Essentials of Economic Theory Part 5

_The Prices of All Increments of Supply Equal._--A consumer always gets a net surplus of benefit from the early increments of the goods he consumes. If the last barrel of apples is worth two dollars,--or, what is the same thing, if the last barrel has in it an amount of utility equal to the final utility of other things that two dollars will buy,--the first barrel has a larger utility; and yet it costs no more than the last one. The sellers of apples, if they expect to dispose of all that they have, must at the outset fix the price at such a point that the very last increment of the supply will successfully compete with other articles for the favor of purchasers.

Compet.i.tion forces them to sell the whole amount so cheaply that the least important part of it may be as important to the purchaser of that part as the corresponding and least important part of the supply of other things. Nothing but a monopoly of the entire available stock would enable them to carry out the auctioning plan and offer the stock piecemeal, so as to get a higher price for the parts offered early.

Even then buyers who should perceive the fact that a large part of the stock remained in reserve and that it must ultimately be sold would be able, by delaying their purchases, to get the benefit of a later and lower rate, so that the monopoly itself would be only partially successful in its policy. In the absence of a monopoly venders are compelled to sell all articles of one kind and quality at one price.

The man who should fix a higher price on his portion of the supply would be pa.s.sed by in favor of other sellers who were disposing of their final increments, and his business would quietly drift away from him. _There cannot be two prices for one commodity in the same market_ at the same time. This fact is fundamental. Even the monopoly is able to get different prices for different parts of its output only by offering them at different times; and competing producers cannot do this. They are forced to keep the price of all they offer at a level that expresses its final utility.

_The Law of Value affected by the Difficulty of using Two Similar Goods at Once._--There are two imperfections in the common statement of this law of final utility which need to be removed in order that the theory of value, which is based on the law, may be true and useful. The first lies in the a.s.sumption that people buy completed articles, such as coats, tables, vehicles, watches, etc., in regular series of units, adding to their stock coat after coat, watch after watch, etc., all just alike, till the utility of the last one becomes so small that it is better to buy other things. On this supposition the price of the whole supply of any such thing corresponds with the utility of the last one in the consumer's series. This fairly well describes the case of commodities like apples, of which men consume now more and now less per day or per week and are always glad to increase the amount they use. Of most kinds of consumers' goods a person wants at one time one unit and no more, and a second unit, if he has to use it himself within the same time in which he uses the first, would be an inc.u.mbrance. Its utility would be a negative quant.i.ty. Two quite similar coats would never be bought by the same person if he had only his own needs in view and must use both coats through the same period. The first unit of his supply is, for this period, also the last.

_The Law of Value affected by the Fact that the Final Unit of a Good is usually a Complex of Unlike Utilities._--The second imperfection consists in the a.s.sumption that in measuring the utility of such a unit the consumer estimates the importance to himself of the article taken in its entirety. In the case of the apples of our ill.u.s.tration the difficulty is not obvious. A man, as we have just noticed, may increase or diminish his consumption of this fruit; the first few apples that he uses will give him more pleasure than a second similar quant.i.ty, and the price of apples in the market may actually depend on the utility of the final peck of apples that each of the customers consumes in a season. In other words, there is, in this instance, a probability that the goods, although supplied at once, may be appraised as if they were offered in a regular series and that the law of final utility, in its common and simple form of statement, may in this particular apply to the case. The second difficulty, however, remains, and even in the case of such goods as apples renders the common statement somewhat inaccurate, while in the case of most kinds of consumers' goods the inaccuracy is glaring. If the price of fine watches corresponded with the utility of the last one that a consumer uses, it would be many times greater than it is. Rather than go without watches altogether many a man would pay one thousand dollars for one for which he actually gives a hundred; and, moreover, this watch may be the "final" one in his case. The utility of the last overcoat that a man uses in the winter may be such that, if he could have it on no other condition, he would readily give five hundred dollars for it instead of fifty.

_How Unlike Services may be rendered by One Good at the Same Time._--What people want of any useful thing is an effect in themselves,--a pleasure or a benefit which they expect to get,--and apart from this subjective result they would not want the thing at all. The power to confer a particular benefit is a utility. Men buy goods solely for their utilities, and they measure these service-rendering powers in the things offered to them and pay for them accordingly. Now, it happens that articles often combine in themselves a considerable number of different utilities, or service-rendering powers, and that in buying an article the man pays for them all. It is as though four or five different servants, each having his own specialty, were to offer themselves for hire and invite an employer to consider what each one could do for him. In buying an article which will serve him in several ways, a man appraises all the unlike services that the article will render. He secures several services at once, as he would do if he hired, in a body, several actual servants. The same thing would happen if, instead of hiring human servants with different apt.i.tudes, one should buy different commodities each of which is, in reality, an inanimate servant, able, in its own way, to do something useful or agreeable for the purchaser.

