Chapter 8 of 26 · Capitalism: A Treatise on Economics by George Reisman
Chapter 5. The Dependence of the Division of Labor on Capitalism I
CHAPTER 5
THE DEPENDENCE OF THE DIVISION
OF LABOR ON CAPITALISM I
PART A
THE NATURE OF THE
DEPENDENCIES
C hapter 4 explained how the division of labor is essential to the existence of a high and rising productivity of labor. This and the next three chapters demonstrate the dependence of the division of labor on the fundamental economic institutions of a capitalist society. These institutions, of course, are private ownership of the means of production, saving and capital accumulation, exchange and money, economic competition, economic inequality, and the profit motive and the price system. By the end of Chapter 8, the dependence of the division of labor on the institutions of capitalism will have been established so thoroughly that the proposition will appear unexceptionable that in the long run the division of labor itself is an institution of capitalism.
1. Dependence of the Division of Labor on Private Ownership of the Means of Production
Private ownership of the means of production is the most fundamental of the institutions of capitalism, along with freedom and the pursuit of material self-interest. It underlies a division-of-labor society in a direct way and in a variety of indirect ways.
The direct dependence of the division of labor on private ownership of the means of production is based on the very nature of the gains provided by the division of labor. These gains, above all the multiplication of knowledge and the benefit from the existence of geniuses, fundamentally derive from the fact that individuals possess separate, independent minds, which permit, indeed, require them to have separate independent knowledge and to make separate, independent judgments and decisions. In a division-of-labor society, each person benefits from the fact that other people possess knowledge which he does not, and an intelligence separate from and often greater than his own. His benefit requires that others be able to acquire and apply their knowledge on their own initiative, without having to await his orders, approval, or permission, which, in the nature of the case, he would be unable to give in any rational way, since he necessarily lacks the knowledge that would be required to do so.
Now, in order for people to act and produce on any significant scale, they must possess material means of action and production: they must possess wealth. In order for them to act and produce separately and independently from one another, they must hold wealth separately and independently from one another—that is, there must be private property, including private ownership of the means of production. 1
In essence, private property and private ownership of the means of production are fundamental and essential to a division-of-labor society because the separate, independent thinking and acting of individuals is fundamental and essential to it, and because they are the material
requirement of such separate, independent thinking and acting. 2
Socialism and Collectivism Versus
Economic Planning
Just as capitalism—private ownership of the means of production—is indispensable to the existence of a division-of-labor society, so, by the same token, socialism and collectivism are incompatible with the existence of a division-of-labor society. 3 The truth of these propositions is confirmed by the collapse of socialism in Eastern Europe and—how wonderful the words sound—the former Soviet Union. Despite extensive Western aid, economic conditions in the Communist bloc were so bad for so long that finally all hope of improvement under socialism has been abandoned and attempts are now underway to institute private ownership of the means of production and establish a price system.
The incompatibility of socialism and collectivism with a division-of-labor society would long since have been blatant if the capitalist countries had not continuously rescued the Soviet Union and its allies from famine, with massive supplies of grain sent for free or on government-guaranteed credit that was never intended to be repaid. Even the grain purchases made by the Soviet Union and its allies ultimately depended on the aid of Western governments, which guaranteed investments made in the development of natural resources and in the construction of factories in the Soviet Union and other Communist-bloc countries. These investments, particularly those in the development of natural resources, in which the quality of the product does not enter as a decisive factor, were the foundation of most of the exports of the Soviet Union and the Communist bloc and thus of their ability to obtain funds with which to make purchases from abroad. In the absence of such Western aid, a series of famines—the necessary consequence of the massive inefficiencies of socialism—would have led to a flight from the cities and resettlement of practically the whole of the surviving population of the Communist countries on farms, in an effort of people to secure a food supply. This would have meant the end of all significant division of labor in those countries and their reversion to the economic conditions of feudalism.
It should be realized that collectivism openly demands that everyone think and act as a unit. It leaves no room for the vast differentiation and individuation of knowledge on which a division-of-labor society rests. The propaganda of socialism fully displays this absurdity when it pretends that under socialism all economic decisions will be arrived at democratically. In order for people intelligently to vote on all economic decisions, everyone would have to have all the necessary knowledge pertaining to all economic decisions, which is clearly impossible in a division-of-labor society. It would mean, for example, that the voters would have to decide such questions as whether a new steel mill should be built in Gary, Indiana, or somewhere else, what kind of steel mill it should be, how large it should be, and so on. In the face of hundreds or thousands of such questions arising every day, the voters would have to devote their lives to nothing else, and still they would be almost entirely ignorant about the matters raised in each case.
Socialism is not rescued from its incompatibility with a division-of-labor society by substituting the dictatorship of an alleged expert or body of experts for the democracy of the ignorant masses. For now, instead of demanding that everyone know everything about production, it demands that one person or several people— the Supreme Dictator or the members of the Central Planning Board—know everything about production. The very expression “central planning” describes the essence of this absurdity. It means that one consciousness must be able to see and plan the entire economic system, either alone or in consultation with one or more other such all-seeing consciousnesses. For central planning means the planning of the entire economic system as an indivisible whole.
Socialism is incompatible with a division-of-labor society because in all of its versions it is incompatible with a division of the intellectual labor required in the planning of the conduct of the economic system. When it attempts such an intellectual division of labor, as it necessarily must, the result is contradictory partial planning. This is a state of affairs in which separate ministries, industries, regions, and even individual factories and farms plan in discoordination and at cross purposes. In a word, it is economic chaos. 4 As a result of this chaos, the whole division of labor disintegrates—or would in the absence of aid from capitalist countries. For people are subjected to a chronic inability to obtain vital supplies from others and thus must attempt to produce them themselves.
The lack of vital supplies includes all manner of things. There are not only shortages of food, but also shortages of such things as lubricants, electric power, and raw materials and component parts of all kinds, and, of course, labor and all kinds of consumers’ goods. 5 It is in response to such conditions that Soviet factories found it necessary to attempt to manufacture even their own screws and nails. Thus, for example, without any awareness of the fact that the conditions he described were hostile to the division of labor, an admirer of the Soviet system wrote:
There is considerable evidence that Russian plants do
for themselves many things—like producing screws with
slow-speed machinery—which could be better done by others—in this case, specialized screw manufacturers using high speed equipment. But this desire to be independent of others, in part at least, grows out of the Soviet effort to operate its plant capacity at a pace rarely achieved under capitalism except in wartime. In fact, the sort of barter deals just discussed are not too different from those which take place in a capitalist economy under the impact of wartime shortages. 6
In describing such conditions, another observer wrote:
For a Soviet factory—or a Soviet research institute—the best response to unreliable business partners is self-sufficiency. When the planners decided to build the giant Fiat factory, they decided to make it almost entirely self-sufficient. Except for electrical equipment, window glass and tires, every part used in Zhiguli—every nut, bolt, seat cover and piston ring—is made in the factory itself. Gersh Bud— ker’s Institute of Nuclear Physics in Novosibirsk couldn’t buy the instruments it needed, so the scientists there began to make their own. This kind of self-reliance is expensive and inefficient. Yet no amount of planning can provide the trust and reliability that could substitute for it. 7
The fact is that such results are inescapable under socalled central planning. They can be avoided only by means of capitalism and its price system.
Happily, at long last, it appears that after more than seventy years of abject failure, the concept of central planning is now being abandoned in the former Soviet Union. The process of abandonment of the concept appears to be well underway even in Communist China. Hopefully, within the next few years, these and all other socialist countries will have made the transition to private ownership of the means of production and capitalism.
Capitalist Planning and the Price System
Division of labor in the planning process is possible only under capitalism. This is because of the existence of the price system, which is unique to capitalism. Under capitalism each individual plans his own particular sphere of economic activity. But he plans on the basis of a consideration of prices—the prices he will receive as a seller and must pay as a buyer.
The consideration of prices is what integrates and harmonizes the plans of each individual with the plans of all other individuals and produces a fully and rationally planned economic system under capitalism. For example, a student changes his career plan from actor to accountant when he contemplates the vast difference in income he can expect to earn. A prospective home buyer changes his plan concerning which neighborhood to live in when he compares house prices in the different neighborhoods. And businesses change their plans concerning product lines, methods and locations of production, and every other aspect of their activities, in response to profit-and-loss calculations.
All of these changes represent the adjustment of the plans of particular individuals and businesses to the plans of others in the economic system. For it is the plans of others to purchase accounting services rather than acting services that cause the higher income our student can expect to earn as an accountant rather than as an actor. It is the plans of others willing and able to pay more to live in certain neighborhoods, and less to live in certain others, that determine the relative house prices confronting our home buyer. It is the plans of its prospective customers, of all competing sellers of its goods, and of all other buyers of the means of production it uses or otherwise depends on, that enter into the formation of the prices determining the revenues and costs of any business firm and thus what it finds profitable or unprofitable to produce.
Now the fact that capitalism even has economic planning, let alone the only possible kind of rational economic planning, is almost completely unknown. Practically everyone under capitalism has been in the position of Molière’s M. Jourdan, who spoke prose all his life without ever knowing it. The overwhelming majority of people have not realized that all the thinking and planning about their economic activities that they perform in their capacity as individuals actually is economic planning. 8 By the same token, the term “planning” has been reserved for the feeble efforts of a comparative handful of government officials, who, having prohibited the planning of everyone else, presume to substitute their knowledge and intelligence for the knowledge and intelligence of tens of millions, and to call that planning. This is an incredible state of affairs, one which implies the most enormous ignorance on the part of the great majority of today’s intellectuals, from journalists to professors.
The dependence of the division of labor on the price system points the way to its indirect dependence on the institution of private ownership of the means of production. The price system rests on the profit motive and the freedom of competition. Operating in conjunction with one another, these are the elements that drive and regulate the price system—that determine the formation of all individual prices and their integration into a system. The profit motive and the freedom of competition, in turn, vitally depend on the institution of private ownership of the means of production.
It is necessary to explain here the nature of both of these sets of dependencies: that of the price system on the profit motive and the freedom of competition and, in turn, that of the profit motive and the freedom of competition on private ownership of the means of production.
The profit motive—financial self-interest—makes every—
138 CAPITALISM one be concerned with the revenue or income he earns and the costs or expenses he incurs. As stated, precisely this is what harmonizes and integrates the economic plans and the economic activities of all the separate businesses and individuals who make up a division-of-labor society. While the principles describing just how this occurs are the subject matter of price theory and are explained at length in the next three chapters of this book, this much can be stated now, as a brief, advance indication: Namely, the profit motive provides powerful incentives for the steady expansion and improvement of production and, at the same time, operates to keep the relative size of all the various industries and occupations in proper balance. It makes production accord with the will of the ultimate buyers—the consumers—and ensures that the production of each individual good takes place in a way that is maximally conducive to production in the rest of the economic system. The profit motive is what balances the demand and supply of each product and ensures the most rational and efficient distribution of each product over space and time—among all the markets that compete for it—and its delivery into the hands of those individuals who, within the limits of their wealth and income, need or desire it the most. The profit motive ensures the most rational and efficient allocation of capital and of every type of labor and material among its possible alternative uses, and makes the economic system respond to changes in economic conditions in the most rational and efficient manner possible.
Thus, the profit motive is what prevents any sort of “anarchy of production” and, instead, creates economic order and harmony out of the activities of all the different individuals who comprise the economic system. It is what enables capitalism to be an economic system that is rationally and cohesively planned by each and every individual who participates in it.
If the profit motive is the engine which drives the price system, competition and the freedom of competition are the built-in regulator which provide the essential context in which that engine operates. What this means is that in seeking to serve his financial self-interest, every seller under capitalism must be aware that there are other sellers or potential sellers who might sell to his customers and thus that he must accordingly limit the prices he asks. By the same token, every buyer under capitalism must be aware that there are other buyers or potential buyers who might buy from his suppliers and thus that he must set the prices he offers accordingly.
Now while the profit motive and the freedom of competition are the elements that drive and regulate the price system, as stated, they themselves in turn rest on the foundation of private ownership of the means of production.
Private ownership of the means of production is what makes the profit motive operative in the formation of prices, the prices both of means of production and of products. Furthermore, private ownership of the means of production underlies the very existence of the incentives of profit and loss, in that it is private property, above all in the form of private ownership of the means of production, that is the substance of what is gained or lost by producers. Without the ability to accumulate holdings of private property, there would be nothing for producers to gain except the ability to enlarge their immediate consumption, and nothing at all for them to lose, because losses can be losses only of preexisting property. With private ownership of the means of production there is not only the incentive of profit and loss to use the means of production profitably but also the vitally important fact that an individual’s control over the means of production is increased or decreased to the extent that he uses them profitably or unprofitably.
This last results from the fact that those owners who use the means of production profitably are in a position to save and reinvest, in proportion to the extent of their profits. To the extent that their sales proceeds exceed their costs, they obtain the funds not only to replace the means of production with which they began but to more than replace. They are thus enabled to enlarge their control over the means of production. By the same token, those owners of the means of production who suffer losses correspondingly lose control over the means of production. Their losses mean that their sales proceeds are less than their initial outlays and thus that they lack the funds to replace the means of production with which they began.
Thus private ownership of the means of production is what gives the profit motive virtually all of its economic influence: it enables the profit motive both to be operative in the formation of the prices of means of production and products and to direct the use of the means of production. At the same time, it enables success or failure in earning profits to determine the extent of one’s control over means of production in the future. And, of course, it is what gives the profit motive its strength.
As to economic competition: private ownership of the means of production underlies economic competition, in that economic competition presupposes separate, independent producers, who, in order to be separate and independent, must hold the wealth they use in production separately and independently from one another. Thus competition among producers presupposes private ownership of the means of production. Furthermore, the freedom of competition, like virtually all other freedoms, is an aspect of property rights: it is the freedom of owners of means of production to employ their means of produc—
tion in any branch of industry they choose. 9
In addition to its dependence on the profit motive and freedom of competition, the price system, of course, also depends on the institutions of exchange and money. Prices are sums of money exchanged for units of goods or services. The very phenomenon of exchange presupposes the separate ownership of the things exchanged. Exchange is a mutual transfer of property between two parties, with the property of each being given as the condition of receiving the property of the other. A collectivist monopoly on production, which is the essence of socialism, is incompatible with the means of production being exchanged or, therefore, having prices. Capital goods cannot be bought or sold because all capital goods are owned by the same party: the state. At the same time, the leading purpose of socialism is supposed to be the removal of labor from the status of a commodity that is bought and sold in the market; and, indeed, labor cannot be bought and sold under socialism except on the terms arbitrarily dictated by a universal monopoly employer: the state. Thus, private ownership of the means of production is essential for the existence of markets and of market prices of the means of production. 10 It is essential both for the very existence of a market in capital goods and thus for prices of capital goods, and for the existence of employer competition in the market for labor and thus for wage rates greater than the barest minimum of subsistence.
Closely related to the above, the price system further depends on the institution of saving and capital accumulation, in that the prices of the means of production are not paid by the consumers, who purchase only the ultimate final products, but by businessmen. All the materials and supplies, all the tools, equipment, and labor services used in production are purchased and paid for by businessmen, almost entirely out of accumulated capital, not by the ultimate consumers out of consumption spending. 11 The prices of all the means of production, therefore, depend on saving and capital accumulation. And, as indicated previously, saving and capital accumulation vitally depend on the institution of private ownership of the means of production and its security. In order for people to save and accumulate capital, to improve the productive property at their disposal in any way, or even just to maintain it, they must have the expectation of benefitting from such action. They can rationally have that expectation only if that wealth—those means of production—are securely their private property.
Thus, through each of these four roots—the profit motive, competition, exchange and money, and saving and capital accumulation—the price system is grounded in the institution of private ownership of the means of production.
Further dependencies of a division-of-labor society on the institutions of saving and capital accumulation, exchange and money, economic competition, and also economic inequality—all of them leading features of capitalism—can now be explored.
2. The Dependence of the Division of Labor on Saving and Capital Accumulation
Even before the development of money and monetary exchange, saving and capital accumulation are vital to the development of the division of labor. They are necessary to release people’s labor from the immediate production of food, so that they can turn to the production of other things, including tools for producing food. In the absence of any saving and capital accumulation whatever, everyone’s labor would have to be devoted almost exclusively to securing his next meal. With saving and capital accumulation, even if only in the form of stores of food, people can turn their attention to the production of other things. For example, primitive hunters or fishermen who have accumulated stocks of food can live off them while they set about constructing huts and also better means of hunting and fishing, such as bows and arrows and boats and nets.
