BOOK V
 
GENERAL RELATIONS OF DEMAND, SUPPLY AND VALUE
 
CHAPTER 1
 
INTRODUCTORY. ON MARKETS
 
1. A business firm grows and attains great strength, and afterwards perhaps stagnates and decays; and at the turning point there is a balancing or equilibrium of the forces of life and decay: the latter part of Book IV has been chiefly occupied with such balancing of forces in the life and decay of a people, or of a method of industry or trading. And as we reach to the higher stages of our work, we shall need ever more and more to think of economic forces as resembling those which make a young man grow in strength, till he reaches his prime; after which he gradually becomes stiff and inactive, till at last he 
sinks to make room for other and more vigorous life. But to prepare the way for this advanced study we want first to look at a simpler balancing of forces which corresponds rather to the mechanical equilibrium of a stone hanging by an elastic string, or of a number of balls resting against one another in a basin.
 
We have now to examine the general relations of demand and supply; especially 
those which are connected with that adjustment of price, by which they are 
maintained in "equilibrium." This term is in common use and may be used for the 
present without special explanation. But there are many difficulties connected 
with it, which can only be handled gradually: and indeed they will occupy our 
attention during a great part of this Book.
 
Illustrations will be taken now from one class of economic problems and now from 
another, but the main course of the reasoning will be kept free from assumptions 
which specially belong to any particular class.
 
Thus it is not descriptive, nor does it deal constructively with real problems. 
But it sets out the theoretical backbone of our knowledge of the causes which 
govern value, and thus prepares the way for the construction which is to begin 
in the following Book. It aims not so much at the attainment of knowledge, as at 
the power to obtain and arrange knowledge with regard to two opposing sets of 
forces, those which impel man to economic efforts and sacrifices, and those 
which hold him back.
 
We must begin with a short and provisional account of markets: for that is 
needed to give precision to the ideas in this and the following Books. But the 
organization of markets is intimately connected both as cause and effect with 
money, credit, and foreign trade; a full study of it must therefore be deferred 
to a later volume, where it will be taken in connection with commercial and 
industrial fluctuations, and with combinations of producers and of merchants, of 
employers and employed.
 
2. When demand and supply are spoken of in relation to one another, it is of 
course necessary that the markets to which they refer should be the same. As 
Cournot says, "Economists understand by the term Market, not any particular 
market place in which things are bought and sold, but the whole of any region in 
which buyers and sellers are in such free intercourse with one another that the 
prices of the same goods tend to equality easily and quickly."(1*) Or again as 
Jevons says: -- "Originally a market was a public place in a town where 
provisions and other objects were exposed for sale; but the word has been 
generalized, so as to mean any body of persons who are in intimate business 
relations and carry on extensive transactions in any commodity. A great city may 
contain as many markets as there are important branches of trade, and these 
markets may or may not be localized. The central point of a market is the public 
exchange, mart or auction rooms, where the traders agree to meet and transact 
business. In London the Stock Market, the Corn Market, the Coal Market, the 
Sugar Market, and many others are distinctly localized; in Manchester the Cotton 
Market, the Cotton Waste Market, and others. But this distinction of locality is 
not necessary. The traders may be spread over a whole town, or region of 
country, and vet make a market, if they are, by means of fairs, meetings, 
published price lists, the post-office or otherwise, in close communication with 
each other."(2*)
 
Thus the more nearly perfect a market is, the stronger is the tendency for the 
same price to be paid for the same thing at the same time in all parts of the 
market: but of course if the market is large, allowance must be made for the 
expense of delivering the goods to different purchasers; each of whom must be 
supposed to pay in addition to the market price a special charge on account of 
delivery.(3*)
 
3. In applying economic reasonings in practice it is often difficult to 
ascertain how far the movements of supply and demand in any one place are 
influenced by those in another. It is clear that the general tendency of the 
telegraph, the printing-press and steam traffic is to extend the area over which 
such influences act and to increase their force. The whole Western World may, in 
a sense, be regarded as one market for many kinds of stock exchange securities, 
for the more valuable metals, and to a less extent for wool and cotton and even 
wheat; proper allowance being made for expenses of transport, in which may be 
included taxes levied by any customs houses through which the goods have to 
pass. For in all these cases the expenses of transport, including customs 
duties, are not sufficient to prevent buyers from all parts of the Western World 
from competing with one another for the same supplies.
 
There are many special causes which may widen or narrow the market of any 
particular commodity: but nearly all those things for which there is a very wide 
market are in universal demand, and capable of being easily and exactly 
described. Thus for instance cotton, wheat, and iron satisfy wants that are 
urgent and nearly universal. They can be easily described, so that they can be 
bought and sold by persons at a distance from one another and at a distance also 
from the commodities. If necessary, samples can be taken of them which are truly 
representative: and they can even be "graded," as is the actual practice with 
regard to grain in America, by an independent authority; so that the purchaser 
may be secure that what he buys will come up to a given standard, though he has 
never seen a sample of the goods which he is buying and perhaps would not be 
able himself to form an opinion on it if he did.(4*)
 
Commodities for which there is a very wide market must also be such as will bear 
a long carriage: they must be somewhat durable, and their value must be 
considerable in proportion to their bulk. A thing which is so bulky that its 
price is necessarily raised very much when it is sold far away from the place in 
which it is produced, must as a rule have a narrow market. The market for common 
bricks for instance is practically confined to the near neighbourhood of the 
kilns in which they are made: they can scarcely ever bear a long carriage by 
land to a district which has any kilns of its own. But bricks of certain 
exceptional kinds have markets extending over a great part of England.
 
4. Let us then consider more closely the markets for things which satisfy in an 
exceptional way these conditions of being in general demand, cognizable and 
portable. They are, as we have said, stock exchange securities and the more 
valuable metals.
 
Any one share or bond of a public company, or any bond of a government is of 
exactly the same value as any other of the same issue: it can make no difference 
to any purchaser which of the two he buys. Some securities, principally those of 
comparatively small mining, shipping, and other companies, require local 
knowledge, and are not very easily dealt in except on the stock exchanges of 
provincial towns in their immediate neighbourhood. But the whole of England is 
one market for the shares and bonds of a large English railway. In ordinary 
times a dealer will sell, say, Midland Railway shares, even if he has not them 
himself; because he knows they are always coming into the market, and he is sure 
to be able to buy them.
 
But the strongest case of all is that of securities which are called 
"international," because they are in request in every part of the globe. They 
are the bonds of the chief governments, and of very large public companies such 
as those of the Suez Canal and the New York Central Railway. For bonds of this 
class the telegraph keeps prices at almost exactly the same level in all the 
stock exchanges of the world. If the price of one of them rises in New York or 
in Paris, in London or in Berlin, the mere news of the rise tends to cause a 
rise in other markets; and if for any reason the rise is delayed, that 
particular class of bonds is likely soon to be offered for sale in the high 
priced market under telegraphic orders from the other markets, while dealers in 
the first market will be making telegraphic purchases in other markets. These 
sales on the one hand, and purchases on the other, strengthen the tendency which 
the price has to seek the same level everywhere; and unless some of the markets 
are in an abnormal condition, the tendency soon becomes irresistible.
 
On the stock exchange also a dealer can generally make sure of selling at nearly 
the same price as that at which he buys; and he is often willing to buy first 
class stocks at a half, or a quarter, or an eighth, or in some cases even a 
sixteenth per cent less than he offers in the same breath to sell them at. If 
there are two securities equally good, but one of them belongs to a large issue 
of bonds, and the other to a small issue by the same government, so that the 
first is constantly coming on the market, and the latter but seldom, then the 
dealers will on this account alone require a larger margin between their selling 
price and their buying price in the latter case than in the former.(5*) This 
illustrates well the great law, that the larger the market for a commodity the 
smaller generally are the fluctuations in its price, and the lower is the 
percentage on the turnover which dealers charge for doing business in it.
 
Stock exchanges then are the pattern on which markets have been, and are being 
formed for dealing in many kinds of produce which can be easily and exactly 
described, are portable and in general demand. The material commodities however 
which possess these qualities in the highest degree are gold and silver. For 
that very reason they have been chosen by common consent for use as money, to 
represent the value of other things: the world market for them is most highly 
organized, and will be found to offer many subtle illustrations of the actions 
of the laws which we are now discussing.
 
5. At the opposite extremity to international stock exchange securities and the 
more valuable metals are, firstly, things which must be made to order to suit 
particular individuals, such as well-fitting clothes; and, secondly, perishable 
and bulky goods, such as fresh vegetables, which can seldom be profitably 
carried long distances. The first can scarcely be said to have a wholesale 
market at all; the conditions by which their price is determined are those of 
retail buying and selling, and the study of them may be postponed.(6*)
 
There are indeed wholesale markets for the second class, but they are confined 
within narrow boundaries; we may find our typical instance in the sale of the 
commoner kinds of vegetables in a country town. The market-gardeners in the 
neighbourhood have probably to arrange for the sale of their vegetables to the 
townspeople with but little external interference on either side. There may be 
some check to extreme prices by the power on the one side of selling, and on the 
other of buying elsewhere; but under ordinary circumstances the check is 
inoperative, and it may happen that the dealers in such a case are able to 
combine, and thus fix an artificial monopoly price; that is, a price determined 
with little direct reference to cost of production, but chiefly by a 
consideration of what the market will bear.
 
On the other hand, it may happen that some of the market-gardeners are almost 
equally near a second country town, and send their vegetables now to one and now 
to the other; and some people who occasionally buy in the first town may have 
equally good access to the second. The least variation in price will lead them 
to prefer the better market; and thus make the bargainings in the two towns to 
some extent mutually dependent. It may happen that this second town is in close 
communication with London or some other central market, so that its prices are 
controlled by the prices in the central market; and in that case prices in our 
first town also must move to a considerable extent in harmony with them. As news 
passes from mouth to mouth till a rumour spreads far away from its forgotten 
sources, so even the most secluded market is liable to be influenced by changes 
of which those in the market have no direct cognizance, changes that have had 
their origin far away and have spread gradually from market to market.
 
Thus at the one extreme are world markets in which competition acts directly 
from all parts of the globe; and at the other those secluded markets in which 
all direct competition from afar is shut out, though indirect and transmitted 
competition may make itself felt even in these; and about midway between these 
extremes lie the great majority of the markets which the economist and the 
business man have to study.
 
6. Again, markets vary with regard to the period of time which is allowed to the 
forces of demand and supply to bring themselves into equilibrium with one 
another, as well as with regard to the area over which they extend. And this 
element of Time requires more careful attention just now than does that of 
Space. For the nature of the equilibrium itself, and that of the causes by which 
it is determined, depend on the length of the period over which the market is 
taken to extend. We shall find that if the period is short, the supply is 
limited to the stores which happen to be at hand: if the period is longer, the 
supply will be influenced, more or less, by the cost of producing the commodity 
in question; and if the period is very long, this cost will in its turn be 
influenced, more or less, by the cost of producing the labour and the material 
things required for producing the commodity. These three classes of course merge 
into one another by imperceptible degrees. We will begin with the first class; 
and consider in the next chapter those temporary equilibria of demand and 
supply, in which "supply" means in effect merely the stock available at the time 
for sale in the market; so that it cannot be directly influenced by the cost of 
production.
 
NOTES:
 
1. Recherches sur les Principes Mathématiques de la Théorie des Richesses, ch. 
IV. See also above III, IV, section 7.
 
2. Theory of Political Economy, ch. IV.
 
3. Thus it is common to see the prices of bulky goods quoted as delivered "free 
on board" (f.o.b.) any vessel in a certain port, each purchaser having to make 
his own reckoning for bringing the goods home.
 
4. Thus the managers of a public or private "elevator," receive grain from a 
farmer, divide it into different grades, and return to him certificates for as 
many bushels of each grade as he has delivered. His grain is then mixed with 
those of other farmers; his certificates are likely to change hands several 
times before they reach a purchaser who demands that the grain shall be actually 
delivered to him; and little or none of what that purchaser receives may have 
come from the farm of the original recipient of the certificate.
 
5. In the case of shares of very small and little known companies, the 
difference between the price at which a dealer is willing to buy and that at 
which he will sell may amount to from five per cent. or more of the selling 
value. If he buys, he may have to carry this security a long time before he 
meets with any one who comes to take it from him, and meanwhile it may fall in 
value: while if he undertakes to deliver a security which he has not himself got 
and which does not come on the market every day, he may be unable to complete 
his contract without much trouble and expense.
 
6. A man may not trouble himself much about small retail purchases: he may give 
half-a-crown for a packet of paper in one shop which he could have got for two 
shillings in another. But it is otherwise with wholesale prices. A manufacturer 
cannot sell a ream of paper for six shillings while his neighbour is selling it 
at five. For those whose business it is to deal in paper know almost exactly the 
lowest price at which it can be bought, and will not pay more than this. The 
manufacturer has to sell at about the market price, that is at about the price 
at which other manufacturers are selling at the same time.
 
CHAPTER 2
 
TEMPORARY EQUILIBRIUM OF DEMAND AND SUPPLY
 
1. The simplest case of balance or equilibrium between. desire and effort is 
found when a person satisfies one of his wants by his own direct work. When a 
boy picks blackberries for his own eating, the action of picking is probably 
itself pleasurable for a while; and for some time longer the pleasure of eating 
is more than enough to repay the trouble of picking. But after he has eaten a 
good deal, the desire for more diminishes; while the task of picking begins to 
cause weariness, which may indeed be a feeling of monotony rather than of 
fatigue. Equilibrium is reached when at last his eagerness to play and his 
disinclination for the work of picking counterbalance the desire for eating. The 
satisfaction which he can get from picking fruit has arrived at its maximum: for 
up to that time every fresh picking has added more to his pleasure than it has 
taken away; and after that time any further picking would take away from his 
pleasure more than it would add.(1*)
 
In a casual bargain that one person makes with another, as for instance when two 
backwoodsmen barter a rifle for a canoe, there is seldom anything that can 
properly be called an equilibrium of supply and demand: there is probably a 
margin of satisfaction on either side; for probably the one would be willing to 
give something besides the rifle for the canoe, if he could not get the canoe 
otherwise; while the other would in case of necessity give something besides the 
canoe for the rifle.
 
It is indeed possible that a true equilibrium may be arrived at under a system 
of barter; but barter, though earlier in history than buying and selling, is in 
some ways more intricate; and the simplest cases of a true equilibrium value are 
found in the markets of a more advanced state of civilization.
 
We may put aside as of little practical importance a class of dealings which has 
been much discussed. They relate to pictures by old masters, rare coins and 
other things, which cannot be "graded" at all. The price at which each is sold, 
will depend much on whether any rich persons with a fancy for it happen to be 
present at its sale. If not, it will probably be bought by dealers who reckon on 
being able to sell it at a profit; and the variations in the price for which the 
same picture sells at successive auctions, great as they are, would be greater 
still if it were not for the steadying influence of professional purchasers.
 
2. Let us then turn to the ordinary dealings of modern life; and take an 
illustration from a corn-market in a country town, and let us assume for the 
sake of simplicity that all the corn in the market is of the same quality. The 
amount which each farmer or other seller offers for sale at any price is 
governed by his own need for money in hand, and by his calculation of the 
present and future conditions of the market with which he is connected. There 
are some prices which no seller would accept, some which no one would refuse. 
There are other intermediate prices which would be accepted for larger or 
smaller amounts by many or all of the sellers. Everyone will try to guess the 
state of the market and to govern his actions accordingly. Let us suppose that 
in fact there are not more than 600 quarters, the holders of which are willing 
to accept as low a price as 35s.; but that holders of another hundred would be 
tempted by 36s.; and holders of yet another three hundred by 37s. Let us suppose 
also that a price of 37s. would tempt buyers for only 600 quarters; while 
another hundred could be sold at 36s., and yet another two hundred at 35s. These 
facts may be put out in a table thus:--
 
At the price Holders will be Buyer will be
 
willing to sell willing to buy
 
37s. 1000 quarters 600 quarters
 
36s. 700 " 700 "
 
35s. 600 " 900 "
 
Of course some of those who are really willing to take 36s. rather than leave 
the market without selling, will not show at once that they are ready to accept 
that price. And in like manner buyers will fence, and pretend to be less eager 
than they really are. So the price may be tossed hither and thither like a 
shuttlecock, as one side or the other gets the better in the "higgling and 
bargaining" of the market. But unless they are unequally matched; unless, for 
instance, one side is very simple or unfortunate in failing to gauge the 
strength of the other side, the price is likely to be never very far from 36s.; 
and it is nearly sure to be pretty close to 36s. at the end of the market. For 
if a holder thinks that the buyers will really be able to get at 36s. all that 
they care to take at that price, he will be unwilling to let slip past him any 
offer that is well above that price.
 
Buyers on their part will make similar calculations; and if at any time the 
price should rise considerably above 36s. they will argue that the supply will 
be much greater than the demand at that price: therefore even those of them who 
would rather pay that price than go unserved, wait; and by waiting they help to 
bring the price down. On the other hand, when the price is much below 36s., even 
those sellers who would rather take the price than leave the market with their 
corn unsold, will argue that at that price the demand will be in excess of the 
supply: so they will wait, and by waiting help to bring the price up.
 
The price of 36s. has thus some claim to be called the true equilibrium price: 
because if it were fixed on at the beginning, and adhered to throughout, it 
would exactly equate demand and supply (i.e. the amount which buyers were 
willing to purchase at that price would be just equal to that for which sellers 
were willing to take that price); and because every dealer who has a perfect 
knowledge of the circumstances of the market expects that price to be 
established If he sees the price differing much from 36s. he expects that a 
change will come before long, and by anticipating it he helps it to come 
quickly.
 
It is not indeed necessary for our argument that any dealers should have a 
thorough knowledge of the circumstances of the market. Many of the buyers may 
perhaps underrate the willingness of the sellers to sell, with the effect that 
for some time the price rules at the highest level at which any buyers can be 
found; and thus 500 quarters may be sold before the price sinks below 37s. But 
afterwards the price must begin to fall and the result will still probably be 
that 200 more quarters will be sold, and the market will close on a price of 
about 36s. For when 700 quarters have been sold, no seller will be anxious to 
dispose of any more except at a higher price than 36s., and no buyer will be 
anxious to purchase any more except at a lower price than 36s. In the same way 
if the sellers had underrated the willingness of the buyers to pay a high price, 
some of them might begin to sell at the lowest price they would take, rather 
than have their corn left on their hands, and in this case much corn might be 
sold at a price of 35s.; but the market would probably close on a price of 36s. 
and a total sale of 700 quarters.(2*)
 
3. In this illustration there is a latent assumption which is in accordance with 
the actual conditions of most markets; but which ought to be distinctly 
recognized in order to prevent its creeping into those cases in which it is not 
justifiable. We tacitly assumed that the sum which purchasers were willing to 
pay, and which sellers were willing to take, for the seven hundredth quarter 
would not be affected by the question whether the earlier bargains had been made 
at a high or a low rate. We allowed for the diminution in the buyers' need of 
corn [its marginal utility to them] as the amount bought increased. But we did 
not allow for any appreciable change in their unwillingness to part with money 
[its marginal utility]; we assumed that that would be practically the same 
whether the early payments had been at a high or a low rate.
 
This assumption is justifiable with regard to most of the market dealings with 
which we are practically concerned. When a person buys anything for his own 
consumption, he generally spends on it a small part of his total resources; 
while when he buys it for the purposes of trade, he looks to re-selling it, and 
therefore his potential resources are not diminished. In either case there is no 
appreciable change in his willingness to part with money. There may indeed be 
individuals of whom this is not true; but there are sure to be present some 
dealers with large stocks of money at their command; and their influence 
steadies the market.(3*)
 
The exceptions are rare and unimportant in markets for commodities; but in 
markets for labour they are frequent and important. When a workman is in fear of 
hunger, his need of money [its marginal utility to him] is very great; and, if 
at starting, he gets the worst of the bargaining, and is employed at low wages, 
it remains great, and he may go on selling his labour at a low rate. That is all 
the more probable because, while the advantage in bargaining is likely to be 
pretty well distributed between the two sides of a market for commodities, it is 
more often on the side of the buyers than on that of the sellers in a market for 
labour. Another difference between a labour market and a market for commodities 
arises from the fact that each seller of labour has only one unit of labour to 
dispose of. These are two among many facts, in which we shall find, as we go on, 
the explanation of much of that instinctive objection which the working classes 
have felt to the habit of some economists, particularly those of the employer 
class, of treating labour simply as a commodity and regarding the labour market 
as like every other market; whereas in fact the differences between the two 
cases, though not fundamental from the point of view of theory, are yet clearly 
marked, and in practice often very important.
 
The theory of buying and selling becomes therefore much more complex when we 
take account of the dependence of marginal utility on amount in the case of 
money as well as of the commodity itself. The practical importance of this 
consideration is not very great. But a contrast is drawn in Appendix F between 
barter and dealings in which one side of each exchange is in the form of general 
purchasing power. In barter a person 's stock of either commodity exchanged 
needs to be adjusted closely to his individual wants. If his stock is too large 
he may have no good use for it. If his stock is too small he may have some 
difficulty in finding any one who can conveniently give him what he wants and is 
also in need of the particular things of which he himself has a superfluity. But 
any one who has a stock of general purchasing power, can obtain any thing he 
wants as soon as he meets with any one who has a superfluity of that thing. he 
needs not to hunt about till he comes across "the double coincidence" of a 
person who can spare what he wants, and also wants what he can spare. 
Consequently every one, and especially a professional dealer, can afford to keep 
command over a large stock of money; and can therefore make considerable 
purchases without depleting his stock of money or greatly altering its marginal 
value.
 
NOTES:
 
1. See IV, I, section 2, and Note XII in the Mathematical Appendix.
 
2. A simple form of the influence which opinion exerts on the action of dealers, 
and therefore on market price, is indicated in this illustration: we shall be 
much occupied with more complex developments of it later on.
 
3. For instance a buyer is sometimes straitened for want of ready money, and has 
to let offers pass by him in no way inferior to others which he has gladly 
accepted: his own funds being exhausted, he could not perhaps borrow except on 
terms that would take away all the profit that the bargains had at first sight 
offered. But if the bargain is really a good one, some one else, who is not so 
straitened, is nearly sure to get hold of it.
 
Again, it is possible that several of those who had been counted as ready to 
sell corn at a price of 36s. were willing to sell only because they were in 
urgent need of a certain amount of ready money; if they succeeded in selling 
some corn at a high price, there might be a perceptible diminution in the 
marginal utility of ready money to them; and therefore they might refuse to sell 
for 36s. a quarter all the corn which they would have sold if the price had been 
36s. throughout.
 
In this case the sellers in consequence of getting an advantage in bargaining at 
the beginning of the market might retain to the end a price higher than the 
equilibrium price. The price at which the market dosed would be an equilibrium 
price; and though not properly described as the equilibrium price, it would be 
very unlikely to diverge widely from that price.
 
Conversely, if the market had opened much to the disadvantage of the sellers and 
they had sold some corn very cheap, so that they remained in great want of ready 
money, the final utility of money to them might have remained so high that they 
would have gone on selling considerably below 36s. until the buyers had been 
supplied with all that they cared to take. The market would then close without 
the true equilibrium price having ever been reached, but a very near approach 
would have been made to it.
 
CHAPTER 3
 
EQUILIBRIUM OF NORMAN DEMAND AND SUPPLY
 
1. We have next to inquire what causes govern supply prices, that is prices 
which dealers are willing to accept for different amounts. In the last chapter 
we looked at the affairs of only a single day. and supposed the stocks offered 
for sale to be already in existence. But of course these stocks are dependent on 
the amount of wheat sown in the preceding year; and that, in its turn, was 
largely influenced by the farmers' guesses as to the price which they would get 
for it in this year. This is the point at which we have to work in the present 
chapter.
 
Even in the corn-exchange of a country town on a market-day the equilibrium 
price is affected by calculations of the future relations of production and 
consumption; while in the leading corn-markets of America and Europe dealings 
for future delivery already predominate and are rapidly weaving into one web all 
the leading threads of trade in corn throughout the whole world. Some of these 
dealings in "futures" are but incidents in speculative manoeuvres; but in the 
main they are governed by calculations of the world's consumption on the one 
hand, and of the existing stocks and coming harvests in the Northern and 
Southern hemispheres on the other. Dealers take account of the areas sown with 
each kind of grain, of the forwardness and weight of the crops, of the supply of 
things which can be used as substitutes for grain, and of the things for which 
grain can be used as a substitute. Thus, when buying or selling barley, they 
take account of the supplies of such things as sugar, which can be used as 
substitutes for it in brewing, and again of all the various feeding stuffs, a 
scarcity of which might raise the value of barley for consumption on the farm. 
If it is thought that the growers of any kind of grain in any part of the world 
have been losing money, and are likely to sow a less area for a future harvest; 
it is argued that prices are likely to rise as soon as that harvest comes into 
sight, and its shortness is manifest to all. Anticipations of that rise exercise 
an influence on present sales for future delivery, and that in its turn 
influences cash prices; so that these prices are indirectly affected by 
estimates of the expenses of producing further supplies.
 
But in this and the following chapters we are specially concerned with movements 
of price ranging over still longer periods than those for which the most 
far-sighted dealers in futures generally make their reckoning.. we have to 
consider the volume of production adjusting itself to the conditions of the 
market, and the normal price being thus determined at the position of stable 
equilibrium of normal demand and normal supply.
 
2. In this discussion we shall have to make frequent use of the terms cost and 
expenses of production; and some provisional account of them must be given 
before proceeding further.
 
We may revert to the analogy between the supply price and the demand price of a 
commodity. Assuming for the moment that the efficiency of production depends 
solely upon the exertions of the workers, we saw that "the price required to 
call forth the exertion necessary for producing any given amount of a commodity 
may be called the supply price for that amount, with reference of course to a 
given unit of time."(1*) But now we have to take account of the fact that the 
production of a commodity generally requires many different kinds of labour and 
the use of capital in many forms. The exertions of all the different kinds of 
labour that are directly or indirectly involved in making it; together with the 
abstinences or rather the waitings required for saving the capital used in 
making it: all these efforts and sacrifices together will be called the real 
cost of production of the commodity. The sums of money that have to be paid for 
these efforts and sacrifices will be called either its money cost of production, 
or, for shortness, its expenses of production; they are the prices which have to 
be paid in order to call forth an adequate supply of the efforts and waitings 
that are required for making it; or, in other words, they are its supply 
price.(2*)
 
The analysis of the expenses of production of a commodity might be carried 
backward to any length; but it is seldom worth while to go back very far. It is 
for instance often sufficient to take the supply prices of the different kinds 
of raw materials used in any manufacture as ultimate facts, without analysing 
these supply prices into the several elements of which they are composed; 
otherwise indeed the analysis would never end. We may then arrange the things 
that are required for making a commodity into whatever groups are convenient, 
and call them its factors of production.
 
Its expenses of production when any given amount of it is produced are thus the 
supply prices of the corresponding quantities of its factors of production. And 
the sum of these is the supply price of that amount of the commodity.
 
3. The typical modern market is often regarded as that in which manufacturers 
sell goods to wholesale dealers at prices into which but few trading expenses 
enter. But taking a broader view, we may consider that the supply price of a 
commodity is the price at which it will be delivered for sale to that group of 
persons whose demand for it we are have considering; or, in other words, in the 
market which we have in view. On the character of that market will depend how 
many trading expenses have to be reckoned to make up the supply price.(3*) For 
instance, the supply price of wood in the neighbourhood of Canadian forests 
often consists almost exclusively of the price of the labour of lumber men: but 
the supply price of the same wood in the wholesale London market consists in a 
large measure of freights; while its supply price to a small retail buyer in an 
English country town is more than half made up of the charges of the railways 
and middlemen who have brought what he wants to his doors, and keep a stock of 
it ready for him. Again, the supply price of a certain kind of labour may for 
some purposes be divided up into the expenses of rearing, of general education 
and of special trade education. The possible combinations are numberless; and 
though each may have incidents of its own which will require separate treatment 
in the complete solution of any problem connected with it, yet all such 
incidents may be ignored, so far as the general reasonings of this Book are 
concerned.
 
