Introductory economics

Preface

In a democratic State economic science should be for the many, not for the few. The science is admittedly a difficult one; and until a royal road through its domains has been found, there is ample justification for the publication of a new text-book on economics, for the many excellent manuals now before the American public have not reached all classes nor met all needs. It has appeared to the writer that an economics text-book of moderate dimensions, dealing with only the more fundamental problems of the science, and written, so far as this is possible, in the language of every-day life, would prove useful to at least a limited class of students, and especially to those students of mature mind who seek to gain an introduction to modern economic thought, but who are not in a position to avail themselves of the advantages of class-room instruction. What students of this class — as well as many other students — most need is not a compendium of economic facts nor even an exhaustive treatment of economic principles, but a series of rigorous exercises in economic reasoning which will enable them better to organize the mass of practical economic knowledge that their daily experience affords.

The distinctive character of modern economic theory consists chiefly in its method of applying the principles of diminishing utility and diminishing returns. The student who is thoroughly familiar with these two principles, and who is trained to recognize their operation in practically every economic problem, will be able to follow the reasoning of the most profound of the modern economists, provided, of course, that this reasoning is not rendered unintelligible by a special terminology. But it is not alone as an introduction to economic theory that training in the use of these two principles is of vital importance. Most, if not all, of

IV PREFACE

the problems of practical economic policy involve one or both of these principles. The writer is persuaded that by far the greater proportion of the fallacies that vitiate popular reasoning on economic subjects originate in disregard of these principles. His aim in the theoretical part of the work has therefore been to present rather a series of studies throwing into relief the operation of these principles than an exhaustive treatment of the topics discussed. This method involves the exclusion of many topics that are ordinarily presented in an introductory treatise ; it involves, further, a degree of repetition that can be justified only if it attains its purpose in making the student thoroughly conversant with the laws of diminishing utility and diminishing returns.

The teacher of economics will observe that very little use has been made of the terminology of the Austrian school. This does not imply that the writer regards that terminology as useless ; on the contrary, he believes that in the development of some such special terminology lies the hope of substantial progress in economic theory. It seems, however, unfair to the student to cumber the pages that he is to read with unfamiliar terms, the mastery of which will avail him little unless he is to devote himself to advanced theoretical study.

It will further be observed that no attempt is made to group the chapters of this manual in "Parts" or "Books." The traditional fourfold division of the science is not suited to a theory which explains distribution in terms of production and makes frequent use of the concept value in its discussion of production. The division of the science into Statics and Dynamics, proposed by the author's friend and former teacher. Professor John B. Clark, while doubtless of great value in a work which is complete in itself, is too important an innovation to be conveniently employed in a book of a purely introductory character.

It is perhaps superfluous for the author to mention the

PREFACE V

names of the economists to whom he is especially indebted, since such indebtedness will be readily recognized in his pages. The theory of value presented is in large part derived from that of Professor von Wieser; the theories of wages and interest follow closely those of Professor Clark. The treatment of rent and capitalization is largely influenced by the writings of Professor Felter and Professor Seligman. In his discussion of monopoly value the author has made free use of the writings of Professors Marshall, Clark and Ely ; in his discussion of diminishing returns he has borrowed liberally from Professors Marshall and Carver. The discussion of banking follows that of the late Professor Dunbar ; the discussions of money and international trade follow the accepted classical models.

December, 1907.

Contents

I. The Nature and Significance of Economic Science 3

II. Utility, Value and Price 18

III. Normal Price . 37

CHAPTER I The Nature and Significance of Economic Science

From the earliest time of which we have any record a great part of the activities of man has been occupied with the production or acquisition of wealth — material objects and personal services upon the possession of which human welfare depends, or seems to depend. In the long ages of savagery and barbarism primitive man was engaged in a ceaseless struggle with nature for the bare means of existence — food, clothing, and shelter. Limited as were the supplies of nature, a savage tribe never for a long time enjoyed them in peace; other tribes coveted the hunting grounds, or the bays where shellfish abounded; the rich pastures or the groves of fruit-bearing trees. Hence the difficulty of obtaining from nature the means of subsistence was aggravated by constant warfare between tribe and tribe. A struggle for mere existence against nature and against hostile tribes — such was the life of primitive man.

