The Common Sense of Political Economy

Wicksteed, Philip H.
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London: Macmillan and Co.
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1st edition.
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Summary.—The laws of "increasing and diminishing returns," as currently stated, are in no sense co-ordinate, and do not form an antithesis. The use of the terms in economic argument seldom coincides with the definitions given to them. As applied to "cost of production" the conception of diminishing returns is often misleading and confused; and a fatal graphic resemblance between two intersecting curves of demand on the one hand, and a curve of demand intersected by a curve of "cost of production" on the other, has (together with other misleading influences) produced a habit, in graphic demonstrations, of treating increasing cost of production, as the amount produced increases, as the normal case. Other and less academic influences are at work to foster an irrational dread of "decreasing returns" to labour in the near future.


Diagrams of intersecting curves have been used with many different meanings, and a failure to distinguish precisely between them has given rise to much confusion. Our path to the further investigation of this subject lies through a consideration of what are known as the laws of "increasing" and "diminishing" returns.


In books on Political Economy our attention is called to the following facts. If successive doses or increments of labour (or labour and capital) are applied to a piece of land, we find that, at any rate after a certain point, doubling the amount of labour does not double the product. As we increase the amount of labour, therefore, each successive increment secures a smaller return in the shape of product. This is called the "law of diminishing returns," and is said to apply generally to agricultural and extractive industries. On the other hand, if an industry such as that of the cotton or iron trade so increases that, say, twice as much labour (or labour and capital) is employed in it as before, it will generally be found that the result is a more than doubled output. This is said to illustrate the "law of increasing returns," and to apply generally to manufactures.


When the statements are made thus baldly the reader can hardly fail to see that the two "laws" are in no sense co-ordinate, and cannot be regarded as standing side by side and proclaiming "divisum habemus imperium." The cases are not parallel. In stating the law of diminishing returns, it is assumed that the factor of land is constant, and if, when a number of factors co-operate to produce a result, you double some of them without doubling others, of course you cannot expect to double the result. If you double the pastry without doubling the apples, you do not double the pie. If you double the diners without doubling the dinner, or double the dinner without doubling the diners, you do not double the dining experience. In like manner if you double the land without doubling the operations on it, or double the operations without doubling the land, you cannot expect to double the crop. This principle would apply to manufactures just as much as to agriculture. If, for example, you had doubled the number of hands, retaining the same machinery and buildings, or if you had doubled the raw material without doubling the labour bestowed upon elaborating it, or if you had doubled the labour bestowed on the same raw material, you could in no case expect the exact doubling (or other proportionate increase) of the product. Or if a tradesman doubles his accommodation without doubling his stock and staff, or doubles his stock without doubling his accommodation and his staff, he will not double the effectiveness of his whole establishment. There are circumstances under which any of these operations might more than double the total result. If a business were desperately under-staffed or under-stocked, for instance, doubling the defective factor might more than double the effect of the whole; but if doubling any one of these factors without doubling the others exactly doubled the efficiency of the concern, it could only be a coincidence; and "after a certain point" it would certainly less than double it. The "law of diminishing returns," then, is really no more than an axiomatic statement of a universal principle that applies equally to all forms of industry, and to a great range of non-industrial experiences and phenomena as well.


The law of increasing returns, on the other hand, includes all those cases in which economies may be effected in one or more of the factors by increasing the scale of production. There is no kind of parallel or contrast between the two principles. If you double some of the factors and not the others you will not exactly double the product (except by a coincidence). If you increase all the factors in a suitable proportion you will in many cases be able to secure double the product without more than doubling any of the factors and without as much as doubling some of them.


The law of increasing returns, then, is an intelligible formulating of a very interesting and important phenomenon. Production on a large scale makes certain economies possible. A man who is cultivating 50 acres of land may require a waggon, but if he were cultivating 200 acres he might only require two, not four. And if, instead of supposing one man to increase his holding, we imagine four holders of 50 acres each to be working in co-operation, we may still suppose the same economy to be effected. Or, without any "co-operation" in the technical sense, a man may own a steam thrashing-machine, and may do the thrashing for all the farmers and holders in the neighbourhood more economically than they could do it for themselves; but it is only if there is a great deal of wheat grown in the district that this can be done. No limit seems yet to have been reached to the possibility of economising in one direction or another as the bulk of any industry increases. It seems always possible, at every stage, to introduce some new process of specialising or division of labour, and so to effect some new economy for which the industry was not ripe until it had reached its present dimensions. And note that the phenomenon we are now examining is independent of the question how far the business of a single concern, or under a single management, may be carried advantageously. The economies which a large volume of production, as such, renders possible are in principle independent of the question whether the industry is in few or many hands.


