This section seeks to definitively situate the Marshallian firm, as a supply-side agent, in output markets at least roughly characterized by price competition between large numbers of suppliers, facing, in turn, large numbers of demand-side agents, where the distribution of information among agents on both sides of the market may not be perfect but is sufficient to ensure that short run cost disparities cannot generate durable cumulative pricing advantages. Assuming in this respect that we are dealing with circumstances approaching a perfectly competitive market, the meaningful comparison that I mean to draw relates to the performance of perfect competition for the Walrasian/Paretian firm. Our treatment of the latter emphasized the captive nature of the firm, sandwiched between two household utility maximization problems that wholly determine an equilibrium vector of relative prices for all outputs and production factors by means of tâtonnement. Taking both factor and output prices as given and producing with technologies characterized by linear homogeneity/constant returns to scale, I argued that the output supply curves faced by Walrasian/Paretian firms are perfectly elastic/horizontal at the level of the output price, defined either in monetary terms or in relation to a numeraire. The point is that, for any static moment in the operation of a given market in a general equilibrium system, the collective decisions of all participating households, as consumers and owners of production factors, completely determine pricing for all firms, and decisions on production quantities are universally determined by the technological contours of production functions.
As we have argued so far, the particular conditions on factor supply (fixed versus variable) that govern the operation of Marshallian firms in the short run make their approach to short run market equilibrium different. Most critically, Marshallian firms face increasing marginal costs as they increase outputs in the short run. The entire range of the Marshallian short run supply schedule for individual firms, from the firm's shut down boundary to positive infinity, is characterized by increasing marginal costs. If we accept the principle that all perfectly competitive firms take prices as given, then pricing and production decisions for a Marshallian entrepreneur should be relatively simple, increasing marginal costs notwithstanding. Complications arise, however, when we impose restrictions on the production decisions made by entrepreneurs, as in the last section where we constrain the entrepreneur in our automotive remanufacturing operation to only hire workers on a full work day rate. In general, any circumstance where we impose constraints on decision-makers for firms, we create a space for production and/or pricing strategies that would disappear if we enable decision-makers to operate with complete freedom.
The linchpin in our account on Marshallian firms operating in perfect competition is the short run marginal cost pricing rule. Restated, every firm, as a rational profit maximizing/cost minimizing entity, will produce a quantity of output at which the marginal revenue received from the sale of the last additional unit will equal the marginal cost of producing the last additional unit, or:
Proceeding again through the logic of this condition under the assumption that a firm is dealing with increasing short run marginal costs as a function of quantity produced, if the firm produces a quantity where marginal cost is less than the marginal revenue received for the last unit produced, then the last unit it produces will cost less than the revenue that it receives for the unit, but it will forego additional revenues that it could have received if it had produced additional units at increasing marginal costs. This lost revenue represents a tangible (opportunity) cost to the firm that can only be eliminated by increasing production. Alternatively, if it produces quantities up to the point at which the marginal cost of the last unit produced exceeds the marginal revenues that it receives for the unit, then this unit is sold at a loss. The only way to eliminate this loss is to decrease production. Producing under the condition that marginal revenue equals marginal cost eliminates either opportunity costs from producing inadequate quantities and production costs in excess of marginal revenues from producing superabundant quantities.
This condition applies equally to Walrasian/Paretian firms as to Marshallian firms. In the case of the former, marginal costs simply remain constant and equal to average costs per unit at a profit maximizing/cost minimizing factor combination, where the firm operates under constant returns/constant costs per unit. Thus, under perfect competition, a Walrasian/Paretian firm produces a quantity of output consistent with its financing constraint at which the marginal cost of producing the last unit of output is equal to the additional revenue that it receives at the equilibrium relative price for the output. I failed to emphasize the condition, on the other hand, with Walrasian/Paretian firms because their financing constraints remain their critical output barrier - if firms can always maintain a perfect profit maximizing balance of production factors then there is never a question that marginal costs will ever diverge from their average along their expansion paths. For Marshallian firms, divergence from an optimal expansion path is the rule in the short run.
With regard to perfect competition, marginal revenue is continuously equivalent to the output market price and, thus, for all additional units of output sold, the marginal revenue of the last unit of output is constant. Intuitively, this should be the case. If firms cannot affect market output through their behavior among relatively large numbers of producers, then the output price should always be consonant with the revenue received by firms for each additional unit of output. Under less than perfect competition, this might not be the case. Oligopolistic firms and monopolies are relatively free to impose prices that readily diverge from the prices that would obtain under perfect competition. Likewise, competitors in markets where information dissemination is sufficiently constrained maintain a capacity to charge prices in excess of those that would operate under perfect competition by virtue of occluded pricing. In such circumstances, marginal revenue would vary as a function of output quantities. In this document, we are consciously assuming that, to the extent that agents possess imperfect information, no information disproportionalities exist that might enable certain agents to take advantage of competitors or contracting parties.