From century to century, however, man learned to equip himself better for the struggle for existence. Tools, at first rudely wrought from stone, later from the metals, greatly increased his productive power. A yet greater step in advance was made when animals were domesticated, and a certain and steady food supply took the place of the precarious products of the chase. The cultivation of roots and grains that had in their wild state yielded scanty returns to the gatherer marked another stage of progress. Methods were crude, and the tasks of pastoral and agricultural life exceedingly laborious — a condition which gave rise to the enslaving of captives taken in war. With the increase in the productive power of a tribe, at least limited classes were freed from the struggle for the merest necessities. A leisure class, using the term in a restricted sense, appeared; and with it the germ of culture and civilization. Thus productive power and civilization have advanced hand in hand, until to-day, in the most progressive societies, there are comparatively few whose days are altogether devoted to a quest for food and shelter.

Although civilized man is for the most part liberated from the dangers of starvation and of death through exposure to storm and winter cold, his desire for the material objects and human services that constitute wealth is in no way relaxed. Merely to possess food sufficient to satisfy hunger does not content him; the food must be pleasing to the palate as well as nutritious. Warm clothing is an excellent thing; but civilized man demands that his clothes be of good appearance as well as comfortable. A sod house on the prairie is constructed with no great 'amount of labor and almost no expense; in such a house one may defy the worst storms of winter and the hottest winds of summer. Yet the modern dweller on the plains would scorn to live in such an abode; his home must present an appearance of comfort and prosperity. To stand well with one's fellows is to most men hardly less important than life itself, and in all human history an important factor in winning and retaining the esteem of others has been the possession of proper attire and other personal appointments. There is a standard of wealth consumption which each little group of associates in society are under some sort of compulsion to attain. If my neighbors and boyhood playmates all have fine houses, I cannot enter my humble dwelling without a sense of inferiority. If they are well fed and well dressed and well housed, I would be as good as they are. If they are wise or learned or cultured, I naturally strive to emulate them in this respect. But one cannot be well clad or well housed, Qm cannot very well even be wise or learned or cultured, unless one can command a fair amount of wealth, an amount far in excess of the bare needs of existence. Under modern conditions wealth has become a means — though, of course, not the only means — to most of the things which one can desire. And as it is not in the nature of man to be content for any long time with what he possesses and what he has attained, it is inevitable that his desire for wealth, which is so potent a means for further attainment, should continue unabated.

This desire for wealth is what is meant by the economic motive. It necessarily plays a large part in the lives of most men. It animates the purest and most unselfish as well as the most sordid. For the desire for wealth is a desire for means to ends, and these may be good or evil. The philanthropist who wishes to found a home for invalid children must have wealth, just as the voluptuary who desires a palace of all delights to please his jaded senses. The economic motive animates both; very likely the philanthropist desires wealth the more ardently. What differentiates the two is the end which the wealth is meant to subserve. To assert, then, that all men are in great measure actuated by economic motives is not to assert that all men are selfish or sordid. It is merely to assert that wealth has been placed between man and the satisfaction of most of his desires; that as he seeks to attain any end whatsoever, he will seek to possess the means to that end.

Economics is the science which deals with such of the activities of man as spring out of the economic motive. It treats of the creation, acquisition, and use of wealth. The subject-matter for economic science, therefore, is to be found in every society — as well in the most primitive tribe as in the most advanced nation. Yet the facts of economic life have only recently been worked up into a systematic body of knowledge. For the beginnings of the science it is not necessary to go back more than three centuries, although fragmentary treatment of economic questions may be found in earlier writings. How can we explain this late development of the study of facts with which humanity has from the earliest time been concerned?

Throughout the periods of savagery and barbarism men lived in small groups, which produced, through the chase, agriculture, and pasturage, practically everything that the members of the group consumed. Whether the group prospered or fared ill depended upon the weather, the fertility of the soil, the quantity and character of game, the relation to other groups — whether tribute was given or received. Within the group the relative welfare of each member depended to a certain extent upon his own prowess and efficiency; perhaps to a greater extent upon the tribal customs in accordance with which the common products of the group were distributed among its members. As conditions varied widely among different peoples, a general science of tribal economics would have been difficult to create. In the civilized states of antiquity a somewhat similar condition rendered the rise of economic science impossible. Industry was based on slavery; the lord of landed estates produced by slave labor almost everything that was needed on the estate. His welfare depended upon the amount and fertility of the land he possessed; the number of his slaves and his skill in managing them ; the state of the weather, and freedom from hostile invasion. No systematic body of knowledge explaining the economic life of the people as a whole was developed, because there could scarcely be said to be an economic life of the people apart from that of the separate families. So, also, in the mediaeval villages. They were self-sufficing; the welfare of the community depended upon natural forces and the energy of the members of the community and their capacity for co-operation. Each individual depended for his welfare partly upon the same conditions, partly upon village custom in the apportionment of services and rewards.

