Class 
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 COPYRIGHT DEPO£ 
 
INTRODUCTORY ECONOMICS 
 
 BY 
 
 ALVIN S. JOHNSON, Ph.D. 
 
 Professor of Political Econoroy in the 
 University of Nebraska 
 
 NEW YORK 
 
 SCHOOL OF LIBERAL ARTS AND SCIENCES 
 
 FOR NON-RESIDENTS 
 
 1907 
 
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 Copyright, 1907 
 By THE SCHOOL OF LIBERAL ARTS AND SCIENCES FOR NON-RESIDENTS 
 
PREFACE 
 
 In a democratic State economic science should be for 
 the many, not for the few. The science is admittedly a 
 difficult one; and until a royal road through its domains 
 has been found, there is ample justification for the publi- 
 cation of a new text-book on economics, for the many 
 excellent manuals now before the American public have 
 not reached all classes nor met all needs. It has appeared 
 to the writer that an economics text-book of moderate 
 dimensions, dealing with only the more fundamental prob- 
 lems of the science, and written, so far as this is possible, 
 in the language of every-day life, would prove useful to at 
 least a limited class of students, and especially to those 
 students of mature mind who seek to gain an introduction 
 to modern economic thought, but who are not in a position 
 to avail themselves of the advantages of class-room instruc- 
 tion. What students of this class — as well as many other 
 students — most need is not a compendium of economic facts 
 nor even an exhaustive treatment of economic principles, but 
 a series of rigorous exercises in economic reasoning which 
 will enable them better to organize the mass of practical 
 economic knowledge that their daily experience affords. 
 
 The distinctive character of modern economic theory 
 consists chiefly in its method of applying the principles of 
 diminishing utility and diminishing returns. The student 
 who is thoroughly familiar with these two principles, and 
 who is trained to recognize their operation in practically 
 every economic problem, will be able to follow the reasoning 
 of the most profound of the modern economists, provided, 
 of course, that this reasoning is not rendered unintelligible 
 by a special terminology. But it is not alone as an intro- 
 duction to economic theory that training in the use of these 
 two principles is of vital importance. Most, if not all, of 
 
IV PREFACE 
 
 the problems of practical economic policy involve one or 
 both of these principles. The writer is persuaded that by 
 far the greater proportion of the fallacies that vitiate popular 
 reasoning on economic subjects originate in disregard of 
 these principles. His aim in the theoretical part of the work 
 has therefore been to present rather a series of studies 
 throwing into relief the operation of these principles than 
 an exhaustive treatment of the topics discussed. This 
 method involves the exclusion of many topics that are 
 ordinarily presented in an introductory treatise ; it involves, 
 further, a degree of repetition that can be justified only if it 
 attains its purpose in making the student thoroughly con- 
 versant with the laws of diminishing utility and diminishing 
 returns. 
 
 The teacher of economics will observe that very little 
 use has been made of the terminology of the Austrian school. 
 This does not imply that the writer regards that terminology 
 as useless ; on the contrary, he believes that in the develop- 
 ment of some such special terminology lies the hope of sub- 
 stantial progress in economic theory. It seems, however, 
 unfair to the student to cumber the pages that he is to read 
 with unfamiliar terms, the mastery of which will avail him 
 little unless he is to devote himself to advanced theoretical 
 study. 
 
 It will further be observed that no attempt is made to 
 group the chapters of this manual in "Parts" or "Books." 
 The traditional fourfold division of the science is not 
 suited to a theory which explains distribution in terms 
 of production and makes frequent use of the concept 
 value in its discussion of production. The division of the 
 science into Statics and Dynamics, proposed by the author's 
 friend and former teacher. Professor John B. Clark, while 
 doubtless of great value in a work which is complete in it- 
 self, is too important an innovation to be conveniently em- 
 ployed in a book of a purely introductory character. 
 
 It is perhaps superfluous for the author to mention the 
 
PREFACE V 
 
 names of the economists to whom he is especially indebted, 
 since such indebtedness will be readily recognized in his 
 pages. The theory of value presented is in large part de- 
 rived from that of Professor von Wieser; the theories of 
 wages and interest follow closely those of Professor Clark. 
 The treatment of rent and capitalization is largely influenced 
 by the writings of Professor Felter and Professor Seligman. 
 In his discussion of monopoly value the author has made 
 free use of the writings of Professors Marshall, Clark and 
 Ely ; in his discussion of diminishing returns he has borrowed 
 liberally from Professors Marshall and Carver. The discus- 
 sion of banking follows that of the late Professor Dunbar ; 
 the discussions of money and international trade follow the 
 accepted classical models. 
 Lincoln, Nebraska, Alvin Saunders Johnson. 
 
 December, 1907. 
 
CONTENTS 
 
 I. The Nature and Significance of Eco- 
 nomic Science 3 
 
 II. Utility, Value and Price 18 
 
 III. Normal Price . 37 
 
 IV. Monopoly Price 49^ 
 
 V. The Cost of Production 64^% 
 
 VI. The Law of Diminishing Returns . . 79 
 
 VII. The Division of Labor 97 
 
 VIII. The Concentration of Industry . . . 109 
 
 IX. The General Law of Wages .... 120 
 
 X. Influences Giving Rise to Differences 
 
 in Wages 135 
 
 XI. Capital 151 
 
 XII. The Rate of Interest 164 
 
 XIII. Rent and Capitalization 181 
 
 XIV. Business Profits ^97/ 
 
 XV. Money . 213 
 
 XVI. Financial Institutions: The Bank . 234 
 XVII. Other Financial Institutions . , . 254 
 XVIII. International Trade and Foreign Ex- 
 change 273 
 
 XIX. The Regulation of International Trade 293 
 
 XX. The Economic Relations of Government 317 
 
CHAPTER I 
 
 The Nature and Significance of Economic Science 
 
 From the earliest time of which we have any record 
 a great part of the activities of man has been occupied with 
 the production or acquisition of wealth — material objects 
 and personal services upon the possession of which human 
 welfare depends, or seems to depend. In the long ages of 
 savagery and barbarism primitive man was engaged in a 
 ceaseless struggle with nature for the bare means of exist- 
 ence — food, clothing, and shelter. Limited as were the 
 supplies of nature, a savage tribe never for a long time 
 enjoyed them in peace; other tribes coveted the hunting 
 grounds, or the bays where shellfish abounded; the rich 
 pastures or the groves of fruit-bearing trees. Hence the 
 difficulty of obtaining from nature the means of subsistence 
 was aggravated by constant warfare between tribe and tribe. 
 A struggle for mere existence against nature and against 
 hostile tribes — such was the life of primitive man. 
 
 From century to century, however, man learned to equip 
 himself better for the struggle for existence. Tools, at first 
 rudely wrought from stone, later from the metals, greatly 
 increased his productive power. A yet greater step in ad- 
 vance was made when animals were domesticated, and a 
 certain and steady food supply took the place of the pre- 
 carious products of the chase. The cultivation of roots and 
 grains that had in their wild state yielded scanty returns to 
 the gatherer marked another stage of progress. Methods 
 were crude, and the tasks of pastoral and agricultural life 
 exceedingly laborious — a condition which gave rise to the 
 enslaving of captives taken in war. With the increase in the 
 
4 INTRODUCTORY ECONOMICS 
 
 productive power of a tribe, at least limited classes were 
 freed from the struggle for the merest necessities. A leisure 
 class, using the term in a restricted sense, appeared; and 
 with it the germ of culture and civilization. Thus pro- 
 ductive power and civilization have advanced hand in hand, 
 until to-day, in the most progressive societies, there are 
 comparatively few whose days are altogether devoted to a 
 quest for food and shelter. 
 
 Although civilized man is for the most part liberated 
 from the dangers of starvation and of death through ex- 
 posure to storm and winter cold, his desire for the material 
 objects and human services that constitute wealth is in no 
 way relaxed. Merely to possess food sufficient to satisfy 
 hunger does not content him; the food must be pleasing 
 to the palate as well as nutritious. Warm clothing is an 
 excellent thing; but civilized man demands that his clothes 
 be of good appearance as well as comfortable. A sod house 
 on the prairie is constructed with no great 'amount of labor 
 and almost no expense; in such a house one may defy the 
 worst storms of winter and the hottest winds of summer. 
 Yet the modern dweller on the plains would scorn to live 
 in such an abode; his home must present an appearance 
 of comfort and prosperity. To stand well with one's fellows 
 is to most men hardly less important than life itself, and in 
 all human history an important factor in winning and retain- 
 ing the esteem of others has been the possession of proper 
 attire and other personal appointments. There is a standard 
 of wealth consumption which each little group of associates 
 in society are under some sort of compulsion to attain. If 
 my neighbors and boyhood playmates all have fine houses, 
 I cannot enter my humble dwelling without a sense of in- 
 feriority. If they are well fed and well dressed and well 
 housed, I would be as good as they are. If they are wise 
 or learned or cultured, I naturally strive to emulate them in 
 this respect. But one cannot be well clad or well housed, 
 Qm cannot very well even be wise or learned or cultured, 
 
INTRODUCTORY ECONOMICS 5 
 
 unless one can command a fair amount of wealth, an 
 amount far in excess of the bare needs of existence. Under 
 modern conditions wealth has become a means — though, of 
 course, not the only means — to most of the things which one 
 can desire. And as it is not in the nature of man to be 
 content for any long time with what he possesses and what 
 he has attained, it is inevitable that his desire for wealth, 
 which is so potent a means for further attainment, should 
 continue unabated. 
 
 This desire for wealth is what is meant by the economic 
 motive. It necessarily plays a large part in the lives of 
 most men. It animates the purest and most unselfish as 
 well as the most sordid. For the desire for wealth is a 
 desire for means to ends, and these may be good or evil. 
 The philanthropist who wishes to found a home for invalid 
 children must have wealth, just as the voluptuary who de- 
 sires a palace of all delights to please his jaded senses. The 
 economic motive animates both; very likely the philanthro- 
 pist desires wealth the more ardently. What differentiates 
 the two is the end which the wealth is meant to subserve. 
 To assert, then, that all men are in great measure actuated 
 by economic motives is not to assert that all men are selfish 
 or sordid. It is merely to assert that wealth has been placed 
 between man and the satisfaction of most of his desires; 
 that as he seeks to attain any end whatsoever, he will seek 
 to possess the means to that end. 
 
 Economics is the science which deals with such of the 
 activities of man as spring out of the economic motive. 
 It treats of the creation, acquisition, and use of wealth. The 
 subject-matter for economic science, therefore, is to be found 
 in every society — as well in the most primitive tribe as in 
 the most advanced nation. Yet the facts of economic life 
 have only recently been worked up into a systematic body 
 of knowledge. For the beginnings of the science it is not 
 necessary to go back more than three centuries, although 
 fragmentary treatment of economic questions may be found 
 
6 INTRODUCTORY ECONOMICS 
 
 in earlier writings. How can we explain this late develop- 
 ment of the study of facts with which humanity has from 
 the earliest time been concerned? 
 
 Throughout the periods of savagery and barbarism men 
 lived in small groups, which produced, through the chase, 
 agriculture, and pasturage, practically everything that the 
 members of the group consumed. Whether the group pros- 
 pered or fared ill depended upon the weather, the fertility 
 of the soil, the quantity and character of game, the relation 
 to other groups — whether tribute was given or received. 
 Within the group the relative welfare of each member de- 
 pended to a certain extent upon his own prowess and effi- 
 ciency; perhaps to a greater extent upon the tribal customs 
 in accordance with which the common products of the group 
 were distributed among its members. As conditions varied 
 widely among different peoples, a general science of tribal 
 economics would have been difficult to create. In the civ- 
 ilized states of antiquity a somewhat similar condition 
 rendered the rise of economic science impossible. Industry 
 was based on slavery; the lord of landed estates produced 
 by slave labor almost everything that was needed on the 
 estate. His welfare depended upon the amount and fer- 
 tility of the land he possessed; the number of his slaves 
 and his skill in managing them ; the state of the weather, 
 and freedom from hostile invasion. No systematic body of 
 knowledge explaining the economic life of the people as a 
 whole was developed, because there could scarcely be said 
 to be an economic life of the people apart from that of the 
 separate families. So, also, in the mediaeval villages. They 
 were self-sufficing; the welfare of the community depended 
 upon natural forces and the energy of the members of the 
 community and their capacity for co-operation. Each indi- 
 vidual depended for his welfare partly upon the same con- 
 ditions, partly upon village custom in the apportionment of 
 services and rewards. 
 
 With the rise of modern trade a significant change took 
 
INTRODUCTORY ECONOMICS 7 
 
 place in economic life. In greater and greater measure men 
 engaged in production for distant markets, instead of for 
 their own use. Under such conditions welfare depended 
 not only upon the producer's energy and success in the cre- 
 ation of goods. It depended also in large measure upon 
 the price of the goods which were sent to market. The 
 transition from production for one's own use to production 
 for the market took place at various times in different 
 countries and in different industries. In some branches of 
 production it is only recently that the change has been 
 effected. Thus the production of bread, formerly almost 
 everywhere carried on in the household for consumption 
 there, has in the cities become an independent branch of 
 industry, carried on for supplying a market, just as the 
 production of shoes, cloth or iron. 
 
 The striking characteristic of modern economic life, then, 
 is that men produce goods not for their own use, but for 
 the market. The employee in a shoe factory will very prob- 
 ably never wear any of the shoes he helps to produce; if 
 the maker of clothes ever works on garments for himself, 
 this is the exception to the rule of his daily labor. The 
 farmer consumes little, if any, of the wheat which he raises ; 
 the woolgrower rarely spins and works up into cloth for 
 his own use the product of his flocks. The modern economic 
 system is therefore called an exchange economy, for it is 
 through exchange of goods that each man gets the com- 
 modities which he needs. And with the rise of the ex- 
 change economy a new set of laws of wealth and welfare 
 have come into operation. The welfare of a farmer under'' 
 modern conditions depends in some degree upon his own 
 energy and intelligence, and in some degree upon the 
 weather. But in a very large degree it depends upon the 
 price at which he can sell his products. A high price of 
 iron brings prosperity to all the classes engaged in the 
 production of iron, as a low price involves them in loss and 
 distress. And so with practically all members of modern 
 
8 INTRODUCTORY ECONOMICS 
 
 society; their welfare is bound up with the prices of 
 products. 
 
 A farmer or a manufacturer is popularly said to "put a 
 price" upon his products. In the majority of cases, how- 
 ever, what the seller really does is to make a choice between 
 selling at a given price or keeping his goods unsold. Except 
 in rare cases there is a market price for goods which the 
 buyers and sellers must accept if they desire to engage in 
 business at all, and over this price no single person has any 
 control. Yet prices do not exist apart from the action of 
 men; they are the creation of man in society. Many per- 
 sons, each acting with a view to his own interest, offer wheat 
 for sale ; many persons stand ready to buy it. The price of 
 wheat is fixed as a result of the offers and purchases of all 
 persons who buy or sell wheat. It is therefore a social 
 phenomenon — the creation of all society, or of a large part 
 of it. And so it is with almost all prices. They are set 
 by society. Hence the laws of price are properly called 
 the laws of social economics, or of political economy. 
 
 While each man produced goods for his own use, the 
 tools and appliances which he used were of necessity simple. 
 To cut enough wood for one's own use did not require a 
 very expensive axe ; to furnish boards for one's own dwell- 
 ing required only a handsaw, to be worked by two men. 
 Spinning wheels and looms were likewise of the simplest 
 make. These tools and appliances could be made by the 
 workman himself, or secured through exchange at small 
 sacrifice. Accordingly the laborer as a rule owned the im- 
 plements he worked with. In early modern times, although 
 production for the market had become fairly common, the 
 means of production still remained in the worker's hands. 
 The increasing demand for products, however, soon led to 
 the introduction of more expensive tools, and at last to the 
 invention of machinery. Every step in this direction made 
 it more difficult for the worker to provide himself with the 
 means of production. So these had to be supplied by per- 
 
INTRODUCTORY ECONOMICS 9 
 
 sons of wealth — capitalists. Under present conditions man- 
 ufacturing industry in almost all its branches requires so 
 large an expenditure for equipment that no single laborer 
 can work with his own tools and machines ; nor is it possible 
 for a group of laborers to equip themselves for production 
 through combining their small savings. The capital outlay 
 for a mill employing a hundred workmen is usually far in 
 excess of what a hundred workmen can accumulate. 
 Industry must therefore be conducted by wage laborers and 
 employer-capitalists. To a certain extent the employer and 
 the capitalist have been further differentiated, the former 
 borrowing capital from the latter at a fixed rate of interest. 
 When the products are sold, whatever remains after paying 
 wages and interest is a profit, the reward of the employer, 
 or, as he is generally called, the entrepreneur or enterpriser. 
 
 Under modern conditions, as we have seen, the prosperity 
 of each industry as a whole depends largely upon the prices 
 of its products. Within each industry the prosperity of each 
 laborer, capitalist or employer depends in great degree upon 
 the way in which the total product of the industry is divided. 
 And here again we encounter social laws. There is a general 
 rate of wages, which the laborer must accept if he wishes 
 employment. In the same way, there is a general rate of 
 interest. No one man exercises any appreciable influence in 
 fixing these rates; they are the resultant of the actions of 
 all those who have labor to sell or capital to lend, on the 
 one hand, and on the other hand, of those who desire to hire 
 laborers or to borrow capital. 
 
 The prices of goods, the wages of labor, the rate of inter- 
 est on capital, elude the control of any single individual. 
 May they not, however, be controlled by combinations of 
 individuals, or by the action of a sovereign state? Within 
 limits this is possible. A trade union may force up the rate 
 of wages ; a protective tariff may enhance the prices of many 
 classes of goods. But there are limits beyond which com- 
 bination and political action are unavailing — -limits which 
 
10 INTRODUCTORY ECONOMICS 
 
 are set by social forces. What these forces are, how they 
 Operate, how far they can be controlled, and with what 
 results for society as a whole — these are the problems which 
 social economics endeavors to solve. 
 
 Social economics as a distinct science may be said to have 
 taken its rise in studies concerning taxation and public 
 finance. In early modern times the expenditures of govern- 
 ment in most European states were steadily increasing. The 
 various princes vied with one another in the splendor of their 
 palaces and in the number and brilliancy of their personal 
 following; the cost of maintaining the tranquillity of the 
 nation at home and its dignity and influence in foreign lands 
 became heavier from decade to decade. More than all, meth- 
 ods of warfare by land and by sea were changing, and 
 military success was coming to depend quite as much upon 
 the size of the war chest as upon the valor of the soldiers. 
 These new expenditures could be met only through taxation ; 
 accordingly, it became a very practical matter for the states- 
 man to devise means for increasing the prosperity of a 
 nation in order to increase its capacity for paying taxes. As 
 the precious metals seemed to be the most convenient and 
 the most reliable form of wealth, it was the aim of the 
 statesman to provide these in abundance. European coun- 
 tries, having no important mines of silver and gold, could 
 secure these metals only through foreign trade. Hence the 
 kernel of early modern economic policy was the regulation 
 of foreign trade, with a view to bringing into a nation large 
 supplies of treasure. These regulations formed a system 
 which in the end became burdensome in the extreme ; their 
 futility and injuriousness were exposed in the latter half 
 of the eighteenth century by the Economistes in France and 
 by Adam Smith in Great Britain, whose writings first placed 
 economics on a scientific basis. Through the nineteenth 
 century economic discussion has progressed from one prac- 
 tical problem to another — money and banking, trade union- 
 ism, socialism, monopoly, etc. The chief function of the 
 
INTRODUCTORY ECONOMICS II 
 
 science is still, as in its earliest period, to ascertain what 
 economic policy of government will be most conducive to 
 the general welfare. Although it is known as the "science 
 of wealth,'' it is no part of the function of economics to 
 instruct individuals how they may best acquire wealth. Its 
 principal aim has been attained when it has thrown all possi- 
 ble light upon the economic problems which a state, and its 
 members as citizens of a state, have to solve. 
 
 We have seen that under modern conditions the wel- 
 fare of industries, and of individuals engaged in those 
 industries, is largely determined by the social forces of 
 price. The influence of price extends even further. In 
 large measure the same social forces determine what each of 
 us shall do; they fix one's place of residence as well as his 
 occupation. If the price of glass is high, and remains high 
 for a considerable period of time, high profits and high wages 
 are possible in the glass industry. New establishments will 
 be opened ; boys and young men who otherwise would have 
 engaged in other industries become glass blowers. By fix- 
 ing a high price on glass, society, as it were, decrees that 
 more persons and more capital shall be devoted to that 
 industry. If coal or other sources of power are excep- 
 tionally cheap in a given locality, if conditions of transpor- 
 tation are exceptionally favorable, large profits may be made 
 by manufacturers in that locality; they increase their 
 investments and new capital flows in from less favored 
 districts. A city is built, and the population that was 
 formerly scattered in hamlets and country is under a sort 
 of compulsion to congregate there. Why are our cities 
 becoming greater and greater? The social laws of price 
 decree it. If we would understand just why modern society 
 presents a given form, our inquiry must take into account, 
 as perhaps the most important factor, these laws of price. 
 
 Since the fixing of prices is a work in which all, or most 
 of society co-operates, whatever affects any industry, for 
 good or evil, must react in some manner upon all society. 
 
12 INTRODUCTORY ECONOMICS 
 
 A dry year in India, with consequent shortage of crops, 
 affects not only the Hindoo ryot, but also the British work- 
 man, the farmer in Dakota or in Argentina. Large crops in 
 the West, concurrent with high prices, exert a powerful 
 influence, not only upon the interests of the local merchants, 
 bankers and mechanics, but upon the manufacturing and 
 financial interests of the entire country. The railways are 
 prosperous, having an immense amount of transportation 
 work to perform, and their stockholders receive large divi- 
 dends, out of which they may improve their homes, or 
 increase their investments in factories or what not, in every 
 case creating a new demand for labor and extending pros- 
 perity in ever widening circles to the remotest industrial 
 classes in the land. A part of the surplus earnings of the 
 railways may be turned to the extension of lines into new 
 territory; to the double tracking of congested single lines; 
 to the installation of new equipment, with the immediate 
 result of an increased demand upon the rail mills and car 
 works, and all the enterprises subsidiary to these. A crop 
 failure, on the other hand, may disarrange the entire indus- 
 trial mechanism and bring distress to the laborers and capi- 
 talists apparently farthest removed from the immediate 
 cause of the disturbance. 
 
 An excellent example of the influences set in motion by a 
 great economic event is given by Mr. David A. Wells in his 
 Recent Economic Changes. In the year 1869 the Suez Canal 
 was opened. Up to that time trade with the East Indies 
 was carried on in sailing vessels, which rounded Cape Horn 
 or the Cape of Good Hope with an expenditure of time of 
 three to eight months. A large fleet was necessary to carry 
 on this trade, and this consisted of sailing vessels, since it 
 was impossible for the steamships of the time to make 
 so long a voyage with the coal which they could carry. 
 Because of the uncertainties attending so circuitous a voy- 
 age, and because of the risk of war, vast stores of Indian 
 and Chinese products were kept on hand in England, the 
 
INTRODUCTORY ECONOMICS 1 3 
 
 natural emporium for this trade. There arose in England 
 a great warehousing system, and a parallel development of 
 banking, the warehouse receipts serving as excellent secur- 
 ity for banking loans. After the opening of the canal, most 
 of the commerce with the Indies passed through the 
 Mediterranean. In this sea, and more especially in the 
 Red Sea, the sailing ship was practically useless. Hence a 
 great number of steamships were constructed, and an amount 
 of sailing shipping of about two million tons was virtually 
 destroyed. Ships that formerly would have done service 
 for years rotted in the wharves ; others were sold at far less 
 than cost to be used in other branches of trade. Persons 
 whose property consisted in sailing vessels of any kind 
 suffered heavy losses. Towns along the seacoast that had 
 been engaged in building sailing ships saw their prosperity 
 wane. Captains and trained seamen who had been employed 
 on the East India ships were forced to seek other employ- 
 ment. As the new method of transporting goods was 
 relatively quick and certain, there was no longer any need 
 for keeping anywhere in Europe large stores of India goods. 
 Moreover, goods destined for consumption in the Mediter- 
 ranean countries, and even in Central Europe, were no longer 
 conveyed to England and thence distributed, but were landed 
 at various Mediterranean ports. The warehousing system, 
 accordingly, fell into decay so far as this branch of the trade 
 was concerned, and the banking houses which had depended 
 upon the warehousing business were involved in losses. On 
 the other hand, the increasing demand for steamships 
 brought prosperity to the towns where such ships were built, 
 and to the laborers who were fitted for the work of steam- 
 ship construction. 
 
 Such were some of the immediate effects. No less im- 
 portant were the remoter ones. It was found that a vessel 
 constructed of wood did not well withstand the vibrations 
 of the engines ; hence the iron, and later the steel, ship took 
 its place. So long as ships were built of wood there were 
 
14 INTRODUCTORY ECONOMICS 
 
 few countries better fitted for shipbuilding than the United 
 States. Iron and steel were, however, far dearer in the 
 United States than in England; moreover, American labor- 
 ers did not quickly acquire the skill necessary for the suc- 
 cessful construction of iron ships. Accordingly, the Ameri- 
 can merchant marine was forced to give way before the 
 British. American enterprise was diverted to other chan- 
 nels, and has not yet returned to the sea. 
 
 The same event hastened the development of steam navi- 
 gation, with consequent cheapening of freight rates, in the 
 trade between Europe and America, and this helped to 
 enable the American farmer to flood the European markets 
 with his produce. This greatly increased the prosperity of 
 America; it gave cheaper food to the British factory hand, 
 and in less degree cheapened food supplies in Continental 
 countries. The European farmer, on the other hand, was 
 forced to take lower prices for his products. In England, 
 where American competition was keenest, the agricultural 
 districts were involved in a depression from which they have 
 not yet recovered. 
 
 It would be superfluous to multiply examples to show the 
 close interdependence of parts in the mechanism of economic 
 society. What affects one part of the economic organism 
 must inevitably affect other parts. And this it is that renders 
 it difficult to devise plans for obviating the economic evils 
 which remain in spite of the progress of civilization. 
 Through legislation it may be comparatively easy to restore 
 to vigor a decaying industry, and bring comfort and wealth 
 to those engaged in it. But the effects of legislation of this 
 nature will not be bounded by the industry which it is sought 
 to aid. Suppose that we are moved to action by the decay 
 of the old ship-building cities, which once sent vessels to 
 every important port in the world, but which now are com- 
 pelled to seek a precarious sustenance from the entertain- 
 ment of summer boarders; by the shipyards closed month 
 after month; by the efficient seamen forced to do odds and 
 
INTRODUCTORY ECONOMICS 1$ 
 
 ends of work ashore. It would be possible, through lavish 
 grants from the public treasury, to make the ship-building 
 industry pay. We should see a great industry spring up; 
 we should have the gratification of knowing that the 
 American flag might be seen on every sea — very good 
 things in themselves. What we might not see, but what 
 would be none the less real, would be a sacrifice imposed 
 upon each farmer and miner and mechanic in the way 
 of taxation necessary to meet the drain upon the public 
 treasury. 
 
 Most of us have at some time speculated upon the apparent 
 injustice in the distribution of rewards and services under 
 the existing economic system. Is it right that the unskilled 
 laborers, whose hours are long, and whose toil is hard and 
 uninteresting, should receive only the smallest pittance, while 
 the successful lawyer or architect receives a princely income 
 for work that may afford him the greatest pleasure ? Many 
 able thinkers have utterly condemned the existing economic 
 system because of this inequality of rewards; they wOuld 
 substitute a plan of sharing which would give to each accord- 
 ing to the time spent or according to the degree of exertion. 
 Certainly, this would increase the welfare of many who 
 now have far too little; it might not seriously injure those 
 who have more than is necessary for comfortable existence. 
 Yet could such a change be made without setting in motion 
 influences which in the end would leave the rich poor and 
 the poor more wretched than they now are? The question 
 is one that cannot be answered without a thorough study 
 of the laws governing the production and distribution of 
 wealth under modern conditions. 
 
 It is now clear why economic study, though of recent 
 origin, is prosecuted with more zeal than almost any other 
 department of science. It is concerned with one of the most 
 vital of all subjects — the general welfare. Without economic 
 science the existing constitution of society cannot be under- 
 stood ; unless based upon an adequate understanding of 
 
l6 INTRODUCTORY ECONOMICS 
 
 economic laws, attempts at practical reform of admitted evils 
 are likely to do more harm than good. 
 
 By what method are we to proceed in order to arrive 
 at an understanding of economic laws ? Not by systematic 
 experimentation, as in other sciences, for when human wel- 
 fare is concerned, experiments extensive enough to be of 
 value are not to be thought of. Not by an investigation of 
 the facts of history, for present conditions differ so widely 
 from those of earlier periods that past experience throws 
 doubtful light upon the problems of to-day. Moreover, 
 history records what is seen ; but what is not seen, but still 
 exists, is a no less important part of economic life. 
 
 The essential phenomena to be explained are prices — 
 prices paid for commodities, for labor, for the use of capital. 
 Now, if we can grasp the forces that are at work determin- 
 ing prices, we must make some progress, at any rate, toward 
 an understanding of the laws governing modern industry. 
 Shall our method then be to study prices as they actually 
 exist? Unfortunately, while a study of the markets will 
 show whether prices are rising or falling, it will not show 
 what forces determine prices in general. Some other method 
 of approach to the problem must therefore be found. 
 
 Although no individual exercises a controlling influence 
 over price, yet prices, we know, result from the actions of 
 individuals. When I buy a loaf of bread, I take the price as 
 I find it, yet by my action I contribute an infinitesimal part 
 to the sustaining or increasing of the price of bread, and 
 with it, the price of wheat. Thus we all contribute to the 
 determination of prices. And much as we may differ from 
 one another in other respects, in our economic conduct we 
 are much alike. Practically every one seeks to obtain for 
 his money the largest possible amount of gratification. Prac- 
 tically every one seeks to sell his labor for the highest wage 
 he can obtain, and to secure the highest possible rate of 
 interest on his capital. Exceptions occur, it is true. There 
 are those who have fixed ideas as to fair prices and fair 
 
INTRODUCTORY ECONOMICS VJ 
 
 wages, who refuse to accept either more or less than what 
 accords with their standards. But these exceptions are so 
 rare as to be negligible. In business life, as a general rule, 
 each man acts with a view to his own best interests. The 
 problem, then, is to discover the principles underlying 
 economic conduct — how our desires arise and develop, how 
 they are limited, how they are compelled to adapt them- 
 selves to the conditions of external nature. In this study we 
 have a key to the actions of other men in our own motives. 
 
 Though each man seeks to buy as cheaply as possible 
 and to sell at the highest possible price, he soon learns that 
 there are other men who desire to buy or sell like products 
 or services. That is, he encounters competition. And where 
 competition exists one cannot follow his own desires in fix- 
 ing the prices upon commodities which he has for sale or 
 wishes to buy. He must meet the low prices of competing 
 sellers by equally low prices, or abandon the field to them. 
 If he hopes to buy, he must make his offer as good as those 
 of competing buyers. Competition is not everywhere 
 present; but in the great majority of business transactions 
 prices are fixed with some reference to it. A monopoly may 
 control the whole supply of meat. The monopolistic seller 
 need not fear that meat will be offered by competitors at a 
 lower price. Yet if he fixes his prices too high, intending 
 purchasers will supply a part of their need for food with 
 other products. The seller of cereals and vegetables is in a 
 sense a competitor of the meat monopoly. 
 
 We may, then, assume that under existing conditions 
 prices are fixed through the concurrent action of buyers and 
 sellers, each of whom seeks to increase his wealth and the 
 resulting gratification at the least possible expenditure to 
 himself. We may also assume that the fixing of prices 
 takes place under conditions of competition in the widest 
 sense of the term. With these assumptions we may pro- 
 ceed to an examination of the process by which the indi- 
 vidual and society arrive at the prices of commodities. 
 
CHAPTER II 
 Utility, Value and Price 
 
 Man is distinguished from all other living creatures by 
 the number and complexity of his needs. The lowest savage 
 requires better shelter and more varied and nutritious food 
 than his next of kin in the animal world. And the higher 
 man rises in the scale of civilization, the more numerous 
 and complex are his needs. 
 
 Corresponding roughly with man's needs are his wants 
 or desires. From his general need for nutrition springs his 
 want for particular kinds of food, and for anything that 
 may help him to secure these — weapons, tools, etc. His 
 need for warmth and protection against storm gives rise 
 to a want for a hut or a cave, and for furs and skins 
 and whatever else may serve as clothing. Under primi- 
 tive conditions it was only through cooperation with his 
 fellows that a man could procure adequate means of subsis- 
 tence and could protect himself against his natural enemies ; 
 moreover, without the society of his fellows he would have 
 been miserable. Next to the needs for the means of physi- 
 cal existence then, man needed whatever would win him the 
 approval and admiration of his fellows. Hence arose wants 
 for objects of personal adornment and the like. Finally, 
 various puzzling experiences created in him the belief that 
 his life was subject to the influence of unseen beings, whose 
 favor he needed to gain ; therefore he developed a want for 
 things w^hich he believed would propitiate such beings. 
 
 Thus from the earliest time man has desired objects 
 which would satisfy his physical, social and spiritual needs. 
 In general, the same classification of wants or desires holds 
 to-day. But in the evolution of wants the clear distinc- 
 
INTRODUCTORY ECONOMICS 19 
 
 tions of earlier conditions have become somewhat ob- 
 scured. Leaving aside the want for objects ministering to 
 spiritual needs — as in a sense beyond the realm of economics 
 — it is plain that most physical wants have a social element, 
 as most social wants have a physical element. The want 
 for food is of course predominantly physical; yet most of 
 us demand that in its quality and preparation it shall 
 conform to the standards of the society in which we live. 
 The want for jewelry was at first almost purely social; it 
 remains predominantly so. But in the progress of time 
 man has developed a strong sense of personal satisfaction 
 in gold and gems — he desires them perhaps more for their 
 mere beauty than for the envy and admiration they excite — 
 and this esthetic element may in many cases quite supplant 
 the original social element. 
 
 Every concrete want of man is capable of complete 
 satisfaction. But the different wants vary widely in their 
 insistency and in the ease with which they may be entirely 
 satisfied. The want for bread, for instance, is extremely 
 insistent, yet easily satisfied. I must have bread, but I would 
 not care to have even a petty baker's entire supply. Such 
 a want is known in economics as an inelastic one. The 
 people of the United States require a fairly determinate 
 quantity of wheat for food, and this quantity they will 
 strive to secure even at great sacrifice. Much more than 
 this, however, would not be wanted at all, unless of course it 
 could be sold in other lands, or some use other than the 
 supplying of food could be found for it. On the other 
 hand, the want for some classes of things is very hard to 
 satisfy at all, although it is not absolutely essential that 
 the want be satisfied. I can get on very well without pos- 
 sessing paintings ; but I should like to have all there are 
 in the Louvre. The people of the United States may live 
 comfortably without having many art galleries; but it is 
 almost inconceivable that they covild have too many. Such 
 wants, then, are elastic. 
 
20 INTRODUCTORY ECONOMICS 
 
 As the examples given indicate, it is as a rule the wants 
 for objects satisfying physical needs that are inelastic, and 
 the wants arising out of social needs that are elastic. The 
 wants for so-called necessaries are inelastic; for luxuries, 
 elastic. Civilization tends to develop the wants for objects 
 satisfying social needs, and for luxuries of all kinds. Hence 
 it may be said that the higher a people stands in the scale 
 of civilization, the farther it is from the complete satisfac- 
 tion of all its wants. 
 
 Every man wants enough food to keep him alive; a 
 quantity sufficient for this purpose he desires intensely. 
 An equal additional quantity will keep him in good condi- 
 tion; this quantity he desires only less intensely. Give him 
 more food ; it may still please his palate, and satisfy a want. 
 But a point is soon reached where the man wants no more 
 food at all. 
 
 So the want for a suit of clothes is hardly less insistent 
 than the want for food enough for life. A second suit of 
 clothes will be highly desired, even if of identical quality, as 
 it may be worn when the first is soaked with rain or other- 
 wise out of condition for wear. A third suit of the same 
 kind would not be desired very intensely; a fourth, or at 
 any rate a fifth or sixth, would be a superfluity. But if 
 it is possible to vary the quality, the want becomes far more 
 expansive. The social element becomes predominant; the 
 man would dress at least as well as men in the social group 
 to which he belongs, or of which he desires to become a 
 member. Yet a point is eventually reached where neither 
 increase in quantity nor improvement in quality is desired. 
 
 It may then be stated, as one of the general laws of 
 human nature, that each want is capable of varying degrees 
 of satisfaction, that with each increase in the means of satis- 
 faction the desire for additional means grows less, until 
 a point is reached where desire is no longer felt. 
 
 Whatever satisfies a want is a good, in economic termi- 
 nology. Its power to satisfy wants is known as utility. 
 
INTRODUCTORY ECONOMICS 21 
 
 It is, of course, plain that nothing has utility in this sense 
 unless it is wanted. Utility is strictly parallel with want; 
 human want for a certain object endows it with utility; 
 and the degree of utility is measured by the degree of 
 want. Before men knew the use of iron, iron ore had no 
 utility at all; with every advance in the art of metallurgy, 
 the utility of iron ore has increased. In the days of 
 Marco Polo, the only utility that existed in the petroleum 
 of Asia Minor arose from its use "to anoint camels suffer- 
 ing from the mange"; now the progress of science and 
 industry has endowed the same material with a very high 
 utility. 
 
 Utility, it is to be borne in mind, is not usefulness. 
 Opium prepared for smoking, being ardently desired by 
 the victims of the opium habit, has a very high utility, in 
 the economic sense; but it is the reverse of useful. As a 
 rule, whatever is useful has utility, but there is no close 
 correspondence between the degree of usefulness and the 
 degree of utility. 
 
 We have seen that wants are capable of varying degrees 
 of satisfaction. As utility is strictly parallel with want, con- 
 crete goods, satisfying the dififerent degrees of want, have 
 different degrees of utility. Three bushels of wheat may 
 supply me with bread enough to sustain life through a year ; 
 the utility of these three bushels — supposing I have no other 
 source of food supply — is exceedingly great; I want them 
 as I want life and all that life contains. It would not be 
 easy to fix an estimate upon this amount of utility, but 
 let us call it i,ooo;ir. Another three bushels would enable 
 me to keep in fairly good physical condition ; but their util- 
 ity to me is evidently less ; perhaps it would be lOO x. An- 
 other three bushels might mean overfeeding; yet some per- 
 sons are desirous of being overfed; hence I may still de- 
 sire these three bushels, and thus endow them with util- 
 ity, which may possibly be measured by io,i'. With an- 
 other three bushels I might feed a cat and a dog; it would 
 
22 INTRODUCTORY ECONOMICS 
 
 give me pleasure to have these as pets; therefore I should 
 desire the additional supply of wheat, and it might repre- 
 sent a utility of 5 x. An additional three bushels I could 
 probably not use in any way giving me satisfaction. They 
 would have no utility for me at all. 
 
 Suppose that I find a particularly beautiful sea-shell. 
 As it seems beautiful to me, it has utility to me. The amount 
 of utility to me may equal 103;. Another shell will not be 
 so much of an acquisition, but I shall still desire it. Its 
 utility may perhaps be gy. Additional ones will give me 
 less pleasure, but as the want for things of beauty is hard 
 to satisfy, I may still experience a desire for a hundredth 
 or a thousandth shell, and these would have some utility 
 for me. There is, however, a point beyond which addi- 
 tional shells would merely cumber my premises ; they would 
 then have no utility. 
 
 These examples assume, of course, that I do not un- 
 dergo a change while I am acquiring these goods. If 
 repeated examination of the sea-shell inspires me with an 
 increasing sense of its perfection of form, I may desire 
 a second even more than I desired the first. Its utility will 
 be greater than that of the first originally was. But not 
 greater than the utility of a first shell would be in my 
 present state. 
 
 So one's first experience of classical music may be less 
 enjoyable than his second experience of the same kind of 
 music. He has, in the meantime, become a more cultured 
 person. But assuming that no opportunity for development 
 in taste is permitted, the pleasure derived from the first 
 hour of listening to good music will be greater than that 
 derived from a second hour of equally good music. The 
 utility of the second hour of music is less. And so we 
 may accept it as a general rule that the utility of a unit 
 of any kind of good diminishes as the number of such units 
 in one's possession increases. 
 
 In the foregoing examples it has been assumed that 
 
INTRODUCTORY ECONOMICS 23 
 
 the quantity of the goods increased until no desire for fur- 
 ther units existed. Most of the things which we desire 
 are not to be had in superfluous quantities. Instead of hav- 
 ing five units, each consisting of three bushels of wheat, 
 let us assume that I have but three. The third unit would 
 still have a utility of lo ;r. As this is the utility of the last 
 or final or marginal part of my supply, it is called final 
 or marginal utility. Suppose that I have only ten sea- 
 shells, and that the utility of the tenth is 5 y. In economic 
 language 5 j' is the final or marginal utility of sea-shells. 
 Final utility, it is clear, is a very variable quantity; if the 
 desire for a good increases, with no increase in the number 
 of units of the good, final utility increases; if the desire 
 remains the same, but the number of units of the good 
 diminishes, final utility again increases. In the first example, 
 if the third unit of wheat were destroyed, the marginal 
 utility of wheat would at once become 100 .r. 
 
 Conversely, marginal utility diminishes with decrease 
 in want or increase in number of units. I might tire of col- 
 lecting sea-shells, or the waves might wash up a wagon- 
 load of them. In either case the marginal utility would 
 shrink — perhaps to zero. 
 
 But does any man really arrange his wheat or other goods 
 in series of units and say to himself : "This unit is worth 
 1000 x; without it I should starve ; this unit is worth 100 x, 
 as my comfort and strength depend upon it; this unit is 
 worth 5 X, for if I did not have it I should be compelled to 
 do without my pets"? Not at all; the different units are 
 just alike, and one is thought of as just as desirable as 
 another. For practical purposes, the utility of one unit is 
 the same as that of another. Let us suppose that there are 
 four units of wheat, and that the last has a utility of 5 x. 
 What is lost if any one of the four units is lost? Simply 
 5 X. What sacrifice would one make to prevent the loss 
 of any unit, even the one which would have been used to 
 sustain life, and by itself was worth looow? A sacrifice 
 
24 INTRODUCTORY ECONOMICS 
 
 not greater than 5 x. For if any other unit is lost, the least 
 important one will be substituted for it, and the effective 
 loss will be properly placed at 5 x. 
 
 The utility of the last and least important unit, then, 
 exercises an important influence in determining what util- 
 ity one will in effect ascribe to any unit. For practical pur- 
 poses the utility of any unit is exactly equal to that of the 
 least important one. The utility of a unit, thus measured 
 by that of the least important one, is called "effective utility." 
 
 If the total number of units of a good is so great that 
 the last one has no utility, the good has no effective utility 
 at all. No one would do anything to prevent the destruc- 
 tion of part of his supply; no one would give anything 
 to increase his supply. Thus water, although a single gallon 
 would have indefinitely great utility, if this were the only 
 gallon available, is in most places so abundant that the 
 last units of the supply have no utility. Therefore no unit 
 has effective utility. 
 
 Anything which a man can acquire or hold possession 
 of, which is capable of satisfying a desire, and the available 
 quantity of which is so limited that every portion of it has 
 effective utility, is an economic good. To possess any such 
 thing is an object worth incurring sacrifice for; and no 
 one will be ready to suffer deprivation of it. All such goods 
 constitute wealth. 
 
 Economic goods may be classified according as they 
 satisfy wants immediately or indirectly. Bread, clothing, 
 dwelling houses and the like minister directly to wants; 
 they exist only for direct use, or "consumption"; they are 
 therefore spoken of as consumer's goods. Tools, ma- 
 chines, raw material, land and the like serve as means to 
 the production of goods having the quality of direct utility. 
 They are accordingly known as producer's goods. Under 
 modern conditions the distinction is hard to draw, because 
 through exchange goods destined for immediate consump- 
 tion may be used indirectly to procure other goods. Thus 
 
INTRODUCTORY ECONOMICS 2$ 
 
 the baker's loaves are not consumer's goods to him, but 
 means for procuring whatever he may wish to consume. All 
 material goods used either as materials or instruments of 
 production, or as means of acquisition through exchange, are 
 classed as capital goods. 
 
 In order to direct one's economic activities intelligently, 
 it is important to know how the effective utility of one kind 
 of goods compares with that of another. Suppose that a cul- 
 tivator can produce, with the expenditure of one day's labor, 
 two bushels of potatoes or one bushel of wheat. Should he 
 spend his time in producing wheat, or potatoes, or both? 
 If the effective utility of two bushels of potatoes is greater 
 than that of a bushel of wheat, the rational thing is for him 
 to produce more potatoes and to spend less time producing 
 wheat. According to the law of diminishing utility, the 
 effective utility of potatoes will decline as their quantity i*^- 
 creases ; at the same time, that of wheat will increase, as our 
 example assumes that labor formerly occupied in wheat 
 production is diverted to the raising of potatoes. A point 
 will probably be reached where a day's labor will produce as 
 much utility in one branch of agriculture as in the other; 
 and until this point is reached, the cultivator has it in his 
 power to increase his welfare simply by making a more ra- 
 tional distribution of his labor. 
 
 But before one can rationally distribute his labor or other 
 resources, he must have a definite notion of the relative ef- 
 fective utilities of goods. He must measure the utility of 
 one — the degree to which it seems desirable to him — in terms 
 of the utility of the other ; or he must measure them both by 
 a common standard. And this, of course, is easy to do. 
 Think of any two objects. Which seems the more de- 
 sirable ? That one has the greater utility for you. How far 
 would one walk in order to get good No. i ? If he would 
 walk twice as far to get good No. 2, the latter has twice 
 the effective utility of the former. Any good, or any sacri- 
 fice, may serve thus as a standard for measuring the com- 
 
26 INTRODUCTORY ECONOMICS 
 
 parative utilities of goods. Under existing economic con- 
 ditions, of course, the standard which most readily occurs 
 to one is money. If one wishes to compare the utilities of 
 wheat and potatoes, he naturally considers how much money 
 he would give for a bushel of either. 
 
 Now, the effective utility of a commodity, compared with 
 that of some other commodity, or compared with some sacri- 
 fice which serves as a standard, is value. Value is effective 
 utility measured. And as effective utility is constantly fluc- 
 tuating with changes in the amount of a good, or in the 
 desire for it, value is also always fluctuating. 
 
 We often hear of the ''real" value of a thing, or of the 
 "intrinsic" value, as if there were some kind of value resi- 
 dent in a thing apart from man's desire for it. Of course, 
 there can be no such thing. The value of a thing to any 
 person is its importance at a given time and place. 
 
 Values will naturally be different for different persons. 
 What is the value of my grandfather's watch ? To me, it 
 may be equal to that of $i,ooo. Perhaps you would not 
 give $io for such an antiquated timepiece. In less extreme 
 degree the same things holds of every good. Some will 
 place a high value upon an object; others a low value; and 
 the one is as properly the true or intrinsic value as the 
 other. 
 
 But is there not a certain scale of values in which most 
 persons agree, and has not this general value a claim to the^ 
 title ''true value"? There is indeed something like a scale 
 of values established, as it were, by common consent; and 
 the economic activities of each seem directed toward making 
 his own scale of values conform to that of society. How 
 this social scale of values arises out of the purely personal 
 values just described, it will be our next task to consider. 
 It is of course self-evident that the social value does so arise. 
 One can not conceive of society as such discovering values, 
 and imparting them to individuals. 
 
 Utility, as we have seen, is a quality with which an ob- 
 
INTRODUCTORY ECONOMICS 27 
 
 ject is endowed b)?" virtue of a human want. This want 
 may arise out of physicial or out of social need. If a par- 
 ticular social need should disappear or change, certain of our 
 wants would disappear or change. Certain classes of goods, 
 destined to satisfy such wants, would lose their value, or 
 undergo some change in it. There was a time when gen- 
 tlemen clipped their own hair and covered their heads with 
 wigs. To move in polite society, one had to follow this, as 
 other customs. Hence there was a want for wigs, and these 
 were endowed with effective utility and value accordingly. 
 As the fashion of wearing one's own hair came into vogue, 
 this particular kind of wig ceased to have either utility or 
 value. Now it is clear enough that the great majority of 
 those who followed the earlier custom could have had no 
 personal need nor want for a wig. They derived the want 
 from their associates. The custom, I suppose, originated 
 with some bald-headed prince, who really needed a wig. 
 And so it was transmitted from the court to the gentry, and 
 persisted long after the reason for its existence had disap- 
 peared. The value of wigs thus arose from a personal need ; 
 it attained vogue through imitation, and by a similar process, 
 faded out and disappeared. 
 
 Suppose that I attend an auction of the efifects of an 
 eccentric gentleman, who has led a solitary life collecting 
 odds and ends of all kinds, among them some things of value. 
 I find a painting that pleases me. I know nothing of art, and 
 all that the painting represents to me is a group of dull, 
 brutish persons, making unnecessarily hard work out of some 
 simple agricultural operation. What is its value to me? It 
 would be difficult to say ; certainly in my own mind the value 
 is something very tentative. But finding that the picture can 
 be had for no great sum, I resolve to buy it. I hang my 
 acquisition in an inconspicuous place, for I am not sure 
 whether I should be proud of it or ashamed of it. A friend 
 who knows something of art calls upon me. Perhaps he 
 takes merely a glance at the picture and says nothing. Its 
 
28 INTRODUCTORY ECONOMICS 
 
 value to me shrinks to zero. But if he cries enthusiastically, 
 "Ah! a Millet!" immediately its value for me expands in 
 an extraordinary fashion ; what had been scarcely a valuable 
 object at all becomes a priceless treasure. 
 
 Here then is one reason why values for different per- 
 sons tend to conform to the same scale. If I find that most 
 of my friends think that a riding horse is dear at $300, 
 I think so, too, although I might get more satisfaction out 
 of the horse than they. Value is thus in large measure 
 a matter of imitation. But before one can imitate, there 
 must be something original to serve as a center of imita- 
 tion; and in the matter of values, this must be the original 
 personal value of some, arising out of effective utility to 
 them. 
 
 Moreover, though imitation brings about a certain uni- 
 formity in the scales of values of different persons, it can 
 not of itself make them absolutely alike. If most of my 
 friends think that a particular horse is worth $200, I cer- 
 tainly would not value it at $300, unless indeed I am a 
 connoisseur in horseflesh and my friends are not. But I 
 think the horse is cheap at $200, while my friends think 
 it is dear. And this shows that in spite of all tendency to 
 conform, I retain a scale of values that is peculiarly my own. 
 
 So long as men lived in self-sufficing groups, producing 
 whatever they needed for their own use, there was no other 
 force than imitation which could make the personal valua- 
 tions of one group correspond with those of another. But 
 in an exchange economy a much more potent force making 
 for the socialization of values exists. 
 
 Suppose that two farmers, with adjoining fields, both 
 grow potatoes and wheat. Farmer A may consider that a 
 bushel of wheat is worth two bushels of potatoes ; Farmer B 
 may consider a bushel of potatoes worth two bushels of 
 wheat. Of course, such a divergence could exist only in 
 case the two farmers were so far from a market that they 
 could exchange their products only with each other. 
 
INTRODUCTORY ECONOMICS 2g 
 
 Assuming such divergence, however, the natural re- 
 sult would be, not that they would debate the relative justice 
 of their views of value, but that they would trade. Farmer 
 A could afford to offer Farmer B two bushels of potatoes 
 for a bushel of wheat ; Farmer B could afford to accept even 
 a half bushel of potatoes for a bushel of wheat. Exactly 
 how much A would at first offer, we can not say, nor is that 
 of much importance. What is certain is that he can, and 
 probably will, offer terms that will be acceptable to B, and 
 some bushels will be exchanged. 
 
 Now, as A parts with some of his potatoes, the effective 
 utility, and with it the value, of potatoes to him increases. 
 As he gets more wheat, the effective utility of wheat de- 
 clines. And the reverse will be the case with B, who is in- 
 creasing his stock of potatoes and diminishing his stock of 
 wheat. It may still be worth while for the two farmers to 
 exchange more bushels; but it is not so much worth while 
 as it was at first. In the end, exchange must cease, for 
 each will value wheat in terms of potatoes exactly as the 
 other does. 
 
 Perhaps Farmer A has land that is very well adapted 
 to potato production, while Farmer B's land is best fitted for 
 the growing of wheat. In another year A will have a super- 
 fluity of potatoes and B of wheat, and the process of ex- 
 change will again be necessary to equalize values. So in a 
 developed economic system the value of wheat as measured 
 in some commodity universally possessed, in regions where 
 it is produced, tends continually to fall below the value of 
 it in regions where little wheat is grown ; and this it is that 
 keeps up a constant exchange between distant regions. And 
 this constant exchange, in turn, tends to eliminate the dis- 
 crepancies in values. 
 
 Returning to the case of the two neighbors, perhaps one 
 has a cow which he does not care to keep, but the other 
 would like to have ; while the latter has a harrow which he 
 does not need, but the former could well use. Possibly A 
 
30 INTRODUCTORY ECONOMICS 
 
 values the cow at twenty bushels of wheat and the harrow 
 at thirty ; while B values the cow at thirty bushels of wheat 
 and the harrow at twenty. Here is a good opportunity for 
 a trade. Either one might give the other a certain number 
 of bushels of wheat "to boot," in order to bring about the 
 trade. At what terms will the exchange be made ? We can 
 not tell. Nor will the exchange, at whatever terms, affect 
 the relative values placed upon cows and harrows by either 
 party to the exchange. It would be different if more cows 
 and harrows were to be exchanged. In that case the scales 
 of values of the two exchanges would tend to uniformity, as 
 was the case with the potatoes and wheat. But very likely 
 no further exchanges are to be made. So I may be able to 
 buy for $25 a coat that I would regard as cheap at $50. 
 Another coat at $25, however, might not seem worth more 
 to me than $20; accordingly I refrain from buying it. 
 Hence the coat which I do buy retains a personal value 
 for me in excess of the value placed upon it by the seller. 
 It is a value that as a whole refuses to be socialized. 
 A similar state of affairs exists wherever one buys single 
 goods, not quantities of like units, as in the case of 
 wheat. 
 
 In the examples that have been used in the last section 
 it was assumed that both parties to the exchange had per- 
 sonal values, arising out of his own wants, for both com- 
 modities exchanged. This may have been the usual case un- 
 der primitive conditions ; but now, when we produce almost 
 exclusively for sale, the seller of a commodity must fix a per- 
 sonal value in some other way. I may be a dealer in ladies' 
 shoes. It is safe to say that for my personal use they have 
 no value whatsoever. Yet when a prospective customer 
 appears, I have just as definite a value, below which I would 
 not sell the shoes, as I should have if I were trading off a 
 pair of shoes that I might use myself. Whence do I derive 
 this value? I know that if I do not sell shoes to this par- 
 ticular buyer, I shall probably be able to sell them to some 
 
INTRODUCTORY ECONOMICS 3 1 
 
 one else. And I will take no less for them than I think some 
 one else will pay. If experience shows me that few persons 
 will pay the price, I must alter my personal value, or the 
 fashions will change, and I shall have a stock of unsaleable 
 leather on my hands. 
 
 Now it must be plain that this kind of personal value 
 is entirely a secondary phenomenon. It is derived from the 
 estimate of other men's personal values, arising from per- 
 sonal needs. It has its importance ; but it does not explain 
 the values that are actually placed upon goods. This explana- 
 tion lies in the facts of direct personal valuation. 
 
 Personal values, as we have seen, naturally vary widely 
 with different individuals. We need not believe that any 
 two persons would affix exactly the same valuation upon a 
 particular horse. One man might value the horse, for his 
 personal use, at $500; another at $50. Yet we find that 
 for a certain grade of horses there is something like a uni- 
 form value in terms of money—or price. Perhaps this 
 money value, or price, is $250. In that case the personal 
 values of $50 and $500 are both ignored. They have no 
 influence upon the price actually set. 
 
 Personally I should abhor the idea of ballooning. If I 
 were to place a value upon balloons for my own use, it would 
 be far less than nothing. Clearly my personal value of bal- 
 loons has nothing to do with their price, which for a given 
 grade may be $5,000. If I had a mild interest in this form 
 of sport I might value a balloon at $1,000; yet I should not 
 influence their price. Were I so passionately fond of bal- 
 looning, and so plentifully provided with money, as to value 
 a balloon at $100,000, this valuation would nevertheless be 
 incapable of raising the price of balloons much if any above 
 $5,000. It is clear, then, that some personal values count, 
 and some do not, in the determination of prices as they are 
 fixed in the market. 
 
 To show just what it is that determines what personal 
 values shall count in fixing market prices, we may employ a 
 
32 INTRODUCTORY ECONOMICS 
 
 somewhat tedious and artificial example which is the com- 
 mon property of modern text-books in economics. Let us 
 imagine a horse market, in which there are six persons with 
 horses to sell, and six persons each of whom would like to 
 buy a horse. We will assume that the horses are as alike as 
 peas, so that each buyer would as willingly have one as an- 
 other. Of course each buyer desires to buy as cheaply as 
 possible, and each seller desires the highest possible price 
 for his horse. Each buyer has in his own mind a top price — 
 the most he would pay under any circumstances — and each 
 seller has a bottom price, below which he would absolutely 
 refuse to go. Being rational men, the buyers carefully re- 
 frain from letting their top prices be known ; and in the same 
 way the sellers keep their lowest prices a close secret. We 
 shall assume the fiction writer's omniscience, and set down 
 the top and bottom prices of the buyers and sellers respec- 
 tively, as follows : 
 
 Buyers 
 
 Sel 
 
 lers 
 
 A $ioo 
 
 M 
 
 $90 
 
 B 90 
 
 N 
 
 80 
 
 C 80 
 
 
 
 70 
 
 D 70 
 
 P 
 
 60 
 
 E 60 
 
 Q 
 
 50 
 
 F 50 
 
 R 
 
 40 
 
 How many horses will be sold, and at what price? Of 
 course if each of the buyers in the first column were shut 
 up in a stall with the seller in the opposite column, all the 
 horses would be sold, and at different prices. But we are 
 assuming that all are in an open yard, and hear one an- 
 other's bids and offers. Under these circumstances no buyer 
 will pay more than another, nor will one seller take less 
 for his horse than another. What price will actually be 
 fixed can be seen by following out in detail the probable 
 action of these buyers and sellers, 
 
INTRODUCTORY ECONOMICS 33 
 
 Suppose A, a buyer, offers $40 as his first bid. 
 R could afford to take it ; but as any of the other five buyers 
 would be glad to get a horse at that price, they each offer a 
 little more than $40. Competition for this horse goes on 
 until the price is raised to $50. At this point two horses 
 may be had; but there are six competing buyers, and the 
 price goes higher. Thereupon F, who will pay no more 
 than $50, drops out. He can exercise no more influence 
 in determining the price of these horses than I can in deter- 
 mining the price of balloons. Bidding goes on, and the price 
 is forced up to $60. Three horses are to be had at this 
 price; but there are still five buyers the price goes above 
 $60, and E drops out. At last the price reaches $70. There 
 are now four sellers willing to part with their horses at this 
 price; and four buyers willing to pay the price. Imagine 
 that bidding goes on, and the price rises to $71. D would 
 then drop out, and four horses would be offered, with only 
 three buyers. Any one of the four sellers would rather 
 sell at $70 than have his horse unsold; bidding among the 
 sellers, therefore, forces the price back to $70. Under the 
 conditions this price represents an equilibrium between the 
 values of the buyers and those of the sellers. 
 
 Let us imagine, however, that before the sale is actually 
 effected, another buyer, with a maximum valuation of $110, 
 appears. The price will then be forced above $70, and D 
 will drop out. It will not reach $80, however, for then five 
 sellers will compete to meet the needs of four buyers. The 
 actual price will be fixed somewhere between $70 and $80. 
 If an additional seller, with a valuation of $30, were to 
 appear, the number of buyers remaining the same, the price 
 will drop below $70, but not quite to $60. 
 
 Where competition exists, then, the price will be fixed 
 at such a point that all that is offered at a given price will 
 be taken at that price. If we define as demand the aggregate 
 of offers of money for a commodity at a given price, and as 
 supply the aggregate of the commodity offered at the same 
 
34 INTRODUCTORY ECONOMICS 
 
 price, we may say that price is fixed at the point where de- 
 mand and supply are equal. 
 
 At a given time the aggregate demands for wheat at 
 $2 a bushel may extend to one million bushels; but the 
 sellers of wheat may be willing to place on the market 
 two million bushels at that price. Manifestly $2 a bushel 
 cannot be the price set by the market, for the owners 
 of the second million bushels, not finding purchasers, will 
 offer it for less. At a lower price, some sellers will drop 
 out, and some additional purchasers will appear. At $1.50 
 a bushel, perhaps fifteen hundred thousand bushels will be 
 offered, and the same amount taken. $1.50 is then the price 
 that will actually be set. 
 
 Now, not a single buyer pays more for the wheat than 
 its effective utility to him, measured in terms of money. 
 Some pay less than they would be willing to pay. These 
 have a personal value which does not correspond with mar- 
 ket value, and which has only an indirect influence in deter- 
 mining it. On the side of the buyers the personal values 
 that count most are those of the purchasers who find it just 
 worth while to buy. For these are ready to drop out at any 
 increase in price, and so tend to hold it at a given point. 
 These buyers are known in ecomonics as the marginal buy- 
 ers. On the sellers' side, the personal values that count 
 most are those of the sellers who find it just worth while to 
 remain in the market, since with a fall in price, these would 
 drop out. 
 
 Yet while it is the buyers and sellers who are just ready 
 to drop out with changes in price — the marginal buyers and 
 sellers — who at a given time hold the price where it is, price 
 changes may take place in spite of them, through changes in 
 the wants of many purchasers, or through the appearance 
 of new sellers. The introduction of the automobile resulted 
 in a new demand for gasolene, and as a consequence the 
 price rose, eliminating the purchasers who had before been 
 in a price-determining position. If alcohol should be sue- 
 
INTRODUCTORY ECONOMICS 35 
 
 cessfully substituted for gasolene for the same purpose, the 
 price of gasolene would fall and a new set of purchasers, 
 who formerly had nothing to do with fixing its price, as 
 they did not desire it enough to buy it, would come to occupy 
 the position of controllers of the price. 
 
 In existing conditions we do not find ourselves in the 
 presence of unpriced goods upon which a price is to be placed. 
 Everything that one wishes to buy already bears a price; 
 one accepts the price, or refrains from purchasing. I com- 
 pare my personal value of anything — say a hat — with the 
 value of the commodity in the market. If I decide that a 
 hat is worth more than $5 to me, I purchase it if it 
 is to be had at that price. Parting with some of my money, 
 each dollar I have is worth more to me ; and hats are worth 
 less. Thus I make my personal value approximate that of 
 the market. If I am a seller of hats, and I find that $5 
 are worth more to me than a hat, I willingly part with 
 the hat at that price. Having m^ore dollars, one is worth 
 less to me; having fewer hats, I am_ not so anxious 
 to part with one. Thus by buying- and selling one makes 
 his personal values conform more nearly to that of the 
 market. At the same time, by taking a hat from the seller, 
 I reduce by a trifle the member to be sold to other pur- 
 chasers ; I make the hat sellers less anxious to sell, and con- 
 tribute of my puny strength to draw up the general level 
 of value of hats to my own personal value. So all of us 
 who are purchasers are joining our efi:*orts to raise prices 
 to a high level, although what we desire is low prices ; and 
 all of us v/ho are sellers are exerting our combined strength 
 to pull them down, although we are anxious to have high 
 prices. Those of us who are least anxious to buy or to 
 sell exercise an equalizing function; when the buyers' side 
 prevails, and prices are rising, the least willing buyers drop 
 out; and similarly with the least willing sellers, when the 
 sellers succeed in pulling prices down. 
 
 Of course if there is an increase in the number of buy- 
 
36 INTRODUCTORY ECONOMICS 
 
 ers, or if the wants of existing buyers are intensified, then 
 the buyers will be successful in raising prices. On the other 
 hand, if the number of sellers, or the amount which each can 
 sell, increases, the sellers prevail in the price contest, and 
 draw the price down. Now it is very difficult to describe 
 the influences that increase the number of buyers, or the in- 
 tensity of their desires. But it is easier to describe the in- 
 fluences determining the number of sellers and the amount 
 they will sell. If for any reason the price of wheat should 
 rise to $2 a bushel, we can predict with absolute certainty 
 that the number of sellers will go on increasing until the 
 price comes down. $2 for wheat is therefore an abnormal, 
 or unnatural, price. On the other hand, if the price were 
 fifty cents a bushel, we may count with certainty that in 
 time sellers will drop out, and the price will rise. Fifty 
 cents is an abnormal price, just as $2 is. Between the two 
 prices must somewhere be one that is normal or natural. 
 The market price will be constantly rising above or falling 
 Delow it ; yet there will always be an increase of sellers when 
 the price is above the normal, and a diminution in the number 
 of sellers when the price is below the normal ; consequently 
 the price will fluctuate about this point, never remaining 
 long much above or much below it. The next chapter will 
 show what forces fix the normal price, or, to use a nearly 
 equivalent term, normal value, under conditions of com- 
 petition. 
 
CHAPTER III 
 Normal Price 
 
 At the close of the last chapter it was indicated that 
 although market prices are continually fluctuating, they nev- 
 ertheless tend to rise or fall toward a certain point, which 
 may be called the normal or natural price. A particular 
 fabric comes into vogue; everybody must have it, and as 
 there is not an indefinite amount of it, its price rises. Per- 
 haps it was worth $i a yard before fashion touched it 
 with its magic wand; the price may easily become $5. 
 Now, is this price one that is likely to continue — even 
 supposing that the fashion should be transformed into a 
 custom, and the enlarged demand for the fabric should thus 
 become permanent ? Would it be safe for one to buy large 
 stocks of this cloth, with the expectation of selling them at 
 $5 a yard? Would it be wise for one to put up a 
 mill for the manufacture of this kind of goods, with the ex- 
 pectation that the high price would continue? There are 
 conceivable conditions under which one might prudently do 
 these things ; but in most cases it would be very bad business. 
 Most probably, the price would sink again toward the $1 
 mark. In all likelihood $1 is about what that fabric will sell 
 for in the long run. 
 
 So it is with the great majority of the commodities sold 
 on the market. Their prices may at any time double ; but in 
 all probability this will be a transient phenomenon. If any- 
 thing is sold at an extremely low price — a price that has 
 rarely been known before — most probably this also is a 
 transient phenomenon. And just as it would be bad busi- 
 ness to buy large stocks, or build factories, in anticipation of 
 the continuance of excessively high prices, so it would be 
 folly to quit a business, or sell out all one's stock, because 
 
38 INTRODUCTORY ECONOMICS 
 
 of excessively low ones. The business man who is most 
 likely to succeed is the one who has a due appreciation of 
 normal price and who directs his business, so far as it is 
 concerned with a more or less distant future, in accordance 
 with its laws. Normal price, therefore, is a phenomenon of 
 the greatest practical importance. And in so far as it deter- 
 mines the direction of the productive forces of society, it is 
 of the highest importance to the student of economics, as 
 well as to the man of affairs. This is true even though 
 actual prices may at any given time be above or below the 
 normal, and may perhaps never remain for an appreciable 
 time at precisely the normal level. 
 
 The supply of most commodities may in some measure be 
 increased or diminished at the will of the producers. Many 
 producers are in a position to increase their output by 
 slightly enlarging their working force, or by running over- 
 time. Some producers are engaged in the manufacture of 
 a number of different commodities, or of grades of one kind 
 of commodity. By discontinuing the production of some 
 of these and concentrating their energies on a single one, 
 they are able to exert an appreciable influence upon supply. 
 Moreover, there are always some persons who are in doubt 
 whether or not they shall enter upon a certain line of pro- 
 duction ; still others, now engaged in that line of production, 
 who are in doubt whether or not they shall go out of busi- 
 ness. 
 
 When the price of a given commodity is very high, fac- 
 tories producing that commodity run on full time, or over- 
 time ; factories that would otherv/ise have produced several 
 other commodities turn all their energies in this direction; 
 manufacturers who were in doubt as to whether or not they 
 should go on producing, find their doubt stilled; and new 
 producers are lured into the industry. And this makes for 
 an increased supply and a falling price. How long will the 
 expansion of business continue? 
 ^ The two factors determining the business conduct of a 
 
INTRODUCTORY ECONOMICS 39 
 
 producer are price and cost of production.! In the cost of 
 production are included the value of materials used up and 
 the wear and tear and general depreciation of machinery, 
 buildings, lands; interest on all capital used, whether bor- 
 rowed, or owned by the producer; wages of all labor, 
 whether hired or that of the producer himself ; premiums to 
 insurance companies for the assumption of the risk of de- 
 struction of buildings and stock; taxes, water rates, etc. If 
 the price of a commodity exceeds its cost, including in the 
 term all the above-named elements, the supply of the com- 
 modity can be profitably increased. If the price just equals 
 cost, there is no sufficient reason for either increasing or 
 dimiriishing the supply. If the price is less than cost, the 
 supply will diminish. 
 
 Suppose that it costs an average manufacturer $i 
 to produce a yard of woolen cloth. If he can sell it for 
 $1, he will probably go on producing about as much 
 this month as he did last. For this price enables him to pay 
 his operatives, to pay interest on capital borrowed, to pay 
 taxes and insurance premiums, etc. It also affords him as 
 much of a reward for his labor of management as he could 
 get if he placed his services at another manufacturer's dis- 
 posal ; and as large a return on his own capital as he could 
 get from any other equally safe investment. But suppose 
 the price rises to $i.io. For every yard he can sell he gets 
 ten cents over and above all costs. This amount we shall 
 call a net profit. Of course he will desire to sell as many 
 yards as possible. He will work his mill to its fullest ca- 
 pacity; if he has looms that are pretty well worn out, he 
 makes haste to replace them with more efficient machinery ; 
 if he has been contemplating the erection of an annex to his 
 mill, he pushes the work forward as rapidly as he can. 
 Every other manufacturer in his line does the same. And 
 in time the increased supply of the fabric forces the price 
 down, until it reaches $i, where the manufacturer 
 no longer has any reason for increasing operations. Possibly 
 
40 INTRODUCTORY ECONOMICS 
 
 the price goes still lower and reaches ninety cents. This does 
 not pay all costs, but the manufacturer may still continue to 
 produce, as it may be better for him to pocket his loss than 
 to let the mill stand idle. But it is plain that he will curtail 
 operations wherever he can. He will discharge his least 
 efficient workmen, and discontinue the use of the least effi- 
 cient machines. Every other manufacturer, in greater or 
 less degree, is doing likewise. So the supply falls away and 
 the price rises toward $i. This, then, is the normal 
 price — a price that just covers cost of production, using the 
 term cost of production so as to include all the items enu- 
 merated above. 
 
 If the price of a commodity exceeds cost, then, forces are 
 set in motion which tend to bring the price back to the cost 
 level. Now, no producer wishes to sell at cost ; every pro- 
 ducer desires an excess above cost, and the greater the ex- 
 cess, the better he likes it. If a manufacturer can produce 
 a certain fabric at a total cost of $i, and can sell it at 
 $1.10, he enjoys a very comfortable net profit; and the same 
 thing is true of all other manufacturers in the same line. 
 And they might continue to secure this net profit if each 
 one would but refrain from enlarging his output. There is, 
 then, something illogical in the conduct of the several pro- 
 ducers, viewed in a certain way. Each of them is anxious 
 to get as large a sum of net profit as possible ; but the result 
 of their action is that nobody long continues to get any net 
 profit at all. 
 
 The reason for this is that there are too many of them 
 for any one to have a perceptible influence over price. 
 Suppose our manufacturer increases his output loo per cent. 
 Probably this would not reduce the price one-fiftieth of a 
 cent a yard. Therefore he obtains nearly twice as large a 
 sum of net profit as he would have done if he had kept his 
 output unchanged in volume. The temptation to increase 
 his output, then, is very strong; it is strengthened by the 
 fact that he knows that every one of the other thousand pro- 
 
INTRODUCTORY ECONOMICS 4I 
 
 ducers is subject to the same temptation; some will yield to 
 it; then others, finally all. And those who yield first will 
 be the ones who will get the greatest sum of profit. Under 
 the circumstances, the best thing for the manufacturer to do 
 is to yield to the temptation the moment it offers. 
 
 And this is what must inevitably occur where competi- 
 tion exists — where each producer may increase his output if 
 he desires to do so. However much it may be against the 
 interests of all the members of a group of producers to in- 
 crease operations, it is to the interest of each one to increase 
 his own operations, if the price of his products exceeds their 
 total cost. 
 
 Often, in American history, have different classes of 
 producers planned a universal curtailment of production, in 
 order to force prices above cost level and hold them there. 
 At one time the producers of raw petroleum, at another time 
 the producers of wheat, at still another time the producers 
 of cotton, have beguiled themselves with such plans. If 
 each cotton producer would plant ten per cent, less ground 
 next year, the price of cotton would probably rise twenty 
 per cent., and every producer would get more money for less 
 labor. Perhaps the cotton producers may make a general 
 agreement to this effect. Well, every producer who violated 
 his agreement, and doubled his acreage, would get the benefit 
 of the high price, and the additional benefit from an unus- 
 ually large quantity to sell. Each producer, having his own 
 interest at heart, and suspecting the integrity of the motives 
 of others, would be under the strongest temptation to in- 
 crease his output. Some would refrain from doing so; but 
 enough would increase their acreage to keep cotton very near 
 to cost price. 
 
 But let us suppose that the cotton producers were able 
 to bind themselves legally to diminish production, ten, 
 twenty, fifty per cent., or that some Croesus should buy up all 
 the cotton lands and fix production at the figure which 
 seemed most profitable to him. In either case, prices would 
 
42 INTRODUCTORY ECONOMICS 
 
 cease to hover about cost of production. They would be 
 such as always to afford a net profit. Such prices, in con- 
 trast with normal or competitive prices, are called monopoly 
 prices. They are controlled by laws, but these laws are 
 quite different from those which prevail in competitive in- 
 dustry. To state the law of monopoly price will be the chief 
 purpose of the next chapter. 
 
