§1.An Illustration from Coal. We have already had occasion to note the symmetry which characterizes the relations of demand and supply to price. This symmetry was apparent throughout the argument of Chapter II, and it was a striking feature of the diagrams which we employed to illustrate the argument. We shall do well to cultivate a lively sense of this symmetry, for it will frequently save us from ignoring factors which have a vital bearing on the problems we are considering. We should never leave an important feature of demand without turning to see whether it has a counterpart on the supply side, though indeed we may not always find one. In the last chapter we examined the relation between utility and price, and found that the true relation was between the price and what we termed the marginal utility. Corresponding to utility on the demand side is cost of production on the supply side. The question should thus at once suggest itself—"Can we speak appropriately of the marginal cost of production, and will this serve to make clear the relation between cost and price?" To answer these questions, let us take one of the instances in which we found that price could not be explained satisfactorily by the bare phrase "cost of production."
An important feature of the coal industry, which recent events have brought into sharp prominence, is the great diversity of conditions between different coalfields and different collieries. We speak of rich seams and poor seams, of fertile and unfertile mines, and we are aware that the costs of raising coal to the surface differ very widely in accordance with these diverse natural conditions. Nor must we confine our attention to the cost price at the pit-head. If we wish to speak of cost of production as a factor determining price, we must use the term in a broad sense to include the transport and other charges necessary to bring the coal to market.
In this respect also one coalfield differs greatly from another. Some are well situated close to a large market, or within easy reach of the seaboard; others must incur very heavy transport charges to bring their coal to any considerable centre of consumption. These varying conditions lead, as we well know, to great variations in the financial prosperity of different colliery concerns. In Great Britain, under the abnormal conditions which prevailed during the war, and subsequently, these variations were so huge as to constitute a most formidable embarrassment and to contribute, more perhaps than any other single factor, to the unrest and instability by which the industry has been afflicted. But they are always with us, if usually upon a more modest scale.
What, then, is the normal relation between price and cost in the case of coal? Should we direct our attention to the average costs over the whole industry, or the costs incurred by the richer and better situated mines,or, lastly, that of the poorer and worse situated? Now, as things are, it is clear enough that no concern will continue indefinitely producing at a loss. It may do so for a time, rather than close down altogether, hoping to recoup itself later when the market has taken a more favorable turn. But, in the long run, taking good years with bad, it must expect to obtain receipts sufficient not only to cover its necessary expenditure, but to provide also a reasonable profit on the capital employed. Of course, once the capital has been sunk and embodied in plant and buildings, which are of little use for any other purpose, a business may continue for many years, with a rate of profit far below what it had anticipated. But plant and buildings gradually wear out, and need to be replaced; the course of technical improvement calls continually for fresh capital outlay, which a business in a bad way is reluctant to undertake. The tendency, therefore, when profits rule low over a considerable period, is for the plant to fall gradually into disrepair and obsolescence, and finally for the business to disappear. We can thus include an ordinary rate of profit under the head of cost of production, and say with substantial accuracy that for no business can this cost for long exceed the price if the business is to continue to exist. If then the relatively poor and badly situated mines are to be worked, the price of coal, taking good years together with bad, must cover the costs at which these mines can produce. If the price rules lower than this, sooner or later they will close down, and we will be left with a smaller number of mines, among which great variations of conditions will still prevail. Once more,the price must cover the cost incurred by the least profitable of these remaining mines, unless their number is still further to be diminished. Thus we can conceive of a "margin of production" which will shift backwards to more profitable or forwards to include less profitable mines, according as the demand for coal contracts or expands. But, wherever this margin may be, there is no escaping the conclusion that it is the cost of production of the "marginal mines," of those that is to say which it is only just worth while to work, to which the price of coal will approximate.
It follows that there is no real connection between price and cost of production throughout the industry as a whole. It follows incidentally that those concerns which can market their coal at an appreciably lower cost than the marginal concerns, are likely to reap more than an ordinary rate of profit, though royalties may absorb part of the excess.
§2.The Various Aspects of Marginal Cost. This relation cuts much deeper than the particular system under which the mines are at present owned and worked. If, for instance, we supposed that the various mines were amalgamated together in a few giant concerns, each of which comprised some of the richer and some of the poorer mines, the preceding argument would need to be recast in form, but its substance would be unaffected. For though a great coal trust could in a senseaffordto sell at a price lower than the marginal cost, setting its losses on the poorer against its gains on the better pits, is it likely it would do so? Why should it dissipate its profits in this way? It is clearlymore reasonable to suppose that it would close down the poorer pits (unless it could advance the price of coal), and thereby maintain its profits at a higher figure. If, indeed, the mines were nationalized the deliberate policy might be pursued of selling coal at a price which left the industry no more than self-supporting as a whole. Some coal might thus be sold at less than its cost price, and the selling price would conform roughly to theaveragecost. But such a policy, though in special circumstances it might be justified, would represent a very dangerous principle, which could not be applied widely without the most serious results. Nothing could be more fatal to any enterprise, whether it be in the hands of an individual, a joint-stock company, a State department, or a Guild, than that the management should content themselves with results which in the lump seem satisfactory, and regard losses here or there with an indifferent eye. That way lies stagnation, waste, progressive inefficiency and ultimate disaster. To inquire searchingly into every nook and cranny of the business, to construct, as it were, for each part a separate balance-sheet of profit and loss, to expand in those directions where further development promises good results, and to curtail activity where loss is already evident, is the very essence of good management. Here, it will be observed, we are using language very similar to that in which we described the principles which govern a business man's expenditure. The resemblance is inevitable and significant, for we are dealing here with what is essentially another aspect of the same thing. The object is to secure that nowhere does expenditure fail to yield a commensuratereturn. This we express, when we consider a business in its aspect as a consumer, by saying that its consumption of anything will not be carried beyond the point at which the marginal utility exceeds the price it will have to pay. When we consider it as a producer, we say that its production of anything will not be carried beyond the point at which the marginal cost exceeds the price it will obtain.
