 11. Marginal costs in relation to urban values. 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 labor 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 labor 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 neighborhood, 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 cultivated gets good markets in which to supply us once, 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. Again, we have seen how the economies which result from a high industrial organization 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 growth of 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 on the same market 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 labor market specially adapted to his trade, can be translated in like manner to 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 favored 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 the 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. If we suppose that two farms which sell in the same market return severally to equal applications of capital and labor amounts of produce, the first of which exceeds the second by the extra cost of carrying its produce to market, then the rent of the two farms will be the same. The capital and labor applied to the two farms are here supposed to be reduced to the same money measure or which comes to the same thing, the two farms are supposed to have equally good access to markets in which to buy. Again if we suppose that two mineral springs, A and B, supplying exactly the same water are capable of being worked each to an unlimited extent at a constant money cost of production. This cost being say two pence a bottle at A, whatever the amount produced by it, and two pence half penny at B, then those places to which the cost of carriage per bottle from B is a half penny less than from A will be the neutral zone for their competition. If the cost of carriage be proportional to the distance, this neutral zone is a hyperbole of which A and B are foci. A can undersell B for all places on A's side of it and vice versa, and each of them will be able to derive a monopoly rent from the sale of its produce within its own area. This is a type of a great many fanciful, but not uninstructive, problems which readily suggest themselves. Compare Von Thunen's brilliant researches in Der Israeler Stadt. It is obvious that the greater part of the situation value is public value, see above page 434. 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 position 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 Salter 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 neighborhood of a dense population. And similar considerations have influenced those who, having fixed upon a site adapted by nature to become a favorite 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. Cases of this kind are most frequent in new countries, but they are not very rare in old countries. Saltburn is a conspicuous instance, while a more recent instance of exceptional interest is furnished by Lechworth Garden City. In almost 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 Salter or Pullman City is built, or that which affords a high ground rent. As the site of a shop or store, a situation will enable it to do 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 crew or a new Swindon for manufacturing railway plant without running any great risk. Governments have great facilities for carrying out schemes of this kind, especially in the matter of choosing new sites for garrison towns, arsenals, and establishments for the manufacture of materials of war. In comparisons of the expenses of production by government and by private firms, the sites of the government works are often reckoned only at their agricultural value. But such a plan is misleading. A private firm has either to pay heavy annual charges on account of its site or to run very heavy risks if it tries to make a town for itself. And therefore, in order to prove that government management is for general purposes as efficient and economical as private management, a full charge ought to be made in the balance sheets of government factories for the town value of their sites. In those exceptional branches of production for which a government can found a manufacturing town without incurring the risks that a private firm would incur in a similar case, that point of advantage may fairly be reckoned as an argument for governments undertaking those particular businesses. Somewhat 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 agriculture or town property insofar 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 on 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 needs 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 a neighborhood 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 the dormant public value which the site as a whole derives from the growth of a prosperous town in its neighborhood. 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 neighborhood. In other words, the site value of the plot is governed by causes which are mostly beyond the control of him who determines what building 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. 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 of which he can sell the land on 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 residents. 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. The value of agricultural land is commonly expressed as a certain number of times the current money rental, or in other words, a certain number of years purchase of that rental. In other things being equal, it will be the higher and more important these direct gratifications are, as well as greater the chance that they and the money income afforded by the land will rise. The number of years purchase would be increased also by an expected fall either in the future normal rate of interest or in the purchasing power of money. The discounted value of a very distant rise in the value of land is much less than is commonly supposed. For instance, if we take interest at 5% and higher rates prevail during the Middle Ages, one pound invested at compound interest would amount to about 17,000 pounds in 200 years and 40 billion in 500 years. Therefore, an expenditure by the state of one pound in securing to itself the reversion of a rise in the value of land which came into operation now for the first time would have been a bad investment unless the value of that rise now exceeded 17,000 pounds. If the payment was made 200 years ago, if 500 years ago to 40 billion pounds. This assumes that it would have been possible to invest some of this dimension at 5%, which of course it would not. Next, let us consider what governs the ground rent which the owner can obtain for a plot which he lets on, say, a 99 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. A few site values have fallen in districts which have been deserted by fashion or trade, but on the other hand annual site values have risen to be many times as great as the ground rents in the case of land which was leased when it had no special situation value, but has since become a chief center of fashion or of trade and all the more at the lease were grounded in the first half of the 18th century when gold was scarce and the incomes of all classes of the people measured in money were very low. The present discounted value of the return of property to the ground landlord a hundred years hence which will then be worth a thousand pounds is less perhaps than is commonly supposed, though the error is not so great as in the case of anticipations ranging over many hundreds of years which were discussed in a recent note. If interest be taken at 3% it is about 50 pounds if at 5% as was the rule three or four generations ago it is but eight pounds. Among estimated out goings 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 Expendix G. 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. Of course in the trade of building as an agriculture it is possible to apply capital too thinly just as a homesteader may find that he can raise more produce by cultivating only half of the 160 acres allotted to him then by spreading his labor 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 an agriculture there is a certain application of capital and labor 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 worthwhile 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 and 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 worthwhile to get from a given site and which would not be got from it if the land were less scarce. To fix the ideas we may suppose this accommodation to be given by the top floor of the building houses built in flats are often provided with a lift which is run at the expense of the owner of the house. But in such cases at all events in America the top floor sometimes lets for a higher rent than any other. If the site is very valuable and the law does not limit the height of his house in the interest of his neighbors he may build very high. But at last he will reach the margin of building. At last he will find that the extra expenses for foundations and thick walls and for his lift together with some resulting depreciation of the lower floors make him stand to lose more than he gains by adding one more floor. The extra accommodation which it only just answers his purpose to supply is then to be regarded as the margin of building even though the gross rent be greater for the higher floors than for the lower. Compare the footnote on page 168. But in England bylaws restrained an individual from building so high as to deprive his near neighbors of air and light. In the course of time those who build high will be forced to have a good deal of free space about their buildings and this will render very high buildings unprofitable. By erecting this floor instead of spreading the building over more ground a saving in the cost of land is affected 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 cost 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 the manufacturers may then be reckoned as those of the goods which are made in the margin of the building so as to pay no rent for the 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 demanded supply and 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 planes after capitalizing future expenditure shows an advantage of 500 pounds in favor of the larger area. He will then be inclined to take the larger if the land is to be got at less than 50 pounds per square foot of frontage but not otherwise and 50 pounds 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 and other respects on the larger side as compared with the smaller. Or again by building on less expensive ground instead of in a less favorable situation. But by whatever route he makes his calculation his character is similar to that by which he decides whether it is worth his while to buy a 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 pounds per foot of frontage then that will be the current value of the land. 