed with ideas of rent and price as sordid irrelevancies, and +allocated our land on the basis of a balancing of the loftiest +arguments of a vague and sentimental character. If you are prepared +for the distribution of land to become stereotyped, for each piece to +continue indefinitely in its present use, then indeed you might +dispense with rent, as primitive societies very largely do. That would +mean stagnation and, for an industrial country, decay. But if changes +are ever to be contemplated, a simple quantitative measure is the only +safeguard against utter chaos. Thus rent, like interest, will be found +indispensable as a measure under any efficient system of society, even +if it might not always represent the payment of sums of money to +private individuals. And that is why the principles governing rent +possess, as I indicated at the outset of this chapter, an importance +more fundamental than our present system of ownership and tenure. + + +Sec.6. _The Question of Real Costs_. But we must not forget the +preliminary question that started us upon our analysis of the agents +of production. The rent which a manufacturer or farmer has to pay for +his land he naturally includes in his cost of production. But does +this money cost to the individual correspond to, and measure, any real +cost to the community as a whole? Here let us note in the first place +that if only we could disregard the variety of uses to which land is +put, if we could suppose that all industry was agriculture, and that +agriculture was a single industry with a single product, we could +argue that rent does not enter into marginal costs at all. For we +could regard the marginal producer as the one working on a marginal +farm, whereas we have seen there is no pure rent. The rent which other +producers have to pay would thus represent merely the destination of +the surplus profits which arise wherever actual costs fall short of +marginal costs. This way of looking at the matter has proved +attractive to some thinkers, not in the least because of a desire to +palliate the effects of landlordism, but because it fits in so well +with our general sense of rent as a "surplus," and a surplus as +something distinct from a necessary price. But it is clearly +illegitimate in an economic theory which professes "to describe the +facts." The marginal land for many purposes fetches, as we have seen, +a considerable rent; and this rent is certainly part of the marginal +costs and of the necessary price of the products of the particular +industry. The answer to our question is, however, not now very +difficult to see. Land, greatly as it differs in many respects from +the other agents of production, resembles them in the very important +respect that, being used for one purpose, it is not available for +other purposes, and that the productive powers of the community in +other directions are thereby diminished. This is the real cost to the +community, which attaches to the products of any industry, in virtue +of the land which it occupies; not any human labors or sacrifices +required to produce the land itself, but the curtailment of the +natural resources available for productive use elsewhere. This is the +real cost of which rent is the money measure, and generally speaking +an accurate measure at the margin of transference between one +occupation and another. A somewhat fanciful use of the term cost, this +may seem perhaps, one not quite in accordance with our instinctive +sense of what real costs should be. But possibly the real costs +represented by wages and profits may turn out to be not so very +different, and we had best leave the matter there, until we have +examined the nature of these other costs. + + +Sec.7. _Rent and Selling Price_. In this chapter we have spoken mainly of +the rent rather than the price of land: the relation between the two +things is fairly obvious and well understood, but it will be well not +to close the chapter without a brief account of it. The price of any +piece of land is affected by all the considerations on which its rent +depends, but it is also affected by another factor which has no +influence whatever upon rent. This factor is the rate of +interest. The higher the rate of interest, the higher the return which +a man could obtain by buying gilt-edged securities, the lower will be +the price that he will pay for a piece of land which yields a given +rent. We can express the relation more precisely by the formula Price += (Rent * 100)/(Rate of Interest), though we must be careful, in +applying this formula in practice to allow for the possible deviations +between the nominal and the true rent, and similar complications. The +price, it must be observed, is derived in this way from the rent, not +the rent from the price.[1] Rent is thus logically the simpler, price +the more complex thing. It is well, therefore, to analyze in the +first instance the principles of rent, if we live in a country where +the practice of leasing land for annual rent is less common than it is +in Great Britain, even if, for whatever reason, it is the price of +land with which we are concerned in practice. The problem of price +contains two distinct elements which it is not easy to handle when +mixed up together. For the rate of interest represents in itself an +important branch of economics, which will require a separate chapter +to itself. + +[Footnote 1: In this the rent of land differs fundamentally from that +of other things, such as houses. For the price of a house is largely +influenced by the costs of construction of new houses, and should +correspond closely to them in the long run. The same relation between +rent, price and rate of interest will hold good; but the rents will be +affected by changes in the rate of interest, owing to the reactions of +such changes on the supply of houses.] + + + +CHAPTER VII + +RISK-BEARING AND ENTERPRISE + + +Sec.1. _Profits and Earnings of Management_. The profits of a business, +as they are ordinarily reckoned, whether for the purposes of income +tax or of a balance sheet, comprise several elements which are +fundamentally distinct. The relative importance of these various +elements varies greatly from one type of business to another. The +profits of a private business include, for instance, the remuneration +of the work of management, which in the case of a Joint Stock Company +is mostly paid for by salaries or directors' fees. It is to their +profit that farmers, small shopkeepers, and the partners of a private +firm look not merely for a return upon their capital, but for the +reward of their own labors. "Earnings of Management," as they are +usually termed (though in truth they often cover other and humbler +forms of labor) are thus frequently one of the ingredients of profits. + + +Sec.2. _The Payment for Risk-bearing_. There is another element of great +importance about which our ordinary ideas are apt to be so vague that +it will be well to devote a chapter to its examination. This is the +element of payment for risk, or rather the reward of risk-bearing. +Risk is inherent in all business, as it is inherent in all life. The +vagaries of nature and the vagaries of man are alike responsible. The +farmer may find his harvest ruined by a drought or by a deluge; the +coal or the gold, for the extraction of which you have perhaps set up +an extensive mining plant, may come to an end which is unexpectedly +abrupt. You may put your money into roller-skating rinks and find that +cinemas have become the rage with the fickle public; sometimes "the +market" may decline for causes which remain obscure but with +consequences which are disagreeably plain. But while risk is always +present in some degree, the degree varies enormously from one industry +to another. Now, it is obvious enough that in an exceptionally risky +industry, where there is a considerable possibility that the capital +invested will yield no return at all, the profits of those concerns +which succeed are likely to exceed the rate of interest on gilt-edged +securities. But what is likely to be the magnitude of this excess? Is +risk-taking rewarded if there is any such excess, however small? Or +will it suffice that the gains and losses should average out to a fair +rate of interest over the whole industry? To enable us to think +closely let us suppose for a moment that we can measure accurately +what the chances are. + +Suppose, then, that there were a precisely equal chance of success on +the one hand and failure on the other in any enterprise, failure +involving a complete loss of all the capital invested. Suppose, +further, 6 per cent to be at the time a fair return on a perfectly +secure investment. What would be the return which must be expected +from the risky enterprise, in the event of its succeeding, before it +will be undertaken? The reader may be tempted to answer, 12 per cent. +But 12 per cent would not suffice. An equal chance of 12 per cent or +nothing, as compared with a certainty of 6 per cent, does not mean +that the risk in the former case is paid for to the tune of 6 per +cent. It means that it is not paid for at all. In each case what a +mathematician would call the _expectation_ is a return of 6 per +cent. The odds are evenly balanced; in the long run, over a large +number of cases, if the law of averages works as we assume it does, +you would get just as much from the one type of investment as the +other. Now, risky enterprises will not, as a rule, be undertaken on +terms like these; investors and business men will not take risks with +the odds precisely equal; they must have them, or believe that they +have them, in their favor. + + +Sec.3. _Monte Carlo and Insurance_. To assert this is not to ignore the +strength of the appeal which the gambling instinct makes to many, if +not to most of us. The taste for gambling is, indeed, so deep and +widespread that it would be foolish to leave it out of account in this +connection. It is clear enough that at places like Monte Carlo people +are prepared to have the odds unmistakably against them, apparently +for the sheer pleasure and exhilaration of taking risks. Moreover, +though for most people play at Monte Carlo represents a mere holiday +indulgence, it would be unsafe to assume that what appeals to them +there will not also appeal to them in their business affairs. But what +exactly is the secret of the charm of Monte Carlo? It is the great +attractive force of a small chance of a large gain, as compared with +the deterrent force of a large chance of a small loss. People will +readily pay $5 for one chance in a hundred of making no more, perhaps, +than $400 or $450. And it is very likely that this holds good in the +world of business. If, for example, we were to suppose that the +promoters of a new enterprise were confronted with one chance in fifty +of a profit of 50 per cent per annum on their capital, as against +forty-nine chances of a profit of 5 per cent, this might well prove a +more attractive prospect than a certain return of 6 per cent, although +the strict _expectation_ of profit would be smaller in the former +case. But the risks of business enterprise are not often of this +type. They conform more usually to the opposite type of a large chance +of a relatively small gain, balanced by a small chance of serious loss +or entire failure. Now for almost everyone the possibility of a great +loss will count as a deterrent (just as the possibility of a great +gain may count as an attraction) for much more than its strict +actuarial value. + +The truth of this proposition is demonstrated by the existence of +institutions more impressive than Monte Carlo--the Insurance +Companies, which play so large a part in the economic life of modern +times. Every year, and upon an ever-growing scale, both private +individuals and business concerns pay sums of money, which reach in +the aggregate a colossal sum, as premiums to insure themselves against +loss by Fire, Shipwreck, Burglary, Death, Death Duties, against every +risk which Insurance Companies will cover. Now Insurance Companies +are not, as we say, in business for their health. They find their +business profitable, and pay good dividends to their shareholders. +Moreover, they incur a considerable expenditure on offices, on +clerical staff, on agents, and the like. All these payments must be +defrayed out of the premiums they receive; so that it is plain that +the premiums greatly exceed the _expectation_ of the risks insured. +The odds are heavily in favor of the Insurance Company--of that the +stupidest person can have no shadow of doubt. Yet we continue to +insure, as private individuals and as business men, and so far from +being ashamed of our proceedings as a weak and nerveless folly, which +somehow we are unable to resist, we blazon them forth in the strong +accents of conscious pride. We preach insurance to our neighbors as +the core of self-regarding duty, and, if ever we feel a twinge of +uneasiness, it is lest we, too, may have omitted in some particular to +practice what we preach. + +The significance of this is unmistakable. Be our psychology what it +may, however deep and irrepressible our taste for derring-do, however +inadequate the scope which the dull routine of modern life affords for +our adventurous impulses, we are most of us anxious to avoid the risk +of great financial loss. We are very glad to find someone to take it +off our shoulders if we can; so glad that we are prepared to pay him +for the service, to pay him a sum which covers not only the actuarial +equivalent of the risk, but something substantial over and above. In +this we are entirely rational. Our conduct is justified by the law of +the diminishing utility of money, which was noted at the end of +Chapter III. It would be plainly foolish, for instance, to substitute +for the certainty of an income of $2500 per annum an even chance of +$5000 or nothing, since the utility to us of $5000 is not twice as +great as that of $2500. + +The majority of business risks are not of a kind against which it is +possible to insure. Insurance companies confine themselves to risks +which are mainly a matter of what we call objective rather than +subjective chance, i.e. risks in respect of which knowledge of +detailed facts peculiar to the individual case is of minor +importance. But such knowledge is of paramount importance in the case +of ordinary business risks. If, for example, a new enterprise is to be +undertaken, the special knowledge and experience which its promoters +possess is a vital factor in determining their estimate of the risk +involved. An outsider with no special knowledge would necessarily +require to estimate the risk far more highly if we were to form a +rational opinion on the basis of _his_ knowledge. So great, indeed, +would be the risk to him, that we can lay it down as a sound maxim +that people are extremely rash who invest their money in risky +undertakings about which they know very little. This subjective aspect +of business risk has a significance to which it will be necessary to +revert. + +But, though most business risks are not and cannot be a matter for +premiums and policies, the principle, which the practice of insurance +illustrates, applies none the less. In the light of their knowledge +and experience, the promoters of a new undertaking must weigh up the +chances of failure and success, though they will not do so by the +precise methods of an actuary. They will require that any chances of +serious loss should be balanced by such chances of exceptional gain, +as would raise the _expectation_ of profit well above the normal +return on secure investments. The more risky the project seems the +greater, generally speaking, must be the _expectation_ of profit +required to induce people to undertake it. + +If we suppose business men to calculate reasonably, it follows that +the average profits in any industry over a long period of years, +reckoning in the losses of the concerns which disappear altogether, +are likely to be higher, the more risky is the industry. Such a result +will not, of course, occur in every case. Even when the calculations +are reasonable, they may be entirely falsified by the event. Moreover, +business men may not calculate reasonably on the information which +they have. But, unless we suppose their judgment to be subject to a +prevailing bias in one direction, i.e. to be unduly optimistic as a +general rule, _we_ should expect, and in any case _they_ must expect, +profits above the ordinary in