L.S.E. Essays on Cost
A lecture delivered before the Nationalökonomischen Gesellschaft, Vienna, 7 April 1933. First published in the Economic Journal (March 1934).
The theory of costs is not one of those parts of economic analysis which can properly be said to have been unduly neglected. It has always occupied a more or less central position, and in recent years it has been the subject of a quite formidable body of new work. There is, indeed, no part of his subject about which the contemporary economist may legitimately feel more gratified, either as regards the quality of the work which has been done or as regards the temper in which it has been undertaken. Yet, in spite of this, the present state of affairs in this field is not altogether satisfactory. The various problems involved have been tackled by different sets of people; and the conclusions which have been reached in one part of the field have sometimes a rather disquieting appearance of incompatibility with conclusions which have been reached elsewhere. No doubt some of this apparent incompatibility is real. It is not to be expected that here—any more than elsewhere—economists should have reached finality. But some of it is probably illusory; and if in discussing these matters we were to state more decisively the problems which we are attempting to solve, and the assumptions on which we proceed, it seems likely that not only should we be able to clear up our outstanding real points of difference more quickly, but that, in the course of doing so, we should also discover that many of them depended essentially upon subtle differences of object and assumption, hitherto insufficiently stated. At any rate, it is in the belief that this would be so that these very tentative remarks are put forward.
The paper falls into four parts. In the first I discuss the fundamental nature of costs; in the second the relation between this conception and the Marshallian supply curve; in the third the relation between costs and technical productivity. I conclude with some notes on cost variation through time.
I start, then, with fundamentals. The conception of costs in modern economic theory is a conception of displaced alternatives: the cost of obtaining anything is what must be surrendered in order to get it. The process of valuation is essentially a process of choice, and costs are the negative aspect of this process. In the theory of exchange, therefore, costs reflect the value of the things surrendered. In the theory of production they reflect also the value of alternative uses of productive factors—that is, of products which do not come into existence because existing products are preferred.*10 Such is the conception of costs first systematically developed by Wieser*11 and made familiar in English-speaking areas by Green, Wicksteed, Davenport, Knight and Henderson.*12 Following the usage of Pantaleoni*13 and many others, we may refer to it for short as Wieser's Law.
It is probably true to say that at the present day the broad outlines of this conception are generally acceptable.*14 The work of Wieser's successors in this field—in particular the various writings of Professor Mayer—have brought home to us all its central importance as a unifying principle in the structure of modern analysis. And, in the sphere of applied economics, it becomes more and more clear that many of the most urgent problems of the day can be understood only in the light of the knowledge that it furnishes.*15
But there is one matter on which there is not yet full agreement. It relates to the precise mode in which the displaced alternatives are to be conceived. Wieser's usage is clear. They are to be conceived in terms of values—in terms of the values of the goods of the first order displaced. 'The cost of production of one thing', said Wicksteed, 'is the marginal value of another thing.'*16 This is the sense in which it has usually been understood. In recent years, however, it has been suggested in some quarters that they should be conceived in terms of technical quantities-in terms of the quantities (as distinct from the values) of the goods of the first order which might have been produced. This is the procedure suggested by Professor Knight in his 'Suggestion for Simplifying the Statement of the General Theory of Price'.*17 He invokes Adam Smith's parable of the beaver and the deer and concludes: 'In sum, the cost of beaver is deer and the cost of deer is beaver, and that is the only objective and scientific content of the cost notion.' The same procedure is adopted by Dr Haberler in his recent article on the theory of comparative cost.*18
Now there can be no doubt that there is much that can be said for this suggestion. The conception of costs as technical displacement has an objectivity and precision which is in itself an advantage. It has none of that elusiveness which seems to inhere in concepts involving subjective valuation. Moreover it is true that in equilibrium the values of goods produced with common factors of production and variability of technical coefficients are necessarily in harmony with their displacement-cost ratios. It has been well known since the time of the classical economists that this was the case with the products of simple unskilled labour. This is, of course, the moral of the parable of the beaver and the deer. It is the achievement of Professor Knight and Dr Haberler to have shown that the same generalization can be extended to cover the case of production with more than one factor of production. If the amount of a commodity produced by a combination of factors of production is not the same as can be procured by devoting the same combination to the production of something else and procuring the first commodity by way of exchange, then clearly, if the conditions of production are technically variable, there will be evoked movements which tend to bring about this harmony.