§3.The Dangers of Ignoring the Margin. This at least is the general rule. A business may decide deliberately to sell part of its output below cost, because, for instance, this will serve as an advertisement, bring it connections, and enable it to obtain a larger profit at a later date, or immediately on other portions of its sales. In so acting, it recognizes that the price obtained for a thing may be an inadequate measure of the real return it yields. In the same way, though for different reasons, a nationalized coal industry might conceivably be justified in selling some coal below cost price, because, let us say, it held that the price which the immediate purchasers were willing to pay was an inadequate measure of the utility of coal to the community as a whole. But in all such cases it is essential to be very clear as to what exactly you are doing; so that you may be at least moderately clear as to whether the policy is well advised. It may be sound enough to lose on the swings and make good this loss on the roundabouts, but only if your loss on the swingshelpsyou to a larger profit on the roundabouts. If you would get the same return on the roundabouts in any case, it would be better to cut the swings out altogether.So, if you are directing the policy of a nationalized coal industry, and decide to make a loss on a portion of your sales, you will need to know that the indirect benefit which the community will derive from this particular part of your coal output is worth the loss which you incur. You will certainly come to grief, if you pursue a vague ideal of lumping all results together, and regarding a profit somewhere as a sufficient excuse or a positive reason for making a loss elsewhere.
It is quite true that in big undertakings, where there are large standing charges, and where the organization possesses some of the characteristics of an integral whole, it is not easy to measure accurately the specific costs which should be assigned to any particular portion of the output. But this difficulty is one of the most serious weaknesses of large undertakings; precise detailed measurement is the great prophylactic of business efficiency, and, where it is lacking the bacilli of waste will enter in and multiply. So clearly is this recognized, that the development of large scale business has led to the evolution of new methods of accountancy, designed to make detailed mensuration possible. We have most of us heard of them vaguely under such names as "comparative costings," but too few of us appreciate their full significance. It is hardly too much to say that the issue as to whether the size of the typical business unit will continue to become larger and larger, or whether it has already overshot the point of maximum efficiency will turn largely upon the capacity of accountancy to supply large and complex undertakings with more accurate instruments of detailed financial measurement.
§4.A Misinterpretation. The price, then, of a commodity tends roughly to equal its marginal cost of production; and this marginal cost (in perfect symmetry with what we observed as regards marginal utility), may be conceived as applying either to the marginal producer or to the marginal output of any producer. In the former aspect it is open to a misinterpretation, against which it will be well to guard. Some advocates of socialism have argued, as one of the counts in their indictment of the present industrial system, that the price of a commodity is determined by the cost at which the least efficient concern in the industry can produce. They say, in effect, "Under the present competitive regime, you have to pay for everything you buy a price which far exceeds the necessary cost to a concern which is managed with ordinary ability. For, as economic theory has shown, it is the cost of themarginalconcern, i.e. the concern managed by the most incompetent, and half-witted fellow in the trade; it is the cost incurred by him, together with a profit on his capital, that the price has got to cover. The producer of no more than average capacity is therefore making out of you a surplus profit, which would be quite unnecessary in any well-arranged society." Such an argument is a gross caricature of the marginal conception. The half-witted incompetent will, as we know well enough, speedily disappear under the stress of competition, and his place will be taken by more efficient men. There is an essential difference between him and the "marginal coal mine" of which we spoke above. For the probabilities are that of the coal resources, whose existence is clearly known, themore fertile and better situated parts will already be in process of exploitation; and there is not likely, therefore, to be a supply of substantially better seams which can be substituted for the worst of those in actual use. Thereislikely, on the other hand, to be available a supply of decent business capacity which can be substituted for the most inefficient of existing business men. The marginal concern, in other words, must be conceived as that working under the least advantageous conditions in respect of the assistance it derives from the strictly limited resources of nature, but under average conditions as regards managerial capacity and human qualities in general. Thus in agriculture we can speak of a marginal farm, which we should conceive as the least fertile and worst situated farm which it is just worth while to cultivate (of which more will be said when we come to the phenomenon of rent), but we must assume it to be cultivated by a farmer of average ability.
