THEORYOFEMPLOYMENT

thirddayasonthesecond，andsoon，eventhoughtherebenofurtherchangeinexpectations。Inthecaseofshort-termexpectationsthisisbecausechangesinexpectationarenot，asarule，sufficientlyviolentorrapid，whentheyarefortheworse，tocausetheabandonmentofworkonalltheproductiveprocesseswhich，inthelightoftherevisedexpectation，itwasamistaketohavebegun；whilst，whentheyareforthebetter，sometimeforpreparationmustneedselapsebeforeemploymentcanreachthelevelatwhichitwouldhavestoodifthestateofexpectationhadbeenrevisedsooner。Inthecaseoflong-termexpectations，equipmentwhichwillnotbereplacedwillcontinuetogiveemploymentuntilitiswornout；whilstwhenthechangeinlong-termexpectationsisforthebetter，employmentmaybeatahigherlevelatfirst，thanitwillbeaftertherehasbeentimetoadjusttheequipmenttothenewsituation。

Ifwesupposeastateofexpectationtocontinueforasufficientlengthoftimefortheeffectonemploymenttohaveworkeditselfoutsocompletelythatthereis，broadlyspeaking，nopieceofemploymentgoingonwhichwouldnothavetakenplaceifthenewstateofexpectationhadalwaysexisted，thesteadylevelofemploymentthusattainedmaybecalledthelong-periodemployment[46]correspondingtothatstateofexpectation。Itfollowsthat，althoughexpectationmaychangesofrequentlythattheactuallevelofemploymenthasneverhadtimetoreachthelong-periodemploymentcorrespondingtotheexistingstateofexpectation，neverthelesseverystateofexpectationhasitsdefinitecorrespondingleveloflong-periodemployment。

Letusconsider，firstofall，theprocessoftransition[Page49]EXPECTATION

ANDEMPLOYMENT

toalong-periodpositionduetoachangeinexpectation，whichisnotconfusedorinterruptedbyanyfurtherchangeinexpectation。Wewillfirstsupposethatthechangeisofsuchacharacterthatthenewlong-periodemploymentwillbegreaterthantheold。Now，asarule，itwillonlybetherateofinputwhichwillbemuchaffectedatthebeginning，thatistosay，thevolumeofworkontheearlierstagesofnewprocessesofproduction，whilsttheoutputofconsumption-goodsandtheamountofemploymentonthelaterstagesofprocesseswhichwerestartedbeforethechangewillremainmuchthesameasbefore。Insofarastherewerestocksofpartlyfinishedgoods，thisconclusionmaybemodified；thoughitislikelytoremaintruethattheinitialincreaseinemploymentwillbemodest。As，however，thedayspassby，employmentwillgraduallyincrease。Moreover，itiseasytoconceiveofconditionswhichwillcauseittoincreaseatsomestagetoahigherlevelthanthenewlong-periodemployment。

Fortheprocessofbuildingupcapitaltosatisfythenewstateofexpectationmayleadtomoreemploymentandalsotomorecurrentconsumptionthanwilloccurwhenthelong-periodpositionhasbeenreached。Thusthechangeinexpectationmayleadtoagradualcrescendointhelevelofemployment，risingtoapeakandthendecliningtothenewlong-periodlevel。Thesamethingmayoccurevenifthenewlong-periodlevelisthesameastheold，ifthechangerepresentsachangeinthedirectionofconsumptionwhichrenderscertainexistingprocessesandtheirequipmentobsolete。

Oragain，ifthenewlong-periodemploymentislessthantheold，thelevelofemploymentduringthetransitionmayfallforatimebelowwhatthenewlong-periodlevelisgoingtobe。Thusamerechangeinexpectationiscapableofproducinganoscillationofthesamekindofshapeasacyclicalmovement，inthecourseofworkingitselfout。ItwasmovementsofthiskindwhichIdiscussedinmyTreatiseonMoneyinconnection[Page50]THEGENERAL

THEORYOFEMPLOYMENT

withthebuildinguporthedepletionofstocksofworkingandliquidcapitalconsequentonchange。

Anuninterruptedprocessoftransition，suchastheabove，toanewlong-periodpositioncanbecomplicatedindetail。Buttheactualcourseofeventsismorecomplicatedstill。Forthestateofexpectationisliabletoconstantchange，anewexpectationbeingsuperimposedlongbeforethepreviouschangehasfullyworkeditselfout；sothattheeconomicmachineisoccupiedatanygiventimewithanumberofoverlappingactivities，theexistenceofwhichisduetovariouspaststatesofexpectation。

II

Thisleadsustotherelevanceofthisdiscussionforourpresentpurpose。

Itisevidentfromtheabovethatthelevelofemploymentatanytimedepends，inasense，notmerelyontheexistingstateofexpectationbutonthestatesofexpectationwhichhaveexistedoveracertainpastperiod。Neverthelesspastexpectations，whichhavenotyetworkedthemselvesout，areembodiedintheto-day'scapitalequipmentwithreferencetowhichtheentrepreneurhastomaketo-day'sdecisions，andonlyinfluencehisdecisionsinsofarastheyaresoembodied。Itfollows，therefore，that，inspiteoftheabove，to-day'semploymentcanbecorrectlydescribedasbeinggovernedbyto-day'sexpectationstakeninconjunctionwithto-day'scapitalequipment。

Expressreferencetocurrentlong-termexpectationscanseldombeavoided。

Butitwilloftenbesafetoomitexpressreferencetoshort-termexpectation，inviewofthefactthatinpracticetheprocessofrevisionofshort-termexpectationisagradualandcontinuousone，carriedonlargelyinthelightofrealisedresults；sothatexpectedandrealisedresultsrunintoandoverlaponeanotherintheirinfluence。For，althoughoutputandemploymentaredeterminedby[Page51]EXPECTATION

ANDEMPLOYMENT

theproducer'sshort-termexpectationsandnotbypastresults，themostrecentresultsusuallyplayapredominantpartindeterminingwhattheseexpectationsare。Itwouldbetoocomplicatedtoworkouttheexpectationsdenovowheneveraproductiveprocesswasbeingstarted；anditwould，moreover，beawasteoftimesincealargepartofthecircumstancesusuallycontinuesubstantiallyunchangedfromonedaytothenext。Accordinglyitissensibleforproducerstobasetheirexpectationsontheassumptionthatthemostrecentlyrealisedresultswillcontinue，exceptinsofarastherearedefinitereasonsforexpectingachange。Thusinpracticethereisalargeoverlapbetweentheeffectsonemploymentoftherealisedsale-proceedsofrecentoutputandthoseofthesale-proceedsexpectedfromcurrentinput；andproducers'forecastsaremoreoftengraduallymodifiedinthelightofresultsthaninanticipationofprospectivechanges。[

47]

Nevertheless，wemustnotforgetthat，inthecaseofdurablegoods，theproducer'sshort-termexpectationsarebasedonthecurrentlong-termexpectationsoftheinvestor；anditisofthenatureoflong-termexpectationsthattheycannotbecheckedatshortintervalsinthelightofrealisedresults。Moreover，asweshallseeinchapter12，whereweshallconsiderlong-termexpectationsinmoredetail，theyareliabletosuddenrevision。

Thusthefactorofcurrentlong-termexpectationscannotbeevenapproximatelyeliminatedorreplacedbyrealisedresults。

TheDefinitionofIncome[Page52]

Chapter6

THEDEFINITIONOFINCOME，SAVINGANDINVESTMENT

I。IncomeDuringanyperiodoftimeanentrepreneurwillhavesoldfinishedoutputtoconsumersortootherentrepreneursforacertainsumwhichwewilldesignateasA。Hewillalsohavespentacertainsum，designatedbyA1，onpurchasingfinishedoutputfromotherentrepreneurs。

Andhewillendupwithacapitalequipment，whichtermincludesbothhisstocksofunfinishedgoodsorworkingcapitalandhisstocksoffinishedgoods，havingavalueG。

Somepart，however，ofA+G-A1willbeattributable，nottotheactivitiesoftheperiodinquestion，buttothecapitalequipmentwhichhehadatthebeginningoftheperiod。Wemust，therefore，inordertoarriveatwhatwemeanbytheincomeofthecurrentperiod，deductfromA+G-A1acertainsum，torepresentthatpartofitsvaluewhichhasbeen(insomesense)contributedbytheequipmentinheritedfromthepreviousperiod。Theproblemofdefiningincomeissolvedassoonaswehavefoundasatisfactorymethodforcalculatingthisdeduction。

Therearetwopossibleprinciplesforcalculatingit，eachofwhichhasacertainsignificance；&frac34；oneoftheminconnectionwithproduction，andtheotherinconnectionwithconsumption。