So far so good. The argument seems overwhelmingly convincing. But on closer inspection certain difficulties present themselves. In the first place it is important to recognize that there are wide areas where the conception of costs as technical displacements clearly has no application. This is the case if the productive process involves fixed technical coefficients. The imputation problem (and hence the cost problem) here can only be solved in value terms. Costs of production in value terms can and will change with changes in demand.*19 But the idea of changes in technical displacements in this instance has no meaning. The same is true where we are considering commodities produced with different factors of production. If A and B are produced with n and m and C and D with p and q, there will exist exchange ratios between members of the first group and members of the second, but it is impossible to conceive of technical displacement cost ratios save within them. There may be an exchange ratio between A and D, but when A is produced there is no technical quantity of D sacrificed. Yet there will certainly exist costs of production in the value sense.
Moreover—and this is even more important—it is the central requirement of any theory of cost that it shall explain the actual resistances which production in any line of industry encounters; that it shall explain to us the influences determining the elements of which account is taken by those responsible for production. Now there can be no doubt that these influences are of the nature of valuations. The isolated producer thinks of the sacrifice he is making by not producing something else. The entrepreneur in the exchange economy thinks of the prices he has to pay for the factors of production. In each case, although—as with all valuations—there may be in the background a technical condition, yet the final determinant is not merely technical. The isolated producer thinks not merely of the quantity of goods he gives up, but of their place on the relative scale, compared with the place on the relative scale of the goods he acquires. The price which the entrepreneur pays for the factors of production he uses is determined not by the number of products which they can produce elsewhere, but by the value of such products. Indeed it is most highly improbable that he knows at all the number of products which can be produced elsewhere. All that he knows are values of the factors of production, which are, of course, reflections of the value of other products. If we reflect upon the way in which equilibrium is established, it is surely obvious that it is only through regard for cost in the value sense that any harmony between technical displacements and prices can be conceived to come about. It is only in equilibrium that such a harmony exists. In a state of disequilibrium, prices, costs and displacement ratios may all be different. If we do not keep these things conceptually discrete, we cannot understand the actual process of equilibration. This is not merely true of the Austrian approach. The condition that prices shall be equal to cost of production in the value sense is as essential a condition of equilibrium in the Walrasian system as the condition that marginal products shall be proportionate to factor prices.
For both these reasons, therefore, because there are whole areas where technical displacements are not conceivable, and because it does not focus attention on the actual process of price formation, I conclude that the conception of costs as quantities of goods forgone is not acceptable. No doubt the technical conditions of production play an important part in determining the conditions of equilibrium. But to make the cost concept purely technical is to deprive it of important analytical functions and to run the risk of misunderstanding. We shall see that a very similar procedure underlies some of the deficiencies of particular equilibrium analysis.
But this brings me to the second part of my paper: the relation between this general conception of costs and the Marshallian supply curve.
According to Wieser's Law, costs of production under competitive conditions are a reflection of the value of the alternatives which are displaced in order that the goods in that line of production may be produced and appropriated by the ultimate consumers. That is to say, they are essentially a reflection of the strength of excluded demands—demands both for the specific factors specialized to such lines of production and the non-specific factors capable of employment elsewhere. It seems to follow that, in the normal case, at the point of equilibrium, just as demand price will be decreasing, so will cost be increasing. This is quite obvious in the case of equilibrium of two commodities. To push production beyond that point would involve a product of diminishing relative utility—that is, a sacrifice of increased relative utility. I do not think that the situation is fundamentally changed when we consider many commodities. Nor do I think that in this connection it is necessary to take account of the possibilities of unusual utility functions. To move in any direction from a position of equilibrium is to encounter increased resistance: this is the fundamental conception.
But if this is so, what are we to say of the constructions, so familiar in the Marshallian system of what is sometimes called—in my opinion not very helpfully-'partial equilibrium analysis': the supply curve parallel to the x axis, and the supply curve with a negative inclination? At first sight we seem to be faced with a complete contradiction. Here are constructions which, if they are valid, seem to point to a definite rejection of our fundamental conception, while if it is valid, seem themselves to be doomed to be rejected. Nor are we in any way reassured when, turning to post Marshallian criticism, we find it stated on high authority that, for the analysis of competitive conditions—and of course it is competitive conditions which are in question—constant cost is to be regarded as the normal and increasing cost as the quite exceptional condition.*20 We seem to have discovered a major inconsistency in the very centre of the corpus of pure economics.
Now in circumstances of this kind, before concluding that it is necessary to make a complete break with one or other of the apparently conflicting usages, it is always advisable to inquire more closely into the implicit assumptions on which they proceed. Again and again in the history of economic thought the apparent contradiction between different usages has come to be seen to rest not upon deficiencies of logic on the one side or the other, but upon differences of assumption concerning the problem to be solved. This was notoriously so in the case of the historic disputes regarding the theory of rent.*21 A similar difference can, I think, be shown to underlie part at least of this apparent contradiction in the theory of costs.
