Chapter 7—Production: General Pricing of the
Factors (continued)
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Chapter
7—Production: General Pricing of the Factors (continued)
2.
Determination of the Discounted Marginal Value Product
A.
Discounting
If the DMVP schedules determine the prices of nonspecific factor
services, what determines the shape and position of the DMVP schedules?
In the first place, by definition it is clear that the DMVP schedule is
the MVP schedule for that factor discounted. There
is no mystery about the discounting; as we have
stated, the MVP of the factor is discounted in accordance with
the going pure rate of interest on the market. The
relation of the MVP schedule and the DMVP schedule may be
diagrammed as in Figure 57.
The supply of the factor is the EF line at the
given quantity 0E. The solid line is the MVP
schedule at various supplies. The MVP of the supply 0E
is EA. Now the broken line D1D1
is the discounted marginal value product schedule at a certain rate of
interest. Since it is discounted, it is uniformly lower than the MVP
curve. In absolute terms, it is relatively lower at the left of the
diagram, because an equal percentage drop implies a greater absolute
drop where the amount is greater. The DMVP for supply 0E
equals EB. EB will be the price
of the factor in the evenly rotating economy. Now suppose that the rate
of interest in the economy rises, as a result, of course, of
rises in time-preference schedules. This means that the rate
of discount for every hypothetical MVP will be greater, and the
absolute levels lower. The new DMVP schedule is depicted as the dotted
line D2D2.
The new price for the same supply of the factor is EC,
a lower price than before.
One of the determinants of the DMVP schedule, then, is the rate of
discount, and we have seen above that the rate of discount is
determined by individual time preferences. The higher the rate of
discount, the lower will tend to be the DMVP and, therefore, the lower
the price of the factor; the lower the interest rate, the
higher the DMVP and the price of the factor.
B.
The Marginal Physical Product
What, then, determines the position and shape of the MVP schedule? What
is the marginal value product? It is the amount of revenue intake
attributable to a unit of a factor. And this revenue depends on two
elements: (1) the physical product produced and (2) the price
of that product. If one hour of factor X is
estimated by the market to produce a value of 20 gold ounces, this
might be because one hour produces 20 units of the physical
product, which are sold at a price of one gold ounce per unit. Or the
same MVP might result from the production of 10 units of the product,
sold at two gold ounces per unit, etc. In short, the marginal
value product of a factor service unit is equal to its marginal
physical product times the price of that product.
Let us, then, investigate the determinants of the marginal
physical product (MPP). In the first place, there can be no
general schedule for the MPP as there is for the MVP, for the simple
reason that physical units of various goods are not
comparable. How can a dozen eggs, a pound of butter, and a house be
compared in physical terms? Yet the same
factor might be useful in the production of any of these goods. There
can be an MPP schedule, therefore, only in particular
terms, i.e., in terms of each particular production process in which
the factor can be engaged. For each production process there will be
for the factor a marginal physical production schedule of a
certain shape. The MPP for a supply in that process
is the amount of the physical product imputable to one unit of that
factor, i.e., the amount of the product that will be lost if one unit
of the factor is removed. If the supply of the factor in the process is
increased by one unit, other factors remaining the same, then the MPP
of the supply becomes the additional physical product that can be
gained from the addition of the unit. The supply of the factor that is
relevant for the MPP schedules is not the total supply in the society,
but the supply in each process, since the MPP
schedules are established for each process separately.
(1)
The Law of Returns
In order to investigate the MPP schedule further, let us
recall the law of returns, set forth in chapter 1. According
to the law of returns, an eternal truth of human action, if the
quantity of one factor varies, and the quantities of other factors
remain constant, there is a point at which the physical
product per factor is at a maximum. Physical product per factor may be
termed the average physical product (APP). The
law further states that with either a lesser or a greater
supply of the factor the APP must be lower. We may diagram a typical
APP curve as in Figure 58.