Having considered the supply side of output markets in relation to the short run marginal cost pricing rule, we should also evaluate the demand side, which, effectively, constituted the centerpiece of our explanation of Walrasian/Paretian output markets. For the latter, we argued that all commodity production and exchange is ultimately grounded in the utility enjoyed by households from consumption of goods and services. The maximization of utility in consumption constitutes a series of mathematical arguments at the level of each individual household utility function, in conjunction with the minimization of dis-utility from factor supply, determining how much of each good or service should be produced, how much financing/factor supply each firm should receive in order to produce such quantities under the most efficient existing technologies, and how much each household should receive in proportion to their supply of production factors. The fact that a single utility function, at the level of each individual household, uniquely contributes to answering each of these questions at the level of the larger economic system establishes the centrality of household utility maximization to the functioning of a general equilibrium system.
We cannot accord this degree of centrality to utility maximization by demand-side agents in our consideration of Marshallian output market consumers. While it is not my intention to elaborate a broader theory of utility maximization by Marshallian consumption agents in this context, we need to specify at least a rough, partial definition of the Marshallian consumer in order to situate the firm as its other in output market price determination. Without delving into the rationalistic terrain of utility functions, the most evident means of defining the consumption agent would involve an empirical analysis of demand patterns within markets characterized by a relative fluidity of market prices where, among other things, qualitative characteristics of the good or service transacted remain fairly constant over the analyzed period. As such, the point is to establish the contours of a market demand schedule and, to a certain. limited extent, to probe its microfoundations at the level of the individual/household. In these terms, we can definitively argue that short run Marshallian market demand functions are generally negatively sloped in relation to price and that this negative relationship, at a microfoundational level, reflects the diminishing marginal utility of individual consuming agents as we increase the quantities of each commodity consumed. Beyond this basic reflection, we might further encounter a broad portfolio of theoretic concerns in the demand theory, involving the differentiation between Marshallian additive, cardinal utility functions and Walrasian/Paretian generalized utility functions. These issues need not concern us here, however.
At the level of individual markets, Marshallian theory compels us to simply add up all of the individual production and consumption agents on each side of the market in order to compile schedules enumerating how many units of a given commodity can be supplied at a given price and how many units will be demanded at the same price. Let us say, for example, that we have a given individual market for a particular, well defined and relatively homogeneous commodity, retail raw whole chicken breasts, over a one week period, in a regionally-defined small metropolitan market (< 750,000 inhabitants). Nine relatively large retail suppliers make up a majority of the market, regularly selling slightly over fifty percent of total outputs on average. The remainder of the market is divided among dozens of smaller retail outlets. Table 5 represents a schedule of output quantities, aggregating the three largest suppliers, six middle-range suppliers, and the remaining small suppliers, delineating marginal, average fixed, variable, and total costs.
Table 5: Costs for Retail, Raw Whole Chicken Breasts (in lbs) in a Small Metropolitan Regional Market for a Given Week at Marginal Costs from $2.00 to 3.20 for Three Supplier Categories
Under the short run marginal cost pricing rule, the firms represented above should be willing to supply quantities of output up to the marginal cost of the last unit produced. Acknowledging that we are running over the theoretic complexities involved in full-blown micro-foundational analysis of production at the level of each individual firm in the interest of simplification, table 5 aggregates output quantities for the three size categories of roughly analogous firms, valuing additional outputs at each marginal cost level for each category of firms at the marginal cost (i.e. for the three largest firms, 14400 - 11220 = 3180 additional outputs are collectively valued at $2.20 per unit across all three firms). If we add up outputs in each of the three size categories for production at a price/marginal cost of $2.00 for the last unit(s) produced, we get a total output of 22,000 lbs of raw whole chicken breasts supplied.
Approaching the demand-side of the market, incorporating thousands of households consuming divergent quantities of raw whole chicken breasts for cooking at home, we can, for each individual/household, compile a set of reservation prices, at which each individual/household might delineate a monetized value on different quantities of the product being consumed as a register for the marginal utility enjoyed by the individual/household from consumption of the product as it increases the quantities it consumes. For a given household, for example, two pounds of whole chicken breasts might command a reservation price of $6.00. A third pound might, conversely, command $5.25 and a fourth $4.00, with successive pounds valued at even lower reservation prices. The point here, for Marshallian theory as for all other Neoclassical approaches, is that the marginal utility enjoyed by consumers diminishes with each successive unit consumed, matched by a diminution of the monetary value that consumers are willing to expend to obtain larger quantities. On an aggregate level, this constitutes the (micro-founded) explanation for a downward sloping market demand schedule.
