Value And The Producer
( Originally Published Early 1900's )
1. The producer controls the supply.—In the pre-ceding chapter we have seen that the consumer has much to do in the creation of the phenomenon called value. From him comes the demand for commodities, and so-he might seem to be in absolute control of their value.
But the consumer cannot wholly control his desires. Imperious wants possess his soul and he demands their gratification. The producer, knowing the existence of those wants, brings into existence the things that gratify them and demands a price which will give him compensation for his labor and sacrifices.
The producer controls the supply. If the price offered him is unsatisfactory, he declines to produce, and the competition which follows among consumers for the possession of the lessened supply causes the price to rise.
Thus it is evident that in the determining of market prices or values the producer is a factor quite as important as the consumer. In one the demand originates; the other brings forth the supply.
2. Value and cost of production. As we have said in a previous chapter, cost of production means the amount of human effort necessary to produce an article. A farmer who builds a fence around a new pasture, devoting a week to the task and doing all the work himself, would probably think it had cost him only the amount of money he paid out for posts, boards, nails, but he would be mistaken. That would be merely ifs expense of production. The real cost would be the week's labor plus the labor that brought him the money which paid for the materials used, plus the care and constraint necessary to save the money.
In the production of goods capital as well as labor is employed. The producer expects to sell at a price that will enable him to replace the capital used up, to pay interest to its owner, to pay the wages of labor, and still have left a surplus or profit at least equal to what he might have made by working for others. If the market for any article is disappointing and some producers are compelled to sell below cost, those who are less able to hold on in the hope of a higher price in the future will cease to produce, whereupon as a result of the lessening of .the supply the market price tends to rise. On the other hand, if the market for an article is far above the cost, so that its makers are earning unusual profit, new men are tempted to put their capital and energy into the industry, and those already engaged in it are inclined to increase their output; the result is an increase of production, an increase of supply and a tendency of the price to move downward.
Thus it is clear that value or price in the long run fluctuates about the cost of production, always tending to coincide with it. This fact was so obvious to the economists of the last century, particularly those of the English Classical School, that many of them made cost the determining factor in the creation of value. This was a mistake; as we have seen, utility is also an important factor. Which is the more important, cost or utility, it would be idle to discuss. It would be like trying to decide which is the more important—the fishhook or the fishline, the pipe or the tobacco, the lamp or the kerosene, the button or . the button hole, the hook or the eye, the upper or the lower blade of a pair of scissors.
3. Marginal producer.—The cost of producing an article varies in different factories and in different locations. This fact is most noticeable in the extractive industries, such as agriculture and mining, where production is clearly subject to the law of diminishing returns and increasing costs. But it is true also in the case of manufacturing industries. The costs in one factory may be relatively low because of its advantageous location near a railway, or because it utilizes water power at little expense, or because its owner has mastered a process known only to a few, or because it is located in a community where cheap labor is available. On account of circumstances like these it is not possible to say definitely what the cost of any article is. If we knew what its cost was in all the factories where it was produced, we could, of course, get its average cost, but that is impracticable and the information would not be worth the effort to get it.
Society is greatly benefited by any reduction of costs and men of inventive genius are constantly at work seeking to bring this about. The man whose costs are lowest can sell at the lowest price without suffering loss and, on the other hand, make the biggest profit when prices are high.
With which of these various costs does value tend to coincide? Is it with the lowest cost, with the highest cost, or with the average cost?
It may seem paradoxical to the reader, who has never thought of this subject before, yet it is a fact that the value of any article always tends to coincide with the cost of that part of the supply which is produced at the greatest disadvantage, so that in any industry those factories in which costs are highest are more important in the determination of value and market prices than all the others. For convenience such factories are called the marginal producers. They are said to be on the margin of production.
It is evident that the marginal producer, the man whose costs are highest, is the most anxious about prices, is least willing to sell when prices are low, and is the first to suffer loss when the market for his article weakens. He stands, as it were, on the margin of prosperity, on its very edge, and is easily pushed over the precipice into bankruptcy.