With the rise of modern trade a significant change took place in economic life. In greater and greater measure men engaged in production for distant markets, instead of for their own use. Under such conditions welfare depended not only upon the producer's energy and success in the creation of goods. It depended also in large measure upon the price of the goods which were sent to market. The transition from production for one's own use to production for the market took place at various times in different countries and in different industries. In some branches of production it is only recently that the change has been effected. Thus the production of bread, formerly almost everywhere carried on in the household for consumption there, has in the cities become an independent branch of industry, carried on for supplying a market, just as the production of shoes, cloth or iron.

The striking characteristic of modern economic life, then, is that men produce goods not for their own use, but for the market. The employee in a shoe factory will very probably never wear any of the shoes he helps to produce; if the maker of clothes ever works on garments for himself, this is the exception to the rule of his daily labor. The farmer consumes little, if any, of the wheat which he raises ; the woolgrower rarely spins and works up into cloth for his own use the product of his flocks. The modern economic system is therefore called an exchange economy, for it is through exchange of goods that each man gets the commodities which he needs. And with the rise of the exchange economy a new set of laws of wealth and welfare have come into operation. The welfare of a farmer under'' modern conditions depends in some degree upon his own energy and intelligence, and in some degree upon the weather. But in a very large degree it depends upon the price at which he can sell his products. A high price of iron brings prosperity to all the classes engaged in the production of iron, as a low price involves them in loss and distress. And so with practically all members of modern society; their welfare is bound up with the prices of products.

A farmer or a manufacturer is popularly said to "put a price" upon his products. In the majority of cases, however, what the seller really does is to make a choice between selling at a given price or keeping his goods unsold. Except in rare cases there is a market price for goods which the buyers and sellers must accept if they desire to engage in business at all, and over this price no single person has any control. Yet prices do not exist apart from the action of men; they are the creation of man in society. Many persons, each acting with a view to his own interest, offer wheat for sale ; many persons stand ready to buy it. The price of wheat is fixed as a result of the offers and purchases of all persons who buy or sell wheat. It is therefore a social phenomenon — the creation of all society, or of a large part of it. And so it is with almost all prices. They are set by society. Hence the laws of price are properly called the laws of social economics, or of political economy.

While each man produced goods for his own use, the tools and appliances which he used were of necessity simple. To cut enough wood for one's own use did not require a very expensive axe ; to furnish boards for one's own dwelling required only a handsaw, to be worked by two men. Spinning wheels and looms were likewise of the simplest make. These tools and appliances could be made by the workman himself, or secured through exchange at small sacrifice. Accordingly the laborer as a rule owned the implements he worked with. In early modern times, although production for the market had become fairly common, the means of production still remained in the worker's hands. The increasing demand for products, however, soon led to the introduction of more expensive tools, and at last to the invention of machinery. Every step in this direction made it more difficult for the worker to provide himself with the means of production. So these had to be supplied by persons of wealth — capitalists. Under present conditions manufacturing industry in almost all its branches requires so large an expenditure for equipment that no single laborer can work with his own tools and machines ; nor is it possible for a group of laborers to equip themselves for production through combining their small savings. The capital outlay for a mill employing a hundred workmen is usually far in excess of what a hundred workmen can accumulate. Industry must therefore be conducted by wage laborers and employer-capitalists. To a certain extent the employer and the capitalist have been further differentiated, the former borrowing capital from the latter at a fixed rate of interest. When the products are sold, whatever remains after paying wages and interest is a profit, the reward of the employer, or, as he is generally called, the entrepreneur or enterpriser.