§5.Some Consequences of a Higher Price Level. The foregoing controversy will be of service to us, if it makes clear the manner and the spirit in which the marginal conception should be handled. It should be regarded not as a rigid formula which we can apply to diverse problems without considering the special features they present, but rather as a signpost which will enable us to find our way, a compass by which we may steer between the shoals of triviality and sophistry to the crux of any problem with which we have to deal. Let us illustrate its practical uses by an example which is of great interest and far-reaching practical importanceat the present day. As has been already observed, the war has left behind it in all countries a great and almost certainly permanent increase in nominal purchasing power. Since the armistice prices have moved upwards and downwards with unprecedented violence; and it would be very rash to prophesy the precise level at which they will ultimately settle (using that word with considerable relativity). But, for reasons for which the reader is referred to Volume II in this series, it is safe enough to say that the general level of post-war will greatly exceed that of pre-war prices. Now this will apply not only to consumers' goods like milk and clothes, or to raw materials like pig-iron and cotton, but in very much the same degree to things like factories and machinery. Things of this last type are sometimes called "capital goods," because it is in them that a large part of the capital of a business is embodied. Now the fact that it will cost much more than it did before the war to construct fresh capital goods, has a significance which very few people appreciate. An existing factory cost, let us say, $500,000 to build and equip with machinery before the war. To construct a similar factory to-day would cost, let us assume (it is probably a moderate assumption) $1,000,000. Suppose 10 per cent to be the gross profit that is necessary to attract capital to the particular industry. Then it will not pay to construct this new factory unless the trade prospects point to the probability of a profit of about $100,000 per annum. But if the old factory is equally well managed, it too should be able to earn this $100,000, which upon the capital actually sunk would represent a rate of 20 per cent. The particular figuresgiven are, of course, purely illustrative; the conclusion to which they point is that, if new enterprises are to be undertaken, pre-war enterprises are likely to yield a rate of profit, on their fixed capital at least, increased in rough proportion to the price-level. Of course, in years when trade is bad, the factory which dates from pre-war times will not earn a profit of this kind, it may very likely make an actual loss. At those times it is very certain that few new factories will be erected. But it is difficult to reconcile a condition of trade activity, in which the constructional industries are busily employed, with a rate of profit to pre-war businesses on the fixed part of their capital of a lesser order of magnitude than has been indicated. It makes no difference, it should be observed, whether we suppose the new enterprises to take the form of starting of new concerns or extending old ones; in neither case will they be undertaken, unless there is reason to expect an adequate return on the capital which they require at post-war constructional prices. High profits (taking always good years together with bad) on capital sunk before the war in buildings and machinery are thus a likely consequence of an increase in the price-level.
This fact is, indeed, the counterpart or complement of another phenomenon with which we are more familiar. While prices are actually rising, profits, as we have come to recognize, necessarily rule high, because every trader or manufacturer is constantly in the position of selling at a higher price-level, stock which he purchased, or goods made from materials which he purchased at a lower level. He thus acquires an abnormalprofit on his circulating capital, which is essentially similar to the profit on fixed capital, which we have just examined. The difference is that the former profit is crowded into the years when prices are actually on the increase, and thus is very noticeable indeed; while the latter profit continues to accrue in smaller instalments after prices have settled down, as it were, at the higher level, and is not exhausted until the buildings and machinery have become obsolete. But the two profits are essentially similar, and in the long run should be commensurate. In the one case, stock can be sold for a large profit, because it cannot be replaced except at a higher price; in the other case, plant and buildings yield a higher income becausetheycannot be replaced except at a higher price. Indeed, if the owners choose, the plant and building can, like the stock, be sold at their appreciated value, as has been widely done by the owners of cotton mills in Great Britain since the armistice.
There is nothing in these considerations that should surprise us, or even shock our moral sense. For what they have indicated is an increase of money profits in rough proportion to the price-level, so that the aggregate profits will represent about as much real income as before.[1] The conclusion therefore amounts to no more than this, that you cannot alter fundamentally the distribution of wealth between labor and capital by merely inflating the currency, or otherwise jugglingwith the price-level. And this is only what we should expect, if there are any laws of distribution of sufficient importance and permanence to justify the many volumes which have been devoted to them.
[1]Assuming that the rate of interest has remained unaltered. In fact it has greatly increased since pre-war days, and this points to a still further increase of money profits, and an increase in the real income which they represent. See Chapter VIII, p.138.
But this somewhat tame conclusion does not make it any less important to grasp clearly the significance of the appreciation in the value of capital goods. A failure to realize it lies at the root of our bewildered muddling of many crucial problems of the day. In the matter of housing, for instance, we know we cannot build houses at less than two or three times their prewar cost, and yet we cannot endure to see the owners of pre-war houses obtaining a commensurate increase of rent. And so, in Great Britain, we pass Rent Restriction Acts, and Housing Acts, and then, in a fit of economy we suspend the latter, and let the former stand, while the housing shortage becomes steadily more acute. When we hand the railways back from State control to private hands, our horror at the idea of the companies receiving larger money profits than they did before the war leads us to lay down principles for the fixing of fares and freight charges, which take no account of post-war construction costs; and then, in alarm lest we may have thereby made it unprofitable for the companies to spend a single penny of fresh capital upon further development, we seek to provide for capital expenditure by cumbrous and dubious expedients. Doubtless we shall muddle through somehow with such policies: and, public opinion being what it is, they may perhaps have been about the best policies that were practicable. But the problems would have been easier to handle, if the public generally werea little less disposed to think in terms of averages, and a little more in terms of margins, if we all of us instinctively realized that the cost that really matters is the cost at which additional production is profitable under the conditions ruling at the time, or in the immediate future.