In calculating the expenses of production of a commodity we must take account of 
the fact that changes in the amounts produced are likely, even when there is no 
new invention, to be accompanied by changes in the relative quantities of its 
several factors of production. For instance, when the scale of production 
increases, horse or steam power is likely to be substituted for manual labour; 
materials are likely to be brought from a greater distance and in greater 
quantities, thus increasing those expenses of production which correspond to the 
work of carriers, middlemen and traders of all kinds.
 
As far as the knowledge and business enterprise of the producers reach, they in 
each case choose those factors of production which are best for their purpose; 
the sum of the supply prices of those factors which are used is, as a rule, less 
than the sum of the supply prices of any other set of factors which could be 
substituted for them; and whenever it appears to the producers that this is not 
the case, they will, as a rule, set to work to substitute the less expensive 
method. And further on we shall see how in a somewhat similar way society 
substitutes one undertaker for another who is less efficient in proportion to 
his charges. We may call this, for convenience of reference, The principle of 
substitution.
 
The applications of this principle extend over almost every field of economic 
inquiry.(4*)
 
4. The position then is this: we are investigating the equilibrium of normal 
demand and normal supply in their most general form; we are neglecting those 
features which are special to particular parts of economic science, and are 
confining our attention to those broad relations which are common to nearly the 
whole of it. Thus we assume that the forces of demand and supply have free play; 
that there is no close combination among dealers on either side, but each acts 
for himself, and there is much free competition; that is, buyers generally 
compete freely with buyers, and sellers compete freely with sellers. But though 
everyone acts for himself, his knowledge of what others are doing is supposed to 
be generally sufficient to prevent him from taking a lower or paying a higher 
price than others are doing. This is assumed provisionally to be true both of 
finished goods and of their factors of production, of the hire of labour and of 
the borrowing of capital. We have already inquired to some extent, and we shall 
have to inquire further, how far these assumptions are in accordance with the 
actual facts of life. But meanwhile this is the supposition on which we proceed; 
we assume that there is only one price in the market at one and the same time; 
it being understood that separate allowance is made, when necessary, for 
differences in the expense of delivering goods to dealers in different parts of 
the market; including allowance for the special expenses of retailing, if it is 
a retail market.
 
In such a market there is a demand price for each amount of the commodity, that 
is, a price at which each particular amount of the commodity can find purchasers 
in a day or week or year. The circumstances which govern this price for any 
given amount of the commodity vary in character from one problem to another; but 
in every case the more of a thing is offered for sale in a market the lower is 
the price at which it will find purchasers; or in other words, the demand price 
for each bushel or yard diminishes with every increase in the amount offered.
 
The unit of time may be chosen according to the circumstances of each particular 
problem: it may be a day, a month, a year, or even a generation: but in every 
case it must be short relatively to the period of the market under discussion. 
It is to be assumed that the general circumstances of the market remain 
unchanged throughout this period; that there is, for instance, no change in 
fashion or taste, no new substitute which might affect the demand, no new 
invention to disturb the supply.
 
The conditions of normal supply are less definite; and a full study of them must 
be reserved for later chapters. They will be found to vary in detail with the 
length of the period of time to which the investigation refers; chiefly because 
both the material capital of machinery and other business plant, and the 
immaterial capital of business skill and ability and organization, are of slow 
growth and slow decay.
 
Let us call to mind the "representative firm," whose economies of production, 
internal and external, are dependent on the aggregate volume of production of 
the commodity that it makes;(5*) and, postponing all further study of the nature 
of this dependence, let us assume that the normal supply price of any amount of 
that commodity may be taken to be its normal expenses of production (including 
gross earnings of management(6*)) by that firm. That is, let us assume that this 
is the price the expectation of which will just suffice to maintain the existing 
aggregate amount of production; some firms meanwhile rising and increasing their 
output, and others falling and diminishing theirs; but the aggregate production 
remaining unchanged. A price higher than this would increase the growth of the 
rising firms, and slacken, though it might not arrest, the decay of the falling 
firms; with the net result of an increase in the aggregate production. On the 
other hand, a price lower than this would hasten the decay of the falling firms, 
and slacken the growth of the rising firms; and on the whole diminish 
production: and a rise or fall of price would affect in like manner though 
perhaps not in an equal degree those great joint-stock companies which often 
stagnate, but seldom die.
 
5. To give definiteness to our ideas let us take an illustration from the 
woollen trade. Let us suppose that a person well acquainted with the woollen 
trade sets himself to inquire what would be the normal supply price of a certain 
number of millions of yards annually of a particular kind of cloth. He would 
have to reckon (i) the price of the wool, coal, and other materials which would 
be used up in making it, (ii) wear-and-tear and depreciation of the buildings, 
machinery and other fixed capital, (iii) interest and insurance on all the 
capital, (iv) the wages of those who work in the factories, and (v) the gross 
earnings of management (including insurance against loss), of those who 
undertake the risks, who engineer and superintend the working. He would of 
course estimate the supply prices of all these different factors of production 
of the cloth with reference to the amounts of each of them that would be wanted, 
and on the supposition that the conditions of supply would be normal; and he 
would add them all together to find the supply price of the cloth.
 
Let us suppose a list of supply prices (or a supply schedule) made on a similar 
plan to that of our list of demand prices:(7*) the supply price of each amount 
of the commodity in a year, or any other unit of time, being written against 
that amount.(8*) As the flow, or (annual) amount of the commodity increases, the 
supply price may either increase or diminish; or it may even alternately 
increase and diminish.(9*) For if nature is offering a sturdy resistance to 
man's efforts to wring from her a larger supply of raw material, while at that 
particular stage there is no great room for introducing important new economies 
into the manufacture, the supply price will rise; but if the volume of 
production were greater, it would perhaps be profitable to substitute largely 
machine work for hand work and steam power for muscular force; and the increase 
in the volume of production would have diminished the expenses of production of 
the commodity of our representative firm. But those cases in which the supply 
price falls as the amount increases involve special difficulties of their own; 
and they are postponed to chapter XII of this Book.
 
6. When therefore the amount produced (in a unit of time) is such that the 
demand price is greater than the supply price, then sellers receive more than is 
sufficient to make it worth their while to bring goods to market to that amount; 
and there is at work an active force tending to increase the amount brought 
forward for sale. On the other hand, when the amount produced is such that the 
demand price is less than the supply price, sellers receive less than is 
sufficient to make it worth their while to bring goods to market on that scale; 
so that those who were just on the margin of doubt as to whether to go on 
producing are decided not to do so, and there is an active force at work tending 
to diminish the amount brought forward for sale. When the demand price is equal 
to the supply price, the amount produced has no tendency either to be increased 
or to be diminished; it is in equilibrium.
 
When demand and supply are in equilibrium, the amount of the commodity which is 
being produced in a unit of time may be called the equilibrium-amount, and the 
price at which it is being sold may be called the equilibrium-price.
 
Such an equilibrium is stable; that is, the price, if displaced a little from 
it, will tend to return, as a pendulum oscillates about its lowest point; and it 
will be found to be a characteristic of stable equilibria that in them the 
demand price is greater than the supply price for amounts just less than the 
equilibrium amount, and vice versa. For when the demand price is greater than 
the supply price, the amount produced tends to increase. Therefore, if the 
demand price is greater than the supply price for amounts just less than an 
equilibrium amount; then, if the scale of production is temporarily diminished 
somewhat below that equilibrium amount, it will tend to return; thus the 
equilibrium is stable for displacements in that direction. If the demand price 
is greater than the supply price for amounts just less than the equilibrium 
amount, it is sure to be less than the supply price for amounts just greater: 
and therefore, if the scale of production is somewhat increased beyond the 
equilibrium position, it will tend to return; and the equilibrium will be stable 
for displacements in that direction also.
 
When demand and supply are in stable equilibrium, if any accident should move 
the scale of production from its equilibrium position, there will be instantly 
brought into play forces tending to push it back to that position; just as, if a 
stone hanging by a string is displaced from its equilibrium position, the force 
of gravity will at once tend to bring it back to its equilibrium position. The 
movements of the scale of production about its position of equilibrium will be 
of a somewhat similar kind.(10*)
 
But in real life such oscillations are seldom as rhythmical as those of a stone 
hanging freely from a string; the comparison would be more exact if the string 
were supposed to hang in the troubled waters of a mill-race, whose stream was at 
one time allowed to flow freely, and at another partially cut off. Nor are these 
complexities sufficient to illustrate all the disturbances with which the 
economist and the merchant alike are forced to concern themselves. If the person 
holding the string swings his hand with movements partly rhythmical and partly 
arbitrary, the illustration will not outrun the difficulties of some very real 
and practical problems of value. For indeed the demand and supply schedules do 
not in practice remain unchanged for a long time together, but are constantly 
being changed; and every change in them alters the equilibrium amount and the 
equilibrium price, and thus gives new positions to the centres about which the 
amount and the price tend to oscillate.
 
These considerations point to the great importance of the element of time in 
relation to demand and supply, to the study of which we now proceed. We shall 
gradually discover a great many different limitations of the doctrine that the 
price at which a thing can be produced represents its real cost of production, 
that is, the efforts and sacrifices which have been directly and indirectly 
devoted to its production. For, in an age of rapid change such as this, the 
equilibrium of normal demand and supply does not thus correspond to any distinct 
relation of a certain aggregate of pleasures got from the consumption of the 
commodity and an aggregate of efforts and sacrifices involved in producing it: 
the correspondence would not be exact, even if normal earnings and interest were 
exact measures of the efforts and sacrifices for which they are the money 
payments. This is the real drift of that much quoted, and much-misunderstood 
doctrine of Adam Smith and other economists that the normal, or "natural," value 
of a commodity is that which economic forces tend to bring about in the long 
run. It is the average value which economic forces would bring about if the 
general conditions of life were stationary for a run of time long enough to 
enable them all to work out their full effect.(11*)
 
But we cannot foresee the future perfectly. The unexpected may happen; and the 
existing tendencies may be modified before they have had time to accomplish what 
appears now to be their full and complete work. The fact that the general 
conditions of life are not stationary is the source of many of the difficulties 
that are met with in applying economic doctrines to practical problems.
 
Of course Normal does not mean Competitive. Market prices and Normal prices are 
alike brought about by a multitude of influences, of which some rest on a moral 
basis and some on a physical; of which some are competitive and some are not. It 
is to the persistence of the influences considered, and the time allowed for 
them to work out their effects that we refer when contrasting Market and Normal 
price, and again when contrasting the narrower and the broader use of the term 
Normal price.(12*)
 
7. The remainder of the present volume will be chiefly occupied with 
interpreting and limiting this doctrine that the value of a thing tends in the 
long run to correspond to its cost of production. In particular the notion of 
equilibrium, which has been treated rather slightly in this chapter, will be 
studied more carefully in chapters V and XII of this Book: and some account of 
the controversy whether "cost of production" or "utility" governs value will be 
given in Appendix I. But it may be well to say a word or two here on this last 
point.
 
We might as reasonably dispute whether it is the upper or the under blade of a 
pair of scissors that cuts a piece of paper, as whether value is governed by 
utility or cost of production. It is true that when one blade is held still, and 
the cutting is effected by moving the other, we may say with careless brevity 
that the cutting is done by the second; but the statement is not strictly 
accurate, and is to be excused only so long as it claims to be merely a popular 
and not a strictly scientific account of what happens.
 
In the same way, when a thing already made has to be sold, the price which 
people will be willing to pay for it will be governed by their desire to have 
it, together with the amount they can afford to spend on it. Their desire to 
have it depends partly on the chance that, if they do not buy it, they will be 
able to get another thing like it at as low a price: this depends on the causes 
that govern the supply of it, and this again upon cost of production. But it may 
so happen that the stock to be sold is practically fixed. This, for instance, is 
the case with a fish market, in which the value of fish for the day is governed 
almost exclusively by the stock on the slabs in relation to the demand: and if a 
person chooses to take the stock for granted, and say that the price is governed 
by demand, his brevity may perhaps be excused so long as he does not claim 
strict accuracy. So again it may be pardonable, but it is not strictly accurate 
to say that the varying prices which the same rare book fetches, when sold and 
resold at Christie 's auction room, are governed exclusively by demand.
 
Taking a case at the opposite extreme, we find some commodities which conform 
pretty closely to the law of constant return; that is to say, their average cost 
of production will be very nearly the same whether they are produced in small 
quantities or in large. In such a case the normal level about which the market 
price fluctuates will be this definite and fixed (money) cost of production. If 
the demand happens to be great, the market price will rise for a time above the 
level; but as a result production will increase and the market price will fall: 
and conversely, if the demand falls for a time below its ordinary level.
 
In such a case, if a person chooses to neglect market fluctuations, and to take 
it for granted that there will anyhow be enough demand for the commodity to 
insure that some of it, more or less, will find purchasers at a price equal to 
this cost of production, then he may be excused for ignoring the influence of 
demand, and speaking of (normal) price as governed by cost of production -- 
provided only he does not claim scientific accuracy for the wording of his 
doctrine, and explains the influence of demand in its right place.
 
Thus we may conclude that, as a general rule, the shorter the period which we 
are considering, the greater must be the share of our attention which is given 
to the influence of demand on value; and the longer the period, the more 
important will be the influence of cost of production on value. For the 
influence of changes in cost of production takes as a rule a longer time to work 
itself out than does the influence of changes in demand. The actual value at any 
time, the market value as it is often called, is often more influenced by 
passing events and by causes whose action is fitful and short lived, than by 
those which work persistently. But in long periods these fitful and irregular 
causes in large measure efface one another's influence; so that in the long run 
persistent causes dominate value completely. Even the most persistent causes are 
however liable to change. For the whole structure of production is modified, and 
the relative costs of production of different things are permanently altered, 
from one generation to another.
 
When considering costs from the point of view of the capitalist employer, we of 
course measure them in money; because his direct concern with the efforts needed 
for the work of his employees lies in the money payments he must make. His 
concern with the real costs of their effort and of the training required for it 
is only indirect, though a monetary assessment of his own labour is necessary 
for some problems, as will be seen later on. But when considering costs from the 
social point of view, when inquiring whether the cost of attaining a given 
result is increasing or diminishing with changing economic conditions, then we 
are concerned with the real costs of efforts of various qualities, and with the 
real cost of waiting. If the purchasing power of money, in terms of effort has 
remained about constant, and if the rate of remuneration for waiting has 
remained about constant, then the money measure of costs corresponds to the real 
costs: but such a correspondence is never to be assumed lightly. These 
considerations will generally suffice for the interpretation of the term Cost in 
what follows, even where no distinct indication is given in the context.
 
NOTES:
 
1. IV, I, section 2.
 
2. Mill and some other economists have followed the practice of ordinary life in 
using the term Cost of production in two senses, sometimes to signify the 
difficulty of producing a thing, and sometimes to express the outlay of money 
that has to be incurred in order to induce people to overcome this difficulty 
and produce it. But by passing from one use of the term to the other without 
giving explicit warning, they have led to many misunderstandings and much barren 
controversy. The attack on Mill's doctrine of Cost of Production in relation to 
Value, which is made in Cairnes' leading Principles, was published just after 
Mill's death; and unfortunately his interpretation of Mill's words was generally 
accepted as authoritative, because he was regarded as a follower of Mill. But in 
an article by the present writer on "Mill's Theory of Value" (Fortnightly 
Review, April 1876) it is argued that Cairnes had mistaken Mill's meaning, and 
had really seen not more but less of the truth than Mill had done.
 
The expenses of production of any amount of a raw commodity may best be 
estimated with reference to the "margin of production" at which no rent is paid. 
But this method of speaking has great difficulties with regard to commodities 
that obey the law of increasing return. It seemed best to note this point in 
passing: it will be fully discussed later on, chiefly in ch. XII.
 
3. We have already (II, iii) noticed that the economic use of the term 
"production", includes the production of new utilities by moving a thing from a 
place in which it is less wanted to a place in which it is more wanted, or by 
helping consumers to satisfy their needs.
 
4. See III, v and IV, VII, section 8.
 
5. See IV XIII, section 2.
 
6. See last paragraph of IV, XII.
 
7. See III, III, section 4.
 
8. Measuring, as in the case of the demand curve, amounts of the commodity along 
Ox and prices parallel to 0y, We get for each point M along Ox a line MP drawn 
at right angles to it measuring the supply price for the amount OM, the 
extremity of which, P, may be called a supply point; this price MP being made up 
of the supply prices of the several factors of production for the amount OM. The 
locus of P may be called the supply curve.
 
Suppose, for instance, that we classify the expenses of production of our 
representative firm, when an amount OM of cloth is being produced under the 
heads of (i) Mp1' the supply price of the wool and other circulating capital 
which would be consumed in making it, (ii) p1 p2 the corresponding wearand-tear 
and depreciation on buildings, machinery and other fixed capital; (iii) p2p3 the 
interest and insurance on all the capital, (iv) p3p4 the wages of those who work 
in the factory, and (v) p4P the gross earnings of management, etc. of those who 
undertake the risks and direct the work. Thus as M moves from O towards the 
right p1' p2, p3' p4 will each trace out a curve, and the ultimate supply curve 
traced out by P will be thus shown as obtained by superimposing the supply 
curves for the several factors of production of the cloth.
 
It must be remembered that these supply prices are the prices not of units of 
the several factors but of those amounts of the several factors which for 
producing a yard of the cloth. Thus, for instance, p3p4 is the supply price are 
required not of any fixed amount of labour but of that amount of labour which is 
employed in making a yard where there is an aggregate production of OM yards. 
(See above, section 3.) We need not trouble ourselves to consider just here 
whether the groundrent of the factory must be put into a class by itself: this 
belongs to a group of questions which will be discussed later. We are taking no 
notice of rates and taxes, for which he would of course have to make his 
account.
 
9. That is, a point moving along the supply curve towards the right may either 
rise or fall, or even it may alternately rise and fall; in other words, the 
supply curve may be inclined positively or negatively, or even at some parts of 
its course it may be inclined positively and at others negatively. (See footnote 
on p. 99.)
 
10. Compare V, I, section 1. To represent the equilibrium of demand and supply 
geometrically we may draw the demand and supply curves together as in Fig. 19. 
If then OR represents the rate at which production is being actually carried on, 
and Rd the demand price is greater than Rs the supply price, the production is 
exceptionally profitable, and will be increased. R, the amount-index, as we may 
call it, will move to the right. On the other hand, if Rd is less than Rs, R 
will move to the left. If Rd is equal to Rs, that is, if R is vertically under a 
point of intersection of the curves, demand and supply are in equilibrium.
 
This may be taken as the typical diagram for stable equilibrium for a commodity 
that obeys the law of diminishing return. But if we had made SS' a horizontal 
straight line, we should have represented the case of "constant return," in 
which the supply price is the same for all amounts of the commodity. And if we 
had made SS' inclined negatively, but less steeply than DD' (the necessity for 
this condition will appear more fully later on), we should have got a case of 
stable equilibrium for a commodity which obeys the law of increasing return. In 
either case the above reasoning remains unchanged without the alteration of a 
word or a letter; but the last case introduces difficulties which we have 
arranged to postpone.
 
11. See below V, v, section 2 and Appendix H, section 4.
 
12. See above, pp. 34-6.
 
CHAPTER 4
 
THE INVESTMENT AND DISTRIBUTION OF RESOURCES
 
1. The first difficulty to be cleared up in our study of normal values, is the 
nature of the motives which govern the investment of resources for a distant 
return. It will be well to begin by watching the action of a person who neither 
buys what he wants nor sells what he makes, but works on his own behalf; and who 
therefore balances the, efforts and sacrifices which he makes on the one hand 
against the pleasures which he expects to derive from their fruit on the other, 
without the intervention of any money payments at all.
 
Let us then take the case of a man who builds a house for himself on land, and 
of materials, which nature supplies gratis; and who makes his implements as he 
goes, the labour of making them being counted as part of the labour of building 
the house. He would have to estimate the efforts required for building on any 
proposed plan; and to allow almost instinctively an amount increasing in 
geometrical proportion (a sort of compound interest) for the period that would 
elapse between each effort and the time when the house would be ready for his 
use. The utility of the house to him when finished would have to compensate him 
not only for the efforts, but for the waitings.(1*)
 
If the two motives, one deterring, the other impelling, seemed equally balanced, 
he would be on the margin of doubt. Probably the gain would much more than 
outweigh the "real" cost with regard to some part of the house. But as he turned 
over more and more ambitious plans, he would at last find the advantages of any 
further extension balanced by the efforts and waitings required for making it; 
and that extension of the building would be on the outer limit, or margin of 
profitableness of the investment of his capital.
 
There would probably be several ways of building parts of the house; some parts 
for instance might almost equally well be built of wood or of rough stones: the 
investment of capital on each plan for each part of the accommodation would be 
compared with the advantages offered thereby, and each would be pushed forward 
till the outer limit or margin of profitableness had been reached. Thus there 
would be a great many margins of profitableness: one corresponding to each kind 
of plan on which each kind of accommodation might be provided.
 
2. This illustration may serve to keep before us the way in which the efforts 
and sacrifices which are the real cost of production of a thing, underlie the 
expenses which are its money cost. But, as has just been remarked, the modern 
business man commonly takes the payments which he has to make, whether for wages 
or raw material, as he finds them; without staying to inquire how far they are 
an accurate measure of the efforts and sacrifices to which they correspond. His 
expenditure is generally made piece-meal; and the longer he expects to wait for 
the fruit of any outlay, the richer must that fruit be in order to compensate 
him. The anticipated fruit may not be certain; and in that case he will have to 
allow for the risk of failure. After making that allowance, the fruit of the 
outlay must be expected to exceed the outlay itself by an amount which, 
independently of his own remuneration, increases at compound interest in 
proportion to the time of waiting.(2*) Under this head are to be entered the 
heavy expenses, direct and indirect, which every business must incur in building 
up its connection.
 
For brevity we may speak of any element of outlay (allowance being made for the 
remuneration of the undertaker himself) when increased by compound interest in 
this way, as accumulated; just as we used the term discounted to represent the 
present value of a future gratification. Each element of outlay has then to be 
accumulated for the time which will elapse between its being incurred and its 
bearing fruit; and the aggregate of these accumulated elements is the total 
outlay involved in the enterprise. The balance between efforts and the 
satisfactions resulting from them may be made up to any day that is found 
convenient. But whatever day is chosen, one simple rule must be followed: -- 
Every element whether an effort or a satisfaction, which dates from a time 
anterior to that day, must have compound interest for the interval accumulated 
upon it: and every element, which dates from a time posterior to that day, must 
have compound interest for the interval discounted from it. If the day be 
anterior to the beginning of the enterprise, then every element must be 
discounted. But if, as is usual in such cases, the day be that when the efforts 
are finished, and the house is ready for use; then the efforts must carry 
compound interest up to that day, and the satisfactions must all be discounted 
back to that day.
 
Waiting is an element of cost as truly as effort is, and it is entered in the 
cost when accumulated: it is therefore of course not counted separately. 
Similarly, on the converse side, whatever money or command over satisfaction 
"comes in" at any time is part of the income of that time: if the time is before 
the day for which accounts are balanced up, then it must be accumulated up to 
that day; if after it must be discounted back. If, instead of being converted to 
immediate enjoyment, it is used as a stored up source of future income, that 
later income must not be counted as an additional return to the investment.(3*)
 
If the enterprise were, say, to dig out a dock-basin on a contract, the payment 
for which would be made without fail when the work was finished; and if the 
plant used in the work might be taken to be worn out in the process, and 
valueless at the end of it; then the enterprise would be just remunerative if 
this aggregate of outlays, accumulated up to the period of payment, were just 
equal to that payment.
 
But, as a rule, the proceeds of the sales come in gradually. and we must suppose 
a balance-sheet struck, looking both backwards and forwards. Looking backwards 
we should sum up the net outlays, and add in accumulated compound interest on 
each element of outlay. Looking forwards we should sum up all net incomings, and 
from the value of each subtract compound interest for the period during which it 
would be deferred. The aggregate of the net incomings so discounted would be 
balanced against the aggregate of the accumulated outlays: and if the two were 
just equal, the business would be just remunerative. In calculating the 
outgoings the head of the business must reckon in the value of his own work.(4*)
 
3. At the beginning of his undertaking, and at every successive stage, the alert 
business man strives so to modify his arrangements as to obtain better results 
with a given expenditure, or equal results with a less expenditure. In other 
words, he ceaselessly applies the principle of substitution, with the purpose of 
increasing his profits; and, in so doing, he seldom fails to increase the total 
efficiency of work, the total power over nature which man derives from 
organization and knowledge.
 
Every locality has incidents of its own which affect in various ways the methods 
of arrangement of every class of business that is carried on in it: and even in 
the same place and the same trade no two persons pursuing the same aims will 
adopt exactly the same routes. The tendency to variation is a chief cause of 
progress; and the abler are the undertakers in any trade the greater will this 
tendency be. In some trades, as for instance cotton-spinning, the possible 
variations are confined within narrow limits; no one can hold his own at all who 
does not use machinery, and very nearly the latest machinery, for every part of 
the work. But in others, as for instance in some branches of the wood and metal 
trades, in farming, and in shopkeeping, there can be great variations. For 
instance, of two manufacturers in the same trade, one will perhaps have a larger 
wages bill and the other heavier charges on account of machinery; of two retail 
dealers one will have a larger capital locked up in stock and the other will 
spend more on advertisements and other means of building up the immaterial 
capital of a profitable trade connection. And in minor details the variations 
are numberless.
 
Each man's actions are influenced by his special opportunities and resources, as 
well as by his temperament and his associations: but each, taking account of his 
own means, will push the investment of capital in his business in each several 
direction until what appears in his judgment to be the outer limit, or margin, 
of profitableness is reached; that is, until there seems to him no good reason 
for thinking that the gains resulting from any further investment in that 
particular direction would compensate him for his outlay. The margin of 
profitableness, even in regard to one and the same branch or sub-branch of 
industry, is not to be regarded as a mere point on any one fixed line of 
possible investment; but as a boundary line of irregular shape cutting one after 
another every possible line of investment.
 
4. This principle of substitution is closely connected with, and is indeed 
partly based on, that tendency to a diminishing rate of return from any 
excessive application of resources or of energies in any given direction, which 
is in accordance with general experience. It is thus linked up with the broad 
tendency of a diminishing return to increased applications of capital and labour 
to land in old countries which plays a prominent part in classical economics. 
And it is so closely akin to the principle of the diminution of marginal utility 
that results in general from increased expenditure, that some applications of 
the two principles are almost identical. It has already been observed that new 
methods of production bring into existence new commodities, or lower the price 
of old commodities so as to bring them within the reach of increased numbers of 
consumers: that on the other hand changes in the methods and volume of 
consumption cause new developments of production, and new distribution of the 
resources of production: and that though some methods of consumption which 
contribute most to man's higher life, do little if anything towards furthering 
the production of material wealth, yet production and consumption are intimately 
correlated.(5*) But now we are to consider more in detail how the distribution 
of the resources of production between different industrial undertakings is the 
counterpart and reflex of the distribution of the consumers' purchases between 
different classes of commodities.(6*)
 
Let us revert to the primitive housewife, who having "a limited number of hanks 
of yarn from the year's shearing, considers all the domestic wants for clothing 
and tries to distribute the yarn between them in such a way as to contribUte as 
much as possible to the family well-being. She will think she has failed if, 
when it is done, she has reason to regret that she did not apply more to making, 
say, socks, and less to vests. But if, on the other hand, she hit on the right 
points to stop at, then she made just so many socks and vests that she got an 
equal amount of good out of the last bundle of yarn that she applied to socks, 
and the last she applied to vests."(7*) If it happened that two ways of making a 
vest were open to her, which were equally satisfactory as regards results, but 
of which one, while using up a little more yarn, involved a little less trouble 
than the other; then her problems would be typical of those of the larger 
business world. They would include first decisions as to the relative urgency of 
various ends; secondly, decisions as to the relative advantages of various means 
of attaining each end; thirdly, decisions, based on these two sets of decisions, 
as to the margin up to which she could most profitably carry the application of 
each means towards each end.
 
