Supply and Demand - Hubert D. Henderson
SUPPLY AND DEMAND
By Hubert D. Henderson M.A.
With an Introduction by J.M. Keynes M.A., C.B.
1922.
INTRODUCTION
The Theory of Economics does not furnish a body of settled conclusions
immediately applicable to policy. It is a method rather than a
doctrine, an apparatus of the mind, a technique of thinking, which
helps its possessor to draw correct conclusions. It is not difficult
in the sense in which mathematical and scientific techniques are
difficult; but the fact that its modes of expression are much less
precise than these, renders decidedly difficult the task of conveying
it correctly to the minds of learners.
Before Adam Smith this apparatus of thought scarcely existed. Between
his time and this it has been steadily enlarged and improved. Nor is
there any branch of knowledge in the formation of which Englishmen can
claim a more predominant part. It is not complete yet, but important
improvements in its elements are becoming rare. The main task of the
professional economist now consists, either in obtaining a wide
knowledge of _relevant_ facts and exercising skill in the application
of economic principles to them, or in expounding the elements of his
method in a lucid, accurate and illuminating way, so that, through his
instruction, the number of those who can think for themselves may be
increased.
This Series is directed towards the latter aim. It is intended to
convey to the ordinary reader and to the uninitiated student some
conception of the general principles of thought which economists now
apply to economic problems. The writers are not concerned to make
original contributions to knowledge, or even to attempt a complete
summary of all the principles of the subject. They have been more
anxious to avoid obscure forms of expression than difficult ideas; and
their object has been to expound to intelligent readers, previously
unfamiliar with the subject, the most significant elements of economic
method. Most of the omissions of matter often treated in textbooks are
intentional; for as a subject develops, it is important, especially in
books meant to be introductory, to discard the marks of the chrysalid
stage before thought had wings.
Even on matters of principle there is not yet a complete unanimity of
opinion amongst professors. Generally speaking, the writers of these
volumes believe themselves to be orthodox members of the Cambridge
School of Economics. At any rate, most of their ideas about the
subject, and even their prejudices, are traceable to the contact they
have enjoyed with the writings and lectures of the two economists who
have chiefly influenced Cambridge thought for the past fifty years,
Dr. Marshall and Professor Pigou.
J.M. Keynes.
CONTENTS
CHAPTER I
THE ECONOMIC WORLD
Sec.1. THEORY AND FACT
Sec.2. THE DIVISION OF LABOR
Sec.3. THE EXISTENCE OF ORDER
Sec.4. SOME REFLECTIONS UPON JOINT PRODUCTS
Sec.5. SOME REFLECTIONS UPON CAPITAL
Sec.6. THE FUNDAMENTAL CHARACTER OF MANY ECONOMIC LAWS
CHAPTER II
THE GENERAL LAWS OF SUPPLY AND DEMAND
Sec.1. PRELIMINARY STATEMENT OF THREE LAWS
Sec.2. DIAGRAMS AND THEIR USES
Sec.3. AMBIGUITIES OF THE EXPRESSIONS, "INCREASE IN DEMAND," ETC.