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 worthwhile 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, leads rises because of the increased competition for it by shops, warehouses, ironworks, etc., then a woolen manufacturer finding 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 by shops and warehouses, for which a town situation is more valuable than it is for factories. For he may think that the saving of 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 worthwhile 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 too narrow a 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 greater 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 60 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 neighborhood may again become so great that the aggregate price which the market gardener obtains for his produce will not pay its expenses of production including rent and so he in his turn makes room for say a building company. In each case the rising demand for land alters the margin to which it is profitable to carry the intensive use of land. The costs at this margin indicate the action of those fundamental causes which govern the value of the land. And at the same time they are themselves those costs to which the general conditions of demand and supply compel value to conform and therefore it is right for our purpose to go straight to them. Though any such inquiry would be irrelevant to the purpose of a private balance sheet. The demand for exceptionally valuable urban land comes from traders of various kinds wholesale and retail more than from manufacturers and it may be worthwhile to say something here as to the very interesting features of demand that are peculiar to their case. If two factories in the same branch of trade have equal outputs they are sure to have nearly equal floor space. But there is no close relation between the size of trading establishments and their turnovers. Plenty of space is for them a matter of convenience and a source of extra profit. It is not physically indispensable but the larger their space the greater their stock which they can keep on hand and the greater the advantage to which they can display specimens of it. And especially is this the case in trades that are subject to changes of taste and fashion. In such trades the dealers exert themselves to collect within a comparatively small space representatives of all the best ideas that are in vogue and still more of those that are likely soon to be so. In the higher the rental values of their sites the more prompt they must be in getting rid even at a loss of such things as are a little behind the time and do not improve the general character of their stocks. If the locality is one in which customers are more likely to be tempted by a well chosen stock than by low prices the traders will charge prices that give a high rate of profit on the comparatively small turnover. But if not they will charge low prices and try to force a large business in proportion to their capital and the size of their premises. Just as in some neighborhoods the market gardener finds it best to gather his peas young when they are full of flavor and in others to let them grow till they weigh heavily on the scales. Whichever plan the traders follow there will be some conveniences which they are in doubt whether it is worthwhile to offer to the public since they calculate that the extra sales gained by such conveniences are only just renumerative and do not contribute any surplus towards rent. The goods which they sell in consequence of these conveniences are goods into whose expenses of marketing rent does not enter any more than it does into those of the peas which the market gardener only just finds it worthwhile to produce. Prices are low in some very highly rented shops because their doors are passed by great numbers of people who cannot afford to pay high prices for the gratification of their fancy and the shopkeeper knows that he must sell cheaply or not sell at all. He has to be content with a low rate of profit each time he turns over his capital. But as the wants of his customers are simple he need not keep a large stock of goods and he can turn over his capital many times a year. So his annual net profits are very great and he is willing to pay a very high rent for the situation in which they can be earned. On the other hand prices are very high in some of the quiet streets in the fashionable parts of London and in many villages because on the one case customers must be attracted by very choice stock which can only be sold slowly and in the other the aggregate turnover is very small indeed. In neither place can the trader make profits that will enable him to pay as high a rent as those of some cheap but bustling shops in the east end of London. It is however true that if without any increase in traffic such as brings extra custom a situation becomes more valuable for purposes other than shopkeeping. Then only those shopkeepers will be able to pay their way who can manage to secure a large custom relatively to the prices which they charge and the class of business which they do. There will therefore be a smaller supply of shopkeepers in all trades for which the demand has not increased and those who remain will be able to charge a higher price than before without offering any great conveniences and attractions to their customers. The rise of ground values in the district will thus be an indication of a scarcity of space which other things being equal will raise the prices of retail goods just as in the same way as in the rise of agricultural rents in any district will indicate a scarcity of land which will raise the marginal expenses of production and therefore the price of any particular crop. The rent of a house or other building is a composite rent of which one part belongs to the site and the other to the buildings themselves. The relations between these two are rather intricate and may be deferred to appendix G. A few words may however be said here as to the composite rents in general. At starting there may appear to be some contradiction in the statement that a thing is yielding at the same time two rents. Where its rent is in some sense a residual income after deducting the expenses of working it and there cannot be two residues in regard to the same process of working and the same resulting revenue. But when the thing is composite each of its parts may be capable of being so worked as to yield a surplus of revenue over the expenses of working it. The corresponding rents can always be distinguished analytically and sometimes they can be separated commercially. It will be borne in mind that if a house is not appropriate to its site its aggregate rent will not exceed its site rent by the full building rent which the house would command on an appropriate site. Similar limitations apply to most composite rents. For instance the rent of a flour mill worked by water includes the rent of the site on which it is built and the rent of the water power which it uses. Suppose that it is contemplated to build a mill in a place where there is a limited water power which could be applied equally well on any one of many sites. Then the rent of the water power together with the site selected for it is a sum of two rents which are respectively the equivalent of the differential advantages which possession of the site gives for production of any kind. And which the ownership of the water power gives for working a mill on any of the sites. And these two rents whether they happen to be owned by the same person or not can be clearly distinguished and separately estimated both in theory and in practice. But this cannot be done if there are no other sites on which a mill can be built. And in that case should the water power in the site belong to different persons there is nothing but higgling and bargaining to settle how much of the excess of the value of the two together over that which the site has for other purposes shall go to the owner of the ladder. And even if there were other sites at which the water power could be applied but not with equal efficiency there would still be no means of deciding how the owners of the site and the water power should share the excess of the producer surplus which they got by acting together over the sum of that which the site would yield for some other purpose. And that which the water power would yield if applied elsewhere. The mill would probably not be put up till an agreement had been made for the supply of water power for a term of years but at the end of that term similar difficulties would arise as to the division of the aggregate producer surplus afforded by the water power and the site with a mill on it. Difficulties of this kind are continually arising with regard to attempts by partial monopolists such as railway, gas, water and electrical companies to raise their charges on the consumer who has adapted his business arrangements to make use of their services and perhaps laid down at his own expense a costly plant for the purpose. For instance at Pittsburgh when manufacturers had just put up furnaces to be worked by natural gas instead of coal the price of the gas was suddenly doubled and the history of mines affords many instances of difficulties of this kind with neighboring landowners as to the rights of way etc. And with the owners of neighboring cottages, railways and docks. The relations between the interests of different classes of workers in the same