Principles of Economics with Applications to Practical Problems

<h2>CHAPTER 9</h2> <h3>THE LAW OF DIMINISHING RETURNS</h3> <h4>§ I. DEFINITION OF THE CONCEPT OF (ECONOMIC) DIMINISHING RETURNS</h4> <div class="sidenote">Economic agents contain uses to be obtained only with progressive difficulty</div> <p>1. <i>The phrase "diminishing returns of industrial agents" is the expression of the fact that there is an elastic limit to the utility any indirect good can afford within a given time.</i> Successive attempts to get additional services from a thing are usually in part successful, but each additional service is gained with more difficulty, or a smaller added service is gained for an equal expenditure of materials or effort. A book stands many hours untouched on the shelves of the library; but if, as often happens, two or more persons wish to use it at the same hour, time and energy are wasted. The book has a potential use during the twenty-four hours, but all this can be secured only at the cost of the greatest inconvenience. The greatest net uses, therefore, are seen to be to the first user and in the first hour, for these uses cost the least time and trouble. If the members of a family will take turns, one chair will serve for all of them; but if all are to be able to sit down together, a chair must be provided for each. Often it will happen that only one chair is in use, the other nine chairs being valued only for their potential uses. I knew two young men who owned a dress-coat in partnership, and as they had different evenings free from business all went well until both were invited to a reception which both were very eager to attend.</p> <p><span class="pagenum"><SPAN name="Page_62" id="Page_62">[Pg 62]</SPAN></span></p> <div class="sidenote">This is true of all classes of agents</div> <p>Illustrations of this principle may be drawn from every class of durable goods. The example generally given is that of a field used for agriculture. It was long ago seen that a larger crop could usually be obtained on the same area, only with greater effort or expenditure; but this fact has been thought to be peculiar to the use of land. The examples given above have been purposely chosen from very different fields, to show that the truth is a general one: a good that affords a given service can be made to increase that service, ordinarily, only on condition that men put forth greater effort, or sacrifice more goods.</p> <p>The decreased utility is most clearly seen in the diminished effect which other agents produce when used in connection with the thing. When several are trying to use the same book, and are wasting time trying to get it, we often say their study hours are less fruitful because of the poor library facilities. Again, we speak either of the diminished returns of the field, or of the labor applied to the field. Either the particular thing is said to show diminished returns or the other coöperating agents are said to show them.</p> <div class="sidenote">Decreasing technical effectiveness of material things</div> <p>2. <i>As the agents used in connection with a fixed amount of any other agent (for mechanical, chemical, physiological, psychological, and other purposes) increase, their objective effectiveness after a given point decreases.</i> Objective or technical effectiveness means effectiveness independent of the thought or estimate of men. It is not the effectiveness to produce a feeling in men, but to produce results on the material world. In a mechanism, if one part is increased without increasing the other parts, a point is reached where it does not add to the result. If in the building of a bridge the weight of the floor is increased beyond a certain point, the rest of the bridge being left unchanged, the bridge is weakened instead of strengthened. If the weight of the iron in the framework is increased beyond a certain point without strengthening the piers, the structure is weakened. If the pier is greatly enlarged, the bridge may not be weakened, but there is an utter waste of material and effort, and perhaps<span class="pagenum"><SPAN name="Page_63" id="Page_63">[Pg 63]</SPAN></span> the main purpose of the bridge is defeated by the damming up of the stream. A bicycle frame, like a chain, is no stronger than its weakest part. If the strength of all parts of the wheel and frame is in equal proportion to the strain they must bear, added weight to any single part weakens the whole machine. The development of the modern type of bicycle, by many experiments, is a good example of the adjustment of materials according to the principle of technical efficiency.</p> <p>A variation of the same principle is seen in chemical combinations. Exact proportions of materials must be used to get a certain result. Increase of one ingredient will not increase the desired product. Either the added part is rejected, does not enter at all into the compound, or it unites to form another and different product.</p> <p>That the same principle holds good of the psychological effects of things, we have already fully recognized in discussing wants and marginal utility. A given amount of a good will affect the senses in a pleasurable way, but an increase in the amount will not cause a proportional addition to pleasure of sight, sound, or smell. On the contrary, such an increase may defeat the object entirely. Here we are at the threshold of the economic problem, for we have touched on "feeling."</p> <div class="sidenote">Economic diminishing returns relate to value</div> <p>3. <i>The idea of economic diminishing returns arises when man recognizes these technical facts and their relation to gratification, in his use of a limited supply of indirect agents.</i> All economy begins with scarcity. The varying effects produced by different agents therefore require to be studied or the sum or direct goods of enjoyment will not be as great as is possible. Waste will take place. A bridge will have its maximum use with a minimum outlay when the parts are in a certain proportion. Beyond that point, the increase of any part may add something to the usefulness of the bridge, but the agents must be taken from some other and greater use.