The Replacement of Capital. It is clear, then, that saving which necessitates waiting, is a prerequisite to the formation of new capital, that is, to an increase of the supply of capital already in existence. But at any given time the capital already in existence forms a very large proportion of the total supply of capital, and it may be thought that the present interest rate does not affect this portion of the supply. We must, however, take into consideration the fact that almost all kinds of capital are being continually used up in production. This using up may be a matter of a single use, as in the case of fuel or raw materials, or it may be a gradual wearing out, as in the case of a machine, but such differences are differences in degree of durability rather than differences in kind.

As we have seen, the entrepreneur will normally not employ any given additional unit of capital unless he expects to get enough from the selling value of the added product to replace the capital actually used up in production as well as to pay interest. This means that if the entrepreneur's estimates prove correct, part of the money income he gets for his product may be regarded as a replacement fund, sufficient in amount to replace the capital used up in production.

We must not, however, make the error of thinking of the replacement fund as definite in quantity. Whether or not any unit of capital produces enough to furnish a replacement fund, depends on whether the entrepreneur's estimate is a correct one. There is no reason why unproductive forms of capital should be kept intact in amount. He would be a foolish business man, for instance, who would keep reinvesting a certain amount of money in raw materials in the face of a diminishing demand for the finished product. Even if enough income is earned to form a replacement fund, the capital used up need not be replaced unless the entrepreneur so chooses. A farmer may have saved for years in order to buy a reaper. The reaper will enable him to raise more wheat, or, possibly, to produce the same amount of wheat at less expense. In either case it will mean an increase in his net money income. He may, if he chooses, set aside enough of this added income so that, when the first reaper wears out, his

accumulated funds will replace it. From one point of view we may say that in this way the reaper "replaces itself." But the farmer may, if he prefers, use all of his increased income in the purchase of additional comforts and luxuries for himself and his family. In deciding whether he will replace his capital or increase his present consumption, he will be guided by the same kind of an estimate of the relative importance of present and future wants on the one hand, and of the amount which the capital will add to his income, on the other hand, that guided him in the original saving which led to the purchase of the first reaper.

Similar illustrations can be found in other kinds of undertakings. Many business enterprises have failed because business men have "lived beyond their incomes "— which often means simply that they have not replaced their capital so rapidly as they have used it up. Many American railways have maintained a specious prosperity for many years by paying "unearned dividends "; that is, by letting their capital (roadbed, rolling stock, buildings, etc.) deteriorate through not expending enough of their gross income in the maintenance of their way and equipment.

The stock of capital in existence at any one time is the result of past saving. But this stock of capital cannot be maintained intact without more saving. From this point of view we may say that the sacrifice of present satisfactions for future satisfactions which society undergoes in order to reap the advantages of capitalistic production is not something that is done "once for all," but is a continuous sacrifice.

The Shifting of Investment. As a matter of fact, a large amount of the capital that is used up in production is not replaced, for the simple reason that entrepreneurs find that some particular kinds of capital are not profitable; that is, they do not add enough to the selling value of the entrepreneur's total product to repay them for their cost (including interest and repayment of principal). It may happen that the entrepreneur has been mistaken as to the technical efficiency (or productivity) of his capital, or that he has overestimated the demand for his

products. New inventions or new methods of production may lessen the income-yielding power of part of the existing stock of capital, or capricious changes in demand may have a similar effect. At the same time, these new methods of production and these changes in demand are making new forms of capital profitable. Even if the "replacement fund" were a definite and rigid annual sum, it would not be entirely devoted to replacing the particular kinds of capital that had been used up in production. There would be a continual shifting from the less profitable to the more profitable forms of capital.

We often hear it said that capital is transferred from one industry to another, or from one locality to another, or from one country to another. Such expressions are misleading. Capital goods are not usually transferred in this fashion, although in exceptional cases it may happen. These statements often mean that the ownership of capital changes, as when a capitalist sells his holdings in one industry to another capitalist and invests his own funds in another undertaking. The most important way in which " capital is transferred" is through that gradual process of shifting in the forms of investment which has just been described.

