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1. Some Fundamental Principles of Action

The analysis of production activities-the actions that eventually result in the attainment of consumers' goods-is a highly intricate one for a complex, monetary market economy. It is best, therefore, to summarize now some of the most applicable of the fundamental principles formulated in chapter 1. In that chapter we applied those principles to a Crusoe economy only. Actually, however, they are applicable to any type of economy and are the indispensable keys to the analysis of the complex modern economy. Some of these fundamental principles are:

(1) Each individual acts so that the expected psychic revenue, or achievement of utility, from his action will exceed its psychic cost. The latter is the forgone utility of the next best alternative that he could adopt with the available means. Both the psychic revenue and the psychic cost are purely subjective to the individual. Since all action deals with units of supply of a good, we may refer to these subjective estimates as marginal utility and marginal cost, the marginal signifying action in steps.

(2) Each person acts in the present instant, on the basis of present value scales, to obtain anticipated end results in the future. Each person acts, therefore, to arrive at a certain satisfactory state in the future. Each has a temporal horizon of future dates toward which his actions are directed. He uses present given means, according to his technological ideas, to attain his ends in the future.

(3) Every person prefers and will attempt to achieve the satisfaction of a given end in the present to the satisfaction of that end in the future. This is the law of time preference.

(4) All goods are distributed by each individual in accordance with their utility to him. A stock of the units of a good is allocated first to its most highly valued uses, then to its next most highly valued use, etc. The definition of a good is that it consists of an interchangeable supply of one or more units. Therefore, every unit will always be valued equally with every other. If a unit of a stock is given up or disposed of, the least highly valued use for one unit will be the one given up. Therefore, the value of each unit of the supply of a good is equal to the utility of the least highly valued of its present uses. This marginal utility diminishes as the stock of each good increases. The marginal utility of addi­tion of a unit to the stock equals the utility of a unit in its next most highly valued use, i.e., the most highly valued of the not yet satisfied ends. This provides us with the law of marginal utility and the law of allocation of goods.

(5) In the technical combination of factors of production to yield a product, as one factor varies and the others remain con­stant, there is an optimum point-a point of maximum average product produced by the factor. This is the law of returns. It is based on the very fact of the existence of human action.

(6) And we know from chapter 2 that the price of any good on the market will tend to be uniform throughout the market. The price is determined by supply and demand schedules, which are themselves determined by the value scales of the individuals in the market.

2. The Evenly Rotating Economy

Analysis of the activities of production in a monetary market economy is a highly complex matter. An explanation of these activities, in particular the determination of prices and therefore the return to factors, the allocation of factors, and the formation of capital, can be developed only if we use the mental construction of the evenly rotating economy.

This construction is developed as follows: We realize that the real world of action is one of continual change. Individual value scales, technological ideas, and the quantities of means available are always changing. These changes continually impel the econ­omy in various directions. Value scales change, and consumer demand shifts from one good to another. Technological ideas change, and factors are used in different ways. Both types of change have differing effects on prices. Time preferences change, with certain effects on interest and capital formation. The crucial point is this: before the effects of any one change are completely worked out, other changes intervene. What we must consider, however, by the use of reasoning, is what would happen if no changes intervened. In other words, what would occur if value scales, technological ideas, and the given resources remained con­stant? What would then happen to prices and production and their relations? Given values, technology, and resources, whatever their concrete form, remain constant. In that case, the economy tends toward a state of affairs in which it is evenly rotating, i.e., in which the same activities tend to be repeated in the same pattern over and over again. Rates of production of each good remain constant, all prices remain constant, total population re­mains constant, etc. Thus, if values, technology, and resources remain constant, we have two successive states of affairs: (a) the period of transition to an unchanging, evenly rotating economy, and (b) the unchanging round of the evenly rotating economy itself. This latter stage is the state of final equilibrium. It is to be distinguished from the market equilibrium prices that are set each day by the interaction of supply and demand. The final equilibrium state is one which the economy is always tending to approach. If our data-values, technology, and resources-re­mained constant, the economy would move toward the final equi­librium position and remain there. In actual life, however, the data are always changing, and therefore, before arriving at a final equilibrium point, the economy must shift direction, towards some other final equilibrium position.

Hence, the final equilibrium position is always changing, and consequently no one such position is ever reached in practice. But even though it is never reached in practice, it has a very real importance. In the first place, it is like the mechanical rabbit being chased by the dog. It is never reached in practice and it is always changing, but it explains the direction in which the dog is moving. Secondly, the complexity of the market system is such that we cannot analyze factor prices and incomes in a world of continual change unless we first analyze their determination in an evenly rotating world where there is no change and where given conditions are allowed to work themselves out to the full.

Certainly at this stage of inquiry we are not interested in ethi­cal evaluations of our knowledge. We are attaching no ethical merit to the equilibrium position. It is a concept for scientific explanation of human activity.

