Interest of capital

Book 6, Chapter 6

§1. Marshall begins with a caveat often omitted these days:

The aid which economic science has given towards understanding the part played by capital in our industrial system is solid and substantial; but it has made no startling discoveries. Everything of importance which is now known to economists has long been acted upon by able business men, though they may not have been able to express their knowledge clearly, or even accurately. (p 482)

Then he lists a number of uses for capital, all of which are reconciled via interest rates: Everyone is aware that the accumulation of wealth is held in check, and the rate of interest so far sustained, by the preference which the great mass of humanity have for present over deferred gratifications, or, in other words, by their unwillingness to “wait” (p 483). I teach students that discount rates (which vary by individual) are related to interest rates in the following way: People with low discount rates are patient relative to those with high discount rates, and they “trade” money — as lenders and borrowers, respectively — at an interest rate that lies between their discount rates.

§2. Ancient prejudice against lending money for interest (usury) makes no sense if it is ok to charge interest when lending things (a house or horse). In both cases, the lender forgoes the use of the money or thing; in both cases, the borrower pays to make use of the money or thing.

§3. Claims by Marx and others that surpluses should be attributed to labor but not capital are based on the same confusion over money and things. If one sees capital as contributing to production and understands that capital accumulation depends on “patience”, then it is hard to deny that productive surpluses should be jointly attributed to capital and labor.

Indeed it is hard to find examples of labor-only production that is equally efficient to production that combines labor and capital. Yes, I can dig a hole with my hands, but it’s much easier to use a shovel, which is why I am happy to pay the shovel-owning capitalist for its use.

§4. With Marx dismissed (one page!), Marshall differentiates between net and gross interest — or what we now call “risk-free” and “market” rates respectively. Gross interest is the rate a lender charges while net interest is what the lender receives after deducting losses from deadbeat borrowers and other elements of a “troublesome business.”

§5. Lenders face risks from borrowers who are unable to put borrowed money to good use (adverse selection) or who are lazy or dishonest (moral hazard). Borrowers face risks from lenders who might refuse to renew their loans, leaving them to face a “cash crunch” that no other lender — on hearing of that refusal — will relieve.

§6. A large share of “investments” merely replace capital that has been lost in use (depreciation). Only a small share of investment adds to capital stocks.

§7. Interest rates must take inflation into account. If buying power is falling, then rates must be higher to return the lender to status quo ante –– and vice versa.


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.

Earnings of labour, continued

Book 6, Chapter 5

§1. Workers need training and education whose value often outlasts capital equipment. Investing in such education requires a long time horizon. Parents might be better equipped to evaluate such an investment than their children or employers.

§2. Parents often choose potential trades (and training) for their children based on current trends, conditions and wages. Such a view  implies that future supply will be (mis)calibrated to past demand.

§3. That said, labor can and will switch between trades in direct proportion to workers’ ability to adapt skills to other work.

§4. Since labor skills are slow to change, it is not sure that they will be efficiently awarded for productivity or matched to demand at all times.

§5. The slow pace of change in labor supply means that workers will make excess profits when demand in their industry rises quickly but also face excess losses when demand flees.

§6. Ignoring wages, physical and mental stress will rise (fall) as demand for labor rises (falls).

§7. Although it may be tempting to describe the extra wages (or reduction in  effort) to good workers as “rents” (see 6.1), Marshall describes them as “lucky” — in explicit contrast to the losses and extra work that “unlucky” workers face from be mismatched into a job or trade that they might have a hard time leaving for another.


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.

Earnings of labour, continued

Book 6, Chapter 4

§1. Wages might reflect custom more than current values. In cases where the interaction of supply and demand pushes down wages, workers’ difficult conditions are made worse.

§2. A businessman investing in machines (or slaves) will do so with the intention of future returns. Improvements to workers stays with those workers, which can lead to underinvestment by outsiders but efficient investment if the worker makes those decisions. (Marshall quotes Smith’s point that a slave-owner will not invest as wisely as the slave would themself.) While parents are eager to invest in their children (converting financial into human capital), it is easier for middle-class parents than working-class parents, which can trap generations in poverty.