We could bunch a lot of these goods and buy them collectively. Venders of the goods could tie them together in bundles and offer them thus for sale. If the different goods were also sold separately in the market, they would command in the bundles the same prices that they would command when sold each by itself, and a bundle would bring the sum of the several prices of its component articles. _In just this way in which an aggregate of different goods would get its valuation does any one article which is made up of different utilities get its rating. The utilities are appraised separately._ In buying an article which is a composite of different utilities, we virtually employ a company of servants who have different specialties and insist on being hired all together or not at all.

_How the Normal Price of a Bundle of Unlike Goods would be Fixed._--We have now to see how the action of the market a.n.a.lyzes an article and puts a price on the several utilities which compose it. The market does this in exactly the same way in which it would appraise a bundle of dissimilar articles which had to be sold separately, and we will therefore trace the operation by which a package containing the commodities A, B, C, and D would get its value in an actual market.

_How the Normal Price of a Single Good in a Bundle of Unlike Goods would be Fixed._--Let us see how a bundle made up of commodities A, B, C, and D would get its value in the market. We will suppose that these articles are here named in the order of their importance, and that A has the highest utility, since it renders the most important service, and that D has the least. It may be that the article A has a utility rated at one hundred dollars in a particular man's esteem. He would give one hundred dollars for it rather than do without it altogether.

The service, then, that one article of this kind can render is expressed by the sum one hundred dollars. Article B taken separately may be worth fifty dollars, since it may render such services that the man would give fifty dollars rather than be without it. A third article, C, may in the same way be valued at twenty dollars and a fourth at ten. Now, if a man has to buy the whole bundle, must he pay one hundred dollars plus fifty plus twenty plus ten, or one hundred and eighty for the whole? This does not by any means follow. The first article may be sold separately at a price far below one hundred dollars. There may be so large a supply of it that, in order to find a market for it all, the makers must take ten dollars for it. This fixes the market price of that amount of this commodity at ten dollars. If we now glance beyond the question of the "market price" of the goods and consider their more permanent or "normal price," the inquiry requires us to do more than ascertain why a definite quant.i.ty of the goods offered at a certain time sells for a certain amount. An appeal to the law of final utility answers that question. To know, however, why the permanent price is what it is, we have to know what fixes the permanent supply, and we discover that the cost of making the goods is here a dominant influence. For the present we a.s.sume that this cost does not change, since such changes are a subject for the dynamic studies which will come later. The present fact is that production has been carried to such a point that no more of these goods can be sold at the cost price, and there the enlargement of the output has stopped; the supply has at some time in the past reached this normal point and now remains there. Ten dollars represents the final utility of the article, and this sum is what it costs to make it. If it could be sold for any more than that, compet.i.tion would bring new producers into this business and would impel those already in it to enlarge their production till the price would stand at the normal or cost level of ten dollars.

_The Consumers' Surplus._--In every such case there are men who would give much more for the article rather than be without it, and we have supposed that some one would pay a hundred dollars for this commodity if he could not otherwise obtain it. Ninety dollars, then, measures what we may call his _consumers' surplus_, or the clear benefit he gets from buying at its market price an article that is worth to him so much more. This comes about by the fact that the makers of article A, in order to sell the amount of goods that compet.i.tion has impelled them to make, must accept the offers of persons who can consistently give only ten dollars for it. These are relatively poor persons, and as the sum of ten dollars expended on other articles would benefit them as much as ten dollars spent on this one, it is a "final"

purchase, or a final increment of their consumers' wealth. In order to get it they sacrifice, in some other form, a benefit as great as the one they get from acquiring this commodity and receive, therefore, no consumers' surplus from it. These are the men whose demand helps to fix the price of the article A, and the willingness of other persons to give more does not make it bring any more. The rich men, who stand ready to pay a hundred dollars, if necessary, are gainers by letting poorer men fix this price. It is by catching the patronage of these poorer men that the makers can dispose of their large output, and in doing this they have to bring the price down to ten dollars.

