WEBVTT NOTE 5.05. Cost 1 00:00:00.000 --> 00:00:06.160 5. Cost At this point, let us reintroduce the concept 2 00:00:06.160 --> 00:00:14.440 of cost into the analysis. We have seen that the cost, or marginal cost, of any decision 3 00:00:14.440 --> 00:00:22.080 is the next highest utility that must be foregone because of the decision, when a means, M, 4 00:00:22.080 --> 00:00:32.080 must be distributed among ends E1, E2 and E3, with E1 ranked highest on the individual's value scale. 5 00:00:32.080 --> 00:00:39.080 The individual attempts to allocate the means so as to attain his most highly valued ends, 6 00:00:39.080 --> 00:00:48.080 and to forgo those ranked lower, although he will attain as many of his ends as he can with the means available. 7 00:00:48.080 --> 00:00:58.080 If he allocates his means to E1 and E2 and must forgo E3, E3 is the marginal cost of 8 00:00:58.080 --> 00:00:59.620 his decision. 9 00:00:59.620 --> 00:01:08.420 If he errs in his decision and arrives at E3 instead of E2, then ex post, in retrospect, 10 00:01:08.420 --> 00:01:14.880 he is seen to have suffered a loss compared to the course he could have taken. 11 00:01:14.880 --> 00:01:20.680 What are the costs involved in the decisions made by the owners of the factors? 12 00:01:20.680 --> 00:01:27.280 In the first place, it must be stressed that these costs are subjective and cannot be precisely 13 00:01:27.280 --> 00:01:34.440 determined by outside observers or be gauged ex post by observing accountants. 14 00:01:34.440 --> 00:01:41.560 Secondly, it is clear that since such factors as land and the produced capital goods have 15 00:01:41.560 --> 00:01:49.660 only one use, namely the production of this product, by virtue of being purely specific. 16 00:01:49.660 --> 00:01:55.420 They involve no cost to their owner in being used in production. 17 00:01:55.420 --> 00:02:01.320 By the very terms of our problem, the only alternative for their owner would be to let 18 00:02:01.320 --> 00:02:05.580 the land lie unused, earning no return. 19 00:02:05.580 --> 00:02:11.420 The use of labor, however, does have a cost, in accordance with the value of the leisure 20 00:02:11.420 --> 00:02:35.340 Once the final product has been produced, the analysis of the previous chapter follows, 21 00:02:35.340 --> 00:02:41.340 And it becomes clear that in most cases the sale of the good at the market price, whatever 22 00:02:41.340 --> 00:02:49.460 the price may be, is costless, except for rare cases of direct consumption by the producer 23 00:02:49.460 --> 00:02:55.100 or in cases of anticipation of a price increase in the near future. 24 00:02:55.100 --> 00:03:01.740 This sale is costless from the proper point of view, the point of view of acting man at 25 00:03:01.740 --> 00:03:04.580 the relevant instant of action. 26 00:03:04.580 --> 00:03:09.940 The fact that he would not have engaged in the labor at all if he had known in advance 27 00:03:09.940 --> 00:03:16.540 of the present price might indicate a deplorable instance of poor judgment, but it does not 28 00:03:16.540 --> 00:03:19.240 affect the present situation. 29 00:03:19.240 --> 00:03:26.340 At present, with all the labor already exerted and the product finished, the original subjective 30 00:03:26.340 --> 00:03:33.100 cost has already been incurred and vanished with the original making of the decision. 31 00:03:33.100 --> 00:03:38.860 At present, there is no alternative to the sale of the good at the market price, and 32 00:03:38.860 --> 00:03:42.180 therefore, the sale is costless. 33 00:03:42.180 --> 00:03:46.140 As G.F. Thirlby says, cost is ephemeral. 34 00:03:46.140 --> 00:03:51.780 The cost involved in a particular decision loses its significance with the making of 35 00:03:51.780 --> 00:03:58.100 a decision, because the decision displaces the alternative course of action. 36 00:03:58.100 --> 00:04:06.580 Stanley Jevons writes, labor once spent has no influence on the future value of any article. 37 00:04:06.580 --> 00:04:09.340 It is gone and lost forever. 38 00:04:09.340 --> 00:04:16.860 In commerce, bygones are forever bygones, and we are always starting clear at each moment, 39 00:04:16.860 --> 00:04:22.300 judging the values of things with a view to future utility. 40 00:04:22.300 --> 00:04:28.100 Theory is essentially prospective, not retrospective. 