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due rather to their usefulness in consumption. He who builds
a dwelling house, or hires someone else to build it, and then
rents it to an occupant, is virtually selling the flow of utilities
which the house furnishes to the occupant during a definite
period of time. These utilities are in the form of comfort,
convenience, luxury, and even style in some cases ; but the
problem of interest is much the same, in the last analysis,
whether the capital be productive or acquisitive.



THE SOURCE OF INTEREST 425

Capital itself, not its value, is productive. Those who
deny the productivity of capital generally have a special defi-
nition of capital. Instead of thinking of productive agents they
are usually thinking of a sum of value. They do not neces-
sarily mean money, but a fund of value which is embodied in
capital goods. Of course the value of capital goods does not
produce anything. The value of the horse does not cause him
to do good farm work ; it is the fact that he does good farm
work which causes him to have value. If, instead of think-
ing of the farmer's capital as horses, cows, and other equip-
ment, we think merely of the value which is embodied in
them, we may easily reach the conclusion that capital is not
productive ; but if, instead of thinking of the value which is
embodied in them, we think of the objects themselves, we can
hardly avoid the conclusion that they are the agents by which
production is increased.

In order to bring the law of interest under the general law
of value, let us recall the fact that things have value only when
they are wanted by someone. This is as true of capital as of
anything else. If we confine our attention to that portion of
capital which consists of producers' goods, without considering
the subject of consumers' goods which are used by their owners
for the getting of an income, it is safe to say that the use of
capital is desired only for the sake of what it will add to the
productive power of the user. He does not want it for his own
sake. If it added nothing to his productive power, he would
not want it and would not be willing to pay a price for the
privilege of using it. Even the owner desires to own capital
not because capital is itself capable of use later but because it
is capable of adding to his income. If it added nothing to his
income (that is, if, as the result of using it in his business, he
was merely able to get back the original cost, that is, the prin-
cipal), he would have no motive for owning it or using it. The
more it will add to the productivity of his business, the more
he will desire the use of it.



426 PRINCIPLES OF POLITICAL ECONOMY

Why capital is wanted. The productivity of capital, or the
advantage of having the use of it, is subject to the principle
of marginal productivity, as is the productivity of labor and
land. If you increase the number of instruments of a given
kind in any industrial establishment, leaving everything else in
the establishment the same as before, you may within limits
increase the total product of the establishment somewhat,
but you will not increase the product in proportion to the
increase in the number of instruments in question. If you in-
crease all the instruments in a given industrial establishment
without increasing the labor at the same time, each instrument
will be used a little less intensively, or it will be idle a greater
number of minutes per day, simply because of the scarcity of
labor. On the other hand, of course, if you diminish the num-
ber of instruments or the total equipment, leaving the amount
of labor the same, each instrument, or each unit of the equip-
ment, will have to be used more intensively.

The productivity of capital decreases, other things being
equal, as its quantity increases. Take a farm, for example.
With a given labor force, the greater the number and variety of
tools and implements, the less intensively each one is likely to
be used ; and the smaller the number, the more intensively each
is likely to be used. There are many farms on which it is found
that there are such a number and variety of tools and implements
that the farmer is really not getting any interest on a large part
of his investment. Some expensive tools are idle so much of
the year that they do not pay for themselves ; that is, the farmer
never gets back the original price which he paid, to say nothing
about getting interest on that price. On the other hand, there are
other farms so poorly equipped that every tool in the farmer's
equipment is used very intensively, and it would be money in
the farmer's pocket to invest in additional equipment. For
every dollar which he put into more and better tools, he would
get back not only the original cost price but something in
addition which could be called interest on the investment.



THE SOURCE OF INTEREST 427

That which is found to happen on farms is also found to hap-
pen in larger industrial establishments, factories, railroads, etc.

