Front Page Titles (by Subject) Chapter XV: The Marginal Efficiency of Consumers' Wealth the Basis of Group Distribution - The Distribution of Wealth: A Theory of Wages, Interest and Profits
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Chapter XV: The Marginal Efficiency of Consumers' Wealth the Basis of Group Distribution - John Bates Clark, The Distribution of Wealth: A Theory of Wages, Interest and Profits 
The Distribution of Wealth: A Theory of Wages, Interest and Profits (New York: Macmillan, 1908).
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The Marginal Efficiency of Consumers' Wealth the Basis of Group Distribution
Very practical is the correction that has to be made in the accepted theory of value. If we were to to through the shops of a city, selecting at random articles of high quality and learning the prices at which they are actually sold, we might multiply all these prices by ten, without bringing them up to the figures at which, according to the final utility theory as it is usually stated, these goods ought to sell. If this theory in its uncorrected form were true, a man would pay five hundred dollars or more for an overcoat for which he actually gives fifty, and a thousand dollars for a watch for which he actually pays a hundred. A very rich man would give ten million dollars for a dwelling instead of one million, etc. The final utility theory of value, when it is thus applied to commodities in their entirety, gives results that are grotesquely at variance with the values that the market establishes. It exaggerates the prices of all goods, except the poorest and cheapest.
Here we record a charge of some gravity against a modern theory. We assert that the so-called Austrian teachings concerning value rest on a perfectly sound principle,—that, namely, of final utility,—but that the mode of applying this principle needs to be changed. It is final increments of wealth in commodities, and not, as a rule, commodities in their entirety, that furnish those test measures of utility to which market values conform.
The difference between the last commodity of a given kind that a man buys for his own consumption, and the last addition that he makes to the consumers' wealth that he uses, is a very real one. As we have seen, the man adds the last increment to the wealth that is embodied in his wardrobe, when he replaces a coat that cost forty-five dollars with one that costs fifty. The last five dollars that are spent on the coat are represented by some quality that this garment possesses. It is a final utility in the coat; but the garment in its entirety is far from being a final utility, even though it be the last one of its class that the owner procures. It is only what the man pays the last five dollars for that acts directly in adjusting the value of the coat; and what he gives the forty-five dollars for consists of elements that get their value in another way, and a way that is not directly connected with this action.
In a few cases, however, commodities in their entirety are final units of consumers' wealth. There are some goods that cater to no wants except the last and least intense ones that a consumer satisfies. In these cases, the entire articles figure directly in the adjustment of values. But in most cases there are elements in the goods that do not figure directly in the adjustment of values; and these elements often constitute almost the whole of the goods. Very analytical is the test that the actual market applies to the goods that are offered for sale. Very subtle is its process of resolving goods into their economic elements, and of putting an appraisal on each of the separate utilities that compose them.
Here we forecast the correction that has to be made in the theory of value, for the distinction between final commodities and final units of wealth in commodities is equally important in the theory of wages and interest. The earnings of all capital, in fact, are gauged by the product of the final increment of capital; and this final increment consists, not mainly of entire instruments of production, but of elements in these instruments.
Wages and interest are the chief subjects of our present studies; but they depend on a general law of economic variation which, in another application, adjusts also the market values of goods. In all the applications of this law, the distinction between final goods and final wealth-elements in goods is of primary consequence. The so-called Austrian theory of value—with which our readers are assumed to be familiar—gives a psychological basis for the commercial fact that the more goods of a kind there are to be sold, the lower must be the price, in order that all may be purchased. As the classical economists said, the price must be reduced, in order that men who have not as yet bought goods of this kind may take some of them, and also in order that those who have already bought some may take more. For this result the Austrian theory accounts. It furnishes the philosophy of the adjustment of what may be called, in the case of each kind of goods, the consumers' purchase limit. It tells why a man who has bought three units of the commodity A, when the price of it was a dollar, buys four units and no more, when the price falls to ninety cents. The purchaser, it shows, simply obeys the rule of getting the largest obtainable utility for each dime that he spends.27
Single articles that are exactly alike grow, as is usually said, less and less important to a user, as he comes to have more and more of them. The commodity A may be the most necessary thing that the man uses; and the first unit of it, if indispensable to his life, has an indefinitely great utility. A second unit of this article will be much less needed, and it may be that a first unit of the commodity B will now be preferred. We may for convenience define, as a unit of each kind of goods whatsoever, what is offered in the market for a dime. The man will buy, with the dimes that he can spend each day, a series of things that arrange themselves in the order of their importance to him; and the law that determines what he will actually buy is that of the diminishing utility of the successive units.