For if we look more closely at the constructions in question, it becomes fairly clear that they are appropriate to the investigation of fundamentally separate problems. The general propositions regarding costs which spring from Wieser's Law are essentially a description of the conditions of equilibrium. They answer the question, what would happen to costs if, from a position of equilibrium-other things remaining equal-it were attempted to increase or diminish production in any particular line of industry. The constructions which we associate with particular equilibrium analysis, on the other hand, deal with what would happen if other things were varied; i.e. if production were to be increased in response to an increase in demand. That is to say, that they are essentially germane to a theory of variations. They relate not to forces which maintain equilibrium once it is established, but rather to the differences between one equilibrium position and another.
Once this is realized the apparent contradiction which we have been considering vanishes. If other things do not change and it is attempted to increase the supply of a certain product, from the point of equilibrium, then it is natural that costs should rise, for the increase must be brought about by the use of factors which are more urgently demanded elsewhere. But if other things change—if, for instance, there is an increase in the demand for this line of product—then an increase of production to meet it need not encounter such an increased resistance. The change in the data which is characterized by the increase in demand here must be accompanied by a diminution of demand elsewhere, and this may be such as to release factors of production in such measure as to permit the necessary extension at constant, or even at diminishing cost. Once the data change, there is no presumption that an increase in output of a particular kind must be accompanied by more than proportionately increased outlay.
There is therefore no fundamental incompatibility between the implications of Wieser's Law and the constructions of 'particular equilibrium' cost analysis. But it still remains to decide what degree of validity is to be attributed to these constructions in the actual connections in which they are most frequently employed.
If what I have been urging is correct, it seems clear that we cannot regard the Marshallian supply curves as serving the exact purposes of any causal explanation. They are rather to be regarded as providing schemata of certain possibilities of price variation. If the demand varies in this way and if the cost varies in this way, then it is implicit in these assumptions that the price will change in this way. They provide, as it were, a convenient shorthand note of different ways in which particular changes may be regarded. According to Edgeworth, 'movement along a supply and demand curve of international trade should be regarded as attended with rearrangements of internal trade: as the move ments of the hand of a clock corresponds to considerable unseen movements of the machinery'.*22 It is the implication of what I have already said, that this too must be the way in which we should view the supply curves of the theory of domestic values, if our usage is not to be out of harmony with the more precise implications of general-equilibrium analysis. They are notes of the implications of given changes of the general conditions of demand and supply, even though one curve is not shifted.
If this is true, it follows that the construction in question must have a very limited validity for the analysis of the ultimate conditions of equilibrium. Its essential function is to facilitate the examination of what happens when certain conditions are varied. The assumption which underlies its use in descriptions of final equilibrium, that all possible variations outside the particular industry or market under consideration may be neglected, is essentially incompatible with the assumptions upon which any exhaustive description of such conditions must necessarily be based. This, indeed, is only another way of putting the point which has already been made. The assumption that the factors of production have an infinitely elastic supply leads to a concentration on the purely technical features of the situation which necessarily misleads when the conditions of final equilibrium have to be determined. The objection made earlier to the Knight-Haberler method of treating technical displacements as equivalent to value costs applies much more strongly to a treatment of value costs which proceeds as if only technical determinants were relevant. It is quite true that, in a condition of competitive equilibrium, the prices of factors common to different industries are the same for the different industries concerned. But this is one of the results of the equilibrating process. It cannot be assumed to be a condition which would necessarily persist, were the other relations in the equilibrium disturbed. Yet this, of course, is the implication of a 'constant cost' supply curve which is prolonged on either side of the point of equilibrium intersection.
Now, no doubt, once we get away from the hypothesis of pure competition, there are many problems in which the technical element is so predominant that for certain purposes constructions which focus attention upon such elements are permissible and helpful. It is well known that this is so in the case of the theory of monopoly. Recent work suggests that it is so in the case of the analysis of imperfect competition.
But such uses have their limitations. It is clear that they may be very definitely misleading when it is a question of deciding the significance for the economic system as a whole of one equilibrium position as compared with another. As I have argued elsewhere,*23 I am of the view that most investigations of this sort beg other, more fundamental, methodological questions. But, putting this on one side, it is surely clear that constructions which depend on the assumption that other things elsewhere remain unchanged, must necessarily lead to false conclusions when it is a question of estimating the total significance of changes which, by definition, cannot be unaccompanied by changes elsewhere.
