This section is from the "Economics In Two Volumes: Volume I. Economic Principles" book, by Frank A. Fetter. Also available from Amazon: Economic
§ 1. Competitive prices and unequal costs of competition. § 2. Selling and cost-finding. § 3. Examples of joint costs. § 4. Main classes of costs. § 5. The problem of cost accounting. § 6. Homogeneous products with unequal costs. § 7. Principle of charging what the traffic will bear. § 8. How prices are limited under competition. § 9. Borderland of monopoly. § 10. Difficulty of departing from average costs in competition.
§ 1. Competitive prices and unequal costs of competition. The product of a business must be sold, and for this some special selling management and selling organization is required. In a mercantile business selling is the largest part of the activity, and to this end well-located stores, window displays, clerks, agents, expensive advertising, and delivery wagons are needed. The prime cost of the articles at wholesale, plus certain minor expenses, plus the selling cost, make up the whole cost of doing business. In all other kinds of business whether agricultural, manufacturing, transportation, etc., selling is an important task, which must be well done if all the other labors of management are not to be in vain. The products of a factory will not sell themselves, and the obtaining of a regular series of orders sufficient to use the equipment fully is one of the most essential conditions of a low unit cost of production.
The selling price must as a whole equal cost or there will be a loss. New factories are constantly arising with new and better adjustments and the processes are always changing. No two enterprises have exactly equal advantages of location for materials or markets, etc., or are managed with exactly equal ability. Hence there is always a pressure of competition on some managers who constantly complain that they must sell below the cost of production. Business men say that competition is destructive, and it certainly does destroy the less favorably situated enterprises. Each enterpriser's price is the highest he can get in the market for his product; it may far exceed his costs; it may fall below them, but only temporarily, for if sales continue to encroach on capital, the sheriff soon closes the doors. Successful competitors are constantly pressing upon the marginal enterpriser, fixing a price that leaves themselves a profit, but is below his cost. Even the most successful manager comes into contact with cost, and seems to be compelled by it. He reaches out for trade, and sells some (not all) goods at a price which leaves him little if any profit. He enlarges his factory and ships goods farther, paying the freight, which means a lower price at the factory. The expanding business, therefore, comes at length to the point where it can not go farther at the prevailing prices. Hence the business man's view of the costs is that they determine price. It is true in the sense that the supply of a particular product in any market is at last limited by cost to marginal producers or of marginal portions of supply. But it is not true of all the units of product that costs determine, or equal, market-price. There is a margin above costs to the successful enterpriser on a large portion of his output. The margin may be narrow or wide, according to the business. The margin is "profit," on the particular sale, and helps to determine the true profit remaining at the end of the year.
§2. Selling and cost-finding. Speaking generally, there is no upper limit to the selling price the seller would take, but he can never get an unlimited, and rarely what he deems a really liberal price. Buyers are striving to buy as low as they can. The seller must often decide whether to sell at an offered price or to refuse the offer. Success in getting orders requires under most circumstances that the cost of each article to the seller shall be pretty exactly determined, or at least a minimum fixed below which the selling agent must not go. The ascertaining of the cost of particular articles, which before a study of the facts appears so simple, is in a literal sense well nigh impossible. It is easiest where the whole undertaking is treated as one transaction, as the buying of a house, perhaps making some improvements in it, and selling it. There the total of first cost, plus costs of improvements, taxes, insurance, repairs, fixed charges, etc., subtracted from selling-price plus other receipts as rents, etc., give the balance as profit. Similarly it is easy to determine with sufficient practical accuracy the cost of the whole business in a year, which, subtracted from total receipts (and taking due account of the difference in inventory and appraisement of the plant at the beginning and end of the year), gives the profit. But the difficulty is in deciding how much of this total cost should be allotted to particular units of product, for most of the costs have been incurred for a number of different units which must be produced at once. The costs are joint, and not several. Some simple illustrations will make this clearer.
§ 3. Examples of joint costs. A woman at the death of her husband is left with an excellent, well-furnished house and a scanty income. For sentimental or family reasons, whatever they be, she is determined to keep the house in any case, tho it is larger than she needs. To lighten the burden of taxes, repairs, and family expenses, she wishes to let some rooms if she can at anything above cost. Now what is cost in that case? To her it would consist of, first, the price of the extra service that must be hired, of the extra washing, light, and heat, of the extra wear and tear on furniture, linen, etc., as compared with leaving the rooms empty, and secondly, enough additional to make it "worth while" for herself - either in merely psychic terms, trouble, or in this plus the worth of her time in doing something else that might pay better. She would not need to count a fair normal return on the original cost, or the present cost, of new rooms and furniture, for she has them and intends to keep them in any case. It is only the extra cost attributable to taking roomers that need be considered, and the minimum addition to her income need be no more than the meagerest pay at which she values her own services. This minimum price of bare cost, yielding nothing to the main investment, may be also the maximum she can get if there is little demand for rooms in the neighborhood. If, however, there is a brisk or growing demand for rooms of that kind, the price she can get may be higher in any degree, up to the point where more houses will be built, and rooms let at prices that include a full estimate of the cost of building, of new furniture, etc. The price at that point may be called a normal supply price, or normal cost price; but before there has been time to build new houses the price of room rent might go much above, as it had before been much below, this normal cost.
Another illustration of the same problem in a different set of conditions may be helpful. An autobus service was begun between a small city and a village a few miles away. A few months later the proprietor declared it did not pay the cost of running it, which he estimated to be $7.50 a day, including repairs, interest on the cost of the car, depreciation, etc. This was $1.871/2 for each of the four round trips, whereas on some trips the receipts were nothing at all. He admitted, however, that it would be a mistake to count the cost and receipts of each trip separately, and that the success of the whole enterprise depended on maintaining a regular, dependable service, even tho sometimes the car traveled empty. The light trips were helping to secure the traffic that paid on the heavy trips, on some of which, every week, receipts were as much as $5. Taking all the receipts of the service together, however, there was still a deficit of a few dollars a week on the average, which the owner had to make up out of the earnings of his garage. After the auto service was started it helped to advertise the garage, and many bicyclists and autoists along that line who had never come to the garage found it a very convenient place to send for repairing and for supplies. The increased profits of the garage about offset the loss on the bus service. Another new kind of business was developed, as the autobus in summer was often hired for parties to the shore at $15 to $20 a day, and at such times a smaller car could be sent on the regular trip. And there were some other incidental advantages that at length converted a tale of loss into a story of business success.