The pricing process is a social process. It is consummated by an interaction of all members of the society. All collaborate and cooperate, each in the particular role he has chosen for himself in the framework of the division of labor. Competing in cooperation and cooperating in competition all people are instrumental in bringing about the result, viz., the price structure of the market, the allocation of the factors of production to the various lines of want-satisfaction, and the determination of the share of each individual. These three events are not three different matters. They are only different aspects of one indivisible phenomenon which our analytical scrutiny separates into three parts. In the market process they are accomplished uno actu. Only people prepossessed by socialist leanings who cannot free themselves from longing glances at socialist methods speak of three different processes in dealing with the market phenomena: the determination of prices, the direction of productive efforts, and distribution.
A Limitation on the Pricing of Factors of Production
The process which makes the prices of the factors of production spring from the prices of products can achieve its results only if, of the complementary factors not replaceable by substitutes, not more than one is of absolutely specific character, that is, is not suitable for any other employment. If the production of a product requires two or more absolutely specific factors, only a cumulative price can be assigned to them. If all factors of production were absolutely specific, the pricing process would not achieve more than such cumulative prices. It would accomplish nothing more than statements like this: as combining 3 a and 5 b produces one unit of p, 3 a and 5 b together are equal to 1 p and the final price of 3 a ÷ 5 b is—due allowance being made for time preference—equal to the final price of 1 p. As entrepreneurs who want to use a and b for purposes other than the production of p do not bid for them, a more detailed price determination is impossible. Only if a demand emerges for a (or for b) on the part of entrepreneurs who want to employ a (or b) for other purposes, does competition between them and the entrepreneurs planning the production of p arise and a price for a (or for b) comes into existence, the height of which determines also the price of b (or a).
A world in which all the factors of production are absolutely specific could manage its affairs with such cumulative prices. In such a world there would not exist the problem of how to allocate the means of production to various branches of want-satisfaction. In our real world things are different. There are many scarce means of production which can be employed for various tasks. There the economic problem is to employ these factors in such a way that no unit of them should be used for the satisfaction of a less urgent need if this employment prevents the satisfaction of a more urgent need. It is this that the market solves in determining the prices of the factors of production. The social service rendered by this solution is not in the least impaired by the fact that for factors which can be employed only cumulatively no other than cumulative prices are determined.
Factors of production which can be used in the same ratio of combination for the production of various commodities but do not allow of any other use, are to be considered as absolutely specific factors. They are absolutely specific with regard to the production of an intermediary product which can be utilized for various purposes. The price of this intermediary product can be assigned to them cumulatively only. Whether this intermediary product can be directly apperceived by the senses or whether it is merely the invisible and intangible outcome of their joint employment makes no difference.
4. Cost Accounting
In the calculation of the entrepreneur costs are the amount of money required for the procurement of the factors of production. The entrepreneur is intent upon embarking upon those business projects from which he expects the highest surplus of proceeds over costs and upon shunning projects from which he expects a lower amount of profit or even a loss. In doing this he adjusts his effort to the best possible satisfaction of the needs of the consumers. The fact that a project is not profitable because costs are higher than proceeds is the outcome of the fact that there is a more useful employment available for the factors of production required. There are other products in the purchase of which the consumers are prepared to allow for the prices of the factors of production required. But the consumers are not prepared to pay these prices in buying the commodity the production of which is not profitable.
Cost accounting is affected by the fact that the two following conditions are not always present:
First, every increase in the quantity of factors expended for the production of a consumers’ good increases its power to remove uneasiness.
Second, every increase in the quantity of a consumers’ good requires a proportional increase in the expenditure of factors of production or even a more than proportional increase in their expenditure.
If both these conditions were always and without any exception fulfilled, every increment z expended for increasing the quantity m of a commodity g would be employed for the satisfaction of a need viewed as less urgent than the least urgent need already satisfied by the quantity m available previously. At the same time the increment z would require the employment of factors of production to be withdrawn from the satisfaction of other needs considered as more pressing than those needs whose satisfaction was foregone in order to produce the marginal unit of m. On the one hand the marginal value of the satisfaction derived from the increase in the quantity available of g would drop. On the other hand the costs required for the production of additional quantities of g would increase in marginal disutility; factors of production would be withheld from employments in which they could satisfy more urgent needs. Production must stop at the point at which the marginal utility of the increment no longer compensates for the marginal increase in the disutility of costs.
