An introduction to economics

Preface

This book is designed as an introductory treatise on the science of Economics. In its preparation the author has had constantly in mind the demands of secondary schools for a textbook that lays stress upon the discussion of economic principles with especial reference to American conditions.

Two aims have been followed. First, to give a working basis in the knowledge of the methods and terms to be used, and of the content of the subject, such as society as a developed organism, the laws of production, the methods and organization of production and exchange. The growth of productive methods from the time of communal working, through domestic manufacture to the factory system, has been carefully discussed. This discussion shows how manufacturing has developed from small units with hand labor to production on a large scale by machinery, which has resulted in the very large increase in trades and industries. The meaning of the terms production and value, and the laws which govern the production of commodities, have been carefully explained.

The second aim has been to present the methods employed in the application of economic principles, with especial reference to exchange. In dealing with the banking system, for example, a comprehensive account is given of the Federal Reserve System which

IV PREFACE

has played so important a part in the commercial organization of the United States during the past few years. Banking, as a general subject, has been considered from the point of view of its function rather than of its technique. J

Because of the importance of international trade in the future economic development of American industry, careful attention has been given to the principles involved, as well as to the closely related subject of foreign exchange.

Throughout the book emphasis has been placed on the fact that all economic organization and industry are only a means to an end, and that, therefore, the welfare of those who carry on production must be given consideration. Labor problems have been treated without bias, as have also the suggestions for the reconstruction of society. Exhaustive treatment of these subjects in^a textbook of this kind is impossible, but it is hoped that the student will feel that he has sufficient basis on which to build a real knowledge of those problems with which he will, later on, be called upon to deal.

Thanks are due to Professor Solomon Blum of the University of California for his interest and kindness in reading the manuscript, and to Professor F. R. Macaulay, for helpful suggestions and criticisms.

Graham A. Laing

Berkeley, Cal.

May, 1919.

Chapter I Page

Statement of the Problem of Living — Definition of Economics — Economics a Social Science — The Subject Matter of Economics — Economic Laws — The Deductive Method— The Syllogism— The Inductive Method — Value of Economic Laws — The Scope of Economics — Summary 1

Chapter II

Economic History — The Four Stages of Development — Definition of Economic Unit — Characteristics of Development — Relations between the Stages of Development — Variations in Rate of Development — Modern Civilization Dynamic — Growth of Civilization Accompanied by Increase in Needs of Man — Physical and Conventional Necessities — The Economic Problem . . 15

Chapter III

Economic Freedom — Regulation of Industry — Production for Profit Most Satisfactory System — Basis of Argument in Favor of Production for Profit — Limitation to Demand for Necessities — The Idea of Competition — Meaning of Competition — Labor Viewed as a Commodity — Claims Made for the Competitive System — Some Defects of the Competitive System — Failure of Competition — Change in Principle of Government Regulation — Summary

Chapter IV

Physical and Conventional Necessities — Characteristics of Civilization—Meaning of the Term PFeaZ</^ — Wealth Comprises Services as well as Material Goods — Utility, Distmguished from Usefulness — Consumption of Utilities — Production De-

VI CONTENTS

page" termined by Consumption — Definition of Production — The Miner as a Producer — The Steel Manufacturer — The "Production" of a Ship — Agriculture as Production — Production of Utilities — Summary ......... 40

Chapter V

Meaning of the Word Land, as an Agent of Production — Meaning of Labor — Meaning of Capital — Capital and Consumer's Wealth — Classification of Forms of Capital — Circulating and Fixed Capital — Division of Labor under Capitalistic System — Scientific Labor — Specialization in Location of Industry . . 55

Chapter VI

Production Stimulated by Profits — Production Secured through Application of Capital and Labor to Natural Resources — Necessity for a Certain Minimum Capital and Effects of Increases — The "Dose" of Capital and Labor — Law of Increasing Returns — Illustration from Ship-building Industry — Law of Diminishing Returns — Graphic Illustration — Effect of the Operation of the Laws of Increasing and Diminishing Returns . . 66