(2)
Marginal Physical Product and Average Physical Product
What is the relationship between the APP and MPP? The MPP is
the amount of physical product that will be produced with the addition
of one unit of a factor, other factors being given. The APP is the
ratio of the total product to the total quantity of the variable
factor, other factors being given. To illustrate the meanings
of APP and MPP, let us consider a hypothetical case in which
all units of other factors are constant, and the number of units of one
factor is variable. In Table 13 the first column lists the number of
units of the variable factor, and the second column the total physical
product produced when these varying units are combined with fixed units
of the other factors. The third column is the APP = total product
divided by the number of units of the factor, i.e., the average
physical productivity of a unit of the factor. The fourth
column is the MPP = the difference in total product yielded by adding
one more unit of the variable factor, i.e., the total product of the
current row minus the total product of the preceding row:
In the first place, it is quite clear that no factor will
ever be employed in the region where the MPP is negative.
In our example, this occurs where seven units of the factor are being
employed. Six units of the factor, combined with given other
factors, produced 30 units of the product. An addition of another unit
results in a loss of two units of the product. The MPP of the factor
when seven units are employed is -2. Obviously, no factor will ever be
employed in this region, and this holds true whether the factor-owner
is also owner of the product, or a capitalist hires the factor to work
on the product. It would be senseless and contrary to the principles of
human action to expend either effort or money on added factors
only to have the quantity of the total product decline.
In the tabulation, we follow the law of returns, in that the APP,
beginning, of course, at zero with zero units of the factor, rises to a
peak and then falls. We also observe the following from our chart: (1) when
the APP is rising (with the exception of the very first step
where TP, APP, and MPP are all equal) MPP is higher than APP;
(2) when the APP is falling, MPP is lower than APP;
(3) at the point of maximum APP, MPP is equal to APP.
We shall now prove, algebraically, that these three laws always hold.
Now
the new APP might be higher or lower than the previous one. Let us
suppose that the new APP is higher and that therefore we are in a
region where the APP is increasing. This means
that:
In
short, the MPP is also greater than the new
APP.
In other words, if APP is increasing, then the marginal
physical product is greater than the average physical product
in this region. This proves the first law above. Now, if we go back in
our proof and substitute “less than” signs for
“greater than” signs and carry out similar steps,
we arrive at the opposite conclusion: where APP is
decreasing, the marginal physical product is lower than the average
physical product. This proves the second of our three laws
about the relation between the marginal and the average
physical product. But if MPP is greater than APP when the latter is
rising, and is lower than APP when the latter is falling, then it
follows that when APP is at its maximum, MPP must be neither
lower nor higher than, but equal to, APP. And this proves the
third law. We see that these characteristics of our table apply to all
possible cases of production.
The diagram in Figure 59 depicts a typical set of MPP and APP
schedules. It shows the various relationships between APP and MPP. Both
curves begin from zero and are identical very close to their origin.
The APP curve rises until it reaches a peak at B,
then declines. The MPP curve rises faster, so that it is higher than
APP, reaches its peak earlier at C, then declines
until it intersects with APP at B. From then on,
the MPP curve declines faster than APP, until finally it crosses the
horizontal axis and becomes negative at some point A.
No firm will operate beyond the 0A area.
Now let us explore further the area of increasing
APP, between 0 and D. Let us take another
hypothetical tabulation (Table 14), which will be simpler for
our purpose.
This is a segment of the increasing section of the average
physical product schedule, with the peak being reached at four
units and 6.2 APP. The question is: What is the likelihood that this
region will be settled upon by a firm as the right
input-output combination? Let us take the top line of the chart. Two
units of the variable factor, plus a bundle of what we may call U
units of all the other factors, yield 10 units of the product. On the
other hand, at the maximum APP for the factor, four units of it, plus U
units of other factors, yield 25 units of the product. We have seen
above that it is a fundamental truth in nature that the same
quantitative causes produce the same quantitative effects.
Therefore, if we halve the quantities of all of the factors in the
third line, we shall get half the product. In other words, two units of
the factor combined with U/2—with half of
the various units of each of the other factors—will
yield 12.5 units of the product.
