Risk, uncertainty and profit

o^— 2

S3

'i_

10

PREFACE

This series of books owes its existence to the generosity of
Messrs. Hart, Schaffner & Marx, of Chicago, who have
shown a special interest in trying to draw the attention of
American youth to the study of economic and commercial
subjects. For this purpose they have delegated to the un-
dersigned committee the task of selecting or approving of
topics, making announcements, and awarding prizes an-
nually for those who wish to compete.

For the year ending June 1, 1917, there were offered:

In Class A, which included any American without re-
striction, a first prize of $1000, and a second prize of $500.

In Class B, which included any who were at the time
undergraduates of an American college, a first prize of $300,
and a second prize of $200.

Any essay submitted in Class B, if deemed of sufficient
merit, could receive a prize in Class A.

The present volume, submitted in Class A, was awarded
second prize in that class.

J. Laurence Laughlin, Chairman

University of Chicago
J. B. Clark

Columbia University
Henry C. Adams

University of Michigan
Edwin F. Gay

N.Y. Evening Post
Theodore E. Burton

New York City

447383

^

AUTHOR'S PREFACE

There is little that is fundamentally new in this book' It
represents an attempt to state the essential principles of
the conventional economic doctrine more accurately, and
to show their implications more clearly, than has previ-
ously been done. That is, its object is refinement, not re- ,
construction; it is a study in "pure theory." The motive
back of its presentation is twofold. In the first place,
the writer cherishes, in the face of the pragmatic, philistine
tendencies of the present age, especially characteristic of
the thought of our own country, the hope that careful,
rigorous thinking in the field of social problems does after
all have some significance for human weal and woe. In the
second place, he has a feeling that the "practicalism" of
the times is a passing phase, even to some extent a pose;
that there is a strong undercurrent of discontent with loose
and superficial thinking and a real desire, out of sheer in-
tellectual self-respect, to reach a clearer understanding of
the meaning of terms and dogmas which pass current as
representing ideas. For the first of these assumptions a few
words of elaboration or defense may be in place, in antici-
pation of the essay itself.

The "practical " justification for the study of general eco-
nomics is a belief in the possibility of improving the qual-
ity of human life through changes in the form of organiza-
tion of want-satisfying activity. More specifically, most
projects of social betterment involve the substitution of
some more consciously social or political form of control for
private property and individual freedom of contract. The
assumption underlying such studies as the present is that
changes of this character will offer greater prospect of pro-
ducing real improvement if they are carried out in the light

viii AUTHOR'S PREFACE

of a clear understanding of the nature and tendencies of
the system which it is proposed to modify or displace. The
essay, therefore, endeavors to isolate and define the essen-
tial characteristics of free enterprise as a system or method
of securing anddirectingcooperative effort in a social group.
rAs a necessary condition of success in this endeavor it is
[ assumed that the description and explanation of phe-
I nomena must be radically separated from all questions
\<$ defense or criticism of the system under examination.
By means of first showing what the system is, it is hoped
that advance may be made toward discovering what such
a system can, and what it cannot, accomplish. A closely
related aim is that of formulating the data of the problem of
economic organization, the unchangeable materials with
which, and conditions under which, any machinery of or-
ganization has to work. A sharp and clear conception of
these fundamentals is viewed as a necessary foundation for
answering the question as to what is reasonably to be ex-
pected of a method of organization, and hence of whether
the system as such is to be blamed for the failure to achieve
ideal results, of where if at all it is at fault, and the sort
of change or substitution which offers sufficient chance for
improvement to justify experimentation.
/ The net result of the inquiry is by no means a defense of
/ the existing order. On the contrary, it is probably to em-
phasize the inherent defects of free enterprise. But it must
be admitted that careful analysis also emphasizes the fun-
damental difficulties of the problem and the fatuousness
of over-sanguine expectations from mere changes in social
machinery. Only this foundation-laying is within the scope
of this study, or included within the province of economic
theory. The final verdict on questions of social policy
depends upon a similar study of other possible systems of
organization and a comparison of these with free enterprise
in relation to the tasks to be accomplished. This one "con-
clusion" may be hazarded, that no one mode of organiza-

AUTHOR'S PREFACE ix

tion is adequate or tolerable for all purposes in all fields.
In the ultimate society, no doubt, every conceivable type of
organization machinery will find its place, and the problem
takes the form of defining the tasks and spheres of social
endeavor for which each type is best adapted.

The particular technical contribution to the theory of
free enterprise which this essay purports to make is a fuller
and more careful examination of the role of the entrepreneur
or enterpriser, the recognized "central figure" of the sys-
tem, and of the forces which fix the remuneration of his
special function. The problem of profit was suggested to
the writer as a suitable topic for a doctoral dissertation
in the spring of 1914 by Dr. Alvin Johnson, then Professor
of Economics in Cornell University. The study was chiefly
worked out under the direction of Professor Allyn A. Young
after Dr. Johnson left Cornell. My debt to these two teach-
ers I can only gratefully acknowledge. Since the accept-
ance of the essay as a thesis at Cornell in June, 1916, and
its submission in the Hart, Schaffner & Marx competition
in 1917, it has been entirely rewritten under the editorial
supervision of Professor J. M. Clark, of the University of
Chicago. I have also profited much by discussions with
Professor C. O. Hardy, my colleague at the same institu-
tion, and by access to his unpublished "Readings on Risk
and Risk-Bearing." Professor Jacob Viner, of the Uni-
versity of Chicago, has kindly read the proof of the entire
work. My obligations to various economists through
their published work are very inadequately shown by
text and footnote references, but are too comprehensive
and indefinite to express in detail.

F. H. Knight

Iowa City, Iowa

January, 1921

I3L7S1 I*

CONTENTS

PART ONE

INTRODUCTORY

Chapter I. The Place of Profit and Uncertainty
in Economic Theory 3

The nature and necessity of a deductive science of economics —
Analogy of physical science — Necessity of emphasizing the
abstract character of hypotheses — Thought means analysis
and analysis abstraction — The assumption of perfect com-
petition — Profit absent — The conditions of perfect competi-
tion include especially perfect knowledge, and profit is to be ex-
plained by uncertainty — Plan of the book.

Chapter II. Theories of Profit; Change and Risk
in Relation to Profit 22

Historical sketch of the treatment of profit in economic litera-
ture — Special consideration of the Dynamic and the Risk the-
ories — The former confuses the effects of change with those of
the uncertainty connected with change — The latter falls into
confusion by failing to distinguish between risk in the sense of
a measurable probability and an uncertainty which cannot be
measured — Change according to a known law does not give rise
to profit, nor does risk if measurable, since it can be eliminated
by insurance or some equivalent device.

PART TWO

PERFECT COMPETITION

Chapter III. The Theory of Choice and of Ex-
change 51 Is

Wants, and the economic order as a mechanism for organizing
want-satisfying activity — Conflict of wants — Resources, and
their use to satisfy a plurality of wants — Utility and Dimin-
ishing Utility — Simple choices; the boy and the berries; Crusoe
and the Crusoe economy; the production and exchange of goods
under simplified social conditions — The problem that of com-
bining alternatives — Pleasure and pain relative — Cost is
a sacrificed alternative — The true significance of resources and
resource costs — Formulation of the relations in functions,
curves and equilibria.

xii CONTENTS

, Chapter IV. Joint Production and Capitalization 94
v

The use of a plurality of kinds of resource in producing various
commodities and the resulting problem of organization — The
law of diminishing returns, analogue of the law of diminishing
utility — The imputation of product- values to resources or
cost-goods and resultant placing of the latter to maximize their
yield — Critique of the productivity theory — The values of
productive services in terms of demand and supply — No valid
classification of productive agencies into "factors" is possible
— The r61e of time in production and the fallacy of time-
preference.

Chapter V. Change and Progress with Uncer-
^ taint y Absent 141

The meaning of static conditions and the forms of progress —
Question of classifying productive agencies along conventional
tripartite lines — Changes in supply and demand of productive
goods and in the distributive shares — Question of progress
toward equilibrium levels — All modes of progress represent
alternative methods of investing present resources for a future
gain — With uncertainty absent the rate of return would be
equal in all these fields — Contrast with present facts — The
nature of interest as a peculiar form of income, distinguishable
from rent.

Chapter VI. Minor Prerequisites for Perfect
Competition 174

Brief consideration of conditions requisite for perfect competi-
tion other than the absence of uncertainty — Divisibility of
elements in the adjustment — Lack of moral connotation of
the term "productivity" — Monopoly; various forms; is pro-
ductive in the economic sense — Tendency of a competitive
system toward monopoly and a universal dead-lock.

PART THREE

IMPERFECT COMPETITION THROUGH RISK AND
UNCERTAINTY

Chapter VII. The Meaning of Bisk and Uncer-
tainty 197

Outlines of a theory of knowledge — The r61e of consciousness
in behavior — Conduct is forward-looking and the problem of
knowledge is prediction — Knowledge of the future depends on
the fact that experience can be analyzed into the behavior of ob-

CONTENTS xiii

jects which maintain their identity — But there are too many
of these for our intelligence to handle, so we depend on inferring
one mode of behavior from another; i.e., upon constancy in asso-
ciation of properties — Generally speaking, exhaustive and
quantitative analysis is impossible, and we "estimate" — Com-
monly there is a diversity in the possible modes of behavior to
be inferred, and we reason in terms of "probability" of various
outcomes — Probability a priori vs. statistical — Errors in
judgment usually not susceptible to objective evaluation on
any ground, though they are estimated as probabilities — The
"risks" which give rise to profit are chiefly of the nature of
chances of error in judgment, and hence not measurable, be-
cause too unique to form into classes.

Chapter VIII. Structures and Methods for
Meeting Uncertainty 233

Attitudes toward uncertainty — Variable factors — Free enter-
prise — The economic organization deals with uncertainty by
reducing it or specializing the function of meeting it — The
chief method of reduction is by consolidation, though impor-
tant structures exist for perfecting information and for the
direct control of the future — Insurance the chief device for
consolidation — Speculation specializes risk, but is fully as
important as a means of consolidation — Large-scale operation,
especially the corporation — Promotion.

Chapter IX. Enterprise and Profit 264

Introduction of uncertainty into a perfectly equilibrated static
society — Specialization of the function of management and
risk-assumption — Contractual income and residual income —
Conditions which control the amount of the profit share, chiefly
timidity vs. optimism of entrepreneurs, especially in estimating
their own powers — Supply and demand of entrepreneur
ability.

Chapter X. Enterprise and Profit (continued)
The Salaried Manager 291

Indirectness of knowledge and control — We generally judge the
capacity of some one else to judge for us and not our problem
itself — In the same way we get things done by getting others
to do them — The characteristic quality of the executive is
judgment of men — The final control is the selection of men to
control in business organization, and this is inseparable from
responsibility — The distribution of authority and responsibil-
ity in the modern business world.

xiv CONTENTS

Chapter XI. Uncertainty and Social Progress 313

Change, the main source of uncertainty, is the source of the
problem of control — Uncertainty in the investment of re-
sources gives rise to a separation of the function of investment
from that of saving — The theory of interest — The uncer-
tainty element in relation to the various forms of progressive
change — Complicated problems arising out of the capitaliza-
tion of profits — The permanence of profit; friction, and mo-
bility.

Chapter XII. Social Aspects of Uncertainty and
Profit 347

All methods of reducing or redistributing uncertainty involve
costs — The extent to which they should be carried depends
upon how far uncertainty as such is undesirable — Free enter-
prise concentrates control and responsibility in the hands of
property-owners, and a small class of these — Contrast between
free enterprise and freedom — From the standpoint of efficiency
alone it is fairly clear that men work more interestedly and
effectively for an uncertain than for a certain reward — Ques-
tion of the aggregate amount of the profit share — All evidence
indicates that it is negative — Question of abolishing free enter-
prise in favor of some other system — Largely a problem of get-
ting those in control of economic activity to feel an independent
creative spirit — The great difficulty of control beyond one's
own life-time; social continuity and the family problem.

Index 377

RISK, UNCERTAINTY, AND PROFIT

PART I

INTRODUCTORY

RISK, UNCERTAINTY, AND PROFIT

CHAPTER I

THE PLACE OF PROFIT AND UNCERTAINTY IN
ECONOMIC THEORY

Economics, or more properly theoretical economics, is
the only one of the social sciences which has aspired to the
distinction of an exact science. To the extent that it is an
exact science it must accept the limitations as well as share
the dignity thereto pertaining, and it thus becomes like
physics or mathematics in being necessarily somewhat
abstract and unreal. In fact it is different from physics in
degree, since, though it cannot well be made so exact, yet
for special reasons it secures a moderate degree of exactness
only at the cost of much greater unreality. The very con-
ception of an exact science involves abstraction; its ideal is
analytic treatment, and analysis and abstraction are vir-
tually synonyms. We have given us the task of reducing to
order a complex mass of interrelated changes, which is
to say, of analyzing them into uniformities of sequence or
behavior, called laws, and the isolation of the different
elementary sequences for separate study.

Sometimes the various elementary constituents of our
complex phenomenon are met with in nature in isolation
complete or partial, and sometimes artificial experiments
can be devised to present them either alone or with attend-
ant conditions subject to control. The latter is, of course,
the characteristic procedure of physical science. Its applica-
tion to the study of industrial society is, however, generally
impracticable. Here we must commonly search for man-

4 RISK, UNCERTAINTY, AND PROFIT

ifestaiious of the Various factors in our complex, under
varying associations, or rely upon intuitive knowledge of
general principles and follow through the workings of in-
dividual chains of sequence by logical processes.

The application of the analytic method in any class of
problems is always very incomplete. It is never possible to
deal in this way with a very large proportion, numerically
speaking, of the vast complexity of factors entering into a
normal real situation such as we must cope with in practi-
cal life. The value of the method depends on the fact that
in large groups of problem situations certain elements are
common and are not merely present in each single case, but
in addition are both few in number and important enough
largely to dominate the situations. The laws of these few
elements, therefore, enable us to reach an approximation
to the law of the situation as a whole. They give us state-
ments of what "tends" to hold true or "would" hold
true under "ideal" conditions, meaning merely in a situa-
tion where the numerous and variable but less important
"other things" which our laws do not take into account
were entirely absent.

Thus, in physics, the model and archetype of an exact
science of nature, a relatively small and workable number
of laws or principles tell us what would happenjf simplified
conditions be assumed and all disturbing factors elimi-
natedt The simplified conditions include specifications as
to dimensions, mass, shape, smoothness, rigidity, elasticity
and properties generally of the objects worked with,
specifications usually quite impossible to realize in fact,
yet absolutely necessary to make, while the "disturbing
factors " are simply anything not included in the specifica-
tions, and their actual elimination is probably equally
impossible to realize, and, again, equally necessary to
assume. Only thus could we ever obtain "laws," de-
scriptions of the separate elements of phenomena and their
separate behavior. And while such laws, of course, never

IN ECONOMIC THEORY 5

accurately hold good in any particular case, because they
are incomplete, not including all the elements in the case,
yet they enable us to deal with practical problems intelli-
gently because they are approximately true and we know
how to discount their incompleteness. Only by such ap-
proximations, reached by dealing analytically with the
more important and more universal aspects of phenom-
ena, could we ever have attained any intelligent concep-
tion of the behavior of masses of matter in motion and
secured our present marvelous mastery over the forces of
nature.

In a similar way, but for various reasons not so com-
pletely and satisfactorily, we have developed a historic
body of theoretical economics which deals with "tenden-
cies"; i.e., with what "would" happen under simplified
conditions never realized, but always more or less closely
approached in practice. But theoretical economics has
been much less successful than theoretical physics in
making the procedure useful, largely. faBfi&HQfl ft ^a,s tufed
to make its nature and limitations explicit and jilear. It
studies what would happen under "perfect competition,"
noting betimes respects in which competition is not per-
fect; but much remains to be done to establish a systematic
and coherent view of what is necessary to perfect competi-
tion, just how far and in what ways its conditions deviate
from those of real life and what "corrections" have ac-
cordingly to be made in applying its conclusions to actual
situations.1

The vague and unsettled state of ideas on this subject is
manifest in the difference of opinion rife among economists
as to the meaning and use of theoretical methods. At
one extreme we have mathematical economists and pure
theorists 2 to whom little if anything outside of a closed

1 Cf . Mackenzie, Introduction to Social Philosophy, p. 58. Also Bagehot,
Economic Studies, no. 1: "The Presuppositions of English Political
Economy."

2 There are three types or schools of mathematical economic theory.

6 RISK, UNCERTAINTY, AND PROFIT

system of deductions from a very small number of prem-
ises assumed as universal laws is to be regarded as
scientific economics at all. At the other extreme there is
,, certainly a strong and perhaps growing tendency to re-
pudiate abstraction and deduction altogether, and insist
upon a purely objective, descriptive science. And in be-
tween are all shades of opinion.

In the present writer's view the correct "middle way"
between these extreme views, doing justice to both, is not
hard to find. An abstract deductive system is only one
small division of the great domain of economic science,
but there is opportunity and the greatest necessity for
cultivating that field. Indeed, in our analogy, theoret-
ical mechanics is a very small section of the science of
physical nature; but it is a very fundamental section, in a
sense the "first" of all, the foundation and prerequisite of
those that follow. CAnd this also may very well hold good
of a body of "pure theory" in economics; it may be that a
small step, but the first step, toward a practical compre-
hension of the social system is to isolate and follow out to
their logical conclusion a relatively small number of fun-
damental tendencies discoverable in it. 1 There is abundant
need for the use of both deduction and induction in eco-
nomics as in other sciences, if indeed the two methods are
theoretically separable. As Mill has well argued 1 we must
reason deductively as far as possible, always collating our
conclusions with observed facts at every stage. Where the
data are too complex to handle in this way induction must
be applied and empirical laws formulated, to be connected
deductively with the general principles of "ethology"
(we should now say simply "human behavior"). Em-
connected with the names of Cournot, Jevons, and Walras respectively.
Dr. Vilfredo Pareto, of the University of Lausanne (successor of Walras),
is now the most prominent exponent of the mathematical method. Among
"literary" pure theorists, Wicksteed, Schumpeter, and Pantaleoni stand
out.

1 Logic, book vi, chaps, ix and x.

/

IN ECONOMIC THEORY 7

phasis being laid on the provisos, in both cases, that in
using deduction the conclusions must be constantly checked
with facts by observation and premises revised accordingly,
while the empirical laws resulting from induction must in
turn be shown to follow from the general principles of the
science before they can be credited with much significance
or dependability, we see that there is little divergence left
between the two methods.1

1 The relations between deduction and induction are intimate, and a
rigid separation or contrast between the two methods is misleading. A
more careful study of the fundamentals of scientific method will be under-

- taken hereafter (chapter vii). We shall see that there is ultimately no
,guch fact as deduction as commonly understood, that inference is from
particulars to particular, and that generalization is always tentative and
a mere labor-saving device. The fact is, however, that we can study facts

• intelligently and fruitfully only in the light of hypotheses, while hypothe-
seshave value more orjess., in proportion to theamount of antecedent
concrete "Knowledge of fact on which they are teased. The actual pro-
cedure~of science thus consists of making and testing hypotheses.-] The
first hypotheses in any rleld are usually the impressions of "common
sense"; i.e., of that superficial knowledge forced upon intelligence by
direct contact with the world. Study, in the light of any hypothesis,
corrects or refutes the guiding generalization and suggests new points of
view, to be criticized and tested in the same way, and so the organization
of the material proceeds. The importance of generalization arises from
the fact that as our minds are built, it is nearly fruitless to attempt to
observe phenomena unless we approach them with questions to be an-
swer id. This is what a hypothesis really is, a question. Superficial ob-
servation suggests questions which study answers. If and so long as it
answers a question affirmatively and the answer is not contradicted by
the test of practical application or casual observation, we have a law of
nature, a truth about our environment which enables us to react intelli-
gen ly to it in our conduct.

There is, then, little if .any use for induction in the Baconian sense of an
exhaustive collection and collation of facts, though in some cases this
ma,' be necessary and fruitful. On the other hand, there is equally little
use for deduction taken as doing more than suggesting hypotheses, sub-
ject to verification. It is to be noted, however, that our common-sense
generalizations have a very high degree of certainty in some fields, giving
us, in regard to the* external world, for instance, the "axioms" of mathe-
matics. Even more important in the present connection is the r61e of
common sense or intuition in the study of human phenomena. Observa-
tion and intuition are, indeed, hardly distinguishable operations in much
of the field of human behavior. Our knowledge of ourselves is based on

8 RISK, UNCERTAINTY, AND PROFIT

The method of economics is simply that of any field of
inquiry where analysis is in any degree applicable and any-
thing more than mere description possible. It is the scien-
tific method, the method of successive approximations.1
The study will begin with a theoretical branch dealing with
*fl ?nly the most general aspects of the subject matter, and
proceed downward through a succession of principles ap-
plicable to more and more restricted classes of phenomena.
How far the process is carried will be a matter of taste and
of the practical requirements of any problem. In science
generally it does not pay to elaborate laws of a very great
degree of accuracy of detail. When the number of factors
taken into account in deduction becomeslarge, the process
rapidly becomes unmanageable and errors creep in, while
the results lose in generality of application more signifi-
cance than they gain by the closeness of approximation to
fact in a given case. It is better to stop dealing with ele-

introspective observation, but is so direct that it may be called intuitive.
Its extension to our fellow human beings is also based upon the interpre-
tation of the communicative signs of speech, gesture, facial expression,
etc., far more than upon direct observation of behavior, and this process
of interpretation is highly instinctive and subconscious in 'character.
Many of the fundamental laws of economics are therefore properly "in-
tuitive" to begin with, though of course always subject to correction by
induction in the ordinary sense of observation and statistical treatment
of data.

These brief statements must not be thought of as dealing with philo-
sophical problems. The writer is, like Mill, an empiricist, holding that all
general truths or axioms are ultimately inductions from experience. By
induction as a method is meant deliberate, scientific induction, the plar ned
study of instances for the purpose of ascertaining their "law." And de-
duction means reaching new truth by the application of general law i to
particular cases. In the present view both of these processes are regar ded
as suggestive merely, exhaustive induction and conclusive deduction be-
ing alike impossible.

1 The reader will recall Comte's arrangement of the sciences in the
order of generality of the principles they establish. Mathematics, 1 he
properties of space and of quantity in the abstract, is applicable to all
phenomena — and tells us correspondingly little about any of them.
The laws of matter, of living matter, etc., are less general and more con-
cretely real. The same principles are applicable within any grand divi-
sion of knowledge.

IN ECONOMIC THEORY 9

ments separately before they get too numerous and deal
with the final stages of the approximation by applying
corrections empirically determined.

tJThe theoretical method in its pure form consists, then, y
in the complete and separate study of general principles, |
with the rigid exclusion of all fluctuations, modifications, / «^
and accidents of all sorts due to the influence of factors/
less general than those under investigation at any particular \
stage of the inquiry jOur question relates to the advisability
of using this method in a tolerably rigid form in economics.
The answer to this question depends on whether in the
phenomena to be studied general principles can in fact be
found of sufficient constancy and importance to justify
their careful isolation and separate study. The writer is
strongly of the opinion that the question must be an-
swered affirmatively. Economics is the study of a particu-
lar form of organization of human want-satisfying activity CA*9*
which has become prevalent in Western nations and spread £u>w
over the greater part of the field of conduct. It is called a j
free enterprise or the competitive system. It is obviously
not at all completely or perfectly competitive, but just as
indisputably its general principles are those of free com-
petition. Under these circumstances the study, as a first
approximation, of a perfectly competitive system, in which
the multitudinous degrees and kinds of divergences are
eliminated by abstraction, is clearly indicated. The method
is particularly indicated in a practical sense because our
most important questions of social policy hinge directly
upon the question of the character of the "natural" results
of competition, and take the form of queries as to whether
the tendencies of competition are to be furthered and sup-
plemented or obstructed and replaced.

That such a theoretical first approximation is indicated
in a theoretical sense, that it is the natural logical way of
going at the problem, conforming to the workings of our
thought processes, is sufficiently evidenced by the fact that

10 RISK, UNCERTAINTY, AND PROFIT

this is what economists have always in fact done, ever since
there has been such a science or such a social system to

^'be studied. They have, to be sure, been criticized for do-
ing it, and severely. But in the present writer's judgment

» f\ theorists of the past and present are to be justly criti-
cized not for following the theoretical method and studying
a simplified and idealized form of competitive organi-
zation, but for not following it in a sufficiently self-
conscious, critical, and explicit way. In their discussions
of methodology the historic economists have, indeed, been
as clear and explicit as could be desired,1 but in the use
of the method as much cannot, unfortunately, be said.

It should go without saying that in the use of the scienti-
fic method of reasoning from simplified premises, it is im-
perative that it be clear to the reasoner and be made un-
mistakable to those who use his work what his procedure
is and what presuppositions are involved. Two supreme
difficulties have underlain controversies regarding method
in the past. The first is the strong aversion of the masses
of humanity, including even a large proportion of " schol-
ars, " to all thinking in general terms. The second difficulty,
on the other side, is the fact referred to above, that the
persons employing methods of approximation in econom-
ics have not themselves adequately and always recognized,
and still less have they made clear to their readers, the
approximate character of their conclusions, as descriptions
of tendency only, but have frequently hastened to base
principles of social and business policy upon very incom-
plete data. The evil results of the failure to emphasize the
theoretical character of economic speculation are apparent

1 Cf. Mill's Essays on Unsettled Questions, no. 5, which really leaves
little to be said on the subject. Also Cairnes, on the Character and Logical
Method of Political Economy, and the discussions of methodology of the
English economists generally. The conception of the "economic man"
was one way of emphasizing the abstract and simplified character of the
premises of the science. Keynes's Scope and Logical Method of Political
Economy is an admirably clear and conclusive discussion of this whole
subject.

IN ECONOMIC THEORY 11

in every field of practical economics. The theorist not
having definite assumptions clearly in mind in working
out the "principles," it is but natural that he, and still
more the practical workers building upon his foundations,
should forget that unreal assumptions were made, and
should take the principles over bodily, apply them to con-
crete cases, and draw sweeping and wholly unwarranted
conclusions from them. The clearly untenable and often
vicious character of such deductions naturally works to
discredit theory itself. This, of course, is wrong; we do not
allow perpetual motion schemes to discredit theoretical
mechanics, which is built upon the assumption of perpetual
motion at every stage. But in economics a distrust of
general principles, fatal as it is to clear thinking, will be in-
evitable as long as the postulates of theory are so nebulous
and shifting. They can hardly be made sufficiently explicit;
it is imperative that the contrast between these simplified
assumptions and the complex facts of life be made as con-
spicuous and as familiar as has been done in mechanics.

The present essay is an attempt in the direction in-
dicated above. cWe shall endeavor to search out and plac-
ard the unrealities of the postulates of theoretical econom- *
ics, not for the purpose of discrediting the doctrine, but
with a view to making clear its theoretical limitations.J
There are several reasons why the approximate character
of theoretical economic laws and their inapplicability
without empirical correction to real situations should be
especially emphasized as compared, for instance, with
those of mechanics. The first reason is historical and has
already been indicated. The limitations of the results
have not always been clear, and theorists themselves as
well as writers in practical economics and statecraft have
carelessly used them without regard for the corrections
necessary to make them fit concrete facts. Policies must
fail, and fail disastrously, which are based on perpetual
motion reasoning without the recognition that it is such.

12 RISK, UNCERTAINTY, AND PROFIT

In the second place, the allowances and corrections
necessary in the case of theoretical economics are vastly
greater than in the case of mechanics, and the importance
of not losing sight of them is correspondingly accentuated.
The general principles do not bring us so close to reality;
there is a larger proportion of factors in an economic situa-
tion which are of the variable and fluctuating sort.

Again, in spite of the greater contrast between theory
and practice in the study of the mechanics of competition,
as compared with the mechanics of matter and motion,
the contrast is less familiar and more easily overlooked.
Our race has been observing and handling in a rude way
the latter type of phenomena ever since it has lived on the
earth, while competitive relations among men were es-
tablished only a few generations ago. In consequence the
habit of clear thinking according to scientific method, the
vjuse of hypotheses and separation of fundamental princi-
ples from the accidents of particular instances, has become
in some measure built up in the minds of at least a respect-
able body of the more cultivated division of the race. Per-
haps it is even in some degree instinctive in certain strains.1

Finally, it makes vastly more difference practically
whether we disseminate correct ideas among the people at
large in the field of human relations than is the case with

1 It is necessary to admit that in fact only a pitifully small fraction of
the race have any particular theoretical sense in the mechanical field
either. Certainly a vast majority of literate adults with elementary ex-
perience with machinery have no real comprehension of the most funda-
mental principles of the transformation and equivalence of forces. As
far as their own insight is concerned, they could easily be taken in with
crude perpetual motion schemes, and an astonishing proportion are will-
ing to back their own judgment in such matters against what they know
to be the unanimous verdict of the scientific world. The recurrent dis-
cussion of such projects in our National Congress are familiar. A certain
mechanical "handiness" is probably all that is to be found in any but the
rare scientific minds, and these handy men are precisely the ones who
seem most likely to waste their lives and means over palpably absurd
enterprises. A large proportion even of competent engineers have neither
comprehension nor appreciation of physical theory.

IN ECONOMIC THEORY 18

mechanical problems. For good or ill, we are committed .
to the policy of democratic control in the former case, and
are n#t likely to resort to it in the latter. As far as material
results are concerned, it is relatively unimportant whether
people generally believe in their hearts that energy can be
manufactured or that a cannon ball will sink part of the
way to the bottom of the ocean and remain suspended, or
any other fundamental misconception. We have here at
least established the tradition that knowledge and train-
ing count and have persuaded the ignorant to defer to the
judgment of the informed. In the field of natural science
the masses can and will gladly take and use and construct
appliances in regard to whose scientific basis they are as
ignorant as they are indifferent. It is usually possible to
demonstrate such things on a moderate scale, and literally
to knock men down with "results." In the field of social
science, however, fortunately or unfortunately, these things
are not true. Our whole established tradition tends to the
view that "Tom, Dick, and Harry" know as much about
it as any "highbrow"; the ignorant will not in general de-
fer toT;he opinion of the informed, and in the absence of
voluntary deference it is usually impossible to give an
objective demonstration. If our social science is to yield
fruits in an improved quality of human life, it must for the
most part be "sold" to the masses first. The necessity of
making its literature not merely accurate and convincing,
but as nearly "fool-proof" as possible, is therefore mani-
fest.

Whether or not the use of the method of exact science is
as necessary in the field of social phenonena as the present
writer believes, it will doubtless be conceded, even by op-
ponents of this view, that it has been employed in the great
mass of the literature since the modern science of economics
was founded. It may also be granted that the terminology,
concepts, and modes of thinking in our economic instruc-
tion and in general discussion are and for a long time must

14 RISK, UNCERTAINTY, AND PROFIT

be largely dominated by the established tradition. And it
will certainly not be denied that if the method of reason-
ing from hypothetical or simplified premises is followed,
its use must be thoroughly safeguarded by emphasizing the
character of the premises and the consequent conditional
or approximate validity of the conclusions reached. If,
finally, it is admitted that this has not been adequately
done hitherto, and that mischief and misunderstanding
have followed from the loose use of assumptions and looser
application of conclusions, then the call for such a study as
the present will be established.

The tendency toward a sharper separation of the theo-
retical portion of economics from the empirical portion,
and toward the clearer formulation of premises, can be
traced in the literature of the subject, and notable progress
in the right direction has recently been made. The work of
the mathematical economists and non-mathematical pure
theorists has already been mentioned. A considerable and
fairly satisfactory body of consciously and rigidly "theoret-
ical" (i.e., general and approximate) doctrine has been
built up. The work of Pareto and Wicksteed seems to the
writer especially worthy of note. Unfortunately it has not
achieved the recognition and been accorded the funda-
mental place in the general program of the science which
we think it should have; mathematical economics in par-
ticular seems likely to remain little more than a cult, a
closed book to all except a few of the "initiated." In the
great mass of economic literature there is certainly still
wanting the evidence of a comprehensive grasp of general
principles and even more of the meaning and importance
of general principles in a scientific program. There is still
a need for thoroughgoing and critical comparison and con-
trast of theoretical assumptions with the conditions of real
life and of theoretical conclusions with concrete facts.
The makers and users of economic analysis have in general
still to be made to see that deductions from theory are

IN ECONOMIC THEORY 15

necessary, not because literally true — that in the strict
sense they are useful because not literally true — but only
if they bear a certain relation to literal truth and if all who
work with them constantly bear in mind what that relation
is. It must be admitted that even the pure theorists have
not generally been assiduous in emphasizing the practical
significance of their work and its relation to the outside
body of the science; they have been too exclusively inter-
ested in the construction of their a priori systems, and per-
haps a little disposed to regard these as a disproportionate
part of economic science. Such a bias is natural and even
useful, but in a field where the relations between theory
and practice do not come instinctively to the minds of the
users of both, the supplementation of theory by works of
interpretation becomes indispensable.

Indication of progress in this field is furnished especially
by the discussion centering around the concept of normal-
ity in the work of Marshall in England and the related
notion of the static state espoused in particular in this
country by J. B. Clark.1 The meaning and bearings of the
fundamental concepts are in the writer's opinion much
better worked out by Marshall than by any other* writer
generally read. But Marshall himself has adopted a
cautious, almost anti-theoretical attitude toward funda-
mentals; he refuses to lay down and follow rigidly defined
hypotheses, but insists on sticking as closely as possible
to concrete reality and discussing "representative" con-
ditions as opposed to limiting tendencies. The gain in con-
creteness and realism is in our opinion much more than
offset by the obscurity, vagueness, and unsystematic
character of the discussion, the inevitable consequence of
burying fundamentals in an overwhelming mass of quali-
fication and detail. Professor Clark, on the other hand, is
frankly theoretical and insistent upon the deliberate use of

1 The static state idea is further developed along rigidly theoretical
lines by Professor Schumpeter in Austria.

16 RISK, UNCERTAINTY, AND PROFIT

abstraction. But the writer at least is unable to agree with
him on the question of what abstractions should be made
and the manner of their use. While the specifications for his
theoretical state are more definite and explicit than those
of Marshall, they seem to us less correctly drawn up.1
y The opposition to pure theory in general is based on a
failure to understand it, and especially common is the mis-
conception as to the meaning of static or normal hypothe-
ses. It is not recognized that their use is inherent in the
methodology of science, is in fact the very essence of
scientific procedure; that it is not at all recondite or in-
tellectual in its appeal, but is mere practical common
sense. The aim of science is to predict the future for the
purpose of making our conduct intelligent.2 Intelligence
predicts, as shown above, through analysis, by isolating
the different forces or tendencies in a situation and study-
ing the character and effects of each separately. Static
method and reasoning are therefore coextensive.CPFe have
^ no way of discussing a force or change except to describe its
effects or results under given conditions. 1

The "static" method in economics does merely this.

f It inquires what conditions exist and studies the results

• which recognizable forces at work (or changes in progress —

f\ we know nothing about force ; it is the assumed " cause " of

change, which is the only fact) tend to produce under those

conditions. It is "unreal" only in the simplification of its

problem; i.e., in taking the more conspicuous forces and

more important conditions and provisionally neglecting

others. This the limitations of our minds compel us to do,

We must first discuss one change at a time, assuming the

. others suspended while that one is working itself out to its

final results, and then attempt to combine the tendencies at

1 We shall attempt to show that it does not represent, as Professor
Clark contends, the assumptions implicit in the classical economic theory.
(See chapter n.)

2 Cf. Dewey's definition of reason as the method of social diagnosis
and prognosis.

IN ECONOMIC THEORY 17

work, estimate their relative importance, and make actual
predictions. This is the way our minds work; we must
divide to conquer. Where a complex situation can be
dealt with as a whole — if that ever happens — there is no
occasion for "thought." Thought in the scientific sense,
and analysis, are the same thing.

cThe reference to final results calls for a further word.
The concept of equilibrium is closely related to that of
static method. It is the nature of every change in the
universe known to science to have " final' ' results under
any given conditions, and the description of the change is
incomplete if it stops short of the statement of these ul-
timate tendencies. Every movement in the world is and
can be clearly seen to be a progress toward an equilib-
rium."3 Water seeks its level, air moves toward an equality
of pressure, electricity toward a uniform potential, radia-
tion toward a uniform temperature, etc. CE very change is an
equalization of the forces which produce that change, and
tends to bring about a condition in which the change will
no longer take place? The water continues to flow, the
wind to blow, etc., only because the sun's heat — itself a
similar but more long-drawn-out redistribution of energy
— constantly restores the inequalities which these move-
ments themselves constantly destroy.

r^So also in economic phenomena. Goods move from the
point of lower to one of higher demand or price, and every
such movement obliterates the price difference which
causes it. The circulation of goods continues because the
life activities of man (the production of wealth) keep new
supplies forthcoming. The same applies to shifts in pro-
ductive energy from one use to another. There are really
as many static states as there are changes to be studied, /
sets of given conditions to be asumed. It is arbitrary but1
convenient to speak of the static state in relation to given
conditions of the supply and demand (production and
consumption) of consumption goods. We shall see that

<^

18 RISK, UNCERTAINTY, AND PROFIT

there are in fact two other fundamental static problems; the
first assumes given supplies of consumption goods, and the
second, given general conditions under which the creation
of production goods and changes in wants take place; the
first is the problem of the market or of market price, and
the second that of social economic progress, often referred

tjj to as economic dynamics. 1

.>■*■"' c_The argument of the present essay will center around
the general idea of normality, viewed as an attempt to
isolate for study the essentials or general principles of a
competitive social economic organization. The aim will be
to bring out the content of the assumptions or hypotheses
of the historic body of economic thought, referred to by
the classical writers as "natural price" theory. By this is
meant, not the assumptions definitely in the minds of the
classical economists, but the assumptions necessary to
define the conditions of perfect competition, at which the
classical thought was aimed, and which are significant as
forming the limiting tendency of actual economic proc-
esses. *3

As the title of the essay indicates, our task will be en-
visaged from the immediate standpoint of the problem of
profit in distributive theory. C-The primary attribute of
competition, universally recognized and evident at a
glance, is the "tendency" to eliminate profit 2 or loss, and
bring the value of economic goods to equality with their
! cost. J(Dr, since costs are in the large identical with the

1 We need not here more than mention the obvious fact that the
theoretical method is applicable to monopoly as well as competition
and has dealt with both. It has been, of course, a theoretically "ideal"
monopoly also — the real assumption being an exceptional instance of
perfect monopoly in a general system of perfect competition. The con-
trast between theory and reality and the significance of the former is of
the same sort in both cases, and we shall also discuss the meaning of per-
fect monopoly in the proper connection. (Chapter vi.)

2 It will be perceived that the word "profit" is here used in the sense
of "pure profit," a distributive share different from the returns to the
productive services of land, labor, and capital.

IN ECONOMIC THEORY 19

distributive shares other than profit, we may express the
same principle by saying that the tendency is toward a
remainderless distribution of products among the agencies
contributing to their production. But in actual society,
cost and value only "tend" to equality; it is only by an
occasional accident that they are precisely equal in fact;
they are usually separated by a margin of "profit," posi-
tive or negative. Hence the problem of profit is one way of
looking at the problem of the contrast between perfect
competition and actual competition. J

Our preliminary examination of the problem of profit
will show, however, that the difficulties in this field have
arisen from a confusion of ideas which goes deep down into
the foundations of our thinking. The key to the whole
tangle will be found to lie in the notion of risk or uncer-
tainty and the ambiguities concealed therein. It is around
this idea, therefore, that our main argument will finally
center. A satisfactory explanation of profit will bring into
relief the nature of the distinction between the perfect
competition of theory and the remote approach which is
made to it by the actual competition of, say, twentieth-
century United States; and the answer to this twofold
problem is to be found in a thorough examination and
criticism of the concept of Uncertainty, and its bearings
upon economic processes.

But Uncertainty must be taken in a sense radically
distinct from the familiar notion of Risk, from which it
has never been properly separated. The term "risk," as
loosely used in everyday speech and in economic dis-
cussion, really covers two things which, functionally at
least, in their causal relations to the phenomena of
economic organization, are categorically different. The
nature of this confusion will be dealt with at length in
chapter vn, but the essence of it may be stated in a few
words at this point. The essential fact is that "risk"
means in some cases a quantity susceptible of measure-

20 RISK, UNCERTAINTY, AND PROFIT

ment, while at other times it is something distinctly not of
this character; and there are far-reaching and crucial differ-
ences in the bearings of the phenomenon depending on
which of the two is really present and operating. There are
other ambiguities m the term "risk" as well, which will be
pointed out; but^this is the most important. It will appear
that a measurable uncertainty, or "risk" proper, as we shall
use the term, is so far different from an unmeasurable one
that it is not in effect an uncertainty at all. We shall
accordingly restrict the term "uncertainty" to cases of the
non-quantitive type. It is this "true" uncertainty, and
kpt risk, as has been argued, which forms the basis of a
V jralid theory of profit and accounts for the divergence be*
fcween actual and theoretical competitijon.

Aya background for the discussion of the meaning and
causal relations of uncertainty, we shall first make a brief
survey of previously proposed theories of profit. After a
summary glance at the history of the treatment of the sub-
ject down to recent decades, it will be necessary to dwell at
slightly greater length upon the controversy recently car-
ried on in connection with the explanation of profit in
terms of risk. The crucial character of the distinction
between measurable risk and unmeasurable uncertainty
will become apparent in this discussion.

Part Two (chapters m-vi) will be taken up with an out-
line study of a theoretical, perfectly competitive society.
In the course of the argument it will become increasingly
evident that the prime essential to that perfect competition
which would secure in fact those results to which actual
competition only "tends," is the absence of Uncertainty
(in the true, unmeasurable sense). Other presuppositions
are mostly included in or subordinate to this, that men
,t**^ must know what they are doing, and not merely guess more
or less accurately. The "tendency" toward perfect com-
petition is at once explained, since men are creatures en-
dowed with the capacity to learn, and tend to find out the

IN ECONOMIC THEORY 21

results of their acts, while the cause of the failure ever to
reach the goal is equally evident so long as omniscience
remains unattainable. Now since risk, in the ordinary
sense, does not preclude perfect planning (for reasc^
which can easily be made clear), such risk cannot pre-
vent the complete realization of the tendencies of competi-
tive forces, or give rise to profit.

At the conclusion of this brief treatment of perfect com-
petition we shall devote a short chapter to limitations of
perfect competition other than the imperfection of knowl-
edge, and then take up in Part Three a careful analysis of
the concepts of Risk and Uncertainty (chapter vu), pro-
ceeding (in the remaining chapters) with a somewhat de-
tailed study of the effects of both, but especially of true or
unmeasurable uncertainty upon the economic organization
and of its bearings upon economic theory. The economic
relations of risk in the narrower sense of a measurable prob-
ability have been extensively dealt with in the literature of
the subject and do not call for elaborate treatment here.
Our main concern will be with the contrast between Risk
as a known chance and true Uncertainty, and treatment
of the former is incidental to this purpose.

CHAPTER II

THEORIES OF PROFIT; * CHANGE AND RISK IN
RELATION TO PROFIT

In view of the facts set forth in the introductory chapter
as to the relation of profit to theoretical economics, and the
vagueness in the minds of economic writers as to funda-
mental postulates, it is not surprising that the theory of
profit has remained one of the most unsatisfactory and
controversial divisions of economic doctrine. Considering,
however, the universal recognition of the " tendency " of
competition to eliminate profit, it is perhaps somewhat re-
markable that the problem of profit itself has not, with one
important exception,2 been attacked from the direct point
of view adopted in this essay, of an inquiry into the causes
of the failure of ideal competition to be fully realized in fact.
It is, indeed, only within comparatively recent years that
the existence of profit as a really distinct share has become
established and the problem of its explanation given de-
finite status.

As in the case of most sciences whose subject matter is
some field of human activity, economic theory has been
much influenced by practice, and in particular the loose use

1 Excellent histories of profit theory are to be found in the introduc-
tory sections of several monographs on profit and make it superfluous to
go into this phase of the subject in detail. See especially the following:

Mangoldt, H. v., Die Lehre vom Unternehmergewinn. Leipsic, 1855.
Pierstorff, J., Die Lehre vom Unternehmergewinn. Berlin, 1875.
Mataja, V., Der Unternehmergewinn. Vienna, 1884.
Gross, G., Die Lehre vom Unternehmergewinn. Leipsic, 1884.
Porte, M., Entrepreneurs et 'profits industriels. Paris, 1901.

2 The exception is Professor Clark's theory of perfect competition as
equivalent to the "static state" and the corresponding "dynamic
theory " of profit as the result of progress. This view will presently be
taken up and criticized.

THEORIES OF PROFIT 23

of terms in everyday affairs has given rise to serious con-
fusions in terminology. The concept of profit is bound up
in a certain type of organization of industry, a type realized
in various degrees in different places and times, and always
undergoing modification and development.

At the time when the English classical school of eco-
nomists were writing — i.e., in the later eighteenth and
early nineteenth centuries — corporations were relatively
unimportant, being practically restricted to a few banks
and trading companies. There was, of course, some lend-
ing at interest, but in the dominant form of industry men
used their own capital, hiring labor and renting land from
others. The managerial function centered in the capital-
ist. Moreover, English industries were new and rapidly
expanding; competition was not highly developed; the
possession of capital seemed to be and was the dominant
factor in the situation. Only in more recent times has the
accumulation of capital, the perfection of financial institu-
tions, and the growth of competition transferred the center
of interest to business ability, made it easy or at least
generally possible for ability to secure capital when not in
possession of it by direct ownership, and made common
the carrying-on of business predominantly with borrowed
resources.

Under these early conditions it was natural to connect
the income of the business manager with the ownership of
capital, and in all the classical writings we find the word
"profit" used in this sense. A further source of confusion
was the indefiniteness of the conception and use of the
ideas of natural and market price in the minds of the early
writers. It is natural and inevitable that a distinction
which goes to the heart of the fundamental problems of the
nature and methodology of economic science should be
but imperfectly worked out in the initial stages of the
speculation. Only recently, again, has the analysis of
long-time normal price by Marshall and of the "static

24 RISK, UNCERTAINTY, AND PROFIT

state" by Clark and Schumpeter begun to give to econo-
mists a clearer notion of what is really involved in "natu-
ral" or normal conditions. To the earlier classical writers
this obscurity hid the fundamental difference between the
total income of the capitalist manager and contract in-
terest. The only separation considered necessary in the
explanation of distribution was to restrict the theory of the
business manager's income to the explanation of "normal
profit," which was regarded as substantially equivalent to
contract interest. Another barrier to the formulation of a
clear statement of the relations between interest and pro-
fit was the lack of an adequate understanding of the pro-
ductivity of capital, which also these authors did not pos-
sess and which has first been worked out in recent years.
The qualification of "near" or "substantial" identifica-
tion of normal profit and interest is necessary, however, in
referring to the classical treatments. Even Adam Smith
and his immediate followers recognized that profits even
normally contain an element which is not interest on capi-
tal. Remuneration for the work and care of supervising
the business was always distinguished. Reference was also
made to risk, but in the sense of risk of loss of capital, which
does not clearly distinguish profit from interest.1 Adam
Smith is explicit in regard to these elements, while Malthus
and M'Culloch were more so. J. S. Mill pointed out in
a somewhat groping way that the wages of management
are determined in a different way from other wages, and

1 For a fuller discussion of the views of the English writers, with cita-
tions, see Cannan, Theories of Production and Distribution, chap, vi,
sec. 2; also the same author's article on "Profit" in Palgrave's Dictionary
of Political Economy. In opposition to the German historians and critics,
who take the classical economists very literally, Cannan is sure that they
really held, like their French followers, a wage theory of profit. Between
the two views this seems the fairer on the whole, but it could hardly be
maintained that the difference in expression does not represent some
difference in thought. However, much of the contrast is undoubtedly
due to differences in the use of terms. Old words used to designate new
things necessarily become ambiguous, and "profit" is still correctly used
with several different meanings.

THEORIES OF PROFIT 25

noted also that profits, so called, include as a third ele-
ment a payment for risk, as well as wages of management
(and interest). The inclusion of interest in profit was op-
posed by Bagehot, and in the United States by Walker,
but the use of the term is still somewhat loose in England,
as is seen in Marshall. Even in this country the develop-
ment of corporation accounting, while separating wages of
management from profit, has tended to a new confusion of
profit and interest.

The early French writers, beginning with J. B. Say,
adopted a different view of profit, or at least a different
use of the word, insisting on a separation of profit from in-
terest and defining the former explicitly as a wage. The
difference in procedure may have been due, as v. Man-
goldt suggests,1 to the different character of typical French
industry and the greater importance of the manager's
personality in it relatively to the capital factor. It is
worthy of note that in the fourth edition of his "Traite,"
Say included in profit the reward for risk-taking; he had in
Hhe earlier editions viewed this income as accruing to the
capitalist as such, but now transferred it to the entrepre-
neur. Especial mention should be made of Courcelle-\
Seneuil, who insisted that profit is not a wage, but is due to
the assumption of risk.2

The older German economists varied widely in their

1 Op. cit.t p. 19, note.

2 Article, "Profit," in Coquelin and Guillaumin's Dictionnaire de
VSconomie politique, Paris, 1852. It is true that in another work (TraitS
d'Sconomie politique, 2d ed., 1867) Courcelle was not so explicit, and also
that in the same article he says that profit depends on the intelligence of
the entrepreneur and the favorable or unfavorable conditions under which
he works. This hesitation may explain Kleinwachter's classifying him
with the followers of Say and adherents of the wages theory. (See Das
Einkommen und seine Verteilung, p. 278.) It seems more probable, how-
ever, that Courcelle glimpsed the fact (which KleinwSchter did not) that
the assumption of a "risk" of error in one's own judgment, inherent in
the making of a responsible decision, is a phenomenon of a different char-
acter from the assumption of "risk" in the insurance sense. We shall
build largely upon this distinction later.

26 RISK, UNCERTAINTY, AND PROFIT

treatment of profits. Some, of whom Schaffle is perhaps
the most notable example, follow the "English" view in
glassing profit as essentially a return to capital. Others,
notably Roscher, adopt the "French"1 attitude and treat
it as a form of wages. Roscher does not even use the term
"profit," but substitutes Unternehmerlohn. Other writers,
such as Hermann and Rau, took a more or less intermediate
position.

Still another group, of more importance for our purposes,
contended that profit should be recognized as a unique
form of income, not susceptible of reduction to remunera-
tion for either capital or labor. This position was taken in a
somewhat timid way by Hufeland 2 and more definitely by
Riedel, 3 but its most notable advocates were Thiinen and
v. Mangoldt. Thiinen's great work, "Der Isolirte Staat," 4
defines profit as what is left after (a) interest, (b) insurance,
and (c) wages of management, are met. This residuum con-
sists of two parts: (1) payment for certain risks, especially
changes in values and the chance of failure of the whole
enterprise, which cannot be insured against, and (2) the
extra productivity of the manager's labor due to the fact
that he is working for himself, his "sleepless nights" when
he is planning for the business. Thiinen called these ele-

1 These national designations of the two schools hold closely. The
only notable exceptions (aside from Courcelle) are on the one side, Rossi,
a French (naturalized Italian) writer, who strongly espoused the capital-
istic or English view, and on the other Samuel Read, who, while agreeing
with the current English treatment in terminology, broke with it in sub-
stance and agreed with Say and his followers. Read insisted on identify-
ing "profit" with the return to capital, or interest, and treating the dis-
tinctive income of the entrepreneur as a wage. He also emphasized the
"compensation for risk" element in his "profit" (really interest), but
thought it due to no determinate causes and "outside the pale of science/*
This last phrase shows at least an insight into the unique character of
this sort of risk, since the assertion would certainly not have been made of
an insurance premium. See his Political Economy, Edinburgh, 1829, pp.
263 and 269, note.

a Neue Grundlage der Staatsimssenschaft, vol. I. Giessen, 1807.

3 National Okonomie, 1839.

4 Appeared 1826. 3d ed., 1876. See 3d ed., vol. n, pp. 83 ff.

THEORIES OF PROFIT 27

ments respectively Industriebelohnung and Unternehmer-
gewinn, and their sum Gewerbsprqfit.

A most careful and exhaustive analysis of profit is con-
tained in the monograph of H. v. Mangoldt, already re-
ferred to. Proceeding on the basis of an elaborate classifi-
cation of the forms of industrial organization and a dis-
cussion of the economic advantages of the entrepreneur
form, this writer finds in the income of the business enter-
priser a complex group of unique elements. He divides it
first into three parts: (1) a premium on those risks which
v are of such a nature that he cannot shift them by insurance;

(2) entrepreneur interest and wages, including only pay-
ments for special forms of capital or productive effort which
do not admit of exploitation by any other than their owner;

(3) entrepreneur rents. These last again fall into four sub-
divisions: (a) capital rents, (b) wage rents, (c) large enter-
prise rent, and (d) "entrepreneur rent in the narrower
sense." They are all due to the limitation of special capac-
ities or characteristics (the last to special combinations of
such) and are called "premiums on scarcity" (Seltenheits-
prameien). This is, of course, a question-begging term
(though many writers have used it) since all incomes de-
pend in the same way on the limitation of the agencies to
which they are imputed. It would seem that every im-
aginable source of income is included in this minute and
subtle classification.

A special place in the history of theories of profit should
be given to the German socialist school, the so-called
"scientific" socialists, Rodbertus, Marx, Engels, Lassalle,
and their followers. These writers take the English classi-
cal treatment of profit in a narrowly literal (one must say
whoUyjmcriticjdjm^ sense as including all in-

come accruing to capital, to which they add land. Com-
bining this with an equally blind reading of the labor theory
pf value which was the starting-point of Smith andRicardo,
they derive a simple classification of income in which all

28 RISK, U TAINTY, AND PROFIT

that is not wages is a profit which represents exploitation
^jpf the working classes. Capital is equivalent to property,
which is to be regarded as mere power over the economic
activities of others due to the strategic position of owner-
ship over the implements of labor. It is analogous to a
robber baron's crag, a toll-gate on a natural highway, or a
political franchise to exploit. Pierstorff, in the monograph
referred to above, follows Rodbertus in the main, after
criticizing alternative views.1

After the publication in 1871 of Menger's "Grund-
satze" had given a new interest and new turn to value
theory in Austria and Germany, a notable series of dis-
cussions of profit appeared in those countries. Those call-
ing for especial mention are the monographs of Gross 2
and Mataja 3 and the treatments by Mithoff 4 and Klein-
wachter 6 in Schonberg's "Handbuch," the last-named
elaborated in the author's book already referred to. Gross
takes as his starting-point the plain fact that profit is the
difference between the cost of goods and their value, and
studies the position of the entrepreneur in the two markets
in which he buys productive services and raw materials and
sells his finished product. He may be said to reduce profit
to bargaining power, in which, of course, superior knowl-
edge and foresight are recognized as playing a large part,

1 See also the article " Unternehmergewinn," by Pierstorff in Con-
rad's Handworterbuch der Staatswissenschaften. Dr. Thorstein Veblen's
conceptions of capital and profit show strong leanings toward the same
views.

2 Referred to above, p. 22 n. 8 Ibid.

4 G. Schonberg, Handbuch der Politischen OJconomie, 2d ed. (Tubingen,
1885), pp. 670 ff.
6 Ibid., pp. 220 ff.
Other works in the same group with the above are:

E. Aug. Schroeder, Das Unternehmen und der Unternehmergewinn.
Vienna, 1884. (The same date of publication as Gross and Mataja.)/
A. Wirminghaus, Das Unternehmergewinn und die Beteiligung

Arbeiter am Unternehmergewinn. Jena, 1886.
E. Zuns, Swei Fragen des Unternehmer-Einkommens. Berlin, 1881!
A. Korner, Unternehmen und Unternehmergewinn. Vienna, 1893.

THEORIES OF PROFIT 29

but Gross does not work out a systematic treatment of the
nature and significance of risk or uncertainty. He thinks an
income which is a premium for taking risks is inherently
impossible, as gains and losses would necessarily balance.
Few other writers agree with this proposition. Socially,
profit is for Gross the inducement to follow closely the
economic law of cheapest possible production and most
effective utilization of goods.

Mataja's analysis of profit is a more literal application
of Menger's utility theory of value. He seeks to explain
price differences by means of the differences between the
various uses of "goods of higher order' * in making differ-
ent kinds of "goods of lower order" and ultimately different
consumption ge*ds. His discussion does not get beyond a
statement of the problem.

Mithoff holds that the entrepreneur's income consists of
rents, wages, etc., at market rates for the productive serv-
ices which he furnishes to the business, plus a "profit"
which may be regarded as remuneration for taking the risk
of its failure. He contends, however, that this profit is at
best a mere abstraction, a complex of a number of inde-
terminate surpluses, and that the entrepreneur income as a
whole alone has definite meaning or practical significance.

Kbrner is another writer who explains the entrepreneur's
income in terms of superior bargaining power. His position
is figured as that of a watchman on a tower and is summed
up in the expression that his is a wider market than that of
the men he buys from and sells to, especially the laborer
whom he hires. The essential mystery of why the com-
petition of other watchmen on similar towers does not
eliminate his peculiar gain is not touched upon. The non-
socialistic German writers are usually particularly con-
cerned to combat the allegations of the socialists and fur-
nish a social justification of profit.

Kleinwachter views profit from the social standpoint as
pay for taking the twofold risk of production — technical

30 RISK, UNCERTAINTY, AND PROFIT

and economic, a distinction made by Gross — and for the
care of supervision. From the individual point of view it is
a speculative gain arising from advantage taken of differ-
ences between the prices of economic goods and the prices
of the agents necessary to their production. In his fuller
treatment in his book on distribution, Kleinwachter de-
votes most of his energy to a sarcastic polemic against the
English classical economic theory, according to which the
prices of commodities should equal their costs of produc-
tion or the sum of the wages, interest, and rent paid the
agents employed to produce them. No serious criticism of
this theory is attempted, however, nor any sign displayed
of a comprehension of its real meaning as a statement of the
limits of tendencies. The general conclusion that the exist-
ence of profit follows from a divergence between the con-
ditions of theory and those of fact is the starting-point of
the present study. It is, of course, a statement of the
problem, and not a solution of it; Kleinwachter virtually
explains profit by ridiculing the idea that it should be
thought to call for explanation.

In other than the German-speaking countries the sub-
ject of profit has not been prolific of independent mono-
graphs and treatises, but has usually been dealt with as an
integral part of the general theory of distribution (though
there are some exceptions in France and Italy which would
have to be noticed in a fuller historical treatment). It is, of
course, impossible to take up even the important theorists
in all countries and summarize their views, while any brief
treatment by schools or groups would be misleading rather
than helpful. The writers already mentioned pretty well
cover the fundamental theories and standpoints, with ex-
ceptions yet to be noted.1 A very common procedure is to
treat profit as a special case of monopoly gain, or to com-

1 A noteworthy innovation in the treatment of profit has been made
by a recent French writer, M. B. Lavergne, in his ThSorie des Triarchies
Sconomiques (Paris, 1910). In his view profit is the remuneration of the
idte productrice, which is elevated to the position of an independent pro-

THEORIES OF PROFIT 31

bine elements of monopoly position with other factors.
This method is apt to degenerate into a mere confusion of
the two income categories. The common use of the term
■x " monopoly profit " to designate monopoly revenue directly
incites to this confusion.

The first notable development in the field of profit theory

* in America was the work of General Francis A. Walked *
Walker effectually emphasized the place and importance of
the entrepreneur or "captain of industry," and helped to
free economic treatises in English from the careless han-
dling of profit as an element in interest. His own "rent
theory," however, in spite of its vogue at the time of its
promulgation, need not now detain us. Walker wrote be-
fore Marshall, Clark,2 and Hobson 3 had shown that all

* incomes are like rent in the mode of their determination,
and with that point once made clear the rent theory is

" reduced to a wage theory merely, and its special signifi-
cance disappears.

More recently the center of interest in the discussion of
profit has shifted from Walker's theory to two other op-
posed views, the "dynamic theory" and the "risk theory "
respectively. The former is the view upheld by Professor
J. B. Clark and his followers and the latter is sponsored in
particular by Mr. F. B. Hawley.4 Neither the connection

ductive factor. His book outlines an ingenious and suggestive theory of
distribution. See review by Professor A. A. Young, American Econoyti
Review, vol. I, pp. 549 ff. ^S

1 Political Economy, part iv, chap. iv. See also "The Source of Busi-
ness Profits and Reply to Mr. Mac vane," Quarterly Journal of Economics,
vol. i, pp. 265 ff ., and vol. n, pp. 263 ff. (Macvane held a monopoly theory;
cf. Quarterly Journal of Economics, vol. n, pp. 1 ff. and 453 ff.) A view
similar to that of Walker has been advocated in France by Leroy-Beau-
lieu (Sr.). See Memories de V Academic des sciences morales et politiques,
vol. i, pp. 717 ff, and TraitS oViconomie 'politique, part iv, chap. ix.

2 " Distribution as Determined by a Law of Rent," Quarterly Journal
of Economics, vol. v, pp. 289 ff.

8 "The Law of the Three Rents," ibid., vol. v, pp. 263 ff.
More exhaustive than either Clark or Hobson is Wicksteed, The
Coordination of the Laws of Distribution, London, 1894.
4 It is not meant that these are the only noteworthy advocates of the

32 RISK, UNCERTAINTY, AND PROFIT

between profit and changes in conditions nor that between
profit and risk is an entirely new idea, but hitherto neither
had been erected into a definite and ostensibly sufficient
principle of explanation of the peculiar income of the en-
trepreneur. These two theories call for somewhat fuller
treatment.

The dynamic theory is a correlate of Professor J. B.
Clark's theory of distribution in the profitless "static
state."1 Professor Clark outlines a systematic structure of
theoretical economics in three main divisions.

The first treats of universal phenomena, and the second of
static social phenomena. Starting with those laws of economics
which act whether humanity is organized or not, we next study
the forces that depend on organization but do not depend on
progress. Finally it is necessary to study the forces of progress.
To influences that would act if society were in a stationary state,
we must add those which act only as society is thrown into a
condition of movement and disturbance. This will give us a
science of Social Economic Dynamics.2

The static state is the state of "natural" adjustments of
Ricardo and the early classical writers.

What are called "natural" standards of values and "natural"
or normal rates of wages, interest, and profits are in reality, static
rates. They are identical with those which would be realized, if

views in question, nor that other American writers on distribution have
not been in some degree original in their treatment of profit. The dis-
cussions by the various authors — Davenport, Ely, Fetter, Fisher,
Johnson, Seager, Seligman, Taussig, and others — are accessible every-
where. Perhaps especial mention should be made of the chapter on profit
in Carver's Distribution of Wealth. Carver's distinction between com-
pensation for risk-taking and the results of successful risk-taking points
to the direction in which a solution of the problem is to be sought. Other
writers also have seen the importance of a critical dissection of the risk
concept, but none have so far carried out the work. Unquestionably the
best of these textbook discussions is that of Professor F. M. Taylor in
his unpublished Principles of Economics, a work characterized through-
out by correctly reasoned and accurately stated theoretical argument.

1 See The Distribution of Wealth, 1900; and Essentials of Economic
Theory, 1907.

2 The Distribution of Wealth, pp. 30, 31.

THEORIES OF PROFIT 33

a society were perfectly organized, but were free from the dis-
turbances that progress causes. . . . Reduce society to a station-
ary state, let industry go on with entire freedom, make labor
and capital absolutely mobile . . . and you will have a regime of
natural values.1

To realize the static state, we should have to eliminate
five kinds of change which are constantly in progress :

Five generic changes are going on, every one of which reacts
on the structure of society, by changing the arrangements of that
group system which it is the work of catallactics to study: nf Ji

1. Population is increasing. u^

% Capital is increasing.

3. Methods of production are improving. -ft*

4. The forms of industrial establishments are changing, the
less efficient shops, etc., are passing from the field, and the,
more efficient are surviving. . I p/* '

5. The wants of consumers are multiplying.2 \£ T*

In the static state each factor secures what it produces,^
and since cost and selling price are always equal there can
be no profits beyond wages for the routine work of super-
vision.

The prices of goods are in these older theories said to be
"natural" when they equal the cost of producing them; ... in
reality their "natural prices" were static prices.3

The prices that conform to the cost of production are, of course,
those which give no clear profit to the entrepreneur. A business
man whose goods sell at such rates will get wages for whatever
amount of labor he may perform, and interest for any capital
that he may furnish; but he will have nothing more to show in the
way of gain. He will sell his product for what the elements that
compose it have really cost him, if his own labor and the use of
his capital be counted among the costs. We shall see that this
condition of no-profit prices exactly corresponds to the one that
would result from the static adjustment of the producing groups.4

1 The Distribution of Wealth, p. 29.

2 Ibid., p. 56. s Ibid., pp. 68-69.

4 Ibid. Professor Joseph Schumpeter, who has carried the static
analysis farther in some respects than Professor Clark, points out that in

34 BISK, UNCERTAINTY, AND PROFIT

V Profits are, then, the result exclusively of dynamic
change. "Obviously, from all these changes two general
results must follow: first, values, wages and interest will
differ from the static standards; secondly, the static stand-
ards themselves will always be changing." 1 The type of
dynamic change is invention; "an invention makes it
possible to produce something more cheaply. It first gives
a profit to entrepreneurs and then . . . adds something to
wages and interest. . . . Let another invention be made.
... It also creates a profit; and this profit, like the first, is
an elusive sum, which entrepreneurs grasp but cannot
hold." It "slips through their fingers and bestows itself on
all members of society." 2 Thus the effect of any one
dynamic change is to produce temporary profits. But in
actual society such changes constantly occur, and the re-
adjustments are always in process. "As a result, we . . .
have the standard of wages moving continuously upward
and actual wages steadily pursuing the standard rate in its
upward movement, but always remaining by a certain in-
terval behind it." 3

In another sense profit is dependent on "friction":
"The interval between actual wages and the static stand-
ard is the result of friction; for, if competition worked with-
out let or hindrance, pure business profit would be an-
nihilated as fast as it could be created. . . ." 4 "Were it not
for that interval, entrepreneurs as such would get nothing,

the static state there is no entrepreneur, properly speaking. The con-
sumer, he adds, is really the entrepreneur; but it would seem preferable
to say that the function is absent and let it go at that. (Theorie der
Wirtschaftliche Entwickelung.) /ww A •

1 The Distribution of Wealth, p. 404.

2 Ibid., p. 405. 3 Ibid., p. 406.

4 Ibid., p. 410. This is fallacious even under the assumptions, since
the profits of change come largely in the form of readjustments of capital
values. The difficulty is, of course, avoided if "friction" be so broadly
defined that "perfect mobility" means the absence of all resistance to
the human will. But in a world where a breath could transform a brick
factory building into a railway yard or an ocean greyhound there would
be no need for economic activity or economic science.

THEORIES OF PROFIT 35

however much they might add to the world's productive
power." l

The fatal criticism of this procedure of taking changes
in conditions as the explanation and cause of profit is that
it overlooks the fundamental question of the difference
between a change that is foreseen a reasonable time in
advance and one that is unforeseen. Now, if we merely
assume that all the "dynamic changes" which Professor
Clark enumerates, and any others which may be named,
are foreknown for a sufficient time before they take place, or
that they take place continuously in accordance with laws
generally and accurately known, so that their course may
be predicted as far into the future as occasion may require,
then the whole argument based on the effects of change will
fall completely to the ground. If the retort is made that
this is a supposition contrary to fact and illicit, the answer
is that it is only partly contrary to fact. Some changes are
foreseen and some are not, the laws of some are tolerably
accurately known, of others hardly at all;2 and the vari-

1 The Distribution of Wealth, p. 411. At this point Professor Clark
makes a statement which if followed out would lead to serious question-
ings in regard to his analysis: "Profit," he says (p. 411), "is the |n/e that
insures improvement, and improvement is the source of permanent addi-
tions to wages. To secure progress, this lure must be sufficient to make
men overcome obstructions and take risks." (My italics.) It would seem
that effort and risk have some connection with the income of the "entre-
preneur as such," as well as change and friction. Along the same line is
the statement in his first chapter (p. 3) that "free competition tends to
give to labor what labor creates, to capitalists what capital creates, and
to entrepreneurs what the coordinating function creates." When we ask,
as we presently shall, whether the "effort" and "risk" connected with
making progress, or the income to which they give rise, are essentially
different from any other effort and risk and their incomes, we shall find
ourselves forced to answer in the negative, and to look outside the fact
of change altogether for an explanation of the unique income of the
entrepreneur.

2 It may be objected that in regard to some changes it is an absurdity
to imagine their being foreseen, since this would cause them to take place
at once. The statement doubtless holds in regard to some discoveries
of fact, which to anticipate would be to make them now. But not many
of the dynamic economic changes are of this sort. The accumulation of

36 RISK, UNCERTAINTY, AND PROFIT

ation in foreknowledge makes it clearly indispensable to
separate its effects from those of change as such if any real
understanding of the elements of the situation is to be
attained. It is evident that a society might be ever so
dynamic, as Professor Clark demies the term, and yet have
all its prices "natural" or constantly equal to production
costs, excluding any chance for the entrepreneur to secure
a net profit. It is fallacious to define "natural" conditions
as "static" conditions.

No a priori argument is necessary to prove that with
general foreknowledge of progressive changes no losses and
no chance to make profits will arise out of them. This is the
first principle of speculation, and is particularly familiar in
the capitalization of the anticipated increase in the value of
land. The effect of any change which can be foreseen will
be adequately discounted in advance, any "costs" con-
nected with it will be affected in exactly the same way as
the corresponding "values" and no separation between the
two will take place.

It will be interesting to follow this line of thought some-
what farther, as suggested above in connection with Pro-
fessor Clark's characterization of profit as the lure that
causes men to make the efforts and take the risks involved in
progress. It is in fact but a short step from the foreknowl-
edge of change to the fact that change in reality does not
usually just happen, but is largely itself the result of hu-
man activity. It is evident that if the laws of economically

capital and increase in population are in fact relatively predictable and
the broader features in the development of wants are known and the
knowledge has no effect on the changes themselves. It is possible even
to predict discovery of natural resources without saying just where they
will be found, and the making of an invention without actually writing
the specifications. The probability that inventions will be made and
processes improved is in fact very frequently taken into account in mak-
ing valuations and determining business policies. The assumption that
all change might be predictable is contrary to fact, but not self-contra-
dictory, and we leave it to the argument as a whole to justify its useful-
ness as well as legitimacy.

THEORIES OF PROFIT 37

significant changes are known, those human actions which
give rise to such changes will be governed by the same
motives as the operations productive of immediate utili-
ties, and in the competition of resources for profitable em-
ployment returns will be adjusted to equality between the
two fields of use. Industrial progress would certainly take
place under these conditions quite as readily as where the
operations giving rise to it gave highly unpredictable re-
sults, but the rewards of making inventions, discovering
new natural resources, etc., with the speculative character
of the operations once removed, would be in no wise differ-
ent from wages, interest, and rent in any other line of pro-
ductive activity. They would be equal in amount, deter-
mined in the same way, in the same competitive market,
and in short would be wages, interest, and rent merely, and
not profit. And this is what does come about to the extent
that progress can be foreseen, which is to say in very large
measure. Dynamic changes give rise to a peculiar form ofl
income only in so far as the changes and their consequences j
are unpredictable in character.

It cannot, then, be change, which is the cause of profit,
since if the law of the change is known, as in fact is largely the
case, no profits can arise. The connection between change
and profit is uncertain and always indirect. Change may
cause a situation out of which profit will be made, if it
brings about ignorance of the future. Without change of
some sort there would, it is true, be no profits, for if every-
thing moved along in an absolutely uniform way, the
future would be completely foreknown in the present and
competition would certainly adjust things to the ideal state
where all prices would equal costs. It is this fact that
change is a necessary condition of our being ignorant of the
future (though ignorance need not follow from the fact of
change and only to a limited extent does so) that has given
rise to the error that change is the cause of profit.

Not only may change take place without occasioning

38 RISK, UNCERTAINTY, AND PROFIT

profit, but profit may also arise in the entire absence of
any "dynamic'* or progressive changes of the kind enu-
merated by Professor Clark. If conditions are subject to
unpredictable fluctuations,1 ignorance of the future will
result in the same way and inaccuracies in the competitive
adjustment and profits will be the inevitable consequence.
And the failure of an anticipated change to occur is the
game in effect as the occurrence of an unanticipated one.
• It is not dynamic change, nor any change, as such, which
I causes profit, but the divergence of actual conditions
lfrom those which have been expected and on the basis of
! which business arrangements have been made. For a sat-
isfactory explanation of profit we seem to be thrown back
from the "dynamic" theory to the Uncertainty of the
Future, a condition of affairs loosely designated by the
term "risk" in ordinary language and in business par-
lance.

Except for one or two passing references, Professor Clark
does not take up the subject of risk in the treatise from
which we have quoted. In a short article on "Insurance
and Profits"2 (written in refutation of Mr. Hawley) he
takes the position that risk-taking gives rise to a special
category of income, but that it accrues to the capitalist,
and cannot go to the entrepreneur, as such. How he would
treat this income, what relation it would bear to interest, he
does not tell us. But it is no part of profit, which is de-
fined as "the excess of the price of goods over their cost."3
"It goes without saying that the hazard of business falls
on the capitalist. The entrepreneur, as such, is empty-
handed. No man can carry risk who has nothing to lose."4
In his later work, the "Essentials of Economic Theory,"

1 It is necessary to stipulate that the fluctuations must be of sufficient
extent and irregularity that they do not cancel out and reduce to uniform-
ity or regular periodicity in a time-interval short in comparison with the
length of human life.

2 Quarterly Journal of Economics, vol. vn, pp. 40-54.
8 Ibid., p. 41. * Ibid., p. 46.

THEORIES OF PROFIT 39

the subject of risk again receives scant attention.1 Risks
are simply ruled out of the discussion, since "the greater
part of them arise from dynamic causes," and the "un-
avoidable remainder" of static risk can be taken care of by
setting aside "a small percentage of the annual gains [of
each establishment, which] . . . will make good these losses
as they occur and leave the businesses in a condition in
which they can yield as a steady return to owners of stock,
to lenders of . . . capital, and to laborers all of their real
product."

It is clear that Professor Clark admits that his perfectly
competitive state implies substantially perfect knowledge
on the part of all members of society of present and future
facts significant for the ordering of their business conduct.
Dr. A. H. Willett2 has supplemented the theory of the
static state in this field, and Dr. A. S. Johnson has some dis-
cussion of it in his study of rent.3 Willett recognizes that
the disturbing effects of progress do not constitute the sole
cause of divergence between actual society and the theo-
retical ideal; "the conception of the static state is reached
by a process of abstraction," which "cannot stop" with
the elimination of the five dynamic changes :

If all dynamic changes were to cease, the ideal static state
would never be realized in human society. There are other as-
sumptions which have to be made, such as a high degree of
mobility of capital and labor, the universal prevalence of the
economic motive, and the power of accurately foreseeing the
future. . . .

It is the influence of the last of these disturbing factors on
static rates of wages and interest that we are to seek to deter-
mine. The ideal adjustment could be realized only on the condi-

1 Footnote, pp. 122-23.

2 The Economic Theory of Risk and Insurance, Columbia University
Studies in Political Science, vol. xiv, no. 2.

3 Rent in Modern Economic Theory. Publications of the American
Economic Association, 3d Series, vol. in, no. 4. See chapter vi: "Rent,
Profit, and Monopoly Return." (Both these monographs are doctoral
dissertations written under Professor Clark's supervision.)

40 RISK, UNCERTAINTY, AND PROFIT

tion that there were no discrepancies between the anticipated and
the actual results of economic activity. Production and consump-
tion must go on either with absolute uniformity or with a regular
periodicity.1

t1 From the above admission that the static state is not an
adequate formulation of the conditions of ideal competi-
tion, it would be an easy inference in line with static theory
as a whole that some modification in the treatment of
profit would be called for. But this inference is not drawn
by the author quoted. He is not looking for and does not
find any connection between profit and risk. He agrees
explicitly with Clark that the entrepreneur takes risk only
as a capitalist, and that the income resulting is therefore
not profit. In his discussion of the reward for risk-taking,
Willett states even more emphatically than Clark had done
the contention that only the capitalist as such can take
risk or get the reward of risk-assumption. To him this
"seems to be a self-evident proposition,"2 but he fails to
take account of the familiar fact that men may secure their
obligations in other ways than through pledging material
resources already owned and invested, as for example by
mortgaging their current income from all sources and their
future earning power.

In his discussion of profits referred to above, Dr. John-
son makes some reference to risk, but he also makes no
attempt to find in it an explanation of profit. He dis-
covers four elements in "the income of a fortunate and
capable entrepreneur."

(1) A gain due to chance, offset by a smaller loss (borne, how-
ever, by some other entrepreneur); (2) a gain due to his own
power of combining labor and capital in ways more effective than
those usually employed in the community; (3) a certain share in
the first fruits of economic improvements; (4) a part of the gains
which entrepreneurs as a class secure through the fact that their
services are limited in proportion to the demand for them.

1 Willett, op. cit.t pp. 13-14. (My italics.)

2 Ibid., p. 72.

THEORIES OF PROFIT 41

We need not stop to criticize this analysis in detail; it
might be pointed out that shares (2) and (4) are identical,
and that neither formulation would distinguish profit
from wages (and (4) not from any other income, as we have
remarked above); (3) is a reference to the "dynamic" ex-
planation of profit and is unclear without further elabora-
tion; (1) seems to point to a connection between profit
and risk, but this is not worked out. It is clear that these
discussions of risk, as emendations of the dynamic theory,
make no pretense of explaining the connection between
profit and uncertainty which our discussion of Professor
Clark's treatment showed to be necessary. Both writers
are, indeed, opposed to and attempt to refute the doctrine
that profit is the result of assuming risk.

