three fundamental concepts of economics

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Three Fundamental Concepts Of Economics

( Originally Published Early 1900's )

1. Human wants.—Two characteristics

of human wantspossess greatimportance in their bearing upon theproduction and

consumption of wealth.

First, there seemsto be no limit to the

number of wants of which a human being is


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capable. This is one reason why mostpeople find saving so difcult; any growth of income is speedily outdistanced by thegrowth of wants. This characteristic also ex-plains why a general overproduction of wealth is impossible; there may be too muchof one thing but not too much of all things. Italso accounts for the al-most infinite varietyof goods found in the markets of any modern

city.

Second, the continued gratification of anysingle want finally leads to satiety and maybecome even tedious and irksome. It is a

well-known fact of everyday life that anypleasure loses its zest if indulged in too long.

2. Law of diminishing utility.—The fact thatwe get less and less satisfaction out of the

continued gratification of any single want isso important that it is laid down as afundamental proposition and is known as thelaw of diminishing utility. It may be stated asfollows: The intensity of any utility, or of aman's desire for any good, tends to decline


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as he consumes successive units of it.

This law doubtless has both a physiologicaland a psychological basis. Sports weary

certain muscles and finally cease to givepleasure. The hungry man gets greatsatisfaction out of the first few minutes of hisdinner, but his enjoyment of the meal soonbegins to decline. A man who is already the

owner of a silk hat, is not profusely grateful if a friend sends him a second silk hat as aChristmas gift, and if he gets a third on hisnext birthday he will probably look at itgloomily and wonder if he has some friend or

relative whose head it will fit, for to him it isonly a nuisance.

This principle of diminishing utility applieswith varying force in the case of different

articles and different men. In the case of thesilk hat, the utility declines very rapidly as thesupply is increased. In the case of shirts thedecline will be much less rapid. To the manwho has only one shirt it will possess verygreat utility; he will prize it much more than


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he would any one shirt if he had twelve in hisbureau drawer. It may be said that up to acertain point there is possible an increase inthe supply of any commodity in our possession without any appreciable declinein its utility. We want a certain number of suits of clothes and a house with a certainnumber of rooms. Additional clothing andadditional space in our house would be only

a burden, something to be cared for but notwanted.

Bread, potatoes and beans are nourishing.Potatoes and beans in ordinary times are

cheap. If the human race would be satisfiedwith such food, the population of the earthmight be doubled and yet all be well fed; butwe demand variety in food and would protestvigorously if the same rations were placed

before us day after day.

3. The law of demand and supply.—Everybusiness man knows that the value or priceof any article depends upon the demand for and supply of it. The law of demand and


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supply may be briefly stated as follows: Theprice or value of any article tends to varydirectly with the demand and inversely withthe supply; increasing or declining as thedemand increases or declines, but tending torise as the sup-ply declines and to fall as thesupply increases.

The reader must not think of this law as a

complete explanation of value. It is not in anysense a theory of value. It merely states ingeneral terms a truth well known to all menfamiliar with the operations of trade andindustry.

If we analyze this law we run up againstsome difficult questions. What is meant bydemand? Why does the value rise when thedemand increases? Why does the value

tend to fall when the supply increases? Wefind also that there is a curious interactionbetween value on the one hand and demandand supply on the other. If the price of anarticle is lowered, we discover that thedemand for it tends to increase and that at


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the same time the supply tends to decrease.We will not undertake to discuss all theseproblems in this chapter, but will be satisfiedwith an examination of the terms demandand supply.

4. Analysis of demand.—The desire for acommodity is not in itself an economicdemand for it. No matter how much a man

may want an automobile, his desire canhave no effect upon the prices or value of automobiles unless be has the necessarymeans of payment. Desire must beaccompanied by the necessary purchasing

power before it can become economic or effective demand, or have any influence inthe market.

The second point to notice in connection with

demand is that it varies with the price. For example, if the price of automobiles and. thecost of operation could be cut one-half, therewould undoubtedly be a great increase in thedemand for automobiles and many morecars would, be made and sold. On the other


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hand, if any conditions cause the prices of automobiles and gasolene to be advanced,the tendency will be toward a weaker demand and smaller sales. Hence when wespeak of the demand for any article,manifestly we must always have in mind acertain price, for the demand varies with theprice.

There is only one way of measuring thedemand for an article at any given price, andthat is by the quantity of it which is sold atthat price. That shows how many people arewilling to buy at such a price.

Hence it is possible for us to define demandas being the amount of goods which peopleare willing to take at a given price.

5. Analysis of supply.—The word supply ascommonly used includes the entire stock of goods within reach of the market, buteconomists use it in a stricter sense,meaning by it only that portion of the entirestock which is actually offered for sale at a


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given price. The entire stock of wheat, for example, in a country might be 500,000bushels and the price $2. If only 100,000bushels were offered for sale, that would bethe economic or effective supply at thatprice, and if 100,000 bushels were sold atthat price, that would constitute also theeconomic demand.