Consider this situation. From the top line we see that two units of the
variable factor, plus U units of given factors,
yield 10 units of the product. But, extrapolating from the bottom line,
we see that two units of the variable factor, plus U/2
units of given factors, yield 12.5 units of the product. It is
obvious that, as in the case of going beyond 0A,
any firm that allocated factors so as to be in the 0D
region would be making a most unwise decision. Obviously, no one would
want to spend more in effort or money on factors
(the “other” factors) and obtain less
total output or, for that matter, the same total output. It is evident
that if the producer remains in the 0D region, he
is in an area of negative marginal physical productivity of
the other factors. He would be in a situation where he would
obtain a greater total product by throwing away some of the other
factors. In the same way, after 0A, he would be in
a position to gain greater total output if he threw away some of the
present variable factor. A region of increasing APP for one
factor, then, signifies a region of negative MPP
for other factors, and vice versa. A
producer, then, will never wish to allocate his factor in the 0D
region or in the region beyond A.
Neither will the producer set the factor so that its MPP is at the
points B or A. Indeed, the
variable factor will be set so that it has zero marginal productivity
(at A) only if it is a free good.
There is however, no such thing as a free good; there is only a
condition of human welfare not subject to action, and therefore not an
element in productivity schedules. Conversely, the APP is at B,
its maximum for the variable factor, only when the other
factors are free goods and therefore have zero marginal
productivity at this point. Only if all the other factors were
free and could be left out of account could the producer simply
concentrate on maximizing the productivity of one factor
alone. However, there can be no production with only one
factor, as we saw in chapter 1.
The conclusion, therefore, is inescapable. A factor will
always be employed in a production process in such a way that it
is in a region of declining APP and declining but positive MPP—between
points D and A on the chart. In
every production process, therefore, every factor will be employed in a
region of diminishing MPP and diminishing APP so that
additional units of the factor employed in the process will lower the
MPP, and decreased units will raise it.
C.
Marginal Value Product
As we have seen, the MVP for any factor is its MPP multiplied
by the selling price of its product. We have just concluded that every
factor will be employed in its region of diminishing marginal physical
product in each process of production. What will be the shape of the
marginal value product schedule? As the supply of a
factor increases, and other factors remain the same, it follows that
the total physical output of the product is greater. A greater stock,
given the consumers’ demand curve, will lead to a lowering of
the market price. The price of the product will then fall as the MPP
diminishes and rise as the latter increases. It follows that the MVP
curve of the factor will always be falling, and falling at a more
rapid rate than the MPP curve. For each specific
production process, any factor will be employed in the region of
diminishing MVP.
This correlates with the
previous conclusion, based on the law of utility, that the
factor in general, among various production processes, will be employed
in such a way that its MVP is diminishing. Therefore, its general
MVP (between various uses and within each use) is
diminishing, and its various particular MVPs are
diminishing (within each use). Its DMVP is, therefore, diminishing as
well.
The price of a unit of any factor will, as we have seen, be
established in the market as equal to its discounted marginal
value product. This will be the DMVP as determined by the general
schedule including all the various uses to which it can be put. Now the
producers will employ the factor in such a way that its DMVP
will be equalized among all the uses. If the DMVP in one use
is greater than in another, then employers in the former line of
production will be in a position to bid more for the factor
and will use more of it until (according to the principle of
diminishing MVP) the DMVP of the expanding use diminishes to the point
at which it equals the increasing DMVP in the contracting use.
The price of the factor will be set as equal to the general DMVP, which
in the ERE will be uniform throughout all the particular uses.
Thus, by looking at a factor in all of its interrelations, we
have been able to explain the pricing of its unit service without
previously assuming the existence of the price itself.
To focus the analysis on the situation as it looks from the vantage
point of the firm is to succumb to such an error, for the individual
firm obviously finds a certain factor price given on the market. The
price of a factor unit will be established by the market as equal to
its marginal value product, discounted by the rate of interest for the
length of time until the product is produced, provided that this
valuation of the share of the factor is isolable. It is isolable if the
factor is nonspecific or is a single residual specific factor in a
process. The MVP in question is determined by the general MVP schedule
covering the various uses of the factor and the supply of the factor
available in the economy. The general MVP schedule of a factor
diminishes as the supply of the factor increases; it is made up of
particular MVP schedules for the various uses of the factor,
which in turn are compounded of diminishing Marginal Physical
Product schedules and declining product prices. Therefore, if the
supply of the factor increases, the MVP schedule in the economy
remaining the same, the MVP and hence the price of the factor will
drop; and as the supply of the factor dwindles, ceteris
paribus, the price of the factor will rise.
