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ELEMENTARY PRINCIPLES OF ECONOMICS

• Ine

THE MACMILLAN COMPANY
new York - Boston - CHICAGO
Dallas - san Francisco

MACMILLAN & CO., LIMITED
London -

Bombay - calcutta
Melbourne

THE MACMILLAN CO. OF CANADA, LTD.
Toronto

ELEMENTARY PRINCIPLES
OF

ECONOMICS :

IRVING FISHER
PROFESSOR OF POLITICAL ECONOMY
YALE UNIVERSITY

Meto gork
THE MACMILLAN COMPANY
1913
*

Set up and electrotyped.
January, 1913.

Published July, 1912. Reprinted

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Nortgcob 33regg
J. S. Cushing Co. — Berwick & Smith Co.
Norwood, Mass., U.S.A.

(Co
THE MEMORY OF MY FRIEND
AND

COLLEAGUE

PROFESSOR LESTER W. ZARTMAN

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~~~~ º）

PREFACE
FOR TEACHERS

THE words “Elementary Principles” in the title of this
book indicate the limits of its scope; the book is intended
to be elementary, not advanced, and concerns itself with
economic principles, not their applications.
First, being elementary, it does not attempt to unravel
the most difficult tangles of economic theory or to intro
duce controversial matter.

For such studies it should be

succeeded by more extensive treatises (e.g., my own: Nature
of Capital and Income, Mathematical Investigations in the
Theory of Value and Prices, Purchasing Power of Money,
and Rate of Interest, which follow out the same general
system of thought and exposition as adopted in this book).
Secondly, being devoted to principles, the book is con
fined to that part or aspect of economics which is now
coming to be recognized as capable of scientific treatment
in the sense, for instance, in which that term may be ap
plied to physics or biology. The fundamental distinction
of a scientific principle is that it is always conditional ; its
form of statement is : If A is true, then B is true. A prin
ciple differs in this respect from a fact which asserts
unconditionally that B is true. Science is primarily con
cerned with the formulation of principles. The aim of this
book is to formulate some of the fundamental principles
relating to economics.

The method and order of treatment are not altogether
traditional. The time-honored order of topics — produc
tion, exchange, distribution, consumption – has been found
vii

viii

impracticable.

PREFACE

Such an order was probably originally in

tended to parallel the natural course of events from the

production of an article to its consumption ; but to-day
these four topics scarcely retain any traces of such a
parallelism. “Distribution,” for instance, has, in theo
retical discussions, long ceased to be a description of the
processes by which food, clothing, and other goods are
distributed after being produced and prior to being con
sumed, and has become simply a study of the determi
nation of rent, interest, and other market magnitudes.
It is not, therefore, surprising that many other textbooks
on economics have also broken away from this unfortunate
order of topics.
Of the many possible methods of writing economic text
books, there are three which follow well-defined, though
widely different, orders of topics. These are the “his
torical,” the “logical,” and the “pedagogical.” The his
torical method follows the order provided by economic
history; the logical begins with a classification of economics
in relation to other studies, explains its methodology,
and then proceeds by means of abstract examples from the
simplest imaginary case of “Robinson Crusoe economics”
to the more complex conditions of real life; the pedagog
ical begins with the student's existing experience, theories,
and prejudices as to economic topics, and proceeds to mold
them into a correct and self-consistent whole.

The order

of the first method, therefore, is from ancient to modern ;
that of the second, from simple to complex ; and that of

the third, from familiar to unfamiliar. The third order is
the one here adopted. That the proper method of study
ing geography is to begin with the locality where the pupil
lives is now well recognized. Without such a beginning
the effect on the student’s mind may be like that betrayed
by the schoolgirl, who, after a year's study of geography,
was surprised to learn that her own playground was a part
of the surface of the earth.

In like manner we cannot

PREFACE

expect to teach economics successfully unless we begin
with the material already existing in the student's mind.
Those textbooks which open with a discussion of the rela
tions of economics to anthropology, Sociology, jurispru
dence, natural science, and biology, overlook the fact that
the beginner in economics is totally unprepared even to
understand the meaning of these great subjects, much less
their relations to one another.

The same sort of error is

made by those textbooks which begin with a comparative
study of the logical machinery by which truth is ground
out in economics and in other sciences.

The student's

logical faculty must be exercised before it can profitably
be analyzed.
This book, therefore, aims to take due account of those

ideas with which the student’s mind is already furnished,
and to build on and transform these ideas in a manner

adapted to the mind containing them. This is especially
needful where the ideas are apt to be fallacious. The eco
nomic ideas most familiar to those first approaching the
study of economics concern money, -personal pocket
money and bank accounts, household expenses and in
come, the fortunes of the rich.

Moreover, these ideas are

largely fallacious. Therefore, the subject of money is
introduced early in the book and recurred to continually
as each new branch of the study is unfolded. For the
same reason considerable attention is given to cash ac
counting, and to those fundamental but neglected princi
ples of economics which underlie accounting in general.
Every student at first is a natural “mercantilist,” and
every teacher has to cope eventually with the prejudices
and misconceptions which result from this fact. Yet no
textbook has apparently attempted to meet these difficul
ties at the point where they are first encountered, which is
at the beginning.
It may be worth while to distinguish the pedagogical
procedure here proposed from that recently advocated

PREFACE

under the somewhat infelicitous title of the “Inductive

Method.” I refer to the method by which the student is
at first to be taught economic facts without any formula
tion of principles. This proposal seems to assume that the
student’s mind is quite a blank to start with, and that it
is possible on this tabula rasa to inscribe facts without at
the same time intimating how they are related. The truth
is, however, that the student's mind is already familiar
with a great mass of economic facts acquired at home,
on the street, and from the newspapers. He knows some
thing, not only of money and accounts, but of banks, rail
ways, retail trade, labor unions, trusts, the stock market,
speculation, the tariff, poverty, wealth, and innumerable
other topics. It is equally true that his head is full of
theories as to the relations of these facts, – the working
of supply and demand, the nature of money, the operation
of a protective tariff, etc. The difficulty is that most of
his theories and many of his supposed facts are false; and
before we add to his ill-assorted collection of mental furni

ture we must arrange in orderly fashion that which he
already possesses. Moreover, it is almost impossible to
impart successfully any considerable mass of disconnected
facts.

If the teacher does not indicate the true connec

tions, the student will almost inevitably supply false ones;
º

or else the facts without connections will be also without
interest.

These objections to the so-called “inductive method”
are not, however, intended as militating against the object
which its advocates strive to attain, viz., to make the stu

iº
t

dent think for himself, nor against the chief means by
which they actually attain this object, viz., the use of
original problems. Every teacher can and should illus
trate, emphasize, and elaborate every step in the study of

principles by propounding problems. Sumner's collection
of problems, or the more recent collections of Taylor or of

the University of Chicago, may profitably be used to sup

l,
t

PREFACE

plement those which every good teacher will readily invent
for himself from the suggestions of the text, of current
newspapers, or of students’ questions. These should vary
from year to year according to current events and the
exigencies of the case as understood by the teacher.
A pamphlet of suggestions as to problems to be used in
connection with this book has been prepared for teachers
and may be obtained of the publishers. It is submitted
that the present treatment of the subject lends itself pecul
iarly to the use of definite soluble problems in place of the
vague “problems” which are usually employed in economics
and which call for little more than an expression of opinion.
Incidentally, the teacher will find that these definite
arithmetical problems are not only much more useful to
the student, but are much less trouble for the instructor

to correct and grade.
Problems should, I believe, supplement and not supplant
a textbook. The effort to substitute problems for textbooks
has always failed even in those subjects which, like algebra
and geometry, may be said to consist naturally of a series
of problems. A preliminary framework of general prin
ciples is needed in order to formulate special problems of
real value. Problems which are really soluble by the
beginner can be little more than applications of general
principles to special cases.
What has been said will help explain why greater atten
tion than usual is here paid to certain themes, such as
money, bank deposits, accounting, the rate of interest, and
the personal distribution of wealth ; as well as why less
attention than usual is paid to certain other themes, such
as methodology and those obsolete theories like the “wage
fund” theory which (unlike some other obsolete theories)
has probably never formed any part of the student's
mental stock in trade.

To some critics the abundant use of curves may seem
too advanced for an elementary work. But their use is

xii

PREFACE

now so common in the advanced treatises to which the

student is, if possible, to be led, that their introduction
here is but a necessary part of his preparation. The very
fact that there is at present no elementary book in which
the nature and use of the graphic method has been made
clear for the elementary student is a strong argument for
its adoption. Moreover, I am persuaded that the “diffi
culties” in the elementary use of curves are largely imagi
nary. Every beginner in economics may be assumed to be
familiar with latitude and longitude on a map, and perhaps
also with the temperature charts in the daily paper. It is
a very easy step from these to curves of supply and de
mand, provided they be used with sufficient frequency and

with sufficient system to take lodgment in the student's
memory. The student who sees but one diagram in a book
will find the initial effort of understanding that diagram
scarcely worth while, – not much more worth while than
to be taught the use of logarithms without applying them
to more than one or two practical examples. As a matter
of fact, there are few things which so facilitate the under
standing of economic relations at every stage of economic
study as the use of diagrams; and it is believed that, with
them, the elementary student can proceed both faster and
further in economic analysis than without them.
Some friends are inclined to criticize the book as being
too cold an analysis. They point out that the student's
main interest in the subject is a “human interest” and
concerned primarily with the practical and immediate
solution of great public problems. No one acquainted
with my interest in some of these problems can accuse me
of lack of appreciation of the “human” element in them all.
But the more one studies these problems and the attempts
at their solution, the more evident it becomes that most
students approach them with an insufficient grounding in
fundamental principles. In social as in medical therapeu

tics a lack of knowledge of anatomy and physiology results in

PREFACE

xiii

quackery — in remedies worse than the disease which it
is proposed to treat. I believe that one of the greatest
needs to-day in the teaching of elementary economics is
to curb this popular tendency to run after remedies before

formulating principles. Un the present book, therefore,
while most of the great practical problems of economics are
outlined in connection with the principles which must be
employed in their solution, the solutions themselves are

not discussed. Full discussion of all these problems is
impossible in any textbook, and I earnestly deprecate a
general ex cathedra pronouncement of personal opinion by
an author on moot questions, especially in a book for imma

ture students. The only proper course, in my opinion,
is for the student first to master the fundamental economic

principles on which all or most competent economists can
agree, and then, as suggested on the closing page of this
book, to take up some one moot question — some burning
issue of the day — and, so far as possible, master that also.
In the meantime he should, so far as possible, keep an open
mind on other problems until, in course of time, they may
also be taken up intensively, one by one. A textbook
which attempts to supply the student with ready-made
opinions on all practical problems “while he waits,” may
be supplying a real demand, but is not performing a high
service.

Possibly the slight emphasis here put on historical, de
scriptive, and practical economics may decide some teachers
against the use of this book and lead them to choose a
book in which “the whole subject of economics” is treated.
I submit, however, that no such “complete” book exists,
since no author exists capable of writing it, and that all
which aim to be complete lack at least half of the subject
matter here presented and which is taken for granted as if
fully known by the student. In many books the terms
“assets,” “liabilities,” “income,” “cost,” and “rapidity
of circulation” are used without discussion or even definition.

xiv.

PREFACE

It would be out of place here to criticize other textbooks, but
it has been my hope that the present book may be found a
useful introduction to other books, even those which

attempt to cover the subject “completely.” I would
also point out that, by omitting the more “therapeutical”
parts of the subject, I have escaped most of its controversies,
for the controversies to-day are more as to the solution of
practical problems than as to the validity of such elementary
principles as are contained in this book. Freedom is thus
allowed to each teacher who uses this textbook to follow

it up by whichever among others contains the therapeutical
treatment which he personally regards as correct. I have
been struck by the fact that my critics seldom question the
correctness of the propositions here laid down. If this
book may afford a common starting point for economic
instruction of different schools of thought and different
attitudes toward public problems, it will have served one
important purpose.
Especial care has been taken in formulating definitions
so that the concepts described by these definitions may
become firmly fixed in the students' minds. These defini
tions and concepts have been chosen in reference to their
usefulness in economic analysis as well as their conformity
to practical usage. I am one of those who believe that
when the usage of academic economics conflicts with the
ordinary usage of business, the latter is generally the better
guide. This is not only because business usage has a
thousand times the currency of academic usage, but also
because in general it comes closer to the needs of economic
analysis. Here is not the place to argue why this is true,
or even to prove that it is true. I will, however, mention
one consideration which appeals increasingly to practical
teachers: An academic tradition which is unconvincing to
the student is sure later, when he himself becomes a business

man and perceives how badly academic traditions are out
of tune with modern business usage, to breed a deep distrust,

PREFACE

if not contempt, for all academic economics. Thus, expedi
ency, as well as sound theory, should urge teachers to
respect the usage of business men.
I have taken so much space to justify those features of
this book which will seem new, because several teachers to

whom the experimental editions were submitted have
condemned it at sight as unteachable. I am glad to re
port, however, that the teachers who have actually tested
the book in classroom have usually become extremely
enthusiastic over its “teachableness,” although many of
them had begun its use with grave misgivings.
The experimental editions, of which there were two,
were made possible by special arrangement with the pub
lishers. This gave opportunity for thorough trial for two
years in classrooms at Yale, under nearly a dozen different
instructors. As a result of this trial and the many valuable
suggestions and criticisms which were obtained from

teachers, students, and friends, the book has been virtually
written three times. The present — the third and final —
edition is the first to be offered to the general public.
I am under obligations to President Hadley of Yale for
the fundamental idea employed in the discussion of those
supply curves which illustrate the willingness to produce
“a given amount or more” instead of, as ordinarily assumed,
“a given amount or less”; also for helpful criticism on the
presentation of that most difficult subject, the rate of
interest. I am also indebted for helpful criticism to my
colleagues, Professor Clive Day, Assistant Professors F. R.
Fairchild, H. P. Fairchild, W. H. Price, and A. L. Bishop,
Dr. H. G. Brown, Dr. E. J. Clapp, now in New York Univer
sity, and Dr. J. L. Leonard; also to Professor Charles W.
Mixter of the University of Vermont, Professor Harvey A.
Wooster of De Pauw University, Professor Louis N. Robin
son of Swarthmore College, Dean David Kinley of the
University of Illinois, Professor E. W. Kemmerer of Cornell

University, Professor H. J. Davenport of the University

xvi

PREFACE

of Missouri, Professors E. R. A. Seligman, H. R. Seager,
and H. R. Mussey of Columbia University, R. T. Ely and
W. A. Scott of Wisconsin University, and W. M. Adriance
of Princeton University, Mr. W. F. Hickernell, now with
the Brookmire Economic Chart Company of St. Louis,
Mr. Morrell W. Gaines of the Statistical Department of
Brown Brothers and Company of New York, Mr. Julius H.
Parmelee, statistician of the Bureau of Railway Economics,
Washington, D.C., Professor E. B. Wilson of the Massa

chusetts Institute of Technology, Dr. Leonard Bacon of
New Haven, and to Mr. J. M. Shortliffe of the Graduate
Department of Yale University.

I endeavored to obtain a clear idea of the undergraduates'
viewpoint by offering prizes for the best criticisms from
students using the book as a textbook, the prizes being
awarded by a committee of instructors other than myself.
In the college year 1910–1911, the students who won the
prizes were R. H. Gabriel, 1913, E. J. Webster, 1913, and
G. G. Chandler, 1912, and in the year 1911–1912, Edward
Glick, 1914, W. Van B. Hart, 1914, and M. W. Brush, 1913.

The criticisms of others besides the prize winners were
found helpful. To H. Briar Scott, 1913, I am also indebted
for suggesting the insertion of Figure 2. My greatest
obligations for criticism, especially as to the mode of pres
entation, are due to my brother, Herbert W. Fisher, who has
kindly read and criticized all of the original manuscript and
both preliminary editions.
-

MAY, 1912.

IRWING FISHER.

SUMMARY
FouxDATION STONES
Introduction

Capital

Income

Capital and Income

Chapters I–II
Chapter III
Chapters IV-V
Chapters VI–VII

DETERMINATION OF PRICES
.

Particular Prices.

Rate of Interest .

Ownership of Income .

General Prices

Chapters VIII-XIV
Chapters XV-XVIII
Chapters XIX-XXII

PRINCIPLES OF DISTRIBUTION

Sources of Income

Chapters XXIII-XXIV
Chapters XXV-XXVI

CONTENTS BY CHAPTERS
charrºr

I.
II.

pace

WEALTH

PROPERTY

•

III.

CAPITAL

•

IV.

INCOME

COMBINING INCOME ACCOUNTS

•

CAPITALIZING INCOME.

...

I O2

VII.

VARIATIONs of INCOME IN RELATION to CAPITAL .

127

L-VIII.

PRINCIPLES GOVERNING THE PURCHASING Power OF

V.
VI.

MONEY
IX.
X.

INFLUENCE OF DEPOSIT CURRENCY

XII.
XIII.
L-XIV.
XV.
XVI.
XVII.
XVIII.
XIX.

XX.
XXI.

•

I44

165

CAUSES AND EFFECTS OF PURCHASING POWER DUR
ING TRANSITION PERIODS

XI.

REMOTE INFLUENCES ON PRICES

REMOTE INFLUENCES (Continued)

184

I 92

204

OPERATION OF MONETARY SYSTEMS .

22 I

24O

CONCLUSIONS ON MONEY

•

SUPPLY AND DEMAND

. 258

THE INFLUENCES BEHIND DEMAND

THE INFLUENCES BEHIND SUPPLY

303

MUTUALLY RELATED PRICES

•

333

INTEREST AND MONEY

•

354

IMPATIENCE For INCOME THE BASIs of INTEREST

365

INFLUENCES ON IMPATIENCE FOR INCOME .

•

375

XXII. THE DETERMINATION of THE RATE of INTEREST

278

389

INCOME FROM CAPITAL

4 IO

XXIV.

INCOME FROM LABOR .

•

433

XXV.

WEALTH AND POWERTY

•

464

XXVI.

WEALTH AND WELFARE

•

494

XXIII.

CONTENTS BY SECTIONS
CHAPTER I
WEALTH
section

race

Definition of Economics and of Wealth

Distinction between Money and Wealth

Classification of Wealth

Measurement of Wealth
Price
.
Value

5
9

•

I3
17

•
.

Limit of Accuracy in Economic Measurements

•

•
•

23
25

CHAPTER II
PROPERTY
. The Benefits of Wealth .
The Costs of Wealth
.

Property, the Right to Benefits
.
The Relation between Wealth and Property .
Table of Typical Property Rights .
Practical Problems of Property
.
-

•

•
•

33
34

CHAPTER III
CAPITAL

1.
2.
3.
4.
5.

Capital and Income
Capital-goods, Capital-value, Capital-balance .
Book and Market Values
Case of decreasing Capital-balance.
Insolvency .
-

6. Real and Fictitious Persons

•

7. Two Methods of Combining Capital Accounts
8. Ultimate Result of Method of Couples .
9- Confusions to be Avoided
.
-

xxi

•

xxii

CONTENTS

SECTIONS

CHAPTER IV
INCOME
seCTION

PAGE

Concepts of Income and Outgo

Income Accounts.

Devices for Making Net Income Regular

How to Credit and Debit

Omissions and Errors in Practice.

75
77

CHAPTER V
COMBINING INCOME ACCOUNTS

1. Methods of “Balances” and “Couples.” “Interactions”

Production: Interactions which change the Form of Wealth
Transportation: Interactions which change the Position of
Wealth
4.

Wealth

Accounts Illustrative of Interactions in Production

Preliminary Results of Combining these Income Accounts
Analogies with Capital Accounting
.
Double Entry in Accounts of Fictitious Persons .
Double Entry in Accounts of Real Persons .

Exchange: Interactions which change the Ownership of

Ultimate Costs and Income .

CHAPTER VI
CAPITALIZING INCOME

The Link between Capital and Income

Capital as Discounted Income

The Discount Curve

Io2

Application to Valuing Instruments and Property
Effect of Changing the Rate of Interest
-

IoW
Io8
II 2

125

CHAPTER VII
VARIATIONS OF INCOME IN RELATION TO CAPITAL
Interest Accrued and Income Taken Out

Illustrations .

127
-

I29

CONTENTS

xxiii

BY SECTIONS

sECTION

PAGE

3. Confusions to be Avoided
4.

Standardizing Income .

5 The Risk Element.
6. Review .
-

I 32

136
138

I40

CHAPTER VIII
PRINCIPLES Governing THE PURCHASING Power OF MONEY

Introductory .
The Nature of Money
The Equation of Exchange Arithmetically Expressed
The Equation of Exchange Mechanically Expressed
The Equation of Exchange Algebraically Expressed
The “Quantity Theory of Money”

I44
I47

15I

I 56
I 59

16o

CHAPTER IX
INFLUENCE OF DEPOSIT CURRENCY

The Mystery of Circulating Credit.
The Basis of Circulating Credit
.
Banking Limitations
.
The Total Currency and its Circulation .
Deposit Currency Normally Proportional to Money
-

;

165

171
I74

178

Summary

18O

183

CHAPTER X
CAUSES AND EFFECTS OF PURCHASING POWER DURING
TRANSITION PERIODS
Transition Periods

184

How a Rise of Prices Generates a Further Rise
How a Rise of Prices Culminates in a Crisis .

187

Completion of the Credit Cycle

189

I86

CHAPTER XI
REMOTE INFLUENCES ON PRICES

1. Influences which Conditions of Production and Consumption
Exert on Trade, and therefore on Prices .

192

xxiv.

CONTENTS BY SECTIONS

SECTION

PAGE

2. Influences which Conditions Connecting Producers and Con
sumers Exert on Trade, and therefore on Prices

I94

3. Influence of Individual Habits on Velocities of Circulation, and
therefore on Prices

- *

196

4. Influence of Systems of Payments on Velocities of Circulation,
and therefore on Prices

I99

5. Influence of General Causes on Velocities of Circulation, and
therefore on Prices

2O I

6. Influences on the Volume of Deposit Currency, and therefore
on Prices .

2O2

CHAPTER XII

REMOTE INFLUENCES (Continued)
1. Influence of “The Balance of Trade” on the Quantity of
Money, and therefore on Prices
2. Influence of Melting and Minting on the Quantity of Money,
and therefore on Prices

3. Influence of the Production and Consumption of Money Metals
on the Quantity of Money, and therefore on Prices
4. Mechanical Illustration of these Influences
.
-

CHAPTER XIII

2O4

209
2II

215

22 I

OPERATION OF MONETARY SYSTEMS
I. Gresham's Law

2. Bimetallism

3.
4.
5.
6.

When Bimetallism Fails
When Bimetallism Succeeds .
Changes in Production and Consumption
The “Limping” Standard .
-

223
226

230
233
235

* --

CHAPTER XIV
CONCLUSIONS ON MONEY

1.
2.
3.
4.

Can “Other Things Remain Equal?” .
An Increase of Money does not Decrease its Velocity
An Index Number of Prices .
The History of Price Levels .
-

24o
242

247
253

CONTENTS

SECTIONS

CHAPTER XV
SUPPLY AND DEMAND
SECTIox

1.
2.
3.
4.
5.

PAGE

Individual Prices Presuppose a Price Level
A Market and Competition .
Demand and Supply Schedules
.
Demand and Supply Curves .
Shifting of Demand or Supply
-

•

258
26o

261

263
268

CHAPTER XVI
THE INFLUENCES BEHIND DEMAND
1. Individual Demand Schedules and Curves

2.
3.
4.
5.
6.
7.
8.

Desirability .
Illustration .
Some Remarks on Desirability
.
Individual Demands Derived from Marginal Desirabilities
Relation of Market Price to Desirability.
Importance of the Marginal Desirability of Money.
Desires or Wants, the Foundation of Demand
-

278
28 I

283
286

287
294

298
3oo

CHAPTER XVII
THE INFLUENCES BEHIND SUPPLY
I

Analogies between Supply and Demand
Principle of Marginal Cost .
Upward Supply Curves which Turn Back
Downward Supply Curves
.
Resulting Cutthroat Competition
Resulting Tendency toward Monopoly .
Fixed and Running Costs
.
General and Particular Running Costs .
-

Monopoly Price

303

307

312
3I4

317

32 I

323

326

329

338

CHAPTER XVIII
MUTUALLY RELATED PRICES

Arbitrage

Speculation

333

XXVI

CONTENTS BY SECTIONS

section

PAGE

3. Prices of Goods which Compete on the Demand Side .
• 344
4. Prices of Goods which are Complementary on the Demand Side 347
5. Similar Relations on the Supply Side .
- 348
6. Prices of Goods in Series

•

350

•

35 I

354

7. Efforts and Satisfactions the Ultimate Factors
CHAPTER XIX
INTEREST AND MONEY

1.
2.
3.
4.

The Importance of Interest .
A Common Money Fallacy .
Effect during Appreciation or Depreciation
Effect of Unequal Foresight .
-

•

. 356

•

359

362

CHAPTER XX
IMPATIENCE FOR INCOME THE BASIS OF INTEREST

1. The Productivity Theory
2. The Socialist Theory .
3. Impatience the Source of Interest .
-

365

369

•

37 I

CHAPTER XXI
INFLUENCES ON IMPATIENCE FOR INCOME

1. Differences in Impatience Due to Differences in Human Nature 375
2. Differences in Impatience Due to Differences in Income.
. 378

3. Influence of the Distribution in Time of the Income-stream . 379
4. Influence of the Size of the Income-stream

5. Influence of Uncertainties of Income
6. Summary
.
-

.
.
.

381
383
386

CHAPTER XXII
THE DETERMINATION OF THE RATE OF INTEREST

1. Equalizing Marginal Rates of Impatience by Borrowing and
Lending .
389
2. Equalizing Marginal Rates of Impatience by Spending and
Investing .
• 394
-

CONTENTS

xxvii

SECTIONS

section

PAGE

3. Futility of Prohibiting Interest
.
4. Clearing the Loan Market
.
5. The Conditions Determining the Rate of Interest .
-

Historical Illustrations

7. Interest and Prices

396

398

8. Classification of Price Influences

4OO

4O4

. .

406
408

CHAPTER XXIII
INCOME FROM CAPITAL

Distribution according to Agents of Production and according
to Owners

4 Io

2. The Rent of Land .

413

3. Rent and Interest .

4. Four Forms of Income: Interest, Rent, Dividends, and Profits

5. Avoidance of Risk.

422

423
427

CHAPTER XXIV
INCOME FROM LABOR

1.
2.
3.
4.
5.
6.
7.

Similarity of Rent and Wages
Peculiarities of Labor Supply.
The Demand for Labor .
The Efficiency of Labor.
The “Make-work” Fallacy .
Wages and Enterprisers' Profits .
Profits and Distribution Generally.
-

433

436

45 I
454

458

469

472

CHAPTER XXV
WEALTH AND POVERTY

. The Problems of Wealth and Poverty
National Wealth or Poverty .

. Per Capita Wealth or Poverty
. Population in Relation to Wealth .
-

. Distribution of Wealth .

6. Fauality of Distribution an Unstable Condition
7. The Limits of Enrichment and Impoverishment

464
467

476
478
483

xxviii

CONTENTS BY SECTIONS

section

PAGE

8. The Cycle of Wealth .
9. The Actual State of Distribution .
Io. The Inheritance of Property
-

487
489

49 I

CHAPTER XXVI
WEALTH AND WELFARE
True and Market Worth

Evils Connected with the Quantity of Wealth
Forms of Wealth Injurious to the Owner
Forms of Wealth Injurious to Society .
-

Forms of Wealth used for Social Rivalr

The Cost of Vanity
.
Remedies for the Evils of Vanity.
Recapitulation
.
-

494
495

498
499
500

508

5II

ELEMENTARY PRINCIPLES OF ECONOMICS

CHAPTER I
WEALTH

§ 1. Definition of Economics and of Wealth

ECONOMICs may be most simply defined as the Science of
Wealth.