The doctrine that profit is to be explained exclusively
in terms of risk has been vigorously upheld by Mr. F. B.
Hawley,1 who finds in risk-taking the essential function of
the entrepreneur and therefore the basis of his peculiar in-
come. In Mr. Hawley's distributive theory the entre-
preneur, or "enterpriser" as he is called, plays a role of
unique importance. Enterprise is the only really produc-
tive factor, strictly speaking, land, labor, and capital be-
ing relegated to the position of "means" of production.
In regard to profit, the reward of enterprise, Hawley says: 2

1 The most complete exposition of Hawley's theory is in his book.
Enterprise and the Productive Process (1907). Articles of earlier date in
the Quarterly Journal of Economics contain briefer statements.

2 An earlier attempt by Mr. Hawley to present the essentials of his
theory in the most compact form is superior in some respects and is
worth quoting:

"The final consumer is forced to include in the price he pays for any
product not only enough to cover all the items of cost to the entre-
preneur, — among which items is a sum sufficient to cover the actuarial
or average losses incidental to the various risks of all kinds necessarily
assumed by the entrepreneur and his insurers, — but a further sum, with-
out which, as an inducement, the entrepreneur, or enterpriser, and his
insurers will not undergo or suffer the irksomeness of being exposed to
risk.

"This surplus of consumer's cost over entrepreneur's cost, universally

42 RISK, UNCERTAINTY, AND PROFIT

. . . the profit of an undertaking, or the residue of the product
after the claims of land, capital, and labor (furnished by others
or by the undertaker himself) are satisfied, is not the reward of
management or coordination, but of the risks and responsibilities
that the undertaker . . . subjects himself to. And as no one, as a
matter of business, subjects himself to risk for what he believes
the actuarial value of the risk amounts to — in the calculation
of which he is on the average" correct — a net income accrues to
Enterprise, as a whole, equal to the difference between the gains
derived from undertakings and the actual losses incurred in them.
This net income, being manifestly an unpredetermined residue,
must be a profit, and as there cannot be two unpredetermined
residues in the same undertaking, profit is identified with the re-
ward for the assumption of responsibility, especially, though not
exclusively, that involved in ownership,1

Mr. Hawley is in agreement with Professor Clark and
his followers in defining profit as "residual income," and
as to the nature and basis of the special income connected
with the assumption of risk as an excess of payment above
the actuarial value of the risk, demanded because exposure
to risk is "irksome"; but Hawley insists that residual in-
come and uncertain income are interchangeable concepts,2
while Clark is equally sure that the reward of risk-taking
necessarily goes to the capitalist as such and that the pure
profit of the entrepreneur is a species of monopoly gain
arising in connection with dynamic disturbances, and that
his only income under static conditions would be wages of
management or coordination. Hawley contends that such

regarded as profit, and, from the nature of the case, an unpredetermined
residue, is the inducement for the assumption by the entrepreneur, or
enterpriser, of all the risks, whatever their nature, necessitated by the
process of production. As the inducement to any given action and the
reward for that action are the same thing, — the difference being not
in the thing itself, but only in the point of time from which it is looked
upon, — the unpredetermined residue, which served as the inducement
to risk at the commencement of any industrial transaction must necessa-
rily, when determined and realized at its close, be regarded as the result,
reward, of the risks undergone." {Quarterly Journal of Economics, vol.
xv, pp. 603-20.) (In the original the portion quoted is all in italics.)

1 Op. cit, pp. 106-07.

2 Quarterly Journal of Economics, vol. vn, p. 465; vol. xv, p. 88.

THEORIES OF PROFIT 43

income is wages merely, and not profit, and does not
distinguish between "static" and "dynamic" conditions.
Coordination, however, is in his view distinguished from
labor by the fact of proprietorship, "which is the very
essence of the matter in dispute."1 Profit cannot be the
reward of management, for this can be performed by hired
labor if the manager takes no risk, but this individual is no
longer an entrepreneur.

It is admitted that the entrepreneur may get rid of risk
in some cases for a fixed cost, by means of insurance. But
by the act of insurance the business man abdicates so much
of his entrepreneurship, "for it is manifest that an entre-
preneur who should eliminate all his risks by means of in-
surance would have left no income at all which was not
resolvable into wages of management and monopoly
gains" (i.e., no profit).2 To the extent to which the busi-
ness man insures, he restricts the exercise of his peculiar
function, but the risk is merely transferred to the insurer,
who by accepting it becomes himself an enterpriser and the
recipient of an unpredetermined residue or profit. "The
reward of an insurer is not the premium he receives, but the
difference between that premium and the loss he eventu-
ally suffers." 3

The clue to the disagreement and to the straightening-
out of the facts as well is to be found in a confusion
fallen into by those on both sides of the controversy, in
assuming that the "actuarial value" of the risks taken is
known to the entrepreneur. There is a fundamental dis-
tinction between the reward for taking a known risk and

1 "Enterprise and Profit," Quarterly Journal of Economics, vol. xv,
p. 86.

2 Quarterly Journal of Economics, vol. vii, p. 464. It should be ex-
plained that "monopoly gain" for Mr. Hawley includes all income due
to limitation, and he finds that it forms a considerable portion of wages
and interest, all of rent, and a large part of profit. We have repeatedly
observed examples of this fallacy and remarked that there is no income
which is not due to the "scarcity" of the agent securing it.

3 Enterprise and the Productive Process, p. 111.

44 RISK, UNCERTAINTY, AND PROFIT

that for assuming a risk whose value itself is not known.
It is so fundamental, indeed, that, as we shall see, a known
risk will not lead to any reward or special payment at all.
Though Willett distinguishes between "uncertainty" and
"risk" and the mathematical probability of loss,1 he still
treats uncertainty throughout his study as a known quan-
tity.2 The same applies to Johnson; he also implicitly rec-
ognizes at various points that the true chance or actuarial
value of the risk may not be known, and devotes some
space 3 to Thunen's emphasis on the distinction between
insurable and uninsurable risks; but he also fails entirely to
take account in his discussion of profit of the fact that the
risk involved in entrepreneurship is not and cannot be a
known quantity.

In a similar way Hawley repeatedly refers to the fact of
uninsurable risk as well as to "pure luck" and to "changes
that no one could have foreseen," but he fails to inquire
into its meaning or to recognize its theoretical import.4
Once he goes so far as to say that "the great source of

1 Op. cit., pp. 27 ff.

2 Risk is defined as "the objective correlative of the subjective un-
certainty" (p. 29), which varies with the mathematical chance of loss in
such a way as to be at a maximum when the chances for and against the
event are exactly even. But it is still to be regarded as a known quantity,
since the mathematical chance is assumed to be known. Willett nowhere
makes an explicit statement on this point, as Hawley does (see quotation
in text on p. 42 above), but his discussion clearly shows that it is viewed
as a known quantity. He takes his illustrations from games of chance or
from the field of insurance, speaks of the influence of "a given degree of
risk" (p. 65) on investors, etc. He does recognize the fact that the degree
of risk is not always known in fact, and discusses methods of estimating
the degree of risk; but (pp. 66 and 76) he expressly eliminates from the
discussion the consequences of error in estimating the true value of the
risk.

8 Op. cil.t p. 112.

4 The reader will recall that many of the early discussions of profit
(discussed in the early pages of this chapter), notably those of v. Man-
goldt and v. Thunen, recognized the fact that some risks are insurable
and others are not. No explanation of the fact, however, has been given,
beyond phrases such as "in the nature of the case," which imply that it
does not call for explanation.

THEORIES OF PROFIT 45

monopoly profit is to be found in the fact that the actuarial
risk of any given undertaking is not the same for different
entrepreneurs, owing to differences among them in ability
and environment";1 and again, that "profit is the result of
risks wisely selected." 2 Even here, however, he fails to
develop the point and draw the consequences from the fact
that the actuarial value of the risk undergone by any ven-
turer is not known, either to himself or to his competitors.

In a sense Mr. Hawley comes still nearer to the crux of
the matter in his insistence on the responsibility and risk of
proprietorship as the essential attributes of entrepreneur-
ship. The entrepreneur is the owner of all real wealth, and
ownership involves risk; the coordinator "makes decisions,"
but it is the entrepreneur who "accepts the consequences of
decisions." 3 He admits that others than the recognized
entrepreneur are subject to risk; the landlord is also a pro-,
prietor, and his land may change in value; the capitalist \
especially requires payment for the large risks he runs, and
a part of both rent and interest is accordingly profit. _A :
person who invests his own capital in any form of opportu-
nity necessarily combines the two functions of capitalist
and enterpriser. The same should apparently apply to the
\Jaborer, who is also admitted to run risks.

Mr. Hawley does not regard the term "risk" as calling

for special definition, but it is clear that, like the other

writers, he treats it as a known quantity; he says this much

1 "The Risk Theory of Profit," Quarterly Journal of Economics, vol.
Vii, p. 468.

* Enterprise and the Productive Process, p. 108. Cf. Carver, "Risk
Theory of Profits," Quarterly Journal of Economics, vol. xv, pp. 456 ff.,
and The Distribution of Wealth, chap. vii. Also A. A. Young in Ely's
Outlines of Economics, 3d ed., chap. xxv. The phrase "successful risk-
taking," used by both Carver and Young, like Hawley's "risks wisely
selected," is certainly descriptive of the origin of profits. What is wanted
is an examination of the meaning of risk-taking which will elucidate the
conditions under which it will be successful and show the significant
differences between cases of success and cases of failure.

* "Enterprise and Profit," Quarterly Journal of Economics, vol. xv,
p. 88.

46 RISK, UNCERTAINTY, AND PROFIT

explicitly.1 He and his opponents alike have failed to ap-
preciate the fundamental difference between a determinate
uncertainty or risk and an indeterminate, unmeasurable
one. The only practical bearing of the question as to
whether the value of the risk is known which is recognized
by Hawley is to determine whether it is likely to be insured,
which is to say merely who will get the "profit" for as-
suming it; even this point is not very explicitly made.
Now a little consideration will show that there can be no
considerable "irksomeness" attached to exposure to an in-
surable risk, for if there is it will be insured; hence there
can be no peculiar income arising out of this alleged in-
disposition. If risk were exclusively of the nature of a
known chance or mathematical probability, there could be
no reward of risk-taking; the fact of risk could exert no
considerable influence on the distribution of income in any
way. For if the actuarial chance of gain or loss in any trans-
action is ascertainable, either by calculation a priori or by
the application of statistical methods to past experience,
the burden of bearing the risk can be avoided by the pay-
ment of a small fixed cost limited to the administrative
expense of providing insurance. s

The fact is that while a single situation involving a
known risk may be regarded as "uncertain," this uncer-
tainty is easily converted into effective certainty; for in
a considerable number of such cases the results become
predictable in accordance with the laws of chance, and the
error in such prediction approaches zero as the number of
cases is increased. Hence it is simply a matter of an elef
mentary development of business organization to com-
bine a sufficient number of cases to reduce the uncertainty
to any desired limits. This is, of course, what is accom-
plished by the institution of insurance.

It is true that the person subject to such a risk may
voluntarily choose not to insure, but it is hard to distin-
1 See above, p. 42.

THEORIES OF PROFIT 47

guish such a course from deliberate gambling, and econo-
mists have not felt constrained to recognize gambling gains
in general as a special income category in the theory of dis-
tribution. If it is objected that practical difficulties may
prevent insurance even where the risk is determinate, the
reply is that insurance, in the technical sense, is only one
method of applying the same principle. We shall show at
length in our general discussion of risk and uncertainty
that if the risk is measurable, but the "moral factor" or
some other consideration makes ordinary insurance in-
applicable, some other method of securing the same result
will be developed and employed. When the technique of
business organization has reached a fairly high stage of
development a known degree of uncertainty is practically
no uncertainty at all, for such risks will be borne in groups
large enough to reduce the uncertainty to substantially
negligible proportions.

The result of the foregoing analysis should be to show the
inadequacy of the two opposed theories of profit and to in-
dicate the reasons for it and the direction in which a tenable
solution of the problem of profit is to be sought. It has
been seen, first, that change as such cannot upset the com-
petitive adjustment if the law of the change is known; and
now, secondly, that an unpredictable change will be simi-
larly ineffective if the chance of its occurrence can be
measured in any way. In a well-organized society, if
business men know either (1) what actual changes are im-
pending or (2) the "risks" they run — i.e., what is the
probability of any particular occurrence, — the effect in
the long run is the same; the only result of such changes
will be a certain redistribution of productive energy which
will take place continuously and without any disturbance
of perfect competitive conditions.1 The fact that predic-

1 It must be understood that by laws and chances being "known,"
we mean that they are generally known, known to all to whom they are of
any concern.

48 RISK, UNCERTAINTY, AND PROFIT

tion may involve costs, and likewise the organization for
grouping risks and eliminating their uncertainty, does not
negate the truth of the proposition, so long as these costs
are given elements in the competitive situation.

Yet it is equally evident that there is a principle of truth
in both the "dynamic" and the "risk" theories, and the
true theory must to a considerable degree reconcile the two
views. On the one hand, profit is in fact bound up in
economic change (but because change is the condition of
uncertainty), and on the other, it is clearly the result of
risk, or what good usage calls such, but only of a unique
kind of risk, which is not susceptible of measurement.
The Clark school has confused change with a common but
not universal or necessary implication of change, and both
schools have followed everyday speech into the fallacy of
treating risk as a substantially homogeneous category,
where a fundamental difference in kinds of risk is in fact
the key to the whole mystery.

The meaning of "uncertainty," and of the different
kinds of uncertainties, and their significance in competitive
economic relations, will therefore constitute the principal
subject which we have finally to investigate in the present
study. The next step in the progress of the argument will
be to lay a comparative basis for this investigation by at-
tempting to gain a clear view of the mechanism of com-
petitive valuation and distribution as they would be if un-
certainty and its correlative profit were entirely absent.
The next three chapters will therefore be taken up with an
examination of the conditions and workings of a perfectly
competitive society; of these conditions the crucial one
will constantly appear as the possession of accurate and
certain knowledge of the whole economic situation by all
the competitors.

PART TWO
PERFECT COMPETITION

CHAPTER III

THE THEORY OF CHOICE AND OF EXCHANGE

We turn now from historical and critical considerations
to the real work of construction. We have seen that the
historic body of economic theory rests upon the assumption
of perfect competition, but that the precise character of
this assumption has been partially implicit and never ade-
quately formulated. We do not criticize the older econ-
omists for making abstract assumptions in order to sim-
plify and analyze their problem, but contend that the
assumptions actually made and their implications need to
be brought to the surface and emphasized. To display
these implicit premises of theoretical reasoning is, we have
argued, to explain the problem of profit, the absence of
which is the essential distinction between theoretical and
actual economic society. This explanation will immediately ^.
take the form of a general inquiry into "Uncertainty," the \
presence or absence of which will appear as the most \
important underlying difference * between the conditions }
which theory is compelled to assume and those which
exist in fact. The present chapter and the two next follow-
ing will be taken up with the attempt to define and analyze
perfect competition. The argument is to be regarded as a
condensed summary of classical economic theory, with es-
pecial reference to and emphasis upon those premises and
implications which have not been adequately emphasized
in the theory itself and have been liable to escape the ob-
servation of its readers. Aside from this special emphasis
the argument will differ not a great deal from that of J. S.
Mill and very little from Marshall's "Principles."

Economics is a human science; its foundations are laid in
1 Outside of monopoly considerations. But see chapter VI.

52 RISK, UNCERTAINTY, AND PROFIT

the principles of human behavior, and consequently we
must begin with some observations on the psychology of
human conduct which controls economic life. Economic
analysis may be truly said to deal with "conduct," in the
Spencerian sense of acts adapted to ends, or of the adapta-
tion of acts to ends, in contrast with the broader category
of "behavior" in general. It assumes that men's acts are
ruled by conscious motives; that, as it is more ordinarily
expressed, they are directed toward the "satisfaction of
wants." 1 At the very outset the science is thus subjected
to notable restrictions, since it is only to a limited extent
that our behavior, even our economic behavior, is of this
character. Much of it is more or less impulsive and capri-
cious. The conclusions of economic theory must in general
be admitted subject to the qualification, in so far as men's
economic activities are rational or planned.

This limitation is far more sweeping in its scope and im-
port than is easily imagined. It raises the fundamental
question of how far human behavior is inherently subject
to scientific treatment. In his views on this point the
writer is very much of an irrationalist. In this view the

1 This is intended as a statement of historic fact, not a dogma of
necessity or desirability. To the extent that in behavior of any other sort
principles may be discovered of a sufficiently general applicability to en-
able useful conclusions to be drawn from them, there is no reason why
such principles should not be incorporated in the premises of pure theory.
On the other hand, it is indisputably legitimate to begin, as an early ap-
proximation to reality, with the assumption that all the behavior of which
we treat is of the character which certainly belongs to a great part of it.
In any case we have to separate fundamental tendencies by such a proc-
ess of analysis (i.e., abstraction) if we are to know anything about them
individually. Here we are not concerned to inquire into the possibilities
of an economics of instinct and reflex, much less to build up the science;
we rest on the fact that the historic body of speculation has dealt with
that section of behavior which we call "conduct," and, in line with our
leading aim, point out the corresponding limitations of the conclusions
from the reasoning. It would be futile to insist further (for those who
have not grasped the point already) that limitations are no valid ob-
jection to a theory, — may even be a condition of its having any worth,
— but the limitations must be recognized and appreciated.

THEORY OF CHOICE AND OF EXCHANGE 53

whole interpretation of life as activity directed toward
securing anything considered as really wanted, is highly
artificial and unreal. To be sure, this characterization seems
to hold good for an individual at a given time and place, if
the time is short enough. It is the way we think of our-
selves as acting, not for the sake of the action or experience
itself, but in order to some ulterior object. If, however, the
object is merely accidental and temporary, such "wants"
are of little service in interpreting an economic process
which must look far forward. It is the writer's belief that
this view of behavior, even though it is the view taken by
the subject himself, is superficial at best. It appears that a
relatively small fraction of the activities of civilized man
are devoted to the gratification of needs or desires having
any foundation beyond the mere fact that an impulse
exists at the moment in the mind of the subject/

Most human motives tend on scrutiny to assimilate
themselves to the game spirit. It is little matter, if any,
what we set ourselves to do; it is imperative to have
some objective in view, and we seize upon and set up for
ourselves objectives more or less at random — getting an
education, acquiring skill at some art, making money, or
what-not. But once having set ourselves to achieve some
goal it becomes an absolute value, weaving itself into and
absorbing life itself. It is just as in a game where the con-
crete objective — capturing our opponents' pieces, carry-
ing a ball across a mark, or whatever it may be — is a
matter of accident, but to achieve it is for the moment the
end and aim of being. And, as in a game again, so with
life generally, the social situation furnishes much of the
driving power, though again there are many who can be-
come intensely interested in solitaire.

The basis of a science of conduct must be fixed principles
of action, enduring and stable motives. It is doubtful,
however, whether this is fundamentally the character of
human life. What men want is not so much to get things

54 RISK, UNCERTAINTY, AND PROFIT

that they want as it is to have interesting experiences.
And the fact seems to be that an important condition of
our interest in things is an element of the unanticipated, of
novelty, of surprise. We must beware of the temptation to
judge the nature of our conduct by the way in which we
think about it. To think about it is, of course, to rational-
ize it, at least to "think" in the scientific sense, which has
pretty well preempted the word. Logical thought is in-
strumental in character, a device for controlling and using
the environment. It is, perhaps, a vice of Western civiliza-
tion that the habits of thought which condition our won-
derful material achievements tend to be carried over into
the sphere of our personal lives. The writer ventures to
surmise that this sort of thing is approaching, if it has not
already reached, a climax. The fever of achievement in an
external sense which now dominates our attitude toward
life may be expected to give place to a saner, more epi-
curean view. Men will think more in terms of thought,
beauty, and joy for their own sakes and less in terms of
what things are good for, what can be done or gotten with
them.1

Economics, as we have observed before, is the science of a
certain form of organization of human activities. The fact
of organization still further limits the scope of the dis-
cussion to the rationalistic view of activity as directed to
the satisfaction of wants conceived as given and permanent

1 It is impossible to follow out this line of thought to the length that
its importance really justifies. Considerations somewhat along the line
suggested are ably put forward in a lecture on John Rushin as an Econ-
omist, by Patrick Geddes (The Round Table Series); also by Professor
H. W. Stuart in his essay on "The Phases of the Economic Interest," in
the volume by Dewey and others entitled Creative Intelligence. Cf. also
Wesley C. Mitchell, "Human Behaviour and Economics," Quarterly
Journal of Economics, vol. xxix, pp. 1 ff.

At the opposite extreme a presentation of economics uncritically ration-
alized and devitalized to the point of approximate chemical purity may be
found in the writings of Professor T. N. Carver. The old economists em-
ployed the concept of an economic man deliberately and intelligently; for
Carver he is literally the man in the street.

THEORY OF CHOICE AND OF EXCHANGE 55

entities. Conduct itself is necessarily forward-looking, but
organized conduct is still more so. Any machinery of or-
ganization implies relatively much taking thought, since it
requires time for its development and time for its operation.
A most essential feature of economic organization as it
exists is its anticipation of the wants of the consumer
over a long and ever longer period of production; and
this anticipation implies stability in the character of the
wants themselves.

A clear view of what we are doing demands special em-
phasis on this character of economic theory as the science
of a system of organization. Human activity might be
relatively unorganized or it might be organized in many
different ways. History, and especially modern history, is
largely the story of progressive organization and its changes
in form. Organization is nearly synonymous with division
of labor. In organized activity individuals perform differ-
ent tasks, and each enjoys the fruits of the labor of others.
The two fundamental problems of organization are the
assignment of tasks and the apportionment of rewards.
In unorganized action each person performs all the tasks
by whose performance he benefits, and his reward is the
immediate, physical benefit of his own work. But when
men work together some machinery must be provided to
give each his special work and to determine the amount of
the results of others' effort which he shall obtain and the
amount of his own product which he shall give up to
others.

Modern industrial society, the "existing economic
order," performs this twofold task chiefly through free
agreement and voluntary exchange between individuals
themselves. Economic theory is the analysis of this
mechanism, viewed for the scientific purpose of simplifica-
tion as the only form of human relation. Going back to
mediaeval times or to the American frontier, we find rel-
atively little joint activity, except for the division of labor

H*t

Khl<JL> »

56 RISK, UNCERTAINTY, AND PROFIT

between the sexes and in the family. Such organization as
existed for war, religion, etc., was not along free exchange
lines. But there was always some commerce with different
regions, and this has always been worked out largely
through exchange. As time passes we find that the greatest
change is in the development of organization, and espe-
cially of the voluntary, free exchange type, though, to be
sure, the functions of the political state develop also. We
can imagine that industrial progress might have taken a
very different form. The problems of the apportionment
of tasks and rewards might be solved for a complicated,
technical civilization by an autocratic, theocratic, or mili-
taristic giving of orders and rationing of produce in which
the individual would have no voice in the least detail either
of his work or his enjoyment.1 Or, again, we might have
any one of numerous forms of democratic socialism. Some
(the anarchists) have imagined that organization might be
carried out without either exchange relations or a central-
ization of authority, simply by general consent. But it has
been and is done principally through competitive free
agreement, and our task is to study this mechanism and
not any other. (#<*y ~*+~" **«V(U ^A i.***!]

The first essential of the existing system is that it solves
its two fundamental problems together, as one. It is individ-
ualistic; it apportions tasks through the apportionment of
rewards; it is an automatic system, in which the interrela-
tions of individuals are determined by self-seeking on the
part of each. The foundation of the process is the private
ownership of productive resources — a synonym for indi-
vidual freedom. There is (as we shall see more at length as
we proceed) no difference in principle between the ownership
of one's own powers and the ownership of other productive
resources. The essence of ownership is the association or
union of these two facts: (1) control of the agency, and (2)

1 The extinct civilizations of Mexico, and especially of Peru, are
alleged to have been largely of this character.

ndi
anl
be |

THEORY OF CHOICE AND OF EXCHANGE 57

the right of disposition over its product. Modern society
(on the economic side) is organized on the theory that the
owners of productive resources will find their best use and
place them in it, because in that way they can procure the
largest returns for themselves. This system, therefore, in-
volves the assumption that even in a complex organization
the separate contribution of each separate productive
agency can be identified, and that free competitive relations
tend to impute to each agency its specific contribution as
its reward for participation in productive activity. And
to the extent that the system works at all, that we have
economic order and not chaos, this assumption must^
justified.

Trom another point of view we may envisage the task of
organization in three steps or stages :

1. Society as an organized entity must decide the rela-
tive importance of different lines of consumption as a basis
for the guidance of production. Closely connected with
this task, and worked out together with it, is the apportion-
ment of existing stocks of goods, the product of past in-
dustry, in the satisfaction of existing wants. This twofold
problem is worked out in the consumption goods market
from day to day. The study of the process constitutes the
first main division of economic science, the theory of mar-
ket price.

2. Society must actually organize production. Every
available productive agency is, so far as the system is
successful, to be assigned to that task, and grouped with
others in that way which will enable it to make the great-
est possible contribution to the social dividend (of goods
equated quantitatively according to the value scale estab-
lished in the consumption goods market). The machinery
for the direction of productive resources to their different
uses is organized in the market for productive resources.
The study of its workings is the second fundamental divi-
sion of the science. It falls into two subdivisions, short-

58 RISK, UNCERTAINTY, AND PROFIT

time distribution theory and long-time value theory.1 For
the purpose of this study the supplies of productive re-
sources must be taken as fixed, as well as the demand which
they are to satisfy. Both the prices of consumption goods
and the distributive shares are in fact much affected by
the third general problem cutting across both the others.

3. At the same time that society is employing existing
resources to satisfy existing wants it is also setting aside a
portion of its existing resources to increase the supplies of
those resources themselves, to improve the effectiveness of
their use by working out better methods of production, and
to increase its own membership in numbers and quality by
providing for an excess of births over deaths and through
education and refinement. There is thus another aspect to
the problems of relative importances and of organization.
Decision must be made as to how much of society's income
is to be diverted from present consumption and to be used
for the purpose of furthering social progress, and the di-
verted income must be applied to this purpose as effectively
as may be. The first part of the problem is solved in the
market by competition between present goods and the
prospective fruits of theiHnvestment, giving rise to a rate
of capitalization or of interest; and the second part is solved
by competition for savings between different opportunities
for their use.2

The fact that theoretical reasoning must take a large,
long-run view of life leads to a difficulty in the treatment of
wants which has been the source of much confusion. Our

1 For fuller statement see below, chapter v.

2 We must by no means be understood to assert or assume that these
things are done ideally or even in the best practicable manner by the free
exchange system of organization. In the first and third problems in par-
ticular, the formation of the social value scale and the use of resources in
furthering progress, its methods and results, are open to severe criticism.
But again we do not assert that there is any better method or solution
practically available. It is our business simply to analyze and describe the
workings of a purely voluntary, individualistic, competitive system in
relation to the fundamental tasks of ojganization.

THEORY OF CHOICE AND OF EXCHANGE 59

wants have the character of intermittence and recurrence;
in any short period of time they are satisfied with a rela-
tively small amount of what the want calls for, and we
turn to the satisfaction of some other want. But if it is
a true fundamental want it comes back again, and from
a long-run point of view they all, with their satisfactions,
take on the character of continuity. The periodicity, al-
ternation between desire and satisfaction in the case of any
one and dominance of different wants in succession, drops
out if we look ahead a considerable distance so as to in-
clude a number of "complete cycles," so to speak. This
long-run point of view is the one necessarily taken by a
planned program of satisfying wants; it is evident that our
activities at a moment are not predominantly affected by
the thing we happen to be "hungry" for at that moment.
When we go into a store to make our purchases we do not
consult the momentary state of appetite or satiety in re-
spect of any particular need, but its long-run importance
in our existence viewed as a continuous process.

The problem of want-satisfaction is, therefore, a problem
in 'proportions, or relative rates. The question is not how
much absolutely of this or that, but how much — i.e., how
large a share — of our time or income is to be devoted to
each need or line of activity, how much per year or some
other period long enough to get rid of the fluctuations.
We can get the point of view by imagining that we had to
plan our lives for a year on the first of January and live out
the plan in detail. Economic discussion in terms of " quan-
tities" of effort or satisfaction or choice between alterna-
tives, under the influence of motives as immediate desires,
is therefore elliptical, and more or less dangerous. The
quantities of economics are properly rates, the motives not
desires immediately present to consciousness, but detached
judgments of need or value.

A fundamental fact about wants is their habit of con-
flicting among themselves. In fact, conflict seems to be

60 RISK, UNCERTAINTY, AND PROFIT

essential to the very nature of conscious desire. It is
questionable whether wants, as conscious motives to con-
duct, ever exist unless we are in a position of having to
choose, to adopt one line of conduct and renounce another.
Wants must be distinguished from needs which do not enter
into our planful ordering of life. We "need" iodides and
vitamines, and an infinite number of things of whose exist-
ence the race at large has been blissfully ignorant; but we
do not "want" them, because they give rise to no con-
flicts and hence no "conduct." The common basis of con-
flict, and we may say of the existence of wants at all, is the
limitation in the means of gratifying some impulse or need.
When some means of satisfaction is limited in amount so that
we have to plan its use and plan to increase its supply,
then it enters into the field of conduct and we have a want.
The most common and fundamental conflicts are between i
claims for our own time -and energy, and after these upon
some limited material agency or means employed as an aid
in satisfying ourselves. Our personal powers are, of course,
limited absolutely, and limited in fact still further, con-
ditionally, by the tendency of exertion to become disagree-
able, giving rise to a "want" to avoid it.1 The confusion
to be avoided is that between a want, proper, as related to
consciously planned action, the weighing of alternatives,
and such things as supposed needs or metaphysical ex-
planations of the immediate fact.

1 It is outside our purpose to attempt a detailed classification of wants.
We may notice in passing the difficulty of distinguishing between really
different wants and different means of satisfying the same want. For
example, we may speak of the want for food, or wants for different foods;
one can supply the place of another within limits, but only within limits,
and finally the desire for variety itself becomes a want. In our view
wants must be classified for the purposes of economic science in accordance
with the actual market classification of goods. Nor shall we pretend to go
into the psychological problem of the basis of desire. Our discussion deals
with things in relation to conduct, and it is a matter of no concern
whether we want the things or the conscious states we expect to derive
from them, or what, so long as the relation between the acts themselves
and the material changes toward which they are directed is clear.

THEORY OF CHOICE AND OF EXCHANGE 61

The power of things to satisfy conscious wants, or
quality of being wanted, is utility in the economic sense,
which is equivalent to "power over conduct." Utility, of
course, must have the same fundamental properties or
dimensions as want; it is not, therefore, a quantity in any
simple sense, but a quality having intensity, or a rate. We
speak of the utility of a given amount of a thing, but this
again is elliptical; the psychological variable is in fact a
degree of utility of a certain rate of consumption of the
good. And as want is a correlate of conflict, utility is a
correlate of limitation; intensity of want and rate of supply
of means of satisfying it are strictly connected, each vary-
ing inversely as the other; that is to say, as a good is sup-
plied for the satisfaction of any want at higher rates it
loses degree or intensity of utility in that use and gains
(degree of) utility in the conflicting employment.1 The
confusion between a want and a need or hypothetical
reason for having the want is manifest in the field of
utility in ascribing economic utility to "free" goods, goods
that exist in superabundance. This is a pernicious error.
Such goods have no causal relation to conduct and no
place in a science of conduct. The confusion has doubtless
arisen from the fact that there are many things like air and
water which under some circumstances do come to have
power over conduct, or utility, though ordinarily they do
not. This fact brings home to our consciousness their
"potential" utility, the fact that they would have great
utility if cut off or subject to limitation; but they have
utility only when not free.

1 There seem to be and perhaps are exceptional cases where this de-
scription does not fit the facts; there seem to be, that is, absolute wants,
based on absolute limitation and not on limitation due to conflicting
demand for the means of satisfaction. These are certainly of negligible im-
portance in economics, however, and on scrutiny they have a tendency to
lose the character of "wants" altogether. It is hard to see how a science
can deal fruitfully in a constructive way with utterly capricious phenom-
ena; of course it must deal with them in the sense of recognizing that
they exist and form a limitation on the completeness of theory, but they
can hardly be taken account of in the theory itself.

62 RISK, UNCERTAINTY, AND PROFIT

/ Diminishing utility is the scientific designation for the
general fact that as any want is satisfied relatively to
others x it diminishes in intensity, or, from the point of
view of the means of satisfaction, that the one loses in
utility and the other gains. The essential relation of con-
flict and relativity of utilities is somewhat obscured by the
existence of intermediate "means" of satisfaction, and even
of series of such. But the further course of the analysis
will show that without significant exception there is always
in question a diversion of the ultimate means from one use
to another; it is a matter of alternatives, and the ground of
one want or satisfaction being alternative to another is the
r dependence on a common, limited means of satisfaction.

The intermittence of wants, with wave-like alternation
of desire and satisfaction, tends to give a false conception
of diminishing utility. It is beside the point to talk of
boys eating successive oranges or other "dinner-table"
illustrations as is so commonly done. The serious error
resulting from this method is that it gives the impression
that there is a difference between the utilities of different
portions of supply. This also is fatal to clear thinking, as
will be seen if the contrast between such a situation and
that of laying in supplies for a long time in advance (or
even an ordinary shopping trip) is considered for a mo-
ment. The utility of any one unit is, in its effect on con-
duct, which is the only relevant consideration, exactly
like that of any other; the essential fact is that as there
are more units relatively, the utility per unit or utility of
any unit is relatively less.

1 We carry some wants to complete satiety because it takes less effort
than would be required to calculate accurately the most desirable place
to stop when this point would be near the absolute satiety limit, as in the
case of eating bread, for example. The fact may serve to illustrate the
fundamental "irrationality" of a perfectly "rational" attitude to life.
One of our most significant "wants" is freedom from the bother of cal-
culating things or making close estimates. Cf . J. M. Clark, " Economics
and Modern Psychology," Journal of Political Economy, vol. 26, nos.
1 and 2.

THEORY OF CHOICE AND OF EXCHANGE 63

The fact of relativity is important, because easily and
commonly lost sight of. Every valuation is a comparison; <
we have no conception of an absolute utility or an absolute
standard of utility. The notion of value is meaningless
except in relation to alternatives of choice. Not only is
utility measured by another utility, — all things are
measured by things of their own kind as standards, —
but its existence is conditioned by that of the alternative; it
is like a force in the physical world; action and reaction are
equal, a force cannot be imagined separate from an equal
and opposite force or resistance.

The case of conflict of utilities most crucial in economic
analysis is the familiar alternative of enjoying utilities at
the expense of effort vs. sacrificing the utility for the sake of
freedom from the exertion. "Labor" is usually thought of
in an inverted, positive sense as a disutility. It is im-
portant to see that there is sufficient practical reason for
this usage, but also that there is really no exception to
the general principle of alternatives without distinction of
kind.cThe point is that "labor" is really the sacrifice of
some desirable alternative use of one's time and strength.
.rlf there is no alternative there is no sacrifice, nor any
motivation, valuation, or "problem" of any kind. In
truth, there is no distinction for conduct between a pain
and the absence of a pleasure; it is all a matter of choice
between alternatives, of "preference." The pleasure-pain
question belongs exclusively in the field of the inner con-
sciousness, and has no bearing on problems such as those
of economics.1 ;:The valid reason for the distinction between

1 Even "for consciousness" the difference between pleasure and the
absence of pain and conversely, though real, is of an "accidental" and
very elusive character; we cannot formulate a difference between the two
series or classify experiences between them. It is too obvious to call for
discussion that the same event will be a pleasure to one person and a pain
to another, and even pleasurable to the same person at one time and pain-
ful at another, according to circumstances, and, especially, expectations.
The difference fades out on scrutiny. An inheritance of a hundred thou-
sand, which is a pleasure to one to whom it is a surprise, may be an in-

64 RISK, UNCERTAINTY, AND PROFIT

kinds of alternatives, for fixing our attention on something
chosen in one case and something avoided in another, is,
as will be shown more at length later on, that we are inter-
ested in measuring the alternatives, and we can come nearer
a satisfactory quantitative determination of time and
effort than we can of the indeterminate uses that would
have been made of them if the labor of producing the
(measurable quantity of) goods had not been performed.

The whole theory of conduct may now be summed up,
as far as it is relevant for our purposes, in a comprehensive
Law of Choice": When confronted with alternative, quanti-
tatively variable lines of action or experience, we tend to com-
bine them in such proportions that the physically correlated
amounts or degrees of each are of equal utility to the person
\ choosing.1

tense grief if he has expected and made his plans for ten million. A prison
sentence is undoubtedly a source of joy to a man who counted on being
hanged, and it is ridiculous to say that it is "really" only an escape from a
worse pain, or the inheritance a deprivation of a greater pleasure. The
comparison of alternatives and fact of preference is the real thing; pleas-
ure and pain are accidental and arbitrary matters.

1 The phrase "equal utility," as we shall presently see, should be
taken to refer merely to the fact of indifference in choice, and not a com-
parison between quantities in the true sense at all. We avoid the expres-
sion "marginal " utility, because of its implication that there is a difference
in the significance of different portions of the same supply. In speaking of
the utility of a supply, however, it is sometimes useful to have some word
to distinguish between the utility per unit and the utility of the supply
as a whole. When it seems advisable we shall use the expression " specific
utility" to indicate utility per unit.

The general method of taking the principle of choice as the starting-
point of economic reasoning and treating "diminishing utility" in a com-
parative sense has been used with especial clearness and force by Wick-
steed {Common Sense of Political Economy), and is also adopted by Fetter
in his recent work {Economic Principles). Economists generally have been
coming to recognize that the psychology of the subject is properly be-
havioristic; that an economist need not be a hedonist (Jevons and Edge-
worth notwithstanding), and that he does not need even to consider the
issue between rival psychologies of choice. See Mitchell, "The Role of
Money in Economic Theory," Proceedings, Twenty-Eighth Annual Meet-
ing of the American Economic Association. The principle of relativity of
utility and value holds in the same way under any theory of motivation.

THEORY OF CHOICE AND OF EXCHANGE 65

A somewhat different statement of the principle of
choice may better emphasize the basis of the alternative
character of the alternative lines of conduct, the fact that
not only must one give up more of the one to get more of
the other, but that this is true in a quantitative sense,
that a definite amount of one is given up in return for a
definite amount of the other. The reason for this fact we
have found in the circumstance that the two kinds of satis-
faction are both dependent on some common "means"
or "resource." Accordingly we may restate the funda-
mental law of conduct in this way: In the utilization of
limited resources in competing fields of employment, which is
the form of all rational activity in conduct, we tend to ap-
portion our resources among the alternative uses that are open
in such a way that equal amounts of resource yield equivalent
returns in all the fields. ;

This formulation makes it possibly a little more obvious
that the principle is a true statement of the goal of rational
planning. For, clearly, if a given unit of a given resource
is yielding in one use a want satisfaction preferable to that
which a similar unit is yielding in another, the yield of that
resource can be increased by transferring some of it from
the second use to the first until the importance of the one is
increased and of the other decreased to the point of equiva-
lence.1

B. M. Anderson, Jr. (Social Value, and Value of Money, chap, i) advocates
a theory of absolute social value, defining value, as we have done, as power
to motivate conduct. It is hard to explain his failure to see that this
notion is as relative as any other, is in fact the most obviously relative of
all. Motivation of conduct means of "this" conduct rather than some
other, and is obviously inconceivable apart from a situation presenting
alternatives between which comparison and choice must be made.
Davenport, also (Economics of Enterprise, chap, vii), while insisting on
the importance of relative utility in economic reasoning, treats utility
itself as an absolute magnitude. The present writer finds it impossible
to conceive such an entity.

1 Close scrutiny makes it appear doubtful just how much real ex-
planatory value the viewpoint of the utilization of resources adds to the
bare principle of combining alternatives. It seems that what we call a

66 RISK, UNCERTAINTY, AND PROFIT

It will be apparent that utility curves, as commonly
drawn, representing diminishing utility and increasing
sacrifice as absolute and independent magnitudes, and as-
cribing varying utility to successive units of commodities
(and of disutility of exertion), require considerable modi-
fication or reinterpretation if the foregoing reasoning is
valid. If utility is relative and in its essence a comparison,
such a curve can only represent one variable measured in
terms of the other, or each curve presupposes the other
already drawn. The role of money in the process tends
to complicate and confuse the exposition still further.
w^The principles above stated in general terms can be
brought into relation with current treatments of the sub-
ject and with concrete fact if we begin by taking up a
simple case of choice between alternatives such as is con-
stantly dealt with in economic analysis. Let us take Mar-
shall's 1 example of a boy gathering and eating berries, but
with the stipulation that some re-wording would be neces-
sary to make the exposition accurately fit the case of
choice between (i.e., combination of) alternatives in a com-
prehensive, long-time, plan of conduct. We can hardly
suppose that the boy goes through such mental operations
as drawing curves or making estimates of utility and dis-
utility scales. What he does, in so far as he deliberates

"resource" is such, not on its own account, but solely because of the uses
to which it can be put, and its quantitative aspect, how much resource
there is, is still more evidently determinable only in terms of the use.
But at least the resource idea helps us to mediate in thought the fact of
the quantitatively alternative character of the opposed lines of utilization,
as is shown by the fact that we habitually make use of it. The form of the
unsophisticated psychosis in regard to sacrifices or "costs" is in fact a
bit puzzling. If we ask what a thing has cost, we seem inclined to answer
first in terms of money or effort, etc., i.e., of "resources " ; but when pressed,
we are likely to go back of the latter and evaluate the resource in turn in
tefms of some other utility which might have been had for it. The "on-
tologizing" of the notion of resources seems to be an illustration of an
"instrumental concept," but one which it would be difficult to get along
without.

1 Principles of Economics, book v, chap, n, sec. 1.

THEORY OF CHOICE AND OF EXCHANGE 67

between the alternatives at all,1 is to consider together,
with reference to successive amounts of his "commodity,"
the utility of each increment against its "cost in effort,"
and evaluate the net result as either positive or negative,
either of a character to prompt the combined action of
production and consumption of that unit, or not of this
character. The "cost in effort" is evidently in fact the
sacrifice of some alternative use or uses of the effort. Even
that nondescript conduct called merely idling is still con-
duct, an alternative motive, and subject to the law of
diminishing utility or relative proportions like any other.
However, while to the eye of critical scrutiny there is no
"logical" distinction between an increasing disutility ex-
perienced and an increasing utility foregone, a "psycho-
logical" difference must be admitted; there is no difference
for conduct, but there is one for consciousness, to our
pecuniarily sophisticated consciousness at least.

If it is desired to represent the situation graphically
without the misleading implications of a comparison of
separate absolute variables, it can be done by omitting the
commodity axis as in the accompanying figure. The line
OY is merely directed in space to show that "preference"
increases in a vertical direction. Quantities of commodity
are measured by a scale as shown, but the "utilities" are
not fitted to any scale at all. If we call the curve U which
represents the desirability of the commodity, and the

1 Which, to be sure, is not very far. Nor is this any criticism of the
boy. Quite the contrary ! It is evident that the rational thing to do is to
be irrational, where deliberation and estimation cost more than they are
worth. That this is very often true, and that men still oftener (perhaps)
behave as if it were, does not vitiate economic reasoning to the extent
that might be supposed. For these irrationalities (whether rational or
irrational!) tend to offset each other. The applicability of the general
"theory" of conduct to a particular individual in a particular case is
likely to give results bordering on the grotesque, but en masse and in
the long run it is not so. The market behaves as if men were wont to
calculate with the utmost precision in making their choices. We live
largely, of necessity, by rule and blindly; but the results approximate
rationality fairly well on an average.

68

RISK, UNCERTAINTY, AND PROFIT

other E for exertion, the one will show a (relative) fall in

value and the other a (rela-
tive) rise as the production
and consumption of the
commodity increases. It is
a matter of indifference
whether the ascending curve
is thought of as a sacrifice
or a positive pain, whether
the growing motive to di-
vert energy from the use in
question is imaged as an
attraction or a repulsion.
The intersection shows that
at a certain point (on the commodity scale) the diversion
will take place.

Beyond this point the curves have still less meaning
for the reason that the E curve really represents nothing
definite, but merely any alternative whatever; as drawn
they indicate a rapidly increasing pressure against this
particular line of activity. The curves indicate no absolute
values of any sort; the vertical distance between them alone
has meaning, each being the "base" for the other; this
distance shows what might be called the "net utility" of
picking and eating the successive increments of berries, as
compared with all possible alternatives of conduct.

A still simpler and less ambiguous way to represent the
facts would be to draw on a Cartesian plane a single curve
of "net utility," as in the accompanying sketch. This
curve will cut the X or commodity axis at the point where
some other alternative becomes preferable, and then fall
away rapidly into the "negative utility" field. It will be
seen that the Y values of the curve have only the vaguest
quantitative character. The boy not only does not ask
how much sacrifice is how many berries worth, but merely,
are these berries worth the sacrifice; he does not even ask,

THEORY OF CHOICE AND OF EXCHANGE

"by how much** are these berries worth "the" sacrifice.
There is no true psychic
quantity involved; only
the commodity is meas-
ured or measurable. Still,
there is a certain feeling
of quantitative variability
in the degree of prefer-
ence, and such a curve is
not utterly false to the
facts of consciousness. The
only point of clearly de-
terminate locus on the
curve is the zero point, and
it is questionable whether that is to be interpreted as a
quantitative equality between opposite incentives to ac-
tion or merely the absence of incentive altogether.1

It follows at once from the non-quantitative or indefi-
nitely quantitative character of the psychic variables2

1 The discussion assumes that the quantitative relation between the
alternatives themselves remains unchanged, that one is sacrificed for the
other in the same ratio throughout, or "resources" converted into both at
the same rate. In practice this is only exceptionally possible; in general
not only the relative importance of given quantities of alternative goods
will change as the supply changes, but in addition the amount of one which
must be sacrificed to obtain a given amount of the other will increase as
the supply of the first increases; i.e., a "law of diminishing productivity"
(likewise a law of proportions merely) becomes operative in addition to
the law of diminishing utility (and works in the same direction).

Professor Patten has raised the objection to the utility analysis that
consumption also requires time, which must be saved out of the pro-
ductive operations. (See Annals, Amer. Acad. 1892-93, pp. 726-28. Cf.
also Edgeworth, Mathematical Psychics, p. 68, where the energy as well as
time required for consumption is considered.) It seems logically more
accurate, however, to include in production everything except the actual
experience of satisfaction, and if this is done the objection loses its force.
In our method of approach to the problem, viewing it as a matter of
choice between (i.e., combination of) alternatives, and taking the al-
ternatives simply for whatever they may be in the facts of the case, the
whole issue loses its relevance.

2 This may be expressed in technical phrase by saying that they are

70 RISK, UNCERTAINTY, AND PROFIT

that the "surpluses" which have cut so much figure in eco-
nomic discussion are very shadowy and elusive things, if
not altogether unreal. If the ordinates of the curves dis-
cussed above mean nothing definite, of course the areas
under the curves mean no more. The fallacious notion of
the surplus follows naturally from the confusion between
momentary satiety and the correct standpoint, the estima-
tion of relative importance of things in planning ahead,
commented on above. The illicit use of "dinner- table"
illustrations in the exposition of diminishing utility shows
the same error. We cannot insist too strongly upon the
point that men do not determine the expenditure of their
income, generally speaking, on the basis of a comparison of
momentary cravings for things for instantaneous consump-
tion. A child in a candy store would not do that. From
such a viewpoint there is a psychic difference in different
units of a commodity, and it might be possible to sub-
stantiate a surplus doctrine. But this is not the view-
point of economic reasoning, because in so far as men plan
at all, they do not expend their incomes and so fix the
prices of things and determine the utilization of social re-
sources and the whole structure of the competitive eco-

" ordinal" rather than "quantitative"; they are variable, but not meas-
urable, can be ranked, but not added. The nature of this attribute will lose
its mystery if any simple sensation, as a sensation, is considered for a
moment. It is easy to tell when one light is brighter than another, im-
possible to tell how much brighter. The intensity of light is indeed
"measured" by science, but it is done by a method analogous in principle
to the discussion of utility above. One light is removed to such a distance
that it becomes equal in intensity to the standard, and the distance is
measured. Obviously this does not involve the measurement of sensation
at all. Similarly, a thermometer does not measure the sensation of heat, or
a balance that of weight. A better illustration of "ordinal" variables is
furnished by the field of aesthetics (another form of "value," of course).
We can tell that one poem or picture is better than another, but no one
would seriously propose measuring the superiority. To be sure, in school
and in contests we may go through the motion of "grading" such things
(even deportment !) on a percentage scale, but no one whose opinion is
entitled to respect attaches any particular weight to the results of this
make-believe.

THEORY OF CHOICE AND OF EXCHANGE 71

nomic system, on the basis of that sort of calculation.1
If we take a rational attitude toward the problem of value
— as, for example, by the device, previously suggested, of
placing ourselves in the position of one who had to deter-
mine the apportionment of his resources for a year or five
years in advance — we shall get a different view of it. Then
the earlier units are no different from the later ones, on
either side of the balance; up to a certain point the balance
is positive, then it suddenly becomes negative, and when
the balance is struck the debits and credits are equal.
There is a sort of Emersonian principle of Compensation
applicable to every item; each is worth what it costs, but
also costs what it is worth.

It does not at all follow that we have proved the pleasures
of life just equal to its pains. That question is irrelevant to
our problems, and our analysis has nothing to say about it.
It is not the province of economics to determine the value
of life in "hedonic units" or any other units, but to work
out, on the basis of the general principles of conduct and
the fundamental facts of the social situation, the laws
which determine the prices of commodities and the di-
rection of the social economic process.2 It is therefore not

1 That to a considerable extent purchases are based on momentary
impulse and not on an estimaticr- of relative long-time significance, is,
of course, true, and perhaps increasingly so with the development of the
"anti-social" arts of window-dressing, display advertising, and salesman-
ship. This is one of the important "allowances" that has to be made in
applying economic theory to actual fact, until the progress of the science
reduces the phenomena to general laws and incorporates them into the
deductive system. (Cf. above, p. 52, and note; also p. 61, note.) Effects
balance out to approximate rationality under the law of large numbers.

2 The doctrine of the surplus is one of the few points where the writer
is compelled to disagree with Marshall on a fundamental matter of doc-
trine. (See Principles, 6th ed., pp. 125-33, esp. p. 129, note.) The ques-
tion relates to "scope and method," however, rather than to fact or logic.
I simply cannot see any use for the notion in understanding human con-
duct or explaining economic phenomena, and am convinced that the con-
fusion of viewpoint which underlies putting it to the fore has led to serious
error and the drawing of wholly irrelevant conclusions from economic
reasoning. Moreover, an appeal to "unsophisticated common sense"

72 RISK, UNCERTAINTY, AND PROFIT

quantities, nor even intensities, of satisfaction with which
we are concerned (though the limitations of language com-
pel the use of these terms at times), or any absolute magni-
tude whatever, but the purely relative judgment of com-
parative significance of alternatives open to choice. Now,
for conducty it is self-evident that the importance of any-
thing is the effort or sacrifice necessary to get it. Two
things, each of which can be obtained at will by the sacri-
fice of the other, cannot conceivably have any other than
equal importance from this point of view, and it is mean-
ingless to speak of a surplus. The situation is especially
clear in an exchange system wkith fixed prices where
things can be converted at will at known rates by purchase
and sale. We submit that it is clearly impossible, in such a
situation, to conceive of things serving as motives to ac-
tion in any other than the established ratios of conversion
or substitution.

For understanding the psychology of valuation, the two
points are equally important: (1) that, logically, choice is
a matter of comparing alternatives and combining them
according to the law of rational procedure above formu-
lated,1 and (2) that there is none the less a practical differ-
ence between two kinds of alternatives in an ordinary
situation. This difference is perhaps connected with the
distinction between our feelings of painfulness and pleas-
antness, but in its essence it relates to the quantitative
character of the alternatives (in their physical aspects, not
the psychic states involved). In the case just considered, of
the boy and berries, the difference is evident from the fact

seems to fail utterly to substantiate the existence of the phenomenon,
A man might pay, say, a thousand dollars for the "first" loaf of bread
(whichever one that is) rather than do without it, but it does not follow
and is not true that when he gets it for a dime he gets $999.90 worth of
free satisfaction. Various thinkers have perceived the mythical character
of these alleged surpluses; it is hoped that the argument above will sug-
gest the source of the error and so render it more easily identified and
avoided.

1 Pages 64, 65.

THEORY OF CHOICE AND OF EXCHANGE 73

that we use the berry alternative to measure the leisure
alternative. We speak of a certain quantity of berries and
the sacrificed alternatives corresponding to them, not
of a certain quantity of alternative independently deter-
mined. The "trouble," "exertion," or what-not is not
quantitative on its own account, it is measured by the
berries; it is "the" amount of exertion, etc., connected with
a specified amount of the measurable commodity. This
result is inevitable because, as remarked above, "the" al-
ternative is not in fact some particular alternative, but any
alternative; it is not merely not measurable, but is hetero-
geneous and wholly indeterminate. It is this fact which
throws us back on the conception of "resources" for ra-
tionalizing the deliberative process, making of it a quan-
titative comparison; it is this fact which gives its great
importance to the "time" measure of effort. Time does
not in any true sense measure the alternative or sacrifice,
and, as we have seen, its employment in any use is a sacri-
fice in the first place only because there are other uses for
it, which are the real sacrifice; but it is measurable, and our
intelligence, forced to have something quantitative to feed
upon, like the proverbial drowning man catches at any
straw.

In spite, therefore, of the purely relative character of
pain and pleasure and of the essential parity as motives of
all alternatives of conduct, it is pragmatically necessary
to distinguish in productive activity between the incoming
"economic" utility and the sacrificed (resources, repre-
senting) non-economic, unspecified alternatives in general,
between utility and disutility, or commodity and cost.
"Cost," in this sense, is "pain cost," or "opportunity cost,"
as one prefers; there is no real difference in meaning be-
tween the two.

From this long but apparently necessary discussion of
the fundamentals of valuation of psychology, we may pro-
ceed to consider a somewhat more complicated situation,

74. RISK, UNCERTAINTY, AND PROFIT

as an approach to the study of the principles as mani-
fested in the field of exchange relations. We will suppose
an individual choosing between the production and con-
sumption of a large number of " commodities,' ' in addition
to the alternative of not producing any of them, but of
putting his time, etc., to "non-economic" uses. This is the
situation of Crusoe on his island, of which many economists
have made use. The same law of choice will hold as before;
between any two alternatives or among all that are open,
the man will choose such amounts, or divide his time and
"resources" among them in such proportions, that the
physically alternative or correlated quantities of all are to
him equally desirable. The only difference is that the alter-
natives are more complicated than in the case of the boy
and his berries, and of a somewhat different character; in
particular, the presence of a number of economic alterna-
tives, involving concrete, measurable sources of satisfac-
tion, is important.

In Crusoe's mind there would undoubtedly be built up
something of the nature of a price system or value scale, if
he seriously attempted to get the maximum of satisfaction
out of the conditions of his environment. For an "intelli-
gent" use of his opportunities can be arrived at in no other
way. He must ascertain the ratios in which different goods
are to be obtained for subjectively equivalent sacrifices in
"effort," and similarly form judgments of their relative
subjective importance to him, and attempt to bring the
two sets of ratios into coincidence. But a set of equivalence
ratios or scale of equivalent amounts of things is the essence
of a price system. Exchange is a means by which things
may be conveniently converted into or sacrificed for each
other in determinate amounts, and substantially the same
result follows from choosing between different lines of
production in a Crusoe economy. It is sufficiently evi-
dent that the quantities involved in such a calculation are
quantities of things and not of satisfaction or any psychic
magnitude.

THEORY OF CHOICE AND OF EXCHANGE 75

The role of the "resource" idea and the concept of
"cost" will also take on characteristic form in the Crusoe
case. The mental labor of evaluating everything in terms
of everything else must force recourse to a crude meas-
urement of "effort" as the common standard of value or
"medium of exchange" (it is almost like that) for medi-
ating the comparisons. It is clear that this is an "in-
strumental" but none the less very important device.
"Really," it is purely a question of combining alternatives,
among which are those indefinite, "non-economic" occu-
pations, exploring the island, chatting with the parrot,
sport or recreation of any appealing kind, or "loafing and
inviting the soul." But the indefinite, heterogeneous, and
uncertain character of these last, and the convenience
of "time" as a rough basis for an approximate evaluation
of the stuff they are made of, make it a matter of economy
to resort to its use as a common denominator of alterna-
tives. It will not be true that all things produced in equal
times will be equated, for there are elements of "irksome-
ness," etc., which have to be taken account of. Crusoe's
value scale will probably be based on time as a "first ap-
proximation" with mental allowances for the other factors
to be considered.

Measurement relations will be reciprocal, in this case as
always. The use of effort to measure other things amounts
to an evaluation of effort in terms of other things. Thus
we get the concept of a quantitative outlay cost meaning
something more than merely any sacrificed alternative.
As pointed out before, in stating in terms of "resources"
the general law of choice among alternatives, this con-
cept of cost has no very substantial independent meaning;
"when pressed" we reformulate our resource or effort (or
money) costs in terms of positive alternatives we might
have had; but as a mediating, instrumental idea, it is none
the less a useful and universally used notion. There is,
however, no occasion to speak of a possible divergence

76 RISK, UNCERTAINTY, AND PROFIT

between outlay cost and value return, of anything like a
"profit" from operations.

There are many intermediate stages in the successive
complication of alternatives which might be discussed, and
which would shed light on various phases of economic
relations; but for present purposes it is best to pass at
once to the case of a group of people producing goods for
exchange in a free market. The relations among the want-
satisfying activities of a plurality of persons are based
upon another "conflict," the conflict between similar wants
of different individuals, to a large extent dependent on
common, immediate means of satisfaction, while these im-
mediate goods are almost entirely dependent upon a com-
mon fund of ultimate productive resources. The effect of
the possibility of exchange is vastly to multiply and com-
plicate the alternatives open to any individual. He is now
free, not merely to make any possible combination of com-
modities for production and consumption, but to com-
bine the production of some with the consumption of any
combination — on terms afforded by an established set of
exchange ratios, the investigation of which is the principal
problem before us. In order to study first the most essen-
tial features of exchange relations, it will be necessary to
simplify the situation as far as possible by a process of
"heroic" abstraction. We therefore explicitly make the
following assumptions as to the characteristics of our im-
aginary society:

1. The members of the society are supposed to be nor-
mal human beings in essential respects as to inherited and
acquired dispositions, differing among themselves in the
ways and to the degrees familiar in a modern Western
nation — a "random sample" of the population of the
industrial nations of to-day.

%. We assume that the members of the society act with
complete "rationality." By this we do not mean that they
are to be "as angels, knowing good from evil"; we assume

THEORY OF CHOICE AND OF EXCHANGE 77

ordinary human motives (with the reservations noted in
the following paragraphs); but they are supposed to "know
what they want" and to seek it "intelligently." Their be-
havior, that is, is all "conduct," as we have previously de-
fined the term; all their acts take place in response to real,
conscious, and stable and consistent motives, dispositions,
or desires; nothing is capricious or experimental, every-
thing deliberate. They are supposed to know absolutely
the consequences of their acts when they are performed,
and to perform them in the light of the consequences.

3. The people are formally free to act as their motives
prompt in the production, exchange, and consumption of
goods. They "own themselves"; there is no exercise of
constraint over any individual by another individual or by
"society"; each controls his own activities with a view to
results which accrue to him individually. Every person is
the final and absolute judge of his own welfare and in-
terests.1

4. We must also assume complete absence of physical
obstacles to the making, execution, and changing of plans
at will; that is, there must be "perfect mobility" in all
economic adjustments, no cost involved in movements or
changes. To realize this ideal all the elements entering
into economic calculations — effort, commodities, etc. —
must be continuously variable, divisible without limit.
Productive operations must not form habits, preferences,
or aversions, or develop or reduce the capacity to perform

1 Dependent members of the society must be completely dependent on
some particular individual in it. The wants of any dependent person will
then operate only through wants on his behalf felt by his sponsor, and we
need not consider them at all. We need simply regard the independent
members of the society as having normal solicitudes in regard to families,
etc., but each person enters into economic life on an absolute equality
with others or not at all.

The meaning of the above assumptions is not necessarily that they
form a complete description of the people and their relations. This is
but an emphatic way of saying that we here consider only their mar-
ket behavior, which is assumed to conform to these specifications.

78 RISK, UNCERTAINTY, AND PROFIT

them. In addition, the production process must be con-
stantly and continuously complete; there is no time cycle
of operations to be broken into or left incomplete by sud-
den readjustments. Each person continuously produces a
complete commodity which is consumed as fast as pro-
duced. The exchange of commodities must be virtually
instantaneous and costless.

5. It follows as a corollary from number 4 that there
is perfect competition. There must be perfect, continuous,
costless intercommunication between all individual mem-
bers of the society.1 Every potential buyer of a good con-
stantly knows and chooses among the offers of all potential
sellers, and conversely. Every commodity, it will be re-
called, is divisible into an indefinite number of units which
must be separately owned and compete effectually with
each other.

6. Every member of the society is to act as an individual
only, in entire independence of all other persons. To com-
plete his independence he must be free from social wants,
prejudices, preferences, or repulsions, or any values which
are not completely manifested in market dealing. Ex-
change of finished goods is the only form of relation be-
tween individuals, or at least there is no other form which
influences economic conduct. And in exchanges between
individuals, no interests of persons not parties to the ex-
change are to be concerned, either for good or for ill. In-
dividual independence in action excludes all forms of
collusion, all degrees of monopoly or tendency to monopoly.

7. We formally exclude all preying of individuals upon
each other. There must be no way of acquiring goods
except through production and free exchange in the open
market. This specification is really a corollary from num-
bers 2 and 3, which exclude fraud or deceit and theft or

1 It goes without saying that our imaginary society is "isolated."
Every individual who has anything at all to do with it is in it and of it on
a par with all the rest.

THEORY OF CHOICE AND OF EXCHANGE 79

brigandage respectively, but it deserves explicit mention.

8. The motives for division of labor and exchange must
be present and operative. These have never been ade-
quately treated in the literature of economics in spite of
the fact that the subject has been discussed more or less
by countless writers on social problems from Plato down.
The principal condition is diversification of wants associated
with specialization of productive capacities or dispositions,
or with physical restrictions on the range of productive
activity. An important fact in this connection in the real
world is the space distribution of the different resources of
the earth and the limitations on human mobility. In
addition the physical nature of the production process fre-
quently calls for the simultaneous prosecution of a number
of operations. For simplicity we shall assume that the first
two conditions alone are sufficient to restrict each individ-
ual to the production of one single commodity at any given
time. (Cf. number 11.)

9. All given factors and conditions are for the purposes
of this and the following chapter and until notice to the
contrary is expressly given, to remain absolutely un-
changed. They must be free from periodic or progressive
modification as well as irregular fluctuation. The con-
nection between this specification and number 2 (perfect
knowledge) is clear. Under static conditions every person
would soon find out, if he did not already know, every-
thing in his situation and surroundings which affected his
conduct.

The above assumptions, especially the first eight, are
idealizations or purifications of tendencies which hold good
more or less in reality. They are the conditions necessary
to perfect competition. The ninth, as we shall see, is on a
somewhat different footing. Only its corollary of perfect
knowledge (specification number 2) which may be present
even when change takes place, is necessary for perfect
competition. In addition to these differences in degree only

80 RISK, UNCERTAINTY, AND PROFIT

from actual life, we must lay down for the special purpose
of the immediate analysis two further suppositions quite
contrary to the facts.

10. The first is that for the present there is to be no
productive property in the ordinary sense in the society.
Every productive agency or capacity is an inseparable
part of the personal endowment of some member of the
society. Material implements of production may be used
provided they are either superabundant, and consequently
free goods, or else are absolutely joined to their owners
(not subject to lease or sale) and not subject to increase or
decrease. The last characteristic, if not that of insepara-
bility, is, of course, really implied in the specification of
static conditions. ' We must also observe explicitly that
personal powers themselves are similarly fixed in amount
and character. The social consequences of the transfer of
productive goods between individuals, and especially of
their increase by "investment," will call for extended dis-
cussion later, and must be isolated by a preliminary study
of a society in which they are absent.

11. The second "analytic" assumption is also contained
in the preceding "idealizing" group. Under number 8 we
declared that division of labor was to be carried to the
point where each individual produced a single commodity.
In modern industrial life it is, of course, carried vastly
farther. But it is important to study separately a society
where production is organized through the exchange of
finished products only.1 At a later stage we can then dis-
cuss the special problems of that further stage of organiza-
tion called secondary division of labor.

This isolation is of especial importance in view of the
fact that the distribution of products is very much com-
plicated when the agencies of production cooperate in the

1 We might characterize such a society as a "handicraft" system in
contrast with "enterprise," in which the operative has lost his responsible
status and lives, not by the production and sale of a commodity, but by
the sale of productive services to an entrepreneur.

THEORY OF CHOICE AND OF EXCHANGE 81

production of a single commodity, the product of a single
agent being then no longer immediately identifiable. The
problem of isolating the product of a single agency, where a
number work jointly, is, of course, the familiar problem of
"imputation" or distribution in the technical sense, which
has been the greatest single center of controversy in eco-
nomic discussion.

The above list of assumptions and artificial abstractions
is indeed rather a formidable array. The intention has been
to make the list no longer than really necessary or useful,
but in no way to minimize its degree of artificiality, the
amount of divergence of the hypothetical conditions from
those of actual economic life about us. For the most part
these same assumptions, especially the first eight, and to
a considerable extent the ninth, are really involved at
one point or another in a large part of the discussion of
economic literature. If they are present, and necessary,
and when present whether necessary or not, there will
be no disparaging the importance of having their ab-
stract and unreal character brought conspicuously to the
surface.

Our next task is to form a picture of such a society in
action, and to discover the conditions of equilibrium or
natural results of the operation of the forces and tendencies
at work in it. We are therefore to imagine such a population,
set down in such an environment as described, starting
out de novo in the business of satisfying their wants. Each
person, on taking in the situation in its essential outlines,
will enter upon the production of some commodity, with a
view, through exchange with others, of securing the means
of satisfying his varied wants. After a brief interval of
time has elapsed, each will have accumulated a small stock
of his particular good, and we may think of them all as
meeting in a central market to exchange their wares.

The situation now presented is the familiar one in
economic discussion, of a group of individuals with given

82 RISK, UNCERTAINTY, AND PROFIT

stocks of goods which have to be disposed of,1 and we need
not dwell upon the process by which fixed rates of exchange
among all commodities will be established.2 When the
process is finished the whole mass of commodities will have
been reduced to a single homogeneous fund of exchange
equivalence or value. Nor do we need to concern ourselves
with the mode of expressing and handling this fund; in
practice it would be inevitable that some sort of standard
exchange medium would be set apart; but it is immaterial
for present purposes whether there is some one kind of
money or as many kinds as there are different com-
modities.

If intercommunication is actually perfect, exchanges
can take place at only one price.3 We may imagine it to be
determined all around what the ratios are to be through
the medium of inquiries. Every individual, knowing the
worth of the thing he possesses in terms of everything else,
is in substantially the same position as a person spending a
given money income in a market where selling prices are
fixed by the seller and placarded. The good in his hands
represents exchange power, a "resource," and he will ap-
portion it among the possible uses according to the law of
choice, so that each unit of it purchases equivalent utili-
ties, want satisfactions, or "importances."

1 We treat the entire stock as for sale without reserve. The demands
of present owners for their own goods, which underlie any possible reser-
vation prices, are in fact no different from the demand of other persons,
and the situation as a whole is most truthfully and significantly represented
as given quantities of goods over against given dispositions to own them,
since the question of whose disposition it is has nothing to do with the
price that will be established. We must, of course, include the demand of
present owners in the demand for every good; that it is "backed up" by
the good itself instead of some other good in hand has nothing to do with
the result. (Cf . Davenport, Economics of Enterprise, chap, v, pp. 48 ff .)

2 The problem of a perfect market is best treated mathematically
(i.e., symbolically) and has been well handled by mathematical econ-
omists. See Edgeworth, Mathematical Psychics, pp. 40 ff., and Marshall,
Principles, Appendix F, and Mathematical Appendix, note xn bis.

3 Easily proved by disproving the contrary. If exchanges be thought
of as taking place at different prices the buyer at the higher price and
seller at the lower will get together at an intermediate figure.

THEORY OF CHOICE AND OF EXCHANGE 83

To show just how the price scale itself results from the "
fact that individuals act according to the law of choice in
apportioning their purchasing power in a situation where
the prices are given, is the task of that branch of eco-
nomics known as the theory of market price. At any
given price (ratio of sacrificing one good for the other) the
more purchasing good is expended for any one commodity
the less becomes the amount of want satisfaction pur-
chased with each unit (relatively to the want-satisfying
capacity either of the good given up or of any other good
for which it might have been exchanged). From this it
follows that the higher the price of any good (relative to
others, including the purchase good), the less of it will be
purchased by any individual.1 It is therefore theoretically
possible to construct a schedule, or curve, of the amounts
of any good that will be taken by any individual at every
price in terms of other goods, and by adding these amounts ?
fprjdl individuals, to construct a similar schedule for the
society as a whole. But there is a fixed amount of each
good available in any given short space of time to be dis-
posed of, and it must all be sold at one price. Therefore,

1 These two propositions are often treated as equivalent in economic
discussion, but the relation between them is not so simple as that. To
prove the second from the first, suppose that at any given price the in-
dividual has determined upon the proper amount to purchase. (For the
sake of similarity with the pecuniary situation let us leave the purchase
good out of account and think of a comparison between two commodities
being bought with money which has no commodity value.) Now let the
price of one commodity rise, relatively to that of another. If the com-
modity which has risen in value is a very important one, it is probable
that the individual will spend as much of his resources for it as before,
quite possibly even more. But he will not buy as much of the commod-.
ity, measured in physical units. For to do so he would have to spend cor-
respondingly less resources for the alternative good, and buy less of it.
But if he buys the same amount of one good as before, and less of the
other, the utility ratio between the two is upset (since it was in equilib-
rium), and a given amount of resources is buying less utility in the good
of which relatively more is purchased; resources will therefore be di-
verted from this good to the other. That is, he will buy less of the good
which has risen (relatively) in price. Q. E. D.

84 RISK, UNCERTAINTY, AND PROFIT

in a perfect market each commodity will command a def-
inite price, which is the highest uniform price at which the
entire existing stock can be disposed of (including taking
out of the market by present owners).

The diagrammatic representation of the market-price
equilibrium is simple and obvious. The utility relations
involved in the figures and analysis for the boy-and-berries
situation above x are applicable. The exchange situation
is shown in the accompanying sketch. The horizontal base
line is a scale of prices. The "demand" curve D shows the

potential purchases at each
price, for any individual or
for the society as a whole,
according to the scale used.
The amount for sale is in-
dependent of price, a fixed
physical quantity, and is
represented by a horizontal
line cutting the vertical or
commodity axis at the proper point. The horizontal value
of the intersection point gives the market price under the
conditions.2

It is especially to be observed that all the quantities in-
volved in this whole analysis are physical and not psychic.
If utility in the individual consciousness is not a true,
measurable magnitude, as argued, it is still more evident
that utility in any social sense, involving a sublimation of
individual utilities into a "social" estimate is a wholly in-
admissible supposition. The concept of social utility is in

1 Pages 66 ff.

2 It is also possible, but complicates matters needlessly, to plot the
demand of others than present owners of the good, only, in the demand
curve, and draw an ascending curve to represent the sales at different
prices, taking account of the present holders' reservation prices. The
same data will give the same price point whichever method is used, and
the one described in the text is the more significant description of the
situation, since there is no practical difference in the causes or motives
back of reservation prices and demand prices.

Prices

THEORY OF CHOICE AND OF EXCHANGE 85

fact a mere substitute for analysis. The whole problem is
precisely this of showing how an objective and uniform
price results from palpably subjective and variable in-
dividual preferences. This must be done by exhibiting the
interactions of individual offers and bids in the actual
market.1 We in fact know nothing about any absolute
utility to any individual or about absolute amounts pur-
chased by any one. All that can be said about the ad-
justment which results from perfect competition is com-
prised in three statements: (1) Under the conditions (the
price alternatives as they are fixed) each individual achieves
the goal of rational action, maximizing the want satisfac-
tion procurable with his given resources (whatever they
are) in purchasing power, by distributing them among the
alternatives according to the law of choice; (2) the condi-
tions themselves, the prices or exchange ratios being the
same for all individuals, and the relative utilities adjusted
to equality with these, it follows that the relative utilities
of all goods (which any individual purchases at all) are the
same to every individual; (3) the exchange ratios will be
so adjusted that at those ratios no individual will wish to
exchange anything in his possession for anything in the
possession of any one else.

The emphasized expressions are so treated because of
current ambiguous or actually confused conclusions in re-
gard to the beneficence of the results of ideal competition.
To call this result socially ideal or the best possible, in-
volves assuming in addition to all the theoretical condi-

1 Seligman's treatment (Principles of Economics, pp. 179 ff. and 192 ff.)
is a particularly glaring instance of the organism fallacy. B. M. Ander-
son, Jr.'s Social Value involves the same error. Anderson palpably con-
fuses social influences back of individual judgments and preferences with
social judgments and preferences in any proper sense. Of course the
individual is a social product, but consciousness is still an individual
phenomenon, and the conduct with which economists are concerned no
less so. It is individual purchases and sales which fix prices, not social,
unless in a socialistic state or one organized in some other way than
through free exchange between individuals, the kind economics deals
with.

86 RISK, UNCERTAINTY, AND PROFIT

tions as to the workings of the process itself1 that the
initial situation, the distribution of goods before the ex-
changes commenced, was the best possible (i.e., either ab-
solutely ideal or absolutely beyond human power to mod-
ify). All that is true (and stated baldly it is little better
than a truism) is that free exchange tends toward that
redistribution of goods which is the most satisfactory all
around of any that can be obtained by voluntary consent
all around.

It is self-evident that in ideal exchange the quantities ex-
changed are equal in value terms, and there is no chance
for anything like a "profit" to arise.

The main condition of perfect exchange not realized in
real life is that of "perfect intercommunication," which is
to say perfect knowledge of what they are doing on the
part of all exchangers.2

In our actual system middlemen fix a price which inihe
absence of monopoly is their best estimate of the theoreti-
cal price — which would just enable the visible supply to
be disposed of — and change it from time to time as the
rate of sales indicates it to be too high or too low. It is a fa-
miliar fact that in consequence of imperfect intercommuni-
cation appreciably different prices for the same commodity
may obtain at different points in the general market area.
Certain factors aggravate the effect of uncertainty in dis-

1 See above, pp. 76-80.

2 The use of money does not affect the theory at all, and the use of
circulating credit not in any way that vitiates the argument, if it does not
change in value.

In one respect the actual situation is very much simplified as com-
pared with the theoretical, and the disparities which would otherwise
arise mitigated. The continuity of the process and the constant existence
of published prices means in general that sellers will not come into the
market at all unless they are willing to take the quoted price (or more)
and buyers not unless they are willing to pay that or anything less. It is
then easy to see how an excess of goods offered or an excess of purchase
offers will move the price downward or upward to the equilibrium point.
The real, practical problem, that is, relates to price changes, not to the
establishment of price, and is vastly less complicated than the latter.

THEORY OF CHOICE AND OF EXCHANGE 87

turbing the theoretical adjustment: (1) Inertia or inflexi-
bility of prices, due to habit, indifference, rounding off of
figures, etc.; (2) variations in the "con.. " (and

fraudulent representations of variations h *io not

exist); and this both in the crude physical a i still

more in by-perquisite utilities, convenience or fa ihionable-
ness of place of sale, ornamental containers, v mes,

personality of vendor, etc.; (3) consumers' speculation;
consumers do not buy continuously for their current needs,
but lay in supplies or hold off, according to their prognos-
tications of the market.

When terms are properly defined and allowances made
for real commodity differences (which include all the
factors under number 2 above) the tendency toward a
definite and uniform price for similar goods is strong and
conspicuous, and a fair approximation to this result is
generally reached. There is, of course, the greatest differ-
ence in commodities in respect of this standardization,
from wheat and cotton at one extreme to artistic products
at the other. '

When in our imaginary perfectly competitive society the
exchanges are finished and the goods consumed, everybody
will again start out to engage in production. But occu-
pations will not be chosen as before; there will now be an
established scale of prices of every good in terms of every
other, and in accordance with this price scale every one will
direct his effort and gauge its intensity, conforming, of
course, to the Law of Choice in making his decision^ The
commodities produced will be thought of simply as pur-
chasing power over goods in general, and the immediate
alternatives are simply producing "wealth" and not pro-
ducing it, which means doing something, or nothing (which
is also doing "something") entirely outside the scale of
quantitative comparisons, and this now means outside the
market sphere. Every man will, therefore, like Crusoe, or
the boy in the berry patch, carry his exertions to the point

88 RISK, UNCERTAINTY, AND PROFIT

where utility and disutility — "really" sacrificed utility,
but of an unspecified and non-quantitative sort — are of
equal importance in the amounts which are alternative to
each other.