To the individual firm, the price of a factor established on the market
is the signal of its discounted marginal value product elsewhere. This
is the opportunity cost of the firm’s using the product,
since it equals the value product that is forgone through failure to
use the factor unit elsewhere. In the ERE, where all factor prices
equal discounted marginal value products, it follows that factor prices
and (opportunity) “costs” will be equal.
Critics of the marginal productivity analysis have contended that in
the “modern complex world” all factors co-operate
in producing a product, and therefore it is impossible to establish any
sort of imputation of part of the product to various co-operating
factors. Hence, they assert, “distribution” of
product to factors is separable from production and takes place
arbitrarily according to bargaining theory. To be sure, no one
denies that many factors do co-operate in producing goods. But
the fact that most factors (and all labor factors) are nonspecific, and
that there is very rarely more than one purely specific factor in a
production process, enables the market to isolate value
productivity and to tend to pay each factor in accordance with
this marginal product. On the free market, therefore, the price of each
factor is not determined by “arbitrary” bargaining,
but tends to be set strictly in accordance with its discounted marginal
value product. The importance of this market process becomes greater
as the economy becomes more specialized and complex and the adjustments
more delicate. The more uses develop for a factor, and the more types
of factors arise, the more important is this market
“imputation” process as compared to simple
bargaining. For it is this process that causes the effective allocation
of factors and the flow of production in accordance with the
most urgent demands of the consumers (including the nonmonetary desires
of the producers themselves). In the free-market process, therefore,
there is no separation between production and
“distribution.” There is no heap somewhere
on which “products” are arbitrarily thrown and from
which someone does or can arbitrarily
“distribute” them among various people. On the
contrary, individuals produce goods and sell them to consumers for
money, which they in turn spend on consumption or on investment in
order to increase future consumption. There is no separate
“distribution”; there is only production
and its corollary, exchange.
It should always be understood, even where it is not explicitly stated
in the text for reasons of exposition, that the MVP schedules
used to set prices are discounted MVP schedules,
discounting the final MVP by the length of time remaining
until the final consumers’ product is produced. It is the
DMVPs that are equalized throughout the various uses of the factor. The
importance of this fact is that it explains the market
allocation of nonspecific factors among various productive stages
of the same or of different goods. Thus, if the DMVP of a factor is six
gold ounces, and if the factor is employed on a process practically
instantaneous with consumption, its MVP will be six. Suppose that the
pure rate of interest is 5 percent. If the factor is at work on a
process that will mature in final consumption five years from now, a
DMVP of six signifies an MVP of 7.5; if it is at work on a 10-year
process, a DMVP of six signifies an MVP of 10; etc. The more remote the
time of operation is from the time when the final product is completed,
the greater must be the difference allowed for the annual
interest income earned by the capitalists who advance present
goods and thereby make possible the entire length of the production
process. The amount of the discount from
the MVP is greater here because the higher stage is more remote than
the others from final consumption. Therefore, in order for investment
to take place in the higher stages, their MVP has to be far higher than
the MVP in the shorter processes.
3.
The Source of Factor Incomes
Our analysis permits us now to resolve that time-honored controversy in
economics: Which is the source of wages—capital or
consumption? Or, as we should rephrase it, which is the source of
original-factor incomes (for labor and land factors)? It is clear that
the ultimate goal of the investment of capital is future
consumption. In that sense, consumption is the necessary
requisite without which there would be no capital. Furthermore, for
each particular good, consumption dictates, through market demands, the
prices of the various products and the shifting of
(nonspecific) factors from one process to another. However,
consumption by itself provides nothing. Savings and investment are
needed in order to permit any consumption at all, since very little
consumption could be obtained with no production processes or
capital structure at all—perhaps only the direct
picking of berries.