The ability to carry on the production of things other than immediate food supplies is an obvious precondition of the development of the division of labor, in that without it there would be the production of essentially just one thing, in which virtually everyone would be engaged, namely, food for the next meal. Probably there would be some division of labor even at that level—for example, some members of a tribe might concentrate on chasing animals, while others concentrated on the actual killing of them. But a precondition of people specializing in the production of distinctly different products is the ability to carry on the production of such products, and here saving and capital accumulation are necessary in the case of every product whose production entails the lapse of more time than transpires between two meals. They are necessary insofar as people must have that second meal (or whatever else they normally consume) before their labor results in the consumers’ goods they help to produce. Their ability to consume before their product is produced is possible only to the extent that savings exist.
As indicated, the accumulation of capital is also vital in raising the productivity of the labor of food producers, so that not everyone’s labor is required in the production of food. It is only to the degree that fewer people are required to produce the food needed by all, that more people can devote their labor to things other than food, and thus the division of labor develop. The relationship between the productivity of labor in food production and
140 CAPITALISM the division of labor is reciprocal. To the degree that the productivity of labor in food production rises, more people can be spared for other branches of production. The effect of the expansion of these other branches in turn is a higher productivity of labor in food production, because food producers are thereby enabled to work with the aid of more and better products of other branches of production—for example, farmers can work with the aid of more of the products of manufacturing.
Saving and capital accumulation, of course, are no less vital in the context of a monetary economy, as has already been shown. Closely connected with the fact that they are the source of the demand for factors of production is the fact that their existence is what enables producers to be paid within a reasonable period of time after the completion of their work. In the absence of savings and capital in terms of money, any significant division of labor would be impossible, because it would then be necessary for many producers to wait years, decades, generations, or even centuries before being paid.
Consider the case of automobile workers today. At present, like most other workers, they are paid after the completion of a week’s work. Yet far more than a week goes by between the performance of the auto workers’ labor and the time the auto companies are paid for the cars those workers help to produce. What makes this possible is the fact that the auto companies possess capital. They pay the wages of their workers week after week out of capital, and only months later do they recover the outlays of any given week in sales revenues.
Indeed, even most of the sales revenues of the auto companies are paid out of savings and capital. Most new-car buyers buy on installment credit. Under this arrangement a bank or some other financial institution advances them the funds to buy their car, and they then pay off over a period of two to four years. In the absence of this capital and the capital of the auto companies, auto workers would have to wait in excess of two to four years before being fully paid for their work. And the same would be true of all the suppliers of the auto companies, such as the steel and tire companies, and the like. They would all have to wait to receive the installment payments from the car buyers.
In the absence of capital in the hands of steel and tire producers as well as auto producers and companies financing automobile purchases, the period for which companies and workers would have to wait to be paid would be increased still further. The workers employed by the steel and tire companies, and the suppliers of the steel and tire companies, such as iron mining concerns and rubber plantations, would all have to wait the full period of time waited by the auto workers plus the period of time that presently elapses between the payments by the steel and tire companies and the receipt of sales revenues by these companies. The consequence of a still further lack of capital, this time by the iron mining concerns and rubber plantations, would, of course, be to make the plight of the employees and suppliers of these concerns even worse. And so it would be with every further stage of remove from the production of automobiles.
The full magnitude of the time factor in production becomes clear if we begin to look at the equipment and buildings used by an industry. For example, the auto industry’s equipment probably lasts on the order of a generation; its factory buildings, on the order of two or three generations. If the auto industry did not possess capital funds to pay for that equipment and those buildings, the suppliers of the equipment and the construction contractors involved would have to wait to be paid out of the sales revenues earned by the auto companies over a period of from one to three generations.
In the absence of capital in the hands of the equipment makers and construction contractors as well, it would be their employees and suppliers who would have to wait this period of time to be paid. These workers and suppliers would also have to wait the additional time that transpires within these industries in the making of the equipment and the construction of the buildings. Indeed, those involved in the production of such things as construction equipment and in the building of factories for producing machinery and construction equipment would be confronted with periods of waiting time that extended beyond their life spans and their children’s life spans. This would be the case, for example, where the steel girders used to erect an auto plant that will last fifty years come from a steel mill that is itself fifty years old and was constructed with materials produced in a previous plant that at that time was fifty years old. Here a time span of a hundred and fifty years is involved between the performance of labor and the payment by an ultimate consumer. 12
In the absence of capital in the hands of business enterprises, there would simply be no way for heavily time-consuming processes of production to exist. Even substantial savings in the hands of workers would not be sufficient. We might imagine a few workers with enough savings to enable them to work for a few years before they were paid, but we certainly cannot imagine an economic system in which there are workers willing to work and not be paid in their lifetimes, indeed, in which payment would not occur even in the lifetimes of their children or grandchildren.
In order for the division of labor to exist in an extensive temporal succession, in which groups of workers produce tools or materials taken up by other, succeeding groups, in processes extending over long periods of time,
it is absolutely essential that there be capital funds, so that each group can be paid within a reasonable time after completing its work. The existence of capital funds introduces a necessary division of payments, so to speak, that corresponds to the temporal division of labor.
In the absence of capital funds, there is only one source of payment—the ultimate, final consumers, whose outlays lie months, years, generations, even centuries in the future. With the existence of capital funds, there is immediate payment, however far in the future the expenditures of the ultimate, final consumers may lie. Only because of the existence of capital funds can the division of labor exist in an extensive temporal succession.
And, as will be shown later in this book, the greater is the accumulation of capital funds relative to consumer spending, the greater is the employment of labor serving the achievement of temporally remoter ends. This means, the greater is the accumulation of capital funds relative to consumer spending, the more does labor in the present serve consumption in the future, and the more is consumption in the present served by labor performed in the past. As will be shown, the effect of labor being able to be employed for temporally more remote ends is to accelerate the rise in its productivity. 13
The existence of division of labor in the form of a temporal succession of producers can be termed the vertical aspect of the division of labor. It is important to realize that saving and the provision of capital it makes possible also vitally contribute to the division of labor in what may be termed its horizontal aspect—that is, the extent to which it can be carried at any given stage of production. The extent to which the division of labor can be carried at any given stage of production depends on the scale on which production is carried on at that stage. For example, if automobiles are produced on a scale of only one or two a day in a given establishment, there is obviously room for far less division of labor than if they are produced on a scale of hundreds or thousands a day in a given establishment. In the former case, it is impossible to make a full-time job, or anything approaching a full-time job, of any individual operation that requires only a small amount of labor per unit of output. But in the latter case, it becomes possible to make full-time jobs of individual operations requiring quite small amounts of labor per unit of output. 14
What is important to realize here is that in order for production to be carried on, on the larger scale, more capital is required. To be able to produce automobiles on a scale of hundreds or thousands per day rather than one or two per day, vastly more capital is required. In this way, more capital becomes the precondition for the extension of the division of labor in its horizontal, as well as vertical, aspect. 15
Thus, saving and capital accumulation lay the groundwork for the division of labor in four ways. They make possible the production of goods other than the food required for the next meal. They raise the productivity of labor in food production, so that people can be spared for other branches of production, which makes possible further increases in the productivity of labor in food production. They make possible a division of payments, so that the time which elapses between the performance of labor and the receipt of payment by the producers is relatively short, no matter how long is the time which must elapse between the performance of labor and payment by the ultimate, final consumers. Finally, they provide the foundation for larger-scale production and thus the basis for carrying the division of labor further at any given stage of production.
3. The Dependence of the Division of Labor on Exchange and Money
The division of labor presupposes the ability to make exchanges, and the existence of an extensive division of labor presupposes the existence specifically of money and monetary exchange. The necessity of exchange and money is implied by the fact that in a division-of-labor society each person produces or helps to produce just one or at most a very few things, and is dependent for his consumption on the goods and services produced by a vast number of others. In these circumstances, some mechanism must exist whereby the products of each can be channelled to others and the products of others channelled to each. Exchange is that mechanism. A division-of-labor society requires exchange on a massive scale, as a constant, major feature of economic life. In a division-of-labor society, all or practically all of everyone’s production must leave him through the process of exchange, and all or practically all of everyone’s consumption must come to him through the process of exchange.
But a special kind of exchange is required to make this possible. The direct, barter exchange of goods for goods is not sufficient. In order for exchange to take place under such conditions, a socalled double coincidence of wants must exist—that is, each of the two parties must possess what the other desires and desire more what the other possesses. This condition very often, indeed, usually, cannot be realized. For example, a producer of ball bearings, steel girders, or sulfuric acid desires food possessed by grocers or farmers. Yet few or no grocers or farmers desire ball bearings, steel girders, or sulfuric acid. If exchange were confined to barter, producers of such goods could not live by producing them, and so people would not produce them. The economic system would thus have to get along without such vital goods.
Indeed, hardly anyone could live by producing the goods or services he now produces, because hardly anyone produces things that are consumed to any significant extent by those who supply him. (The reader should consider to what extent the goods or services he produces or helps to produce are consumed by those who regularly supply him.)
And even where people might be engaged in producing things that would be desired by their suppliers, it would still be impossible to effect many valuable exchanges. For example, the producers of television sets, or the builders of houses, desire bread and shoes; and the producers of bread and shoes desire television sets and houses. Putting aside such obvious problems as the particular houses probably being in the wrong location for the bread and shoe producers, there is the very serious problem of how could the producers of bread and shoes make change for the producers of television sets and houses when the latter wished to purchase a loaf of bread or pair of shoes? Would they require them to accept hundreds or thousands of loaves of bread or pairs of shoes? Also, how could the producers of the television sets or houses pay their employees? With a fraction of a television set per hour? With a piece of a house per week? With the change they received in the form of loaves of bread or pairs of shoes? 16
It might be thought that a series of indirect exchanges could provide a solution—that if the goods for which a product was exchanged were not of the kind desired by those from whom one wanted goods oneself, then one could reexchange these goods for goods that were in fact desired by those from whom one wanted goods oneself. But this could not actually provide a solution. A producer of ball bearings or sulfuric acid would probably acquire quantities of goods that ball bearings or sulfuric acid helped to produce. (A producer of steel girders, however, would immediately confront a problem of indivisibilities, in that he could not acquire a fraction of a building or bridge.)
Putting the problem of indivisibilities aside, it would be necessary to engage in an enormous series of exchanges, spanning who knows what distances and time intervals, if one were to assemble the various goods that even just a few of the producers desired from whom one wished to obtain goods oneself. To obtain the things he now does, the producer of ball bearings, for example, would have to reexchange the products he received for his ball bearings for the collections of goods desired by all the various suppliers of the consumers’ goods he now obtains, from his grocer and landlord to his physician and travel agent. He would also have to reexchange them for the collections of goods desired by all the various suppliers of the means of production he uses in producing ball bearings, namely, all his suppliers of materials, equipment, fuel, and labor services. The same would be true of the producers of virtually all goods, whose output now goes to people other than those from whom they receive goods and who are supplied by people other than those whom they supply. The problem here is that the costs of indirect exchanges, in terms of the time and effort that would have to be spent in effectuating them, would be too great to make the system practicable.
Thus, an economic system operating under the constraints of barter exchange would obviously offer only very limited opportunities for division of labor and would thus be extremely primitive. In essence, to live in such an economic system, one would either have to be a farmer or produce the kinds of things that could be readily exchanged with farmers, such as blacksmithing services.
What is required for the existence of a division-of-labor society is the existence of money and monetary exchange. Money is a good readily acceptable in exchange by everyone in a given geographical area, and is sought for the purpose of being reexchanged. 17 Of course, one of the properties of money, which helps to make it universally acceptable, is its divisibility into small units.
With money, those for whom the individual produces and those by whom he is supplied can be, and almost always are, different and distinct parties. With money, a process of indirect exchange takes place about which no one need be concerned—it takes place virtually automatically and without cost. Each produces for others, though not the others by whom he is supplied. The individual produces for anyone who has money to offer, and then uses the money to buy from anyone who has the goods he wants. With the existence of money, the producers of ball bearings, steel girders, and so on sell them for money to whoever wants them and has money to offer for them, and then they turn around and spend the money in buying food or whatever else they may wish, from whomever they choose. Everyone works in his particular specialization, is paid money, and buys from all manner of people who do not at all consume the goods or services that he himself produces.
With money, the producers of television sets and the builders of houses can easily obtain items as small as a loaf of bread or pair of shoes, because they sell their products for sums of money, which in turn are divisible into parts as small as the price of a loaf of bread or a pair of shoes. The employees of these producers are likewise easily paid out of capital funds.
In these ways, money radically enlarges the opportunities for specialization. It makes specialization possible not merely in a comparative handful of cases, but universally.
Closely related to the previous discussion of the price
system, the use of money also solves another problem that would otherwise be insoluble and prevent the existence of a division-of-labor society. Namely, it makes it possible to perform economic calculations and thus economic comparisons. Without the use of money, a productive process would show only a variety of physical means of production at the beginning and some physical product at the end. For example, it would show at the beginning quantities of building materials, equipment, and goods exchanged for labor services, and at the end a finished building.
In such circumstances, it would be impossible to determine if the product represented a gain or a loss of wealth, because one would be comparing quantities of different kinds, with no common denominator in terms of which to add them or subtract them. 18 One could not even answer such usually simple questions as which represents the higher wage or price? This is because, without the use of money, these questions would have to be posed in such forms as, which is more, a dozen eggs plus a loaf of bread plus a pair of shoes or two shirts plus a blender? But with the use of money, producers are able to compare the money value of their outputs with the money value of their inputs. They can also compare the costs of using different methods of production, the profitability of the different branches of production, and the remuneration of the various occupations. All of this is vital if production in the various branches of the division-of-labor system is to be properly coordinated and not collapse into chaos.
Guidance by monetary calculations and comparisons, in contrast, provides an objectively valid standard for economic behavior. 19 This is because following this standard enables the individual actually to increase the wealth at his disposal. For example, if the purchasing power of money has not significantly declined in the interval, selling a building or any other product for a larger sum of money than the sum of money one has previously expended to produce it, means that one really does increase one’s command over goods and services, for one now has the means of buying a larger quantity of them than before. Similarly, using a lower-cost method of production in place of a higher-cost method, buying anything at a lower price rather than a higher price, and earning a higher profit or wage rather than a lower profit or wage—all of these things in fact serve to increase the quantity of goods and services one can obtain in the market.
Thus, the existence of money is vital to the existence of a division-of-labor society, in that it makes possible economic calculations and thus economic comparisons serving as an objectively valid standard of economic behavior, as well as radically widens the possibilities for specialization.
On the basis of what has been shown concerning the importance of money, it should be obvious what ignorance and injustice underlie the utterance that money is “the root of all evil.” It would be far more correct and reasonable to argue that money is the root of all good. It is an essential root of the division of labor and of all the benefits to human life that flow from the division of labor. 20 The destruction of money would mean nothing less than the destruction of the division of labor and thus of modern material civilization. It would mean radical depopulation and utter impoverishment for whoever remained alive. 21
The notion that money is the root of all evil finds expression in the alleged moral ideal propounded by the Communists of “from each according to his ability to each according to his need” and in the accompanying resentments against the necessity of earning money and against the great prominence accorded to the earning and spending of money in a capitalist society. 22
Those who hold the antimoney mentality, and who yearn for goods simply to be “free” for the taking, have apparently not stopped to consider what the alternatives to money are. The alternatives can only be either the absurdly cumbersome procedures of barter, which would make the acquisition of goods far more difficult or altogether impossible, or, worse, having to go naked into the forest to hunt and gather what little nature offers to human beings without any mechanisms of exchange at all—namely, a handful of nuts and berries (if others have not appropriated them first), or else the establishment of a totalitarian socialist dictatorship that is economically chaotic.
In a capitalist society on the other hand, by the relatively simple process of earning and spending money, the individual integrates his activities into a division of labor that has come to embrace the entire world and that stretches back in time to the point when man first began to employ previously produced goods in all of his productive activities. Thus, by earning money an individual is able to buy products that represent the application of the intelligence and knowledge of enormous numbers of other human beings both living and dead. He is thereby enabled to obtain goods in a way that is incomparably easier and more rewarding than any conceivable alternative.