Sec.4. REACTIONS OF CHANGES IN DEMAND AND SUPPLY ON PRICE
Sec.5. SOME PARADOXICAL REACTIONS OF PRICE CHANGES ON SUPPLY
Sec.6. THE DISTURBANCES OF MONETARY CHANGES
Sec.7. THE TRADE CYCLE
CHAPTER III
UTILITY AND THE MARGIN OF CONSUMPTION
Sec.1. THE FORCES BEHIND SUPPLY AND DEMAND
Sec.2. THE LAW OF DIMINISHING UTILITY
Sec.3. THE RELATION BETWEEN PRICE AND MARGINAL UTILITY
Sec.4. THE MARGINAL PURCHASER
Sec.5. THE BUSINESS MAN AS PURCHASER
Sec.6. THE DIMINISHING UTILITY OF MONEY
CHAPTER IV
COST AND THE MARGIN OF PRODUCTION
Sec.1. AN ILLUSTRATION FROM COAL
Sec.2. THE VARIOUS ASPECTS OF MARGINAL COST
Sec.3. THE DANGERS OF IGNORING THE MARGIN
Sec.4. A MISINTERPRETATION
Sec.5. SOME CONSEQUENCES OF A HIGHER PRICE LEVEL
Sec.6. GENERAL RELATION BETWEEN PRICE, UTILITY AND COST
CHAPTER V
JOINT DEMAND AND SUPPLY
Sec.1. MARGINAL COST UNDER JOINT SUPPLY
Sec.2. MARGINAL UTILITY UNDER JOINT DEMAND
Sec.3. A CONTRAST BETWEEN COTTON AND COTTON-SEED, AND WOOL AND MUTTON
Sec.4. THE IMPORTANCE OF BEING UNIMPORTANT
Sec.5. CAPITAL AND LABOR
Sec.6. CONCLUSIONS AS TO JOINT SUPPLY AND JOINT DEMAND
Sec.7. COMPOSITE SUPPLY AND COMPOSITE DEMAND
Sec.8. ULTIMATE REAL COSTS
CHAPTER VI
LAND
Sec.1. THE SPECIAL CHARACTERISTICS OF LAND
Sec.2. THE SCARCITY ASPECT
Sec.3. THE DIFFERENTIAL ASPECT
Sec.4. THE MARGIN OF TRANSFERENCE
Sec.5. THE NECESSITY OF RENT
Sec.6. THE QUESTION OF REAL COSTS
Sec.7. RENT AND SELLING PRICE
CHAPTER VII
RISK-BEARING AND ENTERPRISE
Sec.1. PROFITS AND EARNINGS OF MANAGEMENT
Sec.2. THE PAYMENT FOR RISK-BEARING
Sec.3. MONTE CARLO AND INSURANCE
Sec.4. RISK UNDER LARGE SCALE ORGANIZATION
Sec.5. THE ENTREPRENEUR
Sec.6. RISK-TAKING AND CONTROL
Sec.7. GENERAL ANALYSIS OF PROFITS
CHAPTER VIII
CAPITAL
Sec.1. A REFERENCE TO MARX
Sec.2. WAITING FOR PRODUCTION
Sec.3. WAITING FOR CONSUMPTION
Sec.4. CAPITAL NOT A STOCK OF CONSUMABLE GOODS
Sec.5. THE ESSENCE OF WAITING
Sec.6. INDIVIDUAL AND SOCIAL SAVING
Sec.7. THE NECESSITY OF INTEREST
Sec.8. THE SUPPLY OF CAPITAL
Sec.9. INVOLUNTARY SAVING
Sec.10. INTEREST AND DISTRIBUTION
CHAPTER IX
LABOR
Sec.1. A RETROSPECT ON LAISSEZ-FAIRE
Sec.2. IDEAS AND INSTITUTIONS
Sec.3. THE GENERAL WAGE-LEVEL
Sec.4. THE SUPPLY OF LABOR IN GENERAL
Sec.5. THE APPORTIONMENT OF LABOR AMONG PLACES
Sec.6. THE APPORTIONMENT OF LABOR AMONG SOCIAL GRADES
Sec.7. THE APPORTIONMENT OF LABOR AMONG OCCUPATIONS
Sec.8. WOMEN'S WAGES
CHAPTER X
THE REAL COSTS OF PRODUCTION
Sec.1. COMPARATIVE COSTS
Sec.2. THE ALLOCATION OF RESOURCES
Sec.3. UTILITY AND WEALTH
Sec.4. CRITERIA OF POLICY
SUPPLY AND DEMAND
CHAPTER I
THE ECONOMIC WORLD
Sec.1. _Theory and Fact_. The controversy between the "Theorist" and the
"Practical Man" is common to all branches of human affairs, but it is
more than usually prevalent, and perhaps more than usually acrid in
the economic sphere. It is always a rather foolish controversy, and I
have no intention of entering into it, but its prevalence makes it
desirable to emphasize a platitude. Economic theory must be based
upon actual fact: indeed, it must be essentially an attempt, like all
theory, to _describe_ the actual facts in proper sequence, and in true
perspective; and if it does not do this it is an imposture. Moreover,
the facts which economic theory seeks to describe are primarily
economic facts, facts, that is to say, which emerge in, and are
concerned with, the ordinary business world; and it is, therefore,
mainly upon such facts that the theory must be based. People
sometimes speak as though they supposed the economist to start from a
few psychological assumptions (e. g. that a man is actuated mainly by
his own self-interest) and to build up his theories upon such
foundations by a process of pure reasoning. When, therefore, some
advance in the study of psychology throws into apparent disrepute such
ancient maxims about human nature, these people are disposed to
conclude that the old economic theory is exploded, since its
psychological premises have been shown to be untrue. Such an attitude
involves a complete misunderstanding not merely of economics, but of
