The Investment And Distribution Of Resources

§ 4. This principle of substitution is closely connected with, and is indeed partly based on, that tendency to a diminishing rate of return from any excessive application of resources or of energies in any given direction, which is in accordance with general experience.

It is thus linked up with the broad tendency of a diminishing return to increased applications of capital and labour to land in old countries which plays a prominent part in classical economics. And it is so closely akin to the principle of the diminution of marginal utility that results in general from increased expenditure, that some applications of the two principles are almost identical.

New methods of production bring into existence new commodities, or lower the price of old commodities so as to bring them within the reach of increased numbers of consumers: that on the other hand changes in the methods and volume of consumption cause new developments of production, and new distribution of the resources of production: and that though some methods of consumption which contribute most to man’s higher life, do little if anything towards furthering the production of material wealth, yet production and consumption are intimately correlated.

But now we are to consider more in detail how the distribution of the resources of production between different industrial undertakings is the counterpart and reflex of the distribution of the consumers’ purchases between different classes of commodities.

Let us revert to the primitive housewife, who having “a limited number of hanks of yarn from the year’s shearing, considers all the domestic wants for clothing and tries to distribute the yarn between them in such a way as to contribute as much as possible to the family wellbeing. She will think she has failed if, when it is done, she has reason to regret that she did not apply more to making, say, socks, and less to vests. But if, on the other hand, she hit on the right points to stop at, then she made just so many socks and vests that she got an equal amount of good out of the last bundle of yarn that she applied to socks, and the last she applied to vests28 .” If it happened that two ways of making a vest were open to her, which were equally satisfactory as regards results, but of which one, while using up a little more yarn, involved a little less trouble than the other; then her problems would be typical of those of the larger business world. They would include first decisions as to the relative urgency of various ends; secondly, decisions as to the relative advantages of various means of attaining each end; thirdly, decisions, based on these two sets of decisions, as to the margin up to which she could most profitably carry the application of each means towards each end.

These three classes of decisions have to be taken on a larger scale by the business man, who has more complex balancings and adjustments to make before reaching each decision29 . Let us take an illustration from the building trade. Let us watch the operations of a “speculative builder” in the honourable sense of the term: that is, a man who sets out to erect honest buildings in anticipation of general demand; who bears the penalty of any error in his judgment; and who, if his judgment is approved by events, benefits the community as well as himself. Let him be considering whether to erect dwelling houses, or warehouses, or factories or shops. He is trained to form at once a fairly good opinion as to the method of working most suitable for each class of building, and to make a rough estimate of its cost. He estimates the cost of various sites adapted for each class of building: and he reckons in the price that he would have to pay for any site as a part of his capital expenditure, just as he does the expense to which he would be put for laying foundations in it, and so on. He brings this estimate of cost into relation with his estimate of the price he is likely to get for any given building, together with its site. If he can find no case in which the demand price exceeds his outlays by enough to yield him a good profit, with some margin against risks, he may remain idle. Or he may possibly build at some risk in order to keep his most trusty workmen together, and to find some occupation for his plant and his salaried assistance: but more on this later on.

Suppose him now to have decided that (say) villa residences of a certain type, erected on a plot of ground which he can buy, are likely to yield him a good profit. The main end to be sought being thus settled, he sets himself to study more carefully the means by which it is to be obtained, and, in connection with that study, to consider possible modifications in the details of his plans. Given the general character of the houses to be built, he will have to consider in what proportions to use various materials—brick, stone, steel, cement, plaster, wood, etc., with a view to obtaining the result which will contribute most, in proportion to its cost, to the efficiency of the house in gratifying the artistic taste of purchasers and in ministering to their comfort. In thus deciding what is the best distribution of his resources between various commodities, he is dealing with substantially the same problem as the primitive housewife, who has to consider the most economic distribution of her yarn between the various needs of her household.

Like her, he has to reflect that the yield of benefit which any particular use gave would be relatively large up to a certain point, and would then gradually diminish. Like her, he has so to distribute his resources that they have the same marginal utility in each use: he has to weigh the loss that would result from taking away a little expenditure here, with the gain that would result from adding a little there. In effect both of them work on lines similar to those which guide the farmer in so adjusting the application of his capital and labour to land, that no field is stinted of extra cultivation to which it would have given a generous return, and none receives so great an expenditure as to call into strong activity the tendency to diminishing return in agriculture30 .

Thus it is that the alert business man, as has just been said, “pushes the investment of capital in his business in each several direction until what appears in his judgment to be the outer limit, or margin, of profitableness is reached; that is, until there seems to him no good reason for thinking that the gains resulting from any further investment in that particular direction would compensate him for his outlay.” He never assumes that roundabout methods will be remunerative in the long run. But he is always on the look out for roundabout methods that promise to be more effective in proportion to their cost than direct methods: and he adopts the best of them, if it lies within his means.

