Keywords

JEL Classifications

Real cost doctrine is the doctrine that the supply price of a good is the price required to overcome the disutility involved in producing it. The worker, in other words, produces output up to the point at which his (decreasing) marginal utility of income equals his (increasing) marginal disutility of labour. The real cost doctrine can be seen as a half-way house inhabited by economists who had adopted a subjective theory of value but stopped short of the ‘alternative cost’ doctrine whereby the supply price of a resource is equal to its potential earning in its next most productive use. Much of the discussion which took place between English and Austrian economists concerned whether, and to what extent, the two doctrines logically came to the same thing.

Jevons (1871) formulated the real cost doctrine in terms of the diagram in Fig. 1. Jevons assumes here (no such assumption is strictly necessary) that the worker at the start of the day not only enjoys his work but that, for a while, his enjoyment increases as he warms up to it. But, as the hours pass, the fatigue and boredom come to predominate over pleasure at an ever-increasing rate. The worker will maximize his surplus of utility over disutility by stopping at point X (ab = bc.)

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Real Cost Doctrine, Fig. 1

The idea that subjective disutility of labour is central in determining output and price is, perhaps, Jevons’s most unquestionably original idea. Not only is it absent from the work of Walras and Menger, but its prefigurations in the classical period are rare and rudimentary when compared with the pre-1871 analyses of marginal utility theory. (Jennings 1855, points out that marginal disutility of labour increases as the working day progresses but fails to build anything upon it.)

Marshall’s theory of price determination, unveiled in his Principles of Economics (1890), differs little from Jevons’s. Yet what looked radical in Jevons appears almost backward-looking in Marshall. This has something to do with the extension and dissemination of neoclassical principles in the intervening 20 years. But it also stems from a difference of presentation grounded in the contrast between Jevons’s impatience with and Marshall’s deference towards the Ricardian tradition. Much of Marshall’s frequent praise for the English classical economists deftly sidesteps the question of how far they had actually been right. In the Principles, however, not only are cost and utility considerations given equal importance when determining price, but the fact that Marshall’s conception of cost is ultimately a Jevonian ‘subjective disutility’ one is played down. It receives the strongest emphasis when Marshall argues that the capitalist as well as the worker undergoes real costs in the productive process, the capitalist’s cost being that of ‘waiting’ rather than consuming his wealth immediately. (Nassau Senior had invoked Marx’s sarcasm by speaking of capitalist ‘abstinence’ in the same context: Marshall tried both to circumvent the ridicule by renaming abstinence ‘waiting’ and to defend Senior from a neoclassical perspective, pointing out that at the margin of aggregate saving, considerable immediate sacrifice was undoubtedly involved.)

The rival doctrine, that of alternative cost, was espoused principally by the Austrians Wieser and Böhm-Bawerk and advertised in Britain by Wicksteed. All three denied the existence of any such thing as a supply curve, ‘supply’ simply being reverse demand. Böhm-Bawerk cited a horse fair: the buyer’s utility from acquiring a horse and the seller’s utility from keeping his horse played not just an equal but an identical role in determining price. Hence only a demand curve need be drawn; at the equilibrium price, it crosses the vertical line representing the fixed stock of horses. Both Marshallian and Austrian analysis predict the same price.

But, of course, the fixed stock of horses makes this a very simple case: we are ignoring the cost of producing them. Such considerations, however, were no problem to the Austrians, who proclaimed that the costs of factors of production and raw materials ultimately depended on utilities from alternative uses forgone. Thus, as regards the labour market, the wage in a particular industry was governed by the demand for labour in other industries. Each worker had to be paid enough to keep him out of his next best paid available job. The Jevonian notion of disutility of labour dropped out of the picture, Böhm-Bawerk (1894) arguing against it on the empirical ground that few workers had the chance to make fine adjustments to the length of their working day. To this Edgeworth retorted that the Austrian doctrine implied that individuals made the choice to work or not to work once and for all at the beginning of their careers – it could not handle variations in labour supply due to variations in the wage rate.

The debate as a whole thus seemed to imply that the choice between real cost and alternative cost depended on whether flexible labour supply at the individual level (assumed by Jevons) or inflexible labour supply at the aggregate level (implied by the Austrians) was the more objectionable violation of reality. Yet logically the two theories come to exactly the same thing, and are seen to do so as long as the two ‘sides’ make one clarification apiece.

Austrians must make it clear that ‘forgone utility’ includes not only forgone income but also forgone leisure (when you work at all) and forgone non-pecuniary benefits (when you choose a less pleasant but better-paid job in preference to a more pleasant but worse-paid one). Böhm-Bawerk (1894) did spell this out.

Real cost theorists must make it clear that when a baker ponders whether to work another hour, what matters is not the disutility of the work as compared with doing nothing, but the disutility of work as compared with what he would choose to do (it might still be nothing!) if he were not baking. Equally it is not the ‘gross’ marginal utility of income which matters but the marginal utility of the additional income gained from spending another hour at the bakery rather than doing something else (other paid work, some leisure activity, or nothing). Edgeworth (1894) failed to spell this out; had he done so, a number of economists might have realized sooner than they actually did that both theories ultimately come to the same thing. (See Hobson 1926, for an example of confusion persisting well into the 20th century.)

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