§6.General Relation between Price, Utility and Cost. Let us conclude this chapter by summing up the conclusions which have emerged as to the relations of utility and cost to price.
The price of a commodity is determined by the conditions of both supply and demand; and neither can logically be said to be the superior influence, though it may sometimes be convenient to concentrate our attention on one or other of them. The chief factor on which the conditions of demand depend is the utility (as measured in terms of money). The chief factor on which the conditions of supply depend is the cost of production (again as measured in terms of money). The prevailing trend towards an equilibrium of demand and supply can thus be expressed as follows:—
VI. A commodity tends to be produced on a scale at which its marginal cost of production is equal to its marginal utility, as measured in terms of money, and both are equal to its price.
§1.Marginal Cost under Joint Supply. Several references have been made above to joint products, a relation which it will be convenient now to describe as that of Joint Supply. Our sense of symmetry should make us look for a parallel relation on the side of demand; and it is not far to seek. There is a "joint demand" for carriages and horses, for golf clubs and golf balls, for pens and ink, for the many groups of things which we use together in ordinary life. But the most important instances of Joint Demand are to be found when we pass from consumers' to producers' goods. There, indeed, Joint Demand is the universal rule. Iron ore, coal and the services of many grades of operatives are all jointly demanded for the production of steel; wool, textile machinery and again the services of many operatives are jointly demanded for the production of woollen goods (to mention in each case only a few things out of a very extensive list). Now we have already noted that, when commodities are jointly supplied, there is an obvious difficulty in allocating to each of them its proper share of the joint cost of production. There is a similar difficulty in estimating the utility of a commodity which is demanded jointly with others. Thus, the utility of wool is derived from that of the woollen goods which it helps to make. But the utility of the factories, the machinery and the operatives employed in the woollen and worsted industries is derived from preciselythe same source. How much, then, of the utility of woollen goods should be attributed to the wool and how much to the textile machinery? Can we make any sense of the notion of utility as applying to one of these things, taken by itself? And, if not, how can we explain the price of a thing like wool in terms of utility and cost, since we cannot disentangle its cost from that of mutton, nor its utility from that of a great variety of other things?
Here the conception of the margin enables us to grapple with a problem which would otherwise be insoluble. For, while it is impossible to separate out the total utility and cost of wool, it is not impossible to disentangle its marginal utility and its marginal cost. The proportion in which wool and mutton are supplied cannot be radically transformed; but it can be varied within certain limits, by rearing, for instance, a different breed of sheep. Variations of this kind have been an important feature of the economic history of Australasia, where sheep farming is the leading industry. Before the days of cold storage, Australia and New Zealand could not export their mutton to European markets, though they could export their wool. Wool was accordingly much the most valuable product; the mutton was sold in the home markets, where, the supply being very plentiful, the price was very low. In the circumstances, the Australasian farmers naturally concentrated on breeding a variety of sheep whose wool-yielding were superior to their mutton-yielding qualities. The development of the arts of refrigeration led in the eighties to an important change. It became possible to obtain relatively high prices for frozen mutton in overseas markets. There was, therefore, a marked tendency,especially in New Zealand, to substitute, for the merino, the crossbred sheep which yields a larger quantity of mutton and a smaller quantity of wool of poorer quality. Now if we calculate the cost of maintaining the number of merino sheep which will yield a given quantity of wool, and calculate the cost of maintaining the larger number of crossbred sheep which will be required to yield thesamequantity of wool (allowing for differences of quality) the extra cost which would be incurred in the latter case must be attributed entirely to the extra mutton that would be obtained. This extra cost we can regard as constituting the marginal cost of mutton. So long as this marginal cost falls short of the price of mutton, it will be profitable to extend further the substitution of crossbred for merino sheep. The process of substitution will in fact be continued until we reach the point at which the marginal cost is about equal to the price. Similarly by starting with the numbers of merino and crossbred sheep which would yield the same quantity of mutton, we can calculate the marginal cost of wool; and again the tendency will be for this marginal cost to be equal to the price.[1]
