Practical economics

Front matter

Class __HBi-lZi

Book '-Z.

Copyright }ll

Preface

The rise and rapid spread of business education which has been such a prominent feature of our modern educational system has not only resulted in a call for courses dealing with particular fields of business activity, ks accounting, banking and selling, but has considerably augmented the demand for a knowledge of the general theory of business as treated in the science of economics.

From long association with business men as well as from the teaching and discussion of economics with students drawn largely from the ranks of practical men of affairs, I have been impressed with the insistent demand for a simpler and more concrete statement of economic theory than is usually found in the standard works.

To satisfy this demand the present book has been prepared.

No attempt has been made to depart radically from standard economic theory. The aim has rather been to state in simple language and to explain as concisely as possible, the general laws and principles underlying and governing the production and distribution of wealth in the United States today, for the benefit of all who desire to gain a clearer understanding of the structure of our economic system and of the forces operating within it. In consideration of the increasingly important part played in modern affairs by business organization, more attention has been devoted to it than has been customary; and it is treated as a separate factor in production along with land, labor and capital.

While of course economics is concerned with the theory of business and its peculiar function is to set forth the operation of those broad and fundamental laws governing business as a whole, special pains have been taken to point out their practical consequences in everyday business life. In other words, the connection between theory and practice has been kept constantly in view and wherever possible the practical application of laws has been pointed out by illustrations drawn from modern business practice.

Furthermore, the human side of the subject has been emphasized vi PREFACE

and frequent reference has been made to the bearing of economic laws on the personal interests of individuals whose welfare in the aggregate constitutes the national well-being.

The economic problems of today have assumed such proportions as to have completely outgrown adequate treatment in an elementary text and are now rightly and better dealt with in separate treatises. No attempt has been made, therefore, to crowd these in, but rather to state clearly the laws and principles on which they rest. Here again every opportunity has been taken to point out the relationship between the laws discussed and the questions of the day upon which they bear.

In writing on a subject which has so challenged the attention of thoughtful men for centuries and which already has such a rich literatm-e one must naturally owe much to previous writers. On account of their number, I regret that I must limit myself to a general acknowledgment of my indebtedness. To my old colleague Dr. Wm. M. Deviny and to Dr. Wm. H. Walker, both of whom read a large part of the manuscript, I tender my thanks. During the five years the book was in progress, very able and courteous service was afforded me in research and statistical work by the staff of the reference department of the Carnegie Library of Pittsburgh.

Henry P. Shearman Pittsburgh, Pa.