Elaborating, if we consolidate the quantities demanded by all households, at each reservation price, then we can define a market demand schedule in which each each point on the schedule represents the highest reservation price at which a given quantity of output enjoys positive quantity demanded from a subset of consumers. For example, let us say that consumers demand 4,000 lbs of whole chicken breasts at $6.00/lb. By interpretation, this quantity consolidates households like the one mentioned previously that would purchase two pounds of whole chicken breasts for $6.00/lb. Some consumers, no doubt, demand more than two pounds while many consume less or nothing. The point is that the total quantity demanded across the market at a price of $6.00/lb reflects an aggregation of quantities demanded by each consuming agent engaged in the market if only to conclude that $6.00/lb is too high to justify the purchase of any whole chicken breasts. With this in mind, table 6 consolidates a truncated set of reservation prices across consuming agents in the market for whole chicken breasts and a set of marginal costs across all producing agents from each of the size categories represented in table 5.
Table 6: Supplier Marginal Costs and Consumer Reservation Prices for Retail, Raw Whole Chicken Breasts at a Range of Quantities in Small Metropolitan Regional Market on a Weekly Time Frame
With regard to perfect competition, marginal revenue is continuously equivalent to the output market price and, thus, for all additional units of output sold, the marginal revenue of the last unit of output is constant. Intuitively, this should be the case. If firms cannot affect market output through their behavior among relatively large numbers of producers, then the output price should always be consonant with the revenue received by firms for each additional unit of output. Under less than perfect competition, this might not be the case. Oligopolistic firms and monopolies are relatively free to impose prices that readily diverge from the prices that would obtain under perfect competition. Likewise, competitors in markets where information dissemination is sufficiently constrained maintain a capacity to charge prices in excess of those that would operate under perfect competition by virtue of occluded pricing. In such circumstances, marginal revenue would vary as a function of output quantities. In this document, we are consciously assuming that, to the extent that agents possess imperfect information, no information disproportionalities exist that might enable certain agents to take advantage of competitors or contracting parties.
Having considered the supply side of output markets in relation to the short run marginal cost pricing rule, we should also evaluate the demand side, which, effectively, constituted the centerpiece of our explanation of Walrasian/Paretian output markets. For the latter, we argued that all commodity production and exchange is ultimately grounded in the utility enjoyed by households from consumption of goods and services. The maximization of utility in consumption constitutes a series of mathematical arguments at the level of each individual household utility function, in conjunction with the minimization of dis-utility from factor supply, determining how much of each good or service should be produced, how much financing/factor supply each firm should receive in order to produce such quantities under the most efficient existing technologies, and how much each household should receive in proportion to their supply of production factors. The fact that a single utility function, at the level of each individual household, uniquely contributes to answering each of these questions at the level of the larger economic system establishes the centrality of household utility maximization to the functioning of a general equilibrium system.
We cannot accord this degree of centrality to utility maximization by demand-side agents in our consideration of Marshallian output market consumers. While it is not my intention to elaborate a broader theory of utility maximization by Marshallian consumption agents in this context, we need to specify at least a rough, partial definition of the Marshallian consumer in order to situate the firm as its other in output market price determination. Without delving into the rationalistic terrain of utility functions, the most evident means of defining the consumption agent would involve an empirical analysis of demand patterns within markets characterized by a relative fluidity of market prices where, among other things, qualitative characteristics of the good or service transacted remain fairly constant over the analyzed period. As such, the point is to establish the contours of a market demand schedule and, to a certain. limited extent, to probe its microfoundations at the level of the individual/household. In these terms, we can definitively argue that short run Marshallian market demand functions are generally negatively sloped in relation to price and that this negative relationship, at a microfoundational level, reflects the diminishing marginal utility of individual consuming agents as we increase the quantities of each commodity consumed. Beyond this basic reflection, we might further encounter a broad portfolio of theoretic concerns in the demand theory, involving the differentiation between Marshallian additive, cardinal utility functions and Walrasian/Paretian generalized utility functions. These issues need not concern us here, however.
At the level of individual markets, Marshallian theory compels us to simply add up all of the individual production and consumption agents on each side of the market in order to compile schedules enumerating how many units of a given commodity can be supplied at a given price and how many units will be demanded at the same price. Let us say, for example, that we have a given individual market for a particular, well defined and relatively homogeneous commodity, retail raw whole chicken breasts, over a one week period, in a regionally-defined small metropolitan market (< 750,000 inhabitants). Nine relatively large retail suppliers make up a majority of the market, regularly selling slightly over fifty percent of total outputs on average. The remainder of the market is divided among dozens of smaller retail outlets. Table 5 represents a schedule of output quantities, aggregating the three largest suppliers, six middle-range suppliers, and the remaining small suppliers, delineating marginal, average fixed, variable, and total costs.