[1]It may be found difficult to grasp this point when stated in general terms. The following arithmetical example may make it plainer:—Suppose a merino sheep yields 9 units of mutton and 10 units of wool.Suppose a crossbred sheep yields 10 units of mutton and 8 units of wool.Suppose, further, that a merino sheep and a crossbred sheep each cost the same sum, say, for convenience, £10, to rear and maintain; and that there are no special costs assignable to the wool and the mutton respectively, as, of course, in fact there are.Then 10 merino sheep, yielding 90 units of mutton + 100 unitsof wool, cost £100; while 9 crossbred sheep, yielding 90 units of mutton + 72 units of wool, cost £90.Hence you could obtain an extra 28 units of wool for an extra cost of £10, by maintaining 10 merino sheep rather than 9 crossbred sheep. The marginal cost of wool is thus £ 10/28 per unit.Similarly 8 merino sheep, yielding 72 units of mutton + 80 units of wool, cost £80; while 10 crossbred sheep, yielding 100 units of mutton + 80 units of wool, cost £100.Hence you could obtain an extra 28 units of mutton for an extra cost of £20, by maintaining 10 crossbred sheep in place of 8 merinos. The marginal cost of mutton is thus £ 20/28 per unit.So long as the price obtainable for wool exceeds £ 10/28, and that obtainable for mutton does not exceed £ 20/28 per unit, it will pay to substitute merino for crossbred; and conversely. If the price of wool exceeds £ 10/28 and the price of mutton also exceeds £ 20/28, it will be profitable to expand the supply of both breeds, until as the result of the increased supply, one of the above conditions ceases to obtain. Conversely, if the prices of both products are less than the figures indicated, sheep farming of both kinds will be restricted. The resultant of the processes of expansion or restriction, and substitution, will be that, unless one of the breeds is eliminated, the prices of mutton and wool will equal their respective marginal costs. These marginal costs may, of course, alter as the process of substitution extends. For the relative cost of maintaining merinos and crossbreds will not be the same for every farmer. Here again it is the costs at the "margin of substitution" that matter.
[1]It may be found difficult to grasp this point when stated in general terms. The following arithmetical example may make it plainer:—
Suppose a merino sheep yields 9 units of mutton and 10 units of wool.
Suppose a crossbred sheep yields 10 units of mutton and 8 units of wool.
Suppose, further, that a merino sheep and a crossbred sheep each cost the same sum, say, for convenience, £10, to rear and maintain; and that there are no special costs assignable to the wool and the mutton respectively, as, of course, in fact there are.
Then 10 merino sheep, yielding 90 units of mutton + 100 unitsof wool, cost £100; while 9 crossbred sheep, yielding 90 units of mutton + 72 units of wool, cost £90.
Hence you could obtain an extra 28 units of wool for an extra cost of £10, by maintaining 10 merino sheep rather than 9 crossbred sheep. The marginal cost of wool is thus £ 10/28 per unit.
Similarly 8 merino sheep, yielding 72 units of mutton + 80 units of wool, cost £80; while 10 crossbred sheep, yielding 100 units of mutton + 80 units of wool, cost £100.
Hence you could obtain an extra 28 units of mutton for an extra cost of £20, by maintaining 10 crossbred sheep in place of 8 merinos. The marginal cost of mutton is thus £ 20/28 per unit.
So long as the price obtainable for wool exceeds £ 10/28, and that obtainable for mutton does not exceed £ 20/28 per unit, it will pay to substitute merino for crossbred; and conversely. If the price of wool exceeds £ 10/28 and the price of mutton also exceeds £ 20/28, it will be profitable to expand the supply of both breeds, until as the result of the increased supply, one of the above conditions ceases to obtain. Conversely, if the prices of both products are less than the figures indicated, sheep farming of both kinds will be restricted. The resultant of the processes of expansion or restriction, and substitution, will be that, unless one of the breeds is eliminated, the prices of mutton and wool will equal their respective marginal costs. These marginal costs may, of course, alter as the process of substitution extends. For the relative cost of maintaining merinos and crossbreds will not be the same for every farmer. Here again it is the costs at the "margin of substitution" that matter.
§2.Marginal Utility under Joint Demand. On the side of demand there exist as a rule similar possibilities of variation.Somemachinery,somelabor,somematerials of various kinds, are all indispensable in the production of any manufactured commodity. But the proportions in which these factors are combined together can be varied, and are frequently varied in practice as the result of the ceaseless pursuit of economy by business men. To produce pig-iron, you need both coal and iron ore; but, if coal becomes more costly, it is possible to economize its use. Machinery and labor must beused together, in some cases in proportions which are absolutely fixed. But there is in nearly every industry a debated question as to whether the introduction of some further labor-saving machine would be worth while, or some improved machine which would represent the substitution of more capital plus less labor for less capital plus more labor. A farmer can cultivate his land, to use a common expression, more intensively or less intensively; in other words, he can apply larger or smaller quantities of capital and labor (the proportion between which he can also vary) to the same amount of land. The problem is essentially the same as that of the substitution of the crossbred for the merino. We can take the various possible combinations of the factors of production, and contrast two cases in which different quantities of one factor are employed, together with equal quantities of the others. The extra product which will be yielded in the case in which the larger quantity of the varying factor is employed can then be regarded as the marginal product (or marginal utility) of the extra quantity of that factor; and we can say that the employment of this factor will be pushed forward to the point where this marginal product will be roughly equal to the price that must be paid for it. We can thus lay down the most important proposition that the relation between marginal utility and price holds good generally of the ultimate agents of production; that the rent of land, the wages of labor, and, we can even add, the profits of capital tend to equal their (derived) marginal utilities, or, as it is sometimes expressed, their marginal net products.
