Essentials of Economic Theory - As Applied to Modern Problems of Industry and Public Policy
by John Bates Clark
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How Primitive Man tests Value.—It is a mistake to suppose that what is essential in value depends on the existence of an actual market in which things are exchanged for each other. In a market, it is true, values are established and their amounts are expressed in ways that cannot be adopted in primitive life. When we buy a thing, we help to fix the value of it and of other things which are like it. The mere ratios in which things exchange for each other in a market are, however, by no means the essence of value itself. That is something deeper and is one of the universal phenomena of wealth. Value, as we have said, is the measure of the effective utility of things, a kind of measure that every one is frequently compelled to employ, whether he is making goods for himself or buying them from others. A producer who has the option of making different things for himself needs to know what variety of goods can be increased in supply with the greatest advantage to himself as a consumer. Adding to the supply of any one of them is getting a "final" or "marginal" unit of consumers' wealth. It is something that is needed less than the things that were already on hand. Without making such a comparison of the importance of marginal units of different commodities he cannot use his resources in the way that will do him the most good.[3]


The terms marginal and final mean essentially the same thing, but the modes of conceiving it differ. When utilities are thought of as supplied one after another, the last is the least important. We may represent a man's enlarging gratifications, not by such a mere series of quantitative increments, but by an enlarging area. We may draw a series of concentric circles, beginning with the smallest, and let this central area inclose the most necessary forms of consumers' wealth. When we draw a second and larger circle, we inclose between it and the first one a zone which includes those forms which come next in importance. By continuing to draw circles we reach an outermost one which bounds a zone in which are included the least important of the consumer's acquisitions. These are the things which he gets with his costliest increment of labor, and the things which lie beyond the circle last drawn would not pay for the sacrifice which acquiring them would cost. In the accompanying figure the fifth zone includes these "marginal" forms of wealth.

How Isolated Men measure Final Utility.—If a cave dweller possesses a store of one hundred measures of nuts, he measures the final utility and the value of this store in the manner which we have described. If he were to be deprived of the whole stock, he might starve, but this fact does not afford the basis of the value which he puts on the nuts. He measures the importance of this consumers' wealth specifically. He tests the effect of losing one measure and no more, and finds that he could lose the single measure without suffering greatly. The difference between having an appetite fully satiated and having it very nearly so is not serious.

Let AD represent the savage's total supply of food. AB will represent the utility of the first unit; CD of the hundredth. If we supply the food unit by unit, the utility of the successive increments will decline along the curve BC. When the man has a hundred units of food, no one unit of it is worth any more than the last one, since if any one were taken away, the last one could be put in the place of it.

The total absolute utility of the food is measured by the area ABCD, but the total value will be represented by the rectangle ADCE. The area EBC measures the surplus of utility contained in the earlier units in the series.

The Motive for measuring Values in Primitive Life.—Even the cave dweller would have to measure values, and would thus have to apply the principle of final utility, because he would need to spend his limited productive energies in the way that would do him the most good. When he is nearly satiated with food, he needs other things more than he does food stuffs. If he has secured so much of one product that any additional amount that he may get by an hour's labor would be of less use to him than what he could get of some other product by the same amount of labor, it is important for him to change his occupation and produce that thing of which an additional unit—which will perhaps be the final unit of this more desirable article—has the higher degree of usefulness.

Final Utility and Labor Cost.—On the supposition that a small store of roots and nuts were incapable of being replaced by any amount of effort and that no other food were to be had, the utility of it would be indefinitely great, since the man's life would depend on this one increment of food alone. A man would value that life-sustaining good for what it would do for him and without any reference to the amount of work he had performed in order to get it, or to the amount he would have to perform in order to get another store like it. On the supposition that by labor the man could replace this essential supply, the effective utility of it would be gauged by the sacrifice he would have to make in order to replace it. The effective utility of any unit of a good that an hour's labor will produce can never be more than enough to offset the disutility of a marginal or final hour of labor; and thus even a single unit of replaceable food stuff, even when it stands alone and constitutes the whole supply, is valued according to the cost of getting another one like it. A man will prize it according to his dread of the sacrifice involved in getting the duplicate. If he gets this by adding an hour of labor to his day's work, this fact is an evidence that the importance of the original supply of the food is measured and expressed by this personal cost of replacement; and as any similar quantity in a large supply of food can be duplicated by the same amount of labor, it appears that, by a standard based on cost, the effective utilities of all units are equal, that of each one is measured by the "disutility" of an hour's labor and that of the whole supply is this amount multiplied by the number of units that this supply contains.[4]


Although we may use the terms final utility and effective utility in a way that makes them nearly interchangeable, it is clear that the qualities for which the two terms stand are by no means identical, and that effective utility must be studied in any complete analysis of value. In distinguishing final utility we assume that the units of the supply of goods of a particular kind are furnished one by one, and we measure the absolute utility of each unit. The line AB measures the absolute utility of the first unit supplied. This measurement does not take any account of the cost of replacing this unit, for it does not recognize the possibility of replacing it. What is estimated is the absolute importance of the service which this first unit of the article renders, on the supposition that, if this first increment of the supply were wanting, the service would not be rendered at all. It is, in like manner, the absolute utility of the successive increments supplied which declines along the curve BC. DC measures the absolute utility of the final increment, and the area ABCD the total absolute utility of the supply. If the goods can be reproduced by labor, the total effective utility is less, since it is measured, as we have seen, by the amount of sacrifice which the replacing of one lost unit would entail multiplied by the number of units in the supply. It is the amount expressed by the area AECD which is the amount of the value of the goods, since measure of effective utility and value are the same, both in the case of a single unit and in that of a total supply.

We have discovered two reasons why the effective utility of any one of the earlier units is equal to the absolute utility of the final one. The first reason is that, if any one of them were lost, the final one would be put in the place of it and the consumer would suffer no loss except what would be entailed by going without the last unit. The second reason is that if the consumer should lose any one of the earlier units, he could replace it by the same amount of labor that would replace the final one. We have seen that the line DC of the figure expresses not only the absolute utility of the final unit of goods, but the disutility of the labor of reproducing it or of reproducing any other unit. The cost of replacing the whole supply is expressed by the area AECD, on the supposition that the units are replaced, one at a time, by means of labor performed at the end of several working days when the sacrifice is greatest. Total value is thus quantitatively equivalent to total effective sacrifice of replacement, as well as to total effective utility. If, by adding a brief period to the length of one working day, a man can make good the loss of one unit of the goods, by adding the same period to the length of a number of working days, he can make good the loss of the total supply. For simplicity we assume that the man's physical condition remains unchanged, and that an extra hour of labor at the end of any one day costs him as much as it would at the end of any other.

How Primitive Man measures the Productivity of Labor and Capital.—There is a truth relating to producers' wealth that resembles the truth that we have just stated with regard to consumers' wealth. The more consumers' goods of one kind a man has, the less is the value that any one of them has to him. The more producers' goods of a given kind a man has, the less is the efficiency that any particular one of them possesses as an aid to labor. The last bit of bread serves the man himself in a less important way than does the first, inasmuch as it gratifies a want that is less intense; and the last implement of a given kind—the last hatchet or spade or arrow—helps him less in his productive operations than did the first one. On the one hand, we have the law of the diminishing utility of successive units of consumers' goods, and on the other hand, we have a parallel law of the diminishing productivity of successive increments of producers' goods.