The principle of increasing returns, therefore, is intelligible and important; and it directs our attention to a significant point in the analysis of the processes of production. The "law of decreasing returns," on the other hand, as ordinarily stated, is, as we have seen, the mere enunciation, with special reference to land, of an axiomatic and sterile proposition. Of course you cannot indefinitely increase a product in proportion to the increase of certain selected factors of production if you do not increase the other factors.


This utter disparity of the two "laws" is sometimes veiled by stating the case merely in terms of "labour," or, it may be, of "labour and capital." Thus it is said that in agricultural and extractive industries the increase in the output will not be proportional to the increase in labour and capital, whereas in manufactures it will be more than proportionate. But manifestly this is only a partial statement. There is a suppressed assumption that you do not (or a suppressed postulate that you cannot) contemporaneously increase the other factors in the one case, and that you do (or can) increase them in the other. The enunciation of the "law" of diminishing returns, then, reduces itself to a veiled statement, or hypothesis, as to facts. Sometimes writers perceive this, and base their argument on explicit statements as to the actual limitation of the supply of land on the surface of the earth, or place their whole investigation on the footing of a hypothetical isolation, say, of England in time of war. On the relevancy or legitimacy of these statements or hypotheses we may have something to say presently,*40 but meanwhile it is abundantly evident that there is no possibility, along any of these lines, of formulating two co-ordinate "laws," in the proper sense, parallel one to the other. The only "law" is that (within limits that do not appear as yet to have been ascertained or realised) successive economies in the administration of the factors of production may be introduced as the volume of production increases. But of course that does not mean that these economies are always such as to secure an increase in the product more than proportionate to the increase of some of the factors, if the other factors are not increased at all. The two "laws" therefore hold united, not divided, sway over industry.


But the semblance of a parallel in the statement of the genuine law of increasing returns on the one hand, and of the axiom and the disguised assumption (or hypothesis) which jostle each other under the cloke of a "law of diminishing returns" on the other, has led to a frequent treatment of the two as parallel, and this has reacted upon the conception of the "law of diminishing returns" itself. This "law" accordingly has made a series of masked movements by which it has in some degree approximated itself to a parallelism with the other.


If we were to construct an interpretation of the phrase law of diminishing returns in strict analogy to the rational use of law of increasing returns, we should formulate it thus:—"There are some industries of such a nature or in such a stage of development that you could double the output without more than doubling any of the factors of production, and by less than doubling some of them; but there are other industries of such a nature, or in such a stage of development, that you cannot double the output except by as much as doubling all the factors of production and more than doubling some of them." This would be an enunciation of two parallel principles which really might divide the realm of industry between them. It would remain to be shewn what industries, if any, came under the latter law. But this completely consistent use of the terms has never, so far as I am aware, entered either consciously or unconsciously into books of Political Economy; and that for a very sufficient reason. The terms in which we have attempted to give precision to the law of increasing returns are not the terms in which we habitually think. "No more than doubling any of the factors of production, and less than doubling some of them," is not a working formula. We might more than double some, but the economies effected by the reduction of others might more than compensate this increase; and, moreover, the question is complicated by substitutions, by the introduction of totally fresh factors, by the partial or complete elimination of existing factors, and so forth. And in order to make comparisons we need a common denominator to which all these entering and vanishing, waxing and waning factors can be reduced. This common denominator, as we have already seen,*41 we have; and its index is the value in exchange of the several factors, that is to say, their marginal efficiency in other industries; and this we measure in terms of gold. What we practically mean, then, by the law of increasing returns is that in certain industries (or conditions of an industry) an increased output means a cheaper production, as measured in gold values; and, by analogy, we should interpret the law of decreasing returns to mean that in certain other industries (or conditions of an industry) an increased output would mean an increased cost of production.


Here, then, we have an intelligible use of the two terms in a parallel and consistent sense; and in most generalisations and inferences concerning "industries which obey the law of increasing returns" and "industries which obey the law of diminishing returns" this seems to be what is in the mind of the writers. But the reader will see that by a process of attraction the meaning of the "law of diminishing returns" has been drawn completely away from its original basis. Both laws have effected a masked movement from terms of specific factors of production, measured in their proper units, to terms of generalised productive resources measured in the unit of gold. And the law of diminishing returns has effected a further, and if possible more important movement, from the statement that if you do not adequately increase some important factor you must not expect an increase in the product proportional to the increase in the other factors, to the statement that in certain industries it will not be normally possible largely to increase certain important factors or to find adequate substitutes for them, except on terms so unfavourable, pecuniarily, that the net result will be an increase in the cost of production as the volume of the output increases.


