BOOK V



GENERAL RELATIONS OF DEMAND, SUPPLY AND VALUE




CHAPTER 1




INTRODUCTORY. ON MARKETS




1. A business firm grows and attains great strength, and afterwards perhaps
stagnates and decays; and at the turning point there is a balancing or equilibrium
of the forces of life and decay: the latter part of Book IV has been chiefly
occupied with such balancing of forces in the life and decay of a people,
or of a method of industry or trading. And as we reach to the higher stages
of our work, we shall need ever more and more to think of economic forces
as resembling those which make a young man grow in strength, till he reaches
his prime; after which he gradually becomes stiff and inactive, till at last
he sinks to make room for other and more vigorous life. But to prepare the
way for this advanced study we want first to look at a simpler balancing
of forces which corresponds rather to the mechanical equilibrium of a stone
hanging by an elastic string, or of a number of balls resting against one
another in a basin.




We have now to examine the general relations of demand and supply; especially
those which are connected with that adjustment of price, by which they are
maintained in "equilibrium." This term is in common use and may
be used for the present without special explanation. But there are many difficulties
connected with it, which can only be handled gradually: and indeed they will
occupy our attention during a great part of this Book.




Illustrations will be taken now from one class of economic problems and
now from another, but the main course of the reasoning will be kept free
from assumptions which specially belong to any particular class.




Thus it is not descriptive, nor does it deal constructively with real
problems. But it sets out the theoretical backbone of our knowledge of the
causes which govern value, and thus prepares the way for the construction
which is to begin in the following Book. It aims not so much at the attainment
of knowledge, as at the power to obtain and arrange knowledge with regard
to two opposing sets of forces, those which impel man to economic efforts
and sacrifices, and those which hold him back.




We must begin with a short and provisional account of markets: for that
is needed to give precision to the ideas in this and the following Books.
But the organization of markets is intimately connected both as cause and
effect with money, credit, and foreign trade; a full study of it must therefore
be deferred to a later volume, where it will be taken in connection with
commercial and industrial fluctuations, and with combinations of producers
and of merchants, of employers and employed.




2. When demand and supply are spoken of in relation to one another, it
is of course necessary that the markets to which they refer should be the
same. As Cournot says, "Economists understand by the term Market, not
any particular market place in which things are bought and sold, but the
whole of any region in which buyers and sellers are in such free intercourse
with one another that the prices of the same goods tend to equality easily
and quickly."(1*) Or again as Jevons says: -- "Originally a market
was a public place in a town where provisions and other objects were exposed
for sale; but the word has been generalized, so as to mean any body of persons
who are in intimate business relations and carry on extensive transactions
in any commodity. A great city may contain as many markets as there are important
branches of trade, and these markets may or may not be localized. The central
point of a market is the public exchange, mart or auction rooms, where the
traders agree to meet and transact business. In London the Stock Market,
the Corn Market, the Coal Market, the Sugar Market, and many others are distinctly
localized; in Manchester the Cotton Market, the Cotton Waste Market, and
others. But this distinction of locality is not necessary. The traders may
be spread over a whole town, or region of country, and vet make a market,
if they are, by means of fairs, meetings, published price lists, the post-office
or otherwise, in close communication with each other."(2*)




Thus the more nearly perfect a market is, the stronger is the tendency
for the same price to be paid for the same thing at the same time in all
parts of the market: but of course if the market is large, allowance must
be made for the expense of delivering the goods to different purchasers;
each of whom must be supposed to pay in addition to the market price a special
charge on account of delivery.(3*)




3. In applying economic reasonings in practice it is often difficult to
ascertain how far the movements of supply and demand in any one place are
influenced by those in another. It is clear that the general tendency of
the telegraph, the printing-press and steam traffic is to extend the area
over which such influences act and to increase their force. The whole Western
World may, in a sense, be regarded as one market for many kinds of stock
exchange securities, for the more valuable metals, and to a less extent for
wool and cotton and even wheat; proper allowance being made for expenses
of transport, in which may be included taxes levied by any customs houses
through which the goods have to pass. For in all these cases the expenses
of transport, including customs duties, are not sufficient to prevent buyers
from all parts of the Western World from competing with one another for the
same supplies.




There are many special causes which may widen or narrow the market of
any particular commodity: but nearly all those things for which there is
a very wide market are in universal demand, and capable of being easily and
exactly described. Thus for instance cotton, wheat, and iron satisfy wants
that are urgent and nearly universal. They can be easily described, so that
they can be bought and sold by persons at a distance from one another and
at a distance also from the commodities. If necessary, samples can be taken
of them which are truly representative: and they can even be "graded,"
as is the actual practice with regard to grain in America, by an independent
authority; so that the purchaser may be secure that what he buys will come
up to a given standard, though he has never seen a sample of the goods which
he is buying and perhaps would not be able himself to form an opinion on
it if he did.(4*)




Commodities for which there is a very wide market must also be such as
will bear a long carriage: they must be somewhat durable, and their value
must be considerable in proportion to their bulk. A thing which is so bulky
that its price is necessarily raised very much when it is sold far away from
the place in which it is produced, must as a rule have a narrow market. The
market for common bricks for instance is practically confined to the near
neighbourhood of the kilns in which they are made: they can scarcely ever
bear a long carriage by land to a district which has any kilns of its own.
But bricks of certain exceptional kinds have markets extending over a great
part of England.




4. Let us then consider more closely the markets for things which satisfy
in an exceptional way these conditions of being in general demand, cognizable
and portable. They are, as we have said, stock exchange securities and the
more valuable metals.




Any one share or bond of a public company, or any bond of a government
is of exactly the same value as any other of the same issue: it can make
no difference to any purchaser which of the two he buys. Some securities,
principally those of comparatively small mining, shipping, and other companies,
require local knowledge, and are not very easily dealt in except on the stock
exchanges of provincial towns in their immediate neighbourhood. But the whole
of England is one market for the shares and bonds of a large English railway.
In ordinary times a dealer will sell, say, Midland Railway shares, even if
he has not them himself; because he knows they are always coming into the
market, and he is sure to be able to buy them.




But the strongest case of all is that of securities which are called "international,"
because they are in request in every part of the globe. They are the bonds
of the chief governments, and of very large public companies such as those
of the Suez Canal and the New York Central Railway. For bonds of this class
the telegraph keeps prices at almost exactly the same level in all the stock
exchanges of the world. If the price of one of them rises in New York or
in Paris, in London or in Berlin, the mere news of the rise tends to cause
a rise in other markets; and if for any reason the rise is delayed, that
particular class of bonds is likely soon to be offered for sale in the high
priced market under telegraphic orders from the other markets, while dealers
in the first market will be making telegraphic purchases in other markets.
These sales on the one hand, and purchases on the other, strengthen the tendency
which the price has to seek the same level everywhere; and unless some of
the markets are in an abnormal condition, the tendency soon becomes irresistible.




On the stock exchange also a dealer can generally make sure of selling
at nearly the same price as that at which he buys; and he is often willing
to buy first class stocks at a half, or a quarter, or an eighth, or in some
cases even a sixteenth per cent less than he offers in the same breath to
sell them at. If there are two securities equally good, but one of them belongs
to a large issue of bonds, and the other to a small issue by the same government,
so that the first is constantly coming on the market, and the latter but
seldom, then the dealers will on this account alone require a larger margin
between their selling price and their buying price in the latter case than
in the former.(5*) This illustrates well the great law, that the larger the
market for a commodity the smaller generally are the fluctuations in its
price, and the lower is the percentage on the turnover which dealers charge
for doing business in it.




Stock exchanges then are the pattern on which markets have been, and are
being formed for dealing in many kinds of produce which can be easily and
exactly described, are portable and in general demand. The material commodities
however which possess these qualities in the highest degree are gold and
silver. For that very reason they have been chosen by common consent for
use as money, to represent the value of other things: the world market for
them is most highly organized, and will be found to offer many subtle illustrations
of the actions of the laws which we are now discussing.




5. At the opposite extremity to international stock exchange securities
and the more valuable metals are, firstly, things which must be made to order
to suit particular individuals, such as well-fitting clothes; and, secondly,
perishable and bulky goods, such as fresh vegetables, which can seldom be
profitably carried long distances. The first can scarcely be said to have
a wholesale market at all; the conditions by which their price is determined
are those of retail buying and selling, and the study of them may be postponed.(6*)




There are indeed wholesale markets for the second class, but they are
confined within narrow boundaries; we may find our typical instance in the
sale of the commoner kinds of vegetables in a country town. The market-gardeners
in the neighbourhood have probably to arrange for the sale of their vegetables
to the townspeople with but little external interference on either side.
There may be some check to extreme prices by the power on the one side of
selling, and on the other of buying elsewhere; but under ordinary circumstances
the check is inoperative, and it may happen that the dealers in such a case
are able to combine, and thus fix an artificial monopoly price; that is,
a price determined with little direct reference to cost of production, but
chiefly by a consideration of what the market will bear.




On the other hand, it may happen that some of the market-gardeners are
almost equally near a second country town, and send their vegetables now
to one and now to the other; and some people who occasionally buy in the
first town may have equally good access to the second. The least variation
in price will lead them to prefer the better market; and thus make the bargainings
in the two towns to some extent mutually dependent. It may happen that this
second town is in close communication with London or some other central market,
so that its prices are controlled by the prices in the central market; and
in that case prices in our first town also must move to a considerable extent
in harmony with them. As news passes from mouth to mouth till a rumour spreads
far away from its forgotten sources, so even the most secluded market is
liable to be influenced by changes of which those in the market have no direct
cognizance, changes that have had their origin far away and have spread gradually
from market to market.




Thus at the one extreme are world markets in which competition acts directly
from all parts of the globe; and at the other those secluded markets in which
all direct competition from afar is shut out, though indirect and transmitted
competition may make itself felt even in these; and about midway between
these extremes lie the great majority of the markets which the economist
and the business man have to study.




6. Again, markets vary with regard to the period of time which is allowed
to the forces of demand and supply to bring themselves into equilibrium with
one another, as well as with regard to the area over which they extend. And
this element of Time requires more careful attention just now than does that
of Space. For the nature of the equilibrium itself, and that of the causes
by which it is determined, depend on the length of the period over which
the market is taken to extend. We shall find that if the period is short,
the supply is limited to the stores which happen to be at hand: if the period
is longer, the supply will be influenced, more or less, by the cost of producing
the commodity in question; and if the period is very long, this cost will
in its turn be influenced, more or less, by the cost of producing the labour
and the material things required for producing the commodity. These three
classes of course merge into one another by imperceptible degrees. We will
begin with the first class; and consider in the next chapter those temporary
equilibria of demand and supply, in which "supply" means in effect
merely the stock available at the time for sale in the market; so that it
cannot be directly influenced by the cost of production.




NOTES:




1. Recherches sur les Principes Mathématiques de la Théorie
des Richesses, ch. IV. See also above III, IV, section 7.




2. Theory of Political Economy, ch. IV.




3. Thus it is common to see the prices of bulky goods quoted as delivered
"free on board" (f.o.b.) any vessel in a certain port, each purchaser
having to make his own reckoning for bringing the goods home.




4. Thus the managers of a public or private "elevator," receive
grain from a farmer, divide it into different grades, and return to him certificates
for as many bushels of each grade as he has delivered. His grain is then
mixed with those of other farmers; his certificates are likely to change
hands several times before they reach a purchaser who demands that the grain
shall be actually delivered to him; and little or none of what that purchaser
receives may have come from the farm of the original recipient of the certificate.




5. In the case of shares of very small and little known companies, the
difference between the price at which a dealer is willing to buy and that
at which he will sell may amount to from five per cent. or more of the selling
value. If he buys, he may have to carry this security a long time before
he meets with any one who comes to take it from him, and meanwhile it may
fall in value: while if he undertakes to deliver a security which he has
not himself got and which does not come on the market every day, he may be
unable to complete his contract without much trouble and expense.




6. A man may not trouble himself much about small retail purchases: he
may give half-a-crown for a packet of paper in one shop which he could have
got for two shillings in another. But it is otherwise with wholesale prices.
A manufacturer cannot sell a ream of paper for six shillings while his neighbour
is selling it at five. For those whose business it is to deal in paper know
almost exactly the lowest price at which it can be bought, and will not pay
more than this. The manufacturer has to sell at about the market price, that
is at about the price at which other manufacturers are selling at the same
time.




CHAPTER 2




TEMPORARY EQUILIBRIUM OF DEMAND AND SUPPLY




1. The simplest case of balance or equilibrium between. desire and effort
is found when a person satisfies one of his wants by his own direct work.
When a boy picks blackberries for his own eating, the action of picking is
probably itself pleasurable for a while; and for some time longer the pleasure
of eating is more than enough to repay the trouble of picking. But after
he has eaten a good deal, the desire for more diminishes; while the task
of picking begins to cause weariness, which may indeed be a feeling of monotony
rather than of fatigue. Equilibrium is reached when at last his eagerness
to play and his disinclination for the work of picking counterbalance the
desire for eating. The satisfaction which he can get from picking fruit has
arrived at its maximum: for up to that time every fresh picking has added
more to his pleasure than it has taken away; and after that time any further
picking would take away from his pleasure more than it would add.(1*)




In a casual bargain that one person makes with another, as for instance
when two backwoodsmen barter a rifle for a canoe, there is seldom anything
that can properly be called an equilibrium of supply and demand: there is
probably a margin of satisfaction on either side; for probably the one would
be willing to give something besides the rifle for the canoe, if he could
not get the canoe otherwise; while the other would in case of necessity give
something besides the canoe for the rifle.




It is indeed possible that a true equilibrium may be arrived at under
a system of barter; but barter, though earlier in history than buying and
selling, is in some ways more intricate; and the simplest cases of a true
equilibrium value are found in the markets of a more advanced state of civilization.




We may put aside as of little practical importance a class of dealings
which has been much discussed. They relate to pictures by old masters, rare
coins and other things, which cannot be "graded" at all. The price
at which each is sold, will depend much on whether any rich persons with
a fancy for it happen to be present at its sale. If not, it will probably
be bought by dealers who reckon on being able to sell it at a profit; and
the variations in the price for which the same picture sells at successive
auctions, great as they are, would be greater still if it were not for the
steadying influence of professional purchasers.




2. Let us then turn to the ordinary dealings of modern life; and take
an illustration from a corn-market in a country town, and let us assume for
the sake of simplicity that all the corn in the market is of the same quality.
The amount which each farmer or other seller offers for sale at any price
is governed by his own need for money in hand, and by his calculation of
the present and future conditions of the market with which he is connected.
There are some prices which no seller would accept, some which no one would
refuse. There are other intermediate prices which would be accepted for larger
or smaller amounts by many or all of the sellers. Everyone will try to guess
the state of the market and to govern his actions accordingly. Let us suppose
that in fact there are not more than 600 quarters, the holders of which are
willing to accept as low a price as 35s.; but that holders of another hundred
would be tempted by 36s.; and holders of yet another three hundred by 37s.
Let us suppose also that a price of 37s. would tempt buyers for only 600
quarters; while another hundred could be sold at 36s., and yet another two
hundred at 35s. These facts may be put out in a table thus:--




At the price Holders will be Buyer will be




 willing to sell willing to buy




37s. 1000 quarters 600 quarters




36s. 700 " 700 "




35s. 600 " 900 "




Of course some of those who are really willing to take 36s. rather than
leave the market without selling, will not show at once that they are ready
to accept that price. And in like manner buyers will fence, and pretend to
be less eager than they really are. So the price may be tossed hither and
thither like a shuttlecock, as one side or the other gets the better in the
"higgling and bargaining" of the market. But unless they are unequally
matched; unless, for instance, one side is very simple or unfortunate in
failing to gauge the strength of the other side, the price is likely to be
never very far from 36s.; and it is nearly sure to be pretty close to 36s.
at the end of the market. For if a holder thinks that the buyers will really
be able to get at 36s. all that they care to take at that price, he will
be unwilling to let slip past him any offer that is well above that price.




Buyers on their part will make similar calculations; and if at any time
the price should rise considerably above 36s. they will argue that the supply
will be much greater than the demand at that price: therefore even those
of them who would rather pay that price than go unserved, wait; and by waiting
they help to bring the price down. On the other hand, when the price is much
below 36s., even those sellers who would rather take the price than leave
the market with their corn unsold, will argue that at that price the demand
will be in excess of the supply: so they will wait, and by waiting help to
bring the price up.




The price of 36s. has thus some claim to be called the true equilibrium
price: because if it were fixed on at the beginning, and adhered to throughout,
it would exactly equate demand and supply (i.e. the amount which buyers were
willing to purchase at that price would be just equal to that for which sellers
were willing to take that price); and because every dealer who has a perfect
knowledge of the circumstances of the market expects that price to be established
If he sees the price differing much from 36s. he expects that a change will
come before long, and by anticipating it he helps it to come quickly.




It is not indeed necessary for our argument that any dealers should have
a thorough knowledge of the circumstances of the market. Many of the buyers
may perhaps underrate the willingness of the sellers to sell, with the effect
that for some time the price rules at the highest level at which any buyers
can be found; and thus 500 quarters may be sold before the price sinks below
37s. But afterwards the price must begin to fall and the result will still
probably be that 200 more quarters will be sold, and the market will close
on a price of about 36s. For when 700 quarters have been sold, no seller
will be anxious to dispose of any more except at a higher price than 36s.,
and no buyer will be anxious to purchase any more except at a lower price
than 36s. In the same way if the sellers had underrated the willingness of
the buyers to pay a high price, some of them might begin to sell at the lowest
price they would take, rather than have their corn left on their hands, and
in this case much corn might be sold at a price of 35s.; but the market would
probably close on a price of 36s. and a total sale of 700 quarters.(2*)




3. In this illustration there is a latent assumption which is in accordance
with the actual conditions of most markets; but which ought to be distinctly
recognized in order to prevent its creeping into those cases in which it
is not justifiable. We tacitly assumed that the sum which purchasers were
willing to pay, and which sellers were willing to take, for the seven hundredth
quarter would not be affected by the question whether the earlier bargains
had been made at a high or a low rate. We allowed for the diminution in the
buyers' need of corn [its marginal utility to them] as the amount bought
increased. But we did not allow for any appreciable change in their unwillingness
to part with money [its marginal utility]; we assumed that that would be
practically the same whether the early payments had been at a high or a low
rate.




This assumption is justifiable with regard to most of the market dealings
with which we are practically concerned. When a person buys anything for
his own consumption, he generally spends on it a small part of his total
resources; while when he buys it for the purposes of trade, he looks to re-selling
it, and therefore his potential resources are not diminished. In either case
there is no appreciable change in his willingness to part with money. There
may indeed be individuals of whom this is not true; but there are sure to
be present some dealers with large stocks of money at their command; and
their influence steadies the market.(3*)




The exceptions are rare and unimportant in markets for commodities; but
in markets for labour they are frequent and important. When a workman is
in fear of hunger, his need of money [its marginal utility to him] is very
great; and, if at starting, he gets the worst of the bargaining, and is employed
at low wages, it remains great, and he may go on selling his labour at a
low rate. That is all the more probable because, while the advantage in bargaining
is likely to be pretty well distributed between the two sides of a market
for commodities, it is more often on the side of the buyers than on that
of the sellers in a market for labour. Another difference between a labour
market and a market for commodities arises from the fact that each seller
of labour has only one unit of labour to dispose of. These are two among
many facts, in which we shall find, as we go on, the explanation of much
of that instinctive objection which the working classes have felt to the
habit of some economists, particularly those of the employer class, of treating
labour simply as a commodity and regarding the labour market as like every
other market; whereas in fact the differences between the two cases, though
not fundamental from the point of view of theory, are yet clearly marked,
and in practice often very important.




The theory of buying and selling becomes therefore much more complex when
we take account of the dependence of marginal utility on amount in the case
of money as well as of the commodity itself. The practical importance of
this consideration is not very great. But a contrast is drawn in Appendix
F between barter and dealings in which one side of each exchange is in the
form of general purchasing power. In barter a person 's stock of either commodity
exchanged needs to be adjusted closely to his individual wants. If his stock
is too large he may have no good use for it. If his stock is too small he
may have some difficulty in finding any one who can conveniently give him
what he wants and is also in need of the particular things of which he himself
has a superfluity. But any one who has a stock of general purchasing power,
can obtain any thing he wants as soon as he meets with any one who has a
superfluity of that thing. he needs not to hunt about till he comes across
"the double coincidence" of a person who can spare what he wants,
and also wants what he can spare. Consequently every one, and especially
a professional dealer, can afford to keep command over a large stock of money;
and can therefore make considerable purchases without depleting his stock
of money or greatly altering its marginal value.




NOTES:




1. See IV, I, section 2, and Note XII in the Mathematical Appendix.




2. A simple form of the influence which opinion exerts on the action of
dealers, and therefore on market price, is indicated in this illustration:
we shall be much occupied with more complex developments of it later on.




3. For instance a buyer is sometimes straitened for want of ready money,
and has to let offers pass by him in no way inferior to others which he has
gladly accepted: his own funds being exhausted, he could not perhaps borrow
except on terms that would take away all the profit that the bargains had
at first sight offered. But if the bargain is really a good one, some one
else, who is not so straitened, is nearly sure to get hold of it.




Again, it is possible that several of those who had been counted as ready
to sell corn at a price of 36s. were willing to sell only because they were
in urgent need of a certain amount of ready money; if they succeeded in selling
some corn at a high price, there might be a perceptible diminution in the
marginal utility of ready money to them; and therefore they might refuse
to sell for 36s. a quarter all the corn which they would have sold if the
price had been 36s. throughout.




In this case the sellers in consequence of getting an advantage in bargaining
at the beginning of the market might retain to the end a price higher than
the equilibrium price. The price at which the market dosed would be an equilibrium
price; and though not properly described as the equilibrium price, it would
be very unlikely to diverge widely from that price.




Conversely, if the market had opened much to the disadvantage of the sellers
and they had sold some corn very cheap, so that they remained in great want
of ready money, the final utility of money to them might have remained so
high that they would have gone on selling considerably below 36s. until the
buyers had been supplied with all that they cared to take. The market would
then close without the true equilibrium price having ever been reached, but
a very near approach would have been made to it.






CHAPTER 3




EQUILIBRIUM OF NORMAN DEMAND AND SUPPLY




1. We have next to inquire what causes govern supply prices, that is prices
which dealers are willing to accept for different amounts. In the last chapter
we looked at the affairs of only a single day. and supposed the stocks offered
for sale to be already in existence. But of course these stocks are dependent
on the amount of wheat sown in the preceding year; and that, in its turn,
was largely influenced by the farmers' guesses as to the price which they
would get for it in this year. This is the point at which we have to work
in the present chapter.




Even in the corn-exchange of a country town on a market-day the equilibrium
price is affected by calculations of the future relations of production and
consumption; while in the leading corn-markets of America and Europe dealings
for future delivery already predominate and are rapidly weaving into one
web all the leading threads of trade in corn throughout the whole world.
Some of these dealings in "futures" are but incidents in speculative
manoeuvres; but in the main they are governed by calculations of the world's
consumption on the one hand, and of the existing stocks and coming harvests
in the Northern and Southern hemispheres on the other. Dealers take account
of the areas sown with each kind of grain, of the forwardness and weight
of the crops, of the supply of things which can be used as substitutes for
grain, and of the things for which grain can be used as a substitute. Thus,
when buying or selling barley, they take account of the supplies of such
things as sugar, which can be used as substitutes for it in brewing, and
again of all the various feeding stuffs, a scarcity of which might raise
the value of barley for consumption on the farm. If it is thought that the
growers of any kind of grain in any part of the world have been losing money,
and are likely to sow a less area for a future harvest; it is argued that
prices are likely to rise as soon as that harvest comes into sight, and its
shortness is manifest to all. Anticipations of that rise exercise an influence
on present sales for future delivery, and that in its turn influences cash
prices; so that these prices are indirectly affected by estimates of the
expenses of producing further supplies.




But in this and the following chapters we are specially concerned with
movements of price ranging over still longer periods than those for which
the most far-sighted dealers in futures generally make their reckoning..
we have to consider the volume of production adjusting itself to the conditions
of the market, and the normal price being thus determined at the position
of stable equilibrium of normal demand and normal supply.




2. In this discussion we shall have to make frequent use of the terms
cost and expenses of production; and some provisional account of them must
be given before proceeding further.




We may revert to the analogy between the supply price and the demand price
of a commodity. Assuming for the moment that the efficiency of production
depends solely upon the exertions of the workers, we saw that "the price
required to call forth the exertion necessary for producing any given amount
of a commodity may be called the supply price for that amount, with reference
of course to a given unit of time."(1*) But now we have to take account
of the fact that the production of a commodity generally requires many different
kinds of labour and the use of capital in many forms. The exertions of all
the different kinds of labour that are directly or indirectly involved in
making it; together with the abstinences or rather the waitings required
for saving the capital used in making it: all these efforts and sacrifices
together will be called the real cost of production of the commodity. The
sums of money that have to be paid for these efforts and sacrifices will
be called either its money cost of production, or, for shortness, its expenses
of production; they are the prices which have to be paid in order to call
forth an adequate supply of the efforts and waitings that are required for
making it; or, in other words, they are its supply price.(2*)




The analysis of the expenses of production of a commodity might be carried
backward to any length; but it is seldom worth while to go back very far.
It is for instance often sufficient to take the supply prices of the different
kinds of raw materials used in any manufacture as ultimate facts, without
analysing these supply prices into the several elements of which they are
composed; otherwise indeed the analysis would never end. We may then arrange
the things that are required for making a commodity into whatever groups
are convenient, and call them its factors of production.




Its expenses of production when any given amount of it is produced are
thus the supply prices of the corresponding quantities of its factors of
production. And the sum of these is the supply price of that amount of the
commodity.




3. The typical modern market is often regarded as that in which manufacturers
sell goods to wholesale dealers at prices into which but few trading expenses
enter. But taking a broader view, we may consider that the supply price of
a commodity is the price at which it will be delivered for sale to that group
of persons whose demand for it we are have considering; or, in other words,
in the market which we have in view. On the character of that market will
depend how many trading expenses have to be reckoned to make up the supply
price.(3*) For instance, the supply price of wood in the neighbourhood of
Canadian forests often consists almost exclusively of the price of the labour
of lumber men: but the supply price of the same wood in the wholesale London
market consists in a large measure of freights; while its supply price to
a small retail buyer in an English country town is more than half made up
of the charges of the railways and middlemen who have brought what he wants
to his doors, and keep a stock of it ready for him. Again, the supply price
of a certain kind of labour may for some purposes be divided up into the
expenses of rearing, of general education and of special trade education.
The possible combinations are numberless; and though each may have incidents
of its own which will require separate treatment in the complete solution
of any problem connected with it, yet all such incidents may be ignored,
so far as the general reasonings of this Book are concerned.




In calculating the expenses of production of a commodity we must take
account of the fact that changes in the amounts produced are likely, even
when there is no new invention, to be accompanied by changes in the relative
quantities of its several factors of production. For instance, when the scale
of production increases, horse or steam power is likely to be substituted
for manual labour; materials are likely to be brought from a greater distance
and in greater quantities, thus increasing those expenses of production which
correspond to the work of carriers, middlemen and traders of all kinds.




As far as the knowledge and business enterprise of the producers reach,
they in each case choose those factors of production which are best for their
purpose; the sum of the supply prices of those factors which are used is,
as a rule, less than the sum of the supply prices of any other set of factors
which could be substituted for them; and whenever it appears to the producers
that this is not the case, they will, as a rule, set to work to substitute
the less expensive method. And further on we shall see how in a somewhat
similar way society substitutes one undertaker for another who is less efficient
in proportion to his charges. We may call this, for convenience of reference,
The principle of substitution.




The applications of this principle extend over almost every field of economic
inquiry.(4*)




4. The position then is this: we are investigating the equilibrium of
normal demand and normal supply in their most general form; we are neglecting
those features which are special to particular parts of economic science,
and are confining our attention to those broad relations which are common
to nearly the whole of it. Thus we assume that the forces of demand and supply
have free play; that there is no close combination among dealers on either
side, but each acts for himself, and there is much free competition; that
is, buyers generally compete freely with buyers, and sellers compete freely
with sellers. But though everyone acts for himself, his knowledge of what
others are doing is supposed to be generally sufficient to prevent him from
taking a lower or paying a higher price than others are doing. This is assumed
provisionally to be true both of finished goods and of their factors of production,
of the hire of labour and of the borrowing of capital. We have already inquired
to some extent, and we shall have to inquire further, how far these assumptions
are in accordance with the actual facts of life. But meanwhile this is the
supposition on which we proceed; we assume that there is only one price in
the market at one and the same time; it being understood that separate allowance
is made, when necessary, for differences in the expense of delivering goods
to dealers in different parts of the market; including allowance for the
special expenses of retailing, if it is a retail market.




In such a market there is a demand price for each amount of the commodity,
that is, a price at which each particular amount of the commodity can find
purchasers in a day or week or year. The circumstances which govern this
price for any given amount of the commodity vary in character from one problem
to another; but in every case the more of a thing is offered for sale in
a market the lower is the price at which it will find purchasers; or in other
words, the demand price for each bushel or yard diminishes with every increase
in the amount offered.




The unit of time may be chosen according to the circumstances of each
particular problem: it may be a day, a month, a year, or even a generation:
but in every case it must be short relatively to the period of the market
under discussion. It is to be assumed that the general circumstances of the
market remain unchanged throughout this period; that there is, for instance,
no change in fashion or taste, no new substitute which might affect the demand,
no new invention to disturb the supply.




The conditions of normal supply are less definite; and a full study of
them must be reserved for later chapters. They will be found to vary in detail
with the length of the period of time to which the investigation refers;
chiefly because both the material capital of machinery and other business
plant, and the immaterial capital of business skill and ability and organization,
are of slow growth and slow decay.




Let us call to mind the "representative firm," whose economies
of production, internal and external, are dependent on the aggregate volume
of production of the commodity that it makes;(5*) and, postponing all further
study of the nature of this dependence, let us assume that the normal supply
price of any amount of that commodity may be taken to be its normal expenses
of production (including gross earnings of management(6*)) by that firm.
That is, let us assume that this is the price the expectation of which will
just suffice to maintain the existing aggregate amount of production; some
firms meanwhile rising and increasing their output, and others falling and
diminishing theirs; but the aggregate production remaining unchanged. A price
higher than this would increase the growth of the rising firms, and slacken,
though it might not arrest, the decay of the falling firms; with the net
result of an increase in the aggregate production. On the other hand, a price
lower than this would hasten the decay of the falling firms, and slacken
the growth of the rising firms; and on the whole diminish production: and
a rise or fall of price would affect in like manner though perhaps not in
an equal degree those great joint-stock companies which often stagnate, but
seldom die.




5. To give definiteness to our ideas let us take an illustration from
the woollen trade. Let us suppose that a person well acquainted with the
woollen trade sets himself to inquire what would be the normal supply price
of a certain number of millions of yards annually of a particular kind of
cloth. He would have to reckon (i) the price of the wool, coal, and other
materials which would be used up in making it, (ii) wear-and-tear and depreciation
of the buildings, machinery and other fixed capital, (iii) interest and insurance
on all the capital, (iv) the wages of those who work in the factories, and
(v) the gross earnings of management (including insurance against loss),
of those who undertake the risks, who engineer and superintend the working.
He would of course estimate the supply prices of all these different factors
of production of the cloth with reference to the amounts of each of them
that would be wanted, and on the supposition that the conditions of supply
would be normal; and he would add them all together to find the supply price
of the cloth.




Let us suppose a list of supply prices (or a supply schedule) made on
a similar plan to that of our list of demand prices:(7*) the supply price
of each amount of the commodity in a year, or any other unit of time, being
written against that amount.(8*) As the flow, or (annual) amount of the commodity
increases, the supply price may either increase or diminish; or it may even
alternately increase and diminish.(9*) For if nature is offering a sturdy
resistance to man's efforts to wring from her a larger supply of raw material,
while at that particular stage there is no great room for introducing important
new economies into the manufacture, the supply price will rise; but if the
volume of production were greater, it would perhaps be profitable to substitute
largely machine work for hand work and steam power for muscular force; and
the increase in the volume of production would have diminished the expenses
of production of the commodity of our representative firm. But those cases
in which the supply price falls as the amount increases involve special difficulties
of their own; and they are postponed to chapter XII of this Book.




6. When therefore the amount produced (in a unit of time) is such that
the demand price is greater than the supply price, then sellers receive more
than is sufficient to make it worth their while to bring goods to market
to that amount; and there is at work an active force tending to increase
the amount brought forward for sale. On the other hand, when the amount produced
is such that the demand price is less than the supply price, sellers receive
less than is sufficient to make it worth their while to bring goods to market
on that scale; so that those who were just on the margin of doubt as to whether
to go on producing are decided not to do so, and there is an active force
at work tending to diminish the amount brought forward for sale. When the
demand price is equal to the supply price, the amount produced has no tendency
either to be increased or to be diminished; it is in equilibrium.




When demand and supply are in equilibrium, the amount of the commodity
which is being produced in a unit of time may be called the equilibrium-amount,
and the price at which it is being sold may be called the equilibrium-price.




Such an equilibrium is stable; that is, the price, if displaced a little
from it, will tend to return, as a pendulum oscillates about its lowest point;
and it will be found to be a characteristic of stable equilibria that in
them the demand price is greater than the supply price for amounts just less
than the equilibrium amount, and vice versa. For when the demand price is
greater than the supply price, the amount produced tends to increase. Therefore,
if the demand price is greater than the supply price for amounts just less
than an equilibrium amount; then, if the scale of production is temporarily
diminished somewhat below that equilibrium amount, it will tend to return;
thus the equilibrium is stable for displacements in that direction. If the
demand price is greater than the supply price for amounts just less than
the equilibrium amount, it is sure to be less than the supply price for amounts
just greater: and therefore, if the scale of production is somewhat increased
beyond the equilibrium position, it will tend to return; and the equilibrium
will be stable for displacements in that direction also.




When demand and supply are in stable equilibrium, if any accident should
move the scale of production from its equilibrium position, there will be
instantly brought into play forces tending to push it back to that position;
just as, if a stone hanging by a string is displaced from its equilibrium
position, the force of gravity will at once tend to bring it back to its
equilibrium position. The movements of the scale of production about its
position of equilibrium will be of a somewhat similar kind.(10*)




But in real life such oscillations are seldom as rhythmical as those of
a stone hanging freely from a string; the comparison would be more exact
if the string were supposed to hang in the troubled waters of a mill-race,
whose stream was at one time allowed to flow freely, and at another partially
cut off. Nor are these complexities sufficient to illustrate all the disturbances
with which the economist and the merchant alike are forced to concern themselves.
If the person holding the string swings his hand with movements partly rhythmical
and partly arbitrary, the illustration will not outrun the difficulties of
some very real and practical problems of value. For indeed the demand and
supply schedules do not in practice remain unchanged for a long time together,
but are constantly being changed; and every change in them alters the equilibrium
amount and the equilibrium price, and thus gives new positions to the centres
about which the amount and the price tend to oscillate.




These considerations point to the great importance of the element of time
in relation to demand and supply, to the study of which we now proceed. We
shall gradually discover a great many different limitations of the doctrine
that the price at which a thing can be produced represents its real cost
of production, that is, the efforts and sacrifices which have been directly
and indirectly devoted to its production. For, in an age of rapid change
such as this, the equilibrium of normal demand and supply does not thus correspond
to any distinct relation of a certain aggregate of pleasures got from the
consumption of the commodity and an aggregate of efforts and sacrifices involved
in producing it: the correspondence would not be exact, even if normal earnings
and interest were exact measures of the efforts and sacrifices for which
they are the money payments. This is the real drift of that much quoted,
and much-misunderstood doctrine of Adam Smith and other economists that the
normal, or "natural," value of a commodity is that which economic
forces tend to bring about in the long run. It is the average value which
economic forces would bring about if the general conditions of life were
stationary for a run of time long enough to enable them all to work out their
full effect.(11*)




But we cannot foresee the future perfectly. The unexpected may happen;
and the existing tendencies may be modified before they have had time to
accomplish what appears now to be their full and complete work. The fact
that the general conditions of life are not stationary is the source of many
of the difficulties that are met with in applying economic doctrines to practical
problems.




Of course Normal does not mean Competitive. Market prices and Normal prices
are alike brought about by a multitude of influences, of which some rest
on a moral basis and some on a physical; of which some are competitive and
some are not. It is to the persistence of the influences considered, and
the time allowed for them to work out their effects that we refer when contrasting
Market and Normal price, and again when contrasting the narrower and the
broader use of the term Normal price.(12*)




7. The remainder of the present volume will be chiefly occupied with interpreting
and limiting this doctrine that the value of a thing tends in the long run
to correspond to its cost of production. In particular the notion of equilibrium,
which has been treated rather slightly in this chapter, will be studied more
carefully in chapters V and XII of this Book: and some account of the controversy
whether "cost of production" or "utility" governs value
will be given in Appendix I. But it may be well to say a word or two here
on this last point.




We might as reasonably dispute whether it is the upper or the under blade
of a pair of scissors that cuts a piece of paper, as whether value is governed
by utility or cost of production. It is true that when one blade is held
still, and the cutting is effected by moving the other, we may say with careless
brevity that the cutting is done by the second; but the statement is not
strictly accurate, and is to be excused only so long as it claims to be merely
a popular and not a strictly scientific account of what happens.




In the same way, when a thing already made has to be sold, the price which
people will be willing to pay for it will be governed by their desire to
have it, together with the amount they can afford to spend on it. Their desire
to have it depends partly on the chance that, if they do not buy it, they
will be able to get another thing like it at as low a price: this depends
on the causes that govern the supply of it, and this again upon cost of production.
But it may so happen that the stock to be sold is practically fixed. This,
for instance, is the case with a fish market, in which the value of fish
for the day is governed almost exclusively by the stock on the slabs in relation
to the demand: and if a person chooses to take the stock for granted, and
say that the price is governed by demand, his brevity may perhaps be excused
so long as he does not claim strict accuracy. So again it may be pardonable,
but it is not strictly accurate to say that the varying prices which the
same rare book fetches, when sold and resold at Christie 's auction room,
are governed exclusively by demand.