These three classes of decisions have to be taken on a larger scale by the 
business man, who has more complex balancings and adjustments to make before 
reaching each decision.(8*) Let us take an illustration from the building trade. 
Set us watch the operations of a "speculative builder" in the honourable sense 
of the term: that is, a man who sets out to erect honest buildings in 
anticipation of general demand; who bears the penalty of any error in his 
judgment; and who, if his judgment is approved by events, benefits the community 
as well as himself. Let him be considering whether to erect dwelling houses, or 
warehouses, or factories or shops. He is trained to form at once a fairly good 
opinion as to the method of working most suitable for each class of building, 
and to make a rough estimate of its cost. He estimates the cost of various sites 
adapted for each class of building: and he reckons in the price that he would 
have to pay for any site as a part of his capital expenditure, just as he does 
the expense to which he would be put for laying foundations in it, and so on. He 
brings this estimate of cost into relation with his estimate of the price he is 
likely to get for any given building, together with its site. If he can find no 
case in which the demand price exceeds his outlays by enough to yield him a good 
profit, with some margin against risks, he may remain idle. Or he may possibly 
build at some risk in order to keep his most trusty workmen together, and to 
find some occupation for his plant and his salaried assistance: but more on this 
later on.
 
Suppose him now to have decided that (say) villa residences of a certain type, 
erected on a plot of ground which he can buy, are likely to yield him a good 
profit. The main end to be sought being thus settled, he sets himself to study 
more carefully the means by which it is to be obtained, and, in connection with 
that study, to consider possible modifications in the details of his plans.
Given the general character of the houses to be built, he will have to consider 
in what proportions to use various materials-brick, stone, steel, cement, 
plaster, wood, etc., with a view to obtaining the result which will contribute 
most, in proportion to its cost, to the efficiency of the house in gratifying 
the artistic taste of purchasers and in ministering to their comfort. In thus 
deciding what is the best distribution of his resources between various 
commodities, he is dealing with substantially the same problem as the primitive 
housewife, who has to consider the most economic distribution of her yarn 
between the various needs of her household.
 
Like her, he has to reflect that the yield of benefit which any particular use 
gave would be relatively large up to a certain point, and would then gradually 
diminish. Like her, he has so to distribute his resources that they have the 
same marginal utility in each use: he has to weigh the loss that would result 
from taking away a little expenditure here, with the gain that would result from 
adding a little there. In effect both of them work on lines similar to those 
which guide the farmer in so adjusting the application of his capital and labour 
to land, that no field is stinted of extra cultivation to which it would have 
given a generous return, and none receives so great an expenditure as to call 
into strong activity the tendency to diminishing return in agriculture.(9*)
 
Thus it is that the alert business man, as has just been said, "pushes the 
investment of capital in his business in each several direction until what 
appears in his judgment to be the outer limit, or margin, of profitableness is 
reached; that is, until there seems to him no good reason for thinking that the 
gains resulting from any further investment in that particular direction would 
compensate him for his outlay." He never assumes that roundabout methods will be 
remunerative in the long run. But he is always on the look out for roundabout 
methods that promise to be more effective in proportion to their cost than 
direct methods: and he adopts the best of them, if it lies within his means.
 
######
 
5. Some technical terms relating to costs may be considered here. When investing 
his capital in providing the means of carrying on an undertaking, the business 
man looks to being recouped by the price obtained for its various products; and 
he expects to be able under normal conditions to charge for each of them a 
sufficient price; that is, one which will not only cover the special, direct, or 
prime cost, but also bear its proper share of the general expenses of the 
business; and these we may call its general, or supplementary cost. These two 
elements together make its total cost.
 
There are great variations in the usage of the term Prime cost in business. But 
it is taken here in a narrow sense. Supplementary costs are taken to include 
standing charges on account of the durable plant in which much of the capital of 
the business has been invested, and also the salaries of the upper employees: 
for the charges to which the business is put on account of their salaries cannot 
generally be adapted quickly to changes in the amount of work there is for them 
to do. There remains nothing but the (money) cost of the raw material used in 
making the commodity and the wages of that part of the labour spent on it which 
is paid by the hour or the piece and the extra wear-and-tear of plant. This is 
the special cost which a manufacturer has in view, when his works are not fully 
employed, and he is calculating the lowest price at which it will be worth his 
while to accept an order, irrespectively of any effect that his action may have 
in spoiling the market for future orders, and trade being slack at the time. But 
in fact he must as a rule take account of this effect: the price at which it is 
just worth his while to produce, even when trade is slack, is in practice 
generally a good deal above this prime cost, as we shall see later on.(10*)
 
6. Supplementary costs must generally be covered by the selling price to some 
considerable extent in the short run. And they must be completely covered by it 
in the long run; for, if they are not, production will be checked. Supplementary 
costs are of many different kinds; and some of them differ only in degree from 
prime costs. For instance, if an engineering firm is in doubt whether to accept 
an order at a rather low price for a certain locomotive, the absolute prime 
costs include the value of the raw material and the wages of the artisans and 
labourers employed on the locomotive. But there is no clear rule as to the 
salaried staff: for, if work is slack, they will probably have some time on 
their hands; and their salaries will therefore commonly be classed among general 
or supplementary costs. The line of division is however often blurred over. For 
instance, foremen and other trusted artisans are seldom dismissed merely because 
of a temporary scarcity of work; and therefore an occasional order may be taken 
to fill up idle time, even though its price does not cover their salaries and 
wages. That is they may not be regarded as prime costs in such a case. But, of 
course the staff in the office can be in some measure adjusted to variations in 
the work of the firm by leaving vacancies unfilled and even by weeding out 
inefficient men during slack times; and by getting extra help or putting out 
some of the work in busy times.
 
If we pass from such tasks to larger and longer tasks, as for instance the 
working out a contract to deliver a great number of locomotives gradually over a 
period of several years, then most of the office work done in connection with 
that order must be regarded as special for it: for if it had been declined and 
nothing else taken in its place, the expenses under the head of salaries could 
have been reduced almost to a proportionate extent.
 
The case is much stronger when we consider a fairly steady market for any class 
of staple manufactures extending over a long time. For then the outlay incurred 
for installing specialized skill and organization, the permanent office staff, 
and the durable plant of the workshops can all be regarded as part of the costs 
necessary for the process of production. That outlay will be increased up to a 
margin at which the branch of manufacture seems in danger of growing too fast 
for its market.
 
In the next chapter the argument of Chapter III and of this chapter is 
continued. It is shown in more detail how those costs which most powerfully act 
on supply and therefore on price, are limited to a narrow and arbitrary group in 
the case of a single contract for, say, a locomotive; but are much fuller, and 
correspond much more truly to the broad features of industrial economy in the 
case of a continuous supply to a fairly steady general market: the influence of 
cost of production on value does not show itself clearly except in relatively 
long periods; and it is to be estimated with regard to a whole process of 
production rather than a particular locomotive, or a particular parcel of goods. 
And a similar study is made in Chapters VIII-X of variations in the character of 
those prime and supplementary costs which consist of charges for interest (or 
profits) on investments in agents of production, according as the periods of the 
market under consideration are long or short.
 
Meanwhile it may be noticed that the distinction between prime and supplementary 
costs operates in every phase of civilization, though it is not likely to 
attract much attention except in a capitalistic phase. Robinson Crusoe had to do 
only with real costs and real satisfactions: and an old-fashioned peasant 
family, which bought little and sold little, arranged its investments of present 
"effort and waiting" for future benefits on nearly the same lines. But, if 
either were doubting whether it was worth while to take a light ladder on a trip 
to gather wild fruits, the prime costs alone would be weighed against the 
expected benefits: and yet the ladder would not have been made, unless it had 
been expected to render sufficient service in the aggregate of many little 
tasks, to remunerate the cost of making it. In the long run it had to repay its 
total costs, supplementary as well as prime.
 
Even the modern employer has to look at his own labour as a real cost in the 
first instance. He may think that a certain enterprise is likely to yield a 
surplus of money incomings over money outgoings (after proper allowances for 
risks and for discountings of future happenings); but that the surplus will 
amount to less than the money equivalent of the trouble and worry that the 
enterprise will cause to himself: and, in that case, he will avoid it.(11*)
 
NOTES:
 
1. For he might have applied these efforts, or efforts equivalent to them, to 
producing immediate gratifications; and if he deliberately chose the deferred 
gratifications, it would be because, even after allowing for the disadvantages 
of waiting, he regarded them as outweighing the earlier gratifications which he 
could have substituted for them. The motive force then tending to deter him from 
building the house would be his estimate of the aggregate of these efforts, the 
evil or discommodity of each being increased in geometrical proportion (a sort 
of compound interest) according to the corresponding interval of waiting. The 
motive on the other hand impelling him to build it, would be expectation of the 
satisfaction which he would have from the house when completed; and that again 
might be resolved into the aggregate of many satisfactions more or less remote, 
and more or less certain, which he expected to derive from its use. If he 
thought that this aggregate of discounted values of satisfactions that it would 
afford him, would be more than a recompense to him for all the efforts and 
waitings which he had undergone, he would decide to build. (See III, v, section 
3, IV, VII, section 8 and Note XIII in the Mathematical Appendix.)
 
2. We may, if we choose, regard the price of the business undertaker's own work 
as part of the original outlay, and reckon compound interest on it together with 
the rest. Or we may substitute for compound interest a sort of "compound 
profit." The two courses are not strictly convertible: and at a later stage we 
shall find that in certain cases the first is to be preferred, and in others the 
second.
 
3. In the aggregate the income from the saving will in the ordinary course be 
larger in amount than the saving by the amount of the interest that is the 
reward of saving. But, as it will be turned to account in enjoyment later than 
the original saving could have been, it will be discounted for a longer period 
(or accumulated for a shorter); and if entered in the balance sheet of the 
investment in place of the original saving, it would stand for exactly the same 
sum. (Both the original income which was saved and the subsequent income earned 
by it are assessed to income tax; on grounds similar to those which make it 
expedient to levy a larger income tax from the industrious than from the lazy 
man.) The main argument of this section is expressed mathematically in Note 
XIII.
 
4. Almost every trade has its own difficulties and its own customs connected 
with the task of valuing the capital that has been invested in a business, and 
of allowing for the depreciation which that capital has undergone from 
wear-and-tear, from the influence of the elements, from new inventions, and from 
changes in the course of trade. These two last causes may temporarily raise the 
value of some kinds of fixed capital, at the same time that they are lowering 
that of others. And people whose minds are cast in different moulds, or whose 
interests in the matter point in different directions, will often differ widely 
on the question what part of the expenditure required for adapting buildings and 
plant to changing conditions of trade, may be regarded as an investment of new 
capital; and what ought to be set down as charges incurred to balance 
depreciation, and treated as expedenditure deducted from the current receipts, 
before determining the net profits of true income earned by the business. These 
difficulties, and the consequent differences of opinion, are greatest of all 
with regard to the investment of capital in building up a business connection, 
and the proper method of appraising the goodwill of a business, or its value "as 
a going concern." On the whole of this subject see Matheson's Depreciation of 
Factories and their Valuation.
 
Another group of difficulties arises from changes in the general purchasing 
Power of money. If that has fallen, or, in other words, if there has been a rise 
of general prices, the value of a factory may appear to have risen when it has 
really remained stationary. Confusions arising from this source introduce 
greater errors into estimates of the real profitableness of different classes of 
business than would at first sight appear probable. But all questions of this 
kind must be deferred till we have discussed the theory of money.
 
5. See pp. 84-91, and 64-7.
 
6. The substance of part of this section was placed in VI, i, section 7 in 
earlier editions. But it seems to be needed here in preparation for the central 
chapters of Book V.
 
7. See III, v, section i.
 
8. The remainder of this section goes very much on the lines of the earlier half 
of Note XIV in the Mathematical Appendix; which may be read in connection with 
it. The subject is one in which the language of the differential calculusnot its 
reasonings -- are specially helpful to clear thought: but the main outlines can 
be presented in ordinary language.
 
9. See above III, iii section 1; and the footnote on pp. 156-7.
 
10. Especially in V, IX, "There are many systems of Prime Cost in vogue... we 
take Prime Cost to mean, as in fact the words imply, only the original or direct 
cost of production; and while in some trades it may be a matter of convenience 
to include in the cost of production a proportion of indirect expenses, and a 
charge for depreciation on plant and buildings, in no case should it comprise 
interest on capital or profit." (Garcke and Fells, Factory Accounts, ch. i.)
 
11. The Supplementary costs, which the owner of a factory expects to be able to 
add to the prime costs of its products, are the source of the quasi-rents which 
it will yield to him. If they come up to his expectation, then his business so 
far yields good profits: if they fall much short of it, his business tends to go 
to the bad. But this statement bears only on long-period problems of value: and 
in that connection the difference between Prime and Supplementary costs has no 
special significance. The importance of the distinction between them is confined 
to shortperiod problems.
 
CHAPTER 5
 
EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY, CONTINUED, WITH REFERENCE TO LONG AND 
SHORT PERIODS
 
1. The variations in the scope of the term Normal, according as the periods of 
time under discussion are long or short, were indicated in Chapter III. We are 
now ready to study them more closely.
 
In this case, as in others, the economist merely brings to light difficulties 
that are latent in the common discourse of life, so that by being frankly faced 
they may be thoroughly overcome. For in ordinary life it is customary to use the 
word Normal in different senses, with reference to different periods of time; 
and to leave the context to explain the transition from one to another. The 
economist follows this practice of every-day life: but, by taking pains to 
indicate the transition, he sometimes seems to have created a complication which 
in fact he has only revealed.
 
Thus, when it is said that the price of wool on a certain day was abnormally 
high though the average price for the year was abnormally low, that the wages of 
coal-miners were abnormally high in 1872 and abnormally low in 1879, that the 
(real) wages of labour were abnormally high at the end of the fourteenth century 
and abnormally low in the middle of the sixteenth; everyone understands that the 
scope of the term normal is not the same in these various cases.
 
The best illustrations of this come from manufactures where the plant is 
long-lived, and the product is short-lived.
 
When a new textile fabric is first introduced into favour, and there is very 
little plant suitable for making it, its normal price for some months may be 
twice as high as those of other fabrics which are not less difficult to make, 
but for making which there is an abundant stock of suitable plant and skill. 
Looking at long periods we may say that its normal price is on a par with that 
of the others: but if during the first few months a good deal of it were offered 
for sale in a bankrupt's stock we might say that its price was abnormally low 
even when it was selling for half as much again as the others. Everyone takes 
the context as indicating the special use of the term in each several case; and 
a formal interpretation clause is seldom necessary, because in ordinary 
conversation misunderstandings can be nipped in the bud by question and answer. 
But let us look at this matter more closely.
 
We have noticed(1*) how a cloth manufacturer would need to calculate the 
expenses of producing all the different things required for making cloth with 
reference to the amounts of each of them that would be wanted; and on the 
supposition in the first instance that the conditions of supply would be normal. 
But we have yet to take account of the fact that he must give to this term a 
wider or narrower range, according as he was looking more or less far ahead.
 
Thus in estimating the wages required to call forth an adequate supply of labour 
to work a certain class of looms, he might take the current wages of similar 
work in the neighbourhood: or he might argue that there was a scarcity of that 
particular class of labour in the neighbourhood, that its current wages there 
were higher than in other parts of England, and that looking forward over 
several years so as to allow for immigration, he might take the normal rate of 
wages at a rather lower rate than that prevailing there at the time. Or lastly, 
he might think that the wages of weavers all over the country were abnormally 
low relatively to others of the same grade, in consequence of a too sanguine 
view having been taken of the prospects of the trade half a generation ago. He 
might argue that this branch of work was overcrowded, that parents had already 
begun to choose other trades for their children which offered greater net 
advantages and yet were not more difficult; that in consequence a few years 
would see a falling-off in the supply of labour suited for his purpose; so that 
looking forward a long time he must take normal wages at a rate rather higher 
than the present average.(2*)
 
Again, in estimating the normal supply price of wool, he would take the average 
of several past years. He would make allowance for any change that would be 
likely to affect the supply in the immediate future; and he would reckon for the 
effect of such droughts as from time to time occur in Australia and elsewhere; 
since their occurrence is too common to be regarded as abnormal. But he would 
not allow here for the chance of our being involved in a great war, by which the 
Australian supplies might be cut off; he would consider that any allowance for 
this should come under the head of extraordinary trade risks, and not enter into 
his estimate of the normal supply price of wool.
 
He would deal in the same way with the risk of civil tumult or any violent and 
long-continued disturbance of the labour market of an unusual character; but in 
his estimate of the amount of work that could be got out of the machinery, etc. 
under normal conditions, he would probably reckon for minor interruptions from 
trade disputes such as are continually occurring, and are therefore to be 
regarded as belonging to the regular course of events, that is as not abnormal.
 
In all these calculations he would not concern himself specially to inquire how 
far mankind are under the exclusive influence of selfish or self-regarding 
motives. He might be aware that anger and vanity, jealousy and offended dignity 
are still almost as common causes of strikes and lockouts, as the desire for 
pecuniary gain: but that would not enter into his calculations. All that he 
would want to know about them would be whether they acted with sufficient 
regularity for him to be able to make a reasonably good allowance for their 
influence in interrupting work and raising the normal supply price of the 
goods.(3*)
 
2. The element of time is a chief cause of those difficulties in economic 
investigations which make it necessary for man with his limited powers to go 
step by step; breaking up a complex question, studying one bit at a time, and at 
last combining his partial solutions into a more or less complete solution of 
the whole riddle. In breaking it up, he segregates those disturbing causes, 
whose wanderings happen to be inconvenient, for the time in a pound called 
Caeteris Paribus. The study of some group of tendencies is isolated by the 
assumption other things being equal: the existence of other tendencies is not 
denied, but their disturbing effect is neglected for a time. The more the issue 
is thus narrowed, the more exactly can it be handled: but also the less closely 
does it correspond to real life. Each exact and firm handling of a narrow issue, 
however, helps towards treating broader issues, in which that narrow issue is 
contained, more exactly than would otherwise have been possible. With each step 
more things can be let out of the pound; exact discussions can be made less 
abstract, realistic discussions can be made less inexact than was possible at an 
earlier stage.(4*)
 
Our first step towards studying the influences exerted by the element of time on 
the relations between cost of production and value may well be to consider the 
famous fiction of the "Stationary state" in which those influences would be but 
little felt; and to contrast the results which would be found there with those 
in the modern world.
 
This state obtains its name from the fact that in it the general conditions of 
production and consumption, of distribution and exchange remain motionless; but 
yet it is full of movement; for it is a mode of life. The average age of the 
population may be stationary; though each individual is growing up from youth 
towards his prime, or downwards to old age. And the same amount of things per 
head of the population will have been produced in the same ways by the same 
classes of people for many generations together; and therefore this supply of 
the appliances for production will have had full time to be adjusted to the 
steady demand.
 
Of course we might assume that in our stationary state every business remained 
always of the same size, and with the same trade connection. But we need not go 
so far as that; it will suffice to suppose that firms rise and fall, but that 
the "representative" firm remains always of about the same size, as does the 
representative tree of a virgin forest, and that therefore the economies 
resulting from its own resources are constant: and since the aggregate volume of 
production is constant, so also are those economies resulting from subsidiary 
industries in the neighbourhood, etc. [That is, its internal and external 
economies are both constant. The price, the expectation of which just induced 
persons to enter the trade, must be sufficient to cover in the long run the cost 
of building up a trade connection; and a proportionate share of it must be added 
in to make up the total cost of production.]
 
In a stationary state then the plain rule would be that cost of production 
governs value. Each effect would be attributable mainly to one cause; there 
would not be much complex action and reaction between cause and effect. Each 
element of cost would be governed by "natural" laws, subject to some control 
from fixed custom. There would be no reflex influence of demand; no fundamental 
difference between the immediate and the later effects of economic causes. There 
would be no distinction between long-period and short-period normal value, at 
all events if we supposed that in that monotonous world the harvests themselves 
were uniform: for the representative firm being always of the same size, and 
always doing the same class of business to the same extent and in the same way, 
with no slack times, and no specially busy times, its normal expenses by which 
the normal supply price is governed would be always the same. The demand lists 
of prices would always be the same, and so would the supply lists; and normal 
price would never vary.
 
But nothing of this is true in the world in which we live. Here every economic 
force is constantly changing its action, under the influence of other forces 
which are acting around it. Here changes in the volume of production, in its 
methods, and in its cost are ever mutually modifying one another; they are 
always affecting and being affected by the character and the extent of demand. 
Further all these mutual influences take time to work themselves out, and, as a 
rule, no two influences move at equal pace. In this world therefore every plain 
and simple doctrine as to the relations between cost of production, demand and 
value is necessarily false: and the greater the appearance of lucidity which is 
given to it by skilful exposition, the more mischievous it is. A man is likely 
to be a better economist if he trusts to his common sense, and practical 
instincts, than if he professes to study the theory of value and is resolved to 
find it easy.
 
3. The Stationary state has just been taken to be one in which population is 
stationary. But nearly all its distinctive features may be exhibited in a place 
where population and wealth are both growing, provided they are growing at about 
the same rate, and there is no scarcity of land: and provided also the methods 
of production and the conditions of trade change but little; and above all, 
where the character of man himself is a constant quantity. For in such a state 
by far the most important conditions of production and consumption, of exchange 
and distribution will remain of the same quality, and in the same general 
relations to one another, though they are all increasing in volume.(5*)
 
This relaxation of the rigid bonds of a purely stationary state brings us one 
step nearer to the actual conditions of life: and by relaxing them still further 
we get nearer still. We thus approach by gradual steps towards the difficult 
problem of the interaction of countless economic causes. In the stationary state 
all the conditions of production and consumption are reduced to rest: but less 
violent assumptions are made by what is, not quite accurately, called the 
statical method. By that method we fix our minds on some central point: we 
suppose it for the time to be reduced to a stationary state; and we then study 
in relation to it the forces that affect the things by which it is surrounded, 
and any tendency there may be to equilibrium of these forces. A number of these 
partial studies may lead the way towards a solution of problems too difficult to 
be grasped at one effort.(6*)
 
4. We may roughly classify problems connected with fishing industries as those 
which are affected by very quick changes, such as uncertainties of the weather; 
or by changes of moderate length, such as the increased demand for fish caused 
by the scarcity of meat during the year or two following a cattle plague; or 
lastly, we may consider the great increase during a whole generation of the 
demand for fish which might result from the rapid growth of a high-strung 
artisan population making little use of their muscles.
 
The day to day oscillations of the price of fish resulting from uncertainties of 
the weather, etc., are governed by practically the same causes in modern England 
as in the supposed stationary state. The changes in the general economic 
conditions around us are quick; but they are not quick enough to affect 
perceptibly the short-period normal level about which the price fluctuates from 
day to day: and they may be neglected [impounded in caeteris paribus] during a 
study of such fluctuations.
 
Let us then pass on; and suppose a great increase in the general demand for 
fish, such for instance as might arise from a disease affecting farm stock, by 
which meat was made a dear and dangerous food for several years together. We now 
impound fluctuations due to the weather in caeteris paribus, and neglect them 
provisionally: they are so quick that they speedily obliterate one another, and 
are therefore not important for problems of this class. And for the opposite 
reason we neglect variations in the numbers of those who are brought up as 
seafaring men: for these variations are too slow to produce much effect in the 
year or two during which the scarcity of meat lasts. Having impounded these two 
sets for the time, we give our full attention to such influences as the 
inducements which good fishing wages will offer to sailors to stay in their 
fishing homes for a year or two, instead of applying for work on a ship. We 
consider what old fishing boats, and even vessels that were not specially made 
for fishing, can be adapted and sent to fish for a year or two. The normal price 
for any given daily supply of fish, which we are now seeking, is the price which 
will quickly call into the fishing trade capital and labour enough to obtain 
that supply in a day's fishing of average good fortune; the influence which the 
price of fish will have upon capital and labour available in the fishing trade 
being governed by rather narrow causes such as these. This new level about which 
the price oscillates during these years of exceptionally great demand, will 
obviously be higher than before. Here we see an illustration of the almost 
universal law that the term Normal being taken to refer to a short period of 
time an increase in the amount demanded raises the normal supply price. This law 
is almost universal even as regards industries which in long periods follow the 
tendency to increasing return.(7*)
 
But if we turn to consider the normal supply price with reference to a long 
period of time, we shall find that it is governed by a different set of causes, 
and with different results. For suppose that the disuse of meat causes a 
permanent distaste for it, and that an increased demand for fish continues long 
enough to enable the forces by which its supply is governed to work out their 
action fully (of course oscillations from day to day and from year to year would 
continue: but we may leave them on one side). The source of supply in the sea 
might perhaps show signs of exhaustion, and the fishermen might have to resort 
to more distant coasts v, and to deeper waters, Nature giving a Diminishing 
Return to the increased application of capital and labour of a given order of 
efficiency. On the other hand, those might turn out to be right who think that 
man is responsible for but a very small part of the destruction of fish that is 
constantly going on; and in that case a boat starting with equally good 
appliances and an equally efficient crew would be likely to get nearly as good a 
haul after the increase in the total volume of the fishing trade as before. In 
any case the normal cost of equipping a good boat with an efficient crew would 
certainly not be higher, and probably be a little lower after the trade had 
settled down to its now increased dimensions than before. For since fishermen 
require only trained aptitudes, and not any exceptional natural qualities, their 
number could be increased in less than a generation to almost any extent that 
was necessary to meet the demand; while the industries connected with building 
boats, making nets, etc. being now on a larger scale would be organized more 
thoroughly and economically. If therefore the waters of the sea showed no signs 
of depletion of fish, an increased supply could be produced at a lower price 
after a time sufficiently long to enable the normal action of economic causes to 
work itself out: and, the term Normal being taken to refer to a long period of 
time, the normal price of fish would decrease with an increase in demand.(8*)
 
Thus we may emphasize the distinction already made between average price and 
normal price. An average may be taken of the prices of any set of sales 
extending over a day or a week or a year or any other time: or it may be the 
average of sales at any time in many markets; or it may be the average of many 
such averages. But the conditions which are normal to any one set of sales are 
not likely to be exactly those which are normal to the others: and therefore it 
is only by accident that an average price will be a normal price; that is, the 
price which any one set of conditions tends to produce. In a stationary state 
alone, as we have just seen, the term normal always means the same thing: there, 
but only there, "average price" and "normal price" are convertible terms.(9*)
 
5. To go over the ground in another way. Market values are governed by the 
relation of demand to stocks actually in the market; with more or less reference 
to "future" supplies, and not without some influence of trade combinations.
 
But the current supply is in itself partly due to the action of producers in the 
past; and this action has been determined on as the result of a comparison of 
the prices which they expect to get for their goods with the expenses to which 
they will be put in producing them. The range of expenses of which they take 
account depends on whether they are merely considering the extra expenses of 
certain extra production with their existing plant, or are considering whether 
to lay down new plant for the purpose. In the case, for instance, of an order 
for a single locomotive, which was discussed a little while ago(10*), the 
question of readjusting the plant to demand would hardly arise: the main 
question would be whether more work could conveniently be got out of the 
existing plant. But in view of an order for a large number of locomotives to be 
delivered gradually over a series of years, some extension of plant "specially" 
made for the Purpose, and therefore truly to be regarded as prime marginal costs 
would almost certainly be carefully considered.
 
