APPENDIX H^*76

LIMITATIONS OF THE USE OF STATICAL ASSUMPTIONS IN REGARD TO INCREASING RETURN.

§ 1. Some hints have already been given of the difficulties which beset the theory of equilibrium in regard to commodities which obey the law of increasing return. Those hints are now to be developed a little.

The central point is that the term "margin of production" has no significance for long periods in relation to commodities the cost of production of which diminishes with a gradual increase in the output: and a tendency to increasing return does not exist generally for short periods. Therefore, when we are discussing the special conditions of value of those commodities which conform to that tendency, the term "margin" should be avoided. It may be used of course for these commodities as for all others, with regard to a short and quick fluctuation in demand; because in relation to such fluctuations the production of those commodities, as well as others, conforms to the law of diminishing and not increasing return. But in problems in which the tendency to increasing return is in effective force, there is no clearly defined marginal product. In such problems our units have to be larger, we have to consider the conditions of the representative firm rather than a given individual firm: and above all we have to consider the cost of a whole process of production, without any attempt to isolate that of a single commodity, such as a single rifle or yard of cloth. It is true that when nearly the whole of any branch of industry is in the hands of a few giant businesses, none of them can be fairly described as "representative." If these businesses are fused in a trust, or even closely combined with one another, the term "normal expenses of production" ceases to have a precise meaning. And, as will be argued fully in a later volume, it must be regarded as primâ facie a monopoly; and its procedure must be analysed on the lines of Book V. chapter XIV.; though the last years of the nineteenth century and the early years of this have shown that even in such cases competition has a much greater force, and the use of the term "normal" is less inappropriate than seemed probable à priori.

§ 2. Let us return to the instance of an increased demand for aneroid barometers, caused by a movement of fashion, which after a while had led to improved organization and to a lower supply price^*77. When at last the force of fashion died away, and the demand for aneroids was again based solely on their real utility; this price might be either greater or less than the normal demand price for the corresponding scale of production. In the former case capital and labour would avoid that trade. Of the firms already started some might pursue their course, though with less net gains than they had hoped; but others would try to edge their way into some nearly related branch of production that was more prosperous: and as old firms dwindled, there would be few new ones to take their place. The scale of production would dwindle again; and the old position of equilibrium would have shown itself fairly stable against assaults.

But now let us turn to the other case, in which the long-period supply price for the increased output fell so far that the demand price remained above it. In that case undertakers, looking forward to the life of a firm started in that trade, considering its chances of prosperity and decay, discounting its future outlays and its future incomings, would conclude that the latter showed a good balance over the former. Capital and labour would stream rapidly into the trade; and the production might perhaps be increased tenfold before the fall in the demand price became as great as the fall in the long-period supply price, and a position of stable equilibrium had been found.

For indeed, though in the account of the oscillations of demand and supply about a position of stable equilibrium, which was given in the third chapter, it was tacitly implied, as is commonly done, that there could be only one position of stable equilibrium in a market: yet in fact under certain conceivable, though rare, conditions there can be two or more positions of real equilibrium of demand and supply, any one of which is equally consistent with the general circumstances of the market, and any one of which if once reached would be stable, until some great disturbance occurred^*78.

§ 3. It must however be admitted that this theory is out of touch with real conditions of life, in so far as it assumes that, if the normal production of a commodity increases and afterwards again diminishes to its old amount, the demand price and the supply price will return to their old positions for that amount^*79.

Whether a commodity conforms to the law of diminishing or increasing return, the increase in consumption arising from a fall in price is gradual^*80: and, further, habits which have once grown up around the use of a commodity while its price is low, are not quickly abandoned when its price rises again. If therefore after the supply has gradually increased, some of the sources from which it is derived should be closed, or any other cause should occur to make the commodity scarce, many consumers will be reluctant to depart from their wonted ways. For instance, the price of cotton during the American war was higher than it would have been if the previous low price had not brought cotton into common use to meet wants, many of which had been created by the low price. Thus then the list of demand prices which holds for the forward movement of the production of a commodity will seldom hold for the return movement, but will in general require to be raised^*81.