A simple example will make this clear. In the analysis of monopoly, for certain purposes the apparatus of intersecting demand-and-supply curves provides first approximations which are acceptable. But in any attempt to discover the significance for the economic system as a whole of monopoly in any line of industry it is open to very grave objections. For the assumption on which it proceeds—the assumption that other things remain equal—is incompatible with the most obvious implication of monopolistic restrictions; namely, the assumption that, since the number of factors employed in the monopolized industry is different from what would otherwise have been the case, their productivity in price terms must necessarily be different. It is illegitimate to argue that this change is of the second order of smalls. It may be of the second order of smalls for the monopolist's price policy. It may be of the second order of smalls in each of the other branches of industry affected; but for all the other branches of industry taken collectively it must be of a magnitude comparable in the universe of discourse—the 'social' effect of the policy—with the magnitude of the primary variation. The objection, it will be noted, is almost exactly symmetrical with the fundamental objection to the use of the concept of consumers' surplus.
The case I have chosen is, of course, a very simple one. I should be very sorry to be understood as suggesting that those who use the apparatus I am discussing more frequently than I would care to do are likely to be unaware of the proposition it exemplifies. But experience of the controversies of the last twenty years does, I think, suggest that the use of supply curves, rather than the apparatus of general-equilibrium analysis, in discussing questions of this sort, carries with it dangers which may entrap even the subtlest and acutest intellects. There is a passage in the late Professor Young's critique of Professor Pigou's former position with regard to diminishing return industries*24 which has always seemed to me to be especially significant in this respect although, curiously enough, it has not attracted as much attention as other parts of the article. 'The problem as a whole, it seems to me,' he says, 'is one to which the general theory of the diminishing productivity of individual factors is appropriate rather than the curve of marginal supply prices.'*25 A fallacy which ensnared both Edgeworth and Professor Pigou is one which must necessarily be regarded as peculiarly deceptive. But I doubt very much whether they would have been thus ensnared if, instead of approaching the problem from the point of view of the intersecting curves of particular-equilibrium analysis, they had started from the marginal-productivity theorems—the example par excellence of the general-equilibrium approach.
I hope I have said enough to make clear my view that there are profound dangers in any approach to the cost problem which identifies cost with the merely technical or which treats costs as if only technical influences were significant. It is therefore with an easy conscience that I can advance to an examination of certain aspects of the relation between costs and productivity in the technical sense.
There is no need for me to detain the reader with an examination of those variations of technical productivity which lead to increasing supply price. This is one of those parts of economic analysis where there is little ground for disagreement on purely analytical considerations. Dr Sraffa, who is sceptical of the importance of the conception, bases his scepticism avowedly upon empirical grounds. Cases where one line of production utilizes so large a proportion of the total supply of any factor of production that changes in the demand for the product will bring about changes in its price, he thinks, are rare. This view is apparently shared by Professor Knight. Whether or not one regards this as having prima facie plausibility, depends in part, I think, upon one's view on the classification of the factors of production. It sounds much more plausible if one thinks of two factors of production than if one thinks of many. But, in any case, no analytical issue is at stake.
But, on the other hand, when we come to those technical conditions which lead to diminishing supply price we find a very different state of affairs. The broad considerations involved in the discussion of imperfect competition and monopoly are perhaps not open to serious question. But the problems of diminishing costs under competition are still the subject of dispute and it is interesting to linger a little in this region.
We have seen already that if demand for a particular commodity increases, it may be accompanied by changes in demand elsewhere such as to cheapen the factors of production in the line of production in question. This is a possibility which emerges from general-equilibrium theory, but it is not the possibility with which I wish to concern myself in this connection. What I want to do rather is to concentrate upon the possibility of cost reductions which are due to the operation of technical factors.
Now at the present time it is generally agreed that, under purely competitive conditions, such reductions must be the effect in the first instance of the operation of external economies. That is clear even if, with Marshall and Mr Shove, we recognize that the operation of external economies may be accompanied by changes in the optimal size of firms which themselves involve cost reduction. Unless external economies are operative, the technical influences making for diminishing costs will exhaust themselves before the first point of competitive equilibrium is reached. The influences making for cost reduction must be outside the firms whose costs per unit are under observation.
So far so good; but now the question arises why the external economies operate only as the scale of production increases. Clearly the answer is that it does not pay to initiate the enterprises from which they spring until the demand for the ultimate produce is of a certain size. The doctrine of external economies, as Young emphasized, is merely one way of introducing into analytical constructions the old Smithian doctrine of the advantages of division of labour. It is one of the most familiar platitudes of this doctrine that the wider the market the wider the division of labour which is made possible.
