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Book IV, Chapter VII: The Law of Costs - Eugen von Böhm-Bawerk, The Positive Theory of Capital 
The Positive Theory of Capital, trans. William A. Smart (London: Macmillan and Co., 1891).
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Book IV, Chapter VII
The Law of Costs
In the sphere of price, as in the theory of subjective value, we find a law firmly rooted in economic literature and accredited by common experience. It tells us that the market price of goods reproducible at will tends to equalise itself, in the long-run, with Costs of Production. The following perfectly valid line of argument is usually adduced in proof of this. The market price of goods reproducible at will cannot, in the long-run, be maintained either much above or much below their cost. If at any time the price of an article rises appreciably above the cost, its production will be particularly profitable to the undertakers. This will not only induce the latter to extend their already flourishing businesses, but will encourage new undertakers to enter the same remunerative branch of industry. Thus the amount of product brought to market will be increased, and finally—according to the law of supply and demand—a fall in price will ensue. If, conversely, at any time the market price falls below costs, continued production will show a loss; many undertakers will reduce their output; the supply of the commodities will be reduced; and this, finally, in virtue of the law of supply and demand, must lead to a raising of the market price.
Round this law of costs has gathered a great mass of theoretical detail,27 which may, for our purposes, be left entirely on one side. Our whole interest is centred in the question as to the position which the law, so well accredited by experience, takes in the systematic theory of price. Does it run counter to our law of marginal pairs or not?
Our answer is that it does not. It is as little of a contradiction as we before found to exist between the proposition that the marginal utility determines the height of subjective value, and the other proposition that the costs determine it. The line of thought which, in both cases, leads to the solution of the apparent contradiction is the same, feature for feature; except that, in the present case, in virtue of the intervention of exchange,—in virtue, that is, of the translation of the phenomena out of individual economy into social economy,—there appear richer developments at every station on the line of thought.
In what follows I shall try, as briefly and clearly as possible, to describe the concatenation between Value, Price, and Costs; and I think I am not exaggerating when I say that, to understand clearly this connection, is to understand clearly the better part of Political Economy.
The formation of value and price takes its start from the subjective valuations put upon finished products by their consumers. These valuations determine the demand for those products. As supply, over against this demand, stand, in the first instance, the stocks of finished commodities held by producers. The point of intersection of the two-sided valuations, the valuation of the marginal pairs, determines, as we know, the price, and, of course, determines the price of each kind of product separately. Thus, for instance, the price of iron rails is determined by the relation of supply and demand for rails; the price of nails, by the relation of supply and demand for nails; and, similarly, the price of every other product made out of the productive good iron—such as spades, ploughshares, hammers, sheet-iron, boilers, machines, etc.—is determined by the relation between the supply and demand which obtains for these special kinds of products. To make this perfectly clear, let us assume that the relations between requirements and stocks of the various iron products—and, accordingly, their prices to begin with—are very various; that the price of a quantum of commodity which can be made out of one and the same unit of productive material28 —for instance, from a cwt. of iron—varies from 2s. for the cheapest to 20s. for the dearest class of products. These prices are the result of the position of the market at the moment, and we have first assumed that the stocks of products (the supply) are a given quantity. But they are only for the moment a given quantity. As time goes on, they are always getting supplemented from production, and this makes them a variable quantity. Let us follow the circumstances of this production. For the manufacture of iron fabrics producers, of course, require iron.29 Under the system of division of labour they must buy this in the iron market. The manufacturers represent this demand for iron. As regards the extent of the demand, it is clear that every producer will buy as much iron as he requires to produce that amount of the commodity which he may expect to sell among his customers. But how will it be as regards the intensity of the demand? Obviously no producer will give more for the cwt. of iron than he can get for it30 from his own customers in the shape of price; but, up to this point, even in the worst case, he can and will compete rather than let his production come to a standstill for want of raw material. The manufacturer, therefore, who can profitably employ the cwt. of iron if he gets 20s. from his customers will be a buyer in the iron market up to the price of 20s. as maximum; he who can profitably employ the cwt. of iron at 16s. will, naturally, not buy at a price over 16s., and so on. In this way the market price which each producer of iron wares gets for his particular wares (or the share of the market price which falls to iron according to the law of complementary goods) furnishes him with the concrete valuation which he has in his mind when joining in the demand for iron.