These ambiguities would hardly have maintained their place in the textbooks had they not been supported by the assumption that in the case of agriculture there really is a normal difficulty or impossibility in obtaining at will an increased command of land, whereas in the case of manufactures there is no such normal and permanent limitation to the increase of any factor. Thus, the axiomatic statement that if you do not increase the land you will not increase the product in proportion to the increase of the other factors, coupled with the postulate that you cannot increase the land, yields the result that you cannot increase agricultural products except at an increase in the cost of production; and this result (flagrantly as it contradicts the facts in many instances) is accepted as representative of an important though undefined class of industries, the characteristics of which are often developed without further challenge, and without examination as to the extent to which such industries, or such conditions, actually exist. The generalisation, which still seems to pass loosely current, that the law of "increasing returns" applies to manufactures and the law of "decreasing returns" to extractive and agricultural industries, when translated into terms of cost of production, seems to derive little or no support from history, nor is it easy to apply it to the analysis of the actual phenomena of industry. It is true, of course, that land is ultimately limited in quantity, but at present there is plenty of land to be had for any specific use, either by withdrawing it from other uses,*42 or by taking in fresh land not at present used for anything. And, on the other hand, if any specific manufacturing industry calls for an increase of labour, that labour can only be had by being withdrawn or withheld from other occupations, or taken up from labour-power that is not at present being used at all. As a matter of fact, no practical difficulty has been found in increasing to any required extent the area of the earth's surface applied to the production of wheat. And seeing that the men who, in an English manufacturing centre, construct thrashing-machines or other agricultural implements for use in Russia, are just as truly and certainly taking their part in the agricultural industries of Russia as the peasants who are on the spot, we cannot even say that the land of the great wheat-growing countries of the old and new worlds is out of the reach of the inhabitants of English cities; for they are actually harvesting the crops. In truth, the great industry of wheat-growing might be taken as affording a typical example of the economies of large scale production, and the abundance and cheapness of wheat in the world market indicates the fact. And, on the other hand, it is monstrous to assume it as self-evident that all the factors of production in a manufacturing industry can be increased at will. The raw material of many of them, as of the cotton industry, is itself an agricultural product, and none of them can at short notice indefinitely increase the factor of adequately skilled labour.


The most general case alike in manufactures and in extractive industries appears to be that a large and sudden increase of output must be made at an industrial disadvantage, because the supply of one or more important factors cannot be largely increased at a moment's notice. The increase, therefore, must be made at more than proportional sacrifice, since the proportions of the factors will necessarily be disturbed; and unless a sufficiently higher price is offered an increased product will not be forthcoming at all. On the other hand, if an increased demand continues for a long period, an increased flow of all the requisite factors will set in, and ultimately the advantages and economies of large production, with the factors of production duly balanced against each other, will be realised. Hence, whether in agriculture or manufactures, it seems to be a fairly general rule that when an increased demand causes an increased production that presses against the existing limits, at first cost of production will rise, but ultimately it will fall. There may, of course, be numerous and important exceptions; for there may be real and permanent difficulty in increasing the supply of certain materials; but the cereals, and generally the great vegetable staples, are a singularly unfortunate example to allege. Here at any rate there is no theoretical difficulty, and has been no practical difficulty, in increasing all the factors of production ad libitum.


We are now in a position to examine various diagrammatic methods which have been employed to exhibit the relation between value in exchange and cost of production, determining the normal price of an article by the method of intersection. It is usual to speak in this connection, as in that of the market,*43 of a demand curve and a supply curve, but to distinguish between the cases that illustrate diminishing and those that illustrate increasing returns. Thus, we might take Figure 36.  Click to enlarge in new window.Fig. 36 to illustrate the case of an industry following the law of increasing returns. This would mean that if the quantity Ox of the commodity were produced its market value would be xp per unit, and the cost of production of a unit would be xc. Under these conditions there would obviously be an inducement to extend the industry. As Ox increased xp would, of course, fall. But so, by the action of the law of increasing returns, would xc; for as the output increased, economies could be introduced which would bring down the cost of production. There is a limit, however, to the decline of xc, whereas there is no limit to that of xp, and therefore a point of intersection must ultimately be reached. If the production were carried beyond this point, the cost of production would be greater than the price; that is to say, the effect of applying the necessary combination of factors of production at the margin of this industry would be the sacrifice of (objectively) higher values at the margin of other industries; and there would consequently be a tendency for these factors to flow from this industry to others, and so to contract the supply.