Taking a case at the opposite extreme, we find some commodities which
conform pretty closely to the law of constant return; that is to say, their
average cost of production will be very nearly the same whether they are
produced in small quantities or in large. In such a case the normal level
about which the market price fluctuates will be this definite and fixed (money)
cost of production. If the demand happens to be great, the market price will
rise for a time above the level; but as a result production will increase
and the market price will fall: and conversely, if the demand falls for a
time below its ordinary level.




In such a case, if a person chooses to neglect market fluctuations, and
to take it for granted that there will anyhow be enough demand for the commodity
to insure that some of it, more or less, will find purchasers at a price
equal to this cost of production, then he may be excused for ignoring the
influence of demand, and speaking of (normal) price as governed by cost of
production -- provided only he does not claim scientific accuracy for the
wording of his doctrine, and explains the influence of demand in its right
place.




Thus we may conclude that, as a general rule, the shorter the period which
we are considering, the greater must be the share of our attention which
is given to the influence of demand on value; and the longer the period,
the more important will be the influence of cost of production on value.
For the influence of changes in cost of production takes as a rule a longer
time to work itself out than does the influence of changes in demand. The
actual value at any time, the market value as it is often called, is often
more influenced by passing events and by causes whose action is fitful and
short lived, than by those which work persistently. But in long periods these
fitful and irregular causes in large measure efface one another's influence;
so that in the long run persistent causes dominate value completely. Even
the most persistent causes are however liable to change. For the whole structure
of production is modified, and the relative costs of production of different
things are permanently altered, from one generation to another.




When considering costs from the point of view of the capitalist employer,
we of course measure them in money; because his direct concern with the efforts
needed for the work of his employees lies in the money payments he must make.
His concern with the real costs of their effort and of the training required
for it is only indirect, though a monetary assessment of his own labour is
necessary for some problems, as will be seen later on. But when considering
costs from the social point of view, when inquiring whether the cost of attaining
a given result is increasing or diminishing with changing economic conditions,
then we are concerned with the real costs of efforts of various qualities,
and with the real cost of waiting. If the purchasing power of money, in terms
of effort has remained about constant, and if the rate of remuneration for
waiting has remained about constant, then the money measure of costs corresponds
to the real costs: but such a correspondence is never to be assumed lightly.
These considerations will generally suffice for the interpretation of the
term Cost in what follows, even where no distinct indication is given in
the context.




NOTES:




1. IV, I, section 2.




2. Mill and some other economists have followed the practice of ordinary
life in using the term Cost of production in two senses, sometimes to signify
the difficulty of producing a thing, and sometimes to express the outlay
of money that has to be incurred in order to induce people to overcome this
difficulty and produce it. But by passing from one use of the term to the
other without giving explicit warning, they have led to many misunderstandings
and much barren controversy. The attack on Mill's doctrine of Cost of Production
in relation to Value, which is made in Cairnes' leading Principles, was published
just after Mill's death; and unfortunately his interpretation of Mill's words
was generally accepted as authoritative, because he was regarded as a follower
of Mill. But in an article by the present writer on "Mill's Theory of
Value" (Fortnightly Review, April 1876) it is argued that Cairnes had
mistaken Mill's meaning, and had really seen not more but less of the truth
than Mill had done.




The expenses of production of any amount of a raw commodity may best be
estimated with reference to the "margin of production" at which
no rent is paid. But this method of speaking has great difficulties with
regard to commodities that obey the law of increasing return. It seemed best
to note this point in passing: it will be fully discussed later on, chiefly
in ch. XII.




3. We have already (II, iii) noticed that the economic use of the term
"production", includes the production of new utilities by moving
a thing from a place in which it is less wanted to a place in which it is
more wanted, or by helping consumers to satisfy their needs.




4. See III, v and IV, VII, section 8.




5. See IV XIII, section 2.




6. See last paragraph of IV, XII.




7. See III, III, section 4.




8. Measuring, as in the case of the demand curve, amounts of the commodity
along Ox and prices parallel to 0y, We get for each point M along Ox a line
MP drawn at right angles to it measuring the supply price for the amount
OM, the extremity of which, P, may be called a supply point; this price MP
being made up of the supply prices of the several factors of production for
the amount OM. The locus of P may be called the supply curve.




Suppose, for instance, that we classify the expenses of production of
our representative firm, when an amount OM of cloth is being produced under
the heads of (i) Mp1' the supply price of the wool and other circulating
capital which would be consumed in making it, (ii) p1 p2 the corresponding
wearand-tear and depreciation on buildings, machinery and other fixed capital;
(iii) p2p3 the interest and insurance on all the capital, (iv) p3p4 the wages
of those who work in the factory, and (v) p4P the gross earnings of management,
etc. of those who undertake the risks and direct the work. Thus as M moves
from O towards the right p1' p2, p3' p4 will each trace out a curve, and
the ultimate supply curve traced out by P will be thus shown as obtained
by superimposing the supply curves for the several factors of production
of the cloth.




It must be remembered that these supply prices are the prices not of units
of the several factors but of those amounts of the several factors which
for producing a yard of the cloth. Thus, for instance, p3p4 is the supply
price are required not of any fixed amount of labour but of that amount of
labour which is employed in making a yard where there is an aggregate production
of OM yards. (See above, section 3.) We need not trouble ourselves to consider
just here whether the groundrent of the factory must be put into a class
by itself: this belongs to a group of questions which will be discussed later.
We are taking no notice of rates and taxes, for which he would of course
have to make his account.




9. That is, a point moving along the supply curve towards the right may
either rise or fall, or even it may alternately rise and fall; in other words,
the supply curve may be inclined positively or negatively, or even at some
parts of its course it may be inclined positively and at others negatively.
(See footnote on p. 99.)




10. Compare V, I, section 1. To represent the equilibrium of demand and
supply geometrically we may draw the demand and supply curves together as
in Fig. 19. If then OR represents the rate at which production is being actually
carried on, and Rd the demand price is greater than Rs the supply price,
the production is exceptionally profitable, and will be increased. R, the
amount-index, as we may call it, will move to the right. On the other hand,
if Rd is less than Rs, R will move to the left. If Rd is equal to Rs, that
is, if R is vertically under a point of intersection of the curves, demand
and supply are in equilibrium.




This may be taken as the typical diagram for stable equilibrium for a
commodity that obeys the law of diminishing return. But if we had made SS'
a horizontal straight line, we should have represented the case of "constant
return," in which the supply price is the same for all amounts of the
commodity. And if we had made SS' inclined negatively, but less steeply than
DD' (the necessity for this condition will appear more fully later on), we
should have got a case of stable equilibrium for a commodity which obeys
the law of increasing return. In either case the above reasoning remains
unchanged without the alteration of a word or a letter; but the last case
introduces difficulties which we have arranged to postpone.




11. See below V, v, section 2 and Appendix H, section 4.




12. See above, pp. 34-6.




CHAPTER 4




THE INVESTMENT AND DISTRIBUTION OF RESOURCES




1. The first difficulty to be cleared up in our study of normal values,
is the nature of the motives which govern the investment of resources for
a distant return. It will be well to begin by watching the action of a person
who neither buys what he wants nor sells what he makes, but works on his
own behalf; and who therefore balances the, efforts and sacrifices which
he makes on the one hand against the pleasures which he expects to derive
from their fruit on the other, without the intervention of any money payments
at all.




Let us then take the case of a man who builds a house for himself on land,
and of materials, which nature supplies gratis; and who makes his implements
as he goes, the labour of making them being counted as part of the labour
of building the house. He would have to estimate the efforts required for
building on any proposed plan; and to allow almost instinctively an amount
increasing in geometrical proportion (a sort of compound interest) for the
period that would elapse between each effort and the time when the house
would be ready for his use. The utility of the house to him when finished
would have to compensate him not only for the efforts, but for the waitings.(1*)




If the two motives, one deterring, the other impelling, seemed equally
balanced, he would be on the margin of doubt. Probably the gain would much
more than outweigh the "real" cost with regard to some part of
the house. But as he turned over more and more ambitious plans, he would
at last find the advantages of any further extension balanced by the efforts
and waitings required for making it; and that extension of the building would
be on the outer limit, or margin of profitableness of the investment of his
capital.




There would probably be several ways of building parts of the house; some
parts for instance might almost equally well be built of wood or of rough
stones: the investment of capital on each plan for each part of the accommodation
would be compared with the advantages offered thereby, and each would be
pushed forward till the outer limit or margin of profitableness had been
reached. Thus there would be a great many margins of profitableness: one
corresponding to each kind of plan on which each kind of accommodation might
be provided.




2. This illustration may serve to keep before us the way in which the
efforts and sacrifices which are the real cost of production of a thing,
underlie the expenses which are its money cost. But, as has just been remarked,
the modern business man commonly takes the payments which he has to make,
whether for wages or raw material, as he finds them; without staying to inquire
how far they are an accurate measure of the efforts and sacrifices to which
they correspond. His expenditure is generally made piece-meal; and the longer
he expects to wait for the fruit of any outlay, the richer must that fruit
be in order to compensate him. The anticipated fruit may not be certain;
and in that case he will have to allow for the risk of failure. After making
that allowance, the fruit of the outlay must be expected to exceed the outlay
itself by an amount which, independently of his own remuneration, increases
at compound interest in proportion to the time of waiting.(2*) Under this
head are to be entered the heavy expenses, direct and indirect, which every
business must incur in building up its connection.




For brevity we may speak of any element of outlay (allowance being made
for the remuneration of the undertaker himself) when increased by compound
interest in this way, as accumulated; just as we used the term discounted
to represent the present value of a future gratification. Each element of
outlay has then to be accumulated for the time which will elapse between
its being incurred and its bearing fruit; and the aggregate of these accumulated
elements is the total outlay involved in the enterprise. The balance between
efforts and the satisfactions resulting from them may be made up to any day
that is found convenient. But whatever day is chosen, one simple rule must
be followed: -- Every element whether an effort or a satisfaction, which
dates from a time anterior to that day, must have compound interest for the
interval accumulated upon it: and every element, which dates from a time
posterior to that day, must have compound interest for the interval discounted
from it. If the day be anterior to the beginning of the enterprise, then
every element must be discounted. But if, as is usual in such cases, the
day be that when the efforts are finished, and the house is ready for use;
then the efforts must carry compound interest up to that day, and the satisfactions
must all be discounted back to that day.




Waiting is an element of cost as truly as effort is, and it is entered
in the cost when accumulated: it is therefore of course not counted separately.
Similarly, on the converse side, whatever money or command over satisfaction
"comes in" at any time is part of the income of that time: if the
time is before the day for which accounts are balanced up, then it must be
accumulated up to that day; if after it must be discounted back. If, instead
of being converted to immediate enjoyment, it is used as a stored up source
of future income, that later income must not be counted as an additional
return to the investment.(3*)




If the enterprise were, say, to dig out a dock-basin on a contract, the
payment for which would be made without fail when the work was finished;
and if the plant used in the work might be taken to be worn out in the process,
and valueless at the end of it; then the enterprise would be just remunerative
if this aggregate of outlays, accumulated up to the period of payment, were
just equal to that payment.




But, as a rule, the proceeds of the sales come in gradually. and we must
suppose a balance-sheet struck, looking both backwards and forwards. Looking
backwards we should sum up the net outlays, and add in accumulated compound
interest on each element of outlay. Looking forwards we should sum up all
net incomings, and from the value of each subtract compound interest for
the period during which it would be deferred. The aggregate of the net incomings
so discounted would be balanced against the aggregate of the accumulated
outlays: and if the two were just equal, the business would be just remunerative.
In calculating the outgoings the head of the business must reckon in the
value of his own work.(4*)




3. At the beginning of his undertaking, and at every successive stage,
the alert business man strives so to modify his arrangements as to obtain
better results with a given expenditure, or equal results with a less expenditure.
In other words, he ceaselessly applies the principle of substitution, with
the purpose of increasing his profits; and, in so doing, he seldom fails
to increase the total efficiency of work, the total power over nature which
man derives from organization and knowledge.




Every locality has incidents of its own which affect in various ways the
methods of arrangement of every class of business that is carried on in it:
and even in the same place and the same trade no two persons pursuing the
same aims will adopt exactly the same routes. The tendency to variation is
a chief cause of progress; and the abler are the undertakers in any trade
the greater will this tendency be. In some trades, as for instance cotton-spinning,
the possible variations are confined within narrow limits; no one can hold
his own at all who does not use machinery, and very nearly the latest machinery,
for every part of the work. But in others, as for instance in some branches
of the wood and metal trades, in farming, and in shopkeeping, there can be
great variations. For instance, of two manufacturers in the same trade, one
will perhaps have a larger wages bill and the other heavier charges on account
of machinery; of two retail dealers one will have a larger capital locked
up in stock and the other will spend more on advertisements and other means
of building up the immaterial capital of a profitable trade connection. And
in minor details the variations are numberless.




Each man's actions are influenced by his special opportunities and resources,
as well as by his temperament and his associations: but each, taking account
of his own means, will push the investment of capital in his business in
each several direction until what appears in his judgment to be the outer
limit, or margin, of profitableness is reached; that is, until there seems
to him no good reason for thinking that the gains resulting from any further
investment in that particular direction would compensate him for his outlay.
The margin of profitableness, even in regard to one and the same branch or
sub-branch of industry, is not to be regarded as a mere point on any one
fixed line of possible investment; but as a boundary line of irregular shape
cutting one after another every possible line of investment.




4. This principle of substitution is closely connected with, and is indeed
partly based on, that tendency to a diminishing rate of return from any excessive
application of resources or of energies in any given direction, which is
in accordance with general experience. It is thus linked up with the broad
tendency of a diminishing return to increased applications of capital and
labour to land in old countries which plays a prominent part in classical
economics. And it is so closely akin to the principle of the diminution of
marginal utility that results in general from increased expenditure, that
some applications of the two principles are almost identical. It has already
been observed that new methods of production bring into existence new commodities,
or lower the price of old commodities so as to bring them within the reach
of increased numbers of consumers: that on the other hand changes in the
methods and volume of consumption cause new developments of production, and
new distribution of the resources of production: and that though some methods
of consumption which contribute most to man's higher life, do little if anything
towards furthering the production of material wealth, yet production and
consumption are intimately correlated.(5*) But now we are to consider more
in detail how the distribution of the resources of production between different
industrial undertakings is the counterpart and reflex of the distribution
of the consumers' purchases between different classes of commodities.(6*)




Let us revert to the primitive housewife, who having "a limited number
of hanks of yarn from the year's shearing, considers all the domestic wants
for clothing and tries to distribute the yarn between them in such a way
as to contribUte as much as possible to the family well-being. She will think
she has failed if, when it is done, she has reason to regret that she did
not apply more to making, say, socks, and less to vests. But if, on the other
hand, she hit on the right points to stop at, then she made just so many
socks and vests that she got an equal amount of good out of the last bundle
of yarn that she applied to socks, and the last she applied to vests."(7*)
If it happened that two ways of making a vest were open to her, which were
equally satisfactory as regards results, but of which one, while using up
a little more yarn, involved a little less trouble than the other; then her
problems would be typical of those of the larger business world. They would
include first decisions as to the relative urgency of various ends; secondly,
decisions as to the relative advantages of various means of attaining each
end; thirdly, decisions, based on these two sets of decisions, as to the
margin up to which she could most profitably carry the application of each
means towards each end.




These three classes of decisions have to be taken on a larger scale by
the business man, who has more complex balancings and adjustments to make
before reaching each decision.(8*) Let us take an illustration from the building
trade. Set us watch the operations of a "speculative builder" in
the honourable sense of the term: that is, a man who sets out to erect honest
buildings in anticipation of general demand; who bears the penalty of any
error in his judgment; and who, if his judgment is approved by events, benefits
the community as well as himself. Let him be considering whether to erect
dwelling houses, or warehouses, or factories or shops. He is trained to form
at once a fairly good opinion as to the method of working most suitable for
each class of building, and to make a rough estimate of its cost. He estimates
the cost of various sites adapted for each class of building: and he reckons
in the price that he would have to pay for any site as a part of his capital
expenditure, just as he does the expense to which he would be put for laying
foundations in it, and so on. He brings this estimate of cost into relation
with his estimate of the price he is likely to get for any given building,
together with its site. If he can find no case in which the demand price
exceeds his outlays by enough to yield him a good profit, with some margin
against risks, he may remain idle. Or he may possibly build at some risk
in order to keep his most trusty workmen together, and to find some occupation
for his plant and his salaried assistance: but more on this later on.




Suppose him now to have decided that (say) villa residences of a certain
type, erected on a plot of ground which he can buy, are likely to yield him
a good profit. The main end to be sought being thus settled, he sets himself
to study more carefully the means by which it is to be obtained, and, in
connection with that study, to consider possible modifications in the details
of his plans.

Given the general character of the houses to be built, he will have to
consider in what proportions to use various materials-brick, stone, steel,
cement, plaster, wood, etc., with a view to obtaining the result which will
contribute most, in proportion to its cost, to the efficiency of the house
in gratifying the artistic taste of purchasers and in ministering to their
comfort. In thus deciding what is the best distribution of his resources
between various commodities, he is dealing with substantially the same problem
as the primitive housewife, who has to consider the most economic distribution
of her yarn between the various needs of her household.




Like her, he has to reflect that the yield of benefit which any particular
use gave would be relatively large up to a certain point, and would then
gradually diminish. Like her, he has so to distribute his resources that
they have the same marginal utility in each use: he has to weigh the loss
that would result from taking away a little expenditure here, with the gain
that would result from adding a little there. In effect both of them work
on lines similar to those which guide the farmer in so adjusting the application
of his capital and labour to land, that no field is stinted of extra cultivation
to which it would have given a generous return, and none receives so great
an expenditure as to call into strong activity the tendency to diminishing
return in agriculture.(9*)




Thus it is that the alert business man, as has just been said, "pushes
the investment of capital in his business in each several direction until
what appears in his judgment to be the outer limit, or margin, of profitableness
is reached; that is, until there seems to him no good reason for thinking
that the gains resulting from any further investment in that particular direction
would compensate him for his outlay." He never assumes that roundabout
methods will be remunerative in the long run. But he is always on the look
out for roundabout methods that promise to be more effective in proportion
to their cost than direct methods: and he adopts the best of them, if it
lies within his means.




 ######




5. Some technical terms relating to costs may be considered here. When
investing his capital in providing the means of carrying on an undertaking,
the business man looks to being recouped by the price obtained for its various
products; and he expects to be able under normal conditions to charge for
each of them a sufficient price; that is, one which will not only cover the
special, direct, or prime cost, but also bear its proper share of the general
expenses of the business; and these we may call its general, or supplementary
cost. These two elements together make its total cost.




There are great variations in the usage of the term Prime cost in business.
But it is taken here in a narrow sense. Supplementary costs are taken to
include standing charges on account of the durable plant in which much of
the capital of the business has been invested, and also the salaries of the
upper employees: for the charges to which the business is put on account
of their salaries cannot generally be adapted quickly to changes in the amount
of work there is for them to do. There remains nothing but the (money) cost
of the raw material used in making the commodity and the wages of that part
of the labour spent on it which is paid by the hour or the piece and the
extra wear-and-tear of plant. This is the special cost which a manufacturer
has in view, when his works are not fully employed, and he is calculating
the lowest price at which it will be worth his while to accept an order,
irrespectively of any effect that his action may have in spoiling the market
for future orders, and trade being slack at the time. But in fact he must
as a rule take account of this effect: the price at which it is just worth
his while to produce, even when trade is slack, is in practice generally
a good deal above this prime cost, as we shall see later on.(10*)




6. Supplementary costs must generally be covered by the selling price
to some considerable extent in the short run. And they must be completely
covered by it in the long run; for, if they are not, production will be checked.
Supplementary costs are of many different kinds; and some of them differ
only in degree from prime costs. For instance, if an engineering firm is
in doubt whether to accept an order at a rather low price for a certain locomotive,
the absolute prime costs include the value of the raw material and the wages
of the artisans and labourers employed on the locomotive. But there is no
clear rule as to the salaried staff: for, if work is slack, they will probably
have some time on their hands; and their salaries will therefore commonly
be classed among general or supplementary costs. The line of division is
however often blurred over. For instance, foremen and other trusted artisans
are seldom dismissed merely because of a temporary scarcity of work; and
therefore an occasional order may be taken to fill up idle time, even though
its price does not cover their salaries and wages. That is they may not be
regarded as prime costs in such a case. But, of course the staff in the office
can be in some measure adjusted to variations in the work of the firm by
leaving vacancies unfilled and even by weeding out inefficient men during
slack times; and by getting extra help or putting out some of the work in
busy times.




If we pass from such tasks to larger and longer tasks, as for instance
the working out a contract to deliver a great number of locomotives gradually
over a period of several years, then most of the office work done in connection
with that order must be regarded as special for it: for if it had been declined
and nothing else taken in its place, the expenses under the head of salaries
could have been reduced almost to a proportionate extent.




The case is much stronger when we consider a fairly steady market for
any class of staple manufactures extending over a long time. For then the
outlay incurred for installing specialized skill and organization, the permanent
office staff, and the durable plant of the workshops can all be regarded
as part of the costs necessary for the process of production. That outlay
will be increased up to a margin at which the branch of manufacture seems
in danger of growing too fast for its market.




In the next chapter the argument of Chapter III and of this chapter is
continued. It is shown in more detail how those costs which most powerfully
act on supply and therefore on price, are limited to a narrow and arbitrary
group in the case of a single contract for, say, a locomotive; but are much
fuller, and correspond much more truly to the broad features of industrial
economy in the case of a continuous supply to a fairly steady general market:
the influence of cost of production on value does not show itself clearly
except in relatively long periods; and it is to be estimated with regard
to a whole process of production rather than a particular locomotive, or
a particular parcel of goods. And a similar study is made in Chapters VIII-X
of variations in the character of those prime and supplementary costs which
consist of charges for interest (or profits) on investments in agents of
production, according as the periods of the market under consideration are
long or short.




Meanwhile it may be noticed that the distinction between prime and supplementary
costs operates in every phase of civilization, though it is not likely to
attract much attention except in a capitalistic phase. Robinson Crusoe had
to do only with real costs and real satisfactions: and an old-fashioned peasant
family, which bought little and sold little, arranged its investments of
present "effort and waiting" for future benefits on nearly the
same lines. But, if either were doubting whether it was worth while to take
a light ladder on a trip to gather wild fruits, the prime costs alone would
be weighed against the expected benefits: and yet the ladder would not have
been made, unless it had been expected to render sufficient service in the
aggregate of many little tasks, to remunerate the cost of making it. In the
long run it had to repay its total costs, supplementary as well as prime.




Even the modern employer has to look at his own labour as a real cost
in the first instance. He may think that a certain enterprise is likely to
yield a surplus of money incomings over money outgoings (after proper allowances
for risks and for discountings of future happenings); but that the surplus
will amount to less than the money equivalent of the trouble and worry that
the enterprise will cause to himself: and, in that case, he will avoid it.(11*)




NOTES:




1. For he might have applied these efforts, or efforts equivalent to them,
to producing immediate gratifications; and if he deliberately chose the deferred
gratifications, it would be because, even after allowing for the disadvantages
of waiting, he regarded them as outweighing the earlier gratifications which
he could have substituted for them. The motive force then tending to deter
him from building the house would be his estimate of the aggregate of these
efforts, the evil or discommodity of each being increased in geometrical
proportion (a sort of compound interest) according to the corresponding interval
of waiting. The motive on the other hand impelling him to build it, would
be expectation of the satisfaction which he would have from the house when
completed; and that again might be resolved into the aggregate of many satisfactions
more or less remote, and more or less certain, which he expected to derive
from its use. If he thought that this aggregate of discounted values of satisfactions
that it would afford him, would be more than a recompense to him for all
the efforts and waitings which he had undergone, he would decide to build.
(See III, v, section 3, IV, VII, section 8 and Note XIII in the Mathematical
Appendix.)




2. We may, if we choose, regard the price of the business undertaker's
own work as part of the original outlay, and reckon compound interest on
it together with the rest. Or we may substitute for compound interest a sort
of "compound profit." The two courses are not strictly convertible:
and at a later stage we shall find that in certain cases the first is to
be preferred, and in others the second.




3. In the aggregate the income from the saving will in the ordinary course
be larger in amount than the saving by the amount of the interest that is
the reward of saving. But, as it will be turned to account in enjoyment later
than the original saving could have been, it will be discounted for a longer
period (or accumulated for a shorter); and if entered in the balance sheet
of the investment in place of the original saving, it would stand for exactly
the same sum. (Both the original income which was saved and the subsequent
income earned by it are assessed to income tax; on grounds similar to those
which make it expedient to levy a larger income tax from the industrious
than from the lazy man.) The main argument of this section is expressed mathematically
in Note XIII.




4. Almost every trade has its own difficulties and its own customs connected
with the task of valuing the capital that has been invested in a business,
and of allowing for the depreciation which that capital has undergone from
wear-and-tear, from the influence of the elements, from new inventions, and
from changes in the course of trade. These two last causes may temporarily
raise the value of some kinds of fixed capital, at the same time that they
are lowering that of others. And people whose minds are cast in different
moulds, or whose interests in the matter point in different directions, will
often differ widely on the question what part of the expenditure required
for adapting buildings and plant to changing conditions of trade, may be
regarded as an investment of new capital; and what ought to be set down as
charges incurred to balance depreciation, and treated as expedenditure deducted
from the current receipts, before determining the net profits of true income
earned by the business. These difficulties, and the consequent differences
of opinion, are greatest of all with regard to the investment of capital
in building up a business connection, and the proper method of appraising
the goodwill of a business, or its value "as a going concern."
On the whole of this subject see Matheson's Depreciation of Factories and
their Valuation.




Another group of difficulties arises from changes in the general purchasing
Power of money. If that has fallen, or, in other words, if there has been
a rise of general prices, the value of a factory may appear to have risen
when it has really remained stationary. Confusions arising from this source
introduce greater errors into estimates of the real profitableness of different
classes of business than would at first sight appear probable. But all questions
of this kind must be deferred till we have discussed the theory of money.




5. See pp. 84-91, and 64-7.




6. The substance of part of this section was placed in VI, i, section
7 in earlier editions. But it seems to be needed here in preparation for
the central chapters of Book V.




7. See III, v, section i.




8. The remainder of this section goes very much on the lines of the earlier
half of Note XIV in the Mathematical Appendix; which may be read in connection
with it. The subject is one in which the language of the differential calculusnot
its reasonings -- are specially helpful to clear thought: but the main outlines
can be presented in ordinary language.




9. See above III, iii section 1; and the footnote on pp. 156-7.




10. Especially in V, IX, "There are many systems of Prime Cost in
vogue... we take Prime Cost to mean, as in fact the words imply, only the
original or direct cost of production; and while in some trades it may be
a matter of convenience to include in the cost of production a proportion
of indirect expenses, and a charge for depreciation on plant and buildings,
in no case should it comprise interest on capital or profit." (Garcke
and Fells, Factory Accounts, ch. i.)




11. The Supplementary costs, which the owner of a factory expects to be
able to add to the prime costs of its products, are the source of the quasi-rents
which it will yield to him. If they come up to his expectation, then his
business so far yields good profits: if they fall much short of it, his business
tends to go to the bad. But this statement bears only on long-period problems
of value: and in that connection the difference between Prime and Supplementary
costs has no special significance. The importance of the distinction between
them is confined to shortperiod problems.






CHAPTER 5




EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY, CONTINUED, WITH REFERENCE TO
LONG AND SHORT PERIODS




1. The variations in the scope of the term Normal, according as the periods
of time under discussion are long or short, were indicated in Chapter III.
We are now ready to study them more closely.




In this case, as in others, the economist merely brings to light difficulties
that are latent in the common discourse of life, so that by being frankly
faced they may be thoroughly overcome. For in ordinary life it is customary
to use the word Normal in different senses, with reference to different periods
of time; and to leave the context to explain the transition from one to another.
The economist follows this practice of every-day life: but, by taking pains
to indicate the transition, he sometimes seems to have created a complication
which in fact he has only revealed.




Thus, when it is said that the price of wool on a certain day was abnormally
high though the average price for the year was abnormally low, that the wages
of coal-miners were abnormally high in 1872 and abnormally low in 1879, that
the (real) wages of labour were abnormally high at the end of the fourteenth
century and abnormally low in the middle of the sixteenth; everyone understands
that the scope of the term normal is not the same in these various cases.




The best illustrations of this come from manufactures where the plant
is long-lived, and the product is short-lived.




When a new textile fabric is first introduced into favour, and there is
very little plant suitable for making it, its normal price for some months
may be twice as high as those of other fabrics which are not less difficult
to make, but for making which there is an abundant stock of suitable plant
and skill. Looking at long periods we may say that its normal price is on
a par with that of the others: but if during the first few months a good
deal of it were offered for sale in a bankrupt's stock we might say that
its price was abnormally low even when it was selling for half as much again
as the others. Everyone takes the context as indicating the special use of
the term in each several case; and a formal interpretation clause is seldom
necessary, because in ordinary conversation misunderstandings can be nipped
in the bud by question and answer. But let us look at this matter more closely.




We have noticed(1*) how a cloth manufacturer would need to calculate the
expenses of producing all the different things required for making cloth
with reference to the amounts of each of them that would be wanted; and on
the supposition in the first instance that the conditions of supply would
be normal. But we have yet to take account of the fact that he must give
to this term a wider or narrower range, according as he was looking more
or less far ahead.




Thus in estimating the wages required to call forth an adequate supply
of labour to work a certain class of looms, he might take the current wages
of similar work in the neighbourhood: or he might argue that there was a
scarcity of that particular class of labour in the neighbourhood, that its
current wages there were higher than in other parts of England, and that
looking forward over several years so as to allow for immigration, he might
take the normal rate of wages at a rather lower rate than that prevailing
there at the time. Or lastly, he might think that the wages of weavers all
over the country were abnormally low relatively to others of the same grade,
in consequence of a too sanguine view having been taken of the prospects
of the trade half a generation ago. He might argue that this branch of work
was overcrowded, that parents had already begun to choose other trades for
their children which offered greater net advantages and yet were not more
difficult; that in consequence a few years would see a falling-off in the
supply of labour suited for his purpose; so that looking forward a long time
he must take normal wages at a rate rather higher than the present average.(2*)




Again, in estimating the normal supply price of wool, he would take the
average of several past years. He would make allowance for any change that
would be likely to affect the supply in the immediate future; and he would
reckon for the effect of such droughts as from time to time occur in Australia
and elsewhere; since their occurrence is too common to be regarded as abnormal.
But he would not allow here for the chance of our being involved in a great
war, by which the Australian supplies might be cut off; he would consider
that any allowance for this should come under the head of extraordinary trade
risks, and not enter into his estimate of the normal supply price of wool.




He would deal in the same way with the risk of civil tumult or any violent
and long-continued disturbance of the labour market of an unusual character;
but in his estimate of the amount of work that could be got out of the machinery,
etc. under normal conditions, he would probably reckon for minor interruptions
from trade disputes such as are continually occurring, and are therefore
to be regarded as belonging to the regular course of events, that is as not
abnormal.




In all these calculations he would not concern himself specially to inquire
how far mankind are under the exclusive influence of selfish or self-regarding
motives. He might be aware that anger and vanity, jealousy and offended dignity
are still almost as common causes of strikes and lockouts, as the desire
for pecuniary gain: but that would not enter into his calculations. All that
he would want to know about them would be whether they acted with sufficient
regularity for him to be able to make a reasonably good allowance for their
influence in interrupting work and raising the normal supply price of the
goods.(3*)




2. The element of time is a chief cause of those difficulties in economic
investigations which make it necessary for man with his limited powers to
go step by step; breaking up a complex question, studying one bit at a time,
and at last combining his partial solutions into a more or less complete
solution of the whole riddle. In breaking it up, he segregates those disturbing
causes, whose wanderings happen to be inconvenient, for the time in a pound
called Caeteris Paribus. The study of some group of tendencies is isolated
by the assumption other things being equal: the existence of other tendencies
is not denied, but their disturbing effect is neglected for a time. The more
the issue is thus narrowed, the more exactly can it be handled: but also
the less closely does it correspond to real life. Each exact and firm handling
of a narrow issue, however, helps towards treating broader issues, in which
that narrow issue is contained, more exactly than would otherwise have been
possible. With each step more things can be let out of the pound; exact discussions
can be made less abstract, realistic discussions can be made less inexact
than was possible at an earlier stage.(4*)




Our first step towards studying the influences exerted by the element
of time on the relations between cost of production and value may well be
to consider the famous fiction of the "Stationary state" in which
those influences would be but little felt; and to contrast the results which
would be found there with those in the modern world.




This state obtains its name from the fact that in it the general conditions
of production and consumption, of distribution and exchange remain motionless;
but yet it is full of movement; for it is a mode of life. The average age
of the population may be stationary; though each individual is growing up
from youth towards his prime, or downwards to old age. And the same amount
of things per head of the population will have been produced in the same
ways by the same classes of people for many generations together; and therefore
this supply of the appliances for production will have had full time to be
adjusted to the steady demand.




Of course we might assume that in our stationary state every business
remained always of the same size, and with the same trade connection. But
we need not go so far as that; it will suffice to suppose that firms rise
and fall, but that the "representative" firm remains always of
about the same size, as does the representative tree of a virgin forest,
and that therefore the economies resulting from its own resources are constant:
and since the aggregate volume of production is constant, so also are those
economies resulting from subsidiary industries in the neighbourhood, etc.
[That is, its internal and external economies are both constant. The price,
the expectation of which just induced persons to enter the trade, must be
sufficient to cover in the long run the cost of building up a trade connection;
and a proportionate share of it must be added in to make up the total cost
of production.]




In a stationary state then the plain rule would be that cost of production
governs value. Each effect would be attributable mainly to one cause; there
would not be much complex action and reaction between cause and effect. Each
element of cost would be governed by "natural" laws, subject to
some control from fixed custom. There would be no reflex influence of demand;
no fundamental difference between the immediate and the later effects of
economic causes. There would be no distinction between long-period and short-period
normal value, at all events if we supposed that in that monotonous world
the harvests themselves were uniform: for the representative firm being always
of the same size, and always doing the same class of business to the same
extent and in the same way, with no slack times, and no specially busy times,
its normal expenses by which the normal supply price is governed would be
always the same. The demand lists of prices would always be the same, and
so would the supply lists; and normal price would never vary.




But nothing of this is true in the world in which we live. Here every
economic force is constantly changing its action, under the influence of
other forces which are acting around it. Here changes in the volume of production,
in its methods, and in its cost are ever mutually modifying one another;
they are always affecting and being affected by the character and the extent
of demand. Further all these mutual influences take time to work themselves
out, and, as a rule, no two influences move at equal pace. In this world
therefore every plain and simple doctrine as to the relations between cost
of production, demand and value is necessarily false: and the greater the
appearance of lucidity which is given to it by skilful exposition, the more
mischievous it is. A man is likely to be a better economist if he trusts
to his common sense, and practical instincts, than if he professes to study
the theory of value and is resolved to find it easy.




3. The Stationary state has just been taken to be one in which population
is stationary. But nearly all its distinctive features may be exhibited in
a place where population and wealth are both growing, provided they are growing
at about the same rate, and there is no scarcity of land: and provided also
the methods of production and the conditions of trade change but little;
and above all, where the character of man himself is a constant quantity.
For in such a state by far the most important conditions of production and
consumption, of exchange and distribution will remain of the same quality,
and in the same general relations to one another, though they are all increasing
in volume.(5*)




This relaxation of the rigid bonds of a purely stationary state brings
us one step nearer to the actual conditions of life: and by relaxing them
still further we get nearer still. We thus approach by gradual steps towards
the difficult problem of the interaction of countless economic causes. In
the stationary state all the conditions of production and consumption are
reduced to rest: but less violent assumptions are made by what is, not quite
accurately, called the statical method. By that method we fix our minds on
some central point: we suppose it for the time to be reduced to a stationary
state; and we then study in relation to it the forces that affect the things
by which it is surrounded, and any tendency there may be to equilibrium of
these forces. A number of these partial studies may lead the way towards
a solution of problems too difficult to be grasped at one effort.(6*)




4. We may roughly classify problems connected with fishing industries
as those which are affected by very quick changes, such as uncertainties
of the weather; or by changes of moderate length, such as the increased demand
for fish caused by the scarcity of meat during the year or two following
a cattle plague; or lastly, we may consider the great increase during a whole
generation of the demand for fish which might result from the rapid growth
of a high-strung artisan population making little use of their muscles.




The day to day oscillations of the price of fish resulting from uncertainties
of the weather, etc., are governed by practically the same causes in modern
England as in the supposed stationary state. The changes in the general economic
conditions around us are quick; but they are not quick enough to affect perceptibly
the short-period normal level about which the price fluctuates from day to
day: and they may be neglected [impounded in caeteris paribus] during a study
of such fluctuations.




