The brevity book on economics

Front matter

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The Brevity Book on ECONOMICS

EDITORIAL BOARD

Preface

This .book is a simplified statement of the essential principles of Economics as accepted by representative economists. Its aim is to give the reader, in return for a minimum amount of his time and effort, a good working knowledge of this underlying science of business.

Harrison Mcjohnston Chicago, Illinois, July 1,' 1919 otr -b idib

Copyrighted, 1919, by

Harrison McJohnston

All rights reserved

Contents

CHAPTER PAGE

I The Aims of Economics 1

II Price and Price Changes 6

CHAPTER I The Aims of Economics

(Economics is a scientific study of man's efforts in satisfying his wants for material things and services. It is an underlying science of business. The entire business world is the laboratory of the economist.

The economist is mainly interested in promoting the material well-being of society as a whole. He aims to help improve the general standard of living and to pro- % mote better distribution of wealth and income. His task jj is to study scientifically all the essential factors involved J in the promotion of national and world prosperity. To him, prosperity means an abundance of economic goods for distribution and abundant opportunity for all to possess and enjoy the good things of life.

Very few economists oppose the individual's right to possess private property ; but they all challenge abuses of this fundamental institution, wherein public welfare is sacrificed to the gain of individuals. Because business activities are now so thoroughly cooperative, society must have public rights — designed to make individual rights more valuable and more equitable. Public ownership of highways, tof waterways, of schools, and of similar "public utilities" which can clearly render better service when owned by all the people, is now generally advocated. But all the costs should be considered before making extensions of public ownership. Government ownership and regulation are treated in Chapter IH with the question of monopoly.

Economists commonly emphasize the advantages of free and open competition as a fundamental incentive to econ-

Page one omic progress — when competitive trade is conducted fairly and within the bounds of good public policy. Brisk trade is considered to be a chief source of general prosperity, and intelligent regulation of trade is generally believed to be necessary. The extent of state "interference" in the policies and methods of business has always been a bone of contention among the economists of various schools.

Historically, economists are divided into several schools. Prior to the time of Adam Smith — whose "Wealth of Nations," 1776, ushered in the Classical School — the Mercantilists, mainly in England, and the French Physiocrats were the cjbief schools of economic thought.

The Mercantilists held that national prosperity depended mainly upon accumulating a large stock of gold and silver. They therefore advocated strict state regulation of industry and commerce, designed primarily to increase exports and to decrease imports of merchandise, and thus to help increase imports of gold and silver. The Physiocrats were inclined to look upon agriculture alone as truly productive, excluding the work of merchants, traders, professional men, and the like; while the Classical School taught that manufacturing and trade, as well as agriculture, were productive.

The leading economists of the Classical School were Adam Smith, Thomas Robert Malthus, David Ricardo, and John Stuart Mill. They lived in the last half of the eighteenth century and the first half of the nineteenth.

Adam Smith is often called "the father of political economy." There is no distinction between "economics" and "political economy"; the latter being the name given to this science by the early economists. "Economics" comes from a Greek word which means household economy. "Political" was added in order to distinguish household from state economy.

The economists of the Classical School emphasized in particular the so-called laissez-faire (let-things-alone)

THE AIMS OF ECONOMICS 3

principle, believing in freedom of business enterprise, and particularly in freedom of the individual from the dictation of the state. They therefore advocated free trade — a movement which became so strong that England about the middle of the nineteenth century adopted her freetrade policy. This was a decided change from the attitude of the mercantilists who gave individual enterprise very little freedom from state supervision. The Classical School believed that "intelligent self-interest," operating under conditions of free, fair, and open competition, would most effectively foster aggressive production and equitable distribution of wealth.

Modern economists have reacted against the Classical School's extreme opposition to governmental "interference." The trend of economic thought, for at least thirty or forty years, has been toward greater state regulation of production and trade. Except for this one important point, however, most of the thought of the classical economists remains in modern economics ; and a very large part of modern economic thought may be traced to the classical economists. Adam Smith, for example, pointed out clearly the productive advantages of specialization, or division of labor, which is the most marked and fundamental characteristic of modern large-scale production.

Later schools of economic thought, however, have modified somewhat and have greatly supplemented the thought of the classical economists. The Historical School, arising in Germany about the middle of the nineteenth century, reacted against the abstract methods of the Classical School, claiming that economic inquiry should be concerned mainly with historical facts. The Austrian School, sometimes called the Psychological School, has made an intensive analysis of human wants. This school developed the principles of "marginal utility" explained in the first part of the next chapter.