Let A, B, C, etc., represent different kinds of consumers' goods; and let the utility, to the same consumer, of a dime's worth of each of them be measured by the vertical distance of the letter that represents it from the line JI. The first unit of A has a utility amounting to AJ, and the first of H has a utility of HI; while B, C, D, etc., have the utilities that are severally measured by vertical lines descending from them to the line JI. A, B, C, etc., are first increments of the several commodities; while A', B', C', etc., are second increments of the same kind of goods; and A'' B'', C'', are third increments. In like manner, we may designate fourth and fifth increments, etc.
We will say that the man arranges in a series the dimes that he can spend in a day, and buys with the first dime what is of most importance to him; with the second dime that which stands next in the order of importance; and so on, till with his last dimes he buys things that are needed least of all. The first increment of his day's purchase of consumers' wealth is, then, one dime's worth of the article A. The second unit is B. As a return for the next dime to be spent, there are two articles offering themselves which have equal degrees of utility. They are C and a second unit of A, here designated as A'. The man will spend two dimes and get these two articles. D and B' are next in importance, and they have equal utilities. The man's fifth and sixth dimes will get them. With the seventh dime he buys C', or a second unit of the article C; and with the eighth, ninth and tenth dimes he buys E, B'' and A''. When he reaches H, he finds that that article and B''', C'', D', E' and F are on a par in importance to him, and he spends his last six dimes on these things. In all, he has spent twenty-one dimes and has exhausted the free income of a day.
The last increments of each commodity that this man buys are price-making increments. The sale of them is secured by bringing the price down to such a point that nothing else that the man can buy with the money has for him a higher degree of utility. In other words, the lowering of the price of the article brings this increment of it within the man's purchasing limit and within the purchasing limit of other men who are in the same economic condition. If the price were higher, no one of these men would take what is now his final increment. If the whole supply needs to be sold, the price must be reduced to the point thus defined. If, for example, in our diagram, the article H were costlier than it is, the article I would be preferred to it by all of this class of purchasers. As it is, the increment of H indicated in the diagram is sold; and the price that insures this sale is also the price of all other units of this commodity.
Final increments, then, are commercially strategic. Their utilities count in price making; while the excess of utility in the earlier increments does not, in this connection, have any influence. In fixing the prices of these things the great usefulness of the earlier units of A and B counts for nothing. These units would be purchased, even though the prices were higher than they are; and there is, therefore, no need that the venders should bring the price of A and B to the present level, in order to insure the sale of these highly serviceable units of them. This is saying that, in the case of each kind of goods, all increments except the last one give net gains to the purchasers. They insure to them what has been called "consumers' rent" The utility of final increments to the men who buy them, however, gives no surplus benefit, since it is fully offset by the cost of them. What the man sacrifices in order to get them is worth to him as much as they are. The extra utility of the earlier increments, on the other hand, is uncompensated. It is a differential amount of personal benefit, or an amount of good that is done to the consumers by certain units of a commodity, in excess of the benefit conferred by the last unit.
If, for example, the utility of successive increments of A declines along the curve AAv, and if AB measures the utility of the fast increment, A'B' that of the second, and AvBv that of the last, the differential benefit conferred on consumers by the earlier increment of this article is measured by AC + A'C' + A''C'' + A'''C''' + AIVCIV. If we suppose that the lines are contiguous, having width to fill an area, then the area CAAv measures the whole of what been called the consumer's rent, derived from the article A by one purchaser. Such consumers' rent, differential benefit or uncompensated utility cannot enter into the adjusting of prices. This is a principle that everywhere holds true.
Final increments of different goods, then, are supposed to compete with each other for the favor of purchasers—with the result that final utilities secured at equal expense are equal; that the earlier utilities in the series are unequal to each other, and are always greater than the final ones; and that the amount of this excess has no effect on prices.
What if even the final increments themselves do not always count in the adjusting of market values? Careful statements of the law have already shown that this is sometimes the case. There may, indeed, be a large difference between the utility of the first increment of a commodity and that of the second, and the utility curve for such an article may show a series of considerable gaps. It is not a continuous downward curve, but a series of points more or less widely separated. The points in the diagram on page 222 that are marked by the letters A', A'', B', and B'', etc., constitute such a series. In cases of this kind, the last increment of a commodity that a particular man gets may not figure in the adjustment of values. He would pay more for it rather than go without it. The last units of many articles that the consumer buys have a degree of usefulness to him that exceeds the utility of the really marginal things that he buys for the same price. The prices of A and G might go up considerably before he would cease to buy these articles; and the prices might go far down without inducing him to buy more. The articles B''', C'', D', E', and F' in this diagram are really in the strategic or price-making positions. If you raise the price of any one of these, the consumers of this class will cease to buy it, and will take another article in place of it.
