Appendix on User Cost

1. Classical User Cost

The Classical theory of value has an important concept called the USER cost, which has been overlooked.

U = A1 + (G' - B') - G

• U= An entrepreneur’s user cost
• A1 is the amount of our entrepreneur’s purchases from other entrepreneurs
• G the actual value of his capital equipment at the end of the period
• G’ the value it might have had at the end of the period if he had refrained from using it and had spent the optimum sum B’ on its maintenance and improvement.

G - (G' - B')

is the increment in the value of the entrepreneurs equipment beyond the net value which he has inherited from the previous period, represents the entrepreneur’s current investment in his equipment and can be written

I. Thus U, the user cost of his sales-turnover A, is equal to A1 - I where A1 is what he has bought from other entrepreneurs and I is what he has currently invested in his own equipment.

This is common sense.

Some part of his outgoings to other entrepreneurs is balanced by the value of his current investment in his own equipment. The rest represents the sacrifice which the output he has sold must have cost him over and above the total sum which he has paid out to the factors of production.

If the reader tries to express the substance of this otherwise, he will end up with insoluble and unnecessary accounting problems.

There is no other way of analysing the current proceeds of production unambiguously.

If industry is completely integrated or if the entrepreneur has bought nothing from outside, so that A1 = 0, the user cost is simply the equivalent of the current disinvestment involved in using the equipment.

But we are still left with the advantage that we do not require at any stage of the analysis to allocate the factor cost between the goods which are sold and the equipment which is retained.

Thus, we can regard the employment given by a firm, whether integrated or individual, as depending on a single consolidated decision — a procedure which corresponds to the actual interlocking character of the production of what is currently sold with total production.

The concept of user cost enables us to give a clearer definition than that usually adopted of the short-period supply price of a unit of a firm’s saleable output.

For the short-period supply price is the sum of the marginal factor cost and the marginal user cost. Now in the modern theory of value it has been a usual practice to equate the short-period supply price to the marginal factor cost alone.

It is obvious, however, that this is only legitimate if marginal user cost is zero or if supply-price is specially defined so as to be net of marginal user cost, just as I have defined (Chapter 3) “proceeds” and “aggregate supply price” as being net of aggregate user cost.

It might be convenient in dealing with output as a whole to deduct user cost.

But this deprives our analysis of all reality if it is habitually (and tacitly) applied to the output of a single industry or firm, since it divorces the “supply price” of an article from any ordinary sense of its “price”.

This might cause some confusion

“Supply price” has an obvious meaning as applied to a unit of the saleable output of an individual firm.

Yet the treatment both of what is purchased from other firms and of the wastage of the firm’s own equipment as a consequence of producing the marginal output involves the whole pack of perplexities which attend the definition of income.

For, even if we assume that the marginal cost of purchases from other firms involved in selling an additional unit of output has to be deducted from the sale-proceeds per unit in order to give us what we mean by our firm’s supply price, we still have to allow for the marginal disinvestment in the firm’s own equipment involved in producing the marginal output.

Even if all production is carried on by a completely integrated firm, it is still illegitimate to suppose that the marginal user cost is zero, i.e. that the marginal disinvestment in equipment due to the production of the marginal output can generally be neglected.

The concepts of user cost and of supplementary cost also enable us to establish a clearer relationship between long-period supply price and short-period supply price.

Long-period cost must include an amount to cover:

• the basic supplementary cost and
• the expected prime cost appropriately averaged over the life of the equipment.

The long-period cost of the output is equal to the expected sum of the prime cost and the supplementary cost.

In order to yield a normal profit, the long-period supply price must exceed the long-period cost thus calculated by an amount determined by the current rate of interest on loans of comparable term and risk, reckoned as a percentage of the cost of the equipment.

Taking a standard “pure” rate of interest view, we must include in the long-period cost a third term which we might call the risk-cost to cover the unknown possibilities of the actual yield differing from the expected yield.

Thus, the long-period supply price is equal to the sum of the prime cost, the supplementary cost, the risk cost and the interest cost, into which several components it can be analysed.

The short-period supply price, on the other hand, is equal to the marginal prime cost. The entrepreneur must, therefore, expect, when he buys or constructs his equipment, to cover his supplementary cost, his risk cost and his interest cost out of the excess marginal value of the prime cost over its average value; so that in long-period equilibrium the excess of the marginal prime cost over the average prime cost is equal to the sum of the supplementary, risk and interest costs*.

The level of output, at which marginal prime cost is exactly equal to the sum of the average prime and supplementary costs, has a special importance, because it is the point at which the entrepreneur’s trading account breaks even. It corresponds, that is to say, to the point of zero net profit; whilst with a smaller output than this he is trading at a net loss. The extent to which the supplementary cost has to be provided for apart from the prime cost varies very much from one type of equipment to another. Two extreme cases are the following= (i) Some part of the maintenance of the equipment must necessarily take place pari passu with the act of using it (e.g. oiling the machine). The expense of this (apart from outside purchases) is included in the factor cost.

If, for physical reasons, the exact amount of the whole of the current depreciation has necessarily to be made good in this way, the amount of the user cost (apart from outside purchases) would be equal and opposite to that of the supplementary cost; and in long-period equilibrium the marginal factor cost would exceed the average factor cost by an amount equal to the risk and interest cost. (ii) Some part of the deterioration in the value of the equipment only occurs if it is used.

The cost of this is charged in user cost, in so far as it is not made good pari passu with the act of using it. If loss in the value of the equipment could only occur in this way, supplementary cost would be zero. It may be worth pointing out that an entrepreneur does not use his oldest and worst equipment first, merely because its user cost is low; since its low user cost may be outweighed by its relative inefficiency, i.e. by its high factor cost. Thus an entrepreneur uses by preference that part of his equipment for which the user cost plus factor cost is least per unit of output.[8]

It follows that for any given volume of output of the product in question there is a corresponding user cost*, but that this total user cost does not bear a uniform relation to the marginal user cost, i.e. to the increment of user cost due to an increment in the rate of output.