Economic Record
Volume 29, Issue 1-2 pp. 51-62
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A NOTE ONE SOME MARGINALIST AND OTHER EXPLANATIONS OF FULL COST PRICE THEORY1

KINGSLEY LAFFER, 

KINGSLEY LAFFER

The University of Sydney

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First published: May 1953
https://doi.org/10.1111/j.1475-4932.1953.tb02891.x
Citations: 1

This paper is substantially the same as that read before section ‘G’ of the Australian and New Zealand Association for the Advancement of Science, Sydney, August 25, 1952.

Footnotes

  • 1 This paper is substantially the same as that read before section ‘G’ of the Australian and New Zealand Association for the Advancement of Science, Sydney, August 25, 1952.
  • 2 P. W. S. Andrews, Monufacturing Business (Macmillan, London, 1949), hereinafter called Man. Bus.; Oxford Studies in the Price Mechanism, ed T. Wilson and P. W. S. Andrews (Oxford 1951) Ch. IV, hereinafter called Oxford Studies. For a very brief summary of Mr. Andrews's main propositions see E. A. G. robinson, “The Pricing of manufactured Products”Economic Journal, December 1950, p. 772. See also the pioneer work of R. L. Hall and C. J. Hitch, “price Theory and Business Behaviours. Oxford Economic Papers No. 2. reprinted in Oxford Studies in the Price Mechanism, Ch. III. C. Clive Saxton's The Economics of Price Determination (Oxford 1942) also contains much full cost material, as also does the more superficial study by W. J. Eiteman, Price Determination, Business Practice versus Economic Theory (University of Michigan, 1946). Periodical articles will be referred to as the occasion arises. It will be noted that we have not adopted H. r. Edwards' distinction between full cost and normal cost theories (Economic record, May 1952. p. 52; Economic Journal, September, 1952, p. 666). As both theories are of the same basic type the introduction of a special terminology to describe Mr. Andrews's approach seems unnecessary.
  • 3 Andrews. Man. Bus. pp. 83–84. Professor E. A, G. Robinson. loc. cit. pp. 774–775 footnote, finds it difficult to understand why “Mr. Andrews assumes that the business produces a single product only. In practice there is good reason for thinking that the prevalence of the many product organization is an important explanation of the ritual he describes.” for Mr. Andrews. However, the firm's adoption of full cost pricing does not depend on the firm being a multi-product one. and he appears to be correct to base his analysis on the single-product case.
  • 4 See Saxton. op. cit., pp. 127–128; P. Wiles. “Empirical Research and Marginal Analysis”, Economic Journal, September, 1950, pp. 521–522.
  • 5 Oxford Studies, p. 164.
  • 6 Andrews. Man. Bus., p. 87.
  • 7 Ibid., pp. 87–98.
  • 8 Ibid., pp. 102–109.
  • 9 Ibid., pp. 99–102.
  • 10 Oxford Studies. pp. 148–155. 161–162.
  • 11 Andrews, Man. Bus., pp. 157. 164. Mr. Andrews recognizes some variation in practice. e.g. an appropriate costing margin may be added to average total costs (Oxford Studies. p. 164). but this is of no special significance for the present study.
  • 12 F. Machlup, “Marginal Analysis and Empirical Research”, American Economic Review, September, 1946. p. 539, reprinted in readings in Economic Analysis, vol. 2. ed. Richard V. Clemence (Addison-Wesley Press, 1950), Compare D. H. Macgregor's “irregularities”, Economic Thought and Policy, p. 33.
  • 13 See P. Wiles, “Empirical Research and Marginal Analysis”, Economic Journal. September, 1950, p. 520.
  • 14 Andrews, Man. Bus., p. 153–154.
  • 15 Oxford Studies, p. 170.
  • 16 Andrews. Man. Bus., pp. 91, 95.
  • 17 Oxford Studies, p. 170.
  • 18 Mr. Andrews's direct costs. though defined as “outlays directly linked to production” are usually used by him to include only direct materials and labour costs (Man. Bus. pp. 38–48. 86). They are therefore somewhat less than marginal costs, which would include wear and tear of plant.
  • 19 Andreas. Man Bus., pp. 109–110.
  • 21 Mr. Wiles, loc. cit., attempts to explain the excess of price over marginal cost within the Season by Drawing a distinction between SRMC (partial adaptation) and LRMC (partial adaptation). The latter include extra costs escapable at first but eventually incurred because of extra maintenance, etc., when fixed plant is used to produce “similar to Mr. Andrew's “extraordinary” costs. and Mr. Wiles suggests that “in the neighbourhood of” expected output they might rise so sharply as to bring about equality of price and his LRMC (p.s.). This exposition of the possible compatibility of full cost and marginal theories appears, however, to be unconvincing, because: (1) There is nothing in Mr. Andrews's analysis to suggest that production around the expected rate of output involves any undue strain on plant or costs; (2) there is no reserve for growth in Mr. Wiles's analysis; (3) Mr. Wiles's results have no empirical basis. being merely derived. as he himself recognizes, form his definition of “capacity” output as that which gives the optimum long-run use of plant See also H. R. Edwards, “Mr. Wiles and the Normal Cost Theory of Price”, Economic Journal, September, 1952.