It is also known under several other titles, of

which the most common is “Political Economy.” The P
purpose of economics is to treat the nature of wealth; the
human wants served by wealth; the satisfaction of those
wants and the efforts required to satisfy them; the forms
of the ownership of wealth; the modes of its accumulation
and dissipation; the reasons that some people have so
much of it and others so little; and the principles that regu
late its exchange and the prices which result from exchange. ,
In a word, everything which concerns wealth in its general
sense comes within the scope of economics. It is worth
emphasizing at the outset, that the chief purpose of eco
nomics is to set forth the relations of wealth to human life

and welfare. It is not, however, within the province of
economics to study all aspects of human life and welfare,
but only such as are connected in some rather direct manner
with wealth.

To most persons the chief interest in the subject lies in its
practical applications to public problems, such as those
connected with the tariff, taxation, currency, trusts, trade
unions, strikes, or socialism. These problems suggest that
something is wrong in the present economic order of society
and that there is a way to remedy it. But before we can
treat of economic diseases, we must first understand the
b

. . . . ; ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

çconomic principles which these public questions involve.
(hat
is, the study of economic principles must precede the
application of those principles to problems of public policy.

ſ Tn the end the student will reach more satisfactory con
clusions, if at the beginning he will put aside all thought

of such applications, and cease to count himself a free trader
or a protectionist, an individualist or a socialist, or, indeed,
any other kind of partisan.

We must, then, in the first place, distinguish economic
principles from their applications to public problems; in
the second place, we must distinguish those principles from
their applications to private problems. Economics does
not concern itself with teaching men how to become rich;
nor does a practical skill in the art of becoming rich imply,
necessarily, a sound knowledge of economics. Economics, it
is true, represents the theory of business; and business, the
practice of economics. But, though they are not in the least
conflicting — indeed, to some extent they are mutually

helpful – economics and business are nevertheless totally
different. The primary requisite of a good business man
is to master the detailed facts which concern his own indi

vidual operations; the primary requisite of a good economist

G to master the general principles based on business facts.
S ome of

the wildest economic theories have originated among

uccessful financiers.

Men who have been trained in Wall

Street are often the most sadly lacking in elementary in
struction in economics. This is so because the very matters
with which people have longest been familiar are frequently
the ones which they have been least disposed to analyze.
In business theory, no less than in the theory of public
problems, men take too much for granted.
Our first rule, then, in approaching the study of economics
is to take nothing for granted. It is quite as important to
be careful in defining familiar terms, such as “prices"
and “wages,” as in explaining unfamiliar ones, such as
“index numbers ” and “marginal utility.”

Sec. 1]

WEALTH

…”
_*
º
º

The chief purpose of this book is to define clearly the
fundamental concepts of economics and to state and prove
the fundamental principles of the science. These concepts
and principles will then serve as a basis for further study.
In other books the student will find these concepts and prin
ciples applied to problems of public policy, or of business
management, or of the economic history of nations. We
are not concerned in this book either with practical prob
lems or economic history except as they are used occa
sionally to illustrate the principles under consideration.
Wealth having been designated as the subject matter of
economics, the question at once arises: What is wealth?
By wealth in its broader sense is meant material objects

owned by human beings. This meaning, however, is broader
than the ordinary meaning of the term; for it includes
human beings themselves. Every human being is a “ma
terial object” and is “owned ” either by another human
being, as in the case of slavery, or by himself, if he is a
freeman. But in ordinary usage men except themselves
from the category of “wealth '' just as, with equal incon
sistency, they except themselves from the category of “ani
mals.” Properly speaking man is wealth, just as, properly
speaking, man is an animal. But we so seldom need in
practice to take account of man as wealth that the ordinary
meaning of wealth includes only material objects owned by
human beings and external to the owner." In this book we
* Every writer may define a term as he pleases, except that he should
justify his definition in one or both of two ways: (1) by showing that it
accords with common practice; and (2) by showing that it leads to useful
results. The above definition of wealth meets both of these requirements.
It agrees substantially with the usual understanding of business men, and it
is useful in the development of the science of economics.
Some economists add to the definition that an object, to be wealth, must
be useful. But utility is really implied in ownership. Unless a thing
is thought to be useful, no one would care to own it. Nothing is owned
which is not useful in the sense that its owner hopes to receive benefits from
it, and it is only in this sense that utility is to be employed as a technical
term in economics. Therefore, as utility is already implied in ownership, it

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

shall follow ordinary usage by employing this narrower
meaning except occasionally when it will be found conven

ient to refer to the broader meaning. Any particular
article of wealth may be called an “instrument.” Thus a
locomotive is an article of wealth or an instrument.

Other

examples are an automobile, a horse, a house, a lot, a
chair, a book, a hat, a loaf of bread, a coin.

In common parlance “wealth '' is often opposed to
“poverty,’” the contrast being between a large amount of
wealth and a small amount; precisely as in common par

lance “heat" is opposed to “cold,” the contrast being
between a large degree of heat and a small degree. But
just as in physics ice is regarded as having some degree of
heat, so in economics a poor man is regarded as having some
degree of wealth.

f Wealth, then, includes all those parts of the material
| universe that have been appropriated to the uses of man
kind." It includes the food we eat, the clothing we wear, the
dwellings we inhabit, the merchandise we buy and sell, the
tools, machinery, factories, ships, and railways, by which
other wealth is manufactured and transported, the land on
which we live and work, and the gold by which we buy and

sell other wealth. It does not include the sun, moon, or
stars, for no man owns them. It is confined to this little
need not be mentioned separately in our definition. Other writers, while
including in their definition the idea of utility, omit the idea of ownership
and simply define wealth as “useful material objects.” But this definition
includes too many “objects.” Rain, wind, clouds, the Gulf Stream, the

heavenly bodies, especially the sun, from which we derive light, heat, and
energy, are all useful and material, but are not appropriated, and so are not
wealth as commonly understood. Even more objectionable are those defi
nitions of wealth which omit the qualification that it must be material; they
do this in order to include stocks, bonds, and other property rights, as well
as human and other services. While it is true that property and services
are inseparable from wealth, and wealth from them, yet they are not them
selves wealth. To include wealth, property, and services all under “wealth,”
involves a species of triple counting. A railway, a railway share, and a
railway trip are not three separate items of wealth; they are respectively
wealth, a title to that wealth, and a service of that wealth.

SEc. 2)

WEALTH

planet of ours, and only to certain parts of that; namely,
the appropriated sections of its surface and the appropriated
objects upon that surface.
§ 2. Distinction between Money and Wealth

One of the first warnings needed by the beginner is to
avoid the common confusion of wealth with money. Few
persons, to be sure, are so naïve as to imagine that a million

aire is one who has a million dollars of actual money stored
away; but, because money is that particular kind of wealth in
terms of which the value of all other kinds of wealth is meas
ured, it is sometimes forgotten that not all wealth is money.
We are not yet ready for an extended study of money, nor
even for a definition of money, but as a warning we shall here
enumerate a few of the most common fallacies which beset

the subject. The nature of these fallacies the student will
understand at a later stage.

They are introduced here not

with any idea that the student will at once see where the
error lies, but chiefly for the purpose of ridding his mind of
the ordinary unwarranted assumptions about money.
First among these fallacies, is the assertion that if one
man “makes money,” some one else must “lose ’’ it, since
there is only a fixed stock of money in the world, and it
seems clear that “whatever money the money-maker gets
must come out of some one else's pocket.” The flaw in
this reasoning is the assumption that gains in trade are
simply gains in actual money, so that in every business
transaction only one party can be the gainer. If this were
true, we might as well substitute gambling for business and
for manufacturing; for in gambling the number of dollars
won is equal to the number of dollars lost. As a matter
of fact, however, it is not in order to obtain money that
people engage in trade, but in order to obtain what money

will buy, and that is precisely what both parties to a normal
transaction eventually do obtain.

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

Again, some persons have tried to prove that the people of
the earth can never pay off their debts because these debts
amount to more than the existing supply of money. “If
we owe money,” it is argued, “we can't pay more money
than there is.”

This assertion sounds plausible, but a

moment's thought will show that the same money can be,
and in fact is, paid over and over again in discharge of
several different debts; not to mention that some debts are

paid without the use of money at all.
A few years ago at a meeting of the American Economic
Association a Western banker expressed the opinion that
the total amount of money in the world ought to be equiva
lent to the total wealth of the world; else, he suggested,
people would never be able to pay their debts. He explained
that in the United States there were twenty dollars of wealth
for every dollar of money; and he inferred that therefore
there was but one chance in twenty of a debtor's paying his
debts. “I will give five dollars,” he said, “to any one who
can disprove that statement.” When no one accepted the
challenge, a wag suggested that it was because there was

but one chance in twenty of getting the promised five
dollars |

The attempt to equalize money and wealth by increasing
money twenty fold would, as we shall see later, prove abso
lutely futile. The moment we increased the amount of
money, the money value of all other forms of wealth would

rise, and there would, therefore, still be a discrepancy be
tween the amount of money and the amount of wealth.
A very persistent money fallacy is the notion that some
times there is not enough money to do the world's business,
and that unless at such times the quantity of money is
increased, the wheels of business will either stop or slacken
their pace. The fact is, however, that any quantity of
money, whether large or small, will do the world's business
as soon as the level of prices is properly adjusted to that
quantity. In a recent article on this subject, an editor of a

Sec. 2)

WEALTH

popular magazine put this fallacy into the very title: “There
is not enough money in the world to do the world's work.”
He says, “The money is not coming out of the ground fast
enough to meet the new conditions of life.” In reality,
money is coming out of the ground faster than the “new
conditions' require, with the consequent result of raising
prices.

A more subtle form of money fallacy is one which admits
that money is not identical with wealth, but contends that
money is an indispensable means of getting wealth. At a
recent meeting of the American Economic Association a very
intelligent gentleman asserted that the railways of this
country could never have been built in the early fifties had
it not been for the lucky discovery of gold in California in
1849, which provided the “means by which we could pay
for the construction of the railways.” He overlooked the
fact that the world does not get its wealth by buying it.
One person may buy from another; but the world as a
whole does not buy wealth, for the simple reason that there
would be no one to buy it from. The world gets its railways,
not by buying them, but by building them. What provides
our railways is not the gold mines, but the iron mines. Even
though there were not a single cent of money in the world,
it would still be possible to have railways. The gold of
California enriched those who discovered it, because it en

abled them to buy wealth of others; but it did not provide
the world with railways any more than Robinson Crusoe’s
discovery of money in the ship provided him with food. If
money could make the world rich, we should not need to

wait for gold discoveries. We could make paper money.
* This, in fact, has often been tried. The French people once
thought they were going to get rich by having the govern

ment print unlimited quantities of paper money. Austria,
Italy, Argentina, Japan, as well as many other countries,
including the American colonies, and the United States,

have tried the same experiment with the same results — no
*

ELEMENTARY

PRINCIPLES OF

ECONOMICS

[CHAP. I

real increase in wealth, but simply an increase in the amount
money to be exchanged for wealth.
The idea that money is the essence of wealth was one of

the ideas which gave rise to a set of doctrines and practices,
called Colbertism or Mercantilism, the earliest so-called

“school’ of political economy.

Colbert was a distinguished

minister under Louis XIV of France in the seventeenth

century, and a firm believer in the theory that, in order to
be wealthy, a nation must have an abundance of money.
His theory became known as Mercantilism because it re

garded trade between nations in the same light in which
merchants look upon their business — each measuring his
prosperity by the difference between the amount of money
he expends and the amount he takes in. To keep money
within the country, Colbert and the Mercantilists advo

cated the policy now known as “protection.”
To-day it is generally understood that, in trade between
nations, as in that between individuals, both parties may
gain in an exchange transaction; but the mercantilistic fal–
lacy that a nation may get rich by selling more than it pur
chases, and collecting the “favorable balance of trade ’’ in
money, still forms one of the popular bases of protectionism
in the United States. The more intelligent protectionists
give quite different reasons for a protective tariff, but the
old fallacious reason still appeals to the multitude. They
continue to think that by putting up a high tariff so that
people are prevented from spending money abroad and are
compelled to keep it at home, the country will in some way
be made richer. One reason for the persistence of this
fallacy is the continued use of the misleading phrase “favor
able balance of trade '' to indicate an excess of exports over
imports and “unfavorable balance of trade '' to indicate
the opposite condition.
Money fallacies of the kinds we have described must be
carefully avoided by the student. He should realize that

no technical term, such as “money,” can be used as a basis

•.

SEC. 3]

WEALTH

of reasoning without a carefully formulated definition. All
catch phrases should be avoided. Especially should the
student be on his guard against every proposition concerning
money. “Making money,” for instance, is a catch phrase
used without any definition. Properly speaking, nobody
can “make ’’ money except the man in the mint. The rest
of us may gain wealth, but, unless we are counterfeiters, we
cannot literally “make ’’ money.
We live in a complicated civilization in which we talk in
terms of money. Money has come to be a sort of veil which
hides the other and more important wealth of the world.
Our first task is to take off the veil and see the wealth under

neath. We shall then see clearly that wealth can be accu
mulated only as it is actually produced and saved.
§ 3. Classification of Wealth

Various kinds of wealth may be distinguished. That
kind of wealth which consists of portions of the earth's sur
face is called land. ) Among examples of land are to be in
cluded not o
farms, city lots and streets, but mines,
quarries, oyster beds, fisheries, waterways, etc. All waters
which are owned are in economics called land, being a part
of the surface of the earth. Fixed structures upon land are
called land improvements. The chief examples of land im
provements are houses and other buildings, fences, drains,
railways, tramways, macadamized streets, etc.

Land and

land improvements taken together are called real estate, the
word “real" signifying immovable. All wealth which is
movable may conveniently be called commodities, although
the usage for this term is not altogether certain. Among
examples of commodities are wheat, pig iron, food, fuel, fur
niture, jewelry, clothing, books, chairs, machinery, etc.
The term “commodities" also includes slaves, so far as this

particular species of wealth exists.
It will be remembered, however, that the definition of

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

wealth which has been adopted excludes free human beings.
It was in order to exclude free human beings from the cate
gory of wealth that the phrase “external to the owner’’ was
inserted in the definition. Slaves are wealth, for they are
external to their owner; but freemen are not wealth in its

narrower or ordinary meaning."
There are, of course, many admissible ways of classifying
wealth. That which follows is intended to exhibit the prin
cipal groups into which wealth most naturally falls. It is
advisable that the student construct other classifications for
himself.

Land
Real Estate

Land improve-

Agricultural land
Building land
Ways of transit
Buildings
Improvements

on highways

mentS

WEALTH

Miscellaneous
-

Raw materials

Commodities

Mineral

Agricultural
Manufactured

Finish

inished products

{{.

Consumable

* In the broader meaning of the term “wealth” all men, even freemen,
are, as has been said, wealth. But they are wealth of a peculiar kind be
cause they are not, like ordinary wealth, bought and sold and because the
wealth owned and its owner are in this case, identical. It is difficult, how
ever, to draw a strict line of distinction between slaves (human beings
owned by other human beings) and freemen (human beings owned by them
selves); for in some cases human beings are owned partly by others and
partly by themselves; as, for instance, vassals, serfs, indentured servants,

long-time apprentices, and men held in peonage. A man bound out to ser
vice for thirty years is almost indistinguishable from a slave, and if his
term of service be long enough, the distinction fades away completely. On
the other hand, the shorter the term of service the nearer does his condition
approach freedom. As a matter of fact, almost all workers in modern

society are bound by contract to some extent and for some period of time,
even though it be no more than an hour; and to that extent they are not
free. In short, there are many degrees of freedom and many degrees of
slavery, with no fixed line of demarcation. This is one reason why the
broader meaning of “wealth” is often more useful than the narrower.

SEc. 4)

WEALTH

It scarcely needs to be stated that these groups are not
always absolutely distinct. Like all classes of concrete
things, they merge imperceptibly into one another. For
this reason the classification is of importance only as it
gives a bird’s-eye view of the subject matter of economics.
§ 4. Measurement of Wealth

Having seen what wealth is and what it is not, and having
classified it roughly, we shall next examine separately its
two essential attributes, materiality and ownership, devoting
the remainder of this chapter to the first of these.
The materiality of wealth provides a basis for a physical
measurement of the various articles of wealth.

Wealth is

of many kinds, and each kind has its own appropriate
unit of measurement.

Some kinds of wealth are measured

by weight. This is true, for instance, of coal, iron, beef,
and in fact of most “commodities.” Of units of weight,
a great diversity has been handed down to us, such as the
pound avoirdupois, the kilogram, etc. In England, besides
the avoirdupois pound, and the Troy pound, there is the
pound sterling, used for measuring gold coin. This is much
smaller than any other pound, owing partly to the frequent
debasements of coinage that have occurred, and partly to
changes in the past from silver to gold money. In the

United States a dollar of “standard gold" (gold which is
Tº fine) is a unit of weight employed for measuring gold
coin. It is equivalent to 25.8 grains, or to #5% of a pound
avoirdupois, since there are 7ooo grains in a pound avoirdu
pois. We can scarcely put too much emphasis on the fact

that the pound sterling and the dollar are units of weight..
They should be understood as such before any attempt is
made to understand them as units of “value.”

For many articles it is not so convenient to measure by

units of weight as by units of space, whether of volume, of
area, or of length. Thus we have, for volume, milk meas

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

ured by the quart, wheat by the bushel, wood by the cord,
and gas by the cubic foot. For areas, we have lumber
measured by the square foot, and land by the acre. For
length, we have rope, wire, ribbons, and cloth measured in
feet and yards.
Many articles are already in the form of more or less
convenient units.

In these cases the measure of their

quantity is the number of such units. For instance, eggs
or oranges are usually measured by their number, expressed
in dozens. Similarly, sheets of writing paper are reckoned
by the “quire,” pencils and screws by the “gross.” In
such cases the article is said to be measured “by number.”
But “number" is by no means peculiar to such cases. All
measurement whatever implies an abstract number, as well
as a concrete unit. The only peculiarity of so-called measure
ment “by number * is that the unit, instead of being one
which is applied from the outside, as by the yardstick, is
one into which the things measured happen to be already
conveniently divided.
In measuring the quantity of any particular kind of
wealth it is assumed that the wealth measured is homogene
ous, or so nearly so as to admit of measurement by a given
unit. If different qualities or grades have to be distin
guished, the amount of each quality or grade requires sepa
rate measurement. A continuous gradation in quality,
such as is usually found in real estate, makes it necessary to
distinguish a great number of different qualities. A tract of
land of Ioo acres may consist of a dozen different qualities of
land, variously adapted to pasture, crops, or other uses.
To describe all this land as simply so many “acres" is
misleading. It is necessary to specify separately the num
ber of acres of “pasture-land,” “wheat-land,” etc.
The unit of measure of any kind of wealth, therefore,
when fully expressed, implies a description, not only (1) of
size, but also (2) of quality; as, for instance, a “pound of
granulated sugar.” It is necessary to enumerate the attri

SEC. 5]

WEALTH

butes of the particular wealth under consideration, or
enough of these attributes to distinguish that species of
wealth from others with which it might be confused.

Thus it is often necessary to specify what “grade ’’ or
“brand ” is meant, as “grade A,” “Eagle brand,” etc.
Sometimes the special variety is denoted by a “trademark''
or “hall-mark.”

Some writers have erroneously supposed that the attri

butes of wealth constitute separate and independent “im
material" sorts of wealth.

But “

rtilityx

for instance,

is not wealth, though “fertile land" is wealth. “Sweet
ness” is not wealth, though “ sweet

sº is

wealth;

“Abeauty” is not wealth, although a “beautiful gem" or
other object of art is wealth; “strength” and “power”
are not wealth, although “powerful horses,” automobiles, or
waterfalls are wealth."

§ 5. Price

We have considered articles of wealth as measured sepa
rately. Each kind has its own special unit, as the pound,
gallon, or yard. But it is convenient also to measure
the combined value of aggregations of wealth. The term
“value" introduces the subject of exchange. So much
mystery has surrounded the term “value" that we cannot
be too careful to obtain a correct and clear idea of it at the

outset. In the explanation which follows, the concept of
value is made to depend on that of price; that of price, in
turn, on that of exchange; and finally, that of exchange on
that of transfer. In this section we shall treat of price;
* Some people speak of human qualities — strength, beauty, skill, honesty,
intelligence, etc. — as though they were wealth. But these bear the same
relation to human beings as similar qualities of articles of wealth bear to
those articles; and the only way we can logically make them even attri
butes of wealth is, as already stated, to call human beings wealth. Then
their attributes become attributes of wealth in the broader meaning of that
term.
-

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

and, to observe the order of sequence, we must begin with
transfer.

Wealth is said to be transferred when it changes owners.
A transfer is a change of ownership. Such a change does not
necessarily imply a change of place. Ordinarily, of course,
the transfer of an article is accompanied by a change in its
position, the purchase of tea or sugar being accompanied by
the physical delivery of these articles across the counter
from dealer to customer; but in many cases such a change of
position does not occur, and in the case of real estate it is
even impossible.
Transfers may be voluntary or involuntary. Examples of
involuntary transfers of wealth are: (1) through force and
fraud of individuals, as in the case of robbery, burglary, or
embezzlement; (2) through force of government, as in the
case of taxes, court fines, and “eminent domain.”

But

at present we have to do only with voluntary transfers.
These are of two kinds: (1) one-sided transfers, i.e., gifts
and bequests; and (2) reciprocal transfers, or exchanges,
which are of most importance for economics. An exchange
of wealth, then, is a pair of mutual and voluntary transfers of
wealth between two owners, each transfer being in considera

tion of the other.
When a certain quantity of wealth of one kind is ex
changed for a certain quantity of wealth of another kind,
we may divide either of the two quantities by the other and
obtain what is called the price of the latter. That is, the
price of wealth of any given kind is the amount of any other
kind of wealth supposed to be exchanged for one unit of the
given kind of wealth. Thus if Ioo bushels of wheat are ex
changed for 75 dollars of gold, the price of the wheat in
terms of gold is 75 + Ioo, or three-fourths of a dollar of
gold per bushel of wheat. Contrariwise, the price of gold
in terms of wheat is Ioo + 7.5, or one and one-third bushels
of wheat per dollar of gold. Thus there are always two
prices in any exchange. Practically, however, we usually
_-T

c
*

- Sec. Sl

WEALTH

.
º

speak only of one, viz., the price in terms of money, obtained

F by dividing the number of units of money by the number of
* units of the article exchanged for that money. It follows

that, practically, the price in money of any particular sort of

wealth is the amount of money for which a unit of that wealth
is exchanged. The fact that wealth is exchangeable and in
the civilized world is constantly changing ownership is of
great importance for our study. Articles of wealth which

3 are seldom exchanged, such as public parks, are not com
~
monly thought of as wealth at all, although logically they
.s
* must be included in that category.
*

While it is true that any two kinds of wealth may be

exchanged, some kinds of wealth are more acceptable in ex

change than others. Money primarily means wealth which
is generally acceptable in exchange. Here for the first time
y
we reach a preliminary definition of money. This definition
is based on the most important characteristic of money —
*
its exchangeability. An exchange in which money does not
:
figure is called barter. An exchange in which money does
figure is called a purchase and sale – a purchase for the
* man who parts with the money (or its representative, a
check), a sale for the man who receives it. Originally, all
, exchange was barter, but to-day most exchange is, as we
*

all know, purchase and sale.
S- In order that there may be a price, it is not necessary that
the exchange in question shall actually take place. It
may be only a contemplated exchange. A real estate agent
often has an “asking price ’’; that is, a price at which he
tries to sell. This is usually above the price of any actual
sale which may occur later. In the same way there is often
a “bidding price,” which is usually below the price of actual
sale. Hence, the price of actual sale usually lies between
the price first bid and the price first asked. But it sometimes
happens that the bidder refuses to raise his bidding price,
and the seller refuses to lower his asking price enough to

bring the two together. In such a case no sale takes place,

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

and the only prices are those bid and asked. For many
commodities the trade journals report, preferably, prices of
actual sales; but, where there have been no sales, they
simply report the prices bid or asked, or both.
When there is no sale, especially when there is no price bid
or asked, it is not so easy to answer the question: What is
the price? Recourse is then had to an “appraisal,” which
is simply a more or less skillful guess as to what price the
article would or should bring. Appraising or guessing at
prices is often very difficult. It frequently has to be em
ployed, however, by the government, for the purpose of
assessing taxes and customs duties and condemning land;
by insurance companies for settling claims and adjusting
losses; by merchants for making up inventories and similar
statements; and by statisticians for numerous purposes.
In fact, some people make a living by appraising wealth
on which, for one purpose or another, a price of some sort
must be set. The purpose evidently makes a great differ
ence in the appraisal. Sometimes we want to know the
price for which an article could be sold in an immediate
forced sale; sometimes, the price it might be expected to
bring if a reasonable time were allowed; sometimes, the
price the owner would probably take; sometimes, the price
a purchaser would probably give. These prices may all be
different. A family portrait may be worth a big price to
the owner, and yet bring next to nothing if sold to strangers.
The owner would naturally appraise it at a high figure if he
wished to insure it against fire, but if he should try to bor
row money on it from a pawnbroker, the appraisal would
undoubtedly be low.

Consequently, in applying an appraisal, we encounter
many difficulties because the parties involved usually have
some interest to serve.

When a farmer has land for sale,

he will hold it at a high price to prospective purchasers,

but will enter it, if the truth must be told, at a low price on
the tax list. When a fire loss is adjusted, the two conflict

Sec. 6]

WEALTH

ing interests, viz., the “insured ” and the “company,” are
usually represented by two experts, who in case of disagree
ment call in a third.

§ 6. Value

Having succeeded in defining the price of any kind of
wealth, we may next proceed to define the value of any given
quantity of that wealth. The value of a given quantity of
wealth is that quantity multiplied by the price." Arithmetic

ally expressed, if the price of wheat is # of a dollar per bushel,
then a lot consisting of 3ooo bushels would have a value of

3ooo times # of a dollar, or 2000 dollars. Algebraically ex
pressed, if the price of any good is p and its quantity is Q,
its value is expressed as p0. In other words, the value of a
certain quantity of one kind of wealth at a given price is the
quantity of some other kind for which it would be exchanged,
if the whole quantity were exchanged at the price set.
The distinctions between quantity, price, and value of
wealth may be illustrated by an inventory such as the fol
lowing: —
QUANTITY

Shoes . . . .
Beef . . . . .
Dwelling house .
Wheat

PRICE IN TERMS OF WHEAT

. . Iooo pairs |4} bu. *per pair
. 3oo lb.
# bu. per pound
.
1 house | Io,000 bu. per house
. . Ioo bu.
I bu. per bushel

VALUE IN TERMs
of we eat

42.5o bu.
6o bu.

Io,0oo bu.
Ioo bu.