Whether the new production for which there appears to be a market be large or 
small, the general rule will be that unless the price is expected to be very low 
that portion of the supply which can be most easily produced, with but small 
prime costs, will be produced: that portion is not likely to be on the margin of 
production. As the expectations of price improve, an increased part of the 
production will yield a considerable surplus above prime costs, and the margin 
of production will be pushed outwards. Every increase in the price expected 
will, as a rule, induce some people who would not otherwise have produced 
anything, to produce a little; and those, who have produced something for the 
lower price, will produce more for the higher price. That part of their 
production with regard to which such persons are on the margin of doubt as to 
whether it is worth while for them to produce it at the price, is to be included 
together with that of the persons who are in doubt whether to produce at all; 
the two together constitute the marginal production at that price. The 
producers, who are in doubt whether to produce anything at all, may be said to 
lie altogether on the margin of production (or) if they are agriculturists, on 
the margin of cultivation). But as a rule they are very few in number, and their 
action is less important than that of those who would in any case produce 
something.
 
The general drift of the term normal supply price is always the same whether the 
period to which it refers is short or long; but there are great differences in 
detail. In every case reference is made to a certain given rate of aggregate 
production; that is, to the production of a certain aggregate amount daily or 
annually. In every case the price is that the expectation of which is sufficient 
and only just sufficient to make it worth while for people to set themselves to 
produce that aggregate amount; in every case the cost of production is marginal; 
that is, it is the cost of production of those goods which are on the margin of 
not being produced at all, and which would not be produced if the price to be 
got for them were expected to be lower. But the causes which determine this 
margin vary with the length of the period under consideration. For short periods 
people take the stock of appliances for production as practically fixed; and 
they are governed by their expectations of demand in considering how actively 
they shall set themselves to work those appliances. In long periods they set 
themselves to adjust the flow of these appliances to their expectations of 
demand for the goods which the appliances help to produce. Let us examine this 
difference closely.
 
6. The immediate effect of the expectation of a high price is to cause people to 
bring into active work all their appliances of production, and to work them full 
time and perhaps overtime. The supply price is then the money cost of production 
of that part of the produce which forces the undertaker to hire such inefficient 
labour (perhaps tired by working overtime) at so high a price, and to put 
himself and others to so much strain and inconvenience that he is on the margin 
of doubt whether it is worth his while to do it or not. The immediate effect of 
the expectation of a low price is to throw many appliances for production out of 
work, and slacken the work of others; and if the producers had no fear of 
spoiling their markets, it would be worth their while to produce for a time for 
any price that covered the prime costs of production and rewarded them for their 
own trouble.
 
But, as it is, they generally hold out for a higher price; each man fears to 
spoil his chance of getting a better price later on from his own customers; or, 
if he produces for a large and open market, he is more or less in fear of 
incurring the resentment of other producers, should he sell needlessly at a 
price that spoils the common market for all. The marginal production in this 
case is the production of those whom a little further fall of price would cause, 
either from a regard to their own interest or by formal or informal agreement 
with other producers, to suspend production for fear of further spoiling the 
market. The price which, for these reasons, producers are just on the point of 
refusing, is the true marginal supply price for short periods. It is nearly 
always above, and generally very much above the special or prime cost for raw 
materials, labour and wear-and-tear of plant, which is immediately and directly 
involved by getting a little further use out of appliances which are not fully 
employed. This point needs further study.
 
In a trade which uses very expensive plant, the prime cost of goods is but a 
small part of their total cost; and an order at much less than their normal 
price may leave a large surplus above their prime cost. But if producers accept 
such orders in their anxiety to prevent their plant from being idle, they glut 
the market and tend to prevent prices from reviving. In fact however they seldom 
pursue this policy constantly and without moderation. If they did, they might 
ruin many of those in the trade, themselves perhaps among the number; and in 
that case a revival of demand would find little response in supply, and would 
raise violently the prices of the goods produced by the trade. Extreme 
variations of this kind are in the long run beneficial neither to producers nor 
to consumers; and general opinion is not altogether hostile to that code of 
trade morality which condemns the action of anyone who "spoils the market" by 
being too ready to accept a price that does little more than cover the prime 
cost of his goods, and allows but little on account of his general 
expenses.(11*)
 
For example, if at any time the prime cost, in the narrowest sense of the word, 
of a bale of cloth is £100; and if another £100 are needed to make the cloth pay 
its due share of the general expenses of the establishment, including normal 
profits to its owners, then the practically effective supply price is perhaps 
not very likely to fall below £150 under ordinary conditions, even for short 
periods; though of course a few special bargains may be made at lower prices 
without much affecting the general market.
 
Thus, although nothing but prime cost enters necessarily and directly into the 
supply price for short periods, it is yet true that supplementary costs also 
exert some influence indirectly. A producer does not often isolate the cost of 
each separate small parcel of his output; he is apt to treat a considerable part 
of it, even in some cases the whole of it, more or less as a unit. He inquires 
whether it is worth his while to add a certain new line to his present 
undertakings, whether it is worth while to introduce a new machine and so on. He 
treats the extra output that would result from the change more or less as a unit 
beforehand; and afterwards he quotes the lowest prices, which he is willing to 
accept, with more or less reference to the whole cost of that extra output 
regarded as a unit.
 
In other words he regards an increase in his processes of production, rather 
than an individual parcel of his products, as a unit in most of his 
transactions. And the analytical economist must follow suit, if he would keep in 
close touch with actual conditions. These considerations tend to blur the 
sharpness of outline of the theory of value: but they do not affect its 
substance.(12*)
 
To sum up then as regards short periods. The supply of specialized skill and 
ability, of suitable machinery and other material capital, and of the 
appropriate industrial organization has not time to be fully adapted to demand; 
but the producers have to adjust their supply to the demand as best they can 
with the appliances already at their disposal. On the one hand there is not time 
materially to increase those appliances if the supply of them is deficient; and 
on the other, if the supply is excessive, some of them must remain imperfectly 
employed, since there is not time for the supply to be much reduced by gradual 
decay, and by conversion to other uses. Variations in the particular income 
derived from them do not for the time affect perceptibly the supply; and do not 
directly affect the price of the commodities produced by them. The income is a 
surplus of total receipts over prime cost; [that is, it has something of the 
nature of a rent as will be seen more clearly in chapter VIII]. But unless it is 
sufficient to cover in the long run a fair share of the general costs of the 
business, production will gradually fall off. In this way a controlling 
influence over the relatively quick movements of supply price during short 
periods is exercised by causes in the background which range over a long period; 
and the fear of "spoiling the market" often makes those causes act more promptly 
than they otherwise would.
 
7. In long periods on the other hand all investments of capital and effort in 
providing the material plant and the organization of a business, and in 
acquiring trade knowledge and specialized ability, have time to be adjusted to 
the incomes which are expected to be earned by them: and the estimates of those 
incomes therefore directly govern supply, and are the true long-period normal 
supply price of the commodities produced.
 
A great part of the capital invested in a business is generally spent on 
building up its internal organization and its external trade connections. If the 
business does not prosper all that capital is lost, even though its material 
plant may realize a considerable part of its original cost. And anyone proposing 
to start a new business in any trade must reckon for the chance of this loss. If 
himself a man of normal capacity for that class of work, be may look forward ere 
long to his business being a representative one, in the sense in which we have 
used this term, with its fair share of the economies of production on a large 
scale. If the net earnings of such a representative business seem likely to be 
greater than he could get by similar investments in other trades to which he has 
access, he will choose this trade. Thus that investment of capital in a trade, 
on which the price of the commodity produced by it depends in the long run, is 
governed by estimates on the one hand of the outgoings required to build up and 
to work a representative firm, and on the other of the incomings, spread over a 
long period of time, to be got by such a price.
 
At any particular moment some businesses will be rising and others falling: but 
when we are taking a broad view of the causes which govern normal supply price, 
we need not trouble ourselves with these eddies on the surface of the great 
tide. Any particular increase of production may be due to some new manufacturer 
who is struggling against difficulties, working with insufficient capital, and 
enduring great privations in the hope that he may gradually build up a good 
business. Or it may be due to some wealthy firm which by enlarging its premises 
is enabled to attain new economies, and thus obtain a larger output at a lower 
proportionate cost: and, as this additional output will be small relatively to 
the aggregate volume of production in the trade, it will not much lower the 
price; so that the firm will reap great gains from its successful adaptation to 
its surroundings. But while these variations are occurring in the fortunes of 
individual businesses, there may be a steady tendency of the long-period normal 
supply price to diminish, as a direct consequence of an increase in the 
aggregate volume of production.
 
8. Of course there is no hard and sharp line of division between "long" and 
"short" periods. Nature has drawn no such lines in the economic conditions of 
actual life; and in dealing with practical problems they are not wanted. Just as 
we contrast civilized with uncivilized races, and establish many general 
propositions about either group, though no hard and fast division can be drawn 
between the two; so we contrast long and short periods without attempting any 
rigid demarcation between them. If it is necessary for the purposes of any 
particular argument to divide one case sharply from the other, it can be done by 
a special interpretation clause: but the occasions on which this is necessary 
are neither frequent nor important.
 
Four classes stand out. In each, price is governed by the relations between 
demand and supply. As regards market prices, Supply is taken to mean the stock 
of the commodity in question which is on hand, or at all events " in sight." As 
regards normal prices, when the term Normal is taken to relate to short periods 
of a few months or a year, supply means broadly what can be produced for the 
price in question with the existing stock of plant, personal and impersonal, in 
the given time. As regards normal prices, when the term Normal is to refer to 
long periods of several years, Supply means what can be produced by plant, which 
itself can be remuneratively produced and applied within the given time; while 
lastly, there are very gradual or Secular movements of normal price, caused by 
the gradual growth of knowledge, of population and of capital, and the changing 
conditions of demand and supply from one generation to another.(13*)
 
The remainder of the present volume is chiefly concerned with the third of the 
above classes: that is, with the normal relations of wages, profits, prices, 
etc., for rather long periods. But occasionally account has to be taken of 
changes that extend over very many years; and one chapter, Book VI, ch. XII, is 
given up to "The Influence of Progress on Value," that is, to the study of 
secular changes of value.
 
NOTES:
 
1. V, III, section 5.
 
2. There are indeed not many occasions on which the calculations of a business 
man for practical purposes need to look forward so far, and to extend the range 
of the term Normal over a whole generation: but in the broader applications of 
economic science it is sometimes necessary to extend the range even further, and 
to take account of the slow changes that in the course of centuries affect the 
supply price of the labour of each industrial grade.
 
3. Compare I, II, section 7.
 
4. As has been explained in the Preface, pp. vi-ix, this volume is concerned 
mainly with normal conditions; and these are sometimes described as Statical. 
But in the opinion of the present writer the problem of normal value belongs to 
economic Dynamics: partly because Statics is really but a branch of Dynamics, 
and partly because all suggestions as to economic rest, of which the hypothesis 
of a Stationary state is the chief, are merely provisional, used only to 
illustrate particular steps in the argument, and to be thrown aside when that is 
done.
 
5. See below, V, XII, section 3; and compare Keynes, Scope and Method of 
Political Economy, VI, 2.
 
6. Compare the Preface and Appendix H, section 4.
 
7. See V, XII, section I.
 
8. Tooke (History of Prices, Vol. I, p. 104) tells us: "There are particular 
articles of which the demand for naval and military purposes forms so large a 
proportion to the total supply, that no diminution of consumption by individuals 
can keep pace with the immediate increase of demand by government; and 
consequently, the breaking out of a war tends to raise the price of such 
articles to a great relative height. But even of such articles, if the 
consumption were not on a progressive scale of increase so rapid that the 
supply, with all the encourage ment of a relatively high price, could not keep 
pace with the demand, the tendency is (supposing no impediment, natural or 
artificial, to production or importation) to occasion such an increase of 
quantity, as to reduce the price to nearly the same level as that from which it 
had advanced. And accordingly it will be observed, by reference to the table of 
prices, that salt petre, hemp, iron, etc., after advancing very considerably 
under the influence of a greatly extended demand for military and naval 
purposes, tended downwards again whenever that demand was not progressively and 
rapidly increasing." Thus a continuously progressive increase in demand may 
raise the supply price of a thing even for several years together; though a 
steady increase of demand for that thing, at a rate not too great for supply to 
keep pace with it, would lower price.
 
9. V, III, section 6. The distinction will be yet further discussed in V, XII 
and Appendix H. See also Keynes, Scope and Method of Political Economy, ch. VII.
 
10. pp. 360-7.
 
11. Where there is a strong combination, tacit or overt, producers may sometimes 
regulate the price for a considerable time together with very little reference 
to cost of production. And if the leaders in that combination were those who had 
the best facilities for production, it might be said, in apparent though not in 
real contradiction to Ricardo's doctrines, that the price was governed by that 
part of the supply which was most easily produced. But as a fact, those 
producers whose finances are weakest, and who are bound to go on producing to 
escape failure, often impose their policy on the rest of the combination: 
insomuch that it is a common saying, both in America and England, that the 
weakest members of a combination are frequently its rulers.
 
12. This general description may suffice for most purposes: but in chapter XII 
there will be found a more detailed study of that extremely complex notion, a 
marginal increment in the processes of production by a representative firm; 
together with a fuller explanation of the necessity of referring our reasonings 
to the circumstances of a representative firm, especially when we are 
considering industries which show a tendency to increasing return.
 
13. Compare the first section of this chapter. Of course the periods required to 
adapt the several factors of production to the demand may be very different; the 
number of skilled compositors, for instance, cannot be increased nearly as fast 
as the supply of type and printing presses. And this cause alone would prevent 
any rigid division being made between long and short periods. But in fact a 
theoretically perfect long period must give time enough to enable not only the 
factors of production of the commodity to be adjusted to the demand, but also 
the factors of production of those factors of production to be adjusted and so 
on; and this, when carried to its logical consequences, will be found to involve 
the supposition of a stationary state of industry, in which the requirements of 
a future age can be anticipated an indefinite time beforehand. Some such 
assumption is indeed unconsciously implied in many popular renderings of 
Ricardo's theory of value, if not in his own versions of it; and it is to this 
cause more than any other that we must attribute that simplicity and sharpness 
of outline, from which the economic doctrines in fashion in the first half of 
this century derived some of their seductive charm, as well as most of whatever 
tendency they may have to lead to false practical conclusions.
 
Relatively short and long period problems go generally on similar lines. In both 
use is made of that paramount device, the partial or total isolation for special 
study of some set of relations. In both opportunity is gained for analysing and 
comparing similar episodes, and making them throw light upon one another; and 
for ordering and co-ordinating facts which are suggestive in their similarities, 
and are still more suggestive in the differences that peer out through their 
similarities. But there is a broad distinction between the two cases. In the 
relatively short-period problem no great violence is needed for the assumption 
that the forces not specially under consideration may be taken for the time to 
be inactive. But violence is required for keeping broad forces in the pound of 
Caeteris Paribus during, say, a whole generation, on the ground that they have 
only an indirect bearing on the question in hand. For even indirect influences 
may produce great effects in the course of a generation, if they happen to act 
cumulatively; and it is not safe to ignore them even provisionally in a 
practical problem without special study. Thus the uses of the statical method in 
problems relating to very long periods are dangerous; care and forethought and 
self-restraint are needed at every step. The difficulties and risks of the task 
reach their highest point in connection with industries which conform to the law 
of Increasing Return; and it is just in connection with those industries that 
the most alluring applications of the method are to be found. We must postpone 
these questions to chapter XII and Appendix H.
 
But an answer may be given here to the objection that since "the economic world 
is subject to continual changes, and is becoming more complex,... the longer the 
run the more hopeless the rectification": so that to speak of that position 
which value tends to reach in the long run is to treat "variables as constants." 
(Devas, Political Economy, Book IV, ch. v.) It is true that we do treat 
variables provisionally as constants. But it is also true that this is the only 
method by which science has ever made any great progress in dealing with complex 
and changeful matter, whether in the physical or moral world. See above V, v, 
section 2.
 
CHAPTER 6
 
JOINT AND COMPOSITE DEMAND. JOINT AND COMPOSITE SUPPLY
 
1. Bread satisfies man's wants directly: and the demand for it is said to be 
direct. But a flour mill and an oven satisfy wants only indirectly, by helping 
to make bread, etc., and the demand for them is said to be indirect. More 
generally: --
 
The demand for raw materials and other means of production is indirect and is 
derived from the direct demand for those directly serviceable products which 
they help to produce.
 
The services of the flour mill and the oven are joined together in the ultimate 
product, bread: the demand for them is therefore called a joint demand. Again, 
hops and malt are complementary to one another; and are joined together in the 
common destination of ale: and so on. Thus the demand for each of several 
complementary things is derived from the services which they jointly render in 
the production of some ultimate product, as for instance a loaf of bread, a cask 
of ale. In other words there is a joint demand for the services which any of 
these things render in helping to produce a thing which satisfies wants directly 
and for which there is therefore a direct demand: the direct demand for the 
finished product is in effect split up into many derived demands for the things 
used in producing it.(1*)
 
To take another illustration, the direct demand for houses gives rise to a joint 
demand for the labour of all the various building trades, and for bricks, stone, 
wood, etc. which are factors of production of building work of all kinds, or as 
we may say for shortness, of new houses. The demand for any one of these, as for 
instance the labour of plasterers, is only an indirect or derived demand.
 
Let us pursue this last illustration with reference to a class of events that 
are of frequent occurrence in the labour market; the period over which the 
disturbance extends being short, and the causes of which we have to take account 
as readjusting demand and supply being only such as are able to operate within 
that short period.
 
This case has important practical bearings, which give it a special claim on our 
attention; but we should notice that, referring as it does to short periods, it 
is an exception to our general rule of selecting illustrations in this and the 
neighbouring chapters from cases in which there is time enough for the full 
long-period action of the forces of supply to be developed.
 
Let us then suppose that the supply and demand for building being in 
equilibrium, there is a strike on the part of one group of workers, say the 
plasterers, or that there is some other disturbance to the supply of plasterers' 
labour. In order to isolate and make a separate study of the demand for that 
factor, we suppose firstly that the general conditions of the demand for new 
houses remain unchanged (that is, that the demand schedule for new houses 
remains valid); and secondly we assume that there is no change in the general 
conditions of supply of the other factors, two of which are of course the 
business faculties and the business organizations of the master builders; (that 
is, we assume that their lists of supply prices also remain valid). Then a 
temporary check to the supply of plasterers' labour will cause a proportionate 
check to the amount of building: the demand price for the diminished number of 
houses will be a little higher than before; and the supply prices for the other 
factors of production will not be greater than before.(2*) Thus new houses can 
now be sold at prices which exceed by a good margin the sum of the prices at 
which these other requisites for the production of houses can be bought; and 
that margin gives the limit to the possible rise of the price that will be 
offered for plasterers' labour, on the supposition that plasterers' labour is 
indispensable. The different amounts of this margin, corresponding to different 
checks to the supply of plasterers' labour, are governed by the general rule 
that: The price that will be offered for any thing used in producing a commodity 
is, for each separate amount of the commodity, limited by the excess of the 
price at which that amount of the commodity can find purchasers, over the sum of 
the prices at which the corresponding supplies of the other things needed for 
making it will be forthcoming.
 
To use technical terms, the demand schedule for any factor of production of a 
commodity can be derived from that for the commodity by subtracting from the 
demand price of each separate amount of the commodity the sum of the supply 
prices for corresponding amounts of the other factors.(3*)
 
2. When however we come to apply this theory to the actual conditions of life, 
it will be important to remember that if the supply of one factor is disturbed, 
the supply of others is likely to be disturbed also. In particular, when the 
factor of which the supply is disturbed is one class of labour, as that of the 
plasterers, the employers' earnings generally act as a buffer. That is to say, 
the loss falls in the first instance on them; but by discharging some of their 
workmen and lowering the wages of others, they ultimately distribute a great 
part of it among the other factors of production. The details of the process by 
which this is effected are various, and depend on the action of trade 
combinations, on the higgling and bargaining of the market, and on other causes 
with which we are not just at present concerned.
 
Let us inquire what are the conditions, under which a check to the supply of a 
thing that is wanted not for direct use, but as a factor of production of some 
commodity, may cause a very great rise in its price. The first condition is that 
the factor itself should be essential, or nearly essential to the production of 
the commodity, no good substitute being available at a moderate price.
 
The second condition is that the commodity in the production of which it is a 
necessary factor, should be one for which the demand is stiff and inelastic; so 
that a check to its supply will cause consumers to offer a much increased price 
for it rather than go without it; and this of course includes the condition that 
no good substitutes for the commodity are available at a price but little higher 
than its equilibrium price. If the check to house building raises the price of 
houses very much, builders, anxious to secure the exceptional profits, will bid 
against one another for such plasterers' labour as there is in the market.(4*)
 
The third condition is that only a small part of the expenses of production of 
the commodity should consist of the price of this factor. Since the plasterers' 
wages are but a small part of the total expenses of building a house, a rise of 
even 50 per cent in them would add but a very small percentage to the expenses 
of production of a house and would check demand but little.(5*)
 
The fourth condition is that even a small check to amount demanded should cause 
a considerable fall in the supply prices of other factors of production; as that 
will increase the margin available for paying a high price for this one.(6*) If, 
for instance, bricklayers and other classes of workmen, or the employers 
themselves cannot easily find other things to do, and cannot afford to remain 
idle, they may be willing to work for much lower earnings than before, and this 
will increase the margin available for paying higher wages to plasterers. These 
four conditions are independent, and the effects of the last three are 
cumulative.
 
The rise in plasterers' wages would be checked if it were possible either to 
avoid the use of plaster, or to get the work done tolerably well and at a 
moderate price by people outside the plasterers' trade: the tyranny, which one 
factor of production of a commodity might in some cases exercise over the other 
factors through the action of derived demand, is tempered by the principle of 
substitution.(7*)
 
Again, an increased difficulty in obtaining one of the factors of a finished 
commodity can often be met by modifying the character of the finished product. 
Some plasterers' labour may be indispensable; but people are often in doubt how 
much plaster work it is worth while to have in their houses, and if there is a 
rise in its price they will have less of it. The intensity of the satisfaction 
of which they would be deprived if they had a little less of it, is its marginal 
utility; the price which they are just willing to pay in order to have it, is 
the true demand price for plasterers' work up to the amount which is being used.
 
So again there is a joint demand for malt and hops in ale. But their proportions 
can be varied. A higher price can be got for an ale which differs from others 
only in containing more hops; and this excess price represents the demand for 
hops.(8*)
 
The relations between plasterers, bricklayers, etc., are representative of much 
that is both instructive and romantic in the history of alliances and conflicts 
between trades-unions in allied trades. But the most numerous instances of joint 
demand are those of the demand for a raw material and the operatives who work it 
up; as for instance cotton or jute or iron or copper, and those who work up 
these several materials. Again, the relative prices of different articles of 
food vary a good deal with the supply of skilled cooks' labour: thus for 
instance many kinds of meat and many parts of vegetables which are almost 
valueless in America, where skilled cooks are rare and expensive, have a good 
value in France, where the art of cooking is widely diffused.
 
3. We have already(9*) discussed the way in which the aggregate demand for any 
commodity is compounded of the demands of the different groups of people who may 
need it. But we now may extend this notion of composite demand to requisites of 
production which are needed by several groups of producers.
 
Nearly every raw material and nearly every kind of labour is applied in many 
different branches of industry, and contributes to the production of a great 
variety of commodities. Each of these commodities has its own direct demand; and 
from that the derived demand for any of the things used in making it can be 
found, and the thing is "distributed between its various uses" in the manner 
which we have already discussed.(10*) The various uses are rivals, or 
competitors with one another; and the corresponding derived demands are rival or 
competitive demands relatively to one another. But in relation to the supply of 
the product, they co-operate with one another; being "compounded" into the total 
demand that carries off the supply: in just the same way as the partial demands 
of several classes of society for a finished commodity are aggregated, or 
compounded together into the total demand for it.(11*)
 
4. We may now pass to consider the case of joint products: i.e. of things which 
cannot easily be produced separately; but are joined in a common origin, and may 
therefore be said to have a joint supply, such as beef and hides, or wheat and 
straw.(12*) This case corresponds to that of things which have a joint demand, 
and it may be discussed almost in the same words, by merely substituting 
"demand" for "supply," and vice versa. As there is a joint demand for things 
joined in a common destination: so there is a joint supply of things which have 
a common origin. The single supply of the common origin is split up into so many 
derived supplies of the things that proceed from it.(13*)
 
For instance, since the repeal of the Corn Laws much of the wheat consumed in 
England has been imported, of course without any straw. This has caused a 
scarcity and a consequent rise in the price of straw, and the farmer who grows 
wheat looks to the straw for a great part of the value of the crop. The value of 
straw then is high in countries which import wheat, and low in those which 
export wheat. In the same way the price of mutton in the wool-producing 
districts of Australia was at one time very low. The wool was exported, the meat 
had to be consumed at home; and as there was no great demand for it, the price 
of the wool had to defray almost the whole of the joint expenses of production 
of the wool and the meat. Afterwards the low price of meat gave a stimulus to 
the industries of preserving meat for exportation, and now its price in 
Australia is higher.
 
There are very few cases of joint products the cost of production of both of 
which together is exactly the same as that of one of them alone. So long as any 
product of a business has a market value, it is almost sure to have devoted to 
it some special care and expense, which would be diminished, or dispensed with 
if the demand for that product were to fall very much. Thus, for instance, if 
straw were valueless, farmers would exert themselves more than they do to make 
the ear bear as large a proportion as possible to the stalk. Again, the 
importation of foreign wool has caused English sheep to be adapted by judicious 
crossing and selection so as to develop heavy weights of good meat at an early 
age, even at the expense of some deterioration of their wool. It is only when 
one of two things produced by the same process is valueless, unsaleable, and yet 
does not involve any expense for its removal, that there is no inducement to 
attempt to alter its amount; and, it is only in these exceptional cases that we 
have no means of assigning its separate supply price to each of the joint 
products. For when it is possible to modify the proportions of these products, 
we can ascertain what part of the whole expense of the process of production 
would be saved, by so modifying these proportions as slightly to diminish the 
amount of one of the joint products without affecting the amounts of the others. 
That part of the expense is the expense of production of the marginal element of 
that product; it is the supply price of which we are in search.(14*)
 
But these are exceptional cases. It more frequently happens that a business, or 
even an industry finds its advantage in using a good deal of the same plant, 
technical skill, and business organization for several classes of products. In 
such cases the cost of anything used for several purposes has to be defrayed by 
its fruits in all of them: but there is seldom any rule of nature to determine 
either the relative importance of these uses, or the proportions in which the 
total cost should be distributed among them: much depends on the changing 
features of markets.(15*)
 
5. We may pass to the problem of composite supply which is analogous to that of 
composite demand. A demand can often be satisfied by any one of several routes, 
according to the principle of substitution. These various routes are rivals or 
competitors with one another; and the corresponding supplies of commodities are 
rival, or competitive supplies relatively to one another. But in relation to the 
demand they co-operate with one another; being "compounded" into the total 
supply that meets the demands.(16*)
 
If the causes which govern their production are nearly the same, they may for 
many purposes be treated as one commodity.(17*) For instance, beef and mutton 
may be treated as varieties of one commodity for many purposes; but they must be 
treated as separate for others, as for instance for those in which the question 
of the supply of wool enters. Rival things are however often not finished 
commodities, but factors of production: for instance, there are many rival 
fibres which are used in making ordinary printing paper. We have just noticed 
how the fierce action of derived demand for one of several complementary 
supplies, as e.g. for the supply of plasterers' labour, was liable to be 
moderated, when the demand was met by the competitive supply of a rival thing, 
which could be substituted for it.(18*)
 
6. All the four chief problems which have been discussed in this chapter have 
some bearing on the causes that govern the value of almost every commodity: and 
many of the most important cross connections between the values of different 
commodities are not obvious at first sight.
 
Thus when charcoal was generally used in making iron, the price of leather 
depended in some measure on that of iron; and the tanners petitioned for the 
exclusion of foreign iron in order that the demand on the part of English iron 
smelters for oak charcoal might cause the production of English oak to be kept 
up, and thus prevent oak bark from becoming dear.(19*) This instance may serve 
to remind us of the way in which an excessive demand for a thing may cause its 
sources of supply to be destroyed, and thus render scarce any joint products 
that it may have: for the demand for wood on the part of the ironmakers led to a 
relentless destruction of many forests in England. Again, an excessive demand 
for lamb was assigned as a cause of the prevailing scarcity of sheep some years 
ago; while some argued on the contrary that the better the price to be got for 
spring lamb sold to the rich, the more profitable would be the production of 
sheep, and the cheaper would mutton be for the people. The fact is that an 
increase of demand may have opposite effects according as it does or does not 
act so suddenly as to prevent producers from adapting their action to it.
 