September, 1922

Contents

Pkeface V

PART I Explanatory and Introductory

Chapter . Page

I. Economics — Its Purpose and Value 3

PART II An Analysis of the Basic Factors on which the Production of All

Wealth Depends — Their Nature and the

Causes of Their Productivity

n. Nature as a Factor in Production — with Some Account of the

Natural Resources of the United States 15

III. Man as a Factor in Production 31

IV. The QuaUties Determining the Efficiency of Labor 40

V. The "Division of Labor." Its Advantages and Disadvantages . 50

VI. Capital as a Factor in Production 64

VII. The Two Important Functions Performed by Capital in Modern Production 74

VIII. Organization as a Factor in Production 84

IX. Large-Scale Organization 96

X. The Economics of Large-Scale Organization 105

PART III Exchange, Values and Prices

XI. Origin and Nature of Value 117

XII. The Law of Demand and Supply 127

XIII. The Forces behind Demand; the Determination of Individual

Demand 138

XIV. The Determination of Total Demand 149

XV. The Forces behind Supply — Cost of Production 168

XVI. Influence of Cost on Price 180

XVII. Influence of Cost and Utihty on Price 192

XVIII. The Influence of Monopoly on Price 204

XIX. Competitive Price: Monopoly Price: Price Regulation and the

Law of Demand and Supply 217

vii viii CONTENTS

Chapter Page

XX. Money and Our Monetary System 223

XXI. Deposit Currency and Banking 241

XXII. Changes in the Value of Money or the Level of Prices and

Their Measurement 259

XXIII. Causes and Effects of Price Changes; and Foreign Exchange . 276

PART IV An Analysis op the Four Forms of Income Through Which All Wealth

Produced is Distributed and the Factors

Determining Their Amounts

XXIV. The Distribution of Wealth 293

XXVI. Wages— Factors on the Demand Side 320

XXVII. Wages— Factors on the Supply Side 334

XXVIII. Interest 355

XXIX. Profit 368

Index 383

PARTI

EXPLANATORY AND INTRODUCTORY

Chapter I Economics: Its Purpose And Value

DEFINITION

In approaching a study, a definition serves somewhat the same purpose as a telescope in the hands of a passenger on an Atlantic liner; it enables him to locate and obtain a bird's-eye view of a distant port long before it is even visible to the naked eye. Although the view is of necessity compressed into a small compass, it at least affords him some idea of the location of the place toward which he is heading and of its main outlines. A long distance definition of economics, or political economy as it is sometimes termed, tells us it is that science which treats of man's efforts to provide himself with food, clothing, shelter, and whatever else he deems essential to his welfare. Drawing a little closer we see that it is concerned with business activities and institutions. Hence it is often spoken of as the science of business, and if the word business is used in its broadest sense to cover a nation's activities in the production, exchange and distribution of wealth such a definition is both practical and sound.

POINT OF VIEW

The business activities of a modern nation like the United States comprise a miscellaneous mass of practices by means of which more than a hundred million people in competition and cooperation with each other satisfy their varied wants. Each individual engrossed in his own particular work and interested in his own private ends rarely understands the working of the whole system of which he and his affairs occupy but a fractional part. In consequence his views of certain sections of activity or of the system as a whole are apt to be warped by his own interests. It is precisely this deficiency that economics seeks to correct by substituting for the viewpoint of the private individual, the broader one of society as a whole. It is important to stress this feature of economics, for the angle from which a subject is studied makes an appreciable difference in one's understanding of it. The same institution or phenomenon observed from opposite sides may not only appear different in character but actually be different. Wages to the worker are his means of livelihood, to the employer they are costs; to the economist they constitute the share of the net product of industry paid to the worker for the part he has played in production. Profits to the individual business concern are the difference between costs and receipts; but from the viewpoint of society they are the amounts necessary to stimulate and insure business enterprise. A strike or a lockout in a given industry may appear to the combatants a perfectly justifiable method of settling a wage dispute, but to the community it may mean discomfort and even privation. An invention that throws a worker out of a job is a harmful thing in his eyes; to the inventor to whom it brings a fortune it appears in just the opposite light. To society it is an instrument of progress, hurtful perhaps to the individual worker for the time being, though beneficial to labor in the long run. The business corporation is to the stockholders a source of profit; to the economist it is the agency by means of which land, labor and capital are coordinated to supply the nations' needs. Economics studies business institutions and activities not solely in relation to individual or class interests but in their bearing on the interests of the nation at large. It stands as the champion of the economic welfare of the people as a whole.

STUDIES BUSINESS AS A WHOLE

The aggregate of business institutions and practices of a nation at a given time is sometimes referred to as its economic system. But it is evident these do not constitute a separate system in the sense that a government is a system with a central controlling head. It is possible either by revolution such as we have witnessed in Russia or by the more peaceful path of evolution, that these may become merged into one unified organization operating under the control of a centralized man-

ECONOMICS: ITS PURPOSE AND VALUE 5

agement. Such is the dream of the Socialists. But in the world as it is, the economic activities of each nation are carried on by a host of separate though closely related individuals and organizations. This vast and varied mass of institutions and activities is the economic system by means of which the wealth of the nation is produced, exchanged and apportioned among its members. It is the object of economics as a science, to study these activities as a whole in a systematic way, to describe them, show the relationships of the various parts. and the laws and principles governing them.