| Suppliers | Quantity (xwcb) | Marginal Cost | Average Fixed Cost | Average Variable Cost | Average Total Cost |
| 3 Largest | 11220 | 2 | 0.53 | 1.87 | 2.4 |
| 3 Largest | 14400 | 2.2 | 0.41 | 1.96 | 2.36 |
| 3 Largest | 17670 | 2.4 | 0.34 | 2.03 | 2.37 |
| 3 Largest | 19950 | 2.6 | 0.3 | 2.1 | 2.4 |
| 3 Largest | 22120 | 2.8 | 0.27 | 2.17 | 2.44 |
| 3 Largest | 23800 | 3 | 0.25 | 2.23 | 2.48 |
| 3 Largest | 24920 | 3.2 | 0.24 | 2.27 | 2.51 |
| Middle 6 | 7480 | 2 | 0.65 | 1.92 | 2.57 |
| Middle 6 | 12400 | 2.2 | 0.39 | 2.03 | 2.42 |
| Middle 6 | 15960 | 2.4 | 0.31 | 2.11 | 2.42 |
| Middle 6 | 17290 | 2.6 | 0.28 | 2.16 | 2.44 |
| Middle 6 | 18170 | 2.8 | 0.27 | 2.19 | 2.46 |
| Middle 6 | 18700 | 3 | 0.26 | 2.22 | 2.48 |
| Middle 6 | 19580 | 3.2 | 0.25 | 2.26 | 2.51 |
| Remainder | 3300 | 2 | 0.81 | 1.98 | 2.79 |
| Remainder | 13200 | 2.2 | 0.2 | 2.15 | 2.35 |
| Remainder | 23370 | 2.4 | 0.12 | 2.25 | 2.37 |
| Remainder | 29260 | 2.6 | 0.09 | 2.33 | 2.42 |
| Remainder | 38710 | 2.8 | 0.07 | 2.44 | 2.51 |
| Remainder | 42500 | 3 | 0.06 | 2.49 | 2.55 |
| Remainder | 44500 | 3.2 | 0.06 | 2.52 | 2.58 |
Under the short run marginal cost pricing rule, the firms represented above should be willing to supply quantities of output up to the marginal cost of the last unit produced. Acknowledging that we are running over the theoretic complexities involved in full-blown micro-foundational analysis of production at the level of each individual firm in the interest of simplification, table 5 aggregates output quantities for the three size categories of roughly analogous firms, valuing additional outputs at each marginal cost level for each category of firms at the marginal cost (i.e. for the three largest firms, 14400 - 11220 = 3180 additional outputs are collectively valued at $2.20 per unit across all three firms). If we add up outputs in each of the three size categories for production at a price/marginal cost of $2.00 for the last unit(s) produced, we get a total output of 22,000 lbs of raw whole chicken breasts supplied.
Approaching the demand-side of the market, incorporating thousands of households consuming divergent quantities of raw whole chicken breasts for cooking at home, we can, for each individual/household, compile a set of reservation prices, at which each individual/household might delineate a monetized value on different quantities of the product being consumed as a register for the marginal utility enjoyed by the individual/household from consumption of the product as it increases the quantities it consumes. For a given household, for example, two pounds of whole chicken breasts might command a reservation price of $6.00. A third pound might, conversely, command $5.25 and a fourth $4.00, with successive pounds valued at even lower reservation prices. The point here, for Marshallian theory as for all other Neoclassical approaches, is that the marginal utility enjoyed by consumers diminishes with each successive unit consumed, matched by a diminution of the monetary value that consumers are willing to expend to obtain larger quantities. On an aggregate level, this constitutes the (micro-founded) explanation for a downward sloping market demand schedule.
Elaborating, if we consolidate the quantities demanded by all households, at each reservation price, then we can define a market demand schedule in which each each point on the schedule represents the highest reservation price at which a given quantity of output enjoys positive quantity demanded from a subset of consumers. For example, let us say that consumers demand 4,000 lbs of whole chicken breasts at $6.00/lb. By interpretation, this quantity consolidates households like the one mentioned previously that would purchase two pounds of whole chicken breasts for $6.00/lb. Some consumers, no doubt, demand more than two pounds while many consume less or nothing. The point is that the total quantity demanded across the market at a price of $6.00/lb reflects an aggregation of quantities demanded by each consuming agent engaged in the market if only to conclude that $6.00/lb is too high to justify the purchase of any whole chicken breasts. With this in mind, table 6 consolidates a truncated set of reservation prices across consuming agents in the market for whole chicken breasts and a set of marginal costs across all producing agents from each of the size categories represented in table 5.
| Quantity (Xwcb) | Marginal Cost | Reservation Price |
| 22000 | 2 | 3.58 |
| 40000 | 2.2 | 2.91 |
| 57000 | 2.4 | 2.7 |
| 66500 | 2.6 | 2.6 |
| 79000 | 2.8 | 2.53 |
| 85000 | 3 | 2.46 |
| 89000 | 3.2 | 2.42 |
Approaching the table 6 data graphically, we can articulate the basic Marshallian cross, depicting output supply and demand schedules with a short run market equilibrium of 66,500 lbs of raw whole chicken breasts exchanging at an equilibrium market price of $2.60 per pound. We illustrate this result in figure 15.