The reader might ask why such an "unrealistic" concept as final equilibrium is permissible, when we have already presented and will present grave strictures against the use of various un­realistic and antirealistic premises in economics. For example, as we shall see, the theory of "pure competition," so prevalent among writers today, is based on impossible premises. The theory is then worked out along these lines and not only applied un­critically to the real world, but actually used as an ethical base from which to criticize the real "deviations" from this theory. The concepts of "indifference classes" and of infinitely small steps are other examples of false premises that are used as the basis of highly elaborate theoretical structures. The concept of the evenly rotating economy, however, when used with care, is not open to these criticisms. For this is an ever-present force, since it is the goal toward which the actual system is always mov­ing, the final position of rest, at which, on the basis of the given, actually existing value scales, all individuals would have attained the highest positions on their value scales, given the technology and resources. This concept, then, is of legitimate and realistic importance.

We must always remember, however, that while a final equi­librium is the goal toward which the economy is moving at any particular time, changes in the data alter this position and there­fore shift the direction of movement. Therefore, there is nothing in a dynamic world that is ethically better about a final equilib­rium position. As a matter of fact, since wants are unsatisfied (otherwise there would be no action), such a position of no change would be most unfortunate, since it would imply that no further want-satisfaction would be possible. Furthermore, we must re­member that a final equilibrium situation tends to be, though it can never actually be, the result of market activity, and not the condition of such activity. Far too many writers, for example, discerning that in the evenly rotating economy entrepreneurial profits and losses would all be zero, have somehow concluded that this must be the condition for any legitimate activity on the mar­ket. There could hardly be a greater misconception of the market or a greater abuse of the equilibrium concept.

Another danger in the use of this concept is that its purely static, essentially timeless, conditions are all too well suited for the use of mathematics. Mathematics rests on equations, which portray mutual relationships between two or more "functions." Of themselves, of course, such mathematical procedures are un­important, since they do not establish causal relationships. They are of the greatest importance in physics, for example, because that science deals with certain observed regularities of motion by particles of matter that we must regard as unmotivated. These particles move according to certain precisely observable, exact, quantitative laws. Mathematics is indispensable in formulating the laws among these variables and in formulating theoretical explanations for the observed phenomena. In human action, the situation is entirely different, if not diametrically opposite. Where­as in physics, causal relations can only be assumed hypothetically and later approximately verified by referring to precise observ­able regularities, in praxeology we know the causal force at work. This causal force is human action, motivated, purposeful behavior, directed at certain ends. The universal aspects of this behavior can be logically analyzed. We are not dealing with "functional," quantitative relations among variables, but with human reason and will causing certain action, which is not "determinable" or reducible to outside forces. Furthermore, since the data of human action are always changing, there are no precise, quantitative relationships in human history. In physics, the quantitative re­lationships, or laws, are constant; they are considered to be valid for any point in human history, past, present, or future. In the field of human action, there are no such quantitative constants. There are no constant relationships valid for different periods in human history. The only "natural laws" (if we may use such an old-fashioned but perfectly legitimate label for such constant regularities) in human action are qualitative rather than quantita­tive. They are, for example, precisely the laws educed in praxe­ology and economics-the fact of action, the use of means to achieve ends, time preference, diminishing marginal utility, etc.[1]

Mathematical equations, then, are appropriate and useful where there are constant quantitative relations among unmotivated variables. They are singularly inappropriate in praxeology and economics. In the latter fields, verbal, logical analysis of action and its processes through time is the appropriate method. It is not surprising that the main efforts of the "mathematical econo­mists" have been directed toward describing the final equilibrium state by means of equations. For in this state, since activities merely repeat themselves, there seems to be more scope for de­scribing conditions by means of functional equations. These equations, at best, however, can do no more than describe this equilibrium state.

Aside from doing no more than verbal logic can do, and there­fore violating the scientific principle of Occam's razor-that sci­ence should be as simple and clear as possible-such a use of mathematics contains grave errors and defects within itself. In the first place, it cannot describe the path by which the economy approaches the final equilibrium position. This task can be per­formed only by verbal, logical analysis of the causal action of human beings. It is evident that this task is the important one, since it is this analysis that is significant for human action. Action moves along a path and is not describable in an unchanging, evenly rotating world. The world is an uncertain one, and we shall see shortly that we cannot even pursue to its logical con­clusion the analysis of a static, evenly rotating economy. The assumption of an evenly rotating economy is only an auxiliary tool in aiding us in the analysis of real action. Since mathematics is least badly accommodated to a static state, mathematical writers have tended to be preoccupied with this state, thus providing a particularly misleading picture of the world of action. Finally, the mathematical equations of the evenly rotating economy de­scribe only a static situation, outside of time.[2] They differ dras­tically from the mathematical equations of physics, which de­scribe a process through time; it is precisely through this description of constant, quantitative relations in the motion of elements that mathematics renders its great service in natural science. How different is economics, where mathematics, at best, can only in­adequately describe a timeless end result! [3]

The use of the mathematical concept of "function" is particu­larly inappropriate in a science of human action. On the one hand, action itself is not a function of anything, since "function" implies definite, unique, mechanical regularity and determina­tion. On the other hand, the mathematics of simultaneous equa­tions, dealing in physics with unmotivated motion, stresses mutual determination. In human action, however, the known causal force of action unilinearly determines the results. This gross misconception by mathematically inclined writers on the study of human action was exemplified during a running attack on Eugen Böhm-Bawerk, one of the greatest of all economists, by Professor George Stigler:

. . . yet the postulate of continuity of utility and demand functions (which is unrealistic only to a minor degree, and essential to analytic treatment) is never granted. A more important weakness is Böhm-­Bawerk's failure to understand some of the most essential elements of modern economic theory, the concepts of mutual determination and equilibrium (developed by the use of the theory of simultaneous equa­tions). Mutual determination is spurned for the older concept of cause and effect.[4]

The "weakness" displayed here is not that of Böhm-Bawerk, but of those, like Professor Stigler, who attempt vainly and fal­laciously to construct economics on the model of mathematical physics, specifically, of classical mechanics.[5]

To return to the concept of the evenly rotating economy, the error of the mathematical economists is to treat it as a real and even ideal state of affairs, whereas it is simply a mental concept enabling us to analyze the market and human activities on the market. It is indispensable because it is the goal, though ever­shifting, of action and exchange; on the other hand, the data can never remain unchanged long enough for it to be brought into being. We cannot conceive in all consistency of a state of affairs without change or uncertainty, and therefore without action. The evenly rotating state, for example, would be incompatible with the existence of money, the very medium at the center of the entire exchange structure. For the money commodity is de­manded and held only because it is more marketable than other commodities, i.e., because the holder is more sure of being able to exchange it. In a world where prices and demands remain per­petually the same, such demand for money would be unnecessary. Money is demanded and held only because it gives greater as­surance of finding a market and because of the uncertainties of the person's demands in the near future. If everyone, for example, knew his spending precisely over his entire future-and this would be known under the evenly rotating system-there would be no point in his keeping a cash balance of money. It would be in­vested so that money would be returned in precisely the needed amounts on the day of expenditure. But if no one wishes to hold money, there will be no money and no system of money prices. The entire monetary market would break down. Thus, the evenly rotating economy is unrealistic, for it cannot actually be established and we cannot even conceive consistently of its estab­lishment. But the idea of the evenly rotating economy is indis­pensable in analyzing the real economy; through hypothesizing a world where all change has worked itself out, we can analyze the directions of actual change.

3. The Structure of Production: A World of Specific Factors

Crucial to understanding the process of production is the question of the specificity of factors, a problem we touched on in chapter 1. A specific factor is one suitable to the production of only one product. A purely nonspecific factor would be one equally suited to the production of all possible products. It is clear that not all factors could be purely nonspecific, for in that case all factors would be purely interchangeable, i.e., there would be need for only one factor. But we have seen that human ac­tion implies more than one existing factor. Even the existence of one purely nonspecific factor is inconceivable if we properly consider "suitability in production" in value terms rather than in technological terms.[6] In fact, if we analyze the concept, we find that there is no sense in saying that a factor is "equally suit­able" in purely technological terms, since there is no way of comparing the physical quantities of one product with those of another. If X can help to produce three units of A or two units of B, there is no way by which we can compare these units. Only the valuation of consumers establishes a hierarchy of valued goods, their interaction setting the prices of the consumers' goods. (Rel­atively) nonspecific factors, then, are allocated to those products that the consumers have valued most highly. It is difficult to con­ceive of any good that would be purely nonspecific and equally valuable in all processes of production. Our major distinction, then, is between the specific factor, which can be used in only one line of production, and the nonspecific factor (of varying de­grees of convertibility), which can be used in more than one pro­duction process.

Now let us for a time consider a world where every good is produced only by several specific factors. In this world, a world that is conceivable, though highly unlikely, every person, every piece of land, every capital good, would necessarily be irrevocably committed to the production of one particular product. There would be no alternative uses of any good from one line of pro­duction to another. In the entire world of production, then, there would be little or no "economic problem," i.e., no prob­lem of allocating scarce means to alternative ends. Certainly, the consumers would still have to allocate their scarce monetary re­sources to be most preferred consumers' goods. In the nonmarket sphere, everyone-again as a consumer-would have to allocate his time and energies to the enjoyment of various consumers' goods. There would still, in the sphere of production of exchangeable goods, be one allocation that every man would make: how much time to devote to labor and how much to leisure. But there would be no problem of which field to labor in, no problem of what to do with any piece of land, no problem of how to allocate capital goods. The employment of the factors would all depend on the consumers' demand for the final product.

The structure of production in such a world of purely specific factors would be somewhat as in Figure 39. In this diagram, we see two typical consumers' goods, A and B. Each, depicted as a solid rectangle at the bottom of the diagram, is produced by co-operating factors of the next higher rank, designated P1, or the first order of producers' goods. The capital goods of the first rank are, in turn, produced with the help of co-operating factors, these being of the second-rank, and so on upward. The process logically continues upward until capital goods are produced com­pletely by land and labor factors, although this stage is not de­picted on the diagram. Lines connect the dots to designate the causal pattern of the factors. In the diagram, all factors are purely specific, since no good is used at different stages of the process or for different goods. The center arrows indicate the causal direction of effort downward, from the highest ranked producers' goods through the intermediate ranks, finally concluding in consumers' goods. At each stage, labor uses nature-given factors to produce capital goods, and the capital goods are again com­bined with labor and nature-given factors, transformed into lower and lower orders of capital goods, until consumers' goods are reached.