In so far as labor or land factors produce and sell
consumers’ goods immediately, no capital
is required for their payment. They are paid directly by consumption.
This was true for Crusoe’s berry-picking. It is also true in
a highly capitalistic economy for labor (and land) in the final stages
of the production process. In these final stages, which include pure
labor incomes earned in the sale of personal services (of doctors,
artists, lawyers, etc.) to consumers, the factors earn MVP directly
without being discounted in advance. All the other labor and
land factors participating in the production process are paid
by saved capital in advance of the produced and consumed product.
We must conclude that in the dispute between the classical theory that
wages are paid out of capital and the theory of Henry George, J.B.
Clark, and others that wages are paid out of the annual product
consumed, the former theory is correct in the overwhelming majority of
cases, and that this majority becomes more preponderant the greater the
stock of capital in the society.
4.
Land and Capital Goods
The price of the unit service of every factor, then, is equal to its
discounted marginal value product. This is true of all
factors, whether they be “original” (land
and labor) or “produced” (capital goods). However,
as we have seen, there is no net income to the owners of capital goods,
since their prices contain the prices of the various factors that
co-operate in their production. Essentially, then, net income accrues
only to owners of land and labor factors and to capitalists for their
“time” services. It is still true, however, that
the pricing principle—equality to discounted
MVP—applies whatever the factor, whether capital good or any
other.
Let us revert to the diagram in Figure 41. This time, let us
assume for simplicity that we are dealing with one unit of one
consumers’ good, which sells for 100 ounces, and that one
unit of each particular factor enters into its production.
Thus, on Rank 1, 80 refers to one unit of a capital good. Let us
consider the first rank first. Capitalistslpurchase
one capital good for 80 ounces and (we assume) one labor factor for
eight ounces and one land factor for seven ounces. The joint MVP for
the three factors is 100. Yet their total price is 95 ounces. The
remainder is the discount accruing to the
capitalists because of the time element. The sum of the discounted
MVPs, then, is 95 ounces, and this is precisely what the owners of
three factors received in total. The discounted MVP of the labor
factor’s service was eight, the DMVP of the land’s
service was seven, the DMVP of the capital good’s service was
80. Thus, each factor obtains its DMVP as its received price. But what
happens in the case of the capital good? It has been sold for 80, but
it has had to be produced, and this production cost money to pay the
income of the various factors. The price of the capital good, then, is
reduced to, say, another land factor, paid eight ounces; another labor
factor paid 8 ounces, and a capital-goods factor paid 60 ounces. The
prices, and therefore the incomes, of all these factors are
discounted again to account for the time, and this discount is
earned by Capitalists2. The sum of these factor
incomes is 76, and once again each factor service earns its
DMVP.
Each capital-goods factor must be produced and must continue to be
produced in the ERE. Since this is so, we see that the
capital-goods factor, though obtaining its DMVP, does not earn
it net, for its owner, in turn,
must pay money to the factors that produce it. Ultimately, only land,
labor, and time factors earn net incomes.
This type of analysis has been severely criticized on the
following grounds:
This
“Austrian” method of tracing everything back to
land and labor (and time!) may be an interesting historical exercise,
and we may grant that, if we trace back production and investment far
enough, we shall ultimately reach the world of primitive men, who began
to produce capital with their bare hands. But of what relevance is this
for the modern, complex world around us, a world in which a huge amount
of capital already exists and can be worked with? In the modern world
there is no production without the aid of capital, and therefore the
whole Austrian capital analysis is valueless for the modern
economy.
There is no question about the fact that we are not interested in
historical analysis, but rather in an economic analysis of the complex
economy. In particular, acting man has no interest in the historical
origin of his resources; he is acting in the present
on behalf of a goal to be achieved in the future.
Praxeological analysis
recognizes this and deals with the individual acting at present to
satisfy ends of varying degrees of futurity (from
instantaneous to remote).