 It is clear that the only reason why the value of a com- 
 modity tends to equal its cost of production is the automatic 
 increase or decrease of supply when price temporarily 
 swerves away from cost. It has already been pointed out 
 that through combination such an increase in supply as will 
 reduce prices to cost of production may be prevented. If 
 for any other reason supply is unable to change, the price 
 of a commodity may remain permanently high, or perma- 
 nently low. Let us assume that a certain country has only 
 one armor plate works, and owing to a deficiency in the 
 public revenues would prefer to cease strengthening its 
 navy rather than pay a price for armor plate corresponding 
 to cost of production. The cost to the armor plate manu- 
 facturer may perhaps be divided into the following elements : 
 Interest on capital invested in buildings and lands, fifty per 
 cent. ; cost of raw material, fuel, etc., twenty-five per cent. ; 
 wages of labor employed, twenty-five per cent. The price 
 offered for armor plate, let us assume, is sixty per cent, of 
 the total cost. This price will cover the cost of materials, 
 labor, etc., and will yield in addition one-fifth of the normal 
 return on the capital invested in buildings, machinery, land. 
 If the owner of the plate works refuses to take orders for 
 plate, he will have to close down his works ; in that case he 
 will secure no return on his capital at all. Clearly, it will 
 pay him better to continue production. 
 
 But suppose the price offered for armor plate is only forty 
 per cent, of its cost. In that case, if the owner of the works 
 is paying his men exactly what they could get in other in- 
 dustries, and is paying merely the market price for his raw 
 
INTRODUCTORY ECONOMICS 43 
 
 materials and fuel, he will have to close down his works. 
 For by continuing operations he would lose not only interest 
 on his fixed capital, but would also incur a net loss on every 
 dollar he paid out for labor or for materials. 
 
 Conversely, if a period of financial prosperity should 
 enable the nation to enter upon an ambitious naval pro- 
 gramme, the price of armor plate might rise considerably 
 above cost of production without inducing any one to put 
 additional capital into such an industry, from which it could 
 not easily be withdrawn in case prices should fall. As sup- 
 ply would not increase, therefore, price might long remain 
 above the level of cost of production. 
 
 When a street railway line is constructed, it is expected 
 that the receipts from fares will cover all costs of operation, 
 together with interest on all capital expended in constructing 
 the line. Possibly the traffic will be so much less than was 
 anticipated that the receipts will do little more than cover 
 costs of operation, leaving hardly any return for the capital 
 sunk in the road. This capital cannot, however, be removed 
 to a more lucrative enterprise. To raise fares, even if this 
 were permitted by the charter of the company, might still 
 further discourage traffic and reduce net receipts. The 
 street railway line will therefore be compelled to operate at 
 a loss, preferring a small return on fixed capital to none at 
 all. On the other hand, if the receipts are far in excess of 
 cost, including under that head interest on fixed capital as 
 well as operating expenses, it will still be impossible for 
 other capitalists to construct another line on the same street, 
 and so reduce fares to the cost level through competition. 
 
 Similarly, it cannot be said that there is any tendency for 
 railway freight and passenger charges to approximate cost 
 of production. For the most part, such charges are gov- 
 erned by other laws than those of normal price. 
 
 The laws of normal price operate wherever supply auto- 
 matically increases or diminishes with increase or decline of 
 price. And this is particularly the case with common manu- 
 
44 INTRODUCTORY ECONOMICS 
 
 factures. In a manufacturing industry there may be i,ooo 
 mills producing the same grade of goods and selling them in 
 a common market at a uniform price. Fifty of these mills 
 become so dilapidated each year, through age, that they are 
 dismantled ; fifty mills of equal capacity must be put up each 
 year in order to maintain a constant supply of goods. If 
 prices are so low that not all costs of production are covered, 
 no new mills are erected to take the place of those which are 
 abandoned, and a part of the supply fails. If prices are 
 above cost, instead of fifty new mills, there may be lOO, and 
 the increased supply tends to draw prices back toward the 
 cost level. 
 
 In the case of agricultural products much the same thing 
 is true. If the price of wheat is high this year, more land 
 will probably be prepared for the wheat crop of next year. 
 Of course, if the price has been low for a series of years pre- 
 ceding, it may be assumed that it is only some chance occur- 
 rence that has raised the price — a famine in India or in Rus- 
 sia, a foreign war, or some other transitory cause. In that 
 case the prudent farmer will hesitate about applying an un- 
 due share of his energies to wheat production. The supply 
 of wheat, for the next year, may not be materially increased ; 
 and owing to a similar unanticipated cause, may sell at an 
 abnormally high price. Abnormally low prices in any year 
 may be ascribed, by most farmers, to transient causes, and 
 may lead to no decrease in acreage. Thus, for a period of 
 years the products of agriculture may respond very slug- 
 gishly to the influences of price. 
 
 Again, it is possible that the high price of wheat during 
 a period of years may lead to an unduly great expansion of 
 the wheat growing area. As a consequence, so much wheat 
 may be grown that for another period of years the price 
 will be abnormally low — too low to compensate the farmer 
 for his costs. And thus it is not impossible that the price 
 of a commodity may constantly be alternating between an 
 abnormally high level and an abnormally low one. Yet the 
 
INTRODUCTORY ECONOMICS 45 
 
 high price must in the end bring about a reaction, just as the 
 low price must do so. And for this reason we may call such 
 prices abnormal, as contrasted with a theoretical price which 
 would not show a tendency to be followed by a reaction in 
 either direction. 
 
 It is often impossible to tell exactly what it costs to 
 produce a particular commodity. Some comm.odities are in- 
 variably produced together, as beef and hides, cotton and 
 cotton seed, wool and mutton. In most great industries, it 
 is found possible to make use of parts of the raw material 
 that are ordinarily regarded as waste. Thus, in the refining 
 of petroleum, besides the main product, kerosene, a host of 
 by-products — gasolene, lubricants, tars, dyes, etc. — are pro- 
 duced. How much does it cost to produce these? Nobody 
 can tell. They could not be produced at all, in commercial 
 quantities, were it not for the immense capital engaged 
 primarily in the production of kerosene. Part of the cost 
 of the use of that capital ought to be counted as cost of by- 
 products. But it is not possible to say how great that part 
 should be. No one can say how much it costs to produce 
 hides, or cotton seed, or wool. In such cases, there is of 
 course an ascertainable cost, and hence a definite normal 
 value, of live cattle, of sheep, of unginned cotton, of petro- 
 leum products as a whole. If the price of beef, added to 
 the price of hides, is more than reasonable compensation for 
 the cost of raising cattle, the business of cattle raising tends 
 to expand. And so with other cases of joint products. 
 
 Where the cost of a particular commodity is ascertainable, 
 and any one is free to enter upon its production, the price 
 constantly tends toward the level of cost. Cost, then, may 
 be said to determine normal value. It is, however, to be 
 borne in mind that cost itself is something variable and fluc- 
 tuating. Cost of production in any industry is greater for 
 some producers than for others. A given grade of cotton 
 goods may be produced either in Rhode Island or in North 
 Carolina. It may cost an average of ten cents a yard in 
 
46 INTRODUCTORY ECONOMICS 
 
 Rhode Island, and nine cents a yard in North Carolina. 
 Some Rhode Island factories are better than others ; perhaps 
 the cost of producing the cloth is eight cents in the best 
 factories and twelve cents in the worst equipped ones. And 
 similar gradations may exist in North Carolina. So when 
 we say that normal price is fixed by cost of production, 
 exactly what do we mean? Average cost? Greatest cost? 
 Least cost ? 
 
 It may be supposed that a factory which produces at a 
 cost of eight cents will run on full time, and with full work- 
 ing force, if the price is 8^2 cents. If the price is ten or 
 twelve cents, it can do no more, unless it can be expanded 
 by the erection of an annex. Let us suppose that it would 
 take a year to construct such an annex and get it into work- 
 ing order. In the meantime the factory produces as much 
 as it can when the price rises ; but so it would have done if 
 the price had not risen. So far as this factory is concerned, 
 the rise in price does not immediately create an expansion of 
 supply that reacts upon the price. This factory, then, can- 
 not be said to be in a position to control prices. 
 
 But let us suppose that there are other factories which 
 produce at a cost of nine, ten, eleven, twelve cents a yard. 
 So long as the price remains at 8^ cents, none of 
 these, w^e may assume, will be in operation. As soon as 
 the price rises to nine cents, the factories producing at that 
 cost will open their doors, and by increasing the supply of 
 goods, will tend to check further rise in prices. If prices 
 rise nevertheless, the factories producing at a cost of ten 
 cents will begin operations, and will exert their influence on 
 supply and on price. When the price rises to twelve cents, 
 it will be the factories producing at this cost that will tend 
 to check a further rise in price. When the price is twelve 
 cents, the costs of production of the better equipped mills — 
 those producing at eight and one-half, nine, ten, and eleven 
 cents — have little to do with the determining of price. If 
 the price rose a little higher, or fell a little lower, these f ac- 
 
INTRODUCTORY ECONOMICS 47 
 
 tories would continue to produce exactly as much as they 
 do when the price remains at twelve cents. They do not, 
 therefore, regulate the supply. This the twelve-cent mills 
 do, since they are ready to drop out, and reduce supply, if the 
 price falls. 
 
 It is not to be understood, however, that a manufacturer 
 can say : "I produce at a cost of twelve cents ; I must have 
 at least that price," and so force the price up to twelve cents. 
 If the market demands that manufacturer's contribution to 
 the supply, it must pay twelve cents for every part of the 
 supply. The manufacturer in the least favorable position 
 cannot fix the price at his cost. He can only withhold what 
 he might have supplied, and so bring to bear upon the market 
 some small pressure, making for higher prices. 
 
 It is only in a restricted sense, then, that we can say 
 that normal prices are fixed by cost of production. Those 
 who produce at a cost of twelve cents, by their action in 
 placing a product on the market or withholding it, make 
 an attempt at holding the price at that point. Perhaps the 
 task is too great for them; the price slips away; and those 
 producing at a cost of eleven cents make an endeavor, by 
 the same means, to hold prices at their cost level. They 
 also may be unequal to the task, but at last the price rests in 
 the hands of producers who are just able to hold it at their 
 costs. We may think of these as being on the fringe or 
 ''margin" of production ; they are often called, in economics, 
 the marginal producers. 
 
 The price does not, however, rest permanently with the 
 same marginal producers. Those producers whose costs are 
 less than the price are continually reaping profits ; they invest 
 them in new mills, equally well equipped, and borrow capital 
 further to increase their productive capacity. In time they 
 greatly increase their output, and this tends to reduce the 
 price of the commodity. The producers who are holding 
 the price at their cost level find the burden growing heavier 
 and heavier; soon the price breaks away from them al- 
 
48 INTRODUCTORY ECONOMICS 
 
 together, and is held for a time at the cost level of slightly 
 more efficient producers. But the most efficient producers 
 continue to enlarge their works; an increasing supply is 
 thrown upon the market, and the price settles to a still lower 
 level, where it equals cost to producers who formerly en- 
 joyed a slight profit. In this way prices are continually 
 gravitating toward the level of cost to the most efficient pro- 
 ducers. 
 
 It may therefore be said that for a short period of time, 
 price is determined by the costs of production of those who 
 produce at the greatest expense, but whose contribution to 
 the supply is necessary in order that the existing demand 
 may be met. In the progress of time, however, such pro- 
 ducers are unable to hold prices at their cost level, and are 
 forced out of business. The final adjustment — if it should 
 ever be attained — would leave price at the level of cost to 
 the most efficient producers, all of whom would stand on a 
 plane of equality as to costs. 
 
 This does not mean, however, that the price of a given 
 commodity must continue to decrease. The cost itself may 
 increase, for the more efficient as well as for the less efficient 
 producers. As we have used the term, cost includes the 
 value of raw materials and fuel ; interest on capital, whether 
 fixed in land, buildings, and machinery, or invested in raw 
 materials, etc. ; wages of all labor employed ; and a number 
 of lesser items — taxes, insurance premiums, etc. Now, 
 every one of these elements in cost is perpetually fluctuating 
 in magnitude according to its own peculiar laws. The 
 sources of raw material may be approaching exhaustion; 
 wages and interest may be rising; taxes may be growing 
 heavier. But while such an increase in costs may prevent 
 the more efficient factory from producing as cheaply as be- 
 fore, it burdens the less efficient proportionately. It cannot, 
 then, prevent prices from tending toward costs to the most 
 efficient producer. 
 
CHAPTER IV 
 Monopoly Price 
 
 As has been shown in the preceding chapter, the mech^ 
 anism which keeps prices hovering about cost of production 
 consists in the automatic adjustment of supply and demand. 
 If price rises, supply increases, and thus price is forced down 
 again. If then the supply of a commodity can be controlled 
 by the producers, the price is also within their control. With 
 this control, the producers are in the happy situation where 
 they can, within limits, enrich themselves at their pleasure. 
 It is no wonder, then, that producers and dealers from very 
 early times have sought to bring supply under control. 
 Joseph controlled the total supply of grain in Egypt, we are 
 told; he was thereby enabled to charge whatever prices he 
 pleased; and the prices he fixed were such that he got in 
 exchange for his grain all the possessions that the Egyptians 
 had. In ancient and mediaeval times, when roads were bad 
 and the costs of carriage prohibitive, whoever should buy up 
 the stock of grain in a town would practically make himself 
 master of the town. He could measure out the grain in small 
 quantities, charging whatever prices seemed good to him. 
 Quite naturally, then, men desired to monopolize the neces- 
 saries of life. There was great wealth to be gained in this 
 manner. And quite as naturally, the townsmen, who were 
 thus compelled to pay high prices, desired to hang the 
 monopolists, or at least to put them in prison. 
 
 Monopolies we still have; and few of us have much 
 love for them. But the monopolists of modern times can- 
 not charge such exorbitant prices as their mediaeval and 
 ancient prototypes. The mightiest monopoly in the United 
 States can draw to itself only a fraction of the wealth of 
 the community. The prices which it can fix and the profits 
 
50 INTRODUCTORY ECONOMICS 
 
 which it can enjoy are strictly limited by economic laws, 
 although the limitations are not so narrow, perhaps, as we 
 should wish them to be. 
 
 Before considering what these laws are, we must exam- 
 ine the conditions under which monopoly may arise. One 
 possible way has already been indicated. All the producers 
 of a given commodity may agree among themselves not to 
 sell below a certain price, or, what would amount to the 
 same thing, not to produce more than an amount so small 
 as to command scarcity prices. If the number of producers 
 is small — say half a dozen — such an agreement might stand. 
 No one could materially increase his sales without attracting 
 attention ; moreover, no one could increase his sales without 
 an immediate effect on price. If the producers number 
 millions, such an agreement would be empty words ; almost 
 any one could violate it without detection, and without any 
 appreciable effect on price. And the number of violators of 
 the agreement would be so great that no control of supply 
 or of price could be exercised. 
 
 When the number of producers is small, then, there 
 may be effective control of supply. But such control cannot 
 long be retained unless new producers can be kept out of the 
 field. 
 
 The producers of cotton yarn of the higher grades are 
 not so very numerous. It is therefore conceivable that they 
 might agree to limit supply and force the price to a point 
 paying a "fair" profit. But it is not a very difficult matter 
 to build and equip a mill to produce a given grade of cotton 
 yarn. If then the price were forced to a high level, new 
 producers would soon appear. These v/ould enjoy the bene- 
 fit of the high price, although to effect sales they would have 
 to undercut the prices of the combine. The latter would 
 have to reduce its prices ; the new producers would then cut 
 still lower, and so on until the price had reached cost of 
 production. Indeed, the price would almost certainly go 
 lower than this, for the number of producers, each striving 
 
INTRODUCTORY ECONOMICS $1 
 
 to get more customers, would have increased. The last state 
 of the cotton yarn business, accordingly, would be far worse 
 than its first. We have had in America not a few examples of 
 attempted monopolies which in the end merely intensified 
 competition. 
 
 If the industry in question requires a very high grade 
 of skilled labor, and the members of the combine control the 
 whole supply of labor of this grade, the monopoly may rest 
 secure until new labor can be trained for the shops of would- 
 be competitors. If the only satisfactory way of training 
 such labor is through apprenticeship under men already 
 working in the trade, it becomes difficult indeed for a com- 
 petitor to get an independent supply of labor. This situation 
 might become a serious one in some industries were it not 
 for the fact that it is not easy for one set of employers per- 
 manently to control their workmen. The latter would know 
 that at any time they could thwart their employers' schemes 
 by accepting employment with competitors ; and this knowl- 
 edge would be made good use of, in forcing constantly 
 higher wages. Where monopolies of this kind have arisen, 
 they have generally been broken up on account of disputes 
 between the employers and their workmen. 
 
 Some products depend upon supplies of raw material 
 that are found in comparatively few parts of the earth, and 
 in limited quantity. If a combination of producers can get 
 possession of all or most of the mining or agricultural lands 
 which are capable of yielding a certain product, they may 
 win their desired freedom from the danger of new competi- 
 tors. Anthracite coal, for example, is found in only a re- 
 stricted area in the United States. A combination of 
 capitalists of very great wealth might with comparative ease 
 control the total output — and indeed, something of the kind 
 now exists. Such a combination has nothing to fear from 
 new competitors, although of course it must meet the com- 
 petition of producers of other fuels. 
 
 Where a combination does not enjoy the ownership of 
 
52 INTRODUCTORY ECONOMICS 
 
 limited natural resources, it may yet attain much the same 
 result through systematic intimidation of those who might 
 desire to become competitors in its field. The combination 
 may be very rich, and quite ready to lose money on some part 
 of its sales whenever this may be necessary to stifle compe- 
 tition. Let us suppose that there is a combination of the 
 more important producers of coal who yet have nothing like 
 complete ownership of the coal lands. There may be a 
 number of small competitors whose natural market is a city 
 which we will call X. Other markets, we will assume, are 
 so far distant that cost of transportation prohibits their sup- 
 ply from the mines of the small producers. The combine, 
 on the other hand, may have mines from which it may supply 
 the market X, as well as a host of mines supplying other 
 cities. If then it desires to destroy the business of its small 
 competitors, it may decide, for a while, to sell coal in X for 
 less than the cost of raising it from the pit. This the com- 
 bination can afford to do, because it is enjoying high profits 
 from its monopolistic position in the supplying of other 
 markets. Of course the small competitors can sell no coal 
 at prices which will meet those of the combine; very soon 
 they become discouraged and retire from business. Then 
 the combine can raise prices of coal in X to a profit-yielding 
 point. The small producers will probably not again attempt 
 to compete, knowing that the same tactics will again be em- 
 ployed to destroy their business. 
 
 Of course, if coal were easy to transport, this method 
 would prove very expensive to the monopolistic combination. 
 An enterprising dealer in the town X, finding that the 
 combination sold coal there at much lower prices than in 
 town Y, might buy up coal in the former place and ship it 
 to the latter. On every ton of coal sold in X, we have as- 
 sumed, the combination is losing money ; and every ton sold 
 in Y helps to depress the price there, to the further disad- 
 vantage of the combine. In a sense, it would be underselling 
 itself. 
 
INTRODUCTORY ECONOMICS 53 
 
 Accordingly, some other method of destroying competi- 
 tors must be employed when the commodities which it is 
 sought to monopolize are of little weight and bulk, as com- 
 pared with their value, and hence easily transported. Sup- 
 pose that a monopolistic combination controls most of the 
 manufacture of cigars, and that an overbold outsider, 
 anxious to share the benefits of high prices, enters the field. 
 He may place on the market an excellent brand of cigars, 
 charging for them less than the combine charges for similar 
 ones. The combine cannot lower the prices of all cigars in 
 the competitor's vicinity, for in that case dealers will buy 
 them up and express them to all parts of the country; and 
 thus the combine would be inflicting losses upon itself. But 
 there is another method which it will find efficacious. 
 
 Let us say that the independent producer calls his brand 
 of cigars the "Rex." It is his all ; his fate is bound up with 
 its fortune. The combine has 500 brands ; it makes profits 
 on all of them. Accordingly, it can afford to put out a new 
 brand of cigars — say the "Regina" — for half the price of the 
 Rex, though of as good quality, and place it on the market 
 wherever the Rex is sold. Before long the Rex is no longer 
 purchased; its producer goes out of business. Then the 
 combine puts worse tobacco into the Regina, until at last, like 
 all its other products, this cigar is dear at the price.* 
 
 Some businesses, by their very nature, tend to come un- 
 der unified control. The supplying of gas to a city is of this 
 character. A dozen competing companies, in a great city, 
 would be an intolerable nuisance; besides, the cost of pro- 
 ducing and distributing gas would be vastly increased by 
 such competitive supply. A single street railway system, or 
 a single telephone company, is much more convenient, and 
 can operate more economically than competing businesses 
 could do. A majority of the towns in the United States are 
 
 * For the above, and other methods employed by monopolistic 
 combinations in keeping competitors out of the field, see Clark, 
 The Control of Trusts, Ch. IV. 
 
54 INTRODUCTORY ECONOMICS 
 
 served by only one railway ; and this is of course in the posi- 
 tion of a monopoly. In most of the remaining cities there 
 can never be more than three or four competing railways, at 
 most; and these, by virtue of their small number and by 
 virtue of the peculiarly disastrous effects of competition in 
 the railway business upon the railways themselves — which 
 we cannot in this place discuss — almost certainly operate 
 under agreements as to charges. There is, then, a large field 
 of modern business in which monopoly is natural; and in 
 this entire field, barring the existence of statutes fixing 
 prices and charges, the monopolist may fix his terms accord- 
 ing to his own views of what is profitable to him. 
 
 A monopoly may also be created by law. In certain 
 countries the manufacture of tobacco is monopolized by the 
 state. Since no one can purchase from any other seller, the 
 state can charge such prices for tobacco as will give a rev- 
 enue to the treasury. A monopoly created by law may be 
 given to a private individual. Once this was done for the 
 benefit of royal favorites ; but nowadays such a monopoly is 
 given in return for some service to the public. A city may 
 thus give a monopoly of the sale of refreshments in a public 
 park; but the dealer is expected to pay for it, either in a 
 lump sum, or in a percentage of his profits. 
 
 But the most common kind of monopoly created by law 
 is the patent. Invent a new kind of machine, a new process 
 of treating raw materials, a new kind of fuel or way of 
 utilizing fuel. If the invention is really new, the govern- 
 ment, in most modern countries, stands ready to protect you 
 for a certain number of years in the exclusive enjoyment of 
 it. If it is an article for sale, you may manufacture it and 
 sell it for whatever you can get. You may sell your right, 
 and the buyer proceeds to enjoy the monopoly. This mo- 
 nopoly is of the strongest ; all the power of the state can be 
 invoked to keep competitors out of the field. 
 
 The above are by no means all the possible ways by 
 which monopoly control may be secured. They are only the 
 
INTRODUCTORY ECONOMICS 55 
 
 more common ways. Now it must be plain that there will 
 be a great deal of monopoly in a society like our own. Com- 
 bines exist ; limited natural resources are controlled ; devices 
 for intimidation of possible competitors have reached a high 
 degree of perfection ; more and more businesses are develop- 
 ing into a state in which, like the manufacture of gas for a 
 municipality, they are natural monopolies. Patents, also, 
 were never more numerous ; and as they often fall into the 
 control of businesses having other sources of monopoly 
 power, they are a potent cause of monopoly growth. 
 
 We may therefore expect to find in actual business, be- 
 sides the branches in which prices are controlled by cost of 
 production, other branches in which the producers have more 
 or less power to hold prices above cost of production. This 
 power varies from monopoly to monopoly, according as com- 
 petitors are excluded by a strong means or by weak ones. It 
 also varies according to laws which have only an indirect 
 connection with competition. 
 
 Suppose that a monopoly has complete control of the 
 salt that is to be sold in the United States. It may cost one 
 cent a pound to produce it. At what price will the monopoly 
 sell it? If the price is one cent, perhaps one billion pounds 
 will be sold. If the price were raised to two cents, who 
 would eat his food unsalted ? Who would economize salt in 
 the least? It is safe to say that there are few persons in the 
 United States so poor that they would not go on eating as 
 much salt as before. And the same thing would be true if 
 the price v/ere raised to five cents a pound — a price of which 
 four-fifths would be monopoly profit. 
 
 But not all the salt is for table use ; a large part of the 
 total supply is used for live stock and for manufacturing 
 purposes. If the price of salt rises, the use of it for 
 these purposes will decline. When salt is very cheap many 
 farmers scatter it on the ground for their cattle, or leave it 
 in troughs with no shelter, where the weather devours more 
 of it than do the cattle. High price would mean economy. 
 
56 INTRODUCTORY ECONOMICS 
 
 So, at tvv'o cents a pound, probably not more than 900,000,000 
 pounds will be used, instead of 1,000,000,000. At five cents 
 a pound the amount taken might shrink to 800,000,000 
 pounds ; at ten cents, to 700,000,000 ; at twenty, to 500,000,- 
 000. Were the price forced up to $1 a pound, very likely 
 great economy would be exercised even in the use of salt in 
 human food. Perhaps not more than 80,000,000 pounds 
 would be used. 
 
 Now, while the monopoly would make the enormous 
 profit of ninety-nine cents a pound at the last-mentioned 
 price, this would be a very irrational price for it to set. The 
 total profit from the sale of salt would, according to our as- 
 sumed volume of sales, be $79,200,000. And this would be 
 much better than selling 1,000,000,000 pounds at cost, or 
 900,000,000 at two cents. The latter price would yield just 
 $9,000,000 profit. At five cents the monopoly would get a 
 profit of $32,000,000 ; at ten cents, of $63,000,000 ; at twenty 
 cents, $95,000,000. So twenty cents is really a more profit- 
 able price for the monopoly than $1. At twenty-five 
 cents, however, 400,000,000 pounds might be taken ; and this 
 would mean a profit aggregating $96,000,000. This, then, is 
 a still better price than twenty cents, from the monopolists' 
 point of view. Let us suppose that at thirty cents 300,000,- 
 000 pounds will be taken. The profit at this price would 
 amount to only $87,000,000. The price, accordingly, is too 
 high; and the best price for the monopolist lies between 
 twenty-five and thirty cents. 
 
 Of course this would be an exorbitant price; and far 
 more extortionate than any existing monopoly price. But 
 given the conditions — a monopoly of salt — -extortionate 
 prices could be collected. One must have salt ; he must have 
 a certain amount of it. There is nothing in the world that 
 can be substituted for it. And even if the price were exor- 
 bitant, it would form no very large item in any one's expen- 
 diture. No one would leave the country to escape the mo- 
 nopoly. 
 
INTRODUCTORY ECONOMICS 57 
 
 Let us suppose, now, that a monopoly has gained control 
 of the entire supply of beef in the United States. Perhaps 
 the cost price at which beef could be placed on the market 
 is ten cents a pound. With beef at this price, the American 
 people might conceivably eat loo pounds per capita — 8,000,- 
 000,000 pounds in round numbers. At eleven cents, some of 
 the poorest people would cease eating beef and use mutton 
 or pork instead, or use less meat of any kind. Perhaps the 
 amount consumed would fall to 7,000,000,000 pounds. That 
 would give the beef monopoly a princely income — $70,000,- 
 000. At twelve cents the amount consumed might fall to 
 6,000,000,000 pounds; but this would yield a net profit of 
 $120,000,000; and if the amount at thirteen cents fell to 
 5,000,000,000 pounds, the profit would yet amount to $150,- 
 000,000. Fourteen cents and 4,000,000,000 pounds would 
 be still better for the monopoly — $160,000,000. But fifteen 
 cents and 3,000,000,000 would be a step backward, for the 
 profit would be only $150,000,000. Fourteen cents, then, is 
 the most that the monopoly could wisely charge. 
 
 Of course, if the demand did not shrink so rapidly as I 
 have assumed, the maximum price could safely be placed at 
 a higher figure. If the shrinkage were more rapid than I 
 have assumed, fourteen cents would be too high. 
 
 If it is the intention of the monopolist simply to ex- 
 ploit the beef market for one year — to corner the present 
 supply, make the most out of it, and then retire to live on his 
 plunder — he may find that at fourteen cents there will be no 
 greater shrinkage of demand than has been assumed in the 
 example, and this will then be the best price for him to set. 
 Most persons who are accustomed to this article of diet will 
 continue to buy it even at the higher price. But in a year more 
 and more of them will form other habits. A corner in beef 
 organized in the following year might not be able to charge 
 more than twelve cents without diminishing total net profit ; 
 and in the third year a corner might not be able to charge 
 more than eleven cents. Accordingly, a monopolist who 
 
58 INTRODUCTORY ECONOMICS 
 
 does not mean to retire from business must generally avoid 
 charging a price that would give the highest possible returns 
 for one year. He must fix prices in such a way as to keep 
 the bulk of his custom from year to year. And this is 
 one reason why modern monopolists are less extortionate 
 than the ancient and mediaeval "engrossers" of the neces- 
 saries of life. As a rule, the modern monopolist hopes for 
 steadily increasing profits from a growing business ; he there- 
 fore cultivates his clientele through prices that are moderate. 
 
 If a ring of speculators of immense wealth should buy 
 up the entire American cotton crop, they could fix the price 
 of cotton at twice the normal price, and yet sell most of it. 
 Cotton fabrics would advance in price, but not proportion- 
 ately, for many persons would go without cotton cloth rather 
 than pay unreasonably high prices. The profits of cotton 
 manufacturers would fall ; wages of cotton operatives would 
 be reduced. The cotton manufacture would decline; many 
 cotton operatives would go into other employments. Cotton 
 production in Egypt, India, and Australia would be stimu- 
 lated. It would take more than a year, however, for such 
 adjustments to take place. In the meantime the speculators 
 would have sold their cotton at high prices, and reaped their 
 extortionate profits. The injury occasioned by the changes 
 in cotton manufacture would fall upon the producers of the 
 next American cotton crop. 
 
 If a combination of capitalists were to secure possession 
 of the entire business of petroleum refining, it would be no 
 less easy for them to obtain exorbitant profits for one year. 
 But the decline in consumption that would follow, when 
 time had been given the people to provide themselves with 
 other sources of light and power, would seriously impair the 
 future profits of the petroleum monopoly. Now, no profit, 
 however exorbitant, on a single year's sales, is to be com- 
 pared with comfortably high profits for an indefinite series 
 of years. Great fortunes are to be obtained through the 
 permanent monopolization of the means of producing a cer- 
 
INTRODUCTORY ECONOMICS 59 
 
 tain commodity, rather than through cornering the visible 
 supply and exacting excessive prices, without regard to the 
 effect of the policy on future sales. For this reason mo- 
 nopolies of the permanent kind are continually increasing in 
 number and importance, while it is only rarely that a tem- 
 porary monopoly is successfully carried through. 
 
 Of course there are some classes of consumers who will 
 pay increased prices without a murmur, while other classes 
 will not only feel greatly aggrieved, but will even refuse to 
 buy, when prices are appreciably increased. To the rich it 
 makes little difference whether beef is high or low. If the 
 monopoly can array its customers in groups^ according to 
 their readiness to pay high prices, it can grade its prices ac- 
 cordingly. The classes that will endure only a slight in- 
 crease in price are given prices so moderate that they con- 
 tinue to buy, while the classes that are less apt to complain 
 over an increase are forced to pay prices that yield a higher 
 profit. This would be much better for the monopoly than 
 to fix an average price which would drive away the former 
 classes, and not exploit the latter to the highest possible 
 degree. 
 
 How then may a monopoly make such a division of its 
 customers into classes according to their profit-yielding ca- 
 pacity? One way consists in different prices for different 
 localities. If there is greater per capita wealth in Califor- 
 nia than in North Dakota, a monopoly would charge higher 
 prices in the former than in the latter State, even allowing 
 for all costs of transportation. Suppose that the cost of 
 production of beef for North Dakota is ten cents and the 
 cost of transportation practically nothing; the cost of pro- 
 duction of beef for California we may assume is the same, 
 and the cost of shipping two cents a pound. The beef may 
 be sold in Dakota for eleven cents and for fifteen in Califor- 
 nia — giving a net profit of one cent in the former State and 
 three in the latter. Of course, the difference could be as 
 great as this only in case shipping beef in small quantities is 
 
60 INTRODUCTORY ECONOMICS 
 
 expensive; otherwise outsiders would buy beef in Dakota 
 at eleven cents, ship it to California, and make a good profit. 
 And here we have one limitation upon a monopoly's power 
 to vary in its charges for different localities. The different 
 cannot permanently remain at a figure which is greater than 
 the sum an outsider would have to pay in transporting the 
 monopoly's goods from the point where they are cheap to the 
 point where they are dear. 
 
 In the case of many goods, however, different qualities 
 are sold to different classes of customers. The choicest cuts 
 of meat go to one set of consumers, and in the remaining cuts, 
 in order of toughness, to the various sets of consumers who 
 have less to spend. Now the consumers of the cheapest beef 
 may stand a slight increase in price before substituting some- 
 thing else for beef; while the consumers of the best quality 
 may see the price double before substituting even a cheaper 
 grade. The far-sighted monopolist, then, instead of in- 
 creasing the prices of all grades uniformly, will so distribute 
 the increase of price as to burden each class of customers 
 as much as they will bear without withdrawing custom. 
 
 In some cases where no real differences in quality exist, 
 the consumer is made to believe that there are such differ- 
 ences. Some years ago — and perhaps to-day — there were 
 several grades of salt in the market, selling at different 
 prices. The manufacturer who produced them all has ad- 
 mitted that they were all exactly the same. The classes who 
 could afford to pay high prices for salt bought the grade 
 that was alleged to be the best; those who could pay less 
 bought cheaper grades. Thus the manufacturer, who en- 
 joyed a limited monopoly, was able to make each class of 
 customers pay according to ability. It is easy to see how 
 far this principle might be carried in the case of such articles 
 as soap, chocolate, canned goods.* It is a wise man who 
 
 * Some excellent examples of this kind of juggling with the con- 
 sumer's desire for good qualities are to be found in Professor Ely's 
 Monopolies and Trusts, 
 
INTRODUCTORY ECONOMICS 6l 
 
 knows what ingredients go into these commodities; and if 
 the manufacturer, who must know, says that one is purer or 
 more choice than another, what can you or I do but accept 
 his statement and pay the higher price for the so-called better 
 quality ? 
 
 It must already be sufficiently evident that the monopo- 
 list who wishes to get the very highest possible profit has a 
 very complicated problem, even in the case of goods ready 
 for consumption. In the case of goods that may also serve 
 as means for further production, the problem is still more 
 complicated. Let us take as an example anthracite coal. 
 Part of the supply is used to heat dwellings and other build- 
 ings ; part of it is used to provide power for manufacturing. 
 Suppose now that in New York City, where smokeless fuel 
 is required by public authority, and where it would be some- 
 what difficult to find a substitute for anthracite, the price is 
 forced up to $io a ton. The very poor might prefer to 
 freeze rather than pay the price; but the great majority of 
 the inhabitants of New York would continue to buy anthra- 
 cite much as before. 
 
 Now in all the great cities of the North Atlantic sea- 
 board anthracite is extensively used in manufacturing oper- 
 ations. If the price goes up to $io — almost double the ordi- 
 nary price — many manufacturers will substitute coke or 
 bituminous coal. If these are not to be had, factory after 
 factory closes down, since manufacturers in this section have 
 to sell their goods in competition with manufacturers in the 
 Middle West, where bituminous coal is cheap. The great 
 demand for anthracite for manufacturing can remain only if 
 the price remains moderate. Exorbitant prices for this fuel, 
 if made universal, would result in limiting the consumption 
 of it from year to year. 
 
 Why might not very high prices be charged in New 
 York City, and more reasonable ones in the factory towns ? 
 Of course, if the price were much higher in New York than 
 in Newark or Paterson, enterprising teamsters would cart 
 
62 INTRODUCTORY ECONOMICS 
 
 coal from those cities into New York. The difference in 
 price between different places cannot greatly exceed cost of 
 transportation. 
 
 The profit of our imaginary anthracite monopoly then 
 is bound up with the welfare of the manufacturing commu- 
 nity. In like manner, a railway may be the only means 
 of carrying goods to and from a given agricultural region ; 
 but if it charges very high rates on what it carries, the 
 region is soon impoverished; lands go out of cultivation; 
 towns decay; and their inhabitants move to districts where 
 better transportation conditions prevail. And with the 
 ruin of local business would come the ruin of the railway. 
 So narrowly are the charges of railways limited — even 
 though they possess a monopoly — ^that in perhaps a ma- 
 jority of cases they cannot charge more than will cover 
 expenses and pay a reasonable return on the capital sunk in 
 the road. 
 
 To sum up then, even an absolute monopoly is limited 
 in its power to extort money from the public. The more 
 elastic the demand for a commodity — i. e., the more readily 
 demand increases with a fall in price, or diminishes with a 
 rise in price — the more moderate will be the price which 
 yields the highest return to the monopolist. And the more 
 permanent the plans of the monopolist, the less does he seek 
 the maximum profit for a single year. 
 
 Now, the demand for most commodities is growing 
 more and more elastic. We have more wants to satisfy than 
 our ancestors had; and if a monopoly gets control of the 
 means of satisfying one want, and seeks to extort money 
 from us by this means, we may leave this want unsatisfied 
 and turn our attention to some other one which demands 
 satisfaction only less insistently, and which we can gratify 
 without paying tribute to a monopoly. At the same time, the 
 monopolists are growing more and more far-sighted; they 
 refuse to sacrifice steady profits through years to the desire 
 for a huge profit for a brief time. Thus economic forces 
 
INTRODUCTORY ECONOMICS 63 
 
 are at work limiting more and more the possibilities of vast 
 monopoly profits. 
 
 Yet the prices of goods controlled by monopolies would 
 be considerably higher than competitive prices were the 
 monopolies really absolute. There are, however, few even 
 of the most powerful trusts that have gained anything like 
 complete control in their fields. There remain competitors, 
 often very active ones, ready to expand their output when- 
 ever prices become very high. What an intelligent monopo- 
 list will aim to do, therefore, is to fix prices high enough to 
 make a good profit, but not so high as to give a great induce- 
 ment to new producers to enter the field, nor so high as 
 seriously to limit his market in the long run. 
 
 While monopoly prices tend to remain above cost of 
 production, yet there is always some relation between the cost 
 of production and the price. There may not be an excessive 
 difiference between the two. To arrive at a more thorough- 
 going explanation of price, therefore, it will be necessary to 
 analyze further the costs of production and to study the 
 forces which fix the rates paid for the goods and services 
 that enter into the work of production. 
 
CHAPTER V 
 The Cost of Production 
 
 The preceding chapters have shown that the costs of 
 production play an exceedingly important part in determin- 
 ing the values of goods. Commodities produced under com- 
 petitive conditions tend to sell at cost ; commodities the pro- 
 duction of which is controlled by monopolies sell above cost, 
 as a rule ; but at prices which usually stand in a close relation 
 to the costs of production. Accordingly, to carry our 
 study of values a step farther, we must enter upon a study of 
 the laws governing the costs of production. 
 
 At the outset it is worth while to bear in mind that what 
 is "cost of production" to one man or class of men is "in- 
 come" to another man or class of men. To the employing 
 producer who conducts an independent enterprise (and 
 whom we shall therefore call the enterpriser) wages are sim- 
 ply a part of the cost of production. To the workman wages 
 are earnings, income. The enterpriser counts in his outlay 
 or costs the interest on the capital invested in his plant. To 
 the capitalist this same item is income. The price of the coal 
 which is consumed in providing power represents nothing 
 but an expense to the enterpriser; but to the coal mine op- 
 erator the price of the coal represents gross income. A 
 closer examination of this gross income shows that it con- 
 tains a net income to the coal mine operator; wages of 
 labor employed in mining; interest on capital invested in 
 the business, and certain other items — a sum for the replace- 
 ment of machinery and other apparatus worn out, taxes, etc. 
 — which further analysis will show to be in part or wholly 
 incomes to some one. 
 
 But we are not concerned in this chapter with incomes 
 as such; our immediate concern is with cost of production, 
 
INTRODUCTORY ECONOMICS 65 
 
 Our point of view will be that of the enterpriser, whom we 
 shall assume to be acting frankly with a view to his own 
 interest, paying no higher wages or interest than he is com- 
 pelled to pay. 
 
 The materials that enter into production are commodi- 
 ties, and their market value and normal value are determined 
 much as the market and normal values of the commodities 
 fit for immediate consumption. We may examine briefly 
 the process by which cotton yarn, the material of the cotton 
 weaving industry, is valued. A multitude of weavers desire 
 to buy it; some of them would pay a price of lox per hun- 
 dred pounds rather than go without it; others would pay 
 only 5x per hundred pounds, A multitude of sellers stand 
 ready to furnish cotton yarn; some may be willing to sell 
 at 5x rather than not sell at all ; others may be willing to sell 
 only if the price is lox. What price will actually be set? 
 Just as in the case of commodities for direct use, the market 
 price will be fixed at a point where demand and supply are 
 equal — that is, where the amount offered at a given price is 
 exactly equal to the amount that will be taken at that price. 
 
 But the price fixed at any moment by demand and sup- 
 ply may exceed the cost of producing the yarn, even in the 
 mills of those enterprisers who produce at the greatest cost. 
 In such case the output of cotton yarn will increase; the 
 price will come down, until it just covers cost of production 
 to those who are producing at the greatest disadvantage. If 
 the price were to fall still lower, these producers would have 
 to quit the business ; and this would reduce supply and thus 
 of itself tend to force up the price of cotton yarn. But the 
 same price may be high enough to give excellent profits to 
 the more efficient producers; these continue to extend their 
 business, and the increase in supply from this source may be 
 more than an offset for the decrease resulting from the clos- 
 ing of the less efficient mills. Thus the price gravitates 
 steadily downward, resting momentarily at cost of produc- 
 tion to the least efficient producers ; then sinking to the cost 
 
66 INTRODUCTORY ECONOMICS - 
 
 level of slightly more efficient producers; finally resting at 
 the level of cost of the most efficient producers of all. Thus 
 it appears that we need no new law of valuation to explain 
 the action of sellers of cotton yarn. They act just as they 
 would if they were selling a commodity ready for con- 
 sumption. 
 
 Do the buyers of cotton yarn act just as do the buyers 
 of commodities ready for consumption? Not quite. One 
 consumer may get ten times as much satisfaction out of a 
 barrel of apples as another. He may for that reason be will- 
 ing to pay ten times as high a price. But one buyer of cotton 
 yarn probably turns out just the same grade of cloth as an- 
 other, and sells it for the same price. As one cloth manufac- 
 turer thus sells at the same price as another, and buys mate- 
 rial at the same price, why should one be able to bid a higher 
 price for the material than another? It must be because 
 other elements in the cost of production of cloth — fuel, labor, 
 the use of capital — cost him less, or because he has greater 
 skill in utilizing material or in organizing his labor force. 
 We see, then, that there can hardly be such wide differences 
 in the prices which different manufacturers of cloth can 
 afford to pay for cotton yarn as in the prices different con- 
 sumers can afford to pay for apples. 
 
 Now let us see what would happen if, through a gen- 
 eral increase in the demand for cotton fabrics, the price of 
 cotton cloth should everywhere rise. All the manufactur- 
 ers of cloth would at first enjoy a profit. To increase that 
 profit each manufacturer would try to extend his business 
 somewhat, and this would tend to bring down the price of 
 cloth. But in order to extend the cotton cloth manufacture, 
 more yarn must be had ; and our hypothesis did not include 
 a simultaneous expansion of the spinning industry. The cloth 
 manufacturers would have to bid against each other for the 
 existing supply of yarn; the price of the yam would rise, 
 until cloth again sold at cost. We see, then, that it is not 
 merely because of competition in the sale of finished product3 
 
INTRODUCTORY ECONOMICS 6/ 
 
 that such products sell at cost ; it is also because of competi- 
 tion in the purchase of the elements of production. If the 
 price of cloth is for a time much above cost the expansion 
 of the cloth manufacture tends to lower the price of cloth 
 and raise the price of yarn and other elements in cost, until 
 the price of cloth and its cost are again nearly equal. 
 
 Looking now at the manufacture of yarn, we see that 
 such an increase in the price as we have assumed will give 
 high profits throughout the industry, and consequently will 
 give rise to an attempt on the part of each manufacturer of 
 yarn to extend his output. But this he can do only by in- 
 creasing his consumption of raw cotton. As the business 
 expands, the price of yarn tends downward, and that of raw 
 cotton upward, until no exceptional profits are left to the 
 yarn manufacturers as a class. 
 
 Such an increase in the price of raw cotton means high 
 returns to the growers of cotton. These, we may assume, 
 had been selling their cotton at a price which gave a fair 
 equivalent for the cost of labor, of the use of agricultural 
 implements, of fertilizers and of the use of the land. The 
 price now exceeds these costs. If this state of affairs con- 
 tinues, more men will desire to grow cotton, either buying 
 cotton lands or renting them. As such lands, of the best 
 quality, are not unlimited, the rental and the price of land 
 will go up. Here again the cost of production rises with the 
 price of the product. Part of the increase in cost of produc- 
 tion may assume the form of increase in the price of fertil- 
 izers ; and this part we could trace still farther if we desired. 
 The part which represents increase in rental of land can be 
 traced no farther, for there is no cost of production of land. 
 
 In the example given above it has been assumed that 
 labor cost and the cost of the use of capital remain un- 
 changed, in spite of the expansion of the cotton industry. 
 This assumption may or may not be justifiable. An increase 
 in the number of laborers and an increase in the amount of 
 capital invested in buildings and machines, or used in the 
 
68 INTRODUCTORY ECONOMICS 
 
 purchase of materials and other suppHes, would necessarily 
 attend any expansion of the industry. To secure the addi- 
 tional labor and capital, the manufacturers of cotton cloth 
 may be compelled to offer slightly higher wages and interest 
 than they formerly paid. But the amount of capital to be 
 had at the prevailing rate is enormous ; and the slight in- 
 crease in demand from the cotton industry would hardly be 
 able to exert a perceptible influence in raising the rate. The 
 same thing would be true of labor. To attract more laborers 
 to the cotton industry, it would be necessary to offer only 
 a slight increase in wages, as it is fair to assume that before 
 the changes in the cotton industry occurred, wages in that 
 industry were roughly equal to those in other textile 
 industries, or even to those in manufacturing industries in 
 general, allowance made for differences in the skill required 
 and in the relative agreeableness of occupation. In such 
 case, labor cost may be regarded as fixed, or more correctly, 
 as rising and falling with the general trend of social pros- 
 perity, not with the expansion or decline of a particular 
 industry. 
 
 It sometimes happens, however, that a more intimate re- 
 lation exists between labor cost and the fortunes of a single 
 industry. This is the case where for some reason a definite 
 labor force is dependent for employment upon one industry. 
 Here we see a rise in the price of the finished product fol- 
 lowed by a rise in wages. Other elements in cost may also 
 rise, and take a share of the increased price, or they may re- 
 main relatively stationary. 
 
 Let us imagine that a new branch of production arises — 
 say, the manufacture of wrapping paper from corn-stalks. 
 A single factory is erected, and let us assume that it will be 
 operated in the winter months only. Of course the factory 
 will have to be located in the country, the source of raw mate- 
 rial. And in the country there is a great deal of labor that is 
 hardly employed at all in the winter months. At what rate 
 will our manufacturer be able to hire this labor ? 
 
INTRODUCTORY ECONOMICS 69 
 
 It is clear that the cost of living will have nothing 
 to do with the wages fixed. Country laborers are paid 
 enough in the open months of the year to carry them through 
 the winter. What they earn in the paper factory is a net addi- 
 tion to their annual income. They can work for nothing, and 
 be no poorer than they were before the factory was erected. 
 The work in the factory may be pleasant rather than other- 
 wise. Nevertheless, it is safe to assume that some rate of 
 wages must be paid. Perhaps a wage of fifty cents a day 
 will provide the requisite amount of labor. If so, that is all 
 the manufacturer will pay. 
 
 Now, if the manufacturer gets his labor at such a low 
 rate, he may make extraordinarily high profits. In this case 
 other enterprisers are likely to go into the business. If the 
 industry assumes extensive proportions, it soon drains off 
 the supply of labor that can be had for fifty cents a day. 
 Further expansion becomes possible only through an in- 
 crease in wages which will tempt into the industry workmen 
 who regard their ease as worth more than fifty cents a day, 
 or who are earning at least that wage in caring for live-stock, 
 etc. But profits may still be high, and new enterprisers may 
 be continually entering the business. To secure laborers at 
 all, they are compelled to offer wages slightly higher than 
 those paid by the enterprisers whose business is already es- 
 tablished. The latter, in order to retain their laborers, are 
 compelled to meet the bids of their new competitors. Thus 
 wages for this kind of work go up, until all the enterprisers 
 are fully supplied with workmen. 
 
 Any further expansion will be followed by a similar 
 increase in competition among employers of labor, and a rise 
 in the rate of wages will be necessary in order to induce less 
 industrious workers, or workers having some alternative em- 
 ployment, to enter the factories. But each expansion of the 
 industry means an increased product thrown on the market, 
 and, other things equal, a lower price for it. What with the 
 rising of wages and the falling price of paper, it seems clear 
 
70 INTRODUCTORY ECONOMICS 
 
 enough that the profits of the enterpriser must be dedining. 
 Possibly the expansion will continue until wages have risen 
 to $2. All will depend upon the amount of paper that will 
 be taken at a given price, and the amount of labor available. 
 
 From this example it appears that wages cost cannot 
 always be regarded as a fixed element in the enterpriser's 
 calculations. The same competition among enterprisers that 
 forces prices down forces wages up. Of course if the enter- 
 prisers were to combine, agreeing upon a harmonious line 
 of action, they might hold wages down, through limiting 
 the demand for labor, just as they may keep prices of fin- 
 ished products up by limiting the supply placed on the mar- 
 ket. And here it may not be amiss to remark upon a fre- 
 quent defense of combinations and monopoly. "Competition 
 in the sale of goods so reduces prices that it is impossible 
 to pay fair wages to the workman." As a fact, increasing 
 competition — the appearance of new enterprisers — is likely 
 to force wages up while forcing prices down. A monopoly, 
 limiting output and limiting demand for labor, may be able 
 to pay high wages to its employees. But will it do so ? 
 
 We may now take another example, which will illus- 
 trate some further points in the law^ of wages cost. Let us 
 assume that there is a city which has been devoted almost 
 exclusively to the manufacture of iron and steel goods. A 
 cotton manufacturer, visiting the city — Ironton, let us call 
 it — shrewdly concludes that the iron workers must have a 
 number of sisters and daughters and other female relatives, 
 who are practically wasting their time, and who would be 
 glad to earn a small income by cotton spinning and weaving. 
 Accordingly he erects a mill at Ironton. Very likely he will 
 get all the labor he cares for at twenty-five cents a day, while 
 his competitors, in the established centers of the trade, are 
 paying a dollar a day for the same grade of labor. 
 
 It is true that other elements in cost may be greater in 
 Ironton than in other centers. It may cost more to bring 
 the raw material to that place, and to ship away the finished 
 
INTRODUCTORY ECONOMICS Jl 
 
 product. Fuel may be more expensive; and the wages of 
 the mechanics who erect the mills and set the machinery in 
 working order may be higher. The salaries that must be 
 paid to foremen and overseers may also be higher than in the 
 older centers. But in spite of all this, the cost of producing 
 a given grade of cottons at Ironton, with wages at twenty- 
 five cents a day, may be twenty per cent, lower than the cost 
 of producing the same grade in the older centers, while the 
 selling price may be just the same. Of course this will give 
 the enterpriser at Ironton large profits. Before long other 
 enterprisers will begin to wonder why a cotton mill has been 
 set up at Ironton ; and finding, upon investigation, what ad- 
 vantages that city offers in the way of low costs, they too 
 begin to erect mills there. 
 
 The effect of the appearance of these new manufacturers 
 at Ironton is to increase the demand for cheap labor. Pos- 
 sibly there are so many women and girls who are ready to 
 work for "pin money" that the new mills can be plentifully 
 supplied with labor at the same price as has been paid by the 
 enterpriser first in the field. But it cannot be a great while 
 before the supply of twenty-five-cent labor falls short of the 
 demand; enterprisers erecting new mills will have to of¥er 
 a little higher wages to entice workers away from the older 
 mills ; and these wull have to raise wages to the rate offered 
 by the newcomers. The competition will continue until 
 wages are so high as to induce a new set of workers to enter 
 the mills. Costs at Ironton may still be abnormally low 
 after wages have risen, say, to fifty cents a day. In that case 
 the cotton industry at Ironton will go on expanding, until 
 at last aggregate costs are as great at Ironton as in the older 
 centers of the trade. This does not mean that wages will be 
 just the same. They may be seventy-five cents in Ironton 
 and $1 in the older centers. 
 
 If coal had been cheaper, mechanics' services cheaper 
 and more efficient, transportation facilities better, at Iron- 
 ton than in the older centers of the cotton industry, the ej^- 
 
7^ INTRODUCTORY ECONOMICS 
 
 pansion of the industry at Ironton would not have stopped 
 when wages had reached the level prevailing in older centers. 
 With wages at that level total costs would still have been 
 less in Ironton than in the older centers ; and so the industry 
 would have continued to expand, until the rise in wages com- 
 pletely offset the other advantages in favor of production at 
 Ironton. 
 
 From this example we see that the rate of wages which 
 competition of manufacturers tends to fix cannot be uni- 
 form for the different localities where a given commodity 
 is produced. Where other costs are relatively low, competi- 
 tion will force wages to a relatively high figure, and vice 
 versa. 
 
 Now let us suppose that, while the cotton industry in 
 Ironton is developing, woolen manufacturers decide to erect 
 mills in that place. They know that the cost of labor in their 
 factories must bear a close relation to cost of labor in the 
 cotton industry. If they could make the work in the woolen 
 mills easier than work in the cotton mills, they might count 
 on getting labor at a trifle less. On the other hand, if work 
 in the woolen mills were less agreeable than work in the cot- 
 ton mills, wages would have to be slightly higher in the 
 former than in the latter. 
 
 The appearance of the woolen mills would have exactly 
 the same effect upon the wages of the cotton operatives as 
 the appearance of new cotton mills would have. The woolen 
 manufacturers would offer wages sufficiently high to attract 
 workers away from the cotton mills, and the cotton manu- 
 facturers would be forced to raise wages slightly in order 
 to keep their working force intact. Further, this develop- 
 ment in the demand for labor in the textile industries might 
 in the end react upon wages in other industries — even in 
 the iron industry. As soon as wages in the cotton and 
 woolen mills rose above the wages paid certain classes of 
 laborers in the iron works, boys and young men would leave 
 the iron works to learn to operate looms. The resulting 
 
INTRODUCTORY ECONOMICS 73 
 
 scarcity of labor in the iron works would naturally raise 
 wages there. 
 
 If we wish to formulate, provisionally, a law of wages 
 cost, we may say that, at a given time, wages in any industry 
 must be sufficient to prevent workmen from leaving that in- 
 dustry to seek employment in other industries in the vicinity ; 
 and that if competition exists among different producing cen- 
 ters, all supplying the same markets, wages in an industry in 
 one center will rise or fall until, together with other costs of 
 production, they equal wages plus other costs of production 
 in the other centers where the industry is carried on. To give 
 a numerical example, if in city A one hundred yards of 
 cotton cloth cost $io, of which $8 consists of cost of ma- 
 terials, fuel, interest on capital, etc., and $2, of wages ; and 
 if in city B, which obtains the same price for cloth at the 
 mill, all other costs amount to only $7, wages in B will rise, 
 under competition, until labor cost amounts to $3. 
 
 But may it not happen that an enterpriser is enabled 
 to keep costs of production low by forcing workers in par- 
 ticularly necessitous circumstances to accept a lower rate 
 than is prevailing in the district ? And can he not undersell 
 enterprisers who pay the prevailing rate, and so force the 
 latter to cut wages? Assuredly there are employers who 
 take advantage of the ignorance or poverty of their em- 
 ployees, and pay lower wages than their competitors pay. 
 It is evident, however, that no large business can long be 
 conducted on such a plan. Other employers will in the end 
 entice away workers thus underpaid. And it is evident that 
 the unfair employer will not sell his goods at a lower rate 
 than his competitors, and so force prices down. It is not 
 through producing at low costs, but through increasing one's 
 output, that one forces prices down. The unfair employer 
 will find it difficult enough to keep his present labor force; 
 he will hardly be able constantly to increase it by offering 
 starvation wages. 
 
 May not the cost of labor be increased through the de- 
 
74 INTRODUCTORY ECONOMICS 
 
 mands of labor organizations? This question can only be 
 touched upon here. If there is no organization of labor, 
 and if active competition among employers exists, wages for 
 labor of a given grade of skill will in the end be as high in 
 one industry as in other industries in the same vicinity, 
 allowance being made for agreeableness or disagreeableness 
 of employment. General wages in one industrial center will 
 in the end be what they are in other industrial centers, allow- 
 ance being made for differences in other costs. Now, a 
 trade union can help wages to rise to these natural levels: 
 if it forces them higher, it is likely to destroy the industry 
 of the places under its control. 
 
 We may now consider how far it is true that the price 
 of the use of capital, or interest, remains constant in spite 
 of the expansion of an industry. We may imagine that in 
 a certain district the rate of interest is low. An enterpriser 
 engaged in an industry requiring large investment of capital 
 may find that he can produce more profitably there than in 
 a locality where interest rates are high. Of course this can 
 be the case only if other elements in cost of production — 
 wages, fuel, materials — are not so much higher than in other 
 localities as to balance the advantage of low interest rates. 
 Granting, however, that the low interest rates are not thus 
 offset, the enterpriser will for a time enjoy low aggregate 
 costs, and therefore high profits. But soon competitors ap- 
 pear, who offer a slightly higher rate of interest for the capi- 
 tal offered by local capitalists. Enterprisers in other indus- 
 tries likewise seek to take advantage of the low interest 
 rates, until the rise in interest eats up the margin between 
 selling price and cost of production. 
 
 It must be admitted that this example is more nearly an 
 imaginary one than were the examples employed to illustrate 
 the laws governing wages cost. Why should interest rates be 
 particularly low in one locality ? Is there any reason why a 
 person residing in Boston should loan his capital to Boston 
 business men ? It is no more difficult, practically, to lend it 
 
INTRODUCTORY ECONOMICS 75 
 
 to enterprisers in Pittsburg. For this reason interest rates 
 on capital are pretty well equalized throughout the country. 
 It is easy to find industries migrating to sections where labor 
 is cheap, or where the cost of fuel or of raw material is 
 low. But it is not easy to find an industry migrating to a 
 certain point because interest rates are lower than at other 
 points in the same country. It is less difficult for the capital 
 to migrate than for the industry to do so. 
 
 Not all capital, however, is embodied in forms which 
 permit it to migrate from one industry to another. A part 
 of the capital of the manufacturer consists in the land upon 
 which his mill is erected. A much larger proportion of the 
 capital of a farmer is invested in land. The capital of a 
 railway company consists partly in rolling stock, which grad- 
 ually wears out and must be replaced; it consists partly in 
 right of way, in grades and tunnels, which have perpetual 
 life, as it were. Capital which consists in goods that must 
 be periodically replaced may at the moment of replacement 
 be diverted to other industries. But capital which is em- 
 bodied in permanent goods cannot thus change from one 
 industry to another. 
 
 What will determine the amount that an enterpriser will 
 have to pay for the use of land, or of other forms of durable 
 capital? In the first place, it is clear enough that he will 
 have to pay what any other enterpriser will offer. If, for 
 example, one wishes to rent a field upon which to grow sugar 
 beets, he will have to pay as high a rental as other beet 
 growers in the vicinity pay for equally good land. And this 
 rental will have to be as great as wheat growers in the 
 vicinity pay for the same quality of land used for wheat. 
 
 Beet growers may find, after paying all other costs, 
 that a considerable profit remains in their hands from the 
 sale of their beets. In such case the industry will expand, 
 new enterprisers converting wheat lands to beet culture. 
 The increasing output of beets might conceivably reduce 
 their price; but more probably, since an enormous increase 
 
"J^i INTRODUCTORY ECONOMICS 
 
 in the sugar output of a given locality would yet be a very 
 small addition to the world's sugar supply, the price of beets 
 will remain fairly constant. If no difficulty is experienced 
 in obtaining labor and auxiliary capital the expansion of 
 the industry wull continue until all the lands especially well 
 fitted for beet growing are given over to that branch of 
 agriculture. If the beet growers still have a surplus profit, 
 they will compete among themselves for land, each desiring 
 to increase his acreage. Higher rents will be offered, until 
 the extra profits of the enterpriser are absorbed by this 
 increasing element in cost. 
 
 Of course if the labor supply is limited, relatively to 
 the demand for it in beet culture, the expansion of that form 
 of agriculture will gradually force wages up. Possibly the 
 rise in wages will swallow up the profits of the enterpriser 
 before all the ground that is well adapted to beet culture has 
 been taken. In that case the expansion of the industry will 
 cease without occasioning a perceptible rise in rents. 
 
 :We may now give our attention to another element in 
 the cost of production of many commodities — ^the price paid 
 for crude materials as they exist in nature before any change 
 has been wrought in them by industry. To illustrate the 
 laws governing the value of these crude materials, we need 
 to go back to an early stage, when they existed in quantities 
 far in excess of any need for them. The cost of bricks under 
 such conditions would contain no element representing clay 
 in the bank or trees on the hillside. It would consist solely 
 in wages of labor employed in cutting and hauling the wood, 
 in digging and mixing the clay and shaping the bricks, and 
 in interest on capital invested in kilns and drying sheds, etc. 
 Bricks might at a given time sell at a price in excess of these 
 costs; but this would cause new brick works to be erected 
 and the price of bricks would fall, or the rate of wages would 
 rise, until bricks were selling at a price merely covering cost. 
 
 As population increased the demand for wood for brick- 
 making would increase, as would also the demand for wood 
 
INTRODUCTORY ECONOMICS "J*] 
 
 for other purposes. In time the proprietor of woodlands 
 would see an end of the supply within easy distances, and 
 would demand a price for wood in the tree. Here, then, 
 would be a new element in the cost of bricks. Further 
 growth of population might make the supplies of suitable 
 clay seem insufficient to meet all demands, present and pros- 
 pective. The owner of clay deposits could therefore demand 
 a royalty for every cubic yard of this material. If the de- 
 mand for bricks continued to increase, the price of wood 
 and of clay would steadily rise. As soon as labor became 
 so abundant that the brick-making industry could readily 
 expand without materially forcing up the rate of wages, a 
 constantly increasing proportion of the selling price of the 
 bricks would be absorbed by the cost of the raw material. 
 
 In an earlier chapter it was shown that price is continu- 
 ally tending toward cost of production. We now see that in 
 a sense cost of production itself is influenced by the price of 
 finished products, a high price increasing the cost of certain 
 elements in production, if not of all. It appears then as if 
 we had been reasoning in a circle. Cost of production de- 
 termines price; price determines cost of production. 
 
 If we take a very broad view, we see that the value of 
 anything which serves as a means of further production de- 
 pends in large measure upon the price of all the products 
 into which it enters. The value of labor thus depends largely 
 upon the price of the products which it helps to create. All 
 the other elements that cooperate with labor in production 
 derive their values in a similar way from the finished prod- 
 ucts. The price of all the elements in production, taken to- 
 gether, tends to equal the prices of all products. Thus we may 
 properly say that cost is constantly adjusting itself to price. 
 
 If, however, we take a narrower view, confining our 
 attention to a single industry, the costs of production may 
 appear to be unvarying. If the price of cotton fabrics is 
 high, competition in the end forces it down, instead of forc- 
 ing wages and interest up. This is because the value of 
 
7^ INTRODUCTORY ECONOMICS 
 
 labor and of the use of capital is derived not from the price 
 of cotton fabrics alone, but from the prices of all commodi- 
 ties into which these factors enter. And the cotton industry 
 is not great enough to cause a perceptible rise in the wages 
 of all labor and in the interest on all capital. So far as this 
 industry alone is concerned, or any other single industry, 
 price adjusts itself to cost. If, however, a certain element in 
 cost is confined to a single industry, we see before our eyes 
 the cost of a commodity adjusting itself to the price of a 
 commodity, just as in the whole field of industry all costs are 
 adjusting themselves to all prices. The classical economists 
 were puzzled by these instances of costs that rise or fall with 
 the price of particular commodities. As they did not reaHze 
 that all costs, viewed broadly, thus rise or fall, they con- 
 cluded that such shifting costs were not costs at all. 
 
 It has been indicated that if, in one out of several cen- 
 ters producing the same commodity, other elements in cost 
 are relatively low, the cost of labor will be relatively high, 
 and vice versa. In a district where the interest on capital 
 and the cost of fuel are abnormally high, a manufacturing 
 industry may often be carried on successfully in competition 
 with other districts where capital is to be had at a low rate 
 of interest and where fuel is cheap. But wages in the first 
 district will probably have to be low to offset the high cost 
 of the other elements. If any district enjoys the advantages 
 of very cheap coal and low interest rates, wages in a branch 
 of manufacture carried on there will rise to offset these 
 advantages. 
 
 We see then that the price of one element in production 
 must bear some relation to that of the other elements. The 
 rate of wages in special industries in particular districts is 
 affected in some measure by the rate of interest in the same 
 district. Whether the general rate of wages is similarly 
 affected by the general rate of interest, will be a question for 
 consideration in later chapters, when we shall seek to ascer- 
 tain the laws governing these forms of income. 
 
CHAPTER VI 
 The Law of Diminishing Returns 
 
 In the last chapter we saw that one of the forces limit- 
 ing the expansion of an industry is the tendency of costs to 
 rise to the selling price of the product of the industry. The 
 American cotton spinning industry may be very profitable 
 this year — that is, the margin between the selling price of 
 cotton yarn and the cost of producing it may be wide. But 
 before long an expansion of the industry will take place; 
 increasing demands upon the existing supply of skilled 
 labor, of raw cotton, and of other factors in the production 
 of cotton yarn will force the expenses of the enterprisers 
 engaged in the industry to a higher level. 
 
 We saw further that not all elements in cost show the 
 same tendency to increase. In cotton spinning, part of the 
 labor force is skilled, part of it unskilled. If the industry 
 were to expand, say, by fifty per cent., a great strain would 
 be put upon the supply of labor specially trained for cotton 
 spinning. No particular strain would be felt by the supply 
 of unskilled labor, for outside of the spinning industry 
 enormous quantities of unskilled labor are to be had. The 
 skilled labor might therefore for a time enjoy a large in- 
 crease in wages, while the wages of unskilled labor would 
 scarcely be affected at all. 
 
 Similarly, such an expansion of the industry would 
 represent a great strain upon the supply of raw cotton, 
 which for a year could not be increased at all. Quite possi- 
 bly the price of raw cotton would be doubled. The same 
 expansion of the cotton spinning industry would result in 
 an increased demand for coal for power. But the use of 
 coal is so universal, and the volume of its consumption so 
 vast, that the increased demand from the cotton industry 
 
80 INTRODUCTORY ECONOMICS 
 
 would be a negligible factor in influencing its price. Coal 
 would probably not rise perceptibly. 
 
 For a somewhat different reason, the output of a single 
 enterpriser can often be increased only at increasing cost. 
 It is true that one enterpriser out of a multitude cannot 
 force up the wages of labor against himself, as a whole in- 
 dustry can do. Nor can he exert any perceptible influence 
 upon the price of raw material and other supplies. But 
 there are usually certain factors entering into his produc- 
 tion that, so far as he is concerned, are either limited abso- 
 lutely, or can be increased only at a disproportionately 
 heavy outlay. In any agricultural section you may find an 
 enterprising farmer forced to limit his operations to a single 
 hundred acres. He could hire as many men as he pleased at 
 $25 a month, the price he pays his one "hired hand." He 
 could buy additional teams and additional machinery at no 
 advance over the price of those he already has. Why 
 should he not buy or rent additional land, and carry on a 
 large scale business? Because all the adjoining lands are 
 occupied by men who prefer to till them with their own 
 labor and who would consequently demand a very high 
 rental, if they consented to give up their land at all. Our 
 farmer might be compelled to go a distance of three or four 
 miles to get additional land at reasonable rates. Of course 
 land could not be advantageously managed from such a dis- 
 tance. Hence he is forced to content himself with his own 
 one hundred acres. 
 
 In almost any town you may find a bright and capable 
 young grocer, conducting the pettiest corner grocery busi- 
 ness. The possibilities of trade may be numerous; a store 
 ten times as large might easily be supported by the potential 
 custom. Why then do we find a little store? The young 
 merchant might easily rent larger premises, without more 
 than a proportionate increase in rent. He might hire as 
 many clerks and delivery boys as he wished, without pay- 
 ing a rate of wages in excess of the rate he pays to the 
 
INTRODUCTORY ECONOMICS 8l 
 
 one or two already in his employ. What he especially 
 lacks is capital. Perhaps he has $5,000 of his own. The cost 
 which the use of this capital represents is merely the interest 
 he could get in a savings bank — say, four per cent. With 
 $5,000 capital of his own, he may be able to borrow another 
 $5,000 at six per cent. For an additional $5,000 he would 
 probably have to pay ten per cent., as the security he has to 
 offer is not so good. It is unlikely that he can borrow more 
 capital, no matter how high a rate of interest he may be will- 
 ing to pay. The maximum business he can conduct, then, is 
 one for which a capital of $15,000 will suffice. 
 
 A small stream, flowing between high, rocky banks, 
 may offer an excellent opportunity for the establishment of 
 a factory, to be operated by water-power. Let us suppose 
 that a manufacturer, acquainted with the advantages of the 
 location, decides to erect a mill. He may be able to com- 
 mand practically unlimited capital. Whether his mill will 
 require one hundred hands or one thousand will make no 
 difference in the rate of wages he will have to pay. Raw 
 material can be obtained at least as cheaply in large lots as 
 in small. Plainly, what will determine the size of the factory 
 will be the power to be obtained from the stream. A ten- 
 foot dam will give a certain power; a twenty-foot dam a 
 much greater one, and every additional foot in height of 
 dam means additional power. But there is an absolute limit 
 to the height to which the dam may reach, without forcing 
 the stream above its banks and ruining a large amount of 
 property on the lower levels adjacent to it. There may also 
 be limits of expense;, after the dam has reached a height 
 of twenty feet, further addition to its height may imply such 
 a great increase in its length and in the character of the 
 materials required to stand the increased strain that the ad- 
 ditional power is not worth its cost. 
 
 It will not be necessary to multiply instances further. 
 If the student will examine the various businesses with 
 which he is acquainted he will observe that in a large pro- 
 
82 INTRODUCTORY ECONOMICS 
 
 portion of them it is difficult, if not impossible, to duplicate 
 all the elements in production without incurring dispropor- 
 tionate expense. Businesses do increase in spite of this ; but 
 the increase does not take place in a symmetrical fashion. 
 The labor and movable capital may be increased while the 
 land area is left unchanged ; the number of laborers may be 
 increased while the capital remains fixed in amount. Some 
 of the factors in production respond readily to the strain of 
 an expanding business ; others show great resistance to such 
 strain, but yield slightly ; others yield not at all. 
 
 Let us return now to the case of the farmer, confined 
 to his one hundred acres of tillable land. By his own labor 
 and with a single team and the appropriate machinery he 
 may till the whole tract. Fifty acres, we may imagine, are 
 put into wheat, fifty acres into corn. In the time for sowing 
 wheat, a few good days may be followed by a week of rainy 
 weather. Half of the wheat field may be sowed in time to 
 get the benefit of the wet weather ; the other half of the field 
 may have to be left until the ground is dry, and so this part 
 of the crop will lose the advantage of a fair start. Similarly 
 part of the corn planting may be belated, with resultant 
 danger to the crop from early frosts. There may not be 
 enough dry days in the late spring to enable the farmer to 
 keep his cornfield free from weeds. In harvest time, the 
 chances of loss from delays in cutting and stacking the 
 wheat are still greater. Of course these adverse chances 
 may not be realized. The weather may be dry just when it 
 should be; the rains may come just when they are wanted. 
 But experience proves that the weather is not thus happily 
 regulated. One year with another, our farmer will be for- 
 tunate if he gets twelve bushels of wheat and forty bushels 
 of corn per acre. 
 
 Instead of tilling the whole tract with his own labor, 
 the farmer may hire a man to help him. He buys an addi- 
 tional team, plow, harrow, cultivator, etc., practically dupli- 
 cating his stock of machinery as well as his supply of labor. 
 
INTRODUCTORY ECONOMICS 83 
 
 The land can now be much more carefully tilled; it will 
 almost surely yield a greater aggregate return. Will the re- 
 turn be doubled? It would be unreasonable to expect this. 
 More probably, the wheat yield will increase to fifteen 
 bushels ; the corn yield, to fifty bushels. If wheat is worth 
 seventy-five cents a bushel and corn twenty-five, what the 
 farmer will gain from the additional labor and capital will be 
 $112.50 worth of wheat and $125 worth of corn — $237.50 in 
 all. Does it pay to employ the additional laborer? If he is 
 employed for only six months of the year, at $25 per month, 
 we must set $150 against the $237.50 for wages. If the ad- 
 ditional capital amounts to $500, borrowed at the rate of 
 five per cent., and if the wear and tear of capital goods — 
 horses and machines — be placed at $50, we must add another 
 $75 to the cost. Thus, in order to obtain $237.50 worth of 
 wheat and corn, our farmer must incur $225 of cost. His 
 net gain, then, is $12.50. 
 
