Essentials of Economic Theory / As Applied to Modern Problems of Industry and Public Policy

by John Bates Clark

The Law of Value affected by the Fact that the Final Unit of a Good is usually a Complex of Unlike Utilities.—The second imperfection consists in the assumption that in measuring the utility of such a unit the consumer estimates the importance to himself of the article taken in its entirety. In the case of the apples of our illustration the difficulty is not obvious. A man, as we have just noticed, may increase or diminish his consumption of this fruit; the first few apples that he uses will give him more pleasure than a second similar quantity, and the price of apples in the market may actually depend on the utility of the final peck of apples that each of the customers consumes in a season. In other words, there is, in this instance, a probability that the goods, although supplied at once, may be appraised as if they were offered in a regular series and that the law of final utility, in its common and simple form of statement, may in this particular apply to the case. The second difficulty, however, remains, and even in the case of such goods as apples renders the common statement somewhat inaccurate, while in the case of most kinds of consumers' goods the inaccuracy is glaring. If the price of fine watches corresponded with the utility of the last one that a consumer uses, it would be many times greater than it is. Rather than go without watches altogether many a man would pay one thousand dollars for one for which he actually gives a hundred; and, moreover, this watch may be the "final" one in his case. The utility of the last overcoat that a man uses in the winter may be such that, if he could have it on no other condition, he would readily give five hundred dollars for it instead of fifty.

How Unlike Services may be rendered by One Good at the Same Time.—What people want of any useful thing is an effect in themselves,—a pleasure or a benefit which they expect to get,—and apart from this subjective result they would not want the thing at all. The power to confer a particular benefit is a utility. Men buy goods solely for their utilities, and they measure these service-rendering powers in the things offered to them and pay for them accordingly. Now, it happens that articles often combine in themselves a considerable number of different utilities, or service-rendering powers, and that in buying an article the man pays for them all. It is as though four or five different servants, each having his own specialty, were to offer themselves for hire and invite an employer to consider what each one could do for him. In buying an article which will serve him in several ways, a man appraises all the unlike services that the article will render. He secures several services at once, as he would do if he hired, in a body, several actual servants. The same thing would happen if, instead of hiring human servants with different aptitudes, one should buy different commodities each of which is, in reality, an inanimate servant, able, in its own way, to do something useful or agreeable for the purchaser. We could bunch a lot of these goods and buy them collectively. Venders of the goods could tie them together in bundles and offer them thus for sale. If the different goods were also sold separately in the market, they would command in the bundles the same prices that they would command when sold each by itself, and a bundle would bring the sum of the several prices of its component articles. In just this way in which an aggregate of different goods would get its valuation does any one article which is made up of different utilities get its rating. The utilities are appraised separately. In buying an article which is a composite of different utilities, we virtually employ a company of servants who have different specialties and insist on being hired all together or not at all.

How the Normal Price of a Bundle of Unlike Goods would be Fixed.—We have now to see how the action of the market analyzes an article and puts a price on the several utilities which compose it. The market does this in exactly the same way in which it would appraise a bundle of dissimilar articles which had to be sold separately, and we will therefore trace the operation by which a package containing the commodities A, B, C, and D would get its value in an actual market.

How the Normal Price of a Single Good in a Bundle of Unlike Goods would be Fixed.—Let us see how a bundle made up of commodities A, B, C, and D would get its value in the market. We will suppose that these articles are here named in the order of their importance, and that A has the highest utility, since it renders the most important service, and that D has the least. It may be that the article A has a utility rated at one hundred dollars in a particular man's esteem. He would give one hundred dollars for it rather than do without it altogether. The service, then, that one article of this kind can render is expressed by the sum one hundred dollars. Article B taken separately may be worth fifty dollars, since it may render such services that the man would give fifty dollars rather than be without it. A third article, C, may in the same way be valued at twenty dollars and a fourth at ten. Now, if a man has to buy the whole bundle, must he pay one hundred dollars plus fifty plus twenty plus ten, or one hundred and eighty for the whole? This does not by any means follow. The first article may be sold separately at a price far below one hundred dollars. There may be so large a supply of it that, in order to find a market for it all, the makers must take ten dollars for it. This fixes the market price of that amount of this commodity at ten dollars. If we now glance beyond the question of the "market price" of the goods and consider their more permanent or "normal price," the inquiry requires us to do more than ascertain why a definite quantity of the goods offered at a certain time sells for a certain amount. An appeal to the law of final utility answers that question. To know, however, why the permanent price is what it is, we have to know what fixes the permanent supply, and we discover that the cost of making the goods is here a dominant influence. For the present we assume that this cost does not change, since such changes are a subject for the dynamic studies which will come later. The present fact is that production has been carried to such a point that no more of these goods can be sold at the cost price, and there the enlargement of the output has stopped; the supply has at some time in the past reached this normal point and now remains there. Ten dollars represents the final utility of the article, and this sum is what it costs to make it. If it could be sold for any more than that, competition would bring new producers into this business and would impel those already in it to enlarge their production till the price would stand at the normal or cost level of ten dollars.