Now these two conditions are present very often, but not generally without exception. There exist many commodities of all orders of goods whose physical structure is not homogeneous and which are therefore not perfectly divisible.
It would, of course, be possible to conjure away the deviation from the first condition mentioned above by a sophisticated play on words. One could say: half a motorcar is not a motorcar. If one adds to half a motorcar a quarter of a motorcar, one does not increase the “quantity” available; only the perfection of the process of production which turns out a complete car produces a unit and an increase in the “quantity” available. However, such an interpretation misses the point. The problem we must face is that not every increase in expenditure increases proportionately the objective use-value, the physical power of a thing to render a definite service. The various increments in expenditure bring about different results. There are increments the expenditure of which remains useless if no further increments of a definite quantity are added.
On the other hand—and this is the deviation from the second condition—an increase in physical output does not always require a proportionate increase in expenditure or even any additional expenditure. It may happen that costs do not rise at all or that their rise increases output more than proportionately. For many means of production are not homogeneous either and not perfectly divisible. This is the phenomenon known to business as the superiority of bigscale production. The economists speak of the law of increasing returns or decreasing costs.
We consider—as case A—a state of affairs in which all factors of production are not perfectly divisible in such a way that full utilization of the productive services rendered by every further indivisible element of each factor requires full utilization of the further indivisible elements of every other of the complementary factors. Then in every aggregate of productive agents each of the assembled elements—every machine, every worker, every piece of raw material— can be fully utilized only if all the productive services of the other elements are fully employed too. Within these limits the production of a part of the maximum output attainable does not require a higher expenditure than the production of the highest possible output. We may als
o say that the minimum-size aggregate always produces the same quantity of products; it is impossible to produce a smaller quantity of products even if there is no use for a part of it.
We consider—as case B—a state of affairs in which one group of the productive agents (p) is for all practical purposes perfectly divisible. On the other hand the imperfectly divisible agents can be divided in such a wav that full utilization of the services rendered by each further indivisible part of one agent requires full utilization of the further indivisible parts of the other imperfectly divisible complementary factors. Then increasing production of an aggregate of further indivisible factors from a partial to a more complete utilization of their productive capacity requires merely an increase in the quantity of p, the perfectly divisible factors. However, one must guard oneself against the fallacy that this necessarily implies a decrease in the average cost of production. It is true that within the aggregate of imperfectly divisible factors each of them is now better utilized, that therefore costs of production as far as they are caused by the cooperation of these factors remain unchanged, and that the quotas falling to a unit of output are decreasing. But on the other hand an increase in the employment of the perfectly divisible factors of production can be attained only by withdrawing them from other employments. The value of these other employments increases, other things being equal, with their shrinking; the price of these perfectly divisible factors tends to rise as more of them are used for the better utilization of the productive capacity of the aggregate of the not further divisible factors in question. One must not limit the consideration of our problem to the case in which the additional quantity of p is withdrawn from other enterprises producing the same product in a less efficient way and forces these enterprises to restrict their output. It is obvious that in this case—competition between a more and a less efficient enterprise producing the same article out of the same raw materials—the average cost of production is decreasing in the expanding plant. A more general scrutiny of the problem leads to a different result. If the units of p are withdrawn from other employments in which they would have been utilized for the production of other articles, there emerges a tendency toward an increase in the price of these units. This tendency may be compensated by accidental tendencies operating in the opposite direction; it may sometimes be so feeble that its effects are negligible. But it is always present and potentially influences the configuration of costs.
Finally we consider—as case C—a state of affairs in which the various imperfectly divisible factors of production can be divided only in such a way that, given the conditions of the market, any size which can be chosen for their assemblage in a production aggregate does not allow for a combination in which full utilization of the productive capacity of one factor makes possible full utilization of the productive capacity of the other imperfectly divisible factors. This case C alone is of practical significance, while the cases A and B hardly play any role in real business. The characteristic feature of case C is that the configuration of production costs varies unevenly. If all imperfectly divisible factors are utilized to less than full capacity, an expansion of production results in a decrease of average costs of production unless a rise in the prices to be paid for the perfectly divisible factors counterbalances this outcome. But as soon as full utilization of the capacity of one of the imperfectly divisible factors is attained, further expansion of production causes a sudden sharp rise in costs. Then again a tendency toward a decrease in average production costs sets in and goes on working until full utilization of one of the imperfectly divisible factors is attained anew.
