§7. The Nature of the Opportunity Line Discussed

This chapter differs from Chapter X chiefly in the introduction of the concept of investment opportunity which is depicted on the charts as the Opportunity line, or O line. Just what does this line represent in the real world? Is there any distinction between investing in the opportunities offered by man's environment and lending at the market rate of interest? Is not lending, or buying a bond, just as truly investing as digging an oil well, building a factory, or making shoes? Reserving the merely verbal part of the answer, let us first go to the main question as to the possibility of definitely distinguishing the two lines.

Under the assumptions explained in Chapters V, VI, VII, and VIII, there is a clear distinction between an O line and an M line. The O line, unlike the Market lines, is not straight, is not common to all individuals, and is not a family of lines but a single line. It may be defined as the limiting line of a group of points which represent all the optional income situations available to an individual who Edition: current; Page: [278] neither borrows nor lends. Every one has opportunities to shift along his O line at a rate above or below the market rate of interest, even if it be merely in the degree of care he gives his clothes, his house, his fences, or even his food. At a certain stage it is literally true that a "stitch in time saves nine". That is, mending one's clothes yields 900 per cent. But beyond a certain point mending one's clothes, or a roof, painting a house, or tilling the soil will not repay the cost. Each activity has its marginal point and enters into the construction of every person's O line. An individual's Opportunity line is a composite of his separate potential activities—what he might do if he chose.

Of course the O line cannot be drawn without the aid of valuations which involve the market principles and so involve the rate of interest. The farmer who encounters the law of diminishing returns in agriculture buys machinery and labor and sells grain. His O line is thus some-what dependent on the prices of machinery and, since the price of every good is a discounted valuation, it depends on the rate of interest. Only in a primitive or imaginary Robinson Crusoe land can we get a pure case of investing successive amounts of this year's income for the sake of getting a diminishing return in future years without the presence of some buying or selling as an ingredient in the make-up of the O line. It is largely because the element of the rate of interest is almost omnipresent in the valuations entering into the O line that the other and essential ingredient of technical limitations has been overlooked so generally. Even the farmer does some of that omnipresent trading, but besides this trading with other men, he is dealing with nature—the soil, the seasons, the weather, insect enemies, and all the rest. Every investment Edition: current; Page: [279]in his farm will have a variable decreasing return as contrasted with the (to him) constant return to be got in the loan market. Yet every investment in his farm will somewhat imply an interest element and will theoretically change as the interest rate changes. Thus, strictly speaking, his O line is not to be pictured as immovable like a rock but as subject to some slight change with every change in the slope of the M line. Nevertheless this fact evidently does not alter the principles by which the slope of the M line is determined. The M line still rolls around an O line, even if that curve changes a little as it rolls.

The O lines have been exemplified by the law of decreasing returns in agriculture. Such a curve is concave toward the origin and represents a law of decreasing returns in the sense that each succeeding dose of $100 invested out of this year's income will return less and less next year.

But may there not be a law of increasing return? That is, may not the curve be convex in parts instead of concave?

We may imagine the O line, bounding or enclosing the group of points representing the possible options, to be convex or to have any conceivable shape. It may be reentrant, jagged, discontinuous, straight in parts. It is largely for convenience that we have hitherto pictured it as concave, curved and continuous. But if it were otherwise, almost the same result would follow. The line PQ would still roll around it. The result would evidently be that, wherever the curve was re-entrant (convex toward the origin), the straight Market line, in rolling around the group of points, would jump across this chasm at the slightest provocation due to a change in the interest rate. Edition: current; Page: [280] These re-entrant parts would be as inoperative as if they did not exist, and only the points on which the rolling took place would really count in establishing equilibrium. What is left, after dropping out such re-entrant parts as ineligible, is thus the "envelope" of the group of points representing an individual's opportunities to invest rationally and must therefore be concave toward the origin. We are justified then in assuming the curved concave Opportunity line as typical.

As to the applicability of the term investment to a shift on the M line, this is a matter of choice of words. Undoubtedly it is so applied in ordinary usage. In fact, such investments are more commonly so called than any other. I have not been able to think of a short phrase in common use which will apply exclusively to an investment the return on which varies with each successive amount invested. Perhaps "investment with diminishing returns" or "investment involving exploitation," as distinct from investment by mere sale and purchase, would come nearer to conforming both to usage and to the requirements of the case. Yet the full phrase which I have provisionally adopted, investment opportunity, seems fairly correct in its implications. We seldom speak of buying a bond as an investment opportunity, but investing in new industrial, mining or agricultural enterprises, such as radio production, or in oil wells, or orange groves, is spoken of as a real opportunity because the return is not a standardized market figure but subject to technical conditions as to productivity.