Letusconsidertheminturn。

(i)TheactualvalueGofthecapitalequipmentat[Page53]THEDEFINITION

OFINCOME

theendoftheperiodisthenetresultoftheentrepreneur，ontheonehand，havingmaintainedandimproveditduringtheperiod，bothbypurchasesfromotherentrepreneursandbyworkdoneuponitbyhimself，and，ontheotherhand，havingexhaustedordepreciateditthroughusingittoproduceoutput。Ifhehaddecidednottouseittoproduceoutput，thereis，nevertheless，acertainoptimumsumwhichitwouldhavepaidhimtospendonmaintainingandimprovingit。Letussupposethat，inthisevent，hewouldhavespentB'onitsmaintenanceandimprovement，andthat，havinghadthisspentonit，itwouldhavebeenworthG'attheendoftheperiod。Thatistosay，G'-B'isthemaximumnetvaluewhichmighthavebeenconservedfromthepreviousperiod，ifithadnotbeenusedtoproduceA。TheexcessofthispotentialvalueoftheequipmentoverG-A1isthemeasureofwhathasbeensacrificed(onewayoranother)toproduceA。Letuscallthisquantity，namely(G'-B')-(G-A1)，whichmeasuresthesacrificeofvalueinvolvedintheproductionofA，theusercostofA。UsercostwillbewrittenU。

[48]Theamountpaidoutbytheentrepreneurtotheotherfactorsofproductioninreturnfortheirservices，whichfromtheirpointofviewistheirincome，wewillcallthefactorcostofA。ThesumofthefactorcostFandtheusercostUweshallcalltheprimecostoftheoutputA。

Wecanthendefinetheincome[49]oftheentrepreneurasbeingtheexcessofthevalueofhisfinishedoutputsoldduringtheperiodoverhisprimecost。Theentrepreneur'sincome，thatistosay，istakenasbeingequaltothequantity，dependingonhisscaleofproduction，whichheendeavourstomaximise，i。e。tohisgrossprofit[Page54]THEGENERAL

THEORYOFEMPLOYMENT

intheordinarysenseofthisterm；&frac34；whichagreeswithcommonsense。Hence，sincetheincomeoftherestofthecommunityisequaltotheentrepreneur'sfactorcost，aggregateincomeisequaltoA-U。

Income，thusdefined，isacompletelyunambiguousquantity。Moreover，sinceitistheentrepreneur'sexpectationoftheexcessofthisquantityoverhisoutgoingstotheotherfactorsofproductionwhichheendeavourstomaximisewhenhedecideshowmuchemploymenttogivetotheotherfactorsofproduction，itisthequantitywhichiscausallysignificantforemployment。

Itisconceivable，ofcourse，thatG-A1mayexceedG'-B'，sothatusercostwillbenegative。Forexample，thismaywellbethecaseifwehappentochooseourperiodinsuchawaythatinputhasbeenincreasingduringtheperiodbutwithouttherehavingbeentimefortheincreasedoutputtoreachthestageofbeingfinishedandsold。

Itwillalsobethecase，wheneverthereispositiveinvestment，ifweimagineindustrytobesomuchintegratedthatentrepreneursmakemostoftheirequipmentforthemselves。Since，however，usercostisonlynegativewhentheentrepreneurhasbeenincreasinghiscapitalequipmentbyhisownlabour，wecan，inaneconomywherecapitalequipmentislargelymanufacturedbydifferentfirmsfromthosewhichuseit，normallythinkofusercostasbeingpositive。Moreover，itisdifficulttoconceiveofacasewheremarginalusercostassociatedwithanincreaseinA，i。e。dU/dA，willbeotherthanpositive。

Itmaybeconvenienttomentionhere，inanticipationofthelatterpartofthischapter，that，forthecommunityasawhole，theaggregateconsumption(C)oftheperiodisequaltoS(A-A1)，andtheaggregateinvestment(I)isequaltoS(A1-U)。Moreover，Uistheindividualentrepreneur'sdisinvestment(and-Uhisinvestment)inrespectofhisownequipmentexclusive[Page55]THEDEFINITION

OFINCOME

ofwhathebuysfromotherentrepreneurs。Thusinacompletelyintegratedsystem(whereA1=0)consumptionisequaltoAandinvestmentto-U，i。e。

toG-(G'-B')。Theslightcomplicationoftheabove，throughtheintroductionofA1，issimplyduetothedesirabilityofprovidinginageneralisedwayforthecaseofanon-integratedsystemofproduction。

Furthermore，theeffectivedemandissimplytheaggregateincome(orproceeds)whichtheentrepreneursexpecttoreceive，inclusiveoftheincomeswhichtheywillhandontotheotherfactorsofproduction，fromtheamountofcurrentemploymentwhichtheydecidetogive。Theaggregatedemandfunctionrelatesvarioushypotheticalquantitiesofemploymenttotheproceedswhichtheiroutputsareexpectedtoyield；andtheeffectivedemandisthepointontheaggregatedemandfunctionwhichbecomeseffectivebecause，takeninconjunctionwiththeconditionsofsupply，itcorrespondstothelevelofemploymentwhichmaximisestheentrepreneur'sexpectationofprofit。

Thissetofdefinitionsalsohastheadvantagethatwecanequatethemarginalproceeds(orincome)tothemarginalfactorcost；andthusarriveatthesamesortofpropositionsrelatingmarginalproceedsthusdefinedtomarginalfactorcostsashavebeenstatedbythoseeconomistswho，byignoringusercostorassumingittobezero，haveequatedsupplyprice[50]tomarginalfactorcost。[51]

[Page56]THEGENERAL

THEORYOFEMPLOYMENT

(ii)Weturn，next，tothesecondoftheprinciplesreferredtoabove。

Wehavedealtsofarwiththatpartofthechangeinthevalueofthecapitalequipmentattheendoftheperiodascomparedwithitsvalueatthebeginningwhichisduetothevoluntarydecisionsoftheentrepreneurinseekingtomaximisehisprofit。Buttheremay，inaddition，beaninvoluntaryloss(orgain)inthevalueofhiscapitalequipment，occurringforreasonsbeyondhiscontrolandirrespectiveofhiscurrentdecisions，onaccountof(e。g。)achangeinmarketvalues，wastagebyobsolescenceorthemerepassageoftime，ordestructionbycatastrophesuchaswarorearthquake。Nowsomepartoftheseinvoluntarylosses，whilsttheyareunavoidable，are&frac34；broadlyspeaking&frac34；notunexpected；suchaslossesthroughthelapseoftimeirrespectiveofuse，andalso'normal'obsolescencewhich，asProfessorPigouexpressesit，'issufficientlyregulartobeforeseen，ifnotindetail，atleastinthelarge'，including，wemayadd，thoselossestothecommunityasawholewhicharesufficientlyregulartobecommonlyregardedas'insurablerisks'。

Letusignoreforthemomentthefactthattheamountoftheexpectedlossdependsonwhentheexpectationisassumedtobeframed，andletuscallthedepreciationoftheequipment，whichisinvoluntarybutnotunexpected，i。e。theexcessoftheexpecteddepreciationovertheusercost，thesupplementarycost，whichwillbewrittenV。Itis，perhaps，hardlynecessarytopointoutthatthisdefinitionisnotthesameasMarshall'sdefinitionofsupplementarycost，thoughtheunderlyingidea，namely，ofdealingwiththatpartoftheexpecteddepreciationwhichdoesnotenterintoprimecost，issimilar。

[Page57]THEDEFINITION

OFINCOME

Inreckoning，therefore，thenetincomeandthenetprofitoftheentrepreneuritisusualtodeducttheestimatedamountofthesupplementarycostfromhisincomeandgrossprofitasdefinedabove。Forthepsychologicaleffectontheentrepreneur，whenheisconsideringwhatheisfreetospendandtosave，ofthesupplementarycostisvirtuallythesameasthoughitcameoffhisgrossprofit。Inhiscapacityasaproducerdecidingwhetherornottousetheequipment，primecostandgrossprofit，asdefinedabove，arethesignificantconcepts。Butinhiscapacityasaconsumertheamountofthesupplementarycostworksonhismindinthesamewayasifitwereapartoftheprimecost。Henceweshallnotonlycomenearesttocommonusagebutwillalsoarriveataconceptwhichisrelevanttotheamountofconsumption，if，indefiningaggregatenetincome，wedeductthesupplementarycostaswellastheusercost，sothataggregatenetincomeisequaltoA-U-V。

Thereremainsthechangeinthevalueoftheequipment，duetounforeseenchangesinmarketvalues，exceptionalobsolescenceordestructionbycatastrophe，whichisbothinvoluntaryand&frac34；inabroadsense&frac34；unforeseen。Theactuallossunderthishead，whichwedisregardeveninreckoningnetincomeandchargetocapitalaccount，maybecalledthewindfallloss。