The Necessity for measuring the Productive Powers of Capital Goods even in Primitive Life.—Now, it is necessary for every producer, though living in the simplest possible manner, to measure in some way the efficiency of the last unit of each kind of productive instrument that he uses. He has, let us say, a certain number of hatchets and of arrows, and he can produce one hatchet with the same amount of labor that would produce an arrow. Now, if a hatchet will do more good than an arrow, he will direct his energies to the making of the hatchet. It is important that any producer should bring the final units of the different parts of his equipment to a certain uniformity of producing power. He must not go on adding to the stock of implement No. 1 when implement No. 2, which could be had by the same expenditure of labor, would do more good; nor must he add to the stock of either of these after he has acquired such a supply of them that the first unit of implement No. 3 would be of greater importance. Measuring the efficiency of producers' goods is necessary in the case of every one who creates wealth at all, and such measurements reveal the fact that the more producers' goods of one kind a man has, the less is the productive power that resides in one of them.[5]

[5] The law of diminishing returns of successive units of capital goods is based on the same principle as the law of diminishing returns of capital, but it is not identical with it. We shall see, in due time, how a permanent fund of producers' wealth actually grows and why each new unit, as it adds itself to the fund, creates a smaller income than did its predecessor.

The Foregoing Truths Universal.—All the general facts which have been thus far stated hold true wherever wealth is produced. They do not presuppose the facts of a division of labor and a system of exchanges, and they do not even require that there should be any social organization. Men in the most primitive tribes and even men living in Crusoe-like isolation would create wealth by labor aided by capital. The essence of that wealth would be effective utility, and the measure of this, which is value, would be made in the specific way that we have described. The varieties of capital, the distinction between capital and capital goods, and the law of diminishing productivity of such goods would appear in the most primitive economics as well as in the most advanced. These are by no means all of the facts and principles which are thus of universal application. They are merely a few of the more important and may serve as a foundation or a "Grundlegung," for further study. If we should extend our list of general and basic truths, it would quickly appear that the incomes that have been treated as rent and the various surplus gains which are analogous to rent are universal economic phenomena which it would be not illogical to discuss in the preliminary part of this treatise. What has been stated, however, concerning the laws of diminishing productivity of successive units of producers' wealth, concerning the diminishing utility of successive units of consumers' wealth, and also concerning the increasing burdensomeness of continuous hours of labor, presents the essential principles on which all rents and quasi-rents rest. It is best to study the applications of these principles as they are made in a civilized state.

Universal Economic Truths independent of the Special Facts of Sociology.—This first division of economic science borrows none of its premises from sociology, for the truths which compose it would abide if there were no society in existence. Basic facts it takes from Physics, Biology, Psychology, Chemistry, etc. Facts concerning man, nature, and the relation between them are material for it, but relations between man and man come into view only in the later divisions. There, indeed, they do come into the very foreground with results which immeasurably enrich the science. What we may call the socialization of the economic process we shall have next before us, and we shall find it full of critical problems involving the future well-being of humanity. Industry is carried on by a social organism in which men are atomic parts and to which nature has given a constitution with laws of action and development. We have first to study the nature of this industrial organism and the mode in which it would act if it were not subject to any constitutional change; and later we must study it in its process of growth. The economic action of a society which is undergoing no organic changes is the subject of Social Economic Statics, while such changes with their causes and effects constitute the subject of the science of Social Economic Dynamics.



We have now before us a few principles of so general a kind that they apply to the economy of the most primitive state as well as to that of the most advanced. It is not necessary that men should live in any particular relation to each other, in order that, in creating and consuming wealth, they should exemplify these principles. They would do this even though they never came into touch with each other, but lived, as best they could, each man on his solitary farm. Laws of this general kind result from man's relation to nature, and not at all from the relation of different men to each other. Let a man keep wholly aloof from other men, apply his labor directly to nature, and he can produce wealth of the various kinds that we have described. He can secure food, clothing, and other things for his own use, and he can make tools to help him in securing them. He will appraise the consumers' goods according to the law of what has been called final utility or, in another view, effective specific utility, and he will also test the comparative usefulness of his various tools by an appeal to the law of final or specific productivity.

Social Economy the Chief Subject of Study.—We care most to know how an organized society produces and uses its wealth, and in making this inquiry we encounter at once phenomena that are not universal. The civilized society creates its wealth cooeperatively, by the joint action of its various members; that is, it proceeds by means of a division of labor and an exchanging of products. Moreover, it has, in some way, to share the sum total of its gains among its various members. It has to apportion labor among different occupations for the sake of collective production, which is a grand synthetic operation whereby each man puts something into a common total which is the income of all society. It has, further, to divide the grand total into shares for its different members—an analytical operation in which each man takes something out of the aggregate for his personal use. This is distribution in the narrower sense of that term—the apportionment among the members of a civilized society of the fruits of production. In the wider sense the term also includes the apportionment of the sacrifices incurred in the joint production. Distribution, as thus defined, is the element that appears in economic life in consequence of social organization. This is a secondary element, indeed; for man, nature and their relations and interactions are the primary facts, and the relations of men to each other come logically after these. Social organization, however, is so transforming in its effects as to reduce to small proportions the amount of attention it is worth our while to devote to the economy of the primitive types of life. It is necessary to make some study of that economy, for it is thus that we place before ourselves the fact that there are universal economic laws and perceive distinctly the nature of some of the more important of them.

Facts Peculiar to Socialized Industry.—The term Political Economy denotes a science of industry[1] as thus socialized, for it is a science of the wealth which is produced in an organized way by the people of a more or less civilized state. The general truths which we have thus far stated apply to such an economy, indeed, but they also apply to the wealth-creating and wealth-consuming processes of uncivilized peoples, and even of isolated individuals who have no dealings with each other. They are truths of Economics in the unrestricted sense, and we have now to study the special truths of Political Economy. When production goes on by division of labor, as when one man works at one occupation and another at another, phenomena appear that do not appear in more primitive life; and still others appear when, within each occupation, there is a division of functions between the laborer and the capitalist, as is the case whenever one set of men furnish tools of production and another set do the work. The special laws of this highly developed economic system require far more extended study than do those more general laws which are common to it and simpler systems. We now continue to recognize the universal and basic truths which have been stated in the foregoing chapters and proceed to the study of the special principles which apply only to organized economic life.

[1] We use this term in a broad sense, including agriculture and commerce as well as manufacturing.

Specialized Production the Means of Diversified Consumption.—As the kinds of goods that we individually make become fewer, the things which we get and use become more numerous and varied—such is the law of economic specialization. Society as a whole produces an infinite variety of things, and the individual member of it secures for himself goods of very many kinds. The typical modern worker is, in his production, a very narrow specialist, but in his consumption he is far less a specialist than was the rude hunter who was able to enjoy only the few goods which he himself produced. The modern worker's tastes are omnivorous, for he has developed an immense variety of wants and, through social organization, he has acquired the means of satisfying many of them.

The Position of Individuals in the Producing Organism.—When we say that production has been socialized, we mean something very far-reaching. We mean that an organization has grown up in which men are members or parts of members, and that this great organization has undertaken to do the productive work for all the individuals that compose it. For the first time we now recognize a sociological fact among the premises of economic science. When men, whose predecessors may have lived in isolated families or in a society organized for defense or for the mere pleasures of association, now develop a truly economic society, the individual depends on other individuals as well as on nature for the supply of his wants. Economic independence gives way to interdependence, because the fortune of each man is largely dependent, not merely on his own efforts, but on the relations which he sustains to other men. Simple laws of nature still largely control his income, but social laws also have a certain control over it.

