Price and the Margin of Production

William H. Pitt

[Reprinted from Progress, November, 1972]

An adequate appreciation of the economic fundamentals seems impossible unless the various relationships formed at what, in economic language, is termed the margin of production are first apprehended. One such relationship is that of price.

At the margin of production, any slight increase or decrease in costs, in demand, or in supply from elsewhere, will cause an almost immediate alteration in output.

There at the margin, no one has special advantage, relative to the article in question, in those economies of time and effort that are available to producers at locations where the bulk of production occurs. The price received for the article therefore becomes either the wage of the producer or interest on the capital which he employs. In economic terms no part of the gross return goes as rent.

The Last Little Fraction

Only the smallest and last little fraction of total production can occur at the marginal location, for this, so to speak, occupies no more ground than does the fence-line around a paddock. The great bulk of production obviously takes place at locations where superior advantages in the economising of time and effort are, through the presence of the community and its specialties, open to be availed of - the area, so to speak, that is enclosed within the fence.

These economies in time and effort bring lowered costs to those who operate on the locations of superior advantage, but not to those whose locations proffer no such superiority. They, then reflect, not in the. wages of the operator, nor in the interest that he receives if, as he always will, he employs capital, but in the rent which must be paid because of competition for the situation which he occupies.

The Pivot

The pivotal point for the comprehending of the relationship of "price" to "the economic margin" lies perhaps in seeing that the market accords an identical price to an article, regardless of whether the location whereat it was produced was a place where, due to the advantages of a central position within a great civilization, its immediate cost of production was relatively low, or one where, near the verge of that civilization, it was produced with much great effort.

It is on the "margin" that the rate of wages hinges. There, where there is no locational advantage, there is likewise no economic rent. Whatever is received for an article produced there is clearly wages, or wages and interest. It cannot be rent. No part of it can be rent.

The Slave May Live Better

Thus "the margin" establishes the level of wages - the basic wage - to be got by a person working for himself on the best location open to him without the payment of rent. It conditions the choice that faces him if either he or an employer decides that he should work as a free man. He may well earn more than this if he surrenders his freedom and work under contract for an employer. But if he wishes to be properly independent, the return he must accept will be that which he can obtain if he pursues his profession at a spot where, for that profession, there is such a complete lack of locational advantage that no part of the price received for his goods is paid out for rent and where the slightest increase in costs or diminution in demand will put him out of business.

When affected by the same causes, a neighbour who operates on a slightly more advantageous site would likewise cease to pay rent but would nevertheless remain in production.

The Monetary Figure

The price paid for a commodity is therefore a monetary figure representative of the exertion that would have to be put forth to produce it at the most advantageous location obtainable without the payment of rent.

When, as is the case with the vast bulk of any commodity, production occurs at locations where superior advantages are available for the economising of time and effort, the price received contains an element that is representative of the exertion which at such locations is saved to the producers.. The economising of effort that which each and every transaction is conferred - and is conferred on each party of the transaction - thus becomes monetarised through price and appears as the economic rent (an apt and commonsense term) that flows automatically to the holder of land title. It is in expectation of this monetary flow from economic rent that a cash rental value for land then builds up which, unless it is taken into the Treasury for public spending, gives rise in turn to land price, or, as it is known in Australian municipal circles, the Unimproved Capital Value of Land.

The Nexus

The "margin" is thus not only the point whereat the price level for commodities is established. It also is the nexus whereat the proportionality of rent, of wages, and of interest come into their mutual relationship, thus making economic theory into a coherent whole where the theorising merges easily with the practical matters of everyday experience.

The Flow Of Satisfactions

You ask about interest! Man is adept at economising his tune and effort. It is therefore natural for him to set aside something from the product of his past labours to aid in furthering his present or future efforts. However, he will not do so unless it will bring an increase in his total flow of satisfactions. In that increase of satisfactions, lies the origin of interest. As with rent and wages, "economic interest" is distributed through the price mechanism.

It is a subdivision of wages, in that it is a reward for individual effort. But it is different, a little, for it is a reward that comes when products do not pass immediately into consumption, but are used or applied as a tool or material for subsequent production, and result then in an increase in the sum total of satisfactions.

The Sharing

One sees that the increase in production made possible by the use of capital (the product of past exertion) is at the margin shared between the operator who there puts forth his exertion and the supplier of the capital who at an earlier time exerted himself similarly but chose for a period to defer his enjoyment of the reward. The share passing to the proprietor of the capital becomes known as "interest." The share passing to the operator is an addition to his wages and it the reward properly due to the additional skill and enterprise which the use of capital involves.

At locations "above the margin" the rewards for the supply of the capital and for the additional effort and responsibility exercised by the operator will both be greater than they would be at the extreme margin, and a decision by the operator there to use capital involves him in a decision to allocate part of the resultant increase as additional rental to the holder of land title. Competition from his fellows forces him to this, for were he not so to employ capital, or not to allocate part of the increase to the landholder, some of his fellow producers would offer to. He then neither could match the rent that they would proffer, nor enjoy the fraction by which the use of capital might increase his own net income.

Three Choices

Of course, while the economic rent that flows to the holders of land title remains in their hands as a source for their private enrichment, he who sets aside something from the product of his current labour in the hopes of increased satisfactions later on, has three alternatives from which to chose. He may use the saving directly to further his own future efforts. He may apply it in the purchase of land title so as then to become a receiver of a flow of economic rent. Or he may lend it to a fellow producer. But if he decides upon the latter course, he will naturally expect that the return which he will get will be commensurate with what might be got from investment in economic rent - and competition will ensure that he gets it.

But Still Spurious

Although the returns for lending are in this way connected with land rent, it is not possible to isolate the true interest return that a lender might expect were there nc such connection. But whatever this figure might be, it must in logic be a lower one than that which would exclude the element of land rent. It is therefore apparent that this element, although very real in a monetary sense, is a spurious one and must be treated as such in any serious study. But spurious or otherwise, the relationship to "the margin" i; undeniable.

Eliminating, therefore, in our minds the question as tc whether the payment of interest, spurious or otherwise might have upon price - for it can have none - we an brought back to the fact that the price paid for a commodity represents the average cost, in time and effort, o producing it at the most advantageous location obtainable without the payment of rent, i.e. at the margin.

The Final Appreciation

Out of production and out of the increase in it that the usage of capital makes possible, there is therefore some thing for wages, something for rent, and something for interest. The proportionality of each is determined at "the margin," and the conversion into substantive monetary figures is one function of the price mechanism, the pivot and nexus being, of course, that serf-same margin.

A comprehension of this is therefore fundamental to any full understanding of economics, or even to a reason able appreciation of the care with which the ordering o society seems to have been accomplished.