# The Ludwig von Mises Institute

## Advancing the scholarship of liberty in the tradition of the Austrian School

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.[6]

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.[7]

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.[8] 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.[9]

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.[10]

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.[11]

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.[12] 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.”[13]  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.[14]

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.[15] 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.[16] 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.[17]

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.[18][19]

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.[20]

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.[21] 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.

[6]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.”

[7]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.

[8]This law applies to all factors, specific and nonspecific.

[9]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.”

[10]See Wicksell, Lectures on Political Economy, I, 108.

[11]See the excellent analysis in ibid., pp. 189–91, 193–95.

[12]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.

[13]Böhm-Bawerk, Positive Theory of Capital, p. 88.

[14]Mises, Human Action, pp. 477, 485f. Also see Menger, Principles of Economics, pp. 166–­67.

[15]“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.

[16]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.”

[17]Cf. Wicksell, Lectures on Political Economy I, 186 and passim; and Hayek, Pure Theory of Capital, pp. 54–58.

[18]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.

[19]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.

[20]John V. Van Sickle and Benjamin A. Rogge, Introduction to Economics (New York: D. Van Nostrand, 1954), p. 141.

[21]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.