But this does not completely answer our question. For we still remain in the dark concerning the reason why the advantages of division of labour must wait upon extensions of the market. Why cannot the various cost-reducing divisions take place ab initio, but each on a smaller scale? If we put the question in this way, the answer is obvious. For technical reasons they cannot be on a smaller scale. The quantities of factors which are exploited in a progressive division of labour are indivisible below a certain absolute size. Division of labour, external economies, depend upon demand conditions which render indivisible potentialities of production profitable.
But to solve the question in this way is only to find ourselves confronted with another. We have explained the possibility of diminshing costs in this sense by invoking the existence of indivisibility in the methods of production. But the assumption of competition seems to preclude the existence of indivisible factors; in a fully competitive situation the factors of production must be capable of infinite division—or, in practical terms, of such degree of divisibility as to preclude the existence of any increasing return combination, using the term in its technical sense. How then, as the market enlarge with a general increase of factors of production, can we assume indivisibility to be exploited?
The answer is, I think, to be found in the distinction between actual and potential uses of factors of production. It may very well be the case that, given the total conditions of production, productive factors are sufficiently divisible in all the uses to which they are put for the situation to be regarded as competitive. But it is quite possible, at the same time, that some of these factors have potential uses of a different sort which, because of their technical indivisibility, are not exploited until the system as a whole, or large parts of it, has expanded. This, I believe, is a proposition which throws light, not only on the questions we are discussing, but also upon wider questions of localization and general-population theory. Let me try to explain what I mean.
Let me start with the simplest possible example. Among a group of independent producers of some simple product there may be one producer who has special skill at—shall we say—marketing. As a marketer he is greatly superior to the others. As a producer of the simple product he has equal skill. But his skill as a marketer cannot be satisfactorily employed unless there is a certain minimum quantity of marketing to do. Until demand has reached that point, therefore, he appears in the system as a provider of units of simple homogeneous undifferentiated labour like the rest. The competitive situation is stable. But beyond that point he emerges in a new role. He is now another factor of production—hitherto not appearing in the equations of equilibrium. At first, of course, in this situation he may be in a monopolistic position. But until the point at which it paid to employ him in this way the situation was fully competitive.
The example I have given is one which can be supposed to occur under conditions which, to all intents and purposes, may be regarded as a capitalistic—that is, a condition in which production has not yet become, in important senses, roundabout: conditions in which there is little vertical division of labour. But, of course, it is under more fully developed capitalistic conditions that the phenomena which it typifies become important. As capital accumulates, and demand increases, it pays to combine original factors of production, hitherto used in other ways, to produce technically indivisible means of production—machines, means of transport, and so on, which hitherto, because of their indivisibility, have not figured in the realized system of productive combinations at all. (If we think of the way in which capital accumulation has made possible the utilization of indivisible transport systems, we can see how important considerations of this sort must be in any theory of localization.) It is clear that the advantages of roundabout production are essentially the advantages of this vertical division of labour and that another way of describing them is to say that they consist in the progressive exploitation of potential methods of production excluded in less expanded systems by their technical indivisibility.
It is in this sense, I take it, that we are to interpret the theory of increasing returns developed by the late Professor Allyn Young in his presidential address to the British Association.*26 And it is worth noting, as he showed, how the phenomena in question escape the apparatus of particular-equilibrium analysis and, indeed, involve changes which are quite incompatible with its assumptions. Granted the assumption of the Youngian analysis, we can see how diminishing costs can be regarded as implicit in a situation which is actually competitive. But we see, too, that such developments are to be regarded as being much more probably the function of the development of many industries than of one of them. We see too—and this is perhaps the more important point—that the diminution of costs here contemplated is essentially the product of vertical division of labour—that is, of the disintegration of industries. Neither of these things is compatible with the implications of the supply curve. This seems to constitute a presumption that the use of this instrument in the analysis of variation may well involve a concentration on the insignificant exception to the neglect of what, both from the point of view of theory and practice, must be regarded as the typical and significant cases.
So far in this paper the propositions I have discussed have for the most part dealt with variations of costs in terms of what has been well called comparative statics. That is to say, they consist essentially of a comparison of two states of equilibrium, and an investigation of the causes of difference. The demand for a group of products increases so that in the new equilibrium position factor prices and costs of production are different, and so on. They do little to elucidate the actual process of change—the path followed through time between one equilibrium position and the other.*27 This is notoriously the field of theoretical economics in which least has been done and in which most remains still to do. In concluding this survey, therefore, it seems appropriate to add certain remarks on this matter.