ThecausalsignificanceofnetincomeliesinthepsychologicalinfluenceofthemagnitudeofVontheamountofcurrentconsumption，sincenetincomeiswhatwesupposetheordinarymantoreckonhisavailableincometobewhenheisdecidinghowmuchtospendoncurrentconsumption。Thisisnot，ofcourse，theonlyfactorofwhichhetakesaccountwhenheisdecidinghowmuchtospend。Itmakesaconsiderabledifference，forexample，howmuchwindfallgainorlossheismakingoncapitalaccount。Butthereisadifferencebetweenthesupplementarycostandawindfalllossinthatchangesintheformerareapttoaffect[Page58]THEGENERAL

THEORYOFEMPLOYMENT

himinjustthesamewayaschangesinhisgrossprofit。Itistheexcessoftheproceedsofthecurrentoutputoverthesumoftheprimecostandthesupplementarycostwhichisrelevanttotheentrepreneur'sconsumption；

whereas，althoughthewindfallloss(orgain)entersintohisdecisions，itdoesnotenterintothemonthesamescale&frac34；agivenwindfalllossdoesnothavethesameeffectasanequalsupplementarycost。

Wemustnowrecur，however，tothepointthatthelinebetweensupplementarycostsandwindfalllosses，i。e。betweenthoseunavoidablelosseswhichwethinkitpropertodebittoincomeaccountandthosewhichitisreasonabletoreckonasawindfallloss(orgain)oncapitalaccount，ispartlyaconventionalorpsychologicalone，dependingonwhatarethecommonlyacceptedcriteriaforestimatingtheformer。Fornouniqueprinciplecanbeestablishedfortheestimationofsupplementarycost，anditsamountwilldependonourchoiceofanaccountingmethod。Theexpectedvalueofthesupplementarycost，whentheequipmentwasoriginallyproduced，isadefinitequantity。

Butifitisre-estimatedsubsequently，itsamountovertheremainderofthelifeoftheequipmentmayhavechangedasaresultofachangeinthemeantimeinourexpectations；thewindfallcapitallossbeingthediscountedvalueofthedifferencebetweentheformerandtherevisedexpectationoftheprospectiveseriesofU+V。Itisawidelyapprovedprincipleofbusinessaccounting，endorsedbytheInlandRevenueauthorities，toestablishafigureforthesumofthesupplementarycostandtheusercostwhentheequipmentisacquiredandtomaintainthisunalteredduringthelifeoftheequipment，irrespectiveofsubsequentchangesinexpectation。

Inthiscasethesupplementarycostoveranyperiodmustbetakenastheexcessofthispredeterminedfigureovertheactualusercost。Thishastheadvantageofensuringthatthewindfallgainorlossshallbezerooverthelifeofthe[Page59]THEDEFINITION

OFINCOME

equipmenttakenasawhole。Butitisalsoreasonableincertaincircumstancestorecalculatetheallowanceforsupplementarycostonthebasisofcurrentvaluesandexpectationsatanarbitraryaccountinginterval，e。g。annually。

Businessmeninfactdifferastowhichcoursetheyadopt。Itmaybeconvenienttocalltheinitialexpectationofsupplementarycostwhentheequipmentisfirstacquiredthebasicsupplementarycost，andthesamequantityrecalculateduptodateonthebasisofcurrentvaluesandexpectationsthecurrentsupplementarycost。

Thuswecannotgetclosertoaquantitativedefinitionofsupplementarycostthanthatitcomprisesthosedeductionsfromhisincomewhichatypicalentrepreneurmakesbeforereckoningwhatheconsidershisnetincomeforthepurposeofdeclaringadividend(inthecaseofacorporation)orofdecidingthescaleofhiscurrentconsumption(inthecaseofanindividual)。

Sincewindfallchargesoncapitalaccountarenotgoingtoberuledoutofthepicture，itisclearlybetter，incaseofdoubt，toassignanitemtocapitalaccount，andtoincludeinsupplementarycostonlywhatratherobviouslybelongsthere。Foranyoverloadingoftheformercanbecorrectedbyallowingitmoreinfluenceontherateofcurrentconsumptionthanitwouldotherwisehavehad。

ItwillbeseenthatourdefinitionofnetincomecomesveryclosetoMarshall'sdefinitionofincome，whenhedecidedtotakerefugeinthepracticesoftheIncomeTaxCommissionersand&frac34；broadlyspeakingtoregardasincomewhateverthey，withtheirexperience，choosetotreatassuch。Forthefabricoftheirdecisionscanberegardedastheresultofthemostcarefulandextensiveinvestigationwhichisavailable，tointerpretwhat，inpractice，itisusualtotreatasnetincome。ItalsocorrespondstothemoneyvalueofProfessorPigou'smostrecentdefinitionofthenationaldividend。[52]

[Page60]THEGENERAL

THEORYOFEMPLOYMENT

Itremainstrue，however，thatnetincome，beingbasedonanequivocalcriterionwhichdifferentauthoritiesmightinterpretdifferently，isnotperfectlyclear-cut。ProfessorHayek，forexample，hassuggestedthatanindividualownerofcapitalgoodsmightaimatkeepingtheincomehederivesfromhispossessionsconstant，sothathewouldnotfeelhimselffreetospendhisincomeonconsumptionuntilhehadsetasidesufficienttooffsetanytendencyofhisinvestment-incometodeclineforwhateverreason。[

53]Idoubtifsuchanindividualexists；but，obviously，notheoreticalobjectioncanberaisedagainstthisdeductionasprovidingapossiblepsychologicalcriterionofnetincome。ButwhenProfessorHayekinfersthattheconceptsofsavingandinvestmentsufferfromacorrespondingvagueness，heisonlyrightifhemeansnetsavingandnetinvestment。

Thesavingandtheinvestment，whicharerelevanttothetheoryofemployment，areclearofthisdefect，andarecapableofobjectivedefinition，aswehaveshownabove。

Thusitisamistaketoputalltheemphasisonnetincome，whichisonlyrelevanttodecisionsconcerningconsumption，andis，moreover，onlyseparatedfromvariousotherfactorsaffectingconsumptionbyanarrowline；andtooverlook(ashasbeenusual)theconceptofincomeproper，whichistheconceptrelevanttodecisionsconcerningcurrentproductionandisquiteunambiguous。

Theabovedefinitionsofincomeandofnetincomeareintendedtoconformascloselyaspossibletocommonusage。Itisnecessary，therefore，thatIshouldatonceremindthereaderthatinmyTreatiseonMoneyI

definedincomeinaspecialsense。Thepeculiarityinmyformerdefinitionrelatedtothatpartofaggregateincomewhichaccruestotheentrepreneurs，sinceItookneithertheprofit(whethergrossornet)actuallyrealisedfromtheircurrentoperationsnortheprofitwhichtheyexpectedwhentheydecidedtounder-

[Page61]THEDEFINITION

OFINCOME

taketheircurrentoperations，butinsomesense(not，asInowthink，sufficientlydefinedifweallowforthepossibilityofchangesinthescaleofoutput)anormalorequilibriumprofit；withtheresultthatonthisdefinitionsavingexceededinvestmentbytheamountoftheexcessofnormalprofitovertheactualprofit。Iamafraidthatthisuseoftermshascausedconsiderableconfusion，especiallyinthecaseofthecorrelativeuseofsaving；sinceconclusions(relating，inparticular，totheexcessofsavingoverinvestment)，whichwereonlyvalidifthetermsemployedwereinterpretedinmyspecialsense，havebeenfrequentlyadoptedinpopulardiscussionasthoughthetermswerebeingemployedintheirmorefamiliarsense。Forthisreason，andalsobecauseInolongerrequiremyformertermstoexpressmyideasaccurately，Ihavedecidedtodiscardthem&frac34；withmuchregretfortheconfusionwhichtheyhavecaused。

II。SavingandInvestmentAmidstthewelterofdivergentusagesofterms，itisagreeabletodiscoveronefixedpoint。SofarasIknow，everyoneisagreedthatsavingmeanstheexcessofincomeoverexpenditureonconsumption。Thusanydoubtsaboutthemeaningofsavingmustarisefromdoubtsaboutthemeaningeitherofincomeorofconsumption。Incomewehavedefinedabove。

Expenditureonconsumptionduringanyperiodmustmeanthevalueofgoodssoldtoconsumersduringthatperiod，whichthrowsusbacktothequestionofwhatismeantbyaconsumer-purchaser。Anyreasonabledefinitionofthelinebetweenconsumer-purchasersandinvestor-purchaserswillserveusequallywell，providedthatitisconsistentlyapplied。Suchproblemasthereis，e。g。whetheritisrighttoregardthepurchaseofamotor-carasaconsumer-purchaseandthepurchaseofahouseasaninvestor-purchase，hasbeenfrequentlydiscussedandIhavenothingmaterialtoaddtothediscussion。