_The Function of a Special Cla.s.s of Marginal Purchasers of Each Article._--In like manner there is a cla.s.s of "marginal purchasers" of the article B, or the persons who pay for it so much that they get no net benefit or consumers' surplus from the purchase. If they did not buy this article, they could get something else that would do them as much good for the same outlay. It costs, let us say, only ten dollars in the making, and enough of these articles are made and offered for sale at that price to supply all customers who are attracted by the offer. The men who would pay more for it do not count. Each of the other articles in the bundle, when it is offered separately and at the cost price which compet.i.tion establishes, represents a final utility to some one cla.s.s of purchasers. Compet.i.tion has made the whole supply so large that, in order to dispose of it, venders must attract the particular cla.s.s who will take it at the ten-dollar rate. This cla.s.s is in the strategic position of market-price makers for this one thing. They are the last cla.s.s to whom the producers can afford to cater. If each of the five articles in the bundle costs the makers ten dollars, and if so many of each are made that they just supply the needs of the cla.s.ses that will buy them at ten dollars apiece, the price of all five, when sold separately, will be fifty dollars. Most of the purchasers of each article would give more than ten for it if they had to, but some would not do so, and the producers cater to the needs of these marginal persons.

_How the Prices of the Goods are fixed when they are sold in Various Combinations._--How do these articles get their valuation when they are tied in bundles containing all five of them and the bundles are sold unbroken? In essentially the same way as when sold separately.

Article A, we will suppose, is one of the necessaries of life and is to be had by itself in the market. Article B represents a comfort, and C and D are luxuries. The bundles are so made that A and B are often sold together; as are also A, B, and C; and A, B, C, and D. A purchaser may have at his option the first only, the first and the second combined, the first three, or all four. Article A, when it stands alone, can be had at the natural or cost price and in quant.i.ty sufficient to supply the wants of all cla.s.ses of buyers from the highest down to the cla.s.s which will take it at ten dollars--the cost of making it--but at no higher price. Any one can have the A either alone or tied to other articles at this price. One who buys A and B in combination will pay for article A only the same price that it commands when sold separately; and since he buys B, the utility of which is less than that of A, at ten dollars, it is clear that he gets A for less than it is worth to him, but the ten dollars may be all he would give for the B. This man is not the marginal purchaser of A, for in buying it he realizes a consumers' surplus; but for the article B, which is tied to it, he may pay all that it is worth to him. For that he is a marginal purchaser, and as such he gets no consumers' surplus out of it. What he pays for B will just suffice to buy something else which is equally important to him. The price of this bundle of two articles is ultimately determined by the cost of the two components, which is twenty dollars, and enough of each component is made and offered in the market to supply the wants of a cla.s.s of persons who will barely decide to take it at the cost rate. The cla.s.s that hesitates at taking A will not consider B, but the cla.s.s that hesitates at taking B gets a clear benefit from buying A at the price that expresses the utility of A to a poorer cla.s.s of persons.

_How Different Cla.s.ses of Purchasers cooperate in this Price Making._--The rule of one price for one article of course holds, and the man who would have a clear and decisive motive for buying the A for more than ten dollars, if he had to do so, gets the benefit of two facts: first, that it costs only that amount in the producing, and secondly, that compet.i.tion makes the supply of it so large that it is brought within the reach of those persons who value it at only ten dollars. It takes two different cla.s.ses of purchasers to fix the price of this package of two articles, and their ratings fix it at twenty dollars. Exactly the same influences regulate the price of the bundle which includes A, B, and C. Men who buy C can afford to have a luxury, and therefore, if they had had to do so, would have given more than they do give for the articles of necessity and comfort. If the price of A and B were higher than it is, they would still buy these two things, but they would not raise their bids for C, since for this they are marginal purchasers. This commodity is therefore sold at the price that will just induce this cla.s.s of persons to add it to their list of consumers' goods. There is a further cla.s.s in whose list of purchases D is marginal, while A, B, and C yield a consumers' surplus in the form of an uncompensated personal benefit.

_Different Utilities in an Article appraised as are Different Goods in a Package._--It is an actual fact that most commodities are like these packages of unlike articles. They are bundles of unlike utilities, and the market actually finds a way to a.n.a.lyze composite things and put a separate price on each utility. It may seem very theoretical to say that a concrete thing, like a watch, a coat, a dining table, or a roast fowl, is made up of such abstract things as utilities and that each of these has its separate price; yet such is actually the fact, and if goods were not valued in the market in this way, the prices of all articles of comfort and luxury would be very much higher than they are.

