through savings institutions to entrepreneurs. This is the important exception, previously mentioned, to the statement that" the prices paid for consumers' shares in the social dividend constitute the fund which pays for the annual product." The truth is that as the flow of money income passes from entrepreneur to entrepreneur, a part only, although the larger part, is put into expenditures for gain. The residuum is used by entrepreneurs in paying for their own shares in the social dividend. In much the same way the money income received by those who furnish labor, land, or capital is only in part paid back to entrepreneurs in return for consumption goods, the residuum being put (through loans to entrepreneurs) into expenditures for gain. The Interest Rate. It will be seen, then, that as the flow of money income passes through the hands of entrepreneurs, laborers, capitalists, and landowners, it is divided into two streams, one of which goes to pay for the present goods that have been produced in the past, while the other goes to pay for the present expenses of forwarding the production of goods for future consumption. This division represents a kind of social balancing of possible present satisfactions over against the larger future satisfactions which the productive use of capital makes possible. On the one hand we have the entrepreneurs' estimates of how much specific amounts of capital funds are worth to them,estimates which involve judgments as to the amount of salable product dependent upon the use of these specific amounts of capital funds, the prices that can be got for such products, and the period of time that will elapse before they will be remunerated for such investments. On the other hand we have the judgments of those who supply capital funds as to the relative. importance of future and present satisfactions. The interest rate will normally be fixed, of course, at a point where the supply and demand of money funds for investment will be in equilibrium.1 1 Short-time fluctuations in the interest rate are dependent very largely on the condition of bank reserves. This relation has been explained in the chapters on money and banking In the long run, however, it is the "supply of waiting" that is the important thing. The process of production involves the expenditure of rent wages, and interest for returns of all possible degrees of futurity, and a consequent comparison and balancing of the productivity of investments for shorter and longer periods of time. That is, social estimates of productivity are estimates of the relative importance of the ultimate products, realizable at different periods of time in the future, that are dependent upon specific present expenditures in the form of rent, wages, or interest. Or, in other words, there is a continuous effort to make the most advantageous of all the various possible combinations of land, labor, and waiting. For just as rent, wages, and interest are the ultimate expenses of production, so the ultimate factors in production may be said to be land, labor, and waiting. The entrepreneur bases his demand for investment funds upon his estimate of the demand for his products, together with his estimate of the relative economy of the use of methods calling for greater or less degrees of "roundaboutness," involving different amounts of waiting on the part of himself and of others who supply him with investment funds. This means that the interest rate is itself one of the factors determining the demand for waiting. The higher the rate of interest, the greater will be the expense of using roundabout methods, involving much waiting. The supply of waiting varies with the interest rate. Other things being equal, the higher the interest rate, the larger will be the parts of money incomes that will be saved rather than spent immediately in the satisfaction of wants. It has sometimes been said that saving increases as wealth increases. If this is taken to mean that the larger the income of the individual, the larger, other things being equal, will be the amount he will save, the statement probably expresses a general truth. The larger the income, the less important are the immediate wants dependent for their satisfaction on a given amount of money. It does not follow that the proportion of the income that is saved is apt to be 1 By "social estimates" of productivity we mean only the net outcome of the individual estimates of all the different individual buyers and sellers, lenders and borrowers. any larger in the case of a large income than a small income. If, on the other hand, the statement is taken to refer to the increase of wealth in society at large, we have to take account of the fact that as wealth increases new wants develop, and the net effect on saving is apt to depend on the character of the new wants, whether they call for increased current expenditures or whether they involve the accumulation of considerable sums. Convenient opportunities for saving, such as those afforded by savings banks, insurance companies, and the supply of convenient forms of investment securities have (apart from the rate of interest they offer) an important effect upon the amount of saving. Gross Interest and Net