 Now let us imagine that he employs a second hired 
 laborer, and invests an additional $500 in a team and ma- 
 chinery. How much will be added to the crop? It is un- 
 likely that the addition will be as great as that resulting 
 from the employment of the first hired workman. We will 
 assume that the wheat crop per acre is increased to seven- 
 teen bushels, the corn crop to fifty-five. On the same price 
 basis as we assumed before, the value of the addition to the 
 crop will be $137.50, while the additional cost of tillage 
 will be $225. We see that it does not pay to put three 
 men upon the one hundred acre farm. 
 
 A practical farmer might experiment in this way with 
 a second hired workman; having discovered how unsatis- 
 factory the result, he would in the future content himself 
 with one hand. To satisfy our own curiosity, however, 
 let us see what would happen if a third hand were employed. 
 Perhaps the crop of wheat would increase to eighteen bushels, 
 and the crop of corn to fifty-eight, an increase of value 
 of $75. A fourth hand might increase the crop of wheat to 
 
84 INTRODUCTORY ECONOMICS 
 
 eighteen and one-half bushels; that of corn to fifty-nine. 
 There is no reason why every additional workman should 
 not make some small addition to the crop, until the wheat 
 crop had become fifty bushels and the corn crop one hundred 
 and fifty. But it is idle to spend time in carrying out in de- 
 tail a study of the results of a workman's labor, when these 
 results are so much less than cost that no enterpriser would 
 undertake to secure them. 
 
 An important principle, involved in this example, may 
 now be stated. From a given area of ground, an amount of 
 produce can be obtained increasing with every increase in 
 the labor and auxiliary capital employed in tillage, but in- 
 creasing less than proportionally with the increase in labor 
 and auxiliary capital. This principle is called the law of di- 
 minishing returns in agriculture. 
 
 If the rate of wages had been $io a month, all the 
 other factors in our problem remaining unchanged, the gain 
 to the farmer from the first workman hired would have 
 been $102.50, instead of $12.50; the second workman, in- 
 stead of representing a loss, would have given a net gain 
 of $2.50. To employ a third hand, adding $75 to the total 
 yield, but entailing an expense of $60 for wages and $75 
 for interest and replacement of capital, would not have 
 paid. 
 
 It is to be observed that the rate at which the produc- 
 tiveness of additional increments of labor and auxiliary 
 capital declines varies for different lands and for different 
 crops. The example which has been employed assumed a 
 light, well-drained soil, such as is found in large tracts of 
 the upper Mississippi Valley. If the hundred acre farm had 
 consisted instead of heavy, boggy land, one man could 
 hardly have kept it all under cultivation. If he had tried 
 to do so, very likely his crop would have averaged less than 
 ten bushels of wheat and thirty of corn. A hired workman, 
 with auxiliary capital as in the earlier example, might have 
 raised the product to thirteen bushels of wheat and forty of 
 
INTRODUCTORY ECONOMICS 8$ 
 
 corn; a second hired workman might have increased the 
 crop to sixteen and one-half bushels of wheat and forty-nine 
 bushels of corn; a third, to eighteen bushels of wheat and 
 fifty-seven of corn; a fourth, to nineteen bushels of wheat 
 and sixty-four of corn. With wages at $25, it would 
 still not have paid to put the second workman upon the land. 
 But with wages at $10 a fourth workman could have been 
 profitably employed, as the additional product arising from 
 his employment would have been worth $143.75, while his 
 wages, together with interest and replacement of wear and 
 tear of capital goods, would have amounted to only $135. 
 Possibly, under the circumstances, a fifth hired man might 
 be employed upon the land. 
 
 If the farmer is engaged in raising potatoes instead of 
 corn and wheat, one hundred acres will be much more than 
 he can handle alone. If he cultivates as large a part of the 
 area as he can, say twenty-five acres, he may produce one 
 thousand bushels. A hired workman could be set at work 
 on another twenty-five acres, and add one thousand bushels 
 to the product. Diminishing returns will not appear at all, 
 for the field as a whole, until four are at work there. A 
 fifth would probably add less than one thousand bushels, 
 but might add nine hundred and fifty. Even a tenth might 
 add five hundred bushels. Let the price be fifty cents a 
 bushel : the tenth workman adds $250 to the product ; and if 
 it costs $225 to pay his wages and the other expenses attend- 
 ing his employment, it is well worth while to employ a tenth 
 workman. With wages at $10, very likely a twenty-fifth 
 workman would add more to the total product than the ex- 
 pense which he would occasion. 
 
 If wages remain stationary through a period of time, 
 but the prices of agricultural produce rise, the number 
 of laborers that may profitably be employed upon a given 
 area of land will of course increase. If in our first example 
 wheat had sold at $1.50 a bushel and corn at fifty cents, the 
 increase in product arising from the employment of the first 
 
86 INTRODUCTORY ECONOMICS 
 
 hand would have had a value of $475; from the second, 
 $275; from the third, $150. Under the circumstances, the 
 farmer would find it profitable to employ two laborers in- 
 stead of one. The increase in number of laborers that might 
 profitably be employed would be still more striking in the case 
 of the farm with heavy soil, given a doubling of the price 
 of the produce. If we assume high prices as well as low 
 wages, the land of both grades will be cultivated with 
 still greater expenditure of labor. And this is in some 
 measure an explanation of the fact that where labor is 
 cheap and the prices of agricultural products high, as in 
 some of the countries of Europe, land is cultivated far 
 more intensively than in places where labor is dear and 
 the prices of produce low, as in the western part of the 
 United States. 
 
 The principle of diminishing returns, as it operates in 
 agriculture, was first formulated by economists more than 
 a hundred years ago, although practical men have of 
 course taken account of it in their business conduct ever 
 since agriculture became man's chief source of food. The 
 applicability of the principle to land devoted to trading and 
 manufacturing purposes was for a long time ignored by 
 economists. This may be explained by the fact that 
 formerly urban land was so cheap that the small amount re- 
 quired for the erection of a shop or a factory represented 
 an almost negligible element in the total costs of carrying 
 on a business of this nature. The enterpriser rarely found 
 himself forced to adjust his business with a view to obtain- 
 ing the greatest possible use out of a definite amount of 
 land. If his capital sufficed for so large a business, he 
 purchased or leased a city block on which to erect his build- 
 ings ; if his capital was small, he limited his use of land to 
 a few lots. To-day conditions have changed in consequence 
 of the extraordinary growth of the cities. The merchant 
 who desires to carry on a business in the heart of the busi- 
 ness district of a great city often finds himself restricted 
 
INTRODUCTORY ECONOMICS ^7 
 
 to a given number of front feet. The adjacent lots are taken 
 tip by establishments which show no disposition to remove. 
 It is then a question how to conduct a maximum paying 
 business upon a fixed ground space. 
 
 One way of overcoming the limitation of ground space 
 consists in erecting a very lofty building. Instead of con- 
 tenting himself with a building of six stories, the enterpriser 
 may push the height to fifteen or more. Perhaps it costs 
 $600,000 to erect a six-story building. An additional $ioo,- 
 000 may possibly give another story ; but more probably the 
 seventh story will in effect cost more than this. To raise the 
 building materials to this height is more expensive than to 
 raise materials to a lower story. Moreover, a seven-story 
 building is not merely a six-story one with a floor super- 
 added. In planning the taller building, it is necessary to 
 allow for greater strength of wall in the lower stories, in 
 view of the additional weight to be borne by them. Greater 
 care must be exercised to reduce risk from fire. In addi- 
 tion to the increased cost of construction, there will be 
 greater costs in connection with the permanent use of the 
 seventh floor than in connection with the use of lower floors. 
 More labor will be spent in carrying up the goods to be ex- 
 posed for sale, and in carrying down the articles sold. More 
 numerous and more powerful elevators will be required for 
 the higher building. We may therefore place the initial cost 
 of the additional floor at $120,000. The net profit from the 
 use of this floor, allowance being made for the in- 
 creased costs, may, however, represent a fair return on 
 $200,000. The erection of the higher building is therefore 
 profitable. 
 
 An eighth floor would, in effect, cost still more than 
 the seventh — $140,000, let us say. The cost of operation 
 would also be increased. As there is ordinarily no reason 
 why the business accommodated by this floor should be in 
 any way greater than that accommodated by the seventh, the 
 profit may be assumed to be less — say, a fair return on 
 
88 INTRODUCTORY ECONOMICS 
 
 $180,000. A ninth floor may yield a fair return on $160,000 
 and cost about the same sum. Here then is the limit to up- 
 ward extension of the business. 
 
 If for any reason the cost of construction should be re- 
 duced, as through the substitution of steel frame for solid 
 masonry, the height to which a building might economically 
 be raised would naturally be increased. Let us suppose that 
 the ninth floor, instead of costing $160,000, represents a cost 
 of only $140,000. In this case a tenth floor, or even an 
 eleventh, may be worth while. 
 
 If the cost of construction remains unchanged but the 
 rate of interest on capital invested in buildings falls, a tenth 
 or eleventh story would perhaps be a good investment. As 
 has been indicated, a floor "pays" when the profits from its 
 use are a fair return on the capital represented by the cost 
 of the floor. If this fair return is figured at ten per cent., 
 the ninth floor, costing $160,000, must produce profits 
 amounting to $16,000. If the rate of interest is reckoned 
 at five per cent., the same $16,000 is a fair return on 
 $320,000 — much more than the cost of the floor. Accord- 
 ingly, with the lower rate of interest on building capital, 
 there would be no reason for stopping with the ninth floor. 
 A tenth floor may cost $180,000 and yield a profit of $12,000. 
 This sum equals a five per cent, return on $240,000. Another 
 story may cost $200,000 and yield a return of $10,000. As 
 $10,000 is a five per cent, return on $200,000, this story just 
 pays. 
 
 Given a building already completed, no extension of 
 business through increase in floor space is usually prac- 
 ticable. But the business is not therefore altogether pre- 
 vented from expanding. Wide aisles and relatively few 
 counters may give way to narrow aisles and numerous 
 counters. A small number of salesmen may be replaced by 
 a large number. It is not necessary to follow out in detail 
 the effect of thus increasing expenses for salaries and for 
 capital invested in counters and in stock. The first $100,000 
 
INTRODUCTORY ECONOMICS 89 
 
 Spent in thus expanding the business may pay very well; a 
 second $100,000 may also pay; but it will hardly yield pro- 
 portionate returns; after a time the floor space is so well 
 utilized that an additional $100,000 expended in this way 
 will not bring a fair return. 
 
 Just as in agriculture we found that the rate at which 
 returns diminish varies for different crops, so in mercantile 
 establishments with limited floor space the rate at which 
 returns diminish varies for different lines of trade. Let us 
 compare, in this respect, a tinware and a jewelry business. 
 If the merchant dealing in tinware should double his stock, 
 it is probable that he would crowd his store too much for 
 convenience; but the increased business might make this 
 profitable. A point would soon be reached, however, where 
 further increase in stock would not pay. A jeweler, on the 
 other hand, might double his stock, increase it three-fold, 
 four-fold — perhaps ten-fold — without serious crowding of 
 space. 
 
 We may now go over into other fields, to find other 
 manifestations of the law of diminishing returns. In a cer- 
 tain city a street railway company, let us assume, has ex- 
 tended its lines of track through all the streets which promise 
 any considerable traflic. The trackage is then a fixed ele- 
 ment in the company's business, analogous with the land of 
 the farmer or the floor space of the merchant. The variable 
 elements are labor, fuel for power, and auxiliary capital in 
 the shape of cars. We may assume — although not strictly 
 in accord with the facts — that the cost of running a car is 
 just the same whether one hundred cars are operated or one 
 thousand. The cost of running one car we will place arbi- 
 trarily at $2 a trip.' 
 
 With one hundred cars in the entire system, running at 
 intervals of twenty minutes, the company may carry an 
 average of one hundred passengers per car per trip, thus 
 earning $5 at a cost of $2. It is easy to see that the number 
 of passengers carried would be increased if the service were 
 
go INTRODUCTORY ECONOMICS 
 
 more frequent. Persons who have only a short distance to 
 go will form the habit of walking, if the alternative usually 
 means waiting fifteen or twenty minutes for an overcrowded 
 car. Quite possibly the company would get twice as many 
 fares with two hundred cars, running at intervals of ten 
 minutes. The second hundred cars therefore would pay a 
 handsome profit above the cost of operating them. 
 
 Imagine now that the company places a third hundred 
 cars upon its lines, still further reducing the intervals be- 
 tween cars. In large measure these cars will simply carry 
 passengers who would have been carried by the other cars ; 
 and this is of course no gain to the company. The greater 
 efficiency of the system, and the greater comfort of riding in 
 cars that are never overcrowded, will develop some increase 
 in traffic. Possibly this increase will amount to fifty passen- 
 gers for each of the new cars. This would mean, according 
 to our assumed cost per trip, a gain of $2.50 at a cost of $2. 
 An additional hundred cars may increase the number of pas- 
 sengers carried by an average of twenty-five for each addi- 
 tional car. This would represent $1.25 receipts for every $2 
 outlay, and would therefore be uneconomical. 
 
 Of course if costs of operation should diminish or if the 
 number of potential passengers should increase, the service 
 might profitably be improved still further. 
 
 The manufacturer, of one of our earlier examples, who 
 erects a mill to utilize the power obtained by damming a 
 stream, is limited in his operations by the power repre- 
 sented by the head of water. This is the fundamental limit- 
 ing element in his calculations. But it is not to be supposed 
 that the power which he will actually obtain is a definite 
 quantity. Human ingenuity has devised no means whereby 
 all the power actually resident in any natural source may be 
 transmuted into a form which lends itself to use. All our 
 devices for securing and transmitting power are imperfect, 
 the best of them being only less wasteful of energy than the 
 worst. Our manufacturer may install a mechanism which 
 
INTRODUCTORY ECONOMICS QI 
 
 Costs little but permits a large part of the power to go to 
 waste. Or he may install a more complicated and costly set 
 of devices, which will come far nearer turning to account 
 the whole power represented by the fall. We may then 
 think of the manufacturer as weighing the advantages of 
 different kinds of power plant. The expenditure of $i,ooo 
 will permit the utilization of, perhaps, one-half of the power. 
 A second $i,ooo may make it possible to utilize two-thirds 
 of the power. With a plant costing $3,000 perhaps three- 
 fourths of the total power will be utilized. A $4,000 plant 
 may utilize four-fifths of the power, and so on. At what 
 point will it be more profitable to let power go to waste 
 than to incur additional expense to save it ? One-half of the 
 power may have a value of $300 per year. Interest and 
 depreciation on the $1,000 necessary to obtain this power 
 may amount to $150. The value of the power which would 
 be obtained through the $2,000 plant, on the basis we have 
 assumed, would be $400 ; and the cost, figuring interest and 
 depreciation as before, would be $300. The simple plant 
 therefore would yield a net value of $150 above cost; while 
 the more complicated plant would yield only $100. It would 
 accordingly pay best to install the $1,000 plant. If the 
 value of the power should double, however, the cost of the 
 several kinds of power installations remaining unchanged, 
 the $1,000 plant would yield a value of $600 at a cost of 
 $150, leaving a net gain of $450; while the $2,000 plant 
 would give a power worth $800 at a cost of $300, leaving a 
 net gain of $500. The $3,000 plant would yield a power 
 worth $900, but at a cost of $450. The net gain is evidently 
 diminished through the installation of the $3,000 plant. The 
 $2,000 plant is, under the circumstances, the most economi- 
 cal available. It is easy to calculate that were the value of 
 the power again doubled, the $3,000 plant would yield the 
 highest surplus above cost, and so would be the most ad- 
 vantageous economically. 
 
 Under present conditions it is an excellent steam engine 
 
92 INTRODUCTORY ECONOMICS 
 
 which transforms into mechanical power one-sixth of the 
 energy of the coal which it consumes. A simple and inex- 
 pensive type of engine does not do nearly so well as this. At 
 a given place and time, will it be more economical to employ 
 an engine of the very highest type, and which naturally is 
 very costly, or an inexpensive engine of a simple type ? The 
 former may transform into power fifteen per cent, of the 
 energy latent in the coal ; the latter, only five per cent. If the 
 additional power obtained through the better engine does not 
 equal the excess of interest and depreciation charge on the 
 more costly engine, the simpler engine is the more economi- 
 cal in spite of its wastefulness, from the mechanical point 
 of view. 
 
 The element in production which operates to limit the 
 expansion of a given business may be capital in its general 
 form, not any particular form of capital, as a given amount 
 of land, a waterfall, a railway track. It is a fortunate busi- 
 ness man who finds his capital limited only by the possi- 
 bilities of profitable employment which he commands. In 
 practical life a man can secure for use in his business, be- 
 sides his own capital, only the additional capital for which he 
 can give security. And this is usually limited to some pro- 
 portion of the value of his own property. 
 
 Assuming that a manufacturer possesses a capital of 
 $50,000, and can borrow $50,000 more, the sum $100,000 
 limits his operations as narrowly as any other fixed element 
 in his production could do. He has, of course, many 
 choices as to the exact disposition of the capital. If he is 
 engaged in cotton manufacture, he may use first-class 
 machinery, or he may employ a poor grade of machines — 
 perhaps machines that have been discarded in other sections, 
 as was for a long time a common practice in the South. 
 Perhaps he will decide upon investing $50,000 of his capital 
 in looms, the remainder being invested partly in the building 
 and partly in materials, etc. With twenty-five laborers and 
 high-grade looms, the output per laborer will be high ; with 
 
INTRODUCTORY ECONOMICS 93 
 
 fifty laborers and lower grade looms, the output per laborer 
 will probably be less, although the total output of the mill 
 will be increased. A third force of twenty-five laborers 
 with a still cheaper grade of looms will add something to the 
 total output, but the output per man will be still further di- 
 minished. Perhaps the output per man, when twenty-five 
 are employed, will be $2,000, while wages, cost of material, 
 wear and tear, etc., amount to $1,600 per man, leaving a 
 total net return of $10,000. With cheaper looms and fifty 
 men, the output per man may be $1,900, the cost remaining 
 $1,600. This would leave a net return of $15,000, and 
 hence would be advantageous. Seventy-five men, with the 
 capital put into appropriate form, might produce $1,800 per 
 man at the cost of $1,600 as before; and this also would 
 represent a return of $15,000. One hundred men, with a 
 return per man of $1,700, would yield only $10,000 net. Ac- 
 cordingly the most advantageous form in which to put the 
 capital devoted to looms must be such as to employ between 
 fifty and seventy-five men. If wages were less, a still 
 cheaper loom would be the most advantageous. If in the 
 examples given, labor and other costs had been $1,000 in- 
 stead of $1,600, the net return from the mill equipped with 
 the most expensive machinery would have been $25,000 ; the 
 return from the mill with the next lower grade, $45,000; 
 the next lower grade, $60,000; the next lower, $70,000. If 
 we assume that with one hundred and twenty-five men the 
 product per man would sink to $1,600, such an arrangement 
 of capital as would employ one hundred and twenty-five men 
 would yield $75,000 ne<t. With one hundred and fifty men 
 and a product of $1,500 each, the net return would be again 
 $75,000. Any further increase in the number of men would 
 sink the net return below $75,000, and would therefore be 
 uneconomical. 
 
 One further instance of the law of diminishing returns 
 may be presented here. A farmer and his sons, having 
 abundant means, migrate to the Canadian Northwest and 
 
94 INTRODUCTORY ECONOMICS 
 
 purchase six thousand acres of fertile land. But as land is to 
 be had by bona fide settlers at very attractive rates, it would 
 be difficult for the immigrating farmer to secure the services 
 of hired laborers, even at very high wages, as every able- 
 bodied man in the vicinity will wish to acquire land of his 
 own by residence thereon. The inelastic element in our 
 farmer's enterprise will, therefore, be labor. He will have to 
 rely mainly on himself and on his own family for this 
 element. 
 
 Under the circumstances, how much of the tract will be 
 placed under cultivation? The farmer and his family may 
 represent five able-bodied men. With steam plow and steam 
 harvesting machinery it would be an easy matter, perhaps, 
 for the family to place five hundred acres under cultivation. 
 This area might yield ten thousand bushels of wheat. To 
 place an additional five hundred acres under cultivation 
 would perhaps be possible. With the larger field the plow- 
 ing and the harvesting would extend over longer periods, 
 and no doubt some of the crop would be lost. The total yield 
 might, nevertheless, be fifteen thousand bushels. If an at- 
 tempt were made to cultivate a third five hundred acres, very 
 likely the work would be done so hurriedly and so much 
 waste would be entailed, that the total yield would be only 
 fourteen thousand bushels. The most profitable area to be 
 cultivated by the working force of five men would therefore 
 lie somewhere between one thousand and one thousand five 
 hundred acres — far short of the entire tillable area pur- 
 chased. 
 
 We may now state the law of diminishing returns in its 
 general form. When any one of the several factors whose 
 cooperation is essential to production is limited in quantity, 
 either absolutely, or by conditions of increasing cost, while 
 the quantity of the other factors may be increased practically 
 without limit, every unit of increase in the variable factors 
 results in an increase of output less than proportionate with 
 the increase in the variable factors. 
 
INTRODUCTORY ECONOMICS 95 
 
 The mere fact that an additional unit of one of the 
 variable elements yields a return less than that yielded by an 
 earlier unit is no reason why the unit should not be em- 
 ployed. It may yield more than it costs, and therefore its 
 employment is advantageous to the enterpriser. The product 
 of a field with one laborer may be $i,ooo, while the product 
 of the same field with two laborers employed would be 
 $1,300. The gross gain to the enterpriser from the employ- 
 ment of the first workman is $i,ooo, while that from the 
 employment of the second is only $300. Yet if wages are 
 less than $300 per man, the employment of the second man 
 pays. As a general rule, the enterpriser will increase the 
 variable factors in his employ as long as the increase in 
 gross product resulting from the employment of an addi- 
 tional unit exceeds the cost of that unit. 
 
 The examples that have been given have all been drawn 
 from the experience of the individual enterpriser. If we 
 look at industrial society as a whole, we observe that the 
 law of diminishing returns has a still wider application. 
 Labor and capital may be thought of as the two factors 
 cooperating in producing a vast mass of commodities — ^the 
 social income. If one of the two factors remains fixed in 
 amount, while the other factor increases, the aggregate 
 product of society will increase, but not in proportion to the 
 increase in the varying factor. As in a single enterprise, the 
 product increases in proportion to the increase of either 
 factor only when the other factor increases concurrently and 
 in practically the same proportion. 
 
 One apparent qualification must be made at this point. 
 Improvements in methods of production are constantly tak- 
 ing place, with the result that a given amount of labor or of 
 capital increases in efftciency. If the amount of labor em- 
 ployed upon a hundred-acre field increases, the increase in 
 product will not ordinarily be proportionate to the increase 
 in labor. But if at the same time a new way of cultivating or 
 fertilizing the soil should be discovered^ or if the quality of 
 
9^ INTRODUCTORY ECONOMICS 
 
 the seed should be improved, the product might very well 
 increase relatively to the amount of labor. This fact does 
 not prove that the law of diminishing returns is non-existent. 
 It merely proves that there are other forces at work which 
 may, at times, neutralize its effects. These forces are of 
 course of the greatest practical importance, and will later 
 demand our attention. 
 
 A more important qualification of the principle of 
 diminishing returns consists in the fact that the very process 
 of increasing the number of units of variable factors em- 
 ployed in connection with an unvarying factor may, under 
 certain circumstances, increase the productive efficiency of 
 each unit of the varying factors. To employ two men on an 
 acre of land that could be cultivated by one would result in 
 a diminished return per man if each worked alone. But 
 many tasks may be better performed when two or more 
 men cooperate than when each works by himself. Accord- 
 ingly, it may happen that an increase in labor which makes 
 cooperation possible, or an increase in capital which makes 
 possible better methods, may be accompanied by increasing, 
 instead of diminishing returns. 
 
CHAPTER VII 
 The Division of Labor 
 
 In a frontier community, where almost the entire popu- 
 lation consists of independent families living upon farms, the 
 economic functions performed by each person are numerous 
 and diverse. The frontiersman must, in the first place, be 
 an agriculturist and a grazier. Each of these occupations 
 includes numerous functions calling for different qualities, 
 the agriculturist being a plowman, sower, reaper, etc. The 
 frontiersman must also be a woodcutter at times, a car- 
 penter, a mason, a cabinet-maker, a smith, a butcher, and a 
 hunter, not to speak of a host of miscellaneous functions 
 that he must occasionally perform. His wife probably has 
 a no less varied array of occupations. She is a cook, a 
 laundress, a sempstress, a dairymaid, a spinner, a weaver, a 
 nurse, and a teacher. To survive on the frontier one must 
 be a jack of all trades. And practically the same range of 
 duties falls upon the strong and the weak, the intelligent and 
 the dull, the man who quickly acquires skill and the man 
 who acquires it with great difficulty. 
 
 Under such conditions it is natural that every kind of 
 work should be performed but indifferently well. The 
 house erected by a man who is usually occupied in tillage 
 may afford comfortable shelter ; that it will have any great 
 degree of convenience or beauty is improbable. The cloth 
 woven by the frontiersman's wife will necessarily be coarse 
 and lacking in finish. The tillage of the field and the man- 
 agement of the household will be conducted less satisfac- 
 torily than they would have been if the farmer and his wife 
 had not had so many other matters to divert their attention 
 and energy. 
 
 Not only will the quality of the work performed under 
 
98 INTRODUCTORY ECONOMICS 
 
 such conditions be poor, but it will also entail a relatively 
 high cost in labor. The frontiersman does not work for a 
 sufficient time at any one thing to acquire the "knack" of 
 doing it — that is, such a habit of mind and muscle as will 
 give the work a semi-automatic character. If he hews 
 beams for a house, it will, at first, be only by the greatest 
 effort that he will hew true to the line. A great deal of 
 time will be lost in smoothing out the irregularities of sur- 
 face due to unskillful use of the ax. A second beam is hewn 
 with a less expenditure of time and labor than the first; a 
 third with still less. But by the time a reasonable degree 
 of skill is attained, all the beams are hewn, and there will be 
 no further use for the acquired facility in this line for sev- 
 eral years, when it will largely have disappeared through 
 disuse. 
 
 Another disadvantage under which the frontier economy 
 suffers is the waste of time involved in passing from one 
 task to another. The frontiersman may want meat, and so 
 be compelled to interrupt the labors of the field in order to 
 kill. With his low grade of skill as a butcher, this operation 
 may take him three-fourths of a day. To return to the field 
 for the remaining fraction of the day would hardly seem 
 worth while. And so our frontiersman will "potter around," 
 trying to find some neglected task about the house or barn, 
 which might almost as well never be done, or will decide to 
 rest from his labors. 
 
 Of course some families will prosper better under the 
 circumstances than others. Some men will excel in one 
 function, some in another, and those who excel in the 
 functions that happen to be most vital under the conditions 
 will have the greatest degree of success. Some will be utter 
 failures, wasting so much time turning irresolutely from 
 task to task that they accomplish nothing. These same men 
 might have proven highly efficient workmen under different 
 industrial conditions. If our frontier communities had kept 
 detailed records, we should find that they contained many a 
 
INTRODUCTORY ECONOMICS 99 
 
 man who would have made a good architect or engineer, 
 many a woman who would have made an excellent modiste 
 or teacher, but who proved hopeless failures in the environ- 
 ment in which they were placed. Architecture and engineer- 
 ing, designing of costumes and teaching of children, were 
 indeed functions not wholly neglected, but they made up a 
 very small part in the life of each family and gave little 
 opportunity to any one for the full development of his 
 natural talents. 
 
 Were the frontier community wholly isolated for many 
 generations, a transformation of its industrial organization 
 would gradually take place. A person with more than the 
 ordinary talent for building would be called upon to assist 
 in the construction of his neighbors' houses, receiving in 
 return assistance in work for which he had no special quali- 
 fication. Little by little, occupations would be differentiated, 
 and eventually the community would contain among its 
 population carpenters, smiths, masons, weavers, etc. While 
 these craftsmen might still own land, and spend their odd 
 hours in agriculture, the main source of their livelihood 
 would be the exercise of their several crafts. Division of 
 labor in its ' simplest form would thus have come into 
 existence. 
 
 Whether this division of labor could be carried far or 
 not would depend in large measure upon the growth of 
 population and wealth in the comm.unity. Good work must 
 be appreciated before wages will be offered which are suffi- 
 ciently attractive to induce men to devote all their time to 
 the crafts. There must be a wide enough demand for such 
 labor to keep the craftsman busy most of his time. If a" 
 dozen houses are built every year, a carpenter may find 
 steady employment; if the community is so small that only 
 one or two houses are built yearly, no one can make car- 
 penter's wages his chief reliance. The community must be 
 of a considerable size before any man can earn his liveli- 
 hood as a smith. Weaving carried on as a regular occupa- 
 
 LOFa 
 
TOO INTRODUCTORY ECONOMICS 
 
 tion likewise presupposes a fairly advanced condition of 
 society. 
 
 But, of course, our frontier community would not 
 remain thus isolated for generations. Traders would soon 
 appear, to carry away the lighter surplus products, giving in 
 exchange the manufactured goods of older communities. A 
 railroad would, in time, transform the frontier community 
 into an integral part of the civilized world. And this might 
 retard the progress of division of labor within the community. 
 Instead of weaving its own cloth, it would barter its sur- 
 plus products of the soil for textiles produced in other parts 
 of the world. Many functions, however, would have to be 
 performed on the spot, and these would leave occasion for a 
 considerable division of labor. 
 
 As the community advanced in numbers and wealth 
 one function after another would be taken out of the 
 province of the man of all work, and given over to persons 
 specially qualified by nature and training to perform it effec- 
 tively. Each trade, again, would tend to subdivide. The 
 carpenter would no longer plan the building upon which he 
 worked, this function being given over to the architect. The 
 planing of boards would cease to be a part of the carpenter's 
 work, as planing mills would be established which would do 
 the work far more economically. Even in agriculture some 
 differentiation would take place, one man devoting himself 
 chiefly to the growing of grain, another to raising vegetables, 
 etc. Owing to the seasonal character of agricultural labor, 
 however, and the advantages of combining crops in such a 
 way that the work may be distributed as evenly as possible 
 throughout the open months, specialization in agriculture 
 could not be carried very far. Indeed, even in the best 
 developed agriculture, we do not find some farmers specially 
 devoted to wheat culture, others growing nothing but corn, 
 others potatoes or turnips. Agriculture by its nature pre- 
 cludes a high degree of division of labor. 
 
 We may now proceed to a statement of the conditions 
 
INTRODUCTORY ECONOMICS lOI 
 
 under which division of labor can take place. The first of 
 these is the existence in a community of a sufficient demand 
 for a particular kind of work to make it possible for a man 
 to devote himself almost entirely to that kind of work. It 
 has been pointed out that a considerable number of houses 
 must be erected every year in order to call into existence the 
 carpenter's trade. The local demand for well made clothing 
 must be fairly extensive before clothes-making can detach 
 itself from the province of the housewife and take the form 
 of a separate trade. 
 
 If the demand for well made clothes becomes very 
 great, opportunity for still further diJfferentiation, within the 
 tailor's trade itself, may arise. One man may devote him- 
 self exclusively to the making of overcoats, another to the 
 making of coats or waistcoats. The making of a single gar- 
 ment may be further split up among different workmen, one 
 occupying himself with the fitting of garments, another with 
 cutting, while the sewing may be distributed among several 
 persons, each doing the work for which he is best fitted. 
 Similarly, if the demand for furniture is extensive, one man 
 may devote himself entirely to the making of chairs, another 
 to the making of desks; or one man may specialize in the 
 making of plain articles of ordinary use, while another 
 makes only fine pieces. 
 
 Where the producer of a commodity deals directly with 
 the consumer, the opportunity for minute division of labor 
 is not so great as where the producer is brought into rela- 
 tions with the consumer through the intermediation of a 
 general market. The amount of work that may be secured 
 by a single custom tailor's shop is limited by the number of 
 purchasers of custom-made garments within easy distance. 
 In a village this number may be so small that anything like 
 subdivision of the tailor's trade may be impracticable. In a 
 large city the case is different. A single shop may easily 
 find customers enough to keep twenty men at work. In the 
 latter case division of labor is entirely practicable. If transit 
 
102 INTRODUCTORY ECONOMICS 
 
 facilities in the large city are excellent, the number of men 
 that may be employed by a single tailoring establishment may 
 be one hundred or more, and labor may be as minutely sub- 
 divided as the employer may desire. In the making of fur- 
 niture at the order of the consumer, similar limitations upon 
 division of labor are found, the small town being able to 
 support only a small shop, where all the work is performed 
 by two or three men, while the large city renders possible 
 the large shop, with minute subdivision of labor. 
 
 Division of labor finds its highest development where 
 the nature of the commodity produced is such as to permit 
 the easy assembling of materials in one place and the sale 
 of the finished product throughout a wide area. Thus the 
 materials for an ordinary grade of cotton cloth may be 
 assembled in almost unlimited quantities in a New England 
 town, and the finished product may be sent without great 
 cost to any part of the world. Division of labor in a cotton 
 mxill will be hardly at all subject to limitations of the kind 
 that we have discussed. Ordinary grades of furniture may 
 likewise be manufactured by one establishment without re- 
 gard to limitations of the local market, and the division of la- 
 bor in such an establishment may be carried as far as the in- 
 herent advantages of the system may urge. The business of 
 making ready-made clothing may be cited as another case in 
 which the intervention of a general market has made pos- 
 sible minute division of labor. How great is the revolution in 
 methods that has been brought about by this divorcing of the 
 producer from the consumer, through the development of 
 the general market, may best be brought home to us by con- 
 trasting the methods of the local cobbler, making shoes to 
 order, with those of the modern shoe manufacturer, supply- 
 ing a world market. The work which the cobbler performs 
 in making a shoe is, in the factory, split up into over a hun- 
 dred different functions, each being performed by a separate 
 set of workmen. 
 
 The contrast between the two systems, that of the small 
 
INTRODUCTORY ECONOMICS lO^ 
 
 shop with hardly any division of labor, and that of the large 
 establishment with labor minutely subdivided, may be seen 
 in many industries that are at present in a stage of transition 
 from the former system to the latter; and in most cases the 
 transition is largely explainable by forces that have ren- 
 dered the producer independent of the local consumer. 
 Until refrigeration had been reduced to a science, and the 
 methods of transporting products preserved by ice had been 
 perfected, every locality depended, for its supply of meat, 
 upon the local butcher. If the consumers in the vicinity 
 were few, they were ordinarily supplied by small shops 
 which permitted only a low degree of division of labor. In 
 the cities, the shops v/ere larger, and division of labor was 
 carried farther. To-day there is almost no limit to the 
 market for a single establishment. Fresh mutton killed in 
 New Zealand and Australia finds a ready market in England. 
 Fresh meats from Chicago may be found in practically any 
 city or town in the land. The parallel development of live 
 stock transportation has given the slaughtering centers a 
 practically unlimited supply of raw material. Accordingly a 
 minute division of labor has been evolved in the slaughter 
 houses. In the Chicago slaughter houses the killing and 
 dressing of a bullock is subdivided into fifty or sixty separate 
 functions, each assigned to a separate set of workmen, each 
 set making some small change in the material and passing 
 it on to another set. Of course some functions are per- 
 formed by single workmen, some by several. The laborers- 
 are organized in gangs of 230 men, each gang containing 
 just the appropriate number of men of each class. 
 
 The extent to which division of labor may be carried 
 depends also upon the prevailing form of the economic 
 organization. Where each workman is his own employer, as 
 was generally the case in the medieval industrial organiza- 
 tion, labor cannot be very minutely subdivided. In such an 
 industrial organization the spinner buys his wool and sells 
 his product to the weaver ; the latter sells the cloth to the 
 
104 INTRODUCTORY ECONOMICS 
 
 fuller, who, in turn, sells it to the dyer. The product is 
 again sold, perhaps, to the shearer, who may in turn sell the 
 finished cloth to a draper, who deals directly with the con- 
 sumer. With such a form of organization much time is 
 necessarily wasted in the buying and selling of the material 
 in its several stages, and the greater the number of stages, 
 the greater the waste from this source. Again, as each per- 
 son follows his own taste in choosing his trade — subject, of 
 course, to family tradition and trade restrictions — it is un- 
 likely that the society will have just the right number of 
 craftsmen of each kind. At one time there will be too many 
 spinners, relatively to the num.ber of weavers; at another 
 time fullers will be so numerous that not all can be employed. 
 And this element of waste also increases with increasing 
 subdivision of labor. 
 
 Where, on the other hand, industry is carried on under 
 the factory system, the workmen all being assembled under 
 one roof, subject to the control of an employer, the material 
 passes through the shop without interruption, and appren- 
 tices are taken on in each branch in the proportions which 
 experience shows to be most desirable. Of course this im- 
 plies a large accumulation of wealth on the part of the 
 employer, who must provide the premises, furnish materials, 
 pay wages, and assume all other expenses of production. In 
 fact, we may say that large capital and efficient management 
 are prerequisites to a thoroughgoing system of division of 
 labor. And, of course, efficient management on the part of 
 the employer implies a corresponding readiness to submit to 
 direction on the part of the employee. We might easily con- 
 ceive of a society in which all other conditions requisite to 
 division of labor might exist, but in which division of labor 
 of an advanced type would, nevertheless, be impracticable 
 on account of the restlessness of the working population 
 under close direction. 
 
 The fact that division of labor is so generally employed 
 wherever the conditions are ripe for it is a sufficient indica- 
 
INTRODUCTORY ECONOMICS 105 
 
 tion that the system must offer important economic advan- 
 tages. To enumerate all these advantages would require 
 a volume; but we may group the more important ones 
 under a few heads. In the first place, the limitation of 
 the labor to be performed by one man to a single func- 
 tion, which involves the use of a single tool, and which 
 may be reduced to a few simple movements, makes 
 possible accurate workmanship and great speed, with rela- 
 tively little weariness. The workman soon reduces his 
 movements to a rhythm ; he grasps each piece of material in 
 the same way, delivering his blows upon it in such a way as 
 never to throw away his energy. Every one knows how 
 much better results a trained oarsman secures from the 
 expenditure of a given amount of muscular energy than the 
 raw beginner, who puts forth his strength now on the water, 
 now on the air, now in the right direction, now in the wrong 
 one. The difference in effectiveness between the strokes 
 delivered by the man who works with a single tool, and the 
 strokes delivered by one who works with a dozen tools, is 
 hardly exaggerated by the comparison. 
 
 The best workman loses some time in changing from 
 tool to tool. It is not difficult to find a carpenter who spends 
 many fruitless moments searching now for his saw, now for 
 his hammer, while the whereabouts of the plane or square, 
 when these implements are needed, proves a baffling, if not 
 insoluble problem. And this is the man who leaves his work 
 with the loudest complaints of his weariness. A division of 
 labor that holds a man so strictly to business that he never has 
 any chance to stop to search for anything, obviously con- 
 tributes materially to reduce such waste of time and energy. 
 
 Division of labor makes it possible for persons who 
 have not the time or the versatility to learn how to perform 
 a variety of functions to attain to a place of usefulness in 
 industry. There are many persons who have not the time 
 to learn the tailor's trade; many who have the time for 
 apprenticeship, but not the general ability required for the 
 
I06 INTRODUCTORY ECONOMICS 
 
 making of a well-fitting coat. Few persons are so stupid 
 that they cannot, with slight waste of time, learn how to sew 
 a straight seam. If the work of making a coat is distributed 
 among a dozen persons, each one can quickly learn to do his 
 particular part well. Further, in the distribution of the 
 work, each one may be given a task proportioned to his 
 ■ability. The skilled cutter will not waste his time picking 
 basting threads, and the person for whom the latter function 
 is a sufficient profession, will be kept from spoiling material 
 through attempting something more ambitious. 
 
 The simplification of the task of each laborer makes it a 
 comparatively easy matter to ascertain how much any par- 
 ticular one is actually getting done. One who has lived in 
 the country has probably made the acquaintance of two 
 types of laborers: the first, those who are always bustling 
 about in a hurry and yet accomplishing little; the second, 
 never in a hurry, yet showing, in the end, a good record of 
 achievement. Because of the miscellaneous character of the 
 work of the agricultural laborer, it takes a long time to 
 measure the relative efficiency of different men. Where a 
 man is compelled to repeat the same operation throughout 
 the day, no show of bustling energy will create the illusion 
 of achievement. The pieces of work done have simply to be 
 counted, to give an accurate idea of the laborer's efficiency. 
 It is obvious, then, that the difficulty of supervision is 
 greatly reduced by systematic division of labor. 
 
 Perhaps the greatest advantage that arises from division 
 of labor is the stimulus it gives to the invention of labor- 
 saving machinery. A hundred years ago it would have 
 seemed quite impossible to manufacture shoes largely by 
 machinery. The process of manufacture appeared so com- 
 plicated that hand labor alone would answer. To-day shoes 
 are largely the product of machines. Many forces cooper- 
 ated, of course, to bring about this result, but only one of 
 these concerns us here, the division of labor. When a com- 
 plicated operation like the making of a shoe is split up into 
 
INTRODUCTORY ECONOMICS IO7 
 
 several score of simpler operations, some of these are likely 
 to prove so nearly mechanical that the idea of machines to 
 take over the work suggests itself. If the process of pro- 
 duction is divided into twenty-five parts, perhaps the third, 
 and eleventh, and seventeenth are taken over by machines. 
 In time division of labor still further simplifies the remain- 
 ing operations ; additional ones prove themselves to be fitted 
 for machine work, and thus more of the hand-workers are 
 displaced. It is conceivable that in the end practically the 
 whole process might be taken over by machines, the hand- 
 worker' being transformed into an attendant of the machine, 
 so to speak, feeding it with material, and passing on the 
 product to another machine. 
 
 We may now consider how far the principle of division 
 of labor modifies the operation of the principle of diminish- 
 ing returns, described in the last chapter. According to that 
 principle, an increase in the amount of labor employed in 
 connection with a limited amount of capital gives a return 
 which is not proportionate with the increase in labor. But 
 what if the additional laborers give opportunity for division 
 of labor which had not before existed? Suppose that a 
 tailor's shop with a capital of $20,000 formerly employed 
 six men ; it now employs twelve men. Division of labor can 
 be carried farther with twelve men; hence is it not pos- 
 sible that the employment of the second six men will double 
 the output of the shop? This is quite possible. An addi- 
 tional six men will give occasion to more systematic division 
 of labor, and so many still further increase the efficiency of 
 each man. And so with a fourth set of six men. But it is 
 evident that one cannot go on indefinitely subdividing the 
 work of making a coat. Eventually a point will be reached 
 where further subdivision of labor increases the efficiency of 
 each laborer only slightly ; still further subdivision, even less ; 
 finally a degree of subdivision will be found that will not 
 pay. That is, the principle of division of labor is itself sub- 
 ject to diminishing returns. A practical proof of this fact is 
 
I08 INTRODUCTORY ECONOMICS 
 
 to be found in the organization of the working force in many 
 large estabhshments where much use is made of division of 
 labor. The making of a complete article is not assigned to a 
 single man; nor is it assigned to all the men in the shop, 
 each contributing a trifling modification to the material. 
 Each article is assigned to a "team," among the members of 
 which the successive manipulations of the material are dis- 
 tributed. The entire working force may contain scores of 
 teams. Now the size of each team indicates the limits upon 
 profitable division of labor. If an enterpriser limits each 
 team to sixty men, this is proof that in his opinion a team of 
 seventy men would not show so large a product per man. 
 
 We may grant that an increase in laborers employed in 
 connection with a given capital may possibly result in an 
 increase in product more than proportionate with the in- 
 crease in labor. This may hold true until the number of 
 laborers is sufficient to compose a team of maximum effi- 
 ciency. If an additional team is engaged, without increase 
 in capital, it is doubtful that returns will increase in propor- 
 tion to the number of teams ; a third team will show a return 
 less than that of the second, and so on until the point is 
 reached where it does not pay to employ an additional team. 
 So far as the principle of division of labor is concerned, 
 then, the only qualification to be made in the law of diminish- 
 ing returns is that when we assume that labor increases, we 
 must assume that it increases by teams, not by individual 
 men. 
 
CHAPTER VIII 
 The Concentration of Industry 
 
 It is a matter of common observation that it requires a 
 larger capital to launch a business to-day than was required 
 twenty years ago; and most men believe that twenty years 
 hence a still larger capital will be required to give an estab- 
 lishment a fair start. This tendency toward ever larger 
 establishments is what is commonly known as concentration 
 of industry, or industrial concentration. 
 
 At the outset, the fact must be noticed that not all 
 branches of business are equally affected by the tendency 
 toward industrial concentration; and that even in the 
 branches that show the best instances of this development, 
 many establishments are checked in their growth by the dif- 
 ficulties they experience in extending their control over cer- 
 tain of the essential factors of production. In agriculture, 
 for example, there is little evidence of any such tendency. 
 In that industry, an important element in success consists in 
 keeping the dwelling place of the laborers so near to the 
 fields that no great amount of time is wasted in going to and 
 from the work. It is also essential that the barns and 
 granaries be near enough to the fields to obviate excessively 
 long haulage of the products. It follows, then, that the 
 number of acres that may be managed from a common cen- 
 ter is somewhat narrowly limited. An apparent exception 
 to this rule is to be found in the great wheat farms of Cali- 
 fornia, the Dakotas and the Canadian Northwest. Here the 
 land is level and free from stones and stumps of trees ; the 
 natural fertility is great, and evenly distributed over large 
 areas. Cultivation consists simply in plowing, sowing and 
 harvesting ; and this can be done by aid of the highest type 
 of agricultural machinery. As soon as the natural fertility 
 
no INTRODUCTORY ECONOMICS 
 
 of the soil is exhausted, however, a more intensive tillage 
 will be necessary; fertilizers will have to be applied; rota- 
 tion of crops will succeed continuous wheat-cropping. For 
 such tillage the immense unbroken fields are not well 
 adapted. The "bonanza" farm is a transient as well as an 
 exceptional phenomenon. 
 
 In many sections of the country the making of bricks 
 remains in the hands of small enterprisers. Common bricks 
 are so bulky a commodity that they cannot be transported 
 long distances without paying an excessively high charge for 
 freight — unless made in a locality specially favored by water 
 or cheap railway transportation. The size of a brick-making 
 establishment, then, must ordinarily be gauged by the de- 
 mand for bricks within a reasonable radius of the kilns ; and 
 if this demand is not a growing one, there cannot appear a 
 tendency toward larger brick-making establishments. 
 
 Somewhat analogous is the case of the local merchant. 
 Those persons living within a reasonable distance of his 
 store can be reached by his order clerks and delivery 
 wagons. Beyond this distance, however, it will not pay to 
 solicit orders. If the population within the radius of profit- 
 able business is large, of course the store may be large. If 
 the region is sparsely settled, the store must be small. 
 
 Instances of businesses thus limited by external circum- 
 stances might be multiplied. We may say, in general, that 
 such limitations arise wherever either materials of produc- 
 tion or the finished product must be conveyed increasing dis- 
 tances, with rapidly increasing cost, whenever an establish- 
 ment enlarges its business. Of course anything that reduces 
 cost of conveyance materially enlarges the area within which 
 a given business is confined. The advent of the gasoline 
 motor delivery wagon has enabled some village "general 
 stores" to develop into more ambitious "department stores." 
 
 Again, when a business is once established, it may not 
 admit of any great degree of expansion, even if market 
 conditions are favorable. A shoe factory, for example, may 
 
INTRODUCTORY ECONOMICS III 
 
 find a practically unlimited demand for its products at 
 remunerative prices. By a rearrangement of its machinery, 
 and the employment of additional laborers, it may some- 
 what enlarge its output; but, as we saw in Chapter VI, this 
 process cannot long continue without calling into operation 
 the law of diminishing returns. A new factory may be 
 established alongside the old one; but the advantages to be 
 gained from such duplication of plant are inconsiderable as 
 compared with the advantages that would have arisen could 
 the old factory have been completely remodeled on a larger 
 scale. 
 
 The advantages to be gained through industrial con- 
 centration are best brought to view by an examination of the 
 considerations that determine the size of a new establishment 
 in an industry which is only slightly dependent upon local 
 conditions of supply of material and consumption of product. 
 Such independence of local market conditions is most com- 
 monly met with in industries which work up materials that 
 can easily be assembled in large quantities, and the products 
 of which are of such a nature that they can bear the ex- 
 pense of transportation to distant markets. The textile and 
 the iron and steel industries may be regarded as typical of 
 the branches of production giving the best opportunity for 
 industrial concentration. 
 
 Let us imagine that we are present at the launching of 
 a new enterprise in one of these branches of business. What 
 will be the size of establishment determined upon? Of 
 course a first consideration must be what amount of capital 
 can be raised. If, however, it is generally believed that with 
 a capital of $500,000 an establishment in a given industry 
 can prosper, while one with a capital of $100,000 would with 
 difficulty survive, it is likely that an enterpriser proposing 
 to start the larger business will find less difficulty in raising 
 the capital than would an enterpriser proposing to found a 
 $100,000 business. The real determinant of the size of a new 
 establishment, then, will be, not the financial consideration 
 
112 INTRODUCTORY ECONOMICS 
 
 as to the amount of capital that can be raised, but the tech- 
 nical consideration as to how much capital is necessary for 
 success. If this amount cannot be raised the project is 
 dropped. 
 
 As we saw in the last chapter, manifold advantages 
 spring from the division of labor. The establishment to be 
 launched must be at least large enough to make the fullest 
 practicable use of this principle. Perhaps this end would be 
 attained, so far as the working force directly engaged in the 
 process of manufacture is concerned, in an establishment 
 with a capital of $100,000 and with 100 laborers. A second 
 100 laborers, supplied with an equal amount of capital, might 
 double the output, but they would not increase the efficiency 
 of the first hundred men. So with a third and fourth hun- 
 dred men. No further economy in concentration arises un- 
 der this head. 
 
 In addition to its manual laborers, the establishment 
 must have an "office" force; possibly it may have buying 
 agents, who travel long distances in search of the various 
 materials, and selling agents, likewise compelled to travel 
 about in search of buyers. A small establishment could sup- 
 port only a small number of employees of these classes ; 
 there could be no extended division of labor among them. 
 An establishment of larger size might be able to assign one 
 man exclusively to the purchase of one kind of material, an- 
 other to the purchase of another kind, and so enjoy the ad- 
 vantages of specialized skill. Similar division of labor might 
 be effected among the selling agents and among the mem- 
 bers of the office force. In this way a very large establish- 
 ment could assure itself that every commercial situation aris- 
 ing would receive expert attention. There is, of course, no 
 theoretical limit to the possible gains from this source. An 
 establishment might be so large that it could have a man 
 devoting his full time to the purchase of machine oil for its 
 use, and something would doubtless be gained through the 
 skill he would develop. But in practical life such trifling 
 
INTRODUCTORY ECONOMICS 1 13 
 
 gains would have little effect in determining the size of an 
 establishment. They are too small to make a perceptible 
 addition to dividends. 
 
 The process of manufacture may involve a score or 
 more of manipulations of the material, and at each stage sev- 
 eral machines may be drawn into use. A number of differ- 
 ent types of machinery are on the market, some performing 
 the function required with greater celerity and certainty than 
 others, the better machines, naturally, representing a larger 
 investment. To equip a factory throughout with the best 
 machinery would require a large capital, even if the process 
 could be reduced to a series of steps occupying one set of 
 machines as long as another. Such a division of the process 
 is not ordinarily practicable ; some machines contribute only 
 very slight changes in the material, delaying it but a mo- 
 ment as it passes through, while other machines subject the 
 material to rnore important changes and delay it for a longer 
 period. In order that the machines may all be used to their 
 full capacity, there must be a number of machines engaged 
 in the slower parts of the process to one engaged in the part 
 which can be performed quickly. And this involves a still 
 further increase in the capital of the establishment. 
 
 The providing of power, in most manufacturing indus- 
 tries, is one of the most important of technical problems, 
 and here the large establishment usually has decided advan- 
 tages. The larger the power plant, in general, the cheaper 
 can power be furnished. There is not so much heat wasted 
 in a large furnace as in a small one; a large power plant 
 can be so arranged as to prevent much of the waste of power 
 in transmission that usually takes place in a small establish- 
 ment. Here it would be difficult to find a theoretical limit 
 to the advantages that follow from an increase in size of 
 plant. In practice, however, the economies to be gained in 
 this way are not very important after a moderate size of 
 plant has been reached. We do not find men constructing 
 huge factories merely to obtain the advantages of cheaper 
 
114 INTRODUCTORY ECONOMICS 
 
 power, although these advantages may not be entirely neg- 
 lected in determining upon the size of a business to be 
 estabHshed. 
 
 In most industries, the general progress of invention is 
 in the direction of more and more costly machines, and this 
 is one of the more important reasons for the trend toward 
 industrial concentration. At a particular time, however, 
 there is a theoretical size of business which permits full 
 equipment with the best machines then available. An in- 
 crease in the establishment beyond this point brings no ad- 
 vantage in the direct process of manufacture. There may, 
 however, be other important advantages to be gained 
 through such enlargement of plant. 
 
 In almost every industry the material undergoes some 
 shrinkage in the process of manufacture, through the re- 
 moval of parts not fitted to enter into the main product. 
 These parts are waste in a small establishment, and the 
 problem of getting rid of them is often a serious one. In 
 the large establishment they accumulate in enormous quanti- 
 ties, and the question whether they could not be utilized in 
 some way readily suggests itself. Through successive ex- 
 periments, one element after another ceases to figure as 
 waste, being transformed instead into a ''by-product." Thus 
 forty years ago much of the residue of the small oil refineries 
 was allowed to flow away in the streams. The same material 
 to-day is the basis of scores of by-products, the value of 
 which is an important element in the profits of the petroleum 
 industry. Compare the methods of waste disposal of the 
 small butcher shops of to-day with those of the great pack- 
 ing houses. To the former from forty to sixty j)er cent, of 
 every animal slaughtered is sheer waste, to be got rid of in 
 whatever way the public health authorities will permit. This 
 waste in the large establishment is transformed into over a 
 hundred by-products, practically no part of it being consid- 
 ered wholly valueless. Such utilization of waste requires 
 the investment of a considerable capital in various kinds of 
 
INTRODUCTORY ECONOMICS Il5 
 
 plant and the employment of a large body of laborers who 
 have nothing to do with the main product. Some of the 
 by-products take from the mass of waste only insignificant 
 elements ; hence their utilization is possible only when waste 
 accumulates in enormous quantities. It is obvious that only 
 a very large establishment can carry on a thoroughly sys- 
 tematic plan of developing by-products. An establishment 
 large enough to enjoy all the advantages of division of labor 
 and of costly machinery may not be one-tenth large enough 
 to gain all the profits of waste utiHzation. 
 
 It has already been pointed out that an important ad- 
 vantage of the large establishment is the possibility of or- 
 ganizing its buying and selling agents in such a way as to 
 develop special skill for each kind of transaction. A further 
 commercial advantage consists in the fact that purchases 
 can be made on a large scale, and therefore, generally, on 
 especially favorable terms. The dealer in raw material can 
 afford to sell at an unusually low price to a customer whose 
 purchases may mount up into millions. The same thing is 
 true of all other dealers who supply the large establishment. 
 There may, indeed, be a combination among such dealers, 
 fixing the margin of profit at which each must sell ; but such 
 a combination can do little toward extorting high profits 
 from an enterpriser who can, if he chooses, dispense with 
 the middlemen altogether, and deal directly with the pro- 
 ducer of the materials. The maker of machinery is likewise 
 compelled to content himself with a small profit when deal- 
 ing with a concern which has capital and enterprise enough 
 to make its own machinery, if it finds a profit in so doing. 
 In its sales, it enjoys similar advantages. It can provide any 
 purchaser v/ith such quantities and such qualities as he may 
 desire. If part of the product is to be exported, the large 
 establishment can afford to send agents to foreign countries 
 to find out what qualities are desired, and in what form the 
 product will be most acceptable to the foreign taste. 
 
 The large enterpriser, further, can make a more sys- 
 
Il6 INTRODUCTORY ECONOMICS 
 
 tematic study of the market than can the smaller one, and so 
 can make his purchases and sales when the markets are most 
 favorable. Moreover, the products of the large establish- 
 ment are usually transported more cheaply than those of the 
 smaller estabHshment. Practically all supplies, even those 
 that form a relatively insignificant part of the total pur- 
 chases, can be taken in carload lots ; the more important sup- 
 plies in train loads, peirhaps. Where the transportation 
 companies are not prohibited by law from making excessive 
 reductions in favor of the large shipper, the latter can often 
 force the transportation company to discriminate heavily in 
 his favor, under threat of giving the entire business to a rival 
 company. And even where the transportation company is 
 required by law to treat all its patrons alike, the large estab- 
 lishment is likely to get special favors from the company, un- 
 der one pretext or another. In sea transportation, the large 
 company may build ships of its own, especially adapted to 
 its needs, if ship owners are not ready to make suitable 
 concessions. 
 
 No matter how large the capital of an enterprise may 
 be, there will at times be need of borrowing money. At a 
 particular time the market for materials may be so favorable 
 that it will be profitable to purchase large supplies beyond 
 current needs. An active business will not have on hand 
 any large amount of idle cash; hence the necessity for bor- 
 rowing. As a rule bankers lend money at a lower interest 
 rate to a large enterpriser than to a small one. The principal 
 reason why they do this is that the large establishment ap- 
 pears to offer better security than the small one. 
 
 The foregoing is of course very far from an exhaustive 
 statement of the advantages of the large enterprise as com- 
 pared with the small one. Other advantages will readily 
 occur to any one who observes the economic development of 
 the locality in which he lives. It will be observed that 
 some of the advantages are prominent in one industry, some 
 in another. In the manufacture of cotton cloth, for example, 
 
INTRODUCTORY ECONOMICS Il7 
 
 there are no important by-products to be utilized. The mar- 
 ket for ordinary grades of cloth is well developed; the job- 
 ber takes the product from the manufacturer's hands and 
 disposes of it to the retailer, charging a commission so low 
 that it would hardly pay the manufacturer to develop selling 
 agencies of his own. Neither the material nor the product 
 is very bulky, in comparison with its value; hence the ad- 
 vantages enjoyed by the large concern in the matter of freight 
 transportation are not likely to be of very great importance. 
 To equip a mill thoroughly with the best machinery in the 
 market does not require a very enormous capital; nor does 
 an establishment have to be very large to enjoy to the full 
 the advantages of division of labor. Certain advantages do 
 indeed attend mere size, even in this industry ; but they are 
 not so important that they may not be counterbalanced by 
 slightly better management on the part of the smaller 
 establishment. 
 
 In the iron and steel industries, on the other hand, a 
 complete equipment of machinery is usually very costly, re- 
 quiring a large capital to keep every important machine in 
 constant use. The transportation of materials and products 
 is expensive, and a great part of the profit of an establish- 
 ment may depend upon the kind of contract that can be made 
 with the transportation companies. By-products are not very 
 important, but the larger establishment can secure large 
 economies through making the best use of its material. Fuel 
 is of course an immensely important item in the industry, 
 and decided advantages are to be obtained through purchases 
 on a large scale. Furthermore, the larger the establishment 
 the greater the economy possible in the use of the fuel. Ac- 
 cordingly, in this industry a very large plant will have sub- 
 stantial advantages over one of moderate size. In the meat 
 packing industry, so far as the use of machinery is con- 
 cerned, there is no important advantage enjoyed by the 
 very large plant of which a plant of moderate size could 
 not avail itself. Economy of fuel is another minor con- 
 
Il8 INTRODUCTORY ECONOMICS 
 
 sideration in this industry. The important advantages of 
 the large plant consist in better division of labor, better 
 utilization of by-products, better conditions of transporta- 
 tion, and more effective advertising. In the refining of 
 petroleum almost every form of advantage that has been 
 mentioned favors the large establishment. 
 
 It is not to be inferred that the advantages of the large 
 establishment are confined to manufacturing industry. Mer- 
 cantile business shows much the same tendency toward con- 
 centration. In the retail trade, the large establishment en- 
 joys great advantages in the purchase and sale of goods ; it 
 not only buys more cheaply, but it is better able to cater to 
 the tastes of its customers than the small store. It can 
 afiford a style of advertising that reaches the public, while 
 the small establishment is likely to throw away the money 
 it spends in advertising, not succeeding in imposing the con- 
 viction of its merits upon the prospective customer. 
 
 Theoretically it is difficult to establish a point beyond 
 which further enlargement of a business establishment would 
 be unprofitable. Every enlargement of a petroleum refin- 
 ery, for example, makes possible some new economies. After 
 a certain size has been reached, however, an establishment is 
 able to enjoy most of the known advantages of large scale 
 production. In some industries this involves an investment 
 of $500,000 ; in other industries, perhaps, of $50,000,000. 
 A capital of such size the enterpriser will vigorously strive 
 to bring together. A profitable business may perhaps be 
 conducted with a much smaller capital ; but it will be more 
 and more seriously handicapped as time passes, and the 
 average size of new competing establishments increases. 
 
 There is of course no reason why an establishment 
 should not be much larger than is necessary to obtain prac- 
 tically all the benefits of large scale production known at the 
 time. Say that a $2,000,000 plant offers all these advantages, 
 there is no reason why a $4,000,000 or a $6,000,000 plant 
 should not be established. But capital cannot be got to- 
 gether without effort ; and unless substantial advantages are 
 
INTRODUCTORY ECONOMICS llQ 
 
 to be gained through the larger investment, the enterpriser 
 is likely to rest content with the smaller one. 
 
 As we have seen, the expansion of businesses already 
 established, in whatever branch of industry, is confined to 
 narrow limits by the law of diminishing returns. There is 
 a similar law which confines within narrow limits the size of 
 a new enterprise in an industry dependent upon local sup- 
 plies of material, or a local market for its products. With 
 such enterprises, a point is reached where increasing busi- 
 ness is attended by increasing cost, transportation generally 
 representing the expanding element in cost. Finally, we 
 have the new enterprises in industries which are practically 
 independent of local supplies of material and of the local 
 demand for products. In these enterprises we may assume 
 that no element in production is as yet fixed. They may, 
 within limits, assume such magnitude as will give them com- 
 mand over all the economies of large scale production. These 
 economies have a determining importance in the choice be- 
 tween a small business and one of moderate size; they are 
 of less importance in the choice between a moderate sized 
 establishment and a large one ; with further increase in size 
 of establishment their importance dwindles. Perhaps there 
 is no point at which further economies cease ; but there is a 
 point at which they cease to be of practical importance. In 
 economic language, the economies from concentration of in- 
 dustry are subject to a law of diminishing returns. 
 
CHAPTER IX 
 
 The General Law of Wages 
 
 We have found frequent occasion in earlier chapters to 
 touch upon wages and interest. Wages and interest are 
 parts of the cost of production of commodities, as we saw 
 in Chapter V, and as such have an important part to 
 play in determining values. As incomes of great social 
 classes, they are, however, of far greater importance. In 
 the present and the following chapters we shall endeavor 
 to ascertain the laws determining the rates of wages, interest, 
 and whatever other forms of social income may remain after 
 the shares of the laborer and of the capitalist are paid. In 
 other words, we are entering upon a study of the distribution 
 of wealth, or, more properly, of the distribution of the social 
 income. 
 
 Political economy, like most other sciences, often finds 
 reason for defining terms the general meaning of which has 
 been known to us all since childhood. Who is so innocent 
 of the realities of life that he does not know in a general 
 way what is meant by the terms "labor" and "wages" .^ 
 Nevertheless, it is still possible for intelligent persons to fall 
 into fruitless dispute over the "rights of labor," when one 
 means one thing by labor, another a different thing. The 
 possibility of mistaking the meaning of one who talks about 
 "v\^ages" is still greater. One independent farmer will say 
 that the thousand dollars he obtains for his produce is 
 "wages" ; another will say that it is mostly the rent of his 
 land; still a third will regard the same income as chiefly 
 profits. Such conflicting use of terms may be a matter of 
 indifference in ordinary conversation, which is mainly de- 
 signed to furnish entertainment, not instruction. Scientific 
 discussion, on the other hand, demands first of all perfect 
 agreement in the use of terms. 
 
INTRODUCTORY ECONOMICS 121 
 
 Every expenditure of human energy having for its chief 
 purpose the production or the preservation of economic 
 goods, or the increase in the valuable qualities of existing 
 goods, is labor in the economic sense of the term. Labor in- 
 cludes not only the exertions of the manual workers, by 
 whom actual changes in material commodities are wrought, 
 but also the exertions of the foremen, superintendents, man- 
 agers, under whose direction the manual tasks are advan- 
 tageously performed. It includes the activities of police, of 
 judge, and of legislature, upon whose efficient performance 
 rests the possibility of continued production in most of the 
 existing branches of industry. Labor does not include, how- 
 ever, efforts undertaken for their own sake, without regard 
 to economic result. The amateur football team spends an 
 immense amount of energy, and gets its reward in the spend- 
 ing. The amateur hunter often cares little or nothing for 
 the birds he brings down ; his reward is the gratification of 
 the prehistoric thirst for blood. The professional football 
 player and the professional hunter, on the other hand, are 
 laborers. If any one thinks that this is a distinction with- 
 out a difference, let him ask the football amateur what claim 
 to superiority he enjoys over the "professional"; let him ask 
 the sportsman wherein the latter differs from the pot-hunter. 
 
 As the term "wages" is generally used, it signifies the 
 money or other things of value paid by an employer to those 
 who serve him in capacities of inferior dignity; employees 
 of higher rank receive "salaries." Political economy does 
 not recognize any such distinction as this, based as it is upon 
 the pretended social status of the recipient, rather than upon 
 a difference of economic function. The ten cents a day paid 
 to a child slave and the $100,000 a year paid to the president 
 of an insurance company are alike wages in the blunt speech 
 of the economist. Moreover, in economic language, the term 
 "wages" extends to part of the income of a workman who is 
 his own employer. One peanut vender may be working for 
 a push-cart enterpriser, receiving a dollar a day for his ef- 
 
12^ INTRODUCTORY ECONOMICS 
 
 forts. This sum, all will agree, is nothing but wages. At 
 the opposite corner of the square you may find another pea- 
 nut vender, who is his own employer. The latter may gain 
 over and above the cost of raw nuts, gasolene, push-cart hire, 
 etc., just a dollar a day. The two men then receive equal 
 rewards for identical services. Possibly the second vender 
 calls his income ''profits." Political economy cannot afford 
 to use two different terms to designate essentially the same 
 thing, especially when one of the terms, ''profits," has a very 
 definite m.eaning of its own. Whatever a man receives sim- 
 ply as a reward for his exertions, whether directly or through 
 the intermediation of an employer, is wages. 
 
 While we cannot properly exclude from the term wages 
 so much of the income of an independent workman as arises 
 from his personal exertions, we are nevertheless justified 
 in devoting our attention almost exclusively to wages as 
 determined by contract between employer and employee. An 
 increasing proportion of the world's work is being done un- 
 der this system; and most of the important economic prob- 
 lems of the day are concerned with it. Who ever heard 
 of a "labor problem" in an agricultural community where 
 every farmer relies exclusively on his own two hands? In 
 such a community, what importance attaches to the genera] 
 movement of wages, whether upward or downward? In- 
 deed, who can determine, in such a society, how much of 
 the total income of each farmer is wages, how much interest 
 on capital invested in the farm? Wages have existed ever 
 since our first ancestors were condemned to eat their bread 
 in the sweat of their brows ; but it is only under modern con- 
 ditions, where one man pays another to work for him, that 
 it comes to be of great importance to ascertain what laws 
 govern the rate of wages. We shall therefore confine our 
 study to that part of the economic field in which differentia- 
 tion between employer and employee has taken place — where 
 the "wage system" exists — and shall endeavor to ascertain 
 the laws operative therein. These laws, indeed, exert an in- 
 
INTRODUCTORY ECONOMICS 123 
 
 fluence in the rest of the economic field as well, and are in 
 turn influenced by forces lying outside of the field in which 
 the wage system prevails. What a man could get as his 
 own employer helps to determine how much he must have 
 as a mere wage-earner ; what he could get as a mere wage- 
 earner helps to determine what he must gain as an inde^ 
 pendent workman. 
 
 Let us set before us, in imagination, an agricultural 
 community in which all the land is owned by a few wealthy 
 men who do not themselves engage in tillage, but hire the 
 landless population to work upon their fields. And let us 
 further assume that this population is unable or unwilling to 
 migrate to other communities in search of employment. 
 Whether there are many workmen or few, they must all 
 seek employment upon the land, or starve. 
 
 Some of the land in the community will naturally be 
 fertile, some of it barren. Some of it will require a large 
 expenditure of labor for every bushel of wheat or potatoes 
 produced; some of it will yield rich crops with little labor. 
 Every good field will yield a moderate crop with a small 
 expenditure of labor ; if a larger crop is sought, it must be 
 at the expense of a disproportionately large application of 
 labor, as we saw in the chapter on Diminishing Returns. 
 
 Accordingl}^, we may safely lay down the proposition 
 that the results arising from the application of labor to dif- 
 ferent fields, and in different methods of cultivation, will be 
 unequal. Good land, in extensive cultivation, may yield 
 three bushels of wheat per day's labor expended, while 
 poorer land would yield, perhaps, two bushels and yet poorer 
 land one bushel. Adding one day's labor to the amount pre- 
 viously spent on a piece of the best land, may add only two 
 bushels to the product, and adding still another day's labor 
 may add only one bushel. 
 
 Now, however unequal the results of labor on different 
 fields and under different methods of cultivation, the reward 
 of labor — wages — will be uniform, allowance made, of 
 
124 INTRODUCTORY ECONOMICS 
 
 course, for differences in the physical efficiency of different 
 laborers. Suppose that a farmer has ten fields, of different 
 degrees of fertility, and employs one man to cultivate each, 
 the work on the different fields being uniformly arduous. 
 He would be a very unusual employer if he should propose 
 to pay the men different rates of wages, according to the 
 fertility of the field upon which each is employed. The 
 probable result of such a plan would be that competition 
 would arise among the men to win the employer's favor, 
 each one desiring to be employed on the best field; and in 
 the end we should probably find that the better fields would 
 be apportioned to the men who would agree to perform for 
 the employer various miscellaneous services which would, 
 generally speaking, be equal in value to the advantages they 
 enjoyed in the way of higher remuneration. How this would 
 work out we might consider at greater length if we did not 
 know by experience that even the fairest employer is averse 
 to grading the wages of his men, not on a basis of their skill 
 and faithfulness, but on a basis of the facilities for work 
 which the employer himself furnishes. Cases of unequal 
 rewards for the performance of equal tasks are of course to 
 be found; but for these cases the explanation, as we shall 
 see later, is of a wholly different nature. 
 
 Just as uniform wages will be paid for like tasks by any 
 one employer, so uniform wages will be paid by all the em- 
 ployers in the community. No employer can keep in busi- 
 ness unless he pays as good wages as any other. If any 
 one raises wages slightly, he will attract to himself an in- 
 creasing number of workmen; and he will soon get all he 
 cares to have. In an earlier chapter we saw that there can- 
 not be different prices for the same commodity in the same 
 market. This law holds good for labor as for anything else 
 one buys or sells. 
 
 Of ten fields the best one, when cultivated by one work- 
 man, may yield a product worth $500; the worst one may 
 yield only $150. What will be the maximum wage that the 
 
INTRODUCTORY ECONOMICS 12$ 
 
 employer will pay? Not more than $150. For he will not 
 pay any workman more than the entire product created by 
 the aid of that workman ; and he will not, of his own volition, 
 pay one workman more than another. Nor can any work- 
 man compel the employer to pay him more than the one on 
 the worst field receives. Suppose that the one employed on 
 the best field insisted on a wage of $200. The employer 
 would dismiss him, and place on that field the laborer 
 formerly employed on the worst field. And so with any one 
 of the ten laborers. What the employer would lose, if any 
 one of them should "strike," would be simply the product 
 of the worst field — $150, according to our premises. 
 
 If we assume that the ten fields are owned by different 
 men, we arrive at an identical result. The employer who 
 owns the poorest field cannot possibly pay more than $150 
 to the workman who tills it. If a workman on a better field 
 demands more, his employer will dismiss him, and put in his 
 place the workman formerly employed on the poorest field, 
 whom he can easily induce to change employers by offering 
 him a trifle more than the owner of the poorest field is able 
 to pay. The dismissed workman must live ; probably he will 
 have to seek employment on the abandoned field, and content 
 himself with the wages that the owner of that field can pay. 
 
 If we assume, instead of ten fields of varying fertility, 
 one large, fertile field, giving employment to ten men, we 
 see exactly the same principle at work. One of the men, 
 cultivating the land extensively, may produce $500 ; a second 
 may add to this product $450 ; a tenth may add to the total 
 product of the nine previously employed only $150. The 
 employer will not pay the first $500, the second $450, and so 
 on down to $150. He will pay each one not more than $150. 
 If any one should demand more, he would be dismissed, and 
 his functions performed equally well by the man who other- 
 wise would have added only $150. What the employer loses, 
 when he loses any man of the ten, is the product created by 
 the least important one of them all. 
 