As production goes on and goods accumulate in the
hands of our "homines ceconomici," they will be exchanged
as before, distributed among the exchange possibilities in
accordance with the Law of Choice; and the exchange
possibilities will continuously be modified by the same
process so as to be kept constantly at that point where
momentarily the utility ratios of every one can be brought
to equality with the price ratios. But this process of ad-
justment and readjustment also tends toward an equilib-
rium; the investigation of this tendency toward a condition
in which production and consumption of all commodities
would go forward at unvarying rates falls in the province
of the second grand division of economic theory, one
branch of which is the theory of normal price.1
* In a situation such as we have described, with the pro-
duction, exchange, and consumption of commodities going
on continuously, the value scale or system of quantitative
equivalences of commodities, becomes much more ob-
jective and definite than it could ever be in the economy
of an individual Crusoe. The constant presence of the
published scale of exchange ratios and the working-out of
the whole organization in terms of it must have a tremen-
dous influence in "rationalizing" the economic activity, in
impressing its quantitative features on men's minds, and
enforcing precise calculations and comparisons. The re-
sult is that all goods are reduced to a homogeneous aggre-
gate or fund of value units. This fund of value, as the
medium of solving the problems of alternatives, naturally
divides the economic process for each individual into two

1 The other branch is the theory of distribution under static condi-
tions, but under our present assumptions there is no such problem since
joint production is absent.

THEORY OF CHOICE AND OF EXCHANGE 91

On the production side of the twofold alternative, the
utility or importance of any good is its purchasing power,
and the higher the price the more of it will be produced, for
the same reason that Crusoe would produce more of a
more wanted good or an individual in a market purchase
more of a similar one. But the higher the price of any
good the less of it can be disposed of. Now since the
amounts produced and disposed of are axiomatically the
same, the price will move ^
toward the point at which S
the natural amounts of pro- g g
duction and sales at that »e
price are the same. Dia- g'g
"grammatically, takin g again § ^
a scale of prices as a hori- «£&
zontal basis, an ascending $1:

curve will represent the ^ ' — ~~p~-

(rate of) production or sup-
ply at different prices (in terms of other goods), while a
descending curve will represent the (rate of) sales or de-
mand. The intersection of the curves gives the price point.

A slightly different way of viewing exactly the same
facts will make clearer the individual motivation and show
the bearings of the idea of value-cost. The demand curve,
viewed from the other direction, or with the axes inter-
changed, is in fact a cost of production curve. cThe amount
produced (in unit time, the rate of production) at any
price is the amount that can be produced at that price
without either profit or loss. For if any given price yields ^
a profit, resources will be diverted to, and if a loss, from
the production of that good; the real meaning of profit is
simply that resources being used to produce other goods
(and valued in the other uses) will yield more in the
production of the good in question; while similarly, loss
means that resources producing the good in question are
worth more in other uses (their value being determined

92 RISK, UNCERTAINTY, AND PROFIT

by that of the best use) f From the present point of view
the demand curve shows the possible selling prices of
different sizes of supply, and the condition of equilibrium
t/ is that cost and selling price shall be equal. The inter-
section of the curves then shows on one axis the equili-
brium rate of production and consumption, and on the
other the equilibrium price. The character of the whole
analysis as an easy deduction from thestaw of Choic^ is
clear enough without further elaboration.1^ ^^u^l^vi
Space does not permit us to give more consideration to
these first fundamentals, and we must allow the above
brief and perhaps somewhat dogmatic treatment of con-
troverted issues to stand. It is difficult in the light of such
an analysis to see any real meaning in such questions as
the causal relation between cost and value, and others about
which controversy has raged. cUnder competitive con-
ditions a value involves an equal cost and a cost an equal
• value, so directly and obviously (since it is all a purely
relative matter of choosing between alternatives in such a
way as to equate them) that the two are but little more
than different words for the same phenomenon viewed
from different standpoints. "3 Cost is the value of the re-
sources embodied in a thing, which is to say the value of
some use for them; it may be an "economic" or a "non-
economic" (measurable and marketable or the opposite)
use, but if there is not a competing attraction of some
sort the "resources" will not be "resources" at all, just as
if the thing itself is not wanted somewhere else it will not

1 It will be noticed that our cost curve is one of increasing costs.
This is the only case to be considered from the present point of view. The
question of decreasing costs comes in at a later stage of the analysis under
more complicated conditions. It is obvious that to increase the pro-
duction of any good involves the diversion of resources from producing
other goods, which will raise their value while lowering that of the good
first considered, and since resources are valued according to the best
available use, this means increasing cost with increased output. At the
present stage of the argument there is no problem as to the cost of any
unit of commodity or yield of any unit of productive agency, since only
one kind of agency is used in making any one good.

THEORY OF CHOICE AND OF EXCHANGE 93

have (exchange) value, and we should say not even utility
if the word is properly defined.

The whole argument is merely an elaboration of the Law
of Choice (the correct form of the principle of utility), that
preference ratios between alternatives will by combining
the alternatives in the requisite proportions be made equal
to the externally given physical equivalence ratios, first in
the market and then in production. That "goods" are
largely alternative to each other in production (involving
the use of the same ultimate resources) is the condition of
our having an economic order, an organization of want-
satisfying activities based on free production and exchange.
We turn now to consider the further complications of the
competitive situation arising from the organization of a
plurality of productive agents in the making of a single
commodity.

CHAPTER IV

JOINT PRODUCTION AND CAPITALIZATION

The present chapter will bring a greater semblance of
reality into the imaginary, highly simplified economic
system partially constructed above. Many of the features
of everyday life abstracted for simplification can now be
introduced in succession and their relations and bearings
separately studied. In this way we shall ultimately deter-
mine what is necessary to perfect competition and what is
not. It will be found that most of the simplifying assump-
tions hitherto made can be dropped without destroying the
conditions necessary to a perfect equilibrium in which costs
and values are identical throughout. So long as we adhere to
the fundamental condition already emphasized, that men
know exactly what they are doing, that no uncertainty is pres-
ent, other elements of reality hitherto abstracted merely
complicate the process of adjustment without changing the
character of the result. Their elimination has served the
necessary end of simplifying the study of the fundamen-
tals of economic behavior and made possible the separate
study of these complicating considerations themselves,
which we shall now undertake.

The first step in this further development of the imagi-
nary social structure is to examine the nature and bear-
ings of organized production. Hitherto our society has
been arbitrarily restricted to the unorganized or individual
creation of goods; there has been only "primary" division
of labor, through the exchange of products. We now turn
to consider "secondary" division of labor, or division of
occupations within the separate industries, the coopera-
tion of a large number of persons in the making of a single
product. This added element in the situation gives us

JOINT PRODUCTION AND CAPITALIZATION 95

two serious new problems, though closely related; first, the
mechanism of the actual organization of productive groups
through free contract alone, and, second, the division of a
joint product among the individuals making different
kinds of contributions to its production. The latter is the
familiar problem of "imputation" (Zurechnung) or "dis-
tribution" in the technical sense.

Practically speaking, we are now turning to the second
general problem of economics as it is met with in the real
world. For methodological reasons we have, indeed, found
it necessary to discuss a society in which specialized pro-
duction takes place, but not joint production. In reality,
of course, production is joint, practically without excep-
tion. The subject for discussion now is, therefore, the
general principles of social organization under free ex-
change where given resources are used (in the production
of goods) for the satisfaction of given wants (and under
given conditions as to available methods of technical or-
ganization, etc.). It is the problem of the "static state."
In order to keep the problems of the organization of pro-
duction and the division of the product as simple as possi-
ble and to introduce complicating factors one at a time,
no other changes are now to be made in the arbitrary speci-
fications of the system we are studying. In regard to pro-
duction particularly, we assume the absolutely continuous
creation of the complete article and its immediate exchange
and consumption when complete, and the absence of pro-
ductive "property" in the ordinary sense.1 That is, there
are to be no material productive agents which are not either
superabundant, and therefore free, or else rigidly attached
to the persons of their owners, and no way is to be open
either to increase the productive efficiency of person or
thing or to decrease it through use. The only change now
introduced in the conditions of our problem is that at least

1 See above, chapter in, pp. 76-80, for the assumptions under which
we are working.

96 RISK, UNCERTAINTY, AND PROFIT

a large part of the commodities produced and consumed in
our society are to be made by groups of individuals, per-
forming a number of different kinds of productive work.
It is not necessary that every individual perform a unique
function; rather let it be typically true that considerable
numbers perform the same sort of work and that there are
gradations of similarity in the different tasks.1
c-The possibility of an automatic organization of pro-
duction through free agreements between individuals de-
pends upon a technological principle governing joint pro-
duction and not hitherto introduced. This new axiom is as
fundamental to economic thought and process as the prin-
ciple of choice or diminishing utility, and very similar to it
in statement. It is the principle of the variation of pro-
portions in the factors of production, already long famous
.Sunder the name of "diminishing returns," though its clear
and approximately accurate formulation in general terms is
a relatively recent achievement. This new law is a general-
ization from the facts of physical nature as the former is a
generalization from the facts of human nature.^ Like the
other, and all other "laws," it is an approximation, and its
approximateness must be kept in mind in making practical
applications of conclusions resting on it as a premise. Like
the other great axioms in economics, it is purely a princi-
ple of relativity, dealing with proportions only.' In this re-
spect the current statements of the principle are generally
les. misleading than in the case of diminishing utility,
there being less temptation to give it an absolutistic in-
terpretation. It does seem strange, however, that it took
economists so long (nearly a century) to recognize the
inherent reversibility of a change in proportions and to
draw the obvious inferences from the fact. We may ob-
serve finally that the new principle is much"truer"; i.e.,
more universally and accurately in conformity with the

1 See note above, p. 86 n., on indifference as to the presence and use
of money.

JOINT PRODUCTION AND CAPITALIZATION 97

facts, more dependable, than its psychological counter-
part.

In many other respects, also, there is similarity between
the two fundamental principles of proportionality, the
psychological law of diminishing utility and the techno-
logical one of diminishing returns. A formal and accurate
statement of either presupposes continuous divisibility
of the variable element, which is not true to fact in a par-
ticular case, but which does hold good with practical ac-
curacy in a large market. In both cases divisibility breaks
down completely (in an individual case) for minimum
amounts. As there is a definite minimum quantity of any
consumption good required to give it any significance, so
there are limits to the proportions of productivity agencies
which will yield any effect at all. As to minima in the case
of consumption goods in the different sense of minimum
amounts necessary to life, this, though commonly assumed,
is ordinarily not true. It is only under very special circum-
stances that any particular commodity, as the market de-
fines and differentiates commodities (and this is the only
sound or relevant method), is indispensable. ^

In the case of both the law of diminishing utility and
that of diminishing returns, also, there are maxima to be,, rHtl
taken into account beyond which the good or agency ceases sc**
to enter into problems of conduct at all, becoming a "free JJ^<
good" — better called a potential good, as we have seen.
The correct procedure is of course to treat superabundant
elements in production as we did those in consumption;
i.e., to take them absolutely for granted and ignore them
completely. Only the "possibility" of a situation arising
in which a thing would not be superabundant can give it
significance or lead to its being consciously considered in
any way. ^

In discussing the principle of diminishing returns a
special difficulty arises in the confusion of varying propor-
tions in a combination with changes in the absolute size

98 RISK, UNCERTAINTY, AND PROFIT

of the combination as a whole. These things must im-
peratively be kept separate; in the writer's opinion more
error has arisen over this point than any other single
matter in distributive theory. If the amounts of all ele-
ments in a combination were freely variable without limit
and the product also continuously divisible, it is evident
that one size of combination would be precisely similar in
its workings to any other similarly composed. But under
this condition the tendency to monopoly in the production
of every good would be unimpeded. For the competitive
system to work, it is necessary to postulate that the con-

f ditions as to divisibility of factors are such that the bar-
gaining unit of any one factor is quite small in relation to
the total stock of agencies which more or less effectively
compete with that unit, and also that an establishment of
relatively small size in proportion to the industry as a
whole is more efficient than a larger one. Under these con-

• ditions the first effect of competition must be to bring all
the plants within an industry to the most economical size,
and leave a sufficient number in operation to compete
effectively for the productive agencies which all use.1
£• The principle of diminishing returns in its now current
form runs somewhat as follows: As successive increments
of any one agency are added to fixed amounts of other

1 Competitive relations between similar establishments are much com-
plicated in real life by the fact that practically every business enjoys
a certain degree of partial monopoly. It does not turn out exactly the
same product (bundle of utilities) as its competitors. An extreme ex-
ample is the case of railroads where a part of the output, the through
traffic, is competitive while the other part, the local traffic, is monopolis-
tic. This whole question of the relation between the size of an industry
and the size of an establishment seems to the writer badly mixed up in
the literature. Professor Bullock has distinguished between the three
principles of diminishing returns with varying proportions between the
factors, diminishing costs in an industry as a whole and decreasing costs
in the single establishment, or economy of large-scale production. (Cf.
Quarterly Journal of Economics, vol. xvr, pp. 473 ff.) But no one, so far
as I know, has worked out these cost laws adequately. (Cf. also Daven-
port, Economics of Enterprise, chap. xxiv). Davenport does not go as
far as Bullock in the analysis of the problem.

JOINT PRODUCTION AND CAPITALIZATION 99 ,

agencies in a combination, the physical product of the

combination will increase, but after a certain point the

output will increase in less proportion than that of the

agency in question and will ultimately decrease absolutely. x3

A more general formulation, emphasizing the reference to

proportionality in contrast with absolute size, and the

reversibility of the law, might run as follows: When the

proportion of agencies in a combination is continuously

. varied over a very wide range, there is generally a first

, stage in which the product per unit of either agency in-

, creases; then a stage in which the product per unit of the

, relatively increased agency decreases and the product per

. unit of the relatively decreased agency increases ; and finally

. a third stage in which the product relative to either agency

decreases. Since either agency may be the increasing and

• the other the decreasing one, the first and third stages are

• identical in meaning.2

1 See F. M. Taylor, Principles of Economics, chap, iv, for a very
thorough and sound non-mathematical discussion of the whole question
of variable proportions and diminishing returns. I must remark, how-
ever, that Taylor's treatment of the economy of large-scale production
seems to me to be based on fallacy.

2 The second statement of the law is deducible from the first. All
that is involved in the law of diminishing returns is properly to be re-
garded as a deduction from the following self-evident premises:

1. The proportions of agencies in a combination may be varied without
destroying its productivity.

2. If to a certain amount of one agency (say, labor) another agency
(say, land) is added in amounts varying continuously from zero to in-
finity, a definite amount or range of amounts of this second agency
(neither zero nor infinity) will yield a larger total product than will larger
or smaller amounts. In other words, if the proportion of one agency to
another is increased without limit, the product per unit of the decreasing
agency will first increase and then decrease; i.e., there is a maximum
point, or range, beyond which in either direction the product (per unit
of the increasing agency) will decrease.

3. It is demonstrably true, and is necessary to the theory of distribu-
tion that extreme variation (short of infinity) in either direction will
yield a zero product.

It is most essential in regard to this law that it relate to any variation
in proportions irrespective of the absolute amount of any factor present
and of the direction of the change. But the conventional case of the ap-

100 RISK, UNCERTAINTY, AND PROFIT

It is requisite for an intelligent organization of produc-
tion and a determinate division of the produce among the
factors by competitive price forces that not merely the
product increase in less ratio than the factor, but that equal
arithmetic increments of factor yield decreasing incre-
ments of product. These two principles have entirely
different meanings, of course, but they are badly confused
in many statements of the theory of diminishing returns.
The second can, however, be deduced from the first, which
follows from the very nature of an economic situation, as
shown below. The relations of the various elements in the
problem can best be shown by reference to a graph. In the
accompanying figure, the horizontal or X distances repre-
sent quantities of the single variable productive factor in a

J4i

7*

w

/

w

z

plication of labor to land, or rather of land to labor, is easy to visualize
and suitable for illustration. Let us imagine a group of new settlers on a
virgin continent faced with the problem of how much of the unlimited
supply of land to use with their limited supply of labor. It is surely evi-
dent: (1) that they can use different amounts and still get some product
(Ax. 1) ; (2) that they can use too little or too much to get the largest
amount of product (Ax. 2) ; (3) that they might conceivably try to use so
little or so much land that no product at all would be secured (Ax. 3).

JOINT PRODUCTION AND CA±>ITAJ.IZA;I:JON- 101

combination, and the vertical or Y distances, the corre-
sponding total physical output of the group. In graphic
terms the point where diminishing returns begin is the
point (3) where this curve becomes tangent to a straight
line through the origin. Less than this proportion of the
variable agent cannot intelligently be employed even if it
is free, for the output could be increased by discarding a
portion of the other factors, if no more of the variable one
could be obtained at a uniform price. It is true, necessarily
and a priori, that there is such a point on the curve, that for
less amounts the product increases in greater ratio than
the factor. That is, for any point on the curve between this
point (3) and the intersection of the curve with the X
axis the tangent must cut the X axis positively. Now, if
below this point (3) the tangent to the curve cuts the posi-
tive X axis, if at this point it passes through the origin and
beyond this point it cuts the positive Y axis, then mani-
festly the curve is concave downward at the point in
question. And this is the graphic condition representing
decreasing increments of product. It seems reasonable to
assume that the same condition (concavity downward)
holds from point 3 to the maximum point (4), but this is
not demonstrable a priori. If it is untrue for a certain stage
in this interval between points 3 and 4 over the whole field
of industry, as represented by the dotted line in the figure,
there is indeterminateness in the competitive situation in
that interval and to that extent, but this is a rather in-
credible supposition.

It is immaterial what shape the curve has below point 3
so long as its tangent always cuts the X axis. No doubt in
any one industry the curve will show stages of increasing
returns interspersed with stages of decreasing returns, and
various proportions of combination of the factors are wise
and stable.1

1 It is to be noted that we must assume the size of individual establish-
ments to be nearly a matter of indifference.
The above reasoning proves also that the curve itself cuts the X axis

102 EISK; UNCERTAINTY, AND PROFIT

If men are supposed to know what they are doing there
is no occasion for discussing the first and third stages at all.
The boundaries of the second stage represent extreme
limits where one agency or the other becomes a free good
and passes out of consideration altogether. Beyond this
point the product is absolutely diminished by increasing
one agency or the other, as the case may be, which is an
absurdity. The identity in meaning of the first and the
third stages is evident; the first stage when passing in one
direction is the third when reading the data in the opposite
order. It is a mere matter of the arrangement of results,
not of the results themselves. Beyond the limits of the
stage of "decreasing returns," therefore, or under cir-
cumstances where the law did not hold, there could not
exist an "economic" situation. Unless the return per unit
of any agency does decrease it is not productive at all; its
use adds nothing to the output of the combination. If we
imagine increasing returns the agency is negatively pro-
ductive. This fact has been recognized in the case of land
in the common statement that additional land would
never be taken up until diminishing returns set in on that 1
already in use.

The facts of variability in the proportions of agencies in

the productive organization, and of the variation of the

yield relative to the different agencies in accordance with

the principle of diminishing returns not merely make

positively as drawn in our figure, and does not pass through the origin.
It follows further from the symmetry of the relation between factors that
the curve will cut the X axis again beyond the maximum point and not
become asymptotic, as it should do if it passed through the origin. Pro-
fessor Taylor's curve was incorrectly drawn in this detail as it should
either become asymptotic or else not pass through the origin.

1 Really on the other agencies applied to the land, but we follow the
usual formulation. The assumption must be borne in mind that men
know what they are doing and are motivated by the desire to maximize
production. In fact, the results are much distorted by ignorance, the
effect of tradition carried over from a place where land is scarce to new
countries where it is abundant, ingrained land hunger, etc., and in the
United States by the conditions of land settlement and preemption.

JOINT PRODUCTION AND CAPITALIZATION 103

possible the economic organization of society through free
contract, but in their absence the whole question of or-
ganization would be meaningless; there would be no such
problem. Unless there were open for use various com-
binations of various productivities, with the possibility of
comparing them, there would be no question of using any
one arrangement rather than any other. Organization is
called for, is possible, and is carried out only through the
fact that the separate contributions of separate agencies to
a joint product can be identified. The organization through
free contract under competition is possible and real and
effective in so far as such a system tends to give to the
owner of each agency the separate contribution of that
agency. Modern society is organized through the associa-
tion of control over productive agencies with the right to
their yield. Only because the income is greater where the
product is larger is such organization possible at all. In the
absence of a law connecting distributive share with effective
contribution our social system would be no system, but
chaos. It is, therefore, inappropriate for economists to argue
as to whether the separation of contributions to a joint
product can or cannot be made; it is made; it is our business
to explain the mechanism by which it is accomplished.

The business man does find out how much different
agencies or units of productive power are worth to the pro-
ductive process or he could not carry on his business. It
is obvious that the business man, in bidding for the use of
separate agencies, must think in terms of the added con-
tributions of added units, — in technical economic par-
lance the " marginal' ' product, — and it is demonstrable
that when the units are sufficiently small the sum of the
separate, specific contribution of all the agencies exhausts
the total joint product.1

It is to be observed that when a new productive unit is
added to a productive combination the technical law of
1 Cf. below, p. 108 and note.

104 RISK, UNCERTAINTY, AND PROFIT

diminishing returns does not fully describe the variation in
the output. In consequence of this law alone, the added
physical product of similar agencies will rise in the position
from which the one in question is withdrawn and fall in
that into which it moves.1 But in addition, since the trans-
fer decreases the total output of the commodity from whose
production the agency is withdrawn, and increases the out-
put of the industry into which it is moved, the price of the
former will rise and of the latter fall relatively. In an or-
ganized free exchange society, producers naturally estimate
product in terms of its exchange value and not of its
physical magnitude. The variations in physical contribu-
tion and in the value of that contribution when an addition
of any kind of agency is made, work in the same direction
and must be added to give the total decrease in the value
product. We shall call the aggregate variation by the name
of diminishing value productivity or simply diminishing
'productivity, which must always be distinguished from the
diminishing physical returns.2

1 The fall in specific or marginal contribution is an easy inference from
the law of the variation of product per unit.. For a detailed demonstration
see Taylor, loc dt.t especially pp. 101, 102. The "added product" of a
unit in the text above is what Taylor and most writers call "the marginal
product" of the "factor." For reasons which will presently appear I
prefer to avoid the misleading terminology of factors and margins al-
together.

2 This terminology is more or less arbitrary, but is one way of straight-
ening out the current confusion and giving different names to different
things. Taylor (loc. cit.) uses both expressions "diminishing returns" and
"diminishing productivity," in connection with the instrumental law;
in fact in virtually the same sense, and does not bring out the contrast
between the variation of physical product and that of value product.
Strange to say, he does not use the principle of diminishing returns which
he so well formulates in his discussion of distribution, but adopts a
different line of reasoning through different proportions of factors in
different industries without variability of proportions in single industries.
That this same principle is involved is recognized by Taylor, who thus
shows a considerable advance over Wieser. This author, it will be recalled,
uses the same theory of imputation which Taylor uses, but advances it in
place of the specific productivity theory, applied to industries independ-
ently, which he repudiates. (See below, p. 110.)

JOINT PRODUCTION AND CAPITALIZATION 105

It is unnecessary to introduce into our society any factors
or agencies other than labor in order to study the mechan-
ism of imputation. Groups of individuals more or less
specialized to and specializing in different productive
functions in the making of the same commodity represent
in principle all that is involved in the cooperation of agen-
cies of whatever difference in nature. We may, therefore,
refer to these different functionaries as types of agencies,
or indeed as "factors" of production, though we shall
presently find reasons for avoiding this term, on account
of its misleading connotations. When the conditions of a
"static" society — i.e., given conditions of the production
and consumption of goods — are correctly laid down, there
is, as we have seen, no room for property in any sense
which differentiates it from productive capacities inherent
in the person of the owner.1

This matter will be discussed at greater length as we
proceed. Let it merely be understood at this point that any
class or group of agencies, or "factor" of production to
which we refer, is formed on the basis of the physical facts
and includes those things which are actually interchange-
able one with another in the production process. If we
speak of "factors " at all, there will thus be not three, but a
quite indefinitely large number of them.2

As a matter of fact, a great deal of unnecessary mysti-
fication has been thrown around the problem of imputa-
tion. It is merely a case of joint demand, and the same
situation is common in the case of consumption goods.
There is really no more mystery or special difficulty about
separating the demand for labor or any particular kind of
labor, due to the fact that it is not employed alone, than
there is about constructing a separate demand curve for
butter, which is always consumed along with other com-

1 Cf. above, chapter in.

2 As Davenport has remarked. (Cf. Economics of Enterprise, chap.
xxii.) But Davenport's position will come up for criticism later on.
(Below, p. 124.)

106 RISK, UNCERTAINTY, AND PROFIT

modities. The principle of variable proportions is the key
to the solution in both cases. Commodities always used
together and always in the same proportions would not be
separate commodities, as far as consumption is concerned,
but parts of one commodity, though they might still be
valued separately if the conditions of production were dis-
tinct.

Keeping in mind the above facts and the simplified con-
ditions under which we are working, it is not difficult to
picture the actual mechanism of the organization. Let us
begin as in the last chapter with a random adjustment and
follow through the successive readjustments to the equi-
librium condition. Suppose that groups of producers are
formed by guess in any chance way, the product of each
group as a whole being determined in the manner already
described and its division among the members of the group
arranged on any basis whatever. It is evident that the
desire of every individual to better himself will lead at
once to three sorts of inquiries. cFirst, each person will
endeavor to ascertain his own value to the group of which
he is a member and compare it with the share which he is
receiving; and second, he will similarly inquire what he
* might be worth to other groups. Third, as a member of a
group each individual will interest himself in the value to
the group of other individuals in it and in the value which
individuals outside it would have if they could be pro-
r cured for his group. As a result, (1) remunerations will
^•rapidly be readjusted toward the values which the individ-
uals contribute to the output of the groups with which they
^ work, and (2) all individuals will gravitate toward those
groups in which they can make the largest contributions to
output. Any individual receiving from his group more
than he is worth will be released or have his remuneration
reduced. Any individual receiving less than he is worth
will be able to secure his full value,1 since we have specified
1 The mode of internal organization of the groups need not trouble us

JOINT PRODUCTION AND CAPITALIZATION 107

conditions under which perfect competition will exist
between the groups. 3

All productive groups would thus compete among them-
selves for the services of actual and potential members, and
the individuals in the society would compete for positions
in the group in a manner quite analogous to the existing
order of things.cThe standard of what a group could afford
to pay for a man is clearly the amount which he enables it
to produce more than it would produce without him. In
the final adjustment the individual's contribution to the
income of the group is his contribution to the income of
society as a whole, which he is under pressure to make as
large as possible by placing himself in the position where he
is really most effective.1.! The tendency of a competitive

here. It might take any form which would produce effective common
action and responsibility. In life, it is, of course, generally worked out
through a responsible entrepreneur as intermediary, but it is necessary
to exclude such a functionary at this point in the argument, and in fact
his services would be superfluous, except, perhaps, temporarily while the
adjustment was being worked out. Greater violence is done to reality by
the specification of perfect competition among organizations for members.
This assumption involves, in the first place, perfect knowledge and inter-
communication throughout the society. In addition it calls for a large
number of groups exploiting every sort of service, and entire absence of
collusive action among them. The number of establishments in any line
of production depends upon the size of each, which in turn depends on the
divisibility of the factors being combined. Hence the principle laid down
above (p. 98) that competition depends on a degree of divisibility in
productive factors. That division of labor is limited by the scope of the
market is true, but commodities sold in different markets do not repre-
sent the same aggregations of utilities, and are different commodities.

1 There is a difficulty in regard to the meaning of the value contribution
to a social total. Exchange values being essentially ratios, an aggregate of
exchange value has very little meaning. We cannot be sure that the value
income of society as measured by the market, in terms, say, of a particular
commodity, would be larger when the final adjustment was reached than
under any other arrangement, and, of course, it will not do to say that the
individual gets the physical commodities which he enables the society to
produce. The answer is that he will get the value of the physical contri-
bution which he makes, enough value income to buy it. The actual
physical contribution should theoretically consist of infinitesimal incre-
ments of practically all the commodities produced in the society, perhaps
including an increment of "leisure.".

108 RISK, UNCERTAINTY, AND PROFIT

organization is, therefore, toward that ideal adjustment
familiar in the literature of laissez-faire. In the final ad-
justment the organization could not be changed without
bringing uncompensated losses, and the total produce
would be divided among all claimants by giving each his
added product.1

The conditions precedent to this theoretical result are
indeed abstract; but they are the conditions of perfect com-
petition, and they are the conditions which actual society
more or less closely approaches. It is important both to
understand free competition because society does approach
S it more or less closely as an ideal, and to be fully aware of the
artificiality of the conditions necessary to realize it perfectly.

Another way of formulating the condition of equlibrium
is to view the adjustment as a continual repricing of pro-
ductive services. This process would be more closely analo-
gous to the process by which the prices of consumption
goods are determined. We can think of each producer or
group as being in the market with a certain amount of
money to spend for productive power in the abstract. At
the price level established at any moment those productive
agencies will, of course, be purchased which make the
largest price contribution to product for a given price
outlay. But since the amounts of all agencies in existence
are fixed, competition will quickly force a readjustment of
prices to that point at which equal price amounts of all
agencies make equal price contributions to product, just as
in the former case equal price amounts of all goods must

1 For a full discussion and demonstration of the theoretical exhaustive-
ness of the distributive process as described above (though in a somewhat
different setting), see Wicksteed, Common Sense of Political Economy,
book ii, chap, vi, and The Coordination of the Laws of Distribution,
Pflssim. The reader will notice that the lines along which the adjust-
ment is supposed to be worked out above are very different from the
"dosing method" familiar in American economic literature. (Cf. espe-
cially J. B. Clark, The Distribution of Wealth, chap, xii.) This latter
procedure seems to the writer unnecessarily abstract and unreal and more
difficult to follow than the realistic method of tracing out the effect of
competition among establishments.

JOINT PRODUCTION AND CAPITALIZATION 109

represent "equal utilities" to all consumers. The organiza-
tion of the productive system as a whole is in fact quite
analogous to that of the expenditure of income. Productive
agencies are now the given resources of which the best use
is to be made by distributing them so as to secure equality
of remuneration for similar units in all employments. In
the organization as a whole, the two principles combine.
The money income may be omitted, as an instrumental
intermediary, andcthe result stated by saying that the real
resources of society tend to be so distributed among all em- v^~-
ployments that similar physical units everywhere make
contributions psychically equivalent to all persons in the
system in a position to choose between them.3

It will now be in order to notice the more important ob-
jections which have been made to the productivity theory
of distribution, though many or all of them have already
been answered and probably would not be made against the
form of the theory presented above. To begin with, let us
insist on the complete separation of the theory of distribu-
tion proper from certain sweeping moral and social dog-
mas, which have been deduced from it. Professor J. B.
Clark, the leading American exponent of the theory, is
partly responsible for this confusion, through a few un-
guarded paragraphs in "The Distribution of Wealth."1
The illegitimacy of these ethical deductions has been well
argued, however, by Professor Carver,2 another expositor
of the theory, as well as by Professor J. M. Clark in de-
fending the theory itself.3 We may, therefore, pass over the
strictures of those writers who do not like social implica- mH*
tions which the theory does not have, which include a y •
considerable part of the criticism of Professors Daven- £^»
port4 and Adriance;5 we shall take up briefly the ques- ^

1 See especially pp. 8, 9.

2 Quarterly Journal of Economics, August, 1901.
8 Political Science Quarterly, June, 1915.

4 The Economics of Enterprise, chap. x.

5 "Specific Productivity," Quarterly Journal of Economics, vol. xxix,
pp. 149 ff., esp. pp. 159 and 160.

110 RISK, UNCERTAINTY, AND PROFIT

tion of the ethical aspects of the competitive system in
chapter vi.

Against the productivity theory itself an old and com-
mon criticism is that well stated by Wieser,1 who attempts
to refute Menger's presentation of it, and substantially
the same line of attack has been followed more recently
by Hobson,2 who refers especially to Wicksteed. The con-
tention is that specific or marginal productivity cannot
afford a theoretically adequate method of distribution, for
the reason that the sum of the products of the separate
agencies, as defined by the theory, will be not equal to the
total joint product, but considerably larger. The amount
subtracted from the total product when "one unit" is
withdrawn will, it is argued, be much greater than can
be imputed to that agent alone, since the loss of any agent
will more or less dislocate the organization. It, therefore,
becomes impossible by this method to divide the total ac-
curately into parts ascribable to the separate "factors"
individually as the specific contribution of each. Wieser
proposes an alternative method, which is identical with
Professor F. M. Taylor's exposition of the productivity
theory itself.8 Hobson dogmatically declares the problem
impossible.

The error in this line of reasoning lies in fixing the
attention upon a comparatively small organization and
comparatively large blocks or units of productive service.
When account is taken of the actual size of industrial

1 Der Natiirliche Werth, 3. Abschnitt, "Die Nattirliche Zurenchnung
des Productiven Ertrages," § 22.

2 The Industrial System, chap, v, appendix, pp. 112-20. A somewhat
different (quasi-mathematical) line of argument to the same end is put
forth by R. S. Padan, Journal of Political Economy, March, 1901 (vol. ix,
pp. 161 ff.).

8 Cf. above, p. 104, note. Taylor is right in the contention that specific
productivity can be imputed through differences in the proportions of
agencies in different industries alone without variability of proportions in
the industries individually. In fact, both elements come into play. We
have mentioned and shall presently discuss further the fallacy involved
in the concept of the "factor" of production.

JOINT PRODUCTION AND CAPITALIZATION 111

society and of the ordinary unit of most agencies, it will
be seen that the "dislocation" is negligible; theoretically,
to be sure, the units would have to be of infinitesimal
size, separately owned and effectively competing; i.e., the
proportions must be continuously variable, in the mathe-
matical sense. But in the typical case the error resulting
from this assumption is not large in comparison with other
inaccuracies in the competitive adjustment. It is true that
there are exceptional cases where agencies are not highly
divisible, or even not divisible at all, and competition gives
place to a greater or less degree of monopoly. These ex-
ceptions are relatively infrequent in the mass of industry
as a whole, but are of considerable absolute importance, and
we shall have something to say later on in regard to unique
and indivisible agencies.1

Padan, in the article referred to, further attacks Pro-
fessor Clark's exposition of the productivity theory on the
express ground that the amount received by any factor
would depend on the arbitrary size assigned to the marginal
unit. This point also is hypothetically sound, but irrelevant.
The size of the unit is not an arbitrary matter of method-
ology, but a question of fact, and Professor Clark may be
open to criticism only for seeming to imply the contrary.
The soundness of the theory, the possibility of competitive
distribution at all, in fact, depends on the actual division of
productive agencies into bargaining units of small size.2

1 See chapter vi.

2 We may notice here another point raised by Padan, the bearing of
increasing returns upon the theory. It is generally recognized that in the
earlier stages of a hypothetical dosing process, increasing returns will be
secured, up to a certain point. By "supposing" this stage of increasing
returns to last throughout the process, Padan easily makes the applica-
tion of the method appear absurd. This line of reasoning is still more
arbitrary than his earlier point, however, and need not detain us. We have
shown at sufficient length that increasing returns is an absurdity; that an
agency worked under such conditions is negatively productive and had
better not be used at all. Professor A. Landry, in criticizing Professor
Carver, has also overworked this supposition. (See Quarterly Journal of
Economics, vol. xxm, pp. 557 ff.)

112 RISK, UNCERTAINTY, AND PROFIT

We should hold that it is an error to say that "labor"
or any "factor" gets or tends to get its product. This
holds good only for the actual individual men or other
agencies.

A third, somewhat philosophical, criticism is also ad-
vanced by Davenport and Adriance. It is contended that
the "marginal" product of labor, for example, is as much a
joint product as that of any other than the marginal unit.
The laborer who uses no-rent land still has to use it, can
produce nothing without it, and hence the product can-
not be ascribed to the labor alone. Professor Taussig also,
though like Davenport somewhat guardedly, asserts that
all product is joint product and cannot be divided into
parcels attributable to separate agencies, though at the
same time he inclines to regard all income as the "pro-
duct" of labor.1 An examination of this reasoning would
carry us into the question of the meaning of production
and causality, which will be taken up presently. For the
present it must suffice to point out that it involves a
confusion between mechanical and economic productivity.
The land used by marginal labor may be necessary to the
operations in the former sense, but is not in the latter, since
by hypothesis if it is withheld from use it can at once be
replaced by other land equally good; otherwise it would
not be free land. The fallacy is parallel to the confusion
between "utility" (as usually defined) and economic value.
Free goods, like air, may be necessary to life, but no par-
ticular portion being necessary, the good cannot have
economic value (nor, as we have argued above, should it be
said to have utility if this term is to be used to connote
any sort of economic significance).

We must notice, finally, another objection raised by

1 Proceedings, Twenty-Second Annual Meeting of the American
Economic Association, p. 143. Taussig's statement that labor produces
all wealth, but is not entitled to all of it, would better, it seems to me,
be reversed. Labor cannot claim to be the only causal source of goods,
but may put forth a superficial claim to a right to consume them all.

JOINT PRODUCTION AND CAPITALIZATION 113

Hobson to the general doctrine of "marginalism." 1 With
Hobson's fundamental position, that marginalism is the
necessary form of a rational treatment of choice, and that
the rational view of life is subject to drastic limitations,
the writer is in hearty accord. It is not clear that Hobson
intends his strictures to apply specifically to the productiv-
ity theory of distribution, but it may not be out of place
to remark that such an application would be an error. In
general we submit that there is much more deliberate,
quantitative balancing of alternatives in economic con-
duct than the discussion under notice would have us
believe, but this is a large issue which cannot be threshed
out here. It does not seem to us that the composition of
life is closely analogous to Hobson's painting or cake in
which the proportion of the ingredients is rigidly deter-
mined by a recipe or a preconceived ideal of the whole.
In any case, the production of goods by industry is very
emphatically a rational process, an adjustment worked
out by the producer in terms of these very separable effects
of separate agencies. Nor is it true, as Hobson does argue
elsewhere,2 that technical conditions prescribe the pro-
portions in which agencies are to be used. The proportions
of labor to land and of capital to either, and to a large ex-
tent of various sorts of each among themselves, are open
to variation through a range almost without technical
limit, in the fundamental industries at least. Again, the
final appeal is to fact. It is the value to the producer as an
addition to his organization as a whole which determines
the amount which he will bid in the market for the use of
any unit of labor, land, or capital, or the amount of any one
which he will purchase at an established price. Hence it is
this "specific product" which rules the apportionment of
income at large among productive agencies at large.
As remarked above, most of the objections to the pro-

1 Work and Wealth, chap/ xxn.

2 The Industrial System, cited above.

114 RISK, UNCERTAINTY, AND PROFIT

ductivity theory relate to the meaning of production and
of product, and come down in fine to the propriety of using
the word, rather than to any fundamental disagreement as
to how the distributive mechanism actually works. We
wish now to point out that in calling the addition made by
any agency to the total output of a large organization its
specific or separate product, we are using the word "pro-
duct" in the same meaning and the only meaning which
the. words "cause" and "effect" or equivalent terms
ever have. It is never true in an absolute sense that one
event is the cause of another. The whole state of the
universe at one moment may perhaps be said to cause its
whole state at the next moment, but when we say that " A "
is the "cause" of "B" we always assume that other things
are equal; we never mean that if the rest of the universe
were removed "A" alone would produce "B." And the
imputation of any single event to another as cause or
effect is always largely arbitrary. Every event has an
infinite number of causes, and it depends upon circum-
stances, the point of view, the problem in hand, which of
these we single out for designation as "The" cause.
"The" cause of a phenomenon is merely that one of its
necessary conditions which is for some practical reason
crucial, generally from the standpoint of control. It is the
one about which we must concern ourselves, the circum-
stances enabling us to take the others for granted.* It may
be quite correct to name a dozen different antecedents as
"the" cause of a particular occurrence, according to the
point of view. The fact that other agencies, even the
whole social system, may be concerned in the production of
a certain good does not therefore argue against its being
the (specific) product of the particular agency upon whose
activity its creation actually hinges under the actual cir-
cumstances of the case.1

1 In the writer's opinion, the hostility to the productivity theory is
due mainly to the notion that the productivity of labor and capital repre-

JOINT PRODUCTION AND CAPITALIZATION 115

A general analytic statement of the principles of static
organization, in price terms and on the basis of supply and
demand, will consist of two main parts. We have to con-
sider two valuation problems relating respectively to con-
sumption goods and productive services. The problems,
are usually designated as "value" and "distribution."
It will be convenient to take up the second of these prob-
lems first. We have already seen that the effective form
of the law of variation of proportions of factors is the law of
diminishing value productivity. It is obvious that all re-
adjustments involve transfers of productive resources and
that every such transfer implies a price change, raising the
prices of goods produced by the organization from which
resources are taken and lowering the prices of goods to
whose production resources are diverted. And the effect
of this price change coincides in direction with the effect of
diminishing physical returns. We may content ourselves
for the present with this superficial view of the price re-
actions on the side of consumption goods and proceed to
work out the price conditions of equilibrium of the system
in terms of the distributive shares. After which the view-
point will be shifted to regard these shares, not as the re-
munerations of agencies, but as costs of the goods into
which their services enter. When the adjustment and its
equilibrium have been studied as a relation between

sents their moral desert in distribution, joined to the conviction that the
existing order is not morally ideal. The theorists who treat a productivity
remuneration as synonymous with ideal justice are merely uncritically
voicing the popular view. It is this popular dogma which is the seat of
the difficulty, and which represents a confusion of the most egregious sort
and leads to equally muddled reasoning on the question of causality in
order to avoid a repugnant conclusion as to the justice of things as they
are. The question cannot be gone into here, but a little consideration
will show that there is almost no case at all for an identification or close
assimilation of causal contribution to production with moral desert in
distribution. The inequalities in inherited property and opportunity in
several senses are obvious, but it must also be recognized that natural
differences in personal capacity are equally powerless to create a valid
moral claim to favored treatment.

116 RISK, UNCERTAINTY, AND PROFIT

prices and costs of consumption goods, we can bring the
two analyses together and see the relations of the three
sets of price facts — values of goods, costs of goods, and
values of productive services. It is obvious that as aggre-
gates the three concepts are identical, all being in fact the
social income looked at from different points of view.

From the standpoint of the present problem of the
"static state" the supplies of all productive agencies are
rigidly fixed, and the theory of the valuation of their serv-
ices is closely parallel to the market price theory as given
in the last chapter for consumption goods. The facts of
demand and supply for any particular kind of agency can
be presented in the form of schedules or graphs showing
the respective amounts that will be forthcoming and that
can be sold at each price, and the equilibrium point would
be manifest in such a presentation. The facts on both the
supply and demand sides of the relation are more com-
plicated than in the case of consumption goods. On the
supply side we cannot take the amount in existence even
at a moment as a given physical datum. For we are deal-
ing with the services of a particular kind of agency, not the
agency as such. The amount of the agency is fixed, but
the amount of marketable service forthcoming from it may
well vary with the price offered. Two courses are open.
We may define and classify services on the basis of the
physical characteristics of the agencies which render them
or in terms of the physical result produced.1 Let us take
first agencies as physically defined. In this case the effect of
the substitution of more or less similar agencies is to be
taken into account in plotting the demand curve; supply
means the supply of the services of a particular kind of
physical agent, things which are perfectly homogeneous and
universally interchangeable alone being grouped together.

1 It seems to me a manifest absurdity to define them in price terms as
does Professor J. B. Clark. (The Distribution of Wealth, chap, vi.) There
would be only one factor if measured in price terms, and the theory of dis-
tribution would be a pure petitio principii.

JOINT PRODUCTION AND CAPITALIZATION 117

It is usual, because superficially "natural'* to assume
that a man will work more — i.e., work harder or more
hours per day — for a higher wage than for a lower one.
But a little examination will show that this assumption
is for rational behavior incorrect. In so far as men act
rationally — i.e., from fixed motives subject to the law of
diminishing utility — they will at a higher rate divide
their time between wage-earning and non-industrial uses <v,_
in such a way as to earn more money, indeed, but to work
fewer hours. Just where the balance will be struck depends
upon the shape of the curve of comparison between money
(representing the group of things purchasable with money) v
and leisure (representing all non-pecuniary, alternative
uses of time). We therefore draw our momentary supply
line in terms of price with some downward slope.1

1 If this conclusion is not evident after a little reflection it may be
demonstrated by reasoning as follows. Suppose that at a higher rate per
hour or per piece, a man previously at the perfect equilibrium adjust-
ment works as before and earns a proportionally larger income. When,
now, he goes to spend the extra money, he will naturally want to in-
crease his expenditures for many commodities consumed and to take on
some new ones. To divide his resources in such a way as to preserve equal •■ * >
importance of equal expenditures in .all fields he must evidently lay out
part of his new funds for increased leisure; i.e., buy back some of his
working time or spend some of his money by the process of not earning it.
The conclusion is enforced by the important practical consideration that
the expenditure of money also requires time and energy which must be
saved from the work period if the best results are to be secured.

The facts as to the shape of the supply curve of labor from given labor-
ers are well known to employers of native workmen in backward coun-
tries, especially the tropics. White men in the advanced industrial nations
have not always behaved so rationally; their traditions give them a
higher preference for the kinds of satisfactions purchasable with money
in comparison with the more inward and spiritual enjoyments. But the
effect which was to be anticipated was very conspicuous after the out-
break of the World War, when the wages for certain kinds of work rose CKjl«
to unprecedented heights and produced increased loafing and dissipation
instead of increased production. (It is important to bear in mind that we
are speaking of a permanent change; it would be in keeping with rationality
to work harder at a temporarily higher rate in order to purchase more
leisure later on.)

While on the subject we may observe that it is also an error to assume

118

RISK, UNCERTAINTY, AND PROFIT

The second alternative is to define agencies or factors
in terms of the physical results which they produce. When
this is done the shape of the supply curve at a moment will
depend simply on the degree of specialization of the service
under discussion. At one extreme we would have an un-
specialized service, such as unskilled labor in a certain
employment. For such a service there would be no supply
at all below the established competitive price in all uses,
and a virtually unlimited supply above that price. That is,
the supply curve as a function of price would be a vertical
line. At the other extreme would be absolutely specialized
services, such as diamond cutters or aviators. For these
there would be no supply below a certain minimum price,
what such men can earn in other lines of work, and as the
price rose the supply would rapidly increase until the men
trained for the service were all employed in it, beyond
which the curve would merge into the supply curve pre-
viously discussed of services from given agencies. (See
accompanying graphs, which show supply as a function
of price.)

Services from given
agencies

An unspecialized
service

A specialized service

In regard to demand, also, the case of productive serv-
ices is less simple than that of consumptive goods; de-
mand is (a) always indirect or derived, a reflection of the

that in this respect land or other property services will be different from
labor. These agencies also have alternative non-pecuniary uses, and if,
say, the rent on land were to rise, landowners could afford to use more
of it for lawns, flower gardens, athletic grounds, game preserves, pleasure
parks, etc., and less for cultivation and marketable crops; and if they
calculated closely they would do so.

JOINT PRODUCTION AND CAPITALIZATION 119

demand for the products of the agency, and (b) always
joint in character. In connection with the first fact, the
demand is also highly composite; identical productive
agencies minister alternately to a vast range of wants and
widely different agencies to the same wants. These com-
plexities in the use of productive services make a really
logical classification of them a difficult if not impossible
problem. The fact of joint demand, as we have seen,
differentiates producer's goods from consumer's goods in
degree only, and to a relatively limited degree.

The shape of the demand curve showing possible sales of
the services of any physically defined type of agency as a
function of price is similar to that of the consumption goods
demand curve. It is the curve of diminishing value pro-
ductivity already described, descending in consequence
both of decreasing physical productivity and decreasing
price. That is, if the supply of any productive agency be
increased the proportion of that agency in combinations in
which it is employed will be raised all along the line, and at
the same time there will be a relative increase in the pro-
duction of those commodities in which its use is relatively
important with a consequent decline in their relative price.
^The equilibrium price point under static conditions is
practically the specific productivity of the given supply of
the agency (though we must remember that there is some
variation in supply of service as price varies even at a mo-
ment). In the equilibrium condition, that is to say, the'
value of each service is equal to the value of its contribu-
tion to the total product, and the contributions of physi-
cally similar agencies are of equal value throughout the
systemP It is evident that this adjustment fixes the prices
of consumption goods at the same time with those of pro-
ductive services, and we may apply the supply and de-
mand analysis to consumption goods also, giving the
theory of normal price in contrast with the theory of
market price studied in the last chapter.

120 RISK, UNCERTAINTY, AND PROFIT

At a moment, the theoretical price of any good is the
("marginal") demand price of the existing supply, the
highest uniform price that will take the supply out of the
market. The supply is a given physical fact, not an eco-
nomic variable, but a constant in the equation. The
equilibrium price of a good over a long period is a different
problem. Here it is not the amount of the good that is
constant (together with the facts of demand), but (under
"static" conditions) the conditions of production of goods
in general (and of demand). The supply of any particular
good may change freely and will do so as its price varies,
other things being equal. The price must be adjusted not
to dispose of a fixed supply, but to equate a rate 1 of pro-

y duction with a rate of consumption, both variable with or
"functions of" the price.

No particular reinterpretation of the demand curve is
called for, however, the only new problem being on the
supply side. cAssuming for the moment that the rate of
supply as well as the rate of demand is in fact a function of
price, it is evident that the price must move toward an
equilibrium point equating the two rates; for goods can-

*/' not be consumed more rapidly than they are produced
and will not be produced more rapidly than they are con-
sumed. Any difference either way will at once react on
the price and the price will react on the production and
consumption rates in accordance with the assumed func-
tional relations, and so on until the demand and supply
both correspond to the existing priced
c To investigate the basis and character of the relation
between supply and price, we must consider the motives

yr which control production. The productive group or es-
tablishment, however organized, must pay its members
(the owners of productive services) enough to retain them;

1 Marshall correctly treats long-time demand and supply as time rates,
but does not sharply contrast this form of the variable with the absolute
amounts dealt with in market price.

JOINT PRODUCTION AND CAPITALIZATION 121

i.e., it must meet competition. When any group can hire a
new member at a profit it will do so, and clearly it can get
any new member by raising ever so little the remuneration
he is receiving elsewhere. Clearly, also, it will dispense with
any member who must be employed at a loss; i.e., any to
whom competing groups can afford to pay more than it
can afford to pay. The amount of any commodity that
will be produced at any price, therefore, tends quickly
toward the amount that will yield neither profit nor loss,
for when production yields ever so little profit it will in-
crease, and vice versa J For the study of this adjustment it
is convenient to interchange the axes of our previous graph
and view cost and selling price as functions of the size of
supply.

It is usually assumed that cost may either increase, re-
main constant or decrease as supply is increased.1 (Sell-
ing price, of course, practically always decreases.) The
question is really one of the most difficult and perhaps
one of the worst muddled in economic theory and cannot
be adequately treated here. But examination seems to show
that under the conditions necessary to perfect competition,
costs must always increase as supply increases. If there
is to be competition, conditions must be such that an
establishment of relatively small size in comparison with
the industry as a whole is more efficient than a large one;
otherwise monopoly will result. New supply will then
come through an increase in the number of similar es-
tablishments, not through an increase in the size of any
of them, and no economies of large-scale production will
be realized.

On the contrary, the increased supply must mean a di-
version of productive resources from other uses, which will
raise their price in those uses through the decreased out-
put and consequent rise in price of the competing product.
Of course, if competition exists the price will go up uni-
x Cf. Taussig, Principles of Economics, chaps. 12, 13, 14.

122 RISK, UNCERTAINTY, AND PROFIT

formly to all producers, and it goes without saying that the
cost of all units of the supply is the same.1

The precise form of the cost function will depend on the
importance of the particular good in the demand for the
productive services which enter into it. If its production
constitutes a negligible fraction of the demand for all these
services, we shall have practically constant cost; if a con-
siderable fraction, a more rapidly rising cost. It will also
vary with the character of the function representing the
law of decreasing returns in the given technological sit-
uation; for as production is increased the proportions of
more abundant agencies will be increased relatively to
those more limited in supply. The graph on p. 91 shows
the character of the functions and the meaning of equi-
librium, and is applicable also to conditions of joint pro-
duction.

c The equilibrium condition or long-run tendency for the
static state has now been formulated in three ways from as
many different standpoints. From the standpoint of dis-
tribution, every agency must be in the situation where it
can make the greatest possible value contribution to the
social income and be valued by the contribution which it
makes. From the standpoint of consumption goods, prices
must be such that rates of production and consumption are
equal or that costs and selling prices per unit are every-
where the same.^It is important to see clearly that these
statements are logically equivalent, presenting different
aspects of the same phenomena. It is self-evident that
costs of goods are identical in the aggregate with distrib-
utive shares, and both with prices of goods; all three are
in fact different names for the total income of the society.

1 Economic literature is full of the contrary assumption, but it is a
definite error, in dealing with long-time normal price. The existence of
differences in costs in different establishments in an industry is proof,
when not due to differences in accounting practice, that the competitive
adjustment is imperfect. The current conception of marginal cost
necessarily falls away through the same reasoning. The producer's cal-
culations are made in terms of cost per unit and selling price per unit.

JOINT PRODUCTION AND CAPITALIZATION 123

tA formulation including all these statements would be that
consumption goods and productive services must be so
priced that equal price amounts of the second make equal
price contributions of the first which have equal utilities to
all persons in the system. It is really self-evident that this
condition alone can be stable, that any other sets forces to
work to bring it about-3

Hitherto we have dealt only with different sorts of hu-
man services as giving rise to the phenomena of competitive
imputation. The meaning and role of property in the
problem of economic organization next call for notice.
We have seen that material productive goods do not
modify the principles of organization so long as they are
not subject to increase or decrease and not separable from
the persons of their owners, to whose personal capacities
the same restrictions must apply.

The conventional classification of productive agencies
under the three categories of land, labor, and capital has
several times in the foregoing pages been referred to ad-
versely, and it is appropriate at this point to take up for
somewhat more detailed notice the difficult problem of
correct definition and classification. It is evident that all
these classes are anything but homogeneous, that different
human beings, different machines, and different natural
agents show the greatest diversity in characteristics and in
the services which they perform. Cairnes's attempt to
reduce labor to more approximately homogeneous bodies
gave us the famous "non-competing groups." Still more
obtrusive are the dissimilarities of different natural agents
— wheat land vs. pineapple land, arable vs. grazing or
timber, and all contrasted with mineral-bearing and the
multitudinous kinds of the latter. Capital is somewhat
peculiar in this respect, its "fluidity" depending on the
length of time taken into view.

On the other hand, it is if possible a more important fact
that agencies from different classes and of the most diver-

124 RISK, UNCERTAINTY, AND PROFIT

gent physical properties may be equivalent and inter-
changeable with respect to the results which they achieve.
As Carver has observed, a (human) ditch-digger is eco-
nomically as closely akin to a steam shovel as he is to
a bookkeeper.1 Indeed, the possibility of a competitive
organization of society depends on the fact of varying
proportions, that no particular agency is indispensable,
but that within limits they may be substituted for each
other and therefore each must compete with others of
different kinds for its place. It is evident that otherwise
producers would not be in the market for the agencies
separately and they could not be separately evaluated
through competitive bidding. The existence of a problem
of distribution depends on the cooperation of different
kinds of agencies performing physically different operations
in the creation of product, and the possibility of solving
the problem depends on the equivalence of determinate
amounts of the several services in contributing to the value
result. It follows at once that, as already observed, no
classification or measurement of productive services on the
basis of their contributions has any meaning for the dis-
tribution problem. According to such a standard they all
form one vast homogeneous fund.2

1 The Distribution of Wealth, p. 85; cf. also Davenport, Economics of
Enterprise, chaps, xi and xxii.

2 Reference has been made to the absurdity of the two-factor analysis,
as exemplified particularly in the work of Professor J. B. Clark. The same
author falls into the closely related fallacy of measuring separate agencies
by their productive contributions. He recognizes and clearly states the
difficulty {The Distribution of Wealth, p. 374, note) and ostensibly gets
around it by setting up an absolute subjective standard of measurement.
It is very difficult for the present writer to criticize this reasoning, and
out of the question in the space available; I can see nothing in it but a
complete failure to make connections, a palpable non sequitur. It is to be
observed that the fallacy is equally involved in all other distribution
theory which makes use of " factors " at all — the number is immaterial —
and this includes most of the literature of the subject.

A conspicuous exception is Davenport's discussion (Economics of
Enterprise, chaps, xi and xxii) already mentioned, which is excellent for
this phase of the question. Where it falls short is in failing adequately to

JOINT PRODUCTION AND CAPITALIZATION 125

The problem is really a difficult one, and cannot be
passed over, since we cannot discuss the valuation of
things without knowing what it is that is being evaluated.
Much the same difficulty, however, was met with, as will
be recalled, in the sphere of consumption goods, and the
answer must come from the same source in the two cases —
an appeal to the unsophisticated facts of the market.
Things quoted under the same name and identically priced
may be taken as identical, and vice versa. Some special
features of the present case may be mentioned, however.
In the first place, interchangeability of productive agents
depends on the use; two things may be equivalent for one
purpose, entirely dissimilar for another. This is not nearly
so true of consumption goods, which, indeed, are not
generally open to such a complex variety of uses. Inter-
changeability is also a matter of time. The problem of
changing the form of productive agencies and adapting
them to new uses carries us into long-time considerations,

separate the long and short period problems of distribution. It is this
failure which in the writer's view explains most of the controversial
differences between economists in so far as they relate to the scientific ex-
planation of distribution, and not to questions of propriety or policy. It
is essential to take account of the fact that from the long-time point of
view the question of classification takes on a different aspect, becoming a
question of the conditions of supply of different types of agents. The
case for the conventional tripartite division (or more especially the separa-
tion of land and capital) is argued at length in A. S. Johnson's Rent in
Modern Economic Theory. (See especially pp. 35 ff.) This phase of the
problem will presently come up for discussion, and it will be pointed out
that there is danger of over-simplification here also. (See below, chap-
ter v.

It may strike the attention of the reader that while the tripartite
classification is emphatically repudiated, the factors are still commonly
referred to in the present essay as "land, labor, and capital." If ex-
planation is called for, it is to be found in the necessity, for mere exposi-
tory purposes, of some expression which explicitly covers the whole
group. The significance is the opposite of classificatory; "animal,
vegetable, and mineral," or "solid, liquid, and gaseous agencies" could
have been used but for their unfamiliarity in this connection. Also the
familiar terms have social and ethical significance if none of a strictly
economic sort.

126 RISK, UNCERTAINTY, AND PROFIT

and especially the meaning of capital, which will come up
in the next chapter. It will be seen that examination tends
to widen the capital category greatly; most productive serv-
ices ultimately represent a previous investment of resources
of some sort.

The variation in interchangeability in different uses in-
troduces a special complication which has caused confusion.
The consideration which finally determines is not inter-
changeability in creating any particular physical product,
but a certain amount of value. The former variety of inter-
changeability is not in fact a necessary condition for the
operation of competitive distribution. If agencies are com-
bined in different uses, effective substitution is secured
through relative growth or decay of the different industries.
We have previously remarked that Wieser, who repudiates
the productivity theory of distribution as based on varia-
tion in proportions, puts forth the really equivalent theory,
based on different proportions in different combinations.
Taylor, however, takes the latter method for his explanation
of the productivity theory, but points out that the two are
equivalent. Both sorts of variations in proportion are, of
course, concerned in the actual working of the market for
productive services, and systematically occur together, as
explained in our exposition of distribution theory just
given.1

To conclude this brief discussion of the productive serv-
ices, we may merely notice the invalidity of four com-
monly assumed grounds of distinction between labor and
property services: (1) Activity vs. passivity. It is char-
acteristic of the enterprise organization that labor is di-
rected by its employer, not its owner, in a way analogous to
material equipment. Certainly there is in this respect no
sharp difference between a free laborer and a horse, not to
mention a slave, who would, of course, be property. Closely
related is (2) the question of preference in the agency itself
1 See above, p. 119.

JOINT PRODUCTION AND CAPITALIZATION 127

as to (a) the kind and (b) the amount of service to be per-
formed. But here also there is at most a vague difference in
degree; the owner of property quite commonly does have
moral or sentimental reasons for restricting the field of its
employment. We must not confuse the agency actually
performing work with the personality of its owner, and it
appears that a tool or a building or a piece of land is in this
regard similar to a man's hand or brain. Similarly as to (b)
the amount of work done. It may be urged that material
agents do not care whether they work or not. But the
ground for restricting hours of labor or taking a vacation
is a possible alternative use for one's personal resources
or the desire to conserve them unimpaired, and the same
considerations apply to property resources.1

(3) Another superficial difference which similarly dis-
solves under scrutiny relates to "sub-marginal" agencies
— too poor in quality to be employed. It may be urged
that there is no wageless labor analogous to free land. As
a matter of fact, however, marginal and sub-marginal hu-

1 The notion of sacrifice has been overworked in economics. Econo-
mists as well as employers have been too prone to assume that sub-
jective willingness is the principal limitation on the amount of labor ob-
tained from given persons or for a given outlay. And employers as well
as economists are waking up to the efficiency of well-paid labor. There is
no doubt that employers as a class have lost much money (not to mention
the higher considerations involved) through working their employees
beyond, and feeding, clothing, and amusing them below, the point of
maximum physical efficiency. This would not be done with a dumb
animal! Of course it may be profitable to the individual employer to pay
a wage below what is necessary to maintain maximum efficiency and an
adequate supply of labor from generation to generation (if the working
class maintains the labor supply partly at its own cost) ; what is meant is
that they have paid uneconomically low wages even from the standpoint
of the short periods for which they have to deal with the same individual
laborer. The presence of idle equipment is a great temptation to an em-
ployer, and the debit side of overworked help is less conspicuous to view.
Of course the ignorance and imprudence of the workers are as much
in point as those of the employer. It is of interest that Lord Leverhulme
has recently put forth the contention that a six-hour day, without de-
creased pay, would be profitable to British employers in many industries,
if the men would consent to two shifts during each twenty-four hours.

128 RISK, UNCERTAINTY, AND PROFIT

man beings are nearly as common and significant a phenom-
enon as in the case of land, and far surpass capital in this
respect. Every man is a sub-marginal laborer for a con-
siderable fraction of his life at each end of it, and institutions
are full of sub-marginal men. And there are thousands and
millions of other idle man-hours in a year which would be
devoted to anything that brought in the least return above
the competitive pay which would have to be given to the
equipment necessary to employ them. On the other hand,
the same fallacious reasoning noted in connection with
overwork undoubtedly leads to the employment of large
numbers who use equipment which would yield more pro-
duct if employed in the "more intensive exploitation" of
more competent workers.1

(4) The most important alleged difference between
property and. personal powers, the moral aspect, is not
strictly within the scope of a purely descriptive discussion
such as the present, but it may be in place to observe that
it also is largely unreal. The contrast between personal-
service income as " earned " and property income as "un-
earned," of which much is made by "reformers," is dis-
tinctly misleading; it is difficult if not impossible to find
grounds for a moral distinction of any general validity be-
tween the two. "Some are born great, some achieve great-
ness, and some have greatness thrust upon them"; and the
same applies quite as well to wealth. And the task of
separating the portion of product or capacity to produce
which is due to conscientious effort from that which goes

1 This is being recognized in the case of child labor by many employers
who refuse to employ children simply on the ground that it does not pay
in the business sense. This whole problem becomes more important as
the amount of capital per worker increases. It is also true that the in-
creasing use of machinery provides tasks which a lower and lower grade of
human capacities are required to perform. The net result is difficult to
estimate. The social problem of the "unemployable" — how to identify
him and what to do with him — is surely forbidding enough. Like most
of our new troubles, it is partly a product of the disintegration of the
family as well as of industrial changes directly.

JOINT PRODUCTION AND CAPITALIZATION 129

back to inherited advantage or pure luck is about as im-
possible — and the evil results of making a false separation
perhaps about as great — in one case as in the other. There
is a difference of some significance in the practical possi-
bility of effecting a redistribution in the two cases, which
brings us back to the one specification which we found it
necessary to lay down in regard to property in order to
exclude it as a complicating fact; it is separable from the
person of its owner, and labor generally is not, or is so to
nothing like the same degree. The only conclusion as to
social policy which we shall insert here is the insistence
that "society" must get rid of the idea that because in-
come is "earned" it is "deserved "and not otherwise. We
are already far from this view in practice, as is shown by
the indiscriminate taxation of large "service" incomes and
assistance of the unfortunate and incapable. If we are
to have organized society and maintain human standards
of life, we must either radically eliminate weakness or im-
pose upon strength the burdens which weakness cannot
bear. (And even then there are limits to the possible tol-
eration of weakness, and the luck element would still re-
main!)

Turning again now to consider the causal relations to
economic organization of the one causally significant dis-
tinguishing attribute of property, let us first suppose that in
our society some property is separable by lease, though not
by sale, from the person of its owner. The only difference
will be that the owner of such property may belong to more
than one productive group and contribute more than one
kind of service at the same time. The principles of or-
ganization of the system as a whole are in no wise affected
by this change in the conditions of competitive arrange-
ments.

The possibility of the permanent transfer of property by
exchange, even though not subject to increase or decrease,
does introduce some new factors into our problem. These

130 RISK, UNCERTAINTY, AND PROFIT

results are closely related to the bearings of another ab-
straction hitherto made, the continuity and timelessness of
the production-consumption process. Consequently, we
must first get rid of this simplification and consider the
effect of the abstracted element. What then will hap-
pen in a society such as we have studied when conditions
are so modified in the direction of reality that, while per-
fect knowledge and static conditions in other respects are
maintained, the production process is protracted over a
considerable period of time and split up into complicated
stages and subdivisions, and when, moreover, goods need
no longer be consumed at once when finished, but may be
stored for future use, or exchanged?

The division of the productive process into stages car-
ried on in different groups or plants is a detail connected
with the time length of the process, but which we can pass
over with brief notice. It is in fact a relatively accidental
matter of organization, and under the "frictionless" con-
ditions here assumed it would make no practical difference
whether successive processes in the making of an article
were integrated through the internal organization of a sin-
gle group or through the external mechanism of market
dealings between groups. Under these conditions there
will be in existence at any time a complex aggregate of
partial products, goods in process, which of course will
have value. We must separate that element in the value
of the partial products which is due merely to the stored-
up productive energy which they contain from any modi-
fication of this value due to the direct psychical influence of
the time which must elapse before they are ready for con-
sumption.

The relation of time to the production and consump-
tion of goods is a complicated and controversial question;
while only a very brief discussion can be attempted here,
it is necessary to make a superficial survey. The assump-
tion of a general preference in human nature for present

JOINT PRODUCTION AND CAPITALIZATION 131

over future goods is so commonly and confidently made
that some courage is required to call in question the founda-
tions of the entire body of doctrine on the subject; yet it
must be done. Most discussion of the subject is, in the
writer's view, vitiated by a false conception of the nature of
the problem. The fact of the existence of interest in society
is wrongly taken as proving that men discount the future.
The relation between interest and time preference is, in
fact, inverted in this view. In a free market where interest
can be obtained it is natural that men should esteem a
present dollar equally with its amount at the current
interest rate at a future date, since one can be freely ex-
changed for the other. Nor does the fact that men do not
postpone all consumption of goods indefinitely into the
future argue an ingrained abstract preference of present
to future consumption. Neither do they wish to compress
all the satisfactions of a lifetime into the present moment
and fast forever after,1 which act by the same reasoning
would prove a disposition to discount the present in favor
of the future.

The error in the current reasoning is a wrong choice of a
zero point from which to measure time preference. The
correct basis is not everything to-day and nothing in the
future; a more sensible form of question would be this:
If one had to choose between enjoyment to-day with ab-
stinence to-morrow on the one hand, and abstinence to-day
with enjoyment to-morrow, on the other, which would be
more desirable, all other things being equal? Or better
still, if a man were given his entire income for a year in a
lump-sum payment on January first, how would he dis-
tribute its expenditure through the year? There would
clearly be no question either of eating it all up the first day

1 The point may be illustrated by the anecdote of a tramp who, finding
a hundred-dollar bill, made a bee-line to the nearest quick lunch and ex-
citedly ordered a hundred dollars' worth of ham and eggs. That men do
not behave after this fashion does not prove that, other things equal,
they prefer a future satisfaction to a present one of the same magnitude.

132 RISK, UNCERTAINTY, AND PROFIT

or saving it all till the last day; a zero time preference ob-
viously means a uniform distribution in time. Any piling-
up of consumption at an earlier date to be compensated
by reduced consumption later on would be a real discount
of the future, while to skimp now for the sake of plenty or
luxury in the future would be to discount the present. Of
course, we abstract from the element of uncertainty as to
the future. We seem justified in pronouncing either tend-
ency irrational if other things are really reduced to equality
in the alternatives.1

As to the facts of human nature it is safe to assume that
different individuals would give the most varied forms of
distribution. Doubtless few, if any, of these would con-
form to straight lines or smooth curves of any sort, as-
cending, descending, or level. Most would go in waves of
greater or less period and amplitude, intervals of modera-
tion or even abstemiousness alternating with " blow-outs "
of various sorts and degrees. Irregularity seems in fact to
be a virtue on its own account, at least to the spirited in-
dividual.2 Whether there would be an upward or down-
ward trend would depend also upon the individual. To
many, a bird in the hand is worth two or more in the bush,

1 H. Sidgwick similarly takes the view that a preference on the ground
of time alone is irrational, criticizing Bentham for including "propinquity"
as a basis of preference between otherwise similar enjoyments. See
History of Ethics, p. 241, note. Cf. also Jevons's discussion, Theory of Politi-
cal Economy, pp. 72 ff., where the same position is taken. Jevons's illus-
trative problem of the consumption of provisions on a vessel at sea is
very effective in bringing out the issue.

It will be noted that the effect of the uncertainty of the future is very
complex. Against the chance of loss of future enjoyment through death or
incapacitation must be set the danger of future privation due to other
contingencies. We are more likely to suffer loss of earning power than of
power to enjoy, and the consequences of need without ability to gratify
need are very unpleasant. Perhaps the perfectly rational homo ceconomicus
would discount the present up to the point of making provision for the
more urgent necessities as far ahead as he was at all likely to live and dis-
count the future beyond this point in increasing degree. The point is sig-
nificant chiefly as showing the absurdity of hedonistic rationalism as a
theory of actual behavior.

2 Cf. Spencer, First Principles, chap, x, "The Rhythm of Motion."

JOINT PRODUCTION AND CAPITALIZATION 133

while others take much thought for the morrow. Some
children, as Marshall remarks, pick the plums out of the
pudding to eat first, while others save them until the last,
and many do not pick them out at all; and adults differ in
the same way. The improvidence of savages is proverbial.
Of course, the physical conditions of life set limits to the
discounting process in both directions; we cannot enjoy
to-morrow unless we live to-day, and many have learned at
a cost that too high a rate of living in the present may have
a similar effect upon the capacity for future enjoyment.
No generalization in regard to the human race at large
seems to be worth making, especially in view of the un-
reality of any simple assumptions as to the conditions sur-
rounding the choice. The facts of mere prodigality on the
one hand and mere miserliness on the other are indispu-
table and may be studied without attempting to strike any
precise balance.

It is perhaps even more important at this point to in-
sist that the mere question of time preference in consump-
tion is relatively unimportant at best as an explanation of
the phenomenon of saving. The disposition to spend or to
save, to consume income in the present or to store up
wealth, is much more influenced, in fact, by other motives.1
Like human conduct in other respects it is mostly a matter

1 It is fundamental to the actual phenomenon of capital accumulation,
that the principal, once saved, never is consumed; if it is consumed later,
there is no net addition to the capital supply of society. Men save in
large measure with no thought of ever consuming the capital, or even the
income which it yields. For this reason the older term "abstinence"!
seems to me far more descriptive than its modern substitute "waiting." [
To be sure, an income of five dollars a year in perpetuity represents more
consumption than one hundred dollars now; but no one consumes an in-
come in perpetuity or expects to do so. Even if the saver consumes the
entire income from his investment as long as he lives, he may or may not
consume a total amount equal to the principal saved. Capital formation
is the result of abstinence rather than waiting.

In fact, the term "saving" itself is misleading. Men do not generally
produce wealth to consume it and then decide to invest it instead. Most
of that which is invested is destined to that purpose in the first place and
would otherwise never be produced at all.

132 BISK, UNCERTAINTY, AND PROFIT

or saving it all till the last day; a zero time preference ob-
viously means a uniform distribution in time. Any piling-
up of consumption at an earlier date to be compensated
by reduced consumption later on would be a real discount
of the future, while to skimp now for the sake of plenty or
luxury in the future would be to discount the present. Of
course, we abstract from the element of uncertainty as to
the future. We seem justified in pronouncing either tend-
ency irrational if other things are really reduced to equality
in the alternatives.1

As to the facts of human nature it is safe to assume that
different individuals would give the most varied forms of
distribution. Doubtless few, if any, of these would con-
form to straight lines or smooth curves of any sort, as-
cending, descending, or level. Most would go in waves of
greater or less period and amplitude, intervals of modera-
tion or even abstemiousness alternating with "blow-outs"
of various sorts and degrees. Irregularity seems in fact to
be a virtue on its own account, at least to the spirited in-
dividual.2 Whether there would be an upward or down-
ward trend would depend also upon the individual. To
many, a bird in the hand is worth two or more in the bush,

1 H. Sidgwick similarly takes the view that a preference on the ground
of time alone is irrational, criticizing Bentham for including "propinquity"
as a basis of preference between otherwise similar enjoyments. See
History of Ethics, p. 241, note. Cf. also Jevons's discussion, Theory of Politi-
cal Economy, pp. 72 ff., where the same position is taken. Jevons's illus-
trative problem of the consumption of provisions on a vessel at sea is
very effective in bringing out the issue.

It will be noted that the effect of the uncertainty of the future is very
complex. Against the chance of loss of future enjoyment through death or
incapacitation must be set the danger of future privation due to other
contingencies. We are more likely to suffer loss of earning power than of
power to enjoy, and the consequences of need without ability to gratify
need are very unpleasant. Perhaps the perfectly rational homo ceconomicus
would discount the present up to the point of making provision for the
more urgent necessities as far ahead as he was at all likely to live and dis-
count the future beyond this point in increasing degree. The point is sig-
nificant chiefly as showing the absurdity of hedonistic rationalism as a
theory of actual behavior.

2 Cf. Spencer, First Principles, chap, x, "The Rhythm of Motion."

JOINT PRODUCTION AND CAPITALIZATION 133

while others take much thought for the morrow. Some
children, as Marshall remarks, pick the plums out of the
pudding to eat first, while others save them until the last,
and many do not pick them out at all; and adults differ in
the same way. The improvidence of savages is proverbial.
Of course, the physical conditions of life set limits to the
discounting process in both directions; we cannot enjoy
to-morrow unless we live to-day, and many have learned at
a cost that too high a rate of living in the present may have
a similar effect upon the capacity for future enjoyment.
No generalization in regard to the human race at large
seems to be worth making, especially in view of the un-
reality of any simple assumptions as to the conditions sur-
rounding the choice. The facts of mere prodigality on the
one hand and mere miserliness on the other are indispu-
table and may be studied without attempting to strike any
precise balance.

It is perhaps even more important at this point to in-
sist that the mere question of time preference in consump-
tion is relatively unimportant at best as an explanation of
the phenomenon of saving. The disposition to spend or to
save, to consume income in the present or to store up
wealth, is much more influenced, in fact, by other motives.1
Like human conduct in other respects it is mostly a matter

1 It is fundamental to the actual phenomenon of capital accumulation,
that the principal, once saved, never is consumed; if it is consumed later,
there is no net addition to the capital supply of society. Men save in
large measure with no thought of ever consuming the capital, or even the
income which it yields. For this reason the older term "abstinence"
seems to me far more descriptive than its modern substitute "waiting." ;
To be sure, an income of five dollars a year in perpetuity represents more
consumption than one hundred dollars now; but no one consumes an in-
come in perpetuity or expects to do so. Even if the saver consumes the
entire income from his investment as long as he lives, he may or may not
consume a total amount equal to the principal saved. Capital formation
is the result of abstinence rather than waiting.

In fact, the term "saving" itself is misleading. Men do not generally
produce wealth to consume it and then decide to invest it instead. Most
of that which is invested is destined to that purpose in the first place and
would otherwise never be produced at all.

134 RISK, UNCERTAINTY, AND PROFIT

of social standards, of what is "good form," "the thing"
or not the thing to do. The fact of possessing an accumula-
tion of goods confers social prestige and in addition vast
power over one's fellows. Even where, as we are now as-
suming, productive employment is not open to wealth,
the rich man will be in a position to make his favor solicited,
his ill-will feared, and may, of course, turn his situation to
material profit if so disposed. Accumulations are necessary
to lavish displays or magnificence of any kind. On the
other hand, we must suppose that where accumulation is
limited to consumption goods, it will be subject to con-
siderable costs, for storage, preservation, protection, and
doubtless inevitable deterioration.1

It will be evident that differences among the individual
members of society in economic position and taste with
reference to the time of use of goods create a situation in
which exchange will be mutually advantageous. To one, a
present or early allotment of goods in advance of his own
production and against an obligation to repay later will
be or seem a benefit, while to another, with an accumulated
and growing idle stock, a dependable obligation 2 for the
future delivery of a certain amount of value, may be highly
preferable to the possession of the goods themselves,
c If the balance of the time preference in the population as
a whole is in favor of the present, no appreciable net ac-
cumulation of goods will take place. Those disposed to
accumulate will transfer their surplus production as fast
as made to others disposed to draw on the future. The
conditions of supply and demand will establish a market
ratio of exchange between present and future goods which
in this case will show a premium on the present, the magni-
tude of the premium depending on the strength of the ex-

1 We pass over here the effects of divergence in suitability for accumula-
tion of different classes of goods, due to differences in bulk, perishability,
universality of appeal, elasticity of demand, etc.

2 We must here assume it to be made absolutely dependable by in-
surance or otherwise.

JOINT PRODUCTION AND CAPITALIZATION 135

cess desire to anticipate the future. Obviously the pre-
mium on the present goods will constitute an additional
motive for surplus production and a deterrent to surplus
present consumption. The rate established will be that at
which the amount of surplus present production will equal
the amount of surplus present consumptions The repay-
ment of loans does not affect the principles involved, as it is
a repetition of the original transaction with the roles of
the parties interchanged. In the aggregate an excess of
present consumption over current production is, of course,
impossible.