a risky industry. + +This conclusion is sufficiently important. Far too many people, though +they admit it when it is expressly stated and dismiss it even as a +tiresome commonplace, are apt to neglect it when the occasion for +applying it arises. For example, the great importance to any industry +of good management is generally recognized, and the consequent +desirability of paying adequate salaries to the managerial staff. The +importance of securing a supply of capital is very widely recognized, +and the practical necessity of paying a fair rate of interest is thus, +however grudgingly, conceded. But the "residuary profits," as they +are called, which accrue at present to the owners of a business, are +denounced in some quarters in a sweeping fashion, which seems to +ignore altogether the all-pervading element of risk. People speak as +though you might appropriately limit profits in every industry to some +uniform percentage on the capital employed, without making it clear +whether you would even be allowed to make up in good years for the +losses incurred in bad. The effect of introducing any such crude +device into our present industrial system could only be to paralyze +enterprises of an unusually risky kind, which, so far from being +pushed to an excess at present, are more probably curtailed unduly +from the standpoint of what is socially desirable. Like the fixing of +a low maximum price for a commodity it would cause the supply to +wither up and disappear. + + +Sec.4. _Risk under Large-scale Organization_. While this is true of the +present economic system, the question is worth considering whether it +represents a fundamental necessity, whether, for instance, under our +world socialist commonwealth the factor of risk-bearing need play so +important a part as it does in the actual business world. This +question cannot be answered with a conclusive simplicity; opposing +considerations present themselves, between which it is not easy to +strike a balance. On the one hand, in accordance with the law of +averages gains and losses tend to cancel out over a large series of +transactions, _when reasonable calculations have been made_. Thus +Insurance Companies, while they take heavy risks off the shoulders of +policy-holders, incur relatively trifling risks themselves; they can +predict the aggregate sums which they will be called upon to pay +within a small margin of error. In the same way it might seem that +every enlargement of the scale of business would make for an automatic +insurance and a consequent economy of risk; and thus that if all +businesses were comprised in a single financial unit, gains and losses +would cancel out over so wide a range that the degree of risk +remaining would be almost negligible. + +This might indeed happen, if business risks were mainly of that +objective kind in which the insurance companies specialize; for then +we could assume that the chances of success or failure would be +estimated reasonably. But, in fact, most business risks, not being of +this kind, must be estimated by processes of human judgment, which are +very fallible. And here we must take account of the law of averages in +another aspect, with a different bearing on the argument. When an +industry comprises a large number of separate concerns, and the +decisions accordingly are taken by many men, acting independently of +one another, the errors of calculation will tend to some extent to +cancel one another out. The undue optimism of one man will be balanced +by the undue pessimism of another; and, if there is no prevailing bias +in either direction, the errors of judgment will not affect the +results for the industry as a whole. But where the effective decisions +are taken by very few men, the chances are far greater of a +preponderating balance of error in one direction. The risks dependent +on the factor of human judgment tend therefore to increase. + +This truth can be illustrated by a phenomenon which is fairly +familiar. It is recognized by intelligent persons that the risks of +speculation in a particular commodity market or stock market increase +more than proportionately to the scale of operations. A man who sets +out as a "bull" upon a small scale can buy without sending up the +price against him in the process, and, if he decides later that his +judgment is mistaken, he can at any time cut his losses and sell out +without much difficulty. But a "bull" on a very large scale cannot +complete his purchases except at a price which has been raised in +consequence of his own action, and he cannot count on being able to +"unload" at or near the market price, should he decide to do so. If, +accordingly, he miscalculates, he cannot save himself from serious +loss as a smaller man might do by a prompt discovery of his error. His +difficulties spring from the fundamental fact that the effects of his +calculations are too great to be offset by those of the different, and +often opposite, calculations of other men. + +Upon the issue whether a growth in the size of the business unit is +likely to diminish risk, the law of averages thus cuts both ways. The +risks arising from the element of pure chance are more likely, those +arising from miscalculation are less likely, to cancel out. Upon +these grounds alone, it would be unsafe to conclude that there would +be on balance an economy of risk under any system of national or world +socialism. + + +Sec.5. _The Entrepreneur_. There remains, however, an aspect of the +problem which is perhaps more important than those discussed above. It +is probable that risks would be estimated and undertaken more wisely +or less wisely under a different system of society or of industrial +organization? Upon this issue, methods of precise analysis are out of +place, but we may have something to learn from the emphatic testimony +of tradition. It has become an axiom of business men that, while +Governments can manage with more or less competence a safe and routine +business like a Postal Service, their success would be unlikely to +prove conspicuous in undertakings where the element of risk is +great. There, it is said, we owe everything in the past to the +enterprise of individual men (for even joint-stock companies have not +been notable as pioneers) adventuring their own fortunes in accordance +with their own unfettered judgment. This contention, however much we +may desire to qualify it, has unquestionably a large measure of truth, +and the explanation is not difficult to discover. For the wise taking +of risks in industrial development of an experimental character, +peculiar conditions and special qualities are required. First, it is +necessary to envisage distinctly the promising though risky +opportunity, and this calls not infrequently for imagination of a none +too common order. Then it must be studied with insight and expert +knowledge and weighed by processes which are as much intuitive as +intellectual. The reasons for or against taking a particular business +risk are seldom such as can adequately be expressed in terms of +arithmetic, or even by clear arguments the soundness of which is +proportioned to their logical cogency. The mysterious faculty of +judgment enters in; and from mental processes which defy analysis +there emerge ultimately conviction and the will to act. But it is +precisely here that Government Departments are apt to fail. It is here +that the individual, who need consult no one but himself, has a pull +over any form of organization, where decisions are reached by the +method of debate and agreement among a heterogeneous committee. Hence +it is that we have come to regard exceptional risk-taking as the +peculiar province of individual enterprise. It is probable that these +deficiencies of corporate organization are tending to diminish, and it +is an interesting question how far it may be found possible to +eliminate them in the future. + +Meanwhile the above considerations have an important bearing on the +rewards which can often be obtained from risky enterprises. The number +of individuals who are in a position to envisage a business +opportunity, and to assess with some confidence the chances of success +and failure is very limited. Not only must they possess special +knowledge, ability, imagination, confidence in their own judgment, and +the capacity to act on it; they must also have at their disposal +considerable financial resources. To combine all these advantages +represents a union of circumstances which is distinctly rare. The +fortunate few, who do combine them, are thus generally able to extract +in the form of profits a high price for their services, a price which +covers not only the strict reward of risk-bearing, and the necessary +remuneration of their own service, but a handsome payment for the +special qualities and advantages which have been indicated. Profits, +moreover, may vary between one industry and another, not only in +accordance with the real risk which is entailed, but with the degree +to which the supply of special knowledge, etc., is scarce or abundant. + +This consideration goes a long way to explain the large fortunes which +enterprising business men are often able to amass. It also throws some +much-needed light upon the functions which such men discharge. They +perform to a large extent the work of management; they supply capital +on what may be a considerable scale; but it is the taking of business +risk which is perhaps their most characteristic function. It is the +union of these functions which distinguishes them as an essentially +different type from the salaried manager who has invested his savings +in rubber or in oil. In other languages there is a specific name for +the man who combines all these three functions; in French he is called +an "entrepreneur," in German an "Unternehmer." It is much to be +regretted that in English we have no clear corresponding word. The +word "capitalist" is not uncommonly employed to do duty in this +connection, but this is a source of much confusion. For the word is +also used, and more appropriately, to include all investors, whether +or not they are active business men. + + +Sec.6. _Risk-taking and Control_. But there is an allied confusion of +more importance. We commonly suppose it to be a leading feature of our +present "capitalist system" that the control of industry rests in the +hands of those who supply the capital. Nor, as a general statement, is +this untrue. But it conceals the essential point. Strictly speaking, +it is risk-taking with which control is associated. The mere lending +of money carries with it no title to control. Governments and +municipalities concede no such title to the subscribers to their +loans; nor does a company to its debenture holders. The shareholders' +ultimate control is based upon the fact that they bear the financial +risks of the concern. Nor is this a matter of mere legal form. It is +not uncommon for ordinary shares to carry with them a greater voting +power than the preference shares of a corresponding value. The +principle which such arrangements endeavor to express is clear: +control should rest with him who bears the risk. It is with this +principle rather than with a mulish insistence on the rights of +property, that advocates of "workers' control" and the like have got +to reckon. It is upon this ground that (as they may quite conceivably +do) they must make good their case. + + +Sec.7. _General Analysis of Profits_. Let us conclude this chapter by +clearing the ground for the next. Earnings of management, payments for +risk-taking and for the special knowledge and advantages associated +with it, are ingredients of the gross profits of a business. The chief +element that remains is that of interest on capital. Frequently, +indeed, it is not the only one. As we saw in the last chapter, a +farmer may not be required by his landlord to pay the full economic +rent for his farm; and he may therefore make profits above the normal +level, above the ordinary return for his own services, his own capital +expenditure, and the risks to which he is necessarily exposed. In such +a case the farmer is really the recipient, as we have already +suggested, of part of the economic rent of the land; and an element of +rent accordingly enters into his gross profits. But profits may +include a surplus element which may arise in a great variety of other +ways. A business may possess some decided advantage which is not open +to competitors; and it may reap high profits accordingly. You can, +for instance, if you choose, regard the high money profits, which, as +was suggested in Chapter IV, are likely to accrue in future to the +owners of pre-war factories, as a surplus profit of this kind. But +while, as this illustration indicates, the phenomenon of surplus +profits becomes of very great importance when we seek to study the +distribution of wealth, it need not detain us here. For the surplus +element arises only in so far as the costs of a business are lower +than the marginal costs; and it is the marginal costs, which, with +good reason, we are now endeavoring to analyze. The marginal costs +must include a normal profit, i.e. a profit which will cover earnings +of management, the reward of risk and enterprise, interest on capital, +but nothing further. It remains, then, only to consider this last +element of interest. + + + +CHAPTER VIII + +CAPITAL + + +Sec.1. _A Reference to Marx_. Interest is the price paid simply for the +use of capital. But what is capital, and in what does its use consist? +What claim has it to be regarded as an independent factor of +production? Our very familiarity with the term, our habit of employing +it with the rich looseness of every-day life is an obstacle to the +clearness of thought, which is again essential. We recognize, most of +us, clearly enough that capital, although we reckon it in terms of +money, consists, like income, of real things; factories, machinery, +materials and the like. It is quite obvious that these things are of +use, are, indeed, indispensable for production; what more natural than +that capital should command a price? It almost seems as though we +might pass, without further ado, to a detailed discussion of the +forces which determine the amount of this price. + +But this account does not bring out the essential point as brief +reference to a very famous controversy will show. Some ingenious +writers in the last century, the most notable of whom was Karl Marx, +set out to prove that, in our modern society, workpeople are +"exploited," robbed of the "whole produce of their labor," to the full +extent of the return which accrues to capital. The argument was +exceedingly complex in detail; but it boils down to this: The +factories and machinery which are admittedly essential to production +were themselves produced in exactly the same way as consumable +goods. They were produced by labor, working with the assistance of +nature, and, again, if you choose, of capital in the form of further +factories, machinery, etc. But these further capital goods can in +their turn be regarded as the product of labor, nature and capital; +and so we can proceed until it seems as though the element of capital +must disappear in the last analysis, as though labor and nature were +the sole ultimate agents of production, and the reward of capital +represented no more than the exercise of the exploiter's power. In one +form or another this argument still dominates the minds of a large +proportion of the so-called "rebels" against the existing social +order. + +If we are to meet this argument, if, which is perhaps more important, +we are to understand the true nature of capital, we cannot rest +content with saying that it consists of factories and machinery, and +that these are essential to the worker. Just as it was well to get +behind the money terms, in which we often think of capital, to the +real goods; so we have now to get behind the real goods to something +else. What this something else is, the first chapter may have already +done something to reveal. + + +Sec.2. _Waiting for Production_. Between production and consumption there +is an interval of time. All productive processes take time to +accomplish. The farmer must plow the soil and sow the seed months +before he can reap the harvest which will reward him for his +efforts. Meanwhile, he must live, and in order that he may live he +must consume. If he employs laborers he must pay them wages, that they +too may consume and live. For both purposes he requires