Exchanges in their Primitive Stage.—The exchanging of products is, of course, the process with which the organization begins, and this process is introduced by easy and natural stages. The man who at first makes everything for himself develops a particular aptitude for making some one thing; and, though he may still continue to make most things for himself, he finds it advantageous to barter off a part of the supply of the one article for the making of which he is especially well fitted. He seeks out a neighbor whose special aptitude lies in a different direction and who has a surplus of some other article. It may be that one is a successful fisherman and the other is, by preference, a maker of clothing, and that they can get a mutual benefit by an exchange of food for raiment.[2]

[2] If we were giving a history of the division of labor, we should have to record the effects of differences of climate and of agricultural and mineral resources in occasioning, at an early period, a territorial division of labor. We are here describing the division of labor which occurs within a society and in consequence of what may be called social economic causes.

The Intermediate Type of Exchanges and the Final One.—In the next stage a man becomes wholly a specialist, making one kind of product only and bartering it away for others. It might seem, at the first glance, that differentiation has now done its full work; but it is very far from having done so. Making one complete good for consumption is still a complex operation, which can advantageously be subdivided in such a way that one man produces a raw material while another works it up into a useful shape. A gain may be made by a further division of the manufacturing process, whereby the first worker makes only the rawest material, another fashions it somewhat, a third carries the process farther, and a fourth or a still later one completes it. In modern industry the material must often pass through very many hands before it is ready to be made over to the consumer. Each man in the series puts a touch on it and passes it on to his successor.

A''' A'' A' A

A''' is an article of consumers' wealth and A is the rawest material that enters into it. A' is this material somewhat transformed; A'' is the same material after it has received the second transformation and needs only a final touch to convert it into A''', in which state it will be ready for the consumer's use. We have here a symbol of what is actually taking place in the industry of the world. Cattle are grazing on western ranches; hides are tanning in the woods of Pennsylvania; leather is going through the many changes that fashion it into shoes in the mills of Brockton; shoes are arranged on the shelves of retailers in New York in readiness for the people who are to wear them. These are stages in the making of a single product, and a thousand different products are coming into existence in a like way.

A Representation of the Groups, or Specific Industries, which compose Economic Society.—If we put beside the series of A's a series of B's and one of C's, we have a much simplified representation of what is actually taking place. There are, in reality, a myriad of different things which almost every consumer uses, and every one of them is made by a series of productive operations like the one we have described.

The very fact that there are so many of them that it is hopeless to try to represent them all in the table makes it desirable to illustrate the principle by tabulating only a few and to assume that these few are all that there are. For the purposes that we have in mind it is entirely safe to suppose that a series of A's, one of B's, and one of C's represent all the consumers' goods that society uses. What we wish to ascertain is how the different series work together to furnish an income for each member of society.

The Organization Spontaneous.—Laborers can go where they will, and yet they are in some way brought into an orderly relation to each other, being placed in certain proportions in different industries. Capitalists also are free to invest their funds as they will, and yet there is a certain amount that is naturally devoted to each branch of business. How this apportionment takes place we can most readily ascertain by creating such an imaginary and very much simplified society as this table furnishes.

A''' B''' C''' A'' B'' C'' A' B' C' A B C

The series of A's, which we have already studied, represents one kind of raw material ripening into a finished product. B represents a second kind of raw material, which, like the A, is produced by its own set of workers and is then passed on to a second, who transform it into B'—a partly finished product. These then pass it on, as the corresponding set of men passed on the A'. They hand it over to a set of workmen who change it into B'', a nearly completed product, and these hand it over to men at B''', who, by giving the final fashioning, bring it into the form of a finished consumers' good. The C's represent another general group of workers who transform the raw material, C, into the finished product, C'''.

Industrial Groups and Subgroups.—Each of these more general bodies of workmen and employers, such as the entire series of A's, we may call an industrial group, and the divisions within each of them, such as A' or A'', we may term subgroups. The product of a group is a complete article, while that of a subgroup is not a complete article nor any part of an article that can be taken bodily from it. Yet it is a distinguishable element in the article. The product of the shoe factory is certainly not complete shoes, for the owners of the factory buy leather which has already passed through the hands of tanners; and the tanners themselves bought it in the shape of raw hides, which were furnished by still earlier producers. What the shoe factory has done is to impart a new utility to dressed leather by transforming it into shoes. It would be impossible ever to get that utility out again, or to point to any one part of the shoe as the only part that contains it. What the factory has really made is therefore a utility—a distinguishable quality which pervades a concrete thing. It makes the difference between the leather and the shoes. What the tanner has created is, in like manner, another utility, which makes the difference between raw hides and leather. Groups, then, in their entirety produce whole articles for direct use, while subgroups produce distinguishable utilities which are embodied in such articles. The sum total of all the different utilities constitutes the article. It is a complex of useful qualities held together by the fact that they are attached to the same original matter.

Proportionate Production.—All the subgroups working together in an orderly way not only produce the consumers' wealth that society needs, but produce the different kinds of consumers' goods in nicely adjusted proportions. Unless the general order of the group system is disturbed, there is a normal amount of A''' put on the market and also normal amounts of B''' and C'''. This result is attained by influences that run through the productive organism and bring about an adjustment of the comparative amounts of labor in the different occupations. If competition worked quite freely, this adjustment would be so nice that no military apportionment of forces among different brigades, regiments, etc., made consciously and by the most intelligent commanding officer, could surpass the perfection of it. There would be also an equally fine adjustment of the comparative amounts of capital devoted to different industries. In the actual productive organism each man goes where he will—capitalist, laborer, and employer of capital and labor alike. Each man acts in this respect as though there were no such thing as coercion, and as though he might, with unchecked freedom, do solely what is good in his own sight. By reason of the fact that all are seeking to produce what they can in order that they may get what they can, there comes into operation an organic law which brings the groups and subgroups into a delicate balance, in point of size and output, whereby the grand total of force that society commands is prevented from making too much of one product and too little of another, and is made to do its utmost in getting a large sum total of wealth for the benefit of its various members.

What the "Division of Labor" Involves.—This is the real signification of what it has been common to call the division of labor. It is the socialization of labor, or the gathering of isolated laborers into a great organism that, entirely without coercion, determines in some way what each one shall do, and not only makes the product of the whole a myriadfold greater than without any organization it could be, but causes this product to take certain well-adjusted shapes which, as we shall later see, serve consumers better than they could be served by products in misadjusted proportions.

Capital as well as Labor Apportioned.—As we have said, there is a corresponding division of capital or an assignment of different parts of the total fund to different employments; and this is made in the same way as is the division of labor and results in an equally nice adjustment. Each bit of capital, like each workman, becomes, as it were, a specialist. It may take the shape of an instrument which is capable of performing only its one service, like the loom, which is capable of doing nothing except weaving; but even if the tool is somewhat adaptable, like a hammer which can be used in several trades, it is, as it were, stationed in one trade and held, by economic influences, at that one point in the system. The house carpenter keeps his hammer though the cabinet maker could use it. Each bit of capital helps to create a particular utility, and the number of units of the fund that each subgroup contains is, as we shall see, so arranged as to enable the fund as a whole to do its utmost for the general good. It is all without the use of force, since each bit of capital does what its owner pleases to have it do.