* This definition of value departs from the usage of some textbooks, but
follows closely that of business men and practical statisticians. Economists
have sometimes confined “price” to what is in this book called money price
and applied the term “value” to what is here called price. Other econo
mists have used the term “price” in the sense of market price — what an
article actually sells for — and “value” in the sense of appraised price or
reasonable price—what it ought to sell for. Still others have used the term
“price” in the sense employed in this book, but “value” in the sense of the
degree of esteem in which an article is held — what in this book will later be
called “marginal utility” or “marginal desirability.”
* “Bushels” refers to bushels of wheat throughout this table.
C

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

The three columns must be carefully distinguished.
Only in special cases can any two of the three magnitudes,
quantity, price, and value, be identical. The table illus
trates these special cases.

Thus in the last line we find

quantity and value identical because, in this special case,
the value of the good is reckoned in terms of itself, wheat in wheat. In the line above, price and value are
identical because, in this special case, the quantity valued is
only one unit. The value of one house is the price per
house.

The measurement of various items of wealth in respect
of “value,” expressed in terms of a single commodity, such
as wheat or money, has one great advantage over its meas
urement in respect of “quantity.” This advantage is that
it enables us to translate many kinds of wealth into
one kind and thus to add them all together. To add

up the “quantity” column would be ridiculous, because
pairs of shoes, pounds of beef, houses, and bushels of
wheat are unlike quantities. But the items in the last
column (representing values), being expressed in a single
common unit (the bushel), may be added together de
spite the diversity of the various articles thus valued in
bushels of wheat.

Since prices and values are usually expressed in terms of
money — the most exchangeable kind of wealth — money
may be said to bring uniformity of measurement out of
diversity. In other words, it is not only a medium of ex
change, but it can be used also as a measure of value.

serves as a means of comparing values of different things by
expressing them both in a common denominator. It would
be far more trouble to compare each article directly with
every other article, for there would be many more com
parisons.
Although this reduction to a common measure is a great
practical convenience, we must not imagine that it gives what
could in any fair sense be called “the only true measure"

Sec. 6]

WEALTH

of wealth. In fact, to measure the amount of wealth by
its value — i.e., its money value – is often misleading.
The money value of car wheels exported from the United
States in one month was $12,000 and in a later month,
$15,000, from which fact we might infer that the quantity
of these exports had increased. But the number of car
wheels exported in the first of those two months was 2200,
and in the second only 21oo, showing a decrease.

The

price had increased faster than the number had decreased.
Likewise, the figures for imports of coffee in these periods
show a decline in dollars, despite an increase in pounds.
Here the price had fallen faster than the number of pounds
had risen. It is conceivable that the quantity of every
article might decrease, and yet the price simultaneously
increase so much that there would be an apparent increase
of wealth when there really was nothing of the kind. This
is apt to be the case in times of inflation of the currency.
Even when we are confessedly trying to measure the value
of wealth and not its quantity, it is difficult or impossible
to find a right way. Imports into the United States from
Mexico in one year were worth twenty-eight millions of
American gold dollars, and ten years later their value was

forty millions — an increase in value of forty-two per cent;
but these very same imports measured in Mexican silver
dollars were forty-one millions in the first year and ninety
millions in the second – an increase in value of nearly one
hundred and twenty per cent. These two rates of increase,
although they represent exactly the same facts, do not agree
with each other; yet the American merchant reckons the

values one way, and the Mexican merchant, the other. In
a sense both are right; that is to say, both are true state
ments of the value of the articles imported, one of the
value in gold and the other of the value in silver. If the
value were to be measured in iron, copper, coal, cotton, or
any other article, we should have many other different
“values,” no two of which would necessarily agree. “The

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

value of wealth,” therefore, is an incomplete phrase; to be
definite we should say, “the value of wealth in terms of
gold,” or in terms of some other particular article. Hence
we cannot employ such values for comparing different
groups of wealth, except under certain conditions, and to a
limited degree. To compare the wealth values of distant
places or times — as America and China, Ancient Rome
and Modern Italy — will inevitably give conflicting and
unsatisfactory results.
§ 7. Limit of Accuracy in Economic Measurements

We have learned how the three magnitudes — quantity,
price, and value of wealth — are usually measured, and that
their measurement is practically a very inaccurate affair.
Yet in the minds of most persons, even of business men, the
degree of accuracy attainable is exaggerated. Even in the
measurement of the mere quantities of wealth there are two
sources of error; for every such measurement includes, as
we have seen, two elements: a unit and a number or ratio

(as the pound, and the number of pounds); and both the
unit and the number or ratio may be inaccurate.

modern times the first source of error — that of the unit —

is practically eliminated. Our units of weight and meas
ure are standardized by law, and a pound in California is,
for all practical purposes, equal to a pound in Connecticut.
There is, moreover, at Washington a national bureau and a
special building for preserving and testing standards of
measurement. Different towns have their sealers of weights
and measures, to prevent error through ignorance or fraud.
Fraud and error still exist, but are much rarer than in

former times. The Egyptians are said to have been un
able to test the accuracy of their units of length closer
than to 1 part in 350. The Roman weights were true only
to 1 part in 50. And when we go back to primitive units,
we find that they were very rough indeed. A yard was

SEc. 7]

WEALTH

probably at first the length around the waist, which naturally
was apt to vary considerably. So also the distance between
the elbow and the end of the finger was taken as a unit
and called the ell. Fraud was, therefore, as easy as it was
common. At Bergen, in Norway, among other relics of
the old Hanseatic League, are the scales used for buying
and selling fish, with two sorts of weights used, one con
siderably heavier than the other. The heavier were used for
buying and the lighter for selling ! Such tampering with
weights and measures is probably much less frequent to-day,
although instances of short weights, as in the “sugar trust
frauds,” are often brought to light.
To-day, therefore, the chief source of error lies not in the
unit, but in the ratio of the quantity of wealth to that unit.
In retail trade the inaccuracy from this source is very great.
If we get our apples or potatoes measured correctly within
five per cent, we are fortunate. Wholesale transactions
are more accurate. Probably the greatest degree of accu
racy ever attained in commercial measurements is on the
mint scales employed by the federal government in Phila
delphia and San Francisco. These scales weigh accurately
to within about one part in two million.
Besides the two sources of error in the measurement of

mere quantity, when we proceed from quantity to value,
we introduce still a third source of inaccuracy, viz., the price
factor by which we multiply the quantity in order to get
the value. This is especially true if the price be merely
an “appraised " price. The price in an actual sale is an
absolute fact and cannot be said to have any inaccuracy;
but the price at which we estimate that a thing would sell
under certain conditions is always uncertain. In the case of
“staple '' articles, i.e., articles regularly on the market, a
dealer can often appraise correctly within one per cent.

Real estate in certain parts of a city where sales are active
can sometimes be appraised correctly within five or ten per
cent, but in the “dead " or out-of-the-way parts of some

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. I

towns where sales are infrequent, the appraisement be
comes merely a rough guess. Again, in the country districts,
while farms in the settled parts of Iowa and Texas can be
appraised within ten or fifteen per cent, in the backward
parts even an expert's valuation is often proved wrong by
more than fifty per cent. And where a sale of the article
in question is scarcely conceivable, an appraisement is almost
out of the question. To estimate the value of Yellow
stone Park is impossible, unless we allow ourselves very
wide limits of error."
* Still wider limits must be allowed when we try to value human beings.
We can often give a lower limit, but seldom an upper one. The estimates
may vary enormously with the point of view. It is sometimes said, “If I
could buy Mr. So-and-so at my valuation and sell him at his, I'd get rich.”
Freemen are seldom appraised at all. When the slaves in the South
became freemen, they ceased to be appraised as wealth. The result has
been somewhat confusing to our census statistics. The “Manufacturers’
Record” of Baltimore recently issued figures showing a sharp drop in the
assessed valuations of wealth in the South after the war.

The inference

was drawn that the value of wealth had immensely decreased; but a large
part of this so-called decrease consisted merely in the change of ownership
of slaves from their old masters to themselves, and their consequent omis
sion as items of value. Any valuation of freemen, should exceed that of
slaves; but even on the basis of slave values the total value of the human
beings in any country is always greatly in excess of the total value of all
other wealth.

CHAPTER II

PROPERTY

§ 1. The Benefits of Wealth

THE definition of wealth which has been given restricts
it to concrete material objects owned by man. Accord

ingly, wealth has two essential attributes: materiality
and ownership.

Its materiality was the subject of the

preceding Chapter; its ownership will be the subject of
the present chapter.

To own wealth is to have a right to the benefits of wealth,
and before proceeding further with the discussion of owner
ship, we must consider these “benefits" of wealth. To

own a loaf of bread means nothing more nor less than to have
the right to benefit by it – i.e., to eat it, sell it, or otherwise

employ it to satisfy one's desires. To own a suit of clothes

is to have the right to wear it. To own a carriage is to
have the right to drive in it or otherwise utilize it as long
as it lasts. To own a plot of land means to have the right
to use it forever. The ultimate objects for which wealth
exists are the benefits which it confers. If some one should
give you a house on condition that you should never use it,
sell it, rent it, or give it away, you might be justified in refus
ing it as worthless.

Benefits may also be rendered by free human beings (who,

according to our broader definition, are included under
wealth). Such benefits are then usually called services ren
dered or work done. When rendered by things rather
than persons, benefits are commonly called uses. Some
23

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

times benefits consist of positive advantages and sometimes
of the prevention of disadvantages. Benefits, then, mean
desirable events obtained or undesirable events averted by means

of wealth or free human beings. For example, when a
loom changes yarn into cloth, the transformation is a de
sirable change due to the loom; it is a benefit conferred or
performed by the loom. The benefit from a plow is the
turning up of the soil. The benefits or services performed
by a bricklayer consist in the laying of bricks. The benefits
or uses conferred by a fence around a farm consist in pre
venting the cattle from roaming away. The dikes in Hol
land confer the benefit of keeping out the ocean. The
benefits conferred by a diamond necklace consist in its
pleasing glitter.
Many articles confer benefits on their owners by yielding
them money. The benefit to the landlord from the land or
building which he lets is the receipt by him of rent. The
benefit to the owners of a railway from the railway is the
receipt by them of their dividends. But not all benefits,
of course, are simply the receipt of money.
To be desirable to the owner, an article must confer bene
fits on the owner, but not necessarily on the community
at large. For instance, the noise of a factory whistle may
be a nuisance to the community, but as long as it is service
able to the owner of the factory, it is for him a benefit.
Benefits to the owner and benefits to society may be very
different or may be mutually incompatible. The benefits to
society are of the greater importance, but, under our present
system of ownership, the benefits to the owner control the
prices and values of wealth. In order, therefore, to under
stand prices and values as they are actually determined,
we must fix our attention for the present on the benefits to
the owner rather than on those to society.
Benefits may be measured just as wealth may be measured,
although the units of measurement are, of course, not the
same. We measure some benefits by number—as when we

Sec. 2)

PROPERTY

count the strokes of a printing press. We measure other
benefits by time — as when we reckon a laborer's work by
the number of hours or days during which he works. Some
benefits we measure by the quantity of wealth which is pro
duced or treated — as when the work of a coal miner is

measured by the amount of coal he mines, or when the use of
a loom is measured by the number of yards of cloth it
weaves, or when the services of a lawn-mowing outfit are
measured by the number of acres covered.

The measure

ment of services or benefits is usually rougher than that of
wealth, because it is more difficult to establish units of
measure.

The shelter of a house or the use or “wear” of a

suit of clothes is difficult to measure accurately. To save
trouble, benefits are usually measured by time, although, as
soon as it becomes profitable to do so, the tendency is to
establish a more satisfactory measure “by the piece.”
When we have measured the benefits of wealth or of free

human beings, we may apply to them the same concepts of
transfer, exchange, price, and value, which, in the last chap
ter, we applied to wealth. We have seen that wealth may
be exchanged. The same is true of benefits. In fact, every
exchange is an exchange of benefits; for to exchange wealth
is really to exchange the benefits of wealth, the only object
in getting wealth being to get its benefits.
-

§ 2. The Costs of Wealth

Opposed to the benefits of wealth are its costs. Costs
may be called negative benefits. The purpose of wealth is
to benefit its owner; that is, to cause to happen what he

desires to happen, and to prevent from happening what he
desires not to happen.

But often wealth can work no

benefit without entailing some cost, i.e., preventing what is
desirable or occasioning what is undesirable.

For instance,

one cannot enjoy the benefits of a dwelling without the costs
of taking care of it, either through the actual labor of clean

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

ing, heating, repairing, and keeping it in order, or the pay
ment of money to servants for such purposes; one cannot

get the benefit of flour without assuming the cost of knead
ing and baking it into bread; one cannot get the benefit of
a farm without the cost of tilling it. Whatever wealth brings
about to the pleasure of the owner is a benefit; whatever
it brings about to his displeasure is a cost. He assumes the
costs only as a means of securing the benefits. Costs are
thus the necessary evils which must be if we are to obtain
the good which wealth affords.
Like benefits, costs are not only occasioned by wealth,
but also by free human beings. An employer can
get benefits from a workman only at the cost of pay
ing him wages; an independent workman can get bene
fits from his own exertions only at the cost of his own
labor.

The costs of wealth or of free human beings may, of course,
be measured, just as benefits are measured — by number,
by time, or by other appropriate units; and costs when
thus measured may, by price and value, be translated into
terms of money precisely like the opposite items—benefits.

We must beware of assuming that cost is always in the
form of an expenditure of money.

Such money cost has

received exaggerated importance in the eyes of business
men and has tended to hide the more important and funda
mental kind of cost, namely, labor. Even labor appears to
the employer in the guise of a money cost – the expenditure
of wages. This expenditure, however, is not itself labor.
Those who feel a real labor cost are the laborers themselves.

It is by their physical and mental exertions that the work

of the world is chiefly done.
§ 3. Property, the Right to Benefits
We have said that to own wealth means to have the

right to its benefits.

We have seen what is meant by

SEC. 3]

PROPERTY

“benefits,” and shall next examine what is meant by
“rights.” "

A property right is the liberty or permit (under the sanc
tion and protection of custom and law) to enjoy benefits of
wealth (in its broader sense) while assuming the costs which
those benefits entail. The term “property" is merely an

abbreviation for “property right” or “property rights.”

Just as different kinds of wealth are more or less exchange
able, so different kinds of property rights differ greatly in
exchangeability. Those forms which are most easily and
commonly exchanged are of most importance for our study.
Those the exchange of which is infrequent, difficult, or for
bidden, are in fact seldom thought of as property rights at
all, although logically they must be included in that cate
gory. In the modern world the right of a parent over a
child or of a husband over a wife is not by ordinary usage
called property; for, except in certain remote corners of
the earth, their exchange is tabooed.

It will be observed that property rights, unlike wealth or
benefits, are not physical objects nor events, but are abstract
social relations. A property right is not a thing. It is that
relation of man to things, called ownership. It is in this
human relationship to wealth that we are most interested,
and not in the physical objects as such.
The benefits flowing from wealth require time for their
occurrence and are therefore either past or future. The past
and the future are separated by the present, which is a mere
point of time. The only benefits from wealth which can be
owned at this present point of time are future benefits.
Past benefits have vanished. When a man owns any form
of property, he owns a right to future benefits.

The idea of

“futurity” is, therefore, implied in our definition of property,
which may, therefore, be more explicitly expressed as follows:
* As we have seen that “benefits” may be occasioned not only by wealth
in its narrow sense, but by free human beings, we shall consider “rights”
to benefits from both of these sources.

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

Property is the right to future benefits of wealth (in its broader
sense). It is also to be observed that the future is always
uncertain; no man can ever tell in advance exactly how
much future benefit he can obtain; he can only take the
chances and risks involved. Consequently, the idea of un
certainty is also implied in our definition of property, which
may, therefore, be still more explicitly expressed as follows:
Property is the right to the more or less probable future benefits

of wealth (in its broader sense).
If a man has the right to all the benefits which may come
in the future from a particular article of wealth, he is said
to have its complete ownership, or its ownership without
encumbrance. If he has a right to only some of the bene
fits from a particular article of wealth, he is said to own that
wealth partially, or to “ have an interest" in it. When
two brothers own a farm equally in partnership, each is a
part owner; each has a half interest in the farm; that is,
each has a right to half of the benefits to be had from the
farm.

What is divided between the two brothers is not

the farm, but the benefits of the farm. To emphasize this
fact, the law describes each brother's share as an “undivided

half interest.” Partnership rights are usually employed only
when the number of coöwners is small.

When the number

is large, the ownership is usually subdivided into shares of
stock; but the principle is the same – each individual owns
a right to a certain fraction of the benefits which come to
the owners.

After the quantities of property of different kinds are
measured, we may apply the same concepts of transfer,
exchange, price, and value which have already been applied
to wealth and benefits, each particular kind being measured
in its own particular unit. Consider, for example, the prop
erty called stock in the Pennsylvania Railway Company.
This is measured by the “number of shares,” the share here
being the unit of measurement.
It is important that the student should become accus

SEc. 3]

PROPERTY

tomed to see the real basis underlying property rights. This
basis is either wealth or free persons, or both. Practically it
is usually wealth. A mortgage is based on land, and great
care is taken not to have the mortgage too large for the basis
on which it rests.

Railroad stocks and bonds are based on

the real railway. Personal notes are based partly on the
person issuing them and partly on his wealth. A street
railway franchise is a property right, the physical basis of
which consists in the streets. Sometimes the property
rights are removed several steps from the real basis. If a
number of factories are combined into a “trust,” the origi
nal stockholders surrender their stock certificates to trustees

and receive in their place trust certificates. Their rights are
then a claim against the trustees who hold the stock which

represents the factories. The ultimate basis for their rights
is still the factories, but their ownership is indirect.
The future benefits flowing from wealth may be compared
to a pennant attached to a flagstaff — a long streamer
stretching out into the future. Two of the possible ways
in which the present ownership of these benefits may be sub
divided are indicated in Fig. 1. Here are two “streamers ”
representing the streams of benefits which may come from
a dwelling house. These begin at the present and stretch
out indefinitely into the future. If two brothers own the
house in partnership, each has a right to half the shelter
of the house, i.e., to half of its benefits; the benefits are

therefore divided, so to speak, longitudinally in time.
But if the house is rented, the division of benefits between
the tenant and the landlord is transverse, as shown in the
lower “streamer" of the diagram. The tenant has all the

shelter of the house until the time when his lease is to expire,
while the right to all shelter beyond the time of the lease
rests in the landlord, either to use himself or to sell to

others by new leases.
These are not, of course, the only ways in which future
benefits may be parceled out among their several owners,

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. II

but they are the principal and usual modes of sub
division.

In common speech, the minor rights to wealth are not
ordinarily dignified as rights of ownership. Thus a tenant's
right in the dwelling
B's st-ARE of FUTURE BENEFITs. T he occupies is sharply
A's 5HARE of FUTURE BENEFITS,

}

distinguished from the

right of the owner.
Yet, strictly speaking,
every right to the
benefits of wealth or

to the services of free

TENANTs

LANDLORD's

human beings, how

uman beings,
ever insignificant that
right
may
g
y be, is a Dpart
ownership. When an

PRESENT

INSTANT

FIG. I

owner of land wishes

to give an unencum
bered title, he finds it necessary to extinguish all out
standing leases, or claims for future benefits, often at

considerable cost. It is the total ownership which he is
selling, and the total ownership always includes the owner
ship which the tenant enjoys. Thus the tenant of a
dwelling is, to a very slight extent, a part owner of that
dwelling. In the same way the employer is, to a very
slight extent, a part owner of the employee.
§ 4. The Relation between Wealth and Property

We have thus far considered three very important and

fundamental concepts: wealth, benefits, and property. A
convenient collective term for all of them is “goods.”
Wealth and property are only present representatives of
future benefits and future costs. Wealth (in its broader

sense) is the present means by which we secure future bene
fits; while property is the present right to these benefits,

SEc. 4)

PROPERTY

and so to the wealth (in its broader sense) which yields
them. It follows that wealth (in its broader sense) on
the one hand, and property rights on the other, may be

said to correspond to one another. The wealth (including

free human beings) consists in real tangible things, while
the property rights represent intangible, abstract relations
which persons, as owners, hold toward them (the wealth,
including free human beings). Wealth and persons are
the important things; property is the human right of
ownership of the wealth or of the services of free

human beings. In specific cases we can readily see the
correspondence between the wealth and its ownership.
In fact, in cases where wealth is owned unencumbered

or completely, the correspondence is altogether too ob
vious; so obvious that in ordinary parlance the two
terms, “wealth '' and “property,” become confused, as
when speaking of a piece of wealth, in the form, say, of
land, we call it a “piece of property.”
On the other hand, where the ownership is minutely
subdivided, the wealth and the property rights to that
wealth become so dissociated in our minds that we are apt

to fall into the opposite error, and entirely lose sight of
their connection.

For instance, when railway shares are

sold in Wall Street, the investor rarely thinks of those shares
as connected with any actual wealth. All that he sees are
the engraved certificates of his property rights; he has no
visual picture of the railway. Sometimes the rights are so
far separated from the thing to which the rights relate, that
people are unaware that there is anything behind the rights
at all, and delude themselves with the notion that there
need not be anything behind them. A government bond, for
instance, is often regarded as a kind of property behind which
there is no wealth.

But if we examine the case, we shall

find that the wealth of the entire community is behind
this property right; for it is by means of the taxing power
that the bonds are to be paid, and this taxing power can

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

only be effective by means of wealth (including freemen)
as sources of income. For cities, in fact, this is definitely
recognized; there is usually a legal debt limit expressed
in terms of the value of taxable wealth, to insure the
creditors that there shall always be sufficient real wealth
behind the city bonds to make their ultimate payment
SeCure.

Not only should the student clearly distinguish in his
mind between the three important concepts, wealth (in

cluding man), benefits and property, but he should avoid
confusing any of these with a fourth relatively unimpor
tant concept, namely, certificates of ownership. To avoid
misunderstanding, it is often necessary that property rights
should be evidenced by written documents. Examples of
such written evidence or certification of property rights are
deeds for real estate, receipted bills for goods bought and paid
for, engraved stock certificates, railway tickets, signed prom

issory notes, written contracts with laborers to “work out”
a sum of money advanced, etc. It is clear, however, that
such written evidence of property rights is very different
from the property rights themselves; and in many cases
such rights exist without any written evidence. Thus, the
farmer who rears his own cattle, or horses, or sheep, usually
has no written evidence of property rights in them. Or,
two brothers might own and operate a farm in partnership,
without any written evidence as to their partnership rights,
i.e., their respective rights in the products of the farm. Or,
again, one person might, without written evidence, lease
(say) a cottage for a season from a friend. In all these
cases, there are no documentary evidences of property
rights. Yet in all three cases property rights exist. In
the first case the right is complete; in the other two cases
partial, the benefits being subdivided, -in one case lon
gitudinally, in the other, transversely.

SEc. 5]

PROPERTY

§ 5. Table of Typical Property Rights
The following table indicates the most important types of
property, and shows in each case the wealth on which the

property right is based and the benefits accruing from that
wealth. The most important forms are: unencumbered,
stocks, bonds, notes, leases, and partnership rights.
TYPICAL CASES ILLUSTRATING THE EXISTENCE OF
WEALTH

BEHIND

PROPERTY

RIGHTS

WEALTH on which

CERTIFICATE

Naws or caseſ." Hº ;º. º.º.
Unencumbered

Yielding crops

Farm

Right to all use | Deed
of farm for
ever

Partnership

Yiclqing profits One

Dry goods

from sale

partner's Articles

“undivided ”
fractional in

agreement

terest

Joint Stock

Railway

Yielding

profits. The

shares
stock

Stock

certifi

cate

Street Franchisel Street

Use of same for Right to run Charter
passage, etc.
cars through

Lease or Hire | Dwelling

Use of same for Right of tenant Lease

Railway Ticket Railway

Transportation | Right to speci- Ticket

Railway Bond

Payment of “in- Right to same Bond

shelter, etc.

till fixed date

fied trip
Railway

terest"

and

“principal''

and

contin-

certifi

Cate

gent right to
foreclose

Personal Note All the posses- || Payments
sions of

the

and

signer

Work due from Workmen
Contract Labor

Right to same | Note

Work

fault thereof,
right to collat
eral security
Right of employ- Written
er to perform- tract
ance of same

con

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

§ 6. Practical Problems of Property
We have seen that wealth (including man), on the one
hand, and property rights, on the other, correspond to each
other.

When we treat of the welfare of a community, we

think rather of wealth (in its broader sense) than of prop
erty. When we treat of the welfare of an individual, we
think rather of property than of wealth. This fact of corre
spondence between property rights, on the one hand, and
wealth (including man), on the other, should be empha
sized, because it will save us from confusions which are all

too common, and it will save us also from many practical
blunders growing out of these confusions. If our State
legislators understood this, there would be less of the
iniquitous double taxation that is the bane of the present
systems of State and local taxation. Such unjust taxation
is illustrated by the case of the Massachusetts factory owner

who decided to transfer his property to a stock company of
which he himself should hold all the stock. Previously he
paid taxes only on the factory itself; but when the “com
pany” was formed (under a Maine charter), the tax collector
came along and informed him that henceforth not only
must the “company ” pay taxes on the factory, but that
he personally must pay taxes on the stock also, since stock
in a Maine company is taxable “personal property.”
Thus the owner was taxed both on the stock which repre
sented the factory and on the factory itself. Instances
of double taxation are quite common in the United States,
though they are not all so self-evident as this.

It is not

within the scope of this book to discuss taxation or other
practical problems of economics. The object of this
section is merely to point out what practical problems are
related to “property.”
Many of the most important problems of economic
policy are problems of the form of ownership of wealth.

SEc. 6]

PROPERTY

The great question of slavery, for instance, turned upon the
question whether one man should be owned by another.
A more modern problem of property is that of perpetual
franchises. Is it, for instance, good public policy to grant to
a street railway company in perpetuity the right to use a
city's streets? Or ought we to fix a time limit, say fifty
years, after which the right shall revert to the city? A
kindred question has been raised as to private property in
land. Is it wise public policy that the present form of land
ownership in fee simple should continue? Ought a man
to have the right to a piece of land forever, perhaps abus
ing that right, obstructing others, and neglecting the oppor
tunities which it affords; or should the government own
the land and lease it to individuals for limited periods?
This question is now being discussed with reference to our
mineral lands, and particularly our coal lands in Alaska.
Questions of land ownership have in all ages vexed men's
minds and been the source of social unrest.

Rome had

her agrarian troubles, not unlike those of modern England
and Ireland.

The right to bequeath property is also a prime source of
trouble. This right to dispose of property by will has not
always been recognized. It was developed by the Romans,
from whose system of law we borrowed it. Even now it

is a limited right, and its exercise differs with law and custom.
These differences are responsible for peasant proprietorship
in France and for primogeniture in England. The right has,
indeed, been limited so as to prevent the perpetual tying-up
of an estate by a testator. Its further limitation will prob
ably be one of the problems of the future.
An even broader question of the same sort is the question
of socialism. Shall we discontinue what is called private
property, except in the things that we wear and eat, and pos
sibly the houses in which we live? That is, shall we allow
our railways and our factories to be owned by private indi
viduals? Or shall they be owned by the community at

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. II

large so that we may all have shares in them, as we already
have in the post office and the government printing office?
These are some of the greatest problems in economics;
and they are problems concerning the ownership of wealth.

The answers to these questions do not come within the pur
pose of this book, which is concerned merely with principles.

* The problems are mentioned, however, as illustrating the
-**

application of principles here discussed.