purchasing +power, which represents of course command over real things; and if he +has not sufficient purchasing power of his own, he must borrow from +someone else who has. In either case it is not enough that the farmer +and his laborers should work; no less essential is it that someone +should _wait_. The farmer must wait till he has sold his crops, both +for the reward of his own labor and for the repayment of the wages he +advances in the meantime to his laborers. Or, if he cannot afford to +wait, and borrows in anticipation of the harvest, then the lender must +wait, until the farmer, having sold his crop, is able to repay +him. Thus the period of time involved in all production gives rise to +a demand for _waiting_, which someone or other must supply, if the +production is to take place. It is this waiting which is the essential +reality underlying the phenomena of capital and interest. It is really +this which constitutes an independent factor of production, distinct +from labor and nature, and equally necessary. + + +Sec.3. _Waiting for Consumption_. But let us carry the argument a step +further. After the farmer has sold his crops, there are many stages +through which they must pass, at each of which more waiting is +required, before they reach the ultimate consumer. But then the +waiting is at an end. + +This, however, is by no means the case with a great number of +commodities. Let us take the case of a speculative builder. While he +is building a house he, like the farmer, must wait (or find someone to +wait on his behalf), for his own reward, and for the repayment of his +expenditure on wages and materials. But, after the house is built, if +he lets it to a tenant for an annual rent, his waiting is far from +over. Not until many years have passed will the rent payments add up +to a sum which equals or exceeds his outlay. He may, of course, sell +the house, and thus bring his waiting to an end. But then the +purchaser must wait, no matter whether or not he is the occupier. For +no one would consider the use of a house for a day, a month, or a year +as an adequate return for the price it cost to buy. The occupier-owner +pays for the prospect of its use for a long and perhaps indefinite +number of years ahead, and he must wait to enjoy the benefits for +which he pays now in full. Waiting is as inherent in the consumption +of durable things as it is in all production. + +Now most industries are consumers of durable things of a very +expensive kind. Here we come back to the factories and machinery which +ordinarily spring to our mind at the mention of the word capital. Not +merely does the construction of these things involve waiting; their +consumption involves waiting on a vastly larger scale. Just as with a +house, many years must elapse before their derived utility can even +approximate to their purchase price. It is mainly to supply the +waiting involved in the consumption of such durable goods, that a +typical joint-stock company issues shares for public subscription. The +waiting required to cover the period of time, which its own productive +process requires, is largely supplied by means of bank overdrafts or +other forms of short-period borrowing. More strictly, fixed capital +represents the waiting involved in the consumption of durable things; +circulating capital the waiting involved in current production. + +This distinction loses its sharpness when we consider not the affairs +of a particular business, but the industrial system as a whole. Then +the period of time involved in the consumption of durable instruments +falls into place as part of the time required for the production of +the ultimate consumers' goods. We can even, perhaps, conceive of an +"average period of production" for industry and commerce as a whole; +and this conception is not without its uses. For it serves to bring +out the fact that the period of consumption, and the period of +production in the narrower sense, are only two aspects of the same +fundamental thing, the interval of time which elapses between work and +the utility, which is its ultimate purpose. It serves, moreover, to +make clear that anything which lengthens this interval of time +increases the demand for waiting, or in other words, the demand for +capital; and, conversely, that anything which shortens this interval +diminishes the demand for capital. + + +Sec.4. _Capital not a Stock of Consumable Goods_. But the distinction +between the two forms of waiting, though not fundamental, is none the +less worth noting. It enables us to keep our theory in conformity +with fact, to look at the phenomenon of capital the right way up; and +it is easy, if we are not careful, to slip into the habit of looking +at it upside down. People sometimes speak as though the commodities +which constitute our capital, instead of being mainly, as our plain +sense tells us that they are, factories, machinery and other durable +instruments, were rather a _store_ or _stock_ of immediately +consumable goods. The argument takes the following form. It is +consumers' goods, things like food and clothes, which the farmer, the +builder and their workpeople consume while they are working. To enable +them to work, therefore, it is vital that such things should not in +the past have been consumed as soon as they were made; part of them +must have been saved, and carried forward for future use. +Furthermore, the longer the time that the work on which people are now +engaged takes to yield its product, the larger must be this store of +consumers' goods. For these products, when they are completed, will +serve (taking society as a whole) to replace the store which in the +meantime is being used up, so that the longer this replacement takes, +the larger must be the initial store. Conversely, the larger the +store of consumers' goods available, the more distant is the future +for which we can afford to work. It is thus the store or stock of +consumers' goods which represents our real capital; for it is the +magnitude of this store which determines how far we can devote our +energies to purposes which are remote in time. + +Now this is pure mysticism. Regarded literally, it is in direct +conflict with the facts. The processes of industry are fairly regular +and continuous. At any moment, large quantities of consumers' goods of +almost every kind are on the point of completion; at the same moment +equally large quantities are consumed. The things which we buy were +finished, very likely, only recently; or, if in fact they have lain +idle for some time in stock, there is nothing essential or at all +helpful in that fact. It represents rather a defect--a maladjustment +which should be rectified. Even many kinds of agricultural produce do +not need to be carried forward from one year to another, for they are +produced in many parts of the world, where the seasons come at +different periods of the year. It is conceivable, therefore, that we +might consume all non-durable things the moment they were ready, and +the degree to which we approximate to this ideal is a mark of the +efficiency of our economic system. A large store of consumable goods +is thus _not_ a fundamental necessity of a prosperous society. + +What _is_ necessary is plainly the power to produce these things in +large quantities as they are required. And this power is furnished by +the durable instruments of production, which we thus rightly regard as +the true representatives of modern capital. If it is argued that this +power to produce consumable goods may be regarded as being _in effect_ +a store of consumable goods, it must be sternly replied that this is +the language of symbolism, not of science, and that symbolism is +highly dangerous in this connection. The false conception of capital +as essentially a store of consumers' goods has led and still leads to +many serious fallacies. It was this that gave rise to the notorious +doctrine of the Wages Fund; the notion that the sum which can at any +time be paid in wages is equal to the quantity of capital, _alias_ +consumable goods, which happens to exist. To this day it blocks, with +an undergrowth of obscurantist controversies, the way to a +straightforward account of the problem of trade cycles. + + +Sec.5. _The Essence of Waiting_. But it is with positive conclusions that +we must here concern ourselves. What is the essence of this waiting, +as we have called it? What are its results from the point of view of +the community? The individual, who saves and lends, waits in the +obvious sense that he postpones consumption. He foregoes his right to +purchase now a quantity of consumers' goods in consideration of the +prospect of purchasing a larger quantity of such things in the +future. From the standpoint of the whole community, there is a similar +postponement of consumption, though it need not commence so soon. The +store of consumable goods is what it is: the quantity of goods in +_process_ of manufacture, which will shortly be coming forward, is +also what it is. For some time, therefore, a sudden access of saving +cannot affect the quantity of goods available for consumption; and if, +in fact, they should be consumed less rapidly, that will represent an +unfortunate defect, not an essential condition of a smoothly working +system. The _necessary_ consequence comes later. The increased saving +will cause labor, materials, land, agents of production generally, to +be devoted to distant purposes. Men will be set to work producing +durable goods, largely durable instruments of production like ships or +railways or factories or plant. If the increased saving is +considerable, the labor, materials, etc., required for these purposes +will be withdrawn even under our present system, as under a smoothly +working system they clearly must be, from the production of other and +more immediately consumable things. Hence, some time later, the +supplies of consumable things will be diminished, while at a later +period still they will be more than correspondingly increased as the +result of the assistance of the new durable instruments. That is the +essence of saving from the social standpoint. An early future is +sacrificed to a more remote future. The aggregate consumable income of +the present is unaffected; the aggregate consumable income of the near +future is actually diminished; it is not until at least some years +later that the aggregate consumable income is increased. + + +Sec.6. _Individual and Social Saving_. This conclusion is important: but +there is an obvious misinterpretation against which it will be well to +guard. It is customary for social moralists to preach thrift and +saving as a public duty, and to impart to their appeals a special note +of urgency in times like the present, when, as the result of the havoc +of the war, destitution is widespread over Europe. Now obviously these +advisers do not mean to recommend something which will impoverish the +world next year and the year after and the benefit of which will +accrue only in a distant future: it is the immediate urgency of the +world's needs which is rather the substance of their case. Nor would +it be right to conclude that these wise men are the victims of a +delusion, and advocate a course, the consequence of which they do not +understand. The explanation of the paradox is simple. The more the +community as a whole saves now, the less in the near future will be +the aggregate consumable income of the whole community: but not of the +_remainder_ of the community, exclusive of the savers. It is the saver +who must wait, whose consumption must be postponed to perhaps a +distant future; but _at no time_ does his saving result in a smaller +income of consumable goods for other people. The aggregate consumable +income of the near future will be diminished, but it may be better +distributed, and it may consist of things of a different _kind_. For +consumers' goods, we must remember, comprise champagne and motor cars +as well as food and clothes; and, if a rich man saves, it may be +purely articles of luxury, the production of which will shortly be +diminished. Moreover, if his saving has the effect of transferring +purchasing power to impoverished people, like those in Central Europe, +it will not be devoted to a distant future; it will very likely be +devoted to quite immediate ends. In other words, it may not result in +any "creation of capital"; it may not represent any saving on the part +of the community as a whole. A relatively rich man waits, and a +relatively poor man _anticipates_ his income to a corresponding +extent; and it is precisely this that is so urgently desirable in a +time of widespread poverty and chaos. + +This is no matter of hair-splitting, and making plain things +obscure. While it is always better for the _rest_ of us that an +individual, who can afford to save, should save rather than spend +(though it might be better for us still if we could have his money to +spend ourselves) and while this is the more important the greater is +the poverty which generally prevails; yet, as a community we cannot +save so much, we _ought_ not to save so much, when we are impoverished +as when we are prosperous. It is vital to appreciate this truth, +because, as we shall see, by no means all the saving of the world is +done by individuals. There are many forms of "collective saving," +which take place in actual fact; still more which we are often urged +to undertake. And it is of practical importance to realize that the +very considerations, which call most urgently for individual thrift, +forbid a great indulgence in such projects. A time of national poverty +is not a time when it is suitable for the State to embark on large +schemes of capital development: we require our resources for more +immediate ends. Faced with such problems, our practical sense may no +doubt suffice to keep us straight; but it is apt to do so at the +expense of a complete inversion of the real issues. If, for instance, +we call for Governmental retrenchment on what we deem extravagant +policies of housing and education, we usually speak as though they +represented the profligacy of a spendthrift as contrasted with the +saving that is indispensable. The truth is rather that these policies +represent a saving, an investment for future purposes, which may +conceivably be greater (this must not be taken as representing my +personal opinion) than the community can properly afford. This is +another instance of what I mean by looking at the problem of capital +the right way up. + + +Sec.7. _The Necessity of Interest_. It is only now that we are in a +position to appreciate the true functions of a rate of interest, and +the nature of its claims to be regarded as a "real cost." Interest, it +is sometimes said, is necessary to provide for the future. It is far +more certain that interest is necessary to provide for the present. It +is a matter of legitimate doubt how far it is necessary to _pay_ +interest to secure a supply of capital; there is no doubt at all that +it is necessary to _charge_ interest to limit the demand for it. As we +saw in Chapter I, a world socialist commonwealth would require to +retain a rate of interest, if only as a matter of bookkeeping, in +order to choose between the various capital undertakings that were +technically possible. And this is the primary function which the fate +of interest fulfils in our present-day society. It separates the sheep +from the goats. It serves as a screen, by means of which capital +projects are sifted, and through which only those are allowed to pass +which will benefit the future in a high degree. For this essential +purpose it is hard to imagine how a better instrument could be +devised. + + +Sec.8. _The Supply of Capital_. Let us dwell for a moment on this image +of a screen, or sieve. One condition of a good sieve is that its +meshes should all be of the same size. This condition the rate of +interest almost perfectly fulfils. But it is also important that the +meshes should be of the _right_ size. Whether this is true of the +actual rate of interest is a far more doubtful matter. It is, indeed, +plain that it is not altogether devoid of merit in this respect. In +times of general world poverty, like those which follow upon a great +war, it is desirable, as has been argued, that more of our productive +resources should be devoted to immediately useful purposes, and a +smaller portion dedicated to a distant future. This readjustment the +rate of interest helps to bring about. For it rises