[Page62]THEGENERAL

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Thecriterionmustobviouslycorrespondtowherewedrawthelinebetweentheconsumerandtheentrepreneur。ThuswhenwehavedefinedA1asthevalueofwhatoneentrepreneurhaspurchasedfromanother，wehaveimplicitlysettledthequestion。ItfollowsthatexpenditureonconsumptioncanbeunambiguouslydefinedasS(A-A1)，whereAisthetotalsalesmadeduringtheperiodandA1isthetotalsalesmadebyoneentrepreneurtoanother。Inwhatfollowsitwillbeconvenient，asarule，toomitandwriteAfortheaggregatesalesofallkinds，A1fortheaggregatesalesfromoneentrepreneurtoanotherandUfortheaggregateusercostsoftheentrepreneurs。

Havingnowdefinedbothincomeandconsumption，thedefinitionofsaving，whichistheexcessofincomeoverconsumption，naturallyfollows。SinceincomeisequaltoA-UandconsumptionisequaltoA-A1，itfollowsthatsavingisequaltoA1-U。Similarly，wehavenetsavingfortheexcessofnetincomeoverconsumption，equaltoA1-U-V。

Ourdefinitionofincomealsoleadsatoncetothedefinitionofcurrentinvestment。Forwemustmeanbythisthecurrentadditiontothevalueofthecapitalequipmentwhichhasresultedfromtheproductiveactivityoftheperiod。Thisis，clearly，equaltowhatwehavejustdefinedassaving。Foritisthatpartoftheincomeoftheperiodwhichhasnotpassedintoconsumption。WehaveseenabovethatastheresultoftheproductionofanyperiodentrepreneursendupwithhavingsoldfinishedoutputhavingavalueAandwithacapitalequipmentwhichhassufferedadeteriorationmeasuredbyU(oranimprovementmeasuredby-UwhereUisnegative)asaresultofhavingproducedandpartedwithA，afterallowingforpurchasesA1fromotherentrepreneurs。DuringthesameperiodfinishedoutputhavingavalueA-A1willhavepassedintoconsumption。TheexcessofA-UoverA-A1，namelyA1-U，istheadditiontocapital[Page63]THEDEFINITION

OFINCOME

equipmentasaresultoftheproductiveactivitiesoftheperiodandis，therefore，theinvestmentoftheperiod。SimilarlyA1-U-V；

whichisthenetadditiontocapitalequipment，afterallowingfornormalimpairmentinthevalueofcapitalapartfromitsbeingusedandapartfromwindfallchangesinthevalueoftheequipmentchargeabletocapitalaccount，isthenetinvestmentoftheperiod。

Whilst，therefore，theamountofsavingisanoutcomeofthecollectivebehaviourofindividualconsumersandtheamountofinvestmentofthecollectivebehaviourofindividualentrepreneurs，thesetwoamountsarenecessarilyequal，sinceeachofthemisequaltotheexcessofincomeoverconsumption。

Moreover，thisconclusioninnowaydependsonanysubtletiesorpeculiaritiesinthedefinitionofincomegivenabove。Provideditisagreedthatincomeisequaltothevalueofcurrentoutput，thatcurrentinvestmentisequaltothevalueofthatpartofcurrentoutputwhichisnotconsumed，andthatsavingisequaltotheexcessofincomeoverconsumption&frac34；allofwhichisconformablebothtocommonsenseandtothetraditionalusageofthegreatmajorityofeconomists&frac34；theequalityofsavingandinvestmentnecessarilyfollows。Inshort-Income=valueofoutput=consumption+investment。Saving=income-consumption。Thereforesaving=investment。Thusanysetofdefinitionswhichsatisfytheaboveconditionsleadstothesameconclusion。Itisonlybydenyingthevalidityofoneorotherofthemthattheconclusioncanbeavoided。

Theequivalencebetweenthequantityofsavingandthequantityofinvestmentemergesfromthebilateralcharacterofthetransactionsbetweentheproducerontheonehandand，ontheotherhand，theconsumerorthepurchaserofcapitalequipment。

[Page64]THEGENERAL

THEORYOFEMPLOYMENT

Incomeiscreatedbythevalueinexcessofusercostwhichtheproducerobtainsfortheoutputhehassold；butthewholeofthisoutputmustobviouslyhavebeensoldeithertoaconsumerortoanotherentrepreneur；andeachentrepreneur'scurrentinvestmentisequaltotheexcessoftheequipmentwhichhehaspurchasedfromotherentrepreneursoverhisownusercost。

Hence，intheaggregatetheexcessofincomeoverconsumption，whichwecallsaving，cannotdifferfromtheadditiontocapitalequipmentwhichwecallinvestment。Andsimilarlywithnetsavingandnetinvestment。Saving，infact，isamereresidual。Thedecisionstoconsumeandthedecisionstoinvestbetweenthemdetermineincomes。Assumingthatthedecisionstoinvestbecomeeffective，theymustindoingsoeithercurtailconsumptionorexpandincome。Thustheactofinvestmentinitselfcannothelpcausingtheresidualormargin，whichwecallsaving，toincreasebyacorrespondingamount。

Itmightbe，ofcourse，thatindividualsweresot&ecirc；temont&eacute；eintheirdecisionsastohowmuchtheythemselveswouldsaveandinvestrespectively，thattherewouldbenopointofpriceequilibriumatwhichtransactionscouldtakeplace。Inthiscaseourtermswouldceasetobeapplicable，sinceoutputwouldnolongerhaveadefinitemarketvalue，priceswouldfindnoresting-placebetweenzeroandinfinity。Experienceshows，however，thatthis，infact，isnotso；andthattherearehabitsofpsychologicalresponsewhichallowofanequilibriumbeingreachedatwhichthereadinesstobuyisequaltothereadinesstosell。Thatthereshouldbesuchathingasamarketvalueforoutputis，atthesametime，anecessaryconditionformoney-incometopossessadefinitevalueandasufficientconditionfortheaggregateamountwhichsavingindividualsdecidetosavetobeequaltotheaggregateamountwhichinvestingindividualsdecidetoinvest。

Clearnessofmindonthismatterisbestreached，[Page65]THEDEFINITION

OFINCOME

perhaps，bythinkingintermsofdecisionstoconsume(ortorefrainfromconsuming)ratherthanofdecisionstosave。Adecisiontoconsumeornottoconsumetrulylieswithinthepoweroftheindividual；sodoesadecisiontoinvestornottoinvest。Theamountsofaggregateincomeandofaggregatesavingaretheresultsofthefreechoicesofindividualswhetherornottoconsumeandwhetherornottoinvest；buttheyareneitherofthemcapableofassuminganindependentvalueresultingfromaseparatesetofdecisionstakenirrespectiveofthedecisionsconcerningconsumptionandinvestment。Inaccordancewiththisprinciple，theconceptionofthepropensitytoconsumewill，inwhatfollows，taketheplaceofthepropensityordispositiontosave。

AppendixonUserCost[Page66]

AppendixonUserCostI

Usercosthas，Ithink，animportancefortheclassicaltheoryofvaluewhichhasbeenoverlooked。Thereismoretobesaidaboutitthanwouldberelevantorappropriateinthisplace。But，asadigression，wewillexamineitsomewhatfurtherinthisappendix。

Anentrepreneur'susercostisbydefinitionequaltoA1+(G'-B')-G，whereA1istheamountofourentrepreneur'spurchasesfromotherentrepreneurs，Gtheactualvalueofhiscapitalequipmentattheendoftheperiod，andG'thevalueitmighthavehadattheendoftheperiodifhehadrefrainedfromusingitandhadspenttheoptimumsumB'onitsmaintenanceandimprovement。NowG-(G'-B')，namelytheincrementinthevalueoftheentrepreneur'sequipmentbeyondthenetvaluewhichhehasinheritedfromthepreviousperiod，representstheentrepreneur'scurrentinvestmentinhisequipmentandcanbewrittenI。ThusU，theusercostofhissales-turnoverA，isequaltoA1-IwhereA1iswhathehasboughtfromotherentrepreneursandIiswhathehascurrentlyinvestedinhisownequipment。A

littlereflectionwillshowthatallthisisnomorethancommonsense。

Somepartofhisoutgoingstootherentrepreneursisbalancedbythevalueofhiscurrentinvestmentinhisownequipment，andtherestrepresentsthesacrificewhichtheoutputhehassoldmusthavecosthimoverandabovethetotalsumwhichhehaspaidouttothefactorsofproduction。