A Government Presupposed.—Of course there must be a government over it all. Such a method of producing wealth could never continue unless property were secure and unless it were made so without much effort on the part of its owners. A blacksmith who should have at one moment to use his hammer as a tool and at another to wield it as a weapon of defense could make but poor headway, and a society in which such a state of things existed in various trades would be too anarchic to permit the elaborate division of trades which is the key to success in industry. The most noticeable fact about organized production is that man is forever letting go the thing he has made or helped to make and allowing it to pass out of sight and reach without losing or greatly imperiling his title to the amount of wealth it represents. He casts his bread on the waters, but they bring him a return for it. Under these circumstances it is impossible for him to protect his product as the savage protects his tools, his clothing, and his hut. What a modern worker makes passes into the hands of other men and gets completely out of the maker's direct personal control. If he wanted it again, he could never find it; and if he could find it, it would be in a new shape and other men would have claims upon it. The man who has sold some hides that in the end have become shoes can hardly identify his product on the shelves of retail shoe dealers all over the country, or perhaps all over the world. If by a miracle he could find the particular bits of leather that in their raw stage he himself has furnished, they would be in new and far more valuable forms than they were when he had possession of them. The shoes contain utilities which the man who furnished the hides cannot claim to have created. They have been changed and improved by elements contributed by many other persons, such as manufacturers, carriers, merchants, etc., and he could never carry away the concrete thing that he himself produced without carrying with it other men's property.

The Surrendering of Goods and the Retention of Values Features of Social Industry.—Socialization of industry means, then, that individuals forego all effort to retain their own concrete products, but that they retain certain parts of the value of the products to which they have made contributions. The value of A''' when it is sold is claimed by men at A''', A'', A', and A according to some principle. The values of B''' and C''' can be followed until they reach the pockets of the men who have contributed their several shares to the making of these things. All this requires a government and a well-developed system of laws and courts for the protection of property, including the protection of it in the form of a claim to a value that is embodied in things which have gone beyond the maker's reach. Property here takes a refined form which requires that the man should forego all desire to keep the literal thing he has made and should make it his aim to retain the value of it in some other form. It is a comparatively simple matter to guard a concrete article which a man has in his possession, though even that requires some energy on the part of the police force and is never quite perfectly accomplished; but it is a far more difficult matter to enforce a claim that a man has against other men, in consequence of some utility that has been created by him but has gone away from him and mingled with utilities created by many other persons in a product that the man will never see. It is the problem of guaranteeing to the shoemaker the due return for the stitches he has put into shoes when the shoes themselves have gone to buyers and wearers in every quarter of the land and many quarters of the globe.

Groups under a Socialistic State.—In political economy as distinct from general economy we take one premise from sociology and another from politics. We assume that society exists and that it has taken on a political character, by establishing laws with courts to interpret them and officials to enforce them. We do not, however, assume that the direction of industrial affairs is in the hands of such officials. In the main industry is organized in a spontaneous way. Men choose such occupations as they like, and when there are too many of them in one group and too few in another, the rewards naturally increase in the group where a larger force is needed, and this lures men in that direction.

In a socialistic society such adjustments would be made under the direction of the state. Officials would have to decide when more workers are needed in the A series and less in the B series and would have to use either inducements or some kind of compulsion in order to move them from the one group to the other. What we actually have to deal with is a society that shapes itself by the free acts of individuals, and we have to see how, in this way, it organizes itself for production and divides among different claimants the product that, by the joint action of all of them, it creates.

Gains from the Organization of Industry.—The advantages of the division of labor consist in an increase in the quantity of products and in an improvement in their quality, and the quantitative gain is almost beyond computing. The advantage appears mainly in the middle and upper subgroups of the series, which transform the materials, rather than in the lower subgroups, which produce them; and yet there is a gain everywhere from such organization. A man produces far more when he performs the same operation many times than when he goes through a whole series of unlike operations. Moreover, he can perform the single operation far more accurately and can thus attain a more perfect result. He can learn his minute trade more easily than he could a complex one. Where unusual strength or skill is required, the work may be given to persons who have the requisite quality so that a good product can be insured, and none of the labor of these superior workers will need to be wasted on work which inferior labor can perfectly well perform.

Improvement in the Forms of Capital.—The greatest of all the advantages that come from this division and subdivision of wealth-creating processes comes in the way of applying machinery. A machine is a hopeless specialist and can, as a rule, put only a single minute touch on the material submitted to it; and the introduction of machines differentiates capital in a way that is parallel to the minute subdivision of labor. If the machine is to work at all economically, it must put its touch quickly on one after another of a series of articles, as they are submitted to it in uninterrupted succession. If only one kind of machine were employed in the making of shoes—if, for instance, the sewing of the uppers to the soles were done on sewing machines, even though all the rest were done by hand—it would be natural and almost necessary to have one class of workers to prepare the uppers, another to prepare the soles, and a third to sew them together by aid of the machine. When the several stages of the process are thus given over to different classes of workers, the situation is ripe for the application of more machines, and inventors readily devise apparatus that will perform one or another minute part of the manufacturing process. In the end most branches of manufacture take such shapes that the raw material is intrusted to a series of machines and passes from one to another by a nearly continuous movement, till it emerges from the hands of these automata as complete as any manipulation can make it and ready for the merchants who will convey it to their customers.

Economy of Capital.—There is an economy of capital involved in the fact that instruments can be used thus continuously. A worker does not have to have several sets of tools, many of which would be idle the greater part of the time, as would be the case if the man performed several unlike operations; but the greatest economy comes from the energy, rapidity, and accuracy with which the new instruments act. The tools are far more efficient than they could be if human muscles furnished the power and eyes and nerves supplied the deftness and accuracy that the making of the goods requires. Automata which men set working excel hand tools with men wielding them by a greater ratio than can be calculated.



The essential fact about production, as it is carried on by all society, is that it is a synthetic operation, by which a grand total is made up by the contributions of different industries. There is a corresponding fact about the production which is carried on within a particular line of business, or, as we should express it, within a particular subgroup; for within the subgroup there are laborers, on the one hand, and capitalists, on the other, helping each other to make a joint product. In our table A''', B''', and C''' are the goods of which the social income is composed. Subgroups, such as A, A', etc., help to make this grand total of finished goods; but in A, A', and all the other subdivisions there are laborers and capitalists working together. Farming, mining, cotton spinning, shoemaking, building, and a myriad of other occupations all work together to create an aggregate of goods which constitute the social income. In each of these branches of business there are men and working appliances contributing each a part to the quota that this branch furnishes.

Distribution as an Analysis.—The essential fact about distribution is that it is an analysis. It reverses the synthetic operation step by step, resolving the grand total produced by society into shares corresponding with the amounts contributed by the specific industries, such as mining, cotton spinning, shoemaking, etc. The men who own and work the mines do not keep the ore they secure, nor do they wish to keep it. The ore goes into a stock of goods for the general use of society, and it constitutes a definite addition to the value of that stock. As ore it is transmuted into a myriad of forms, merged with other materials and lost; but the amount that it adds to the total product of society is definite. It is a certain definable quantity of wealth, and that quantity of wealth the producers of the ore should get for themselves. Distribution further resolves the share of each particular industry into final portions for the use of the laborers and capitalists in that industry; and these correspond with the amounts which these laborers and capitalists contribute. The result of distribution is to fix the rate of wages, the rate of interest, and the amount of the profits of employers, if such profits exist; and the general thesis which is here advanced and remains to be proved is that, if society were without changes and disturbances, if competition were absolutely free, and if labor and capital were so mobile that the slightest inducement would cause them to pass from one branch of business to another,[1] there would be no true profits[2] in any business, and labor and capital would create and get the whole social income. Moreover, each laborer and each capitalist would get the amount of his personal contribution to this sum total. Amid all the complications of society the modern worker would be in a position akin to that of the solitary hunter in a primitive forest—his income would be essentially of his own making and would include all that he makes. He would not, like the primitive man, get the literal things that he fashions, but he would get the amount of wealth that he creates—the value of the literal products which take shape under his hand.