We may note, once for all, that what appears to be in the mind of writers who use this diagram is prevailingly cost of production as measured in the standard unit (gold). But as the distinction between this measurement and the measurement of the factors of production themselves, in their proper units, has seldom been kept steadily in view, there has naturally been some ambiguity in this matter.


Apart from this, we must carefully note that the two curves cannot be interpreted in the same manner. The demand curve represents a group of facts or possibilities which all of them exist contemporaneously. It is a synopsis. The high values near the origin represent possibilities as to market price, should an isolated change take place in the supply of this particular commodity, and they represent actualities in the shape of the (objective) value of certain units of the commodity to the persons who actually consume them; whereas the supply curve does not represent a series of co-existing facts. It is not true that some units are produced at the high cost represented by the points of the curve near the origin. The economies resultant on the larger output affect the conditions of production generally, and if the amount produced is Ox, the cost xc (except for temporary and individual reasons) will apply to one unit as much as to another. Scrupulous writers are also careful to note that the curve is often used with a historical significance, and in that case the high values near the origin no longer represent even potentialities in case of a reduced supply, for many of the economies which have been effected are permanent and might be applied even to a smaller supply. The supply curve, in such a case, represents a historic development on which the industry has travelled forward, but on which it could not travel backward without modification. This being so, it would be an altogether grotesque supposition that during the whole of this historical process the demand curve had remained constant. Thus the two curves could hardly be regarded as co-existing on the same plane, and no satisfactory interpretation can be given to their intersection.


It is undoubtedly true, however, that in some cases economies can at once be effected, if the scale of production is increased, without awaiting the elaboration of new methods. In such cases all the possibilities represented by the declining cost of production curve may be conceived as actually co-existing, qua possibilities, though not as actualities. In the same way an amount-of-the-supply and market-price curve represents a series of prices that co-exist as possibilities but not as actualities; whereas a curve of marginal significances represents, if properly constructed, a group of co-existing actualities. With these limitations a curve (as in Fig. 36) may be accepted as theoretically giving a closer approximation to the truth than the straight line of Figure 31.  Click to enlarge in new window.Fig. 31, in cases where the whole curve of demand is given from the origin onwards, or in which a large part of the whole curve is under consideration. Within the limits of actual oscillation, while "other things remain the same," a straight line will often best represent the facts.


The case is far worse for the application of the method of intersection of supply and demand curves, as in Figure 37.  Click to enlarge in new window.Fig. 37, to instances that are supposed to illustrate the "law of diminishing returns," and this unfortunately has been its favourite application. We have seen that it is normal for a sudden increase in the demand which provokes a sudden increase in the supply to meet with the check caused by the difficulty of suddenly increasing certain of the factors of production, whether land, or skilled labour, or elaborate machinery, or premises. Hence an up-sloping curve will represent the immediate effect on cost of production of an expansion of the supply. We have seen, however, that these effects are transitory. It is only a question of time; for if time be given, all the factors of production will probably be made to flow into this particular industry in proportions corresponding to, if not identical with, those that prevailed before; and the increased scale of production will give scope to all the usual economies. Broadly speaking, then, the up-sloping curve of supply, as contrasted with the down-sloping one, represents not a class of industries, but the condition that the increased demand is recent and has been sudden. There is not only a difference but a contrast between the immediate and the ultimate effect of an increased demand accompanied by an increased supply. The obvious application, however, of the up-sloping curve of supply to the immediate effects of an increased demand has, I think, misled students into the assumption, never sufficiently examined, that there is a large and normal class of industries to which this form of curve permanently applies.


The remark which has been made with reference to Fig. 36 is also applicable here. The lower curve represents a succession of facts and is not a synopsis of co-existing ones. Lower ordinates of the supply curve nearer the origin do not represent any actual facts which exist contemporaneously with those represented by the ordinate of the point which the production has actually reached; whereas the higher (objective) significance of the units nearer the origin, as represented by the demand curve, does represent facts that co-exist with the lower objective significance of the marginal units.


