Principles of economics

Preface

It is hardly necessary to say that this book is intended only for use as a textbook. There is perhaps more need to explain that it does not cover quite the same ground as the conventional type of such books. First, it contains less descriptive matter than is commonly offered. As this perhaps assumes more knowledge of economic phenomena than the average student in elementary economics possesses, it may' be desirable to use along with this text, especially in the early stages of the course, some book on economic organization. At Ann Arbor we have been trying this plan during the current semester and expect to continue doing so next year.

But this book not only starts at a point somewhat later than the conventional textbook, it also stops at an earlier point. More specifically it stops short of any serious study of practical problems such as the Tarifif, Business Cycles, and Labor Legislation. In so far as such problems receive any comment at all, this occurs in the process of illustrating economic principles, — no attempt being made to pass judgment on such problems taken as a whole. In short, this book is not intended to be a general treatise, the mastery of which will give the student a fairly adequate knowledge of the whole economic field. Instead, it is intended to perform just one special function in the student's economic education, namely, helping him to master the body of principles, mostly quite abstract, which are generally held by economic authorities.

I have noted that this textbook is designed to perform a narrower function than is usually undertaken by such books. It may be well to add that it also differs from most others in that it lays more stress on securing for the student a very definite mastery of the accepted body of economic principles, — such mastery as the student of Chemistry or Physics is expected to acquire. This will explain the rather rigid methods of statement, the presentation of

IV PREFACE

principles in formal shape, and the extensive use of problems or examples which the student is expected to work out.

In view of the air of finality given by the method of presentation just remarked upon, it seems almost necessary to explain that this book has no real finality in the mind or purpose of the author. In fact, it is only a book in the making. It has been revised almost every year since it was first brought out in a series of separate leaflets fifteen or sixteen years ago; and the contract with the present publisher provides for a continuation of that policy. This does not mean that the author considers such a procedure requisite in order to keep up with fundamental changes in economic doctrine, but merely that, in working out his plan, he seems to find it necessary to resort to the method of trial and error. Each edition, therefore, contains experiments in analysis and presentation which are expected to show a need for revision and to get such revision in later editions. The necessity for this procedure is diminishing; but it has by no means disappeared. I expect, therefore, to continue the policy indicated for some time to come.

A cursory reading of this book will show that it makes little or no claim to originality in substance. Still, it would be quite impossible that any man who has taught elementary economics for thirtyfour years and advanced courses in economic theory for twenty-eight years, should not secretly cherish the belief that he has made some trifling modifications in economic analysis which seem to partake of the nature of contributions. However, it is not worth while to give these more specific comment. If such modifications are of any significance the fair-minded student will note the fact; if not, the less said about them the better.

If it had not already been sufficiently brought out by implication in this preface, the reader of the text would very soon learn that the body of doctrine herein contained is, on the whole, rather markedly orthodox. I should have been sorry to be obliged to make it otherwise; for I should have been sorry to believe that our predecessors have left no body of doctrine which is to abide for an indefinite period in the future. I have been at some pains, however, to stress the point that the acceptance of orthodox economic doctrine is entirely compatible with giving support to whatever

PREFACE V

degree of interference with the working of the present economic order may prove on the whole conducive to the welfare of society.

It is not my intention to enumerate the particular persons who in one way or another have contributed to the preparation of this text, chiefly, perhaps, because the list would be too long. In general I feel that I owe most to the small army of young men who in the course of the last fifteen years have assisted in teaching it at this university. From them I have received many useful criticisms and many valuable suggestions. The only person whose hand is largely shown in the present form of the book is Mr. Elmer C. Adams — now with the Detroit Evening News — who collaborated with me in the preparation of the fifth edition.

The most important change in the present edition is the revised treatment of the prices of primary factors presented in Chapters XXIX and XXX. Minor ones appear at various points, particularly in the introductory chapter and the chapter preliminary to the discussion of price.

Frederick M. Taylor

Ann Arbor, Michigan July 5, 192 1

Contents

Chapter Page

I Introductory i

II General Survey of the Existing Economic Order i6

Chapter I Introductory

Goods. — One of the most characteristic marks of a sentient being Hke man is to have wants, — we might almost say that to feel wants and secure their satisfaction is the very essence of living. Again, it is manifest that the satisfaction of any want depends on the presence of the appropriate condition. The satisfaction of physical hunger depends on having food at our disposal ; the satisfaction of our craving for affection requires a certain attitude on the part of some other person or persons ; the satisfaction of our love of beauty depends on the presence of beautiful objects ; and so on. All objects or conditions on which the satisfying of wants is dependent, we shall call goods, using the term very broadly. The property of goods whereby they are thus able to satisfy wants we call their utility.

