The demand for industrial equipment is partly a replacement demand and partly a demand for betterments and extensions. The replacement demand for equipment doubtless varies with the physical quantity of demand for products; since, as a rule, the more rapidly machines and rolling stock are run, the more rapidly they wear out. The demand for betterments and extensions, on the other hand, varies not with the physical quantity of the products demanded, but with the fluctuations in this quantity.
To illustrate the peculiar changes in demand for industrial equipment which follow from this situation, suppose that the physical quantity of a certain product varied in five successive years as follows: First year 100,000 tons Second year 95,000 tons Third year 100,000 tons Fourth year 110,000 tons Fifth year 115,000 tons This product is turned out by machines each of which will produce one hundred tons per year. Thus the number of machines in operation each year was: First year 1,000 machines Second year 950 machines Third year 1,000 machines Fourth year 1,100 machines Fifth year 1,150 machines Each year one-tenth of the machines in operation wears out. The replacement demand for machines was therefore: First year 100 machines Second year 95 machines Third year 100 machines Fourth year 110 machines Fifth year 115 machines The demand for additional machines was far more variable. Neglecting the first year, for which our illustration does not supply data, it is plain that no additions to equipment were required the second year when fifty of the machines in existence stood idle, and also none the third year. But after all the existing machines had been utilized new machines had to be bought at the rate of one machine for each one hundred tons added to the product. Hence the demand for additions to equipment shown by the number of machines in operation was: First year no data Second year none Third year none Fourth year 100 machines Fifth year 50 machines Adding the replacement demand and the demand for additions to equipment, we find the total demand for industrial equipment of this type to be: First year no data Second year 95 machines Third year 100 machines Fourth year 210 machines Fifth year 165 machines Of course the figures in this example are fanciful. But they illustrate
genuine characteristics of the demand for industrial equipment. During depression and early revival the equipment-building trades get little business except what is provided by the replacement demand. When the demand for products has reached the stage where it promises soon to exceed the capacity of existing facilities, however, the equipment trades experience a sudden and intense boom. But their business falls off again before prosperity has reached its maximum, provided the increase in the physical quantity of products slackens before it stops. Hence the seeming anomalies pointed out by J. Maurice Clark: The demand for equipment may decrease . . . even though the demand for the finished product is still growing. The total demand for [equipment] tends to vary more sharply than the demand for finished products. . . . The maximum and minimum points in the demand for [equipment] tend to precede the maximum and minimum points in the demand for the finished products, the effect being that the change may appear to precede its own cause.
When we add to the check in the orders for new equipment arising from any slackening in the increase of demand for products, the further check which arises from stringency in the bond market and the high cost of construction, we have no difficulty in understanding why contracts for this kind of work become less numerous as the climax of prosperity approaches. Then the steel mills, foundries, machine factories, copper smelters, quarries, lumber mills, cement plants, construction companies, general contractors, and the like find their orders for future delivery falling off. While for the present they may be working at high pressure to complete old contracts within the stipulated time, they face a serious restriction of trade in the near future.
The imposing fabric of prosperity is built with a liberal factor of safety; but the larger grows the structure, the more severe become these internal stresses. The only effective means of preventing disaster while continuing to build is to raise selling prices time after time high enough to offset the encroachments of costs upon profits, to cancel the advancing rates of interest, and to keep producers willing to contract for fresh industrial equipment.