Because of their outlook into the future, some economists have been called optimists and others pessimists. The "optimistic school" is essentially a reaction against pessimistic forecasts, of which the views of Malthus are representative. In his "Theory of Population," 1798, Malthus maintained that population tends to increase faster than the food supply; and the generally bad living conditions of common labor in England in the middle of the nineteenth century seemed to verify the Malthusian doctrine. Since then, however, the standard of living of the laboring classes has undoubtedly improved, with a marked decrease in the relative number of the very poor in nearly all countries. Never more than today have we been so much interested in bettering the living conditions of the poorer classes.

Economics has never been a "closet philosophy." Economists have always been interested in practical affairs. Adam Smith was keenly interested in the business men of his own town in Scotland. David Ricardo had made a fortune in business before he was forty years of age. But nearly all economists, until recently, confined themselves mainly to public problems. Today, however, they are becoming more and more interested in current business problems, such as the major problems of organization, finance, marketing, and accounting.

Although economists now, more than ever, try to help solve the practical problems of individual business concerns, the broader problems that affect all business are still the primary problems of economics — to make plain, for instance, the true relation of capital to labor, and the relation of capital and labor to the welfare of the general public.

The number of business and professional men who now recognize the practical value of this science is increasing rapidly. Leading business men now more than ever see the importance of a scientific study of business in general, apart from consideration solely of the welfare of a single business enterprise. They recognize the

THE AIMS OF ECONOMICS 5

increasing interdependence of all commerce and industry, and of the several classes in society.

The study of modern economics helps the individual business man in many ways. It aids him in exercising independent judgment of the best means and methods of solving many current business problems — problems of money, credit, and banking, of domestic and foreign trade and the tariff, of government ownership and regulation of industry and commerce, of transportation, of business and public finance, of social reforms; in short, all the major problems of the business world. Perhaps the business man's most important direct use of a thorough knowledge of economic laws and principles, however, is in helping him to forecast fundamental changes in business conditions.

Almost all these changes in business conditions have something to do with prices and markets. Everywhere and at all times we are face to face with alterations in relative values, revealed in changing prices. Modern economists therefore occupy themselves largely with a study of the fundamental causes and effects of changes in prices.

Chapter II

Price is value expressed in money. The value of a commodity or service, \s expressed by its price, arises from its utility and scarcity. Utility, in Economics, means power to satisfy want. Economic scarcity exists when the amount of any commodity or service is less than sufficient to satisfy all want for it. Air and water, for example, are seldom scarce commodities. At certain times and places, and in some forms, air and water are, of course, economically scarce. But, as a whole, they are "free goods." They are indispensable, but they do not have exchange value; they do not have a price. Both utility and scarcity are requirements in all commodities that are bought and sold.

The satisfaction of human wants is the ultimate aim of economic activities ; and the possible development of the number and variety of human wants seems to be almost without limitation. But any single want is capable of being completely satisfied.

If a person is hungry and, for example, has a few apples, all about alike, the first apple he eats will yield him greater utility or want-satisfying power than the second apple he eats; the second will yield greater utility than the third; and so on until his want is completely satisfied. This is the principle of diminishing utility: each successive unit of any commodity, as consumed, yields less and less utility in satisfying a single zvant.

If a person has, say, three apples, and the satisfaction of his own immediate hunger alone is considered, it is obvious that any one of his three apples will be worth no more to him than the third apple to be eaten. Its value measures the value of each of the other two; for if he should sell or give away or lose one of his three apples, it would be the amount of satisfaction he would get from eating the third apple that he would lose. Thus the value of the last unit consumed in a stock of goods measures the value of each of the other units. This last unit to be consumed — the "least important" unit — is called the final or marginal unit of supply; and the fact that the value of the final unit to be consumed measures the value of the other units, is called the principle of final or marginal utility.

These principles of diminishing and final utility help somewhat in explaining the law of supply and demand. The greater the stock of any commodity, relative to the amount wanted or demanded, the less the value of the final unit of that commodity to be consumed, according to the principle of diminishing utility; and the value of this final or marginal unit measures the value of each of the other units, according to the principle of final or marginal utility. Therefore, the value of any unit in the total stock of any commodity, such as wheat or corn or cotton, tends to go down when the stock increases relative to the amount wanted, and up when the stock decreases. If the amount wanted increases or decreases relative to the stock, the effect upon the price is the same as an opposite change in stock relative to want.