Economic Goods. — But, now, as students of economics, we are concerned, not with every kind of goods, but only with one particular kind known as economic goods. Our next duty, therefore, is to learn something about the characteristics which enable us to distinguish economic goods from other goods. Under the present economic order, such a characteristic, and one very easy of application, is to be found in what we call exchange value or, still more exactly, price.^ The great majority of those goods which all recognize as economic enable their owner to command in exchange money or other economic goods; and, on the other hand, can be obtained by people who do not themselves produce those goods, only by giving in exchange money or other goods of the same general nature.

^ This would not be true under a system of pure communism such as that which Russia apparently set out to establish in the fall of 1917. Under that system, there was to be no exchange, no selling and buying; yet there would surely be economic goods, since the people of Russia would continue, in the main, to feel the same wants, and so to need the same goods, as they had before the new system was introduced.

Since we are mainly concerned with the economics of the present order, it would perhaps be just as well at this stage of our study to leave the student to depend on this simplest test of what is and what is not an economic good. Experience, however, inclines me to think that considerable advantage would be gained if the student were to get at the very outset a deeper understanding of the real nature of economic goods. Before going on, therefore, we will attempt a little more thorough analysis of this matter.

Economic Goods Conduct-Determining. — In trying to find a mark of economic goods which is more fundamental than mere exchange value or price, we first note a characteristic which, though possessed by many non-economic goods, after all shuts out a considerable number of them, and is at the same time of very great importance. That characteristic may be designated conduct-determining or conduct-conditioned.^ That is, goods of this sort are goods which call on us for appropriate conduct : we need to act in a certain way to get these goods or to enjoy them. Thus, we cannot hope to possess the affection of our friends or the approval of our neighbors unless we conduct our lives in a suitable manner. The conduct-conditioned goods last named are, of course, not economic goods ; but the statement made in respect to them surely applies to goods of the latter kind also. Thus, we cannot hope to have clothing or food unless we expend effort and trouble producing these things or producing other goods to exchange for them. Again, having obtained these goods, we could not hope long to enjoy them unless we were willing to take care of them, store them, guard them against thieves, protect them from fire, and so on. Economic goods, then, belong in the class of goods which are conduct-determining or conduct-conditioned; and this is one of their most important characteristics.

Economic Goods Have Importance. — The last paragraph emphasized the point that the property of being conduct-determin-

' These designations are not quite equivalent, but I shall take the liberty of using them interchangeably, choosing in each particular connection the one which seems most suitable.

ing, though not limited to economic goods, is one of the most important characteristics of such goods. Another point needing comment is the precise reason why certain types of goods have this property of being conduct-determining. For, on this point, there is much erroneous opinion. The general answer to this question is to be found in the statement that goods of this kind have importance for us, our welfare depends on them, we have something at stake in them. But this, again, needs sharper definition. There is a kind of imporfe,nce which is not conduct-determining and therefore does not interest us, — is not a real, actual importance at all. The air we breathe has an importance of this kind. Importance it has, since without it we die. But, then, this importance is one which does not count; — from the practical standpoint it does not really exist, just because it does not call on us to regulate our conduct with respect to itself. Thus, we do not need to see that we are provided with air, do not need to worry about it, do not need to give it so much as a thought ; for it is supplied to us as a matter of course.

Economic Goods Have Effective Importance. — This contrast between the kind of importance which does not make things conduct-determining, and the kind of importance which does, is sometimes expressed by saying that the former is merely potential importance, the latter actual importance. Again, that contrast is at times expressed by saying that the former kind of importance is merely generic importance, while the latter is specific importance. The former phrase means that the goods in question have importance as a mere kind of goods; the latter means also that every unit of these goods which is at our disposal has importance. A phrase we shall often use instead of specific importance is effective importance.

The point just made, we must emphasize still further even at the risk of being tiresome. For a failure to understand it is the cause of a very wide-spread and persistent economic error. From highly intelligent and often highly educated people, we are constantly hearing talk like this : "The valuations which society puts on things are incredibly absurd. Things which serve only for the satisfying of the most trifling of wants are esteemed more highly than things on which our very existence depends. We rate the services of a professional singer, a Caruso, far above those of a coal miner or a farmer; we esteem diamonds infinitely more than bread; we pay teachers, who perform one of the most important of social functions, less than the poorest workman in an automobile factory."