CHAPTER III
CAPITAL

§ 1. Capital and Income
IN the foregoing chapters we have set forth several funda
mental concepts of economics – wealth, property, benefits,
price, and value. We have seen that wealth in its broader
sense includes human beings, and that property in its
broader sense includes all rights whatsoever; that benefits
are the desirable occurrences which happen through wealth
(in its broader sense); that prices are the ratios of exchange
between quantities of goods of various kinds (wealth,

property, or benefits); and that value is price multiplied
by quantity. These concepts are the chief tools needed in
economic study.
Little has yet been said about the relation of these
various magnitudes to time. When we speak of a certain
quantity of wealth, benefits, or property, we may refer either
(1) to a quantity existing at a particular instant of time, or
(2) to a quantity produced, exchanged, transported, or con
sumed during a particular period of time. The first is a
stock of “goods”; the second is a flow of “goods.” Ex
amples of stocks are the stock in trade of a merchant on

a certain date, the cargo of wheat on board a ship, the
amount of food in a pantry at a particular instant, the
number of shares of stock owned by a particular individual
in a particular corporation at a particular date. Examples
of flows are the sales of merchandise made in the course of

a given month by a given merchant, the amount of wheat
37

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

imported into a given country during a given year, the
quantity of food consumed by a family in a given week,
the sales of a given kind of stock on the New York Stock
Exchange during a given number of days, the transporta
tion accomplished by a railway in the course of a certain

year, the work done by a given man in a given time.
The most important purpose of the distinction between a
stock and a flowis to differentiate between capital and income.
Capital is a stock, and income a flow. This, however, is not
the only difference between capital and income. There is
another, equally important; namely, that capital consists
of wealth, while income consists of benefits. We have,
therefore, the following definitions: A stock of wealth existing
at a given instant of time is called capital; a flow of benefits
from wealth through a period of time is called income.
Many authors restrict the name capital to a particular
kind or species of wealth, or to wealth used for a particular
purpose, such as the production of new wealth; in short, to
some specific part of wealth instead of any or all of it.
Such a limitation, however, is not only difficult to make,
but cripples the usefulness of the concept in economic
analysis."
A dwelling house is capital; the shelter or the rent it
affords, during any given period of time, is income. The

railways of the country are capital; their benefits (in the
form of transportation or its equivalent in dividends) are
the income they yield.
The term capital is also applied to a stock or fund
of property existing at an instant of time. But such

“capital property” is not, of course, in addition to “cap
*Just as wealth may be considered in a broader sense as including
freemen, so capital may also be considered in this broader sense. Thus
an individual, because of his ability to work, may be considered as capital,
while the benefits resulting from his labor (services rendered employer or
self) should be considered as income. However, in the following dis

cussion of “capital,” we shall, except where the contrary is expressly
stated, use the term in its narrower sense.

SEc. 2]

CAPITAL

ital wealth,” but merely instead of it; for we have seen
that wealth and property are coextensive. The only
true capital of society as a whole is its capital-wealth, –
its lands, railways, factories, dwellings, and in its broader
sense its human inhabitants also; but since the owner

ship of many of these things is subdivided, the capital
of an individual can often be stated only in terms of
property—his stocks, bonds, mortgages, personal notes, etc.
§ 2. Capital-goods, Capital-value, Capital-balance
We have defined capital as a stock of wealth existing
at a given point of time. An instantaneous photograph of
wealth would reveal, not only a stock of durable wealth,
but also a stock of wealth more rapid in consumption.
It would disclose, not the annual procession of such wealth,
but the members of that procession that had not yet passed
off the stage of existence, however swiftly they might be
moving across it. It would show trainloads of meat, eggs,
and milk in transit, as well as the contents of private store
rooms, ice chests, and wine cellars. Even the supplies on
the table of a man bolting his dinner would find a place.
So the clothes in one's wardrobe, or on one's back, the

tobacco in a smoker's pouch or pipe, the oil in the can or
lamp, would all be elements in this flashlight picture.
We have seen in the last two chapters that wealth and
property may be measured either by quantities (such as so
many bushels or pounds or so many shares or bonds of a
particular description) or by value (such as so many dollars'
worth). When a given collection of capital is measured in
terms of the quantities of the various goods of which it is
composed, it is called capital-wealth or capital-property or,
to include either, capital-goods; when it is measured in
terms of its value, it is sometimes called capital-value.
One of the best methods of understanding the nature of
capital is to understand the method of keeping capital ac

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

counts. We shall, therefore, in the remainder of this chapter
indicate some of the principles of capital accounting. Such
a study is useful not only because it enables us to keep our
own capital accounts and to understand the accounts of
banks, railways, and other institutions as published, but,
what is more important for our present purpose, because
it shows how in the present complicated world of divided
ownership of capital, with its interrelated arrangement of
stocks, bonds, debts, and credits, the capitals of individuals
dovetail into one another, forming together the capital of
the community.

A capital account or balance sheet is a statement of the
quantity and value of the wealth of a specific owner at any
instant of time.

It consists of two columns — the assets and

the liabilities—the positive and negative items of his capital.
The liabilities of an owner are his debts and obligations to
others; that is, they are the property rights of others for
which this owner is responsible. The assets or resources of
the owner include all his capital, irrespective of his liabilities.
These assets include both the capital which makes good
the liabilities, and that, if any, in excess of the liabilities.
The owner may be either a physical human being or an
abstract entity called a “fictitious person’’ made up of a
collection of human beings and keeping a balance sheet
distinct from those of the individuals composing it. Ex
amples of fictitious persons are an association, a partner
ship, a joint stock company, a government. With respect
to a debt or liability, the person who owes it is the debtor,
and the person owed is the creditor. The difference in
value between the total assets and the total liabilities in

any capital account is called the net capital, or capital
balance of the person or company whose account it is.
A fictitious person is to be regarded as owning all the
capital nominally intrusted to it and as owing its individ
ual members for their respective shares; consequently,
there is no net capital-balance belonging to the fictitious

SEc. 2)

CAPITAL

person, although in most cases there is a liability item
called capital which represents what is owed to those
most responsible for the management of the business.
The most important example of a fictitious person is a
joint stock company. This may be roughly described as
an aggregation of individuals uniting for the purpose of
holding property jointly, and so organized that the in
dividual shares of ownership and management are repre
sented by “stock certificates.” Associated with the stock
holders are usually also bondholders without voting power,
but with the right to receive fixed payments stipulated

in the bonds which they hold. The “capital” item in
the capital account of a joint stock company is a liability
due to the stockholders.

It represents what is left after

the value of all other liabilities is deducted from the value
of the assets.

The items in a capital account are constantly changing,
as also their values; so that, after one statement of assets

and liabilities is drawn up, and another is constructed at a
later time, the balancing item, or net capital, may have
changed considerably. However, bookkeepers are accus

tomed to keep this recorded “capital” or “capital-balance”
item unchanged from the beginning of their account, and

to characterize any increase of it as “surplus” or “un
divided profits” rather than as capital. There are several
reasons for this bookkeeping policy. In the first place,
the less often the bookkeeper's entries are altered, the
simpler the bookkeeping. Again, by stating separately
the original capital and its later increase, the books show
at a glance what the history of the individual or company
has been as to the accumulations of net capital. Finally,
in the case of joint stock companies, the stockholders'
capital is represented by stock certificates, the engraved
“face value " of which cannot conveniently be altered
to keep pace with changes in real value. Consequently,
it is customary for bookkeepers to maintain the book

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

value of the recorded “capital,” or “capital-balance,”
equal to the face value of the certificates. But this book
keeping policy does not alter the fact that at a given instant
the stockholders' capital consists of the entire excess of as
sets over liabilities, including in that excess the accumulated
surplus and undivided profits. If the excess of assets over
liabilities be added to the liabilities, the two sides of the

account will exactly balance. A capital account so made out
is therefore called a “balance sheet.”

The following two balance sheets illustrate the accumula
tion in a year of that part of capital which bookkeepers sepa
rate from the “capital ’’ item and call “surplus.”
JANUARY 1, 1910
ASSETS

Plant .

LIABILITIES

. $200,000

$200,000

Debts
. . . .
$1oo,0oo
Capital (owed to the
stockholders) . .
Ioo,ooo
$200,ooo

JANUARY 1, 1911
ASSETS

LIABILITIES

Plant, etc. . . . . $246,324

$246,324

Debts
. . . . . $100,ooo
Capital . . . . .
Ioo,ooo
Surplus . . . . .
46,324
$246,324

Not only is the book item, “capital,” maintained intact
as long as possible, but often the surplus also is put in
round numbers and kept at the same figure for several succes

sive reports. This leads bookkeepers to distinguish a third
part of the capital, namely, the odd sum usually existing
in addition to the surplus. This third item is called “un

divided profits,” and is subject to constant fluctuation
from one date to another.

The distinction between sur

plus and undivided profits is thus merely one of degree.

SEc. 2)

CAPITAL

The three items — capital, surplus, and undivided profits —
together make up the total capital-balance due the stock
holders. Of this, “capital ’’ represents the original capi
tal, “surplus ” the earlier and larger accumulations, and
“undivided profits” the later and minor accumulations.
The undivided profits are more likely soon to disappear in
dividends, i.e., to become divided profits, although this may
also happen to the surplus, or even in certain cases to the
“capital " itself.
We see, then, that the capital of a company, firm, or
person, is to be understood in two senses: first, as the item en
tered in the balance sheet under that head—the original cap
ital; and secondly, this sum plus surplus and undivided profits
— the true net capital at the instant under consideration.
In the case of a joint stock company, since the stock
certificates were issued at the time of the formation of the

company, and cannot be perpetually changed, they ordi
narily correspond to the original capital instead of the present
capital. Recapitalization may be effected, however, by
recalling the stock certificates and issuing new ones. In this
way the nominal or book value may be either decreased or
increased. It is sometimes scaled down because of shrinking
assets, and sometimes increased because of new subscrip
tions or expanding assets. If, for instance, the original
capital was $1oo,0oo, and the present capital (including the
surplus and undivided profits) is $300,ooo, it would be pos
sible, in order that the total certificates outstanding might
become $300,ooo, and the surplus and undivided profits be
enrolled as capital, to issue additional stock certificates to
the amount of $200,000 free to the holders of the original
stock.

Such an issue of stock is called a stock dividend.

Ordinarily, however, the stock certificates remain as origi
nally, and merely increase in value. Thus, if the present
capital is $300,ooo, whereas the original capital or the out
standing certificates amounted to only $100,000, the
“market value " of the shares will be triple the “face

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

value "; for the stockholders own a total of $300,ooo,
represented by certificates the face value of which is
$100,000.
§ 3. Book and Market Values
If, however, we attempt to verify such a relation by refer
ence to the company's books, we shall find some discrepancies
in the results.

For instance, a certain bank of New York

recently reported a total capital, surplus, and undivided
profits of $1,295,952.59, of which the original capital was
only $300,ooo. We should expect, therefore, that the stock
certificates, the total face value of which was $300,ooo,
would be worth $1,295,952.59; or, in other words, that each
stock certificate with a face value of $1oo would be worth

$432. The actual selling price, however, was about $700.
The discrepancy between $432 and $700 is due to the fact that
there are two estimates of the value of capital — one that
of the bookkeeper, which is seldom revised and usually
conservative, and the other that of the market, which is

revised almost daily. The stockholders of this bank were
credited by the bookkeeper with owning $1,295,952.59,
whereas in reality, the total value of their property was more
nearly $2,100,000. The bookkeeper systematically under
valued the assets of the bank, and even omitted some valu

able assets altogether, such as “good will.” The object of a
conservative business man in keeping his books is not to
obtain mathematical accuracy, but to make so conservative a
valuation as to be well within the requirements of the law and
expediency. The law discountenances the valuation of assets
above their original cost; and sometimes there is an addi
tional motive to undervalue, – the wish to conceal a large
surplus, from fear either of competition or of taxation.
Of the two valuations of the capital of a company, the
bookkeeper's and the market's, the latter, being more fre
quently revised, is apt to be the truer of the two, al
though it must be remembered that each of them is merely

SEc. 4)

CAPITAL

an appraisement. The ordinary bookkeeper's figures,
which have so imposing an appearance of accuracy, are,
in reality, and often of necessity, very wide of the mark.
For instance, a certain bank recently reported its capital,
surplus, and undivided profits at $444,814.40, but at the
same time the president of the bank boasted that the bank
ing house was entered among the assets at $20,000, while
its real value was probably $50,000. Thus the figure giving
the capital, surplus, or undivided profits, instead of being
correct to the last cent or even the last dollar, was not
correct even to the last ten thousand dollars.

§ 4. Case of Decreasing Capital-balance
We have seen that the effect upon the balance sheet of an
increase in the value of the assets is to swell the surplus or
the undivided profits. Conversely, a shrinkage of value
tends to diminish those items. For instance, if the plant of
a company having a capital of $100,000 and a surplus of
$50,000 depreciates to the extent of $40,000, the effect
on the account will be as follows:–
ORIGINAL BALANCE SHEET
Assets
Plant

LIABILITIES

. . . . $200,ooo.oo

Miscellaneous .

IoI,256.42

Debts

. . . . . $150,000.oo

Capital . . . .
Surplus . . . .
Undivided profits .

$3ol,256.42

Ioo,ooo.oo
50,000.00

1,256.42

$3o1,256.42

PRESENT BALANCE SHEET

Assets

LIABILITIES

Plant . . . . . $160,000.oo

Debts

Miscellaneous .

Capital . . . .
Surplus . . . .
Undivided profits

IoI,256.42

$261,256.42

. . . . $150,000.oo
Ioo,ooo.oo
Io,ooo.oo

I,256.42
$261,256.42

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

Here the shrinkage in the value of the plant, as recorded on
the assets side, “comes out of the surplus,” as recorded on
the liabilities side.

In case the surplus and undivided profits have both been
wiped out, the capital itself becomes impaired. In this case
the bookkeeper may indicate the result by scaling down the
capitalization.

This sometimes occurs in banks and trust

companies, but not often in ordinary business. It is often
avoided by making up the deficiencies through assessment
of stockholders or postponement of dividends. Such meas
ures are sometimes required by law, as in the case of insur
ance companies.
Dishonest concerns, however, often conceal their true con
dition by the reverse process of exaggerating the value of the

assets. Sometimes this is done systematically, as in the case
of stock-jobbing concerns. The sums intrusted to unscrupu
lous promoters by confiding stockholders are often invested
in unwise or fraudulent ways. For instance, take an Oil
Well Company in California, of the illegitimate type called

“stock-producing wells.” Suppose it borrows $50,000 and
collects $50,000 more from the sale of stock (at par), and
with this $100,ooopurchases land at a fancy price from friends
who collusively agree that a part of the proceeds shall be

secretly returned to the promoter. In such a case the books
of the bubble concern will show the following figures: —
ASSETs

Land .

LIABILITIES

. . . . . $100,000

Debts .
Capital

$1oo,ooo

. . . . . $50,000
. . . . .
50,000
$1oo,0oo

But if the land is worth, say, only $60,000, these accounts
should have been quite different, viz.:
ASSETs

Land

. .

LIABILITIES

. $60,000
$60,000

Debts .

Capital

. . . . . . Io,0oo
$60,000

$50,000

SEC. 41

CAPITAL

In other words, the investor has only $10,000 worth of
property, instead of the $50,000 which he put in, or 20 cents

for every dollar invested. The rest has been diverted into

** the pockets of the promoter and of those in collusion with
him.
---This is stock jobbing. It is one example of what, in
commercial slang, is called “stock watering,” being an
issue of stock whose nominal or face value is greater than the
actual capital. Another and more usual use of the term
“stock watering” makes it mean not an issue of stock beyond
the original cost value of the capital as shown by the actual
money paid in, whether or not this be beyond the real

commercial capital-value. . Thus a “trust” may buy up
a number of factories and then capitalize them far beyond
that cost, because the combination of the factories gives
them a monopoly value beyond the sum of their values
when separate. By this kind of stock watering, conceal
ment is made of the fact that the trust is earning an enor
mous rate of dividends in proportion to the original invest
ment; for the dividends make a much smaller rate on the
inflated, or watered, capitalization than on the cost value.
Stock watering is usually employed to prevent a knowl

edge of the original value of the capital, for instance, to
avoid public displeasure, taxation, or legal regulation of
the rates charged. It is sometimes said that there is no
wrong in such stock watering, so long as it is fully known.
This is much like saying that to lie is not wrong, pro
vided everybody knows you are lying. Stock watering
of the kind described is the exaggeration of the “capital ’’
item entered on the liabilities side of the balance sheet;
and, since the two sides must balance, it involves the

exaggeration of the assets also. It usually represents an
intention to deceive, and through this deceit injury may
be done both to buyers of stock and buyers of bonds.
The buyers of stock are injured if they buy without knowl
edge of the proposed stock watering, and the bond buyer

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

is injured if the watering of the stock, having given him a
false idea of the actual capital, induces him to lend more
money than the capital can satisfactorily Secure.

$ 5. Insolvency
The original capital of a concern may be either increased
or decreased. It may even disappear altogether if the
assets shrink so much as no longer to exceed the liabilities
(other than the capital liability itself). Insolvency is the
condition in which the assets fall short of the liabilities

other than capital. The capital-balance is intended to
prevent this very calamity; it is for the express purpose
of guaranteeing the value of the other liabilities — those to
bondholders and other creditors.

These other liabilities, for the most part, are fixed blocks
of property, carved, as it were, out of assets, the value of
which property the merchant or company has agreed to keep
intact at all hazards. The fortunes of business will naturally
cause the whole volume of assets to vary in value, but all
the “slack ’’ ought properly to be taken up or given out by
the capital, the surplus, and the undivided profits. A man's
capital thus acts as a safety fund or buffer to keep the liabili
ties from overtaking the assets. It is the “margin'” he
puts up as a guarantee to others who intrust their capital to
him.

The amount of capital-balance necessary to make a busi

mess reasonably safe will differ with circumstances. A capi
tal-balance equal to five per cent of the liabilities may, in
one kind of business, such as the business of a mortgage
company, be perfectly adequate, whereas fifty per cent may

be required in another kind. Much depends on how likely
the assets are to shrink, and to what extent; and much,

likewise, depends on the character of the liabilities.
The risk of insolvency is the chance that the assets may
shrink below the liabilities — to others than stockholders.

Sec. 5)

CAPITAL

This risk is the greater, the more shrinkable the assets,
and the less the margin of capital-value between assets and
liabilities.

Insolvency must be distinguished from insufficiency of
cash. The assets may comfortably exceed the liabilities,
and yet the cash assets at a particular moment may be less
than the cash liabilities due at that moment.

This condi

tion is not true insolvency, but only insufficiency of cash.
In such a case, a little forbearance on the part of creditors
may be all that is necessary to prevent financial ship
wreck.

A wise merchant, however, will not only avoid insolvency,
but also insufficiency of cash. He will not only keep his as
sets in excess of his liabilities by a safe margin, but he will
also see that his assets are invested in such a manner that

he shall be able, by exchanging them for cash, to cancel
each claim at the time and in the manner agreed upon.
From this point of view there are three chief forms of
assets; namely, cash assets, quick assets, and slow assets. A
cash asset is in actual money, or what is acceptable in place
of money. A quick asset is one which may be exchanged for
cash in a relatively short time, as, for instance, gold or silver
bullion, wheat, short-time loans, and other marketable se

curities. A slow asset is one which may require a relatively
long time to be exchanged for cash. Such are real estate,
office fixtures, and manufacturers’ equipment.
If all property were as acceptable as money, there would
be no need of classifying assets into these three groups.
But since the creditor will not accept railwaystock or bonds,
when he has contracted for payment in money, the debtor
must maneuver so as to keep on hand a sufficient quantity
of cash assets to enable him to meet his immediate obli

gations and enough quick assets to enable him to exchange
them for cash in time to meet obligations soon to fall due.

A large part of the skill of a business man consists in marshal
ing his assets so that he always has enough cash and enough
E

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

quick assets to provide for impending debts, while maintain
ing at the same time enough slow assets to insure a satis
factory income from his business.
Originally, before business was separated from private life,
all of a debtor's assets, even including his own person, were
regarded as pledged to the payment of a debt. An insolvent
debtor could be imprisoned. To-day, however, laws exist
in most countries by which a bankrupt may, under certain
conditions, be discharged, free from further liability.
Since the liabilities of one man are also the assets of

another, when one man fails and is able to pay only fifty
cents on the dollar, the unlucky man who is his creditor –
who has the first man's notes as assets – suffers a shrinkage

in his own assets which may in turn mean embarrassment
or even bankruptcy to him. It is usually true in a panic that
the failures start with the collapse of some big firm, involv
ing a shrinkage in the assets of others. This indicates why
assets ought usually to be undervalued. A man who is in
debt has no right to exaggerate his means of payment. A
conservative and honest business man will always under
value rather than overvalue his assets, in order to be fair to
his creditors.

§ 6. Real and Fictitious Persons
It is well to note here the distinction between the account

ing of real persons and of fictitious persons. For a real per
son, the assets may be, and usually are, in excess of the
liabilities, and the difference is the capital-balance of that
person. This capital is not, in the case of real persons,
to be regarded as a liability, but as a balance or difference
between the liabilities and the assets.

For a fictitious

person (i.e., a corporation, partnership, association, etc.,
regarded as independent of the real persons comprising
it), on the other hand, the liabilities are always exactly
equal to the assets; for the balancing item called capital

Sec. 7]

CAPITAL

is as truly an obligation (from the fictitious person to the
real stockholders) as any of the other liabilities. For
instance, the items entered as “capital,” “surplus,” and
“undivided profits” in the accounts of a joint stock company
do not belong to the company, as such, but to the stock
holders. So far as the “company ” is concerned, they are
its liabilities; they represent what it owes to the stockholders,
just as truly as the other items of liabilities represent what
it owes to the bondholders, etc. A fictitious person, in fact,
is a mere imaginary being, holding certain assets and owing
all of them out again to real persons, including the stock
holders. A joint stock company may, it is true, be re

garded as consisting of real persons (stockholders, etc.).
But if we prefer, it may be regarded as a separate entity.
In this case, of course, the “company ” becomes a mere
bookkeeping dummy having no capital-balance of its own
and apart from what it owes the stockholders.
§ 7. Two Methods of Combining Capital Accounts
We have seen how the capital account of each person in a
community is formed. Our next task is to express the total
net capital of any community. This is the sum of the net
capitals of its members, i.e., all the innumerable assets of all
the persons less all the liabilities of those persons. This net
sum will be the same, of course, in whatever order the items
are added and subtracted. We might write each item on a

slip of paper, marking each asset item as positive and each
liability item as negative, and, shuffling them into any ran
dom order, add and subtract them one by one according as
they are positive or negative. But there are two ways in
particular which need to be emphasized.
The simplest is, first, to obtain the net capital-balance of
each person by subtracting the value of his liabilities from
that of his assets, and then to add together these net capitals
of different persons to get the capital of society. This

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. III

method of obtaining society's net capital may be called the
method of balances; for we balance the books of each indi

vidual. The other method is to cancel each liability against
an equal and opposite asset, which equal and opposite
asset, as we shall see, must exist somewhere in another

individual's account, and then add the remaining assets.
This method may be called the method of couples; for we
couple items in two different accounts. The method of
couples is based on the fact that every liability item in a
balance sheet implies the existence of an equal asset in
some other balance sheet. This is true because every
debit implies a credit. A debt may be owed to somebody,
a creditor, as well as from somebody, a debtor, and the
debt of the debtor is the credit of the creditor.

It follows

that every negative term in one balance sheet may be can
celed against a corresponding positive term in Some other.
Each of these two methods—of balances and of couples —
is important in its own way.
Let us illustrate each by the balance sheets of three real
persons, say X, Y, and Z.
PERSON X
ASSETS

LIABILITIES

Z's note . . . . $30,000 A
Residence . . . .
7o,ooo
Railroad shares . . 20,000
$120,000
Capital-balance
. $70,000

Mortgage held by Y.

$50,000 b

$50,000
-

PERSON Y
ASSETS

LIABILITIES

X's mortgage . . . $50,000 B
Personal effects
Railroad shares

.
.

Capital-balance

20,000
Io,000
$80,000
. $40,000

Debt to Z . . . . $40,000 c

.
.

$40,000

Sec. 7]

CAPITAL

PERSON Z
ASSETS

Y’s debt . .
Farm . . .
Railroad bonds
Capital-balance

LIABILITIES

.
.
.

$40,000 C
50,000
20,000
$1 Io,000
. $80,000

Debt to X

$30,000 a

$30,000

As the persons are real, not fictitious, the “capital” is
in this case not a true liability, but is the excess of the
total assets over the total liabilities.

The sum of these

capital-balances is the total net capital of X, Y, and Z, and
is thus obtained by the method of balances. To show the
method of couples in the table, each couple of corresponding
items—i.e., each item which appears twice, once as a liability
of one man and again as an asset of another — is indicated

in both places by the same letter. Thus, “A ’’ in X's
assets is matched by the equal and opposite item “a " in
Z's liabilities. The method of couples thus consists in
canceling, and, therefore, omitting from society's balance
sheet, these pairs of items, and entering and adding only
those which remain uncanceled. These, in the present
case, are all assets.

Adding these, we again obtain a sum

representing the total net capital of X, Y, and Z, this time
by the method of couples.

The results of summing up the capital accounts by the
two methods are shown in the following tables:–
METHOD OF BALANCES

X's capital
Y’s capital
Z's capital

. .
. .
. .

.
.
.

. $70,000
. 40,000
.
80,000

$190,000

METHOD OF COUPLES

Residence . .
Personal effects
Farm . . .
Railroad shares
Railroad bonds

. . . $70,000
. . . 20,000
. . .
50,000
. . . 30,000
. . .
20,000
$190,000

The totals are the same by both methods, but the method
of balances exhibits the share of this total capital which is

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. III

owned by each individual, while the method of couples ex
hibits the portion ascribable to each different capital-good.
§8. Ultimate Result of Method of Couples
Let us now introduce into our addition the capital ac
counts of the railroad whose stocks and bonds were included

among the assets of persons X, Y, and Z. For simplicity,
we shall suppose that these three persons are the only

persons interested in the road. The balance sheet of the
railroad company will accordingly appear as follows:–
RAILROAD COMPANY
ASSETS

Railway

LIABILITIES

. $50,000

Bonds (held by Z) . . $20,000
Capital stock

(held by X) $20,0oo
(held by Y) $10,000
$50,000
Capital-balance of the R.R. Co. itself $oo,ooo

3o,Ooo

$50,000

If now, by the method of balances, we combine this balance
sheet with those of X, Y, and Z, we shall see that its inclu

sion does not affect the results which were obtained by the
same method before the railroad was introduced into the
discussion. The totals will stand as follows: —

X's capital-balance.
Y’s capital-balance .
Z's capital-balance .

.
.
.

. . . . . .
. . . . . .
. . . . . .

$70,000
40,000
80,000

Railroad Co.'s capital-balance . . . . . ooooo
$190,000

When we apply the method of couples, we find, however,
that the inclusion in our consideration of the railway

company's capital account will affect the items, though not
the final sum.

The stocks and bonds, as assets of X, Y,

and Z, will then pair off or couple with the corresponding
liabilities of the railroad company, and their place will be
taken by the concrete railroad itself, as follows:–

Sec. 8]

CAPITAL

METHOD OF COUPLES

Residence . . . . . . . . . $70,000
Personal effects. . . . . . . .
20,000
Farm . . . . . . . . . . .
50,000

Railway . . . . . . . . . .