In times of great prosperity, when the prices of many articles are advancing, the marginal producers in some industries begin to make great profits, then more entrepreneurs and more capital are attracted into those industries, more factories are built, and more goods are manufactured, even tho the cost in the new factories exceeds that in any of the old. The old marginal producers are now no longer on the margin, a new class stands there, and as a result of the increase in the output there is normally a tendency toward lower prices. If prices do go back to the old level, the new marginal producers are the first to suffer and those who are financially weak are compelled to withdraw from the game. On the other hand, if in spite of the increased supply the market absorbs all the product and demands more, then prices will continue to rise and still other producers, some of them not well equipped to cope with the problem of costs, will enter the field and thus again a new class of marginal producers will be created.
It follows therefore that in economics the marginal producer is an important personage, rivaling the marginal consumer. The one is least anxious to sell and most anxious for a high price; the other is least anxious to buy and is insistent upon a low price.
Figuratively speaking, these two people meet in the world's markets, do their best to circumvent each other, higgle and haggle and bargain, accuse each other of various unfair practices—and the outcome of all their dickering and bickering is the market price.
It goes without saying that no man would like to admit that he is a marginal producer; it would seem to be an admission of incompetence or stupidity. Nor do marginal consumers advertise themselves as such lest they be suspected of meanness and stinginess. In reality these two important classes in any community fight out the price-fixing battle, not only with-out knowing one another, but even without knowing that they are engaged in it. The marginal consumer fights when he walks out of a store without buying because the price is too high; the marginal producer fights when he shuts down his factory and curtails the output, virtually saying to the consumer, "If you won't pay my price, you can't have any more goods from me."
4. Costs when competition is free.—In the foregoing discussion freedom of competition has been assumed, men being free to enter any industry which offers satisfactory returns. But this should not be understood to mean that there is any large body of capital standing ready to enter an industry at an instant's notice as soon as a prospect of a satisfactory return appears. For several reasons capital and labor cannot always be advantageously transferred from one industry to another. In the first place, in many industries different kinds of skilled labor are required, and the supply of this is usually limited. In the second place, the business manager of many an industry must be a man possessing not only executive ability but also technical knowledge, and the number of such men is limited; in fact, such men are usually well employed. In the third place, many industries are dominated by such large combinations of capital that a newcomer is at a disadvantage in the purchase of raw materials and in the transportation of his products, not to mention the fact that his big competitor enjoys the advantages of large-scale production, can usually increase its output easily, undersell him, and finally drive him from the market.
In so far, however, as competitive conditions do prevail, the market price of an article tends to coincide with its highest cost of production. An agricultural product like wheat furnishes a good illustration. When wheat sells at $1 a bushel, no farmer will knowingly sow it on a field where its cost will exceed that sum. If its price advances to $1.50 be-cause of an increase in the demand for it, without a corresponding increase in the supply, farmers will then cultivate it on fields where, because of less fertility or more distant location, the cost is near that figure. If the price rises to $2, still poorer and more distant land is brought under cultivation.
Let us suppose that there are ten different varieties of wheat land in a certain country, calling the best No. 1 and the poorest No. 10, and let us suppose that $2 a bushel covers the cost of producing wheat on land No. 8. If the demand for wheat is such that wheat can be sold at $2, land No. 8 will be cultivated; but if the price falls below $2, the cultivation of that land will cease. Thus variations in the supply of wheat which. affect value are due to changes in the supply of wheat produced on the poorest land under cultivation. For this reason economists call, such land marginal land and hold that the price of wheat in the long run tends to coincide with its marginal cost, that is, with its cost of production on the land least fitted for its cultivation.
The reader should note that the value of wheat is not determined by the cost of its production. No consumer pays $2 for wheat because it costs that sum. Nor is any producer, or set of producers, able to fix the price. The price is the result of competition among the buyers who want the goods, and of competition among the producers who are unwilling to produce unless they can make a profit. In a sense this competition is involuntary and unconscious; the consumer is simply seeking to get the most satisfaction out of the expenditure of his income; the producer is thinking merely of compensation for his labor and enterprise. The consumer will not pay for an article more than it seems worth to him. The producer will not make the article unless he can sell it at a profit. As a result of this involuntary competition among consumers and producers, we have changes in the demand for and supply of goods and, consequently, changes in their values.