126 INTRODUCTORY ECONOMICS 
 
 We have, then, an upper limit of wages above which an 
 employer cannot be compelled to go : the addition to the 
 total output created by the man who works at the greatest 
 disadvantage. Is there, similarly, a lower limit? In the 
 situation we have assumed — a number of competing em- 
 ployers, each able to increase his employment of men 
 through breaking up new, though less fertile lands, or 
 through more intensive tillage of lands already under cul- 
 tivation — it is unlikely that any employer will make a large 
 net return on the last man he employs. Let us assume that 
 the uniform yearly rate of wages is $120, while the product 
 of the least important man varies from $120 on the least 
 fertile farms to $175 on the most fertile ones. The man who 
 has a fertile farm can increase his net income by offering a 
 little more than $120 for an additional workman. Such a 
 workman will not add $175 to the total output — the law of 
 diminishing returns forbids this — but he may add $170. As 
 the employer on the least fertile field secured a product of 
 only $120 from his last man, he is compelled to let a man go. 
 Perhaps the man who now becomes his least important hand 
 is worth $125 to him, and $125 may be what the man on the 
 next better field is worth. It still pays the farmer with the 
 best fields to seek additional hands. The wage he must now 
 offer is more than $125 — let us say, $130. And the addi- 
 tional men will be worth less to him — perhaps $165 each. 
 Competition will still go on between the employers having 
 the better fields and those having fields that are not so good, 
 each rise in wages affecting, of course, the wages of all the 
 workmen in the community. At last a point is reached 
 where no employer can take a workman away from his com- 
 petitor without offering a wage so high as to outweigh the 
 advantages to be derived from an additional employee. 
 Here, then, wages will tend to remain stationary. Each 
 employer will be paying his least important man so much 
 that any increase in wages would make that man an un- 
 profitable member of his working force. No employer 
 
INTRODUCTORY ECONOMICS 12/ 
 
 would care to take on an additional man at the existing rate 
 of wages. This means that on every farm the least im- 
 portant workman adds to the total product only enough to 
 cover his wages. The addition to product made by the man 
 working under the least favorable circumstances is, then, not 
 only the maximum that the employer can be compelled to 
 pay; it is also the minimum which he cannot avoid paying. 
 If we describe as the "product of labor" that amount of valu- 
 able products which is brought into being by the presence of 
 any particular laborer, we may say that, under competition, 
 wages are determined by the product of the laborer working 
 under the least advantageous circumstances (in this case, 
 on the poorest land). This laborer is known in economics 
 as the marginal laborer, as he is on the "margin" or fringe 
 of employment, as it were — in a position where his continued 
 employment is almost a matter of indifference to the em- 
 ployer, since his presence means neither profit nor loss. In 
 the customary economic formula, wages, under competitive 
 conditions, are determined by the marginal productivity of 
 labor (i. e., the productivity of the marginal workman). 
 
 Now let us assume that the number of workmen in the 
 community is increased by the immigration of equally ef- 
 ficient workmen from another part of the country. The new 
 men must have employment; and there is of course plenty 
 of work in the community for them to do — on one condition, 
 however. They must accept employment on fields yet poorer 
 than any now cultivated, or they must be added to the force 
 at work upon the better land, occupying themselves with 
 tasks that formerly were neglected. In either case they will 
 add less to the product than was created by the "marginal" 
 workman before the arrival of the new hands. They must 
 accept a rate of pay lower than that which formerly pre- 
 vailed ; else no employer could afford to hire them. And as 
 there will not be two rates of wages for equally efficient men, 
 the general rate for all the workmen originally employed in 
 the community must be reduced, If the immigration con- 
 
128 INTRODUCTORY ECONOMICS 
 
 linues steadily, other things remaining the same, the mar- 
 ginal product of labor, and with it the rate of wages, must 
 steadily sink. 
 
 Jf on the other hand some of the original landless popu- 
 lation had moved away, some of the worst fields would have 
 been abandoned, and it would have become impossible to 
 cultivate the better fields as intensively as before. On each 
 field the importance of the marginal man would have in- 
 creased. If any employer persisted in paying the old rate 
 of wages, his competitors, by ofifering a little more, would 
 have enticed his men away. The tendency for wages to rise, 
 with decline in the laboring population, would be as irre- 
 sistible as the tendency for wages to fall with an increase in 
 population. 
 
 It may be worth while at this point for us to consider 
 a position frequently taken by writers on the labor problem. 
 They assert that full and free competition must end in the 
 abject misery of the working population. One laborer, they 
 say, will ofifer to work at a trifle less than the prevailing 
 rate; soon another is compelled to limit his demands; and 
 eventually the whole body is forced, by the action of one cut- 
 throat laborer, to accept lower wages. These writers forget 
 that competition of employers also exists, and that one can 
 argue with equal cogency that any employer, by offering 
 higher wages, can compel all employers to raise wages. In 
 general we may say that competition, if full and free, neither 
 lowers nor raises wages ; it simply equalizes them. 
 
 Now let us suppose that in this community are found 
 extensive tracts of marshy land, of practically no eco- 
 nomic importance at all. A competent engineer enters the 
 community, and at a comparatively low expense drains these 
 lands and transforms them into the very best quality of till- 
 able soil. The owners of the drained lands must have labor, 
 and can bid a higher price than prevails generally. If the 
 laboring population remains stationary, the effect of the new 
 demand for labor is to withdraw men from the least favor- 
 
INTRODUCTORY ECONOMICS I29 
 
 able situations and place them upon the new land. On every 
 farm, the product of the marginal workman will be in- 
 creased ; and wages will rise accordingly. If immigration of 
 laborers is going on, the new demand for labor does some- 
 thing to counteract the effect upon wages of the new supply ; 
 if emigration is taking place, the rise in wages that would 
 otherwise occur is emphasized. 
 
 A similar influence may be exerted by a general im- 
 provement in agricultural practice. It is said that by the 
 use of seed corn which has been grown in an isolated field 
 from which all barren stalks have been removed before ma- 
 turity, the average yield of corn may be increased from ten 
 to thirty per cent. This increased yield is obtained without 
 additional labor, excepting a small amount entailed by the 
 care of the seed corn field. The use of such seed corn in the 
 community we are studying would increase the product of 
 every laborer, that of the marginal ones as well as of the 
 rest; and the competition of employers with one another 
 would force them to raise wages in the measure of the in- 
 creased marginal productivity. The introduction of a new 
 forage plant, like Kaffir corn or alfalfa, might have a similar 
 effect in increasing the productivity of the marginal laborers. 
 So also might the use of a new kind of fertilizer, or the in- 
 vention of a new agricultural implement. Almost all agri- 
 cultural improvements, in fact, are likely to have the effect of 
 increasing the productivity of labor and the rate of wages. 
 
 It is not in the least necessary that such improvements 
 find general application. An improvement increasing the 
 productivity of labor on one-tenth of the farms will gener- 
 ally lead to an increased demand for labor on those farms. 
 The demand is met by the withdrawal of labor from the 
 farms not affected by the improvement ; and this will result 
 in raising the productivity of the least favorably situated 
 laborers on those farms, and so will raise general wages. 
 
 Up to the present we have had no occasion to consider 
 the effect of changes in price upon the rate of wages. In our 
 
130 INTRODUCTORY ECONOMICS 
 
 agricultural community, the prices of produce are, we may 
 fairly assume, equal to the prices prevailing in the nearest 
 large city, less cost of transportation to that city. If through 
 some improvement in railway management or some change 
 in railway policy, the cost of transportation is reduced, the 
 local price of produce will be correspondingly increased. Be- 
 fore this change, we have assumed, the product of the mar- 
 ginal workman was worth just enough to cover his wages. 
 After the change, his product is worth more than this. His 
 wages must rise, for otherwise an active competition will 
 spring up among the employers. By a similar process of 
 reasoning, it would be easy to show that a rise in costs of 
 transportation, with a consequent fall in local prices, would 
 necessarily reduce the value product of the marginal la- 
 borer, and with it the rate of wages. 
 
 One other influence needs to be noted here : namely, a 
 fall in the rate of interest. There are few farms that could 
 not be made to yield a much larger product, if abundance 
 of auxiliary capital were to be had at a low rate of interest. 
 If a farmer must pay ten per cent, on borrowed money, he 
 cannot build a good barn or drain a marsh until he has ac- 
 cumulated a considerable amount of money of his own. In 
 the meantime opportunities for labor which would be thrown 
 open if capital were to be had at five per cent, lie untouched, 
 and the existing labor supply is spread over barren fields, 
 with consequent low productivity. Every reduction in the 
 interest rate creates a new demand for labor, and withdraws 
 part of the existing supply from the poorer fields, thus in- 
 creasing marginal productivity and wages. 
 
 We may now sum up the results of our study of wages 
 under the assumed conditions. Wages are determined by 
 marginal productivity of labor, but marginal productivity it^ 
 self is subject to many and varied influences, such as arise 
 from increase or decrease in number of laborers; increase 
 or decrease in the amount of available land; the progress 
 of improvements; the fluctuations in the interest rate. Let 
 
INTRODUCTORY ECONOMICS I3I 
 
 US now see how far we can apply the same reasoning to the 
 determination of wages under conditions nearer Hke those 
 of modern industry, confining ourselves, however, to those 
 parts of the industrial field in which competition exists 
 among employers on the one hand and among workmen on 
 the other. 
 
 The first fact that we must take into consideration is 
 that we cannot assume that in this wide field of industry 
 every workman can enter upon direct competition with every 
 other workman, and thus bring about an immediate equal- 
 ization of wages. The journeyman tailor cannot be replaced 
 by the excavator nor by the farm hand ; the cotton mill opera- 
 tive cannot take the place of the iron and steel worker. At 
 any given time, then, there may be many rates of wages, not 
 one universal rate. How the rate of wages for any partic- 
 ular class of laborers is determined we have now to consider. 
 In the next chapter we shall see how the rate paid in one in- 
 dustry may indirectly affect the rates paid in other industries. 
 
 Let us take, as our typical industry, cotton spinning — 
 an industry which still remains highly competitive. We may 
 safely say that one rate will prevail in any one district, as 
 the New England or the Lancashire centers. The movement 
 of workers from mill to mill is easy, and higher wages in 
 one mill would quickly attract workers away from other 
 mills. 
 
 Now, we cannot assume, as we did in our agricultural 
 example, that the different manufacturers can ascertain how 
 much their laborers are worth to them by simply dismissing 
 a few, and estimating the loss of product resulting. If a 
 mill works without a full complement of hands, a part of the 
 plant will be idle ; and a part of the loss will be due to this 
 fact. When a manufacturer is erecting a mill, however, he 
 can and must forecast the productivity, measured in value, 
 of labor. With a mill employing one hundred men, he can 
 figure upon a certain output. Probably he has business cour 
 nections which make it easy for him to secure a market for 
 
132 INTRODUCTORY ECONOMICS 
 
 that output. The price at which he will sell is of course 
 uncertain, but admits of approximation. He knows what 
 he must pay for capital, or if he proposes to use his own 
 capital, how much he could obtain in the way of interest if 
 he loaned it to some one else. He knows what he v/ill have 
 to pay for a manager, or if he intends to manage the mill 
 himself, what salary he could otherwise command in a mill 
 belonging to some one else. After calculating all such ele- 
 ments in cost, and subtracting their sum from the estimated 
 value of the product, he has a remainder which is a fair esti- 
 mate of the worth of the labor of a hundred men. Similarly, 
 he can calculate what a second or third or tenth hundred 
 men would be worth to him, if he should decide to erect a 
 larger mill. Possibly the second hundred men would be 
 worth more to him than the first, and the third more than the 
 second, owing to the economies of concentration which we 
 considered in the last chapter. As the projected plant in- 
 creases in size, a point is eventually reached where the manu- 
 facturer has to figure upon increasing difficulty in obtain- 
 ing capital, in managing so large a concern, in marketing his 
 product. Additional laborers will be worth less to him, 
 accordingly. 
 
 The first hundred workers employed may be worth to 
 the employer an average of $300 annually; the second may 
 so increase the product as to be worth an average of $350 
 annually ; the third, $400, and so on up to the sixth, who may 
 be worth $600. A seventh hundred may be worth only an 
 average of $550, and so on until a twelfth is again worth 
 only $300 annually. What size of mill will our enterpriser 
 decide to erect, and what rate of wages will he pay? Let 
 us assume that every year ten new mills are erected for every 
 hundred already in operation. Of course the enterpriser who 
 erects a new mill knows that the owners of the mills already 
 established will make considerable sacrifices in the way of 
 increased wages rather than see their complement of employ- 
 ees enticed away. He must therefore count either upon an 
 
INTRODUCTORY ECONOMICS 133 
 
 existing surplus of labor, trained to the business, or upon 
 new laborers who may be brought into the industry from 
 other fields. Assume that the aggregate supply of unem- 
 ployed cotton spinners and of untrained workers who can 
 readily be drawn into the trade is equivalent to 10,000 
 trained laborers for every hundred mills in the trade. The 
 projectors of the ten new mills can then calculate on 1,000 
 workers each. Each can pay his tenth hundred an average 
 of $400 annually. If one employer attempted to place the 
 figure at $350, he would find that his competitors would 
 enlarge their plants, and deprive him of this unit of labor; 
 if the men demanded $450, he would limit his employment to 
 900 men, and the superfluous hundred would have to seek 
 employment at disadvantageous terms from his competitors. 
 Thus we see that the prospective marginal productivity of 
 labor will play a chief role in determining what wages shall 
 be throughout the industry. 
 
 It is not necessary to go through our earlier reasoning 
 to show that an increase in the number of cotton operatives 
 will reduce the prospective marginal productivity of each 
 one, and with it general wages in the industry ; or that the 
 progress of improvements, changes in costs of transportation 
 and in interest rates must affect the marginal productivity of 
 labor. Nor is it necessary to seek for illustrations in other 
 fields of competitive industry. Everywhere we should find 
 the same principles at work ; uniformity of rewards for uni- 
 form services ; a tendency for wages to be set at the marginal 
 product of labor. Everywhere we should find that produc- 
 tivity tends to diminish and wages to fall when the number 
 of laborers increases, other things remaining the same; 
 everywhere a tendency for productivity to rise with increase 
 in artificial capital or in available natural resources. 
 
 But it is far from the truth to say that competition pre- 
 vails over the whole field of industry. There are problems 
 connected with the wages paid by monopolistic concerns; 
 with wages paid to persons who have no power to bargain on 
 
134 INTRODUCTORY ECONOMICS 
 
 even terms with their employers. We encounter, moreover, 
 a number of competing explanations of differences in wages. 
 In one industry wages are high ; if we inquire the reason, v/e 
 are told that it is to be found in the risks to life and limb 
 peculiar to the trade. In another industry we find high 
 wages ; we are told that the cause of this is the strength of 
 the trade union. If we desire an explanation of the fact that 
 wages are high in the United States and low in China, we are 
 often told that the reason is that the Chinaman will live on 
 rats and rice, while our workman must have three honest 
 meals a day. How do these explanations square with the 
 marginal productivity theory of wages sketched in the pre- 
 ceding pages ? This we shall consider in the next chapter. 
 
CHAPTER X 
 Influences Giving Rise to Differences in Wages 
 
 In the last chapter we arrived at the conclusion that in 
 so far as full and free competition exists, both on the side 
 of the employers and on that of the employees, wages tend 
 to a uniformity, and are determined by the marginal pro- 
 ductivity of labor. In practice, however, we seldom find 
 competition thus operating without check. In some cases a 
 workman has to rely for employment upon a single employer, 
 or a body of employers combined in a single organization ; 
 in other cases, an employer has to obtain his labor supply 
 from the membership of a trade union, which exists chiefly 
 for the sake of restraining competition among the workmen. 
 In yet other cases combinations of employers confront com- 
 binations of workmen, and the wages determined upon are 
 the result of a "collective bargain," which appears to express 
 rather the relative strength of the two parties than the pro- 
 ductivity of labor. 
 
 Even where two-sided competition exists within an in- 
 dustry, so that the productivity test obtains, we often find 
 that there are barriers which prevent any large number of 
 employers or of employees from entering the industry. In 
 early modern times there existed great trading companies 
 which enjoyed the exclusive right of trading in certain re- 
 gions—the East Indies, the Levant, the Hudson Bay terri- 
 tory. Any member of the company might fit out an expedi- 
 tion, and trade on his own account; all the profits he ob- 
 tained were his, not the company's. Thus there was compe- 
 tition within the company, and the earnings of a member 
 were in this sense competitive earnings. But persons who 
 were not members of the company were not allowed to trade 
 at all. Competition of outsiders was impossible; and thus 
 
136 INTRODUCTORY ECONOMICS 
 
 in some measure the earnings of all the members in the com- 
 pany were non-competitive — monopolistic. In a similar way, 
 in many trades competition among workmen is fairly active ; 
 but barriers of diverse nature exist to check outsiders from 
 entering the trade. Hence the earnings of those who are 
 in the trade are in one sense competitive, in another sense non- 
 competitive, or monopolistic. Our present concern is to give 
 due weight to these various considerations, and to determine 
 how far they merely qualify the theory laid down in the last 
 chapter, how far they impair its validity. 
 
 We may begin with an examination of cases in which 
 there are manifest inequalities of reward for equal services. 
 
 A large part of the ready-made clothing in the United 
 States is produced under the "sweating system." Under 
 one form of this system, the "manufacturer" buys the mate- 
 rials, but instead of having them worked up on his own 
 premises, turns them over to a contractor, who agrees, for a 
 stipulated price, to get the work done. The contractor then 
 distributes the work among the needy persons of his ac- 
 quaintance — those who are prevented by age, ignorance or 
 other disabilities from seeking employment outside of the 
 tenements in which they live. The lower the wage at which 
 these people can be induced to work, the higher the profits 
 of the contractor. He learns by experience to estimate the 
 depth of their poverty and the intensity of their need, and 
 makes his bargains accordingly. Among his clients are per- 
 haps some who depend upon him alone for employment — 
 Russian Jewish widows, fugitives from the cruelties and op- 
 pression of their native land. These will work blindly, un- 
 complainingly, for the most meager wage. What they will 
 receive will be barely enough to keep them alive, and the con- 
 tractor will make considerable profits out of their labor. 
 Others of his clients are less helpless; they may not have 
 children dependent upon them ; they may have a smattering 
 of the English language, and so may learn of other oppor- 
 tunities for employment; they may fall within the "sphere 
 
INTRODUCTORY ECONOMICS I37 
 
 of influence" of another sweating contractor, who will also 
 desire to secure their services. All these circumstances the 
 contractor will take into account, and will grade his wages 
 accordingly. Under the conditions, then, wages are paid, 
 not according to productivity, but according to need, in the 
 sense that those who are in the direst need are the most 
 wretchedly paid. 
 
 The above is perhaps an extreme case ; but one does not 
 need to have a very wide acquaintance with practical affairs 
 to know of instances which illustrate the same principle. 
 It is only where the workman is ready and able to change 
 employers whenever he feels that he is unjustly treated, or 
 where he is a member of an organization which insists upon 
 equal rewards for equal services, that an employer can be 
 forced to pay wages which correspond with the marginal 
 productivity of labor. Fortunately, the field in which such 
 conscienceless discriminations are made is a comparatively 
 narrow one, and grows still narrower with every improve- 
 ment in the material conditions and every advance in the 
 general enlightenment of the working classes. 
 
 Somewhat analogous is the case of unequal wages, paid 
 in different localities, for substantially equal services. In- 
 stances of such inequalities have been given in Chapter V. 
 We saw there how an enterpriser might gain important ad- 
 vantages by establishing a new branch of manufacture in a 
 locality where a supply of unemployed labor exists. Under 
 the circumstances, it cannot be said that wages at the outset 
 correspond with the productivity of labor. The enterpriser 
 may be able fully to man his works while offering a wage so 
 low that he makes a substantial profit even on the last work- 
 man employed. This advantage, as we saw, cannot long 
 continue. Other enterprisers will enter the field ; competition 
 among them will raise wages, until a point is reached where 
 no one can gain a profit by extending his operations and 
 employing more men. This means that in the end each will 
 be paying for marginal labor all that it is worth to him. 
 
138 INTRODUCTORY ECONOMICS 
 
 Wages, as we saw, may still be unequal in the different 
 localities. The abundance of natural resources — cheap coal, 
 water power, etc. — or proximity to m^arkets or to supplies of 
 raw miaterial, may give one locality a distinct advantage in 
 production over another, and this advantage will be reflected 
 in higher productivity of labor and higher wages. We need 
 look no farther for the reason why the American iron and 
 steel industries, enjoying unsurpassable deposits of ore and 
 coal, are able to pay higher wages than their Belgian com- 
 petitors, handicapped as are the latter by lean ores and 
 costly coal. 
 
 We may next consider the case of an industry controlled 
 by a monopoly. Here equal wages may be paid ; but there is 
 no reason for assuming that they will correspond with the 
 marginal productivity of labor in the industry. Indeed, this 
 is something we may be quite sure they will not do. Imagine 
 that a monopoly controlled the entire iron and steel manu- 
 facture of the United States. It might secure the services of 
 50,000 men comparatively cheaply, as there are at least 
 50,000 men who are so specialized by long service in the 
 industry that they would shrink from the prospect of seeking 
 other employment. A second 50,000 men would probably 
 include many who would find little difficulty in entering other 
 industries. To obtain the services of these, higher wages 
 must be paid; and this would exert a decided influence in 
 raising wages for those who are, as it were, committed to the 
 iron and steel industry for good or ill. This would be still 
 more true of a third 50,000; and to obtain the services of a 
 fourth set of 50,000 men the monopoly would have to ad- 
 vance wages considerably. Now the mere fact that the 
 fourth set of 50,000 men may create an increase in the 
 product which exceeds the wages demanded by them, is not 
 a sufficient reason why the monopolist should employ them. 
 The monopolist must set against the profit represented by the 
 increased output, the loss occasioned by the increase in 
 wages which will be demanded by the men already in his 
 
INTRODUCTORY ECONOMICS 139 
 
 employ. We may, therefore, say that a monopolist will cease 
 extending his operations at a point where the product of the 
 last laborers employed considerably exceeds the wages which 
 must be paid them. 
 
 Although there are no monopolies so absolute as our 
 imaginary iron and steel monopoly, the country is full of 
 enterprises that have a limited monopoly power. In all of 
 these the wages paid will fall somewhat short of marginal 
 productivity in the industry. Wages may, of course, still be 
 higher than in competitive industries; indeed, it is a com- 
 mon thing for a monopoly to strive to win a reputation as 
 a benevolent employer of labor. The monopoly, we may say, 
 limits the amount of labor that may be employed in the field 
 it controls, and thereby insures a high marginal productivity 
 of labor. Part of the excess of productivity it turns over 
 to the laborer in the shape of higher wages, in partial expia- 
 tion of its manifold sins against the public. The remainder 
 of the excess it retains, and adds to its profits. 
 
 We may now enter upon a study of the forces which 
 are responsible for the differences in wages in the various 
 trades and occupations. And here we encounter at the out- 
 set a difficulty which has not hitherto arisen to vex us. How 
 can we say what differences in general rates really exist? 
 In all our discussion up to this point, we have spoken of 
 equal rewards for equal services. Of course if one brick- 
 layer does twice as much work as another, he ought to re- 
 ceive twice the wages. The essential equality of wages re- 
 quires this. But if a tailor receives twice the wages of a 
 bricklayer, how can we say that it is because he does twice 
 as much work? Clearly, it is not possible to reduce tailor's 
 labor to terms of bricklayer's labor, so as to show whether 
 one is rewarded more liberally than the other. 
 
 Let us suppose that there are half a dozen occupations 
 in a community, all of which require of beginners about the 
 same degree of intelligence, dexterity, and strength, al- 
 though they differ as widely in their nature as bricklayer's 
 
140 INTRODUCTORY ECONOMICS 
 
 and tailor's labor, so that no direct comparison of wages is 
 possible. Is there any reason why differences in wages per 
 day should exist? At first, we should expect, the choice of 
 occupations would be more or less a matter of chance. A 
 boy would enter one of the trades because his father exer- 
 cised it; another, because his best friend intended to enter 
 it, and so on. 
 
 Once in the trade, a man would have to remain there, 
 unless he wished once more to go through the tedious tasks 
 of a beginner. The different trades would thus be walled 
 off, as it were, one from the other. Mature reflection might 
 convince a man that he had made a mistake in choosing his 
 trade ; but this would not mend matters. His earnings would 
 be wholly subject to the laws of his trade. If many men 
 happened to be in the trade, and the demand for their ser- 
 vices were limited, some of them would have to be set at 
 unimportant tasks, which could not be well remunerated. 
 And competition among the men would force wages down 
 to the level of remuneration of these. If the trade were but 
 scantily supplied with men, even the least important of them 
 all might be employed at work that could pay a high reward, 
 and so a high rate of wages would prevail. In each trade 
 the rule that marginal productivity determines wages would 
 apply ; but marginal productivity would be unequal, for men 
 of equal native ability, in the different trades. 
 
 In every trade, however, a constant supply of new re- 
 cruits is necessary to keep its ranks full. And the prospec- 
 tive apprentice has at any rate some freedom of choice. In 
 one trade, he finds men discontented and impoverished; in 
 another trade, he finds every appearance of prosperity. Un- 
 less he is very blind, he will choose a trade in which the lat- 
 ter condition prevails. So the tide of apprentices sets stead- 
 ily away from the underpaid trades, and in the direction of 
 the better paid ones. Failing numbers, in the former trades, 
 raise the marginal productivity of labor ; increasing numbers, 
 in the more prosperous trades, reduce wages there. Whether 
 
INTRODUCTORY ECONOMICS I4I 
 
 this process will continue until perfect equality of rewards is 
 established for men of equal native ability in different trades, 
 we cannot say. The equalization depends upon the good 
 judgment of the prospective apprentices in their choice of 
 trades ; and these, like all men, are likely to err. But gross 
 inequality, under the circumstances, could hardly long 
 persist. 
 
 Some of the differences in wages actually existing ap- 
 pear to be fortuitous, as those assumed in the foregoing ex- 
 ample. But some of these differences are clearly connected 
 with the personal qualifications of the workman — his 
 strength and skill, his intelligence and reliability. Others 
 are connected with the different degrees of risk, agreeable- 
 ness, and dignity of the employment itself. Still others de- 
 pend upon trade union requirements, or legal restrictions. 
 What we are concerned with here, however, is not to classify 
 the causes of differences in the wages paid in different occu- 
 pations, but to see exactly how these causes operate. 
 
 We know, for example, that a dangerous occupation is 
 likely to carry with it a higher remuneration than a safe one ; 
 that an occupation requiring a long apprenticeship is 
 ordinarily better paid than one requiring practically no train- 
 ing at all. Why may we not say, then, that a part of a man's 
 reward is for labor, part of it for risk? If a tedious appren- 
 ticeship is necessary, may we not say that part of the reward 
 of the journeyman is a compensation for the time and trouble 
 spent in learning the trade? Such an explanation would be 
 quite satisfactory if we actually found that, other things equal, 
 wages were nicely graded according to risk, or to length of 
 the period of apprenticeship — if, for example, we found that 
 a workman in an occupation involving no appreciable risk re- 
 ceived a wage represented by jir; an equally efficient work- 
 man in an occupation involving a considerable risk received 
 X -{- y, and a third workman, in an occupation twice as dan- 
 gerous as the second, received x -\- 2.y, and so on. But we do 
 not find in real life any such simple rule as this. Danger- 
 
142 INTRODUCTORY ECONOMICS 
 
 ous occupations, we often find, are very ill paid in compari- 
 son with occupations requiring no greater natural ability and 
 entailing no risk worth speaking of. Almost the least remun- 
 erative occupation that an able-bodied citizen of the United 
 States can engage in is that of soldier, and this in spite of 
 the fact that the Federal Government prides itself upon being 
 a liberal employer. Certainly the risks of the occupation are 
 considerable. A man who accepts employment as trainman 
 on the American railways stands one chance out of one hun- 
 dred and twenty of meeting a violent death within a year, 
 and one chance out of nine of being injured. His average 
 daily compensation will vary from $2.09, if he is a fireman, 
 to $4.25, if he is an engineer. In either case, he is a man of 
 more than average physical strength and general intelli- 
 gence. If he is an engineer, he is also a man who has at 
 least as much training as the average skilled laborer. What 
 we really find is that in some cases no allowance appears 
 to be made for risk; in more cases some allowance appears 
 to be made for it, but that there is no apparent tendency 
 for this allowance to vary regularly with the degree of risk. 
 Similarly with different degrees oi skill. Ordinarily, the 
 skilled laborer, who has undergone a long apprenticeship, 
 receives a higher reward than the unskilled laborer of equal 
 native intelligence. In some cases, however, this does not 
 appear to hold true; and it is idle to attempt to show that 
 there is any ascertainable proportion between degrees of 
 skill and differences of remuneration. So also with disagree- 
 ableness of work. Little, if any, allowance is ordinarily 
 made for it in wages, although in some cases it seems to 
 play a very important part. Clearly, then, it is not enough 
 to say that wages are affected by risk, by skill required, by 
 disagreeableness of occupation. We must know how these 
 causes operate, and why they operate with such irregularity. 
 Let us see if a concrete example will not make clear the 
 relation risk actually bears to wages. Imagine that a gun- 
 powder factory is erected at a distance of a few miles from 
 
INTRODUCTORY ECONOMICS 143 
 
 a city of some size. And let us suppose that five hundred 
 workmen will be required, and that they will be of a grade 
 of skill that would command an average of $3 a day in per- 
 fectly safe occupations. How much will it be necessary to 
 add to this sum, to induce them to enter the powder works? 
 Now, the first question that is likely to arise is : How 
 much danger is there that the works will blow up? You 
 do not know this ; neither do I ; nor, we may venture to say, 
 do the workmen whom it is sought to employ. Perhaps 
 there is no danger at all in the present stage of the powder 
 manufacture. Powder mills have often blown up, however, 
 and most of us would prefer to stay out of them. 
 
 In every community, there are some men who do not 
 seem to be in the least afraid of danger. They may know 
 that destruction has befallen others ; but, each argues, every- 
 body can't be killed; why should I be? Such men have su- 
 preme confidence in their luck. Danger, real or imputed, 
 does not influence their conduct. Now, if there are a thou- 
 sand men of this kind in the city, it will be quite possible to 
 man the powder mill without offering any more of an ad- 
 vance in wages than would have to be offered by an enter- 
 priser who proposed to establish a new shoe factory or nail 
 mill. The powder manufacturer, as any one else starting a 
 new enterprise, will offer wages a little higher than those 
 prevailing in the city— ten cents more per day, perhaps. Not 
 every one will jump at the chance to improve his wages; 
 but the men who despise danger will one by one leave their 
 former employments and enter the doors of the powder mill. 
 Presently wages will be reduced to the general level. No 
 man will for this reason leave the mill, nor need the enter- 
 priser care if a few should do so, for there are still plenty 
 of men in the city who are not disturbed by fear of accident. 
 But suppose that instead of one thousand such men, 
 there are only one hundred. The powder manufacturer will 
 find that ten cents extra a day fails to bring the full com- 
 plement of men. Perhaps he will offer twenty-five cents ex- 
 
144 INTRODUCTORY ECONOMICS 
 
 tra ; and this may bring another hundred men, who fear for 
 their lives, indeed, but desire the additional income ex- 
 tremely. An additional twenty-five cents may bring another 
 hundred, more timid or less eager for high wages. At the 
 rate of $i a day above the prevailing rate, the enterpriser 
 may be able fully to man his works. 
 
 Now, we may ask ourselves, is this extra dollar a com- 
 pensation for risk? Remember, there may be no real risk 
 at all ; and it may be that it is nothing but the name of pow- 
 der that has kept the workmen back and forced up wages. 
 And how is it that a powder manufacturer is able to pay 
 men for risk, at their own estimate — very likely a mistaken 
 one, too? Well, the powder manufacturer is experiencing 
 the ordinary incidents of his business. Everywhere powder 
 manufacturers have to contend with the same indisposition 
 on the part of the ordinary workman to enter their mills. 
 Everywhere the amount of available labor is limited, rela- 
 tively to the demand for it. And so the productivity of a 
 laborer, measured in value of powder produced, is high, and 
 wages may be high accordingly. If, however, the number 
 of men who do not mind the danger were sufficient fully 
 to man all the powder works, more powder would be pro- 
 duced ; its value would be less, and the productivity of labor, 
 in value, would fall until it corresponded with that of labor 
 in other occupations requiring equal skill. 
 
 If the risks to life and limb undergone by locomotive 
 firemen and engineers were reduced by fifty per cent., 
 through the introduction of better safety appliances, the 
 improvement of track, etc., how much could wages be re- 
 duced ? I have never heard of a railway president who pro- 
 posed to spend the company's money in reducing the chances 
 of accident, with the expectation that part of the cost might 
 be met by a reduction in wages. Nor do we find that wages 
 are particularly high in the sections of the country where 
 transportation is conducted at the greatest cost in life and 
 limb. Here, it appears, is a case in which a great industry 
 
INTRODUCTORY ECONOMICS 145 
 
 is able to rely upon the existing supply of men who bear 
 risks cheerfully, without any extra compensation. The mar- 
 ginal laborer, in transportation, is no more productive than 
 the marginal laborer in general industry ; therefore he is no 
 better paid. 
 
 The case is similar with disagreeable labor. Certainly 
 men ought to have extra compensation for engaging in work 
 that is dirty and malodorous. But if the amount of such 
 work in a community is small, a very slight advance in 
 wages is usually enough to draw a sufficient supply of labor- 
 ers from other occupations. If the amount is large, part of 
 the working force must be recruited from among the more 
 fastidious. Higher wages must be paid. Here again we 
 may ask : How can the enterpriser afford to pay higher 
 wages for this kind of work? And the answer is the same. 
 As labor is relatively scarce, its productivity is relatively 
 high. 
 
 The principles which explain the higher rewards that 
 are usually received by skilled laborers are not essentially 
 different. Where a long apprenticeship is necessary, only 
 those young men who have sufficient perseverance to work 
 through several years without pay, and who are sufficiently 
 free from family obligations to be able to do so, can enter 
 the trade. Here is a barrier which, unlike that of risk, can 
 be surmounted by none without some difficulty. There will 
 not, ordinarily, be any one who will set patiently about ac- 
 quiring skill, without a reasonable expectation that he will 
 earn higher wages than he would have been able to earn 
 as an unskilled laborer. Men in the skilled trades are hence 
 relatively scarce; their productivity is relatively high. 
 
 If, however, a position requiring skill is one of superior 
 dignity, or if the work to be performed is of a peculiarly 
 agreeable nature, the number of men who will undertake 
 the burden of a long period of preparation may be so great 
 that the productivity of each and his reward will be 
 insignificant. 
 
146 INTRODUCTORY ECONOMICS 
 
 If entrance to a trade is controlled by the men who are 
 already exercising the trade, we may be quite sure that in 
 one way or another the barriers to be surmounted by the 
 aspirant to a place in the trade will be made more formid- 
 able. If, for example, the existing body of carpenters were 
 given the right to admit to the exercise of the trade only 
 those whom they chose to admit, the number of apprentices 
 would be narrowly limited indeed. Carpenters' labor would 
 become relatively scarce ; its productivity would be increased, 
 and wages would rise accordingly. We do not to-day have 
 trades that actually control apprenticeship in this absolute 
 way. But we do find, in many parts of the country, that 
 trade unions insist upon a limitation by the employer of the 
 number of apprentices, and that they are able to enforce 
 their demands in this respect. We also find, in many cases, 
 that they hedge the employment of apprentices about with 
 so many restrictions that an employer can hardly afford to 
 have apprentices in his works. In some cases heavy fees 
 are exacted from men who wish to become members of a 
 trade union ; and persons who are not members of the union 
 are not permitted to work at all. Most trade unions are bit- 
 terly hostile to the establishment of trade schools by the 
 state. This monopolizing tendency is not by any means con- 
 fined to the trade union. It is reported that in Germany the 
 medical profession is clamoring for a restriction upon the 
 number of students to be admitted to the medical courses. 
 There are, it is said, so many physicians and surgeons in 
 Germany that it is difficult for most of the members of the 
 profession to make a living. 
 
 Apart from positive limitations of the nature described, 
 such high qualifications may be prescribed by those already 
 in a trade or profession that the number of new members will 
 be narrowly restricted. In the middle ages, before a man 
 was permitted in certain crafts to attain to the position of 
 an independent master workman, he was required to prove 
 his finished skill by the execution of a typical piece of work 
 
INTRODUCTORY ECONOMICS 147 
 
 —his "masterpiece." The purpose of the masterpiece, orig- 
 inally, was to insure a high grade of workmanship ; and its 
 character was naturally prescribed by the masters already 
 in the trade. But when those in the trade felt that there 
 were masters enough, they sometimes prescribed a master- 
 piece so difficult, or requiring such expensive materials, that 
 an ordinary journeyman was effectively excluded from the 
 mastership. To-day, although we have no masterpiece re- 
 quirements, we do, in some cases, require the passing of an 
 examination before a man is permitted to enter upon the ex- 
 ercise of a trade. This also is designed to secure good 
 workmanship. But it is easy to see how entrance examina- 
 tions may be so distorted from their original purpose as to 
 establish a restriction upon entrance to a trade. Such re- 
 strictions have the effect of raising productivity within the 
 trade. At the same time, they, of course, make it necessary 
 for the rejected candidate to seek some other employment, 
 which, very probably, is still more overcrowded. They in- 
 crease productivity in one trade at the expense of a reduc- 
 tion of productivity in another. Whether from a public 
 point of view this is justifiable or not does not concern us 
 here. What we need to hold clearly in mind is the way in 
 which such restrictions work. 
 
 Now let us suppose that a trade union, instead of limit- 
 ing directly the number who practice the trade, fixes a stand- 
 ard wage, and prevents any man in the trade from working 
 for less. Can we say that this is a matter concerning merely 
 the workman and his employer ; that if the workman receives 
 a higher wage, the employer receives lower profits? By no 
 means. If the union controls the entire trade throughout 
 the country, fixing a uniform wage, the employer is, as a 
 rule, injured very little, if at all. The effect of the estab- 
 lishment of a fixed wage is to put a stop to all work in the 
 trade where the productivity of labor is not equal to the 
 wage set. Perhaps this will leave unemployed some of the 
 men capable of practicing the trade. These will have to seek 
 
14^ INTRODUCTORY ECONOMICS 
 
 Other occupations, reducing productivity there. The rule that 
 wages tend to be equal to the marginal productivity still 
 holds; although in this case it is marginal productivity that 
 adjusts itself to wages rather than wages to marginal 
 productivity. 
 
 Finally, we may consider the effect of the so-called 
 ''standard of living" upon productivity and wages. There 
 are some who believe that wages are adjusted to the average 
 needs of the workman; and if these needs increase, wages 
 must rise. What a man feels that he ought to have, in the 
 way of the material necessaries and comforts of existence, 
 is his standard of living. This, according to certain op- 
 timistic social philosophers, he will get. Accordingly, if you 
 are modest in your demands, you will receive a modest 
 stipend; if you are convinced that the world owes you not 
 only a living, but a good living, the world will kindly ac- 
 commodate itself to your view of the matter. Certainly, this 
 theory is a far more agreeable one, and far easier to grasp, 
 than the laborious one presented in this and the foregoing 
 chapters. How much truth is there in it? 
 
 If you are planning to become a physician, you are likely 
 to seek the advice of some who are now practicing the pro- 
 fession. You will probably receive some such advice as 
 this: "Whatever you do, don't make a physician of your- 
 self. A physician must dress well ; he must live in a good 
 house ; he must keep a carriage ; in short, he must live at great 
 expense. And in the majority of cases, he will find great 
 difficulty in obtaining an adequate income." Now, what this 
 means is that physicians have a comparatively high standard 
 of living, and that their average incomes are scarcely suf- 
 ficient to meet all the demands upon them. You may not be 
 deterred by the doleful account of the physician's financial 
 difficulties. But is it not probable that, in the length and 
 breadth of the land, hosts of young men are in this way 
 turned to other professions ? If, on the other hand, the ma- 
 jority of physicians were recommending their profession as 
 
INTRODUCTORY ECONOMICS 149 
 
 one in which a good Hving is assured, is it not likely that 
 many young men would be attracted to the profession? 
 In the former case, the average income of the physician is 
 likely to be increased by the growing scarcity of competent 
 medical men; in the latter case it would be likely to be de- 
 creased, by increase in numbers. 
 
 If, then, the earnings in a profession or trade are not suf- 
 ficient to command, on an average, the necessaries and com- 
 forts that are deemed essential to happiness, some influence 
 is exerted upon those entering the profession or trade. The 
 standard of living thus exerts some slight influence, at least, 
 upon wages. 
 
 In the example just given, the effectiveness of the stand- 
 ard of living in one profession depended upon the absence 
 of a similar standard in other professions. Suppose that 
 after getting the opinion of a physician as to the advisability 
 of entering his profession, you apply to a lawyer for his 
 opinion on law as a profession. "Whatever you do, avoid 
 the law," he will probably tell you. Next, you go to one 
 who has chosen journalism. *'I pity a young man who se- 
 lects journalism as his profession," is probably what you 
 hear. Then you go to a teacher. He shakes his head. "If 
 I were a young man, I should choose some other profession." 
 Indeed, if you do not happen upon one of the few optimists 
 who still survive, you are likely to conclude that you may as 
 well choose the profession toward which you were originally 
 inclined, since all the professions seem to be inadequately 
 paid. The fact is that most of us think that we need more 
 than we get ; and the result is that no one profession is able 
 to frighten aspiring youths into choosing some other line 
 of activity. The standard of living of any profession, there- 
 fore, has little effect upon its average earnings. 
 
 Suppose, however, that a whole nation, practically, is 
 afifected by this feeling of discrepancy between income and 
 need. A considerable proportion of its young men will 
 marry late or not at all ; children will be few, and, if immi- 
 
ISO INTRODUCTORY ECONOMICS 
 
 gration is not active, the population will gradually decline. 
 In every occupation, men will be withdrawn from the less 
 important tasks ; the less fertile fields and the less productive 
 mines will be abandoned. The marginal productivity of 
 labor, and the average rate of wages, will increase. On the 
 other hand, if a nation consists of people who will thank- 
 fully receive little if they cannot get much, who will forego 
 one luxury or comfort after another rather than change their 
 traditional mode of life, no check upon population will exist, 
 until the bare necessaries of existence are insufficient for all. 
 Here, as elsewhere, it is because the productivity of labor is 
 low that wages will be low. Such people will obtain only a 
 bare minimum of existence, because that is all the marginal 
 laborer is worth, not because that is all he needs. 
 
 We may now sum up the principles which we have 
 sought in the foregoing long array of apparently unrelated 
 examples. The marginal productivity of labor is in most 
 cases the immediate determinant of wages. Risk or dis- 
 agreeableness of labor, the skill required, the barriers to be 
 surmounted, the standard of life, may all affect the rate of 
 wages, but only in so far as they afifect the marginal pro- 
 ductivity of labor, through determining its supply. 
 
CHAPTER XI 
 Capital 
 
 Perhaps the most confusing term with which the stu- 
 dent of economics has to deal is ''capital." Almost every 
 writer on political economy has an independent view of what 
 the term capital really includes. One writer, for example, 
 assures the student that land can never be capital, while an- 
 other asserts that it is always capital. One authority de- 
 clares that a dwelling house is not capital, while another is 
 certain that such a house is as much a part of capital as is 
 any other form of wealth. When scientific writers disagree 
 as to the meaning of a word, the best plan is often to return 
 to the speech of the plain man, and find what the word means 
 on his lips. Let us ask the plain man what he means by 
 "capital." 
 
 Suppose that we number among our acquaintances a 
 clothing merchant. We ask him what he means by his capi- 
 tal. "My capital," he will probably say, "is the money T 
 have in the clothing business." If we question him further, 
 he will admit that by "money" he means not actual coins 
 or bills, but money's worth, in one form or another. Still 
 further questioning will probably lead our merchant to give 
 something like an inventory of his stock, a valuation of his 
 building, an estimate of the "good will" attaching to the busi- 
 ness (i. e., the value of the steady patronage which the con- 
 cern has won for itself through upright dealings in the past). 
 
 It is certain that the merchant will place in his inventory 
 each one of the suits of clothes which he has for sale. But 
 we cannot safely infer from this fact that a suit of clothes, 
 as such, is capital. For if the merchant decides to take away 
 one of them for his own wear, he no longer counts it as 
 capital at all. The same thing is true of the suits of clothes 
 
152 INTRODUCTORY ECONOMICS 
 
 that pass into the hands of his customers. Though the mer- 
 chant may assure each customer that a particular suit is a 
 "fine investment," he knows in his heart that he is speaking 
 in metaphor; and this the customer knows as well. 
 
 Thus it appears that whether a thing is capital or not 
 must depend, not on the nature of the thing, but on the pur- 
 pose for which it exists among a man's possessions. If 
 for sale or for use in connection with one's business, it is 
 capital ; if for the personal use of the owner, it is not capital. 
 
 But this is only the beginning of the perplexity. A year 
 later you may ask the same merchant what his capital now is. 
 Very likely it is still $100,000. Now, is this the same capital, 
 or is it a new one ? The merchant certainly will say that it is 
 the same capital — unless, of course, he has lost, in the course 
 of the year, his original capital and has replaced it from some 
 new source. But how can the capital be the same after the 
 lapse of a year? Nearly all the things that figured in the 
 first inventory, except the building and the good will, have 
 been replaced, in the second inventory, by objects which may 
 be of a quite different character. In the first inventory, per- 
 haps, cheap grades of goods preponderate; in the second 
 these may be largely replaced by higher grades. However 
 this may be, there can be no denying that the goods have 
 changed, yet the merchant says that the capital is the same. 
 
 Perhaps we are making ourselves unnecessary difficul- 
 ties in our endeavor to arrive at the merchant's meaning 
 when he says that his capital remains the same even after 
 most of the things originally composing it have left his pos- 
 session. Perhaps he means simply that he has as large a 
 capital at one time as at another. Two things that are equal 
 in magnitude are of course not the same thing, but we often 
 speak of them as if they were. 
 
 Yet if we reflect upon it, this does not appear to be what 
 the business man means. Suppose that fire or flood had 
 destroyed his store and stock, and that a rich relative, to set 
 him on his feet again, had given him $100,000 to replace 
 
INTRODUCTORY ECONOMICS 153 
 
 them. The merchant would not say that he was continiiing 
 in business with the same capital, although in magnitude it 
 would be the same. Clearly, a business man thinks of his 
 capital as something that is capable of remaining perma- 
 nently the same although the goods that compose it are 
 constantly changing. And this conception we shall adopt, 
 as it is, on the whole, one of the simplest of all that have 
 been proposed, and one which gives perhaps a better ap- 
 proach to the problems connected with capital than would 
 any other. We may define capital, then, as a fund of pro- 
 ductive wealth, which has the power of self-perpetuation. 
 To quote from Professor Clark, "we may think of capital 
 as a sum of productive wealth, invested in material things 
 which are perpetually shifting — which come and go con- 
 tinually — although the fund abides. Capital thus lives, as 
 it were, by transmigration, taking itself out of one set of 
 bodies and putting itself into another, again and again."* 
 
 These material objects, in which a fund of capital is in- 
 vested, do not, in ordinary language, bear a characteristic 
 name. Following Professor Clark, however, we shall call 
 them "capital goods." A merchant's stock in trade, his 
 building, the land upon which his building is situated, are 
 capital goods. That part of the merchant's capital which re- 
 sides in his stock may change its material embodiment a 
 dozen times a year ; that part which resides in the building 
 may not wholly change its form in less than fifty years ; that 
 which is invested in land may remain unchanged for an in- 
 definite period. Thus, according to the character of the 
 capital goods, "transmigration" from one material form to 
 another takes place with greater or less frequency. 
 
 Let us now try to see, in the concrete, what this process 
 of "transmigration" really is ; we shall then be able to arrive 
 at a clearer view of the nature of capital. An enterpriser 
 possessing $100,000 in cash proposes to establish a clothing 
 store. The first thing he must consider is the best location 
 "^The Distribution of Wealth, pp. 1 19-120. 
 
1^4 INTRODUCTORY ECONOMICS 
 
 for his business. He must find a place where, he has good 
 reason to believe, the goods in which he proposes to deal will 
 sell at a higher price than that which he must pay for them. 
 This, of course, is comparatively easy to do Goods, as they 
 come from the factory, may in a physical sense be ready for 
 use ; economically, however, much remains to be done before 
 they can be placed where they will fulfil their ultimate pur- 
 pose — -the direct satisfaction of human wants. They must 
 be conveyed to places where they are accessible to the con- 
 sumer; they must be so arranged that inspection is easy. 
 Expert clerks must be at hand to point out their good quali- 
 ties and explain away their bad ones. This means that a 
 considerable addition to the value of goods may be made 
 after they have left the factory; and this addition, properly 
 speaking, is the product of the mercantile establishment as a 
 whole. 
 
 We need not stop simply with the affirmation that this 
 increase in value is the product of the mercantile establish- 
 ment in its entirety. Part of it is the product of the clerks 
 and of the labors of the enterpriser himself ; part of it is the 
 product of the building in which the goods are housed ; of 
 the counters and shelves ; of the display windows ; of the 
 elevators and the lighting and heating apparatus. And while 
 it would be difficult, after the establishment is under way, to 
 appraise exactly the services of each laborer and each ap- 
 pliance, the enterpriser must, at the time when he founds his 
 business, form some idea of what these services will be, in 
 order that he may adjust his outlay accordingly. 
 
 Each item of the stock ought to sell at a price which will 
 at least replace that item with one of equal value, together 
 with a surplus which will cover the cost in labor employed 
 in handling it, and which will also make some contribution 
 to the expense of keeping up the building. Any item which 
 does not do this is carried at a loss ; and a business man who 
 should continue to carry such items would be in danger of 
 seeing his capital diminish, and perhaps ultimately disappear. 
 
INTRODUCTORY ECONOMICS 155 
 
 Some parts of the stock may afford a far larger surplus, and 
 the aggregate income of the establishment may be much 
 more than enough to keep stock and store intact, after pay- 
 ing for all human services directly employed. The nature 
 of this excess of income above outlay we shall consider at 
 a later point. For the present we are concerned primarily 
 with the fact that the first demand upon the business is that 
 each item should maintain itself — i. e., through sale, repro- 
 duce itself together with auxiliary costs connected with it. 
 
 We may in a similar manner follow in imagination the 
 process whereby capital persists through transmutation in 
 a manufacturing establishment. An enterpriser with $ioo,- 
 000 in cash decides to erect a cotton mill. The difference 
 between the aggregate value of the product — cotton yarn — 
 and the value of the raw cotton represents the gross value 
 product of the mill. And this product is in part due to labor, 
 in part due to machines and building, fuel and power plant. 
 Each grade of yarn produced in the mill should, at the 
 very least, replace through its selling price the raw cotton 
 and fuel consumed, the wear and tear of machines and other 
 appliances, and the cost of the labor employed in connection 
 with it. The enterpriser will quickly discontinue the pro- 
 duction of a grade of yarn which does not do this. Some 
 of the grades — probably all — will produce a surplus above 
 the costs which have just been enumerated. 
 
 This surplus, as well as the sums necessary for the 
 repair of building and machinery, the replacement of raw 
 material and fuel consumed, first appears in the selling price 
 of the cotton yarn. This selling price is the joint product of 
 the labor, materials, fuel and machines; and the manufac- 
 turer must be able to estimate how much each machine, each 
 bale of cotton, each ton of coal, contributes. Every capital 
 good must produce a value at least equal to its own before it 
 wears out. Otherwise there results to the manufacturer a 
 net loss from its use. 
 
 It must now be clear how it is that a fund of capital 
 
156 INTRODUCTORY ECONOMICS 
 
 persists. Each capital good, before it is sold or worn out, 
 produces a sum of value that enables the owner of the good 
 to purchase or make another good of the same character, 
 which in its turn possesses the power of replacing itself by 
 a successor of equal value. The capital goods of this year 
 are therefore not merely the successors in time of those of 
 last year, now mostly destroyed. They are, economically, 
 the offspring of the capital goods of the earlier period, and 
 they inherit from their predecessors the same power of re- 
 placing themselves with other goods having the power of 
 self-replacement. 
 
 It is, of course, to be understood that this self-replace- 
 ment is neither automatic nor inevitable. We may say that 
 under certain conditions a particular capital good will add 
 something to the total product of an industry, but not enough 
 to keep itself in repair and replace itself when worn out. 
 Under other conditions a capital good will just do this ; un- 
 der still other conditions a capital good will add to the 
 product of an establishment not only enough for its own 
 repair and replacement, but a surplus besides. Experience 
 has taught enterprisers how to avoid the employment of 
 capital goods that do not maintain themselves, and of those 
 that do nothing more than this. Mistakes are of course 
 sometimes made, but not so frequently as to invalidate the 
 statement that capital goods, as a rule, reproduce them- 
 selves economically through the values which they create. 
 Intelligent action on the part of the owner of such goods is 
 essential to the truth of this proposition; but such action 
 may generally be taken for granted. 
 
 But perhaps it is not yet entirely clear that the capital 
 to-day embodied in a merchant's stock is essentially the same 
 capital that will exist a year hence, when the concrete capi- 
 tal goods will all have changed. An illustration from a 
 related field may help to remove the difficulty. A man has 
 in his purse, let us say, a one hundred dollar bill; he ex- 
 changes it for ten gold eagles. Does he continue to have the 
 
INTRODUCTORY ECONOMICS 1 57 
 
 same hundred dollars ? For all practical purposes, yes. The 
 hundred dollar bill represented a certain purchasing power ; 
 the ten eagles represent not a new purchasing power, but 
 identically the same one. True, the eagles may happen to 
 be a more convenient form in which to clothe this purchas- 
 ing power. So a merchant may have $ioo of his capital in 
 the form of shoes, let us say. To-morrow he may part with 
 the shoes for cash, with which he may purchase hats. Again 
 the capital is turned into cash ; again it is reinvested in capi- 
 tal goods. The hundred dollars worth of capital with which 
 we started represented a certain amount of productive 
 wealth. Soon it took the form of money, only to be trans- 
 formed again into goods, and so on indefinitely. The hun- 
 dred dollars after each act of exchange is not a new produc- 
 tive power added to the wealth of its owner ; it is a new form 
 assumed by the original productive power. 
 
 A threshing machine may continue in good order for 
 ten years ; at the end of that time it begins rapidly to run 
 down, and after fifteen years of operation it may have to 
 go to the scrap heap. In the fifteen years of the machine's 
 life it probably yields, as we have seen, a sum at least suf- 
 ficient to replace itself. This sum will begin to accumulate 
 in the early years, existing first as a part of the product 
 which the machine assists in creating — threshed wheat — 
 then in the form of money, the price of the wheat. It is 
 unlikely that the owner of the machine will keep the replace- 
 ment fund in the form of idle cash; more probably he will 
 transform it into some other form of productive wealth — 
 cattle or hogs, perhaps. Long before the machine is worn 
 out these have reached maturity and have been sold, and the 
 proceeds of the sale reinvested. If we look at the process 
 from an economic viewpoint we shall see the threshing ma- 
 chine gradually transforming itself into an increasing herd 
 of live-stock. When at last the machine is abandoned, the 
 capital formerly resident in it exists in the form, let us say, 
 of a herd of cattle. This capital may be transformed into 
 
158 INTRODUCTORY ECONOMICS 
 
 cash through sale, and the money may in turn be exchanged 
 for another threshing machine. Or, the money may be used 
 to purchase shares in an ironworks or a weaving mill. In 
 the latter case we have an instance of capital shifting from 
 industry to industry. 
 
 We have seen how capital, once in existence, perpetuates 
 itself; we must now discover the conditions under which 
 it comes into existence. It may^at first appear that capital 
 comes into existence whenever a productive instrument is 
 created. Reflection shows, however, that this cannot be 
 true, for a new capital good often merely embodies the capi- 
 tal formerly existing in a capital good which has reached 
 the limit of its usefulness. 
 
 When a man employs, in producing a tool or a stock of 
 the materials of production, time which he would otherwise 
 have used to procure for himself the means of immediate 
 enjoyment, he is creating capital. These capital goods are 
 not merely replacing capital goods previously existing; they 
 are a net addition to the stock of productive wealth at the 
 command of society, which like other capital goods will 
 for the future maintain themselves. When a man uses, to 
 employ workmen in the production of capital goods, a part 
 of his income which he would otherwise have spent for con- 
 sumer's goods, he is causing new capital to be created ; or, 
 we may say, he is indirectly creating capital. When he uses 
 part of his income to buy capital goods that are already 
 in existence, he is creating new capital by a still more in- 
 direct process. Thus if a man buys a threshing machine out 
 of his savings, he places in the hands of the manufacturing 
 company purchasing power with which the company can hire 
 men to make another machine. The process of creating new 
 capital may take a yet more roundabout course. The man 
 who saves may invest his savings in a share of railway stock 
 — which is nothing more than an evidence of ownership of 
 property already existing. The man who sells the share of 
 stock may use the proceeds to buy a share in a manufac- 
 
INTRODUCTORY ECONOMICS 159 
 
 turing company. Here again it is evident that nothing new 
 is created. The seller of the manufacturing stock may, how- 
 ever, use the money to buy a share in a new manufacturing 
 company, and this company may employ the proceeds to hire 
 men to produce new capital goods for use in its business. 
 Evidently it is the man who saved the money in the first 
 instance who is the true creator of the capital thus added to 
 the stock of society. 
 
 Under present conditions the process of creating capital 
 is usually indirect. One man saves and other men produce 
 the concrete capital goods in which the savings are invested. 
 Of course it sometimes happens that such a complicated 
 process fails to attain its proper end. One man may 
 save $ioo and buy a share of stock from another man, 
 who uses the proceeds to meet his current expenses. 
 In this case no new capital is created. What has happened 
 is that a part of the existing fund of capital has changed 
 hands. But normally men avoid trenching upon their capi- 
 tal; accordingly we are justified in regarding each act of 
 saving as the creation of new capital. 
 
 Just as it is improper to regard the creation of a capital 
 good as in itself a creation of capital, so it is improper to 
 regard the destruction of a capital good through use as the 
 destruction of capital. For during its lifetime a capital good 
 produces, as we have seen, a replacement fund. After the 
 capital good has been destroyed the capital exists under an- 
 other form — as money or as other productive goods con- 
 stituting a replacement fund. The capital is destroyed only 
 if the replacement fund is used for consumption instead of 
 being reinvested in productive wealth. 
 
 Capital is a fund of productive wealth embodied in con- 
 crete capital goods. We must nov/ ascertain the nature of 
 the productivity of capital goods and of capital, and the 
 methods by which such productivity may be measured. For 
 that the business man does measure the productivity of each 
 capital good and of each unit of capital is evident. Other- 
 
l60 INTRODUCTORY ECONOMICS 
 
 wise how could he know how much he can afford to pay for 
 the capital goods which he buys or for the capital which he 
 borrows ? 
 
 In the case of some classes of capital goods the test is 
 easily made. Thus if one wishes to know how much a ton 
 of fertilizer will produce, he has only to apply it to one of 
 two acres of ground of practically equal fertility. The dif- 
 ference in the product of the two acres, less the cost of labor 
 employed in applying the fertilizer, is a fair test of the pro- 
 ductivity of a ton of fertilizer. We may term this the gross 
 product of the capital good. After deducting from this 
 product a sum of value sufficient to replace the fertility de- 
 stroyed through the year's cropping, whatever remains is 
 the net product of the capital good. 
 
 It may be that in the existing state of agriculture satis- 
 factory crops cannot be produced without the use of a certain 
 amount of fertilizer. Let us suppose that five tons per acre 
 are generally applied to land of a given grade. No practical 
 farmer will be at pains to ascertain how large a share of the 
 crop is the product of this amount of fertilizer. But if there 
 is a possibility that an additional ton will pay, progressive 
 farmers will experiment with that additional amount. In 
 practice men get an idea of the productivity, not of every 
 part of their supply of a given kind of capital goods, but of 
 that part of the supply which is least essential to the conduct 
 of their business. It is the productivity of this least essen- 
 tial part of the supply that it is most important to know, for 
 this knowledge shows whether one should increase his busi- 
 ness or restrict its scope. 
 
 Productivity, in the case of such capital goods as fer- 
 tilizer, is ascertained through the efifect of the removal or the 
 addition of a small quantity of the capital good. Some 
 capital goods do not readily admit of any such process of ex- 
 perimentation. Thus it might be difficult to determine the 
 productivity of a field, apart from that of the seed, fertilizer, 
 machinery and labor employed in connection with it. Of 
 
INTRODUCTORY ECONOMICS l6l 
 
 course one might leave one acre untilled, employing all 
 the labor and auxiliary capital on the rest of the field. 
 The total product would be less than it would have been had 
 all the field been tilled ; and this diminution in product would 
 indicate roughly the productivity of an acre of ground. This 
 method is a clumsy and expensive one, and so far as I know 
 is never employed in practice. It is, moreover, unnecessary, 
 since the productivity of labor and of auxiliary capital em- 
 ployed upon the land may be determined, for the most part, 
 by the method already illustrated. Hence we may arrive at 
 the gross product of the field by subtracting from the total 
 product of the farm the values produced by the labor and 
 the auxiliary capital. By subtracting from the gross product 
 of the land a sum of value sufficient to replace the elements 
 of fertility destroyed in the course of the year, we arrive 
 at the net product of the land. 
 
 The cotton manufacturer would find it impossible to 
 distinguish, in a physical sense, between the product of his 
 looms and the product of his engines. Neither looms nor 
 engines would produce anything the one without the other. 
 The manufacturer can, however, ascertain how much greater 
 the productivity of one kind of loom is than that of another ; 
 similarly, he can measure the differences in productivity of 
 different types of engines. Now it is exactly this that it 
 is of practical importance to know. If one intends to manu- 
 facture cotton cloth he must have some kind of looms and 
 engines. But what kind? One kind of loom costs x; an- 
 other kind, x-\-y. What the manufacturer needs to know 
 is whether the extra product of the more expensive loom is 
 sufficient to maintain the capital which we have represented 
 by the symbol 3;. Unless it does this, the manufacturer will 
 have to employ the cheaper loom. 
 
 From the foregoing discussion it appears that the pro- 
 ductivity, not of every form of capital goods, but of only 
 those that are in a position which makes it possible to dis- 
 pense with their services, is readily determinable. Marginal 
 
l62 INTRODUCTORY ECONOMICS 
 
 productivity is the only form of productivity that is defi- 
 nitely ascertainable. What determines marginal produc- 
 tivity we shall consider in the next chapter. 
 
 It is obvious that the productivity of capital goods must 
 vary widely, since some capital goods must produce enough 
 to replace themselves every day while others need only 
 a trifling allowance for repair. Thus $ioo worth of 
 coal — a day's fuel for a factory — must yield in one day 
 a value of at least $ioo. Let us suppose that it does a little 
 more than this — that it produces each day $100.02. Every 
 day, after replacing his fuel supply, the factory owner may 
 set aside two cents — ^the net product of the coal. In the 
 three hundred working days of the year the net earnings of 
 all the coal consumed will be $6. In the same establishment 
 there may be a machine costing $100 which produces a gross 
 return of only $16 during the entire year. Yet $10 may be 
 enough to keep the machine in repair and to provide a year's 
 proper contribution to the replacement fund. Six dollars 
 will then be the net product of the machine. 
 
 Now, the net product of capital goods is what we mean 
 by the product of the capital invested in the goods. The 
 $100 worth of capital invested in coal produces two cents a 
 day, or $6 a year; the $100 invested in the machine produces 
 an identical sum. While capital may differ in its productiv- 
 ity under different circumstances, there can be no such vari- 
 ation as in the case of capital goods. The productivity of the 
 latter must vary on account of the differences in the time for 
 which the different classes of capital goods can be used. 
 Capital, on the other hand, is all equally permanent ; variation 
 in productivity is therefore not inevitable. 
 
 It is also obvious that the practical man will concern 
 himself chiefly with the productivity of capital, not that of 
 capital goods. He will strive to place his capital where its 
 productivity is greatest, not to invest it in the goods which 
 yield the greatest gross product. Accordingly, for the future 
 we shall concern ourselves exclusively with the product of 
 
INTRODUCTORY ECONOMICS 163 
 
 capital, remembering, however, that it is identical with the 
 net product of capital goods. 
 
 In order to ascertain the comparative productivity of 
 different investments of capital, we naturally compare the 
 capital sums invested with their respective returns, during a 
 period of time — say, a year. This gives us results which are 
 conveniently expressed in ratios — still more conveniently in 
 percentages. The capital invested in a machine worth 
 originally $120 yields, let us say $12 per annum. The ratio 
 of annual product to the value of the capital is then one to 
 ten, or ten per cent. The product of capital during a period 
 of time thus reduced to a percentage of the capital value, is 
 interest, in the economic sense of the term. In ordinary 
 usage, it is true, the term interest is usually confined to pay- 
 ments for the use of borrowed capital. But it is clear that 
 the nature of the return is the same whether one uses his 
 own or borrowed capital. 
 
CHAPTER XII 
 The Rate of Interest 
 
 In the last chapter interest was defined as the product 
 of capital through a period of time, expressed in the form of 
 a percentage of the value of the capital sum. In order to 
 understand the forces governing, at any particular time, the 
 rate of interest, we must therefore enter upon a study of 
 the productivity of capital, or the net product of capital 
 goods. 
 
 For convenience we may begin our study with an exami- 
 nation of the manner in which a practical business man would 
 determine the productivity of a particular form of capital, 
 as, for example, capital invested in agricultural machinery, 
 live stock, and whatever other movable capital goods may 
 be necessary for conducting agricultural operations. 
 
 Let us assume that a farmer possesses ten fields, varying 
 in natural fertility from a very high degree to a very low 
 degree. And further let us assume that $i,ooo worth of 
 capital in the form of machinery, stock, etc., or auxiliary 
 capital, is necessary for the tillage of any one of the ten 
 fields. 
 
 If the farmer has control over only $i,ooo worth of 
 auxiliary capital, he will of course place it upon the best 
 field. If from the gross product of that field he deducts 
 the cost of labor employed in connection with it, together 
 with a sum sufficient to cover the cost of upkeep of land 
 and stock, he arrives at the net product of his agricultural 
 capital — that is, of fields and stock. How much is due to 
 the bare land, how much to the auxiliary capital? This it 
 would be difficult to say, as neither would have produced 
 anything without the other. 
 
 Now let us suppose that the farmer gets possession of 
 
INTRODUCTORY ECONOMICS 165 
 
 another $i,ooo to invest in auxiliary capital. He may now 
 till the field which is least inferior to the first one cultivated. 
 The joint product of this field and of the $i,ooo of capital 
 will be less than that of the first field because of the differ- 
 ence in natural fertility. Shall we say that $i,ooo is more 
 productive on one field than on the other ? The two units of 
 capital are just alike; the two fields are unlike. So it would 
 seem to be more reasonable to assign the difference in pro- 
 ductivity to the fields, not to the auxiliary capital. And this 
 is what a practical man would do. If the first field produces 
 $1,000 and the second $900, we may properly say that at 
 least $100 of the product of the first is the product of the 
 land, apart from that of the auxiliary capital. 
 
 Is the $900 produced on the second field the product of 
 the auxiliary capital alone? In a physical sense, certainly 
 not; in an economic sense it is. This sum is what the addi- 
 tional $1,000 worth of auxiliary capital adds to the farmer's 
 income. $900 is what he would lose if he were deprived of 
 either of his two units of capital. 
 
 With another $1,000 the farmer is enabled to till a third 
 field, which is somewhat less fertile than the second. Per- 
 haps this field produces $800 net. If this is the case the 
 farmer will no longer regard the total product of the second 
 field as the product of the auxiliary capital alone. This 
 auxiliary capital produces no more than that on the third 
 field — $800. The other $100 now comes to be considered as 
 the product of the land. At the same time, of course, a 
 second $100 is subtracted from the product of auxiliary 
 capital on the best grade of land. And as the farmer adds 
 unit after unit of auxiliary capital and opens field after field 
 to tillage, the productivity of auxiliary capital steadily 
 shrinks and that of the better land as steadily increases. 
 Perhaps the tenth field yields a net return of only $100. In 
 such case no one of the ten units of auxiliary capital can be 
 said to yield more than this. The use of no one of the units 
 is worth more to the farmer than $100, for if any one were 
 
1 66 INTRODUCTORY ECONOMICS 
 
 taken away from his control he would replace it with the one 
 employed in connection with the poorest field. 
 
 We may demonstrate the same principle on the assump- 
 tion that instead of ten fields of varying productivity the 
 farmer possesses a single large and uniformly fertile farm. 
 If the whole farm is cultivated extensively by the aid of 
 $1,000 in movable capital goods, the net product, defined as 
 above, may be $i,ooo. A second $i,ooo unit of auxiliary 
 capital would no doubt greatly increase the net product, but 
 the law of diminishing returns forbids us to believe that it 
 would add $i,ooo to the product. Perhaps the second unit 
 would add $900. This sum then measures the importance to 
 the farmer of either unit of auxiliary capital. The extra $100 
 appearing in connection with the first unit of auxiliary capi- 
 tal may be regarded as the product of the land. A third 
 $1,000 would still further reduce the productivity of each 
 unit of capital and cause a larger share of the total product 
 to be ascribed to the land; a tenth unit might add only $100. 
 This sum then measures the loss that the farmer would 
 incur if any of the ten units of capital were taken from 
 his control. 
 
 In the foregoing examples it has been assumed that the 
 farmer is in possession of a fixed amount of land while the 
 auxiliary capital at his command is subject to variation. 
 This corresponds roughly with the facts of life ; yet for the 
 sake of getting a clearer view of the principles governing the 
 productivity of capital we must supplement the above dis- 
 cussion by a reversal of the assumptions. The farmer has, 
 let us say, $10,000 in auxiliary capital; the amount of land 
 under his control is not determined. If he employs all his 
 auxiliary capital in connection with a $1,000 tract of land — 
 which we shall call a unit of land capital — he may secure a 
 net capital product of $1,000. A second unit of land capital 
 may add $900 to the aggregate net product. As the 
 two units of land are by assumption alike, neither can be 
 said to be more productive than the other; and the second 
 
INTRODUCTORY ECONOMICS 167 
 
 one, we have assumed, produces $900. The extra hundred 
 appearing in connection with the first unit of land is there- 
 fore ascribable to the auxiHary capital. A tenth unit of land 
 capital may add only $100 to the product of the business. 
 Under the circumstances, no unit of land adds more. For if 
 any one of the ten is taken from the control of the farmer, 
 what he loses is merely the $100 that would have been pro- 
 duced by the tenth unit. 
 
 The principle involved in the cases that have been 
 discussed may be stated as follows : The productivity of 
 any unit of capital embodied in a given class of capital 
 goods is measured by the amount added to the aggregate 
 net product of a business by that unit which it is least 
 worth while to employ. The same principle holds true of 
 capital in general. 
 
 Suppose that a farmer can command practically an in- 
 definite amount of agricultural capital, whether in the form 
 of land or in the form of movable capital goods, but that 
 the amount of labor that he can secure is limited to ten men. 
 With $5,000 invested partly in land, partly in movable capi- 
 tal goods, he may be able to produce $5,000 net. We should 
 here find difficulty in determining what part of this sum is 
 produced by the labor, what part by the capital. An addi- 
 tional $5,000 of capital m.ay increase the aggregate product 
 of the business by $4,000. This sum we should properly 
 ascribe to the new capital. And as this second unit of capi- 
 tal does not differ in any essential respect from the unit at 
 first employed, and as the removal of one unit of the two 
 would have the same effect as the removal of the other, we 
 may properly regard them as equally productive. The extra 
 thousand appearing in connection with the first unit must 
 then be assigned to the other factor in production — the 
 labor. If a third unit of capital increases the product of the 
 business by $3,000, this amount will measure the importance 
 of any one of the three units of capital. This is what the 
 farmer would lose if he were deprived of the use of any of 
 
1 68 INTRODUCTORY ECONOMICS 
 
 the units. If a fifth unit adds only $i,ooo, the product 
 assignable to any unit shrinks to that figure. And of 
 course with each reduction in the product assignable to 
 capital, the product assignable to labor increases. 
 
 Up to the present point our study of the productivity 
 of capital has been confined to the single business establish- 
 ment. We must now consider whether similar principles 
 are applicable to an industry in its entirety. The iron and 
 steel industry of the United States may serve as our type. 
 
 The capital at present engaged in the production of iron 
 and steel may be placed at about $500,000,000 ; the number 
 of men, at two hundred thousand. Now let us suppose that 
 without any revolutionary change in the demand for iron 
 and steel the capital of the industry is increased by $100,- 
 000,000. What will be the effect upon the productivity of 
 capital in the industry? 
 
 It is fair to assume that before the increase in capital 
 those branches of the industry promising the highest profits 
 were already pretty well developed ; that the richest deposits 
 of ore and coking coal were already being exploited; that 
 the best manufacturing sites had been selected. To what 
 use, then, will the new capital be put? Some of the enter- 
 prisers may attempt to duplicate existing plant. This 
 requires additional labor, and such labor is to be had only 
 by inducing new men to enter the industry or by enticing 
 men away from other iron manufacturers. In either case 
 an advance in wages would follow, which would soon 
 become general throughout the industry. In the old estab- 
 lishments as well as the new this would obviously reduce the 
 share of the aggregate product which capital would receive. 
 Again, the increase in iron and steel products thrown upon 
 the market would lower prices. Thus, while the wages bill 
 of an establishment per unit of product would increase, the 
 value of each unit of product would diminish. 
 
 If all the new capital were used simply to duplicate 
 existing plant, the rise in wages would be very great. The 
 
INTRODUCTORY ECONOMICS 169 
 
 industry would need one-fifth more men than it has at 
 present, and these would be slow to appear unless they were 
 offered very high wages. The fall in prices, moreover, 
 would be a serious one, as the output would be increased 
 about twenty per cent. Accordingly it is clear that the new 
 capital would not be used in this way. Some of it would be 
 employed to develop new branches of the industry, which, 
 under the earlier circumstances, were not regarded as 
 profitable. Some of it would be used to replace worn-out 
 blast furnaces by larger ones, requiring a smaller expendi- 
 ture of labor per unit of product; some of it to provide 
 better facilities for handling the material in its progress 
 through the shops ; some of it to equip the mills with more 
 nearly automatic machinery for manipulating the material. 
 In these ways the pressure upon the labor supply would be 
 somewhat relieved, and prices would be kept from sinking 
 too low. The fact remains that the capital would be less 
 productive after the increase than before it; wages would 
 be higher and prices lower. The increase in the aggregate 
 capital of the industry, other things equal, would reduce the 
 productivity of each unit. 
 
