Marginal costs in relation to values. General principles

Book 5, Chapter 8

§1. “And again this demand [for an input], because it is so derived, is largely dependent on the supply of other things which will work with them in making those commodities [final goods]. And again the supply of anything available for use in making any commodity is apt to be greatly influenced by the demand for that thing derived from its uses in making other commodities: and so on. These inter-relations can be and must be ignored in rapid and popular discussions on the business affairs of the world. But no study that makes any claim to thoroughness can escape from a close investigation of them. This requires many things to be borne in mind at the same time: and for that reason economics can never become a simple science” [p 334 emphasis added].

§2. The demand (=price) of inputs that can be substituted for each other (e.g., steam vs horse-power) will depend on relative efficiencies, with exceptions for laws, custom and other frictions. A horse that produces 10% of a machine’s output will attract offers equal to 10% of that machine’s price.

§3. Businessmen are always experimenting with the mix of inputs required to get a desired output. Although accounting for marginal and capital costs (and depreciation) is not easy, prices and costs will, over time, tend to reflect each input’s value added.

§4. The balance among inputs of capital, labor and materials will tend to equate, at the margin, with their marginal products (i.e., ratios of values to costs). An over-application of any input is wasteful due to decreasing marginal returns (on that input) and opportunity costs (not using other inputs).

In a long footnote, Marshall argues against those who see any given input as “essential” in that a small reduction in its use (e.g., a worker who labors one hour less) will have dramatic effects on the productivity of other inputs.  While this might be true in the short run, Marshall argues that changes here  can be balanced by (continuous) adjustments elsewhere. This appeal to continuity underpins the use of calculus (finding minima and maxima by taking derivatives of functions), which makes sense in many circumstances. I disagree with the continuity assumption when it comes to constraints (an 8 hour shift) or innovations (the shift is eliminated). I assume Marshall would have agreed but modern (=mathy) economists may have forgotten those important caveats and exceptions.

§5. The decision to add/subtract inputs is made “at the margin” in terms of weighing additional profits (or value) vs costs. That calculation takes existing levels of inputs as given, which also means that removing a unit at the margin has a far smaller effect than removing an “inframarginal” unit. In this way, we can see how it might be ok to, say, skip another hour of sanding down a chair while it might be a bad idea to skip an hour of adding legs to that chair. Order matters.

§6. The rents (or interest) returned to “free floating” capital versus “invested” capital varies with the longevity and idiosyncrasies of investments, but they tend to converge.


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Interesting stuff

  1. Audrey Tang, Taiwan’s “digital minister”, is an original thinker
  2. So Moynihan was wrong about “black families”? Listen to this.
  3. San Francisco is losing its Private Investigators
  4. Margaret Atwood sees the darkness of our times — and how to resist
  5. The economics of vending machines (a lot has changed since I ran one!)
  6. How targeted (vote! stay home!) political advertising works 
  7. Thomas Friedman looks at US politics through a foreign policy lens
  8. Gaming chairs are getting better at supporting immobility, which is bad for your circulation (and probably your soul), but also part of the “retreat from reality” I predicted for a good part of society.
  9. Anne Appelbaum on the twilight of democracy (the comments to this podcast leave me worried for America; seems that lots of people are excited to trade freedom for controls on “left-wing terrorists” [sic]. Read Jacob’s Dark Age Ahead (2005) for more.
  10. An over-caffinated guy says “don’t get into watches!” (Too late 😉

Prime and total cost in relation to joint products. Cost of marketing. Insurance against risk. Cost of reproduction

Book 5, Chapter 7

Marshall, like many of his contemporaries, used long titles. 

§1. How should one price two goods that share common elements in their costs (e.g., a machine or management time) but are sold into different markets (e.g., passengers and freight on ships). Pricing from the cost side is tricky. Pricing from the demand side (“what the market will bear”) makes more sense, but it’s ultimately linked to costs, since competing firms selling similar goods and services must also cover their costs.

§2. A manufacturer will want to allocate marketing expenses among goods in proportion to their marketing “needs” but that manufacturer may cut that allocation in the most competitive markets (e.g., for loss leaders). Manufacturers who achieve economies of scale will have falling per unit costs but rising marketing costs based on trying to differentiate similar goods (e.g., cola advertising).

