The Principles of Economics Part 7

If the value of the product increases less rapidly than the cost of the agents successively added to secure it, a point must at length be reached where the value of the added agents and of the additional product just balance; this is called the point of marginal utility.

If a certain value in labor, fertilizer, or material, be applied to an acre of land, it may be more than recovered in the value of the product.

Further applications give a product increased not in equal proportion to the former yield, and so on till the value of the last-added agent just balances that of the added product. This is the best adjustment possible, and beyond this point there will be a deficit in value. Just where the equilibrium is found at any time is the margin of cultivation.

The term "cultivation" is taken from agriculture but must be understood in the broader sense of utilization, as the principle is not confined to the case of land or agriculture, but applies as well to the use of furniture, books, clothing, horses, or any other indirect agents.

[Sidenote: Meaning of intensive margin of utilization]

[Sidenote: The extensive margin of utilization]

4. _There are two margins, the intensive and the extensive._ The margin of utilization in the case of a single piece of wealth is called the intensive margin. Any form of indirect wealth, anything kept to use, may be considered as containing a series of uses. Using one thing more and more while uniting other things with it, is using it more intensively.

Getting more use out of the book by effort, out of the farm by applying more fertilizer, out of the house by putting more people into it, is intensive utilization. The earlier uses come easily, naturally; the later ones are gotten with increasing difficulty.

When a number of agents are of different qualities, the point between the one last used and the next unused is the extensive margin of utilization. The best agents that are available are naturally used first, but as they are more intensively used there is increasing inconvenience. Then recourse must be made to the inferior agents, whose first uses, however, are greater than the later, intensive uses, of the better grades. When the step is made to the use of agents that were before unused because inferior, it is extending the margin of utilization. The intensive margin of use is in the particular thing; the extensive margin of use lies outside of this.

[Ill.u.s.tration: _Extensive Grades of Uses_]

The relation of the two margins may be shown in a simple diagram. Let the better grades of indirect agents be represented by longer rectangles, the upper parts of which represent the more accessible, more easily secured utilities. Each agent consists of many strata of uses.

The best uses are grades a, b, and c, in M; but after M has been utilized intensively down to d, N will begin to be utilized at its highest point. When utilization goes down to f, O comes into use, and so on. Therefore it will be seen that until the intensive margin takes in d, M is on the extreme margin of utilization, and N is just outside it; when the intensive margin falls to g and h, P is inside the extensive margin, and Q is just outside.

[Sidenote: Equilibrium of the two margins]

The marginal utility or effectiveness of added agents tends to be equal on the intensive and the extensive margins. This is simply a case of the subst.i.tution of goods in the use of indirect agents. If the value of the added product in the use of a particular good decreases, a point finally is reached where it is better to transfer the outlay to another agent, to change from intensive to extensive utilization, to go over to the use of another field or of another machine not so good. The effectiveness of the labor or capital that men have to apply is being compared constantly in the two cases, and to the extent that this comparison is perfect the effectiveness of the agents tends to be equal on the margin in the two applications.

-- II. OTHER MEANINGS OF THE PHRASE "DIMINISHING RETURNS"

[Sidenote: Does not mean declining prosperity]

1. _The phrase diminishing returns is sometimes taken as meaning merely a decrease in prosperity._ Many ideas are connected with this phrase. It is not self-explanatory. It suggests various thoughts according to context and these have not failed to give rise to different uses. The student must be cautious if he is to think clearly about it. If population declines, or industry changes from one place to another, or from one kind of goods to another, it is sometimes said that returns are diminishing in the deserted district.

[Sidenote: Nor exhaustion of the soil]

2. _A more common misuse of the term is to apply it to the exhaustion of the soil._ If the soil of a district has been robbed of its fertile qualities and smaller crops are raised than was the case fifty years before, it is said to be a case of of the increased difficulty in the extraction of natural stores in mining. The veins near the surface being mined first, later the galleries must be cut deeper and greater expense incurred to get the stores. But the conditions here are very different from those we have considered under diminishing returns. Mines are used not under the renting contract, but under the royalty contract, which permits and contemplates a progressive using up of the limited stores of natural resources.