That which is true of an individual farm, shop, or other busi-
ness establishment is also true of the community as a whole.
If, for example, there are very few plows in a given community
where there is an abundance of land, many laborers, and much
other capital besides plows, each and every plow would be a
matter of considerable importance ; it would be in general de-
mand and would be used a great number of days in the year.
Under these conditions you could say of that community, " One
more plow, considerably more product ; one less plow, consider-
ably less product " ; in short, the marginal productivity, in that
particular community, of that form of capital called plows would
be high. If, on the other hand, there were a great number and
variety of plows in the community, other factors remaining the
same, each one would be a matter of much less importance ;
each one would be idle a greater number of days in the year.
Then you could say, " One more plow, comparatively little more
product; one less plow, comparatively little less product"; in
short, the marginal productivity of plows would be low.

Applying the same method of reasoning to other forms of
capital or to all forms of capital, we reach the same conclu-
sions. An abundance of all forms of capital, land and labor
remaining the same, would give a low marginal productivity to
capital ; whereas a scarcity of all forms of capital, land and labor
remaining the same, would give a high productivity to all forms
of capital. This would show itself in the case of liquid, or unin-
vested, capital. Where all forms of capital are scarce, one hun-
dred dollars invested in tools would add considerably to the
productivity of the community ; but where all forms of capital are
very abundant, then one hundred dollars invested in additional
tools would be of comparatively little value.

The following diagram will serve as an illustration of this
law and also as a means of introducing the next question to
be considered in the general problem of interest.



428 PRINCIPLES OF POLITICAL ECONOMY

Let the amount of capital in the industrial community be measured

along the horizontal line AC; let the productivity of capital be measured

along the perpendicular line AE; and let the descending line EC represent

the rate of decrease in the marginal productivity of capital. If the amount

_ of capital were measured

by AD, the marginal
productivity would be
measured by the line
BD, or AF. If the

B' amount of capital were

measured by AD', the
'** marginal productivity

"^^ would, other things re-

_, ^, maining equal, be meas-
ured by the line RH,

or AF' ; and when the amount of capital equaled AD", marginal pro-
ductivity would equal B" D" , or AF" . From this it follows inevitably
that if capital went on increasing to AC, the marginal productivity of
capital would be destroyed altogether. That is to say, the supply of capi-
tal would have reached that limit where no more could be used to advan-
tage, and some could be spared without loss. 1

1 T. N. Carver, The Distribution of Wealth, pp. 223-224. The Macmillan
Company, New York.



CHAPTER XXXVI

THE COST OF CAPITAL AND ITS PRICE

Why capital is scarce. Seeing that the productivity of capi-
tal, or its advantageous use, diminishes as the supply of capital
increases relatively to other factors, and increases as the sup-
ply of capital diminishes relatively to other factors, it is quite
important that we should be able to account for the supply of
capital as well as for its demand. Its demand, as has already
been suggested, is based upon its desirability in production,
that is, upon its productivity or the opportunity for its advan-
tageous use. Unless, therefore, the supply were in some way
limited, capital might become so abundant as to leave it with
no marginal productivity. We found, when we were discussing
the value of commodities, that the cost of producing them
operated as a check on production and kept the supply within
such limits as would give them a price approximately sufficient
to pay the cost of production. Some factor must be found
which will limit the supply of capital.

The irksomeness of waiting. There are two factors which
are obviously at work. One is the mere cost of producing the
capital goods ; the other is the cost of waiting, or the disincli-
nation which the average individual feels toward waiting. The
cost of producing tools needs very little discussion. Unless
the farmer's plow will return him, before it is worn out,
enough to replace the price which he originally paid for it,
he will of course have no motive for paying that price. If
plows should become so numerous on a given farm that the
farmer felt that he would probably never get back enough from
a new plow, added to those already in use, to repay the price
of that plow, it would be foolish for him to buy it. If every

429



430 PRINCIPLES OF POLITICAL ECONOMY

farmer behaves in this way, certainly no more plows will be
bought than can be used with that degree of advantage. If he
has to pay fifty dollars for a new riding plow, and if he figures
that in the course of its lifetime it will add only fifty dollars
to his product over and above what he could produce with his
existing equipment, then he would of course gain nothing from
its purchase ; he would merely get back the original purchase
price. If the average farmer had no disinclination toward wait-
ing, it is probable that farmers would buy so "many plows as
to reduce the marginal productivity of plows to the level of the
cost, that is, to the level of the purchase price.