Whenever, therefore, the proportions in which two ormore things are produced or used together can be varied, the relations of joint supply and joint demand are perfectly consistent with a specific marginal cost and marginal utility for each commodity.
§3.A contrast between Cotton and Cotton-seed, and Wool and Mutton. But it sometimes happens that such variations cannot be made. Thus, it has not been found possible (so far as I am aware) to alter the proportions in which cotton lint and cotton-seed are yielded by the cotton plant. Roughly speaking, you get about 2 pounds of cotton-seed for every 1 pound of cotton lint (or raw cotton), and though this proportion may vary somewhat from plantation to plantation, it is upon the knees of the gods, and not upon the will of the planter that the variation depends. We cannot, therefore, speak with accuracy of the separate marginal costs of raw cotton and cotton-seed. It is true that some plantations are so far distant from any seed-crushing mill that it is not worth while to sell the seed as a commercial product; and it might seem, therefore, as though we might regard the entire costs of cotton growing onsuchplantations as constituting the marginal costs of raw cotton. But planters, so situated, derive a considerable value from their cotton-seed by using it as fodder for their live stock or as a manure. You can, of course, argue that proper allowance is automatically made for this factor, as a deduction from the costs of raw cotton, when you add up the expenses of the plantation. In the same way you can deduct the price which a planter who sells his cotton-seed obtains for it, from the total costs of the plantation, and call theremainder the costs of the raw cotton. But this is really to reason in a circle. For in either case the magnitude of the deduction depends on the marginal utility of the cotton-seed. And the notion of the cost of anything becomes blurred and blunted if we so use it that it must be deduced from the utility of something else, which is not an agent in the production of the thing in question.
This point is not merely an academic one. It means that we cannot explain therelativeprices of cotton lint and cotton-seed in terms of cost at all, whether marginal or otherwise. The influence of cost will be confined to thesumof the prices of the two things. Upon this sum it will exert precisely the same influence as it exerts upon price in general, by affecting the total quantities of the two things that will be supplied. But upon the distribution of this sum between lint and seed, cost will exert no influence whatever, because it cannot affect the proportions in which they are supplied. It may assist some readers if I state the matter in more concrete terms. Cost of production will be one of the factors which will result in the production of an annual cotton crop in the United States of, let us say, 10 million tons of seed cotton. This crop will yield roughly 6-2/3 million tons of cotton-seed, and 3-1/3 million tons (or rather more than 13 million bales) of lint. The combined price received by the planter of (let us say) 14.4 cents for 1 pound of lint plus 2 pounds of seed should correspond roughly to the marginal joint costs of production. But the factor of cost has no influence at all in determining that this combined price is made up of a price of 12 cents per pound for lint, and only 1.2 centsper pound (or $24 per ton) for cotton-seed. To account for this we must rely entirely upon demand. We can say, shortly, that the respective prices must be such as will enable the demand to carry off 6-2/3 million tons of seed, and 3-1/3 million tons of raw cotton. Or we can go further and say that the marginal utility of a pound of raw cotton, when 3-1/3 million tons are supplied, is ten times as great as that of a pound of seed when 6-2/3 million tons are supplied.
If accordingly the demand for cotton-seed were to expand considerably owing, say, to the discovery of some new use for the oil, which is its most valuable constituent; the effect would be first a rise in the price of cotton-seed, and, subsequently, by stimulating cotton growing, a more plentiful supply and a lower price for raw cotton. And so far at least as the increased supply is concerned, this must necessarily be the effect, "other things being equal"; though, to be sure, it might be outweighed and obscured by other influences such as the boll-weevil. But it isnotthe case that an increased demand for mutton must necessarily increase the supply or lower the price of wool; and it is most unlikely to do so in any similar degree. For, here, the separate marginal costs of the two things exert their influence. An increased demand for mutton will stimulate sheep farming, but it will also stimulate the substitution of crossbred for merino breeds; and the resultant of these two opposite tendencies upon the supply of wool is logically indeterminate. As a matter of history we know that the development of cold storage in the eighties (which we may regard for the present purpose as equivalent to an increased demand for Australian mutton)caused considerable perturbation in the woollen and worsted industries of Yorkshire. They were faced with a dwindling supply and a soaring price of merino wool; and the adaptability with which they met the situation, and won prestige for the crossbred tops, and yarns and fabrics, to which they largely turned is a matter of just pride in the trade to-day. The fact, however, that this alteration in the supply of wool was a matter not only of quantity but of quality, while it takes nothing from the substance of the preceding argument, makes it difficult to draw a clear moral, bearing on the present issue, from this incursion into history.
