 Book 5, Chapter 1 of Principles of Economics. Principles of Economics by Alfred Marshall. Book 5, General Relations of Demand, Supply and Value. Chapter 1, Introductory on Markets. A business firm grows and attains great strength, and afterwards perhaps stagnates and decays, and at the turning point there is a balancing or equilibrium of the forces of life and decay. The latter part of Book 4 has been chiefly occupied with such balancing of forces in the life and decay of a people, or of a method of industry or trading. And as we reach the higher stages of our work, we shall need ever more and more to think of economic forces as resembling those which make a young man grow in strength till he reaches his prime, after which he gradually becomes stiff and inactive, till at last he sinks to make room for other and more vigorous life. But to prepare the way for this advanced study, we want first to look at a simpler balancing of forces, which corresponds rather to the mechanical equilibrium of a stone hanging by an elastic string, or of a number of balls resting against one another in a basin. We have now to examine the general relations of demand and supply, especially those which are connected with that adjustment of price by which they are maintained in equilibrium. This term is in common use, and may be used for the present without special explanation, but there are many difficulties connected with it, which can only be handled gradually, and indeed they will occupy our attention during a great part of this book. Illustrations will be taken now from one class of economic problems and now from another, but the main course of the reasoning will be kept free from assumptions which specially belong to any particular class. Thus it is not descriptive, nor does it deal constructively with real problems, but it sets out the theoretical backbone of our knowledge of the causes which govern the idea, and thus prepares the way for the construction which is to begin in the following book. It aims not so much at the attainment of knowledge, as at the power to obtain and arrange knowledge with regard to two opposing sets of forces, those which impale man to economic efforts and sacrifices, and those which hold him back. We must begin with a short and provisional account of markets, for that is needed to give precision to the ideas in this and the following books, but the organisation of markets is intimately connected both as cause and effect with money, credit and foreign trade. A full study of it must therefore be deferred to a later volume, where it will be taken in connection with commercial and industrial fluctuations, and with combinations of producers and of merchants, of employers and employed. When demand and supply are spoken of in relation to one another, it is of course necessary that the markets to which they refer should be the same. As Cournot says, "...economists understand by the term market not any particular marketplace in which things are bought and sold, but the whole of the region in which buyers and sellers are in such free intercourse with one another that the prices of the same goods tend to equality easily and quickly." End quote Footnote Recherche sur les principes mathématiques de la théorie des richesses Chapter 4 End footnote Or again, as Jevons says, "...originally a market was a public place in a town where provisions and other objects were exposed for sale, but the word has been generalised, so as to mean any body of persons who are in intimate business relations and carry on extensive transactions in any commodity. A great city may contain as many markets as there are important branches of trade, and these markets may or may not be localised. The central point of a market is the public exchange, mart, or auction rooms, where the traders agree to meet and transact business. In London, the stock market, the corn market, the coal market, the sugar market, and many others are distinctly localised. In Manchester, the cotton market, the cotton waste market, and others. But this distinction of locality is not necessary. The traders may be spread over a whole town or region of country, and yet make a market if they are by means of fares, meetings, published price lists, the post office, or otherwise, in close communication with each other." End quote Footnote Thus the more nearly perfect a market is, the stronger is the tendency for the same price to be paid for the same thing at the same time in all parts of the market. But of course, if the market is large, allowance must be made for the expense of delivering the goods to different purchasers, each of whom must be supposed to pay in addition to the market price a special charge on account of delivery. Footnote Thus it is common to see the prices of bulky goods quoted as delivered free on board, FOB. Any vessel in a certain port, each purchaser having to make his own reckoning for bringing the goods home. End footnote Section 3 In applying economic reasonings in practice it is often difficult to ascertain how far the movements of supply and demand in any one place are influenced by those in another. It is clear that the general tendency of the telegraph, the printing press, and steam traffic is to extend the area over which such influences act and to increase their force. The whole western world may in a sense be regarded as one market for many kinds of stock exchange securities, for the more valuable metals, and to a less extent for wool and cotton and even wheat. Proper allowance being made for expenses of transport, in which may be included taxes levied by any customs houses through which the goods have to pass. For in all these cases, the expenses of transport, including customs duties, are not sufficient to prevent buyers from all parts of the western world from competing with one another for the same supplies. There are many special causes which may widen or narrow the market of any particular commodity, but nearly all those things for which there is a very wide market are in universal demand and capable of being easily and exactly described. Thus for instance, cotton, wheat and iron satisfy once that are urgent and nearly universal. They can be easily described so that they can be bought and sold by persons at a distance from one another and at a distance also from the commodities. If necessary samples can be taken of them which are truly representative and they can even be graded, as is the actual practice, with regard to grain in America by an independent authority, so that the purchaser may be secure that what he buys will come up to a given standard, though he has never seen a sample of the goods which he is buying and perhaps would not be able himself to form an opinion on it, if he did. Footnote Thus the managers of a public or private elevator receive grain from a farmer, divide it into different grades and return to him certificates for as many bushels of each grade as he has delivered. His grain is then mixed with those of other farmers. His certificates are likely to change hands several times before they reach a purchaser who demands that the grain should be actually delivered to him, and little or none of what the purchaser receives may have come from the farm of the original recipient of the certificate. End footnote Commodities for which there is a very wide market must also be such as will bear a long carriage. They must be somewhat durable, and their value must be considerable in proportion to their bulk. A thing which is so bulky that its price is necessarily raised very much when it is sold far away from the place in which it is produced, must as a rule have a narrow market. The market for common bricks, for instance, is practically confined to the near neighborhood of the kilns in which they are made. They can scarcely ever bear a long carriage by land to a district which has any kilns of its own. But bricks of certain exceptional kinds have markets extending over a great part of England. Section 4 Let us then consider more closely the markets for things which satisfy in an exceptional way these conditions of being in general demand cognisable and portable. They are, as we have said, stock exchange securities and the more valuable metals. Any one share or bond of a public company, or any bond of a government, is of exactly the same value as any other of the same issue. It can make no difference to any purchaser which of the two he buys. Some securities, principally those of comparatively small mining, shipping and other companies, have a local knowledge and are not very easily dealt in except on the stock exchanges of provincial towns in their immediate neighborhood. But the whole of England is one market for the shares and bonds of a large English railway. In ordinary times a dealer will sell, say, Midland railway shares even if he has not them himself, because he knows they are always coming into the market and he is sure to be able to buy them. But the strongest case of all is that of securities which are called international because they are in request in every part of the globe. They are the bonds of the chief governments and of very large public companies such as those of the Suez Canal and the New York Central Railway. For bonds of this class the telegraph keeps prices at almost exactly the same level in all the stock exchanges of the world. If the price of one of them rises in New York or in Paris, in London or in Berlin, the mere news of the rise tends to cause a rise in other markets, and if for any reason the rise is delayed, that particular class of bonds is likely soon to be offered for sale in the high priced market under telegraphic orders from the other markets, while dealers in the first market will be making telegraphic purchases in other markets. These sales on the one hand and purchases on the other strengthen the tendency which the price has to seek the same level everywhere, and unless some of the markets are in abnormal condition the tendency soon becomes irresistible. On the stock exchange also a dealer can generally make sure of selling at nearly the same price as that at which he buys, and he is often willing to buy first class stocks at a half or a quarter or an eighth or in some cases even a sixteenth percent less than he offers in the same breath to sell them at. If there are two securities equally good but one of them belongs to a large issue of bonds and the other to a small issue by the same government, so that the first is