It is not necessary in this connection to expatiate on the significance of the Austrian contribution to this theory. It is clear that, in the characteristically Austrian constructions, we have a technique which is pre-eminently suited to the explanation of the phenomena of movement. On the demand side, the conception of the dependent use (abhängige Nutzen); on the supply side, the conception of the displaced alternative—here we are dealing with elements which are the actual focus of attention of the economic subjects through whom changes come about. No one who has followed Wicksteed's exposition of the continuous relevance of Wieser's Law to the explanation of change*28 can doubt that the main instrument of explanation in this field has already been devised.*29
These things are well known. Rather than linger in this neighbourhood, it is more profitable to turn once more to the Marshallian system. For here we have theories in which propositions which are true and helpful are not altogether disentangled from ways of expression which sometimes give rise to misapprehension.
The Marshallian doctrine of short and long period price is essentially an attempt to provide a theory of price change in terms of the length of time which is taken to overcome various technical obstacles on the supply side. The relative specificity—to use Wieser's term—of productive factors means that the immediate response to a change in the conditions of demand or supply is not necessarily a response to an ultimate equilibrium position. To take Marshall's own example: in the short period, a change in the demand for fish will be met by an increased output from existing fishermen and a more intensive use of fishing gear already in existence. In the long period, however—I use Marshall's own words—'the normal supply price... is governed by a different set of causes, and with different results'.*30 Capital and labour come into the industry or leave it; the fixed equipment involved is augmented or depleted. In the sphere of cost theory this leads to the distinction between prime and supplementary expenses; in the sphere of distribution theory, to the distinction between quasi-rents and interest.
Now there can be no doubt that this doctrine contains much that is most valuable and important. The distinction between the immediate and more distant effects of a given change in demand, the imposition of a small tax, and so on and so forth—this is one of the most significant distinctions of the theory of variations, and it is one of Marshall's most conspicuous achievements that it has become universally recognized. None the less, as it stands, it is by no means immune from criticism. In particular two criticisms suggest themselves.
In the first place it may be suggested that it is liable to give rise to considerable misapprehension if one speaks, as Marshall does in the passage I have quoted, as if the causes operating in the long run are different from the causes operating in the short. Given a change in the data and the other fundamental conditions—including, as we shall see, what other people think about the data—the process of price change through time is determinate. The path followed by price, the rate and magnitude of the change, is determined by the total situation. Although the effects of the different conditions operative may show themselves at different points in the path, it is misleading to speak as if, from the moment of change onward, they were not each in operation. When the demand for fish increases, if it is supposed that the increase will be permanent, there is not an interval which elapses before the 'long period tendencies' begin to operate. They operate from the beginning, but, owing to their nature, their effects are not manifest until some time has elapsed. It is therefore arguable, I think, that to have different labels for the discussion of long- and short-period effects here is liable to veil the essentially continuous nature of the economic process. Short-period and long-period theory in this sense do not explain different processes. They explain different sections of the same process. It would be absurd to suggest that this was not known to Marshall. But it is none the less true that his particular mode of expressing himself has sometimes led to its being overlooked by his readers.
Secondly—and this criticism is more substantial—here too, as in other Marshallian constructions which we have examined, it may be objected that the emphasis tends to have too technical a complexion. No doubt the technical obstacles to change, the resistances through time, are fundamental. But it should be clear that, given the range of technical obstacles, the obstacles that will actually be encountered in any process of adaptation depend essentially upon estimates of the permanence of the change to which the adaptation is a response. The change which is expected to last for a short period invokes responses essentially different from the responses which are evoked by the change which is expected to be permanent. What are prime and what are supplementary expenses depend essentially upon the length of time over which a change of output is expected to be operative. Thus, if by long period we understand a period long enough for final equilibrium to be reached, we can say that the length of the period is not only a function of the magnitude of the technical obstacles but also of the expectations entertained by the producers. The time it takes for an industry to become adapted to a permanent shrinkage of demand depends in part upon the rate of physical depreciation. But it depends, too, upon the length of time taken by producers to become convinced that the chnage is permanent.