business and in the same trade have some affinity in the subject of composite rents. End of Chapter 11. Chapter 12 of Principles of Economics Book 5. This is a LibriVox recording. All LibriVox recordings are in the public domain. For more information or to volunteer please visit LibriVox.org. Principles of Economics Book 5 by Alfred Marshall. Chapter 12 Equilibrium of Normal Demand and Supply Continued with Reference to the Law of Increasing Return. We may now continue the study begun in chapters 3 and 5 and examine some difficulties connected with the relations of demand and supply as regards commodities. The production of which tends to increasing return. We have noted that this tendency seldom shows itself immediately on an increase of demand. To take an example the first effect of a sudden fashion for watch shaped aneroids would be a temporary rise of price in spite of the fact that they contain no material of which there is but a scanty stock. For highly paid labor that had no special training for the work would have to be drawn in from other trades a good deal of effort would be wasted and for a time the real and the money cost to production would be increased. But yet if the fashion lasted a considerable time then even independently of any new invention the cost of making aneroids would fall gradually. For specialized skill and abundance would be trained and properly graduated to the various work to be done. With a large use of the method of interchangeable parts specialized machinery would do better and more cheaply much of the work that is now done by hand. And thus a continued increase in the annual output of watch shaped aneroids would lower their price very much. Here there is to be noted an important difference between demand and supply. A fall in the price at which a commodity is offered acts on demand always in one direction. The amount of the commodity demanded may increase much or a little according as the demand is elastic or inelastic and a long or short time may be required for developing the new and extended uses of the commodity which are rendered possible by the fall in price. But at all events if exceptional cases in which a thing is driven out of fashion by a fall in its price be neglected the influence of price on demand is similar in character for all commodities. And further those demands which show high elasticity in the long run show a high elasticity almost at once. So that subject to a few exceptions we may speak of the demand for commodity as being of high or low elasticity without specifying how far we are looking ahead. But there are no such simple rules with regard to supply. An increase in the price offered by purchasers does indeed always increase supply and thus it is true that if we have a regard to short periods only and especially to the transactions of a dealer's market there is an elasticity of supply which corresponds closely to elasticity of demand. That is to say a given rise in price will cause a great or a small increase in the offers which sellers accept according as they have large or small reserves in the background and as they have formed low or high estimates of the level of prices at the next market. And this rule applies nearly in the same way to things which in the long run have a tendency to diminishing return as to those which have a tendency to increasing return. In fact if the large plant needed in a branch of manufacture is fully occupied and cannot be rapidly increased an increase in the price offered for its products may have no perceptible effect in increasing the output for some considerable time. While a similar increase in the demand for a handmade commodity might call forth quickly a great increase in supply though in the long run its supply conformed to that of constant return or even of diminishing return. In the more fundamental questions which relate to long periods the matter is even more complex. For the ultimate output corresponding to an unconditional demand at even current prices would be theoretically infinite and therefore the elasticity of supply of a commodity which conforms to the law of increasing return or even to that of constant return is theoretically infinite for long periods. The next point to be observed is that this tendency to a fall in the price of a commodity is the result of a gradual development of the industry by which it is made is quite a different thing from the tendency to the rapid introduction of new economies by an individual firm that is increasing its business. We have seen how every step in the advance of an able and enterprising manufacturer makes the succeeding step easier and more rapid so that his progress upwards is likely to continue so long as he has fairly good fortune and retains his full energy and elasticity and his liking for hard work. But these cannot last forever and as soon as they decay his business is likely to be destroyed through the very action of some of those very causes which enabled it to arise unless indeed he can pass it over into hands as strong as his used to be. Thus the rise and fall of individual firms may be frequent while a great industry is going through one long oscillation or even moving steadily forwards as the leaves of a tree to repeat an earlier illustration grow to maturity reach equilibrium and decay many times while the tree is steadily growing upwards year by year. The causes which govern the facilities for production at the command of a single firm thus conform to quite different laws from those which control the whole output of an industry and the contrast is perhaps heightened when we take the difficulties of marketing into account. For instance, manufacturers which are adapted to special tastes are likely to be on a small scale and they are generally of such a character that the machinery and modes of organization already developed in other trades could be easily adapted to them so that a great increase in their scale of production would be sure to introduce vast economies at once. But these are the very industries in which each firm is likely to be confirmed more or less to its own particular market and if it is so confined any hasty increase in its production is likely to lower the demand price in that market out of all proportion to the increased economies that it will gain even though its production is but small relatively to the broad market for which in a more general sense it may be said to produce. In fact when trade is slack a producer will often try to sell some of his surplus goods outside of his own particular market at prices that do little more than cover their prime costs. While within that market he still tries to sell at prices that nearly cover supplementary costs and a great part of these are the returns expected on capital invested in building up the external organization of his business. Again supplementary costs are, as a rule, larger relative to prime costs for things that obey the law of increasing return than for other things because their production needs the investment of a large capital in material appliances and in building up trade connections. This increases the intensity of those fears of spoiling his own peculiar market or incurring odium from other producers for spoiling the common market which we have already learned to regard as controlling the short period supply price of goods when the appliances of production are not fully employed. We cannot then regard the conditions of supply by an individual producer as typical of those which govern the general supply in a market. We must take account of the fact that very few firms have long continued life of active progress and of the fact that the relations between the individual producer and his special market differ in important respects from those between the whole body of producers and the general market. Thus the history of the individual firm cannot be made into the history of an industry any more than the history of an individual man can be made into the history of mankind. And yet the history of mankind is the outcome of the history of individuals and the aggregate production for a general market is the outcome of the motives which induce individual producers to expand or contract their production. It is just here that our device of a representative firm comes to our aid. We imagine to ourselves at any time a firm that has its fair share of those internal and external economies which appertain to the aggregate scale of production in the industry to which it belongs. We recognize that the size of such a firm, while partly depending on changes in technique and in the cost of transport, is governed other things being equal by the general expansion of the industry. We regard the manager of it as reckoning up whether it would be worth his while to add a certain line to his undertakings, whether he should introduce a certain new machine, and so on. We regard him as treating the output which would result from that change more or less as a unit and weighing in his mind the cost against the gain. This, then, is the marginal cost on which we fix our eyes. We do not expect it to fall immediately in consequence of a sudden increase of demand. On the contrary, we expect the short period supply price to increase with increasing output. But we also expect a gradual increase in demand to increase gradually the size and the efficiency of this representative firm, and to increase the economies both internal and external which are at its disposal. That is to say, when making lists of supply prices, supply schedules for long periods in these industries, we set down a diminished supply price against an increased amount of the flow of the goods, meaning thereby that a flow of that increased amount will in the course of time be supplied profitably at that lower price to meet a fairly steady corresponding demand. We exclude from view any economies that may result from substantial new inventions, but we include those which may be expected to arise naturally out of adaptations of existing ideas. And we look towards a position of balance or equilibrium between the forces of production and decay, which would be attained if the conditions under view were supposed to act uniformly for a long time. But such notions must be taken