Thus in our analysis of demand and supply,we find that at any particular time and pricethey are measured by the same quantity of goods.

This conclusion is not remarkable, for aman's purchasing power depends upon thegoods he possesses, plus his credit or borrowing power which in turn depends onhis power to produce in the future. How he

shall use it is determined by his wants. Afarmer going to market with 10 bushels of potatoes, intending to sell them andpurchase groceries with the proceeds, isincreasing the supply of potatoes in themarket and the demand for certain groceries.


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To the buyers of potatoes his loadconstitutes an addition to the sup-ply, but tothe grocer it represents a demand for certaingroceries. Money is merely the medium bywhich the exchanges are effected; theeconomic demand for goods is the goodsthat are in the buyer's possession. In modernbusiness the buyer always goes to marketequipped with money or credit, and this he

has obtained either by the production of goods or by the performance of valuableservices.

6. Potential demand and supply.—That part

of the stock of an article which is not offeredfor sale at a given price is sometimes calledthe potential sup-ply. When would-be buyersof an article are not quite satisfied with thepresent price and hold back for a lower price,

this is referred to as the potential demand.Dealers in any article when determining whatprice they may hope for naturally take intoaccount,, so far as possible, the intensity of the potential demand and the amount of the


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potential supply.

The great enlargement of cold storage andware-housing facilities in recent years has

made the potential supply of manycommodities exceedingly important. Thethrifty farmer is no longer compelled tomarket all his eggs. in the spring andsummer, nor all his potatoes and grain crops

in the fall. In normal times this withholding of foodstuffs from the market, so that they arenot part of the effective supply, tends, firsttoward the steadying of prices and, secondtoward the lowering of prices, for the farmer,

his profits being larger and more secure, isstimulated to an increase of production.

In this book we shall use,the words demandand supply in the sense given them

ordinarily by business men, meaning bysupply the goods in the market seeking apurchaser, and by demand the quantity of goods which people will buy at or near anygiven price.


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7. The value equation.—Any business manknows that the price or value of an articletends to rise when-ever the demand for it atthe existing price is in excess of the supplyoffered for sale at that price; and converselythat the price of an article is likely to declinewhenever the supply offered at the existingprice is greater than the demand. It isconditions of this sort which account for the

zigzagging of prices in the speculativemarkets. In the world's great exchanges,where the prices of certain basiccommodities are fixed, the traders giveconsideration to all possible circumstances

that may affect the present or future demandor supply of the article in which they aretrading. A drought in Argentina may fore-shadow a lessened supply of wheat andcause traders to bid a higher price for it, or

storms in Kansas and Nebraska maythreaten the corn crop and bring on a rise inthe price both of corn and of pork.

At any given time there are in any market a


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number of men more or less anxious to buya certain commodity and others who wish tosell. If the sellers are asking too high a price,certain buyers hold off and all the stockcannot be sold. On the other hand, if theyshould offer their goods at too low a price,the demand would exceed the supply,certain buyers would get all they wanted andothers would be disappointed.

Assuming that the buyers and sellers are allkeenly competing with one another, eachanxious to get all possible advantage out of the market, it is evident that the sellers, even

tho they enter into no agreement with oneanother, will endeavor to put the price at thehighest possible figure at which all their supply can be sold. So we may say ingeneral that value or price is such a ratio of

exchange as tends to establish an equationbetween demand and sup-ply. The reader will not understand this definition unless hegives careful consideration to the fact thatchanges in the. price or value of a


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commodity tend to cause changes in thedemand and supply. In the chapter on Valuewe shall discuss this subject from other points of view.

8. Agricultural law of diminishing returns.—One of the most important laws in economicswas borrowed from the science of agricultureand is known as the law of diminishing

returns. Most .economists have treated itmainly with reference to its bearing upon theprofits of agriculture, but it applies also toother industries.

The law as it applies to land may be statedas follows: In the cultivation of a piece of land, after a certain point is reached theapplication of additional labor and capitalfails to cause a proportionate in-crease in the

yield.This law states a truth that the experience of every farmer confirms. On a given field afanner knows how many loads of fertilizer and how many men can be employed to the


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greatest advantage. He knows that if he putson additional loads of fertilizer or em-ploysan additional man in the cultivation of thefield, altho the total yield may be increased,the re-turn per unit of capital and labor willbe less. Sup-pose that the land whencultivated by two men and enriched by tenloads of fertilizer yields 1,000 bushels of wheat. The next season let him increase the

use of capital and labor by 50 per cent, thatis, apply 15 loads of fertilizer and keep threemen at work in the field. If he obtains lessthan 1,500 bushels of wheat it is manifestthat the point of diminishing re-turns has

been reached and that his wheat costs himmore per bushel the second year than in thefirst.

This law is important because of its bearing

upon the cost of production. As populationincreases farmers must do one of two things:(1) They must bring poorer or more distantlands into cultivation; (2) the land alreadytilled must be cultivated more intensively, by


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which is meant that more labor and capitalmust be applied. The result in either case isthe same, namely, higher costs of productionand hence higher prices of foodstuffs in themarkets.