Figure 15: Short Run Market Supply and Demand Schedules for Retail Raw Whole Chicken Breasts on a Weekly Time Frame in a Small Metropolitan Regional Market
If we now transition from the level of the market to the level of individual firms, we can specify the basic logic of the short run marginal cost pricing rule with the specific production technologies in place for individual suppliers. Let us say, for example, that we have a single small firm, among the aggregate above labeled "Remainder." For a wide range of prices, the costs incurred by the firm remain too high to justify producing any output. At $2.00 per pound, for example, we can assume that the average variable costs for the firm exceed $2.00 per pound of raw whole chicken breasts produced for sale. As such, the firm produces zero output. In fact, it only begins to produce positive outputs at a market price of $2.40, where it produces 30 lbs for sale. The marginal cost, average fixed cost, average variable cost, and average total costs incurred by the firm at various output market prices are introduced in table 7 below.
| Quantity (xwcb) | Market Price | Marginal Cost | Average Fixed Cost | Average Variable Cost | Average Total Cost |
| 0 | 2 | - | - | - | - |
| 0 | 2.2 | - | - | - | - |
| 30 | 2.4 | 2.4 | 0.29 | 2.22 | 2.51 |
| 45 | 2.6 | 2.6 | 0.19 | 2.35 | 2.54 |
| 55 | 2.8 | 2.8 | 0.16 | 2.43 | 2.59 |
| 63 | 3 | 3 | 0.14 | 2.5 | 2.64 |
| 67 | 3.2 | 3.2 | 0.13 | 2.54 | 2.67 |
Table 7: Short Run Output Supply for an Individual Small Firm in the Market for Retail Raw Whole Chicken Breasts on a Weekly Time Frame in a Small Metropolitan Market
Considered graphically, our market equilibrium price of $2.60 represents a hard constraint for the firm. As a single participant within a perfectly competitive market in which a very large number of competing suppliers operate, the firm cannot meaningfully affect market prices by varying output quantities. Rather, it can only expect to sell all available outputs that it can produce at the equilibrium price, consistent with its short run marginal cost pricing profit maximization condition. Thus, at a market price of $2.60, it supplies 45 lbs of raw whole chicken breasts, selling all that it produces for the market. This outcome is shown graphically, in relation to the market equilibrium outcome, in figure 16.
Figure 16: Short Run Supply for an Individual Firm in a Perfectly Competitive Market for Retail, Raw Whole Chicken Breasts, with Marginal Cost, Average Total Costs, and Average Variable Costs for Various Market Prices
The larger point here is that individual firms, either at this relatively finite scale of operation or at larger scales, are unable to palpable affect market quantities and, thus, unable to impact the equilibrium output market price. Hence, in figure 16, our individual firm faces a perfectly elastic demand curve at the equilibrium output market price for their product. This condition graphically reiterates our previous conclusion that the marginal revenue that the firm receives from the last unit it sells is strictly equal to the output market price in equilibrium.
Before concluding this section, it is worth elaborating on the issue of short run profit in competitive markets. This will not be the last word on profit in our discussion of Marshallian theory, but avoiding some discussion of profit at this point would leave an untenable loose end in our theory of short run competitive markets. As such, we need to differentiate between three distinct concepts pertinent to our discussion: accounting profit, economic profit, and normal profit. Accounting profit constitutes the difference between the total monetary revenues received by the firm and its total monetary costs. That is to say, it is the difference between what the firm pays out in money for factors of production and other production or transaction costs and the money that it receives from sales and other revenue sources. Operating with this definition of accounting profit in relation to our example of the market for retail raw whole chicken breasts, our individual small firm earns an accounting profit of $.06 per pound of chicken breasts ($2.60 - 2.54 = .06), giving it a total accounting profit from the sale of raw whole chicken breasts of $2.70 over forty-five pounds of chicken breasts at a market price of $2.60 (presumably this firm is offering many, many other, more profitable items to its customers!).
Economic profit, by contrast, constitutes the difference between total monetary revenues and total monetary costs plus opportunity costs, a category including implicit costs to the firm from undertaking production strategies that do not strictly maximize profits in accordance with the variability of its production factors. In these terms, if, at a market price of $2.60 per pound, our firm decided to produce only thirty pounds of raw whole chicken breasts for sale at an average total cost of $2.51 per pound, then, at $.09 accounting profit per pound, it would achieve the same total accounting profit across thirty pounds that it would obtain from producing forty-five pounds (30 x .09 = $2.70). However, by only producing thirty pounds, the firm foregoes $39 in additional revenues from the sale of an additional fifteen pounds of chicken breasts, at an average cost of $2.54. The accounting profit here does not change, but we have to add an implicit opportunity cost of $39 to account for the firm's failure to maximize profits subject to the marginal cost pricing rule. In per unit terms, we would be deducting $.03 from each pound of chicken breasts sold by the firm at the lower quantity in order to equalize the rate of profit in relation to total costs in both circumstances. In both circumstances, therefore, the firm incurs total costs (monetary costs plus implicit/opportunity costs) of $114.30 whether it produces thirty pounds of raw whole chicken breasts or forty-five pounds, where, in the latter case, all of its opportunity costs have been eliminated by producing in accordance with the marginal cost pricing rule.