Ifthereadertriestoexpressthesubstanceofthisotherwise，hewillfindthatitsadvantageliesinitsavoidanceofinsoluble(andunnecessary)

accountingproblems。Thereis，Ithink，nootherwayofanalysingthecurrentproceedsofproductionunambiguously。Ifindustryiscompletelyintegratedoriftheentrepreneurhasboughtnothingfromoutside，sothatA1

=0，the[Page67]APPENDIX

ONUSERCOST

usercostissimplytheequivalentofthecurrentdisinvestmentinvolvedinusingtheequipment；butwearestillleftwiththeadvantagethatwedonotrequireatanystageoftheanalysistoallocatethefactorcostbetweenthegoodswhicharesoldandtheequipmentwhichisretained。Thuswecanregardtheemploymentgivenbyafirm，whetherintegratedorindividual，asdependingonasingleconsolidateddecision&frac34；aprocedurewhichcorrespondstotheactualinterlockingcharacteroftheproductionofwhatiscurrentlysoldwithtotalproduction。

Theconceptofusercostenablesus，moreover，togiveaclearerdefinitionthanthatusuallyadoptedoftheshort-periodsupplypriceofaunitofafirm'ssaleableoutput。Fortheshort-periodsupplypriceisthesumofthemarginalfactorcostandthemarginalusercost。

Nowinthemoderntheoryofvalueithasbeenausualpracticetoequatetheshort-periodsupplypricetothemarginalfactorcostalone。Itisobvious，however，thatthisisonlylegitimateifmarginalusercostiszeroorifsupplypriceisspeciallydefinedsoastobenetofmarginalusercost，justasIhavedefined(p。24above)'proceeds'and'aggregatesupplyprice'asbeingnetofaggregateusercost。But，whereasitmaybeoccasionallyconvenientindealingwithoutputasawholetodeductusercost，thisproceduredeprivesouranalysisofallrealityifitishabitually(andtacitly)appliedtotheoutputofasingleindustryorfirm，sinceitdivorcesthe'supplyprice'ofanarticlefromanyordinarysenseofits'price'；andsomeconfusionmayhaveresultedfromthepracticeofdoingso。Itseemstohavebeenassumedthat'supplyprice'hasanobviousmeaningasappliedtoaunitofthesaleableoutputofanindividualfirm，andthematterhasnotbeendeemedtorequirediscussion。

Yetthetreatmentbothofwhatispurchasedfromotherfirmsandofthewastageofthefirm'sownequipmentasaconsequenceofproducingthemarginaloutputinvolvesthewholepackofperplexitieswhichattendthedefinitionofincome。For，evenifweassumethatthemarginalcostofpurchasesfromotherfirmsinvolvedinsellinganadditionalunitofoutputhastobedeductedfromthesale-proceedsperunitinordertogiveuswhatwemeanbyourfirm'ssupplyprice，westillhavetoallowforthemarginaldisinvestmentinthefirm'sownequipmentinvolvedinproducingthemarginaloutput。

Evenifallproductioniscarriedonbyacompletelyintegratedfirm，itisstillillegitimatetosupposethatthemarginalusercostiszero，i。e。

thatthemarginaldisinvestmentinequipmentduetotheproductionofthemarginaloutputcangenerallybeneglected。

[Page68]THEGENERAL

THEORYOFEMPLOYMENT

Theconceptsofusercostandofsupplementarycostalsoenableustoestablishaclearerrelationshipbetweenlong-periodsupplypriceandshort-periodsupplyprice。Long-periodcostmustobviouslyincludeanamounttocoverthebasicsupplementarycostaswellastheexpectedprimecostappropriatelyaveragedoverthelifeoftheequipment。Thatistosay，thelong-periodcostoftheoutputisequaltotheexpectedsumoftheprimecostandthesupplementarycost；and，furthermore，inordertoyieldanormalprofit，thelong-periodsupplypricemustexceedthelong-periodcostthuscalculatedbyanamountdeterminedbythecurrentrateofinterestonloansofcomparabletermandrisk，reckonedasapercentageofthecostoftheequipment。Orifweprefertotakeastandard'pure'rateofinterest，wemustincludeinthelong-periodcostathirdtermwhichwemightcalltherisk-costtocovertheunknownpossibilitiesoftheactualyielddifferingfromtheexpectedyield。Thusthelong-periodsupplypriceisequaltothesumoftheprimecost，thesupplementarycost，theriskcostandtheinterestcost，intowhichseveralcomponentsitcanbeanalysed。Theshort-periodsupplyprice，ontheotherhand，isequaltothemarginalprimecost。Theentrepreneurmust，therefore，expect，whenhebuysorconstructshisequipment，tocoverhissupplementarycost，hisriskcostandhisinterestcostoutoftheexcessofthemarginalvalueoftheprimecostoveritsaveragevalue；sothatinlong-periodequilibriumtheexcessofthemarginalprimecostovertheaverageprimecostisequaltothesumofthesupplementary，riskandinterestcosts。[54]

Thelevelofoutput，atwhichmarginalprimecostisexactlyequaltothesumoftheaverageprimeandsupplementarycosts，hasaspecialimportance，becauseitisthepointatwhichtheentrepreneur'stradingaccountbreakseven。Itcorresponds，[Page69]APPENDIX

ONUSERCOST

thatistosay，tothepointofzeronetprofit；whilstwithasmalleroutputthanthisheistradingatanetloss。

Theextenttowhichthesupplementarycosthastobeprovidedforapartfromtheprimecostvariesverymuchfromonetypeofequipmenttoanother。

Twoextremecasesarethefollowing:

(i)Somepartofthemaintenanceoftheequipmentmustnecessarilytakeplaceparipassuwiththeactofusingit(e。g。oilingthemachine)。Theexpenseofthis(apartfromoutsidepurchases)isincludedinthefactorcost。If，forphysicalreasons，theexactamountofthewholeofthecurrentdepreciationhasnecessarilytobemadegoodinthisway，theamountoftheusercost(apartfromoutsidepurchases)wouldbeequalandoppositetothatofthesupplementarycost；andinlong-periodequilibriumthemarginalfactorcostwouldexceedtheaveragefactorcostbyanamountequaltotheriskandinterestcost。

(ii)Somepartofthedeteriorationinthevalueoftheequipmentonlyoccursifitisused。Thecostofthisischargedinusercost，insofarasitisnotmadegoodparipassuwiththeactofusingit。

Iflossinthevalueoftheequipmentcouldonlyoccurinthisway，supplementarycostwouldbezero。

Itmaybeworthpointingoutthatanentrepreneurdoesnotusehisoldestandworstequipmentfirst，merelybecauseitsusercostislow；sinceitslowusercostmaybeoutweighedbyitsrelativeinefficiency，i。e。byitshighfactorcost。Thusanentrepreneurusesbypreferencethatpartofhisequipmentforwhichtheusercostplusfactorcostisleastperunitofoutput。[55]Itfollowsthatforanygivenvolumeofoutputoftheproductinquestionthereisacorrespondingusercost，[56]butthatthistotalusercostdoesnotbearauniformrelationtothemarginalusercost，i。e。totheincrementofusercostduetoanincrementintherateofoutput。

II

Usercostconstitutesoneofthelinksbetweenthepresentandthefuture。

Forindecidinghisscaleofproductionan[Page70]THEGENERAL

THEORYOFEMPLOYMENT

entrepreneurhastoexerciseachoicebetweenusinguphisequipmentnowandpreservingittobeusedlateron。Itistheexpectedsacrificeoffuturebenefitinvolvedinpresentusewhichdeterminestheamountoftheusercost，anditisthemarginalamountofthissacrificewhich，togetherwiththemarginalfactorcostandtheexpectationofthemarginalproceeds，determineshisscaleofproduction。How，then，istheusercostofanactofproductioncalculatedbytheentrepreneur？

Wehavedefinedtheusercostasthereductioninthevalueoftheequipmentduetousingitascomparedwithnotusingit，afterallowingforthecostofthemaintenanceandimprovementswhichitwouldbeworthwhiletoundertakeandforpurchasesfromotherentrepreneurs。Itmustbearrivedat，therefore，bycalculatingthediscountedvalueoftheadditionalprospectiveyieldwhichwouldbeobtainedatsomelaterdateifitwerenotusednow。Nowthismustbeatleastequaltothepresentvalueoftheopportunitytopostponereplacementwhichwillresultfromlayinguptheequipment；anditmaybemore。[57]

Ifthereisnosurplusorredundantstock，sothatmoreunitsofsimilarequipmentarebeingnewlyproducedeveryyeareitherasanadditionorinreplacement，itisevidentthatmarginalusercostwillbecalculablebyreferencetotheamountbywhichthelifeorefficiencyoftheequipmentwillbeshortenedifitisused，andthecurrentreplacementcost。If，however，thereisredundantequipment，thentheusercostwillalsodependontherateofinterestandthecurrent(i。e。re-estimated)supplementarycostovertheperiodoftimebeforetheredundancyisexpectedtobeabsorbedthroughwastage，etc。Inthiswayinterestcostandcurrentsupplementarycostenterindirectlyintothecalculationofusercost。