 The same principle is still more clearly applicable to 
 industrial society as a whole. The iron and steel industry 
 can relieve the pressure upon its labor supply by inducing 
 men to leave other industries. If the capital of society as a 
 whole increases, a similar pressure is placed upon the labor 
 supply, for which there is no ready means of relief. The ex- 
 isting capital is normally sufficient to provide every one who 
 desires to work with the necessary appliances. If, then, the 
 capital of all industries increases more rapidly than the 
 population, the average capital employed with each laborer 
 must increase. Such increase in capital must be embodied 
 in improvements upon existing appliances, and owing to the 
 operation of the law of diminishing returns, will increase the 
 product of industry less than an equal amount of capital did 
 when the social fund was smaller. 
 
170 INTRODUCTORY ECONOMICS 
 
 There are of course conditions under which an increase 
 in capital may not result in a reduction in the productivity 
 of capital. If, for example, the labor supply increased more 
 rapidly than the supply of capital, a larger share of the joint 
 product of labor and capital would be imputable to the 
 latter factor in production. Again, suppose that some cheap 
 method of draining extensive swampy regions or of irri- 
 gating vast tracts of arid land were discovered. Capital 
 would then abandon the least productive existing invest- 
 ments and flow into the new fields thus opened. The 
 product of capital on the least attractive fields — which is the 
 measure of the productivity of capital in all fields — would 
 be greater after the change than before it. In like manner, 
 an invention may increase the efficiency of capital through- 
 out an industry and lead to the withdrawal of capital from 
 the least productive investments and to an increase in the 
 general productivity of capital. 
 
 It has already been indicated that an increase in the 
 amount of capital invested in one form of capital goods 
 without a corresponding increase in the capital invested in 
 other forms will reduce the productivity of capital in the 
 one form while increasing the productivity of capital in the 
 other forms. By placing more and more auxiliary capital 
 upon a given area of land one must ordinarily reduce the 
 productivity of auxiliary capital and increase the produc- 
 tivity of land. It will naturally be the aim of the business 
 man to keep his capital uniformly productive ; if he has too 
 much auxiliary capital he will endeavor to get more land, 
 and vice versa. He will ask himself: Would it pay me 
 better to invest my next $1,000 in land or in auxiliary capi- 
 tal? And he will continue to direct his investments toward 
 whichever class of capital goods is for the moment the more 
 productive, until the superiority of that class disappears. Of 
 course to do so implies the necessity of taking some land 
 away from his neighbors. If he cannot do this, he must soon 
 cease to extend his business. 
 
INTRODUCTORY ECONOMICS I7I 
 
 Similarly an entire industry may expand with more or 
 less symmetry, distributing its new capital among the 
 various classes of capital goods of which it stands in need. If 
 the beet sugar industry expands, not only are more factories 
 constructed, more machinery for the cultivation of beets 
 purchased, but more land is drawn into the service of the 
 industry. This land is, of course, taken away from other 
 industries — wheat culture, dairying, etc. The increase of 
 auxiliary capital in the industry may, therefore, not materi- 
 ally affect the productivity of capital invested in land. 
 
 When the social fund of capital increases, on the other 
 hand, it is not possible for a symmetrical increase in all 
 classes of capital to take place. The land, we may suppose, 
 is already almost all in use ; the best mines are opened ; the 
 most available courses for railways and canals are already 
 occupied. These things the new capital cannot duplicate. 
 On the other hand, steel rails, locomotives, factory buildings 
 and thousands of other forms of capital goods are readily 
 duplicated. It follows that with increase in social capital 
 that which is invested in the former class of goods will 
 probably increase in productivity, while that part which is 
 invested in the latter class of goods will decrease in 
 productivity. 
 
 When, however, we speak of the productivity of capital 
 in general, or of the rate of interest, we usually take as our 
 test the productivity of new capital — and this, we see, is 
 practically the capital in goods which are capable of duplica- 
 tion. And instead of thinking of the old capital in non- 
 duplicable goods as more than normally productive, we are 
 likely to revalue the capital in such forms. Ten years ago, 
 let us say, a five-acre lot gave rise to as large a net 
 product as a threshing machine. To-day the same piece of 
 land yields twice as large a net return as a threshing 
 machine equal in value to the one of ten years ago. We 
 might say that the capital in land has doubled in produc- 
 tivity. But it is more usual to say that the land represents 
 
172 INTRODUCTORY ECONOMICS 
 
 twice as much capital as the threshing machine, to-day, 
 although it represented no more capital than the threshing 
 machine ten years ago. By a similar process of revaluation 
 the productivity of all capital which is abnormally produc- 
 tive is reduced to the general level. This process of revalu- 
 ation will receive our further attention in the next chapter. 
 
 Even capital which is embodied in capital goods that 
 are capable of reduplication may at any given time vary 
 widely in productivity from establishment to establishment 
 or from industry to industry. It is only by experimentation 
 that the actual productivity of capital can be determined; 
 and owing to the changing character of modern industry 
 the process of experimentation must go on without ceasing. 
 Accordingly there are always chances of mistakes in invest- 
 ments. A cotton manufacturer may overestimate the pro- 
 ductivity of capital in a given type of loom ; after purchasing 
 and installing the machine he must content himself with 
 what it will produce, even though he knows that the same 
 amount of capital would in another form yield a far higher 
 return. Cotton manufacturers as a class may overestimate 
 the future demand for cotton goods, and so may be led to 
 invest heavily in buildings and machinery which prove 
 incapable of returning the normal rate of interest on capital. 
 At the same time the shoe industry may be undersupplied 
 with capital ; for a time, at least, every one hundred dollars 
 invested in the industry may yield an abnormally high 
 return. 
 
 Such disparity in the productivity of capital in the two 
 industries would, however, tend to disappear. The capital 
 invested in new cotton mills would, of course, be fixed in the 
 industry for a long period of time. But in the industry as 
 a whole there are always some mills that are about to be dis- 
 mantled, having reached the limit of their useful existence. 
 These mills have presumably earned in the past a sum suffi- 
 cient to replace themselves with new mills of a value equal 
 to that of the original ones. If the cotton industry is suf- 
 
INTRODUCTORY ECONOMICS 1^3 
 
 fering from a depression while the shoe industry is highly 
 prosperous, the replacement fund will be diverted to the 
 latter industry. Through the reduction of capital in the 
 cotton industry the productivity of capital in that field is 
 increased ; through the increase of capital in the shoe indus- 
 try the productivity of capital is reduced in that industry. 
 It is easy to see that if this process continues for any 
 length of time the original disparity in productivity must 
 disappear. 
 
 The equalization of productivity is hastened by the dis- 
 position of new accumulations of capital. The fund of 
 capital, under modern conditions, is constantly growing in 
 magnitude; consequently industries are, as a rule, expand- 
 ing. The new capital naturally seeks the most productive 
 fields. If, therefore, the rate of return in the cotton indus- 
 try is abnormally low while that in the shoe industry is 
 abnormally high, the new capital will avoid the former 
 industry and seek investment in the latter. The influx of 
 new capital into the shoe industry reduces productivity 
 there, until at last capital is no more productive in the one 
 industry than in the other. When this point has been 
 reached further additions to the supply of capital are 
 divided impartially between the two industries, reducing 
 productivity uniformly. 
 
 It is, of course, possible that the productivity of capital 
 in the two industries may never be absolutely equal. While 
 the tide of new capital is setting steadily toward the shoe 
 industry a new demand for cotton goods or a new method 
 of manufacture may appear and raise the productivity of 
 capital in the cotton industry above that of the shoe industry. 
 Some time will elapse before the change in the relative posi- 
 tions of the two industries is generally known ; in the mean- 
 time the flow of new capital into the shoe industry con- 
 tinues. Eventually the new capital is diverted to the cotton 
 industry ; it may continue to flow in that direction after the 
 cotton industry has lost its relative superiority. We can 
 
174 INTRODUCTORY ECONOMICS 
 
 only say that a tendency toward equalization of produc- 
 tivity exists; not that the tendency is ever exactly realized. 
 
 Our imaginary case will illustrate very well what is 
 actually taking place in industrial society. Only, instead of 
 two industries between which adjustment is to be made, we 
 have thousands, big and little. Accordingly the chances of 
 realizing absolute equality are far more remote. It may at 
 first appear that the chances are so very remote that the 
 tendency toward equalization of productivity is more or 
 less mythical. The owner of new capital, we would all 
 admit, wishes to place it where it will be most productive. 
 But how can he acquaint himself so well with our bewilder- 
 ingly complex industrial system that he will be able to 
 search out the most productive opportunities for invest- 
 ment? Suppose that a physician saves $i,ooo from his cur- 
 rent income. Should he invest it in steel or cottons, or 
 should he seek out some minor industrial field — straw-board 
 or bicycle tires ? In all probability he knows little or nothing 
 of the actual possibilities of any one of these fields of 
 investment. 
 
 If we examine the process by which new capital actu- 
 ally finds its way into the various industrfes we shall find 
 that this difficulty is not a very serious one. To a large 
 extent, those who are already engaged in an industry, and 
 consequently know most about it, act as agents for the 
 investment of new capital. If an iron master believes that 
 he can make additional capital yield eight per cent, he will 
 be ready to borrow capital so long as it can be had for a 
 little less than eight per cent. If the cotton manufacturer 
 doubts that he can make capital produce more than five per 
 cent., this is the maximum that he will pay for loanable 
 capital. If then the supply of loanable capital is limited — 
 and it always is limited — those industries promising the 
 highest returns will bid a little higher for it, and draw it 
 away from the industries yielding low returns. All that the 
 investor has to do^ in order to place his capital in the more 
 
INTRODUCTORY ECONOMICS 1/5 
 
 productive fields, is to accept the highest rate of interest he 
 can get. 
 
 But not all new capital finds its way into industry 
 through loans. Some of it originates in the very industries 
 that are expanding, and is directly invested by the income 
 recipient. Some of it, though originating outside of the in- 
 dustry, is invested without the agency of an intermediate 
 borrower. Thus a new joint stock company may be launched 
 in the cotton industry. Its capital is obtained through the sale 
 of stock and the buyers of this stock are probably of divers 
 trades and professions. Each purchaser of stock is nomi- 
 nally investing on his own responsibility. But those invest- 
 ors who know nothing of the business, unless they are very 
 reckless, do so only after they have found that men who do 
 know something about the business consider it a profitable 
 venture. 
 
 It is, of course, to be remembered that the productivity 
 of capital is not the only thing that an investor takes into 
 account in deciding in what industry he shall invest his sav- 
 ings. In some investments the danger of losing all or a part 
 of the capital invested is great. Capital employed in devel- 
 oping the asphalt deposits of Venezuela may be highly pro- 
 ductive. But there is a chance that the existing government 
 of Venezuela, from which title to the asphalt deposits is 
 derived, may be overturned, and a new government may 
 confiscate the capital invested in the business. Capital 
 invested in street railways in the lesser cities may be very 
 productive. But if those cities do not follow a consistent 
 policy in chartering new companies, it is possible that at any 
 time rival lines may be established on parallel streets and, 
 if unable to make large returns themselves, they may, 
 nevertheless, reduce the return on capital invested in the 
 original lines to almost nothing. The capital still remains 
 in the possession of the investor, but it is "dead capital." A 
 merchant's capital, invested in a fancy fabric, may promise 
 high returns ; but a sudden change in fashion may force the 
 
176 INTRODUCTORY ECONOMICS 
 
 merchant to sell the goods at a price which not only yields 
 no return on the capital invested, but which entails an 
 actual impairment of the capital fund itself. 
 
 Some risk, it is plain, inheres in every business ; in some 
 fields of investment, however, the risk is so small as to be 
 negligible, while in other fields no prudent investor can dis- 
 regard it. Other things equal, the vast majority of investors 
 will prefer to invest in the safer fields. A disproportionately 
 large share of the capital of society therefore seeks the 
 safer investments, and as a result the productivity of capital 
 in such investments falls below the rate of return to capital 
 in the more hazardous investments. And thus it is that 
 there appears a regular variation in the productivity of capi- 
 tal corresponding with variations in risk. 
 
 It is, of course, clear that it is not actual risk, but esti- 
 mated risk that affects the distribution, and hence the pro- 
 ductivity of capital. It is quite possible that the risk of 
 losing capital invested in real estate in Texas is less than 
 the risk of losing capital similarly invested in New York. 
 But if most of the persons having capital to invest mis- 
 takenly believe that the reverse is true, a disproportionately 
 large part of the flow of new capital will enter the New 
 York investment field and reduce the productivity of capital 
 there below the level prevailing in Texas. 
 
 In an earlier chapter we saw that risk affected wages 
 only in so far as it affected the distribution of labor ; further, 
 that if enough reckless workmen can be found to man the 
 dangerous trades risk will not affect wages at all. Exactly 
 the same thing is true of capital. If there were enough 
 investors who always chose the more remunerative employ- 
 ments for capital, regardless of risk, the hazardous fields 
 would soon be so well supplied with capital that they would 
 yield no higher returns than the safer ones. As a rule, how- 
 ever, capital is far more timid in assuming risks than labor. 
 It is therefore more anomalous to find capital in a haz- 
 ardous field yielding only normal returns than it is to 
 
INTRODUCTORY ECONOMICS 177 
 
 find workmen in dangerous occupations receiving only 
 normal wages. 
 
 Risk, then, may be regarded as a barrier which pre- 
 vents capital from flowing freely into some of the more 
 productive fields. It is of course not the only natural bar- 
 rier affecting the flow of capital. If a particular industry is 
 subject to the universal moral disapproval of a community, 
 most capitalists will refuse to invest in it. Those who are 
 unscrupulous enough to do so may enjoy the high returns 
 that flow from an industry that is under-supplied with capi- 
 tal. Thus high returns are often obtained from capital 
 invested in gambHng dens and opium "joints." It is, of course, 
 possible that the investment institutions of a country may 
 be of such a nature that a man can hold stock in disrepu- 
 table enterprises without the knowledge of his associates, 
 and that investors who have no personal scruples are 
 numerous. Under these conditions the productivity of capi- 
 tal in such ventures will eventually fall to the normal level. 
 
 It has been said above that those who are already 
 engaged in an industry, and who have invested their own 
 capital in it, serve as agents for investing in that field the 
 capital of outsiders. But the appearance of the new capital 
 reduces the productivity of that which was originally 
 invested in the industry. Thus it appears that the original 
 investors serve as agents for reducing their own incomes. 
 This they do only because of divided interests — competition. 
 Each enterpriser in an unusually productive industry who 
 can borrow capital at a rate of interest which is less than 
 the productivity of capital in his business can for a time 
 increase his total income by doing so. The effect of similar 
 action on the part of all the other enterprisers in the indus- 
 try is to reduce the productivity of all the capital in the 
 industry, including, of course, that of the capital originally 
 employed in the field. If all the enterprisers were to act 
 together, it is easy to see that they might find it to their 
 advantage to check the influx of new capital before the 
 
178 INTRODUCTORY ECONOMICS 
 
 productivity of capital in the industry reached the normal 
 level. 
 
 This in fact a monopoly does. Controlling all the 
 Opportunities that an industry represents, it takes pains to 
 limit the entire amount invested in such a w^ay that each 
 unit of capital remains highly productive. New capital is 
 thus turned away from the fields controlled by monopolies, 
 and is forced into the fields where the productivity of capi- 
 tal has already reached a comparatively low level. 
 
 We may now sum up the foregoing discussion in the 
 statement that the rate of interest on capital embodied in 
 reproducible capital goods tends, in any industrial field, to 
 equal the productivity of the capital thus embodied which is 
 least essential to the economic exploitation of the field ; and 
 further that there is a constant tendency toward equalization 
 of productivity and of interest among the several fields of 
 economic activity. If there were no barriers impeding the 
 free action of competition and if changes in economic con- 
 ditions were sufficiently gradual to permit of complete 
 adjustment of the social fund of capital to the opportunities 
 for its investment, the rate of return to capital would 
 eventually be uniform throughout industrial society. Under 
 such circumstances we should say that the rate of interest 
 on capital is determined by the productivity of that capi- 
 tal which is least essential to the business of society; in 
 other words by the marginal productivity of social capital. 
 
 The term interest is often used in a narrower sense, 
 namely, to designate payments for borrowed money or capi- 
 tal. We may consider briefly the laws governing such pay- 
 ments. In former times loans were largely confined to 
 advances to persons who desired to increase present con- 
 sumption, with the more or less vague hope of obtaining 
 sufficient means in the future to cancel the obligations thus 
 created. Thus the heir presumptive to a landed estate 
 often had dealings with usurers, who advanced the means 
 of present luxurious living. It would be difficult to estab- 
 
INTRODUCTORY ECONOMICS 1 79 
 
 lish a law governing the rate of interest on such loans. It 
 varies from one case to another according to the necessities 
 and improvidence of the borrower and according to the 
 greed and cunning of the lender. 
 
 In the typical loan transaction of to-day money is bor- 
 rowed for the purpose of increasing one's equipment of 
 capital goods. What is really borrowed is capital. The 
 laws governing the rate of interest on such loans lend them- 
 selves readily to scientific formulation. 
 
 Let us suppose that in a certain community there are 
 some business men who can make additional capital yield 
 ten per cent. Of course they cannot employ an unlimited 
 amount of capital in such productive investments. But 
 perhaps they can make an aggregate sum of $100,000 return 
 a rate of ten per cent. An additional $100,000 they might 
 be able to invest in such a way as to yield nine per cent. 
 Other business men, less favorably situated, might perhaps 
 be able to make another $100,000 yield nine per cent. 
 These two classes together might be able to use $300,000 
 more in investments yielding eight per cent., and a third 
 class of business men might be able to invest $200,000 more 
 at this rate. Now, if the entire supply of loanable capital 
 is limited to $100,000, it is clear that the interest on such 
 capital must be above nine per cent. Otherwise the men 
 enjoying the most productive opportunities for investment 
 would see the men having less productive opportunities 
 securing part of the supply of capital. Indeed, the rate must 
 be very near ten per cent., as the men having the best oppor- 
 tunities will compete among themselves for the limited sup- 
 ply and so force the rate up. If the supply of loanable 
 capital is more than $100,000, but less than $300,000, the 
 rate on all the capital would, for similar reasons, be nine 
 per cent. If the supply of such capital exceeds $300,000, 
 but is less than $800,000, the rate would be eight per cent. 
 We may state the principle involved in the following terms : 
 The rate of interest paid on loanable capital tends to equal 
 
l8o INTRODUCTORY ECONOMICS 
 
 its productivity in the hands of the business men who enjoy 
 the least favorable opportunities for investment, but whose 
 demand is, nevertheless, necessary to carry off the entire 
 supply of such capital. 
 
 It is furthermore clear that the rate of interest on 
 loanable capital must in the end very nearly coincide with 
 the rate of interest on capital directly invested by its owner. 
 If the rate on loans is less than that on direct investments, 
 many who now lend their capital will become direct invest- 
 ors. If the rate on loans is relatively high, many who now 
 invest directly will wind up their business and become 
 lenders of capital. 
 
 It must of course be understood that in so far as capi- 
 tal directly invested is more than normally productive on 
 account of the hazardous nature of a business, a discrepancy 
 between the loan rate and the direct rate will persist. When 
 losses occur they fall ordinarily on the capital directly 
 invested. Until a business man's own capital is entirely 
 wiped out he must pay his obligations to the lender in full. 
 Thus the business man's own capital serves to insure the 
 maintenance of the borrowed capital ; and the business man 
 naturally deducts a part of the return to the borrowed capi- 
 tal and keeps it for himself, assigning it to his own capital. 
 If such insurance is inadequate, a part of the extra product 
 is transferred to the lender in the form of high interest. 
 Thus the returns to loanable capital vary somewhat, accord- 
 ing to degree of risk, but naturally not in the same degree 
 as the returns to capital directly invested. 
 
 Again, if capital is abnormally productive in a given 
 industry on account of the existence of a monopoly, this 
 does not profit the lender. The Standard Oil Company 
 may perhaps be able to make capital yield twenty per cent, 
 but if it borrows money it pays only four or five per cent. — 
 whatever the market rate may be. The extra product is 
 retained by the monopoly and assigned to the capital 
 directly invested. 
 
CHAPTER XIII 
 Rent and Capitalization 
 
 In popular usage the term rent is applied to any pay- 
 ment which one person makes to another for the temporary 
 use of a concrete capital good or group of goods. Thus 
 rent may be paid for the use of a farm, a house, a piano, a 
 square yard of advertising space on a bill board. In the 
 nature of the case, only those things can be rented which 
 remain practically intact through the period of use. One 
 never rents a bin of coal or a stock of merchandise. Nor 
 does one ever rent goods which can serve their purpose 
 only by entering into permanent combination with other 
 capital goods. No one would think of trying to rent steel 
 beams to be used in the construction of his house. The 
 more nearly indestructible a capital good is, and the more 
 perfectly it yields up its services without losing its identity, 
 the better is it adapted to the renting contract. Thus a field, 
 being practically indestructible, may very well be rented for 
 a period of years, although if its cultivation requires the 
 incorporation of a large amount of auxiliary capital in the 
 soil, in the form of drains or irrigation ditches, the field and 
 the auxiliary capital must usually be rented together. A 
 piano, which is much more likely to be injured, nevertheless 
 lends itself readily to the renting contract because no other 
 capital good enters into permanent combination with it in 
 use. 
 
 In economic discussion the term rent may properly be 
 given a more general application. If a man owns and 
 manages a farm which he could let at a rental of $i,ooo, we 
 may say that $i,ooo out of his income is really the rent of 
 his farm. True, he does not pay this sum to any one ; but 
 neither does he pay any one wages for the labor which he 
 
1 82 INTRODUCTORY ECONOMICS 
 
 himself performs. It would be absurd, however, to say- 
 that a man earns no wages when he is working for himself. 
 As employer he pays himself wages as workman. In like 
 manner, the man who cultivates his own field may be thought 
 of as paying rent, as cultivator, to himself, as landlord. So, 
 if an ocean transportation company owns and sails a ship 
 which it could let for $5,000 a year, we may regard $5,000 
 out of the proceeds of the company's business as the rent 
 of this particular ship. In this broad sense of the term, 
 rent may be defined as that part of the proceeds of a busi- 
 ness which is economically due to a particular capital good. 
 It is the economic product of a capital good, regarded as a 
 lump sum. And as even the most perishable of capital 
 goods yield a product which may be measured in this way, 
 we may strain the ordinary meaning of the term rent so as 
 to include the concrete products of all capital goods 
 whatsoever. 
 
 We must be careful to distinguish between the total 
 product of a capital good, or its gross rent, and that part of 
 the product remaining after the cost of depreciation of the 
 capital good has been deducted, or net rent. To arrive at 
 the net rent of a house we must deduct from the gross rent 
 a sum sufficient to meet the cost of repairs, together with a 
 year's proper contribution to a fund for the replacement of 
 the house when it shall cease to be habitable. Even the pay- 
 ment for the use of a field is a gross rent. The field wears 
 out — that is, it loses through cropping a part of its original 
 or acquired fertility. The owner of the field must, there- 
 fore, set aside a part of the product of the land to restore 
 the fertility of the soil. 
 
 While the term rent is, as has been said, properly 
 applied to the product of any concrete capital good, we shall 
 in this chapter confine our study to the rent of those classes 
 of goods that are of such a nature as to permit the trans- 
 fer of their uses under renting contracts. The distinguish- 
 ing characteristic of this class of goods is that the capital. 
 
INTRODUCTORY ECONOx\IICS 1 83 
 
 embodied in them is fixed there, for a considerable period 
 of time at least. It takes perhaps ten years before the 
 capital invested in a boat can migrate to some industry upon 
 the dry land. The capital embodied in a well-built house 
 may be fixed there for fifty years; and the capital invested 
 in a field, in a tunnel or in an excavation must remain where 
 it is forever. It is true that you may take your capital out 
 of a field; this you do v/hen you sell it. But what you 
 really do when you sell the field is to transfer your claim to 
 the capital it represents to another person. The capital in 
 the field is the same after the transaction as it was before it. 
 Such permanently invested capital may be contrasted with 
 the capital invested in transitory forms, as coal, raw 
 materials, merchants' stocks. The capital invested in these 
 forms returns to its owner in a relatively short time in the 
 form of purchasing power, and may be reinvested in any 
 one out of a thousand different classes of capital goods. The 
 return to such transitory goods is most conveniently calcu- 
 lated as a percentage return to the capital invested in them. 
 It is natural to think of the return to a farm or a building 
 as a certain sum of money, or a rent. One may, of course, 
 translate the rent into terms of interest on the capital 
 invested in the farm or building. On the other hand, it is 
 natural to think of the return to a merchant's stock in trade 
 as interest on the capital invested in the stock, although it 
 would be quite possible to arrive at the returns to the stock 
 by adding together the net products of all the capital goods 
 whose services have been used. It will be noted that net 
 rent, in the sense in which the term is used here, is 
 nothing but interest under another form. Reduce the rent 
 to a percentage of the capital value embodied in the 
 goods which produce the rent, and what you have is 
 interest. 
 
 In an earlier chapter we saw that there are two ways of 
 arriving at the product of a concrete capital good, or its 
 rent. One way is to withdraw the capital good from the 
 
I(S4 INTRODUCTORY ECONOMICS 
 
 productive combination into which it enters, noting the 
 shrinkage in product that follows. The other way is to 
 deduct from the gross receipts from a group of several 
 goods the shares (if these can be independently ascertained) 
 that are due to all of the goods except one. What is left 
 is of course the product of the remaining good. Either 
 method may be employed in ascertaining the rent of many 
 capital goods; but the latter method is most frequently 
 employed in the case of goods that lend themselves readily 
 to the renting contract. If one wishes to rent a steam 
 thresher, for example, he will first of all inquire what the 
 gross earnings from the operation of the machine are likely 
 to be. Perhaps such earnings will average $20 a day. In 
 order to operate the thresher, it is, of course, necessary to 
 employ labor and auxiliary capital goods — as coal and 
 machine oil — in connection with it. The labor must be paid 
 for at the prevailing rate of wages; coal and oil must be 
 paid for at the market price. There are accordingly definite 
 sums that must be deducted from the gross receipts from 
 the operation of the machine. Whatever is left after these 
 charges have been met — possibly $10 — is the gross rent of 
 the machine for the day. 
 
 In the foregoing example the cost of labor and of coal, 
 etc., are regarded as preferred charges upon the earnings of 
 the enterprise, and this indeed they are. The operator of 
 the threshing machine must pay at least the prevailing rate 
 of wages, or he cannot get labor to run the machine at all. 
 Similarly, he must pay the market price of coal. Labor and 
 coal have a multitude of uses outside of the business of 
 threshing ; if not properly rewarded in that business they go 
 elsewhere. The machine, on the other hand, cannot seek 
 other employment. It is committed to a particular function ; 
 consequently it cannot enforce any claim for a specific 
 remuneration. The machine is, as it were, a residuary 
 claimant. And this is more or less true of most of the 
 capital goods that are actually rented. Economists there- 
 
INTRODUCTORY ECONOMICS 1 85 
 
 fore find it convenient to treat rent as though it were always 
 determined in this way. 
 
 A steamship building company, not having sufficient 
 orders on hand, launches a freighter on its own account, 
 trusting to the chance that some ocean transportation com- 
 pany will be ready to pay a fair rental for its use. What will 
 determine the rent that the transportation company will 
 offer to pay? The managers of that company can probably 
 estimate pretty accurately what the gross receipts from a 
 year's operation of such a ship would be. Let us say that 
 the estimated gross receipts are $25,000. From this sum 
 must be deducted the wages of officers and men, $7,000; 
 charges for pilotage, harbor dues, etc., $1,000; the cost of 
 coal and provisions, $10,000; miscellaneous expenses, 
 $1,000. Nor is this quite all. The $10,000 invested in coal 
 and provisions— supposing that the transportation company 
 must purchase the whole amount at the beginning of the 
 year — is capital that would in any other field earn $500 
 interest. This sum must therefore be added to the pre- 
 ferred charges of operating the ship. The $5,500 remain- 
 ing out of the estimated gross receipts is the maximum 
 rent that the transportation company can pay for the 
 use of the ship. This sum, the gross rent of the 
 ship, includes, however, payment for the depreciation of 
 the ship through one year's use. If this amounts to 
 $1,000 we have remaining the sum of $4,500 as the 
 net rent. 
 
 Similarly the gross rent of a farm is found by deducting 
 from gross receipts a sum that is sufficient to pay the wages 
 of all labor employed in cultivating it ; to replace all capital 
 goods used up; to keep up the efficiency of all stock and 
 machinery, together with interest at the prevailing rate on 
 the capital invested in such movable capital goods. To 
 arrive at the net rent we must deduct from the gross rent 
 thus determined whatever may be necessary to keep build- 
 ings, fences, etc., in repair and to restore to the soil any ele- 
 
1 86 INTRODUCTORY ECONOMICS 
 
 ments of fertility that have been destroyed in the year's 
 cropping. 
 
 In the cases that have been cited the rent-yielding object 
 was a group of capital goods, more or less securely bound 
 together in use. The farm, for example, may be analyzed 
 into several distinct factors. One factor in the group is the 
 bare land; another factor consists of improvements merged 
 in the soil, as drains or irrigation ditches; a third factor 
 consists of farm bulidings, fences, tree plantations, etc. 
 Some part of the rent must be ascribable to each one of 
 these factors. The productivity of such a factor cannot be 
 found by withdrawing it; nor can it be found by treating 
 it as a residue, after ascertaining the shares of the other 
 factors combined with it, for these shares cannot be ascer- 
 tained directly. There remains the method of comparisons. 
 How much more will a well-drained field yield than another 
 field in the vicinity, of apparently equal natural fertility, 
 but without drains ? By such comparisons it is usually pos- 
 sible to tell pretty nearly what each factor in a permanent 
 combination of capital goods is producing. One may dis- 
 tinguish in this way between the rent paid for a city house 
 and the rent paid for the ground it stands on, although the 
 two rents usually make parts of a single payment. Find an 
 equally spacious and costly house in a suburb, where a 
 building lot is to be had for practically nothing. The differ- 
 ence in the rent of the two houses is a fairly accurate mea- 
 sure of the rent of the city lot. 
 
 The rent of a ship, a building or a machine, may, as we 
 have seen, be ascertained, in the first instance, by subtract- 
 ing from the gross receipts arising from its operation a sum 
 covering all other expenses connected with its use. The 
 value of such a rent-bearing object does not immediately 
 affect the amount of rent it yields. A ship that yields a net 
 surplus of $5,000 above operating expenses may be worth 
 $50,000 or $100,000. The value of the ship has nothing to 
 do with the amount of rent that its owner will receive in the 
 
INTRODUCTORY ECONOMICS 187 
 
 immediate future. But a ship is a capital good that requires 
 periodic renewal. Out of i,ooo ships sailing the ocean to-day 
 probably fifty are near the end of their economic existence, 
 and will have to be replaced by new ships if the existing ton- 
 nage is to be maintained. Now, if the rent of ships happens 
 to be so low as not to pay the ordinary rate of interest on 
 the capital invested in them, no new ships will be built to 
 take the places of those that are no longer seaworthy. The 
 aggregate tonnage will thus be reduced; freights will be 
 advanced until the rent of ships rises to a figure which 
 affords a normal return to shipping capital. If, on the other 
 hand, the rent of ships represents an abnormally high return 
 to capital, more ships will be built, and freights will decline 
 until the rent of ships is only sufiicient to pay a fair rate of 
 interest on the capital invested in them. And this is in gen- 
 eral true of the rents of all capital goods requiring periodic 
 renewal. For a time the rent may be too high or too low to 
 afford just a normal return to the capital invested in such 
 goods. In the long run, however, the rent is controlled by 
 the prevailing rate of interest. 
 
 We have seen how it is possible to distinguish the rent 
 of the bare land from the rent of the improvements fixed in 
 it. The rent of the land as such is practically of more 
 importance than the rent of any other class of capital goods, 
 as land is more frequently held under lease than any other 
 class of capital goods. For this reason, and because land 
 rent displays certain peculiar characteristics, it is worth 
 while to devote especial attention to a study of the laws 
 determining it. This does not mean that we should follow 
 the earlier economists in treating ground rent as a peculiar 
 form of income, to be sharply distinguished from all other 
 rents. 
 
 Let us assume that the construction of a railway throws 
 open to exploitation a large section of territory in the British 
 Northwest, and that all the land is at once bought up by 
 wealthy persons who intend to hold it permanently, par- 
 
l88 INTRODUCTORY ECONOMICS 
 
 celing It out in tracts suitable for tenant farmers. We shall 
 further assume that the owners of the land leave its equip- 
 ment with auxiliary capital goods entirely to the tenants, 
 and that the deterioration of the land is so slight as to be 
 negligible. Whatever the tenant can be made to pay, under 
 these conditions, is practically the rent of the bare land. 
 
 In making up his bid the tenant will have to estimate, 
 on the one hand, the gross receipts from the land which he 
 expects to occupy, and, on the other hand, all expenses of 
 cultivation, including the wages of all labor employed, his 
 own as well as that of hired hands ; interest on the auxiliary 
 capital which he furnishes, whether his own or borrowed 
 capital; and a sum sufficient to replace or repair capital 
 goods destroyed or impaired through use. Let us suppose 
 that all these items of expense amount to $i,ooo. If the 
 tenant has reason to believe that one year with another the 
 gross receipts from the farm will be only $i,ooo he will pay 
 nothing at all to the owner of the land for its use. If on the 
 other hand he believes that the gross receipts will be $2,000 
 he will be prepared to pay a rent of $1,000. 
 
 It is obvious that what the tenant can afford to pay for 
 the use of the land depends, in large measure, upon the 
 rates at which he must reckon the wages of labor and inter- 
 est on auxiliary capital. If these rates are high the deduc- 
 tions from gross receipt's to be made in calculating rent will 
 be large. Accordingly, in order to arrive at the forces de- 
 termining the rent of land in the section which we are study- 
 ing, we must examine the influences affecting the local rates 
 of wages and interest. 
 
 Land in the Canadian Northwest, as in every other part 
 of the world, varies in natural fertility and in accessibility. 
 If the supply of auxiliary capital and of labor is very small, 
 only the most fertile and most accessible lands will be culti- 
 vated at all. The owners of slightly poorer or slightly less 
 accessible lands will of course derive no revenue from them ; 
 they could afford to let such lands for a nominal rent. On 
 
INTRODUCTORY ECONOMICS 189 
 
 these lands, then, labor and auxiliary capital are free to 
 divide between them whatever they can produce. The labor 
 and auxiliary capital employed on the better land can 
 demand at least as much for themselves; if this is refused 
 they will migrate to the unoccupied fields. 
 
 Now let us suppose that a new body of laborers, bring- 
 ing with them the appropriate auxiliary capital, enter the 
 region. These occupy the lands which in fertility and acces- 
 sibility are least inferior to those first cultivated. If after 
 this accession of labor and capital any one is dissatisfied 
 with wages on the better lands, he may, as before, migrate 
 to land still remaining unoccupied. But the unoccupied 
 land is now more remote and less fertile than was that exist- 
 ing before the accession of new labor and capital, and the 
 product of labor and capital on such lands will be less. The 
 cultivator of the better grade of land v/ill, therefore, not 
 have to pay so much for either factor as before. A larger 
 share of his gross receipts may therefore be paid out in rent. 
 And with every increase in the labor and auxiliary capital 
 of the community, remoter and less fertile lands are brought 
 under cultivation, with consequent decline in wages and in 
 interest on auxiliary capital, and increase in the rent of all 
 the better grades of land. At any particular time we may 
 say that in this community the wages of labor and the inter- 
 est on auxiliary capital are determined, respectively, by 
 the productivity of labor and of auxiliary capital on the 
 poorest land actually cultivated. This is of course only 
 a special instance of the law stated in earlier chapters, 
 that wages and interest are determined by marginal prod- 
 uctivity. 
 
 If we exclude from our consideration the relation of the 
 community which we are studying with the rest of the 
 world, we may say, as did the classical economists, that the 
 rent of any piece of land is the difference between the value 
 of what is produced on that land and the value of what can 
 be produced by an equal amount of labor and auxiliary 
 
IQO INTRODUCTORY ECONOMICS 
 
 capital on the poorest land actually in cultivation. But we 
 cannot suppose that any such community will long remain 
 unrelated with the rest of the world. If the wages of labor 
 in the community are higher than the wages of similar 
 labor in older centers of civilization, population will increase 
 through immigration; poorer and poorer lands will be 
 brought under cultivation ; the wages of labor will fall, until 
 there is no longer special inducement to immigrate. In a 
 similar manner capital for investment in agricultural stock 
 will flow into the community so long as the rate of interest 
 is above the rate prevailing elsewhere. Thus the ultimate 
 forces controlling wages of labor and interest on auxiliary 
 capital are the forces that determine the rewards of these 
 economic factors in the industrial world at large. General 
 wages and interest are determined, we have seen, by the 
 marginal productivity of labor and capital, respectively, not 
 only in agriculture, but in manufactures, mining, transpor- 
 tation, and all other fields of economic endeavor. And as 
 the productivity of labor and auxiliary capital in the general 
 economic field increases or diminishes, the shares of these 
 agents in our imaginary community increase or diminish. 
 The rent of land, in the community, increases as these shares 
 diminish and decreases as they increase. 
 
 From the fact that when labor and capital flow into a 
 new region the rent of land steadily rises, it is often assumed 
 that the aggregate of land rents is constantly increasing. 
 But it is to be borne in mind that when labor and capital are 
 drawn into a new region, the older communities may come 
 to be less fully supplied than before. And this would in- 
 crease the shares of labor and of auxiliary capital in those 
 communities, and reduce the share that is assigned to land. 
 The increase in rents in America, in the last half century, has 
 in some measure been offset by a decline in rents in Europe. 
 If, however, population and capital in reproducible forms 
 continue to increase, without any corresponding increase in 
 the amount of land accessible to the cultivator, and without 
 
INTRODUCTORY ECONOMICS I9I 
 
 improvements that increase the general productivity of labor 
 and capital, the aggregate of land rent must increase. 
 
 In the foregoing example we have assumed that the 
 value of the product of a farm remains fixed, while the rates 
 of wages and interest vary. Let us now see what would be 
 the effect on rent of an increase in the value of the product — 
 which we shall assume to be wheat. Such an increase might 
 be brought about by a reduction in the cost of transporta- 
 tion. For the local price of wheat is practically equal to the 
 price in England, the great wheat market of the world, less 
 cost of transporting the wheat thither. If the cost of trans- 
 portation is reduced five cents a bushel, the local price of 
 wheat will rise five cents a bushel. 
 
 If the growers of wheat are forced to rely upon the 
 local supplies of labor and capital the efifect of the rise in the 
 price of wheat will be an increase in wages of labor and 
 interest on auxiliary capital; the rent of land will scarcely 
 be affected at all. For under the conditions assumed, wages 
 and interest are determined by the value of the product of 
 these agents on the poorest lands in the community actually 
 in use. The value of this product will be increased by the 
 rise in the price of wheat ; hence wages and interest will rise 
 throughout the territory. The cultivator will have greater 
 gross receipts, but he will have greater deductions to make 
 under the heads of wages and interest. There is no reason 
 why the surplus, or land rent, should rise at all. 
 
 If on the other hand close relations have been estab- 
 lished between this region and the rest of the world, so that 
 wages and interest are determined by the general influences 
 prevailing in society, practically the whole of the advance in 
 wheat prices will be applied to rent. For suppose that at 
 first wages and interest are raised above the general level. 
 Additional labor and capital will flow into the region ; com- 
 petition will arise for employment on the better lands, or 
 worse lands will be put under cultivation. Thus the mar- 
 ginal productivity of labor and of auxiliary capital will be 
 
19^ INTRODUCTORY ECONOMICS 
 
 reduced and the rent of land will increase, until labor and 
 capital are rewarded no better than they were before — that 
 is, until land rent has absorbed the entire benefit of the 
 increase in price. It is true that the withdrawal of labor 
 and capital from the general field that this movement implies 
 will tend to raise the rewards of these agents slightly. But 
 this influence will be hardly perceptible. 
 
 We can now understand what it is that forces up rents 
 in the vicinity of a growing city. The value of the gross 
 product of a given area is constantly increasing, as a result of 
 increased demand, while the charges to be deducted, wages 
 and interest on capital in reproducible forms, are controlled 
 by general laws which are affected only slightly, if at all, by 
 the growth of this particular city. Similarly with the rent 
 of city lots. The aggregate profits from the business that 
 may be transacted on a given ground space increase with 
 the growth of a city, and as wages and interest on repro- 
 ducible capital do not increase in equal degree, a larger sur- 
 plus is left for the owner of the land. It is obvious that the 
 same Reasoning will apply to the rent of a railway or a canal 
 in a rapidly developing region. The route of railway or 
 canal is a capital good which cannot readily be reproduced. 
 Accordingly, if the aggregate business to be carried on 
 increases, an increasing share of the value product of the 
 business will take the form of rent on the irreproducible 
 elements. 
 
 In all the cases that we have examined, an important 
 factor in raising rents of land and similar capital goods is 
 the influx, or possibility of influx, of capital and labor from 
 the general field. If we view society as a whole, there is, of 
 course, no possibility of a similar influx of labor and capital 
 from outside regions. Nothing can transfer to the owners 
 of land the benefits of increased value product except 
 increase in the aggregate supply of labor and auxiliary capi- 
 tal. If these agents remain stationary in quantity, while the 
 progress of improvements raises the productivity of those 
 
INTRODUCTORY ECONOMICS 193 
 
 units placed at the greatest disadvantage — ^that is, if general 
 wages and interest rise — it is obvious that the rent of land 
 may fall. So also if population and auxiliary capital de- 
 crease in amount. If, on the other hand, labor and auxiliary 
 capital increase so rapidly that wages and the interest on 
 such capital fall, land rents must in general rise. It is of 
 course possible that increase of capital and of labor may be 
 attended by such great improvements in methods of produc- 
 tion that wages, interest on reproducible capital goods, and 
 land rent will all increase. This has been more or less true 
 of the economic development of the last century. 
 
 The net rent of a concrete capital good, as has already 
 been indicated, is nothing but the interest on the capital 
 invested in that capital good, expressed in the form of a 
 lump sum. It is accordingly natural that payments which 
 figure in one man's accounts as rent often figure in the 
 accounts of another man as interest. A business man may 
 count as rent the $10,000 he pays for the use of a store build- 
 ing; the owner of the building may regard the same pay- 
 ment as interest on the capital invested in the building. The 
 business man may have his choice between paying $5,000 a 
 year for the building, or becoming the nominal owner, 
 giving his note for $100,000 at five per cent, interest. In 
 the latter case he regards his annual payment of $5,000 as 
 interest, not rent. Obviously, whether the payment is called 
 interest or rent is rather a matter of legal form than of 
 economic essence. 
 
 Given the net rent of a capital good, and the current 
 rate of interest on capital, it is an easy matter to ascertain 
 the amount of capital invested in the good. This process 
 of computing the capital through the net rent is known as 
 capitalization. If a building earns $10,000 a year, and there 
 is good reason for believing that it will continue to earn the 
 same net rent indefinitely, the simplest way of ascertaining 
 how much capital is invested in the building is to find how 
 large a sum of capital, in general investments, is required to 
 
194 INTRODUCTORY ECONOMICS 
 
 earn an equal sum. If the general rate of interest is teti 
 per cent., this sum will be $100,000. If the rate of interest 
 is five per cent., the sum will be $200,000. In the one case 
 the rent is capitalized at ten per cent. ; in the other case at 
 five per cent. 
 
 In the case of reproducible capital goods, the net rent 
 alone is no sufficient indication of capital value. The cost 
 of producing similar goods must be taken into account; 
 indeed, this is by far the more important element in the com- 
 putation. A ship, for example, may yield a net rent of 
 $10,000 at a time when the current rate of interest is five 
 per cent. It would, however, be a reckless business man 
 who would assume, from these data, that the ship represents 
 a capital of $200,000, and that he could afford to pay that 
 sum for it. If a similar ship can be built for $100,000, this 
 sum is the true measure of the capital invested. The net 
 rent of $10,000 merely indicates that capital in ships is, for 
 the time, highly productive. Soon the supply of ships will, 
 doubtless, be increased and the net rent will fall to about 
 $5,000. It may be a year before the decline will take place ; 
 in that case the buyer of a ship already afloat can afford to 
 pay about $105,000 for it. This sum may be analyzed into 
 two parts : $100,000 for the capital in the ship, and $5,000 
 for the transfer of the extra productivity of the ship through 
 one year. If several years must elapse before the net rent 
 of ships falls, the second element in the price of the ship 
 will be placed at a higher figure. And if in some way this 
 extra productivity could be made perpetual — if the ship, 
 worth originally $100,000, could be made to yield indefi- 
 nitely $5,000 in addition to the normal earnings of the capi- 
 tal invested in it — ^the buyer could afford to pay as much 
 for this extra product as for the original capital. That is, 
 he would arrive at the value of the ship, not through a com- 
 putation of its cost of production, but through a capitaliza-^ 
 tion of its entire net rent. 
 
 Now, a tract of land is a capital good in a situation 
 
INTRODUCTORY ECONOMICS 195 
 
 analogous to that of the ship in our hypothetical case. The 
 capital invested in the land, in the first instance, may have 
 been nothing at all. But if the land yields a net rent of 
 $5,000 a year, that fact is the only one that buyer or seller 
 will need to consider. For it is not possible that the supply 
 of similar pieces of land at the command of society will be 
 so increased that the net rent will shrink to zero, as would 
 be the case with a reproducible good originally costing 
 nothing. Because of the natural limitation upon the supply 
 of land, there is good reason for supposing that the existing 
 rent will continue to be paid indefinitely. The right to re- 
 ceive the $5,000 land rent for all time is therefore worth 
 just as much as the possession of a capital in reproducible 
 forms yielding $5,000 interest annually. If capital in repro- 
 ducible goods yields, as a rule, ten per cent., the rent of the 
 land will be capitalized at $50,000; if the current rate on 
 such capital is only five per cent., the rent will be capitalized 
 at $100,000. 
 
 Shall we say that a tract of land that yields $5,000 rent, 
 and is capitalized at $100,000, is really a capital of $100,000, 
 or shall we say that the real capital in the land is only the 
 sum originally employed to clear it and render it fit for 
 economic use? If we adopt the former mode of expression, 
 we shall regard the capital in the land as no more productive 
 than capital in any other form. If we adopt the latter mode 
 of expression, we shall regard the capital in the land as 
 extraordinarily productive. Business men, and many mod- 
 ern economists, adopt the former mode of expression. A 
 property that yields regularly the income of a capital of 
 $100,000 is a capital of $100,000. 
 
 It matters little what mode of expression we employ so 
 long as we bear in mind the fact that the value of the land 
 is merely the capitalization of its rent at the current rate of 
 interest; that with an increase in the rent of a given tract 
 of land, if interest on capital in reproducible goods remains 
 unchanged, the capital value of the land automatically 
 
196 INTRODUCTORY ECONOMICS 
 
 increases, until the ratio of the capital value of land to its 
 net rent is the same as the ratio of the capital value of a 
 group of typical reproducible capital goods to their net rent ; 
 that with a decline in the interest rate on capital in repro- 
 ducible goods, the value of land yielding a given rent 
 increases until the rate of interest on so-called capital in 
 land is no higher than the rate of interest on other forms of 
 capital. If the rate of interest on capital in reproducible 
 capital goods falls, it is because the earning power of such 
 goods declines. If the rate of interest on capital in land 
 declines, it is usually because the land is revalued at a higher 
 figure — that is, counts for a larger sum of capital. 
 
 We have already seen that with increase in the social 
 fund of reproducible capital the productivity of such capital 
 declines ; the rate of interest falls, and a larger share of the 
 product of society takes the form of ground rent. This of 
 itself would have the effect of increasing the capital value 
 of land. The decline of the interest rate affects the value of 
 land further through changing the rate at which a given rent 
 is capitalized. If the current rate of interest is ten per cent., 
 a certain field may produce a net rent of $1,000. This sum, 
 capitalized at ten per cent., gives a value of $10,000, which 
 we may, if we choose, call the capital invested in the field. 
 At the end of two decades the current rate of interest may 
 have fallen to five per cent. This would naturally increase 
 the rent of the field in question — perhaps to $2,000. This 
 rent we must now capitalize, not at ten per cent., as for- 
 merly, but at the new current rate of five per cent. The 
 value of the land thus comes to be $40,000. 
 
CHAPTER XIV 
 
 Business Profits 
 
 In popular language the term "profit" is usually applied 
 to the net earnings of a business — that is, gross receipts less 
 actual expenses. These net earnings include the return to 
 the capital that is contributed by the man in whose name the 
 business is conducted, as well as his reward for the labors 
 of management. Since political economy extends the mean- 
 ing of the term "wages" so as to include the reward for the 
 labor of management, and extends the meaning of the term 
 "interest" so as to include the earnings of all capital, whether 
 owned by the business man or not, the scope of the term 
 "profit" must be correspondingly restricted. As the term is 
 used in modern economic literature, it designates a surplus 
 remaining after all costs, including interest on all capital 
 and wages for all labor, have been met. 
 
 Profit in this sense of the term forms no part of the 
 income of the capitalist as such, for his claims are satisfied 
 when interest is paid on his capital. It forms no part of 
 wages. It is the proper income of the enterpriser — ^the man 
 who employs both labor and capital in a business enterprise. 
 What functions the enterpriser performs we must now 
 consider. 
 
 Let us suppose that a man of known integrity and busi- 
 ness capacity decides to establish a manufacturing business. 
 He may be able to borrow at a stipulated rate of interest all 
 the capital that the enterprise requires. Having command 
 of this capital, he proceeds to acquire a building and the 
 appropriate equipment, and selects subordinates whose duty 
 it is to secure the necessary office force and manual workers. 
 The actual work of the business man himself may be a negli- 
 gible minimum. His secretaries may collect the information 
 
198 INTRODUCTORY ECONOMICS 
 
 on which he acts in deciding to found such a business. His 
 attorneys may arrange the details of the loan contract; his 
 banker may find for him the persons who have capital to 
 lend. Even the business of selecting a building and choos- 
 ing a responsible manager may be given over to salaried 
 employees. What, then, is the connection of the business 
 man with the enterprise? He lends it his name, he assumes 
 legal responsibility for the conduct of the business, and he 
 reserves to himself the ultimate power of approving or veto- 
 ing proposals made by his staff. These are the only func- 
 tions that the enterpriser must necessarily retain. 
 
 In real life it would be difficult to discover a man who 
 is an enterpriser and nothing more. It is rarely the case 
 that a man without capital can borrow any considerable 
 amount of it. Lenders demand the security that only the 
 owner of independent resources can give. It would, more- 
 over, be a fortunate enterpriser who could find secretaries 
 and managers who can be trusted to the extent we have 
 assumed. A part of the labor of oversight must ordinarily 
 be performed by the business man himself. The fact that 
 the same man combines in himself the functions of enter- 
 priser, laborer and capitalist does not, however, make the 
 functions indistinguishable. 
 
 What we are concerned with in the present chapter is 
 the nature of profit, the income of the enterpriser as such. 
 Profit appears only when the selling prices of the products 
 of an enterprise exceed the cost of those products. We may, 
 therefore, study profit from the viewpoint of the forces 
 determining prices. Or, we may study profit from the point 
 of view of distribution, inquiring into the conditions under 
 which wages and interest fail to absorb the entire net 
 product of labor and capital. The latter will be the point of 
 view of this chapter, as we have already approached the 
 problem from the point of view of prices in the chapters on 
 ''Market Price" and "Cost of Production." 
 
 If competition were all pervading and instantaneous in 
 
INTRODUCTORY ECONOMICS I99 
 
 its action, every laborer and every unit of capital would 
 receive precisely the product created by that laborer or unit 
 of capital. Enterprisers would bid against one another so 
 long as labor or capital received a reward inferior to the 
 total value of the product of labor or of capital. Every 
 laborer would produce a value equal to that produced by 
 any similar laborer ; the product of all equal units of capital 
 would be equalized. How this equalization of products 
 would be realized we have already seen : through the move- 
 ment of labor and capital from fields of low productivity to 
 fields of high productivity. 
 
 In the existing state of industry, however, competi- 
 tion does not operate thus uniformly and effectively. There 
 are circumstances under which enterprisers as a class hesi- 
 tate to bid for additional labor and capital even when it 
 would be profitable for any member of the class to do so — 
 that is, when contract wages and interest are inferior to the 
 product of labor and capital. Labor and capital, further, 
 vary in productivity from locality to locality and from in- 
 dustry to industry. There is accordingly a possibility that 
 enterprisers may engage laborers at the rates prevailing in 
 the employments of low productivity and set them at work 
 in the employments of high productivity, retaining for them- 
 selves a part of the increased product of the labor. Similar 
 gains may be obtained through borrowing capital where its 
 productivity is low and employing it in fields where its 
 productivity is high. Again, certain laborers may be ab- 
 solutely dependent upon a single enterpriser for their employ- 
 ment ; certain capitalists may be under similar disabilities in 
 the disposal of their loanable funds. In such cases, the enter- 
 priser may fix rates of wages and of interest which do not 
 correspond with the productivity of labor and capital. 
 Profits arising from this source are comparatively unimpor- 
 tant. They appear in such enterprises as are represented by 
 the sweating trade. 
 
 We may first examine the conditions under which en- 
 
200 INTRODUCTORY ECONOMICS 
 
 terprisers as a class obtain a- profit through refraining from 
 the competition that tends to force wages and interest to a 
 level where they absorb the entire product of labor and 
 capital. In times of so-called prosperity it often happens 
 that, for reasons which are not generally understood, the 
 prices of almost all commodities rise; or, what amounts to 
 the same thing, the products of labor and capital, measured 
 in terms of price, increase. For a time enterprisers fear 
 that the rise in prices is a merely temporary phenomenon, 
 to be followed, perhaps, by a fall of prices to a level lower 
 than that existing before the rise. So long as enterprisers 
 maintain this attitude, they naturally refrain from enlarg- 
 ing their businesses. No enterpriser attempts to entice away 
 the workmen in the employ of other enterprisers, as he 
 would do if he believed that the high level of prices would 
 be maintained, nor does he increase his demands upon the 
 fund of loanable capital. There is accordingly no reason 
 why wages and interest should rise. The effect of the rise 
 of prices is thus to increase the price of the products of 
 labor and capital without increasing the cost of labor or of 
 the use of capital. If before the rise in prices labor and 
 capital received the whole value of their products, it is ob- 
 vious that they receive less than this after the rise. A part 
 of the product of labor and of capital remains in the hands 
 of the enterprisers as a profit. 
 
 If the high prices are maintained for any length of time, 
 one enterpriser after another decides to enlarge his busi- 
 ness in order to increase his aggregate profits. He can do 
 this only by enticing away some of the men employed by 
 other enterprisers, through the offer of slightly higher wages. 
 Those enterprisers, averse to losing their working force at 
 a time of high profits, are compelled to raise wages them- 
 selves. And thus a force is set in motion which will eventu- 
 ally raise the cost of labor until it absorbs the whole value 
 product of labor. Similarly enterprisers bid against one 
 another for capital, thus forcing up the rate of interest until 
 
INTRODUCTORY ECONOMICS 201 
 
 it absorbs the whole product of capital. Thus eventually 
 the general profits of a period of prosperity disappear. 
 
 It is a familiar fact that wages and interest vary greatly 
 from locality to locality. A carpenter in Boston does not 
 receive as high wages as he would receive in San Francisco. 
 Interest rates are higher in Montana and Texas than in 
 Massachusetts. Between different countries the differences 
 in wages and in interest rates are much more striking. An 
 American laborer receives wages one hundred per cent. 
 higher than the wages paid similar laborers in most parts 
 of Europe. The wages of labor in China and India are 
 still lower than those of Europe. Interest rates in England 
 and Holland are on the average considerably lower than 
 interest rates in the United States ; in parts of Latin Amer- 
 ica interest rates are considerably higher than in the United 
 States. The explanation of these facts is of course to be 
 found in the differences in the productivity of labor and 
 capital in the different localities and countries. We are 
 here concerned with the effects of such differences upon the 
 profits of the enterpriser. 
 
 Let us suppose that an employer of large numbers of 
 unskilled laborers in the United States sends agents to 
 Europe, or even to the Orient, to obtain a supply of labor. 
 What the agent will offer for, say, two years' labor will be 
 the local rate of wages for that period of time together with 
 such a premium as may be necessary to overcome the re- 
 luctance of laborers to leave their native land. The cost 
 of labor is thus determined chiefly by the standards of pro- 
 ductivity prevailing in countries from which the laborers 
 are imported, while the value of the labor to the enterpriser 
 is determined by American conditions of productivity which 
 are admittedly more favorable. By virtue of the labor con- 
 tract the employer is thus enabled to retain for himself a 
 part of the product of the labor. 
 
 It is obvious that the possibility of obtaining a profit of 
 this nature depends upon the character of the laws relating 
 
202 INTRODUCTORY ECONOMICS 
 
 to labor contracts. If the enterpriser cannot enforce the 
 contract by law the laborers whom lie has imported may 
 desert him before their services have yielded adequate com- 
 pensation for the cost of bringing them to the country. In 
 the United States to-day, not only would such a contract 
 be unenforceable, but the importation of laborers from 
 foreign countries under such contracts is a punishable 
 offense. This was not formerly the case, and one of the 
 important sources of profits in early American economic 
 history was of the character that has been described. In 
 many parts of the world, especially in the tropics, the same 
 thing is true to-day. There are even companies which make 
 it their sole business to supply enterprisers with contract 
 laborers from China and India. Such companies derive 
 their profit from the product of the laborers, part of which 
 is made over to the company by the enterpriser who employs 
 the laborers. 
 
 We need not here consider the reasons that have led 
 to the general condemnation of enterprise that relies for 
 its profits on differences in local rates of wages. What we 
 are more immediately concerned with is the natural limita- 
 tion upon profits of this nature. Let us suppose that the 
 Chinese coolie in his own home can obtain an annual wage 
 of $50, while his services on a Spanish- American plantation 
 or other enterprise are worth $250 per annum. Allowing 
 $150 for bringing the laborer from China and for his return, 
 and $50 a year to overcome his reluctance to leave his native 
 land, there would remain, on a two-year labor contract, a 
 profit of $150 to the enterpriser, if he imported the labor 
 directly, or to be divided between the enterpriser and the 
 coolie labor company, if the latter acts as intermediary. 
 
 Under the assumed conditions the business of import- 
 ing coolie laborers would quickly expand. As the number 
 of Chinese laborers who are willing to leave their native 
 country under such contracts is by no means unlimited, com- 
 petition among labor importers would force up the wages 
 
INTRODUCTORY ECONOMICS 203 
 
 offered to the coolies. Again, the increasing supply of 
 coolie labor in the employing region would reduce marginal 
 productivity — that is, the value of the services of a laborer — 
 in those regions. And these tendencies would continue to 
 operate until the profit of the business of importing laborers 
 disappeared. 
 
 We may apply the same reasoning to the case of profits 
 arising from the transfer of capital from regions where its 
 productivity is low to regions where its productivity is 
 relatively high. A mortgage loan company may borrow 
 capital in New York at five per cent, interest and loan it in 
 Texas at seven per cent. The loan company thus receives 
 a profit of two per cent. How is this profit produced? 
 Clearly it is a part of the product of the capital set at work 
 in Texas. A Texas enterpriser might have borrowed the 
 capital directly, keeping for himself the profit that would 
 otherwise have gone to the loan company. 
 
 This source of profit, also, is one that must eventually 
 run dry. The draining away of capital from New York 
 would tend to raise the interest rate there — though hardly 
 perceptibly, owing to the vast supply of capital in the na- 
 tion's financial center. The influx of capital into Texas 
 would reduce the productivity of capital in that State, until 
 at last nothing would be gained by further transfer of 
 capital. 
 
 In any important industrial center the productivity of 
 labor and of capital may at a given time vary from industry 
 to industry, while the wages of labor and interest on loan- 
 able capital vary little, if at all. We may in thought ar- 
 range the different industries of such a center in a series, 
 according to degree of productivity of labor and capital in 
 each one. Labor and capital will receive no higher rewards 
 in any industry than in the one that stands lowest in the 
 series. If we assume that in this least productive industry 
 labor and capital receive all that they produce — and we 
 can hardly assume that they receive more than this — we 
 
204 ' INTRODUCTORY ECONOMICS 
 
 see clearly that they must receive less than they produce in 
 all the industries higher in the series. In the more pro- 
 ductive industries the products of labor and capital afford 
 a surplus above wages and interest, which takes the form of 
 a profit to the enterpriser. 
 
 Let us suppose that the American public, awakening to 
 the significance of the ghastly record of railway accidents, 
 insists that steel passenger coaches replace the wooden cars 
 now in use, and withholds its patronage from railway com- 
 panies that refuse to change their equipment. The demand 
 for steel cars would become enormous ; years would have to 
 elapse before the existing establishments could satisfy it. 
 The car building companies, for a time, could sell their 
 output at very high prices. The productivity of labor and 
 capital in such establishments, measured in terms of price, 
 would be abnormally high. But the wages of laborers en- 
 gaged in building steel cars would be no higher than the 
 wages of equally skilled laborers in any other branch of the 
 iron and steel industries. There would accordingly be a 
 surplus above costs, or a profit to the enterpriser. The car 
 building companies would pay no higher rate of interest 
 on borrowed capital than any other manufacturing com- 
 panies in the vicinity. A surplus originating in the ab- 
 normally high productivity of capital would thus be added 
 to the profit from labor. 
 
 In the course of time the existing establishments would 
 increase their capacity and new companies would enter the 
 field. The price of steel cars would fall — that is, the pro- 
 ductivity of labor and capital in the industry, measured in 
 terms of value, would decline. The increased demand for 
 labor might slightly raise wages in all the iron and 
 steel industries. Thus the profits of the enterpriser would 
 gradually be reduced, until at last they disappeared alto- 
 gether. 
 
 In any industry the productivity of labor and capital 
 may vary from establishment to establishment, although 
 
INTRODUCTORY ECONOMICS 20^ 
 
 there may be no variation in the rates of wages paia. We 
 may, if we Hke, arrange the establishments in a series, ac- 
 cording to the degree of productivity of labor and capital, 
 just as we did in the case of industries of varying produc- 
 tivity. No higher wages or interest will be paid by any 
 establishment than by the establishment working at the 
 greatest disadvantage. As this establishment will pay to 
 labor and capital no more than these agents produce, 
 it follows that the better establishments will not need 
 to pay out in wages and interest the whole product of 
 labor and capital. A profit is left over for the enter- 
 priser. 
 
 Differences in the productivity of labor and capital in 
 the same industry may be due to differences in methods of 
 production, to differences in the business capacity of enter- 
 prisers, or to differences in the location of plant. If the 
 superiority of one establishment over others arises from bet- 
 ter methods of production, it cannot continue for any great 
 length of time — unless indeed the establishment enjoys a 
 monopoly of its method, secured by a patent. In the end 
 the better method of production is adopted generally ; prices 
 fall or wages rise until there remains no profit for the 
 enterpriser. 
 
 One business man may, however, show greater enter- 
 prise than others in adopting new methods as soon as they 
 appear. By the time that any particular invention has be- 
 come the common property of the industry, the more enter- 
 prising business men have introduced some new method, 
 from which they are able to derive profits for a time, until 
 this method, too, becomes the common property of the in- 
 dustry. Thus an able enterpriser may secure a permanent 
 flow of profits from a series of improvements of method, 
 although the profits from each successive improvement are 
 quickly annihilated by competition. 
 
 One business man may have greater skill than another 
 in selecting workmen and in maintaining harmonious rela- 
 
206 INTRODUCTORY ECONOMICS 
 
 tions with them; in deciding just what grade of the com- 
 modity which he produces will best suit the needs of the 
 purchasing public ; in determining the proper proportions in 
 which to combine materials in the production of commodi- 
 ties of ephemeral demand. Advantages that are secured in 
 this way have a certain degree of permanence. Other enter- 
 prisers may adopt methods that are to all appearances the 
 same ; yet they may fail of attaining the same results. What 
 they lack is the business instinct with which the more com- 
 petent enterpriser is endowed. The latter may therefore 
 enjoy a permanent income from this source. Such an in- 
 come is usually classed with profits; but if we examine it 
 carefully we shall see that it is more properly a special kind 
 of wages. It exists only by virtue of the continued exercise 
 of the faculties, mental and physical, of the enterpriser. 
 For the exercise of such faculties a man might demand, and 
 would receive, a salary if he chose to enter the employ of 
 another instead of continuing in business on his own 
 account. 
 
 The income arising from superiority of location may be 
 transient or permanent. It may be that by virtue of prox- 
 imity to the sources of raw material or of fuel, or by virtue 
 of a cheaper labor supply, a certain grade of cotton cloth 
 can be manufactured more cheaply in the Carolinas than in 
 New England. So long, however, as the Carolinas are un- 
 able to supply the demand for that grade of cloth, the price 
 will remain high enough to cover cost of production in 
 New England — that is, high enough to give Carolina pro- 
 ducers a profit. If this is the case, enterprisers who con- 
 template the erection of new mills will naturally choose the 
 Carolinas as their location. Whenever New England mills 
 wear out, their owners, instead of rebuilding in the same 
 spot, will transfer their business to the South. Under the 
 conditions the entire industry will eventually migrate to the 
 more favorable location. The price of labor in the Carolinas 
 will gradually rise and the price of the cloth will gradually 
 
INTRODUCTORY ECONOMICS 207 
 
 fall until no producer longer receives a profit on account of 
 location. 
 
 But let us suppose that in the favored location there is 
 room for only a limited number of establishments. Let us 
 say that on the banks of a certain river, which serves as a 
 cheap means of transportation of raw materials and of fin- 
 ished products, there are suitable locations for only a dozen 
 establishments, while a hundred establishments are required 
 to supply the demand for the commodity which these es- 
 tablishments produce. The price of the commodity will then 
 remain permanently at a figure that covers cost of produc- 
 tion in the establishments that do not enjoy the advantages 
 of the favored location. The establishments that do enjoy 
 these advantages will therefore yield a permanent income 
 that resembles profit. 
 
 If, however, we analyze this income carefully we shall 
 see that it is not a true profit. If the land on which the 
 establishments stand is held by the enterpriser under lease, 
 he will, at each renewal of the lease, make over to the owner 
 of the land, as rent, a payment corresponding with the so- 
 called profit arising from superiority of location. And this 
 reveals the nature of the apparent profit. It is ground rent, 
 irrespective of the facts of ownership. 
 
 All the forms of profit that have been described — so far 
 as they are true profits — are alike in that they are transitory 
 in their nature. The very existence of such profits gives 
 rise to competition, and competition eventually annihilates 
 them. It is evident that if, in any case, competition can be 
 prevented from appearing, profits may be transformed into 
 a permanent income. 
 
 We have seen that one of the possible sources of profit 
 is the introduction of a new and more fruitful method of 
 production. So long as the method is confined to one out 
 of a number of competing establishments, prices remain at 
 a level which covers cost of production in the establish- 
 ments which do not employ the new method. If the new 
 
208 INTRODUCTORY ECONOMICS 
 
 method of production is really an innovation in industry, 
 and if it is of such a nature as to admit of definite de- 
 scription — as, for example, a mechanical device for saving 
 labor — the enterpriser who invented it may take out a 
 patent, which will assure to him the exclusive right of using 
 it for a period of time — seventeen years, in the United 
 States. During this period he may continue to enjoy the 
 profits arising from the use of the method. He may, of 
 course, sell the right of use to other enterprisers, in which 
 case he makes labor and capital more productive in the es- 
 tablishments buying the right, reserving for himself, in the 
 shape of payments for the use of the patent, a part of the 
 product of these agents of production. 
 
 Somewhat analogous to the profits arising from a 
 patent are the profits arising from the use of a trade-mark 
 or from the "good will" of a concern. A certain brand of 
 soap, bearing the name of the man who first placed it on 
 the market, has, let us say, a reputation for purity estab- 
 lished by long years of honest business. Another soap bear- 
 ing another name may be just as pure; but the consumer 
 has no adequate means of determining qualities, and so pre- 
 fers the brand which he has always believed to be good. It 
 is evident that the manufacturers enjoying such a firm hold 
 on the popular favor can charge somewhat higher prices 
 for goods of a given grade than can manufacturers who 
 have their reputation yet to establish. So a merchant who 
 has established a reputation for upright dealing, or who has 
 succeeded in attracting to himself the patronage of the 
 wealthier classes of a city, can charge somewhat more than 
 can his less fortunate competitors. The public esteem which 
 an enterpriser enjoys — the good will of the business — is 
 sometimes only an insignificant source of profits. Some- 
 times, however, it is an exceedingly important source. In 
 many cases the good will of a manufacturing or mercantile 
 establishment is worth more than its aggregate tangible 
 assets. 
 
INTRODUCTORY ECONOMICS 209 
 
 One further source of permanent profits deserves con- 
 sideration here — ^monopoly. In the strictest sense of the 
 term the profits from a trade-mark or a patent are monopoly 
 profits. Such profits, however, are Hmited to one out of a 
 number of competing enterprisers in an industry. The 
 monopoly profit which we are now considering may be en- 
 joyed by all the enterprisers in an industry. 
 
 Let us suppose that all the manufacturers of tin plate 
 agree to reduce output twenty per cent, in order to force up 
 prices. If the various producers can be held to their agree- 
 ments and if new producers can be kept from entering the 
 field, there is no reason why every enterpriser in the busi- 
 ness should not enjoy a permanent profit. In the chapter 
 on monopoly price we saw how this can be done. What the 
 monopolists do, from the point of view of distribution, is 
 this: A group of allied enterprisers throw a fence, as it 
 were, around a particular field of industry. They limit the 
 amount of labor and capital admitted to the field, so that 
 the productivity of these agents remains higher than in the 
 unmonopolized fields. The wages and interest paid by the 
 monopoly are no higher than wages and interest in the un- 
 monopolized fields. Consequently there remains in the hands 
 of the monopolistic enterprisers a surplus, or profit. 
 
 We saw in the last chapter how it is possible to arrive 
 at the value of a capital good, such as a field, by capitalizing 
 the income at the current rate of interest. Permanent profits 
 may be reduced to a capital value in the same way. If the 
 profit from a monopoly is $100,000 a year, and if there is 
 good reason for believing that it will continue to be the same 
 from year to year, the monopoly itself is worth as much as 
 a sum of capital that will yield $100,000 interest per an- 
 num. If capital generally yields five per cent., the monopoly 
 is worth $2,000,000. If the enterprisers having such a 
 monopoly were to sell out their interests, they would de- 
 mand that sum over and above full payment for all the 
 buildings, machinery, and other tangible assets of their busi- 
 
210 INTRODUCTORY ECONOMICS 
 
 ness. The same thing is true of the profits arising from 
 the good will of a business. These profits will be capi- 
 talized, and the buyer of the business will have to add the 
 capital value of the profits to the value of the tangible capi- 
 tal goods. 
 
 The value of a patent is found in a similar manner. 
 The only difference is that the profits from this source cease 
 upon the expiry of the patent. What the buyer pays for is 
 the right to a certain estimated income for a definite num- 
 ber of years. If the annual income is estimated at $5,000 
 a year, and the patent has ten years to run, the simplest way 
 of arriving at the value of the patent is to find the present 
 value of each year's income, and add these sums together. 
 If the current rate of interest is four per cent., the present 
 value of $5,000 due in one year is obviously equal to a 
 sum which, plus interest for a year, will amount to $5,000. 
 That sum is about $4,810. $5,000 to fall due two years 
 hence is worth a present sum which together with compound 
 interest at four per cent, will in two years amount to $5,000 — 
 $4,625. By a similar process — known as discounting — ^the 
 value of each year's income may be ascertained, and by addi- 
 tion, the present value of the patent is established. 
 
 All profits, whether monopolistic or not, are from the 
 point of view of distribution a part of the product of labor 
 and capital which various circumstances enable the enter- 
 priser to retain for himself. It may therefore appear, at 
 first thought, that the existence of profits is evidence of in- 
 justice in the distribution of wealth. 
 
 Upon reflection, however, we see that this is not true. 
 Profit in many cases plays an important part in stimulating 
 economic progress; in many other cases the existence of 
 profit serves as a means of distributing the agents of pro- 
 duction in such a way as best subserves the interests of so- 
 ciety. An income that must exist if society is to be progres- 
 sive and if the best disposition is to be made of its produc- 
 tive resources can hardly be regarded as unjustifiable. 
 
INTRODUCTORY ECONOMICS 211 
 
 It is the hope of profits that induces the enterpriser to 
 devise improved methods of production, or to adopt im- 
 provements devised by others. In doing this the enterpriser 
 increases the productivity of labor and capital, reserving 
 for himself, as long as he can, the benefits of this increased 
 productivity. But sooner or later the new method finds 
 general application in the industry, and the enterprisers are 
 forced to turn over the benefits arising from it to labor and 
 capital, in the form of increased wages and interest, or to 
 the consumer of commodities in the form of lower prices. 
 In the latter case all laborers and capitalists gain by an in- 
 crease in the purchasing power of their incomes. 
 
 When profits arise from a general increase in the de- 
 mand for a commodity, the title of the enterpriser to the 
 income is perhaps not quite so clear. But such an increase 
 in demand shows that the amount of labor and capital de- 
 voted to the industry affected by the increased demand 
 should be increased. This result can be brought about only 
 through the action of enterprisers. Now, if enterprisers re- 
 ceived no profit from enlarging old works and establishing 
 new ones, why should they trouble themselves with doing 
 this? If on the other hand they may for a time keep for 
 themselves as a profit a part of the price of their products 
 they will naturally endeavor to enlarge their works as 
 quickly as possible. When at last as much labor and capital is 
 devoted to the industry as is socially expedient, profits cease 
 through rise in wages and interest or through fall in prices. 
 
