Reply To: Money Costs, Prices, and Alfred Marshall


Prices for the factors of production, labor, land, materials, etc. are determined by the demand entrepreneurs have to use them in their various production processes across the economy. The land has a price of $3 m because their are entrepreneurs who will pay that price to employ that land in their productive processes. The same is true of the price for labor and the price for materials. Prices for factors of production are determined by entrepreneur demands for them which in turn are determined by the revenues that consumers generate from the output produced and the productivity of the factor of production in producing those outputs.

The net income entrepreneurs earn in their production processes comes from the productive contributions made by the entrepreneurs: wages for their labor used; interest for their capital invested; and profit for their foresight. In the ERE, profit would be zero, but net income would remain because entrepreneurial labor and capital funding still has value in producing goods.

The spread between output prices and input prices in the ERE, then, reflects the interest return on investment. This must be uniform for a similar types of investments, because capitalist would invest more heavily in higher return areas than lower return areas. By expanding production in higher return areas, output prices decline and input prices rise, reducing the price spread and by contracting production in lower return areas, output prices rise and input prices fall, increasing the price spread.

As we approached the ERE, in your example, production of malls would increase because of the greater return. This would lower output prices and raise input prices. Which input prices rise by how much cannot be determined by theory alone. All we can say is that factors more specific to a production process would rise more and prices less specific to a production process would rise less. In your example, land prices probably would rise the most.

Prices of output do not move to conform to replacement costs. Prices of output fall because of the additional supply of entrepreneurs who are taking advantage of the profit opportunity. Prices of inputs rise for the same reason. Price spreads conform to the interest return.