In seeking for the reason why the article A is sold at the price that it actually commands, we must, of course, find the reason why some part of the supply will remain unsold at a price that is in the least degree higher. With this adjustment the men whose consumption is represented in the diagram on page 222 have no connection. There are, however, other men in whose cases an increment of A is a part of the true final increment of consumers' wealth. To them this commodity is on a plane, in usefulness, with other things that are bought with their final units of available income. If you raise the price, those men will cease to buy some of A; and then some of this product will remain unsold. Thus far we have stated, in outline, the accepted theory of value, and have added nothing that is not already contained in careful presentations of it. The discontinuity of successive units of some commodities, as they are arranged in a series joined by a utility curve, is a part of this theory. In this there is enough to show that, if we understand the philosophy of value, we must take all society into view as the purchaser of things. If you raise the price of an article, you will find, somewhere in the consumption of the public, a point where purchases of this article will cease. The action of raising the price singles out the particular men, in the strategic position, whose action fixes the value of this commodity for all other men. They are the social price makers for this commodity.
It is not enough, however, to say that this principle merely introduces a refinement of the theory of value, as that theory stood before the discontinuity of successive units in the utility curve of a particular article was recognized. It is not final commodities, but final units of wealth, that figure in the adjustments of values, and articles in their entirety are seldom final units of wealth in any consumer's scale. Search through the whole of society, and you will probably not find a man in whose estimates the commodity C is a final or price-making utility. There are, as we have seen, a few cases in which whole articles are included in the last social unit of consumers' wealth, and the utility of these things is a factor in price making. As, in most cases, only one element in an article is a part of this test increment of consumers' wealth, only that element is a factor in price making. There is no class in all society to whom the last unit of C does not afford a surplus of utility. If C is a house, it affords shelter; but it also caters to the more luxurious wants. In the house, merged with other qualities, there is something that is a true final utility. This quality acts on prices, and the other utilities that the house contains do not.
What is essential in a theory of value that shall account for prices, as they actually exist, is contained in the following propositions. We state them here, because something akin to what they assert is true of capital, and is essential in a theory of distribution that shall account for the rtales of wages and interest that actually prevail. The universal law of economic variation must be stated with accuracy, if it is to account for either values, wages or interest.
If the principle of final utility be applied to entire articles, it will give values that are, in most cases, many fold greater than are the actual values that the dealings of the market establish. If, on the other hand, it be applied to value elements in goods, it will give results that the market will confirm. Here we are bringing theory into harmony with life. The modern theory of value analyzes the psychological process that lies back of the phenomena of the market—that is, it traces the phenomena of the market to their causes, in the mental operations of those who buy goods. In every market there are measuring operations going on, and the things measured are personal benefits. If a commodity has embodied in itself the power to render several distinct kinds of service,—if it is a composite thing, having a number of distinct utilities,—there is no escaping the fact that true valuation must find a way to appraise each of these qualities by itself.
If we were not to push the analysis of this process to the end, we should do well to adhere to the older and more simple theory of value, and to keep altogether clear of the psychology of market dealings. Mr. John Stuart Mill has told us that, if the tentative price of an article is too high to insure the sale of the whole supply, the price is lowered till new purchasers take some of the goods and old purchasers take more than they formerly did. This statement is, in any view, a correct one; and unless we want to understand the mental operations that determine the action of consumers and bring their purchases to a stop at certain definite points, it is enough. But if we do wish to understand that operation, we must find how each utility in that composite thing, an average commodity, is actually measured, and how the measurement controls the market. We shall, therefore, now examine the manner in which utilities, as such, are tested in commercial dealings. Only thus is it possible to perceive how values and the group shares that depend on them are actually adjusted.
[27.]The money that the man spends really represents some sacrifice on his own part; and a full statement of the theory of value would take us into a psychological region whenever we speak of cost, as it does whenever we speak of utility. Cost is, in the last analysis, pain inflicted, just as utility is pleasure conferred. So far in the study we do not now need to go. It is enough, for present purposes, that the man, as a result of his sacrifices, has dimes to spend and is studying how to make the most of them.