But the same form of curve has often been used for quite a different purpose to which this last objection does not apply, but which is open to other objections still more grave. If we select some factor, such as land, to exclude from consideration, and then draw a curve on which we arrange the individual units of the product in order of the proportion in which they depend on this factor and not on the others, we shall again obtain a curve of the form presented in Fig. 37. Thus, if land were the factor excluded from representation in our supply curve, we should register at the origin that individual unit, say of wheat, which had been produced by the smallest output of labour and capital because it was raised on the most fertile land; that is to say, the land employed in its production, having the highest marginal efficiency, would have been combined with the smallest amount of the other factors.


In every industry the different units will be produced under very different conditions, and when they are brought to market the ratio in which wages, rent, transport, expenses of management, and so forth, enter into their costs of production will be different in each case, whether we measure some or all of these agents in their proper units, or measure all of them in the general standard (gold). And we may of course arrange them if we like in the order dictated by the proportion in which any one selected factor or factors (or all the factors except one or more selected ones) have entered into the process of their production. We should then have a curve of the form represented in Fig. 37. Here the ordinate of a certain unit would not be xc because the total number of units produced is Ox, but that particular unit would be registered in that place because its ordinate is xc. It is as if you were to collect a number of men and arrange them in order of their heights. A certain man would not be, say, 5 ft. 11 in. because he was the twentieth man originally brought in, but would be put into the twentieth place because he was 5 ft. 11 in.


The habit of treating land as something wholly exceptional that does not enter into production on the same footing as other factors has led to a frequent use of this form of diagram as though it represented cost of production. It will be worth while to dwell on this point for a moment. It is usual to speak of wheat which has been grown on specially fertile ground as having been raised "under favourable conditions." This is quite natural and intelligible in itself, but if we translate it into a statement that the cost of production of this wheat has been less than that of other wheat grown on less fertile ground, we at once land ourselves in a tangle of confusion. There is no presumption that the cost has been less to the man who raised it, for he has had to pay higher rent for the more fertile land. Nor is there any reason to suppose, from the communal point of view, that a smaller sacrifice of open alternatives has been made for this unit of wheat than for any other. Just as in a broad generalisation we assume that labour might be withdrawn from the margin of any one industry and applied at the margin of other industries, not indeed without loss, but without great and conspicuous loss if the transfer were only small, and with a loss that diminishes without limit as we suppose the transfer to be smaller, so we must also assume that if land were withdrawn in small quantities from any given use, agricultural or other, it could be applied to some other use where it would be only a little less valued. The cost of production of any commodity, as we have seen, is determined by the significance of the alternatives sacrificed in its production, and there seems to be no kind of justification for excluding land, and the other purposes that it might have served, from the cost of production either of wheat or of anything else. If we ask the origin of so strange a practice as that of excluding land (which, moreover, we cannot separate from capital) from consideration when estimating the cost of production, the answer seems to be as follows: It was taken as an axiom that cost of production determined the value of the product. It was then seen that wheat raised upon land for which a high rent had been paid sold for no more than wheat of the same quality that had been raised on inferior land. Hence the syllogism: "Cost of production determines exchange value; rent does not affect the exchange value of wheat; therefore rent is not part of its cost of production." The major premise was false and the conclusion absurd, but so firmly was the premise established as an axiom that even a reductio ad absurdum did not lead to its revision. The argument, such as it is, would of course apply just as much to labour, raw material, or capital, as to land. For some wheat less has been paid in wages than for other wheat of the same quality; it would follow that if cost of production determines exchange value, wages are not part of the cost of production. The general truth is, as we have seen, that the value of the factors of production is derivative from the value of the product. The price or hire of some land is higher than that of other land because its products or services are more valued, but the same is true of all raw material and of all kinds and grades of skill. Their value is derivative from the value of the commodity, or ultimately the experience, they produce. This derivative nature of the value of factors of production was perceived in the case of land earlier than in other cases; and thinkers who were still under the impression that in general the product derived its value from the value of the factors of production, and who perceived that this was not true in the case of land, at once set land on a footing of its own, with the resultant confusions which we have been examining.


