other capital besides plows, each and every plow would be a matter of considerable importance; it would be in general demand and would be used a great number of days in the year. Under these conditions you could say of that community, "One more plow, considerably more product; one less plow, considerably less product"; in short, the marginal productivity, in that particular community, of that form of capital called plows would be high. If, on the other hand, there were a great number and variety of plows in the community, other factors remaining the same,

E

A

B

B'

D D' D"

one less plow, comparatively little less product"; in short, the marginal productivity of plows would be low.

Applying the same method of reasoning to other forms of capital or to all forms of capital, we reach the same conclusions. An abundance of all forms of capital, land and labor remaining the same, would give a low marginal productivity to capital; whereas a scarcity of all forms of capital, land and labor remaining the same, would give a high productivity to all forms of capital. This would show itself also in the case of liquid, or uninvested, capital. Where all forms of capital are scarce, one hundred dollars invested in tools would add considerably to the productivity of the community; but where all forms of capital are very abundant, then one hundred dollars invested in additional tools would be of comparatively little value.

The preceding diagram will serve as an illustration of this law and also as a means of introducing the next question to be considered in the general problem of interest.

Let the amount of capital in the industrial community be measured along the horizontal line AC; let the productivity of capital be measured along the perpendicular line AE; and let the descending line EC represent the rate of decrease in the marginal productivity of capital. If the amount of capital were measured by AD, the marginal productivity would be measured by the line BD, or AF. If the amount of capital were measured by AD', the marginal productivity would, other things remaining equal, be measured by the line B'D', or AF'; and when the amount of capital equaled AD", marginal productivity would equal B"D", or AF". From this it follows inevitably that if capital went on increasing to AC, the marginal productivity of capital would be destroyed altogether. That is to say, the supply of capital would have reached that limit where no more could be used to advantage, and some could be spared without loss.1

1T. N. Carver, The Distribution of Wealth, pp. 223-224. The Macmillan 'Company, New York.

CHAPTER XXXIX

THE COST OF CAPITAL AND ITS RELATION TO INTEREST

Why capital is scarce. Seeing that the marginal productivity of capital, or the advantageous use of its marginal increment, diminishes as the supply of capital increases relatively to other factors, it is quite important that we should be able to account for the supply of capital as well as for its demand. Its demand, as has already been suggested, is based upon its desirability in production or in consumption; that is, upon its productivity or the opportunity for its advantageous use. Unless, therefore, the supply were in some way limited, productive capital might become so abundant as to leave it with no marginal productivity at all. We found, when we were discussing the value of commodities, that the cost of producing them operated as a check on production and kept the supply within such limits as would give them a price approximately sufficient to pay the cost of production. Some factor must be found which limits the supply of capital as cost of production limits the supply of an ordinary commodity.

The irksomeness of waiting. There are two factors which are obviously at work: one is the mere cost of producing the capital goods; the other is the cost of waiting, or the disinclination which many individuals feel toward waiting. The cost of producing tools needs very little discussion. Unless the farmer's plow will return him, before it is worn out, enough to replace the price which he originally paid for it, he will of course have no motive for paying that price. If plows should become so numerous on a given farm that the farmer felt that he would probably never get back enough from a new plow, added to those already in use, to repay the price of that plow, it would

be foolish for him to buy it. If every farmer behaves in this way, certainly no more plows will be bought than can be used with that degree of advantage. If he has to pay fifty dollars for a new riding plow, and if he figures that in the course of its lifetime it will add only fifty dollars to his product over and above what he could produce with his existing equipment, then he would of course gain nothing from its purchase; he would merely get back the original purchase price. If the average farmer had no disinclination toward waiting it is probable that farmers would buy so many plows as to reduce the marginal productivity of plows to the level of the cost; that is, to the level of the purchase price.

But suppose that the plow which cost fifty dollars will return the farmer only five dollars a year and will last ten years; it then just replaces its original cost; the farmer will have got back at the end of ten years the money which he put into it, and no more. Meanwhile he has had to wait ten years. If he does not mind waiting,-if waiting is not in the slightest degree irksome to him, he will probably be willing to buy a plow under such circumstances, though there will be neither loss nor gain. If, however, he does not like to wait,-if he prefers present enjoyment to future enjoyment, then he will hold on to his fifty dollars in the first place rather than spend it for something which will return fifty dollars in ten years' time. Under these circumstances he will certainly not buy the plow unless he has so few plows as to give a higher marginal productivity than that which we have been discussing. If he has so few plows that the possession of an additional plow will in the course of ten years add one hundred dollars to his income, he will add fifty dollars to his wealth during the ten-year period,—that is to say, fifty dollars will go to replace the purchase price of the plow; the other fifty dollars is surplus. This and this alone is interest, and a rather high rate of interest; namely, 10 per cent per annum. But if every farmer is likewise disinclined to wait, the market for plows will be limited. Only as many will be purchased as will yield a return large enough to more

than pay the purchase price. In other words, farmers in general will get some interest on that which they invest in plows.

This may be illustrated by the following diagram.

E

Let us suppose, as in the former diagram, that the number of implements of a certain kind, say plows, is measured along the line AC, and their marginal productivity along the line AE. In this case, however, we mean their total marginal product during their average lifetime, or that amount which an average plow will add to the product of the community during its lifetime, over and above what could be produced without it. Todistinguish this from the marginal product per year we shall call it the total earnings of a plow. Letting the descending line represent the decline in the total earnings of each plow as the number of plows increases, the line DB, or

F

F

F

"

B

B'

B"

D

D'

AF, would represent the total earnings of each plow when their number was represented by the line AD. When their number is AD' the total earnings of each would be D'B', or AF'; and when the number is AD" the total earnings of each would be D"B", or AF". Let us further suppose that the cost of making plows is represented by the perpendicular distance of the various points on the ascending line GB' above the base line AC. If this cost were the only check on the production of plows there is no reason why they should not increase to the point D', where the total earnings of each plow would just pay the cost of making the most expensive plow of the total supply. They would sell at the uniform price of D'B', or AF', which would be their normal equilibrium price. The total earnings of a plow would then just cover the price which the buyer would have to give for it.1

Why the present value of a productive agent is less than the future value of all its products. Now as a matter of fact, people

1T. N. Carver, The Distribution of Wealth, pp. 226-227. The Macmillan Company, New York.