Political economy or economics is a study of mankind in the ordinary business of
life; it examines that part of individual and social action which is most closely
connected with the attainment and with the use of the material requisites of wellbeing.
Thus it is on the one side a study of wealth; and on the other, and more important side, a part of the study of man.
It is sometimes said that the laws of economics are "hypothetical". Of course, like every other science, it undertakes to study the effects which will be produced by certain causes, not absolutely, but subject to the condition that other things are equal, and that the causes are able to work out their effects undisturbed. Almost every scientific doctrine, when carefully and formally stated, will be found to contain some proviso to the effect that other things are equal: the action of the causes in question is supposed to be isolated; certain effects are attributed to them, but only on the hypothesis that no cause is permitted to enter except those distinctly allowed for. It is true however that the condition that time must be allowed for causes to produce their effects is a source of great difficulty in economics. For meanwhile the material on which they work, and perhaps even the causes themselves, may have changed; and the tendencies which are being described will not have a sufficiently "long run" in which to work themselves out fully.
[On marginal utility and demand]
Utility is taken to be correlative to Desire or Want. ... desires cannot be measured directly, but only indirectly by the outward phenomena to which they give rise: ... in those cases with which economics is chiefly concerned the measure is found in the price which a person is willing to pay for the fulfilment or satisfaction of his desire. He may have desires and aspirations which are not consciously set for any satisfaction: but for the present we are concerned chiefly with those which do so aim; and we assume that the resulting satisfaction corresponds in general fairly well to that which was anticipated when the purchase was made.
There is an endless variety of wants, but there is a limit to each separate want. This familiar and fundamental tendency of human nature may be stated in the law of satiable wants or of diminishing utility thus:-The total utility of a thing to anyone (that is, the total pleasure or other benefit it yields him) increases with every increase in his stock of it, but not as fast as his stock increases. If his stock of it increases at a uniform rate the benefit derived from it increases at a diminishing rate. In other words, the additional benefit which a person derives from a given increase of his stock of a thing, diminishes with every increase in the stock that he already has.
That part of the thing which he is only just induced to purchase may be called his marginal purchase, because he is on the margin of doubt whether it is worth his while to incur the outlay required to obtain it. And the utility of his marginal purchase may be called the marginal utility of the thing to him. Or, if instead of buying it, he makes the thing himself, then its marginal utility is the utility of that part which he thinks it only just worth his while to make. And thus the law just given may be worded:-
The marginal utility of a thing to anyone diminishes with every increase in the amount of it he already has.
There is however an implicit condition in this law which should be made clear. It is that we do not suppose time to be allowed for any alteration in the character or tastes of the man himself. It is therefore no exception to the law that the more good music a man hears, the stronger is his taste for it likely to become; that avarice and ambition are often insatiable; or that the virtue of cleanliness and the vice of drunkenness alike grow on what they feed upon. For in such cases our observations range over some period of time; and the man is not the same at the beginning as at the end of it. If we take a man as he is, without allowing time for any change in his character, the marginal utility of a thing to him diminishes steadily with every increase in his supply of it.
Now let us translate this law of diminishing utility into terms of price. Let us take an illustration from the case of a commodity such as tea, which is in constant demand and which can be purchased in small quantities. Suppose, for instance, that tea of a certain quality is to be had at 2s. per lb. A person might be willing to give 10s. for a single pound once a year rather than go without it altogether; while if he could have any amount of it for nothing he would perhaps not care to use more than 30 lbs. in the year. But as it is, he buys perhaps 10 lbs. in the year; that is to say, the difference between the satisfaction which he gets from buying 9 lbs. and 10 lbs. is enough for him to be willing to pay 2s. for it: while the fact that he does not buy an eleventh pound, shows that he does not think that it would be worth an extra 2s. to him. That is, 2s. a pound measures the utility to him of the tea which lies at the margin or terminus or end of his purchases; it measures the marginal utility to him. If the price which he is just willing to pay for any pound be called his demand price, then 2s. is his marginal demand price. And our law may be worded:-
The larger the amount of a thing that a person has the less, other things being equal (i.e. the purchasing power of money, and the amount of money at his command being equal), will be the price which he will pay for a little more of it: or in other words his marginal demand price for it diminishes.