If, on the other hand, the balance of time preference is
on the side of a disposition to postpone, the result will be
an excess for the time being of production over consump-
tion with net accumulation in the society as a whole. The
exchanges between present and future goods will establish
a premium on the latter. The ratio at which exchanges
take place must constantly be such as to equate the amounts
of each sort of service offered in the market to the amount
that will be taken at the price. With a premium on future
goods, accumulation will continue at a rate depending in
part on the amount of the premium, until the premium
disappears or becomes equal to the cost of keeping the
accumulated stocks. Any greater premium on the future
is impossible as a permanent thing. But the conditions of
accumulation might well be such that an indefinitely long
time would be required to reach the equilibrium result. In
that case the actual condition at any time is a premium on
the future with progressive accumulation taking place.

The " premium* ' or time preference rate under the con-
ditions described, though similar to (positive or negative)
interest, must be distinguished from that phenomenon as it
is met with in modern industrial life; it is, indeed, an ele-
ment, but a relatively insignificant one, affecting the in-
terest rate on loans of productive capital.1

1 Wicksteed has an excellent discussion of this point. (See Common
Sense of Political Economy, chap, vn.) It is noteworthy that the "usury"

186 RISK, UNCERTAINTY, AND PROFIT

Time value, presentness or futureness, is perhaps best
regarded as a special sort of utility in a good, like nutritive
value or beauty or any other quality conferring or enhanc-
ing desirability. The rate of payment for it, where sep-
arated from other considerations, is evidently determined
by " psychological' ' considerations on both the demand
and supply sides, and the current interest theory of the
psychological school is based on a confusion of this phenom-
enon with interest proper as a distributive share. The
subject of interest proper will claim attention at a later
stage of the discussion. We shall find that interest in the
correct sense may not be met with at all in a society where
uncertainty is absent, even if accumulated wealth is pro-
ductively used and even if the society is progressive with
respect to the accumulation of capital, if knowledge and
foreknowledge are complete.

We may now return, and in view of the knowledge ob-
tained of the rdle of time in economic conduct take up the
relations of property in the simple sense of productive
agencies separable from the persons of their owners and
subject to lease and sale. It must be borne in mind that
for the present we exclude any possibility of either increase
or decrease in the property or any physical change of such

against which moralists have universally thundered in pre-industrial soci-
ety corresponds to the phenomenon just described rather than to modern
interest. The productive investment of accumulated wealth was nearly
unknown in earlier times and even the purchase of existing productive
property was rare. Practically the only productive agencies known were
land and slaves. Land was not private property in the modern sense and
was hardly ever bought and sold commercially, while slaves were used al-
most exclusively in connection with land and by its owner even when not
legally attached to the land itself. If there had been a free market for con-
sumption loans the correspondence with the phenomenon we have de-
scribed would have been complete except for the element of risk. The ab-
sence of a competitive market was the source of much of the evil of usury,
and the payments made doubtless did represent extortion largely. Be it
observed, also, that historically speaking modern interest developed out of
the consumption loan through the intermediary of passive partnerships in
trade ventures and not out of dealings in canoes, fish nets, etc., in which
the fancies of a certain school of interest theorists are prone to revel.

JOINT PRODUCTION AND CAPITALIZATION 137

a character as to modify its functioning. Such changes
and their effects belong to our third division of econom-
ics, which deals with changes in the conditions of the pro-
duction and consumption of wealth. To realize static con-
ditions they must be abstracted. It will be convenient to
refer to property of the sort we have in view as "land,"1
since land has been conventionally treated as if qualita-
tively and quantitatively given once for all by nature.
This is not at all the view of land which will be presented in
this study when the time comes to discuss the subject.
But it is a convenient name at this point for a productive
agency of a certain described character. We assume, as a
matter of course, that such property is limited in amount
(i.e., subject to "diminishing returns") and that there is
no other sort of property present in the society. On the
production side, then, the side of demand, and in relation
to functional distribution it will be exactly like other agen-
cies (human services), but its presence may affect the per-
sonal distribution of income very considerably.

Supposing the final adjustment to have been reached in
the organization of production, any piece of property such
as described may be regarded as a right or title to a com-
modity or money income in perpetuity. As such, its bear-
ings on conduct are closely related to the time distribution
of consumption. A piece of land represents future goods
in the very special form of a value income distributed uni-
formly throughout all future time. We may assume with-
out argument that such a piece of property will be desirable
and that under conditions of free contract a definite mar-
ket rate of exchange between land and consumption goods
will be established. More accurately this price will be a
ratio between the income from the land (of which there is

1 With the actual history of property we are, of course, not concerned.
Doubtless, the first approximation to private productive property was in
human beings, slaves, or, perhaps, women or children, while the last thing
to become really privately owned was land. But the proper order for our
purpose is not chronological, but rather that of increasing complexity.

138 RISK, UNCERTAINTY, AND PROFIT

no significant measure other than its income) and a
quantity of present goods also measured in value terms.
The price could, therefore, be stated as a certain number
of years' purchase or a rate per cent per annum, and rep-
resents the familiar phenomenon of capitalization. Our
present problem is to formulate the conditions determining
this capitalization rate.

Land will be in demand especially by persons disposed to
store up wealth for future use; i.e., to discount the present.
It is in effect future goods, but the manner of their distri-
bution in the future imposes a new special limitation on
the conditions of their demand. We have seen that it is
reasonable and common for human beings to prefer future
goods to present, within limits, as compared with a uniform
distribution in time. Most civilized persons, in fact, plan
for a rising standard of living through life rather than a
constant, much less a falling one. But when infinite time
comes under consideration the case is different.

Any finite amount of consumption or enjoyment dis-
tributed uniformly through infinite time becomes a zero
rate of real income. Hence there must be an apparent
discount on the future in the demand for perpetual in-
come goods. Indeed, it is self-evident that future incomes
must be discounted at some rate greater than zero or they
would have infinite present worth. The discount of the
present in favor of the future can hold good only for finite
periods of time in a society where present goods are limited
at all; i.e., under economic conditions. We must note also,
however, that when a capitalization rate and a market
price for land have been established, the land will be con-
vertible at will into a fund of present consumption goods.
The existence of a free market for permanent income goods
makes the apparent rate of time preference uniform for all
real (finite) intervals. The individual who may not wish to
keep on postponing to the end of a long period knows that
he does not need to do so unless he wishes; for at any time

JOINT PRODUCTION AND CAPITALIZATION 139

he can realize upon his accumulation in present consump-
tion form as rapidly as he may wish. There must be a pre-
mium on present over future goods in the market for per-
petual income property; but such a premium, even if high,
is not incompatible with a premium on the future over the
present for any finite interval, and might perfectly well
exist in a society where every individual and the group as
a whole distributed its consumption in time in a curve
ascending at any finite slope.

Under these conditions a person could arrange, by the
purchase and sale of income property, for any desired
iistribution of consumption over any specified period, or,
through an appropriate life insurance organization, over
the uncertain period of his life. Those wishing to post-
pone consumption, to secure a rising distribution of real
income, would buy such property in the earlier years and
gradually sell it off in the later ones. Those wishing to
anticipate future production and secure a descending
curve of consumption would progressively sell off their
land. (Persons possessing no land could make the anticipa-
tion arrangement only in the manner described above in
discussing a situation where such goods were absent.)
The society as a whole cannot anticipate future production
unless there is some other society from which it can borrow.
It can postpone in the aggregate only as in the situation
above described, through an actual accumulation of con-
sumption goods. The process of net accumulation would
again tend toward an equilibrium with current production
and consumption equal, though the goal might be an in-
definite distance in the future. There must at any time be
an equilibration of the two sorts of motives through the
discount rate established, together with, in the case just
mentioned, a certain rate of net accumulation.

The rate at which perpetual income goods are capital-
ized in the market is not yet a rate of interest in the sense
of a distributive share. Nor would there be any necessity

140 RISK, UNCERTAINTY, AND PROFIT

under the conditions we have described for lending money
in connection with the transfer or use of income-bearing
property (though consumption loans might be effected in
much the familiar form). The capital loan for productive
purposes is, as we shall presently see, a device for separating
the ownership of value equities in production goods from
the direct ownership of the goods themselves. It is mainly
the presence of the risk or uncertainty factor which makes
such a separation desirable. In a progressive society some
motives for specializing to individuals other than the savers
the function of making the investment might exist even in
the absence of uncertainty. In the society which we have
described with both uncertainty and progress absent, there
would be no motive for lending or borrowing value funds
for the purchase of productive agencies.

CHAPTER V

CHANGE AND PROGRESS WITH UNCERTAINTY
ABSENT

We turn now to the third grand division of theoretical
economics, the study of the use of resources in the increase
of resources for the making of goods andjn the refinement
of wants alongside of and alternative to their direct use
in making goods for consumption. The relations of these
three theoretical problems are somewhat complex and con-
fusions in regard to them have been a prolific source of error
in economic thinking. The first problem is the use of given
goods in the satisfaction of given wants (with a given dis-
tribution of the goods to begin with, and free exchange)
and its analysis and solution constitute the theory of
market price. Market prices, besides determining the ap-
portionment of given stocks of goods, the product of past
industry, at the same time show the social estimate of the
relative importance of different goods according to which
the apportionment of resources under the second problem
is worked out. In this first division, production goods do
not enter at all, since costs already incurred have no bear-
ing on price; as Jevons puts it, "bygones are forever by-
gones."

The second problem deals with the use of given pro-
ductive resources in the production of goods to be used,
(always in accordance with market price principles) in the
satisfaction of given wants; it has become known as the
problem of the static society or "static state," and has two
aspects. The first phase relates to the value of productive
services separately; the second, to the values of particular
consumption goods, in relation to the values of the pro-
ductive services which go into them, or their costs; this

142 RISK, UNCERTAINTY, AND PROFIT

is the problem of the long-time or normal prices of consump-
tion goods. In a sense it is, as Marshall suggests, a case of
two classifications crossing each other. The first problem
classifies on the basis of consumption goods, showing the
equation of the value of a commodity to that of the bundle
of productive services entering into it. The second takes
the productive service as a basis and shows the equation of
the value of each unit of productive service to the value of
the portion of each kind of consumption goods in whose
creation it is used, for which it is responsible. The first
is the long-time "value" problem, the second is the short-
time "distribution" problem. The changes in supply (and
value) of consumption goods are studied in relation to
fixed conditions of production, including especially fixed
supplies and methods of organization of productive re-
sources.

The third general problem also relates to both value and
distribution phenomena. Changes in the "fundamental
conditions of demand and supply" of goods give rise to
what Marshall calls "secular changes in normal price."
But the principal "fundamental conditions" subject to
change are the supplies of the different productive serv-
ices which evidently affect still more directly the prices
of these services, the distributive shares. Our discussion,
like Marshall's, will be practically limited to this more
simple and direct effect, the modification of the distribution
situation, and its tendency toward an equilibrium.1

1 Marshall's organization of economic theory about the fundamental
problems is not very clear. We have already seen that he does not bring
out the relations between market and normal price in the case of con-
sumption goods. He refers to the problem of secular changes in normal
price, but relegates discussion of the subject to later volumes not yet
published. In his treatment of distribution he fails to make clear that the
short-time distribution problem is a phase of the same fundamental analy-
sis as normal prices of consumption goods. Moreover, he has very little
interest in this short-time distribution problem. Book vi of the Princi-
ples is almost entirely devoted to the long-time equilibrium tendencies of
the distributive shares, hardly more than passing notice being given to the

CHANGE WITH UNCERTAINTY ABSENT 143

First, let us try to formulate clearly and accurately what
is involved in the problem of progress. What new variables
come in for study? What is the exact content of the "gen-
eral conditions of demand and supply," or the "given re-
sources used in the satisfaction of given wants," which our
previous analysis has assumed? And finally, what are the
changes in these factors which call for consideration in

conditions of equilibrium from the standpoint of distribution at any given
time or for short periods when the supply is to be taken as fixed. Nor does
he identify or even explicitly connect the question of the long-time tend-
encies in distribution with that of secular changes in normal price, which
are phases or points of view in the analysis of the same fundamental prob-
lem of social economic organization. In the writer's view the problem of
intelligible exposition and of fundamental comprehension of the price or-
ganization can be greatly lightened by the recognition and emphasis of
these lines of relation. In addition, it is helpful to stress the close analogy
in methodology of treatment between the short-time price theory of value
and that of distribution, and similarly with respect to the two long-time
or normal price theories.

In this connection it is interesting to compare Marshall with Professor
J. B. Clark, who is especially known in connection with the use of the
static hypothesis in this country. Clark's organization is even more in-
adequate, and it is especially striking that he does not acknowledge the
connection between his method and that of Marshall. The "static state"
of Clark is the same problem as Marshall's long-time normal price, while
his economic dynamics corresponds with the secular changes in the field
of value and the long-time tendencies in distribution. But Clark, under
Austrian and German historical influence as Marshall was under. English
classical, gives us as the theory of distribution the short-time analysis,
and hardly goes beyond recognizing the existence of the problem of pro-
gressive change, the long-run results or conditions of equilibrium of which
are Marshall's almost exclusive concern. He is, indeed, much less satis-
factory in this field than is Marshall in the short-time theory, for the
latter does give, in passing, a very fair statement of the productivity
analysis. It would, of course, be a serious error to confuse Clark's "static
state" with the "stationary state" of the classical economists. The
stationary state of these writers was the naturally static or equilibrium
condition, which is the goal of progress or the subject matter of the third
division of the study, not a state made static by arbitrary abstraction as a
methodological device. It seems, however, that virtually all discussion
of static conditions is vitiated by the failure to distinguish adequately
between these two concepts. And we still lack a complete discussion of
distribution which will give due weight to both the short-time and long-
time problems; i.e., separate the assumption of fixed supplies of pro-
ductive agencies from the assumption that supply is a function of price. A

144

RISK, UNCERTAINTY, AND PROFIT

order to bring our society into the closest possible approx-
imation to reality? Marshall, whom the present study
more closely follows than it does any other writer, seems
to avoid, not to say evade, answering this question ex-
plicitly. He does at one point begin an enumeration of
elements, but cuts it short at once with the blanket ex-
pression quoted above. l A well-known explicit list of static
state or dynamic factors to be excluded is that of Professor
J. B. Clark, whose name is especially associated with the
contrast between static and dynamic problems in this
country. He gives these five elements of progress: 2
(1) growth of population; (2) accumulation of new capital;
(3) progress in technology; (4) improvement in methods of
business organization; (5) development of new wants.
Professor Seager modifies this list, and in the writer's view

rough tabulation of the natural divisions of the theory may help to
clarify their relations:

Problem I

Given supplies of
goods and given
wants to be satisfied.
(The situation at a
moment.)

Problem II.

Given productive re-
sources and given
wants to be satisfied.

Problem III.

Use of resources to
increase resources
and change wants as
well as satisfy exist-
ing wants.

Value

(i.e., consumption

goods)

Market price.

Normal price (Mar-
shall's long-time nor-
mal price). Supply
of each good a func-
tion of price.

Secular changes
normal price.

Distribution
(productive serv-
ices)

No problem of distri-
bution involved.

Short-time or market
price distribution the-
ory. (Fixed supply of
thing being priced.)

Long-time or normal-
price distribution the-
ory. Supply a func-
tion of price.

1 Cf. Principles of Economics, 6th ed., p. 379.

2 The Distribution of Wealth, chap. v.

CHANGE WITH UNCERTAINTY ABSENT 145

greatly improves it, by combining the third and fourth
factors and adding a new one, the impairment of natural
resources or discovery of new natural wealth.

It will aid in clarifying the issues if we first consider
separately the conditions of demand and of the supply of
goods. Conditions of demand seem to include the follow-
ing fundamental facts :

1. The population considered as consuming units; its
numbers and physical composition as to age, sex,
race, etc.

2. The psychic attributes of the population, its behavior
attitudes toward the consumption of all sorts of goods,
both inherited " instincts' ' (in whatever sense such
things exist), and the "social inheritance " of habit,
custom, tastes, standards, mores, and what-not, in-
cluding, of course, actual knowledge or beliefs as to
the real characteristics of commodities. We must
also include here any institutional facts as to the con-
trol of the consumption of some persons by other
persons, such as authority of parents, sumptuary
laws, etc.

3. Immediately, the money income of the population
both as to aggregate amount and distribution. Ul-
timately, in the equilibrium adjustment, the income
and its distribution depend on the whole set of con-
ditions of the supply of goods, especially the amount
and distribution of productive resources in the society.
It is imperative to remember that the end result of
the competitive adjustment depends on the initial
facts in all these respects.

4. For completeness it is important, also, to consider
the given facts as to the geographic distribution of
the population as consuming units; this is determined,
of course, by the distribution of productive resources
and of environmental conditions affecting desirability
of sites for habitation. Differences here would also

146 RISK, UNCERTAINTY, AND PROFIT

produce effects ramifying throughout the whole or-
ganization.
Given conditions of supply include especially the supply
of the factors of production, but there are other vital
considerations. We may classify as follows:

1. The population considered as labor force, numbers,
and composition.

2. The psychic or behavior attitudes, tastes, prejudices,
etc., toward productive activities, inherited or ac-
quired.

3. Immediately, money income and its distribution;
ultimately, the distribution of ownership of produc-
tive resources of every kind. There is no difference
between personal ability and productive property in
this respect. It is obvious that income affects dis-
position to engage in productive activities and enters
as a variable, independent of taste.

4. Although it belongs logically under number 3, or is
at most a corollary from it, we specify separately the
institutional situation as to the meaning and extent
of private property. This includes all facts as to
(a) control of the use of productive services and (b)
of valid and enforceable rights to income. There is
again no distinction to be made between personal
powers and other productive facts.

5. The amount and form of material agents of pro-
duction in existence. Under the static conditions
hitherto discussed these can include only natural
agents in the narrowest sense, or, what would amount
to the same thing, implements inherited from past
generations, and in either case subject to neither
deterioration nor improvement.

6. The geographical distribution of productive agencies.

7. The state of the arts; the development of technology,
business organization, etc.

^ t Combining the two groups and removing duplication we

CHANGE WITH UNCERTAINTY ABSENT 147

find the following factors in regard to which change or the
possibility of change must be studied :

1. The population, numbers and composition.

2. The tastes and dispositions of the people.

3. The amounts and kinds of productive capacities in
existence, including

a. Personal powers.

b. Material agents.

i. Given by nature.1
ii. Artificially produced.1

4. The distribution of ownership of these, including all
rights of control by persons over persons or things.
(Impersonal control, by laws or mores, is indistin-
guishable from number % tastes and dispositions.)

5. Geographic distribution of people and things. This
stands in close relation to the facts of technology.

6. The state of the arts; the whole situation as to science,
education, technology, social organization, etc. 3

Systematic completeness would call for a survey of possi-
ble changes in each of these elements and the relation of
such changes to both value and distribution phenomena,
the prices of consumption goods and of productive services
(and in addition their relations to the capitalization rate,
the sale prices of productive agencies). No such ambitious
program can be entered upon, however. We shall merely
point out some of the more important price bearings of
changes and make such comments as seem especially sig-
nificant in illuminating dark places in theory. The point
for especial emphasis is that the really far-reaching effects of
change are not the results of the fact of change itself, but
of the uncertainty which is involved in a changing world.
If any or all of these changes take place regularly, whether
progressively or periodically or according to whatever
known law, their consequences in the price system and the

1 This distinction follows conventional usage; it will be examined
presently and shown to be untenable. (See below, pp. 159 ff.)

148 RISK, UNCERTAINTY, AND PROFIT

economic organization can be briefly disposed of. Through
the machinery of the exchange of present and future values
all of them will be fully " discounted " an indefinite time
before they occur. They will not upset human calculations
or destroy universal perfect equalization of alternatives.
Hence, in particular, changes, if foreseeable, do not disturb
the prerequisites of perfect competition for productive
services, bringing about exact equivalence between costs
and values, with absence of profit.

As a matter of fact the effects of changes in the general
conditions of the production and consumption of goods
upon the prices of consumption goods are either so obvious
or so complicated and hopeless of practical prediction that
it does not seem worth while to attempt systematic treat-
ment of them. Our discussion will be confined almost
entirely to the theory of distribution. In this field, also,
let us note that progressive changes can usually be fairly
well foreseen and discounted and their effects are not
generally important over short periods of time. They pro-
duce relatively little real disturbance in the competitive
adjustment and are not a significant cause of profit. The
significant disturbances and sources of profit are rather
the short-period and erratic fluctuations, and the irregulari-
ties of progressive change, not the change itself. The in-
crease in population and accumulation of new capital are
not disturbing facts to any appreciable extent, and the dis-
turbances arising from invention and improvement are due
to the local and spasmodic way in which they originate,
not to the general tendency.

In discussing the short-time theory of distribution (dis-
tribution under conditions of fixed supplies of productive
agencies) we have repeatedly emphasized the absence of
any valid ground for a general classification of productive
agencies, either along the lines of the traditional three
factors or along any other lines. That is, on the demand
side they are alike or differ by innumerable impercepti-

CHANGE WITH UNCERTAINTY ABSENT 149

ble gradations, and for short-time problems the conditions
of supply — given quantities in existence — are also ob-
viously identical for all. The long-time point of view, how-
ever, brings in the new question of changes in supply, in
regard to which there are real differences. These differences
in the conditions of supply afford a basis for legitimate
classification, somewhat along the lines of the tripartite
division. It is superficially reasonable to recognize three
categorically different conditions of supply. First we should
have agencies whose supply is given once for all even over
long periods, things not subject to increase or decrease,
improvement or deterioration. The traditional definition of
land fits this description. (We do not here raise the ques-
tion whether anything exists to which the definition ap-
plies.) In the second place, some productive goods may
be, and obviously are, freely reproducible in the same man-
ner as consumption goods, under conditions in which supply
becomes a definite function of the price of their services.
The traditional view of capital gives it this character.
(Again we make no assertions as to the correctness of the
view.) And finally, the supply of still other agencies may
be variable, but not a function of price, or not connected
with price in an immediate or direct way. The traditional
treatment of the long-time supply of labor (the merits of
which are also reserved for later examination) differen-
tiate it in this respect from other productive powers. This
traditional classification is not accepted as valid, even from
the long-time point of view, and will be criticized at length
as we proceed. But the superficial basis for it and the fact
that it is well established in the thought and terminology
of the science may justify taking it as a starting-point.

The ramifications and interconnections of effects of any
particular change are ultimately rather complicated, and
may be followed out until nearly every aspect of the ad-
justment is modified in some way. This is obviously true
of the first of the static characteristics named. Historically

148 RISK, UNCERTAINTY, AND PROFIT

economic organization can be briefly disposed of. Through
the machinery of the exchange of present and future values
all of them will be fully " discounted " an indefinite time
before they occur. They will not upset human calculations
or destroy universal perfect equalization of alternatives.
Hence, in particular, changes, if foreseeable, do not disturb
the prerequisites of perfect competition for productive
services, bringing about exact equivalence between costs
and values, with absence of profit.

As a matter of fact the effects of changes in the general
conditions of the production and consumption of goods
upon the prices of consumption goods are either so obvious
or so complicated and hopeless of practical prediction that
it does not seem worth while to attempt systematic treat-
ment of them. Our discussion will be confined almost
entirely to the theory of distribution. In this field, also,
let us note that progressive changes can usually be fairly
well foreseen and discounted and their effects are not
generally important over short periods of time. They pro-
duce relatively little real disturbance in the competitive
adjustment and are not a significant cause of profit. The
significant disturbances and sources of profit are rather
the short-period and erratic fluctuations, and the irregulari-
ties of progressive change, not the change itself. The in-
crease in population and accumulation of new capital are
not disturbing facts to any appreciable extent, and the dis-
turbances arising from invention and improvement are due
to the local and spasmodic way in which they originate,
not to the general tendency.

In discussing the short-time theory of distribution (dis-
tribution under conditions of fixed supplies of productive
agencies) we have repeatedly emphasized the absence of
any valid ground for a general classification of productive
agencies, either along the lines of the traditional three
factors or along any other lines. That is, on the demand
side they are alike or differ by innumerable impercepti-

CHANGE WITH UNCERTAINTY ABSENT 149

ble gradations, and for short-time problems the conditions
of supply — given quantities in existence — are also ob-
viously identical for all. The long-time point of view, how-
ever, brings in the new question of changes in supply, in
regard to which there are real differences. These differences
in the conditions of supply afford a basis for legitimate
classification, somewhat along the lines of the tripartite
division. It is superficially reasonable to recognize three
categorically different conditions of supply. First we should
have agencies whose supply is given once for all even over
long periods, things not subject to increase or decrease,
improvement or deterioration. The traditional definition of
land fits this description. (We do not here raise the ques-
tion whether anything exists to which the definition ap-
plies.) In the second place, some productive goods may
be, and obviously are, freely reproducible in the same man-
ner as consumption goods, under conditions in which supply
becomes a definite function of the price of their services.
The traditional view of capital gives it this character.
(Again we make no assertions as to the correctness of the
view.) And finally, the supply of still other agencies may
be variable, but not a function of price, or not connected
with price in an immediate or direct way. The traditional
treatment of the long-time supply of labor (the merits of
which are also reserved for later examination) differen-
tiate it in this respect from other productive powers. This
traditional classification is not accepted as valid, even from
the long-time point of view, and will be criticized at length
as we proceed. But the superficial basis for it and the fact
that it is well established in the thought and terminology
of the science may justify taking it as a starting-point.

The ramifications and interconnections of effects of any
particular change are ultimately rather complicated, and
may be followed out until nearly every aspect of the ad-
justment is modified in some way. This is obviously true
of the first of the static characteristics named. Historically

150 RISK, UNCERTAINTY, AND PROFIT

the population question has been considered with distribu-
tion in connection with wage theory through its relation
to the supply of labor. Of course, an increase of population
is an increase in the demand for goods and hence in the
demand for all the productive services including labor it-
self. LBut the demand for any productive service depends
finally upon two elements, the total output of industry
and the relative importance of that service in increasing
the output. In accordance with the law of diminishing re-
turns and the specific productivity theory based upon that
law, a relative increase in the supply of labor will increase
the product of industry less than proportionally and de-
crease the relative productivity of labor. Both effects tend
to lower wages per man. The same reasoning applies to any
other productive service as well as to labor. 3

Much confusion has arisen in economic discussion
through different meanings given to a distributive share.
We may speak of wages, for example, as above, as wages
per man, and similarly of other incomes in relation to the
concrete agency which produces them. The problem of
distribution from this point of view Cannan calls "pseudo-
distribution," 1 seemingly an unfortunate term, for this is
surely the phase of the subject in which we have the great-
est and most direct interest. The classical economists
themselves, led by Ricardo, usually centered their dis-
cussion around the fraction of the total social produce re-
ceived by the "factor" under discussion. Another clearly
possible meaning is the aggregate share of a "factor"
measured in absolute terms.

The effect of an increase in a factor (meaning a large
group of physically interchangeable productive units) on
the fraction of the social income it will receive, depends on
the rate of diminishing returns realized from the applica-
tion of that agency to others in the vicinity of the pro-
portions already in existence. If the increase in total pro-
1 Theories of Production and Distribution, chap. vn.

CHANGE WITH UNCERTAINTY ABSENT 151

duction is nearly proportional to the increase in the factor
(remembering that it cannot be equal or greater), its frac-
tional share will rise; if much less, it will fall. The aggre-
gate absolute share of income falling to the agency will in-
crease unless the falling-off in product is in equal or greater
ratio with the increase in the agency. Both points, how-
ever, are rather remote from the problem of immediate
interest. If the income per unit is known, the relative and
absolute shares of the factor can more naturally be deter-
mined indirectly.

Obviously a shift in the amount of any productive
agency will, through its effect on incomes, react on the de-
mands for goods, and ultimately affect nearly every feature
of the organization of industry and of the price system.
The resulting changes in the prices of consumption goods
are what Marshall calls secular changes in normal price.
It does not seem profitable, if indeed it is possible, to dis-
cuss these in the abstract. About the only general ob-
servation which seems worth making is that those goods in
whose production any particular agency predominates will
tend to fall in value as the supply of that agency increases,
other things being equal.

The really difficult problem in the theory of progress
relates not so much to the effects of particular changes.
These effects, though complicated, can be traced out by
the application of the principles of the market, the " laws "
of supply and demand. The difficulty comes in the pre-
diction of the changes themselves. What are the conditions
of supply of the productive services? What changes in the
supplies of the different services may be reasonably an-
ticipated, and to what goals or equilibria do they tend?
The question is of especial interest because it was in terms
of these ultimate equilibrium levels that the classical theory
of distribution was almost exclusively worked out. In our
opinion the meaning of these equilibrium conditions was
misconceived in classical economics and their significance

152 RISK, UNCERTAINTY, AND PROFIT

perhaps somewhat overestimated.!: The early writers re-
garded the equilibrium condition as constantly at hand in
a sense analogous to the normal price equilibrium between
the production and consumption, cost and value, of con-
sumption goods. Their " static state " was, if not the actual
condition of society, a condition on which it constantly
verged.1 It makes a great deal of difference in the theory
when we recognize, as the facts require, that the equilib-

y rium is an indefinite and usually a very great distance in
the future.^ The condition must then be viewed as the
theoretical result of a particular tendency only, which may
be modified to any extent or reversed by the effect of other
tendencies, or the conditions may be entirely changed by
unforeseen developments long before any considerable ap-
proach to the equilibrium has been made. LThe equilibrium,

/ then, in a particular case, is not a result actually to be
anticipated; a concrete prediction of the future course of
events must take into account all the tendencies at work
and estimate their relative importance, and in addition
must always be made subject to wide reservations for un-
predictable influences.;,' In fact, as we shall see, the interre-
lations of the various factors of progress are so complicated,
and the functions themselves are so inaccurately known
and are affected by so many unknown variables, that defi-
nite predictions extending any considerable distance into
the future seem to be quite out of the question.

Turning now to the question of the conditions influenc-
ing the progress variables and of the changes to be ex-
pected in regard to each, we may begin with the factor of
population once more and go through the list. The plan,
of course, is not to investigate hypotheses at random, but
to inquire seriously about the facts of the world we live in.
The only arbitrary or unreal element in the procedure is
the selection of the outstanding dominant features and
their isolation with a view to ascertaining if possible their
1 Mills, Principles of Political Economy, book iv, chap, iv, sec. 4.

CHANGE WITH UNCERTAINTY ABSENT 153

own inherent tendencies. The products of such an inquiry
are, like all theoretical deductions, — all general principles,
— partial truths which cannot be applied uncritically, but
must be combined according to circumstances and supple-
mented with empirical data. Historic population theory,
or Malthusianism, pictured laborers as analogous to a
good supplied under conditions of constant cost. Wages
were accordingly held to tend toward an equilibrium level
equal to this cost, the (real or commodity, not money)
cost of maintaining a static population. The premise was
not, of course, that the production of laborers takes
place from motives of pecuniary profit,1 but that in con-
sequence of the physiological-psychological law of popula-
tion, the supply varied in a strictly analogous way. The
tendency of wages to the minimum of subsistence is in-
deed a natural and correct deduction from the tendency of
population to press constantly upon the supply of the
necessaries of life.2
This early version of the theory of the cost of labor was

1 It is a neglected fact that in the "lower" strata of society the pro-
duction of children is by no means so unrelated to the ordinary economic
calculation as generally assumed. The age of marriage and the size of
families probably depend much more in fact on the amount of economic
gain or loss between the prospective earning of children and the cost of
their keep while under their parents' control than they do upon calcula-
tions as to the possibility of maintaining standards of living from one
generation to another. (Of course, the two sets of considerations are inter-
related.) A comparison of birth-rates with living conditions in the city
and country and in different social environments, also a study of the
effects of child labor and compulsory education laws on birth-rates, are
very suggestive in this connection.

2 It is hardly necessary to point out that the famous "iron law" of
wages of Lassalle and the Marxian socialists is this classical theory of the
equilibrium wage taken over bodily, but with the logical foundation on
which it rested repudiated indignantly. If the tendency of wages to a
minimum is based on a principle of population, all schemes of social re-
organization (except in so far as they affect that principle) are helpless to
produce any result save possibly a temporary amelioration, with a later
increase in misery. This, it will be recalled, is the very thesis which the
essay on population was originally written to prove in answer to the
millennial hopes held out by Godwin's Political Justice.

156 RISK, UNCERTAINTY, AND PROFIT

manifest themselves in the market, and assume perfect
intercommunication and freedom of movement, the migra-
tion factors would quickly come to an equilibrium.

The second of our progress variables is the psychological
element, the dispositions and tastes of the people. Like the
number and composition of the population, it affects con-
ditions on both the consumption and production sides of
the problem. Changes and great changes do, of course, take
place in wants for consumption goods and in attitudes to-
ward different lines of productive activity.1 Most of these
changes cannot profitably be treated as functions of price
and no conditions of equilibrium can be formulated for
them. They remain in the class of external disturbing
causes little subject to prediction, especially on the pro-
duction side. Tendencies can often be noted, such as the
"lure of the city" which now operates to increase industrial
production at the expense of agriculture. In America the
irrational preference for white-collar jobs has raised the
wages of mechanics above those of clerical tasks calling for
much more ability and education. Other preferences and
vogues for particular kinds of work must be ^passed over
with the mere pointing-out that they are part of the given
conditions of the economic process and that changes in
them have widely ramified effects. These considerations
apply to uses of property as well as to personal powers,
though in a much less degree.

On the consumption side there is a very important
problem more amenable to scientific treatment, though still
very treacherous to deal with. We refer to the familiar
fact of the use of economic resources by private business
to develop, create, or direct consumptive wants; i.e., the

1 Strong social disapproval of any line of business or occupation un^
doubtedly tends to aggravate any real evil connected with it, by throwing
it into the hands of persons (of whom there is never any dearth) to whom
social approval and disapproval are a matter of indifference. Conspic-
uous examples are money-lending in the Middle Ages (and the same type
of money-lending now) and the liquor business in modern times.

CHANGE WITH UNCERTAINTY ABSENT 157

phenomenon of advertising.1 The increase of value through
advertising, whether informative or merely persuasive,
is quite parallel to any other form of production, or "crea-
tion of utilities. " Such values are largely transferred from
other goods, but except in so far as they result from a
positive disparagement of competing commodities they
are to be regarded as merely an additional utility in the
advertised commodity.2

The business of want creation is, of course, very uncer-
tain and aleatory or "risky"; but it is evident that, as with
other changes, in so far as the results of action can be fore-
seen, competition will equalize gains with those in other
fields. Costs will then be equal to values throughout the
system, the conditions of profitless adjustment being pres-
ent. Whether the creation of wants is subject to diminish-
ing returns, the process consequently tending toward an
equilibrium, where it would no longer take place, or whether
it is inherently a perpetual cause making for continued
change, is a matter we cannot discuss on its merits. The
writer's guess would favor the latter alternative.

1 Efforts on the part of society, the public, organized and unorganized,
to direct consumption along approved lines, fall outside the scope of a
study of private competitive organization.

2 Disparagement of competing commodities must be eliminated from
consideration for the same reasons as burglary and such crude fraud as
the dispensing of gold bricks, liquozone, etc. It will be recalled that we
have expressly eliminated effects of interests not represented in market
transactions.

The suggestion may seem fanciful, but I find it impossible to differen-
tiate between elements in the physical form and appearance of a com-
modity which make no difference in its efficiency for the purpose in-
tended (an agreeable color, decorative ornament often actually interfer-
ing with its uses, fancy containers, etc.), on the one hand, and on the
other an element of appeal due to a high-sounding name or any other
form of "puffing." These things do make a difference in the commodity
to the consumer and in an exchange system the consumer is the last
court of appeal. If they are different to him, they are different; if he is
willing to buy one sort in preference to the other, then the first is superior
to the second; it contains "utilities" which the other does not have. I do
not see that it makes any real difference whether these utilities are in the
thing itself or in some associated fact.

158 RISK, UNCERTAINTY, AND PROFIT

i In regard to the third progress factor, the amount of pro-
ductive resources in existence, the first question relates to
the classification of these resources from the standpoint of
changes in supply. We have shown above that differences
must be recognized somewhat along the lines of the con-
ventional tripartite division, but we must emphasize that
the differences have been much exaggerated and that
definite classification along the traditional lines cannot
be maintained.1

The long-time conditions of the supply of labor consist
of two elements: The first, the population, has already
been discussed. The second is the factor of education,
taken in the broad sense. Now training, which results in
increased productive efficiency, is evidently similar to a
material productive agency or capital good created by
the diversion of resources from present consumptive uses.
Even the population itself, as observed above, depends to a
large extent upon considerations of pecuniary profit in the
case of the social classes which subsist mainly by labor.
The distinction between labor and capital thus shows a
tendency to fade away. A degree of distinction, indeed,
persists. Technical training cannot be sold or leased for
use separate from its owner, and cannot in any direct
sense be perpetuated beyond the owner's working life.
Capital is at least less attached to its owner's personality
(it is important to note that it is never absolutely detached)
and may function in perpetuity. In addition the invest-
ment in education is more affected by other than profit-
seeking motives, and in consequence is not so closely ad-
justed by effective competition to equality of return with
other forms of investment.2 Investment in the improve-

1 It will be kept in mind that from the standpoint of short-time prob-
lems, where changes in supply are not at issue, and demand alone deter-
mines distributive relations, no classification at all is valid.

2 The fact that so many opportunities for the profitable investment of
resources in the development of human potentialities are neglected, and so
many wasteful investments of the same kind made, is perhaps one of the

CHANGE WITH UNCERTAINTY ABSENT 159

ment of human powers is rather a long-time proposition,
yet does not look so far ahead as many other forms of in-
vestment; in other ways, however, it is subject to a very
high degree of uncertainty. After all there seems to be as
much difference between different cases or types of labor
production and between different varieties of material
productive goods creation as there is between the two
classes of investment of resources as types. Jn so far as un-
certainty is absent and competition obtains, it is clear that
investment will distribute itself between the two fields and
over all parts of each in such a way as constantly to equal-
ize their net advantages. Which is to say (remembering
that costs merely register competing attractions) that
with uncertainty absent costs and values would be equal
throughout the system; that is, there would be a perfect,
profitless organization of production and exchange.^

There is a fundamental similarity in the conditions of
supply of all the productive services involving the in-
vestment of resources. In every case there is a diversion of
productive power from use in making present consump-
tion goods to the creation of sources of new consumption
goods income. A discussion of the conditions of equilibrium
for any of them will therefore be postponed until all can be
dealt with together. The general theory of equilibrium in
this case is in fact the long-run theory of interest^

The classical economist treated land, or natural agents,
as given in supply. This assumption was the basis for
propounding a theory of rent different from the reasoning
by which the other distributive shares were explained,1

most serious criticisms of existing society. The fault, however, is in the
family system rather than in the private enterprise organization of in-
dustry in any sense in which the two may be dissociated.

1 The differential theory of rent has long since been recognized as
applying equally well to the other shares. See J. B. Clark, "Distribution
as Determined by a Law of Rent," and J. A. Hobson, "The Law of the
Three Rents," Quarterly Journal of Economics, vol. v. It is not so generally
recognized that in consequence it explains none of them. It is especially
remarkable that the theory of distribution propounded by General

160 RISK, UNCERTAINTY, AND PROFIT

and for positing a special relation between rent and cost.
The definition given for land to make it fit the description
of a fixed supply — the original and inexhaustible powers
of the soil — is indeed drastic in its limitation. Later, this
dogma of unconditional fixity of supply was made the basis
for the single-tax propaganda. We cannot discuss this
position at length, but must take space to remark quite
briefly that it is utterly fallacious. It should be self-
evident that when the discovery, appropriation, and devel-
opment of new natural resources is an open, competitive
game, there is unlikely to be any difference between the
returns from resources put to this use and those put to any
other. Moreover, any disparity which exists is either a
result of chance and as likely to be in the favor of one field
as the other, or else is due to some difference in psychologi-
cal appeal between the fields; i.e., goes to offset some other
difference in their net advantages. Viewing as a whole the
historic process by which land is made available for pro-
ductive employment, it must be said to be "prdduced";
i.e., to have its utility conferred upon it in a way quite on a
par with that which holds for any other exchangeable good./
This, of course, again abstracts from the factor of uncer-
tainty. In real life a large speculative element is intro-
duced; but this cannot be said to differentiate land gener-
ically from any other class of goods, though the results
are met with on an especially large scale in the case of land.
A new form of productive resource has become of very
great importance in modern society, consisting of special
methods of production or exclusive technical processes,
whether patented or kept secret, or merely not "yet" ex-
tended in use over the whole field of production. Such a

Francis A. Walker, whose book was long a standard text in American
colleges, amounted to nothing more than an elaboration of the proposi-
tion that each factor gets what is left after the others are paid. It is easy
to show that the differential theory when stated in its significant form is
identical with the specific productivity theory. Cf. A. A. Young, Ely's
Outlines of Economics, 3d ed., pp. 415-16.

CHANGE WITH UNCERTAINTY ABSENT 161

process is a source of income like any other agent, and is
produced in the first place in the same way, by the invest-
ment of present resources (in research and experiment).
They are different from most capital goods, however, in
that their cost of maintenance and multiple reproduction
is so low * that it is profitable to multiply them to the point
of becoming free goods, except in so far as they inhere in the
persons of their possessors. They thus tend to revert to the
category of enhanced individual capacities, unless in some
way "monopolized." New productive processes are like
natural resources in being produced under conditions in
which the gambling element is large, but in so far as the
results of operations can be foreseen they also tend to
equality of return on investment in comparison with other
fields.

We turn, therefore, to the ordinary and simple case of
the investment of resources in the creation of new produc-
tive capacities; i.e., to the case of capital goods. In this
connection we can conveniently discuss the general case,
subsequently returning briefly to the problems of human
powers, natural agents, and productive methods just men-
tioned. The argument will be closely related to, in fact
may be said to take up and continue, the discussion in the
last chapter on the subject of time preference and the pur-
chase and sale of productive goods. We now have the fur-
ther complication that our productive goods are no longer
fixed in supply, but that opportunity exists for the indefi-
nite creation of such goods through the diversion of re-
sources from the production of present consumption goods.

1 Ideas are not, however, free from these costs, as sometimes assumed.
Thus A. S. Johnson (Rent in Modern Economic Theory, p. 120) contends
that an idea cannot be regarded as productive, because it is "its nature"
to multiply itself indefinitely. It would simplify the problem of education
if it were so! But perhaps we should wish some discrimination to be ex-
ercised in the extension of the quality to ideas generally! Even so, if the
"natural" tendency is obstructed, the idea limited in application seems
to be productive in the sense in which anything else is productive. (See
below, chapter vi.)

162 RISK, UNCERTAINTY, AND PROFIT

For it will be seen that to the individual the investment of
present goods (their use to pay productive agencies while
the latter, being liberated by the "advance,"1 devote them-
selves to the making of the new equipment) is equivalent to
their exchange for productive services already in existence
in the possession of others; it is an alternative method for
securing the same result. The previous discussion of the
motivation involved, therefore, applies to the present
case; i.e., it fits the assumptions usually made as to the
motives for capital formation. We would emphasize the
importance of a new motive not present in the former
hypothetical case, the opportunity to create, which we hold
to be a motive on its own account very distinct from, or at
least very much more than, the mere desire to possess the
thing created. However, in this brief survey, it seems nec-
essary to abstract from the complicating factors in the
motive for saving and to treat new productive equipment
as a perpetual value-income merely (with the possibility
of cashing in by sale at any time, as in the previous case).2

1 The classical writers' view of capital as "advances to laborers" was
correct except for the failure — natural from their labor theory point of
view — to include the other productive factors as well as labor.

2 Beyond the dogma that the desire to secure the income from capital
is the sole motive for saving, it is a still further and questionable assump-
tion that the strength of the motive varies in proportion to the size of the
income expected or is connected with it by some simple law. Again we
make, for convenience, the conventional simple supposition, merely taking
this opportunity to record grave doubts as to the validity of any of this
procedure. The saving of capital seems to us to be in fact the result mainly
of two or three motives of which the desire for increased consumption of
goods in the future is only one and probably one of the less important.
Like other acts of man in society, it is largely a mere matter of established
social custom, good form, the thing to do, the mores. Then«we must em-
phasize the impulse to create. Probably the greatest single source of sav-
ing is the putting of income back into a business, because of sheer interest
in the business and the desire to make it grow. That the desire for the in-
creased income is not the dominant motive in much of this is proved by
the fact that men invest as desperately in an enterprise never likely to be
profitable as they do in the most prosperous concern, and by the further
fact that much of the reinvestment in society is made by directors of cor-
porations who will not get the fruits of the work for themselves at all.

CHANGE WITH UNCERTAINTY ABSENT 163

The demand for capital goods is, therefore, merely the
demand for future income, already discussed. Assuming a
static and universally known technology, all forms of such
goods will necessarily be kept at a uniform level of pro-
ductivity in relation to the investment necessary to create
them, and they can be treated as a homogeneous class.
The demand for capital goods in industry, like that for any
other productive agency, is subject to the twofold law of
diminishing productivity already familiar, and the more of
such goods created the lower the value income they will
yield, in terms of the goods themselves measured physi-
cally. But the base on which the investor figures is not the
physical productive goods created. These are as non-ex-
istent to his calculation. He is interested exclusively in the
relation between (a) the amount (i.e., value) of present
goods he gives up and (b) the size of the value income
which he receives. Hence, we have in this case a really
fourfold law of diminishing effective demand: (1) The
creation of producers' goods involves a diversion of re-
sources from the making of consumption goods, and this
transfer takes place subject to diminishing physical re-
turns. The sacrifice of a given amount and kind of con-
sumption goods makes possible the creation of a smaller
amount of any given kind of capital goods the further the.
process is carried.1 (2) Those productive goods which are

The truth is, we believe, that the real motives of human life, at least of
those people who do big things, are idealistic in character. The business
man has the same fundamental psychology as the artist, inventor, or
statesman. He has set himself at a certain work and the work absorbs
and becomes himself. It is the expression of his personality; he lives in its
growth and perfection according to his plans.

1 The statement is applicable to the other methods of investing re-
sources — the development of new natural agents, training of labor and
improvement of technology — as well as to the creation of capital goods
in the narrow sense. The use of resources to increase population in num-
bers appears to be exceptional as population subsists upon consumption
goods themselves, and no change in the forms of production is involved.
This action, however, is only to a very limited extent a matter of the cal-
culated exchange of present for future goods.

164 RISK, UNCERTAINTY, AND PROFIT

more readily multiplied by the investment of resources
must increase relatively to the other agents with which
they are combined in production, and become subject to
diminishing physical returns in their use. (3) To the
extent that the relatively increased agencies enter into
the production of certain commodities more than of
others these commodities will have their supply relatively
increased and will fall in price relatively to other com-
modities. (4) Finally, as present goods are progressively
sacrificed to the creation of future income, the relative
preference of the latter to the former must fall off as more
of it becomes available.
, z Other things being equal, the investment of resources
i should ultimately be carried to a point of equilibrium at
i which the amount of value income and the amount of
§ present value which must be sacrificed to create it become
} equal to every person in the system. As long as the income
which can be produced by sacrificing a given amount of
present goods has a sufficient appeal to induce new sav-
ings, the new savings must continue to be made and to re-
duce the amount of value income obtainable from a given
amount of investment. A point must ultimately be reached
at which the product of investment is just attractive
enough to hold in existence capital already saved, without
calling forth new savings. Of course some individuals may
at any time be consuming capital previously saved, while
others are saving and investing, provided the two offset
each other.1!!

1 A caution is in place against taking this equilibrium as strictly analo-
gous to the normal price of a consumption good. A consumption good is
destroyed in use. The equilibrium condition in regard to it is equality in
the rates of its consumption and production with a negligible amount of
the good actually in existence. (Durable consumers' goods are, of course,
capital in fact.) Capital, on the other hand, accumulates, new production
being constantly added to the whole net product of the past. The equilib-
rium in its case is a constant amount in existence, current production and
consumption amounting in the equilibrium condition only to replacement
of wear and tear. In this respect capital is like gold in the theory of its

CHANGE WITH UNCERTAINTY ABSENT 165

j, The above is a brief statement of the "eclectic" theory
of interest. The equilibrium ratio of the annual value in-
come yielded by the capital goods created to the present
value sacrificed in creating them — that ratio at which no
further net conversion (saving and investment) takes
place — is the theoretical long-time rate of interest. It is
the magnitude toward which, as Marshall says,1 the in-
terest rate constantly "tends.';} Of course, "other things"
must be assumed to be "equal." But in the nature of the
case other things are not and cannot be equal. As in-
vestment takes place, the new income derived from it
makes the saving of any given amount constantly easier,
thus progressively changing the conditions of supply of new
capital. In addition it is inconceivable that wants and
tastes, or even the state of the arts, should remain static
while such an adjustment worked itself out. The theory is
logically sound if correctly understood. It describes con-
ditions under which the interest rate would not tend to
change, and is of service in predicting the future move-
ments of the rate. But it gives a very incomplete view of
the facts which must be taken into account in an actual
prediction. Changes in the other things — especially the
psychology of spending and saving (partly a matter of the
size of income) — in the given amounts of agencies not
freely reproducible through investment, and the develop-
ment of technology, not to mention wars and other catas-
trophes — do in fact commonly exert quite as much in-
fluence on the interest rate as does the tendency to equilib-
rium due to progressive saving and investment.2

valuation. It is like gold, again, in the respect which we proceed to dis-
cuss, that the equilibrium condition is actually an indefinite distance in
the future, that new production is constant and sure, but still small in
amount in comparison with the existing supply, and that, therefore, con-
ditions of production have a negligible effect on value over moderate
periods of time.

1 Principles, 6th ed., p. 536.

2 Mention should also be made of banking, speculation, and the vicis-
situdes of foreign trade, which may completely dominate the rate for very

166 RISK, UNCERTAINTY, AND PROFIT

But the most serious criticism to be made of the eclectic

theory as it is currently presented (e.g., in Marshall) is its

failure to recognize the true meaning of the equilibrium,

and its assumption that actual conditions at a given time

approach that state. The contrary is true; the case is similar

to that of population already discussed, but more striking

and important. At a given moment in a society where new

investment is taking place the rate of capitalization is the

technical ratio of conversion of present goods into future

income. It is the "productivity" ratio of new investment,

the ratio between the annual value yield of the capital

goods to be created 1 and the value of the present goods

short periods. Passing over such phenomena as the call-loan rate and the
relation of international transactions to the interest rate, a word should be
said on the subject of the bank rate. An issue of new currency by banks
through an expansion of loans creates a momentary new supply of capital
and, other things equal, tends to lower the interest rate. The effect is
chiefly limited to those short-time loans in which banks mainly deal, but
perhaps not entirely so. It is imperative to recognize, however, that in-
flation produces its effect through an actual saving, a diversion of income
from present consumption to capital goods creation. The new currency
which the bank lends to the investor is not new purchasing power from the
standpoint of society as a whole. It is axiomatic in theory that the aggre-
gate real value of the circulating medium is independent of the number
of units of which it is composed. When inflation occurs, therefore, pur-
chasing power is not created, but merely transferred from the previous
owners of circulating medium to the persons into whose hands the new
currency is placed for its first expenditure. The enormous r61e played in
history by inflationism and the persistence of the heresy rest upon the
fact that the effects of the expenditure of the new money are more con-
spicuous than the diminished effects of that which already existed. It is
another case of the familiar type, "ce qiion voit et ce qtCon ne voit pas."

However, it is to be emphasized also, that the psychology of business is
fundamental in the economic process and that it is a very complex, sensi-
tive, even treacherous thing. It will not do to draw conclusions as to
policy from mere cause-and-effect reasoning based on any simple or reason-
able assumptions about human behavior. Bank loans may, after all,
create more demand for capital than they supply. But it is outside our
plan to enter into the intricate problem of changes in business conditions
or the business cycle. Some interesting suggestions in this field may be
found in a series of articles on " Commercial Banking and Capital Forma-
tion," by H. G. Moulton and Myron W. Watkins, Journal of Political
Economy, 1918 and 1919.

1 In real life, where uncertainty is present, it is the product generally

CHANGE WITH UNCERTAINTY ABSENT 167

sacrificed to create them. Where the possibility of con-
version— of saving and investment or of consuming
capital already in existence through inadequate mainte-
nance — exists, it cannot be otherwise. The psychology of
saving and spending can have no appreciable influence on
the interest rate at a moment. The supply of capital is not |
for short periods a function of the interest rate, but a fixed I
physical fact. Changes in psychical attitudes may cause
people to save (or consume) a little more or a little less, but
the effect will be insignificant in comparison with the total
supply and demand of capital in the society. The rate of
time preference fixes the rate at which new capital ac-
cumulates, and influences the rate of interest at future
times, but not at the moment. The possibility of conver-
sion impels every individual to equate his time preference
rate to the existing productivity rate, which is causal, by
saving more or less of his income or consuming more or less
capital already saved.

There are no limits to the time which may be requisite
at any moment to bring about the equilibrium adjustment,
even assuming all other things static. Throughout the
modern industrial period the rate of interest has been
above the equilibrium level, social conditions being as they
are (including human psychology, the mores, and especially
the concentration of income in a few hands), as is proved
by the fact that capital has constantly and rapidly accumu-
lated. How long it would take to reach the equilibrium, if

anticipated in the market, which may not be the same as that subse-
quently realized in any particular case.

The correct statement of the productivity theory as given in the text
- manifestly sidetracks the objection of Professor Fetter and the time dis-
count school that the product of capital is not homogeneous with the
capital, and that consequently no such ratio can exist until the capitaliza-
tion process has been applied to the capital itself. Before the investment
is made the capital and its anticipated product are quite homogeneous,
and it is in the market for capital not yet invested that the interest rate is
determined. Capital goods once created are, of course, valued by capital-
ization; this operation presupposes an interest rate, which is therefore in
no wise affected by the relation between capital goods and their income.

168 RISK, UNCERTAINTY, AND PROFIT

the demand for capital and other things remained con-
stant, depends on the rate at which people save corre-
sponding to any divergence between the actual interest rate
and the equilibrium rate (allowance being made for the in-
crease in income and reduction in the psychic cost of saving)
and the rapidity of operation of the law of diminishing
returns in the application of new capital to other productive
agencies existing in society. Historically, of course, the
other things have been so far from equal — especially the
demand for capital has increased so rapidly through the
increase of population and opening-up of new natural re-
sources — that the interest rate shows an astonishing con-
stancy. We should note, also, that improvements in tech-
nology generally tend to economize labor and land and
relatively increase the demand for capital. The conditions
of equilibrium we can formulate; the actual course of the
events which are to bring about those conditions or the
length of time they will occupy are probably matters of
pure and unfruitful speculation. It is quite unnecessary to
believe that there will really be any progress toward equi-
librium, and it goes without saying that the failure of
such progress to occur militates against neither the logical
soundness nor the practical utility of the theory itself.

The above analysis does not refer to an interest rate in
the ordinary sense of the term, but merely to a capitaliza-
tion rate or ratio of exchange between present consump-
tion goods and income property which is also the ratio of
productivity of investment to the investment where the
opportunity for investment is open. It is not clear whether
the phenomenon of lending free capital at interest would be
met with in a society where uncertainty was absent. The
capital loan is an institution or device for separating the
ownership of the value of a productive agent from the
ownership of the concrete thing itself. The principal, if not
the only significant motive for this separation, is the un-
certainty as to future changes in the value of the agents.

CHANGE WITH UNCERTAINTY ABSENT 169

Where this value is not subject to change, or where it is
variable, but the variations are predictable, the sale price
of the agency will inevitably be such as to make it a mat-
ter of complete indifference to a prospective user whether
he leases the agency or buys it with borrowed funds. The
loan contract is an alternative to a rental contract. Pro-
ducers borrow capital and invest it, converting it into pro-
ductive goods by "advancing" it to laborers, landlords,
and capitalists, who furnish the resources to make the new
equipment. It is apparent that the original owner of the
capital could just as well invest it himself and lease the
agencies thus created as to lend the money. Investment
would be a practically costless operation in a world where
the future was perfectly foreknown. However, it may be
reasonable to suppose that the inevitable minimum of care
and trouble would be sufficient to specialize the investment
function and separate it from the furnishing of the capital.
If so, the capital loan and interest proper would appear,
the rate of interest being, of course, the capitalization and
productivity ratio just discussed (less pay for investment
costs if these were appreciable).

After investment is once made we have already ob-
served that the income is simply a matter of the value
yield of the goods, and the value of the agency is deter-
mined by capitalization of this yield at the interest rate
determined in the market for free capital. But with freely
reproducible productive goods this value can never di-
verge appreciably from the cost of production. Capital
goods in fact differ widely in the length of time required
to adjust supply to changes in demand. If there are any
agencies not subject to reproduction through investment
at all, they conform to the classical description of land. It
is the writer's view that such agents are practically negli-
gible and that in the long run land is like any other capital
good. Investment in exploration and development work
competes with investment in other fields and is similar in

170 RISK, UNCERTAINTY, AND PROFIT

all essential respects to other production costs. The dis-
tinction between goods relatively flexible and those rela-
tively inflexible in supply and the recognition of a special
category of income (Marshall's "quasi-rent ") for the latter
is possibly expedient. With uncertainty absent such a dis-
tinction is, of course, irrelevant.

We must deal briefly with the remaining items in the list
of factors assumed invariable in discussing the static state.
The fourth was the distribution of ownership of productive
services. The only points to be noted here are that the
condition affects personal powers (labor) in precisely the
same way as property, and that the facts depend entirely
on social institutions. It is only because we have been
accustomed to it that we think in terms of rights to income
from either inherited property or inherited ability. Nor is
it any more inevitable that out-and-out ownership (nearly
unlimited right of control plus right to entire income)
should be conferred even for his own lifetime upon an in-
dividual who by the investment of present income has
developed productive powers, whether in his own person,
or in produced capital goods, or by the discovery and
development of natural resources.1 That we should sepa-
rate the two categories in our thinking, taking property
rights for granted in the case of inherited personal powers
and stigmatizing the yield of inherited material goods as
"unearned income" seems to be quite inexplicable. So-
ciety will always have to find some way to encourage the

1 It is noteworthy that in the fourth great field for the investment of
resources, the improvement of productive methods through research and
experiment (we are not including the numerical increase of population)
perpetual rights to the earnings of the improvement are not conferred
upon the person who makes the advance. The individual may retain a
monopoly on his idea as long as he can keep it secret or otherwise prevent
its being copied, but this is usually quite impracticable for any length of
time. In the case of specified sorts of technical inventions, society con-
fers and protects a temporary monopoly in the form of a patent. (In the
United States we find a growing tendency to limit the method of exploita-
tion of even this temporary monopoly. Witness the prohibition of tying
contracts.)

CHANGE WITH UNCERTAINTY ABSENT 171

development and serious, interested use of productive
capacities of all sorts (as it may always have to recognize
family relationships in securing continuity of control from
one generation to another). But many other ways are con-
ceivable for doing these things, though their practical
availability is not a subject for discussion here. It is to be
noted that society is now progressing rapidly in the limita-
tion of ownership, on both the control and income sides;
more and more restrictions are being thrown around the use
of property and the conditions under which an individual
may agree to work, and more and more income is being
taken through taxation for "social" purposes.

In regard to geographical distributions — much might
be said on this neglected topic, but space and the plan of
this work do not permit. The question of mere concentra-
tion of population, irrespective of where it is concentrated,
i.e., of city versus country, is far-reaching and fascinating.
Immigration and emigration and internal migration are ob-
viously important and intricate problems. In this field
also we can recognize the condition of an ultimate equilib-
rium wherein the advantages of all locations would be
equalized; and here also progress toward the theoretical
goal is slow in comparison with the interval which separates
us from it at any particular time. Changes in wants, and
activities directed to change wants from motives of pri-
vate gain, are especially important in this connection. It is
hardly too much to say that the political as well as eco-
nomic history of America has been dominated by real
estate speculation and by the cheap money controversy,
largely an offshoot from the former. The actual distribu-
tion of population is, of course, largely determined by the
distribution of natural productive resources and by the
topography of the country in relation to transportation;
partly also by mere desirability of locations for residentM
purposes. But it is interesting to observe that considera-
tions of consumption and social motives alone would prob-

172 RISK, UNCERTAINTY, AND PROFIT

ably bring people together in groups of all sizes and degrees
of compactness even in a world whose physical conditions
were absolutely uniform.

Static conditions include finally static technology and
knowledge in general, and this is one of the most treacher-
ous concepts of all as a subject for scientific discourse.
Activities directed to the increase of knowledge may be
very productive, but it is too great a strain on the imagina-
tion to try to think of their results as being predictable in a
particular case. We have, however, an approach to pre-
dictability in large groups; in many fields research can even
now be carried on more or less " intelligently " where the
scale of operations is sufficiently large. It seems almost
fanciful also to speak seriously of a condition of equilibrium
where the rewards or chances of reward from further effort
would no longer be adequate to entice productive energy
into this field. But it is clear that even here, in so far as re-
sults can be foreseen, resources will be distributed so as to
secure equality of return over the whole field of investment
and under competition every value realized will be just
equal to the cost incurred in creating it. In this field un-
certainty is indeed an inevitable concomitant of progress.
Yet there is an approach to predictability, a variation in
the amount of unpredictability independent of variation
in the amount of progress and the two factors must be
separated in the causal analysis, for their effects are very
different.

CThis completes the list of progressive changes. In every
case the necessary and sufficient condition of a perfect,
remainderless distribution of the product of industry
among the agencies causally concerned in creating it, in
addition to perfect competition itself, is that the change
can be anticipated over the period of time to which pro- »
ducers' calculations relate. Where the results of the em-
ployment of resources can be foreseen, competition will
force every user of any productive resource to pay all that

CHANGE WITH UNCERTAINTY ABSENT 173

he can afford to pay, which is its net specific contribution to
the total product of industry. No sort of change interferes
with the no-profit adjustment if the law of the change is
known. 3

t
tt

CHAPTER VI

MINOR PREREQUISITES FOR PERFECT
COMPETITION

cIn Part Two we have attempted an analytical construction
of a perfectly competitive society, with a view to drter-
v- mining the precise meaning of the theoretical tendenc^s of
a private property, free exchange organization of so<Pety,
and especially the conditions necessary to the realizat -% of
those tendencies. 3The abstract conditions first enume ated
in chapter in represented in part divergencies in ^gree
only from real life, and were in part arbitrary abstractions
from fundamental characteristics of the pecuniary or-
ganization made for the purpose of a separate study of the
constituent elements. Those of the latter type have been
dealt with in chapters rv and v, and the result, up to the
present point, is an outline picture of the essentials of a
perfect competitive system.1 The first, rather preliminary,
objective of the study has thus been achieved, as far as the
author is prepared or feels it advisable to go. The second
and more fundamental purpose is to contrast this ideal,
perfect competition with the facts of ordinary life, to ex-
amine the limitations of the general principles developed,
and to inquire as to the directions in which they must be
supplemented by detailed, empirical data before com-
pletely applicable conclusions can be drawn.

1 There is one important exception to this statement. As observed in
chapters i and n, the presence of uncertainty in regard to individual
events does not necessarily obstruct the workings of competition or pre-
vent the realization of its theoretical result in a remainderless distribution
of the product of industry among the productive agents. If the uncer-
tainty in a particular case is measurable, it may in effect be eliminated by
the grouping or clubbing of a sufficient number of cases to secure cer-
tainty in regard to the group. This point cannot be dealt with until after
the general theory of risk and uncertainty has been presented. (See
chapter vm.)

PREREQUISITES FOR PERFECT COMPETITION 175

But it is not the intention to cover this field with any
great degree of exhaustiveness. Only one of the theoretical
simplifications is to be studied in detail, the assumption of
perfect knowledge. Part Three of the essay will be devoted
to a discussion of the meaning and consequences of uncer-
tainty, the incompleteness and inaccuracy of the beliefs
and opinions upon which economic conduct is based. But
it is desirable to have as a background some brief notice of
the other abstracted factors.1

It will readily be seen that many of the objections to the
pure theory of distribution commented upon in chapter iv
relate to these necessary scientific idealizations, and have
real significance as limitations on the completeness and
accuracy of the generalizations of theory. They are not,
therefore, valid objections to the theory and have been
advanced as such only because of the common failure to
comprehend the nature of scientific reasoning, the mean-
ing and use of general principles. This is especially ap-
plicable to the first point to be noticed, the assumption of
continuous variability in the magnitude of all factors dealt
with. The question of the size of the "marginal unit" is

1 Specifications numbered (2) and (5) in chapter in — that people are
perfectly rational and that there is perfect intercommunication among
them — are clearly phases of the problem of perfect knowledge to be
taken up in Part Three. In the present chapter we are concerned espe-
cially with numbers (3) and (4) — formal freedom of action and perfect
mobility, implying perfect divisibility; (6) and (7) the absence of mono-
poly and predation. Numbers (8), (9), (10), and (11) have already been
considered, but some further remarks will be in place in regard to the
first point mentioned under number (8), the relations of social as con-
trasted with individual wants. We may note here that the timelessness
of the production process necessary to secure perfect mobility has been
dealt with in one aspect in chapter iv. In addition it retards the speed of
readjustments by holding productive forces committed to certain uses for
an interval after it would otherwise be profitable for them to change.
But it does not affect the final results, the character of adjustment when
achieved. Some discussion of the intermediate effects is necessary in
connection with the study of profits, and the whole subject of "friction"
will be gone into after the treatment of uncertainty has cleared the way
for a discussion of profit.

176 RISK, UNCERTAINTY, AND PROFIT

clearly relative to that of the flexibility of industrial organ-
ization, and the two must be considered together. When we
give up the illicit procedure of funding productive agents
into "factors" and deal with the actual competing units on
their own account, this problem becomes of practical sig-
nificance and constitutes an effective limitation on the ap-
plication of the theory.' In the case of labor especially, with
which we are here particularly concerned, the human in-
dividual is a very effective unit; not only does he bargain
as a unit, but he cannot practically be divided up between
different establishments, and the range of occupations in
which he can engage in any short interval of time is also
very narrowly restricted. He may also be in a high and
surprising degree unique; he does not always shade off by
imperceptible gradations from one variety to another to
the extent that perfect competitive imputation demands.
His numbers (in proportion to the number of variants)
are not nearly always so large as to make an individual a
negligible fraction of a group of similars.1

As a consequence of the appreciable dimensions of the
natural agent, the flexibility of the economic organization
as a whole is restricted, and the criticism made by Mr. J.
A. Hobson and Professor Wieser against the productivity
theory is true to a considerable extent in many individual
cases. There are many productive organizations consisting
of small numbers of rather unique agents which very effec-
tively supplement each other and are not so effectively
demanded elsewhere. In such a case competition does not
afford means of distributing the entire yield of the group
among its members; an appreciable part of it resists auto-
matic division and remains a joint product, dependent on

1 It is not necessary that he be an infinitesimal fraction of the pro-
ductive power of a particular establishment. The imputation process
works itself out through the competition of establishments for the differ-
ent agents. If a number of establishments exist in which a certain type of
agencies is on an indifference margin, the income of all similar agencies
will be accurately determined.

PREREQUISITES FOR PERFECT COMPETITION 177

the peculiar effectiveness of the particular organization.
Many partnerships illustrate this point. Imputation goes
as far as the group, giving that its proper income, but fails
to distribute accurately within it. In case of a partnership
this division between the members is usually made on
ethical grounds or on the basis of "bargaining power,"
sheer personal force. In industry at large the special
product of the organization above that competitively
assigned to its components is likely to go, largely at
least, to the entrepreneur, though bargaining power or
the strategic situation always plays a large part in the
proceedings.

The same factors give rise to a peculiar difficulty in deal-
ing with the law of diminishing returns. When any agent
is by its physical nature or any particular circumstances
available only in relatively large blocks, so that only a few,
perhaps only one, is used in a single competitive organiza-
tion, the technological features of particular combinations
may cause apparent exceptions to the " law " at some points;
these may be apparent for certain sections of the curve for
the simple reason that one element is not subject to de-
crease and the best proportions can be secured only by in-
creasing the other elements. A conspicuous example is the
case of railways, the principal crucial "agent" being the
right of way. If the demand for transportation were large
enough to require an indefinite number of tracks the curve
would be smoothed out and would ultimately show in-
creasing costs from the other elements in the equipment.
So with gas or water mains, until a certain size has been
reached, and many similar cases. The fact of limited divisi-
bility is responsible for all differences in the economy of
operation of establishments of different sizes. The amounts
of certain agencies or elements in the operations not being
continuously variable, other things have to be proportioned
to them to get the best ratio, thus imposing restrictions on
the size of the plant as a whole. Many, if not most, of these

178 RISK, UNCERTAINTY, AND PROFIT

questions of size ultimately come back to the human being
as a relatively indivisible unit.

Preliminary to a discussion of predatory activity, or
acquisition which is not production, we must again refer to
the question of the ethical implications of the productivity
analysis. The purely causal meaning of productivity in a
scientific explanation of economic phenomena is apt to be
confused with social or moral issues which belong in an
entirely different sphere. We have insisted that the word
"produce" in the sense of the specific productivity theory
of distribution, is used in precisely the same way as the
word "cause" in scientific discourse in general. But the
word "cause" itself is vague in ordinary speech, and it is
natural that confusion should arise in regard to the eco-
nomic synonym. For example, the socialists, with no lack
of suggestion and justification from the loose usage of words
by economists of non-socialistic schools, have insisted that
all wealth is "produced" by labor. We need do no more
than mention the names of Smith and Ricardo in this
connection, while among contemporary writers Professor
Taussig exemplifies the same practice, expressly stating
that labor produces all wealth, but may not be entitled to
all.1 We should say that the reverse is more correct, that
labor does not "produce" all wealth, but may be entitled
to all, on ideal grounds.

Inasmuch as any assertion of a cause and effect relation
between particular events is always (as already pointed
out) made on the ground of some special human interest or
"bias," there is much justification for such usage, but this
only makes the more imperative, a clear separation from
the "scientific," use of causal terminology. Thus it is quite
proper to say, in ordinary speech, that the cook "prepares "
the meal, that the opening of the throttle of the locomo-

1 Paper entitled "Outlines of a Theory of Wages," read at the twenty-
second annual meeting of the American Economic Association. See
Proceedings, pp. 143-44, note.

PREREQUISITES FOR PERFECT COMPETITION 179

tive by the engineer is the "cause" of the starting of the
train, and that his failure to see the signal is the "cause"
of the wreck and the deaths of the passengers. In an
analogous way a small group of agents might for some
purposes be credited with nearly the whole output of a
large establishment; "other things equal," the product de-
pends on their cooperation.

But it must be evident that scientific economics cannot
use the word "produce" in this sense. The product of any
productive service can for scientific purposes be only what
we have defined it to be, that which is really dependent
upon the service in question, that which can be produced
by its aid and which cannot be produced without it, in the
social situation as it is, allowing for the change in organiza-
tion which would accompany its withdrawal from use.
It follows that we cannot properly speak of the "product"
of an economic "factor," even if we use the word "factor"
in the possibly legitimate sense of a group of physically
interchangeable things. The product of "labor," "land,"
or "capital," as aggregates, involves a still more illicit and
meaningless use of terms. The only specific product which
can be recognized is that of a single agent as such, an in-
dividual human being or machine, or such a parcel of land
(or of liquid capital) as is actually bargained for and used in
the production process (and for perfect competition to take
place it must be negligible in size).

More important, however, is the error of attributing any
sort of moral significance to economic productivity. It is a
physical, mechanical attribute, attaching to inanimate ob-
jects quite as properly as to persons, and to non-moral or
even immoral as well as virtuous activities of the latter.
The confusion of causality with desert is an inexcusable
blunder for which the bourgeois psychology of modern
society is perhaps ultimately to blame, though productivity
theorists are not guiltless.1 We must guard against think-

1 Notably Professor J. B. Clark. Cf . above, p. 109. The concessions of

180 RISK, UNCERTAINTY, AND PROFIT

ing of the "natural" adjustment of the competitive system
as having any moral import, though it is of course "ideal"
in the scientific sense of being a condition of stability. To
call it the "best possible" arrangement is merely to beg
the question or to misuse words. The natural arrangement
is only that under which, with the given conditions as to
the demand and supply of goods, especially the existing dis-
tribution of productive power, no one is under any induce-
ment to make any change. If we pass over the question of
how far individual wants for specific things really domi-
nate conduct, and neglect equally the whole category of
wants for certain social relationships and interests in other
individuals (not absolutely dependent), and assume in
addition (we shall investigate the point presently) that no
interests are involved in any exchange except those of the
direct parties to it — then the result is a mere mechanical
equilibrium of the pull and haul of interacting individual
self-interests.

It is imperative that we bear in mind that the serpent's
tail is always in the serpent's mouth, that what the com-
petitive system tends to give back is just what is put into it
in the way of human motives and human powers, natural,
acquired, or conferred, and has in itself no moral attribute
whatever. In real life the possession of property (or supe-
rior training) is supposed to represent saving or invention or
some contribution to social progress. But it is clear that
there is no technical (much less moral) equivalence between
these services and the right to their entire fruits in perpetu-
ity, and to confer it on one's heirs and assigns forever —
particularly when we consider the enormous element of

Professor J. M. Clark {he. cit.) seem to me to cover only a portion of the
ground. I see nothing morally ideal in a distribution according to in-
nate personal ability — certainly not ability measured by pecuniary de-
mand for its products, unless the rest of the human race are idealized —
and suggest that such a distribution would yield vastly more inequality,
misery, and despair than does the present order. Nor, in the abstract, can
I see any connection between innate ability and moral desert. Is inherited
ability on any better footing morally than inherited property?

PREREQUISITES FOR PERFECT COMPETITION 181

pure luck in all operations of this sort. The only sense and
the only degree in which rewards for service are ethical is
that of the necessity of paying the reward in order to get
the service performed. From this point of view the only
defense of most of the existing system is the difficulty of
suggesting a workable alternative.

We must now turn again briefly to the point mentioned
above, the extent to which outside interests not represented
in agreements between individuals are affected by them
(otherwise than through direct competition in the market).
The mere mechanical effectiveness of competitive free con-
tract in producing a reconciliation of individual interests
under given conditions depends largely on the answer to
this question. Obviously, outsiders may be affected either
advantageously or disadvantageously. In the former case
voluntary agreements will not be carried far enough to
secure maximum social (total individual) advantage, while
in the latter case they will be carried too far. These facts*
form the most important source of the need for social in-
terference. Many services, such as communication and
education, not to mention the administration of justice,
confer a general benefit on the community in addition to the
special benefit to the individual, and must be encouraged
by bounties or actually taken over and performed by pub-
lic agencies or they will not be developed to the point of
maximunl benefit. The most familiar illustrations of the
opposite case in our society relate to the use of land for
purposes which damage the neighborhood, or are thought
to do so. It is perhaps of nearly equal importance that im-
provements on land and industrial developments generally
may benefit neighboring property, and might be made
much more readily and in ways involving less injustice if
there were some practicable way of assessing these benefits.
This is notably true of public and quasi-public works,
which effect enormous uncompensated transfers of values.
It may be doubted whether in fact any agreement between

182 RISK, UNCERTAINTY, AND PROFIT

individuals is ever made which does not affect for good or
ill many persons other than the immediate parties, and a
large proportion have wide ramifications over "society.'*

In this brief sketch we can only mention and insist on the
fundamental importance of the fact that a large part of
what men want relates directly to other members of society.
Man is, after all, zoon politikon and quite on a par with his
personal needs are all sorts of interests in furthering the
plans of people whom he likes and, always relatively and
generally absolutely, obstructing those of others, in a wide
scale of gradations down to Thackeray's "'e's a furriner;
'eave a 'arf a brick at 'im!" or, "kill the nigger!" The
relative importance of other-regarding motives and de-
sires, directed not to material things, but to forms of social
relationships, is sure to be underestimated by any one
treating economic phenomena in a "scientific" way.

The extreme phase of the problem o{ the moral character
of the economic system relates to positively predatory
activity. Davenport, following Veblen, has stressed the
contrast between (private) acquisition and (social) pro-
duction, making much of the hiring of sluggers, assassins,
and incendiaries as part of the demand for labor, the pro-
ductivity of burglars and their implements, and the like.
It is not really very difficult in most cases for one who is
disposed to do so to distinguish between theft or brigandage
and free contract, and perhaps all that is needful to say of
them in treating the theory of contractual organization is
that they are obviously outside of it. A large part of the
critics' strictures on the existing system come down to pro-
tests against the individual wanting what he wants in-
stead of what is good for him, of which the critic is to be
the judge; and the critic does not feel himself called upon
even to outline any standards other than his own prefer-
ences upon a basis of which judgment is to be passed. It
would be well for the progress of science if we had less
of this sort of thing and more serious effort to formulate

PREREQUISITES FOR PERFECT COMPETITION 183

standards and to determine the conditions under which
free contract does or does not promote individual interests
harmoniously and realize social ideals, jjn addition it is
most desirable that some attempt be made to separate the
evils for which the form of organization is more or less
reasonably blamable from those which are inherent in
nature and human nature, or in organization as such, ir-
respective of its formTanoTto keep the question in view, in
criticizing the exchange system, of whether any other con-
ceivable system would offer any possible chance for change
or improvement.1 3

1 See Davenport, Economics of Enterprise, chap, ix, especially p. 127;
and cf. L. H. Haney, "The Social Point of View," Quarterly Journal of
Economics, vol. xxvm, pp. 31&-21.