5. Monopoly costs and prices.—When a concern has a virtual monopoly in the manufacture and sale of any article, the competition of other producers being a negligible quantity, it is able by the regulation of its own output to exercise great command over the value and market price. An absolute monopoly can of course, exact any price from a consumer that it pleases to ask, but it cannot compel the consumer to buy. If it wishes to make the most money possible it must give heed to consumers' wants, whims and caprices. It may regulate supply, but it cannot control demand. For this reason it is wrong to think of monopolistic prices as being dependent entirely upon the will of the monopolist.
A monopolistic concern is, of course, in business for the purpose of making money. If it is a corporation its directors wish to be able to pay large dividends to its stockholders. The aim of monopoly is the greatest possible profit, not the highest possible price at which some of its goods may be sold. In determining the price that shall be asked, the manager of a monopolistic business thinks not of the cost of production but of the possible sales and profits at different prices. He is anxious to find the price that will yield the maximum net profit. That price may be a low one, not far above the cost of production, for at the low figure the demand may be enormous; or the price may be 100 per cent above the cost and yet the sales be sufficient to yield a profit larger than if the price were lower. A monopolist is not much concerned about the amount of profit per article; the largest possible net income is what he wants., and he is quite ready to offer his article at a low price if in that way he secures the desired result.
6. Regulation of supply.—The regulation of the supply of an article produced under conditions of free competition is manifestly a difficult matter. The greater the number of competitors, the greater the difficulty. If there are only a few competitors, each can get some knowledge of the plans and of the capacity of the others and so regulate his own output that a surplus product shall not be thrown on the market. But when the number of competitors is large, each works more or less in the dark, being uncertain both as to the strength of the demand and the amount of the forthcoming supply.,
Since it is most important that the supply of an article shall not exceed the demand at a price which will net a profit, nearly every industry has its trade paper, which seeks to keep its subscribers informed as to market conditions and prospects and as to the probable output. The value of these trade papers is attested by the fact that in the last thirty years they have become the most lucrative branch of journalism.
Of monopoly we might say that it is able to examine the present with a microscope and look at the future thru a telescope, so that it is able to regulate its output in such a way as to protect itself against the ebb and flow of demand. But competition is blind; it must either depend upon the eyes of trained observers or grope its way thru the industrial labyrinth, guided almost solely by instinct.
The mining of gold furnishes an excellent illustration of the results of unrestricted competition. Most of the world uses gold as money; and its value tends to fall, and prices to rise, as the 'supply in-creases. No man knows today what the value of money will be a year hence. Its value is not deter-mined by any legislative body nor by any mint. It depends wholly upon the supply of money in relation to the demand for it. Since 1897, because the supply of gold increased faster than the demand, its value has greatly fallen; and the prices of commodities in general have greatly advanced, causing much distress to people of small and fixed incomes. If the mining of gold could be made a governmental monopoly, all governments concerned acting in harmony, the annual output might be so regulated as to prevent any great change in the value of gold, so that the prices of commodities in general would never greatly decline or advance.
In this section I have spoken of a part of a product as being a surplus. The reader should be careful to notice that this word, which is much used in business, does not mean an excess of production above possible consumption. It means a greater surplus of goods than can be sold at a certain price. In discussions of foreign trade it is often said that the United States exports its surplus cotton to Europe. This so-called surplus is merely that part of the sup-ply of cotton which the people of the United States do not wish to buy at the price which prevails in the world's market.
7. Law of increasing disutility.—Every man who has done any work requiring muscular effort knows the ache of labor, and if he has worked continuously for several hours he knows that the ache is greater at the end than at the beginning. All animals love activity if it can be followed by rest when weariness comes. The man who hoes half an hour in his garden every morning for the sake of exercise doubtless gets pleasure out of it, but let him hoe all day and he will know what the economist means by the pain of work.