Thecalculationisexhibitedinitssimplestandmostintelligibleformwhenthefactorcostiszero，e。g。inthecaseofaredundantstockofarawmaterialsuchascopper，onthelineswhichIhaveworkedoutinmyTreatiseonMoney，vol。ii。chap。29。Letustaketheprospectivevaluesofcopperatvariousfuturedates，aserieswhichwillbegovernedbytherateatwhichredundancyisbeingabsorbedandgraduallyapproachestheestimatednormalcost。Thepresentvalueorusercostofatonofsurpluscopperwillthenbeequaltothegreatestofthevaluesobtainablebysubtractingfromtheestimatedfuturevalueatany[Page71]APPENDIX

ONUSERCOST

givendateofatonofcoppertheinterestcostandthecurrentsupplementarycostonatonofcopperbetweenthatdateandthepresent。

Inthesamewaytheusercostofashiporfactoryormachine，whentheseequipmentsareinredundantsupply，isitsestimatedreplacementcostdiscountedatthepercentagerateofitsinterestandcurrentsupplementarycoststotheprospectivedateofabsorptionoftheredundancy。

Wehaveassumedabovethattheequipmentwillbereplacedinduecoursebyanidenticalarticle。Iftheequipmentinquestionwillnotberenewedidenticallywhenitiswornout，thenitsusercosthastobecalculatedbytakingaproportionoftheusercostofthenewequipment，whichwillbeerectedtodoitsworkwhenitisdiscarded，givenbyitscomparativeefficiency。

III

Thereadershouldnoticethat，wheretheequipmentisnotobsolescentbutmerelyredundantforthetimebeing，thedifferencebetweentheactualusercostanditsnormalvalue(i。e。thevaluewhenthereisnoredundantequipment)varieswiththeintervaloftimewhichisexpectedtoelapsebeforetheredundancyisabsorbed。Thusifthetypeofequipmentinquestionisofallagesandnot'bunched'，sothatafairproportionisreachingtheendofitslifeannually，themarginalusercostwillnotdeclinegreatlyunlesstheredundancyisexceptionallyexcessive。Inthecaseofageneralslump，marginalusercostwilldependonhowlongentrepreneursexpecttheslumptolast。Thustheriseinthesupplypricewhenaffairsbegintomendmaybepartlyduetoasharpincreaseinmarginalusercostduetoarevisionoftheirexpectations。

Ithassometimesbeenargued，contrarytotheopinionofbusinessmen，thatorganisedschemesforscrappingredundantplantcannothavethedesiredeffectofraisingpricesunlesstheyapplytothewholeoftheredundantplant。Buttheconceptofusercostshowshowthescrappingof(say)halftheredundantplantmayhavetheeffectofraisingpricesimmediately。

Forbybringingthedateoftheabsorptionoftheredundancynearer，thispolicyraisesmarginalusercostandconsequentlyincreasesthecurrentsupplyprice。Thusbusinessmenwouldseemtohavethenotionofusercostimplicitlyinmind，thoughtheydonotformulateitdistinctly。Ifthesupplementarycostisheavy，itfollowsthatthemarginalusercostwillbelowwhenthereissurplusequipment。Moreover，[Page72]THEGENERAL

THEORYOFEMPLOYMENT

whenthereissurplusequipment，themarginalfactorandusercostsareunlikelytobemuchinexcessoftheiraveragevalue。Ifboththeseconditionsarefulfilled，theexistenceofsurplusequipmentislikelytoleadtotheentrepreneur'sworkingatanetloss，andperhapsataheavynetloss。Therewillnotbeasuddentransitionfromthisstateofaffairstoanormalprofit，takingplaceatthemomentwhentheredundancyisabsorbed。

Astheredundancybecomesless，theusercostwillgraduallyincrease；

andtheexcessofmarginaloveraveragefactorandusercostmayalsograduallyincrease。

IV

InMarshall'sPrinciplesofEconomics(6thed。p。360)apartofusercostisincludedinprimecostundertheheadingof'extrawear-and-tearofplant'。Butnoguidanceisgivenastohowthisitemistobecalculatedorastoitsimportance。InhisTheoryofUnemployment(p。42)ProfessorPigouexpresslyassumesthatthemarginaldisinvestmentinequipmentduetothemarginaloutputcan，ingeneral，beneglected:'Thedifferencesinthequantityofwear-and-tearsufferedbyequipmentandinthecostsofnon-manuallabouremployed，thatareassociatedwithdifferencesinoutput，areignored，asbeing，ingeneral，ofsecondaryimportance'。[

58]Indeed，thenotionthatthedisinvestmentinequipmentiszeroatthemarginofproductionrunsthroughagooddealofrecenteconomictheory。

Butthewholeproblemisbroughttoanobviousheadassoonasitisthoughtnecessarytoexplainexactlywhatismeantbythesupplypriceofanindividualfirm。

Itistruethatthecostofmaintenanceofidleplantmayoften，forthereasonsgivenabove，reducethemagnitudeofmarginalusercost，especiallyinaslumpwhichisexpectedtolastalongtime。Neverthelessaverylowusercostatthemarginisnotacharacteristicoftheshortperiodassuch，butofparticularsituationsandtypesofequipmentwherethecostofmaintainingidleplanthappenstobeheavy，andofthosedisequilibriawhicharecharacterisedbyveryrapidobsolescenceorgreatredundancy，especiallyifitiscoupledwithalargeproportionofcomparativelynewplant。

Inthecaseofrawmaterialsthenecessityofallowingforusercostisobvious；&frac34；ifatonofcopperisusedupto-dayitcannotbe[Page73]APPENDIX

ONUSERCOST

usedto-morrow，andthevaluewhichthecopperwouldhaveforthepurposesofto-morrowmustclearlyhereckonedasapartofthemarginalcost。Butthefacthasbeenoverlookedthatcopperisonlyanextremecaseofwhatoccurswhenevercapitalequipmentisusedtoproduce。Theassumptionthatthereisasharpdivisionbetweenrawmaterialswherewemustallowforthedisinvestmentduetousingthemandfixedcapitalwherewecansafelyneglectitdoesnotcorrespondtothefacts；&frac34；especiallyinnormalconditionswhereequipmentisfallingdueforreplacementeveryyearandtheuseofequipmentbringsnearerthedateatwhichreplacementisnecessary。

Itisanadvantageoftheconceptsofusercostandsupplementarycostthattheyareasapplicabletoworkingandliquidcapitalastofixedcapital。

Theessentialdifferencebetweenrawmaterialsandfixedcapitalliesnotintheirliabilitytouserandsupplementarycosts，butinthefactthatthereturntoliquidcapitalconsistsofasingleterm；whereasinthecaseoffixedcapital，whichisdurableandusedupgradually，thereturnconsistsofaseriesofusercostsandprofitsearnedinsuccessiveperiods。

TheMeaningofSavingandInvestment[Page74]

Chapter7

THEMEANINGOFSAVINGANDINVESTMENT

FURTHERCONSIDERED

I

Inthepreviouschaptersavingandinvestmenthavebeensodefinedthattheyarenecessarilyequalinamount，being，forthecommunityasawhole，merelydifferentaspectsofthesamething。Severalcontemporarywriters(includingmyselfinmyTreatiseonMoney)have，however，givenspecialdefinitionsofthesetermsonwhichtheyarenotnecessarilyequal。

Othershavewrittenontheassumptionthattheymaybeunequalwithoutprefacingtheirdiscussionwithanydefinitionsatall。Itwillbeuseful，therefore，withaviewtorelatingtheforegoingtootherdiscussionsoftheseterms，toclassifysomeofthevarioususesofthemwhichappeartobecurrent。

SofarasIknow，everyoneagreesinmeaningbysavingtheexcessofincomeoverwhatisspentonconsumption。Itwouldcertainlybeveryinconvenientandmisleadingnottomeanthis。Noristhereanyimportantdifferenceofopinionastowhatismeantbyexpenditureonconsumption。Thusthedifferencesofusageariseeitheroutofthedefinitionofinvestmentoroutofthatofincome。

II

Letustakeinvestmentfirst。Inpopularusageitiscommontomeanbythisthepurchaseofanasset，old[Page75]THEMEANING