§3. Within families, the father can earn wages to help the family and introduce his sons into trade, while the mother raises and improves children as they grow. Among the poor, fathers are often tired and mothers forced to work, leaving their children worse off in the present and future.

In a footnote on page 469, Marshall discusses the “net contribution” of migrant workers and warns against overvaluing men and undervaluing women due to the their joint-importance in raising children (the next generation of workers). This topic (migration, national accounts, and brain-drain) is still hotly debated.

§4. An employer’s investment in workers will only be partially repaid in higher output and profits, but a minority of employers invest as part of their overall quest for performance. Their workers will benefit immediately, as will their families. A majority of employers will not invest more than they immediately get back — weakening future returns to themselves, their workers and society.

§5. The location and quality of the workplace matters. Workers will demand higher wages in dirty or dangerous workplaces. A big distance between home and workplace limits the supply of labor unless wages rise. Immobile workers have fewer options and lower wages. Related:  US-labor mobility is at an all-time low:

§6. Workers who lose their jobs lose wages. If they do not have reserve savings, they suffer from a lack of necessities as well as a decline in their labor value based on greater hunger and poverty. (The homeless are challenged by a lack of an address for employers, bad sleeping conditions, needing to buy food “by the plate” and other burdens.) Workers with special skills and/or union membership will have greater job security and earn a larger share of their “value added.”


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.

Earnings of labour

Book 6, Chapter 3

§1. This chapter looks more deeply into the factors (e.g., natural skills or experience) affecting wages, as later chapters will examine business profits and land rents.

§2. The prices of commodities vary with their quality or the terms of sale, so wages for (more irregular) labor will very more. Assuming a competitive labor market and similar capital inputs, then we will see a greater difference in wages between workers with different skills (i.e., efficiency). Put differently, wages will be equal for workers of different skill if laws prohibit wage discrimination or if there is little competition. More interesting (or counterintuitive), it makes sense to pay more to higher skilled workers because they can operate expensive machinery more efficiently and produce  more output per hour per machine than the less skilled.

§3. Real wages, unlike nominal wages (cash payments), depend on the cost of living and the mix of goods workers consume. (They usually care more for the price of bread than the price of opera tickets.)

§4. Gross wages do not translate into real wages as it is necessary to deduct the cost of education, special tools, and other expenses needed to do one’s job. In some cases, those expenses may include membership to a club, fancy clothes, etc. (My dad was a real estate agent in Southern California, where a fancy car is de rigeur.)

§5. The employee’s value of non-cash “wages” often differs from their cost to the employer, so it’s a mistake to assert their value based on cost, price or some other number. In some cases, the value is less than the cost; in others the opposite (read Marshall’s footnote on scams). It’s no problem that these matters affect employer-employee dynamics. It’s a problem when outsiders misunderstand how values, prices and costs affect decisions.

§6.  A 50% chance of earning either x or 3x is less valuable than 100% chance at 2x (cf. Book 3, Chapter 6). Entry-level workers will accept below-market wages if they can potentially be promoted to above-market-wage positions (young men often take these odds). To compensate for the “anxiety and worry of waiting,” irregular employment requires higher wages than steady employment.

§7. Besides the worker’s wages, it’s important to consider the situation (e.g., potential jobs and wages) affecting the worker’s family.

§8. The attraction of a trade — and thus its wage level — depends on the tastes, skills, background, social position of potential workers. Some are willing to accept jobs others won’t. After lamenting that “the progress of science has kept alive many  people who are unfit for any but the lowest grade of work” (p 464), Marshall explains that some jobs are kept dirty (not made attractive to skilled workers) employers know they can save money by hiring the lowest classes to do them. “There is no more urgent social need than that labour of this kind should be made scarce and therefore dear” (p 464).


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.

