FROM MARGINAL PRODUCTS TO COST OF PRODUCTION
Thus far the matter has been comparatively simple. We have looked
at a concatenation of successive groups with one final product, and
with, of course, one marginal utility and one value. But we have now
to face the fact that productive groups may pass into a great number
of final products, each with a different marginal utility and value.
The more industry is divided, the more is this the case. Productive
goods, such as coal, oil, labour, go more or less to the making of
millions of products. It is this that gives the Supply side its almost
overwhelming weight in modern economic science. And it is here that we
find the _raison d’être_ of the law of cost as a convenient abbreviated
expression of a deeper law. Let us follow the matter out methodically.
A stock of productive goods, which we shall call X, is capable of
producing finished products A, B, and C. The value of these products
for the time is, respectively, 100, 110, and 120. Which product will
determine the value of the productive unit of X?—It will be the least
of the three. For, suppose so many units of the stock X get lost that
it is impossible to make A, B, _and_ C, the one given up will, of
course, be A,—the employment of X which produces the least valuable
product. Any other choice would be contrary to economic conduct. When
we say, then, that means of production get their value from their
product, we must be understood as meaning the value of their final or
Marginal Product.
But, again, if B and C are articles of large common manufacture, they
cannot long retain their value of 110 and 120; it is merely a question
of time till their value falls to 100. Here we begin to see the
plausibility of the idea that cost of production determines value.
To put this concretely. A man has a farm of 90 acres divided among
three crops, which, in the circumstances of the market, give him
three different returns. On 30 acres, he grows wheat, which, we shall
suppose, yields him a value represented by 100; on another 30 acres,
he grows potatoes, which yield him, say, 110; on another 30 acres, he
grows barley, which yields him 120. What is the value of the productive
group made up of his labour and one third of his land? (We leave out
of account, for simplicity’s sake, the other co-operating factors.) If
the value were given to land and labour by the _actual_ returns there
would be three different values, and this really is the case where
competition has not its full play. But, if there is no monopolist
factor, these three values cannot be maintained. The value of the
first product, 100, determines the value of the means of production,
the labour and land, and it is only a question of time and competition
till this value of the means of production has imposed itself on
the potatoes and the barley, and reduced their price to the same
comparative level as that of wheat.
Here, then, we have the explanation of the law of cost of production.
It is quite true that, in the case of goods reproducible at will, or,
in our vocabulary, in cases where substitutes are immediately available
either by exchange or from production, the costs of production
determine the value, and the formula is both true and convenient. All
the same, it is merely a particular instance of the universal law
of Marginal Utility. In all cases, the marginal utility of the last
product economically produced determines the value of the means of
production; these means of production then become the intermediate
standard; and the value of goods produced from them cannot, in the long
run, be higher than the value got from the marginal product.
The practical working of the law may be seen from a personal experience
of the writer. In the cotton thread trade, there was for years a
demand for a thread which should be a fair substitute for the much
more expensive article, sewing silk. The prices of cotton thread and
of silk thread respectively gave housewives and shopkeepers a rough
guide to a subjective valuation, and the figure put upon this demand
was something like 20/. (It could not be more for the reason that no
cotton substitute was able to take the place of silk in any but a few
of its least important uses.) This price, offered by shopkeepers to
travellers, told the cotton thread manufacturers what they could offer
to cotton spinners for superior yarns, and what they could afford for
more expensive chemicals and polishing machinery. As consequence, after
many experiments the silk substitute was produced, and sent into the
market at a price of 20/. But once those superior yarns were made,
the cotton spinners, increasing the production of them, found other
outlets. Before long the thread makers saw that this silk substitute
was not the _marginal_ product of those particular yarns: that, in
fact, other cotton threads of lower price were being made from the same
yarns. These yarns then entered into the cost of silk substitute with
the predetermined lower value given them by the other finished goods,
and, in a short time, the price of the silk substitute fell from 20/
to 18/, in conformity with the value put upon the yarns by the new
marginal product. The same phenomenon occurs whenever a demand for a
new article or a modification of an old one arises, and is interpreted
by the enterprise of manufacturers.