3. The Supply and Demand of Entrepreneurs. The Law of Costs

The entrepreneur purchases factors of production and sells their product to his buyers. Clearly, no entrepreneur will carry out production from which the revenue is less than the cost of purchasing the factors of production. This obvious fact only becomes worthy of closer consideration because a situation is at hand here which opens up a path towards understanding the problem of the employment of all factors of production. Thus, here in particular it will be necessary to begin by considering the most elementary cases in order to describe precisely the conditions that determine the role of the entrepreneur as demander of factors of production as well as supplier vis-à-vis demanding purchasers—whether these be consumers or buyers of intermediate products. We had the opportunity earlier to point out that the determination of demand and supply curves becomes an issue here.

The situation will be an extremely simple one if we imagine that the entrepreneur only requires one single (originary) factor of production in his production process. So as not to have to speak in completely abstract terms, we would like to present an example here with respect to which it might be noted that such a simplistic situation will only rarely occur today. Yet the range of possible examples is not too large, and one must be satisfied with being able to find a somewhat arbitrarily construed example if this can be used in our case without strong objections. We will thus assume that in a mid-sized town there are a number of entrepreneurs who are in the business of house-cleaning. They employ laborers and see to it that residences are cleaned by these workers.²² On the one hand, the entrepreneurs are faced with a demand for their services, but it is clear that if the prices for these services increase, the demand will decrease—the housewives will then either carry out the cleaning themselves or restrict their use of the service. On the other hand, the entrepreneurs are faced with a relatively limited supply of cleaning women which will clearly remain low if wages are too low, yet in a mid-sized town a significantly greater demand can only be satisfied with increased wages. It is easy to see that the entrepreneurs’ demand for laborers will be determined by the demand of “consumers” for the services offered by the entrepreneur. The entrepreneur will not be able to take on any job for which he does not receive at least his cost for labor wages; moreover he will strive for a profit for himself and will probably not take on work without expecting to achieve such a profit. However, the entrepreneur will also not be able to make an “excessive profit” under free competition because otherwise another entrepreneur could be cheaper and would be able to take away work from him. Every entrepreneur would have an interest in attaining a greater profit by expanding his operations. A uniform market price will arise for wages as well as for the entrepreneur’s services, and finally, so to say, also for the entrepreneurs’ profits. The “mechanism” of the law of cost in the free market can be seen clearly in our example:

A. If the price for an entrepreneur’s service is a loss price, then the entrepreneurs will:

1. cease to serve those least able to pay for their services and only satisfy those more able to pay by raising their prices; however, they will also

2. discharge part of their employees and lower wages such that only the “cheaper” laborers remain employed, thereby lowering costs.

Both tendencies—raising the price for the product as well as lowering cost—will complement each other. The movement will come to a standstill at the point at which the cost (including the entrepreneur’s profit) is equal to the price of the service offered by the entrepreneur.

B. If the price of the entrepreneur’s service is significantly above cost, then the entrepreneurs will:

1. see that by expanding their supply they will make additional profits, and the expansion of the supply will force the price down;

2. need more laborers and will only be able to attract them at higher wages.

Again, both of these tendencies—lowering the price of the product and raising the cost—will converge, and the movement will only come to a standstill when a situation is reached where costs (including the entrepreneur’s profits) are equal to the price of the service.

This convergence of two price magnitudes is not at all to be considered a “middle line.” It is clear that the movement—precisely as in the most simple case of a price formation on the free market—is a movement along two curves which must intersect. Hence, it is also obvious that it depends on the shape of the two curves, on their slope, whether the quantitative change will be a large one and whether the price of the entrepreneur’s service or the price of the cost-items will change dramatically. The entire process of adjustment to the law of costs means, however—and it is important to emphasize this again—nothing but a transformation of supply and demand curves. Let us consider the case in which losses have occurred. Here there is an equilibrium on the market in which the labor services are demanded as well as on the market in which the entrepreneurs’ services are offered. The entrepreneurs have demonstrated a certain demand for labor, and this has been satisfied according to the given supply of labor. Simultaneously, the entrepreneurs have brought a supply of their services onto the market and this has been accepted by those demanding the service who are most able to pay. The law of costs has not yet come into effect, but on both markets in which prices have formed, this has occurred according to the general law of price formation. According to the law of costs, however, the relationship between these two prices was not correct, and this circumstance forces the entrepreneurs to change their position as demanders of labor as well as suppliers of services. The entrepreneurs must revise their position as suppliers and demanders. Under the influence of losses they must recognize that at the wages paid until now, they can no longer employ as many laborers as before. Their demand has changed, and at the prevailing prices they can no longer offer so many services; hence, their supply has changed.

The function of entrepreneurs under the effectiveness of the law of costs and free competition has been made clear: They obtain the supply of factors of production and compare it to the demand of consumers, or—which is essentially the same thing—they obtain the demand of the consumers and compare it to the supply of factors of production. Whether the entrepreneurs appear as suppliers or as demanders, they must adjust the structuring of their supply and demand to constraints arising from the fact that they only function as middlemen.

It was our task here to present the relationship dealt with by the law of costs in their simplest form. One must not forget these relationships if one proceeds to consider reality in its more complex forms.