The Marginalist Controversy, Lee

The Marginalist Controversy and the Demise of Full Cost Pricing
Author(s): Frederic S. Lee

Source: Journal of Economic Issues, Vol. 18, No. 4 (Dec., 1984), pp. 1107-1132
Published by: Association for Evolutionary Economics
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JOURNAL OF ECONOMICISSUES
Vol. XVIII No. 4 December 1984
The MarginalistControversyand the

Demise of Full Cost Pricing
Frederic S. Lee
In the decade followingWorldWar II, U.S. economistsengagedin a

somewhatpolemicalcontroversyover the meritsof the full cost pricing
doctrineas opposedto marginalism:"Thefightwas spirited,even fierce.
Thousandsof studentsof economics,voluntaryor involuntaryreaders,
have been either shockedor entertainedby the violence of some of the
blows exchanged"[Machlup1967, p. 1]. The contestantsin the debate
were concerned with the theoretical compatibility of full cost pricing and
marginalism;and the debateendedwhen the majorityof economistsbecame convincedthat the two were completelycompatible.Thus after a
decadeof nationalexposure,the doctrinequicklyceased to be of significanttheoreticalinterestto the majorityof U.S. economists.'
Still, economistsperiodicallyresurrectit in orderto providea "theoretical"explanationfor pressingeconomic problems,such as inflation,
thathave not been adequatelyhandledby neoclassicalpricetheory[Okun
1981; Bator 1981; Peterson 1982; and Wachteland Adelsheim1976].
Moreover, some economistsare now suggestingthat the doctrineprovides, in part, a theoreticalbasis on whichto develop a non-neoclassical
theoryof prices [Eichner1978; and Lee 1983, 1984a]. Thus the demise
of full cost pricingin the mid-1950s appearsto have been unfortunate
and,unwarranted.
Still,it happened!Thereforethe questionthat needs to
The author is Assistant Professor of Economics, Roosevelt University. He would
like to thank Craig Justice, Dorene Isenberg,and the editor and anonymous referees
of this journalfor their helpful comments on previousdrafts of this article.
1107

1108
FredericS. Lee
be answeredis why the marginalistcontroversyended. Yet to answerit

requiresmore than a simplechronologicalaccountingof the events that
broughtit to a close. What is needed is an investigativeanalysisof the
entirecontroversyso that the reasonswhy it came to an end are clearly
perceived.Hence this articlewill deal with the events that led up to the
controversy,with the Lester-Machlupexchange,with the eventsthat led
to the ending of the controversy,and with the cost curve controversy.
Throughthis approachit will be shown that the demise of the full cost
pricingdoctrineresultedfrom a concertedeffortby neoclassicaleconomiststo eliminatethis theoreticalchallengeto theirpricetheory.
Before beginning,we must definemarginalism,neoclassicalprice theory, and the full cost pricingdoctrine.I definemarginalismas a body of
theory whose principalpropositionis that profitsare maximizedwhen
marginalcosts equal marginalrevenueand that assumesthat firmshave
completeknowledge(or at least the appropriateamountand kind) when
establishingprice policiesand settingprices.Neoclassicalprice theoryis
seen as a more generalbody of theorywhose principaltheoreticalconcepts includedemandand cost functions,equilibrium,scarcity,and allocative efficiency,and whose objectivesof the firmincludemaximization
of profit,sales,growth,andwealthif completeknowledgeis assumed,and
satisficingof the same if uncertaintyand incompleteknowledgeare assumed.In the latterinstance,it is possiblefor firmsto employ rules-ofthumband to adopt complex organizationalstructuresin orderto, say,
discovertheir"true"cost and demandfunctionsin an effortto efficiently
fulfill their objectives.Thus neoclassicalprice theory includesnot only
marginalismand managerialtheoriesof the firm (or extendedmarginalism), but also behavioraltheoriesof the firm;however,it shouldbe noted
that neoclassicalprice theoryand marginalismwere synonymousup until the early 1950s when attemptsto reconcilemarginalismwith full cost
pricing in part brought about the generalizationof neoclassical price
theory.
The full cost pricingdoctrineis seen as includingfull cost pricesetting
proceduresin which the full cost price is set by addingtogetherdirect
materialand laborcosts per unit output,plus overheadcosts determined
at standardvolume output, plus a predetermined(conventional) profit
margin.Becausethe pricingprocedureis not explicitlydesignedto maximize profits,the full cost priceis not a profitmaximizingpriceor, in fact,
a pricethatmaximizesanything.Ratherthe pricingprocedureis designed
to enablethe firmto reproduceitself and grow. Thereforeit is consistent
with the firm'sprice policy promotingprice stability,hence firm reproducibilityin the short term, and price variability,hence firm growthin

