Supply and Demand

Chapter X

These conclusions enable us to give a general answer to the question which was raised at the end of Chapter V: What are the ultimate real costs to which the money cost of production correspond? The attempt has often been made to relate money costs to such things as the effort of working and the sacrifice of waiting. The existence of such costs is beyond dispute. Much saving does mean a sacrifice of immediate enjoyment to the man who saves. Most labor is irksome and disagreeable in itself, and involves strain and wear and tear; while all labor means a deprivation of the utility of leisure. Workpeople, moreover, do not grow on gooseberry bushes, but must be fed and clothed from the cradle; and their rearing and maintenance represents a real cost which someone must incur.

But the existence (or the importance) of such costs is one thing, their relation to money costs is another. In Chapter VIII we saw how difficult it was to establish any clear relation between the rate of interest and the sacrifice of saving. The costs of labor present similar difficulties. The relative irksomeness of two occupations may affect the relative wages which will rule in the two cases; so, certainly, will the differences in the cost of education and training which they require. But these are matters which concern the apportionment of labor between different employments. There is no good reason to suppose that the general wage-level would be reduced, merely because work as a whole became less irksome, or involved a smaller physical or mental strain. The supply of people is not determined by the same kind of influences as is the supply of a commodity. Parents do not produce children for the sake of the wages which the children will receive when they go out to work; or, if this happens, we rightly regard it as a horrible anomaly. In so far as parents are affected by economic conditions it is by their own economic conditions; the question is rather one of how many children they can afford to have, than of a balancing of the cost to them against the incomes which their children may subsequently acquire. But other considerations enter in; and, in fact, it is doubtful how the aggregate supply of labor will react to changes in prosperity. Finally, the supply of land involves neither effort nor sacrifice; and, among our money costs, we have to account for the item of the rent of land. To dispose of this difficulty by arguing that rent does not enter into marginal costs (in any sense which is not equally true of wages and profits) is to lose contact with reality. Thus the attempt to explain money costs in terms of the costs of producing the ultimate agents of production leads us into a quagmire of unreality and dubious hypothesis. For a systematic theory, which will rest on firm foundations, we must interpret money costs in very different terms.

The real costs which the price of a commodity measures are not absolute, but comparative. Marginal money costs reduce themselves in the last analysis to the payments which must be made to secure the use of the requisite agents of productions. These payments tend to equal the payments which the same agents could have commanded in alternative employments. The payments which they could have commanded in alternative employments, tend in their turn to equal the derived marginal utilities of their services in those employments. It is thus the loss of Utility which arises from the fact that these agents of production are not available for alternative employments that is measured by the money costs of a commodity at the margin of production.

This conception of ultimate costs encounters an instinctive repugnance, arising from a mistaken sense of logical symmetry, which it will be well to examine. Cost, it is objected, so interpreted loses its character as an independent entity. It is merely something derived from utility. Now in the earlier chapters of this volume, we found reason to be impressed with the general symmetry which pervades the relations of demand and supply. Moreover, when we considered the case of ordinary commodities we found that at the back of demand and giving rise to it was utility; at the back of supply, and limiting it, was cost. The general symmetry between demand and supply thus seemed almost to imply a fundamental symmetry between utility and cost. If, then, cost in the last analysis is derived from utility, does not this make nonsense of the symmetry between demand and supply, or, if we cling to this last symmetry as a demonstrable truth, must we not refuse to admit that cost can be derived from utility?

This is one of those false dilemmas which supply the wiseacres of the world with a plausible case for distrusting the logical faculty. If we have good reason for believing that both of two apparently inconsistent things are true, the explanation is seldom that one of them is really false; it is more usually that they are not really inconsistent. So it is here. The symmetry between demand and supply is very great, and we should always look to see if it holds good, but it is by no means perfect, and it is in the last analysis that it most notably fails. It is most important to distinguish clearly between the utility and the cost of a commodity as two separate and independent things. In Chapter V, it will be remembered, we did not permit ourselves to derive the costs of producing cotton lint from the utility of cotton-seed. The refusal to do so was essential to clear thought; it led to some very useful practical corollaries. But to derive the cost of a commodity from the utility of something which is produced with it, as part of the same productive process; and to derive the cost from the utilities which the agents, which help to produce it, possess for other purposes, are two entirely different things. In works on International Trade, the reader will discover that the comparative nature of real costs is so unmistakable that a Doctrine of Comparative Costs is expounded with much formality at the outset. This doctrine is apt to prove somewhat puzzling, when we have to deal with it as an apparent exception to the general tenor of economic theory. Its difficulties disappear when we realize clearly that the real cost of anything is the curtailment of the supply of other useful things, which the production of that particular thing entails.