 Of the forms of profit that are classed as monopolistic, 
 those arising from patented inventions and from good will 
 need no defense. The former is the reward for one of the 
 most important services to society. The inventor can never 
 get for his services, at any time, more than they are worth 
 to society ; at the expiry of the patent the invention becomes 
 the common possession of all. The profits arising from good 
 will are a reward for honorable business dealings, and can 
 be retained only so long as the enterpriser is worthy of them, 
 
212 INTRODUCTORY ECONOMICS 
 
 The profits of an ordinary monopoly stand on an en- 
 tirely different footing. The productivity of labor and capi- 
 tal in the field controlled by the monopoly is rendered ab- 
 normally high not through superior organization and com- 
 bination of these factors in production, but through the 
 maintenance of an artificial scarcity of them, which is di- 
 rectly opposed to the interests of society. While the action 
 of any one out of a number of competing enterprisers, each 
 striving to increase his own profit, necessarily operates to 
 increase the aggregate wealth produced by society, the ac- 
 tion of a combination of enterprisers striving to secure a 
 monopoly profit as necessarily operates to reduce the aggre- 
 gate wealth production of society. Through his anti-social 
 conduct the monopolistic enterpriser receives a permanent 
 profit, the fruits of other men's labor and capital. The enter- 
 priser who carries on business under conditions of competi- 
 tion receives, as a reward for his important services to so- 
 ciety, only a temporary profit. 
 
 It appears, therefore, that the elimination of monopoly 
 profit through legislative action, if possible, is eminently de- 
 sirable. It is, however, to be borne in mind that this cannot 
 always be done without injustice. We have seen that 
 monopoly profit, being permanent, may be capitalized. If 
 a combination of manufacturing enterprises makes possible 
 a monopoly profit of $100,000, the selling value of the com- 
 bined enterprise — or of the capital stock representing it — is 
 increased by the capital value of an income of $100,000. 
 Now, the original promoters of the monopoly do not con- 
 tinue to own it forever. Some of the stock in it may pass 
 to their heirs ; some of it may be sold to persons who do not 
 know that a great part of its value is merely the capitaliza- 
 tion of a wrongful monopoly profit. If then the profit of 
 the monopoly is eliminated, the latter class of persons find 
 themselves deprived of an income the right to which they 
 purchased in good faith as an income from capital. 
 
CHAPTER XV 
 Money 
 
 In the foregoing chapters frequent use has been made 
 of the concept price, which of course implies the concept 
 money, since price is nothing but exchange value, expressed 
 in terms of money. It has been tacitly assumed that money 
 is in general use and that its value remains constant, price 
 fluctuations being due to changes in the conditions of produc- 
 tion or consumption of other things. The latter assumption, 
 as every one familiar with recent discussions of economic 
 policy is aware, cannot pass unchallenged. The value of 
 money, like the value of all other things, is subject to con- 
 tinual fluctuations, and these fluctuations give rise to some 
 of the most important problems of practical economics. 
 
 What is money? How did it originate, and what func- 
 tions does it perform? What is meant by the value of 
 money, and how is this value determined? When the value 
 of money changes, what are the effects of such changes upon 
 the welfare of society at large and that of the several classes 
 making up society? What should be the policy of govern- 
 ment in respect to the monetary system of a country ? These 
 are some of the questions that political economy has for a cen- 
 tury or more been endeavoring to answer. Such is the com- 
 plexity of the problems involved, however, that the conclu- 
 sions even of professional economists are widely divergent, 
 to say nothing of the differences of opinion among men of 
 affairs. 
 
 We may profitably begin our study by considering what 
 it is that the plain man regards as money. Anything that 
 is accepted by practically every one in exchange for his goods 
 or services, with the intention of using it only for the pur- 
 pose of exchanging it ultimately for other goods or services, 
 
2T4 INTRODUCTORY ECONOMICS 
 
 is popularly regarded as money. This view, which is also 
 that of many of the ablest writers on money, we may safely 
 adopt as our own. Under different conditions of economic 
 development, different concrete things have served as money 
 — shells, beads and other ornaments, bits of metal coined 
 or uncoined, and even consumable commodities, like cattle, 
 furs, spirits. With the evolution of trade, a corresponding 
 evolution of money has taken place, those forms of money 
 which were fitted for use when trade was merely an inci- 
 dental part of economic life giving way to forms of money 
 adapted to a complex system of commerce. 
 
 The origin of money antedates all historical records. 
 Nevertheless, we know enough about the life of primitive 
 man to construct a plausible view of the circumstances under 
 which money must have come into existence. In the earlier 
 stages of human evolution exchange, at least in the modern 
 sense of the term, was unknown; hence of course money 
 could not have existed. When it first became customary to 
 make exchanges, goods were doubtless bartered directly for 
 goods, as is sometimes the case even to-day. Certain arti- 
 cles, however, were more frequently the objects of exchange 
 than others, as, for example, strings of sea shells, articles of 
 copper, silver and gold suitable for personal adornment. 
 Such articles, unlike the common necessaries of existence, 
 could not be produced by any one desiring them. Not being 
 essential to life, they would naturally be sacrificed by their 
 possessors in time of need. We can easily see, therefore, 
 why articles of this nature should have been among the earli- 
 est to be freely purchased and sold. How a medium of ex- 
 change evolved from them we can best understand if we try 
 to picture to ourselves the conditions under which the evolu- 
 tion took place. 
 
 Let us imagine that in a primitive community, where 
 trade, in the form of barter, has become customary, one man 
 finds himself possessed of a larger herd of cattle than he 
 needs. He may be in great need of an additional slave. Yet 
 
INTRODUCTORY ECONOMICS 21$ 
 
 he may be quite unable to find a person who has a super- 
 fluous slave and who would desire more cattle. Direct ex- 
 change, therefore, is out of the question. 
 
 But the owner of cattle may not decide to keep a su- 
 perfluity of them merely because he cannot get for them 
 exactly the thing that he most needs. He may cast about 
 for some other article against which to exchange the cattle. 
 In common with all primitive men — and some men who are 
 not to be classed as primitive — he has an insatiable desire 
 for ornaments which may arouse the admiration or envy 
 of his fellows. Quite naturally, then, if opportunity offers, 
 he exchanges his superfluous cattle for a silver bracelet. 
 Shortly afterward he may meet with some one quite willing 
 to exchange a slave for the bracelet. The final result of the 
 two transactions, from the point of view of the owner of the 
 cattle, is simply the exchange of the cattle for the slave. The 
 bracelet has served as a medium through which the exchange 
 has been effected. And this is true, although none of the 
 parties to the two transactions is conscious of the fact. 
 
 Now let us suppose that the owner of the cattle, at the 
 time of exchanging his cattle for a bracelet, has no particular 
 desire for any other form of wealth. At the end of a year, 
 however, he may come to need a slave, and use the bracelet 
 to procure one. In this case, too, the bracelet serves as a 
 medium in the exchange of the cattle for the slave. It further 
 serves to enable the owner of the cattle to retain their value 
 in his hands until he may desire to transform it into some 
 other useful commodity. Thus the bracelet serves as a store, 
 or repository of value. 
 
 It is highly probable that the same bracelet will on fre- 
 quent occasions perform the same function of medium of 
 exchange and store of value. If there are many similar 
 bracelets in the community, it is quite possible that men will 
 get into the habit of selling their goods for bracelets, with 
 the expectation of using the bracelets merely to buy other 
 goods with. In such case the bracelet ceases to be an ordi- 
 
2l6 INTRODUCTORY ECONOMICS 
 
 nary object of use, and becomes money. It will then assume 
 a further function. Whenever men think of buying or sell- 
 ing commodities, they will estimate the worth of such com- 
 modities in terms of bracelets. The latter, then, become a 
 measure or a standard of value. 
 
 Just at what point bracelets cease to be ordinary com- 
 modities and become money it would of course be impossible 
 to say. Some men may accept them solely with a view to a 
 further exchange. Some may accept them primarily with 
 a view to further exchange, yet with the alternative of per- 
 sonal use before them ; still others may accept them with no 
 intention of exchanging them for something else. To the 
 first class of persons, the bracelets are money ; to the second, 
 neither money nor ordinary commodities but something half 
 way between; to the last class they are merely ordinary 
 commodities. If the last two classes are relatively insig- 
 nificant, the bracelets are properly money. We do not hesi- 
 tate to call nickels and dimes money, although certain of 
 the aboriginal inhabitants of the United States perforate 
 all they can obtain and hang them in strings from their ears. 
 
 Such articles as bracelets, being primarily designed for 
 personal use, would be an awkward medium of exchange. 
 Ornaments, in order to satisfy the desire for distinction, 
 must differ in form, size, quality. Such differences in arti- 
 cles serving as a medium of exchange, would be a serious 
 handicap to trade. At each purchase or sale it would be 
 necessary to discuss not only the qualities of the article 
 sought or offered, but also the qualities of the article used as 
 money. Hence as trade becomes more common, the articles 
 serving as medium of exchange must become more and more 
 uniform in appearance and quality. In some cases orna- 
 ments assume a conventional form, like the sword coin of 
 parts of the Orient. In other cases, representing a later 
 stage in the development of money, the original purpose for 
 which such articles were made is lost sight of ; the silver or 
 copper is hammered into forms of more or less regular shape 
 
INTRODUCTORY ECONOMICS 21^ 
 
 and uniform quality. In parts of the Philippine Islands, as 
 late as the time of the American occupation, copper disks 
 made by some of the native tribes circulated as money. 
 
 A further stage in the development of money is the 
 assumption by government of the exclusive right of making 
 the bars or disks — coins — to be used as money. The disks 
 of metal of private manufacture naturally differed consider- 
 ably in quality as well as in weight. Such differences, 
 negligible while trade was only slightly developed, became 
 a serious matter when men began to rely upon exchange for 
 many of the commodities of daily use. It seems probable 
 that the purpose of governments in taking over the func- 
 tion of coining money was to bring about the uniformity 
 that an expanding trade demands. Whether this was the 
 original purpose or not, the fact remains, however, that the 
 most important function of government, in respect to mone- 
 tary matters, is the establishment of uniformity of coinage. 
 In the more advanced nations the coinage is now practically 
 uniform. One gold eagle is in all essential respects as good 
 as another. 
 
 For an advanced commercial nation, uniformity in the 
 value of money is, we can readily see, quite indispensable. 
 No less indispensable is variety in the forms of money. In 
 the rural districts of China, where trade is chiefly local and 
 the articles of trade of low value, one kind of coins, and 
 these of very low value, meets practically all needs. In a 
 country like our own, with the greatest variety of business 
 transactions to be performed through the medium of money, 
 a wide variety of forms of money is required. For the 
 smallest transactions it is necessary to have coins of a value 
 which is low, relatively to bulk, as bronze cents, nickel 
 five-cent pieces. For slightly larger transactions, coins 
 of silver, which represent a greater value per unit of bulk, 
 are more convenient. For transactions involving still 
 greater values, gold coins are better adapted than silver; 
 for the largest cash payments, paper money, which may be 
 
2t8 introductory ECONOMlt:S 
 
 of any denomination, is the most convenient of all. How 
 important is this variety in forms of money will be under- 
 stood by any one who happens to be engaged in business 
 in a town where at times the supply of small coins is not 
 sufficient to meet the needs of petty trade, or in a section 
 where silver coins are employed to the exclusion of paper 
 in all transactions involving $io or less. 
 
 We may now consider what is meant by the value of 
 money, and how this value differs from that of other com- 
 modities. Here also we may gain clearness of view by 
 keeping in mind the probable evolution of money. If the 
 bracelet of our earlier example is accepted by a man in 
 exchange for his products with a view to his personal use, 
 he will naturally value it solely with reference to the satis- 
 faction which he expects to derive from it. If it is accepted 
 with a view to its possible exchange for some other com- 
 modity, he will value it partly with reference to the satis- 
 factions to be derived from its use, partly with reference to 
 its power to command other commodities. If the bracelet is 
 accepted solely with a view to further exchange, its value to 
 the man is nothing but its purchasing power. There must 
 indeed be a stage in the evolution when bracelets are valued 
 by some men with reference to their use as ornaments, by 
 others with reference to their purchasing power. When, 
 however, practically every one regards bracelets merely as 
 the means for purchasing other things, the value of brace- 
 lets to the community at large is their power to command 
 other things in exchange. Each man will ascribe a high 
 or a low value to bracelets according as their purchasing 
 power is high or low. 
 
 Under present conditions all men accept money in 
 exchange for their possessions solely with reference to its 
 employment in the purchase of other things. We may, 
 therefore, define the value of money as its power to com- 
 mand other things in exchange, or briefly, its purchasing 
 power. Other commodities are valued by some men for 
 
INTRODUCTORY ECONOMICS 210 
 
 what they will bring in exchange, by other men for the satis- 
 faction to be derived from them directly or indirectly. The 
 true cause of the value which men who hold ordinary com- 
 modities for sale ascribe to such commodities is the value 
 ascribed to them by those who will use them in the satis- 
 faction of wants. There are practically no men who ascribe 
 value to money as a means of direct satisfaction. In this 
 respect, accordingly, the value of money is a unique phe- 
 nomenon, requiring special explanation. 
 
 The value of money, then, is its purchasing power. 
 How is this power to be measured? Evidently not by 
 reference to any particular commodity. A dollar may buy 
 one and one-quarter bushels of wheat to-day and only one 
 and one-fifth bushels to-morrow. We should not say that 
 the value of money has declined, but that the price of wheat 
 has risen. For there may be many other commodities in 
 respect to which the purchasing power of money has in- 
 creased. To form a true estimate of the value of money 
 we must consider its power to command commodities in 
 general. In order to measure changes in the value of 
 money, we may form a list of the principal commodities, 
 showing how much of each a dollar will command at differ- 
 ent dates. By the method of averages we can then ascer- 
 tain pretty exactly whether the general purchasing power of 
 money has changed. This method has long been employed 
 by economists, and it has been shown that through long 
 periods of time the value of money fluctuates widely. A 
 dollar will not buy so much to-day as it would have bought 
 ten years ago. Very likely a dollar will buy more ten years 
 hence than it buys to-day. 
 
 The factors which determine the value of money, and 
 hence the general level of prices, are so numerous and com- 
 plex that only a provisional account of them can be given in 
 this work. It is quite generally agreed that, other things 
 equal, the greater the volume of money there is in the world, 
 the lower will be the value of any unit of it. It is of course 
 
^20 INTRODUCTORY ECONOMICS 
 
 true that there are in operation many influences affecting 
 prices besides changes in the volume of money. Hence we 
 cannot say that if the volume of money, twenty years hence, 
 shall be twice as great as it is to-day, prices will be higher 
 than they are to-day. This fact does not make it the less 
 important for us to gain a clear view of the effect of a change 
 in the volume of money. 
 
 Let us suppose that through the discovery of a new 
 gold field the world's supply of that metal is perceptibly in- 
 creased. $100,000,000 worth of gold, let us say, is taken 
 from the new mines every year. Some of the new 
 gold may be used in the arts; but the greater part of 
 it will find its way to the mints of the nations, and 
 issue thence as coin. 
 
 The only use which money subserves is that of purchas- 
 ing other commodities. The fortunate owners of the new 
 mines will therefore quickly enter the market as purchasers, 
 either of consumable commodities or of capital goods or 
 rights to capital goods — stocks, bonds, etc. There is no 
 reason why the production of goods, whether consumable 
 goods or instruments of production, should at once increase 
 upon the discovery of gold. We may think of the supply 
 of such goods as substantially unchanged. Now, new pur- 
 chasers, with $100,000,000 to spend, appear upon the mar- 
 ket. It is quite evident that competition for commodities 
 will increase and prices will rise. 
 
 Let us assume, for the m.oment, that the rise in price of 
 the commodities purchased by the first owners of the new 
 gold has no effect in stimulating the production of such com- 
 modities. The enterprisers engaged in the production of 
 these commodities, then, will enjoy abnormally large money 
 incomes as a result of the high prices at which they sell their 
 products. They will have more money to spend on other 
 classes of commodities for their own use. As the production 
 of these, we assume, has not yet been affected, they also 
 must rise in price. And so the new gold will percolate 
 
INTRODUCTORY ECONOMICS 221 
 
 from one economic stratum to another, everywhere raising 
 prices. 
 
 Our assumption that the production of the commodities 
 demanded by the original owners of the new gold remains 
 unchanged is purely arbitrary. The rise in prices would prob- 
 ably lead enterprisers to enlarge their mills, or to run them 
 overtime, and this would require more laborers and more cap- 
 ital. The total supply of labor and capital at the command of 
 society has not, however, been affected by the increase in the 
 volume of money. The only way, then, in which an enter- 
 priser can secure additional labor and capital is by enticing 
 these agents away from the employment of other enterprisers. 
 And this, it is evident, must raise the rates of wages and 
 interest in the district where the expansion of enterprise oc- 
 curs. 
 
 After the rise in wages and interest, each laborer has 
 more money to spend; he will therefore increase his pur- 
 chases of the commodities suitable for his use. The supply 
 of these, however, has not yet increased ; their price is forced 
 to a higher level. Similarly the increased money income of 
 the capitalists raises the prices of commodities taken by the 
 members of that class. Eventually not only the price of all 
 finished products, but the price of all raw material and other 
 capital goods, and of all labor, will be affected. 
 
 The new gold may be first used to purchase consumable 
 goods, or it may be used to purchase stocks or bonds. In 
 the latter case, the first effect is an increase in the price of 
 these securities. But the sellers of the securities will use 
 the money to buy other things. Eventually the effect must 
 be felt in the market for commodities and labor. 
 
 Instead of assuming that the supply of money is in- 
 creased through new gold discoveries, we may assume that 
 such increase in the money supply is brought about through 
 an issue of paper money by the government. Suppose that 
 the United States Government, in order to finance projected 
 irrigation works, issues $100,000,000 in paper money. This 
 
222 INTRODUCTORY ECONOMICS 
 
 money will find its way into circulation through the purchase, 
 by the Government, of additional supplies and the payment 
 of wages to new employees. The supply of steel, cement, 
 and other commodities needed by the Government, however, 
 is not increased at once by the issue of new money ; hence the 
 price of these supplies must rise when the Government enters 
 the market as an unanticipated purchaser. Similarly, wages 
 are forced up by the new demand for labor created in this 
 way. Through attempted expansion of business and through 
 increased liberality of expenditure, the enterprisers and la- 
 borers first affected by the increase in the money supply 
 transmit its effects, in the form of increased prices, to men 
 engaged in other industries. In the end general prices and 
 general costs are on a higher level than they would other- 
 wise have been. 
 
 Not all exchanges are effected through the medium of 
 money. Barter exists even to-day, although this form of ex- 
 change may be ignored, as of very slight importance. Many 
 exchanges — indeed, much the greater number, in a society 
 like our own — are effected through the medium of various 
 substitutes for money. Let us suppose that A, a person of 
 unquestioned financial standing, buys of B commodities 
 worth $100, and instead of paying cash, gives a promissory 
 note, due in six months. B in turn may buy $ioo worth of 
 goods from C, paying for them not with cash, but with A's 
 note, properly endorsed. C may use the same note to effect 
 a purchase. At any given time a vast number of such notes 
 may be at work effecting exchanges, although each one may 
 be transferred only two or three times before its maturity. 
 The effect of the use of such notes as a means of exchange 
 is the same as that of an increase in the supply of money. 
 A man who can use a note in this way is enabled to enter 
 the market for the purchase of goods as he could not have 
 done if sellers all insisted upon cash payment. The effec- 
 tive demand for commodities, therefore, is increased, just as 
 it would be by an increase in money. We need not at this 
 
INTRODUCTORY ECONOMICS 223 
 
 point carry further the analysis of the effects of the intro- 
 duction of such substitutes for money, as these effects will 
 receive full discussion in the next chapter. 
 
 The value of money, as we have seen, is affected by 
 changes in the volume of money and in the use of substitutes 
 for money. It is also affected by changes in the volume of 
 business to be transacted through the use of money. Where 
 most men produce for themselves the principal commodities 
 which they need, exchanging only their superfluities for 
 luxuries, a very little money will meet the requirements of 
 trade. Where on the other hand men produce almost ex- 
 clusively for sale, a large volume of money or of substitutes 
 for money is required. If we imagine that men suddenly 
 change from the system of production for immediate con- 
 sumption to the system of production for the market, with- 
 out any change in the volume of money and of its substitutes, 
 we can easily see that the price level must be lowered. 
 Where one commodity under the earlier system was offered 
 for sale to the possessors of money, one hundred may be 
 offered under the later system. Some sellers of commodities 
 would then find that at the scale of values originally existing 
 they would be unable to find purchasers with money to pay. 
 They would accordingly reduce prices, and so attract to 
 themselves a part of the money supply. This would leave 
 other sellers without buyers, and these in turn would lower 
 prices. Thus the price level would fall or, what amounts to 
 the same thing, the value of money would rise, until all sell- 
 ers could find buyers at the prevailing prices. 
 
 The assumption that the system of production could 
 change thus rapidly without a change in the volume of the 
 media of exchange involves unrealities, as we know that 
 exchange and the medium of exchange must evolve together. 
 Yet it points to a real fact : that exchange may expand more 
 rapidly than the volume of the media of exchange, necessi- 
 tating a lower price level. 
 
 It must now be evident that changes in the volume of 
 
224 INTRODUCTORY ECONOMICS 
 
 money are not alone sufficient to explain changes in the value 
 of money, or price changes. The development of substitutes 
 for money and changes in the volume and character of busi- 
 ness transactions must also be taken into account. There- 
 fore, although we may say that an increase in the volume of 
 money will, other things equal, raise general prices, we can- 
 not say in what degree any specific addition to the money 
 supply will raise prices. A doubling of the money supply of 
 the world might conceivably double prices. In all probability, 
 however, prices would be increased by less or by more than 
 one hundred per cent. For the readjustments consequent 
 upon such an extraordinary expansion in the volume of 
 money would probably result in vital changes in the volume 
 and character of business, the nature of which it would be 
 impossible to predict. The student is cautioned against the 
 view that an increase in the money supply, brought about in 
 any way that is known to practical experience, can leave the 
 industrial mechanism unchanged while changing the scale of 
 prices. 
 
 We may also say that, other things equal, all prices will 
 be raised by any important increase in the volume of money. 
 But we cannot say that all prices will rise in the same pro- 
 portion. Indeed, this is something that a little reflection on 
 business conditions shows to be impossible. The supply of 
 some commodities is easily increased, while the supply of 
 other commodities can be increased only after the lapse of a 
 considerable time. If the new money is spent largely on 
 commodities of the first class, the attendant rise in price is 
 quickly counteracted, in some degree, by increase of produc- 
 tion. If it is spent on commodities of the second class, there 
 can for a time be no such counteracting influence. 
 
 The fact that not all prices rise in the same degree, and 
 the fact that some classes of business relations are not directly 
 affected by price changes, render the question of increase 
 or decrease in the volume of money of vital practical impor- 
 tance, It lies in the power of g^overnrnent, within certain 
 
INTRODUCTORY ECONOMICS 225 
 
 limits, to expand or contract the money supply, and there- 
 fore to change the price level. In order to form an intelligent 
 opinion of proposed plans for changing the volume of money 
 through governmental action, we must consider what social 
 classes are affected favorably or adversely by such changes. 
 
 When general prices are rising, the wages of labor will 
 also tend to rise. But it may take some time after prices have 
 begun to rise before enterprisers decide to extend their busi- 
 ness operations. The demand for labor, accordingly, does 
 not for a time increase and wages remain unchanged. The 
 laborer receives no higher wages per week or month; the 
 commodities he buys with his wages have risen in price. It 
 follows that the command of the laborer over the neces- 
 saries and comforts of life is for the time diminished. Even- 
 tually, to be sure, enterprisers will endeavor to enlarge their 
 businesses, and wages will rise. But if the prices of commo- 
 dities continue to rise, it may well be that for a long period of 
 time the rise in money wages will not be an adequate offset 
 for the increased expense of living. It is a well-known fact 
 that during the Civil War the prices of commodities rose far 
 more than the price of labor. 
 
 For many services compensation is fixed by law or by 
 custom. The salaries of public officials remain fixed through 
 long periods of time notwithstanding changes in the price 
 level. The postal employee receiving $2,000 a year is seri- 
 ously injured if prices of commodities rise, since years may 
 elapse before the Government grants him an increase of 
 salary. Physicians' fees, in most cases, are regulated by 
 custom and can seldom be increased on account of an advance 
 in general prices. 
 
 The business relations most seriously disturbed by price 
 changes, however, are those of creditor and debtor. Let us 
 suppose that a farmer has borrowed $10,000, agreeing to pay 
 off the loan in ten years, together with annual interest at 
 six per cent. After the contract has been made, general 
 prices, we will assume, rise twenty per cent. The farmer 
 
226 INTRODUCTORY ECONOMICS 
 
 does not have to pay more than $600 interest each year, al- 
 though the purchasing power of that sum has declined twenty 
 per cent. At the end of the ten years, he will not need to 
 pay more than $10,000, although this sum, for the same rea- 
 son, represents a lower value. The creditor has been injured 
 through the change in the price level just as much as he 
 would have been if the debt had been arbitrarily scaled down 
 to $8,000, prices remaining unchanged. The farmer, on the 
 other hand, has gained materially. He receives higher prices 
 for what he has to sell, and so is enabled to pay the annual 
 interest and the principal when due with much less sacrifice 
 than would otherwise have been necessary. 
 
 Enterprisers as a class are benefited through a rise in 
 general prices. What they have to sell commands a higher 
 price ; their costs of production increase, but not proportion- 
 ately. Mention has already been made of the fact that wages 
 may not rise so rapidly as prices. Furthermore, most enter- 
 prisers have some charges to meet that remain unchanged 
 from year to year. If they occupy buildings and land not 
 owned by themselves, these are probably held under long 
 time leases. Until it is necessary to renew such leases, the 
 rental cannot be adjusted to the change in the price level. 
 Most enterprisers are heavily in debt, and the rise in the level 
 of prices has the effect of reducing the burden of such debts, 
 as in the case of the farmer of our illustration. A period 
 of rising prices, to the active business man, is, therefore, a 
 period of prosperity, whether it is a period of prosperity to 
 the people as a whole or not. 
 
 We have only to reverse our argument to show that in a 
 period of falling prices, or rising value of money, the wage 
 earners as a class gain, because wages do not fall as rapidly 
 as prices; those receiving salaries fixed by law or custom 
 gain yet more, because a readjustment of such incomes to 
 the new scale of prices is long delayed; creditors gain 
 through increase in the purchasing power of the interest and 
 principal due them. The enterprisers as a class find profits 
 
INTRODUCTORY ECONOMICS 227 
 
 succeeded by losses, and complain bitterly of business depres- 
 sion. 
 
 The value of money can neither rise nor fall without in- 
 flicting unmerited hardship upon some members of society. 
 Any change in the value of money, therefore, is an evil. 
 The evils of a rise in the value of money are, however, more 
 easily perceived than the evils resulting from a fall in the 
 value of money. When money rises in value — or, what 
 amounts to the same thing, prices fall — enterprisers incur 
 losses, and restrict their operations, reducing their working 
 force as far as possible. Many debtors find themselves un- 
 able to sustain their burdens, and become bankrupt. The 
 hardships of unemployment and bankruptcy quickly attract 
 public attention. The hardships arising from a fall in the 
 value of money, or rising prices, are more widely diffused 
 and less patent to the eye of the observer. Wage earners 
 and the recipients of fixed incomes, whether from labor or 
 from loaned capital, encounter greater and greater difficulty 
 in making ends meet, but this fact receives little 'attention at 
 a time when enterprisers great and small are enjoying pros- 
 perity. Accordingly it is quite natural that when prices are 
 falling men should endeavor to mend matters through the 
 action of government, while the evil effects of a general rise 
 in prices are usually left to mend themselves. 
 
 It has already been indicated that money in its earliest 
 form was not the creation of government, but the result of the 
 natural evolution of trade. Governments early assumed the 
 function of supervising the coinage of money, and this 
 greatly facilitated the development of trade through the intro- 
 duction of uniformity in quality and weight of coins. 
 
 Although governments monopolize the manufacture of 
 coined money, they do not thereby determine the value of the 
 money. Coinage originally was simply an authoritative cer- 
 tification of the weight and fineness of a bit of metal. The 
 value of the coin depended upon laws of trade quite inde- 
 pendent of the action of the government, 
 
228 INTRODUCTORY ECONOMICS 
 
 In most modern nations the coinage of gold is nothing 
 but this governmental certification of weight and fineness. 
 Any owner of the metal may take it to the mints and have it 
 coined, either freely, or upon payment of a small charge to 
 cover the cost of coinage. The supply of gold coin, then, 
 is in no way determined by government. It increases or 
 declines with changes in the production of gold, and in the 
 demand for it for use in the arts. This was formerly the 
 case with silver coin also. Any owner of silver could take 
 it to the mints and have it transformed into coin. In the 
 popular phrase, the coinage of silver, as of gold, was free. 
 
 If the government limited its action solely to the certi- 
 fication of the weight and fineness of the metal coined, and 
 admitted gold and silver alike to free coinage, business would 
 be hampered by the existence of two independent forms of 
 money, each fluctuating in value according to its own laws. 
 There would be two scales of prices, one measured in gold 
 and the other in silver. As a consequence numerous oppor- 
 tunities for petty trickery would be presented to the unscru- 
 pulous. 
 
 But the government does not thus narrowly limit its ac- 
 tion. Besides vouching for the weight and quality of metal 
 in coins of silver and gold, it endows either all or a part of its 
 coinage with legal tender quality. That is, certain kinds of 
 money are declared by the government to be receivable in 
 payment of all debts, public or private, when no particular 
 kind of money has been specified in the contract creating the 
 debt. This does not mean that debtor and creditor may not 
 make private arrangements for the use of some other kind 
 of money. If gold coin is the sole legal tender, a man may 
 nevertheless borrow money, agreeing to repay the loan in 
 silver. Such a contract would ordinarily be enforced by the 
 courts. But if a man promises merely to pay $i,ooo, his cre- 
 ditor can, if he wishes, demand payment in gold. Similarly, 
 if a man agrees to pay a certain salary to an employee, he 
 Qan be compelled to pay in gold. If on the other hand the 
 
INTRODUCTORY ECONOMICS 229 
 
 creditor would prefer some other form of money to gold, he 
 cannot compel his debtor to respect his preference in the 
 matter. 
 
 When gold and silver are freely coined and are equally 
 endowed with the legal tender quality, it may happen that a 
 dollar of the one metal is inferior in value to a dollar of the 
 other. Suppose that the pure metal contained in a gold 
 dollar is one-sixteenth in weight of the pure metal in a 
 silver dollar — approximately the ratio formerly employed 
 in the United States. The market value of uncoined gold, 
 however, might be more than sixteen times as great, per unit 
 of weight, as that of uncoined silver. If both gold and silver 
 coins remained in circulation, it would be possible for a man 
 to make a profit by purchasing uncoined silver, turning it 
 into coin at the mints, and exchanging the silver coins thus 
 obtained for gold coins. Silver would be brought from all 
 the quarters of the world, coined, and exchanged for gold 
 coins, and the gold coins would be exported in payment for 
 it. Thus gold coin would tend to disappear from the cir- 
 culation altogether. 
 
 If on the other hand uncoined gold was worth less than 
 sixteen times its weight in silver, the latter metal would 
 be withdrawn from the circulation. In the history of the 
 United States the tendency for the cheaper money, whether 
 silver or gold, to displace the dearer money, was constantly 
 manifesting itself, until the policy of the free coinage of sil- 
 ver was abandoned in 1873. All other countries that have 
 attempted to coin both metals freely have had a similar ex- 
 perience. As a consequence all the more advanced commer- 
 cial nations have ceased to coin silver freely. Only enough 
 silver is now coined to meet the needs of petty trade, and 
 provision is made, in a manner to be described later, to main- 
 tain such coins at a parity with gold. 
 
 Let us suppose that a country like the United States 
 should abandon the present plan of coining only gold freely, 
 ^nd admit to free coinage both silver and gold, at the fixed 
 
230 INTRODUCTORY ECONOMICS 
 
 ratio of sixteen to one, as was proposed in 1896 by one of the 
 great political parties. What would be the effect upon the 
 American coinage? The market value of silver has fallen 
 so low that an ounce of silver is worth less than one-twenty- 
 fifth of the value of an ounce of gold. Consequently it would 
 be very profitable to buy up uncoined silver, both in America 
 and in other countries, present it at the mints, and exchange 
 the coined silver for gold, so long as any gold coins remained 
 in circulation. It would obviously be only a very short time 
 before gold disappeared entirely from the circulation. 
 
 The great demand upon the silver supply that would 
 thus be occasioned would no doubt increase the value of that 
 metal. The gold displaced from the American coinage 
 would be thrown upon the markets of other countries, and 
 would reduce the value of gold there. Nevertheless, an 
 ounce of gold would probably continue to command more 
 than sixteen ounces of silver — ^perhaps twenty ounces. A 
 dollar (silver) would then be worth less, in gold, than a dol- 
 lar (gold) was worth before the opening of the mints to 
 silver. It would be worth still less relatively to commodities. 
 That is, general prices in the United States would have been 
 forced to a higher level. 
 
 If all the countries of the world had agreed to coin sil- 
 ver and gold freely at the same ratio, it is quite probable that 
 coins of both metals would have continued to circulate side 
 by side. The chief reason why gold would leave the circula- 
 tion of a single country, if placed at an unfavorable ratio with 
 silver, is that in other countries it is given a higher coinage 
 value. More gold would be used in the arts, perhaps, but 
 much of it would remain in the coinage if all countries under- 
 valued it equally, relatively to silver. 
 
 The effect of such a universal adoption of bimetallism 
 would be to increase the world's supply of money, and hence 
 to raise prices. Now in the early nineties of the last cen- 
 tury, it came to be generally known that prices were falling, 
 and had been falling for a quarter of a century. The mov§- 
 
INTRODUCTORY ECONOMICS 23 1 
 
 ment in favor of bimetallism, or the free coinage of both 
 silver and gold at a fixed ratio, was an effort, probably mis- 
 taken, to remedy the defects of an appreciating currency. 
 Since that time the production of gold has greatly increased, 
 and prices have been steadily rising. 
 
 The money supply of a country may be increased 
 through the issue of paper money by the government. Such 
 money usually takes the form of notes, issued in behalf of 
 the government and alleged to be payable at the treasury on 
 demand. But a government is sovereign, and cannot be 
 compelled to meet its promises unless it chooses to do so. 
 Hence the person who receives such a note usually takes it 
 with the intention of parting with it in the purchase of goods 
 or in the payment of debts, not of presenting it at the trea- 
 sury for specie. 
 
 In order to give such notes currency, the government 
 endows them with the legal tender quality. If the volume of 
 paper money is narrowly limited, it may circulate at par. 
 Most of us have taxes to pay, and paper money is accepted 
 at par in payment of taxes. Many of us have debts to pay, 
 and the law makes paper as good as gold for that purpose. 
 If occasionally we receive paper money in exchange, we know 
 that we can use it in one of these ways. So certain of this 
 may we be, under the conditions, and so confident that others 
 are in a like position, that we do not hesitate in accepting 
 paper money at par in exchange for our goods and services. 
 
 If, however, an enormous amount of paper money is 
 issued by the government, so that we are all likely to receive 
 more of it in exchange than we can certainly use at par, we 
 begin to look upon it with suspicion. We exchange it, if 
 we can, for "hard money" — gold or silver; if possible, we 
 stipulate that we shall be paid in hard money for our commo- 
 dities or services, offering our goods, if necessary, at lower 
 prices than we would accept if paid in paper. Relatively to 
 gold, paper depreciates. If there is enough of it issued, no 
 one pays gold if he can avoid it, but uses paper instead. 
 
2^2 INTRODUCTORY ECONOMICS 
 
 Thus the gold disappears from circulation, and paper be- 
 comes the only money in use. Under the circumstances it 
 is the worst possible kind of money : it fluctuates wildly in 
 value, falling with rumors of additional issues, rising when it 
 is rumored that the government intends to redeem it. At 
 every change in its value some men gain unmerited profits 
 and others suffer unmerited losses. 
 
 If then a government exercises great moderation in the 
 issue of paper money, depreciation may not occur. The in- 
 crease in money will tend to raise prices, but not perceptibly ; 
 and if prices are tending downward this effect may be bene- 
 ficial. Why then do practically all students of monetary 
 science agree that paper money is always an unmitigated evil ? 
 Because governments almost never exercise moderation in 
 the issue of paper money. They resort to paper money in 
 time of need, usually while carrying on war. Thus they 
 obtain funds without burdening the people with taxation. 
 As the expenses of the war increase, more and more paper 
 money is issued, until hard money is driven out of circula- 
 tion, and the redundant paper currency falls lower and 
 lower in value, as evidenced by constantly rising prices. 
 
 In a well regulated monetary system, such as almost all 
 the advanced nations now fortunately enjoy, all forms of 
 money are maintained at a parity by the government. In the 
 monetary system of the United States, for example, are to be 
 found coins of gold, silver, nickel and bronze, as well as 
 paper money. Part of the paper money consists of gold and 
 silver certificates ; a small part of it of treasury notes, issued 
 in payment for silver bullion ; part of it of "greenbacks" — 
 promissory notes of the Government, a legacy of the Civil 
 War. All these forms of money are maintained at an ab- 
 solute parity by the Government. The gold certificates 
 cannot fall below the value of gold coin, because for every 
 dollar of such certificates there is a dollar's worth of gold 
 coin or bullion in the United States Treasury, payable to the 
 certificate holder on demand. The silver certificates are like- 
 
INTRODUCTORY ECONOMICS ^33 
 
 wise secured in value by treasury holdings of silver. It is a 
 part of the settled policy of the United States to maintain the 
 silver dollars at a parity with gold ; and although no specific 
 provision is made by law for the exchange of silver dollars 
 for gold at the treasury, the privilege of making such an 
 exchange would doubtless be accorded the holder of silver 
 dollars if the latter showed any tendency to depreciate. A 
 reserve of $150,000,000 in gold is held by the treasury for 
 the purpose of redeeming any greenbacks that may be pre- 
 sented for redemption. Any one who desires may exchange 
 the lesser silver, nickel and copper coins for gold by present- 
 ing them in suitable quantities at the treasury. 
 
CHAPTER XVI 
 Financial Institutions : The Bank 
 
 In a complex industrial society it is natural that there 
 should be some men possessing capital who are unable or 
 unwilling to employ it under their own management in busi- 
 ness undertakings. Some men, while able to use part of 
 their capital in the conduct of businesses under their own con- 
 trol, are unable to use all of it advantageously. And some 
 men, while able to use all their capital part of the time, fail 
 to find use for it during some weeks or months of the, year. 
 On the other hand there are men who have not enough capi- 
 tal of their own for the proper exploitation of the oppor- 
 tunities for its employment which they command. Some 
 men, while having capital enough during the greater part of 
 the year, require an additional amount during certain sea- 
 sons. 
 
 Accordingly one of the functions of the modern indus- 
 trial organization is the transfer of capital from those who 
 have a superfluity of it to those who can use it profitably. 
 This function, which in view of the enormous amount of 
 capital to be thus transferred is one of vast importance, may 
 be designated by the term "finance." Institutions designed 
 primarily to effect the transfer, or "placing," of capital are 
 known as financial institutions. It is to be noted that we are 
 here using the word "finance" in a sense in some respects more 
 restricted, in some respects broader, than is usually conveyed 
 by the term. But we are justified in this by the analogies of 
 such words as "capital," "rent," "labor," etc., which have 
 one meaning in economics and a slightly different meaning 
 in popular language. 
 
 The typical financial transaction, or transfer of capital, 
 takes the form of a loan. A loan of capital may be effected 
 
INTRODUCTORY ECONOMICS 235 
 
 by personal arrangement between lender and borrower, just 
 as a sale may be effected by personal arrangement between 
 producer and consumer. But just as the complexity of the 
 conditions of the supply of and demand for commodities has 
 rendered necessary the creation of a special commercial class 
 and an elaborate commercial organization, as an intermediary 
 between producer and consumer, so the conditions of the 
 supply of and demand for capital have given rise to a finan- 
 cial class, with highly developed financial institutions, as an 
 intermediary between the man who has capital to lend and 
 the man who desires to borrow it — or between the capitalist 
 proper and the enterpriser. Of these financial institutions 
 the bank is the most important. The placing of capital is 
 indeed not the only function of the bank ; but it is its most 
 important one, all other functions of the bank having grown 
 up as accessories to the placing of capital. 
 
 In its simplest form a loan is a transfer of a sum of 
 money from one person to another, with the stipulation that 
 at some future time, usually specified, an equivalent sum of 
 money shall be repaid. The borrower naturally transforms 
 the money thus obtained into goods at the earliest possible 
 moment. If the goods purchased are designed for further 
 production, the loan is virtually the transfer of capital. Such 
 a loan is called a productive loan. If the money is spent for 
 commodities for consumption, the loan is called a consumer's 
 loan. The productive loan is by far the more common, and 
 we shall concern ourselves chiefly with it. 
 
 It is of course obvious that loans, whether productive 
 or consumer's, will be made only to persons who have 
 "credit," that is, to persons who are regarded as sufficiently 
 honorable and efficient to be willing and able to repay the 
 sums loaned when they fall due. A man's credit may rest 
 upon his reputation for personal integrity and business ca- 
 pacity ; more commonly it rests in part at least upon the fact 
 that he has property which, under the law, can be seized by 
 his creditors in case of default in payment of his debts. 
 
236 INTRODUCTORY ECONOMICS 
 
 The agreement between creditor and debtor as to time 
 of repayment, rate of interest, etc., may be merely verbal, as 
 is said often to be the case in China, where the standards of 
 business honor are extraordinarily high. In most modern 
 states, such agreements are usually written, the borrower 
 giving the creditor a promissory note, or written promise to 
 pay a given sum at a specified date, with or without interest, 
 as the case may be. Such notes are one form of "credit in- 
 struments." If law or custom permits the creditor to trans- 
 fer his claim upon the debtor to another person, the note is a 
 "negotiable credit instrument," or "negotiable paper." 
 
 The agreement between creditor and debtor may con- 
 sist in the mere promise of the latter to pay, in which case 
 the creditor relies for security upon the general effects which 
 the debtor may possess at the time when the debt falls due. 
 The borrower may, however, give more definite security to 
 the lender by giving the latter a special claim upon some 
 specific possession of the borrower, as a parcel of real estate. 
 A note thus secured is popularly known as a "mortgage." 
 The property given in pledge may not be alienated without 
 the consent of the creditor until the debt has been extin- 
 guished. 
 
 Very frequently loans are disguised in the form of sales 
 "on credit." The seller, instead of demanding spot cash for 
 his wares, may agree to wait for a certain period of time — 
 say, three months — ^before demanding payment. In this case 
 the seller really lends the buyer a sum equal to the price of 
 the goods. A company engaged in the manufacture of agri- 
 cultural implements sells a self-binder to a farmer. The lat- 
 ter has not the ready cash to pay for it, but expects to have 
 the necessary sum four months later, when he sells his crops. 
 He may borrow the money from a neighbor, giving his note, 
 payable in four months, with interest. Or, instead of bor- 
 rowing the money and paying cash for the machine, the 
 farmer may buy it "on time," agreeing to pay for it at the 
 end of four months. In this case we sometimes say that the 
 
INTRODUCTORY ECONOMICS 237 
 
 farmer has purchased the machine with his credit. If we 
 analyze the transaction into its elements, we shall see that this 
 expression is inaccurate. The company has not merely sold 
 the machine; it has also, in effect, loaned the farmer the 
 money with which to pay for it. Every sale "on time" or 
 ''on credit" is a double transaction, involving a sale, in the 
 proper sense of the word, and a loan of the capital repre- 
 sented by the goods sold. It makes no difference whether or 
 not the person who lends the capital is the same person who 
 sells the goods. 
 
 But the objection may be raised that the man who buys 
 goods on time does not always agree to pay interest on the 
 capital of which he has gained command through the pur- 
 chase. This, however, is only apparently so. There is al- 
 ways a difference between the credit price of goods and the 
 cash price. This difference may be disguised under one 
 form or another — as a discount, rebate, or what not — ^but it is 
 always present. It represents interest, often at a very high 
 rate, on the loan involved in the credit sale. 
 
 We see then that a loan is involved in every credit sale ; 
 and this is the distinguishing characteristic of such sales. 
 We may with propriety extend the meaning of credit to all 
 transactions involving loans. A man uses his credit in the 
 same way whether he borrows money with which to buy 
 goods or buys goods on time. A man who does business on 
 credit is doing business on borrowed capital, whether he goes 
 through the form of raising loans or not. 
 
 There are some writers on economics who regard credit 
 as a mysterious productive instrument, a form of capital, or 
 at any rate a substitute for capital. The above illustration 
 will show that this view has no justification. What the 
 farmer cuts his wheat with is a capital good, embodying 
 capital furnished either by his neighbor or by the agricul- 
 tural implement company. This capital existed before the 
 farmer gained possession of it, and would doubtless have 
 been employed productively if the farmer had not decided 
 
238 INTRODUCTORY ECONOMICS 
 
 to buy a machine. The fact that he buys the machine with 
 borrowed capital shows that he beHeves that he can make 
 this capital yield more than the interest which he must pay 
 for its use. His "credit" enables him to procure capital 
 to use in an emplo3^ment which he believes to be superior to 
 the average in productivity. If he is right in his opinion, he 
 is able to keep for himself a part of the product of this 
 capital, as a profit. But the profit is not produced by his 
 credit, any more than the wheat is cut by it. The profit is 
 produced by the capital. 
 
 Capital loans display wide variation in the length of 
 time for which the lender loses control of his capital. Some- 
 times the lender retains the right of calling for his capital at 
 any time he desires ; sometimes the date when the debt falls 
 due is fixed at thirty, sixty, or ninety days ; sometimes at five, 
 ten, fifty years. This variation in the life period of loans 
 is a reflection of the economic situation of the various classes 
 of lenders and borrowers. 
 
 At any given time there are men who have more capital 
 than they need immediately ; they cannot tell, however, how 
 soon they may need all they have. On the other hand there 
 are men who can use capital profitably for an indefinite 
 period of time, who can yet return it to its owner whenever 
 it is demanded. Thus a man who deals in stocks and bonds 
 may find exceedingly profitable employment for capital in the 
 purchase of such securities when prices are rising. If he is 
 operating with borrowed capital, he can sell the securities 
 at any time when payment is demanded, and so restore the 
 capital to its owner. 
 
 Again, there are men who can safely part with the con- 
 trol of their capital for a definite period of time — say, from 
 one to six months. Corresponding with this class of lenders 
 is a class of borrowers who cannot agree to pay off a loan on 
 demand, but who are able to make arrangements for payment 
 at a definite date some weeks or months after borrowing 
 the capital. The merchant may serve as a type of this class. 
 
INTRODUCTORY ECONOMICS 239 
 
 He may safely purchase a line of goods with the proceeds of 
 a three months' loan, feeling quite sure that within the three 
 months he will be able to sell the goods and so gain posses- 
 sion of the means of repayment. 
 
 Finally, there is a class of lenders who have no desire 
 for the early repayment of their capital. With satisfactory 
 arrangement made as to the rate of interest to be paid, they 
 may be willing to transfer control of their capital for a period 
 of ten, twenty or fifty years. There is a corresponding class 
 of borrowers, who desire capital for investment in land, 
 buildings, and permanent equipment, and who would be 
 greatly embarrassed by the necessity of early payment. 
 
 There are, then, three distinguishable sources of supply 
 of loanable capital, and three corresponding sources of de- 
 mand for it. In practical life, of course, with highly de- 
 veloped financial institutions, there is a certain degree of 
 interchangeability in the different funds of capital. Let us 
 suppose that lenders of the first class make over their capital 
 to a bank, reserving the right of withdrawing it at any time. 
 Experience will show that while some lenders may withdraw 
 their capital each day, new lenders will each day offer capi- 
 tal at the bank. Thus the bank has a perm.anent fund of 
 capital which it may lend to business men for stated periods 
 of time. Men who wish to lend their capital for long periods 
 of time may place it with a bank, which may use it in short 
 time loans, experience showing that when one business man 
 repays a loan of this kind another will be ready to borrow 
 the capital. 
 
 The bank proper is chiefly engaged in providing business 
 men with demand and short term loans. The capital em- 
 ployed in this way is in part the bank's own, and is perma- 
 nently devoted to the purpose. By far the greater part of 
 the capital, however, is supplied by other persons, who loan 
 their surplus funds to the bank, receiving for the service 
 either interest or some other form of compensation. Provi- 
 sion for long term loans ifs usually made by various other 
 
240 INTRODUCTORY ECONOMICS 
 
 financial institutions, such as the savings bank, the insur- 
 ance company, the investment company, and the exchanges. 
 These institutions will receive attention in the next chapter. 
 Our present concern is the economic nature of the transac- 
 tions in which the bank proper is engaged. 
 
 Let us suppose that in a town of considerable size, not 
 formerly enjoying banking facilities, a company is formed 
 to establish a bank. An initial capital of $100,000 is sub- 
 scribed. This capital consists, in the first instance, of cash. 
 A part of the sum — say, $10,000 — is spent in erecting and 
 equipping a building; the remaining $90,000 is placed in 
 the vaults, to be loaned to business men who can give proper 
 evidence of their ability to meet their obligations when due. 
 
 As the bank has doubtless better means for keeping 
 money safe than any other institution in the town, we may 
 suppose that many persons will be glad to deposit with it 
 any money which they do not immediately need, reserving 
 the privilege of withdrawing it whenever they need it. On 
 pay days salaried employees will deposit most of their 
 month's earnings, expecting to withdraw the money day by 
 day to meet their current expenses. Similarly capitalists 
 will deposit their annual or semi-annual interest receipts, to 
 be withdrawn in like manner for current expenditures. Mer- 
 chants will deposit surplus cash which they will not need to 
 reinvest in stock for some days or weeks. Lenders whose 
 loans have been repaid will deposit the money until they 
 find another satisfactory opportunity for lending. Thus a 
 great part of the community will use the bank in greater or 
 less degree for the storing of surplus funds. The sums so 
 deposited are credited to the depositors on the books of the 
 bank. 
 
 The use of checks, or written orders for the transfer of 
 funds, greatly increases the usefulness of the bank as a re- 
 pository of funds of this kind. The depositor, instead of 
 going in person to the bank to withdraw money for a pur- 
 chase, may give the seller a check for the sum involved in 
 
INTRODUCTORY ECONOMICS 24I 
 
 the transaction. The recipient of the check may present it 
 at the bank for payment, carrying away the sum in money. 
 If he is in the habit of depositing his own surplus funds in 
 the bank, he is more likely to deposit the check, instead of 
 cashing it. The sum called for in the check is then trans- 
 ferred, on the books of the bank, from the account of the one 
 person to the account of the other. Thus payment is effected 
 without the handling of money by any one. When the check 
 system is well developed funds deposited with the bank may 
 change owners scores of times without ever leaving the 
 vaults. 
 
 The aggregate of cash entrusted to the bank may 
 amount to a very considerable sum. At one time such de- 
 posits may aggregate $50,000, at another time $75,000. Ex- 
 perience may show that the volume of deposits never falls 
 below $40,000. This sum of $40,000 may be regarded as a 
 perpetual fund entrusted to the bank by the body of deposi- 
 tors, although actual ownership of each part of it is continu- 
 ally changing. 
 
 The bank is, of course, under no obligation to keep in its 
 vaults the money that has thus been entrusted to it. All that 
 the bank is required to do is to hold itself in readiness to pay 
 the money on demand. So long as it does this, it may use 
 the deposits in any way that it may find profitable — observ- 
 ing, of course, such restrictions in the use of its funds as the 
 law prescribes. And this fact indicates the economic nature 
 of such deposits. They are loans, payable on demand, the 
 depositor being the creditor, the bank the debtor. 
 
 Up to the present point we have been concerned with the 
 bank as a borrower of capital. We have now to consider its 
 position as a lender of capital. Let us suppose that one of 
 the inhabitants of the town is a manufacturer of hardware, 
 who sells his products "on time" to jobbers. This manufac- 
 turer has sold, let us say, $10,000 worth of products, receiv- 
 ing in lieu of payment notes for $10,000 at three months 
 time. This means, as we have already seen, that the manu- 
 
242 INTRODUCTORY ECONOMICS 
 
 facturer has made a disguised loan of capital to the jobbers. 
 The manufacturer, however, needs his capital in order to con- 
 tinue his business of manufacture. 
 
 He may, if his credit is good, borrow $10,000 from the 
 bank, agreeing to repay the loan in three months. In this 
 case he is at the same time a lender of capital and a borrower 
 of capital. The capital which he has loaned finds tangible 
 form in goods in the possession of the jobbers. The capital 
 which he has borrowed finds tangible form first in $10,000 
 cash, then in the capital goods for which he exchanges the 
 money. 
 
 Instead of borrowing directly, he may sell to the bank 
 the notes which he has received from the jobbers. When he 
 has done this he is neither creditor nor debtor. The bank 
 has become the creditor of the jobbers; its $10,000 of capital 
 is no longer embodied in the goods which the manufacturer 
 purchases with the money received from the bank, but in the 
 goods in the hands of the jobbers. It is as if the manufac- 
 turer had sold his wares to the bank, which in turn had sold 
 them on time to the jobbers. 
 
 For simplicity we have taken no account of interest. If 
 the jobbers' notes bear no interest, the bank will not buy 
 them for $10,000. It will deduct from the face value of the 
 notes a sum representing interest for ninety days. This 
 practice of deducting interest in advance is known as "dis- 
 counting." A loan effected through the purchase of a note 
 thus discounted is known as a "discount." If the manufac- 
 turer offers his own note instead of the notes of the jobbers, 
 it is of course discounted in the same way. 
 
 At first sight it may appear that the manufacturer has 
 suffered a loss by the transaction. The notes of the jobbers, 
 representing purchases of $10,000, discounted at six per 
 cent., net the manufacturer only $9,850. His own note, on 
 which he would have to pay $10,000 on maturity, would net 
 him an equal sum. We may be sure, however, that he 
 charged the jobbers at least $150 more for his goods than he 
 
INTRODUCTORY ECONOMICS 243 
 
 would have charged if they had been ready to pay spot cash. 
 The jobbers, again, would not have submitted to the extra 
 charge if they had not believed that the capital thus placed 
 at their command would yield at least $150 in the three 
 months. Or if the manufacturer obtains $9,850 from the 
 bank on his own note, we may be sure that he expects that the 
 capital in which he invests the money will earn at least $150 
 in the three months. The "discount" which represents the 
 gains of the bank is the product of its capital, either in the 
 hands of the jobbers or in the hands of the manufacturer. 
 
 Let us now suppose that the bank has loaned all its own 
 cash in the way described. Will its operations cease for the 
 time ? Not at all. For it has, we have assumed, a consider- 
 able volume of cash deposits — other people's capital, en- 
 trusted to it for safe keeping. On some days more of this 
 cash may be withdrawn than is deposited, but experience 
 may show that the excess of withdrawals never is more than 
 twenty-five per cent, of the aggregate deposits. Why should 
 not the bank lend the other seventy-five per cent., and thus 
 get a profit out of it ? This in fact it would do. A manufac- 
 turer, let us say, sells to the bank, or "discounts," jobbers' 
 notes for $10,000. The bank buys the notes with its deposi- 
 tors' money. Clearly enough, the capital at work in the 
 business of the jobbers is, from an economic point of view, 
 the capital of the depositors. The interest which the jobbers 
 pay is, however, retained by the bank as a recompense for 
 the trouble involved in keeping the funds of its depositors 
 safe, and in effecting transfers of such accounts upon its 
 books. 
 
 The bank may find the business of lending the money 
 of depositors so profitable that it will offer interest on 
 deposits left with it for definite periods of time. It will of 
 course pay a lower rate than it receives. In this case the 
 earnings of the depositors' capital are divided between the 
 bank and the depositors. 
 
 When a manufacturer gets a note discounted at the 
 
244 INTRODUCTORY ECONOMICS 
 
 bank he may, if he chooses, carry away with him the cash 
 represented by the discounted value of the note. This, how- 
 ever, he is not Hkely to do. What he wants the money for 
 is to make purchases of materials, to pay salaries and wages, 
 and to meet other business expenses. The most convenient 
 method of payment is by checks drawn on the bank. So 
 instead of carrying the money away from the bank he is 
 likely to leave it as a deposit, subject to withdrawal on de- 
 mand. Of course there is no reason why the bank should 
 go through the form of counting out the cash to the manu- 
 facturer if it is to be redeposited in this way. What it will 
 do is to credit the manufacturer with the discounted value 
 of the notes which he has transferred to it. It is easy to 
 see that business men who transfer notes to the bank, 
 whether their own or the notes of their debtors, will as a 
 rule be satisfied if the bank will credit them with deposits 
 represented by the discounted value of the notes transferred. 
 It is in this way, not by the actual deposit of cash, that the 
 greater part of the deposits of modern banks originates. 
 
 We must now endeavor to disentangle the complicated 
 relations of debtor and creditor involved in a deposit created 
 in this way. The questions we must answer are these: 
 Where is the actual capital which is producing the interest 
 that the bank receives ; and who is, economically speaking, 
 the ultimate lender of the capital? When the manufacturer 
 sells to the bank jobbers' notes, the actual capital is invested 
 in goods in the jobbers' possession. If the manufacturer 
 redeposits the sum which the bank pays for the notes, he 
 remains, for the time being, the ultimate lender of capital to 
 the jobbers. He does indeed make over the interest to the 
 bank, in return for the latter's guarantee that he may have 
 his capital when he wishes it. In this respect his position is 
 identical with that of the cash depositor, who permits the 
 bank to enjoy the fruits of his capital on condition that he 
 may withdraw it at will. 
 
 Now let us follow, in imagination, the history of the 
 
INTRODUCTORY ECONOMICS 245 
 
 manufacturer's deposit. After a few days he may draw 
 checks aggregating $i,ooo in payment of salaries. These 
 are deposited in the bank by his employees. The employees 
 then become to the extent of $i,ooo the ultimate lenders of 
 capital to the jobbers, the bank still keeping the interest paid 
 by the latter. The employees may draw checks on the bank 
 payable to their landlords; the latter then succeed to the 
 place of lenders. And so the claim upon the jobbers may 
 be passed from hand to hand for months. In the end, to be 
 sure, some one may demand cash payment from the bank; 
 the latter then assumes the role of ultimate lender, if it is 
 compelled to draw upon its own cash. Very likely, however, 
 the jobbers' notes have fallen due and the debts have been 
 paid in cash, before the bank is called upon to assume the 
 role of lender of its own funds. 
 
 If the manufacturer sells to the bank his own note, and 
 leaves the proceeds of the sale as a deposit, he is at once 
 debtor to the bank for the value of the note and creditor of 
 the bank for nearly the same sum. The bank's own capital 
 plays no part in the transaction: the manufacturer is vir- 
 tually his own creditor and his own debtor. No loan has 
 really been made by the bank until the deposit is drawn 
 upon. When the manufacturer draws on the deposit to buy 
 materials the loan becomes a true transfer of capital, or eco- 
 nomic loan. If the checks drawn by the manufacturer are 
 deposited with the bank by the seller of materials, the latter 
 becomes the ultimate creditor of the manufacturer. If the 
 checks are cashed, the bank assumes this role, unless indeed 
 it uses cash deposits for the purpose. 
 
 In the foregoing discussion it has been assumed that 
 the transfer of claims upon the bank is made through checks, 
 drawn upon a deposit, and redeposited by the holder. A 
 man who receives a check may, however, transfer it, prop- 
 erly endorsed, to another man, who in turn may transfer the 
 check to a third person. Each holder of the check becomes 
 in turn the creditor of the bank, and through the bank the 
 
246 INTRODUCTORY ECONOMICS 
 
 creditor of some business man who is using capital bor- 
 rowed from the bank. When the check is at last deposited 
 with the bank, the claim upon the bank is formally trans- 
 ferred on its books. But it is obvious that the claim on the 
 bank is just as certainly transferred whenever the check 
 changes hands. 
 
 Let us now suppose that the bank, instead of crediting 
 the manufacturer with the discounted value of his note, 
 gives him a parcel of its own promissory notes, representing 
 the bank's promise to pay cash to the holder on demand. 
 The manufacturer is then debtor to the bank for the amount 
 stated in his note; he is the creditor of the bank for the 
 amounts stated in the bank notes in his possession. As soon as 
 he uses the notes for the purchase of supplies, etc., he trans- 
 fers the claim upon the bank to the seller of the supplies. 
 Such notes might pass from hand to hand for years, each 
 successive holder of a note becoming the creditor of the bank, 
 and through the bank, the ultimate creditor of some business 
 man. 
 
 Obviously it makes little difference to the bank whether 
 the manufacturer in our example is credited with a deposit on 
 the books of the bank in payment for his note or takes the 
 bank's notes in the same sum. The deposit represents a right 
 to cash on demand ; the bank notes represent exactly the same 
 thing. The deposit may pass from owner to owner through 
 checks drawn upon it and redeposited with the bank; the 
 note passes from owner to owner without the formality of 
 a transfer on the books of the bank. Any one of the series 
 of owners of the deposit may demand cash at any time ; the 
 same is true of any one of the series of holders of a bank 
 note. For some classes of transactions, it is true, a deposit 
 subject to check is the more convenient means of payment, 
 while for other classes of transactions bank notes are the 
 more convenient. 
 
 It is often said that a bank loans not only its capital, 
 but its credit also. If the student has followed the fore- 
 
INTRODUCTORY ECONOMICS ^47 
 
 going analysis, he has seen that what the bank really lends 
 is capital, and nothing but capital, either its own or that of 
 other persons. Because its credit is good, men entrust it 
 with their surplus funds, which it uses so as to gain a profit, 
 by placing them at interest in the hands of business men. 
 
 We assumed that the bank begins business with a capi- 
 tal of $100,000, of which $90,000 consists of cash; further, 
 that the surplus cash of the inhabitants of the town, amount- 
 ing to at least $40,000, is deposited with the bank. Let us 
 suppose that the bank lends $100,000, or, to use another 
 form of expression, invests $100,000 in the notes of business 
 men. These men, we have seen, will not care to take the 
 cash from the bank's vaults, preferring to leave it on deposit. 
 As these depositors draw upon the bank in the course of 
 their business, some cash is withdrawn; for the most part, 
 however, the checks are redeposited. So the bank will con- 
 tinue to hold almost as much cash after making its loans as 
 it had at first. Why should it not lend another $100,000, 
 and another, and another? To do so will only slightly re- 
 duce the amount of cash held by the bank, as the borrowers 
 Vv^ill for the most part be content with deposits credited to 
 their accounts. The deposits thus created may amount to 
 $350,000 ; the original cash deposits, $50,000. Against this 
 volume of deposits the bank may have only a little over 
 $100,000 in cash. 
 
 This would mean that the bank has borrowed $400,000, 
 any part of which sum it must hold itself in readiness to 
 pay on demand, although it has only $100,000 in cash. 
 What if all its depositors should suddenly demand payment? 
 The bank would have to suspend payment, of course. But 
 as a matter of fact there is very little danger that the de- 
 positors will all demand payment at once. As long as the 
 credit of the bank is good, its depositors will draw from it 
 only so much cash as they may need for minor business 
 transactions ; and this cash for the most part finds its way 
 into the hands of merchants, who redeposit it in the bank. 
 
248 INTRODUCTORY ECONOMICS 
 
 Larger transactions are effected by means of checks, and 
 these, we have seen, are as a rule redeposited. If the bank 
 keeps in its reserves cash amounting to one-quarter or one- 
 fifth of its demand obhgations, it will under ordinary cir- 
 cumstances be in a position to meet promptly all demands 
 upon it. How great the proportion of cash reserves to 
 demand obligations must be, experience alone can tell. Each 
 bank, within the Hmits of the law, must determine for itself 
 how great a reserve it needs. 
 
 Remote as is the chance that all the depositors, or any 
 great part of them, will simultaneously present their claims 
 upon the bank, there is always a possibility that the demands 
 upon the bank may at any time reduce the cash reserve 
 below the point of safety. If the credit of the bank is not 
 impaired, it can usually replenish its reserve simply through 
 refraining from making further loans. We must remember 
 that the bank holds business men's notes exceeding in face 
 value its volume of deposits. These notes attain maturity 
 at different dates, but none of them, we may suppose, runs 
 for a period of over three months. If then the bank col- 
 lects when due the sums which it has loaned to business 
 men, it will gradually restore its cash reserve, or at any rate 
 reduce the volume of its outstanding obligations. In three 
 months' time it will be able to pay all its depositors in full, 
 without suffering any serious embarrassment. 
 
 There are, however, circumstances under which the 
 volume of demands upon the bank for cash is too great to be 
 met in this way. It may be that a rumor has gone abroad 
 that the failure of the bank is imminent, resulting in a 
 ''run" on the bank, a large number of depositors demand- 
 ing their funds at once. If there are in the vicinity other 
 banks the credit of which is unshaken, these may be willing 
 to buy of the embarrassed institution some of the notes 
 which it holds, and thus provide it with the cash it needs. 
 
 It is obvious that the solvency of the bank depends upon 
 the ability of its debtors to meet their obligations when due. 
 
INTRODUCTORY ECONOMICS 249 
 
 If the notes which it holds are worthless, it cannot pay its de- 
 positors at all. If the notes cannot be paid at the time 
 agreed upon, the bank may have to suspend payment for a 
 considerable period of time, and this would seriously im- 
 pair its credit and so destroy its business. Sound banking 
 requires that the utmost care be exercised in the making of 
 loans. The business standing of each man who desires a 
 loan is closely scrutinized. Loans are limited to short peri- 
 ods of time, so that in case of need the bank's funds may not 
 be long out of its control. Banks do sometimes fail to pay 
 their creditors, through fraud or mismanagement. But this 
 is a comparatively rare occurrence. 
 
 While the funds of a bank may be invested almost ex- 
 clusively in short time notes, this is not necessarily the case. 
 Any kind of property that finds a ready sale and that is not 
 subject to marked fluctuations of value may serve as a bank- 
 ing investment. If the bank has funds invested in such 
 property, it can recover them, through sale, whenever it finds 
 this necessary. Tangible property does not answer the 
 purpose, since such property fluctuates widely in value, and 
 is often unsalable for a considerable period of time. The 
 stocks of a great corporation can always find a market, but 
 their value is subject to wide fluctuations. Corporation 
 bonds are more stable in value, but not as a rule sufficiently 
 stable for the purpose of bank investment. Government 
 bonds, on the other hand, fluctuate in value only slightly, 
 and always find a ready market. Accordingly it is quite as 
 safe for the bank to invest in such bonds as in short term 
 notes. But government bonds yield a very low rate of 
 interest ; hence a bank is not likely to invest heavily in them, 
 unless there is some special inducement offered to the banks 
 to do so. 
 
 Let us now assume that, instead of one bank in the town, 
 there are several, which we may designate as A, B, C, etc. 
 Some of the citizens of the town will deposit their funds 
 with bank A, some with B, some with C. Often a man will 
 
250 INTRODUCTORY ECONOMICS 
 
 use his check, drawn on bank A, in making a payment to a 
 man who keeps his deposit with bank B or C. The recipi- 
 ent of the check might of course take the check to bank A, 
 obtain cash for it, and deposit the money with his own bank. 
 It is more convenient, however, for him to transfer the 
 check, by endorsement, to his own bank. The bank then 
 credits him with the sum represented by the check, and 
 assumes the trouble of collecting the sum from bank A. 
 And so every day, we may suppose, checks drawn on bank 
 A are deposited with banks B and C; checks drawn on 
 these banks are deposited with bank A. At the end of 
 each business day a clerk in the employ of bank A takes the 
 checks drawn on B and C and presents them for payment 
 at those banks. Similarly a clerk from bank B presents for 
 payment checks deposited with that bank, drawn upon A 
 and C, The student can easily see that such a method of 
 settlement involves some waste of energy. While a clerk 
 of bank A is presenting for payment at bank B checks 
 drawn upon that bank, a clerk of bank B is presenting 
 for payment at bank A checks drawn upon the latter bank. 
 Money is being carried from A to B at the same time that 
 money is carried from B to A. Obviously some method of 
 balancing can be devised which will save the unnecessary 
 labor and risk of thus carrying money to and fro. Espe- 
 cially would this be necessary in a large city, where there are 
 scores of banks. 
 
 In every important banking center the banks form an 
 association which provides a building or a hall known as a 
 clearing house, where representatives of the several banks 
 meet daily for the settlement of the claims of each bank upon 
 the other banks. The claims of each bank upon all the 
 others are set off against the claims of all the other banks 
 upon it. When this has been done, it will be found that 
 some of the banks have a balance in their favor, while others 
 have a deficit to make good. Each debtor bank then pays 
 a single lump sum, representing its indebtedness to all the 
 
INTRODUCTORY ECONOMICS 25 1 
 
 associated banks; each creditor bank receives a lump sum 
 representing the balance of its claims upon all the banks. 
 By this method the transfer of cash from bank to bank is 
 reduced to the lowest terms. 
 
 Sometimes, of course, checks or drafts drawn on banks 
 in other cities will be deposited with a bank. It is obvious 
 that arrangements for the handling of payments between 
 banks in different cities analogous with the arrangements 
 just described for payments between banks in the same city 
 may be made. These we shall consider in a later chapter. 
 
 An illustration was given in the last chapter of the 
 way in which a promissory note might serve as a substitute 
 for money in effecting exchanges. It is easy to see how 
 bank deposits and bank notes may serve as excellent sub- 
 stitutes for actual money. A deposit, we have seen, is not 
 a definite sum of actual money, kept safe in the vaults of a 
 bank. It is a right to demand money at the bank. When a 
 man pays for goods by means of a check drawn on such a 
 deposit, he simply transfers his claim upon the bank. Such 
 a claim may be transferred again and again, effecting scores 
 of exchanges. A bank note, as we have seen, is a claim 
 upon the bank differing only in form from a deposit. It, too, 
 may pass from hand to hand, effecting exchanges. Much 
 the greater proportion of the total volume of exchanges in 
 a country like the United States is effected through the 
 transfer of bank deposits and notes. 
 
 The banking system of a country plays obviously an 
 exceedingly important part in its economic life. It not 
 only serves the important purpose of collecting capital from 
 men who do not need it and of placing it in the hands of men 
 who can use it productively, but it also furnishes what is 
 now the more important element in the medium of exchange. 
 Almost every business man has daily occasion to use the 
 services of banks. Indeed, it is difficult to imagine how 
 business on a modern scale could be conducted without the 
 aid of a banking system. 
 
252 INTRODUCTORY ECONOMICS 
 
 A banking system, however, cannot be conducted with- 
 out certain risks, both to the banker and to the pubHc. The 
 greater the aggregate of loans a bank can make, the greater 
 the profit to the bank. But after lending its own capital, 
 every increase in volume of loans is of course attended by 
 a «orresponding increase in volume of deposits — obligations 
 which the bank must meet on demand. If the volume of 
 deposits becomes too great, there is danger that the bank 
 will not be able to meet its obligations of payment on de- 
 mand. When this happens, the credit of the bank is se- 
 verely shaken, and its depositors are seriously inconveni- 
 enced, at the very least. Moreover, a banker who is eager 
 to expand his volume of loans is not likely to scrutinize the 
 character of security so carefully as he should. Thus he 
 may be led to lend the bank's capital, and other people's cap- 
 ital as well, to men who will be unable to repay the loans. 
 As a result the bank may fail and the depositors also be in- 
 volved in ruin. 
 
 It is accordingly natural that governments should 
 make various regulations designed to insure the stability of 
 the banking system. Such regulations usually prescribe the 
 minimum cash reserve which must be held against outstand- 
 ing demand liabilities. Thus some of the States require 
 banks chartered in those States to maintain a cash reserve 
 equal to fifteen per cent, of all deposits. The United States 
 requires all banks chartered under federal laws — national 
 banks — to maintain cash reserves equal to a certain pro- 
 portion of their demand liabilities — deposits and notes. 
 This proportion is fifteen per cent, in the lesser towns and 
 cities and twenty-five per cent, in certain large cities, desig- 
 nated as reserve cities. But three-fifths of the reserve of 
 banks in the lesser cities may be placed on deposit in banks 
 in the reserve cities ; one-half of the reserve of banks in or- 
 dinary reserve cities may be deposited in banks in New 
 York, Chicago and St. Louis. 
 
 The issue of bank notes is usually carefully regulated 
 
INTRODUCTORY ECONOMICS 253 
 
 by government, so as to safeguard the holder of notes 
 against loss. Now, we have seen that the positions of the 
 note holder and the depositor are quite analogous. Both 
 are creditors of the bank ; both have a right to cash on de- 
 mand. Why then should the government take greater pains 
 to insure the note holder against loss than to insure the de- 
 positor against loss? 
 
 The depositor usually lives in the city in which the 
 bank which holds his funds on deposit is established. He 
 is therefore in a position to know something of the standing 
 of the bank. If he has reason to believe that the bank is not 
 well managed, he can at once withdraw his deposit. On 
 the other hand, bank notes often find their way to distant 
 cities. The holders of such notes can know nothing about 
 the credit of the issuing bank. For this reason it is only 
 just that their interests should be protected by the govern- 
 ment. 
 
 Various methods are employed by the different govern- 
 ments to protect the note holder against loss. In some 
 countries the volume of notes that a bank may issue is lim- 
 ited to a certain proportion of the capital of the bank; in 
 case of failure the note holders have a prior claim upon all 
 the resources of the bank; furthermore, each bank is re- 
 quired to contribute to a fund for the immediate payment of 
 notes of banks that have failed. In the United States na- 
 tional banks alone have the privilege of issuing notes ; other 
 banks may indeed issue notes, but are taxed so heavily 
 on all notes issued that issue is unprofitable. A national 
 bank which avails itself of the privilege of issue must pur- 
 chase, and deposit with the United States Treasury, United 
 States bonds the par value and the market value of which is 
 equal to the value of the notes issued. In case the bank fails, 
 these bonds are sold and the proceeds used to redeem the 
 notes. Thus it is quite impossible for the holder of bank 
 notes to suffer any loss, even if the bank of issue fails. 
 