</p> <p><span class="pagenum"><SPAN name="Page_64" id="Page_64">[Pg 64]</SPAN></span></p> <p>The thought of economic diminishing returns always has reference to value. If a particular kind and amount of a certain material is used in varying combinations with other agents, the value of the added product will not always be in the same proportion to the value of the added agent. The bridge-builder must consider not only what the added material will add to strength, but what it will cost, and whether the result will justify this expense. So the economic problem of diminishing returns is more complicated than the mechanical one, for it contains not only the technical but other factors.</p> <div class="sidenote">The marginal utility in goods</div> <p>If the value of the product increases less rapidly than the cost of the agents successively added to secure it, a point must at length be reached where the value of the added agents and of the additional product just balance; this is called the point of marginal utility.</p> <p>If a certain value in labor, fertilizer, or material, be applied to an acre of land, it may be more than recovered in the value of the product. Further applications give a product increased not in equal proportion to the former yield, and so on till the value of the last-added agent just balances that of the added product. This is the best adjustment possible, and beyond this point there will be a deficit in value. Just where the equilibrium is found at any time is the margin of cultivation.</p> <p>The term "cultivation" is taken from agriculture but must be understood in the broader sense of utilization, as the principle is not confined to the case of land or agriculture, but applies as well to the use of furniture, books, clothing, horses, or any other indirect agents.</p> <div class="sidenote">Meaning of intensive margin of utilization</div> <div class="sidenote">The extensive margin of utilization</div> <p>4. <i>There are two margins, the intensive and the extensive.</i> The margin of utilization in the case of a single piece of wealth is called the intensive margin. Any form of indirect wealth, anything kept to use, may be considered as containing a series of uses. Using one thing more and more while uniting other things with it, is using it more intensively.</p> <p><span class="pagenum"><SPAN name="Page_65" id="Page_65">[Pg 65]</SPAN></span></p> <p>Getting more use out of the book by effort, out of the farm by applying more fertilizer, out of the house by putting more people into it, is intensive utilization. The earlier uses come easily, naturally; the later ones are gotten with increasing difficulty.</p> <p>When a number of agents are of different qualities, the point between the one last used and the next unused is the extensive margin of utilization. The best agents that are available are naturally used first, but as they are more intensively used there is increasing inconvenience. Then recourse must be made to the inferior agents, whose first uses, however, are greater than the later, intensive uses, of the better grades. When the step is made to the use of agents that were before unused because inferior, it is extending the margin of utilization. The intensive margin of use is in the particular thing; the extensive margin of use lies outside of this.</p> <div class="figcenter"> <ANTIMG src="images/i65.jpg" width-obs="500" height-obs="471" alt="" /> <span class="caption"><i>Extensive Grades of Uses</i></span></div> <p>The relation of the two margins may be shown in a simple diagram. Let the better grades of indirect agents be represented by longer rectangles, the upper parts of which represent the more accessible, more easily secured utilities. Each agent consists of many strata of uses. The best uses are grades a, b, and c, in M; but after M has been utilized intensively<span class="pagenum"><SPAN name="Page_66" id="Page_66">[Pg 66]</SPAN></span> down to d, N will begin to be utilized at its highest point. When utilization goes down to f, O comes into use, and so on. Therefore it will be seen that until the intensive margin takes in d, M is on the extreme margin of utilization, and N is just outside it; when the intensive margin falls to g and h, P is inside the extensive margin, and Q is just outside.</p> <div class="sidenote">Equilibrium of the two margins</div> <p>The marginal utility or effectiveness of added agents tends to be equal on the intensive and the extensive margins. This is simply a case of the substitution of goods in the use of indirect agents. If the value of the added product in the use of a particular good decreases, a point finally is reached where it is better to transfer the outlay to another agent, to change from intensive to extensive utilization, to go over to the use of another field or of another machine not so good. The effectiveness of the labor or capital that men have to apply is being compared constantly in the two cases, and to the extent that this comparison is perfect the effectiveness of the agents tends to be equal on the margin in the two applications.</p> <h4>§ II. OTHER MEANINGS OF THE PHRASE "DIMINISHING RETURNS"</h4> <div class="sidenote">Does not mean declining prosperity</div> <p>1. <i>The phrase diminishing returns is sometimes taken as meaning merely a decrease in prosperity.</i> Many ideas are connected with this phrase. It is not self-explanatory. It suggests various thoughts according to context and these have not failed to give rise to different uses. The student must be cautious if he is to think clearly about it. If population declines, or industry changes from one place to another, or from one kind of goods to another, it is sometimes said that returns are diminishing in the deserted district.