§2. The Allocation of Resources. However strange the above conception may seem, there should be no doubt that this cost is very "real." Here the irregularities and maladjustments of the economic world, the recurrence of trade depressions and the like, do much to obscure a clear vision of the essential realities. At a time when there is much unemployment, and much machinery standing idle, it is so clear to common sense that we could produce more of some particular thing without diminishing the supply of other things, that any apparent statement to the contrary may perhaps seem the height of academic pedantry. But let me ask the reader to consider with an open mind a familiar parallel. During the recent war there was inevitably much waste and muddle in the utilization of the military resources of the Allies. Some regiments would be kept inactive for long periods, not for purposes of rest or training, but owing to some defect of organization. In the manufacture of munitions, an insufficient appreciation of the principles of joint demand led to the piling up of excessive stores of certain materials, which were useless until commensurate supplies of the complementary factors could be obtained. It is unnecessary to multiply examples. The waste of both man-power and material was immense. But the allocation of these resources between, for instance, the various theaters of war was none the less a very real problem, which gave rise to much engrossing controversy. It was an axiom that the more resources you employed in Mesopotamia or in Palestine, the less resources remained available for France. No one thought of maintaining that, as long as there was any waste of these resources, so long as there remained any men to be "combed out" of unessential industries, you could pour troops and munitions into Salonika without stopping to consider the needs of other theaters of war. Such a notion would have been clearly imbecile, for the sufficient reason that the sending of armies to Salonika would do nothing in itself to secure (however much it might incidentally stimulate) the more efficient use of the resources which remained.

Now this is precisely analogous to the problem of the allocation of our resources for the purpose of peace. Notwithstanding all the wastes and maladjustments of the economic system, the use of resources to produce one commodity does in general curtail the production of others. The mere launching of a new business enterprise does no more than the sending of an army to Salonika, to eliminate waste in the remainder of the economic organism. Unemployment, broadly speaking, is a function not of the magnitude of the normal demand for labor (which affects rather the wage-level), but of fluctuations in the demand for labor; fluctuations from one day to another as at the docks, from one season to another as in the building trades, above all from one period of years to another as in the cycles of general trade boom and depression. Nothing will diminish unemployment which does not serve to diminish these fluctuations. A new business will not, as a rule, have any such effect. If it is launched during a trade depression (a most unusual proceeding), it may temporarily absorb unemployed labor and idle materials. But when the next boom comes, it will be using, though presumably to greater advantage, labor and materials which, but for it, would have been employed for other purposes. Meanwhile the causes making for unemployment will be unaffected. Miscalculations will still be made, the building trades will still become slack in the winter, the casual methods of engaging dock laborers will still continue, trade cycles will still recur, while beneath them, and concealed by them, some industries will expand and others will decay. Thus, like the armies at Salonika, the new business would in effect divert resources from elsewhere.

This truth needs to be firmly grasped in mind. It is this that makes it in general unsound policy to subsidize industries, either directly or indirectly, by means of a protective tariff. It is this, indeed, that supplies the answer to half the economic fallacies that are always current.

The allocation of resources so as to yield the maximum effect was rightly recognized as one of the most vital and difficult of our war-time problems. To cope with it, the Allied peoples devised one instrument after another, and finally evolved the Supreme Allied Council. The analogous problem in the economic world of peace time is no less important and far more difficult; but there is nothing to correspond to the Supreme Allied Council. There we rely upon a co-operation which, as was stressed in Chapter I, is unco-ordinated. That co-operation has been evolved by the mutual competition of innumerable business concerns, controlled by men largely animated by the motive of pecuniary profit. But it has not been evolved wholly by such means: and how far that competition or that motive of profit is essential to its efficiency are questions with which this volume has not been in any way concerned. The economic laws, the relations between utility, and price and cost, with which it has been occupied, are an entirely different matter; and these are essential to the efficiency of any system of society. For if the marginal utility of a commodity is equal to its marginal cost, and if this marginal cost is composed of payments to the various agents of production at least as great as they could have obtained if they had been used otherwise, this amounts to saying that the agents of production are so utilized as to yield the maximum utility; and this is the same thing as saying that they are so utilized as to produce the maximum wealth.