RELATION OF ECONOMICS TO SPECIALIZED ECONOMIC

STUDIES

To explain the operation of all parts and branches of modern business; to describe all kinds of business organizations; to present the laws and principles governing manufacturing, transportation, commerce and finance; to solve the baffling problems arising in connection with the production, exchange and distribution of wealth, such as the tariff, monopoly control, government regulation of industry, the question of labor and capital and so on, — would be today a stupendous task for any one science. When economics was in its infancy in the time of Adam Smith, all the known laws and principles governing business might have been included in one general treatise. Since that time, especially during recent years as a result of inductive study of increased statistical investigation and research, an ever growing body of data covering separate fields has been gathered, new laws and principles have been formulated and many corollaries to the general laws have been added. To include these in one treatise is practically impossible. Since the first general treatise was written by Adam Smith in 1776, the present science has branched out. The leading universities in the United States and similar institutions in England, Germany and other countries, are now teaching intensive courses in many separate fields of business activity.

Of these separate subjects some, like salesmanship and industrial organization and management, are yet relatively undeveloped and to a certain extent lack the broad, social viewpoint.

Others like money and currency, foreign exchange, industrial combinations, labor organizations, etc., are in reality divisions of economics, being separate treatises the outcome of intensive study of special phases of economic activity looked at from the social viewpoint.

The relation between these separate economic studies and economics is evident. Each of the former is confined to a specific sphere of business activity and aims to explain its institutions and activities, to discover the laws and principles governing its operation, whether it be selling, management, finance, or tariff regulations. But economics covers the whole field in a general way and aims to display those broad general laws and principles that govern business as a whole. It carries out a survey of the entire field in order to give a bird's-eye view and enable the individual to obtain a perspective of that miscellaneous complex of acitivities constituting modern business, so that whatever particular branch he may study or practice later, he may by virtue of his broader vision sense his relation to other activities and his part in the whole. For this reason economics is sometimes spoken of as the general science of business.

METHODS

There are two methods of building up a science, deduction and induction. In the older sciences such as astronomy and mathematics the former was chiefly used, in the more modern the latter method, sometimes termed the Baconian method on account of the emphasis placed on it by Francis Bacon, is largely employed. In deduction, the general conclusion or hypothesis is put forth first and then tested out by application to particular cases. In induction a study is made of a particular case, as a result of which a general conclusion is arrived at. But in deduction the a priori conclusion is itself the result of a certain amount of observation, while in induction the selection of specific instances is more or less aided by preconceived conclusions. Indeed, as someone has aptly remarked, in the building up of any science bo1?h deduction and indxiction are as essential as the right and left foot in walking.

In the early stages of economics, deduction played an

ECONOMICS: ITS PURPOSE AND VALUE 7

important part in formulating the general laws of the science but more recently the inductive method, especially in its statistical form, has been increasingly used. The growth of statistics has much enriched the science of economics both in the discovery of new laws and in the verification of the old. Whatever economics was in its infancy, it has taken on a very practical aspect of later years. Some of its early doctrines not standing the acid test of experience have been thrown aside; and with modern research and statistical investigation into actual business practices and facts laws and principles haA^e resulted which are forged out of actual practice and tested by business experience.

