The Evolution of Modern Capitalism: A Study of Machine Production

by J. A. Hobson

Excepting by the inverse and questionable method of arguing that the high profits distributed by a Trust are themselves proof that prices have not fallen as they would have fallen under free competition, it is not possible to build a very convincing condemnation of the Trust from statistics of price. And even when profits are high it is open to the defenders of the Trust to maintain that they only represent the saving of the cost of competition, and that if competition were introduced the profits would be squandered in the struggle instead of passing into the consumer's pocket.

It is only from a deductive treatment of the subject that we are able to clearly convict the Trust of possessing a power over prices antagonistic to the interests of the consuming public.

A Trust, or other company, or a single individual who has a complete monopoly of a class of goods for which there is a demand, will strive to fix that price which shall give him the largest net profit on his capital. The question with him will be simply this, "How many articles shall I offer for sale?" If he offers only a small number the competition of more urgent wants among the consumers will enable him to sell the small number at a high price. Assuming, for the moment, that the production of these articles was subject to the law of constant returns—i.e., that a few things were produced relatively as cheaply as many, this small sale would give the highest rate of profit on each sale, for the "marginal utility" of the supply would be high and would enable a high price to be obtained for the whole supply. But if he possesses large facilities of production it may pay him better to sell a larger number of articles at a lower price with a lower rate of profit on each sale, because the aggregate of a larger number of small profits may yield a larger net profit on his whole capital. How far it will pay him to go on increasing the supply and selling a larger number of articles at a lower price will entirely depend upon the effect each increment of supply exercises upon demand, and so upon prices and profits. Everything will hinge upon the "elasticity of demand" in the particular case. If the object of the monopoly satisfies a keen, widely-felt want, or stimulates a craving for increased consumption among those who take off the earlier supply, a large increase in supply may be attended by a comparatively small fall in prices. Sometimes a large increase of supply at a lowered price will, by reaching a new social stratum, or by forcing the substitution of this article for another in consumption, so enlarge the sale that though the margin of profit on each sale is small, the net profit on the whole capital is very large. In all such cases of great elasticity it may pay a monopolist to sell a large number of articles at a low price.

Where the article belongs to that class in which the law of increasing returns is strongly operative—i.e., where great economies in expenses of production attend a larger scale of production, this increase of supply and fall of prices may continue with no assignable limit. On the other hand, where there is little elasticity of demand, where an increase of supply can be taken off only at a considerable fall of price, it will probably pay a monopolist to restrict production and sell a small number of articles at a high price. It is this motive which often induces the destruction of tons of fish and fruit in the London markets for fear of spoiling the market. These goods could be sold at a sufficiently low price, but it pays the companies owning them to destroy them, and to sell a smaller number which satisfies the wants of a limited class of people who "can afford to pay." Now, when free competition exists among sellers, as among buyers, this can never happen. It will always be to the interest of a competing producer or dealer to lower his price below that which would yield him the largest net profit on his capital were he a monopolist. If he is a monopolist he will only lower his prices provided the elasticity of demand in the commodity in question is so great that the increased consumption will be so considerable as to yield him a larger net profit. But if he is a competing dealer he does not look chiefly to the consumption of the community, but to the proportion of that consumption which he himself shall supply. The elasticity of demand, so far as his individual business is concerned, is not limited to the amount of the increased consumption of the community stimulated by a lowering of prices, but includes that portion of the custom of his rivals which he may be able to divert to himself. Hence it arises that under free competition it will be the tendency of the several competitors to drive down the prices to the point at which the most advantageously placed competitors make the minimum profit on their capital.

§ 5. It is all important to an understanding of the subject to recognise that a monopoly price and a competitive price are determined by the operation of an entirely different set of economic forces. The loose opinion that it must be to the interest of a Trust or other monopoly to sell at the same price as would be fixed by competition is quite groundless.

Let us look more closely at the determinants of a monopoly price. Suppose we are dealing with a Trust owning a large amount of fixed capital, some of it more and some less favourably ordered for production, and having an absolute monopoly in the market for steel rails, cotton bagging, or other manufactured articles. First look at expenses of production. A very small output, though produced by the exclusive use of the very best machinery and labour, would not be produced very cheaply, because the economies attending large-scale production would be sacrificed. Each successive increment in output would involve a decreased expense per unit of production so long as the most favourably situated plant was employed. If the output grew so large that worse material or works fitted with inferior plant, or less favourably placed, were called into requisition, the economies of an increased scale of production would be encroached upon by this lowering of the margin of production. Taking the Trust's capital at a fixed amount, there would necessarily come an increment of output which it would not pay to produce even if sold at the price fetched by the previous increment. The ton of steel or of cotton bagging which would only yield a bare margin of profit, if sold at the price fetched by the last ton, limits the maximum output of the business. Under the pressure of free competition this marginal ton will be actually produced. But though, considered by itself, it yields a margin of profit, it will rarely if ever be produced as part of the actual output of a Trust. The actual output of a Trust, we shall find, will be determined at any point between the first unit of output and this marginal increment. The expenses of production will not increase in any close correspondence with the growth of the output, but will represent the fluctuating resultant of the several economies of production at the several points.

CURVE OF PROFIT IN TRUST.

In the figures A and B the perpendicular line ai represents a number of increments of production. The expense of producing a supply of 100 will be measured by the line bb', that of producing 200 by cc', and so on. But never in actual industry will the lines of growing expense be regular in their relation to the increase of production, as would be the case in the figure A; they will always be irregular, as in the figure B. The curve of expense ai' in the figure B will be determined by the resultant of the various forces which make for increasing and diminishing returns for each new increment of the requisites of production required to produce the new portion of output. When the increased scale of production makes some new application of machinery economically possible, or where recourse must be had to some decidedly inferior land for the raw material, a large sudden irregularity may show itself in the curve of expense.

When we turn from expenses of production to the aggregate takings from the sale of the several quantities of supply, we shall find a similar irregularity of increase. Elasticity in demand, as tested by the stimulus given to consumption by a fall of price, differs not merely in different commodities, but at different points in a falling scale of prices. A number of equal decrements in price, according as they stimulate the satisfaction of weaker wants of earlier consumers, or strike into new classes of consumers, or supply new kinds of wants, will have widely different effects in increasing the aggregate takings.