[On elasticity of demand]
We have seen that the only universal law as to a person's desire for a commodity is that it diminishes, other things being equal, with every increase in his supply of that commodity. But this diminution may be slow or rapid. If it is slow the price that he will give for the commodity will not fall much in consequence of a considerable increase in his supply of it; and a small fall in price will cause a comparatively large increase in his purchases. But if it is rapid, a small fall in price will cause only a very small increase in his purchases. In the former case his willingness to purchase the thing stretches itself out a great deal under the action of a small inducement: the elasticity of his wants, we may say, is great. In the latter case the extra inducement given by the fall in price causes hardly any extension of his desire to purchase: the elasticity of his demand is small. If a fall in price from say 16d. to 15d. per lb. of tea would much increase his purchases, then a rise in price from 15 d. to 16d. would much diminish them. That is, when the demand is elastic for a fall in price, it is elastic also for a rise. And as with the demand of one person so with that of a whole market. And we may say generally: - The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price.
[On market equilibrium]
Let us then turn to the ordinary dealings of modern life; and take an illustration from a corn-market in a country town, and let us assume for the sake of simplicity that all the corn in the market is of the same quality. The amount which each farmer or other seller offers for sale at any price is governed by his own need for money in hand, and by his calculation of the present and future conditions of the market with which he is connected. There are some prices which no seller would accept, some which no one would refuse. There are other intermediate prices which would be accepted for larger or smaller amounts by many or all of the sellers. Everyone will try to guess the state of the market and to govern his actions accordingly. Let us suppose that in fact there are not more than 600 quarters, the holders of which are willing to accept as low a price as 35s.; but that holders of another hundred would be tempted by 36s.; and holders of yet another three hundred by 37s. Let us suppose also that a price of 37s. would tempt buyers for only 600 quarters; while another hundred could be sold at 36s., and yet another two hundred at 35s. These facts may be put out in a table thus:--
| At the price | Holders will be willing to sell | Buyers will be willing to buy |
| 37s. | 1000 quarters | 600 quarters |
| 36s. | 700 | 700 |
| 35s. | 600 | 900 |
Of course some of those who are really willing to take 36s. rather than leave the market without selling, will not show at once that they are ready to accept that price. And in like manner buyers will fence, and pretend to be less eager than they really are. So the price may be tossed hither and thither like a shuttlecock, as one side or the other gets the better in the "higgling and bargaining" of the market. But unless they are unequally matched; unless, for instance, one side is very simple or unfortunate in failing to gauge the strength of the other side, the price is likely to be never very far from 36s.; and it is nearly sure to be pretty close to 36s. at the end of the market. For if a holder thinks that the buyers will really be able to get at 36s. all that they care to take at that price, he will be unwilling to let slip past him any offer that is well above that price.
Buyers on their part will make similar calculations; and if at any time the price should rise considerably above 36s. they will argue that the supply will be much greater than the demand at that price: therefore even those of them who would rather pay that price than go unserved, wait; and by waiting they help to bring the price down. On the other hand, when the price is much below 36s., even those sellers who would rather take the price than leave the market with their corn unsold, will argue that at that price the demand will be in excess of the supply: so they will wait, and by waiting help to bring the price up.
The price of 36s. has thus some claim to be called the true equilibrium price: because if it were fixed on at the beginning, and adhered to throughout, it would exactly equate demand and supply (i.e. the amount which buyers were willing to purchase at that price would be just equal to that for which sellers were willing to take that price); and because every dealer who has a perfect knowledge of the circumstances of the market expects that price to be established If he sees the price differing much from 36s. he expects that a change will come before long, and by anticipating it he helps it to come quickly.
When demand and supply are in equilibrium, the amount of the commodity which is being produced in a unit of time may be called the equilibrium-amount, and the price at which it is being sold may be called the equilibrium-price.
Such an equilibrium is stable; that is, the price, if displaced a little from it, will tend to return, as a pendulum oscillates about its lowest point; and it will be found to be a characteristic of stable equilibria that in them the demand price is greater than the supply price for amounts just less than the equilibrium amount, and vice versa. For when the demand price is greater than the supply price, the amount produced tends to increase.