A certain semblance of rationality has been given to this arrangement of the units of wheat in the order of the decreasing ratio in which the cost of land stands to the cost of the other factors in their production, by dwelling on the idea that the most fertile land is likely to be occupied first, so that every extension of agricultural industry will be from more to less suitable land; and then the reaction of the considerations already dwelt on*44 in relation to the immediate effect of a rise or fall of demand has enabled writers to pass from this specific conception of progressive recourse to inferior land in wheat-growing to the general conception of the necessity of progressive recourse to less and less favourable conditions as any industry expands; and so again a rising curve has been taken, without adequate examination, as representative of a large and normal class of industries. But this whole conception is illusory. The conditions that are favourable or otherwise to any particular industry are constantly changing, and an increasing scale of production is itself a factor in the change. A man may be at a positive disadvantage because he set up his machinery yesterday as against the man who is to set it up to-day. Manitoba may offer more favourable conditions for growing wheat for the London market than Essex does. It is quite as likely that the established man has to work at a disadvantage because he is committed to less favourable conditions than are now open, as it is that the man who is entering upon the industry is at a disadvantage because he finds all the most favourable sites and conditions preoccupied.


But probably the most deeply seated of all the predisposing causes which keep the up-sloping curve of cost of production in favour is one that has no connection whatever with the theory of decreasing returns. Neither of the intersecting curves of Figure 20.  Click to enlarge in new window.Fig. 20, on page 499, has any connection with production, or cost of production, at all. Yet one of them slopes up as the other slopes down. If we place all the holders on the up-sloping curve, so that all the "supply" is in the hands of the persons whose desires it represents, it is easy to fall into the habit of calling it the "supply" curve. We have seen that it is no such thing. It is the demand curve of a certain number of the persons in the market arbitrarily grouped together. The supply is not represented by a curve at all, but by a length on the abscissa. But once use crossing curves to illustrate the determination of the market price, and call the up-sloping one the "supply" curve, and you have at once a figure that you can transfer bodily, and without knowing that you are doing it, to the illustration of the regulation of "supply" as determined by cost of production. Thus crossing curves may come to be used indifferently to represent "demand and supply" or "demand and cost of production," the term "curve of supply" may be used indifferently in either case, the up-sloping curve of the one (which is merely a down-sloping curve of exactly the same nature as the other, reversed for convenience, and having no constitutional connection with "supply" whatever) may be transferred to the other; it may then be read as a curve of diminishing returns and increasing cost of production, and may create a habit of mind to which cases of "increasing return" present themselves as graphically inconvenient phenomena which must be recognised from time to time but can generally be comfortably neglected. A more disreputable origin for a respected figure in the economic world it would be difficult to conceive!


It remains true, however, that there may be industries in which an increased volume of production must normally imply increased cost, and under the limitations insisted on in the parallel case of decreasing cost of production*45 such industries might legitimately be illustrated by a diagram such as that of Fig. 37. But when this very ambiguous diagram is employed without examination to represent unspecified industries that obey the "law of decreasing returns"; when that law, as originally defined, has been the mere statement of a truism that applies to all industries; when the unwarrantable exclusion of rent from a place amongst the costs of production, and unwarranted assumptions and delusive analogies as to increasingly unfavourable conditions and as to the nature of supposed "supply" curves, have presided over the construction and the interpretation of the curve and strengthened its hold on the imagination, and when purely geometrical deductions from it have then been applied to important practical matters, it is surely time to submit all the emergent theories to a thorough revision, based on a severely precise definition of the meaning to be assigned to the curve, and a demonstration that it actually represents an important body of industrial fact.


We may now summarise our results. A curve representing the conditions of increasing or diminishing returns, if properly constructed, would be an attempt to register a continuous series of changes of the nature of that represented by the transition in Fig. 31, page 519, from the unbroken to the dotted lines parallel to the axis of X. It might be in the same sense (increasing returns) or in the opposite sense (diminishing returns) to what is there represented. It would have no connection or relation whatever to the up-sloping curve on Figs. 20, etc.


A final word as to the processes illustrated in Figure 19.  Click to enlarge in new window.Figs. 19, etc., may be introduced. We must distinguish between the process by which the ordinate Oy was obtained, and the merely graphic presentation of the quantities which each of the consumers, A, B, C, etc., will take out of the market. The height Oy was only obtained by a process which involved the securing by A of the precise amount Oa, and by B of the precise amount Ob. These amounts were determined by the form of the curves (a), (b), etc., and the device of adding them together indicates that a claim is met or is not met, without reference to whose claim it is, according as its position is high or low on the relative scale. The shares which A, B, etc., have respectively taken in determining the final result are registered on the curves (a), (b), etc., but though the results may be registered separately, the process could only be conducted in combination. We start with the marginal significance of the commodity to A at about 8½, to B at 36½, etc., and we learn from combining all the curves that if the total quantity of the commodity is Ox (d), the market will tend to bring the marginal significance to all the consumers to the magnitude Oy, and in proportion as its action is frictionless and effective will actually do so.