§3. Utility and Wealth. Upon this last point it is important to be quite clear. An increase in wealth seems a solid, tangible reality; something, which, however much we may scorn it in our more precious moods, we recognize, for a rather poor community, to be an important object of endeavor. But an increase in utility seems a vague, impalpable notion, hardly deserving the same practical concern. None the less the two things are identical. We greatly deceive ourselves if we suppose wealth to be an objective reality. It is true that, when we get behind the money in which it is measured, we come upon commodities, like food and clothes and houses and factories, which seem comfortably solid and objective things; but we also come upon many services, like those of gardeners and doctors and hospital nurses, which we are bound to reckon as part of our wealth, although they are not embodied in any tangible commodities. Moreover, although material commodities are objective realities in themselves, and in many of their properties, they are not objective realities in their property as wealth. A pair of boots is an objective fact; so is the number of pairs in existence at any time, so is their size, their weight, the quantity of leather or of paper which they happen to contain. But the wealth which those boots represent is not an objective fact. It depends upon the opinion which men and women entertain as to their utility; and these opinions take us into the subjective regions of human psychology. Let us suppose, for instance, that we calculated, on the basis of present prices, that the boots in existence at the present time represented 1/1000 part of our total wealth. Suppose, then, that a miracle were to happen; that the skies opened and rained boots upon us, of every size and shape and pattern, until we had 1000 times as many boots as we had before. Could we say that our total real wealth had been doubled? Clearly we could not. To obtain boots for nothing, and to wear a new pair every week, would make us somewhat better off, but not twice as well off as we were previously. In other words, the real wealth of a thousand times as many boots as we have now, is not a thousand times as great as the wealth of the present number of boots. We are, indeed, practically restating the Law of Diminishing Utility; and this perhaps is enough to show that wealth is fundamentally the same thing as utility.

Another point, however, is worth noting. Our real wealth would be somewhat increased in the case supposed; but if we were to turn to the money measure of wealth, the opposite result would be far more likely, For the price of boots would most likely fall to nothing, and the total value of boots, in the commercial sense, would accordingly be nothing also. This shows that money values may be a most imperfect measure of aggregate wealth; for what money values represent is the product of the quantity of the commodity and its marginal utility, while aggregate wealth is total utility, which is a very different thing. This, it may be observed, makes all attempts to compare the wealth of different countries or different times, and no less to construct Index Numbers of Prices, imperfect of necessity, and arbitrary in their foundations.

§4. Criteria of Policy. The point has now been reached at which we must take into account the very important fact which was mentioned at the close of Chapter III. The maximum utility which the laws of supply and demand tend to bring about is a maximum total utility indeed, but one still measured in terms of money. An unequal distribution of wealth destroys any necessary correspondence between that and the maximum real utility. This consideration, however, does not affect the general validity of the conclusion that the laws of supply and demand represent what is socially desirable now or under any system. For what is at fault here is the distribution of wealth; and it is that which should be changed, in so far as it is possible to do so. Now it is important to realize that whenever it is possible to supply a commodity to poor people below cost price, it is possible to alter the distribution of wealth, for that in effect is what is done. Purchasing power, which may be taken from richer people by taxation, or which may be obtained from "collective" profits on other trading, is in effect transferred to the poor people in question, though the transference is coupled with the condition that the purchasing power must be expended in a particular way. It is in general desirable that the transference should be made without this condition being attached. To this general statement, exceptions indeed exist so numerous and important as possibly to justify a great extension of social expenditure of this type. Education should certainly be provided free of charge, there are strong arguments for subsidizing housing; the provision of milk to expectant mothers, the feeding of school children, such instances can be multiplied into a very extensive list. But it is important to observe that in each case the justification of the policy rests in the presumption that the service supplied is one which it is particularly important that the beneficiaries should have, as compared with the other things upon which they might have preferred to expend the equivalent purchasing power, had it been transferred to them without conditions. Where there is no such presumption, as surely there is none in the case of the great bulk of commodities, the relation between price and marginal cost should be rigidly maintained; it is the distribution of purchasing power which we should rather seek to alter. How far is it possible to alter that?