Under modern conditions, as we have seen, the prosperity of each industry as a whole depends largely upon the prices of its products. Within each industry the prosperity of each laborer, capitalist or employer depends in great degree upon the way in which the total product of the industry is divided. And here again we encounter social laws. There is a general rate of wages, which the laborer must accept if he wishes employment. In the same way, there is a general rate of interest. No one man exercises any appreciable influence in fixing these rates; they are the resultant of the actions of all those who have labor to sell or capital to lend, on the one hand, and on the other hand, of those who desire to hire laborers or to borrow capital.

The prices of goods, the wages of labor, the rate of interest on capital, elude the control of any single individual. May they not, however, be controlled by combinations of individuals, or by the action of a sovereign state? Within limits this is possible. A trade union may force up the rate of wages ; a protective tariff may enhance the prices of many classes of goods. But there are limits beyond which combination and political action are unavailing — -limits which are set by social forces. What these forces are, how they Operate, how far they can be controlled, and with what results for society as a whole — these are the problems which social economics endeavors to solve.

Social economics as a distinct science may be said to have taken its rise in studies concerning taxation and public finance. In early modern times the expenditures of government in most European states were steadily increasing. The various princes vied with one another in the splendor of their palaces and in the number and brilliancy of their personal following; the cost of maintaining the tranquillity of the nation at home and its dignity and influence in foreign lands became heavier from decade to decade. More than all, methods of warfare by land and by sea were changing, and military success was coming to depend quite as much upon the size of the war chest as upon the valor of the soldiers. These new expenditures could be met only through taxation ; accordingly, it became a very practical matter for the statesman to devise means for increasing the prosperity of a nation in order to increase its capacity for paying taxes. As the precious metals seemed to be the most convenient and the most reliable form of wealth, it was the aim of the statesman to provide these in abundance. European countries, having no important mines of silver and gold, could secure these metals only through foreign trade. Hence the kernel of early modern economic policy was the regulation of foreign trade, with a view to bringing into a nation large supplies of treasure. These regulations formed a system which in the end became burdensome in the extreme ; their futility and injuriousness were exposed in the latter half of the eighteenth century by the Economistes in France and by Adam Smith in Great Britain, whose writings first placed economics on a scientific basis. Through the nineteenth century economic discussion has progressed from one practical problem to another — money and banking, trade unionism, socialism, monopoly, etc. The chief function of the science is still, as in its earliest period, to ascertain what economic policy of government will be most conducive to the general welfare. Although it is known as the "science of wealth,'' it is no part of the function of economics to instruct individuals how they may best acquire wealth. Its principal aim has been attained when it has thrown all possible light upon the economic problems which a state, and its members as citizens of a state, have to solve.

We have seen that under modern conditions the welfare of industries, and of individuals engaged in those industries, is largely determined by the social forces of price. The influence of price extends even further. In large measure the same social forces determine what each of us shall do; they fix one's place of residence as well as his occupation. If the price of glass is high, and remains high for a considerable period of time, high profits and high wages are possible in the glass industry. New establishments will be opened ; boys and young men who otherwise would have engaged in other industries become glass blowers. By fixing a high price on glass, society, as it were, decrees that more persons and more capital shall be devoted to that industry. If coal or other sources of power are exceptionally cheap in a given locality, if conditions of transportation are exceptionally favorable, large profits may be made by manufacturers in that locality; they increase their investments and new capital flows in from less favored districts. A city is built, and the population that was formerly scattered in hamlets and country is under a sort of compulsion to congregate there. Why are our cities becoming greater and greater? The social laws of price decree it. If we would understand just why modern society presents a given form, our inquiry must take into account, as perhaps the most important factor, these laws of price.

Since the fixing of prices is a work in which all, or most of society co-operates, whatever affects any industry, for good or evil, must react in some manner upon all society.

A dry year in India, with consequent shortage of crops, affects not only the Hindoo ryot, but also the British workman, the farmer in Dakota or in Argentina. Large crops in the West, concurrent with high prices, exert a powerful influence, not only upon the interests of the local merchants, bankers and mechanics, but upon the manufacturing and financial interests of the entire country. The railways are prosperous, having an immense amount of transportation work to perform, and their stockholders receive large dividends, out of which they may improve their homes, or increase their investments in factories or what not, in every case creating a new demand for labor and extending prosperity in ever widening circles to the remotest industrial classes in the land. A part of the surplus earnings of the railways may be turned to the extension of lines into new territory; to the double tracking of congested single lines; to the installation of new equipment, with the immediate result of an increased demand upon the rail mills and car works, and all the enterprises subsidiary to these. A crop failure, on the other hand, may disarrange the entire industrial mechanism and bring distress to the laborers and capitalists apparently farthest removed from the immediate cause of the disturbance.