to a higher +level, and there is accordingly a strong inducement to all +manufacturers and traders to economize their use of capital, and thus +to set free productive resources for more urgent needs. But, while the +meshes of the sieve, as it were, contract in times when it is +desirable that they should contract, we have no reason for supposing +that they will contract in just the degree that is desired, neither +more nor less; or, indeed, that at any time they approximate to the +right size. We in the twentieth century owe much of the material +wealth that we enjoy to the fact that over the last century men saved +as largely as they did. But our natural gratitude should not restrain +us from doubting whether they were really well advised to do so. If we +ask the question _how_ they managed to do so, our doubts are +deepened. For first place among the explanations must be assigned to +the inequality in the then distribution of wealth. It was because many +men in England were rich enough to save that our railways were built, +and the resources of new Continents were opened up. But England, a +century or even half a century ago, was not really a rich +community. And if the national income in those days had been +distributed more evenly among the people, can we doubt that they would +have spent a far larger proportion of it on immediate needs; can we +doubt that they would have been right to do so? We may rather doubt, +in view of the reactions of poverty on physical and mental efficiency, +on social harmony, even possibly on population, whether we to-day +would have been really injured as much as might appear. How, then, can +we suppose that the sum of the amounts which it suits individuals to +save will bear any close relation to the resources which the community +can properly devote to future ends? Are we to regard an unjust +distribution of wealth as a mysterious dispensation of Providence for +securing perfect harmony between the future and the present? The +point need not be labored further. There are no grounds for assuming +that we save, as a community, even roughly what we ought to save. If +we wish to believe we do, we must turn for support from economics to +theology. + +It is important to be clear upon this issue in order to distinguish it +from another, with which it sometimes seems to be confused. This is +the question, briefly outlined in Chapter II, of the effect of changes +in the rate of interest on the supply of capital. As was there +indicated, there are good reasons for supposing that a fall in the +rate of interest would induce some people to save more, and +conversely. But the balance of probability is in favor of the +conclusion that the _net_ effect of changes in the rate of interest, +though perhaps slight, is usually of the more ordinary kind. The +decisive argument in this connection is the fact, upon which we have +just touched, that savings are supplied largely by people who are +relatively rich, and who become richer when the rate of interest +rises. For at this point it is necessary to be careful. It is easy to +slide from the above conclusion into an argument of the following +kind. A higher rate of interest leads to more saving; it is thus +necessary to _evoke_ more saving; it is thus required as an +_incentive_ to induce people to incur the _sacrifice_ of waiting; this +sacrifice represents the "real cost" for which interest is paid. + +This terminology of incentive, inducement and sacrifice is of very +dubious validity. A rich man, who is made richer by a rise in the rate +of interest, will probably save more, but it will be rather because he +has become richer than because he is tempted by the higher rate: and +the less we talk about his sacrifice the better. Nor is it clear that +the attraction of a high rate of interest is an operative factor on +the mind of a man to whom saving means a real sacrifice of immediate +comfort or enjoyment. Certainly it is only one among many factors, and +seldom an important one. A really poor man will think not so much of +the annual income which will accrue from his savings, as of the +capital sum upon which he or his family can fall back if a rainy day +should come. And for this purpose he might save as much as he saves +now, even if there were no interest to be obtained thereby. He might +even be prepared to lend what he had saved, at least to banks (a +deposit with a bank is in effect a loan), for the mere advantage of +safe custody. The people who save rather for the sake of the capital +sum that can be realized than for that of the annual interest are very +numerous, and probably include many men in receipt of quite +considerable earned incomes. Moreover, those who consider mainly the +future annual income which their savings will yield them, are usually +more concerned with its absolute amount than with the ratio it bears +to the amount they must save in order to acquire it. For this reason, +as has been often recognized, they may save less when the rate of +interest rises, since a smaller quantity of savings will insure to +them the future annual income they desire to obtain. There is no need +to be dogmatic upon any of these points. The psychology of saving is +both complex and obscure. Our conclusion must be the negative one that +we have insufficient evidence to warrant the assertion that the +particular rate of interest which happens to prevail is a measure of +the sacrifice involved in saving, even in the case of what we might +regard as the "marginal saving." And, if we cannot assert this, we +must be careful not to assume it as the basis of other arguments, or +as part of a general analysis of price or exchange value. + +It is of some interest to observe that the difficulties which our +world socialist commonwealth would encounter if it attempted to +dispense with the rate of interest, would not necessarily include that +of obtaining a supply of capital. It might, indeed, not find it easy +to determine the proportions in which it should allocate its +productive resources between immediate and distant ends. Our present +system cannot be said to have evolved satisfactory principles for the +solution of this question; and the socialist commonwealth would have +to work out its own solution. But when it directed that labor and +materials should be devoted to purposes of long-period utility, there +would be an automatic collective saving, of which no one would be +conscious as an individual sacrifice. Even at the present time, our +capital is not supplied entirely by the savings of individuals, but to +an extent, which though quite incalculable is yet certainly +considerable, by involuntary saving of an essentially similar type to +the above. + + +Sec.9. _Involuntary Saving_. When a municipality embarks on a municipal +tramways scheme or any other industrial enterprise, and pays off by +means of a sinking-fund the capital which it borrows in the first +instance, the proceeding amounts, as the defenders of municipal +trading have rightly claimed, to a compulsory and unconscious saving +on the part of the citizens. Their consumption has been postponed +willy-nilly as the result of the increased rates or the high charges +which they have had to pay; and, when the subscribers to the original +loan have been paid off, the capital of the community is enhanced to +the extent of that loan. Central governments might similarly increase +the supply of capital by devoting annual revenue to capital purposes; +though their actual record, as it happens, is mainly of a different +kind. But what is chiefly a possibility in the case of Governments has +actually been carried out on an enormous scale by other institutions. +The development of the joint-stock company system has introduced a new +factor into the problem of the supply of capital, which is of immense +though but dimly perceived importance. The directors of a company are +technically no more than the servants of the shareholders. It is the +profit of the shareholders that it is the directors' duty to promote +with a single mind, and the whole capital of the concern, including +its reserves both open and concealed, is the shareholders' exclusive +property. But realities have a way of differing from forms, and just +as in political affairs it is common to regard the State as a very +different thing to the people who compose it, as a sublime entity with +a separate existence of its own, so directors are apt to distinguish +between the company and the shareholders. It is the company to which +they owe allegiance. To pay away in dividends to shareholders money +which they could employ in extending the business or strengthening the +position of the company appears to some directors a necessity hardly +less unpleasant than an increased wages bill, or an Excess Profits +Duty. Concessions must indeed be made to the shareholders' rapacity: +but when something has been done in this direction, dust can easily be +thrown in their not very observant eyes. Reserves, which within +limits are a necessity of sound finance, can be accumulated beyond +those limits, and, when the further limits of an extreme but just +arguable conservatism have been passed, there remain the innumerable +devices, known to every resourceful Board, of hidden reserves, the +secret of which is unmenaced by the meager information of a +balance-sheet. In all this the shareholder, as the directors +occasionally assure themselves, has no real grievance, for he will +gain in the long run, from the appreciation in the capital value of +his shares, all and perhaps more than all that he foregoes in the +meantime in the way of dividends. + +In the long run the shareholder is not injured; but in the meantime he +is in effect compelled, without any consciousness of the proceeding, +to save and to reinvest in the company a portion of the dividends, +which he might otherwise have spent. The reserves which are +accumulated are not allowed to lie idle: they are employed either in +what are really capital extensions of the business, or in the purchase +of outside securities, and in either case they represent an increase +in the total supply of capital. The principal which these proceedings +represent is capable of indefinite extension. + +But however possible it might be to secure a supply of capital without +the inducement of a rate of interest, that rate is indispensable for +dealing with the demand. It is no good saying, "Three per cent seems +a fair rate of interest; let us try and limit it to that." Given the +amount of savings which are supplied, the rate of interest must be +allowed to reach whatever figure is necessary to confine the demand to +that amount. Given the quantity of resources which you have available +for future needs, the meshes of the sieve must be made as narrow as is +necessary to confine the projects that pass through within those +limits. And so, indeed, it becomes necessary for any particular +business to pay for its capital interest at the market rate, not so +much to secure the saving of it as to secure its allocation from the +common pool. + + +Sec.10. _Interest and Distribution_. It is unavoidable that this interest +should accrue to whoever it is that supplies the capital. If the +capital were supplied, as it might conceivably be, collectively by the +community, the interest would accrue to the community, and all would +be well. But as things are, the capital is supplied mainly by the +savings of individuals, and largely by individuals confined to a +relatively narrow class. The profits of Capital have thus a vital +influence on the very serious matter of the distribution of wealth +between social classes. Now, as experience shows, there is no element +in profits which is capable of such radical change in so short a space +of time, as is the rate of interest. Even before the war it had become +hard for people in Great Britain to realize that 3 per cent Consols +had stood at 114 as late as 1896. "How blest," wrote two cynical +satirists of society in the same period: + +"How blest the prudent man, the maiden pure, +Whose income is both ample and secure, +Arising from Consolidated Three +Per cent Annuities, paid quarterly."[1] + +It is impossible to read those lines now without a sense of irony, +different from that which they were intended to convey. + +Not only is the rate of interest now double what it was a generation +ago; we have no good reason to suppose that the present high level +will quickly be reduced. The havoc of the war, of which the +widespread poverty of Europe and the huge debts of Governments are but +two different aspects, makes it almost inevitable that the rate should +rule high in the present decade. This cannot but exercise a profound +influence, of a most disquieting character on the general level of +profits, and to a lesser extent (for here we must allow for the +effects of high taxation) on the distribution of real wealth between +social classes. Here we are on the threshold of tremendous issues. We +almost feel the earth quake beneath our feet. We hear the muffled roar +of far-reaching social controversy: + +"And 'mid this tumult Kubla heard from far +Ancestral voices prophesying war." + +[Footnote 1: _Narcissus_, by Samuel Butler and Henry Festing Jones.] + + + +CHAPTER IX + +LABOR + + +Sec.1. _A Retrospect on Laissez-faire_. When, a century and a half ago, +the foundations were being laid in the Western world of systematic +economic theory, the public attention was much occupied with a +subject, which indeed has not ceased to hold it: that of the failings +of Governments. The general interest in that topic was shared by the +pioneers of economic thought, of whom, in Great Britain, Adam Smith +was the most notable. It was indeed their practical concern with the +concrete economic issues of the day which very naturally gave the +impetus to their scientific quest. It was hardly less natural that +they should have expressed their opinions on these concrete issues +with considerable emphasis. + +Now the keynote of their practical conclusions was that Governments +were doing immense mischief by meddling with a great many matters, +which they would have done better to leave alone. In this they were in +general agreement with one another; incidentally--let there be no +mistake about it--they were right. But, as invariably happens in +public controversy, their opinions became crystallized in a compact +formula, or cry, with unduly sweeping implications. This was the cry +of "_laissez-faire_." Let Governments preserve law and order; and +leave the economic sphere alone. The economists picked no quarrel with +this formula; it served well enough for workaday purposes to indicate +the lines of policy which they rightly thought essential in their day. + +The history of this cry is the history of every cry which has won a +wide acceptance from mankind. It did good work for perhaps half a +century; but then many crimes were committed in its name. The +instrument which had been forged to clear away a noxious tariff jungle +and the monstrous laws of Settlement, was turned against Lord +Shaftesbury and the Factory Acts. Not only was inaction recommended +to Governments as the highest wisdom; other institutions, like trade +unions, were warned off the economic grass. An ideal of perfect +competition became an idol to which much human flesh and blood were +sacrificed. + +But, what is more to our present purpose, the idea took root of an +intimate association between the laws of economics and the policy of +_laissez-faire_. People who opposed some long-overdue measure of State +regulation believed themselves to be justified by the eternal verities +of economic law, and this claim even the advocates of the measure +seldom ventured to dispute. They took refuge rather in a conception of +economic law as a dangerous monster, whose claws must be clipped in +the interests of the higher good. This notion that all interference +with so-called "free competition," is a violation (though very likely +fully justified) of economic laws has sunk deep into our common +thought. So that to this day, whenever we see at work the hand of a +State department, a trust or a trade union, we are apt to say "Demand +and supply are here in abeyance," and possibly we add "A good thing +too." Since in the matter of wages, the hand of the trade union is +very generally evident, it is impossible to discuss the subject-matter +of this chapter, until we have rid our minds of this quite baseless +prepossession. To sweep away this cobweb, I urge