Ironically, the earning of money could be substantially easier and less worrisome for many people than it now is, if only the enemies of capitalism had not in their ignorance succeeded in making it unnecessarily difficult. They have made it more difficult by such means as the imposition of minimum-wage laws and prounion legis—
lation. In raising wage rates above the freemarket level, such measures have the effect of reducing the quantity of labor demanded below the supply available and thus of preventing people seeking to earn money from becoming employed and thereby earning it. In the absence of such measures, not only would employment and thus the earning of money be readily possible for everyone, but also costs of production and prices would be correspondingly lower. This last would mean that the buying power of the money earned more easily as the result of lower wage rates would be increased. Thus, the lower wage rates needed to secure full employment and the consequent ease of earning money would not imply any corresponding reduction in the goods a worker could obtain by virtue of his labor. Indeed, the goods the average worker could obtain would almost certainly be greater, precisely because of everyone who wanted to work being able to work and thus not having to be supported by others. Moreover, the productivity of labor would certainly rise more rapidly in the absence of government-supported labor-union efforts to sabotage it, such as preventing or delaying the introduction of labor-saving machinery. As a result, not only would the earning of money be substantially easier and less worrisome, but it would also be substantially more rewarding in terms of the goods it brought. 23
4. The Dependence of the Division of Labor on Economic Competition
As explained in Chapter 4, a major source of the gains from the division of labor is that the production of everything tends to be carried on by those who are able to do it best. Economic competition is the process of establishing who is able to produce things best.
The significance of economic competition for the division of labor is actually even wider than this statement may suggest. It is the process that establishes not only which individuals are best suited in the eyes of the market for all the various occupations, from wealthy businessman on down to janitor, but also which products are best suited for any given market, and which technological methods are best suited for the production of any given product. (This last embraces, for example, such choices as machine versus handicraft production, larger-scale production versus smaller-scale production, using copper versus using aluminum as a material, or coal versus oil as a fuel, producing in one geographical location rather than in another, and so forth.) Thus, economic competition is the process of determining the organization of a division-of-labor society with respect to the choice of products for markets and the technological methods of producing any given product, as well as of persons for occupations.
Economic competition is necessary because the most efficient form of organization of a division-of-labor society is not automatically known. Also, it is subject to constant change, as new products and methods of production are discovered and old ones must be abandoned, as individuals’ personal knowledge and preferences change, as capital is accumulated or decumulated, as the size and composition of the population changes, as new mineral deposits are found or old ones exhausted, and as soil and climate conditions change. In a free market, those who have differing opinions about which product is best suited for given customers, which method is most appropriate for producing a given product, or who is best qualified for a given job, come forward and submit their goods, their investments, and their talents to the judgment of the markets in which they seek to operate, and succeed or fail according to the judgment of those markets. (The judgment of a market, of course, is never final, in that individuals are always free to make further appeals to it, and again and again succeed in swaying it to their side when they have something better to offer.)
Thus, economic competition, far from representing any kind of antisocial phenomenon, as its critics claim, is a highly positive social phenomenon. It is an essential mechanism of organizing production under the division of labor, and thus an essential mechanism for improving the efficiency of the social cooperation which the division of labor represents. 24
Consistent with our earlier discussion of the price system, economic competition, or, more correctly, the freedom of such competition, is necessary to a division-of-labor society in a further respect as well. Namely to prevent it from being put at the mercy of the arbitrary demands of particular categories of producers.
By its very nature, a division-of-labor society vitally depends on the work done by various small minorities of people constituting particular categories of producers. In many cases, as the result of the government’s intervention into economic activity, coupled with its refusal to enforce ordinary laws protecting individual rights, such minorities have been able to coerce the rest of the society into meeting their arbitrary demands, on pain of a breakdown of the economic system. One has only to think of the consequences of prolonged strikes in such fields as transportation, steelmaking, coal mining, electric power production, and even garbage collection—and the terms on which such strikes are almost always settled.
The existence of such cases is the result of violations of the freedom of competition by or on behalf of labor unions. In practically every country, the unions have succeeded in having laws enacted that greatly restrict the
employment of workers taking the place of strikers. For example, for many years, striking workers in the United States were held by law virtually to own their jobs, which had to be held open for them even though they refused to work, on pain of the employers having to pay triple back wages to the strikers in damages. (At the time of writing, efforts are underway in Congress to reimpose such conditions.) In addition, where replacement workers for strikers are legally allowed to work, the unions are able to practice violence and intimidation against which there is little or no legal recourse. For it is almost impossible to obtain legal protection against socalled mass picketing, which is inherently intimidating, and the police and district attorneys rarely enforce the laws against assault and battery and property damage when it comes to union violence. 25 The recent strike against The Daily News in New York City, in which some newsstands were actually set on fire in efforts to intimidate vendors into not selling the newspaper, and in which no arrests were made, is a glaring illustration of this fact. For further illustration, one has only to recall any of dozens of news pictures of mobs of burly workers blocking factory gates during a strike and the reports of slashed tires, shootings, and bombings that so frequently accompany strikes, and the fact that rarely if ever does any legal action take place against the perpetrators. In these ways, the unions and the government have succeeded in prohibiting freedom of competition in the labor market and thus in compelling the entire rest of society to give in to whatever arbitrary demands the unions in various critical branches of production may choose to make.
While this is a subject that requires a much fuller discussion, it can be said that the freedom of competition would be a sufficient guarantee against arbitrary demands by business firms as well as wage earners—even in cases in which the result of competition might be the establishment of just one company in a particular branch of production, such as one electric power company or one gas company in a given town. The freedom of competition would permit the entry of a new electric or gas company if the existing one’s rates became excessive, and this fact would operate as a powerful check on the rates charged by the existing company. Also, in cases such as these, it is almost certain that different suppliers would compete with one another in terms of offering the customers in a given area longterm contractual guarantees concerning rates and service, so that when a company did succeed in becoming the sole supplier, it would operate under the terms of such a contract and not be able to impose arbitrarily high rates even temporarily. Under such an arrangement, an excessive rate or price would certainly not mean one that was arbitrarily increased by a supplier, but, at most, one that failed to reflect improvements in efficiency made by other, potential suppliers. But even this situation could not long exist, if others possess the legal freedom of entry into the field. 26
5. The Dependence of the Division of Labor on the Freedom of Economic Inequality
A division-of-labor society depends on the institution of economic inequality, insofar as the latter results from the process of economic competition or, more broadly, from individuals freely engaging in production and exchange, whether they are in competition with one another or not.
Economic inequality inexorably emerges from the freedom of the individual to pursue his own prosperity and to keep as his own whatever he achieves. It emerges simply because not everyone is equally intelligent, talented, ambitious, or hardworking, or saves as great a proportion of his income. In effect, it emerges as the consequence of different individuals enacting different degrees of economic causation. 27
A division-of-labor society depends on economic inequality in the sense that it depends on individuals being free and motivated to produce. The abolition of economic inequality would mean the abolition of all connection between an individual’s efforts and his income. It would be tantamount to the abolition of causality in the receipt of income.
To understand why this would be the result, imagine that a group of just ten people were formed whose members agreed to share equally all the income earned by each of them. Now imagine that a member of this group found a way to increase the income he earns by some given amount. Since he has to turn it over to the group and share it equally with the other nine members of the group, the personal benefit which he would obtain would be only one-tenth of that amount. 28
If the group consisted of a thousand people, then any individual who increased or decreased the income he earned by any given amount, would personally experience a gain or loss of only one one-thousandth of that amount: he would personally gain or lose only one dollar for every one thousand dollars by which he increased or decreased the income of the group. If, as the egalitarians desire, the group consisted of the whole population of the United States or of the world, then for any given amount by which an individual increased or decreased the income of the group, he would increase or decrease the income available to him personally by only one 250-millionth or one 5-billionth of that amount.
It is obvious that once the size of the egalitarian group becomes substantial—probably anything much in excess
of ten—no significant connection can exist between what an individual produces and what he receives. And, what is also very important, no significant connection can exist between what an individual produces and what any other particular individual receives.
In a group as small as ten, say, especially if it consists of close friends and relatives, an individual might rationally consider the effect of his actions on the income available to the other members of the group and give it substantial weight in deciding how much to produce. But in any large group, the individual loses the power significantly to affect the income available to any other individual, as well as losing the power significantly to affect the income available to himself. In a group of a thousand, a million, or a billion, nothing the average individual does can significantly affect the income received by his wife and children or parents and friends; even their combined share is an insignificant part of the group’s total income. Nothing he does can have any significant effect on the income of the group as a whole or, therefore, on any given proportion of that income, for he is only one among many, and his production, a small part of the total production. In collectivizing his product and spreading it over a large group, egalitarianism destroys the ability of the great majority of individuals to achieve results that are of significance to anyone.
The average person is capable of accomplishing results that are large in relation to himself, and large in relation to his immediate family. But very few people are capable of accomplishing results that are large in relation to significantly greater numbers of people. It is as though egalitarianism, seeing that individuals had legs easily strong enough to support their own weight, demanded that each individual’s legs had to support the weight of the whole human race as the requirement for his being permitted to walk. To make it the job of the individual to improve his own life and wellbeing only insofar as he equally improves the life and wellbeing of everyone else in the country or the world is a demand that is fully comparable.
If implemented, it would give everyone the incentive to do as little as possible. In the same way that doubling one’s production, if that were possible, would increase one’s own income by only one 250-millionth, if egalitarianism were practiced on a national scale—or by one 5-billionth, if it were practiced on a world scale—and thus would not be undertaken, so getting away with not producing at all would reduce one’s own income only by that amount. 29 Increasing one’s production would not be of perceptible benefit to anyone, and decreasing it would not be a perceptible loss to anyone. As a result, everyone would have the incentive to do nothing.
It should be obvious that equality of income implies forced labor—because, as shown, it eliminates the earning of income as an incentive to work. If people are to work without income as the incentive, the only remaining means of getting them to work is force.
It is true that there are other positive incentives for working besides income—such as the enjoyment of the work itself. But for the great majority of jobs, this factor exists in a form that is closely related to the earning of income and is largely felt only after the work is completed and the satisfaction of supporting oneself can be experienced. For example, no one digs ditches, hauls garbage, mines coal, works on an assembly line or in an office, or is even president of a bank, for the sheer love of his work, apart from all connection with the income it brings him. And even in the cases in which the work all by itself may really be a source of pleasure—for example, in the arts and sciences—this would not be sufficient to induce the amount of work that is presently done and that only the earning of income elicits. For example, I personally very much enjoy lecturing on economics and would want to continue my teaching career even if I were a millionaire and did not need the income from it. But instead of teaching two or three classes every term, I might want to teach only one class every other term. In the absence of personal material incentives, the only way of inducing any significant amount of work is by means of force.
There is an exception to the inability of individuals to achieve perceptible results in relation to large groups. This is the case of individuals of unusually great ability. A great scientist, inventor, or businessman is capable of increasing production so greatly that the whole world can experience a perceptible benefit. Yet this exception certainly does not represent a case in which economic equality would be practicable. On the contrary, precisely this case presupposes the possibility of very great economic inequality.
No scientist, inventor, or businessman should be imagined to be motivated to devote his life to raising the standard of living of the world by one, two, five, or x percent in order that he may, as part of the process, raise his own standard of living by one, two, five, or x percent. That would be an absurdly bad bargain: to work so hard and achieve so much for the rest of the world and so little for oneself.
The main value that a scientist achieves is the intellectual satisfaction of making his discoveries. In his case, this may stand in the place of any very great material reward. But inventors generally require the prospect of substantial material rewards, or they will not devote the time and effort or go to the expense that is necessary to make an invention. And as for businessmen, who are the
ones who actually implement the work of scientists and inventors—who search out and perfect the inventions, and who often set the scientists and inventors to work in the first place—their work takes place for virtually no other reason than as the means of accumulating a personal fortune, and, indeed, is possible for the most part, only to the extent that they have already accumulated one. This last follows from the fact that only to the degree that businessmen possess capital are they able to implement their ideas—that is, to buy or build the necessary factories and machines, purchase the necessary materials and supplies, and hire the necessary workers. Ford, Rockefeller, and Carnegie, for example, could raise the standard of living of the world only in the course of accumulating their fortunes, and only on the basis of the fortunes they had already accumulated. 30
Thus, the whole foundation of individuals of exceptional ability being able to act on a scale that raises the standard of living of everyone is the existence of enormous economic inequality, in the form of their being able to accumulate personal fortunes both as the incentive and as the means for raising the general standard of living.
The demand for economic equality turns out to be opposed to causality in a double respect: in respect both to the incentives for production and to the means of production. It would deprive the average person of the incentive to produce by depriving his productive effort of virtually all effect on his own or any other individual’s standard of living. It would deprive the exceptionally able person of the incentive to produce by making the effect of his productive effort on his standard of living too small and by depriving him of the material means of achieving very great productive effects in the first place.
It should be realized that economic inequality plays a vital role in connection with the institutions of saving and capital accumulation and economic competition. The highest incomes in a capitalist society are those earned by successful businessmen. Insofar as such incomes represent the earning of high rates of profit on capital invested, the greater part of them tends to be saved and reinvested as the means of accumulating a fortune. Fortunes are earned by earning a high rate of profit on a rapidly growing capital—a capital which grows rapidly because most of the high rate of profit is constantly reinvested. 31 High incomes are also frequently of the kind that must be regarded as temporary or exceptional by their recipients—for example, the incomes of authors of bestselling books and of successful professional athletes and movie stars. If such people want to enjoy the benefit of their currently high incomes over the course of their whole lives, during most of which they will probably not earn comparably high incomes, they must save a very substantial portion of them. 32
It is for these reasons that a close, observable relationship exists between relatively high incomes and high rates of saving out of income, and that attempts to restrict economic inequality must substantially reduce saving and capital accumulation.
The role played by economic inequality in connection with economic competition is that it profoundly influences the areas in which people choose to compete. For example, the fact that Mr. A the engineer earns substantially more than Mr. B the mechanic ensures that Mr. A will not compete against Mr. B for the job of a mechanic, even though he might make a much better mechanic. The inequality of income leads people to compete only in the areas of those of their talents that pay the most, and to abstain from competing in the areas of their talents that pay less. It operates, when necessary, to enable the less able actually to outcompete the more able, and thus it guarantees the less able a place in the economic system. 33
Economic inequality, of course, can also be the product of government coercion, as occurs under feudalism and socialism, or as the result of any other arrangement under which the government grants privileges or imposes arbitrary burdens. 34 This latter sort of economic inequality is of a radically different character and is not only totally unnecessary, but also positively inimical, to a division-of-labor society. This is the case because the government’s establishment of such inequalities deprives producers of a more or less considerable part of their product or income and directly infringes their freedom to produce in the first place. In so doing, it deprives producers both of the incentive to produce and even, in varying measure, of the very possibility of producing. It deprives them of the very possibility of producing insofar as it establishes arbitrary economic inequality by means of monopolistic restrictions against their entry into various lines of production. It also deprives them of the very possibility of producing insofar as it appropriates their incomes and thereby reduces their ability to save and invest, which deprives them of the ability to purchase the means of production. At the same time, in giving their product or income to others or in bestowing monopolistic privileges on others, the government rewards nonproducers or less efficient producers. Thus, economic inequality based on government coercion is economically destructive.
The fact that economic inequality can be the result of coercion is the reason why I did not describe it earlier in this chapter as an institution to which private ownership of the means of production is essential, as I did in the cases of the price system, the profit motive, economic competition, saving and capital accumulation, and ex—
change and money. Private property and private ownership of the means of production are essential only to earned inequalities of wealth and income—that is, to inequalities arising out of differences in the ability and willingness to produce and save, where the freedom to own and use property is essential. By the same token, unearned inequalities of wealth and income—that is, inequalities forcibly imposed by the government—represent a violation of property rights and thus of the institution of private property and private ownership of the means of production. For they entail depriving people of their property or the freedom to use their property, including, of course, their means of production. 35
Thus it should be understood that at a fundamental level the case for economic inequality that I have presented is not at all a case for economic inequality per se, but only for the economic inequality that results from the existence of individual freedom and respect for individual rights. (Such inequality, of course, includes that which is based on inherited wealth insofar as the wealth was accumulated by means of production and saving under free competition and then must be maintained by the heirs in the face of free competition. 36 )
In connection with the distinction between the sources of economic inequality, it is worth noting that economic inequality that is founded on economic freedom is accompanied by much less in the way of visible inequality than is economic inequality founded on the initiation of physical force. This is because, as I will show in Chapter 9, the economic inequality that is based on economic freedom, serves to raise the standard of living of all. 37 As a result, under economic freedom, even the poorest strata of society consume substantial and progressively increasing quantities of wealth. Thus, the inequality that prevails is not one of a contrast between those who are starving, half-naked, and living in hovels, and those who are fat, clad in furs, and living in castles, as is the case under feudal inequality, for example. Rather it is an inequality between those who are rich enough to drive Chevrolet or Ford automobiles, and those who are rich enough to drive Cadillacs or Rolls Royces. Under modern capitalism, everyone who works is well-fed, comfortably housed, and attractively dressed. Indeed, it often takes an expert to distinguish between the clothing worn by a well-dressed secretary and that worn by a millionairess.