A man pays seventy-five dollars for an overcoat, but if he could not get the service that the coat as a whole renders without paying five hundred dollars for it, he would pay it; for otherwise he could hardly get through a winter. No man who buys an overcoat worth seventy-five dollars would refuse to pay more if that were the necessary condition of having an overcoat at all. The garment as a whole is far from being a "marginal utility" to any one; and yet there is something in it that is so. This element is like the article D in the fourth bundle referred to in our ill.u.s.tration. There is a particular utility in the composite good for which the man pays all that it is worth to him; and he would go without that utility if the seller charged more than he does. The most important service that the coat renders is that of keeping the man warm; but a very cheap garment would render that service, and six dollars will buy such a garment. The man does not need to pay more than six dollars for that one service. The supply of cheap coats is such that the final one must be offered for six dollars in order to induce certain poor purchasers to buy it, and that, moreover, is all that it costs to make it. No one, therefore, is obliged to pay more than six dollars for something that will keep him warm, however much such a service may be worth to him. Coats of another grade have a second utility combined with this one, since they are made of better cloth and are more comely in appearance. Utilities of an aesthetic kind are combined with the crude qualities represented by the cheapest coats. The supply of coats of this grade is such that they must be offered for twenty dollars in order to induce some one to take the final or marginal one. What does this mean? It means that this purchaser will pay fourteen dollars and no more in order to have the second utility, consisting in comeliness, added to the first utility, capacity to keep him warm. This man would give more than twenty dollars rather than go uncloaked; for it is plain that, if he will pay fourteen dollars for comeliness, he will give more than six for warmth. Probably he would pay one hundred dollars for the article if he had to, and in getting it for twenty he gets a large consumers'

surplus. This is because he secures the first utility (1) for less than it is worth to him, (2) for just what it costs in the making, and (3) for just what it is worth to the poorer purchasers. He is willing to pay only fourteen dollars for the comeliness, which is the second utility that the garment contains, and he is therefore a marginal purchaser of this second utility. It costs only the sum of fourteen dollars to add the second utility to the first, and enough coats of the second grade are made to catch the patronage of the cla.s.s of buyers who will give so much and no more for it. They are the persons whose demand figures in adjusting the market price of this second utility. Competing producers of coats cause the supply of those of the second grade to be so large that they could not all be sold unless the second utility were offered for fourteen dollars. This makes the price of the entire coat twenty dollars as the result of catering in a detailed way to the demand of two different cla.s.ses of buyers.

In exactly the same way the price of the third grade is fixed at forty dollars and that of the still higher grade at seventy-five. In the third grade there is a utility which it costs twenty dollars to add to those possessed by garments of the second grade, and this is added to enough of them to supply all persons who will pay twenty dollars or more for it. These coats are made of more highly finished goods and have better linings, and this gives them the third utility which the market appraises at its cost, which is twenty dollars. The men who buy the forty dollar coats get a surplus of benefit in securing the first two of the utilities that are embodied in them, since for these they pay less than they would pay if they had to; but they get no surplus over the cost of the third utility. It is to secure their custom that the vender must sell it for twenty dollars. In a like manner a coat of the next grade, which is a more fashionable garment, sells for seventy-five dollars because it has a fourth utility which costs another sum of thirty-five dollars and, to the marginal buyers, is worth that amount. These men get a surplus from buying the first three utilities at what they cost their producers and what they are worth to poorer purchasers. It appears, then, that a seventy-five dollar coat is a bundle of distinct elements, or utilities, each of which has its separate cost and is sold at that cost price to a particular marginal cla.s.s of purchasers. Each element is valued exactly as if it were in itself a complete article tied in this case to others, but also offered separately in the market. Persons of one cla.s.s are final purchasers of the first utility when it is offered at its cost, six dollars. Another cla.s.s, in a like manner, helps to set the price of the second utility at fourteen, and still other cla.s.ses figure in the adjustment of the prices of the third and fourth utilities. These cost the manufacturers twenty dollars and thirty-five dollars respectively, and compet.i.tion insures the making of enough of them to catch the patronage of those who will pay just these amounts. Members of one cla.s.s act as marginal purchasers in price making in the case of one utility only. The concurrent action of all of them results in setting the price of the best coat at eighty dollars. It is a very practical fact that the rates at which all fine articles sell in the market are fixed in this way. Such articles contain utilities unlike each other.

They have power to render services of varying degrees of importance, and each of the several services gets its normal valuation when producers make enough to supply the want of a particular group of persons to whom it is a marginal service and who are willing to pay only what it costs. They would go without that one service if they had to pay more for it.

