Alfred Marshall Supply Supplies

Alfred Marshall Supply, Marshall Supplies, Supply in Marshall

Marshall laid the foundation for the currently accepted analysis of cost and supply that is taught in undergraduate courses. His most important contribution to the theory of supply was his concept of the time period, particularly the short run and the long run. He correctly perceived the shapes of industry supply curves in the market period, the short run, and the long run, even though his explanation of the economic reasons for these shapes was often deficient and confused and sometimes incorrect.

The market period causes no difficulties; here supply is perfectly inelastic. In the short run, modern microeconomic theory explains the shape of supply curves for the firm and for the industry as depending upon the principle of diminishing returns. Marshall pointed out that for analytical purposes, it is useful to divide the firm's costs in the short run into fixed costs and variable costs. Marshall did not, however, establish a precise relationship between his distinction between fixed costs and variable costs and the derivation of the short-run cost curves of the firm based on the principle of diminishing returns. His main application of the principle of diminishing returns was to land, usually in the context of long-run analysis.

He did use his distinction between fixed and variable costs in the short run to show that a firm would continue to operate in the short run even if it was incurring a loss, as long as it was covering its total variable costs. Under these circumstances, the firm actually minimizes losses by operating: shutting down would result in a loss equal to total fixed costs, but the losses incurred by operating are less than total fixed costs as long as total revenue exceeds total variable costs. The supply curve of the "firm in the short run in a perfectly competitive industry, therefore, is equivalent to that portion of its marginal cost curve that is above its average variable cost curve. With characteristic realism, Marshall went on to conclude that the real supply curve for the firm in the short run is not likely to be its marginal cost curve when prices have fallen below average costs and losses are incurred. He said that firms would be hesitant to sell at a price that does not cover all their costs, both fixed and variable, because they are concerned about "spoiling the market." Spoiling the market means selling at low prices today and preventing the rise of market prices tomorrow, or selling at prices that incur the resentment of other firms in the industry. Thus, when losses are incurred, the true short-run supply curve is not the portion of the marginal cost curve between the average variable cost and average cost curves but a supply curve to the left of the marginal cost curve. In this discussion, Marshall dropped the assumption of perfectly competitive markets, because under a strict definition *of perfect competition, no firm would be concerned about glutting the market or about the consequences of its actions for other firms in the industry. The inspiration for Joan Robinson's Imperfect Competition and E. H. Chamberlin's Theory of Monopolistic Competition can be found in part in Marshall's discussion of the operation of markets when the assumption of perfect competition is discarded.

Although Marshall's discussion of long-run firm cost curves and supply curves and industry supply curves is clearly deficient by modern standards, his early attempts in these areas provoked an interesting series of articles in the 1920s and 1930s, the most important being by Clapham, Knight, Sraffa, and Viner. Mar­shall indicated the long-run forces that determine the shape and position of the firm's cost and supply curves. First are the forces internal to the firm. As the size of the firm is increased, internal economies of scale lead to decreasing costs and internal diseconomies result in increasing costs. Marshall's discussion of the economic reasons for internal economies of scale is reasonably satisfactory, but his discussion of internal diseconomies is minimal, and he did not really confront the issue of the relationship between economies and diseconomies and its influence on the optimum size of the firm.

Marshall's discussion of external economies and diseconomies nevertheless precipitated a plethora of literature on the theoretical issues implicit in his analysis. Marshall wanted to reconcile the upward-sloping short-run supply curves of firms and industries with historical evidence suggesting that in some industries, costs and prices have decreased over time. He based this reconciliation on his notion of external economies. External economies—Marshall never made it clear whether these are external to the firm or to the industry—result in the downward shift of firm and industry cost curves and supply curves as an industry develops. Under these circumstances, the industry's long-run supply curve will slope downward: larger quantities will be supplied at lower prices. The major causes of external economies are the reductions in costs for all firms in an industry that take place when all the firms locate together and share their ideas. Localization also brings cost-saving subsidiary industries and skilled labor to the area.

Marshall's examination of costs and supply raised a number of important theoretical issues that were examined between 1900 and 1940. What are the economic reasons for the shape of cost and supply curves? Why do supply curves rise in the short run while costs and prices fall in the long run for some industries? Are internal and external economies compatible with competitive markets?