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Cost of Production and Price Over Long and Short Periods
JPE, 1921

Great difficulties are met with in stating a clear and straightforward exposition of price theory because of the fact that the given conditions or data of the problem are so different according to the length of the time period which the explanation takes into account. The forces which immediately regulate prices are different from those which ultimately control, and there are degrees or stages in both immediateness and ultimateness. The average student of economics is likely to be quite baffled by these distinctions and to get no clear ideas at all; but he is still more baffled by differences in degree, where distinctions are not sharply drawn and statements are left in the form of "it depends." This paper looks to the problem of exposition from the standpoint of the student rather than to the correction of errors in accepted doctrine, but the course of the argument will have to note cases in which current phraseology is misleading to unwary readers if it does not represent fundamental misconceptions on the part of economists themselves.

I

The most familiar device for separating certain short-time and long-time aspects of economic problems is the fiction of the "static state," and our first critical duty is to raise serious question as to this conception in its current form. The writer doubts whether its popularization has represented an advance in clearness of ideas or a service to the science. Passing over the technical point that there is no discoverable analogy between the meaning of static and dynamic in economics and their established meaning in mechanics, our objections are more serious. All science is static in the sense that it describes the unchanging aspects of things. There is no sense in making statements that will not continue to be true after they are made. The possibility of saying anything about a thing rests on the assumption that it preserves its identity, or continues to be the same thing in the respect described, that it will behave in future situations as it has in past. The essential fact in economics is that different changes take place at different rates, that for certain time periods certain aspects of the situation may be assumed to remain unchanged, while for longer periods some of these will undergo change. The data or given conditions are different when different periods of time are under consideration.

It may not, however, be true, and generally is not, that the different changes can be completely separated in this way. The effects of long-period changes are not generally in fact practically negligible over the shorter periods. But scientific treatment, in view of the mere limitations of the human mind and the necessity of considering one thing at a time, is forced to treat the separation as absolute. We must ascertain the separate effects of the different causes and combine them after we understand them. This would have to be done just the same if the causes did not generally operate in different periods of time, but the latter fact greatly simplifies our thinking. It is more realistic and intelligible to isolate a short-period effect, abstract entirely from perturbations due to the operation of more slowly working forces because for short periods the effects of the latter are in reality relatively less important. There are thus, in fact, as many "static states" as there are economic problems worth studying. All that is really involved in the static method is the use of analysis, the assumption in studying the effects of any one cause that the operation of other causes does not interfere.

Another serious confusion in connection with static hypotheses relates to the conception of equilibrium. It is true practically if not altogether without exception that the changes studied by any science tend to equilibrate or neutralize the forces which bring them about, and finally to come to rest. The simplest example perhaps is that "water seeks its level"; the movement is always the effect of a difference in level and its result is to obliterate that difference and come to a stop. In the same way the wind is caused by a difference in air pressure, the transfer of radiant energy is due to a difference in temperature, of electricity to a difference in electrical potential, and so forth, the change or movement in every case being of a character to equilibrate the forces which cause the movement.

In consequence of this fact it is a practical necessity to describe the action of any force by stating the final condition which it tends to bring about, the conditions under which it would cease to work. Any other description is partial and arbitrarily so. The only complete or logical procedure is to state the ultimate goal of the tendency in question. Such a statement or description does not imply at all that this final condition is likely to come about. When we say that the movement of water or air is of such a character as to obliterate the stresses which produce the movement we do not mean that these movements are likely soon to cease on the earth, just as we define north as toward the North Pole without implying that everything moving northward is bound for that goal. The final effect of even a short-period change may be an indefinite distance in the future, involving the practical certainty that in the meantime the original cause will change in character or cease to operate or be interfered with by innumerable other causes; it may be never so improbable that the final result will ever be reached, yet the proper and only proper way to describe the situation at the moment is to state a "tendency" toward this theoretical final result.

The static method therefore involves two fundamental but badly confused ideas. The first is simply that in describing any change it is assumed that "other things are equal." The second is that changes are described by stating the condition of affairs to which they would lead if they continued without interference until they equilibrated the forces at work and came to a natural end. These principles are the same in economics as in mechanics or any other science which attempts to predict effects from the knowledge of causes. Goods move in response to price differences from points of low to points of higher price, the movement tending to obliterate the price difference and come to rest. Productive services are shifted from one field of use to another in response to differences in remuneration and the transfer tends to bring the remuneration to equality in all fields—produce equilibrium.

After a considerable amount of experimentation the writer has tentatively settled, for instruction purposes, upon a division of the problem of explaining prices into four, or possibly five, stages, relative to the time length of the changes to be discussed.1 In all these stages or "cases" the general principle is that price is adjusted to the point at which supply and demand are equal. They differ in that supply and demand have different meanings, especially the supply. The first stage in the explanation is to state the character and condition of equilibrium of the forces operative at a given instant of time. Here the motives of both sellers and buyers are based on speculative considerations, the former entirely and the latter almost so. Supply and demand are both functions of price, meaning that the amounts that sellers will offer and the amounts that buyers will take depend upon the price. In general, sellers will offer more and buyers take less, the higher the price. The reason is that the higher the price the less is the likelihood that it will go higher and the greater the likelihood that it will go lower in the immediate future. In the primary markets, where prices are determined, this is the only consideration in the mind of sellers, and the buying is almost entirely speculative. For the moment, the demand for goods for immediate consumption is practically negligible, and purchases are determined by opinions as to the probable course of prices in the near future.2

[1.]This division differs from Marshall's four cases in important respects which will be developed at length. My fivefold division corresponds more closely to his fourfold one.

This article discusses the problem of the explanation of price. It is appropriate to say that I think we have talked rather too much about prices as such, and should strive to keep more in the foreground the forces which are measured by prices and the changes which they bring about. The real subject matter of economics is the organization of production and consumption. The desideratum is to get students to see how in our social system, in so far as it is based upon private property and free contract, consumption is controlled by the prices of finished goods, how these prices are translated through entrepreneurs' calculations into price offers for productive services which control the utilization of the productive resources of society, and finally and most sadly neglected of all, the circular character of the whole process. The pecuniary demand for goods has little relation to their objective human significance. It depends on the existing distribution of ownership and opportunity and the facts as to consumers' tastes, both of which are largely molded by the workings of the system itself.

[2.]The situation in the market at a moment is represented by the familiar demand and supply curves. In the writer's view these gain enormously in reality and clearness by taking price as the base line, the independent variable, and interpreting the price point as the point where the amount off offered is equal to the amount taken (see Diagram I). This is the procedure of the so-called mathematical economists. American textbooks generally plot quantity of goods horizontally and price vertically in order to make the demand curve identical with a curve of diminishing utility (utility as a function of supply). When it is remembered that utility in the sense in which it influences price is relative utility, measured in terms of money, the value of the utility analysis for explaining price becomes somewhat problematical, especially for purposes of elementary exposition. It is not clear that such utility curves add much to the mere statement that purchases are a function of price. Certainly they have to be translated into curves of purchases as a function of price before they are usable, for a utility curve can at most represent the facts for a single purchaser. There is no possibility of comparing or adding utilities for a group of individuals differing in taste and in income, and the only way of representing the social facts is to add the amounts of the good which different individuals are willing to purchase at the different prices.

In any case utility calculations are nearly negligible in relation to price at a given moment, since prices are fixed in primary markets where purchases are made far in advance of actual consumption. Purchases in advance of immediate needs by consumers, and still more by middlemen, and controlled by speculative motives, make up the effective momentary demand.