§4.The Importance of being Unimportant. The above contrast between cases in which variation is possible, and those in which it is not possible, is reproduced with a heightened significance when we turn back to joint demand. The cases are perhaps less common in which it isimpossibleto alter the proportions in which different commodities are jointly demanded, but there are many cases in which it is not nearly worth while to do so (and this amounts to very much the same thing). Cases of this sort are especially likely to occur when we are dealing with a commodity which accounts for only a tiny fraction of the costs of the industry which is its chief consumer. Sewing cotton, for example, is jointly demanded, with many other things, by the tailoring and other clothing trades; but the money which these trades spend on sewing cotton is so small a part of their total expenditure, that no ordinary variation in its price is likely to make it worth while to study the ways and means of using it in smaller quantities. Whensewing cotton is bought by the domestic consumer, considerations which are fundamentally the same, though somewhat different in form, point to a similar conclusion. It is thus very difficult to assign to sewing cotton a specific marginal utility. This difficulty is of great importance in connection with the possibilities of monopolistic exploitation. For it means that the demand blade of the scissors upon which we rely to cut off excrescences of price is blunted, and if accordingly the producers constitute a strong enough combination to control the supply blade, they will possess an unusual power of advancing their selling prices as they choose. I am far from suggesting that Messrs. J. & P. Coats are to be condemned as an extortionate monopoly. On the contrary, during 1919, when the profits in highly competitive industries like the main branches of the cotton and woollen trades, soared exuberantly, the record of this concern seems to me one of distinct moderation. But the present point is that they possess an exceptionalpowerto fix the price of sewing cotton as they choose, and that this is attributable in no small degree to the fact that sewing cotton constitutes an essential but relatively trifling item in the expenses of the processes in which it is employed.
Perhaps the point will be made clearer if we turn from the selling prices of commercial products, in regard to which there is a strong and not ineffective public sentiment against "profiteering," to the remuneration of different classes of labor. With an instinctive disposition towards megalomania, it is often claimed in Great Britain that the miners, being a very numerous and well-organized body of workpeople, were in astronger strategic position than most workpeople for exacting the remuneration they desire. It is quite true that a stoppage of work in the coal industry causes us a high degree of inconvenience, and temporary concessions may thereby be obtained which might otherwise have been refused. But this is a dubious advantage, and we grossly exaggerate its real importance. The truth is that the strategic position of the miners in regard to wages questions is by no means strong. For their wages constitute a very large percentage of the cost of coal; and the price of coal in its turn is a most important element in the costs of many of the industries which are its principal consumers. Great Britain, moreover, is far from possessing a monopoly of coal. If, accordingly, the wages of the miners are temporarily pushed up to a high point, the result will certainly be a diminished demand for British coal, which will lead before long to their fighting a losing battle to maintain the concessions they have won. Contrast their position with that of the steel smelters, whose wages (high though the wage rates are) constitute a very small percentage of the costs of steel production, and we must agree I think that we have in this distinction the main reason why the steel smelters, though they hardly ever go on strike, have as a rule been able to do so much better for themselves than the miners.
When a commodity or service is such that an appreciable alteration in its price has only a slight effect upon the quantity demanded, the demand is said to beinelastic. Conversely, when a small change in price greatly alters the quantity demanded, we call thedemandelastic. In the former case, it is worth nothing, a larger aggregate sum of money will be spent upon the thing when its price is high than when it is low, while the opposite is true in the latter case. This distinction is of considerable importance in connection with many problems (e.g. of taxation); and the terms, elastic demand and inelastic demand, are worth remembering. We may thus express the above conclusions by saying that the demand for sewing-cotton is highly inelastic, and that the demand for coal miners is more elastic than that for steel smelters.
§5.Capital and Labor. Cases in which it is impracticable to make any variation in the proportions in which different things are used together are, however, the exception rather than the rule. Where variation is possible, we are confronted with an uncertainty as to the way in which an increased supply of one thing will react on the demand for another, similar to our uncertainty as to whether an increased demand for mutton would augment or diminish the supply of wool. It is, for instance, of the highest importance to give a clear answer, if we can, to the question whether an increased supply of capital will increase the demand for labor. The chief effect of an increased supply of capital is to facilitate the extended use of expensive machines: to some extent these machines will increase the demand for labor; to some extent they will be substituted for it. Which of these two tendencies will outweigh the other we cannot be absolutely sure. But fortunately we can be far more nearly sure than was possible in the analogous case of wool and mutton. An increase in thesupply of capital increases the demand for the commodities, from which the demand for labor is derived, in both the senses discussed in Chapter II. First it makes them cheaper to buy, and thus increases the quantity that will be bought. It is this that is parallel to the effect of an increased demand for mutton in making it more profitable to breed sheep. But it also serves to increase the purchasing power with which to buy commodities, because it increases the aggregate real wealth of the community, and it thus serves to raise the whole demand curve. This last consideration is so important as to make it overwhelmingly probable, apart from the evidence of history, that an increase in the supply of capital (and the same may be said of an increase in the supply of the other agents of production) will on balance increase the demand for labor. The evidence of history points to the same conclusion. The history of the last hundred years displays an unprecedented accumulation of capital, and an unprecedented extension of machinery, associated with an unprecedented improvement in the standard of living throughout the whole community. This is powerful testimony in favor of the view that an increase in the supply of capital and the use of machinery will usually enhance on balance the demand for labor. Moreover, though this is not conclusive, there is little room for doubt that an obstructive attitude towards the extension of machinery in a particular country, or a particular district, is misguided. For its effect must be to make production more costly there than it is elsewhere, and to lead, slowly perhaps, but very surely, to the transference of the industry to other regions.