50,000
$190,000

The appearance of the capital inventory is thus changed.
Formerly, the items of property rights in it included such
part-rights as stocks and bonds; now they consist only of
complete property rights. But the complete right to any
article of wealth is best expressed in terms of the article of
wealth itself. Consequently, instead of the long phrase,
the “right to a residence,” we may merely use the term
“residence.” The property no longer veils the wealth be
neath it; and the inventory, which before was an inventory
of both capital wealth and capital properly becomes an in
ventory of only capital wealth.
Such a result is sure to follow when we combine capital
accounts, provided we combine enough of them to supply,
for every liability item, its counterpart asset, and for every

asset which has one, its counterpart liability. Those assets
which have no counterparts are what we have called the
complete rights to wealth; while those assets which do
have canceling counterparts are the partial rights to wealth.
The reason is that partial rights to wealth necessarily
have canceling counterparts in that whenever any partial
ownership of a given article of wealth is held by a partic
ular person, its whole ownership must be supposed to be
held by some fictitious person even if specially created for
the purpose.

Thus, if a farmer named Smith owns an un

divided half interest in a farm jointly owned by himself
and brother, we conceive of the whole farm as owned by
the fictitious person, the partnership, known as the “Smith
brothers.” The owner of the half interest, “John Smith,”
thus holds a claim against the partnership “Smith broth
ers.” This claim is an asset to Smith but a liability to the

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. III

partnership. It is clear that an individual cannot own a
part interest in any given, wealth without its being true
that the fictitious owner of it all is liable to him to that

extent. Therefore every partial right to wealth, while an
asset to the owner of that right, is a liability to the ficti
tious person owning the whole. Every article of concrete
wealth has to be regarded as owned by some one, even if
we have to set up a fictitious person or dummy for that
very purpose.

To follow out totals of capital thus requires the inclusion
of many fictitious persons, for it is often only the fictitious
persons who hold the complete rights. Locomotives and
railway stations, for instance, are owned by corporations,
not individuals. In fact, these fictitious persons — partner
ships, corporations, trusts, municipalities, associations, and
the like — are devices for the express purpose of holding
large aggregations of concrete wealth and parceling out its
ownership among a number of real persons.
If, then, we suppose balance sheets so constructed as to
include all the real and fictitious persons in the world, with
entries in them for every asset and liability, - even public
parks and streets, household furniture, and other possessions
not formally accounted for in ordinary practice,—it is evi
dent that we shall obtain, by the method of balances, a
complete account of the distribution of capital-value among
real persons; and, by the method of couples, a complete
list of the articles of actual wealth thus owned.

In this list

there will be no stocks, bonds, mortgages, notes, or other
part-rights, but only land, buildings, and other land improve
ments, and commodities. All debit and credit items being
two faced — positive and negative — cancel out in the total.
This self-effacement, however, does not mean that the total

would be just the same if there were no stocks, bonds,
mortgages, notes, or other two-faced items. On the con
trary, the existence of such property rights indirectly adds
a great deal to the effectiveness of wealth. They make

SEc. 9]

CAPITAL

possible the coöperative ownership of great aggregations
of capital which without such ownership could scarcely
exist, and thus result in increasing greatly the total bene
fits we enjoy from capital.

§ 9. Confusions to be Avoided
Among the forms of part-rights in real wealth is “credit.”
Credit is simply a debt looked at from the standpoint of the
creditor.

of credit.

There has been much discussion as to the nature

It has been sometimes regarded as an item of

wealth; and an increase or inflation of credit has been
looked on as a real addition to the wealth of the commu

nity.

But, of course, since every credit is also a debit, it

cannot be regarded as a simple addition to the wealth

of the community as a whole. The phenomenon of
credit means nothing more nor less than a specific form of
divided ownership of wealth. Credit merely enables one
man temporarily to control more wealth or property than he
owns – i.e., some part of the wealth or property of others.
It is, therefore, a cardinal error to regard credit as increas

ing the capital of the debtor.

Indirectly, of course, credit

may result in an increase of society's capital, by stimulating
trade and production, as well as by getting the management
of capital into the right hands and its ownership into the most
effective form. In these ways the earth is made to yield up
more wealth, or greater benefits from the same wealth — in

either case entailing an increase of capital; but the amount
of any such increase of capital thus indirectly produced bears
no necessary relation to the amount of the credit which
facilitated its production. Even when capital is increased
through credit, the credit does not constitute the increase.
A great deal of confusion in legislation and discussion could
be avoided if the two methods of combining capital accounts
were distinguished and their interrelations recognized. In
taxation, the two methods are often confused. An impor

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. III

tant problem of efficient taxation of property is how to avoid
unintentional double taxation and at the same time not to

allow some property unintentionally to escape any taxa
tion.

There are two solutions.

One is to tax the amount

owned by each real person as obtained by the method
of balances; this method seeks out the real owners or

part-owners of wealth. The other is to tax the actual
concrete wealth as obtained by the method of couples;
this method seeks out the real wealth owned. In short,
one method follows the person, the other the thing. At

present the two methods are much confused. Legislators
too often fail to perceive that under the first, or owner
method, corporations should not be taxed, for they are not
true owners; and that under the second, or wealth-method,

bonds, stocks, and other part-rights to wealth should not
be taxed, for these are already taxed when the actual rail
ways and other items of physical wealth underlying such
part-rights are taxed. It is not claimed, of course, that a
complete system of taxation can be worked out merely by
choosing one of the two methods just indicated. But the
distinction between the two should be borne in mind, when

ever any scheme of taxation is considered; for where one
system is applied, the other cannot also be applied without
double taxation.

The study of capital accounting, therefore, enables
us to avoid many common confusions. More important
still, it gives us a clear picture of the relations between the
capital of a community and the capital of the individuals
of which the community is composed, i.e., between the
stocks of actual wealth in a community and the stocks of
property representing the ownership of this wealth among
different individuals.

In short, it enables us to see both

individually and as a whole the items which make up private
and collective property, as stocks, bonds, mortgages, debts,
etc., on the one hand, and land, ships, dwellings, and other
concrete wealth, on the other.

SEc. 9]

CAPITAL

In the light of the foregoing principles we are in a position to take a bird's-eye view of the capital in any country. In
America, for instance, we find a stock of wealth of various
kinds with an estimated value of over $100,000,000,ooo.
More than half of this consists of real estate; about ten

per cent consists of railways and their equipment; manu
factured products make up about $8,000,000,ooo; furniture,
carriages, and kindred articles about $6,000,000,ooo; live
stock on farms about $4,000,000,ooo; tools, implements,
and machinery in factories about $3,000,000,ooo; clothing
and personal adornments about $2,500,000,ooo; street
railways about $2,000,ooo,ooo; agricultural products about
$2,000,000,ooo; gold and silver coin and bullion about
$2,000,000,ooo; and there are numerous other smaller items.

The ownership of this real wealth is divided up in various
ways. To a very large extent, especially in the case of farms,
the real estate is owned completely by the occupier. In other
cases it is mortgaged, the occupier then owning merely the

excess of value over the mortgage. Of the national capital
apart from real estate, on the other hand, probably by far
the greater part is owned by corporations, which means, of
course, simply that its ownership is parceled out among the
stockholders and bondholders of these corporations.

From

what has been said the student will not make the mistake

of adding the value of stocks and bonds to the value of
the tangible wealth which these represent. Stocks, bonds,

mortgages, and other items which are assets to some persons
are liabilities to others, and thus cancel themselves out for
the country as a whole. The student will also notice how

insignificant is the stock of gold and silver as compared with
the total capital, although the value of all is measured in
terms of gold.

CHAPTER IV
INCOME

§ 1. Concepts of Income and Outgo

THE income from any particular article of wealth has been

defined as the flow of benefits from that article. These bene
fits may sometimes consist of money payments; but it is
important to avoid the mistaken notion that they always
consist of money payments. (Income is the flow of whatever
benefits accrue from any article, whether these benefits
happen to be in the form of money payments or not) A self
supporting farmer, for instance, may not receive or expend
a single dollar from one year's end to the other. He has,
nevertheless, an income. He gets a “living ” — the very
essence of income — from the farm. A windmill pumps
water; the pumping is the benefit or income resulting from
the windmill.

A derrick hoists coal from a mine; the hoist

ing is the income from the derrick. A wife does housework;
her work is an item of the family's income, for, as was
stated in the last chapter, the services of a human being
are income. The warmth and shelter that a house provides
for its occupants constitute the income furnished by the
house. All the operations of industry and all the transac
tions of commerce are items of income.

When axes fell

trees and sawmills turn them into lumber, these changes
constitute items in the income flowing from the agencies

which produce them. When a manufacturing plant con
verts raw materials into food or into fabrics or into imple6o

SEc. 1]

INCOME

ments, these changes constitute income produced by the
plant. What we call agriculture, mining, commerce, and
domestic operations constitute large and important classes
of income.

Practically, of course, most of the examples given of bene
fits or services are not income to the owner of the instru

ments rendering those services; for, practically, those
services are not enjoyed by the owner, but are sold to some
one else, the owner receiving a money payment instead.
Thus, although a farmer may get his living directly from the
farm, it is more usual for him to sell some of the farm products
and to receive money payments instead. Likewise it may
be that the owner of the windmill pumps water for others
and receives money payments in return; and that the
owner of a house sells its use for a money rental. Simi
larly the owners of the derrick, axes, sawmill, manufacturing
plant, etc., do not get the direct benefit of the hoisting,
cutting, sawing, manufacturing, etc., but exchange these for
money payments. In such cases the owners get their in
come in the form of money payments by selling to others
the direct benefits of their capital. Thus their capital yields
them an indirect money income through the sale of the direct
income produced by the capital. So usual is it for the owner
of capital to sell his direct or natural income for a money
income that ordinarily we think of income as consisting only
of such money return. One of the early economists seri
ously maintained that the owner of a house could receive
no income from it except by renting it, forgetting that to
let a house is merely to sell the shelter income for money
income. A man who lives in his own house gets the shelter
income directly. A man who lets his house to another
secures a money income as the equivalent of the shelter in
come which he sells to the tenant.

Income, being a flow of benefits, implies a stock or fund
which produces the flow. This stock or fund may consist
partly of instruments of external wealth, which we have

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

designated as capital (in the narrow sense), and partly of
the population itself, which is also capital (in the broader
sense).
It has already been noted that income differs from capital
in two respects. In the first place, income is a flow relating
to a given period, whereas capital is a stock or fund relating
to a given instant.

In the second place, income consists of

(intangible) benefits, whereas capital consists of (tangible)
instruments; not farms, therefore, nor houses, nor food, nor

railroads, nor artesian wells, nor instruments of any sort can,
strictly speaking, ever constitute income. Income consists
rather in the yielding of crops by the farms; the warming
and sheltering of people by the houses; the nourishing of
people by the food; the transporting of passengers and
freight by the railroads; the raising of water by the wells;
and benefits of any sort rendered by instruments of wealth.
Although income consists partly of other benefits than

money receipts, all income, like all capital, may be translated
into terms of money. For, as was pointed out in chapter
II, § 1, to all items of income, i.e., benefits, may be applied
the concepts of price and value.
Income, as well as capital, is subject to accounting.
Thus far we have considered only such items as would
belong to the positive side of income accounts. But just
as in our capital account we found a negative side — com
prising the liabilities — so we shall find a negative side
to income. The negative of income is called outgo, and
the items which constitute outgo are called costs. A cost
occasioned by an article has already been defined as the
opposite of a benefit. It is an undesirable event occa
sioned by that article. Labor, trouble, expense, and sacri
fices of all sorts are entailed by wealth and are counted
among its costs. An instrument seldom confers benefits
without also involving costs. A dwelling, while it gives
shelter, compels its. owner to assume important costs in
keeping it in repair, painting it, cleaning it, caring for it,

SEc. 1]

INCOME

insuring it, and paying taxes upon it. A saddle horse yields
income to the owner when it gives him a pleasure ride, but
it requires feeding, stabling, and shoeing — the negative side
of the account, constituting the outgo or flow of costs oc
casioned by the horse. A farm produces benefits in yielding
crops; but it requires fertilizing, tilling, and seeding, all of
which are costs occasioned by the farm. A railroad pro
duces benefits called “transportation” – hauling passengers
and commodities; but it involves an expenditure of money,
it burns coal, it requires labor; and these are the outgo, or
the negative side of its account.

Costs, too, may be measured in money just as income may
be measured in money; and some costs, whether of dwel
lings, farms, railways, or other articles, consist in the actual
expenditure of money, just as some benefits consist in the

receipt of money. Strictly speaking, neither consists of actual
money. We must, therefore, distinguish carefully three
money items: (1) money on hand at an instant of time,
which is an example of capital; (2) the receipt of money
during a period of time, which is an example of income (from
whatever instrument occasions the receipt of the money);
and (3) the expenditure of money during a period of time,
which is an example of outgo (on the part of whatever instru
ment occasions the expense).
In general, the costs of a given item of capital are out
weighed by its benefits. For if it should occasion more
costs than benefits, it would be thrown away, thereupon
ceasing to be wealth according to our definition. Or if it
should still remain in any one's possession, it might be called
negative wealth, of which ashes, rubbish, garbage, etc., are
familiar examples.
Costs, then, are never voluntarily assumed except in the
hope of benefits which will make them worth while. The
total value of all the benefits flowing from a given instrument
in a given time is called gross income-value or simply
gross income, during that time. Similarly, the total value

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

of its costs is called outgo-value or simply outgo. The
total gross income during a given time minus the total
outgo (i.e., the value of its costs), constitutes net income.
Thus, just as net capital is found by subtracting the lia
bilities from the assets in a capital account, so net income
in an income account is found by subtracting the value
of the costs from the value of the benefits.

Both benefits

and costs, moreover, are attributable to a definite capital
source. In income-accounting the benefits or income-items
are credited to capital, and the outgo or cost-items are

debited to capital. In keeping income accounts, therefore,
it is important to know to what category of capital any item
of income should be credited, or any item of outgo debited.
§ 2. Income Accounts

We are now in a position to apply the foregoing definitions
to income accounts. Perhaps no other subject in economics
has been so fraught with confusion, misunderstanding, and
double counting, as income. It will help the student to
understand these accounts if he will bear in mind that they
show the income and outgo which any given capital (or free
human being) yields. We are apt to think of income and
outgo too much with reference to the owner of the income
instead of the source of the income. It will be easy later
to make up the owner's income account; but first we must
construct the income account for an isolated article of capital.
We may begin by imagining a certain “house-and-lot ”
as one composite instrument or article of wealth, and may
first consider its income and outgo during the calendar
year 1910. The instrument is capital, and the income which
this capital brings to its owner may be either a money rental
or the direct shelter and similar benefits of the house enjoyed
by himself and his family. In either case the income may
be measured in money, although in the case of occupancy
by the owner this measurement requires a special appraise

Sec. 2)

INCOME

ment. The house, let us suppose, was built many years
ago, and is now nearly worn out. It yields an income worth
$1ooo a year. Against its income there are offsets in the
form of repairs, taxes, etc. — costs which it occasions. We
have, then, the following “income account ’’: —
INCOME ACCOUNT FOR HOUSE AND LOT DURING THE
YEAR 1910

OUTGO

INCOME

Use of house and lot .

. $10oo

Repairs
Taxes

. . . .

. $200

180

Insurance . . . . . . . 20
Net income

$4oo

$1ooo
$600

Next year the house is found to have rotten timbers, is
condemned, and must be abandoned or torn down.

Its

benefits are ended, but the land is still good, and the owner
can build a new house. The period consumed by this opera
tion is the first six months of the year 1911, so that during
such period there is no income attributable to the house and
lot, but only outgo. During the second half of the year the
house is occupied, and its use is valued at $600. In the first
six months not only did the “house-and-lot ” fail to yield
any income, but it occasioned a cost. This cost was the
cost of production of the new house.
We have, then, the following account: —
INCOME ACCOUNT FOR HOUSE AND LOT DURING THE
YEAR 1911
INCOME

OUTGO

Use of house and lot (six
months). . . . . . $600

Expense
house

of building
. . . . . $10,000

Taxes and insurance .

$600

Net outgo.

Ioo

$1o, Ioo
$9,500

During this year, then, the house causes a net outgo of

$9500. As we know, all costs are “necessary evils’’; they
F

ELEMENTARY PRINCIPLES OF ECONOMICS

ICHAP. IV

lead to good, though not good themselves; and this cost of
constructing the house was incurred only for the sake of
expected future benefits. The adverse balance it creates is
only temporary, and should be more than made up in the
years which follow.
For the year 1912, for instance, we may have the follow
Ing: —
INCOME ACCOUNT FOR HOUSE AND LOT DURING THE
YEAR 1912
INCOME

Use

OUTGO

. .

. $1300

Net income .

Repairs . . . . .
Taxes and insurance .

$130.o
.

. $ 50
.
.25o
$300

$10oo

These figures remain about the same for forty-nine years
and give $49,000 net income during that time, offsetting the
1912

to 13

1914,

1915

is 16

is ir

1918

19te
tezo

INcome
shelter

ouTGO
repairs
etc.

excess in cost for 1911 ($9500) and leav
ing a large margin besides. Then the
house is worn out a second time and has

to be rebuilt. The same cycle is repeated,
one year of excess of cost being offset by
forty-nine years of excess of income. Figure 2 shows a
part of this cycle, picturing graphically the figures in the
above income-and-outgo accounts.
It will be observed that the cost of reconstructing the
house was entered in the accounts in exactly the same way
as the cost of repairing it or as any other costs. This may

SEC. 3]

INCOME

be puzzling at first, because most of the other costs are
fairly regular year by year, whereas the cost of reconstruc
tion occurs only once, or at any rate only once in a long while.
It may also seem puzzling because the cost of reconstruc
tion is so large in comparison with other costs. But the
irregularity or size of costs is, of itself, no reason for omitting
them from our accounts. The only way in which we can
escape recording such a cost– for instance, the cost of
constructing the house – is by substituting in its place an
equivalent series of smaller and more regular costs. What
is called a depreciation fund is sometimes created for this
very purpose. This fund is accumulated during the exist
ence of the house by setting aside annually small portions
of the income yielded by the house, sufficient in the aggre
gate to replace the house when it is worn out. The depreci
ation fund, combined with the “house-and-lot ” renders

the flow of costs uniform or regular. But even when a
depreciation fund is used, we can only say that the com
bination of the two things (the fund and the house) has a
regular cost. We cannot say that this is true of the house
by itself; and when no such device as a depreciation fund
at all is used, there can be no escape from charging the cost
of reconstruction in precisely the same way as we charge any
other cost. If this still seems puzzling, it is because we are
in the habit of seeing the cost of reconstruction entered as
the value of the house and, hearing it called, for that
reason, a “capital cost.” It is true that the value of the new

house must be entered on the capital-balance sheet; but
the cost of producing it belongs properly to the income ac
count. The value relates to an instant of time (which
may be any instant from the time the house is begun till
the time when it ceases to exist); the cost relates to a period
of time (which may be all or any part of the time during
which the labor and other sacrifices occasioned by the house
occur). The value of the house is quite distinct from the
series of costs by which it was built, although the confusion

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

between the two is natural in view of the bookkeeping
practice of entering capital at its “cost value.” The house
on which $10,000 was expended for construction may be
worth either more or less than $10,000.

In either case the

income account should contain $10,000 on the outgo side,
and the capital account a larger or smaller figure, as the
case may require.
§ 3. Devices for Making Net Income Regular
We have seen that the irregularities in the net annual

income or outgo flowing from the “house-and-lot” may be
combined with the opposite irregularities of the net an
nual outgo or income from a “depreciation fund,” so that
the net result from the two combined is a steady net in
come. . The same result may be secured in other ways.
For instance, if the owner of the house-and-lot happens to
own a large number of other houses-and-lots in different
degrees of repair, the irregularities in income from them in
dividually may tend to offset each other.

Thus, if a man

owns fifty houses, each lasting fifty years, and every year
one wears out and has to be rebuilt, it is then evident

that he will have an expense of $10,000 every year for the
rebuilding of a house, which will be a regular item; and
he will have a regular income balance as a consequence,
because he will get the benefit of forty-nine houses, which
will far outweigh the cost of building only one. The differ
ence will be his net income, which will be a fairly regular
amount year after year.
This example ought to set at rest any lingering doubts
as to the correctness of our including the cost of recon
structing a house as an item of outgo, to be entered as
such in a true and complete income account. The only
reason this may, at first, seem wrong is that the cost of
reconstruction is not usually a regular item. In the case
of the fifty houses it becomes a more or less regular item.

SEC. 4)

INCOME

But if it is correct to call it outgo when there are fifty
houses, it must be correct to call it outgo when there are
ten houses or when there is only one. Irregularity of in
come is an inconvenience and we usually seek to avoid it
by depreciation funds, by having a large number of articles
at different stages of repair, or otherwise. But so long as
irregularity of income exists it must be entered as such.
The effect of reducing irregularities by combining a large
assortment of articles is present wherever a sufficiently
large assortment exists. Professor Clark of Columbia Uni
versity suggests a helpful simile when he compares a stock
or fund of capital to a waterfall: the drops of water, or
component parts of the waterfall or fund, are constantly

changing; but the waterfall or fund remains substantially
the same.

§ 4. How to Credit and Debit

Before leaving the subject of income accounts, we shall
speak of one particular kind of capital, namely, a stock of
cash. This will furnish an opportunity to illustrate anew
some of the principles of accounting which we have just dis
cussed. What puzzles the novice in accounting is the manner
of debiting and crediting a stock of cash, or what is called
the “cash drawer.” At first sight the usage seems to be the
opposite of what it should be. To understand the practice
of accountants in this particular is to go a long way toward
understanding the main principles of accounting. It will
help us to understand it if we liken a cash drawer to a gold
mine. We credit a gold mine with all the gold extracted,
and we debit it with all the costs put into it. In the case of
the gold mine, what it costs to run it is outgo; all of the
yield of gold is gross income; and the difference is the net
income. Similarly, the gross income from the cash drawer
consists of what the cash drawer yields, or whatever comes
out of it. It benefits us whenever it pays our bills; it costs
us whenever we pay its bills, i.e., whenever we pay some

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

thing into it. All the payments which we have to make to
the drawer are a cost of that drawer to us, whereas all the

payments that we make by the drawer are the benefits which
it produces for us. As long as we pay money into the drawer,
we realize no income, but merely accumulate capital for
future use. If we should only pay money into the drawer and
never throughout our life take any out, the “drawer" would
benefit us nothing.

Its benefits would go to our descendants

whenever they should take the money out. Ordinarily,
however, the money is taken out soon after it is put in. What
met benefit, then, does the cash drawer yield in the long run?
Seldom anything at all. We pay out just as much as we
put in; and if we subtract one amount from the other, the
net annual income from the cash drawer will be about zero,

unless during a certain year we store up more than we take
out, or take out more than we put in.
The reason that these credits and debits of “cash ’’ seem

at first the reverse of what they should be is that we are ac
customed to think of money receipts and expenditures, not
in their relation to the stock of cash into or out of which they
are paid, but in their relation to some other item of wealth
on account of which the payments are made. If a lodging
house keeper receives $10 from a lodger and puts it into her
cash drawer, she finds it hard to debit $10 to “cash.” She

thinks of the $10 as income; and it is income with respect to
her lodging-house, for the latter has yielded it to her. Her
stock of cash, however, has not yielded the $10 to her. On
the contrary, it has taken that amount from her. Later on
it will yield back that amount or some portion of it, and
at that time may properly be credited with the sum it
yields up.
We are now ready to understand how to derive a man's
total income. It is simply the combined income from all
the capital he owns. We could obtain a full account of it by
keeping a separate income account for each item of capital
he owns, crediting and debiting each such item with its re

SEC. 4)

INCOME

spective benefits and costs. The difference of all the benefits
and costs of all his capital is his net income. In these
accounts we should include, therefore, all positive and nega
tive items of income pertaining to all positive and nega
tive items of capital. The negative items of capital are
the liabilities. Liabilities yield a net outgo instead of a
net income.

In order, then, to find out the net income of

any person during a certain day or month or year, the
proper method is to make a complete statement of all his
assets and all his liabilities; and for each asset as well

as each liability, credit all the benefits and debit all the
costs.

The net result will be the

net income of the

person.

A real person will have a net income, but a fictitious
person will not. We have seen, in the case of fictitious per
sons, that there is no net capital because the liabilities always
equal the assets; for what is often called the capital of a
“company” really means the capital of its stockholders. As
there is no net capital of the company, as such, the “com
pany ” owing it all to the stockholders, so there is no net
income of the company, as such, the “company ” paying
it all to the stockholders or others.

The following is an imaginary income account of a rail
road company: —
INCOME ACCOUNT OF A RAILROAD CORPORATION
INCOME

By passenger and
freight service .

OUTGO

$1,246,147

To operating expenses $8oo,ooo
To interest to bond
holders . . . .
Ioo,ooo
To dividends to stock
holders
. .
.

200,000

To surplus applied to
(1) purchase of land
(2) cash paid into
treasury .

$1,246,147

140,000
.

6,147

$1,246,147

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

The passenger and freight service has yielded $1,246,147.
That is the gross income of the road. All the benefits flowing
from that road are worth this amount of money. On the
other side of the railroad account we find the costs of the

road to the company; they exactly equal the benefits, for
the company is an abstraction – a mere holding concern —
not a real individual. The outgo consists principally of
operating expenses, $800,000; interest to bondholders,
$100,ooo; dividends to stockholders, $200,000.

The words

by and to are usual in income accounts. The receipts are
benefits; they come by virtue of the services designated.
The costs represent something which has to be given to
these several items in order to make the benefits possible.
These items leave a surplus, part of which is expended for
land ($140,000); this is a cost just as much as anything
else.

Then there is cash left in the treasury to the amount

of $6147. It must not be concluded that this cash is a net
income. The cash drawer swallows it up. The company
loses $6147, so to speak, in feeding its cash drawer. There
fore the two sides of the account balance, and there is no

net income at all to the “company.”
§ 5. Omissions and Errors in Practice

Practically, however, it is not convenient to enter in an
income or a capital account everything which theoretically
ought to be entered there.

Moreover, capital and income

accounts are not always treated consistently in practice.
For instance, in a capital account a man would not ordi
narily enter his own person, as a free human being is not
ordinarily counted as wealth; and yet in his income ac
count he will enter the money he earns or the work that
he does. That is, work and wages are entered in the income
accounts, but the corresponding items representing the
agencies which do this work or earn these wages are not

entered in the capital accounts. The correspondence be

SEC. 5)

INCOME

tween the two accountsis, therefore, obscured. On the other

hand, a man never, in practice, enters in his income account
the shelter of his own house as a benefit, and yet he may
include the house among his assets in his capital account.
In ideal accounting we should insist upon recording every
benefit of any kind, every cost, and every source of benefit
or cost. As we have already indicated, an early economist
fell into error when he said that a dwelling occupied by the
owner yields no income. He claimed that, on the contrary,
it is a source of expense. Evidently he had in mind only
those costs and benefits which come in the form of money
payments. One certainly gets no money benefits by living in
his own house, while he does suffer a money cost to run it.
So far as money receipts and expenditures are concerned,
therefore, the house costs more than it brings in.