Interest. Net interest is pure interest the amount actually necessary to recompense marginal waiting. Gross interest - the interest actually paid on loans - includes payments for other things. In the first place, actual interest often includes some payment for the supervision which the capitalist has to maintain over his investment. Even the man who "lives on his income" usually has to devote a certain amount of time to the investigation of the safety of different possible investments, to the collection of interest and principal and similar things. The net earnings of savings banks the difference between the interest they get on their investments and the interest they pay their depositors partly a payment for this element of supervision. are A second element in gross interest is the payment for the risk the lender undergoes of losing all or part of his expected return (including principal and interest). This does not mean, as some writers have said, that the interest rate contains an element of insurance, for insurance means the elimination of individual risk through the combination of risks. The fact is simply that, as every one knows, lenders will not take greater risks without the prospect of greater gains. There is some element of speculation in all loans but the very safest, and the extra income received on the more legitimate loans is profit rather than insurance. Usury Laws. Interest is one form of price in regard to which society still expresses some distrust of the operation of un hindered competitive forces. Only nine American states do not provide a legal maximum above which the interest rate cannot legally be fixed. Such laws are based on the justifiable assumption that the borrower is in many cases the weaker bargainer, pressed often by that necessity which "never drove a good bargain." In many places the laws are not enforced, but elsewhere they have an important effect on some kinds of loans, especially bank loans in the rural districts, farm mortgages and overdue book credits. It is to be feared, however, that their result is often not so much to lower the rate of interest as to cut off many loans which lenders would not be justified in making except at high rates of interest. In the case of many loans on fairly good security, however, usury laws have probably operated to the advantage of the borrowers. QUESTIONS 1. Could a socialist state dispense with interest? with waiting? 2. How has the rate of interest been affected by the opening up of new and fertile lands? 3. Use supply and demand curves to illustrate the determination of the rate of interest. 4. Is a rented house capital or a consumption good? 5. Analyze the effect of an increase of expenditures for present goods upon present and future social dividends. 6. If money wages could be suddenly increased by 10 per cent would there be a corresponding increase in real wages? 7. Are the roulette tables at Monte Carlo capital? Is a burglar's jimmy capital? Is a battleship capital? REFERENCES BÖHM-BAWERK, E. VON. Capital and Interest; Positive Theory of Capital, Books v-vii. CARVER, T. N. The Distribution of Wealth, Chap. vi. CASSELL, G. The Nature and Necessity of Interest. DAVENPORT, H. J. Economics of Enterprise, Chaps. xviii-xxi. FISHER, IRVING. GONNER, E. C. K. Capital and Income; The Rate of Interest. Interest and Saving. MARSHALL, ALFRED. Principles of Economics, 6th ed., Vol. i, Book ii, Chap. iv; Book iv, Chap. vii; Book vi, Chap. vi. TAUSSIG, F. W. Principles of Economics, Vol. ii, Chaps. xxxviii-xl. CHAPTER XXV PROFITS THE difference between the total money income which an entrepreneur receives and his expenses of production constitutes his profits. Profits, then, are a surplus over and above the expenses of production. There are two ways of measuring profits: first, with reference to some unit of time, such as a year; and, second, with reference to particular units of product. Thus, when a manufacturer speaks of his profits during a year, he has in mind the difference between his total expenditures and total receipts for that year. But when he speaks of his profits on a particular sale, he has in mind the difference between the expense of producing and selling the particular goods sold and the prices received for them. The two ways of measuring profits are not alike, because a large part of the expenses incurred by an entrepreneur in any given year may be payments for work done in connection with the production of goods that will not be marketed until some time later. In the long run, however, the amount of annual profits will be determined by the profits on particular transactions or on particular products, so that for present purposes it is not necessary to press the distinction any farther. It is sometimes more convenient to use the word "profits" in one sense, and sometimes in the other sense. Profits, being a surplus, do not constitute a homogeneous income determined by any one principle or set of principles. They are the resultant of all the forces that tend to bring about. inequalities between the prices paid for things and the expenses of producing them. It is not possible in a brief analysis even to attempt to break up this mixed form of income into all of |