In the same way if we take any individual industry, the price is determined by the collective curve of demand and the quantity possessed. This corresponds to the ordinates of the points a, b, g in the curves of Fig. 19. It may be, like the ordinate of b, above, or like the ordinate of a, below the ideal equilibrating ordinate, but the curve itself enters, together with other curves, into the determination of that ideal ordinate; and the amount produced, that is to say, the amount of the productive resources which flows into this particular industry, tends to coincide with the abscissa corresponding to that ordinate.


If the amount of the product can be increased or diminished by the inflow or outflow of the productive resources of the community in relatively fluid forms, the approach to the equilibrating ordinate will be rapid. If the forms in which the factors of production can be added or withdrawn are such as require a long period of time to mature or to wear out (deep shafts, for instance, or extensive premises and elaborate machinery), the movement will be slow; but in any case the price will only be changed by a change in the amount produced. Except as it affects that, the ideal equilibrating ordinate can have no influence on the price. Thus, if we know the course of the curve in the neighbourhood of the actual point reached by the supply, and know what the supply is, we know the price. If we wish further to know whether the tendency will be in the direction of expanding or contracting the supply we must know what the cost of production in the existing state of the industry actually is. This cost of production is represented by the ideal equilibrating ordinate and is no other than the marginal value of other commodities, measured for convenience in the standard (gold); just as the equilibrating point to which A's desire for plums can be satisfied is determined by the place of plums on the relative scales of B, C, etc. If by any combination of factors (and there will probably be a number of different combinations realisable under different conditions, and equivalent to each other as measured by the standard) a unit of the commodity can be produced at a cost less than its present price in the market, the tendency will be for the supply to increase. If no such combinations will produce it except at a cost which exceeds its present price, the tendency will be for the supply to contract.


But as we advance from individual curves to the collective curves of great industries it comes out more and more clearly that all the elements of a commercial civilisation mutually determine each other; that any marked change in the conditions disturbs the whole structure, composition, and significance of our units; and that the diagrammatic method can only be regarded as precise, even ideally, when it refers to an industry or a portion of an industry that is too insignificant a fraction of the whole to cause serious disturbance in general relations. In other words, it is only in the neighbourhood of present margins that our standard units can be regarded as stable. In an individual curve we may fruitfully imagine ourselves, if due caution is exercised, as travelling far; but only on the supposition that the general margins are maintained. In great collective curves we must never think of ourselves as commanding, even conjecturally, more than a minute portion of the tracing, in the neighbourhood of the actual point of realisation.


We have been engaged throughout almost the whole of this chapter in the discussion of theories about increasing and diminishing returns, and our conclusions have been almost entirely negative. One important point, however, remains, as to which we may hope for more positive results. The habit of isolating "labour," and tacitly assuming sometimes that it is, and sometimes that it is not, proportionately backed by other factors, has caused us a great deal of trouble, but it is not difficult to explain. It is the reward of labour, in the general sense of output of human effort, about which we are ultimately concerned, and all the questions about increasing and diminishing returns derive their interest from attempts to estimate or to forecast the conditions under which humanity conducts or will conduct its attempt to secure the satisfaction of its desires from the resources and opportunities of nature. If the law of diminishing returns to labour is, or will ever become, dominant, these conditions will become less favourable, and the thought of this possibility has sometimes been a nightmare to the speculative thinker. I am not about to enter upon any investigation of the terrors that haunt many minds as to the ultimate limitation of the resources of the planet. Though it be true at the present moment that the whole of the inhabitants of the globe could stand shoulder to shoulder on the surface of the Isle of Wight, it is of course easy to shew that if the increase of the population proceeded uniformly at a moderate rate, a state of things would come about within a calculable and imaginatively not a very remote period at which there would be no room for them to stand shoulder to shoulder on the face of the dry land and on the floor of the ocean. For the matter of that, it would be equally easy to shew that within a calculable period the atmospheric envelope of the planet would not contain sufficient nitrogen to renew the tissues of the population, if all other obstacles to their increase were removed; and possibly the one speculation may be found as suitable food for melancholy as the other to one whose temperament promotes "going far to seek disquietude."


But apart from these speculations which are too remote to cause any rational anxiety if they stood alone, there is a reason why a perpetual suggestion of the possibility of decreasing returns to labour, as an instant possibility, should force itself upon our minds irrespective of any foundation that it may or may not have in reality; and if we can rob this dismal suggestion of the unfair advantage it derives from a wholly irrelevant group of phenomena we may perhaps have contributed in some modest degree to the gaiety of nations.