The law is manifestly applicable not only toagriculture, but to all extractive industries,such as mining and lumbering. As the

demand for ores and lumber increases,mines must be worked to greater depths andlumber must be brought from forests morere-mote, all of which means higher costs of production and a tendency toward higher

prices.

9. General law of diminishing returns.—Thelaw is applicable to all forms of industry andmay be stated as follows: In the

development of any industry there is a pointat which the returns upon capital and labor invested are at a maximum; after this point isreached, the application of further labor andcapital does not cause a proportionateincrease in the value of the return.


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Note the difference between the agriculturallaw and this more general law. In agriculturethere is a decline of product per unit of capital and labor; in industry in general thereis a decline, not necessarily of product, but inthe value of the product. This difference isdue to the fact that the supply of land islimited, whereas in industry the number of factories may be indefinitely increased.

If we consider the producing power of asingle factory, the law applies to it exactly asto a piece of land. In a given building only acertain number of machines and men can be

employed to the greatest advantage. If moreare introduced, the output per man and ma-chine declines, altho the total product maybe in-creased. Hence it follows that inindustry in general, after a certain point of

development has been reached, more menand capital cannot be employed without a.certain decline in the output per capital andper man unless additional space for their employment has been provided. Since


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additional space for manufacturing industriescan easily be found, an increasing demandfor manufactured articles does not alwayslead to higher costs of production and higher prices. On the contrary, it often lowers costsbecause of the economies made possible bylarge-scale production.

But in any industry, if the demand for its

product remain unchanged, then after acertain period in its development has beenreached the employment of additional menand machines will not yield a proportionateincrease in the value of the product, for the

supply of the product on the market would bein-creased and the value would tenddownward as a result. At any given time inany country only a definite number of menand a definite amount of capital can be

employed to the greatest advantage in anyindustry.

Take shoes, for instance. The manufacturer must take into account the cost of leather and other materials, the wages of labor, the


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cost of machinery and its depreciation, andfinally the market demand at prices whichwill yield him profit. These are things whichhe cannot control, yet upon them depend hiscosts of production and the price of hisproduct. He has control solely of the amountof his own output; he knows the amount thathe can produce with his present plant and hehas pretty carefully estimated the probable

output of his competitors, and he may decidethat any increase of output by him or by anyother manufacturer would tend to demoralizethe market and compel sales at lower prices,even tho the cost of making a pair of shoes

had not declined.

In all industries, therefore, there is constanteffort on the part of managers to keep their output at the point which shall yield them

maximum profit. In an industry where there isabsolute freedom of competition this is oneof the manager's hardest problems.

10. Counteracting forces.—Wherever the lawof diminishing returns applies, each increase


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in product is obtained at an increased cost.While this is true for a given time and a givenprocedure in industry, it does not follow thatonly thru increased cost per unit can therebe an increase of product. Increase in theefficiency of capital and labor may effect acorresponding increase in production. Theprogress of civilization, as shown ininventions, better methods of transportation,

the lessening of taxation, improvements ineducation, tends to lessen the cost of production, and it is therefore bound to bringabout greater returns from the application tonature of capital and labor. As John Stuart

Mill says: "There is scarcely any possibleamelioration of human affairs which wouldnot, among its other benefits, have afavorable operation, direct and indirect, uponthe productiveness of industry."

It was the improvement in agriculturalmachinery and the extension andcheapening of transportation facilities thatbrought the western lands of the United


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States and Canada into the wheat-producingarea and made them profitable because of alessened producing cost. The rise in theprice of an ore will bring a mine into themarket with its product, while a lowering of the price will exclude it. This is frequentlyillustrated in the case of bituminous coal.

Improvements in production have the same

effect. The immense depths of the copper mines in northern Michigan are accountedfor by the rise in the price of copper, and themarked improvements in pumps, enginesand drills as well as in mining technic. Yet

without question the increase in thetemperature at the lower depths of themines, the large amount of water to bepumped out, and the gradual lessening of the supply will in time bring about an

increased cost of producing the supply.Unless there is a corresponding rise in theprice of copper such mines will be forced intothe margin of production, where their ownerswill be confronted by the question whether to


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continue at a loss in the hope of better prices, or to abandon operations.Furthermore, the history of mining recordsmany instances where a rise in the price of the product has led to the re-working of properties once abandoned.

The law of diminishing returns, while it is trueand does apply in an industry at a given

time, is not to be extended in its applicationfrom one season to an-other, or from oneperiod to another, without taking intoconsideration the introduction of machineryor new methods of production which may

change the ratio of return.

What is the law of diminishing utility? Givean illustration of it.

What are the essential things to be noted indemand? How is it measured?

Show by an illustration how the economistuses supply in a different sense from thatordinarily given to it. How are demand and


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supply measured?

Define potential demand and supply.

What is the agricultural law of diminishingreturns? How

does the general law of diminishing returnsdiffer from it? Does increase of product

always imply an increased unit cost of production? Illustrate.

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three fundamental concepts of economics

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