Let us then pass on; and suppose a great increase in the general demand
for fish, such for instance as might arise from a disease affecting farm
stock, by which meat was made a dear and dangerous food for several years
together. We now impound fluctuations due to the weather in caeteris paribus,
and neglect them provisionally: they are so quick that they speedily obliterate
one another, and are therefore not important for problems of this class.
And for the opposite reason we neglect variations in the numbers of those
who are brought up as seafaring men: for these variations are too slow to
produce much effect in the year or two during which the scarcity of meat
lasts. Having impounded these two sets for the time, we give our full attention
to such influences as the inducements which good fishing wages will offer
to sailors to stay in their fishing homes for a year or two, instead of applying
for work on a ship. We consider what old fishing boats, and even vessels
that were not specially made for fishing, can be adapted and sent to fish
for a year or two. The normal price for any given daily supply of fish, which
we are now seeking, is the price which will quickly call into the fishing
trade capital and labour enough to obtain that supply in a day's fishing
of average good fortune; the influence which the price of fish will have
upon capital and labour available in the fishing trade being governed by
rather narrow causes such as these. This new level about which the price
oscillates during these years of exceptionally great demand, will obviously
be higher than before. Here we see an illustration of the almost universal
law that the term Normal being taken to refer to a short period of time an
increase in the amount demanded raises the normal supply price. This law
is almost universal even as regards industries which in long periods follow
the tendency to increasing return.(7*)




But if we turn to consider the normal supply price with reference to a
long period of time, we shall find that it is governed by a different set
of causes, and with different results. For suppose that the disuse of meat
causes a permanent distaste for it, and that an increased demand for fish
continues long enough to enable the forces by which its supply is governed
to work out their action fully (of course oscillations from day to day and
from year to year would continue: but we may leave them on one side). The
source of supply in the sea might perhaps show signs of exhaustion, and the
fishermen might have to resort to more distant coasts v, and to deeper waters,
Nature giving a Diminishing Return to the increased application of capital
and labour of a given order of efficiency. On the other hand, those might
turn out to be right who think that man is responsible for but a very small
part of the destruction of fish that is constantly going on; and in that
case a boat starting with equally good appliances and an equally efficient
crew would be likely to get nearly as good a haul after the increase in the
total volume of the fishing trade as before. In any case the normal cost
of equipping a good boat with an efficient crew would certainly not be higher,
and probably be a little lower after the trade had settled down to its now
increased dimensions than before. For since fishermen require only trained
aptitudes, and not any exceptional natural qualities, their number could
be increased in less than a generation to almost any extent that was necessary
to meet the demand; while the industries connected with building boats, making
nets, etc. being now on a larger scale would be organized more thoroughly
and economically. If therefore the waters of the sea showed no signs of depletion
of fish, an increased supply could be produced at a lower price after a time
sufficiently long to enable the normal action of economic causes to work
itself out: and, the term Normal being taken to refer to a long period of
time, the normal price of fish would decrease with an increase in demand.(8*)




Thus we may emphasize the distinction already made between average price
and normal price. An average may be taken of the prices of any set of sales
extending over a day or a week or a year or any other time: or it may be
the average of sales at any time in many markets; or it may be the average
of many such averages. But the conditions which are normal to any one set
of sales are not likely to be exactly those which are normal to the others:
and therefore it is only by accident that an average price will be a normal
price; that is, the price which any one set of conditions tends to produce.
In a stationary state alone, as we have just seen, the term normal always
means the same thing: there, but only there, "average price" and
"normal price" are convertible terms.(9*)




5. To go over the ground in another way. Market values are governed by
the relation of demand to stocks actually in the market; with more or less
reference to "future" supplies, and not without some influence
of trade combinations.




But the current supply is in itself partly due to the action of producers
in the past; and this action has been determined on as the result of a comparison
of the prices which they expect to get for their goods with the expenses
to which they will be put in producing them. The range of expenses of which
they take account depends on whether they are merely considering the extra
expenses of certain extra production with their existing plant, or are considering
whether to lay down new plant for the purpose. In the case, for instance,
of an order for a single locomotive, which was discussed a little while ago(10*),
the question of readjusting the plant to demand would hardly arise: the main
question would be whether more work could conveniently be got out of the
existing plant. But in view of an order for a large number of locomotives
to be delivered gradually over a series of years, some extension of plant
"specially" made for the Purpose, and therefore truly to be regarded
as prime marginal costs would almost certainly be carefully considered.




Whether the new production for which there appears to be a market be large
or small, the general rule will be that unless the price is expected to be
very low that portion of the supply which can be most easily produced, with
but small prime costs, will be produced: that portion is not likely to be
on the margin of production. As the expectations of price improve, an increased
part of the production will yield a considerable surplus above prime costs,
and the margin of production will be pushed outwards. Every increase in the
price expected will, as a rule, induce some people who would not otherwise
have produced anything, to produce a little; and those, who have produced
something for the lower price, will produce more for the higher price. That
part of their production with regard to which such persons are on the margin
of doubt as to whether it is worth while for them to produce it at the price,
is to be included together with that of the persons who are in doubt whether
to produce at all; the two together constitute the marginal production at
that price. The producers, who are in doubt whether to produce anything at
all, may be said to lie altogether on the margin of production (or) if they
are agriculturists, on the margin of cultivation). But as a rule they are
very few in number, and their action is less important than that of those
who would in any case produce something.




The general drift of the term normal supply price is always the same whether
the period to which it refers is short or long; but there are great differences
in detail. In every case reference is made to a certain given rate of aggregate
production; that is, to the production of a certain aggregate amount daily
or annually. In every case the price is that the expectation of which is
sufficient and only just sufficient to make it worth while for people to
set themselves to produce that aggregate amount; in every case the cost of
production is marginal; that is, it is the cost of production of those goods
which are on the margin of not being produced at all, and which would not
be produced if the price to be got for them were expected to be lower. But
the causes which determine this margin vary with the length of the period
under consideration. For short periods people take the stock of appliances
for production as practically fixed; and they are governed by their expectations
of demand in considering how actively they shall set themselves to work those
appliances. In long periods they set themselves to adjust the flow of these
appliances to their expectations of demand for the goods which the appliances
help to produce. Let us examine this difference closely.




6. The immediate effect of the expectation of a high price is to cause
people to bring into active work all their appliances of production, and
to work them full time and perhaps overtime. The supply price is then the
money cost of production of that part of the produce which forces the undertaker
to hire such inefficient labour (perhaps tired by working overtime) at so
high a price, and to put himself and others to so much strain and inconvenience
that he is on the margin of doubt whether it is worth his while to do it
or not. The immediate effect of the expectation of a low price is to throw
many appliances for production out of work, and slacken the work of others;
and if the producers had no fear of spoiling their markets, it would be worth
their while to produce for a time for any price that covered the prime costs
of production and rewarded them for their own trouble.




But, as it is, they generally hold out for a higher price; each man fears
to spoil his chance of getting a better price later on from his own customers;
or, if he produces for a large and open market, he is more or less in fear
of incurring the resentment of other producers, should he sell needlessly
at a price that spoils the common market for all. The marginal production
in this case is the production of those whom a little further fall of price
would cause, either from a regard to their own interest or by formal or informal
agreement with other producers, to suspend production for fear of further
spoiling the market. The price which, for these reasons, producers are just
on the point of refusing, is the true marginal supply price for short periods.
It is nearly always above, and generally very much above the special or prime
cost for raw materials, labour and wear-and-tear of plant, which is immediately
and directly involved by getting a little further use out of appliances which
are not fully employed. This point needs further study.




In a trade which uses very expensive plant, the prime cost of goods is
but a small part of their total cost; and an order at much less than their
normal price may leave a large surplus above their prime cost. But if producers
accept such orders in their anxiety to prevent their plant from being idle,
they glut the market and tend to prevent prices from reviving. In fact however
they seldom pursue this policy constantly and without moderation. If they
did, they might ruin many of those in the trade, themselves perhaps among
the number; and in that case a revival of demand would find little response
in supply, and would raise violently the prices of the goods produced by
the trade. Extreme variations of this kind are in the long run beneficial
neither to producers nor to consumers; and general opinion is not altogether
hostile to that code of trade morality which condemns the action of anyone
who "spoils the market" by being too ready to accept a price that
does little more than cover the prime cost of his goods, and allows but little
on account of his general expenses.(11*)




For example, if at any time the prime cost, in the narrowest sense of
the word, of a bale of cloth is £100; and if another £100 are needed
to make the cloth pay its due share of the general expenses of the establishment,
including normal profits to its owners, then the practically effective supply
price is perhaps not very likely to fall below £150 under ordinary conditions,
even for short periods; though of course a few special bargains may be made
at lower prices without much affecting the general market.




Thus, although nothing but prime cost enters necessarily and directly
into the supply price for short periods, it is yet true that supplementary
costs also exert some influence indirectly. A producer does not often isolate
the cost of each separate small parcel of his output; he is apt to treat
a considerable part of it, even in some cases the whole of it, more or less
as a unit. He inquires whether it is worth his while to add a certain new
line to his present undertakings, whether it is worth while to introduce
a new machine and so on. He treats the extra output that would result from
the change more or less as a unit beforehand; and afterwards he quotes the
lowest prices, which he is willing to accept, with more or less reference
to the whole cost of that extra output regarded as a unit.




In other words he regards an increase in his processes of production,
rather than an individual parcel of his products, as a unit in most of his
transactions. And the analytical economist must follow suit, if he would
keep in close touch with actual conditions. These considerations tend to
blur the sharpness of outline of the theory of value: but they do not affect
its substance.(12*)




To sum up then as regards short periods. The supply of specialized skill
and ability, of suitable machinery and other material capital, and of the
appropriate industrial organization has not time to be fully adapted to demand;
but the producers have to adjust their supply to the demand as best they
can with the appliances already at their disposal. On the one hand there
is not time materially to increase those appliances if the supply of them
is deficient; and on the other, if the supply is excessive, some of them
must remain imperfectly employed, since there is not time for the supply
to be much reduced by gradual decay, and by conversion to other uses. Variations
in the particular income derived from them do not for the time affect perceptibly
the supply; and do not directly affect the price of the commodities produced
by them. The income is a surplus of total receipts over prime cost; [that
is, it has something of the nature of a rent as will be seen more clearly
in chapter VIII]. But unless it is sufficient to cover in the long run a
fair share of the general costs of the business, production will gradually
fall off. In this way a controlling influence over the relatively quick movements
of supply price during short periods is exercised by causes in the background
which range over a long period; and the fear of "spoiling the market"
often makes those causes act more promptly than they otherwise would.




7. In long periods on the other hand all investments of capital and effort
in providing the material plant and the organization of a business, and in
acquiring trade knowledge and specialized ability, have time to be adjusted
to the incomes which are expected to be earned by them: and the estimates
of those incomes therefore directly govern supply, and are the true long-period
normal supply price of the commodities produced.




A great part of the capital invested in a business is generally spent
on building up its internal organization and its external trade connections.
If the business does not prosper all that capital is lost, even though its
material plant may realize a considerable part of its original cost. And
anyone proposing to start a new business in any trade must reckon for the
chance of this loss. If himself a man of normal capacity for that class of
work, be may look forward ere long to his business being a representative
one, in the sense in which we have used this term, with its fair share of
the economies of production on a large scale. If the net earnings of such
a representative business seem likely to be greater than he could get by
similar investments in other trades to which he has access, he will choose
this trade. Thus that investment of capital in a trade, on which the price
of the commodity produced by it depends in the long run, is governed by estimates
on the one hand of the outgoings required to build up and to work a representative
firm, and on the other of the incomings, spread over a long period of time,
to be got by such a price.




At any particular moment some businesses will be rising and others falling:
but when we are taking a broad view of the causes which govern normal supply
price, we need not trouble ourselves with these eddies on the surface of
the great tide. Any particular increase of production may be due to some
new manufacturer who is struggling against difficulties, working with insufficient
capital, and enduring great privations in the hope that he may gradually
build up a good business. Or it may be due to some wealthy firm which by
enlarging its premises is enabled to attain new economies, and thus obtain
a larger output at a lower proportionate cost: and, as this additional output
will be small relatively to the aggregate volume of production in the trade,
it will not much lower the price; so that the firm will reap great gains
from its successful adaptation to its surroundings. But while these variations
are occurring in the fortunes of individual businesses, there may be a steady
tendency of the long-period normal supply price to diminish, as a direct
consequence of an increase in the aggregate volume of production.




8. Of course there is no hard and sharp line of division between "long"
and "short" periods. Nature has drawn no such lines in the economic
conditions of actual life; and in dealing with practical problems they are
not wanted. Just as we contrast civilized with uncivilized races, and establish
many general propositions about either group, though no hard and fast division
can be drawn between the two; so we contrast long and short periods without
attempting any rigid demarcation between them. If it is necessary for the
purposes of any particular argument to divide one case sharply from the other,
it can be done by a special interpretation clause: but the occasions on which
this is necessary are neither frequent nor important.




Four classes stand out. In each, price is governed by the relations between
demand and supply. As regards market prices, Supply is taken to mean the
stock of the commodity in question which is on hand, or at all events "
in sight." As regards normal prices, when the term Normal is taken to
relate to short periods of a few months or a year, supply means broadly what
can be produced for the price in question with the existing stock of plant,
personal and impersonal, in the given time. As regards normal prices, when
the term Normal is to refer to long periods of several years, Supply means
what can be produced by plant, which itself can be remuneratively produced
and applied within the given time; while lastly, there are very gradual or
Secular movements of normal price, caused by the gradual growth of knowledge,
of population and of capital, and the changing conditions of demand and supply
from one generation to another.(13*)




The remainder of the present volume is chiefly concerned with the third
of the above classes: that is, with the normal relations of wages, profits,
prices, etc., for rather long periods. But occasionally account has to be
taken of changes that extend over very many years; and one chapter, Book
VI, ch. XII, is given up to "The Influence of Progress on Value,"
that is, to the study of secular changes of value.




NOTES:




1. V, III, section 5.




2. There are indeed not many occasions on which the calculations of a
business man for practical purposes need to look forward so far, and to extend
the range of the term Normal over a whole generation: but in the broader
applications of economic science it is sometimes necessary to extend the
range even further, and to take account of the slow changes that in the course
of centuries affect the supply price of the labour of each industrial grade.




3. Compare I, II, section 7.




4. As has been explained in the Preface, pp. vi-ix, this volume is concerned
mainly with normal conditions; and these are sometimes described as Statical.
But in the opinion of the present writer the problem of normal value belongs
to economic Dynamics: partly because Statics is really but a branch of Dynamics,
and partly because all suggestions as to economic rest, of which the hypothesis
of a Stationary state is the chief, are merely provisional, used only to
illustrate particular steps in the argument, and to be thrown aside when
that is done.




5. See below, V, XII, section 3; and compare Keynes, Scope and Method
of Political Economy, VI, 2.




6. Compare the Preface and Appendix H, section 4.




7. See V, XII, section I.




8. Tooke (History of Prices, Vol. I, p. 104) tells us: "There are
particular articles of which the demand for naval and military purposes forms
so large a proportion to the total supply, that no diminution of consumption
by individuals can keep pace with the immediate increase of demand by government;
and consequently, the breaking out of a war tends to raise the price of such
articles to a great relative height. But even of such articles, if the consumption
were not on a progressive scale of increase so rapid that the supply, with
all the encourage ment of a relatively high price, could not keep pace with
the demand, the tendency is (supposing no impediment, natural or artificial,
to production or importation) to occasion such an increase of quantity, as
to reduce the price to nearly the same level as that from which it had advanced.
And accordingly it will be observed, by reference to the table of prices,
that salt petre, hemp, iron, etc., after advancing very considerably under
the influence of a greatly extended demand for military and naval purposes,
tended downwards again whenever that demand was not progressively and rapidly
increasing." Thus a continuously progressive increase in demand may
raise the supply price of a thing even for several years together; though
a steady increase of demand for that thing, at a rate not too great for supply
to keep pace with it, would lower price.




9. V, III, section 6. The distinction will be yet further discussed in
V, XII and Appendix H. See also Keynes, Scope and Method of Political Economy,
ch. VII.




10. pp. 360-7.




11. Where there is a strong combination, tacit or overt, producers may
sometimes regulate the price for a considerable time together with very little
reference to cost of production. And if the leaders in that combination were
those who had the best facilities for production, it might be said, in apparent
though not in real contradiction to Ricardo's doctrines, that the price was
governed by that part of the supply which was most easily produced. But as
a fact, those producers whose finances are weakest, and who are bound to
go on producing to escape failure, often impose their policy on the rest
of the combination: insomuch that it is a common saying, both in America
and England, that the weakest members of a combination are frequently its
rulers.




12. This general description may suffice for most purposes: but in chapter
XII there will be found a more detailed study of that extremely complex notion,
a marginal increment in the processes of production by a representative firm;
together with a fuller explanation of the necessity of referring our reasonings
to the circumstances of a representative firm, especially when we are considering
industries which show a tendency to increasing return.




13. Compare the first section of this chapter. Of course the periods required
to adapt the several factors of production to the demand may be very different;
the number of skilled compositors, for instance, cannot be increased nearly
as fast as the supply of type and printing presses. And this cause alone
would prevent any rigid division being made between long and short periods.
But in fact a theoretically perfect long period must give time enough to
enable not only the factors of production of the commodity to be adjusted
to the demand, but also the factors of production of those factors of production
to be adjusted and so on; and this, when carried to its logical consequences,
will be found to involve the supposition of a stationary state of industry,
in which the requirements of a future age can be anticipated an indefinite
time beforehand. Some such assumption is indeed unconsciously implied in
many popular renderings of Ricardo's theory of value, if not in his own versions
of it; and it is to this cause more than any other that we must attribute
that simplicity and sharpness of outline, from which the economic doctrines
in fashion in the first half of this century derived some of their seductive
charm, as well as most of whatever tendency they may have to lead to false
practical conclusions.




Relatively short and long period problems go generally on similar lines.
In both use is made of that paramount device, the partial or total isolation
for special study of some set of relations. In both opportunity is gained
for analysing and comparing similar episodes, and making them throw light
upon one another; and for ordering and co-ordinating facts which are suggestive
in their similarities, and are still more suggestive in the differences that
peer out through their similarities. But there is a broad distinction between
the two cases. In the relatively short-period problem no great violence is
needed for the assumption that the forces not specially under consideration
may be taken for the time to be inactive. But violence is required for keeping
broad forces in the pound of Caeteris Paribus during, say, a whole generation,
on the ground that they have only an indirect bearing on the question in
hand. For even indirect influences may produce great effects in the course
of a generation, if they happen to act cumulatively; and it is not safe to
ignore them even provisionally in a practical problem without special study.
Thus the uses of the statical method in problems relating to very long periods
are dangerous; care and forethought and self-restraint are needed at every
step. The difficulties and risks of the task reach their highest point in
connection with industries which conform to the law of Increasing Return;
and it is just in connection with those industries that the most alluring
applications of the method are to be found. We must postpone these questions
to chapter XII and Appendix H.




But an answer may be given here to the objection that since "the
economic world is subject to continual changes, and is becoming more complex,...
the longer the run the more hopeless the rectification": so that to
speak of that position which value tends to reach in the long run is to treat
"variables as constants." (Devas, Political Economy, Book IV, ch.
v.) It is true that we do treat variables provisionally as constants. But
it is also true that this is the only method by which science has ever made
any great progress in dealing with complex and changeful matter, whether
in the physical or moral world. See above V, v, section 2.




CHAPTER 6




JOINT AND COMPOSITE DEMAND. JOINT AND COMPOSITE SUPPLY




1. Bread satisfies man's wants directly: and the demand for it is said
to be direct. But a flour mill and an oven satisfy wants only indirectly,
by helping to make bread, etc., and the demand for them is said to be indirect.
More generally: --




The demand for raw materials and other means of production is indirect
and is derived from the direct demand for those directly serviceable products
which they help to produce.




The services of the flour mill and the oven are joined together in the
ultimate product, bread: the demand for them is therefore called a joint
demand. Again, hops and malt are complementary to one another; and are joined
together in the common destination of ale: and so on. Thus the demand for
each of several complementary things is derived from the services which they
jointly render in the production of some ultimate product, as for instance
a loaf of bread, a cask of ale. In other words there is a joint demand for
the services which any of these things render in helping to produce a thing
which satisfies wants directly and for which there is therefore a direct
demand: the direct demand for the finished product is in effect split up
into many derived demands for the things used in producing it.(1*)




To take another illustration, the direct demand for houses gives rise
to a joint demand for the labour of all the various building trades, and
for bricks, stone, wood, etc. which are factors of production of building
work of all kinds, or as we may say for shortness, of new houses. The demand
for any one of these, as for instance the labour of plasterers, is only an
indirect or derived demand.




Let us pursue this last illustration with reference to a class of events
that are of frequent occurrence in the labour market; the period over which
the disturbance extends being short, and the causes of which we have to take
account as readjusting demand and supply being only such as are able to operate
within that short period.




This case has important practical bearings, which give it a special claim
on our attention; but we should notice that, referring as it does to short
periods, it is an exception to our general rule of selecting illustrations
in this and the neighbouring chapters from cases in which there is time enough
for the full long-period action of the forces of supply to be developed.




Let us then suppose that the supply and demand for building being in equilibrium,
there is a strike on the part of one group of workers, say the plasterers,
or that there is some other disturbance to the supply of plasterers' labour.
In order to isolate and make a separate study of the demand for that factor,
we suppose firstly that the general conditions of the demand for new houses
remain unchanged (that is, that the demand schedule for new houses remains
valid); and secondly we assume that there is no change in the general conditions
of supply of the other factors, two of which are of course the business faculties
and the business organizations of the master builders; (that is, we assume
that their lists of supply prices also remain valid). Then a temporary check
to the supply of plasterers' labour will cause a proportionate check to the
amount of building: the demand price for the diminished number of houses
will be a little higher than before; and the supply prices for the other
factors of production will not be greater than before.(2*) Thus new houses
can now be sold at prices which exceed by a good margin the sum of the prices
at which these other requisites for the production of houses can be bought;
and that margin gives the limit to the possible rise of the price that will
be offered for plasterers' labour, on the supposition that plasterers' labour
is indispensable. The different amounts of this margin, corresponding to
different checks to the supply of plasterers' labour, are governed by the
general rule that: The price that will be offered for any thing used in producing
a commodity is, for each separate amount of the commodity, limited by the
excess of the price at which that amount of the commodity can find purchasers,
over the sum of the prices at which the corresponding supplies of the other
things needed for making it will be forthcoming.




To use technical terms, the demand schedule for any factor of production
of a commodity can be derived from that for the commodity by subtracting
from the demand price of each separate amount of the commodity the sum of
the supply prices for corresponding amounts of the other factors.(3*)




2. When however we come to apply this theory to the actual conditions
of life, it will be important to remember that if the supply of one factor
is disturbed, the supply of others is likely to be disturbed also. In particular,
when the factor of which the supply is disturbed is one class of labour,
as that of the plasterers, the employers' earnings generally act as a buffer.
That is to say, the loss falls in the first instance on them; but by discharging
some of their workmen and lowering the wages of others, they ultimately distribute
a great part of it among the other factors of production. The details of
the process by which this is effected are various, and depend on the action
of trade combinations, on the higgling and bargaining of the market, and
on other causes with which we are not just at present concerned.




Let us inquire what are the conditions, under which a check to the supply
of a thing that is wanted not for direct use, but as a factor of production
of some commodity, may cause a very great rise in its price. The first condition
is that the factor itself should be essential, or nearly essential to the
production of the commodity, no good substitute being available at a moderate
price.




The second condition is that the commodity in the production of which
it is a necessary factor, should be one for which the demand is stiff and
inelastic; so that a check to its supply will cause consumers to offer a
much increased price for it rather than go without it; and this of course
includes the condition that no good substitutes for the commodity are available
at a price but little higher than its equilibrium price. If the check to
house building raises the price of houses very much, builders, anxious to
secure the exceptional profits, will bid against one another for such plasterers'
labour as there is in the market.(4*)




The third condition is that only a small part of the expenses of production
of the commodity should consist of the price of this factor. Since the plasterers'
wages are but a small part of the total expenses of building a house, a rise
of even 50 per cent in them would add but a very small percentage to the
expenses of production of a house and would check demand but little.(5*)




The fourth condition is that even a small check to amount demanded should
cause a considerable fall in the supply prices of other factors of production;
as that will increase the margin available for paying a high price for this
one.(6*) If, for instance, bricklayers and other classes of workmen, or the
employers themselves cannot easily find other things to do, and cannot afford
to remain idle, they may be willing to work for much lower earnings than
before, and this will increase the margin available for paying higher wages
to plasterers. These four conditions are independent, and the effects of
the last three are cumulative.




The rise in plasterers' wages would be checked if it were possible either
to avoid the use of plaster, or to get the work done tolerably well and at
a moderate price by people outside the plasterers' trade: the tyranny, which
one factor of production of a commodity might in some cases exercise over
the other factors through the action of derived demand, is tempered by the
principle of substitution.(7*)




Again, an increased difficulty in obtaining one of the factors of a finished
commodity can often be met by modifying the character of the finished product.
Some plasterers' labour may be indispensable; but people are often in doubt
how much plaster work it is worth while to have in their houses, and if there
is a rise in its price they will have less of it. The intensity of the satisfaction
of which they would be deprived if they had a little less of it, is its marginal
utility; the price which they are just willing to pay in order to have it,
is the true demand price for plasterers' work up to the amount which is being
used.




So again there is a joint demand for malt and hops in ale. But their proportions
can be varied. A higher price can be got for an ale which differs from others
only in containing more hops; and this excess price represents the demand
for hops.(8*)




The relations between plasterers, bricklayers, etc., are representative
of much that is both instructive and romantic in the history of alliances
and conflicts between trades-unions in allied trades. But the most numerous
instances of joint demand are those of the demand for a raw material and
the operatives who work it up; as for instance cotton or jute or iron or
copper, and those who work up these several materials. Again, the relative
prices of different articles of food vary a good deal with the supply of
skilled cooks' labour: thus for instance many kinds of meat and many parts
of vegetables which are almost valueless in America, where skilled cooks
are rare and expensive, have a good value in France, where the art of cooking
is widely diffused.




3. We have already(9*) discussed the way in which the aggregate demand
for any commodity is compounded of the demands of the different groups of
people who may need it. But we now may extend this notion of composite demand
to requisites of production which are needed by several groups of producers.




Nearly every raw material and nearly every kind of labour is applied in
many different branches of industry, and contributes to the production of
a great variety of commodities. Each of these commodities has its own direct
demand; and from that the derived demand for any of the things used in making
it can be found, and the thing is "distributed between its various uses"
in the manner which we have already discussed.(10*) The various uses are
rivals, or competitors with one another; and the corresponding derived demands
are rival or competitive demands relatively to one another. But in relation
to the supply of the product, they co-operate with one another; being "compounded"
into the total demand that carries off the supply: in just the same way as
the partial demands of several classes of society for a finished commodity
are aggregated, or compounded together into the total demand for it.(11*)




4. We may now pass to consider the case of joint products: i.e. of things
which cannot easily be produced separately; but are joined in a common origin,
and may therefore be said to have a joint supply, such as beef and hides,
or wheat and straw.(12*) This case corresponds to that of things which have
a joint demand, and it may be discussed almost in the same words, by merely
substituting "demand" for "supply," and vice versa. As
there is a joint demand for things joined in a common destination: so there
is a joint supply of things which have a common origin. The single supply
of the common origin is split up into so many derived supplies of the things
that proceed from it.(13*)




For instance, since the repeal of the Corn Laws much of the wheat consumed
in England has been imported, of course without any straw. This has caused
a scarcity and a consequent rise in the price of straw, and the farmer who
grows wheat looks to the straw for a great part of the value of the crop.
The value of straw then is high in countries which import wheat, and low
in those which export wheat. In the same way the price of mutton in the wool-producing
districts of Australia was at one time very low. The wool was exported, the
meat had to be consumed at home; and as there was no great demand for it,
the price of the wool had to defray almost the whole of the joint expenses
of production of the wool and the meat. Afterwards the low price of meat
gave a stimulus to the industries of preserving meat for exportation, and
now its price in Australia is higher.




There are very few cases of joint products the cost of production of both
of which together is exactly the same as that of one of them alone. So long
as any product of a business has a market value, it is almost sure to have
devoted to it some special care and expense, which would be diminished, or
dispensed with if the demand for that product were to fall very much. Thus,
for instance, if straw were valueless, farmers would exert themselves more
than they do to make the ear bear as large a proportion as possible to the
stalk. Again, the importation of foreign wool has caused English sheep to
be adapted by judicious crossing and selection so as to develop heavy weights
of good meat at an early age, even at the expense of some deterioration of
their wool. It is only when one of two things produced by the same process
is valueless, unsaleable, and yet does not involve any expense for its removal,
that there is no inducement to attempt to alter its amount; and, it is only
in these exceptional cases that we have no means of assigning its separate
supply price to each of the joint products. For when it is possible to modify
the proportions of these products, we can ascertain what part of the whole
expense of the process of production would be saved, by so modifying these
proportions as slightly to diminish the amount of one of the joint products
without affecting the amounts of the others. That part of the expense is
the expense of production of the marginal element of that product; it is
the supply price of which we are in search.(14*)




But these are exceptional cases. It more frequently happens that a business,
or even an industry finds its advantage in using a good deal of the same
plant, technical skill, and business organization for several classes of
products. In such cases the cost of anything used for several purposes has
to be defrayed by its fruits in all of them: but there is seldom any rule
of nature to determine either the relative importance of these uses, or the
proportions in which the total cost should be distributed among them: much
depends on the changing features of markets.(15*)




5. We may pass to the problem of composite supply which is analogous to
that of composite demand. A demand can often be satisfied by any one of several
routes, according to the principle of substitution. These various routes
are rivals or competitors with one another; and the corresponding supplies
of commodities are rival, or competitive supplies relatively to one another.
But in relation to the demand they co-operate with one another; being "compounded"
into the total supply that meets the demands.(16*)




If the causes which govern their production are nearly the same, they
may for many purposes be treated as one commodity.(17*) For instance, beef
and mutton may be treated as varieties of one commodity for many purposes;
but they must be treated as separate for others, as for instance for those
in which the question of the supply of wool enters. Rival things are however
often not finished commodities, but factors of production: for instance,
there are many rival fibres which are used in making ordinary printing paper.
We have just noticed how the fierce action of derived demand for one of several
complementary supplies, as e.g. for the supply of plasterers' labour, was
liable to be moderated, when the demand was met by the competitive supply
of a rival thing, which could be substituted for it.(18*)




6. All the four chief problems which have been discussed in this chapter
have some bearing on the causes that govern the value of almost every commodity:
and many of the most important cross connections between the values of different
commodities are not obvious at first sight.




Thus when charcoal was generally used in making iron, the price of leather
depended in some measure on that of iron; and the tanners petitioned for
the exclusion of foreign iron in order that the demand on the part of English
iron smelters for oak charcoal might cause the production of English oak
to be kept up, and thus prevent oak bark from becoming dear.(19*) This instance
may serve to remind us of the way in which an excessive demand for a thing
may cause its sources of supply to be destroyed, and thus render scarce any
joint products that it may have: for the demand for wood on the part of the
ironmakers led to a relentless destruction of many forests in England. Again,
an excessive demand for lamb was assigned as a cause of the prevailing scarcity
of sheep some years ago; while some argued on the contrary that the better
the price to be got for spring lamb sold to the rich, the more profitable
would be the production of sheep, and the cheaper would mutton be for the
people. The fact is that an increase of demand may have opposite effects
according as it does or does not act so suddenly as to prevent producers
from adapting their action to it.




Again, the development of railways and other means of communication for
the benefit of one trade, as for instance wheat growing in some parts of
America and silver mining in others, greatly lowers some of the chief expenses
of production of nearly every other product of those districts. Again, the
prices of soda, and bleaching materials and other products of industries,
the chief raw material of which is salt, move up and down relatively to one
another with almost every improvement in the various processes which are
used in those industries; and every change in those prices affects the prices
of many other goods, for the various products of the salt industries are
more or less important factors in many branches of manufacture.




Again, cotton and cotton-seed oil are joint products, and the recent fall
in the price of cotton is largely due to the improved manufacture and uses
of cotton-seed oil: and further, as the history of the cotton famine shows,
the price of cotton largely affects that of wool, linen and other things
of its own class; while cotton-seed oil is ever opening up new rivalries
with things of its own class. Again, many new uses have been found for straw
in manufacture; and these inventions are giving value to straw that used
to be burnt in the West of America, and tend to hinder the rise in the marginal
cost of producing wheat.(20*)




NOTES:




1. Compare III, III, section 6. It will be recollected that the things
in a form ready for immediate use have been called goods of the first order,
or consumers' goods; and that things used as factors of production of other
goods have been called producers' goods, or goods of the second and higher
orders or intermediate goods: also that it is difficult to say when goods
are really finished; that many things are commonly treated as finished consumers'
goods before they are really ready for consumption, e.g. flour. See II, iii,
section I. The vagueness of the notion of instrumental goods, regarded as
things the value of which is derived from that of their products, is indicated
in Appendix E, section 3.




2. This is at any rate true under all ordinary conditions: there will
be less extra charges for overtime; and the price of the labour of carpenters,
bricklayers and others is likely rather to go down than to go up, and the
same is true of brick and other building materials.




3. The broad account given in the text may suffice for most purposes;
and the general reader should perhaps omit the remaining footnotes to this
chapter.




It must be remembered that this Derived schedule has no validity except
on the suppositions that we are isolating this one factor for separate study;
that its own conditions of supply are disturbed; that there is at the time
no independent disturbance affecting any other element in the problem; and
that therefore in the case of each of the other factors of production the
selling price may be taken to coincide always with the supply price.




In illustrating this by a diagram, it will be well, for the sake of shortness
of wording, to divide the expenses of production of a commodity into the
supply prices of two things of which it is made; let us then regard the supply
price of a knife as the sum of the supply prices of its blade and handle,
and neglect the expense of putting the two together. Let ss' be the supply
curve for handles and SS' that for knives; so that M being any point on Ox,
and MqQ being drawn vertically to cut ss'. in q and SS' in Q, Mq is the supply
price for OM handles, qQ is the supply price for OM blades and MQ the supply
price for OM knives. Let DD' the demand curve for knives cut SS' in A, and
AaB be drawn vertically as in the figure. Then in equilibrium OB knives are
sold at a price BA of which Ba goes for the handle and aA for the blade.




(In this illustration we may suppose that sufficient time is allowed to
enable the forces which govern supply price to work themselves out fully;
and we are at liberty therefore to make our supply curves inclined negatively.
This change will not affect the argument; but on the whole it is best to
take our typical instance with the supply curve inclined positively.)




Now let us suppose that we want to isolate for separate study the demand
for knife handles. Accordingly we suppose that the demand for knives and
the supply of blades conform to the laws indicated by their respective curves:
also that the supply curve for handles still remains in force and represents
the circumstances of normal supply for handles, although the supply of handles
is temporarily disturbed. Let MQ cut DD' in P, then MP is the demand price
for OM knives and Qq is the supply price for OM blades. Take a point p in
MP such that Pp is equal to Qq, and therefore Mp is the excess of MP over
Qq; then Mp is the demand price for OM handles. Let dd' be the locus of p
obtained by giving M successive positions along Ox and finding the corresponding
positions of p; then dd' is the derived demand curve for handles. Of course
it passes through a. We may now neglect all the rest of the figure except
the curves dd', ss'; and regard them as representing the relations of demand
for and supply of handles, other things being equal, that is to say, in the
absence of any disturbing cause which affects the law of supply of blades
and the law of demand for knives. Ba is then the equilibrium price of handles,
about which the market price oscillates, in the manner investigated in the
preceding chapter, under the influence of demand and supply, of which the
schedules are represented by dd' and ss' It has already been remarked that
the ordinary demand and supply curves have no practical value except in the
immediate neighbourhood of the point of equilibrium. And the same remark
applies with even greater force to the equation of derived demand.




[Since Mp Mq = MP - MQ; therefore A being a point of stable equilibrium,
the equilibrium at a also is stable. But this statement needs to be somewhat
qualified if the supply curves are negatively inclined: see Appendix H.]




In the illustration that has just been worked out the unit of each of
the factors remains unchanged whatever be the amount of the commodity produced;
for one blade and one handle are always required for each knife; but when
a change in the amount of the commodity produced occasions a change in the
amount of each factor that is required for the production of a unit of the
commodity, the demand and supply curves for the factor got by the above process
are not expressed in terms of fixed units of the factor. They must be translated
back into fixed units before they are available for general use. (See Mathematical
Note XIV bis.)




4. We have to inquire under what conditions the ratio pM to aB will be
the greatest, pM being the demand price for the factor in question corresponding
to a supply reduced from OB to OM, that is reduced by the given amount BM.
The second condition is that PM should be large; and since the elasticity
of demand is measured by the ratio which BM bears to the excess of PM over
AB, the greater PM is, the smaller, other things being equal, is the elasticity
of demand.




5. The third condition is that when PM exceeds AB in a given ratio, pM
shall be caused to exceed Ba in a large ratio: and other things being equal,
that requires Ba to be but a small part of BA.




6. That is, if Qq had been smaller than it is, Pp would have been smaller
and Mp would have been larger. See also Mathematical Note XV .




7. It is shown in Böhm Bawerk's excellent Grundzüge der Theorie
des wirtschaftlichen Güterwerts (Jahrbuch für Natoonaiökonomie
und Statistik, vol. XIII, p. 59) that if all but one of the factors of production
of a commodity have available substitutes in unlimited supply, by which their
own price is rigidly fixed, the derived demand price for the remaining factor
will be the excess of the demand price for the finished product over the
sum of the supply prices thus fixed for the remaining factors. This is an
interesting special case of the law given in the text .




8. See Mathematical Note XVI.




9. See above, III, IV, sections 2, 4.




10. See III, v.




11. Thus, let a factor of production have three uses. Let d1d1' be the
demand curve for it in its first use. From N any point on Oy draw Np1 horizontally
to cut d1d1' in p1; then Np1 is the amount that is demanded for the first
use at price ON . Produce Np1 to p2, and further on to P making p1p2 and
p2P of such lengths as to represent the amounts of the factor demanded at
price ON for the second and third uses respectively. As N moves along Oy
let p2 trace out the curve d2d2' and let P trace out the curve DD'. Thus
d2d2' would be the demand curve for the factor if it had only its first and
second uses. DD' is its demand curve for all three uses. It is immaterial
in what order we take the several uses. In the case represented, the demand
for the second use begins at a lower price and that for the third use begins
at a higher price than does the demand for the first use. (See Mathematical
Note XVII.)




12. Professor Dewsnup (American Economic Review, Supplement 1914, p. 89)
suggests that things should be described as joint products, when their "total
costs of production by a single plant are less than the sum of the costs
of their production by separate plants." This definition is less general
than that reached at the end of this section; but it is convenient for some
special uses.




13. If it is desired to isolate the relations of demand and supply for
a joint product, the derived supply price is found in just the same way as
the derived demand price for a factor of production was found in the parallel
case of demand. Other things must be assumed to be equal (that is, the supply
schedule for the whole process of production must be assumed to remain in
force and so must the demand schedule for each of the joint products except
that to be isolated). The derived supply price is then found by the rule
that it must equal the excess of the supply price for the whole process of
production over the sum of the demand prices of all the other joint products;
the prices being taken throughout with reference to corresponding amounts.




We must again illustrate by a simple example in which it is assumed that
the relative amounts of the two joint products are unalterable. Let SS' be
the supply curve for bullocks which yield meat and leather in fixed quantities;
dd' the demand curve for their carcases, that is, for the meat derived from
them. M being any point on Ox draw Mp vertically to cut dd' in p, and produce
it to P so that pP represents the demand price for OM hides. Then MP is the
demand price for OM bullocks, and DD' the locus of P is the demand curve
for bullocks: it may be called the total demand curve. Let DD' cut SS' in
A; and draw AaB as in the figure. Then in equilibrium OB bullocks are produced
and sold at the price BA of which Ba goes for the carcase and aA for the
hide.