These tendencies imply freedom of choice and freedom of competition. Entirely free and open competition implies that all bids and offers are known to all buyers and sellers, also that each buyer is competing with all other buyers and that each seller is competing with all other sellers. This condition of entirely free and open competition seldom exists, but it is a helpful supposition in the study of market price.

The market for any commodity may be technically defined as the area in which one price prevails for that commodity; or it may be defined as the area wherein the main factors which determine this one price, operate. Under free competition, a market price is the prevailing or generally current price which results from the bids and offers of competing buyers and sellers.

All buyers who are willing to buy at the market price, but would not buy if the price were any higher, are known as the marginal buyers. All sellers who would not sell if the market price were any lower, are known as the marginal sellers. All other sellers, who would be willing to sell if the price were lower, gain what is sometimes called seller^s or producer's surplus when they sell at the market price; and all other buyers, who would buy even if the price were higher, gain buyer's or consumer s surplus when they buy at the market price.

Buyers will not knowingly pay more than the market price, nor will sellers knowingly sell for less than the market price. Yet, rather than fail to buy all they want of a commodity or service, many buyers would be willing to pay more than the current market price ; and many sellers, rather than fail to sell all they want to sell, would be willing to sell for less than the current market price. Therefore, if demand at the market price falls off for any reason, some sellers will lower their price in order to get ahead of other sellers; and if supply at the market price falls off for any reason, some buyers will raise their bids in order to get ahead of other buyers or to tempt more sellers into the market. Thus relative changes in supply and demand at the current market price are reflected by changes in the bids and offers of buyers and sellers. These bids and offers cause the market price both to be what it is at any one time and to change from time to time.

It is necessary to remember that supply and demand are different at different prices. The amount of any commodity or service offered at the current market price is called the effective supply; the amount demanded at that price is the effective demand. The amount that would be offered or demanded at any other than the market price is known as potential supply or demand.

The movement of the market price for any commodity, under freely competitive conditions, is toward the point which equals the cost of production to marginal producers — those whose costs of production are highest. If the price falls below this point, the marginal producers will suspend production, and will probably transfer their attention to the production of some other commodity the market price of which will be more likely to yield them a satisfactory profit, A new set of marginal producers will then be in the market. But if the market price yields the marginal producer a relatively wide margin of profit, additional producers are attracted into the industry. They increase the supply — and the market price tends to fall. This tendency of the market price, in a competitive industry, to travel toward and to remain at the point which equals the cost of production of marginal producers — plus the least acceptable profit to them — is the lazv of normal competitive price. Fixing prices for the service of public utilities— railroad rates, for example — upon the basis of cost plus a reasonable profit, is recognition of the law of normal competitive price.

While the market price tends to be established by the bids and the offers of marginal producers and sellers, and tends to move toward the normal competitive price, as explained above, lack of complete information on the part of both buyers and sellers, and lack of free competition among buyers and among sellers, particularly among sellers, cause the market price of many commodities to vary from the normal competitive price.

Monopoly, representing various kinds and degrees of unified control of supply — or of demand in exceptional cases — affects in some degree the market price of many commodities. Economic monopoly exists when this unified control is sufficient to enable the monopolist, usually by manipulating supply, to cause the market price to be above or below the normal competitive level.

Monopoly, however, may or may not result in a high price; that is to say, in a price higher than the normal competitive price. Unified control of supply, as in the case of city electric light and power service, may result in savings which permit even a lower price than would be the case were two or more companies competing for trade. In many other industries one large monopolistic company may enjoy many economies which enable it to make a lower price than could be made when several smaller competing companies are operating; and this lower price may yield the company its greatest possible net profit. This result, however, would depend upon the relative cost per unit of product when diflFerent quantities are produced, and the extent to which low prices would bring greater demand.