But no

man would keep his house if it did not afford him benefits
greater than its costs. We should, therefore, appraise the
shelter of the house and enter this as its gross income.
If we do not, we reach the absurd conclusion that if I live

in my own house and you live in your own house, neither of
us receives any income; but if you rent your house to me
and I rent mine to you, then we shall each be receiving
income ! Obviously the income is really there, all the time,
in the form of shelter; and when one man rents another

man's house, he gets the shelter-income and gives the other
man a money-income in its place.
An account of money received and expended by a given
person can sometimes furnish a fairly complete picture of
his income; but only when two conditions exist; namely,
that all the income from his property is in the form of
money, and all the outgo is in the form of money spent
for personal satisfactions (i.e., goes directly to pay for
clothes, food, shelter, amusements, and the like, and is not
expended in investments, repairs, and the expenses of run
ning a business). Under these conditions the cash drawer
and the cash account constitute a kind of money meter of

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. IV

income. These conditions are approximately fulfilled when
people live in a city and rent the houses or furniture of
others instead of owning them themselves. Such people
get practically all of their income in the form of money
receipts, as salaries, dividends, and interest. This money
is spent for benefits, as food, clothing, theater going, etc.
The cash drawer (or bank account) then intervenes be
tween the money-income on the one hand, and the final

income which this money-income buys, on the other hand;
much as a cogwheel intervenes to transmit motion from
one part of a machine to another. A man who receives
$5000 a year in money or checks and spends it all on
food, clothing, shelter, amusements, and other final or
enjoyable benefits, and gets no such benefits from any
other source, evidently receives a real income of $5000
a year. His money income correctly measures his real
income. But if he “saves” part of the $5000, i.e., ex
pends it for stocks, bonds, or a savings bank account or
any other capital, the benefits from which are greatly de
ferred, his real income may be less than $5000; while if
he derives shelter from his own house, or food from his

own garden, his real income may be greater than his
money income. Thus money income is an unsafe indica
tion of real income. The only method, then, of construct
ing income and outgo accounts which will be correct and
which can serve as a basis for economic analysis is the
method already indicated — the method by which are re

corded, for each article of capital (including human beings),
the values of all its benefits and all its costs.

These benefits

and costs are of many kinds. Sometimes they consist of
money payments — not in themselves enjoyable to anybody;
sometimes they consist of merely intermediate or produc
tive operations; and sometimes, of truly final or enjoyable
elements.

All these items should be entered in the accounts

on the same footing; but we shall see that all except the
“enjoyable ’ elements will cancel among themselves.

CHAPTER V

COMBINING INCOME ACCOUNTS

§ 1. Methods of “Balances” and “Couples”
“Interactions '

WE have now learned how to reckon the income of either

a real or a fictitious person. Of reckoning the income of all
society, on the other hand, there are many ways, including,

in particular, two that correspond to the two ways which we
discussed in Chapter III of reckoning society's capital.
These are the method of

balances and the method of

couples. The method of balances is very easy to apply. All
that is necessary is to make up an income account for any
given period for each instrument or article of wealth so as
to include all possible income or outgo in society and, de
riving from each such account the net balance, add these
net balances together. The result is the total income of
society. Its constituent parts are the net incomes from
the several articles of society's wealth.
The “method of couples’’ is somewhat more difficult to
follow. But it is also more important. Just as it often
happens that the same item in capital accounts is both asset
and liability, according to the point of view, and is therefore
self-canceling, so it often happens that the same item in
income accounts is both benefit and cost, and is, therefore,
likewise self-canceling. In fact, the reader may have felt
that, in many of the examples cited, what we called costs
were really benefits. He may have asked himself: Why
75

ELEMENTARY PRINCIPLES OF

ECONOMICS

[CHAP. V

should we call repairing a house a cost? When a carpenter
and his tools repair it, do we not credit him and them with
a service performed? Is not any production a benefit?
Have we not, then, placed repairs on the wrong side of the
ledger? It all depends upon which of two accounts we are
considering. When a carpenter with his plane, hammer, and
saw helps to rebuild a house, we have to consider two groups

of capital." One group, the carpenter and tools, is acting on
the other group, the house. The carpenter and tools cer
tainly perform a service or benefit, but the house does not.
Considered as occasioned by the house, the repairs are costs.
The house absorbs or soaks up these costs, promising to com
pensate for them by benefits to be yielded later on. The
renailing of loose shingles is certainly not what the house is

for; with respect to the house, it is a necessary evil; with
respect to the hammer, however, it is a service rendered.
Therefore the repairing of the house is at once a benefit and
a COSt.

Such double-faced events are so important as to require a
special name. We shall call them interactions. Each inter
action takes place between two instruments or groups of
instruments.

An interaction, then, is a double-faced event, at once a bene
fit or service of the acting instrument, and a cost or disserv
ice of the instrument acted on.

There can never arise the

slightest doubt as to when it is to be regarded as positive and
when negative. The definitions of benefit and cost settle
this question in each case. If it is desired by the owner of
a given instrument that this instrument should occasion a

given event, then the event is “desirable” or a benefit.
If it is desired that an instrument should not occasion a

given event, then the event is “undesirable” or a cost.
Thus, since the house owner desires that the house should
not occasion repairs, these repairs are costs of the house;
* In this instance and throughout the following discussion we shall
consider capital in its broader sense as including free human beings.

Sec. 2)

COMBINING INCOME ACCOUNTS

and since he desires that the tools should produce repairs,
such repairs are the benefits from those tools.
The example given is typical of the general relations be
tween interacting instruments.

The mental picture we

should construct is that of two distinct groups of capital.
Group A acts on, and, so to speak, benefits Group B. What
ever the nature of this interaction, A, the giver of the bene
fit, is credited with it and B, the recipient, is debited with
it as a cost. These two items of credit and debit are equal
and simultaneous because they are the selfsame event
looked at from opposite sides.
Interactions constitute the great majority of the elements
which enter into income and outgo accounts. The only
benefits which do not form merely the positive side of such
canceling interactions, and so do not cancel out, are satis

factions — desirable conscious experiences – often called

“consumption ” (these are credited to the things enjoyed
— for instance, a house); and the only costs which do
not form merely the negative side of such canceling inter
actions, and so do not cancel out, are “labor and trouble ’’

(these are debited to human beings).

But these two

final elements – “satisfactions,” on the one hand, and

“labor and trouble,” on the other — are only the outer
edges of the series of interactions. Between them lies a
connective chain of productive processes and commercial
transactions, every link of which has two sides, a positive
side of benefits or services and a negative side of costs,
always mutually canceling.
§ 2. Production: Interactions which Change the Form of
Wealth

The interactions between two articles or groups of articles
are of three chief kinds: changes in the form of wealth,
changes in the position of wealth, and changes in the owner
ship of wealth; in other words, transformation, transporta

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. V

tion, and transfer or exchange. All three may be called
“production,” although this term is sometimes confined to
the first two and sometimes even to the first alone.

These

we shall take up in order, and show how each is a two
faced event or an interaction.

First, what is here called “transformation ” of wealth is

practically identical with what is usually understood by
“production ” or “productive processes.” By this trans
formation or change in the form of wealth is meant the
change of relative position of its parts. Weaving, for
instance, is the transformation of yarn into cloth by a re

arrangement in the relative positions of the warp and woof.
Spinning, likewise, consists in moving, stretching, and twist
ing fibers into yarn; sewing, in changing the position of
thread so that it may hold cloth together; and so it is
with carding, wool sorting, shearing, and all the other
operations which constitute the manufacture of fabrics.
All these operations—which include all manufacture and all
agriculture — consist simply of a series of transformations
of wealth, each transformation being a two-faced operation.
With respect to the transformed instrument or instruments,
the transformation is a cost; with respect to the transform
ing instrument or instruments it is a benefit. So it is
when a loom produces cloth out of yarn, or when land
renders a service in producing wheat. So it is, not only
when a carpenter and his tools build or repair a house,
but also when the painter decorates it or the janitor
cleans it; or when a cobbler transforms leather into shoes,
or when a bootblack transforms dirty shoes into clean and
polished ones.
The principle is not altered when the interaction consists,
not in producing a change, but in preventing one. A ware
house renders its service as a means of storing bales of cotton,
i.e., protecting them from the elements; and this storage is,
on the part of the stock of cotton, an element of outgo, or ex
pense, as on the part of the warehouse it is an item of income.

Sec. 2)

COMBINING INCOME ACCOUNTS

Nor is the principle altered when there are, as indeed is
usually the case, more articles than one in either or both of

the two interacting capitals. Plowing, or the transformation
of land into a furrowed form, is performed by a plow, a
horse, and a man. The plowing is a cost debited to the land,
on the one hand, and at the same time a service credited to

the group consisting of the plow, horse, and man, on the
other.

Nor is the principle altered if one or more of the trans
forming agents perish in the transformation and another
comes for the first time into existence. Bread making is a
transformation debited to the bread and credited to the cook,
the range, the flour, and the fuel, of which the last two are con

sumed as soon as they perform their services. Agents which
disappear in the transformation, but reappear in whole or
in part in the product (as here the flour), are called “raw
materials.” The production of cloth from yarn is a trans
formation effected by means not only of the loom, but also of
a number of other agents, among them the yarn itself,
which thus vanishes as yarn and reappears as cloth. The
cost of weaving includes the consumption of raw material
— yarn; and this consumption of yarn is, on the part of
the yarn itself, not cost, but service. It is the use for
which the yarn existed. When cloth is turned into clothes,
this transformation is a service to be credited to the cloth,
and a cost to be debited to the clothes.

All raw materials

yield benefits as they are converted into finished products.
Their conversion is, however, on the part of these prod
ucts, always outgo and not income.
In general, production consists of a succession of stages,
and at each stage there is an interaction. The finished
product of one stage passes over as the raw material of the
next, and its passage from the earlier to the later stage is an
interaction between the capitals of the two. Each opera
tion is credited to the group of instruments earlier in the
series and debited to the group next later in the Series.

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. W.

§3. Transportation: Interactions which Change the Posi
tion of Wealth

The second class of interactions we have called “trans

portation.” It is a very slight distinction which separates
this class from the preceding class. Transforming or pro
ducing wealth consists in changing the position of its parts
as related to one another; transporting wealth consists
mechanically in changing the position of that wealth as a
whole. But “part ’’ and “whole ’ are themselves loose and
relative terms. Bookbinding is a transformation or pro
duction of wealth; it assembles the paper, leather, thread,
and paste into a whole book. Delivering the finished book
to a library is transportation. Yet the library is, in a sense,
a whole; and to assemble books into a classified and organized
library is to make a whole out of parts and may be regarded
as a transformation or production of wealth. The distinction
between transformation and transportation is thus merely
one of convenience. Many writers prefer to include them
both under “production.” We prefer to include them under
the less ambiguous and more inclusive head of “inter
actions,” and our object here is not to emphasize their
difference but their similarity. The principles already
discussed of coupling and canceling equal and opposite
items apply also to transportation. The following are
examples. When merchandise is transmitted from one
warehouse to another, the stock in the first warehouse is

credited with the change and that in the second, debited.
The stock which has rendered up the merchandise has done
a service; that which has received it is charged with a
cost. A banker who takes money from his vault and puts
it into his till will, if he keeps separate accounts for the two,
credit the vault and debit the till. When wheat is carried
from wheatfield to barn the wheatfield is credited and the

barn debited. When wheat is imported from Canada,
Canada is credited, and the United States debited.

SEc. 4)

COMBINING INCOME ACCOUNTS

§ 4. Exchange: Interactions which Change the Ownership
of Wealth

The third class of interactions is the change of ownership
of wealth or of property. This has been called “transfer.”
Every transfer is a species of interaction. If two dollars
are transferred from Smith's cash drawer to Jones's, Smith's
cash drawer is credited with the two dollars yielded up, and
Jones's is debited with receipt of the same. Transfers usually
occur in pairs, and involve two objects transferred in oppo
site directions between two owners. One transfer pertains
to each object. Such a double transfer we have called an
exchange. Since an exchange consists of two transfers, and
since a transfer is a species of interaction and as such is self

canceling, every exchange is self-canceling, and hence cannot
be counted as a part of the total income of society unless it
be counted out again (although it may lead to later items

which are not self-canceling). Whatever is credited on one
side is debited on the other. This is shown in the following
scheme which gives the credits and debits involved when
goods worth $2 are sold. The dealer credits his stock of

goods and debits his “cash,” while the buyer does the
Stocks of Goods | Stocks of CASH

Seller's .

Buyer's.

Cr. $2
Dr. $2

Dr. $2
Cr. $2

opposite. We see, then, that an exchange, whether of
goods against goods or of goods against money, occasions
an element of income to the seller equal to the corre
sponding element of outgo to the purchaser, and an element
of outgo to the seller equal to the corresponding element of
income to the purchaser, and therefore no immediate in
come at all to Society.
G

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. W.

The effect of canceling these items — the credit item of
the seller and the debit item of the purchaser — is to free
the income account for any article from all entanglements
with exchange, to wipe out all money-income, and to leave

exposed to view the direct or natural income from that
article. Thus books yield their natural income, not when
the book dealer sells them, but later when the reader

peruses them. The sale is a mere preparatory service, a
credit item to the book dealer, and a debit item to the

buyer. Only the book remains in the hands of the pur
chaser. Again, a forest of trees yields no natural income
until the trees are felled and pass into the next stage of logs.
The owner of the forest may, to be sure, “realize " on the
forest long before it is ready to be cut, by simply selling it to
another. To the seller the forest has then yielded income;
but, as the purchaser has suffered an equal outgo, the net
result of this interaction, as of every other, is zero.
Only the forest remains ready for future use. Similarly,
the money “rent" of a rented house is, for society, not
income at all. It is income to the landlord, but outgo
to the tenant – outgo which he is willing to suffer solely
because of the shelter he receives. As we may cancel the
landlord's money-income against the tenant's money-outgo,
it is clear that the shelter alone remains as the income from

the house. The shelter-income is the essential and abiding
item, and without it there could be no rent-income to the

andlord. Thus we see clearly the fallacy of the old view
that a dwelling yields income only when it is rented. In
like manner, a railway yields as its natural income solely
the transporting of goods and passengers. Its owners sell
this transportation service for money, and regard the rail
way simply as a money-maker; but to the shippers and pas
sengers this same money is an expense, and exactly offsets

the railway's money earnings. Of the three items —
money-income of the road, money-outgo of its patrons, and
transportation—the first two mutually cancel and leave only

SEC. 4]

COMBINING INCOME ACCOUNTS

the third, transportation, as the real contribution of the
railway to the sum total of income.
We do not mean, of course, that interactions are useless,
but simply that in the accounting of Society they are self
canceling. They are a necessary step toward achieving the
final income which remains uncanceled, but they themselves
** disappear under the method of couples. We see that

&*capital is not a money-making machine, but that its income
to Sºciety is simply its services of production, transporta
tion, and gratification. The income from the farm is the
yielding of its crops; from the mine, the giving up of
its ore; from the factory, its transformation of raw into
finished products; from commercial capital, the passage of
goods between producer and consumer; from articles in con
sumers’ hands, their enjoyment or so-called “consumption.”
Although these items are all measured in terms of money,
they do not consist of money receipts. Those items which
do consist of money receipts are money receipts for in
dividuals, never for the world as a whole; since each dollar
received by one person implies that some other person —
the one from whom it was received — expended it.
Similar principles apply to outgo, no part of which, for
society, occurs in money form. The great bulk of what
merchants call “cost of production,” expense, or outgo,
consists of money costs which, as concerns society, carry with
them their own cancellation, and so are not ultimate costs
at all. For manufacturers, merchants, and other business
men, almost every outgo is an expense, i.e., consists of a
money payment. But such money payments are for
wages, raw materials, rent, and interest charges, all of which
are incomes for other people. The wages are the earnings
of labor; the payment for raw material is received by some
other manufacturer, farmer, or miner; the rent is received
by the landlord; the interest charges, by the creditor.
Labor itself — human effort, not the payment for it—re
mains, however, uncanceled.

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. V

§ 5. Accounts Illustrative of Interactions in Production
Not only do money transactions completely cancel them
selves out in reckoning the total income of society, but the
great majority even of the natural benefits of capital do the
same. Even these natural benefits of capital consist for

the most part of “interactions”; they are transformations
or transportations of wealth. They are intermediate stages,
merely preparatory to the final enjoyable benefits of wealth,
and, after the interactions have been canceled out, do not

enter as items either on the income or the outgo side of the
social balance sheet.

In order to show the effect of cancel

ing out the equal and opposite items entering into every
interaction throughout all productive processes, let us ob
serve the various stages of production which begin with the
forest above referred to. The gross income produced by
the forest is the series of events called the turning out of
logs. This log production is a mere preparatory service, a
credit item to the forest and a debit item to the stock of

logs of the sawmill, to which the logs next pass. Next the
sawmill turns its logs into lumber, and is therefore cred
ited with its share in this transformation while the lumber

yard is debited with the production of lumber. Intermedi
ate categories may, of course, be created, and we may
follow, in like manner, the further transformation, transpor
tation, and exchange to the end of the stages of produc
tion — or rather, to the ends; for these stages split up and
form several streams flowing in different directions. To fol
low one only of these streams, let us suppose that the lumber
which goes out from the yard is used in repairing a certain

warehouse. The warehouse is used for storing cloth; the
cloth goes from the warehouse to the tailor; the tailor con
verts the cloth into suits for his customers; and his cus
tomers receive and wear those suits.

In this series of

productive services, all the intermediate services cancel
out in “couples’’ and leave as the only uncanceled ele

SEc. 5)

COMBINING INCOME ACCOUNTS

ment, or fringe of final services, the use of clothes in the
consumers' possession.
Should we stop our accounts, however, at earlier points in
the series, the uncanceled fringe at which we should find
ourselves would be some other item.

The uncanceled in

come item in a production series is always the positive side
of some intermediate service or interaction whose negative
side does not appear, as it belongs to a later stage in the
series. This will be clear if we put the matter in figures,
stage by stage. The following are the items for the logging
camp above mentioned, in the accounts of its owner.
INCOME ACCOUNT FOR LOGGING CAMP
INCOME

Yielding of logs to sawmill

OUTGO

$50,000

The income from the logging camp is here seen to consist
in the production of $50,000 worth of logs. Of course
there are usually large outgoes; but as these do not con

cern our present point, for simplicity we leave them out
of account. If we now combine the account of the logging
camp with that of the sawmill, we shall have accounts like
the following, in which, to avoid irrelevant complica
tions, no mention is made of any outgoes which do not
happen to be interactions between the groups of capital
considered:—
INCOME ACCOUNT FOR LOGGING CAMP

AND SAW

MILL
CAPITAL SOURCE

Logging camp .

INCOME

OUTGO

. . Yielding logs to saw
mill . . . $50,000

Sawmill . . . . . . Yielding lumber to
lumber yard $60,000

Receiving logs from
camp

. $50,000

g
9o,ooo Receiving
.
stock
500,ooo
stock
tailor's
from
suits

8Warehouse.
.
cloth
to
shelter
|Warehouse
70,000
yard
from
lumber
0,000
Receiving

warehouse
from
cloth
Receiving

|YSawmill
60,000
yard
to
lumber
$50,000
camp
logging
from
logs
.
ielding
Receiving
6YLumber
.
sawmill
from
Receiving
7o,ooo
warehouse
to
lumber
yard
ielding
0,000
SNPECIFIED
A
ACCOUNT
IINCOME
OF
SERIES
1910
FOR
STRUMENTS
OUTGO
INCOME
SOURCE
CAPITAL

Yielding
in
of
9Stock
tailor.
to
Scloth
8|
.
warehouse
from
helter
o,ooo
0,000

6oo,ooo
.
“wear”
Yielding
5oo,000
.
customers
to
suits
Yielding

$Logging
.
sawmill
to
logs
Yielding
camp.
50,000

customers
clothes
of
Stock
tailor.
cloth
of
Stock

SEc. 5]

COMBINING INCOME ACCOUNTS

In this case, canceling the two log items of $50,000 each,
we have left only the lumber item; that is, the net income
from the combined logging camp and sawmill consists only
of the production of lumber, their final product. The
transfer of logs from one department to the other no longer
appears. This transfer is like the taking of money from
one pocket and putting it into another – a fact which
would be particularly evident in case the logging camp and
sawmill were combined under the same management.

Extending the same principles to the entire series, we have
the accounts as given in the table on the preceding page.
In this table we may successively cancel each pair of
items constituting an interaction. An item on the left is
the positive side of an interaction of which the item on the
right in the line next below is the negative side. Thus, as
previously, the $50,000 in the first line on the left cancels the

$50,000 in the second line on the right. Similarly, the two
items of $60,000 cancel in the two lines next below, to the

right and left, respectively. If we stop after the first two
cancellations, thus restricting the account to the first three
horizontal lines of the table, we shall find that the net in
come from logging camp, sawmill, and lumber yard consists

only of the production of retail lumber, worth $70,000; it
includes neither the transfer of logs from the camp to the mill
nor the transfer of lumber from the mill to the yard.

like manner, if we proceed one stage further, i.e., if we stop
our cancellations at the end of the first three interactions,

the production of retail lumber no longer appears as an ele
ment of income; and so on, step by step to the end, when the
only surviving item will be the “wear ” of the suits.
It is, of course, true that in any actual accounts there will
be other items besides those which have been exhibited in

this simple, chainlike fashion. Were it worth while, we
might insert these additional entries of income and outgo
elements.

Most of them would likewise consist of the posi

tive or the negative side of interactions; and if we were to

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. V

introduce their respective mates, the opposite aspects of the
same interactions, it would be necessary to include the
accounts of still other instruments.

If we should follow

up all such leads, we should soon have, instead of the simple
chain represented in the table, an intricate network of re
lated accounts; but the same principle of the interaction as
a self-effacing element would continue to apply.
§ 6. Preliminary Results of Combining these Income
Accounts

The table given will throw light on the question: Of
what does income consist?

or, to be more definite: Of

what does the income from a particular group of capital
goods consist? Whether the yielding of logs by the logging
camp to the sawmill is income or not depends upon what
capital we are including. It is income with respect to the
first link of capital in our series (the logging camp); it is

not income with respect to the first two links (the logging
camp and the sawmill taken together), but merely a self
canceling interaction between the two. Likewise the use
of the warehouse is income with respect to the first four
links of capital, but is not income with respect to the first
five links.

We see, therefore, that in reckoning up the income from
any group of capital we may as well omit all interactions
taking place within it, and confine ourselves to the outer
fringe of services performed by the group as a whole. As
the group is enlarged, this particular outer fringe disappears
by being joined to the next part of the economic fabric, and
another fringe still more remote appears.

To answer the

question whether any particular item is or is not income—
as, for instance, the question, “Is sawing lumber income P”
— we must first ask, “Income from what?” Income is
always relative to its source.
Contrasting the method of couples with the method of

SEC. 6

COMBINING INCOME ACCOUNTS

balances, we may say that the method of couples is useful
in showing of what elements income consists in any given
case.

The method of balances, on the other hand, is useful

in exhibiting the amount of income contributed from each
capital source. The two methods, as applied to the example
just given, are as follows: —
(Summarized from Table on p. 86)
METHOD OF BALANCES

CAPITAL

INCOME

Logging camp . .
Sawmill . . . .
Lumber yard . .

.
.
.

. $ 50,000
. 60,000
. 7o,ooo

Warehouse .

OUTGO

NET INCOME

$ 50,000
$ 50,000

Io, Ooo

60,000

Io, Ooo

8o,ooo

7o,ooo

Io,000

Stock of cloth in warehouse 90,000
Stock of cloth of tailor . . 5oo,ooo
Stock of clothes of customers 6oo,ooo

8o,ooo

Io,000

90,000

4Io,ooo

5oo,ooo

Ioo,ooo

$600,ooo

METHOD OF COUPLES

INCOME

OUTGO

The two methods — balances and couples — show the

same final result ($600,000), but from different points of
view.

By means of the method of balances we are enabled

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. V.

to see that, of this $600,ooo, the part contributed by the
logging camp is $50,000, that contributed by the sawmill,
$10,000, and so on. By means of the method of couples,
we are enabled to see that, canceling by the oblique lines,
we have left but one item, $600,ooo, representing the
“wear” of the suits. Thus the entire $600,ooo consists of
the use or “wear” of the suits, although five-sixths of it is
contributed by other kinds of capital than the stock of
clothes of customers. Combining the results of both meth
ods, we may state that the total net income from the speci
fied group of instruments consists of $600,000 worth of
“wear” of suits, and that this is due partly to the stock of
clothes and partly to other capital. Of course our table
does not give all the capital to which the wear of the suits
is indebted. We have, as already noted, omitted, for the
sake of simplicity, all items of cost which do not belong
to our chosen series.

But the inclusion of other items,

while it complicates the accounts, does not change the
principle of cancellation. It merely introduces other chains
of interactions.

§ 7. Analogies with Capital Accounting
The two methods correspond in a general way to the two
methods for canceling liabilities and assets in capital ac
counts. Applied to capital, the method of balances gave,
it will be remembered, the amount of capital belonging to
each individual; the method of couples showed of what
elements the total capital consists. Similarly, applied to
income, the method of balances shows what share of the

resulting income is contributed by any articles or groups of
articles of capital; while the method of couples shows
wherein that resulting income consists.
Let us consider for a moment the method of couples as
applied to the two sorts of accounts. In capital accounts
the self-effacing items were debts; in income accounts the
self-effacing items were interactions. These concepts —

Sec. 7]

COMBINING INCOME ACCOUNTS

debts and interactions — supply the key for the mutual
cancellations between accounts. A debt is both positive
and negative and so is self-canceling. An interaction is
likewise both positive and negative and so self-canceling.
A realization of the two-faced nature of debts helps us to
avoid the confusions of double counting in capital accounts
and double taxation; a realization of the two-faced nature

of interactions saves the confusions of double counting in
income accounts.

It is important here to observe of income, as was pre

viously observed of capital (Chapter III, § 8), that the self
effacement of the self-effacing elements (interactions in
the case of income) does not mean that the total income

would be just the same if there were no interactions.

the contrary, the existence of interactions—the operations
of industry and commerce – are essential steps toward the
final goal of uncanceled income to which they lead.
Without them the final uncanceled income would be very
much less and often nonexistent.

Debts mean subdivided

ownership of capital and interactions mean subdivided
steps in income. They make capital and income respec
tively more abundant and effective.
We may illustrate what has been said by two simple
examples. If a man owns a piece of real estate worth
$1oooo and mortgages it for $6000, this debt must be
entered in his accounts as a liability of $6000 and in the
accounts of the mortgagee as an asset of $6000. Conse
quently, as between the two men the item cancels out.
But this does not mean that the mortgage is of no ac

count. It does not mean that the two men would be just
as well off if there were no mortgage. If we should force
them against their will to cancel the debt, it would be an
inconvenience to both.

The owner would find it difficult

to make the payment and the mortgagee would have the
inconvenience of finding another investment for the $6000

returned to him.

The inconvenience to the owner might

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. V

be so great that he would be forced to sell his land per
haps at a sacrifice below the $10,000 which is its real
worth, while if the mortgage is allowed to stand, he might
not be willing to sell even for a sum considerably above
the $10,000. The inconvenience to the mortgagee might
be less.

We find the same thing true of interactions.

A book

seller who sells $2000 worth of books in the course of a

year credits his business with this sum while his customers
debit their libraries with $2000 worth of books.

These

entries are evidently correct accounting, and the receipts
of the bookseller and the expenditures of his customers
exactly offset each other.

But this does not mean that

the transactions are of no account.

Without them the

bookseller would find a great accumulation of books which
would be entirely useless to him while his customers would

be deprived of the satisfaction of reading these books. If
we could force the reversal of the normal process and
make the customers resell their books to the dealer, there

would be an obvious loss to both parties. The dealer
would refuse to take them except at a price far below the
$2000, while their possessors would not be willing to sell
them unless for more than $2000.

§8. Double Entry in Accounts of Fictitious Persons
We have now followed the cancellations to which inter

actions lead, whether they be interactions of exchange or of
production. The case of exchange, however, needs further
consideration. Since every exchange consists of two trans
fers, and every transfer of two items, a credit and a debit,
the exchange evidently consists of four items in all, two of
which are credits and two of which are debits.