Again, the development of railways and other means of communication for the 
benefit of one trade, as for instance wheat growing in some parts of America and 
silver mining in others, greatly lowers some of the chief expenses of production 
of nearly every other product of those districts. Again, the prices of soda, and 
bleaching materials and other products of industries, the chief raw material of 
which is salt, move up and down relatively to one another with almost every 
improvement in the various processes which are used in those industries; and 
every change in those prices affects the prices of many other goods, for the 
various products of the salt industries are more or less important factors in 
many branches of manufacture.
 
Again, cotton and cotton-seed oil are joint products, and the recent fall in the 
price of cotton is largely due to the improved manufacture and uses of 
cotton-seed oil: and further, as the history of the cotton famine shows, the 
price of cotton largely affects that of wool, linen and other things of its own 
class; while cotton-seed oil is ever opening up new rivalries with things of its 
own class. Again, many new uses have been found for straw in manufacture; and 
these inventions are giving value to straw that used to be burnt in the West of 
America, and tend to hinder the rise in the marginal cost of producing 
wheat.(20*)
 
NOTES:
 
1. Compare III, III, section 6. It will be recollected that the things in a form 
ready for immediate use have been called goods of the first order, or consumers' 
goods; and that things used as factors of production of other goods have been 
called producers' goods, or goods of the second and higher orders or 
intermediate goods: also that it is difficult to say when goods are really 
finished; that many things are commonly treated as finished consumers' goods 
before they are really ready for consumption, e.g. flour. See II, iii, section 
I. The vagueness of the notion of instrumental goods, regarded as things the 
value of which is derived from that of their products, is indicated in Appendix 
E, section 3.
 
2. This is at any rate true under all ordinary conditions: there will be less 
extra charges for overtime; and the price of the labour of carpenters, 
bricklayers and others is likely rather to go down than to go up, and the same 
is true of brick and other building materials.
 
3. The broad account given in the text may suffice for most purposes; and the 
general reader should perhaps omit the remaining footnotes to this chapter.
 
It must be remembered that this Derived schedule has no validity except on the 
suppositions that we are isolating this one factor for separate study; that its 
own conditions of supply are disturbed; that there is at the time no independent 
disturbance affecting any other element in the problem; and that therefore in 
the case of each of the other factors of production the selling price may be 
taken to coincide always with the supply price.
 
In illustrating this by a diagram, it will be well, for the sake of shortness of 
wording, to divide the expenses of production of a commodity into the supply 
prices of two things of which it is made; let us then regard the supply price of 
a knife as the sum of the supply prices of its blade and handle, and neglect the 
expense of putting the two together. Let ss' be the supply curve for handles and 
SS' that for knives; so that M being any point on Ox, and MqQ being drawn 
vertically to cut ss'. in q and SS' in Q, Mq is the supply price for OM handles, 
qQ is the supply price for OM blades and MQ the supply price for OM knives. Let 
DD' the demand curve for knives cut SS' in A, and AaB be drawn vertically as in 
the figure. Then in equilibrium OB knives are sold at a price BA of which Ba 
goes for the handle and aA for the blade.
 
(In this illustration we may suppose that sufficient time is allowed to enable 
the forces which govern supply price to work themselves out fully; and we are at 
liberty therefore to make our supply curves inclined negatively. This change 
will not affect the argument; but on the whole it is best to take our typical 
instance with the supply curve inclined positively.)
 
Now let us suppose that we want to isolate for separate study the demand for 
knife handles. Accordingly we suppose that the demand for knives and the supply 
of blades conform to the laws indicated by their respective curves: also that 
the supply curve for handles still remains in force and represents the 
circumstances of normal supply for handles, although the supply of handles is 
temporarily disturbed. Let MQ cut DD' in P, then MP is the demand price for OM 
knives and Qq is the supply price for OM blades. Take a point p in MP such that 
Pp is equal to Qq, and therefore Mp is the excess of MP over Qq; then Mp is the 
demand price for OM handles. Let dd' be the locus of p obtained by giving M 
successive positions along Ox and finding the corresponding positions of p; then 
dd' is the derived demand curve for handles. Of course it passes through a. We 
may now neglect all the rest of the figure except the curves dd', ss'; and 
regard them as representing the relations of demand for and supply of handles, 
other things being equal, that is to say, in the absence of any disturbing cause 
which affects the law of supply of blades and the law of demand for knives. Ba 
is then the equilibrium price of handles, about which the market price 
oscillates, in the manner investigated in the preceding chapter, under the 
influence of demand and supply, of which the schedules are represented by dd' 
and ss' It has already been remarked that the ordinary demand and supply curves 
have no practical value except in the immediate neighbourhood of the point of 
equilibrium. And the same remark applies with even greater force to the equation 
of derived demand.
 
[Since Mp Mq = MP - MQ; therefore A being a point of stable equilibrium, the 
equilibrium at a also is stable. But this statement needs to be somewhat 
qualified if the supply curves are negatively inclined: see Appendix H.]
 
In the illustration that has just been worked out the unit of each of the 
factors remains unchanged whatever be the amount of the commodity produced; for 
one blade and one handle are always required for each knife; but when a change 
in the amount of the commodity produced occasions a change in the amount of each 
factor that is required for the production of a unit of the commodity, the 
demand and supply curves for the factor got by the above process are not 
expressed in terms of fixed units of the factor. They must be translated back 
into fixed units before they are available for general use. (See Mathematical 
Note XIV bis.)
 
4. We have to inquire under what conditions the ratio pM to aB will be the 
greatest, pM being the demand price for the factor in question corresponding to 
a supply reduced from OB to OM, that is reduced by the given amount BM. The 
second condition is that PM should be large; and since the elasticity of demand 
is measured by the ratio which BM bears to the excess of PM over AB, the greater 
PM is, the smaller, other things being equal, is the elasticity of demand.
 
5. The third condition is that when PM exceeds AB in a given ratio, pM shall be 
caused to exceed Ba in a large ratio: and other things being equal, that 
requires Ba to be but a small part of BA.
 
6. That is, if Qq had been smaller than it is, Pp would have been smaller and Mp 
would have been larger. See also Mathematical Note XV .
 
7. It is shown in Böhm Bawerk's excellent Grundzüge der Theorie des 
wirtschaftlichen Güterwerts (Jahrbuch für Natoonaiökonomie und Statistik, vol. 
XIII, p. 59) that if all but one of the factors of production of a commodity 
have available substitutes in unlimited supply, by which their own price is 
rigidly fixed, the derived demand price for the remaining factor will be the 
excess of the demand price for the finished product over the sum of the supply 
prices thus fixed for the remaining factors. This is an interesting special case 
of the law given in the text .
 
8. See Mathematical Note XVI.
 
9. See above, III, IV, sections 2, 4.
 
10. See III, v.
 
11. Thus, let a factor of production have three uses. Let d1d1' be the demand 
curve for it in its first use. From N any point on Oy draw Np1 horizontally to 
cut d1d1' in p1; then Np1 is the amount that is demanded for the first use at 
price ON . Produce Np1 to p2, and further on to P making p1p2 and p2P of such 
lengths as to represent the amounts of the factor demanded at price ON for the 
second and third uses respectively. As N moves along Oy let p2 trace out the 
curve d2d2' and let P trace out the curve DD'. Thus d2d2' would be the demand 
curve for the factor if it had only its first and second uses. DD' is its demand 
curve for all three uses. It is immaterial in what order we take the several 
uses. In the case represented, the demand for the second use begins at a lower 
price and that for the third use begins at a higher price than does the demand 
for the first use. (See Mathematical Note XVII.)
 
12. Professor Dewsnup (American Economic Review, Supplement 1914, p. 89) 
suggests that things should be described as joint products, when their "total 
costs of production by a single plant are less than the sum of the costs of 
their production by separate plants." This definition is less general than that 
reached at the end of this section; but it is convenient for some special uses.
 
13. If it is desired to isolate the relations of demand and supply for a joint 
product, the derived supply price is found in just the same way as the derived 
demand price for a factor of production was found in the parallel case of 
demand. Other things must be assumed to be equal (that is, the supply schedule 
for the whole process of production must be assumed to remain in force and so 
must the demand schedule for each of the joint products except that to be 
isolated). The derived supply price is then found by the rule that it must equal 
the excess of the supply price for the whole process of production over the sum 
of the demand prices of all the other joint products; the prices being taken 
throughout with reference to corresponding amounts.
 
We must again illustrate by a simple example in which it is assumed that the 
relative amounts of the two joint products are unalterable. Let SS' be the 
supply curve for bullocks which yield meat and leather in fixed quantities; dd' 
the demand curve for their carcases, that is, for the meat derived from them. M 
being any point on Ox draw Mp vertically to cut dd' in p, and produce it to P so 
that pP represents the demand price for OM hides. Then MP is the demand price 
for OM bullocks, and DD' the locus of P is the demand curve for bullocks: it may 
be called the total demand curve. Let DD' cut SS' in A; and draw AaB as in the 
figure. Then in equilibrium OB bullocks are produced and sold at the price BA of 
which Ba goes for the carcase and aA for the hide.
 
Let MP cut SS' in Q. From QM cut off Qq equal to Pp; then q is a point on the 
derived supply curve for carcases. For if we assume that the selling price of OM 
hides is always equal to the corresponding demand price Pp, it follows that 
since it costs QM to produce each of OM bullocks there remains a price QM Pp, 
that is qM, to be borne by each of the OM carcases. Then ss' the locus of q, and 
yy' are the supply and demand curves for carcases. (See Mathematical Note 
XVIII.)
 
14. See Mathematical Note XIX.
 
15. A little more is said on this subject in the next chapter: it is discussed 
fully in the forthcoming work on Industry and Trade.
 
16. The latter phrase "competing commodities" is used by Prof. Fisher in his 
brilliant Mathematical Investigations in the Theory of Value and Prices, which 
throw much light on the subjects discussed in the present chapter.
 
17. Comp. Jevons, l. c. pp. 145-6. See also above, footnotes on pp. 100, 105.
 
18. The want which all the rivals tend to satisfy is met by a composite supply, 
the total supply at any price being the sum of the partial supplies at that 
price.
 
Thus, for instance, N being any point on Oy draw Nq1q2Q parallel to Ox such that 
Nq1' q1q2 and q2Q are respectively the amounts of the irst, second and third of 
those rivals which can be supplied at the price ON. Then NQ is the total 
composite supply at that price, and the locus of Q is the total supply curve of 
the means of satisfying the want in question. Of course the units of the several 
things which are rivals must be so taken that each of them satisfies the same 
amount of the want. In the case represented in the figure small quantities of 
the first rival can be put on the market at a price too low to call forth any 
supply of the other two, and small quantities of the second at a price too low 
to call forth any of the third. (See Mathematical Note XX.)
 
Continued rivalry is as a rule possible only when none of the rivals has its 
supply governed by the law of increasing return. The equilibrium is stable only 
when none of them is able to drive the others out; and this is the case when all 
of them conform to the law of diminishing return; because then if one did obtain 
a temporary advantage and its use increased, its supply price would rise, and 
then the others would begin to undersell it. But if one of them conformed to the 
law of increasing return, the rivalry would soon cease; for whenever it happened 
to gain a temporary advantage over its rivals its increased use would lower its 
supply price and therefore increase its saleits supply price would then be 
further lowered, and so on: thus its advantage over its rivals would be 
continually increased until it had driven them out of the field. It is true that 
there are apparent exceptions to this rule; and things which conform to the law 
of increasing return do sometimes seem to remain for a long time in the field as 
rivals: such is the case perhaps with different kinds of sewing machines and of 
electric lights. But in these cases the things do not really satisfy the same 
wants, they appeal to slightly different needs or tastes; there is still some 
difference of opinion as to their relative merits; or else perhaps some of them 
are patented or in some other way have become the monopoly of particular firms. 
In such cases custom and the force of advertising may keep many rivals in the 
field for a long time; particularly if the producers of those things which are 
really the best in proportion to their expenses of production are not able 
effectively to advertise and push their wares by travellers and other agencies.
 
19. Toynbee (Industrial Revolution, p. 80).
 
20. Again, since sheep and oxen compete for the use of land, leather and cloth 
compete in indirect demand for the use of a factor of production. But also in 
the upholsterer's shop they compete as supplying means for meeting the same 
want. There is thus a composite demand on the part of upholsterer and shoemaker 
for leather. and also for cloth when the upper part of a shoe is made of cloth: 
the shoe offers a joint demand for cloth and leather, they offering 
complementary supplies: and so on, in endless complications. See Mathematical 
Note XXI. The Austrian doctrine of "imputed value" has something in common with 
that of derived value given in this chapter. Whichever phrase be used, it is 
important that we should recognize the continuity between the old doctrine of 
value and the new; and that we should treat imputed or derived values merely as 
elements which take their place with many others in the broad problem of 
distribution and exchange. The new phrases merely give the means of applying to 
the ordinary affairs of life, some of that precision of _expression which is the 
special property of mathematical language. Producers have alw.ays to consider 
how the demand for any raw material in which they are interested is dependent on 
the demand for the things in making which it is used, and how it is influenced 
by every change that affects them; and this is really a special case of the 
problem of ascertaining the efficient strength of any one of the forces, which 
contribute to a common result. In mathematical language this common result is 
called a function of the various forces: and the (marginal) contribution, which 
any of them is making to it, is represented by the (small) change in the result 
which would result from a (small) change in that force; that is by the 
differential coefficient of the result with regard to that force. In other 
words, the imputed value, or the derived value of a factor of production, if 
used for only one product, is the differential coefficient of that product with 
regard to that factor; and so on in successive complications, as indicated in 
Notes XIV-XXI of the Mathematical Appendix. (Some objections to parts of Prof. 
Wieser's doctrine of imputed values are well urged by Prof. Edgeworth, Economic 
Journal, Vol. v, pp. 279-85.)
 
CHAPTER 7
 
PRIME AND TOTAL COST IN RELATION TO JOINT PRODUCTS.
COST OF MARKETING.
INSURANCE AGAINST RISK.
COST OF PRODUCTION
 
1. We may now return to the consideration of prime and supplementary costs, with 
special reference to the proper distribution of the latter between the joint 
products of a business.
 
It often happens that a thing made in one branch of a business is used as a raw 
material in another, and then the question of the relative profitableness of the 
two branches can be accurately ascertained only by an elaborate system of 
book-keeping by double entry; though in practice it is more common to rely on 
rough estimates made by an almost instinctive guess. Some of the best 
illustrations of this difficulty are found in agriculture, especially when the 
same farm combines permanent pasture and arable land worked on long 
rotation.(1*)
 
Another difficult case is that of the shipowner who has to apportion the 
expenses of his ship between heavy goods and goods that are bulky but not heavy. 
He tries, as far as may be, to get a mixed cargo of both kinds; and an important 
element in the struggle for existence of rival ports is the disadvantage under 
which those ports lie which are able to offer a cargo only of bulky or only of 
heavy goods: while a port whose chief exports are weighty but not bulky, 
attracts to its neighbourhood industries which make for export goods that can be 
shipped from it at low freights. The Staffordshire Potteries, for example, owe 
part of their success to the low freights at which their goods are carried by 
ships sailing from the Mersey with iron and other heavy cargoes.
 
But there is free competition in the shipowning trade, and it has great powers 
of variation as regards the size and shape of ships, the routes which they take, 
and the whole method of trading; and thus in many ways the general principle can 
be applied, that the relative proportions of the joint products of a business 
should be so modified that the marginal expenses of production of either product 
should be equal to its marginal demand price.(2*) Or, in other words, the amount 
of carrying power for each kind of cargo has a constant tendency to move towards 
equilibrium at a point at which the demand price for that amount in a normal 
state of trade is just sufficient to cover the expenses of providing it; these 
expenses being reckoned so as to include not only its (money) prime cost, but 
also all those general expenses of the business which are in the long run 
incurred on its account, whether directly or indirectly.(3*)
 
In some branches of manufacture it is customary to make a first approximation to 
the total cost of producing any class of goods, by assuming that their share of 
the general expenses of the business is proportionate either to their prime 
cost, or to the special labour bill that is incurred in making them. Corrections 
can then be made to meet such cases as those of goods which require either more 
or less than an average share of space or light, or of the use of expensive 
machinery; and so on.
 
2. There are two elements of the general a business, the sharing of which 
between the different requires some special attention. They are the expense 
marketing and that of insurance against risk. Some kinds of goods are easily 
marketed; there is steady demand for them, and it is always safe to make them 
for stock. But for that very reason competition cuts their price "very fine," 
and does not allow a large margin above the direct cost of making them. 
Sometimes the tasks of making and selling them can be rendered almost automatic, 
so as to require very little to be charged on their account under the heads of 
the expenses of management and marketing. But in practice it is not uncommon to 
charge such goods with even less than the small share that would properly fall 
to them, and to use them as a means of obtaining and maintaining a business 
connection, that will facilitate the marketing of other classes of goods, the 
production of which cannot so well be reduced to routine; for as to these there 
is not so close a competition. Manufacturers, especially in trades connected 
with furniture and dress, and retailers in almost all trades, frequently find it 
best to use certain of their goods as a means of advertising others, and to 
charge the first with less and the second with more than their proportionate 
share of supplementary expenses. In the former class they put those goods which 
are so uniform in character and so largely consumed that nearly all purchasers 
know their value well, in the second those with regard to which purchasers think 
more of consulting their fancy than of buying at the lowest possible price.
 
All difficulties of this kind are much increased by that instability of supply 
price, which results whenever the tendency to increasing return is acting 
strongly. We have seen that in seeking the normal supply price in such cases we 
must select as representative a business which is managed with normal ability 
and so as to get its fair share of the economies, both internal and external, 
resulting from industrial organization: also that these economies, though they 
fluctuate with the fortunes of particular businesses, yet increase generally 
when the aggregate production increases. Now it is obvious that if a 
manufacturer makes a commodity the increased production of which would put 
largely increased internal economies within his reach, it is worth his while to 
sacrifice a great deal in order to push its sales in a new market. If he has a 
large capital, and the commodity is one in much demand, his expenditure for this 
purpose may be very great, even exceeding that which he devotes directly to the 
manufacture: and if, as is likely, he is pushing at the same time several other 
commodities, nothing more than a very rough guess can be made as to what share 
of this expenditure should be charged to the sales of each of them in the 
current year, and what share should be charged to the connection which he is 
endeavouring to build up for them in the future.
 
In fact when the production of a commodity conforms to the law of increasing 
return in such a way as to give a very great advantage to large producers, it is 
apt to fall almost entirely into the hands of a few large firms; and then the 
normal marginal supply price cannot be isolated on the plan just referred to, 
because that plan assumes the existence of a great many competitors with 
businesses of all sizes, some of them being young and some old, some in the 
ascending and some in the descending phase. The production of such a commodity 
really partakes in a great measure of the nature of a monopoly; and its price is 
likely to be so much influenced by the incidents of the campaign between rival 
producers, each struggling for an extension of territory, as scarcely to have a 
true normal level.
 
Economic progress is constantly offering new facilities for marketing goods at a 
distance: it not only lowers cost of carriage, but what is often more important, 
it enables producers and consumers in distant places to get in touch with one 
another. In spite of this, the advantages of the producer who lives on the spot 
are very great in many trades; they often enable him to hold his own against 
competitors at a distance whose methods of production are more economical. He 
can sell in his own neighbourhood as cheaply as they can, because though the 
cost of making is greater for his goods than for theirs, he escapes much of the 
cost which they incur for marketing. But time is on the side of the more 
economic methods of production; his distant competitors will gradually get a 
stronger footing in the place, unless he or some new man adopts their improved 
methods.
 
It remains to make a closer study of the relation in which insurance against the 
risks of a business stands to the supply price of any particular commodity 
produced in it.
 
3. The manufacturer and the trader commonly insure against injury by fire and 
loss at sea; and the premiums which they pay are among the general expenses, a 
share of which has to be added to the prime cost in order to determine the total 
cost of their goods. But no insurance can be effected against the great majority 
of business risks.
 
Even as regards losses by fire and sea, insurance companies have to allow for 
possible carelessness and fraud; and must therefore, independently of all 
allowances for their own expenses and profits, charge premiums considerably 
higher than the true equivalent of the risks run by the buildings or the ships 
of those who manage their affairs well. The injury done by fire or sea however 
is likely, if it occurs at all, to be so very great that it is generally worth 
while to pay this extra charge; partly for special trade reasons, but chiefly 
because the total utility of increasing wealth increases less than in proportion 
to its amount. But the greater part of business risks are so inseparably 
connected with the general management of the business that an insurance company 
which undertook them would really make itself responsible for the business: and 
in consequence every firm has to act as its own insurance office with regard to 
them. The charges to which it is put under this head are part of its general 
expenses, and a share of them has to be added to the prime cost of each of its 
products.
 
But here there are two difficulties. In some cases insurance against risk is apt 
to be left out of account altogether, in others it is apt to be counted twice 
over. Thus a large shipowner sometimes declines to insure his ships with the 
underwriters: and sets aside part at least of the premiums that he might have 
paid to them, to build up an insurance fund of his own. But he must still, when 
calculating the total cost of working a ship, add to its prime cost a charge on 
account of insurance. And he must do the same thing, in some form or other, with 
regard to those risks against which he could not buy an insurance policy on 
reasonable terms even if he wanted to. At times, for instance, some of his ships 
will be idle in port, or will earn only nominal freights: and to make his 
business remunerative in the long run he must, in some form or other, charge his 
successful voyages with an insurance premium to make up for his losses on those 
which are unsuccessful.
 
In general, however, he does this, not by making a formal entry in his accounts 
under a separate head, but by the simple plan of taking the average of 
successful and unsuccessful voyages together; and when that has once been done, 
insurance against these risks cannot be entered as a separate item in cost of 
production, without counting the same thing twice over. Having decided to run 
these risks himself, he is likely to spend a little more than the average of his 
competitors, in providing against their occurrence; and this extra expense 
enters in the ordinary way into his balance-sheet. It is really an insurance 
premium in another form; and therefore he must not count insurance against this 
part of the risk separately, for then he would be counting it twice over.(4*)
 
When a manufacturer has taken the average of his sales of dress materials over a 
long time, and bases his future action on the results of his past experience, he 
has already allowed for the risk that the machinery will be depreciated by new 
inventions rendering it nearly obsolete, and for the risk that his goods will be 
depreciated by changes in fashion. If he were to allow separately for insurance 
against these risks, he would be counting the same thin twice over.(5*)
 
4. Thus, though when we have counted up the average receipts of a risky trade, 
we must not make a separate full allowance for insurance against risk; though 
there may be something to be allowed as a charge on account of uncertainty. It 
is true that an adventurous occupation, such as gold mining, has special 
attractions for some people: the deterrent force of risks of loss in it is less 
than the attractive force of chances of great gain, even when the value of the 
latter estimated on the actuarial principle is much less than that of the 
former; and as Adam Smith pointed out, a risky trade, in which there is an 
element of romance, often becomes so overcrowded that the average earnings in it 
are lower than if there were no risks to be run.(6*) But in the large majority 
of cases the influence of risk is in the opposite direction; a railway stock 
that is certain to pay four per cent. will sell for a higher price than one 
which is equally likely to pay one or seven per cent. or any intermediate 
amount.
 
Every trade then has its own peculiarities, but in most cases the evils of 
uncertainty count for something, though not very much: in some cases a slightly 
higher average price is required to induce a given outlay, if that average is 
the mean of widely divergent and uncertain results, than if the adventurer may 
reckon confidently on a return that differs but little from that average. To the 
average price therefore we must add a recompense for uncertainty, if that is 
unusually great; though if we added insurance against risk we should be counting 
the greater part of that twice over.(7*)
 
5. This discussion of the risks of trade has again brought before us the fact 
that the value of a thing, though it tends to equal its normal (money) cost of 
production, does not coincide with it at any particular time, save by accident. 
Carey, observing this, suggested that we should speak of value in relation to 
(money) cost of reproduction instead of in relation to cost of production.
 
The suggestion has, however, no significance so far as normal values are 
concerned. For normal cost of production and normal cost of reproduction are 
convertible terms; and no real change is made by saying that the normal value of 
a thing tends to equal its normal (money) cost of reproduction instead of its 
normal (money) cost of production. The former phrase is less simple than the 
latter, but means the same thing.
 
And no valid argument for the change can be founded on the fact, which may be 
readily admitted, that there are some few cases in which the market value of a 
thing is nearer its cost of reproduction than the cost that was actually 
incurred in producing that particular thing. The present price of an iron ship 
for instance, made before the great recent improvements in the manufacture of 
iron, might diverge less from the cost of reproducing it, that is of producing 
another just like it by modern methods, than from that which was actually 
incurred in producing it. But the price of the old ship would be less than the 
cost of reproduction of the ship, because the art of designing ships has 
improved as fast as that of manufacturing iron; and moreover steel has displaced 
iron as the material of shipbuilding. It may still be urged that the price of 
the ship is equal to that of producing a ship, which would be equally 
serviceable, on a modern plan and by modern methods. But that would not be the 
same thing as saying that the value of the ship is equal to its cost of 
reproduction; and, as a matter of fact, when, as often happens, an unexpected 
scarcity of ships causes freights to increase very rapidly, those who are 
anxious to reap the harvest of profitable trade, will pay for a ship in sailing 
order a price much above that for which a shipbuilding firm would contract to 
produce another equally good and deliver it some time hence. Cost of 
reproduction influence on value, save when purchasers can wait for the 
production of new supplies.
 
Again, there is no connection between cost of reproduction and price in the 
cases of food in a beleaguered city, of quinine the supply of which has run 
short in a fever-stricken island, of a picture by Raphael, of a book that nobody 
cares to read, of an armour-clad ship of obsolete pattern, of fish when the 
market is glutted, of fish when the market is nearly empty, of a cracked bell, 
of a dress material that has gone out of fashion, or of a house in a deserted 
mining village.
 
####
 
The reader, unless already experienced in economic analysis, is recommended to 
omit the next seven chapters, and pass at once to Chapter XV, which contains a 
brief summary of this Book. It is true that the four chapters on marginal costs 
in relation to values, and especially Chapters VIII and IX, bear upon some 
difficulties which are latent in the phrase "the net product of labour"; and 
that this phrase is used in Book VI. But the broad explanation of it given there 
will suffice provisionally for most purposes; and the intricacies connected with 
it may be best appreciated at a somewhat advanced stage of economic studies.
 
NOTES:
 
1. There is scope for applications of mathematical or semi-mathematical 
analyses, such as are indicated in the last chapter, to some of the chief 
practical difficulties of book-keeping by double entry in different trades.
 
2. Compare VI, section 4.
 
3. Of course this does not apply to railway rates. For a railway company having 
little elasticity as to its methods of working, and often not much competition 
from outside, has no inducement to endeavour to adjust the charges which it 
makes for different kinds of traffic to their cost to itself. In fact though it 
may ascertain the prime cost in each case easily enough, it cannot determine 
accUrately what are the relative total costs of fast and slow traffic, of short 
and long distance traffic, of light and heavy traffic; nor again of extra 
traffic when its lines and its trains are crowded and when they are nearly 
empty.
 
4. Again, certain insurance companies in America take risks against fire in 
factories at very much less than the ordinary rates, on condition that some 
prescribed precautions are taken, such as providing automatic sprinklers and 
making the walls and floor solid. The expense incurred in these arrangements is 
really an insurance premium; and care must be taken not to count it twice over. 
A factory which undertakes its own risks against fire will have to add to the 
prime cost of its goods an allowance for insurance at a lower rate, if it is 
arranged on this plan, than if built in the ordinary way.
 