Though the case of the pickpocket offers no real difficulty and is not
likely to be taken seriously, there are many cases where standards of pro-
ductivity are very hard to define. Gambling, for example, is definitely
ambiguous. If the men who gamble know what they are about, play for
fun, at a game which is "fair," and do not risk more than they can afford
to pay for the excitement, I should say that the gains of the banker rep-
resent product. If all are interested in winning only, and play because
they expect to win, I suppose the operation is unproductive and produces
a transfer, not a production of wealth. It will doubtless be conceded that
there is such a thing as a transfer of wealth, distinguishable from pro-
duction, or else receiving gifts must also be classed as productive
work!

Other cases are more difficult still, since no clear line can be drawn
between being tricked and gratifying a perverted taste. The difficulty is
the ultimate impossibility of saying what one "really" wants. In cases
where each knows what he is getting and what he is giving — no "compul-
sion" (artificial manipulation of alternatives) being present — and
actually gets the means of satisfying his actual want, we must hold that
the operation is a production of utility in the economic sense. But what
we may call "crude" fraud must be classed outside of exchange relations
along with forced transfers. The man who sells whiskey, patent medicine,
corrupt literature or art, etc., to people who want them and are willing to
pay for them is productive; but one who sells gilded chunks of lead to un-
suspecting rustics for gold bricks clearly is not. If the buyer be in a
position where it never can make any difference whether the metal is lead
or gold and never could find out which it is, the action is hard to classify,
but we must consider that he could have had what he got for vastly less
money, if he had known. Is the buyer of an imitation jewel or antique for
a genuine, and who never knows the difference, really cheated? And sup-
pose the purchaser of Liquozone or Peruna is really cured of his (real or

184 RISK, UNCERTAINTY, AND PROFIT

There is a close connection between the moral aspect of
the economic order and the problem of monopoly. This
subject is of especial importance in the theory of profit,
since profit has often been ascribed wholly or in part to
monopoly gain, as already noticed in the case of Macvane
and the Clark School. "Monopoly" is a word used to
cover things which for present purposes must be kept dis-
tinct, and its meaning must first be made clear. Monopoly
is usually denned as the control of the supply of a com-
modity. A common but disastrous error is the confusion of
control with natural limitation of supply. We need not
pause longer than to characterize as a serious misuse of
words the denomination of land rent, for example, as a
monopoly income. Even J. S. Mill fell into the error of
defining monopoly as limitation, and it is exemplified in its
extreme form by Mr. F. B. Hawley, who virtually calls all
income due to the "scarcity" of any productive resource a
mom^poly return. Now, as all income, from the distributive
standpoint, is dependent on the scarcity of the agents
which produce it, and all in exactly the same way, the
meaninglessness of such a description is apparent. And of
course the same applies to "scarcity income" in general,
whether called monopoly gain or not. There is under free
competition no other sort of income, qualitatively or
quantitatively, and the designation neither distinguishes or
in any significant way describes anything.

imaginary) ailment! And suppose he is not! Was it the medicine, or a
cure, that he really bought?

We are carried back to the already oft-reiterated observation that any
scientific thinking about conduct presupposes that wants are given en-
tities, and that exchange organization of the satisfaction of wants pre-
supposes that their character is known. Capricious and experimental con-
duct are not amenable to scientific treatment (unless subject to prediction
in large groups, a case which we have postponed for later consideration).
In the language of abstract logic, a must remain a throughout the dis-
cussion. This it can do either by remaining sensibly unchanged or by
changing in accordance with a known law. The last alternative reverts to
the first, since such a change can be thought of only as an expression of
an inner, unchanging attribute of the thing changing.

PREREQUISITES FOR PERFECT COMPETITION 185

It is no part of our present purpose to go into an ex-
haustive discussion of monopoly, and we may pass over the
ordinary type of the phenomenon very briefly. In its
original meaning the word signified an exclusive right to
produce or sell a certain commodity, and was essentially a
legal concept. The "legitimate" representative of the type
in modern industry is the patented article for consumption
— not patented production process (including machines,
etc.), which will be considered later. Monopoly may also be
based on mere financial power, on the threat of local under-
selling, boycott, and other forms of "unfair competition";
this amounts in effect to a voice in the control of property
owned by others or their persons as well; that is, to part
ownership. Free competition, of course, involves the com-
plete, separate ownership of every productive agent or
natural unit, and the exploitation of every one in a way to
secure its maximum value yield. Any sort of violent inter-
ference with competition manifestly contradicts this as-
sumption and may be roughly designated monopoly.

In the same category of monopoly (control of a consump-
tion good) we may place two other varieties significant in
the modern economic world. The first is the "corner," in
which only a temporary control is secured, amounting in
reality to control over the time of marketing of an existing
stock not subject to rapid increase at the moment by fur-
ther production. The other is the use of trademarks, trade
names, advertising slogans, etc., and we may include the
services of professional men with established reputations
(whatever their real foundation). The buyer being the
judge of his own wants, if the name makes a difference to
him it constitutes a peculiarity in the commodity, however
similar it may be in physical properties to competing wares.
And the difference from physically equivalent goods may be
very real, in the way of confidence in what one is getting.
Such goods are then commodities whose supply is controlled
by the producer, and competition with other makes or

186 RISK, UNCERTAINTY, AND PROFIT

brands is a case of substitution of more or less similar
goods, such as a monopolist always has to take into ac-
count.

A monopoly, of the category described, is evidently
"productive" in the economic or mechanical causality
sense. It may be viewed either as a separate productive
element, in which case it is property in perfectly good
business standing, and may be exchanged for other prop-
erty on an income basis. Allowance will be made for the
security of the income, but this allowance is perhaps as
likely to be in favor of the monopoly as against it. Or we
may take the view that the monopoly of a consumption
good confers superior productivity on the agencies pro-
ducing it, above physically identical agencies in other uses.
As long as these are debarred in any way from producing
the monopolized good the effect is the same as that of a
physical incapacity to do so, and they are, like the branded
article, economically differentiated, however similar physi-
cally. If the monopoly is of the character of a patent, and
freely salable separately from the plant producing the
goods, it is better to treat it as a productive agency on its
own account.

Again, monopoly may consist in the exclusive control of
the supply of some productive agency, physically denned as
a group of interchangeable units. The only incentive to
obtain such a monopoly is the desire to secure one of the
former type, the power to restrict the supply of some con-
sumption good. The control of any type of productive
agent, of course, gives control of the supply of commodities
whose production is dependent on the use of that agent,
through the power to withhold the agent from use alto-
gether or restrict its use in the making of any particular
commodity while leaving its employment in other uses free.
Whether the monopolist produces these goods himself or
leases his monopolized agency to others, he can secure the
entire increase in the net revenue from the final commodity

PREREQUISITES FOR PERFECT COMPETITION 187

as a rent on the restricted and restricting agency. It is evi-
dent in this case also that the restriction on the use of the
agency, whatever its basis, is equivalent in effect to a phy-
sical peculiarity, and that the causal productivity of the
agency is increased by its limitation in the same way as if
part of it had gone out of existence or undergone some in-
capacitating change. Nor should it be necessary to insist
again on the separation of the causality aspect of the case
from the question of social policy.

A somewhat different case is the exclusive control of a
peculiarly effective method or system of organization of
production. The question of the productivity of a special
process protected by patent or kept secret is a difficult one.
Treatment of it in economic literature varies from that of
Lavergne,1 who insists that the idee productrice is an in-
dependent factor, always present along with land, labor,
and capital, to that of A. S. Johnson, who contends that an
idea or method cannot be regarded as productive because it
is the nature of an idea to multiply itself indefinitely.2 Here,
again, the crucial test can only be the facts in the case.
Does the method or idea get product imputed to it? This
is largely a question of whether it is salable and so takes on
capital value. If so, it is productive in the sense of economic
causality. If it is not salable it will represent an element
in the productivity of its possessor and its yield will accrue
to him in the form of a wage. The moral question, whether
it "ought" to be a source of income, is of course another
matter. It seems evident 3 on the one hand that the highest
social advantage would require the most rapid and general
extension of the use of the best methods, and it is of signif-
icance that this can theoretically be done nearly without

1 Bertrand Lavergne, ThSorie des marchSs Economiques. Paris, 1910.

2 Rent in Modern Economic Theory, p. 120, note.

8 Supposing the desideratum to be the greatest possible consumption
of commodities. Supposing it to be maximum happiness, the case is not
so clear, while the question of maximum "welfare" involves us in still
greater uncertainty.

188 RISK, UNCERTAINTY, AND PROFIT

cost. On the other hand, it is equally evident that both
justice and expediency demand a fair reward for the
origination of better ways of doing things. It would seem
to be a matter of political development to provide a better
way of rewarding these services than even a temporary
monopoly of their use; but this inquiry belongs in the
theory of progress, and as a question of social policy is out-
side the scope of the present study.

We must again insist, however, that the method must be
recognized as being productive, or as conferring superior
productivity on the agencies employed in connection with
it.1 An arbitrary restriction is again causally equivalent to
physical limitation. The method or idea is merely less pro-
ductive of goods (and more productive of exchange value)
than it would be if its use were unrestricted. The same
paradox holds for any productive good; if multiplied indefi-
nitely it would yield more goods in physical units, but have
no value at all. The only difference in the case of a method
of production is that it can be multiplied indefinitely
without much cost (after once worked out), an important
distinction from the standpoint of social policy (perhaps),
but not significant from the standpoint of a cause and
effect explanation of things. And we must again insist that
the danger of reasoning about social totals of exchange
value, and still more the extreme treachery of all reason-
ing about human welfare in terms of any such concept as
economic utility, be borne in mind in attempting to reach
conclusions as to social policy.2

1 There is a danger in over-emphasizing the difference between these
two views of productivity. Remembering that all production is joint, it
is clear that any separate productivity of a particular agency means ul-
timately superior productivity conferred upon others used in connection
with it.

2 It seems in place to remark that a confusion is involved in laying
down "appropriability" or what might be called competitive self-
assertion, as a condition of economic productivity. Productivity is a
matter of limitation. If an agency is limited relatively to the need for its
use, it must be appropriated by some one, to be administered, to decide

PREREQUISITES FOR PERFECT COMPETITION 189

The position taken above, that monopoly is productive,
is in opposition to the doctrine of Professor J. B. Clark and
his followers that the monopolist merely appropriates prod-
uct created by other agents. But when monopoly income
is said to be "diverted from its real producers,"1 or is
called "exploitative," in the sense that it "is not secured
by the agent that creates it,"2 the words "create" and
"produce" are not used in their correct (causal) meaning.
Monopoly is impossible except on the basis of some control
over an element essential in the production of a commodity,
and the extra product is rightly imputed to this essential
element, or to the condition which makes control possible,
if separable from the rest of the situation.

Monopoly of productive agencies has hitherto been of
restricted importance in actual affairs, for several reasons.
Most productive resources are specialized only to a limited
extent, and are subject to effective competition from a
wide range of substitutes. And in the hitherto undeveloped
and rapidly changing condition of the world, most agencies,
even of the most specialized types, have been rapidly and
irregularly increasing in supply through new discoveries,
and open to deliberate increase through moderate expend-
itures in exploration and development work. Finally, the

who is to have the use of it and who is to do without. And any productiv-
ity conferred on an object by appropriation must come through and in
connection with restriction on its use. Thus Professor Young (Outlines
of Economics, by R. T. Ely and others, ed. of 1908, pp. 555-56) contends
that the Strait of Gibraltar would be productive wealth if the British
Government were to charge for its use. But they could not charge for its
use without reducing its volume; it would be a case of monopoly merely.
This and several other confusions are involved in Veblen's contention
(on the "Nature of Capital," Quarterly Journal of Economics, vol. xxii,
pp. 917 ff., and vol. xxiii, pp. 104 ff.) that the world's stock of knowledge
is its most important "capital," which is without value merely because
not privately exploited. It could be exploited only by having its use re-
stricted; i.e., by monopoly. The notion that capital is significant as
limiting access to the world fund of technical knowledge is absurd, for the
reason, already noted, that production is joint, and the productivity of
anything may be viewed as a productivity conferred on other things.
1 Willett. 2 Johnson, pp. 106. 107.

190 RISK, UNCERTAINTY, AND PROFIT

technique of the large-scale organization requisite to secure
unified control has been crude and imperfect, while the op-
position of public opinion has been increasing in force. It is
of some interest to inquire into the implications of abso-
lutely free competition in this regard.

With perfect intercommunication it would seem that the
assumed absence of collusion is very improbable, as or-
ganization costs would naturally tend to a low level. Under
static conditions (with the existing stocks of all agencies
fixed and known), a great development of monopoly would
apparently be inevitable. It is not unreasonable to suppose
even that in the absence of organized social interference
conditions would approach the result contended for by the
Marxian socialists, monopoly universal, or at least preva-
lent to an extent involving the complete breakdown of the
competitive system of organization.

A further consideration, which goes back to the require-
ment of negligible size in the marginal unit as a condition
of effective competition, tends to reinforce this view. In
the ordinary sense of monopoly, concentration of control
is not profitable unless it is nearly complete. But with
organization costs absent or small, there might be a con-
tinuous incentive to increase the size of the bargaining
unit. It is true, as some objectors to the productivity the-
ory of distribution contend, that as the bargaining unit is
larger the product theoretically dependent upon it is larger
in greater ratio, and this fact affords a small incentive to
combine even on a very small scale, and to increase the
size of the unit without limit. The extra remuneration of
the block over what it could obtain if its constituent units
bargained separately would come out of the shares of the
other agents used in connection with the one affected, not
out of increased payments extorted from consumers as in
case of monopoly./

The argument may be shown graphically by recourse to
the "dosing method" of explaining specific productivity,

PREREQUISITES FOR PERFECT COMPETITION 191

made familiar by Professor J. B. Clark. There is no fallacy
in this analysis if by a "factor" of production we mean
merely a group of physically interchangeable things, and
not a sort of labor or capital pulp obtained by putting
things of all degrees of heterogeneity through the mill of
the competitive process itself and reducing them to value
productivity units. We must also remember that the
method is a logical device purely, and in no sense repre- /
sents the process by which productive services actually get
evaluated. If, then, we imagine a static society, and fix
our attention upon such a group of competing agents, it will
be seen that the different units or members composing it
may be regarded as placed along the descending curve of
diminishing productivity of the familiar diagram. The
curve, like that of diminishing utility and diminishing
demand price,1 is purely hypothetical ; the ordinate of each
point merely shows what would be the productivity of each
unit in the series if the total number were reduced to that
indicated by the corresponding abscissa and production
reorganized along "natural" lines. It does not indicate
differences in productivity, or anything else, at the moment.
We also pass over the fact that it is impossible to construct
such a curve except for a very limited range in the region of
known conditions and that any considerable extension of it
(for an important productive service) soon carries us into
the realm of pure fantasy.

But ignoring the difficulties and imagining the curve
drawn, it is obvious that under theoretical imputation each
member of any such group of competing agents will get
what is directly dependent upon that which occupies the
least important position, which is all that is ultimately
"dependent" upon any one. But if two or more such
agents combine so as to compete as a unit instead of sepa-
rately, they can get the total product of that number of
units at the lower end of the series, which is more than
1 Cf. chapter in.

192 RISK, UNCERTAINTY, AND PROFIT

their separate "marginal" products. Therefore, under
perfect competition, they will combine and bargain as a
unit; and the same incentive will urge them to keep on
combining until a monopoly results.

The situation is easily understood from the conventional
diagram. If the curve CD represents the relative importance
of successive agents of a series, or units of some really fund-
able agent, then under per-
fect competition every unit
will get the product DE,
and a certain group E'E
will get FDE'E. If now
these EE' units combine
so as to become marginal
as a group, they can get
instead D'DE'E, gaining
D'DFover the former arrangement. The owner of the group
can prevent the substitution of a (marginal) unit outside
the group for any unit in it, and so cause a larger prod-
uct to be dependent on the employment of the group than
the aggregate marginal products of its members. Similar
agencies outside the combination will only get the wage DE,
and the surplus income received by our consolidated block
will come out of the shares of the agencies with which it is
combined, not out of an increase in the price of the prod-
uct to consumers. The employers of the "block" use no
more nor less of the agency than before and make no more
nor less product; hence they must sell the same supply at
the same price. But the other agencies are forced to take
less for their services because the block cannot be replaced
a unit at a time from the margin, but only by an equal
number of marginal units at once, a transfer which will
raise their price all along the line. Only "friction" (human
limitations) prevents this in actual society, the "diminish-
ing returns of entrepreneurship."

It need not be remarked that this process would not go

PREREQUISITES FOR PERFECT COMPETITION 193

far in fact until something would have to be done to stop
it. There does seem to be a certain Hegelian self-contra-
diction in the idea of theoretically perfect competition after
all. As to what the end would be, it is fruitless to speculate,
but it would have to be some arbitrary system of distribu-
tion under some sort of social control, doubtless based on
ethics or political power or brute force, according to the
circumstances — providing that society or somebody in it
had sufficient intelligence and power to prevent a reversion
to the helium omnium contra omnes. Competitive industry
is or hitherto has been saved by the fact that the human
individual has been found normally incapable of wielding
to his own advantage much more industrial power than,
aided by legal and moral restraints, society as a whole can
safely permit him to possess. How long this beneficent
limitation can be counted upon to play its saving role may
in the light of current business development occasion some
doubt. With this subject we are not here particularly con-
cerned, but it has seemed worth while to point out, in con-
nection with the discussion of an ideal system of perfect
competition, that such a system is inherently self-defeat-
ing and could not exist in the real world. Perfect competi-
tion implies conditions, especially as to the presence of
human limitations, which would at the same time facilitate
monopoly, make organization through free contract im-
possible, and force an authoritarian system upon society.1

1 In addition to the incentives to combination afforded by the gains
through increase in the size of the bargaining unit, another tendency
might work in the same direction. In many cases it might be profitable
for the owner of a considerable block, though not the whole supply of an
important productive service, to restrict its use and so increase the value
of the product. Whether the owner of a part of a supply can gain by with-
holding some of that part from use will depend upon the fraction of the
supply which he holds and on the flexibility of the supply obtainable from
competing sources and the elasticity of the demand for the product. In
view of the fact that practically every business is a partial monopoly, it
is remarkable that the theoretical treatment of economics has related so
exclusively to complete monopoly and perfect competition.

Attention may be directed to another tendency fatal to free competition

194 RISK, UNCERTAINTY, AND PROFIT

In connection with the meaning of productivity it is of
interest to raise the question of the economic value of the
State. What would be the effect upon our economic life if
society as such, acting through the political organization,
should assert itself as an economic individual and charge
"what the traffic will bear" for its own service? Obviously
the Government has a monopoly on an absolutely indis-
pensable commodity. Business could not be carried on at
all without the protection of property and enforcement of
contract. Into this interesting, but intricate, question it
is impossible to enter at length here, but it appears that
what the Government could take, its economic product, is
hardly limited.1 The writer is much more optimistic as to
the possibilities of a drastic program of taxation for secur-
ing a greater degree of economic equality than over most
proposals for social interference in contractual relations.

under theoretical conditions. This is the matter of the inflation of credit.
With all forms of friction eliminated there would seem to be hardly a
limit to the substitution of credit for any sort of commodity as a medium of
exchange and a stable value-standard would apparently be impossible to
establish.

1 Concerning the "economic surplus" of which much has been made
by some writers, notably Hobson, the remark made above (page 188 n.)
is applicable. The payment necessary to secure the performance of any
service depends on how much of that service is desired. The question is
much complicated by human mortality and the fact of inheritance, but
in general there are no surpluses available without reducing the volume
of the service. This will not be true of monopolized or highly specialized
agencies, and there are, no doubt, many remunerations which are too
high absolutely and which if reduced would positively increase the vol-
ume of the services for which they are paid.

PART III

IMPERFECT COMPETITION THROUGH
RISK AND UNCERTAINTY

CHAPTER VII

THE MEANING OF RISK AND UNCERTAINTY

Starting with the individual psychology of valuation and
adding new factors step by step, we have now built up a
competitive industrial society involving valuation and dis-
tribution under the highly simplified conditions necessary
to perfect competition. The drastic assumptions made
were necessary to show the operation of the forces at work
free from all disturbing influences; and impossible as the
presuppositions have been, the principles involved have
not been falsified or changed, but merely exhibited in
purity and isolation. Chief among the simplifications of
reality prerequisite to the achievement of perfect com-
petition is, as has been emphasized all along, the assump-
tion of practical omniscience on the part of every member
of the competitive system. The task of the present chapter
is to inquire more fully into the meaning of this assump-
tion. We must take a brief excursion into the field of the
theory of knowledge and clarify our ideas as to its nature
and limitations, and the relation between knowledge and
behavior. On the basis of the insight thus gained, it will
be possible to illuminate that large group of economic
phenomena which are connected with the imperfection of
knowledge.

The problem may be set in view and its significance
made clear by recalling certain points already brought out
in the previous discussion. In chapter n it was pointed ©ut
that the failure of competition and the emergence of profit
are connected with changes in economic conditions, but
that the connection is indirect. For profit arises from the
fact that entrepreneurs contract for productive services in
advance at fixed rates, and realize upon their use by the i

' I

198 RISK, UNCERTAINTY, AND PROFIT

j\, sale of the product in the market after it is made. Thus
f ' the competition for productive services is based upon an-
ticipations. The prices of the productive services being
the costs of production, changes in conditions give rise to
profit by upsetting anticipations and producing a divergence
between costs and selling price, which would otherwise be
equalized by competition. If all changes were to take
place in accordance with invariable and universally known
laws, they could be foreseen for an indefinite period in ad-
vance of their occurrence, and would not upset the perfect
apportionment of product values among the contributing
agencies, and profit (or loss) would not arise. Hence it is
our imperfect knowledge of the future, a consequence of
change, not change as such, which is crucial for the under-
standing of our problem.

Again, in chapters in and iv, it was found necessary to
assume static conditions in order to realize perfect com-
petition. But, as expressly stated, this assumption was
made because it follows from it as a corollary that the
future will be foreknown, and not for the sake of the prop-
osition itself. It is conceivable that all changes might take
place in accordance with known laws, and in fact very
many changes do occur with sufficient regularity to be
practically predictable in large measure. Hence the justi-
fication and the necessity for separating in our study the
effects of change from the effects of ignorance of the future.
And chapter v was devoted to a study of the effects of
change as such with uncertainty absent. Here it was found
that under such conditions distribution or the imputation
of product values to production services will always be
perfect and exhaustive and profit absent.

Furthermore, as also argued in chapter n, it is unneces-
sary to perfect, profitless imputation that particular occur-
rences be foreseeable, if only all the alternative possibilities
are known and the probability of the occurrence of each
can be accurately ascertained. Even though the business

MEANING of RISK AND UNCERTAINTY 199

man could not know in advance the results of individual
ventures, lie could operate and base his competitive offers
upon accurate foreknowledge of the future if quantitative
knowledge of the probability of every possible outcome can
be had. For by figuring on the basis of a large number of
ventures (whether in his own business alone or in that of
business in general) the losses could be converted into fixed
costs. Such special costs would, of course, have to be given
full weight, but they would be costs merely, like any other
necessary outlays, and would not give rise to profit, which
is a difference between cost and selling price. Such situa-
tions in more or less pure form are also common in every-
day life, and various devices for dealing with them form
an important phase of contemporary business organization.
Some of the more important of these devices will come up -.
for brief discussion later. At present we are concerned C~A
only to emphasize the fact that knowledge is in a sense V
variable in degree and that the practical problem may f
relate to the degree of knowledge rather than to its presence V
or absence in toto. J

The facts of life in this regard are in a superficial sense-^
obtrusively obvious and are a matter of common observa-
tion. It is a world of change in which we live, and a world
of uncertainty. We live only by knowing something about
the future; while the problems of life, or of conduct at
least, arise from the fact that we know so little. This is as
true of business as of other spheres of activity. The es-
sence of the situation is action according to opinion, of
greater or less foundation and value, neither entire ig-
norance nor complete and perfect information, but partial
knowledge. If we are to understand the workings of the
economic system we must examine the meaning and sig-
nificance of uncertainty; and to this end some inquiry into
the nature and function of knowledge itself is necessary.1

1 The problem of uncertainty and risk in economics is, of course, not
new. Some reference has already been made to the literature. It has

200 RISK, UNCERTAINTY, AND PROFIT

The first datum for the study of knowledge and behavior
is the fact of consciousness itself. Apparently the higher
mental operations of reason are different only in degree,
only elaborations of what is inherent in the first spark of
"awareness." The essence of mentality from a functional
standpoint seems to be its forward-looking character. Life
has been described as internal adaptations to external
coexistences and sequences. On the vegetable or uncon-
scious plane, the internal changes are simultaneous with
the external. The fundamental difference in the case of
animal or conscious life is that it can re Act to a situation
before that situation materializes; it can "see things com-
ing." This is what the whole complicated mechanism of
the nervous system is "for," in the biological sense. The
readjustments by which the organism adapts itself to the
environment require time, and the farther ahead the or-
ganism can "see," the more adequately it can adapt itself,
the more fully and competently it can live.

been recognized and discussed in three connections: (1) insurance; (2)
speculation; and (3) entrepreneurship. For a full treatment of the last-
named it is necessary to go to the German works cited in the historical
portion of this study. English economics has been too exclusively oc-
cupied with long-time tendencies or with "static" economics to give
adequate attention to this problem. For a very general discussion of un-
certainty see, in addition to works already cited, Ross, Uncertainty as a
Factor in Production, Annals, American Academy, vol. viii, pp. 304 ff.
See also Leslie, T. E. Cliffe, "The Known and the Unknown in the
Economic World," Essays in Political Economy, pp. 221-42; Lavington,
F., "Uncertainty in its Relation to the Rate of Interest," in Economic
Journal, vol. xxn, pp. 398-409; and "The Social Interest in Speculation,"
ibid., vol. xxiii, pp. 36-52; Pigou, A. C, Wealth and Welfare, part v;
Haynes, John, "Risk as an Economic Factor," Quarterly Journal of
Economics, July, 1895.

In this superficial sketch of the theory of knowledge it has not seemed
important to give extended reference to philosophic literature. It will be
evident that the doctrine expounded is a functional or pragmatic view,
with some reservations. By way of further "reservation" we should
point out that the tone of the discussion merely results from the fact
that it is the function of consciousness and knowledge in relation to con-
duct that we are interested in, for present purposes, and the text must not
be taken as expressing any view whatever as to the ultimate nature of

MEANING OF RISK AND UNCERTAINTY 201

Just what consciousness as such has to do with it is a
mystery which will doubtless remain inscrutable.1 It is a
mere brute fact that wherever we find complicated adapta-
tions we find consciousness, or at least are compelled to
infer it. Science can find no place for it, and no role for it
to perform in the causal sequence. It is epiphenomenal. An
explanation of the readjustment necessarily runs in terms of
stimulus and reaction, in this temporal order. Yet in our
own experience we know that we do not react to the past
stimulus, but to the "image" of a future state of affairs;
and for common sense, consciousness, the "image," is both
present and operative wherever adaptations are dissociated
from any immediate stimulus; i.e., are "spontaneous" and
forward-looking. It is evident that all organic reactions
relate to future situations, farther in the future as the type
of life and activity is "higher." However successful mech-
anistic science may be in explaining the reaction in terms
of a past cause, it will still be irresistibly convenient for
common sense to think of it as prompted by a future situa-
tion present to consciousness. The role of consciousness is
to give the organism this "knowledge" of the future. For
all we can see or for all that science can ever tell us, we
might just as well have been unconscious automata, but
we are not. At least the person speaking is not, and he
cannot help attributing to other creatures similarly con-
stituted and behaving in the same way with himself "in-
sides," to use Descartes' picturesque term, like his own.
We perceive the world before we react to it, and we react
not to what we perceive, but always to what we infer.

The universal form of conscious behavior is thus action
designed to change a future situation inferred from a

reality or any other philosophic position. The writer is in fact a radical
empiricist in logic, which is to say, as far as theoretical reasoning is con-
cerned, an agnostic on all questions beyond the fairly immediate facts of
experience.

1 See the brilliant lectures of E. DuBois-Raymond, " Uber die Grenzen
des Naturerkennens" and "Die sieben Weltratsel."

202 RISK, UNCERTAINTY, AND PROFIT

present one. It involves perception and, in addition,
twofold inference. We must infer what the future situation
would have been without our interference, and what change
will be wrought in it by our action. Fortunately or unfor-
tunately, none of these processes is infallible, or indeed
ever accurate and complete. We do not perceive the pres-
ent as it is and in its totality, nor do we infer the future
from the present with any high degree of dependability,
nor yet do we accurately know the consequences of our own
actions. In addition, there is a fourth source of error to
be taken into account, for we do not execute actions in
the precise form in which they are imaged and willed.
The presence of error in these processes is perhaps a phase
of the fundamental mystery of the processes themselves. It
seems to be an earnest of their non-mechanical character,
for machines, generally speaking, do not make mistakes.
(Though it may not be legitimate to draw inferences from
the crude machines of our own construction to the infinitely
more sensitive and intricate physico-chemical complexes
which make up organic systems.) In any case the fact of
liability to err is painfully familiar and is all that concerns
us here. It is interesting to note that the perceptive
faculties seem often to be less acute and dependable in the
higher forms of life than in some of the lower. At least
civilized man is often weak in this respect in comparison
with primitive man and the higher animals. Higher powers
of inference may take the place of perceptive faculties to a
large extent, and we have undoubtedly developed reasoning
power and lost ground with respect to keenness of sense.

It must be recognized further that no sharp distinction
can be drawn between perception and reason. Our per-
ceptive faculties are highly educated and sophisticated,
and what is present to consciousness in the simplest situa-
tion is more the product of inference, more an imaginative
construct than a direct communication from the nerve
terminal organs. A rational animal differs from a merely

MEANING OF RISK AND UNCERTAINTY 203

conscious one in degree only; it is more conscious. It is im-
material whether we say that it infers more or perceives
more. Scientifically we can analyze the mental content into
sense data and imagination data, but the difference hardly
exists for consciousness itself, at least in its practical as-
pects. Even in "thought" in the narrow sense, when the
object of reflection is not present to sense at all, the expe-
rience itself is substantially the same. The function of con-
sciousness is to infer, and all consciousness is largely in-
ferential, rational. By which, again, we mean that things
not present to sense are operative in directing behavior, that
reason, and all consciousness, is forward-looking; and an
essential element in the phenomena is its lack of automatic
mechanical accuracy, its liability to error.

The statement that a situation not in physical relations
with an organism, not even in existence, influences that
organism, is of course in a sense figurative; the influence
is indirect, operating through a situation with which the
organism is in contact at the moment. Hence, as already
pointed out, it is always theoretically possible to ignore the
form of the conscious relation, and interpret the reaction
as a mechanical effect of the cause actually present. But
it remains true that practically we must regard the situa-
tion present to consciousness, not the one physically
present, as the controlling cause. In spite of rash state-
ments by over-ardent devotees of the new science of "be-
havior," it is preposterous to suppose that it will ever
supersede psychology (which is something very different)
or the theory of knowledge, in something like their historic
for £s.

It is evident that the possibility of a situation not pres-
ent, operating through one which is present, is conditioned
upon some sort of dependable relation between the two.
This postulate of all knowledge and thought has been
variously formulated as the "law" or "principle" of "cau-
sality," and "uniformity" or "regularity" of nature, etc.

204 RISK, UNCERTAINTY, AND PROFIT

Remembering that we are speaking of the surface facts,
not metaphysical interpretations, we may say that all
reasoning rests on the principle of analogy. We know the
absent from the present, the future from the now, by as-
suming that connections or associations among phenom-
ena which have been valid will be so; we judge the future
by the past. Experience has taught us that certain time
and space relations subsist among phenomena in a degree
to be depended upon. This dogma of uniformity of coex-
istence and sequence among phenomena is a fairly satis-
factory statement of the postulate of thought and forward-
looking action from the standpoint of the philosopher.
But from the more superficial standpoint of common
sense (and hence of an inquiry such as the present) the
term "phenomenon" is rather vague and elusive, and a
more serviceable formulation seems possible. Common
sense works in terms of a world of objects or merely
"things." Consequently the idea of things manifesting
constant modes of behavior seems to be a better "category"
than that of uniformity of relation among phenomena.
This may be unsatisfactory to the philosopher, who will
protest at once that the thing is merely a sum of its modes
of behavior, that no such separation is really possible. It is
the ancient riddle which so puzzled Locke, of the attribute
and substratum, the substratum, of course, tending to
evaporate under critical scrutiny. But this weakness may
prove rather a source of strength for the use which we in-
tend to make of the notion, as will be argued.

We have, then, our dogma which is the presupposition
of knowledge, in this form; that the world is made up of
things, which, under the same circumstances, always behave
in the same way. The practical problem of inference or pre-
diction in any particular situation centers around the first
two of these three factors : what things are we dealing with,
and what are the circumstances which condition their ac-
tion? From knowledge of these two sets of facts it must be

MEANING OF RISK AND UNCERTAINTY 205

possible to say what behavior is to be expected. The chief
logical problem, as already noticed, lies in the conception
of a "thing." For it is obvious that the "circumstances"
which condition the behavior of any particular thing are
composed of other things and their behavior. The as-
sumption that under the same circumstances the same
things behave in the same ways thus raises the single ques-
tion of how far and in what sense the universe is really
made up of such "things" which preserve an unvarying
identity (mode of behavior). It is manifest that the or-
dinary objects of experience do not fit this description
closely, certainly not such "things" as men and animals
and probably not even rocks and planets in the strict
sense. Science has rested upon the further assumption that
this superficial divergence of fact from theory arises be-
cause the "things" of everyday experience are not the
"ultimate" things, but are complexes of things which really
are unchanging. And the progress of science has consisted
mostly in analyzing variable complexes into unvarying
constituents, until now we have with us the electron.

But workable knowledge of the world requires much more
than the assumption that the world is made up of units
which maintain an unvarying identity in time. There are
far too many objects to be dealt with by a finite intelli-
gence, however unvarying they might be, if they were all
different. We require the further dogma of identical sim-
ilarity between large numbers of things. It must be pos-
sible not merely to assume that the same thing will always
behave in the same way, but that the same kind of thing
will do the same, and that there is in fact a finite, practi-
cally manageable number of kinds of things. Hence the
fundamental role which classification has always played in
thought and the theory of thought. For our limited in-
telligence to deal with the world, it must be possible to
infer from a perceived similarity in the behavior of objects
to a similarity in respects not open to immediate observa-

206 RISK, UNCERTAINTY, AND PROFIT

tion. That is, we must assume that the properties of things
are not shuffled and combined at random in nature, but
that the number of groupings is limited or that there is
constancy of association. This is the dogma of the "reality
of classes," familiar to students of logic.

But even this is not enough. If the classification of ob-
jects be restricted to the grouping of things in all respects
similar or substantially identical, there would still be a
quite impossible number of kinds of things for intelligence
to grasp. Even in the sense of practical degrees of com-
pleteness of similarity, identity to ordinary observation,
our groups would be far too small and too numerous. It is
questionable whether classification would be carried far
enough on this basis to be of substantial assistance in sim-
plifying our problems to the point of manageability. It is
not that kind of a world. And even abstracting from mere
differences in degree such as size and the like, for which
intelligence readily makes allowance, the same would still
hold true. It is clear that to live intelligently in our world,
— that is, to adapt our conduct to future facts, — we must
use the principle that things similar in some respects will
behave similarly in certain other respects even when they
are very different in still other respects. We cannot make
an exhaustive classification of things, but must take various
and shifting groupings according to the purpose or prob-
lem in view, assimilating things now on the basis of one
common property (mode of behavior) and now on the basis
of another. The working assumption of practical inference
about the environment is thus a working number of prop-
erties or modes of resemblance between things, not a work-
able number of kinds of things; this latter we do not
have. That is, the properties of things which influence
our reactions toward them must be sufficiently limited in
number and in modes of association for intelligence to
grasp.

We may sum up these facts about the environment of

MEANING OF RISK AND UNCERTAINTY 207

our lives which are fundamental for conduct in the follow-
ing propositions :

1. The world is made up of objects which are practically\
infinite in variety as aggregates of sensible qualities )
and modes of behavior not immediately sensible. /
And when we consider the number of objects which/
function in any particular conduct situation, and /
their possible variety, it is evident that only an ffi-(
finite intelligence could grasp all the possible~com-
binations.
£7 Finite intelligence is able to deal with the world be-
cause y/

a. The number of distinguishable properties and
modes of behavior is limited, the infinite variety
in nature being due to different combinations of
the attributes in objects.

b. Because the properties of things remain fairly
constant; and

c. Such changes in them as take place occur in
fairly constant and ascertainable ways.

d. The non-sensible properties and modes of be-
havior of things are associated with sensible
properties in at least fairly uniform ways.

It is to be noted under (a) that differences in kind are
referred to rather than differences in degree, and we should
add that

3. The quantitative aspect of things and the power of
intelligence to deal with quantity is a fundamental
element in the situation.

4. It is also fundamental that in regard to certain proper-
ties objects differ only in degree, that mass and spacial
magnitude axe universal qualities of things, which do
not exhibit differences in kind.

5. Following out the same principle of (4) many of the
most significant properties are common \p vpry largp
groups; in respect to the qualities most important for

208 RISK, UNCERTAINTY, AND PROFIT

conduct, there are a very few kinds. The intelligi-
bility of the world is enormously increased if not
actually made possible by the_simplicity of the great
divisions into solid, liquid, and..ga,S intf> living and
not-living things, and the like. And there is a hier-
archy of attributes l in order of generahty_down J;o^
the slight peculiarities which probably distinguish
in some mariner "and degree (other than mere situa-
tion) every nameable thing in the universe from every
other, giving it individuality.

6. The postulates of intelligent behavior would be very
incomplete without formal insistence on the role
played by the fact of consciousness inj;* objects " out-
side ourselves, human beings and animals. The be-
haviorist notwithstanding, the inferences as to the
behavior to be anticipated which we draw from the
configuration of the lines about the mouth, the gleam
or "twinkle" of an eye or a shrill or "soft" vocal
sound, are not made from these physical features as
such or alone, but through "sympathetic introspec-
tion" 2 into what is going on in the "mind" of the
"object" contemplated, and would be impossible
without this mysterious capacity of interpretation.
It is always possible for the scientist to argue the con-
trary, as it is for him to demonstrate that we are not
really conscious ourselves, but common sense properly
revolts against the one conclusion as against the
other.

7. It goes without saying that we must know ourselves
as well as the world. Hence we must list our sense of
our own powers of movement, etc.

It is perhaps superfluous to speak here of the syllogism
and its place in logical theory. Empirical logicians such

1 Cf. Comte's Classification of the Sciences.

2 Professor Cooley's descriptive phrase. See Social Organization,
chap. i.

MEANING OF RISK AND UNCERTAINTY 209

as Mill and Venn have ventilated the subject sufficiently
and shown that no real inference is involved in the syllo-
gisnritself, that the inference takes place in the formula-
tion of the premises and consists in the recognition of a
constant factual connection between the predicates de-
noted by the different terms.

We are rather concerned here with pointing out that the
theory of knowledge as it is worked out by logicians is
primarily a theory of exact knowledge, of rigorous demon-
stration. It has become somewhat the fashion, especially
since Bergson came into vogue, to be iirationalistic, and
question the validity of logical processes. It seems to the
writer that there is much ground for this position, but that
its implications are very liable to be misunderstood. There
is to my mind no question of understanding the world by
any other method. There is, however, much question as to
how far the world is intelligible at all. This will be seen
to be a question of the facts as to the uniformity of be-
havior of natural objects and the similarities subsisting be-
tween them, on the ground of which inference is made from
one to another. In so far as there is "real change" in the
Bergsonian (i.e., Heracleitean) sense it seems clear that
reasoning is impossible. In addition we have to make the
still more questionable assumption that the situation ele-
ments or fundamental kinds of object properties upon
which we fall back for simplicity (practically finitude) in
view of the unmanageable number of kinds of objects as
wholes, are unvarying from one "combination" (i.e., one
object) to another. This assumption is doubtless valid in
some connections. Thus weight, inertia, etc., are undoubt-
edly the same in a living as in a non-living object. But
that the quality "living" is really the same in any two
kinds of living things is more open to doubt. In so far as
these general attributes are not uniform and cannot be
given a definite meaning which is the same for all the ob-
jects in the class which they designate, reasoning from one

210 RISK, UNCERTAINTY, AND PROFIT

member of the class to another is clearly invalid. That is,
valid classification assumes identity in some respect. It is
not absolutely certain that the ground on which we as-
cribe similarity to things and class them together and rea-
son from the behavior of one to that of the other is always
of this character. The power of one thing to suggest an-
other is often quite mysterious, and may possibly not rest
upon the possession of any common real qualities which
will support a valid inference.1

The practical limitation of knowledge, however, rests
upon very different grounds. The universe may not be
ultimately knowable (we speak, of course, only of objective
phenomena, of behavior, not of problems which transcend
ordinary experience of fact) ; but it is certainly knowable to
a degree so far beyond our actual powers of dealing with it
through knowledge that any limitations of knowledge due
to lack of real consistency in the cosmos may be ignored.
It probably occasions surprise to most persons the first
time they consider seriously what a small portion of our
conduct makes any pretense to a foundation in accurate
and exhaustive knowledge of the things we are dealing
with.

It is only when our interest is restricted to a very nar-
row aspect of the behavior of an object, dependent upon
its physical attributes of size, mass, strength, elasticity, or
the like, that exact determination is theoretically possible;
and only by refined laboratory technique that the deter-
mination can be actually made. The ordinary decisions of
life are made on tlie ba,si« of "^tfimntn" nf a midft nnd
superficial character. In general the future situation in
relation to which we act depends upon the behavior of
an indefinitely large number of objects, and is influenced
by so many factors that no real effort is made to take ac-
count of them all, much less estimate and summate their
separate significances. It is only in very special and crucial

1 See James, Psychology, chap, xxii, on "Association by Similarity."

MEANING OF RISK AND UNCERTAINTY 211

cases that anything like a mathematical (exhaustive and
quantitative) study can be made.

The mental operations by which ordinary practical de-
cisions are made are very obscure, and it is a matter for
surprise that neither logicians nor psychologists have
shown much interest in them. Perhaps (the writer is in-
clined to this view) it is because there is really very little
to say about the subject. Prophecy seems to be a good
deal like memory itself, on which it is based. When we wish
to think of some man's name, or recall a quotation which
has slipped our memory, we go to work to do it, and the
desired idea comes to mind, often when we are thinking
about something else — or else it does not come, but in
either case there is very little that we can tell about the
operation, very little "technique." So when we try to de-
cide what to expect in a certain situation, and how to be-
have ourselves accordingly, we are likely to do a lot of ir-
relevant mental rambling, and the first thing we know we
find that we have made up our minds, that our course of
action is settled. There seems to be very little meaning in
what has gone on in our minds, and certainly little kinship
with the formal processes of logic which the scientist uses
in an investigation. We contrast the two processes by rec-
ognizing that the former is not reasoned knowledge, but
"judgment," "common sense," or "intuition." There is
doubtless some analysis of a crude type involved, but in
the main it seems that we "infer" largely from our expe-
rience of the past as a whole, somewhat in the same way
that we deal with intrinsically simple (unanalyzable) prob-
lems like estimating distances, weights, or other physical
magnitudes, when measuring instruments are not at hand.1

The foregoing discussion of reasoning relates to ideal or
complete inference based on uniformity of association of
predicates and which can be formulated in universal propo-

1 Marshall remarks that the business manager's decisions are guided by
"trained instinct" rather than knowledge. (Principles, 6th ed., p. 406.)

212 RISK, UNCERTAINTY, AND PROFIT

sitions. The theory of formal deductive logic has, of
course, always recognized also reasoning from what are
undescriptively called "particular" propositions — "occa-
sional " would be a better term — asserting that two pred-
icates sometimes belong to the same subject, or that two
classes of objects overlap. The goal of science is always to
get rid of this form of assertion, to "explain" the occur-
rence and non-occurrence of the quality by finding some
other general fact in the past history of the object with
which the association is universal. But there are large
classes of cases in which this cannot be done even scientifi-
cally, and the rough operations of everyday unscientific
thinking employ the form* quite commonly. In the crude
form of "some X is F," such generalizations are very un-
satisfactory to the scientific mind and practically useless
except as a challenge and starting-point for further inquiry.
But when, as is so commonly the case, it is impossible or
impracticable to do better, the data can often be put in a
form of a great deal of scientific utility. This is done by
ascertaining the numerical proportion of the cases in which
X is associated with F, which yields the familiar probability
judgment. If, say, ninety per cent of X is F, — i.e., if
that fraction of objects characterized by property X shows
also property F, — the fact may obviously have much the
same significance for conduct as if the association were
universal.1

Furthermore, even if the proportion is not approximately
one hundred per cent, even if it is only half or less, the
same fact may hold good. If, in a certain class of cases a

1 When variations in degree in the attributes X and Y are taken into
account, the problem must be dealt with by applying the statistical theory
of correlation, which is a further development of probability theory.
See especially the works of K. Pearson and F. Y. Edgeworth. An ele-
mentary discussion will be found in any treatise on statistics. A. L.
Bowley's Measurement of Groups and Series is particularly serviceable
for the general reader. A rough idea may be obtained from Elderton's
Primer of Statistics. Pearson's Grammar of Science, chaps, iv and v, may
be consulted on the whole ground of the present chapter.

MEANING OF RISK AND UNCERTAINTY 213

given outcome is not certain, nor even extremely probable,
but only eontingent. hnt if the nqmeriWI prpjfrflhilit.y of its
occurrence is known, conduct in relation to the situation in
question may be ordered intelligently. Business operations,
as already observed, illustrate the point perfectly. Thus, in
the example given by von Mangoldt, the bursting of bot-
tles does not .introduce an uncertainty or hazard into the
^Business of producing champagne; since in the operations
of any producer a practically constant and known propor-
tion of the bottles burst, it does not especially matter even
whetheMhe proportion is large or small. The loss becomes
a fixed cost in the industry and is passed on to the con-
sumer, like the outlays for labor or materials or any other.
And even if a single producer does not deal with a suffi-
ciently large number of cases of the contingency in ques-
tion (in a sufficiently short period of time) to secure con-
stancy in its effects, the same result may easily be realized,
through an organization taking in a large number of pro-
ducers. This, of course, is the principle of insurance, as
familiarly illustrated by the chance of fire loss. No one can
say whether a particular building will burn, and most build-
ing owners do not operate on a sufficient scale to reduce the
loss to constancy (though some do) . But as is well known, the
effect of insurance is to extend this base to cover the opera-
tions of a large number of persons and convert, the eonttin-
jjency mto a fixed cost. It makes no difference in the prin-
ciples whether the grouping of eases is effected through a
mutual organization of the persons directly aitected or
through an outside commercial agency.

It will be evident that the practical difficulties of order-
ing conduct intelligently are enormously increased where
the inference is contingent instead of being positive. The
difficulties of establishing an association between predicates
are great enough where the association is universal; so
great, as we have already seen, that it is never done with
any approach to accuracy except for critical cases of very

214 RISK, UNCERTAINTY, AND PROFIT

special importance justifying extensive study in laboratory
or "field." Where the connection is occasional, demonstra-
tion of a dependable connection is vastly more difficult,
and there is the added problem of ascertaining the precise
proportion of cases in which the connection occurs. In re-
lation to everyday problems, where rigorous scientific
procedure is excluded, the difficulty and chance of error are,
of course, multiplied in still greater degree I We have to
"estimate" not merely factors whose associates, implica-
tions, or effects are known, but in addition the degree of
dependability of the association between the (estimated)
factors (the immediately perceptible attributes or modes of
behavior) and the inferred factors with relation to which
our action in the case is to be controlled. Most of the real
decisions of life are based on "reasoning" (if such it may be
called) of this still more tenuous and uncertain character,
and not even that which has already been described. We
have to estimate the given factors in a situation and also
estimate the probability that any particular consequence
will follow from any of them if present in the degree as^-
sumed.

For logical accuracy and in order to understand the
different kinds of situations and modes of dealing with
them in practice, a further distinction must be drawn, a
distinction of far-reaching consequences and much neg-
lected in the discussion of economic problems. There are
two fundamentally different ways of arriving at the proba-
bility judgment of the form that a given numerical prp-
b portion of X's are also Fs. The first method is by a priori
calculation, and is applicable to and used in games of
chance. This is also the type of case usually assumed in
logical and mathematical treatments of probability. It
must be strongly contrasted with the very different type of
^-^ problem in which calculation is impossible and the result is
i £ )renohe.(\ by the empirical method of applying statistics to
actual instances. As an illustration of the first type of

MEANING OF RISK AND UNCERTAINTY 215

probability we may take throwing a perfect die. If the die
is really perfect and known to be so, it would be merely
ridiculous to undertake to throw it a few hundred thousand
times to ascertain the probability of its resting on one face
or another. And even if the experiment were performed,
the result of it would not be accepted as throwing any
light on the actual probability. The mathematician can
easily calculate the probability that any proposed dis-
tribution of results will come out of any given number of
throws, and no finite number would give certainty as to the
probable distribution. On the other hand, consider the
case already mentioned, the chance that a building will
burn. It would be as ridiculous to suggest calculating from
a priori principles the proportion of buildings to be acciden-
tally destroyed by fire in a given region and time as it
would to take statistics of the throws of dice.

The import of this distinction for present purposes is
that the first, mathematical ova priori, type of probability
is practically never met with in business, while the second
is extremely common. It is difficult to think of a business
"hazard" with regard to which it is in any degree possi-
ble to calculate in advance the proportion of distribution
among the different possible outcomes.1 This must be
dealt with, if at all, by tabulating the results of experience.
The "if at all" is an important reservation, which will be
discussed presently. It is evident that a great many haz-
ards can be reduced to a fair degree of certainty bvstatis-
tical grouping — also that an equally imporfrfi.nf. ™.»pgnry
cannot. We should note, however, two other facts. First,
the statistical treatment never gives closely accurate
quantitative results. Even in such simple cases as mechan-
ical games of chance it would never be final, short of an
infinite number of instances, as already observed. Fur-
thermore, the fact that a priori methods are inapplicable is

1 The calling of bonds by lot is an illustration. In Germany bond-
holders often insure against this chance.

216 RISK, UNCERTAINTY, AND PROFIT

connected with a much greater complication in the data,
which again carries with it a difficulty, in fact impossibil-
ity, of securing the same degree of homogeneity in the in-
stances classed together. This point will have to be gone
into more fully. The second fact mentioned in regard to
the two methods is that the hazards or probabilities met
with in business do admit of a certain small degree of
theoretical treatment, supplementing the application of
experience data. Thus in the case of fire risk on buildings,
the fact that the cases are not really homogeneous may be
offset in part by the use of judgment, if not calculation.
It is possible to tell with some accuracy whether the
"real risk" in a particular case is higher or lower than that
of a group as a whole, and by how much. This procedure,
however, must be treated with caution. It is not clear
that there is an ultimate separation between the calcula-
tion of departures from a standard type and more minute
classification of types. There is, however, a difference in
form, and insurance companies constantly follow both
practices, that of defining groups as accurately as possible
and also that of modifying or adjusting the coefficient ap-
plied within a class according to special circumstances
which are practically always present.

We thus find that there are two logically different types
of inference included in the probability judgment. We shall
ref erfto these foT brevity under the names of the "a priori "
and/xhe "statistical" respectively. The relations between
thetwo concepts as employed in the crude usage of com-
mon sense are much confused and the ideas themselves
blurred, so that it is important to emphasize the con-
trast. The precise meaning of "real probability" will have
to be examined more in detail presently, but we can see
that there is a difference in this respect in our feelings to-
ward the two classes of cases. It seems clear that the prob-
ability of getting a six in throwing a die is "really" one in
six, no matter what actually happens in any particular

MEANING OF RISK AND UNCERTAINTY 217

number of throws; but no one would assert confidently that
the chance of a particular building burning on a particular
day is "really" of any definite assigned value. The first
statement has intuitive certainty with reference to a par-
ticular instance; in case of the second it is merely an em-
pirical generalization with reference to a group. Possibly
the difference is partly a matter of habit in our thinking
and to some extent illusory, but it is none the less real and
functional in our thinking. There is, indeed, a sort of
logical paradox in the problem. If the probability in a
game of chance is questioned, there is no test except that of
experimental trial of a large number of cases, and under
some circumstances we should conclude that the die was
probably "loaded." This would itself be a probability
judgment, to be sure, and would depend on the fact of our
ignorance of the composition and manufacture of the die.
Given this ignorance, a mathematician could tell the prob-
ability that the die is false, indicated by any given number
and distribution of throws.

The practical difference between a priori and statistical j (
probability seems to depend upon the accuracy of classifi-
cation of the instances grouped together.. In the case of
the die, the successive throws are held to be "alike" in a
degree and a sense which cannot be predicated of the dift'er-
ent buildings exposed to hrejiazard. There is, of course,
a constant effort on the part of the actuary to make his
classifications more exact, dividing groups into subgroups
to secure the greatest possible homogeneity. Yet we can
hardly conceive this process being carried so far as to make
applicable the idea of real probability in a particular in-
stance.

There is a further (Jjffiqiltv. amounting to paradox, in
the idea of homogeneous grouping. Much is made of this
point in treatises on statistics, the student being warned
against drawing conclusions from distributions in non-
homogeneous groups. Perhaps the most familiar example

218 RISK, UNCERTAINTY, AND PEG. IT

is the age and sex distribution of population aggregates.
An illustration (used by Secrist) is the death rate of the
American soldiers in the Philippines, which was lower than
that of the general population in the United States. The
fallacy in the inference as to healthfulness of environment
is, of course, that the "general population" is not a ho-
mogeneous group, but is made up of numerous age, sex,
race, and occupation classes, "naturally" subject to widely
different death rates. The paradox, which carries us at
once into the heart of the logical problem of probability, is
that if we had absolutely homogeneous groups we should
have uniformity and not probability in the result, or else
we must repudiate the dogma of the ultimate uniformity of
nature, the persistence of identity in things. If the idea of
natural law is valid at all, it would seem that men exactly
alike and identically circumstanced would all die at once;
in any particular interval either all or none would suc-
cumb, and the idea of probability becomes meaningless.
So even in the case of the dice; if we believe in the postulates
which make knowledge possible, then dice made alike and
thrown alike will fall alike, and that is the end of it.

Yet practically there is no danger, figuratively speak-
ing, that any of these phenomena will ever be amenable to
prediction in the individual instance. T?he fundamental
fact underlying probability reasoning is generally assumed
tojbe our jgnorfl/nQp. If it were possible to measure with
absolute accuracy all the determining circumstances in
the case it would seem that we should be able to predict
the result in the individual instance, but it is obtrusively
manifest that in many cases we cannot do this. It will cer-
tainly not be proposed in the typical insurance situations,
the chance of death and of fire loss, probably not even in
the case of gambling devices. The question arises whether
we should draw a distinction between necessary and only
factual ignorance of the data in a given case. Take the
case of balls in an urn. One man knows that there are

MEANING OF RIS5 AND UNCERTAINTY 219

red and black balls, but is ignorant of the numbers of each;
another knows that the numbers are three of the former to
one of the latter. It may be argued that "to the first man "
the probability of drawing a red ball is fifty-fifty, while to
the second it is seventy-five to twenty-five. Or it may be
contended that the probability is "really" in the latter
ratio, but that the first man simply does not know it. It
must be admitted that practically, if any decision as to
conduct is involved, such as a wager, the first man would
have to act on the supposition that the chances are equal.
And if the real probability reasoning is followed out to its
conclusion, it seems that there is "really" no probability at
all, but certainty, if knowledge is complete. The doctrine
of real probability, if it is to be valid, must, iL seems, rest
upon inherent unknowability in the factors, naljnerely_the
fact of ignorance. And even then we must always consult
the empirical facts, for it will not do to assume out of hand
that the unknown causes in a case will distribute them-
selves according to the law of indifference among the differ-
ent instances. We seem to be driven back to a logical
impasse. The postulates of knowledge generally involve
the conclusion that it is really determined in the nature of
things which house will burn, which man die, and which
face of the thrown die will come uppermost. The logic
which we actually use, however, assumes that the result
is really indeterminate, that the unknowable causes ac-
tually follow a law of indifference. The phenomenal con-
stancy of distribution to which we are forced to appeal
justifies this reasoning on the whole, but clearly is not its
actual basis in our thinking. Wherever we find that there
is not indifference, that the results show "bias," we as-
sume some determinable cause at work; and the results of
experience on the whole justify this assumption also.

There is a further point of some interest in regard to our
probability reasoning. Examination of the mathematical
theory of probability will show that the argument always

220 RISK, UNCERTAINTY, AND PROFIT

proceeds on the assumption that there is no middle ground
between complete determination and complete indifference.
That is, the elementary probabilities in any form of prob-
lem must always be equal. If the chance of any particular
result is more or less than one half, it is held to be axio-
matic that there is a greater number of possible alternatives
which yield this result (or do not yield it) than of the other
kind; the alternatives themselves must be equally probable.
The whole mathematical theory of probability is obviously
a simple application of the principles of permutations and
combinations for finding out the number of alternatives.
Absolute indifference between the alternatives is taken for
granted. Wherever the results do not show complete in-
difference between alternatives it is assumed that these
are not simple, and further analysis is applied to reduce
them to combinations of equally possible ones. And ex-
perience confirms these assumptions also.

Are we, then, to assume real indeterminateness, in the
cosmos itself? This was the view of Cournot, and the mere
ignorance theory common among writers on probability
seems inadequate and untenable. There are, to be sure,
cases which it seems to fit, like that referred to, where the
probability of drawing a red or black ball is even to one
who knows only that there are balls of the two colors in the
urn, but is ignorant of the numbers of each.1 But the case of
the man who does know the numbers of each seems to be
different. The dogmatic determinist can always maintain
that there are causes at work which decide the result, but
common sense is not satisfied. How does it "happen"
that experience justifies the calculation of probabilities
unless these unknown causes are really indifferent? When-
ever we find "biflg" in the rpg]ilt,fi, p divergence from the
anticipations on the basis of probability theory, we assume

1 Professor Irving Fisher is particularly insistent upon the interpreta-
tion of probability as due to ignorance alone. See The Nature of Capital
and Income, chap, xvi, sec. 1.

MEANING OF RISK AND UNCERTAINTY 221

the presence of some cause which is not indifferent, and
this procedure is also justified of its fruits. When we can be
sure that we have eliminated every circumstance which
can be measured or which might act consistently, we feel
confident in assuming that in a large number ofjtriajs_the
results will come out in accordance with the assumption
that the factors not subject to measurement or elimination
are in fact indifferent^ And not merely do we feel this way,
but "it works."

It is interesting to observe that the common applications
of probability in games of chance relate to some action of
the human organism itself, the drawing of a card from a
deck or ball from an urn after random manipulations, the
impulse given to a wheel or coin or die, etc. The facts
suggest a connection with that other age-old bone of con-
tention, the freedom of the will.1 If there is real indeter-
minateness, and if the ultimate seat of it is in the activities
of the human (or perhaps organic) machine, there is in a
sense an opening of the door to a conception of freedom in
conduct. And when we consider the mystery of the role of
consciousness in behavior and the repugnance which is felt
by common sense to the epiphenomenal theory, we feel
justified in further contending for at least the possibility
that "mind" may in some inscrutable way originate action.
Just how much or what sort of significance the admission
may have for practical ethics is another question, which
must be passed over here. Of course we cannot prove that
the exact distribution of all the coups of the roulette wheels
at Monte Carlo was not stowed away somewhere in the
primeval nebula; the final appeal must be to "intrinsic
reasonableness," the inveterate and necessary preference of
intelligence for the simplest formulation which conforms
to the facts. And about this, there may indeed be differences
of opinion, and from these there is apparently no appeal.2

1 Cf. E. Borel, Le Hasard, pp. 196-97.

2 See Karl Pearson's essay on "The Scientific Aspects of Monte Carlo

222 RISK, UNCERTAINTY, AND PROFIT

There may be different brands of "common sense"
(which some wag has averred is so called because so very-
uncommon). In the writer's view the doctrine of igno-
rance or "insufficient reason" is untrue to the feelings of
unsophisticated intelligence. We do not merely feel that
we know no reason why the coin shall fall heads or tails;
we know in a positive sense that there is no reason^smd only
under this condition do we make the probability judgment
with any confidence. And furthermore, as already argued,
it appears that only on condition that there is no reason
would the results of experience confirm the judgment, as
they do. The entire science of probability in the mathemat-
ical sense is based on the dogmatic assumption that the
ultimate alternatives are really equally vrobable. which
seems to the writer to mean real indeterminateness.1

Professor Irving Fisher's view of probability as "always
an estimate " becomes conditionally valid, however, on two
interpretations. In the first place, it may be saved "theo-
retically" if the term "estimate" is construed broadly
enough. If there is no difference between our a priori
judgment of the absence of any cause which should lead a

Roulette," in The Chances of Death and Other Studies in Evolution. The
necessity of constant appeal to a dogmatic preference of simple to com-
plicated hypotheses is brilliantly treated in Poincare's chapter on "Prob-
abilities," in The Foundations of Science, Science and Hypothesis, chap,
xi. See also Poincare's fascinating treatment of the relations between
small causes and large effects in the same volume, Science and Method,
chap. iv. Poincare bases the doctrine of equal probability on the mathe-
matical principle that for small changes any continuous analytical func-
tion changes in the same ratio as the variable. The same unsatisfactory,
if not absurd, doctrine of "intrinsic reasonableness" (for how can one
thing be "intrinsically" more probable than another?) is developed from
a different point of view in Balfour's Theism and Humanism, lecture
vii, on "Probability, Calculable and Intuitive."

1 For an excellent brief discussion of the issue, with references to the
literature, the reader is referred to Arne Fisher, The Mathematical Theory
of Probability, chap, i: "General Principles and Philosophic Aspects."
The writer's position is that taken by Fisher and designated the principle
of "cogent reason" in opposition to the older view common among
mathematicians, of "insufficient reason." Compare also La Place,
Essay on the Philosophical Theory of Probability.

MEANING OF RISK AND UNCERTAINTY 223 (.

coin or a die to fall on one face rather than another and an
"estimate" of equal probability, then there is no opposi-
tion between the two views. This is, however, repugnant
to common sense (the present writer's brand). We seem
to experience an "apodeictic certainty" about the situa-
tion of a game of chance, on a level with our confidence in
the axioms of mathematics, and quite different from an
"estimate." To illustrate, suppose we are allowed to look
into the urn containing a large number of black and red
balls before making a wager, but are not allowed to count
the balls; this would give rise to an estimate of probability
in the correct sense; it is something very different from
either the mere consciousness or ignorance on which we
act if we know only that there are balls of both colors
without any knowledge or opinion as to the numbers or
the exact knowledge of real probability attained by an
accurate counting of the balls. In the second place, we
must admit that the actual basis of action in a large pro-
portion of real cases is an estimate. Neither of these inter-
pretations, however, justifies identifying probability with
an estimate.

But the probability^ which the student, of business
risk is interested is an estimate, though in a sense different
from any of the propositions so far considered. To discuss
the question from this new point of view we must go back
for a moment to the general principles of the logic of con-
duct. We have emphasized above that the exact science of
inference has little place in forming the opinions upon
which -decisions of conduct are based, and that this is true
whether the implicit logic of the case is prediction on the
ground of exhaustive analysis or a probability judgment,
a priori or statistical. We act upon estimates rather than
inferences, upon "judgment" or "intuition," not reason-
ingJFor the most part. Now an estimate or intuitive judg-
ment is somewhat like a probability judgment, but very
different from either of the types of probability judg-

224 RISK, UNCERTAINTY, AND PROFIT

ment already described. The relations between the two
sorts" are in fact amazingly complex and as fraught with
logical paradox as the probability judgment itself. If the
term "probability" is to be applied to an estimate — and
the usage is so well established that there is no hope of
getting away from it — a third species under that genus
must be recognized. Such a third type of probability fits
very nicely in a scheme of classification with the two al-
ready discussed. We have insisted that there Jsjl funda-
mental difference between "a priori" probability, on the
one hand, and "statistical," on the other. In the former
the "chances" can be computed on general principles,
while in the latter they can only be determined empirically.
This distinction is in opposition to the views of writers
such as Venn and Edgeworth,1 who reduce the former
type to the latter on the basis of an empirical law of large
numbers and accept practically the assumption of real
indeterminateness. We have already raised the question
of accuracy of classification in this connection, suggesting
that the "instances," "throws," or "coups" in a game of
chance form a homogeneous group in a higher sense than
can be predicated on life or fire hazards. This view and our
entire theory tend to be confirmed by the attempt to
secure complete homogeneity through more minute clas-
sification. The end result of this endeavor would be group-
ings in which only really indeterminate factors should
differ from one instance to another.

Taking, then, the classification point of view, we shall
find the following simple scheme for separating three differ-
ent types of probability situation :

1. A pnon^rjiobability. Absolutely homogeneous clas-
sification of instances completely identical except for
really indeterminate factors. This judgment of prob-
ability is on the same logical plane as the propositions
of mathematics (which also may be viewed, and are
1 "The Philosophy of Chance," Mind, vol. 9, 1884.

MEANING OF RISK AND UNCERTAINTY 225

viewed by the writer, as "ultimately" inductions
from experience).

2. Statistical probability. Empirical evaluation of the
frequency of association between predicates, not an-
alyzable into varying combinations of equally prob-
able alternatives. It must be emphasized that any
high degree of confidence that the proportions found
in the past will hold in the future is still based on an
a priori judgment of indeterminateness. Two com-
plications are to be kept separate: firsts the impos-
sibility of eliminating all factors not really indeter-
minate; andl feeconcLtne impossibility of enumerating
the equally probable alternatives involved and
determining their mode of combination so as .to
evaluate the probability by a priori calculation. The
main distinguishing characteristic of this type is that
it rests on an empirical classification of instances.

3. Estimates. The distinction here is that there is no
valid basis of any kind for classifying instances. This
form"ofpSobability is involved in the greatest logical
difficulties of all, and no very satisfactory discussion
of it can be given, but its distinction from the other
types must be emphasized and some of its com-
plicated relations indicated.

We know that estimates or judgments are "liable" to
err. Sometimes a rough determination of the magnitude of
this "liability" is possible, but more generally it is not. In
general, any determination of the value of an estimate
must be merely empirical, secured by the tabulation of
instances, thus reducing it to. a probability of the second or
statistical type. Indeed, since, as we have noticed, entirely
homogeneous classification of instances is practically never
possible in dealing with statistical probability, it is clear
that the divergence from it of this third type where all
classification is excluded is a matter of degree only. There
are all gradations from a perfectly homogeneous group of

226 RISK, UNCERTAINTY, AND PROFIT

life or fire hazards at one extreme to an absolutely unique
exercise of judgment at the other. All gradations, we
should say, except the ideal extremes themselves; for as
we can never in practice secure completely homogeneous
classes in the one case, so in the other it probably never
happens that there is no basis of comparison for determin-
ing the probability of error in a judgment.

The theoretical difference between the probability
connected with an estimate and that involved in such
phenomena as are dealt with by insurance is, however, of
the greatest importance, and is clearly discernible in nearly
any instance of the exercise of judgment. Take as an illus-
tration any typical business decision. A manufacturer is
considering the advisability of making a large commit-
ment in increasing the capacity of his works. He "figures'*
more or less on the proposition, taking account as well as
possible of the various factors more or less susceptible of
measurement, but the final result is an "estimate" of the
probable outcome of any proposed course of action. What
is the " probability " of error (strictly, of any assigned de-
gree of error) in the judgment? It is manifestly meaning-
less to speak of either calculating such a probability a
priori or of determining it empirically by studying a large
number of instances. The essential and outstanding fact
is that the "instance" in question is so entirely unique that
there are no others or not a sufficient number to make it
possible to tabulate enough like it to form a basis for any
inference of value about any real probability in the case we
are interested in. The same obviously applies to the most
of conduct and not to business decisions alone.

Yet it is true, and the fact can hardly be over-em-
phasized, that a judgment of probability is actually made
in such cases. The business man himself not merely forms
the best estimate he can of the outcome of his actions, but
he is likely also to estimate the probability that his esti-
mate is correct. The " degree " of certainty or of confidence

MEANING OF RISK AND UNCERTAINTY <m

felt in the conclusion after it is reached cannot be ignored,
for it is of the greatest practical significance. The action
which follows upon an opinion depends as much upon the
amount of confidence in that opinion as it does upon the
favorableness of the opinion itself. The ultimate logic, or .
psychology, of these deliberations is obscure, a part of the
scientifically unfathomable mystery of life and mind. We
must simply fall back upon a " capacity " in the intelligent
animal to form more or less correct judgments about things,
an intuitive sense of values. We are so built that what
seems to us reasonable is likely to be confirmed by expe-
rience, or we could not live in the world at all.

Fidelity to the actual psychology of the situation re-
quires, we must insist, recognition of these two separate
exercises of judgment, the formation of an estimate and the
estimation of its value. We must, therefore, disagree with
Professor Irving Fisher's contention -1 that there is only
one estimate, the subjective feeling of probability itself.
Moreover, it appears that the original estimate maybe a
probability judgment. A man may act upon an estimate
of the chance that his estimate of the chance of an event is
a correct estimate. To be sure, after the decision is made
he will be likely to sum all up in a certain degree of con-
fidence that a certain outcome will be realized, and in
practice may go farther and assume that the outcome
itself is a certainty.

Two sorts of difficulty tend to obscure the relation be-
tween our second and third types of probability, that which
rests upon an empirical classification of instances and that
which rests upon no classification, but is an estimate of an
estimate. In the first place, nothing in the universe of
experience is absolutely unique any more than any two
things are absolutely alike. Consequently it is always pos-
sible to form classes if the bars are let down and a loose
enough interpretation of similarity is accepted. Thus, in
1 See The Nature of Capital and Income, p. 266.

228 RISK, UNCERTAINTY, AND PROFIT

the case above mentioned, it might or might not be
entirely meaningless to inquire as to the proportion of
successful factory extensions and the proportion of those
which are not. In this particular case it is hard to imagine
that any one would base conduct upon a judgment of the
probability of success arrived at in this way, but in other
situations the method could conceivably have more or less
validity. We must keep in mind that for conduct a proba-
bility judgment based on mere ignorance may be deter-
mining if it is the best that can be had. It would be a
question, however, whether the person placed in the posi-
tion of our business manager should regard the probability
for him of success as that indicated by statistics of "simi-
lar" instances or simply even chances each way based on
the fact of pure ignorance. What does appear certain is
that his own estimate of the value of his own judgment
would be given far greater weight than either sort of
computation.

A still more interesting complication, and one of much
greater practical significance, is the possibility of forming a
class of similar instances on entirely different grounds. That
is, instead of taking the decisions of other men in situations
more or less similar objectively, we may take decisions of
the same man in all sorts of situations. It is indisputable
that this procedure is followed in fact to a very large extent
and that an astounding number of decisions actually rest
upon such a probability judgment, though it cannot be
placed in the form of a definite statistical determination.
That is, men do form, on the basis of experience, more or
less valid opinions as to their own capacity to form correct
judgments, and even of the capacities of other men in this
regard. To be sure, both bases of classification are more or
less taken into account; the estimate (by A or any one else)
of the probability that the outcome of a situation will be
that which A has predicted is not based on a perfectly gen-
eral estimate of A's capacity to form judgments, but of his

MEANING OF RISK AND UNCERTAINTY 229

powers in a more or less defined field of prediction. It will
at once occur to the reader that this capacity for forming
correct judgments (in a more or less extended or restricted
field) is the principal fact which makes a man serviceable
in business; it is the characteristic human activity, the
most important endowment for which wages are received.
The stability and success of business enterprise in general
is largely dependent upon the possibility of estimating the
powers of men in this regard, both for assigning men to
their positions and for fixing the remunerations which they
are to receive for filling positions. The judgment or esti-
mate as to the value of a man is a probability judgment of
a complex nature, indeed. More or less based on experi-
ence and observation of the outcome of his predictions,
it is doubtless principally after all simply an intuitive judg-
ment or "unconscious induction," as one prefers.
z It seems likely that a still further distinction may be
drawn, leading to the recognition of another basis of clas-
sification of instances in order to reach a probability judg-
ment. We mean the subjective feeling of confidence of the
person making a prediction. I may have an intuitive feel-
ing or "hunch" that a situation will eventuate in a cer-
tain way, and this feeling may inspire a more or less delib-
erative confidence by its very strength and persistence.
The confidence in a prediction which is based on the
strength of an intuition may appear to be compounded to
the point of nonsense, but in so far as there exist such feel-
ings reached unconsciously or without deliberation and in
so far as they may become the objects of deliberative con-
templation, the situation is none the less real. However,
we cannot extend our inquiry to cover all the grounds on
which men, even educated men, actually make decisions,
or it will degenerate into a catalogue of superstitions. Let
us try, then, to sum up the conclusions, significant for
present purposes, to which the argument of the chapter
leads.

230 RISK, UNCERTAINTY, AND PROFIT

The importance of uncertainty as a factor interfering
with the perfect workings of competition in accordance
with the laws of pure theory necessitated an examination
of foundations of knowledge and conduct. The most im-
portant result of this survey is the emphatic contrast be-
tween knowledge as the scientist and the logician of science
uses the term and the convictions or opinions upon which
conduct is based outside of laboratory experiments. The
opinions upon which we act in everyday affairs and those
which govern the decisions of responsible business mana-
gers for the most part have little similarity with conclu-
sions reached by exhaustive analysis and accurate measure-
ment. The mental processes are entirely different in the
two cases. In everyday life they are mostly subconscious.
We know as little why we expect certain things to happen
as we do the mechanism by which we recall a forgotten
name. There is doubtless some analogy between the sub-
conscious processes of "intuition" and the structure of
logical deliberation, for the function of both is to anticipate
the future and the possibility of prediction seems to rest
upon the uniformity of nature. Hence there must be, in the
one case as in the other, some sort and amount of analysis
and synthesis; but the striking feature of the judging
faculty is its liability to error.

The real logic or psychology of ordinary conduct is
rather a neglected branch of inquiry, logicians having
devoted their attention more to the structure of demonstra-
tive reasoning. This is in a way inevitable, since the proc-
esses of intuition or judgment, being unconscious, are in-
accessible to study. Such attention as has been given to
the problem of intuitive estimation has been connected
with and largely vitiated by confusion with the logic of
CL probability. A brief examination of the probability judg-
J> ment shows it to fall into two types, which we called the
a priori and the statistical. In the latter type of situation,
we cannot, as we can in the former, calculate the true

l/

MEANING OF RISK AND UNCERTAINTY 231

probabilit * from external data, but must derive it from an A
inductive study of a large group of cases. This limitation '
involves a serious logical weakness, since at best statistics
give but a probability as to what the true probability is.
In practice we are still further handicapped by the im-
possibility of attaining complete homogeneity in our
groups of instances, in the sense in which the "coups" in
a priori probability are homogeneous; that is, that the
divergences are practically indeterminate as well as un-
determined.

The liability of opinion or estimate to error must be
radically distinguished from probability or chance of either
type, for there is no possibility of forming in any way
groups of instances of sufficient homogeneity to make
possible a quantitative determination of true probability.
Business decisions, for example, deal with situations which
are far too unique, generally speaking, for any sort of
statistical tabulation to have any value for guidance. The
conception of an objectively measurable probability or
chance is simply inapplicable. The confusion arises from
the fact that we do estimate the value or validity or de-
pendability of our opinions and estimates, and such an
estimate has the same form as a probability judgment; it
is a ratio, expressed by a proper fraction. But in fact it
appears to be meaningless and fatally misleading to speak
of the probability, in an objective sense, that a judgment is
correct. As there is little hope of breaking away from well-
established linguistic usage, even when vicious, we propose
to call the value of estimates a third type of probability
judgment, insisting on its differences from the other types
rather than its similarity to them.

It is this third type of probability or uncertainty which
has been neglected in economic theory, and which we pro-
pose to put in its rightful place. As we have repeatedly
pointed out, an uncertainty which can by any method
be reduced to an objective, quantitatively determinate

2S2 RISK, UNCERTAINTY, AND PROFIT

probability, can be reduced to complete ceiJ:ainty by
grouping cases. The business world has evolved several
organization devices for effectuating this consolidation,
with the result that when the technique of business or-
ganization is fairly developed, measurable uncertainties
do not introduce into business any uncertainty whatever.
Later in our study we shall glance hurriedly at some of
these organization expedients, which are the only economic
effect of uncertainty in the probability sense; but the pres-
ent and more important task is to follow out the con-
sequences of that higher form of uncertainty not suscepti-
ble to measurement and hence to elimination. It is this
true uncertainty which by preventing the theoretically per-
fect outworking of the tendencies of competition gives the
characteristic form of "enterprise*' to economic organiza-
tion as a whole and accounts for the peculiar income of the
entrepreneur.

CHAPTER VIII

STRUCTURES AND METHODS FOR MEETING
UNCERTAINTY

To preserve the distinction which has been drawn in the
last chapter hejween the naeasurable uncertainty and an
unmeasurable onj) we may use the term "risk" to designate
the former and the term "uncertainty" for the latter. The
word "risk" is ordinarily used in a loose way to refer to any
sort of uncertainty viewed from the standpoint of the un-
favorable contingency, and the term "uncertainty" sim-
ilarly with reference to the favorable outcome; we speak of
the "risk" of a loss, the "uncertainty" of a gain. But if
our reasoning so far is at all correct, there is a fatal am-
biguity in these terms, which must be gotten rid of, and the
use of the term "risk" in connection with the measurable
uncertainties or probabilities of insurance gives some jus-
tification for specializing the terms asjust indicatej^ We
can also employ the terms j^oSjectiy^^ and (^subject ivgT
probability to designate the ^isk ^nd uncertainty} respec-
tively, as these expressions are already ingenefaT use with
a signification akin to that proposed.