These four

may be paired off in two ways, only one of which has thus far
been mentioned.

They stand, as it were, at the four corners

of a square, as in~
the scheme given
in § 4.
--~
--

SEc. 8]

COMBINING INCOME ACCOUNTS

The two transfers into which any exchange may be re
solved are represented by the second and third columns of
that scheme. The second column indicates that a $2
article has been transferred from the stock of the seller to

that of the buyer, being, therefore, credited to the one and
debited to the other; the third column indicates that $2
of money has been transferred from the stock of cash of

the buyer to that of the seller and credited and debited
accordingly. But this same exchange may also be resolved
into two pairs of items represented by the two horizontal
lines of the scheme. The upper line indicates that the
seller has exchanged goods for cash crediting his goods
with the sale and debiting his cash; the lower line indi
cates the reverse conditions for the buyer.
Every exchange, then, consists of four items, and may be
resolved either into two transfers (one for each good ex
changed) or into two transactions (one for each person
exchanging those goods).
These latter items, namely, transactions represented by
the horizontal lines, we must now consider more fully.

Each of the previous income accounts is an account of in
come flowing from a specified good owned, not of the entire
income received by a given person as owner. But it is easy
now to form the income accounts of any given person, i.e.,
the income and outgo of all his assets and liabilities, simply
by combining in each case, by the method of balances, the
accounts of all his items of property (whether assets or lia
bilities). We must distinguish, however, the accounts of
real and of fictitious persons. We begin with the income
account of a fictitious person.
The following account represents the entries during a given
year for a dry goods company. In this account we observe
that every item on the income side is balanced by an equal
and opposite item on the outgo side. All items thus paid
are represented by the same letters, the capitals being
used for positive items and the small letters for negative.

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. V.

INCOME AND OUTGO OF A DRY GOODS COMPANY
FOR

CAPITAL SOURCE

INCOME

1910

OUTGO

Stock of goods | By goods sold $1o,ooo A. To goods bought $5,000 b
Cash .

. . By cash taken out
To cash received
for purchases $5,000 B | from sales . . $1o,ooo a
for profits
$2,000 C

Capital Stock .
(a liability)

To dividends

$2,000 c

The rule we have learned in Chapter IV for making com
plete income accounts is to start with the capital account,
taking each item of assets and each item of liabilities, and to
enter for each item of either kind all the items of income to

which they give rise, plus or minus, as the case may be.
For simplicity, it is here assumed that, instead of fifty or one
hundred different items of capital, there are only three items;
namely, the stock of goods, the stock of cash, and the “capi
tal stock,” which is “negative capital.” The stock of goods
yields $10,000 worth of sales. But, on the other hand, it
costs $5000 to replenish this stock of goods. Therefore it is
credited with a plus item of $10,000, and debited with a
minus item of $5000. The student will notice, moreover,
that each of these items is entered twice, once on each side.
The doubly entered items may be mutually canceled. A
cancels with a ; that is, though the stock of goods is credited

with bringing in $10,000 (A) in cash, the cash drawer must
be debited with the $10,000 (a) which it swallows up. Like
wise the stock of goods costs $5000 (b), which must therefore
be debited to it; but the cash drawer has to supply this
$5000, and is therefore credited with $5000 (B), so that items
B and b cancel. Finally, when the profits are paid, they
also come out of the cash drawer, and the cash drawer is

SEc. 9]

COMBINING INCOME ACCOUNTS

credited with exactly that amount, $2000 (C); while the
“capital stock” is debited with that amount as a cost (c).
So we see that all six items cancel one another in pairs.
The two sides of the account of such a fictitious person
necessarily balance. Even if the company accumulates its

profit instead of paying it in dividends to the shareholders,
the two sides of its account still balance; for, as has been

seen, all money received is not only credited to the capital
source which brought it in, but is also debited to the cash
account. Here, for instance, the $2000 item (doubly entered
as C and c) would merely be omitted. There would be no
$2000 dividends, but the cash drawer would be $2000
fuller.

$9. Double Entry in Accounts of Real Persons
In the case of real persons, however, the two sides do not
balance, for the accounts do not then consist solely of double
entries. To show this, let us consider the accounts of a

real person as given in the next table. In these accounts, as
in the previous ones, both of which are much simplified,
we have indicated the like items on opposite sides by like
letters, the positive items being represented by capitals and
the negative by small letters. We observe that, as in the
accounts of the previous company, many of the items will
“pair.” But, unlike the company's accounts, the present
accounts contain a residue of items which will not pair.
The letters representing these unpaired items are designated
on the next page by being inclosed in square brackets.
They show that [B] and [C] – the shelter of the house, and
the use of food — constitute a kind of income which does

not appear elsewhere as outgo.
When studying the accounts of goods owned, we found in
considering the chain of productive services of a lumber
camp, etc., that there always remains some outer fringe of
uncanceled income.

We have now reached this same kind

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. V

INCOME AND OUTGO OF A REAL PERSON FOR THE
YEAR 1910
CAPITAL SOURCE

INCOME

OUTGO

Stocks and bonds. By receipt of money from To money expended
stocks and bonds $200o A

for

stocks

and

bonds . $500 d

Lease right .

. . By shelter .

Food .

. . By use of food .

$10o [B]|To money rent
paid . . $10o e
. $150 [C]|To money cost of
food . . $150 f

“Cash” . . . . By cash taken out for

To receipt of money
stocks and bonds $500 D | from stocks and
bonds . $2000 a

By payment for rent $100 E |To
receipt
of
money for work
done . $20oog

By payment for food $150 F
Self

. . By receipt of money for work
done

. $ 2000 G

Uncanceled items: Shelter [B]

$10o

Use of food [C] . $150
Total uncanceled income

$250

of outer fringe in studying the accounts of owners, provided
they are real persons. This outer fringe consists of the
final benefits of their goods. All other items are merely
interactions preparatory to such final benefits, and pass
from one category of capital to another. Thus the in
come from investments, being paid into the cash drawer, is
outgo with respect to the drawer; the drawer yields income
by paying for stocks and bonds, food, etc., but in each case
the same item enters as outgo with respect to these or other

Sec. 9]

COMBINING INCOME ACCOUNTS

categories of capital. In all these cases the individual re
ceives no income which is not at the same time outgo. It
is only as he receives shelter from the house, consumes food,
wears clothes, or uses furniture, or some other article, that
he receives income. And these final benefits are, of course,
the end and goal of all the preceding economic processes and
activities.

We have thus reached what may be called the stage of
final or enjoyable income. This is the stage at which wealth
at last acts upon the person of the recipient. This final
income is that of which the economist is in search, and is

that which the ordinary statistics of workingmen's expen
ditures represent. It has been made clear that, in the
final net income which we derive from wealth, all interactions

between different articles of wealth drop out—all the trans
formations of production, such as the operations of mining,
agriculture, and industry, all the operations of transportation,
and all transfers and exchanges in business. For in all such
cases the debits and credits inevitably occur in pairs of equal
and opposite items. Each pair consists of the opposite facets
of the same interaction. The only items which survive are
the final personal uses of wealth. The chief classes of such
uses or benefits are those of nourishment, shelter, and
clothing.
Having reached the action of wealth on the human
body, we may, as students of economics, be content to
stop. But, theoretically, there is one step more before
the process of tracing a series of interactions has reached
its final goal. Indeed, no benefits outside ourselves
are of significance to us except as they lead to feelings

within our minds. And if we regard the human body in
the same light in which we have regarded articles of
wealth, we could extend our accounts bby conceiving wealth
as interacting with the human body. We would then
debit the human body with the nourishment, shelter, pro
tection from cold, etc., which it receives from food, dwellings,
H

ELEMENTARY

PRINCIPLES OF ECONOMICS

[CHAP. W.

clothing, etc., and credit it with the satisfactions experienced
through the brain, i.e., the feelings of enjoyment of food or
avoidance of pain, etc. As, however, we have in general,
in this textbook, limited the concept of wealth to its nar

rower definition, excluding free human beings, we shall not
attempt to follow these transformations of income after
they reach the person of the owner. Usually the mental
satisfactions follow so closely after the physical effects of
wealth on the human body that practically we scarcely
need to distinguish between those physical effects and the

resulting satisfactions. Hereafter we shall speak of satis
factions of food, shelter, clothing, etc., as if they flowed
directly from these external objects.
§ Io. Ultimate Costs and Income
We have now reached a convenient place at which to
emphasize a point of great importance, but one which is
seldom understood; namely, that most of what is called

“cost of production ” is, in the last analysis, not cost at all.
We have found, in using the method of couples, that every
item of money cost is also an item of income, and that in
the final total no such items survive cancellation.

It costs

the baker flour to produce bread; but the cost of flour to
the baker is a benefit to the miller. To society as a
whole, on the other hand, it is neither cost nor benefit,
but a mere interaction.

As has been said, in the last analysis, payments of
wages, interest, rent, or any other payments from one mem
ber of Society to another, are not costs to society as a whole.
This fact should now be clear; yet it is commonly over
looked. When people talk of the cost of producing coal or
wheat, they usually think of money payments. The items
called costs of production are mostly payments from per
son to person, or interactions, at various stages of produc
tion. We have seen that each such item is two-faced and,

Sec. Iol

COMBINING INCOME ACCOUNTS

in the final total, wipes itself off the slate. The only ulti
mate item of cost is labor cost or efforts; that is, all the
experiences of an undesirable nature which are undergon
in order that experiences of a desirable nature may be
secured.

We may conclude, therefore, that in the last

analysis income consists of satisfactions and outgo of efforts
to secure satisfactions.

Between efforts and satisfactions

may intervene innumerable interactions, but they all must
cancel out in the end. They are merely the machinery
connecting the efforts and satisfactions. At bottom, eco
nomics treats simply of efforts and satisfactions. This is
evident in the case of an isolated individual like Robinson

Crusoe, who handles no money; but it is equally true of
the most highly organized society, though obscured by the
fact that each member of such a society talks and thinks
in terms of money.
In the light of the foregoing principles we are now in a
position to take a bird's-eye view of the income of any coun
try.

Unfortunately, there are no available statistics for

income in the United States. We can only guess as to what
the amount of it may be. Possibly $20,000,000,000 worth
of final income is annually enjoyed in the United States,
of which about one third is in the form of nourishment or

food uses, about one sixth in the form of shelter, and

about one eighth in the form of clothing. These and
the other items of the direct uses of wealth constitute the

real income of society. In other words, our real income is
what is often called our “living.” Money-income, as we
have seen, is not real income, but is converted or spent for
real income in what we call our “bread and butter,”
which, more exactly expressed, means the use of our

“bread and butter” and of the other goods contributing
direct benefits to human beings.

These uses include the

necessaries, comforts, luxuries, and amusements of life.

These are what make up our “living.” The more money
wages it costs to acquire a given amount of real wages,

IOO

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP.W

the higher the “cost of living” of which we hear so much
to-day. The money which the workman is paid in wages
is not his real wages, but only his nominal wages. The
real wages are the workman's living for which that money
is spent. Money payments, as we have seen, cancel
themselves out when we take a view of the whole, for they
are not only receipts, but also payments. They there
fore disappear, just as in our view of capital the bonds
and stocks disappear, being not only assets, but also liabili
ties. And in exactly the same way the operations of pro
duction and transportation cancel themselves out in the
total production of the farms. The ten billions of dollars'
worth of farm products, for instance, which we are produc
ing are not a part of the income of the country to be added
to our consumption of food, etc., any more than they are
a part of the costs of the country. To the farmer they
represent income, but to those who buy of the farmer they
represent outgo, while to the country as a whole they rep
resent neither income nor outgo. By the method of couples
they vanish, and in their stead we have the consumption of
bread and the other finished products which originated with
the farm; and should we, as is sometimes erroneously
done, try to add together the value of these finished products
and the value of the farm products, we should be guilty of
double counting, as would be the case in capital accounting
if we should add the value of mortgages to the value of
real estate.

The method of couples thus provides us with a view of real
income, making clear what it consists of and what it does
not consist of. If, however, we wish to know the extent to
which various agencies have produced this income, we must
look at the matter from the standpoint of the method of
balances. From this standpoint, perhaps three quarters of
the total income enjoyed in the country is produced by
human beings, the workers of society, the remainder being
produced by capital in
its narrower sense. Of this capi
—-T

SEC. Iol

coMBINING INCOME Accounts. : :

- ; 15: ...”

tal that which produces the greater part of our income is
land, but some of our income must also be credited to

railways, ships, factories, shops, dwellings, etc. It does
not matter whether the capital is or is not itself the prod
uct of other capital, of human beings, or of nature.
There will usually be a net income to be credited opposite
each kind of capital, as shown in the table of the Method
of Balances in § 6.

CHAPTER VI
CAPITALIZING INCOME

§ 1. The Link between Capital and Income
WE have now learned what capital and income are, and
how each is measured. We have seen that the term “capi
tal” is not to be confined to any particular part or kind of
wealth, but that it applies to any or all wealth existing at a
given instant of time, or to property rights in that wealth,
or to the values of that wealth or of those property rights.
We have seen that income is not restricted to money
income, but that it consists of all kinds of benefits of wealth.

We have seen that, like capital, income may be measured
either by the mere quantity of the various benefits or by the
value of those benefits.

We have seen that in the addition

both of capital-value and of income-value there are two
methods available for canceling positive and negative items,
called respectively the “method of balances" and the
“method of couples.” By the method of balances the nega
tive items in any individual account are deducted from the
positive items in the same account, and the difference or
“balance ’’ gives the net capital (or income, as the case
may be) with which that account deals, whether this net
capital (or income) pertains to a particular instrument or
instruments, or to all the property of a particular owner.
The method of couples, on the other hand, cancels items in

pairs and is founded on the fact that, as to capital, every
liability relation has a credit as well as a debit side—
IO2

SEc. 1]

CAPITALIZING INCOME

IO3

namely, as related to creditor and debtor respectively; and
that, as to income, every interaction is at once a benefit and
a cost — a benefit occasioned by that good (or person) by
which the event originates; a cost occasioned by that good

(or person) for which it originates.
We observed that it is the method of couples alone which,
if fully carried out, reveals wherein capital and income
ultimately consist. This method, applied to capital, gradu
ally obliterates all partial rights, such as stocks and bonds,
and exposes to view the concrete capital-wealth of a com
munity.

The same method applied to income obliterates

the “interactions” such as money payments between
persons, and exposes to view an uncanceled outer fringe of
benefits and costs. It leaves simply the final benefits of the
wealth, poured, so to speak, into the human organism —
the satisfactions and the efforts of human life.

We have seen that capital and income are in many re
pects correlative; that all capital yields income and that
all income flows from capital including human beings.
In spite of this close association between them, capital
and income have thus far been considered separately. The
question now arises: How can we calculate the value of
capital from that of income or vice versa 2 The bridge or
link between them is the rate of interest. The rate of interest
is the ratio between income and capital, both the income and
the capital being expressed in money value. Business men,
therefore, sometimes call the rate of interest the “price of
capital’’ or the “price of ready money.” Suppose, for
instance, that a merchant wants a capital worth $10,000 and
is willing to pay a bank $400 per year for it perpetually;

then the price the merchant pays for the capital (or the ratio
between the annual payment to the bank and the capital
received from it) is $400 + $10,000 = {{m, or four per cent,
and the rate of interest is, therefore, said to be four per cent.

We may also define the rate of interest as the premium
on goods in hand at one date in terms of goods of the same

IO4

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

kind to be in hand one year later. Present and future goods
seldom exchange at par. One hundred dollars, if in hand
to-day, is worth more than if due one year hence. To-day's
ready money will always buy the right to more than its full
value of next year's money. If, then, $100 to-day will ex
change for $104 to be received one year hence, the premium

– or rate of interest — is four per cent.

That is, the price

of to-day's money in terms of next year's money is four per
cent above par; for $104 + $100 exceeds $1oo + $1oo by
1$o, which is four per cent.
We have, then, two definitions of the rate of interest,
viz., “the price of capital in terms of income " and “the
premium which present goods command over similar goods
due one year hence.”
But the two definitions are quite consistent, and either defi
nition may be converted into the other. The rates of interest

in the two senses are, in fact, normally equal. For instance,
if a man borrows $100 to-day and agrees to pay it back in
one year with interest at four per cent, we may conceive of
him as selling for $100 a perpetual income of $4 a year –
and at the same time agreeing to buy it back for $100 at the
end of one year. But these two stipulations — to sell and
to buy back — amount simply to an exchange of $100
to-day for $104 next year – i.e., an exchange of present for
future money at four per cent. Thus the rate of interest in
the price sense becomes equivalent to the same rate in the
premium sense. Or, beginning at the other end, conversely
if we suppose $100 to-day to be exchanged for $104 due
one year hence, so that the rate of interest in the premium
sense is four per cent, we may suppose that when the time
comes to receive the $104, only $4 of it is really kept, the
$1oo being again exchanged for $104 due the year follow
ing. If this process is repeated indefinitely, the man will
continue to receive simply $4 a year; and thus the rate of
interest in the premium sense becomes equivalent to the
same rate in the price sense.

Sec. 1]

CAPITALIZING INCOME

IOS

By means of the rate of interest we can evidently translate,
as it were, present money-value into its equivalent future

money-value, or future money-value into its equivalent
present money-value. To translate any present value into
next year's value, when interest is four per cent, we multiply
this year's value by the factor I.O4; to translate any next
year's value into this year's value, we divide next year's

value by the factor 1.04. Thus if the rate of interest is
four per cent, $25 to-day is the equivalent of $25 × 1.04 due

one year hence, i.e., $26.

Or, vice versa, $26 due one year

hence is worth in the present $26+ 1.04, or $25. Again,
$1 due one year hence is worth in the present $1 + 1.04,
or $o.962. In general we may obtain the present worth of
any sum due one year hence by dividing that sum by one
plus the rate of interest. This latter operation is what we
learned in our school arithmetics as “discounting,” by which
is meant finding the “present worth " of a given future sum.
The rate of interest is thus a link between values at any
two points of time – a link by means of which we may
compare values at any different dates.
The rate of interest, however defined, may be regarded as
a species of price; but it is a very different species from any
prices mentioned in previous chapters. We have seen that
the price of wheat enables us to translate any given number
of bushels of wheat into so many dollars' worth of wheat;
and the prices of other goods in like manner, to translate
their respective quantities into their money equivalents.
Any price thus serves as a bridge or link between the quan
tity of any good and its value in some other good, as money.
By means of prices we can convert a miscellaneous assort
ment of goods at any time into their money-value for that
same time, or convert a miscellaneous assortment of benefits

occurring through a period of time into their money-value
for that same period. By such prices we may only convert
quantities into simultaneous money-values. We cannot, by
them, pass from one time to another. By means, however,

Ioé

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

of that unique price called the rate of interest, we may
convert the money-values found for one time into their
equivalent at another time. The rate of interest is thus the
hitherto missing link necessary to make our reckoning of
money equivalents universal.
We are not yet ready to explain how the rate of interest
comes about. In fact, we are not yet ready to explain how
any prices come about. We must, for the present, take
the rate of interest ready-made, as it were, just as we have
taken other prices ready-made. In the preceding chapters
we have seen how to form capital accounts and income ac
counts by assuming the prices necessary in each case to turn
quantities into money-values. We are now ready, by as
suming a rate of interest, to show the relations between these
two sets of accounts – i.e., to turn income into capital. It
is worth while, however, at the outset to rid our minds of the

idea that money is the one and only source of interest, just
as we have already rid our minds of the idea that money is
the only kind of wealth. We may, as we have seen, express
a great many things in terms of money-value which are not
themselves money. This habit leads us unconsciously into
the fallacy of thinking of these things as though they were
actual money. If we question a man who says, “I have
$10,000 of money invested, and from it I get $500 of money
each year as interest,” implying a rate of interest of five per
cent, he will be forced to admit that he has not really got
$10,000 of money at all, and, perhaps, even that the $500 of
money interest which he says he gets each year is not at
first in money form. The true form of statement is simply
that he has a farm (or other capital-wealth) which yields
crops (or other products), and that both of these may be
measured in terms of money, the farm being worth $10,000
and the crops $500. Money need not enter at all except as
a matter of evaluating in bookkeeping. Hence, if we are
careful, we shall avoid thinking and speaking of a fund of
$10,000 producing an interest of $500, but will instead think

SEc. 2]

CAPITALIZING INCOME

IoW

and speak of actual capital, such as farms, factories, rail
ways, or ships, worth $10,000 and producing actual benefits
(such as yielding crops, manufacturing cloth, or transporting
goods) which are worth $500.
There is another confusion to be carefully avoided, viz.,
the confusion between interest and the rate of interest.

the interest from $10,000 worth of capital is $500 worth of
benefits, the rate of interest is five per cent. Interest and
the rate of interest are as distinct as value and price and in
the same way.

The rate of interest, then, is a sort of universal time price
representing the terms on which men consider this year's
values exchangeable in next year's or future years' values.
By assuming this rate, we are enabled to convert future values
into present, and present values into future.
§ 2. Capital as Discounted Income
But although the rate of interest may be used either for
computing from present to future values, or from future to

present values, the latter process is far the more important
of the two. Accountants, of course, are constantly comput
ing in both directions, for they have both sets of problems to
deal with ; but the problem of time valuation which nature
sets us is that of translating the future into the present;
that is, the problem of ascertaining the value of capital.
The value of capital must be computed from the value of its
expected future income. We cannot proceed in the opposite
direction and derive the value of future income from the

value of present capital.
This statement may at first puzzle the student, for he may
have thought of income as derived from capital, and, in a
sense, this is true. Income is derived from capital-goods.
But the value of the income is not derived from the value of

those capital-goods. On the contrary, the value of the
capital is derived from the value of the income. These re

Io8

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

lations are shown in the following scheme in which the
arrows represent the order of sequence – from capital
wealth to its future benefits, from its benefits to their

value; and from their value back to capital-value:—
Capital-wealth

–2-

Flow of benefits (income)

Capital-value

-6-

Income-value

Not until we know how much income an item of capital
will bring us can we set any valuation on that capital at
all. It is true that the wheat crop depends on the land
which yields it. But the value of the crop does not depend
on the value of the land. On the contrary, the value of
the land depends on the value of its crop.
The present worth of anything is what men are willing to
give for it. In order that each man may decide what he is
willing to give, he must have: (1) some idea of the value of
the future benefits his purchase will bring him, and (2) some
idea of the rate of interest by which these future values may
be translated into present values by discounting.
With these data he may derive the value of any capital
from the value of its income by means of the connecting
link between them called the rate of interest.

This deriva

tion of capital-value from income-value is called “capi

talizing” income or “discounting” income.
§ 3. The Discount Curve
Let us assume that, for any given article of wealth or
property, the expected income is foreknown with certainty,
and that the rate of interest is also known. With these pro
visos, it is very easy, by the use of the rate of interest, to
compute the capital-value of said wealth or property; and
this, whether the income accrues continuously or discon

tinuously; whether it is uniform or fluctuating; whether
the installments of it are few or infinite in number.

Sec. 3]

CAPITALIZING INCOME

Io9

We begin by considering the simplest case; namely, that
in which the future income consists of a single item becoming
due at some particular time.

If, for instance, one holds a

property right by virtue of which he will receive at the end
of one year a benefit worth $1.04, the present value of this
right, if the rate of interest is four per cent, will be $1. Or if
the future benefit one year hence is worth $1, its present
value (interest being at four per cent) is found, as we have
seen in § 1, by dividing the $1 by the factor 1.04. The
result is $1 + 1.04, or $o.962. If the value to which the
right entitles the owner is any other amount than $1, its
present value is simply that given amount divided by 1.04.
Thus the present value of $432 due in one year is
$432 + 1.04, which is $415.38.
Let us now take a period of two years instead of one. We
know by “compound interest” (at 4 per cent) that not only
will $1 amount to $1.04 next year, but that this $1.04 next
year will amount to $1.04 × 1.04 or $1.082 the year after, -

in short, that $1 to-day amounts in two years to $1 X (1.04)*
or $1.082. Conversely, of course, the sum of $1.082 due two

years hence is worth in present value $1.082 + (1.04)”, or $1.
Similarly, the present value of, let us say, $10oo due two
years hence is $10oo + (1.04)” or $924.21. We see then that,

if interest is 4 per cent, we can, by multiplying by (1.04)*,
translate any present sum into its equivalent two years

hence, and we can, by dividing by (1.04)*, translate any
sum due two years hence into its equivalent present value.
By the same reasoning it is easy to show that we must

multiply any sum in hand to-day by (1.04)” to obtain the
equivalent sum due three years hence, and must divide
any sum due three years hence by (1.04)” to obtain its

present value. If the period is four years, we must multi
ply or divide by (1.04)*; for five, by (1.04)", etc. For our
present purposes we shall need to apply the process of divi
sion by (1.04) or (1.04)” or (1.04)”, etc.; for our chief object
is to translate future sums into present, not the reverse.

ELEMENTARY PRINCIPLES OF ECONOMICS

IIO

[CHAP. VI

We may illustrate this process by a diagram, much in the
same way as geography is illustrated by a map. Curves
sometimes puzzle beginners, but they are very important
in economics, and render the subjects which they illustrate
so clear and simple that the student should not fail to make
himself master of their use at the outset.

In Figure 3 the vertical distances measure the money
and the horizontal distances measure the lapse of time.
The sum of $100 (represented as b|3) is supposed to be
due at the beginning of the year 1901. The problem is
to find its value at the point of time represented by a ;
that is, at the beginning of the year 1900, which we

shall consider the “present instant ’’ or simply the “pres
ent.”

This discounted value is a A.

If we draw the line

BA, its slope downward from right to left pictures the fact
that a future sum becomes smaller and smaller in present
value the longer the period of
time involved.

# a

This line BA is

called the discount curve.

It is

not a straight line, but a line such
that its height at any point rep
resents the discounted value of

bH for the particular instant cor
responding to that point. If the
$100 due in 1901 be discounted
in 1900 at four per cent, its value
in the latter date will be $96.15,

4O
4900

JSOI

the difference in value between

the two points of time being
$3.85, as indicated in the dia
gram, where a0 is equal to bb, and AC is the difference
between ac or bp, the amount due in 1901, and a A, the
discounted value of that amount in 1900.
We shall understand the nature of this curve better if,
instead of taking merely the interval of one year, we con
sider a longer interval such as ten years. This is represented
FIG. 3.

SEC. 3]

CAPITALIZING INCOME

III

in Figure 4. In this figure, as in the preceding figure, the
vertical distances (or “latitudes”) above the base line
represent sums of money and the horizontal distances (or
“longitudes") represent periods of time. The curve,
ABCDM is the discount curve.

