Why capital is wanted. The productivity of capital, or the advantage of having the use of it, is subject to the principle of marginal productivity, as is the productivity of labor and land. If you increase the number of instruments of a given kind in any industrial establishment, leaving everything else in the establishment the same as before, you may within limits increase the total product of the establishment somewhat, but you will not increase the product in proportion to the increase in the number of instruments in question. If you increase all the instruments in a given industrial establishment without increasing the labor at the same time, each instrument will be used a little less intensively, or it will be idle a greater number of minutes per day, simply because of the scarcity of labor. On the other hand, of course, if you diminish the number of instruments or the total equipment, leaving the amount of labor the same, each instrument, or each unit of the equipment, will have to be used more intensively.

The productivity of capital decreases, other things being equal, as its quantity increases. Take a farm, for example. With a given labor force, the greater the number and variety of tools and implements, the less intensively each one is likely to be used; and the smaller the number, the more intensively each is likely to be used. There are many farms on which it is found that there are such a number and variety of tools and implements that the farmer is really not getting any interest on a large part of his investment. Some expensive tools are idle so much of the year that they do not pay for themselves; that is, the farmer never gets back the original price which he paid, to say nothing about getting interest on that price. On the other hand, there are other farms so poorly equipped that every tool in the farmer's equipment is used very intensively, and it would be money in the farmer's pocket to invest in additional equipment. For every dollar which he put into more and better tools, he would get back not only the original cost price but something in addition which could be called interest on the investment,

That which is found to happen on farms is also found to happen in larger industrial establishments, factories, railroads, etc. That which is true of an individual farm, shop, or other business establishment is also true of the community as a whole. If, for example, there are very few plows in a given community where there is an abundance of land, many laborers, and much 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, each one would be a matter of much less importance; each one would be idle a greater number of days in the year. Then you could say, "One more plow, comparatively little more product; 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 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 following 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

F

Α

D D' D"

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

1 T. N. Carver, The Distribution of Wealth, pp. 223-224. The Macmillan Company, New York.

CHAPTER XXXVI

THE COST OF CAPITAL AND ITS PRICE

Why capital is scarce. Seeing that the productivity of capital, or its advantageous use, diminishes as the supply of capital increases relatively to other factors, and increases as the supply of capital diminishes 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, that is, upon its productivity or the opportunity for its advantageous use. Unless, therefore, the supply were in some way limited, capital might become so abundant as to leave it with no marginal productivity. 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 will limit the supply of capital. )

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 the average individual feels 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 did not mind waiting, if waiting were not in the slightest degree irksome to him, he would probably be willing to buy a plow under such circumstances, though there would be neither loss nor gain. If, however, he does not like to wait, if he prefers present enjoyment to future enjoyment, — then he would 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. 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