Let us then suppose that some individual industry illustrates the law of increasing returns in the sense that if an increasing volume of human effort were devoted to it, land, capital, and so forth, could be obtained on such terms that the marginal effectiveness of labour, measured by product in bulk, would increase. Now, taking Figure 38.  Click to enlarge in new window.Fig. 38 in which as usual we measure on the axis of X units of the product, and on the axis of Y their marginal exchange value, we are to suppose that if we double, treble, or quadruple the amount of labour devoted to this industry we shall in each case more than proportionately increase the material output. The divisions of the paper then represent the selected unit of the commodity, and the numerals, 1, 2, 3, 4, placed at increasing intervals, represent the successive additions to the product caused by the doubling, trebling, or quadrupling of the output of effort. The figure would then mean that whereas a given number of men, which we take as our unit, properly backed by capital and so forth, would produce an amount of the commodity represented by 10, double that number of men would produce not 20 but 25, three times the number not 30 but 45, and four times the number not 40 but 70. But we are dealing with the material product in bulk, not with its value, and as the amount of the product increases, its marginal significance per unit will decline. If the curve takes such a form as that indicated in the figure, we see that doubling the number of men will give a more than proportional increase not only to the amount of the output, but also to its value, for the declining height of the ordinates is more than compensated by the increased length of the basis from 1 to 2. But when we pass from doubling to trebling, and from trebling to quadrupling, the original number of men, the still increasing proportional bulk of the output is now more than compensated by its decreasing value. Thus, although the industry obeys the law of increasing returns as interpreted in the return to labour of the material product, the law of diminishing returns is illustrated in the return to labour as measured in command of other commodities. For the units on the axis of Y which represent the value of the product must be interpreted in terms of other commodities. Men will give less of them in return for a unit of the commodity under investigation, because they are now better supplied with it.


But suppose they were better supplied with other things also. Suppose that the gradual increase of the population, accompanied by a suitable increase of capital and applications of fresh land or fresh and improved applications of land, enabled all the other industries to increase in volume also; and suppose that all likewise obeyed the law of increasing returns of material product to labour. Every one, then, having not only more of the particular commodity we first took into consideration, but having in suitable proportion more of all other commodities as well, will give as much of these other commodities for a unit of the first as they did before, and every one, therefore, will have more of everything, including opportunities of leisure and every form of self-expression. This would be the ideal condition of a progressive community, in which every generation, partly because of progress in the arts, but partly also from the mere increase of population and the resultant economies in every industry, would find itself wealthier than the last, and able to secure the co-operation and alliance of nature on ever pleasanter and easier terms. But it would still remain true that in each individual industry the position of its members would be strengthened if the other industries absorbed a relatively larger amount of the new energies and resources, and weakened if it absorbed a relatively larger amount itself. Every one would be aware that however much the ordinates of his industry were being raised by general processes that made all other commodities more abundant, and therefore to be had on easier terms, they would be falling in virtue of his own advance along his own line.


Thus generalising from his own industry every one will argue that the law of decreasing returns is already in full swing, that the more persons there are engaged in producing things, and the more abundantly they produce them, the poorer every one will be.


Thus we have arrived at a more exact analysis of the phenomenon which we have already described as the microbe of the disease of civilisation,*46 the fact, namely, that every man is convinced (except in exceptional periods) that his own industry or profession is overstocked. However true it may be that an increase in the numbers engaged in every industry, accompanied by a suitable increase in tools and appliances, would secure a larger general command of resources, it remains true that in any industry, taken in isolation, the reverse must seem to be (and in a sense must really be) the truth. Hence it is to the interest of the existing members of every industry, taken severally, that every other industry should recruit its staff and increase its output, while they themselves retain the exclusive right of ministering to the increased demand for their own product thus created. They will then reap the full benefit of the raising of their own curve which the advance of other industries down their declining slopes secures, and will themselves escape the obligation of raising the curves of others by advancing on the down-slope of theirs. But it is obvious that if the advance were even in all industries the remuneration of each factor of productivity, measured in the sum of things in the circle of exchange of which it represented the command, would increase.

Notes for this chapter

Pages 533 sq., 539 sq.
Pages 361 sqq.
Cf. below, page 540.
Page 504.
Page 538.
Page 537.
Pages 345 sqq.

End of Notes

18 of 23

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