[Sidenote: Fallacious contract between manufacture and agriculture]

[Sidenote: All industries if limited as to one factor, as area, show diminishing returns]

3. _Manufactures are often said to show increasing returns in contrast with agriculture as an industry of decreasing returns._ There is here an inconsistent shifting of thought. Agriculture is thought of as limited to a certain area of ground, whereon evidently diminishing returns will take place. But the fixed limit of ground-s.p.a.ce is not thought of in connection with manufactures. Taking the same view of manufactures, commerce, education, etc., that is, a.s.suming each industry to be confined to limited area of ground, each is seen to be subject to diminishing returns. Some ground-s.p.a.ce is one of the essentials to carry on any business. If the attempt is made to acc.u.mulate a large library in one small room, a point is reached where much energy is wasted in trying to find the books. In a university the psychical product, education, may be limited by the need of s.p.a.ce. The school-room, laboratory, or college cla.s.s-room could be used at midnight, it is true, but not conveniently; and as students increase, buildings must be added. The same is true of any industry. We cannot conveniently increase the business of a lumber-yard without a larger yard-s.p.a.ce, or of a factory without a larger floor-s.p.a.ce. But the added s.p.a.ce may be gotten by spreading horizontally or piling up perpendicularly. A ten-story building on an acre lot represents ten acres of floor-s.p.a.ce. Putting up higher buildings is an expansion in area by the more intensive utilization of the land. Devices like elevators, and more compact appliances, make possible an increasing business in manufacture, trade, or commerce upon the same area of land. All industries, if looked at consistently from this standpoint, are subject to the same condition, though it is true this will make itself felt in varying degrees in different lines of industry. In agriculture some similar devices are possible by the use of greenhouses, but it is true that in it, on account of the need of sun, light, and air, the limits of s.p.a.ce are more quickly felt, and are less elastic than in most other industries. The difference, however, is one of degree, and not of kind. Higher factories, larger stores, enable manufacturers to adapt themselves to the law as applied to the surface of land, but not to escape its operations. Neither the law of gravitation nor the law of diminishing returns is violated or broken when materials are lifted to build the upper stories. Both "laws" are at work, even when the building is rising from the ground. Men are merely adapting their conduct to the conditions imposed by gravitation and diminishing returns.

[Sidenote: Confused with the question of large production]

Manufactures usually are thought of as enlarging by increase of the amount of capital employed, without limitation as to the area covered.

But even here a limit is reached in the amount of capital that can be employed at any one location because of the difficulty of widening the market. The question, however, is one of the advantages of large production with large capital, not of the increasing use of a limited area of land. If manufactures and agriculture are to be compared with reference to their economic nature, it is essential to clear thinking that both be looked at with reference to the same conditions, and from the same point of view.

[Sidenote: Technical confused with historical diminishing returns]

4. _Technical diminishing returns are often confused with historical diminishing returns._ The principle of technical diminishing returns is that at any given moment the uses obtainable from any indirect agent cannot be indefinitely increased without increasing difficulty.

Historical diminishing returns occur when, in fact, human effort is less bountifully rewarded in a later period than in an earlier one. If to-day a day's labor in agriculture produced less than fifty years ago, historical diminishing returns would have occurred. In fact, labor is more bountifully rewarded in agriculture than fifty years ago, yet it is true to-day that there are few fields or appliances which, if used more intensively with the prevailing prices of labor and material, would not show a diminishing return to the additional capital applied. Therefore, in the historical sense, increasing returns have prevailed, yet at every moment it has been necessary to apply resources under the guidance of the principle of diminishing returns.

-- III. DEVELOPMENT OF THE CONCEPT OF DIMINISHING RETURNS

[Sidenote: Recognition of diminishing returns to land]

1. _The law of "diminishing returns" was first recognized and expressed with reference to the use of land in agriculture._ There are several evident reasons why this occurred. It is obvious to every farmer and gardener that he cannot indefinitely increase his crop, that two men cannot always produce twice as much as one man, and that in general the product does not always vary in proportion to the labor and materials applied. Moreover, the food supply is a fundamental factor in industry and in the welfare of states. The limit to the supply of food on a given area, cultivated by a given method, early appeared and became a serious practical problem.