_This Method of Valuation Applicable to All Commodities of High Grade._--Ill.u.s.trations of this principle might be multiplied indefinitely. A fine watch tells the time of day, but something that would do that could be had for a dollar, and that is all that this fundamental element in the fine watch sells for. It takes a series of purchasers bidding on the higher utilities of the fine watch to make it sell for five hundred dollars. The man who buys such a watch would give, perhaps, ten thousand for it rather than be without a watch altogether, but he is saved from the necessity of doing so by the fact that poorer customers have done the appraising in the case of all the more fundamental qualities which the watch possesses. So long as an Ingersoll "dollar watch" will tell the time of day, no one will pay more than a dollar for exactly that same service rendered by any watch whatever; and the same thing is true of other services. Social in a very concrete and literal sense is the operation of fixing prices.

Only the simplest and cheapest things that are sold in the market at all bring just what they are worth to the buyers, and all articles of higher grade offer to all who buy them a surplus of service not offset by what is paid for them. If we rule out the cheapest and poorest grades of articles, we find all others affording a "consumers'

surplus."[2]

[2] It will be seen that to a man who buys the seventy-five dollar coat that article in its entirety is the final one of its kind which he will buy. He does not want a second coat exactly like the first. The same thing is true of the man who buys the five hundred dollar watch, since he does not think of buying more than one. In each case the first unit of the article bought is the last one, and it contains utilities which are worth more than they cost. It contains one utility only which is marginal in the true sense of affording no surplus of gain above cost. This utility stands on the boundary line where consumers' surpluses stop.

CHAPTER VII

NORMAL VALUE

_Natural Supply._--We have attained a law of market value, which determines the price at which a given amount of any commodity will sell, and have taken a quick glance at the influence which fixes the amount that is offered and thus furnishes a natural standard to which the market value tends to conform. At any one moment the amount which is supplied is an exact quant.i.ty, and if it all has to be sold, it will bring a price which is fixed by the final utility of that amount of the commodity. If the quant.i.ty offered for sale should become greater or less, the final utility and the price would change. Final utility controls the immediate selling price, and if that is above the cost of production, a margin of gain is afforded which appeals to producers, sets compet.i.tion working, and brings the quant.i.ty made up to the full amount which can be sold at cost. The amount of the supply itself is therefore not a matter of chance or caprice. It is natural that a certain quant.i.ty of each article should be supplied, and that the price should hover about the level which the final utility of that quant.i.ty of the good fixes. "Natural" or "normal" price is, in this view, the market price of a natural quant.i.ty.

_Cost as a Standard of Normal Price._--It is commonly and correctly stated that the normal price of anything is that which just covers the cost of producing it. Cost in this case is the total amount of money that the _entrepreneur_ pays out in order to bring the commodity into existence. He buys raw materials and pays for all the labor and capital that transform them into a new and saleable shape. If he can make a net profit, he does so; but compet.i.tion tends to adjust the quant.i.ty produced and the consequent price in such a way that he can make no net profit. What he gets for the article will then reimburse him for his total outlay, but it will do no more. Since the quant.i.ty produced is normal when it brings the market price to this level of cost, it appears that the cost is the ultimate standard in the case.

The quant.i.ty supplied varies till it causes the market price just to cover the cost; and so long as the quant.i.ty supplied is thus natural, other influences remaining the same, the price is so. This states the cost of production in terms of money paid by an _entrepreneur_ and the returns from the operation as money received by him; but there is a more philosophical way of conceiving the law of cost, and to this we shall soon recur.

_Elements of Cost._--Whatever the _entrepreneur_ has to pay for in the production of an article is of course an element in its monetary cost to him. If he does not begin the making of it by drawing his raw materials from what nature freely furnishes, he must pay some one for the raw material. He must also pay for the labor, and this is equivalent to buying the fraction of the article that is produced by labor; for the laborer, as we have seen, is the producer of a certain fractional share of the article and the natural owner of that share, and when he agrees to let his labor for hire, what he really does is to sell out his individual interest in the forthcoming product of the industry in which he is about to engage. When a workman in a shoe factory agrees to work for two dollars and a half a day, he really contracts to sell every day for that amount a certain quant.i.ty of shoes. The leather is one element which enters into the finished shoes, and therefore the entire shoe is not really made in the factory; but of the part which is there made, namely, the utility that results from transforming the leather into shoes, one part is made by labor and another by capital. The _entrepreneur_ has to buy both of these if he is to acquire a valid t.i.tle to the product and have a right to sell it. These costs are therefore "purchase money" paid for undivided shares of goods.

