Supply and Demand

by Sir Hubert Douglas Henderson

This point is not merely an academic one. It means that we cannot explain the relative prices of cotton lint and cotton-seed in terms of cost at all, whether marginal or otherwise. The influence of cost will be confined to the sum of the prices of the two things. Upon this sum it will exert precisely the same influence as it exerts upon price in general, by affecting the total quantities of the two things that will be supplied. But upon the distribution of this sum between lint and seed, cost will exert no influence whatever, because it cannot affect the proportions in which they are supplied. It may assist some readers if I state the matter in more concrete terms. Cost of production will be one of the factors which will result in the production of an annual cotton crop in the United States of, let us say, 10 million tons of seed cotton. This crop will yield roughly 6-2/3 million tons of cotton-seed, and 3-1/3 million tons (or rather more than 13 million bales) of lint. The combined price received by the planter of (let us say) 14.4 cents for 1 pound of lint plus 2 pounds of seed should correspond roughly to the marginal joint costs of production. But the factor of cost has no influence at all in determining that this combined price is made up of a price of 12 cents per pound for lint, and only 1.2 cents per pound (or $24 per ton) for cotton-seed. To account for this we must rely entirely upon demand. We can say, shortly, that the respective prices must be such as will enable the demand to carry off 6-2/3 million tons of seed, and 3-1/3 million tons of raw cotton. Or we can go further and say that the marginal utility of a pound of raw cotton, when 3-1/3 million tons are supplied, is ten times as great as that of a pound of seed when 6-2/3 million tons are supplied.

If accordingly the demand for cotton-seed were to expand considerably owing, say, to the discovery of some new use for the oil, which is its most valuable constituent; the effect would be first a rise in the price of cotton-seed, and, subsequently, by stimulating cotton growing, a more plentiful supply and a lower price for raw cotton. And so far at least as the increased supply is concerned, this must necessarily be the effect, "other things being equal"; though, to be sure, it might be outweighed and obscured by other influences such as the boll-weevil. But it is not the case that an increased demand for mutton must necessarily increase the supply or lower the price of wool; and it is most unlikely to do so in any similar degree. For, here, the separate marginal costs of the two things exert their influence. An increased demand for mutton will stimulate sheep farming, but it will also stimulate the substitution of crossbred for merino breeds; and the resultant of these two opposite tendencies upon the supply of wool is logically indeterminate. As a matter of history we know that the development of cold storage in the eighties (which we may regard for the present purpose as equivalent to an increased demand for Australian mutton) caused considerable perturbation in the woollen and worsted industries of Yorkshire. They were faced with a dwindling supply and a soaring price of merino wool; and the adaptability with which they met the situation, and won prestige for the crossbred tops, and yarns and fabrics, to which they largely turned is a matter of just pride in the trade to-day. The fact, however, that this alteration in the supply of wool was a matter not only of quantity but of quality, while it takes nothing from the substance of the preceding argument, makes it difficult to draw a clear moral, bearing on the present issue, from this incursion into history.

§4. The Importance of being Unimportant. The above contrast between cases in which variation is possible, and those in which it is not possible, is reproduced with a heightened significance when we turn back to joint demand. The cases are perhaps less common in which it is impossible to alter the proportions in which different commodities are jointly demanded, but there are many cases in which it is not nearly worth while to do so (and this amounts to very much the same thing). Cases of this sort are especially likely to occur when we are dealing with a commodity which accounts for only a tiny fraction of the costs of the industry which is its chief consumer. Sewing cotton, for example, is jointly demanded, with many other things, by the tailoring and other clothing trades; but the money which these trades spend on sewing cotton is so small a part of their total expenditure, that no ordinary variation in its price is likely to make it worth while to study the ways and means of using it in smaller quantities. When sewing cotton is bought by the domestic consumer, considerations which are fundamentally the same, though somewhat different in form, point to a similar conclusion. It is thus very difficult to assign to sewing cotton a specific marginal utility. This difficulty is of great importance in connection with the possibilities of monopolistic exploitation. For it means that the demand blade of the scissors upon which we rely to cut off excrescences of price is blunted, and if accordingly the producers constitute a strong enough combination to control the supply blade, they will possess an unusual power of advancing their selling prices as they choose. I am far from suggesting that Messrs. J. & P. Coats are to be condemned as an extortionate monopoly. On the contrary, during 1919, when the profits in highly competitive industries like the main branches of the cotton and woollen trades, soared exuberantly, the record of this concern seems to me one of distinct moderation. But the present point is that they possess an exceptional power to fix the price of sewing cotton as they choose, and that this is attributable in no small degree to the fact that sewing cotton constitutes an essential but relatively trifling item in the expenses of the processes in which it is employed.

Perhaps the point will be made clearer if we turn from the selling prices of commercial products, in regard to which there is a strong and not ineffective public sentiment against "profiteering," to the remuneration of different classes of labor. With an instinctive disposition towards megalomania, it is often claimed in Great Britain that the miners, being a very numerous and well-organized body of workpeople, were in a stronger strategic position than most workpeople for exacting the remuneration they desire. It is quite true that a stoppage of work in the coal industry causes us a high degree of inconvenience, and temporary concessions may thereby be obtained which might otherwise have been refused. But this is a dubious advantage, and we grossly exaggerate its real importance. The truth is that the strategic position of the miners in regard to wages questions is by no means strong. For their wages constitute a very large percentage of the cost of coal; and the price of coal in its turn is a most important element in the costs of many of the industries which are its principal consumers. Great Britain, moreover, is far from possessing a monopoly of coal. If, accordingly, the wages of the miners are temporarily pushed up to a high point, the result will certainly be a diminished demand for British coal, which will lead before long to their fighting a losing battle to maintain the concessions they have won. Contrast their position with that of the steel smelters, whose wages (high though the wage rates are) constitute a very small percentage of the costs of steel production, and we must agree I think that we have in this distinction the main reason why the steel smelters, though they hardly ever go on strike, have as a rule been able to do so much better for themselves than the miners.

