Marshall's dilemma: equilibrium versus evolution.

Author:Hart, Neil
Position:Alfred Marshall

Alfred Marshall remains somewhat of an enigmatic figure in the evolution of economic analysis. Historians of economic thought almost invariably accord Marshall a prominent role in the early development of "neoclassical" economics and in partial equilibrium analysis in particular. However, as Gerald Shove's (1942) and Joseph Schumpeter's (1941) semi-centennial appraisals observed more than fifty years ago, despite the prominent position designated to him, little in fact remains of Marshall's theoretical structure and methodological approach. Paul Samuelson, who was to play a prominent role in the subsequent development of mainstream economic analysis, placed the demise of Marshall's theoretical structure in the following context:

Although harsh, these are my well-considered judgments on the matter, and I mention them only because no one can understand the history of the subject if he does not realize that much of the work from 1920 to 1933 was merely the negative task of getting Marshall out of the way. (1967, 111) Contrary to the judgment of Samuelson and others, the central argument developed in this paper is that the nature of the difficulties that Marshall had unsuccessfully attempted to resolve was fundamentally misunderstood by many of Marshall's critics, supporters, and subsequent contributors to the development of mainstream economics. This misunderstanding emerges largely from a misinterpretation of the intended role of Marshall's Representative Firm concept, which was at the center of the cost controversies of the 1920s.

In particular, it is essential to understand that Marshall's difficulties were far removed from the contortions of the mind that characterized the attempts at preserving a notion of competitive equilibrium when confronted with the damaging implications of increasing returns. It could indeed be argued that this was a "false problem"; however, it was not concocted by Marshall. Rather, the chief source of Marshall's difficulties in Principles of Economics (1) arose from an unsuccessful attempt to construct an equilibrium concept that could be used to shed light on the outcomes of processes that are recognized as being continuous and irreversible in time. In this context the Representative Firm plays an indispensable role in terms of the analysis Marshall was attempting to construct in successive editions of Principles. It was an avenue through which Marshall conjectured a notion of equilibrium at a point in time for the industry as a whole, while at the same time individual firms were in disequilibrium, being subject to an "organic" process of change. The Representative Firm therefore meets at the junction of Marshall's biological and mechanical notions of opposed forces described in the introductory comments in book 4 of Principles.

Marshall's dilemma essentially involved a struggle of ascendancy between conflicting metaphors. As Warren Gramm (1996) has observed, metaphors' origins and initial significance are often sublimated or forgotten with casual and habitual use. (2) Metaphors and associated analogies are not simply literary ornaments; they form the foundations for the thought processes that develop theories directed at explaining complex systems. A metaphor is not taken literally, and unlike a theory or hypothesis it is not directly refutable. The cognitive powers of a metaphor arise from the context in which it is applied, and it is in this respect that the legitimacy and usefulness of a metaphor is to be evaluated. While Marshall is associated with the popularization of the mechanical equilibrium metaphor in economics, his own writings suggest that the application of biological analogies represented the best way forward. The Representative Firm emerges from an attempt to reconcile the inconsistencies arising from the, at times, conflicting metaphors introduced in Principles. The Marshallians who followed instead abandoned the biological pathways and transformed Marshall's Representative Firm into the now familiar Equilibrium Firm. (3)

Discussion in the paper is organized as follows. The role Marshall intended the Representative Firm to play in his Principles is closely examined. Marshall's recognition of the limitations of his Representative Firm theory and long-period analysis is then discussed. This leads to an outline of the character and purpose of Marshall's incomplete journey into "economic biology." The subsequent reaction to the Representative Firm concept, particularly with respect to Marshall's immediate followers and critics, is considered in the final section in the paper.

Marshall's Representative Firm

Lionel Robbins (1928, 386) delivered the following obituary to Marshall's Representative Firm in the course of the cost controversies of the 1920s:

The Marshallian conception of a Representative Firm has always been a somewhat unsubstantial notion. Conceived as an afterthought ... it lurks in the obscurer corners of Book V like some pale visitant from the world of the unborn waiting in vain for the comforts of complete tangibility. Robbins' assertion that the Representative Firm was a mere "afterthought" is based on his observation that the concept did not appear at all in the first edition of Marshall's Principles, being added a year later to the second edition. However, while the terminology is not directly used, an indication as to subsequent role is found in a section in the first edition where Marshall states that when deriving the supply price under increasing returns "we must select as representative a business which is managed with normal ability and so as to get its fair share of the economies both Internal and External resulting from industrial organisation" (Marshall 1890, 523). (4) Moreover, in a letter to A. W. Flux, Marshall suggested that the Representative Firm idea was conceived well before the publication of the first edition of Principles:

One of the chief purposes of my Wander-jahre among factories, etc., was to discover how Cournot's premises were wrong. The chief outcome of my work in this direction, which occupied me a good deal between 1870 and 1890, is in the 'Representative firm' theory.... [a]s well as the parts that directly relate to the supply price for IR [Increasing Returns]. (Pigou 1925, 407). In order to place Marshall's Representative Firm in its intended context, it is necessary to consider Marshall's life cycle theory of the firm analogy.

In the tradition of Adam Smith, a defining characteristic for Marshall in the long period is the likely existence of increasing returns to scale, particularly in the sphere of manufacturing industries. The improvements in efficiency associated with increasing returns, whether internal or external, was primarily the outcome of improved organization, which in turn provided the stimulus for the realization of further economies.

The initial problem Marshall identified as arising from the existence of increasing returns was that production under such circumstances would "give a very great advantage to large producers," leading toward a tendency for production to "fall entirely into the hands of a few large firms." This would challenge the theoretical structure of Principles because "the normal marginal supply price cannot be isolated," with prices instead being "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" (397). Moreover, from his observations of industry, Marshall had concluded that while increasing returns were widespread and played a key role in industrial expansion, monopolization was not the natural outcome of this process. (5)

Therefore the task Marshall allocated to his biological analogy is basically one of illustrating how internal economies may not be fully exploited by an individual firm because of limits to its productive life span. The analogy likens the growth process of firms to the growth of trees in a forest:

But here we may read a lesson from the young trees of the forest as they struggle upwards through the benumbing shade of their older rivals. Many succumb on the way, and a few only survive; those few become stronger every year, they get a larger share of light and air with every increase of their height, and at last in their turn they tower above their neighbours, and seem as though they would grow on for ever ... but they do not. One tree will last longer in full vigour and attain a greater size than another; but sooner or later age tells on them all. Though the taller ones have a better access to light and air than their rivals, they gradually lose vitality; and one after another they give their place to others. (1920b, 315-316) Analogously, "the full life of a firm seldom lasts very long," as the firm is likely to "ere long quickly to decay" having lost the "exceptional energy which enabled it to rise" (Marshall 1920b, 287). It is nature, by pressing "on the private business by limiting the length of the life of its original founders, and by limiting even more narrowly the part of their lives in which their faculties retain full vigor" which Marshall argued breaks the nexus between increasing returns and the tendency toward monopoly (316).

If accepted, Marshall's life cycle of the firm analogy clearly implied that a position of long-period equilibrium for an industry, if attained, coincided with a situation in which individual firms are at disequilibrium. In Marshall's terminology, some businesses will be rising and others falling (1920b, 378). Even if that analogy was discarded, it was apparent from the discussion of industrial organization in book 4 that it would not be possible to isolate an individual producer whose supply conditions could be argued to be "typical" of the industry as a whole; "thus the history of the individual firm cannot be made into the history of an industry any more than the history of an individual man can be made into the...

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