Now that we have traced the direction of productive effort, we must trace the direction of monetary income. This is a re­verse one, from the consumers back to the producers. The con­sumers purchase the stock of a consumers' good at a price de­termined on the market, yielding the producers a certain in­come. Two of the crucial problems of production theory are the method by which the monetary income is allocated and the corol­lary problem of the pricing of the factors of production. First, let us consider only the "lowest" stage of production, the stage that brings about the final product. In that stage, numerous fac­tors, all now assumed to be specific, co-operate in producing the consumers' good. There are three types of such factors: labor, original nature, and produced capital goods.[7] Let us assume that on a certain day, consumers purchase a certain quantity of a good X for, say, 100 ounces of gold. Given the quantity of the good sold, the price of the total quantity is equal to the (gross) income obtained from the sale of the good. How will these 100 ounces be allocated to the producing factors?

In the first place, we must make an assumption about the ownership of the consumers' good just before it is sold. It is obvious that this owner or these owners will be the immediate recipients of the 100 ounces of gold income. Let us say that, in the final stage, there have been seven factors participating in the production: two types of labor, two types of land, and three types of capital goods. There are two alternatives in regard to the final ownership of the product (before it is sold to the consumer): (a) all the owners of these factors jointly own the final product; or (b) the owner of each of the factors sells the services of his factor to someone else, and the latter (who may himself contribute a factor) sells the good at a later date to the consumer. Although the latter is the nearly universal condition, it will be convenient to begin by analyzing the first alternative.

Those who own the final product, whatever the alternative adopted, are "capitalists," since they are the owners of capital goods. It is better, however, to confine the term "capitalists" to those who have saved money capital with which to buy factors. This, by definition, does not occur under the first alternative, where owners of factors are joint owners of the products. The term "product-owner" suffices for designating the owner of the capital assets, whatever the alternative adopted. Product-owners are also "entrepreneurs," since they assume the major entrepre­neurial burden of adjusting to uncertain future conditions. To call them "entrepreneurs" alone, however, is to run the danger of forgetting that they are also capitalists or product-owners and that they would continue to perform that function in an evenly rotating economy.

4. Joint Ownership of the Product by the Owners of the Factors

Let us first consider the case of joint ownership by the owners of all the final co-operating factors.[8] It is clear that the 100 ounces of gold accrue to the owners jointly. Let us now be purely arbi­trary and state that a total of 80 ounces accrues to the owners of capital goods and a total of 20 ounces to the owners of labor and nature-given factors. It is obvious that, whatever the allocation, it will be, on the unhampered market, in accordance with the voluntary contractual agreement of each and every factor-owner concerned. Now it is clear that there is an important difference between what happens to the monetary income of the laborer and the landowner, on the one hand, and of the owner of capital goods, on the other. For the capital goods must in turn be pro­duced by labor, nature, and other capital goods. Therefore, while the contributor of personal "labor" energy (and this, of course, includes the energy of direction as well as what are called "labor­ers" in popular parlance) has earned a pure return, the owner of capital goods has previously spent some money for the production or the purchase of his owned factors.

Now it is clear that, since only factors of production may obtain income from the consumer, the price of the consumers' good-i.e., the income from the consumers' good, equals the sum of the prices accruing to the producing factors, i.e., the income accruing to the factors. In the case of joint ownership, this is a truism, since only a factor can receive income from the sale of a good. It is the same as saying that 100 ounces equals 100 ounces.

But what of the 80 ounces that we have arbitrarily allocated to the owners of capital goods? To whom do they finally accrue? Since we are assuming in this example of joint ownership that all products are owned by their factor-owners, it also follows that capital goods, which are also products, are themselves jointly owned by the factors on the second rank of production. Let us say that each of the three first-order capital goods was produced by five co-operating factors: two types of labor, one type of land, two types of capital goods. All these factor-owners jointly own the 80 ounces. Let us say that each of the first-order capital goods had obtained the following:

Capital good A: 30 ounces
Capital good B: 30 ounces
Capital good C: 20 ounces

The income to each capital good will then be owned by five factor-owners on the second rank of production.

It is clear that, conceptually, no one, in the last analysis, re­ceives a return as the owner of a capital good. Since every capital good analytically resolves itself into original nature-given and labor factors, it is evident that no money could accrue to the owner of a capital good. All 100 ounces must eventually be al­located to labor and owners of nature-given factors exclusively. Thus, the 30 ounces accruing to the owners of capital good A will be allocated to the five factor-owners, while the, say, four ounces accruing to one of the capital goods of third rank helping to produce good A will, in turn, be allocated to land, labor, and capital-goods factors of the fourth rank, etc. Eventually, all the money is allocated to labor and nature-given factors only. The diagram in Figure 40 illustrates this process.

At the bottom of the diagram, we see that 100 ounces of gold are transferred from the consumers to the producers. Some of this money goes to owners of capital goods, some to landowners, some to owners of labor. (The proportion going to one group and the other is arbitrarily assumed in the example and is of no importance for this analysis.) The amount accruing to the capital­-goods owners is included in the shaded portion of the diagram and the amount accruing both to labor and nature-owners is in­cluded in the clear portion of the diagram. In the lowest, the first block, the 20 ounces received by owners of land and of labor factors is marked with an upward arrow, followed by a similar upward arrow at the top of the diagram, the top line designating the money ultimately received by the owners of the various factors. The width of the top line (100 ounces) must be equal to the width of the bottom line (100 ounces), since the money ultimately re­ceived by the owners of the factors must equal the money spent by the consumers.