broadly. The attempt to make them precise overreaches our strength. If we include, in our account, nearly all the conditions of real life, the problem is too heavy to be handled. If we select a few, then long drawn out and subtle reasonings with regard to them become scientific toys rather than engines for practical work. The theory of stable equilibrium of normal demand and supply helps indeed to give definiteness to our ideas. And in its elementary stages, it does not diverge from the actual facts of life, so far as to prevent its giving a fairly trustworthy picture of the chief methods of action of the strongest and most persistent group of economic forces. But when pushed to its more remote and intricate logical consequences, it slips away from the conditions of real life. In fact, we are here verging on the high theme of economic progress, and here therefore it is especially needful to remember that economic problems are imperfectly presented when they are treated as problems of statical equilibrium and not of organic growth. For though the statical treatment alone can give us definiteness and precision of thought, and is therefore a necessary introduction to a more philosophic treatment of society as an organism, it is yet only an introduction. The statical theory of equilibrium is only an introduction to economic studies, and it is barely even an introduction to the study of the progress and development of industries which show a tendency to increasing return. Its limitations are so constantly overlooked, especially by those who approach it from an abstract point of view, that there is a danger in throwing it into definite form at all. But with this caution the risk may be taken, and a short study of the subject is given in Appendix H. End of Chapter 12 Chapter 13 of Principles of Economics Book 5 This is a LibriVox recording. All LibriVox recordings are in the public domain. For more information or to volunteer, please visit LibriVox.org. Principles of Economics Book 5 by Alfred Marshall Chapter 13. Theory of changes of normal demand and supply in relation to the doctrine of maximum satisfaction In earlier chapters of this book, and especially in Chapter 12, we have considered gradual changes in the adjustment of demand and supply. But any great and lasting change in fashion, any substantive new invention, any diminution of population by war or pestilence, or the development or dwindling the way of a source of supply of the commodity in question, or of a raw material used in it, or of another commodity which is a rival and possible substitute for it, such a change as any of these may cause the prices set against any given annual or daily consumption and production of the commodity to cease to be its normal demand and supply prices for that volume of consumption and production, or in other words they may render it necessary to make out a new demand schedule or a new supply schedule or both of them. We proceed to study the problem thus suggested. An increase of normal demand for commodity involves an increase in the price at which each several amount can find purchasers, or, which is the same thing, an increase of the quantity which can find purchasers at any price. This increase of demand may be caused by the commodities coming more into fashion, by the opening out of a new use for it or of new markets for it, by the permanent falling off in the supply of some commodity for which it can be used as a substitute, by a permanent increase in the wealth and general purchasing power of the community, and so on. Changes in the opposite direction will cause a falling off in demand and a sinking of the demand prices. Similarly, an increase of normal supply means an increase of the amounts that can be supplied at each several price, and a diminution of the price at which each separate amount can be supplied. This change may be caused by the opening up of a new source of supply, whether by improved means of transport or in any other way, by an advance in the arts of production, such as the invention of a new process or of new machinery, or again by the granting of a bounty on production. Conversely, a diminution of normal supply or a raising of the supply schedule may be caused by the closing up of a new source of supply or by the imposition of attacks. We have then to regard the effects of an increase of normal demand from three points of view, according as the commodity in question obeys the law of constant or of diminishing or of increasing return, that is, its supply price is practically constant for all amounts, or increases or diminishes with an increase in the amount produced. In the first case, an increase of demand simply increases the amount produced without altering its price, for the normal price of a commodity which obeys the law of constant return is determined absolutely by its expenses of production. Demand has no influence in the matter beyond this, that the thing will not be produced at all unless there is some demand for it at this fixed price. If the commodity obeys the law of diminishing return, an increase of demand for it raises its price and causes more of it to be produced, but not so much more as if it obeyed the law of constant return. On the other hand, if the commodity obeys the law of increasing return, an increase of demand causes much more of it to be produced, more than if the commodity obeyed the law of constant return, and at the same time lowers its price. If, for instance, a thousand things of a weekly certain kind have been produced and sold weekly at a price of ten shillings, while the supply price for two thousand weekly would be only nine shillings, a small rate of increase in normal demand may gradually cause this to become the normal price, since we are considering periods long enough for the full normal action of the causes that determine supply to work itself out. The converse holds in each case should normal demand fall off instead of increasing. The argument of this section has been thought by some writers to lend support to the claim that a protective duty on manufactured imports in general increases the home market for those imports, and by calling into play the law of increasing return ultimately lowers their price to the home consumer. Such a result may indeed ultimately be reached by a wise chosen system of protection to nascent industries in a new country, where manufacturers like young children have a power of rapid growth. But even there the policy is apt to be wrenched from its proper uses to the enrichment of particular interests. For those industries which can send the greatest number of votes to the poll are those which are already on so large a scale that a further increase would bring very few new economies. And of course the industries in a country so long familiar with machinery as England is have generally passed the stage at which they can derive much real help from such protection, while protection to any one industry nearly always tends to narrow the markets, especially the foreign markets for other industries. These few remarks show that the question is complex. They do not pretend to reach further than that. We have seen that an increase in normal demand while leading in every case to an increased production will in some cases raise and in others lower prices. But now we are to see that increased facilities for supply causing the supply schedule to be lowered will always lower the normal price at the same time that it leads to an increase in the amount produced. For so long as the normal demand remains unchanged an increased supply can only be sold at a diminished price. But the fall of price consequent on a given increase of supply will be much greater in some cases than in others. It will be small if the commodity obeys the law of diminishing return because then the difficulties attendant on an increased production will tend to counteract the new facilities of supply. On the other hand if the commodity obeys the law of increasing return the increased production will bring with it increased facilities which will cooperate with those arising from the change in the general conditions of supply and the two together will enable a great increase in production and consequent fall in price to be attained before the fall of the supply price is overtaken by the fall of the demand price. If it happens that the demand is very elastic then a small increase in the facilities of normal supply such as a new invention a new application of machinery the opening up of new and cheaper sources of supply the taking off attacks or granting a bounty may cause an enormous increase of production and fall of price. If we take account of the circumstances of composite and joint supply and demand discussed in Chapter 6 we have suggested to us an almost endless variety of problems which can be worked out by the methods adopted in these two chapters. We may now consider the effects which a change in the conditions of supply may exert on consumers surplus or rent. For brevity of language attacks may be taken as representative of those changes which may cause a general increase and a bounty as representative of those which may cause a general diminution in the normal supply price for each several amount of the commodity. Firstly if the commodity is one the production of which obeys the law of constant return so that the supply price is the same for all amounts of the commodity consumers surplus will be diminished by more than the increased payments to the producer and therefore in the special case of attacks by more than the gross receipts of the state. For on that part of the consumption of commodity which is maintained the consumer loses what the state receives and on that part of the consumption which is destroyed by the rise in price the consumers surplus is destroyed and of course there is no payment for it to the producer or to the state. Conversely the gain of consumers surplus caused by a bounty on a commodity that obeys the law of constant return is less than the bounty itself. For on that part of the consumption which existed before the bounty consumers surplus is increased by just the amount of the bounty while on the new consumption that is caused by the bounty the gain of the consumers surplus is less