§ 5. Some technical terms relating to costs may be considered here. When investing his capital in providing the means of carrying on an undertaking, the business man looks to being recouped by the price obtained for its various products; and he expects to be able under normal conditions to charge for each of them a sufficient price; that is, one which will not only cover the special, direct, or prime cost, but also bear its proper share of the general expenses of the business; and these we may call its general, or supplementary cost. These two elements together make its total cost. There are great variations in the usage of the term Prime cost in business. But it is taken here in a narrow sense. Supplementary costs are taken to include standing charges on account of the durable plant in which much of the capital of the business has been invested, and also the salaries of the upper employees: for the charges to which the business is put on account of their salaries cannot generally be adapted quickly to changes in the amount of work there is for them to do.

There remains nothing but the (money) cost of the raw material used in making the commodity and the wages of that part of the labour spent on it which is paid by the hour or the piece and the extra wear-and-tear of plant. This is the special cost which a manufacturer has in view, when his works are not fully employed, and he is calculating the lowest price at which it will be worth his while to accept an order, irrespectively of any effect that his action may have in spoiling the market for future orders, and trade being slack at the time. But in fact he must as a rule take account of this effect: the price at which it is just worth his while to produce, even when trade is slack, is in practice generally a good deal above this prime cost, as we shall see later on31 .

§ 6. Supplementary cost must generally be covered by the selling price to some considerable extent in the short run. And they must be completely covered by it in the long run; for, if they are not, production will be checked. Supplementary costs are of many different kinds; and some of them differ only in degree from prime costs. For instance, if an engineering firm is in doubt whether to accept an order at a rather low price for a certain locomotive, the absolute prime costs include the value of the raw material and the wages of the artisans and labourers employed on the locomotive. But there is no clear rule as to the salaried staff: for, if work is slack, they will probably have some time on their hands; and their salaries will therefore commonly be classed among general or supplementary costs.

The line of division is however often blurred over. For instance, foremen and other trusted artisans are seldom dismissed merely because of a temporary scarcity of work; and therefore an occasional order may be taken to fill up idle time, even though its price does not cover their salaries and wages. That is they may not be regarded as prime costs in such a case. But, of course the staff in the office can be in some measure adjusted to variations in the work of the firm by leaving vacancies unfilled and even by weeding out inefficient men during slack times; and by getting extra help or putting out some of the work in busy times. If we pass from such tasks to larger and longer tasks, as for instance the working out a contract to deliver a great number of locomotives gradually over a period of several years, then most of the office work done in connection with that order must be regarded as special to it: for if it had been declined and nothing else taken in its place, the expenses under the head of salaries could have been reduced almost to a proportionate extent.

The case is much stronger when we consider a fairly steady market for any class of staple manufactures extending over a long time. For then the outlay incurred for installing specialized skill and organization, the permanent office staff, and the durable plant of the workshops can all be regarded as part of the costs necessary for the process of production. That outlay will be increased up to a margin at which the branch of manufacture seems in danger of growing too fast for its market. In the next chapter the argument of Chapter 3 and of this chapter is continued.

It is shown in more detail how those costs which most powerfully act on supply and therefore on price, are limited to a narrow and arbitrary group in the case of a single contract for, say, a locomotive; but are much fuller, and correspond much more truly to the broad features of industrial economy in the case of a continuous supply to a fairly steady general market: the influence of cost of production on value does not show itself clearly except in relatively long periods; and it is to be estimated with regard to a whole process of production rather than a particular locomotive, or a particular parcel of goods. And a similar study is made in Chapters VIII.—X. of variations in the character of those prime and supplementary costs which consist of charges for interest (or profits) on investments in agents of production, according as the periods of the market under consideration are long or short.

Meanwhile it may be noticed that the distinction between prime and supplementary costs operates in every phase of civilization, though it is not likely to attract much attention except in a capitalistic phase. Robinson Crusoe had to do only with real costs and real satisfactions: and an old-fashioned peasant family, which bought little and sold little, arranged its investments of present “effort and waiting” for future benefits on nearly the same lines. But, if either were doubting whether it was worth while to take a light ladder on a trip to gather wild fruits, the prime costs alone would be weighed against the expected benefits: and yet the ladder would not have been made, unless it had been expected to render sufficient service in the aggregate of many little tasks, to remunerate the cost of making it. In the long run it had to repay its total costs, supplementary as well as prime.

Even the modern employer has to look at his own labour as a real cost in the first instance. He may think that a certain enterprise is likely to yield a surplus of money incomings over money outgoings (after proper allowances for risks and for discountings of future happenings); but that the surplus will amount to less than the money equivalent of the trouble and worry that the enterprise will cause to himself: and, in that case, he will avoid it32 .