In this illustration there is a latent assumption which is in accordance with the actual conditions of most markets; but which ought to be distinctly recognized in order to prevent its creeping into those cases in which it is not justifiable. We tacitly assumed that the sum which purchasers were willing to pay, and which sellers were willing to take, for the seven hundredth quarter would not be affected by the question whether the earlier bargains had been made at a high or a low rate. We allowed for the diminution in the buyers' need of corn [its marginal utility to them] as the amount bought increased. But we did not allow for any appreciable change in their unwillingness to part with money [its marginal utility]; we assumed that that would be practically the same whether the early payments had been at a high or a low rate.
This assumption is justifiable with regard to most of the market dealings with which we are practically concerned. When a person buys anything for his own consumption, he generally spends on it a small part of his total resources; while when he buys it for the purposes of trade, he looks to re-selling it, and therefore his potential resources are not diminished. In either case there is no appreciable change in his willingness to part with money. There may indeed be individuals of whom this is not true; but there are sure to be present some dealers with large stocks of money at their command; and their influence steadies the market.
The exceptions are rare and unimportant in markets for commodities; but in markets for labour they are frequent and important.
[On the long and short run]
The remainder of the present volume will be chiefly occupied with interpreting and limiting this doctrine that the value of a thing tends in the long run to correspond to its cost of production. In particular ... [we will consider] the controversy whether "cost of production" or "utility" governs value. We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. In the same way, when a thing already made has to be sold, the price which people will be willing to pay for it will be governed by their desire to have it, together with the amount they can afford to spend on it. Their desire to have it depends partly on the chance that, if they do not buy it, they will be able to get another thing like it at as low a price: this depends on the causes that govern the supply of it, and this again upon cost of production. But it may so happen that the stock to be sold is practically fixed. This, for instance, is the case with a fish market, in which the value of fish for the day is governed almost exclusively by the stock on the slabs in relation to the demand: and if a person chooses to take the stock for granted, and say that the price is governed by demand, his brevity may perhaps be excused so long as he does not claim strict accuracy. So again it may be pardonable, but it is not strictly accurate to say that the varying prices which the same rare book fetches, when sold and resold at Christie 's auction room, are governed exclusively by demand.
Taking a case at the opposite extreme, we find some commodities which conform pretty closely to the law of constant return; that is to say, their average cost of production will be very nearly the same whether they are produced in small quantities or in large. In such a case the normal level about which the market price fluctuates will be this definite and fixed (money) cost of production. If the demand happens to be great, the market price will rise for a time above the level; but as a result production will increase and the market price will fall: and conversely, if the demand falls for a time below its ordinary level.
Thus we may conclude that, as a general rule, the shorter the period which we are considering, the greater must be the share of our attention which is given to the influence of demand on value; and the longer the period, the more important will be the influence of cost of production on value. For the influence of changes in cost of production takes as a rule a longer time to work itself out than does the influence of changes in demand. The actual value at any time, the market value as it is often called, is often more influenced by passing events and by causes whose action is fitful and short lived, than by those which work persistently. But in long periods these fitful and irregular causes in large measure efface one another's influence; so that in the long run persistent causes dominate value completely. Even the most persistent causes are however liable to change. For the whole structure of production is modified, and the relative costs of production of different things are permanently altered, from one generation to another.
As far as the knowledge and business enterprise of the producers reach, they in each case choose those factors of production which are best for their purpose; the sum of the supply prices of those factors which are used is, as a rule, less than the sum of the supply prices of any other set of factors which could be substituted for them; and whenever it appears to the producers that this is not the case, they will, as a rule, set to work to substitute the less expensive method. And further on we shall see how in a somewhat similar way society substitutes one undertaker for another who is less efficient in proportion to his charges. We may call this, for convenience of reference, The principle of substitution. This principle of substitution is closely connected with, and is indeed partly based on, that tendency to a diminishing rate of return from any excessive application of resources or of energies in any given direction, which is in accordance with general experience. It is thus linked up with the broad tendency of a diminishing return to increased applications of capital and labour to land in old countries which plays a prominent part in classical economics. And it is so closely akin to the principle of the diminution of marginal utility that results in general from increased expenditure, that some applications of the two principles are almost identical.
Our first step towards studying the influences exerted by the element of time on the relations between cost of production and value may well be to consider the famous fiction of the "Stationary state" in which those influences would be but little felt; and to contrast the results which would be found there with those in the modern world.