CHAPTER XVII 
 Other Financal Institutions 
 
 The chief function of the bank, as we have seen, is the 
 supplying of the demand for short time loans, through the 
 accumulation and placing of capital which is available for 
 use for short periods of time. In the present chapter we 
 shall study the mechanism by which the placing of capital in 
 long time and permanent investments is effected. 
 
 In order to gain an understanding of this mechanism 
 we must endeavor to present to ourselves a general view of 
 the sources of the demand for and the supply of free capital 
 for long time investments. 
 
 Throughout the country there is a constant demand for 
 capital for the purchase and improvement of real estate. 
 Men with small capitals of their own desire to buy farms or 
 building lots; men who possess land desire to prepare it 
 for cultivation or to equip it with the necessary stock or 
 buildings. Those with insufficient capital — and they are 
 many — enter the capital market as borrowers. They ex- 
 pect such capital as they may raise through loans to be 
 highly productive; but they cannot be sure that they will 
 be able to restore it to the lenders for several years. To 
 meet the needs of such borrowers, lenders must surrender 
 control of their funds for a considerable period of time — 
 five, ten or fifteen years. 
 
 A second source of demand for capital arises from the 
 needs of the modern large scale business enterprise. In 
 many forms of business the capital necessary for effective 
 operation exceeds the amount that an ordinary enterpriser 
 owns, or can raise through personal loans. The number of 
 million-dollar enterprises in the United States vastly ex- 
 ceeds the number of millionaires. Accordingly there must 
 
INTRODUCTORY ECONOMICS 255 
 
 be some method of transferring to a single active enter- 
 priser the capitals accumulated by numerous individuals. 
 
 A third source of demand for capital — and the last with 
 which we need concern ourselves — arises from the extraor- 
 dinary needs of government. Under ordinary circum- 
 stances the expenditures of most governments are met by 
 current revenues. Owing to unforeseen circumstances reve- 
 nues may be less than was anticipated, while the expendi- 
 tures may prove unusually heavy. As it takes time to 
 revise a revenue system, a considerable deficit may appear, 
 which involves borrowing under one form or another. 
 
 A much more important cause of public borrowing is 
 the enormous expense entailed by modern warfare. No 
 great war can be carried to a successful issue without the 
 employment of far greater resources than any practicable 
 system of taxation will afford. Recourse must therefore 
 be had to loans. Government loans thus arising cannot 
 quickly be paid off. Often loans are negotiated for ten, 
 twenty or thirty years; and even at the expiration of the 
 period for which they are contracted, they are frequently 
 paid out of the proceeds of new loans. The greater part of 
 the public debt of the United States dates from the Civil 
 War; a large part of the debt of Great Britain had its 
 origin in the Napoleonic wars. 
 
 Again, governments may borrow money for the pur- 
 pose of carrying out a policy of permanent improvements. 
 The United States, for example, raises the funds for the 
 construction of the Isthmian Canal through loans. The 
 Prussian, Russian, Indian and Australian governments bor- 
 rowed vast sums for the purpose of purchasing and con- 
 structing railways. Cities are continually borrowing money 
 for similar purposes. Especially where the policy of muni- 
 cipal ownership finds favor, the demand for capital for pub- 
 lic use is enormous. 
 
 We may now consider the sources of the supply of capi- 
 tal for long time investment. Just as there are always men 
 
256 INTRODUCTORY ECONOMICS 
 
 who are entering business life, so there are always men 
 who are retiring from active business affairs. Men of the 
 latter class desire to obtain an income from their accumula- 
 tions without the labor that personal management entails. 
 Universities, hospitals and other institutions receive money 
 endowments, which must be invested in such a way as to 
 yield a steady income. Thus some part of society's perma- 
 nent fund of capital is continually requiring to be rein- 
 vested. Further, the capital of society is steadily increasing 
 through saving. Wage-earners and professional men are 
 under the necessity of putting by a part of their incomes as 
 a reserve against sickness and old age, or as a provision for 
 their dependents in case of death. Capitalists who look 
 forward to increasing burdens save some part of their in- 
 terest receipts ; active business men save part of their profits. 
 Of these savings some part is reinvested in their own busi- 
 nesses by the men who save. A great part of the total 
 fund of savings must, however, be placed under the control 
 of other persons, if it is to yield a considerable income. 
 
 We have now a view of the work that the financial 
 mechanism must perform. It must gather together the 
 funds of free capital and place them under the control of 
 those who can make best use of such funds. We may next 
 proceed to a study of the methods by which this work of 
 placing capital is performed. 
 
 The transfer of capital may assume the form of a loan, 
 or it may assume the form of a partnership arrangement. 
 To illustrate, let us suppose that a mine operator holds a 
 lease of advantageously situated coal lands. To develop 
 these lands he may need a capital of $100,000. A retired 
 merchant in the vicinity has, we will say, $100,000 from 
 which he desires to get an income without the labor of man- 
 aging a business on his own account. The mine operator 
 may borrow the $100,000, agreeing to pay a stipulated rate 
 of interest. On the other hand, he may be willing to form 
 a partnership with the owner of the capital, agreeing to 
 
INTRODUCTORY ECONOMICS 257 
 
 share the profits in fixed proportions. In either case the 
 capital is virtually placed under the control of the mine 
 operator. From a legal point of view the distinction be- 
 tween the two methods of transfer of capital is clear. If 
 the transfer is effected through a loan, the mine operator 
 becomes the legal owner of the goods in which the capital 
 is invested, subject to the claims of the lender for interest 
 and principal. The lender has no voice in the management 
 of the business. If the transfer of capital is effected through 
 a partnership agreement, the capitalist becomes part owner 
 of all the capital goods employed in the business, and is 
 entitled to a voice in the management of it. From an eco- 
 nomic point of view, the chief distinction is that in case of 
 a loan transfer of capital, the capitalist receives a fixed in- 
 come, not affected by the vicissitudes of the business, while 
 in the case of the partnership transfer, the capitalist re- 
 ceives a share of the proceeds of the business, fluctuating 
 with the alternation of prosperity and depression. The 
 relation between the two methods of capital transfer will 
 appear more clearly when we study them in their more 
 highly developed forms — bonds and stocks. 
 
 Where economic conditions are simple, as in an agri- 
 cultural district or in a small town, the placing of capital 
 may be effected through direct arrangements between those 
 who need capital and those who have it to spare. The 
 character and capacity of an enterpriser is easily ascer- 
 tained by those who wish to place their capital. A man 
 who wishes to borrow capital can easily establish relations 
 with those who have capital to lend. Even in such simple 
 conditions, however, the individual borrower or lender is 
 often at a disadvantage. The former may fail to meet the 
 men who are ready to lend at the lowest interest rate; the 
 latter may fail to find the safest and most productive invest- 
 ments for his capital. Hence the need for a middleman, to 
 bring together borrower and lender, enterpriser and capital- 
 ist. As industrial conditions become more complex, the 
 
258 INTRODUCTORY ECONOMICS 
 
 need for the middleman becomes more intense. It would 
 be quite impossible for the small capitalist of a city like 
 New York or London to search out the most productive in- 
 vestments afforded by the business of such a city, were there 
 no men who made it their business to bring capitalist and 
 enterpriser together. 
 
 The men who perform this function may employ either 
 of two methods. They may act as mere agents, in behalf 
 of lender or of borrower or of both. Thus in some towns 
 there are men who undertake, for a fee or "commission," 
 to place any man who wishes to borrow in relations with 
 men who have capital to lend. The function may, however, 
 be performed in another way. Men with some capital of 
 their own may hold themselves in readiness to borrow any 
 capital that is offered for a definite period of time, trusting 
 to the chance that they will be able to lend it again on more 
 advantageous terms. The difference between the interest 
 received and the interest paid represents the profits of the 
 middleman. This, we have seen, is the method employed by 
 the bank in its proper field. 
 
 The distinction which we have drawn between the two 
 methods of placing, or marketing, capital, finds its analogue, 
 we readily see, in a similar distinction in the methods of 
 marketing commodities. A manufacturer may employ an 
 agent, at a fixed commission, to bring his wares before the 
 consuming public, or he may sell them to a merchant, who 
 undertakes the responsibility of disposing of them to con- 
 sumers.. 
 
 We have now a view of the primitive forms out of 
 which the complex structure of the modern financial me- 
 chanism has evolved. Capital may be transferred through 
 loans or through partnership agreements ; the transfer may 
 be effected through agents, or through the medium of men 
 or of institutions who borrow of those who have capital to 
 lend, in order to lend, on more advantageous terms, to thosg 
 who have opportunities for the use of capital 
 
INTRODUCTORY ECONOMICS 259 
 
 The transfer of capital implies the creation of various 
 instruments which serve as evidence of the claims of the 
 capitalist. The simplest type of such instruments is the 
 promissory note given by the debtor to his creditor. Where 
 the sum to be raised by a loan is very great, as in the case of 
 corporation loans, the resources of numerous lenders must 
 be drawn upon. Instead of executing a great number of 
 separate notes, representing the amount borrowed from 
 each person, the corporation may execute a note covering 
 the whole sum and deposit it with a trustee. The trustee 
 may then prepare certificates representing shares in the 
 loan, and deliver them to lenders as evidence of the sums 
 loaned. Such certificates are known as "bonds." A 
 government may issue similar certificates of indebtedness 
 without executing a note representing the entire loan. In 
 any case it is clear that government and corporation bonds 
 are merely forms of promissory notes. 
 
 If money is to be raised through a partnership arrange- 
 ment, the capitalist may receive, as evidence of his claims, 
 a written instrument specifying his share in the capital of 
 the business, and in the control of its operations. If a large 
 sum is to be raised in this way, it is convenient to divide it 
 into shares, represented by stock certificates, each entitling 
 the holder to a definite share in the profits of the business 
 and to a voice in its management. 
 
 Such instruments — promissory notes, bonds and stocks 
 —are clearly not capital, but merely evidence of ownership 
 of capital. We may, however, think of the purchase and 
 sale of such instruments as the purchase and sale of capital, 
 since the ownership of the underlying productive goods is 
 transferred with the transfer of such instruments. For con- 
 venience we may speak of notes, bonds and stocks as "in- 
 vestments." 
 
 Investments of this character naturally differ widely in 
 security and in productiveness. The long-period notes of 
 business men are usually secured by the pledge of tangible 
 
26o INTRODUCTORY ECONOMICS 
 
 property of some kind, but the property pledged may repre- 
 sent a more or a less adequate guarantee of repayment. A 
 loan secured by the pledge of land in the semi-arid region 
 is not so safe as a loan secured by the pledge of land in a 
 locality where crop failures are unknown. A series of dry 
 years may depopulate a semi-arid district, and practically 
 destroy the value of land there. Loans secured by subur- 
 ban real estate are not as a rule so safe as loans secured by 
 business property in the heart of a city. The bonds of a 
 government like that of the United States are generally re- 
 garded as far safer investments than those of Japan; the 
 bonds of the latter country are safer than those of Guate- 
 mala or Venezuela. Corporation bonds similarly vary 
 widely in security. Experience has shown that corporations 
 frequently fall bankrupt, in which case the bond holders may 
 lose part or all of their invested capital. Stocks, as a rule, 
 are yet more uncertain investments. When a new inter- 
 urban railway is constructed, no one knows certainly that 
 the business which it will carry on will yield a fair return on 
 the capital invested; if it does not do this, dividends on its 
 stocks will be low. Even in the case of an established busi- 
 ness, changed conditions may annihilate profits and cause a 
 suspension of dividend payments. 
 
 The rate of return on such investments naturally varies 
 widely. Personal notes, secured by mortgage, may vary in 
 return from four per cent, interest to ten per cent, or more. 
 Corporation bonds may vary from three per cent, to eight; 
 government bonds from two to ten or more. Dividends on 
 stock vary from nothing to fifty or sixty per cent, on the par 
 value. In the case of loans of all kinds, the productiveness 
 varies inversely with the security, or rather, with the popu- 
 lar estimate of security. Turkish bonds yield a higher rate 
 of interest than those of the United States, largely because 
 no one knows how long the present Turkish constitution 
 will stand. 
 
 Investments further differ in transferability. Suppose 
 
INTRODUCTORY ECONOMICS 261 
 
 that an investor in New York holds a note secured by a 
 mortgage on a farm in one of the Western States. In some 
 of the States such a note is not transferable at all. Even if 
 the laws are such as to permit the sale of the note to a third 
 party, the holder would find difficulty in disposing of it. 
 The buyer would need to know something of the value of 
 the property pledged as security, and this he might be un- 
 able to ascertain without examining it himself. The bonds 
 of a small manufacturing or mercantile corporation in one 
 of the minor cities would more easily find buyers in distant 
 financial centers. Even these, however, would ordinarily be 
 difficult to dispose of. The bonds of a great railway or of 
 an industrial consolidation always find a ready sale. One 
 who invests in a Pennsylvania Railway or a United States 
 Steel Corporation bond knows that he can at any time find 
 some one who will be ready to buy it from him. 
 
 As a rule, the greater the transferability of a form of 
 investment, the lower will be its productiveness. Few in- 
 vestors are absolutely certain that they will not at some time 
 desire to regain control of their funds. They will therefore 
 take at par a bond that is easily disposed of rather than one 
 of equal security and equal productiveness which they might 
 find difficulty in selling. Consequently, the price of bonds 
 of the former class will generally be higher than that of 
 bonds of the latter class. A hundred dollars invested in 
 the former class of bonds will yield a lower rate of interest 
 than a hundred dollars invested in the latter class. 
 
 We may divide investments into two classes, those of 
 a high degree of transferability and those of a low degree. 
 Investments of the former class are specially adapted for 
 those individuals who have funds of moderate size to invest. 
 A small merchant, let us say, has retired from business, 
 receiving for his store and stock $100,000 in cash. He 
 may, if he likes, buy State or municipal bonds, which will 
 yield him an income of $3,500 or $4,000. If later he wishes 
 a larger income, and is willing to take some risks, he may 
 
262 INTRODUCTORY ECONOMICS 
 
 sell his State or municipal bonds for very nearly the sum 
 which he paid for them, and reinvest his capital in rail- 
 way or industrial bonds, yielding $4,000 or $5,000. Or, he 
 may buy railway or industrial stocks, yielding from $5,000 
 to $7,000. The variety of such investments open to him is 
 very wide, and if he is a good judge of market conditions 
 he may be able to invest in highly productive securities with- 
 out incurring a high degree of risk. 
 
 In the purchase and sale of such securities the investor 
 must employ the services of professional dealers, or 
 ''brokers," who execute orders on commission. If you have 
 bonds or stocks which you wish to dispose of, you authorize 
 a broker to find a buyer for you. If you wish to buy, you 
 authorize the broker to find a seller. Naturally, the brokers 
 dealing in stocks and bonds establish the custom of meeting 
 at a fixed place, where those who have orders to buy may 
 meet those who have orders to sell. Such a meeting-place, 
 or market, is known, as a stock exchange. For convenience, 
 each exchange makes rules which brokers doing business 
 there must observe. In their details these rules do not con- 
 cern us here ; in principle they are designed to insure effec- 
 tiveness and fair dealing. 
 
 Practically all the securities dealt in on the exchanges 
 are constantly fluctuating in price. The bonds of a country 
 like the United States are unusually stable in value, yet a 
 hundred dollar bond is somewhat cheaper at one time than 
 at another. If the United States should become involved in a 
 war, the price of its bonds would decline, because of the prob- 
 ability of new issues. Even the rumor of a war, however 
 slight its foundation, hiay affect adversely the price of a 
 nation's bonds. The bonds of a city may decline in value if 
 the city government announces its intention of undertaking 
 improvements on a large scale. The price of bonds of 
 railway and industrial corporations is affected by every 
 change in business conditions. Price fluctuation is still more 
 common in the case of stocks. It is not unusual for the pric§ 
 
INTRODUCTORY ECONOMICS 263 
 
 of a given stock to decline from $150 per share to $60 per 
 share within a single year. Suppose that a company has 
 been formed to exploit gold mines in Alaska. Its shares 
 are offered on the market; we have read glowing accounts 
 of the prospects of the company. It may earn enough to 
 pay enormous dividends; it may earn nothing. What can 
 be more natural than that opinion as to the value of the 
 stock should fluctuate, and that the price of the stock should 
 fluctuate accordingly? 
 
 In view of the constant fluctuations in securities, it is 
 natural that some men should make it their business to buy 
 stocks when they appear to be cheap, with the purpose of 
 selling them when prices rise. This is one of the numerous 
 forms of speculation. The buyers of stocks and bonds are 
 commonly divided into two classes^ — investors and specula- 
 tors. The former class buy chiefly with the purpose of en- 
 joying a permanent income from the securities purchased; 
 the latter, chiefly with the hope of profiting from a rise in 
 price of the securities. 
 
 Naturally, the speculative buyer deals commonly in the 
 securities that show great fluctuations in price, while the in- 
 vestor prefers the securities that have a comparatively 
 steady price. Now, it is the securities of new companies 
 that are most likely to fluctuate in value. After a com- 
 pany has been in operation for a number of years, its nor- 
 mal earning power becomes established, and the real value 
 of its securities becomes fairly well settled. Thus there 
 is a constant progress of securities from the speculative class 
 to the investment class. 
 
 We can now see what one of the economic functions of 
 stock speculation must be. So long as the success of a com- 
 pany is in doubt, the cautious investor will have nothing to 
 do with it. Men who are willing to take risks — speculators 
 — buy the securities of such a company, with the expectation 
 of selling them later at a profit. In so doing they furnish 
 the company with the funds necessary for carrying on busi- 
 
264 INTRODUCTORY ECONOMICS 
 
 ness operations. If the company succeeds, and demon- 
 strates its power to produce a large and steady income, its 
 securities acquire a stability of value fitting them for pur- 
 poses of permanent investment. The speculators, in such 
 case, gain large profits. In case the company is a failure, 
 the speculator bears the loss. 
 
 It is of course true that stock speculation offers great 
 opportunities for sharp practice. A group of speculators 
 holding the stock of a gold-mining company may succeed 
 in placing in circulation deceptive accounts of the prospects 
 of the company, and so manage to dispose of their holdings 
 to the unwary at unreasonably high prices. A group of 
 speculators, desiring to purchase certain stocks at a low 
 price, may circulate rumors of impending disaster, and so 
 create a panic among holders of stocks. Nevertheless, it is 
 to be borne in mind that the speculative buyer of stocks per- 
 forms a very important economic function in furnishing 
 capital for enterprises the success of which is still in doubt, 
 but which may eventually prove to be highly profitable. 
 The speculator stands in the position of a middleman, be- 
 tween the company which needs capital and the cautious 
 investor. 
 
 Where enormous sums of capital must be raised, an- 
 other functionary may be inserted between the company 
 needing capital and the individual speculator or investor. 
 Let us suppose that a great railway desires to raise 
 $50,000,000 by a new issue of four per cent, bonds. The 
 bonds of that railway which are already outstanding may be 
 selling above par. But no one can say exactly what effect 
 on the price of bonds the new issue will have. Possibly the 
 bonds will be taken by investors at par ; possibly the price 
 will fall to $85 per hundred dollar bond. The railway 
 company desires a definite amount of capital, and cannot 
 afford to experiment. So its agents may make an arrange- 
 ment with a group of financiers whereby the latter agree 
 to insure the sale of the entire issue at $95 per hundred 
 
INTRODUCTORY ECONOMICS 265 
 
 dollar bond. The bonds are then placed on sale at, say, 
 $100. If the investing public takes the bonds at this price, 
 the group of financiers, or "underwriting syndicate," gains 
 a profit equal to the difference between the price to the 
 public and the price agreed upon between the railway com- 
 pany and the syndicate. If the public refuses to buy, the 
 syndicate is compelled to take the issue of bonds at the 
 price agreed upon — $95. Possibly the syndicate will be able 
 to dispose of the bonds later on favorable terms ; possibly it 
 will in the end be compelled to sell them at less than the 
 price it has paid. 
 
 Where the securities underwritten by a syndicate are 
 of a more speculative character, as for example the stocks 
 of a new industrial corporation, the difference between the 
 price placed upon securities offered to the public and the 
 price to the syndicate is much greater. The possible profits 
 of the syndicate are much greater ; but so also are the pos- 
 sible losses. 
 
 We may now trace, in imagination, the course of the 
 flow of capital from investor to enterpriser. A group of 
 enterprisers desire to establish a great iron manufacturing 
 business. They form a corporation with an authorized cap- 
 italization, say, of $100,000,000. Stocks and bonds repre- 
 senting this capitalization are prepared, and arrangements 
 made with an underwriting syndicate, whereby the latter 
 guarantees the sale of the securities at an average price of, 
 say, $60 per hundred dollars of par value. The enterprisers 
 can then proceed with their project of manufacturing, being 
 assured of $60,000,000 in cash. 
 
 The underwriters, of course, had no intention of per- 
 manently investing $60,000,000 in the iron business. Pos- 
 sibly the public does not at first care to take the securities, 
 however, in which case the syndicate must make at least a 
 temporary advance of the capital. 
 
 As the company progresses with its operations, public 
 interest is aroused. Speculators become convinced that the 
 
266 INTRODUCTORY ECONOMICS 
 
 securities of the company will advance in value, and place 
 orders with their brokers for such securities. After a time 
 the syndicate has sold all its securities to speculators. These, 
 then, are the persons advancing the capital to the company. 
 With every report of the progress of the company the price 
 of its securities changes. If the progress is unsatisfactory, 
 the speculators who first purchased securities may lose heart, 
 and sell at a loss to other speculators. If the company 
 makes rapid progress, the first purchasers may sell at an 
 advance, preferring to take profits rather than wait for still 
 further advances. After the lapse of a few years, during 
 which time the securities pass rapidly from one set of specu- 
 lators to another, the earning power of the company be- 
 comes established. It becomes generally known, let us say, 
 that the company will be able to pay interest on its bonds 
 and five per cent, on its stock. Gradually the prices of its 
 securities become fairly stable, and these securities find their 
 way into the hands of permanent investors. 
 
 It is, of course, not inevitable that the flow of capital 
 from permanent investor to active enterpriser should take 
 such a roundabout course. A company may send circulars 
 to persons who are believed to have capital to invest, offer- 
 ing stocks or bonds at fixed terms. This method may be 
 entirely satisfactory when the business of the company is 
 already well established, and its reputation excellent. If 
 the business is a new one and its results doubtful, the round- 
 about method is more likely to be successful. 
 
 We may now consider briefly certain institutions which 
 place themselves between the investor and the enterpriser 
 who seeks to raise capital, and which subserve especially the 
 requirements of the small investor, who has not the time or 
 the knowledge to form a correct judgment of the value of 
 securities. 
 
 A company may be formed for the sole purpose of deal- 
 ing in the securities of other companies. Such a company — 
 which we may call an investment company — ^places its stock 
 
INTRODUCTORY ECONOMICS 267 
 
 upon the market, and invests the proceeds of the sales of 
 such stock in the stocks and bonds of banking, railway, 
 franchise and industrial corporations. The interest and di- 
 vidends from such securities make up the gross profits of the 
 investment company. From these profits are deducted the 
 expenses of administering the company ; the remainder may 
 be distributed among its stockholders as dividends. The 
 advantages of such a company are obvious. It can employ 
 men who are thoroughly familiar with the securities market 
 to purchase stocks and bonds when the condition of the 
 market is favorable. Since it purchases on a larger scale 
 than the ordinary investor, it may participate in underwrit- 
 ing syndicates, and so obtain securities at a much lower 
 price than the outside investor must pay. It may distribute 
 its investments so that when some of them fail to yield the 
 expected returns, there may be a chance that others will 
 yield unusually large returns. Thus the stockholders of the 
 investment company are made more certain of a steady in- 
 come than they would be if they invested their funds di- 
 rectly. 
 
 Further, the investment company may deal in securities 
 of undoubted value, which are nevertheless not well enough 
 known to be easily transferred. There is no reason why the 
 investment company should ever part with such securities. 
 It may purchase mortgage notes which never would find a 
 purchaser on the general market; it may lend its funds di- 
 rectly, with proper security. Now, the non-transferable in- 
 vestments yield, as a rule, higher returns than those that 
 are easily transferred. Accordingly, the man who invests his 
 funds through an investment company may enjoy the higher 
 income that non-transferable investments yield ; at the same 
 time, he can at any time regain control of his funds through 
 the sale of his stock in the investment company. 
 
 From an economic point of view, the investment com- 
 pany is a device which serves to direct capital to the more 
 productive channels. In present-day business it has largely 
 
268 INTRODUCTORY ECONOMICS 
 
 been diverted to another purpose — that of stifling competi- 
 tion. Let us suppose that in a given territory two railways 
 are actively competing for business. Neither can charge 
 as high rates as it could if it enjoyed a monopoly. Now, 
 let us suppose that an investment company buys up a major- 
 ity of the stock of both railways. It may then appoint the 
 directors of both railways, and require them to adopt poli- 
 cies which enable each to fix high charges for service. In 
 this way the earnings of the railway companies, and hence 
 of the investment company^ are increased. Hostile federal 
 legislation, it is true, has limited the efficacy of the invest- 
 ment company as a means for destroying competition be- 
 tween railways ; but the same device is widely employed in 
 the case of manufacturing corporations. 
 
 It is only persons possessing at least a moderate amount 
 of free capital who can purchase with advantage investment- 
 company shares. Persons who have no other resource 
 than their daily labor need to save some part of their in- 
 comes against sickness, old age or misfortune; and these 
 savings should be placed where they may at once begin to 
 earn interest. The artisan who saves $5 a month cannot be 
 expected to keep the money on his premises until he has 
 accumulated enough to buy a share of stock. This would 
 involve keeping part of his savings idle for perhaps twenty 
 months. It would, moreover, expose such savings to the re- 
 current temptation to spend. Hence the need of an institu- 
 tion which will accept savings deposits, however small, 
 paying interest on them from the beginning, and which will 
 return them to the depositor upon reasonable notice. Such 
 an institution is the savings bank. 
 
 Unlike the commercial bank, described in the last chap- 
 ter, the savings bank can depend upon a certain permanence 
 of deposits. Men who entrust their funds to such an insti- 
 tution do so, as a rule, with the expectation of leaving them 
 for an indefinite time, to earn interest. The savings bank 
 may require its depositors to give some days' or weeks' 
 
INTRODUCTORY ECONOMICS 269 
 
 notice of intention to withdraw deposits. Furthermore, in- 
 terest may be allowed only at the end of six months' periods ; 
 withdrawal at any time within such periods may involve 
 the forfeiture of accrued interest. 
 
 Some part of the deposits of a savings bank must be 
 kept as a cash reserve, to meet possible withdrawals, but this 
 reserve need not be so large as that of a commercial bank. 
 The remainder of the deposits may be invested. State laws 
 generally specify the classes of investments that a savings 
 bank may make, with a view to insuring the depositor 
 against loss through insecure investments. Real estate 
 mortgages. Federal, State and municipal bonds, are the 
 favorite investments of such institutions. The real estate 
 mortgages present the advantages of security and a high de- 
 gree of productiveness; government bonds, while yielding 
 low returns, are easily convertible into cash whenever an 
 unusual volume of withdrawals renders this necessary. 
 
 Savings banks may be organized as mutual associa- 
 tions, in which case all the profits from investments are dis- 
 tributed among the depositors as interest. They may be 
 organized as joint stock associations, the excess of earnings 
 above stipulated interest to depositors being distributed 
 among the stockholders as dividends. The latter form of 
 organization prevails in the West, the former in the East. 
 In foreign countries the place of the mutual savings bank is 
 taken by trustee, municipal and postal savings banks. In 
 general, it is recognized that the proper function of the 
 savings bank is to promote thrift among the poorer classes, 
 not to afford an opportunity for profit to the well-to-do. 
 Hence the small depositor is frequently given the preference 
 over the large depositor, receiving a higher rate of interest. 
 In many cases the size of the individual deposit is narrowly 
 limited. 
 
 In recent years an institution has appeared which of- 
 fers better opportunity for the deposit of large sums than the 
 mutual or governmental savings banks can offer. This in- 
 
270 INTRODUCTORY ECONOMICS 
 
 stitution is the "trust company." Persons having large 
 funds of free capital may deposit them with a trust com- 
 pany, receiving interest at a low rate, and retaining the 
 privilege of withdrawal on demand. The trust company 
 is usually, by law, granted far greater latitude in the invest- 
 ment of its deposits than the savings bank enjoys. In many 
 cases it may participate in syndicate operations, and so ob- 
 tain securities more cheaply than most individuals could do. 
 In any case it is in an excellent position to invest funds 
 entrusted to it in highly productive ways ; hence it is able to 
 pay large dividends to its stockholders while paying a rea- 
 sonable rate of interest on deposits. 
 
 A financial institution which in some parts of the coun- 
 try takes the place of the savings bank in promoting saving 
 among the working classes is the building and loan associa- 
 tion. Each member of the association purchases a certain 
 number of shares of "stock," paying for them in monthly 
 instalments. If at any time he wishes to withdraw, the 
 association returns to him the sums which he has paid in, 
 with or without interest, according to the time that has 
 elapsed since his first payment. If a member desires to build 
 a house, he may borrow from the association a sum not 
 exceeding the par value of the stock in the association which 
 he holds. As security for the loan, he gives a mortgage 
 upon the house which he builds with the aid of the loan. He 
 further binds himself to make monthly payments to the 
 association which represent interest on the loan, plus some 
 part of the principal. Without entering upon the details 
 of the organization of such an association, we can see that 
 its purpose is to collect sums of capital from persons of small 
 means, with the purpose of loaning them to other persons of 
 small means who desire to own homes. The latter class 
 pay the interest that the former class receive. 
 
 One further institution requires notice here: the life 
 insurance company. From a financial point of view, the life 
 insurance company is a device for accumulating savings 
 
INTRODUCTORY ECONOMICS 27I 
 
 which shall be returned, not to the man who saves, but to 
 his heirs at his demise. Some of the insured, it is true, 
 die long before the sum of the premiums they have paid 
 equals the sum that the insurance company has agreed to pay 
 at their deaths. On the average, however, the insured live 
 long enough so that their premiums, together with the earn- 
 ings of the capital which those premiums form, are at least 
 equal to the sums which the insurance company pays out at 
 the death of the insured. 
 
 It is obvious that in a country like the United States, 
 where life insurance is exceedingly common, immense sums 
 of money must be collected by the companies every year, to 
 be held as a reserve against death claims. As the business of 
 life insurance is steadily growing, the funds representing life 
 insurance reserves are also steadily on the increase. The 
 annual receipts of practically every important life insurance 
 company exceed the annual disbursements. Accordingly, a 
 life insurance company may invest its reserves without much 
 regard to the possibility of turning its investments into cash 
 at short notice. It is important, however, that the business 
 should be conducted in a conservative manner, since the fail- 
 ure of an insurance company would be a more widely felt 
 calamity than the failure of almost any other business enter- 
 prise of equal magnitude. The loss would be borne in the 
 end largely by the dependents of propertyless men. 
 
 The reserves of life insurance companies are largely 
 invested in real estate mortgages, in State and municipal 
 bonds, and in the bonds of banking, railway, commercial 
 and industrial corporations. Stock investments have been 
 made by insurance companies, but the practice is now gener- 
 ally regarded with disfavor, since the values of stocks are 
 likely to show a wide range of fluctuation. 
 
 It is to be understood, of course, that the various finan- 
 cial institutions are all more or less closely interrelated. The 
 insurance company and the savings bank may make use of 
 the commercial bank and the trust company for the hand- 
 
272 INTRODUCTORY ECONOMICS 
 
 ling of current funds. The trust company has played an 
 important role in the underwriting of new issues of securi- 
 ties, and so has taken direct part in the more speculative 
 side of finance. Commercial banks, moreover, are increas- 
 ingly important factors in the world of speculative finance. 
 Individual speculators who anticipate a rise in the price of 
 a certain stock buy not only as much as their own resources 
 will permit, but also borrow large sums from the banks for 
 the purpose of stock purchase. Thus some part of the 
 fund of temporary capital is drawn into the field of perma- 
 nent investment. 
 
CHAPTER XVIII 
 International Trade and Foreign Exchange 
 
 From early modern times, when men first began to 
 think systematically upon economic subjects, a great deal of 
 attention has been bestowed upon the exchange of goods 
 between persons living under different governments, or in- 
 ternational trade. It was for a long time believed (and it 
 is still widely believed) that such trade differs radically in 
 its nature from trade that is carried on within the limits of 
 a single country. While the latter, it is generally admitted, 
 is an unmixed good, and ought to be encouraged, or at any 
 rate granted the most perfect freedom by government, the 
 former, many believe, is often a doubtful blessing and ought 
 to be closely scrutinized and regulated, and, under many cir- 
 cumstances, discouraged or even prohibited. Whether there 
 is any justice in this distinction between the two branches of 
 trade is a question that we must defer to the next chapter. 
 For the present, we are concerned with the conditions giv- 
 ing rise to international trade and the mechanism by which 
 it is carried on. 
 
 All permanent exchange originates in differences in 
 character of productive powers. To employ a simple ex- 
 ample, drawn from the field of domestic trade, if A can 
 make three pairs of shoes in a day while B can make only 
 two, and B can cut two cords of wood in a day while A can 
 cut only one, the basis for permanent exchange between 
 them exists. It will pay A to get all his wood from B, 
 exchanging shoes for it. The assumed difference in charac- 
 ter of productive powers may have originated in differences 
 in natural aptitudes or it may have originated in differences 
 in training. In either case the difference in productive pow- 
 
274 INTRODUCTORY ECONOMICS 
 
 ers is the essential basis of a continuous interchange of com- 
 modities. 
 
 But suppose that A can not only make more shoes in a 
 day than B can make, but can also cut more wood. Does 
 this supposition preclude the possibility of a permanent in- 
 terchange of products between A and B ? Not at all. Sup- 
 pose that A can make three pairs of shoes in a day or cut 
 two cords of wood, while B can make only one pair of shoes, 
 or cut only one cord of wood. With two days' work B can 
 produce as much wood as A can with one; with two days' 
 work he cannot produce as many shoes as A can with one. 
 Accordingly, it would pay him to offer A the product of a 
 little more than two days of his own work at woodcutting, 
 in exchange for the product of one day of A's work at mak- 
 ing shoes. And it would pay A to accept the offer. B 
 suffers under a disadvantage in either occupation, but his 
 disadvantage is less in woodcutting than in shoemaking. A 
 enjoys an advantage in either occupation, but his advantage 
 is greater in shoemaking than in woodcutting. Common 
 sense, then, urges B to confine himself to cutting wood, A to 
 making shoes. 
 
 In the trade between inhabitants of one part of the 
 earth's surface with those of another part, differences in 
 personal aptitudes and training of the character assumed in 
 the foregoing example are supplemented by differences of a 
 more general nature. One region may have excellent min- 
 eral deposits but lack fertile land for the growing of food; 
 another region may be quite devoid of minerals, but abun- 
 dantly supplied with rich lands. In one region the charac- 
 ter of the population may be such as to fit it for kinds of 
 work requiring skill and taste, but not such as to fit it for 
 kinds of work requiring great muscular strength and endur- 
 ance. In another region the population may be almost in- 
 capable of acquiring taste and skill, although it is well fitted 
 for labors demanding rude muscular power. Capital may be 
 plentiful and cheap in one region and scarce and dear in 
 
INTRODUCTORY ECONOMICS 275 
 
 another. In this case industries requiring vast capitals can 
 be operated to greater advantage in the former region than 
 in the latter. Land may be plentiful in one region, rela- 
 tively to the population, and scarce in another. Industries 
 requiring an extensive use of land will find their natural 
 habitat in the former region. The populations of two re- 
 gions, though differing little in fundamental character, may 
 differ widely in their attitude toward particular forms of 
 toil. They possess different habits, or, more properly, tra- 
 ditions of workmanship, which fit the one better for one 
 kind of labor, the other for another. So long as any of these 
 differences persists, there is obviously reason why there 
 should be differences in the industries of the two regions. 
 With adequate means of communication, trade between the 
 two regions naturally arises. 
 
 We have spoken of differences between regions, not 
 differences between nations. From a purely economic point 
 of view, trade is either local or interregional, not do- 
 mestic or international. The trade between Belgium and 
 the adjacent departements of France is economically of the 
 same character as the trade between Rhode Island and Mas- 
 sachusetts. The trade between California and Hawaii is of 
 the same essential character as the trade between New York 
 and Santo Domingo. From an economic point of view do- 
 mestic trade is that which originates in such differences in 
 natural aptitudes and industrial training as may for a long 
 time persist on the same soil. Differences in natural endow- 
 ment, in general character of population, in rates of wages 
 and interest, characterize interregional trade. As a rule, 
 however, international trade is also interregional ; hence the 
 principles that apply to the latter may without serious quali- 
 fication be applied to the former. 
 
 In some cases the products of two regions are quite 
 dissimilar. Neither region can produce the commodities 
 which it receives from the other. Thus in the Middle Ages 
 an important trade was carried on between Northern 
 
2'](y INTRODUCTORY ECONOMICS 
 
 Europe and the Indies. The former region furnished furs 
 and amber, the latter, spices and gems. A modern example 
 of the same sort of trade is the exchange of iron and steel 
 products for teas, coffee and spices between England on 
 the one hand and the East Indies on the other. In general, 
 the trade between countries in the temperate zone and coun- 
 tries in the torrid zone is largely of this character. Trade 
 having this basis is naturally permanent; with every re- 
 duction in costs of transportation it tends to increase. De- 
 cline in railway and ocean shipping charges places more 
 and cheaper tropical products in our hands, and places more 
 of our products in the hands of the inhabitants of the tropics. 
 Furthermore, we are, as a people, gradually learning to 
 appreciate the good qualities in tropical products that a 
 short time ago we held in slight esteem; and we may as- 
 sume that a corresponding evolution is taking place in the 
 tastes of the inhabitants of the tropics. 
 
 More commonly one of the trading regions, or both, 
 can produce both classes of commodities exchanged. The 
 United States can produce both sugar and pork; so also 
 can Cuba. But the United States possesses exceptional ad- 
 vantages for the production of pork ; for the production of 
 sugar it is not especially well adapted. Cuba, on the other 
 hand, has unsurpassed advantages for the production of 
 sugar, but can produce pork with only a moderate degree of 
 success. It is, therefore, natural that an exchange of prod- 
 ucts between the two countries should take place. Were 
 there no artificial hindrances to such exchange, we should 
 readjust our production somewhat, so as to produce more of 
 the commodities that Cuba needs, and Cuba would devote 
 more of her productive resources to the growing of sugar 
 for our consumption. 
 
 Differences in the essential character of the populations 
 of two trading regions are difficult to define, since the char- 
 acters of nations, as of individuals, are always thickly over- 
 laid with custom and habit. Nevertheless, we may be quite 
 
INTRODUCTORY ECONOMICS 277 
 
 sure that such differences exist. The German is not ex- 
 actly the same kind of man as the EngUshman, even if due 
 allowance is made for acquired traits. Still less is the 
 Japanese the same kind of man as the American. It is 
 therefore safe to assume that in some of the manifold 
 branches of industry the German will be superior to the 
 Englishman, while in some he will be inferior. We may 
 certainly assume that in some branches of industry the Jap- 
 anese will be more successful than the American, while in 
 other branches he will be less successful. 
 
 Cotton can be grown successfully by the native popula- 
 tion of Central Africa. The tedious labor under a tropic 
 sun is more easily borne by the native blacks than it would 
 be by persons of European descent. The manufacture of 
 cotton cloth by modern methods requires a higher degree of 
 intelligence, perseverance and responsibility than the native 
 population possesses. This branch of the industry may 
 better be carried on in a country like England, where the 
 population has the required traits in a high degree of de- 
 velopment. Accordingly, there is a natural basis for per- 
 manent trade between England and Central Africa. Trade 
 based upon such essential differences in national character 
 also tends to increase in importance with improvements in 
 the means of transportation and communication. 
 
 Trade based upon differences in relative supply of land 
 attained extraordinary proportions during the nineteenth 
 century. The Old World, for the most part, was densely 
 peopled; in the New World population was sparse. It is 
 a well-known fact that the largest output per workman of 
 agricultural products is attained through the superficial cul- 
 tivation of large areas. England may have lands that are 
 naturally better adapted for the growing of wheat than the 
 lands of Argentina. But one man cultivating twenty acres 
 in England cannot possibly produce as many bushels of 
 wheat as one man cultivating two hundred acres in Argen- 
 tina. 
 
278 INTRODUCTORY ECONOMICS 
 
 In manufactures, on the other hand, density of popula- 
 tion, instead of reducing productive efficiency, tends to in- 
 crease it. Men who Hve in constant association are better 
 fitted for the organized activity of the modern factory than 
 are men v^ho pass their Hves in the isolation of the frontier. 
 Hence an exchange of agricultural products for manufac- 
 tures between the New World and the Old was in the nat- 
 ural order of events. 
 
 During the greater part of the nineteenth century trade 
 between the United States and England was chiefly of the 
 character just described. The United States had vast tracts 
 of land for extensive cultivation; England had a dense 
 population well fitted for factory labor. Hence we exported 
 foodstuffs and raw materials and imported manufactures. 
 
 While trade upon this basis tends to increase with re- 
 duction in costs of transportation, there is a countertendency 
 at work which in time checks it. Immigration flows into the 
 regions rich in land; the natural increase of population in 
 those regions is likely to be rapid. In the end such regions 
 lose their peculiar advantages in the production of foodstuffs 
 and raw materials, and gain in power to produce manufac- 
 tures cheaply. Trade of the character under discussion may 
 continue for centuries, but ultimately it decays. The United 
 States still exports large quantities of foodstuffs and raw 
 materials, and imports manufactured goods. But these ele- 
 ments in our foreign trade no longer maintain their former 
 supremacy. In another century the United States will doubt- 
 less import chiefly raw materials and foodstuffs from re- 
 gions which remain sparsely peopled and export manufac- 
 tures in exchange. 
 
 We need not dwell at length upon the trade that is based 
 upon differences in the supply and cheapness of capital. So 
 long as England was par excellence the land of capital, and 
 so long as English capitalists were unwilling to invest their 
 funds in foreign lands, there were many branches of manu- 
 facture that could be prosecuted with far greater advantage 
 
INTRODUCTORY ECONOMICS 279 
 
 in England than in other countries. In practically every 
 branch of manufacture, in fact, the interest on capital makes 
 up a far larger proportion of the total expenses than in 
 grazing, agriculture, lumbering, etc. It is easy to see, then, 
 that English manufacturers, with interest at five per cent., 
 enjoyed a decided advantage over American manufacturers, 
 with interest at eight per cent. The English farmers and 
 stockmen, it is true, also had an advantage in interest rates 
 over their American competitors. But the advantage was of 
 less relative importance and more easily offset by other 
 factors in which the Americans enjoyed an advantage, such 
 as cheaper land. 
 
 Under present-day conditions no country can long hold 
 a branch of trade merely through cheapness of capital. Like 
 labor, capital tends to migrate to the less developed regions 
 of the world ; its migration involves far less personal sacri- 
 fice and far less cost. Furthermore, capital increases rapidly 
 in the newer lands. If interest rates were much higher in 
 the United States than in Great Britain, British capital would 
 steadily flow into the former country ; and this influx of cap- 
 ital, added to the new capital constantly accumulating here, 
 would tend to depress interest rates, until there remained no 
 perceptible difference in the rates prevailing in the two coun- 
 tries. The trade based upon differences in capital supply 
 may, therefore, be regarded as transitory. 
 
 In a region that has long been devoted chiefly to a given 
 branch of industry, something that we may call a tradition 
 of workmanship evolves. The best type of iron worker is 
 not developed in a single generation. The mill that is 
 manned with workers whose fathers and whose fathers' 
 fathers were reared in a world of iron manipulation possesses 
 a decided though indefinable advantage over the mill that 
 is manned with workers whose antecedents were of the field 
 or forest. Costly experiments in settling urban stock upon 
 farms have demonstrated the soundness of the popular view 
 that it takes generations to make a farmer. Still more im- 
 
28o INTRODUCTORY ECONOMICS 
 
 portant is the tradition of workmanship in industries requir- 
 ing a high degree of taste and skill. Where is the Occiden- 
 tal who can produce a true Oriental rug? 
 
 When other conditions are ripe, the population of any 
 region may develop the tradition of workmanship necessary 
 for the successful prosecution of any specific branch of in- 
 dustry. But no region can be expected to gain a superi- 
 ority in all lines. We may at some future time be able to 
 make gowns as well as the French, and ivory toys as well as 
 the Japanese. But there will always be objects of taste 
 which we must buy from the French and the Japanese. 
 Trade based upon such differences may, therefore, be treated 
 as permanent in character. 
 
 In the foreign trade of a great country like the United 
 States or Great Britain, it is natural that we should find 
 one part having one underlying basis, another part another 
 basis. In many cases the exportation or importation of a 
 commodity arises from a combination of several of the causes 
 which we have described as bases of trade. The exporta- 
 tion of iron and steel products from Great Britain to India 
 is based upon the fact that Great Britain has vastly superior 
 deposits of iron ore and coal, cheaper capital, and a popula- 
 tion better fitted than that of India for metallurgical industry 
 and possessing a superior tradition of workmanship. The 
 exportation of wheat from the United States to England is 
 based solely upon the greater abundance of land, relatively 
 to the population, in the former country. The importation 
 into the United States of French articles of taste may be due 
 in part to superiority of the French national character, in this 
 respect; but it is undoubtedly due in large part to a su- 
 perior tradition of workmanship on the part of the French. 
 
 We have, hitherto, considered only cases in which each 
 one of two trading regions possesses unique, or at any rate 
 superior, advantages in the production of the commodities 
 which it exports. Under certain conditions trade may be 
 advantageous even when this is not the case. To use a 
 
INTRODUCTORY ECONOMICS 281 
 
 time-honored illustration, let us suppose that the United 
 States,, by reason of its natural wealth and the character of 
 its population, is in a better position to produce both wheat 
 and steel than England. A day's labor will produce more of 
 either commodity in America than in England. Yet it may 
 be profitable for the United States to buy its steel from Eng- 
 land, giving wheat in exchange. We will assume that in 
 America a day's labor will produce four bushels of wheat or 
 two hundredweights of steel, while in England a day's labor 
 will produce one bushel of wheat or one hundredweight of 
 steel. Disregarding the costs of transportation, it would be 
 profitable for America to offer England three bushels of 
 wheat in exchange for two hundredweights of steel, and it 
 would be profitable for England to accept the offer. America 
 would thus obtain two hundredweights of steel for three- 
 fourths of a day spent in wheat growing, instead of spending 
 a whole day's labor in making the steel. England would 
 obtain three bushels of wheat through two days' labor spent 
 in steel making, instead of spending three days' labor in 
 producing the same amount of wheat. America possesses 
 an advantage in either industry, but her advantage is greater 
 in wheat growing. England is at a disadvantage in either- 
 branch of production, but her disadvantage is less in steel 
 making. It is, therefore, natural, under the assumed condi- 
 tions, that America should make a specialty of wheat pro- 
 duction, England of steel making, and that the two countries 
 should carry on a mutually profitable trade. 
 
 This case is obviously analogous with the case of ex- 
 change between shoemaker and woodcutter which we em- 
 ployed in the early part of this chapter. But while any 
 person of ordinary intelligence can see how it may be prof- 
 itable for an efficient shoemaker to hire a man less fitted 
 than himself for woodcutting to supply him with wood, it 
 appears to be beyond the comprehension of most ordinary 
 men, and many extraordinary ones, that a country can profit- 
 ably pursue the same business policy. Since a day's labor 
 
282 INTRODUCTORY ECONOMICS 
 
 does actually produce more steel in the United States than 
 in England, many men believe that it must be unprofitable 
 for us to buy steel from England. Obviously, they fail to 
 consider the possibility that wq may have other industries 
 so much more productive than those of England that we can- 
 not afford to divert our labor to the making of steel. 
 
 Let us look at the matter from another point of view — 
 that of prices and money cost of production. The men who 
 engage in the business of importing and exporting commodi- 
 ties do not inquire into underlying bases of trade. Their 
 inquiries begin and end with prices. Is steel cheaper in 
 England than in America? If so, and if the difference is 
 great enough to pay the cost of transportation, they import 
 the steel, unless they are prevented by government from 
 doing so. Is wheat cheaper in America than in England? 
 If it is enough cheaper to pay the costs of transportation, 
 they export it. 
 
 But why should steel be cheaper in England than in 
 America, while wheat is cheaper in the latter country? 
 Prices, we know, tend to equal money cost of production ; 
 therefore we may assume that it costs less to produce steel 
 in England, wheat in America. Our inquiries cannot stop 
 here, however, for we must know why it costs more to pro- 
 duce the one commodity in the one country, the other com- 
 modity in the other country. 
 
 Ask a steel manufacturer why it costs more to produce 
 steel in this country than in England, and he will probably 
 reply, "Labor is dearer." The pay of English steel workers 
 is, indeed, lower than that of steel workers in America, but 
 so also is the pay of English agricultural laborers lower than 
 that of farm hands in America. It is, therefore, plain that it 
 is not the low wages, absolutely considered, that give the 
 British steel manufacturer an advantage, but the low wages, 
 relatively to the high productive efficiency of the workmen. 
 Low wages do not make British agriculture prosperous, be- 
 cause the productive efficiency of laborers in that industry 
 
INTRODUCTORY ECONOMICS 283 
 
 is low, relatively to wages. The disadvantage of the British 
 steel industry as compared with the American is less than 
 the disadvantage of British agriculture as compared with 
 American. 
 
 We shall get a clearer view of the situation if we stop to 
 consider the principles determining cost of production. 
 Wages and interest are the chief constituents of cost of pro- 
 duction; but we will fix our attention upon wages alone. 
 In earlier chapters we saw that wages are determined by 
 the marginal productivity of labor. Now, let us suppose 
 that one trading region has a vast extent of fertile land and 
 a sparse population. Only the best lands are tilled and 
 these in a superficial way. Add a thousand laborers to the 
 population. How much can they produce? Perhaps five 
 bushels per man a day. This amount of wheat, or the price 
 of it, they can demand as wages; all other equally efficient 
 workmen will get as much, but no more. Another trading 
 region has, let us say, a dense population and little land. 
 All the good lands are carefully tilled; most of the poor 
 lands are also under cultivation. Add a thousand men to the 
 working population. It is highly improbable that these men 
 will increase the product by five bushels per man per day. 
 Rather, we may assume that the daily product of a man is 
 only one bushel. And this, or its price, is all that any 
 equally efficient laborer in the society can get. 
 
 If the two regions are in easy communication with each 
 other, the price of wheat in the one will be the same as the 
 price in the other, allowance made for the cost of shipping 
 wheat from the one to the other — a few cents per bushel, we 
 will assume. This means that money wages will be much 
 higher in the region which is sparsely settled than in the 
 region where population is dense. 
 
 Now let us suppose that each region possesses ores and 
 coal, but that the deposits of the sparsely settled region are 
 so much the richer that a day's labor will produce from them 
 twice as much steel as a day's labor will produce from the 
 
284 INTRODUCTORY ECONOMICS 
 
 deposits of the densely settled region. Enterprisers of the 
 former region will have to pay miners, furnacemen, etc., at 
 least as much as they could earn in agriculture — the price 
 of five bushels a day. Enterprisers in the region of dense 
 population will also pay wages gauged by the returns to 
 agricultural labor — ^the price of one bushel a day. A simple 
 calculation will show that steel manufacturers in the region 
 of dense population can produce steel much more cheaply 
 than their competitors in the other region. 
 
 In order to make our example correspond more closely 
 with reality, we should need to substitute, for steel making 
 only, a wide range of industries, mainly manufacturing ; for 
 wheat raising we should substitute a wide range of indus- 
 tries, mainly extractive. We might then say, with perfect 
 truth, that in a sparsely settled land the marginal productiv- 
 ity and consequently the wages of labor are likely to be so 
 high that manufactures cannot be carried on profitably in 
 competition with a densely settled land, where the marginal 
 productivity of labor, and hence wages, are low. American 
 manufacturers of iron and steel products have for a century 
 been forced to pay higher wages than English manufac- 
 turers, largely because the productivity of labor in agricul- 
 ture was so much higher here than in England. 
 
 We have now to consider the mechanism whereby the 
 exchange of goods between trading regions takes place. In 
 early times, interregional trade, like all other forms of trade, 
 was carried on through barter. The Phoenician merchant, 
 we may safely assume, carried to each port commodities that 
 he thought would be in demand there, and bartered them for 
 commodities which he desired. In a later stage money was 
 employed, but chiefly for effecting exchanges within a single 
 locality. The artisan merchants of the mediaeval Hanse towns 
 trading with England carried cloth and other wares to 
 London and exchanged them for wool and other English 
 products. Doubtless when in England the Hanse merchants 
 often first exchanged their v\^ares for the local currency, and 
 
INTRODUCTORY ECONOMICS 285 
 
 exchanged the currency in turn for goods to carry back to 
 Germany. From the point of view of the two trading 
 regions, the trade was an exchange of goods for goods, in 
 spite of the employment of currency in England. 
 
 In a later stage the importation of goods is partly di- 
 vorced from the exportation of goods. Men having goods 
 that they believe will fetch a high price in a foreign market 
 ship them abroad, expecting to receive the price of the goods 
 in the form of gold and silver. Men wishing to buy foreign 
 goods send gold and silver in payment for them. Hence, 
 exportation and importation of the precious metals may be 
 often carried on concurrently, at a considerable risk and 
 expense. Here obviously is opportunity for the develop- 
 ment of a system of set-offs, to reduce the transmission of 
 the precious metals between two trading regions to a mere 
 settlement of balances. This mechanism, which long ago 
 attained perfection, we shall now describe in its essential 
 elements. 
 
 Let us suppose that A, a New York exporter, has sold 
 10,000 bushels of wheat to X, a Liverpool importer, at the 
 price of $1 a bushel. If he wishes the $10,000 delivered to 
 him at New York, in gold, he must, of course, pay freight 
 and insurance on it. This will cost about $3 for every $500, 
 or $60 for the entire sum. 
 
 But suppose that after shipping the wheat, and before 
 giving orders for the delivery of the gold, he meets B, a 
 New York importer, who is about to order $10,000 worth of 
 woolen goods from Y, a Liverpool exporter. If B were to 
 ship the $10,000 in gold to Liverpool, it would cost him 
 $60 for freight and insurance. Now, if A will give B an 
 order instructing X to pay Y the $10,000, instead of re- 
 mitting it to himself, B can pay A the $10,000 that he would 
 otherwise have remitted to Y. Both debts will be extin- 
 guished by such an arrangement, and both A and B can save 
 $60 by it. 
 
 Such an order as we have assumed that A gives to B| 
 
286 INTRODUCTORY ECONOMICS 
 
 requesting- X to pay Y a Certain sum originally due to A, 
 is known as a bill of exchange. Such a bill may be payable 
 as soon as it is presented to the person upon whom it is 
 drawn, or it may be payable after the expiration of a period 
 of time — twenty, thirty, sixty days. In the former case it is 
 a "sight bill," in the latter a "time bill." Time bills usu- 
 ally bear interest — a fact that assimilates them to other 
 credit instruments, but has no bearing on the principles of 
 exchange. We shall therefore assume that bills of exchange 
 are sight bills only. 
 
 In our example it appeared that both A and B "gained 
 $60 by the arrangement. Now, if B had been unwilling, 
 for some reason, to give A $10,000 for the latter's bill of 
 exchange, A might have taken less. It would have been 
 more profitable for him to take $9,950 than to incur the 
 expense of importing the gold. If B had offered $9,940, it 
 would have been a matter of indifference to A whether he 
 sold his bill to B or imported the gold. $9,940 is evidently 
 the very lowest price at which the bill would be sold at all. 
 On the other hand, if A had been unwilling to part with his 
 bill for just $10,000, B might have offered more, for he 
 could better have afforded to pay $10,050 for the bill than 
 stand the expense of exporting gold. If A had demanded 
 $10,060, it would have been a matter of indifference to B 
 whether he bought the bill or shipped the gold. $10,060 is 
 then the very highest price that a $10,000 bill can be made to 
 fetch. 
 
 When a bill of exchange sells for just its face value, it 
 is said to be at par; when for more or less, it is above or 
 below par. We have now to inquire under what conditions 
 bills will be at par, or above or below par. 
 
 If the importer whom we designated as B thinks that 
 the chances are good that he can find other exporters besides 
 A who are anxious to dispose of bills of exchange, he is 
 likely to offer less than par for A's bill. If one of the 
 holders of bills will not sell at a low price, another probably 
 
INTRODUCTORY ECONOMICS 287 
 
 will. If, on the other hand, A thinks that he can easily find 
 Other persons besides B who have payments to make abroad, 
 and who are anxious to purchase bills for the purpose, he 
 is likely to hold his bill at a price above par. In general 
 terms, when the volume of bills offered for sale appears to 
 exceed the volume of remittances to be made to a foreign 
 center, bills fall below par. When the volume of bills ap- 
 pears to be inferior to the volume of remittances to be made, 
 bills rise above par. In the former case, each holder of a 
 bill knows that some bills cannot be sold at all ; their holders 
 will have to go to the expense of importing specie. Rather 
 than be left in this position himself, he is willing to sell his 
 bill at less than its par value, provided that the price offered 
 is not so low that to bear the cost of importing specie would 
 be a lesser evil. In the latter case each person having remit- 
 tances to make knows that some men will have to go to the 
 expense of exporting specie. Hence each one will offer more 
 than its par value for a bill of exchange. 
 
 If the volume of bills to be sold just equals the volume 
 of remittances to be made, it is easy to see that bills must 
 sell at par. 
 
 We must now endeavor to determine the conditions 
 under which the volume of bills equals, is superior to, or 
 inferior to, the volume of remittances. We shall assume 
 that the relations between the United States and Great Brit- 
 ain are carried on without regard to relations with other 
 countries, and that American business is all handled through 
 New York, British through London. 
 
 The United States, we will assume, exports in one year 
 products worth $300,000,000 to Great Britain, and Great 
 Britain exports products worth $200,000,000 to the United 
 States. Under the head of exports and imports, we shall 
 have bills on London aggregating $300,000,000, and remit- 
 tances to make aggregating only $200,000,000. 
 
 Citizens of the United States still owe vast sums to 
 citizens of Great Britain; citizens of Great Britain owe 
 
288 INTRODUCTORY ECONOMICS 
 
 lesser sums to citizens of the United States. Interest on 
 these debts will be transmitted by way of exchange. Let 
 us say that Great Britain must pay us $5,000,000 while we 
 must pay Great Britain $25,000,000. This will add $5,000,000 
 to the total volume of bills, and $25,000,000 to the aggregate 
 of remittances. 
 
 Some American borrowers are paying off their debts to 
 British capitalists ; others are borrowing fresh capital. The 
 sum of payments at present probably greatly exceeds the 
 sum of new loans. We will put the former at $50,000,000, 
 the latter at $25,000,000. Under this head, then, we may 
 add $25,000,000 to the volume of bills, $50,000,000 to the 
 volume of remittances. 
 
 Americans living or traveling in England must have 
 their incomes sent them from here; Englishmen living or 
 traveling here must have their incomes sent from England. 
 Let us suppose that we must send $15,000,000 to our citizens 
 in England; England must send $5,000,000 to her citizens 
 here. This would add another $5,000,000 to the volume of 
 bills, $15,000,000 to the volume of remittances. 
 
 Most of our trade with Great Britain is carried on by 
 British ships. We must, of course, pay for the service, and 
 our payments must be sent to Great Britain. We will place 
 the aggregate at $75,000,000. What we carry for Great 
 Britain is too little to take into account. So we must add 
 $75,000,000 to the volume of remittances without any 
 offsetting increase in the volume of bills. 
 
 DUE THE UNITED STATES DUE GREAT BRITAIN 
 
 Exports $300,000,000 $200,000,000 
 
 Interest 5,000,000 25,000,000 
 
 Proceeds of new Repayment of old 
 
 loans 25,000,000 loans 50,000,000 
 
 British travelers' ex- American travelers' 
 
 penses 5,000,000 expenses 15,000,000 
 
 Payment for ocean 
 
 transportation 75,000,000 
 
 l335»ooOfOOO $365,000,000 
 
INTRODUCTORY ECONOMICS 289 
 
 Footing up the assumed items of indebtedness, we 
 find that the United States can draw bills to the amount of 
 $335,000,000, but must make remittances to the amount of 
 $365,000,000. Obviously, exchange on London will be above 
 par under the conditions. Any or all of the items may change 
 before the end of another year, so that the balance will incline 
 the other way. 
 
 For simplicity we assumed that the exchange relations 
 between the United States and England were not rendered 
 more complicated by relations with other countries. This 
 assumption we must now abandon. The United States buys 
 coffee from Brazil. Brazil buys manufactures from England. 
 England buys wheat from the United States. Now, it is evi- 
 dent that Brazilian coffee exporters will be glad to accept 
 from American importers bills of exchange drawn on Lon- 
 don, as these bills will be in demand among Brazilian im- 
 porters of British manufactures. 
 
 If the sums that Americans must remit directly to 
 England aggregate $300,000,000, and the sums that Eng- 
 land must pay directly to the United States aggregate 
 $325,000,000, bills drawn on London may yet be above par. 
 For*^ American coffee importers may need, say, $40,000,000 
 in bills on London to make payments in Brazil. In this 
 case, the remainder of the volume of bills will not be suffi- 
 cient to meet the demand for them, and they will go above 
 par. 
 
 Even if the Brazilians imported nothing from England, 
 bills drawn on London would nevertheless be acceptable to 
 them as means of payment for their exports. Brazil must 
 import from some country, and that country, in all probabil- 
 ity, has payments to make in England, and so will accept 
 bills on London in preference to gold. This follows from 
 the fact that England has for a century been the financial 
 and commercial center of the world. The whole world deals 
 with England. Hence bills of exchange drawn on London 
 have become a favorite medium of international payments 
 
290 INTRODUCTORY ECONOMICS 
 
 throughout the world. If you wish to remit money to a 
 missionary in China or to a stockman in Patagonia, you will 
 probably do it through exchange on London. Similarly, 
 if Chinese or Patagonians have remittances to make to you, 
 they will employ exchange on London for the purpose. 
 
 Accordingly, the demand for bills on London is prac- 
 tically equal to the whole volume of payments to be made 
 by Americans to persons living outside of the United States ; 
 the supply of bills amounts practically to the aggregate 
 payments to be made by such persons to Americans. When 
 we must pay foreigners exactly as much as they must pay us, 
 exchange on London is about at par. When the balance 
 of payments is in our favor, exchange is below par; when 
 the balance is against us, it is above par. Naturally, ex- 
 change on London is expressed in terms of the British 
 currency — pounds sterling. When exchange is at par, the 
 pound sterling is quoted at $4.86f. When exchange is 
 above par, an American who wishes to remit a pound ster- 
 ling to England must pay more than $4.86f for it — perhaps 
 $4.88. If the price of a pound sterling (exchange) rises 
 above $4.89!, it pays better to ship gold. The point at 
 which all advantage in employing bills of exchange instead 
 of gold ceases, is known as the gold point. If the price of 
 the pound sterling declines to $4.83!, it pays holders of 
 bills to send them over to England for collection, with orders 
 that the gold be shipped to America. $4.83! is therefore also 
 known as a gold point. 
 
 If we assume that other items of international payments 
 (transmission of capital, interest payments, travelers' ex- 
 penses, payments for ocean transportation) remain con- 
 stant, it follows that fluctuations in exchange follow fluc- 
 tuations in exports and imports. If we increase our exports, 
 imports remaining unchanged, the supply of bills increases, 
 and their price tends to fall. If we increase our imports, 
 exports remaining the same, the volume of remittances to 
 be made increases, and exchange rises in price. 
 
INTRODUCTORY ECONOMICS 29I 
 
 Now, when bills are above par it is more than usually 
 profitable to export goods. Let us suppose that in New York 
 the price of wheat is ninety-four cents a bushel, while in 
 England the price is $i. If it costs five cents a bushel to 
 ship wheat from New York to England, the exporter will 
 make $ioo on a 10,000 bushel shipment, if exchange is at 
 par. If exchange is at its maximum above par, the exporter 
 will be able to sell his $10,000 bill for $10,060, thus adding 
 $60 to his nominal profit of $100. If exchange is at its mini- 
 mum below par, the exporter can get only $9,940 for his 
 $10,000 bill, thus losing $60 of his nominal profit of $100. If 
 a profit of $100 on 10,000 bushels is just sufficient to induce 
 exporters to ship wheat, no wheat will be shipped if ex- 
 change is below par. 
 
 When exchange is below par, it is more than usually 
 profitable to import goods. Let us suppose that it barely 
 pays to import a certain kind of woolen goods when ex- 
 change is at par ; that under these conditions the importer 
 makes only $100 on a $10,000 shipment. If exchange is 
 at its lowest price the importer can pay for his goods with 
 a $10,000 bill costing only $9,940. Thus he adds $60 to his 
 profits. If exchange is at its highest price, and the im- 
 porter must pay $10,060 for a $10,000 bill, $60 is deducted 
 from his profit, and the business ceases to be worth while. 
 
 It follows that there is a tendency for an excess of 
 either exports or of imports to check itself. If our exports 
 increase, other things equal, exchange falls, and this dis- 
 courages further exports, but encourages imports. If our 
 imports increase too rapidly, exchange rises, and this dis- 
 courages further imports and encourages exports. 
 
 The fluctuations of the rate of exchange, then, have a 
 tendency to create a balance of exports and imports — allow- 
 ance made for other items of international indebtedness, 
 Exports and imports, in the long run, must increase or 
 decline together. 
 
 put suppose that the margin between prices in two 
 
292 INTRODUCTORY ECONOMICS 
 
 countries is so wide that it pays to export in spite of a low 
 price for exchange, or to import in spite of a high price. In 
 the former case, gold must be imported to pay for the ex- 
 ports; in the latter gold must be exported to pay for the 
 imports. Now, we saw in an earlier chapter that an increase 
 in the supply of money tends to raise prices ; a reduction of 
 the money supply causes prices to fall. If, then, our prices 
 are so low that men find it profitable to send an excess of 
 commodities abroad for sale, to be paid for in gold, the con- 
 dition must be transitory. For as the gold flows into the 
 country, prices rise, and the exporters' gains grow smaller 
 and smaller. If on the other hand general prices here are 
 so high that it pays importers to bring into the country vast 
 amounts of goods, to be paid for by exportation of gold, 
 the condition must be equally transitory. With the efflux 
 of gold, prices fall, and the profits of importers dwindle 
 away. In the end more of our commodities become cheap 
 enough to export; and so the balance between exports and 
 imports is restored. 
 
 There are men who hold that the United States should 
 endeavor to increase its exports, but systematically dis- 
 courage importation. It is obvious that such a policy would 
 be futile. If our exports increase, our imports will neces- 
 sarily increase also, and vice versa. The fluctuations in the 
 price of foreign exchange, and the effects of influx or efflux 
 of gold, insure this result. Exports and imports are indis- 
 solubly united by natural law; governments can destroy 
 both, but no policy can be successful which aims to foster 
 the one while persecuting the other. 
 
CHAPTER XIX 
 The Regulation of International Trade 
 
 Since early modern times a great part of the energies 
 of governments has been expended upon the regulation 
 of international trade. The reasons for such regulation 
 have been twofold. In the first place, there is a deep-rooted 
 belief in the people of every nation that the national pros- 
 perity may be furthered by restrictions upon trade with for- 
 eigners. In the second place, such trade has long been 
 recognized as a convenient and appropriate source of public 
 revenue. Most modern regulation of international trade is 
 carried on through the mechanism of revenue legislation. 
 We shall therefore give to this aspect of the problem our first 
 attention. 
 
 Every government needs large funds for the mainte- 
 nance of the numerous corps of officials and servants mak- 
 ing up its civil and military establishments and for the meet- 
 ing of other expenses incurred in the discharge of its vari- 
 ous functions. These funds must be obtained chiefly 
 through taxation. Two methods of raising taxes are open 
 to the government. It may send its officials to each man's 
 house, and levy upon his person or property. In this case 
 it is said to levy direct taxes. The government may, on the 
 other hand, impose taxes upon salable commodities as they 
 are found in the hands of producers or dealers. The latter 
 then add the tax, in whole or in part, to the selling price 
 of the commodities taxed. The buyer of the commodities 
 thus bears ultimately all or the greater part of the tax. 
 Such taxes are said to be indirect. 
 
 To most of us the tax gatherer is a most unwelcome 
 visitor. He inquires politely or otherwise into the extent of 
 Qur possessions ; then claps upon us exactions that it may 
 
294 INTRODUCTORY ECONOMICS 
 
 not be at all convenient to meet. We grumble, but, unless 
 we are bad citizens, we recognize that schools must be sup- 
 ported, streets must be kept in repair, public order must be 
 maintained. For such obvious and imperative public needs 
 we are willing to pay taxes. 
 
 But suppose that one of our fellow-citizens, in the hope 
 of bettering his private fortunes, betakes himself to a semi- 
 barbarous country and builds a railroad. A revolution takes 
 place ; the new government confiscates his property. Well, 
 we must send a warship, bombard a port, land troops, and 
 perhaps engage in a war costing immensely more than the 
 railroad is worth. Now, if the tax gatherer came around 
 to you and to me, and compelled us to contribute directly 
 to the expenses of the affair, we should probably raise the 
 question why the man who embarked his fortunes in such 
 a venture did not do it at his own risk, not at ours, since 
 he left his country for his own profit, not for ours. This 
 would of course be reprehensibly unpatriotic; but direct 
 taxes are a heavy strain upon patriotism. 
 
 With indirect taxes the case is very different. When- 
 ever you buy a pound of imported sugar (and most of our 
 sugar is imported) you pay a tax. Whenever you buy 
 English woolens or cottons or French silks, you are taxed. 
 If you use tobacco in any form, or spirituous, malt or vinous 
 liquors, you pay taxes. And so with a host of other com- 
 modities. How great is the aggregate yearly sum that you 
 contribute to the Government in indirect taxes ? You prob- 
 ably have not the least idea. But this is certain ; if the en- 
 tire amount were collected from you in cash at one time, 
 you would feel that this Government of ours is an expensive 
 luxury. Statesmen would find much greater difficulty in 
 convincing you that we should have the greatest navy afloat, 
 or that we should hold ourselves in readiness to enter upon 
 a $2,000,000,000 war over a $200 matter. 
 
 For the ambitious purposes of a central government, 
 then, indirect taxes are vastly superior to direct taxes. And 
 
INTRODUCTORY ECONOMICS ^95 
 
 of indirect taxes, those levied on foreign trade are the most 
 convenient. All foreign goods must cross the national 
 frontier, where there are always officials and soldiers whose 
 services can be employed in preventing goods from being 
 secretly carried into the country. A few points through 
 which such goods must pass may be designated ; a compara- 
 tively small body of officials may be stationed at these 
 points, to levy and collect the taxes. The foreign merchant 
 may protest against what seem unduly heavy exactions, but 
 the protests of foreigners never make a government un- 
 popular. If on the other hand we levied a tax on the prod- 
 uct of a domestic industry — say sugar — we should meet 
 with much greater difficulties. An official would have to 
 be stationed at every point where sugar is made, to see that 
 the manufacturers did not defraud the revenue. Minute 
 regulations of the process of manufacture might be neces- 
 sary, to the same end, and these would restrict the liberty 
 of the producer and check the progress of the industry. 
 Small establishments might have to be discouraged, to avoid 
 excessive costs in collecting the revenue, and this would 
 mean discrimination against our poorer citizens in favor 
 of our richer ones. If the tax were heavy, manufacturers 
 would complain that their business was ruined, and this 
 would weaken the position of the political party responsible 
 for the imposition of the tax. It is, therefore, easy to see 
 why we have few indirect taxes on production, and these 
 limited to commodities that are regarded as deleterious 
 (tobacco, spirituous, malt and vinous liquors), while our 
 taxes on imported commodities are innumerable. 
 
 Another reason for the popularity of taxes on imports 
 is that many persons believe that such taxes are borne by 
 foreigners. If we tax British woolens, French silks and 
 German sugar, are we not compelling the British, French 
 and Germans to help pay the expenses of conducting our 
 Government? Only in minor degree, if at all. Let us 
 say that a given grade of woolen goods is produced in Eng- 
 
296 INTRODUCTORY ECONOMICS 
 
 land at a cost of fifty cents a yard. Under the laws of com- 
 petitive industry, the cloth sells in England for very nearly 
 fifty cents. If the cost of bringing it to this country is one 
 cent a yard, and there is no tax on imports to pay, the cloth 
 will sell here for about fifty-one cents. Now if we place a 
 duty of fifty cents a yard on the cloth, none of it will be 
 sold here for less than the British price plus the cost of 
 transportation plus the tax, or a dollar and one cent. The 
 man who buys the goods for use pays the tax, in the last 
 instance. And so with most import duties. There are ex- 
 ceptional cases in which the whole amount of the duty can- 
 not be added to the original price of imported goods. In 
 these cases the foreign producer may be said to bear part of 
 the tax. As a general rule, however, the consumer of the 
 goods pays the tax, although he may not be conscious of 
 the fact. 
 
 Taxes on foreign trade may be levied upon either im- 
 ports or exports or upon both. Export taxes are generally 
 unpopular, because of the common belief that it is a good 
 thing to export as many goods as possible. In the United 
 States export taxes are prohibited by the Constitution. We 
 shall therefore confine our study to taxes on imports. 
 