[1] It will be seen that we here assume for the process known as competition a degree of perfection which it does not attain in actual life. This process would be absolutely free if labor could and would instantly abandon one industry and enter another whenever it appeared that it could create an increased product by so doing, and if capital also moved with the same promptness on the smallest inducement. In actual life there is friction to be overcome in the making of such transfers, and this constitutes one of the subjects of the theory of Economic Dynamics and will in later chapters be fully considered.

Whenever either labor or capital thus moves to a new place in the group system, it becomes an active competitor of the labor or capital that was already there. We need a definition of the competing process. In the case of producing agents it consists in a rivalry in selling. The laborer who moves from A' of the table that, in the preceding chapter, has been used to represent organized industry to B', offers for sale, as some would say, his service, or more accurately, the product which his labor can create. The purchasers are the employers in the subgroup B', and in order to induce them to accept the new labor it is necessary to offer it at a rate of pay which will make it worth their while to take it. If the workers already in this division of the field are getting just what they are worth, a larger force cannot be employed at the same rate of wages, because, for a reason that will later appear, the new labor cannot offer for sale as large a product as an equal amount of the labor that is already there. If the transfer to B' were made, the new labor would have to accept lower pay than the old has been getting, and the old labor would be forced to accept a cut in its rate of pay or be supplanted by the new. A rate sufficiently low would insure the employment of all. If the labor formerly in this subgroup has been getting less than it is worth, there will ensue a competition among employers who desire to realize, each for himself, the margin of profit which can be made by getting additional labor, and this will either raise the pay of the men already in this subgroup or call new men into it, or do both. In any case it will, in the absence of all trace of monopoly on the side of the employers, end by giving to the men what they are worth. It is, in fact, such a bidding for new labor by employers in any branch of business that moves labor from point to point in the industrial system. The entrepreneur is the agent in the case, profits are the lure, and competition—rivalry in buying—is the means; and competition is, as we use terms, absolutely free whenever it is certain that the smallest margin of net profit will set it working and draw labor or capital to the profit-yielding point.

There is competition among the entrepreneurs at A''' in selling this finished product to the consuming public, and among different purchasers in buying it. Whenever the price of A''' is so high that the whole output of it cannot be sold, each vender tries to supplant others and insure a sale of his own product rather than that of any one else. Competition here is overt and active. When all can be sold at the current price, finding a market for one vender's supply does not require that he win away another's customers, and although the different sellers continue to be rivals and each would welcome an increase of patronage made at others' cost, no one is forced to underbid others in order to continue to sell his accustomed output. Competition is here quiescent, since actual underbidding and the luring away of rivals' customers do not take place. When entrepreneurs who are not now in the subgroup A''' are ready to enter it and to become rivals of those already there whenever any profit is to be had by such a course, their competition is not actual but potential; and yet it is a real influence and serves to deter producers already in the field from establishing such a price for their product that the possible competitors will become real and active ones. These three influences may conceivably act without obstruction or may be hindered and deprived of much of their power. In actual life they are subjected to hindrances, and whether they shall hereafter insure a certain approximation to the general state which a perfectly free competition would insure or whether the economic condition of the world shall be permitted to drift far from that normal state, depends on the success which governments will have in reducing or removing the hindrances.

[2] In this treatise the term profits will be used to designate the net increase which may remain in employers' hands after paying the wages of labor of every kind and interest on all capital used. The term gross profits describes a sum made up of this net profit and interest on the capital.

Standards of Wages and Interest.—This accurate correspondence between men's incomes and their contributions to the general earnings of society would exist only in the absence of certain changes and disturbances which it will be our aim, in the latter part of this work, to study. These changes give to society the quality that we shall term dynamic, and we shall examine them at length. What can, however, be asserted in advance is that the rates of wages and interest which would prevail if the changes and disturbances were entirely absent constitute standards toward which, in spite of all the changes that are going on, actual wages and interest are continually tending. How nearly in practice the earnings of labor and capital approximate the ideal rates which perfect competition would establish is a question which it is not necessary at this point to raise. We have to define the standard rates and show that fundamental forces impel the actual rates toward them. The waters of a pond have an ideal level toward which they tend under the action of gravity; and though a gale were to force them to one end of the pond and cause the surface there to stand much higher than the surface at the other end, the standard level would be unaffected and the steady force of gravity would all the while be drawing the actual surface toward it. In our study of Economic Dynamics we shall encounter influences which act like the gale in the illustration, but at present we are studying what is more akin to gravity—a fundamental and steady force drawing wages and interest toward certain definable levels. In our present study of Economic Statics we must seek to discover how these standards are fixed, in the midst of the overturnings which industrial society undergoes.

A''' B''' C''' H''' A'' B'' C'' H'' A' B' C' H' A B C H

We have already represented, in a highly simplified form, the synthesis by which the goods which make up the income of society are produced. A, B, and C represent different raw materials, and they are changed by a series of transmutations into A''', B''', and C''', which stand for all the consumers' goods that the society uses. They represent food, clothing, furnishings, vehicles, and countless means of comfort and pleasure.

The Making of Active Instruments of Production.—It is necessary always to have and use a stock of tools, machines, buildings, and other active instruments of production; and as these wear out in the using, it is necessary that there should be persons who occupy themselves in keeping the stock replenished. Under a system of division of labor there would be special industries devoted to the making of new appliances of production to take the place of those which are worn out and discarded, and also to make repairs on those which are still in use. For illustration, we may let the symbol H''' represent all active capital goods that the society uses, the various raw materials which enter into such active goods being represented by H and the partly made instruments by H' and H''. If the stock of appliances is not growing larger, just enough of the articles H''' are made to replace the discarded ones. No producer gets new machinery, but every one keeps his stock intact.

The Simplified Representation Correct in Principle.—We have now a very simple representation of what actually goes on under the name of the division of labor, and yet the representation is in essential points accurate. In reality a very detailed and minute division and subdivision of industries takes place and the varieties of goods produced are innumerable. Society, as a whole, is making the most highly composite product that can be conceived; namely, consumers' wealth in its countless forms. Each of the grand divisions of society—the general groups that we have represented by the series of A's or of B's—makes a complete article; but even that is in its own way far more composite than the symbol indicates, for it is apt to contain several kinds of raw material and to be made up of a large number of distinct utilities, each of which has its own set of producers. This complexity of the process of production does not change the principle of distribution, by which the product is virtually analyzed into its component elements and the value of each element is assigned to those who create it. This principle can be clearly represented by assuming that each subgroup has one distinct utility to create and that it takes only four of these to make an A''', a B''' or a C'''.