The practical difference between the two categories, risk
and uncertainty, is that in the former the distribution of
the, outcome in a group of instances is known (either
through calculation* a priori j©r from statistics of past ex-
perience), while in the case of uncertainty this is not true,
the reason being in general that it is impossible to form
a group of instances, because the situation dealt with is in a
high degree unique. The best example of uncertainty is in
connection with the exercise of judgment or the formation
of those opinions as to the future course of events, which
opinions (and not scientific knowledge) actually guide
most of our conduct. Now if the distribution of the differ-

234 RISK, UNCERTAINTY, AND PROFIT

ent possible outcomes in a group of instances is known, it
is possible to get rid of any real uncertainty by the expe-
dient of grouping or "consolidating" instances. But that
it is possible does not necessarily mean that it will be done,
and we must observe at the outset that when an individual
instance only is at issue, there is no difference for conduct
between a measurable risk and an unmeasurable uncer-
tainty. The individual, as already observed, throws his
estimate of the value of an opinion into the probability
form of "a successes in b trials" (a/b being a proper frac-
tion) and "feels " toward it as toward any other probability
situation.

As so commonly in this subject fraught with logical
difficulty and paradox, reservations must be made to the
above statement. In the first place, it does not matter how
unique the instance, if a real probability can be calculated,
if we can know with certainty how many successes there
would be in (say) one hundred trials if the one hundred
trials could be made. If we know the odds against us it
does not matter in the least whether we place all our wagers
in one kind of game or in as many different games as there
are wagers; the laws of probability hold in the second case
just as well as in the first. But in business situations it so
rarely happens that a probability can be computed for
a single unique instance that this qualification has less
weight than might be supposed. However, in so far as ob-
jective probability enters into a calculation, it is hard to
imagine an intelligent individual considering any single
case as absolutely isolated. The only exception would be a
decision in which one's whole fortune (or his life) were at
stake. The importance of the contingency and probable
frequency of recurrence in the individual lifetime of situa-
tions similar in the magnitude of the issues involved should
make a difference in the attitude assumed toward any one
case as well as the mathematical probability of success or
failure.

METHODS FOR MEETING UNCERTAINTY 235

A second reservation of more importance is connected
with the possibility referred to in the preceding chapter, of
forming classes of cases by grouping the decisions of a given
person. That is, even though we do not get a quantitative
probability by the process of grouping, still there is some
tendency for fluctuations to cancel out and for the result
to approach constancy in some degree. There appear to
be in the making of judgments the same two kinds of
elements that we find in probability situations proper;
i.e., (a) determinate factors (the quality of the judging
faculty, which is more or less stable) and (b) truly acci-
dental factors varying from one decision to another accord-
ing to a principle of indifference. The difference between
the uncertainty of an opinion and a true probability is that
we have no means of separating the two and evaluating
them, either by calculation a priori or by empirical sorting.
But in the second case the difference is not absolute; the
sorting method does apply to some extent, though within
narrow limits. Life is mostly made up of uncertainties,
and the conditions under which an error or loss in one case
may be compensated by other cases are bafflingly complex.
We can only say that "in so far as" one confronts a situa-
tion involving uncertainty and deals with it on its merits
as an isolated case, it is a matter of practical indifference
whether the uncertainty is measurable or not.

The problem of the human attitude toward uncertainty
(not for the present purpose distinguishing kinds) is as
beset with difficulties as that of uncertainty itself. Not
merely is the human reaction to situations of this character
apt to be erratic and extremely various from one individual
to another, but the " normal' ' reaction is subject to well-
recognized deviations from the conduct which sound logic
would dictate. Thus it is a familiar fact, well discussed by
Adam Smith, that men will readily risk a small amount in
the hope of winning a large when the adverse probability
(known or estimated) against winning is much in excess of

236 RISK, UNCERTAINTY, AND PROFIT

the ratio of the two amounts, while they commonly will
refuse to incur a small chance of losing a larger amount for
a virtual certainty of winning a smaller, even though the
actuarial value of the chance is in their favor. To this bias
must be added an inveterate belief on the part of the typi-
cal individual in his own "luck," especially strong when the
basis of the uncertainty is the quality of his own judgment.
The man in the street has little more sense of the real
value of his opinions than he has knowledge of the "logic"
(if such it may be called) on which they rest. In addition,
we must consider the almost universal prevalence of super-
stitions. Any coincidence that strikes attention is likely
to be elevated into a law of nature, giving rise to a belief
in an unerring "sign." Even a mere "hunch" or "some-
thing tells me," with no real or imaginary basis in the
mind of the person himself, may readily be accepted as
valid ground for action and treated as an unquestionable
verity.
/^j{ I Doubtless in the long run of history there is a tendency
* toward rationality even in men's whims and impulses. And
if for no other reason than the impossibility of intelligently
dealing with conduct on any other hypothesis, we seem
justified in limiting our discussion to rational grounds of
action. We shall assume, then, that if a man is undergoing
a sacrifice for the sake of a future benefit, the expected re-
ward must be larger in order to evoke the sacrifice if it is
viewed as contingent than if it is considered certain, and
that it will have to be larger in at least some general pro-
portion to the degree of felt uncertainty in the anticipa-
tion.1 It is clearly the subjective uncertainty which is

1 The chief limitation in fact relates less to the proposition as stated
than to the dogma of "conduct" or activity exclusively in order to a
future reward. Means and end seem to be the form in which we think
about our behavior rather than the actual form of the behavior itself.
The literature of ethics is one long record of failure to find any absolute
end; in life every end becomes a means to some new and farther goal. The
attempt to rationalize human behavior seems to be a perpetual chase

METHODS FOR MEETING UNCERTAINTY 237

decisive in such a case, what the man believes the chances
to be, whether his degree of confidence is based upon an
objective probability in the situation itself or in an esti-
mate of his own powers of prediction. We hold also that
both the objective and subjective types may be involved
at the same time, though no doubt most men do not carry
their deliberations so far; the man's opinion or prediction
may be an estimate of an obj'ective probability, and the
estimate itself be recognized as having a certain degree of
validity, so that the degree of felt uncertainty is a product
of two probability ratios. It is to be emphasized again
that practically all decisions as to conduct in real life rest
upon opinions, and doubtless the greater part rest upon
opinions which on scrutiny easily resolve themselves into
an opinion of a probability — though as noted this "scru-
tiny" may not in most cases be given to the judgment
by the individual making it.

The normal economic situation is of this character:
The adventurer has an opinion as to the outcome, within
more or less narrow limits. If he is inclined to make the
venture, this opinion is either an expectation of a certain
definite gain or a belief in the real probability of a larger
one. Outside the limits of the anticipation any other re-
sult becomes more and more improbable in his mind as the
amount thought of diverges either way. Hence it is cor- _^
rect to treat all instances of economic uncertainty as cases
of choice between a smaller reward more confidently and a
larger one less confidently anticipated.

At the bottom of the uncertaintyproblem in economics

is the forward-looking character of the economic process

itself. Goods are produced to satisfy wants; the production

of goods requires time, and two elements of uncertainty

after one's own shadow, and the conclusion forces itself upon us that the
"summum bonum" or any other objective "bonum" is an ignis jatuus.
We are compelled to believe that in a great proportion of cases we take
more interest in action whose fruition is only probable than we would if
it were certain.

238 RISK, UNCERTAINTY, AND PROFIT

are introduced, corresponding to two different kinds of fore-
sight which must be exercised. First, the end of productive
operations must be estimated from the beginning. It is
notoriously impossible to tell accurately when entering
upon productive activity what will be its results in physi-
cal terms, what (a) quantities and (b) qualities of goods
will result from the expenditure of given resources. Second,
the wants which the goods are to satisfy are also, of course,
in the future to the same extent, and their prediction in-
volves uncertainty in the same way. The producer, then,
must estimate (1) the future demand which he is striving
to satisfy and (2) the future results of his operations in
attempting to satisfy that demand.

It goes without saying that rational conduct strives to
reduce to a minimum the uncertainties involved in adapt-
ing means to ends. This does not mean, be it emphasized,
that uncertainty as such is abhorrent to the human species,
which probably is not true. We should not really prefer
to live in a world where everything was "cut and dried,"
which is merely to say that we should not want our activity
to be all perfectly rational. But in attempting to. act "in-
telligently" we are attempting to secure adaptation, which
means foresight, as perfect as possible. There is, as already
noted, an element of paradox in conduct which is not to
be ignored. We find ourselves compelled to strive after
things which in a "calm, cool hour" we admit we do not
want, at least not in fullness and perfection. Perhaps it is
the manifest impossibility of reaching the end which makes
it interesting to strive after it. In any case we do strive to
reduce uncertainty, even though we should not want it
eliminated from our lives.

The possibility of reducing uncertainty depends again

on two fundamental sets of conditions : First, uncertainties

ii — * — L

are less in groups of cases than in single instances. In the
case of a priori probability the uncertainty tends to dis-
appear altogether, as the group increases in inclusiveness;

METHODS FOR MEETING UNCERTAINTY 239

with statistical probabilities the same tendency is manifest
in a less degree, being limited by defectiveness of classifica-
tion. And even the third type, true uncertainties, show
some tendency toward regularity when grouped on the basis
of nearly any similarity or common element. The second
fact or set of facts making for a reduction of uncertainty is
the differences among human individuals in regard to it.
These differences are of many kinds and an enumeration of
them will be undertaken presently. We may note here
that they may be differences in the men themselves or
differences in their position in relation to the problem. We
may call the two fundamental methods of dealing with
uncertainty^ based respectively upon reduction by group-
ing and upon selection of men to "bear" it, "consolida-
tion" * fi^gfe^peciahzation," respectively. To these two
methods wcTmust add two others which are so obvious as
hardly to call for discussion : (3) control of the future, and
(4) increased power of prediction. These are closely inter-
related, since the chief practical significance of knowledge
is control, and both are clo0!ly identified with the general
progress of civilization, the improvement of technology
and the increase of knowledge. Possibly a fifth method
should be named, tH&^diffusion " of the consequences of
untoward contingencies. Ofther things equal, it is a gain
to have an event cause a loss of a thousand dollars each to a
hundred persons rather than a hundred thousand to one
person; it is better for two/men to lose one eye than for one
to lose two, and a syste^of production which wounds a
larger number of workers and kills a smaller nnmhpr fc t.n
be regarded as an improvement. In practice this diffusion
is perhaps always associated with consolidation, buFthere
is a logical distinction between the two and they may be
practically separable in some cases. We must observe also

1 Professor Irving Fisher's term {The Nature of Capital and Income,
p. 288). I should prefer simply "grouping" as both shorter and more
descriptive.

240 RISK, UNCERTAINTY, AND PROFIT

that consolidation and specialization are intimately con-
nected, a fact which will call for repeated emphasis as we
proceed. In addition to these methods of dealing with un-
certainty there is (6) the possibility of directing industrial
activity more or less along lines in which a minimal amount
of uncertainty is involved and avoiding those involving a
greater degree.

One of the most immediate and most important conse-
quences of uncertainty in economics may be disposed of as
a preliminary to a detailed technical discussion. The es-
sence of organized economic activity is the production by
certain persons of goods which will be used to satisfy the
wants of other persons. The first question which arises
then is, which of these groups in any particular case, pro-
ducers or consumers, shall do the foreseeing as to the future
wants to be satisfied. It is perhaps obvious that the func-
tion of prediction in the technological side of production
itself inevitably devolves upon the producer. At first sight
it would appear that the consumer should be in a better
position to anticipate his own wants than the producer to
anticipate them for him, but we notice at once that this is
not what takes place. The primary phase of economic or-
ganization is the production of goods for a general market,
not upon direct order of the consumer. With uncertainty
absent it would be immaterial whether the exchange of
goods preceded or followed actual production. With un-
certainty (in the two fields, production and wants) present
it is still conceivable that men might exchange productive
services instead of products, but the fact of uncertainty
operates to bring about a different result. LTo begin with,
modern society is organized on the theory (whatever the
facts, about which some dOUbt may be expressed) that
men predict the future and adapt their conduct to jt more
effectively when the results accrue to themselves than
when j£ey accrue to othersj The responsibilities of con-
trolling production thus devolve upon the producer.

METHODS FOR MEETING UNCERTAINTY 241

But the consumer does not even contract for his goods in
advance, generally speaking. A part of the reason might
be the consumer's uncertainty as to his ability to pay at
the end of the period, but this does not seem to be impor-
tant in fact. The main reason is that he does not know
what he will want, and how much, and how badly; conse-
quently he leaves it to producers to create goods and hold
them ready for his decision when the time comes. The clue
to the apparent paradox is, of course, in the "law of large
numbers," the consolidation of risks (or uncertainties).
The consumer is, to himself, only one ; to the producer he is a
mere multitude in which individuality is lost. It turns out
that an outsider can foresee the wants of a multitude with
more ease and accuracy than an individual can attain with
respect to his own. ] This phenomenon gives us the most
fundamental feature of the economic system, production
for a market, and hence also the general character of the
environment in relation to which the effects of uncertainty
are to be further investigated. Before continuing the in-
quiry into other phases and methods of the consolidation
of risks, we shall turn briefly to consider the differences
among individuals in their attitudes and reactions toward
measurable or unmeasurable uncertainty.

We assume, as already observed, that although life is no
doubt more interesting when conduct involves a certain
amount of uncertainty, — the proper amount varying with
individuals and circumstances, — yet that men do actually
strive to anticipate the future accurately and adapt their
conduct to it. In this respect we may distinguish at least
five variable elements in individual attributes and capaci-
ties^ tt) Men differ in their capacity by perception and
inference to form correct judgments as to the future course
of events in the environment. This capacity, furthermore,
is far from homogeneous, some persons excelling in fore-
sight in one kind of problem situations, others in other
kinds, in almost endless variety. Of especial importance

242 RISK, UNCERTAINTY, AND PROFIT

is the variation in the power of reading human nature, of
forecasting the conduct of other men, as contrasted with
scientific judgment in regard to natural phenomena. (2)
Another, though related, difference is found in men's ca-
pacities to judge means and discern and plan the steps
and adjustments necessary to meet the anticipated future
situation. (3) There is a similar variation in the power to
execute the plans and adjustments believed to be requisite
and desirable. (4) In addition there is diversity in conduct
in situations involving uncertainty due to differences in
the" "amount of confidence which individuals feel in their
judgments when formed and in their powers of execution;
this degree of confidence is in large measure independent
of the "true value" of the judgments and powers them-
selves. (5) Distinct from confidence felt is the conative
attitude ±Qj3i situation upon which judgment is passed with
a given degree of confidence. It is a familiar fact that some
individuals want to be sure and will hardly "take chances "
at all, while others like to work on original hypotheses and
seem to prefer rather than to shun uncertainty. It is
common to see people act on assumptions in ways which
their own opinions of the value of the assumption do not
warrant; there is a disposition to "trust in one's luck."

The amount of uncertainty effective in a conduct situa-
tion is the degree of subjective confidence felt in the contem-
plated act as a correct adaptation to the future — number
4 above. It is clear that we may speak in some sense of the
"true value" of judgment and of capacity to act, but it is
the person's own opinion of these values which controls his
activities. Hence the five variables are, from the standpoint
of the person concerned, reduced ro two v the (subjective
or felt ) uncertainty and his conative feeling toward it. For
completeness we should perhaps add a sixth uncertainty
factor, in the shape of occurrences so revolutionary and un-
expected by any one as hardly to be brought under the
category of an error in judgment at all.

METHODS FOR MEETING UNCERTAINTY 243

In addition to the above enumeration of five or six dis-
tinct elements in the uncertainty situation we must point
out that the first three variables named are themselves not
simple. Judgment or foresight and the capacity for plan-
ning and the ability to execute action are each the prod-
uct of at least four distinguishable factors, in regard to
which the faculties in question may vary independently.
These are (a) accuracy, fh) promptness or speed J (c) Jime
range, and (d) space rangeJ of the capacity or action. The
first two of these require no explanation; it is evident that
accuracy and rapidity of judgment and execution are more
or less independent endowments. The third refers to the
length of time in the future to which conduct is or may be
adjusted, and the fourth to the scope or magnitude of the
situation envisaged and the operations planned. Familiar
also is the difference between individuals who have a mind
for detail and those who confine their attention to the
larger outlines of a situation. Even this rather complex
outline is extremely simplified as compared with the facts of
life in that it compasses only a rigidly "static" view of the
problem. Quite as important as differences obtaining at
any moment among individuals in regard to the attributes
mentioned are their differences in capacity for change or
development along the various lines. Knowledge is more a
matter of learning than of the exercise of absolute judg-
ment. Learning requires time, and in time the situation
dealt with, as well as the learner, undergoes change.

We have classified the possible reactions t.o nnrarta.int.y
under some half-dozenjieads, each of which gives rise to
special problems, though the social structures for dealing
with these problems overlap a good deal. The most funda-
mental facts regarding uncertainty from our point of view
are, first, the possibility of reducing it in amount by group-
ing instances; and, second, the differences in individuals in
relation to uncertainty, giving rise to a tendency to spe-
cialize the function of meeting it in the hands of certain

244 RISK, UNCERTAINTY, AND PROFIT

individuals and classes. The most fundamental effect of
uncertainty on the social-economic organization — produc-
tion for a general market on the producer's responsibility
— has already been taken up; it is primarily a case of re-
duction of uncertainty by consolidation or grouping of cases.
In the mere fact of production for a market, there is little
specialization of uncertainty-bearing, and what there is is
on a basis of the producer's position in relation to the prob-
lem, not his peculiar characteristics as a man. To isolate
the phenomenon of production for a market from other
considerations we must picture a pure "handicraft stage"
of social organization. In such a system every individual
would be an independent producer of some one finished
commodity, and a consumer of a great variety of products.
The late Middle Ages afford a picture of an approxima-
tion to such a state of affairs in a part of the industrial
field.

The approximation is rather remote, however. A handi-
craft organization shows an irresistible tendency to pass
over, even before well established, into a very different
system, and this further development is also a consequence
of the presence of uncertainty. The second system is that
of "free enterprise" which we find dominant to-day. The
difference between free enterprise and mere production for
a market represents the addition of specialization of un-
certainty-bearing to the grouping of uncertainties, and
takes place under pressure of the same problem, the antici-
pation of wants and control of production with reference
to the future. Under free enterprise the solution of this
problem, already removed from the consumer himself, is
further taken out of the hands of the great mass of produc-
ers as well and placed in charge of a limited class of "entre-
preneurs" or "business men." The bulk of the producing
population cease to exercise responsible control over pro-
duction and take up the subsidiary role of furnishing pro-
ductive resources (labor, land, and capital) to the entre-

METHODS FOR MEETING UNCERTAINTY 245

preneur, placing them under his sole direction for a fixed
contract price.

We shall take up this phenomenon of free enterprise for
detailed discussion in the next chapter, though we may
note here two further facts regarding it; first, the "spe-
cialization " of uncertainty-bearing in the hands of entre-
preneurs involves also a further consolidation; and, second,
it is closely connected with changes in technological meth-
ods which (a) increase the time length of the production
process and correspondingly increase the uncertainty in-
volved, and (b) form producers into large groups working
together in a single establishment or productive enterprise
and hence necessitates concentration of control. The re-
mainder of the present chapter will be devoted to a survey
of the social structures evolved for dealing with uncertainty.
Some of the phenomena will thus be finally disposed of,
so far as the present work is concerned, especially those
which already have a literature of their own and whose
general bearings and place in a systematic treatment of
uncertainty alone call for notice here. Other problems will
be merely sketched in outline and reserved for fuller treat-
ment in subsequent chapters, as has just been done with
the subject of entrepreneurship.

Following the order of the classification already given of
methods of dealing with uncertainty, the first subject for
discussion is the institutions or special phenomena arising
from the tendency to deal with uncertainty by consolida-
tion. The most obvious and best known of these devices is,
of course, insurance, which has already been repeatedly used
as an illustration of the principle of eliminating uncertainty
by dealing with groups of cases instead of individual cases.
In our discussion of the theory of uncertainty in the forego-
ing chapter and at other points in the study we have em-
phasized the radical difference between a measurable and
an unmeasurable uncertainty. Now measurability depends
on the possibility of assimilating a given situation to a

246 RISK, UNCERTAINTY, AND PROFIT

group of similars and finding the proportions of the mem-
bers of the group which may be expected to exhibit the
various possible outcomes. This assimilation of cases into
classes may be exceedingly accurate, and the proportions
of the various outcomes may be computable on a priori
grounds by the application of the theory of permutations
and combinations to determine the possible groupings of
equally probable alternatives; but this rarely if ever happens
in a practical business situation. The classification will be
of all degrees of precision, but the ascertainment of pro-
portions must be empirical. The application of the in-
surance principle, converting a larger contingent loss into a
smaller fixed charge, depends upon the measurement of
probability on the basis of a fairly accurate grouping into
classes. It is in general not enough that the insurer who
takes the "risk" of a large number of cases be able to pre-
dict his aggregate losses with sufficient accuracy to quote
premiums which will keep his business solvent while at the
same time imposing a burden on the insurer which is not
too large a fraction of his contingent loss. In addition he
must be able to present a fairly plausible contention that
the particular insured is contributing to the total fund out
of which losses are paid as they accrue in an amount corre-
sponding reasonably well with his real probability of loss;
i.e., that he is bearing his fair share of the burden.

The difficulty of a satisfactory logical discussion of the
questions we are dealing with has repeatedly been em-
phasized, due to the fact that distinctions of the greatest
importance tend to run together through intermediate
degrees and become blurred. This is conspicuously the case
with the measurability of uncertainty through classifica-
tion of instances. We hardly find in practice really homo-
geneous classifications (in the sense in which mathematical
probability implies, as in the case of successive throws of a
perfect die) and at the other extreme it is hard to find cases
which do not admit of some possibility of assimilation into

of i

es
of

METHODS FOR MEETING UNCERTAINTY 247

groups and hence of measurement. Indeed, the very con-
cept of contingency seems to preclude absolute uniqueness
(as for that matter there is doubtless nothing absolutely
unique in the universe). For to say that a certain event is
contingent or "possible" or "may happen" appears to be
equivalent to saying that "such things " have been known to
happen before, and the "such things" manifestly consti-
tute a class of cases formed on some ground or other. The
principal subject for investigation is thus the degree of
assimilability, or the amount of homogeneity of classes
securable, or, stated inversely, the degree of uniqueness
various kinds of business contingencies. Insurance deals
with those which are "fairly" classifiable' or show a rela-
tively low degree of uniqueness, but the different branches
of insurance show a wide range of variation in the accuracy
of measurement of probability which they secure.

Before taking up various types of insurance we may note
in passing a point which it is superfluous to elaborate in
this connection, namely, that different forms of organiza-
tion in the insurance field all operate on the same principle.
It matters not at all whether the persons liable to a given
contingency organize among themselves into a fraternal or
mutual society or whether they separately contract with
an outside party to bear their losses as they fall in. Under
competitive conditions and assuming that the probabilities
involved are accurately known, an outside insurer will make
no clear profit and the premiums will under either sys-
tem be equal to the administrative costs of carrying on the
business.

The branch of insurance which is most highly developed,
meaning that its contingencies are most accurately meas-
ured because its classifications are most perfect, and which
is thus on the most nearly "mathematical" basis is, of
course, what is called "life insurance." (In so far as it is
"insurance" at all, and not a mere investment proposition,
it is clear that it is insurance against "premature" loss of

248 RISK, UNCERTAINTY, AND PROFIT

earning power, and not against death.) It is possible, on
the basis of medical examinations, and taking into account
age, sex, place of residence, occupation, and habits of life,
to select "risks" which closely approximate the ideal of
mechanical probability. The chance of death of two
healthy individuals similarly circumstanced in the above
regards seems to be about as near an objective equality,
the life or death of one rather than the other about as nearly
really indeterminate, as anything in nature. To be sure,
when we pass outside the relatively narrow circle of "nor-
mal" individuals, difficulties are encountered, but the ex-
tension of life insurance outside this circle has also been
restricted. Some development has taken place in the insur-
ance of sub-standard lives at higher rates, but it is limited
in amount and could be characterized as exceptional.1

The very opposite situation from life insurance is found
in insurance against sickness and accident. Here an ob-
jective description and classification of cases is impossible,
the business is fraught with great difficulties and suscepti-
ble of only a limited development. It is notorious that such
policies cost vastly more than they should; indeed, the
companies find it profitable to adopt a generous attitude in
the adjustment of claims, raising the premium rates ac-
cordingly, it is needless to say. Accident compensation for
workkigmen, under social control, is on a somewhat better
footing, but only on condition that the payments are re-

1 It would be out of place here to go into the social aspects of life in-
surance, but one observation may be worth making. From the social
point of view it is arguable that all classification of risks is a bad thing,
except in so far as the special hazard is purely occupational and the cost
of carrying it can be transferred to the consumer of the product. It is
hard to discover any good reason why the unfortunate should be especially
burdened because of their handicaps. It would, therefore, be better if all
were insured at a uniform rate. Indeed, we may go farther and contend
that the rate should be graduated inversely with the risk (occupational
risks excepted, as noted). It goes without saying that only a state com-
pulsory insurance scheme could operate on any such principles; under
private profit incentives, competition will compel any insurance agency to
classify its risks as accurately and minutely as practicable.

METHODS FOR MEETING UNCERTAINTY 249

stricted to not too large a fraction of the actual economic
loss to the individual, with nothing for discomfort, pain, or
inconvenience. In the whole field of personal, physical con-
tingencies, however, there is nothing that is strictly of the
nature of a "business risk," unless it be the now happily
obsolescent phenomenon of commercial employers' liability
insurance.

The typical application of insurance to business hazards
is in the protection against loss by fire, and the theory of
fire insurance rates forms an interesting contrast with the
actuarial mathematics of life insurance. The latter, as we
have observed, is a fairly close approximation to objective
probability; it is in fact so close to this ideal that life in-
surance problems are worked by the formulae derived from
the binomial law, in the same way as problems in mechan-
ical probability. Fire insurance rating is a very different
proposition; only in rather recent years has any approach
been made to the formation of fairly homogeneous classes
of risks and the measurement of real probability in a par-
ticular case. At best there is a large field for the exercise
of "judgment" even after literally thousands of classes of
risks have been more or less accurately defined.1 More im-
portant is the fact that, in consequence, insurance does not
take care of the whole risk against loss by fire. On account
of the "moral hazard" and practical difficulties, it is nec-
essary to restrict the amount of insurance to the "direct
loss or damage" or even to a part of that, while of course
there are usually large indirect losses due to the interrup-
tion of business and dislocation of business plans which are
entirely unprovided for. Thus there is a large margin of
uncertainty both to insurer and insured, in consequence
of the impossibility of objectively homogeneous groupings
and accurate measurement of the chance of loss. Corre-
sponding to this margin of uncertainty in the calculations
there is a chance for a profit or loss to either party, in
1 Cf. Huebner, Property Insurance, chaps, xvr, xvn.

250 RISK, UNCERTAINTY, AND PROFIT

connection with the fire hazard. The probabilities in the
case of fire are, of course, complicated by the fact that risks
are not entirely independent. A fire once started is likely
to spread and there is a tendency for losses to occur in
groups. In so far, however, as fire losses in the aggregate
are calculable in advance, they are or may be converted
into fixed costs by every individual exposed to the possi-
bility of loss, and in so far no profit, positive or negative,
will be realized by any one on account of this uncertainty
in his business.

The principle of insurance has also been utilized to pro-
vide against a great variety of business hazards other than
fire — the loss of ships and cargoes at sea, destruction of
crops by storms, theft and burglary, embezzlement by
employees (indirectly through bonding, the employee do-
ing the insuring), payment of damages to injured em-
ployees, excessive losses through credit extension, etc.
The unusual forms of policies issued by some of the Lloyd's
underwriters have attained a certain amount of publicity
as popular curiosities. These various types of contingencies
offer widely divergent possibilities for "scientific" rate-
making, from something like the statistical certainty of
life insurance at one extreme to almost pure guesswork at
the other, as when Lloyd's insures the business inter-
ests concerned that a royal coronation will take place as
scheduled, or guarantees the weather in some place having
no records to base calculations upon. Even in these ex-
treme cases, however, there is a certain vague grouping of
cases on the basis of intuition or judgment; only in this
way can we imagine any estimate of a probability being
arrived at.

It is therefore seen that the insurance principle can be
\ applied even in the almost complete absence of scientific
data for the computation of rates. If the estimates are
conservative and competent, it turns out that the pre-
miums received for insuring the most unique contingen-

METHODS FOR MEETING UNCERTAINTY 251

cies cover the losses; that there is an offsetting of losses and
gains from one venture to another, even when there is no
discoverable kinship among the ventures themselves. The
point seems to be, as already noticed, that the mere fact
that judgment is being exercised in regard to the situations
forms a fairly valid basis for assimilating them into groups.
Various instances of the exercise of (fairly competent)
judgment even in regard to the most heterogeneous prob-
lems, show a tendency to approach a constancy and pre-
dictability of result when aggregated into groups.

The fact which limits the application of the insurance
principle to business risks generally is not therefore their
inherent uniqueness alone, and the subject calls for further
examination. This task will be undertaken in detail in the
next chapter, which deals with entrepreneurship. At this
point we may anticipate to the extent of making two
observations: first, the typical uninsurable (because un-
measurable and this because unclassifiable) business risk
relates to the exercise of judgment in the making of de-
cisions by the business man; second, although such es-
timates do tend to fall into groups within which fluctuations
cancel out and hence to approach constancy and measur-
ability, this happens only after the fact and, especially in
view of the brevity of a man's active life, can only to a
limited extent be made the basis of prediction. Further-
more, the classification or grouping can only to a limited
extent be carried out by any agency outside the person
himself who makes the decisions, because of the peculiarly
obstinate connection of a moral hazard with this sort of
risks. The decisive factors in the case are so largely on the
inside of the person making the decisions that the "in-
stances" are not amenable to objective description and
external control.

Manifestly these difficulties, insuperable when the
" consolidation' ' is to be carried out by an external agency
such as an insurance company or association, fall away in

252 RISK, UNCERTAINTY, AND PROFIT

so far as consolidation can be effected within the scale of
operations of a single individual; and the same will be true
of an organization if responsibility can be adequately
centralized and unity of interest secured. The possibility of
thus reducing uncertainty by transforming it into a meas-
urable risk through grouping constitutes a strong incentive
to extend the scale of operations of a business establishment.
This fact must constitute one of the important causes of the
)henomenal growth in the average size of industrial es-
tablishments which is a familiar characteristic of modern
economic life. In so far as a single business man, by bor-
rowing capital or otherwise, can extend the scope of his
exercise of judgment over a greater number of decisions or
estimates, there is a greater probability that bad guesses
will be offset by good ones and that a degree of constancy
and dependability in the total results will be achieved. In
so far uncertainty is eliminated and the desideratum of
rational activity realized.

Not less important is the incentive to substitute more
effective and intimate forms of association for insurance, so
as to eliminate or reduce the moral hazard and make possi-
ble the application of the insurance principle of consolida-
tion to groups of ventures too broad in scope to be " swung "
by a single enterpriser. Since it is capital which is especially
at risk in operations based on opinions and estimates, the
form of organization centers around the provisions relating
to capital. It is undoubtedly true that the reduction of
risk to borrowed capital is the principal desideratum lead-
ing to the displacement of individual enterprise by the
partnership and the same fact with reference to both
owned and borrowed capital explains the substitution of
corporate organization for the partnership. The superior-
ity of the higher form of organization over the lower from
this point of view consists both in the extension of the
scope of operations to include a larger number of indi-
vidual decisions, ventures, or "instances," and in the

METHODS FOR MEETING UNCERTAINTY 253

more effective unification of interest which reduces the
moral hazard connected with the assumption by one per-
son of the consequences of another person's decisions.

The close connection between these two considerations is
manifest. It is the special "risk" to which large amounts
of capital loaned to a single enterpriser are subject which
limits the scope of operations of this form of business unit
by making it impossible to secure the necessary property
resources. On the other hand, it is the inefficiency of or-
ganization, the failure to secure effective unity of interest,
and the consequent large risk due to moral hazard when a
partnership grows to considerable size, which in turn limit
its extension to still larger magnitudes and bring about the
substitution of the corporate form of organization. With
the growth of large fortunes it becomes possible for a
limited number of persons to carry on enterprises of greater
and greater magnitude, and to-day we find many very
large businesses organized as partnerships. Modifications
of partnership law giving this form more of the flexibility
of the corporation with reference to the distribution of
rights of control, of participation in income, and of title to
assets in case of dissolution have also contributed to this
change.

With reference to the first of our two points above men-
tioned, the extension of the scope of operations, the cor-
poration may be said to have solved the organization prob-
lem. There appears to be hardly any limit to the magnitude
of enterprise which it is possible to organize in this form, so
far as mere ability to get the public to buy the securities is
concerned. On the second score, however, the effective
unification of interests, though the corporation has ac-
complished much in comparison with other forms of organi-
zation, there is still much to be desired. Doubtless the
task is impossible, in any absolute sense; nothing but a
revolutionary transformation in human nature itself can
apparently solve this problem finally, and such a change

254 RISK, UNCERTAINTY, AND PROFIT

would, of course, obliterate all moral hazards at once, with-
out organization. In the meanwhile the internal problems
of the corporation, the protection of its various types of
members and adherents against each other's predatory
propensities, are quite as vital as the external problem of
safeguarding the public interests against exploitation by
the corporation as a unit.1

Another important aspect of the relations of corporate
organization to risk involves what we have called "diffu-
sion" as well as consolidation. The minute divisibility
of ownership and ease of transfer of shares enables an
investor to distribute his holdings over a large number of
enterprises in addition to increasing the size of a single
enterprise. The effect of this distribution on risk is evi-
dently twofold. In the first place, there is to the investor a
further offsetting through consolidation; the losses and
gains in different corporations in which he owns stock must
tend to cancel out in large measure and provide a higher
degree of regularity and predictability in his total returns.
And again, the chance of loss of a small fraction of his
total resources is of less moment even proportionally than
a chance of losing a larger part.

There are other aspects of the question which must be
passed over in this summary view. Doubtless a signifi-
cant fact is the greater publicity attendant upon the or-
ganization, resources, and operations of a corporation,
due to its being a creature of the State and to legal safe-
guards. It must be emphasized that this type of organiza-
tion actually reduces risks, and does not merely transfer
them from one party to another, as might seem at first
glance to be the case. Superficial discussions of limited

1 Haney (Business Organization and Combination, chap, xxm) uses the
terms "The Corporation Problem" and "The Trust Problem" to desig-
nate what I have called the "internal" and "external" problems respec-
tively. He properly emphasizes the importance of the former in view of
the tendency of the evils of monopoly, etc., to overshadow it in the pop-
ular mind and in much of the literature of the subject.

METHODS FOR MEETING UNCERTAINTY 255

liability tend to give the impression, or at least leave the
way open to the conclusion, that this is the main advantage
over the partnership. But it must be evident that the
mere fact of limited liability only serves to transfer losses
in excess of invested resources from the owners of the con-
cern to its creditors; and if this were the only effect of in-
corporation, the loss in credit standing should offset the
gain in security to the owners. Theyital facts are the two-
fold consolidation of risks, together with greater publicity,
and diffusion in a minor role, not really separable from the
fact of consolidation.

It is particularly noteworthy that large-scale organiza-
tion has shown a tendency to grow in fields where division
of labor is absent and consolidation or grouping of uncer-
tainties is the principal incentive. Occupations in which
the work is of an occasional and intermittent character
tend to run into partnerships and even corporations where
there is no capital investment, or relatively little, and the
members work independently at identical tasks. Examples
are the syndicating of detectives, stenographers, and even
lawyers and doctors.

The second of the two main principles for dealing with
uncertainty is Specialization. The most important in-
strument in modern economic society for the specializa-
tion of uncertainty, after the institution of free enterprise
itself, is Speculation. This phenomenon also combines
different principles, and the n?^ speriahVati™1 ^ Uftte*
tainty-bearinff in the ha^g dt perftp"* moat, willing to as-
sume the function is probably among the lesser rather than
the greater sources of gain. It seems best to postpone for
the present a detailecTtneoretical analysis of the factors
of specialization of uncertainty-bearing in the light of the
many ways in which individuals differ in their relations to
uncertainty; this discussion will be taken up in the next
chapter, in connection with the treatment of enterprise and
entrepreneurship. At this point we wish merely to em-

D

\

256 RISK, UNCERTAINTY, AND PROFIT

phasize the association in several ways between specializa-
tion and actual reduction of uncertainty.

Most fundamental among these effects in reducing un-
certainty is its conversion into a measured risk or elimina-
tion by grouping which is implied in the very fact of special-
ization. The typical illustration to show the advantage of
organized speculation to business at large is the use of the
hedging contract. By this simple device the industrial
producer is enabled to eliminate the chance of loss or gain
due to changes in the value of materials used in his opera-
tions during the interval between the time he purchases
them as raw materials and the time he disposes of them as
finished product, "shifting" this risk to the professional
speculator. It is manifest at once that even aside from
any superior judgment or foresight or better informa-
tion possessed by such a professional speculator, he gains
an enormous advantage from the sheer magnitude or
breadth of the scope of his operations. Where a single
flour miller or cotton spinner would be in the market
once, the speculator enters it hundreds or thousands of
times, and his errors in judgment must show a corre-
spondingly stronger tendency to cancel out and leave him
a constant and predictable return on his operations.

The same reasoning holds good for any method of
specializing uncertainty-bearing. Specialization implies
concentration, and concentration involves consolidation;
and no matter how heterogeneous the "cases" the gains
and losses neutralize each other in the aggregate to an ex-
tent increasing as the number of cases thrown together is
larger. Specialization itself is primarily an application of
the insurance principle; but, like large-scale enterprise, it
grows up to meet uncertainty situations where, on account
of the impossibility of objective definition and external con-
trol of the individual ventures or uncertainties, a "moral
hazard" prevents fflfifljaace ^y ap pvternal agency or a
loose association of venturers for this single purpose.^

METHODS FOR MEETING UNCERTAINTY 257

Besides organized speculation as carried on in connection
with produce and security exchanges, the principle of
specialization is exemplified m the tendency for the highly
uncertain or speculative aspects of industry to become
separated from the stable and predictable aspects and be
taken over by different establishments. This is, of course,
what has really taken place in the ordinary form of spec-
ulation already noticed, namely, the separation of the
marketing function from the technological side of produc-
tion, the former being much more speculative than the
latter. A separation perhaps equally significant in modern
economic life is that which so commonly takes place be-
tween the establishment or founding of new enterprises and
their operation after they are set going. To be sure, by no
means all the business of promotion comes under this head,
but still the tendency is manifest. A part of the investors
in promoted concerns look to the future earnings from
regular operations for their return, but a large part expect
to sell out at a profit after the business is established, and
to devote their capital to some new venture of the same
sort. A considerable and increasing number of individual
promoters and corporations give their exclusive attention
to the launching of new enterprises, withdrawing entirely
as soon as the prospects of the business become fairly deter-
minate. The gain from arrangements of this sort arises
largely from the consolidation of uncertainties, their con-
version by grouping into measured risks which are for the
group of cases not uncertainties at all. Such a promoter
takes it as a matter of course that a certain proportion of
his ventures will be failures and involve heavy losses,
while a larger proportion will be relatively unprofitable,
and counts on making his gains from the occasional con-
spicuous successes. That is — to face frankly that para-
doxical element which is really involved in such calcula-
tions — he does not "expect" to have his "expectations"
verified by the results in every case; the expectations on

i

258 RISK, UNCERTAINTY, AND PROFIT

which he really counts are based on an average, on an "es-
timate" of the long-run value of his "estimates." The
specialization in the speculative phase of the business en-
ables a single man or firm to deal with a larger number of
ventures, and is clearly a mode of applying the same prin-
ciple which underlies ordinary insurance.

Other illustrations of the same phenomenon will come
to the reader's mind. Industries which utilize land whose
value is largely speculative are more likely to rent rather
than own their sites where the nature of the utilization
makes such a procedure practicable. Even expensive
machines and articles of equipment of other sorts, owner-
ship of which involves heavy risks to a small concern, may
be rented instead of bought outright. The owner of leased
land or equipment is presumably a specialist in that sort of
business and his risks are reduced by the grouping of a
larger number of ventures.

Other advantages of specialization of speculative func-
tions in addition to the reduction" of uncertainty through
consolidation are manifest, and no intention of belittling or
concealing them is implied in the separation of the latter
aspect of the case in the foregoing discussion. It is apparent
in particular that the specialist in any line of risk-taking
naturally knows more about the problem with which he
deals than would a venturer who dealt with them only
occasionally. Hence, since most of these uncertainties
relate chiefly to the exercise of judgment, the uncertainty
itself is reduced by this fact also. There is in this respect a
fundamental difference between the speculator or promoter
and the insurer, which must be kept clearly in view. The
insurer knows more about the risk in a particular case —
say of a building burning — but the real risk is no less be-
cause he assumes it in that particular case. His risk is less
only because he assumes a large number. But the trans-
fer of the" risk" of an error in judgment is a very differ-
ent matter. The "insurer" (entrepreneur, speculator, or

METHODS FOR MEETING UNCERTAINTY 259

promoter) now substitutes his own judgment for the judg-
ment of the man who is getting rid of the uncertainty
through transferring it to the specialist. In so far as his
knowledge and judgment are better, which they almost
certainly will be from the mere fact that he is a specialist,
the individual risk is less likely to become a loss, in addition
to the gain from grouping. There is better management,
greater economy in the use of economic resources, as well
as a mere transformation of uncertainty into certainty.

The problem of meeting uncertainty thus passes in-
evitably into the general problem of management, of
economic control. The fundamental uncertainties of eco-
nomic life are the errors in predicting the future and in
making present adjustments to ht future conditionsTln so
far as ignorance of the future is due to practical indeter-
minateness in nature itself we can only appeal to the law of
large numbers to distribute the losses, and make them
calculable, not to reduce them in amount, and this is only
possible in so far as iEe contingencies to be dealt with
admit of assimilation into homogeneous groups; i.e., in so
far as they repeat themselves. When our ignorance of the
future is only partial ignorance, incomplete knowledge and
imperfect inference, it becomes impossible to classify in-
stances objectively, and any changes brought about in the
conditions surrounding the formation of an opinion are
nearly sure to affect the intrinsic value of the opinion it-
self. This is true even of the method of grouping by extend-
ing the scale of operations of a single entrepreneur, for the
quality of his estimates will not be independent of the
number he has to make and the mass of the data involved.
But it is especially true of grouping by specialization, as
we have seen. The inseparability of the uncertainty prob-
lem and the managerial problem will be especially impor-
tant in the discussion (in the next chapter) of entrepreneur-
ship, which is the characteristic phenomenon of modern
economic organization and is essentially a device for

260 RISK, UNCERTAINTY, AND PROFIT

specializing uncertainty-bearing or the improvement of
economic control. The relation between management,
which consists of making decisions, and taking the conse-
quences of decisions, which is the most fundamental form
of risk-taking in industry, will be found to be a very intri-
cate as well as intimate one. When the sequence of control
is followed through to the end, it will be found that from
the standpoint of the ultimately responsible manager, the
two functions are always inseparable.

We are thus brought naturally around to a discussion of
the most thoroughgoing methods of dealing with uncer-
tainty; i.e., by securing better knowledge of and control
over the future. As previously observed, however, these
methods represent merely the objective of all rational
conduct from the outset, and they call for discussion in
such a work as the present only in so far as they affect the
general outline of the social economic structure. Thus it is
fundamental to the entrepreneur system that it tends to
promote better management in addition to consolidating
risks and throwing them into the hands of those most dis-
posed to assume them. The only further comment here
called for is to point out the existence of highly specialized
industrial structures performing the functions of furnish-
ing knowledge and guidance.

One of the principal gains through organized speculation
is the provision of information on business conditions,
making possible more intelligent forecasting of market
changes. Not merely do the market associations or ex-
changes and their members engage in this work on their
own account. Its importance to society at large is so well
recognized that vast sums of public money are annually
expended in securing and disseminating information as to
the output of various industries, crop conditions, and the
like. Great investments of capital and elaborate organiza-
tions are also devoted to the work as a private enterprise,
on a profit-seeking basis, and the importance of trade

METHODS FOR MEETING UNCERTAINTY 261

journals and statistical bureaus and services tends to in-
crease, as does that of the activities of the Government in
this field. The collection, digestion, and dissemination in
usable form of economic information is one of the stagger-
ing problems connected with our modern large-scale social
organization. It goes without saying that no very satis-
factory solution of this problem has been achieved, and it
is safe to predict that none will be found in the near future.
But all these specialized agencies for the supply of informa-
tion help to bridge the wide gap between what the individ-
ual business manager knows or can find out by the use of
his own resources and what he would have to know to con-
duct his business in a perfectly intelligent fashion. Their
output increases the value of the intuitive "judgments"
on the basis of which his decisions are finally made after
all, and greatly extends the scope of the environment in
relation to which he can more or less intelligently react.
The foregoing relates chiefly to the production side of
the problem of economic information. In the field of in-
formation for consumers, we have the still more staggering
development of advertising. This complex phenomenon
cannot be discussed in detail here, beyond pointing out its
connection with the fact of ignorance and the necessity of
knowledge to guide conduct. Only a part of advertising is
in any proper sense of the term informative. A larger part
is devoted to persuasion, which is a different thing from
conviction, and perhaps the stimulation or creation of new
wants is a function distinguishable from either. In addi-
tion to advertising, most of the social outlay for education
is connected with informing the population about the
means of satisfying wants, the education of taste. The
outstanding fact is that the ubiquitous presence of uncer-
tainty permeating every relation of life has brought it
about that information is one of the principal commodities
that the economic organization is engaged in supplying.
From this point of view it is not material whether the "in-

262 RISK, UNCERTAINTY, AND PROFIT

formation " is false or true, or whether it is merely hypnotic
suggestion. As in all other spheres of competitive eco-
nomic activity, the consumer is the final judge. If people
are willing to pay for "Sunny Jim" poetry and "It Floats"
when they buy cereals and soap, then these wares are
economic goods. If a certain name on a fountain pen or
safety razor enables it to sell at a fifty per cent higher price
than the same article would otherwise fetch, then the name
represents one third of the economic utility in the article,
and is economically no different from its color or design or
the quality of the point or cutting edge, or any other qual-
ity which makes it useful or appealing. The morally
fastidious (and naive) may protest that there is a dis-
tinction between "real" and "nominal" utilities; but
they will find it very dangerous to their optimism to at-
tempt to follow the distinction very far. On scrutiny it
will be found that most of the things we spend our incomes
for and agonize over, and notably practically all the higher
"spiritual" values, gravitate swiftly into the second class.
Somewhat different from the production and sale of in-
formation is the dealing in actual instructions for the
guidance of conduct directly. Modern society is character-
ized by the rapid growth of this line of industry also. There
have always been a few professions whose activities con-
sisted essentially of the sale of guidance, notably medicine
and the law, and more or less the preaching and teach-
ing professions. Recent years, however, have witnessed a
veritable swarming of experts and consultants in nearly
every department of industrial life. The difference from
dealing in information is that these people do not stop at
diagnosis; in addition they prescribe. They are equally con-
spicuous in the fields of business organization, accounting,
the treatment of labor, the lay-out of plants, and the proc-
essing of materials; they are the scientific managers of
the managers of business; and though they by no means
serve business or its managers for naught, and in spite of

METHODS FOR MEETING UNCERTAINTY 263

a large amount of quackery, they probably pay their way
and more on the whole in increasing the efficiency of pro-
duction. Certainly they do a useful work in forcing the
intelligent, critical consideration of business problems in-
stead of a blind following of tradition or the use of guess-
work methods.1

The last of the alternatives named for meeting uncer-
tainty relates to the problem of a tendency to prefer rela-
tively predictable lines of activity to more speculative
operations. It is common to assume 2 that society pays for
the assumption of risk in the form of higher prices for
commodities whose production involves uncertainty and a
deficient supply of these in comparison with goods of an
opposite character. This subject will come up again in
connection with the closely related question of a tendency
of profit to zero, and it seems best to postpone discussion
of it for the present.3 We shall find reasons for being very
skeptical as to the reality of any such abhorrence of uncer-
tainty as to decrease productivity in any line below the
level that an equivalent fixed cost would bring about.

1 On the production and sale of "guidance" see J. M. Clark, Journal of
Political Economy, vol. 26, Nos. 1 and 2.

2 Cf . Willett, Economic Theory of Risk and Insurance, chap. ni.
8 Cf. chapter xn.

CHAPTER IX

ENTERPRISE AND PROFIT

We must now consider more concretely and in detail the
effects of uncertainty on the general form of organization
of economic life. The best method seems to be to take up a
society in which uncertainty is absent, imagine uncertainty
introduced, and try to ascertain what changes will take
place in its structure. We therefore return to the argu-
ment of chapter iv in which the mechanics of exchange and
competition were studied with uncertainty (and progress)
absent. The same method will be followed, beginning with
the problem in as simple a form as possible and studying
the effects of different factors separately, analyzing the
complexity of real life "synthetically" by building it up
in imagination out of its elements.

To secure the minimum degree of uncertainty and at the
same time keep the discussion as close to reality as possible,
it is necessary to exercise some care in defining the as-
sumptions with which we are working. The most obvious
initial requirement is to eliminate the factors of social
progress from consideration and consider first a static
society. But this postulate calls for discrimination in
handling. In an absolutely unchanging social life there
would, as we have repeatedly observed, be no uncertainty
whatever, and our analysis in chapter iv proceeded on this
assumption. Such conditions are thoroughly incompatible
with the most fundamental facts of the world in which we
live, but their study serves the analytic purpose of isolating
the effects of uncertainty. For different kinds of change
and different degrees of change are real facts, and it will
therefore involve less abstraction to study hypothetical
conditions under which change is restricted to the most

ENTERPRISE AND PROFIT 265

fundamental and ineradicable kind and amount. Societies
may be and have been nearly unprogressive, and the ob-
vious simplification to make is therefore the elimination of
progressive change.

After abstracting all the elements of general progressive
change enumerated in chapter v a large amount of uncer-
tainty will be left in human life, due to changes of the
character of fluctuations which cannot be thought away
without violence to material possibility. Strictly accurate
formulation of conditions involving a realistic minimum of
uncertainty cannot be made, but are not necessary; it is
sufficient to indicate in a rough way the situation we pro-
pose to discuss. Several factors affect the amount of
uncertainty to be recognized, and have to be taken into ac-
count. The first to be noted is the time length of the pro-
duction process, for the longer it is, the more uncertainty
will naturally be involved. Of very great importance also
is the general level of economic life. The lower wants of
man, those having in the greatest degree the nature of
necessities, are the most stable and predictable. The higher
up the scale we go, the larger the proportion of the aes-
thetic element and of social suggestion there is involved in
motivation, the greater becomes the uncertainty connected
with foreseeing wants and satisfying them. On the pro-
duction side, on the other hand, most manufacturing proc-
esses are more controllable and calculable as to outcome
than are agricultural operations under usual conditions.
We must notice also the development of science and of
the technique of social organization. Greater ability to
forecast the future and greater power to control the course
of events manifestly reduce uncertainty, and of still greater
importance is the status of the various devices noted in the
last chapter for reducing uncertainty by consolidation.

All these perplexities about which some more or less
definite assumption must be made can be disposed of by
being as realistic as possible. Let us say simply that we are

266 RISK, UNCERTAINTY, AND PROFIT

talking about the United States in the early years of the
twentieth century, but with abstraction made of progres-
sive changes. That is, we assume a population static in
numbers and composition and without the mania of change
and advance which characterizes modern life. Inventions
and improvements in technology and organization are to
be eliminated, leaving the general situation as we know it
to-day to remain stationary. Similarly in regard to the
saving of new capital, development of new natural re-
sources, redistribution of population over the soil or re-
distribution of ownership of goods, education, etc., among
the people. But we shall not assume that men are omnis-
cient and immortal or perfectly rational and free from
caprice as individuals. We shall neglect natural catastro-
phes, epidemics, wars, etc., but take for granted the
"usual" uncertainties of the weather and the like, along
with the " normal' * vicissitudes of mortal life,1 and un-
certainties of human choice.

Returning now to the kind of social organization de-
scribed in chapter iv,2 let us inquire as to what will be the

1 The situation which we here endeavor to delineate is what Dr. A. H.
Willett appears to have in mind under the designation of the "approxi-
mate static state." See The Economic Theory of Risk and Insurance,
pp. 15, 16.

In this connection, again, we cannot be rigorously logical and definite
without getting off into mere subtleties. We do not know whether there
is ultimately real uncertainty and caprice in either physical nature or
human nature. It may be that all changes are self-compensating some
time, and that if progress were eliminated we should finally achieve pro-
phetic powers in regard to phenomena in the aggregate (through applica-
tion of the principle of consolidation) if not in individual instances. But
in view of the tragically limited success of science in predicting the weather,
for example, it is clear that there is no strain on credulity in assuming a
large amount of real uncertainty. We must not forget that the periodicity
of change or the interval required for canceling out of fluctuations is in
practice relative to the length of human life. If such a cancellation would
occur ultimately (as some writers, notably Nietzsche, have ventured to
suppose) the period is so long in relation to human life that no advantage
of it could be taken.

2 Chapter v, the reader will recall, dealt with the effects of progress
with uncertainty absent. We here retrace our steps somewhat in order to

ENTERPRISE AND PROFIT 267

effects of introducing the minimum degree of uncertainty
into the situation. The essential features of the hypotheti-
cal society as thus far constructed need to be kept clearly
in mind. Acting as individuals under absolute freedom
but without collusion, men are supposed to have organized
economic life with primary and secondary division of labor,
the use of capital, etc., developed to the point familiar in
present-day America. The principal fact which calls for
exercise of the imagination is the internal organization of
the productive groups or establishments. With uncertainty
entirely absent, every individual being in possession of
perfect knowledge of the situation, there would be no
occasion for anything of the nature of responsible manage-
ment or control of productive activity. Even marketing
operations in any realistic sense would not be found. The
flow of raw materials and productive services through
productive processes to the consumer would be entirely
automatic.

We do not need to strain the imagination by supposing
supernatural powers of prescience on the part of men. We
can think of the adjustment as the result of a long process
of experimentation, worked out by trial-and-error methods
alone. If the conditions of life and the people themselves
were entirely unchanging a definite organization would
result, perfect in the sense that no one would be under an
incentive to change. So in the organization of the pro-
ductive groups, it is not necessary to imagine every worker
doing exactly the right thing at the right time in a sort of
" preestablished harmony" with the work of others. There
might be managers, superintendents, etc., for the purpose
of coordinating the activities of individuals. But under

consider uncertainty with progress absent, thus completing the design of
studying the two factors separately. After completing the present task
we shall (in chapter xi) study them in combination. A confusion between
the effects of uncertainty and those of progress, which are largely, though
never quite completely, separable facts, has been seen to underlie the
reasoning of the "dynamic" theory of profit.

268 RISK, UNCERTAINTY, AND PROFIT

conditions of perfect knowledge and certainty such func-
tionaries would be laborers merely, performing a purely
routine function, without responsibility of any sort, on a
level with men engaged in mechanical operations.

With the introduction of uncertainty — the fact of ig-
norance and necessity of acting upon opinion rather than
knowledge — into this Eden-like situation, its character
is completely changed. With uncertainty absent, man's
energies are devoted altogether to doing things; it is
doubtful whether intelligence itself would exist in such a
situation; in a world so built that perfect knowledge was
theoretically possible, it seems likely that all organic re-
adjustments would become mechanical, all organisms
automata. With uncertainty present, doing things, the
actual execution of activity, becomes in a real sense a
secondary part of life; the primary problem or function
is deciding what to do and how to do it. The two most
important characteristics of social organization brought
about by the fact of uncertainty have already been noticed.
In the first place, goods are produced for a market, on the
basis of an entirely impersonal prediction of wants, not for
the satisfaction of the wants of the producers themselves.
The producer takes the responsibility of forecasting the
consumers' wants. In the second place, the work of fore-
casting and at the same time a large part of the technologi-
cal direction and control of production are still further
concentrated upon a very narrow class of the producers,
and we meet with a new economic functionary, the entre-
preneur.

When uncertainty is present and the task of deciding
what to do and how to do it takes the ascendancy over that
of execution, the internal organization of the productive
groups is no longer a matter of indifference or a mechanical
detail.1 Centralization of this deciding and controlling
function is imperative, a process of "cephalization," such
1 See above, chapter iv, p. 106, note.

ENTERPRISE AND PROFIT 269

as has taken place in the evolution of organic life, is in-
evitable, and for the same reasons as in the case of biologi-
cal evolution. Let us consider this process and the cir-
cumstances which condition it. The order of attack on the
problem is suggested by the classification worked out in
chapter vn of the elements in uncertainty in regard to
which men may in large measure differ independently.

In the first place, occupations differ in respect to the
kind and amount of knowledge and judgment required for
their successful direction as well as in the kind of abilities
and tastes adapted to the routine operations. Productive
groups or establishments now compete for managerial
capacity as well as skill, and a considerable rearrangement
of personnel is the natural result. The final adjustment will
place each producer in the place where his particular com-
bination of the two kinds of attributes seems to be most
effective.

But a more important change is the tendency of the
groups themselves to specialize, finding the individuals
with the greatest managerial capacity of the requisite kinds
and placing them in charge of the work of the group, sub-
mitting the activities of the other members to their direc-
tion and control. It need hardly be mentioned explicitly
that the organization of industry depends on the funda-
mental fact that the intelligence of one person can be made
to direct in a general way the routine manual and mental
operations of others. It will also be taken into account
that men differ in their powers of effective control over
other men as well as in intellectual capacity to decide what
should be done. In addition, there must come into play the
diversity among men in degree of confidence in their judg-
ment and powers and in disposition to act on their opinions,
to "venture." This fact is responsible for the most funda-
mental change of all in the form of organization, the sys-
tem under which the confident and venturesome "assume
the risk" or "insure" the doubtful and timid by guaran-

wr

270 RISK, UNCERTAINTY, AND PROFIT

teeing to the latter a specified income in return for an
assignment of the actual results.

Uncertainty thus exerts a fourfold tendency to select
men and specialize functions: (1) an adaptation of men to
occupations on the basis of kind of knowledge and judg-
ment; (2) a similar selection on the basis of degree of fore-
sight, for some lines of activity call for this endowment in
a very different degree from others; (3) a specialization
within productive groups, the individuals with superior
managerial ability (foresight and capacity of ruling others)
being placed in control of the group and the others working
under their direction; and (4) those with confidence in their
judgment and disposition to "back it up" in action special-
ize in risk-taking. The close relations obtaining among these
tendencies will be manifest. We have not separated con-
fidence and vent tiresomeness at all, since they act along
parallel lines and are little more than phases of the same
faculty — just as courage and the tendency to minimize
danger are proverbially commingled in all fields, though
they are separable in thought. In addition the tendencies
numbered (3) and (4) operate together. With human
nature as we know it it would be impracticable or very
unusual for one man to guarantee to another a definite
result of the latter 's actions without being given power to
direct his work. And on the other hand the second party
would not place himself under the direction of the first
without such a guaranty. The result is a "double con-
tract" of the type famous in the history of the evasion of
usury laws. It seems evident also that the system would
not work at all if good judgment were not in fact generally
associated with confidence in one's judgment on the part
both of himself and others. That is, men's judgment of
their own judgment and of others' judgment as to both
kind and grade must in the large be much more right than

ong.1
1 The statement implies that a man's judgment has in an effective

ENTERPRISE AND PROFIT 271

The result of this manifold specialization of function is
enterprise and the wage system of industry. Its existence in
the world is a direct result of the fact of uncertainty; our
task in the remainder of this study is to examine this
phenomenon in detail in its various phases and divers re-
lations with the economic activities of man and the struc-
ture of society. It is not necessary or inevitable, not the
only conceivable form of organization, but under certain
conditions has certain advantages, and is capable of devel-
opment in different degrees. The essence of enterprise is
the specialization of the function of responsible direction of
economic life, the neglected feature of which is the insep-
arability of these two elements, responsibility and control.
Under the enterprise system, a special social class, the
business men, direct economic activity; they are in the
strict sense the producers, while the great mass of the
population merely furnish them with productive services,
placing their persons and their property at the disposal
of this class; the entrepreneurs also guarantee to those who
furnish productive services a fixed remuneration. Ac-
curately to define these functions and trace them through
the social structure will be a long task, for the specializa-
tion is never complete; but at the end of it we shall find
that in a free society the two are essentially inseparable.
Any degree of effective exercise of judgment, or making
decisions, is in a free society coupled with a corresponding
degree of uncertainty-bearing, of taking the responsibility
for those decisions.

With the specialization of function goes also a differen-
tiation of reward. The produce of society is similarly di-
vided into two kinds of income, and two only, contractual
income, which is essentially rent, as economic theory has
described incomes, and residual income or profit. But the
differentiation of contractual income, like that of profit, is

sense a true or objective value. This assumption will be justified by the
further course of the argument.

272 RISK, UNCERTAINTY, AND PROFIT

never complete; neither variety is ever met with in a pure
form, and every real income contains elements of both rent
and profit. And with uncertainty present (the condition
of the differentiation itself) it is not possible even to deter-
mine just how much of any income is of one kind and how
much of the other; but a partial separation can be made,
and the causal distinction between the two kinds is sharp
and clear.

We may imagine a society in which uncertainty is absent
transformed on the introduction of uncertainty into an
enterprise organization. The readjustments will be carried
out by the same trial-and-error methods under the same
motives, the effort of each individual to better himself,
which we have already described. The ideal or limiting
condition constantly in view would still be the equaliza-
tion of all available alternatives of conduct by each in-
dividual through the distribution of efforts and of expendi-
ture of the proceeds of effort among the lines open. Under
the new system labor and property services actually come
into the market, become commodities and are bought and
sold. They are thus brought into the comparative value
scale and reduced to homogeneity in price terms with the
fund of values made up of the direct means of want satis-
faction.

Another feature of the new adjustment is that a condi-
tion of perfect equilibrium is no longer possible. Since
productive arrangements are made on the basis of anticipa-
tions and the results actually achieved do not coincide with
these as a usual thing, the oscillations will not settle down
to zero. For all changes made by individuals relate to the
established value scale and this price-system will be subject
to fluctuations due to unforeseen causes; consequently in-
dividual changes in arrangements will continue indefinitely
to take place. The experiments by which alone the value of
human judgment is determined involve a proportion of
failures or errors, are never complete, and in view of hu-

ENTERPRISE AND PROFIT 273

man mortality have constantly to be recommenced at the
beginning.

We turn now to consider in broad outline the two types
of individual income implied in the enterprise system of or-
ganization, contractual income and profit.1 We shall try as
hitherto to explain events by placing ourselves in the actual
positions of the men acting or making decisions and inter-
preting their acts in terms of ordinary human motives.
The setting of the problem is a free competitive situation
in which all men and material agents are competing for
employment, including all men at the time engaged as en-
trepreneurs, while all entrepreneurs are competing for pro-
ductive services and at the same time all men are competing
for positions as entrepreneurs. The essential fact in under-
standing the reaction to this situation is that men are act-
ing, competing, on the basis of what they think of the
future. To simplify the picture and make it concrete we
shall as before assume that there exists some sort of group-
ing of men and things under the control of other men as
entrepreneurs (a random grouping will do as a start) and
that entrepreneurs and others are in competition as above
stated.

The production-distribution system is worked out
through offers and counter-offers, made on the basis of
anticipations, of two kinds. The laborer asks what he thinks
the entrepreneur will be able to pay, and in any case will
not accept less than he can get from some other entrepre-
neur, or by turning entrepreneur himself. In the same way
the entrepreneur offers to any laborer what he thinks he
must in order to secure his services, and in any case not

1 As already observed, the theoretical features of contractual income
are those associated with rent in the conventional distributive analysis.
From the point of view of our present assumptions, all productive goods
being fixed in amount and in their distribution among the members of
society, such incomes might naturally be called wages. As we have in-
sisted that there is no significant causal or ethical difference in the sources
of income it does not particularly matter what they are called.

274 RISK, UNCERTAINTY, AND PROFIT

more than he thinks the laborer will actually be worth to
him, keeping in mind what he can get by turning laborer
himself. The whole calculation is in the future; past and
even present conditions operate only as grounds of pre-
diction as to what may be anticipated.1

Since in a free market there can be but one price on any
commodity, a general wage rate must result from this com-
petitive bidding. The rate established may be described
as the socially or competitively anticipated value of the
laborer's product, using the term "product " in the sense of
specific contribution, as already explained. It is not the
opinion of the future held by either party to an employment
bargain which determines the rate; these opinions merely
set maximum and minimum limits outside of which the
agreement cannot take place. The mechanism of price ad-
justment is the same as in any other market. There is al-
ways an established uniform rate, which is kept constantly
at the point which equates the supply and demand. If at
any moment there are more bidders willing to employ at a
higher rate than there are employees willing to accept the
established rate, the rate will rise accordingly, and similarly
if there is a balance of opinion in the opposite direction.
The final decision by any individual as to what to do is
based on a comparison of a momentarily existing price with
a subjective judgment of significance of the commodity.
The judgment in this case relates to the indirect significance
derived from a twofold estimate of the future, involving

1 In actual society freedom of choice between employer and employee
status depends normally on the possession of a minimum amount of capi-
tal. The degree of abstraction involved in assuming such freedom is not
serious, however, since demonstrated ability can always get funds for
business operations. A propertyless employer can make the contractual
payments secure by insurance even when they may involve loss, and com-
plete separation of the risk-taking and control function from that of fur-
nishing productive services is possible if there is a high development of
organization and a high code of business honor. But the conditions
generally necessary in real life for the giving of effective guarantees must
also be taken into account as we proceed.

ENTERPRISE AND PROFIT 275

both technological and price uncertainties. The employer
in deciding whether to offer the current wage, and the em-
ployee in deciding whether to accept it, must estimate the
technical or physically measured product (specific con-
tribution) of the labor and the price to be expected for
that product when it comes upon the market. The es-
timation may involve two sorts of calculation or estimate
of probability. The venture itself may be of the nature of
a gamble, involving a large proportion of inherently un-
predictable factors. In such a case the decision depends
upon an "estimate" of an "objective probability" of
success, or of a series of such probabilities corresponding
to various degrees of success or failure. And normally, in
the case of intelligent men, account will be taken of the
probable "true value" of the estimates in the case of
all estimated factors.

The meaning of the term "social" or "competitive"
anticipation will now be clear. The question in the mind of
either party to an employment agreement relates simply
to the fact of a difference between the current standard of
remuneration for the services being bargained for and his
own estimate of their worth, discounted by probability
allowances. The magnitude of the difference is altogether
immaterial. The prospective employer may know abso-
lutely that the service has a value to him ever so much
greater than the price he is paying, but he will have to pay
only the competitively established rate, and his purchase
will affect this rate no more than if he were ever so hesitant
about the bargain, just so he makes it. It is the general
estimate of the magnitudes involved, in the sense of a
"marginal" demand price, which fixes the actual current
rate.

In many respects the nature of the organization we are
now dealing with is the same as that described in chapter
iv, with uncertainty and progress absent. The value of a
laborer or piece of material equipment to a particular pro-

276 RISK, UNCERTAINTY, AND PROFIT

ductive group is determined by the specific physical con-
tribution to output under the principle of diminishing re-
turns with increase in the proportion of that kind of agency
in the combination, and on the price of this contribution
under the principle of diminishing utility with increase in
the proportion of productive energy devoted to making
the particular product turned out by the establishment in
question. But the facts upon which the working-out of the
organization depends can no longer be objectively deter-
mined with accuracy by experiment; all the data in the
case must be estimated, subject to a larger or smaller mar-
gin of error, and this fact causes differences more funda-
mental than the resemblances in the two situations. The
function of making these estimates and of "guaranteeing"
their value to the other participating members of the group
falls to the responsible entrepreneur in each establishment,
producing a new type of activity and a new type of income
entirely unknown in a society where uncertainty is absent.
Even in the hypothetical situation dealt with in chap-
ter iv there would be likely to be a concentration of certain
control and coordinating functions in a separate person or
group of persons in each productive group. But the duties
of such persons would be of a routine character merely, in
no significant respect different from those of any other op-
eratives; they would be laborers among laborers and their
incomes would be wages like other wages. When, however,
the managerial function comes to require the exercise of
judgment involving liability to error, and when in con-
sequence the assumption of responsibility for the correct-
ness of his opinions becomes a condition prerequisite to
getting the other members of the group to submit to the
manager's direction, the nature of the function is revolu-
tionized; the manager becomes an entrepreneur. He may,
and typically will, to be sure, continue to perform the old
mechanical routine functions and to receive the old wages;
but in addition he makes responsible decisions, and his

ENTERPRISE AND PROFIT 277

income will normally contain in addition to wages a pure
differential element designated as "profit" by the economic
theorist. This profit is simply the difference between the
market price of the productive agencies he employs, the
amount which the competition of other entrepreneurs
forces him to guarantee to them as a condition of securing
their services, and the amount which he finally realizes
from the disposition of the product which under his direc-
tion they turn out.

The character of the entrepreneur's income is evidently
complex, and the relations of its component elements sub-
tle. It contains an element which is ordinary contractual
income, received on the ground of routine services per-
formed by the entrepreneur personally for the business
(wages) or earned by property which belongs to him (rent
or capital return). And the differential element is again
complex, for it is clear that there is an element of calcula-
tion and an element of luck in it. An adequate examination
and analysis of this phenomenon requires time and careful
thinking. The background of the problem should now be
clear: the uncertainty of all life and conduct which call for
the exercise of judgment in business, the economy of divi-
sion of labor which compels men to work in groups and to
delegate the function of control as other functions are
specialized, the facts of human nature which make it
necessary for one who directs the activities of others to as-
sume responsibility for the results of the operations, and
finally the competitive situation which pits the judgment
of each entrepreneur against that of the extant business
world in adjusting the contractual incomes which he must [
pay before he gets anything for himself.

The first step in attacking the problem is to inquire into
the meaning of entrepreneur ability and its conditions of
demand and supply. In regard to the first main division
of the entrepreneur's income, the ordinary wage for the
routine services of labor and property furnished to the

278 RISK, UNCERTAINTY, AND PROFIT

business, no comment is necessary. This return is merely
the competitive rate of pay for the grade of ability or kind
of property in question. To be sure, it may not be possible
in practice to say exactly what this rate is. Not merely is
perfect standardization of things and services unattainable
under the fluctuating conditions of real life, but in addition
the conditions of the entrepreneur specialization may well
bring it about that the same things are not done under
closely comparable conditions by entrepreneurs and non-
entrepreneurs. Hence the separation between the pure
wage or rent element and the elements arising out of un-
certainty cannot generally be made with complete accu-
racy. The serious difficulty comes with the attempt to deal
with the relation between judgment and luck in deter-
mining that part of the entrepreneur's income which is
associated with the performance of his peculiar twofold
function of (a) exercising responsible control and (b) se-
curing the owners of productive services against uncer-
tainty and fluctuation in their incomes. Clearly this
special income is also connected with a sort of effort and
sacrifice and into the nature and conditions of supply and
demand of the capacities and dispositions for these efforts
and sacrifices it must be pertinent to inquire.

It is unquestionable that the entrepreneur's activities
effect an enormous saving to society, vastly increasing the
efficiency of economic production. Large-scale operations,
highly organized industry, and minute division of labor
would be impossible without specialization of the manage-
rial function, and human nature being as it is, the guaran-
teeing function must apparently go along with that of con-
trol; indeed, in the ultimate sense of control the two are
not even theoretically separable. Thus there would be a
large saving even outside of any question of the superior
abilities of certain individuals over other individuals for
the performance of this function. And there is still another
gain of large magnitude through the reduction of uncer-

ENTERPRISE AND PROFIT 279

tainty by the principle of consolidation, which also is in-
dependent of the personal attributes of the entrepreneur.
But these economies, due to the system as such, and not to
activities of the individuals performing a special function,
accrue to society; no cause can be discovered in this con-
nection alone which would give rise to a special distributive
share.

As to the actual comparative magnitude of the various
elements of gain secured through the enterprise system it
would be rash to guess, but certainly a very large real gain
is secured through the selection of managers having su-
perior fitness for the work. Now it is of supreme importance
that such selection is possible only because and in so far as
such fitness can be identified in advance of its demonstra-
tion in each particular case. The prospective entrepreneur
himself has an opinion of his own suitability, in so far as he
forms an estimate of the true value of his prognostications
and policies. Other persons may or may not agree with his
opinion of himself. A man may actually get into the posi-
tion of entrepreneur in several ways. If he has property
or known personal productive powers of a technological
sort he may assume the functions of entrepreneur without
convincing any one outside himself of any special fitness to
exercise them. As long as his own resources safeguard the
interests of the persons to whom he agrees to pay con-
tractual incomes these persons need not worry about the
correctness of the judgments on which the entrepreneur's
policies are based. If he cannot make such guarantees he
must, of course, convince either the persons with whom he
makes wage or rent bargains or some outside party who
will underwrite the guarantees for him. The effect of this
transfer of the guarantee function on the nature of entre-
preneurship is a subtle question and will be taken up
presently. It might even conceivably happen, in the third
place, that a person not judging himself especially fit to
control industrial policies would get into the place of entre-

280 RISK, UNCERTAINTY, AND PROFIT

preneur, if other persons have a sufficiently high opinion
of his abilities and trustworthiness. This case is more com-
plicated still and its treatment must also be deferred. Dis-
cussion of divided entrepreneurship will lead naturally to
the problem of the hired manager, most difficult of all. Let
us consider first the simple case of unique and undivided
exercise of the function, the control and uncertainty-
bearing being all concentrated in the same individual,
under the assumption that outsiders whether employed by
him or not have neither opinions upon nor interest in the
question of his competence. It will further simplify the
problem if we begin by assuming that this is the only type
of entrepreneurship in our society.

First, a further word as to the character of the process
by which the entrepreneur's income is fixed. It may be dis-
tinguished from the contractual returns received for serv-
ices not involving the exercise of judgment, and which are
paid by the entrepreneur, by pointing out that the latter
are imputed, while his own income is residual. That is, in a
sense, the entrepreneur's income is not "determined" at
all; it is "what is left" after the others are "determined."
The competition of entrepreneurs bidding in the market
for the productive services in existence in the society "fix"
prices upon these; the entrepreneur's income is not fixed,
but consists of whatever remains over after the fixed in-
comes are paid. Hence we must examine the entrepreneur's
income indirectly, by inquiring into the forces which
determine the fixed incomes, in relation to the whole pro-
duct of an enterprise or of society.

Assuming perfect competition in the market for pro-
ductive services, the contractual incomes are fixed for
every entrepreneur by the competitive or marginal antici-
pations of entrepreneurs as a group in relation to the supply
of each kind of agency in existence. Whether any particular
individual becomes an entrepreneur or not depends on his
believing (strongly enough to act upon the conviction)

ENTERPRISE AND PROFIT 281

I that he can make productive services yield more than the
price fixed upon them by what other persons think they can
make them yield (with the same provision that the belief
must lead to action). After any individual has become an
entrepreneur, the amount of his income depends on his suc-
cess in producing the anticipated excess, and in this sense
is a matter of the correctness of his judgment. But it is >Vs
clear that his success is equally a matter of (a) the failure of
the judgment, or (b) an inferiority in capacity, on the part
of his competitors. The two factors of (a) capacity and
(b) judgment of one's capacity are inseparably connected,
and business capacity is again compounded of judgment
(of factors external to the person judging) and executive
capacity.

Moreover, there is in the exercise of the best judgment
and highest capacity an inevitable margin of error. A
successful outcome in any particular case cannot be at-
tributed entirely to judgment and capacity even taken to-
gether. The best men would fail in a certain proportion of
cases and the worst perhaps succeed in a certain propor-
tion. The results of one trial or of a small number of trials
can at most establish a certain presumption in favor of the
view that ability has or has not been shown.1 A dependable
estimate of ability can only come from a considerable num-
ber of trials. Even then there are differences in kind of
ability, as well as degree. And in business management no
two instances, perhaps, are ever very closely alike, in any
objective, describable sense. It is one of the mysteries of
the workings of mind that we are able to form estimates of
"general ability " which have any value, but the fact that
we do is of course indisputable.

1 As has been well observed in connection with games of skill. It is not
necessarily a proof of high skill to make a twenty-foot putt in golf or
pierce a two-inch bull's-eye at a hundred yards with a rifle; nor a lack of
skill to miss a three-foot putt or strike outside the eight-inch circle.
Either would happen sometimes with good shots or poor; only the pro-
portion of successes and failures in a fair number of trials gives any in-
dication of real ability to do the trick.

282 RISK, UNCERTAINTY, AND PROFIT

Still further, the venture itself may be a gamble, as we
have repeatedly pointed out. Most decisions calling for the
exercise of judgment in business or responsible life in any
field involve factors not subject to estimate and which no
one makes any pretense of estimating. The judgment it-
self is a judgment of the probability of a certain outcome,
of the proportion of successes which would be achieved if
the venture could be repeated a large number of times.
The allowance for luck is therefore twofold. It requires a
large number of trials to show the real probabilities in re-
gard to which judgment is exercised in any given kind of
case as well as to distinguish between intrinsic quality in the
judgment and mere accident. And bearing in mind again
the extreme crudeness of the classification of instances at
best, the marvel grows that we are able to live as intelli-
gently as we do. Let us now attempt to state the principles
determining entrepreneur income more accurately and in
the form of laws of demand and supply.

The demand for a productive service depends upon the
steepness of the curve of diminishing returns from increas-
ing amounts of other kinds of services applied to the first.
In the familiar case of land, the more rapidly the returns
from increased applications of labor and capital applied to a
given plot of land fall off, the higher will be the rent on
land. Now there is evidently a law of diminishing returns
governing the combination of productive services with
entrepreneurs. It is based on the fact already stated of
limitation in the space range of foresight and executive
capacity. The greater the magnitude of operations which
any single individual attempts to direct the less effective in
general he will be — "beyond a certain point," as in other
cases of the law. The demand for entrepreneurs, again,
like that for any productive agency, depends directly upon
the supply of other agencies.