The Consumers' Surplus.—In every such case there are men who would give much more for the article rather than be without it, and we have supposed that some one would pay a hundred dollars for this commodity if he could not otherwise obtain it. Ninety dollars, then, measures what we may call his consumers' surplus, or the clear benefit he gets from buying at its market price an article that is worth to him so much more. This comes about by the fact that the makers of article A, in order to sell the amount of goods that competition has impelled them to make, must accept the offers of persons who can consistently give only ten dollars for it. These are relatively poor persons, and as the sum of ten dollars expended on other articles would benefit them as much as ten dollars spent on this one, it is a "final" purchase, or a final increment of their consumers' wealth. In order to get it they sacrifice, in some other form, a benefit as great as the one they get from acquiring this commodity and receive, therefore, no consumers' surplus from it. These are the men whose demand helps to fix the price of the article A, and the willingness of other persons to give more does not make it bring any more. The rich men, who stand ready to pay a hundred dollars, if necessary, are gainers by letting poorer men fix this price. It is by catching the patronage of these poorer men that the makers can dispose of their large output, and in doing this they have to bring the price down to ten dollars.

The Function of a Special Class of Marginal Purchasers of Each Article.—In like manner there is a class of "marginal purchasers" of the article B, or the persons who pay for it so much that they get no net benefit or consumers' surplus from the purchase. If they did not buy this article, they could get something else that would do them as much good for the same outlay. It costs, let us say, only ten dollars in the making, and enough of these articles are made and offered for sale at that price to supply all customers who are attracted by the offer. The men who would pay more for it do not count. Each of the other articles in the bundle, when it is offered separately and at the cost price which competition establishes, represents a final utility to some one class of purchasers. Competition has made the whole supply so large that, in order to dispose of it, venders must attract the particular class who will take it at the ten-dollar rate. This class is in the strategic position of market-price makers for this one thing. They are the last class to whom the producers can afford to cater. If each of the five articles in the bundle costs the makers ten dollars, and if so many of each are made that they just supply the needs of the classes that will buy them at ten dollars apiece, the price of all five, when sold separately, will be fifty dollars. Most of the purchasers of each article would give more than ten for it if they had to, but some would not do so, and the producers cater to the needs of these marginal persons.

How the Prices of the Goods are fixed when they are sold in Various Combinations.—How do these articles get their valuation when they are tied in bundles containing all five of them and the bundles are sold unbroken? In essentially the same way as when sold separately. Article A, we will suppose, is one of the necessaries of life and is to be had by itself in the market. Article B represents a comfort, and C and D are luxuries. The bundles are so made that A and B are often sold together; as are also A, B, and C; and A, B, C, and D. A purchaser may have at his option the first only, the first and the second combined, the first three, or all four. Article A, when it stands alone, can be had at the natural or cost price and in quantity sufficient to supply the wants of all classes of buyers from the highest down to the class which will take it at ten dollars—the cost of making it—but at no higher price. Any one can have the A either alone or tied to other articles at this price. One who buys A and B in combination will pay for article A only the same price that it commands when sold separately; and since he buys B, the utility of which is less than that of A, at ten dollars, it is clear that he gets A for less than it is worth to him, but the ten dollars may be all he would give for the B. This man is not the marginal purchaser of A, for in buying it he realizes a consumers' surplus; but for the article B, which is tied to it, he may pay all that it is worth to him. For that he is a marginal purchaser, and as such he gets no consumers' surplus out of it. What he pays for B will just suffice to buy something else which is equally important to him. The price of this bundle of two articles is ultimately determined by the cost of the two components, which is twenty dollars, and enough of each component is made and offered in the market to supply the wants of a class of persons who will barely decide to take it at the cost rate. The class that hesitates at taking A will not consider B, but the class that hesitates at taking B gets a clear benefit from buying A at the price that expresses the utility of A to a poorer class of persons.