A Synthesis within Each Subgroup.—There is within each subgroup a synthesis going on, and this also may be complex. Labor and capital dig ore from the ground—an unusually simple process; and yet there are several distinct operations to be performed before the ore is ready for smelting. When it comes to fashioning the metal into useful shapes, the operations become very numerous and require many subordinate trades even for the making of one product. How many mechanical operations go to the making of a bicycle, an automobile, or a steam yacht? Too many to be represented in any table, but not enough to change at all the principle according to which those who help to make one of these composite products are paid according to their contributions to it. We may consider that all the work that is done in one kind of mill creates one utility. Though there are many subtrades in making a shoe and many more in making a watch, we may proceed as though there were only one transformation of the raw material required in each case. We may let the division between the contiguous subgroups be made commercially rather than merely mechanically, and regard the establishments that buy material and sell it in a more highly wrought condition as moving it forward by one stage on the road to completion, however many changes they may have made in it in the different departments of their several mills. The difference between shoes, on the one hand, and the leather and findings of which they are made, on the other, thus passes for one utility. A manufacturer of shoes puts his leather and findings through many operations before he has shoes for sale; but it is convenient to call all that the manufacturer imparts to these raw elements before he makes them over in their new form to the merchant, one subproduct.

Further Complexities which may be Disregarded.—One man may be in several of the general groups. It is possible, for example, that he may furnish raw materials which enter into more than one finished article. Iron is so extensively used that it goes into more products than can easily be counted. The man who digs iron ore contributes to the making of bridges, rails, locomotives, buildings, machines, ships, and tools in indefinite number and variety. The price of each of the articles into which any of this material goes contains in itself the price of that part of the raw material which goes into it. There is steel in a ship, and the maker of that part of the output of raw steel which goes into a ship gets his pay from the price of the vessel; and so with the crude metal which goes into a bridge, a building, an engine, etc. What the producer of a material gets from each source tends, under perfectly free competition, to equal in amount what he contributes toward the value of the corresponding article. In terms of our table a miner may furnish ore from which iron is taken for the making of both A''' and B'''; and if so, when the distributive process analyzes these products into their elements, the value of what he has in each case contributed will fall to him. He will be paid according to the help he has afforded in the making of the A''' and the B''', and this fact does not change in principle the manner in which the income of society is divided. If the man helped to make only one thing, he would get a part of the price of that one thing; but if he helps to make several, he will get a part of the price of each of them. Each group has one grand function to perform, such as the making of an A''', and if the man helps in more than one, and is paid accordingly, his total pay is according to the amount he produces in all the different functions he performs, and the principle of distribution works as perfectly as it would if the man were confined to the single subgroup A. For simplicity we assume that he is so.

The Functions of Capitalist, Laborer, and Entrepreneur often performed by One Person.—One person may perform several functions, not only by contributing to the products of several groups, but by contributing in more than one way to the product of one subgroup. He may, for example, both labor and furnish capital, and he may, further, perform a special cooerdinating function which is not labor, in the technical sense, and scarcely involves any continuous personal activity at all, but is essential for rendering labor and capital productive. What this function is we shall presently see. We shall term it the function of the entrepreneur, using this term in an unusually strict way. We shall keep this function quite distinct from the work of the superintendent or manager of a business.

How Much the Term "Labor" Covers.—We include under the term labor all effort expended in a routine way in carrying on business. The overseers in the shops, the bookkeepers, clerks, secretaries, treasurers, agents, and, in short, all who perform any of the labor of management for which they get or can get salaries are laborers in the comprehensive sense in which we use the word. It comes about that the employer usually labors; for he does the highest and most responsible work in his own mill or shop. It is not, however, in his capacity as entrepreneur, or "undertaker," that he labors; for, as the entrepreneur, properly speaking, he employs and pays for all the work that receives a stipend. He may employ himself, indeed, and set aside a stated sum to pay his own salary; but this means that in his capacity as entrepreneur he needs a good manager and hires himself to act in that capacity. Scrupulous fidelity is the most important quality that a manager can possess, and the employer can always trust himself to possess it so long as it is his own interests that he controls.

Entrepreneur and Capitalist.—In the same way we include in the capital of an establishment whatever invested funds the employer himself supplies, as well as what he hires from others. Here again a man is likely to serve in more than one capacity, for as an entrepreneur he hires capital and as a capitalist he lets it out for hire, so that in the one capacity he hires capital from himself acting in the other capacity. The man "puts money" into his own business and gets interest for the use of it.

The Different Functions of the Same Man distinguished in Business.—This distinction between the different functions that one person may perform is not a mere refinement of theory, but is something that is recognized in business and has great practical importance. In a corporation officials who are also stockholders receive salaries that are usually reckoned on the basis of the amount that they could get in the market if they were to enter the employment of other corporations and do the same kind of work they are now doing. Favoritism may give them considerably more than this amount, but even then this amount is the basis of the calculation which fixes their stipend. If they are paid more than their work is worth to their own corporations, what they get is something besides wages or any other normal and legitimate income. If they accept for their time less than they are worth, they make a donation to the corporation. Neither filching something for nothing out of the returns of the corporation, nor giving it a gratuity, is to be here assumed as existent, since we are not dealing with the phenomena of quasi-plunder or eccentric benevolence. The character of wages of management, as the reward for a high grade of labor, is recognized in business life, and the salary of the manager, whether he is a stockholder or not, is usually expressed in a definite sum of money and is gauged, crudely or accurately, according to his value as a servant of the company.

Dividends often Composite.—In like manner it is important in the bookkeeping of a company to ascertain how much of the return to the stockholders is merely interest on the capital they have themselves invested and how much is true profit, or the net gain which is over and above interest. In business life a distinction is pretty clearly maintained between the three kinds of income that have been described; namely, the reward of labor in all its forms, the reward of capital, going to whoever furnishes it, and the reward of a cooerdinating function, or the function of hiring both labor and capital and getting whatever their joint product is worth above the cost of the elements which enter into it. This essentially commercial margin of returns from production above all costs of production is profits in the strict sense and would be nonexistent in an absolutely static industry. It comes into existence in consequence of the changes with which social Economic Dynamics deals.

Three Incomes entirely Distinct.—Wages, interest, and profits, then, are the three incomes that we shall distinguish. We shall keep profits completely separated from the wages of any kind of labor and from the interest on any kind of capital. This income falls to the entrepreneur, otherwise called the undertaker, or the employer and cooerdinator of labor and capital, and it comes only when the product of the operations carried on in his establishment exceeds all wages and all interest that he has to pay.

How a Man could be an Entrepreneur Only.—If a man should hire all the capital that he needs in a business and also all the labor, including the labor of every man in the office force, and reside thereafter in a distant country, holding no consultations with his managers, whatever income he might get would be purely an entrepreneur's profit. It would not be interest—for that amount would have to be paid to the men who had loaned the capital—and it would not be wages—for they would have to be made over to the men actually doing the work. The absent entrepreneur would be, in the eye of the law, the purchaser of all the elements which go into the product, since all the purchases are made in his name. The managers are only his agents, and when they buy raw materials or supplies for the mill, they buy them for him and by his authority, and he is under the obligation to pay for them. Moreover paying wages is, in reality, buying the share which labor contributes to the product of the mill. The workmen have a natural right to the value which their work, of itself and aside from the aid furnished by others, imparts to the material that is put into their hands, and when they sell their labor, they are really selling their part of the product of the mill. In like manner paying interest is buying the share which capital contributes to the product. The owners of the capital have an original right to what the machines, the tools, the buildings, the land, and the raw materials, of themselves and apart from other contributions, put into the joint product. In reality they sell this share for a consideration in the form of interest. In a static state labor and capital together create the whole product of the mill; wages and interest are the prices that they get for their several contributions, and the entrepreneur pays these purchase prices and by virtue of this becomes the owner of the whole product. Having the product, he sells it in the market for what he can get. If this were more than the cost to him of all the elements that have gone into it, he would have a net profit remaining. It would be a remainder accruing to the owner and seller of the product after the costs of getting a title to it have been defrayed. Whether the absent entrepreneur of our illustration gets anything from his business or not depends on the question whether such a remainder of returns above costs is afforded.