Chapter VII

Distinction between Business and Industry — Early Trade — Merchant Fleets — Formation of Partnerships and Companies — Monopolies and Regulated Companies — The Chartered Companies — Advantage and Defects of Partnerships — Early Joint-stock Companies — Limited Liability — Government of the Modern Corporation — Bond Issues and Bondholders — Profits of Bond- and Stockholders — Improvements in Production Due to Corporation Form of Organization — Illustration from Banking Business — Department and Chain Stores ... 77

CHAPTER VIII THE ORGANIZATION OF PRODUCTION {continued)

Agriculture as Industry — Primitive Agriculture — Communal Tillage — Difficulties in the Way of Progress — Extensive Culture in America — Increased Use of Fixed Capital — Manufactures. Subordinate Nature of Early Manufacture — The Gild System — Manufacture on a Small Scale — The Factory System — Increased Use of Fixed Capital in Manufacture — Complexity of Modern Trade Forms — Elimination of Waste — Problems of Production . .91

CONTENTS VU

Chapter IX Page

Failure of Competition — Limitation of Competition. 1. The Corporation 2. Price Agreements — Example of Price Agreement.

3. The Kartel 4. The Pool 5. Monopolies 6. The Trust

7. The Holding Company — Uniform Object to Eliminate Competition — Effects of Monopoly Organization — Control of Monopolies — Justification of Monopolies . . . . .106

Chapter X

Meaning of the Term Value — Diminishing Utility — Marginal Utility — Present and Future Satisfaction — Effective Demand

— Meaning of Price — Relations between Supply and Demand,

and Price — Elasticity of Demand 120

Chapter XI

The Factors of Exchange — Strong and Weak Buyers and Sellers — The Demand Curve — Consumer's Surplus — The Supply Curve

— Producer's Surplus — Market Price — Definition of Term Market — Limits of Price Fluctuation — Normal Price — The Flow

of Capital 133

Chapter XII

Importance of Stability of Prices — Varieties of Monopolies — Monopolies by Royal Grant — Patents and Copyrights — Trade Marks — Monopoly of Location — Necessity of Control of Production and Distribution — Definition of Monopoly — Factors in Determination of Monopoly Price — Latent Competition — Elasticity of Demand 149

Chapter XIII

Problems of Barter Exchange — Cattle Used as Money — Other Forms of Money — The Qualities Desirable in a Money Material — 1. Value in use 2. Universal Acceptability 3. Divisibility

4. Homogeneity 5. Portability 6. Durability 7. Stability

8. Cognizability — Metals as Money — Remedies for Defects in Metallic Money — Coined Money — Definition of a Coin — Debasement of Coinage — Effects of Depreciated Coinage . . 160 viii CONTENTS

CHAPTER XIV Seigniorage — Gresham's Law — Subsidiary Coinage — Token Money

— Bimetallism — Position of Silver Dollars — United States Currency — Money and Price — Relation of Gold Supply to Prices — Fluctuations in the Demand for Currency — Elastic Currency — Effects of Issue of Fiat Money — Currency Inflation — Measurement of Prices. Index Numbers

Chapter XV

Honesty the Basis of Economic Structure — Banks the Lubricants of Commerce — Beginning of the Deposit System — Bank Notes. Origin — The Deposit System — Necessity for Bank Deposit Reserves — The Case of Two or More Banks — The Clearing House

— Debtor and Creditor Banks — The Bank Loan — iVccommodation Loans — Capital Loans — Commercial Loan — Discount

— Value of Discount System — Bank Notes ....