</p> <div class="sidenote">Nor exhaustion of the soil</div> <p>2. <i>A more common misuse of the term is to apply it to the exhaustion of the soil.</i> If the soil of a district has been robbed of its fertile qualities and smaller crops are raised<span class="pagenum"><SPAN name="Page_67" id="Page_67">[Pg 67]</SPAN></span> than was the case fifty years before, it is said to be a case of of the increased difficulty in the extraction of natural stores in mining. The veins near the surface being mined first, later the galleries must be cut deeper and greater expense incurred to get the stores. But the conditions here are very different from those we have considered under diminishing returns. Mines are used not under the renting contract, but under the royalty contract, which permits and contemplates a progressive using up of the limited stores of natural resources.</p> <div class="sidenote">Fallacious contract between manufacture and agriculture</div> <div class="sidenote">All industries if limited as to one factor, as area, show diminishing returns</div> <p>3. <i>Manufactures are often said to show increasing returns in contrast with agriculture as an industry of decreasing returns.</i> There is here an inconsistent shifting of thought. Agriculture is thought of as limited to a certain area of ground, whereon evidently diminishing returns will take place. But the fixed limit of ground-space is not thought of in connection with manufactures. Taking the same view of manufactures, commerce, education, etc., that is, assuming each industry to be confined to limited area of ground, each is seen to be subject to diminishing returns. Some ground-space is one of the essentials to carry on any business. If the attempt is made to accumulate a large library in one small room, a point is reached where much energy is wasted in trying to find the books. In a university the psychical product, education, may be limited by the need of space. The school-room, laboratory, or college class-room could be used at midnight, it is true, but not conveniently; and as students increase, buildings must be added. The same is true of any industry. We cannot conveniently increase the business of a lumber-yard without a larger yard-space, or of a factory without a larger floor-space. But the added space may be gotten by spreading horizontally or piling up perpendicularly. A ten-story building on an acre lot represents ten acres of floor-space. Putting up higher buildings is an expansion in area by the more intensive utilization of the land. Devices like elevators, and more compact appliances,<span class="pagenum"><SPAN name="Page_68" id="Page_68">[Pg 68]</SPAN></span> make possible an increasing business in manufacture, trade, or commerce upon the same area of land. All industries, if looked at consistently from this standpoint, are subject to the same condition, though it is true this will make itself felt in varying degrees in different lines of industry. In agriculture some similar devices are possible by the use of greenhouses, but it is true that in it, on account of the need of sun, light, and air, the limits of space are more quickly felt, and are less elastic than in most other industries. The difference, however, is one of degree, and not of kind. Higher factories, larger stores, enable manufacturers to adapt themselves to the law as applied to the surface of land, but not to escape its operations. Neither the law of gravitation nor the law of diminishing returns is violated or broken when materials are lifted to build the upper stories. Both "laws" are at work, even when the building is rising from the ground. Men are merely adapting their conduct to the conditions imposed by gravitation and diminishing returns.</p> <div class="sidenote">Confused with the question of large production</div> <p>Manufactures usually are thought of as enlarging by increase of the amount of capital employed, without limitation as to the area covered. But even here a limit is reached in the amount of capital that can be employed at any one location because of the difficulty of widening the market. The question, however, is one of the advantages of large production with large capital, not of the increasing use of a limited area of land. If manufactures and agriculture are to be compared with reference to their economic nature, it is essential to clear thinking that both be looked at with reference to the same conditions, and from the same point of view.</p> <div class="sidenote">Technical confused with historical diminishing returns</div> <p>4. <i>Technical diminishing returns are often confused with historical diminishing returns.</i> The principle of technical diminishing returns is that at any given moment the uses obtainable from any indirect agent cannot be indefinitely increased without increasing difficulty. Historical diminishing returns occur when, in fact, human effort is less bountifully<span class="pagenum"><SPAN name="Page_69" id="Page_69">[Pg 69]</SPAN></span> rewarded in a later period than in an earlier one. If to-day a day's labor in agriculture produced less than fifty years ago, historical diminishing returns would have occurred. In fact, labor is more bountifully rewarded in agriculture than fifty years ago, yet it is true to-day that there are few fields or appliances which, if used more intensively with the prevailing prices of labor and material, would not show a diminishing return to the additional capital applied. Therefore, in the historical sense, increasing returns have prevailed, yet at every moment it has been necessary to apply resources under the guidance of the principle of diminishing returns.</p> <h4>§ III. DEVELOPMENT OF THE CONCEPT OF DIMINISHING RETURNS</h4> <div class="sidenote">Recognition of diminishing returns to land</div> <p>1. <i>The law of "diminishing returns" was first recognized and expressed with reference to the use of land in agriculture.