Moving up to line 2, we follow the fortunes of the 80 ounces which had accrued to the owners of capital goods of the first order. We assume that 60 ounces accrue to the owners of second-­order capital goods and 20 ounces to second-order labor and na­ture-given factors. Once again, the 20 ounces' clear area is marked with an upward arrow designating the ultimate receipt of money by the owners of the factors and is equally marked off on the top line of the diagram. The same process is repeated as we go further and further upward in the order of capital goods. At each point, of course, the amount obtained by owners of capital goods be­comes smaller, because more and more has accrued to labor and nature owners. Finally, at the highest conceivable stage, all the remaining 20 ounces earned by the owners of capital goods ac­crue to land and labor factors only, since eventually we must come to the stage where no capital good has yet been produced and only labor and nature remain. The result is that the 100 ounces are all eventually allocated to the clear spaces, to the land and labor factors. The large upward arrow on the left signi­fies the general upward course of the monetary income.

To the truism that the income from sale of the consumers' good equals the consumers' expenditure on the good, we may add a corresponding truism for each stage of production, namely, that the income from sale of a capital good equals the income accruing to the factors of its production.

In the world that we have been examining, where all products, at whatever stage, are owned jointly by the owners of their factors, it is clear that first work is done on the highest stage. Owners of land and of labor invest their land and labor to produce the high­est-order (in this case the fifth) capital good; then these owners turn the good over to the owners of labor and land at the next lower stage; these produce the fourth-order capital good, which in turn co-operates with labor and land factors on that stage to produce the lower-order good, etc. Finally, the lowest stage is reached, and the final factors co-operate to produce the consumers' good. The consumers' good is then sold to consumers.[9]

In the case of joint ownership, then, there does not arise any separate class of owners of capital goods. All the capital goods produced are jointly owned by the owners of the producing land and labor factors; the capital goods of the next lower order are owned by the owners of the land and labor factors at the next lower stage along with the previously co-operating owners, etc. In sum, the entire capital-goods structure engaged in any line of production is jointly owned by the owners of land and labor. And the income gained from the final sale of the product to the consumers accrues only to the owners of land and labor; there is no separate group of owners of capital goods to whom income accrues.[10]

It is obvious that the production process takes time, and the more complex the production process the more time must be taken. During this time, all the factors have had to work without earning any remuneration; they have had to work only in expec­tation of future income. Their income is received only at a much later date.

The income that would be earned by the factors, in a world of purely specific factors, depends entirely on consumer demand for the particular final product. If consumers spend 100 ounces on the good, then the factors will jointly earn 100 ounces. If they spend 500 ounces, the factors will earn that amount. If they spend nothing on the product, and the producers have made the enor­mous entrepreneurial error of working on a product that the consumers do not buy, the factors earn precisely zero. The joint monetary income earned by the owners of the factors fluctuates pari passu with consumer demand for the product.

At this point, a question naturally arises: What happens to owners of factors who earn a zero return? Must they "starve"? Fundamentally, we cannot answer this question for concrete indi­vidual persons, since economics demonstrates truths about "func­tional" earnings in production, and not about the entire earnings of a given person. A particular person, in other words, may ex­perience a zero return on this good, while at the same time earning a substantial return on ownership of another piece of land. In cases where there is no such ownership in another area, the indi­vidual may pursue isolated production that does not yield a monetary return, or, if he has an accumulated monetary cash balance, he may purchase goods by reducing the balance. Further­more, if he has such a balance, he may invest in land or capital goods or in a production organization owning them, in some other line of production. His labor, on our assumptions, may be a specific factor, but his money is usable in every line of production.

Suppose we assume the worst possible case-a man with no cash balance, with no assets of capital, and whose labor is a specific factor the product of which has little or no consumer demand.[11] Is he not truly an example of an individual led astray by the existence of the market and the specialization prevalent on it? By subjecting himself to the consumer has he not placed his happiness and existence in jeopardy? Even granting that people chose a market, could not the choice turn out to be tragic for many people?

The answer is that there is no basis whatever for such strictures on the market process. For even in this impossible case, the indi­vidual is no worse off than he would have been in isolation or barter. He can always revert to isolation if he finds he cannot attain his ends via the market process. The very fact that we con­sider such a possibility ludicrous is evidence of the enormous advantages that the market confers upon everyone. Indeed, em­pirically, we can certainly state that, without the modern, de­veloped market, and thrown back into isolation, the overwhelming majority of individuals could not obtain enough exchangeable goods to exist at all. Yet this choice always remains open to any­one who, for any reason, voluntarily prefers isolation to the vast benefits obtainable from the market system. Certainly, therefore, complaints against the market system by disgruntled persons are misplaced and erroneous. Any person or group, on the un­hampered market, is free to abandon the social market at any time and to withdraw into any other desired form of co-operative arrangement. People may withdraw into individual isolation or establish some sort of group isolation or start from the beginning to re-create their own market. In any case, on the free market, their choice is entirely their own, and they decide according to their preferences unhampered by the use or threat of violence.[12]