5. Again, when a farmer has calculated the expenses of raising any particular 
crop with reference to an average year, he must not count in addition insurance 
against the risk that the season may be bad, and the crop a failure: for in 
taking an average year, he has already set of the chances of exceptionally good 
and bad seasons against one another. When the earnings of a ferryman have been 
calculated on the average of a year, allowance has already been made for the 
risk that he may sometimes have to cross the stream with an empty boat.
 
6. Wealth of Nations, Book I, ch. x.
 
7. The evils resulting from the uncertainty involved in great business risks are 
well shown by von Thünen (Der isolierte Staat, II, I, p. 82).
 
CHAPTER 8
 
MARGINAL COSTS IN RELATION TO VALUES. GENERAL PRINCIPLES
 
1. This Chapter and the three following are given to a study of the marginal 
costs of products in relation to the values of those products on the one hand, 
and on the other hand to the values of the land, machinery, and other appliances 
used in making them. The study relates to normal conditions and long period 
results. This fact must ever be borne in mind. The market value of anything may 
be much above or much below the normal cost of production and the marginal costs 
of a particular producer at any time may stand in no close relation to marginal 
costs under normal conditions.(1*)
 
It was indicated at the end of Chapter VI that no one part of the problem can be 
isolated from the rest. There are comparatively few things the demand for which 
is not greatly affected by the demand for other things to the usefulness of 
which they contribute; and it may even be said that the demand for the majority 
of articles of commerce is not direct but is derived from the demand for those 
commodities to the making of which they contribute, as materials or as 
implements. And again this demand, because it is so derived, is largely 
dependent on the supply of other things which will work with them in making 
those commodities. And again the supply of anything available for use in making 
any commodity is apt to be greatly influenced by the demand for that thing 
derived from its uses in making other commodities: and so on. These 
inter-relations can be and must be ignored in rapid and popular discussions on 
the business affairs of the world. But no study that makes any claim to 
thoroughness can escape from a close investigation of them. This requires many 
things to be borne in mind at the same time: and for that reason economics can 
never become a simple science.(2*)
 
The contribution which this group of chapters aims at making covers little 
ground: but that ground is difficult and we shall need to work over it 
carefully, and from more than one point of view; for it is thickly strewn with 
pitfalls and stumbling blocks. It deals primarily with the earnings of land, 
machinery, and other material agents of production. Its main argument applies to 
the earnings of human beings; but they are influenced by some causes which do 
not Affect the earnings of material agents of production: and the matter in hand 
is sufficiently difficult without further complicating it by side issues.
 
2. Let us begin by recalling the action of the principle of substitution. In the 
modern world nearly all the means of production pass through the hands of 
employers and other business men, who specialize themselves in organizing the 
economic forces of the population. Each of them chooses in every case those 
factors of production which seem best for his purpose. And the sum of the prices 
which he pays for those factors which he uses is, as a rule, less than the sum 
of the prices which he would have to pay for any other set of factors which 
could be substituted for them: for, whenever it appears that this is not the 
case, he will, as a rule, set to work to substitute the less expensive 
arrangement or process.(3*)
 
This statement is in close harmony with such common sayings of every-day life, 
as that "everything tends to find its own level," that "most men earn just about 
what they are worth," that "if one man can earn twice as much as another, that 
shows that his work is worth twice as much," that "machinery will displace 
manual labour whenever it can do the work cheaper." The principle does not 
indeed without hindrance. It may be restricted by custom or act law, by 
professional etiquette or trade-union regulation: it may be weakened by want of 
enterprise, or it may be softened by a generous unwillingness to part with old 
associates. But it never ceases to act, and it permeates all the economic 
adjustments of the modern world.
 
Thus there are some kinds of field work for which horsePower is clearly more 
suitable than steam-power, and vice versa. If we may now suppose that there have 
been no great recent improvements in horse or steam machinery, and that 
therefore the experience of the past has enabled farmers gradually to apply the 
law of substitution; then, on this supposition the application of steam-power 
will have been pushed just so far that any further use of it in the place of 
horse-power would bring no net advantage. There will however remain a margin on 
which they could be indifferently applied (as Jevons would have said); and on 
that margin the net efficiency of either in adding to the money value of the 
total product will be proportionate to the cost of applying it.(4*)
 
Similarly, if there are two methods of obtaining the same result, one by skilled 
and the other by unskilled labour, that one will be adopted which is the more 
efficient in proportion to its cost. There will be a margin on which either will 
be indifferently applied.(5*) On that line the efficiency of each will be in 
proportion to the price paid for it, account being taken of the special 
circumstances of different districts and of different workshops in the same 
district. In other words, the wages of skilled and unskilled labour will bear to 
one another the same ratio that their efficiencies do at the margin of 
indifference.
 
Again, there will be a rivalry between hand-power and machine-power similar to 
that between two different kinds of hand-power or two different kinds of 
machine-power. Thus hand-power has the advantage for some operations, as, for 
instance, for weeding out valuable crops that have an irregular growth; 
horse-power in its turn has a cleat advantage for weeding an ordinary turnip 
field; and the application of each of them will be pushed in each district till 
any further use of it would bring no net advantage there. On the margin of 
indifference between hand-power and horse-power their prices must be 
proportionate to their efficiency; and thus the influence of substitution will 
tend to establish a direct relation between the wages of labour and the price 
that has to be paid for horse-power.
 
3. As a rule many kinds of labour, of raw material, of machinery and other 
plant, and of business organization, both internal and external, go to the 
production of a commodity: and the advantages of economic freedom are never more 
strikingly manifest than when a business man endowed with genius is trying 
experiments, at his own risk, to see whether some new method, or combination of 
old methods, will be more efficient than the old. Every business man indeed, 
according to his energy and ability, is constantly endeavouring to obtain a 
notion of the relative efficiency of every agent of production that he employs; 
as well as of others that might possibly be substituted for some of them. He 
estimates as best he can how much net product (i.e. net addition to the value of 
his total product) will be caused by a certain extra use of any one agent; net 
that is after deducting for any extra expenses that may be indirectly caused by 
the change, and adding for any incidental savings. He endeavours to employ each 
agent up to that margin at which its net product would no longer exceed the 
price he would have to pay for it. He works generally by trained instinct rather 
than formal calculation; but his processes are substantially similar to those 
indicated in our study of derived demand; and, from another point of view, they 
may be described as those which might be reaped by a complex and refined system 
of book-keeping by double entry.(6*)
 
We have already followed some simple estimates of this sort. We have noticed, 
for instance, how the proportion of hops and malt in ale can be varied, how the 
extra price which can be got for ale by increasing the quantity of hops in it is 
a representative of the causes which govern the demand price for hops. Assuming 
that no further trouble or expense of any kind is involved by this additional 
use of hops, and that the expediency of using this extra amount is doubtful, the 
extra value thus given to the ale is the marginal net product of the hops of 
which we are in search. In this case, as in most others, the net product is an 
improvement in quality or a general contribution to the value of the product; it 
is not a definite part of the produce which can be separated from the rest. But 
in exceptional instances that can be done.(7*)
 
4. The notion of the marginal employment of any agent of production implies a 
possible tendency to diminishing return from its increased employment.
 
Excessive applications of any means to the attainment of any end are indeed sure 
to yield diminishing. returns in every branch of business; and, one may say, in 
all the affairs of life. We may take some additional examples of a principle 
that has already been illustrated.(8*) In the manufacture of sewing machines 
some parts may well be made of cast iron; for others a common kind of steel will 
suffice; there are yet others for which a specially expensive steel-compound is 
needed; and all parts should be finished off more or less smoothly, so that the 
machine may work easily. Now if any one devoted a disproportionate care and 
expense to th selection of materials for the less important uses, it might truly 
be said that that expenditure was yielding a rapidly diminishing return; and 
that he would have done better to give some of it to making his machines work 
smoothly, or even to producing more machines: and the case might be even worse 
if he devoted an excessive expenditure to mere brilliancy of finish, and put low 
grade metal to work for which a higher grade was needed.
 
This consideration seems at first to simplify economic problems; but on the 
contrary it is a chief source of difficulty and confusion. For though there is 
some analogy between all these various tendencies to diminishing return, they 
yet are not identical. Thus the diminishing return which arises from an 
ill-proportioned application of the various agents of production into a 
particular task has little in common with that broad tendency to the pressure of 
a crowded and growing population on the means of subsistence. The great 
classical Law of Diminishing Return has its chief application, not to any one 
particular crop, but to all the chief food crops. It takes for granted that 
farmers raise, as a rule, those crops for which their land and other resources 
are best adapted, account being taken of the relative demands for the several 
crops; and that they distribute their resources appropriately between different 
routes. It does not attribute to them unlimited intelligence and wisdom, but it 
assumes that, taking one with another, they have shown a reasonable amount of 
care and discretion in the distribution of these resources. It refers to a 
country the whole land of which is already in the hands of active business men, 
who can supplement their own capital by loans from banks wherever they can show 
it is likely to be well applied; and asserts that an increase in the total 
amount of capital applied to agriculture in that country will yield diminishing 
returns of produce in general. This statement is akin to, but yet quite distinct 
from, the statement that if any farmer makes a bad distribution of his resources 
between different plans of cultivation, he will get a markedly diminishing 
return from those elements of expenditure which he has driven to excess.
 
For instance, in any given case, there is a certain proportion between the 
amounts which may with best advantage be spent on ploughing and harrowing, or 
manuring. There might be some differences of opinion on the matter, but only 
within narrow limits. An inexperienced person who ploughed many times over land, 
which was already in fairly good mechanical condition, while he gave it little 
or none of the manure which it was craving, would be generally condemned as 
having so over applied ploughing as to make it yield a rapidly diminishing 
return. But this result of the misapplication of resources has no very close 
connection with the tendency of agriculture in an old country to yield a 
diminishing return to a general increase of resources well applied in 
cultivation: and indeed exactly parallel cases can be found of a diminishing 
return to particular resources when applied in undue proportion, even in 
industries which yield an increasing return to increased applications of capital 
and labour when appropriately distributed.(9*)
 
5. The part played by the net product at of production in the modern doctrine of 
Distribution is to be misunderstood. In particular many able writers have 
supposed that it represents the marginal use of a thing as governing the value 
of the whole. It is not so; the doctrine says we must go to the margin to study 
the action of those forces which govern the value of the whole: and that is a 
very different affair. Of course the withdrawal of (say) iron from any of its 
necessary uses would have just the same influence on its value as its withdrawal 
from its marginal uses; in the same way as the pressure in a boiler for cooking 
under high pressure would be affected by the escape of any other steam just as 
it would by the escape of the steam in one of the safety valves: but in fact the 
steam does not escape except through the safety valves. In like manner iron, or 
any other agent of production, is not (under ordinary circumstances) thrown out 
of use except at points at which its use yields no clear surplus of profit; that 
is, it is thrown out from its marginal uses only.
 
Again, the finger of an automatic weighing machine determines, in the sense of 
indicating, the weight sought for. So the escape of steam from a safety valve, 
governed by a spring representing a pressure of a hundred pounds to the square 
inch, determines the pressure of steam in the boiler, in the sense of indicating 
that it has reached a hundred pounds to the inch. The pressure is caused by the 
heat; the spring in the valve governs the pressure by yielding and letting out 
some of the steam when its amount is so great, at the existing heat, as to 
overbear the resistance of the spring.
 
Similarly, with regard to machinery and other appliances of production made by 
man, there is a margin through which additional supplies come in after 
overcoming the resistance of a spring, called "cost of production," For when the 
supply of those appliances is so small relatively to the demand that the 
earnings expected from new supplies are more than sufficient to yield normal 
interest (or profits, if earnings of management are reckoned in) on their cost 
of production, besides allowing for depreciation, etc., then the valve opens, 
and the new supplies come in. When the earnings are less than this, the valve 
remains shut: and as anyhow the existing supply is always in process of slow 
destruction by use and the lapse of time, the supply is always shrinking when 
the valve is closed. The valve is that part of the machinery by which the 
general relations of demand and supply govern value. But marginal uses do not 
govern value; because they, together with value, are themselves governed by 
those general relations.
 
6. Thus, so long as the resources of an individual producer are in the form of 
general purchasing power, he will push every investment up to the margin at 
which he no longer expects from it a higher net return than he could get by 
investing in some other material, or machine, or advertisement, or in the hire 
of some additional labour every investment will, as it were, be driven up to a 
valve which offers to it a resistance equal to its own expanding force. If he 
invests in material or in labour, that is soon embodied in some saleable 
product: the sale replenishes his fluid capital, and that again is invested up 
to the margin at which any further investment would yield a return so diminished 
as not to be profitable.
 
But if he invests in land, or in a durable building or machine, the return which 
he gets from his investment may vary widely from his expectation. It will be 
governed by the market for his products, which may change its character largely 
through new inventions, changes in fashion, etc., during the life of a machine, 
to say nothing of the perpetual life of land. The incomes which he thus may 
derive from investments in land and in machinery differ from his individual 
point of view mainly in the longer life of the land. But in regard to production 
in general, a dominant difference between the two lies in the fact that the 
supply of land is fixed (though in a new country, the supply of land utilized in 
man's service may be increased); while the supply of machines may be increased 
without limit. And this difference reacts on the individual producer. For if no 
great new invention renders his machines obsolete, while there is a steady 
demand for the things made by them, they will be constantly on sale at about 
their cost of production; and his machines will generally yield him normal 
profits on that cost of production, with deductions corresponding to their wear 
and tear.
 
Thus the rate of interest is a ratio: and the two things which it connects are 
both sums of money. So long as capital is "free," and the sum of money or 
general purchasing power over which it gives command is known, the net money 
income, expected to be derived from it, can be represented at once as bearing a 
given ratio (four or five or ten per cent) to that sum. But when the free 
capital has been invested in a particular thing, its money value cannot as a 
rule be ascertained except by capitalizing the net income which it will yield: 
and therefore the causes which govern it are likely to be akin in a greater or 
less degree to those which govern rents.
 
We are thus brought to the central doctrine of this part of economics, viz.: -- 
"That which is rightly regarded as interest on 'free' or 'floating' capital, or 
on new investments of capital, is more properly treated as a sort of rent -- a 
Quasi-rent -- On old investments of capital. And there is no sharp line of 
division between floating capital and that which has been 'sunk' for a special 
branch of production, nor between new and old investments of capital; each group 
shades into the other gradually. And thus even the rent of land is seen, not as 
a thing by itself, but as the leading species of a large genus; though indeed it 
has peculiarities of its own which are of vital importance from the point of 
view of theory as well as of practice."(10*)
 
NOTES:
 
1. Numerous objections have been urged against the important place assigned to 
marginal costs in modern analysis. But it will be found that most of them rely 
on arguments, in which statements referring to normal conditions and normal 
value are controverted by statements relating to abnormal or particular 
conditions.
 
2. The reader is referred to the footnote on p. 393 with special reference to 
the compressed mathematical version of the central problem of value which begins 
in Note XIV in the Mathematical Appendix and culminates in Note XXI.
 
3. Compare V, III, section 3; and V, IV, sections 3, 4; and Note XIV in the 
Mathematical Appendix.
 
4. This margin will vary with local circumstances, as well as with the habits, 
inclinations, and resources of individual farmers. The difficulty of applying 
steam machinery in small fields and on rugged ground is overcome more generally 
in those districts in which labour is scarce than in those in which it is 
plentiful; especially if, as is probable, coal is cheaper, and the feed of 
horses dearer in the former than the latter.
 
5. Skilled manual labour being generally used for special orders and for things 
of which not many are required of the same pattern; and unskilled labour aided 
by specialized machinery being used for others. The two methods are to be seen 
side by side on similar work in every large workshop: but the position of the 
line between them will vary a little from one workshop to another.
 
6. The changes, which he desires, may be such as could only be made on a large 
scale; as for instance the substitution of steam-power for hand-power in a 
certain factory; and in that case there would be a certain element of 
uncertainty and risk in the change. Such breaches of continuity are however 
inevitable both in production and consumption if we regard the action of single 
individuals. But as there is a continuous demand in a large market for hats and 
watches and wedding cakes, though no individual buys many of them (see III, III, 
section 5), so there will always be trades in which small businesses are most 
economically conducted without steam power, and larger businesses with; while 
businesses of intermediate size are on the margin. Again, even in large 
establishments in which steam is already in use, there will always be some 
things done by hand-power which are done by steam power elsewhere; and so on .
 
7. See p. 387, and Mathematical Note XVI. See also other illustrations in, VI, 
VII. A further illustration of the relation between the wages of the marginal 
shepherd, and the net product of his labour will be worked out in detail in VI, 
I, section 7 .
 
8. See V, IV, section 4; see also the note on von Thünen, below, p. 523.
 
9. See above IV, iii, section 8; and Carver, Distribution of Wealth, ch. ii, and 
above footnotes on pp. 319, 320. Mr J. A. Hobson is a vigorous and suggestive 
writer on the realistic and social sides of economics: but, as a critic of 
Ricardian doctrines, he is perhaps apt to underrate the difficulty of the 
problems which he discusses. He argues that if the marginal application of any 
agent of production be curtailed, that will so disorganize production that every 
other agent will be working to less effect than before; and that therefore the 
total resulting loss will include not only the true marginal product of that 
agent, but also a part of the products due to the other agents: but he appears 
to have overlooked the following points: -- (1) There are forces constantly at 
work tending so to readjust the distribution of resources between their 
different uses, that any maladjustment will be arrested before it has gone far: 
and the argument does not profess to apply to exceptional cases of violent 
maladjustment. (2) When the adjustment is such as to give the best results, a 
slight change in the proportions in which they are applied diminishes the 
efficiency of that adjustment by a quantity which is very small relatively to 
that change in technical language it is of "the second order of smalls" --; and 
it may therefore be neglected relatively to that change. (In pure mathematical 
phrase, efficiency being regarded as a function of the proportions of the 
agents; when the efficiency is at its maximum, its differential coefficient with 
regard to any one of these proportions is zero.) A grave error would therefore 
have been involved, if any allowance had been made for those elements which Mr 
Hobson asserts to have been overlooked. (3) In economics, as in physics, changes 
are generally continuous. Convulsive changes may indeed occur, but they must be 
dealt with separately: and an illustration drawn from a convulsive change can 
throw no true light on the processes of normal steady evolution. In the 
particular problem before us, this precaution is of special importance: for a 
violent check to the supply of any one agent of production, may easily render 
the work of all other agents practically useless; and therefore it may inflict a 
loss out of all proportion to the harm done by a small check to the supply of 
that agent when applied up to that margin, at which there was doubt whether the 
extra net product due to a small additional application of it would be 
remunerative. The study of changes in complex quantitative relations is often 
vitiated by a neglect of this consideration, to which Mr Hobson seems to be 
prone; as indeed is instanced by his remarks on a "marginal shepherd" in The 
Industrial System, p. i 10. See Professor Edgeworth's masterly analyses of the 
two instances mentioned in this note, Quarterly Journal of Economics, 1904, p. 
167; and Scientia, 1910, pp. 95-100.
 
10. This statement is reproduced from the Preface to the first edition of the 
present volume.
 
CHAPTER 9
 
MARGINAL COSTS IN RELATION TO VALUES.
GENERAL PRINCIPLES, CONTINUED
 
1. The incidents of the tenure of land are so complex: and so many practical 
issues connected with them have raised controversies on side issues of the 
problem of value, that it will be well to supplement our previous illustration 
from land. We may take another from an imaginary commodity so chosen that sharp 
outlines can be assigned to each stage of the problem, without inviting the 
objection that such sharp outlines are not found in the actual relations between 
landlord and tenant.
 
But before entering on this, we may prepare the way for using, as we go, 
illustrations drawn from the incidence of taxation to throw side-lights on the 
problem of value. For indeed a great part of economic science is occupied with 
the diffusion throughout the community of economic changes which primarily 
affect some particular branch of production or consumption; and there is 
scarcely any economic principle which cannot be aptly illustrated by a 
discussion of the shifting of the effects of some tax "forwards," i.e. towards 
the ultimate consumer, and away from the producer of raw material and implements 
of production; or else in the opposite direction, "backwards." But especially is 
this true of the class of problems now under discussion.(1*)
 
It is a general principle that if a tax impinges on anything used by one set of 
persons in the production of goods or services to be disposed of to other 
persons, the tax tends to check production. This tends to shift a large part of 
the burden of the tax forwards on to consumers, and a small part backwards on to 
those who supply the requirements of this set of producers. Similarly, a tax on 
the consumption of anything is shifted in a greater or less degree backwards on 
to its producer.
 
For instance, an unexpected and heavy tax upon printing would strike hard upon 
those engaged in the trade, for if they attempted to raise prices much, demand 
would fall off quickly: but the blow would bear unevenly on various classes 
engaged in the trade. Since printing machines and compositors cannot easily find 
employment out of the trade, the prices of printing machines and wages of 
compositors would be kept low for some time. On the other hand, the buildings 
and steam engines, the porters, engineers, and clerks would not wait for their 
numbers to be adjusted by the slow process of natural decay to the diminished 
demand; some of them would be quickly at work in other trades, and very little 
of the burden would stay long on those of them who remained in the trade. A 
considerable part of the burden, again, would fall on subsidiary industries, 
such as those engaged in making paper and type; because the market for their 
products would be curtailed. Authors and publishers would also suffer a little; 
because they would be forced either to raise the price of books, with a 
consequent diminution of sales, or to see a greater proportion of their gross 
receipts swallowed up by costs. Finally, the total turnover of the booksellers 
would diminish, and they would suffer a little.
 
So far it has been assumed that the tax spreads its net very wide, and covers 
every place to which the printing industry in question could be easily 
transferred. But, if the tax were only local, the compositors would migrate 
beyond its reach; and the owners of printing houses might bear a larger and not 
a smaller proportionate share of the burden than those whose resources were more 
specialized but more mobile. If the local tax were uncompensated by any effect 
which tended to attract population, part of the burden would be thrown on local 
bakers, grocers, etc., whose sales would be diminished.
 
Next suppose the tax to be levied on printing presses instead of on printed 
matter. In that case, if the printers had no semi-obsolete presses which they 
were inclined to destroy or to leave idle, the tax would not strike marginal 
production: it would not immediately affect the output of printing, nor 
therefore its price. It would merely intercept some of the earnings of the 
presses on the way to the owners, and lower the quasi-rents of the presses. But 
it would not affect the rate of net profits which was needed to induce people to 
invest fluid capital in presses: and therefore, as the old presses wore out, the 
tax would add to marginal expenses, that is to expenses which the producer was 
free to incur or not as he liked, and which he was in doubt whether to incur. 
Therefore the supply of printing would be curtailed; its price would rise: and 
new presses would be introduced only up to the margin at which they would be 
able, in the judgment of printers generally, to pay the tax and yet yield normal 
profits on the outlay. When this stage had been reached the distribution of the 
burden of a tax upon presses would henceforth be nearly the same as that of a 
tax upon printing: excepting only that there would be more inducement to get a 
great deal of work out of each press. For instance more of the presses might be 
made to work double shifts; in spite of the fact that night work involves 
special expenses.
 
We now pass to apply these principles of shifting of taxes to our main 
illustration.
 
2. Let us suppose that a meteoric shower of a few thousand large stones harder 
than diamonds fell all in one place; so that they were all picked up at once, 
and no amount of search could find any more. These stones, able to cut every 
material, would revolutionize many branches of industry; and the owners of them 
would have a differential advantage in production, that would afford a large 
producer's surplus. This surplus would be governed wholly by the urgency and 
volume of the demand for their services on the one hand and the number of the 
stones on the other hand: it could not be affected by the cost of obtaining a 
further supply, because none could be had at any price. A cost of production 
might indeed influence their value indirectly: but it would be the cost of tools 
made of hard steel and other materials of which the supply can be increased to 
keep pace with demand. So long as any of the stones were habitually used by 
intelligent producers for work which could be done equally well by such tools, 
the value of a stone could not much exceed the cost of producing tools 
(allowance being made for wear and tear) equally efficient with it in these 
inferior uses.
 
The stones, being so hard as not to be affected by wear, would probably be kept 
in operation during all the working hours of the day. And if their services were 
very valuable, it might be worth while to keep people working overtime, or even 
in double or triple shifts, in order to extract the utmost service from them. 
But the more intensively they were applied, the less net return would be reaped 
from each additional service forced from them; thus illustrating the law that 
the intensive working not only of land, but of every other appliance of 
production is likely to yield a diminishing return if pressed far enough.
 
The total supply of stones is fixed. But of course any particular manufacturer 
might obtain almost as many as he liked to pay for: and in the long run he would 
expect his outlay on them to be returned with interest (or profits, if the 
remuneration for his own work were not reckoned separately), just in the same 
way as if he were buying machinery, the total stock of which could be increased 
indefinitely, so that its price conformed pretty closely to its cost of 
production.
 
But when he had once bought the stones, changes in the processes of production 
or of demand for the things made by their aid, might cause the income yielded by 
them to become twice as great or only half as great as he had expected. In the 
latter case it would resemble the income derived from a machine, which had not 
the latest improvements and could earn only half as much as a new machine of 
equal cost. The values of the stone and of the machine alike would be reached by 
capitalizing the income which they were capable of earning, and that income 
would be governed by the net value of the services rendered by them. The income 
earning power and therefore the value of each would be independent of its own 
costs of production, but would be governed by the general demand for its 
products in relation to the general supply of those products. But in the case of 
the machine that supply would be controlled by the cost of supply of new 
machines equally efficient with it; and in the case of the stone there would be 
no such limit, so long as all the stones in existence were employed on work that 
could not be done by anything else.
 
This argument may be put in another way. Since any one, who bought stones, would 
take them from other producers, his purchase would not materially affect the 
general relations of demand for the services of the stones to the supply of 
those services. It would not therefore affect the price of the stones; which 
would still be the capitalized value of the services which they rendered in 
those uses, in which the need for them was the least urgent: and to say that the 
purchaser expected normal interest on the price which represented the 
capitalized value of the services, would be a circular statement that the value 
of the services rendered by stones is governed by the value of those very 
services.(2*)
 
Next let us suppose that the stones were not all found at once but were 
scattered over the surface of the earth on public ground, and that a laborious 
search might expect to be rewarded by finding one here and there. Then people 
would hunt for the stones only up to that point, or margin, at which the 
probable gain of so doing would in the long run just reward the outlay of labour 
and capital involved; and in the long run, the normal value of the stones would 
be such as to maintain equilibrium between demand and supply, the number of the 
stones gathered annually being in the long run just that for which the normal 
demand price was equal to the normal supply price.
 
Finally, let us bring the case of the stones into accord with that of the 
lighter machinery and other plant ordinarily used in manufacture, by supposing 
that the stones were brittle, and were soon destroyed; and that an inexhaustible 
store existed from which additional supplies could be obtained quickly and 
certainly at a nearly uniform cost. In this case the value of the stones would 
always correspond closely to that cost: variations in demand would have but 
little influence on their price, because even a slight change in price would 
quickly effect a great change in the stock of them in the market. In this case 
the income derived from a stone (allowance being made for wear-and-tear) would 
always adhere closely to interest on its cost of production.
 
3. This series of hypotheses stretches continuously from the one extreme in 
which the income derived from the stones is a rent in the strictest sense of the 
term, to the other extreme in which it is to be classed rather with interest on 
free or floating capital. In the first extreme case the stones cannot be worn 
out or destroyed, and no more can be found. They of course tend to be 
distributed among the various uses to which they are applicable in such a way 
that there is no use to which an increased supply of them could be applied, 
without taking them away from some other use in which they were rendering net 
services at least as valuable. These margins of application of the several uses 
are thus governed by the relation in which the fixed stock of stones stands to 
the aggregate of demands for them in different uses. And the margins being thus 
governed, the prices that will be paid for their use are indicated by the value 
of the services which they render at any one of those margins.
 
A uniform tax on them, collected from the user, will lower their net service in 
each use by the same amount: it will not affect their distribution between 
several uses; and it will fall wholly on the owner, after perhaps some little 
delay caused by a frictional resistance to readjustments.
 