The answer to all this is that it confuses real, actual, effective importance with mere generic importance, and that it is usually ^ the business of society to concern itself, not with the generic importance of services or goods, but with their effective importance. To rate professional singers as such more highly than coal miners as such would of course be absurd ; and we may be quite sure that very few people could be found who really do so. If we had to give up all the singers or all the miners, we should without a second thought decide against the singers. But, under all ordinary conditions, no such alternative is presented to us. We are going to continue to have both Carusos and miners : we are simply called on to decide whether we need one more Caruso more or less than we need one more miner. From this standpoint, there is no room for any answer but the one people generally make : Important as miners are, when considered as a class, one miner more or less is very unimportant as compared with one Caruso more or less. The real effective importance of a Caruso is much greater than that of a miner. Society is not acting foolishly or thoughtlessly or wickedly in acting just as it does in evaluating the services of a Caruso far more highly than those of a miner. On the contrary, its evaluations at this point are just what they ought to be : they express the real comparative importances involved.

I. The lumber of which a frame house is made has much more generic importance than the oxide of lead which enters into the paint which covers the house; yet a hundred pounds of lumber has much less effective importance than a hundred pounds of the oxide of lead. Explain and defend both statements.

'Circumstances arise under which society is in danger of losing some economic good altogether or, anyhow, seeing its stock seriously reduced, — for example, its forests. In such case, it must have regard to totals as well as units.

2. Rain and sunshine, though having vast generic importance, have no effective importance as the phrase is used in the text. Defend that statement.

3. "Alone and lost in the desert, his last morsel of food and his last drop of water gone, he would cheerfully have given his gold, his yachts, his palaces, all his wealth, for the meager fare of the day laborer. At last the illusions which he shared with civilized society were fully dispelled. The unutterable folly of the comparative estimates which men commonly put on things became manifest. At last, on the verge of oblivion, he saw things in their true, their real, proportions." Criticize.

Economic Goods Have Definitely Mensurable Importance. — The preceding paragraphs have narrowed down the field of economic study to those goods which possess effective importance and which, therefore, are conduct-determining. But we must carry further this process of delimitation. Not all goods which have effective importance can properly be designated economic goods, though this is one of the most essential characteristics of economic goods. Thus such goods as the affection of our friends and the respect of our neighbors are by universal consent excluded from this class. What, then, is the characteristic the absence of which shuts these out, — ^the presence of which makes a particular good truly economic ? This question is not an easy one to answer definitively ; and probably would be answered differently by authorities of equal standing. I am disposed to set up, as this final distinctive characteristic of economic goods, the possession by such goods of a special sort of effective importance, namely an effective importance which submits to more definite measurement than the importance of non-economic goods of this same general class. Stated still more specifically, under the present order, anyhow, strictly economic goods consist of those conduct-determining goods the importances of which can properly be measured and usually are measured in terms of money.

Economic Value. — In the above discussion, I have purposely chosen to use the word importance in bringing out the distinctive features of conduct-determining goods, and, particularly, that class of such goods which we call economic. But, usually, we shall employ for this purpose another term, namely, value. Exactly what significance ought to be attached to this term in economic discussions is not easily settled. In general, I am disposed to believe that the economist ought to have in the background of his mind the ordinary conception of value as significance to the well-being of man. Such a concept seems to me desirable as furnishing a link between the idea of importance and the idea of "conduct-determining." That is, because things have importance for us, they come to have value, and, because they have value, we regulate our conduct with reference to them. Perhaps the word "worth" helps to bring out this point. Conduct-determining goods are goods which are worth troubling about. In this broad sense of the word, value, all conduct-determining goods possess value. Wl^ien, in addition, the particular goods in question belong to that division of conduct-determining goods which we call economic, their value, like the importance from which that value is derived, is one which is capable of more definite measurement than is true of the other type, — is capable, that is, of pecuniary measurement. By economic value, then, we shall understand a worth or value thus capable of pecuniary measurement. Or, in short, economic value will be pecuniary value.

