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Wednesday, August 22, 2012

What Are Costs?

The perpetual tension between means and wants (scarcity) at once explains the meaning and fixes the goal of our economic system founded on exchange and the division of labor (business principle). Since we possess only limited means of satisfying our unlimited desires, we are compelled, as we have seen, to make a rigorous selection from among many competing wants and to limit the satisfaction of any one such want in order to make the best use of the means at hand (economic principle). Some will say that this view of economic behavior is quite appropriate to the conduct of the housewife who must hold her expenditures within the limits of a fixed sum of money (use of income, economics of consumption), but that it does not apply either to individual economy insofar as it is economy of acquisition (procuring of income), nor to the national economy since, in these two cases, the means are not fixed but may be increased by production.
Further reflection shows, however, that production changes nothing with respect to the need for practicing economy in the use of means, but that it simply results in the transfer of the problem to a higher level (or levels). Why, for instance, do we not produce as much chocolate or paper as we can consume? Why is production stopped at a certain point—which in our business economy is determined by profitability—when there is still a large and unsatisfied need of paper and chocolate? Is this the result of a stupid organization of our economic system from which socialism will deliver us? Such questions do not merit serious reply, for it is clear that production is tied to “costs.” But “costs of production” mean simply that while the quantity of a given consumption good may be increased by production, we encounter a scarcity of certain ultimate factors of production whose quantity cannot be so increased. Ultimately, we are compelled to acknowledge the harsh facts that our capacity for work and our time are strictly limited; that the location and the fertility of the soil are immutable data of Nature; and that even tools and machinery cannot be increased in quantity according to our good pleasure. In using these ultimate factors of production for the production of one good, we thereby renounce the use of the same factors for the production of another good. When we draw a coverlet by one end, the other end does not become longer. We have, then, no other alternative but by means of choice and limitation to allocate the factors of production to the producing of the kinds and quantities of goods which will procure the maximum advantage from the available means.
It follows that the need to make the most economical use of a given supply of means is not the less urgent simply because we can increase this supply by production. The process of equating means and wants takes place in this case merely on a higher level. It is distinguished from the simple process of determining what use is to be made of a given supply of means in the same manner as the traveler’s estimation of the relative utilities of taking more and bigger bags on a journey is distinguished from the case of the soldier who must pack his sack with foreknowledge of exactly what articles he must get into it. In the case of the traveler, more trunks and suitcases are taken along only “at the cost” of other pleasures of the trip. Just so, the costs of production are nothing more, in the final analysis, than a faithful reflection of the utility that the factors of production would have furnished had they been otherwise employed—a utility which we renounce in favor of the one we have chosen. The costs of production, in sum, owe their existence and their amount to the competition of alternative uses for the factors of  production.4 They stand for utilities which escape us at some other point in the national economy.
This is a principle of such overriding importance that it is worth dwelling on it in some detail. Suppose, for example, that it is planned to build a bridge. What are the problems that must be faced here? The first order of business is, generally, for technicians and engineers to calculate the costs of building a bridge of a given type and quality. These costs are subsequently compared with the traffic needs of the projected bridge site on the one hand, and on the other, with the possibility of financing the bridge out of the public purse. That is to say, we take into account the urgency of other public needs as this urgency is reflected in the possibility or impossibility of diverting a part of current tax revenue to the construction of the bridge or of increasing taxes in general. Taxes, on their side, represent the personal utility which the taxpayers must renounce in transferring a part of their purchasing power to the state. Thus we see that the “costs” of building a bridge are simply an indication that for the land which must be preempted, for the workmen who must be hired, and for the steel which must be used (including all the resources required in the making of the steel), there are still other uses. And it is the intensity of the competition among these alternative uses which determines the costs, greater or less, of the aforementioned factors of production. The process of production then, analyzed to its foundations, clearly shows the alternative nature of costs. In fine, the construction of the bridge will be justified from an economic point of view if it can be shown that it will result in the best possible use being made of the given means with relation to the national economy.
Our example—the building of a bridge—makes clear the important difference between the economic and the technical (or engineering) point of view. The job of the economist is to decide, first, whether the bridge should be built at all; secondly, whether it should be built on one site rather than another. For the economist the total quantity of means is fixed; his task is to discover the best use that can be made of them. The job of the engineer, on the other hand, is to achieve a given end—in our example, the construction of a bridge of a given quality in a given location—with the least means (technical principle). Here, differently than in economics, the end is given, while the means must be found. The successful solution of the technical problems involved in building a bridge does not in the least imply that its construction is justified economically. Economic justification follows only after costs have been entered on the ledger; only, that is, after the proposed use of means is compared with alternative possible uses and a satisfactory balance established among them. For all of this, confusion of technical with economic problems remains a tenacious undergrowth in the economic thought of our time. Fallacies stemming from it are particularly rife in the field of foreign trade (which is a fertile breeding ground for error in any case).
It is almost an idée fixe of contemporary economic policy to see economic advantage for the nation in the exploitation of technical discoveries and inventions and to support the production of synthetic foods or raw materials, even though the synthetic product costs more than the imported natural product and requires special measures to make it “competitive.” Apparently, only a minority comprehends that the same reasoning which is used to defend the production of synthetics can be used to justify cotton growing in the Arctic Circle so long as the engineers can supply the necessary greenhouses and artificial heat. Although the manufacture of synthetic materials has registered some notable successes and shows promise, in some cases, of even greater success in the future, the role of costs in this field cannot be ignored. Every so often, the complaint is heard that the limitations set on production by costs are the result of our stupid “capitalist” system, a ball and chain which we ought to shake off once for all and thereby win both riches and freedom. Such naive assumptions would quickly wither, were it more energetically made known that the problem of costs is nothing other than the problem of deciding whether the productive forces of a country will be better employed in one direction than in another. Here, certainly, is the most elementary problem confronting any economy, whatever be its organization.

Economics of the Free Society

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