But suppose that the plow which cost fifty dollars will return
the farmer only five dollars a year and will last ten years ; it
then just replaces its original cost ; the farmer will have got
back at the end of ten years the money which he put into it,
and no more. Meanwhile he has had to wait ten years. If
he did not mind waiting, if waiting were not in the slightest
degree irksome to him, he would probably be willing to buy
a plow under such circumstances, though there would be
neither loss nor gain. If, however, he does not like to wait,
if he prefers present enjoyment to future enjoyment, then he
would hold on to his fifty dollars in the first place rather than
spend it for something which will return fifty dollars in ten
years' time. Under these circumstances he will certainly not
buy the plow unless he has so few plows as to give a higher
marginal productivity than that which we have been discussing.
If he has so few plows that the possession of an additional
plow will in the course of ten years add one hundred dollars
to his income, he will add fifty dollars to his wealth during
the ten-year period, that is to say, fifty dollars will go to replace
the purchase price of the plow ; the other fifty dollars is surplus.
This and this alone is interest, and a rather high rate of inter-
est, namely, 10 per cent. But if every farmer is likewise disin-
clined to wait, the market for plows will be limited. Only as
many will be purchased as will yield a return large enough to



THE COST OF CAPITAL AND ITS PRICE 431

more than pay the purchase price. In other words, farmers in gen-
eral will get some interest on that which they invested in plows.

This may be illustrated by the following diagram.

Let us suppose, as in the former diagram, that the number of imple-
ments of a certain kind, say plows, is measured along the line AC, and
their marginal productivity along the line AE. In this case, however, we
mean their total marginal product during their average lifetime, or that
amount which an average plow will add to the product of the community
during its lifetime, over and above what could be produced without it. To
distinguish this from the marginal product per year, we shall call it the
total earnings of a plow.
Letting the descending
curve represent the de-
cline in the total earn-
ings of each plow as the
number of plows in-
creases, the line DB, or
AF, would represent the
total earnings of each
plow when their number
was represented by the
line AD* When their

number is AH, the total earnings of each would be HB', or AF' ; and
when the number is AH', the total earnings of each would be H'B",
or AF" . Let us further suppose that the cost of making plows is repre-
sented by the perpendicular distance of the various points on the ascend-
ing curve GB' above the base line AC. If this cost were the only check on
the production of plows, there is no reason why they should not increase
to the point H, where the total earnings of each plow would just pay
the cost of making the most expensive part of the total supply. They
would sell at the uniform price of D ' B ', or AF', which would be their
normal equilibrium price. The total earnings of a plow would then just
cover the price which the buyer would have to give for it. 1

Why the present value of a productive agent is less than
the future value of all its products. Now, as a matter of fact,
people do not like to wait. Waiting is to some quite as irksome



F

r

Q


^ B


B'


\




"""x^







^^^









D D' D'