OFSAVINGANDINVESTMENT

ornew，byanindividualoracorporation。Occasionally，thetermmightberestrictedtothepurchaseofanassetontheStockExchange。Butwespeakjustasreadilyofinvesting，forexample，inahouse，orinamachine，orinastockoffinishedorunfinishedgoods；and，broadlyspeaking，newinvestment，asdistinguishedfromreinvestment，meansthepurchaseofacapitalassetofanykindoutofincome。Ifwereckonthesaleofaninvestmentasbeingnegativeinvestment，i。e。disinvestment，myowndefinitionisinaccordancewithpopularusage；sinceexchangesofoldinvestmentsnecessarilycancelout。Wehave，indeed，toadjustforthecreationanddischargeofdebts(includingchangesinthequantityofcreditormoney)；butsinceforthecommunityasawholetheincreaseordecreaseoftheaggregatecreditorpositionisalwaysexactlyequaltotheincreaseordecreaseoftheaggregatedebtorposition，thiscomplicationalsocancelsoutwhenwearedealingwithaggregateinvestment。Thus，assumingthatincomeinthepopularsensecorrespondstomynetincome，aggregateinvestmentinthepopularsensecoincideswithmydefinitionofnetinvestment，namelythenetadditiontoallkindsofcapitalequipment，afterallowingforthosechangesinthevalueoftheoldcapitalequipmentwhicharetakenintoaccountinreckoningnetincome。

Investment，thusdefined，includes，therefore，theincrementofcapitalequipment，whetheritconsistsoffixedcapital，workingcapitalorliquidcapital；andthesignificantdifferencesofdefinition(apartfromthedistinctionbetweeninvestmentandnetinvestment)areduetotheexclusionfrominvestmentofoneormoreofthesecategories。

MrHawtrey，forexample，whoattachesgreatimportancetochangesinliquidcapital，i。e。toundesignedincrements(ordecrements)inthestockofunsoldgoods，hassuggestedapossibledefinitionof[Page76]THEGENERAL

THEORYOFEMPLOYMENT

investmentfromwhichsuchchangesareexcluded。Inthiscaseanexcessofsavingoverinvestmentwouldbethesamethingasanundesignedincrementinthestockofunsoldgoods，i。e。asanincreaseofliquidcapital。MrHawtreyhasnotconvincedmethatthisisthefactortostress；foritlaysalltheemphasisonthecorrectionofchangeswhichwereinthefirstinstanceunforeseen，ascomparedwiththosewhichare，rightlyorwrongly，anticipated。MrHawtreyregardsthedailydecisionsofentrepreneursconcerningtheirscaleofoutputasbeingvariedfromthescaleofthepreviousdaybyreferencetothechangesintheirstockofunsoldgoods。Certainly，inthecaseofconsumptiongoods，thisplaysanimportantpartintheirdecisions。ButIseenoobjectinexcludingtheplayofotherfactorsontheirdecisions；andIprefer，therefore，toemphasisethetotalchangeofeffectivedemandandnotmerelythatpartofthechangeineffectivedemandwhichreflectstheincreaseordecreaseofunsoldstocksinthepreviousperiod。Moreover，inthecaseoffixedcapital，theincreaseordecreaseofunusedcapacitycorrespondstotheincreaseordecreaseinunsoldstocksinitseffectondecisionstoproduce；andIdonotseehowMrHawtrey'smethodcanhandlethisatleastequallyimportantfactor。

Itseemsprobablethatcapitalformationandcapitalconsumption，asusedbytheAustrianschoolofeconomists，arenotidenticaleitherwithinvestmentanddisinvestmentasdefinedaboveorwithnetinvestmentanddisinvestment。Inparticular，capitalconsumptionissaidtooccurincircumstanceswherethereisquiteclearlynonetdecreaseincapitalequipmentasdefinedabove。Ihave，however，beenunabletodiscoverareferencetoanypassagewherethemeaningofthesetermsisclearlyexplained。Thestatement，forexample，thatcapitalformationoccurswhenthereisalengtheningoftheperiodofproductiondoesnotmuchadvancematters。

[Page77]THEMEANING

OFSAVINGANDINVESTMENT

III

Wecomenexttothedivergencesbetweensavingandinvestmentwhichareduetoaspecialdefinitionofincomeandhenceoftheexcessofincomeoverconsumption。MyownuseoftermsinmyTreatiseonMoneyisanexampleofthis。For，asIhaveexplainedonp。60above，thedefinitionofincome，whichIthereemployed，differedfrommypresentdefinitionbyreckoningastheincomeofentrepreneursnottheiractuallyrealisedprofitsbut(insomesense)their'normalprofit'。ThusbyanexcessofsavingoverinvestmentImeantthatthescaleofoutputwassuchthatentrepreneurswereearningalessthannormalprofitfromtheirownershipofthecapitalequipment；andbyanincreasedexcessofsavingoverinvestmentImeantthatadeclinewastakingplaceintheactualprofits，sothattheywouldbeunderamotivetocontractoutput。

AsInowthink，thevolumeofemployment(andconsequentlyofoutputandrealincome)isfixedbytheentrepreneurunderthemotiveofseekingtomaximisehispresentandprospectiveprofits(theallowanceforusercostbeingdeterminedbyhisviewastotheuseofequipmentwhichwillmaximisehisreturnfromitoveritswholelife)；whilstthevolumeofemploymentwhichwillmaximisehisprofitdependsontheaggregatedemandfunctiongivenbyhisexpectationsofthesumoftheproceedsresultingfromconsumptionandinvestmentrespectivelyonvarioushypotheses。InmyTreatiseonMoneytheconceptofchangesintheexcessofinvestmentoversaving，astheredefined，wasawayofhandlingchangesinprofit，thoughIdidnotinthatbookdistinguishclearlybetweenexpectedandrealisedresults。[59]Itherearguedthatchangeintheexcessof[Page78]THEGENERAL

THEORYOFEMPLOYMENT

investmentoversavingwasthemotiveforcegoverningchangesinthevolumeofoutput。Thusthenewargument，though(asInowthink)muchmoreaccurateandinstructive，isessentiallyadevelopmentoftheold。ExpressedinthelanguageofmyTreatiseonMoney，itwouldrun:theexpectationofanincreasedexcessofinvestmentoversaving，giventheformervolumeofemploymentandoutput，willinduceentrepreneurstoincreasethevolumeofemploymentandoutput。Thesignificanceofbothmypresentandmyformerargumentsliesintheirattempttoshowthatthevolumeofemploymentisdeterminedbytheestimatesofeffectivedemandmadebytheentrepreneurs，anexpectedincreaseofinvestmentrelativelytosavingasdefinedinmyTreatiseonMoneybeingacriterionofanincreaseineffectivedemand。ButtheexpositioninmyTreatiseonMoneyis，ofcourse，veryconfusingandincompleteinthelightofthefurtherdevelopmentsheresetforth。

MrD。H。Robertsonhasdefinedto-day'sincomeasbeingequaltoyesterday'sconsumptionplusinvestment，sothatto-day'ssaving，inhissense，isequaltoyesterday'sinvestmentplustheexcessofyesterday'sconsumptionoverto-day'sconsumption。Onthisdefinitionsavingcanexceedinvestment，namely，bytheexcessofyesterday'sincome(inmysense)overto-day'sincome。ThuswhenMrRobertsonsaysthatthereisanexcessofsavingoverinvestment，hemeansliterallythesamethingasImeanwhenIsaythatincomeisfalling，andtheexcessofsavinginhissenseisexactlyequaltothedeclineofincomeinmysense。Ifitweretruethatcurrentexpectationswerealwaysdeterminedbyyesterday'srealisedresults，to-day'seffectivedemandwouldbeequaltoyesterday'sincome。ThusMrRobertson'smethodmightberegardedasanalternative。attempttomine(being，perhaps，afirstapproximationtoit)tomakethesamedistinction，sovitalforcausalanalysis，thatIhavetried[Page79]THEMEANING

OFSAVINGANDINVESTMENT

tomakebythecontrastbetweeneffectivedemandandincome。[60]

IV

Wecomenexttothemuchvaguerideasassociatedwiththephrase'forcedsaving'。Isanyclearsignificancediscoverableinthese？InmyTreatiseonMoney(vol。1，p。171，footnote[JMK，vol。V，p。154]Igavesomereferencestoearlierusesofthisphraseandsuggestedthattheyboresomeaffinitytothedifferencebetweeninvestmentand'saving'inthesenseinwhichIthereusedthelatterterm。IamnolongerconfidentthattherewasinfactsomuchaffinityasIthensupposed。Inanycase，Ifeelsurethat'forcedsaving'andanalogousphrasesemployedmorerecently(e。g。byProfessorHayekorProfessorRobbins)havenodefiniterelationtothedifferencebetweeninvestmentand'saving'inthesenseintendedinmyTreatiseonMoney。Forwhilsttheseauthorshavenotexplainedexactlywhattheymeanbythisterm，itisclearthat'forcedsaving'，intheirsense，isaphenomenonwhichresultsdirectlyfrom，andismeasuredby，changesinthequantityofmoneyorbank-credit。