Virtually every producer faces conditions of either decreasing, or increasing, or constant cost ; meaning that the cost per unit of product either decreases, increases, or remains constant with increases in the quantity produced in any one period of time. The monopolist tries to discover the price which will yield him the greatest net profit. He wants to know how various prices will affect demand, and how various quantities produced in any period of time will affect the cost per unit of product Is demand elastic or inelastic f If inelastic — if demand would not differ very much at different prices, as in the case of table salt — he would probably fix a relatively high price. If elastic, as in the case of nearly all commodities, the monopolist would want to fix his price at the point where the number of units demanded at that price, multiplied by the net profit per unit, would yield him the best total. Thus the "best" monopoly price would be fixed with a view toward anticipating its effect upon all the factors which would cause present and future changes in the cost per unit of product and in the character and quantity of demand, including the effect upon potential competition. These factors are innumerable. Many of them cannot be anticipated. Usually the monopolist's method of fixing his most profitable price is experimental. Other aspects of monopoly are treated in the next chapter.

In competitive as well as in monopolistic industries, the problem of producing the most profitable quantity is often difficult, especially so when production within the industry as a whole tends to vary a great deal from season to season, and when demand, at any particular price, is somewhat uncertain. The risk of over-production and therefore of loss from a fall in the market price, causes producers in many competitive industries to be careful in their forecasts of the total demand for and supply of their products. Speculation, explained later on, and other indications of future demand relative to supply are of extreme importance to producers in competitive industries.

Even though many conditions prevent competition from being entirely free and open, changes in the ratio of supply and demand are either a primary cause or a primary result of changes in prices. The essential condition of any change in price is a change in the ratio of supply and demand.

Prices are relative to one another, and the price of one commodity is "sympathetically" related to the prices of other commodities. A change in the price of cotton aflfects the price of wool ; and a change in the price of wool affects the price of cotton. In all cases wherein one commodity may be, to some extent, substituted for another, an increase or a decrease in the stock of one tends to affect the price of the other the same as an increase or a decrease in the stock of the other — in so far as the two commodities are satisfactory substitutes one for the other. There is also a connection between the prices of complementary goods such as lumber and paint; or of "goodsin-series," such as iron ore and steel and the many products made of steel. An increased demand for lumber sooner or later increases the demand for paint; while an increased demand for, say, steel ships increases the demand for steel which increases the demand for iron ore — tending to cause the prices of all three to increase.

As yet, however, economists have not studied intensively the various kinds and degrees of "sympathy" between goods of various classes and their respective prices. Only general relationships have been observed. But economists have given a great deal of attention to the causes of changes in the general level of prices. We know that the prices of almost all commodities have sometimes risen and fallen together. Index numbers are used to indicate these changes in the general price level. The average price of a large number of basic commodities during some past period, usually some decade, such as 1880 to 1890, is chosen as a standard price level and is represented by 100. The ratio that the current price level — or the price level for any other time or period — bears to the standard price level, is expressed by a number v/hich bears the same ratio to 100. If the current price level, for instance, is twice as high as the standard, it would be indicated by 200, which would be the so-called index number of the current price level.

Why do all prices in general tend to rise or fall together over long periods of time? Does the law of supply and demand, as it affects the prices of all commodities, explain this satisfactorily, or does the dollar itself change in value?

It is commonly believed that the purchasing power of a dollar bears a definite relation to the quantity of gold in the country, because a dollar represents a fixed amount of gold and because gold is the basis of our active supply of money and credit. It is believed that the value of a dollar tends to vary with changes in the amount of money-and-credit in circulation. Obviously it would take a greater amount of money-and-credit to put through the same amount of purchases at higher prices — unless the money-and-credit were to circulate faster during the period of time involved ; for an increase in the rapidity of circulation of money-and-credit operates the same as an increase in the amount of them in circulation. It is not necessarily true, however, that the greater the available supply of money-and-credit, the less will be the value of the dollar. But the available supply of money-and-credit and its rapidity of circulation seem to have considerable influence upon the rise and fall of prices in general— through the effect upon the demand for and the supply of commodities and services of all kinds.

The ease with which business men can make loans, or otherwise find capital for expansion, affects the general demand for goods of almost all kinds. For example, the pronounced rise in prices during the war was caused primarily by the increased demand for many kinds of goods required for conducting the war. Circulating credit was greatly expanded to enable contractors to buy materials and labor to take care of war orders. These contractors, partly as a result of their "cost-plus" contracts, were able to bid up prices of many materials and of many kinds of labor. All other industries were forced to bid against them — and this was the primary cause of the general rise of prices. Our increased gold supply permitted a great increase in bank credit available for business uses, making it easier for buyers to secure working capital— and to bid up prices on the supplies of materials and labor which were so urgently needed. Increased demand for labor, caused in part by a decreased supply of labor on account of enlistment, forced up the price of labor in nearly all industries, and gave labor more money for the purchase of merchandise at higher prices.