This pain the economists call disutility, for it is the opposite of the pleasure or satisfaction one gets from a utility. Unfortunately to a man who has never worked we can give no idea of the meaning of the pain of labor. We might as well describe a landscape to a man who was born blind, or one of Mozart's symphonies to a man born deaf. All we can say is that pain is a state of consciousness which we do not wish to have repeated.
We have already learned that utility, or enjoyment, tends to decrease with repetition; and we have given that fact general expression in the law of diminishing utility. In the case of pain the opposite is true. The longer a man saws wood the more irk-some it becomes. The performance of any task, even tho agreeable at first, finally becomes tedious and positively painful if continued long without interruption. Pain from its very nature seems to increase so long as the cause is present. A toothache that is hardly noticed in the morning becomes unendurable in the afternoon, altho a dentist might find that the nerve was not exposed more at one time than at the other. This tendency of pain to increase as a result of repetition economists call the law of increasing disutility.
This law has some relation to value; for all goods are the product of work, and their value must be sufficient to compensate the worker for the pain or disutility that has been voluntarily endured. Men dislike long working days, for the pain of labor is much greater after eight hours than after six. Hence, if possible, men avoid occupations which give them little time for rest or recreation. That is one reason for the increasing scarcity of farm labor, the work often beginning at sunrise and not ending till dark.
8. Variations in cost.—In some industries costs of production may remain stationary for a consider-able period of time. Then, as a result of competition, the producers who survive in these industries tend to become equally proficient; and a uniform cost is approximated, in accordance with which the market price is determined thru the regulation of the supply. In such industries a great increase in the output is often possible without any increase in the cost of production per unit.
In other industries, notably the extractive, we have already shown that the law of diminishing returns applies. Hence as population increases, costs tend to rise unless checked by improved methods of production and. transportation.
In many of the manufacturing industries, under certain conditions a law of increasing returns prevails; and the tendency, therefore, is toward lower costs and prices as consumption increases. The causes are various. Among the most important are the advantages of large-scale production, of which one of the most important is the manufacture of machinery in standard parts. A country manufacturing only 1,000 automobiles is evidently at a disadvantage with the country manufacturing 500,000. Furthermore, as an industry increases in volume it becomes more attractive to skilled labor; and its work, therefore, is more efficiently done. At the same time the very size of the industry furnishes an incentive to the manager to improve his organization to the utmost and to introduce economies which would hardly seem worth while in a smaller establishment.
There is a limit, of course, to the profitable growth of any industry under a single management, for there is a point beyond which the difficulty of superintendence becomes insurmountable. There is, further-more, a limit to a man's executive ability. Great executives in business are not numerous; and altho they can delegate much of their authority and responsibility to others, yet experience has proved that too heavy a burden may be placed on the shoulders of any man however great his genius for organization and control.
9. Joint cost.—Numerous articles are called by-products because they are produced, not in the first instance because of their own utility, but in connection with more important articles. For example, the leading products of the Standard Oil Company are refined petroleum, or kerosene, and gasolene; but in the manufacture of these articles numerous other articles of less importance and value are produced, such as candles and vaseline. The demand for cattle is a composite demand for hides and beef. Neither of these could be considered a by-product unless the demand for one was so great that it could be sold at a price so high that the price of the other would be a negligible quantity.
Does the value of two articles produced jointly tend to coincide with their joint cost on the margin of production? Or is the cost of one more important than the cost of the other? It all depends on the strength of the demand. Take a steer, for instance. If there is a strengthening demand for beef and its price doubles, while the demand for leather does not increase, there will be an increase in the production of beef and necessarily also an increase in the supply of leather. Leather will then weaken in price while beef is advancing, and if the demand for beef keeps on increasing, it is conceivable that leather might be-come exceedingly cheap. The ranchman, of course, would think only of the price he could get for his steers; it would not matter to him whether the demand for them was chiefly for hides or for beef.
In the long run, when competition prevails, the combined value of a product and all its by-products must tend to equal their joint cost. But at any time the market value of each is determined by the strength of the demand for it in relation to its supply, and a rise in the value of any one of them may cause some increase in the output of all.