41 00:04:28.100 --> 00:04:35.240 It is evident, therefore, that once the product has been made, cost has no influence on the 42 00:04:35.240 --> 00:04:37.620 price of the product. 43 00:04:37.620 --> 00:04:44.180 Past costs, being ephemeral, are irrelevant to present determination of prices. 44 00:04:44.180 --> 00:04:51.140 The agitation that often takes place over sales below cost is now placed in its proper 45 00:04:51.140 --> 00:04:59.580 perspective, it is obvious that in the relevant sense of cost, no such sales can take place. 46 00:04:59.580 --> 00:05:07.220 The sale of an already produced good is likely to be costless, and if it is not, and price 47 00:05:07.220 --> 00:05:15.380 is below its costs, then the seller will hold on to the good rather than make the sale. 48 00:05:15.380 --> 00:05:21.160 That costs do have an influence in production is not denied by anyone. 49 00:05:21.160 --> 00:05:27.520 However, the influence is not directly on the price, but on the amount that will be 50 00:05:27.520 --> 00:05:34.600 produced or, more specifically, on the degree to which factors will be used. 51 00:05:34.600 --> 00:05:40.160 We have seen in our example that land and capital goods will be used to the fullest 52 00:05:40.160 --> 00:05:47.840 extent practicable, since there is no return or benefit in allowing them to remain idle. 53 00:05:47.840 --> 00:05:53.560 There will undoubtedly be exceptions, such as cases where the owner obtains enjoyment 54 00:05:53.560 --> 00:06:00.480 from the land or capital good from its lying idle, such as the aesthetic enjoyment of using 55 00:06:00.480 --> 00:06:03.200 it as an uncultivated forest. 56 00:06:03.200 --> 00:06:10.640 These alternatives are then also costs when a decision is made on the use of the land. 57 00:06:10.640 --> 00:06:15.780 But man laboring bears the cost of leisure foregone. 58 00:06:15.780 --> 00:06:22.260 What he expects will be the monetary return from his labor is the deciding factor in his 59 00:06:22.260 --> 00:06:29.940 decision concerning how much or whether or not to employ his labor on the product. 60 00:06:29.940 --> 00:06:37.300 The monetary return is ranked on his subjective value scale, along with the costs of foregoing 61 00:06:37.300 --> 00:06:43.900 leisure, and his decision is made on the quantity of labor he will put forth in production. 62 00:06:43.900 --> 00:06:52.260 The height of costs on individual value scales, then, is one of the determinants of the quantity, 63 00:06:52.260 --> 00:06:55.260 the stock, that will be produced. 64 00:06:55.260 --> 00:07:01.980 This stock of course later plays a role in the determination of market price, since stock 65 00:07:01.980 --> 00:07:08.580 is evaluated by consumers according to the law of diminishing marginal utility. 66 00:07:08.580 --> 00:07:15.620 This however is a far cry from stating that cost either determines or is coordinate with 67 00:07:15.620 --> 00:07:19.100 utility in determining price. 68 00:07:19.100 --> 00:07:25.140 We may briefly summarize the law of price, which can be stated at this point only in 69 00:07:25.140 --> 00:07:34.140 in regard to specific factors and joint ownership, but which will be later seen as true for any arrangement of production. 70 00:07:34.140 --> 00:07:42.140 Individuals on their value scales evaluate a given stock of goods according to their utilities, 71 00:07:42.140 --> 00:07:45.140 setting the prices of consumers' goods. 72 00:07:45.140 --> 00:07:50.140 The stock is produced according to previous decisions by producers, 73 00:08:20.140 --> 00:08:27.540 that the determinants of price are only the subjective utilities of individuals in valuing 74 00:08:27.540 --> 00:08:30.700 given conditions and alternatives. 75 00:08:30.700 --> 00:08:38.460 There are no objective or real costs that determine or are coordinate in determining 76 00:08:38.460 --> 00:08:40.420 price. 77 00:08:40.420 --> 00:08:47.300 It is unfortunate that these truths, substantially set forth by the Austrian School of Economics, 78 00:08:47.300 --> 00:08:53.460 which included some Englishmen and Americans, close to three quarters of a century ago, 79 00:08:53.460 --> 00:08:59.560 should have been almost entirely obscured by the fashionable eclectic doctrine that 80 00:08:59.560 --> 00:09:08.460 real costs and utility are somehow coordinate in price determination, with cost being really 81 00:09:08.460 --> 00:09:11.500 more important in the long run. 82 00:09:11.500 --> 00:09:18.540 How often has Alfred Marshall's homely analogy of utility and cost being two blades of a 83 00:09:18.540 --> 00:09:22.980 scissors been invoked as a substitute for analysis? 