At the opposite extreme of our chain of hypotheses, the stones perish so 
quickly, and are so quickly reproduced at about a uniform cost, that variations 
in the urgency and volume of the uses to which the stones can be put will be 
followed so promptly by changes in the stock of them available, that those 
services can never yield much more or much less than normal interest on the 
money cost of obtaining additional stones. In this case a business man, when 
making his estimates for the cost of any undertaking in which stones will be 
used, may enter interest (or if he is counting his own work in, profits), for 
the time during which those stones will be used (together with wear-and-tear), 
as part of the prime, special, or direct expenses of his undertaking. A tax on 
the stones under these conditions would fall entirely on any one who even a 
little while after the tax had come into force, gave out a contract for anything 
in making which the stones would be used.
 
Taking an intermediate hypothesis as to the length of life of the stones and the 
rapidity with which new supplies could be obtained; we find that the charges 
which the borrower of stones must expect to pay, and the revenue which the owner 
of the stones could reckon on deriving from them at any time, might temporarily 
diverge some way from interest (or profits) on their cost. For changes in the 
urgency and volume of the uses to which they could be applied, might have caused 
the value of the services rendered by them in their marginal uses to rise or 
fall a great deal, even though there had been no considerable change in the 
difficulty of obtaining them. And if this rise or fall, arising from variations 
in demand, and not from variations in the cost of the stones, is likely to be 
great during the period of any particular enterprise, or any particular problem 
of value that is under discussion; then for that discussion the income yielded 
by the stones is to be regarded as more nearly akin to a rent than to interest 
on the cost of producing the stones. A tax upon the stones in such a case would 
tend to diminish the rental which people would pay for their use, and therefore 
to diminish the inducements towards investing capital and effort in obtaining 
additional supplies. It would therefore check the supply, and compel those who 
needed the stones to pay gradually increasing rentals for their use, up to the 
point at which the rentals fully covered the costs of producing the stones. But 
the time needed for this readjustment might be long: and in the interval a great 
part of the tax would fall upon the owners of the stones.
 
If the life of the stones was long relatively to that process of production in 
which the stones were used which was under discussion, the stock of stones might 
be in excess of that needed to do all the work for which they were specially 
fitted. Some of them might be lying almost idle, and the owner of these stones 
might make up his estimate of the marginal price for which he was just willing 
to work without entering in that estimate interest on the value of the stones. 
That is to say, some costs which would have been classed as prime costs in 
relation to contracts, or other affairs, which lasted over a long period, would 
be classed as supplementary costs in relation to a particular affair which would 
last but a short time, and which came under consideration when business was 
slack.
 
It is of course just as essential in the long run that the price obtained should 
cover general or supplementary costs as that it should cover prime costs. An 
industry will be driven out of existence in the long run as certainly by failing 
to return even a moderate interest on capital invested in steam engines, as by 
failing to replace the price of the coal or the raw material used up from day to 
day: just as a man's work will be stopped as certainly by depriving him of food 
as by putting him in chains. But the man can go on working fairly well for a day 
without food; while if he is put in chains the check to his work comes at once. 
So an industry may, and often does, keep tolerably active during a whole year or 
even more, in which very little is earned beyond prime costs, and the fixed 
plant has "to work for nothing." But when the price falls so low that it does 
not pay for the out of pocket expenses during the yea r for wages and raw 
material, for coal and for lighting, etc., then the production is likely to come 
to a sharp stop.
 
This is the fundamental difference between those incomes yielded by agents of 
production which are to be regarded as rents or quasi-rents and those which 
(after allowing for the replacement of wear-and-tear and other destruction) may 
be regarded as interest (or profits) on current investments. The difference is 
fundamental, but it is only one of degree. Biology tends to show that the animal 
and vegetable kingdoms have a common origin. But yet there are fundamental 
differences between mammals and trees; while in a narrower sense the differences 
between an oak tree and an apple tree are fundamental; and so are in a still 
narrower sense those between an apple tree and a rose bush, though they are both 
classed as rosaceae. Thus our central doctrine is that interest on free capital 
and quasi-rent on an old investment of capital shade into one another gradually; 
even the rent of land being not a thing by itself, but the leading species of a 
large genus.(3*)
 
4. Again, pure elements are seldom isolated from all others by nature either in 
the physical or moral world. Pure rent in the strict sense of the term is 
scarcely ever met with: nearly all income from land contains more or less 
important elements which are derived from efforts invested in building houses 
and sheds, in draining the land and so on. But economists have learnt to 
recognize diversity of nature in those composite things to which the names of 
rent, profits, wages etc. are given in popular language; they have learnt that 
there is an element of true rent in the composite product that is commonly 
called wages, an element of true earnings in what is commonly called rent and so 
on. They have learnt in short to follow the example of the chemist who seeks for 
the true properties of each element; and who is thus prepared to deal with the 
common oxygen or soda of commerce, though containing admixtures of other 
elements.(4*)
 
They recognize that nearly all land in actual use contains an element of 
capital; that separate reasonings are required for those parts of its value 
which are, and those which are not, due to efforts of man invested in the land 
for the purposes of production; and that the results of these reasonings must be 
combined in dealing with any particular case of that income which commonly goes 
by the name "rent," but not all of which is rent in the narrower sense of the 
term. The manner in which the reasonings are to be combined depends on the 
nature of the problem. Sometimes the mere mechanical "composition of forces" 
suffices; more often allowance must be made for a quasi-chemical interaction of 
the various forces; while in nearly all problems of large scope and importance, 
regard must be had to biological conceptions of growth.
 
5. Finally a little may be said on a distinction that is sometimes made between 
"scarcity rents" and "differential rents." In a sense all rents are scarcity 
rents, and all rents are differential rents. But in some cases it is convenient 
to estimate the rent of a particular agent by comparing its yield to that of an 
inferior (perhaps a marginal) agent, when similarly worked with appropriate 
appliances. And in other cases it is best to go straight to the fundamental 
relations of demand to the scarcity or abundance of the means for the production 
of those commodities for making which the agent is serviceable.
 
Suppose for instance that all the meteoric stones in existence were equally hard 
and imperishable; and that they were in the hands of a single authority: further 
that this authority decided, not to make use of its monopolistic power to 
restrict production so as to raise the price of its services artificially, but 
to work each of the stones to the full extent it could be profitably worked 
(that is up to the margin of pressure so intensive that the resulting product 
could barely be marketed at a price which covered, with profits, its expenses 
without allowing anything for the use of the stone). Then the price of the 
services rendered by the stones would have been governed by the natural scarcity 
of the aggregate output of their services in relation to the demand for those 
services; and the aggregate surplus or rent would most easily be reckoned as the 
excess of this scarcity price over the aggregate expenses of working the stones. 
It would therefore generally be regarded as a scarcity rent. But on the other 
hand it could have been reckoned as the differential excess of the aggregate 
value of the net services of the stones over that which would have been reached 
if all their uses had been as unproductive as their marginal uses. And exactly 
the same would be true if the stones were in the hands of different producers, 
impelled by competition with one another to work each stone up to the margin at 
which its further use ceased to be profitable.
 
This last instance has been so chosen as to bring out the fact that the 
"differential" as well as the "scarcity" routes for estimating rent are 
independent of the existence of inferior agents of production: for the 
differential comparison in favour of the more advantageous uses of the stones 
can be made by reference to the marginal uses of good stones, as clearly as by 
reference to the use of inferior stones which are on the margin of not being 
worth using at all.
 
In this connection it may be noted that the opinion that the existence of 
inferior land, or other agents of production, tends to raise the rents of the 
better agents is not merely untrue. It is the reverse of the truth. For, if the 
bad land were to be flooded and rendered incapable of producing anything at all, 
the cultivation of other land would need to be more intensive; and therefore the 
price of the product would be higher, and rents generally would be higher, than 
if that land had been a poor contributor to the total stock of produce.(5*)
 
NOTES:
 
1. The substance of this section is reproduced from answers to questions 
proposed by the Royal Commission on Local Taxation. See [C. 9528], 1899, pp. 
112-26.
 
2. Such circular reasonings are sometimes nearly harmless: but they always tend 
to overlay and hide the real issues. And they are sometimes applied to 
illegitimate uses by company promoters; and by advocates of special interests, 
who desire to influence the course of legislation in their own favour. For 
instance a semi monopolistic business aggregation or trust is often 
"over-capitalized." To effect this a time is chosen, at which the branch of 
production with which it is concerned is abnormally prosperous: when perhaps 
some solid firms are earning fifty per cent. net on their capital in a single 
year, and thus making up for lean years past and to come in which their receipts 
will do little more than cover prime costs. Financiers connected with the 
flotation sometimes even arrange that the businesses to be offered to the public 
shall have a good many orders to fill at specially favourable prices: the loss 
falling on themselves, or on other companies which they control. The gains to be 
secured by semi-monopolistic selling, and possibly by some further economies in 
production are emphasized: and the stock of the trust is absorbed by the public. 
If ultimately objection to the conduct of the trust is raised, and especially to 
the strengthening of its semi-monopolistic position by a high tariff or any 
other public favour, the answer is given that the shareholders are receiving but 
a moderate return on their investments. Such cases are not uncommon in America. 
In this country a more moderate watering of the stock of some railways has been 
occasionally used indirectly as a defence of the shareholders against a lowering 
of rates, that threatens to reduce dividends on inflated capital below what 
would be a fair return on solid capital.
 
3. See above, p. 412.
 
4. Professor Fetter seems to ignore this lesson in an article on "The Passing of 
the Concept of Rent" in the Quarterly Journal of Economics, May 1901, p. 419; 
where he argues that "if only those things which owe nothing to labour are 
classed as land, and if it is then shown that there is no material thing in 
settled countries of which this can be said, it follows that everything must be 
classed as capital." Again he appears to have missed the true import of the 
doctrines which he assails, when he argues (ib. pp. 423-9) against "Extension as 
the fundamental attribute of land, and the basis of rent." The fact is that its 
extension (or rather the aggregate of "its space relations") is the chief, 
though not the only property ofland, which causes the income derived from it (in 
an old country) to contain a large element of true rent: and that the element of 
true rent, which exists in the income derived from land, or the "rent of land" 
in the popular use of the term, is in practice so much more important than any 
others that it has given a special character to the historical development of 
the Theory of Rent (see above, p. 147). If meteoric stones of absolute hardness, 
in high demand and incapable of increase, had played a more important part in 
the economic history of the world than land, then the elements of true rent 
which attracted the chief attention of students, would have been associated with 
the property of hardness; and this would have given a special tone and character 
to the development of the Theory of Rent. But neither extension nor hardness is 
a fundamental attribute of all things which yield a true rent. Professor Fetter 
seems also to have missed the point of the central doctrine as to rents, 
quasi-rents and interest, given above.
 
5. Compare Cassel, Das Recht auf den vollen Arbeitsertrag, p. 81.
 
The many misconceptions, that have appeared in the writings even of able 
economists, as to the nature of a quasi-rent, seem to arise from an inadequate 
attention to the differences between short periods and long in regard to value 
and costs. Thus it has been said that a quasi-rent is an "unnecessary profit," 
and that it is "no part of cost" Quasi-rent is correctly described as an 
unnecessary profit in regard to short periods, because no "special" or "prime" 
costs have to be incurred for the production of a machine that, by hypothesis, 
is already made and waiting for its work. But it is a necessary profit in regard 
to those other (supplementary) costs which must be incurred in the long run in 
addition to prime costs; and which in some industries, as for instance sub 
marine telegraphy, are very much more important than prime costs. It is no part 
of cost under any conditions: but the confident expectation of coming 
quasi-rents is a necessary condition for the investment of capital in machinery, 
and for the incurring of supplementary costs generally.
 
Again a quasi-rent has been described as a sort of "conjuncture" or 
"opportunity" profit; and, almost in the same breath, as no profit or interest 
at all, but only a rent. For the time being, it is a conjuncture or opportunity 
income: while in the long run it is expected to, and it generally does, yield a 
normal rate of interest (or if earnings of management are counted in, of profit) 
on the free capital, represented by a definite sum of money that was invested in 
producing it. By definition the rate of interest is a percentage; that is a 
relation between two numbers (see above, p. 412). A machine is not a number: its 
value may be a certain number of pounds or dollars: but that value is estimated, 
unless the machine be a new one, as the aggregate of its (discounted) earnings, 
or quasi-rents. If the machine is new, its makers have calculated that this 
aggregate will appear to probable purchasers as the equivalent of a price which 
will repay the makers for it: in that case therefore it is as a rule, both a 
cost price, and a price which represents an aggregate of (discounted) future 
incomes. But when the machine is old and partially obsolete in pattern, there is 
no close relation between its value and its cost of production: its value is 
then simply the aggregate of the discounted values of the future quasi-rents, 
which it is expected to earn.
 
CHAPTER X
 
MARGINAL COSTS IN RELATION TO AGRICULTURAL VALUES
 
1. We now pass from general considerations to those relating to land; and we 
begin with those specially applicable to agricultural land in an old country.
 
Suppose, that a war, which was not expected to last long, were to cut off part 
of the food supplies of England. Englishmen would set themselves to raise 
heavier crops by such extra application of capital or labour as was likely to 
yield a speedy return; they would consider the results of artificial manures, of 
the use of clod-crushing machines, and so on; and the more favourable these 
results were, the less would be the rise in the price of produce in the coming 
year which they regarded as necessary to make it worth their while to incur 
additional outlay in these directions. But the war would have very little effect 
on their action as to those improvements which would not bear fruit till it was 
over. In any inquiry then as to the causes that will determine the prices of 
corn during a short period, that fertility which the soil derives from slowly 
made improvements has to be taken for granted as it then is, almost in the same 
way as if it had been made by nature. Thus, the income derived from these 
permanent improvements gives a surplus above the prime or special costs needed 
for raising extra produce. But it is not a true surplus, in the same sense that 
the rent proper is, i.e. it is not a surplus above the total costs of the 
produce: it is needed to cover the general expenses of the business.
 
To speak more exactly: -- If the extra income derived from improvements that 
have been made in the land by its individual owner is so reckoned as not to 
include any benefit which would have been conferred on the land by the general 
progress of society independently of his efforts and sacrifices; then, as a 
rule, the whole of it is required to remunerate him for those efforts and 
sacrifices. He may have underestimated the gains which will result from them; 
but he is about equally likely to have made an overestimate. If he has estimated 
them rightly, his interest has urged him to make the investment as soon as it 
showed signs of being profitable: and in the absence of any special reason to 
the contrary we may suppose him to have done this. In the long run, then, the 
net returns to the investment of capital in the land, taking successful and 
unsuccessful returns together, do not afford more than an adequate motive to 
such investment. If poorer returns had been expected than those on which people 
actually based their calculations, fewer improvements would have been made.
 
That is to say: -- for periods which are long in comparison with the time needed 
to make improvements of any kind, and bring them into full operation, the net 
incomes derived from them are but the price required to be paid for the efforts 
and sacrifices of those who make them: the expenses of making them thus directly 
enter into marginal expenses of production, and take a direct part in governing 
long-period supply price. But in short periods, that is, in periods short 
relatively to the time required to make and bring into full bearing improvements 
of the class in question, no such direct influence on supply price is exercised 
by the necessity that such improvements should in the long run yield net incomes 
sufficient to give normal profits on their cost. And therefore when we are 
dealing with such periods, these incomes may be regarded as quasi-rents which 
depend on the price of the produce.(1*)
 
We may conclude then: -- (1) The amount of produce raised, and therefore the 
position of the margin of cultivation (i.e. the margin of the profitable 
application of capital and labour to good and bad land alike) are both governed 
by the general conditions of demand and supply. They are governed on the one 
hand by demand; that is, by the numbers of the population who consume the 
produce, the intensity of their need for it, and their means of paying for it; 
and on the other hand by supply; that is, by the extent and fertility of the 
available land, and the numbers and resources of those ready to cultivate it. 
Thus cost of production, eagerness of demand, margin of production, and price of 
the produce mutually govern one another: and no circular reasoning is involved 
in speaking of any one as in part governed by the others. (2) That part of the 
produce which goes as rent is of course thrown on the market, and acts on 
prices, in just the same way as any other part. But the general conditions of 
demand and supply, or their relations to one another, are not affected by the 
division of the produce into the share of rent and the share needed to render 
the farmer's expenditure profitable. The amount of that rent is not a governing 
cause; but is itself governed by the fertility of land, the price of the 
produce, and the position of the margin: it is the excess of the value of the 
total returns which capital and labour applied to land do obtain, over those 
which they would have obtained under circumstances as unfavourable as those on 
the margin of cultivation. (3) If the cost of production were estimated for 
parts of the produce which do not come from the margin, a charge on account of 
rent would of course need to be entered in this estimate; and if this estimate 
were used in an account of the causes which govern the price of the produce; 
then the reasoning would be circular. For that, which is wholly an effect, would 
be reckoned up as part of the cause of those things of which it is an effect. 
(4) The cost of production of the marginal produce can be ascertained without 
reasoning in a circle. The cost of production of other parts of the produce 
cannot. The cost of production on the margin of the profitable application of 
capital and labour is that to which the price of the whole produce tends, under 
the control of the general conditions of demand and supply: it does not govern 
price, but it focusses the causes which do govern price.
 
2. It has sometimes been suggested that if all land were equally advantageous 
and all were occupied, the income derived from it would partake of the nature of 
a monopoly rent: but this seems to be an error. Of course the landowners might 
conceivably combine to stint production, whether their properties were of equal 
fertility or not; the raised prices which would thus be obtained for the produce 
would be monopoly prices; and the incomes of the owners would be monopoly 
revenues rather than rents. But, with a free market, the revenues from land 
would be rents, governed by the same causes and in the same way in a country 
where the land was all of equal advantage, as in those where good and bad land 
were intermingled.(2*)
 
It is, indeed, true that if there were more than enough land, all of about the 
same fertility, to enable everyone to have as much of it as was needed to give 
full scope to the capital he was prepared to apply to it, then it could yield no 
rent. But that merely illustrates the old paradox that water, when abundant, has 
no market value: for though the services of some part of it are essential to 
support life, yet everyone can get without effort to that margin of satiety at 
which any further supplies would be of no service to him. When every cottager 
has a well from which he can draw as much water as he needs, with no more labour 
than is required at his neighbour's well, the water in the well has no market 
value. But let a drought set in, so that the shallow wells are exhausted, and 
even the deeper wells are threatened, then the owners of those wells can exact a 
charge for every bucket which they allow anyone to draw for his own use. The 
denser population becomes, the more numerous will be the occasions on which such 
charges can be made (it being supposed that no new wells are developed): and at 
last every owner of a well may find in it a permanent source of revenue.
 
In the same way the scarcity value of land in a new country gradually emerges. 
The early settler exercises no exclusive privilege, for he only does what anyone 
else is at liberty to do. He undergoes many hardships, if not personal dangers; 
and perhaps he runs some risks that the land may turn out badly, and that he may 
have to abandon his improvements. On the other hand, his venture may turn out 
well; the flow of population may trend his way, and the value of his land may 
soon give as large a surplus over the normal remuneration of his outlay on it as 
the fishermen's haul does when they come home with their boat full. But in this 
there is no surplus above the rewards needed for his venture. He has engaged in 
a risky business which was open to all, and his energy and good fortune have 
given him an exceptionally high reward: anyone else might have taken the same 
chance as he did. Thus the income which he expects the land to afford in the 
future enters into the calculations of the settler, and adds to the motives 
which determine his action when in doubt as to how far to carry his enterprise. 
He regards its "discounted value"(3*) as profits on his capital, and as earnings 
of his own labour, in so far as his improvements are made with his own hands.
 
A settler often takes up land with the expectation that the produce which it 
affords while in his possession, will fall short of an adequate reward for his 
hardships, his labour and his expenditure. He looks for part of his reward to 
the value of the land itself, which he may perhaps after a while sell to some 
new-comer who has no turn for the life of a pioneer. Sometimes even, as the 
British farmer learns to his cost, the new settler regards his wheat almost as a 
by-product; the main product for which he works is a farm, the title-deeds to 
which he will earn by improving the land: he reckons that its value will 
steadily rise, not through his own efforts so much as through the growth of 
those comforts and resources, and of those markets in which to buy and in which 
to sell, that are the product of the growing public prosperity.
 
This may be put in another way. People are generally unwilling to face the 
hardships and isolation of pioneer agriculture, unless they can look forward 
with some confidence to much higher earnings, measured in terms of the 
necessaries of life, than they could get at home. Miners cannot be attracted to 
a rich mine, isolated from other conveniences and varied social opportunities of 
civilization, except by the promise of high wages: and those who superintend the 
investment of their own capital in such mines expect very high profits. For 
similar reasons pioneer farmers require high aggregate gains made up of receipts 
for the sale of their produce, together with the acquisition of valuable 
title-deeds, to remunerate them for their labour and endurance of hardships. And 
the land is peopled up to that margin at which it just yields gains adequate for 
this purpose, without leaving any surplus for rent, when no charge is made for 
the land. When a charge is made, immigration spreads only up to that margin, at 
which the gains will leave a surplus, of the nature of rent, to cover such 
charges, in addition to rewarding the pioneer's endurance.
 
3. With all this it is to be remembered that land is but a particular form of 
capital from the point of view of the individual producer. The question whether 
a farmer has carried his cultivation of a particular piece of land as far as he 
profitably can; and whether he should try to force more from it, or to take in 
another piece of land; is of the same kind as the question whether he should buy 
a new plough, or try to get a little more work out of his present stock of 
ploughs, using them sometimes when the soil is not in a very favourable 
condition, and feeding his horses a little more lavishly. He weighs the net 
product of a little more land against the other uses to which he could put the 
capital sum that he would have to expend in order to obtain it: and in like 
manner he weighs the net product, to be got by working his ploughs under 
unfavourable circumstances, against that got by increasing his stock of ploughs, 
and thus working under more favourable conditions. That part of his produce 
which he is in doubt whether to raise by extra use of his existing ploughs, or 
by introducing a new plough, may be said to be derived from a marginal use of 
the plough. It pays nothing net (i.e. nothing beyond a charge for actual 
wear-and-tear) towards the net income earned by the plough.
 
So again a manufacturer or trader, owning both land and buildings, regards the 
two as bearing similar relations to his business. Either will afford him aid and 
accommodation at first liberally; and afterwards with diminishing return, as he 
endeavours to force more and more from them: till at last he will doubt whether 
the overcrowding of his workshops or his storerooms is not so great a source of 
trouble, that it would answer his purpose to obtain more space. And when he 
comes to decide whether to obtain that space by taking in an extra piece of land 
or by building his factory a floor higher, he weighs the net income to be 
derived from further investments in the one against that to be derived from the 
other. That part of his production which he just forces out of his existing 
appliances (being in doubt whether it would not be better worth his while to 
increase those appliances than to work so intensively those which he has), does 
not contribute to the net income which those appliances yield him. This argument 
says nothing as to whether the appliances were made by man, or part of a stock 
given by nature; it applies to rents and quasi-rents alike.
 
But there is this difference from the point of view of society. If one person 
has possession of a farm, there is less land for others to have. His use of it 
is not in addition to, but in lieu of the use of a farm by other people: whereas 
if he invests in improvements of land or in buildings on it, he will not 
appreciably curtail the opportunities of others to invest capital in like 
improvements. Thus there is likeness amid unlikeness between land and appliances 
made by man. There is unlikeness because land in an old country is approximately 
(and in some senses absolutely) a permanent and fixed stock: while appliances 
made by man, whether improvements in land, or in buildings, or machinery, etc., 
are a flow capable of being increased or diminished according to variations in 
the effective demand for the products which they help in raising. So far there 
is unlikeness. But on the other hand there is likeness, in that, since some of 
them cannot be produced quickly, they are a practically fixed stock for short 
periods: and for those periods the incomes derived from them stand in the same 
relation to the value of the products raised by them, as do true rents.(4*)
 
4. Let us apply these considerations to the supposition that a permanent tax is 
to be levied on "corn," in the sense in which it was used by the classical 
economists as short for all agricultural produce. It is obvious that the farmer 
would try to make the consumer pay some part at least of the tax. But any rise 
in the price charged to the consumer would check demand, and thus react on the 
farmer. In order to decide how much of this tax would be shifted on to the 
consumer, we must study the margin of profitable expenditure, whether that be 
the margin of a little expenditure applied to poor land and land far removed 
from good markets, or the margin of a large expenditure applied to rich land, 
and land near to dense industrial districts.
 
If only a little corn had been raised near the margin, a moderate fall in the 
net price received by the farmer would not cause a great check to the supply of 
corn. There would therefore be no great rise in the price paid for it by the 
consumer; and the consumer would bear very little of the tax. But the surplus 
value of the corn over its expenses of production would fall considerably. The 
farmer, if cultivating his own land, would bear the greater part of the tax. 
And, if he were renting the land, he could demand a great reduction of his rent.
 
If, on the other hand, a great deal of corn had been raised near the margin of 
cultivation, the tax would tend to cause a great shrinkage of production. The 
consequent rise of price would arrest that shrinkage, leaving the farmer in a 
position to cultivate nearly as intensively as before: and the landlord's rent 
would suffer but little.(5*)
 
Thus, on the one hand, a tax which is so levied as to discourage the cultivation 
of land or the erection of farm buildings on it, tends to be shifted forward on 
to the consumers of the produce of land. But, on the other hand, a tax on that 
part of the (annual) value of land, which arises from its position, its 
extension, its yearly income of sunlight and heat and rain and air, cannot 
settle anywhere except on the landlord; a lessee being, of course, landlord for 
the time. This (annual) value of the land is commonly called its "original 
value" or its "inherent value"; but much of that value is the result of the 
action of men, though not of its individual holders. For instance, barren heath 
land may suddenly acquire a high value from the growth of an industrial 
population near it; though its owners have left it untouched as it was made by 
nature. It is, therefore, perhaps more correct to call this part of the annual 
value of land its "public value"; while that part which can be traced to the 
work and outlay of its individual holders may be called its "private value." The 
old terms "inherent value" and "original value" may however be retained for 
general use, with a note of caution as to their partial inaccuracy. And, using 
another term that has precedent in its favour, we may speak of this annual 
public value of the land as "true rent."
 
A tax on the public value of land does not greatly diminish the inducements to 
cultivate the land highly, nor to erect farm buildings on it. Such a tax 
therefore does not greatly diminish the supply of agricultural produce offered 
on the market, nor raise the price of produce; and it is not therefore shifted 
away from the owners of land.
 
This assumes that the true rent of land on which the tax is levied is assessed 
with reference to its general capabilities, and not to the special use which the 
owner makes of it: its net product is supposed to be that which could be got by 
a cultivator of normal ability and enterprise, turning it to good account to the 
best of his judgment. If an improved method of cultivation develops latent 
resources of the soil, so as to yield an increased return much in excess of what 
is required to remunerate the outlay with a good rate of profits; this excess of 
net return above normal profits belongs properly to true rent: and yet, if it is 
known, or even expected, that a very heavy special tax on true rent will be made 
to apply to this excess income, that expectation may deter the owner from making 
the improvement.(6*)
 
5. A little has been said incidentally of the competition between different 
branches of industry for the same raw material or appliances for production. But 
now we have to consider the competition between various branches of agriculture 
for the same land. This case is simpler than that of urban land, because farming 
is a single business so far as the main crops are concerned; though the rearing 
of choice trees (including vines), flowers, vegetables etc. affords scope for 
various kinds of specialized business ability. The classical economists were 
therefore justified in provisionally supposing that all kinds of agricultural 
produce can be regarded as equivalent to certain quantities of corn; and that 
all the land will be used for agricultural purposes, with the exception of 
building sites which are a small and nearly fixed part of the whole. But when we 
concentrate our attention on any one product, as for instance, hops, it may seem 
that a new principle is introduced. That is however not the case. Let us look 
into this.
 