§6.Conclusions as to Joint Supply and Joint Demand. Here, however, we are beginning to digress. Let us sum up in a general form our conclusions as to the way in which changes in the supply or demand of a commodity react upon the demand or supply of the other things with which it is jointly demanded or supplied. Everything turns, as we have seen, on the possibility of variation in the proportions in which the things are used or produced together; and this, it is also clear, is a matter of degree. Our conclusions, therefore, had best take the following form:—
VII. When two or more things are jointly demanded, in proportions which cannot easily be varied, the tendency will be for an increase (or decrease) in the supply of one of them to increase (or decrease) the demand for the others. These results will be more certain, and more marked, the more difficult it is to vary the proportions in which the things are used.Similarly, when two or more things are jointly supplied, in proportions which cannot easily be varied, the tendency will be for an increase (or decrease) in the demand for one of them to increase (or decrease) the supply of the others. These results again will be more certain and more marked, the more difficult it is to vary the proportions in which the things are supplied.
§7.Composite Supply and Composite Demand. Joint Demand and Joint Supply do not complete the list ofrelations between the demand and supply of different things. Between tea and coffee, or beef and mutton there is a relation of a different kind. These things are in large measure what we call "substitutes" for one another. An increased supply, and a lower price of mutton, will probably induce us to consume less beef. This relation it is convenient to describe as Composite Supply. Beef and mutton make up a composite supply of meat; tea and coffee a composite supply of a certain type of beverage. For any group of things, between which the relation of Composite Supply exists, we can say, with complete generality, that an increased supply of one of them will tend to diminish the demand for the others. Parallel to the relation of Composite Supply is that of Composite Demand. There are frequently several alternative uses in which a commodity or service can be employed; and these alternative uses make up a composite demand for the thing in question. Thus railways, gasworks, private households and a great variety of industries contribute to a Composite Demand for coal. It is worth noting that there is frequently an association in practice between Joint Demand and Composite Supply on the one hand; and between Joint Supply and Composite Demand on the other. Wool and mutton, for instance, we have described as an instance of Joint Supply; but, in so far as the proportions of wool and mutton can be varied, we can regard these things as constituting a Composite Demand for sheep. And this conception may help us to retain a clearer and more orderly picture of the problems we have discussed above. We can regard the fact that wool and mutton are produced together as theirJoint Supply aspect, and the fact that these proportions can be varied as their Composite Demand aspect; and the question as to whether an increased demand for mutton will increase the supply of wool turns upon whether the former aspect is more important than the latter. Similarly labor and machinery, employed together for the same purpose, form an instance of Joint Demand; but in so far as they can be substituted for one another, they constitute a Composite Supply of alternative agents of production.
These four relations of Joint Demand, Joint Supply, Composite Demand and Composite Supply are well worth remembering and distinguishing from one another. They are of immense importance in every branch of economic affairs. There are hardly any economic problems upon which we are fitted to express an opinion, unless we have a lively sense of the far-reaching ramifications of cause and consequence, of the subtle and often unexpected interconnections between different industries and different markets. To gape at these complexities in a confused stupor is as foolish as it is to ignore them. But confusion and stupor are only too likely to represent our final state of mind, if we attempt to deal with these complications, one by one as they occur to us, in a piecemeal and haphazard fashion. We need a clear method, a systematic plan by which we may search them out, and fit them into place. The four relations which we have enumerated supply us with such a plan and method. For they represent something more than a series of pompous names for familiar notions. They constitute a classification of the various ways in which the demand andsupply of one thing can affect the demand and supply of others; a classification which is exhaustive when we add the relation of derived demand, and an analogous relation on the supply side which we must now notice.
§8.Ultimate Real Costs. Just as the utility of "producers' goods" is derived from that of the "consumers' goods" which they help to make; so the cost of any commodity is derived from the cost of the things which help to make it. Moreover, just as we recognize that the utility of "consumers' goods" lies at the back of all demand, and constitutes the ultimate end of all production; so we cannot but feel, however obscurely, that behind the phenomena of money costs, there must lie certain ultimate costs, of which all money costs are but the measure. But when we try to explain what the nature of these real costs may be, we are plunged in difficulty. Wages, it may indeed seem at first sight, present no trouble. There is the effort and the fatigue, the unpleasantness of human labor, to represent real costs. But can we suppose that these things are measured with any approach to accuracy by the wages which are paid in actual fact? Is it true, even as a broad general rule, that the services which are most arduous and most disagreeable command the highest price? And wages are not the only ingredient of money costs. There are profits: to what real costs do profits correspond? More difficult still, to what does rent correspond? These plainly are not questions upon which he who runs may read. It will be necessary to devote the next four chapters to their elucidation.