9. Pricing and the Theory of Bargaining
We have seen that for all goods, total receipts to sellers will tend to equal total payments
to factors, and this equality will be established in the evenly rotating economy. In the ERE,
interest income will be earned at the same uniform rate by capitalists throughout the
The Remainder of Income from Production and Sale to Consumers will be earned by the owners of the original factors, land and labor.
Our next task will be to analyze the determination of the prices of factor services and the determination of the interest rate as they tend to be approached in the economy and would be reached in the ERE.
Until now discussion has centered on the capital good structure, treated as if it were in one composite state of production.
Clearly there are numerous stages, but we have seen that earnings in production ultimately resolve themselves,
and certainly do so in the ERE, into the earnings of the original factors, land and labor.
Later on, we shall expand the analysis to include the case of many stages in the production
process, and we shall defend this type of temporal analysis of production against the
very fashionable current view that production is timeless under modern conditions, and that
the original factor analysis might have been useful for the primitive era, but not for
a modern economy.
As a corollary to this, we shall develop further an analysis of the nature of capital and time
in the production process.
What will be the process of pricing productive factors in a world of purely specific factors?
We have been assuming that only services and not whole goods can be acquired.
In the case of labor, this is true because of the nature of the free society.
In the case of land and capital goods, we are assuming that the capitalist product owners
hire or rent rather than own any of the productive factors outright.
In our example, the 95 ounces went to all the factor owners jointly.
By what principles can we determine how the joint income is allocated to the various individual
factor services?
If all the factors are purely specific, we can resort to what is usually called the Theory
of Bargaining.
We are in a very analogous situation to the two-person barter of Chapter 2, for what we
have is not relatively determinate prices or proportions, but exchange ratios with wide
zones between the marginal pairs of prices.
The maximum price of one is widely separated from the minimum price of the other.
In the present case, we have, say, twelve labor and land factors, each of which is indispensable
to the production of the good.
None of the factors, furthermore, can be used anywhere else, in any other line of production.
The question for these factor owners to solve is the proportionate share of each in the
The Total Joint Income
Each factor owner's maximum goal is something slightly less than 100% of the income from
the consumers.
What the final decision will be cannot be indicated by praxeology.
There is, for all practical purposes, no theory of bargaining.
All that can be said is that since the owner of each factor wants to participate and earn
and some income, all will most likely arrive at some sort of voluntary contractual arrangement.
This will be a formal type of partnership agreement if the factors jointly own the product,
or it will be the implicit result if a pure capitalist purchases the services of the factors.
Economists have always been very unhappy about bargaining situations of this kind, since
Economic Analysis is stopped from saying anything more of note.
We must not pursue the temptation, however, to condemn such situations as in some way
exploitative or bad, and thereby convert barrenness for economic analysis into tragedy for the
economy.
Whatever agreement is arrived at by the various individuals will be beneficial to every one
of them.
Otherwise, he would not have so agreed.
It is generally assumed that in the jockeying for proportionate shares, labor factors have
less bargaining power than land factors.
The only meaning that can be seen in the term bargaining power here is that some factor
owners might have minimum reservation prices for their factors, below which they would
not be entered in production.
In that case, these factors would at least have to receive the minimum, while factors
with no minimum, with no reservation price, would work even at an income of only slightly
more than zero.
Now it should be evident that the owner of every labor factor has some minimum selling
price, a price below which he will not work.
In our case, where we are assuming, as we shall see quite unrealistically, that every
factor is specific, it is true that no laborer would be able to earn a return in any other
type of work.
But he could always enjoy leisure, and this sets a minimum supply price for labor service.
On the other hand, the use of land sacrifices no leisure, except in rare cases where the
The owner enjoys a valuable aesthetic pleasure from contemplating a stretch of his own land
not in use.
There is no revenue that the land can bring him except a monetary return in production.
Therefore, land has no reservation price, and the land owner would have to accept a
return of almost zero, rather than allow his land to be idle.
The bargaining power of the owner of labor, therefore, is almost always superior to that
of the owner of land.
In the real world, labor, as will be seen, is uniquely the non-specific factor, so that
the theory of bargaining could never apply to labor incomes.
Contrast the discussion in most textbooks, where bargaining occupies an important place
This is an explanation of market pricing only in the discussion of labor incomes.
Thus, when two or more factors are specific to a given line of production, there is nothing
that economic analysis can say further about the allocation of the joint income from their
product.
It is a matter of voluntary bargaining between them.
Pricing and indeterminate pricing also take place even between two or more nonspecific
factors in the rare case where the proportions in which these factors must be used are identical
in each employment.
In such cases also there is no determinate pricing for any of the factors separately
and the result must be settled by mutual bargaining.
Suppose for example that a certain machine containing two necessary parts can be used
in several fields of production.
The two parts, however, must always be combined in use in a certain fixed proportion.
Suppose that two or more individuals owned these two parts.
That is, two different individuals produce the different parts by their labor and land.
The combined machine will be sold to or used in that line of production where it will yield
the highest monetary income, but the price that will be established for that machine
will necessarily be a cumulative price, so far as the two factors, the two parts, are
concerned.
The price of each part and the allocation of the income to the two owners must be decided
by a Process of Bargaining.
Economics cannot here determine separate prices.
This is true because the proportions between the two are always the same, even though the
combined product can be used in several different ways.
Not only is bargaining theory rarely applicable in the real world, but zones of indeterminacy
The greater the number and variety of goods available, and the greater the number of people with differing valuations, the more negligible will zones of indeterminacy become.
At this point we may introduce another rare explicitly empirical element into our discussion,
that on this earth, labor has been a far scarcer factor than land.
As in the case of Crusoe, so in the case of a modern economy, men have been able to choose
which land to use in various occupations and which to leave idle, and have found themselves
As with idle, no-rent land, that is, land yielding no income, of course, as an economy
advances and population and utilization of resources grow, there is a tendency for this
Superfluity of Land to Diminish, Barring Discoveries of New Fertile Lands.