constantly coming on the market and the latter but sell them, then the dealers will on this account alone require a larger margin between their selling price and their buying price in the latter case than in the former. In the case of shares of very small and little known companies, the difference between the price at which a dealer is willing to buy and that at which he will sell may amount to from five percent or more of the selling value. If he buys he may have to carry this security a long time before he meets with anyone who comes to take it from him, and meanwhile it may fall in value, while if he undertakes to deliver a security which he has not himself got and which does not come on the market every day he may be unable to complete his contract without much trouble and expense. End footnote. This illustrates well the great law that the larger the market for a commodity the smaller generally are the fluctuations in its price, and the lower is the percentage on the turnover which dealers charge for doing business in it. Stock exchanges then are the pattern on which markets have been and are being informed for dealing in many kinds of produce which can be easily and exactly described, a portable and in general demand. The material commodities however which possess these qualities in the highest degree are gold and silver. For that very reason they have been chosen by common consent for use as money to represent the value of other things. The world market for them is most highly organized and will be found to offer many subtle illustrations of the actions of the laws which we are now discussing. Section 5. At the opposite extremity to international stock exchange securities and the more valuable metals are firstly things which must be made to order to suit particular individuals such as well-fitting clothes, and secondly perishable and bulky goods such as fresh vegetables which can seldom be profitably carried long distances. The first can scarcely be said to have a wholesale market at all. The conditions by which their price is determined are those of retail buying and selling, and the study of them may be postponed. Footnote. A man may not trouble himself much about small retail purchases. He may give half a crown for a packet of paper in one shop, which he could have got for two shillings in another, but it is otherwise with wholesale prices. A manufacturer cannot sell a ream of paper for six shillings while his neighbor is selling it at five. For those whose business it is to deal in paper know almost exactly the lowest price at which it can be bought and will not pay more than this. The manufacturer has to sell at about the market price, that is, at about the price at which other manufacturers are selling at the same time. Footnote. There are indeed wholesale markets for the second class, but they are confined within narrow boundaries. We may find our typical instance in the sale of the commoner kinds of vegetables in a country town. The market gardeners in the neighborhood have probably to arrange for the sale of their vegetables to some townspeople with but little external interference on either side. There may be some check to extreme prices by the power on the one side of selling and on the other of buying elsewhere. But under ordinary circumstances the check is inoperative, and it may happen that the dealers in such a case are able to combine and thus fix an artificial monopoly price, that is, a price determined with little direct reference to cost of production but chiefly by a consideration of what the market will bear. On the other hand it may happen that some of the market gardeners are almost equally near a second country town and send their vegetables now to one and now to the other, and some people who occasionally buy in the first town may have equally good access to the second. The least variation in price will lead them to prefer the better market and thus make the bargainings in the two towns to some extent mutually dependent. It may happen that this second town is in close communication with London or some other central market, so that its prices are controlled by the prices in the central market, and in that case prices in our first town must also move to a considerable extent in harmony with them. As news passes from mouth to mouth till a rumour spreads far away from its forgotten sources, so even the most secluded market is liable to be influenced by changes of which those in the market have no direct cognizance. Changes that have had their origin far away and have spread gradually from market to market. Thus at the one extreme are world markets, in which competition acts directly from all parts of the globe, and at the other those secluded markets in which all direct competition from afar is shut out, though indirect and transmitted competition may make itself felt even in these, and about midway between these extremes lie the great majority of the markets which the Economist and the Businessman have to study. Section 6 Again markets vary with regard to the period of time which is allowed to the forces of demand and supply to bring themselves into equilibrium with one another, as well as with regard to the area over which they extend. And this element of time requires more careful attention just now than does that of space, so the nature of the equilibrium itself and that of the causes by which it is determined depend on the length of the period over which the market is taken to extend. We shall find that if the period is short the supply is limited to the stores which happen to be at hand. If the period is longer the supply will be influenced more or less by the cost of producing the commodity in question, and if the period is very long this cost will in its turn be influenced more or less by the cost of producing the labour and the material things required for producing the commodity. These three classes of course merge into one another by imperceptible degrees. We will begin with the first class and consider in the next chapter those temporary equilibria of demand and supply in which supply means in effect merely the stock available at the time for sale in the market, so that it cannot be directly influenced by the cost of production. End of Chapter 1 of Book 5. Chapter 2 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. Recording by Scott Sherris. Principles of Economics, Book 5 by Alfred Marshall. Temporary Equilibrium of Demand and Supply The simplest case of balance or equilibrium between desire and effort is found when a person satisfies one of his wants by his own direct work. When a boy picks blackberries for his own eating, the action of picking is probably itself pleasurable for a while, and for some time longer the pleasure of eating is more than enough to repay the trouble of picking. But after he has eaten a good deal, the desire for more diminishes, while the task of picking begins to cause weariness, which may indeed be a feeling of monotony rather than of fatigue. Equilibrium is reached when it lasts his eagerness to play and his disinclination for the work of picking counterbalance the desire for eating. The satisfaction which he can get from picking fruit has arrived at its maximum. For up to that time, every fresh picking has added more to his pleasure than it has taken away, and after that time any further picking would take away from his pleasure more than it would add. In a casual bargain that one person makes with another, as for instance when two back woodsmen barter a rifle for a canoe, there is seldom anything that can properly be called an equilibrium of supply and demand. There is probably a margin of satisfaction on either side, for probably the one would be willing to give something besides the rifle for the canoe if he could not get the canoe otherwise, while the other would in case of necessity give something besides the canoe for the rifle. It is indeed possible that a true equilibrium may be arrived at under a system of barter, but barter, though earlier in history than buying and selling, is in some ways more intricate, and the simplest cases of a true equilibrium value are found in the markets of a more advanced state of civilization. We may put aside as of little practical importance a class of dealings which has been much discussed. They relate to pictures by old masters, rare coins and other things which cannot be graded at all. The price at which each is sold will depend much on whether any rich person with a fancy for it happened to be present at its sale. If not, it will probably be bought by dealers who reckon on being able to sell it at a profit, and the variations in the price for which the same picture sells at successive auctions, great as they are, would be greater still if it were not for the steadying influence of professional purchasers. Let us then turn to the ordinary dealings of modern life and take an illustration from a corn market in a country town, and let us assume for the sake of simplicity that all the corn in the market is of the same quality. The amount which each farmer or other seller offers for sale at any price is governed by his own need for money in hand, and by his calculation of the present and future conditions of the market with which he is connected. There are some prices which no seller would accept, some which no one would refuse. There are other intermediate prices which would be accepted for larger or smaller amounts by many or all of the sellers. Everyone will try to guess the state of the market and to govern his actions accordingly. Let us suppose that in fact there are not more than 600 quarters, the holders of which are willing to accept his lower price as 35 shillings, but that holders of another 100 would be tempted by 36 shillings, and holders of yet another 300 by 37 shillings. Let us suppose also that a price of 37 shillings would tempt buyers for only 600 quarters, while another 100 could be sold at 36 shillings, and yet another 200 at 35 shillings. These facts may be put out in a table thus. At the price 37 shillings, holders will be willing to sell 1000 quarters. Buyers will be willing to buy 600 quarters. At the price 36 shillings, holders will be willing to sell 700 quarters. Buyers will be willing to buy 700 quarters. At the price 35 shillings, holders will be willing to sell 600 quarters, and buyers will be willing to buy 900 quarters. Of course, some of those who are really willing to take 36 shillings rather than leave the