The supply, which stands over against this demand, consists of the stocks of iron held by the mine-owners and ironmasters. These stocks will pass, in methods familiar to us, into the possession of the most capable buyers, and at a price which, approximately, corresponds to the valuation of the last buyer.31 Suppose the stocks of iron are sufficient to meet the demand of all those buyers who value iron from 20s. down to 6s. per cwt., the valuation of the last buyer, and thus the market price of the iron, will stand at 6s.
And now we have to consider the causal connection which has ended in this price. It runs, in the clearest possible way, in an unbroken chain from value and price of products to value and price of costs—from iron wares to raw iron, and not conversely. The links in the chain are these. The valuation which consumers subjectively put upon iron products forms the first link. This helps, next, to determine the figures of the valuation—the money price at which consumers can take part in the demand for iron products. These prices, then, determine, in methods with which we are now familiar, the resultant price of iron products in the market for such products. This resultant price, again, indicates to the producers the (exchange) valuation which they in turn may attach to the productive material iron, and thus the figure at which they may enter the market as buyers of iron. From their figures, finally, results the market price of iron.
But still another and very important connection may be gathered from all this. It is that here we have simply the great law of marginal utility fulfilling itself. According to that law the available stock of goods is, successively, conducted into the most remunerative employments—put to the most advantageous uses,—and the last use to which the goods are put determines their value. In any individual economy the most remunerative uses are seen to be those which express the most urgent subjective wants, and the value which emerges, as result of these individual relations, is purely personal subjective value. In the more extended sphere of a market, on the other hand, everything is referred, no longer directly to subjective wants, but to those wants as mediated by money—money being, as it were, the neutral common denomination for wants and feelings of various subjects which are not immediately commensurable. Here emerge, as the most remunerative employments, not those which express the wants absolutely most urgent, but those which are represented by the highest money valuation; that is, the best paying employments;32 and the value which results is objective exchange value. Thus it is, first of all, with iron products. In their respective markets they pass to the best paying buyers, and the price which expresses the valuation of the last buyer determines their market value and price. But so it is also, in the second place, in a slightly roundabout way, with the "cost good," iron, itself. In the iron market it goes to the best paying producers, and the valuation of the last of these determines its price. But here the producers are simply mediators. In their conducting of the iron to the best paying consumers, the stock of iron really passes successively to the most remunerative forms of consumption, and the last of these forms provided for determines—through the valuation named by the last producer who enters the market as buyer—the market price of the cost good, iron. It is not this cost good, then, that dictates its fixed price to the products that proceed from it; on the contrary, it receives its own price by the medium of the price of its products, in conformity with the great law of marginal utility, according to which the available stock is forced into the most remunerative employments, and receives its price from the money valuations of the last of these.