Let MP cut SS' in Q. From QM cut off Qq equal to Pp; then q is a point
on the derived supply curve for carcases. For if we assume that the selling
price of OM hides is always equal to the corresponding demand price Pp, it
follows that since it costs QM to produce each of OM bullocks there remains
a price QM Pp, that is qM, to be borne by each of the OM carcases. Then ss'
the locus of q, and yy' are the supply and demand curves for carcases. (See
Mathematical Note XVIII.)




14. See Mathematical Note XIX.




15. A little more is said on this subject in the next chapter: it is discussed
fully in the forthcoming work on Industry and Trade.




16. The latter phrase "competing commodities" is used by Prof.
Fisher in his brilliant Mathematical Investigations in the Theory of Value
and Prices, which throw much light on the subjects discussed in the present
chapter.




17. Comp. Jevons, l. c. pp. 145-6. See also above, footnotes on pp. 100,
105.




18. The want which all the rivals tend to satisfy is met by a composite
supply, the total supply at any price being the sum of the partial supplies
at that price.




Thus, for instance, N being any point on Oy draw Nq1q2Q parallel to Ox
such that Nq1' q1q2 and q2Q are respectively the amounts of the irst, second
and third of those rivals which can be supplied at the price ON. Then NQ
is the total composite supply at that price, and the locus of Q is the total
supply curve of the means of satisfying the want in question. Of course the
units of the several things which are rivals must be so taken that each of
them satisfies the same amount of the want. In the case represented in the
figure small quantities of the first rival can be put on the market at a
price too low to call forth any supply of the other two, and small quantities
of the second at a price too low to call forth any of the third. (See Mathematical
Note XX.)




Continued rivalry is as a rule possible only when none of the rivals has
its supply governed by the law of increasing return. The equilibrium is stable
only when none of them is able to drive the others out; and this is the case
when all of them conform to the law of diminishing return; because then if
one did obtain a temporary advantage and its use increased, its supply price
would rise, and then the others would begin to undersell it. But if one of
them conformed to the law of increasing return, the rivalry would soon cease;
for whenever it happened to gain a temporary advantage over its rivals its
increased use would lower its supply price and therefore increase its saleits
supply price would then be further lowered, and so on: thus its advantage
over its rivals would be continually increased until it had driven them out
of the field. It is true that there are apparent exceptions to this rule;
and things which conform to the law of increasing return do sometimes seem
to remain for a long time in the field as rivals: such is the case perhaps
with different kinds of sewing machines and of electric lights. But in these
cases the things do not really satisfy the same wants, they appeal to slightly
different needs or tastes; there is still some difference of opinion as to
their relative merits; or else perhaps some of them are patented or in some
other way have become the monopoly of particular firms. In such cases custom
and the force of advertising may keep many rivals in the field for a long
time; particularly if the producers of those things which are really the
best in proportion to their expenses of production are not able effectively
to advertise and push their wares by travellers and other agencies.




19. Toynbee (Industrial Revolution, p. 80).




20. Again, since sheep and oxen compete for the use of land, leather and
cloth compete in indirect demand for the use of a factor of production. But
also in the upholsterer's shop they compete as supplying means for meeting
the same want. There is thus a composite demand on the part of upholsterer
and shoemaker for leather. and also for cloth when the upper part of a shoe
is made of cloth: the shoe offers a joint demand for cloth and leather, they
offering complementary supplies: and so on, in endless complications. See
Mathematical Note XXI. The Austrian doctrine of "imputed value"
has something in common with that of derived value given in this chapter.
Whichever phrase be used, it is important that we should recognize the continuity
between the old doctrine of value and the new; and that we should treat imputed
or derived values merely as elements which take their place with many others
in the broad problem of distribution and exchange. The new phrases merely
give the means of applying to the ordinary affairs of life, some of that
precision of expression which is the special property of mathematical language.
Producers have alw.ays to consider how the demand for any raw material in
which they are interested is dependent on the demand for the things in making
which it is used, and how it is influenced by every change that affects them;
and this is really a special case of the problem of ascertaining the efficient
strength of any one of the forces, which contribute to a common result. In
mathematical language this common result is called a function of the various
forces: and the (marginal) contribution, which any of them is making to it,
is represented by the (small) change in the result which would result from
a (small) change in that force; that is by the differential coefficient of
the result with regard to that force. In other words, the imputed value,
or the derived value of a factor of production, if used for only one product,
is the differential coefficient of that product with regard to that factor;
and so on in successive complications, as indicated in Notes XIV-XXI of the
Mathematical Appendix. (Some objections to parts of Prof. Wieser's doctrine
of imputed values are well urged by Prof. Edgeworth, Economic Journal, Vol.
v, pp. 279-85.)




CHAPTER 7




PRIME AND TOTAL COST IN RELATION TO JOINT PRODUCTS.

COST OF MARKETING.

INSURANCE AGAINST RISK.

COST OF PRODUCTION




1. We may now return to the consideration of prime and supplementary costs,
with special reference to the proper distribution of the latter between the
joint products of a business.




It often happens that a thing made in one branch of a business is used
as a raw material in another, and then the question of the relative profitableness
of the two branches can be accurately ascertained only by an elaborate system
of book-keeping by double entry; though in practice it is more common to
rely on rough estimates made by an almost instinctive guess. Some of the
best illustrations of this difficulty are found in agriculture, especially
when the same farm combines permanent pasture and arable land worked on long
rotation.(1*)




Another difficult case is that of the shipowner who has to apportion the
expenses of his ship between heavy goods and goods that are bulky but not
heavy. He tries, as far as may be, to get a mixed cargo of both kinds; and
an important element in the struggle for existence of rival ports is the
disadvantage under which those ports lie which are able to offer a cargo
only of bulky or only of heavy goods: while a port whose chief exports are
weighty but not bulky, attracts to its neighbourhood industries which make
for export goods that can be shipped from it at low freights. The Staffordshire
Potteries, for example, owe part of their success to the low freights at
which their goods are carried by ships sailing from the Mersey with iron
and other heavy cargoes.




But there is free competition in the shipowning trade, and it has great
powers of variation as regards the size and shape of ships, the routes which
they take, and the whole method of trading; and thus in many ways the general
principle can be applied, that the relative proportions of the joint products
of a business should be so modified that the marginal expenses of production
of either product should be equal to its marginal demand price.(2*) Or, in
other words, the amount of carrying power for each kind of cargo has a constant
tendency to move towards equilibrium at a point at which the demand price
for that amount in a normal state of trade is just sufficient to cover the
expenses of providing it; these expenses being reckoned so as to include
not only its (money) prime cost, but also all those general expenses of the
business which are in the long run incurred on its account, whether directly
or indirectly.(3*)




In some branches of manufacture it is customary to make a first approximation
to the total cost of producing any class of goods, by assuming that their
share of the general expenses of the business is proportionate either to
their prime cost, or to the special labour bill that is incurred in making
them. Corrections can then be made to meet such cases as those of goods which
require either more or less than an average share of space or light, or of
the use of expensive machinery; and so on.




2. There are two elements of the general a business, the sharing of which
between the different requires some special attention. They are the expense
marketing and that of insurance against risk. Some kinds of goods are easily
marketed; there is steady demand for them, and it is always safe to make
them for stock. But for that very reason competition cuts their price "very
fine," and does not allow a large margin above the direct cost of making
them. Sometimes the tasks of making and selling them can be rendered almost
automatic, so as to require very little to be charged on their account under
the heads of the expenses of management and marketing. But in practice it
is not uncommon to charge such goods with even less than the small share
that would properly fall to them, and to use them as a means of obtaining
and maintaining a business connection, that will facilitate the marketing
of other classes of goods, the production of which cannot so well be reduced
to routine; for as to these there is not so close a competition. Manufacturers,
especially in trades connected with furniture and dress, and retailers in
almost all trades, frequently find it best to use certain of their goods
as a means of advertising others, and to charge the first with less and the
second with more than their proportionate share of supplementary expenses.
In the former class they put those goods which are so uniform in character
and so largely consumed that nearly all purchasers know their value well,
in the second those with regard to which purchasers think more of consulting
their fancy than of buying at the lowest possible price.




All difficulties of this kind are much increased by that instability of
supply price, which results whenever the tendency to increasing return is
acting strongly. We have seen that in seeking the normal supply price in
such cases we must select as representative a business which is managed with
normal ability and so as to get its fair share of the economies, both internal
and external, resulting from industrial organization: also that these economies,
though they fluctuate with the fortunes of particular businesses, yet increase
generally when the aggregate production increases. Now it is obvious that
if a manufacturer makes a commodity the increased production of which would
put largely increased internal economies within his reach, it is worth his
while to sacrifice a great deal in order to push its sales in a new market.
If he has a large capital, and the commodity is one in much demand, his expenditure
for this purpose may be very great, even exceeding that which he devotes
directly to the manufacture: and if, as is likely, he is pushing at the same
time several other commodities, nothing more than a very rough guess can
be made as to what share of this expenditure should be charged to the sales
of each of them in the current year, and what share should be charged to
the connection which he is endeavouring to build up for them in the future.




In fact when the production of a commodity conforms to the law of increasing
return in such a way as to give a very great advantage to large producers,
it is apt to fall almost entirely into the hands of a few large firms; and
then the normal marginal supply price cannot be isolated on the plan just
referred to, because that plan assumes the existence of a great many competitors
with businesses of all sizes, some of them being young and some old, some
in the ascending and some in the descending phase. The production of such
a commodity really partakes in a great measure of the nature of a monopoly;
and its price is likely to be so much influenced by the incidents of the
campaign between rival producers, each struggling for an extension of territory,
as scarcely to have a true normal level.




Economic progress is constantly offering new facilities for marketing
goods at a distance: it not only lowers cost of carriage, but what is often
more important, it enables producers and consumers in distant places to get
in touch with one another. In spite of this, the advantages of the producer
who lives on the spot are very great in many trades; they often enable him
to hold his own against competitors at a distance whose methods of production
are more economical. He can sell in his own neighbourhood as cheaply as they
can, because though the cost of making is greater for his goods than for
theirs, he escapes much of the cost which they incur for marketing. But time
is on the side of the more economic methods of production; his distant competitors
will gradually get a stronger footing in the place, unless he or some new
man adopts their improved methods.




It remains to make a closer study of the relation in which insurance against
the risks of a business stands to the supply price of any particular commodity
produced in it.




3. The manufacturer and the trader commonly insure against injury by fire
and loss at sea; and the premiums which they pay are among the general expenses,
a share of which has to be added to the prime cost in order to determine
the total cost of their goods. But no insurance can be effected against the
great majority of business risks.




Even as regards losses by fire and sea, insurance companies have to allow
for possible carelessness and fraud; and must therefore, independently of
all allowances for their own expenses and profits, charge premiums considerably
higher than the true equivalent of the risks run by the buildings or the
ships of those who manage their affairs well. The injury done by fire or
sea however is likely, if it occurs at all, to be so very great that it is
generally worth while to pay this extra charge; partly for special trade
reasons, but chiefly because the total utility of increasing wealth increases
less than in proportion to its amount. But the greater part of business risks
are so inseparably connected with the general management of the business
that an insurance company which undertook them would really make itself responsible
for the business: and in consequence every firm has to act as its own insurance
office with regard to them. The charges to which it is put under this head
are part of its general expenses, and a share of them has to be added to
the prime cost of each of its products.




But here there are two difficulties. In some cases insurance against risk
is apt to be left out of account altogether, in others it is apt to be counted
twice over. Thus a large shipowner sometimes declines to insure his ships
with the underwriters: and sets aside part at least of the premiums that
he might have paid to them, to build up an insurance fund of his own. But
he must still, when calculating the total cost of working a ship, add to
its prime cost a charge on account of insurance. And he must do the same
thing, in some form or other, with regard to those risks against which he
could not buy an insurance policy on reasonable terms even if he wanted to.
At times, for instance, some of his ships will be idle in port, or will earn
only nominal freights: and to make his business remunerative in the long
run he must, in some form or other, charge his successful voyages with an
insurance premium to make up for his losses on those which are unsuccessful.




In general, however, he does this, not by making a formal entry in his
accounts under a separate head, but by the simple plan of taking the average
of successful and unsuccessful voyages together; and when that has once been
done, insurance against these risks cannot be entered as a separate item
in cost of production, without counting the same thing twice over. Having
decided to run these risks himself, he is likely to spend a little more than
the average of his competitors, in providing against their occurrence; and
this extra expense enters in the ordinary way into his balance-sheet. It
is really an insurance premium in another form; and therefore he must not
count insurance against this part of the risk separately, for then he would
be counting it twice over.(4*)




When a manufacturer has taken the average of his sales of dress materials
over a long time, and bases his future action on the results of his past
experience, he has already allowed for the risk that the machinery will be
depreciated by new inventions rendering it nearly obsolete, and for the risk
that his goods will be depreciated by changes in fashion. If he were to allow
separately for insurance against these risks, he would be counting the same
thin twice over.(5*)




4. Thus, though when we have counted up the average receipts of a risky
trade, we must not make a separate full allowance for insurance against risk;
though there may be something to be allowed as a charge on account of uncertainty.
It is true that an adventurous occupation, such as gold mining, has special
attractions for some people: the deterrent force of risks of loss in it is
less than the attractive force of chances of great gain, even when the value
of the latter estimated on the actuarial principle is much less than that
of the former; and as Adam Smith pointed out, a risky trade, in which there
is an element of romance, often becomes so overcrowded that the average earnings
in it are lower than if there were no risks to be run.(6*) But in the large
majority of cases the influence of risk is in the opposite direction; a railway
stock that is certain to pay four per cent. will sell for a higher price
than one which is equally likely to pay one or seven per cent. or any intermediate
amount.




Every trade then has its own peculiarities, but in most cases the evils
of uncertainty count for something, though not very much: in some cases a
slightly higher average price is required to induce a given outlay, if that
average is the mean of widely divergent and uncertain results, than if the
adventurer may reckon confidently on a return that differs but little from
that average. To the average price therefore we must add a recompense for
uncertainty, if that is unusually great; though if we added insurance against
risk we should be counting the greater part of that twice over.(7*)




5. This discussion of the risks of trade has again brought before us the
fact that the value of a thing, though it tends to equal its normal (money)
cost of production, does not coincide with it at any particular time, save
by accident. Carey, observing this, suggested that we should speak of value
in relation to (money) cost of reproduction instead of in relation to cost
of production.




The suggestion has, however, no significance so far as normal values are
concerned. For normal cost of production and normal cost of reproduction
are convertible terms; and no real change is made by saying that the normal
value of a thing tends to equal its normal (money) cost of reproduction instead
of its normal (money) cost of production. The former phrase is less simple
than the latter, but means the same thing.




And no valid argument for the change can be founded on the fact, which
may be readily admitted, that there are some few cases in which the market
value of a thing is nearer its cost of reproduction than the cost that was
actually incurred in producing that particular thing. The present price of
an iron ship for instance, made before the great recent improvements in the
manufacture of iron, might diverge less from the cost of reproducing it,
that is of producing another just like it by modern methods, than from that
which was actually incurred in producing it. But the price of the old ship
would be less than the cost of reproduction of the ship, because the art
of designing ships has improved as fast as that of manufacturing iron; and
moreover steel has displaced iron as the material of shipbuilding. It may
still be urged that the price of the ship is equal to that of producing a
ship, which would be equally serviceable, on a modern plan and by modern
methods. But that would not be the same thing as saying that the value of
the ship is equal to its cost of reproduction; and, as a matter of fact,
when, as often happens, an unexpected scarcity of ships causes freights to
increase very rapidly, those who are anxious to reap the harvest of profitable
trade, will pay for a ship in sailing order a price much above that for which
a shipbuilding firm would contract to produce another equally good and deliver
it some time hence. Cost of reproduction influence on value, save when purchasers
can wait for the production of new supplies.




Again, there is no connection between cost of reproduction and price in
the cases of food in a beleaguered city, of quinine the supply of which has
run short in a fever-stricken island, of a picture by Raphael, of a book
that nobody cares to read, of an armour-clad ship of obsolete pattern, of
fish when the market is glutted, of fish when the market is nearly empty,
of a cracked bell, of a dress material that has gone out of fashion, or of
a house in a deserted mining village.




 ####




The reader, unless already experienced in economic analysis, is recommended
to omit the next seven chapters, and pass at once to Chapter XV, which contains
a brief summary of this Book. It is true that the four chapters on marginal
costs in relation to values, and especially Chapters VIII and IX, bear upon
some difficulties which are latent in the phrase "the net product of
labour"; and that this phrase is used in Book VI. But the broad explanation
of it given there will suffice provisionally for most purposes; and the intricacies
connected with it may be best appreciated at a somewhat advanced stage of
economic studies.




NOTES:




1. There is scope for applications of mathematical or semi-mathematical
analyses, such as are indicated in the last chapter, to some of the chief
practical difficulties of book-keeping by double entry in different trades.




2. Compare VI, section 4.




3. Of course this does not apply to railway rates. For a railway company
having little elasticity as to its methods of working, and often not much
competition from outside, has no inducement to endeavour to adjust the charges
which it makes for different kinds of traffic to their cost to itself. In
fact though it may ascertain the prime cost in each case easily enough, it
cannot determine accUrately what are the relative total costs of fast and
slow traffic, of short and long distance traffic, of light and heavy traffic;
nor again of extra traffic when its lines and its trains are crowded and
when they are nearly empty.




4. Again, certain insurance companies in America take risks against fire
in factories at very much less than the ordinary rates, on condition that
some prescribed precautions are taken, such as providing automatic sprinklers
and making the walls and floor solid. The expense incurred in these arrangements
is really an insurance premium; and care must be taken not to count it twice
over. A factory which undertakes its own risks against fire will have to
add to the prime cost of its goods an allowance for insurance at a lower
rate, if it is arranged on this plan, than if built in the ordinary way.




5. Again, when a farmer has calculated the expenses of raising any particular
crop with reference to an average year, he must not count in addition insurance
against the risk that the season may be bad, and the crop a failure: for
in taking an average year, he has already set of the chances of exceptionally
good and bad seasons against one another. When the earnings of a ferryman
have been calculated on the average of a year, allowance has already been
made for the risk that he may sometimes have to cross the stream with an
empty boat.




6. Wealth of Nations, Book I, ch. x.




7. The evils resulting from the uncertainty involved in great business
risks are well shown by von Thünen (Der isolierte Staat, II, I, p. 82).




CHAPTER 8




MARGINAL COSTS IN RELATION TO VALUES. GENERAL PRINCIPLES




1. This Chapter and the three following are given to a study of the marginal
costs of products in relation to the values of those products on the one
hand, and on the other hand to the values of the land, machinery, and other
appliances used in making them. The study relates to normal conditions and
long period results. This fact must ever be borne in mind. The market value
of anything may be much above or much below the normal cost of production
and the marginal costs of a particular producer at any time may stand in
no close relation to marginal costs under normal conditions.(1*)




It was indicated at the end of Chapter VI that no one part of the problem
can be isolated from the rest. There are comparatively few things the demand
for which is not greatly affected by the demand for other things to the usefulness
of which they contribute; and it may even be said that the demand for the
majority of articles of commerce is not direct but is derived from the demand
for those commodities to the making of which they contribute, as materials
or as implements. And again this demand, because it is so derived, is largely
dependent on the supply of other things which will work with them in making
those commodities. And again the supply of anything available for use in
making any commodity is apt to be greatly influenced by the demand for that
thing derived from its uses in making other commodities: and so on. These
inter-relations can be and must be ignored in rapid and popular discussions
on the business affairs of the world. But no study that makes any claim to
thoroughness can escape from a close investigation of them. This requires
many things to be borne in mind at the same time: and for that reason economics
can never become a simple science.(2*)




The contribution which this group of chapters aims at making covers little
ground: but that ground is difficult and we shall need to work over it carefully,
and from more than one point of view; for it is thickly strewn with pitfalls
and stumbling blocks. It deals primarily with the earnings of land, machinery,
and other material agents of production. Its main argument applies to the
earnings of human beings; but they are influenced by some causes which do
not Affect the earnings of material agents of production: and the matter
in hand is sufficiently difficult without further complicating it by side
issues.




2. Let us begin by recalling the action of the principle of substitution.
In the modern world nearly all the means of production pass through the hands
of employers and other business men, who specialize themselves in organizing
the economic forces of the population. Each of them chooses in every case
those factors of production which seem best for his purpose. And the sum
of the prices which he pays for those factors which he uses is, as a rule,
less than the sum of the prices which he would have to pay for any other
set of factors which could be substituted for them: for, whenever it appears
that this is not the case, he will, as a rule, set to work to substitute
the less expensive arrangement or process.(3*)




This statement is in close harmony with such common sayings of every-day
life, as that "everything tends to find its own level," that "most
men earn just about what they are worth," that "if one man can
earn twice as much as another, that shows that his work is worth twice as
much," that "machinery will displace manual labour whenever it
can do the work cheaper." The principle does not indeed without hindrance.
It may be restricted by custom or act law, by professional etiquette or trade-union
regulation: it may be weakened by want of enterprise, or it may be softened
by a generous unwillingness to part with old associates. But it never ceases
to act, and it permeates all the economic adjustments of the modern world.




Thus there are some kinds of field work for which horsePower is clearly
more suitable than steam-power, and vice versa. If we may now suppose that
there have been no great recent improvements in horse or steam machinery,
and that therefore the experience of the past has enabled farmers gradually
to apply the law of substitution; then, on this supposition the application
of steam-power will have been pushed just so far that any further use of
it in the place of horse-power would bring no net advantage. There will however
remain a margin on which they could be indifferently applied (as Jevons would
have said); and on that margin the net efficiency of either in adding to
the money value of the total product will be proportionate to the cost of
applying it.(4*)




Similarly, if there are two methods of obtaining the same result, one
by skilled and the other by unskilled labour, that one will be adopted which
is the more efficient in proportion to its cost. There will be a margin on
which either will be indifferently applied.(5*) On that line the efficiency
of each will be in proportion to the price paid for it, account being taken
of the special circumstances of different districts and of different workshops
in the same district. In other words, the wages of skilled and unskilled
labour will bear to one another the same ratio that their efficiencies do
at the margin of indifference.




Again, there will be a rivalry between hand-power and machine-power similar
to that between two different kinds of hand-power or two different kinds
of machine-power. Thus hand-power has the advantage for some operations,
as, for instance, for weeding out valuable crops that have an irregular growth;
horse-power in its turn has a cleat advantage for weeding an ordinary turnip
field; and the application of each of them will be pushed in each district
till any further use of it would bring no net advantage there. On the margin
of indifference between hand-power and horse-power their prices must be proportionate
to their efficiency; and thus the influence of substitution will tend to
establish a direct relation between the wages of labour and the price that
has to be paid for horse-power.




3. As a rule many kinds of labour, of raw material, of machinery and other
plant, and of business organization, both internal and external, go to the
production of a commodity: and the advantages of economic freedom are never
more strikingly manifest than when a business man endowed with genius is
trying experiments, at his own risk, to see whether some new method, or combination
of old methods, will be more efficient than the old. Every business man indeed,
according to his energy and ability, is constantly endeavouring to obtain
a notion of the relative efficiency of every agent of production that he
employs; as well as of others that might possibly be substituted for some
of them. He estimates as best he can how much net product (i.e. net addition
to the value of his total product) will be caused by a certain extra use
of any one agent; net that is after deducting for any extra expenses that
may be indirectly caused by the change, and adding for any incidental savings.
He endeavours to employ each agent up to that margin at which its net product
would no longer exceed the price he would have to pay for it. He works generally
by trained instinct rather than formal calculation; but his processes are
substantially similar to those indicated in our study of derived demand;
and, from another point of view, they may be described as those which might
be reaped by a complex and refined system of book-keeping by double entry.(6*)




We have already followed some simple estimates of this sort. We have noticed,
for instance, how the proportion of hops and malt in ale can be varied, how
the extra price which can be got for ale by increasing the quantity of hops
in it is a representative of the causes which govern the demand price for
hops. Assuming that no further trouble or expense of any kind is involved
by this additional use of hops, and that the expediency of using this extra
amount is doubtful, the extra value thus given to the ale is the marginal
net product of the hops of which we are in search. In this case, as in most
others, the net product is an improvement in quality or a general contribution
to the value of the product; it is not a definite part of the produce which
can be separated from the rest. But in exceptional instances that can be
done.(7*)




4. The notion of the marginal employment of any agent of production implies
a possible tendency to diminishing return from its increased employment.




Excessive applications of any means to the attainment of any end are indeed
sure to yield diminishing. returns in every branch of business; and, one
may say, in all the affairs of life. We may take some additional examples
of a principle that has already been illustrated.(8*) In the manufacture
of sewing machines some parts may well be made of cast iron; for others a
common kind of steel will suffice; there are yet others for which a specially
expensive steel-compound is needed; and all parts should be finished off
more or less smoothly, so that the machine may work easily. Now if any one
devoted a disproportionate care and expense to th selection of materials
for the less important uses, it might truly be said that that expenditure
was yielding a rapidly diminishing return; and that he would have done better
to give some of it to making his machines work smoothly, or even to producing
more machines: and the case might be even worse if he devoted an excessive
expenditure to mere brilliancy of finish, and put low grade metal to work
for which a higher grade was needed.




This consideration seems at first to simplify economic problems; but on
the contrary it is a chief source of difficulty and confusion. For though
there is some analogy between all these various tendencies to diminishing
return, they yet are not identical. Thus the diminishing return which arises
from an ill-proportioned application of the various agents of production
into a particular task has little in common with that broad tendency to the
pressure of a crowded and growing population on the means of subsistence.
The great classical Law of Diminishing Return has its chief application,
not to any one particular crop, but to all the chief food crops. It takes
for granted that farmers raise, as a rule, those crops for which their land
and other resources are best adapted, account being taken of the relative
demands for the several crops; and that they distribute their resources appropriately
between different routes. It does not attribute to them unlimited intelligence
and wisdom, but it assumes that, taking one with another, they have shown
a reasonable amount of care and discretion in the distribution of these resources.
It refers to a country the whole land of which is already in the hands of
active business men, who can supplement their own capital by loans from banks
wherever they can show it is likely to be well applied; and asserts that
an increase in the total amount of capital applied to agriculture in that
country will yield diminishing returns of produce in general. This statement
is akin to, but yet quite distinct from, the statement that if any farmer
makes a bad distribution of his resources between different plans of cultivation,
he will get a markedly diminishing return from those elements of expenditure
which he has driven to excess.




For instance, in any given case, there is a certain proportion between
the amounts which may with best advantage be spent on ploughing and harrowing,
or manuring. There might be some differences of opinion on the matter, but
only within narrow limits. An inexperienced person who ploughed many times
over land, which was already in fairly good mechanical condition, while he
gave it little or none of the manure which it was craving, would be generally
condemned as having so over applied ploughing as to make it yield a rapidly
diminishing return. But this result of the misapplication of resources has
no very close connection with the tendency of agriculture in an old country
to yield a diminishing return to a general increase of resources well applied
in cultivation: and indeed exactly parallel cases can be found of a diminishing
return to particular resources when applied in undue proportion, even in
industries which yield an increasing return to increased applications of
capital and labour when appropriately distributed.(9*)




5. The part played by the net product at of production in the modern doctrine
of Distribution is to be misunderstood. In particular many able writers have
supposed that it represents the marginal use of a thing as governing the
value of the whole. It is not so; the doctrine says we must go to the margin
to study the action of those forces which govern the value of the whole:
and that is a very different affair. Of course the withdrawal of (say) iron
from any of its necessary uses would have just the same influence on its
value as its withdrawal from its marginal uses; in the same way as the pressure
in a boiler for cooking under high pressure would be affected by the escape
of any other steam just as it would by the escape of the steam in one of
the safety valves: but in fact the steam does not escape except through the
safety valves. In like manner iron, or any other agent of production, is
not (under ordinary circumstances) thrown out of use except at points at
which its use yields no clear surplus of profit; that is, it is thrown out
from its marginal uses only.




Again, the finger of an automatic weighing machine determines, in the
sense of indicating, the weight sought for. So the escape of steam from a
safety valve, governed by a spring representing a pressure of a hundred pounds
to the square inch, determines the pressure of steam in the boiler, in the
sense of indicating that it has reached a hundred pounds to the inch. The
pressure is caused by the heat; the spring in the valve governs the pressure
by yielding and letting out some of the steam when its amount is so great,
at the existing heat, as to overbear the resistance of the spring.




Similarly, with regard to machinery and other appliances of production
made by man, there is a margin through which additional supplies come in
after overcoming the resistance of a spring, called "cost of production,"
For when the supply of those appliances is so small relatively to the demand
that the earnings expected from new supplies are more than sufficient to
yield normal interest (or profits, if earnings of management are reckoned
in) on their cost of production, besides allowing for depreciation, etc.,
then the valve opens, and the new supplies come in. When the earnings are
less than this, the valve remains shut: and as anyhow the existing supply
is always in process of slow destruction by use and the lapse of time, the
supply is always shrinking when the valve is closed. The valve is that part
of the machinery by which the general relations of demand and supply govern
value. But marginal uses do not govern value; because they, together with
value, are themselves governed by those general relations.




6. Thus, so long as the resources of an individual producer are in the
form of general purchasing power, he will push every investment up to the
margin at which he no longer expects from it a higher net return than he
could get by investing in some other material, or machine, or advertisement,
or in the hire of some additional labour every investment will, as it were,
be driven up to a valve which offers to it a resistance equal to its own
expanding force. If he invests in material or in labour, that is soon embodied
in some saleable product: the sale replenishes his fluid capital, and that
again is invested up to the margin at which any further investment would
yield a return so diminished as not to be profitable.




But if he invests in land, or in a durable building or machine, the return
which he gets from his investment may vary widely from his expectation. It
will be governed by the market for his products, which may change its character
largely through new inventions, changes in fashion, etc., during the life
of a machine, to say nothing of the perpetual life of land. The incomes which
he thus may derive from investments in land and in machinery differ from
his individual point of view mainly in the longer life of the land. But in
regard to production in general, a dominant difference between the two lies
in the fact that the supply of land is fixed (though in a new country, the
supply of land utilized in man's service may be increased); while the supply
of machines may be increased without limit. And this difference reacts on
the individual producer. For if no great new invention renders his machines
obsolete, while there is a steady demand for the things made by them, they
will be constantly on sale at about their cost of production; and his machines
will generally yield him normal profits on that cost of production, with
deductions corresponding to their wear and tear.




Thus the rate of interest is a ratio: and the two things which it connects
are both sums of money. So long as capital is "free," and the sum
of money or general purchasing power over which it gives command is known,
the net money income, expected to be derived from it, can be represented
at once as bearing a given ratio (four or five or ten per cent) to that sum.
But when the free capital has been invested in a particular thing, its money
value cannot as a rule be ascertained except by capitalizing the net income
which it will yield: and therefore the causes which govern it are likely
to be akin in a greater or less degree to those which govern rents.




We are thus brought to the central doctrine of this part of economics,
viz.: -- "That which is rightly regarded as interest on 'free' or 'floating'
capital, or on new investments of capital, is more properly treated as a
sort of rent -- a Quasi-rent -- On old investments of capital. And there
is no sharp line of division between floating capital and that which has
been 'sunk' for a special branch of production, nor between new and old investments
of capital; each group shades into the other gradually. And thus even the
rent of land is seen, not as a thing by itself, but as the leading species
of a large genus; though indeed it has peculiarities of its own which are
of vital importance from the point of view of theory as well as of practice."(10*)




NOTES:




1. Numerous objections have been urged against the important place assigned
to marginal costs in modern analysis. But it will be found that most of them
rely on arguments, in which statements referring to normal conditions and
normal value are controverted by statements relating to abnormal or particular
conditions.




2. The reader is referred to the footnote on p. 393 with special reference
to the compressed mathematical version of the central problem of value which
begins in Note XIV in the Mathematical Appendix and culminates in Note XXI.




3. Compare V, III, section 3; and V, IV, sections 3, 4; and Note XIV in
the Mathematical Appendix.




4. This margin will vary with local circumstances, as well as with the
habits, inclinations, and resources of individual farmers. The difficulty
of applying steam machinery in small fields and on rugged ground is overcome
more generally in those districts in which labour is scarce than in those
in which it is plentiful; especially if, as is probable, coal is cheaper,
and the feed of horses dearer in the former than the latter.




5. Skilled manual labour being generally used for special orders and for
things of which not many are required of the same pattern; and unskilled
labour aided by specialized machinery being used for others. The two methods
are to be seen side by side on similar work in every large workshop: but
the position of the line between them will vary a little from one workshop
to another.




6. The changes, which he desires, may be such as could only be made on
a large scale; as for instance the substitution of steam-power for hand-power
in a certain factory; and in that case there would be a certain element of
uncertainty and risk in the change. Such breaches of continuity are however
inevitable both in production and consumption if we regard the action of
single individuals. But as there is a continuous demand in a large market
for hats and watches and wedding cakes, though no individual buys many of
them (see III, III, section 5), so there will always be trades in which small
businesses are most economically conducted without steam power, and larger
businesses with; while businesses of intermediate size are on the margin.
Again, even in large establishments in which steam is already in use, there
will always be some things done by hand-power which are done by steam power
elsewhere; and so on .




7. See p. 387, and Mathematical Note XVI. See also other illustrations
in, VI, VII. A further illustration of the relation between the wages of
the marginal shepherd, and the net product of his labour will be worked out
in detail in VI, I, section 7 .




8. See V, IV, section 4; see also the note on von Thünen, below,
p. 523.




9. See above IV, iii, section 8; and Carver, Distribution of Wealth, ch.
ii, and above footnotes on pp. 319, 320. Mr J. A. Hobson is a vigorous and
suggestive writer on the realistic and social sides of economics: but, as
a critic of Ricardian doctrines, he is perhaps apt to underrate the difficulty
of the problems which he discusses. He argues that if the marginal application
of any agent of production be curtailed, that will so disorganize production
that every other agent will be working to less effect than before; and that
therefore the total resulting loss will include not only the true marginal
product of that agent, but also a part of the products due to the other agents:
but he appears to have overlooked the following points: -- (1) There are
forces constantly at work tending so to readjust the distribution of resources
between their different uses, that any maladjustment will be arrested before
it has gone far: and the argument does not profess to apply to exceptional
cases of violent maladjustment. (2) When the adjustment is such as to give
the best results, a slight change in the proportions in which they are applied
diminishes the efficiency of that adjustment by a quantity which is very
small relatively to that change in technical language it is of "the
second order of smalls" --; and it may therefore be neglected relatively
to that change. (In pure mathematical phrase, efficiency being regarded as
a function of the proportions of the agents; when the efficiency is at its
maximum, its differential coefficient with regard to any one of these proportions
is zero.) A grave error would therefore have been involved, if any allowance
had been made for those elements which Mr Hobson asserts to have been overlooked.
(3) In economics, as in physics, changes are generally continuous. Convulsive
changes may indeed occur, but they must be dealt with separately: and an
illustration drawn from a convulsive change can throw no true light on the
processes of normal steady evolution. In the particular problem before us,
this precaution is of special importance: for a violent check to the supply
of any one agent of production, may easily render the work of all other agents
practically useless; and therefore it may inflict a loss out of all proportion
to the harm done by a small check to the supply of that agent when applied
up to that margin, at which there was doubt whether the extra net product
due to a small additional application of it would be remunerative. The study
of changes in complex quantitative relations is often vitiated by a neglect
of this consideration, to which Mr Hobson seems to be prone; as indeed is
instanced by his remarks on a "marginal shepherd" in The Industrial
System, p. i 10. See Professor Edgeworth's masterly analyses of the two instances
mentioned in this note, Quarterly Journal of Economics, 1904, p. 167; and
Scientia, 1910, pp. 95-100.




10. This statement is reproduced from the Preface to the first edition
of the present volume.




CHAPTER 9




MARGINAL COSTS IN RELATION TO VALUES.

GENERAL PRINCIPLES, CONTINUED




1. The incidents of the tenure of land are so complex: and so many practical
issues connected with them have raised controversies on side issues of the
problem of value, that it will be well to supplement our previous illustration
from land. We may take another from an imaginary commodity so chosen that
sharp outlines can be assigned to each stage of the problem, without inviting
the objection that such sharp outlines are not found in the actual relations
between landlord and tenant.




But before entering on this, we may prepare the way for using, as we go,
illustrations drawn from the incidence of taxation to throw side-lights on
the problem of value. For indeed a great part of economic science is occupied
with the diffusion throughout the community of economic changes which primarily
affect some particular branch of production or consumption; and there is
scarcely any economic principle which cannot be aptly illustrated by a discussion
of the shifting of the effects of some tax "forwards," i.e. towards
the ultimate consumer, and away from the producer of raw material and implements
of production; or else in the opposite direction, "backwards."
But especially is this true of the class of problems now under discussion.(1*)




It is a general principle that if a tax impinges on anything used by one
set of persons in the production of goods or services to be disposed of to
other persons, the tax tends to check production. This tends to shift a large
part of the burden of the tax forwards on to consumers, and a small part
backwards on to those who supply the requirements of this set of producers.
Similarly, a tax on the consumption of anything is shifted in a greater or
less degree backwards on to its producer.




For instance, an unexpected and heavy tax upon printing would strike hard
upon those engaged in the trade, for if they attempted to raise prices much,
demand would fall off quickly: but the blow would bear unevenly on various
classes engaged in the trade. Since printing machines and compositors cannot
easily find employment out of the trade, the prices of printing machines
and wages of compositors would be kept low for some time. On the other hand,
the buildings and steam engines, the porters, engineers, and clerks would
not wait for their numbers to be adjusted by the slow process of natural
decay to the diminished demand; some of them would be quickly at work in
other trades, and very little of the burden would stay long on those of them
who remained in the trade. A considerable part of the burden, again, would
fall on subsidiary industries, such as those engaged in making paper and
type; because the market for their products would be curtailed. Authors and
publishers would also suffer a little; because they would be forced either
to raise the price of books, with a consequent diminution of sales, or to
see a greater proportion of their gross receipts swallowed up by costs. Finally,
the total turnover of the booksellers would diminish, and they would suffer
a little.