market without selling will not show at once that they are ready to accept that price, and in like manner buyers will fence and pretend to be less eager than they really are. So the price may be tossed hither and thither like a shuttlecock as one side or the other gets the better in the higgling and bargaining of the market. But unless they are unequally matched, unless for instance one side is very simple or unfortunate in failing to gauge the strength of the other side, the price is likely to be never very far from 36 shillings. And it is nearly sure to be pretty close to 36 shillings at the end of the market. For if a holder thinks that the buyers will really be able to get at 36 shillings, all that they care to take at that price, he will be unwilling to let slip past him any offer that is well above that price. Buyers on their part will make similar calculations, and if at any time the price should rise considerably above 36 shillings, they will argue that the supply would be much greater than the demand at that price. Therefore, even those of them who would rather pay that price than go unserved wait, and by waiting, they help to bring the price down. On the other hand, when the price is much below 36 shillings, even those sellers who would rather take the price than leave the market with their corn and sold will argue that at that price, the demand will be in excess of the supply, so they will wait, and by waiting help to bring the price up. The price of 36 shillings has thus some claim to be called the true equilibrium price, because if it were fixed on at the beginning and adhered to throughout, it would exactly equate demand and supply. That is, the amount which buyers were willing to purchase at that price would be just equal to that for which sellers were willing to take that price. And because every dealer who has a perfect knowledge of the circumstances of the market expects that price to be established. If he sees the price differing much from 36 shillings, he expects that a change will come before long, and by anticipating it, he helps to come quickly. It is not indeed necessary for our argument that any dealers should have a thorough knowledge of the circumstances of the market. Many of the buyers may perhaps underrate the willingness of the sellers to sell, with the effect that for some time, the price rules at the highest level at which any buyers can be found, and thus 500 quarters may be sold before the price sinks below 37 shillings. But afterwards, the price must begin to fall, and the result will still probably be that 200 more quarters will be sold, and the market will close on a price of about 36 shillings. For when 700 quarters have been sold, no seller will be anxious to dispose of any more, except at a higher price than 36 shillings. And no buyer will be anxious to purchase any more, except at a lower price than 36 shillings. In the same way, if the sellers had underrated the willingness of the buyers to pay a high price, some of them might begin to sell at the lowest price they would take, rather than have their corn left on their hands. And in this case, much corn might be sold at a price of 35 shillings, but the market would probably close on a price of 36 shillings, and a total sale of 700 quarters. In this illustration, there is a latent assumption, which is in accordance with the actual conditions of most markets, but which ought to be distinctly recognized in order to prevent its creeping into those cases in which it is not justifiable. We tacitly assumed that the sum which purchasers were willing to pay and which sellers were willing to take for the 700th quarter would not be affected by the question whether the earlier bargains had been made at a higher low price. We allowed for the diminution of the buyer's need of corn, its marginal utility to them, as the amount bought increased, but we did not allow for any appreciable change in their unwillingness to part with money, its marginal utility. We assumed that that would be practically the same whether the early payments had been at a higher low rate. This assumption is justifiable with regard to most of the market dealings with which we are practically concerned. When a person buys anything for his own consumption, he generally spends on it a small part of his total resources, while when he buys it for the purposes of trade, he looks to reselling it, and therefore his potential resources are not diminished. In either case, there is no appreciable change in his willingness to part with money. There may indeed be individuals of whom this is not true, but there are sure to be present some dealers with large stocks of money at their command, and their influence studies the market. The exceptions are rare and unimportant in markets for commodities, but in markets for labor they are frequent and important. When a workman is in fear of hunger, his need of money, its marginal utility to him, is very great, and if at starting, he gets the worst of the bargaining and is employed at low wages, it remains great, and he may go on selling his labor at a low rate. That is all the more probable, because while the advantage in bargaining is likely to be pretty well distributed between the two sides of a market for commodities, it is more often on the side of the buyers than on the side of the sellers in a market for labor. Another difference between a labor market and a market for commodities arises from the fact that each seller of labor has only one unit of labor to dispose of. There are two among many facts in which we shall find, as we go on, the explanation of much of that instinctive objection which the working classes have felt to the habit of some economists, particularly those of the employer class, of treating labor simply as a commodity and regarding the labor market as like every other market, whereas in fact the differences between the two cases, though not fundamental from the point of view of theory, are yet clearly marked and in practice often very important. The theory of buying and selling becomes therefore much more complex when we take account of the dependence of marginal utility on amount in the case of money, as well as of the commodity itself. The practical importance of this consideration is not very great, but a contrast is drawn in appendix F between barter and dealings in which one side of each exchange is in the form of general purchasing power. In barter, a person's stock of either commodity exchange needs to be adjusted closely to his individual wants. If his stock is too large, he may have no good use for it. If his stock is too small, he may have some difficulty in finding anyone who can conveniently give him what he wants and is also in need of that particular things of which he himself has a superfluity. But anyone who has the stock of general purchasing power can obtain anything he wants as soon as he meets with anyone who has a superfluity of that thing he needs not to hunt about till he comes across the double coincidence of a person who can spare what he wants and also wants what he can spare. Consequently, everyone, and especially a professional dealer, can afford to keep command over a large stock of money and can therefore make considerable purchases without depleting his stock of money or greatly altering its marginal value. End of Chapter 2. Recording by Scott Sherris, Atlanta, Georgia, USA. Chapter 3 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. Recording by Beth Ann. Principles of Economics, Book 5 by Alfred Marshall. Chapter 3, Equilibrium of Normal Demand and Supply. We have next to inquire what causes government supply prices, that is prices which dealers are willing to accept for different amounts. In the last chapter, we looked at the affairs of only a single day, and suppose the stocks offered for sale to be already in existence. But of course, these stocks are largely dependent on the amount of wheat sown in the preceding year. And that, in its turn, was largely influenced by the farmer's guesses as to the price which they would get for it this year. This is the point at which we will have to work in the present chapter. Even in the corn exchange as the country town on market day, the equilibrium price is affected by the calculations of the future relations of production and consumption. While in the leading corn markets of America and Europe, dealings for future delivery already predominate and are rapidly weaving into one web all the leading threads of trading corn throughout the whole world. Some of these dealings and futures are but incidents and speculative maneuvers. But in the main, they are governed by calculations of the world's consumption on the one hand and of the existing stocks and coming harvest in the northern and southern hemispheres on the other. Dealers take account of the area sown with each kind of grain and the forwardness and weight of the crops, of the supply of things which can be used as substitutes for grain, and of the things for which grain can be used as a substitute. Thus, when buying or selling barley, they take account of the supplies of such things as sugar, which can be used as substitutes for it in brewing, and again of all the various feeding stuffs, a scarcity of which might raise the value of barley for consumption on the farm. If it is thought that the growers of any kind of grain in any part of the world have been losing money and are likely to sell less for our future harvest, it is argued that prices are likely to rise as soon as the harvest comes into sight and its shortness is manifest to all. Anticipations of that rise exercise influence on the present sales for future delivery, and that in its turn influences cash prices so that these prices are indirectly affected by estimates of the expenses of producing further supplies. But in this and following chapters, we are especially concerned with movements of price ranging over still longer periods than those for which the most far-sighted dealers and futures generally make their reckoning. We have to consider the volume of production adjusting itself to the conditions of the market and the normal price being thus determined at the position of stable equilibrium of normal demand and normal supply. In this discussion, we shall have to make frequent use of terms cost and expenses of production and some provisional account of them must be given before proceeding further. We may revert to the analogy between the supply price and