1 T. N. Carver, The Distribution of Wealth, pp. 226-227. Tne Macmillan
Company, New York.



432 PRINCIPLES OF POLITICAL ECONOMY

as working. It is also quite as necessary to efficient production.
Anything, whether it be working, waiting, or risking, which
is necessary to efficient production, and which at the same
time is irksome, must be paid for. The fact that it is neces-
sary for production furnishes a sufficient motive for paying for
it ; the fact that it is irksome makes it necessary to pay for it,
because men will not otherwise perform this function. In
order that 'there may be an adequate supply of tools, which is
necessary for efficient production, there must be waiting. Labor
must be performed in the making of the tools, and then some-
body must wait until they have been used for a number of
years in order to get back from their use the equivalent of that
which was originally expended in making them. If the laborers
who make the tools are not themselves willing to wait, they
may sell them to someone else, who then undertakes to wait
for their products to mature. If both the laborers who make
the tools and the one who purchases them are disinclined to
wait, their market price will have to be something less than
the sum of their future earnings. The laborers, being disin-
clined to wait, will be willing to sell for a cash price somewhat
lower than the total sum of the future earnings, and the pur-
chaser will not be willing to pay a price which would equal
the sum total of the future earnings. In the price-making
process, therefore, the capital goods must necessarily sell for
less than the sum of the future earnings. The buyer who
holds them during their lifetime finds himself in possession of
a surplus, which is his compensation for waiting.

Take the case of a blacksmith who, by his own labor, makes a plow
out of materials which cost him five dollars. Let us suppose that he can in
a fortnight make a plow which will earn a total of thirty dollars during
its lifetime of ten years. Deducting the cost of materials, this leaves him
twenty-five as the net earnings of his fortnight's work ; but he must wait
for his wages, receiving them in installments over a period of ten years.
If he does not mind waiting, this will be no drawback, and he would just
as lief make a plow as work for the- same amount in cash or in present
consumable goods. Or, having made such a plow, he would not sell it



THE COST OF CAPITAL AND ITS PRICE 433

for less than thirty dollars, the total amount which it will be expected to
earn during its lifetime.

But if he does mind waiting, and would much prefer to receive his
wages at once, he would not make plows at all so long as he could earn
twenty-five dollars per fortnight in present consumable goods. Or, having
made a plow which will earn thirty dollars in the course of its lifetime,
he would be willing to sell it for less than that amount, which, counting out
the cost of the raw materials, would net him less than twenty-five dollars
for his work. If no blacksmith could be found willing either to wait ten
years for his wages or to accept less than twenty-five dollars for the amount
of work necessary to make a plow, no ploughs with such small earning
capacity would be made unless someone else could be found who did not
mind waiting and who would therefore be willing to pay thirty dollars for
a plow and then wait ten years to get his money back. But if no such
person could be found, the making of plows would stop until their growing
scarcity raised their marginal productivity and their total earnings somewhat
above thirty dollars. 1

Though it is not likely that anyone would be willing to
wait ten years to get his money back, he might be willing
to wait if he could get back not only the original sum of
money but a surplus besides. The farmer, for example,
might be willing to pay thirty dollars for a plow which would
in the course of ten years earn him fifty dollars. The twenty
dollars surplus would be interest. The problem, as it presents
itself to the farmer who is contemplating investing money in
a plow, is very much -the same as the problem which presents
itself to a lender who is contemplating lending money to some-
one else. As a rule he prefers to keep his money rather
than lend it, unless he can get a surplus by lending it. Every
form of investment involves the same problem. The investor
is compelled to give up something in the present that is,
either money or the opportunity to spend money for present
goods in order that he may have the means of securing the
money or goods at some time in the future. The disinclination
which is generally felt toward waiting is such that men will

1 T. N. Carver, The Distribution of Wealth, pp. 229-230. The Macmillan
Company, New York.



434 PRINCIPLES OF POLITICAL ECONOMY

not, as a rule, invest and wait unless there is a chance to get a
surplus. The surplus is then in a sense the reward for waiting.

It is not to be assumed that there is anything inherently
meritorious in waiting merely for the sake of waiting. The
only merit there is in the process is in the increased produc-
tion which comes through the use of effective tools and
equipment. Since, furthermore, one cannot provide one's self
with effective tools and equipment without waiting or inducing
somebody else to wait, we have a sufficient reason why waiting
should be paid for when it results in increased production.
If it does not normally result in increased production, there
is no reason for waiting and therefore no reason why it should
be paid for.