AN INEXACT SCIENCE

One of the chief charms of economics and at the same time I its weakness as a science lies in its very humanness. Unlike astronomy, physics or chemistry, it is not an^eaiofi^ science. By which it is meant that its laws and principles are not statements of relationship or movements of forces that act inevitably in a fixed manner and with an exactness capable of being measured to a fraction. The wages of labor, the upward and downward swings of prices, the movements of foreign exchange rates, the flow of gold, are governed by laws but not rigid laws like those that determine the movement of the stars or of inanimate matter in general. The astronomer is able to predict to a fraction of a second the appearance of a star that swings into his vision but once in a hundred years; the chemist knows with surety that whenever he mixes certain chemicals a given reaction will always result and he is able to measure the result quantitatively. But the economist because he treats largely of human forces and activities based on human relationships cannot predict results with the same sureness or measure causes and effects with the same exactness. He may know that the amount of a commodity that will be purchased will vary inversely with the price charged but he may not know exactly how much an increase of 25 per cent on the price will reduce its sale. The laws of economics, therefore, like those of its sister social sciences, ethics and politics, are not hard and fast statements of invariable facts but rather statements of tendencies admitting of numerous exceptions.

The inexact and general nature of some economic laws by no means deprives them of their usefulness or invalidates economics as a science, though there is no doubt but that a lack of a proper understanding of this feature of the science has been a cause of its mis judgment. The fault lies partly with economists who have sometimes exaggerated the accuracy with which some of the more general laws operate in actual life. On the other hand, some of the criticism has been due to a misconception on the part of many practical business men as to what a science really is and failure to make allowance for the uncertain nature of the subject matter with which economics deals.

It is natural for hard-headed business men to want laws capable o^ specific and immediate application to given conditions. Many of the rules and principles of specialized economic studies are of this character but many of the laws of economics are general in nature and call for judgment in applying them to concrete cases; their action is often modified by other factors and forces which must be taken into consideration. Moreover some are what might be termed long distance laws, requiring considerable periods of time for their operation and often their immediate effects are quite opposite to their ultimate consequences as in the case of the effect of machinery on labor. But to lay the blame of this on economics is to lay it at the wrong door, for the remoteness and uncertainty of its laws are not due to the science but to the complexity of the activities it seeks to explain.

Much of the criticism launched against economics arises from the popular and ancient misconception of the relation between theory and fact which in the minds of some will always appear to be antagonistic. But theory in the only sense in which it finds a permanent place in a science must be in harmony with facts. In themselves, facts are valueless. What is needed is an understanding of facts, of their causes and effects. Such an understanding is gained by an explanation. Such an explanation is a theory. Of course, there are false theories but to condemn all theories because some are false would be equivalent to a refusal

ECONOMICS: ITS PURPOSE AND VALUE 9

to accept money because it is sometimes counterfeited. Yet there is usually some basis for popular beliefs and the origin of the popular susJ3icion of theory is no doubt due to this tendency of theory to depart sometimes from actual facts. In attempting to explain a given phenomenon, to find its cause a scientist will often start with a hypothesis or what the man in the street would call a guess. With this as a guide he will investigate just as a mechanic in trying to find what is wrong with his motor, after listening perhaps will conclude the trouble lies in the carburetor. He then tests his theory out. So also does the scientist, but so complicated are some of the problems of the scientist and so anxious is he to explain them, that he may neglect to test his theory sufficiently and proclaim that which is true in a few cases to be true universally. Or he may become so enamoured by his theory that he is carried away by it, fitting and adapting the facts to the theory instead of the theory .to the facts. The antagonism of the man in the street to theory is thus a warning against fanciful theories and too hasty generalization. Economics like other sciences has doubtless been guilty in this respect but recently it has profited much by criticism and tends more and more to test out its conclusions and discard those which when weighed in the balance of experience are found wanting.

VALUES

In former years a knowledge of economics was mostly confined to those engaged in the administration of public affairs. But while it is evident that those directly responsible for the welfare of the nation should be thoroughly conversant with the laws and principles on which national prosperity is founded, it is not desirable in this democratic age that such knowledge be restricted to the few in the seats of the mighty, especially in consideration of the fact that modern politicians themselves are none too well versed in the science. The majority of the leading questions of the day, upon which decisions directly affect the destinies of the nation and the happiness of the people, are economic. Their issues are often beclouded and warped by deeprooted class or local prejudice. There is needed for their consideration the broad social viewpoint and a clear knowledge of those fundamental laws governing not only domestic affairs but foreign trade. This knowledge should be in the possession of the people themselves. Any country with a large body of its citizens in ignorance of general economic truths on which national prosperity rests is in danger of having its masses influenced by false propaganda and its legislation warped by special interests. The need for an enlightened public opinion on economic subjects was never more acute than today.