By defining economic profit in relation to opportunity costs, we are explicitly linking the definition to the marginal cost pricing rule. This is true for competitive firms, but it is also true for imperfectly competitive firms, where marginal costs and marginal revenues diverge from the reservation prices of consumers. In a specifically competitive Marshallian context, however, where short run market conditions may be expected to deviate from average conditions over longer term periods, the conception of economic profit carries an additional signification. Notably, economic profits are conceived as short run deviations between average total costs and market prices that are expected to disappear over longer term periods. That is to say, if the retail market for raw whole chicken breasts was known to be a market site in which substantial profits were to be made, then more firms would enter the market in order to compete for a share of the excess returns. As they did so, market quantities supplied would increase in relation to quantities demanded, driving down the market price and eliminating opportunities for excess returns over average total costs.
In the above example, I intentionally posit conditions in which the largest firms participating in the market encounter the largest deviations between market price and average total cost, suggesting that there are scale economies to be exploited in the market, even if such economies are not sufficient to completely eliminate competition where levels of market demand are sufficient to impel marginal producers to enter the market. The point is that, as marginal entrants approach the market, economic profits are diminished, even for firms with the largest average total cost advantages. Emphatically, the portrait of the market that I am advancing here is not Walrasian/Paretian. All firms are not the same, and some firms hold strategic advantages that cannot be entirely competed away. Entrants do not appear automatically to instantaneously compete economic profits away in short run circumstances where they arise. If in a Walrasian/Paretian general equilibrium system we are confronted with iron laws of rationality that ensure the continuous impossibility of economic profit, then economic profit appears as a regular and dynamic reality for Marshallian firms, one that dynamically shapes the composition of suppliers within markets.
This leaves us with a final, peculiar, and, yet, indispensable conception, normal profit. Normal profit describes an expectation relative to market activity that an investment in production will generate a particular threshold ratio of returns to total costs. In this circumstance, my conception of total cost will, effectively, reflect our conception of economic profits, to the extent that I am assuming full conformity with the marginal cost pricing rule. The circumstances associated with the formation of such expectations of highly varied. For his part, Marshall committed Book VI, Chapter VIII of the Principles to an elaboration of the conditions governing normal profit. In the end, my interpretation of Marshall's conclusions are primarily motivational. We cannot come to any particular definition of a normal rate of profit, in either a macroeconomic sense or in terms of any particular market activity. Rather, normal profits are contextual in every sense, and regional, temporal, and technological contexts drive the expectations of investors and entrepreneurs.
In the case above, we might conceive of a threshold rate of normal profit from the production and exchange of raw whole chicken breasts between two-and-one half and five percent of total costs, where, again, we interpret normal profit as a ratio rather than a raw quantity. Such a rate appears, on its face, indicative of the activity represented above, where larger producers achieve larger rates of return from scale economies and smaller producers appear to just scratch the surface of desired rates of return.
A larger concern here involves the nature of expectations relative to longer term outcomes. It might be the case that, for any particular short run period, firms are able to meet expectations for profit from a particular set of investments in production factors. However, insofar as such expectations are framed by outcomes of previous short run periods and contemporaneous macroeconomic phenomena (e.g. aggregate polling on consumer and producer confidence), every set of expectations on normal profit rates need to be taken in a specific temporal and spatial context. How might the geographic expanse of the market for a particular good or service or of a range of allied goods and services shape a certain set of expectations for rates of return? If a market is seasonally oriented or otherwise temporally configured in ways that promote alternating moments of superabundant and slack demand for particular goods and services, then shouldn't we expect to see particular market engagement strategies by firms to harmonize profit expectations in temporally varied markets? How do general macroeconomic trends on growth and decline of economic activity impact the profitability expectations of firms producing individual goods or services for individual markets? It may have been my experience that the market for retail raw chicken breasts can be characterized in accordance with fairly uniform trends in market demand relative to seasonal and cyclical phenomena, but this reflection does not imply that patterns of demand and, hence, expectations for profit are apt to be wholly constant over time even in this particular market. Closing this short reflection on normal profit in short run Marshallian market analysis, I want to briefly introduce a subject that will return in our critique of this Marshallian theory of the firm. If we continue to hold that Marshallian firms should follow the short run marginal cost pricing rule and that, hence, our conception of normal profit will reflect economic profit (i.e. minimization of both explicit/monetary and implicit/opportunity costs), then we are left with a basic question on how the existence of normal profits, as an excess return over factor costs, should be interpreted. For our previous Walrasian/Paretian theory of the firm, we avoided this question entirely: there are no economic profits in a seamlessly integrated general equilibrium economy characterized by perfectly distributed information and, therefore, we do not need to explain the source of something that we axiomatically assume to not exist. In Marshallian theory, economic profits do, in fact, exist, at least in the short run, and their existence shapes expectations and impacts the growth and decline of production for individual markets in relation to consumer demand. Normal profit is formative to the overarching functions of a dynamic economic system. If this is true, then we have to derive some meaningful explanation for the persistence of an expected rate of economic profits where we simultaneously adopt an assumption that price competition and the entry of marginal firms into profitable market contexts will drive economic profit to zero in the long run. Somehow, persistent positive economic profit has to be baked into our explanation of market systems.