Hops are grown in varying rotations with other crops; and the farmer is often in 
doubt whether he shall grow hops or something else on one of his fields. Thus 
each crop strives against others for the possession of the land; and if any one 
crop shows signs of being more remunerative than before relatively to others, 
the cultivators will devote more of their land and resources to it. The change 
may be retarded by habit, or diffidence, or obstinacy, or limitations of the 
cultivator's knowledge; or by the terms of his lease. But it will still be true 
in the main that each cultivator -- to recall once more the dominant principle 
of substitution -- "taking account of his own means, will push the investment of 
capital in his business in each several direction until what appears in his 
judgment to be the margin of profitableness is reached; that is, until there 
seems to him no good reason for thinking that the gains resulting from any 
further investment in that particular direction would compensate him for his 
outlay."
 
Thus in equilibrium, oats and hops and every other crop will yield the same net 
return to that outlay of capital and labour, which the cultivator is only just 
induced to apply. For otherwise he would have miscalculated; he would have 
failed to get the maximum reward which his outlay can be made to yield: and it 
would still be open to him to increase his gains by redistributing his crops, by 
increasing or diminishing his cultivation of oats or some other crop.(7*)
 
This brings us to consider taxation in reference to the competition of different 
crops for the use of the same land. Let us suppose that a tax is imposed on 
hops, wherever grown; it is not to be a mere local rate or tax. The farmer can 
evade a part of the pressure of the tax by lessening the intensity of his 
cultivation of the land which he plants with hops; and a yet further part by 
substituting another crop on land which he had proposed to devote to hops. He 
will have recourse to this second plan in so far as he considers that he would 
get a better result by growing another crop, and selling it free from the tax, 
than by growing hops and selling them in spite of the tax. In this case the 
surplus which he could obtain from the land by growing, say, oats upon it would 
come into his mind when deciding where to set the limit to his production of 
hops. But even here there would be no simple numerical relation between the 
surplus, or rent, which the land would yield under oats, and the marginal costs 
which the price of hops must cover. And a farmer whose land produced hops of 
exceptionally high quality, and which happened to be in good condition at the 
time for hops, would have no doubt at all that it was best to grow hops on the 
land; though in consequence of the tax he might decide to curtail a little his 
expenditure on it.(8*)
 
Meanwhile the tendency towards a general restriction in the supply of hops would 
tend to raise their price. If the demand for them were very rigid, and hops of 
adequate quality could not easily be imported from beyond the range of this 
special tax, the price might rise by nearly the full amount of the tax. In that 
case the tendency would be checked, and very nearly as much hops would be grown 
as before the tax had been levied. And here, as in the case of a tax on 
printing, recently discussed, the effect of a local tax is in strong contrast to 
that of a general tax. For unless the local tax covered most of the ground in 
the country on which good hops could be grown, its effect would be to drive them 
beyond its boundary: very little revenue would be got from it, local farmers 
would suffer a good deal, and the public would pay a rather higher price for 
their hops.
 
6. The argument of the last section applies, so far as short periods are 
concerned, to the earning power of farmbuildings and to other quasi-rents. When 
existing farmbuildings, or other appliances which could be used in producing one 
commodity are diverted to producing another because the demand for that is such 
as to enable them to earn a higher income by producing it, then for the time the 
supply of the first will be less, and its price higher than if the appliances 
had not been able to earn a higher income by another use. Thus, when appliances 
are capable of being used in more than one branch of agriculture, the marginal 
cost in each branch will be affected by the extent to which these appliances are 
called off for work in other branches. Other agents of production will be pushed 
to more intensive uses in the first branch, in spite of a diminishing return; 
and the value of its product will rise, because only at a higher value will the 
price be in equilibrium. The increased earning power of the appliances due to 
the external demand will appear to be the cause of this increase in value: for 
it will cause a relative scarcity of the appliances in that branch of 
production, and therefore raise marginal costs. And from this statement it 
appears superficially to be a simple transition to the statement that the 
increased earning power of the appliances enter into those costs which govern 
value. But the transition is illegitimate. There will be no direct or numerical 
relation between the increase in the price of the first commodity and the income 
that the appliances can earn when they have been transferred to the second 
industry and adapted for service in it.
 
Similarly, if a tax be put on factories used in one industry, some of them will 
be diverted to other industries; and consequently the marginal costs and 
therefore the values of the products in those industries will fall; 
simultaneously with a temporary fall in net rental values of factories in all 
uses. But these falls will vary in amount, and there will be no numerical 
relation between the fall in the prices of the product and in these rents, or 
rather quasi-rents.
 
These principles are not applicable to mines, whether for short periods or for 
long. A royalty is not a rent, though often so called. For, except when mines, 
quarries, etc., are practically inexhaustible, the excess of their income over 
their direct outgoings has to be regarded, in part at least, as the price got by 
the sale of stored-up goods -- stored up by nature indeed, but now treated as 
private property; and therefore the marginal supply price of minerals includes a 
royalty in addition to the marginal expenses of working the mine. Of course the 
owner desires to receive the royalty without undue delay; and the contract 
between him and the lessee often provides, partly for this reason, for the 
payment of a rent as well as a royalty. But the royalty itself on a ton of coal, 
when accurately adjusted, represents that diminution in the value of the mine, 
regarded as a source of wealth in the future, which is caused by taking the ton 
out of nature's storehouse.(9*)
 
NOTES:
 
1. Of course the character and extent of the improvements depends partly on the 
conditions of land tenure, and the enterprise and ability and command over 
capital on the part of landlords and tenants which existed at the time and place 
in question. In this connection we shall find, when we come to study land 
tenure, that there are large allowances to be made for the special conditions of 
different places.
 
It may be noted, however, that rent proper is estimated on the understanding 
that the original properties of the soil are unimpaired. And when the income 
derived from improvements is regarded as a quasi-rent, it is to be understood 
that they are kept up in full efficiency: if they are being deteriorated, the 
equivalent of the injury done to them must be deducted from the income they are 
made to yield before we can arrive at that Net income which is to be regarded as 
their quasi rent.
 
That part of the income which is required to cover wear-and-tear bears some 
resemblance to a royalty, which does no more than cover the injury done to a 
mine by taking ore out of it.
 
2. Compare V, IX, section 5.
 
3. Compare III, V, section 3 and V, IV, section 2.
 
4. The relations between rent and profits engaged the attention of the 
economists of the last generation; among whom may be specially mentioned Senior 
and Mill, Hermann and Mangoldt. Senior seemed almost on the point of perceiving 
that the key of the difficulty was held by the element of time: but here as 
elsewhere he contented himself with suggestions; he did not work them out. He 
says (Political Economy, p. 1 29), "for all useful purposes the distinction of 
profits from rent ceases as soon as the capital from which a given revenue 
arises has become, whether by gift or by inheritance, the property of a person 
to whose abstinence and exertions it did not owe its creation." Again, Mill 
says, Political Economy, Book III, ch. v, §4, "Any difference in favour of 
certain producers or in favour of production in certain circumstances is the 
source of a gain, which though not called rent unless paid periodically by one 
person to another, is governed by laws entirely the same with it."
 
It has been well observed that a speculator, who, without manipulating prices by 
false intelligence or otherwise, anticipates the future correctly; and who makes 
his gains by shrewd purchases and sales on the Stock Exchange or in Produce 
Markets, generally renders a public service by pushing forward production where 
it is wanted, and repressing it where it is not: but that a speculator in land 
in an old country can render no such public service, because the stock of land 
is fixed. At the best he can prevent a site with great possibilities from being 
devoted to inferior uses in consequence of the haste, ignorance, or 
impecuniosity of those in control of it.
 
5. Of course the adjustments of rent to the true economic surplus from the land 
are in practice slow and irregular. These matters are discussed in VI, sections 
IX and X, and the incidence of a tax on grain under certain rather arbitrary 
assumptions is studied in some detail in Appendix K.
 
6. The exemption of vacant building land from taxes on its full value retards 
building. See Appendix G.
 
7. In so far as the farmer is producing raw material, or even human food, for 
market, his distribution of resources between different uses is a problem of 
business economy: in so far as he is producing for his own domestic consumption, 
it is, in part at least, a problem of domestic economy. Compare above V, iv, §4. 
It may be added that Note XIV in the Mathematical Appendix emphasizes the fact 
that that distribution of outlay between different enterprises, which will give 
a maximum aggregate return, is fixed by the same set of equations as that for 
the similar problem in domestic economy.
 
Mill (Principles, III, XVI, 2), when discussing "joint products," observed that 
all questions relating to the competition of crops for the possession of 
particular soils are complicated by the rotation of crops and similar causes; an 
intricate debit and credit account by double entry needs to be kept between the 
various members of the rotation. Practice and shrewd instinct enable the farmer 
to do this fairly well. The whole problem might be expressed in simple 
mathematical phrases. But they would be tedious, and perhaps unfruitful. They 
would therefore not be serviceable, so long as they remained abstract; though 
they belong to a class which may ultimately be of good use in the higher science 
of agriculture, when that has advanced far enough to fill in realistic details.
 
8. If for instance he reckoned that he could get a surplus of £30 above his 
expenses (other than rent) in spite of the tax by growing hops, and a surplus of 
only £20 above similar expenses by growing any other crop, it could not be trulv 
said that the rent which the field could be made to yield by growing other 
crops, "entered into" the marginal price of hops. But it is easier to interpret 
the classical doctrine that "Rent does not enter into cost of production" in a 
sense in which it is not true, and to scoff at it, than in the sense in which it 
was intended and is true. It seems best therefore to avoid the phrase.
 
The ordinary man is offended by the old phrase that rent does not enter into the 
price of oats; when he sees that an increase in the demand for land for other 
uses, manifests itself in a rise of the rental value of all land in the 
neighbourhood; leaves less land free for growing oats; consequently makes it 
worth while to force larger crops of oats out of the remaining oat-land, and 
thus raises the marginal expenses of oats and their price. A rise in rent does 
serve as a medium through which the growing scarcity of land available for hops 
and other produce obtrudes itself on his notice; and it is not worth while to 
try to force him to go behind these symptoms of the change in conditions to the 
truly operative causes. It is therefore inexpedient to say that the rent of land 
does not enter into their price. But it is worse than inexpedient to say that 
the rent of the land does enter into their price: that is false.
 
Jevons asks (Preface to Theory of Political Economy, p. liv): "If land which has 
been yielding £2 per acre rent, as pasture, be ploughed up and used for raising 
wheat, must not £2 per acre be debited against the expenses of production of 
wheat;" The answer is in the negative. For there is no connection between this 
particular sum of £2 and the expenses of production of that wheat which only 
just pays its way. What should be said is: "When land capable of being used for 
producing one commodity is used for producing another, the price of the first is 
raised bv the consequent limitation of its field of production. The price of the 
second will be the expenses of production (wages and profits) of that part of it 
which only just pays its way, that which is produced on the margin of profitable 
expenditure. And if for the purposes of any particular argument we take together 
the whole expenses of the production on that land, and divide these among the 
whole of the commodity produced; then the rent which we ought to count in is not 
that which the land would pay if used for producing the first commodity, but 
that which it does pay when used for producing the second."
 
9. See above, Book IV, chapter 3, note. Adam Smith is attacked by Ricardo for 
putting rent on the same footing with wages and profits as parts of (money) cost 
of production; and no doubt he does this sometimes. But yet he says elsewhere, 
"Rent it is to be observed enters into the composition of the price of 
commodities in a different way from wages and profit. High or low wages and 
profit are the causes of high or low price: high or low rent is the effect of 
it. It is because high or low wages and profit must be paid in order to bring a 
particular commodity to market that its price is high or low. But it is because 
its price is high or low a great deal more, or very little more, or no more than 
what is sufficient to pay those wages and profits, that it affords a high rent, 
or a low rent, or no rent at all." (Wealth of Nations, I, XI.) In this, as in 
many other instances, he anticipated in one part of his writings truths which in 
other parts he has seemed to deny.
 
Adam Smith discusses the "price at which coals can be sold for any considerable 
time"; and contends that "the most fertile mine regulates the price of coals at 
all other mines in the neighbourhood." His meaning is not clear; but he does not 
appear to be referring to any temporary underselling; and he seems to imply that 
the mines are leased at so much a year. Ricardo, following on apparently the 
same lines, comes to the opposite conclusion that it "is the least fertile mine 
which regulates price"; which is perhaps nearer the truth than Adam Smith's 
doctrine. But in fact when the charge for the use of a mine is mainly in the 
form of a royalty, neither proposition seems to be applicable. Ricardo was 
technically right (or at all events not definitely wrong) when he said that rent 
does not enter into the marginal cost of production of mineral produce. But he 
ought to have added that if a mine is not practically inexhaustible, the income 
derived from it is partly rent and partly royalty; and that though the rent does 
not, the minimum royalty does enter directly into the expenses incurred on 
behalf of every part of the produce, whether marginal or not.
 
The royalty is of course calculated in regard to those seams in the mine, which 
are neither exceptionally rich and easy of working, nor exceptionally poor and 
difficult. Some seams barely pay the expenses of working them; and some which 
run short, or have a bad fault, do not even nearlv pav the wages of the labour 
spent on them. The whole argument however implicitly assumes the conditions of 
an old country. Professor Taussig is probably right when, having in view the 
circumstances of a new country (Principles, II, p. 96), he "doubts whether any 
payment at all can be secured by the owner of the very poorest mine, assuming he 
has done nothing to develop it."
 
CHAPTER XI
 
MARGINAL COSTS IN RELATION TO URBAN VALUE
 
1. The last three chapters examined the relation in which cost of production 
stands to the income derived from the ownership of the "original powers" of land 
and other free gifts of nature, and also to that which is directly due to the 
investment of private capital. There is a third class, holding an intermediate 
position between these two, which consists of those incomes, or rather those 
parts of incomes which are the indirect result of the general progress of 
society, rather than the direct result of the investment of capital and labour 
by individuals for the sake of gain. This class has to be studied now, with 
special reference to the value of urban sites.
 
We have already noted that, though nature nearly always gives a less than 
proportionate return, when measured by the amount of the produce raised, to 
increasing applications of capital and labour in the cultivation of land; yet, 
on the other hand, if the more intensive cultivation is the result of the growth 
of a non-agricultural population in the neighbourhood, this very concourse of 
people is likely to raise the value of produce. We have seen how this influence 
opposes, and usually outweighs the action of the law of diminishing return when 
the produce is measured according to its value to the producer and not according 
to its amount; the cultivator gets good markets in which to supply his wants, as 
well as good markets in which to sell, he buys more cheaply while he sells more 
dearly, and the conveniences and enjoyments of social life are ever being 
brought more within his reach.(1*)
 
Again, we have seen how the economies which result from a high industrial 
organization(2*) often depend only to a small extent on the resources of 
individual firms. Those internal economies which each establishment has to 
arrange for itself are frequently very small as compared with those external 
economies which result from the general progress of the industrial environment; 
the situation of a business nearly always plays a great part in determining the 
extent to which it can avail itself of external economies; and the situation 
value which a site derives from the grow of a a rich and active population close 
to it, or from the opening up of railways and other good means of communication 
with existing markets, is the most striking of all the influences which changes 
in the industrial environment exert on cost of production.
 
If in any industry, whether agricultural or not, two producers have equal 
facilities in all respects, except that one has a more convenient situation than 
the other, and can buy or sell in the same markets with less cost of carriage, 
the differential advantage which his situation gives him is the aggregate of the 
excess charges for cost of carriage to which his rival is put. And we may 
suppose that other advantages of situation, such for instance as the near access 
to a labour market specially adapted to his trade, can be translated in like 
manner into money values. When this is done, and all are added together we have 
the money value of the advantages of situation which the first business has over 
the second: and this becomes its special situation value, if the second has no 
situation value and its site is reckoned merely at agricultural value. The extra 
income which can be earned on the more favoured site gives rise to what may be 
called a special situation rent: and the aggregate site value of any piece of 
building land is that which it would have if cleared of buildings and sold in a 
free market. The "annual site value" -- to use a convenient, though not strictly 
correct form of speaking -- is the income which that price would yield at the 
current rate of interest. It obviously exceeds the special situation value, 
merely by agricultural value; which is often an almost negligible quantity in 
comparison.(3*)
 
2. It is obvious that the greater part of situation value is "public value." 
There are however exceptional cases, which call for notice. Sometimes the 
settlement of a whole town, or even district is planned on business principles, 
and carried out as an investment at the expense and risk of a single person or 
company. The movement may be partly due to philanthropic or religious motives, 
but its financial basis will in any case be found in the fact that the concourse 
of numbers is itself a cause of increased economic efficiency. Under ordinary 
circumstances the chief gains arising from this efficiency would accrue to those 
who are already in possession of the place: but the chief hopes of commercial 
success, by those who undertake to colonize a new district or build a new town, 
are usually founded on securing these gains for themselves.
 
When, for instance, Mr Salt and Mr Pullman determined to take their factories 
into the country and to found Saltaire and Pullman City, they foresaw that the 
land, which they could purchase at its value for agricultural purposes, would 
obtain the special situation value which town property derives from the 
immediate neighbourhood of a dense population. And similar considerations have 
influenced those, who, having fixed upon a site adapted by nature to become a 
favourite watering-place, have bought the land and spent large sums in 
developing its resources: they have been willing to wait long for any net income 
from their investment in the hope that ultimately their land would derive a high 
situation value from the concourse of people attracted to it.(4*)
 
In all such cases the yearly income derived from the land (or at all events that 
part of it which is in excess of the agricultural rent) is for many purposes to 
be regarded as profits rather than rent. And this is equally true, whether the 
land is that on which the factory itself at Saltaire or Pullman City is built, 
or that which affords a high "ground-rent" as the site of a shop or store, whose 
situation will enable it to do a brisk trade with those who work in the factory. 
For in such cases great risks have to be run; and in all undertakings in which 
there are risks of great losses, there must also be hopes of great gains. The 
normal expenses of production of a commodity must include payment for the 
ventures required for producing it, sufficient to cause those who are on the 
margin of doubt whether to venture or not, to regard the probable net amount of 
their gains net, that is, after deducting the probable amount of their losses as 
compensating them for their trouble and their outlay. And that the gains 
resulting from such ventures are not much more than sufficient for this purpose 
is shown by the fact that they are not as yet very common. They are however 
likely to be more frequent in those industries which are in the hands of very 
powerful corporations. A large railway company, for instance, can found a Crewe 
or a New Swindon for manufacturing railway plant without running any great 
risk.(5*)
 
Some what similar instances are those of a group of landowners who combine to 
make a railway, the net traffic receipts of which are not expected to pay any 
considerable interest on the capital invested in making it; but which will 
greatly raise the value of their land. In such cases part of the increase of 
their incomes as landowners ought to be regarded as profits on capital which 
they have invested in the improvement of their land: though the capital has gone 
towards making a railway instead of being applied directly to their own 
property.
 
Other cases of like nature are main drainage schemes, and other plans for 
improving the general condition of agricultural or town property, in so far as 
they are carried out by the landowners at their own expense, whether by private 
agreement or by the levying of special rates on themselves. Similar cases again 
are found in the investment of capital by a nation in building up its own social 
and political organization as well as in promoting the education of the people 
and in developing its sources of material wealth.
 
Thus that improvement of the environment, which adds to the value of land and of 
other free gifts of nature, is in a good many cases partly due to the deliberate 
investment of capital by the owners of the land for the purpose of raising its 
value; and therefore a portion of the consequent increase of income may be 
regarded as profits when we are considering long periods. But in many cases it 
is not so; and any increase in the net income derived from the free gifts of 
nature which was not brought about by, and did not supply the direct motive to, 
any special outlay on the part of the landowners, is to be regarded as rent for 
all purposes.
 
Cases somewhat analogous to these arise when the owner of a score or more of 
acres in the neighbourhood of a growing town "develops" them for building. He 
probably lays out the roads, decides where houses are to be continuous, and 
where detached; and prescribes the general style of architecture, and perhaps 
the minimum expenditure on each house; for the beauty of each adds to the 
general value of all. This collective value, thus created by him, is of the 
nature of public value; and it is dependent, for the greater part, on that 
dormant public value, which the site as a whole derived from the growth of a 
prosperous town in its neighbourhood. But yet that share of it which results 
from his forethought, constructive faculty and outlay, is to be regarded as the 
reward of business enterprise, rather than as the appropriation of public value 
by a private person.
 
These exceptional cases must be reckoned with. But the general rule holds that 
the amount and character of the building put upon each plot of land is, in the 
main (subject to the local building bylaws), that from which the most profitable 
results are anticipated, with little or no reference to its reaction on the 
situation value of the neighbourhood. In other words the site value of the plot 
is governed by causes which are mostly beyond the control of him who determines 
what buildings shall be put on it: and he adjusts his expenditure on it to his 
estimates of the income to be derived from various descriptions of buildings on 
it.
 
3. The owner of building land sometimes builds on it himself: sometimes he sells 
it outright: very often he lets it at a fixed ground-rent for ninety-nine years, 
after which the land and the buildings on it (which by covenant must be kept in 
good repair) revert to his successor in title. Let us consider what governs the 
value at which he can sell the land and the ground-rent at which he can let it.
 
The capitalized value of any plot of land is the actuarial "discounted" value of 
all the net incomes which it is likely to afford, allowance being made on the 
one hand for all incidental expenses, including those of collecting the rents, 
and on the other for its mineral wealth, its capabilities of development for any 
kind of business, and its advantages, material, social and aesthetic, for the 
purposes of residence. The money equivalent of that social status and those 
other personal gratifications which the ownership of land affords, does not 
appear in the returns of the money income derived from it, but does enter into 
its capital money value.(6*)
 
Next let us consider what governs the "ground-rent" which the owner can obtain 
for a plot which he lets on, say, a ninety-nine years' building lease. The 
present discounted value of all the fixed money payments under that lease tends 
to be equal to the present capital value of the land; after deducting, firstly, 
for the obligation to return the land with the buildings on it to the successor 
in title of the present owner at the end of the lease, and secondly for the 
possible inconvenience of any restrictions on the use of the land contained in 
the lease. In consequence of these deductions the ground-rent would be rather 
less than the "annual site value" of the land, if that site value were expected 
to remain fixed throughout. But in fact the site value is expected to rise in 
consequence of the growth of population, and other causes: and therefore the 
ground-rent is generally a little above the annual site value at the beginning 
of the lease, and much below it towards the end.(7*)
 
Among the estimated outgoings on account of any building, which have to be 
deducted from its estimated gross yield before deciding what is the value of the 
privilege of erecting it on any given plot of land, are the taxes (central and 
local) which may be expected to be levied on the property, and to be paid by the 
owner of the property. But this raises difficult side-issues, which are 
postponed to Appendix G.
 
4. Let us revert to the fact that the law of diminishing return applies to the 
use of land for the purposes of living and working on it in all trades.(8*) Of 
course in the trade of building, as in agriculture, it is possible to apply 
capital too thinly. Just as a homesteader may find that he can raise more 
produce by cultivating only a half of the 160 acres allotted to him than by 
spreading his labour over the whole, so even when ground has scarcely any value, 
a very low house may be dear in proportion to its accommodation. But, as in 
agriculture, there is a certain application of capital and labour to the acre 
which gives the highest return, and further applications after this give a less 
return, so it is in building. The amount of capital per acre which gives the 
maximum return varies in agriculture with the nature of the crops, with the 
state of the arts of production, and with the character of the markets to be 
supplied; and similarly in building, the capital per square foot which would 
give the maximum return, if the site had no scarcity value, varies with the 
purpose for which the building is wanted. But when the site has a scarcity 
value, it is worth while to go on applying capital beyond this maximum rather 
than pay the extra cost of land required for extending the site. In places where 
the value of land is high, each square foot is made to yield perhaps twice the 
accommodation, at more than twice the cost, that it would be made to give, if 
used for similar purposes where the value of land is low.
 
We may apply the phrase the margin of building to that accommodation which it is 
only just worth while to get from a given site, and which would not be got from 
it if land were less scarce. To fix the ideas, we may suppose this accommodation 
to be given by the top floor of the building.(9*)
 
By erecting this floor, instead of spreading the building over more ground, a 
saving in the cost of land is effected, which just compensates for the extra 
expense and inconvenience of the plan. The accommodation given by this floor, 
when allowance has been made for its incidental disadvantages, is only just 
enough to be worth what it costs without allowing anything for the rent of land; 
and the expenses of production of the things raised on this floor, if it is part 
of a factory, are just covered by their price; there is no surplus for the rent 
of land. The expenses of production of manufactures may then be reckoned as 
those of the goods which are made on the margin of building, so as to pay no 
rent for land. That is to say the rent of the land does not enter into that set 
of expenses at the margin at which the action of the forces of demand and supply 
in governing value may be most clearly seen.
 
Suppose, for instance, that a person is planning a hotel or a factory; and 
considering how much land to take for the purpose. If land is cheap he will take 
much of it; if it is dear he will take less and build high. Suppose him to 
calculate the expenses of building and working his establishment with frontages 
of 100 and 110 feet respectively, in ways equally convenient on the whole to 
himself, his customers and employees, and therefore equally profitable to 
himself. Let him find that the difference between the two plans, after 
capitalizing future expenditure, shows an advantage of £500 in favour of the 
larger area; he will then be inclined to take the larger if the land is to be 
got at less than £50 per foot of frontage, but not otherwise; and £50 will be 
the marginal value of land to him. He might have reached this result by 
calculating the increased value of the business that could be done with the same 
outlay in other respects on the larger site as compared with the smaller, or 
again by building on less expensive ground instead of in a more favourable 
situation. But, by whatever route he makes his calculation, its character is 
similar to that by which he decides whether it is worth his while to buy 
business plant of any other kind: and he regards the net income (allowance being 
made for depreciation) which he expects to get from either investment as 
standing in the same general relation to his business; and if the advantages of 
the situation are such, that all the land available on it can find employments 
of different kinds in each of which its marginal use is represented by a capital 
value of £50 per foot of frontage, then that will be the current value of the 
land.
 
5. This assumes that the competition for land for various uses will cause 
building in each locality and for each use to be carried up to that margin, at 
which it is no longer profitable to apply any more capital to the same site. As 
the demand for residential and business accommodation in a district increases, 
it becomes worth while to pay a higher and higher price for land, in order to 
avoid the expense and inconvenience of forcing more accommodation from the same 
ground area.
 
For instance, if the value of land in, say, Leeds rises because of the increased 
competition for it by shops, ware. then a woollen manufacturer finding houses, 
iron works, etc., his expenses of production increased, may move to another town 
or into the country; and thus leave the land on which he used to work to be 
built over with shops and warehouses, for which a town situation is more 
valuable than it is for factories. For he may think that the saving in the cost 
of land that he will make by moving into the country, together with other 
advantages of the change, will more than counterbalance its disadvantages. In a 
discussion as to whether it was worth while to do so, the rental value of the 
site of his factory would be reckoned among the expenses of production of his 
cloth; and rightly.
 
But we have to go behind that fact. The general relations of demand and supply 
cause production to be carried up to a margin at which the expenses of 
production (nothing being entered for rent) are so high that people are willing 
to pay a high value for additional land in order to avoid the inconvenience and 
expense of crowding their work on to a narrow site. These causes govern site 
value; and site value is therefore not properly regarded as governing marginal 
costs.
 
Thus the industrial demand for land is in all respects parallel to the 
agricultural. The expenses of production of oats are increased by the fact that 
land, which could yield good crops of oats, is in great demand for growing other 
crops that enable it to yield a higher rent: and in the same way the 
printing-presses, which may be seen at work in London some sixty feet above the 
ground, could afford to do their work a little cheaper if the demand for ground 
for other uses did not push the margin of building up so high. Again a 
hop-grower may find that on account of the high rent which he pays for his land, 
the price of his hops will not cover their expenses of production where he is, 
and he may abandon hop-growing, or seek other land for it; while the land that 
he leaves may perhaps be let to a market-gardener. After a while the demand for 
land in the neighbourhood may again become so great that the aggregate price 
which the market-gardener obtains for his produce will not pay its expenses of 
production, including rent; and so he in his turn makes room for, say, a 
building compa