Chapter XVI

The National Banks, Early History — National Banking Act. 1. Minimum of Capital 2. Bond Purchases and Note Issues 3. Reserves — Bank Examinations — Criticism of the System

— National Bank Notes — Redemption of Notes — National Notes as Currency — Perverse Elasticity — The Reserve System

— Defects of the System — The Call Loan System — Reserves during Crisis

CHAPTER XVII THE AMERICAN BANKING SYSTEM (continued)

The Federal Reserve Banks — Control of Reserves by Individual Banks — Use of the Discount Rate — Rediscounts — The Federal Reserve Act — The Reserve System — Rediscount Market — Crises and Panics — The Discount Rate — Currency — Federal Reserve Notes

Chapter XVIII

THE FEDERAL RESERVE SYSTEM CONTINUED, WITH A NOTE ON THE CANADIAN BANKING SYSTEM

Elasticity of Currency — Federal Reserve Bank Notes — Summary — ~*'Note on the Canadian Banking System

CONTENTS IX

Chapter XIX Page

The Nature of Trade — The Mechanism of Exchange — The Trade

Acceptance . . . . 247

Chapter XX

Meaning of the word International — Definition of Nation — Essentials of International Trade — Law of Comparative Cost — Benefits of International Trade — Theory of International Value — International Price — The Cost of Transport — The Equation of Indebtedness 254

Chapter XXI

Difficulties in Paying by Check — Gold or Currency Payments — Payment by Draft — Mint Par of Exchange — Method of Paying for Foreign Goods — Finance Bills — Effect of the Time Element on the Price of Exchange — Effects of the Rate of Interest upon Exchange Rates — The Causes of Gold Movements . . 269

Chapter XXII

Definitions of Protective and Revenue Taxation — Effect on Prices — Protection of Young Industries — The National System — The Mercantilist Argument — Cheap Labor — Dumping . . . 287

Chapter XXIII

The Flow of Capital — Investment — Par and Investment Price — The Future Element in Business — Speculation — Stock and Share Investment — The Method of Stock Exchange Speculation — Grain and Produce Speculation — Speculation and the Stability of Prices — Control of Speculation .... 306

CHAPTER XXIV Distribution as an Economic Problem — Rent — Urban Rents

Quasi Rents — Interest — Profits — Summary Analysis . . 320

X CONTENTS

Chapter XXV Page

Statistics — The Present Condition — The Causes of Wealth. 1. Accidental Causes 2. Opportunity 3. Efficiency 4. Monopoly — The Causes of Poverty — Old Age, Sickness, and Death of Chief Wage Earner — Unemployment and Irregular Employment — Low Wages — The Incentives to Wealth. 1. The Will to Live 2. The Acquisitive Instinct 3. Emulation 4. The Will to Power — The Incentives to Work — "The Joy of Working" — The Creative Instinct — The Organizing Instinct — The Dominating Instinct 333

Chapter XXVI

The Meaning of the Word Labor — Labor's Part in Production — Labor as a Commodity — Wage Theories. 1. The Iron Law — Money and Real Wages — The Method of Payment. 1 . Time Wages 2. Piece Wages 3. The Bonus Systems 4. Profit Sharing ........... 355

Chapter XXVII

The Origin of Labor Organizations — The Right to Organize — The Methods of Organization — ■ National Association — The Shop Steward Movement — Aims of Labor Organizations. 1. Collective Bargaining 2. Standard Wage 3. Conditions of Labor 4. Hours of Labor — Trade Union Methods — Arbitration and Conciliation — The Boycott and the Union Label — The Success of Trade Unionism 370

Chapter XXVIII Distribution And The L\bor Problem

Profit Sharing — Co-operation — Co-operative Production — Equality

of Taxation 389

Chapter XXIX

Protective Functions — Regulative Functions — Operative Functions — Government or Private Ownership of Public Utilities — Lessons of the War — Illustration of Government Economic Activity during the War _ . . . 407

CONTENTS XI

Chapter XXX Page

Economic Organization a Steady Growth — Society Dynamic, not Static — Failure of Communistic Experiments — Socialism — Socialist Criticisms — The Central Idea of Socialism — Revolutionary Socialism — State Socialism — Objections to Socialism — Guild Socialism — Conclusion 424

Bibliography • • 447

Chapter I The Meaning Of Economics

Statement of the Problem of Living — Most of the years of a man's hfe are occupied in the solution of the pressing problem of gaining a living. There is no more important problem to solve, and the fact that it is always solved in a more or less satisfactory manner does not detract from its importance. In all ages and places the provision of the fundamentals of life — food, clothing, and shelter — has been a paramount consideration, more pressing, perhaps, in primitive times when man lived from hand to mouth, but nevertheless essential in the highest civilization.

