Theory of changes of normal demand and supply in relation to the doctrine of maximum satisfaction

Book 5, Chapter 13

§1. Gradual changes in demand and supply result in gradual changes (=slides) in price or quantity. Larger changes due to novel tastes, technologies, goods, etc. (=shifts in D or S) will be more disruptive. Marshall’s mix of slides and shifts can be confusing for those new to D & S  figures.

§2. Marshall combines short and long-run supply curves in a way that might seem confusing to those of us taught about supply in the short run (technology and economies of scale are fixed) as compared to the long run (economies of scale can be altered because all costs are variable).

But I think his figures do a better job at explaining level (fig 24), rising (fig 25) and falling (fig 26) prices, via, respectively, constant (CRS), decreasing (DRS) and increasing returns to scale (IRS) that change the supply curve.

Marshall also mentions that IRS are more likely in immature industries where technology and markets are developing. He points out that tariffs to protect “infant industries” might indeed help both suppliers and consumers but warns that most tariffs protect mature (DRS) industries whose prices will rise if foreign supply (competition) is cut.

§3. So prices might rise, fall or not move with an increase in demand.

§4. Marshall investigates the impact of price changes on consumer surplus (CS) with the examples of taxes and subsidies (“bounties”). Without calling it “deadweight loss” (DWL), he explains how a tax — given constant returns, i.e., a flat supply curve — will reduce CS by the amount of the tax (a transfer) as well as the triangular DWL formed by the Δp reducing quantity demanded. A bounty produces the same “disproportionate” CS change in favor of the consumer. In examples with decreasing or increasing returns to scale, Marshall points out at that a tax (bounty) will reduce (increase) costs in such a way as to diminish (expand) the cost of the tax to the treasury.

Marshall notes the tradeoff between tax efficiency (loss of CS) vs fairness (ability to bear):

The net loss aKA is small or great, other things being equal, as aA [the demand curve] is or is not inclined steeply. Thus it [the DWL] is smallest for those commodities the demand for which is most inelastic, that is, for necessaries. If therefore a given aggregate taxation has to be levied ruthlessly from any class it will cause less loss of consumers’ surplus if levied on necessaries than if levied on comforts; though of course the consumption of luxuries and in a less degree of comforts indicates ability to bear taxation. p 387

§5. Marshall notes that “maximum satisfaction” will occur where D and S cross, since both consumers and producers gain from exchange up to that point, with their joint surplus represented by the area above the supply curve and below the demand curve (e.g., the area DSA in fig 24). This is Economics 1.

Marshall then explains how it may be possible to further increase surplus in two cases. First, an increase in quantity supplied when costs are stable (CRS) but benefits are rising (elastic D) might increase total surplus, even if there’s a loss to producers. He gives the example of the benefit to the poor of cheaper food. He also mentions the conventional “solution” to this problem: taxing the rich to subsidize the poor (“lump sum transfer”). Second, he suggests that it may be useful to subsidize production in the case of increasing returns to scale, since that might bring forth so much supply, at lower prices, as to make consumers so much better off as to justify the cost of the subsidy.

§6. Marshall suggests a community might increase its wealth by taxing DRS producers to subsidize IRS producers before listing many “moral” concerns with such a plan, e.g., producers lobbying for subsidies.

§7. A shilling in the hand of a poor person is worth more (happiness) than a shilling in the hand of a rich one, just as one’s spending on DRS-goods harms neighbors (by contributing to higher costs) than spending on IRS-goods. Combined, these examples should convince readers that an ad valorem tax is not — as often asserted [at the time] — “neutral” in its effects on either consumption or production. Thus he cautions against over-confident government “interference” into markets and prices.

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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