The Marginalist Controversy
1109
the long term.In neitherinstanceis the firm'spricepolicy consistentwith

short or long period profit maximizationor maximizationof any kind.
Thus the full cost pricingdoctrinedoes not appearto be consistentwith
neoclassicalpricetheoryor marginalism.
Background to the Controversy
To adequatelyunderstandthe marginalistcontroversy,it is necessary

to look at the tumultuousyears preceeding1946. With the implementation of the National IndustrialRecovery Act (1933) and the AgriculturalAdjustmentAct (1933), governmentofficialsbegangeneratingvast
amountsof statisticaldata on prices and detaileddescriptionsof price
settingproceduresand price policies used by firms.For example,members of the NationalRecoveryAdministration(NRA) Consumer'sAdvisory Board and Researchand PlanningDivision producedstatistical
data showing that prices under the NRA had become relativelymore
stablecomparedto pre-NRAprices.Concurrently,G. C. Meansandother
officialsof the AgriculturalAdjustmentAdministrationarguedthat the
codes of faircompetitionunderthe NRA reinforcedthe stabilityof industrial prices alreadymade stable by the firm'sstrongtechnologicalbase,
which grew out of its scale of productionand the relativeconcentration
of the manufacturingindustries.As a result, they argued,prices in the
economywere grosslymisaligned,hence promotingthe accumulationof
excess savings,the failure of mass purchasingpower, and the resulting
declinein privateinvestmentopportunitiesand prolongingof the depression. Finally, in 1934, Roosevelt establisheda Cabinet Committeeon
PricePolicy;underthe guidanceof WaltonHamiltonit carriedout a number of detailedstudies of prices and price policies and eventuallypublishedthemin 1938 [von Szeliski1936; Means 1935; Hawley 1966; and
Hamilton1938].
In the light of this data, thereemergedtwo economicpolicy proposals
that in turngeneratedadditionaldata on prices,pricesettingprocedures,
and price policies used by fims. On the one hand, Means acceptedthe
phenomenaof stable prices, which he called administeredprices, as inherentin the moderneconomy,even thoughthey contributedgreatlyto
the depression.He believedthatnationaleconomicplanningwouldalleviate the problem.Consequently,whenhe becamedirectorof the industrial
section of the National ResourcesCommitteein 1935, he embarkedon
a series of investigationsthat would lead to guidelinesand some basic
data necessaryfor effectiveplanning.In particular,he investigated"the
structure of prices in order to discover . . . the extent to which they do in

1110
FredericS. Lee
fact contributeto full and effectiveuse of resources"[Means 1939, p.

122]. On the otherhand, the neo-BrandeisiansacceptedMean'sanalysis
of administeredprices,but advocateda ratherdifferentremedy.That is,
Means argued that administeredprices emergedin industriesin which
firmshad developedstructuresof productionthat limitedthe economic
spacein the industryavailableto competingfirmsand thatweremost efficiently operatedif the marketprice was stable and they administeredit.
The neo-Brandeisians,however,did not believe that industrialconcentrationwas based on the firms'productivestructure;ratherthey believed
it emergedfrom unsavorybusinesspractices.Hence, since administered
priceswerefoundin concentratedindustriesand werethe principalcause
for the continuationof the depression,they advocatedthe use of antitrust
laws to breakup the concentratedindustriesso that pricescould become
flexibleand prosperitycould be restored.This programfor action gave
rise to a varietyof inquiriesinto the presentstatus of competitionand
prices conductedby government,privateorganizations,and economists
and to the administeredprice-concentrationcontroversy [Cox 1981;
Backman1940; ConferenceBoard1939; Committeeon PriceDetermination 1943; andNourseand Drury1938].3Moreimportantlyit resultedin
the establishmentin 1939 of the TemporaryNationalEconomicCommittee (TNEC). In the hearingsand monographsthat followed,politicians
and economistsalike were treated to a rich descriptiveand statistical
analysisof prices,pricing,and price policies [Hawley1966; Lynch 1946;
andBrownet al. 1940].
Concurrentlywith the events describedabove, data on prices, price
policies, and price setting procedureswere being broughtto light elsewhere.Concernover the emergingdominanceof the chainstoresand the
increasingrequestsfor and proliferationof fair trade laws resultedin a
numberof detailedstudiesof prices,pricepolicies,andpricingprocedures
usedby firms(see for example,[FTC1934; and Grether1939]). In addition the concernwithbasingpointpricinggenerateda greatdeal of pricerelated information[Daughertyet al. 1937]. Finally, individualeconomists undertookdetailed investigationsof specificindustriesand firms,
and of economic acts such as sales taxes that have a direct impact on
firms.Fromtheirworkemergedinformationspecificto pricingprocedures
and price policies used by firms [Reynolds1938, 1940; Gordon 1966;
andDue 1941].
Withthe emergenceof the above data, economistsbeganto realizeby
the late 1930s that a wide gap existedbetweentheirtheoryof pricesand
the real worldof pricesand pricing.First of all, the data showedthat full