The circ.u.mstances in Europe in the eighteenth century drew attention to the subject. Population was increasing, and the pressure for food was strong. While all the forms of industry most common in cities were increasing, and the wealth of the cities was growing, poverty was increasing among the peasantry. Especially was this true in England during the Napoleonic wars, 1793-1815, owing to exceptional conditions.

The food-supply from abroad was cut off, and when the English farmers, tempted by the high prices, took poorer land into cultivation, and sought to get larger crops from their older fields, a great object-lesson was presented on the principle of diminishing returns in agriculture.

[Sidenote: This confused with historical diminishing returns]

2. _This truth of diminishing returns in agriculture was confused with the thought of historical diminishing returns._ Circ.u.mstances of the time led to the belief that because of lack of food misery must continue among the ma.s.ses of men. It was thought inevitable that the population would continue to increase and food become more scarce. The idea of diminishing returns became thus a prophecy of what would happen, a social philosophy, that affected the thought of men on every practical social question.

[Sidenote: The principle applies to land in all of its uses]

3. _The application of the principle of diminishing returns was soon broadened to include land in other than agricultural uses._ This was a natural and inevitable extension of the thought. It was evident that an unlimited use could not be made of a limited area of land, in any industry whatever. There is no explanation of rent of business sites, residences, lots, wharves, waterfalls, etc., unless account is taken of diminishing returns. If it were possible to do an unlimited amount of business upon a limited area of land, it would never get more scarce and could never rise in value. The idea of diminishing returns came properly, therefore, to be applied to land in all its uses. It is true, however, that the relatively large areas needed in agriculture make the phenomenon of diminishing returns much more striking in it than in most other industries.

[Sidenote: And to all indirect agents]

4. "Diminishing returns" should be broadly applied to all wealth having indirect uses. The argument for this view may take both a negative and a positive form. Why should we say that the principle applies to land and not to cases of other industrial agents? Why in the case of a waterfall and not in the case of the water-wheel? Why in the case of the field and not in the case of the trees in the field? Are they not all scarce and desirable goods yielding a limited supply of uses?

Positively it can be argued that the concept of diminishing returns is indispensable to a reasonable explanation of the value of any indirect agents. Anything that could afford an infinite series of uses at once would be an infinite supply. If an infinite number of uses could be gotten out of one hammer in all places at once, it would pound all the nails in the world. One wagon, one acre of land, one ax, one book of each kind, would serve for all men, and duplicates would be valueless.

But in the case of every material thing there is a limit of convenient and economic use.

[Sidenote: Diminishing returns related to diminishing gratification]

5. _Diminishing returns of indirect agents is a special case of the universal law of the diminishing utility of goods._ Diminishing returns have to do with indirect goods, while diminishing gratification has to do with direct or consumption goods. They are two species or aspects of the same general principle. If the supply of certain indirect agents is increased, thereby increasing consumption goods, the utility of the indirect agents per unit diminishes. In such a case a diminishing return is the reflection, back to the indirect good, of the diminishing utility of the direct goods it helps to secure. Any indirect agent, added to a fixed amount of other agents with which it is technically used, is credited with a diminished utility, just as an additional supply of enjoyable goods, coming to meet a fixed demand, falls in value.

The concept of technical diminishing returns has reference to a limited period of time. Though a definite agent may have bound up in it a long series of uses, these cannot be secured at the moment. If a rent-bearer, such as a fruit-tree, were permanent, and men could wait through eternity for its yield, they would get an infinite yield of fruit. But in any finite period, there can be only a limited yield.

[Sidenote: The basal law of economics]

The concept of diminishing returns is one aspect of the great economic law of proportionality, that is, it is one expression of the fundamental, axiomatic truth, that there is a best or proper adjustment of means and ends. It is, therefore, the central and essential thought in political economy. On it depend all important conclusions with reference to the value of indirect goods. Out of it grow the important economic theories of rent and capitalization.

CHAPTER 10

THE THEORY OF RENT: THE MARKET VALUE OF THE USUFRUCT

-- I. DIFFERENTIAL ADVANTAGES IN CONSUMPTION GOODS

[Sidenote: Connection between gratification, rents, and value of wealth]