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

by John Bates Clark

Cost as a Standard of Normal Price.—It is commonly and correctly stated that the normal price of anything is that which just covers the cost of producing it. Cost in this case is the total amount of money that the entrepreneur pays out in order to bring the commodity into existence. He buys raw materials and pays for all the labor and capital that transform them into a new and saleable shape. If he can make a net profit, he does so; but competition tends to adjust the quantity produced and the consequent price in such a way that he can make no net profit. What he gets for the article will then reimburse him for his total outlay, but it will do no more. Since the quantity produced is normal when it brings the market price to this level of cost, it appears that the cost is the ultimate standard in the case. The quantity supplied varies till it causes the market price just to cover the cost; and so long as the quantity supplied is thus natural, other influences remaining the same, the price is so. This states the cost of production in terms of money paid by an entrepreneur and the returns from the operation as money received by him; but there is a more philosophical way of conceiving the law of cost, and to this we shall soon recur.

Elements of Cost.—Whatever the entrepreneur has to pay for in the production of an article is of course an element in its monetary cost to him. If he does not begin the making of it by drawing his raw materials from what nature freely furnishes, he must pay some one for the raw material. He must also pay for the labor, and this is equivalent to buying the fraction of the article that is produced by labor; for the laborer, as we have seen, is the producer of a certain fractional share of the article and the natural owner of that share, and when he agrees to let his labor for hire, what he really does is to sell out his individual interest in the forthcoming product of the industry in which he is about to engage. When a workman in a shoe factory agrees to work for two dollars and a half a day, he really contracts to sell every day for that amount a certain quantity of shoes. The leather is one element which enters into the finished shoes, and therefore the entire shoe is not really made in the factory; but of the part which is there made, namely, the utility that results from transforming the leather into shoes, one part is made by labor and another by capital. The entrepreneur has to buy both of these if he is to acquire a valid title to the product and have a right to sell it. These costs are therefore "purchase money" paid for undivided shares of goods.

Labor of Management.—It usually happens that an entrepreneur, or employer of labor and capital, performs some labor himself; and we have already noted the reason for this in the fact that the kind of labor that he performs is so important that the fate of the business often depends on it. He may manage the business so well as to make it succeed or so ill as to make it fail. He pays himself for this labor when he draws a salary for his services. As an entrepreneur he treats his own labor as he does that of any one else and buys the fraction of the product of his business that his own labor of management has created. In this he illustrates the general law that all payments of wages are payments of the purchase of a certain quantity of product. Though the owner's own contribution to the product is not always mentioned in terms in the accounting, that is what his salary is paid for, though it is spoken of as a payment for his "time," or his labor.

The Capitalist as the Vender of a Share in a Product.—Capital, as we have seen, also contributes a definite share toward the total amount of every product in the making of which it coöperates. Labor does not do all the transforming of leather into shoes which is done in the factory, since machines, fuel, etc., help; and we shall later find that there is a way of determining how much of the product the help so given creates. It adds a certain amount to what labor can claim as its own special product, and the man who owns the capital becomes the lawful claimant for this additional share. When he agrees to let his capital work for an employer, he virtually sells to the employer the undivided share of the product—shoes or what not—that the capital really creates. The furnisher of productive instruments, like the furnisher of labor, is a vender, and the entrepreneur is a buyer.

Entrepreneur and Capitalist.—As was stated in an earlier chapter, an actual employer nearly always furnishes some of the capital that he uses. If he did not do so, he would have difficulty in borrowing more, since banks or other lenders do not loan to empty-handed men. It is clear that what the employer gets in return for such capital as he may put into the business is in reality a payment for a contribution which that particular part of the capital makes to the product. Since each bit of capital in an establishment contributes something toward the creating of the product, the employer's own capital has the same right to the value of its contributary share as has the capital of any one else. What the employer-capitalist gets for capital the employer, pure and simple, pays. As the furnisher of instruments the man is a vender of the product of these instruments, while as an entrepreneur proper he is the buyer. He must purchase the product of his own capital just as he purchased the product of his own labor. In paying, therefore, wages for all labor, including what he performs himself, interest on all capital, including his own, and the price of raw materials, he gets something which, if competition does a perfect work, he has to sell for what he gives for it. The shoes, when he sells them, tend, under active competition, to yield only what has been paid for them in the making and, in a perfectly static state, would actually yield no net profit. All the entrepreneur's costs, therefore, resolve themselves into purchase money paid, his receipts are money accruing from sales; and under ideally free competition the two sums total are equal.