When a commodity or service is such that an appreciable alteration in its price has only a slight effect upon the quantity demanded, the demand is said to be inelastic. Conversely, when a small change in price greatly alters the quantity demanded, we call the demand elastic. In the former case, it is worth nothing, a larger aggregate sum of money will be spent upon the thing when its price is high than when it is low, while the opposite is true in the latter case. This distinction is of considerable importance in connection with many problems (e.g. of taxation); and the terms, elastic demand and inelastic demand, are worth remembering. We may thus express the above conclusions by saying that the demand for sewing-cotton is highly inelastic, and that the demand for coal miners is more elastic than that for steel smelters.

§5. Capital and Labor. Cases in which it is impracticable to make any variation in the proportions in which different things are used together are, however, the exception rather than the rule. Where variation is possible, we are confronted with an uncertainty as to the way in which an increased supply of one thing will react on the demand for another, similar to our uncertainty as to whether an increased demand for mutton would augment or diminish the supply of wool. It is, for instance, of the highest importance to give a clear answer, if we can, to the question whether an increased supply of capital will increase the demand for labor. The chief effect of an increased supply of capital is to facilitate the extended use of expensive machines: to some extent these machines will increase the demand for labor; to some extent they will be substituted for it. Which of these two tendencies will outweigh the other we cannot be absolutely sure. But fortunately we can be far more nearly sure than was possible in the analogous case of wool and mutton. An increase in the supply of capital increases the demand for the commodities, from which the demand for labor is derived, in both the senses discussed in Chapter II. First it makes them cheaper to buy, and thus increases the quantity that will be bought. It is this that is parallel to the effect of an increased demand for mutton in making it more profitable to breed sheep. But it also serves to increase the purchasing power with which to buy commodities, because it increases the aggregate real wealth of the community, and it thus serves to raise the whole demand curve. This last consideration is so important as to make it overwhelmingly probable, apart from the evidence of history, that an increase in the supply of capital (and the same may be said of an increase in the supply of the other agents of production) will on balance increase the demand for labor. The evidence of history points to the same conclusion. The history of the last hundred years displays an unprecedented accumulation of capital, and an unprecedented extension of machinery, associated with an unprecedented improvement in the standard of living throughout the whole community. This is powerful testimony in favor of the view that an increase in the supply of capital and the use of machinery will usually enhance on balance the demand for labor. Moreover, though this is not conclusive, there is little room for doubt that an obstructive attitude towards the extension of machinery in a particular country, or a particular district, is misguided. For its effect must be to make production more costly there than it is elsewhere, and to lead, slowly perhaps, but very surely, to the transference of the industry to other regions.

§6. Conclusions as to Joint Supply and Joint Demand. Here, however, we are beginning to digress. Let us sum up in a general form our conclusions as to the way in which changes in the supply or demand of a commodity react upon the demand or supply of the other things with which it is jointly demanded or supplied. Everything turns, as we have seen, on the possibility of variation in the proportions in which the things are used or produced together; and this, it is also clear, is a matter of degree. Our conclusions, therefore, had best take the following form:—

VII. When two or more things are jointly demanded, in proportions which cannot easily be varied, the tendency will be for an increase (or decrease) in the supply of one of them to increase (or decrease) the demand for the others. These results will be more certain, and more marked, the more difficult it is to vary the proportions in which the things are used.
Similarly, when two or more things are jointly supplied, in proportions which cannot easily be varied, the tendency will be for an increase (or decrease) in the demand for one of them to increase (or decrease) the supply of the others. These results again will be more certain and more marked, the more difficult it is to vary the proportions in which the things are supplied.

§7. Composite Supply and Composite Demand. Joint Demand and Joint Supply do not complete the list of relations between the demand and supply of different things. Between tea and coffee, or beef and mutton there is a relation of a different kind. These things are in large measure what we call "substitutes" for one another. An increased supply, and a lower price of mutton, will probably induce us to consume less beef. This relation it is convenient to describe as Composite Supply. Beef and mutton make up a composite supply of meat; tea and coffee a composite supply of a certain type of beverage. For any group of things, between which the relation of Composite Supply exists, we can say, with complete generality, that an increased supply of one of them will tend to diminish the demand for the others. Parallel to the relation of Composite Supply is that of Composite Demand. There are frequently several alternative uses in which a commodity or service can be employed; and these alternative uses make up a composite demand for the thing in question. Thus railways, gasworks, private households and a great variety of industries contribute to a Composite Demand for coal. It is worth noting that there is frequently an association in practice between Joint Demand and Composite Supply on the one hand; and between Joint Supply and Composite Demand on the other. Wool and mutton, for instance, we have described as an instance of Joint Supply; but, in so far as the proportions of wool and mutton can be varied, we can regard these things as constituting a Composite Demand for sheep. And this conception may help us to retain a clearer and more orderly picture of the problems we have discussed above. We can regard the fact that wool and mutton are produced together as their Joint Supply aspect, and the fact that these proportions can be varied as their Composite Demand aspect; and the question as to whether an increased demand for mutton will increase the supply of wool turns upon whether the former aspect is more important than the latter. Similarly labor and machinery, employed together for the same purpose, form an instance of Joint Demand; but in so far as they can be substituted for one another, they constitute a Composite Supply of alternative agents of production.