BOOK V

GENERAL RELATIONS OF DEMAND, SUPPLY AND VALUE

CHAPTER XI

MARGINAL COSTS IN RELATION TO URBAN VALUE

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

NOTES:

1. See IV, III, section 6.

2. See IV, X-XIII.

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

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

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

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

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

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

8. See IV, III, section 7.

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

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

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

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

CHAPTER XII

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

NOTES:

1. See above III, IV, section 5.

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

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

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

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

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

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

7. See above V, V, section 6.

CHAPTER XIII

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

NOTES:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

14. Compare III, VI.

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

CHAPTER XIV

THE THEORY OF MONOPOLIES

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

NOTES:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

CHAPTER XV

SUMMARY OF THE GENERAL THEORY OF EQUILIBRIUM OF DEMAND AND SUPPLY

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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