But connected with this is a series of subsequent phenomena, which, obviously, have given rise to the opinion that costs exert a causal influence on the price of products. So long as the price of various products made from iron varies between 20s. and 2s., while the price of the unit of iron stands at 6s., it is an evidence that the economical principle which should guide the stocks of iron into the most remunerative employments is not fully carried out. Iron is being used in employments where the products fetch only 2s. or 3s., where, accordingly, the use is less than the "last" economically permissible; and, on the other hand, there are still numerous employments unprovided for, where the products would obtain a greater value than 6s. If, for instance, the market price of an iron product stands at 20s., it is a proof that only those consumers of that product who value it at 20s. and upwards are actually purchasing, while other consumers, whose valuations range from 18s. down to 6s., are not supplied in the market. Similarly with products whose market price stands at 16s.; there will be an unsatisfied layer of demand, with a use for the product corresponding to the prices 14s. down to 6s., and so on. Now this must be corrected—and the enterprise of undertakers will usually not be long in supplying the needed correction. The production of those iron wares, the price of which still stands above 6s., will, under the inducement of the premium offered by the difference between price and cost, be increased till all those employments where the utility is greater than the amount of 6s. are supplied. Of course this increase of supply has the effect of always reducing the level in which the "last" buyer is found, and thus the market price sinks, till such time as the money valuation of the last buyer, and with it the market price, comes to the normal level of 6s. Conversely, where iron has been put to employments whose products fetch less than 6s., the loss that ensues will prevent more iron being thus employed. This will be brought about by a temporary suspension or limitation of the production of those iron wares, the market price of which is under 6s. This limitation of supply will soon have the effect of raising the price to 6s., and now, as the state of the case demands, the commodity, iron, will only be attainable by those buyers who can use it to make products that will fetch at least 6s. Thus, from above and from below, all iron products come together at the price of 6s., the amount of their costs; but, quite evidently, the cause of this is not that the cost good, iron, can force its own arbitrary fixed price on its products, but that all the products involved, including the cost good, iron, conform to the law of marginal utility, find their way successively into the most remunerative employments, and together receive their price as regulated by the last of these.33
Empirical proofs of this may be had in abundance. It is a very well known fact that active building of railways raises the price of rails, and, through this, the price of iron; that the present strong demand for copper wire in electric lighting puts up the price of copper. In these cases it is evident that the upward movement of price takes its start from the final products, and is transferred from these to the cost goods. But the objection will probably suggest itself to many readers, that there are also cases where the movement of price is from costs to products. The stocks of iron, for instance, of which we have been speaking in our illustration, are not a fixed amount, but are smaller or greater according to the circumstances of iron production. Now if there is an extension of this production, and the supply of iron increases, its price will certainly fall, and that from causes peculiar to the iron; and this fall in prices will drag down the price of iron wares. Does the causal connection here not run from costs to price of products?
To answer this objection we have only to carry the concatenation, of which we have hitherto examined only a few links, back to its beginning. It is quite correct to say that stocks of iron are not a fixed amount, but the varying result of a production which is capable of being extended or limited at will. For the production of iron two things are necessary,—mines, and (to put it shortly) direct and indirect labour. The mines are a given quantity, and cannot be devoted to the production of anything but iron. On the other hand, the quantity of labour available as a whole for economical employment, is an amount given and limited by the current state of population, but this is not the case with that particular labour which is employed in the production of iron. Labour is a productive power capable of being employed in any number of ways, and all the branches of production carried on in the community compete for it. Who or what, now, is it that decides what exact proportion of the original productive powers at the disposal of industry, namely labour and uses of land, is employed in the production of iron, and who and what is it that decides on the value and price of the unit of those productive powers?
Here, then, for the last time, is repeated, in the elements of all economy, the movement which we saw in the case of final products and intermediate products. The original productive powers of the nation force themselves into the most remunerative employments one after another, and receive their value and price from the last of these. As little as, perhaps even less than, any other good have they any a priori fixed value: they receive it only from the opportunities of employment. Whether the day's work is worth 2s. or 6s. depends on the worth of the product which can be turned out in the day's work, and, indeed, on the "last" product—the one worst paid—for the production of which there is still enough labour of the necessary quality left, after all the better paid employments have been supplied.
Production may be compared to a giant pump. Every branch of want has its separate pipe sunk down to the great reservoir of the original productive powers, and competes with all the other branches of want in trying to draw its supply by suction from that reservoir. Every branch has a different power of suction, the power increasing with the number and the remunerativeness (that is to say, in the case of organised exchange, the money value) of the employments it embraces. In the nature of the suction pipes, too, there is a difference. Many are quite simple: others have independent intermediate lengths, that convey the pressure that comes from the want, as it were, by stages; and, in correspondence with that, the productive powers which supply the want are raised by stages.