_Labor of Management._--It usually happens that an _entrepreneur_, or employer of labor and capital, performs some labor himself; and we have already noted the reason for this in the fact that the kind of labor that he performs is so important that the fate of the business often depends on it. He may manage the business so well as to make it succeed or so ill as to make it fail. He pays himself for this labor when he draws a salary for his services. As an _entrepreneur_ he treats his own labor as he does that of any one else and buys the fraction of the product of his business that his own labor of management has created. In this he ill.u.s.trates the general law that all payments of wages are payments of the purchase of a certain quant.i.ty of product. Though the owner's own contribution to the product is not always mentioned in terms in the accounting, that is what his salary is paid for, though it is spoken of as a payment for his "time," or his labor.

_The Capitalist as the Vender of a Share in a Product._--Capital, as we have seen, also contributes a definite share toward the total amount of every product in the making of which it cooperates. Labor does not do all the transforming of leather into shoes which is done in the factory, since machines, fuel, etc., help; and we shall later find that there is a way of determining how much of the product the help so given creates. It adds a certain amount to what labor can claim as its own special product, and the man who owns the capital becomes the lawful claimant for this additional share. When he agrees to let his capital work for an employer, he virtually sells to the employer the undivided share of the product--shoes or what not--that the capital really creates. The furnisher of productive instruments, like the furnisher of labor, is a vender, and the _entrepreneur_ is a buyer.

_Entrepreneur and Capitalist._--As was stated in an earlier chapter, an actual employer nearly always furnishes some of the capital that he uses. If he did not do so, he would have difficulty in borrowing more, since banks or other lenders do not loan to empty-handed men. It is clear that what the employer gets in return for such capital as he may put into the business is in reality a payment for a contribution which that particular part of the capital makes to the product. Since each bit of capital in an establishment contributes something toward the creating of the product, the employer's own capital has the same right to the value of its contributary share as has the capital of any one else. What the employer-capitalist gets for capital the employer, pure and simple, pays. As the furnisher of instruments the man is a vender of the product of these instruments, while as an _entrepreneur_ proper he is the buyer. He must purchase the product of his own capital just as he purchased the product of his own labor. In paying, therefore, wages for all labor, including what he performs himself, interest on all capital, including his own, and the price of raw materials, he gets something which, if compet.i.tion does a perfect work, he has to sell for what he gives for it. The shoes, when he sells them, tend, under active compet.i.tion, to yield only what has been paid for them in the making and, in a perfectly static state, would actually yield no net profit. All the _entrepreneur's_ costs, therefore, resolve themselves into purchase money paid, his receipts are money accruing from sales; and under ideally free compet.i.tion the two sums total are equal.

_The Entrepreneur's Proper Function not Labor of Management._--In some theoretical discussions the management of a business figures as the princ.i.p.al function of the _entrepreneur_, and all or nearly all of the reward that comes to him is represented as coming in the shape of a reward for a responsible kind of labor that calls great abilities into requisition. But it is very clear that, whether he personally performs any labor or not, the employer has a distinctly mercantile function to perform; and this in itself is totally unlike the work of overseeing the mill, the shop, or the salesroom. He acquires a t.i.tle to the whole product by paying for the contributions which labor and producers of raw material separately make toward it, and then parts with the product; and if he gets any more than he has paid out, he makes a profit. When industry is in what we have termed a dynamic state, such a difference between the value of the product and the cost of the elements that go into it is continually appearing, and that, too, largely in consequence of causes over which, as a mere manager, the employer has no control. A profit so gained cannot be wages of management. It is a purely commercial gain, or a difference between what is paid for something and what is received for it.

_Mercantile Profit._--It is best, therefore, to distinguish in some perfectly clear way between that function of the _entrepreneur_, which consists in buying and selling, and any work that he may find it best to do in the way of superintending the business. At the cost of using the term _entrepreneur_ in a stricter sense than the one customarily attached to it, we will make this word describe the purely mercantile functionary who pays for the elements of a product and then sells the product. The reason for the very division between gains from this source and gains from management we shall soon appreciate, for we shall see that compet.i.tion tends to reduce one of these incomes to nothing, but tends to perpetuate the other and to make the amount of it conform to a positive standard. The _entrepreneur_, as we shall use the term, is neither the manager nor the capitalist, and when we have occasion to speak of either of these functionaries, we shall call him by his own distinctive name; though we know perfectly well that, in actual business, it is desirable and often quite essential that the same one who acts as an _entrepreneur_ should also put into the business some labor as well as some capital. A man who performs two unlike functions, buying and selling, on the one hand, and managing the business, on the other, serves in two capacities that are clearly distinguished from each other; while if he furnishes any of the capital, he adds to these a third capacity ent.i.tling him to the value of the product of his capital. As a manager he directly aids in producing goods, and he gets pay for so doing from his other self, the _entrepreneur_, who acquires the t.i.tle to the goods; as a capitalist he has another legitimate claim upon himself as _entrepreneur_.

