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5. Production: The Structure

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.