Failure to realize that the economic inequality that results from economic freedom and capitalism is less extreme than the economic inequality that is based on the initiation of physical force, sometimes leads to the absurd conclusion that forcible restrictions on the freedom of economic inequality can promote prosperity. Thus one compares the extreme inequality of semifeudal societies such as Saudi Arabia, with the lesser inequality of relatively free societies such as the United States, and attributes the greater prosperity of the latter to their greater equality rather than to their greater freedom. The fact is, of course, that it is greater freedom which is responsible both for greater prosperity and for a less extreme degree of economic inequality, while forcible restrictions on the freedom of economic inequality only serve to undermine prosperity. 38
Egalitarianism and the Abolition of Cost: The
Example of Socialized Medicine
In addition to encouraging people to do nothing, egalitarianism also leads them to demand everything. It is tantamount to the abolition not only of causality in the earning of income, but also of cost in the spending of income. To make something free to the individual and chargeable to the group as a whole, is to make the consumption of the individual virtually costless—both to himself and to every other individual.
Socialized medicine provides an excellent illustration of this principle. When visits to doctors are made free to the individual and chargeable to the taxpayers collectively, then each individual perceives the benefit of his going to a doctor, while he and every other taxpayer experiences a personal cost equal to the cost of the visit divided by the number of millions of taxpayers. In such circumstances, every individual is encouraged to take advantage of the situation and, as a result, the overall cost to everyone actually ends up greatly increasing.
What happens is this: A doctor’s visit that might cost an individual fifty dollars, is passed on to, say, one hundred million taxpayers, to each of whom it costs a hundred-millionth of fifty dollars. But now, perhaps, two hundred million people each want to make five times as many visits to doctors, and so the total cost to everyone ends up being vastly greater than it would otherwise have been. Furthermore, the absence of cost to the individual patient is responsible for an enormous increase in the amount of medical tests, hospitalizations, and surgeries performed, which add even more to the cost of the system. And, of course, there is the substantial overhead cost added by the need for a large bureaucracy to administer the system.
Ironically, even though they pay vastly more, people end up obtaining less actual medical service than before. In large measure, the effect of the system is simply to make doctors’ and other medical fees rise and to create shortages of doctors’ time and hospital beds—as manifested in crowded waiting rooms and reduced time with the individual patient, and in waiting lists to enter hospitals. A large portion of the additional medical tests,
THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I 149 hospitalizations, and surgeries is actually unnecessary, and serves to prevent or delay the meeting of genuine medical needs. The measures adopted to deal with these problems, such as controlling doctors’ fees and their methods of treatment, and thereby thoroughly bureaucratizing the field, ultimately make medicine unattractive as a profession and deter talented individuals from entering it. In addition, they frequently serve to deny necessary treatment to people, since the government has no rational method of determining what is the appropriate treatment in the individual case.
In what is perhaps the supreme irony of the system, in efforts to control costs, the government ends up actually opposing advances in medical technology. It comes to regard such procedures as the implantation of artificial hearts as a major threat to its budget. This is with good reason, since, by the logic of socialized medicine, everyone who needs it is entitled to demand a procedure as soon as it becomes recognized as practicable. The result of this is that the normal, freemarket incentives which work to reduce costs before something becomes available to a mass market are not present under socialized medicine. Thus, for these reasons, advances in medical technology become feared and arrested under socialized medicine.
In addition, in further cost-containment procedures, the government begins to restrict or prohibit whole categories of procedures, from cosmetic surgery to bypass operations. Such procedures are excluded from the socialized system on the grounds that they are “nonessential” or “too costly relative to the benefits obtained” (benefits for the government). Thus, people who under private medicine could have obtained such procedures by spending their own money for them are denied the ability to obtain them. They are denied this ability because taxes to pay for the medical care of others, and simply to squander, drain them of the necessary financial resources. The possibility of obtaining the necessary procedures, of course, can also end up being prohibited outright, if the socialized system achieves a complete monopoly and decides not to perform the procedures or not to make them available to specific categories of individuals.
Along these lines, the government begins to deny medical care to those whom it regards as only “marginally valuable to society,” such as the aged. From the perspective of the government’s budget, medical care for the aged is a poor investment: the cost is high and the remaining ability of the aged to pay taxes is relatively small in view both of the limitation of their remaining years and of their possibly diminished capacity, or total lack of capacity, for working and earning taxable income. Thus it should not be surprising that under socialized medicine in Great Britain, for example, bypass operations are made difficult to obtain for people over fifty-five years of age, and an elderly person who breaks a hip is likely to die before being able to obtain corrective surgery.
Thus, in an irony with truly ominous implications, the same system of socialized medicine which began in the United States largely as a means of financing the medical bills of the aged has the longrun potential of turning the aged into sacrificial victims. It has the potential not only of depriving them of all the advances in medical care that they could have obtained in a free market and of making them share in the general decline in the quality of medical care that must result from socialized medicine, but also of placing them in a position of helplessness, in which they are the mercy of a system which attaches little value to their lives.
The fact that socialized medicine has such results should not come as a surprise. It is a profound mistake to believe that there is such a thing as any form of free lunch from the government in the first place. And only someone very foolish indeed should be surprised that when the government buys him lunch it is not eager to increase its expenses on his behalf and thus is not willing to buy him a steak for lunch. He should not be surprised that the government will much more likely end up placing him on short rations, in order to have more funds left over for paying the bills for those whose needs it considers to have a higher “social priority.” Thus, anyone who wants his medical care to be free by virtue of having the government pay for it, should not expect very much or very good medical care. He should rather expect his medical care and treatment to resemble that of the general care and treatment of an unfortunate child whose life has been entrusted to uncaring and potentially cruel stepparents. The state will likely prove just such a guardian of the aged. A child, of course, does not usually select such stepparents. The aged of today, in a state of knowledge below that which should be expected of children, are selecting such a guardian for themselves. 39
It should be realized that the collectivization of medical costs—an essential feature of socialized medicine— has existed for many years in the United States. It was brought into existence not only by the medicare and medicaid programs that date from the mid-1960s but also by unsound private medical insurance practices imposed by government intervention, and which date back to World War II. Like medicare and medicaid, and socialized medicine in general, most private medical insurance plans of the last fifty years give medical care the appearance of being free or substantially free to the user, and thus substantially increase the demand for it and its cost.
Such private insurance came into being as a substitute for socialized medicine and was greeted as a means of forestalling the enactment of socialized medicine. It was extended to a significant part of the population first through a World-War-II decision by the price-control authorities that while ordinary, take-home wages were subject to controls, employer-financed medical insurance for employees was not. And then, following the war, in the remaining years of the 1940s and in the 1950s, it was extended to the great bulk of the population by the contract demands of coercive labor unions, which most nonunion employers felt obliged to meet, as part of their efforts to remain nonunion. The growth of such insurance was also fostered by the fact that from the beginning employer contributions to medical insurance on behalf of employees was made tax exempt, while the payment of the same amount of compensation directly to employees has been fully taxable to the employees.
Government Intervention, Democracy, and the
Destruction of the Individual’s Causal Role
Essentially the same kind of destruction of causality as results from the establishment of equality of income or an equal sharing of costs among the entire population results from all governmental usurpations of power and responsibility. When, for example, the government comes to decide the manner in which individuals provide for their old age, or to decide matters pertaining to education, it destroys the ability of the individual to choose for himself.
The fact that the government may be subject to the verdict of democratic elections only serves to highlight this fact. Instead of signifying that nothing is wrong, because the government is still subject to the will of the people, the fact is that the power of the individual to determine his own life is submerged in that of an enormous mass of voters. True enough, under democracy if a majority of a voting population ranging from several hundred to a hundred million or more (depending on the level of the election—local, state, or federal) votes against an existing policy, the policy will likely be changed. But this does not mean, as the supporters of government intervention often argue, that the government is still “controlled by us.” As far as any individual is concerned, the government is totally out of control.
For example, when it comes to the use of savings in the socalled individual retirement accounts that the government supervises (let alone the use of savings siphoned off into the social security system), instead of the individual being able to decide for himself that he wants to use a portion of his savings to make the down payment on a home, he must wait until tens of millions of other citizens have become ready to join with him to bring about this possibility. In the same way, instead of an individual set of parents being able to decide to send their child to an elementary school that is close to their home, they may have to wait until that possibility is established by means of a national election.
Thus, to the extent government intervention exists, even under democracy, the individual by himself is prevented from accomplishing what he wants to accomplish. His power to act as an individual causal agent is destroyed. For government control under democracy still means collectivization of the power to make decisions. And thus from the perspective of any individual the result for all practical purposes is as much a loss of the freedom of choice and the power to act as exists under dictatorship. Only limitation of the powers of government can secure individual freedom and the ability of the individual to act as a causal agent. Violations of individual freedom by democratic majorities are as much violations of individual freedom and the ability of the individual to act as those imposed by dictators.
Summary
The preceding sections have shown why the division of labor is entirely dependent on the institutions of capitalism. Section 1 showed how it depends on private property and private ownership of the means of production as the basis for enabling people to act and produce separately and independently of one another. Such independence is essential if people are to be able to take advantage of the fundamental facts underlying the gains from the division of labor, namely, that individuals possess separate, independent minds and separate, independent knowledge. This section showed that socialism and central planning are incompatible with the necessary intellectual division of labor that must exist in order to have rational economic planning. It showed why the existence of the price system is essential for such planning and both why the price system depends on the profit motive and the freedom of competition and why these two institutions in turn depend in turn on private ownership of the means of production. The section also showed why the price system depends on exchange and money and saving and capital accumulation and why they too are dependent on the institution of private ownership of the means of production.
Subsequent sections explained the direct dependence of the division of labor on the institutions of saving and capital accumulation, exchange and money, competition, and the freedom of economic inequality. Saving and capital accumulation were shown to provide the essential basis for making possible the production of goods requiring more or less considerable lapses of time between the
THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I 151 performance of labor and the appearance of the resulting product. Saving and capital accumulation were also shown to be responsible for initially raising the productivity of labor to the point where labor could be spared from food production for the production of other things, and then for making it possible for wage earners and suppliers to be paid within a reasonable period of time after the performance of their work, and, finally, to provide the foundation for larger-scale production and thus the basis for carrying the division of labor further at any given stage of production.
Exchange and money were shown to be essential to the channelling of goods from their producers to their consumers. The existence specifically of money and monetary exchange was shown to be essential to overcoming the problem posed under barter of the need for the existence of a double coincidence of wants as the precondition of an exchange. In overcoming this problem, the existence of money was shown to make possible a radical widening of the extent of the division of labor. Money was further shown to be vital to the existence of a division-of-labor society in making possible economic calculations and comparisons. The gross injustice of regarding money as the root of all evil was pointed out, along with other common errors found in the antimoney mentality.
Economic competition was shown to perform the vital function of determining the ongoing organization of a division-of-labor society with respect to the choice of which persons are to hold which occupations, which products are to be produced for which specific markets, and which technological methods of producing any given product are to be used. Economic competition, or at least the freedom of such competition, was also shown to be necessary to prevent a division-of-labor society from being placed at the mercy of the arbitrary demands of various vital industries or occupations.
Finally, the existence of economic inequality, resulting from unequal degrees of achievement, was shown to be essential to individuals being able to act as causal agents in accomplishing results, whether within a division-of-labor society or outside of a division-of-labor society. The alternative to such economic inequality was shown to be forced labor, as the only means of inducing people to work in the absence of economic incentives. In addition, such economic inequality was shown to play a major role in promoting saving and capital accumulation and in making it possible for the less able to compete with the more able. The imposition of equality in the meeting of costs was shown to be tantamount to the abolition of cost from the perspective of the individual user of a good or service. The destructive consequences of such impositions were explained, using socialized medicine as an example. And then, government intervention in general, even under democracy, was shown to represent the destruction of the individual’s ability to act as a causal agent, inasmuch as it requires that before the individual can accomplish what he wants to accomplish, he must first join with perhaps millions or tens of millions of others to make it possible.
PART B
ELEMENTS OF PRICE THEORY:
DEMAND, SUPPLY, AND COST OF
PRODUCTION
Before proceeding to the substance of price theory, it is necessary to deal with matters which occupy the major portion of most of today’s courses and textbooks on the subject, namely, the concepts of demand and supply, and, in particular, their representation as curves. This material is included in this book in part for the benefit of economics instructors who are obliged to present a geometric analysis using such curves. It is offered in the hope that if they are otherwise inclined to adopt this book, they will not have to turn elsewhere in order to expose their students to such curves.
Frankly, while I believe that the ability to understand and visualize downward sloping demand curves, and vertical lines as representing supply, is of some significant value, I do not attach very great weight to geometrical analysis in economics. I share with von Mises the conviction that the substantive relationships of economics must all be explained by an essentially verbal analysis and that the drawing of such curves is mere byplay as far as real economic analysis is concerned. 40 I present my substantive, verbal analysis of price theory in the next three chapters of this book. Indeed, I believe that geometrical analysis using demand and supply curves masks some major confusions. The clearing up of these confusions is an important objective of the remainder of this chapter and is the main justification for including the extended discussions of the derivation of supply curves and of the prevailing confusions between the concepts of supply and cost of production. On a positive note, in the following pages I explain the various meanings that are attached to the words demand and supply, demonstrate why price and quantity demanded vary inversely, and present what is genuinely valuable in being able to visualize demand and supply curves.
The connection of the following discussions to my theme that the division of labor depends on the institutions of capitalism is perforce indirect. As I have already
indicated, the division of labor depends on the existence of the price system both for its successful functioning and, indeed, for its very existence. The following discussions are preliminary to the detailed demonstration of that proposition.
1. The Meaning of Demand and Supply
Perhaps no proposition of economics is more frequently uttered than that prices are determined by demand and supply. Yet in the history of economics, and to an important extent even at the present time, the concepts of demand and supply have had more than one meaning, which can make the above proposition highly ambiguous.
According to the classical economists, demand is to be understood predominantly as an amount of expenditure of money, such as $1 billion, while supply is to be understood as an amount of a good or service offered for sale. On this basis, prices are to be conceived as formed by the ratio of the demand to the supply, with demand as the numerator and supply as the denominator, and to vary in direct proportion to the demand and in inverse proportion to the supply. The classical view of price determination by demand and supply is expressed in the formula
D
P = ,
S where P is the price, D is the demand, and S is the supply. 41
The classical economists also frequently defined demand as “the will combined with the power of purchasing.” 42 Here demand is to be understood in terms of the goods or services one is actually able to obtain by virtue of the expenditure of money. While certainly not inconsistent with the view of demand as an expenditure of money, this is a different concept of demand. To avoid confusion, it is best to describe demand in this second sense as real demand, with the word “real” denoting the fact that the quantity of goods or services one can obtain for the money expended is essential.
As used in contemporary economics, the concepts demand and supply mean the set of quantities buyers are prepared to buy or sellers to sell at varying prices, arranged in descending (ascending) order, all other things being equal. Viewed in this light, the concepts refer to hypothetical schedules, which when diagrammed, appear as curves. Illustrations of such hypothetical schedules and curves appear in Table 5–1 and Figure 5–1 respectively.
In the usage of contemporary economics, the entire set of prices in Table 5–1, ranging from $10 down to $3, together with the entire set of quantities demanded at those prices, ranging from 100 up to 500, represents one demand schedule—the demand—for the good in question. Strictly speaking, the concept of the demand schedule embraces prices ranging from zero to infinity, proceeding by the smallest possible increments in price, and all of the quantities demanded at all of these prices. The demand schedule presented in Table 5–1, therefore, represents only a few selected points on the actual demand schedule.