Other things being equal, the more the production of a certain article increases, the more factors of production must be withdrawn from other employments in which they would have been used for the production of other articles. Hence—other things being equal— average production costs increase with the increase in the quantity produced. But this general law is by sections superseded by the phenomenon that not all factors of production are perfectly divisible and that, as far as they can be divided, they are not divisible in such a way that full utilization of one of them results in full utilization of the other imperfectly divisible factors.
The planning entrepreneur is always faced with the question: To what extent will the anticipated prices of the products exceed the anticipated costs? If the entrepreneur is still free with regard to the project in question, because he has not yet made any inconvertible investments for its realization, it is average costs that count for him. But if he has already a vested interest in the line of business concerned, he sees things from the angle of additional costs to be expended. He who already owns a not fully utilized production aggregate does not take into account average cost of production but marginal cost. Without regard to the amount already expended for inconvertible investments he is merely interested in the question whether or not the proceeds from the sale of an additional quantity of products will exceed the additional cost incurred by their production. Even if the whole amount invested in the inconvertible production facilities must be wiped off as loss, he goes on producing provided he expects a reasonable 4 surplus of proceeds over current costs.
With regard to popular errors it is necessary to emphasize that if the conditions required for the appearance of monopoly prices are not present, an entrepreneur is not in a position to increase his net returns by restricting production beyond the amount conforming with consumers’ demand. But this problem will be dealt with later in section 6.
That a factor of production is not perfectly divisible does not always mean that it can be constructed and employed in one size only. This, of course, may occur in some cases. But as a rule it is possible to vary the dimensions of these factors. If out of the various dimensions which are possible for such a factor—e.g., a machine— one dimension is distinguished by the fact that the costs incurred by its production and operation are rendered lower per unit of the productive services than those for other dimensions, things are essentially identical. Then the superiority of the bigger plant does not consist in the fact that it utilizes a machine to full capacity while the smaller plant utilizes only a part of the capacity of a machine of the same size. It consists rather in the fact that the bigger plant employs a machine which operates with a better utilization of the factors of production required for its construction and operation than does the smaller machine employed by the smaller plant.
The role played in all branches of production by the fact that many factors of production are not perfectly divisible is very great. It is of paramount importance in the course of industrial affairs. But one must guard oneself against many misinterpretations of its significance.
One of these errors was the doctrine according to which in the processing industries there prevails a law of increasing returns, while in agriculture and mining a law of decreasing returns prevails. The fallacies implied have been exploded above.5 As far as there is a difference in this regard between conditions in agriculture and those in the processing industries, differences in the data bring them about. The immobility of the soil and the fact that the performance of the various agricultural operations depends on the seasons make it impossible for farmers to take advantage of the capacity of many movable factors of production to the degree which conditions in manufacturing for the most part allow. The optimum size of a production outfit in agricultural production is as a rule much smaller than in the processing industries. It is obvious and does not need any further explanation why the concentration of farming cannot be pushed to anything near the degree obtaining in the processing industries.
However, the inequality in the distribution of natural resources over the earth’s surface, which is one of the two factors making for the higher productivity of the division of labor, puts a limit to the progress of concentration in the processing industries also. The tendency toward a progressive specialization and the concentration of integrated industrial processes in only a few plants is counteracted by the geographical dispers
ion of natural resources. The fact that the production of raw materials and foodstuffs cannot be centralized and forces people to disperse over the various parts of the earth’s surface enjoins also upon the processing industries a certain degree of decentralization. It makes it necessary to consider the problems of transportation as a particular factor of production costs. The costs of transportation must be weighed against the economies to be expected from more thoroughgoing specialization. While in some branches of the processing industries the utmost concentration is the most adequate method of reducing costs, in other branches a certain degree of decentralization is more advantageous. In the servicing trades the disadvantages of concentration become so great that they almost entirely overweigh the advantages derived.
Then a historical factor comes into play. In the past capital goods were immobilized on sites on which our contemporaries would not have set them. It is immaterial whether or not this immobilization was the most economical procedure to which the generations that brought it about could resort. In any event the present generation is faced with a fait accompli. It must adjust its operations to the fact and it must take it into account in dealing with problems of the location of the processing industries.6
Human Action: A Treatise on Economics Page 50