THE FIRST set of complications arises when allowance is made for the fact that in the modern commercial world the goods which he sells have no direct utility to the seller: they are “worth” to him merely what they have cost. His willing· ness to sell is a function, not of their utility to him (as in our corn and cloth example), but of their cost. An analysis of cost is therefore required. Here it would seem that economists had returned to the issue which principally exercised their classical forebears. The cost of a finished commodity consists of the price paid to the factors of production required to produce it. The problem becomes one of determining the value of the factors of production, land, labour and capital. Much confusion indeed has been caused by the habit of economists of labelling this part of their enquiry “Distribution,” and imagining that here they were adequately answering the same questions as the Physiocrats and Ricardo were doing. Actually the issue was, in large part, a different one. The classical question was mainly one of the share (of the total produce) accruing to different social classes and the contrasting characteristics of these shares. The new question was simply one of the market price per unit of the constituent commodities which entered into the creation of finished commodities. The factors of production, whether they were treated as three in number or twenty, were simply these constituent commodities; and for the purpose of this enquiry they were differentiated among themselves by no more fundamental characteristics than those which marked the x’s and y’s of our cloth and com example. To enquire into their value was simply to add certain additional variables to the set of simultaneous equations, requiring the addition of a similar number of fresh equations to complete a solution. They were part of the conditions of simultaneous equilibrium of finished and intermediate (or instrumental) commodities.

The Austrians adopted a simple condition in order to solve this problem. They assumed the quantity of the agents of production to be independently determined. By “independent,” for this purpose, they meant that changes in the supply of them did not depend on the price of these agents or of commodities, or on any other of the variables directly involved in the problem. Hence the supply of land, labour and capital could be treated for any one problem as fixed: they could figure in the equations as “constants.” The problem had then a simple solution: the value of each factor could then be expressed simply as a function of the prices of the commodities which it produced. This is the famous “Theory of Marginal Productivity.” Given the supply of, say, labour, the supply of labour will tend to be distributed between various sorts of production, so that the value of an increment of product yielded by an increment of labour (its marginal productivity) in all uses is equal; and the value of this increment which the final or marginal unit of labour is responsible for adding to the total produce determines the value of this factor of production. There are, then, n additional unknowns in the problem (the price of the n factors of production) and n additional functional equations.

Walras, and later Cassel, introduced in addition the conception of the “technical coefficients.” The production of different commodities will require the factors of production to be combined in different proportions: corn production will require more land relatively to capital than will the production of cloth. The “technical coefficients” for commodity x can be expressed by a series representing the quantities of the different factors required to produce a unit of x. The weighted average for all commodities (x, y, z) will then give the “technical coefficients” for the economic system in general. Every change in technique will change these “technical coefficients” in particular industries and in industry in general – for instance a new invention which increases the proportion of mechanical power to human labour in some industry or group of industries; and these changes will affect both the prices of commodities and the relative prices of the factors of production.

Jevons, on the other hand, did not make this simplifying assumption concerning the supply of the factors of production, except in the case of land. The supply of labour, for instance, was likely to change with changes in wages, according as a higher wage gave a greater inducement to work harder and longer. The supply of labour, therefore, constituted an additional unknown quantity to determine. Here Jevons consistently applied the same Hedonist concept as he had applied to the problems of demand. As demand could be expressed as a function of “pleasure” or “utility,” so the supply of labour could be expressed as a function of the “pain,” or “disutility,” involved in work. Not the supply of labour itself, but the disutility-function of work, was for him the independent constant by which the problem was resolved. “Labour,” he wrote, “will be carried on until the increase of utility from any of the employments just balances the increase of pain. This amounts to saying that ... the increase of utility derived from the first employment of labour is equal in amount of feeling to... the increase of labour by which it is obtained."[1]