Not only on grounds of public policy is a knowledge of economics desirable but for the sake of individual economic advancement. Personal experience will always be the basis of business ability but the influences that play upon a modern business extend far beyond any one man's individual experience. Less and less are business concerns influenced only by local conditions; more and more are they affected by world happenings. The narrow provincialism which has so often characterized American business men in the past is necessarily giving away to a more cosmopolitan outlook. The granting of credits by banks, the borrowing of funds by corporations, the purchasing of raw materials, the planning of selling campaigns, the extension of plants, the location of new factories, — all demand on the part of those responsible, not only a specialized knowledge of credits, plant management, selling, etc., but a familiarity with business conditions in general. The executive today needs to be master not merely of his particular field but of the broad fundamental laws governing business as a whole. The ability to interpret conditions, read the signs of the times, forecast depressions or booms, price rises or falls, the effect of a tariff, and other economic tendencies which might wreck or further his plans, enables him to adjust his affairs to outside conditions in such a manner as to avoid failure and achieve success. What the science of navigation and a knowledge of undercurrents and hidden rocks of the ocean are to the captain on the bridge of the Atlantic liner, the science of economics is to the executive at the helm of a business, enabling him to avoid the hidden shoals in the sea of business affairs.

It has been said that while economics is essential for execu-

ECONOMICS: ITS PURPOSE AND VALUE U

tives or college men who later will assume positions of responsibility, it is wasted time teaching it to clerks or mechanics. There is an element of truth in this. A clerk does not require the same education as a banker. And providing the clerk intends to remain a clerk, a couple of courses in accounting will better fit his needs and bring him in the immediate remuneration which as a rule marks the limit of his mental horizon. Moreover, to attempt to load economic laws into the minds of this species of the clerical genus is akin to trying to put 44 caliber shells into a 22 rifle. Economics should, however, have a strong appeal to the 44 caliber man in clerical work ambitious to prepare himself for more important service in the future.

One danger facing the young man entering business life today is its narrow specialization. Where his father started in a small concern in which he was able to pick up by experience a working knowledge of the different branches of the business, the youth today pigeon-holed perhaps in one department of a big corporation finds sparse opportunity for securing that all-round training and broader viewpoint so necessary for executive work. While a study of economics alone cannot remedy this, it will materially help him to broaden out. His knowledge of economic laws and principles will give him an insight into the meaning of happenings in his own concern and the world around him which the man beside him will lack. He will be able to read with intelligence articles on economic subjects in the financial and business magazines which are unintelligible to the man in the street. In the office or club or on the platform, he will be better equipped to discuss the questions of the day. Truly, it will give him a deeper insight into life itself, for no study is more thoroughly enlightening regarding human affairs than that which treats of mankind's struggle to make a living.

1. What is "Economics"?

2. From what point of view are business activities studied in economics?

3. What is the relation of economics to the specialized business courses such as accounting, banking and selling?

4. What is meant by referring to economics as an inexact science?

5. What is theory? What kind of theory is referred to the statement — "The eternal conflict between theory and fact"? How can theory and practice be reconciled?

6. Name some of the values to be derived from a study of economics.

Cairnes, J. E., Character and Logical Method of Political Economy (Second Ed., 1845).

Cl.\y, H., Economics for the General Reader (Chap. I).

Ely, R. T., The Past and Present of Political Economy (Johns Hopkins University Studies in Historical and Political Science).

GiDE, C. Pohtical Economy (Book II, Chap. II).

Keynes, J. N., The Scope and Method of Political Economy (London, 1891).

