In the following chapters the principle of distribution according to marginal productivity, as it affects the different factors, will be considered in detail. In this preliminary chapter we shall consider the principle in its most general outlines; and to make this consideration as clear as possible we shall make certain assumptions which will have the effects of removing some of the superimposed detail and of laying the principle itself open to plainer view.

To simplify our illustration as much as possible, let us assume a community with a definite supply of land and labor and capital and organizing skill. Let us assume further that all the acres of land are equally productive; that all the laborers are of like efficiency; that there is no difference in the productive capacities of different units of capital of equal amount; and that all employers are equally capable. Suppose, further, that there is keen competition among the possessors of the several factors. With these assumptions made it is clear that there is one best combination of land and labor and capital and management, and that combination is found when all of the factors are completely employed. Let us assume, then, that this proportion of employment of factors has been arrived at. The question now arises, how will the product be shared among the producers? And the answer is, each producer will receive his marginal product. For if it were not so, let us see what would happen.

Suppose that the laborers were not receiving their marginal product. This would mean that one of the laborers, any one of them, if he quit working for his employer, would cause a loss to his employer of an appreciable amount in addition to his wages. On the other hand, if this employee hired himself to some other employer, he would increase the output of that employer by an amount greater than the wages which he had been receiving. Since we have assumed perfect competition among enterprisers as well as among laborers, as long as any employer sees that he can take an employee away from some other employer and have him produce more than his wages he will try to hire him. On the other hand, when an employer sees some other employer hiring his laborers away from him he will realize that for every additional laborer taken away from him he suffers more than a proportionate loss. Thus, if he loses two laborers, he suffers more than twice as much loss as if he loses one laborer; if he loses four laborers, his loss is more than twice as much as if he loses only two laborers, and so on. While the loss of a single laborer might be a trifling matter to him, he cannot afford to have many laborers taken away from him, and therefore he enters into the competition to retain his laborers. But the only means by which he can retain them is to raise their wages. He can afford to bid his wages up to the point where each laborer gets his marginal product rather than to see any considerable number of them leave his employment.

On the other hand, the enterprisers who are trying to take his laborers away from him can afford to bid wages up to the point where the last laborer hired just adds to the total product the amount of his wages, but they cannot afford to bid wages up any higher than this for the reason that every man hired who is paid more than is added by his working presence represents a loss to the business. Clearly, then, the competition between enterprisers, both those who desire to take laborers away from other enterprisers and those who desire to retain their labor, will have the effect of giving to the laborer his marginal product.

The rent of land will be arrived at in a similar fashion. We have assumed that all of the acres are of equal productivity. If any enterpriser pays for the use of an acre of land appreciably less than the marginal product of the acre; that is, less than the difference between what his total product is when that acre is being used and what it is when that acre is not being used, he is making an appreciable profit out of it, and some competing enterpriser who is aware of this profit will attempt to secure a part of it for himself by securing this acre at the same or a slightly higher rental. If the first enterpriser loses not only this acre but other acres to other enterprisers, he suffers more than a proportionate loss, for the reason that a loss of two acres means more than twice as much to him as the loss of one acre, and the loss of four acres means more than twice as much as the loss of two acres, and so forth. In order, therefore, to avoid suffering this loss, he will compete to hold his proportionate share of the acres, and he can do this only by paying more rent. On the other hand, the other enterprisers who desire more acres will continue to compete for them up to the point where they see no gain in continuing further. This point will be reached when in the enterprise the loss in product sustained by subtracting just one acre from the business is equivalent to the rent of that acre. Competition then will tend to secure for each land owner the marginal product of a unit of his land.

Similarly, in the case of capital, if any capitalist is receiving for his capital appreciably less than the marginal product of a unit of it as interest, it will pay some enterpriser to borrow this capital at the same or a slightly higher rate of interest. And while the former borrower realizes that the loss of one unit of capital will make only a slight difference to him, he realizes also that if he loses the use of additional capital, he suffers an accelerated and cumulative loss. For the loss of two units of capital means more than twice as much to him as the loss of one unit, and a loss of four units means more than twice as much to him as the loss of two units, and so forth. He therefore will compete with other enterprisers to retain his capital and will offer a higher rate of interest for it up to the point where he would suffer loss by giving more.

On the other hand, the other enterprisers will compete for the capital and will increase the rate of interest up to the point where if they increase the rate of interest any more, the use of the capital will cost them more than it brings to them. In other words, it will represent a loss to them. This point is the point where the unit of capital just gets its marginal product as interest. But the employer who already has the use of the unit of capital and the other enterprisers who desire to take it away from him will therefore compete for the capital until they force its rate of remuneration, - that is, its interest, - up to the point where its owner gets its marginal product for it.

In a similar manner the enterpriser gets his marginal product. It is evident that the better the management is, the larger will be the total product. We have assumed that all of the enterprisers are equally efficient. If now any one enterpriser withdraws from production and, by hypothesis, no one takes his place because the supply of enterprisers is limited, the total product of industry will be lessened. The marginal product of land and of labor and of capital will be lowered and the landlord and the laborer and the capitalist will receive less interest and wages and rent. Any enterpriser, therefore, under our hypothesis, is able to make terms with capitalists and laborers and landlords which will insure to him a surplus equivalent to the difference between the total product when all enterprisers are producing, and the total product when all enterprisers except one are producing. A competition of laborers and landlords and capitalists, therefore, will tend to give each enterpriser his marginal product, because if any enterpriser threatens to withdraw from production because he cannot make agreements with landlords and laborers and capitalists which will secure to him his marginal product, other enterprisers will be enabled to lower the rates of rent and interest and wages, and capitalists and laborers and landlords will gladly come to this employer who is at the point of withdrawing and give to him the use of land and labor and capital at rates which will permit him to receive his marginal product.

In this illustration, by hypothesis, there is no fluctuation in the amounts of the various factors. This will tend to establish an equilibrium of economic forces and to standardize the incomes of enterprisers. Under these conditions there will be absent certain elements in the reward of enterprisers which are present under other conditions, as for instance where there are constant fluctuations in the supply of capital and labor, and where it becomes the task of the enterprisers to estimate the extent of the changes which must be made in the combination of the different factors. When the incomes of enterprisers have become standardized through the establishment of an equilibrium of economic forces, their incomes, which are determined according to the principle of marginal productivity, are more nearly allied to wages than to the profits which come as a recompense for risk undertaken. This standardized income of enterprisers may therefore be, and often is, spoken of as wages of management. It is classed by some economists as wages rather than as profits. Other elements of the enterpriser's income than wages of management will be considered in the next chapter.