10. Marginal utility compensates for marginal cost.—No sane man will work to produce something unless he expects satisfactory compensation in its enjoyment. In economics this amounts to saying that no man will produce an article unless he can sell it at a price covering the money cost of production plus a satisfactory profit.
Let us take a simple illustration from rural life. Some children go berrying solely for the pleasure of eating the berries. They get great enjoyment out of it the first hour, a little less during the second hour; and by the end of the third hour their enjoyment of the berries has declined and they have become so tired that they decide to rest before going home. In the language of economics the cost of berries to them has begun to exceed the utility of berries. Theoretically and strictly speaking, a child would stop picking berries the very moment the pain of the effort was not counterbalanced by the pleasure of eating them; or in the language of economics, when the marginal utility of berries had declined and the cost of production had increased until the two were equal. In this simple illustration we see at work the very forces which determine market prices.
Let us briefly consider the market price for potatoes. They are an agricultural product that tends to increase in cost when any increase in supply is called for. If they are selling at $1 a bushel, there are certain grades of land on which farmers will pro-duce potatoes, but no farmer will willingly produce them on land where their cost exceeds $1 unless he has good reason for believing that the price in the following winter will be much higher. In normal times most staple articles like potatoes, pork, corn and beef, have a normal or customary price, producers having learned by experience to make a pretty ac-curate forecast of the demand: and the one thing they are most anxious about is that the supply of any article shall not be so great that its price must fall below the cost of production; in other words, that its marginal utility shall not be less than its cost.
Hence wise producers are slow to increase their output of any article unless there is evidently an in-crease in the demand for it; or, in other words, unless there has been a rise in its marginal utility sufficient to counterbalance any increase in the cost of production.
Practically, of course, any increase in the marginal utility of an article finds expression in a rise of the market price; and when that rises above the cost of producing any portion of the existing supply producers begin to plan larger production even tho their costs increase.
So as a result of our examination of value from two points of view, the consumer's and the producer's, we may say that it is such a ratio of exchange as tends to make the marginal utility of a good just compensate for its marginal cost. When a good exchanges on such a basis it is said to possess normal value. When any good sells much above its normal value, we must find the cause in abnormal conditions, such as war, monopoly, or some freakish. change in demand.
11. Producer's surplus or differential gain. Producers who enjoy special advantages evidently make a bigger profit than those on the margin of production, whose costs are the highest. If a manufacturer produces an article which commonly sells at $2; at a cost of 50 cents he is evidently making a profit of $1.50 on each article. But if other manufacturers have costs close to $2 their profits are barely sufficient to enable them to continue production.
That part of any producer's profit which is in excess of his cost of production plus a reasonable profit, is called by economists the producer's surplus or differential gain. It is due to the differences between his advantages and those enjoyed by competitors who are working at the greatest disadvantage. As we shall see later, the rent of land has its origin in the producer's surplus.
Some readers may be disposed to question the assertion that value is determined by unconscious competition among marginal consumers and producers. It may seem to them that the highly favored producer, the one with low costs, will be quite ready to accept a low price provided by so doing he can quickly market his product. Or it may seem that the impatient consumer with plenty of money in his pocket will promptly pay almost any high price that is asked, and that neither buyers nor sellers will wait for the outcome of the conflict between the marginal consumer and the marginal producer.
This view is entirely erroneous because it ignores three important facts: first, that most men like to sell their services and the products of their labor at the best price they can get; second, that most men like to gratify their wants with the least expenditure of money or effort; and, third, that market prices are determined, not by the actual producers and consumers, but by professional traders who represent them. The trader's important work we shall discuss in the next chapter.
Why does value or price in the long run tend to coincide with the cost of production?
Who is the marginal producer in industry? How does he aid in determining the market price?
Why is it impossible to transfer labor and capital from one industry to another on a moment's notice?
Does an absolute monopoly necessarily lead to high prices? What is the law of increasing disutility and what relation has it to value?
Discuss the statement that the value of two articles produced jointly tends to coincide with their joint cost on the margin of production.