than the bounty. If however the commodity obeys the law of diminishing return attacks by raising its price and diminishing its consumption will lower its expenses of production other than the tax and the result will be to raise the supply price by something less than the full amount of the tax. In this case the gross receipts from the tax may be greater than the resulting loss of consumers surplus and they will be greater if the law of diminishing return acts so sharply that a small diminution of consumption causes a great falling off in the expenses of production other than the tax. On the other hand a bounty on a commodity which obeys the law of diminishing return will lead to increased production and will extend the margin of cultivation to places and conditions in which the expenses of production exclusive of the bounty are greater than before. Thus it will lower the price to the consumer and increase consumers surplus less than if it were given for the production of a commodity which obeyed the law of constant return. In that case the increase of consumers surplus was seen to be less than the direct cost of the bounty to the state and therefore in this case it is much less. By similar reasoning it may be shown that a tax on a commodity which obeys the law of increasing return is more injurious to the consumer than if levied on one which obeys the law of constant return for it lessens the demand and therefore the output. It thus probably increases the expenses of manufacturers somewhat, sends up the price by more than the amount of the tax and finally diminishes consumers surplus by much more than the total payments which it brings into the X checker. On the other hand a bounty on such a commodity causes so great a fall in its price to the consumer that the consequent increase of consumers surplus may exceed the total payments made by the state to the producers and certainly will do so in case the law of increasing return acts at all sharply. These results are suggestive of some principles of taxation which require careful attention in any study of financial policy when it will be necessary to take account of the expenses of collecting a tax and of administering a bounty and of the many indirect effects some economic and some moral which attacks or bounty is likely to produce. But these partial results are well adapted for our immediate purpose of examining a little more closely than we have done hitherto the general doctrine that a position of stable equilibrium of demand and supply is a position also of maximum satisfaction and there is one abstract and trenchant form of that doctrine which has had more vogue especially since the time of Bastiat's economic harmonics and which falls within the narrow range of the present discussion. There is indeed one interpretation of the doctrine according to which every position of equilibrium of demand and supply may be fairly regarded as a position of maximum satisfaction. For it is true that so long as the demand prices in excess of the supply price exchanges can be affected at prices which give a surplus of satisfaction to buyer or to seller or to both. The marginal utility of what he receives is greater than that of what he gives up to at least one of the two parties while the other if he does not gain by the exchange yet does not lose by it. So far then every step in the exchange increases the aggregate satisfaction of the two parties but when equilibrium has been reached demand price being now equal to supply price there is no room for any such surplus. The marginal utility of what each receives no longer exceeds that of what he gives up in exchange and when the production increases beyond the equilibrium amount the demand price being now less than the supply price no terms can be arranged which will be acceptable to the buyer and will not involve a loss to the seller. It is true then that a position of equilibrium of demand and supply is a position of maximum satisfaction in this limited sense that the aggregate satisfaction of the two parties concerned increases until that position is reached and that any production beyond the equilibrium amount could not be permanently maintained so long as buyers and sellers acted freely as individuals each in his own interest. But occasionally it is stated and very often it is implied that a position of equilibrium of demand and supply is one of maximum aggregate satisfaction in the full sense of the term that is that an increase of production beyond the equilibrium level would directly i.e. independently of the difficulties of arranging for it and of any indirect evils it might cause diminish the aggregate satisfaction of both parties the doctrine so interpreted is not universally true in the first place it assumes that all differences in wealth between the different parties concerned may be neglected and that the satisfaction which is rated at a shilling by any one of them may be taken as equal to one that is rated as a shilling by any other now it is obvious that if the producers were as a class very much poorer than the consumers the aggregate satisfaction might be increased by a stinting of supply when it would cause a great rise in the demand price i.e. when the demand is an elastic and that if the consumers were as a class much poorer than the producers the aggregate satisfaction might be increased by extending the production beyond the equilibrium amount and selling the commodity at a loss this point however may well be left for future consideration it is in fact only a special case of the broad proposition that the aggregate satisfaction can prima facia be increased by the distribution whether voluntarily or compulsorily of some of the property of the rich among the poor and it is reasonable that the bearings of this proposition should be set aside during the first stages of an inquiry into existing economic conditions this assumption therefore may be properly made provided only it is not allowed to slip out of sight but in the second place the doctrine of maximum satisfaction assumes that every fall in the price which producers receive for the commodity involves a corresponding loss to them and this is not true of a fall in price which results from improvements in industrial organization when a commodity obeys the law of increasing return an increase in its production beyond equilibrium point may cause the supply price to fall much and though the demand price for the increased amount may be reduced even more so that the production would result in some loss to the producers yet this loss may be very much less than the money value of the gain to purchasers which is represented by the increase of consumers surplus in the case then of commodities with regard to which the law of increasing return acts at all sharply or in other words for which the normal supply price diminishes rapidly as the amount produced increases the direct expense of a bounty sufficient to call forth a greatly increased supply at a much lower price would be much less than the consequent increase of consumers surplus and if a general agreement could be obtained among consumers terms might be arranged which would make such action amply remunerative to the producers at the same time that they left a large balance of advantage to the consumers one simple plan would be the levying of a tax by the community on their own incomes or on the production of goods which obey the law of diminishing return and devoting the tax to a bounty on the production of those goods with regard to which the law of increasing return acts sharply but before deciding on such a course they would have to take account of considerations which are not within the scope of the general theory now before us but are yet of great practical importance to reckon up the direct and indirect costs of collecting a tax and administering a bounty the difficulty of securing that the burdens of the tax and the benefits of the bounty were equitably distributed the openings for fraud and corruption and the danger that in the trade which had got a bounty and in other trades which hoped to get one people would divert their energies from managing their own businesses to managing those persons who control the bounties besides these semi-ethical questions there will arise others of a strictly economic nature relating to the effects which any particular tax or bounty may exert on the interests of landlords, urban or agricultural who own land adapted for the production of the commodity in question these are questions which must not be overlooked but they differ so much in their detail that they cannot fitly be discussed here enough has been said to indicate the character of the second great limitation which has to be introduced into the doctrine that the maximum satisfaction is generally to be attained by encouraging each individual to spend his own resources in that way which suits him best it is clear that if he spends his income in such a way as to increase the demand for the services of the poor and to increase their incomes he adds something more to the total happiness than if he adds an equal amount to the incomes of the rich because the happiness which an additional shilling brings to a poor man is much greater than that which it brings to a rich one and that he does good by buying things the production of which raises in preference to things the production which lowers the character of those who make them but further even if we assume that a shillings worth of happiness is of equal importance to whomever it comes and that every shillings worth of consumer surplus is of equal importance from whomever commodity it is derived we have to admit that the manner in which a person spends his income is a matter of direct economic concern to the community for insofar as he spends it on things which obey the law of diminishing return he makes those things more difficult to be obtained by his neighbors and thus lowers the real purchasing power of their incomes while insofar as he spends it on things which obey the law of increasing return he makes those things more easy of attainment to others and thus increases the real purchasing power of their incomes again it is commonly argued that an equal ad valorem tax leviton all economic