So far it has been assumed that the tax spreads its net very wide, and
covers every place to which the printing industry in question could be easily
transferred. But, if the tax were only local, the compositors would migrate
beyond its reach; and the owners of printing houses might bear a larger and
not a smaller proportionate share of the burden than those whose resources
were more specialized but more mobile. If the local tax were uncompensated
by any effect which tended to attract population, part of the burden would
be thrown on local bakers, grocers, etc., whose sales would be diminished.




Next suppose the tax to be levied on printing presses instead of on printed
matter. In that case, if the printers had no semi-obsolete presses which
they were inclined to destroy or to leave idle, the tax would not strike
marginal production: it would not immediately affect the output of printing,
nor therefore its price. It would merely intercept some of the earnings of
the presses on the way to the owners, and lower the quasi-rents of the presses.
But it would not affect the rate of net profits which was needed to induce
people to invest fluid capital in presses: and therefore, as the old presses
wore out, the tax would add to marginal expenses, that is to expenses which
the producer was free to incur or not as he liked, and which he was in doubt
whether to incur. Therefore the supply of printing would be curtailed; its
price would rise: and new presses would be introduced only up to the margin
at which they would be able, in the judgment of printers generally, to pay
the tax and yet yield normal profits on the outlay. When this stage had been
reached the distribution of the burden of a tax upon presses would henceforth
be nearly the same as that of a tax upon printing: excepting only that there
would be more inducement to get a great deal of work out of each press. For
instance more of the presses might be made to work double shifts; in spite
of the fact that night work involves special expenses.




We now pass to apply these principles of shifting of taxes to our main
illustration.




2. Let us suppose that a meteoric shower of a few thousand large stones
harder than diamonds fell all in one place; so that they were all picked
up at once, and no amount of search could find any more. These stones, able
to cut every material, would revolutionize many branches of industry; and
the owners of them would have a differential advantage in production, that
would afford a large producer's surplus. This surplus would be governed wholly
by the urgency and volume of the demand for their services on the one hand
and the number of the stones on the other hand: it could not be affected
by the cost of obtaining a further supply, because none could be had at any
price. A cost of production might indeed influence their value indirectly:
but it would be the cost of tools made of hard steel and other materials
of which the supply can be increased to keep pace with demand. So long as
any of the stones were habitually used by intelligent producers for work
which could be done equally well by such tools, the value of a stone could
not much exceed the cost of producing tools (allowance being made for wear
and tear) equally efficient with it in these inferior uses.




The stones, being so hard as not to be affected by wear, would probably
be kept in operation during all the working hours of the day. And if their
services were very valuable, it might be worth while to keep people working
overtime, or even in double or triple shifts, in order to extract the utmost
service from them. But the more intensively they were applied, the less net
return would be reaped from each additional service forced from them; thus
illustrating the law that the intensive working not only of land, but of
every other appliance of production is likely to yield a diminishing return
if pressed far enough.




The total supply of stones is fixed. But of course any particular manufacturer
might obtain almost as many as he liked to pay for: and in the long run he
would expect his outlay on them to be returned with interest (or profits,
if the remuneration for his own work were not reckoned separately), just
in the same way as if he were buying machinery, the total stock of which
could be increased indefinitely, so that its price conformed pretty closely
to its cost of production.




But when he had once bought the stones, changes in the processes of production
or of demand for the things made by their aid, might cause the income yielded
by them to become twice as great or only half as great as he had expected.
In the latter case it would resemble the income derived from a machine, which
had not the latest improvements and could earn only half as much as a new
machine of equal cost. The values of the stone and of the machine alike would
be reached by capitalizing the income which they were capable of earning,
and that income would be governed by the net value of the services rendered
by them. The income earning power and therefore the value of each would be
independent of its own costs of production, but would be governed by the
general demand for its products in relation to the general supply of those
products. But in the case of the machine that supply would be controlled
by the cost of supply of new machines equally efficient with it; and in the
case of the stone there would be no such limit, so long as all the stones
in existence were employed on work that could not be done by anything else.




This argument may be put in another way. Since any one, who bought stones,
would take them from other producers, his purchase would not materially affect
the general relations of demand for the services of the stones to the supply
of those services. It would not therefore affect the price of the stones;
which would still be the capitalized value of the services which they rendered
in those uses, in which the need for them was the least urgent: and to say
that the purchaser expected normal interest on the price which represented
the capitalized value of the services, would be a circular statement that
the value of the services rendered by stones is governed by the value of
those very services.(2*)




Next let us suppose that the stones were not all found at once but were
scattered over the surface of the earth on public ground, and that a laborious
search might expect to be rewarded by finding one here and there. Then people
would hunt for the stones only up to that point, or margin, at which the
probable gain of so doing would in the long run just reward the outlay of
labour and capital involved; and in the long run, the normal value of the
stones would be such as to maintain equilibrium between demand and supply,
the number of the stones gathered annually being in the long run just that
for which the normal demand price was equal to the normal supply price.




Finally, let us bring the case of the stones into accord with that of
the lighter machinery and other plant ordinarily used in manufacture, by
supposing that the stones were brittle, and were soon destroyed; and that
an inexhaustible store existed from which additional supplies could be obtained
quickly and certainly at a nearly uniform cost. In this case the value of
the stones would always correspond closely to that cost: variations in demand
would have but little influence on their price, because even a slight change
in price would quickly effect a great change in the stock of them in the
market. In this case the income derived from a stone (allowance being made
for wear-and-tear) would always adhere closely to interest on its cost of
production.




3. This series of hypotheses stretches continuously from the one extreme
in which the income derived from the stones is a rent in the strictest sense
of the term, to the other extreme in which it is to be classed rather with
interest on free or floating capital. In the first extreme case the stones
cannot be worn out or destroyed, and no more can be found. They of course
tend to be distributed among the various uses to which they are applicable
in such a way that there is no use to which an increased supply of them could
be applied, without taking them away from some other use in which they were
rendering net services at least as valuable. These margins of application
of the several uses are thus governed by the relation in which the fixed
stock of stones stands to the aggregate of demands for them in different
uses. And the margins being thus governed, the prices that will be paid for
their use are indicated by the value of the services which they render at
any one of those margins.




A uniform tax on them, collected from the user, will lower their net service
in each use by the same amount: it will not affect their distribution between
several uses; and it will fall wholly on the owner, after perhaps some little
delay caused by a frictional resistance to readjustments.




At the opposite extreme of our chain of hypotheses, the stones perish
so quickly, and are so quickly reproduced at about a uniform cost, that variations
in the urgency and volume of the uses to which the stones can be put will
be followed so promptly by changes in the stock of them available, that those
services can never yield much more or much less than normal interest on the
money cost of obtaining additional stones. In this case a business man, when
making his estimates for the cost of any undertaking in which stones will
be used, may enter interest (or if he is counting his own work in, profits),
for the time during which those stones will be used (together with wear-and-tear),
as part of the prime, special, or direct expenses of his undertaking. A tax
on the stones under these conditions would fall entirely on any one who even
a little while after the tax had come into force, gave out a contract for
anything in making which the stones would be used.




Taking an intermediate hypothesis as to the length of life of the stones
and the rapidity with which new supplies could be obtained; we find that
the charges which the borrower of stones must expect to pay, and the revenue
which the owner of the stones could reckon on deriving from them at any time,
might temporarily diverge some way from interest (or profits) on their cost.
For changes in the urgency and volume of the uses to which they could be
applied, might have caused the value of the services rendered by them in
their marginal uses to rise or fall a great deal, even though there had been
no considerable change in the difficulty of obtaining them. And if this rise
or fall, arising from variations in demand, and not from variations in the
cost of the stones, is likely to be great during the period of any particular
enterprise, or any particular problem of value that is under discussion;
then for that discussion the income yielded by the stones is to be regarded
as more nearly akin to a rent than to interest on the cost of producing the
stones. A tax upon the stones in such a case would tend to diminish the rental
which people would pay for their use, and therefore to diminish the inducements
towards investing capital and effort in obtaining additional supplies. It
would therefore check the supply, and compel those who needed the stones
to pay gradually increasing rentals for their use, up to the point at which
the rentals fully covered the costs of producing the stones. But the time
needed for this readjustment might be long: and in the interval a great part
of the tax would fall upon the owners of the stones.




If the life of the stones was long relatively to that process of production
in which the stones were used which was under discussion, the stock of stones
might be in excess of that needed to do all the work for which they were
specially fitted. Some of them might be lying almost idle, and the owner
of these stones might make up his estimate of the marginal price for which
he was just willing to work without entering in that estimate interest on
the value of the stones. That is to say, some costs which would have been
classed as prime costs in relation to contracts, or other affairs, which
lasted over a long period, would be classed as supplementary costs in relation
to a particular affair which would last but a short time, and which came
under consideration when business was slack.




It is of course just as essential in the long run that the price obtained
should cover general or supplementary costs as that it should cover prime
costs. An industry will be driven out of existence in the long run as certainly
by failing to return even a moderate interest on capital invested in steam
engines, as by failing to replace the price of the coal or the raw material
used up from day to day: just as a man's work will be stopped as certainly
by depriving him of food as by putting him in chains. But the man can go
on working fairly well for a day without food; while if he is put in chains
the check to his work comes at once. So an industry may, and often does,
keep tolerably active during a whole year or even more, in which very little
is earned beyond prime costs, and the fixed plant has "to work for nothing."
But when the price falls so low that it does not pay for the out of pocket
expenses during the yea r for wages and raw material, for coal and for lighting,
etc., then the production is likely to come to a sharp stop.




This is the fundamental difference between those incomes yielded by agents
of production which are to be regarded as rents or quasi-rents and those
which (after allowing for the replacement of wear-and-tear and other destruction)
may be regarded as interest (or profits) on current investments. The difference
is fundamental, but it is only one of degree. Biology tends to show that
the animal and vegetable kingdoms have a common origin. But yet there are
fundamental differences between mammals and trees; while in a narrower sense
the differences between an oak tree and an apple tree are fundamental; and
so are in a still narrower sense those between an apple tree and a rose bush,
though they are both classed as rosaceae. Thus our central doctrine is that
interest on free capital and quasi-rent on an old investment of capital shade
into one another gradually; even the rent of land being not a thing by itself,
but the leading species of a large genus.(3*)




4. Again, pure elements are seldom isolated from all others by nature
either in the physical or moral world. Pure rent in the strict sense of the
term is scarcely ever met with: nearly all income from land contains more
or less important elements which are derived from efforts invested in building
houses and sheds, in draining the land and so on. But economists have learnt
to recognize diversity of nature in those composite things to which the names
of rent, profits, wages etc. are given in popular language; they have learnt
that there is an element of true rent in the composite product that is commonly
called wages, an element of true earnings in what is commonly called rent
and so on. They have learnt in short to follow the example of the chemist
who seeks for the true properties of each element; and who is thus prepared
to deal with the common oxygen or soda of commerce, though containing admixtures
of other elements.(4*)




They recognize that nearly all land in actual use contains an element
of capital; that separate reasonings are required for those parts of its
value which are, and those which are not, due to efforts of man invested
in the land for the purposes of production; and that the results of these
reasonings must be combined in dealing with any particular case of that income
which commonly goes by the name "rent," but not all of which is
rent in the narrower sense of the term. The manner in which the reasonings
are to be combined depends on the nature of the problem. Sometimes the mere
mechanical "composition of forces" suffices; more often allowance
must be made for a quasi-chemical interaction of the various forces; while
in nearly all problems of large scope and importance, regard must be had
to biological conceptions of growth.




5. Finally a little may be said on a distinction that is sometimes made
between "scarcity rents" and "differential rents." In
a sense all rents are scarcity rents, and all rents are differential rents.
But in some cases it is convenient to estimate the rent of a particular agent
by comparing its yield to that of an inferior (perhaps a marginal) agent,
when similarly worked with appropriate appliances. And in other cases it
is best to go straight to the fundamental relations of demand to the scarcity
or abundance of the means for the production of those commodities for making
which the agent is serviceable.




Suppose for instance that all the meteoric stones in existence were equally
hard and imperishable; and that they were in the hands of a single authority:
further that this authority decided, not to make use of its monopolistic
power to restrict production so as to raise the price of its services artificially,
but to work each of the stones to the full extent it could be profitably
worked (that is up to the margin of pressure so intensive that the resulting
product could barely be marketed at a price which covered, with profits,
its expenses without allowing anything for the use of the stone). Then the
price of the services rendered by the stones would have been governed by
the natural scarcity of the aggregate output of their services in relation
to the demand for those services; and the aggregate surplus or rent would
most easily be reckoned as the excess of this scarcity price over the aggregate
expenses of working the stones. It would therefore generally be regarded
as a scarcity rent. But on the other hand it could have been reckoned as
the differential excess of the aggregate value of the net services of the
stones over that which would have been reached if all their uses had been
as unproductive as their marginal uses. And exactly the same would be true
if the stones were in the hands of different producers, impelled by competition
with one another to work each stone up to the margin at which its further
use ceased to be profitable.




This last instance has been so chosen as to bring out the fact that the
"differential" as well as the "scarcity" routes for estimating
rent are independent of the existence of inferior agents of production: for
the differential comparison in favour of the more advantageous uses of the
stones can be made by reference to the marginal uses of good stones, as clearly
as by reference to the use of inferior stones which are on the margin of
not being worth using at all.




In this connection it may be noted that the opinion that the existence
of inferior land, or other agents of production, tends to raise the rents
of the better agents is not merely untrue. It is the reverse of the truth.
For, if the bad land were to be flooded and rendered incapable of producing
anything at all, the cultivation of other land would need to be more intensive;
and therefore the price of the product would be higher, and rents generally
would be higher, than if that land had been a poor contributor to the total
stock of produce.(5*)




NOTES:




1. The substance of this section is reproduced from answers to questions
proposed by the Royal Commission on Local Taxation. See [C. 9528], 1899,
pp. 112-26.




2. Such circular reasonings are sometimes nearly harmless: but they always
tend to overlay and hide the real issues. And they are sometimes applied
to illegitimate uses by company promoters; and by advocates of special interests,
who desire to influence the course of legislation in their own favour. For
instance a semi monopolistic business aggregation or trust is often "over-capitalized."
To effect this a time is chosen, at which the branch of production with which
it is concerned is abnormally prosperous: when perhaps some solid firms are
earning fifty per cent. net on their capital in a single year, and thus making
up for lean years past and to come in which their receipts will do little
more than cover prime costs. Financiers connected with the flotation sometimes
even arrange that the businesses to be offered to the public shall have a
good many orders to fill at specially favourable prices: the loss falling
on themselves, or on other companies which they control. The gains to be
secured by semi-monopolistic selling, and possibly by some further economies
in production are emphasized: and the stock of the trust is absorbed by the
public. If ultimately objection to the conduct of the trust is raised, and
especially to the strengthening of its semi-monopolistic position by a high
tariff or any other public favour, the answer is given that the shareholders
are receiving but a moderate return on their investments. Such cases are
not uncommon in America. In this country a more moderate watering of the
stock of some railways has been occasionally used indirectly as a defence
of the shareholders against a lowering of rates, that threatens to reduce
dividends on inflated capital below what would be a fair return on solid
capital.




3. See above, p. 412.




4. Professor Fetter seems to ignore this lesson in an article on "The
Passing of the Concept of Rent" in the Quarterly Journal of Economics,
May 1901, p. 419; where he argues that "if only those things which owe
nothing to labour are classed as land, and if it is then shown that there
is no material thing in settled countries of which this can be said, it follows
that everything must be classed as capital." Again he appears to have
missed the true import of the doctrines which he assails, when he argues
(ib. pp. 423-9) against "Extension as the fundamental attribute of land,
and the basis of rent." The fact is that its extension (or rather the
aggregate of "its space relations") is the chief, though not the
only property ofland, which causes the income derived from it (in an old
country) to contain a large element of true rent: and that the element of
true rent, which exists in the income derived from land, or the "rent
of land" in the popular use of the term, is in practice so much more
important than any others that it has given a special character to the historical
development of the Theory of Rent (see above, p. 147). If meteoric stones
of absolute hardness, in high demand and incapable of increase, had played
a more important part in the economic history of the world than land, then
the elements of true rent which attracted the chief attention of students,
would have been associated with the property of hardness; and this would
have given a special tone and character to the development of the Theory
of Rent. But neither extension nor hardness is a fundamental attribute of
all things which yield a true rent. Professor Fetter seems also to have missed
the point of the central doctrine as to rents, quasi-rents and interest,
given above.




5. Compare Cassel, Das Recht auf den vollen Arbeitsertrag, p. 81.




The many misconceptions, that have appeared in the writings even of able
economists, as to the nature of a quasi-rent, seem to arise from an inadequate
attention to the differences between short periods and long in regard to
value and costs. Thus it has been said that a quasi-rent is an "unnecessary
profit," and that it is "no part of cost" Quasi-rent is correctly
described as an unnecessary profit in regard to short periods, because no
"special" or "prime" costs have to be incurred for the
production of a machine that, by hypothesis, is already made and waiting
for its work. But it is a necessary profit in regard to those other (supplementary)
costs which must be incurred in the long run in addition to prime costs;
and which in some industries, as for instance sub marine telegraphy, are
very much more important than prime costs. It is no part of cost under any
conditions: but the confident expectation of coming quasi-rents is a necessary
condition for the investment of capital in machinery, and for the incurring
of supplementary costs generally.




Again a quasi-rent has been described as a sort of "conjuncture"
or "opportunity" profit; and, almost in the same breath, as no
profit or interest at all, but only a rent. For the time being, it is a conjuncture
or opportunity income: while in the long run it is expected to, and it generally
does, yield a normal rate of interest (or if earnings of management are counted
in, of profit) on the free capital, represented by a definite sum of money
that was invested in producing it. By definition the rate of interest is
a percentage; that is a relation between two numbers (see above, p. 412).
A machine is not a number: its value may be a certain number of pounds or
dollars: but that value is estimated, unless the machine be a new one, as
the aggregate of its (discounted) earnings, or quasi-rents. If the machine
is new, its makers have calculated that this aggregate will appear to probable
purchasers as the equivalent of a price which will repay the makers for it:
in that case therefore it is as a rule, both a cost price, and a price which
represents an aggregate of (discounted) future incomes. But when the machine
is old and partially obsolete in pattern, there is no close relation between
its value and its cost of production: its value is then simply the aggregate
of the discounted values of the future quasi-rents, which it is expected
to earn.




CHAPTER X




MARGINAL COSTS IN RELATION TO AGRICULTURAL VALUES




1. We now pass from general considerations to those relating to land;
and we begin with those specially applicable to agricultural land in an old
country.




Suppose, that a war, which was not expected to last long, were to cut
off part of the food supplies of England. Englishmen would set themselves
to raise heavier crops by such extra application of capital or labour as
was likely to yield a speedy return; they would consider the results of artificial
manures, of the use of clod-crushing machines, and so on; and the more favourable
these results were, the less would be the rise in the price of produce in
the coming year which they regarded as necessary to make it worth their while
to incur additional outlay in these directions. But the war would have very
little effect on their action as to those improvements which would not bear
fruit till it was over. In any inquiry then as to the causes that will determine
the prices of corn during a short period, that fertility which the soil derives
from slowly made improvements has to be taken for granted as it then is,
almost in the same way as if it had been made by nature. Thus, the income
derived from these permanent improvements gives a surplus above the prime
or special costs needed for raising extra produce. But it is not a true surplus,
in the same sense that the rent proper is, i.e. it is not a surplus above
the total costs of the produce: it is needed to cover the general expenses
of the business.




To speak more exactly: -- If the extra income derived from improvements
that have been made in the land by its individual owner is so reckoned as
not to include any benefit which would have been conferred on the land by
the general progress of society independently of his efforts and sacrifices;
then, as a rule, the whole of it is required to remunerate him for those
efforts and sacrifices. He may have underestimated the gains which will result
from them; but he is about equally likely to have made an overestimate. If
he has estimated them rightly, his interest has urged him to make the investment
as soon as it showed signs of being profitable: and in the absence of any
special reason to the contrary we may suppose him to have done this. In the
long run, then, the net returns to the investment of capital in the land,
taking successful and unsuccessful returns together, do not afford more than
an adequate motive to such investment. If poorer returns had been expected
than those on which people actually based their calculations, fewer improvements
would have been made.




That is to say: -- for periods which are long in comparison with the time
needed to make improvements of any kind, and bring them into full operation,
the net incomes derived from them are but the price required to be paid for
the efforts and sacrifices of those who make them: the expenses of making
them thus directly enter into marginal expenses of production, and take a
direct part in governing long-period supply price. But in short periods,
that is, in periods short relatively to the time required to make and bring
into full bearing improvements of the class in question, no such direct influence
on supply price is exercised by the necessity that such improvements should
in the long run yield net incomes sufficient to give normal profits on their
cost. And therefore when we are dealing with such periods, these incomes
may be regarded as quasi-rents which depend on the price of the produce.(1*)




We may conclude then: -- (1) The amount of produce raised, and therefore
the position of the margin of cultivation (i.e. the margin of the profitable
application of capital and labour to good and bad land alike) are both governed
by the general conditions of demand and supply. They are governed on the
one hand by demand; that is, by the numbers of the population who consume
the produce, the intensity of their need for it, and their means of paying
for it; and on the other hand by supply; that is, by the extent and fertility
of the available land, and the numbers and resources of those ready to cultivate
it. Thus cost of production, eagerness of demand, margin of production, and
price of the produce mutually govern one another: and no circular reasoning
is involved in speaking of any one as in part governed by the others. (2)
That part of the produce which goes as rent is of course thrown on the market,
and acts on prices, in just the same way as any other part. But the general
conditions of demand and supply, or their relations to one another, are not
affected by the division of the produce into the share of rent and the share
needed to render the farmer's expenditure profitable. The amount of that
rent is not a governing cause; but is itself governed by the fertility of
land, the price of the produce, and the position of the margin: it is the
excess of the value of the total returns which capital and labour applied
to land do obtain, over those which they would have obtained under circumstances
as unfavourable as those on the margin of cultivation. (3) If the cost of
production were estimated for parts of the produce which do not come from
the margin, a charge on account of rent would of course need to be entered
in this estimate; and if this estimate were used in an account of the causes
which govern the price of the produce; then the reasoning would be circular.
For that, which is wholly an effect, would be reckoned up as part of the
cause of those things of which it is an effect. (4) The cost of production
of the marginal produce can be ascertained without reasoning in a circle.
The cost of production of other parts of the produce cannot. The cost of
production on the margin of the profitable application of capital and labour
is that to which the price of the whole produce tends, under the control
of the general conditions of demand and supply: it does not govern price,
but it focusses the causes which do govern price.




2. It has sometimes been suggested that if all land were equally advantageous
and all were occupied, the income derived from it would partake of the nature
of a monopoly rent: but this seems to be an error. Of course the landowners
might conceivably combine to stint production, whether their properties were
of equal fertility or not; the raised prices which would thus be obtained
for the produce would be monopoly prices; and the incomes of the owners would
be monopoly revenues rather than rents. But, with a free market, the revenues
from land would be rents, governed by the same causes and in the same way
in a country where the land was all of equal advantage, as in those where
good and bad land were intermingled.(2*)




It is, indeed, true that if there were more than enough land, all of about
the same fertility, to enable everyone to have as much of it as was needed
to give full scope to the capital he was prepared to apply to it, then it
could yield no rent. But that merely illustrates the old paradox that water,
when abundant, has no market value: for though the services of some part
of it are essential to support life, yet everyone can get without effort
to that margin of satiety at which any further supplies would be of no service
to him. When every cottager has a well from which he can draw as much water
as he needs, with no more labour than is required at his neighbour's well,
the water in the well has no market value. But let a drought set in, so that
the shallow wells are exhausted, and even the deeper wells are threatened,
then the owners of those wells can exact a charge for every bucket which
they allow anyone to draw for his own use. The denser population becomes,
the more numerous will be the occasions on which such charges can be made
(it being supposed that no new wells are developed): and at last every owner
of a well may find in it a permanent source of revenue.




In the same way the scarcity value of land in a new country gradually
emerges. The early settler exercises no exclusive privilege, for he only
does what anyone else is at liberty to do. He undergoes many hardships, if
not personal dangers; and perhaps he runs some risks that the land may turn
out badly, and that he may have to abandon his improvements. On the other
hand, his venture may turn out well; the flow of population may trend his
way, and the value of his land may soon give as large a surplus over the
normal remuneration of his outlay on it as the fishermen's haul does when
they come home with their boat full. But in this there is no surplus above
the rewards needed for his venture. He has engaged in a risky business which
was open to all, and his energy and good fortune have given him an exceptionally
high reward: anyone else might have taken the same chance as he did. Thus
the income which he expects the land to afford in the future enters into
the calculations of the settler, and adds to the motives which determine
his action when in doubt as to how far to carry his enterprise. He regards
its "discounted value"(3*) as profits on his capital, and as earnings
of his own labour, in so far as his improvements are made with his own hands.




A settler often takes up land with the expectation that the produce which
it affords while in his possession, will fall short of an adequate reward
for his hardships, his labour and his expenditure. He looks for part of his
reward to the value of the land itself, which he may perhaps after a while
sell to some new-comer who has no turn for the life of a pioneer. Sometimes
even, as the British farmer learns to his cost, the new settler regards his
wheat almost as a by-product; the main product for which he works is a farm,
the title-deeds to which he will earn by improving the land: he reckons that
its value will steadily rise, not through his own efforts so much as through
the growth of those comforts and resources, and of those markets in which
to buy and in which to sell, that are the product of the growing public prosperity.




This may be put in another way. People are generally unwilling to face
the hardships and isolation of pioneer agriculture, unless they can look
forward with some confidence to much higher earnings, measured in terms of
the necessaries of life, than they could get at home. Miners cannot be attracted
to a rich mine, isolated from other conveniences and varied social opportunities
of civilization, except by the promise of high wages: and those who superintend
the investment of their own capital in such mines expect very high profits.
For similar reasons pioneer farmers require high aggregate gains made up
of receipts for the sale of their produce, together with the acquisition
of valuable title-deeds, to remunerate them for their labour and endurance
of hardships. And the land is peopled up to that margin at which it just
yields gains adequate for this purpose, without leaving any surplus for rent,
when no charge is made for the land. When a charge is made, immigration spreads
only up to that margin, at which the gains will leave a surplus, of the nature
of rent, to cover such charges, in addition to rewarding the pioneer's endurance.




3. With all this it is to be remembered that land is but a particular
form of capital from the point of view of the individual producer. The question
whether a farmer has carried his cultivation of a particular piece of land
as far as he profitably can; and whether he should try to force more from
it, or to take in another piece of land; is of the same kind as the question
whether he should buy a new plough, or try to get a little more work out
of his present stock of ploughs, using them sometimes when the soil is not
in a very favourable condition, and feeding his horses a little more lavishly.
He weighs the net product of a little more land against the other uses to
which he could put the capital sum that he would have to expend in order
to obtain it: and in like manner he weighs the net product, to be got by
working his ploughs under unfavourable circumstances, against that got by
increasing his stock of ploughs, and thus working under more favourable conditions.
That part of his produce which he is in doubt whether to raise by extra use
of his existing ploughs, or by introducing a new plough, may be said to be
derived from a marginal use of the plough. It pays nothing net (i.e. nothing
beyond a charge for actual wear-and-tear) towards the net income earned by
the plough.




So again a manufacturer or trader, owning both land and buildings, regards
the two as bearing similar relations to his business. Either will afford
him aid and accommodation at first liberally; and afterwards with diminishing
return, as he endeavours to force more and more from them: till at last he
will doubt whether the overcrowding of his workshops or his storerooms is
not so great a source of trouble, that it would answer his purpose to obtain
more space. And when he comes to decide whether to obtain that space by taking
in an extra piece of land or by building his factory a floor higher, he weighs
the net income to be derived from further investments in the one against
that to be derived from the other. That part of his production which he just
forces out of his existing appliances (being in doubt whether it would not
be better worth his while to increase those appliances than to work so intensively
those which he has), does not contribute to the net income which those appliances
yield him. This argument says nothing as to whether the appliances were made
by man, or part of a stock given by nature; it applies to rents and quasi-rents
alike.




But there is this difference from the point of view of society. If one
person has possession of a farm, there is less land for others to have. His
use of it is not in addition to, but in lieu of the use of a farm by other
people: whereas if he invests in improvements of land or in buildings on
it, he will not appreciably curtail the opportunities of others to invest
capital in like improvements. Thus there is likeness amid unlikeness between
land and appliances made by man. There is unlikeness because land in an old
country is approximately (and in some senses absolutely) a permanent and
fixed stock: while appliances made by man, whether improvements in land,
or in buildings, or machinery, etc., are a flow capable of being increased
or diminished according to variations in the effective demand for the products
which they help in raising. So far there is unlikeness. But on the other
hand there is likeness, in that, since some of them cannot be produced quickly,
they are a practically fixed stock for short periods: and for those periods
the incomes derived from them stand in the same relation to the value of
the products raised by them, as do true rents.(4*)




4. Let us apply these considerations to the supposition that a permanent
tax is to be levied on "corn," in the sense in which it was used
by the classical economists as short for all agricultural produce. It is
obvious that the farmer would try to make the consumer pay some part at least
of the tax. But any rise in the price charged to the consumer would check
demand, and thus react on the farmer. In order to decide how much of this
tax would be shifted on to the consumer, we must study the margin of profitable
expenditure, whether that be the margin of a little expenditure applied to
poor land and land far removed from good markets, or the margin of a large
expenditure applied to rich land, and land near to dense industrial districts.




If only a little corn had been raised near the margin, a moderate fall
in the net price received by the farmer would not cause a great check to
the supply of corn. There would therefore be no great rise in the price paid
for it by the consumer; and the consumer would bear very little of the tax.
But the surplus value of the corn over its expenses of production would fall
considerably. The farmer, if cultivating his own land, would bear the greater
part of the tax. And, if he were renting the land, he could demand a great
reduction of his rent.




If, on the other hand, a great deal of corn had been raised near the margin
of cultivation, the tax would tend to cause a great shrinkage of production.
The consequent rise of price would arrest that shrinkage, leaving the farmer
in a position to cultivate nearly as intensively as before: and the landlord's
rent would suffer but little.(5*)




Thus, on the one hand, a tax which is so levied as to discourage the cultivation
of land or the erection of farm buildings on it, tends to be shifted forward
on to the consumers of the produce of land. But, on the other hand, a tax
on that part of the (annual) value of land, which arises from its position,
its extension, its yearly income of sunlight and heat and rain and air, cannot
settle anywhere except on the landlord; a lessee being, of course, landlord
for the time. This (annual) value of the land is commonly called its "original
value" or its "inherent value"; but much of that value is
the result of the action of men, though not of its individual holders. For
instance, barren heath land may suddenly acquire a high value from the growth
of an industrial population near it; though its owners have left it untouched
as it was made by nature. It is, therefore, perhaps more correct to call
this part of the annual value of land its "public value"; while
that part which can be traced to the work and outlay of its individual holders
may be called its "private value." The old terms "inherent
value" and "original value" may however be retained for general
use, with a note of caution as to their partial inaccuracy. And, using another
term that has precedent in its favour, we may speak of this annual public
value of the land as "true rent."




A tax on the public value of land does not greatly diminish the inducements
to cultivate the land highly, nor to erect farm buildings on it. Such a tax
therefore does not greatly diminish the supply of agricultural produce offered
on the market, nor raise the price of produce; and it is not therefore shifted
away from the owners of land.




This assumes that the true rent of land on which the tax is levied is
assessed with reference to its general capabilities, and not to the special
use which the owner makes of it: its net product is supposed to be that which
could be got by a cultivator of normal ability and enterprise, turning it
to good account to the best of his judgment. If an improved method of cultivation
develops latent resources of the soil, so as to yield an increased return
much in excess of what is required to remunerate the outlay with a good rate
of profits; this excess of net return above normal profits belongs properly
to true rent: and yet, if it is known, or even expected, that a very heavy
special tax on true rent will be made to apply to this excess income, that
expectation may deter the owner from making the improvement.(6*)




5. A little has been said incidentally of the competition between different
branches of industry for the same raw material or appliances for production.
But now we have to consider the competition between various branches of agriculture
for the same land. This case is simpler than that of urban land, because
farming is a single business so far as the main crops are concerned; though
the rearing of choice trees (including vines), flowers, vegetables etc. affords
scope for various kinds of specialized business ability. The classical economists
were therefore justified in provisionally supposing that all kinds of agricultural
produce can be regarded as equivalent to certain quantities of corn; and
that all the land will be used for agricultural purposes, with the exception
of building sites which are a small and nearly fixed part of the whole. But
when we concentrate our attention on any one product, as for instance, hops,
it may seem that a new principle is introduced. That is however not the case.
Let us look into this.




Hops are grown in varying rotations with other crops; and the farmer is
often in doubt whether he shall grow hops or something else on one of his
fields. Thus each crop strives against others for the possession of the land;
and if any one crop shows signs of being more remunerative than before relatively
to others, the cultivators will devote more of their land and resources to
it. The change may be retarded by habit, or diffidence, or obstinacy, or
limitations of the cultivator's knowledge; or by the terms of his lease.
But it will still be true in the main that each cultivator -- to recall once
more the dominant principle of substitution -- "taking account of his
own means, will push the investment of capital in his business in each several
direction until what appears in his judgment to be the margin of profitableness
is reached; that is, until there seems to him no good reason for thinking
that the gains resulting from any further investment in that particular direction
would compensate him for his outlay."




Thus in equilibrium, oats and hops and every other crop will yield the
same net return to that outlay of capital and labour, which the cultivator
is only just induced to apply. For otherwise he would have miscalculated;
he would have failed to get the maximum reward which his outlay can be made
to yield: and it would still be open to him to increase his gains by redistributing
his crops, by increasing or diminishing his cultivation of oats or some other
crop.(7*)




This brings us to consider taxation in reference to the competition of
different crops for the use of the same land. Let us suppose that a tax is
imposed on hops, wherever grown; it is not to be a mere local rate or tax.
The farmer can evade a part of the pressure of the tax by lessening the intensity
of his cultivation of the land which he plants with hops; and a yet further
part by substituting another crop on land which he had proposed to devote
to hops. He will have recourse to this second plan in so far as he considers
that he would get a better result by growing another crop, and selling it
free from the tax, than by growing hops and selling them in spite of the
tax. In this case the surplus which he could obtain from the land by growing,
say, oats upon it would come into his mind when deciding where to set the
limit to his production of hops. But even here there would be no simple numerical
relation between the surplus, or rent, which the land would yield under oats,
and the marginal costs which the price of hops must cover. And a farmer whose
land produced hops of exceptionally high quality, and which happened to be
in good condition at the time for hops, would have no doubt at all that it
was best to grow hops on the land; though in consequence of the tax he might
decide to curtail a little his expenditure on it.(8*)




Meanwhile the tendency towards a general restriction in the supply of
hops would tend to raise their price. If the demand for them were very rigid,
and hops of adequate quality could not easily be imported from beyond the
range of this special tax, the price might rise by nearly the full amount
of the tax. In that case the tendency would be checked, and very nearly as
much hops would be grown as before the tax had been levied. And here, as
in the case of a tax on printing, recently discussed, the effect of a local
tax is in strong contrast to that of a general tax. For unless the local
tax covered most of the ground in the country on which good hops could be
grown, its effect would be to drive them beyond its boundary: very little
revenue would be got from it, local farmers would suffer a good deal, and
the public would pay a rather higher price for their hops.




6. The argument of the last section applies, so far as short periods are
concerned, to the earning power of farmbuildings and to other quasi-rents.
When existing farmbuildings, or other appliances which could be used in producing
one commodity are diverted to producing another because the demand for that
is such as to enable them to earn a higher income by producing it, then for
the time the supply of the first will be less, and its price higher than
if the appliances had not been able to earn a higher income by another use.
Thus, when appliances are capable of being used in more than one branch of
agriculture, the marginal cost in each branch will be affected by the extent
to which these appliances are called off for work in other branches. Other
agents of production will be pushed to more intensive uses in the first branch,
in spite of a diminishing return; and the value of its product will rise,
because only at a higher value will the price be in equilibrium. The increased
earning power of the appliances due to the external demand will appear to
be the cause of this increase in value: for it will cause a relative scarcity
of the appliances in that branch of production, and therefore raise marginal
costs. And from this statement it appears superficially to be a simple transition
to the statement that the increased earning power of the appliances enter
into those costs which govern value. But the transition is illegitimate.
There will be no direct or numerical relation between the increase in the
price of the first commodity and the income that the appliances can earn
when they have been transferred to the second industry and adapted for service
in it.




Similarly, if a tax be put on factories used in one industry, some of
them will be diverted to other industries; and consequently the marginal
costs and therefore the values of the products in those industries will fall;
simultaneously with a temporary fall in net rental values of factories in
all uses. But these falls will vary in amount, and there will be no numerical
relation between the fall in the prices of the product and in these rents,
or rather quasi-rents.




These principles are not applicable to mines, whether for short periods
or for long. A royalty is not a rent, though often so called. For, except
when mines, quarries, etc., are practically inexhaustible, the excess of
their income over their direct outgoings has to be regarded, in part at least,
as the price got by the sale of stored-up goods -- stored up by nature indeed,
but now treated as private property; and therefore the marginal supply price
of minerals includes a royalty in addition to the marginal expenses of working
the mine. Of course the owner desires to receive the royalty without undue
delay; and the contract between him and the lessee often provides, partly
for this reason, for the payment of a rent as well as a royalty. But the
royalty itself on a ton of coal, when accurately adjusted, represents that
diminution in the value of the mine, regarded as a source of wealth in the
future, which is caused by taking the ton out of nature's storehouse.(9*)




NOTES:




1. Of course the character and extent of the improvements depends partly
on the conditions of land tenure, and the enterprise and ability and command
over capital on the part of landlords and tenants which existed at the time
and place in question. In this connection we shall find, when we come to
study land tenure, that there are large allowances to be made for the special
conditions of different places.




It may be noted, however, that rent proper is estimated on the understanding
that the original properties of the soil are unimpaired. And when the income
derived from improvements is regarded as a quasi-rent, it is to be understood
that they are kept up in full efficiency: if they are being deteriorated,
the equivalent of the injury done to them must be deducted from the income
they are made to yield before we can arrive at that Net income which is to
be regarded as their quasi rent.