When diagrammed, as in Figure 5–1, the demand schedule appears as the demand curve DD. (In Figure
Table 5–1
Hypothetical Demand and Supply Schedules
Quantity Price
Demanded $10 100 9 125 8 160 77 200 6 250 5 325 4 400 3 500
Quantity Quantity Supplied Demanded II 500 250 325 300 275 400 200 500 150 600 100 725 050 850 000 900
5–1, in accordance with the usual practice, price is shown on the vertical axis, where it is labeled P, and quantity, on the horizontal axis, where it is labeled Q.) The curve results from drawing a line through the various point values derived from Table 5–1. Ideally, the curve would be drawn by plotting all the point values derived from a complete demand schedule. The demand curve of Figure 5–1, of course, represents a limited range of the demand schedule, and most of its values are derived by interpolation between the few selected values that were present in Table 5–1.
In the same way, the entire set of prices and of quantities supplied, ranging from $10 and 500 units down to $3 and 0 units, together with all prices and quantities supplied above and below these limits, represents one supply schedule—the supply—of the good in question. When diagrammed in Figure 5–1 on the basis of the selected data appearing in Table 5–1, the supply schedule appears as the supply curve SS.
Accordingly, in the usage of contemporary economics, a change in demand or supply does not refer to a change in the quantity demanded or supplied within a given demand or supply schedule, or along a given demand or supply curve. For example, the increase in the quantity demanded from 100 to 125, accompanying the fall in price from $10 to $9, is not described as an increase in demand, but merely as an increase in the quantity demanded within a given demand schedule or along a given demand curve. A change in demand or supply is said to occur only when there is a change in the schedule or curve. For example, the column labeled “Quantity Demanded II” in Table 5–1 is said to represent an increase in demand. Here, the quantities demanded are greater at the same set of prices. A change in demand or supply is held to mean a change in the quantities demanded or supplied at the same set of prices, or, equivalently, a change in the prices accompanying the same set of quantities demanded or supplied.
The demand curve D′D′ in Figure 5–1 is an illustration of a shift in the demand curve. In contrast with the curve DD, it shows larger quantities demanded at the same prices, and higher prices offered for the same quantities. It is drawn higher and to the right of DD. By the same token, a fall in demand would be illustrated by a movement from D′D′ back to DD.
In the view of contemporary economics, determination of price by demand and supply means determination of price by the intersection point of demand and supply curves. A rise in demand is held to increase both price and quantity supplied by virtue of the higher demand curve intersecting the given supply curve at a point up and to the right on the latter. Similarly, a fall in demand is held to decrease both price and quantity supplied by virtue of the lower demand curve intersecting the given supply curve at a point down and to the left on the latter. Likewise, an increase in supply, is held to decrease price and increase quantity demanded, while a decrease in supply is held to increase price and reduce quantity
Figure 5–1
Hypothetical Demand and Supply Curves Based on the Data of Table 5-1
P D ′ $10 D
S 9 8 7 6 5 4
D 3 S 2 1 0 100 200 300 400 500
′
D
Q 600 700 800 900
demanded. (To show an increase in supply in Figure 5–1, the reader can draw in a new supply curve, down and to the right of SS, and more or less parallel to it, which would intersect either DD or D′D′ at a point down and to the right of the intersection point given by SS. Movement from that curve back up to SS could then be used to depict the effects of a fall in supply.)
The classical and contemporary concepts of demand and supply are in agreement concerning the direction of price changes resulting from changes in demand or supply: on both views, price varies in the same direction as changes in demand and in the opposite direction of changes in supply. Moreover, it should be noted that when the demand schedule or curve of contemporary economics changes, the change coincides with a change in demand according to the classical concept as well. For what is implied is a change in the expenditure of money for any given quantity of a good supplied. For example, on demand curve DD, the price corresponding to a quantity demanded of 400 is $4; on demand curve D′D′, the price corresponding to this same quantity demanded is $8. Thus, in the first case, demand in the classical sense is $1,600 (400 x $4) and in the second case, it is $3,200 (400 x $8). Whenever, there is a movement of the demand curve, a corresponding change in expenditure is implied for any given quantity of the good. This is implied by the geometry of the situation, because expenditure for the good equals any given quantity of it times the corresponding price indicated by the demand curve; insofar as the demand curve changes and thus the price corresponding to the given quantity changes, the expenditure for the good must change to the same extent.
The classical and contemporary concepts of demand and supply come closest together in the usage of the Austrian school. In the view of the Austrian school, supply fundamentally means a given quantity of a good or service available for sale. 43 Thus, in essence, the Austrian school retains the meaning given the concept of supply by the classical economists. In geometrical terms, when the Austrian economists describe price as determined by demand and supply, they have in mind the kind of demand curve represented by DD in Figure 5–1, but a supply curve constituted by a vertical line drawn upward from the point on the horizontal axis (the quantity axis) that represents the given amount of supply available. This is shown in Figure 5–2. 44
In the Austrian view of things, depicted in Figure 5–2, the sellers are presumed merely to be prepared to sell their given supply of goods at the best price they can obtain, from zero on up. 45 This is because in the context of a division-of-labor economy, the sellers normally possess goods in such great quantities that most of their supply has zero marginal utility—zero personal value—to them. As a result, on the Austrian view, prices that are determined by supply and demand are determined on the basis of the valuations of “the marginal pair of buyers” alone. 46
What this means is that the marginal utility attached to the price of any good that is purchased must simultaneously be below the marginal utility of the last unit of the good purchased and above the marginal utility of one
Figure 5–2
The Austrian View of Demand and Supply
P
S
D
D
S
0
Q
additional unit more of the good that potentially might be purchased. For example, it implies that if a supply of one million shirts of a given kind is to be met with a quantity demanded of shirts that is also one million, then the price of a shirt must be such that the marginal utility of the price of the shirt is simultaneously below the marginal utility of the one millionth shirt and above the marginal utility of a potential one millionth and first shirt. The marginal utility of the price of the shirt must, in effect, be sandwiched between the utility of the marginal pair of shirts, that is, simultaneously below the utility of the marginal shirt and above the utility of the potential first submarginal shirt (that is, of one potential additional shirt more).
This is the necessary condition of equalizing the quantity demanded of any good with any given supply of that good that is to be sold. The marginal utility attaching to the price being below the marginal utility of the good in question is the condition of all the buyers of the good finding its purchase to be the source of a gain and hence worthwhile. By the same token, the marginal utility attaching to the price of the good being above the marginal utility of a potential additional unit of the good is the condition of it not being worthwhile for anyone to attempt to purchase an additional quantity of the good, and thus of the quantity of the good demanded not being greater than the given supply available. Whenever a case exists in which a given quantity of a good or service is to be sold in a free market, its price will tend to be determined within the limits set by the valuations of the marginal pair of buyers—that is, the marginal utility attached to the good by the buyer of the marginal unit and the marginal utility attached to the good by the potential buyer of one additional unit more, that is, the first submarginal unit. 47
In this book, the concepts of demand and supply will be used both in their classical and contemporary—especially Austrian—significations. The classical concept of demand as an amount of expenditure of money will be found to be extremely useful when dealing with questions pertaining to the operation of the economic system as a whole. In that context, it can be related, via the quantity theory of money, directly to the quantity of money in the economic system, which will be shown to be its main determinant. 48 The fact that economy-wide, aggregate demand in the classical sense is determined primarily by the quantity of money in the economic system makes it essentially independent of changes in aggregate supply in the classical sense, which latter can be understood as operating in the face of a given aggregate demand and thus to result in inversely proportionate changes in the general price level. In dealing with demand at the level of individual industries and companies, however—where in essence it is a matter of explaining the adjustment of a part of the economic system to the rest of the economic system—this book will make use of the contemporary, Austrian concept of demand. This procedure will not be found to be in any way inconsistent with the use of the classical concept of demand at the level of the economic system as whole. Rather, it will be found to reflect the fact that at the level of individual industries and companies competitive elements are present which are mutually canceling at the level of the economic system as a whole.
The difference in treatment ultimately comes down to the fact that at the level of the individual industry or company, demand in the classical sense cannot be taken as independent of supply in the classical sense. Changes in supply at this level represent changes in competitive conditions among the various firms and industries, which cause changes in the pattern of expenditure for their various goods and services. This is because a change in the supply of any one good, such as automobiles or copper, means a change in its supply relative to the supply of other goods and a change in its price relative to the prices of other goods. If the supply of the good in question increases, say, and does so in the absence of increases in the supply of other goods, the marginal utility of this particular good may fall precipitously because of its additional supply, thus leading to the amount of money spent to buy it being reduced. For example, while people almost certainly would like to have an additional supply of automobiles, they want them along with more and better housing and clothing, more travel and entertainment, and so on. Until they can have more of all of these things, they will not be prepared to accept merely an additional supply of automobiles except at disproportionately lower prices. 49 On the other hand, in many circumstances the lower price of the given good may enable it to compete more effectively with other goods serving the same purposes, as we shall see very shortly. To the extent that this is so, the amount of money spent to buy it will increase. Thus, while demand in the classical sense can be taken as independent of supply in the classical sense at the level of the economic system as a whole, it cannot be so taken at the level of the individual industry or firm. Hence, at this level, it is necessary to resort to the contemporary, Austrian concept of demand.
2. The Law of Demand
A fundamental proposition of economics, applicable both to the classical and to the contemporary, Austrian concept of demand, is the law of demand. This is the fact that other things being equal, the quantity demanded of a good is the greater, the lower is its price, and the
smaller, the higher is its price.
At the level of the economic system as a whole, the law of demand follows directly from the fact that the need and desire for wealth has no limit and that a fall in the prices of goods and services is all that is necessary to enable any given expenditure of money to purchase a larger quantity of goods and services. The fall in prices expands the buying power of any given amount of expenditure and is potentially capable of making it sufficient to purchase any volume of aggregate supply, however large. 50
At the level of the individual industry or company, however, a fall in any given price always means much more than the fact that the average of prices is now lower relative to the willingness and ability to spend money and thus that the same aggregate expenditure can buy a larger total of goods. As stated, it also means a change in the prices of individual goods and services relative to one another.
For example, an increase in the supply and fall in the price of cotton means a fall in the price of cotton relative to the price of wool and other goods that cotton can more or less satisfactorily be substituted for. As a result, the purchase of cotton becomes competitively favored over their purchase. For now, in purchasing it, one can accomplish the common objective for which cotton, wool, and all the other relevant substitutes are means, and do so without having to forgo as large a quantity of alternative goods as previously. A lower price of cotton relative to the price of wool means that if one buys cotton instead of wool, one still obtains clothing (albeit, of course, with the specific advantages or disadvantages associated with cotton) and can now do so while forgoing a smaller quantity of alternative goods than before relative to the quantity one must forgo to obtain clothing made of wool. This change results in an increase in the quantity demanded of cotton at its lower price, and a decrease in the quantity demanded of wool and of the other goods for which cotton is a substitute, at their given prices. In other words, the quantity demanded of cotton increases, and the demand for wool and the other goods for which cotton is a substitute decreases.
In the literature of contemporary economics, such a change in the quantity demanded of a given good as its price falls is described as “the substitution effect.” This effect is equally present, of course, when the price of a good increases relative to the prices of the goods for which it can be substituted or which can be substituted for it.
As will become clear, the substitution effect is actually just a special case of the operation of the law of diminishing marginal utility. And I turn now to a demonstration of how the existence of diminishing marginal utility explains why, other things being equal, the quantity of a good people are prepared to buy is greater at a lower price than at a higher price. 51
The reason is that in order to purchase a good, people must attach greater marginal utility to the good than they attach to the price of the good. A lower marginal utility is attached to a lower price than to a higher price. This is because the price of a good is the measure of the alternative goods that must be forgone in order to purchase it. A lower price of any given good means that to be able to buy an additional quantity of it, the quantity of alternative goods that must be forgone in order to have the funds available to make its purchase is correspondingly reduced (assuming their prices are unchanged). Since, other things being equal, a smaller quantity of alternative goods represents a lower marginal utility than a larger quantity of alternative goods, this means that the marginal utility represented by a lower price is less than the marginal utility represented by a higher price. (The lower marginal utility of a smaller quantity of goods compared with that of a larger quantity of goods follows on the basis of all that was established about man’s limitless need for wealth. If more wealth is better than less wealth, it must have more utility, and less wealth must have less utility.) Thus a lower price of a good means that in purchasing it, the marginal utility one forgoes in the purchase of other goods is less.
As a result, the marginal utility attached to a lower price tends to stand below the marginal utility of a larger number of units of a good than does the marginal utility attached to a higher price. The consequence is that the purchase of a larger number units is made advantageous at a lower price.
As illustration, imagine that an individual attaches marginal utilities of 40, 30, 20, and 10 to four successive units of given good. Imagine also that to the sum of $100 he attaches a marginal utility of 50, and to the sums $80, $60, $40, and $20, he attaches marginal utilities of 35, 25, 15, and 5, respectively. Thus, at a price of $100, he will not buy any of the good, because the marginal utility of its price, 50, stands above the marginal utility even of the very first unit of the good, which is 40. But at a price of $80, the marginal utility of the price, now 35, stands below the marginal utility of the first unit of the good. And thus this individual will buy one unit of the good. And for every further $20 reduction in the price, he will buy one additional unit, up to a total of four, because the lower marginal utilities attached to these lower prices stand below the marginal utilities of the successive units of the good. 52
The role of the different alternative amounts of wealth that different prices represent can be seen in the following example, which deals with the hypothetical demand
for radios. If the price of a radio is $100, then the purchase of a radio implies that one must forgo the purchase of whatever else that $100 might have bought— that is, an additional quantity or improvement in the quality of alternative goods that one consumes. In order to buy the radio, one must attach a marginal utility to it that is greater than the marginal utility one attaches to the $100 in any alternative line of spending. Those who buy radios at the price of $100 do attach a higher marginal utility to them than to the expenditure of the $100 in any other line or lines. Those who buy two, three, or more radios at the price of $100 attach a marginal utility to each of them that is above the marginal utility they attach to any other, alternative goods the $100 price could buy. By the same token, those who buy no radios at the price of $100, or who buy one radio but not two, or two but not three, and so on, do not buy the radio in question because they attach a marginal utility to it that is below the marginal utility they attach to the purchase of alternative goods with the $100 in question.
If, however, the price of radios fell to $90, say, then the quantity/quality of alternative goods that would have to be forgone in order to make possible the purchase of a radio would be correspondingly reduced. This would mean a reduction in the marginal utility that had to be forgone in order to purchase a radio. This lower, alternative marginal utility would now tend to stand below the marginal utility of an additional quantity of radios. In the face of having to forgo alternative goods purchasable with only $90 instead of $100, in order to secure a radio, there would be people who previously judged the marginal utility of a first, second, or third radio, or whichever, to be less than the marginal utility of its price, who would now decide that it was greater than the marginal utility of its price.
In this way, a lower price of any good, whether it has direct substitutes or not, acts to favor its purchase.
Indeed, as stated, the substitution effect is merely a special case of the operation of the law of diminishing marginal utility. When the price of one substitute falls relative to that of another, as is the case when the price of cotton falls and the price of wool stays the same, what creates the competitive advantage is precisely the fact that the marginal utility of the alternative goods which must be forgone in order to purchase the one becomes less relative to the alternative goods which must be forgone in order to purchase the other. This is what favors the cotton, namely, that by buying cotton rather than wool, one can still meet the common purpose, in this case having cloth or clothing, and yet have greater marginal utility in terms of other things than if one buys wool, because now one gives up less of other things to buy cotton. 53
There is another major aspect of the competition that is present at the level of individual goods and services. A fall in the price of any given good, whether cotton, radios, or whatever, also means that to whatever extent people were already prepared to be purchasers of the good, they can now purchase the quantity they would otherwise have purchased, for a smaller expenditure of money. This means they will have correspondingly more money left over for the purchase either of more of that good or more of other things that they desire. For example, if one otherwise would buy 10 yards of cotton at $2 per yard, a fall in price to $1.50 per yard makes possible the purchase of the same 10 yards for only $15 instead of $20. This makes an additional $5 available for buying either additional cotton or additional quantities of other goods.