  • 22 Machlup. loc. cit. pp. 523–524.
  • 23 Andrews, Man. Bus., pp. 147–148.
  • 24 E. Chamberlin. Theory of Monopolistic Competition, pp. 81–94. It is not necessary, for our special purpose, to consider the validity of his “large group” and related concepts, or such criticisms as those of R. Triffin, Monopolistic Competition and General Equilibrium Theory, pp. 81–89.
  • 25 Chamberlin. op. cit., pp. 111–112: “In so far as the field in general or particular parts of it are protected from incursion, demand curves will lie to the right of the point of tangency with cost curves, and profits will be correspondingly higher. This is the explanation of all monopoly profits, of whatever sort.
  • 26 Chamberlin, op. cit. p. 88.
  • 27 Andrews, Man. Bus. pp. 153–154.
  • 28 E. A. G. Robinson, loc. cit., p. 773.
  • 29 Ibid, p. 777. It should be added that Professor Robinson does not consider that Mr. Andrews's generalizations apply to all industry and all price-making.
  • 30 Chamberlin, op. cit., p. 83.
  • 31 Andrews. Man. Bus., p. 154.
  • 32 Cf. Hall and Hitch, loc. cit., p. 122: “the typical case is that of monopolistic competition with an admixture, which is usually large, of oligopoly”. See also R. F. Kahn, “Oxford Studies in the Price Mechanism”, Economic Journal, March, 1952.
  • 33 Chamberlin. op. cit., p. 6.
  • 34 Ibid., p. 83.
  • 35 Andrews. Man Bus., p. 155. Cf. Saxton. op. cit., p. 157.
  • 36 Andrews, Man. Bus., 154–156.
  • 37 The above discussion suggests that oligopoly is probably extremely common. See N. Kaldor, “Market Imperfection and Excess Capacity”, Economics, February, 1935, pp. 37–40, for a similar views, held on rather different grounds. Professor Chamberlin in “monopolistic Competition Revisited”, Economica, November, 1951, pp. 355, 361–362, has also recently written; “it seems evident to me that oligopolistic elements are very general in the economic system and that economic study must be increasingly concerned with their influence on prices and other economic categories.”
  • 38 F. Machlup. loc. cit., pp. 542–544.
  • 39 Henry M. Oliver, Jr., “Average Cost and Long-Run Elasticity of Demand”. Journal of Political Ecomomy, June, 1947, pp. 213–214.
  • 40 R. L. Hall and C. J. Hitch. loc. cit., pp. 116–117; Paul M. Sweety. Journal of Political Economy, August, 1939. p. 569. See also Andrews in Oxford Studies, p. 160.
  • 41 For other objections to the kinked demand curve analysis see G. J. Stigler. “The Kinky Oligopoly Demand Curve and Rigid Prices:, Journal of Political Economy, October, 1947, and W. Fellner. Competition Among the Few (Knopf, 1949). pp. 181–182.
  • 42 Chamberlin. Theory of Monopolistic Compstition, pp. 105–182.
  • 43 Chunberlin. Economica, November, 1951, pp. 356–357.
  • 44 Chamberlin, Theory of Monopolistic Competition, p. 105. See also Chamberlin, “‘Full Cost’ and Monopolistic Competition”, Economic Journal, June, 1952.
  • 45 We still do not wish to imply acceptance of the “group” concept. professor Chamberlin himself, in Economica, November, 1951, has now abandoned it and argues (p. 355) that in the typical oligopolistic relationship “there is neither market, commodity nor industry for which the number of sellers may be counted. A particular seller may be taken as a focal point and related to others near by; but when we move on to the next seller the grouping changes slightly.” He also says (p. 350) “Monopolistic competition implies lack of free entry in the full sense of freedom for another firm to produce the identical output, since the output of each firm has at least a minimum of individuality of its own”. We accept these views and continue discussion in terms of the group for convenience only.
  • 46 Chamberlin. Thery of Monopolisitc Competition, p. 105.
  • 47 Ibbid., p. 106.
  • 48 Ibiad., PP. 82. 90. See also the comments of R. Triffin. op. cit. pp. 24. 33–36.
  • 49 Oxford Studies, pp. 166–167.
  • 50 Andrews, Man. Bus., p. 164
  • 51 In terms of Professor Chamberlin's model such a firm would be producing an output at which MC was greater than MR. This appears to be the type of situation envisaged by Professor Macgregor, op. cit., 49–53.
  • 52 Ii is possible that a much broader conclusion, applying to monopolistic competition theory in general. might be appropriate. For if “fear of entry” is as important as Mr. Andrews's model suggests, than approaches which neglect it, such as those of professor Chamberlin and Mrs. Joan Robinson, might come to have historical interest only. This is, of course, a different issue from that of the respective merits of marginal and full cost theories.
  • 53 See R. L. Hall and C. J. Hitch, loc. cit., pp. 112–114.
  • 54 W. J. Eiteman, op. cit., Ch. IV.
  • 55 Ibid., p. 73.
  • 56 Fellner. op. cit., pp. 152–157.