Preliminary survey of distribution, continued

Book 6, Chapter 2

§1. Labor earnings are not — as some assert — only a function of the “value” of production. They depend on the supply of labor relative to demand for labor.

§2. Workers, like machines, need time to recover from work. The first hours of work are easier than the last hours but wages are paid at the margin (i.e., to motivate those last hours of work), which implies that workers gain much more surplus from their earlier hours of work. That said, some workers (“from Southern climes”) may see higher wages as an incentive to stop working earlier, since they more quickly hit their “earnings target.”

§3. The supply of labor should increase with wages, assuming higher wages increase productivity-enhancing (e.g., good food or entertainment) rather than productivity-weakening (e.g., alcohol and gambling) consumption.

[D]emand and supply exert coordinate influences on wages; neither has a claim to predominance; any more than has either blade of a pair of scissors, or either pier of an arch. Wages tend to equal the net product of labour; its marginal productivity rules the demand-price for it; and, on the other side, wages tend to retain a close though indirect and intricate relation with the cost of rearing, training and sustaining the energy of efficient labour. The various elements of the problem mutually determine (in the sense of governing) one another; and incidentally this secures that supply-price and demand-price tend to equality: wages are not governed by demand-price nor by supply-price, but by the whole set of causes which govern demand and supply (p 442).

§4.

We have seen that the accumulation of wealth is governed by a great variety of causes: by custom, by habits of self-control and of realizing the future, and above all by the power of family affection: security is a necessary condition for it, and the progress of knowledge and intelligence furthers it in many ways. But though saving in general is affected by many causes other than the rate of interest: and though the saving of many people is but little affected by the rate of interest; while a few, who have determined to secure an income of a certain fixed amount for themselves or their family, will save less with a high rate than with a low rate of interest: yet a strong balance of evidence seems to rest with the opinion that a rise in the rate of interest, or demand-price for saving, tends to increase the volume of saving.

…that said, higher interest only gradually attracts more capital since it takes time to reallocate capital from existing investments.

§5. Increases in the supply and productivity of labor and capital (and thus returns to either) lead to increases in national income, for the benefit of all. Land is different because it is fixed in quantity, which means that increased land use by one user leaves less land for others.

§6. Increases in national income benefits factors in proportion to demand for each of those factors. Higher returns to a factor dampen demand for it as cheaper alternatives are investigated, with a long-run result of factor prices tracking their “real” contribution to productivity.

§7. An increase in the supply of a factor will lower returns to that factor and benefit other factors that that combine with that input without lowering their returns. In general, factors will be able to buy as much as their productivity (=wages) implies, with more productive or scarce factors having more “buying power” than less productive or abundant factors.

§8. Do not assume “perfect information” of any factors but labor and capital are always looking for opportunities.

§9. Since capital can also be understood as the embodiment of past labor, it is better to see capital-labor competition as past vs present labor. Greater savings (or patience) will increase the stock of capital, which can increase labor productivity but also displace demand for labor!

§10. Although labor contributes to finishing products on behalf of capital, most wages to labor are advanced by capitalists planning to repay those advances by selling consumption goods and using (new) capital goods.

Capital in general and labour in general co-operate in the production of the national dividend, and draw from it their earnings in the measure of their respective (marginal) efficiencies. Their mutual dependence is of the closest; capital without labour is dead; the labourer without the aid of his own or someone else’s capital would not long be alive. Where labour is energetic, capital reaps a high reward and grows apace; and, thanks to capital and knowledge, the ordinary labourer in the western world is in many respects better fed, clothed and even housed than were princes in earlier times (p 452).


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.