It will be my contention that Alfred Marshall was content to live with the contradiction implied by these conditions in the interest of conceding the irreducible complexity of market systems. On the other hand, subsequent Marshallians, with theories inflected by Paretian rationalism, operate with a more mechanical vision of the workings of market systems. In such theoretic frames, we cannot simply reduce the persistence of economic profit to a peculiarity of market systems. We require an explanation. In the Marshallian tradition, such explanations have been configured around returns to immeasurable, intangible factors of production sometimes labeled entrepreneurship, relating profits to risk taking and management of informational imperfections. It will be my contention that these explanations are one-sided: they adequately justify the existence of normal profit without explaining its source. Ultimately, it will be my contention that such a source cannot be found within Marshallian theory or the larger Neoclassical tradition.
The larger point here is that individual firms, either at this relatively finite scale of operation or at larger scales, are unable to palpable affect market quantities and, thus, unable to impact the equilibrium output market price. Hence, in figure 16, our individual firm faces a perfectly elastic demand curve at the equilibrium output market price for their product. This condition graphically reiterates our previous conclusion that the marginal revenue that the firm receives from the last unit it sells is strictly equal to the output market price in equilibrium.
Before concluding this section, it is worth elaborating on the issue of short run profit in competitive markets. This will not be the last word on profit in our discussion of Marshallian theory, but avoiding some discussion of profit at this point would leave an untenable loose end in our theory of short run competitive markets. As such, we need to differentiate between three distinct concepts pertinent to our discussion: accounting profit, economic profit, and normal profit. Accounting profit constitutes the difference between the total monetary revenues received by the firm and its total monetary costs. That is to say, it is the difference between what the firm pays out in money for factors of production and other production or transaction costs and the money that it receives from sales and other revenue sources. Operating with this definition of accounting profit in relation to our example of the market for retail raw whole chicken breasts, our individual small firm earns an accounting profit of $.06 per pound of chicken breasts ($2.60 - 2.54 = .06), giving it a total accounting profit from the sale of raw whole chicken breasts of $2.70 over forty-five pounds of chicken breasts at a market price of $2.60 (presumably this firm is offering many, many other, more profitable items to its customers!).
Economic profit, by contrast, constitutes the difference between total monetary revenues and total monetary costs plus opportunity costs, a category including implicit costs to the firm from undertaking production strategies that do not strictly maximize profits in accordance with the variability of its production factors. In these terms, if, at a market price of $2.60 per pound, our firm decided to produce only thirty pounds of raw whole chicken breasts for sale at an average total cost of $2.51 per pound, then, at $.09 accounting profit per pound, it would achieve the same total accounting profit across thirty pounds that it would obtain from producing forty-five pounds (30 x .09 = $2.70). However, by only producing thirty pounds, the firm foregoes $39 in additional revenues from the sale of an additional fifteen pounds of chicken breasts, at an average cost of $2.54. The accounting profit here does not change, but we have to add an implicit opportunity cost of $39 to account for the firm's failure to maximize profits subject to the marginal cost pricing rule. In per unit terms, we would be deducting $.03 from each pound of chicken breasts sold by the firm at the lower quantity in order to equalize the rate of profit in relation to total costs in both circumstances. In both circumstances, therefore, the firm incurs total costs (monetary costs plus implicit/opportunity costs) of $114.30 whether it produces thirty pounds of raw whole chicken breasts or forty-five pounds, where, in the latter case, all of its opportunity costs have been eliminated by producing in accordance with the marginal cost pricing rule.
By defining economic profit in relation to opportunity costs, we are explicitly linking the definition to the marginal cost pricing rule. This is true for competitive firms, but it is also true for imperfectly competitive firms, where marginal costs and marginal revenues diverge from the reservation prices of consumers. In a specifically competitive Marshallian context, however, where short run market conditions may be expected to deviate from average conditions over longer term periods, the conception of economic profit carries an additional signification. Notably, economic profits are conceived as short run deviations between average total costs and market prices that are expected to disappear over longer term periods. That is to say, if the retail market for raw whole chicken breasts was known to be a market site in which substantial profits were to be made, then more firms would enter the market in order to compete for a share of the excess returns. As they did so, market quantities supplied would increase in relation to quantities demanded, driving down the market price and eliminating opportunities for excess returns over average total costs.