Economic Goods Have Pecuniary Value. — It follows from what has just been said that, in defining economic goods, we may substitute for the phrase employed before, that is, importance capable of pecuniary measurement, the simpler phrase, pecuniary value. In other words, economic goods consist of that large class of conduct-determining goods which possess pecuniary value. But, now, in emphasizing as the final distinguishing characteristic of economic goods, pecuniary value, we must not forget that the word "value," as here used, means something deeper than exchange value, means worth or significance for man. This way of conceiving economic goods and value we shall frequently, though not always, have in mind when using these terms.* We should remember, however.

* Let me say once for all that the term "value," as well as some others, will be used in a variety of senses. The policy, quite characteristic of logical minds, of trying to employ every term in just one sense, is almost always impracticable and productive of narrowness in one's thinking. The that if our particular problem is to decide whether or not a given good should be accounted an economic good, under the present order the simplest test, and usually a perfectly adequate one, is the presence or absence of exchange value or price.

Wealth. — Up to this point, in speaking of the goods v^^ith which the Economist is concerned, we have always referred to them as economic goods. I hardly need say that such goods are very commonly brought under the designation "wealth." This is a generic term applied to all goods which under the present order have exchange value or price, and only to such. This practice makes it comparatively easy to decide whether or not a given object should be accounted wealth. It also helps us to work out for ourselves the other characteristics which goods that are accounted wealth must possess. For we need have no great difficulty discovering what characteristics must be present in goods for which people are going to be willing to give money.

1. "In order to be an economic good — wealth — a thing must have utility, — must be capable of satisfying some want." Argue for the truth of this statement.

2. Show that in order to be wealth a thing must be appropriable and transferable.

3. Is the water flowing from a spring by the roadside wealth?

4. Is an amiable disposition wealth? A hundred tons of gold known to be lying on the surface of the moon? A vein of coal existing, but not known to be existing, under a Michigan farm?

5. It would cost a good deal of labor to cover the walls of the houses on Washtenaw Avenue with posters of a circus given two weeks ago. Would the result be wealth? What is the point to be made?

6. "A thing may have value even though it is not useful: e. g., an old stone prized by a collector." Point out the error.

real thing has many sides and there are not words enough to express every different aspect of it by a different term.

7. When we call a man wealthy we mean that he possesses a relatively large amount of this world's goods. Should we understand this to mean that the possessions of the poor man are not wealth ?

Importance of Economic Study. — ^The preceding paragraphs have cleared up the concept of economic goods and their distinguishing mark, economic value. That these goods and the phenomena connected with them deserve serious study of some sort no one would doubt. If scientific curiosity did not suffice, the fact that these goods are conduct-determining, that we must act suitably or go without them, would surely settle the matter. Since we cannot have them unless we act in certain ways with reference to them, it surely behooves us to learn something about them and the conditions necessary to fulfil if we are to have them, in order that we may adjust our conduct accordingly, for, behind all correct, suitable action, there is surely an art, a body of rules which tell us the course which we need to pursue; and behind such an art there must be a body of scientific knowledge on which said rules are based. Economic conduct is no exception to this rule — men need a body of rules to guide their economic conduct; and that body of rules must rest on a body of scientific knowledge with respect to economic phenomena. We, therefore, have highly practical and powerful motives for developing and studying a science of economics.

But just here is needed a word of caution. The scientific basis for any art, the body of knowledge lying behind any art, in most cases consists of materials derived from a number of different sciences. Thus, the art of making an automobile depends on the sciences of metallurgy, chemistry, physics, etc. To this rule, again, the art of economics furnishes no exception. This very making of an automobile just cited is in a sense a part of economic art, since an automobile is an economic good ; and, hence, the art of economics, in the broadest sense, builds on the sciences of metallurgy, chemistry, physics, etc. Similar statements would apply to many other economic activities. In fact, with respect to most parts of that side of economic art which has to do with the producing of economic goods, that art builds on non-economic sciences. Thus, manufacturing in general builds on the sciences just mentioned in connection with automobile production; farming builds on botany, zoology, chemistry, etc. ; mining, on geology, mineralogy, mechanical engineering, etc. In other words, economics as a science does not claim to include the whole body of knowledge needed for the conduct of economic art.

Scope of Economics. — But here, again, we must not go too far. It is true that the art of economics builds on many non-economic sciences. Nevertheless, when all these other sciences have made their contribution, there are kinds of knowledge not yet provided which are found to be needed, and supplying these gives rise to our special science, commonly called economics, or until quite recently, political economy. As to just what should be recognized as the proper boundaries of economic science, authorities are not yet agreed. Still, when it comes to determining the principal topics to be treated, there is no great difference of practice among the best writers.