Our example of the "worst possible case" enables us to analyze one of the most popular objections to the free society: that "it leaves people free to starve." First, from the fact that this objection is so widespread, we can easily conclude that there will be enough charitable people in the society to present these unfortunates with gifts. There is, however, a more fundamental refutation. It is that the "freedom-to-starve" argument rests on a basic con­fusion of "freedom" with "abundance of exchangeable goods." The two must be kept conceptually distinct. Freedom is meaning­fully definable only as absence of interpersonal restrictions. Rob­inson Crusoe on the desert island is absolutely free, since there is no other person to hinder him. But he is not necessarily living an abundant life; indeed, he is likely to be constantly on the verge of starvation. Whether or not man lives at the level of poverty or abundance depends upon the success that he and his ancestors have had in grappling with nature and in transforming naturally given resources into capital goods and consumers' goods. The two problems, therefore, are logically separate. Crusoe is absolutely free, yet starving, while it is certainly possible, though not likely, for a given person at a given instant to be a slave while being kept in riches by his master. Yet there is an important connection between the two, for we have seen that a free market tends to lead to abundance for all of its participants, and we shall see below that violent intervention in the market and a hegemonic society tend to lead to general poverty. That a person is "free to starve" is therefore not a condemnation of the free market, but a simple fact of nature: every child comes into the world without capital or resources of his own. On the contrary, as we shall see further below, it is the free market in a free society that furnishes the only instrument to reduce or eliminate poverty and provide abundance.

5. Cost

At this point, let us reintroduce the concept of "cost" into the analysis. We have seen above that the cost, or "marginal" cost, of any decision is the next highest utility that must be for­gone because of the decision. When a means M must be distributed among ends E1, E2, and E3, with E1 ranked highest on the indi­vidual's value scale, the individual attempts to allocate the means so as to attain his most highly valued ends and to forgo those ranked lower, although he will attain as many of his ends as he can with the means available. If he allocates his means to E1 and E2, and must forgo E3, E3 is the marginal cost of his de­cision. If he errs in his decision, and arrives at E3 instead of E2, then ex post-in retrospect-he is seen to have suffered a loss com­pared to the course he could have taken.

What are the costs involved in the decisions made by the owners of the factors? In the first place, it must be stressed that these costs are subjective and cannot be precisely determined by out­side observers or be gauged ex post by observing accountants.[13] Secondly, it is clear that, since such factors as land and the pro­duced capital goods have only one use, namely, the production of this product (by virtue of being purely specific), they involve no cost to their owner in being used in production. By the very terms of our problem, the only alternative for their owner would be to let the land lie unused, earning no return. The use of labor, however, does have a cost, in accordance with the value of the leisure forgone by the laborers. This value is, of course, un­measurable in money terms, and necessarily differs for each indi­vidual, since there can be no comparison between the value scales of two or more persons.

Once the final product has been produced, the analysis of the previous chapter follows, and it becomes clear that, in most cases, the sale of the good at the market price, whatever the price may be, is costless, except for rare cases of direct consumption by the producer or in cases of anticipation of a price increase in the near future. This sale is costless from the proper point of view-the point of view of acting man at the relevant instant of action. The fact that he would not have engaged in the labor at all if he had known in advance of the present price might indicate a deplorable instance of poor judgment, but it does not affect the present situation. At present, with all the labor already ex­erted and the product finished, the original-subjective-cost has already been incurred and vanished with the original making of the decision. At present, there is no alternative to the sale of the good at the market price, and therefore the sale is costless.[14]

It is evident, therefore, that once the product has been made, "cost" has no influence on the price of the product. Past costs, being ephemeral, are irrelevant to present determination of prices. The agitation that often takes place over sales "below cost" is now placed in its proper perspective. It is obvious that, in the relevant sense of "cost," no such sales can take place. The sale of an already produced good is likely to be costless, and if it is not, and price is below its costs, then the seller will hold on to the good rather than make the sale.

That costs do have an influence in production is not denied by anyone. However, the influence is not directly on the price, but on the amount that will be produced or, more specifically, on the degree to which factors will be used. We have seen in our example that land and capital goods will be used to the fullest extent practicable, since there is no return or benefit in allowing them to remain idle.[15] But man laboring bears the cost of leisure for­gone. What he expects will be the monetary return from his labor is the deciding factor in his decision concerning how much or whether or not to employ his labor on the product. The monetary return is ranked on his subjective value scale along with the costs of forgoing leisure, and his decision is made on the quantity of labor he will put forth in production. The height of costs on individual value scales, then, is one of the determinants of the quantity, the stock, that will be produced. This stock, of course, later plays a role in the determination of market price, since stock is evaluated by consumers according to the law of diminishing marginal utility. This, however, is a far cry from stating that cost either determines, or is co-ordinate with utility in determining, price. We may briefly summarize the law of price (which can be stated at this point only in regard to specific factors and joint ownership, but which will be later seen as true for any arrangement of production): Individuals, on their value scales, evaluate a given stock of goods according to their utilities, setting the prices of consumers' goods; the stock is produced ac­cording to previous decisions by producers, who had weighed on their value scales the expected monetary revenue from consumers against the subjective costs (themselves simply utilities forgone) of engaging in the production. In the former case, the utility valuations are generally (though by no means always) the ones made by consumers; in the latter case, they are made by producers. But it is clear that the determinants of price are only the subjec­tive utilities of individuals in valuing given conditions and alter­natives. There are no "objective" or "real" costs that determine, or are co-ordinate in determining, price.[16]

