Books / Digital Text

5. Production: The Structure

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 account-ants.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.

  • 13. Cf. the excellent discussion of cost by G.F. Thirlby, “The Subjective Theory of Value and Accounting ‘Cost,’ “ Economica, February, 1946, pp. 33 f.; 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.