commodities material and immaterial or which is the same thing a tax on expenditure is prima facia the best tax because it does not divert the expenditure of individuals out of its natural channels we have now seen that this argument is invalid but ignoring for the time the fact that the direct economic effect of a tax or bounty never constitutes the whole and very often not even the chief part of the considerations which have to be weighed before deciding to adopt it we have found firstly that a tax on expenditure generally causes a greater destruction of consumer surplus than one levied exclusively on commodities as to which there is but little room for the economies of production on a large scale and which obey the law of diminishing return and secondly that it might even be for the advantage of the community that the government should levy taxes on commodities which obey the law of diminishing return and devote part of the proceeds to bounties on commodities which obey the law of increasing return these conclusions it will be observed do not by themselves afford a valid ground for government interference but they show that much remains to be done by a careful collection of the statistics of demand and supply and a scientific interpretation of their results in order to discover what are the limits of the work that society can with advantage do towards turning the economic actions of individuals into those channels in which they will add the most to the sum total of happiness end of chapter 13 chapter 14 of principles of economics book 5 this is a LibriVox recording all LibriVox recordings are in the public domain for more information or to volunteer please visit LibriVox.org principles of economics book 5 by Alfred Marshall chapter 14 the theory of monopolies it has never been supposed that the monopolist in seeking his own advantage is naturally gilded in that course which is most conducive to the well-being of society regarded as a whole he himself being reckoned as of no more importance than any other member of it the doctrine of maximum satisfaction has never been applied to the demand for and supply of monopolized commodities but there is much to be learned from a study of the relations in which the interests of the monopolist stand to those of the rest of society and of the general conditions under which it might be possible to make arrangements more beneficial to society as a whole than those which he would adopt if he consulted only his own interests and with this end in view we are now to seek for a scheme for comparing the relative quantities of the benefits which may accrue to the public and to the monopolist from the adoption of different courses of action by him in a later volume a study will be made of the protean shapes of modern trade combinations and monopolies some of the most important of which as for example trusts are a very recent growth at present we consider only those general causes determining monopoly values that can be traced with more or less distinctness in every case which a single person or association of persons has the power of fixing either the amount of a commodity that is offered for sale or the price at which it is offered the prima facia interest of the owner of a monopoly is clearly to adjust the supply to the demand not in such a way that the price at which he can sell his commodity shall just cover its expenses of production but in such a way as to afford him the greatest possible total net revenue but here we meet with a difficulty as to the meaning of the term net revenue for the supply price of a freely produced commodity includes normal profits the whole of which or at all events what remains of them after deducting interest on the capital employed and insurance against loss is often classed indiscriminately as net revenue and when a man manages his own business he often does not distinguish carefully that portion of his profits which really is his own earnings of management from any exceptional gains arising from the fact that the business is to some extent of the nature of a monopoly this difficulty however is in a great measure avoided in the case of a public company where all or nearly all the expenses of management are entered in the ledger as definite sums and are subtracted from the total receipts of the company before its net income is declared the net income divided among the shareholders includes interest on the capital invested and insurance against risk of failure but little or no earnings of management so that the amount by which the dividends are in excess of what may fairly be allowed as interest in insurance is the monopoly revenue which we are seeking since then it is much easier to specify exactly the amount of this net revenue when a monopoly is owned by a public company then when it is owned by an individual or private firm let us take as a typical instance the case of a gas company that has the monopoly of the supply of gas to a town for the sake of simplicity the company base be supposed to have already invested the whole of its own capital in a fixed plant and to borrow any more capital that it may want to extend its business on debentures at a fixed rate of interest the demand schedule for gas remains the same as it would be if gas were freely produced commodity it specifies the price per thousand feet at which consumers in the town will among them use any given number of feet but the supply schedule must represent the normal expenses of production of each several amount supplied and these include interest on all its capital whether belonging to its shareholders or borrowed on debentures at a fixed normal rate they include also the salaries of its directors and permanent officials adjusted more or less accurately to the work required of them and therefore increasing with an increase in the output of gas a monopoly revenue schedule may then be constructed thus having set against each several amount of the commodity its demand price and its supply price estimated on the plan just described subtract each supply price from the corresponding demand price and set the residue in the monopoly revenue column against the corresponding amount of the commodity thus for instance if a thousand million feet could be sold annually at a price of three shillings per thousand feet and the supply price for this amount were two shillings nine pence per thousand feet the monopoly revenue schedule would show three pence against this amount indicating an aggregate net revenue when this amount was sold of three million pence or twelve thousand five hundred pounds the aim of the company having regard only to their immediate dividends will be to fix the price of their gas at such a level as to make this aggregate net revenue the largest possible now suppose that a change takes place in the conditions of supply some new expense has to be incurred or some old expense can be avoided or perhaps a new tax is imposed on the undertaking or a bounty is awarded to it first let this increase or diminution of the expenses be a fixed sum bearing on the undertaking as one undivided whole and not varying with the amount of the commodity produced then whatever be the price charged and the amount of the commodity sold the monopoly revenue will be increased or diminished as the case may be by this sum and therefore that selling price which afforded the maximum monopoly revenue before the change will afford it afterwards the change therefore will not offer to the monopolist any inducement to alter his course of action suppose for instance that the maximum monopoly revenue is got when twelve hundred million cubic feet are sold annually and that this is done when the price is fixed at thirty pence per thousand feet suppose that the expenses of production for this amount are at the rate of twenty six pence leaving a monopoly revenue at the rate of four pence per thousand feet that is twenty thousand pounds in all this is its maximum value if the company fixed the price higher at say thirty one pence and sold only eleven hundred million feet they would perhaps get a monopoly revenue at the rate of four point two pence per thousand feet that is nineteen thousand two hundred fifty pounds in all while in order to sell thirteen hundred millions they would have to lower their price to say twenty eight pence and would get a monopoly revenue at the rate of perhaps three times six pence per thousand feet that is nineteen thousand five hundred pounds in all thus by fixing the price at thirty pence they get seven hundred fifty more pounds than by fixing it at thirty one pence and five hundred more pounds than by fixing it at twenty eight pence now let a tax of ten thousand pounds a year be levied on the gas company as a fixed sum independent of the amount they sell their monopoly revenue will become ten thousand pounds if they charge thirty pence nine thousand two hundred fifty pounds if they charge thirty one pence and nine thousand five hundred pounds if they charge twenty eight pence they will therefore continue to charge thirty pence the same is true of a tax or bounty proportioned not to the gross receipts of the undertaking but to its monopoly revenue for suppose next that a tax is levied not of one fixed sum but a certain percentage say fifty percent of the monopoly revenue the company will then retain a monopoly revenue of ten thousand pounds if they charge thirty pence of nine thousand six hundred twenty five pounds if they charge thirty one pence and of nine thousand seven hundred fifty pounds if they charge twenty eight pence they will therefore still charge thirty pence on the other hand a tax proportional to the amount produced gives an inducement to the monopolist to lessen his output and raise his price for by so doing he diminishes his expenses and the excess of total receipts over total outlay may therefore be now increased by diminution of output though before the imposition of the tax it would have been lessened further if before the imposition of the tax the net revenue was only a little greater than that which would have been afforded by much smaller sales then the monopolist would gain by reducing his production very greatly and hence in such cases as this the change is likely to cause a very great diminution of