An excellent example of the influences set in motion by a great economic event is given by Mr. David A. Wells in his Recent Economic Changes. In the year 1869 the Suez Canal was opened. Up to that time trade with the East Indies was carried on in sailing vessels, which rounded Cape Horn or the Cape of Good Hope with an expenditure of time of three to eight months. A large fleet was necessary to carry on this trade, and this consisted of sailing vessels, since it was impossible for the steamships of the time to make so long a voyage with the coal which they could carry. Because of the uncertainties attending so circuitous a voyage, and because of the risk of war, vast stores of Indian and Chinese products were kept on hand in England, the natural emporium for this trade. There arose in England a great warehousing system, and a parallel development of banking, the warehouse receipts serving as excellent security for banking loans. After the opening of the canal, most of the commerce with the Indies passed through the Mediterranean. In this sea, and more especially in the Red Sea, the sailing ship was practically useless. Hence a great number of steamships were constructed, and an amount of sailing shipping of about two million tons was virtually destroyed. Ships that formerly would have done service for years rotted in the wharves ; others were sold at far less than cost to be used in other branches of trade. Persons whose property consisted in sailing vessels of any kind suffered heavy losses. Towns along the seacoast that had been engaged in building sailing ships saw their prosperity wane. Captains and trained seamen who had been employed on the East India ships were forced to seek other employment. As the new method of transporting goods was relatively quick and certain, there was no longer any need for keeping anywhere in Europe large stores of India goods. Moreover, goods destined for consumption in the Mediterranean countries, and even in Central Europe, were no longer conveyed to England and thence distributed, but were landed at various Mediterranean ports. The warehousing system, accordingly, fell into decay so far as this branch of the trade was concerned, and the banking houses which had depended upon the warehousing business were involved in losses. On the other hand, the increasing demand for steamships brought prosperity to the towns where such ships were built, and to the laborers who were fitted for the work of steamship construction.

Such were some of the immediate effects. No less important were the remoter ones. It was found that a vessel constructed of wood did not well withstand the vibrations of the engines ; hence the iron, and later the steel, ship took its place. So long as ships were built of wood there were few countries better fitted for shipbuilding than the United States. Iron and steel were, however, far dearer in the United States than in England; moreover, American laborers did not quickly acquire the skill necessary for the successful construction of iron ships. Accordingly, the American merchant marine was forced to give way before the British. American enterprise was diverted to other channels, and has not yet returned to the sea.

The same event hastened the development of steam navigation, with consequent cheapening of freight rates, in the trade between Europe and America, and this helped to enable the American farmer to flood the European markets with his produce. This greatly increased the prosperity of America; it gave cheaper food to the British factory hand, and in less degree cheapened food supplies in Continental countries. The European farmer, on the other hand, was forced to take lower prices for his products. In England, where American competition was keenest, the agricultural districts were involved in a depression from which they have not yet recovered.

It would be superfluous to multiply examples to show the close interdependence of parts in the mechanism of economic society. What affects one part of the economic organism must inevitably affect other parts. And this it is that renders it difficult to devise plans for obviating the economic evils which remain in spite of the progress of civilization. Through legislation it may be comparatively easy to restore to vigor a decaying industry, and bring comfort and wealth to those engaged in it. But the effects of legislation of this nature will not be bounded by the industry which it is sought to aid. Suppose that we are moved to action by the decay of the old ship-building cities, which once sent vessels to every important port in the world, but which now are compelled to seek a precarious sustenance from the entertainment of summer boarders; by the shipyards closed month after month; by the efficient seamen forced to do odds and ends of work ashore. It would be possible, through lavish grants from the public treasury, to make the ship-building industry pay. We should see a great industry spring up; we should have the gratification of knowing that the American flag might be seen on every sea — very good things in themselves. What we might not see, but what would be none the less real, would be a sacrifice imposed upon each farmer and miner and mechanic in the way of taxation necessary to meet the drain upon the public treasury.