Profits Nil in a Static Society.—We shall see that if labor and capital can move about in the system of groups so freely that each agent is as productive in one place as it is in another, there will be no product anywhere in excess of wages and interest. Labor and capital then create and claim for themselves the whole output of their industries. When the entrepreneur has given them their shares, by paying wages and interest, and has paid for raw materials, he has nothing left. In actual business competition is often sharp enough to prevent men from getting more than interest on their capital and a fair return for the labor they spend in directing their business; and pure theory here assumes that competition is always and everywhere sharp enough to do this. It is ideally efficient. Labor and capital are ideally mobile and ready to flow at once to the points where any net profits can be made. Such a condition implies that society is in a static state, and we shall see what this condition is. It implies an absence of organic change in society. The great collective producer does not alter either its form or its mode of producing wealth. Industry goes on, indeed, but it goes on in a changeless way. Reserving the full description of this state for a later chapter, we note here that the adjustment which would theoretically bring a society to such a state would preclude all gains for its entrepreneurs.[3]

[3] The preceding paragraphs may seem to show that if an entrepreneur ever gets an income, he does it by wresting from labor and capital a part of their products. We shall see that in dynamic industry there is a normal way in which he may get an income without taking anything from the incomes that labor and capital would get if he did not perform his part. His return may come from the result of an enabling act which he performs, whereby both the labor and the capital of a particular subgroup become more productive than other labor and capital are and more so than they would be if the entrepreneur's enabling act were not performed.

The Merging of Functions Desirable.—The uniting in one person of the functions of capitalist, laborer, and entrepreneur contributed much to the productivity of the small-shop system of former days. The man who had a few thousand dollars invested in a little shop and employed a few men to assist him got three different kinds of income, and the sum of the three was larger than anything he could have secured if he had been only a laborer or only a small capitalist and entrepreneur. He worked harder and more intelligently than a hired superintendent would have done; he was led to be cautious because his own capital was risked in his business, and yet he was spurred to enterprise by the fact that when, by virtue of the influences which we call dynamic, profits were made, he got them. Even in the largest corporations the same conditions contribute to success, and it is best that managers should be owners of some part of the capital which they handle and receivers of some portion of the profits which they try to secure for their companies. Where competition is sharp, companies directed by their owners may supplant those of which the direction is given over to hired managers. The growth of corporations does, however, tend to put salaried men more and more into controlling positions and to reduce the power of the body of stockholders, who perform a joint function as capitalists and entrepreneurs. In itself this tends to reduce profits and detracts from the advantages which the incorporation of a business offers.

Distribution primarily Functional rather than Personal.—Where men get incomes that are composed of wages, interest, and profits, economic science should, in the first instance, tell us how the rates of wages and interest and the amount of profits are determined. A study of the static laws of distribution concerns itself with the reward of labor as such, and the reward of capital as such, while a study of dynamics takes account of pure profits. When we know what the rates of wages and interest are, we can tell what any capitalist-manager should have by knowing how much capital he furnishes and how much and how well he works as a manager. If the business is yielding a net profit, over and above the interest on its capital, we can tell what part of this net income any one stockholder will get—in the form of a rate of dividends in excess of the rate of interest—if we know how much of the common stock of the company he owns. His personal income depends on the incomes attaching to the functions he performs. The science of distribution should tell us primarily, not what any man personally gets as a total income and how well off he is as compared with other men, but in what way the wages of his labor, the interest on his capital, and the return for the entrepreneur's function are fixed. In technical terms this is saying that distribution is primarily functional and not personal. Certain forces assign certain rewards to different functions which are involved in the creating of wealth, and the science of distribution tells us how these forces work—tells us, in short, how wages, interest, and true profits are, in and of themselves, determined. If any man works and gets wages, that part of his income will be determined by the wages law. If he furnishes capital, a second part of his income will be determined by the interest law. If he also cooerdinates labor and capital, whatever he may thus gain is determined by the law of profit. Economic science has to ascertain and state what these three laws are, though in its static division it has only to account for two of them.

Costs as well as Gains Apportioned.—The term distribution, as commonly used, denotes a division of the gains of industry; but as we have said, there are sacrifices which have to be borne in getting the gains, and these also have to be shared. Wealth benefits men in the using, but puts burdens upon them in the making; and when all society does the making, it has to apportion, in some way, not only the benefits but the burdens. We shall take account of these sacrifices because of the relation that they bear to the gains. They act as an ultimate check on production. Men would go on producing indefinitely if the operation cost them nothing, since it would always be agreeable to have a further income; but they necessarily encounter pains and sacrifices that, sooner, or later, bring the enlargement of their incomes to an end. Much that is of importance occurs at that critical point where the sacrifices of production put an end to the extension of it. It is the positive fruits of production that we have first to consider; and what in this connection we wish first to know is how wages and interest are determined when industry is carried on in a social way and under a system of competition. We shall find that these incomes are always tending toward standards which they would reach if society were in the state which we have described as static. How they are forced away from their standards by the changes and disturbances of actual life, and how the standards themselves change with social development, will be the subject of the latter part of this treatise.



Functional distribution controls personal incomes since each man who gets, in a normal way, any income at all performs one or more productive functions, and his total income is the sum of the returns for these several functions. Moreover under such a condition of ideally perfect competition as we have assumed each of these functions is rewarded according to the product that it creates; and each man accordingly is paid an amount that equals the total product which he personally creates. Men's products, even in the disturbed conditions of actual life, set the standards to which their returns tend to conform, though they vary from them in ways that we shall not fail to notice.

Group Distribution.—The grand total of the social income has to go through a preliminary division before it is shared by laborers, capitalists, and entrepreneurs. In each industry the pay of all these functionaries comes from the selling price of the commercial article that they cooeperate in making. The price of shoes pays all shoemakers, whether what they contribute to the manufacturing is labor, capital, or mere cooerdination; and it also pays ranchmen and tanners for what they contribute in the shape of leather, raw and dressed. If the price of shoes should rise, there would be a larger income for the group whose activities create them. So if woolen clothing were to become dearer, there would be more money for the group that makes it, and this would include those who raise sheep and those who convert wool into cloth, as well as the garment makers themselves. The question, what members of a group would get the benefit of a rise in the price of its product, is one that must be discussed in connection with economic dynamics, and we shall find, when we reach this part of the subject, that it is entrepreneurs' gains which come largely from sources like this. We have already seen that, in a static condition and with prices, wages, and interest immovably held at rates to which perfectly free competition would bring them, entrepreneurs as such would get nil, and the whole price of every article would be distributed among the laborers and the capitalists who make it. The proof of this will appear when we have examined the process by which the values of goods are adjusted, and this will help to prepare the way for a study of the sources of net profits, which are an all-important feature of actual business. Society is honest or dishonest according as this entrepreneurs' income is gained in one way or in another; and it is not too much to say that before the court of last resort, the body of the people, no system of business will be allowed permanently to stand unless the basic principle of it tends to eliminate dishonest profits. A chief purpose of static studies is to afford a means of testing the legitimacy of the incomes that come to entrepreneurs.

