THE THEORY OF PRODUCTION
Neo-classical production theory addressed itself to two principal issues. The first concerned the manner in which any producer set about combining the productive factors. The second dealt with the adjustments a producer might be expected to make when market conditions altered.
The first of these points could be handled quite straightforwardly with the aid of analytical tools already considered. Individual business men were regarded as rational calculators seeking to maximize their earnings. So long as competitive conditions prevailed they were powerless to influence the prices of their products. The objective of profit maximization thus amounted to an attempt to minimize costs. Technically, a number of possible combinations of various productive factors could produce whatever volume of output might be desired. The rational manager would naturally select the least-cost combination.
These rules were simple enough. The analysis of the producer's response to a change in market circumstances was more intricate. In particular, it presented the problem of time which Marshall described as 'a chief cause of those difficulties in economic investigation which make it necessary for man with his limited power to go step by step; breaking up a complex question, studying one bit at a time, and at last combining his partial solutions into a more or less complete solution of the whole riddle'.12 This task of disentanglement involved an examination of the consequences of minute changes on the assumption described in Marshallian shorthand as ceteris paribus: i.e. that all the underlying factors remained unchanged.
For Marshall's purposes three time periods were distinguished from one another. The first he described as 'the market period', a period too short for the producer to make any adjustments in his output in response to a change in prices.
The second - labelled 'the short run' - permitted output to be adjusted by changing the intensity with which a given plant was utilized. More workers might be hired (or the present labour force induced to work longer hours) and additional raw materials acquired. All of these measures would enable output to be enlarged in response to an increase in demand. These adjustments, however, would probably be associated with rising marginal costs. If an increase in demand was expected to be sustained, it might well be worth the firm's while to expand capacity in order to reduce its costs. The time period required to effect this adjustment was described asThe nature of these divisions of economic time deserves a momen
sight it might appear that these categories bore a resemblance to the notions of time with which classical economists had worked. Any such appearances would be quite misleading. Classical writers had been interested in historical change. The time distinctions introduced by Marshall were divorced from calendar time, resting instead on logical distinctions.13 If asked to specify the length of the 'long run', Marshall would reply that it was the time span sufficient to accomplish adjustments in the scale of plant necessary to produce a new market equilibrium after an earlier one had been disturbed. In a practical case, the length of this period would depend on the circumstances of individual firms and industries. The 'long run' for a steel fabricator and for the corner hairdressing establishment would not coincide.
These logical distinctions between moments of economic time opened the door to a new and interesting set of theoretical possibilities. After all, it was quite conceivable that in the long-run - when the scale of plant could be altered and the utilization of all productive factors varied - several outcomes with respect to levels of costs might follow. Changes in scale, for example, might be associated with rising, declining, or constant unit costs.
The most interesting case was the one in which average costs declined with the enlargement in the scale of plant; this situation was described as 'increasing returns to scale'. By and large the classical economists had anticipated that 'constant returns to scale' would normally prevail; in other words, that the size of the individual production unit had no effect on average costs. They had, of course, given much attention to the gains in productivity arising from growth in the size of the economy (and the progressive sub-division of labour associated with it), but this scale effect was quite different from the neoclassical concern with individual enterprises. Mill and Marx, to be sure, had caught glimpses of the cost reducing effects of large industrial concentrations though they had not fully worked out their implications.For Marshall, increasing returns to scale associated with the application of high technologies presented an awkward problem. Economies of scale implied that a small number of large producers could operate with lower unit costs than could a large number of small firms producing the same quantum of output. Hence, one of the premisses of a competitive market - namely, that the number of firms producing similar products was sufficiently large to deny market power to any individual seller - was challenged. Bigness might indeed erode the basis of the competitive order and threaten its preservation. Marshall saw the issue when he wrote:
In fact when the production of a commodity conforms to the law of increasing return in such a way as to give a very great advantage to large producers, it is apt to fall almost entirely into the hands of a few large firms; and then the normal marginal supply price cannot be isolated on the plan just referred to, because that plan assumes the existence of a great many competitors with businesses of all sizes, some of them being young and some old, some in the ascending and some in the descending phase. The production of such a commodity really partakes in a great measure of the nature of a monopoly; and its price is likely to be so much influenced by the incidents of the campaign between rival producers, each struggling for an extension of territory, as scarcely to have a true normal level.14
The availability of scale economies had consequences both for the industrial structure of the economy and for the structure of neo-classical reasoning.
At the analytical level it precluded a clear and unambiguous operational definition of a supply schedule. Marshall perceived the implications of this complication (and criticized others for their failure to do so) in the following language:Some... have before them what is in effect the supply schedule of an individual firm; representing that an increase in its output gives it command over so great internal economies as much to diminish its expenses of production; and they follow their mathematics boldly, but apparently without noticing that their premises lead inevitably to the conclusion that whatever firm gets a good start will obtain a monopoly of the whole business of its trade in its district. While others avoiding this horn of the dilemma, maintain that there is no equilibrium at all for commodities which obey the law of increasing return; and some again have called in question the validity of any supply schedule which represents prices diminishing as the amount produced increases.15
For this part, Marshall attempted to build an analysis in which the essentials of the competitive equilibrium model could be preserved despite this challenge to its realism.
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