This method of handling the problem was extended by Marshall, and with him it became the basis for an attempt to redress the classical conception of “surplus,” and to effect a synthesis between the modern and the classical school. We have already noticed that it was never perfectly clear whether the early economists, when they referred to “real costs,” conceived of it in an objective or in a subjective sense. In the main, it seems to have had the significance for them of some objective quantity “used up,” e.g., corn or the expenditure of physical energy. But already with Smith and McCulloch there were signs of a shifting of the idea to a purely subjective content. With Senior the identification of “real cost” with “sacrifice” was explicit. Jevons’s “disutility” and Marshall’s “efforts and sacrifices” were in the direct line of descent from this; and with them the exclusively psychological content of the idea was made abundantly clear. “Sacrifice” was measured, not in any objective quantity, but by the pain or aversion aroused in the mind of the person responsible for this effort or abstinence. For Marshall the labour of the worker and the saving of the investor and the risk-taking of the entrepreneur (the “undertakers,” of the risks of a business) all involved such a “real cost.” To persuade the worker to work, the investor to save, the entrepreneur to be enterprising, a reward equivalent to the sacrifice – a utility to balance the disutility – was necessary; and this necessary reward, required to evoke various quantities of labour, capital and enterprise, could be represented as a supply-function or as a schedule of supply-prices. Marshall said: “The exertion of all the different kinds of labour that are directly or indirectly involved in making it, together with the abstinence, or rather the waitings, required for saving the capital used in making it: all these efforts and sacrifices together will be called the real cost of production of the commodity. The sum of money that has to be paid for these efforts and sacrifices will be called either its money cost of production or its expenses of production; they are the prices which have to be paid in order to call forth an adequate supply of the efforts and waitings that are required for making it: or, in other words, they are its supply-price."[2] The identification of price with “real cost,” be it noted, was only at the margin; and hence the reward of a factor (representing the marginal disutility involved in it) would tend to be in excess of the average disutility involved. This difference between the sacrifice and reward constituted various species of producers’ surplus – a surplus of utility over disutility – which was simply another facet of the so-called consumers’ surplus which a consumer enjoyed from the difference between the marginal utility and total utility – the difference between what he pays ·and what he gets.

Marshall and his school have sometimes been termed the neo-classicists, in contrast to the Austrians and certain of their American followers, such as J. B. Clark and T. N. Carver, who explicitly cut themselves adrift from the earlier Political Economy. The grounds for the label consist in his attempt to preserve the classical conceptions of real cost and of rent. Rent of land, in Marshall’s treatment, remained qualitatively distinct from the rewards of other factors of production, for the reason that the supply of land was fixed, independent of human action, and that no “real cost” – no “effort or sacrifice “ – was involved ·in the supply of it. It followed, as an important corollary, that economic rent could be taxed, or otherwise removed, without making the supply of land any the less; whereas to tax wages or interest, by reducing the reward below the necessary supply-price of working and saving, would cause a shrinkage of supply of these factors of production. Marshall was careful, however, to soften the rigidity of the Ricardian distinction. Rent of land appeared to him “not as a thing by itself but as a leading species of a large genus”: elements of “producers’ surplus” appeared in incomes earned by other factors of production; and, in particular, capital sunk in buildings and plant bore all the characteristics of land for the period of durability of such capital (for which reason he coined the term quasi-rent to designate a short period view of the return on capital that is immobilised in fixed forms).

In the treatment adopted by the Austrians, on the other hand, and still more clearly in the case of Cassel, the basis for any such distinction entirely disappear: all returns are equally “surpluses” or equally “necessary expenses.” The distinction becomes meaningless, since by hypothesis all the factors of production stand on the same footing. The supply of all of them is assumed to be given: no question of a functional relationship between the supply of them and their reward enters in. Explicitly such writers have declared that the only cost is the loss of the utilities which a factor could have produced if applied in a different use from that to which it is actually applied. Cost is simply the other “side of the shield” from utility: it simply consists of utilities of which one is deprived by adopting a certain course of action. The American economist Davenport has analysed all cost as “opportunity cost.” Cassel speaks of the “scarcity-principle” as underlying equally the return to all the factors of production; while in England Wicksteed devoted considerable space to enunciating his thesis that the Ricardian theory of rent was only a special case of the general Theory of Marginal Productivity, and that what could be argued concerning land was equally capable of being argued, on the same assumptions, concerning any of the other factors of production.


1. Theory of Political Economy, p. 185.

2.Principles of Economics (1890), p. 339·,/p>