§7. Opportunities as to Repairs, Renewals, Betterments

In the foregoing examples the options consisted of different employments of a particular instrument or set of instruments of capital which were assumed to retain their physical identities throughout the period of those employments. But now let us regard an instrument, or group of instruments, of capital as retaining only a sort of fictitious identity, through renewals or repairs, just as the proverbial jack-knife is said to be the same knife after its blade and then its handle have been replaced. This brings us to another large and important class of options; namely, the options of effecting, or not effecting, renewals and repairs, and the options of effecting them in any one of many different degrees. If the repairs are just sufficient for the up-keep they may be called renewals; if more than sufficient, or if involving improvement in quality, they may be called betterments. But it will be convenient to include in thought all alterations as to the form, position, or condition of an instrument or group of instruments affecting its stream of services. Edition: current; Page: [195] This will cover the whole subject of the production of reproducible goods.

This class of optional employments, when the employment involves sales from a stock, merges imperceptibly into the special case which we originally called the method of modifying an income stream by buying or selling. Thus, consider a merchant who buys and sells rugs. His stock of rugs is conveniently regarded as retaining its identity, although the particular rugs in it are continually changing. This stock yields its owner a net income equal to the difference between the gross income, consisting of the proceeds of sales, and the outgo, consisting chiefly of the cost of purchases, but including also cost of ware-housing, insurance, wages of salesmen, and so on.

If the merchant buys and sells equal amounts of rugs and at a uniform rate, his stock of rugs will remain constant and its net income to be credited to that stock will theoretically, that is, under our present assumption of a riskless world, be equal to the interest upon its value. It will be standard income.73 This income to be credited to his stock in trade is, of course, to be distinguished from that to be credited to his own efforts—his wages of super-intending (neither need be called profits in a riskless world).

But the owner has many other options than that of thus maintaining a constant stock of goods. He may choose to enlarge his business as fast as he makes money from it, in which case his net realized income will be zero for a time, because all return is "plowed back" into the business. His stock will increase and eventually his income will be larger. In this option, therefore, his income stream is not contant, but ascends from zero to some Edition: current; Page: [196] figure above the standard income which constituted the first option.

A third option is gradually to go out of business by buying less rugs than are sold, or none at all. In this case the realized income at first is very large, as it is relieved of the burden of purchases; but it declines gradually to zero.

Intermediate among these three options there are, of course, endless other options. The merchant thus has a very flexible income stream.

If the expenses and receipts for each rug bought and sold are the same, whichever option is chosen, and if the time of turnover is also the same, it will follow that all of the options possess the same present value and differ only in desirability. We should then be dealing with what we have called modifications of the income stream through buying and selling. The reason for placing optional employments of capital on a different footing from buying and selling is that the optional employments do not all possess the same present value. In actual fact, the rug merchant, and merchants in general, would not find that all the optional methods of proportioning sales and purchases of merchandise possessed equal present values. For one thing, if the rug merchant attempted to enlarge his business too fast he would find that his time of turnover would be lengthened, and if he reduced it too fast he would find that his selling expenses per unit of merchandise would be increased. There is, for each merchant, at any time, one particular line of business policy which is the best, namely, that which will yield him the income stream having the maximum present value. Since, therefore, the various methods of renewing one's capital usually yield income streams differing in present value, Edition: current; Page: [197] they may be properly classed as optional employments of such capital.

The propriety of such a classification becomes still more evident when, instead of mere renewals, we consider repairs and betterments, for it is clear that the income from a farm has a very different present value according as it is tilled or untilled, or tilled in different degrees of intensity, that the income from a house so neglected that a leak in the roof or a broken window pane results in injuring the interior is less valuable than the income it would yield if properly kept up, and that real estate may be underimproved or overimproved as compared with that degree of improvement which secures the best results.

In all cases the "best" results are secured when that particular series of renewals, repairs, or betterments is chosen which renders the present value of the prospective income stream the maximum. This, as we have seen, is tantamount to saying that the renewals, repairs, or betterments are carried up to the point at which the marginal rate of return over cost which they bring is equal to the rate of interest. The owner of an automobile, for instance, will replace a broken part and so prolong the life of his automobile. The first repair may cost him $10 and may save him $200. But such a twenty-fold return cannot be expected from every repair, and beyond a few such really necessary repairs, it soon becomes a question to what extent it is worth while to keep an automobile in repair. Repainting the body and regrinding the valves are both costly, and though, in such instances, the service of the automobile is increased in quantity and improved in quality, the return grows less and less as the owner strives after increased efficiency. Under our present hypothesis Edition: current; Page: [198] in which risk is disregarded, he will spend money on his automobile for repairs and renewals up to that point where the last increment of repairs will secure a return which will just cover the cost with interest. Beyond this he will not go.

In practice, of course, the choice between the various possible repairs, renewals, or betterments will involve some corresponding choice between possible employment of labor, land, and every agent of production. But I have tried here to isolate for study the services and disservices of a physical instrument subject to repairs, renewals, or betterments.

Another case of optional income streams is found in the choice between different methods of production, especially between different degrees of so-called capitalistic production. It is always open to the prospective house builder to build of stone, wood, or brick, to the prospective rail-road builder to use steel or iron rails, to the maker of roads to use macadam, asphalt, wood, cobble, brick, or cement, or to leave the earth unchanged except for a little rolling and hardening. The choice in all cases will depend theoretically on the principles which have been already explained.

To take another example, the mere services of a house which has a durability of 100 years will be equivalent to the services of two houses, each of which has a durability of 50 years, one built today and lasting 50 years, and the other built at the expiration of that period and lasting 50 years more; yet the one house may well be better than the two. The difference between the one and the two will not be in the services but in the cost of construction. The cost of constructing the 100-year house occurs in the present; that of the two successive 50-year houses Edition: current; Page: [199] occurs half in the present and half at the end of 50 years. In order that the more durable house may have any advantage as to cost, the excess of its cost over the cost of the less durable one must be less than the present value of the cost of replacing it 50 years later.

The choice between different instruments for effecting the same purpose may, of course, depend on their relative efficiency, that is, the rate of flow of income, or upon their relative durability, that is, the time of the flow. It is true, however, as John Rae has pointed out,74 that efficiency and durability usually go hand in hand. A house which will endure longer than another is usually more comfortable also; a tool which will cut better will usually wear out more slowly; a machine which does the fastest work will generally be the strongest and most durable.

The alternatives constantly presented to most business men are between policies which may be distinguished as temporary and permanent. The temporary policy involves the use of easily constructed instruments which soon wear out, and the permanent policy involves the construction at great cost of instruments of great durability. When one method of production requires a greater cost at first and yields a greater return afterward, it may be called, conformably to popular usage, the more capitalistic of the two. The word capitalistic refers to methods of employing capital which tend toward an ascending income stream. Although the term is not a happy one, it has a plausible justification in the fact that an ascending income stream means the accumulation of capital, or saving, and still more in the fact that only a capitalist can afford to choose a method of production which at first yields little or no income, or even costs some Edition: current; Page: [200] outgo. Capital involves command over income without which no one could subsist, or at any rate subsist with comfort. The capitalist, by using his capital, even to the extent of using up some of his accumulations, can supply himself with the immediate income necessary while he is waiting for returns on his new ventures. It is as a possessor of income that he is enabled to subsist while waiting. He is enabled to invest in an ascending, or slowly returning, income stream only by first having at command a quickly returning income stream. We may say, therefore, that a capitalistic method is a method resulting in an ascending income stream, and it is so called because it is open chiefly to those who have command of other—often descending—income streams, such persons being necessarily capitalists, that is, possessors of much rather than little capital.