If we investigate the costs of laborers in production more closely, we see that what is involved is not simply a question of leisure forgone. There is another, though in this case intertwined, ele­ment: present goods are being forgone in exchange for an expec­tation of return in the future. Thus, added to the leisure-labor element, the workers, in this case, must wait for some time before earning the return, while they must give up their leisure in the present or in various periods earlier than the return is obtained. Time, therefore, is a critical element in production, and its analysis must pervade any theory of production.

When the owners of the factors embark on a process of pro­duction the yield of which will be necessarily realized in the future, they are giving up leisure and other consumers' goods that they either could have enjoyed without working or could have earned earlier from shorter processes of production. In order to invest their labor and land in a process of production, then, they must restrict their present consumption to less than its possible maximum. This involves forgoing either immediate consumption or the consumption made possible from shorter processes of pro­duction. Present consumption is given up in anticipation of future consumption. Since we have seen that the universal law of time preference holds that any given satisfaction will be preferred earlier than later, an equivalent satisfaction will be preferred as early as possible. Present consumption of a good will be given up only in anticipation of a greater future consumption, the de­gree of the premium being dependent on time preferences. This restriction of present consumption is saving. (See the discussion in chapter 1.)

In a world where products are all jointly owned by owners of factors, the original owners of land and labor must do their own saving; there is no monetary expression to represent total saving, even in a monetary economy. The owners of land and labor forgo a certain amount of present or earlier consumption and save in various amounts in order to invest their time and labor to produce the final product. Their income is finally earned, say after one year, when the good is sold to the consumers and the 100 ounces is received by the joint owners. It is impossible, how­ever, for us to say what this saving or investment was in monetary terms.


[1]Another difference is one we have already discussed: that mathematics, particularly the calculus, rests in large part on assumptions of infinitely small steps. Such assumptions may be perfectly legitimate in a field where behavior of unmotivated matter is under study. But human action disregards infinitely small steps precisely because they are infinitely small and therefore have no relevance to human beings. Hence, the action under study in economics must always occur in finite, discrete steps. It is therefore incorrect to say that such an assumption may just as well be made in the study of human action as in the study of physical par­ticles. In human action, we may describe such assumptions as being not simply unrealistic, but antirealistic.

[2]The mathematical economists, or "econometricians," have been trying without success for years to analyze the path of equilibrium as well as the equilibrium conditions themselves. The econometrician F. Zeuthen recently admitted that such attempts cannot succeed. All that mathe­matics can describe is the final equilibrium point. See the remarks of F. Zeuthen at the 16th European meeting of the Econometric Society, in Econometrica, April, 1955, pp. 199-200.

[3]For a brilliant critique of the use of mathematics in economics, see Mises, Human Action, pp. 251, 347-54, 697-99, 706-11. Also see Mises, "Comments about the Mathematical Treatment of Economic Problems," Studium Generale VI, 2 (1953), (Springer Verlag: unpublished trans­lation by Helena Ratzka); Niksa, "Role of Quantitative Thinking in Modern Economic Theory"; Ischboldin, "Critique of Econometrics"; Paul Pain­levé, "The Place of Mathematical Reasoning in Economics" in Louise Sommer, ed., Essays in European Economic Thought (Princeton, N.J.: D. Van Nostrand, 1960), pp. 120-32; and Wieser, Social Economics, pp. 51ff. For a dis­cussion of the logical method of economics, see Mises, Human Action and the neglected work, J.E. Cairnes, The Character and Logical Method of Political Economy (2nd ed.; London: Macmillan & Co., 1888). Also see Marian Bowley, Nassau Senior and Classical Economics (New York: Augustus M. Kelley, 1949), pp. 55-65. If any mathematics has been used in this treatise, it has been only along the lines charted by Cairnes:

I have no desire to deny that it may be possible to employ geometrical diagrams or mathematical formulae for the purpose of exhibiting economic doctrines reached by other paths. . . . What I venture to deny is the doctrine which Professor Jevons and others have advanced-that economic knowledge can be extended by such means; that Mathematics can be applied to the development of economic truth, as it has been applied to the development of mechanical and physical truth and un­less it can be shown either that mental feelings admit of being expressed in precise quantitative forms, or, on the other hand, that eco­nomic phenomena do not depend on mental feelings, I am unable to see how this conclusion can be avoided. (Cairnes, Character and Logical Method of Political Economy, pp. iv-v)

[4]George J. Stigler, Production and Distribution Theories (New York: Macmillan & Co., 1946), p. 181. For Carl Menger's attack on the concept of mutual determination and his critique of mathematical economics in general, see T.W. Hutchison, A Review of Economic Doctrines, 1870-1929 (Oxford: The Clarendon Press, 1953), pp. 147-48, and the interesting article by Emil Kauder, "Intellectual and Political Roots of the Older Austrian School," Zeitschrift für Nationalökonomie XVII, 4 (1958), 412ff.