In contemporary economics textbooks, such availability of additional funds is called “the income effect.” The income effect derives its name from the fact that the funds made available by the fall in price of something one already buys is viewed as similar to an increase in income with the price of the good unchanged. 54 Thus, the additional $5 made available as the result of the fall in the price of cotton that we have just imagined is viewed as the equivalent of a $5 increase in income with the price of cotton unchanged.
The socalled income effect also operates in accordance with the law of diminishing marginal utility. When, for example, the price of cotton falls, it is considerations of marginal utility that determine how the additional funds made available will be used in the purchase of additional goods. The additional funds will be used to purchase those additional goods which have the highest marginal utility.
Thus, the effect of a fall in the price of anything on the quantity of it demanded can be viewed as the combined effect of two things. One is an increase in available funds that results from the saving in purchasing the quantity of the good that would have been purchased without the fall in price. The other is the enhancement of the good’s competitive position in relation to other goods.
These other, competing goods must be understood not only in the narrow sense of substitutes serving the same particular needs or wants, such as wool versus cotton, but also in the broader sense of goods in general, or combinations of goods, that compete in terms of their marginal utility for the expenditure of the same funds. A lower price of television sets, for example, is capable of drawing funds in competition with goods serving physically dissimilar needs or wants, such as housing or automobiles. This is because a lower price of television sets relative to housing or automobiles means that the marginal utility forgone in buying a television set is that
much lower relative to the marginal utility forgone in buying housing or an automobile. This enhances the competitive position of television sets vis-à-vis housing and automobiles.
The operation of the law of diminishing marginal utility, both in and through the substitution and income effects and otherwise, is responsible for the existence of the law of demand, namely, that, other things being equal, the quantity of a good that is demanded moves in the opposite direction of its price. In the last analysis, the operation of the law of demand, and of the underlying principle of diminishing marginal utility, is tantamount to the fact that a lower price makes possible the acquisition of more wealth, which is always desired.
The Concept of Elasticity of Demand
Elements of the preceding discussion point the way to what has become an exceptionally prominent concept in contemporary economics, namely, that of the elasticity of demand. The elasticity of demand is typically defined as the percentage change in the quantity demanded of a good divided by the percentage in its price. As its name indicates, the concept seeks to measure the “stretch” or “shrinkage” in the quantity of a good or service demanded relative to changes in its price.
Three categories of demand are distinguished according to their degree of elasticity: elastic, inelastic, and unit elastic demands. Each is judged by the effect of a price change on total expenditure for the good (or, equivalently, on the total revenue derived from its sale). If expenditure (revenue) changes in the opposite direction of price, the demand is said to be elastic at that point—the stretch or shrinkage in the quantity demanded outweighs the change in price. In the case of an elastic demand, more is spent in buying the good at a lower price than at a higher price, and when the price rises, less is spent in buying the good. Here the change in the quantity demanded outweighs the change in the price.
If, on the other hand, expenditure (revenue) changes in the same direction as the price, the demand is said to be inelastic at that point—the stretch or shrinkage in the quantity demanded is insufficient to offset the change in price. In the case of an inelastic demand, more is spent in buying the good at a higher price than at a lower price, because of the relative lack of stretch or shrinkage in the quantity demanded.
Finally, if expenditure (revenue) for the good remains the same when the price changes, the demand is said to be unit elastic at that point, which means that the change in quantity demanded accompanying the change in price precisely counterbalances the change in price. When demand has unit elasticity, the change in quantity demanded is inversely proportionate to the change in price— for example, a halving of price is accompanied by a doubling of quantity demanded, a cut to a third is accompanied by a tripling, and so on.
By far the most important example of unit elastic demand, and, at the same time, perhaps the only example that is not essentially accidental and passing, is economy-wide, aggregate demand. As previously stated, the volume of expenditure in the economic system as a whole tends to be the same so long as the quantity of money in the economic system is the same. Any increases or decreases in expenditure for particular goods or services are accompanied by equivalent decreases or increases in expenditure elsewhere in the economic system.
For example, an increase in expenditure for cotton, resulting from the operation of a strong substitution effect accompanying a lower price of cotton, is accompanied by a decrease in expenditure for wool and other substitutes. A possible resulting increase or decrease in the expenditure for clothing as a whole in such circumstances (depending on the marginal utility of additional clothing in comparison with the marginal utility of additional quantities of other things) would tend to be accompanied by a counterbalancing decrease or increase in the expenditure for things other than clothing. In the same way, a possible decrease in the expenditure for cotton, resulting from the existence of a weak substitution effect when its price falls, tends to be accompanied by an equivalent increase in the expenditure for other goods that is made possible by the availability of additional funds stemming from the fall in the price of cotton.
The principle here is that while competitive elements entailed in the substitution and income effects cause the expenditures for the products of individual industries and companies to vary in response to supply and price changes, nevertheless, in the very nature of the case, these elements, being competitive, cancel out when the level of analysis is raised to that of the economic system as a whole. Competition for expenditure takes place only within the economic system, among the various industries and firms that make up the economic system. It does not take place between the economic system and anything outside of the economic system.
Now a total expenditure for goods that is constant essentially so long as the quantity of money in the economic system is constant, is one in which price changes are necessarily accompanied by inversely proportionate changes in quantity demanded. Geometrically, the aggregate demand curve has the property that the area under the curve (found by multiplying the quantity demanded times the price) is a constant. The curve is asymptotic to both axes. 55 Such a demand curve is shown in Figure 5–3.
Turning now to the very different case of elastic demands, important examples of an elastic demand are
THEDEPENDENCEOFTHEDIVISIONOFLABORONCAPITALISMI 159
Figure5–3
TheAggregateUnitElasticDemandCurve
P
D
D
Q
0 providedbygoodswhicharepresentlyluxuries,beyond tiesanditwillstillbelessexpensivethanthesubstitutes the reach of most people, and which price reductions forit.Suchgoodsasbread,wheat,potatoes,andsaltare wouldbringwithintheirreach.Equallyimportantexam-inthiscategory.
ples are provided by goods which can easily substitute Thedemandforagoodwilltendtobeinelastictothe forothergoodsorbesubstitutedforbyothergoods. degreethatthesubstitutesforitarepoorormoreexpen—
Anexampleofthefirstkindwastheautomobileinthe sivethanitis.Itwillalsotendtobeinelasticincasesin firstdecadesofthetwentiethcentury.Televisionsetsand whichitisemployedasafactorofproductionincombi-personal computers are more recent examples of the nationwithother,complementaryfactorsofproduction sametype.Inthesecases,pricereductionssucceededin andinwhichitspriceconstitutesonlyasmallportionof openingupamassmarkettothegood,whichresultedin the total cost of producing the product or products in the expenditure for the good being greater atthe lower question. In the latter instance, a rise in its price raises pricethan atthehigherprice.Possible examplesofthe theoverallcostofproductionandpriceoftheproduct(s) second type, representing varying degrees of substitut-inamuchsmallerproportion.Theconsequentreduction ability, are provided by the caseof cotton versus wool, in the quantity demanded of the product and thus of it, previouslyconsidered,beefversuschickenandpork,and correspondstothismuchsmallerrelativeincreaseinthe steel cans versus aluminum cans and plastic and glass priceoftheproduct(s).
containers. The degree of substitutability, of course, is Bothsetsofconditionsappeartodescribethedemand vastlygreaterbetweentheproductsofcompanieswithin for a great many goods, such as ordinary nails and thesameindustry,suchasthesteelcansofU.S.Steeland screws,silverandmercury,gasolineandheatingoil,and thesteelcansofNipponSteel. mostcomponentsorparts.Nailsandscrews,forexam—
Examples of an inelastic demand arise in cases in ple,bothhavepoorsubstitutesandtheirpriceconstitutes which a good has achieved the status of a lowcost suchasmallfractionoftheoverallcostandpriceofthe necessity. In such cases, in a prosperous country, price productsintowhichtheyenter—housesinparticular—as reductions are not likely to expand the quantity de-hardlytobenoticeable.Thustheirpricecoulddoubleor manded very significantly, since the good is already triple and produce very little effect on the quantity of probably being consumed at or close to the limit of its themdemanded.
usefulness.Atthesametime,thequantitydemandedwill Thedegreeofinelasticityofdemandforgoodstends diminish only slightly, or even not at all, in the face of todiminishtothedegreethattimeisavailableformaking moderate price increases, since people will continue to adjustments.Forexample,ariseinthepriceofheating beabletoaffordthegoodinvirtuallyunchangedquanti-oilwillbeaccompaniedbyagreaterreductioninquantity
demanded as time goes by and a larger proportion of furnaces are equipped to burn alternative fuels.
The concept of elasticity of demand helps to make possible the comprehension of such phenomena as the effect of labor-saving improvements in machinery on employment. From the perspective of the economic system as a whole, such improvements in machinery neither cause unemployment nor additional employment. They enable the same total amount of labor to produce a larger quantity of goods. But from the perspective of individual industries, such improvements in machinery can sometimes result in additional employment and sometimes in less employment. It depends on the elasticity of demand for the particular products.
If a labor-saving improvement in machinery occurs in an industry that is confronted with an elastic demand, the effect will be more employment in that industry and correspondingly less employment in other industries. The saving of labor per unit of product results in a reduction in cost of production and selling price that is accompanied by a more than proportionate increase in the number of units of the product demanded. 56 At the same time, the larger expenditure for the product in question necessitates a reduction in expenditure for other products in comparison with what such expenditure would otherwise have been. Thus, for example, labor-saving improvements in the automobile industry earlier in this century resulted in a vast increase in the number of people employed in the automobile industry. At the same time, they resulted in a vast decrease in the number employed in raising horses and growing oats—goods which experienced a major reduction in demand as the result of the growth of the automobile industry.
If a labor-saving improvement takes place in an industry that is confronted with an inelastic demand, the effect will be less employment in that industry and correspondingly more employment in other industries, which experience a rise in demand as the result of the release of funds from the industry where the labor-saving improvement occurred. For example, labor-saving improvements in agriculture are typically accompanied by a reduction in the number of people employed in agriculture and a corresponding increase in the number employed in industry and commerce. This is in response to less money being spent to buy farm products, and more being spent to buy the products of the rest of the economic system.
Regrettably, the major application of the concept of elasticity in contemporary economics has been in connection with a false theory of monopoly. The practical usefulness of the concept has been thought to lie with enabling ordinary private businessmen, who somehow allegedly possess monopoly power, to decide whether it is more profitable to produce a smaller quantity of a good for sale at a higher price rather than a larger quantity available for sale at a lower price. 57
Two variants of the concept of elasticity have been developed, which are known as “income elasticity” and “cross elasticity” of demand. By income elasticity is meant the percentage change in the quantity demanded of a product divided by the percentage change in people’s incomes. By cross elasticity is meant the percentage change in the quantity demanded of a product divided by the percentage change in the price of one of its substitutes or complements—for example, the percentage change in the quantity demanded of aluminum divided by the percentage change in the price of copper, or the percentage change in the quantity demanded of automobiles divided by the percentage change in the price of gasoline or automobile insurance.
In the face of the construction of such concepts as income and cross elasticity, and of attempts actually to derive concrete measurements of the elasticity of demand, it must be pointed out that there is no such thing as any kind of constancy of elasticities. Elasticities of demand bear no resemblance to such physical measurements as electrical conductivity, specific gravity, or tensile strength, which scientists and engineers can determine for the various elements and compounds. For example, it is simply not the case that as there is a definite electrical conductivity of copper, there is a definite elasticity of demand for copper—or for anything else.
The elasticity of demand varies over the length even of a given demand curve for a good. For example, the demand for automobiles is highly elastic in the zone in which a change in their price either brings them within or places them beyond the reach of a mass market. But once the price of automobiles is low enough to achieve a mass market, further reductions in their price will be accompanied by less elastic responses in the quantity demanded. The demand for automobiles may very well become inelastic. It is possible that a given demand for a good could go through various zones of elasticity, depending on such things as its relationship to the price of various alternative goods at different points. It is possible to imagine a good that becomes a worthwhile substitute for a variety of other goods as its price declines, with its demand alternating between elasticity and inelasticity as it absorbs the market of a competing good and then must await a fall to a substantially lower price to come within range of competing against a further good.
Beyond this, there is no constancy of demand curves themselves. Movement along any given demand curve implies changes in the demand curves of a wide variety of other goods. Every time a fall in the price of a good increases the quantity of it demanded by virtue of making
it a more worthwhile substitute for other goods, the demand curves for those other goods fall. Every time a fall in the price of a good inaugurates the income effect, the demand curves for countless other goods rise. Changes occur mutatis mutandis every time the price of a good rises.
Demand curves change because of changes in the prices of complementary goods as well as substitute goods. For example, a rise in the price of gasoline reduces the demand for automobiles and for the labor and other factors of production used to produce automobiles. In effect, a rise in the price of any complementary good— that is, any good which must be used in conjunction with other goods to accomplish a definite purpose—represents a rise in the price of accomplishing the overall purpose. In the face of this rise in the overall price, there is a reduction in the quantity demanded of all of the complementary goods required for accomplishing the desired purpose. Since the individual prices of all of the complementary goods but one are unchanged, the fall in quantity demanded of them represents a fall in demand pure and simple. Obviously, the same point applies with the necessary changes to the case of a fall in the price of a complementary good.
Demand curves change because of changes in the price of any other good whatever insofar as the effect is a change in the expenditure for that other good. For a change in the expenditure for any good means offsetting changes in expenditure for other goods. Demand curves also change because of changes in the quantity of money and the level of money incomes, changes in knowledge, tastes, and preferences, and the discovery or invention of new substitutes or complements. All such changes entail changes in elasticities of demand along with changes in the demand curves. The belief in any kind of measurable constancy of demand curves or of elasticities of demand is a manifestation of the philosophical determinism and arrogance of mathematical economics described earlier. 58
Seeming Exceptions to the Law of Demand
The downward sloping demand curve rests on the bedrock of fundamental economic principles. The fact that, other things being equal, people will buy more of something at a lower price than at a higher price is not contradicted by zones of demand curves in which the quantity demanded does not increase even though the price decreases. In such cases, either a greater decrease in price is what is required to expand the quantity demanded further, or else the good is already purchased to the point of satiety—thanks to the price already being low enough so that the marginal utility attaching to the price is below the marginal utility of the last unit of the good for which any useful employment whatever can be found. In these cases, of course, the effect of a fall in price is still to increase the quantities demanded (and the demands) of all manner of other goods, for whose purchase the lower price of the good in question makes the necessary funds available.
A seeming exception to the law of demand exists in cases in which the demand for a good depends in part on its already possessing a recognized high value in exchange. For example, the demand for gold and silver as a store of value, and ultimately for use as money, depends upon the fact that in their capacity as ordinary commodities they are already highly valuable. It is for this reason, that when people wish to hold buying power in the form of stocks of physical commodities, they turn to gold and silver rather than other metals: the comparatively high value of the precious metals means that they can be used to hold a given store of value in a smaller bulk, which is easier and less expensive to store and transport.
Similarly, the fact that precious metals, diamonds and other precious stones, and various furs already possess a high value as commodities adds to their suitability for being given as gifts: in addition to their physical properties, their existing high value bestows on them the ability to symbolize the importance of the recipient to the giver. In such cases, it is true, if the price of the good fell below a certain point, part of the demand for it would disappear. But this does not mean that people prefer to pay more, other things being equal, rather than less. In these cases, the decline in value would represent a loss of one of the good’s useful properties. The case is comparable to the demand for anything else being less when one or more of its useful properties is impaired. So long as the good retains sufficient value to serve the purposes for which a high value makes it qualified to serve, then, within that zone, the quantity demanded varies inversely with the price in the normal, uncomplicated way. When and if the price declines to the point that the good ceases to be able to serve the purpose that depends on a high value, the case must be understood in terms of the good having been rendered of lower quality.
Thus, the fact that part of the demand for such things as precious metals, precious stones, and various furs would disappear if their value were substantially lower should not be regarded as a contradiction of the law of demand. It is no more a contradiction of it than the fact that, say, grapes which are unsuitable for being made into good wine are less in demand than those which are suitable for being made into good wine, or that cattle incapable of breeding are less in demand than cattle which are capable.