The Relation of the Durability of Capital Goods to Investment. - The ease with which investments may be shifted varies for different forms of capital. Especially important in this connection is the durability of capital. As has been already suggested, some forms of capital are destroyed as capital by a single use. The fuel and raw materials used in a manufacturing establishment and the merchant's stock in trade belong to this category. The merchant's stock in trade becomes consumption goods in the hands of consumers; raw materials reappear in the finished product, as do other forms of capital for that matter, although in a less obvious sense. But the fact remains that these particular forms of capital investments yield their services only once, and when they are once used by the entre

1 For example, some generally used kinds of machinery (such as lathes, milling or planing machines, engines, or motors) may be transferred from one establishment in one industry to an establishment in another industry.

preneur for the purpose for which they were intended, they cease to be capital, even though they may have successors in new forms of capital.

From such transient forms of capital we may pass by insensible gradations to capital goods which yield a long succession of services, the series culminating in such durable forms of capital as buildings used for productive purposes, or railway roadbeds. If a particular form of capital lasts for exactly a year - the period of time usually taken as a unit in the computation of the rate of interest — estimating the expense of employing such capital is a very simple matter. If, for example, the rate of interest which an entrepreneur sets as his minimum is 6 per cent, he will not invest $1000 in such capital unless he estimates that it will increase his product by an amount that will sell for at least $1060.

In the case of the more transient forms of capital, however, the computation is usually made by taking into account the "rate of turnover." A manufacturer may be constantly buying raw materials and making them into finished products. If the raw materials purchased during a year cost $3000, but if, on the average, only $1000 is invested in raw materials at any one time, the capital is said to be "turned over" three times during the course of the year. The interest rate is computed only on the average amount of capital" tied up," so that interest of 2 per cent on each turnover would amount to 6 per cent on the actual investment of money.

In the case of the more durable forms of capital the computation is more complicated. Here the entrepreneur has to take into account not only the original expense of the capital good and the amounts which it will add to his annual product, but also its durability, and the fact that a large part of the income which it will earn for him is future income. This future income, as we have seen, will not be appraised so highly as the same amount of present income would be.

The Expense and Price of Capital. When we speak of the cost or expense of capital, we may have in mind either one of two distinct things. We may mean (1) the price paid by the

entrepreneur for the loan of the money funds which he invests in specific kinds of capital goods, or we may mean (2) the prices paid for the capital goods themselves. The first thing is, of coarse, loan interest; the second is simply a matter of the market prices of commodities. It is this second thing - the market price of capital goods that we wish to consider at this point. As commodities, these capital goods come under the general laws of value and price, and most of what has been said in earlier chapters about the valuation of consumption goods holds just as true in respect to the valuation of these production goods. Their price at any given time is apt to be fixed rather close to the point where demand and supply would be in equilibrium. In the long run their valuesif they are not patented products, but are competitively produced cannot get very far away from the expenses of producing them.

But there is one fundamental difference which has been suggested in other connections. Consumption goods are valued because they satisfy human wants, and the intensity of the wants which particular units of goods satisfy have, through the principle of marginal utility, a very direct relation to their market values. Capital goods do not satisfy human wants directly; they command a price simply because they aid in the production of goods that do satisfy human wants directly. The demand for them, as we have seen, is the entrepreneur's interpretation of the demand for their products. The law of diminishing productivity bears about the same relation to the determination of their values that the law of diminishing utility does to the determination of the values of consumption goods.

As in the case of the demand for labor, the elasticity of the demand for a particular sort of capital goods is affected not only (1) by the fact that the higher the price of the capital, the higher will have to be the price of the product, and, consequently, the smaller will be the quantity of the product that can be sold, but also (2) by the fact that when the price of any variety of capital goods is relatively high, the entrepreneurs