The Economic Organization

Karl G. Heider, Frank Knight

• Publisher: Routledge
• Year: 2017
• eBook ISBN: 9781351304580
• Topic: Business
• Subtopic: Business General
• Index: Business

When originally released, Frank Hyneman Knight's The Economic Organization revitalized the teaching of economic theory in America during the 1930s, laying the foundation for the price theory revolution led by economists emerging from Knight's circle at The University of Chicago. Knight shows that when societies choose to allow market organization, their economy simultaneously solves the fundamental functions of valuation and efficiency. It also organizes the production and distribution of resources, providing incentives for progress.

The Economic Organization provides a short introduction to the basic principles of supply, demand, and distribution that emerge from neoclassical price theory. The central role of the price mechanism in market organization is illustrated neatly by Knight's "wheel of wealth" the circular flow diagram most often identified with macroeconomic flows, but introduced here for price theoretic reasons. This version also includes his essay on "Utility and Cost," which provides a seamlessly integrated alternative-cost interpretation of neoclassical theory.

This expanded edition of The Economic Organization includes a new introduction by Ross B. Emmett, which expands upon the short note on capital theory inserted in the original. Knight wrote three versions of the note for student use, and all three are included in the second chapter. Few books have changed the landscape of American economics and economic education as much as Knight's The Economic Organization. This book should be read by all economists, historians, and policy makers.

Part I The Economic Organization

Ross B. Emmett

1 Social Economic Organization

Ross B. Emmett

Social Economic Organization and Its Five Primary Functions

It is somewhat unusual to begin the treatment of a subject with a warning against attaching too much importance to it; but in the case of economics, such an injunction is quite as much needed as explanation and emphasis of the importance it really has. It is characteristic of the age in which we live to think too much in terms of economics, to see things too predominantly in their economic aspect; and this is especially true of the American people. There is no more important prerequisite to clear thinking in regard to economics itself than is recognition of its limited place among human interests at large.

Common Definitions of Economics Much Too Broad, Thought the Economic Conception of Life is Too Narrow

In modern usage, the term economic has come to be used in a sense which is practically synonymous with intelligent or rational. This is the first and broadest conception of the term, within which we have to find by narrowing it down progressively, a definition which will describe the actual subject-matter of the science of political economy. It is in accord with good linguistic usage to think and speak of the whole problem of living as one of economy, the economical use of time, energy, etc. - resource of every sort. Many definitions of economics found in text books fall into this error of including virtually all intelligent behavior. One writer has actually given as his definition of economics the “science of rational activity.” Others find its subject matter is “man's activity in making a living,” or “the ordinary business of life.” Such definitions come too near to saying that economics is the science of things generally, of everything that men are for practical reasons interested in. Such a definition is useless and misleading. It is necessary to devote a little time to making clear the restrictions which mark off the modestly limited domain of economic science within the inclusive sphere of knowledge as a whole.

In the first place, it should be understood that economizing, even in this broad sense of rational activity, or the intelligent use of given means in achieving given ends, does not include all human interests, and that the kind of knowledge on which such activity rests does not exhaust the field of human knowledge. It is, as we have said, one of the errors, not to say vices, of an age in which the progress of natural science and the triumphs of its application to life have engrossed men's attention, to look upon life too exclusively under this aspect of scientific rationality. It is requisite to a proper orientation to economic science itself as well as necessary to a sound philosophy of life, to see clearly that life must be more than economics, or rational conduct, or the intelligent accurate manipulation of materials and use of power in achieving results. Such a view is too narrow. It implies that the results to be achieved are to be taken for granted, whereas in fact the results themselves are often quite as much in question as the means and procedures for achieving results. Living intelligently includes more than the intelligent use of means in realizing ends; it is fully as important to select the ends intelligently, for intelligent action directed toward wrong ends only makes evil greater and more certain. One must have intelligent tastes, and intelligent opinions on many things which do not directly relate to conduct at all. Not only are the objectives of action in fact a practical problem, as well as the means of achievement, but intelligent discussion of the means cannot be separated from the discussion of the ends.

Living is an art: and art is more than a matter of a scientific technique, and the richness and value of life are largely bound up in the “more.” In its reaction from the futility of medievalism and mystical speculation, the modern Western world has gone far to the other extreme. It loses much of the value of life through neglect of the imponderables and incommensurables, and gets into a false conception of the character of social and individual problems. Our thinking about life-values runs too much in terms of material prerequisites and costs. It is an exaggeration which may be useful to say that economic goods as a class are predominantly “necessary” rather than truly valuable. The importance of economic provision is chiefly that of a prerequisite to the enjoyment of the free goods of the world, the beauty of the natural scene, the intercourse of friends in “aimless” camaraderie, the appreciation and creation of art, discovery of truth and communion with one's own inner being and the Nature of Things. Civilization should look forward to a day when the material product of industrial activity shall become rather its by-product, and its primary significance shall be that of a sphere for creative self-expression and the development of a higher type of individual and of human fellowship. It ought to be the first aim of economic policy to reduce the importance of economic policy in life as a whole. So it ought to be the highest objective in the study of economics to hasten the day when the study and the practice of economy will recede into the background of men's thoughts, when food and shelter, and all provision for physical needs, can be taken for granted without serious thought, when “production” and “consumption” and “distribution” shall cease from troubling and pass below the threshold of consciousness and the effort and planning of the mass of mankind may be mainly devoted to problems of beauty, truth, right human relations and cultural growth.

