Limitations of the use of statical assumptions in regard to increasing return

Appendix H

§1. Production with increasing returns to scale (or marginal returns) creates a problem with the supply curve (sloping down?) and implies (natural) monopoly power.

§2. Marshall says it would be hard to find equilibrium if demand and supply are both sloping down. Later economists “fixed” this problem, I think, by holding scale constant in the short run (via fixed costs) and then allowing for flat or rising marginal costs. It seems that Marshall was looking at the long run, i.e., where there are no rigidities from fixed costs.

§3. Whoops! Marshall didn’t make that mistake. He discusses how rigidities are likely to affect production (scale) and thus allow for equilibrium (rising supply costs). That said, he does note that some industries with rapidly falling supply costs can result in “plunging” market prices as supply runs ahead of demand. This can happen with new technologies (e.g., cheap airlines) or trade (cheap good from China), for example.

§4. Marshall ends by arguing that declining marginal costs are unlikely in the long run for an entire industry, since demand would never exceed supply. That said, some firms in the industry might have cost advantages, and thus the opportunity to earn quasi-rents in the short run compared to firms on the margin, assuming all receive a market price.

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 from institutional induction to mathematical deduction.

Author: David Zetland

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

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