But the problem is not merely to gain a living somehow: it is to gain it with the least effort and in the fullest possible degree. Our lives are fuller and more worth living than those of the earlier inhabitants of the world who strove with the primal forces of nature. We have learned to subdue nature, to understand her, and to use the abundance of her resources to a greater extent than ever formerly. Yet we have still a vast amount to learn. We have not yet used to anything like the greatest possible degree the knowledge that our scientists have gained for us. Probably the bulk of the inhabitants of the modern world still live from hand to mouth as did their prehistoric ancestors, although it is true that they enjoy many advantages which were lacking in more primitive times.

We cannot, therefore, consider the problem solved as yet. And it will not be solved unless very careful attention is devoted to the study of the best means of ' using the resources of the earth. Our study, therefore, resolves itself into a realization of the fact that we are in possession of a world of vast possibility in the production of the necessities of existence, and a consideration of the best means by which these possibilities ; may be made actualities not only to a few individuals, but to all the inhabitants of the world.

Definition of Economics — Economics, therefore, ' may be defined as the study of man in regard to his activities in gaining a living.

We must be careful, however, to see that we do not narrow our study to the provision of the physical necessities of existence. It is true that a man can live on a certain minimum of food, clothing, and shelter. If his food be sufficient to keep body and soul together and his clothing adequate to protect him from the extremes of climate, he can live. But man does not live by bread alone. Much more goes to the fulfillment of the highest possibilities of life. Variety in food, convenience and art in clothing, space and beauty in architecture are becoming more and more necessary. Literature, art, music are all real necessities although the physical being can be supported without them. In short, man wants to do more than exist; he wants to live; to gain the fullest possible returns from the exertion of his powers.

The study of economics is not mercenary or ignoble. The whole of the graces and beauties of life are dependent upon a sound basis of economic life. To put it crudely, the pursuit of wealth for its own sake may be unworthy and mean, but without wealth all the better sides of life are impossible.

Economics a Social Science — Consequently economics is related to all other social sciences. It is related to history, which is the record of the past activities of man; it is related to psychology, which is the study of his mental processes ; it is related to geography, which is the study of the earth upon which he lives ; it is related to ethics, which is the study of his morals ; and to religion, which is the study of his hopes and aspirations.

The fact of these relations, however, does not prevent us from studying economics as a separate science. It differs in some important essentials from the other subjects. It differs from history in that it is as much concerned with the future as with the present or past, and yet its basis is in history, for without history we cannot interpret the present or attempt to see our way in the future. Economics utilizes geography as the science which explains the phenomena of earth resources with which man as an economic animal must deal. Psychology is essential as an instrument whereby we can understand the mental processes which lead to man's actions. And ethics and religion provide the aims towards which economic activity should lead.

This does not mean that the study of all these subjects in careful detail is necessary for the understanding of the main principles of economics, but it does emphasize the fact that economics is a branch, and not the least important branch, of the great group of sciences which are generally known as the social sciences.

Economics is peculiarly a social science, in that it concerns man, not as an individual, but as a society or group. The vagaries of action in the individual are impossible to predict, but the action of a group under given circumstances can often be predicted with almost mathematical accuracy. This fact must be constantly borne in mind. In economics we are not dealing with any particular Mr. Smith or Mr. Robinson, but with man as averaged in groups. The insurance company with a hundred thousand pohcyholders cannot say which particular policyholder will die in any given year. But it can predict within very close limits how many of the policyholders will die in that year. In fact, if it were not able to do so, there would be no possibility of the existence of an insurance company.

If a banking institution in a certain city should fail, , it would be impossible to say how the failure would affect the individual depositors and shareholders. But it would be a much easier matter to predict how the failure would affect the commercial community in which the bank was situated. The individual man is affected by all sorts of private and individual considerations. But these cancel one another in the large group, and only those effects which are directly the result of the economic cause are seen. Hence in our study we can afford to ignore all private considerations.

