Wages and Interest both adjusted at Social Margins of Production.—It is to be noted that wages and interest are fixed at the social margin of production, which means that they equal what labor and capital respectively can produce by adding themselves to the forces already at work in the general field of employment. In making the supposition that, owing to some disturbing fact, a particular entrepreneur has not enough after paying wages to pay interest, we assume that the rate of interest is fixed, in this way, in the general field and not merely in his establishment.
If B´C´D´ were larger than ABDE, the entrepreneur would be selling goods for more than cost and realizing a net profit, which he cannot do in a static state; but a pure profit is not only possible but actual in a dynamic state.
In actual business total returns represented by ACDE amount to more than the sum represented by ABDE (wages) plus A´B´D´E´ (interest). There are conditions that in practical life are continually bringing this to pass in different lines of business, though not in all of them at once. The real world is dynamic and therefore the true net profit, or the share of the entrepreneur in the strict sense of the term, is a positive quantity. This income is always determined residually. It is a remainder and nothing else. It is what is left when wages and interest are paid out of the general product. To the entrepreneur comes the price of the products that an industry creates. Out of this he pays wages and interest, and very often he has something remaining. There is no way of determining this profit except as a remainder. The return from the sale of the product is a positive amount fixed by the final utility principle. Wages and interest are positive amounts, and each of them is fixed by the final productivity principle. The difference between the first amount and the sum of the two others is profit, and it is never determined in any other way than by subtracting outgoes from a gross income. It is the only share in distribution that is so determined. Entrepreneur's profits and residual income are synonymous terms. In the static state no such residual income exists, but from a dynamic society it is never absent. Every entrepreneur makes some profits or losses, and in society as a whole the profits greatly predominate.
Summary of Facts concerning a Static Adjustment of Wages.—We know then that in any industry wages and interest absorb the whole product, because any deviation from that rule in a particular group is corrected in the way above mentioned. Moreover, general wages and interest, as determined by the law of final productivity, must equal those incomes when they are determined residually. The area of the rectangular portion of one of the foregoing figures must equal the area of the three-sided part of the other. The question arises why all entrepreneurs might not get a uniform profit at once. This would not lure any labor or capital from one group or subgroup to another. If, after paying wages and interest at market rates, the entrepreneurs in each industry have anything left, the entire labor and capital are producing more than they get and there is an inducement to managers and capitalists to withdraw from their present employers and become entrepreneurs on their own account. Such an entrepreneur entering the field, drawing marginal labor and capital away from the entrepreneurs who are already there and combining them in a new establishment, can make them produce more than he will have to pay them and pocket the difference. If such a condition were realized, there would be a gain in starting new enterprises, since luring away marginal agents and combining them in new establishments would always be profitable. When we introduce into the problem dynamic elements we shall see that centralization, which makes shops larger instead of smaller, makes industries more productive, and that what happens when net profits appear is more often the enlarging of one establishment than the creation of new ones. Entrepreneurs in the large establishments can afford to resist the effort made by others to lure away any of the labor or capital which they are employing, and they will do this for the sake of retaining their profits. They can do it by bidding against each other, in case any of them are making additions to their mills or shops, and also by bidding against any new employers who may appear. Perfect competition requires that this bidding for labor and capital shall continue up to the profit-annihilating point. Here, as elsewhere in the purely static part of the discussion, we have to make assumptions that are rigorously theoretical and put out of view in a remorseless way disturbing elements which appear in real life. The static state requires that all entrepreneurs who survive the sharp tests of competition should have equally productive establishments, which means that they should all be able to get the same amount of product from a given amount of labor and capital. The actual fact is that differences of productive power still survive. There are some small establishments which, within the little spheres in which they act, are as productive as large ones; but there are also some which are struggling hopelessly against large rivals in the general market and are destined erelong to give up the contest. In other words, the centralizing and leveling effects of competition are approximated but never completely realized in actual life.
A fact that it is well to note is that the test of final productivity is inaccurately made when unduly large amounts of labor and capital are made the basis of the measurement. Take away, for instance, a quarter of the working force, estimate the reduction of the product which this withdrawal occasions, and attribute this loss entirely to the labor which has been taken away, and you estimate it too highly. With so large a section of the labor withdrawn the capital would work at a disadvantage, and a part of the reduction of the product would be due to this fact. If we should take away all the labor, the capital would be completely paralyzed, and the product would become nil. It would obviously be inaccurate to say that the whole product is attributable to the labor, on the ground that withdrawing the labor annihilates it all. With any large part of the labor treated as a single unit, the loss of product occasioned by a withdrawal of such a unit is more than can be accurately imputed to it as its specific product. The smaller the increments or units are made, the less important is this element of inaccuracy, and it becomes a wholly negligible quantity when they become very small. A study of the forms of the productivity curves will show that if we take as the increment of labor used in making the test only a tenth of the whole force, we exaggerate the product imputable to it by a very minute fraction, say by less than a one-hundredth part; and if we take a hundredth of the labor as a final unit, we exaggerate the product that is solely attributable to it by an amount so minute that it is of no consequence in practice or in any theory that tries to be applicable to practice.
A question may be raised as to whether we are correct in saying that the entrepreneur's profit is residual, in view of the fact that the entire product of a business is at the mercy of the management, so that a bad manager may reduce it or a good one may increase it. It may be further claimed that that part of the management of a business which consists in making the most far-reaching decisions cannot safely be intrusted to a salaried superintendent or other paid official and must get its returns, if at all, in the form of profits. Even in this case the gains are secured by making the gross return, which is the minuend in the case, large, leaving the two subtrahends, wages and interest, unchanged, and thus creating a remainder or residuum. We shall later see to what extent entrepreneurs do in fact create the profits that come to them.
The complete static conception of society requires that no entrepreneur should be left in the field who cannot continue indefinitely to hold his own against the competition of his rivals, and this requires essential equality of productive power on the part of all of them. It is not necessary, however, that all should operate upon an equal scale of magnitude, for an interesting feature of modern life is the need of many small productive establishments that cater to local demands and to wants which, without being local, call for only a few articles of a kind. Repairs, small orders, and peculiar orders are executed more cheaply in small establishments, and they survive under the very rule of essential equality of productive power which static conditions require. For catering to the general market and producing staple goods the large establishment has a decisive advantage, and this insures the centralization which is the marked feature of recent industrial life.