force at work tending to diminish the amount brought forward for sale. When the demand price is equal to the supply price, the amount produced has no tendency either to be increased or to be diminished; it is in equilibrium.

Equilibrium

amount and equilibriumprice.

When demand and supply are in equilibrium, the amount of the commodity which is being produced in a unit of time may be called the EQUILIBRIUMAMOUNT, and the price at which it is being sold may be called the EQUILIBRIUM-PRICE; and such an equilibrium is stable.

For if any accident should move the scale of production from its equilibrium position (or position of rest), there will be instantly brought into play forces tending to bring it back to that position; just as, if a stone hanging by a string is displaced from its equilibrium position, the force of gravity will at once tend to bring it back to its equilibrium position'.

1 It will be found to be a characteristic of stable equilibria that in them the demand price is greater than the supply price for amounts just less than the equilibrium amount, and vice versa. For when the demand price is greater than the supply price, the amount produced tends to increase; and therefore, if the demand price is greater than the supply price for amounts just less than an equilibrium amount, then if the scale of production is temporarily diminished somewhat below that equilibrium position, it will tend to return; thus the equilibrium is stable for displacements in that direction. If the demand price is greater than the supply price for amounts just less than the equilibrium amount, it is sure to be less than the supply price for amounts just greater: and therefore, if the scale of production is somewhat increased beyond the equilibrium position, it will tend to return; and the equilibrium will be stable for displacements in that direction also.

บ

D Fig. (6).

S

RH R

D

To represent the equilibrium of demand and supply geometrically we may draw the demand and supply curves together as in Fig. 6. If then OR represents the rate at which production is being actually carried on, and Rd the demand price is greater than Rs the supply price, the production is exceptionally profitable, and will be increased. R, the amount-index, as we may call it, will move to the right. On the other hand, if Rd is less than Rs, R will move to the left. If Rd is equal to Rs, that is, if R is vertically under a point of intersection

of the curves, demand and supply are in equilibrium.

But in real life such oscillations are seldom as rhythmical as those of a stone hanging freely from a string; the comparison would be more exact if the string were supposed to hang in the troubled waters of a mill-race, whose stream was at one time allowed to flow freely, and at another partially cut off. The demand and supply schedules do not in practice remain unchanged for a long time together, but are constantly being changed; and every change in them alters the equilibrium amount and the equilibrium price, and thus gives new positions to the centres about which the amount and the price tend to oscillate.

Influences

of

§ 6. There has been a long controversy as to whether "Cost of production" or "Utility" governs value. It might as reasonably be disputed whether it is the upper or the lower blade of a pair of scissors

Utility and

Cost of pro

duction on

value.

that cuts a piece of paper. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a "popular" and not a strictly scientific account of what actually happens.

The former

In the same way, when a thing already made has to be sold, the prices which people will be willing to pay for it will be governed by their desire to preponderates have it, together with the amount they can values; afford to spend on it. Their desire to have it

in market

This may be taken as the typical diagram for stable equilibrium for a commodity that obeys the Law of Diminishing Return. But if we had made SS' a horizontal straight line, we should have represented the case of "Constant Return," in which the supply price is the same for all amounts of the commodity. And if we had made SS' inclined negatively, but less steeply than DD', we should have got a case of stable equilibrium for a commodity which obeys the Law of Increasing Return. In either case the above reasoning remains unchanged without the alteration of a word or a letter; but the last case introduces difficulties for a discussion of which the reader must be referred to Principles V. XI.

depends partly on the chance that, if they do not buy it, they will be able to get another thing like it at as low a price: this depends on the causes that govern the supply of it, and this again upon Cost of production. But it may so happen that the stock to be sold is practically fixed. This for instance is the case with a fish market, in which the value of fish for the day is determined almost exclusively by the stock on the slabs in relation to the demand. And if a person chooses to take the stock for granted; and say that the price is governed by demand, his brevity may perhaps be excused so long as he does not claim strict accuracy. So again it may be pardonable, but it is not strictly accurate to say that the varying prices which the same rare book fetches, when sold and resold at Christie's auction room, are determined exclusively by

demand.

Taking a case at the opposite extreme, we find some the latter in commodities which conform pretty closely to the normal values. Law of Constant Return; that is to say, their average cost of production will be very nearly the same whether they are produced in small quantities or in large. In such a case the normal level about which the market price fluctuates will be this definite and fixed (money) Cost of production. If the demand happens to be great, the market price will rise for a time above the level; but as a result production will increase and the market price will fall: and conversely, if the demand falls for a time below its ordinary level.

In such a case, if a person chooses to neglect market fluctuations, and to take it for granted that there will anyhow be enough demand for the commodity to insure that some of it, more or less, will find purchasers at a price equal to this Cost of production, then he may be excused for ignoring the influence of demand, and speaking of (normal) price as determined by Cost of production-provided only he does not claim scientific accuracy for the wording of his

doctrine, and explains the influence of demand in its right place.

Thus we may say that, as a general rule, the shorter the period which we are considering the greater must be the share of our attention which is given to the influence of demand on value; and the longer the period, the more important will be the influence of cost of production on value'.

1 Ricardo and the earlier economists of this century were in the habit of speaking briefly of cost of production as determining value: having in mind the typical case of the normal value of a thing that obeys the Law of Constant Return. But the habit proved mischievous. It confused many of their readers; and they themselves were led by it to pay too little attention to the influence of demand in cases in which it was really important. And about twenty years ago Jevons (and some others) made a careful study of demand, doing excellent work; and it was only natural that he should complain of the way in which demand had been slighted by most (though not all) of the earlier writers. But he went further than this. He declared Ricardo's doctrine to be fundamentally wrong; and asserted in opposition to it that "value depends entirely on utility."

But this seems to be an error. For the half-truth that value is governed by utility, if put forward as the whole truth, is equally unscientific and practically a great deal more misleading and mischievous than the other halftruth that value is governed by cost of production.

The subject of this Section is discussed at length in the "Note on Ricardo's Theory of Value" at the end of Book V. of the Principles; where also Ricardo is defended from the charge that he lends support to the doctrine of Carl Marx and other socialists that normal value is determined by the labour-cost of production of a commodity without any reference to that waiting-cost which is involved by keeping the requisite capital ready for use, and is rewarded by interest on capital.

CHAPTER IV.

INVESTMENT OF CAPITAL IN A BUSINESS. PRIME COST AND TOTAL COST.

mining the investment of capital.

§ 1. LET us suppose a man to build a house for himself on Motives deter- land, and of materials, which Nature supplies gratis, and to make his implements as he goes; the labour of making them being counted as part of the labour of building the house. He would have to estimate the efforts required for building on any proposed plan; and to allow almost instinctively an amount increasing in geometrical proportion (a sort of compound interest) for the period that would elapse between each effort and the time when the house would be ready for his use. The utility of the house to him when finished would have to compensate him not only for the efforts, but for the waitings'.

This case illustrates the way in which the efforts and sacrifices which are the Real cost of production of a thing, underlie the expenses which are its Money cost. But the modern business man commonly takes the payments which he has to make, whether for wages or raw material, as he finds them; without staying to inquire how far they are an accurate measure of the efforts and sacrifices to which they correspond. His expenditure is generally made piece-meal; and the longer he expects to wait for the fruit of any outlay, the richer must that fruit be in order to compensate him. The anticipated fruit may not be certain; and in that case he will have to allow for the risk of failure. After making that allowance,

1 See above Book IV. Ch. VIII. § 6.