§3. Insuring against risk is often wise but allocating those costs can be difficult when they rise and fall with other actions. The price of fire insurance, for example, will fall if a building is built to reduce fire risks. Are those additional building costs part of construction or insurance?

§4. Marshall points out that risk aversion (the loss of bad outcomes outweighing the gains from good outcomes) is more prevalent than risk seeking behavior (p332):

It is true that an adventurous occupation, such as gold mining, has special attractions for some people: the deterrent force of risks of loss in it is less than the attractive force of changes of great gain, even when the value of the latter estimated on the actuarial principle is much less than that of the former… But in the large majority of cases the influence of risk is in the opposite direction; a railway stock that is certain to pay four per cent. will sell for a higher price than one which is equally likely to pay one or seven per cent. or any intermediate amount.

Kahnemann and Tyversky rediscovered these principles in the 1980s.

§5. In some cases, the cost of reproducing a good will be similar to its cost of production, with both closely tracking its price, but that relation weakens if production technologies or input prices have changed, and it breaks down if demand races ahead of supply (e.g., “quinine on a fever-stricken island”).

Marshall ends the chapter with the advice that non-economic readers skip the next seven chapters (!), but I won’t. Fasten your seatbelts!


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Interesting stuff

    1. When we lose weight, where does it go? (Hint: Water!)
    2. A view on what Covid will bring, from 6 months ago
    3. Who steals “famous art”? Underworld criminals looking for swag
    4. China’s civil war isn’t over (bad news for Taiwan)
    5. The Chicago Mercantile Exchange is setting up a “futures market” for water based on California water trades. I think this is a bad idea b/c (1) there’s no “commodity water” equivalent to oil (water prices reflect unique local and regulatory considerations) and (2) there’s no easy way to store or deliver water, due to its weight and low value per unit (a barrel of oil is worth $40; a barrel of [potable tap water] water is worth about $0.16; agricultural water is worth 1% of that, or less).
    6. Equality is not as useful as equity:
    7. Interesting details on how the airline industry is “melting down”
    8. Tired of experts? Lobbyists? Activists? Check out the UK’s Citizen Assembly format and how they approached climate change
    9. How a Chinese millionaire disrupted damaged BitTorrent by trying to rip off people via his crypto-scam
    10. Health care in rich countries: The US ranks very low due to high costs and chaotic results (this is even before Covid!). The NL does well 😉

H/T to AL

Joint and composite demand and supply

Book 5, Chapter 6

§1. A consumer demanding a good from a producer thereby creates derived demand for the inputs to produce that good. In most cases, inputs are not interchangeable (100% substitutes), which means they are joint (or complementary) with other inputs, with all supplied in stable proportions. Thus, the absence of one input can halt overall production, e.g., trying to make beer without hops.

§2. A missing factor (production input) will lead to increased prices for that factor if (1) the factor cannot be replaced (no substitutes), (2) consumers cannot do without that good (thus, they will pay more rather than go without), (3) the missing input plays only a small part in the price (meaning producers able to find some of that input can pay more for it without raising the product’s final price by much), and (4) other inputs can be acquired for lower prices, leaving extra space to pay for the scarcer input. In sum, a scarcer input will still be used if it’s an essential but small part of the production process.

§3. Composite demand for an input results from the summation of demands from all producers using that input for their consumer products.

§4. A joint product produces different goods for different markets (e.g., oil can be cracked into gasoline and lubricants). If the price of one product is significantly higher than that of the other, then producers will focus on it over the other. If demand for the more valuable product collapses, then the less-valuable one will be more scarce, driving up its price.

§5. Marshall uses many figures and mathematical logic to explain joint and separate contributions to supply and demand, but I find these uninteresting. It’s important to understand complements and substitutes on the supply or demand side, but I think it’s quite difficult to work out their exact (financial or mathematical) relations, even with the best data.

§6. Those who demand or supply one input might benefit from lower (or higher) demand or supply for substitutes or complements, and they will lobby for laws and regulations to favor themselves, thereby distorting broader markets.