It seems therefore that in a complete theory of costs the part played by the estimates of the future of the various producers concerned will play a larger part than it plays in the original Marshallian doctrine. But, if this is so, then a further change is probable, which will necessarily bring this part of cost theory into more intimate relations with the other parts of the theory of change. There are certain cases of changes in data where different degrees of foresight on the part of producers have little effect save on the rate of adaptation. A single-line change of demand for consumer's goods in a system otherwise in even balance may be a case of this sort. Here perhaps the old single-line methods of cost analysis may be sufficient to explain the total movement. But there are other cases where the different estimates on the part of producers will themselves bring about further changes in the general situation: a simultaneous falling off of demand for the products of a large group of industries, as at the turn of a trade cycle, is an instance. Here not merely the immediate policy of the producers concerned but the future course of the general oscillation will be, in part at any rate, determined by expectations of the kind here discussed. And here single-line analysis is patently inadequate. If the cost problem here is to be handled properly, it must be dealt with in conjunction with the theory of economic fluctuations. It is probable that the extraordinary sterility of much contemporary thought on the problems of overhead costs and surplus capacity is due to the fact that this junction has not yet been satisfactorily effected.
Notes for this chapter
This somewhat roundabout way of putting matters is deliberate. The money costs of production in any line of industry are a reflection of 1) the value of factors of production wholly specialized to that line of production (Wieser's 'specific' factors) and 2) the value of transferable ('non-specific') divisible factors in other uses. It is in regard to these latter ingredients that Wieser's propositions have special relevance.
Ursprung and Hauptgesetze des wirtschaftlichen Werthers, pp. 146-70; Natural Value, pp. 171-214; Theorie der gesellschaftlichen Wirtschaft, pp. 61-4, 73-81, 142-6; also the juvenile work Über das Verhältnis der Kosten zum Wert ('Gesammelte Abhandlungen', pp. 377-404).
See D. L. Green, 'Opportunity Cost and Pain Cost', Quarterly Journal of Economics (1894), pp. 218-29; P. H. Wicksteed, The Common-sense of Political Economy, p. 373; Davenport, Value and Distribution, pp. 551-2; The Economics of Enterprise, pp. 106-49; Knight, Risk, Uncertainty and Profit, p. 92; 'Fallacies in the Interpretation of Social Cost', Quarterly Journal of Economics (1924), p. 582; Henderson, Supply and Demand, p. 162.
Pure Economics, p. 184.
It is sometimes held that Wieser's Law is only true of a state of affairs in which the supplies of the factors of production are fixed. If these supplies are flexible, it is urged, then the disutility principle—the concept of real cost as real pains and sacrifices—comes into its own as an independent principle of explanation. (See Edgeworth, Papers Relating to Political Economy, 3, pp. 56-64; Robertson, Economic Fragments, p. 21; Viner, 'The Theory of Comparative Costs' in Weltwirtschaftliches Archiv, 36, pp. 411 ff.). The objection is plausible but it is not ultimately valid. Even when we are contemplating a situation in which the total supplies of the factors actually used in production are flexible, it is quite easy to show that Wieser's Law is still applicable. Variations in the total supply of labour in productive industry are accompanied by variations in the amount of time and energy which is available for other uses. Variations in the supply of land in production are accompanied by changes in the supply of land put to consumptive uses. Variations in the supply of capital are accompanied by variations in present consumption. All economic changes are capable of being exhibited as forms of exchange. And hence, as Wicksteed has shown, they can be exhibited further as the resultant of demand operating within a given technical environment. (See Wicksteed, Common-sense of Political Economy, especially I, chapter ix; also F. X. Weiss, 'Die moderne Tendenz in der Lehre vom Geldwert', Zeitschrift für Volkswirtschaft, Socialpolitik, und Verwaltung, 19, p. 518; and Wicksell, Vorlesungen, 1, p. 159). It has been said that this becomes impossible if account be taken of the so-called other advantages and disadvantages of different occupations. Professor Viner in the article cited above has urged this particular objection. The difficulty however seems to be capable of a simple solution. If the other advantages and disadvantages are treated as joint products, the Wicksteed constructions can still be maintained.
An example should make this quite plain. The introduction of improved methods of production sometimes has the effect of causing the price of the particular line of product concerned to fall below costs of production; and observation of this fact has often led to the belief that therefore the mechanism of free markets is incapable of dealing with the effects of scientific invention. But what does such a situation imply? Prices are below costs; the products fetch less than the amounts which have to be paid for the factors which produce them. But why is this? If the factors were completely specialized to the line of production in question—i.e. if they had no mobility—then in a free system their prices would fall automatically with the fall in the prices of their products. There could be no lasting disparity between prices and money costs. But the costs of transferable factors, according to Wieser's Law, are a reflection of their value in other possible uses. If therefore in one line of production costs of production are higher than prices, this means under our assumptions that there are factors of production in that line which are more urgently demanded elsewhere—that the change in technique creates a new equilibrium of factors. As the transfer takes place under the pressure of the costs disparities, there will be movements of prices and costs tending to a restoration of profitability. It follows therefore that, if technical progress is accompanied by more extensive disequilibrium, the causes must be sought outside the area covered by our assumptions; the market is not free, the monetary mechanism is not functioning properly. There is nothing in the institutions of exchange as such which makes technical progress necessarily self-frustrating. This conclusion, which follows directly from Wieser's Law, is surely a conclusion of considerable practical importance.