It is true, too, that the presentation by the master of capital and
production theory, Böhm-Bawerk, sowed confusion by giving an
historical interpretation to the structure of production. This is
particularly true of his concept of the “average period of
production,” which attempted to establish an average
length of production processes operating at present, but
stretching back to the beginning of time. In one of the weakest parts
of his theory, Böhm-Bawerk conceded that “The boy
who cuts a stick with his knife is, strictly speaking, only continuing
the work of the miner who, centuries ago, thrust the first spade into
the ground to sink the shaft from which the ore was brought to make the
blade.” He then tried to
salvage the relevance of the production structure by averaging
periods of production and maintaining that the effect in the present
product of the early centuries’ work is so small (being so
remote) as to be negligible.
Mises has succeeded, however, in refining the Austrian
production theory so as to eliminate reliance on an almost
infinitely high production structure and on the mythical concept of an
“average period of production.”
As Mises states:
Acting
man does not look at his condition with the eyes of an historian. He is
not concerned with how the present situation originated. His
only concern is to make the best use of the means available today for
the best possible removal of future uneasiness. . . . He has at his
disposal a definite quantity of material factors of production. He does
not ask whether these factors are nature-given or the product of
production processes accomplished in the past. It does not matter for
him how great a quantity of nature-given, i.e., original material
factors of production and labor, was expended in their production and
how much time these processes of production have absorbed. He values
the available means exclusively from the aspect of the services they
can render him in his endeavors to make future conditions more
satisfactory. The period of production and the duration of
serviceableness are for him categories in planning future
action, not concepts of academic retrospection. . . . They play a role
in so far as the actor has to choose between periods of production of
different length. . . .
[Böhm-Bawerk]
. . . was not fully aware of the fact that the period of production is
a praxeological category and that the role it plays in action consists
entirely in the choices acting man makes between periods of production
of different length. The length of time expended in the past
for the production of capital goods available today does not count at
all.
But if the past is not taken into account, how can we use the
production-structure analysis? How can it apply to an ERE if the
structure would have to go back almost endlessly in time? If we base
our approach on the present, must we not follow the Knightians in
scrapping the production-structure analysis?
A particular point of contention is the dividing line between land and
capital goods. The Knightians, in scoffing at the idea of tracing
periods of production back through the centuries, scrap the land
concept altogether and include land as simply a part of capital goods.
This change, of course, completely alters production theory.
The Knightians point correctly, for example, to the fact that
present-day land has many varieties and amounts of past labor
“mixed” with it: canals have been dug, forests
cleared, basic improvements have been made in the soil, etc. They
assert that practically nothing is pure “land”
anymore and therefore that the concept has become an empty one.
As
Mises has shown, however, we can revise
Böhm-Bawerk’s theory and still retain the vital
distinction between land and capital goods. We do not have to
throw out, as do the Knightians, the land baby with the
average-period-of-production bathwater. We can, instead, reformulate
the concept of “land.” Up to this point we have
simply assumed land to be the original, nature-given factors.
Now we must modify this, in keeping with our focus on the present and
the future rather than the past. Whether or not a piece of land is
“originally” pure land is in fact
economically immaterial, so long as whatever alterations have
been made are permanent—or rather, so long as these
alterations do not have to be reproduced or replaced.
Land that has been
irrigated by canals or altered through the chopping down of forests has
become a present, permanent given. Because it is a
present given, not worn out in the process of production, and not
needing to be replaced, it becomes a land factor
under our definition. In the ERE, this factor will continue to give
forth its natural powers unstinted and without further investment; it
is therefore land in our analysis. Once this
occurs, and the permanent are separated from the nonpermanent
alterations, we see that the structure of production no longer
stretches back infinitely in time, but comes to a close within
a relatively brief span of time.
The capital goods are
those which are continually wearing out in the process of production
and which labor and land factors must work to replace. When we consider
physical wearing out and replacement, then, it becomes evident that it
would not take many years for the whole capital-goods structure to
collapse, if no work were done on maintenance and replacement,
and this is true even in the modern, highly capitalist
economy. Of course, the higher the degree of
“capitalist” development and the more
stages in production, the longer will it take for all the capital goods
to wear out.