the demand price of a commodity. Assuming for the moment that the efficiency of production depends slowly upon the exertions of the workers, we saw that the price required to call forth the exertion necessary for producing any given amount of a commodity may be called the supply price for that amount with reference, of course, to the given unit of time. But now we have to take account of the fact that the production of a commodity generally requires many different kinds of labor and the use of capital in many forms. The exertions of all the different kinds of labor that are directly or indirectly involved in making it together with the assonances or rather the weightings required for saving the capital used in making it, all these efforts and sacrifices together will be called the real cost of production of the commodity. The sums of money that have to be paid for these efforts and sacrifices will be called either its money cost of production or for shortness its expenses of production. They are the prices which have to be paid in order to call forth an adequate supply of efforts and weightings that are required from making it or in other words, they are at supply price. Mill and some other economists have followed the practice of ordinary life in using the term cost of production in two senses, sometimes to signify the difficulty of producing a thing and sometimes to express the outlay of money that has to be incurred in order to induce people to overcome this difficulty and produce it. But by passing from one use of the term to the other without giving it explicit warning, they have led to many misunderstandings and much barren controversy. The attack on Mill's doctrine of cost of production in relation to value, which is made in Carine's leading principles, was published just after Mill's death and unfortunately his interpretation of Mill's words was generally accepted as authoritative because he was regarded as a follower of Mill. But in an article by the present writer on Mill's theory of value for Lightning Review, April 1876, it is argued that Carine's has mistaken Mill's meeting and had really not seen more but less of the truth than Mill had done. The expenses of production of any amount of a raw commodity may best be estimated with the references to the margin of production, at which no rent is paid, but this method of speaking has great difficulties with regard to commodities that obey the law of increasing return. It seemed best to note this point in passing. It will be fully discussed later on, chiefly in chapter 12. The analysis of the expenses of production of a commodity might be carried backward to any length but it has seldom worthwhile to go back very far. It is, for instance, often sufficient to take the supply prices of the different kinds of raw material used in any manufacturer as ultimate facts without analyzing these supply prices into the several elements of which they are composed. Otherwise, indeed, the analysis would never end. We may then arrange the things that are required for making a commodity into whatever groups are convenient and call them its factors of production. It's expenses of production when any given amount of it is produced are thus the supply price of the corresponding quantities of its factors of production. And the sum of these is the supply price of that amount of the commodity. The typical modern market is often regarded as that in which manufacturers sell goods to wholesale dealers at prices into which few trading expenses enter. But taking a broader view, we may consider that the supply price of a commodity is the price at which it will be delivered for sale to that group of persons whose demand for it we are considering, or in other words, in the market which we have in view. On the character of that market will depend how many trading expenses have to be reckoned to make up the supply price. We have already noticed that the economic use of the term production includes the production of new utilities by moving a thing from a place in which it is less wanted to a place in which it is more wanted, or by helping consumers to satisfy their needs. For instance, the supply price of wood in the neighborhood of Canadian forests often consists almost exclusively of the price of the labor of lumbermen. But the supply price of the same wood in the wholesale London market consists in a large measure of freight. While its supply price to a small retail buyer in an English country town is more than half made up of the charges of the railways and middlemen who have brought what he wants to his doors and keep a stock of it ready for him. Again, the supply price of a certain kind of labor may, for some purposes, be divided up into the expenses of rearing, of general education and special trade education. The possible combinations are numberless and though each may have incidents of its own which will require separate treatment in a complete solution of any problem connected with it, yet all such incidents may be ignored so far as the general reasonings of this book are concerned. In calculating the expenses of production of a commodity, we must take account of the fact that the changes in the amounts produced are likely. Even when there is no new invention to be accompanied by changes in the relative quantities of its several factors of production. For instance, when the scale of production increases, horse or steam power is likely to be substituted for manual labor. Materials are likely to be bought from a greater distance and a greater quantities, thus increasing those expenses of production which correspond to the work of carriers, middlemen and traders of all kinds. As far as the knowledge and business enterprise of the producers reach, they in each case choose those factors of production which are best for their purpose. The sum of the supply prices of those factors which are used is, as a rule, less than the sum of the supply prices of any other set of factors which could be substituted for them. And whenever it appears to the producers that this is not the case, they will, as a rule, set to work to substitute the less expensive method. And further on we shall see how in a somewhat similar way society substitutes one undertaker for another who is less efficient in proportion to his charges. We may call this for convenience of reference, the principle of substitution. The applications of this principle extend over almost every field of economic inquiry. The position then is this. We are investigating equilibrium of normal demand and normal supply in their most general form. We are neglecting those features which are special to particular parts of economic science and are confining our attention to those broad relations which are common to nearly the whole of it. Thus we assume that the forces of demand and supply have free play, that there is no close combination among dealers on either side, but each acts for himself and there is much free competition. That is, buyers generally compete freely with buyers and sellers compete freely with sellers. But though everyone acts for himself, his knowledge of what others are doing is supposed to be generally sufficient to prevent him from taking a lower or paying a higher price than others are doing. This is assumed provisionally to be true both of finished goods and of their factors of production, of the higher of labor and of the borrowing of capital. We have already inquired to some extent and we shall have to inquire further how far these assumptions are in accordance with the actual facts of life. But meanwhile, this is the supposition on which we proceed. We assume that there is only one price in the market at one and the same time. If being understood that separate allowance is made when necessary for differences in the expense of delivering goods to dealers in different parts of the market, including allowance for the special expenses of retailing if it is a retail market. In such a market, there is a demand price for each amount of the commodity. That is, a price at which each particular amount of the commodity can find purchasers in a day or a week or a year. The circumstances which govern this price for any given amount of the commodity vary in character from one problem to another. But in every case, the more of a thing is offered for sale in a market, the lower is the price at which you'll find purchasers. Or in other words, the demand price for each bushel or yard diminishes every increase in the amount offered. The unit of time may be chosen according to the circumstances of each particular problem. It may be a day, a month, a year, or even a generation. But in every case, it must be short relatively to the period of the market under discussion. It is to be assumed that the general circumstances of the market remain unchanged throughout this period. And there is, for instance, no change in fashion or taste, no new substitute which might affect the demand, no new invention to disturb the supply. The conditions of normal supply are less definite and a full study of them must be reserved for later chapters. They will be found to vary in detail with the length of the period of time to which the investigation refers. Chiefly because both the material capital of machinery and other business plant and the immaterial capital of business skill and ability in organization are of slow growth and slow decay. Let us call to mind the representative firm whose economies of production, internal and external are dependent on the aggregate volume of production of the commodity that it makes. And postponing all further study of the nature of this dependence, let us assume that the normal supply price of any amount of that commodity may be taken to be its normal expenses of production, including gross earnings of management by that firm. That is, let us assume that this is the price, the expectation of which will just suffice to maintain the existing aggregate amount of production. Some firms meanwhile rising and increasing their output and others falling and diminishing theirs, with the aggregate production remaining unchanged. A price higher than this would increase the growth of the rising firms and slacken, though it might not arrest the decay of the falling firms with a net result of an increase in the aggregate production. On the other hand, a price lower than this would hasten the decay of the falling firms and slacken the growth of the rising firms and on the whole