Common-sense of Political Economy, p. 382; cf. also, Rosenstein-Rodan, 'Grenznutzen' in Handworterbuch der Staatswissenschaften, 4, pp. 1198 ff.
Journal of Political Economy, 36 (1928), pp. 353-70.
Weltwirtschaftliches Archiv, 32, pp. 353-70, especially the note on p. 358.
We can see this most clearly if we contemplate an extreme case. Suppose a state of affairs in which two commodities are produced by the aid of two classes of factors of production—the factors entering into the manufacture of the two commodities in proportions which are different for each commodity. (For example, PA involves 2x and 1y and PB 1x and 2y.) Now suppose a shift of demand. The relative scarcities of the factors and of the products will change. The cost of production (in money terms) of the commodity whose manufacture involves the higher proportion of the factor which has become relatively scarcer will rise. The cost of production of the commodity whose manufacture involves a higher proportion of the factor which has become relatively less scarce will fall. There is no movement of technical displacements which corresponds to this.
P. Straffa, 'The Laws of Costs under Competitive Conditions', Economic Journal (1926), pp. 535, 550.
I have attempted to indicate some of the more important of such cases in an article entitled 'On a Certain Ambiguity in the Conception of Stationary Equililibrium', Economic Journal (1930), pp. 194-214. The present paper is to be regarded as essentially a continuation of the same train of thought—but applied to a wider area than the simple analysis of final equilibrium.
Papers Relating to Political Economy, 2, p. 32. Of course this usage of the integral curves, which assumes other commodities besides those registered on the coordinates to be produced in the economy under consideration, must be distinguished from the use of similar curves under the assumption that only two commodities are capable of coming into existence. There are objections to the use of such an apparatus, well known to all readers of Pareto, but it is arguable that if Marshall had proceeded on these lines he would have been much more reluctant to adopt his compromise constructions than in fact he was.
See my Essay on the Nature and Significance of Economic Science, chapter vi, para. 2.
Wealth and Welfare, pp. 172-9.
Quarterly Journal of Economics, 27, pp. 676ff. See also Knight, 'Fallacies in the Interpretation of Social Cost', Quarterly Journal of Economics, (1924), pp. 218-29. Professor Pigou's retraction of his original proposition is to be found in the second edition of the Economics of Welfare, p. 194; Edgeworth's endorsement of this retraction in his review of this volume, 'The Doctrine of Social Net Product', Economic Journal (1925) pp. 30 ff.
I ought perhaps to state explicitly that this is merely an interpretation. It is not a transmission of any esoteric oral tradition. My own views on these matters spring chiefly from reflections on the remarks on the variations of productivity in Taylor's Principles of Economics, pp. 141-2.
The distinction between these two stages of the theory of variations is not often clearly recognized in the English and American literature. It is, however, very clearly stated by Pareto (Manual, p. 147), and it has recently been the subject of important studies by Mayer, Rosenstein-Rodan and Schams. See Mayer, 'Der Erkenntniswert der funktionellen Preistheorien', Wirtschaftstheorie der Gegenwart, 2, pp. 146-239; Rosenstein-Rodan, 'Das Zeitmoment in der mathematischen Theorie des wirtschaftlichen Gleichgewitchtes', Zeitschrift für Nationalökonomie, 1, pp. 129-42; Schams, 'Komparatives Statik', Zeitschrift für Nationalökonomie, 2, pp. 27-61. See also my article on Production in the Encyclopedia of the Social Sciences.
Common-sense of Political Economy, 1, chapter ix.
It is significant in this connection that historically the Austrian theories are said to have sprung from Menger's inability to explain the short-term fluctuations of produce and stock markets in terms of the classical generalizations. It is clear that for the most part the classical theories are to be regarded as theories of comparitive statics (in the sense explained above) with the differences between successive states of equilibrium explained in technical terms. The wage-fund theory in certain aspects has of course a more dynamic character.
Principles, 8th ed., p. 370.
Essay 3, Economics and knowledge
End of Notes
Return to top