1111
cost pricingprocedureswere widely used by firms,whetherindustrialor

retail. Thus it becameapparentthat firmsdid not explicitlyemploy the
marginalisttools when setting their prices. Secondly, the data showed
that the behaviorof prices,say with respectto fluctuationsin demandor
to changesin excises or sales taxes, did not conformto the results suggestedby neoclassicalpricetheoryor appearto be adequatelyexplained
by it. On the otherhand,the full cost pricingproceduresdid seem to account for the anomalousprice behavior.Finally,in conjunctionwith the
above results,it becamewidelyapparentto economiststhat firmsdid not
set pricesthatmaximizedshortperiodprofits(for example,see [Hawkins
1939-40, p. 383; and Reynolds 1938, p. 465]). Thus the data generated
throughoutthe 1930s drove many economiststo question marginalism
(or neoclassicalpricetheory) or at least its currentapplicability.4
In light of the apparentgap betweenrealityand theoryand the harsh
criticismthat accompaniedit, three differentargumentswere developed
to defusethe attackon marginalism.F. Machlupput forth one argument,
but in a verysketchymanner.He arguedthatmarginalismis applicableto
marketscharacterizedby perfectcompetitionand monopolisticcompetition (which he definedas perfectcompetitionwith productdifferentiation), where firmsare heedlessof rivals'reactions-thus permittingthe
existenceof a determinantfirmdemandcurve.His argumentimpliedthat
marginalismcould be used only to answerproblemsin pricetheory arising from counterfactualchanges in the environmentof an "abstract"
firmwith no controlover its environment.ConsequentlyMachlupimplied
that marginalismcould not inherentlyexplainor accountfor individual
firmbehavior,especiallyfirmbehaviorthat occurredin oligopolisticmarkets since determinantfirmdemandcurvesdo not exist in such markets.
The implicationof Machlup'sargumentwas that the criticismsof marginalismnoted above were irrelevant[Machlup1937 and 1939].5
A secondargumentwas put forthby E. S. Mason and his associatesat
Harvardand the NationalBureauof EconomicResearch (NBER). To
close the gap betweenfact and theory, Mason proposedthat the pricesettingbehaviorof a firm,hence its price,could be analyzedaccordingto
factorsinternalto it-such as costs, organization,productcharacteristics,
and size-and accordingto its marketstructure,includingproductdifferentiation,demand,and numberof firms.In turn,he felt that the internal
factors and the elementsof the marketstructurecould stand as proxies
for the marginalisttools until such time that the tools had been sufficientlywell developedso as to be directlyusable for empiricalresearch.
Thus by assumingthat the gap betweenfact and theory was bridgeable,

1112
FredericS. Lee
Mason became the first to articulatethe argumentthat the absence of

marginalisttools in price determinationwas only a resultof theirprimitive state of development [Mason 1939; and Phillips and Stevenson
1974].6
The importanceof Mason'sargumentfor the full cost pricingdoctrine