That part of the income which is required to cover wear-and-tear bears
some resemblance to a royalty, which does no more than cover the injury done
to a mine by taking ore out of it.




2. Compare V, IX, section 5.




3. Compare III, V, section 3 and V, IV, section 2.




4. The relations between rent and profits engaged the attention of the
economists of the last generation; among whom may be specially mentioned
Senior and Mill, Hermann and Mangoldt. Senior seemed almost on the point
of perceiving that the key of the difficulty was held by the element of time:
but here as elsewhere he contented himself with suggestions; he did not work
them out. He says (Political Economy, p. 1 29), "for all useful purposes
the distinction of profits from rent ceases as soon as the capital from which
a given revenue arises has become, whether by gift or by inheritance, the
property of a person to whose abstinence and exertions it did not owe its
creation." Again, Mill says, Political Economy, Book III, ch. v, §4,
"Any difference in favour of certain producers or in favour of production
in certain circumstances is the source of a gain, which though not called
rent unless paid periodically by one person to another, is governed by laws
entirely the same with it."




It has been well observed that a speculator, who, without manipulating
prices by false intelligence or otherwise, anticipates the future correctly;
and who makes his gains by shrewd purchases and sales on the Stock Exchange
or in Produce Markets, generally renders a public service by pushing forward
production where it is wanted, and repressing it where it is not: but that
a speculator in land in an old country can render no such public service,
because the stock of land is fixed. At the best he can prevent a site with
great possibilities from being devoted to inferior uses in consequence of
the haste, ignorance, or impecuniosity of those in control of it.




5. Of course the adjustments of rent to the true economic surplus from
the land are in practice slow and irregular. These matters are discussed
in VI, sections IX and X, and the incidence of a tax on grain under certain
rather arbitrary assumptions is studied in some detail in Appendix K.




6. The exemption of vacant building land from taxes on its full value
retards building. See Appendix G.




7. In so far as the farmer is producing raw material, or even human food,
for market, his distribution of resources between different uses is a problem
of business economy: in so far as he is producing for his own domestic consumption,
it is, in part at least, a problem of domestic economy. Compare above V,
iv, §4. It may be added that Note XIV in the Mathematical Appendix emphasizes
the fact that that distribution of outlay between different enterprises,
which will give a maximum aggregate return, is fixed by the same set of equations
as that for the similar problem in domestic economy.




Mill (Principles, III, XVI, 2), when discussing "joint products,"
observed that all questions relating to the competition of crops for the
possession of particular soils are complicated by the rotation of crops and
similar causes; an intricate debit and credit account by double entry needs
to be kept between the various members of the rotation. Practice and shrewd
instinct enable the farmer to do this fairly well. The whole problem might
be expressed in simple mathematical phrases. But they would be tedious, and
perhaps unfruitful. They would therefore not be serviceable, so long as they
remained abstract; though they belong to a class which may ultimately be
of good use in the higher science of agriculture, when that has advanced
far enough to fill in realistic details.




8. If for instance he reckoned that he could get a surplus of £30
above his expenses (other than rent) in spite of the tax by growing hops,
and a surplus of only £20 above similar expenses by growing any other
crop, it could not be trulv said that the rent which the field could be made
to yield by growing other crops, "entered into" the marginal price
of hops. But it is easier to interpret the classical doctrine that "Rent
does not enter into cost of production" in a sense in which it is not
true, and to scoff at it, than in the sense in which it was intended and
is true. It seems best therefore to avoid the phrase.




The ordinary man is offended by the old phrase that rent does not enter
into the price of oats; when he sees that an increase in the demand for land
for other uses, manifests itself in a rise of the rental value of all land
in the neighbourhood; leaves less land free for growing oats; consequently
makes it worth while to force larger crops of oats out of the remaining oat-land,
and thus raises the marginal expenses of oats and their price. A rise in
rent does serve as a medium through which the growing scarcity of land available
for hops and other produce obtrudes itself on his notice; and it is not worth
while to try to force him to go behind these symptoms of the change in conditions
to the truly operative causes. It is therefore inexpedient to say that the
rent of land does not enter into their price. But it is worse than inexpedient
to say that the rent of the land does enter into their price: that is false.




Jevons asks (Preface to Theory of Political Economy, p. liv): "If
land which has been yielding £2 per acre rent, as pasture, be ploughed
up and used for raising wheat, must not £2 per acre be debited against
the expenses of production of wheat;" The answer is in the negative.
For there is no connection between this particular sum of £2 and the
expenses of production of that wheat which only just pays its way. What should
be said is: "When land capable of being used for producing one commodity
is used for producing another, the price of the first is raised bv the consequent
limitation of its field of production. The price of the second will be the
expenses of production (wages and profits) of that part of it which only
just pays its way, that which is produced on the margin of profitable expenditure.
And if for the purposes of any particular argument we take together the whole
expenses of the production on that land, and divide these among the whole
of the commodity produced; then the rent which we ought to count in is not
that which the land would pay if used for producing the first commodity,
but that which it does pay when used for producing the second."




9. See above, Book IV, chapter 3, note. Adam Smith is attacked by Ricardo
for putting rent on the same footing with wages and profits as parts of (money)
cost of production; and no doubt he does this sometimes. But yet he says
elsewhere, "Rent it is to be observed enters into the composition of
the price of commodities in a different way from wages and profit. High or
low wages and profit are the causes of high or low price: high or low rent
is the effect of it. It is because high or low wages and profit must be paid
in order to bring a particular commodity to market that its price is high
or low. But it is because its price is high or low a great deal more, or
very little more, or no more than what is sufficient to pay those wages and
profits, that it affords a high rent, or a low rent, or no rent at all."
(Wealth of Nations, I, XI.) In this, as in many other instances, he anticipated
in one part of his writings truths which in other parts he has seemed to
deny.




Adam Smith discusses the "price at which coals can be sold for any
considerable time"; and contends that "the most fertile mine regulates
the price of coals at all other mines in the neighbourhood." His meaning
is not clear; but he does not appear to be referring to any temporary underselling;
and he seems to imply that the mines are leased at so much a year. Ricardo,
following on apparently the same lines, comes to the opposite conclusion
that it "is the least fertile mine which regulates price"; which
is perhaps nearer the truth than Adam Smith's doctrine. But in fact when
the charge for the use of a mine is mainly in the form of a royalty, neither
proposition seems to be applicable. Ricardo was technically right (or at
all events not definitely wrong) when he said that rent does not enter into
the marginal cost of production of mineral produce. But he ought to have
added that if a mine is not practically inexhaustible, the income derived
from it is partly rent and partly royalty; and that though the rent does
not, the minimum royalty does enter directly into the expenses incurred on
behalf of every part of the produce, whether marginal or not.




The royalty is of course calculated in regard to those seams in the mine,
which are neither exceptionally rich and easy of working, nor exceptionally
poor and difficult. Some seams barely pay the expenses of working them; and
some which run short, or have a bad fault, do not even nearlv pav the wages
of the labour spent on them. The whole argument however implicitly assumes
the conditions of an old country. Professor Taussig is probably right when,
having in view the circumstances of a new country (Principles, II, p. 96),
he "doubts whether any payment at all can be secured by the owner of
the very poorest mine, assuming he has done nothing to develop it."




CHAPTER XI




MARGINAL COSTS IN RELATION TO URBAN VALUE




1. The last three chapters examined the relation in which cost of production
stands to the income derived from the ownership of the "original powers"
of land and other free gifts of nature, and also to that which is directly
due to the investment of private capital. There is a third class, holding
an intermediate position between these two, which consists of those incomes,
or rather those parts of incomes which are the indirect result of the general
progress of society, rather than the direct result of the investment of capital
and labour by individuals for the sake of gain. This class has to be studied
now, with special reference to the value of urban sites.




We have already noted that, though nature nearly always gives a less than
proportionate return, when measured by the amount of the produce raised,
to increasing applications of capital and labour in the cultivation of land;
yet, on the other hand, if the more intensive cultivation is the result of
the growth of a non-agricultural population in the neighbourhood, this very
concourse of people is likely to raise the value of produce. We have seen
how this influence opposes, and usually outweighs the action of the law of
diminishing return when the produce is measured according to its value to
the producer and not according to its amount; the cultivator gets good markets
in which to supply his wants, as well as good markets in which to sell, he
buys more cheaply while he sells more dearly, and the conveniences and enjoyments
of social life are ever being brought more within his reach.(1*)




Again, we have seen how the economies which result from a high industrial
organization(2*) often depend only to a small extent on the resources of
individual firms. Those internal economies which each establishment has to
arrange for itself are frequently very small as compared with those external
economies which result from the general progress of the industrial environment;
the situation of a business nearly always plays a great part in determining
the extent to which it can avail itself of external economies; and the situation
value which a site derives from the grow of a a rich and active population
close to it, or from the opening up of railways and other good means of communication
with existing markets, is the most striking of all the influences which changes
in the industrial environment exert on cost of production.




If in any industry, whether agricultural or not, two producers have equal
facilities in all respects, except that one has a more convenient situation
than the other, and can buy or sell in the same markets with less cost of
carriage, the differential advantage which his situation gives him is the
aggregate of the excess charges for cost of carriage to which his rival is
put. And we may suppose that other advantages of situation, such for instance
as the near access to a labour market specially adapted to his trade, can
be translated in like manner into money values. When this is done, and all
are added together we have the money value of the advantages of situation
which the first business has over the second: and this becomes its special
situation value, if the second has no situation value and its site is reckoned
merely at agricultural value. The extra income which can be earned on the
more favoured site gives rise to what may be called a special situation rent:
and the aggregate site value of any piece of building land is that which
it would have if cleared of buildings and sold in a free market. The "annual
site value" -- to use a convenient, though not strictly correct form
of speaking -- is the income which that price would yield at the current
rate of interest. It obviously exceeds the special situation value, merely
by agricultural value; which is often an almost negligible quantity in comparison.(3*)




2. It is obvious that the greater part of situation value is "public
value." There are however exceptional cases, which call for notice.
Sometimes the settlement of a whole town, or even district is planned on
business principles, and carried out as an investment at the expense and
risk of a single person or company. The movement may be partly due to philanthropic
or religious motives, but its financial basis will in any case be found in
the fact that the concourse of numbers is itself a cause of increased economic
efficiency. Under ordinary circumstances the chief gains arising from this
efficiency would accrue to those who are already in possession of the place:
but the chief hopes of commercial success, by those who undertake to colonize
a new district or build a new town, are usually founded on securing these
gains for themselves.




When, for instance, Mr Salt and Mr Pullman determined to take their factories
into the country and to found Saltaire and Pullman City, they foresaw that
the land, which they could purchase at its value for agricultural purposes,
would obtain the special situation value which town property derives from
the immediate neighbourhood of a dense population. And similar considerations
have influenced those, who, having fixed upon a site adapted by nature to
become a favourite watering-place, have bought the land and spent large sums
in developing its resources: they have been willing to wait long for any
net income from their investment in the hope that ultimately their land would
derive a high situation value from the concourse of people attracted to it.(4*)




In all such cases the yearly income derived from the land (or at all events
that part of it which is in excess of the agricultural rent) is for many
purposes to be regarded as profits rather than rent. And this is equally
true, whether the land is that on which the factory itself at Saltaire or
Pullman City is built, or that which affords a high "ground-rent"
as the site of a shop or store, whose situation will enable it to do a brisk
trade with those who work in the factory. For in such cases great risks have
to be run; and in all undertakings in which there are risks of great losses,
there must also be hopes of great gains. The normal expenses of production
of a commodity must include payment for the ventures required for producing
it, sufficient to cause those who are on the margin of doubt whether to venture
or not, to regard the probable net amount of their gains net, that is, after
deducting the probable amount of their losses as compensating them for their
trouble and their outlay. And that the gains resulting from such ventures
are not much more than sufficient for this purpose is shown by the fact that
they are not as yet very common. They are however likely to be more frequent
in those industries which are in the hands of very powerful corporations.
A large railway company, for instance, can found a Crewe or a New Swindon
for manufacturing railway plant without running any great risk.(5*)




Some what similar instances are those of a group of landowners who combine
to make a railway, the net traffic receipts of which are not expected to
pay any considerable interest on the capital invested in making it; but which
will greatly raise the value of their land. In such cases part of the increase
of their incomes as landowners ought to be regarded as profits on capital
which they have invested in the improvement of their land: though the capital
has gone towards making a railway instead of being applied directly to their
own property.




Other cases of like nature are main drainage schemes, and other plans
for improving the general condition of agricultural or town property, in
so far as they are carried out by the landowners at their own expense, whether
by private agreement or by the levying of special rates on themselves. Similar
cases again are found in the investment of capital by a nation in building
up its own social and political organization as well as in promoting the
education of the people and in developing its sources of material wealth.




Thus that improvement of the environment, which adds to the value of land
and of other free gifts of nature, is in a good many cases partly due to
the deliberate investment of capital by the owners of the land for the purpose
of raising its value; and therefore a portion of the consequent increase
of income may be regarded as profits when we are considering long periods.
But in many cases it is not so; and any increase in the net income derived
from the free gifts of nature which was not brought about by, and did not
supply the direct motive to, any special outlay on the part of the landowners,
is to be regarded as rent for all purposes.




Cases somewhat analogous to these arise when the owner of a score or more
of acres in the neighbourhood of a growing town "develops" them
for building. He probably lays out the roads, decides where houses are to
be continuous, and where detached; and prescribes the general style of architecture,
and perhaps the minimum expenditure on each house; for the beauty of each
adds to the general value of all. This collective value, thus created by
him, is of the nature of public value; and it is dependent, for the greater
part, on that dormant public value, which the site as a whole derived from
the growth of a prosperous town in its neighbourhood. But yet that share
of it which results from his forethought, constructive faculty and outlay,
is to be regarded as the reward of business enterprise, rather than as the
appropriation of public value by a private person.




These exceptional cases must be reckoned with. But the general rule holds
that the amount and character of the building put upon each plot of land
is, in the main (subject to the local building bylaws), that from which the
most profitable results are anticipated, with little or no reference to its
reaction on the situation value of the neighbourhood. In other words the
site value of the plot is governed by causes which are mostly beyond the
control of him who determines what buildings shall be put on it: and he adjusts
his expenditure on it to his estimates of the income to be derived from various
descriptions of buildings on it.




3. The owner of building land sometimes builds on it himself: sometimes
he sells it outright: very often he lets it at a fixed ground-rent for ninety-nine
years, after which the land and the buildings on it (which by covenant must
be kept in good repair) revert to his successor in title. Let us consider
what governs the value at which he can sell the land and the ground-rent
at which he can let it.




The capitalized value of any plot of land is the actuarial "discounted"
value of all the net incomes which it is likely to afford, allowance being
made on the one hand for all incidental expenses, including those of collecting
the rents, and on the other for its mineral wealth, its capabilities of development
for any kind of business, and its advantages, material, social and aesthetic,
for the purposes of residence. The money equivalent of that social status
and those other personal gratifications which the ownership of land affords,
does not appear in the returns of the money income derived from it, but does
enter into its capital money value.(6*)




Next let us consider what governs the "ground-rent" which the
owner can obtain for a plot which he lets on, say, a ninety-nine years' building
lease. The present discounted value of all the fixed money payments under
that lease tends to be equal to the present capital value of the land; after
deducting, firstly, for the obligation to return the land with the buildings
on it to the successor in title of the present owner at the end of the lease,
and secondly for the possible inconvenience of any restrictions on the use
of the land contained in the lease. In consequence of these deductions the
ground-rent would be rather less than the "annual site value" of
the land, if that site value were expected to remain fixed throughout. But
in fact the site value is expected to rise in consequence of the growth of
population, and other causes: and therefore the ground-rent is generally
a little above the annual site value at the beginning of the lease, and much
below it towards the end.(7*)




Among the estimated outgoings on account of any building, which have to
be deducted from its estimated gross yield before deciding what is the value
of the privilege of erecting it on any given plot of land, are the taxes
(central and local) which may be expected to be levied on the property, and
to be paid by the owner of the property. But this raises difficult side-issues,
which are postponed to Appendix G.




4. Let us revert to the fact that the law of diminishing return applies
to the use of land for the purposes of living and working on it in all trades.(8*)
Of course in the trade of building, as in agriculture, it is possible to
apply capital too thinly. Just as a homesteader may find that he can raise
more produce by cultivating only a half of the 160 acres allotted to him
than by spreading his labour over the whole, so even when ground has scarcely
any value, a very low house may be dear in proportion to its accommodation.
But, as in agriculture, there is a certain application of capital and labour
to the acre which gives the highest return, and further applications after
this give a less return, so it is in building. The amount of capital per
acre which gives the maximum return varies in agriculture with the nature
of the crops, with the state of the arts of production, and with the character
of the markets to be supplied; and similarly in building, the capital per
square foot which would give the maximum return, if the site had no scarcity
value, varies with the purpose for which the building is wanted. But when
the site has a scarcity value, it is worth while to go on applying capital
beyond this maximum rather than pay the extra cost of land required for extending
the site. In places where the value of land is high, each square foot is
made to yield perhaps twice the accommodation, at more than twice the cost,
that it would be made to give, if used for similar purposes where the value
of land is low.




We may apply the phrase the margin of building to that accommodation which
it is only just worth while to get from a given site, and which would not
be got from it if land were less scarce. To fix the ideas, we may suppose
this accommodation to be given by the top floor of the building.(9*)




By erecting this floor, instead of spreading the building over more ground,
a saving in the cost of land is effected, which just compensates for the
extra expense and inconvenience of the plan. The accommodation given by this
floor, when allowance has been made for its incidental disadvantages, is
only just enough to be worth what it costs without allowing anything for
the rent of land; and the expenses of production of the things raised on
this floor, if it is part of a factory, are just covered by their price;
there is no surplus for the rent of land. The expenses of production of manufactures
may then be reckoned as those of the goods which are made on the margin of
building, so as to pay no rent for land. That is to say the rent of the land
does not enter into that set of expenses at the margin at which the action
of the forces of demand and supply in governing value may be most clearly
seen.




Suppose, for instance, that a person is planning a hotel or a factory;
and considering how much land to take for the purpose. If land is cheap he
will take much of it; if it is dear he will take less and build high. Suppose
him to calculate the expenses of building and working his establishment with
frontages of 100 and 110 feet respectively, in ways equally convenient on
the whole to himself, his customers and employees, and therefore equally
profitable to himself. Let him find that the difference between the two plans,
after capitalizing future expenditure, shows an advantage of £500 in
favour of the larger area; he will then be inclined to take the larger if
the land is to be got at less than £50 per foot of frontage, but not
otherwise; and £50 will be the marginal value of land to him. He might
have reached this result by calculating the increased value of the business
that could be done with the same outlay in other respects on the larger site
as compared with the smaller, or again by building on less expensive ground
instead of in a more favourable situation. But, by whatever route he makes
his calculation, its character is similar to that by which he decides whether
it is worth his while to buy business plant of any other kind: and he regards
the net income (allowance being made for depreciation) which he expects to
get from either investment as standing in the same general relation to his
business; and if the advantages of the situation are such, that all the land
available on it can find employments of different kinds in each of which
its marginal use is represented by a capital value of £50 per foot of
frontage, then that will be the current value of the land.




5. This assumes that the competition for land for various uses will cause
building in each locality and for each use to be carried up to that margin,
at which it is no longer profitable to apply any more capital to the same
site. As the demand for residential and business accommodation in a district
increases, it becomes worth while to pay a higher and higher price for land,
in order to avoid the expense and inconvenience of forcing more accommodation
from the same ground area.




For instance, if the value of land in, say, Leeds rises because of the
increased competition for it by shops, ware. then a woollen manufacturer
finding houses, iron works, etc., his expenses of production increased, may
move to another town or into the country; and thus leave the land on which
he used to work to be built over with shops and warehouses, for which a town
situation is more valuable than it is for factories. For he may think that
the saving in the cost of land that he will make by moving into the country,
together with other advantages of the change, will more than counterbalance
its disadvantages. In a discussion as to whether it was worth while to do
so, the rental value of the site of his factory would be reckoned among the
expenses of production of his cloth; and rightly.




But we have to go behind that fact. The general relations of demand and
supply cause production to be carried up to a margin at which the expenses
of production (nothing being entered for rent) are so high that people are
willing to pay a high value for additional land in order to avoid the inconvenience
and expense of crowding their work on to a narrow site. These causes govern
site value; and site value is therefore not properly regarded as governing
marginal costs.




Thus the industrial demand for land is in all respects parallel to the
agricultural. The expenses of production of oats are increased by the fact
that land, which could yield good crops of oats, is in great demand for growing
other crops that enable it to yield a higher rent: and in the same way the
printing-presses, which may be seen at work in London some sixty feet above
the ground, could afford to do their work a little cheaper if the demand
for ground for other uses did not push the margin of building up so high.
Again a hop-grower may find that on account of the high rent which he pays
for his land, the price of his hops will not cover their expenses of production
where he is, and he may abandon hop-growing, or seek other land for it; while
the land that he leaves may perhaps be let to a market-gardener. After a
while the demand for land in the neighbourhood may again become so great
that the aggregate price which the market-gardener obtains for his produce
will not pay its expenses of production, including rent; and so he in his
turn makes room for, say, a building company.




In each case the rising demand for land alters the margin to which it
is profitable to carry the intensive use of land: the costs at this margin
indicate the action of those fundamental causes which govern the value of
the land. And at the same time they are themselves those costs to which the
general conditions of demand and supply compel value to conform: and therefore
it is right for our purpose to go straight to them; though any such inquiry
would be irrelevant to the Purposes of a private balance sheet.




6. The demand for exceptionally valuable urban land comes from traders
of various kinds, wholesale and retail, more than from manufacturers; and
it may be worth while to say something here as to the very interesting features
of demand that are peculiar to their case.




If two factories in the same branch of trade have equal outputs they are
sure to have nearly equal floor space. But there is no close relation between
the size of trading establishments and their turn-overs. Plenty of space
is for them a matter of convenience and a source of extra profit. It is not
physically indispensable; but the larger their space, the greater the stock
which they can keep on hand, and the greater the advantage to which they
can display specimens of it; and especially is this the case in trades that
are subject to changes of taste and fashion. In such trades the dealers exert
themselves to collect within a comparatively small space representatives
of all the best ideas that are in vogue, and still more of those that are
likely soon to be so; and the higher the rental values of their sites the
more prompt they must be in getting rid, even at a loss, of such things as
are a little behind the time and do not improve the general character of
their stocks. If the locality is one in which customers are more likely to
be tempted by a well-chosen stock than by low prices, the traders will charge
prices that give a high rate of profit on a comparatively small turn-over:
but, if not, they will charge low prices and try to force a large business
in proportion to their capital and the size of their premises; just as in
some neighbourhoods the market-gardener finds it best to gather his peas
young when they are full of flavour, and in others to let them grow till
they weigh heavily in the scales. Whichever plan the traders follow, there
will be some conveniences which they are in doubt whether it is worth while
to offer to the public; since they calculate that the extra sales gained
by such conveniences are only just remunerative, and do not contribute any
surplus towards rent. The goods which they sell in consequence of these conveniences,
are goods into whose expenses of marketing rent does not enter any more than
it does into those of the peas which the market-gardener only just finds
it worth his while to produce.




Prices are low in some very highly-rented shops, because their doors are
passed by great numbers of people who cannot afford to pay high prices for
the gratification of their fancy; and the shopkeeper knows that he must sell
cheaply, or not sell at all. He has to be content with a low rate of profit
each time he turns over his capital. But, as the wants of his customers are
simple, he need not keep a large stock of goods; and he can turn over his
capital many times a year. So his annual net profits are very great, and
he is willing to pay a very high rent for the situation in which they can
be earned. On the other hand, prices are very high in some of the quiet streets
in the fashionable parts of London and in many villages; because in the one
case customers must be attracted by a very choice stock, which can only be
sold slowly; and in the other the aggregate turn-over is very small indeed.
In neither place can the trader make profits that will enable him to pay
as high a rent as those of some cheap but bustling shops in the East end
of London.




It is however true that, if without any increase in traffic such as brings
extra custom, a situation becomes more valuable for purposes other than shopkeeping;
then only those shopkeepers will be able to pay their way who can manage
to secure a large custom relatively to the prices which they charge and the
class of business which they do. There will therefore be a smaller supply
of shopkeepers in all trades for which the demand has not increased: and
those who remain, will be able to charge a higher price than before, without
offering any greater conveniences and attractions to their customers. The
rise of ground values in the district will thus be an indication of a scarcity
of space which, other things being equal, will raise the prices of retail
goods; just in the same way as the rise of agricultural rents in any district
will indicate a scarcity of land which will raise the marginal expenses of
production, and therefore the price of any particular crop.




7. The rent of a house (or other building) is a composite rent, of which
one part belongs to the site and the other to the buildings themselves. The
relations between these two are rather intricate, and may be deferred to
Appendix G. A few words may however be said here as to composite rents in
general. At starting there may appear to be some contradiction in the statement
that a thing is yielding at the same time two rents: for its rent is in some
sense a residual income after deducting the expenses of working it; and there
cannot be two residues in regard to the same process of working and the same
resulting revenue. But when the thing is composite each of its parts may
be capable of being so worked as to yield a surplus of revenue over the expenses
of working it. The corresponding rents can always be distinguished analytically,
and sometimes they can be separated commercially.(10*)




For instance, the rent of a flour-mill worked by water includes the rent
of the site on which it is built, and the rent of the water power which it
uses. Suppose that it is contemplated to build a mill in a place where there
is a limited water power which could be applied equally well on any one of
many sites; then the rent of the water power together with the site selected
for it is the sum of two rents; which are respectively the equivalent of
the differential advantages which possession of the site gives for production
of any kind, and which the ownership of the water power gives for working
a mill on any of the sites. And these two rents, whether they happen to be
owned by the same person or not, can be clearly distinguished and separately
estimated both in theory and in practice.




But this cannot be done if there are no other sites on which a mill can
be built: and in that case, should the water power and the site belong to
different persons, there is nothing but "higgling and bargaining"
to settle how much of the excess of the value of the two together over that
which the site has for other purposes shall go to the owner of the latter.
And even if there were other sites at which the water power could be applied,
but not with equal efficiency, there would still be no means of deciding
how the owners of the site and the water power should share the excess of
the producer's surplus which they got by acting together, over the sum of
that which the site would yield for some other purpose, and of that which
the water power would yield if applied elsewhere. The mill would probably
not be put up till an agreement had been made for the supply of water power
for a term of years: but at the end of that term similar difficulties would
arise as to the division of the aggregate producer's surplus afforded by
the water power and the site with the mill on it.




Difficulties of this kind are continually arising with regard to attempts
by partial monopolists, such as railway, gas, water and electrical companies,
to raise their charges on the consumer who has adapted his business arrangements
to make use of their services, and perhaps laid down at his own expense a
costly plant for the purpose. For instance, at Pittsburgh when manufacturers
had just put up furnaces to be worked by natural gas instead of coal, the
price of the gas was suddenly doubled. And the history of mines affords many
instances of difficulties of this kind with neighbouring landowners as to
rights of way, etc., and with the owners of neighbouring cottages, railways
and docks.(11*)




NOTES:




1. See IV, III, section 6.




2. See IV, X-XIII.




3. If we suppose that two farms, which sell in the same market, return
severally to equal applications of capital and labour amounts of produce,
the first of which exceeds the second by the extra cost of carrying its produce
to market, then the rent of the two farms will be the same. (The capital
and labour applied to the two farms are here supposed to be reduced to the
same money measure, or which comes to the same thing, the two farms are supposed
to have equally good access to markets in which to buy.) Again, if we suppose
that two mineral springs A and B supplying exactly the same water are capable
of being worked each to an unlimited extent at a constant money cost of production;
this cost being, sav twopence a bottle at A whatever the amount produced
by it, and twopence half penny at B; then those places to which the cost
of carriage per bottle from B is a half-penny less than from A, will be the
neutral zone for their competition. (If the cost of carriage be proportional
to the distance, this neutral zone is a hyperbola of which A and B are foci.)
A can undersell B for all places on A's side of it, and vice versa; and each
of them will be able to derive a monopoly rent from the sale of its produce
within its own area. This is a type of a great many fanciful, but not uninstructive,
problems which readily suggest themselves. Compare von Thünen's brilliant
researches in Der isolierte Staat.




4. Cases of this kind are of course most frequent in new countries. But
they are not very rare in old countries: Saltburn is a conspicuous instance;
awhile a more recent instance of exceptional interest is furnished by Letchworth
Garden City.




5. Governments have great facilities for carrying out schemes of this
kind, especially in the matter of choosing new sites for garrison towns,
arsenals, and establishments for the manufacture of the materials of war.
In comparisons of the expenses of production by Government and by private
firms, the sites of the Government works are often reckoned only at their
agricultural value. But such a plan is misleading. A private firm has either
to pay heavy annual charges on account of its site, or to run very heavy
risks if it tries to make a town for itself. And therefore in order to prove
that Government management is for general purposes as efficient and economical
as private management, a full charge ought to be made in the balance-sheets
of Government factories for the town-value of their sites. In those exceptional
branches of production for which a Government can found a manufacturing town
without incurring the risks that a private firm would incur in a similar
case, that point of advantage may fairly be reckoned as an argument for Governments
undertaking those particular businesses.




6. The value of agricultural land is commonly expressed as a certain number
of times the current money rental, or in other words a certain "number
of years' purchase" of that rental: and other things being equal it
will be the higher, the more important these direct gratifications are, as
well as the greater the chance that they and the money income afforded by
the land will rise. The number of years' purchase would be increased also
by an expected fall either in the future normal rate of interest or in the
purchasing power of money.




The discounted value of a very distant rise in the value of land is much
less than is commonly supposed. For instance, if we take interest at five
per cent (and higher rates prevailed during the Middle Ages), £1 invested
at compound interest would amount to about £17,000 in 200 years, and
£40,000,000,000 in 500 years. Therefore an expenditure by the State
of £1 in securing to itself the reversion of a rise in the value of
land which came into operation now for the first time would have been a bad
investment, unless the value of that rise now exceeded £17,000, if the
payment was made 200 years ago; if 500 years ago to £40,000,000,000.
This assumes that it would have been possible to invest a sum of this dimension
at five per cent: which of course it would not.




7. A few site values have fallen in districts which have been deserted
by fashion or trade. But on the other hand annual site values have risen
to be many times as great as the ground rents in the case of land which was
leased when it had no special situation value, but has since become a chief
centre of fashion, or of trade: and all the more if the lease was granted
in the first half of the eighteenth century, when gold was scarce and the
incomes of all classes of the people, measured in money, were very low The
present discounted value of the return of property to the ground landlord
a hundred years hence, which will then be worth £1000, is less perhaps
than is commonly supposed; though the error is not so great as in the case
of anticipations ranging over many hundred years, which were discussed in
a recent note: if interest be taken at three per cent. it is about £50;
if at five per cent, as was the rule three or four generations ago, it is
but £8.




8. See IV, III, section 7.




9. Houses built in flats are often provided with a lift which is run at
the expense of the owner of the house, and in such cases, at all events in
America, the top floor sometimes lets for a higher rent than any other. If
the site is very valuable and the law does not limit the height of his house
in the interest of his neighbours, he may build very high: but at last he
will reach the margin of building. At last he will find that the extra expenses
for foundations and thick walls, and for his lift, together with some resulting
depreciation of the lower floors, make him stand to lose more than he gains
by adding one more floor; the extra accommodation which it only just answers
his purpose to supply is then to be regarded as at the margin of building,
even though the gross rent be greater for the higher floors than for the
lower.




But in England bylaws restrain an individual from building so high as
to deprive his near neighbours of air and light. In the course of time those
who build high will be forced to have a good deal of free space about their
buildings; and this will render very high buildings unprofitable.




10. It will be borne in mind that if a house is not appropriate to its
site, its aggregate rent will not exceed its site rent by the full building
rent which the house would command on an appropriate site. Similar limitations
apply to most composite rents.




11. The relations between the interests of different classes of workers
in the same business and in the same trade, have some affinity to the subject
of composite rents. See below VI, VIII, sections 9, 10.




CHAPTER XII




EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY, CONTINUED, WITH REFERENCE TO
THE LAW OF INCREASING RETURN




1. We may now continue the study begun in chapters III and V; and examine
some difficulties connected with the relations of demand and supply as regards
commodities the production of which tends to increasing return.




We have noted that this tendency seldom shows itself immediately on an
increase of demand. To take an example, the first effect of a sudden fashion
for watch-shaped aneroids would be a temporary rise of price, in spite of
the fact that they contain no material of which there is but a scanty stock.
For highly paid labour, that had no special training for the work, would
have to be drawn in from other trades; a good deal of effort would be wasted,
and for a time the real and the money cost of production would be increased.




But yet, if the fashion lasted a considerable time, then even independently
of any new invention, the cost of making aneroids would fall gradually. For
specialized skill in abundance would be trained, and properly graduated to
the various work to be done. With a large use of the method of interchangeable
parts, specialized machinery would do better and more cheaply much of the
work that is now done by hand; and thus a continued increase in the annual
output of watch-shaped aneroids would lower their price very much.




Here there is to be noted an important difference between demand and supply.
A fall in the price, at which a commodity is offered, acts on demand always
in one direction. The amount of the commodity demanded may increase much
or little according as the demand is elastic or inelastic: and a long or
short time may be required for developing the new and extended uses of the
commodity, which are rendered possible by the fall in price.(1*) But at all
events if exceptional cases in which a thing is driven out of fashion by
a fall in its price be neglected -- the influence of price on demand is similar
in character for all commodities: and, further, those demands which show
high elasticity in the long run, show a high elasticity almost at once; so
that, subject to a few exceptions, we may speak of the demand for a commodity
as being of high or low elasticity without specifying how far we are looking
ahead.




But there are no such simple rules with regard to supply. An increase
in the price offered by purchasers does indeed always increase supply: and
thus it is true that, if we have regard to short periods only, and especially
to the transactions of a dealer's market, there is an "elasticity of
supply" which corresponds closely to elasticity of demand. That is to
say, a given rise in price will cause a great or a small increase in the
offers which sellers accept, according as they have large or small reserves
in the background, and as they have formed low or high estimates of the level
of prices at the next market: and this rule applies nearly in the same way
to things which in the long run have a tendency to diminishing return as
to those which have a tendency to increasing return. In fact if the large
plant needed in a branch of manufacture is fully occupied, and cannot be
rapidly increased, an increase in the price offered for its products may
have no perceptible effect in increasing the output for some considerable
time: while a similar increase in the demand for a hand-made commodity might
call forth quickly a great increase in supply, though in the long run its
supply conformed to that of constant return or even of diminishing return.




In the more fundamental questions which relate to long periods, the matter
is even more complex. For the ultimate output corresponding to an unconditional
demand at even current prices would be theoretically infinite; and therefore
the elasticity of supply of a commodity which conforms to the law of Increasing
Return, or even to that of Constant Return, is theoretically infinite for
long periods.(2*)




2. The next point to be observed is that this tendency to a fall in the
price of a commodity as a result of a gradual development of the industry
by which it is made, is quite a different thing from the tendency to the
rapid introduction of new economies by an individual firm that is increasing
its business.




We have seen how every step in the advance of an able and enterprising
manufacturer makes the succeeding step easier and more rapid; so that his
progress upwards is likely to continue so long as he has fairly good fortune,
and retains his full energy and elasticity and his liking for hard work.
But these cannot last for ever: and as soon as they decay, his business is
likely to be destroyed through the action of some of those very causes which
enabled it to rise; unless indeed he can pass it over into hands as strong
as his used to be. Thus the rise and fall of individual firms may be frequent,
while a great industry is going through one long oscillation, or even moving
steadily forwards; as the leaves of a tree (to repeat an earlier illustration)
grow to maturity, reach equilibrium, and decay many times, while the tree
is steadily growing upwards year by year.(3*)




The causes which govern the facilities for production at the command of
a single firm, thus conform to quite different laws from those which control
the whole output of an industry. And the contrast is perhaps heightened,
when we take the difficulties of marketing into account. For instance manufactures,
which are adapted to special tastes, are likely to be on a small scale; and
they are generally of such a character that the machinery and modes of organization
already developed in other trades, could be easily adapted to them; so that
a great increase in their scale of production would be sure to introduce
vast economies at once. But these are the very industries in which each firm
is likely to be confined more or less to its own particular market: and,
if it is so confined, any hasty increase in its production is likely to lower
the demand price in that market out of all proportion to the increased economies
that it will gain; even though its production is but small relatively to
the broad market for which in a more general sense it may be said to produce.




In fact, when trade is slack, a producer will often try to sell some of
his surplus goods outside of his own particular market at prices that do
little more than cover their prime costs: while within that market he still
tries to sell at prices that nearly cover supplementary costs; and a great
part of these are the returns expected on capital invested in building up
the external organization of his business.(4*)




Again supplementary costs are, as a rule, larger relatively to prime costs
for things that obey the law of increasing return than for other things;(5*)
because their production needs the investment of a large capital in material
appliances and in building up trade connections. This increases the intensity
of those fears of spoiling his own peculiar market, or incurring odium from
other producers for spoiling the common market; which we have already learnt
to regard as controlling the short-period supply price of goods, when the
appliances of production are not fully employed.




We cannot then regard the conditions of supply by an individual producer
as typical of those which govern the general supply in a market. We must
take account of the fact that very few firms have a long-continued life of
active progress, and of the fact that the relations between the individual
producer and his special market differ in important respects from those between
the whole body of producers and the general market.(6*)




3. Thus the history of the individual firm cannot be made into the history
of an industry any more than the history of an individual man can be made
into the history of mankind. And yet the history of mankind is the outcome
of the history of individuals; and the aggregate production for a general
market is the outcome of the motives which induce individual producers to
expand or contract their production. It is just here that our device of a
representative firm comes to our aid. We imagine to ourselves at any time
a firm that has its fair share of those internal and external economies,
which appertain to the aggregate scale of production in the industry to which
it belongs. We recognize that the size of such a firm, while partly dependent
on changes in technique and in the costs of transport, is governed, other
things being equal, by the general expansion of the industry. We regard the
manager of it as reckoning up whether it would be worth his while to add
a certain new line to his undertakings; whether he should introduce a certain
new machine and so on. We regard him as treating the output which would result
from that change more or less as a unit, and weighing in his mind the cost
against the gain.(7*)




This then is the marginal cost on which we fix our eyes. We do not expect
it to fall immediately in consequence of a sudden increase of demand. On
the contrary we expect the short-period supply price to increase with increasing
output. But we also expect a gradual increase in demand to increase gradually
the size and the efficiency of this representative firm; and to increase
the economies both internal and external which are at its disposal.