the processes of human thought. It is quite true that the various
branches of knowledge are interrelated very intimately, and that an
advance in one will often suggest a development in another. By all
means let the economist and psychologist avoid a pedantic specialism
and let each stray into the other's province whenever he thinks
fit. But the fact remains that they are primarily concerned with
different things: and that each is most to be trusted when he is upon
his own ground. When, therefore, the economist indulges in a
generalization about psychology, even when he gives it as a reason for
an economic proposition, in nine cases out of ten the economics will
not depend upon the psychology; the psychology will rather be an
inference (and very possibly a crude and hasty one) from the economic
facts of which he is tolerably sure.
But the purpose of economic theory is not merely to describe the facts
of the economic world; it is to describe them in their proper sequence
and true perspective. It must begin with those facts which are most
general and which have the widest possible significance. Those are not
likely to be the facts which our practical experience forces most
insistently upon our notice. For it is the particular and not the
general, the differences between things rather than their
resemblances, that concern us most in daily life. Nor are we likely to
find the universal facts which we require in the sphere of public
controversy. We must rather look for them in the dark recesses of our
consciousness, where are stored those truths which are so obvious that
we hardly notice them, which are so indisputable that we seldom
examine them, which seem so trite that we are apt to miss their full
significance.
Sec.2. _The Division of Labor_. There is one such truth in the economic
sphere which it is essential to appreciate vividly and fully, with the
widest sweep of the imagination and the sharpest clarity of
thought. Man lives by cooperating with his fellow-men. In the modern
world, that cooperation is of a boundless range and an indescribable
complexity. Yet it is essentially undesigned and uncontrolled by
man. The humblest inhabitant of the United States or Great Britain
depends for the satisfaction of his simplest needs upon the activities
of innumerable people, in every walk of life and in every corner of
the globe. The ordinary commodities which appear upon his dinner table
represent the final product of the labors of a medley of merchants,
farmers, seamen, engineers, workers of almost every craft. But there
is no human authority presiding over this great complex of labor,
organizing the various units, and directing them towards the common
ends which they subserve. Wheel upon wheel, in a ceaseless succession
of interdependent processes, the business world revolves: but no one
has planned and no one guides the intricate mechanism whose smooth
working is so vital to us all. Man, indeed, can organize and has
organized much. Within a large factory the efforts of thousands of
work-people, each engaged on the repetition of a single small process,
are fitted together so as to form an ordered whole by the conscious
direction of the management. Sometimes factory is joined with factory,
with farms, fisheries, mines, with transport and distributing
agencies, as one gigantic business unit, controlled by a common
will. These giant businesses are remarkable achievements of man's
organizing gifts. The individuals who control them wield an immense
power, which so impresses the public imagination that we dub them
"kings," "supermen," "Napoleons of industry." But how small a portion
of man's economic life is dominated by such men! Even as regards the
affairs of their own businesses, how narrow, after all, are the limits
of their influence! The prices at which they can buy their materials
and borrow their capital, the quantities of their products which the
public will consume, are factors at once vital to their prosperity and
outside their own control.