The distribution of the national income

Book 6, Chapter 1

§1. Marshall’s thoughts on national income are too good to summarise (p 418):

The keynote of this Book is in the fact that free human beings are not brought up to their work on the same principles as a machine, a horse, or a slave. If they were, there would be very little difference between the distribution and the exchange side of value; for every agent of production would reap a return adequate to cover its own expenses of production with wear-and-tear, etc… But as it is, our growing power over nature makes her yield an ever larger surplus above necessaries; and this is not absorbed by an unlimited increase of the population. There remain therefore the questions: What are the general causes which govern the distribution of this surplus among the people? What part is played by conventional necessaries, i.e. the Standard of Comfort? What by the influence which methods of consumption and of living generally exert on efficiency; by wants and activities, i.e. by the Standard of Life? What by the many-sided action of the principle of substitution, and by the struggle for survival between hand-workers and brain-workers of different classes and grades? What by the power which the use of capital gives to those in whose hands it is? What share of the general flow is turned to remunerate those who work (including here the undertaking of ventures) and “wait,” as contrasted with those who work and consume at once the fruits of their endeavours?

Recall that Marshall is writing in 1920, whereas GDP was “invented” in 1934. His points above were (and are) often forgotten by people focussing on the size, rather than the distribution, of GDP.

§2. Marshall delves into historic thinking about labor and capital. He summarises the views of France’s 17th century physiocrats and Malthus as variations on “iron laws” in which capital comes and goes as taxes fall and rise, and labor supply rises and falls as food is plentiful or scarce, respectively. From these views came the idea of “laisser faire, laisser passer“, which advises the King to raise revenues by taxing landowners’ surplus rents (capital and labor having no surplus in equilibrium) while leaving everyone else to do what they like (laissez faire is the expression we’re more familiar with). Adam Smith, David Ricardo, et al. did not agree with these “laws;” instead, they focussed on incentives, e.g., higher wages lead to greater effort, not more children. These thoughts had evolved by Marshall’s time into an empirical investigation of how higher productivity could cause (permanently) higher wages, thereby introducing questions of distribution among “rich” and “poor” labor.

§3. To explain distribution, Marshall begins with an imaginary world in which capital and resources are “free,” and everyone can do any job. In this world, wages and prices are directly proportional to effort (labor theory of value), and increases in labor productivity make everyone better off, i.e., consuming more goods for the same labor input.

§4. Specialisation does not change these relations, since anyone can change trades (with some time), but it does increase the diversity of goods/services on offer.

§5. Population growth brings an increase in demand and diminishing returns on land-based food production. With higher prices for food, land “rents” will grow faster than returns to labor or capital.

§6. By adding back obvious factors affecting labor (mobility, tradition, law and morality), Marshall approaches realism, and unequal returns to labor emerge.

§7. Marshall adds realistic assumptions on capital, i.e., that capital is limited and “lumpy” (not matching each unit of labor). Now managers must match labor and capital “on the margin,” in two ways. First, each labourer’s additional production must exceed their wages. Second, management should decide based on marginal rather than average values. Although economists had been advocating “marginal thinking” for several decades before Marshall’s Principles, he still played an important role in explaining how such thinking was useful for making business decisions.

§8. Interest rates push capital from wasteful to useful investments, since (in)efficient investments (lose) make money.

§9. In sum, “every agent of production, land, machinery, skilled labour, unskilled labour, etc., tends to be applied in production as far as it profitably can be. If employers, and other business men, think that they can get a better result by using a little more of any one agent they will do so” p 432.

§10. The “net” in national income reflects replacement of worn machines plus a fraction of the enduring contribution of new machines, but excludes “income’ (benefits) derived from common practices of individuals, i.e.,

Thus, unless anything is said to the contrary, the services which a person renders to himself, and those which he renders gratuitously to members of his family or friends; the benefits which he derives from using his own personal goods, or public property such as toll-free bridges, are not reckoned as parts of the national dividend, but are left to be accounted for separately (p 434).

This last statement will be familiar to anyone critical of the exclusion of “self-production” or “a mother’s work” from GDP statistics. It’s also unusual (relative to GDP discussions) in calling for those factors to be accounted for separately.


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.

Summary of the general theory of equilibrium of demand and supply

Book 5, Chapter 15

§1. Supply and demand are most likely to change when considering spacial and temporal elements. In the short run, supply capacities are fixed such that an increase in demand means higher prices. In the longer run, capacities can adjust to meet demand.