diminished production and a rise or fall of price would affect in like manner, though perhaps not in equal degree, those great joint stock companies, which often stagnate, but seldom die. To give definiteness to our ideas, let us take an illustration from the woolen trade. Let us suppose that a person well acquainted with the woolen trade sets himself to inquire what would be the normal supply price of a certain number of millions of yards annually of a particular kind of cloth. He would have to reckon, one, the price of the wool, coal, and other materials which would be used up in making it, two, wear and tear and depreciation of the building's machinery and another fixed capital, three, interest and insurance on all the capital, four, the wages of those who work in the factories, and five, the gross earnings of management, including insurance against loss, of those who undertake the risks, who engineer and superintend the working. He would, of course, estimate the supply prices of all these different factors of production of the cloth with reference to the amounts of each of them that would be wanted and on the supposition that the conditions of supply would be normal and he would add them all together to find the supply price of the cloth. Let us suppose a list of supply prices or a supply schedule made on a similar plan to that of our list of demand prices, the supply price of each amount of the commodity in a year or any other unit of time being written against that amount. As the flow or annual amount of the commodity increases, the supply price may either increase or diminish or it may even alternately increase and diminish. That is, a point moving along the supply curve towards the end may either rise or fall or even it may alternately rise and fall. In other words, the supply curve may be inclined positively or negatively or even at some points of its course it may be inclined positively and at others negatively. For if nature is offering a sturdy resistance to man's efforts to ring from her a larger supply of raw material, while at that particular stage there is no great room for introducing important new economies into the manufacturer. The supply price will rise but if the volume of production were greater it would perhaps be profitable to substitute largely machine work or hand work and steam power for muscular force. And the increase in the volume of production would have diminished the expenses of production of the commodity of our representative firm. But those cases in which the supply price falls as the amount increases involves special difficulties of their own and they are postponed to chapter 12 of this book. When therefore the amount produced in a unit of time is such that the demand price is greater than the supply price then sellers receive more than it's sufficient to make it worth their while to bring goods to market to that amount. And there is at work an active force tending to increase the amount brought forward for sell. On the other hand, when the amount produced is such that demand price is less than the supply price sellers receive less than it's sufficient to make it worth their while to bring goods to market on that scale. So that those who were just in the margin of doubt as to whether to go on producing are decided not to do so. And there is an active force at work tending to diminish the amount brought forward for sell. When the demand price is equal to the supply price the amount produced has no tendency either to be increased or to be diminished. It is an equilibrium. When demand and supplier in equilibrium the amount of the commodity which is being produced in a unit of time may be called the equilibrium amount and the price at which it is being sold may be called the equilibrium price. Such an equilibrium is stable. That is, the price it displays a little from it will tend to return as a pendulum oscillates about its lowest point. And it will be found to be a characteristic of stable equilibria that in them the demand price is greater than the supply price for amounts just less than the equilibrium amount and vice versa. For when the demand price is greater than the supply price the amount produced tends to increase. Therefore, if the demand price is greater than the supply price for amounts just less than an equilibrium amount then if the scale of production is temporarily diminished somewhat below that equilibrium amount it will tend to return. Thus the equilibrium is stable for displacements in that direction. If the demand price is greater than the supply price for amounts just less than the equilibrium amount it is sure to be less than the supply price for amounts just greater. And therefore if the scale of production is somewhat increased beyond the equilibrium position it will tend to return and the equilibrium will be stable for displacements in that direction also. When demand and supply are in stable equilibrium if any accident should move the scale of production from its equilibrium position there will be instantly brought into play forces tending to push it back to that position. Just as if a stone hanging by a string is displaced from its equilibrium position the force of gravity will at once tend to bring it back to its equilibrium position. The movements of the scale of production about its position of equilibrium will be of a somewhat similar kind. But in real life such oscillations are seldom as rhythmical as those of a stone hanging freely from a string. The comparison would be more exact if the string were supposed to hang in the troubled waters of a mill race whose stream was at one time allowed to flow freely and at another partially cut off. Nor are these complexities sufficient to illustrate all the disturbances which the economist and the merchant alike are forced to concern themselves. If the person holding the string sways his hand with movements partly rhythmic and partly arbitrary the illustration will not outrun the difficulties of some very real and practical problems of value. For indeed the demand and supply schedules do not in practice remain unchanged for a long time together but are constantly being changed and every change in them alters the equilibrium amount and the equilibrium price and thus gives new positions to the centers about which the amount and the price tend to oscillate. These considerations point to the great importance of the element of time in relation to demand and supply to the study of which we now proceed. We shall gradually discover a great many different limitations of the doctrine that the price at which a thing can be produced represents its real cost of production. That is the efforts and sacrifices which have been directly and indirectly devoted to its production. Four, in an age of rapid change such as this the equilibrium of normal demand and supply does not thus correspond to any distinct relation of a certain aggregate of pleasures got from the consumption of the commodity and an aggregate of efforts and sacrifices involved in producing it. The correspondence would not be exact even if normal earnings and interest were exact measures of the efforts and sacrifices for which they are the money payments. This is the real drift of that much quoted and much misunderstood doctrine of Adam Smith and other economists that the normal or natural value of a commodity is that which economic forces tend to bring about in the long run. It is the average value which economic forces would bring about if the general conditions of life were stationary for a run of time long enough to enable them all to work out their full effect. But we cannot foresee the future perfectly. The unexpected may happen and the existing tendencies may be modified before they have had time to accomplish what appears now to be their full and complete work. The fact that the general conditions of life are not stationary is the source of many of the difficulties that are met with in applying economic doctrines to practical problems. Of course, normal does not mean competitive. Market prices and normal prices are alike brought about by a multitude of influences of which some rest on a moral basis and some on a physical, of which some are competitive and some are not. It is to the persistence of the influences considered and the time allowed for them to work out their effects that we refer when contrasting market and normal price and again when contrasting the narrow and broader use of the term normal price. The remainder of the present volume will be chiefly occupied with interpreting and limiting this doctrine that the value of a thing tends in the long run to correspond to its cost of production. In particular, the notion of equilibrium which has been treated rather slightly in this chapter will be studied more carefully in chapters five and 12 of this book and some account of the controversy whether cost of production or utility governs value will be given in appendix one but it may be well to say a word or two here on this last point. We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper as whether value is governed by utility or cost of production. It is true that when one blade is held still and the cutting is affected by moving the other we may say with careless brevity that the cutting is done by the second but the state is not strictly accurate and it is to be excused only so long as it claims to merely a popular and not a strictly scientific account of what happens. In the same way when a thing already made has to be sold the price which people will be willing to pay for will be governed by the desire to have it together with the amount they can afford to spend on it. Their desire to have it depends partly on the chance that if they do not buy it they will be able to get another thing like it at as lower price. This depends on the causes that govern the supply of it and this again upon cost of production but it may so happen that the stock to be sold is practically fixed. This for instance is the case with the fish market in which the value of fish for the day is governed almost exclusively by the stock on the slabs in relation to the demand and if a person chooses to take the stock for granted and say that the price is governed by demand his brevity may perhaps be excused so long as he does not claim strict accuracy. So again it may be pardonable but it's not strictly accurate to say that the varying prices which the same rare book fetches when sold and resold at Christie's