Itisevidentthatachangeinthevolumeofoutputandemploymentwill，indeed，causeachangeinincomemeasuredinwage-units；thatachangeinthewage-unitwillcausebotharedistributionofincomebetweenborrowersandlendersandachangeinaggregateincomemeasuredinmoney；andthatineithereventtherewill(ormay)beachangeintheamountsaved。Since，therefore，changesinthequantityofmoneymayresult，throughtheireffectontherateofinterest，inachangeinthevolumeanddistributionofincome(asweshallshowlater)，suchchangesmayinvolve，indirectly，achangeintheamountsaved。Butsuch[Page80]THEGENERAL

THEORYOFEMPLOYMENT

changesintheamountssavedarenomore'forcedsavings'thananyotherchangesintheamountssavedduetoachangeincircumstances；andthereisnomeansofdistinguishingbetweenonecaseandanother，unlesswespecifytheamountsavedincertaingivenconditionsasournormorstandard。Moreover，asweshallsee，theamountofthechangeinaggregatesavingwhichresultsfromagivenchangeinthequantityofmoneyishighlyvariableanddependsonmanyotherfactors。

Thus'forcedsaving'hasnomeaninguntilwehavespecifiedsomestandardrateofsaving。Ifweselect(asmightbereasonable)therateofsavingwhichcorrespondstoanestablishedstateoffullemployment，theabovedefinitionwouldbecome:'Forcedsavingistheexcessofactualsavingoverwhatwouldbesavediftherewerefullemploymentinapositionoflong-periodequilibrium'。Thisdefinitionwouldmakegoodsense，butasenseinwhichaforcedexcessofsavingwouldbeaveryrareandaveryunstablephenomenon，andaforceddeficiencyofsavingtheusualstateofaffairs。

ProfessorHayek'sinteresting'NoteontheDevelopmentoftheDoctrineofForcedSaving'[61]showsthatthiswasinfacttheoriginalmeaningoftheterm。'Forcedsaving'or'forcedfrugality'was，inthefirstinstance，aconceptionofBentham's；andBenthamexpresslystatedthathehadinmindtheconsequencesofanincreaseinthequantityofmoney(relativelytothequantityofthingsvendibleformoney)incircumstancesof'allhandsbeingemployedandemployedinthemostadvantageousmanner'。

[62]Insuchcircumstances，Benthampointsout，realincomecannotbeincreased，and，consequently，additionalinvestment，takingplaceasaresultofthetransition，involvesforcedfrugality'attheexpenseofnationalcomfortandnationaljustice'。Allthenineteenth-century[Page81]THEMEANING

OFSAVINGANDINVESTMENT

writerswhodealtwiththismatterhadvirtuallythesameideainmind。

Butanattempttoextendthisperfectlyclearnotiontoconditionsoflessthanfullemploymentinvolvesdifficulties。Itistrue，ofcourse(owingtothefactofdiminishingreturnstoanincreaseintheemploymentappliedtoagivencapitalequipment)，thatanyincreaseinemploymentinvolvessomesacrificeofrealincometothosewhowerealreadyemployed，butanattempttorelatethislosstotheincreaseininvestmentwhichmayaccompanytheincreaseinemploymentisnotlikelytobefruitful。AtanyrateI

amnotawareofanyattempthavingbeenmadebythemodernwriterswhoareinterestedin'forcedsaving'toextendtheideatoconditionswhereemploymentisincreasing；andtheyseem，asarule，tooverlookthefactthattheextensionoftheBenthamiteconceptofforcedfrugalitytoconditionsoflessthanfullemploymentrequiressomeexplanationorqualification。

V

Theprevalenceoftheideathatsavingandinvestment，takenintheirstraightforwardsense，candifferfromoneanother，istobeexplained，Ithink，byanopticalillusionduetoregardinganindividualdepositor'srelationtohisbankasbeingaone-sidedtransaction，insteadofseeingitasthetwo-sidedtransactionwhichitactuallyis。Itissupposedthatadepositorandhisbankcansomehowcontrivebetweenthemtoperformanoperationbywhichsavingscandisappearintothebankingsystemsothattheyarelosttoinvestment，or，contrariwise，thatthebankingsystemcanmakeitpossibleforinvestmenttooccur，towhichnosavingcorresponds。

Butnoonecansavewithoutacquiringanasset，whetheritbecashoradebtorcapital-goods；andnoonecanacquireanassetwhichhedidnotpreviouslypossess，unlesseitheranassetofequalvalueisnewlyproducedorsomeoneelse[Page82]THEGENERAL

THEORYOFEMPLOYMENT

partswithanassetofthatvaluewhichhepreviouslyhad。Inthefirstalternativethereisacorrespondingnewinvestment:inthesecondalternativesomeoneelsemustbedis-savinganequalsum。Forhislossofwealthmustbeduetohisconsumptionexceedinghisincome，andnottoalossoncapitalaccountthroughachangeinthevalueofacapital-asset，sinceitisnotacaseofhissufferingalossofvaluewhichhisassetformerlyhad；heisdulyreceivingthecurrentvalueofhisassetandyetisnotretainingthisvalueinwealthofanyform，i。e。hemustbespendingitoncurrentconsumptioninexcessofcurrentincome。Moreover，ifitisthebankingsystemwhichpartswithanasset，someonemustbepartingwithcash。Itfollowsthattheaggregatesavingofthefirstindividualandofotherstakentogethermustnecessarilybeequaltotheamountofcurrentnewinvestment。

Thenotionthatthecreationofcreditbythebankingsystemallowsinvestmenttotakeplacetowhich'nogenuinesaving'correspondscanonlybetheresultofisolatingoneoftheconsequencesoftheincreasedbank-credittotheexclusionoftheothers。Ifthegrantofabankcredittoanentrepreneuradditionaltothecreditsalreadyexistingallowshimtomakeanadditiontocurrentinvestmentwhichwouldnothaveoccurredotherwise，incomeswillnecessarilybeincreasedandataratewhichwillnormallyexceedtherateofincreasedinvestment。Moreover，exceptinconditionsoffullemployment，therewillbeanincreaseofrealincomeaswellasofmoney-income。Thepublicwillexercise'afreechoice'astotheproportioninwhichtheydividetheirincreaseofincomebetweensavingandspending；

anditisimpossiblethattheintentionoftheentrepreneurwhohasborrowedinordertoincreaseinvestmentcanbecomeeffective(exceptinsubstitutionforinvestmentbyotherentrepreneurswhichwouldhaveoccurredotherwise)

atafasterratethanthepublicdecidetoincreasetheir[Page83]THEMEANING

OFSAVINGANDINVESTMENT

savings。Moreover，thesavingswhichresultfromthisdecisionarejustasgenuineasanyothersavings。Noonecanbecompelledtoowntheadditionalmoneycorrespondingtothenewbank-credit，unlesshedeliberatelypreferstoholdmoremoneyratherthansomeotherformofwealth。Yetemployment，incomesandpricescannothelpmovinginsuchawaythatinthenewsituationsomeonedoeschoosetoholdtheadditionalmoney。Itistruethatanunexpectedincreaseofinvestmentinaparticulardirectionmaycauseanirregularityintherateofaggregatesavingandinvestmentwhichwouldnothaveoccurredifithadbeensufficientlyforeseen。Itisalsotruethatthegrantofthebank-creditwillsetupthreetendencies&frac34；(1)

foroutputtoincrease，(2)forthemarginalproducttoriseinvalueintermsofthewage-unit(whichinconditionsofdecreasingreturnmustnecessarilyaccompanyanincreaseofoutput)，and(3)forthewage-unittoriseintermsofmoney(sincethisisafrequentconcomitantofbetteremployment)；

andthesetendenciesmayaffectthedistributionofrealincomebetweendifferentgroups。Butthesetendenciesarecharacteristicofastateofincreasingoutputassuch，andwilloccurjustasmuchiftheincreaseinoutputhasbeeninitiatedotherwisethanbyanincreaseinbank-credit。

Theycanonlybeavoidedbyavoidinganycourseofactioncapableofimprovingemployment。Muchoftheabove，however，isanticipatingtheresultofdiscussionswhichhavenotyetbeenreached。

Thustheold-fashionedviewthatsavingalwaysinvolvesinvestment，thoughincompleteandmisleading，isformallysounderthanthenew-fangledviewthattherecanbesavingwithoutinvestmentorinvestmentwithout'genuine'saving。Theerrorliesinproceedingtotheplausibleinferencethat，whenanindividualsaves，hewillincreaseaggregateinvestmentbyanequalamount。Itistrue，that，whenanindividualsavesheincreaseshisownwealth。Buttheconclusionthathe[Page84]THEGENERAL

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