_These Distinctions recognized in Practical Accounting._--That this is no bit of mere theoretical subtlety is proved by the fact that the bookkeeping of nearly all establishments distinguishes between these two incomes by actually putting an appraisal on the work the employer does and paying a salary for it. A man may be a large owner of stock in a corporation and yet receive a salary that is fixed by an estimate of what an equally useful man could be hired for. If personal influence secures more for him than this, the excess is taken from the pockets of the stockholders, and the amount of it is accounted for in a way that does not fall within the scope of pure economic law.

_How "Natural" Prices exclude Entrepreneur's Profits._--The old and correct view is that the tendency of compet.i.tion is to make things sell for enough to cover all costs, as we have defined them, and no more. Under a different phraseology this is what Ricardo and others have rightly claimed. They were unconsciously explaining what would happen in a static state, for if society were actually in this state, the goods that come out of the factory would be worth just enough to reimburse the owner for all the outlays that can be called costs. If they sell for more than this, there is to be had from the business an income that costs nothing. It is a net profit above all claims based on personal labor or on the aid furnished by capital, and it furnishes an incentive for enlarging the business, and labor and capital are therefore drawn into it. _Entrepreneurs_ bring them and for a time make a profit by this means; but as their presence increases the output of goods that are here made, it brings down the price till there is no inducement to move any more labor and capital in this direction.

_The Significance of a Natural Adjustment of Different Industries._--The "natural" state of general industry is that in which each particular branch of it is in the no-profit state. It is as though laborers and capitalists in a shoe factory took all the shoes that it turns out, sold them in a market, paid for the raw material out of the proceeds, and kept the remainder, dividing it between themselves in proportions which corresponded with the amounts they had severally contributed toward the making of this product; and as though the laborers in cotton mills and iron foundries received the goods there made and dealt with them in a like manner. It is as though in every branch of business the whole product were turned over in kind to the furnishers of labor and capital.

_The Entrepreneur a Pa.s.sive Functionary under Static Conditions._--Purely pa.s.sive is the function of the _entrepreneur_ under static conditions. In so far as any effect on his income is concerned he might as well reside in a foreign land as in the one where his business is located, provided always that the management were unaffected. When the same man is both _entrepreneur_ and manager, the absence of the first of these functionaries would mean the absence also of the second, and that would cause trouble; but the purely mercantile operation of getting a t.i.tle to a product and then surrendering it can be carried on as well in one place as in another.

The _entrepreneur_ in his capacity of buyer and seller does not even do the work which purchases and sales involve. That is commonly done by agents. Some of it, of course, may be done by the responsible manager himself, and if that person is also the _entrepreneur_, it follows that he does a part of the commercial labor of his business.

In this, however, he goes beyond his function as _entrepreneur_. In that capacity he does, as we have said, no labor of any kind. Sales and purchases are made in his name, but he does none of the work that leads up to them.[1]

[1] The holders of common stock in a corporation are always _entrepreneurs_, and they are also capitalists if the stock represents any real capital actually paid in. If the bonds and the preferred stock represent all the real capital that there is, any dividends that may be paid on the common stock are a pure _entrepreneur's_ profit. If, on the other hand, the stock all represents money actually put into the business, the dividends on it contain an element of net profit if they exceed simple interest on the capital and insurance against the risks that are not guarded against by actual insurance policies. If the rate of simple interest is four per cent, and the value of the unavoidable risk is one per cent, then a dividend of six per cent contains a pure _entrepreneur's_ profit of one per cent. In dynamic conditions such a return is often to be expected, and we shall soon study the conditions that afford it.

In the present study we do not need to consider risks, inasmuch as the greater part of them arise from dynamic causes; that is, from the changes and disturbances to which the business world is subject. An invention promises greatly to cheapen the production of some article and, for a time, to insure large returns for the men who first utilize it. A capitalist may be willing to take a risk for the sake of sharing this gain; but in time both the risk and the gain will vanish. The capacity of the new appliances will have to be tested, a market for their output found, etc. A small remainder of risk is still entailed upon the capitalist if he leaves his money in this business. The death of the managing partner, the defaulting of payments for goods sold, the chances of unwise or dishonest conduct on the part of clerks or overseers, always impend over a business, but these dangers are at a minimum when the man who is at the head of the force of managers has capital of his own in the business.