auction room are governed exclusively by demand. Taking a case of the opposite extreme we find some commodities which confirm pretty closely to the law constant return. That is to say their average cost of production will be very nearly the same whether they are produced in small quantities or in large. In such a case the normal level about which the market price fluctuates will be this definite and fixed money cost of production. If the demand happens to be great the market price will rise for a time above the level but as a result production will increase and the market price will fall and conversely if the demand falls for a time below its ordinary level. In such a case if a person chooses to neglect market fluctuations and to take it for granted that there will anyhow be enough demand for the commodity to ensure that some of it more or less will find purchasers at a price equal to this cost of production that he may be excused for ignoring the influence of demand and speaking of normal price as governed by cost of production provided only he does not claim scientific accuracy for the wording of his doctrine and explains the influence of demand in its right place. Thus we may conclude that as a general rule the shorter the period which we are considering the greater must be the share of our attention which is given to the influence of demand on value and the longer the period the more important will be the influence of cost of production on value for the influence of changes in cost of production takes as a rule a longer time to work itself out than does the influence of changes in demand. The actual value at any time the market value as it is often called is often more influenced by passing events and by causes whose action is fitful and short-lived than by those which work persistently. But in long periods these fitful and irregular causes in large measure efface one another's influence so that in the long run persistent causes dominate value completely even the most persistent causes are however liable to change for the whole structure of production is modified and the relative costs of production of different things are permanently altered from one generation to another. When considering costs from the point of view of the capitalist employer we of course measure them in money because his direct concern with the efforts needed for the work of his employees lies in the money payments he must make his concern with the real costs of their effort and of the training required for it is only indirect though a monetary assessment of his own labor is necessary for some problems as we'll be seeing later on. But when considering costs from the social point of view when inquiring whether the cost of attaining a given result is increasing or diminishing with changing economic conditions then we are concerned with the real costs of efforts of various qualities and with the real cost of waiting. If the purchasing power of money in terms of effort has remained about constant and if the rate of renumeration for waiting has remained about constant then the money measure of costs corresponds to the real costs but such a correspondence is never to be assumed lightly. These considerations will generally suffice for the interpretation of the term cost in what follows even where no distinct indication is given in the context. End of Chapter 3, Book 5 Chapter 4 of Principles of Economics, Book 5 This is the LibriVox recording. All LibriVox recordings are in the public domain. For more information or to volunteer please visit LibriVox.org Recording by IC Jumbo Principles of Economics, Book 5 by Alfred Marshall Chapter 4, The Investment and Distribution of Resources Section 1 The first difficulty to be cleared up in our study of normal values is the nature of the motives which govern the investment of resources for a distant return. It will be well to begin by watching the action of a person who neither buys what he wants nor sells what he makes but works on his own behalf and who therefore balances the efforts and sacrifices which he makes on the one hand against the pleasures which he expects to derive from their fruit on the other without the intervention of any money payments at all. Let us then take the case of a man who builds a house for himself on land and of materials which nature supplies gratis and who makes his implements as he goes the labour of making them being counted as part of the labour of building the house. He would have to estimate the efforts required for building on any proposed plan and to allow almost instinctively an amount increasing in geometrical proportion a sort of compound interest for the period that would elapse between each effort and the time when the house would be ready for his use. The utility of the house to him when finished would have to compensate him not only for the efforts but for the weightings. Footnote for he might have applied these efforts or efforts equivalent to them to producing immediate gratifications and if he deliberately chose the deferred gratifications it would be because even after allowing for the disadvantages of weighting he regarded them as outweighing the earlier gratifications which he could have substituted for them. The motive force then tending to deter him from building the house would be his estimate of the aggregate of these efforts the evil or discomodity of each being increased in geometrical proportion a sort of compound interest according to the corresponding interval of weighting. The motive on the other hand impaling him to build it would be expectation of the satisfaction which he would have from the house when completed and that again might be resolved into the aggregate of many satisfactions more or less remote and more or less certain which he expected to derive from its use if he thought that this aggregate of discounted values of satisfaction that it would afford him would be more than a recompense to him for all his efforts and weightings which he had undergone he would decide to build. End of footnote if the two motives one deterring the other impelling seemed equally balanced he would be on the margin of doubt probably the gain would much more than outweigh the real cost with regard to some part of the house but as he turned over more and more ambitious plans he would at last find the advantages of any further extension balanced by the efforts and weightings required for making it and that extension of the building would be on the outer limit or margin of profitableness of the investment of his capital. There would probably be several ways of building parts of the house some parts for instance might almost equally well be built of wood or of rough stones. The investment of capital on each plan for each part of the accommodation would be compared with the advantages offered thereby and each would be pushed forward till the outer limit or margin of profitableness had been reached. Thus there would be a great many margins of profitableness one corresponding to each kind of plan on which each kind of accommodation might be provided. This illustration may serve to keep before us the way in which the efforts and sacrifices which are the real cost of production of a thing underlie the expenses which are its money cost. But as has just been remarked the modern businessman commonly takes the payments which he has to make whether for wages or raw material as he finds them without staying to inquire how far they are an accurate measure of the efforts and sacrifices to which they correspond. His expenditure is generally made piecemeal and the longer he expects to wait for the fruit of any outlay the richer must that fruit be in order to compensate him. The anticipated fruit may not be certain and in that case he will have to allow for the risk of failure. After making that allowance the fruit of the outlay must be expected to exceed the outlay itself by an amount which independently of his own remuneration increases at compound interest in proportion to the time of waiting. Footnote, we may if we choose regard the price of the business undertaker's own work as part of the original outlay and reckon compound interest on it together with the rest or we may substitute for compound interest a sort of compound profit. The two courses are not strictly convertible and at a later stage we shall find that in certain cases the first is to be preferred and in others the second. End of footnote. Under this head are to be entered the heavy expenses direct and indirect which every business must incur in building up its connection. For brevity we may speak of any element of outlay allowance being made for the remuneration of the undertaker himself when increased by compound interest in this way as accumulated. Just as we use the term discounted to represent the present value of a future gratification. Each element of outlay has then to be accumulated for the time which will elapse between its being incurred and its bearing fruit and the aggregate of these accumulated elements is the total outlay involved in the enterprise. The balance between efforts and the satisfactions resulting from them may be made up to any day that is found convenient but whatever day is chosen one simple rule must be followed. Every element whether an effort or satisfaction which dates from a time anterior to that day must have compound interest for the interval accumulated upon it and every element which dates from a time posterior to that day must have compound interest for the interval discounted from it. If the day be anterior to the beginning of the enterprise then every element must be discounted but if as is usual in such cases the day be that when the efforts are finished and the house is ready for use then the efforts must carry compound interest up to that day and the satisfactions must all be discounted back to that day. Waiting is an element of cost as truly as effort is and it is entered in the cost when accumulated. It is therefore of course not counted separately. Similarly on the converse side whatever money or command over satisfaction comes in at any time is part of the income of that time. If the time is before the day for which accounts are balanced up then it must be accumulated up to that day. If after it must be discounted back. If instead of being converted to immediate enjoyment it is used as a stored up source of future income that later income must not be counted as additional return to the investment. Footnote. In