[5]Stigler appends a footnote to the above paragraph which is meant as the coup de grace to Böhm-Bawerk: "Böhm-Bawerk was not trained in mathematics." Stigler, Production and Distribution Theories. Mathematics, it must be realized, is only the servant of logic and reason, and not their master. "Training" in mathematics is no more necessary to the realization of its uselessness for and inapplicability to the sciences of human action than, for example, "training" in agricultural techniques is essential to knowing that they are not applicable on board an ocean liner. Indeed, training in mathematics, without adequate attention to the epistemology of the sciences of human action, is likely to yield unfortunate results when applied to the latter, as this example demonstrates. Böhm-Bawerk's greatness as an economist needs no defense at this date. For a sensitive tribute to Böhm-Bawerk, see Joseph A. Schumpeter, "Eugen von Böhm-Bawerk, 1851-1914" in Ten Great Economists (New York: Oxford University Press, 1951), pp. 143-90. For a purely assertive and unsupported depreciation of Böhm-Bawerk's stature as an economist, see Howard S. Ellis' review of Schumpeter's book in the Journal of Political Economy, October, 1952, p. 434.

[6]The literature in economics has been immeasurably confused by writers on production theory who deal with problems in terms of technology rather than valuation. For an excellent article on this problem, cf. Lionel Robbins, "Remarks upon Certain Aspects of the Theory of Costs," Economic Journal, March, 1934, pp. 1-18.

[7]We must hasten to add that this does not signify adoption of the old classical fallacy that treated each of these groups of factors as homogeneous. Clearly, they are heterogeneous and for pricing purposes and in human action are treated as such. Only the same good, homogeneous for human valuation, is treated as a common "factor," and all factors are treated alike-for their contribution to revenue-by producers. The cate­gories "land, labor, and capital goods" are essential, however, for a deeper analysis of production problems, in particular the analysis of various income returns and of the relation of time to production.

[8]It must be understood that "factors of production" include every service that advances the product toward the stage of consumption. Thus, such services as "marketing costs," advertising, etc., are just as legitimately productive services as any other factors. The fallacy in the spurious distinction between "production costs" and "selling costs" has been defi­nitely demonstrated by Mises, Human Action, p. 319.

[9]On the structure of production, see Wieser, Social Economics, pp. 47ff.

[10]In practice, one or more persons can be the owners of any of the fac­tors. Thus, the original factors might also be jointly owned by several persons. This would not affect our analysis. The only change would be that the joint owners of a factor would have to allocate the factor's income according to voluntary contract. But the type of allocation would remain the same.

[11]Actually, this case cannot occur, since labor, as we shall see below, is always a nonspecific factor.

[12]It is therefore our contention that the term "consumers' sovereignty" is highly inapt and that "individual sovereignty" would be a more appro­priate term for describing the free market system. For an analysis of the concept of "consumers' sovereignty," see chapter 10 below.

[13]Cf. the excellent discussion of cost by G.F. Thirlby, "The Subjective Theory of Value and Accounting 'Cost,'" Economica, February, 1946, pp. 33f.; and especially Thirlby, "Economists' Cost Rules and Equilibrium Theory," Economica, May, 1960, pp. 148-53.

[14]As Thirlby says, "Cost is ephemeral. The cost involved in a particular decision loses its significance with the making of a decision because the decision displaces the alternative course of action." Thirlby, "Subjective Theory of Value," p. 34. And Jevons:

Labor once spent has no influence on the future value of any article: it is gone and lost forever. In commerce bygones are forever bygones and we are always starting clear at each moment, judging the values of things with a view to future utility. Industry is essentially prospective, not retrospective. (Jevons, Theory of Political Economy, p. 164)

[15]There will undoubtedly be exceptions, such as cases where the owner obtains enjoyment from the land or capital good from its lying idle-such as the esthetic enjoyment of using it as an uncultivated forest. These alternatives are then also costs, when a decision is made on the use of the land.

[16]It is unfortunate that these truths, substantially set forth by the "Austrian School of economics" (which included some Englishmen and Americans) close to three-quarters of a century ago, should have been almost en­tirely obscured by the fashionable eclectic doctrine that "real costs" and utility are somehow co-ordinate in price determination, with "cost" being "really" more important "in the long run." How often has Alfred Marshall's homely analogy of utility and cost being "two blades of a scissors" been invoked as a substitute for analysis! Emil Kauder has supplied an interesting interpretation of the reason for the failure of British thought to adopt the nascent subjective value approach in pre­vious centuries. He attributes the emphasis on labor and real cost, as contrasted to subjective utility and happiness, to the Calvinist back­ground of the British classicists, typified by Smith and Locke. Of particular interest here is his citation of the strongly Evangelical background of Marshall. Implicit in his treatment is the view that the second major reason for the classicists' failure to follow subjectivist leads was their search for an invariable measurement of value. This search em­bodied the "scientistic" desire to imitate the methods of the natural sciences. Emil Kauder, "The Retarded Acceptance of the Marginal Utility Theory," Quarterly Journal of Economics, November, 1953, pp. 564-75.

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