Equilibrium of normal demand and supply, continued, with reference to the law of increasing return

Book 5, Chapter 12

§1. Quantity demanded nearly always* moves in the opposite direction of its price. It’s best to assume that price leads to quantity demanded rather than the other way around.

* Marshall adds the caveat of: [ignoring] “exceptional cases in which a thing is driven out of fashion by a fall in its price,” which refers to Giffen Veblen goods whose demand rises with price due to the exclusivity conveyed by higher prices.

Switching to supply, Marshall asserts that expected quantity drives price by establishing the scale of production. Manufacturers expecting to sell a lot of widgets will install more (high fixed cost, low marginal cost) capacity than when they expect to sell few widgets. This dynamic holds in the long run. In the short run, there’s a chance that higher prices can increase quantity for sale, but that’s usually the result of depleting inventories.

§2. The circumstances and longevity of individual firms are less predictable than the circumstances of an entire industry. Firms come and go; their markets endure.

§3. Progress over time within an industry is equivalent to increasing returns to scale, which means that prices are falling with capacity. Analysts looking for [static] equilibria will miss this dynamic. Many modern economics texts focus so closely on equilibrium (or perhaps equilibria moving over time) that they miss the reality of evolving markets. Damn.

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.

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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