the reader to recall +here the general tenor of the analysis of the preceding +chapters. Whether we were dealing with the price of an ordinary +commodity, with joint products, land or capital, we came across +relationships which seemed altogether more fundamental than our +present industrial system; nor, we may incidentally observe, were we +ever required to suppose that the present system was one of "perfect +competition." These relationships were almost invariably such that +even a world socialist commonwealth would find it necessary to +maintain them. It was not suggested, and most certainly it must not be +thought, that a world socialist commonwealth, or even a more modest +remodeling of the social order would not effect great changes, +possibly for good, and possibly for ill. The same economic laws might +be made to bear very different fruits, but they themselves would +remain unchanged. What is true in all these other fields--this should +be our predisposition--is not likely to be quite untrue in the field +of labor. + + +Sec.2. _Ideas and Institutions_. Another point is worth noting here. We +are sometimes advised to distinguish sharply between "What should be" +and "What is"; often two very different things. The advice is +pertinent and useful, particularly in the sphere of sociology. But +our incorrigible habit of confusing the two things together is not +without justification, or at least excuse. For, in fact, they +gravitate towards one another with a force which is just as strong as +the capacity of man for understanding and controlling his +environment. When we have a system which is clearly bad, _and_ when we +see our way to make it better, we generally make the change however +tardily. Our sense of "What should be" thus reacts upon "What is." +Meanwhile, until we can make the system better, our appreciation of +"What is" affects our sense of "What should be." And the more so, as +we are sensible. For "What should be" is pre-eminently an affair of +relativity. A man may hold very strongly that equal pay to every +individual is desirable, as he puts it, as an ideal. But this will not +prevent him, in a world in which managers are paid far more than +manual workers, from maintaining hotly (at any rate, if he is +sensible) that to pay the manager of a particular concern a manual +worker's wage would be monstrously unfair. He would also argue that it +would be highly inexpedient. Equity and expediency are, in fact, +intricately intertwined in our sense of "What should be"; and our +sense of "What should be" in the particular is governed by our +knowledge of "What is" in the general. + +These may seem unnecessary commonplaces. But they have a vital bearing +on the _modus operandi_ of economic laws. These laws do not work _in +vacuo_. They work through the medium of the acts of men. The acts of +men are greatly influenced by their institutions, and by their ideas +of right and wrong. Both institutions and ideas may serve to smooth +rather than obstruct the path of economic laws; because the laws may +represent either "what should be" in the general, or "what is" in the +general, and therefore "what should be" in the particular. This may +hold true even of a trade union or a sense of "fair wages." The +business of economic theory is not to justify a regime of +_laissez-faire_, still less to show the folly of bringing morals into +business. Its value is rather that it may help us, by improving our +understanding, to shape our institutions, and to adopt our moral +sentiments so as to promote the public welfare. With these general +notions in our minds, let us turn to see how stands the case with +Labor. + + +Sec.3. _The General Wage Level_. The term Labor may be used in a broad or +in a narrow sense. It may be confined to weekly wage-earners: it may +be extended to include all those who work, as the phrase goes, "with +either hand or brain." It is with all classes of Labor, in the +broadest sense of the term, that we must here concern ourselves. It +will be convenient, however, in the first instance to ignore the +differences between them, and to consider the forces which determine +what we may regard as the general wage-level. + +The general laws of supply and demand hold good. The wages of labor +tend to a level at which the demand is equal to the supply. For, if +the demand exceeds the supply, if, in other words, labor is scarce, +wages tend to rise, sooner or later in any case, and the more promptly +in proportion as the workpeople are organized. Conversely, if the +supply exceeds the demand, if in other Words there is general +unemployment, wages tend to fall, and the strongest trade unions +cannot resist the tendency, though they may delay it. Moreover, the +higher the wages that must be paid, the smaller, other things being +equal, is the demand for labor. For, even if we leave foreign +competition out of account, and consider, as it were, labor throughout +the world as a whole, the demand for labor is by no means +inelastic. It is derived along with the demand for the other agents of +production in the manner described in Chapter V. As was there shown, +the greater the supply of the other agents of production, the greater +is likely to be the demand for labor; but these other agents can be +substituted for labor in a great variety of ways, and an increase in +wages (unless accompanied by increased efficiency) will make it +profitable for employers to effect such a substitution, where it was +not profitable before. Thus, higher wages for the same labor +efficiency must stimulate the tendency for capital to act as a +substitute for labor at the expense necessarily (since the aggregate +supply of capital will not be increased thereby) of its tendency to +serve as a complement; and this must mean a decrease in the volume of +employment. Hence the power of labor to secure a general advance of +wages by concerted or simultaneous trade union action, applied if you +will, not merely to every industry, but to every country, is +necessarily very limited. Beyond a certain point, such a policy must +result in general unemployment; and, if pushed sufficiently far, in +unemployment so extensive that it would continue even in periods of +active trade. Such a policy could neither be maintained in practice +nor would it be a wise policy from the workers' point of view. + +In other words, given on the one hand the conditions of the demand for +labor (i.e. the supply of capital, natural resources, business +ability, risk-bearing and knowledge of technical processes, etc., +which happens to exist), and given on the other hand the supply of +labor (i.e. both the numbers of workpeople and their efficiency), the +wage-level in the long run is fairly rigidly determined. The +introduction of the phrase "in the long run" in this connection is apt +to provoke comment which may be pertinent, but may be misconceived. +The worker, it is pointed out, is deeply concerned with "the short +run" in which he has to live. It is very true; and it is this that +supplies one of the many justifications of trade unionism. To secure +for the workers advances of wages, which economic conditions justify, +sooner than would otherwise have been obtained, is certainly no +trivial or contemptible function. But it is none the less an illusion +to suppose that the general wage-level can be appreciably and +permanently raised by trade union action, except in so far as it +increases the efficiency of the workers or incidentally stimulates the +efficiency of the employers. + + +Sec.4. _The Supply of Labor in General_. The efficiency of labor may be +regarded as affecting either the demand for labor on the one hand or +the supply of it on the other, according as we look at the matter from +the worker's or the employer's standpoint. The employer is concerned +with the labor costs per unit of his output, the worker is concerned +with the wages he receives. An increase in the efficiency of labor +may, and usually will, mean both a decrease in labor costs to the +employer and an increase in the earnings of the worker. It is thus +wholly to the good. But the effects of an increase in the supply of +labor in the sense of a growth in the numbers of the population are +far more dubious. Unaccompanied by an increase in the _demand_ for +labor, it _must_ result in a diminished remuneration for the +individual worker. To some extent indeed the demand for labor would +almost certainly be increased. The supply of Capital may expand, +perhaps proportionately, perhaps more than proportionately to the +increase in population. But one factor of production, as we have seen, +is not capable of such expansion. This is the factor of Land, or +Natural Resources. It is the limitation of this factor which gives +rise to what we have most of us heard of as The Law of Diminishing +Returns. It is this that is the essence of the problem of Population, +portrayed in somber hues more than a hundred years ago by Malthus. + +This problem will form the subject of the sixth volume of the present +series. In the meantime it may be suggested that we are easily +credulous if we suppose that the problem has been finally disposed of +by the peculiar progress of an abnormal century. But that experience +has at least destroyed the view that there _need be_, or even is in +fact in Western countries, a relation between real wages and the +numbers of the people so close and direct that an improved standard of +living must be temporary only, doomed to destroy itself by the +increased population it engenders. One may perhaps go further and say +that it is doubtful even in what direction changes in remuneration +will influence the aggregate supply of labor. When we pass to "what +should be," it is plain that there is nothing whatever to be said for +the sort of relation indicated above. The view once widely held that +the principle of population must inevitably keep the mass of people +close to the verge of the bare means of subsistence was no statement +of a desirable ideal. It was a nightmare; a nightmare none the less +though it may haunt us yet. It is far from fanciful to suggest that it +is because this relation is so obviously _not_ "what should be" that +it may be ceasing to hold true in fact. But it would be very fanciful +indeed to maintain that as yet "what should be" is represented by the +actual population. Thus, just as with capital, so with labor, there is +no reason to suppose that the aggregate supply is determined by any +fundamental economic law, or corresponds in practice to what is +socially desirable. + + +Sec.5. _The Apportionment of Labor among Places_. Again, as with capital, +it is when we turn to the _apportionment_ of labor between different +employments that both economic law and social ideal make their +appearance. It will be well, however, to consider briefly in the +first instance the different question of its apportionment between +places. This was hardly necessary in the case of capital, because the +possibilities of foreign investment are very numerous and easy: the +mobility of capital is thus sufficiently strong (once again it is only +_marginal_ adjustment that is necessary) to establish over at least a +large part of the world something near to a uniform rate of +interest. But this is not the case with labor. People do indeed move +from place to place within a country, and from one country to another, +in response to economic opportunities. That even the latter movement +may be a considerable thing, the present population of the United +States is a striking testimony. But obviously the mobility is very +incomplete. Here, then, we have what we might _loosely_ call an +economic law that labor tends to "flow" (as it is sometimes unhappily +phrased) to those places where it can command the highest reward; we +have this tendency in evidence, but it is far too weak to enable us to +lay down what would deserve more strictly the title of an economic +law, that in the long run the reward of the same kind of labor is +roughly equal in all places. Perhaps we can say this for many +districts in a single country; but for few countries is this true as +between all their districts. As between countries, it is not remotely +true. + +Here, however, the imperfection of economic law is balanced by an +extreme uncertainty as to the ideal. Perfect mobility of labor may be +_economically_ desirable in a very narrow sense of the term; but it +opens out a vista of racial, national and cultural problems, into +which it will be better for us not to enter here. We must take for +granted the population of a country, like that of the world, as a +given fact. + +When we do this, the question of its remuneration is on all fours with +the more general question discussed above. That the remuneration of +the labor of a country is mainly governed by the relations between +demand and supply is an inexorable fact. In view of the international +mobility of capital, the main distinctive factor in the demand for the +labor of a particular country is the supply of natural resources, +which it knows how to use. Where the natural resources are great +relatively to the population, there wages will rule high; where the +converse is true, wages will rule low. This result of economic +analysis is abundantly confirmed by experience. The relatively high +wages in the new world, the low standard of living in the densely +populated East; the economic history of Ireland are so many +object-lessons of its truth. + + +Sec.6. _The Apportionment of Labor among Social Grades_. The question of +the apportionment of the labor of a country among different +employments falls under two heads. Some differences of occupation are +associated particularly in Great Britain with differences of what we +know as class. The movement of labor between different social grades +is clearly a very different thing from its movement between different +occupations in the same grade. The grades themselves are not easy to +define: not a little ingenuity has been expended on the attempt, and +perhaps the best brief classification that has been put forward is one +which divides labor into the following four grades:-- + +(1) Automatic manual labor. +(2) Responsible manual labor. +(3) Automatic brain workers. +(4) Responsible brain workers. + +But the matter is one perhaps for the satirist of manners rather than +the economist. It suffices for our purpose that the distinctions, +however vague, are very real. + +It is obvious the mobility of labor between the occupations of a +platelayer and a barrister is not very great. It may seem perhaps to +be even smaller than it is. For here it is important to bear in mind a +general consideration which is equally applicable to horizontal +movements within any social grade. There may be a considerable +movement of labor between different employments without any individual +worker having to change his occupation. The personnel of any industry +is constantly changing. At one end, men die, retire, or are pensioned +off; at the other end, young recruits are taken on. By a diversion of +the new recruits from one employment to another, a radical change can +be made in the occupational census in a comparatively short space of +time. It is in this manner that such movement as takes place is +largely effected at the present time. Within the ranks of the +professional classes, a man does not commonly leave the profession to +which he has been trained. But his _choice_ of profession is +determined by him or his parents not solely on pecuniary grounds but +usually with an anxious scanning of the general prospects, which +include pecuniary advantages together with many other things. The same +thing is true in no small measure of manual wage-earners. This general +consideration must be borne in mind throughout the remainder of this +chapter. + +But even the sons of platelayers do not commonly practise at the +bar. The obstacles in the way are various and subtle. Many of them are +ideas, inherited from a bygone epoch, about keeping other people "in +their proper stations," which the whole drift of circumstance, and the +spirit of the age are rapidly wearing down. In the new world such +obstacles are rare. But an obstacle of a more tangible and formidable +kind arises from the fact that the liberal professions and many +business careers require a long and expensive education and training, +which the platelayer is quite unable to afford to give his son. + +Now this expense of training is highly relevant not only to "what