The “permanence” with which we are dealing refers,
of course, to the physical permanence of the goods,
and not to the permanence of their value. The
latter depends on the shifting desires of consumers and could never be
called permanent. Thus, there might be a land factor uniquely
and permanently suitable as a vineyard. It is land
and remains so, therefore, indefinitely. If, at some time, the
consumers should completely lose their taste for wine, and the land
becomes valueless and no longer used, it is still a
permanent factor, and therefore is land, although now
submarginal. It should be noted that the
“permanence” is relevant to present considerations
of human action. A piece of land might give forth a permanent marginal
(physical) product, without necessity of maintenance, and
suddenly a volcano might erupt or a hurricane strike in the area, and
the permanence could be destroyed. Such conceivable natural
events, however, are not ex ante relevant to human
action, and therefore from the point of view of action this land is
rightly considered as “permanent,” until the
natural changes occur.
The concept of “land” as used throughout this book,
then, is entirely different from the popular concept of land. Let us,
in this section, distinguish between the two by calling the former economic
land and the latter geographic land. The
economic concept includes all nature-given
sources of value: what is usually known as natural resources, land,
water, and air in so far as they are not free goods. On the other hand,
a large part of the value of what is generally considered
“land”—i.e., that part that has to be
maintained with the use of labor—is really a capital good.
That agricultural land is an example of the latter may
surprise the reader who is likely to think of it as
permanently productive. This is completely wrong; the marginal
physical productivity of (geographic) land varies greatly in
accordance with the amount of labor that is devoted to maintaining or
improving the soil, as against such use or nonuse of the soil as leads
to erosion and a lower MPP. The basic soil (and here we are referring
to the soil that would remain now if maintenance
were suspended, not to the soil as it was in the
dim past before cultivation) is the land element,
while the final product—which is popularly known as
agricultural land—is usually a capital good containing this
land element.
And Van Sickle and Rogge say about the soil:
Land,
as the top 12 to 18 inches from which grains, vegetables, grasses, and
trees draw almost their entire nourishment, is highly destructible. Top
soil can be washed or blown away (eroded), or its organic and mineral
content can be dissolved and drawn down out of reach of plant life
(leached) in a relatively few years, unless great care is
exercised in its use. It can also be rebuilt by careful
husbandry. Hence it can be said of all soils . . . that their
maintenance requires saving.
The indestructibility of land is much more clearly exemplified in what
is commonly called “urban land.” For land in urban
areas (and this includes suburban land, land for factories, etc.)
clearly evinces one of its most fundamentally indestructible
features: its physical space—its
part of the surface of the earth. For the surface area of the earth is,
except in rare cases, eternally fixed, as is the geographic position of
each piece of geographic land on the surface. This eternally fixed,
permanent, positional aspect of geographic land is
called the site aspect of the land, or as Mises
aptly puts it, “the land as standing room.” Since
it is permanent and nonreproducible, it very clearly comes under the
category of economic land. The permanence, once again, refers
to its physical spatial aspect; its site values, of
course, are always subject to change.
Midtown Manhattan is on
the same site—the same geographical location—now as
it was in the 1600’s, although the monetary values accruing
to it have changed.
Suppose that a piece of currently unused land can be used for various
agricultural purposes or for urban purposes. In that case, a choice
will be made according to its alternative values as
nonreplaceable economic land: between its discounted MVP as a
result of the fertility of its basic soil and its discounted
MVP as an urban site. And if a decision must be made whether land now
used in agriculture and being maintained for that purpose should remain
in agriculture or be used as a site for building, the
principles of choice are the same. The marginal value return
to the agricultural or urban land is broken down by the owner of the
land—the “landlord”—into the
interest return on the capital maintenance and improvement and
the discounted marginal value return to the basic economic
land.
“Basic land” (or “ground land”)
in this treatise refers to the soil without maintenance,
in the case of agriculture, or the pure site
without depreciating superstructure, in the case of urban
land. The basic land, therefore, whether it be soil or site, earns for
its owner an ultimate unit price, or rent, equaling its DMVP.