Not all waiting is irksome. While it is true that, as a general
rule, men are disinclined toward waiting (that is, they prefer
present to future goods), still there is a certain amount of
waiting which takes place normally without any great amount
of sacrifice, and which therefore does not need to be paid for.
There would be some saving even if no interest could be
secured on savings. In fact, it is probable that a considerable
amount of saving would take place even if men were com-
pelled to hire vaults or storage places in which to keep their
savings. In this case savings could be said to yield negative
interest rather than positive interest.

In so far as it is true that men estimate present consump-
tion higher than future consumption, it applies only to the
consumption of corresponding or similar increments of income.
A man with a large income may be said to derive less utility
from the last dollar of his income than from the others ; or,
to put it in another form, he can lose one dollar of his
income with comparatively little feeling of loss or sacrifice,
but if, with the same general scale of wants, his income were
much smaller, then the loss of a dollar would be more keenly
felt. If his income is very large, he may find it difficult to
spend it all on present consumption. In this case it may be



THE COST OF CAPITAL AND ITS PRICE 435

easier to save it than not to gave it. To invest a little of one's
large income, therefore, involves no cost or sacrifice whatsoever.

On the other hand, anyone who is gifted with a moderate
degree of foresight will look ahead and consider the possibil-
ities of future emergencies. He may therefore lay up for a
rainy day, for sickness, or for old age, even though there
is no possibility whatever of securing interest on his sav-
ings. If one who has a large present income foresees the
possibility that at some future time his income may be cut
off, he may reason somewhat as follows : "I can spare the
few unimportant luxuries which the last hundred dollars of
my income will buy, without any appreciable sacrifice. At
some future time this hundred dollars might supply my most
pressing needs, if I should find myself some day without
an income. Therefore it will be very much better if I save
this hundred dollars, and lay it up against that day, than
if I consume it now." Another person, with a smaller in-
come, would reason in the same way, though the sum which
he would lay up would be smaller. And a person with a
larger income would likewise reason in the same way, though
the sum which he would lay up would be larger. Taking the
whole community, especially if it contains a great many well-
to-do people, a considerable mass of wealth would be saved
for this reason alone. This kind of saving may be said, there-
fore, to involve no cost ; and yet those who save in this way
are able to secure interest on their savings, along with those
who save at considerable sacrifice.

Some capital accumulated without expectation of interest.
If those sums which are saved in this way without sacrifice
were sufficient to meet the demands of all communities for
capital, such a thing as interest would not exist ; that is to
say, if so much were saved in this way, and there were so few
opportunities for using capital as to reduce the marginal pro-
ductivity of capital to the minimum point, capital would practi-
cally be a drug on the market. If, however, the opportunities



436 PRINCIPLES OF POLITICAL ECONOMY

for the productive use of capital are so great that more capital
is demanded than can be saved without cost, then, in order
to induce further saving, a surplus must be paid for its use.

Interest a part of the general law of value and price.
The price which is paid for the use of capital comes under
the same law as the price which is paid for anything else.
In the chapter on Scarcity it was pointed out that some goods
are produced, under certain circumstances, practically without
cost. Trout, where the fishing is good, are caught for the
pleasure of the sport. If the number of trout that can be
caught for pleasure is sufficient to satiate the desire for trout,
then trout commands no price ; if this quantity is not sufficient
to satiate the desire, and consumers are demanding more, then
they must begin to pay a price to induce other fishermen to
undertake the work of providing an adequate supply. The
law here is the same as that which controls capital. Some
capital will be accumulated without cost. There is probably no
community in existence, however, in which enough capital to
supply all demands is provided in this way. It is therefore
necessary for all who need it to offer a price in order to in-
duce a larger volume of saving than would take place if no
interest were paid, that is, no price for the use of capital.

The cost of saving is like other forms of cost, ultimately a



Online LibraryThomas Nixon CarverPrinciples of political economy → online text (page 35 of 48)