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.