Laughlin, J. L., Study of Political Economy.

Marshall, A., Principles of Economics (Chap. I).

Palgrave's, Dictionary of Political Economy, Vol. 3.

PiERSON, N.^G., Principles of Economics (Introduction).

Ross, E. A.. The Foundations of Sociology (Chaps. I, II).

Seligman, E. R. a.. Principles of Economics (Chap. II).

Smith, A., Wealth of Nations (Introductory Sketch).

Smith, R. Mayo, Statistics and Economics (1899, Chap. I).

WiCKSTEED, P. H., The Common Sense of Political Economy (Introduction) .

PART II

ANALYSIS OF THE BASIC FACTORS ON WHICH

THE PRODUCTION OF ALL WEALTH

DEPENDS

Chapter II Factors Of Production: Nature

The primary factors in the production of wealth are nature and man. Nature supplies the material and forces out of which and by which wealth is produced. Man, the active agent, directs the processes of production by physical and mental effort. Capital, usually termed a secondary factor, because itself a product of nature and man, supplies the tools and goods which aid in further production. Organization appears as a fourth factor, the product of the first three, and the means by which they are coordinated for effective production. A clear understanding of each of these factors, of the part each one plays, of the causes affecting the efficiency of each, and of the relationship existing between them, will enable us to secure a comprehensive grasp of the principles governing modern production.

THE PART PLAYED BY NATURE IN PRODUCTION

Nature or "Land" as this factor is often termed, not only provides in the surface of the earth a solid foundation for man's activities but in addition is the sole source of the raw materials and forces used in production. From the mines of the earth come the metals and minerals, iron, coal, copper or petroleum, from the rich productive soil spring crops of cotton or corn. The forests furnish lumber, the rivers and lakes water. In the fashioning of these raw materials into objects of wealth man is greatly aided by forces inherent in the materials themselves. Modern chemistry has shown that matter is not dead but dynamic with latent powers. In the laboratory the industrial chemist experimenting with these hidden forces induces reactions which result in dyes, alloys, gasses, or fuels. Organic chemistry with the theory of valences has opened up a new world of natural forces which under the skillful manipulation of the chemist are being used to produce products hitherto found only in a natural state or to create new ones better adapted to man's new needs. Furthermore man's own labor has been tremendously augmented by the employment of natural forces such as the expansive force of steam, the explosive force of gases and electricity. The revolution which industry has undergone in the last one hundred years is largely due to man's discovery and use of these powerful forces. The earth, the ocean and the atmosphere are the reservoirs of mother nature, from whose depths and heights come not only all the materials on which man depends for the support of life, but the physical, chemical and vital forces employed to work these into shape for the satisfaction of his wants.

ALEXANDER HAMILTON AND THE ERROR OF THE PHYSIOCRATS

The pra^ctical value of a thorough grasp of the part played by nature in production as well as the danger of a half knowledge is illustrated in the stand taken by Alexander Hamilton against the famous "error" of the Physiocrats. The Physiocrats, a French school of economists of the eighteenth century, saw the influence of nature in agriculture but were blind to its connection with manufactures. This led them to exalt agriculture at the expense of manufacturing which they regarded as sterile. Agriculture they asserted was productive because assisted by nature in a special sense but manufactures not receiving this cooperation were unproductive. The farmer planting a seed into the soil reaped a hundred fold through the vital laws of growth and so enriched the nation, but the manufacturer who in their opinion merely changed the form of things added nothing to the existmg wealth.

Their theories were reflected in France by the discouragement of manufactures through heavy taxation which was only thrown off by the French revolution. This same error crossing the Atlantic attempted to stunt the early development of manufactures in the States. At the adoption of the Constitution, this counry with its abundance of fertile land was particularly adapted to agriculture. This natural adaptation was emphasized by the mercantile policy of Great Britain which encouraged the exportation of raw materials from the States, in return for manufactured articles.