production and rise of price the opposite effects will be caused by a change which diminishes the expense of working the monopoly by a sum that varies directly with the amount produced under it in the last example for instance a tax of two pence on each thousand feet sold would have reduced the monopoly revenue of ten thousand eighty three pounds if the company charged thirty one pence per thousand feet and therefore sold eleven hundred millions to ten thousand pounds if they charged thirty pence and therefore sold twelve hundred millions and to eight thousand six hundred sixty six if they charged twenty eight pence and therefore sold thirteen hundred million feet therefore the tax would induce the company to raise the price to something higher than thirty pence they would perhaps go to thirty one pence and perhaps somewhat higher for the figures used before us do not show exactly how far it would be their interest to go on the other hand if there were a bounty of two pence on the sale of each thousand feet the monopoly revenue would rise to twenty eight thousand four hundred sixteen if they charged thirty one pence to thirty thousand if they charged thirty pence and to thirty thousand three hundred thirty three if they charged twenty eight pence it would therefore cause them to lower the price and of course the same result would follow from an improvement in the method of making gas which lowered its cost of production to the monopolist company by two pence per one thousand feet the monopolist would lose all his monopoly revenue if he produced for sale an amount so great that its supply price as here defined was equal to its demand price the amount which gives the maximum monopoly revenue is always considerably less than that it may therefore appear as though the amount produced under a monopoly is always less and its price to the consumer always higher than if there were no monopoly this is not the case for when the production is all in the hands of one person or company the total expenses involved are generally less than would have to be incurred if the same aggregate production were distributed among a multitude of comparatively small rival producers they would have to struggle with one another for the attention of consumers and would necessarily spend in the aggregate a great deal more on advertising in all its various forms than a single firm would and they would be less able to avail themselves of the many various economies which result from production on a large scale in particular they could not afford to spend as much on improving methods of production and the machinery used in it as a single large firm which knew that it was certain itself to reap the whole benefit of any advance it made this argument does indeed assume the single firm to be managed with ability and enterprise and to have an unlimited command of capital an assumption which cannot always be fairly made but where it can be made we may generally conclude that the supply schedule for the commodity if not monopolized would show higher supply prices than those of our monopoly supply schedule and therefore the equilibrium amount of the commodity produced under free competition would be less than that for which the demand price is equal to the monopoly supply price one of the most interesting and difficult applications of the theory of monopolies is to the question whether the public interest is best served by the allotment of a distinct basin to each railway and excluding competition there for the proposal it is urged that a railway can afford to carry two million passengers or tons of goods cheaper than one million and that a division of the public demand between two lines will prevent either of them from offering a cheap surface it must be admitted that other things being equal the monopoly revenue price fixed by a railway will be lowered by every increase in the demand for its services and vice versa but human nature being what it is experience has shown that the breaking of a monopoly by the opening out of competing line accelerates rather than retards the discovery by the older line that it can afford to carry traffic at lower rates there still remains the suggestion that after a while the railways will combine and charge the public with the expense wasted on duplicating the services but this again only opens out new matters of controversy the theory of monopolies starts rather than solves practical issues such as these and we must defer their study so far we have supposed the owner of a monopoly to fix the price of his commodity with exclusive reference to the immediate net revenue which he can derive from it but in fact even if he does not concern himself with the interest of the consumers he is likely to reflect that the demand for a thing depends in a great measure on people's familiarity with it and that if he can increase his sales by taking a price a little below that which would afford him the maximum net revenue the increased use of his commodity will before long recoup him for his present loss the lower the price of gas the more likely people are to have it laid on to their houses and when once it is there they are likely to go on making some use of it even though a rival such as electricity or mineral oil may be competing closely with it the case is stronger when a railway company has a practical monopoly of the transport of persons and goods to a seaport or to a suburban district which is as yet but partly built over the railway company may then find it worthwhile as a matter of business to levy charges much below those which would afford the maximum net revenue in order to get merchants into the habit of using the port to encourage the inhabitants of the port to develop their docks and warehouses or to assist speculative builders in the new suburbs to build houses cheaply and to fill them quickly with tenants thus giving to the suburb an air of early prosperity which goes far towards ensuring its permanent success this sacrifice by a monopolist of part of his present gains in order to develop future business differs in extent rather than kind from the sacrifices which a young firm commonly makes in order to establish a connection in such cases as these a railway company though not pretending to any philanthropic motives yet finds its own interests so closely connected with those of the purchasers of its services that it gains by making some temporary sacrifice of net revenue with the purpose of increasing consumers surplus and an even closer connection between the interest of the producers and the consumers is found when the landowners of any district combine to make a branch railway through it without much hope that the traffic will afford the current rate of interest on the capital which they invest that is without much hope that the monopoly revenue of the railway as we have defined it will be other than a negative quantity but expecting that the railway will add so much to the value of their property as to make their venture on the whole a profitable one and when a municipality undertakes the supply of gas or water or facilities for transport by improved roads by new bridges or by tramways the question always arises whether the scale of charges should be high so as to afford a good net revenue and relieve the pressure on the rates or should be low so as to increase consumer surplus it is clear then that some study is wanted of calculations by which a monopolist should govern his actions and on the supposition that he regards an increase of consumer surplus as equally desirable to him if not with an equal increase of his own monopoly revenue yet with an increase say one half or one quarter is great if the consumers surplus which arises from the sale of the commodity at any price is added to the monopoly revenue derived from it the sum of the two is the money measure of the net benefits accruing from the sale of the commodity to producers and consumers together or as we may say the total benefit of its sale and if the monopolist regards again to the consumers as of equal importance with an equal gain to himself his aim will be to produce just that amount of the commodity which will make this total benefit a maximum but it will seldom happen that the monopolist can and will treat one pound of consumers surplus as equally desirable with one pound of monopoly revenue even a government which considers its own interests coincident with those of the people has to take account of the fact that if it abandons one source of revenue it must in general fall back on others which have their own disadvantages for they will necessarily involve friction and expense in collection together with some injury to the public of the kind which we have described as a loss of consumers surplus and they can never be adjusted with perfect fairness especially when account is taken of the unequal shares that different members of the community will get of the benefits for the sake of which it is proposed that the government should forgo some of its revenue suppose then that the monopolist makes a compromise and reckons one pound of consumers surplus as equivalent to say ten shillings of monopoly revenue let him calculate the monopoly revenue to be got from selling his commodity at any given price and to it let him add one half of the corresponding consumers surplus the sum of the two may be called the compromise benefit and his aim will be to fix on that price which will make the compromise benefit as large as possible the following general results are capable of exact proof but on a little consideration they will appear so manifestly true as hardly to require proof firstly the amount which the monopolist will offer for sale will be greater and the price at which he will sell it will be less if he is to any extent desirous to promote the interest of consumers then if his sole aim is to obtain the greatest possible monopoly revenue and secondly the amount produced will be greater and the selling price will be less the greater be the desire of the monopolist to promote the interest of consumers i.e. the larger be the percentage of its actual value at which he counts in consumers surplus with his own revenue not many years ago it was commonly argued that an English ruler who looks