A great business, like a nation, may cherish visions of
self-sufficiency, may stretch its tentacles forward to the consumer
and backwards to its supplies of raw material; but each fresh
extension of its activities serves only to multiply its points of
contact with the outside world. When those points are reached, the
largest business, like the smallest, is out on the open sea of an
economic system immeasurably larger and more powerful than
itself. There it must meet--the better perhaps for its inherent
strength and accumulated knowledge--the impact of rude forces, which
it is powerless to control. Beneath the blasts of a trade depression,
or some other tendency of world-wide scope, the authority of the
mightiest industrial magnate, and equally of any Government, assumes
the same essential insignificance as the pride of a man humbled by
contact with the elemental powers of nature.
Sec.3. _The Existence of Order_. The parallel can be pursued further with
advantage. Just as in the world of natural phenomena, which for long
seemed to man so wayward and inexplicable, we have come gradually to
perceive an all-pervading uniformity and order; so there is manifest
in the economic world, uniformity, order, of a similar if less
majestic kind. Upon the cooperation of his fellowmen, man depends for
the very means of life: yet he takes this cooperation for granted,
with a complacent confidence and often with a naive unconsciousness,
as he takes the rising of to-morrow's sun. The reliability of this
unorganized cooperation has powerfully impressed the imagination of
many observers.
"On entering Paris which I had come to visit," exclaimed Bastiat some
seventy years ago, "I said to myself--Here are a million of human
beings who would all die in a short time if provisions of every kind
ceased to flow towards this great metropolis. Imagination is baffled
when it tries to appreciate the vast multiplicity of commodities which
must enter to-morrow through the barriers in order to preserve the
inhabitants from falling a prey to the convulsions of famine,
rebellion, and pillage. And yet all sleep at this moment, and their
peaceful slumbers are not disturbed for a single instant by the
prospect of such a frightful catastrophe. On the other hand, eighty
departments have been laboring to-day, without concert, without any
mutual understanding, for the provisioning of Paris."
The theme may well excite wonder. But wonder should always be watched
with a wary eye; for he is apt to bring in his train a hanger-on
called worship, who can do nothing but mischief here. It is a short
step from a passage like that quoted above to a glorification of the
existing system of society, to a defence of all manner of indefensible
things; and a cross-grained attitude towards all projects of
reform. It is a short step; but it is one which it is quite
unjustifiable to take. For the evils of our economic system are too
plain to be ignored; too many people have harsh personal experience of
the wastefulness of its production, the injustice of its distribution;
of its sweating, its unemployment and slums. And when the attempt is
made to plaster over evils, such as these with obsequious rhetoric
about the majesty of economic law, it is not surprising that the
spirit of many men should revolt and that they should retort by
denying the existence of order in the business world, by declaring
that the spectacle which _they_ see is one of discord, confusion and
chaos. And then we are engulfed in a controversy as stale, flat and
unprofitable as that between the "theorist" and the "practical man."
The truth is that the language of praise and obloquy is quite
inappropriate. In the first place, it may be well to note that the
order of which I have spoken manifests itself not merely in those
economic phenomena which are beneficial to man, but hardly less in
those which work to his hurt. Even in those alternations of good and
bad trade, which spell so much unemployment and misery, there is
discernible a rhythmic regularity like that of the process of the
seasons, or the ebb and flow of the tide. This is not an elegance to
be admired. Furthermore, in so far as the order comprises adjustments
and tendencies which are beneficial (as, indeed, is mainly true),
there is no warrant for assuming that these are either adequate to
secure a prosperous community or dependent upon the social
arrangements which happen to exist. Let us, therefore, refrain from
premature polemics and examine in a spirit of detachment some further
aspects of the elaborate, but yet unorganized, cooperation of which so
much has been already said.