84 00:09:22.980 --> 00:09:29.380 Amell Cowder has supplied an interesting interpretation of the reason for the failure of British thought 85 00:09:29.380 --> 00:09:34.580 to adopt the nascent subjective value approach in previous centuries. 86 00:09:34.580 --> 00:09:41.500 He attributes the emphasis on labor and real cost, as contrasted to subjective utility 87 00:09:41.500 --> 00:09:48.140 and happiness, to the Calvinist background of the British classicists, typified by Smith 88 00:09:48.140 --> 00:09:49.620 and Locke. 89 00:09:49.620 --> 00:09:55.100 Of particular interest here is his citation of the strongly evangelical background of 90 00:09:55.100 --> 00:09:56.700 Marshall. 91 00:09:56.700 --> 00:10:01.420 Implicit in his treatment is the view that the second major reason for the classicists' 92 00:10:01.420 --> 00:10:22.960 If we investigate the costs of laborers in production more closely, we see that what 93 00:10:22.960 --> 00:10:27.900 is involved is not simply a question of leisure foregone. 94 00:10:27.900 --> 00:10:33.160 There is another, though in this case intertwined element. 95 00:10:33.160 --> 00:10:41.300 Present goods are being foregone in exchange for an expectation of return in the future. 96 00:10:41.300 --> 00:10:48.220 Thus added to the leisure labor element, the workers in this case must wait for some time 97 00:10:48.220 --> 00:10:54.420 before earning the return, while they must give up their leisure in the present or in 98 00:10:54.420 --> 00:11:14.120 When the owners of the factors embark on a process of production, the yield of which 99 00:11:14.120 --> 00:11:20.920 will be necessarily realized in the future, they are giving up leisure and other consumer's 100 00:11:20.920 --> 00:11:26.960 These goods that they either could have enjoyed without working, or could have earned earlier 101 00:11:26.960 --> 00:11:30.320 from shorter processes of production. 102 00:11:30.320 --> 00:11:37.440 In order to invest their labor and land in a process of production then, they must restrict 103 00:11:37.440 --> 00:11:42.260 their present consumption to less than its possible maximum. 104 00:11:42.260 --> 00:11:48.680 This involves forgoing either immediate consumption, or the consumption made possible from shorter 105 00:11:48.680 --> 00:11:51.680 and the Future Processes of Production. 106 00:11:51.680 --> 00:11:57.680 Present consumption is given up in anticipation of future consumption. 107 00:11:57.680 --> 00:12:07.680 Since we have seen that the universal law of time preference holds that any given satisfaction will be preferred earlier than later, 108 00:12:07.680 --> 00:12:12.680 an equivalent satisfaction will be preferred as early as possible. 109 00:12:12.680 --> 00:12:18.980 Present consumption of a good will be given up only in anticipation of a greater future 110 00:12:18.980 --> 00:12:25.400 consumption, the degree of the premium being dependent on time preferences. 111 00:12:25.400 --> 00:12:30.320 This restriction of present consumption is saving. 112 00:12:30.320 --> 00:12:33.680 See the discussion in Chapter 1. 113 00:12:33.680 --> 00:12:40.140 In a world where products are all jointly owned by owners of factors, the original owners 114 00:12:40.140 --> 00:12:46.300 Owners of land and labor must do their own saving. There is no monetary expression to 115 00:12:46.300 --> 00:12:53.600 represent total saving even in a monetary economy. The owners of land and labor forgo 116 00:12:53.600 --> 00:13:01.300 a certain amount of present or earlier consumption and save in various amounts in order to invest 117 00:13:01.300 --> 00:13:08.260 their time and labor to produce the final product. Their income is finally earned, say, 118 00:13:08.260 --> 00:13:15.140 after one year when the good is sold to the consumers and the 100 ounces is received by 119 00:13:15.140 --> 00:13:21.940 the joint owners. It is impossible, however, for us to say what this saving or investment 120 00:13:21.940 --> 00:13:24.380 was in monetary terms.