CHAPTER 3

THE PRINCIPLE OF EFFECTIVE DEMAND

I

We need, to start with, a few terms which will bedefined precisely later. In a given state of technique,resources and costs, the employment of a given volumeof labour by an entrepreneur involves him in two kindsof expense: first of all, the amounts which he pays outto the factors of production(exclusive of other entre-preneurs) for their current services, which we shall callthe factor cost of the employment in question; andsecondly, the amounts which he pays out to other entre-preneurs for what he has to purchase from themtogether with the sacrifice which he incurs by employ-ing the equipment instead of leaving it idle, which weshall call the user cost of the employment in question.1The excess of the value of the resulting output over thesum of its factor cost and its user cost is the profit or,as we shall call it, the income of the entrepreneur. Thefactor cost is, of course, the same thing, looked at fromthe point of view of the entrepreneur, as what thefactors of production regard as their income. Thus thefactor cost and the entrepreneur's profit make up,between them, what we shall define as the total incomeresulting from the employment given by the entre-preneur. The entrepreneur's profit thus defined is, asit should be, the quantity which he endeavours tomaximise when he is deciding what amount of employ-

1 A precise definition of user cost will be given in Chapter 6.

23