is," +but to "what should be." It includes, it should be observed, a +negative as well as a positive element; a long period of waiting +before income begins, as well as the actual outlay on educational and +other charges. When the burden both of the waiting and the positive +costs must be borne either by the individual or the family, there are +few people who would seriously dispute that this goes to justify, on +grounds of fairness as well as of expediency, a higher level of annual +remuneration later on; though many people would doubtless argue that +the amenities and dignities of the professions should be taken into +account on the other side. But the same consideration makes it a +matter of legitimate doubt whether it would be desirable, even as an +ideal, that the community should provide so completely the costs of +training and of maintenance in the waiting period, as to make it no +longer "fair" that the individual should be remunerated more highly +than workers in less expensive occupations. For this would mean that +more labor would be absorbed in the former employments than in +principle would be socially desirable, for reasons which the argument +of the next chapter will make plain. But the most desirable number of +doctors, barristers, teachers, etc., is not a thing which can be +settled on purely economic grounds, and it is unprofitable to carry +further this particular line of thought. Few people would advocate, as +an ultimate ideal, that the remuneration of the professional grades of +labor should exceed that of lower grades by _more_ than the extra +expense of training and waiting they involve. That the excess is +usually greater than this at the present time seems very probable: +though it is a matter on which it is very hard to generalize. But it +would certainly be far greater than it is if the principle of +_laissez-faire_ ruled supreme in these affairs. Fortunately it does +not, and has never done so. Even before the days of free elementary +education, the endowment of education was not unknown. The ancient +public schools and universities, which have come down to us from the +Middle Ages, are a standing witness to what in this field a far poorer +community thought fit to do. Their systems of scholarships and +exhibitions, no less than their courts and towers, deserve our +notice. For these were designed to form what we now call "a ladder" by +which talent could climb from the humblest origins to the callings +which then seemed the summit either of spiritual or of worldly +ambition. + +This reference to "talent" makes it well to consider here a factor +which necessarily complicates, though it does not substantially +affect, the whole argument of the present chapter. There are +differences of natural ability, which no education or training can +obliterate, which it should rather be their business to excite. These +differences are associated to a great extent with differences of +occupation; they _should be_ so associated far more closely than in +fact they are. They are also associated with differences of +remuneration even within the same occupation; "what should be" here is +a question which we may excuse ourselves from discussing. The +principle which, however vague, is sufficient for our present purpose +is that the same _natural ability_ should command the same reward in +all occupations, subject to differences which should not exceed the +differences of educational cost and initial waiting they involve. We +cannot assert, as an economic law, that this is generally true in +fact. If ever it becomes true, it will be due not to +"_laissez-faire_," or "free competition," but to social arrangements, +which express a sense of what is right. + + +Sec.7. _The Apportionment of Labor among Occupations_. When we pass to +the apportionment of labor among different occupations in the same +social grade, the same principle as to "what should be" applies in a +simpler form. Equal natural ability should command an equal reward in +all occupations; assuming that differences in cost of training can be +ignored. The reward must, of course, be interpreted not in terms of +money only but of "real wages," with allowance for the varying +amenities of different tasks. Now it was here that the extreme +advocates of _laissez-faire_ made one of their cardinal mistakes. They +assumed that this ideal would be best secured by "perfect +competition." The employer would choose the worker who would come for +the lowest wage; the worker would choose the employer who would pay +him the highest wage; and so, by a process similar to the higgling of +a commodity market, the desirable uniform wage-level would become +established. But in fact the conditions of the labor market differ +greatly from those of a commodity market. People are ignorant, do not +look ahead, cannot afford to risk the loss of a job, however wretched, +which they happen to have got. For reasons such as these, a +considerable departure from _laissez-faire_ is necessary in order to +realize the theoretical results of _laissez-faire_. To prevent the +putting of boys in large numbers into "blind alley" occupations, you +must supplement the foresight of parents with Juvenile Employment +Exchanges and After-Care Committees. To secure a proper uniformity of +wages within the same occupation, you must have trade unions. To +secure a proper uniformity between different occupations, you must +have again trade unions, or, failing them, Trade Boards. + +That the actions of trade unions are very largely of this type is a +fact insufficiently appreciated by the middle-class public. The +elaborate system of piece-rate lists which has been evolved in the +Lancashire cotton industry is primarily designed to secure the same +wage for workers of equal efficiency in all mills, irrespective of the +degree to which the machinery is antiquated or up to date. This result +is wholly to the good: not only does it secure "fairness" for the +worker, it stimulates the employer wonderfully to efficiency. The same +result could never be secured so effectively by the free play of +competition. But this tendency, which is easily the predominant +element in the trade union regulations of the cotton trade, is at +least an important element in the policy of "The Common Rule" of all +trade unions, though it may often be mixed up with the more +questionable tendency to eliminate differences of pay for differences +of natural ability, and the unquestionably bad tendency to discourage +output. As between different occupations, the insistence of a trade +union that wages must be leveled up towards the wages obtaining in +similar trades acts again as a far more powerful force than +competition. + +But the actions of trade unions are by no means wholly of this +type. They often serve rather to secure still higher wages for workers +who, comparatively speaking, are already highly paid. It makes little +difference whether this effect is secured directly by wage demands, or +indirectly by restricting the right of the entry to the trade. In +either case the consequences are the same, and there should be no +ambiguity as to their nature. They are certainly bad for the +community, certainly bad for the _other_ workers of the grade, almost +certainly bad for the workers of the grade regarded as a whole. The +higher wages must raise the money costs of production, and result, +sooner or later, in fewer workpeople being employed in that +occupation; larger numbers must accordingly seek employment elsewhere; +and this cannot but depress the wage rates of less strongly organized +trades. Thus the effect is twofold: a larger proportion of workpeople +will be employed in badly paid occupations; and the wages there will +be lessened. + +The power of a strong trade union to secure wage advances of this type +is considerable, but it must not be exaggerated. Trade unions employ +as a matter of course devices which, in the case of trusts, we regard +as the extremest weapons of monopoly. To say, "If you buy from anyone +except us, you must not buy at a lower price than ours," which +Messrs. J. & P. Coats are represented as having done, is analogous to +insisting that if non-unionists are employed, it shall be at the trade +union rate, as every trade union very properly insists. To say, "You +must buy _only_ from us," the method of the boycott, as it is called, +is analogous to the very common refusal to work with non-unionists at +all. But in one important respect the tactical position of a trade +union is weaker than that of an ordinary combination. It has usually +got a buyers' combination up against it, in the shape of an +association of employers. The latter will be governed in their +attitude towards the workpeople's demands, not only by immediate +expediency, but also by their own sense of "what should be"; and they +will usually resist demands for wages greatly in excess of those +obtaining in comparable trades. In this way, the tendency for workers +of the same efficiency to receive the same real wages in all +employments is far stronger than might at first sight appear. + +If we had to rely for this result upon trade unions alone, it would be +highly problematical. For here a psychological curiosity emerges, +which, familiar and intelligible as it is, is none the less a +curiosity. So far from still higher wages for well-paid workpeople +being regarded in the world of manual labor as detrimental to the +interests of other workpeople, it has become almost a point of honor +to believe the contrary. A wage dispute in a particular trade is +conceived as an engagement in a far-flung battle between Capital and +Labor, in which success at any part of the line will facilitate the +victory of the whole army. This conception contains a measure of +truth, as regards immediate and purely temporary effects; though, even +here, it is made to seem unduly plausible by the recurrence of trade +cycles, which cause wages at any time to move in the same direction +all along the line. But, if the foregoing analysis has been +appreciated, the essential falsity of this notion should be evident. +It is an illusion, which should receive no endorsement, either tacit +or express, in any work on economics. The general wage level of a +country cannot be regarded (except temporarily, and within narrow +limits) as a function of the efficiency of labor organization; it +depends on the far deeper economic facts set out in Sec.3 above. + +Let us now try to summarize the conclusions of this section. There +_is_ a tendency towards a uniformity of real wages for workers of the +same grade and of the same efficiency. This tendency is not due to +competition alone. It is helped by many acts of a collective kind, +arising from a sense of "what should be"; it is obstructed by other +acts of a like kind, where the sense of "what should be" is based on +imperfect understanding. The more people act in accordance with "what +should be," and the better their understanding, the more will this +tendency approximate to an accurate economic law. + + +Sec.8. _Women's Wages_. The wages of women represent a problem of great +public interest, upon which the principles laid down in this chapter +have a most important bearing, and which in its turn serves to +illustrate these principles further. It has been suggested that male +and female labor can be regarded as a strong case of Joint Supply, and +the suggestion is not merely facetious. The essential point, that the +proportions of available male and female labor are fairly constant +(not that they may not alter with time and circumstances, but that +they are essentially independent of the conditions of demand) holds +true not only of a country as a whole, but hardly less of a particular +district. If men and women are to be regarded as separate grades, they +are grades between which immobility is complete. Now men and women +differ in many ways which affect both the demand for and the supply of +their services. On the one hand, far fewer women wish to enter +business employments of any kind, as women have plenty of work that +must be done at home. On the other hand, though women can do many +kinds of work as well as or better than men, it so happens that for +much the greater number of services, which are in large demand in the +business world, men are the more efficient. Incidentally, it happens +that many occupations which women _might_ do as well as men are closed +to them by exclusive regulations. The resultant of these forces is +that men and women are for the most part employed in different +occupations, and the scale of payment in women's occupations is far +lower than that in men's. Of this last fact singularly small +complaint is made. + +It is otherwise, however, when we come to occupations where men are +either wholly or partially employed, where women are at least +approximately as efficient as men, and where the barriers to their +entry are at least formally removed. There a ferocious controversy +rages over what is known as the principle of "equal pay for equal +work." It is easy to understand why the male trade unionists in, let +us say, the engineering trades, should support this claim. It is also, +indeed, _intelligible_ why the enthusiasts for Women's Rights should +urge it; but it is much more doubtful whether they are wise. Possibly +they are wise enough in their generation, since it might not serve +them on this matter to get across the men. But it is clearly not +prudential considerations of this kind by which they are mainly +actuated. They make the demand, with extreme intensity of feeling, as +a demand for fundamental justice. They are also very obviously +inspired with the belief (similar to the illusion which is a point of +honor with the male trade unionist) that high wages for women in +well-paid occupations will help to raise the wages of sweated women +workers in other trades. + +Now, here again, any lack of candor would be inexcusable. The effect +of this policy on the wages in women's trades is certainly to reduce +them. The policy serves, as powerfully as any trade union custom, to +restrict the entry of women into the men's employments, and often +spells virtual exclusion. For the "equal efficiency" may be +approximate only, and there may be advantages in male labor from the +employer's standpoint which are none the less important, because they +are not easy to define. Moreover, from the employer's standpoint, the +efficacy of female labor will be largely a matter for _experiment_, +and "equal pay" will give him no inducement to experiment at all. The +diminished number of women in these occupations (as compared with what +might have been) increases the number who must fall back on the purely +women's trades; and it _must_ serve to reduce the wages there, where +organization is by no means strong. I am far from asserting that this +consideration is conclusive against the principle of "equal pay for +equal work" (though I think it conclusive against a rigid +interpretation of it); for other matters, such as the standpoint of +the male trade unionist must be taken into account. But the reactions +on the wages in women's trades permit of no ambiguity. + +In occupations of another type, the issue takes a somewhat different +form. In the teaching profession, "equal pay" would not exclude the +women; it would be far more likely to exclude the men. For, though the +advocates of the principle would declare that their intention is that +the salaries of women should be leveled up to those of men, it is more +probable that the ultimate outcome would be a leveling down. +Educational authorities have the ratepayer and the taxpayer to +consider; and, apart from this, they have their own interpretation of +"what should be." To pay a woman less than a man for the same work may +seem glaringly unfair; but it is not very clear why a woman, who is an +elementary school teacher, should be paid much more than, say, a +hospital nurse, merely because in the former case a number of men +happen also to be employed. In fact, there is a clashing of equities +in this connection; and there is little doubt which of them the +educational authorities would prefer. A leveling down of the men's +salaries would make it all but impossible to attract men of the +desired type into the profession, and would thus lead to the virtual +extinction of the male elementary school teacher. This might seem in a +narrow sense to be economically desirable. Why should not men take +their services to the tasks for which they