the aggregate the income from the saving will in the ordinary course be larger in amount than the saving by the amount of the interest that is the reward of saving. But as it will be turned to account in enjoyment later than the original saving could have been it will be discounted for a longer period or accumulated for a shorter. And if entered in the balance sheet of the investment in place of the original saving it would stand for exactly the same sum. Both the original income which was saved and the subsequent income earned by it are assessed to income tax on grounds similar to those which make it expedient to levy a larger income tax from the industrious than from the lazy man. The main argument of this section is expressed mathematically in note 13. End of footnote. If the enterprise were say to dig out a dock basin on a contract the payment for which would be made without fail when the work was finished and if the plant used in the work might be taken to be worn out in the process and valueless at the end of it then the enterprise would be just remunerative if this aggregate of outlays accumulated up to the period of payment were just equal to that payment. But as a rule the proceeds of the sales come in gradually and we must suppose a balance sheet struck looking both backwards and forwards. Looking backwards we should sum up the net outlays and add in accumulated compound interest on each element of outlay. Looking forwards we should sum up all net incomeings and from the value of each subtract compound interest for the period during which it would be deferred. The aggregate of the net incomeings so discounted would be balanced against the aggregate of the accumulated outlays and if the two were just equal the business would be just remunerative. In calculating the outgoings the head of the business must reckon in the value of his own work. Footnote. Almost every trade has its own difficulties and its own customs connected with the task of valuing the capital that has been invested in a business and of allowing for the depreciation which that capital has undergone from wear and tear, from the influence of the elements, from new inventions, and from changes in the course of trade. These two last causes may temporarily raise the value of some kinds of fixed capital at the same time that they are lowering that of others. And people whose minds are cast in different modes or whose interests in the matter point in different directions will often differ widely on the question what part of the expenditure required for adapting buildings and plant to changing conditions of trade may be regarded as an investment of new capital, and what ought to be set down as charges incurred to balanced depreciation and treated as expenditure deducted from the current receipts before determining the net profits or true income earned by the business. These difficulties and the consequent differences of opinion are greatest of all with regard to the investment of capital in building up a business connection and the proper method of appraising the goodwill of a business or its value as a going concern. On the whole of this subject see Matheson's depreciation of factories and their valuation. Another group of difficulties arises from changes in the general purchasing power of money. If that has fallen, or in other words, if there has been a rise of general prices, the value of a factory may appear to have risen when it has really remained stationary. Confusions arising from this source introduce greater errors into the estimates of the real profitableness of different classes of business than would at first sight appear probable. But all questions of this kind must be deferred till we have discussed the theory of money. End of footnote. Section 3 At the beginning of his undertaking and at every successive stage the alert businessman strives so to modify his arrangements as to obtain better results with a given expenditure or equal results with a less expenditure. In other words, he ceaselessly applies the principle of substitution with the purpose of increasing his profits and in so doing he seldom fails to increase the total efficiency of work, the total power over nature which man derives from organisation and knowledge. Every locality has incidents of its own which affect in various ways the methods of arrangement of every class of business that is carried on in it, and even in the same place and the same trade no two persons pursuing the same aims will adopt exactly the same routes. The tendency to variation is a chief cause of progress, and the abler are the undertakers in any trade the greater will this tendency be. In some trades, as for instance cotton spinning the possible variations are confined within narrow limits. No one can hold his own at all who does not use machinery and very nearly the latest machinery for every part of the work. But in others, as for instance in some branches of the wood and metal trades in farming and in shop keeping there can be great variations. For instance, of two manufacturers in the same trade one will perhaps have a larger wages bill and the other heavier charges on account of machinery. Of two retail dealers one will have a larger capital locked up in stock and the other will spend more on advertisements and other means of building up the immaterial capital of a profitable trade connection and in minor details the variations are numberless. Each man's actions are influenced by his special opportunities and resources as well as by his temperament and his associations. But each taking account of his own means will push the investment of capital in his business in each several direction until what appears in his judgment to be the outer limit or margin of profitableness is reached. That is, until there seems to him no good reason for thinking that the gains resulting from any further investment in that particular direction would compensate him for his outlay. The margin of profitableness even in regard to one and the same branch or sub-branch of industry is not to be regarded as a mere point on any one fixed line of possible investment but as a boundary line of irregular shape cutting one after another every possible line of investment. Section 4 This principle of substitution is closely connected with and is indeed partly based on that tendency to a diminishing rate of return from any excessive application of resources or of energies in any given direction which is in accordance with general experience. It is thus linked up with the broad tendency of a diminishing return to increased applications of capital and labour to land in old countries which plays a prominent part in classical economics. And it is so closely akin to the principle of the diminution of marginal utility that results in general from increased expenditure that some applications of the two principles are almost identical. It has already been observed that new methods of production bring into existence new commodities or lower the price of old commodities so as to bring them within the reach of increased numbers of consumers. That on the other hand changes in the methods and volume of consumption cause new developments of production and new distribution of the resources of production. And that those some methods of consumption which contribute most to man's higher life do little if anything towards furthering the production of material wealth yet production and consumption are intimately correlated. But now we are to consider more in detail how the distribution of the resources of production between different industrial undertakings is the counterpart and reflex of the distribution of the consumers purchases between the different classes of commodities. Let us revert to the primitive housewife who having a limited number of hanks of yarn from the years shearing considers all the domestic wants for clothing and tries to distribute the yarn between them in such a way as to contribute as much as possible to the family well-being. She will think she has failed if when it is done she has reason to regret that she did not apply more to making say socks and less to vests but if on the other hand she hit on the right points to stop at then she made just so many socks and vests that she got an equal amount of good out of the last bundle of yarn that she applied to socks and the last she applied to vests. If it happened that two ways of making a vest were open to her which were equally satisfactory as regards results but of which one while using up a little more yarn involved a little less trouble than the other then her problems would be typical of those of the larger business world. They would include first decisions as to the relative urgency of various ends secondly decisions as to the relative advantages of various means of attaining each end thirdly decisions based on these two sets of decisions as to the margin up to which she could most profitably carry the application of each means towards each end. These three classes of decisions have to be taken on a larger scale by the businessman who has more complex balancing and adjustments to make before reaching each decision. Footnote The remainder of this section goes very much on the lines of the earlier half of note 14 in the mathematical appendix which may be read in connection with it. The subject is one in which the language of the differential calculus not its reasonings are specially helpful to clear thought but the main outlines can be presented in ordinary language. End of footnote Let us take an illustration from the building trade. Let us watch the operations of a speculative builder in the honourable sense of the term. That is, a man who sets out to erect honest buildings in anticipation of general demand who bears the penalty of any error in his judgment and who, if his judgment is approved by events benefits the community as well as himself. Let him be considering whether to erect dwelling houses or warehouses or factories or shops. He is trained to form at once a fairly good opinion as to the method of working most suitable for each class of building and to make a rough estimate of its cost. He estimates the cost of various sites adapted for each class of building and he reckons in the price that he would have to pay for any site as part of his capital expenditure just as he does the expense to which he would be put for laying foundations on it and so on. He brings this estimate of cost into