This state obtains its name from the fact that in it the general conditions of production and consumption, of distribution and exchange remain motionless; but yet it is full of movement; for it is a mode of life. The average age of the population may be stationary; though each individual is growing up from youth towards his prime, or downwards to old age. And the same amount of things per head of the population will have been produced in the same ways by the same classes of people for many generations together; and therefore this supply of the appliances for production will have had full time to be adjusted to the steady demand.
Of course we might assume that in our stationary state every business remained always of the same size, and with the same trade connection. But we need not go so far as that; it will suffice to suppose that firms rise and fall, but that the "representative" firm remains always of about the same size, as does the representative tree of a virgin forest, and that therefore the economies resulting from its own resources are constant: and since the aggregate volume of production is constant, so also are those economies resulting from subsidiary industries in the neighbourhood, etc. [That is, its internal and external economies are both constant. The price, the expectation of which just induced persons to enter the trade, must be sufficient to cover in the long run the cost of building up a trade connection; and a proportionate share of it must be added in to make up the total cost of production.]
In a stationary state then the plain rule would be that cost of production governs value. Each effect would be attributable mainly to one cause; there would not be much complex action and reaction between cause and effect. Each element of cost would be governed by "natural" laws, subject to some control from fixed custom. ... The demand lists of prices would always be the same, and so would the supply lists; and normal price would never vary.
The day to day oscillations of the price of fish resulting from uncertainties of the weather, etc., are governed by practically the same causes in modern England as in the supposed stationary state. The changes in the general economic conditions around us are quick; but they are not quick enough to affect perceptibly the short-period normal level about which the price fluctuates from day to day: and they may be neglected [impounded in caeteris paribus] during a study of such fluctuations.
Let us then pass on; and suppose a great increase in the general demand for fish, such for instance as might arise from a disease affecting farm stock, by which meat was made a dear and dangerous food for several years together. We now impound fluctuations due to the weather in caeteris paribus, and neglect them provisionally: they are so quick that they speedily obliterate one another, and are therefore not important for problems of this class. And for the opposite reason we neglect variations in the numbers of those who are brought up as seafaring men: for these variations are too slow to produce much effect in the year or two during which the scarcity of meat lasts. Having impounded these two sets for the time, we give our full attention to such influences as the inducements which good fishing wages will offer to sailors to stay in their fishing homes for a year or two, instead of applying for work on a ship. We consider what old fishing boats, and even vessels that were not specially made for fishing, can be adapted and sent to fish for a year or two. The normal price for any given daily supply of fish, which we are now seeking, is the price which will quickly call into the fishing trade capital and labour enough to obtain that supply in a day's fishing of average good fortune; the influence which the price of fish will have upon capital and labour available in the fishing trade being governed by rather narrow causes such as these. This new level about which the price oscillates during these years of exceptionally great demand, will obviously be higher than before. Here we see an illustration of the almost universal law that the term Normal being taken to refer to a short period of time an increase in the amount demanded raises the normal supply price. This law is almost universal even as regards industries which in long periods follow the tendency to increasing return.
But if we turn to consider the normal supply price with reference to a long period of time, we shall find that it is governed by a different set of causes, and with different results. For suppose that the disuse of meat causes a permanent distaste for it, and that an increased demand for fish continues long enough to enable the forces by which its supply is governed to work out their action fully (of course oscillations from day to day and from year to year would continue: but we may leave them on one side). The source of supply in the sea might perhaps show signs of exhaustion, and the fishermen might have to resort to more distant coasts, and to deeper waters, Nature giving a Diminishing Return to the increased application of capital and labour of a given order of efficiency. On the other hand, those might turn out to be right who think that man is responsible for but a very small part of the destruction of fish that is constantly going on; and in that case a boat starting with equally good appliances and an equally efficient crew would be likely to get nearly as good a haul after the increase in the total volume of the fishing trade as before. In any case the normal cost of equipping a good boat with an efficient crew would certainly not be higher, and probably be a little lower after the trade had settled down to its now increased dimensions than before. For since fishermen require only trained aptitudes, and not any exceptional natural qualities, their number could be increased in less than a generation to almost any extent that was necessary to meet the demand; while the industries connected with building boats, making nets, etc. being now on a larger scale would be organized more thoroughly and economically. If therefore the waters of the sea showed no signs of depletion of fish, an increased supply could be produced at a lower price after a time sufficiently long to enable the normal action of economic causes to work itself out: and, the term Normal being taken to refer to a long period of time, the normal price of fish would decrease with an increase in demand.