The simile extends still further. Such wants as demand personal services for their satisfaction, attract labour quite directly, according to the payment which they can and will give for them. Such wants, again, as demand material goods for their satisfaction, get these supplied, first, by payment of a market price which is remunerative in itself, and then the remunerative price of the products must attract the productive powers to their manufacture. Sometimes this is done through one or two, sometimes through twenty or thirty, members. In our illustration, human demand asked and paid for iron wares: the market price of iron wares attracted people to the purchase of iron: the price of iron, finally, attracted the original productive powers to the production of iron. In the case of other consumption goods, the number of intermediate members, or, to keep to the terms of our comparison, the number of intermediate lengths in the suction pipe, may be double or twenty times as great. But the principle of the movement, and what chiefly interests us, the result, is always the same. Whether there are many or few intermediate members may hasten or hinder the result, but it cannot weaken or strengthen it; in the end every want, according to the power expressed by its money valuation, draws to itself, mediately or immediately, the productive powers required for its supply. To supply the wants of the rich innumerable productive powers are always active, even if, simultaneously, at other points of the economy, there is want both of men and goods. The reason of this is that the high figures, which the rich are able to offer for the satisfaction of their wants, never fail to exert and continue their attractive force through all the stages of production, right down to the reservoir of the original productive powers.
Thus all human wants exert, as it were, a suction power indicated by the figures of their valuation. Now, that layer of wants which is willing and able to pay, say, 20s. and upwards, for the day's work devoted (mediately or immediately) to its satisfaction, is soon entirely provided for. After it those layers, in succession, draw supply to themselves which can and will pay the day's labour with 18s., 16s., 14s., and 12s., even down to 10s., 8s., 6s., and 4s. If, at the limit of 4s., the entire stock of original powers is required and is taken, this decides two things:—All wants which will not, or cannot, pay the day's labour devoted to their service at 4s., remain unsupplied; and the market price of the day's labour will stand at the figure of the last buyer, namely, 4s. But if, as we may rather assume, the available quantity of labour is greater than this, the wants of still lower levels may be supplied. The last needs—mediate or immediate—which are supplied may be those that pay the day's labour at 2s. only; and, in conformity, the market price of labour also will be fixed at this lower figure of 2s. And, indeed, this market price will be a general one: the uppermost layer will not be paid 20s., and the lowest layer 2s. for the same work or the same commodity: the market price will be the same for all buyers.
And now we come in sight of the answer to the doubt suggested by our former illustration. Suppose that the price of the day's labour is 2s., and the price of a cwt. of iron, which takes three days to produce, is 6s. Suppose now that, all of a sudden, new and productive mines are opened, or some great improvement in process discovered, which makes it possible to produce the cwt. of iron in two days' labour. What is the consequence? So long as the iron and its products maintain the old price of 6s., only those wants in the department of iron wares are supplied which are able and willing to pay 6s. for two days' work; that is, to pay the day's labour at the rate of 3s., while all round, in all other departments of want and branches of production, that layer of want is supplied which pays only 2s. for the day's labour. On economic principles—which are willingly carried out by undertakers of industry, who are always ready to seize the chance of a profit when offered them—those opportunities of employment which pay the day's work at more than 2s., and have hitherto been misapplied, will now be supplied: more original productive powers will, accordingly, be invested in the production of iron; and the supply of iron and iron products will be increased till such time as, here as elsewhere, that level of wants which is willing to pay the day's labour at 2s. is satisfied, and therefore the cwt. of iron, which costs two days' labour, fetches 4s. Parallel with this, of course, the price of iron and iron products34 goes down to the level of 4s. And all this is not in opposition to, but in real fulfilment of our law of Marginal Utility, of which the law of costs, rightly understood, is only a special expression suitable to a special group of phenomena.
If—what is practically inconceivable—production were carried on in ideal circumstances, unfettered by limitations of place and time, with no friction, with the most perfect knowledge of the position of human wants requiring satisfaction, and without any disturbing changes of wants, stocks, or technique, then the original productive powers would, with ideal and mathematical exactitude, be invested in the most remunerative employments, and the law of costs, so far as we can speak of such a law, would hold in ideal completeness. The complementary groups of goods from which, in the long-run, the finished good proceeds, would maintain exactly the same value and price at all stages of the process; the commodity would be exactly equal to its costs; these costs to their costs, and so on, back to the last original productive powers from which ultimately all goods come. But this ideal symmetry is traversed by two disturbing causes.