The Actual Subject Matter of Economics

What is discussed in the science of economics includes a relatively small fraction of the economic side of life taken in the broad sense. It has nothing to do with the concrete processes of producing or distributing goods, or using goods to satisfy wants. The study of these matters comes under the head of technology, including engineering, business management, and home economics. Economics deals with the social organization of economic activity. In practice its scope is much narrower still; there are many ways in which economic activity may be socially organized, but the predominant method in modern nations is the price system, or free enterprise. Consequently it is the structure and working of the system of free enterprise which constitutes the principal topic of discussion in a treatise on economics.

The Meaning of Organization

Everyone is familiar with the idea of division of labor - by which is really meant specialization of labor - and many economists have taken it as their point of departure in expounding the science of economics. This was the procedure of Adam Smith, for example, whose book, The Wealth of Nations, published in the year 1776, ranks as the first modern treatise on economics.

Modern economic society is often compared with a living body or “organism” and the comparison is certainly suggestive. The essential similarity and the fundamental idea for our purpose is precisely that of division of labor or specialization. But the expression “division” of labor, does not tell us enough. The idea is rather division into different kinds of labor. A number of men hoeing in a field or nailing shingles on a roof exemplify “division” of labor, but not organization. The problems of organization arise only when different things are being done, in the furtherance of a common end, and in definite relations to each other, i.e., in coordination. A single man in raising a crop or building a house shows division of labor in another sense, since he does many different things, but this is not yet organization in the sense with which we are concerned. The human body shows organization in the true sense, since the various “organs” not only perform different functions, but must all act in a substantially continuous manner and in proper adjustment to each other. Again, organization must be distinguished from cooperation; it involves cooperation, but more. If a group of men lift a stone which is too heavy for one to move alone, they cooperate, and increase their power by cooperation; their action is cooperative, but they are not organized, since they are all doing the same thing.

It is obvious enough that the economic or living-making activities of the modern world are very elaborately organized. We need not pause to comment on the number of persons who have contributed, and in what different ways, in supplying the wants of the humblest citizen today. The authorities of the federal census prepare a catalogue or classification of occupations which lists many thousands of these economic functions for the working population of the United States alone and which yet makes no pretense of distinguishing all specialized functions. For instance, farm laborers are classed together though different individuals work at the production of a wide variety of crops. It is evident also that the accomplishment of the ultimate purpose of it all, the provision for the needs and desires of the people, depends upon these various operations being carried on with a fair degree of continuity and tolerable coordination. The problem of organization, which sets the problem of economic science, deals with the concrete means or mechanism for dividing the general function of making a living for the people into parts and bringing about the performance of these parts in due proportion and harmony.

More specifically, it is a problem of the social machinery for accom-plishingfive fairly distinct functions. Every system of organization must perform these tasks, and it is its success or failure in discharging these functions which determines its value as a system. Back of the study of economics is the practical need of making the organization better, and we can hope for success in this task only if we proceed to it intelligently, which is to say on the basis of an understanding of the nature of the work which a system of organization has to perform, and of the alternatives open in the way of possible types of organization machinery.

The Five Main Functions ofAn Economic System

The general task of organizing the economic activity of society may be divided into a number of fundamental functions. These are in fact very much interconnected and overlapping, but the distinction is useful as an aid to discussing the existing economic order both descriptively and critically, its structure as well as its workings. These functions fall into a more or less logical sequence. The first is to decide what is to be done, that is, what goods and services are to be produced, and in what proportions. It is the function of setting standards, of establishing a social scale of values, or the function of social choice; the second is the function of organizing production, in the narrow sense, of getting done the things settled upon as most worth doing; third is distribution, the apportioning of the product among the members of society; the fourth is really a group of functions having to do with maintaining and improving the social structure, or promoting social progress.