Risks are at a static level only when they are thus reduced; and for our present purpose it is best to consider that compet.i.tion has eliminated the establishments where any recklessness has been shown in the management, and that the unavoidable remainder of risk resolves itself, nearly enough for practical purposes, into a _deduction from the product_ which the surviving establishments turn out in a long period of time. A small percentage of their annual gains, set aside for meeting unavoidable losses, will make good these losses as they occur and leave the businesses in a condition in which they can yield as a steady return to owners of stock, to lenders of further capital, and to laborers all of their real product.

_How the Entrepreneur contributes to Production under Dynamic Conditions._--In a dynamic state the _entrepreneur_ emerges from this pa.s.sive position. He makes the supreme decisions which now and again lead to changes in the business. "Shall we adopt this new machine?"

"Shall we make this new product?" "Shall we enter this new market?"

are questions which are referred to him, and on the decisions he reaches depends the prospects of profit for the business. This activity is not ordinary labor, but in a true sense it is a productive activity, since it results in placing labor and capital where they can produce more than they have done and more than they could do were it not for the enabling act of the _entrepreneur_ which places them on a vantage ground of superiority. This subject will be discussed in a later chapter and in connection with other phases of economic dynamics.

_Values at a Static Level only when Entrepreneurs' Gains are Nil._--Any net profit on an _entrepreneur's_ part means that his product is selling for more than the elements of it have cost him. But this is a condition which, if labor and capital are as mobile as the static hypothesis requires that they should be, will cause this _entrepreneur_ and others to move labor and capital into his industry, thus increasing its output and lowering the selling price of its product. If there is no such action going on, it shows that the _entrepreneurs_ have no incentive for taking it.

_Values at a Static Level only when the Gains of Labor in the Different Industries are Equalized._--If labor is creating more in one subgroup than in others, as it often is in a dynamic condition, that fact means that some _entrepreneurs_ are making a profit, and, according to the principle stated in the preceding paragraph, this means that values are not at their static or "natural" level. If, owing to new methods or to some other cause, a given amount of labor[2] in the subgroup that produced the A''' of our table creates an amount of that product which sells for more than the B''' or the C''' which labor of like quant.i.ty makes, then the manufacturers of A''' would obviously get a margin of profit. They would not be obliged to pay for labor any more than the market rate, and that, as we shall see, cannot exceed what labor produces in the groups B''' and C'''. In A''' the labor creates more and the employer pockets the difference.

In saying this we a.s.sume one fact which we undertake later to prove; namely, that there is a definite amount of each product which can be attributed to labor alone as its producer. Capital and labor work together, but each is, in effect, the creator of a certain fraction of their joint product.

[2] In measuring labor we, of course, take account of the quality of the men who perform it, and the work of a skillful man is counted as more units of labor than that of an unskillful one.

_Values Static only when the Gains of Capital in Different Industries are Equalized._--If capital is creating more in one industry than in another, there is a margin of profit for the _entrepreneurs_ in the exceptionally productive industry. They pay as interest on the capital they use only the market rate, which is what equal amounts of capital can produce and get elsewhere. If they produce more in the one group, the _entrepreneurs_ there can pocket the excess as they did in the case of the product of labor. We a.s.sume that there is everywhere a definite product that can be attributed to capital alone.

_Values Normal when Moneys paid out by Entrepreneurs equal Moneys Received._--In the preceding paragraphs we have spoken of exchange values as being static under certain conditions, but we might have expressed the essential fact by saying that prices are static under these conditions since the money a product brings is a true expression of its value. If A''' sells for as many dollars as does B''', the two things exchange for each other. In like manner the product of labor and that of capital may be expressed in terms of money, since the quant.i.ties of goods which they respectively make sell for certain sums. Wages and interest are nearly always conceived in terms of money. The commercial mode of computing costs of production and returns from production is to translate them into moneys paid by _entrepreneurs_ and moneys received.

_Costs of Production as related to Static Incomes._--What to an _entrepreneur_ are costs are to workmen and capitalists incomes. The one pays out wages and interest, and the others get them; and these two sums are normal when together they equal the prices received for goods produced. The _entrepreneur_ is the universal paymaster, and in a static condition all incomes come from his hand.