After our long excursion into the subject of labor and its reward, it may be well for us to pause a moment and place in the right connection what is to follow. It should be recalled that under the general subject of distribution, or the division of the social income among the factors that have worked to produce it, we have now discussed the subject of rent, the share received by the owners of land, and wages, the share received by labor. We come now in regular order to a discussion of the share apportioned to the owners of capital. Land and labor, in their broadest sense, are the only original elements in production. Of course, as has been explained, land includes not only building lots and farming land, but also mines and rivers and fisheries, and, in short, all natural and unproduced agencies of production other than labor. Capital, on the other hand, is not a primary or original factor, but a secondary or derived one.

Unlike land, capital is produced, but it is produced for the purpose of further production. In fact, we may define capital as the produced instruments of production.

How Interest is Determined. Interest is the return to capital. By what law is its amount determined ? This question has been under a constant fire of discussion, and still appears to many economists as one of the unsettled problems. The ancients in general denied that interest rested on any justifiable law. Aristotle thought it unjust, and Cicero classes it with murder. Throughout the Middle Ages it was condemned by the Church and prohibited by statute. One of the main reasons for this attitude is found in the fact that until recent centuries little capital was loaned for productive purposes. Loans were usually made for personal consumption and for the relief of the distressed. The lender could not have used the amount loaned productively, and the borrower did not desire the loan for productive uses. Despite public opinion and the law, however, the taking of interest continued customary wherever commerce was developed, and with the industrial awakening in the modern period of capitalism it was, of course, allowed as a necessity. Being allowed, it must needs be justified, and the explanations and justifications have been numerous and various. Earlier economists explained the laws of rent and wages, and then naively concluded that capital had what was left. The owner of capital was thus made the " residual claimant" in distribution. Others have thought that capital and land receive returns according to fixed laws, and that labor is the residual claimant. The truth seems to be that no one of the three is a residual claimant, but that each receives a return determined by fixed laws. What, then, shall we say is the fixed law by which interest is determined ? In answering this question, we shall try to make a statement of the case which shall reconcile conflicting theories, at the same time that we indicate briefly what these theories are.

Demand and Supply. In the first place, it is probable that all economists would agree that interest, which expresses the value of the use of capital, is determined, as is all value, by the relation between demand and supply. Where there is a strong demand for a limited supply of capital, the marginal utility of the capital will be high, and the capitalist can exact a large return in the form of interest. If the demand for capital be slight relatively to the supply, then the rate of interest will be low. Manifestly, however, this does not carry us far upon our way. We must go on to inquire what it is that determines the demand and supply.

The Productivity Theory. Investigation of the demand for capital brings us to one theory of interest which has been widely accepted,the "productivity theory." To the older economists, who regarded most economic questions from the standpoint of the business manager, it seemed sufficient to say that interest is paid because capital is productive, and that the amount of interest is determined by the degree of productiveness. From the side of demand we may agree that the productivity theory does give us an explanation of interest. When capital is very productive there will be a great demand for it. But while this explains in part why men will and can pay interest for the use of capital, it does not explain why they must do so.

The Abstinence Theory. To understand why interest must be paid, we must investigate the subject of the supply of capital, and this brings us to the so-called "abstinence theory." It has been said by some economists that interest is sufficiently explained when it is described as the wage or reward for abstinence. As we have seen, capital is the result of a special production made possible by saving. Saving or abstinence may not in any particular instance involve any great degree of suffering. Millionnaires who do not consume at once and finally all that they have, are not thereby made to suffer the pangs of hunger. It may be that they would have great difficulty in consuming any large part of their goods. But saving does mean, none the less, the consumption of less than one might consume. We cannot have capital if all men consume all the goods that they can obtain. It may help us to understand the relation between saving and interest if we will think of actual saving as being the result of varying degrees of self-denial. There are probably many persons who would rather put by part of their present goods, even if they could not thus obtain interest, or even if they had to pay a slight amount for the safe-keeping of their savings. If very little capital were required, therefore, the interest rate might fall to zero, since those who wished to save would be glad to lend their goods with a simple guarantee of repayment. But if capital is highly productive and in great demand, it will not be possible to secure the desired capital from the savings of those whose abstinence represents no sacrifice. It may be that when more capital is demanded, an increase which will bring the productiveness of the capital and the abstinence necessary to its formation into equilibrium, may be effected at a rate of one per cent. Suppose the productiveness of the capital to be still further increased. Then those who wish to engage in productive enterprises will be able to pay a higher rate and will increase the demand for capital. But, other things being equal, those who would just save the needed amount of capital at one per cent must be paid a higher price if they are to undergo the added sacrifice necessary to the accumulation of more capital. This explanation should make it clear that on the side of supply it is to the estimate of the marginal investorthe investor, or abstainer, who is just tempted to save the marginal investment, by the given rate of interestthat the rate corresponds. It is equally evident that all the savings that would be made for nothing, or that would be made at a lower rate, while they affect the rate very closely, do not directly determine it. We may say in conclusion of this matter, then, that interest is fixed on the side of the supply of capital at a point which just repays the sacrifice involved in the marginal investment. As has been said, this rate, thus fixed, also equalizes the sacrifice of the marginal investor with the productivity of the marginal capital in use.