The supply of entrepreneurs involves the factors of
(a) ability, with the various elements therein included,

ENTERPRISE AND PROFIT 283

(b) willingness, (c) power to give satisfactory guarantees,
and (d) the coincidence of these factors. If society as a
whole secures a high quality of management for its enter-
prises it will be through a coincidence of ability with will-
ingness, or of all three factors, as well as through an abun-
dant supply of the elements separately. Willingness plus
power to give guarantees, not backed up by ability, will
evidently lead to a dissipation of resources, while ability
without the other two factors will be merely wasted. To
find men capable of managing business efficiently and
secure to them the positions of responsible control is per-
haps the most important single problem of economic or-
ganization on the efficiency side.

The supply of entrepreneur qualities in society is one of
the chief factors in determining the number and size of its
productive units. It is a common and perhaps justifiable
opinion that most of the other factors tend toward greater
economy with increasing size in the establishment, and that
the chief limitation on size is the capacity of the leadership.
If this is true the ability to handle large enterprises suc-
cessfully, when it is met with, must tend to secure very
large rewards. The income of any particular entrepreneur
will in general tend to be larger: (1) as he himself has abil-
ity, and good luck; but (2), perhaps more important, as
there is in the society a scarcity of self-confidence com-
bined with the power to make effective guarantees to em-
ployees. The abundance or scarcity of mere ability to
manage business successfully exerts relatively little in-
fluence on profit; the main thing is the rashness or timidity
of entrepreneurs (actual and potential) as a class in bidding
up the prices of productive services. Entrepreneur in-
come, being residual, is determined by the demand for these
other services, which demand is a matter of the self-con-
fidence of entrepreneurs as a class, rather than upon a
demand for entrepreneur services in a direct sense. We
must see at once that it is perfectly possible for entre-

284 RISK, UNCERTAINTY, AND PROFIT

preneurs as a class to sustain a net loss, which would
merely have to be made up out of their earnings in some
other capacity. This would be the natural result in a
population combining low ability with high "courage."
On the other hand, if men generally judge their own abili-
ties well, the general rate of profit will probably be low,
whether ability itself is low or high, but much more va-
riable and fluctuating for a low level of real capacity. The
condition for large profits is a narrowly limited supply of
high-grade ability with a low general level of initiative as
well as ability.

The analysis of profit is much simplified for students of
political economy by the fact that the conventional dis-
tribution has placed such (misguided) emphasis on the
concept of residual income, notably, of course, in the treat-
ment of rent. Yet it will not do to press the parallel too far,
for there is this important difference : Rent — and as every
one now understands, any other share as well — is residual
after the products of the other shares are deducted (pro-
duct being the marginal contribution of a single unit
multiplied by the number of units). But profit (under the
simplified conditions we are now dealing with) is the residue
after deduction of the payment for the other agencies,
determined by the marginal bid of entrepreneurs as a
class for all agencies as aggregates. The residue in the
latter case is not a product residue, but a margin of error
in calculation on the part of the non-entrepreneurs and
entrepreneurs who do not force the successful entrepre-
neurs to pay as much for productive services as they could
be forced to pay.

As the argument is quite complicated, it will be well to
recapitulate. We have assumed in this first approximation
that each man in society knows his own powers as entre-
preneur, but that men know nothing about each other in
this capacity. The division of social income between pro-
fits and contractual income then depends on the supply of

ENTERPRISE AND PROFIT 285

entrepreneur ability in the society and the rapidity of
diminishing returns from (other factors applied to) it, the
size of the profit share increasing as the supply of ability is
small and as the returns diminish more rapidly. If men are
poor judges of their own powers as well as ignorant of
those of other men, the size of the profit share depends on
whether they tend on the whole to overestimate or under-
estimate the prospects of business operations, being larger
if they underestimate. These statements abstract from the
question of possession of means to guarantee the fixed
incomes which they contract to pay; limitations in this
respect act as limitations on the supply of entrepreneur
ability. If entrepreneur ability is of such high quality that
it practically is not subject to diminishing returns, the
competition among even a very few such men will raise
the rate of contractual returns and lower the residual share,
if they know their own powers. If they do not, the size of
their profits will again depend on their "optimism," vary-
ing inversely with the latter.

A man's knowledge of his own powers involves knowledge
of the amount of uncertainty he deals with in trusting his
own judgment, which, if the scale of operations is large
enough, means the absence of uncertainty in the effective
sense, if the knowledge is complete. Even if judgment it-
self subject to error is exercised in regard to the real prob-
abilities in an intrinsic gambling situation, we have for the
uncertainty in the situation as a whole an objective prob-
ability with predictable results for a large number of cases.
The presence of true profit, therefore, depends on an ab-
solute uncertainty in the estimation of the value of judg-
ment, or on the absence of the requisite organization for
combining a sufficient number of instances to secure cer-
tainty through consolidation. With men in complete igno-
rance of the powers of judgment of other men it is hard to
see how such organization could be effected. Yet so elusive
is the mechanism by which we know our world, so great the

286 RISK, UNCERTAINTY, AND PROFIT

capacity of mind for seizing upon indirect methods of in-
creasing certainty, that a further sweeping reservation must
be made. If men, ignorant of other men's powers, know
that these other men themselves know their own powers, the
results of general knowledge of all men's powers may be
secured; and this is true even if such knowledge is (as it is
in fact) very imperfectly or not at all communicable. If
those who furnish productive services for a contractual
remuneration know that those who bid for the services
know what they are worth to themselves, the bidders, or if
each bidder knows this to be true of the others, the latter
will be forced to pay all that they are willing to pay, which
is to say all that they can pay. To be sure, competition
under such conditions would be likely to take on the char-
acter of a poker game, a bluffing contest. But it must be
admitted that actual wage bargains are in no slight degree
of this character.

The case of European exploiters among primitive peoples
illustrates the possibility of large profits to be made by a
small number of men who know what they are doing
among a large number who do not. But if they compete
among themselves there must come a time, if their number
increases, when they will force prices to their competitive
level without any action on the part of the exploited
masses more shrewd than that of accepting a larger offer
in preference to a smaller one. The number of competitors
required to bring about this result depends upon the steep-
ness of the curve of diminishing returns from entrepreneur-
ship, upon the limitation of the scope of enterprise one man
can deal with effectively. And the idea of scope must be
extended to include the variety of situations to be dealt
with. The question of diminishing returns from entre-
preneurship is really a matter of the amount of uncertainty
present.1 To imagine that one man could adequately man-

1 The diminishing returns of management is a subject often referred
to in economic literature, but in regard to which there is a dearth of

ENTERPRISE AND PROFIT 287

age a business enterprise of indefinite size and complexity
is to imagine a situation in which effective uncertainty is
entirely absent.

The entire foregoing argument has dealt with a simpli-
fied situation inasmuch as the members of our society have
been assumed to know something about the true value, each
of his own judgment and ability to control events in ac-
cordance with it, but to know these things about each other
only as the other man's own opinion of himself is mani-
fested in his dispositions to act. In fact men form judg-
ments of other men on the basis of watching their perform-
ances over a period of time, and in addition form impres-
sions having some claim to validity from mere personal
appearance, conversation, etc. Such knowledge of others
is one of the most important factors in our efforts to live
together intelligently in organized society. It is the most
difficult to discuss scientifically of all the data connected
with the practical bearings of knowledge and uncertainty.

Estimates of the worth of other men's opinions and
capabilities probably form by far the largest part of the
data on which any individual makes decisions in his own
life, at least in the sphere of economic activity where such

scientific discussion. For an interesting, but in the present writer's view
fundamentally unsound, treatment, see H. C. Taylor, Agricultural
Economics, chap. vi. Our own discussion of the theory of enterprise is
admitted to be vague and unsatisfactory. A complete and logically rigor-
ous discussion would be a large undertaking. In view of the extreme com-
plexity of the elements involved in uncertainty, most of which may be in-
dependent variables, the number of possible suppositions which might be
followed out is prohibitive. At least it would require so much space and be
so difficult to follow, and of so little practical significance, that the prob-
ability of its being read does not justify the attempt. It is hoped that the
above discussion covers the principal points of interest. The essential
factors are men's ability in the entrepreneur field, which includes fore-
sight and executive capacity, and their knowledge of their own powers
and disposition to trust them in action. The factors likely to be neglected
are the last two, self-knowledge and self-confidence or initiative, which are
closely related, but not identical. In addition, knowledge of, and willing-
ness to trust, other mens powers and judgment is a still more important
consideration, not yet discussed.

/

288 RISK, UNCERTAINTY, AND PROFIT

activity is highly organized. Such estimates function as an
indirect indication of what we may expect to happen in any
set of conditions; we know and give ourselves credit for
knowing nothing of value about the problem itself, but we
know what is the belief of other men whose judgment we
respect and which we accept in place of an opinion of our
own. The degree of confidence which we feel in our own
situation is simply the degree of confidence we feel in the
value of the judgment of the "authority " whose pronounce-
ment we accept as the best information available on the
merits of the case. To be sure, the mode of formation of
these opinions of others' opinions is complex and obscure,
and is rarely free from all passing of judgment on the case
itself independently. There is a mutual reinforcement; we
have some ideas of our own in the premises, and these agree
with the views of some authority. We often if not in gen-
eral believe what we do because the authority believes it,
but to some extent we believe in the authority because he
holds the view to which we were already inclined. In large
measure we even believe in ourselves because and in the
measure that we think others believe in us, though, on the
other hand, again, . . . But it is enough to indicate the
complexity of the relations between our own and others'
opinions without attempting to set all these relations out in
logical statements. The importance of indirect knowledge
of fact through knowledge of others' knowledge is the point
we wish to emphasize.

Correspondingly, the uncertainty of the knowledge on
the basis of which we act is in large measure the margin of
error in our estimates of the authorities whom we elect to
follow. The uncertainties of business are predominantly of
this character, and the genus calls for particularly careful
study. Our discussion hitherto has assumed pure and un-
divided entrepreneurship, which would follow from the im-
possibility of knowledge by one person of another person's
capabilities. In the absence of such knowledge it is clear

ENTERPRISE AND PROFIT 289

that no one would put his resources under the direction of
another without a valid guarantee of the payment agreed
upon, and no one could become an entrepreneur who was
not in a position to make such guarantees without assis-
tance,1 it being equally clear that no one would make such
a guarantee for another. That is, entrepreneurship would
be completely specialized in a pure form, responsibility and
control completely associated. When men have knowledge,
or opinions on which they are willing to act, of other men's
capacities for the entrepreneur function, all this is changed;
entrepreneurship is no longer a simple and sharply isolated
function. This is, of course, the state of affairs in real life,
and it is this partially specialized and more or less dis-
tributed entrepreneurship which merits most careful con-
sideration. Several forms of organization and modes of
distribution of the function call for notice.

The simplest division of entrepreneurship which we can
think of is the separation of the two elements of control and
guarantee and their performance by different individuals.
This is a natural arrangement, for it must often happen
that entrepreneur ability will not be associated with a sit-
uation on the part of its possessor enabling him to make
satisfactory guarantees of the contractual incomes prom-
ised. Under such circumstances it may be mutually profit-
able for him to enter into agreement with some one in a
position to underwrite his employment contracts, but not
himself possessed of the ability or disposition to undertake
the direction of enterprises. The form of this partnership
and conditions of division of the profit may be highly va-
rious. As a matter of fact we know that it commonly takes
the shape of a new wage bargain, the guarantor hiring the

1 It does not follow that he would have to own property, though in the
real world this is the practical consequence. It is easily conceivable, how-
ever, that one might secure the payment of his obligations by pledging his
own earning power. Such an arrangement need not call for more difficult
feats of organization or involve greater strain on human nature than is
true of indemnity insurance at present.

290 RISK, UNCERTAINTY, AND PROFIT

director in much the same way as the latter hires the pro-
ductive services which he organized and controls. This
transfer of function involves a transformation in character
also which must be considered at length, and will be taken
up in the next chapter. Let us note here that it is usually
impracticable to separate all the guaranteeing responsibility
from the control of the enterprise. It is rare that a hired
entrepreneur receives a contractual income as his only
interest in the business. He is usually a part owner, or at
least his salary is so adjusted as to make it clear that his
continuance in the position is contingent upon its pros-
perity under his direction.

An effect of the evaluation of ability nearly as important
as the transformation in entrepreneurship with its partial
transfer to another individual is that the specialization of
the function within the enterprise may be quite incom-
plete. That is, it is no longer true that men are necessarily
unwilling to entrust productive services, of person or
property, to an outsider without an effective material
guarantee of the fixed payment agreed upon. If they have
confidence in the manager's ability and integrity they may
gladly work with only a partial or imperfect security for
their remunerations. To the extent that this is the case
such owners of productive services manifestly share in
bearing the uncertainty or "taking the risk" involved in
the undertaking. That they also share in the effective con-
trol will appear in the course of a more careful examination
of the entrepreneur function under the complicated, vague,
and shifting conditions of real life (except that progress is
still abstracted), which is the next stage in our inquiry.

CHAPTER X

ENTERPRISE AND PROFIT (continued)
THE SALARIED MANAGER

The typical form of business unit in the modern world is
the corporation. Its most important characteristic is the
combination of diffused ownership with concentrated con-
trol.1 In theory the organization is a representative democ-
racy, of an indirect type. The owners elect directors whose
main function is to choose the officials who are said actually H
to carry on the business of the company. The directors
themselves, however, exercise real direction over the gen-
eral policies of the corporation. Moreover, if it is a large
enterprise, the executive officials chosen by the directors
have only a general oversight over business policy, and
their chief function in turn is to select subordinates who
make most of the actual decisions involved in the control of
the concern. And of course the process does not stop there;
there may be many stages in the hierarchy of functionaries
whose chief duties consist of choosing still other subordi-
nates.

The first necessary step in understanding the distribution
of control and responsibility in modern business is to grasp
this fact: What we call "control" consists mainly of
selecting some one else to do the "controlling." Business
judgment is chiefly judgment of men. We know things by
knowledge of men who know them and control things in

1 That is, the most important characteristic from the standpoint of
organization. Of perhaps equal importance is the legal nature of the cor-
poration as an entity separate from its member owners. The term "lim-
ited liability" is not descriptive. The members of a corporation have,
strictly speaking, no responsibility at all; only the property of the cor-
poration, which property does not directly belong to the owners, is liable
for the corporation's obligations.

292 RISK, UNCERTAINTY, AND PROFIT

the same indirect way. Nor can this conclusion be escaped,
as there is some tendency to pretend, by distinguishing
between judgment of ends and judgment of means. The
only problems with which we have any concern are all
problems of means. There is only one end, finally, to
business activity, and this is already decided upon before
the business is founded ; that is, to make money. The de-
cisions made by members of the business organization all
relate to means, at whatever state of "generality" they
may be taken; the difference between decisions as to
general policy and operative detail is one of degree only,
in which all degrees exist; it is an arbitrary distinction.
Decisions as to ends in any proper sense are made only by
consumers — persons outside the productive organization
altogether.

These statements hold good in fact for all other de-
partments of organized social activity as well as for busi-
ness. They are even more true of political organization.
It is hardly an exaggeration to say that the political office-
holder's business is to get the job and then find some one
else to perform its duties. In the field of organization, the
knowledge on which what we call responsible control de-
pends is not knowledge of situations and problems and of
means for effecting changes, but is knowledge of other
men's knowledge of these things. So fundamental to our
problem is this fact that human judgment of things has in
an effective sense a "true value" which can be estimated
more or less correctly by the man possessing it and by
others — so fundamental is it for understanding the con-
trol of organized activity, that the problem of judging
men's powers of judgment overshadows the problem of
judging the facts of the situation to be dealt with. And if
this is true of knowledge it is manifestly true of uncer-
tainty. Under organized dealings with our environment,
attention and interest shift from the errors in men's opin-
ions of things to the errors in their opinions of men. Or-

ENTERPRISE AND PROFIT 293

ganized control of nature in a real sense depends less on the
possibility of knowing nature than it does on the possibility
of knowing the accuracy of other men's knowledge of
nature, and their powers of using this knowledge.

The fundamental principle underlying organized activity
is therefore the reduction of the uncertainty in individual
judgments and decisions by grouping the decisions of a
particular individual and estimating the proportion of
successes and failures, or the average quality of his judg-
ments as a group. It is an application of the broader prin-
ciple of consolidation of risks, but the circumstances are
peculiar. The result can never be calculated, either from
a priori data or from tabulations of instances observed. It
is an estimate in the purest sense, an estimate into which
previous observation may enter little. We form our opin-
ions of the value of men's opinions and powers through an
intuitive faculty of judging personality, with relatively
little reference to observation of their actual performance
in dealing with the kind of problems we are to set them at.
Of course we use this sort of direct evidence as far as possi-
ble, but that is usually not very far. The final decision
comes as near to intuition as we can well imagine; it
constitutes an immediate perception of relations, as mys-
terious as reading another person's thoughts or emotions
from subtle changes in the lines of his face.

The great complexity and difficulty in the analysis of
business uncertainty and of profit as the remuneration
connected with meeting it arises from this peculiar dis-
tribution of responsibility in the organization. There is an
apparent separation of the functions of making decisions
and taking the "risk" of error in decisions. The separa-
tion appears quite sharp in the case of the hired manager,
as in a corporation, where the man who makes decisions
receives a fixed salary, taking no "risk," and those who
take the risk and receive profits — the stockholders —
make no decisions, exercise no control. Yet a little exami-

294 RISK, UNCERTAINTY, AND PROFIT

nation in the light of the preceding discussion of indirect
knowledge and indirect responsibility will show that the
separation is illusory; when control is accurately defined
and located, the functions of making decisions and assum-
ing the responsibility for their correctness will be found to
be one and indivisible.

The phenomena can be best elucidated by beginning at
the very "bottom" of the scale, with the "routine" duties
of the common, unskilled laborer. It will be evident on
reflection that even the coarsest and most mechanical
labor involves in some sense meeting uncertainty, dealing
with contingencies which cannot be exactly foreseen. It
seems to be the function of all conscious life to deal with
"new situations." Consciousness would never have devel-
oped if the environment of living organisms were perfectly
uniform and monotonous, conformable to mechanical laws.
In such a world organisms would be automata. There is a
manifest tendency to economize consciousness, to make all
possible adaptations by unconscious reflex response. In
human life we see complex adaptations such as performing
on a musical instrument drop below the threshold when
learned. If the requisite movements were constant from
generation to generation there is little -doubt that they
would become fixed in the germ plasm by the slow process
of natural selection if we eliminate the more direct method
by inheritance of acquired characters.

Moreover, in industrial life, purely routine operations
are inevitably taken over by machinery. The duties of
the machine tender may seem mechanical and uniform,
but they are really not so throughout the operation. His
function is to complete the carrying-out of the process to
the point where it becomes entirely uniform so that the
machine can take hold of it, or else to begin with the
uniform output of the machine and start it on the way
of diversification. Some part of the task will practically
always be found to require conscious judgment, which is

ENTERPRISE AND PROFIT 295

to say the meeting of uncertainty, the exercise of respon-
sibility, in the ordinary sense of these terms.

But from the standpoint of organization the work of
the common laborer does not involve uncertainty or re-
sponsibility in the effective sense, on account of the prin-
ciple of indirect knowledge and transfer of responsibility
discussed above. Even when it is impossible to reduce
the work itself to routine sufficiently for a machine to
handle it — due usually to lack of uniformity (i.e., un-
certainty) in the material worked with — it is possible to
judge with a high degree of accuracy the capacity of a
human individual to deal with the sort of irregularities to
be met with in the occupation. It is the function of the
operative in industry to deal with uncertainty as a matter
of routine ! The exact movements he shall have to perform
cannot be foretold, but his ability to perform them can
be, and so the uncertainty is eliminated as an element in
the calculations; ignorance of the environmental situation
gives place to knowledge of human judgment.

The contrast again, even in case of the humblest opera-
tive, is not absolute. Most such persons occasionally
meet with contingencies in regard to which they are ex-
pected to appeal to judgment and ability superior to their
own. Nor can the operative's ability to handle his job be
known with complete accuracy to his superior. The opera-
tive must exercise judgment over his own capacities in
knowing when to go ahead independently and when to ap-
peal for guidance. And the official who assigns the opera-
tive to his job and fixes his remuneration for performing it
must exercise a rather higher quality of judgment in es-
timating the powers of the operative. The net effect is that
uncertainty and responsibility are not quite eliminated,
but are partially transferred to the superior in the scale of
organization. The true uncertainty in the case relates to
this official's judgment of his man in relation, of course, to
the position he is to fill. As far as the lowest man in the

296 RISK, UNCERTAINTY, AND PROFIT

scale is concerned, he is freed from all responsibility be-
yond the ("routine") duty of using his best judgment as
occasion requires. His superior is responsible for him, and
he accordingly receives a fixed wage.1

It will already be clear that this process of transferring
responsibility does not end with the first step at the bottom
of the scale, and the goal to which the argument will lead
is in fairly plain view. The foreman (let us say) who passes
judgment on the abilities of operatives and takes the re-
sponsibility for their performing in accordance with his ex-
pectations finds himself in turn in a similar relation to his
own ranking superior in the organization. His capacity to
judge operatives is passed upon and reduced to a routine
function in the same way that he passes upon their capaci-
ties to do their work, and likewise his capacity to deal with
those more exceptional contingencies in which operatives
are likely to appeal to hifti; and his responsibility is in turn
transferred to the higher official (superintendent or what-
not) who selects him, assigns him to his work, and hears
appeals in those still rarer questions which he refers higher
up for decision. The knowledge on which the higher con-
trol is based is again, and still more, knowledge of a man's
capacity to deal with a problem, not concrete knowledge of
the problem itself. The higher official may in fact be very
competent to deal with the problem directly, but he does
not do so. And it is noteworthy that he may not be com-
petent in this sense. Some superintendents would doubt-
less make better foremen than their foremen, and only
serve in the higher capacity because of the still greater

1 It need hardly be pointed out that the principle of consolidation of
risks is operative here to a certain extent. The employer of men passes
judgment on their "average" competency to do the things that they are
expected to do, an average in the case of each individual and an average
involving a further canceling-out of errors if he selects a number of em-
ployees. A still higher order of responsible judgment is involved in laying-
out and subdividing the work of the establishment so that the task of
each single employee is adapted to a certain fairly uniform grade of
ability.

ENTERPRISE AND PROFIT 297

rarity and value of the ability to judge and handle fore-
men. But it is unquestionable that a great many men make
very good superintendents who would not make good fore-
men at all, and perhaps this is the more common case.

On up the scale the same relations hold good until we
come to the supreme head of the business. For simplicity
we may suppose that this individual combines all the
managerial functions in his single person, that he is presi-
dent, general manager, and so forth, that his directors
exercise no control over him whatever beyond giving him
his place and salary and a perfectly free hand. Even such
an individual is in a position similar in essential respects, as
far as the problem of organization is concerned, to that of
the lowly machine tender. His capacities to deal with the
kind of situations he has to deal with are subject to evalua-
tion, are evaluated. His work is also a "routine" task of
exercising his best judgment — and leaving the conse-
quences to others. The real responsibility is again shifted
back, as the effective uncertainty is in the judgment which
placed him in his position. The responsible decision is not
the concrete ordering of policy, but ordering an orderer as a
"laborer" to order it. And this final responsibility necessa-
rily takes the consequences of its decisions. The apparent
separation between control and risk taken turns out, as
predicted, to be illusory. The paradox of the hired mana-
ger, which has caused endless confusion in the analysis of
profit, arises from the failure to recognize the fundamental
fact that in organized activity the crucial decision is the
selection of men to make decisions, that any other sort of
decision-making or exercise of judgment is automatically
reduced to a routine function. All of which follows from
the very nature of large-scale control, based on the re-
placement of knowledge of things by knowledge of men,
as our analysis has shown.

We must refuse to be misled by the superficial similarity
between the daily work of the hired manager and that of

298 RISK, UNCERTAINTY, AND PROFIT

the man in business on his own account. The difference is
far more fundamental. The former has had his task cut
out for him by others and been set to perform it; the latter
has cut out his own task to fit his own measure of himself,
and set himself at it. Here is the really responsible decision,
made for the hired manager, by the independent enter-
priser. Whenever we find an apparent separation between
control and uncertainty-bearing, examination will show
that we are confusing essentially routine activities with
real control.1

Like a large proportion of the practical problems of
business life, as of all life, this one of selecting human capaci-
ties for dealing with unforeseeable situations involves para-
dox and apparent theoretical impossibility of solution. But
like a host of impossible things in life, it is constantly being
done. Though we cannot anticipate a concrete situation
accurately enough to meet it without the intervention of
conscious judgment at that moment, it can be foreseen that
under certain circumstances the kind of things that will
turn up will be of a character to be dealt with by a kind of
capacity which can be selected and evaluated. That large-
scale organizations are formed and operate successfully
demonstrates that this principle is sound, that for these
impossible problems solutions more right than wrong are
actually found. Partly through operation of the principle
of reduction of uncertainty by consolidation, partly for
reasons embodied in our faculties of interpreting personal-
ity and which seem to be inscrutable, knowledge of men's
capacities to know turns out to be more accurate than
direct knowledge of things.

Another phase of entrepreneurship based on the same

fundamental facts of transfer of responsibility, and which

still further complicates its analysis, is the incompleteness

1 Cf. Hawley's contention {Quarterly Journal of Economics, vol. xv,
p. 88) that the hired manager makes decisions, but the enterpriser takes
the consequences of decisions, and that the former is therefore not an
enterpriser.

ENTERPRISE AND PROFIT 299

of specialization. We may introduce the problem as a
continuation of the above argument by inquiring into the
question, To whom is the responsibility ultimately trans-
ferred when the entire conduct and policy of a business are
in the hands of a hired manager? The answer is obvious:
to the owners of the productive services used in the busi-
ness; i.e., to the very shoulders from which the same re-
sponsibility is taken in the case of the specialization of func-
tion involved in contracting with an independent entre-
preneur. In the latter case the entrepreneur, who selects
himself, takes over all the uncertainty of the business along
with control over it. But in view of the difficulty of any
single individual giving adequate security for the perfor-
mance of his contracts in the case of a large undertaking,
such a form of organization has a very limited opportunity
for growth. For it is clear that only the possessor of trans-
ferable wealth already produced (consumers' or producers'
goods) or of future productive capacity in some form can
make guarantees or really bear uncertainty or take risks for
other persons. And it is nearly inevitable that the man who
"undertakes" any line of business as entrepreneur will
commit a part of his own wealth or productive powers to
that business. What naturally happens, then, in any case is
that the control of enterprise falls into the hands of the
owner (or owners) of a part of the productive services
used in the enterprise, which resources are placed in an
exposed position with regard to losses in the business and
so guarantee the owners of the remaining "land, labor, and
capital" against failure to receive their full contractual
remuneration.

It is impossible for entrepreneurship to be completely
specialized or exist in a pure form, except in the rare and
improbable case of a man who owns nothing in a particular
business and contributes nothing to it but responsibility.
Even a man who conducted a business entirely with bor-
rowed funds and hired labor, but managing it himself, would

300 RISK, UNCERTAINTY, AND PROFIT

not exemplify pure entrepreneurship, for a large part of
the work of management is as we have seen reducible to
routine and can be paid for with a fixed wage. The nearest
approach to an entrepreneur only would be a man who
borrowed all the resources for operating a business and then
hired a manager and gave him an absolutely free hand.
And such a man would have to be more than an entre-
preneur in relation to some other business, or he would not
be a true entrepreneur, making responsible decisions, in
the business in question.

- The natural result is a complicated division or diffusion
of entrepreneurship, distributed in the typical modern
business organization by a hierarchy of security issues
carrying every conceivable gradation and combination of
rights to control and to freedom from uncertainty as to in-
come and vested capital. The feature of the system apt to
be overlooked is a large element of real control disguised
under a nominal contract for a fixed return. It is seldom
true that the guarantees given can be regarded as absolute.
If they are not, the owner of resources is taking a certain
share of responsibility or risk, obviously. That he is also
exercising control becomes apparent if we consider that his
decision to allow the use of his labor or property under the
conditions affects the scale of operations of the business.
Control is completely absent from the function of furnish-
ing productive services to a business only in case an ac-
curately determined competitive value of the services is
effectively guaranteed, so that everything but the money
remuneration is made completely indifferent to their
owner.

As a matter of fact we know that it is common for those
who furnish resources to an enterprise to retain a large
amount of direct consultative authority in regard to the
conduct of the business. The voting trust is a device for
securing this end and owes its importance to the necessity
of providing for security owners an assurance of competent

ENTERPRISE AND PROFIT SOI

control when adequate protection of their interests cannot
otherwise be achieved, especially when the value of the
property depends largely on its intelligent employment in
the particular use to which it has been committed. With
the increasing specialization of industry such conditions
become more and more common, effective guarantees
become harder and harder to make, and investors find it
necessary to insist more and more on sharing in the control
of business. The distinction between stocks and bonds
tends to fade out.1 It is hard to find an illustration of an
unconditional transfer of productive resources to a business
for its use for a pecuniary consideration alone without an
outright transfer of ownership. The owners of limited
issues of first-mortgage bonds have an ultimate recourse to
the courts to compel honest management of the concern if
their interests are jeopardized. Only in such a case as the
lease of pure site value which is indestructible and not
changed in any way by use can we find an example of
an income entirely freed from the element of responsible
control.

The case of labor is somewhat peculiar, owing to the
disposition of laboring people to gamble recklessly with life
and limb as well as income. Under free competition there
is little doubt that a considerable proportion of the losses
of enterprise would fall upon labor, since laborers show
themselves ready to engage in hazardous enterprises at
their own risk for an increase in wages which is a fraction of
an adequate compensation for the chances they take. But
the social interest in the man who cannot afford the loss
comes to the rescue with prior claim laws, mechanics' liens,

1 Of course, the machinery by which control is exercised becomes more
indirect and the control itself more remote. Stocks approximate to the
real position of bonds as well as bonds to that of stocks. One form of the
change is a tendency to cover a larger proportion of investment by stock
issues (as compared with bonds) than formerly. The increased recourse
to borrowing from banks shows the same tendency, for banks in particular
keep in touch with the management of businesses in which they invest.

302 RISK, UNCERTAINTY, AND PROFIT

and the like, so that the wages of labor are in fact generally
a fair approximation to a guaranteed contractual return.
The element of control which would be involved in a de-
pendence of business upon laborers' choice of the ventures
they would engage in, is correspondingly absent, as the
effective contracting-out of the risk places different lines of
employment on a plane of indifference at the wages fixed.1
The relations between profit and the contractual shares
call for a few further remarks. As observed in our histori-
cal introduction (chapter n) the older English economists
used the term "profit " to designate the income of the
owner of a business, who was regarded as essentially an
investor. Hence, as the classical economics was essentially
a long-time theoretical treatment, little distinction was
drawn between profit and interest. A wage element was
recognized in the income, and also a risk factor. Little
was made of the latter as constituting a distinction between
profit and interest, as ordinary contract interest so ob-
viously contains an element of payment for risk also.
And in view of our argument above that the assumption of
risk in this connection involves the exercise of effective
control to the same extent, the relegation of this factor into
the background is still further justified.

1 The case of the ultimate entrepreneur, dealing with and knowing
men rather than things, suggests again the analogous political problem.
The progress of democracy toward intelligent efficiency seems to depend
on a tendency for the ultimate sovereign, the electorate, to center its
attention on the selection of competent agents, leaving to them the actual
formulation of policies and conduct of affairs. Commission government,
and still more the manager plan of municipal government, is a case in
point. In the political sphere there is a real problem of ultimate ends,
which must, of course, be dealt with by the electorate if the system re-
mains democratic. And perhaps more than in the case of business the
voter's judgment of the candidate must be connected with passing an
opinion upon the issues, partly because major issues to some extent in-
volve a question of ultimate social ideals. Professor Cooley (Social Or-
ganization, p. 129 and chap, xiii) bases an optimistic view of democracy
on a belief in the capacity of the populace, admittedly ignorant in regard
to political issues and the technique of government, to select men wisely
on the basis of a sort of intuitive recognition of personal superiority.

ENTERPRISE AND PROFIT 303

American economic discussion developed under the in-
fluence of the marginal utility theory, which is essentially a
short time view of the valuation problem. There is some
connection between this fact and the greater emphasis
given in this country to "wages of management" and the
separation of this element from the entrepreneur's income,
leaving "profit" or "pure profit" in a narrower sense
than that given the term by the older writers. For man-
agement is more conspicuous in American industry, due to
the more "dynamic" conditions of this country. In a long-
time view or "static state" it would be relatively much
less important. The greater emphasis given the risk factor
in American (as in German) discussions is explained in the
same way, a more dynamic background and greater in-
terest in short-period changes.

With the recent development of accounting theory, the
question whether interest on investment should be counted
in profit has become acute from another point of view and
has tended to constitute an issue between accountants and
economic theorists. This is of course entirely uncalled-for,
as the difference in position is a matter of obvious differ-
ence in standpoint. Economic theory is interested in the
forces which determine the prices of goods, and in costs
of production as a condition of supply. It goes without
saying that, in the long run again, a return on capital equal
to the competitive rate of interest is a condition of produc-
tion, and so from this point of view a cost. (That things
may be different from a short-time viewpoint serves to
increase the confusion.) The accountant is interested in
proprietorship, the relations between a business and its
owners, and in cost as a deduction from the owner's in-
come. Moreover, scientific accounting is an outgrowth of
corporation problems, and in the corporation the responsi-
ble owner is thought of as an investor, his interest as a
capital interest, whether he has put any money in the
business or not and whether or not it has any value above

304 RISK, UNCERTAINTY, AND PROFIT

its debts. And profit, being a return on investment, is
naturally thought of as a rate of return.

In most cases it would not be fruitful to attempt an
accurate separation of profit from interest.1 For on the
other side of the relation, pure interest is almost as rare a
phenomenon and as elusive a concept as pure profit. The
specialization of the entrepreneur function is a fundamental
fact in business organization, but for reasons which should
already bejglear, it cannot be carried to theoretical com-
pleteness. The entrepreneur must almost of necessity own
some property and the owner of property used in a busi-
ness can hardly be freed from all risk and responsibility.
It is useful, however, to distinguish between the return
actually realized by an entrepreneur and the " competitive "
rate of interest on high-class "gilt-edge" securities where
the risk and responsibility factor is negligible. The differ-
ence would be profit, or "pure profit" in the sense in which
economic theory uses the term.

Even at last some reservation must be made in calling
interest on the entrepreneur's investment a cost of pro-
ducing the commodity. It is generally admitted that if
this rate of return is not realized on the average and in the
long run the investment will not be held in the business in
question. But the truth accurately stated evidently is that
the owner must expect in the future to receive a return equal
to that which he can be sure of elsewhere, on the invest-
ment which he is free to transfer to other uses. And of course
allowance must be made for the connection between differ-
ent elements of investment as well as technological fluidity.
If half the investment in an enterprise represents machin-
ery, working-capital, land, or what-not which can be trans-

1 By "interest" is here meant property income merely. The relation
between interest and rent is essentially a "dynamic" problem, and will be
taken up for discussion in the following chapter. It is questionable
whether interest would be met with at all in an unprogressive society, and
certain that the distinction between interest and rent would be of small
importance. Cf . also above, chapter v.

ENTERPRISE AND PROFIT 305

ferred to other lines, and the other half represents perma-
nent commitment, worthless outside the particular busi-
ness, the cost of producing the output of that business
(after the commitment has been made) is only the (antici-
pation of the) competitive return on the removable half
of the capital alone. Of course this half could not be re-
moved without rendering the remainder worthless.

The association of profit with income on property is
valid, within the limits discussed, for the greater part of
business enterprises, but there are important exceptions.
The independent entrepreneur is not yet by any means
an extinct species. Such a person typically furnishes both
property and labor services to a business, meaning by labor
services personal activities which might be hired and paid
for with a fixed wage. The entrepreneur income in a case
of this sort contains an element of wages as well as an
element of interest. The contention of some accountants
that a salary should be allowed for the owner's work and
the residue considered as a return on his investment does
not seem to be well founded. It is based on a bias derived
from the habitual (and proper) procedure in corporations,
where the responsible owner furnishes property services
only. It would be just as logical to deduct from the owner's
income a competitive rate of interest and call the residue
wages or wages of management. The only significant dis-
tinction is that between the total income and a "pure pro-
fit" secured by deducting both competitive wages for the
work and competitive interest on the investment furnished
by the owner. The determination of the proper wage rate
will be fraught with the same sort of difficulties that have
been referred to in the case of pure interest, but in a much
more aggravated form; it is far more difficult to appraise
labor and find similar services in the competitive field as
a basis of comparison than in the case of property.1

1 We must again refer to the use of the term "interest" as meaning
property income merely, though superficially this is not quite consistent

306 RISK, UNCERTAINTY, AND PROFIT

In some instances, though perhaps a relatively small
proportion of real enterprises and those probably of small
average size, the independent entrepreneur may have no
property investment in his business, furnishing labor
services only. It is in reference to such a situation that the
conventional (American) treatment of profit and wages of
management has most significance. It must be very un-
usual, for reasons already pointed out, for a man to hire
the use of the labor and property of others without putting
up some property as well as labor of his own. It would be
possible, within limits, for such a man to give adequate
security for payment of the fixed remuneration of outside
agencies, if his own earning capacity were high.1

But in reality this probably does not happen on any
considerable scale, or with enterprises of large magnitude.
However, allowance must be made for the ownership of
property used in other enterprises, and also for the "moral
backing" of wealthy relatives or friends. And such "moral
backing " may or may not constitute a division of the entre-
preneur's responsibility. The only ultimate security may
still be the potential earning power of the entrepreneur
himself, which, however, might not be marketable on ac-
count of a moral hazard without being underwritten by
property-owning connections.

On the whole we must say that the discussion of profit
in relation to wages of management has been greatly over-
worked. The connection with property income is enor-
mously more common, direct, and close. The residual share
of income falls of necessity to the person in responsible con-
trol of a business; hence, in most cases to a person who also
receives a property income. He may or may not also receive

with treatment of it as a "rate." Pure interest is much more easily de-
fined than a pure competitive return on actual property, but even the
latter offers less difficulty than an appraisal of the competitive value of
the services of an independent entrepreneur.

1 To the extent that he does not give adequate security the owners of
the productive services exposed to loss are the true entrepreneurs.

ENTERPRISE AND PROFIT 307

a labor income as well. The important distinction for the
purposes of theoretical analysis is that between pure resid-
ual income or pure profit and property income. The rela-
tion to labor income is incidental in importance compara-
tively, and being of the same character, at any rate, does
not call for much space in a discussion of profit. If a dis-
tinction is made between land and capital, it must be recog-
nized that the profit receiver may be also a recipient of rent,
in addition to interest or wages or both. And in exceptional
cases he may receive rent only, as, for instance, a farmer
who owns his land, but borrows all his working capital and
hires all his work done. In such a case the practical prob-
lem would be to distinguish pure profit from rent. But
such a situation is somewhat artificial, and the distinction
between land and other property is from this point of view
even more so.

The importance of property-ownership in connection
with profit will be even greater and more apparent if "good-
will," business connection, and established reputation, etc.,
be regarded as property. If these categories are capitalized
and included in investment the cases are rare indeed where
an employer of others' labor and capital has no investment
of his own in the undertaking. As to the proper procedure
in dealing with these items, whether they should or should
not be regarded as property, the answer depends on whether
they are salable. If good-will is separable from the other
elements in a business, the test of which is that it can be
sold away from them without affecting their value, then it
is property on its own account, and the competitive rate of
return on its sale value must be deducted from the owner's
income before a pure profit is arrived at. If good-will is
inseparable from some other property element, such as a
site, it is a factor in the value of that piece of property, and
income on the total value must similarly be considered a
property income, not a pure profit. If the good-will inheres
in the person of the owner, however, it is not property,

308 RISK, UNCERTAINTY, AND PROFIT

but an element in the personal service of the owner, and
its proper income is a wage; again not a profit. In so far as
its value (in the capital or revenue sense) can be appraised,
it must be considered as entitled to a contractual return
and does not give rise to profit in the narrow sense.

Our discussion of the meaning of profit may now be
summed up in a few brief statements. Organization in-
volves the concentration of responsibility, placing resources
belonging to a large number of individuals under centralized
control. Examination shows that the human functions in
production involve making decisions, exercising control,
/"but that this control is not final unless combined with as-
I sumption of the results of the decisions. The responsible
decision relates to men rather than things; the ultimate
manager is he who plans the organization, lays out func-
tions, selects men for functions and appraises their value to
the organization as a whole, in competition with all other
bidders in the market. 'For this ultimate management
there is but one possible remuneration, the residuum of
product remaining after payment is made at rates es-
tablished in competition with all comers for all services of
men or things for which competition exists.1 This residuum
is profit; it is the remainder out of the value realized from
the sale of product after deduction of the values of all
factors in production which can be valued, or after all the
product has been imputed to productive elements which
can be imputed by the competitive mechanism. Profit is
unimputable income, as distinguished from the total in-
come of the owner of the business. Normally there are
other elements in this total income, which, since they are
not paid out by the business, may be said not to be im-
puted, or they may be described as "residually imputed."
Pure profit is theoretically unimputable, in the sense in
which the competitive system of industrial organization

1 Including, of course, monopoly elements in the situation. Cf . above,
chapter vi.

ENTERPRISE AND PROFIT 309

imputes product value to agencies concerned in production.
In this competitive process, all the product value which
can be associated with any agency will accrue to that
agency. The essence of the process is the bidding of entre-
preneurs or would-be entrepreneurs for the use of produc-
tive services in the future, the rates of remuneration being
determined by a present general competitive estimate of
the values of the services in the market, while the return
finally received from their use may diverge from this esti-
mate in view of the fact of uncertainty or liability to error
in all human prognostications. As far and as fast as any
portion of income can be known in advance to be connected
with the exercise of superior judgment, it will be imputed
to the person possessing the unusual powers, and will be-
come a wage (of management), no longer a profit. Wages
of management are not different in principle from wages
for routine work; management is routine work when the
term is properly understood in the present connection.
The true uncertainty in organized life is the uncertainty
in an estimate of human capacity, which is always a capa-
city to meet uncertainty.

In general practice the ownership of property is neces-
sary to the assumption of genuine responsibility, and in the
typical modern business organization the responsible owner
furnishes no labor services to the business, but property
services only. In such a case profit in our sense of the
term appears as a difference between the rate of return on
the owner's investment and a competitive rate of return
on investment generally. The scientific use of the term
"profit" must therefore be distinguished from the various
loose uses of the term in business, and particularly from the
net revenue of the owner; it is well to use a special expres-
sion, such as "pure profit," to distinguish the share which
is accurately residual, theoretically different from the
returns from routine functions, imputed by competition
to the agents which earn them. We must bear in mind,

310 RISK, UNCERTAINTY, AND PROFIT

however, that the imputed or competitive element in the
owner's income does not bear quite the same relation to
the price of the product as outlays actually incurred. The
expectation of such a return at the general competitive rate
is a condition of the production of that business 's contribu-
tion to the total supply of a commodity, but its realization
cannot be said to be necessary.

If it is necessary to distinguish between profit and wages,
it is just as vital to contrast profit with payment for risk-
taking in any ordinary use of the terms. An insurer, in so
far as his business is reduced to a science, takes no risk; the
risk in the individual case of the insured is obliterated on
being thrown in with the multitude of cases of the insurer.
And it is immaterial whether the "cases" are a homoge-
neous group of similars or whether each is objectively in a
class by itself, if the true probability can be ascertained.
The "risk" which gives rise to profit is an uncertainty which
cannot be evaluated, connected with a situation such that
there is no possibility of grouping on any objective basis
whatever. For while it is true that decisions made by an
individual tend to approximate an objective value when
considered as a group, decisions of this character reduce to
routine and do not involve ultimate responsibility; in so
far as the powers of the entrepreneur become evaluated, a
definite return is imputed to his activity, and this return
is no longer a profit, but a wage.1
I The only "risk" which leads to a profit is a unique un-

1 The hiring of men to meet uncertainty can be illustrated by many
examples from different fields. Corporations employ at set, fixed wages
inventors, experimenters, prospectors for minerals, weather and crop
forecasters, market predictors, speculators, etc. Gambling-houses pay
men weekly salaries to play poker with their clients. It is clear that such
employees, like the hired manager, make decisions as a matter of routine,
without taking responsibility. The responsible decision is made by the
employer, who selects them for their tasks, and the operation of the prin-
ciple of consolidation of uncertainties is also apparent. The latter point
is not so clear in other cases; the doctor makes decisions, but his patients
take the responsibility for their correctness!

ENTERPRISE AND PROFIT 311

certainty resulting from an exercise of ultimate responsi- \
bility which in its very nature cannot be insured nor capi-
talized nor salaried. Profit arises out of the inherent, abso-
lute unpredictability of things, out of the sheer brute fact
that the results of human activity cannot be anticipated
and then only in so far as even a probability calculation in
regard to them is impossible and meaningless. The receipt
of profit in a particular case may be argued to be the result
of superior judgment. But it is judgment of judgment,
especially one's own judgment, and in an individual case
there is no way of telling good judgment from good luck,
and a succession of cases sufficient to evaluate the judg-
ment or determine its probable value transforms the profit
into a wage.

The fundamental fact of organized activity is the ten-
dency to transform the uncertainties of human opinion and
action into measurable probabilities by forming an approxi-
mate evaluation of the judgment and capacity of the man.
The ability to judge men in relation to the problems they
are to deal with, and the power to "inspire" them to effi-
ciency in judging other men and things, are the essential
characteristics of the executive.

If these capacities are known, the compensation for
exercising them can be competitively imputed and is a
wage; only, in so far as they are unknown or known only
to the possessor himself, do they give rise to a profit.
The powers and attributes of leadership form the most
mysterious as well as the most vital endowment which fits
the human species for civilized or organized life, transcend-
ing even that power of perceiving and associating qualities
and relations which is the true nature of what we call
reasoning. It is the margin of error in this most ultimate
faculty of judging faculties* whose exercise is the essence of
responsible control, which constitutes the only true uncer-
tainty in the workings of the competitive organization (as
of any other organization). And it is uncertainty in this

312 RISK, UNCERTAINTY, AND PROFIT

sense which explains profit in the proper use of the term,
the sense toward which economic usage has been groping,

tthat of a pure residual income, unimputable by the mechan-
ism of competition to any agent concerned in its creation.
It remains to follow out this line of reasoning in detail,
to show how a large part of the phenomena of current eco-
nomic life, on the organization side, are the natural results
of the fact of uncertainty and this fundamental method of
meeting it. But it seems best to postpone this further dis-
cussion until we have examined the bearings of progressive
change on the amount and kind of uncertainty involved in
economic life. These two chapters have dealt only with
the more fundamental features of free enterprise which
would be met with even in a society as nearly static as
material possibility admits, and in which a minimum degree
of uncertainty would be present. We have abstracted from
many important features of entrepreneurship which are
connected with the fact of progress or the presence of the
conditions of progress, for progress involves uncertainty in
a high degree and in very special forms. We turn now to
consider the bearings upon economic organization of the
various dynamic factors or elements of progress * and the
uncertainty connected with them.

1 See chapter v.

CHAPTER XI

UNCERTAINTY AND SOCIAL PROGRESS

The general character of the connection between progress
and uncertainty has been dealt with at various points in
the course of our inquiry. Change of some kind is prerequi-
site to the existence of uncertainty; in an absolutely un-
changing world the future would be accurately foreknown,
since it would be exactly like the past. Change in some
sense is a condition of the existence of any problem what-
ever in connection with life or conduct, and is the actual
condition of most of the problems of pure thought, since
these are after all more or less related to practical require-
ments. We live in a world full of contradiction and para-
dox, a fact of which perhaps the most fundamental illus-
tration is this : that the existence of a problem of knowledge
depends on the future being different from the past, while
the possibility of the solution of the problem depends on
the future being like the past. The key to the paradox, as
we have argued above (chapter vii), is to be found in two
facts. In the first place, we analyze our world into objects
which behave more or less consistently. That is, we recog-
nize in things the unchanging property of changing in cer-
tain ways. If this process could be carried out to complete-
ness, we should have a completely knowable world. It
would also, however, be in the practical sense an un-
changing world. It is a fact familiar to students of our
thought processes that we thus explain change by explain-
ing it away. The historic problem of thought is this of
real change. The point for us here is that change according
to known law (whether or not we call it change) does not
give rise to uncertainty. What we practically mean by a
static world is one in which all change is of this character.
But the process of formulating change in terms of un-

314 RISK, UNCERTAINTY, AND PROFIT

changing "laws" (properties or modes of behavior of
"things") cannot be carried to completeness, and here our
minds invent a second refuge to which to flee from an un-
knowable world, in the form of the law of permutations
and combinations. A law of change means given behavior
under given conditions. But the "given conditions" of the
behavior of any object are the momentary states and
changes of other objects. Hence the dogma of science, that
the world is "really" made up of units which not only do
not change (atoms, corpuscles, ether, or what-not), but
whose laws of behavior are simple and comprehensible.
But it is contended that there are so many of these units
that the simple changes which they undergo (ideally move-
ments in space alone) give rise to a variety of combinations
which our minds are unable to grasp in detail. We have
examined this dogma and been forced to the conclusion
that whatever we find it pleasant to assume for philosophic
purposes, the logic of our conduct assumes real indetermin-
ateness, real change, discontinuity.

Even the assumption of real indeterminateness, however,
gives mind a new means of prediction, through grouping
phenomena into classes and applying probability reasoning.
This device enables us to predict what will happen in
groups of instances where we find it impossible to derive
laws fitting individual cases. The second fundamental fact
of uncertainty is that this method also has its limits. Both
methods in fact, prediction by law in individual cases and
by probability reasoning in groups of cases, have rather
narrow limitations in everyday life in consequence of the
organic costs of applying them and the time required to
get the necessary data; both outlay and time are com-
monly much greater than circumstances will allow us to
consume in deciding upon a course of action. The actual
procedure of making decisions in practical life is a rather
inscrutable or "intuitive" formation of "estimates," sub-
ject to a wide margin of error or uncertainty.

UNCERTAINTY AND SOCIAL PROGRESS 315

The significance of change is that it gives rise to the prob-
lem of the control of action, and in this respect the dif-
ference between predictable and unpredictable change is
conspicuous. The succession of day and night or the alter-
nation of the seasons, the vital processes and changes of our
own lives, waking and sleeping, work-time and meal-time
and play-time, infancy, maturity, and age — such events
call for action, but give rise to no problem of action; they
are predictable. Problems of action arise out of departures
from routine in changes of all sorts. It is a common obser-
vation that irregularities would be of much less magnitude
and consequence in the absence of social progress, and
a common practice to distinguish between "static" and
"dynamic" risks. The fundamental difference, as we have
seen, is one of degree only, and consists in the greater un-
predictability of some actual progressive changes. In the
first place, it is impossible to draw a sharp and significant
distinction between progressive change and fluctuations.
Everything depends on the periodicity of the change. If it
is self -compensating in an interval short as compared with
the length of human life, it does not involve uncertainty,
and the increasing perfection of organization devices de-
signed to secure consolidation constantly extends the period
over which effective self-compensation may come about.
On the other hand, all our progressive changes may be
ultimately periodic for all we know.

Again, progressive change does not necessarily carry un-
predictability with it; indeed, a merely progressive change
does not. If the change takes place uniformly, or in ac-
cordance with any known mathematical function of time,
the future may be foreknown as accurately as if there were
no change. It is fluctuation after all which is the true
cause of the uncertainty, fluctuation in progress. In fact
some changes are fairly "constant" in their operation and
do not give rise to uncertainties of the sort which disturb
the operation of competition. Of this sort are the increase

316 RISK, UNCERTAINTY, AND PROFIT

of population and the accumulation of capital. Others are
highly capricious in their action and continually upset the
calculations upon the basis of which entrepreneurs' bids
for productive service are made.

Scrutiny of the character of the progressive changes
which we have recognized (chapter v) as significant in the
study of economics reveals some interesting similarities and
differences among them. If we begin by distinguishing be-
tween natural changes and changes due to human action,
we note that we do not have to consider any progressive
changes under the former head. Natural changes are
either of the nature of fluctuations from a constant con-
dition or else, like the supposed cooling-off of the solar
system, so slow as to make no difference for human cal-
culations. The changes due to acts of man are, however, of
two different kinds. Some are produced by deliberate in-
tent and others come about more or less incidentally as a
result of actions directed toward other ends. A study of
the "real" motives of action would lead far afield, and
probably yield no very clear and satisfactory results at
last, but we can make a rough distinction. The improve-
ment of technology and in large part the discovery of
natural resources are directly willed, though the latter is to
a more considerable extent accidental. The accumulation
of capital may be treated as deliberately effected, though
with some reservations, and the various redistributions of
things among persons may be similarly treated, but with
more reservations. The improvement of wants is partly a
deliberate matter, partly incidental to other endeavors,
and partly it "just happens." The increase in population
is hardly willed at all; the matter of its innate quality is
even less affected by volitional interference (and in fact
unquestionably shows rapid retrogression under modern
industrial conditions); while the education and training
of the individual are controlled by a baffling mixture of
planned action and accident.

UNCERTAINTY AND SOCIAL PROGRESS 317

Another dichotomy of fundamental importance for the
study of uncertainty relates to the production as con-
trasted with the consumption of wealth. This distinction
is also well recognized in discussions of uncertainty, the
technological "risks" being separated from those con-
nected with market changes. It is interesting to observe
in the evolution of the modern industrial organization how
the marketing function has consistently dominated that of
production proper. We have already pointed out that the
most fundamental determining fact in connection with or-
ganization is the meeting of uncertainty. The responsible
decisions in organized economic life are price decisions;
others can be reduced to routine and men can be hired to
make them. The uncertainties of the market resist elimina-
tion or reduction by grouping more doggedly than do those
connected with technological processes. Even in the transi-
tion period between the mediaeval and modern eras it was
the marketing guilds which gravitated into positions of
control, became the "Liveried Companies" and employed
the producers and set them at their tasks, owning the
materials they worked upon and the product when com-
pleted.

It will be observed that the main uncertainty which
affects the entrepreneur is that connected with the sale
price of his product. His position in the price system is
typically 1 that of a purchaser of productive services at
present prices to convert into finished goods for sale at the
prices prevailing when the operation is finished. There is no
uncertainty as to the prices of the things he buys. He
bears the technological uncertainty as to the amount of
physical product he will secure, but the probable error in
calculations of this sort is generally not large; the gamble is
in the price factor in relation to the product. But changes

1 In many instances, of course, this situation is inverted; the selling
price is known in advance by contracting and it is the cost outlays which
are uncertain.

I

318 RISK, UNCERTAINTY, AND PROFIT

in the prices of producers* goods affect him indirectly, be-
cause they are likely to be connected with changes in prod-
uct prices; they form one of the factors to be taken into
account in forecasting the sales market. This is probably a
secondary consideration, however, except in so far as capi-
tal values are involved, a fundamental exception, to be
sure, which will have to be discussed at length presently.
The main immediate sources of uncertainty are the amount
of supply to be expected from other producers and the
consumers' wants and purchasing power.

The most fundamentally and irretrievably uncertain
phases or factors of progress are those which amount es-
sentially to the increase of knowledge as such. This de-
scription evidently holds for the improvement of technologi-
cal processes and the forms of business organization and for
the discovery of new natural resources. Here it is a contra-
diction in terms to speak of anticipation, in an accurate and
detailed sense, for to anticipate the advance would be to
make it at once. Yet even here, as we have seen, change
and the uncertainty of change are in some degree separable
factors. Though we cannot describe a new invention in
advance without making it, nor say what quantity and
quality of new natural productive capacity will be devel-
oped and where, yet it is possible in a large degree to offset
ignorance with knowledge and behave intelligently with
regard to the future. These changes are in large part the
result of deliberate application of resources to bring them
about, and in the large if not in a particular instance, the
results of such activity can be so far foreseen that it is
even possible to hire men and borrow capital at fixed re-
munerations for the purpose of carrying it on.

Two further general observations are called for before we
can take up in detail the effects of the uncertainties in-
volved in progress upon the form and workings of the com-
petitive economic organization. It is common to think of
the economic process as the production of goods for the

UNCERTAINTY AND SOCIAL PROGRESS 319

satisfaction of wants. This view is deficient in two vital
respects. In the first place, the economic process produces
wants as well as goods to satisfy existing wants, and the
amount of social energy devoted to the former and neg-
lected phase of activity is very large and constantly grow-
ing. The second point is that the production of the in-
direct means of want-satisfaction is by no means altogether
directed to the ultimate satisfaction of wants in any direct
sense of the terms. The increase in wealth is to a large
extent an end in itself as well as a means to the increase of
income, and this also again to a rapidly increasing degree as
the standards of life are advanced. Men work "to get rich "
in a large proportion of cases, not merely in addition to,
but in place of, consuming larger amounts of goods. It is a
grave error to assume that in a modern industrial nation
production takes place only in order to consumption. It is
true to a great and ever-increasing degree that consump-
tion is sacrificed to increased production. Whatever our
philosophy of human motives, we must face the fact that
men do "raise more corn to feed more hogs, to buy more
land to raise more corn to feed more hogs to buy more land,"
and, in business generally, produce wealth to be used in pro-
ducing more wealth with no view to any use beyond the
increase of wealth itself.

From the standpoint of effects upon organization we
must distinguish between the various phases of progress
already enumerated (in chapter v), the increase of popula-
tion, education and training, accumulation of capital, im-
provement in technology and business organization, dis-
covery of new natural resources, and changes in the char-
acter of human wants. The most important of these from
our point of view and at the same time the one easiest to
discuss intelligently is the accumulation of capital.

Let us begin with the relation of capital in the sense of
material goods to the fundamental structure of society.
The facts of progress will be seen to have an intimate con-

320 RISK, UNCERTAINTY, AND PROFIT

nection with the very institution of private property. In
an unprogressive society private property in the modern
sense of the term need not exist. The social justification of
private ownership is that the coupling of control of re-
sources with enjoyment of the fruits of their use is sup-
posed to give an incentive to use the goods effectively in
production. The abolition of slavery or property in hu-
man beings rests on the fact that slaves do not work as ef-
fectively as free men, and it turns out to be cheaper to
pay men for their services and leave their private lives un-
der their own control than it is to maintain them and force
them to labor.

The same reasoning applies to property in material
things, but in an unprogressive state the force of the argu-
ment is relatively weak. When production methods are a
matter of routine, as in the Middle Ages, and there is no
thought of progress, common ownership of land and tools
is the rule. The problem of control becomes acute when
methods are changing, and the incentive to change methods
is mainly the desire to increase property values, to "get
rich." We can hardly over-emphasize the fact that the
dynamic urge back of modern economic life is the desire to
increase wealth, rather than a desire to consume goods,
though there is a psychological connection of an irrational
sort between the two considerations. Even when im-
provement in standards of living does result from the in-
crease of wealth, it cannot be assumed that this was the
motive; for as we have previously emphasized, a permanent
net increase of wealth must come from a surplus produc-
tion on the part of individuals which they never plan to
consume, but expect to die and leave behind them.1

1 A small amount of capital wealth would, of course, result from the
temporary investment of savings later withdrawn and consumed. An
adequate discussion of the motives involved in the production of such
surplus wealth would be beyond the scope of this work. The writer would
say, however, that the theory of an "instinct" of acquisition or accumula-
tion seems to him to be even below the plane of scientific thinking of the

UNCERTAINTY AND SOCIAL PROGRESS 321

The most direct connection of the uncertainties of prog-
ress with economic theory in the conventional use of the
term is in relation to the explanation of interest. Interest
is a phenomenon connected with the increase of the ma-
terial equipment of society and dependent on the uncer-
tainty involved in the process. It might or might not exist
in a "static" society, depending largely on how rigidly the
term "static" is interpreted. If productive goods were not
changeable in either form or amount or distribution there
would be no occasion for the lending of free capital, and
interest would not exist; if all equipment were fixed in form
and amount, but transferable from one individual to an-
other, it might exist; with productive goods fixed in amount
(no net saving or consumption of "capital" taking place),
but changeable in form, interest would doubtless be found,
but would make no appreciable difference in the distribu-
tion of income, as it would differ in very little but name
from rent.1

To understand interest it is necessary to have clearly in
view the mechanism of the creation of capital equipment
through the process of saving and investment. The clas-
sical conception of capital as "advances to laborers" 2 is

famous "dormitive virtue" of opiates. The latter at least is a real prop-
erty or mode of behavior of something, while the human activity of ac-
cumulation is not a distinctive reaction, but a manifestation of the same
tendencies found in human conduct generally. The "creative" or "con-
structive" impulse is open to the same objection; the "pleasure of being a
cause" used by Gross, Preyer, Cooley, and others seems to be the best
description of action not directed to gratifying an immediate and con-
scious need of the organism as a vital machine. It is merely a confusing
misuse of terms to call an undifferentiated and undirected tendency to
action-in-general an "instinct."

1 See above, chapter v, where it is shown that the "capitalization rate"
which would determine or rather arise out of the sale- value of property on
the second of the above assumptions is not interest in the proper sense of
the term, and that its rate is determined by "psychological" considera-
tions of "time-preference," very different from the forces which deter-
mine the rate of interest in the present world. These forces we now pro-
ceed to analyze more in detail.

2 Substantially followed by Taussig, and rightly so. See Wages and
Capital; also Principles of Economics, chaps. 38-40.

322 RISK, UNCERTAINTY, AND PROFIT

essentially sound at least as a starting-point, though it
must be amended or qualified in two particulars. The de-
scription applies, first, only to new or "free" capital, capi-
tal in the process of formation; it is true in the sense that
capital goods come into existence through an "advance-
ment" of consumption goods. In the second place, the
advances are not made to laborers only, but to owners of
already existing capital goods (and natural resources if
these are separated from capital goods) as well. The diffi-
culties and confusions with which interest theory is beset
arise largely from the use of terms, notably the ambiguity
of the term "capital." In the discussion which follows we
shall employ the expression "capital goods" to refer to
"the produce of past industry used for further production,"
the concrete instruments and tools, and restrict the term
"capital" to a much narrower meaning, relating to this
antecedent stage in the creation of capital goods or to their
value as distinct from the goods themselves.

The nature of capital creation has been made clear by
many writers. The primitive man constructs his own
equipment to increase the efficiency of his own labor, and
what he dies possessed of is likely to be buried with him.
In organized civilized life the process is different in two
respects. In consequence of specialization certain persons
devote their energies altogether to the production of equip-
ment goods, others not at all; and in the second place, a
great permanent fund of goods is built up and maintained
and increased from generation to generation. Yet what
happens on the whole is fundamentally the same, though
the division of labor makes it somewhat more difficult to
see. Those who are engaged in the making of equipment
goods are naturally not at the same time making their
own living; they must five out of a surplus of consumption
goods either stored up in advance or diverted from the use
of those who produce it contemporaneously. In either case
the first requisite to capital creation is the creation of a

UNCERTAINTY AND SOCIAL PROGRESS 323

surplus, the production of more goods than are consumed,
by somebody at some time prior to the coming into exist-
ence of the capital goods. This is the essential meaning of
"saving."

In civilized society the makers of capital goods in-
clude landlords and owners of capital goods as well as
laborers. All who furnish productive services of any kind
to the capital goods producing operations are manifestly
paid out of prior production or excess contemporary crea-
tion of consumption goods by other persons and equip-
ment. The essence of the process is that a surplus of con-
sumption goods, set aside by being "saved," makes pos-
sible the diversion of productive resources from the creation
of consumption goods to the creation of producers' goods.
This is what is meant by "advances."

The series of events is further complicated by the in-
tervention of money, for a relatively small proportion of
students of economics ever learn to think back of the ex-
change function of money to the transfers of real things
mediated by it. Saving is erroneously thought of as the
saving of money, and the income of the producers of capi-
tal goods as a money income. Of course the money is a
mere medium of exchange. It represents to the saver the
ownership of a certain amount of the wealth of society,
which can be "drawn" or "cashed" in any form he pleases
at existing prices. If the saving is "invested," used for
capital creation, this wealth is transferred to those engaged
in these operations and "cashed" by them in the form of
the things they want, mainly consumption goods. The
title to these things is what the saving is and what is trans-
ferred. The transferred goods maintain or support the pro-
ducers of capital goods, including laborers, landowners, and
owners of capital goods who would otherwise be engaged
in making consumption goods for themselves or for ex-
change. Interest arises when saved wealth is not invested
by the saver, but transferred by loan to another person,

3U RISK, UNCERTAINTY, AND PROFIT

either direct from saver to investor or mediated by a bank
or financial institution as middleman.

The loan at interest is thus a means of securing specializa-
tion of function, enabling one set of persons to save surplus
wealth and another set to convert savings into capital
goods by advancing them to the owners of productive serv-
ices who then use these services to create the capital
goods instead of the consumption goods which they would
have been used to produce had no saving taken place. The
operations could be carried on without specialization; di-
vision of labor here as elsewhere involves economy merely,
but is not the only way of getting things done. The savers
could advance their own surpluses to owners of productive
services and create capital goods on their own account,
either themselves exploiting these new productive goods or
transferring them by lease to other entrepreneurs. The
gains from having them transfer this function to others
who make investment their business are of the same
character as the gains from specialization in any other
connection.

Notably the gains are the same as those which arise
from the specialization of the entrepreneur or control-plus-
responsibility function, for this is what is really involved in
the loan. Let us suppose that the saver does his own ad-
vancing and comes out the owner of the capital equipment
which results from his saving; what will he do with it then?
He might also employ this new equipment himself in the
production of the sort of goods to which it is adapted,
continuing meanwhile the original business or profession
out of which he made the first saved surplus. But we
know that it is in general much better and much more
likely to happen that he shall lease the equipment at a
fixed rate to an entrepreneur for actual operation. Let us
make it as clear as possible that exactly the same sort of
gains are realized by his transferring the surplus of goods
itself to an entrepreneur at a fixed remuneration and leav-

UNCERTAINTY AND SOCIAL PROGRESS 325

ing to the latter the construction as well as operation of
the new equipment (or leaving the construction and opera-
tion to two different outside entrepreneurs).

The saving of surpluses is clearly one function or opera-
tion and their use to make possible the creation of new
equipment another and quite different one, just as the
furnishing of productive services is one function and their
use in the production of goods is another. In fact a little
reflection will show that the operation of converting sur-
plus goods into capital goods partakes in an especial degree
of the characteristics which lead to the specialization of
the entrepreneur function in the field of ordinary productive
operations : namely, it involves special knowledge and fore-
sight of future conditions. A surplus of consumption goods
is fluid capital; it may be used to create any hind of con-
crete productive instruments whatever, within the limits
of physical possibility and arbitrary social control. In a
society which permitted such use it could be made to pro-
duce or increase a supply of slave labor. It can as a matter
of fact be used to increase the supply of natural agents or
to invent and discover new ways of doing things, even to
create new wants for goods, and many things not conven-
tionally considered capital creation.

The burning question in practice is, what form of new '
capital goods shall be created, where, by what methods,
etc. The answer is an exercise of judgment of far the highest
type called for in the business world. It is obviously in-
evitable that the function of answering this type of ques-
tion will be specialized along the same lines and for the
same reasons as the control of enterprise under static con-
ditions. The individuals who control the conversion of
saved surpluses into capital goods must take the responsi-
bility for their decisions, though as in the former case the
"control" may take the form of selecting some one else to
exercise the immediate control as a routine task performed
without responsibility for the results. The call for the

326 RISK, UNCERTAINTY, AND PROFIT

exercise of judgment is greater as the uncertainties of prog-
ress are greater than those of routine operations, and the
necessity that the responsibility be taken by the person
who exercises the judgment — of the situation or of the
human capacity to judge it — is correspondingly great.

Under freedom of contract the machinery which natur-
ally grows up for effecting this specialization is the machin-
ery of the market, working in the same way as in the case
of entrepreneurs' bargains with the owners of productive
services. Surplus consumption goods, or titles to these in
the form of money or bank deposits, form a perfectly stand-
ardized commodity of an ideal sort for trading. It is also
extremely mobile, still further adapting it to the operations
of a market of the widest scope. Banks and financial in-
stitutions have this market highly organized. The actual
workings of the market are the same as those of any other
market. At any time there is a price established, which
in this case is unusually definite and uniform. It is not,
indeed, a single homogeneous commodity that is dealt in,
for funds for different sorts of investment admit of the
specialization of the entrepreneur function in widely differ-
ent degrees. But after all the loan market represents a
narrower range of prices according to grade and kind of the
goods than is true of nearly any other market to be named.
Men who are willing to purchase at the established price
meet men who are willing to sell at that price; others do not
enter the market. If more of the commodity is offered
than will be taken at the existing price the price falls, and
vice versa, keeping the price constantly adjusted to the point
which equates the supply and demand.

The buyers' decisions to enter the market represent a
judgment of an investment opportunity that will yield a
profit (together with ability to give the security demanded
in consideration of the rate on the particular kind of loan).
The entrepreneur in this case must make an estimate of
the future, involving a very complicated series of factors.

UNCERTAINTY AND SOCIAL PROGRESS 327

The borrower of funds (like the hirer of other agencies) for
routine productive operations estimates the physical prod-
uct to be turned out by their use and the sale price of this
product. The borrower for the purpose of creating new
capital equipment 1 must estimate in physical terms the
results of his constructive operations, the physical output
of his equipment after it is in use, and both the cost and the
salability of that product, all of which are in the future by
the interval required to construct the equipment in addi-
tion to the period of production in the industry. Besides
all which it must be kept in mind that the construction of
a new productive plant includes getting it into operation,
building up business connections in the markets for all the
things the business must purchase as well as the things
which it sells; and this normally requires a much longer
time than the mere mechanical construction of the plant.
The specialization of entrepreneur activities may go far-
ther than above indicated in various ways. In particular,
the use of surplus goods, represented by money funds, in
constructing new production goods may be separated from
the operation of the new equipment when constructed. But
for obvious reasons this is also likely not to be the case.
Construction includes, as we have seen, an initial period of
operation longer than the construction period itself in the
narrow sense, and the overlapping in time makes them
difficult to separate. It commonly happens, indeed, that '
the mechanical part of building a plant is turned over for a
fixed consideration to another entrepreneur, a contractor.
Of course the starting of new enterprises with a view to
their sale or even lease to others for operation after they
are established as going concerns is not at all unusual, but
can hardly be said to be the typical procedure in most lines
of business.

1 Borrowing for the purchase of productive equipment already in
existence (land or other goods) manifestly makes no difference in either
the demand or supply of capital and hence has no effect on the interest
rate.

328 RISK, UNCERTAINTY, AND PROFIT

The importance of the distinction between capital and
capital goods should now be clear. The business world
thinks of capital as money funds. Money, however, is only
a medium of exchange, and in the investment function rep-
resents a title to a surplus of wealth, practically speaking
a surplus of consumption goods. This is the real meaning
of free capital, which is a stage in the development of capi-
tal goods. The crux of current confusion in interest theory
lies in the failure to see the significance of the fact that we
live in a progressive society, that new net surplus produc-
tion is constantly flowing through the loan market into the
investment field and being converted into material equip-
ment.1 That is, it is surplus production on the part of the
individuals and classes who save it; from the standpoint of
society as a whole there is no surplus production of con-
sumption goods; the surplus appears in the form of addi-
tions to capital equipment. In an unprogressive society
where new saving was not being used to create new re-
sources, there could not be interest in the sense in which
the term has significance to economic theorists, — i.e.,
as a distributive share, — though interest could be paid
for consumption loans. At present consumption loans are
negligible in comparison with loans for conversion into
new productive goods; when they are made they, of course,
take the same rate of interest, allowance being made for
degree of security against loss of interest and principal.2

Interest is the payment for the use of free capital; for
the use of capital goods when employed by another than
their owner, the payment is a rent. Interest is manifestly

1 From the standpoint of an ultimate long-time treatment of interest
theory it is important that this conversion is not usually utterly irrevo-
cable. The process can generally be reversed, the capital withdrawn, and
the wealth recovered in the form of consumption goods — more or less
quickly and effectively — by under-maintenance of the capital goods.

2 See chapter iv for a discussion of the possibility that interest might
appear in connection with the use of property in a static state, and chap-
ter v for a similar discussion with regard to a progressive society with un-
certainty absent.

UNCERTAINTY AND SOCIAL PROGRESS 329

paid out of the produce of the property created with the
resources obtained by the loan; it is part of the produce of
the capital goods which were in the mind of the borrower
when the loan was made, which the capital represented to
him. This yield of property must again be distinguished
from rent ; the former is the actual return realized from the
exploitation of the material things, while rent is the com-
petitive market value of their use. Rent is paid out of the
property yield if the property is actually leased; if it is
managed by the owner, income should still be imputed to
it on the basis of its fair rental value. The yield should in-
clude rent plus a profit, if the entrepreneur is to get any
remuneration for the performance of his special function.1

These three species of income thus form a sort of con-
catenated series, tied together by two forms of profit. The
actual yield of the property includes the competitive rent,
and the profit which pays the responsible entrepreneur who
exploits it. The rent in turn includes competitive interest
on the investment (the original value sacrificed to create it)
plus a profit which is the remuneration for the entrepreneur
function of converting the investment into the concrete
goods.

One striking difference between rent and interest has
been especially fruitful as a source of confusion in the
theory. Both are expressed as rates, per dollar per year,
but the explanation is very different in the two cases.
Interest is naturally a rate, a ratio between two values. The
object transferred from saver to entrepreneur is expressed
in value terms, a certain amount of money, representing
surplus consumers' goods to a certain value, and the return
to the capitalist is also stated in value terms. If rent is
stated as a rate of return on the investment, however, the
relation is inverse; the investment in this case means not

1 Whether entrepreneurs as a class or on the average do secure re-
muneration for their services as entrepreneurs in the strict sense — i.e.,
exclusive of payment for their work and for the use of their property —
is a point about which question will be raised in the next chapter.

330 RISK, UNCERTAINTY, AND PROFIT

an original value magnitude, but the sale value of the prop-
erty, which is the result of capitalization at the current
rate of interest. For obviously in a progressive society
where men are constantly lending funds of value at interest,
freedom of exchange between value funds and productive
goods will fix a value on the latter equal to the investment
necessary to produce an equivalent return. It is this phe-
nomenon of capitalization which to certain writers of the
"psychological school" 1 has obscured the fact that what
is transferred in a loan at interest is a fund of value which
is not the result of a capitalization process, but is valued as
an immediate utility.

Capitalization and property values are fundamental to
an understanding of the phenomena which arise out of the
uncertainties present in a progressive society, and call for
some further discussion on their own account. When a new
productive enterprise is once established and shows promise
of yielding a profit above the competitive rates of return on
the resources put into it and those necessary for its opera-
tion, this entire future yield, discounted to its present
worth at the current rate of interest, can be drawn or
cashed in at once by the sale of the property.2 Taken in
conjunction with the fact observed above, that the desire
to own productive wealth is by no means merely an in-
direct desire to consume its revenue, this fact of the an-
ticipation of future income by capitalization increases
many fold the incentive to embark on new ventures. Even
when the owner of the enterprise has no intention of selling

1 Time preference or discount of the future, as more fully explained
elsewhere, has nothing to do with the interest rate except in determining
the supply of new capital (rate of saving). This indirect effect becomes
appreciable only over long periods of time, since the saving made in any
short period is negligible at best in comparison with the total investment
previously made, or more strictly that part of this total which retains
some degree of fluidity, and is also negligible in relation to the total de-
mand for capital in the market.

2 Allowance must be made for the uncertainty of the permanence of
the income.

UNCERTAINTY AND SOCIAL PROGRESS 331

the property, but considers only operating it to secure an
income, the paper profit on the capital value must be con-
sidered a part of his remuneration more or less separable
in his mind from the profit in the shape of an income above
the competitive return on the investment.

It would be hard to overestimate the error involved in
the psychological interpretation of economic motive as
desire to consume goods alone. Even the desire for an in-
come is not simply a desire to consume. For societies, or
social classes in any society, near the subsistence margin,
this is more nearly true. Even the so-called "subsistence
margin," however, in any advanced society like the United
States includes probably several times as much as is really
necessary to gratify the animal wants and maintain health
and physical efficiency. This does not mean that an in-
dividual can really live on a fraction of what those with the
lowest incomes actually consume, for in a civilized society,
the conventional necessaries may be as indispensable in
fact as the animal necessaries. The motives for the con-
sumption of even the conventional necessaries are none the
less different from the animal needs. The desire (or neces-
sity) for conforming to conventions is not the same thing as
the need for food and protection; the easy fallacy is con-
fusion of the requirement for food, clothing, and shelter
of the conventional kinds with the requirement for food,
clothing, and shelter as physiological necessities. A large
part of the consumption of persons, in the lower income
strata even, does not yield satisfaction as consumption;
the motives and cravings are social in their origin and
nature. It is a commonplace that many of the necessities
of to-day did not exist or were not available for our an-
cestors a few generations ago, irrespective of their wealth.