[One of Marshall's famous footnotes]
1 Diagrams are of especial
aid in enabling us to comprehend clearly the problems of this chapter.
The three, figures 24, 25, 26 represent the three cases of constant, diminishing and increasing return respectively. The return in the last case is a diminishing one in the earlier stages of the increase of production, but an increasing one in those subsequent to the attainment of the original position of equilibrium, i.e. for amounts of the commodity greater than OH. In each case SS' is the supply curve, DD' the old position of the demand curve, and dd' its position after there has been increase of normal demand. In each case A and a are the old and new positions of equilibrium respectively, AH and ah are the old and new normal or equilibrium prices, and OH and Oh the old and new equilibrium amounts. Oh is in every case greater than OH, but in fig. 25 it is only a little greater, while in fig. 26 it is much greater. (This analysis may be carried further on the plan adopted later on in discussing the similar but more important problem of the effects of changes in the conditions of normal supply.) In fig. 24 ah is equal to AH , in fig. 25 it is greater, in fig. 26 it is less. The effect of a falling-off of normal demand can be traced with the same diagrams, dd'-being now regarded as the old and DD' as the new position of this demand curve; ah being the old equilibrium price, and AH the new one.
Of course there is no hard and sharp line of division between "long" and "short" periods. Nature has drawn no such lines in the economic conditions of actual life; and in dealing with practical problems they are not wanted. Just as we contrast civilized with uncivilized races, and establish many general propositions about either group, though no hard and fast division can be drawn between the two; so we contrast long and short periods without attempting any rigid demarcation between them. If it is necessary for the purposes of any particular argument to divide one case sharply from the other, it can be done by a special interpretation clause: but the occasions on which this is necessary are neither frequent nor important.
Four classes stand out. In each, price is governed by the relations between demand and supply. As regards market prices, Supply is taken to mean the stock of the commodity in question which is on hand, or at all events " in sight." As regards normal prices, when the term Normal is taken to relate to short periods of a few months or a year, supply means broadly what can be produced for the price in question with the existing stock of plant, personal and impersonal, in the given time. As regards normal prices, when the term Normal is to refer to long periods of several years, Supply means what can be produced by plant, which itself can be remuneratively produced and applied within the given time; while lastly, there are very gradual or Secular movements of normal price, caused by the gradual growth of knowledge, of population and of capital, and the changing conditions of demand and supply from one generation to another.
[On altruism and sociobiology]
Even in the vegetable world a species of plants, however vigorous in its growth, which should be neglectful of the interests of its seeds, would soon perish from the earth. The standard of family and race duty is often high in the animal kingdom; and even those predatory animals which we are accustomed to regard as the types of cruelty, which fiercely utilize the environment and do nothing for it in return, must yet be willing as individuals to exert themselves for the benefit of their offspring. And going beyond the narrower interests of the family to those of the race, we find that among so-called social animals, such as bees and ants, those races survive in which the individual is most energetic in performing varied services for the society without the prompting of direct gain to himself.
But when we come to human beings, endowed with reason and speech, the influence of a tribal sense of duty in strengthening the tribe takes a more varied form. It is true that in the ruder stages of human life many of the services rendered by the individual to others are nearly as much due to hereditary habit and unreasoning impulse, as are those of the bees and ants. But deliberate, and therefore moral, self-sacrifice soon makes its appearance; it is fostered by the far-seeing guidance of prophets and priests and legislators, and is inculcated by parable and legend. Gradually the unreasoning sympathy, of which there are germs in the lower animals, extends its area and gets to be deliberately adopted as a basis of action: tribal affection, starting from a level hardly higher than that which prevails in a pack of wolves or a horde of banditti, gradually grows into a notable patriotism; and religious ideals are raised and purified. The races in which these qualities are the most highly developed are sure, other things being equal, to be stronger than others in war and in contests with famine and disease; and ultimately to prevail. Thus the struggle for existence causes in the long run those races of men to survive in which the individual is most willing to sacrifice himself for the benefit of those around him; and which are consequently the best adapted collectively to make use of their environment.