The latitudes of these

points (or their vertical distances above the base line, abodm)
represent the values of the same capital-good at different
instants of time; and the longitudes or horizontal distances
between them represent the intervals of time between those
$
1.50

J.I.O

J
oo

190o on 'oz 'os 'o'; 'os 'o6 oz 'o6 'os 'io
FIG. 4.

instants. Thus, let the point a represent the present
instant, say the beginning of the year 1900, and let the
longitude interval, ab, represent a year, say from the be
ginning of 1900 to the beginning of 1901. Using equal
intervals for successive years, we have a A representing any
capital-value at the beginning of the year 1900, say $1, bb
representing its equivalent next year, say $1.04, c0, the
equivalent two years hence, and so on. We see that be is
what we have called the “amount,” $1.04, of a A put out
at interest for one year, and cc is the “amount” of the same

II 2

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

compounded for two years. Conversely a A represents the
present value in 1900, or discounted value, of any one lati
tude on the curve, such as b13, as well as of any other, such
as cC or d D. The latitude of any point on the curve may
thus be regarded as the “amount" of the sum represented
by any preceding latitude or as the “present value” of the
sum represented by any succeeding latitude. Thus, if the
total breadth of the diagram am represents ten years, we
may either say that mM is the amount, at the end of the

ten years, of the present sum a A, or that a A is the “present
value" of the future sum, mM, discounted for ten years.
The line AM not only ascends, but at an accelerating rate
– i.e., it does not ascend in a straight line, but gradually
bends upward, being continually steeper toward the right.
The slope of the curve is due to the rate of interest, and
the greater the interest in any given period of time, the
more steeply will the curve slope. This curve, if prolonged
to the left to show what the “present value" was prior to
the time a, will, of course, never reach the bottom line.

keeps becoming flatter and flatter, so that its distance
above the line can never become zero.

If there were no rate of interest or if the rate of interest

were zero, the curve would not slope at all, but would be
a horizontal line.

§ 4. Application to Waluing Instruments and Property

The principles which have been explained for obtaining
the present value of a single future sum apply to many com
mercial transactions, such as to the valuation of bank assets,

which exist largely in the form of “discount paper,” or short
time loans of other kinds.

The value of such a note is al

ways the discounted value of the future payment to which it
entitles the holder. Similarly, the value of any article of
wealth, reckoned when that wealth is in course of construc
tion, is the present value of what it will bring when com

Sec. 4)

II3

CAPITALIZING INCOME

pleted (less the present value of the cost of completion).
For instance, the maker of an automobile will, at any of its
stages in the course of construction, appraise it as worth the
discounted value of the price expected for it when finished

and sold, less the discounted value of the costs of construction
and selling which still remain. Thus, if an automobile is to
be sold for $5000 and requires a year before this sum will be
realized, while it will cost to complete a sale $2000, which
sum for simplicity, we also assume is payable at the end of
the year, the present value of the automobile will be the
present value of $5000 minus $2000, which, at four per
cent, will be ($5000 – $2000) + 1.04, or $2884.62. The
element of risk should not, of course, be overlooked; but

its consideration does not belong here.
Another application of these principles of capitalization
is to goods in transit. A cargo leaving Sydney for Liverpool
is worth the discounted value of what it will bring in Liver
pool, less the discounted value of the cost of carrying it
there. Another good example is a young forest, which is
worth the discounted value of the lumber it will ultimately
form.

Ordinarily, however, we have to deal, not with one future
sum, but with a series of future sums.

A man who buys a

bond or a share of stock is really buying the right to a series
of future items of income.

But we can treat a series of items

of income by discount curves in exactly the same way that
we can treat one such item.

For instance, let us consider a $10o “five per cent” ten
year bond. Such a bond is simply a promise to pay $5
each year for ten years and at the end of these ten years

to pay in addition the “principal’’ sum of $100.

The

problem is to discover the present value of the bond. This
is evidently the discounted value of the eleven sums which

the owner will receive from the bond; in other words, the
discounted value of the “principal,” due ten years hence,
together with the discounted values of the ten separate in
I

II4

ELEMENTARY PRINCIPLES OF ECONOMICS

[CHAP. VI

terest payments due respectively one year, two years, three
years, etc., up to and including ten years from date. As
we have just seen how to get the discounted value of any
one of these sums, it is simply a question of arithmetic to
calculate them all and then add them together. Before
we can perform the calculations, however, we must know
what rate of interest to use.

The mere fact that the bond

is called a “five per cent” bond does not mean that those
who buy the bond will calculate its present value to them
by discounting its benefits at five per cent. The five per
cent named in the bond is called the nominal rate of in

terest. It may or may not be the same as the rate of
interest used by investors in ascertaining the present value
of the bond.

This latter rate is called the rate “realized.”

If the rate realized happens to be the same as the nomi
nal rate of interest, i.e., that named in bond, the present
value of the bond will be par, or $100. This can be shown
in various ways, as by calculating separately all the eleven
different sums to which the bond entitles the owner; namely,
the ten interest payments of $5 each and the final principal
of $100. Such a calculation shows that the present value of
the first interest payment of $5 (namely, that due one year
hence) is $5 + 1.05, or $4.76; that the present value of the
second interest payment of $5 is $5+ (1.05)”, or $4.55;
that the present value of the third interest payment is
$5 + (1.05)”, or $4.32; that the present value of the fourth

interest payment is $5 + (1.05)*, or $4.11; and so on up
to the tenth, the present value of which would be $5 +
(1.05)" or $3.07. To this series must be added the present
value of the principal, which, being discounted for ten years,

is $100 + (1.05)", or $61.39. The sum of all these will be
$4.76 + $4.55 + $4.32 + $4.11 + $3.92 + $3.73 + $3.55 +
$3.38 + $3.22 + $3.07 -- $61.39 = $100, which is the present
value of the bond.

Another method of getting the same result is, beginning
our calculation at the time when the bond falls due in the

SEc. 4)

CAPITALIZING INCOME

II5

future, to proceed backwards, discounting year by year. It
is evident that just before the payment of the bond it will
be worth $105; for at that time there is immediately due
$5 of interest and $100 of principal. Any time earlier in
the ninth year, the value of the bond will evidently be
the discounted value of this $100 and this $5, the discount
being for whatever portion of the year may be involved.
Just after the ninth interest payment, and just one year be
fore the date when the $105 are due, the value of the bond
will evidently be found by discounting $105 for one year at
five per cent. This gives $105 + 1.05, or $100. In other
words, the value of the bond at the end of nine years, just
after the ninth interest payment, will be par, or $100. The
instant preceding, namely, just before the ninth interest
payment, the value of the bond will be more by the amount
of interest payment, $5. That is, the value of the bond will
be $105 just before the ninth interest payment and $10o just
after. This sudden drop of $5 is due to the abstraction of the

$5 of interest. For this reason, care is always taken by
brokers at or near the time of interest payments to specify
whether the bond is to be sold with the interest payment
or without it, the higher price being paid if the bond is
bought before the interest has been abstracted.

Thus, the instant before the ninth payment of interest
the bond is worth $105, just as was the case the instant before
the tenth and last payment. By the same reasoning, there
fore, its value one year earlier, just after the eighth interest
payment, will be $100 and just before, $105. In this manner
we may proceed year by year back to the present, finding
that the value of the bond will be $100 just after any interest
payment and $105 just before. Its value will therefore be
$1oo just after the first interest payment, which occurs one

year hence, and $105 just before that payment. The value
of this $105 at the present instant will therefore be $100.
Reviewing these figures in the reverse order, we see that
the value of the bond begins at $100, ascends to $105 one

ELEMENTARY PRINCIPLES OF ECONOMICS

II6

(CHAP. VI

year from date, then drops suddenly to $100, ascends during
the next year to $105, and then drops, and so on, ascending
and dropping, as it were, by a series of teeth until the whole
ten years have elapsed, when the value reaches its last
height of $105 and then disappears altogether. In these
oscillations, the gradual rise of $5 each year is evidently the

accrued, while the sudden fall of $5 at the end of each
\interest
year is the income taken out.
It is appropriate, here, to remind the student, that the
entire height from the base line to any point in this tooth

too

FIG. 5.

like curve— whether at highest or lowest or anywhere
between — represents the value of the capital at the cor
responding instant of time. This should be constantly
borne in mind.

The life history of such a bond can best be seen by the aid

SEc. 4)

CAPITALIZING INCOME

117

of Figure 5. The ten small, dark lines marked “5” stand
ing on the base line MA (or the equivalents of these above
the par line) and the long, dark line A B represent the eleven
sums to which the bondholder is entitled; in other words,

the small, dark lines representing the interest payments
in the ten successive years, and AB, the principal, $100,
due at the end of the ten years. The problem is: Given
these eleven sums to which the bondholder is entitled, to
show in the diagram the value of the bond at different dates.
Assuming as before that the rate of interest used in comput
ing is 5 per cent, we obtain the results seen in Figure 5.
We observe that the value of the bond, just before it be
comes due, is the sum of Aa (or BC, $5 of interest), and
A B (the $100 of principal). This sum is represented by
the vertical line AC. One year earlier, just after the ninth

interest payment A'a' (or B'C'), the value of the bond is A'B',
or $100, being the discounted value of AC obtained by draw

ing the discount curve CB'. The value just before the ninth
interest payment will be A'C', or $105. Continuing in this
manner backward, we obtain the series of “teeth,” as in

dicated in the diagram.
If the various discount curves in Figure 5 are all continued
to the left (as in Fig. 6), they will divide the line MN, rep
resenting the present value ($100) of the bond, into the
eleven parts of which it is composed, each part representing
the present value of one of the eleven payments to which
the bond entitles the owner. Thus the present value of
the principal is seen to be $61.39, this being the height
above M at which the lowest discount curve meets MN;

the present value of the last or tenth interest payment

is $3.07, this being the difference in height between the
two lowest discount curves; the present value of the
ninth interest payment is $3.22, as indicated in the next
space above. Similarly, the present value of each of the
other future payments is indicated in the diagram. The
parts into which MN is divided thus form a picture

II8

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

of the eleven present values calculated earlier in this
section.

As we pass from left to right in the diagram, we see that
the value of the bond at the beginning of each year is
$1oo, made up of the discounted values of all the remain
ing future receipts; and that the value increases each year
along a discount curve to $105 at the end of the year, im

FIG. 6.

mediately before the annual payment is made. The value
then drops again to $100, when this annual income is
received. It thus continues to oscillate (just as in Figure
5) between $100 and $105 each year to the end, when the
final income of $105 is received.
But often the bond is not sold at par because the rate of
interest used by the purchaser in calculating what he is

Sec. 4)

CAPITALIZING INCOME

II9

willing to pay for it may be more or less than the five per
cent named in the bond; in other words, the rate realized

by the purchaser may be more or less than the nominal
rate. When a bond is sold above par, this fact shows
that the rate of interest realized by the investor is less

than five per cent. In this case the bond is only nom
inally a “five per cent bond.” If the rate used in calcu
lating the value of the bond is four per cent, that value
IOB.17
Poir

vite}oo

FIG. 7.

will be found to be $108.17; so that if the bond is sold at
$108.17, the purchaser is said to “realize' four per cent.
It will be seen that the rate realized is that market rate

which is actually used for discounting eleven items, namely
the ten annual items of $5 each and the final item of $100.

I2O

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

The value of the bond, $108.17, is found in the way already
explained and is illustrated by the discount curves in Fig
ure 7. Expressed arithmetically the calculation consists in
adding together the following: the present value of the first
payment of $5 (namely that due one year hence) which is
$5 + 1.04, or $4.81, then that of the second which is
$5 + (1.04)” and so on up to and including the present
value of the principal which is $100 + (1.04)". The sum
is $108.17.
Here the five per cent bond is said to be sold on a four
per cent basis. Its capital-value ($108.17), at the begin

ning of the period represented (i.e., the value of a five per
cent bond, valued on a four per cent basis), is obtained
just as before, except that we now reckon by discounting
at four per cent instead of at five per cent. Thus, in Fig
ure 7, we see that the value of the bond, just before it be
comes due, is $105, or AC; that its value one year earlier,

just after the ninth interest payment, is A'B', or $105 +
1.04, or $100.96, and, just before the interest payment, is

A'C', or $100.96 + $5, or $105.96; and so on back to its
value at the beginning, MN, which is thus found to be
$108.17. This is greater by $8.17 than the value of the
bond as reckoned on the five per cent basis. The fact
that four per cent has been used in our calculations instead
of five per cent has made all of the discount curves less
steep.

We see, therefore, that nominally the rate of interest of
the bond is not necessarily the actual rate of interest used in
buying or selling that bond, and if the value of the bond is
calculated on the basis of a rate of interest below the nominal

rate of interest in the bond, the resulting value of the bond
* Of course, the same result could be obtained by discounting separately
at four per cent each of the eleven items to which the bondholder is en
titled and adding the results together. The elements of which MN is
composed may then be easily indicated just as, for the previous example,
in Figure 6.

SEc. 4)

CAPITALIZING INCOME

I2 I

will be above par. Nominally the rate of interest is that
named in the bond and, as previously noted, this is the
actual rate of interest if the bond is worth par, but not
otherwise. The actual rate is always that rate by which
the actual value of the bond is calculated from the pay
ments to which it entitles the holder. Tracing the history
of the capital-value of the ten-year-five-per-cent bond
reckoned at four per cent from the present toward the
future, we may say that the rise in value during each

... Parn...

yº.
92.61 Too

FIG. 8.

year is the interest accrued during the year on the capital
value at the beginning of the year. Thus, the rise in
value during the first year is four per cent of $108.17, or
$4.32, and in the last year is four per cent of $100.96, or
$4.038. It is also clear that the fall in the capital-value at

I22

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

the end of each year (except the last), when the payment
of the nominal interest is made, is exactly $5. That is, the
income taken out each year is greater than the interest
accruing during the year; hence the general decline in the
capital-value of the bond. In the last year the income
taken out is $105; although if the investor is wise, he will
put back at least $100 into Some other bond or equivalent
property.

The reverse is true if the present value of the bond is
calculated on a six per cent basis, or on any other higher
than the five per cent named in the bond.

Figure 8 repre

sents the case of a five per cent bond valued on a six per
cent basis. In this case the discount curves are steeper
than in Figure 5, and the value of the bond at present, ten

years before it becomes due, is $92.61. In Figure 8, as in
the preceding diagrams, we know that the rise of capital
value during any year is always the accruing interest on
the capital-value at the beginning of that year.

Thus, the

rise in the first year will be six per cent of $92.61, that is,
$5.55, and the rise during the last year will be six per cent
of $99.05, namely, $5.95. It is also clear that the drop in
capital-value at the end of each year is, as before, equal to
the income taken out, or $5; that is, the income taken out
each year is less than the interest accrued during the

year; hence the general increase in the capital-value of the
bond.

It will be seen (as shown in the three figures, 5, 7, and 8)
that the final value of the bond just before it becomes due
will be $105 in all three cases, but that the present value is
different in each case; namely, $100, $108.17, and $92.61.
In each case the value zigzags year by year, but approaches
in a general way $105 as its final value. If the “five per
cent ’’ bond is sold on an actual five per cent basis, the
value of the bond is maintained year by year, as seen
in Figure 5, where the curve indicating capital-value runs
in general horizontally; if it is sold on a four per cent basis,

SEC. 4]

CAPITALIZING

I23

INCOME

its value in general decreases, as shown by the descending
trend of the curve in Figure 7; while, if it is sold on a six

per cent basis, it tends to increase in value, as shown by
the general upward trend in Figure 8.
Elaborate tables have been constructed, called “bond

value books,” calculated on the foregoing principles. They
are used by brokers for indicating the true value of bonds on
different bases; that is, the prices a man ought to pay for
bonds, at different rates of interest and having different
times in which to mature, in order to realize on them the
market rate of interest.

These tables are also used for

solving the converse problem, viz., for finding the true rate
of interest “realized” when a bond is bought at a given price.
This rate realized will be the market rate, if the man has

paid the right price, but sometimes he pays a wrong price.
Given the market rate, we can deduce the right price to
pay. Given the actual price paid, we can deduce the
actual rate realized. The following table is an abridg
ment of these brokers’ tables, for a five per cent bond.
The prices of such a bond are in all cases the prices imme
diately after an installment of interest has been received.
In all cases the gradual increase in capital-value during
any time is equal to the interest accruing during that time,
while the sudden decrease at any time is equal to the value
RATES OF INTEREST
FIVE PER CENT BOND
YEARS to MATURITY
PRICE
r

IO2

3.O

IOI

4.O

4.6
4.8

4.9

IOO

5.o

6. I

5.2

5. I

7.I

5.5

5.3

4.8

I24

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

of the income taken out at that time. The only exceptions
to these statements are when capital-value varies up or down
because of changed opinion as to the chances of future in
come; but we are here assuming that there are no uncer
tainties to be reckoned with.

From this table we see that if the so-called five per cent
bond is sold at $102, and has one year to run, it will

“yield” the investor three per cent; that is, if three per
cent is used in calculating its value, this value will be
$102. Again, if the bond has five years to run and is sold
at $102, it will yield the investor 4.6 per cent; and if ten
years, 4.8 per cent. If the bond is sold at $98 and has
one year to run, it will yield the investor 7.1 per cent; if
ten years, 5.3 per cent. If it is sold at par, it will yield five
per cent, whatever may be the number of years it has to run.
The same principles as have just been applied to valuing
bonds apply also to valuing any other article of property or
wealth.

The student will find it a useful exercise to draw

diagrams for other cases. He may construct a series of
diagrams, the vertical lines representing the successive items
of income expected, and beginning at the last item proceed
backward year by year, by a series of teeth, to obtain the
present value of the capital. The value of the capital must
always befirst traced backward, but, after it has been obtained,
we may retrace our steps.

The zigzag curves which have been indicated for bonds
and which could be constructed for exhibiting the valua
tion of any other property right entitling the owner to
definite sums of money or benefits of definite value at
definite times are visual representations of the fact that

the present value of any future benefit or collection of
benefits gradually rises as the time grows near for their
realization and suddenly falls as the realization occurs.
The rate at which the value thus grows with time (between
benefits-realized) is the rate of interest employed in these
market valuations.

SEC. s]

I25

CAPITALIZING INCOME

§ 5. Effect of Changing the Rate of Interest
From what has been said, it is evident that the value of

any article of capital depends very greatly on the rate of
interest.

If there were no rate of interest, or if, in other

words, the rate of interest were zero, the value of the capital
would be simply the sum of the values of the anticipated
benefits. In the case of the five per cent bond, for instance,
running for ten years, if reckoned on a zero per cent basis, its
value would be simply the sum of the $100 and the ten in
terest payments, amounting to $50, or a total of $150. Since
the rate of interest is always higher than zero, the value
of the bond will always be lower than $150. To change
the rate of interest will always change the value of capital
in the opposite direction. For several generations the
rate of interest has been falling, and consequently the
value of bonds and of capital in general has tended to
rise. Of course, the change in value of capital will be
due also to many other circumstances than the change in
the rate of interest, and, moreover, the effect of the

change in rate of interest will not be the same on all
articles of capital. For instance, the capital, the income
from which is most remotely future, will be most affected.
The following table shows the effect of lowering the rate
|

carrº | Nºr is: º, year || 1: ‘àº'àº."
$1ooo per yr. forever | Infinite $20,000.oo
$1ooo per yr. for 5o
yrs.
$50,000.oo 18,300.oo
Horse
$1oo per yr. for 6 yrs.
6oo.oo
508.oo
Suit of
$20 1st yr.; $10 2d
clothes | yr. . . . . . .
3o.oo
28.oo
Loaf of
$36.5o per yr., for I
bread
day . . . . .
..IO
. IO

Land
House

$40,000.oo
28,400.oo
55I.OO
29.Oo
. IO

* The figures in this table are worked out by the principle of discount

ing previously explained.

I 26

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VI

of interest from 5 per cent to 2% per cent on five typical
articles, whose incomes have different degrees of remote
IneSS.

If the value of the benefits derivable from these various

articles continues in each case uniform, but the rate of in

terest is suddenly cut down from 5 per cent to 2% per cent,
there will result a general increase in the capital-values, but
a very different increase for different articles. The more
enduring ones will be affected the most. These effects are
seen in the last two columns of the table.

When the rate

of interest is halved, the value of the land will be doubled,
rising from $20,000 to $40,000, but the value of the house

will rise by only about sixty per cent, namely, from $18,300
to $28,400; the value of the horse will rise only ten per

cent, namely, from $508 to $551; the value of the suit will
rise only from $28 to $29; and, finally, the value of the
loaf of bread will not rise at all, but will remain at Io cents.

We see from the changes in the values of these five types of
articles that the sensitiveness of capital-value to a change
in the rate of interest is the greater, the more remote the
income. A high rate of interest requires a high premium
on income near at hand as compared with income remotely
future; or, expressed the other way about, a high rate of
interest diminishes the attractiveness of remotely future
income as compared with income close at hand.

CHAPTER VII
VARIATIONS OF INCOME IN RELATION TO CAPITAL

§ 1. Interest Accrued and Income Taken Out
WE have seen how the value of capital is derived from that
of income. We have also seen that the value of capital
rises in anticipation of income and falls after its realization.
The alternate rise and fall may or may not be equal. From
the principles explained it is evident that the rise of the capi
tal-value as it ascends on the discount curve is equal to the
interest accrued on that capital during that time, while the
fall in that capital value due to the taking out of income
is equal to the income taken out. If the income taken out
is just equal to the interest, the capital is thereby restored
to its original value. If more than this amount of income
be taken out, the capital-value will be impaired, that is, made
less than it was at the beginning of the period under considera
tion; if less, the capital-value will increase.
When a man is said to own a capital fund of $10oo, this
means simply that he owns capital-goods worth that much;
and these capital goods are worth that much simply be
cause, in terms of money, the discounted value of the
expected income from them is that much.

The income

which he expects may be a perpetual income flowing uni
formly or in recurring cycles; or it may be an income like
that from the bond, flowing recurrently for a limited time,
at the end of which a large lump sum, ordinarily called the

“principal,” is returned in addition; or it may be any one
of innumerable other forms.

Thus if we assume that five
127

I28

ELEMENTARY PRINCIPLES OF ECONOMICS (CHAP. VII

per cent is the rate of interest used in calculating the capital
value, then any one of the following investments will have
a present value of $10oo: a perpetual annuity of $50 per
year; or an annuity of $50 a year for ten years, together
with $10oo at the end of that period; or $100 a year for
fourteen years, after which nothing at all; or $25 a year
for ten years, followed by $167.50 a year for ten years, after
which nothing at all; or any one of innumerable other
forms. The student can easily prove that any one of these
series of incomes, when discounted at five per cent, will
make up a present value of $10oo.
In the first case the income taken out ($50 a year) is
exactly equal to the annual accrued interest, for $50 is the
interest for one year at five per cent on $10oo. The same
is true of the second instance mentioned, that of the five

per cent bond, except in the last year when the income
taken out ($1050) exceeds the interest for the year by
$1ooo, thereby reducing the value of the bond to zero.
In the third case the income taken out the first year

is $100, while the interest accrued in that year is only $50.
Thus the income taken out exceeds the accrued interest by
$50. This excess of $50 involves a reduction of $50 in the
capital-value of the property, which therefore becomes $950
instead of $10oo. Thus, at the end of the first year and
after the $100 of income has been taken out, $950 is the
discounted value of the remaining thirteen items of $100 a

year for each year. In the second year the interest (on
$950) is $47.50; whereas the income taken out is $100, the
difference being $52.50. Hence, at the end of the second
year, the capital-value of the remaining payments has been
reduced by $52.5o, becoming $897.50. Similarly, the capi
tal-value of the property decreases each year by the excess
of the income over the accrued interest until the last in

come item of $100 is received; after which, no more income

being anticipated, the capital-value is zero.
In the fourth case, the interest accruing during the first

SEc. 2)

VARLATIONS OF INCOME

I29

year is $50, whereas only $25 income is taken out at the
end of the year, the difference being $25. Hence, at the
beginning of the second year the capital-value of the bond
goes up to $1025. During the second year, the interest (on
$1025) is $51.25. After the receipt of the second income
item of $25, therefore, the capital-value of the bond is in
creased by the difference ($26.25) and becomes $1051.25.
Similarly, the value of the bond increases until after the
payment of the tenth income item of $25, when it becomes
$1314.43. The interest on this amount in the eleventh
year is $65.72; whereas the income taken out that year,
and each of the remaining nine years, is $167.50. Hence,
from the beginning of the eleventh year to the end of the
twentieth, the capital-value of the bond decreases, finally
reaching zero at the end of the period.
The principle here shown may be summarized as follows:
(1) When a property yields a specified foreknown income,
and is valued by discounting that income at a specified rate
of interest, if the income taken out is equal to the interest
accrued, the value of the capital will be restored each year
to the level of the year before. (2) If the income taken out
exceeds the interest accrued, the value of the capital will fall

below that of the year before, the amount of the fall being
equal to the amount of the excess. (3) If the amount of in
come taken out is less than the interest accrued, the value of

the capital will rise above that of the year before, the amount
the rise being equal to the amount of the deficiency.
Briefly, the general principle connecting income taken out
and interest accrued is that they differ by the net apprecia
tion or depreciation of capital.

It is thus possible to describe

interest accrued as income taken out less depreciation of cap
ital, or as income taken out plus appreciation of capital.
§ 2. Illustrations
In order that these important relations may be as clear
and vivid as possible, we shall illustrate them by concrete
K

I3o

ELEMENTARY PRINCIPLES OF ECONOMICS

(CHAP. VII

examples, and by business accounting. The following table
gives the income supposed to be taken out for five selected

kinds of capital-wealth; the capital-value found by dis
counting that income at five per cent; the accrued interest .
for the first year; the resulting change or net appreciation
or depreciation of capital-value; and the ratio of the first

year's income to the original capital-value.
The student will readily understand how the figures in
the successive columns are calculated although the actual
calculation of the third column (capital-value) from the
second (income) is a tedious process involving in most
cases the discounting of a large number of separate items.

CAPITAL-

Income TAKEN out

WEALTH

PER YEAR

Cº(I

NT. At 5%)

INCREASE
INTEREST | (+) or DEAccRUED | CREASE (–)
For FIRST
of CAPITAL
YEAR
VALUE. In
FIRST YEAR
r

RATIo of
FIRST
r

tºo
ORIGINAL
CAPITAL
r

value

Forest land $1ooo a yr. for
I4 yrs. and

then $3000 a

yr. forever . $40,000.ool $2000.ool--$1ooo.o.o. 2.5
Farm land $1ooo per yr.
forever . . . 20,000.ool Iooo.oo
o.OO
5.o
House
$1ooo per yr.
for 50 yrs. . 18,300.ool 915.ool
-85.oo
5.4
Horse
$1oo per yr. for
6 yrs.
. .
508.oo
25.40
–74.60. 19.6
Suit of
$20 1st yr.; $10
clothes
2d yr. . .
28.oo
I.4O
– 18.60 71.4

1. The forest land yields $1ooo worth of income the first
year on a capital-value of $40,000, from which, on the five
per cent basis assumed, the interest accrued would be five
per cent of $40,000, or $2000. Consequently, the income
taken out ($1ooo) is less than the interest accrued ($2000)
by $10oo. Therefore the forest will appreciate in the year
by the excess, $2000 – $10oo, or $10oo, and will be worth
$41,000 at the end of the year. Similarly, it will continue

Sec. 2)

VARIATIONS OF INCOME

I31

to appreciate for fourteen years, when it will be worth
$60,000; after which the income that is annually taken out
($3000) will be equal to the annual accrued interest on
$60,000.

2. The farm land yielding $10oo a year in perpetuity
is, on the five per cent basis, worth $20,000, and continues to
be worth that amount each succeeding year. The income
taken out ($10oo) is always equal to the interest accrued
from $20,000.

3. The house yields an income of $10oo on a capital
value the first year of only $18,300. The interest accrued on
$18,300 would be five per cent of $18,300, or only $915. The
consequence is an excess of income taken out over interest
accrued of $10oo — $915, or $85, and a corresponding fall
of $85 in the value of the capital. That is, the house depreci
ates by $85 in the year, or from $18,300 to $18,215. It will
continue to depreciate each year until its value vanishes
entirely at the end of fifty years.
4. The horse also depreciates, and very fast. It