 Taxes on imports may be levied either for the purpose 
 of obtaining a revenue or for the purpose of discouraging 
 importation. Before the annexation of Porto Rico all the 
 coffee used in the United States came from foreign soil. A 
 tax (or ''duty") of, say, five cents a pound under the con- 
 ditions would have discouraged importation in only a slight 
 degree. Most of us would have used as much coffee, even 
 at the higher price. A duty of $20 a ton on steel, on the 
 other hand, would practically prohibit the importation of 
 steel. For our own steel industry can produce steel almost 
 as cheaply as that of any foreign country. Suppose that 
 we can produce steel at $15 a ton while in some foreign 
 country it can be produced at $12. If the cost of bringing 
 steel from the foreign country is $2 a ton, foreign producers 
 
INTRODUCTORY ECONOMICS 297 
 
 can sell steel here at lower prices than our own producers 
 can afford to take. But if foreign steel is compelled to pay 
 a duty of $20 a ton, none of it can be sold here, unless the 
 American producers combine and force steel up to the price 
 of $34 a ton. Such a duty, since it "protects" domestic pro- 
 ducers against foreign competition, is known as a protective 
 duty. 
 
 All duties levied upon imported goods of a character 
 that cannot be produced in a country may be classed to- 
 gether as pure revenue duties. All duties levied on goods 
 of a character that can be produced in a country are protec- 
 tive duties. Of course a duty the aim of which is the rais- 
 ing of revenue may be incidentally protective. Thus if we 
 were to levy a duty on imported coffee, it would "protect" 
 the coffee growers of Porto Rico. On the other hand, pro- 
 tective duties may incidentally yield a revenue. In the case 
 employed above, if the duty on foreign steel had been $1 
 instead of $20, foreign steel would have continued to be 
 imported, and thus a revenue would have been obtained. 
 At the same time the foreigner would have been prevented 
 from underselling the American; accordingly, the latter 
 would have been "protected." Most of our duties are pro- 
 tective, but incidentally yield a revenue, as they are not high 
 enough to prevent importation altogether. 
 
 The schedule of all duties levied by a country is known 
 as the "tariff." A tariff consisting of duties whose main 
 object is the raising of a revenue is known as a revenue 
 tariff. Such a tariff has long been in force in England. A 
 protective tariff consists mainly of duties whose purpose is 
 the protection of domestic producers against foreign com- 
 petition. Such a tariff has been in force in the United States 
 since early in the nineteenth century ; its character has been 
 most strongly marked since the Civil War. 
 
 A revenue tariff needs no defense. A state must have 
 revenues, and there is no easier way of collecting them than 
 through import duties on commodities that we cannot our- 
 
298 INTRODUCTORY ECONOMICS 
 
 selves produce. A protective tariff, on the other hand, re- 
 quires more extended consideration. It is designed to foster 
 domestic industry at the expense of the business of impor- 
 tation. Whether it does this or not is a question of great 
 importance. We must see exactly how such a tariff affects, 
 not merely isolated branches of industry, but the industry 
 of a nation as a whole. 
 
 There is a very primitive view, unfortunately yet far 
 from extinction, that it is an evil thing to buy anything from 
 foreign producers — even the things that cannot be produced 
 in the country at all. Those who hold to this view imagine 
 that we must send abroad money to pay for all purchases, 
 and money, they say, should be kept at home. We saw in 
 the last chapter that the medium through which international 
 payments are effected is, in a vast majority of cases, bills of 
 exchange. The shipping of gold from country to country 
 is reduced, by the mechanism of exchange, to very small 
 proportions. Now, the bills of exchange with which we pay 
 for our imports are really due bills, representing the value 
 of commodities that we export. We saw also that if a coun- 
 try for a time imports more than its exports will pay for, 
 bills on foreign points rise in price, and this discourages 
 further importation and encourages further exportation, 
 until the proper balance between imports and exports is 
 again restored. Accordingly, we may cheerfully proceed 
 to import as large a volume of commodities as we may desire. 
 We shall not thereby run the risk of a serious drain upon 
 our money supply; we shall merely make preparations for 
 an unusually large and profitable export trade in the near 
 future. 
 
 Some men who have advanced beyond the view that 
 all importation of commodities is an evil yet cling to the 
 belief that importation from countries that do not buy as 
 much from us as we buy from them is to be discouraged. 
 They argue that such trade must leave a balance which we 
 must pay in gold, and this they regard as a net loss. Not 
 
INTRODUCTORY ECONOMICS 299 
 
 many years ago one of the administrative departments at 
 Washington published a report containing the statement 
 that our losses from trade with South America, during the 
 last half century, exceeded the cost of the Civil War. For 
 we had purchased from those countries billions of dollars* 
 worth of commodities in excess of their purchases from us. 
 Of course, the facts in the case are not that we have sent 
 billions of dollars in gold to South America, but that we 
 have paid the balance in bills on England. England buys 
 more from us than she sells to us, and in her turn, sells more 
 to South America than she buys from that region. If ever 
 the import trade with South America assumes abnormally 
 large proportions, the export trade with England expands 
 in sympathy. It makes not the slightest difference whether 
 our foreign trade is three-cornered, as in this case, or 
 whether it is carried on directly with one other country. 
 
 Slightly less shallow is the view that one should not 
 buy from foreigners commodities that he can obtain from 
 his fellow-citizens, even if the latter demand higher prices 
 than foreigners are content to receive. If you wish to buy 
 an automobile, it is urged, you should buy one of American 
 make, even if you can get as good a one of French make a 
 little cheaper. By so doing you will increase the prosperity 
 of the American automobile industry. You will enable the 
 industry to employ more men at higher wages, and to pay 
 higher dividends to those who have invested their capital 
 in the industry. That you and the rest of your class may 
 be sure to lend your aid to the American industry, the Gov- 
 ernment should place a tax on French automobiles imported 
 into the country, which, added to the original price, will 
 make them sell at higher prices than those made in this 
 country. If you then persist in encouraging French industry 
 instead of that of your own country you will have to pay 
 dearly for the privilege. 
 
 The ulterior effects of a policy that compels American 
 buyers to patronize the home industry are no less happy (so 
 
300 INTRODUCTORY ECONOMICS 
 
 runs the familiar argument). The laborers and capitalists, 
 being more prosperous, have more to spend on products for 
 their own use. The capitalists erect mansions and the 
 laborers build cottages, and this creates employment for car- 
 penters, masons and other craftsmen in allied trades. These 
 in turn have more money to spend, and increase their pur- 
 chases of clothes, provisions and other articles of use. And 
 so the beneficent effects of confining one's purchases of auto- 
 mobiles to the American industry are widely distributed 
 throughout society. 
 
 In a similar way it is urged that we should buy all our 
 sugar from our own producers. There is not much doubt 
 that in ten years we could extend our production of sugar 
 sufficiently to cover the demand for it, if we would but pay 
 a sufficiently high price to tempt labor and capital into the 
 industry. Instead of sending $100,000,000 abroad to fruc- 
 tify foreign industry, we could keep it at home among our 
 own workingmen and capitalists. 
 
 Let us see whether the foregoing argument will bear 
 close examination. Assuming that we import $100,000,000 
 of sugar in a year, how do we pay for it? Not with gold, 
 but with bills of exchange representing the value of com- 
 modities that we export. 
 
 Now suppose that we place so high a duty on sugar 
 that importation ceases altogether. The immediate effect 
 would be a reduction in the demand for foreign bills aggre- 
 gating $100,000,000 per annum. Bills would, of course, 
 fall below par; men exporting wheat and meat and cotton 
 would get less for their products in consequence. The im- 
 portation of commodities other than sugar would be stimu- 
 lated, as we have seen, by the low price of bills. Exports 
 and imports would have to be brought to a balance again, 
 and this would come to pass through a shrinkage of exports 
 and an increase of imports other than sugar. Perhaps we 
 would buy annually $50,000,000 more of these other im- 
 ports than we did before, and export $50,000,000 less of 
 
INTRODUCTORY ECONOMICS 3OI 
 
 wheat, meat and cotton than we formerly exported. The 
 producers of sugar are indeed benefited by the elimination 
 of foreign competition, but the producers of wheat, cotton, 
 etc., are injured by the reduced prices of exports, and the 
 producers of other commodities, part of the supply of which 
 is imported, are injured by the increase in importation of 
 those commodities. Obviously enough, the evil ulterior 
 effects of the losses of these two classes of producers cancel 
 the beneficent ulterior effects of the gains of the sugar pro- 
 ducers. The one effect of the duty that stands out with- 
 out any corresponding offset is that we shall pay ten cents 
 a pound for sugar instead of five — certainly a result that no 
 one can ardently desire. 
 
 But suppose that the Government places prohibitive 
 duties on all imports. Will not this place all industries in a 
 position where they may enjoy higher prices? And in that 
 case, will it not be as easy for us all to pay ten cents a pound 
 for sugar as it now is to pay five? A protective system, it 
 is often said, is unjust when it singles out a few industries 
 and grants them special favors. But it is just if it favors 
 all industries equally. 
 
 An obvious objection is that if this were possible, if 
 each industry were enabled to charge prices one hundred per 
 cent, higher and each person, accordingly, received twice as 
 large an income as he would otherwise have received, no 
 one would secure any real benefit at all. If the income of 
 each of us should be doubled, and we had to pay twice as 
 much for everything that we buy, none of us would be any 
 better off than we are now. But a more serious objection is 
 this : no protective policy can raise the prices of all com- 
 modities. A duty can affect the prices only of articles that 
 we are in the habit of importing. Now, if we import any- 
 thing, we must export something to pay for it, and the 
 export commodities must ordinarily represent as great a 
 volume of value as the import commodities. In the case 
 of the United States, the volume of export commodities 
 
302 INTRODUCTORY ECONOMICS 
 
 must be greater than that of the import commodities, for the 
 former must pay interest on capital that we have borrowed 
 and the cost of transporting our trade in foreign ships. 
 
 Now, the price of a commodity that we export must be 
 lower in this country than in the countries to which it is 
 sent. The prices of wheat and cotton in America must be 
 less than the prices of the same articles in England, since 
 we are constantly exporting them. It is manifestly absurd 
 to suppose that by placing duties on wheat and cotton im- 
 ported into the United States we can raise the price of those 
 commodities. Who will wish to import them into the 
 United States? The duty on any export product is utterly 
 ineffective. 
 
 We have seen that restrictions on imports restrict ex- 
 ports also. They do this by reducing the amount of money 
 that the producer for export receives for his goods. An 
 *'all around" system of duties, in spite of itself, imposes a 
 positive burden on as large a volume of industry as that 
 which enjoys special favors under it. 
 
 Another argument for protective duties runs as fol- 
 lows: The American laborer requires a greater measure 
 of the necessaries and comforts of life than the laborers 
 of any other country. His wages must therefore be higher. 
 It follows that American enterprisers, having higher wages 
 to pay, are at a disadvantage as compared with their foreign 
 competitors. They must therefore sell their goods at higher 
 prices; and this they would be unable to do if the foreign 
 producer could bring his goods here without payment of 
 duty. From this point of view the tariff is regarded as the 
 bulwark of the American standard of living. 
 
 This argument can no more bear analysis than the pre- 
 ceding ones. All the export industries are able to pay the 
 American scale of wages, and yet undersell their foreign 
 competitors on foreign soil. These industries are hampered, 
 not aided, by the protective system. Apart from the injury 
 inflicted upon them by an unfavorable rate of exchange. 
 
INTRODUCTORY ECONOMICS 303 
 
 these industries are rendered less profitable by the fact that 
 many of their expenses are increased by the tariff. Wheat 
 and cotton growers are compelled to pay higher prices for 
 agricultural implements, lumber, fertilizers and other sup- 
 plies because of the protective duties. The duties on iron 
 and steel increase the costs of railway building and are re- 
 flected in higher freight rates, which represent a deduction 
 from the net gains of the producers of the commodities that 
 are carried to the ports by rail. If restrictions on imports 
 reduce the amount of freight carried to this country from 
 Europe, many ships will be compelled to cross the ocean in 
 ballast to carry away our exports ; and this means that the 
 exports will have to pay ocean freights covering the costs 
 of a return voyage, instead of a single passage of the ocean. 
 Now, when we consider that in spite of all these disadvan- 
 tages the export industries can retain the home market and 
 invade foreign ones, we see clearly that a protective tariff 
 is not needed to maintain the American rate of pay in all 
 industry, although it may be necessary to maintain that rate 
 in special industries — industries in which our advantages 
 for production are less telling than they are in those in- 
 dustries that have succeeded in conquering a place for them- 
 selves in foreign markets. 
 
 In order to obtain a clear view of the relation of a 
 protective duty to the rate of wages we must return to fun- 
 damental principles. In any country, as was shown in earlier 
 chapters, wages are determined by the marginal produc- 
 tivity of labor. We will represent the various opportuni- 
 ties for employment that a country like the United States 
 affords by the symbols A, B, C and D. A may stand for a 
 group of industries in which we have exceptional advan- 
 tages over foreign countries. B stands for a group of indus- 
 tries in which our advantages are less, C one in which they 
 are still less, and D the group of industries in which they are 
 least of all. When our population is so small that all our 
 labor can be engaged in the group represented by A, wages 
 
304 INTRODUCTORY ECONOMICS 
 
 will be at their maximum. When our population increases 
 so that some of the labor will have to be set at work in group 
 B, the wages of all labor must decline to the level of produc- 
 tivity in that group. We will suppose that population has 
 increased up to a point where the opportunities represented 
 by A and B are fairly well manned, and wages are deter- 
 mined by the productivity of labor in B. 
 
 With wages thus determined, it is clear that no em- 
 ployer, without governmental aid, can afford to hire labor 
 to exploit the opportunities represented by C and D. This 
 would necessitate paying labor in C and D as much as it pro- 
 duces in B, and that, by hypothesis, is more than it produces 
 in C and D. 
 
 Now let us suppose that a political party is in power 
 which holds the belief that we should produce everything 
 that we consume— that is, that the opportunities represented 
 by C and D should be exploited as well as those represented 
 by A and B. Labor must be drawn away from A and B and 
 set at work in C and D. This involves the necessity of 
 compensating enterprisers in some way for the disadvan- 
 tages under which they will labor in C and D. Either wages 
 must be reduced in A and B, or some form of subsidy must 
 be granted to C and D. 
 
 The commodities that the industries composing C and D 
 will produce have been hitherto, we assume, obtained from 
 abroad through exchange for commodities produced by A 
 and B. The Government now renders this difficult by plac- 
 ing high duties on the former class of commodities. This 
 means that producers in the groups A and B — both em- 
 ployers and workmen — must pay higher prices for what they 
 buy. They do not receive higher prices for what they sell ; 
 in fact, they receive lower prices, as this, we have seen, is 
 the effect of protective duties on export industries. It 
 appears, then, that part of the disadvantage of producers in 
 C and D is removed by reducing wages (estimated in pur- 
 chasing power) in A and B. 
 
INTRODUCTORY ECONOMICS 305 
 
 After the duty has gone into effect and the prices of 
 commodities that can be produced by C and D have risen 
 sufficiently, enterprisers will be able to hire labor at the wages 
 prevailing in A and B, and establish industries in C and D. 
 So far as the remaining laborers in A and B buy the products 
 of C and D, the difference between the price which they pay 
 for those products and the price that they would pay if they 
 were permitted to import those products duty-free is a tax 
 paid not to the Government, but to the producers in C and 
 D, to enable the latter to remain in business. It is an un- 
 compensated deduction from the natural earnings of the 
 laborers in A and B. Their wages have been reduced ; nor 
 are the workers in C and D paid as much, estimated in 
 purchasing power, as they would have received if they had 
 been allowed to remain in A and B under the earlier condi- 
 tions. The net effect of the imposition of the duty has been 
 to saddle the self-supporting industries, A and B, with the 
 support of the pauper industries, C and D. Yet the inventors 
 of this policy will have the effrontery to tell laborers in A 
 and B that this policy is the bulwark of their high rate of 
 wages 1 
 
 The principles involved in the illustration may be stated 
 in the following general terms : Wages in America will be 
 at their highest point when all our labor is concentrated in 
 the industries in which our relative advantages over other 
 countries are greatest. If there are no protective duties 
 whatsoever, employers will, as a rule, seek out the industries 
 in which we have the greatest relative advantages. Pro- 
 tective duties enable other industries to exist, but only 
 through taxing the more productive industries for their 
 support. Protection as a permanent policy means a slight 
 reduction of money wages, and a greater reduction of wages 
 estimated in purchasing power. Instead of a bulwark of 
 the American standard of living, protection is a serious 
 menace to it. 
 
 The arguments for protection that have been discussed 
 
306 ' INTRODUCTORY ECONOMICS 
 
 are all manifestly fallacious. They are not therefore to be 
 despised, since to hosts of men they appear to be absolutely 
 irrefutable. And this, as a great French economist was 
 wont to say, is because the average man is unable to weigh 
 the unseen effects of an economic policy against the effects 
 that are seen. If we place a high duty on imported fabrics, 
 the resultant high prices enable a new industry, employing 
 thousands of workmen, to be established. This is the effect 
 that is seen, and considered in itself, is wholly good. Every 
 purchaser of the fabrics throughout the land is compelled to 
 pay higher prices for them; but this effect is only dimly 
 seen, if at all. In itself, it is wholly evil. Since part of 
 what the new industry receives in this way from the public 
 goes to compensate that industry for the natural disad- 
 vantages under which it labors, it follows that the aggregate 
 net gain to the industry is less than the aggregate net loss 
 to the public. Again, the national production of wealth is 
 increased by the amount that the new industry adds, and this 
 effect of the duty is one that is seen. The national production 
 is reduced by the amount that the labor and capital diverted 
 to the new Industry would have produced elsewhere; but 
 this effect is not seen. Yet the reduction in national produc- 
 tion that the duty entails is greater than the increase due to 
 it, since labor and capital are diverted from the branches of 
 production enjoying greater natural advantages to branches 
 enjoying lesser advantages — a fact proved by the very need 
 for a duty. 
 
 In the foregoing discussion the assumption has been 
 made that when left to themselves enterprisers will seek 
 out the industries enjoying the greatest natural advantages. 
 On this assumption, all that government can do is to force 
 industry into the less productive fields — a policy that can 
 result only in reducing the national production. 
 
 Now, while the assumption is ordinarily defensible, it is 
 not universally valid. Enterprisers do not always know 
 what fields offer the highest rewards. Furthermore, eyen if 
 
INTRODUCTORY ECONOMICS 307 
 
 an enterpriser suspects that a given field, hitherto unex- 
 ploited, would offer rich returns, conservatism may deter him 
 from abandoning a field in which he is already gaining profits 
 for a field in which he may gain larger profits, but in which 
 he may also incur losses. 
 
 The men who govern a nation may be more far-sighted 
 and more progressive than the business men of the same 
 nation. The former class of men may become convinced that 
 certain fields of production will be profitable long before the 
 latter class will venture into those fields. The government, 
 by placing duties upon the products that those fields might 
 yield, makes success a certainty. Once the new industries 
 are established, the duties might be removed without de- 
 stroying them. The industry of the nation is enriched by 
 the addition of fields of employment that are as good or 
 better than those already under exploitation. 
 
 It must, of course, be borne in mind that this case is 
 a rare one. It is not often that the statesman knows more 
 about business than the body of business men themselves. 
 Where, however, the government is manned by officials of 
 a race intellectually superior to that of the governed, the 
 national industry might be furthered in the way de- 
 scribed. 
 
 Even when there exists no superiority of foresight on 
 the part of those who make up the government, a govern- 
 ment may often succeed in diverting industry from fields in 
 which the natural advantages are less to fields in which 
 they are greater. The United States has always possessed 
 special natural advantages for the production of iron and 
 steel. What it lacked, in its early period, was training in 
 the art of working metals. The enterpriser was unac- 
 quainted with the best processes, and he had to use labor that 
 had not acquired the skill and the traditions necessary for 
 efficient production. 
 
 Now, the only way to acquire an art is to practice it. 
 We had to make iron for a long time before we could become 
 
308 INTRODUCTORY ECONOMICS 
 
 adepts in the art. A generation might have sufficed for 
 estabHshing the industry in a particular locality ; but what 
 enterpriser would have undertaken to produce at a loss 
 through a generation in order that some other enterpriser 
 might ultimately conduct the business with a profit? Obvi- 
 ously, the case demanded governmental aid. And the 
 Government did indeed come to the aid of the industry, 
 through the imposition of duties on imported iron and 
 iron wares. 
 
 A generation may suffice to establish the industry in a 
 given locality, but if the production of iron in other locali- 
 ties promises ultimate success, the duties must be continued 
 for the benefit of these localities. At a time when the first 
 center of the industry is in a position to bid defiance to 
 foreign competition, other centers are still in extreme need of 
 protection. 
 
 To-day our iron and steel industries are highly devel- 
 oped. There is excellent reason for believing that in many 
 sections of the country these industries could get on very 
 well without the protection they continue to receive. In other 
 parts of the country the industry may still be in need of 
 protection. Now, is it expedient to continue protection as 
 long as any part of the industry needs it? To do so is to 
 enable those parts that are already able to stand without aid 
 to levy upon the rest of the industry of the country. 
 
 After an industry has been well established within a 
 couhtry, it migrates without great difficulty to other parts of 
 the same country, if natural conditions warrant. If the iron 
 industry has been established in Pennsylvania, it will readily 
 migrate to Alabama or Colorado, if natural conditions are 
 as good or better than they are in Pennsylvania. Processes 
 that are in use in Pennsylvania can be transferred without 
 cost to the other regions ; a body of workers can be induced, 
 without great difficulty, to migrate v/ith the industry. There 
 is accordingly far less reason for giving governmental aid 
 to the newer centers than there was for giving it to the 
 
INTRODUCTORY ECONOMICS 309 
 
 original one. Accordingly, we may say that it may be ad-' 
 vantageous to protect an industry until it is well established 
 within the national domain ; if it is of a character that fits 
 it for existence there, it will extend itself to other regions 
 even if protection is withdrawn. 
 
 When an industry has become firmly established, fur- 
 ther protection is inexpedient and unjust, as it enables the 
 industry to collect from other industries that are self-sup- 
 porting a tribute that it does not need. Here a practical 
 difficulty arises. How can we determine just when an indus- 
 try has passed through the period of infancy, and therefore 
 should be left to shift for itself ? We cannot find out from 
 those who are engaged in the industry, since they are natur- 
 ally desirous of a continuance of public aid, even though 
 they do not need it. And those who are not engaged in the 
 industry cannot tell. 
 
 At the annual banquets of the various manufacturers' 
 associations, the boast is frequently made that we can manu- 
 facture more cheaply than any other nation on earth. But 
 if Congress proposes to reduce duties, the same men soberly 
 declare that our industries will be ruined if this is done. 
 And shall Congress, in its search for truth to enlighten it, 
 appeal from the manufacturers sober to the manufacturers 
 off their guard and intoxicated with success? The fact is, 
 it is almost impossible for a government to determine just 
 when a protective duty can be removed. As a result every 
 nation retains many such duties long after they have lost all 
 efficacy for doing anything but harm. Accordingly, there is 
 good reason for the view that reckless experimentation in 
 the establishment of new industries is to be avoided. 
 
 A stronger reason for cautious action lies in the fact 
 that an industry established by the aid of a protective duty 
 may never develop sufficiently to maintain itself without 
 governmental aid. The natural conditions upon which it is 
 based may be so unfavorable, relatively to the conditions 
 in other countries, that the industry, if established here, will 
 
3IO INTRODUCTORY ECONOMICS 
 
 be destined to remain forever a burden upon the public — a 
 pauper industry. Let us suppose that in a given branch of 
 industry a commodity can be produced here at a cost of 
 $1, while it can be obtained from abroad for fifty cents. 
 Without government aid, no enterpriser can afiford to under- 
 take its production. Now, let us assume that a statesman, 
 anxious to see the United States producing every possible 
 kind of goods, succeeds in placing a duty of fifty cents on the 
 imported article. The price to consumers must then rise to 
 $1, a price sufficient to induce American enterprisers to pro- 
 duce the goods. 
 
 After all the initial difficulties, such as training a force 
 of men, establishing market conditions, etc., have been over- 
 come, the cost of producing the article may fall to seventy- 
 five cents, and remain there. This is the natural American 
 cost of it. If the duty is removed, the foreign article will 
 again be sold for fifty cents. The men who have put their 
 capitals into the industry will have to close down their plants 
 and discharge their workmen. The buildings and machinery 
 used in the industry will probably be worth almost nothing 
 for any other purpose. The skill acquired by the workmen, 
 at great cost of time, perhaps, will be equally worthless. 
 The removal of the duty, therefore, involves the ruthless 
 destruction of means of wealth production, through no fault 
 of the possessors of such means. 
 
 The question naturally arises, is it right to call an in- 
 dustry into existence by governmental action, and later aban- 
 don it to the mercies of foreign competition? There can be 
 but one answer: It is not right. The government did 
 wrong in calling into existence an industry that would never 
 be able to survive unaided. It does wrong again when it 
 abandons its ill-begotten offspring to die of starvation. If, 
 however, the industry is not abandoned, it is a perpetual ex- 
 pense to the self-supporting industries of the country. A 
 human pauper dies in the end, but a pauper industry ma^ 
 live on forever, 
 
INTRODUCTORY ECONOMICS 3II 
 
 A protective tariff may sometimes be defended on the 
 ground that it preserves the natural resources of a country 
 against wasteful exploitation. If the Government does not 
 restrict international trade, we may, as a rule, assume that 
 enterprisers will seek out the fields in which a given quan- 
 tity of labor and capital will produce the largest amount of 
 value, or the fields in which our advantages over foreign 
 countries are greatest. Let us suppose that one of those 
 fields is the growing of wheat. In most parts of the United 
 States wheat culture represents a heavy drain upon the fer- 
 tility of the soil. Land devoted to constant wheat cropping 
 becomes almost exhausted in a generation. Accordingly, 
 when one sells a bushel of wheat, he sells not only the prod- 
 uct of his labor and capital, but a part of the natural heritage 
 of his country. But why should he care? After his field 
 is worn out, his years will probably be few. The next gen- 
 eration may be left to repair the wastes of this generation. 
 
 Let us suppose that coal and iron mining and the pro- 
 duction of petroleum are other industries in which we have 
 great natural advantages. Enterprisers, if left to themselves, 
 would employ vast amounts of labor and capital in exploit- 
 ing these natural resources. Every year we should send 
 away from our country these commodities, representing not 
 merely the annual product of our labor and capital, but also 
 a part of our irreplaceable natural wealth. In a few genera- 
 tions we should be, as a nation, impoverished. 
 
 We have seen that protection places a burden upon the 
 industries in which we have, for the present, great natural 
 advantages. In order to build up industries in which our 
 natural advantages are less. If the industries that are natur- 
 ally most productive are of the kind that waste the natural 
 wealth of the country, it is a statesman's proper policy to im- 
 pose upon them such burdens, and so reduce the extent to 
 which they are carried on, in favor of industries which in- 
 volve no waste of resources, even though the annual produc- 
 tion of wealth is thereby diminished for a time. 
 
312 INTRODUCTORY ECONOMICS 
 
 The same argument, of course, condemns protection 
 under other circumstances. According to conservative offi- 
 cial estimates, we are using up, each year, four times as 
 much lumber as we are growing. The rising price of lumber 
 stimulates the activity of the woodsman to greater and 
 greater remorselessness. Our mountains are denuded, and 
 the waters, formerly held back by the forest covering and 
 allowed to feed the rivers with regular flow, now sweep 
 down the slopes in devastating flood. Obviously, we should 
 endeavor to stimulate importation of lumber ; if necessary, 
 we should give a bounty on imports, that the price of lumber 
 might be reduced and our few remaining forests saved. But 
 the destroyers of our natural heritage demand protection in 
 their pernicious pursuit, and we accord it to them. 
 
 If extractive industries, prosecuted too relentlessly, 
 waste the natural wealth of a country, manufacturing indus- 
 tries, prosecuted in the same way, waste its men. The popu- 
 lation of a manufacturing center does not compare at all 
 favorably, in health and vigor, with the population of rural 
 districts. Indeed, it is doubtful whether an exclusively urban, 
 manufacturing population can in the long run escape phy- 
 sical degeneration. It might therefore be good policy in a 
 country so largely devoted to manufactures as England to 
 impose protective duties on imported agricultural products, 
 with a view to increasing the proportion of the population em- 
 ployed upon the land. This would indeed burden the manu- 
 facturing population; it would for many years reduce the 
 product of the national industry. But in view of the ulti- 
 mate effect upon the character of the population, this policy 
 might be a good one from the point of view of the statesman, 
 who must consider not merely the prosperity of this year 
 and next, but also that of the remotest generations. 
 
 There are industries that in the end destroy the health 
 of those who are engaged in them. A frequently cited case 
 is a certain branch of the match industry, which condemns 
 its workers to early disability or death. Yet in many coun- 
 
INTRODUCTORY ECONOMICS 313 
 
 tries that industry asks for protection and gets it. Protec- 
 tion and encouragement to an industry that literally devours 
 one's fellow-countrymen ! 
 
 A protective duty is defensible when it serves to main- 
 tain facilities for the production of articles of national neces- 
 sity, the supply of which might be cut off by war. War 
 vessels can be built in Great Britain at far less cost than in 
 the United States. In time of peace we should make im- 
 portant savings by having our war vessels built in Great 
 Britain. If we were engaged in a war, however, we could not 
 have warships built in Great Britain, whether that country 
 were hostile or neutral. Yet it is precisely at such a time that 
 we should most need to increase our navy. Prudence there- 
 fore demands that we should provide ourselves, in time of 
 peace, with establishments capable of turning out warships^ 
 and this involves giving them work to do. 
 
 It is a moot question whether the creation of facilities 
 for constructing merchant ships stands on the same foot- 
 ing. In former times, certainly, a merchant fleet was an 
 indispensable auxiliary to a fighting fleet. The former fur- 
 nished trained seamen, and many merchant vessels were 
 capable of speedy transformation into warships. Modern 
 methods of construction, however, have widely differentiated 
 between merchant ships and ships of war. The former can- 
 not be fitted out in such a way as to enable them to perform 
 eflicient service in line of battle. The crews of merchant 
 ships are not such satisfactory material for a naval force as 
 was formerly the case. Whether the national defense re- 
 quires the development of a sea-going merchant fleet or not 
 is a question for disinterested experts to determine. If it 
 does, protection to the American merchant marine is defens- 
 ible, despite the cost that it inevitably entails. 
 
 Many industries that are not designed directly for the 
 supply of articles of military necessity may be placed in the 
 same class. In order that we may be able to construct ships 
 and produce guns and other instruments of v/ar, we must 
 
314 INTRODUCTORY ECONOMICS 
 
 have men who are trained in metal working ; and if there is 
 no other way of maintaining such a force of workmen, we 
 should create and maintain an iron and steel industry- 
 through protective duties. It is, however, to be borne in 
 mind that the maintenance of an industry large enough to 
 cover all the demand for iron and steel in time of peace can- 
 not be urged on grounds of national defense. 
 
 There are some writers who extend the principle in- 
 volved to an unwarranted extreme. They would have every 
 nation produce practically every article that it consumes, in 
 order that in time of war there might not be the least inter- 
 ruption of supplies. These persons exaggerate the de- 
 pendence of one country upon any other country against 
 which it may at some time wage war. England, every one 
 knows, does not produce enough grain to feed her popula- 
 tion. Suppose that England found herself at war with the 
 United States. That would indeed cut off American sup- 
 plies of wheat and meat and cotton. But there are many 
 other countries that would be glad to provision England at 
 the rates she can afford to pay ; and as for cotton, the Eng- 
 lish buyers would not be a whit worse off than the American 
 sellers, cut off from their natural market. 
 
 But suppose that a coalition of all the powers succeeded 
 in destroying the British fleet, and in cutting off supplies 
 from every source. Would not Great Britain be brought 
 face to face with famine ? Certainly. But a coalition strong 
 enough to do this would be strong enough to invade and sub- 
 jugate Great Britain, even if that country were absolutely 
 self-sufficing. Furthermore, any one who knows anything 
 of the history of coalitions knows that none will ever be 
 formed for the purpose of bringing the British nation to ex- 
 tinction. 
 
 The strength of a nation in time of war does not de- 
 pend upon its ability to produce everything that its inhabi- 
 tants consume. Rather, it depends upon the valor and num- 
 ber of its men, and upon its general wealth. Other things 
 
INTRODUCTORY ECONOMICS 315 
 
 equal, a rich nation will overcome a poor one in war. Great 
 Britain is formidable because she is rich. Now, the endeavor 
 to make a nation absolutely self-sufficing would end in mak- 
 ing it much poorer than it would be if it used its resources 
 in a more economical way. If we were to endeavor to raise 
 coffee and tea, lest an impossible coalition of all the world 
 might inflict upon us the hardships of dry breakfasts, we 
 should waste so much of our energies in the attempt that we 
 should be weakened in the event of an ordinary war, in 
 which we may any day become involved. 
 
 One further possible justification of protective duties 
 requires examination. Other countries impose duties upon 
 American products crossing their borders. Therefore, it is 
 said, we should impose import duties on the products of such 
 countries, by way of retaliation. Let us see whether this 
 position is tenable. 
 
 If Germany places a high duty on American meats, the 
 persons who are injured most seriously are the German 
 consumers of meat. The German producer of meat gains an 
 advantage, but this, under ordinary circumstances, is not 
 commensurate with the loss to the German consumer. The 
 world demand for American meat is somewhat reduced, and 
 this reduces the price of it slightly. A small injury, there- 
 fore, is inflicted upon the American producer of meat. 
 
 Now let us suppose that in retaliation we levy extraor- 
 dinary duties on German sugar. The chief sufferer will be 
 the American consumer of sugar. The American producer 
 will gain, but not commensurately. The world demand for 
 German sugar will be reduced, and this will slightly reduce 
 the price of it. Thus, in order to punish Germany for in- 
 flicting a large loss on German consumers and a small one 
 on American producers, we inflict a large loss on American 
 consumers and a small one on German producers. 
 
 But retaliation is war, and in war the petty rules of 
 logical conduct are not to be observed. The important ques- 
 tion is this: does the policy of retaliation effect its pur- 
 
3l6 INTRODUCTORY ECONOMICS 
 
 pose? Will we compel Germany to remove the obnoxious 
 duty? In all probability, no. After the duty on meat has 
 been in force for some time, German producers will increase 
 their facilities for producing that article. To remove the 
 duty and expose to the mercies of foreign competition the 
 men who had invested their capitals in good faith would be a 
 policy as unjust as it would be unpopular. Similarly, Ameri- 
 can enterprisers would extend their facilities for producing 
 sugar, and this would give them an equitable claim to a con- 
 tinuance of the duty. The only result of retaliation is the 
 institution of permanent protection. If permanent protection 
 is desirable, it should be undertaken without reference to the 
 way in which a foreign government conducts its own affairs. 
 If it is undesirable, it should not be undertaken at all. 
 
 In conclusion we may say that protective duties may be 
 defensible (i) when they make possible the introduction of 
 an industry which in a reasonable time will compare favor- 
 ably in productivity with industries that are already self-sup- 
 porting; (2) when they preserve the natural resources of a 
 country from wasteful exploitation; (3) when they 
 preserve the vigor and progressiveness of the population 
 through the maintenance of a just balance between manu- 
 facturing and agriculture, city and country ; and (4) when 
 they make possible the maintenance of industries that add 
 materially to a country's strength in time of war. In any 
 case such duties are a burden upon the national wealth, at the 
 time when they are instituted, and often for an indefinite 
 time thereafter, and whether the benefit to be gained is a due 
 compensation for the burdens involved is a question demand- 
 ing in each case careful consideration. Duties that are de- 
 signed to raise wages or to increase the national wealth by 
 the introduction of industries in the prosecution of which we 
 have no special advantages, are founded in a delusion. They 
 are rendered possible only by the fact that the ordinary mind 
 does not weigh their unseen disadvantages against their ad- 
 vantages patent to view. 
 
CHAPTER XX 
 The Economic Relations of Government 
 
 The economic world with the study of which we have 
 been engaged is a world of free private enterprise. Its 
 motive forces are the acts of individuals, each seeking to 
 further his own material interests. When such buy or sell 
 material possessions or personal services, they take little 
 thought of the interests of society as a whole, and are little 
 concerned with the wishes or the will of society. Yet the 
 will of society plays a part in all these transactions, for they 
 are shaped with tacit reference to the law. The individual 
 is free to pursue his own interests only within the limits set 
 by the positive law of the land. 
 
 If we attempt to contrast the present economic state 
 with the state that would probably exist were there no polit- 
 ical organization of society, we shall realize that the will 
 of society, as expressed in the acts of government (employ- 
 ing the term in its broadest sense), has played an exceed- 
 ingly important part in economic evolution. Without a gov- 
 ernment strong enough to assure to each man the permanent 
 possession of material goods acquired in ways recognized as 
 legitimate, humanity could hardly have developed beyond 
 the hunting, or at any rate the pastoral, stage. Without a 
 government able to enforce contracts for the future delivery 
 of goods and services, humanity could not have passed be- 
 yond the stage in which the small artisan produced goods, 
 on his own account, for a narrow local market. Progress 
 in the art of government has been a necessary condition 
 of substantial economic progress. On the other hand, it was 
 in large measure progress in economic life that necessitated 
 progress in government. Some of the most serious practical 
 problems of to-day have their origin in the fact that political 
 
3l8 INTRODUCTORY ECONOMICS 
 
 evolution has not kept pace with economic. Our political 
 machinery, which developed under simpler economic condi- 
 tions, is incapable of maintaining justice under the com- 
 plex conditions of the present time. 
 
 A government may limit its economic activities to the 
 defense of private property and the maintenance of the 
 obligation of contracts. It may assume the function of 
 determining the conditions under which economic transac- 
 tions are carried on, and may even interfere in their terms. 
 It may engage directly in the production of goods and ser- 
 vices. In the first case the government is said to pursue a 
 "let alone" or laisser-faire policy; in the second case, a 
 regulative or "paternalistic" policy ; in the third, a socialistic 
 policy. In general, the basis of modern economic policy is 
 laisser-faire. True, the regulation of an industry by govern- 
 ment is a not infrequent phenomenon, and the direct par- 
 ticipation by government in the production of commodities 
 and services is not by any means unknown. Nevertheless an 
 overwhelming majority of modern economic transactions 
 are carried on by private individuals, subject to no direct 
 interference on the part of the government. 
 
 The question may arise whether the existence of protec- 
 tive tariffs in most of the countries of the world does not 
 make it necessary to qualify the statement that laisser-faire 
 is the basis of modern economic policy. In effect, the 
 United States Government prevents us from buying English 
 steel, and compels us to buy steel of American manufacture. 
 Yet the method by which it does this does not resemble the 
 method of governmental regulation, to be discussed below. 
 The Government imposes the condition that every ton of 
 steel crossing our borders shall pay a certain tax. This 
 condition met, the steel becomes an article to be dealt in 
 freely. In buying or selling it men consult only their own 
 self-interest. The imposition of the duty creates a steel 
 industry in this country; but the method by which this is 
 done is very different from the method of governmental 
 
INTRODUCTORY ECONOMICS 319 
 
 production. Prices are enhanced ; and this leads individuals, 
 in the pursuit of their private interests, to engage in steel 
 production. The Government, as it were, creates a favor- 
 able soil in which free enterprise may flourish. We may, 
 therefore, say that the existence of customs barriers does 
 not render necessary a qualification of the statement that the 
 economic policy of modern governments is based upon the 
 principle of laisser-faire, or free enterprise. 
 
 The system of free enterprise has been at once the 
 subject of extravagant praise and of savage criticism. Some 
 writers attribute to it all the progress in civilization that 
 the last centuries have witnessed. To these writers every 
 encroachment by government upon the domain now oc- 
 cupied by private enterprise is fraught with grave dangers. 
 Other writers regard the system as wholly corrupt, and hope 
 to see it replaced either by a system under which all eco- 
 nomic activities are minutely regulated by government, or 
 by one in which the government itself carries on all pro- 
 duction of wealth in behalf of society as a whole. 
 
 An exhaustive treatment of these opposing views would 
 carry us far beyond the scope of the present work. We may, 
 however, consider briefly whether the system of free enter- 
 prise meets the tests of justice and of social expediency. If 
 it does this in the main, there may yet be a distinguishable 
 field in which individual enterprise should be subjected to 
 governmental regulation, and yet another field in which 
 the government should participate in the production of 
 wealth. A part of our task must be to find the boundaries 
 of the respective fields, if such boundaries really exist. 
 
 We may first inquire whether the existing system 
 tends toward justice from the point of view of those who 
 direct production, the class of enterprisers. Any enterpriser 
 may engage in any branch of production, and create and 
 sell wares to his best advantage. Any enterpriser may make 
 a calculation of costs and prices in the various branches of 
 production. If prices are high in any one field, relatively 
 
320 INTRODUCTORY ECONOMICS 
 
 to cost, new enterprisers press into the field ; the supply of 
 the commodity is increased, and its price falls. It follows 
 that there is a tendency for the various classes of goods to 
 exchange, one for the other, in proportions corresponding 
 with their respective costs of production. When this point 
 has been reached, justice, as between different enterprisers, 
 has been established. 
 
 At any given time, it is true, some enterprisers receive 
 greater rewards, in proportion to their outlays, than others. 
 But if competition is free, this can happen only when not 
 enough of one commodity is produced and too much of an- 
 other. The high rewards given to enterprisers in the one 
 field are an inducement to the expansion of production in 
 that field ; the low rewards in another field give warning that 
 less of the product of that field is wanted by society. The 
 unequal treatment of enterprisers is the means by which 
 society compels them to direct their forces in such a way 
 as best to meet society's needs. The inequalities are salutary 
 in their effects; when there is no longer an improper dis- 
 tribution of productive energies, they cease to exist. 
 
 In a similar way, the system of free enterprise tends to 
 establish justice as between different classes of workmen. 
 If in any industry wages are above the average, due allow- 
 ance made for relative agreeableness and safety of employ- 
 ment, labor tends to flow into the industry from industries 
 in which wages are below the average. Wages fall in the 
 former industry and rise in the latter. The initial inequali- 
 ties in wages signified that there was too much labor in some 
 fields, too little in the others, and the very fact of inequalities 
 of reward helped to correct this condition. Justice is done 
 as soon as social expediency permits. Similarly, there is a 
 tendency toward equality of rewards for invested capital. 
 
 Can it be said that the system of free enterprise insures 
 justice in the relations of enterprisers, capitalists and labor- 
 ers with one another? There is no way of weighing the 
 3acrifices undergone by those who direct industry against 
 
INTRODUCTORY ECONOMICS 32 1 
 
 the sacrifices of those who furnish capital and of those who 
 labor. We can, however, weigh the services to society of 
 the respective classes; and we can say that there is a ten- 
 dency for rewards to proportion themselves to services. This 
 is not exactly equivalent to saying that the distribution thus 
 based on services is just. For how came the milHonaire into 
 a position where he can serve, as it were, by proxy, his mil- 
 lions bringing him great rewards, while the laborer, serving 
 in person, receives but an insignificant return? From the 
 point of view of social expediency, however, it seems more 
 plausible that a distribution based on service is satisfactory. 
 Assuring to the capitalist the fruits of his capital encourages 
 the formation of new and greater capitals, and these are 
 powerful instruments for increasing the social production 
 and hence for improving the economic condition of all. 
 
 An economic system based upon free contract will be 
 just and socially expedient only when the parties to each 
 contract stand on a footing of substantial equality. In the 
 first place, the buyer must know the properties of the goods 
 offered to him as well as the seller knows them ; the laborer 
 must know the risks and inconveniences attaching to a given 
 employment as well as the employer knows them. When an 
 unscrupulous horse dealer foists upon an unsuspecting buyer 
 an animal with a hereditary taint of character or defect of 
 body, the social welfare is in some degree reduced. The 
 seller receives wealth, not for his services, but for his rascal- 
 ity ; the buyer parts with his money, not for utilities, but for 
 ''experience." If all trade were of this nature, as it was 
 among the ancient Greeks, we should, like the ancient Greeks, 
 regard trade and piracy as twin callings. 
 
 In the second place, the buyer must be in a position to 
 deal with any one of several sellers, each acting indepen- 
 dently of the others, and the seller must be able to offer his 
 wares to any one of several independent buyers. The laborer 
 must have the option of selling his services to any one out 
 of a number of independent employers, and the employer 
 
322 INTRODUCTORY ECONOMICS 
 
 must have the option of selecting from among a number ^of 
 workmen. In other words, competition must exist on both 
 sides. Otherwise the seller or the buyer, the laborer 
 or the employer, is in danger of being forced to accept 
 terms that are manifestly unfair. And this can issue 
 only in the discouragement of production, and hence in eco- 
 nomic decay. 
 
 Of the two conditions stated, the latter — the existence 
 of competition — is the more important. If competition is 
 active, the seller of wares will point out their good qualities, 
 and his competitors will point out their bad ones. Even an 
 ignorant buyer is thus in some measure protected against 
 injustice. When one party to a contract has no competitors 
 to fear, knowledge on the part of the other party is of little 
 avail. There is a certain town which I can reach only by 
 traveling over a particular railway line. The line is in very 
 bad shape ; the ties are rotten and the rails are light ; the 
 cars are old and unsanitary. Travel on this line involves 
 an unduly large measure of danger and discomfort, and I 
 know it. Yet I must buy tickets over the line, because I 
 have no alternative. 
 
 Now, if there were merely sporadic cases in which con- 
 tracts are made under conditions that make possible a wide 
 departure from fairness, there would be little need for gov- 
 ernmental intervention. But when there is an extensive field 
 in which such conditions prevail, the need for governmental 
 intervention becomes imperative. The government must reg- 
 ulate the conditions and terms of economic contracts when 
 its failure to do so results in substantial injustice. 
 
 In early times the producer and the consumer were, as 
 a rule, neighbors. The tailor and his customer lived in the 
 same village. If then the tailor worked under unsanitary 
 conditions, the customer had a chance of knowing it. If the 
 tailor substituted inferior materials, trusting to the custom- 
 er's ignorance, the deception was likely to make itself known 
 in the wearing of the garments, and react unfavorably upon 
 
INTRODUCTORY ECONOMICS 323 
 
 the tailor's business reputation. Fair dealing, under the cir- 
 cumstances, was a prerequisite of business success, and the 
 man who dealt dishonestly sooner or later reaped the due 
 harvest of his misdeeds. 
 
 To-day the man who makes your clothes may live a 
 thousand miles away from you. He may be suffering from a 
 mild attack of smallpox as he works upon your garments. 
 You cannot see the danger that lurks in them. The milk that 
 you drink may come from a dairy one hundred miles away, 
 where no attempt is made to prevent its contamination with 
 the germs of disease. The appearance of the milk gives you 
 no warning of the fact. Patent medicine manufacturers may 
 for years have supplied you with remedies containing dan- 
 gerous amounts of opium; packing houses may have fur- 
 nished you with meat treated with preservatives that under- 
 mine your health. Only an expert can tell you whether this 
 is true or not ; and you can probably ill afford to employ a 
 corps of experts to investigate the hidden qualities of the 
 things you buy. 
 
 The workman in a large factory is in a similar position 
 of helplessness. He cannot estimate the degree of danger 
 that unfenced machinery represents. He cannot tell whether 
 ventilation is adequate, or whether dust and noxious gases 
 are properly disposed of. Furthermore, he is often unable 
 to judge correctly as to the number of hours that he can toil 
 daily without undermining his health. 
 
 Not less significant than the separation of consumer 
 from producer has been the development of combinations of 
 producers. In many fields, buyers have virtually only one 
 seller to deal with. In this state of affairs, there is no way 
 in which the consumer can enforce a demand for wares of 
 good quality, if wares of poor quality are more profitable. 
 The employee of a monopoly may know that unsanitary con- 
 ditions prevail in its shops, but he may be unable to find other 
 employment. Furthermore, the prices of monopolized prod- 
 ucts are almost certain to be unreasonably high, and this 
 
324 INTRODUCTORY ECONOMICS 
 
 means that the monopoHst takes from the aggregate income 
 of society a larger share than his services warrant. 
 
 There is, then, a field in which governmental regula- 
 tion is necessary. ( i ) The government may be called upon 
 to regulate the qualities of products or of services. (2) It 
 may be called upon to regulate the prices of commodities or 
 services. (3) The government may regulate the conditions 
 under which work is performed. (4) It may regulate wages. 
 (5) It may regulate the relations between the enterpriser 
 and the men who provide him with capital. 
 
 Governmental regulation of the quality of commodities 
 was exceedingly common in the Middle Ages. The weight 
 of the loaf of bread, the width and quality of fabrics, were 
 determined by public authority. With the development of 
 modern industry much of this regulation fell into disuse. 
 Competition was permitted to regulate the quality of com- 
 modities as it regulated their prices. The mediaeval kind of 
 regulation has, however, survived in a few instances, where 
 the retention by a country of a valuable branch of trade for- 
 bids individualistic tampering with the traditional standards 
 of quality. The Persian Government endeavors to suppress 
 the use of aniline dyes in the manufacture of rugs, on the 
 ground that the employment of these dyes will ultimately 
 destroy the foreign demand for Persian rugs. The Japanese 
 Government inspects all mattings produced for export, and 
 regulates their quality. 
 
 The regulation of the qualities of goods in most modern 
 states has for its chief purpose the preservation of the public 
 health. The use of certain ingredients in foods is forbidden ; 
 the use of other ingredients is limited to certain fixed pro- 
 portions. An attempt is made to insure the production of 
 many classes of goods under conditions limiting the risk of 
 transmission of disease from worker to consumer. No at- 
 tempt is ordinarily made to protect the consumer against 
 fraud, so long as such fraud does not involve injury to 
 health. 
 
INTRODUCTORY ECONOMICS 325 
 
 The regulation of qualities is carried farther in the case 
 of certain goods and services furnished by enterprises en- 
 joying a monopolistic position. The quality of gas to be 
 furnished to the inhabitants of a city by a private company 
 is commonly determined by public authority. The service 
 of passenger transportation by street and steam railways is 
 often subject to regulation as to quality. In these cases 
 regulation is often defended on the ground that the enter- 
 prises are of a quasi-public nature. But any enterprise which 
 obtains a monopoly of a branch of production is, from an 
 economic point of view, in the same position. If a powerful 
 monopoly controlled the iron and steel business of the United 
 States, there would be no way, except governmental regula- 
 tion, of preventing the use of ores rich in phosphorus or 
 sulphur in the production of iron destined to be transformed 
 into steel rails. This would be a menace to the safety of all 
 travelers; it would therefore be necessary in the end for 
 government to regulate the quality of steel produced. 
 
 There is, of course, a danger that the government may 
 go so far in the regulation of qualities as to check legitimate 
 improvements. By the aid of certain chemicals, wheat flour 
 of a darker color than consumers like may be bleached to 
 a snowy whiteness. The chemicals are admittedly injurious 
 to health; but they are inevitably driven off, either in the 
 process of flour manufacture or in the baking of bread, so 
 that hardly a trace of them can be found in the latter prod- 
 uct. Yet there is some public sentiment in favor of prohibit- 
 ing the bleaching of flour. At the present writing California 
 fruit growers are greatly concerned over an administrative 
 ruling which limits so narrowly the use of sulphurous acid 
 in the curing of dried fruits as to threaten the ruin of the 
 dried fruit industry. In spite of the danger of over-regu- 
 lation, however, it must be admitted that the principle of 
 regulation of quahties is salutary, and that the scope of regu- 
 lation is destined to extend itself in future. 
 
 Governmental regulation of the prices of commodities 
 
326 INTRODUCTORY ECONOMICS 
 
 and services v/as also exceedingly common in the Middle 
 Ages. In modern times such regulation is limited to the 
 field of the so-called quasi-public enterprises. The charges 
 of railway companies, of gas and electric light companies, 
 of telephone and telegraph companies, and even of such 
 petty enterprises as the carriage of passengers in cabs and 
 similar conveyances, are commonly regulated by law. 
 Such regulation is not actually based upon any economic 
 ground at all, but upon the legal ground that the enterprises 
 in question use the public highways, or employ public powers 
 in obtaining rights of way. 
 
 From an economic point of view, all the enterprises 
 mentioned except the last ought to be subject to govern- 
 mental price regulation, because they are monopolies. With- 
 out such regulation, a railway company might, if it chose, 
 levy such heavy charges upon the carriage of goods away 
 from and into a particular locality as to destroy the business 
 of that locality and reduce the value of property situated 
 there to almost nothing. If the railway is the only means of 
 transportation from a mining district, by raising rates it 
 could reduce the profits of mine owners to nil and force the 
 closing of the mines. It could then buy up the mines at a 
 very low figure, and operate them profitably on its own 
 account. True, this is an extreme case; yet it illustrates 
 very v/ell the evils that an unregulated monopolistic deter- 
 mination of transportation charges would entail. 
 
 If a monopolistic combination succeeded in gaining con- 
 trol of the entire iron and steel industry, or of the business 
 of mining coal, its powers for extortion would be as great 
 as those of the railway in our example. What would one 
 give rather than pass a Northern winter without co^l ? Not 
 all that one has, but a good part of it. If we must inevitably 
 see an extension of monopolistic enterprise, as many believe, 
 it is inevitable that we shall see an extension of the principle 
 of governmental price regulation. 
 
 So long as economic organization remained simple, 
 
INTRODUCTORY ECONOMICS 327 
 
 there was comparatively slight need for a governmental reg- 
 ulation of the conditions under which labor was performed. 
 A large proportion of those who toiled were their own 
 employers, and these could be counted upon to keep their 
 workplaces in tolerably sanitary condition, and to limit their 
 hours of labor and the intensity of their exertion in the 
 degree that considerations of health demanded. Those who 
 worked for wages enjoyed, as a rule, conditions as favorable 
 as those of the workmen who were in their own employ. 
 The advent of the factory system changed conditions materi- 
 ally. Men, women and children were congregated in great 
 masses, under the direct supervision of overseers many of 
 whom v/ere bent upon getting the maximum possible service 
 from the workers under them. Machinery took a place in 
 the productive series, and the workers were forced to adapt 
 themselves to the speed of the machines. Competition be- 
 tween manufacturers led at first to a longer and longer 
 working day,, and to greater and greater intensity of effort. 
 The worker, seeking employment, was in no position to stip- 
 ulate that the v/orking day should be limited to a reasonable 
 number of hours, or that the labor should not be so intense 
 as to be destructive of the health of the laborer. 
 
 Society, it is clear, cannot afiford to see the vitality of its 
 working classes sapped in an effort to raise to its maximum 
 the annual production of wealth. An individual employer 
 may profitably pursue the policy of hiring a set of workmen, 
 wearing them out in a few years, and replacing them by 
 another set. From the viewpoint of society this policy is as 
 wasteful as it is cruel. The daily exertion of each man 
 should be restricted in such measure that he may live a life 
 of normal length, enjoying the normal number of years of 
 health and usefulness. Where labor involves little strain, 
 a man may work ten hours or more a day without injury to 
 health. Where the strain is great, eight hours may be an 
 unduly long work day. 
 
 When laborers are associated in strong unions, they may 
 
328 INTRODUCTORY ECONOMICS 
 
 be able, without governmental aid, to reduce the hours of 
 labor in the measure that is desirable from a social point of 
 view. Each organization is composed of workers of all ages ; 
 and there is a natural tendency to maintain a pace that is not 
 too rapid for the older workers, hence not so rapid as to 
 destroy the physical health of the younger men. 
 
 But strong trade unions control only a small part of 
 the economic field. Such associations are especially weak 
 in industries employing large numbers of women and chil- 
 dren ; and these are precisely the classes that are most seri- 
 ously injured by long hours of work. Hence it has come 
 to be generally recognized that the conditions under which 
 women and children work in factories ought not to be left 
 to free contract. Hours of labor, for these classes, must be 
 regulated by government. 
 
 In almost every modern state some attempt is made to 
 regulate by law the hours of labor of children employed out- 
 side of the household. Such regulation has been carried 
 farthest in the states where the system of large scale produc- 
 tion has long been established, as, for example, in England. 
 In new industrial states, as in Japan, the regulation of the 
 hours of child labor is only in its inception. 
 
 The regulation of hours of labor of women employed 
 under similar circumstances is also a well established policy 
 in the more advanced states. In the United States a serious 
 obstacle to such regulation is found in constitutional provi- 
 sions, originally designed to secure the liberty of the indi- 
 vidual, but now operating in such a way as to obstruct his 
 chances of attaining freedom from industrial slavery. The 
 regulation of hours of labor of men has as yet made com- 
 paratively slight progress ; the policy is, however, destined 
 to extend its scope in the future. 
 
 The regulation of other conditions of employment — 
 ventilation, sanitation, etc. — ^has encountered comparatively 
 few positive obstacles. The field is, however, so wide, and 
 the work of legislatures so slow, that hundreds of thousands 
 
INTRODUCTORY ECONOMICS 329 
 
 of workmen are to-day employed under conditions involving 
 needless risk of mutilation and death. Still greater is the 
 number employed under conditions that predispose the 
 worker to disease. Progress in the direction of regulation 
 of such conditions is steady, but dishearteningly slow. 
 
 The regulation of wages is a policy very seldom em- 
 ployed in modern times. Doubtless there are many cases 
 in which wages are far below the level of productivity of 
 labor; and in these cases it is manifest that injustice is 
 done. To attempt to fix wages by law, however, is to en- 
 counter grave difficulties. If in any industry wages were 
 fixed at a level that seemed to the workers too low, the lat- 
 ter would feel justified in refusing to work. If the level of 
 wages seemed to employers too high, they would feel justi- 
 fied in closing their shops. To force the laborers to abide 
 by the rate determined by government would be to inaugu- 
 rate an era of universal serfdom. Men would be compelled 
 to work, on terms fixed by others ; and this is the essence of 
 serfdom. To force employers to continue production, paying 
 wages that seem to them unduly high, would be to confiscate 
 property. In either case it is likely that economic progress 
 would be checked. 
 
 This does not mean that it would not be possible to se- 
 lect certain industries, in which the laborer is most seriously 
 exploited, and establish minimum wages there. If the rate 
 were too low, some of the laborers could seek other employ- 
 ment. If the rate were too high, some of the employers 
 could remove their capitals to other industries. With the 
 shrinkage in the volume of the industry, the price of its 
 products would rise, and this would enable the remaining 
 employers to pay the rate of wages fixed. True, some of 
 the workers formerly in the industry would be left without 
 employment. Some means would have to be found for 
 transferring them to other employments. However this 
 might be, such regulation, limited to a few fields, would 
 encounter no insuperable obstacles, and might result in alle- 
 
330 INTRODUCTORY ECONOMICS 
 
 viating the distress of some of the most helpless members of 
 society. Some such policy as this has been inaugurated in 
 one of the Australian colonies — with what results, we shall 
 better know after the lapse of another decade. 
 
 Regulation of the relations between enterpriser and cap- 
 italist, or between borrower and lender, tenant and land- 
 lord, has largely fallen into disuse. In modern times the 
 man who borrows capital is usually possessed of some prop- 
 erty and of at least an average degree of business capacity. 
 It may therefore be taken for granted that he will not sub- 
 scribe to terms that are not to his advantage. If a man is 
 willing to borrow capital at ten per cent., there is good 
 reason for believing that the annual use of the capital is 
 worth at least $io per $ioo. Accordingly, there is no reason 
 why the public authority should interfere in the transaction. 
 Many of our States do indeed have usury laws, limiting the 
 rate of interest that may be paid. But these laws are easily 
 evaded, and may be regarded as obsolete. 
 
 Where the enterpriser is a corporate body, as is com- 
 monly the case in large scale production, the relations be- 
 tween those shareholders who are actually in control and 
 those whose voice in the management is seldom heard, often 
 require regulation. The small investor in a large corpora- 
 tion is often at the mercy of a circle of large investors, who 
 manage the property in their own interests, not in those of 
 the entire body of stockholders. Something akin to the con- 
 fiscation of property takes place when the men in control 
 of a corporation undertake a "shaking out" of the "little 
 men." There is probably no class in the United States to-day 
 more in need of governmental regulation than these "little 
 men." In the end, doubtless, regulation will come, and the 
 small investor in a corporation's stock will know whether he 
 is buying property or shadowy hopes ; and whether or not 
 he will be permitted to keep what he has purchased. 
 
 Relations between landlord and tenant assume the guise 
 of a social problem wherever the ownership of land has 
 
INTRODUCTORY ECONOMICS 33I 
 
 become divorced from its cultivation. Where a small num- 
 ber of large landholders deal with a vast number of small 
 tenants there is often opportunity for the oppression of the 
 latter. The tenant who brings a tract of land into an excel- 
 lent state of cultivation cannot at any time carry the fruits 
 of his labor away with him. Justice demands that he shall 
 be permitted to retain his occupancy of the land until he has 
 reaped the fruits of his labor. Upon the renewal of his 
 lease he should not be compelled to pay an additional sum 
 for the use of the productive powers that he has himself 
 created. A wise landlord, it is true, will not deal unjustly 
 with tenants who increase the productive power of his land; 
 but not all landlords are wise. The tenant may, in some 
 measure, safeguard his interests by the terms of the con- 
 tract under which he enters upon his tenancy; but not all 
 the conditions that may arise during a term of tenancy can 
 be covered by a contract. Accordingly, the State, under the 
 conditions assumed, may be called upon to regulate the rela- 
 tions of landlord and tenant in such a way that the latter 
 may proceed confidently with the improvement of the land, 
 knowing that he cannot be deprived of his due reward. No 
 problem of this nature has arisen in the United States. This 
 is due to the fact that it is easy for any energetic cultivator 
 to acquire land of his own. It is quite conceivable that at 
 some future time, when the rising price of land and the 
 resultant concentration of holdings have given rise to a per- 
 manent class of tenant cultivators, the regulation of the 
 relations of landlord and tenant will assume great impor- 
 tance. 
 
 The foregoing survey is sufficient indication of the 
 fact that the regulative activities of government already 
 cover a wide field; and we have excellent reason for be- 
 lieving that the scope of such activities will in the future 
 be greatly extended. In so far, we are drifting away from 
 an economic system based upon free private enterprise. It 
 cannot be said, however, that the essential nature of the 
 
332 INTRODUCTORY ECONOMICS 
 
 existing economic system is thereby altered. That system 
 is based upon private initiative; and though the govern- 
 ment may restrict the field in which private initiative finds 
 exercise, it does not bind initiative itself. The government 
 may prohibit the production of certain articles. In so doing 
 it warns private enterprise away from a limited field; but 
 there remain other fields open. The government may fix 
 the price at which a certain article may be sold, but this price 
 must be left high enough to tempt private enterprise into the 
 field; otherwise the article will not be produced. The 
 government may prohibit the employment of certain classes 
 of persons, and restrict the hours of labor of other classes. 
 Private enterprise is still called upon to furnish employment, 
 and the conditions may not be made so onerous as to exclude 
 the possibility of liberal profits. A system of regulated enter- 
 prise is none the less a system of private enterprise. A 
 range of choice and an opportunity for gain are left open 
 to the enterpriser, and if enterprise is really active, it is 
 forever creating new opportunities beyond the reach of 
 regulation. 
 
 It may appear that while the existing system of eco- 
 nomic organization is in no danger of subversion through 
 the extension of governmental regulation, it is in danger of 
 being supplanted by a system of governmental enterprise, 
 or a socialistic state. We have already many examples 
 of direct production of commodities and services by the 
 state; and we may predict an increasing number of such 
 enterprises for the future. Must we therefore believe that a 
 time will come when the state will enter all branches of 
 industry, and organize the whole working population as a 
 civil service corps? We shall get some light upon this 
 question from a study of the reasons that have led to the 
 direct participation of government in industry. From such 
 a study we may draw reasonable inferences as to whether or 
 not the same reasons will lead to an indefinite extension of 
 the principle of governmental enterprise. 
 
INTRODUCTORY ECONOMICS 333 
 
 In some instances, the production of a commodity or a 
 service is undertaken by government solely with a view to 
 securing a revenue. This is the case with the tobacco mon- 
 opoly of France and of some other countries, the salt mon- 
 opoly in British India, and a few other public monopolies. 
 The profits of the business take the place of revenues that 
 would otherwise be raised by taxation. The government of 
 France, instead of operating a tobacco monopoly, might levy 
 duties on the manufacture and sale of tobacco. If the policy 
 of a government monopoly is resorted to, the product is sold 
 to the public at a price exceeding cost of production. This 
 excess of price represents the net revenue. Let us say that 
 in a given country the price will be so high as to yield a 
 net revenue of $20,000,000. Now, the government might 
 place a tax yielding $20,000,000 on the private manufacture 
 of the article. The manufacturers would add the tax to the 
 price paid by the consumers. In either case the government 
 would get the same revenue. In either case the consumer 
 would bear the burden. Which is the better policy, then, a 
 government monopoly or a tax yielding the same revenue? 
 
 Under private enterprise the price of tobacco will be 
 determined by cost of production plus the tax. Say that the 
 aggregate cost of production of all the tobacco used in the 
 country is $40,000,000. Add to this a tax of $20,000,000, 
 and the consumers will have to pay about $60,000,000 for 
 it. Under government enterprise, what will it cost to pro- 
 duce the tobacco? The government can borrow capital at 
 a lower rate than private enterprisers; it is likely to pay 
 higher wages. Laborers in the employ of the government 
 are not likely to work so hard as those in the employ of 
 private persons. Let us therefore say that the production of 
 tobacco costs the government $50,000,000. To this add 
 $20,000,000 profit for the public revenues, and the con- 
 sumers will have to pay $70,000,000 for what they would 
 have paid $60,000,000 under private enterprise, subject to 
 excise taxation. 
 
334 INTRODUCTORY ECONOMICS 
 
 From this example the following principles may be 
 drawn : When the cost of production in governmental shops 
 is greater than the cost in private shops, with a given burden 
 upon the consumer a larger revenue can be obtained by the 
 government through taxation than through governmental 
 enterprise. The cost of production is ordinarily greater in 
 governmental shops than in private shops. There is accord- 
 ingly little reason for an expansion of governmental enter- 
 prise for the sake of obtaining revenue. 
 
 The government may assume control of an industry for 
 the purpose of regulating the quality or the price of the prod- 
 uct. The assumption by governments of the sole right to 
 coin money is a case in point. Imagine the inconvenience 
 of a currency composed of coins struck by all the private 
 companies that mine gold or silver! Some would be light 
 weight, some heavy; some would have much alloy, some 
 little. Obviously, absolute uniformity, and absolute con- 
 formity to well-known standards, are essentials of a currency 
 employed in a modern state. And such uniformity and in- 
 tegrity of quality can be secured only when the coins are 
 issued by an organ of society which regards the interests 
 of society as paramount. Doubtless it costs more to coin 
 money in government establishments than it would cost in 
 private establishments. But this waste is insignificant as 
 compared with the gains from a currency of unquestioned 
 soundness. 
 
 A similar reason has led to the nationalization of the 
 railway in many countries, and to a popular demand for 
 nationalization in other countries. If we could be sure that 
 private railways would furnish good service, at equal terms 
 to all, and at reasonable charges, we should never regard 
 government ownership of railways as desirable. But of this 
 we cannot be sure. We have tried regulation, and are still 
 trying it; and it may be that we shall succeed in our en- 
 deavors to secure impartial and reasonable treatment of ship- 
 pers and travelers. If we cannot do this, we shall in the 
 
INTRODUCTORY ECONOMICS 335 
 
 end make up our minds that the railway is to other 
 business enterprises what the coinage is to other com- 
 modities — an essential link in almost every business trans- 
 action — and that its social aspects are of paramount 
 importance. 
 
 A similar argument applies to the so-called municipal 
 monopolies — street railway transportation, the furnishing of 
 water and light, and the telephone service. If it is impossible 
 to regulate the quality of service and the charges under 
 private management, public management becomes necessary. 
 It is, however, to be borne in mind that such regulation is im- 
 possible only when the people are unable to select able and 
 honest officials; and when such is the incapacity of the 
 people, government enterprises stand little chance of being 
 managed efficiently and honestly. 
 
 In the foregoing instances, there is no inherent neces- 
 sity for public operation of industry. In the first case this 
 policy is adopted in lieu of a policy of taxation ; in the other 
 cases, in lieu of a policy of regulation. We come now 
 to consider cases in which government enterprise is neces- 
 sary, because it is the only means of securing certain impor- 
 tant utilities for society. 
 
 In some branches of industry, practically all the utilities 
 created embody themselves in a concrete form, so that the 
 producer is able to recoup himself for his costs of production 
 through sale of the utilities to those who are to enjoy them. 
 The utilities created by a shoe manufacturer are embodied in 
 the shoes; and the manufacturer can obtain from the user 
 of shoes a price that will compensate him for his expenses. 
 If the consumer will not pay enough to cover costs, the shoes 
 ought not to be made, for there are no utilities arising from 
 their making that the consumer cannot appraise. 
 
 We may contrast with the utilities furnished by such 
 an industry the utilities furnished by a lighthouse. These 
 are scattered far and wide over the waters that are rendered 
 safe by the light. They benefit every shipowner whose vessel 
 
336 INTRODUCTORY ECONOMICS 
 
 sails in these waters ; every passenger for whom the danger 
 of death at sea is thereby reduced ; every shipper, who pays 
 lower freights because of the smaller chance of the founder- 
 ing of ships. In a year's time the utilities contributed by the 
 lighthouse may far exceed its cost of maintenance. But if 
 you or I were to erect a lighthouse, how would we collect 
 pay for these utilities from the beneficiaries? Clearly, this 
 is no field for private enterprise, and yet it is a field in which 
 labor and capital may produce greater utilities than else- 
 where. The government, as the representative of society, 
 can alone afford to exploit this field. 
 
 Again, an industry may produce some utilities that are 
 concrete and appropriable, and some that are elusive, flowing 
 freely to persons who cannot be made to pay for them. In a 
 very slight degree this is true of all industries ; but we are 
 concerned only with cases in which this differentiation of 
 Vitilities is well marked. We may take as an example com- 
 mon school education. The children who receive instruction 
 are the immediate beneficiaries ; they, or their parents, could 
 be made to pay something for it. But all of us who wish a 
 government of officials selected by intelligent voters ; all of us 
 who prefer intelligent and efficient employees to ignorant 
 ones ; all of us who wish to enjoy the products of a rich and 
 varied national production, are the indirect beneficiaries. A 
 great part of the total benefit from educating a child is 
 reaped by persons not connected with him by ties of blood 
 or personal interest. 
 
 Now, if the benefit to the child is so great, and so clearly 
 appreciated by him or by his guardians, that the entire ex- 
 pense of education can be met by tuition, we who are also 
 beneficiaries may take our gains gratis. But if this is not the 
 case — and, as a rule, it is not — we should be very short- 
 sighted if we refused to contribute our share to the expense. 
 From a social point of view the benefits of popular educa- 
 tion far outweigh the expenses of it; the expenses cannot 
 in each case be assessed upon the beneficiaries ; therefore the 
 
INTRODUCTORY ECONOMICS 337 
 
 production of the utilities in question must be undertaken by 
 government. 
 
 Another case may now be cited. Near one of our large 
 cities there is an island which is capable of providing build- 
 ing lots for a large population. Until recently comparatively 
 few persons could make the island their home, on account of 
 the uncertainty and inconvenience of passage to the city. A 
 ferry service existed, but the boats were small, old and slow. 
 The owners of the ferry line could not furnish better service, 
 however, because the increase in fares would not cover the 
 increase in expense. 
 
 The introduction of an efficient ferry service would 
 have greatly increased the value of land on the island. It 
 would have furnished an outlet to some of the surplus popu- 
 lation of the city, and diminished the evils of overcrowding 
 in tenements. These utilities might very well have been of 
 sufficient annual value to offset the increased cost of service. 
 But the private ferry company could collect no charge for 
 such utilities ; therefore it could not make the improvement. 
 The city, on the other hand, could very well afford to estab- 
 lish a satisfactory service to the island, since the city as a 
 whole would get most of these elusive benefits, in addition 
 to the fares it would collect from passengers. 
 
 It is obvious that the same principle may be extended 
 to a great many enterprises — street railways, steam railways, 
 etc. At any given time most of the utilities produced by such 
 an enterprise as a street railway system may be of such a 
 character that a price can be charged for them. As the city 
 grows in size and questions of transportation assume greater 
 and greater importance, the utilities that are not appropriable 
 increase in number and in value. In the end, these utilities 
 may come to be of such significance that the transit system 
 ought to be managed chiefly with reference to them. In such 
 case public ownership ought to take the place of private 
 ownership. 
 
 Now, as population increases the industries producing 
 
33^ INTRODUCTORY ECONOMICS 
 
 non-appropriable Utilities, along with those that are appro- 
 priable, become more numerous — or, more exactly, the non- 
 appropriable element in utility production becomes more 
 important, relatively to the appropriable element. Accord- 
 ingly, an expansion of public enterprise, in this direction, 
 seems probable. 
 
 One further case in which public enterprise may enter 
 the field of production may here be touched upon. Some- 
 times private enterprise is not sufficiently daring or skillful 
 to enter upon the supplying of utilities even when there is 
 no obstacle in the way of charging a price for them. The 
 government, if under the control of able administrators, may 
 then increase the social welfare by undertaking production 
 directly. When a country, long habituated to one mode of 
 economic life, is suddenly compelled to adapt itself to new 
 conditions, this superiority of public to private enterprise 
 may manifest itself. In the last half century many enter- 
 prises have been undertaken by the Japanese Government, 
 in fields ordinarily left to private business. As a class of 
 enterprisers developed, the control of such business has been 
 gradually transferred to them. When, on the other hand, 
 initiative dies out in a people, owing to the weeding out of 
 the more intelligent and enterprising elements in the popu- 
 lation, the government may gradually assume control of 
 production and trade. Something of this nature occurred 
 in the later years of the Roman Empire and in the declining 
 period of Venetian history. 
 
 So long as there remains in society a large class of 
 persons possessing enterprise and ingenuity, there is little 
 reason for believing that the extension of the field of public 
 enterprise will really narrow the field of private enterprise. 
 For the boundaries of the latter can be extended indefinitely 
 outward, so long as men have wants that remain unsatisfied. 
 Public enterprise will supplant private enterprise only when 
 the latter has become impotent to direct the supplying of the 
 needs of society. 
 
iAB 
 
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