Cases of socalled snob appeal are also essentially similar. If one wishes to be in the company mainly of wealthy people, then restaurants and hotels that only
wealthy people can normally afford derive a further, useful property in the minds of some people by virtue of that fact. One may agree or disagree with these people’s assessment of what is or is not useful or desirable, but one must recognize that their behavior does not contradict the law of demand. So long as the price charged is within the zone of being high enough to restrict the clientele in this way, the normal relationship between price and quantity demanded prevails. And when the price charged falls below this zone, the usefulness of the good is reduced from the perspective of these buyers.
Finally, the law of demand is in no sense contradicted by observations of the fact that over time higher prices are frequently accompanied by increases in the quantity of a good that is demanded. Such results are precisely the effect to be expected from increases in demand—that is, of an upward shift of the demand curve. Increases in demand for this or that good or service can, of course, occur at any time. However, since the abandonment of the gold standard in the United States in 1933, substantial and practically universal increases in demand have become the norm, because of rapid increases in the quantity of money. It should not even be necessary to mention such obvious facts but for the existence of attempts to derive demand curves on the basis of alleged empirical observations.
The Derivation of Supply Curves
While the case for the downward sloping demand curve can be taken as unexceptionable, the same is most certainly not true of the case for the upward sloping supply curve that is presented as typical by contemporary economics textbooks.
It might appear that such a case could be made by working the law of diminishing marginal utility in reverse. For example, it could be argued that a farmer who owns five horses will need a higher price to be willing to part with his second horse than with his first horse, and a still higher price to part with his third horse than with his second, and so on. For as the number of horses remaining in his possession decreases, the marginal utility he attaches to each remaining horse increases. And since the marginal utility he attaches to the price he receives for a horse must exceed the marginal utility he attaches to any horse he sells, the rising marginal utility of his diminishing supply of horses could be taken to imply a need for a rising price of horses as the condition of his offering a larger quantity of them for sale. The same principle could then be applied to all other suppliers of horses and to suppliers of all other goods. On this basis, a case might be thought to exist for assuming that just as demand curves slope downward, so supply curves slope upward.
The law of diminishing marginal utility may well play a significant role in this way in the determination of supply curves in conditions in which the supplies of goods are capable of being used by the suppliers themselves. But, as already pointed out, in the conditions of a
Table 5–2
Hypothetical Total and Partial Demand Schedules
Total Quantity Price
Demanded $10 100 9 125 8 160 7 200 6 250 5 325 4 400 3 500
Quantity Demanded Quantity Demanded in Market I in Market II 060 040 075 050 100 060 125 075 150 100 200 125 250 150 300 200
division-of-labor economy, goods are produced in such enormous concentrations that for all practical purposes they can be viewed as possessing zero marginal utility for their producers. For example, the pin maker, shirt maker, or automobile producer who turns out tens or hundreds of thousands or even millions of units of his product, can attach marginal utility only to an insignificant fraction of his supply. On this basis, Böhm-Bawerk pointed out that it is more reasonable to regard him as attaching no marginal utility whatever to his supply, and thus as being willing to accept any price for his product that he can obtain, from zero on up, as determined by the competition of the buyers. 59 This, of course, is the basis of Böhm-Bawerk and the Austrian school regarding the supply curve as essentially a vertical line, representing a given amount that the sellers are prepared to sell, irrespective of price. 60
Nevertheless, it is possible, with some difficulty, to derive upward sloping supply curves. This can be done by conceiving of them as reflecting the competition for a given overall physical supply that arises from the existence of two or more competing demand curves that represent alternative uses for the same supply. To make this point clear, it is necessary to begin by representing the demand schedule previously shown in Table 5–1, as the summation of two lesser, partial demand schedules. These lesser, partial demand schedules can be understood as the demand for a given good, such as wheat or gasoline, that exists in two distinct geographical markets, such as New York and Chicago, or the demand that exists for wheat or crude oil in two distinct employments, such as the baking of bread versus the making of crackers or the production of gasoline versus the production of heating oil. In reality, of course, the number of partial markets would be far greater, but for the sake of simplicity, we confine ourselves to the consideration of just two, which is adequate to illustrate the principle.
In Table 5–2, the column “Total Quantity Demanded” is identical with the column labeled “Quantity Demanded” in Table 5–1. However, this column is now presented as representing the sum of the quantities demanded at the various prices in Markets I and II, respectively, which are shown in the third and fourth columns of the table.
Figures 5–4 and 5–5 are derived from Table 5–2. Figure 5–4 shows the total demand curve, formed by pairing the prices shown in the first column of Table 5–2 with the quantities demanded in the second column. This results, of course, in the replication of the demand curve DD, previously depicted in Figure 5–1. Figure 5–4 differs from Figure 5–1 only in that a given amount of supply is now assumed to exist, namely, 200 units. This results in the drawing of a vertical supply curve SS, ascending from the quantity 200 on the horizontal axis. The implied equilibrium price of $7 is shown by the
Figure 5–4
Total Demand Curve With Overall Fixed Supply
P
D S $10 9 8 7 6 5 4 3 2
S 1 0 100 200 300 400
D
Q 500 600 700 800 900
intersection of this supply curve with the demand curve DD.
The upper portion of Figure 5–5 shows the demand curves in the two partial markets, Market I and Market II, which when summed, yield the demand curve of Figure 5–4. As can be inferred from Table 5–2, in a state of equilibrium the price both in Market I and in Market II is $7, with Market I purchasing 125 units, and Market
II, 75 units, of the total supply of 200 units. Nevertheless, it is possible to imagine one of the markets, say, Market II, purchasing varying parts of the total supply, from none of it whatever, all the way on up to the entire 200 units. The various possibilities for the division of the supply between Market II and Market I are shown in Figure 5–5 in the diagram immediately below the diagram for the
Figure 5–5
Derivation of the Upward Sloping Supply
Demand in P D I Market I
Curve from a Competing Demand Curve
Demand in
P D II Market II S II
$10 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - $10 - - - - - - - - - - - - - - - - - - - - -
--
9 - - - - - - - - - - - - - - - - - - - - - - - - -
--
- - - - - - - - 9 - - - - - - - - - - - - - - - - -
200 150 100 Q 0 8 7 6 5 4 3 2 1 I 50 Supply - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Supply - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - for - 100 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Market for - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Market - - - - - - - - 150 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - I - - - - - - - Equals - - - - - - - - - - - - - - I - - - - - - - - Q - - - - - - - D 200 - - I= - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - I - - - Q - - - - - - - - - I - - - - - - - - - Q - - - - - - - - - - I - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 200 150 100 - - - - - Q - - - - - - - - - - 8 7 6 5 4 3 2 1 - 0 I - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - S - - - - - - - II - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 50 - - - - - - - - - - Between Allocation - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 100 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - the - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - of Markets Supply - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 150 D 200 II Q II
50
45˚
Q I
0 50 100 150 200
50
Q II
0 50 100 150 200
Market II demand curve, that is, in the diagram labeled “Allocation of Supply Between the Markets.” The allocation line is drawn as the base of an isosceles triangle, with the vertical and horizontal axes forming legs of equal length. Where the allocation line crosses the vertical axis, which is labeled Q I , the entire supply of 200 units is shown as going to Market I and none at all as going to Market II. Where the allocation line crosses the horizontal axis, which is labeled Q II , the entire supply of 200 units is shown as going to Market II and none at all to Market I. The various intermediate points on the allocation line show the various other possible combinations of supplies going to the two markets.
The diagram in the lower left-hand corner of Figure 5–5, labeled “Supply for Market I Equals Supply for Market I,” has the purpose merely of showing the supply for Market I on the horizontal rather than on the vertical axis, which is where it is shown in the “Allocation of Supply Between the Markets” diagram. This is accomplished by drawing a 45 degree line through the origin. Every point on this line represents an equal distance along both axes.
Thus, on the basis of these four interrelated diagrams in Figure 5–5, it is possible to see that the greater is the supply in Market II, the smaller is the supply that remains in Market I. At the same time, corresponding to every given supply in Market I, there is a definite price in Market I, determined by the demand curve in Market I. The price paid for the supply in Market II, must match the price paid in Market I. And since the larger is the supply in Market II, the smaller is the supply that remains for Market I, the higher must be this price.
In this way, it is possible to trace out an upward sloping supply curve in Market II. We begin in the upper righthand diagram with a supply in Market II of zero units. Reading down along the dashed line to the lower righthand diagram, this implies a supply available for Market I of all 200 units. Reading now along the dashed line across to the lower left-hand diagram and then up to the upper left-hand diagram, it is clear that with a supply of 200 units, the price in Market I will be $5. This is the price at which the quantity demanded in Market I equals 200 units. If the price offered in Market II is not above $5, the implication is that Market II has no way to bid supplies away from Market I. Reading the dashed line across from the upper left-hand diagram to the upper righthand diagram, it is clear that a price of $5 and a supply of zero units can be considered as a point on the supply curve in Market II. This is shown in the diagram for Market II.
The remaining points on the supply curve in Market II are derived by the same method, as shown by additional dashed lines. Examination of the set of diagrams shows that in order for a supply of 50 units to be attracted to Market II, which would leave 150 units for Market I, a price of $6 must be paid. For only at that price is the quantity demanded in Market I reduced to 150 units, thereby releasing 50 units of supply for Market II. Similarly, examination of the diagrams shows that in order for a supply of 75 units to be attracted to Market II, leaving only 125 for Market I, a price of $7 must be paid, since only at that price will the quantity demanded in Market I be reduced to 125 units, and 75 units be released for Market II. In the same way, a price of $8 in Market II will attract 100 units to that market, for at a price of $8 in Market I, the quantity demanded is reduced to 100 units and thus 100 units of the total supply are made available for Market II. A price of $9 in Market II will attract 125 units, for at that price the quantity demanded in Market I falls to 75 units, thereby releasing 125 units of the total supply for Market II. Finally, a price of $10 in Market II will attract 140 units, because at that price, the quantity demanded in Market I is only 60 units, thereby releasing 140 units of the total supply to Market II. Connecting these various points constitutes the drawing of the supply curve for Market II.
In effect, the supply curve in Market II is upward sloping by virtue of the fact that bringing additional supplies into Market II requires riding up the demand curve of Market I, so to speak, as the condition of outbidding Market I for progressively greater supplies. The principle is that the greater is the supply in Market II, the smaller is the supply and thus the higher is the price in Market I. It is the rising price in Market I, in the face of dwindling supplies in that market, that necessitates that larger supplies in Market II be accompanied by rising prices, in order to outcompete the buyers in Market I.
The supply schedule underlying the supply curve for Market II can be derived by means of subtracting from the total supply of 200 units available for both markets the quantities demanded at the various prices in Market I. This is done in Table 5–3.
It would be possible, of course, to apply the above procedure to derive an upward sloping supply curve for Market I from the demand curve in Market II. An upward sloping supply curve in any given partial market can be understood as resulting from the downward sloping demand curve(s) in one or more other markets that are in competition for the same overall given total supply.
Limitations of Geometrical Analysis
It should be obvious that the procedure followed for deriving an upward sloping supply curve is extremely cumbersome even when confined to just two partial markets. To apply the procedure to three partial markets would require the use of solid geometry, to show how a
Table 5–3
Derivation of an Upward Sloping Supply Schedule from a Downward Sloping Demand Schedule
Quantity Demanded in
Price
Market I
$10 060
9 075
8 100
7 125
6 150
5 200
4 250
3 300 definite supply in any given market implied various definite pairs of supplies in the other two markets. The simultaneous relationships between four or more partial markets simply cannot be shown by geometrical methods.
What is implied here is a limitation on the usefulness of supply and demand curves and of geometry in general in economic analysis. True enough, one may think in such terms as, say, fifty partial markets, each with its own demand curve, and with a larger supply in any one market causing diminished supplies in each of the remaining forty-nine partial markets and a corresponding riding up along the demand curves of those forty-nine partial markets. But at this point, even though the analysis makes reference to supply and demand curves, the references and the analysis itself have become purely verbal.
A case such as this clearly shows why the substantive relationships of economics must all be explained by an essentially verbal analysis. Geometry is capable of relating two, or at most three, elements at the same time, and can neither make qualitative distinctions among them nor consider any further aspects pertaining to them without regarding what it previously considered to be one element alone, now to be two or more elements—something which rapidly exhausts and then utterly surpasses its capacity for analysis. In contrast, a verbal analysis is capable of proceeding both in far greater breadth and in far greater depth. The relatively simple set of verbal principles concerning price determination presented in Chapters 6 through 8 of this book, will make it possible to grasp the competition that goes on for limited total supplies between any number of partial
Quantity Supplied in
Total Supply
Market II
200 140
200 125
200 100
200 075
200 050
200 000
200 000
200 000 markets. Those principles will also make it possible to understand in a far more meaningful way than is possible by the mere visualization of the intersection point of two curves the market processes by means of which prices are actually determined.
Contemporary economics, for the most part, is not troubled by the needless complexities and limitations created by an excessive reliance on the use of geometry, because, for all practical purposes, when it comes to price theory, its intellectual horizon is narrowly limited to that of partial equilibrium. 61 In effect, the problems of relating what goes on in different partial markets do not arise for contemporary economics, because it is concerned only with what happens in one given market at a time. It does not derive the upward sloping supply curve it presents as typical from any consideration of competition among various partial markets, but from the operation of the law of diminishing returns.
The procedure of contemporary economics is to take the prices of the factors of production as given from the point of view of the individual business enterprise. It then assumes that as the enterprise increases its output from existing plant and equipment, it encounters diminishing returns—less output per unit of the additional factors of production—which implies that larger quantities of the additional factors of production are needed to produce equal additional units of the product. Given the prices of the factors of production, this means rising marginal costs per unit. (“Marginal costs” are the addition to total costs accompanying the production of a given additional
quantity of the product. With plant and equipment taken as fixed, they are the cost of additional labor, materials, and fuel. It is these costs which are assumed to increase per unit of additional output.) The supply curve of an industry is then assumed to consist of a summation of all such individual supply/marginal-cost curves of the constituent firms. Indeed, it is assumed to consist of a mere multiplication of the supply/marginal-cost curve of any one of the various allegedly interchangeable “representative firms” of which the industry is assumed to consist, by the number of such firms. 62
Confusions Between Supply and Cost
Ironically, resort to the law of diminishing returns as the basis for upward sloping supply curves turns out to be inapplicable to actual price formation in the cases in which it might appear to be most plausible—namely, agriculture and mining. These are cases in which diminishing returns occupy a prominent position and are reinforced by the closely related phenomenon of the need to resort to progressively inferior grades of land or mines in order to expand production under a given state of technology. Nevertheless, precisely in these cases, output comes in large discrete bursts, because it is seasonal and depends on the harvests, or because it can be increased or decreased only by substantial discrete increments as, for example, accompany the adding on or elimination of shifts of mine workers or the working or not working of this or that seam of mineral deposit.
In these cases, the concept of supply that is relevant to price formation is the Austro-classical concept of a fixed quantity, with price being determined by the competition of the buyers for that quantity. When the law of diminishing returns is taken as the basis of supply curves and thus of price formation in an industry, via the concept of marginal cost, the result is conceptual chaos of such magnitude that its sorting out is best left for a separate discussion. 63
The derivation of the upward-sloping supply curve from a rising marginal-cost schedule is only one aspect of the confusions contemporary economics suffers from in connection with the relationship between the concepts of cost of production and supply. In agriculture and mining, it confuses cases in which price is actually determined by demand and supply with determination by cost of production in the form of “marginal cost.” In manufacturing, wholesaling, and retailing, it confuses cases in which prices are actually determined in the first instance by cost of production—the full cost of production—with determination by demand and supply. Indeed, this is its most serious confusion in that it totally obscures the very existence of cases in which price is directly determined on the basis of cost, by making them appear to be merely another instance of price determination falling under the general rubric of demand and supply.
Thus, contemporary economics admits the existence of cases in which the supply curve is horizontal, as in Figure 5–6 or, indeed, even downward sloping, as in Figure 5–7. In such cases, however, it continues to proceed as though prices were determined by demand and supply, merely because one can show demand curves intersecting such supply curves.