In separating the desire to increase one's possessions
from the desire to consume goods, we of course make no
pretense of carrying our analysis back to "ultimate"
motives, but an observation in this connection may not be

332 RISK, UNCERTAINTY, AND PROFIT

out of place. Adverse reference has been made to the use of
instinct psychology in economics. In the writer's view the
lists of instincts given by Parker and others are superficial
in the highest degree; yet it must be admitted that this
literature represents progress, in comparison with the
naive psychologizing of conventional economics. The
instincts are a step in the right direction, carrying back the
immediate lines of endeavor to more generalized motives
and impulses. The defect in the procedure is that it stops
halfway on the road to a rather obvious goal. Man has no
instincts in the sense of tendencies to act in a definite way
under definite circumstances, at least above a plane so low
that they are as properly interpreted as reflexes. He has a
few needs, of course, but the knowledge of their mode of
satisfaction is not innate. We should never know, if un-
taught, what to eat, if indeed we should connect the pangs
of hunger with the act of eating at all in the absence of
knowledge gained by teaching through stimulating certain
reflexes. And similar statements probably hold for sex
behavior. It seems clear that in our whole higher life above
the plane of food and sex and primitive pleasure-pain re-
actions, our activities result from a single unspecified, un-
directed tendency to act purposefully \ the specific direction
of the desire and activity being determined by suggestion
from the environment and critical reflection upon such
outside suggestion. All the instincts not directly con-
nected with self-preservation (and the specific content of
even these as we have seen is largely taught) are easily
analyzed into each other; any one of them — or better, any
pair, for they run largely in pairs of opposites — if inter-
preted broadly will account for most of our conduct. The
only differentiation that would have any meaning would
be the separation of an instinct of repose from the instinct
of action; and repose is a mere negative.

Possibly thought is sometimes enough different from
motor activity to justify a separation, but this would cer-

UNCERTAINTY AND SOCIAL PROGRESS 333

tainly be the case with exceptional individuals only, and
the instinct theorists insist on universality as a criterion
for a true instinct.1

The conclusion we are here interested in, however inter-
preted into human nature, is that social progress on the
material side is largely motivated by a desire to possess
wealth, and that the role of uncertainty in connection with
capitalization is to make it possible for an individual
through superior judgment or good luck to obtain a large
increase in his wealth in a short time. In addition capitali-
zation brings about a reduction of uncertainty through
consolidation, in a way pointed out in an earlier chapter.
Persons who are fitted for and enjoy making new ventures
can specialize in this type of economic activity, selling the
new enterprises when established. Thus by bringing many
ventures within the scope of action of a single individual
(or business unit) the errors tend more or less to cancel
out; and an estimate can be formed of the objective value
of the entrepreneur ability exemplified, still further re-
ducing the margin of uncertainty in any particular venture.

It goes without saying that the phenomena of capital-
ization hold good for established enterprises as well as
new ones. Any change in the current yield of any pro-
perty whatever at once accrues, in so far as it is viewed
as permanent, in the form of a change in the capital value
of that property. These changes in capital value often
overshadow in importance the changes in income. Such
changes in capital values, depending on the anticipated
future income of the property, do not necessarily wait for

1 The correct line for a scientific interpretation of human behavior is
in the writer's view well indicated in the "Methodological Introduction"
(by Professor Thomas) to The Polish Peasant in Europe and America, by
Thomas and Czaniecki. Professor Thomas's analysis runs in terms of
"values" (social customs, conventions, or mores) and "attitudes," the
result of individual criticism of the established values and tending con-
stantly to modify and reconstruct the latter. This view is also harmonious
with that of Professor Tufts, formulated in more general terms in the
essay on "The Moral Life" in the volume entitled Creative Intelligence.

234 RISK, UNCERTAINTY, AND PROFIT

ent possible outcomes in a group of instances is known, it
is possible to get rid of any real uncertainty by the expe-
dient of grouping or "consolidating" instances. But that
it is possible does not necessarily mean that it will be done,
and we must observe at the outset that when an individual
instance only is at issue, there is no difference for conduct
between a measurable risk and an unmeasurable uncer-
tainty. The individual, as already observed, throws his
estimate of the value of an opinion into the probability
form of "a successes in b trials" (a/b being a proper frac-
tion) and "feels" toward it as toward any other probability
situation.

As so commonly in this subject fraught with logical
difficulty and paradox, reservations must be made to the
above statement. In the first place, it does not matter how
unique the instance, if a real probability can be calculated,
if we can know with certainty how many successes there
would be in (say) one hundred trials if the one hundred
trials could be made. If we know the odds against us it
does not matter in the least whether we place all our wagers
in one kind of game or in as many different games as there
are wagers; the laws of probability hold in the second case
just as well as in the first. But in business situations it so
rarely happens that a probability can be computed for
a single unique instance that this qualification has less
weight than might be supposed. However, in so far as ob-
jective probability enters into a calculation, it is hard to
imagine an intelligent individual considering any single
case as absolutely isolated. The only exception would be a
decision in which one's whole fortune (or his life) were at
stake. The importance of the contingency and probable
frequency of recurrence in the individual lifetime of situa-
tions similar in the magnitude of the issues involved should
make a difference in the attitude assumed toward any one
case as well as the mathematical probability of success or
failure.

METHODS FOR MEETING UNCERTAINTY 235

A second reservation of more importance is connected
with the possibility referred to in the preceding chapter, of
forming classes of cases by grouping the decisions of a given
person. That is, even though we do not get a quantitative
probability by the process of grouping, still there is some
tendency for fluctuations to cancel out and for the result
to approach constancy in some degree. There appear to
be in the making of judgments the same two kinds of
elements that we find in probability situations proper;
i.e., (a) determinate factors (the quality of the judging
faculty, which is more or less stable) and (b) truly acci-
dental factors varying from one decision to another accord-
ing to a principle of indifference. The difference between
the uncertainty of an opinion and a true probability is that
we have no means of separating the two and evaluating
them, either by calculation a priori or by empirical sorting.
But in the second case the difference is not absolute; the
sorting method does apply to some extent, though within
narrow limits. Life is mostly made up of uncertainties,
and the conditions under which an error or loss in one case
may be compensated by other cases are bafflingly complex.
We can only say that "in so far as" one confronts a situa-
tion involving uncertainty and deals with it on its merits
as an isolated case, it is a matter of practical indifference
whether the uncertainty is measurable or not.

The problem of the human attitude toward uncertainty
(not for the present purpose distinguishing kinds) is as
beset with difficulties as that of uncertainty itself. Not
merely is the human reaction to situations of this character
apt to be erratic and extremely various from one individual
to another, but the "normal" reaction is subject to well-
recognized deviations from the conduct which sound logic
would dictate. Thus it is a familiar fact, well discussed by
Adam Smith, that men will readily risk a small amount in
the hope of winning a large when the adverse probability
(known or estimated) against winning is much in excess of

336 RISK, UNCERTAINTY, AND PROFIT

waves. It is like the oft-cited advance of the tide up a
beach, advance and recession alternating and obscuring
even the fact that a small gain of an occasional wave con-
stitutes a net advance. Economic progress under real con-
ditions shows similar advance and recession, proceeding in
cycles of a character now fairly well understood, but of such
uncertain length that the consequences at the turning-
points are often catastrophic. A large part of the phenome-
non is due to the fact that the creation of new capital is so
closely bound up in the issue of circulating medium by
commercial banks. Price levels and profit margins being
even more dependent on this precarious exchange medium,
the operations of business proper find themselves tied up to
the tendencies of a credit currency under private control to
expand to a point of instability and under the least shock
to collapse. These phenomena enormously increase the
uncertainty of business operations and create opportunities
for making large gains through the exercise of superior
foresight or by good luck.1

The above description of the uncertainty relations of
one of the elements of social progress, brief and inadequate
as it is, must suffice for the present sketch. Moreover, the
other progress factors, though more complicated and diffi-
cult of treatment, will have to be disposed of very briefly by
a mere indication of some of the similarities to and con-
trasts with the growth of capital. The increase of popula-
tion may be briefly handled. In the aggregate, it is not
subject to enough uncertainty to produce any noticeable
effect on the organization of society. Over long periods the
general increase, if it proceeds faster than new lands are
opened, as it has since the industrial revolution, causes a

1 Davenport (Economics of Enterprise) has emphasized the fact that
the short-period changes in the interest rate are due to changes in the
supply of bank funds. He is to be criticized for failing to make it clear
that the long-time questions must be handled along wholly different lines.
Cf. also Moulton, "Commercial Banking and Capital Formation,"
Journal of Political Economy, 1918, pp. 484 ff., 638 ff., 705 ff., 849 ff.

UNCERTAINTY AND SOCIAL PROGRESS 337

rise in the value of "land." This change, however, as an
aggregate is so far overshadowed by the differences in the
changes at different locations that it may be passed over.
There is little question that in fact speculators in land
make on the whole less than the competitive return on their
investment, though this is difficult to prove conclusively.
The outstanding phenomenon is the large gains and losses,
especially the large gains from a few fortunate investments
in real estate held over a period of generations by the same
families. We shall recur to this theme in the next chapter.
It is clear that the main cause of the differential rates of
value increase is another one of our progress factors, the
redistribution of the population over the soil. The mixture
of foresight and pure luck in the production of gains from
such uncertainties is an interesting question, but one about
which there seems to be little comment worth making. An-
other phenomenon in connection with the increase of pop-
ulation over long periods is the redistribution of wealth
and probably of ability among individuals. We know that
the wealthier families increase much more slowly than the
less wealthy, and there is every reason to believe that the
same applies to the more as compared with the less cap-
able. As wealth and ability are both inherited in varying
degrees the consequences are obtrusive, in their general
character at least. These facts do not affect the form or
theory of competitive organization, but as they modify the
material upon which the mechanism works the results are
none the less subject to change.

Another progress factor, the increase in the available
supply of natural resources, has been referred to incidentally
above, and as the relations of "land" to "capital" were
discussed in an earlier chapter, this topic need not detain
us long. Discovery of new natural wealth may result from
pure accident, in which case its value is all pure profit,
which in consequence of the principle of capitalization may
be cashed in at once by the finder. But this is not what

338 RISK, UNCERTAINTY, AND PROFIT

usually happens. In the case of agricultural land the con-
ditions and rewards of pioneering are fairly ascertainable.
If any profit results from these operations it is an exceptional
case or else it is remuneration for some special sacrifice
undergone; i.e., is not a profit at all. With mineral re-
sources things are different. Here there is an enormous
amount of complete unpredictability. Under old-fashioned
methods there is no question that prospecting for the pre-
cious metals involved in the aggregate enormous losses.
In regard to other minerals, coal, oil, iron, copper, etc., the
present writer has no ground for forming an opinion, but
would " guess* ' that the search for these things being less
feverish, the accidental gains are much less in arrear of the
losses. Recently the search for precious metals has been
placed on a much more scientific basis and there is doubt-
less in the aggregate less discrepancy than formerly be-
tween the returns realized and a normal competitive re-
turn on the resources invested.

The point which calls for emphasis is that where the
possibility of securing wealth by the discovery of natural
resources is known, along with something of the operations
and outlays required, resources will be attracted into the
field of searching for them in accordance with men's esti-
mates of the chances of success in relation to the outlays to
be incurred. The quest of wealth by this process thus be-
comes to those engaged in it an ordinary business opera-
tion, differing from the routine production of goods for
immediate consumption in no matter of principle, though
perhaps affected by a larger degree of uncertainty. And
the same organization devices will be called into existence to
deal with the uncertainty present — large-scale operations,
the use of insurance where possible still further to broaden
the base of the calculations, scientific research into the
conditions of prediction and control of results, etc. Entre-
preneurs engaged in exploration and development work
bid in the same market against entrepreneurs in the fields

UNCERTAINTY AND SOCIAL PROGRESS 339

of static industry for the same fundamental productive
resources, and competition must fix a uniform price for
both uses and bring about the same tendency to equality of
cost incurred with output secured over the whole field of
investment.

Another factor of progress having exceedingly complex
uncertainty relations is the changes in human wants.
These changes, again, may just happen, accidentally, or
they may take place more or less in accordance with law
and hence predictably, or they may be deliberately brought
about by the expenditure of resources for the express pur-
pose of effecting such a change. If they happen unexpect-
edly the disturbances in incomes and capital values which
result must be classed as pure profit or loss./fn so far as
they can be foreseen, no profit will be realized. In so far
as they result from a deliberate expenditure of resources,
they become as all other economic operations. The amount
of profit realized will then depend on the effectiveness of
competition based on foreknowledge of the results of the
activity. In this respect the "production" of wants is like
the production of goods. In fact, as we have previously
observed, the advertising, puffing, or salesmanship neces-
sary to create a demand for a commodity is causally in-
distinguishable from a utility inherent in the commodity
itself. ^

The last progress factor calling for notice is that of
knowledge, or what may be designated by the term "in-
vention" taken in a broad sense. It is a commonplace fact
that one of the chief sources of uncertainty in business life
is the improvement of technological processes, methods of
organization, and the like. It is difficult to draw a rigid
distinction in principle between the discovery of new facts
and the production of change in the facts themselves as
objects of knowledge. It is plain that the finding of new
natural resources is equivalent to their creation and the
difference in the case of human wants is also rather hazy

340 RISK, UNCERTAINTY, AND PROFIT

and metaphysical. The important "practical difference
between discovery and creation relates to the matter, re-
ferred to in a previous chapter, of the cost of reproduction
of ideas as compared with things. The knowledge of a fact
may be extensible almost without cost throughout the
membership of competitive society. Of course — and this
is an observation which students of the phenomena have
neglected to make — it also may not be of this character;
it may cost as much to get an idea into a head as it does
to get matter from one form into another, and it always
does cost some expenditure of energy somewhere. In
general, however, a competitor can get the idea of a new
method or process at less cost than he can get new material
equipment, provided energy is not expended in preventing
him from doing it. Moreover, the mere gratification of
curiosity may be ample compensation for the effort re-
quired to get an idea, so that this cost can be entirely
neglected or may even become negative.

The essential facts about new knowledge for our pur-
poses center around the qualities of the productive equip-
ment, including laborers, requisite for carrying it into
effect. A new process usually calls for changes in the forms
and attributes of productive agencies and necessarily in-
volves new combinations among these. In very simple
cases, however, little may be involved beyond new manipu-
lations of old things. Like all the other phases of progress
this one may result from accident or from the planned ex-
penditure of existing resources. Even in the case of ac-
cident we cannot say that anticipation of and allowance for
the change is entirely eliminated. For it is not meaningless
to assert that even of things beyond our knowledge or
control some are more likely to happen than others. We do
make such judgments and in the large they are probably
more right than wrong, however mysterious may be the
basis upon which their value rests. In so far as the prob-
ability of a discovery can be estimated it is evident, as in

UNCERTAINTY AND SOCIAL PROGRESS 341

the case of progressive changes previously discussed, that
entrepreneurs will make allowance for its effects and in so
far it will in the aggregate cause no competitive maladjust-
ment and produce no discrepancy between the prices paid
by entrepreneurs for productive services and the prices
received for their products. The value of such estimates is
naturally very small, and we may assume that most of the
offsetting of gains and losses from disturbances due to
accidental discoveries is itself accidental and not the result
of calculation.

In the case of new knowledge which is the result of
deliberate thought, investigation, and experiment, the
element of predictability is of course greater. As inscrutable
as with accidental discoveries, almost, are the operations
by which we form an estimate of the chances of success in
such operations, but the fact is inescapable that we do
form such estimates and that they have considerable value.
Much scientific and business research is now carried on
under some approximation to competitive conditions by the
employment of large-scale methods. That is, it is possible to
foresee the average long-run results of the operations with
sufficient accuracy to cause the employment of resources in
the field up to a point where the return is approximately
equated with the return from the same resources in the
general competitive market. In any case it is clear that in
so far as the results can be predicted the investment of re-
sources in the acquisition of new knowledge will be so ad-
justed as to equate the return with the general competitive
level, which is to say equate realized values to costs and
eliminate profits.

The matter is indeed frequently, if not usually, com-
plicated by the very low cost of indefinitely multiplying an
idea when it is once secured. As a consequence of this fact
the inventor or discoverer usually has to make some special
provision to limit the use of his results to his own business
operations. In certain fields this can be done through legal

342 RISK, UNCERTAINTY, AND PROFIT

protection granted by the State in recognition of the value
to society of the service. In others artificial measures for
secrecy must be taken. In many cases no direct safeguards
are available and the economic profitableness of the idea is
limited to the period of time required for competitors to
copy the new method. Regular commercial research in
these fields is doubtless rare. Even legal protection is valid
only for a limited period of time and secrecy cannot often
be permanently maintained. When the idea becomes
common property it is like any other superabundant
element in production, a free good and no longer a pro-
ductive factor in the effective economic sense.

It may often happen, however, that one of the results of a
new departure is greatly to increase the value of some lim-
ited kind of material or human productive service. If this
service be that of a non-reproducible natural agent the
inventor may permanently secure that part of the value of
his idea by purchasing such property. If the gain attaches
to reproducible property he may prolong his differential
gain by the period required to increase the supply, and
even in case of a specialized human service a long-time
contract may sometimes be utilized to retard diffusion of
the results of superior methods. As observed in our dis-
cussion of monopoly it is immaterial whether we regard
these cases as monopolization of the idea or method as such
or as monopolization of the limited resources necessary for
its exploitation. The losses which are equally likely to re-
sult from inventions fall upon the owners of the specialized
human qualities or equipment goods.

Discussion of the conditions of permanence of the gains
from improved methods of production leads naturally to
the consideration of the general subject of economic
friction and its opposite, mobility. We have already ob-
served that the advocates of the "dynamic" theory of
profit, the theory that profit is the result of progressive
change, give an exceedingly important place to the phenom-

UNCERTAINTY AND SOCIAL PROGRESS 343

enon of friction in their analysis.1 In this view, indeed,
friction is a necessary condition to the occurrence of pro-
fit, as it is expressly stated that in the absence of friction
profit would disappear as fast as it appeared and that it
does constantly slip through the fingers of the entrepre-
neur and spread over society at large as fast as the friction
can be overcome.

It will be apparent as soon as pointed out that this ar-
gument uses "friction" in an inadmissibly inclusive sense.
To explain profit thus in terms of friction, the term must
be made to cover every form of resistance to change and
readjustment in productive operations. That is, to get rid
of profit by eliminating friction, it would be necessary not
merely to have a perfect market, perfect competition, and
costless mobility, but in addition it would have to be possi-
ble without the consumption of time or effort to change the
form of capital equipment and goods in process, not to
speak of natural agencies and the existing labor force. In a
world where this could be done, it is manifest that there
would be no need for productive effort of any kind. Per-
haps we may distinguish between the readjustments in-
volving only the moving about and recombination of pro-
ductive agencies of all kinds and those calling in addition
for substantial alteration in the form of things. The latter
it is clearly inadmissible to class under the head of over-
coming "friction." But the same may be said even of
mere movement of things. This also is a productive trans-
formation, and undoubtedly the greater part of ordinary
productive activity comes under the head of transporta-
tion, taken in a broad sense.

It is necessary to take up the problem under the heads
of the different types of production costs and investigate
the forces which retard the readjustment of each type to
correspondence with the value of the productive contribu-
tion of the agency to which the payment is made. The
1 Cf . above, p. 34 f.

S44 RISK, UNCERTAINTY, AND PROFIT

first and simplest readjustment is that of values of services
which undergo no change in either form or position as a
result of the introduction of new methods. A new dis-
covery will, as already noted, increase the value contribu-
tions obtainable by the use of some agencies and decrease
those of others. It will ordinarily be true that changes in
the market prices of these services will lag appreciably be-
hind the changes in their theoretical values to the entre-
preneur. Many of them are hired under contracts cover-
ing a longer or shorter period of time which prevent sudden
changes in their rate of remuneration. During any such
interval the employing entrepreneur must, of course, make
a gain or loss by their use.

And even where the factor of a time contract does not
enter, there will probably be a lag in the prices of produc-
tive services, i.e., in the costs of production, as compared
with commodity prices. The former are, of course, in the
aggregate caused by and reflected from the latter and the
forces of competition which impute commodity values to
the productive services upon which production depends do
not operate instantaneously. The chief cause of this lag is
again the difficulty and uncertainty of knowledge; it takes
the owners of productive services and entrepreneurs some
time to learn the facts. Most of this learning has to be done
by crude and rather slow trial-and-error methods; there is
generally no possibility of computing results in advance. In
the interval necessary for every one to find out the exact
relations of dependence between product values and the
employment of each resource and of working out an ideal
adjustment, it is clear that there will be many discrepancies
between entrepreneurs' outlays and their returns, i.e.,
many occurrences of profit, positive or negative.

A somewhat special case is presented by goods in pro-
cess when new methods are introduced. The general tend-
ency must be to decrease the values of most of these,
though not necessarily of all. The loss will fall on the

UNCERTAINTY AND SOCIAL PROGRESS 345

owner in whose hands they are when the price change
takes place, which may not be the owner at the time the
new process is invented, for these price changes will also
lag more or less. The loss in value will depend on several
factors, the amount of superiority of the new process over
the old, the amount of difference between the old inter-
mediate goods and the corresponding new ones, and the
possibility, and the cost, of changing the old intermediate
goods in a way to have the manufacture carried to comple-
tion by the new process.

Material productive goods will fall more or less under
the same head as goods in process according as they are or
are not reproducible, short-lived, and amenable to change
in form. We have seen that the difference between capital
and land is one of degree, depending on these qualities in
the agent. At one extreme, capital is typified by goods in
process. At the other, "land" consists of these agencies
whose supply is most rigidly fixed, the nearest approach to
the theoretical limit being the element of site value. Tak-
ing this extreme first, a piece of pure land will gain or lose
the capitalized value of the change in its income as soon as
this is accurately adjusted. With ordinary capital equip-
ment, allowance must be made for the life of the agency
and also for the possibility and cost, including the time re-
quired, to adapt it to the new conditions. The adaptation
may include both movement from one situation to another
and change in form. Even a revolutionary invention,
making buildings and machinery worthless for use in their
present form, does not usually destroy all their value. At
worst a scrap value of the material is recoverable of the
original free capital invested in them.

Laborers present a still different case. The only thing to
be considered from the standpoint of economic organiza-
tion is here the lag in the readjustment of wages to the new
real value of labor. Changes in the value of specialized skill
accrue to the laborer as an individual only and cannot be

346 RISK, UNCERTAINTY, AND PROFIT

capitalized. The same facts as to possibility of readapta-
tion hold good as in case of material equipment goods, but
again this is a matter of the individual's own personal
economy and does not affect entrepreneurs. The peculiari-
ties of labor in relation to readjustments form one of the
main sources of injustice and hardship in an individualist
economy. The risk of loss in the value of acquired knowl-
edge and training means a constantly impending threat of
indigence. Laborers are attached to their homes and even
to their work by sentimental ties to which market facts
are ruthless. But these matters hardly call for detailed dis-
cussion in a study of the present sort.

CHAPTER XII

SOCIAL ASPECTS OF UNCERTAINTY AND PROFIT

Uncertainty is one of the fundamental facts of life. It is
as ineradicable from business decisions as from those in
any other field. The amount of uncertainty may, however,
be reduced in several ways, as we have seen. In the first
place, we can increase our knowledge of the future through
scientific research and the accumulation and study of the
necessary data. To do this involves cost, the expenditure
of resources which must be drawn from other uses. An-
other way is by the clubbing of uncertainties through large-
scale organization of various forms. This operation also
involves costs, and not merely in the sense of expenditure
of resources. There is also to be considered the loss of
individual freedom involved in any possible plan of or-
ganization, a loss for the great mass of persons affected,
though possibly a gain for a few who may secure wider
powers and a larger range of action from the concentration
of authority.

In the third place it is possible, also at a cost, to increase
control over the future. And here again both sorts of costs
must be faced, substantive outlays and human losses
through organization. Finally, uncertainty might be fur-
ther reduced almost indefinitely by slowing up the march
of progress, which, of course, involves a direct sacrifice in
addition to both the forms of cost already noticed.

All these proposals raise the fundamental issue as to the
essential evil of uncertainty, how great it is and hence how
much we can afford to sacrifice in other ways in order to
reduce it. In this sort of calculation as in all economic
problems we are dealing with a question of proportioning
alternatives subject to a principle of diminishing relative

348 RISK, UNCERTAINTY, AND PROFIT

importance. It would doubtless be possible to use all the
resources of society with more or less effect in reducing un-
certainty, leaving none for any other use. It is a question of
how far to go. The question is complicated by the fact
that the use of resources in reducing uncertainty is an opera-
tion attended with the greatest uncertainty of all. If we
are uncertain as to the results of ordinary business opera-
tions we are doubly so as to the results of expenditures
along any of the lines enumerated looking toward the in-
crease of knowledge and control.

Quite as important as the question of reducing uncer-
tainty is that of its distribution. This question raises again
the same fundamental issue, this time from the individual
point of view instead of the social, as to the intrinsic desir-
ability of reducing uncertainty. How far the burden
should be equalized, how far concentrated or specialized,
depends on the individual attitude toward uncertainty,
and especially on the tendency of the irksomeness to
increase as the amount of uncertainty faced by an individ-
ual increases, and vice-versa. The steeper the curve of in-
creasing disutility the more we must favor a relative dis-
persion of the burden. It is perhaps obvious that high
degrees of "risk" are more irksome; most of us are reluc-
tant to jeopardize our lives or the elemental requirements
of life. But it is also evident that individuals differ widely
in the extent to which they find this true. We have already
noted the more or less paradoxical fact that the very idea of
intelligent conduct implies an effort to reduce uncertainty,
while none the less we recognize, on any calm, cool contem-
plation of the matter, that a life with uncertainty elimin-
ated or perhaps even very greatly reduced would not appeal
to us.

There is a close connection between the two notions, re-
ducing the absolute amount of uncertainty on the whole
and distributing it, for most methods of reducing it effect
either a concentration or a distribution. On this head there

SOCIAL ASPECTS 849

seems to be no generalization which can be made with
confidence and which is worth making.

It is not too much to say that the very essence of free
enterprise is the concentration of responsibility in its two
aspects of making decisions and taking the consequences
of decisions when put into effect. It is therefore of the ut-
most importance to inquire critically and carefully into the
facts as to the results of such a concentration in compari-
son with any possible alternatives. At the outset we shall
raise no question as to large-scale industry; and it is evi-
dent that if we are to have large-scale organization with its
advantages in efficiency we must assume a corresponding
degree of concentration of control in the immediate sense
of executive direction. This, however, as we have been
especially concerned to emphasize, does not necessarily
mean concentration of responsibility. We have seen that
practically all human activity, even that of the purest
routine character, is in some manner and degree forward-
looking and involves meeting unexpected situations and
making decisions. But these decisions do not necessarily
involve responsibility. The outstanding feature of free
enterprise organization is the transfer of the lower grades
of responsibility to men whose decisions relate to the selec-
tion of men for the places under their control and to answer-
ing occasional questions in regard to exceptional contin-
gencies. The two functions are, indeed, never quite sepa-
rate. The ultimate responsibility consists chiefly in the
selection of a man or a very few men to "organize" the
establishment. But the ultimate authority usually if not
always exercises some direct control over business policy.
In most cases also the higher officials of an enterprise have
a direct stake in the business beyond their fixed salaries.
And down through the organization the subordinate func-
tionaries may be said to have responsibility in the sense
that the results which they secure must come up to the ex-
pectations of their superiors or they will lose their positions.

350 RISK, UNCERTAINTY, AND PROFIT

In the existing system of things the ultimate responsi-
bility centers almost altogether in the ownership of the
property "at risk" in the business. There are infinite vari-
ations and complications in the distribution of "risk" and
control, but the general tendency is clear. The lower grades
of labor take practically no risk and exercise correspond-
ingly little control, and the same is only less true of the
higher grades and of borrowed capital. We must remember
that the two things, uncertainty-bearing and responsible
control, are inseparable; in so far as the reward of any
service is contingent upon the success of the undertaking,
the owner of that service, in consenting to its employment
for a contingent remuneration, exercises judgment and
wields power over the enterprise. But the greater part of
the uncertainty and power are centered in the ownership
of certain property which is placed in the position of guar-
anteeing the contractual income of the other property and
that of the labor used in the business.1

1 Limited progress has been made in some countries in the development
of organizations of laborers which engage in enterprise independently,
borrowing any necessary capital and hiring supervision at fixed rates.
Cooperative production in the ordinary sense may also be referred to, but
neither of these cases affords a notable exception to the above generaliza-
tion as the laborers borrow very little capital. It is one of the defects of
our civilization that mechanism has not been involved to enable human
ability to hypothecate its productive power in procuring resources to
make it effective under its own direction and responsibility.

A notable tendency in modern business development is to specialize
and subdivide uncertainty and control in all possible degrees. Corpora-
tions multiply securities representing every conceivable gradation from
the position of a pure creditor with absolute safety and complete indiffer-
ence to the conduct of the business at one extreme to risk and control so
highly concentrated that slight fluctuations in earnings make the differ-
ence between high dividends and assessments at the other. In mercantile
business and even in industrial concerns credit instruments pass through
the hands of a lengthening series of middlemen who add their guarantees
of soundness and pass them on at a little higher price or lower return.
Bond houses, bill brokers, and acceptance banks are an interesting de-
velopment in this field. In the labor field the same tendency is manifest.
Intermediate employers may hire labor for re-hiring to actual exploiters,
as in the familiar case of the padrone, and in some lines of professional

SOCIAL ASPECTS 351

We shall not attempt to take up all the possible or actual
arrangements in regard to responsibility and control, but
shall limit the discussion to the general problem of con-
centration of uncertainty. It will be kept in mind that the
basis of effective assumption of responsibility is necessarily
either the ownership of property or the creation of a lien on
future human productive power and is in fact almost alto-
gether the former. Another preliminary reservation is that
in a sense ultimate control rests with the consumer. But
in so far as economic organization takes the form of free
enterprise this control is exercised only after the fact, and
the responsibility we are concerned with is that of meeting
the consumer's demands at the end of the production proc-
ess. We assume, then, that the entrepreneur system of
organization, with production for the market imperson-
ally, and concentration of direction, arises because it is
superior to, or more satisfactory all around than any other
free contract system. And the first step in our inquiry will
be a brief examination into the meaning of free contract.

With the possible exception of the word "cause" and its
equivalents, it is doubtful if there is a more abused word
than "freedom"; and surely there is no more egregious
confusion in the whole muddled science of politics than
the confusion between "freedom" and "freedom of con-
tract."1 Freedom refers or should refer to the range of
choices open to a person, and in its broad sense is nearly
synonymous with "power." Freedom of contract, on the
other hand, means simply absence of formal restraint in
disposal of "one's own" It may mean in fact the perfect
antithesis of freedom in the sense of power to order one's
life in accordance with one's desires and ideals. The actual
content of freedom of contract depends entirely on what
one owns.

work. Every development of profit-sharing is similarly a redistribution of
risk and control.

1 Sir H. S. Maine and Herbert Spencer are especially responsible for
this vicious and question-begging perversion of thought.

352 RISK, UNCERTAINTY, AND PROFIT

Ownership, as we have seen, consists essentially of the
combination of the rights of control and of usufruct. The
point to be emphasized here is that in a social system based
on pure freedom of contract, ownership and control are
interchangeable terms;1 there is no other form of control.
To be sure, there would have to be a "state" of some sort,
an authoritative organization, to maintain such a system,
but its sole function would be the enforcement of contract
and prevention of non-contractual relations. Its necessity
arises from the fact that contracts are not often executed
on both sides simultaneously and the further fact that men
might prey upon each other. That is, the role of the State
in such a system would be merely to restrict human rela-
tions to the mutually voluntary, or contractual. In such a
system, to repeat, those who owned nothing could not
exist unless by the sufferance and generosity of those who
did own, and the amount of freedom possessed by any per-
son would be equal to the amount of his ownership.

Now, what one owns is under ideally simple conditions a
result of three factors. The first and by far the most im-
portant is the historical "brute fact" of what he has "to
begin with," his inheritance from the past. This is purely
a matter of status — hence the fundamental absurdity of
Maine's contrast between status and contract as descrip-
tions of the position and condition of the individual. All
free contract can mean is that status can be changed by
voluntary agreement with another party, and cannot be
changed without one 's consent. The second factor in owner-
ship is thus the result of previous contracts. And the
possibility of change in status by mutually voluntary agree-
ment depends on one's status — i.e., what one owns — at

1 It is obvious that pure freedom of contract is impossible in a con-
tinuous society, as children and the aged and many others can control
nothing. In order to deal with the concept in a pure form we are com-
pelled (see chapter iv) to assume that all dependent persons were ab-
solutely dependent, which is to say virtually "owned" by the freely con-
tracting members of the society.

SOCIAL ASPECTS 353

the time of the agreement, and hence finally on what one
owned to begin with. The third factor in ownership or
present status is change resulting from the voluntary and
independent employment or transformation by utilization of
one's own in the past. This element is also clearly a matter
of change only, going back to initial status or what one
owned to begin with. In a pure free contract system there
is no power (control) except ownership; only change in
ownership (which is to say really in status) has any con-
nection with the exercise of free choice, and the range of
choice depends absolutely on previous status and hence
ultimately on the initial status in which the individual finds
himself on his first entry into the system of contracting
persons.

All the above, however, assumes that contracts and the
activity directed to increasing ownership by "productive"
transformation of what one already owns are intelligently
carried out. In the world as it is, where all human designs
and acts are fraught with uncertainty, a fourth factor must
be added, the result of luck. Furthermore, we are still as-
suming complete independence and non-interference among
the contracts and activities of different individuals. In the
world as it is the interests affected by contracts are never
all represented in the agreements. This is really a limita-
tion on the assumption of pure freedom of contract, a fail-
ure to restrict human relations to the mutually voluntary
sphere, but it is a fact which has to be taken into account,
like deliberate predation.

These facts are so obtrusive that no one has in practice
ever advocated pure freedom of contract, the restriction of
the action of society as a whole to the negative function of
preventing non-contractual relations. No question is ever
actually raised as to the State limiting freedom of contract
in many directions and encouraging agreements of other
sorts. It also necessarily appropriates through taxation
a considerable part of the usufruct of things privately

354 RISK, UNCERTAINTY, AND PROFIT

"owned," thus modifying ownership in both its phases.
And this modifying influence on private property extends
rapidly in scope as the laissez-faire theory of the State loses
ground in the modern world.

It is a fundamental fact that the possible objects of
ownership fall into two main classes, personal powers in-
herent in the individual, and material things. If an in-
dividual does not have some form and degree of ownership
in the former he is a slave, the property of some outside
party, and outside the system altogether. The modern
world is, of course, pretty well committed to private prop-
erty in the individual's own personal powers in all adults
not dangerously abnormal or incompetent, subject only to
general limitations. It is difficult to secure effective utiliza-
tion of these under any other system, and the live questions
relate only to the ownership of material things.1 We have
seen in different connections that the importance of the
difference between these two classes is at least much ex-
aggerated, that generic natural differences are hard if not
impossible to find in relation either to their cause-and-
effect bearings on price theory and economic organization
or to their moral standing. The conditions of demand,
conditions of supply, and relation to the possessing individ-
ual turn out on examination to be much alike, and differ-
ences which exist at all are mostly artificial and conven-
tional. But from the standpoint of our human interests
outside the production and consumption of goods we must

1 We make no distinction between natural agents and produced equip-
ment goods, as we have shown that under competition no final distinction
can be drawn between preemption and production. (See the discussion of
land and capital in chapters iv, v, and xi.) In this connection we may
remark here that we are not necessarily in disagreement with a separation
of land from capital from the point of view taken by Marshall (Principles
of Economics, book iv, chap. i). From the standpoint of a single political
unit occupying a limited area of the earth whose natural resources are
thoroughly explored, they stand in a different relation as to new supply
from that which they occupy in a world economy or a vast and relatively
new country like the United States.

SOCIAL ASPECTS 355

recognize that the ownership of one's self is in a somewhat
higher position than the ownership of external objects.
Yet in a civilization where man is highly and increasingly
dependent on access to and use of material things for his
very life this distinction tends to fade out, and recognition
of this fact accounts for much of the current ferment and
change in the social attitude toward "property" (used
narrowly as property in things).

Another line of argument on the question of the relations
between ownership of one's own powers and ownership of
material things follows somewhat parallel lines to a some-
what similar uncertain or negative conclusion, beginning
from an opposed point of view. The starting-point of our
inquiry is the fact, clearly brought out by our study of
enterprise, that the drift under non-interference is toward
placing the control of industry, the ultimate entrepreneur-
ship, in the hands of property-owners and not the owners
of the human services, the workers. The ostensible reason
for this is that a business venture offers opportunity for
actual absolute loss, as well as merely a greater or less gain,
and that only property can in the nature of the case make
the guarantees against this net loss. This fact seems at
first sight to afford the basis for another distinction be-
tween labor and property services, namely, that laborers
are only used in industry, while material goods are used up,
that only the services are consumed in the one case, while
the thing itself may be destroyed in the other.

A little critical reflection will show that this also is not
really the case. Perhaps it ought to be so, but it is not, and
cannot be. In the first place, the risk of destruction and to-
tal loss is perhaps as great in fact in the case of the laborer
as in the case of the property-owner, and where in the latter
case the owner loses only productive power the former
loses health or bodily members or his life, which mean
vastly more. The real merits of this situation are also being
recognized by society and we see the growth of legislation

356 RISK, UNCERTAINTY, AND PROFIT

designed to transfer the hazard of loss of the economic
value of the laborer as a productive agent (and this only, so
far) to the business and through it to the consumer of the
product. There is another side to the question in the haz-
ard of loss of specialized skill and training. These are ac-
quired in connection with and for use in the particular
business. The cost of acquisition is borne chiefly by the
worker and if the business proves unprofitable, the loss
generally falls on him. Yet these "risks," seemingly so
much greater than those incurred by the property-owner,
do not carry with them the control of the business, nor do
the bearers of the risks even secure under competitive free
contract (as is perfectly well known) anything like fair com-
pensation in the form of a higher contractual return. And
it must be added that the actuarial value of the worker's
risks depends quite as much on the quality of the manage-
ment as is the case with those of the owner of material
property.

The only visible explanation of this state of things is an
appeal to a "fact of human psychology" that the owners
of "things" are less willing to trust those "things" to the
control of others without an adequate guarantee in kind
than are men who own only themselves to hazard such
outside control without even the poor safeguard of a
guarantee against economic loss.1

It is manifestly impossible to carry on production with-
out incurring both sorts of uncertainties, uncertainty as
to the results and as to the preservation intact of the means
of production employed, both human and material. Since
production must precede consumption and requires time,
all those concerned in it must be maintained during the
production period out of the fruits of previous production.
And these products must be advanced by those who own

1 It is interesting to observe the concern of the management for the
personal security of the workers brought about by compensation laws,
and especially the remarkable results of the "safety first" movement in
reducing accidents.

SOCIAL ASPECTS 357

them. It is not physically necessary that they be per-
manently hazarded by the owners, that the actual pro-
ducers should get their entire wage in advance of the com-
pletion of the process, but this is the way it works out
under free contract. Nor is it inevitable that these products
be owned by any individuals at all, a point which we must
next take up. At the same time the chance of loss of equip-
ment must be borne, temporarily, by those who have
equipment to lose, if equipment is privately owned. The
permanence of the loss to an individual owner is not
physically prescribed, in case of the owner of material
things or of human powers in their purely economic aspect.
But this again is the way it does work out under the "ob-
vious and simple system of natural free contract." We
must now glance briefly at the social bearings of free con-
tract in a more fundamental sense.

There is naturally no intention of implying that freedom
of contract is to any appreciable extent a result of the de-
liberate adoption by society of a reasoned policy of organ-
ization. However, the continuation of the system is a
question which has been much discussed on its merits and
which may ultimately be decided on the basis of discussion.
To discuss the issue systematically we shall first eliminate
and postpone for later notice the point as to personal self-
ownership and limit ourselves provisionally to the owner-
ship of material productive goods, the more or less live
issue between individual and social property in these things.
And we must further distinguish at the outset between two
different and to a large extent opposed sets of interests
involved in social organization. The conventional view
in economics treats social organization as a mechanism for
the satisfaction of "wants" which are assumed to be fixed
conscious desires and tendencies to action, subject to the
principle of diminishing relative utility. The limitations of
this view have been emphasized throughout our study, but
we have to consider this aspect of economic life in purity

358 RISK, UNCERTAINTY, AND PROFIT

and isolation if we are to use the scientific method of
analysis. Other interests are just as fundamental, notably
the desire for freedom and power for their own sakes and
the preference for certain qualities of human relations. It
is largely this second set of interests which, directly and in-
directly, have finally abolished slavery and established self-
ownership.

Viewing society, then, as a want-satisfying machine and
applying the single test of efficiency, free enterprise must
be justified if at all on the ground that men make decisions,
exercise control, more effectively if they are made respon-
sible for the results of the correctness, or the opposite, of
those decisions. If property were socialized we should still
have to concentrate the function of the actual making of
decisions, but it would be in a far greater degree than now
a routine task, with the remuneration independent of the
results. In the light of our previous discussion there is a
difficulty here and we must be careful to make the meaning
clear. Two things, specifically, would happen. Businesses
in which men now work directly with their own resources
would be transformed into public enterprises under the
management of hired functionaries. In this case the nature
of the change is clear enough. More obscure is the case of
the corporation, now controlled by a hired manager. Here
the change is the substitution of the public, organized in
some political way, for the stockholders, and the position
of the immediate decision-maker is superficially not much
changed.

But only superficially. It is true that the growing simi-
larity of large-scale business to the political democracy is
one of the socialist's strongest arguments against a prob-
able loss of efficiency in the exchange of private for public
ownership. But we must emphasize the fact that the simi-
larity is much exaggerated — in fact by both parties to
the controversy, from different motives, of course. The
insistence on the large number of stockholders in some of

SOCIAL ASPECTS 359

our great corporations is definitely misleading. Most of
these do not regard themselves and are not regarded as
owners of the business. In form they are such, but in sub-
stance they are merely creditors, and both they and the
insiders count upon the fact. The great companies are
really owned and managed by small groups of men who
generally know each other's personalities, motives, and
policies tolerably well. Hence in the first place the salaried
manager under a socialist government, whether appointed
by a political superior or chosen in some way by a democra-
tic constituency, would really be in a very different position
from the president or manager of a present-day corpora-
tion. He could not conceivably be so directly accountable
to the ultimate entrepreneur, society, as he now is to the
ultimate entrepreneur, the small group of "insiders" who
are the real owners of the business.

But the greater change would consist in the substitution
of the public at large for the small group of owners. The
main difference is an inevitable concomitant of the mere
size of a group. The insuperable difficulty of cooperative
production has been to make the individual feel that the
results depend upon his own activity. The individual feels
lost in the mass, helpless and insignificant. Political dem-
ocracy, of course, encounters the same difficulty. Perhaps
we may believe that some progress is being made in solving
the problem in the political sphere where decisions are
really much less important in that the alternatives among
which choice is made relate to less vital matters. If so, it
may be possible that some generations of political democ-
racy might train the individual in a sense of personal re-
sponsibility which would make industrial democracy more
feasible.

But this is at best an exceedingly superficial view of the
problem. At bottom it is a matter of feeling for the large
property-owner as well as for the masses served by in-
dustry. He is really a social functionary now. Private

360 RISK, UNCERTAINTY, AND PROFIT

property is a social institution; society has the unquestion-
able right to change or abolish it at will, and will maintain
the institution only so long as property-owners serve the
social interest better than some other form of social agency
promises to do. Of course there is a lot of moral flub-dub
about natural rights, sacred institutions of the past, etc.,
and it has some power to hold back social change. But in
the end, and a not very distant end either, the question will
be decided on the basis of what the majority of the people
think, in a more or less cold-blooded way, about the issues.
If we get more effective management through the system of
concentrated private ownership than we would through
some democratic machinery, it is because men plan better
when they do not feel like government officials doing things
for other people, when they feel their work as their own and
identify their personalities with it.

And this even though the same men know "in their
hearts," subconsciously if not consciously, that they are
the agents of the democracy and ultimately responsible
to it for their trust. For it is clear that the "personal"
interests which our rich and powerful business men work
so hard to promote are not personal interests at all in the
conventional economic sense of a desire to consume com-
modities. They consume in order to produce rather than
produce in order to consume, in so far as they do either.
The real motive is the desire to excel, to win at a game,
the biggest and most fascinating game yet invented, not
excepting even statecraft and war.

The suggestion which inevitably comes to mind is that a
democratic economic order might conceivably appeal as
effectively to the same fundamental motives. What is
necessary is a development of political machinery and of
political intelligence in the democracy itself to a point
where men in responsible positions would actually feel
their tenure secure and dependent only on their success in
filling the position well. It is not mainly a matter of

SOCIAL ASPECTS 361

salary, though undoubtedly such men would have to live
conspicuously well in an economic sense also — just as the
officials of our political democracy expect to do, even when
patriotic and public-spirited. The essential problem is
wisely to select such responsible officials and promote them
strictly on a basis of what they accomplish, to give them a
"free hand" to make or mar their own careers. This is
the lesson that must be learned before the democratization
of industry will become a practical possibility. If we sub-
stitute for business competition, bad as it is, the game
of political demagoguery as conventionally played, with
rotation in office and "to the victors belong the spoils" as
its main principles, the consequences can only be dis-
astrous.

Another interesting misconception in regard to the pub-
lic official should be pointed out before we leave this topic.
It is common and natural to assume that a hired manager,
dealing with resources which belong to others will be less
careful in their use than an owner. The view shows little
insight into human nature and does not square with ob-
served facts. The real trouble with bureaucracies is not
that they are rash, but the opposite. When not actually
rotten with dishonesty and corruption they universally
show a tendency to "play safe" and become hopelessly
conservative. The great danger to be feared from a political
control of economic life under ordinary conditions is not a
reckless dissipation of the social resources so much as the
arrest of progress and the vegetation of life.

This point leads naturally to the question which has
been much discussed in treatments of risk and profit : does
the private business man really abhor risk and uncertainty,
and tend also to "play safe"? Other phases of the same
question, the close relations of which are not always recog-
nized, but which turn out to involve the same issue, relate
to the social cost of risk-taking and the tendency of profits
to a minimum.

362 RISK, UNCERTAINTY, AND PROFIT

The conventional view is, of course, to regard risk-taking
as repugnant and irksome and to treat profit as the "re-
ward" of assuming the "burden." This is, of course, the
business man's own idea of the matter,1 and students of
the problem have often held the same opinion. Thus
Willett 2 argues that society pays for the sacrifice of as-
suming risk through higher prices for commodities in whose
production it is a factor, for the reason that men are deterred
from entering these occupations by their unwillingness to
assume risk and that the supply of such commodities is
consequently reduced. Ross also assumes 3 that risk is
repugnant and draws the same conclusion, and Haynes 4
lays still greater emphasis on the influence of risk as a
deterrent to production, quoting Andrews 5 to the same
effect. Other writers have been more hesitant in general-
izing or have made distinctions, or positively disagreed
with this view. Thus v. Mangoldt 6 remarks that it is
notorious that more money is lost than made in most forms
of speculative activity and asserts the belief that this is
true of business enterprise in communities which are in
comfortable circumstances and have a reasonable surplus
for embarking in venturesome undertakings. Professor
F. M. Taylor also analyzes the problem with some care,7
insisting that the profits of entrepreneurs may be either
larger or smaller than the amount necessary to make up
an insurance fund to cover actual losses. He holds it prob-
able that they are for small risks larger and for large risks
much smaller than the necessary insurance fund, but con-

1 See Merril, J. C. R, article on "Speculation," Price Current Grain
Reporter, September 29, 1915, pp. 26-27: "It is a universal axiom of
business that the greater the risk involved in any line of business the
greater must be the profits to those engaged in it, or . . . profits are in
proportion to risks!"

2 Economic Theory of Risk and Insurance, pp. 55-56.
8 Op. cit. (Annals, Am. Acad., 1896), p. 119.

4 Quarterly Journal of Economics, vol. ix, no. 4, p. 414.

5 Institutes of Economics, p. 54. 6 Unternehmergeivinn, p. 85.
7 Principles of Economics (1913), pp. 366-67, 383-84.

SOCIAL ASPECTS 363

eludes that society has to pay a higher price for a particu-
lar commodity or service than it would have to pay if
risk were eliminated.

There are several confusions of thought to be avoided in
arguing this question. In the first place it is inaccurate to
speak of profit as the reward of risk-taking or as the in-
ducement to take risk. It is of the essence of the situa-
tion that the profit is in the future and uncertain when the
decision is made and hence it is the prospect or estimated
probability x of profit which "moves men's wills" (Taylor).
Hence we cannot assert a connection between actual profit
and the irksomeness of risk in the individual instance. And
from the standpoint of aggregate profit in the society as a
whole the question is whether there is any such share or
not, whether entrepreneurs as a class make a profit or suffer
a loss (speaking, of course, of net or "pure" profit, after
remunerations for all productive services are counted out).

Let us recall for clearness the precise situation of the
profit-seeking business man. He contracts for productive
services in advance, on a basis of what he expects to be able
to make by their use. Like the purchaser of any commodity,
he as an individual finds a price fixed and buys more or
less at the established price, while in the aggregate the com-
petition of all purchasers adjusts the price to the point
where an entire existing supply can just be taken out of
the market. It will be seen that the prices of productive
services at any time, the entrepreneurs' costs of production,
represent under perfect competition what entrepreneurs
expect their products to be worth when sold, while the en-
trepreneurs' incomes represent the facts at a later time as
contrasted with the anticipations at an earlier. The con-
dition, then, under which entrepreneurs as a group will
realize a positive profit is that they underestimate the pros-

1 J. S. Mill stated that chances of profit tend to equality, but in the
fifth edition changed the word "chances" to "expectations." See
Principles, Ashly edition, p. 412.

364 RISK, UNCERTAINTY, AND PROFIT

pects of their business relatively to their dispositions to
venture. If, on the contrary, they overestimate their pros-
pects (considering the degree of conviction necessary to
move their wills), they will in the aggregate suffer loss,
and if they estimate correctly on the whole, neither will
occur. If the estimates are a matter of pure chance it
WOllld seem that the variations in the two directions would
be equal, the average correct, and the general level of pure
profit zero. Many writers, notably Hawley,1 have assumed
that such a distribution of errors necessarily obtains, though
in the absence of a correct theory of profit the appropriate
conclusion is not drawn.2

It may be objected that it is impossible that enterprise
on the whole should suffer a net loss, but a little considera-
tion will show that this is not true. The entrepreneur, as
society is organized, is almost always a property-owner and
must necessarily be the owner of productive power in some
form. It may then well be that entrepreneurs lose more
than they make, the difference coming out of the returns
due them in some capacity other than that of entrepreneur.
The question of fact is thus whether entrepreneurs as a
class receive on the average more or less than the normal
competitive rate of return on the productive services of
person or property which they furnish to business.

The question does not admit of any definitive answer on
inductive grounds. Such evidence as is avaliable in the form
of statistics points to the conclusion that the net result is a
loss, but it is inconclusive.3 Perhaps the best that can be

1 See above, chapter n, p. 42.

2 Hawley sometimes holds that profit is negative (Quarterly Journal of
Economics, vol. xv, p. 609) and at other times that it is positive. (Ibid.,
P. 79.)

8 M. Porte, Entrepreneurs et profits industriels (Paris, 1905), argues to
this conclusion from certain figures on business failures in Massachusetts.
The results of studies of farm accounts by the New York State College of
Agriculture indicate that farmers commonly make less than fair wages
and a fair return on the investment, and investigations of public utility
ventures have yielded similar results. The best study of the distribution

SOCIAL ASPECTS 365

done is to argue the case on a priori grounds and attempt
nothing beyond an opinion as to the probable facts. The
writer is strongly of the opinion that business as a whole
suffers a loss. The main facts in the psychology of the case
are familiar, and some of them have been stated above.
The behavior of men in lotteries and gambling games is
the most striking fact. Adam Smith pointed out the tend-
ency of human nature to exaggerate the value of a small
chance of large winnings. Senior 1 thought that the im-
agination exaggerates the large odds in favor of either
gains or losses. Cannan 2 holds that both unusually risky
and unusually safe investments are especially attractive to
large classes of men and yield too small a return while or-
dinary hazards are neglected and hence yield more. Pro-
fessor Carver contributes the suggestion3 that business
risks are predominantly of the character in which the odds
are not great and the possible losses larger than the prob-
able gains, that these have a negative appeal to the gam-
bling instinct and that profit is a positive quantity. But in
view of the possibility of capitalizing the entire future re-
turn of a venture into present wealth this view of the na-
ture of business risks seems very questionable. The point
we wish to emphasize is that these "risks" do not relate to
objective external probabilities, but to the value of the

of income in the United States, by Dr. W. I. King, reaches the conclusion
that the average profit per entrepreneur in this country is about one and
four tenths times the average wage per laborer. (See Wealth and Income
of the People of the United States, p. 165.) It seems safe to assume that
entrepreneurs have greater ability than laborers in a larger ratio than
this, especially since a large proportion of the wage-earners reported by
the Census are women and young persons and children. But Dr. King's
division of income into shares and his estimates of the numbers of re-
cipients of each type are both replete with long-range deductions and as-
sumptions leaving so much room for error that little if any confidence can
be placed in the result.

1 Cited by Cannan, History of Theories of Production and Distribution,
p. 369.

2 Article on "Profit" in Palgrave's Dictionary of Political Economy.

3 Distribution of Wealth, p. 283.

I

366 RISK, UNCERTAINTY, AND PROFIT

judgment and executive powers of the person taking the
chance. It is certainly true that as Smith and v. Mangoldt
both observed, most men have an irrationally high confi-
dence in their own good fortune, and that this is doubly
true when their personal prowess comes into the reckoning,
when they are betting on themselves. Moreover, there is
little doubt that business men represent mainly the class of
men of whom these things are most strikingly true; they
are not the critical and hesitant individuals, but rather
those with restless energy, buoyant optimism, and large
faith in things generally and themselves in particular.

To these considerations must be added the stimulus of
the competitive situation, constantly exerting pressure to
outbid one's rivals, as in an auction sale, where things often
bring more than any one thinks they are worth. Another
large factor is the human trait of tenacity, also conspicuous
in bourgeois psychology. Men may possibly be timid and
critical on first embarking in new ventures, but once com-
mitted, it seems unquestionable that the general rule is to
hold on to the last ditch, and the greater part of the
bidders for productive services are owners of businesses al-
ready established. The prestige of entrepreneurship and
the satisfaction of being one's own boss must also be con-
sidered. It therefore seems most reasonable to suppose that
the prices of these are fixed at a level above rather than
below that which the facts actually warrant, and as we
have noticed, the statistics, such as they are, point to the
same conclusion.

So much for the pure profit of entrepreneurs. We have
already emphasized the fact that profit and imputed in-
come are never accurately separated on either side of the
dividing line. As there is no income which is pure profit so
there is none which does not contain an element of profit.
This is perhaps most conspicuous, or at least most familiar,
in connection with interest. It is recognized that "pure in-
terest " is impossible of identification, that ordinary inter-

SOCIAL ASPECTS 367

est includes an element of "risk premium." It is no less
true that wages contain a variable element which is to be
explained by the uncertainty of the return. The earnings
of professional men form the notorious case. Men are
attracted into these callings more by the lure of the small
chance of conspicuous success than by the position achieved
by the rank and file. Adam Smith was sure, and the opin-
ion is still corroborated by common observation, that an
occupation offering a small chance of attaining a high
position and a large income will yield a lower average re-
turn to the same ability than one in which earnings are
more uniform. That is, there is a negative premium on
risk-taking in these cases also.

With most kinds of labor the chance element amounts to
relatively little in all probability, and in any case it is per-
haps best regarded as a return on the investment in special
knowledge and skill rather than on effort directly. In any
case, if Smith's reasoning is sound it appears that risk-
taking is the opposite of irksome, that men work (or labor
to acquire the capacity for work) more cheaply on the
average for an uncertain than for a fixed compensation.
To the landowner there is virtually no risk of actual loss
involved in leasing it, and usually little or none of failure to
receive the contract rental. In lending capital we find risk
of loss of principal as well as interest and a great deal of
attention is paid to the risk element in fixing the rate of
return. A rate of pure interest is a concept to which it is so
difficult to attach any definite meaning that it seems futile
to speculate as to the adequacy of the excess of contract
interest above this level to constitute an insurance fund to
cover losses. The question, as before, is whether the actual
receipts from contract interest and repayments of principal
form on the average an amount equal to or less or more than
the pure interest and the original principal. The writer
sees no way of forming an opinion on this subject.

From the standpoint of social policy, two questions are

368 RISK, UNCERTAINTY, AND PROFIT

to be raised. From one point of view, "society" is a hus-
bandman or " vrirtschaf tender Mensch" interested in getting
its work done as well and as cheaply as possible. The fore-
going considerations seem to indicate that from this pure
productive efficiency point of view and with all the factors
measured in competitive pecuniary terms it is better to let
the individual "take the risk. It seems probable that with
society and human nature as they are, the individual not
only charges nothing for this service, but pays something
for the privilege of rendering it — on the average. But we
must remember that in the case of property he really does
not take the risk, and it is a question of making him feel that
he does, for property is and always has been "really" social
and ownership a social function. It is not clear that the
illusion of ownership, with the possibility and actuality of
enormous waste and dissipation involved, is in fact a cheap
way for society to remunerate the management of its mate-
rial wealth. As with all questions involving human motives,
however, only negative statements can be made on this
subject until we begin to know something of what men as
individuals and as society really want. The quality of
management secured has, of course, to be taken into ac-
count along with the cost of securing it, but we have al-
ready said all that it seems worth while to say in the present
connection on this head.

The second question raised is whether it is really good
for the individual, and hence for society which is the in-
dividual in the aggregate, to have the risks of industry as-
sumed by the former even if he is willing to do it at a loss,
on the average, to himself. Some light on the proper an-
swer is to be gained by considering the attitude which we
actually take toward lotteries and gambling generally.
Clearly there are limits to the terms on which the members
of society are to be allowed to take chances, and notably
when the independent members have dependent upon them
other members in whom society is peculiarly interested.

SOCIAL ASPECTS 369

Rapid progress is at present being made toward prohibiting
the laborer from unwisely contracting to assume hazards,
and no theoretical objection can be made to extending the
principle to property risks where the fundamentals of a
decent and self-respecting existence are at stake.

The protection of a minimum standard of life is only one
of many questions of the human interests involved in the
distribution of risk and control, but we cannot here go into
or even attempt to classify or enumerate a list. In conclud-
ing the discussion of the topic we shall only insist again on
the limitations of the economic view of social organization
as a mechanism for satisfying human wants in any static
and hence scientifically describable sense of the term.
Man's chief interest in life is after all to find life interesting,
which is a very different thing from merely consuming a
maximum amount of wealth. Change, novelty, and sur-
prise must be given large consideration as values per se,
and since at best most of us must doubtless spend more
time in producing wealth than in consuming it, the dy-
namic and personal factors must be taken into account on
the production side of economic conduct, and weighed
against the element of efficiency. One of the things we
surely want is the society of other people on a basis of
mutual agreeability, respect, and affection, irrespective of
the question, itself inescapable in any serious reflection on
the issues of life, as to whether personality has some sort
of cosmic value. Hence each individual must be given
responsibility, freedom of choice, a wider sphere of self-
expression than he can have in a system of organization
where control is specialized and concentrated to the last
degree. Whether this is practicable and how it is to be done
is the great problem which confronts the advocates of in-
dustrial democracy.

To conclude our study notice must be taken of certain
long-time aspects of the problem of uncertainty and con-
trol. The distinction between "static" and "dynamic"

370 RISK, UNCERTAINTY, AND PROFIT

"risks" is a much-labored but a fundamental point in
connection with our subject. We have emphasized in this
study also that uncertainty is dependent upon change, and
in fact largely upon progressive change. The problem of
management or control, being a correlate or implication of
uncertainty, is in correspondingly large measure the prob-
lem of progress. In an unprogressive society knowledge of
the future could be perfected to a high degree through ac-
tual forecast and control or the effect of certainty secured
through the grouping of cases and application of prob-
ability reasoning. Under such conditions the problem of
management would be indefinitely simplified as activity
would follow in the main an established routine and real
decisions would rarely be required. The actual form of
economic control, free contract, and especially private
property in material goods, is closely connected with the
acute form of the problem of management which arises
from the highly "dynamic" character of the society we live
in and the extreme degree of uncertainty connected with
change. Before the modern industrial era began, as we
know, the economic life of Europe was unprogressive, and
its organization of control was collectivistic. The establish-
ment of individualism was the result of the desire for
improvement, even though it would be misleading to say
that it came about directly through a social conviction of
its superiority over collectivism in this respect.

The social theory of private property rests, then, not so
much on the premise that productive resources will be
more effectively used in the creation of goods for consump-
tion, as on the belief that there will be a greater stimulus
to progress through inducing men to take the risks of action
increasing the supplies of productive resources themselves,
including both material things and technical knowledge
and skill. We have shown in our discussion of interest the
fallacy in the view that accumulation and forward-looking
sacrifice can be explained on the basis of time preference in

SOCIAL ASPECTS 371

consumption. A sacrifice of present to future consumption
does not generally increase the total consumption by the
individual making it, and in addition the mere postpone-
ment of consumption would give rise to no considerable
net increase in social equipment. The "abstinence" must
be permanent, and not a mere matter of waiting. It follows
that the premise of the justification of private property
must be that the mere desire of ownership is a more potent
motive to bring about sacrifice and effective control in this
field than the desire to consume a larger amount of goods.
The social policy of private property is sound, if at all,
because the craving to own wealth will lead men to sac-
rifice consumption and take risks of complete loss in order
to increase their property.1 The truth or falsity of this
premise is not our present concern, but it seems worth
while to point out some facts in connection with its appli-
cation.

Practically all forms of social economic progress repre-
sent, as has been pointed out, different modes of increasing
the productive power of society through the sacrifice or
"investment " of present consumption. These different
ways are open, competing alternatives, quite comparable
generally speaking in quantitative terms. One may invest
his present goods in creating new equipment goods (the
conventional way, and type of all), or in finding and devel-
oping new natural resources, or in developing his own per-
sonal powers (or even to some extent those of other men),
or in inventing, or in improving business organization, or
in creating new social tastes and wants. The first two
modes of investment give rise to new property and this
society, generally speaking, grants to the successful in-
vestor in. fee simple and to his heirs and assigns forever.

Investment in one's own person likewise gives rise to

1 An accurate and exhaustive discussion of this point would have to
distinguish between the motives of the entrepreneur and those of the
owner who transfers the use of his property to an entrepreneur for a fixed
return.

372 RISK, UNCERTAINTY, AND PROFIT

undisputed possession of the new capacities, but these are
not permanent, passing out of existence with the end of the
individual's own active life. It would be interesting, if it
were possible, to compare the attractiveness of these two
forms of investment, for the effectiveness of control beyond
one's own lifetime as an incentive to investment is one of
the principal issues in the theory of enterprise. We shall
recur to this topic presently.

The case of investment in invention is different again.
Here, owing to the low cost of indefinitely multiplying an
idea, it is usually difficult to capitalize an increase in pro-
ductive power. Society generally permits an inventor or
his assigns to keep his idea secret as long as possible or
to safeguard it in any manner. But this is so commonly
impracticable and the social value of new inventions so
manifest that the patent system has come into general use
establishing and protecting by law a temporary, and rather
short-lived, property right in the improvement. It is mani-
fest that this is an exceedingly crude way of rewarding in-
vention. Not merely do the consumers of the product pay,
which is doubtless fair, but large numbers of other persons
suffer who are prevented from using the commodity by the
artificially high price. And as the thing works out, it is
undoubtedly a very rare and exceptional case where the
really deserving inventor gets anything like a fair reward.
If any one gains, it is some purchaser of the invention or at
best an inventor who adds a detail or finishing touch that
makes an idea practicable where the real work of pioneering
and exploration has been done by others. It would seem
to be a matter of political intelligence and administrative
capacity to replace artificial monopoly with some direct
method of stimulating and rewarding research.

The improvement of business organization and methods
offers still less chance of securing any permanent gain,
since the result is usually neither patentable nor capable of
being kept secret. Yet this form of progress also represents

SOCIAL ASPECTS 373

an investment of present wealth which could have been
placed in fields yielding perpetual property rights. Surely
there is no evidence of any unwillingness to make expendi-
tures in this form of improvement, and the fact raises in-
teresting questions as to the motives which actually oper-
ate in inducing men to make the present sacrifices which
promote economic progress. Expenditure in creating new
wants can be made to yield a more permanent advan-
tage through the use of distinctive brands and legal protec-
tion of trade marks and trade names. Some of these, of
course, become pieces of property of great value and ready
salability.

Remains, then, the final question of the relative im-
portance as stimuli to save and invest, of property rights
and the right to transfer such rights to other individuals
or project control beyond one's own lifetime. We cannot
enter here at length into the question of inheritance. Still
more than ownership in the strict sense, of which it is no
essential part, inheritance rests on no conscious theory,
but has simply happened. The attribute of inheritance
more or less naturally inheres in personal effects where the
family system exists, and it becomes transferred to pro-
ductive goods as these increase in importance, while prop-
erty in productive goods also enormously strengthens and
isolates the private family sentiment. Voluntary bequest
outside the family represents a later development and in a
sense the reverse tendency.

The "theory" of the rights of transmission and bequest
is, of course, that they form an important element in the
inducement to conserve and accumulate wealth. The
writer is extremely skeptical as to the soundness of this
view, but there are considerations which must give pause
to any rash advocacy of fundamental change. The difficulty ,
again, is to suggest an alternative plan which seems work-
able. The public confiscation of wealth at the death of the
owner raises the question of what would be done with it.

374 RISK, UNCERTAINTY, AND PROFIT

For those who are dubious of the direct management of
productive enterprise by public agency, a leasing system
or sale at auction in exchange for income rights in the form
of debentures or the like perhaps offer a possible way out.
This is much like some of the suggestions of the Saint-
Simonian school of socialists.1 Even then the practical
problem of distributing the income among the people or
of its public utilization gives rise to misgivings.

Somewhat similar problems again arise in connection
with the personal powers of individuals, which, as we have
seen, obstinately resist generic separation from material
goods in their economic bearings. Innate ability, in the
sense in which there is such a thing, is inevitably hereditary,
and nothing can be done about it except to modify the
conception of the individual's property rights in his own
powers. But culture in all its subtle significance, as well as
education and training in their cruder forms, are also more
or less transmissible and more or less subject to voluntary
bestowal, and the factor of personal influence or "pull"
can by no means be left out of account. The significance of
control over these things is very great and would probably
be multiplied rather than diminished in a society which
abolished property in material things. It seems that real
equality of opportunity, a true merit system, is hardly
conceivable, and that no very close approach to such a
consummation can be expected in connection with the
private family. Plato, of course, recognized this fact,
which most of his modern successors have a tendency to
blink.

The ultimate difficulties of any arbitrary, artificial,
moral, or rational reconstruction of society center around
the problem of social continuity in a world where indi-
viduals are born naked, destitute, helpless, ignorant, and
untrained, and must spend a third of their lives in ac-

1 See also Alvin S. Johnson, "The Public Capitalization of the In-
heritance Tax," Journal of Political Economy, February, 1914.

SOCIAL ASPECTS 375

quiring the prerequisites of a free contractual existence.
The distribution of control, of personal power, position,
and opportunity, of the burden of labor and of uncertainty,
and of the material produce of social industry cannot easily
be radically altered, whatever we may think ideally ought
to be done. The fundamental fact about society as a going
concern is that it is made up of individuals who are born
and die and give place to others; and the fundamental fact
about modern civilization is that it is dependent upon the
utilization of three great accumulating funds of inheritance
from the past, material goods and appliances, knowledge
and skill, and morale. Besides the torch of life itself, the
material wealth of the world, a technological system of
vast and increasing intricacy and the habituations which
fit men for social life must in some manner be carried for-
ward to new individuals born devoid of all these things as
older individuals pass out. The existing order, with the
institutions of the private family and private property
(in self as well as goods), inheritance and bequest and pa-
rental responsibility, affords one way for securing more or
less tolerable results in grappling with this problem. They
are not ideal, nor even good; but candid consideration of
the difficulties of radical transformation, especially in view
of our ignorance and disagreement as to what we want,
suggests caution and humility in dealing with reconstruc-
tion proposals.

THE END

INDEX

INDEX

Adriance, W. M., 109, 112.

Analysis, identical with static
method, 17.

Anderson, B. M., Jr., 64 n.t 85.

Assumptions of economics, impor-
tance of making explicit, 10 ff .

Bagehot, W., 5, 25.
Balfour, Jas., 221, n. 2.
Borel, E., 221 n.
Bowley, A. L., 212 n.

Cairnes, J. E., 10, 123.

Cannon, E., 24 n., 150, 365.

Capital and capital goods, 166, n. 1,
321 ff.; created by banks through
forced saving, 165, n. 2; is homo-
geneous with its product, 166 n.

Capitalization, 138, 330.

Carver, T. N., 31, n. 4, 109, 124,
365. ^

Choice, theory of, chap, in; prin-
ciple of, 64, 65.

Clark, J. B., 15, 16, 22 n., 24, 31,
32 ff., 108, 124 n., 142 n., 159 n.,
179 n.

Clark, J. M.f 62 n., 109, 179 n
263 n.

Competition, absence of profit test
of perfect, 18 ff.; prerequisites for
perfect, 76-86.

Comte, A., 8 n.

Control, means meeting uncer-
tainty, 259, 271, 288 f.; and
knowledge commonly indirect,
287 ff.; chap. x.

Cooley, C. H., 208, n. 2.

Cost, equal to value with uncer-
tainty absent, 71, 86; increases
with supply under static condi-
tions, 90 f., 92 n., 121 f.; pain cost
and opportunity.cost identical, 73.

Cournot, A., 6.

Crusoe economy, 74 ft.

Davenport, H. J., 31, n. 4, 64 n.,
81 n., 105, 109, 124 n.t 183 n.,
336 n.

Deduction, and induction, 7 n.
Deductive method, place in eco-
nomics, chap, i; 6, 10.
Dewey, John, 16.

Diminishing productivity, 104, 119.
Diminishing returns, 98 ff., 119.
Distribution, theory of, chap. rv.
Du Bois-Reymond, E., 201 n.

Economics, classification of prin-
cipal problems, 134.

Edgeworth, F. Y., 64 n.f 69 n., 82
n., 212 n., 224.

Elderton, W. P., 212 n.

Ely, R. T., 31, n. 4.

Engels, F., 27.

Enterprise versus handicraft, 244.

Entrepreneurship, elements of, 270^
282 f.

Equilibrium, 17; all phases of pro-
gress tend toward, 170 ff .

Equilibrium levels, wages and in-
terest indefinitely remote, 155,
164 n., 166 ff.

Error in judgment distinguished
from risk, 225 f.

Factors of production, tripartite
division illicit, 123 ff.; must be
defined in physical terms, 116;
not adequately differentiated by
conditions of supply, 159 ff., 153
n., 163 n.

Family and free enterprise, 374 f.

Fetter, F. A., 31, n. 4, 64 n.

Fisher, Arne, 222 n.

Fisher, I., 31, n. 4, 220 n., 227, 239 n.

Freedom versus free contract, 351 ff .

Friction, economic, 342 ff .

Geddes, Patrick, 54 n.
Godwin, Wm., 153, n. 2.
Gross, G., 22 n., 28, 29, 30.

Haney, L. H., 183 n., 254 n.
Hawley, F. B., 31, 41 ff ., 184, 298 n.,

364.
Haynes, John, 199 n.f 362

380

INDEX

History of profit theory, chap. n.
Hobson, J. A., 31, 110, 113, 159 n.
Huebner, S., 249 n.
Hufeland, 26.

Imputation, theory of, chap. iv.

Inductive method, chap. I.

Inheritance and saving, 373.

Insurance, theory of, 247 ff .

Interest, theory of, 161 ff.; chap,
xi ; probably absent under static
conditions, 168, 169; contract
alternative to a lease, 169; dis-
tinguished from rent, 328 f.

James, Wm., 210 n.
Jevons, W. S., 6, 64 n., 132 n.
Johnson, Alvin S., 31, n. 4, 39 f.,
124 n., 161 n., 187, 374.

Keynes, J. N., 10.1
King, W. I., 364, n. 3.
Kleinwachter, Fr., 28, 29, 30.
Korner, A., 28 n., 29.

Landry, A., 110.

Laplace, P. S., 222 n.

Large-scale business reduces risk,

252 ff.
Lassalle, F., 27, 153, n. 2.
Lavergne, B., 30 n., 187.
Lavington, F., 199 n.
Leroy-Beaulieu, P. P., Sr., 31 n.
Leslie, T. E. C, 199 n.
Leverhulme, Lord, 127 n.

Mackenzie, J. S., 5.
Macvane, S. M., 31 n.
McCulloch, J. R., 24.
Maine, Sir H. S., 351 n.
Malthus, T. R., 24, 154.
Manager, the salaried, chap. X.
Mangoldt, H. v., 22 n., 25, 26, 27,

362.
Marshall, Alfred, 15, 16, 25, 31,

71, n. 3, 82 n., 142 n., 165, 211 n.
Marx, K., 27.
Mataja, V., 22 n., 28.
Menger, K., 28, 29, 110.
Merril, J. C. F., 362 n.
Mill, John S., 6, 10, 24, 152, 154,

184, 363.
Mitchell, W. C, 54 n., 64 n.
Mithoff, Th., 28, 29.

Monopoly, 184 ff.; is economically
productive, 186, 188 ff.; univer-
sal tendency toward, 190 ff.

Motives, always relative, 59; not
mainly consumption, 52 ff., 319,
331 ff., 369.

Moulton, H. G., 165, n. 2, 336 n.

Organization, central problem of
economics, 54 ff .

Padan, R. S., 110 n., 111.

Palgrave. R. H. I., 24 n.

Pareto, V., 6, 14.

Patten, S. N., 69 n.

Pearson, K., 212, n. 1, 221 n.

Pierstorff, J., 22 n., 28.

Pigou, A. C, 199 n.

Plato, 374.

Poincar6, R., 221, n. 2.

Porte, M., 22 n., 364 n.

Price, theory, classification of main
problems, 134.

Probability, 212 ff . ; types of, 214 ff .,
223 ff.

Productive service supply and de-
mand under static conditions,
117 ff.

Productivity theory, statement,
and criticism, chap, iv; objec-
tions considered, 109-13.

Productivity is an organization con-
cept, has no moral significance,
109, 178; identical with causality,
112, 113 f.

Profit, history of theories, chap, n;
alleged tendency to zero, 361 ff . ;
author's theory, chap, ix; mark
of imperfect competition, 18 ff.;
probably negative in the aggre-
gate, 361 ff., 364; relation to
other shares, 302 ff.

Progress, theory of, with uncer-
tainty absent, chap, v; modes or
factors of, 145-47; uncertainty
and, chap. xi. ^

Promotion, 257.

Property, meaning, 352, 566; owner-
ship a social function, 359 ff.

Psychological theory of interest does
not fit real conditions, 136, 167.

Read, Samuel, 26 n.
Resources, 65.

INDEX

381

Ricardo, D., 27.

Riedel, 26.

Risk versus uncertainty, 19, 225 f . ;
chap, vn ; to person versus ma-
terial property, 355 ff .

Rodbertus, J., 27, 28.

Roscher, W., 26.

Ross, E. A., 199 n., 362.

Rossi, 26 n.

Saving, motives of, 137 ff., 162 f.

Say, J. B., 25.

Schaffle, V., 26.

Schonberg, G., 28.

Schroeder, E. A., 28 n.

Schumpeter, J., 15, 24, 33, n. 4.

Seager, H. R., 31, n. 4.

Seligman, E. R. A., 31, n. 4, 85 n.

Seneuil, Courcelle, 25.

Senior, N. W., 365.

Sidgwick, H., 132 n.

Smith, Adam, 24, 27, 365.

Speculation, theory of, 255 ff.; af-
fects consolidation of risk as well
as specialization, 257.

Spencer, H., 132, n. 2, 351 n.

Static method, 16.

Static state, specifications of, 145-
47.

Stuart, H. W., 54 n.

Supply curves, 84.

Taussig, F. W., 31, n. 4, 112, 321,

n. 2.
Taylor, F. M., 31, n. 4, 99 n., 104,

110; versus Wieser on productiv-
ity, 110 n., 126, 362, 363.

Taylor, H. C, 286 n.

Thomas, W. I., 333 n.

Thunen, H. von, 26.

Time preference, fallacy of, 130 ff .

Tufts, J. H., 333 n.

Uncertainty versus risk, 19; chap,
vn ; methods of meeting, 239 f.;
elements of, 202, 241 ff.; meeting
uncertainty the essence of con-
trol, 259, 271, 288 f.; distribu-
tion of, 300; social policy in re-
lation to, chap, xn ; how far irk-
some, 347 ff.

Utility, 61 f.; utility and disutility
relative, 63; a rate, 59, 70.

Veblen, T., 28 n., 188 n., 334 n.
Venn, J., 224.

Walker, F. A., 25, 31, 159 n.
Walras, L., 6.
Wants, Production of, 339.
Watkins, M. W., 165, n. 2.
Wicksteed, P. H., 14, 64 n., 108 n.,

110, 135 n.
Wieser, Fr. v., 104, n. 2, 110.
Willett, A. H., 39 f., 189 n., 263 n.,

266 n., 362.
Wirminghaus, A., 28 n.

Young, A. A., 30 n., 159 n., 188 n.

Zuns, E., 28 n.

CAMBRIDGE . MASSACHUSETTS

14 DAY USE

RETURN TO DESK FROM WHICH BORROWED

LOAN DEPT.

This book is due on the last date stamped below, or

on the date to which renewed.

Renewed books are subject to immediate recall.

IK

y*o**c*

REceiveo

it

**C'o

%3 n

iSi

VrfM.

IN STACKS x O

nov;

W

M

Rfgg.J

JflNl5'65-3PM

.IJO

* ?3 f g ■-? PM

AMgfr^f.

^

gpl?

\9bi a*

(f

^

^

V

#

~M*

i&y

JAN 5-

70 -1PM

LD 21A-60w-4,'64

(E45.r,5s10)476B

General Library

University of California

Berkeley

fc.

HQ 6,0.)

^V-7 3?3

Hi

THE UNIVERSITY OF CALIFORNIA LIBRARY