1. The Function of Fixing Standards; The Notion of Efficiency

In a world where organizations were absent, where each individual carried on his life activities in isolation and independence of all others, the matter of standards would be simply a matter of individual choice. But when the production of wealth is socialized, there has to be a social decision as to the relative importance of different uses of productive power, as to which wants are to be satisfied and which left unsatisfied or to what extent any one is to be satisfied at the expense of any other. In the case of an individual, choice need be made only among his own wants; but in a social system, the wants of different individuals also come into conflict. As far as this is a quantitative question merely, of how far the wants of one are to be gratified at the expense of the wants of another, or left ungratified in favor of another, the problem is one of distribution, and will be noticed under another heading (the third function). But to a large and increasing extent, society finds it necessary or advisable further to regulate the individual's regulation of his own want-satisfaction, to enforce a community standard of living. As a matter of fact, these two problems are closely interlaced, the question of whose wants and that of which wants are to be given preference, and in what measure. It is important to observe that they are largely the same question. The difference in the “amount” consumed by different persons is not mainly a difference in the amounts of the same commodities; different persons consume different things, which are quantitatively compared only through the agency of the value scale itself. Nevertheless there seems to be ample justification for a logical separation of the questions of what is to be produced from that of who is to get the product, and for discussing separately the relations between the two phases of organization.

A point of fundamental importance in connection with the question of standards is that of the origin or ultimate source of wants. The system of social organization does more than reduce individual values to a common denominator or scale of equivalence. In large part the individual wants themselves are created by social intercourse, and their character is also largely dependent upon the form of organization of the economic system upon which they are dependent for their gratification. The workings of the economic organization in this connection form a problem too large and complex to be discussed at any length in a small book like this one. Indeed, the subject of wants is not only vast in scope but apparently cannot be reduced to scientific terms, except within rather narrow limits, falling rather in the field of art. The scientific discussion of economics has to be restricted in the main to the analysis of the organization of want-satisfaction. In the science of economics the wants are largely taken for granted as facts of the time and place, and the discussion of their origin and formation is left for the most part to the distinct studies of social psychology and cultural anthropology.¹

The problem of standards or values occupies a key position in Economics. The practical objective of economics, it must be kept in mind, is that of improving the social organization and increasing its efficiency. There is a common misconception that it is possible to measure or discuss efficiency in purely physical terms. The first principles of physics or engineering science teach that this is not true, that the term efficiency involves the idea of value, and some measure of value as well. It is perhaps the most important principle of physical science that neither matter nor energy can be created or destroyed, that whatever goes into any process must come out in some form, and hence as a mere matter of physical quantity, the efficiency of all operations would equal one hundred per cent. The correct definition of efficiency is the ratio, not between “output” and “input” but between useful output and total output or input. Hence efficiency, even in the simplest energy transformation, is meaningless without a measure of usefulness or value. In any attempt to understand economic efficiency, the notion of value is more obviously crucial since most economic problems are concerned with a number of kinds both of outlay and of return, and there is no conceivable way of making comparisons without first reducing all the factors to terms of a common measure. It will appear in due course that the science of economics is largely taken up with description and analysis of the process by which this common denominator of things consumed and produced by the economic system is arrived at, that is, with the problem of measuring values.

2. The Function of Organizing Production

The second step, logically speaking, after the ranking and grading of the uses to which productive power may be put, is that of actually putting them to use in accordance with the scale of values thus established. From a social point of view, this process may be viewed under two aspects, (a) the assignment or allocation of the available productive forces and materials among the various lines of industry, and (b) the effective coordination of the various means of production in each industry into such groupings as will produce the greatest result. The second of these tasks properly belongs to technological rather than to economic science, and is treated in economics only with reference to the interrelations between the organization of society as a whole and the internal organization of the industries.

3. The Function of Distribution

This third function would not exist at all in an unorganized world. Each individual, acting independently of all others, would simply consume what he produced. But where production is socialized, the separate productive contribution of one participant in the process cannot be directly identified or separated. It is apparent that a modern factory operative, say one who spends all his time putting buttons on shoes or nailing the covers on packing cases, cannot live on his own product, physically interpreted. When we further consider that different individuals contribute to production in fundamentally different ways, many by furnishing land or other “natural resources” or material equipment or money or managerial or supervisory services, or by selling goods, and in other ways which make no identifiable physical change in any product, it is manifest that if everyone is to get a living out of the process some social mechanism of distribution is called for.

In this connection should be recalled the close relation between distribution and the control of production. The decision as to what to produce is closely bound up with the decision for whom to produce. There is also a close relation between the third function and the second. In our social system distribution is the chief agency relied upon to control production and stimulate efficiency. Ours is a system of “private property,” “free competition” and “contract.” This means that every productive resource or agent, including labor power, typically “belongs” to some person who is free within the legal conditions of marketing, to get what he can out of its use. It is assumed, and the course of the argument will show at length why it is true, that there is in some effective sense a real positive connection between the productive contribution made by any productive agent and the remuneration which its “owner” can secure for ...

Table of contents

• Cover Page
• Half Title
• Title Page
• Copyright Page
• Contents
• Preface and Acknowledgements
• Introduction to the Transaction Edition
• Part I The Economic Organization
• Part II Notes on Utility and Cost
• Index