It seems to be true, however, that generally rising prices over relatively long periods of time, such as the steadily rising prices from 1896 to 1914, were caused mainly by our increasing production of gold and by improvement in our use of gold as the basis of our supply of money-and-credit in circulation.

It is commonly believed that the present increase in the amount of bank credit available for use is largely permanent. Consequently, it seems reasonable to expect the increase in the general price level to be permanent— -in so far as the amount of money and of credit instruments in circulation shall remain proportionately the same as it is today. But, as explained later on in Chapter IV, prices in various countries tend to seek the same level. It is a world rather than a national question. Even after considerable deflation of credit in many European countries, there will doubtless remain there a permanent increase in bank credit. Most economists feel, therefore, that we maj expect a permanent increase in the general price level as compared with the level of prices in 1914. Just how mucli prices in general will eventually fall from their high level and just when the general price level will begin to fall, seem to be impossible to predict. Many special students of the subject feel that prices will settle at somewhere near the 1916 level.

The idea that the general level of prices is regulated by the amount of money-and-credit in circulation, is known as the quantity theory of prices. It is further discussed in Chapter IV.

But whether a rise or a fall in the general price level be caused mainly by more or less interdependent change-- in the demand for, relative to the supply of, many commodities, or mainly by changes in the supply of, relative to the demand for, money-and-credit — or by both, as seems to be the case — it is quite clear that generally falling prices discourage production and trade while they are falling, and that generally rising prices encourage production and trade while they are rising. Manufacturers naturally hesitate to produce many commodities, based upon curreexpenses of production, when they face the prospect of selling these commodities later on for less than the current market prices ; and of course merchants hesitate to buy many commodities the retail prices of which may fall before they sell them. Nearly all consumers are disinclined to buy freely when prices are falling. Thus falling prices tend t© cause "hard times," or a decrease in the volume of trade, involving a decrease in production. Rising prices have an opposite effect They tend to encourage production and trade. Yet a rising price level is a disadvantage to creditors who get back in purchasing power less than they lend by as much as the value of a dollar falls between the time they lend and the time their loan comes due. But when prices are falling, debtors suffer, for they must pay back more, in purchasing power, than they borrowed. This result of changes in the purchasing power of the dollar is known as the problem of i the changing "standard of deferred payments." It em-/ phasizes the desirability of having a dollar of more stable value. Some of the proposals for accomplishing this are stated a little later on.

Although rising prices stimulate business, prices in general cannot continue to rise indefinitely. When they stop rising and begin to come down, business depression follows ; and the depression tends to be severe in proportion to the rapidity of the fall ia prices — and the lack of preparation for it on the part of business men.

Crises or panics are relatively sudden business depressions of varying breadth and depth, which have occurred at intervals of about ten to twenty years. They are marked by an abrupt decline of prices. The true causes of crises are not as yet fully understood. Excessive optimism during a period of rising prices — with feverish promotion of industrj'^ and trade, involving reckless investments and the placing of too much capital into enterprises from which returns would come only in the remote future — is probably the main cause of crises. It is excessive eagerness to take advantage of new opportunities or of steadily rising prices — while they are rising. Then, remembering past experiences, an intuitive feeling that prices cannot indefinitely continue to rise, gains strength as prices mount higher — up to the breaking point, precipitated perhaps by the failure of some big business concern, which is quickly followed by a general attempt to avoid the inevitable losses of a sudden decline in prices.

Thus, although something may be said in favor of a steadily rising price level as a stimulant to business development, the ultimate consequences seem to be undesirable. Whether so to control the supply of money-andcredit, if possible, as to prevent both a general rise and a general decline in prices, is an open question. Some feel that the purchasing power of a dollar and of all monetary units used in other countries, could be and ought to be fixed once for all time and rigidly maintained. Many ingenious methods of thus stabilizing the value of the monetary unit have been proposed. Some suggest altering from time to time the amount of gold represented by one dollar. Others advocate government control of the production of gold. A few suggest doing away with gold as the basis of the value of all monetary units and substituting some abstract unit with its value or purchasing power carefully controlled by an international tribunal authorized to regulate its supply according to changing volumes of trade.