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Interesting stuff

  1. Why you should install Signal and ditch WhatsApp (and probably Telegram)
  2. There is something different in the United States today, and I know that you feel it; something noxious, toxic, sick, diseased, and most of all decadent. The wealthiest nation on Earth with such iniquity, where pandemic burnt—still burns—through the population while the gameshow host emperor froths his supporters into bouts of political necromancy.”
  3. Miami Will Be Underwater Soon. Its Drinking Water Could Go First
  4. The burdens of paperwork are growing heavier 
  5. Amsterdam, the beauty.
  6. A fascinating documentary about Shenzen, shanzhai (copycat innovation) and how (some) Chinese see “IP-theft” as “open sourcing” (spin?)
  7. A fire historian explains why California’s burning is mostly about people encroaching on areas that burn naturally  [paywall]
  8. Iceland’s viking culture explains why they offer coffee & cake to visitors 🙂
  9. How Are Psychedelics and Other Party Drugs Changing Psychiatry?

H/T to CD

Equilibrium of normal demand and supply, continued, with reference to long and short periods.

Book 5, Chapter 5

§1. “Normal” prices in markets for goods, services, labor, etc. can be pushed up or down to “abnormal” levels by technology, time, changes in season or tastes.

§2. Economists gain insights by via “ceteris paribus” (holding all other things equal) analysis that allows them to ignore complexities while focussing on the most important causal factors. Results are “cleaner” with more controls but less realistic. Marshall cautions against abuse (p 306):

But nothing of this [the world standing still] is true in the world in which we live. Here every economic force is constantly changing its action, under the influence of other forces which are acting around it. Here changes in the volume of production, in its methods, and in its cost are ever mutually modifying one another; they are always affecting and being affected by the character and the extent of demand. Further all these mutual influences take time to work themselves out, and, as a rule, no two influences move at equal pace. In this world therefore every plain and simple doctrine as to the relations between cost of production, demand and value is necessarily false: and the greater the appearance of lucidity which is given to it by skilful exposition, the more mischievous it is. A man is likely to be a better economist if he trusts to his common sense, and practical instincts, than if he professes to study the theory of value and is resolved to find it easy.

§3. Marshall recommends starting with a stationary state before introducing “partial perturbations,” which is now known as partial equilibrium analysis.

§4. He then explores how the prices of fish might vary in the short, medium and long terms. In the short term (day-to-day), prices rise and fall with weather, “meatless Fridays,” etc. When looking at the medium term (~2 years), these fluctuations might cancel out and they can be should be ignored while examining the impact of, e.g., a fall in demand for beef due to a multi-year plague that increases demand for fish. In such a case, prices will rise and stay there (should people permanently change their taste for beef) until long-term adjustments (e.g., more boats and fishermen) increase supply.

§5. Producers will consider time when responding to abnormal prices. In the short run, marginal producers will work harder to add more quantity to the market while incumbents enjoy excess profits from above-average prices. If abnormal prices look set to endure, then producers will alter their capital mix to fit the “new normal.”

§6. Producers will sell at a loss in the short run (e.g., when higher production costs cannot be recovered in prices), but not without considering impacts on the market, competition and their long-run (capital) costs. Marshall cautions: “he [the producer] regards an increase in his processes of production [VC and FC], rather than an individual parcel of his products [VC], as a unit in most of his transactions. And the analytical economist must follow suit, if he would keep in close touch with actual conditions” [p 312]. Economists should not let their theory stray too far from reality. In modern industrial organization, it’s “continue to produce while pq>c(q) — even if pq-c(q) < fc — but shut down if pq<c(q).”

§7. In the long run, investments in production capacity depend on the expectation of profits. Changes in those perceptions thus impact changes in long run supply, in terms of prices and quantities.

§8. Thus, Marshall concludes, short-run supply depends on current capacity whereas long-run supply allows for changes in capital and thus capacity. In both cases, prices also depend on changes in demand (tastes) as well as technology, which affects both supply (more efficient production) and demand (via the appearance of competing substitutes).


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Interesting stuff

  1. Fossil fuel companies are dying, and that’s good for the environment
  2. Back in 1920, we knew how to reduce the pandemic spread
  3. So many forecasts are not even close to right
  4. Rapidly melting ice means we are facing a big (not included in IPCC) risk of non-linear sea level rise (e.g., +5 meters in 10 years).
  5. Looking back 50 years on shareholders vs stakeholders
  6. How Republicans used local elections to “queer the pitch” in national elections (via gerrymandering)
  7. Airlines are pushing for 30-min preflight C-19 antibody tests. I can see the profit motive. Let’s hope there’s also a penalty for being too lax on false-negatives.