Again, the list of supply prices may have fairly represented the actual fall in the supply price of the thing that takes place when the supply is being increased; but if the demand should fall off, or if for any other reason, the supply should have to be diminished, the supply price would not move back by the course by which it had come, but would take a lower course. The list of supply prices which had held for the forward movement would not hold for the backward movement, but would have to be replaced by a lower schedule. This is true whether the production of the commodity obeys the law of diminishing or increasing return; but it is of special importance in the latter case, because the fact that the production does obey this law, proves that its increase leads to great improvements in organization.

For, when any casual disturbance has caused a great increase in the production of any commodity, and thereby has led to the introduction of extensive economies, these economies are not readily lost. Developments of mechanical appliances, of division of labour and of the means of transport, and improved organization of all kinds, when they have been once obtained are not readily abandoned. Capital and labour, when they have once been devoted to any particular industry, may indeed become depreciated in value, if there is a falling off in the demand for the wares which they produce: but they cannot quickly be converted to other occupations; and their competition will for a time prevent a diminished demand from causing an increased price of the wares^*82.

Partly for this reason, there are not many cases in which two positions of stable equilibrium would stand out as possible alternatives at one and the same moment, even if all the facts of the market could be ascertained by the dealers concerned. But when the conditions of a branch of manufacture are such that the supply price would fall very rapidly, if there should be any great increase in the scale of production; then a passing disturbance, by which the demand for the commodity was increased, might cause a very great fall in the stable equilibrium price; a very much larger amount than before being henceforward produced for sale at a very much lower price. This is always possible when, if we could trace the lists of demand and supply prices far ahead, we should find them keeping close together^*83. For if the supply prices for largely increased amounts are but very little above the corresponding demand prices, a moderate increase in demand, or a comparatively slight new invention or other cheapening of production may bring supply and demand prices together and make a new equilibrium. Such a change resembles in some respects a movement from one alternative position of stable equilibrium to another, but differs from the latter in that it cannot occur except when there is some change in the conditions of normal demand or normal supply.

The unsatisfactory character of these results is partly due to the imperfections of our analytical methods, and may conceivably be much diminished in a later age by the gradual improvement of our scientific machinery. We should have made a great advance if we could represent the normal demand price and supply price as functions both of the amount normally produced and of the time at which that amount became normal^*84.

§ 4. Next let us revert to the distinction between average values and normal values^*85. In a stationary state the income earned by every appliance of production being truly anticipated beforehand, would represent the normal measure of the efforts and sacrifices required to call it into existence.

The aggregate expenses of production might then be found either by multiplying these marginal expenses by the number of units of the commodity; or by adding together all the actual expenses of production of its several parts, and adding in all the rents earned by differential advantages for production. The aggregate expenses of production being determined by either of these routes, the average expenses could be deduced by dividing out by the amount of the commodity; and the result would be the normal supply price, whether for long periods or for short.

But in the world in which we live, the term "average" expenses of production is somewhat misleading. For most of the appliances of production, material and personal, by which a commodity was made, came into existence long before. Their values are therefore not likely to be just what the producers expected them to be originally; but some of their values will be greater, and others less. Thus present incomes earned by them will be governed by the general relations between the demand for, and the supply of, their products; and their values will be arrived at by capitalizing these incomes. And therefore, when making out a list of normal supply prices, which, in conjunction with the list of normal demand prices, is to determine the equilibrium position of normal value, we cannot take for granted the values of these appliances for production without reasoning in a circle.

This caution, which is of special importance with regard to industries that tend to increasing return, may be emphasized by a diagrammatic presentation of the relations of demand and supply which are possible in a stationary state, but only there. There every particular thing bears its proper share of supplementary costs; and it would not ever be worth while for a producer to accept a particular order at a price other than the total cost, in which is to be reckoned a charge for the task of building up the trade connection and external organization of a representative firm. The illustration has no positive value: it merely guards against a possible error in abstract reasoning^*86.