But while we ignore them, we must not be bhnd to their existence. We must constantly realize that we are deahng with averages. This is a commonplace of science. In chemistry we study the individual elements although probably most of them are seldom found in the pure state. In physics we study simple laws of motion before we consider the effects of modifying forces.

The Subject Matter of Economics — We may now turn to the question of the nature of the material which forms the subject matter of economics. Without exhausting the material, we may say that, fundamentally, economics examines into the causes which affect the production, distribution, and consumption of wealth; and in that examination, the study of the organization of industry and trade, the mechanism of exchange, the relations between employer and employed is essential. The nature of the control exerted upon economic processes' by individuals and by governments falls naturally into its place in the general study.

All social existence necessitates a certain amount of organization and government, and the proportioning of the expense of securing this organization and government also forms part of the study of economics. That is to say, part of the subject consists in the study of the extent and methods of taxation, and part also in the extent and nature of governmental expenditure.

It will readily be seen, therefore, that economics touches very closely upon the allied subjects of political science and history. The basis of the study must be in history, however. Nature does not progress by leaps and bounds, but by slow processes, and the development of a civilization is no exception to the rule. Each institution is more a growth than an invention. We can trace our present institutions back to the past, and show how the gradual changes have been made to secure the remedies for the faults which have appeared with varying conditions. No institution is ever perfect ; all are adaptations of older ideas to new conditions. And so we cannot understand our existing institutions without understanding also the conditions which gave them birth.

We are studying economic conditions and institutions, however, and are not concerned with institutions which have no economic importance. We are not called upon to make an exhaustive study of all the historic influences which have helped to mold the present civilization. We are concerned merely with that portion of history which may be called economic history. In other words, we must study those historical conditions which have directly led to the establishment and growth of our modern economic organization. Again, in this connection, we must remember that economic history is only a part of general history. In the same way religious history is a part, as well as constitutional and legal history. We are not supposing that all development is due to economic conditions, but we do suppose that economic conditions have had a very important influence upon our development, and that they will continue to do so.

Economic Laws — In the study of this historical development, the economist is not interested merely in facts. What he aims at is the correlation of facts so that he can trace the causes which have produced the effects he wishes to study. Just so the scientist is not interested in the phenomena which he investigates purely for themselves, but for the purpose of explaining the phenomena, and evolving from his continued studies the laws which govern the actions of nature. The scientist seeks to discover scientific laws. The economist seeks to discover economic laws.

There are two meanings which we can attach to the word law. We may speak of laws as a legislator uses the term. That is, we may consider them as commands laid down by those in authority to be obeyed by the people. A scientific or natural law is not of this nature. The scientist does not say that all bodies shall be mutually attractive but that, on the contrary, all bodies, as a matter of fact, are so. In other words, the legal law is a command which is often disobeyed and penalties are imposed on the disobedient. The natural law is never disobeyed and consequently there are no penalties for disobedience. The natural law states that, given certain causes, certain results must ensue. It is this latter idea of law which is used in regard to the term economic law. An economic law is a statement of the tendency for certain economic results to follow upon certain given economic causes or conditions. It is of the utmost importance to remember this fact if the student is to avoid the common errors in the colloquial use of the term economic law.

There is nothing final about an economic law any more than there is about a natural law. Whenever a scientist formulates a new natural law, he proceeds to test its validity by creating the given conditions and then watching for the results. As long as his " law "

always satisfactorily explains the results, it is considered as valid. But the moment a case arises which is not covered by the law, then the law must be restated so that it covers the new facts. This is exactly the case with the economist. His laws are valid only so long as they fit the facts. If they do not fit the facts, then thej^ must either be stated in such a manner that they do fit them, or else they must be discarded altogether.