That is to say, when making lists of supply prices (supply schedules)
for long periods in these industries, we set down a diminished supply price
against an increased amount of the flow of the goods; meaning thereby that
a flow of that increased amount will in the course of time be supplied profitably
at that lower price, to meet a fairly steady corresponding demand. We exclude
from view any economies that may result from substantive new inventions;
but we include those which may be expected to arise naturally out of adaptations
of existing ideas; and we look towards a position of balance or equilibrium
between the forces of progress and decay, which would be attained if the
conditions under view were supposed to act uniformly for a long time. But
such notions must be taken broadly. The attempt to make them precise over-reaches
our strength. If we include in our account nearly all the conditions of real
life, the problem is too heavy to be handled; if we select a few, then long-drawn-out
and subtle reasonings with regard to them become scientific toys rather than
engines for practical work.




The theory of stable equilibrium of normal demand and supply helps indeed
to give definiteness to our ideas; and in its elementary stages it does not
diverge from the actual facts of life, so far as to prevent its giving a
fairly trustworthy picture of the chief methods of action of the strongest
and most persistent group of economic forces. But when pushed to its more
remote and intricate logical consequences, it slips away from the conditions
of real life. In fact we are here verging on the high theme of economic progress;
and here therefore it is especially needful to remember that economic problems
are imperfectly presented when they are treated as problems of statical equilibrium,
and not of organic growth. For though the statical treatment alone can give
us definiteness and precision of thought, and is therefore a necessary introduction
to a more philosophic treatment of society as an organism; it is yet only
an introduction.




The Statical theory of equilibrium is only an introduction to economic
studies; and it is barely even an introduction to the study of the progress
and development of industries which show a tendency to increasing return.
Its limitations are so constantly overlooked, especially by those who approach
it from an abstract point of view, that there is a danger in throwing it
into definite form at all. But, with this caution, the risk may be taken;
and a short study of the subject is given in Appendix H.




NOTES:




1. See above III, IV, section 5.




2. Strictly speaking, the amount produced and the price at which it can
be sold, are functions one of another, account being taken of the length
of time allowed for the evolution of appropriate plant and organization for
production on a large scale. But in real life, the cost of production per
unit is deduced from the amount expected to be produced, and not vice versa.
Economists commonly follow this practice; and they follow also the practice
of business life in inverting this order with regard to demand. That is,
they consider the increase of sales that will follow from a given reduction
of price, more frequently than the diminution of price which will be required
to effect a given increase of sales.




3. See IV, IX-XIII; and especially XI, section 5.




4. This may be expressed by saying that when we are considering an individual
producer, we must couple his supply curve not with the general demand curve
for his commodity in a wide market, but with the particular demand curve
of his own special market. And this particular demand curve will generally
be very steep; perhaps as steep as his own supply curve is likely to be,
even when an increased output will give him an important increase of internal
economies.




5. Of course this rule is not universal. It may be noted, for instance,
that the net loss of an omnibus, that is short of passengers throughout its
trip, and loses a fourpenny fare, is nearer fourpence than threepence, though
the omnibus trade conforms perhaps to the law of constant return. Again,
if it were not for the fear of spoiling his market, the Regent Street shoemaker,
whose goods are made by hand, but whose expenses of marketing are very heavy,
would be tempted to go further below his normal price in order to avoid losing
a special order, than a shoe manu facturer who uses much expensive machinery
and avails himself generally of the economies of production on a large scale.
There are other difficulties connected with the supplementary costs of joint
products, e.g. the practice ofselling some goods at near prime cost, for
the purpose of advertisement (see above V, VII, section 2). But these need
not be specially considered here.




6. Abstract reasonings as to the effects of the economies in production,
which an individual firm gets from an increase of its output are apt to be
misleading, not only in detail, but even in their general effect. This is
nearly the same as saying that in such case the conditions governing supply
should be represented in their totality. They are often vitiated by difficulties
which lie rather below the surface, and are especially troublesome in attempts
to express the equilibrium conditions of trade by mathematical formula. Some,
among whom Cournot himself is to be counted, have before them what is in
effect the supply schedule of an individual firm; representing that an increase
in its output gives it command over so great internal economies as much to
diminish its expenses of production; and they follow their mathematics boldly,
but apparently without noticing that their premises lead inevitably to the
conclusion that, whatever firm first gets a good start will obtain a monopoly
of the whole business of its trade in its district. While others avoiding
this horn of the dilemma, maintain that there is no equilibrium at all for
commodities which obey the law of increasing return; and some again have
called in question the validity of any supply schedule which represents prices
diminishing as the amount produced increases. See Mathematical Note XIV,
where reference is made to this discussion.




The remedy for such difficulties as these is to be sought in treating
each important concrete case very much as an independent problem, under the
guidance of staple general reasonings. Attempts so to enlarge the direct
applications of general propositions as to enable them to supply adequate
solutions of all difficulties, would make them so cumbrous as to be of little
service for their main work. The "principles" of economics must
aim at affording guidance to an entry on problems of life, without making
claim to be a substitute for independent study and thought.




7. See above V, V, section 6.




CHAPTER XIII




THEORY OF CHANGES OF NORMAL DEMAND AND SUPPLY IN RELATION TO THE DOCTRINE
OF MAXIMUM SATISFACTION




1. In earlier chapters of this Book, and especially in chapter XII, we
have considered gradual changes in the adjustment of demand and supply. But
any great and lasting change in fashion; any substantive new invention; any
diminution of population by war or pestilence; or the development or dwindling
away of a source of supply of the commodity in question, or of a raw material
used in it, or of another commodity which is a rival and possible substitute
for it: -- such a change as any of these may cause the prices set against
any given annual (or daily) consumption and production of the commodity to
cease to be its normal demand and supply prices for that volume of consumption
and production; or, in other words, they may render it necessary to make
out a new demand schedule or a new supply schedule, or both of them. We proceed
to study the problems thus suggested.




An increase of normal demand for a commodity involves an increase in the
price at which each several amount can find purchasers; or, which is the
same thing, an increase of the quantity which can find purchasers at any
price. This increase of demand may be caused by the commodity's coming more
into fashion, by the opening out of a new use for it or of new markets for
it, by the permanent falling off in the supply of some commodity for which
it can be used as a substitute, by a permanent increase in the wealth and
general purchasing power of the community, and so on. Changes in the opposite
direction will cause a falling off in demand and a sinking of the demand
prices. Similarly an increase of normal supply means an increase of the amounts
that can be supplied at each several price, and a diminution of the price
at which each separate amount can be supplied.(1*) This change may be caused
by the opening up of a new source of supply, whether by improved means of
transport or in any other way, by an advance in the arts of production, such
as the invention of a new process or of new machinery, or again, by the granting
of a bounty on production. Conversely, a diminution of normal supply (or
a raising of the supply schedule) may be caused by the closing up of a new
source of supply or by the imposition of a tax.




2. We have, then, to regard the effects of an increase of normal demand
from three points of view, according as the commodity in question obeys the
law of constant or of diminishing or of increasing return: that is, its supply
price is practically constant for all amounts, or increases or diminishes
with an increase in the amount produced.




In the first case an increase of demand simply increases the amount produced
without altering its price; for the normal price of a commodity which obeys
the law of constant return is determined absolutely by its expenses of production:
demand has no influence in the matter beyond this, that the thing will not
be produced at all unless there is some demand for it at this fixed price.




If the commodity obeys the law of diminishing return an increase of demand
for it raises its price and causes more of it to be produced; but not so
much more as if it obeyed the law of constant return.




On the other hand, if the commodity obeys the law of increasing return,
an increase of demand causes much more of it to be produced, -- more than
if the commodity obeyed the law of constant return, -- and at the same time
lowers its price. If, for instance, a thousand things of a certain kind have
been produced and sold weekly at a price of 10s., while the supply price
for two thousand weekly would be only 9s., a small rate of increase in normal
demand may gradually cause this to become the normal price; since we are
considering periods long enough for the full normal action of the causes
that determine supply to work itself out. The converse holds in each case
should normal demand fall off instead of increasing.(2*)




The argument of this section has been thought by some writers to lend
support to the claim that a Protective duty on manufactured imports in general
increases the home market for those imports; and, by calling into play the
Law of Increasing Return, ultimately lowers their price to the home consumer.
Such a result may indeed ultimately be reached by a wisely chosen system
of "Protection to nascent industries" in a new country; where manufactures,
like young children, have a power of rapid growth. But even there the policy
is apt to be wrenched from its proper uses, to the enrichment of particular
interests: for those industries which can send the greatest number of votes
to the poll, are those which are already on so large a scale, that a further
increase would bring very few new economies. And of course the industries
in a country so long familiar with machinery as England is, have generally
passed the stage at which they can derive much real help from such Protection:
while Protection to any one industry nearly always tends to narrow the markets,
especially the foreign markets, for other industries. These few remarks show
that the question is complex: they do not pretend to reach further than that.




3. We have seen that an increase in normal demand, while leading in every
case to an increased production, will in some cases raise and in others lower
prices. But now we are to see that increased facilities for supply (causing
the supply schedule to be lowered) will always lower the normal price at
the same time that it leads to an increase in the amount produced. For so
long as the normal demand remains unchanged an increased supply can be sold
only at a diminished price; but the fall of price consequent on a given increase
of supply will be much greater in some cases than in others. It will be small
if the commodity obeys the law of diminishing return; because then the difficulties
attendant on an increased production will tend to counteract the new facilities
of supply. On the other hand, if the commodity obeys the law of increasing
return, the increased production will bring with it increased facilities,
which will co-operate with those arising from the change in the general conditions
of supply; and the two together will enable a great increase in production
and consequent fall in price to be attained before the fall of the supply
price is overtaken by the fall of the demand price. If it happens that the
demand is very elastic, then a small increase in the facilities of normal
supply, such as a new invention, a new application of machinery, the opening
up of new and cheaper sources of supply, the taking off a tax or granting
a bounty, may cause an enormous increase of production and fall of price.(3*)




If we take account of the circumstances of composite and joint supply
and demand discussed in chapter VI, we have suggested to us an almost endless
variety of problems which can be worked out by the methods adopted in these
two chapters.




4. We may now consider the effects which a change in the conditions of
supply may exert on consumers' surplus or rent. For brevity of language a
tax may be taken as representative of those changes which may cause a general
increase, and a bounty as representative of those which may cause a general
diminution in the normal supply price for each several amount of the commodity.




Firstly, if the commodity is one, the production of which obeys the law
of constant return, so that the supply price is the same for all amounts
of the commodity, consumers' surplus will be diminished by more than the
increased payments to the producer; and therefore, in the special case of
a tax, by more than the gross receipts of the State. For on that part of
the consumption of the commodity, which is maintained, the consumer loses
what the State receives: and on that part of the consumption which is destroyed
by the rise in price, the consumers' surplus is destroyed; and of course
there is no payment for it to the producer or to the State.(4*) Conversely,
the gain of consumers' surplus caused by a bounty on a commodity that obeys
the law of constant return, is less than the bounty itself. For on that part
of the consumption which existed before the bounty, consumers' surplus is
increased by just the amount of the bounty; while on the new consumption
that is caused by the bounty, the gain of the consumers' surplus is less
than the bounty.(5*)




If however the commodity obeys the law of diminishing return; a tax by
raising its price, and diminishing its consumption, will lower its expenses
of production other than the tax: and the result will be to raise the supply
price by something less than the full amount of the tax. In this case the
gross receipts from the tax may be greater than the resulting loss of consumers'
surplus, and they will be greater if the law of diminishing return acts so
sharply that a small diminution of consumption causes a great falling-off
in the expenses of production other than the tax.(6*)




On the other hand, a bounty on a commodity which obeys the law of diminishing
return will lead to increased production, and will extend the margin of cultivation
to places and conditions in which the expenses of production, exclusive of
the bounty, are greater than before. Thus it will lower the price to the
consumer and increase consumers' surplus less than if it were given for the
production of a commodity which obeyed the law of constant return. In that
case the increase of consumers' surplus was seen to be less than the direct
cost of the bounty to the State; and therefore in this case it is much less.(7*)




By similar reasoning it may be shown that a tax on a commodity which obeys
the law of increasing return is more injurious to the consumer than if levied
on one which obeys the law of constant return. For it lessens the demand
and therefore the output. It thus probably increases the expenses of manufacture
somewhat: sends up the price by more than the amount of the tax; and finally
diminishes consumers' surplus by much more than the total payments which
it brings in to the exchequer.(8*) On the other hand, a bounty on such a
commodity causes so great a fall in its price to the consumer, that the consequent
increase of consumers' surplus may exceed the total payments made by the
State to the producers; and certainly will do so in case the law of increasing
return acts at all sharply.(9*)




These results are suggestive of some principles of taxation which require
careful attention in any study of financial policy; when it will be necessary
to take account of the expenses of collecting a tax and of administering
a bounty, and of the many indirect effects, some economic and some moral,
which a tax or a bounty is likely to produce. But these partial results are
well adapted for our immediate purpose of examining a little more closely
than we have done hitherto the general doctrine that a position of (stable)
equilibrium of demand and supply is a position also of maximum satisfaction:
and there is one abstract and trenchant form of that doctrine which has had
much vogue, especially since the time of Bastiat's Economic Harmonies, and
which falls within the narrow range of the present discussion.




5. There is indeed one interpretation of the doctrine according to which
every position of equilibrium of demand and supply may fairly be regarded
as a position of maximum satisfaction.(10*) For it is true that so long as
the demand price is in excess of the supply price, exchanges can be effected
at prices which give a surplus of satisfaction to buyer or to seller or to
both. The marginal utility of what he receives is greater than that of what
he gives up, to at least one of the two parties; while the other, if he does
not gain by the exchange, yet does not lose by it. So far then every step
in the exchange increases the aggregate satisfaction of the two parties.
But when equilibrium has been reached, demand price being now equal to supply
price, there is no room for any such surplus: the marginal utility of what
each receives no longer exceeds that of what he gives up in exchange: and
when the production increases beyond the equilibrium amount, the demand price
being now less than the supply price, no terms can be arranged which will
be acceptable to the buyer, and will not involve a loss to the seller.




It is true then that a position of equilibrium of demand and supply is
a position of maximum satisfaction in this limited sense. that the aggregate
satisfaction of the two parties concerned increases until that position is
reached; and that any production beyond the equilibrium amount could not
be permanently maintained so long as buyers and sellers acted freely as individuals,
each in his own interest.




But occasionally it is stated, and very often it is implied, that a position
of equilibrium of demand and supply is one of maximum aggregate satisfaction
in the full sense of the term: that is, that an increase of production beyond
the equilibrium level would directly (i.e. independently of the difficulties
of arranging for it, and of any indirect evils it might cause) diminish the
aggregate satisfaction of both parties. The doctrine so interpreted is not
universally true.




In the first place it assumes that all differences in wealth between the
different parties concerned may be neglected, and that the satisfaction which
is rated at a shilling by any one of them, may be taken as equal to one that
is rated at a shilling by any other. Now it is obvious that, if the producers
were as a class very much poorer than the consumers, the aggregate satisfaction
might be increased by a stinting of supply when it would cause a great rise
in demand price (i.e. when the demand is inelastic); and that if the consumers
were as a class much poorer than the producers, the aggregate satisfaction
might be increased by extending the production beyond the equilibrium amount
and selling the commodity at a loss.(11*)




This point however may well be left for future consideration. It is in
fact only a special case of the broad proposition that the aggregate satisfaction
can prima facie be increased by the distribution, whether voluntarily or
compulsorily, of some of the property of the rich among the poor; and it
is reasonable that the bearings of this proposition should be set aside during
the first stages of an inquiry into existing economic conditions. This assumption
therefore may be properly made, provided only it is not allowed to slip out
of sight.




But in the second place the doctrine of maximum satisfaction assumes that
every fall in the price which producers receive for the commodity, involves
a corresponding loss to them; and this is not true of a fall in price which
results from improvements in industrial organization. When a commodity obeys
the law of increasing return, an increase in its production beyond equilibrium
point may cause the supply price to fall much; and though the demand price
for the increased amount may be reduced even more, so that the production
would result in some loss to the producers, yet this loss may be very much
less than that money value of the gain to purchasers which is represented
by the increase of consumers' surplus.




In the case then of commodities with regard to which the law of increasing
return acts at all sharply, or in other words, for which the normal supply
price diminishes rapidly as the amount produced increases, the direct expense
of a bounty sufficient to call forth a greatly increased supply at a much
lower price, would be much less than the consequent increase of consumers'
surplus. And if a general agreement could be obtained among consumers, terms
might be arranged which would make such action amply remunerative to the
producers, at the same time that they left a large balance of advantage to
the consumers.(12*)




6. One simple plan would be the levying of a tax by the community on their
own incomes, or on the production of goods which obey the law of diminishing
return, and devoting the tax to a bounty on the production of those goods
with regard to which the law of increasing return acts sharply. But before
deciding on such a course they would have to take account of considerations,
which are not within the scope of the general theory now before us, but are
yet of great practical importance. They would have to reckon up the direct
and indirect costs of collecting a tax and administering a bounty; the difficulty
of securing that the burdens of the tax and the benefits of the bounty were
equitably distributed; the openings for fraud and corruption; and the danger
that in the trade which had got a bounty and in other trades which hoped
to get one, people would divert their energies from managing their own businesses
to managing those persons who control the bounties.




Besides these semi-ethical questions there will arise others of a strictly
economic nature, relating to the effects which any particular tax or bounty
may exert on the interests of landlords, urban or agricultural, who own land
adapted for the production of the commodity in question. These are questions
which must not be overlooked; but they differ so much in their detail that
they cannot fitly be discussed here.(13*)




7. Enough has been said to indicate the character of the second great
limitation which has to be introduced into the doctrine that the maximum
satisfaction is generally to be attained by encouraging each individual to
spend his own resources in that way which suits him best. It is clear that
if he spends his income in such a way as to increase the demand for the services
of the poor and to increase their incomes, he adds something more to the
total happiness than if he adds an equal amount to the incomes of the rich,
because the happiness which an additional shilling brings to a poor man is
much greater than that which it brings to a rich one; and that he does good
by buying things the production of which raises, in preference to things
the production of which lowers the character of those who make them.(14*)
But further, even if we assume that a shilling's worth of happiness is of
equal importance to whomsoever it comes, and that every shilling's worth
of consumers' surplus is of equal importance from whatever commodity it is
derived, we have to admit that the manner in which a person spends his income
is a matter of direct economic concern to the community. For in so far as
he spends it on things which obey the law of diminishing return, he makes
those things more difficult to be obtained by his neighbours, and thus lowers
the real purchasing power of their incomes; while in so far as he spends
it on things which obey the law of increasing return, he makes those things
more easy of attainment to others, and thus increases the real purchasing
power of their incomes.




Again, it is commonly argued that an equal ad valorem tax levied on all
economic commodities (material and immaterial). or which is the same thing
a tax on expenditure, is prima facie the best tax; because it does not divert
the expenditure of individuals out of its natural channels: we have now seen
that this argument is invalid. But ignoring for the time the fact that the
direct economic effect of a tax or a bounty never constitutes the whole,
and very often not even the chief part of the considerations which have to
be weighed before deciding to adopt it, we have found: -- firstly, that a
tax on expenditure generally causes a greater destruction of consumers, surplus
than one levied exclusively on commodities as to which there is but little
room for the economies of production on a large scale, and which obey the
law of diminishing return; and secondly, that it might even be for the advantage
of the community that the government should levy taxes on commodities which
obey the law of diminishing return, and devote part of the proceeds to bounties
on commodities which obey the law of increasing return.




These conclusions, it will be observed, do not by themselves afford a
valid ground for government interference. But they show that much remains
to be done, by a careful collection of the statistics of demand and supply,
and a scientific interpretation of their results, in order to discover what
are the limits of the work that society can with advantage do towards turning
the economic actions of individuals into those channels in which they will
add the most to the sum total of happiness.(15*)




NOTES:




1. A rise or fall of the demand or supply prices involves of course a
rise or fall of the demand or supply curve.




If the change is gradual, the supply curve will assume in succession a
series of positions, each of which is a little below the preceding one; and
in this way we might have represented the effects of that gradual improvement
of industrial organization which arises from an increase in the scale of
production, and which we have represented by assigning to it an influence
upon the supply price for long-period curves. In an ingenious paper privately
printed by Sir H. Cunynghame, a suggestion is made, which seems to come in
effect to proposing that a long-period supply curve should be regarded as
in some manner representing a series of short-period curves; each of these
curves would assume throughout its whole length that development of industrial
organization which properly belongs to the scale of production represented
by the distance from Oy of the point in which that curve cuts the long period
supply curve (compare Appendix H, § 3) and similarly with regard to
demand.




2. Diagrams are of especial aid in enabling us to comprehend clearly the
problems of this chapter.




The three figures 24, 25, 26 represent the three cases of constant, diminishing
and increasing return respectively. The return in the last case is a diminishing
one in the earlier stages of the increase of production, but an increasing
one in those subsequent to the attainment of the original position of equilibrium,
i.e. for amounts of the commodity greater than OH. In each case SS' is the
supply curve, DD' the old position of the demand curve, and dd' its position
after there has been increase of normal demand. In each case A and a are
the old and new positions of equilibrium respectively, AH and ah are the
old and new normal or equilibrium prices, and OH and Oh the old and new equilibrium
amounts. Oh is in every case greater than OH, but in fig. 25 it is only a
little greater, while in fig. 26 it is much greater. (This analysis may be
carried further on the plan adopted later on in discussing the similar but
more important problem of the effects of changes in the conditions of normal
supply.) In fig. 24 ah is equal to AH, in fig. 25 it is greater, in fig.
26 it is less.




The effect of a falling off of normal demand can be traced with the same
diagrams, dd' being now regarded as the old and DD' as the new position of
this demand curve; ah being the old equilibrium price, and AH the new one.




3. All this can be most clearly seen by the aid of diagrams, and indeed
there are some parts of the problem which cannot be satisfactorily treated
without their aid. The three figures 27, 28, 29 represent the three cases
of constant and diminishing and increasing returns, respectively. In each
case DD' is the demand curve, SS' the old position, and ss' the new position
of the supply curve. A is the old, and a the new position of stable equilibrium.
Oh is greater than OH, and ah is less than AH in every case: but the changes
are small in fig. 28 and great in fig. 29. Of course the demand curve must
lie below the old supply curve to the right of A, otherwise A would be a
point not of stable, but of unstable equilibrium.




But subject to this condition the more elastic the demand is, that is,
the more nearly horizontal the demand curve is at A the further off will
a be from A, and the greater therefore will be the increase of production
and the fall of price.




The whole result is rather complex. But it may be stated thus. Firstly,
given the elasticity of demand at A, the increase in the quantity produced
and the fall in price will both be the greater, the greater be the return
got from additional capital and labour applied to the production. That is,
they w.ill be the greater, the more nearly horizontal the supply curve is
at A in fig. 28, and the more steeply inclined it is in fig. 29 (subject
to the condition mentioned above, that it does not lie below the demand curve
to the right of A, and thus turn A into a position of unstable equilibrium).
Secondly, given the position of the supply curve at A, the greater the elasticity
of demand the greater will be the increase of production in every case; but
the smaller will be the fall of price in fig. 28, and the greater the fall
of price in fig. 29. Fig. 27 may be regarded as a limiting case of either
fig. 28 or 29.




All this reasoning assumes that the commodity either obeys the law of
diminishing return or obeys the law of increasing return throughout. If it
obeys first one, and then the other, so that the supply curve is at one part
inclined positively and at another negatively, no general rule can be laid
down as to the effect on price of increased facilities of supply, though
in every case this must lead to an increased volume of production. A great
variety of curious results may be got by giving the supply curve different
shapes, and in particular such as cut the demand curve more than once.




This method of inquiry is not applicable to a tax on wheat in so far as
it is consumed by a labouring class which spends a great part of its income
on bread; and it is not applicable to a general tax on all commodities: for
in neither of these cases can it be assumed that the marginal value of money
to the individual remains approximately the same after the tax has been levied
as it was before.




4. This is most clearly seen by aid of a diagram. SS', the old constant
return supply curve, cuts DD' the demand curve in A: DSA is the consumers'
surplus. Afterwards a tax Ss being imposed the new equilibrium is found at
a, and consumers' surplus is Dsa. The gross tax is only the rectangle sSKa,
that is, a tax at the rate of Ss on an amount sa of the commodity. And this
falls short of the loss of consumers' surplus by the area aKA. The net loss
aKA is small or great, other things being equal, as aA is or is not inclined
steeply. Thus it is smallest for those commodities the demand for which is
most inelastic, that is, for necessaries. If therefore a given aggregate
taxation has to be levied ruthlessly from any class it will cause less loss
of consumers' surplus if levied on necessaries than if levied on comforts;
though of course the consumption of luxuries and in a less degree of comforts
indicates ability to bear taxation.




5. If we now regard ss' as the old supply curve which is lowered to the
position SS' by the granting of a bounty, we find the gain of consumers'
surplus to be sSAa. But the bounty paid is Ss on an amount SA, which is represented
by the rectangle sSAL: and this exceeds the gain of consumers' surplus by
the area aLA.




6. Let the old supply curve be SS' fig. 31, and let the imposition of
a tax raise it to ss'; let A and a be the old and new positions of equilibrium,
and let straight lines be drawn through them parallel to Ox and Oy, as in
the figure. Then the tax being levied, as shown by the figure, at the rate
of aE on each unit; and Oh, that is, CK units, being produced in the new
position of equilibrium, the gross receipts of the tax will be cFEa, and
the loss of consumers' surplus will be cCAa; that is, the gross receipts
from the tax will be greater or less than the loss of consumers' surplus
as CFEK is greater or less than aKA; and in the figure as its stands it is
much greater. If SS' had been so drawn as to indicate only very slight action
of the law of diminishing return, that is, if it had been nearly horizontal
in the neighbourhood of A, then EK would have been very small; and CFEK would
have become less than aKA.




7. To illustrate this case we may take ss' in fig. 31 to be the position
of the supply curve before the granting of the bounty, and SS' to be its
position afterwards. Thus a was the old equilibrium point, and A is the point
to which the equilibrium moves when the bounty is awarded. The increase of
consumers' surplus is only cCAa, while the payments made by the State under
the bounty are, as shown by the figure, at the rate of AT on each unit of
the commodity; and as in the new position of equilibrium there are produced
OH, that is, CA units, they amount altogether to RCAT which includes and
is necessarily greater than the increase of consumers' surplus.




8. Thus taking SS' in fig. 32 to be the old position of the supply curve,
and ss' its position after the tax, A to be the old and a the new positions
of equilibrium, we have, as in the case of fig. 31, the total tax represented
by cFEa, and the loss of consumers' surplus by' cCAa; the former being always
less than the latter.




The statement in the text is put broadly and in simple outline. If it
were applied to practical problems account would need to be taken of several
considerations which have been ignored. An industry which yields an increasing
return, is nearly sure to be growing, and therefore to be acquiring new economies
of production on a large scale. If the tax is a small one, it may merely
retard this growth and not cause a positive shrinking. Even if the tax is
heavy and the industry shrinks, many of the economies gained will be in part
at least preserved; as is explained above in Appendix H. In consequence ss'
ought properly not to have the same shape as SS', and the distance aE ought
to be less than AT.




9. To illustrate this case we may take ss' in fig. 32 to be the position
of the supply curve before the granting of the bounty, and SS' to be its
position afterwards. Then, as in the case of fig. 31, the increase of consumers'
surplus is represented by cCAa, while the direct payments made by the State
under the bounty are represented by RCHT. As the figure is drawn, the former
is much larger than the latter. But it is true that if we had drawn ss' so
as to indicate it had a very slight action of the law of increasing return,
that is, if it had been very nearly horizontal in the neighbourhood of a,
the bounty would have increased relatively to the gain of consumers' surplus;
and the case would have differed but little from that of a bounty on a commodity
which obeys the law of constant return, represented in fig. 30.




10. Compare V, II, section 1. Unstable equilibrinm may now be left out
of account.




11. In this illustration one of the two things exchanged is general purchasing
power; but of course the argument would hold if a poor population of pearl
divers were dependent for food on a rich population who took pearls in exchange.




12. Though not of great practical importance, the case of multiple positions
of (stable) equilibrium offers a good illustration of the error involved
in the doctrine of maximum satisfaction when stated as a universal truth.
For the position in which a small amount is produced and is sold at a high
price would be the first to be reached, and when reached would be regarded
according to that doctrine as that which gave the absolute maximum of aggregate
satisfaction. But another position of equilibrium corresponding to a larger
production and a lower price would be equally satisfactory to the producers,
and would be much more satisfactory to the consumers; the excess of consumers'
surplus in the second case over the first would represent the increase in
aggregate satisfaction.




13. The incidence of a tax on agricultural produce will be discussed later
on by the aid of diagrams similar to those used to represent the fertility
of land (see IV, III). Landlords' rent absorbs a share of the aggregate selling
price of almost all commodities: but it is most prominent in the case of
those which obev the law of diminishing return; and an assumption of no extreme
violence will enable fig. 33 (a reproduction of 31) to represent roughly
the leading features of the problem.




It will be argued in Appendix H, section 1, that we are not properly at
liberty to assume that the expenses of raising the produce from the richer
lands and under the more favourable circumstances are independent of the
extent to which the production is carried; since an increased produc tion
is likely to lead to an improved organization, if not of farming industries
themselves, yet of those subsidiary to them, and especially of the carrying
trade. We may however permit ourselves to make this assumption provisionally,
so as to get a clear view of the broad outlines of the problem; though we
must not forget thatin anyapplicationsofthe generalreasonings based on it
account must be taken of the facts which we here ignore. On this assumption
then SS' being the supply curve before the imposition of a tax, landlords'
rent is represented by CSA. After the tax has been imposed and the supply
curve raised to ss' the landlords' rent becomes the amount bv which cOha,
the total price got for Oh produce sold at the rate ha, exceeds the total
tax cFEa, together with OhES the total expenses of production, exclusive
of rent, For Oh produce: that is, it becomes FSE. (In the figure the curve
ss' has the same shape as SS', thereby implying that the tax is specific;
that is, is a uniform charge on each unit of the commodity whatever be its
value. The argument so far does not depend on this assumption, but if it
is made we can by a shorter route get the new landlords' rent at csa, which
then is equal to FSE.) Thus the loss of landlords' rent is CFEA; and this
added to cCAa the loss of consumers' surplus, makes up cFEAa, which exceeds
the gross tax by aAE.




On the other hand, the direct payments under a bounty would exceed the
increase of consumers' surplus, and of landlords' surplus calculated on the
above assumptions. For taking ss' to be the original position of the supply
curve, and SS' to be its position after the bounty, the new landlords' surplus
on these assumptions is CSA, or which is the same thing RsT; and this exceeds
the old landlords' rent csa bv RcaT. The increase of consumers' surplus is
cCAa; and therefore the total bounty, which is RCAT, exceeds the gain of
consumers' surplus and landlords' rent together by TaA.




For reasons stated in Appendix H, § 3, the assumption on which this
reasoning proceeds is inapplicable to cases in which the supplv curve is
inclined negatively.




14. Compare III, VI.




15. It is remarkable that Malthus, Political Economy, ch. III, section
9, argued that, though the difficulties thrown in the way of importing Foreign
corn during the great war turned capital from the more profitable employment
of manufacture to the less profitable employment of agriculture, yet if we
take account of the consequent increase of agricultural rent, we may conclude
that the new channel may have been one of "higher national, though not
higher individual profits." In this no doubt he was right; but he overlooked
the far more important injury inflicted on the public by the consequent rise
in the price of corn, and the consequent destruction of consumers' surplus.
Senior takes account of the interests of the consumer in his study of the
different effects of increased demand on the one hand and of taxation on
the other in the case of agricultural and manufactured produce (Political
Economy, pp. 118-23). Advocates of Protection in countries which export raw
produce have made use of arguments tending in the same direction as those
given in this Chapter; and similar arguments are now used, especially in
America (as for instance by Mr H. C. Adams), in support of the active participation
of the State in industries which conform to the law of increasing return.
The graphic method has been applied, in a manner somewhat similar to that
adopted in the present Chapter, by Dupuit in 1844; and, independently, by
Fleeming Jenkin (Edinburgh Philosophical Transactions) in 1871.




CHAPTER XIV




THE THEORY OF MONOPOLIES




1. It has never been supposed that the monopolist in seeking his own advantage
is naturally guided in that course which is most conducive to the wellbeing
of society regarded as a whole, he himself being reckoned as of no more importance
than any other member of it. The doctrine of Maximum Satisfaction has never
been applied to the demand for and supply of monopolized commodities. But
there is much to be learnt from a study of the relations in which the interests
of the monopolist stand to those of the rest of society, and of the general
conditions under which it might be possible to make arrangements more beneficial
to society as a whole than those which he would adopt if he consulted only
his own interests: and with this end in view we are now to seek for a scheme
for comparing the relative quantities of the benefits which may accrue to
the public and to the monopolist from the adoption of different courses of
action by him. In a later volume a study will be made of the Protean shapes
of modern trade combinations and monopolies, some of the most important of
which, as for example "Trusts," are of very recent growth. At present
we consider only those general causes determining monopoly values, that can
be traced with more or less distinctness in every case in which a single
person or association of persons has the power of fixing either the amount
of a commodity that is offered for sale or the price at which it is offered.




2. The prima facie interest of the owner of a monopoly is clearly to adjust
the supply to the demand, not in such a way that the price at which he can
sell his commodity shall just cover its expenses of production, but in such
a way as to afford him the greatest possible total net revenue.




But here we meet with a difficulty as to the meaning of the term Net revenue.
For the supply price of a freely-produced commodity includes normal profits;
the whole of which, or at all events what remains of them after deducting
interest on the capital employed and insurance against loss, is often classed
indiscriminately as net revenue. And when a man manages his own business,
he often does not distinguish carefully that portion of his profits, which
really is his own earnings of management, from any exceptional gains arising
from the fact that the business is to some extent of the nature of a monopoly.




This difficulty however is in a great measure avoided in the case of a
public company; where all, or nearly all, the expenses of management are
entered in the ledger as definite sums, and are subtracted from the total
receipts of the company before its net income is declared.




The net income divided among the shareholders includes interest on the
capital invested and insurance against risk of failure, but little or no
earnings of management; so that the amount by which the dividends are in
excess of what may fairly be allowed as interest and insurance, is the Monopoly
Revenue which we are seeking.




Since then it is much easier to specify exactly the amount of this net
revenue when a monopoly is owned by a public company than when it is owned
by an individual or private firm, let us take as a typical instance the case
of a gas company that has the monopoly of the supply of gas to a town. For
the sake of simplicity the company may be supposed to have already invested
the whole of its own capital in fixed plant, and to borrow any more capital,
that it may want to extend its business, on debentures at a fixed rate of
interest.




3. The demand schedule for gas remains the same as it would be if gas
were a freely-produced commodity; it specifies the price per thousand feet
at which consumers in the town will among them use any given number of feet.
But the supply schedule must represent the normal expenses of production
of each several amount supplied; and these include interest on all its capital,
whether belonging to its shareholders or borrowed on debentures, at a fixed
normal rate; they include also the salaries of its directors, and permanent
officials, adjusted (more or less accurately) to the work required of them,
and therefore increasing with an increase in the output of gas. A monopoly
revenue schedule may then be constructed thus: -- Having set against each
several amount of the commodity its demand price, and its supply price estimated
on the plan just described, subtract each supply price from the corresponding
demand price and set the residue in the monopoly revenue column against the
corresponding amount of the commodity.




Thus for instance if a thousand million feet could be sold annually at
a price of 3s. per thousand feet, and the supply price for this amount were
2s. 9d. per thousand feet, the monopoly revenue schedule would show 3d. against
this amount; indicating an aggregate net revenue when this amount was sold,
of three million pence, or £12,500. The aim of the company, having regard
only to their own immediate dividends, will be to fix the price of their
gas at such a level as to make this aggregate net revenue the largest possible.(1*)




4. Now suppose that a change takes place in the conditions of supply;
some new expense has to be incurred, or some old expense can be avoided;
or perhaps a new tax is imposed on the undertaking or a bounty is awarded
to it.




First let this increase or diminution of the expenses be a fixed sum,
bearing on the undertaking as one undivided whole and not varying with the
amount of the commodity produced. Then, whatever be the price charged and
the amount of the commodity sold, the monopoly revenue will be increased
or diminished, as the case may be, by this sum; and therefore that selling
price which afforded the maximum monopoly revenue before the change will
afford it afterwards; the change therefore will not offer to the monopolist
any inducement to alter his course of action. Suppose for instance that the
maximum monopoly revenue is got when twelve hundred million cubic feet are
sold annually; and that this is done when the price is fixed at 30d. per
thousand feet: suppose that the expenses of production for this amount are
at the rate of 26d., leaving a monopoly revenue at the rate of four pence
per thousand feet, that is £20,000 in all. This is its maximum value:
if the company fixed the price higher at, say, 31d. and sold only eleven
hundred million feet, they would perhaps get a monopoly revenue at the rate
of 4.2 pence per thousand feet, that is £19,250 in all; while in order
to sell thirteen hundred millions they would have to lower their price to,
say, 28d. and would get a monopoly revenue at the rate of perhaps 3.6d. per
thousand feet, that is £19,500 in all. Thus by fixing the price at 30d.
they get £750 more than by fixing it at 31d., and £500 more than
by fixing it at 28d. Now let a tax of £10,000 a year be levied on the
gas company as a fixed sum independent of the amount they sell. Their monopoly
revenue will become £10,000 if they charge 30d., £9,250 if they
charge 31d., and £9,500 if they charge 28d. They will therefore continue
to charge 30d.




