2: Distribution within the Traditional Divisions of Economics
The fundamental problem of distribution is to determine how the profits of a collaborative effort in which men have contributed different quantities and natures of labor and capital are apportioned in a manner that is honest. This is a complex proposal.
He steps back to consider the traditional fundamentals economic activities - production, distribution, exchange, and consumption. These are general categories of activity, nor is it an orderly process. Equipment and materials must be purchased and brought to a workshop before production can take place. An item may be transported and traded multiple times between the producer and the consumer. The product of many disparate groups are brought together into the creation of the item that is at last consumed, there are many sales transactions, and the proceeds are repaid or pre-paid to many hands. This does not change the nature of the activities, but merely their complexity.
The tasks of distribution and exchange are significantly greater in an organized society. The animal eats what it finds in the place that it found it. The savage may carry what he has found back to his village and perhaps trade some portion of what he has gathered with others in exchange for other things. The medieval villager did much the same, carrying the product of his farm to trade with a craftsman in town for something the craftsman produced. The modern worker labors for a wage, receiving money instead of the thing he has produced, and the money can be used in the market to purchase things that were produced by the work of many others, which has been traded several times before he obtains it, and which may have been transported to his location from the far reaches of the earth.
Production is the creation of value, by performing a service or fashioning an object for consumption. It is typically accomplished by a division of labor - even a simple good such as a nail, which was forged by a blacksmith, who bought the iron from a metallurgist, who bought his ore from a miner, with various other parties involved each time the material was transported and exchanged. Thus for material goods, each producer is a specialist who performs one part of the task of gathering raw materials, fashioning them into an item, transporting it to where it is needed, and selling it to one who will consume it. Dozens to thousands of producers contributed to every good that consumers enjoy.
The division of labor rests on a foundation of exchange. In a voluntary exchange, each party provides something to the other in exchange for something else, and each party values what he is getting more than that which he is giving - otherwise the exchange would be irrational. It is in these exchanges that the value of an item is determined - by the desire of someone to have it, regardless of the cost that was required the other party to obtain or produce it. Which is to say, it is the buyer that determines what the seller will receive in compensation, and through the distribution chain the buyer determines how the producers are compensated.
Where there is only one supplier, the buyer must pay the price or do without. When there are two or more, the buyer may negotiate with each and take the best price. In this way, competition influences the amount that the buyer must pay (and that the producers will be compensated). The greater the number of sources and the greater the amount of the commodity, the less power suppliers have to name a high price, and instead compete for sales by lowering their prices. This likewise influences how producers are compensated in aggregate.
These factors and others influence the price the buyer of a good is willing to pay - and that price represents the total compensation that can be shared among producers.
A bit of a side-trip: it is a mistake to consider money to be the equivalent of wealth. Money is only of value because it can be exchanged for something that can be used. Where a government collapses, its state money is so much worthless metal and paper. Money is a token of exchange, and is often looked to as a measure of value: a thing is "worth" a certain number of coins to a person who needs the thing more than other items the coins could buy. But it is only in possessing and consuming the thing that the buyer receives any benefit.
Where labor is divided, there are multiple transactions - the blacksmith pays the smelter, who pays the miner. Each transaction determines the compensation of the producers up to that point. The smelter who sells for $10 a quantity of iron he made from ore that he paid $5 to obtain has created a profit of $5 by his work. There is room for variance in each such transaction, that increases or decreases the profitability of work - if the smelter is offered less for his iron or miners demand more for their ore, his profit is diminished even if the amount of effort to smelt the ore into metal is not changed.
Here, we can begin to recognize the distribution of wealth among the various parties involved in production: $20 of horseshoes is made from $11 of iron that is made from $4 of ore. The miner's share is $4, the smelter's share is $7, and the smith's share is $9 (removing for now the various handlers and transporters that may have existed in-between).
The amount that buyers and sellers willingly agree upon for a given product is called its natural or normal price - and in spite of brief fluctuations, market prices tend to be stable over the long term. And because market prices are stable, this means that the compensation to producers is stable - the good they provide to the market can be exchanged (through the money) for the same amounts of the same other goods. (EN: This is a significant point, as debasement of currency makes all prices seem to steadily rise.)