I suppose that it is inevitable that many readers will have concluded that the preceding chapters must be taken to mean that the distribution of wealth is not susceptible of any appreciable change. I would remind those readers of an important distinction upon which impatient people have sometimes based a complaint against economists. The economist, it is said, analyses with great pomp and ceremony the laws governing the distribution of wealth among the agents of production, but says practically nothing about the distribution between individuals and classes, which is the only thing of any real interest to practical people. Now the economist concentrates on the agents of production for the very good reason that it is only with respect to them that any clear and certain laws as to distribution can be laid down. Into the distribution between individuals and classes there enter other and variable factors, governed by no fundamental economic law; and here, the conclusion should at once suggest itself, is the field for action designed to alter the distribution of wealth. What is possible or desirable in this field, it is again not the purpose of this volume to discuss. It is an obvious, even if not a very helpful conclusion that an increase in the habit of saving among weekly wage-earners might, without appreciably affecting the distribution between Capital and Labor, greatly modify the resulting distribution between social classes. But questions as to how far it might be possible or justifiable to achieve a similar result by the use of the weapon of taxation, by changes in inheritance laws, or by the public ownership of industry take us into a far more uncertain and controversial sphere. The difficulties and objections which present themselves are familiar and formidable; but they are of quite a different order from the economic laws which we have been examining. The laws themselves do not entitle us to make any dogmatic pronouncement upon these large issues of social policy.

But this is not to deprive these laws of practical importance. They represent essential criteria of sound policy in the sphere of social reorganization no less than in ordinary business. In our days a curious obsession has led many people to disparage these criteria, as though they were the sordid prejudices of a stupid tradesman. Because it has been found a matter of obvious practical convenience to maintain the roads out of taxation or of rates, and to dispense with charges for their use, it is suggested that the same principle should be applied to the railways. Or, more commonly, because it has been found convenient to make the same charge for the carrying of letters between Land's End and John o' Groats as between Hampstead and Highgate, it is suggested that this principle should be applied to railway rates and fares. It may be well, therefore, to point out that the justification of uniform postal charges rests upon the facts: (1) that the costs of collection, sorting, etc., are so large a part of the costs of carrying a letter, that the real cost between John o' Groats and Land's End does not differ from that between Hampstead and Highgate by as much as might at first sight appear, (2) that the charges in any case are very small; so that (3) the avoidance of the small degree of taxes and bounties which the present system implies is not worth the book-keeping expenses which differential charges would involve. It should be obvious that these considerations apply to the railways with a greatly diminished force. They might possibly justify what is known as the "zone" system of charges, i.e. uniform rates within certain narrow areas. But the notion of uniform rates throughout Great Britain conjures up a vision of trains taking coal from South Wales to Scotland, and others taking coal from Scotland to South Wales, in accordance with the slightest preferences of the consumers, and without regard to the extra real cost involved, on a scale to which the "wastes of competition" afford no parallel. It would in fact achieve the essential folly of "sending coals to Newcastle." These considerations, however, are not what interest the advocates of the postal principle. They seem to recommend the obliteration or the confusion of the relations between price and cost as a superior ideal. It is important to be clear what exactly this ideal involves.

It involves, in the first place, as the whole argument of this volume has gone to show, a less economical employment of our productive resources; they would be diverted to ends of less utility, and so produce less real wealth. But this is not the worst. There is plenty of waste and maladjustment in our economic system at the present time. The desirable relation of price to marginal cost is but imperfectly attained. The further departures from this relation, which would follow from any likely applications of the postal principle, might not matter in themselves so very much. What is far more serious is that the criteria of efficiency would become blunted, and the clear aims of management would be confused in fog. It is essential that every manager should be on the alert to eliminate waste and to improve efficiency, that he should be always trying to secure the best results; but how can he do this if he has no simple means of measuring what results are good and what are bad? The measure which he has at present is that of price, cost and the resultant profit, and it would be fatal to take that away, unless an equally simple and more accurate measure could be substituted for it.

This is not a question, it should be observed, of motive or incentive. Very likely we much exaggerate the importance of the profit motive. It may be true that men would work, perhaps that they already work in fact, as zealously for a fixed salary, as for personal gain. But aim and motive are two somewhat different things, and the aim of profit, is, and will remain, essential to the efficient conduct of business. In a game the players are not animated by the motive of scoring runs or points, but they aim at them; and the zest disappears very speedily from the game, if that aim ceases to be of interest. Moreover, while a scoring system is always a somewhat arbitrary thing, measuring imperfectly the true merits of the play, if it measures them with the roughest accuracy, we prefer the issue of our games to be decided so, rather than by the decisions of an impartial judge, who can take into account the finest points of skill. So it is in the world of business. The scoring-board of profits may be an imperfect one; let us, by all means, where we can, alter the rules of the game so as to make it better. But let us not imagine that it displays a finer insight or a superior intellect to speak as though the scoring-board could be dispensed with, and the test of profit and loss treated as irrelevant. Quantitative measurement is essential to efficiency. Let us be careful to remember all that this implies.

Index