The case of horizontal supply curves is actually extremely common—probably more common than that of upward sloping supply curves. It describes the willingness and ability of sellers to supply a variable quantity at a given price. It is typical in retailing, wholesaling, manufacturing, and the service industries. For example, at the prices posted on its menu, a restaurant is prepared to serve a number of meals ranging from zero on up to the maximum number it can prepare in its kitchen. The same kind of wide-ranging variability in quantity is true of the number of haircuts a barbershop is willing to provide at the price it posts for haircuts, of the number of television sets an appliance store is willing to sell at the prices it posts, and of the quantity virtually any manufacturer is willing to sell of his product at the price he posts. One can express this phenomenon by saying simply that the supply curve is horizontal, and one can then bring the case under the formula that the price is determined by demand and supply, merely because there is a demand curve and a supply curve, and they have an intersection point.
Nevertheless, it should be obvious that the alleged
Figure 5–6
A Horizontal Supply Curve
P
S S
Q
0
Figure 5–7
A Downward Sloping Supply Curve
P
S
S
0 Q determination of price by demand and supply is totally superficial in cases of this kind. The price is actually determined by the decisions of the sellers. Their asking price, together with the demand curve, determines the quantity of the good that is demanded, and the quantity of the good demanded then determines the quantity supplied at the asking price. The critical question is, what determines the asking prices of the sellers? The answer, as we shall see, is consideration by the sellers of the cost of production of the item—either their own cost of production or that of competitors or potential competitors. Normally, we shall see, cost of production turns out to be the immediate determinant of the prices of manufactured or processed goods—of any goods or services whose quantity can be immediately expanded or contracted in response to changes in demand by such means as the ability temporarily to decrease or increase inventory levels and, before the inventories are depleted or accumulate unduly, to increase or decrease production from existing plant capacity. 64
Cases of this kind may appear to represent a direct contradiction of Böhm-Bawerk’s proposition that prices are determined by the competition of buyers for limited supplies. For these are cases in which price is determined by the competition of sellers prepared to offer highly variable supplies. 65 Actually, there is no contradiction between the two patterns of price formation. They pertain to different situations—one to cases in which supply is a given quantity for a longer or shorter period of time, and the other to cases in which supply can be varied in immediate response to changes in demand. Furthermore, it cannot be stressed too strongly that the bridge between the two cases has been provided by none other than Böhm-Bawerk himself, in his demonstration that determination of value and price by cost of production is itself merely a special case of the operation of the law of diminishing marginal utility. 66
At most, cost of production is a determinant of prices only in the first instance. When one investigates the nature of costs, they are always revealed as constituted by prices of factors of production. These prices are themselves determined by demand and supply, or on the basis of costs that reflect the operation of demand and supply at a further stage of remove. Ultimately, prices determined on the basis of costs are determined on the basis of demand and supply—but on the basis of demand and supply operating in broad factor markets, not the market for the individual product itself. Thus, for example, in saying that the price of new automobiles is determined by cost of production, rather than demand and supply, what is actually meant is that it is determined in the first instance by cost of production; but the wage rates, real estate prices, and many of the raw materials prices—all the prices into which the cost of production of an automobile is ultimately resolvable—are determined by demand and supply. 67
Downward sloping supply curves represent cases in which cost per unit declines as the level of production expands. The charging of lower prices in the face of higher levels of demand, which make possible operation on an expanded scale, is also clearly a case in which prices are set in the first instance on the basis of a consideration of costs of production—specifically, the ability to use declining costs to gain a decisive advantage over potential competitors by charging prices too low for their operations to be profitable, but which are not too low for one’s own operations to be profitable.
The confusions of contemporary economics are such that it is largely unaware that in the cases of horizontal and downward sloping supply curves, it actually is dealing with situations in which cost of production is the immediate determinant of prices. Insofar as it is aware that these cases are different, it regards the resulting prices as standing virtually outside the operation of normal economic law—as representing “administered” prices, set more or less arbitrarily by one or another type of wielder of “monopoly power,” on the basis either of evil motives or at least peculiar motives. These confusions are the result of the fact that contemporary economics has lost the ability to understand determination of price by cost. It cannot deal with cases in which prices are set on the basis of a consideration of the full costs of
THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I 169 production, together with an allowance for earning the going rate of profit, rather than on the basis merely of marginal costs. 68
Putting aside all the confusions that have characterized their use, it is an obvious fallacy to believe that demand and supply curves can ever be derived from empirical observation. Any price and quantity demanded and supplied that one can observe is necessarily only a single point on a demand and supply curve. And, it could, conceivably, be a point on any one of a virtually infinite number of such curves! For through a given point, there is no limit to the number of lines that can be drawn—even if, as in the case of the demand curve, they must possess a negative slope.
Whenever a new price and quantity demanded and supplied are observed, it is inescapable that at least the demand curve or the supply curve has changed, and more than likely that both have changed. If neither had changed, the change in price and quantity would not have been possible. The conclusion to be drawn from this is that when different prices and quantities are observed over time, absolutely no rational basis exists for believing that what is being observed is movement along any given curve.
As previously explained, it should also be apparent on this basis that observations of rising prices associated with rising quantities demanded over time are perfectly consistent with the law of demand. The combination is explained simply by increases in the demand schedule— most likely, nowadays, as the result of an increase in the quantity of money.
The Circularity of Contemporary Economics’
Concept of Demand
Contemporary economics’ concept of demand encounters a problem of circularity. It explains each individual price on the basis of demand and supply. But the demand curve in each case presupposes all other prices in the economic system: it is constructed on the assumption of their existing and remaining unchanged. Yet if the formation of those other prices is to be explained on the basis of demand and supply curves, then the price of the good in question, which is supposedly first to be explained by demand and supply curves, must already be presupposed. Fortunately, the classical concept of demand, when taken in conjunction with the law of diminishing marginal utility, provides a way out of this circularity.
The classical concept of demand makes it possible to understand the absolute level of prices on the foundation of the quantity theory of money, which will be explained in Chapter 12. At the same time, the law of diminishing marginal utility shows that the relative prices of all goods and services that exist in some definite, given supply at any given time, are determined by their relative marginal utilities. 69 For example, the prices of wheat, crude oil, skilled and unskilled labor, the various improved and unimproved land sites, and so forth are all determined in such a way that the marginal utility attaching to the price in each case is below the utility of the marginal unit of the good in question and above the utility of a potential additional unit of the good in question. This means that the prices of these goods relative to one another reflect their relative marginal utilities. In this way, the prices of goods and services in limited supply can be explained without the error of circular reasoning. And because prices determined by cost of production are based on such prices, all prices can thus be explained without falling into the error of circular reasoning. 70
Notes
1. See Ayn Rand, “What Is Capitalism?” in Capitalism: The Unknown Ideal, ed. Ayn Rand (New York: The New American Library, n.d.), pp. 9–12. See also Leonard Peikoff, Objectivism: The Philosophy of Ayn Rand (New York: New American Library, 1992), pp. 380–384.
2. A division-of-labor, capitalist society is, of course, characterized by the existence of medium and large-sized business enterprises, in which large numbers of individual wage earners produce under the direction of businessmen and capitalists. But the formation and extent of all such enterprises is itself the product of the separate, independent thinking and acting of all the individual participants. The individual stockholders decide the extent to which it is advantageous to pool their capitals and employ other people; the individual wage earners decide the extent to which working for such an enterprise is to their advantage compared with working on their own, as businessmen, and with working for any other such enterprise.
3. My discussion of this subject is completely indebted to the writings of von Mises and Hayek. See Ludwig von Mises, Socialism (New Haven: Yale University Press, 1951), pp. 111–142, 211–220, 516–521; reprint ed. (Indianapolis: Liberty Classics, 1981); idem, Human Action, 3d ed. rev. (Chicago: Henry Regnery Co., 1966), pp. 689–715. See also F. A. Hayek, The Road to Serfdom (Chicago: University of Chicago Press, 1944), pp. 48–50.; Individualism and Economic Order (Chicago: University of Chicago Press, 1948), pp. 33–56, 73–91, 119–208.
4. For a detailed discussion of the economic chaos of a socialist
state, see below, pp. 269–275, and the references cited in the preceding note of this chapter.
5. See Hedrick Smith, The Russians (New York: Quadrangle/New York Times Book Company, 1976), pp. 60–61. 6. The quotation is from Henry H. Villard, Economic Development (New York: Reinhart & Co., 1959), p. 171. Italics supplied. 7. Robert Kaiser, Russia (New York: Atheneum, 1976) p. 338. 8. For elaboration on the nature of economic planning under capitalism, see below, pp. 269–275, and 172–294 passim. 9. On the indivisibility of property rights and all other rights, see above, p. 23.
10. This insight, of course, is one of the greatest contributions of von Mises. See above, n. 3.
11. For elaboration of this fundamental fact, see below, pp. 682–699.
12. The truth is that to some extent the consumers’ goods that are paid for in the present can be traced back to the performance of labor in the remotest periods of antiquity, indeed, to the point when man first began to use previously produced goods in the production of all goods. However, the extent to which goods of the present owe their existence to labor performed in the past diminishes in geometric progression. See below, pp. 820–824 and 852.
13. See below, p. 824. See also Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland, Ill.: Libertarian Press, 1959), 2:79–118.
14. For a precise, arithmetic illustration of this point, see below, p. 360.
15. On the relationship between the accumulation of capital and the division of labor, cf. Adam Smith, The Wealth of Nations (London, 1776), bk. 2, Introduction; reprint of Cannan ed. (Chicago: University of Chicago Press, 2 vols. in 1, 1976). 16. Cf. Henry Hazlitt, Time Will Run Back (New Rochelle, N. Y: Arlington House Publishers, 1966); originally published as The Great Idea (New York: Appleton-Century-Crofts, 1951) p. 155.
17. For an account of the origin and evolution of money and the contemporary monetary system, see below, pp. 506–517. 18. Cf. von Mises, Socialism, p. 121.
19. And, as von Mises has shown, it provides the only such standard. See Socialism, pp. 113–128, 131–135.
20. For a brilliant defense of the moral value of money and of the proposition that money is the root of all good, see Ayn Rand, Atlas Shrugged (New York: Random House, 1957), pp. 410– 415.
21. Knowledge of the dependence of the division of labor on the existence of money sheds major light on the causes of the collapse of the Roman Empire, which took place following a century-long process of the destruction of money through inflation. See below, p. 950. The whole of Chapter 19 and much of Chapter 12 make clear the potential for inflation and destruction inherent in the present monetary system.
22. For a brilliant critique of the doctrine of from each according to his ability to each according to his need, see Ayn Rand, Atlas Shrugged, pp. 660–670.
23. On these points, see below, pp. 613–664 passim, and 580– 589.
24. Cf. Ludwig von Mises, Socialism, pp. 319–321.
25. The passage of the Norris-La Guardia Act in 1932 eliminated the possibility of gaining federal court injunctions against mass picketing.
26. For a detailed discussion of these points, see below, pp. 420–421.
27. Of course, economic inequality can also result from differences in luck, but such differences are of relatively minor importance in comparison with the kind of differences described above and are certainly not of sufficient importance to detract in any way from the significance of these differences. 28. The discussion in this and the next several paragraphs was inspired by Henry Hazlitt’s Time Will Run Back, pp. 88–91. 29. See ibid.
30. For a demonstration of how the accumulation of great fortunes is a case of one man’s gain being other men’s gain, see below, pp. 327–328.
31. For further explanation of why incomes that represent high rates of profit are heavily saved, see below, pp. 741–743. 32. See Milton Friedman, A Theory of the Consumption Function (Princeton, N. J.: Princeton University Press, 1957). 33. For elaboration of this point, see below, pp. 355–356. 34. On the feudalistic-type economic inequalities necessarily prevalent under socialism, see below, pp. 288–290.
35. See above, p. 23., for an explanation of why almost all violations of freedom entail violations of property rights. See also below, pp. 331–332, for a demonstration of the fact that the economic advantages of the feudal aristocracy vis-à-vis the serfs rested on a foundation of government power, not economic power, and were the result of a violation of property rights rather than of the use of property rights.
36. For further discussion of inheritance, see below, pp. 306– 308.
37. See below, pp. 326–330 for a comprehensive demonstration of this fact.
38. The New York Times of January 8, 1994, reported an instance of this error with some degree of fanfare, on its first business page, as though it represented a scholarly finding. 39. For a freemarket solution to the growing problems in the area of medical care, see below, pp. 378–380. See also George Reisman, The Real Right to Medical Care Versus Socialized Medicine (Laguna Hills, Calif.: The Jefferson School of Philosophy, Economics, and Psychology, 1994.) This pamphlet is a discussion of all aspects of the cause and cure of the current crisis in medical care.
40. See von Mises, Human Action, p. 333.
41. See John E. Cairnes, Some Leading Principles of Political Economy Newly Expounded (1874; reprint ed., Fairfield, N. J.: Augustus M. Kelley, 1967), pp. 22–29.
42. See John Stuart Mill, Principles of Political Economy, Ashley ed. (1909; reprint ed., Fairfield, N. J.: Augustus M. Kelley, 1976), p. 445.
43. See Böhm-Bawerk, Capital and Interest, 2:244–245. 44. No significance should be attached to the fact that the demand curve in Figure 5–2 is drawn as a straight line. It is drawn that way merely for the sake of convenience and is in accordance with the present-day practice of drawing such curves. 45. Ibid.
46. Ibid.
47. See ibid.
THE DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM I 171
48. See below, pp. 219–221 and 503–506.
49. See above, pp. 53–54, and, below, pp. 566–568.
50. Indeed, it will subsequently be shown in detail that more aggregate supply itself creates equivalently more aggregate real demand precisely in this way. See below, pp. 559–564, especially Figure 13–3, on p. 561.
51. For an explanation of the law of diminishing marginal utility, see above, pp. 49–51.
52. In case the reader is wondering what would happen if the marginal utility attached to a unit of the good and to its price were the same, the answer is, nothing. The precondition of a purchase is the valuation of what is received in exchange above the valuation of what is given in exchange. Actually, as determinants of purchases, marginal utilities should be thought of in terms of ordinal rather than cardinal numbers. On this subject, see von Mises, Human Action, pp. 119–127.
53. Insofar as it is businessmen who buy cotton instead of wool, they will not be the parties who have the gain in marginal utility described here. Those who have the gain in marginal utility will be the consumers of cotton clothing. Precisely as a result of this fact, the consumers will favor the purchase of cotton clothing, and because of this the businessmen will buy more cotton and less wool. The change in the businessmen’s purchases is thus dictated by the effects of changes in marginal utility on the consumers.
54. On the fallacies entailed in viewing a saving of expense as actually the same as an increase in income, see below, pp. 456–459.
55. To anticipate later discussion under the heading of Say’s Law: given the quantity of money and volume of spending in the economic system, what determines the price level and the goods and services the aggregate demand is actually capable of purchasing at any given time is nothing other than the aggregate supply of goods and services. In this way, it is aggregate supply that determines the aggregate real demand. See above, n. 50 of this chapter for further reference.
56. The saving of labor and increase in employment must be understood in terms of the overall, total quantity of labor directly or indirectly required in the production of the product. In the case of automobiles, for example, this means the labor required in the production of the iron ore and steel sheet, all the various parts and the materials required to produce them, and the equipment used at all the various stages, as well as the labor required in the auto plants. If a reduction in the overall quantity of labor required per unit of a product can be assumed to result in a corresponding reduction in the unit cost and price of the product, then a more than proportionate increase in the quantity of the product demanded results in an increase in overall employment in the production of the product.
57. See below, pp. 408–409.
58. See above, p. 9.
59. See Böhm-Bawerk, Capital and Interest, 2:244.
60. See above, p. 154.
61. See above, p. 7.
62. See, for example, Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw-Hill, 1989), pp. 540–545. See also above, pp. 7–8, for a critique of the doctrine of the representative firm.
63. See below, pp. 425–437, which are a critique of contemporary economics’ doctrine of “pure and perfect competition.” 64. See below, pp. 200–201.
65. This was the kind of case Ricardo considered typical. See The Works and Correspondence of David Ricardo, 11 vols., ed. Piero Sraffa (Cambridge: Cambridge University Press, 1952– 73), 8:276–277. The essential passage from Ricardo is quoted below, on p. 414.
66. See above, p. 52, and below, pp. 414–416, for the previously referenced lengthy quotation from Böhm-Bawerk on this subject. 67. See below, p. 201.
68. See below, pp. 425–437 passim.
69. More correctly, insofar as they themselves are not consumers’ goods, their relative prices are determined by the relative marginal utilities of their final products to the ultimate consumers. 70. See below, pp. 200–201, 209.
Capitalism: A Treatise on Economics
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