relation with his estimate of the price he is likely to get for any given building, together with its site. If he can find no case in which the demand price exceeds his outlays by enough to yield him a good profit with some margin against risks he may remain idle or he may possibly build at some risk in order to keep his most trusty workmen together and to find some occupation for his plant and his salary assistance but more on this later on. Suppose him now to have decided that, say, villa residences of a certain type erected on a plot of ground which he can buy are likely to yield him a good profit. The main end to be sought being thus settled he sets himself to study more carefully the means by which it is to be obtained and in connection with that study to consider possible modifications in the details of his plans. Given the general character of the houses to be built he will have to consider in what proportions to use the various materials brick, stone, steel, cement, plaster, wood, etc. with a view to obtaining the result which will contribute most in proportion to its cost to the efficiency of the house in gratifying the artistic taste of purchasers and in ministering to their comfort. In thus deciding what is the best distribution of his resources between various commodities he is dealing with substantially the same problem as the primitive housewife who has to consider the most economic distribution of her yarn between the various needs of her household. Like her he has to reflect that the yield of benefit which any particular use gave would be relatively large up to a certain point and would then gradually diminish. Like her he has so to distribute his resources that they have the same marginal utility in each case he has to weigh the loss that would result from taking away a little expenditure here with the gain that would result from adding a little there. In effect both of them work online similar to those which guide the farmer in so adjusting the application of his capital and labour to land that no field is stinted of extra cultivation to which it would have given a generous return and none receives so great an expenditure as to call into strong activity the tendency to diminishing return in agriculture. Thus it is that the alert businessman as has just been said pushes the investment of capital in his business in each several direction until what appears in his judgment to be the outer limit or margin of profitableness is reached that is until there seems to him no good reason for thinking that the gains resulting from any further investment in that particular direction would compensate him for his outlay. He never assumes that roundabout methods will be remunerative in the long run but he is always on the lookout for roundabout methods that promise to be more effective in proportion to their cost than direct methods and he adopts the best of them if it lies within his means. Section 5 Some technical terms relating to costs may be considered here. When investing his capital in providing the means of carrying on and undertaking the businessman looks to being recouped by the price obtained for its various products and he expects to be able under normal conditions to charge for each of them a sufficient price that is one which will not only cover the special, direct or prime cost but also bear its proper share of the general expenses of the business and these we may call its general or supplementary cost. The two elements together make its total cost. There are great variations in the usage of the term prime cost in business but it is taken here in the narrow sense. Supplementary costs are taken to include standing charges on account of the durable plant in which much of the capital of the business has been invested and also the salaries of the upper employees. For the charges to which the business is put on account of their salaries cannot generally be adapted quickly to changes in the amount of work there is for them to do. There remains nothing but the money cost of the raw material used in making the commodity and the wages of that part of the labour spent on it which is paid by the hour or the piece and the extra wear and tear of plant. This is the special cost which a manufacturer has in view when his works are not fully employed and he is calculating the lowest price at which it will be worth his while to accept an order irrespectively of any effect that his action may have in spoiling the market for future orders and trade being slack at the time but in fact he must as a rule take account of this effect. The price at which it is just worth his while to produce even when trade is slack is in practice generally a good deal above this prime cost as we shall see later on. Footnote especially in book five section nine there are many systems of prime cost in vogue we take prime cost to mean as in fact the words imply only the original or direct cost of production and while in some trades it may be a matter of convenience to include in the cost of production a proportion of indirect expenses and a charge for depreciation on plant and buildings in no case should it comprise interest on capital or profit. Garkand fells factory accounts chapter one end of footnote section six supplementary cost must generally be covered by the selling price to some considerable extent in the short run and they must be completely covered by it in the long run for if they are not production will be checked supplementary costs are of many different kinds and some of them differ only in degree from prime costs. For instance if an engineering firm is in doubt whether to accept an order at a rather low price for a certain locomotive the absolute prime costs include the value of the raw material and the wages of the artisans and labourers employed on the locomotive but there is no clear rule as to the saloid staff for if work is slack they will probably have some time on their hands and their salaries will therefore commonly be classed among general or supplementary costs the line of division is however often blurred over for instance foremen and other trusted artisans are seldom dismissed merely because of a temporary scarcity of work and therefore an occasional order may be taken to fill up idle time even though its price does not cover their salaries and wages that is they may not be regarded as prime costs in such a case but of course the staff in the office can be in some measure adjusted to variations in the work of the firm by leaving vacancies unfilled and even by weeding out inefficient men during slack times and by getting extra help or putting out some of the work in busy times if we pass from such tasks to larger and longer tasks as for instance the working out a contract to deliver a great number of locomotives gradually over a period of several years then most of the office work done in connection with that order must be regarded as special to it for if it had been declined and nothing else taken in its place the expenses under the head of salaries could have been reduced almost to a proportionate extent the case is much stronger when we consider a fairly steady market for any class of staple manufacturers extending over a long time for then the outlaying occurred for installing specialized skill and organization the permanent office staff and the durable plant of the workshops can all be regarded as part of the costs necessary for the process of production that outlay will be increased up to a margin at which the branch of manufacture seems in danger of growing too fast for its market in the next chapter the argument of chapter three and of this chapter is continued it is shown in more detail how those costs which most powerfully act on supply and therefore on price are limited to a narrow and arbitrary group in the case of a single contract for say a locomotive but are much fuller and correspond much more truly to the broad features of industrial economy in the case of a continuous supply to a fairly steady general market the influence of cost of production on value does not show itself clearly except in relatively long periods and it is to be estimated with regard to a whole process of production rather than a particular locomotive or a particular parcel of goods and a similar study is made in chapters 8 to 10 of variations in the character of those prime and supplementary costs which consist of charges for interest or profits on investments in agents of production according as the periods of the market under consideration are long or short meanwhile it may be noted that the distinction between prime and supplementary costs operates in every phase of civilisation though it is not likely to attract much attention except in a capitalistic phase Robinson Crusoe had to do only with real costs and real satisfactions and an old fashioned peasant family which bought little and sold little arranged its investments of present effort and waiting for future benefits on nearly the same lines but if either were doubting whether it was worthwhile to take a light ladder on a trip to gather wild fruits the prime costs alone would be weighed against the expected benefits and yet the ladder would not have been made unless it had been expected to render sufficient service in the aggregate of many little tasks to remunerate the cost of making it in the long run it had to repay its total costs supplementary as well as prime even the modern employer has to look at his own labour as a real cost in the first instance he may think that a certain enterprise is likely to yield a surplus of money incomeings over money outgoings after proper allowances for risks and for discountings of future happenings but that the surplus will amount to less than the money equivalent of the trouble and worry that the enterprise will cause to himself and in that case he will avoid it footnote the supplementary costs which the owner of a factory expects to be able to add to the prime costs of its products are the source of the quasi-rents which it will yield to him if they come up to his expectation then his business so far yields good profits if they fall much short of it his business tends to go to the bad but his statement bears only on long period problems of value and in that connection the difference between prime and supplementary costs has no special significance the importance of the distinction between them is confined to short period problems end of footnote end of chapter four