The Deductive Method — In order that a law once formulated shall stand the tests to which it must be put, it is obviously of extreme importance that the methods by which it is formulated should be sound. Essentially there are two processes of discovering these laws. They may, for example, be formulated on the mathematical method. In geometry, for instance, we postulate certain facts, and from the basis of these postulates, we develop, by a process of pure reasoning, certain conclusions. That is, we use the method of logic, the syllogism. The syllogism consists of three parts. First there is a general statement; this is followed by a subordinate statement related to the first. From these two statements a conclusion is reached. Let us take an example of such reasoning in order better to understand the method.

The Syllogism — The general statement is usually termed the Major Premise, the second or subordinate statement is the Minor Premise, and the third is the Conclusion.

Major Premise. True colonization is impossible unless permanent residence of the colonist is possible.

Minor Premise. Permanent residence of British colonists in India is impossible on account of the climate.

Conclusion. British occupation of India cannot be true

colonisation.

Now the only way in which we can test the truth of this conclusion is to see whether it fits the observed facts. In this case the conclusion is sound, for it satisfies all the facts. But sometimes we find that the conclusion is not justified by the facts. For example, take the following argument.

All workmen desire the highest wages they can get. All workmen are free to move wherever they will. Therefore a rise in wages in one part cf a country will attract workmen from other parts.

In this case the facts do not always agree with the conclusion. Either something is wrong with our conclusion, or else with our premises. Though we may admit the general truth of the major premise, we cannot altogether admit the truth of the minor. There may be no legal objection to the free movement of workmen from one place to another, but nevertheless there are many other objections which tend to prevent such movement. A workman may not wish to leave his present home, or his friends ; he may not know of the rise in wages in the other place ; there may be conditions of climate or situation which make the other place less attractive, and so on. Hence our conclusion is not justified because the premises are not complete.

It is obvious, therefore, that we must exercise great care in examining our premises before we draw, our conclusion. And when we have so examined our premises, then we must apply the conclusion to the facts. This is always the ultimate test. If our conclusion, or " law " does not fit the facts, then it is worthless, no matter how logically it may be drawn.

The Inductive Method — This mathematical method of reasoning is usually called the deductive method. But it is not the only way in which we can formulate those economic laws about which the greater part of our study is concerned. If we note that in past ages a certain result has always followed upon certain causes, we may believe that in the future there is every reason for supposing that that result will continue to follow on the same cause. To take a concrete example, suppose that, on examination, we find that every time slave labor has been abolished and free labor substituted, there has been an increase in efficiency of labor and generally a more abundant and better production ; and if we further note that in all cases where there has been an increase in individual freedom the product of the labor has been improved in quantity and in quality, then we may formulate the " law " that " free labor is more efficient than slave labor." Now it must be noted in this case that there is no attempt at deductive reasoning. We have merely observed certain facts and seen that in every case the same result has followed upon the given causes. There is always a possibility, of course, that in some future time we may find that the result does not follow as before. In that case, we must restate the law so that it meets the new condition, or else we must try to see whether there are not some other circumstances present which have been absent in the previous cases from which our law has been formulated.

This may seem an unscientific method of reaching conclusions, but in fact it is one of the commonest of the methods used in natural science. The familiar story of the discovery of the law of gravitation by Newton is an instance. ^Newton noticed that without support the apple was bound to fall from the tree, and that similarly any other body suspended above the surface of the earth was bound to fall as soon as its support was removed. From these elementary facts and from further close observation, Newton was able to formulate the law that all bodies tend to attract one another with a force varying inversely as the square of the distance, and directly as the mass of the bodies. Test after test produced the same result and hence we have accepted the law as true.

The same method must be used in the discovery of economic laws and the same tests applied. The constant application of the law to existing facts tends to make the statement of the law more and more satisfactory. This process of discovering economic or other laws is called the inductive method. % til

Value of Economic Laws — A natural question to ask is, wha{ is the value of these economic laws ? Without systematization there can be no real knowledge. In fact science is distinguished from ordinary knowledge merely because it is systematized or organized. The value of the laws discovered in physical science is that not only can the present be explained, but the future can be predicted. If the economic laws are to be of any real value, they must enable