can command a higher +reward, and which women cannot do as well? But whether this would be +desirable in the true interests of education is a far more doubtful +matter. And this is the real problem of "equal pay for equal work" for +male and female school teachers. The reader will notice that I have +refrained from alluding to the controversy as to whether men should +receive more on the grounds that they have wives and families to +maintain. That, although a most absorbing issue, is not the real issue +in practice at the present time. The real issue is a clashing between +a sense of "what should be" on obvious general grounds and a sense of +"what should be" in the particular, derived from the very patent and +general "what is" that men receive as a rule far higher pay than +women. + + + +CHAPTER X + +THE REAL COSTS OF PRODUCTION + + +Sec.1. _Comparative Costs_. Beneath the great diversity of the +considerations which are applicable to the different agents of +production, certain general conclusions emerge from the analysis of +the last four chapters. In no case did we find that the aggregate +supply of the agent was determined by clear and certain economic laws, +possessing any fundamental significance. The supply of natural +resources is a fixed thing, quite independent of the efforts or the +desires of man. However the supply of capital and the supply of labor +may react under present conditions towards economic stimuli, these +reactions possess no quality of inevitability and bear no clear +relation to "what should be." The supply of risk-bearing responds +perhaps more decidedly to the prospects of increased reward; but it is +so intimately associated with special knowledge and the qualities of +business enterprise, as to leave some uncertainty attaching even to +this conclusion. When, on the other hand, we turn to the +apportionment of these factors among different uses, we find relations +which are both clear and fundamental. Laws emerge which state at once +not only "what is" or at least "what tends to be," but also "what +should be"; and it is the fact that they taste "what should be" that +gives them their fundamental character. + +These conclusions enable us to give a general answer to the question +which was raised at the end of Chapter V: What are the ultimate real +costs to which the money cost of production correspond? The attempt +has often been made to relate money costs to such things as the effort +of working and the sacrifice of waiting. The existence of such costs +is beyond dispute. Much saving does mean a sacrifice of immediate +enjoyment to the man who saves. Most labor is irksome and disagreeable +in itself, and involves strain and wear and tear; while all labor +means a deprivation of the utility of leisure. Workpeople, moreover, +do not grow on gooseberry bushes, but must be fed and clothed from the +cradle; and their rearing and maintenance represents a real cost which +someone must incur. + +But the existence (or the importance) of such costs is one thing, +their relation to money costs is another. In Chapter VIII we saw how +difficult it was to establish any clear relation between the rate of +interest and the sacrifice of saving. The costs of labor present +similar difficulties. The relative irksomeness of two occupations may +affect the relative wages which will rule in the two cases; so, +certainly, will the differences in the cost of education and training +which they require. But these are matters which concern the +_apportionment_ of labor between different employments. There is no +good reason to suppose that the general wage-level would be reduced, +merely because work as a whole became less irksome, or involved a +smaller physical or mental strain. The supply of people is not +determined by the same kind of influences as is the supply of a +commodity. Parents do not produce children for the sake of the wages +which the children will receive when they go out to work; or, if this +happens, we rightly regard it as a horrible anomaly. In so far as +parents are affected by economic conditions it is by their own +economic conditions; the question is rather one of how many children +they can afford to have, than of a balancing of the cost to them +against the incomes which their children may subsequently acquire. But +other considerations enter in; and, in fact, it is doubtful how the +aggregate supply of labor will react to changes in prosperity. +Finally, the supply of land involves neither effort nor sacrifice; +and, among our money costs, we have to account for the item +of the rent of land. To dispose of this difficulty by arguing that +rent does not enter into marginal costs (in any sense which is not +equally true of wages and profits) is to lose contact with +reality. Thus the attempt to explain money costs in terms of the costs +of producing the ultimate agents of production leads us into a +quagmire of unreality and dubious hypothesis. For a systematic theory, +which will rest on firm foundations, we must interpret money costs in +very different terms. + +The real costs which the price of a commodity measures are not +absolute, but comparative. Marginal money costs reduce themselves in +the last analysis to the payments which must be made to secure the use +of the requisite agents of productions. These payments _tend_ to equal +the payments which the same agents could have commanded in alternative +employments. The payments which they could have commanded in +alternative employments, tend in their turn to equal the derived +marginal utilities of their services in those employments. It is thus +the loss of _Utility_ which arises from the fact that these agents of +production are not available for alternative employments that is +measured by the money costs of a commodity at the margin of +production. + +This conception of ultimate costs encounters an instinctive +repugnance, arising from a mistaken sense of logical symmetry, which +it will be well to examine. Cost, it is objected, so interpreted +loses its character as an independent entity. It is merely something +derived from utility. Now in the earlier chapters of this volume, we +found reason to be impressed with the general symmetry which pervades +the relations of demand and supply. Moreover, when we considered the +case of ordinary commodities we found that at the back of demand and +giving rise to it was utility; at the back of supply, and limiting it, +was cost. The general symmetry between demand and supply thus seemed +almost to imply a fundamental symmetry between utility and cost. If, +then, cost in the last analysis is derived from utility, does not this +make nonsense of the symmetry between demand and supply, or, if we +cling to this last symmetry as a demonstrable truth, must we not +refuse to admit that cost can be derived from utility? + +This is one of those false dilemmas which supply the wiseacres of the +world with a plausible case for distrusting the logical faculty. If we +have good reason for believing that both of two apparently +inconsistent things are true, the explanation is seldom that one of +them is really false; it is more usually that they are not really +inconsistent. So it is here. The symmetry between demand and supply is +very great, and we should always look to see if it holds good, but it +is by no means perfect, and it is in the last analysis that it most +notably fails. It is most important to distinguish clearly between the +utility and the cost of a commodity as two separate and independent +things. In Chapter V, it will be remembered, we did not permit +ourselves to derive the costs of producing cotton lint from the +utility of cotton-seed. The refusal to do so was essential to clear +thought; it led to some very useful practical corollaries. But to +derive the cost of a commodity from the utility of something which is +produced _with_ it, as part of the same productive process; and to +derive the cost from the utilities which the agents, which help to +produce it, possess for other purposes, are two entirely different +things. In works on International Trade, the reader will discover that +the comparative nature of real costs is so unmistakable that a +Doctrine of Comparative Costs is expounded with much formality at the +outset. This doctrine is apt to prove somewhat puzzling, when we have +to deal with it as an apparent exception to the general tenor of +economic theory. Its difficulties disappear when we realize clearly +that the real cost of _anything_ is the curtailment of the supply of +other useful things, which the production of that particular thing +entails. + + +Sec.2. _The Allocation of Resources_. However strange the above +conception may seem, there should be no doubt that this cost is very +"real." Here the irregularities and maladjustments of the economic +world, the recurrence of trade depressions and the like, do much to +obscure a clear vision of the essential realities. At a time when +there is much unemployment, and much machinery standing idle, it is so +clear to common sense that we _could_ produce more of some particular +thing without diminishing the supply of other things, that any +apparent statement to the contrary may perhaps seem the height of +academic pedantry. But let me ask the reader to consider with an open +mind a familiar parallel. During the recent war there was inevitably +much waste and muddle in the utilization of the military resources of +the Allies. Some regiments would be kept inactive for long periods, +not for purposes of rest or training, but owing to some defect of +organization. In the manufacture of munitions, an insufficient +appreciation of the principles of joint demand led to the piling up of +excessive stores of certain materials, which were useless until +commensurate supplies of the complementary factors could be +obtained. It is unnecessary to multiply examples. The waste of both +man-power and material was immense. But the allocation of these +resources between, for instance, the various theaters of war was none +the less a very real problem, which gave rise to much engrossing +controversy. It was an axiom that the more resources you employed in +Mesopotamia or in Palestine, the less resources remained available for +France. No one thought of maintaining that, as long as there was any +waste of these resources, so long as there remained any men to be +"combed out" of unessential industries, you could pour troops and +munitions into Salonika without stopping to consider the needs of +other theaters of war. Such a notion would have been clearly imbecile, +for the sufficient reason that the sending of armies to Salonika would +do nothing in itself to secure (however much it might incidentally +stimulate) the more efficient use of the resources which remained. + +Now this is precisely analogous to the problem of the allocation of +our resources for the purpose of peace. Notwithstanding all the +wastes and maladjustments of the economic system, the use of resources +to produce one commodity _does_ in general curtail the production of +others. The mere launching of a new business enterprise does no more +than the sending of an army to Salonika, to eliminate waste in the +remainder of the economic organism. Unemployment, broadly speaking, is +a function not of the magnitude of the normal demand for labor (which +affects rather the wage-level), but of fluctuations in the demand for +labor; fluctuations from one day to another as at the docks, from one +season to another as in the building trades, above all from one period +of years to another as in the cycles of general trade boom and +depression. Nothing will diminish unemployment which does not serve to +diminish these fluctuations. A new business will not, as a rule, have +any such effect. If it is launched during a trade depression (a most +unusual proceeding), it may temporarily absorb unemployed labor and +idle materials. But when the next boom comes, it will be using, though +presumably to greater advantage, labor and materials which, but for +it, would have been employed for other purposes. Meanwhile the causes +making for unemployment will be unaffected. Miscalculations will +still be made, the building trades will still become slack in the +winter, the casual methods of engaging dock laborers will still +continue, trade cycles will still recur, while beneath them, and +concealed by them, some industries will expand and others will decay. +Thus, like the armies at Salonika, the new business would in effect +divert resources from elsewhere. + +This truth needs to be firmly grasped in mind. It is this that makes +it in general unsound policy to subsidize industries, either directly +or indirectly, by means of a protective tariff. It is this, indeed, +that supplies the answer to half the economic fallacies that are +always current. + +The allocation of resources so as to yield the maximum effect was +rightly recognized as one of the most vital and difficult of our +war-time problems. To cope with it, the Allied peoples devised one +instrument after another, and finally evolved the Supreme Allied +Council. The analogous problem in the economic world of peace time is +no less important and far more difficult; but there is nothing to +correspond to the Supreme Allied Council. There we rely upon a +co-operation which, as was stressed in Chapter I, is unco-ordinated. +That co-operation has been evolved by the mutual competition +of innumerable business concerns, controlled by men largely +animated by the motive of pecuniary profit. But it has not +been evolved wholly by such means: and how far that competition or +that motive of profit is essential to its efficiency are questions +with which this volume has not been in any way concerned. The economic +laws, the relations between utility, and price and cost, with which it +has been occupied, are an entirely different matter; and these _are_ +essential to the efficiency of any system of society. For if the +marginal utility of a commodity is equal to its marginal cost, and if +this marginal cost is composed of payments to the various agents of +production at least as great as they could have obtained if they had +been used otherwise, this amounts to saying that the agents of +production are so utilized as to yield the maximum utility; and this +is the same thing as saying that they are so utilized as to produce +the maximum wealth. + + +Sec.3. _Utility and Wealth_. Upon this last point it is important to be +quite clear. An increase in wealth seems a solid, tangible reality; +something, which, however much we may scorn it in our more precious +moods, we recognize, for a rather poor community, to be an important +object of endeavor. But an increase in utility seems a vague, +impalpable notion, hardly deserving the same practical concern. None +the less the two things are identical. We greatly deceive ourselves if +we suppose wealth to be an objective reality. It is true that, when +we get behind the money in which it is measured, we come upon +commodities, like food and clothes and houses and factories, which +seem comfortably solid and objective things; but we also come upon +many services, like those of gardeners and doctors and hospital +nurses, which we are bound to reckon as part of our wealth, although +they are not embodied in any tangible commodities. Moreover, although +material commodities are objective realities in themselves, and in +many of their properties, they are _not_ objective realities in their +property as wealth. A pair of boots is an objective fact; so is the +number of pairs in existence at any time, so is their size, their +weight, the quantity of leather or of paper which they happen to +contain. But the wealth which those boots represent is not an +objective fact. It depends upon the opinion which men and women +entertain as to their utility; and these opinions take us into the +subjective regions of human psychology. Let us suppose, for instance, +that we calculated, on the basis of present prices, that the boots in +existence at the present time represented 1/1000 part of our total +wealth. Suppose, then, that a miracle were to happen; that the skies +opened and rained boots upon us, of every size and shape and pattern, +until we had 1000 times as many boots as we had before. Could we say +that our total real wealth had been doubled? Clearly we could not. To +obtain boots for nothing, and to wear a new pair every week, would +make us somewhat better off, but not twice as well off as we were +previously. In other words, the real wealth of a thousand times as +many boots as we have now, is not a thousand times as great as the +wealth of the present number of boots. We are, indeed, practically +restating the Law of Diminishing Utility; and this perhaps is enough +to show that wealth is fundamentally the same thing as utility. + +Another point, however, is worth noting. Our real wealth would be +somewhat increased in the case supposed; but if we were to turn to the +money measure of wealth, the opposite result would be far more likely, +For the price of boots would most likely fall to nothing, and the +total value of boots, in the commercial sense, would accordingly be +nothing also. This shows that money values may be a most imperfect +measure of aggregate wealth; for what money values represent is the +product of the quantity of the commodity and its _marginal_ utility, +while aggregate wealth is _total_ utility, which is a very different +thing. This, it may be observed, makes all attempts to compare the +wealth of different countries or different times, and no less to +construct Index Numbers of Prices, imperfect of necessity, and +arbitrary in their foundations. + + +Sec.4. _Criteria of Policy_. The point has now been reached at which we +must take into account the very important fact which was mentioned at +the close of Chapter III. The maximum utility which the laws of +supply and demand tend to bring about is a maximum _total_ utility +indeed, but one still measured in terms of money. An unequal +distribution of wealth destroys any necessary correspondence between +that and the maximum _real_ utility. This consideration, however, does +not affect the general validity of the conclusion that the laws of +supply and demand represent what is socially desirable now or under +any system. For what is at fault here is the distribution of wealth; +and it is that which should be changed, in so far as it is possible to +do so. Now it is important to realize that whenever it is possible to +supply a commodity to poor people below cost price, it is possible to +alter the distribution of wealth, for that in effect is what is +done. Purchasing power, which may be taken from richer people by +taxation, or which may be obtained from "collective" profits on other +trading, is in effect transferred to the poor people in question, +though the transference is coupled with the condition that the +purchasing power must be expended in a particular way. It is _in +general_ desirable that the transference should be made without this +condition being attached. To this general statement, exceptions indeed +exist so numerous and important as possibly to justify a great +extension of social expenditure of this type. Education should +certainly be provided free of charge, there are strong arguments for +subsidizing housing; the provision of milk to expectant mothers, the +feeding of school children, such instances can be multiplied into a +very extensive list. But it is important to observe that in each case +the justification of the policy rests in the presumption that the +service supplied is one which it is particularly important that the +beneficiaries should have, _as compared with_ the other things upon +which they might have preferred to expend the equivalent purchasing +power, had it been transferred to them without conditions. Where there +is no such presumption, as surely there is none in the case of the +great bulk of commodities, the relation between price and marginal +cost should be rigidly maintained; it is the distribution of +purchasing power which we should rather seek to alter. How far is it +possible to alter that? + +I suppose that it is inevitable that many readers will have concluded +that the preceding chapters must be taken to mean that the +distribution of wealth is not susceptible of any appreciable change. I +would remind those readers of an important distinction upon which +impatient people have sometimes based a complaint against +economists. The economist, it is said, analyses with great pomp and +ceremony the laws governing the distribution of wealth among the +agents of production, but says practically nothing about the +distribution between individuals and classes, which is the only thing +of any real interest to practical people. Now the economist +concentrates on the agents of production for the very good reason that +it is only with respect to them that any clear and certain laws as to +distribution can be laid down. Into the distribution between +individuals and classes there enter other and variable factors, +governed by no fundamental economic law; and _here_, the conclusion +should at once suggest itself, is the field for action designed to +alter the distribution of wealth. What is possible or desirable in +this field, it is again not the purpose of this volume to discuss. It +is an obvious, even if not a very helpful conclusion that an increase +in the habit of saving among weekly wage-earners might, without +appreciably affecting the distribution between Capital and Labor, +greatly modify the resulting distribution between social classes. But +questions as to how far it might be possible or justifiable to achieve +a similar result by the use of the weapon of taxation, by changes in +inheritance laws, or by the public ownership of industry take us into +a far more uncertain and controversial sphere. The difficulties and +objections which present themselves are familiar and formidable; but +they are of quite a different order from the economic laws which we +have been examining. The laws themselves do not entitle us to make any +dogmatic pronouncement upon these large issues of social policy. + +But this is not to deprive these laws of practical importance. They +represent essential criteria of sound policy in the sphere of social +reorganization no less than in ordinary business. In our days a +curious obsession has led many people to disparage these criteria, as +though they were the sordid prejudices of a stupid tradesman. Because +it has been found a matter of obvious practical convenience to +maintain the roads out of taxation or of rates, and to dispense with +charges for their use, it is suggested that the same principle should +be applied to the railways. Or, more commonly, because it has been +found convenient to make the same charge for the carrying of letters +between Land's End and John o' Groats as between Hampstead and +Highgate, it is suggested that _this_ principle should be applied to +railway rates and fares. It may be well, therefore, to point out that +the justification of uniform postal charges rests upon the facts: (1) +that the costs of collection, sorting, etc., are so large a part of +the costs of carrying a letter, that the real cost between John o' +Groats and Land's End does not differ from that between Hampstead and +Highgate by as much as might at first sight appear, (2) that the +charges in any case are very small; so that (3) the avoidance of the +small degree of taxes and bounties which the present system implies is +not worth the book-keeping expenses which differential charges would +involve. It should be obvious that these considerations apply to the +railways with a greatly diminished force. They might possibly justify +what is known as the "zone" system of charges, i.e. uniform rates +within certain narrow areas. But the notion of uniform rates +throughout Great Britain conjures up a vision of trains taking coal +from South Wales to Scotland, and others taking coal from Scotland to +South Wales, in accordance with the slightest preferences of the +consumers, and without regard to the extra real cost involved, on a +scale to which the "wastes of competition" afford no parallel. It +would in fact achieve the essential folly of "sending coals to +Newcastle." These considerations, however, are not what interest the +advocates of the postal principle. They seem to recommend the +obliteration or the confusion of the relations between price and cost +as a superior ideal. It is important to be clear what exactly this +ideal involves. + +It involves, in the first place, as the whole argument of this volume +has gone to show, a less economical employment of our productive +resources; they would be diverted to ends of less utility, and so +produce less real wealth. But this is not the worst. There is plenty +of waste and maladjustment in our economic system at the present +time. The desirable relation of price to marginal cost is but +imperfectly attained. The further departures from this relation, which +would follow from any likely applications of the postal principle, +might not matter in themselves so very much. What is far more serious +is that the criteria of efficiency would become blunted, and the clear +aims of management would be confused in fog. It is essential that +every manager should be on the alert to eliminate waste and to improve +efficiency, that he should be always trying to secure the best +results; but how can he do this if he has no simple means of +_measuring_ what results are good and what are bad? The measure which +he has at present is that of price, cost and the resultant profit, and +it would be fatal to take that away, unless an equally simple and more +accurate measure could be substituted for it. + +This is not a question, it should be observed, of motive or +incentive. Very likely we much exaggerate the importance of the profit +motive. It may be true that men would work, perhaps that they already +work in fact, as zealously for a fixed salary, as for personal +gain. But aim and motive are two somewhat different things, and the +_aim_ of profit, is, and will remain, essential to the efficient +conduct of business. In a game the players are not animated by the +motive of scoring runs or points, but they aim at them; and the zest +disappears very speedily from the game, if that aim ceases to be of +interest. Moreover, while a scoring system is always a somewhat +arbitrary thing, measuring imperfectly the true merits of the play, if +it measures them with the roughest accuracy, we prefer the issue of +our games to be decided so, rather than by the decisions of an +impartial judge, who can take into account the finest points of +skill. So it is in the world of business. The scoring-board of profits +may be an imperfect one; let us, by all means, where we can, alter the +rules of the game so as to make it better. But let us not imagine that +it displays a finer insight or a superior intellect to speak as though +the scoring-board could be dispensed with, and the test of profit and +loss treated as irrelevant. Quantitative measurement is essential to +efficiency. Let us be careful to remember all that this implies. + + +INDEX + + +Ability +Accountancy +Allocation of resources +Ambiguities +Australasia + +Bastiat, Frederic +Beef and hides +Borrowing and lending, system of +Business efficiency +Business man as a purchaser +Business risk + +Capital; + as representing a period of waiting; + distribution; + distribution and rate of interest; + effect on labor of an increased supply; + not a stock of consumable goods; + reaction of price charges on; + reflections upon; + supply; + supply as affected by charges in interest rate +Capital goods +Capital market +Capitalism +Capitalist +Chance +Coal industry, cost of production and price; + miners' wages +Coats, J. & P. +Collective saving +Commodities; + labor as a commodity +Competition +Composite demand +Composite supply +Consumable goods +Consumers' goods and producers' goods +Consumption, margin of; + waiting for +Control and risk-taking +Controversy +Cooeperation; + unorganized +Cost, general relation of price, utility and cost; + price relation to; + rent as factor in real costs; + ultimate; + utility and +Cotton and cotton-seed; + contrast to wool and mutton +Cotton industry +Criteria of policy +Currency inflation +Cycles + +Demand, ambiguity of expression "increase in demand,"; + derived; + elastic and inelastic; + _see also_ Composite demand; Joint demand; Supply and demand +Derived demand +Derived utility +Diagrams, use of +Diminishing utility; + money and +Directors +Distribution of wealth; + interest rate and +Dividends +Division of labor + +Economic laws; + fundamental character +Economic theory; + fact and +Economic world, orderly nature +Education +Efficiency +Elastic demand +Employers' associations +Enterprise +Entrepreneur +"Equal pay for equal work," +Expectation + +Fact and theory +Farmers +Fortunes + +Gambling +Government, enterprises; + failings + +Hides and beef +Houses +Housewife as purchaser +Housing + +Ideas and institutions +Incompetents +Increase in demand, ambiguity +Index numbers +Inelastic demand +Inflation +Institutions and ideas +Insurance companies; + significance +Interest; + necessity of +Interest rate; + changes and their effect on supply of capital; + distribution and; + price of land and +Intuition + +Joint demand; + importance of the unimportant; + marginal utility under; + summary of considerations +Joint products; + cost of production +Joint-stock company +Joint supply, marginal cost under; + summary of considerations + +Keynes, J. M. + +Labor; + apportionment among occupations; + apportionment among places; + apportionment among social grades; + as a commodity; + cost, difficulty of estimating; + division; + effect of increased supply of capital; + four grades; + mobility; + product of; + reaction of price changes on; + supply in general +_Laissez-faire_; + retrospect on +Land, characteristics; + differential aspect; + margin of transference; + marginal; + price and rent, relation; + question of real costs; + scarcity aspect; + supply; + tenure; + urban; + _see also_ Rent +Landlords +Large scale business +Laws, fundamental + +Malthus, T.R. +Management +Margin, danger of ignoring +Margin of consumption +Margin of production +Margin of transference +Marginal cost, aspects; + misinterpretation; + under joint supply +Marginal land +Marginal purchaser +Marginal utility; + price relation to; + under joint demand +Market +Marshall, Alfred +Marx, Karl +Mill, J. S. +Miners +Monetary changes, disturbances of +Money, diminishing utility +Monte Carlo +Mutton. _See_ Wool and Mutton + +Natural ability +Normal conditions + +Occupations; + apportionment of labor among +Order, economic + +Pasture versus tillage +Pigou, A. C. +Policy, criteria +Population +Postal charges +Poverty; + national +Price, consequences of higher; + general relation with utility and cost; + law of tendency; + marginal utility and; + post-war; + reaction of changes in demand and supply; + relation of demand and supply to; + utility and +Producers' goods +Production, power of; + real costs; + waiting for +Professions +Profiteering +Profits; + elements; + general analysis; + in risky industries +Protective tariff +Psychology and economics +Purchasers, business man; + housewife; + marginal +Purchasing power + +Railway rates +Railways +Rate of interest. _See_ Interest rate +Rent; + complex character; + marginal land; + necessity; + rate of interest and +Reserves +Residuary profits +Resources, allocation +Risk, reward for; + under large-scale organization + +Satisfaction +Saving; + individual; + involuntary; + psychology; + social +School teachers +Service +Serving cotton +Shareholders +Sinking-fund +Situation +Smith, Adam +Social grades, labor movement among +Socialism +Speculation +Steel smelters +Subsidies, industrial +Substitutes +Supply, reactions of price changes on; + _see also_ Composite supply; Joint supply +Supply and demand, changes in, and their reaction on price; + forces behind; + general laws; + relation of price to; + wages and +Supreme Allied Council + +Teachers +Theory, economic +Thrift +Tillage versus pasture +Trade cycles +Trade depression +Trade unions; + actions; + wage level and + +Ultimate real costs +Unearned increment +Unemployment; + trade union policy and +Utility; + cost and; + derived; + general relation of price, utility and cost; + law of diminishing utility; + law of diminishing utility as applied to money; + marginal; + price relation to; + wealth and + +Wages, general wage level; + trade unions and; + women's +Wages Fund +Waiting, essence of; + for consumption; + for production +Waste, economic +Wealth, distribution; + utility and +"What should be" and "What is," +Women's wages +Wool and mutton; + contrast to cotton and cotton-seed +Workers' control + + + + + +End of Project Gutenberg's Supply and Demand, by Hubert D. 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