The first of these I may call by the general name of Friction. Almost invariably there is some hindrance, great or small, permanent or temporary, to the due investment of the original productive powers in the employments and forms of consumption which are the most remunerative at the time. In consequence the provision for wants, and likewise the prices, are somewhat unsymmetrical. Sometimes it is that individual branches of want are, relatively, more amply supplied than others; so that, for instance, in woollens, those wants are supplied which pay the day's labour indirectly at 1s. 8d. only, while it may be that, in copper goods, no wants are satisfied which cannot pay 3s. for a similar day's labour. But sometimes it may be that groups of productive materials, successively transformed till they are changed at last into the finished commodity, are not equally valued at all stages of the process. If we compare the means of production to a stream, we might say that the stream is not, as it should be, of equal breadth at all stages of its course: from some disturbing cause or other there may be dams at certain particular points, and leakages at others; and these cause an unsymmetrical divergence of price compared with the prices obtained at stages before and after, or, as it is usually conceived and expressed, a divergence of the price of a product (or intermediate product) from its costs. Thus it is, in our illustration of the iron, when production is suddenly cheapened from 6s. to 4s. As a consequence the production of iron is at first increased, and presses down the price of raw material, while the products of iron may still for some time maintain a price greater than their costs. But gradually the increase of supply presses forward to the later stages of production,—passes from the production of raw materials to the manufacture of final products,—and by reducing the price here also to 4s. restores the disturbed symmetry between price and costs.
In practical life such frictional disturbances are innumerable. At no moment and in no branch of production are they entirely absent. And thus it is that the Law of Costs is recognised as a law that is only approximately valid; a law riddled through and through with exceptions. These innumerable exceptions, small and great, are the inexhaustible source of the undertakers' profits, but also of the undertakers' losses.
The second disturbing cause is the Lapse of Time—the weeks, months, years which must stretch between the inception of the original productive powers, and the presentation of their finished and final product. The difference of time, in exerting a far-reaching influence on our valuation of goods, makes a normal difference between the value of the productive groups standing at different points of the production process through which they must all pass; and is, therefore, a difference to be kept quite distinct from the unsymmetrical divergences caused by frictional disturbances. It is this second disturbing cause which gives rise to Interest. Our further task will be to intercalate the theory of interest in its place within the value and price theory already outlined.
PRESENT AND FUTURE
[27.]Thus the question as to costs of production or costs of reproduction; whether, in the case of a variety of costs, it is the highest, the lowest, or an average cost that is to be taken as standard; what elements are to be reckoned among costs, and so on.
[28.]To simplify the matter, we shall omit for the moment the co-operation of any other complementary means of production.
[29.]Again, for simplicity's sake, I leave out the other requisites of production.
[30.]It must be remembered that here we are making abstraction of the co-operation of other complementary means of production, as Labour, Tools, Coal, etc. If otherwise, of course, recording to the principles laid down above (p. 170) on the value of complementary goods, we should have to put a portion of the value of the product to the account of the other co-operating goods, and assign only a quota of the product's value to the iron. But, in that case, exactly the same relations, as are shown in the text to exist between the value of iron and the full value of the product, would hold between the value of the iron and that quota of the product's value.
[31.]See above, p. 221.
[32.]That these two, unfortunately, are not usually the same I have shown at length in Conrad's Jahrbücher, pp. 510-513, when discussing the causes and effects of this fact.
[33.]It is possible that the amount of costs may itself be shifted—raised, for instance—by the process of correction just described. It may happen, that is to say, that in order to satisfy the demand, hitherto unsatisfied, which is desirous of buying iron products at a higher price than 6s., so much iron is taken out of the iron market that the stock is no longer sufficient for the demand that is willing to pay just 6s. This latter, then, will, of course, be shut out by the stronger competitors, and the market price settles at a higher figure than 6s.—another proof that costs are not the fixed point to which the price of products adapts itself, but vice versâ.
[34.]It must not be forgotten that we are simplifying the matter by leaving out of account the co-operation of other complementary goods in the production of iron products. If we were to take these into consideration, and assume, for instance, that, to change the iron into the iron product, the expenditure of other two days of immediate or mediate labour was necessary, then 8s., as the price of iron product, would correspond to 4s. as the price of iron, and of this, according to the law of complementary goods, 4s. would be reckoned to the productive good, iron, as its share.