It has been suggested that competition in the market tends to drive prices toward the cost of production for the most efficient producer, as any producer who attempts to charge an exorbitant premium will be underpriced by his competitors. But at the same time, firms attempt to sell their product in the market in which they will fetch the highest margin - such that the removal of some amount of the supply from one market causes prices in that market to rise as well. So while it can be observed that prices tend to become normalized, there are constant forces at work to nudge the price higher or lower, resulting in short-term fluctuations. Over the long term, the improved efficiency of production tends to decrease the cost of producing goods, which lowers the cost a supplier must demand of buyers to cover his cost of production, which pressures competitors to lower their prices as well.
Investors and entrepreneurs are also instrumental in normalizing market prices. The investor is motivated to seek the greatest return on his capital, thus shifts his investment away from less profitable industries. The decreased investment causes decreased supply, which then increases market prices due to scarcity, making the industry attractive to investors again. The entrepreneur is simply a leader for investors, who creates new companies where they are needed. It's noted that their activity is guided by the comparative portability of industries: they do not determine what the market price or profit margin of a specific good happens to be, but merely move capital and labor to the most profitable sectors. In essence, they are serving the demand created by the buyers.
It is also suggested that markets attempt to be efficient, distributing the productive capabilities toward what is most wanted by society (as demonstrated by their purchasing behavior). While there may be unusual short-term fluctuations, the long-term effect is greater market stability and the direction of productive resources to the places where they create the most good for society (buyers/consumers) and offering the greatest rewards to those who are responsive. That is, if there is a demand of an item that is not being provided by producers, buyers will offer a higher price for it - which makes the profits of the producers higher.
Labor is among the productive capabilities directed by the market. While much of the squabbling over wages is based on the premise that labor is not being fairly compensated, what is "fair" is determined by the marketplace: if a worker can find no better wage than he is earning, then his wage is fair - it is as much as consumers are willing to pay for the goods he produces, and because he is willing to remain in his situation rather than pursue a better wage in a different industry and market, then he has consented that it is fair as well.
There are also theories that pit laborers against capitalists, suggesting the capitalist is cheating the laborer to improve his own profits. However, a laborer can refuse a wage and seek work elsewhere, leaving the capitalist without sufficient laborers to make productive use of his capital. The capitalist must increase his offer as much as he can afford to attract and retain laborer - and if even that is not enough, then his lack of production will create a deficit in supply, causing prices to rise until the profit of the good is sufficient to offer a higher wage to labor. On the other hand, if the wage demanded by laborers in a given industry makes it an unprofitable investment, the capitalist will seek to employ his capital elsewhere.
In this sense, the distribution of wealth in free markets is primarily directed to produce the goods that buyers desire, evidenced by their willingness to pay enough to attract labor and capital to produce those goods. The market pays laborers and capitalists enough to attract them to situations in which their productive resources can render them the most profit. And the market also sorts out disagreements between capital and labor, bringing them to a mutually acceptable compromise so that production can take place.
And all of this is driven by consumption, which the author maintains is an individualistic process. Each person decides what he wishes to consume and how much he is willing to pay others to provide it to him. And while consumer choices may be temporarily limited to what is available in the marketplace, he will in the long run have everything he desires if he is willing to pay enough to have it.
However, the manner in which consumers direct producers is not typically so straightforward. It is most typical for a producer to attempt to guess at what consumers wish to have and in what quantities - and the accuracy of his estimation determines the profitability of his operations. If he guesses wrong, he either produces less than he could sell and fails to make as much profit as he might have, or he produces goods that are not wanted and suffers a loss. It is therefore in his interest to offer the right goods, in the right quantities, and in the right prices to satisfy consumers.
(EN: It would be about half a decade after this book was written for companies to recognize the need to ask the consumer rather than making blind guesses. And even in the modern day, may companies are still guessing rather than asking.)