Sec.4. _Some Reflections upon Joint Products_. A quite inadequate idea of
the complexity of this cooeperation is obtained by dwelling on the
numbers of people who participate in it, or the immense distances over
which it extends. The deficiency can be partially supplied by
referring to some of the more obvious of the many subtle
interconnections which exist between different commodities and
different trades.
There are innumerable groups of commodities (which it is customary to
term "joint products") such that the production of one commodity
belonging to the group necessarily implies or very greatly facilitates
the production of the others. Wool and mutton; beef and hides; cotton
and cotton-seed are a few familiar illustrations. The important
feature of these "joint products" is the fairly precise relation which
must exist between the quantities in which the different products are
supplied. If you plant a certain crop of cotton, it will yield you so
much cotton lint and so much cotton-seed. You can, of course, if you
choose, throw away part of the seed, as indeed at one time planters
used to do; but unless you do this, you cannot vary the proportions of
the two things which you will have for sale. Similarly, if you keep a
flock of sheep, or a herd of cattle, you will obtain wool and mutton
in the one case, or beef and hides in the other, in proportions, which
indeed you can vary within certain limits by choosing a different
breed,[1] but which you cannot radically transform. When, however, we
turn to the uses to which these products are put, no similar relation
is to be discovered. Cotton lint is used chiefly for making articles
of clothing; cotton-seed for crushing into oil, on the one hand, and
cake for cattle fodder on the other. There is no apparent connection
of any kind between the demands for these different things, and still
less is there any obvious reason why these demands should bear to one
another the particular proportions which characterize their respective
supplies. It is very much the same with wool and mutton; with beef and
hides; with all "joint products." Why should we consume mutton on the
one hand and woolen clothing on the other, in a ratio at all
commensurate with that in which they are yielded by the sheep?
[Footnote 1: These possibilities of small variation are of very great
importance as will be shown in Chapter V, but they do not affect the
present argument.]
What, then, might we expect to find if order was nonexistent in the
economic world? Surely that some things such as wool would be produced
in quantities many times in excess of the demand for them, quite
possibly five, ten, or twenty times in excess; while conversely the
supplies of others such as mutton might fall far short of what was
required. But in practice we find nothing of the sort. Somehow it
comes about that an equilibrium is established between the demand for
and the supply of every commodity; and that this applies to wool and
mutton, to beef and hides, as surely as to commodities which are
produced quite independently. It is true that this equilibrium is a
rough, imperfect one; and it may happen that what is called a "glut"
of wool may co-exist for a short period with what is called a scarcity
of mutton. But qualifications of this nature are in the strictest
sense of the phrase, the exceptions which prove the rule. For the
departures from equilibrium which gluts and scarcities represent are
always transient and are usually confined within narrow limits. A
strong prevailing trend towards an adjustment of demand and supply is
unmistakably manifest amid all the vagaries of changing circumstance.
Let me carry the argument a step further for the benefit of any reader
who is restrained by a repugnance too deep and instinctive to be
readily overcome, from admitting fairly to his mind that conception of
order which I am endeavoring to emphasize. He will in all probability
be one who, cherishing ideals of a better and fairer system of
society, looks forward to a time when an organized cooeperation will be
substituted for what he regards as the existing chaos. Let us suppose
that his visions were fulfilled as completely as he could desire; and
that an immense system of Socialism were in existence, embracing not
one country only, but the whole world. Suppose all the difficulties of
human perversity and administrative technique to have been surmounted
and a wise, disinterested executive to be in supreme control of our
business life. Let us suppose all this, and ask only the question: How
would this executive treat the humdrum case of wool and mutton? How
would it decide the number of sheep it would maintain?