</i> There are several evident reasons why this occurred. It is obvious to every farmer and gardener that he cannot indefinitely increase his crop, that two men cannot always produce twice as much as one man, and that in general the product does not always vary in proportion to the labor and materials applied. Moreover, the food supply is a fundamental factor in industry and in the welfare of states. The limit to the supply of food on a given area, cultivated by a given method, early appeared and became a serious practical problem.</p> <p>The circumstances in Europe in the eighteenth century drew attention to the subject. Population was increasing, and the pressure for food was strong. While all the forms of industry most common in cities were increasing, and the wealth of the cities was growing, poverty was increasing among the peasantry. Especially was this true in England during the Napoleonic wars, 1793-1815, owing to exceptional conditions. The food-supply from abroad was cut off, and<span class="pagenum"><SPAN name="Page_70" id="Page_70">[Pg 70]</SPAN></span> when the English farmers, tempted by the high prices, took poorer land into cultivation, and sought to get larger crops from their older fields, a great object-lesson was presented on the principle of diminishing returns in agriculture.</p> <div class="sidenote">This confused with historical diminishing returns</div> <p>2. <i>This truth of diminishing returns in agriculture was confused with the thought of historical diminishing returns.</i> Circumstances of the time led to the belief that because of lack of food misery must continue among the masses of men. It was thought inevitable that the population would continue to increase and food become more scarce. The idea of diminishing returns became thus a prophecy of what would happen, a social philosophy, that affected the thought of men on every practical social question.</p> <div class="sidenote">The principle applies to land in all of its uses</div> <p>3. <i>The application of the principle of diminishing returns was soon broadened to include land in other than agricultural uses.</i> This was a natural and inevitable extension of the thought. It was evident that an unlimited use could not be made of a limited area of land, in any industry whatever. There is no explanation of rent of business sites, residences, lots, wharves, waterfalls, etc., unless account is taken of diminishing returns. If it were possible to do an unlimited amount of business upon a limited area of land, it would never get more scarce and could never rise in value. The idea of diminishing returns came properly, therefore, to be applied to land in all its uses. It is true, however, that the relatively large areas needed in agriculture make the phenomenon of diminishing returns much more striking in it than in most other industries.</p> <div class="sidenote">And to all indirect agents</div> <p>4. "Diminishing returns" should be broadly applied to all wealth having indirect uses. The argument for this view may take both a negative and a positive form. Why should we say that the principle applies to land and not to cases of other industrial agents? Why in the case of a waterfall and not in the case of the water-wheel? Why in the case of the field and not in the case of the trees in the<span class="pagenum"><SPAN name="Page_71" id="Page_71">[Pg 71]</SPAN></span> field? Are they not all scarce and desirable goods yielding a limited supply of uses?</p> <p>Positively it can be argued that the concept of diminishing returns is indispensable to a reasonable explanation of the value of any indirect agents. Anything that could afford an infinite series of uses at once would be an infinite supply. If an infinite number of uses could be gotten out of one hammer in all places at once, it would pound all the nails in the world. One wagon, one acre of land, one ax, one book of each kind, would serve for all men, and duplicates would be valueless. But in the case of every material thing there is a limit of convenient and economic use.</p> <div class="sidenote">Diminishing returns related to diminishing gratification</div> <p>5. <i>Diminishing returns of indirect agents is a special case of the universal law of the diminishing utility of goods.</i> Diminishing returns have to do with indirect goods, while diminishing gratification has to do with direct or consumption goods. They are two species or aspects of the same general principle. If the supply of certain indirect agents is increased, thereby increasing consumption goods, the utility of the indirect agents per unit diminishes. In such a case a diminishing return is the reflection, back to the indirect good, of the diminishing utility of the direct goods it helps to secure. Any indirect agent, added to a fixed amount of other agents with which it is technically used, is credited with a diminished utility, just as an additional supply of enjoyable goods, coming to meet a fixed demand, falls in value.</p> <p>The concept of technical diminishing returns has reference to a limited period of time. Though a definite agent may have bound up in it a long series of uses, these cannot be secured at the moment. If a rent-bearer, such as a fruit-tree, were permanent, and men could wait through eternity for its yield, they would get an infinite yield of fruit. But in any finite period, there can be only a limited yield.</p> <p><span class="pagenum"><SPAN name="Page_72" id="Page_72">[Pg 72]</SPAN></span></p> <div class="sidenote">The basal law of economics</div> <p>The concept of diminishing returns is one aspect of the great economic law of proportionality, that is, it is one expression of the fundamental, axiomatic truth, that there is a best or proper adjustment of means and ends. It is, therefore, the central and essential thought in political economy. On it depend all important conclusions with reference to the value of indirect goods. Out of it grow the important economic theories of rent and capitalization.</p> <hr class="chap" /> <p><span class="pagenum"><SPAN name="Page_73" id="Page_73">[Pg 73]</SPAN></span></p> <div style="break-after:column;"></div><br />