First, all agree in giving a very large amount of attention to the processes or principles under which value or price are determined,' some even going so far as to include no other topic save as it has a pretty close relation to the determination of prices. Another subject receiving much attention is distribution, the processes and system under which the sharing of the wealth and income of a community among its members is effected. In the present economic order, this is little more than a special division of the theory of price, for the reason that the determination of the incomes of the individuals is largely a matter of the prices received by individuals for the services they sell to other persons. As respects production, bringing into existence economic goods, a matter which, at first sight, might seem to be the most important thing in economic science, a large part of this, as already indicated, is relegated to other sciences, — ^the physical or technological side almost entirely so. Economics, however, keeps to itself certain of the most general aspects even of the technique of production, notably, the general conditions of productive efficiency. Further, most of the productive processes in which mental labor plays a large part, especially if these concern the exchange side of the business, are studied in sciences usually grouped under the head of economics. Conspicuous examples of this are business organization.

lO business management, marketing, and accounting. Again, certain lines of productive activity — certain businesses in their entirety— are reserved for economic science. Examples are banking and the different kinds of commercial business, especially wholesale trade and foreign trade. Finally, the study of one public institution of the utmost importance in economic matters — money — is treated as being in a peculiarly important sense the task of economic science.^

Artificial Conditions. — In the above account of economic goods and economic phenomena, we have not hesitated to speak as if the case of economics and that of a science such as chemistry or physics were perfectly analogous. We ought now to remark on a difference of considerable importance between the phenomena with which we have to deal and the phenomena of the other sciences. The latter belong to a group of phenomena which are strictly natural, in the sense that they are not modified through conditions fixed by men. Economic phenomena, in contrast, belong to a group which are in 'no small degree artificial : they are influenced by conditions of human origin. Of course all phenomena are natural in the broadest sense of the term. But, obviously, some are natural in a fuller and deeper sense than others. Now, many economic relations are among the most truly natural and inevitable that can be formed ; many economic phenomena would be just like those we are familiar with in the same connections, even if we lived like Crusoes or, at the opposite extreme, like a communistic society. But, in contrast with these, not a few economic phenomena would be very different from what they are now, provided the conditions fixed by men were altered. For example, if legal changes were introduced giving the state ownership of all the land, the amount of wealth enjoyed by many persons would be quite different ; if all undertaking of production were legally left to the state, more or less conspicuous changes in price would probably take place ; and, again, if the laws permitted us to own laborers like beasts of burden, this circumstance would surely modify many economic phenomena. It is plain also that such conditions may be brought about not only by formal legislation but by custom, conven-

* This does not apply to the techniqae of its manufacture.

I] INTRODUCTORY II

tion, or formal agreements. Thus, a general boycott of manufacturers who employed non-union laborers would be an artificial condition of sufficient significance to influence wages and employment quite seriously.

An Economic Order. — The point just made, that artificial conditions play a considerable part in determining economic phenomena, naturally brings us to a concept which has already appeared in this text under the phrase "economic order." By this I mean the totality of artificial conditions, whether originating in law or custom, under which economic phenomena manifest themselves. Such a concept is necessary to the study of economic science because the potency of artificial conditions to influence economic affairs makes possible the existence of general situations in economic matters which differ so essentially that a body of scientific principles applicable to one of these would be quite inadequate for another. Many such economic orders are possible; but only three, or some combination of these, receive serious consideration. These three are the present order, socialism, and communism. Quite naturally, our study is largely limited to the present order. Not infrequently, however, that study is illuminated by imagining how things would work under a communistic or socialistic order.

Unity of Economic Science. — The emphasis just laid on the possible variations in economic principles growing out of artificial differences — differences in the particular economic order prevailing — must not be taken too seriously. A very large part of the science of economics, a much larger part than is commonly supposed, would be the same under any economic order. This applies not only to such technical matters as the most efficient methods of production, a thing which, of course, cannot be changed by legislation or custom, but also to the most distinctively economic of all the problems of our subject, the theory of value in its deeper aspects. By this I mean the problem, what are the true importances or values of goods inherent in a given situation, values which a wise socialistic government would try to make their guide in the conduct of economic affairs, and which the defenders of the present order claim are in a fairly high degree represented in the system of prices automatically worked out under that order ? The mature student of economic science and economic practice will, I think, be impressed by the essential oneness of fundamental economic phenomena under all systems and in all times and places, much more than by their differences.