Shall we suppose that it is inspired by the ideal "to each according
to his need," and that it resolves accordingly that the commodities
which people require for a decent standard of life shall be supplied
to them as a matter of course? How, then, would it proceed? It might
estimate the amount of woolen clothing which a normal family requires,
allowing for differences in climate, and possibly indulging somewhat
the caprices of human taste. On this basis, a certain number of sheep
would be indicated. It might perform a similar calculation for mutton,
and again a certain number of sheep would be indicated. But it would
be an extraordinary coincidence if the numbers which resulted from
these independent calculations were nearly equal to one another, or
were even of the same order of magnitude; and, if they differed
widely, what number would our world executive select? Would it decide
to waste an immense quantity of either wool or mutton; or would it
decide that it could not, after all, supply the full human needs for
one or other of the commodities?
Of course, if the executive were sensible it could solve the problem
satisfactorily enough. It could retain the monetary system we know
to-day and it could supply the commodities to the consumers, not as a
matter of right, but by selling them to them _at a price_. This price
it could then move upwards or downwards, raising, say, the price of
mutton and reducing that of wool, until it found that the consumption
of the two things was adjusted in the required ratio. But if it acted
in this manner, what essentially would it be doing? It would be
seeking by deliberate contrivance to reproduce, in respect of this
particular problem, the very conditions which occur to-day without aim
or effort on the part of anyone at all.
The moral of this illustration must not be misinterpreted. It does
not show the folly of Socialism or the superiority of
Laissez-faire. What it does show is the existence in the economic
world of an order more profound and more permanent than any of our
social schemes, and equally applicable to them all.
Sec.5. _Some Reflections upon Capital_. Another aspect of the great
cooperation is of even greater significance. It embraces not only a
multitude of living men, but it links the present together with the
future and the past. The goods and services which we enjoy to-day we
owe only in part to the labors of the week, the month, or the year,
only in part even to the efforts of our contemporaries. The men, long
since dead and forgotten, who built our railways, or sunk our coal
mines, or engaged in any of a great variety of tasks, are still
contributing to the satisfaction of our daily wants. The expression is
not altogether fanciful; for, had it not been reasonable to expect
that those labors would be of use to us to-day, many of them in all
probability would never have been undertaken. It was to meet our
present wants, and even our future wants, that many men toiled on
monotonous tasks ten, twenty, thirty years ago. And yet, of course, we
should deceive ourselves if we supposed that this was the motive of
these men, that our welfare was the centre of their heart's desire. We
in our turn dedicate to the future, and often to a distant future, an
immense portion of our energies. Let any reader who doubts this, study
the statistics of the occupations of the people, and reflect on how
long a period must elapse before the labors of this trade or that can
fulfil their ultimate function. How long would the period be in the
case of a man making bricks, which will later be employed in the
erection of a factory, where machinery will be made, to equip an
electrical generating station designed to supply, over a period of
many years, light, heat, and power to people living in a remote
Continent? A longer time, it may be hazarded, than he is accustomed
to look ahead.
Like the daily cooperation of living men, this cooperation of past,
present and future is essential to the well-being of mankind, and yet
it is undesigned and unorganized. As private individuals, men do,
indeed, deliberately provide for their own future, and for that of
their kith and kin: as the directors of businesses, they try to
forecast the trend of demand. But such conscious calculations and
deliberate acts would avail little if they stood alone. They are
hardly more than the necessary spokes in the great wheel which
regulates the relations of past, present and future. The hub of the
wheel is an elaborate system of borrowing and lending, essentially
similar to the buying and selling of commodities. The private
individual in order to provide for his family or for his old age
"saves" and "invests." But what exactly does this mean? It means that
he transfers so much purchasing power, which he might have spent on
his personal pleasures, to some one else in return for the expectation
of receiving, year by year in the future, he and his heirs after him,
a certain smaller quantity of purchasing power. The other party to the
transaction will be, we may suppose, a business man who enters into it
because he sees the opportunity of a promising industrial development,
to undertake which he requires more purchasing power than he himself
possesses. And, because this transaction is entered into, a smaller
number of us will shortly be engaged in making motorcars, or
gramaphones, and a larger number of us in making factories and
machinery, which will later enhance the world's productive power.