upon himself as the minister of the raise he rules is bound to take care that he impresses their energies in no work that is not worth the labor that is spent upon it or to translate the sentiment into planar language that he engages in nothing that will not produce an income sufficient to defray the interest on its cost such phrases as this may sometimes have meant little more than that a benefit which consumers were not willing to purchase at a high price and on a large scale was likely to exist for the greater part only in the specious councils of those who had some personal interest in the proposed undertakings but probably they more often indicated a tendency to underestimate the magnitude of that interest which consumers have in a low price and which we call consumers surplus one of the chief elements of success in private business is the faculty of weighing the advantages and disadvantages of any proposed course and of assigning them their true relative importance he who by practice and genius has acquired the power of attributing to each factor its right quantity is already well on the way to fortune and the increase in the efficiency of our productive forces is in great measure due to the large number of able minds who are devoting themselves ceaselessly to acquiring these business instincts but unfortunately the advantages thus weighed against one another are nearly all regarded from one point of view that of the producer and there are not many who concern themselves to weigh against one another the relative quantities of the interest which the consumers and the producers have in different courses of action for indeed the requisite facts come within the direct experience of only a very few persons and even in the case of those few only to a very limited extent and in a very imperfect way moreover when a great administrator has acquired those instincts with regard to public interests which able businessmen have with regard to their own affairs he is not very likely to be able to carry his plans with a free hand at all events in a democratic country no great public undertaking is secure of being sustained on consistent lines of policy unless its advantages can be made clear not only to the few who have direct experience of high public affairs but also to the many who have no such experience and have to form their judgment on the materials set before them by others judgments of this kind must always be inferior to those which enable business man forms by the aid of instincts based on long experience with regard to his own business but they may be made much more trustworthy than they are at present if they can be based on statistical measures of the relative quantities of the benefits and the injuries which different courses of public action are likely to cause to the several classes of the community much of the failure and much of the injustice in which the economic policies of governments have resulted have been due to the want of statistical measurement a few people who have been strongly interested on one side have raised their voices loudly persistently and all together while little has been heard from the great mass of people whose interests have lain in the opposite direction for even if their attention has been fairly called to the matter few have cared to exert themselves much for a cause in which no one of them has more than a small stake the few therefore get their way although if statistical measures of the interest involved were available it might prove that the aggregate of the interest of the few was only a tenth or a hundredth part of the aggregate of the interest of the silent many no doubt statistics can be easily misinterpreted and are often very misleading when first applied to new problems but many of the worst fallacies involved in the misapplications of statistics are definite and can be definitely exposed till at last no one ventures to repeat them even when addressing an instructed audience and on the whole arguments which can be reduced statistical forms though still in a backward condition are making more sure and more rapid advances than any others towards obtaining the general acceptance of all who have studied the subjects to which they refer the rapid growth of collective interests and the increasing tendency towards collective action in economic affairs make it every day more important that we should know what quantitative measures of public interests are most needed and what statistics are required for them and that we should set ourselves to obtain these statistics it is perhaps not unreasonable to hope that as time goes on the statistics of consumption will be so organized as to afford demand schedules sufficiently trustworthy to show in diagrams that will appeal to the eye the quantities of consumer surplus that will result from different courses of public and private action by the study of these pictures the mind may be gradually trained to get juster notions of the relative magnitudes of the interests which the community has in various schemes of public and private enterprise and sounder doctrines may replace those traditions of an earlier generation which had perhaps a wholesome influence in their time but which damped social enthusiasm by throwing suspicion on all projects for undertakings by the public on its own behalf which would not show a balance of direct pecuniary profit the practical bearings of many of the abstract reasonings in which we have recently been engaged will not be fully apparent till we approach the end of this treatise but there seem to be advantages in introducing them this early partly because of their close connection with the main theory of equilibrium of demand and supply and partly because they throw sidelights on the character and the purposes of that investigation of the causes which determine distribution on which we are about to enter so far it has been assumed that the monopolist can buy and sell freely but in fact monopolistic combinations in one branch of industry foster the growth of monopolistic combinations in those which have occasion to buy from or sell to it and the conflicts and alliances between such associations play a role of ever increasing importance in modern economics abstract reasoning of a general character has little to say on the subject if two absolute monopolies are complementary so that neither can turn its products to any good account without the other's aid there is no means of determining where the price of the ultimate product will be fixed thus if we supposed following Kornot's lead that copper and zinc were each of them useless except when combined to make brass and if we suppose that one man A. owned all the available sources of supply of copper while another B. owned all those of zinc there would then be no means of determining beforehand what amount of brass would be produced nor therefore the price at which it could be sold each would try to get the better of the other in bargaining and though the issue of the contest would greatly affect the purchasers they would not be able to influence it under the conditions supposed A. could not count on reaping the whole nor even any share at all of the benefit from increasing sales that would be got by lowering the price of copper in a market in which the price of zinc was fixed by natural causes rather than strategical higgling and bargaining four if he reduced his price B. might take the action as a sign of commercial weakness and raise the price of zinc thus causing A. to lose both on price and on amount sold each would therefore be tempted to bluff the other and consumers might find that less brass was put on the market and that therefore a higher price could be expected for it then if a single monopolist owned the whole supplies both of copper and of zinc for he might see his way to gaining in the long run by a low price which stimulated consumption but neither A nor B could reckon on the effects of his own action unless the two came together and agreed on a common policy that is unless they made a partial and perhaps temporary fusion of their monopolies on this ground and because monopolies are likely to disturb allied industries it may be reasonably urged that the public interest generally requires that complimentary monopolies should be held in a single hand but there are other considerations of perhaps greater importance on the other side for in real life there are scarcely any monopolies as absolute and permanent as that just discussed on the contrary there is in the modern world an ever increasing tendency towards the substitution of new things and new methods for old which are not being developed progressively in the interest of consumers and the direct or indirect competition thus brought to bear is likely to weaken the position of one of the complimentary monopolies more than the other for instance if there be only one factory for spinning and only one for weaving in a small isolated country it may be for the time to the public interest that the two should be in the same hands but the monopoly so established would be much harder to shake than would either half of it separately for a new venturer might push his way into the spinning business and compete with the old spinning mill for the custom of the old weaving sheds consider again a through route partly by rail and partly by sea between two great centers of industry if competition on either half of the route were permanently impossible it would probably be to the public interest that the ships and the railway line should be in the same hands but as things are no such general statement can be made under some conditions it is more to the public interest that they should be in one hand under others and those perhaps the conditions that occur the more frequently it is in the long run to the public interest that they should remain in different hands similarly the prima facia arguments in favor of the fusion of monopolistic cartels or other associations in the industry though often plausible and even strong will generally be found on closer examination to be treacherous they point to the removal of prominent social and industrial discords but at the probable expense of larger and more enduring discords in the future end of chapter 14