Online Library of Liberty: Economics, vol. 1: Economic Principles

to be observed, the individual adjustment and the general adjustment. Each individual, it may be assumed, moves toward the occupation that (as conditions are, which he can not alter) offers him the best return (theory of wages), and uses his agents (theory of usance) so that they give the best return he knows how to obtain. If no new force is introduced and existing forces are permitted to work themselves out, a static equilibrium will result and will continue unchanged. The principle of proportionality would apply to all the combinations of factors in this equilibrium. At the prevailing prices and with the prevailing methods, so much labor of a certain kind should be used with so many agents of various kinds. If either more or less of any factor is used, the result is a product of less value for the costs and hence yielding a smaller profit (theory of profits). If a new method or a new proportion is found to be better, this is a new dynamic element. But if the theoretic, static equilibrium has been attained, there is no chance to increase the yield except when correcting a previous error by which the ideal adjustment was missed. The individual having found what seems the best adjustment has only to hold steadily to it.

Underlying each individual’s adjustment is the general adjustment of prices and yields. Under these conditions not only this workman but all like workmen can get such an amount of real wages; not only this bushel of wheat and bale of cotton bring the price, but all other like units do the same; not only this acre of land, but all other like acres of land will have equal values and uses. The individual in making his adjustment is simply trying to get into line with the general situation, to find his true place on the various levels of prices made possible by the totality of conditions.

§ 13. Adjustment to dynamic forces. In a dynamic situation the adjustment still has the two aspects. The individual workman, the passive capitalist, and the enterpriser are all endeavoring to attain to an ideal adjustment inherent in the new situation. We have already seen in many connections and in many examples how profits and losses multiply in dynamic conditions.9 Every dynamic force in industry unsettles an equilibrium, makes some factor more or less plentiful, technically efficient, and valuable. The new ideal adjustment must be made quickly and correctly. Sometimes using more of a factor than before yields a larger profit, sometimes using less may do so. The general adjustment that goes on in dynamic conditions is most important because it involves not merely the change of this or that personal fortune, but the raising or lowering of the real incomes for whole sections and classes of the population, and therefore alters the general economic welfare.

Note

Various meanings of diminishing returns. The chief other meanings given to the phrase law of diminishing returns, which must be deemed to be more or less confused and erroneous, will here be noted.

It is confused with the law of proportionality or with the law of enterpriser’s cost, especially as applied to the use of land in agriculture. The fact that a farmer can not profitably employ an unlimited amount of labor in any one year on a single acre is said to be due to the law of diminishing returns. A like application of the term is made in explaining the limitation in the use of land for other purposes, residence, etc. (see

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Online Library of Liberty: Economics, vol. 1: Economic Principles

above, the principle of proportionality, ch. 12). This application is still further extended to the use of all other kinds of agents. Later and exacter criticism (notably Edwin Cannan, in “Production and Distribution,” 1894) has discerned that more than one problem is involved (which he called technical and historical diminishing returns). In our view there are at least three distinct problems: (1) technical proportion, the best mechanical or physical combination; (2) profitable proportion, the enterpriser’s best combination of factors at existing prices; (3) diminishing returns, the social-economic problem of the relation of population to resources.

The converse phrase, law of increasing returns, is applied to the economy of large production, especially in the common contrast between manufacturing, said to be subject to the law of increasing returns, and farming, said to be subject to decreasing returns. There is error here at every point. The manufacturing enterprise as it grows is assumed to enlarge the area of land, as it is needed (problem of investment in large production), whereas the farm is taken as a fixed area (problem of proportionality). This appears to have been first clearly pointed out by J. R. Commons in his “Distribution of Wealth,” 1895.

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