How Different Classes of Purchasers coöperate in this Price Making.—The rule of one price for one article of course holds, and the man who would have a clear and decisive motive for buying the A for more than ten dollars, if he had to do so, gets the benefit of two facts: first, that it costs only that amount in the producing, and secondly, that competition makes the supply of it so large that it is brought within the reach of those persons who value it at only ten dollars. It takes two different classes of purchasers to fix the price of this package of two articles, and their ratings fix it at twenty dollars. Exactly the same influences regulate the price of the bundle which includes A, B, and C. Men who buy C can afford to have a luxury, and therefore, if they had had to do so, would have given more than they do give for the articles of necessity and comfort. If the price of A and B were higher than it is, they would still buy these two things, but they would not raise their bids for C, since for this they are marginal purchasers. This commodity is therefore sold at the price that will just induce this class of persons to add it to their list of consumers' goods. There is a further class in whose list of purchases D is marginal, while A, B, and C yield a consumers' surplus in the form of an uncompensated personal benefit.

Different Utilities in an Article appraised as are Different Goods in a Package.—It is an actual fact that most commodities are like these packages of unlike articles. They are bundles of unlike utilities, and the market actually finds a way to analyze composite things and put a separate price on each utility. It may seem very theoretical to say that a concrete thing, like a watch, a coat, a dining table, or a roast fowl, is made up of such abstract things as utilities and that each of these has its separate price; yet such is actually the fact, and if goods were not valued in the market in this way, the prices of all articles of comfort and luxury would be very much higher than they are.

A man pays seventy-five dollars for an overcoat, but if he could not get the service that the coat as a whole renders without paying five hundred dollars for it, he would pay it; for otherwise he could hardly get through a winter. No man who buys an overcoat worth seventy-five dollars would refuse to pay more if that were the necessary condition of having an overcoat at all. The garment as a whole is far from being a "marginal utility" to any one; and yet there is something in it that is so. This element is like the article D in the fourth bundle referred to in our illustration. There is a particular utility in the composite good for which the man pays all that it is worth to him; and he would go without that utility if the seller charged more than he does. The most important service that the coat renders is that of keeping the man warm; but a very cheap garment would render that service, and six dollars will buy such a garment. The man does not need to pay more than six dollars for that one service. The supply of cheap coats is such that the final one must be offered for six dollars in order to induce certain poor purchasers to buy it, and that, moreover, is all that it costs to make it. No one, therefore, is obliged to pay more than six dollars for something that will keep him warm, however much such a service may be worth to him. Coats of another grade have a second utility combined with this one, since they are made of better cloth and are more comely in appearance. Utilities of an æsthetic kind are combined with the crude qualities represented by the cheapest coats. The supply of coats of this grade is such that they must be offered for twenty dollars in order to induce some one to take the final or marginal one. What does this mean? It means that this purchaser will pay fourteen dollars and no more in order to have the second utility, consisting in comeliness, added to the first utility, capacity to keep him warm. This man would give more than twenty dollars rather than go uncloaked; for it is plain that, if he will pay fourteen dollars for comeliness, he will give more than six for warmth. Probably he would pay one hundred dollars for the article if he had to, and in getting it for twenty he gets a large consumers' surplus. This is because he secures the first utility (1) for less than it is worth to him, (2) for just what it costs in the making, and (3) for just what it is worth to the poorer purchasers. He is willing to pay only fourteen dollars for the comeliness, which is the second utility that the garment contains, and he is therefore a marginal purchaser of this second utility. It costs only the sum of fourteen dollars to add the second utility to the first, and enough coats of the second grade are made to catch the patronage of the class of buyers who will give so much and no more for it. They are the persons whose demand figures in adjusting the market price of this second utility. Competing producers of coats cause the supply of those of the second grade to be so large that they could not all be sold unless the second utility were offered for fourteen dollars. This makes the price of the entire coat twenty dollars as the result of catering in a detailed way to the demand of two different classes of buyers.