The Entrepreneur's Proper Function not Labor of Management.—In some theoretical discussions the management of a business figures as the principal function of the entrepreneur, and all or nearly all of the reward that comes to him is represented as coming in the shape of a reward for a responsible kind of labor that calls great abilities into requisition. But it is very clear that, whether he personally performs any labor or not, the employer has a distinctly mercantile function to perform; and this in itself is totally unlike the work of overseeing the mill, the shop, or the salesroom. He acquires a title to the whole product by paying for the contributions which labor and producers of raw material separately make toward it, and then parts with the product; and if he gets any more than he has paid out, he makes a profit. When industry is in what we have termed a dynamic state, such a difference between the value of the product and the cost of the elements that go into it is continually appearing, and that, too, largely in consequence of causes over which, as a mere manager, the employer has no control. A profit so gained cannot be wages of management. It is a purely commercial gain, or a difference between what is paid for something and what is received for it.

Mercantile Profit.—It is best, therefore, to distinguish in some perfectly clear way between that function of the entrepreneur, which consists in buying and selling, and any work that he may find it best to do in the way of superintending the business. At the cost of using the term entrepreneur in a stricter sense than the one customarily attached to it, we will make this word describe the purely mercantile functionary who pays for the elements of a product and then sells the product. The reason for the very division between gains from this source and gains from management we shall soon appreciate, for we shall see that competition tends to reduce one of these incomes to nothing, but tends to perpetuate the other and to make the amount of it conform to a positive standard. The entrepreneur, as we shall use the term, is neither the manager nor the capitalist, and when we have occasion to speak of either of these functionaries, we shall call him by his own distinctive name; though we know perfectly well that, in actual business, it is desirable and often quite essential that the same one who acts as an entrepreneur should also put into the business some labor as well as some capital. A man who performs two unlike functions, buying and selling, on the one hand, and managing the business, on the other, serves in two capacities that are clearly distinguished from each other; while if he furnishes any of the capital, he adds to these a third capacity entitling him to the value of the product of his capital. As a manager he directly aids in producing goods, and he gets pay for so doing from his other self, the entrepreneur, who acquires the title to the goods; as a capitalist he has another legitimate claim upon himself as entrepreneur.

These Distinctions recognized in Practical Accounting.—That this is no bit of mere theoretical subtlety is proved by the fact that the bookkeeping of nearly all establishments distinguishes between these two incomes by actually putting an appraisal on the work the employer does and paying a salary for it. A man may be a large owner of stock in a corporation and yet receive a salary that is fixed by an estimate of what an equally useful man could be hired for. If personal influence secures more for him than this, the excess is taken from the pockets of the stockholders, and the amount of it is accounted for in a way that does not fall within the scope of pure economic law.

How "Natural" Prices exclude Entrepreneur's Profits.—The old and correct view is that the tendency of competition is to make things sell for enough to cover all costs, as we have defined them, and no more. Under a different phraseology this is what Ricardo and others have rightly claimed. They were unconsciously explaining what would happen in a static state, for if society were actually in this state, the goods that come out of the factory would be worth just enough to reimburse the owner for all the outlays that can be called costs. If they sell for more than this, there is to be had from the business an income that costs nothing. It is a net profit above all claims based on personal labor or on the aid furnished by capital, and it furnishes an incentive for enlarging the business, and labor and capital are therefore drawn into it. Entrepreneurs bring them and for a time make a profit by this means; but as their presence increases the output of goods that are here made, it brings down the price till there is no inducement to move any more labor and capital in this direction.

The Significance of a Natural Adjustment of Different Industries.—The "natural" state of general industry is that in which each particular branch of it is in the no-profit state. It is as though laborers and capitalists in a shoe factory took all the shoes that it turns out, sold them in a market, paid for the raw material out of the proceeds, and kept the remainder, dividing it between themselves in proportions which corresponded with the amounts they had severally contributed toward the making of this product; and as though the laborers in cotton mills and iron foundries received the goods there made and dealt with them in a like manner. It is as though in every branch of business the whole product were turned over in kind to the furnishers of labor and capital.