The same is true of a tax or a bounty proportioned not to the gross receipts
of the undertaking, but to its monopoly revenue. For suppose next that a
tax is levied, not of one fixed sum, but a certain percentage, say 50 per
cent of the monopoly revenue. The company will then retain a monopoly revenue
of £10,000 if they charge 30d., of £9,625 if they charge 31d.,
and of £9,750 if they charge 28d. They will therefore still charge 30d.(2*)




On the other hand a tax proportional to the amount produced gives an inducement
to the monopolist to lessen his output and raise his price. For by so doing
he diminishes his expenses. And the excess of total receipts over total outlay
may therefore be now increased by a diminution of output; though before the
imposition of the tax it would have been lessened. Further, if before the
imposition of the tax the net revenue was only a little greater than that
which would have been afforded by much smaller sales, then the monopolist
would gain by reducing his production very greatly; and hence in such cases
as this, the change is likely to cause a very great diminution of production
and rise of price. The opposite effects will be caused by a change which
diminishes the expense of working the monopoly by a sum that varies directly
with the amount produced under it.




In the last example, for instance, a tax of 2d. on each thousand feet
sold would have reduced the monopoly revenue to £10,083 if the company
charged 31d. per thousand feet and therefore sold eleven hundred millions;
to £10,000 if they charged 30d. and therefore sold twelve hundred millions,
and to £8,666 if they charged 28d. and therefore sold thirteen hundred
million feet. Therefore the tax would induce the company to raise the price
to something higher than 30d.; they would perhaps go to 31d., perhaps somewhat
higher; for the figures before us do not show exactly how far it would be
their interest to go.




On the other hand, if there were a bounty of 2d. on the sale of each thousand
feet, the monopoly revenue would rise to £28,416 if they charged 31d.,
to £30,000 if they charged 30d., and to £30,333 if they charged
28d.: it would therefore cause them to lower the price. And of course the
same result would follow from an improvement in the method of making gas,
which lowered its cost of production to the monopolist company by 2d. per
1000 feet.(3*)




5. The monopolist would lose all his monopoly revenue if he produced for
sale an amount so great that its supply price, as here defined, was equal
to its demand price: the amount which gives the maximum monopoly revenue
is always considerably less than that. It may therefore appear as though
the amount produced under a monopoly is always less and its price to the
consumer always higher than if there were no monopoly. But this is not the
case.




For when the production is all in the hands of one person or company,
the total expenses involved are generally less than would have to be incurred
if the same aggregate production were distributed among a multitude of comparatively
small rival producers. They would have to struggle with one another for the
attention of consumers, and would necessarily spend in the aggregate a great
deal more on advertising in all its various forms than a single firm would;
and they would be less able to avail themselves of the many various economies
which result from production on a large scale. In particular they could not
afford to spend as much on improving methods of production and the machinery
used in it, as a single large firm which knew that it was certain itself
to reap the whole benefit of any advance it made.




This argument does indeed assume the single firm to be managed with ability
and enterprise, and to have an unlimited command of capital an assumption
which cannot always be fairly made. But where it can be made, we may generally
conclude that the supply schedule for the commodity, if not monopolized,
would show higher supply prices than those of our monopoly supply schedule;
and therefore the equilibrium amount of the commodity produced under free
competition would be less than that for which the demand price is equal to
the monopoly supply price.(4*)




One of the most interesting and difficult applications of the theory of
monopolies is to the question whether the public interest is best served
by the allotment of a distinct basin to each great railway, and excluding
competition there. For the proposal it is urged that a railway can afford
to carry two million passengers, or tons of goods, cheaper than one million:
and that a division of the public demand between two lines will prevent either
of them from offering a cheap service. It must be admitted that, other things
being equal, the "monopoly revenue price" fixed by a railway will
be lowered by every increase in the demand for its services, and vice versa.
But, human nature being what it is, experience has shown that the breaking
of a monopoly by the opening out of a competing line accelerates, rather
than retards the discovery by the older line that it can afford to carry
traffic at lower rates. There still remains the suggestion that after a while
the railways will combine and charge the public with the expense wasted on
duplicating the services. But this again only opens out new matters of controversy.
The theory of monopolies starts rather than solves practical issues such
as these: and we must defer their study.(5*)




6. So far we have supposed the owner of a monopoly to fix the price of
his commodity with exclusive reference to the immediate net revenue which
he can derive from it. But, in fact, even if he does not concern himself
with the interests of the consumers, he is likely to reflect that the demand
for a thing depends in a great measure on people's familiarity with it: and
that if be can increase his sales by taking a price a little below that which
would afford him the maximum net revenue, the increased use of his commodity
will before long recoup him for his present loss. The lower the price of
gas, the more likely people are to have it laid on to their houses; and when
once it is there, they are likely to go on making some use of it, even though
a rival, such as electricity or mineral oil, may be competing closely with
it. The case is stronger when a railway company has a practical monopoly
of the transport of persons and goods to a sea-port, or to a suburban district
which is as yet but partly built over; the railway company may then find
it worth while, as a matter of business, to levy charges much below those
which would afford the maximum net revenue, in order to get merchants into
the habit of using the port, to encourage the inhabitants of the port to
develop their docks and warehouses; or to assist speculative builders in
the new suburb to build houses cheaply and to fill them quickly with tenants,
thus giving to the suburb an air of early prosperity which goes far towards
insuring its permanent success. This sacrifice by a monopolist of part of
his present gains in order to develop future business differs in extent rather
than kind from the sacrifices which a young firm commonly makes in order
to establish a connection.




In such cases as these a railway company though not pretending to any
philanthropic motives, yet finds its own interests so closely connected with
those of the purchasers of its services, that it gains by making some temporary
sacrifice of net revenue with the purpose of increasing consumers' surplus.
And an even closer connection between the interests of the producers and
the consumers is found when the landowners of any district combine to make
a branch railway through it, without much hope that the traffic will afford
the current rate of interest on the capital which they invest -- that is,
without much hope that the monopoly revenue of the railway, as we have defined
it, will be other than a negative quantity -- but expecting that the railway
will add so much to the value of their property as to make their venture
on the whole a profitable one. And when a municipality undertakes the supply
of gas or water, or facilities for transport by improved roads, by new bridges,
or by tramways, the question always arises whether the scale of charges should
be high, so as to afford a good net revenue and relieve the pressure on the
rates; or should be low, so as to increase consumers' surplus.




7. It is clear then that some study is wanted of calculations by which
a monopolist should govern his actions, on the supposition that he regards
an increase of consumers' surplus as equally desirable to him, if not with
an equal increase of his own monopoly revenue, yet with an increase, say,
one-half or one-quarter as great.




If the consumers, surplus which arises from the sale of the commodity
at any price, is added to the monopoly revenue derived from it, the sum of
the two is the money measure of the net benefits accruing from the sale of
the commodity to producers and consumers together, or as we may say the total
benefit of its sale. And if the monopolist regards a gain to the consumers
as of equal importance with an equal gain to himself, his aim will be to
produce just that amount of the commodity which will make this total benefit
a maximum.(6*)




But it will seldom happen that the monopolist can and will treat £1
of consumers' surplus as equally desirable with £1 of monopoly revenue.
Even a government which considers its own interests coincident with those
of the people has to take account of the fact that, if it abandons one source
of revenue, it must in general fall back on others which have their own disadvantages.
For they will necessarily involve friction and expense in collection, together
with some injury to the public, of the kind which we have described as a
loss of consumers' surplus: and they can never be adjusted with perfect fairness,
especially when account is taken of the unequal shares that different members
of the community will get of the benefits for the sake of which it is proposed
that the government should forego some of its revenue.




Suppose then that the monopolist makes a compromise, and reckons £1
of consumers' surplus as equivalent to say 10s. of monopoly revenue. Let
him calculate the monopoly revenue to be got from selling his commodity at
any given price, and to it let him add one half the corresponding consumers'
surplus: the sum of the two may be called the compromise benefit; and his
aim will be to fix on that price which will make the compromise benefit as
large as possible.(7*)




The following general results are capable of exact proof; but on a little
consideration they will appear so manifestly true as hardly to require proof.
Firstly, the amount which the monopolist will offer for sale will be greater
(and the price at which he will sell it will be less) if he is to any extent
desirous to promote the interests of consumers than if his sole aim is to
obtain the greatest possible monopoly revenue; and secondly, the amount produced
will be greater (and the selling price will be less) the greater be the desire
of the monopolist to promote the interests of consumers; i.e. the larger
be the percentage of its actual value at which he counts in consumers' surplus
with his own revenue.(8*)




8. Not many years ago it was commonly argued that: "An English ruler,
who looks upon himself as the minister of the race he rules, is bound to
take care that he impresses their energies in no work that is not worth the
labour that is spent upon it, or -- to translate the sentiment into plainer
language -- that he engages in nothing that will not produce an income sufficient
to defray the interest on its cost."(9*) Such phrases as this may sometimes
have meant little more than that a benefit which consumers were not willing
to purchase at a high price and on a large scale, was likely to exist for
the greater part only in the specious counsels of those who had some personal
interest in the proposed undertakings; but probably they more often indicated
a tendency to under-estimate the magnitude of that interest which consumers
have in a low price, and which we call consumers' surplus.(10*)




One of the chief elements of success in private business is the faculty
of weighing the advantages and disadvantages of any proposed course, and
of assigning to them their true relative importance. He who by practice and
genius has acquired the power of attributing to each factor its right quantity,
is already well on the way to fortune; and the increase in the efficiency
of our productive forces is in a great measure due to the large number of
able minds who are devoting themselves ceaselessly to acquiring these business
instincts. But unfortunately the advantages thus weighed against one another
are nearly all regarded from one point of view, that of the producer; and
there are not many who concern themselves to weigh against one another the
relative quantities of the interests which the consumers and the producers
have in different courses of action. For indeed the requisite facts come
within the direct experience of only a very few persons, and even in the
case of those few, only to a very limited extent and in a very imperfect
way. Moreover when a great administrator has acquired those instincts with
regard to public interests which able business men have with regard to their
own affairs, he is not very likely to be able to carry his plans with a free
hand. At all events in a democratic country no great public undertaking is
secure of being sustained on consistent lines of policy, unless its advantages
can be made clear, not only to the few who have direct experience of high
public affairs, but also to the many who have no such experience and have
to form their judgment on the materials set before them by others.




Judgments of this kind must always be inferior to those which an able
business man forms, by the aid of instincts based on long experience with
regard to his own business. But they may be made much more trustworthy than
they are at present, if they can be based on statistical measures of the
relative quantities of the benefits and the injuries which different courses
of public action are likely to cause to the several classes of the community.
Much of the failure and much of the injustice, in which the economic policies
of governments have resulted, have been due to the want of statistical measurement.
A few people who have been strongly interested on one side have raised their
voices loudly, persistently and all together; while little has been heard
from the great mass of people whose interests have lain in the opposite direction;
for, even if their attention has been fairly called to the matter, few have
cared to exert themselves much for a cause in which no one of them has more
than a small stake. The few therefore get their way, although if statistical
measures of the interests involved were available, it might prove that the
aggregate of the interests of the few was only a tenth or a hundredth part
of the aggregate of the interests of the silent many.




No doubt statistics can be easily misinterpreted; and are often very misleading
when first applied to new problems. But many of the worst fallacies involved
in the misapplications of statistics are definite and can be definitely exposed,
till at last no one ventures to repeat them even when addressing an uninstructed
audience: and on the whole arguments which can be reduced to statistical
forms, though still in a backward condition, are making more sure and more
rapid advances than any others towards obtaining the general acceptance of
all who have studied the subjects to which they refer. The rapid growth of
collective interests, and the increasing tendency towards collective action
in economic affairs, make it every day more important that we should know
what quantitative measures of public interests are most needed and what statistics
are required for them, and that we should set ourselves to obtain these statistics.




It is perhaps not unreasonable to hope that as time goes on, the statistics
of consumption will be so organized as to afford demand schedules sufficiently
trustworthy, to show in diagrams that will appeal to the eye, the quantities
of consumers, surplus that will result from different courses of public and
private action. By the study of these pictures the mind may be gradually
trained to get juster notions of the relative magnitudes of the interests
which the community has in various schemes of public and private enterprise;
and sounder doctrines may replace those traditions of an earlier generation,
which had perhaps a wholesome influence in their time; but which damped social
enthusiasm by throwing suspicion on all projects for undertakings by the
public on its own behalf which would not show a balance of direct pecuniary
profit.




The practical bearings of many of the abstract reasonings in which we
have recently been engaged will not be fully apparent till we approach the
end of this treatise. But there seemed to be advantages in introducing them
thus early, partly because of their close connection with the main theory
of equilibrium of demand and supply, and partly because they throw side lights
on the character and the purposes of that investigation of the causes which
determine distribution on which we are about to enter.




9. So far it has been assumed that the monopolist can buy and sell freely.
But in fact monopolistic combinations in one branch of industry foster the
growth of monopolistic combinations in those which have occasion to buy from
or sell to it: and the conflicts and alliances between such associations
play a role of ever increasing importance in modern economics. Abstract reasoning
of a general character has little to say on the subject. If two absolute
monopolies are complementary, so that neither can turn its products to any
good account, without the other's aid, there is no means of determining where
the price of the ultimate product will be fixed. Thus if we supposed, following
Cournot's lead, that copper and zinc were each of them useless except when
combined to make brass: and if we supposed that one man, A, owned all the
available sources of supply of copper; while another, B, owned all those
of zinc; there would then be no means of determining beforehand what amount
of brass would be produced, nor therefore the price at which it could be
sold. Each would try to get the better of the other in bargaining; and though
the issue of the contest would greatly affect the purchasers, they would
not be able to influence it.(11*)




Under the conditions supposed, A could not count on reaping the whole,
nor even any share at all of the benefit, from increased sales, that would
be got by lowering the price of copper in a market in which the price of
zinc was fixed by natural causes rather than strategical higgling and bargaining.
For, if he reduced his price, B might take the action as a sign of commercial
weakness, and raise the price of zinc; thus causing A to lose both on price
and on amount sold. Each would therefore be tempted to bluff the other; and
consumers might find that less brass was put on the market, and that therefore
a higher price could be exacted for it, than if a single monopolist owned
the whole supplies both of copper and of zinc: for he might see his way to
gaining in the long run by a low price which stimulated consumption. But
neither A nor B could reckon on the effects of his own action, unless the
two came together and agreed on a common policy: that is unless they made
a partial, and perhaps temporary fusion of their monopolies. On this ground,
and because monopolies are likely to disturb allied industries it may reasonably
be urged that the public interest generally requires that complementary monopolies
should be held in a single hand.




But there are other considerations of perhaps greater importance on the
other side. For in real life there are scarcely any monopolies as absolute
and permanent as that just discussed. On the contrary there is in the modern
world an ever increasing tendency towards the substitution of new things
and new methods for old, which are not being developed progressively in the
interests of consumers; and the direct or indirect competition thus brought
to bear is likely to weaken the position of one of the complementary monopolies
more than the other. For instance if there be only one factory for spinning
and only one for weaving in a small isolated country, it may be for the time
to the public interest that the two should be in the same hands. But the
monopoly so established will be much harder to shake than would either half
of it separately. For a new venturer might push his way into the spinning
business and compete with the old spinning mill for the custom of the old
weaving sheds.




Consider again a through route, partly by rail and partly by sea, between
two great centres of industry. If competition on either half of the route
were permanently impossible, it would probably be to the public interest
that the ships and the railway line should be in the same hands. But as things
are, no such general statement can be made. Under some conditions it is more
to the public interest that they should be in one hand; under others, and
those perhaps the conditions that occur the more frequently, it is in the
long run to the public interest that they should remain in different hands.




Similarly the prima facie arguments in favour of the fusion of monopolistic
cartels, or other associations, in complementary branches of industry, though
often plausible and even strong, will generally be found on closer examination
to be treacherous. They point to the removal of prominent social and industrial
discords; but at the probable expense of larger and more enduring discords
in the future.(12*)




NOTES:




1. Thus DD' being the demand curve, and SS' the curve corresponding to
the supply schedule described in the text, let MP2P1 be drawn vertically
from any point M in Ox, cutting SS' in P2 and DD' in P1; and from it cut
off MP3 = call P2P1, then the locus of P3 will be our third curve, QQ', which
we may the monopoly revenue Curve. The supply price for a small quantity
of gas will of course be very high; and in the neighbourhood of Oy the supply
curve will be above the demand curve, and therefore the net revenue curve
will be below Ox. It will cut Ox in K and again in H, points which are vertically
under B and A, the two points of interaction of the demand and supply curves.
The maxi mum monopoly revenue will then be obtained by finding a point q3
on QQ' such that Lq3 being drawn perpendicular to Ox, OL x Lq3 is a maximum.
Lq3 being produced to cut SS' in q2 and DD' in q1, the company, if desiring
to obtain the greatest immediate monopoly revenue, will fix the price per
thousand feet at Lq1, and consequently will sell OL thousand feet; the expenses
of pro duction will be Lq2 per thousand feet, and the aggregate net revenue
will be OL x q2q1, or which is the same thing OL x Lq3.




The dotted lines in the diagram are known to mathematicians as rectangular
hyperbolas; but we may call them constant revenue curves: for they are such
that if from a point on any one of them lines be drawn perpendicular to Ox
and Oy respectively (the one representing revenue per thousand feet and the
other representing the number of thousand feet sold), then the product of
these will be a constant quantity for every point on one and the same curve.
This product is of course a smaller quantity for the inner curves, those
nearer Ox and Oy, than it is for the outer curves. And consequently since
P3 is on a smaller constant revenue curve than q3 is, OM x MP 3 is less than
OL x Lq2. It will be noticed that q3 is the point in which QQ' touches one
of these curves. That is, q3 is on a larger constant revenue curve than is
any other point on QQ'; and therefore OL x Lq3 is greater than OM x MP3,
not only in the position given to M in the figure, but also in any position
that M can take along Ox. That is to say, q3 has been correctly determined
as the point on QQ' corresponding to the maximum total monopoly revenue.
And thus we get the rule: -- If through that point in which QQ' touches one
of a series of constant revenue curves, a line be drawn vertically to cut
the demand curve, then the distance of that point of intersection from Ox
will be the price at which the commodity should be offered for sale in order
that it may afford the maximum monopoly revenue. See Note XXII in the Mathematical
Appendix.




2. If to the expenses of working a monopoly there be added (by a tax or
otherwise) a lump sum independent of the amount produced, the result will
be to cause every point on the monopoly revenue curve to move downwards to
a point on a constant revenue curve representing a constant revenue smaller
by a fixed amount than that on which it lies. Therefore the maximum revenue
point on the new monopoly revenue curve lies vertically below that on the
old: that is, the selling price and the amount produced remain unchanged,
and conversely with regard to a fixed bounty or other fixed diminution of
aggregate working expenses. As to the effects of a tax proportional to monopoly
revenue, see Note XXIII in the Mathematical Appendix.




It should however be noticed that if a tax or other new additional expense
exceeds the maximum monopoly revenue, it will prevent the monopoly from being
worked at all; it will convert the price which had afforded the maximum monopoly
revenue into the price which would reduce to a minimum the loss that would
result from continuing to work the monopoly.




3. In the text it is supposed that the tax or bounty is directly proportional
to the sales: but the argument, when closely examined, will be found to involve
no further assumption than that the aggregate tax or bounty increases with
every increase in that amount: the argument does not really require that
it should increase in exact proportion to that amount.




Much instruction is to be got by drawing diagrams to represent various
conditions of demand and of (monopoly) supplv, with the resultant shapes
of the monopoly revenue curve. A careful study of the shapes thus obtained
will give more assistance than any elaborate course of reasoning in the endeavour
to realize the multiform action of economic forces in relation to monopolies.
A tracing may be made on thin paper of the constant revenue curves in one
of the diagrams; and this, when laid over a monopoly revenue curve, will
indicate at once the point, or points, of maximum revenue. For it will be
found, not only when the demand and supply curves cut one another more than
once, but also when they do not, there will often be, as in fig. 35, several
points on a monopoly revenue curve at which it touches a constant revenue
curve. Each of these points will show a true maximum monopoly revenue; but
one of them will generally stand out pre-eminently as being on a larger constant
revenue curve than any of the others and therefore indicating a larger monopoly
revenue than they.




If it happens, as in fig. 35, that this chief maximum q'2 lies a long
way to the right of a smaller maximum q3, then the imposition of a tax on
the commodity, or any other change that raised its supply curve throughout,
would lower by an equal amount the monopoly revenue curve. Let the supply
curve be raised from SS' to the position {SIGMA SIGMA PRIME}; and in consequence
let the monopoly revenue curve fall from its old position QQ' to ZZ'; then
the chief point of maximum revenue will move from q'3 to z3, representing
a great diminution of production, a great rise of price and a great injury
to the consumers. The converse effects of any change, such as a bounty on
the commodity, which lowers its supply price throughout and raises the monopoly
revenue curve, may be seen by regarding ZZ' as the old and QQ' as the new
position of that curve. It will be obvious on a little consideration (but
the fact may with advantage be illustrated by drawing suitable diagrams),
that the more nearly the monopoly revenue curve approximates to the shape
of a constant revenue curve, the greater will be the change in the position
of the maximum avenue point which results from any given alteration in the
expenses of production of the commodity generally. This change is great in
fig. 35 not because DD' and SS' intersect more than once, but because two
parts of QQ', one a long way to the right of the other, lie in the neighbourhood
of the same constant avenue curve.




4. In other words, though L lies necessarily a good deal to the left of
H, according to the notation in fig. 34; yet the supply curve for the commodity,
if there were no monopoly, might lie so much above the present position of
SS' that its point of intersection with DD' would lie much to the left of
A in the figure, and might not improbably lie to the left of L. Something
has already been said (IV XI, XII; and V, XI), as to the advantages which
a single powerful firm has over, its smaller rivals in those industries in
which the law of increasing return acts strongly; and as to the chance which
it might have of obtaining a practical monopoly of its own branch of production,
if it were managed for many generations together by people whose genius,
enterprise and energy equalled those of the original founders of the business.




5. The full theoretical treatment of questions relating to the influence
exerted on monopoly price by an increase of demand requires the use of mathematics
for which the aader is referred to an article on monopolies by Professor
Edgeworth in the Giornale degli Economisti for Oct. 1897. But an inspection
of fig. 34 will show that a uniform raising of DD' will push L much to the
right; and that the resulting position of q1 will probably be lower than
before. If, however, a new class of residents come into the district, who
are so well to do, that their willingness to travel is very little affected
by the railway charges, then the shape of DD' will be altered; its left side
will be raised more in proportion than its right; and the new position of
q1 may be higher than the old.




6. In fig. 36 DD', SS', and QQ' represent the demand, supply, and monopoly
revenue curves drawn on the same plan as in fig. 34. From P1 draw P1F perpendicular
to Oy; then DFP1 is the consumers' surplus derived from the sale of OM thousand
feet of gas at the price MP1. In MP1 take a point P4 such that OM x MP4 =
the area DFP1: then as M moves from O along Ox, P4 will trace out our fourth
curve, OR, which we may call the consumers' surplus curve. (Of course it
passes through O, because when the sale of the commodity is reduced to nothing,
the consumers' surplus also vanishes.)




Next from P3P1 cut off P3P5 equal to MP4, so that MP5 = MP3 + MP4. Then
OM x MP5 = OM x MP3 + OM x MP4: but OM x MP3 is the total monopoly revenue
when an amount OM is being sold at a price MP1, and OM x MP4 is the corresponding
consumers' surplus. Therefore OM x MP5 is the sum of the monopoly revenue
and the consumers' surplus, that is the (money measure of the) total benefit
which the community will derive from the commodity when an amount OM is produced.
The locus of P5 is our fifth curve, QT, which we may call the total benefit
curve. It touches one of the constant revenue curves at t5, and this shows
that the (money measure of the) total benefit is a maximum when the amount
offered for sale is OW; or, which is the same thing, when the price of sale
is fixed at the demand price for OW.




7. If he compromises on the basis that £1 of consumers' surplus is
equally desirable with £n of monopoly revenue, n being a proper fraction,
let us take a point P6 in P3P5 such that P3P6 = n.P3P5, or, which is the
same thing, nMP4. Then OM x MP6 = OM x MP3' + nOM x MP4; that is, it is equal
to the mono poly revenue derived from selling an amount OM of the commodity
at the price MP1, + n times the consumers' surplus derived from this sale:
and is therefore the compromise benefit derived from that sale. The locus
of P6 is our sixth curve, QU, which we may call the compromise benefit curve.
It touches one of the constant revenue curves in u6; which shows that the
compromise benefit attains its maximum when amount OY is sold; or which is
the same thing, when the selling price is fixed at the demand price for the
amount OY.




8. That is to say, firstly, OY fig. 36 is always greater than OL; and
secondly, the greater n is, the greater OY is. (See Note XXIII bis in the
Mathematical Appendix.)




9. The words are quoted from a leading article in The Times for July 30,
1874: they fairly represent a great body of public opinion.




10. Fig. 37 may be taken to represent the case of a proposed Government
undertaking in India. The supply curve is above the demand curve during its
whole length, showing that the enterprise to which it refers is unremunerative,
in the sense that whatever price the producers fix, they will lose money;
their monopoly revenue will be a negative quantitv But QT the total benefit:
curve rises above Ox; and touches a constant revenue curve in t5. If then
they offer for sale an amount OW (or, which is the same thing, fix the price
at the demand price for OW), the resultant consumers' surplus, if taken at
its full value, will outweigh the loss on working by an amount represented
by OW x Wt5;. But suppose that, in order to make up the deficiencv, Government
must levy taxes, and that taking account of all indirect expenses and other
evils, these cost the public twice what they bring in to the Government,
it will then be necessary to count two rupees of the consumers' surplus as
compensating for a Government outlay of only one rupee; and in order to represent
the net gain of the undertaking on this supposition, we must draw the compromise
benefit curve QU as in fig. 36, but putting n = 1/2. Thus MP6 = MP3 + 1/2
MP4. (Another way of putting the same thing is to say that QU is drawn midway
between the monopoly revenue (negative) curve QQ' and the total benefit curve
QT.) QU so drawn in fig. 37 touches a constant revenue curve in u6, showing
that if the amount OY is offered for sale, or, which is the same thing, if
the price is fixed at the demand price for OY, there will result a net gain
to India represented by OY x Yu6.




11. Thus there is a slight analogy between this case and that of composite
rent of water power, and the only site on which it could be turned to account
(see above V, XI, section 7), so far as the indeterminateness of the division
of the producer's surplus is concerned. But in this case there is no means
of knowing what the producer's surplus will be. Cournot's fundamental equations
appear to be based on inconsistent assumptions, see Recherches sur les principes
mathématiques des Richesses, Ch. IX, p. 113. Here, as elsewhere, he
opened up new ground, but overlooked some of its most obvious features. Prof.
H. L. Moore (Quarterly Journal of Economics, Feb. 1906), basing himself partly
on the work of Bertrand and Prof. Edgeworth, lays down clearly the assumptions
which are appropriate to monopoly problems.




12. Book III of Industry and Trade is occupied with a study of problems
akin to those which have been sketched in this chapter.




CHAPTER XV




SUMMARY OF THE GENERAL THEORY OF EQUILIBRIUM OF DEMAND AND SUPPLY




1. The present chapter contains no new matter: it is a mere summary of
the results of Book V. The second half of it may be of service to anyone
who has omitted the later chapters: for it may indicate, though it cannot
explain, their general drift.




In Book V we have studied the theory of the mutual relations of demand
and supply in their most general form; taking as little account as possible
of the special incidents of particular applications of the theory, and leaving
over for the following Book the study of the bearings of the general theory
on the special features of the several agents of production, Labour, Capital,
and Land.




The difficulties of the problem depend chiefly on variations in the area
of space, and the period of time over which the market in question extends;
the influence of time being more fundamental than that of space.




Even in a market of very short period, such as that of a provincial corn-exchange
on market-day, the "higgling and bargaining" might probably oscillate
about a mean position, which would have some sort of a right to be called
the equilibrium price: but the action of dealers in offering one price or
refusing another would depend little, if at all, on calculations with regard
to cost of production. They would look chiefly at present demand on the one
hand, and on the other at the stocks of the commodity already available.
It is true that they would pay some attention to such movements of production
in the near future as might throw their shadow before; but in the case of
perishable goods they would look only a very little way beyond the immediate
present. Cost of production has for instance no perceptible influence on
the day 's bargaining in a fish-market.




In a rigidly stationary state in which supply could be perfectly adjusted
to demand in every particular, the normal expenses of production, the marginal
expenses, and the average expenses (rent being counted in) would be one and
the same thing, for long periods and for short. But, as it is, the language
both of professed writers on economics and of men of business shows much
elasticity in the use of the term Normal when applied to the causes that
determine value. And one fairly well marked division needs study.




On the one side of this division are long periods, in which the normal
action of economic forces has time to work itself out more fully; in which
therefore a temporary scarcity of skilled labour, or of any other of the
agents of production, can be remedied; and in which those economies that
normally result from an increase in the scale of production -- normally,
that is without the aid of any substantive new invention -- have time to
develop themselves. The expenses of a representative firm, managed with normal
ability and having normal access to the internal and external economies of
production on a large scale, may be taken as a standard for estimating normal
expenses of production: and when the period under survey is long enough to
enable the investment of capital in building up a new business to complete
itself and to bear full fruits; then the marginal supply price is that, the
expectation of which in the long run just suffices to induce capitalists
to invest their material capital, and workers of all grades to invest their
personal capital in the trade.




On the other side of the line of division are periods of time long enough
to enable producers to adapt their production to changes in demand, in so
far as that can be done with the existing provision of specialized skill,
specialized capital, and industrial organization; but not long enough to
enable them to make any important changes in the supplies of these factors
of production. For such periods the stock of material and personal appliances
of production has to be taken in a great measure for granted; and the marginal
increment of supply is determined by estimates of producers as to the amount
of production it is worth their while to get out of those appliances. If
trade is brisk all energies are strained to their utmost, overtime is worked,
and then the limit to production is given by want of power rather than by
want of will to go further or faster. But if trade is slack every producer
has to make up his mind how near to prime cost it is worth his while to take
fresh orders. And here there is no definite law, the chief operative force
is the fear of spoiling the market; and that acts in different ways and with
different strengths on different individuals and different industrial groups.
For the chief motive of all open combinations and of all informal silent
and "customary" understandings whether among employers or employed
is the need for preventing individuals from spoiling the common market by
action that may bring them immediate gains, but at the cost of a greater
aggregate loss to the trade.




2. We next turned aside to consider the relations of demand and supply
with reference to things that need to be combined together for the purposes
of satisfying a joint demand; of which the most important instance is that
of the specialized material capital, and the specialized personal skill that
must work together in any trade. For there is no direct demand on the part
of consumers for either alone, but only for the two conjointly; the demand
for either separately is a derived demand, which rises, other things being
equal, with every increase in the demand for the common products, and with
every diminution in the supply price of the joint factors of production.
In like manner commodities of which there is a joint supply, such as gas
and coke, or beef and hides, can each of them have only a derived supply
price, governed by the expenses of the whole process of production on the
one hand, and on the other by the demand for the remaining joint products.




The composite demand for a thing, resulting from its being used for several
different purposes, and the composite supply of a thing, that has several
sources of production, present no great difficulty; for the several amounts
demanded for the different purposes, or supplied from different sources,
can be added together, on the same plan as was adopted in Book III, for combining
the demands of the rich, the middle classes and the poor for the same commodity.




Next we made some study of the division of the supplementary costs of
a business, -- and especially those connected with building up a trade connection,
with marketing, and with insurance -- among the various products of that
business.




3. Returning to those central difficulties of the equilibrium of normal
demand and supply which are connected with the element of time, we investigated
more fully the relation between the value of an appliance for production
and that of the things produced by it.




When different producers have different advantages for producing a thing,
its price must be sufficient to cover the expenses of production of those
producers who have no special and exceptional facilities; for if not they
will withhold or diminish their production, and the scarcity of the amount
supplied, relatively to the demand, will raise the price. When the market
is in equilibrium, and the thing is being sold at a price which covers these
expenses, there remains a surplus beyond their expenses for those who have
the assistance of any exceptional advantages. If these advantages arise from
the command over free gifts of nature, the surplus is called a producer's
surplus or producer's rent: there is a surplus in any case, and if the owner
of a free gift of nature lends it out to another, he can generally get for
its use a money income equivalent to this surplus.




The price of the produce is equal to the cost of production of that part
of it, which is raised on the margin, that is under such unfavourable conditions
as to yield no rent. The cost of this part can be reckoned up without reasoning
in a circle; and the cost of other parts cannot.




If land which had been used for growing hops, is found capable of yielding
a higher rent as market-garden land, the area under hops will undoubtedly
be diminished; and this will raise their marginal cost of production and
therefore their price. The rent which land will yield for one kind of produce,
calls attention to the fact that a demand for the land for that kind of produce
increases the difficulties of supply of other kinds; though it does not directly
enter into those expenses. And similar arguments apply to the relation between
the site values of urban land and the costs of things made on it.




Thus when we are taking a broad view of normal value, when we are investigating
the causes which determine normal value "in the long run," when
we are tracing the "ultimate" effects of economic causes; then
the income that is derived from capital in these forms enters into the payments
by which the expenses of production of the commodity in question have to
be covered; and estimates as to the probable amount of that income directly
control the action of the producers, who are on the margin of doubt as to
whether to increase the means of production or not. But, on the other hand,
when we are considering the causes which determine normal prices for a period
which is short relatively to that required for largely increasing the supply
of those appliances for production; then their influence on value is chiefly
indirect and more or less similar to that exerted by the free gifts of nature.
The shorter the period which we are considering, and the slower the process
of production of those appliances, the less part will variations in the income
derived from them play in checking or increasing the supply of the commodity
produced by them, and in raising or lowering its supply price.




4 This leads to the consideration of some difficulties of a technical
character connected with the marginal expenses of production of a commodity
that obeys the law of increasing return. The difficulties arise from the
temptation to represent supply price as dependent on the amount produced,
without allowing for the length of time that is necessarily occupied by each
individual business in extending its internal, and still more its external
organization; and in consequence they have been most conspicuous in mathematical
and semi-mathematical discussions of the theory of value. For when changes
of supply price and amount produced are regarded as dependent exclusively
on one another without any reference to gradual growth, it appears reasonable
to argue that the marginal supply price for each individual producer is the
addition to his aggregate expenses of production made by producing his last
element; that this marginal price is likely in many cases to be diminished
by an increase in his output much more than the demand price in the general
market would be by the same cause.




The statical theory of equilibrium is therefore not wholly applicable
to commodities which obey the law of increasing return. It should however
be noted that in many industries each producer has a special market in which
he is well known, and which he cannot extend quickly; and that therefore,
though it might be physically possible for him to increase his output rapidly,
he would run the risk of forcing down very much the demand price in his special
market, or else of being driven to sell his surplus production outside on
less favourable terms. And though there are industries in which each producer
has access to the whole of a large market, yet in these there remain but
few internal economies to be got by an increase of output, when the existing
plant is already well occupied. No doubt there are industries as to which
neither of these statements is true: they are in a transitional state, and
it must be conceded that the statical theory of equilibrium of normal demand
and supply cannot be profitably applied to them. But such cases are not numerous;
and with regard to the great bulk of manufacturing industries, the connection
between supply price and amount shows a fundamentally different character
for short periods and for long.




For short periods, the difficulties of adjusting the internal and external
organization of a business to rapid changes in output are so great that the
supply price must generally be taken to rise with an increase, and to fall
with a diminution in the amount produced.




But in long periods both the internal and the external economies of production
on a large scale have time to develop themselves. The marginal supply price
is not the expenses of production of any particular bale of goods: but it
is the whole expenses (including insurance, and gross earnings of management)
of a marginal increment in the aggregate process of production and marketing.




5. Some study of the effects of a tax, regarded as a special case of a
change in the general conditions of demand and supply suggests that, when
proper allowance is made for the interests of consumers, there is on abstract
grounds rather less prima facie cause than the earlier economists supposed,
for the general doctrine of so-called "Maximum Satisfaction"; i.e.
for the doctrine that the free pursuit by each individual of his own immediate
interest, will lead producers to turn their capital and labour, and consumers
to turn their expenditure into such courses as are most conducive to the
general interests. We have nothing to do at this stage of our inquiry, limited
as it is to analysis of the most general character, with the important question
how far, human nature being constituted as it is at present, collective action
is likely to be inferior to individualistic action in energy and elasticity,
in inventiveness and directness of purpose; and whether it is not therefore
likely to waste through practical inefficiency more than it could save by
taking account of all the interests affected by any course of action. But
even without taking account of the evils arising from the unequal distribution
of wealth, there is prima facie reason for believing that the aggregate satisfaction,
so far from being already a maximum, could be much increased by collective
action in promoting the production and consumption of things in regard to
which the law of increasing return acts with especial force.




This position is confirmed by the study of the theory of monopolies. It
is the immediate interest of the monopolist so to adjust the production and
sale of his wares as to obtain for himself the maximum net revenue, and the
course which he thus adopts is unlikely to be that which affords the aggregate
maximum satisfaction. The divergence between individual and collective interests
is prima facie less important with regard to those things which obey the
law of diminishing return, than with regard to those which obey the law of
increasing return: but, in the case of the latter, there is strong prima
facie reason for believing that it might often be to the interest of the
community directly or indirectly to intervene, because a largely increased
production would add much more to consumers' surplus than to the aggregate
expenses of production of the goods. More exact notions on the relations
of demand and supply, particularly when expressed in the form of diagrams,
may help us to see what statistics should be collected, and how they should
be applied in the attempt to estimate the relative magnitudes of various
conflicting economic interests, public and private.




Ricardo's theory of cost of production in relation to value occupies so
important a place in the history of economics that any misunderstanding as
to its real character must necessarily be very mischievous; and unfortunately
it is so expressed as almost to invite misunderstanding. In consequence there
is a widely spread belief that it has needed to be reconstructed by the present
generation of economists. Cause is shown in Appendix I for not accepting
this opinion; and for holding on the contrary that the foundations of the
theory as they were left by Ricardo remain intact; that much has been added
to them, and that very much has been built upon them, but that little has
been taken from them. It is there argued that he knew that demand played
an essential part in governing value, but that he regarded its action as
less obscure than that of cost of production, and therefore passed it lightly
over in the notes which he made for the use of his friends, and himself;
for he never essayed to write a formal treatise: also that he regarded cost
of production as dependent -- not as Marx asserted him to have done on the
mere quantity of labour used up in production, but -- on the quality as well
as quantity of that labour; together with the amount of stored up capital
needed to aid labour, and the length of time during which such aid was invoked.