§2. The demands for complementary goods and production inputs are interdependent.

§3. Producers with access to “the gifts of nature” can earn exceptional rents from their cost advantage. On the other hand, inefficiently employed land or labor will mean less-than-normal profits.

§4. An increase in output in the short run generally leads to higher unit prices, but an increase over the long run might result in lower prices, due to the possibility of changing production technology. For dominant producers (with some measure of monopoly power), an increase in supply might lead to lower prices, which they will want to avoid.

§5. When seeking to promote “maximum satisfaction” (optimal social welfare), it is important to increase (decrease) supply where increasing (decreasing) returns to scale are present. Monopolists should therefore be encouraged (constrained) in their production choices.

When defining “value,” Ricardo has been twice misinterpreted. Some claim his cursory review of demand was dismissive when Ricardo thought demand’s importance too obvious to discuss. Second, Marx assumed Ricardo was only concerned with the quantity of labor used in production when Ricardo included labor quality, capital and timing in understanding the supply side of value.


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.

The theory of monopolies

Book 5, Chapter 14

§1. “It has never been supposed that the monopolist in seeking his own advantage is naturally guided in that course which is most conducive to the wellbeing of society” p 395.

§2. Monopoly revenue (as opposed to “rents,” which Marshall reserves for excess profits from access to scare resources) exceeds production, debt and risk costs.

§3. Marshall uses a figure to show that the monopolist earns the greatest profit at a combination of price and quantity. Since higher prices mean lower quantities (and vice versa), this combination is in a “sweet spot.”

§4. The monopoly’s behavior does not change with lump sum taxes or percentage taxes on profits. A tax (or subsidy) on output quantities or prices will change the profit-maximising quantity.

§5. Although one might assume a monopoly will charge a higher price and provide a lower quantity than a group of competitive firms (modern economics texts do), that assumption would be wrong if competing firms have extra costs from trying to win each other’s customers or lack economies of scale. OTOH, a lazy monopolist may not look for cost savings compared to competing firms, so there’s no easy answer. (Marshall compares a monopoly railway to competing railways — a mix the British are still struggling with!)

§6. The monopolist might lower prices in the short run to encourage more demand (more customers, consuming more) in the long run.

§7. A monopolist who takes consumer surplus into consideration will sell a larger quantity at a lower price.

§8. Producers and individual consumers know their surplus, but the overall situation of consumers is to know, which makes it hard to set policy without better statistics:

Much of the failure and much of the injustice, in which the economic policies of governments have resulted, have been due to the want of statistical measurement. A few people who have been strongly interested on one side have raised their voices loudly, persistently and all together; while little has been heard from the great mass of people whose interests have lain in the opposite direction; for, even if their attention has been fairly called to the matter, few have cared to exert themselves much for a cause in which no one of them has more than a small stake. The few therefore get their way, although if statistical measures of the interests involved were available, it might prove that the aggregate of the interests of the few was only a tenth or a hundredth part of the aggregate of the interests of the silent many (p 407)

In the paragraph that follows, Marshall offers a charming (or naive) hope:

It is perhaps not unreasonable to hope that as time goes on, the statistics of consumption will be so organized as to afford demand schedules sufficiently trustworthy, to show in diagrams that will appeal to the eye, the quantities of consumers’ surplus that will result from different courses of public and private action. By the study of these pictures the mind may be gradually trained to get juster notions of the relative magnitudes of the interests which the community has in various schemes of public and private enterprise (p 408).

Sadly, economists have been unable to generate reliable demand schedules, so most policy discussions depend on special interests, political guesswork, and duelling economists.

§9. Two adjacent monopolies (e.g., for copper and zinc, both needed for brass) might be worse than a merged monopoly for society if their attempts to dominate each other disrupts markets. That said, a merged monopoly will be worse if it can more easily block new competition than separate (weaker) monopolies. Caveat regulator.


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.

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.

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.