  • 57 Professor Fellner suggests (op. cit., pp. 156–157, 224–226) that his safety margin approach might be used along with an approach he attributes to professor Scitovszky. The latter, according to professor fellner, believes that full cost theory might be explained on marginal lines by supposing that “producers may make the assumption that their average variable cost curve is horizontal in the relevant range” and that shifts in their demand curves “do not result in appreciable changes in demand elasticity from one equilibrium point to another”. Profit-maximization would then involve an unchanged percentage mark-up, regardless of shifts n the revenue and theory as set out appears to be no more than a special case of Professor Chamberlin's model and open to the same objection, viz., that it does not take account of fear of entry.
  • 58 Andrews. Man. Bus., pp. 5, 21.
  • 59 See M. J. Farrell, “The Case Against the Imperfect Competition Theory”, Economic Journal June, 1951, pp. 424–425, for a relevant discussion of the difficulties involved in the concept profit-maximization.
  • 60 Oxford Studies, pp. 141, 162.
  • 61 F. Machlup. loc. cit., pp. 545–546; E. A. G. Robinson, loc. cit. pp. 776–778; R. F. Kahn, loc. cit., p. 120.
  • 62 F. Machlup. loc. cit., p. 519.
  • 63 Ibid., p. 522.
  • 64 R. A. Gordon, “Short-Period Price Determination in Theory and Practice”, American Economic Review. June, 1948, pp. 268–269. See also K. F. Walker, “the Psychological Assumption of Economics”, Economic Record, June, 1946, pp. 72–73.
  • 65 K. E. Boulding, “Implications for General Economics of More Realistic Theories of the Firm”, American Economic Review, May, 1952, pp. 42–43.
  • 66 The full cost model developed at length by H. R. Edwards. “Goodwill and the Normal Cost Theory of Price”, Economic Record, May, 1952, Appears to be the Special case in Which, Except perhaps in the short period, there are no obstacles to entry, and therefore no scope for control over price by the existing oligopolistic firms.
  • 67 F. Machlup, loc. cit., pp. 542–543; R. F. Kahn. loc. cit., pp. 122–123.
  • 68 Marginalists usually argue that an income tax levied on a firm affects neither MR nor MC and no cannot be passed on. In full cost theory, however, it would seem that a firm might conceivably treat a rise in income taxation as an indirect cost, increase its costing margin and raise its price. Some price leadership arrangement would probably be necessary for, if the tax were progressive, an efficient highly taxed firm might otherwise suffer from the competition of inefficient lowly taxed firms. In the short period, morever, entry would be facilitated somewhat, as new entrants making low profits would be protected by high prices without correspondingly high taxation. Fear of such entry might prevent the full passing on of tax. This analysis is rudimentary but it may be sufficient to warn against over-readiness to give full cost theory a marginalist interpretation.
  • 69 In his own attempts at fuller development of his theory (Oxford Studies, Ch. IV) Mr. Andrews seeks to rehabilitate the “industry” concept and to focus attention on “normal” Mr. Andrews seeks to rehabilitate the “industry” concept and to focus attention on “normal” cost and “normal” profit. This seems to the writer to be a false start likely to stifle analysis of the great variety of actual situations. In any case. Mr. Andrews solves neither of the two main problems involved in the development of a satisfactory “industry” concept, viz. (a) establishment of a meaningful economic criterion for determining the bounds of an “industry”; (b) formulation of an adequate definition of “industry” which is not relative to one particular firm. the reason for Mr. Andrews's neo-Marshallian developments (including a longing glance at the representative firm) appear to be as follows: (1) he wishes to substitute the Marshallian notion of a firm slowly growing for the modern theory of a firm, in static equilibrium. This may be desirable, but the “industry” seems unnecessary for the purpose. (2) He wishes to reintroduce the notion of a potential entrant judging its prospects by observing a typical firm. But all it is necessary to assume is that the former looks at a particular firm or firms with which it is planning to compete most closely. (3) He wants to speak of prices as being given to the individual firm and determined by demand and supply for the product of the “industry”. But when products are not homogeneous and cross-elasticities not symmetrical such an analysis would not only be extremely cumbersome, but also false. On Mr. Andrews's oligopolistic assumptions interplay between each firm and its closest actual and potential rivals may play on important party in the determination of price. (4) He wants to speak of “normal” costs as including no more than “normal” profits. But he defines “normal” profit as “the margin at which new business will enter the market” (Man. Bus., p. 174) and, if conditions of entry are difficult, the “normal” profit so defined may be relatively high. The term “normal” is extremely mislesding and Mr. Andrews's use of it tends to conceal the great variety of actual situations.

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