In the above example, I intentionally posit conditions in which the largest firms participating in the market encounter the largest deviations between market price and average total cost, suggesting that there are scale economies to be exploited in the market, even if such economies are not sufficient to completely eliminate competition where levels of market demand are sufficient to impel marginal producers to enter the market. The point is that, as marginal entrants approach the market, economic profits are diminished, even for firms with the largest average total cost advantages. Emphatically, the portrait of the market that I am advancing here is not Walrasian/Paretian. All firms are not the same, and some firms hold strategic advantages that cannot be entirely competed away. Entrants do not appear automatically to instantaneously compete economic profits away in short run circumstances where they arise. If in a Walrasian/Paretian general equilibrium system we are confronted with iron laws of rationality that ensure the continuous impossibility of economic profit, then economic profit appears as a regular and dynamic reality for Marshallian firms, one that dynamically shapes the composition of suppliers within markets.
This leaves us with a final, peculiar, and, yet, indispensable conception, normal profit. Normal profit describes an expectation relative to market activity that an investment in production will generate a particular threshold ratio of returns to total costs. In this circumstance, my conception of total cost will, effectively, reflect our conception of economic profits, to the extent that I am assuming full conformity with the marginal cost pricing rule. The circumstances associated with the formation of such expectations of highly varied. For his part, Marshall committed Book VI, Chapter VIII of the Principles to an elaboration of the conditions governing normal profit. In the end, my interpretation of Marshall's conclusions are primarily motivational. We cannot come to any particular definition of a normal rate of profit, in either a macroeconomic sense or in terms of any particular market activity. Rather, normal profits are contextual in every sense, and regional, temporal, and technological contexts drive the expectations of investors and entrepreneurs.
In the case above, we might conceive of a threshold rate of normal profit from the production and exchange of raw whole chicken breasts between two-and-one half and five percent of total costs, where, again, we interpret normal profit as a ratio rather than a raw quantity. Such a rate appears, on its face, indicative of the activity represented above, where larger producers achieve larger rates of return from scale economies and smaller producers appear to just scratch the surface of desired rates of return.
A larger concern here involves the nature of expectations relative to longer term outcomes. It might be the case that, for any particular short run period, firms are able to meet expectations for profit from a particular set of investments in production factors. However, insofar as such expectations are framed by outcomes of previous short run periods and contemporaneous macroeconomic phenomena (e.g. aggregate polling on consumer and producer confidence), every set of expectations on normal profit rates need to be taken in a specific temporal and spatial context. How might the geographic expanse of the market for a particular good or service or of a range of allied goods and services shape a certain set of expectations for rates of return? If a market is seasonally oriented or otherwise temporally configured in ways that promote alternating moments of superabundant and slack demand for particular goods and services, then shouldn't we expect to see particular market engagement strategies by firms to harmonize profit expectations in temporally varied markets? How do general macroeconomic trends on growth and decline of economic activity impact the profitability expectations of firms producing individual goods or services for individual markets? It may have been my experience that the market for retail raw chicken breasts can be characterized in accordance with fairly uniform trends in market demand relative to seasonal and cyclical phenomena, but this reflection does not imply that patterns of demand and, hence, expectations for profit are apt to be wholly constant over time even in this particular market. Closing this short reflection on normal profit in short run Marshallian market analysis, I want to briefly introduce a subject that will return in our critique of this Marshallian theory of the firm. If we continue to hold that Marshallian firms should follow the short run marginal cost pricing rule and that, hence, our conception of normal profit will reflect economic profit (i.e. minimization of both explicit/monetary and implicit/opportunity costs), then we are left with a basic question on how the existence of normal profits, as an excess return over factor costs, should be interpreted. For our previous Walrasian/Paretian theory of the firm, we avoided this question entirely: there are no economic profits in a seamlessly integrated general equilibrium economy characterized by perfectly distributed information and, therefore, we do not need to explain the source of something that we axiomatically assume to not exist. In Marshallian theory, economic profits do, in fact, exist, at least in the short run, and their existence shapes expectations and impacts the growth and decline of production for individual markets in relation to consumer demand. Normal profit is formative to the overarching functions of a dynamic economic system. If this is true, then we have to derive some meaningful explanation for the persistence of an expected rate of economic profits where we simultaneously adopt an assumption that price competition and the entry of marginal firms into profitable market contexts will drive economic profit to zero in the long run. Somehow, persistent positive economic profit has to be baked into our explanation of market systems.
It will be my contention that Alfred Marshall was content to live with the contradiction implied by these conditions in the interest of conceding the irreducible complexity of market systems. On the other hand, subsequent Marshallians, with theories inflected by Paretian rationalism, operate with a more mechanical vision of the workings of market systems. In such theoretic frames, we cannot simply reduce the persistence of economic profit to a peculiarity of market systems. We require an explanation. In the Marshallian tradition, such explanations have been configured around returns to immeasurable, intangible factors of production sometimes labeled entrepreneurship, relating profits to risk taking and management of informational imperfections. It will be my contention that these explanations are one-sided: they adequately justify the existence of normal profit without explaining its source. Ultimately, it will be my contention that such a source cannot be found within Marshallian theory or the larger Neoclassical tradition.