Market Price.—The old phrase supply and demand describes the process by which the market price of anything is determined. The total mercantile stock of goods of a particular kind at any one time on hand is, of course, an exact quantity, and the law of "market value," when these words are used in a restricted and technical sense, determines the price at which this predetermined amount can be sold.

How a Normal Supply is Determined.—This present stock, however, was brought into existence by producers who looked forward to the time when they could probably sell it at a certain price; and the higher this anticipated return for the article, the more of it they were induced to make. The price, which to-day depends on the quantity on hand, acted in advance as a lure to bring that quantity into existence, and among the different articles which men can produce, they are forever singling out for increased production those things which offer the strongest lures—that is, the things that sell for the largest amounts as compared with the cost of making them. The ultimate tendency of all this is a certain adjustment of the relative supplies of different commodities. It is that adjustment which brings all prices to a level determined by cost.

Natural Value.—This tendency toward cost prices—those which afford to the producers wages for all their labor but no true entrepreneurs' profit—establishes a further law, that of "natural value," and this it is that fixes the standard to which, in the long run, market values, as adjusted by supply and demand, tend to conform. A market value is natural or unnatural according as it does or does not conform to a certain standard, and this ultimate standard itself is the cost of producing the several kinds of goods. What the term cost in this connection really means we must later see; but for the present we may take the common and practical view that it is the amount of money that an entrepreneur must pay out in order to bring the article into existence. If there were very little wheat in the granaries of the world, demand acting on this limited supply would determine the selling price of it, and this price would be high as compared with the cost of raising this grain. It would also be higher than the selling prices of other things which are produced by the same expenditure of labor and capital that has to be made in raising the wheat. The market price would, for the time being, be unnatural and would in due time be brought down; but this would have to be done by the raising of more wheat. In other words, though the selling price of a small supply of wheat may be normal for that amount, the amount supplied is itself abnormally small, and in view of that fact the resulting price is too high to be allowed to continue. As a permanent price it would not be natural. The quantity supplied tends to increase till the market price conforms to the cost of raising the wheat. We have to see, first, how demand fixes the price of a definite amount of anything which is offered for sale and, later, how the quantity offered is controlled.

How Prices are Determined.—It is certain that if, in a given market, we increase the quantity of goods that are to be sold, we lower the price,[1] while, if we diminish the quantity, we raise the price. That is the commercial fact and it furnishes a beginning for a theory of value.

[1] The term market, as used in this discussion, means a local area within which goods of given kinds are bought and sold; and for different purposes we may make the area small or large. For some purposes it is necessary to take a "world market" into consideration, while for others it is desirable to include only that part of the world within which competition is very active and within which also goods and persons move freely and cheaply from place to place. A single country like the United States affords a market large enough to illustrate the laws of value, though one must always keep in view the relation of this circumscribed area to its environment. How local areas may, in a scientific way, be delimited and isolated for purposes of study will appear in a later chapter.

Let us suppose that we have a fixed quantity of goods on hand, that all must be sold, and that no one knows at the outset what price they will bring. There might conceivably go on an inverted kind of auctioning process, in which the sellers at the outset would ask a high rate, sell a few of their goods, and then gradually reduce the price till the last article should be sold. At each reduction of the price the "effectual demand," so-called, would increase. This means that the people who want the article are actually willing to take and pay for larger quantities the lower the price falls. Mere desire does not influence the market, but an "effectual demand" means a desire and a tender of the money that is asked for the goods. It is, in short, an actual purchase and the amount of it becomes larger as the price goes down. People who did not buy the article before now add it to the list of goods that they take for use, and the people who were already taking a certain quantity of it now take more.

Equation of Supply and Effective Demand.—If this effective demand, or amount of goods actually bought and paid for, becomes steadily larger the lower the price becomes, it is clear that, however large the total supply may be, it can all be sold by making the price low enough. It was once thought that this is all we need to know of prices current or market values. At some selling rate or other the quantity actually offered will come to equal the quantity that is actually bought. This is the equation of demand and supply. The quantity offered is here supposed to be fixed and to include all of the article that is in dealers' hands and that has to be sold; and the price, starting at a high rate, is supposed to go down till the sale of the entire quantity is effected.

Varying Demand and Price.—The facts that have just been stated account only in a partial way for the adjustment of market price. One who wishes to trace phenomena to their causes cannot help asking why demand and supply insure the selling of a given amount of goods at one rate rather than at another. If apples are offering at two dollars a barrel, why is it that, in a particular local market, one thousand barrels and no more can, at that rate, be sold? We can readily see that at one dollar a barrel more could be sold than at two, and that at three less would be sold. But why is it that, at two dollars, the definite number of one thousand barrels is the amount that is taken and paid for? Why is the equation of demand and supply established at exactly that price?

Demand and Final Utility.—We come nearer to the cause that acts in adjusting the price of apples when we say that they sell at two dollars a barrel because that sum expresses their "final utility." This means that, if such an auctioning process as we have described were resorted to, the last barrel of apples which would be sold would have to the buyer an amount of utility just equal to that of the final unit of any other article that could have been had for the same money. The auctioning, however, would cause different barrels of apples to sell at different prices, whereas there is something in the working of competition which causes all of them to sell at the same price. It is necessary to see, first, how the price of the "final" one is adjusted and, secondly, how that fixes the price of all the others.

The Law of Diminishing Utility.—We revert here to one of those general laws of economics that we have already stated and see it acting under the conditions of distinctly social life. Goods of a given kind have less and less utility, per unit, the more the user has of them. If you offer him apples in increased quantity, he will value the first part of the supply highly, but will attach less value to the later parts. When the desire for this fruit is fairly well satisfied, he will find other articles of more importance. At the price of two dollars a barrel it is just worth his while to buy a final barrel of them. That quantity, as added to his winter's supply, will give him two dollars' worth of benefit. This means that it will do him as much good as anything else which he can get for the same amount of money.

The Equalization of Final Utilities.—Two dollars spent in adding to his previous stock of other things will do the man in the illustration the same amount of good that he can get from a final barrel of apples, and no more. In the case of goods which are all alike and of which consumers are always glad to use an additional amount, prices tend to adjust themselves in such a way that a final unit of any one which the consumer buys with a dollar is worth just as much to him as a final unit of any other article he buys with that amount. The last dollar paid for apples is as remunerative, in the way of pleasure and benefit secured, as is the last dollar used to improve his wardrobe, to add something to his stock of furniture, to buy tickets to the theater, etc. Apples have, as it were, to compete with clothing, furniture, and amusements for the consumer's favor, and if the vender charges more for them than do the venders of other things having the same power to give pleasure, some of the apples will remain unsold; for though customers will always give as much as they would have to pay for other things of equal final utility, they will not give more.

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. Competition 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 passed 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 assumption 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 incumbrance. Its utility would be a negative quantity. 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 assumption 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 illustration 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 quantity, 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 aptitudes, 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 analyzes 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 quantity 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 assume 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, competition 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.

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