Working on this basic land, labor and investment create a
finished capital good. This capital good, like all capital goods, also
earns unit rents equal to its DMVP. However, this earning is broken
down (and relevantly so in the current market, not
as an historical exercise) into basic land rent and
interest return on the capital invested (as well, of course,
as returns to labor that works on the basic land, i.e.,
labor’s wage or “rent-price,” equaling
its DMVP). This capital-good land we have variously termed
“geographic land,” “land in the
popular sense,” “final land,”
“finished land.” When we speak simply of
“land,” on the other hand, we shall always be
referring to the true economic land—the currently
nature-given factor.
This is not strictly true, but the
technical error in the statement does not affect the causal analysis in
the text. In fact, this argument is strengthened, for MVP actually
equals MPP x “marginal revenue,” and marginal
revenue is always less than, or equal to, price. See
Appendix A below, “Marginal Physical and Marginal Value
Product.”
It might be asked why we now
employ mathematics after our strictures against the mathematical method
in economics. The reason is that, in this particular problem, we are
dealing with a purely technological question. We
are not dealing with human decisions here, but with the necessary
technological conditions of the world as given to human
factors. In this external world, given quantities of cause
yield given quantities of effect, and it is this sphere, very
limited in the overall praxeological picture, that, like the natural
sciences in general, is peculiarly susceptible to mathematical methods.
The relationship between average and marginal is an obviously algebraic,
rather than an ends-means, relation. Cf. the algebraic proof
in Stigler, Theory of Price, pp. 44ff.
This law applies to all factors,
specific and nonspecific.
See the excellent discussion in
Böhm-Bawerk, Positive Theory of Capital,
pp. 304–12. For a further discussion of DMVP as against MVP, see
Appendix B below, “Professor Rolph and the Discounted
Marginal Productivity Theory.”
See Wicksell,
Lectures on Political Economy, I, 108.
See the excellent analysis in ibid.,
pp. 189–91, 193–95.
This was realized by Carl Menger. See
F.A. Hayek, “Carl Menger” in Henry W. Spiegel, ed.,
The Development of Economic Thought (New York: John
Wiley, 1952), pp. 530ff.
Böhm-Bawerk, Positive
Theory of Capital, p. 88.
Mises, Human Action,
pp. 477, 485f. Also see Menger, Principles
of Economics, pp. 166–67.
“Nonreplaceable”
as a criterion for land, in contrast to capital
goods, is not equivalent to
“permanent.” “Permanent” is a
subdivision of “nonreplaceable.” It is clear that
permanent improvements do not have to be replaced. However, depletable
natural resources, such as coal, ores, etc., are not permanent, but are
also nonreplaceable. The key question is whether a resource has to be produced,
in which case it earns only gross rents. If it does
not or cannot, it earns net rents as well.
Resources that are being depleted obviously cannot
be replaced and are therefore land, not capital
goods. See the section on depletable resources below.
We may use
“permanent” and “nonpermanent”
in this section, because resources that are being depleted obviously
cannot be included in any evenly rotating equilibrium. For more on
depletable resources, see below. With depletable resources left aside,
“permanent” becomes identical with
“nonreproducible.”
Cf. Wicksell, Lectures on
Political Economy I, 186 and passim; and Hayek, Pure Theory of Capital,
pp. 54–58.
Neither is there any relation
between the present issue of permanence or nonpermanence and the
cosmological question of the permanence of matter and energy. See
Mises, Human Action, p. 634.
Stigler charges that the various
distinctions between land and capital goods based on permanence or
origin, such as are discussed herein, are physical rather than
economic. These strictures miss the point. No one denies that these
homogeneous factors can change greatly in value
over time. But whether or not a given factor is original or improved,
or permanent or needing to be maintained, is a
physical question, and one that is very relevant to economic analysis.
Certainly, the Knightian argument that all land is capital
goods, because no land is original, is also an argument in the physical
realm. Stigler, Production and Distribution Theories,
p. 274.
John V. Van Sickle and Benjamin A.
Rogge, Introduction to Economics (New York: D. Van
Nostrand, 1954), p. 141.
But while the position is
permanent, even the land itself was necessarily altered by man to
prepare it for urban use. See chapter 2 above.
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