Review: Bad Blood

I’d heard about this book — the story of the rise and fall of Elizabeth Homes and her company Theranos — long ago, but I only decided to read it when preparing readings for my course, The World of Entrepreneurs. I wanted to understand her case, as an example of the dark side of Silicon Valley —  not the side of “fake it until you make it” —  but the side of “lie to everyone, about everything, if that gives you an advantage.”

Aside: I worked in three start-ups in Silicon Valley, of which two were dominated by frauds of the “funding secured” and “vaporware” models, respectively, so I have a real interest in similar stories. That said, I am pretty sure that at least 80% of start-ups are, on the whole, legitimate (read this review). The trouble is not the really bad apples — Theranos and WeWork being recent examples — but those that cut corners as a “necessary part of doing business” — Facebook and Uber being high on that list.

This review will be short because Carreyrou is such a good writer and the story comes at a fast pace. What strikes me are the following:

  • Elizabeth Holmes was an aggressive, ambitious founder who wanted to change the world and become rich and famous. Her challenge was reality. She preferred to ignore inconveniences and distorted reality to convince others that she knew what she was doing, i.e., building a machine that could run 200 blood tests based on a finger-prick sample of blood. Outside scientists told her that her goal was impossible, due to physics and chemistry. Inside scientists, lab workers and “beta-test” doctors said her machine was not working or viable. Rather than listen, she lied about using commercial equipment to do the tests supposedly run on her machines and ignored the dangers of bad results from her machines. (One million tests later deemed “inaccurate” translates into one million stories of false positives, false negatives and needless suffering.)
  • Holmes was aided and abetted by Ramesh Balwani, a boyfriend who assumed that his luck (presence) in an earlier start up made him a visionary. Balwani and Holmes bullied staff, fostered a culture of paranoia, and sent lawyers after whistleblowers seeking to protect investors and the innocent. Different product teams were separated, which limited their ability to spot the fraud but also their ability to find solutions. Lawyers like David Boies worked hard to threaten whistleblowers because they were paid in shares. Holmes recruited a bunch of famous old white men (George Schultz, Henry Kissinger, Rupert Murdoch) whose “halo” protected her company from awkward questions. 
  • The end came when an anonymous insider brought the story to Carreyrou, whose investigations resulted in Theranos’s tests being suspended, arrests and trials. Holmes was not a disruptor; she was caught wearing “the Empress’s new clothes.” The women who saw herself as the next Steve Jobs was actually just another blonde grifter
  • Holmes’s most recent defense is that she’s mentally unfit to face charges. Given her history — and 2019 marriage to the male heir of millions — I assume her defense rests on more lies. (I also worry about her husband, especially if he has a high-value life insurance contract.)

My one-handed conclusion: Read this book if you want a fast-paced story of how self-delusion, greed and privilege (high-priced lawyers who will defend your lies) can allow someone to get away with “statistical murder” (all those wrong tests surely resulted in more than one death). FIVE STARS.


Here are all my reviews.

The investment and distribution of resources

Book 5, Chapter 4

§1.Marshal begins with a simple example of a man building his own house, which he uses to explain how present costs must be less than (expected) future benefits, which are “normalized” (discounted to net present value) via a “sort of compound interest.” I find this beginning quite interesting, since I am now teaching students about cost-benefit analysis and discount rates!

§2. Expanding to the example of a businessman incurring costs now for potential (risk-adjusted) future benefits, Marshall explains how present values are “aggregated” to future values, whereas future values are “discounted” to present values, with the net benefit being calculated at the same point in time.

§3. Competing businessmen will change their mix of inputs in an attempt to find a cheaper means to the same end. Their profit-seeking searches increase efficiency and thus deliver “progress.”

§4. Marshall gives examples of a housewife or house builder changing their mixes of products and inputs, to maximize net benefits. These substitutions are mathematically equalized via “marginal products” that both implicitly understand as if solving equations.

§5. A businessman must recover both “prime” (variable) and “supplementary” (fixed) costs when pricing products for sale.

§6. In the short run, a product’s price need only cover variable costs, but revenues total sales must cover fixed costs in the longer run, if the business is to continue.


This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.