can be illustratedin two ways. First, Mason arguedthat firms'adoption
of a stable (full cost) price policy could be explained,given the unuseabilityof the marginalisttools, accordingto the internaland externalfactors mentioned above. Thus he impliedthat the full cost price policy
(hence full cost pricingproceduresand prices) was not inconsistentwith
marginalism[Mason 1939]. Secondly,in responseto the swirlingcontroversysurroundingprices and pricing,and to the establishmentof the
TNEC, the NBER establisheda committeeunderMason'sdirectionto
investigate,amongotherthings,the pricingpoliciesof firms.The committee completedits work in 1941, althoughits findingswere not published
until 1943. Apart from the discussionof costs, the importanceof the
committee'sstudywas its discussionof the full cost pricingdoctrine.
While the NBER investigationsof firms'pricingpolicies proceeded,
there appearedin Englandan importantarticleby R. L. Hall and C. J.
Hitch on the full cost pricingdoctrine[Halland Hitch 1939]. JohnDunlop, who was a memberof the NBER committee,had met both Hall and
Hitch while he was at Cambridgein 1937-38 and becamequite familiar
withthe argumentsfoundin theirarticle.Thus,he was not only in a position to impressthe importanceof the articleupon the committee,but in
his role of draftingthe reporthe was able to includea discussionof its
importantfeatures.The committeealso becameinterestedin the article's
discussionof a firm'spricingand pricepolicy. The kinkeddemandcurve
was favorablyreceivedsinceit provided"arealisticpictureof the demand
situationas envisagedby individualfirmsin a greatnumberof industrial
marketsa large part of the time" [Committeeon Price Determination
1943, p. 278], as well as an explanationof stablepricesthat did not appear to be inconsistentwith marginalism.The committeewas more critical of the full cost pricingdoctrine,however.It was acknowledgedthat
it did not provide an explanationfor stable prices. Yet the committee
could not accept its major premises-that firms neither calculatednor
used marginalcosts or marginalrevenuefor pricingpurposes.For example, it arguedthat firms could and did indirectlycalculatemarginal
costs for pricingpurposesand that it was a mistaketo thinkotherwise.In
additionit arguedthat the process of selectionand rejectionthat multiproductfirmsused to arriveat a productmixthat wouldmaximizeprofits

The MarginalistControversy
1113
couldgive the sameresultsas the marginalisttools. Thus the committee's

adoptionof Mason'spositionled it to concludethat the full cost pricing
doctrinewas not inconsistentwith marginalism[Dunlop 1981; Mason
1982;and Committeeon PriceDetermination1943].
The thirdargumentdevelopedto defusethe attackon marginalismwas
put forthby two Berkeley-educated
economists,E. R. Hawkinsand J. F.
Due. They started their argumentby stating that "the usual pricing
method of retailers . . . does not involve the determination of marginal
revenueand marginalcost schedules,and the setting of price at such a

level as to equatethe two" [Due 1941, p. 3851. This preferencefor nonmarginalistpricingproceduresexistedbecause (1) in oligopolisticmarkets, the firm'sdemandcurve does not exist independentlyof the price
charged;(2) firmsare ignorantof theirdemandcurves;(3) long-period
demandis not independentof short-perioddemand,implyingthat shortand long-periodfirmdemandcurvesare interdependent;
and/or (4) recovering overheadcosts is importantif the multiproductretaileris to
maintainitself as a going concern.Yet, they concluded,this absence of
the use of the marginalcost-marginalrevenue pricing method among
retailersdoes not constitutea significantattack on marginalismfor two
reasons. First, the full cost pricing proceduresdo producemarginalist
resultsif interpretedin a long periodcontext.Second, the use of full cost
pricingprocedurescan be explainedaccordingto marginalist(neoclassical) concepts-such as firmdemandcurves,marginalcost schedules,and
fixedcosts-and thereforecannotbe theoreticallyinconsistentwith marginalism[Due1941, 1942;andHawkins1939-40].
Despitethe vigorwith whichthey were presented,the threearguments
did not convinceall economiststo dismissthe anti-marginalism
criticism,
to concludethat the gap betweenfact and theorywas indeedbridgeable,
or to concludethat the doctrinecan be placedwithin a marginalistcontext.7Thus,by the end of 1941, all the ingredientsnecessaryfor the eruption of a marginalistcontroversywere present;however,the controversy
was preemptedby the bombingof PearlHarborandthe subsequentdrafting of many interestedeconomistsinto the war effort (workingfor the
Departmentof PriceAdministrationand the WarLaborBoard). Yet the
pressureof war work did not preventthem from discussingthe inadequacies of marginalism.Moreover,the war work generatedadditional
datathat showedthat firmsused full cost pricingprocedures.Finally,the
war years gave economistsnot directlyconnectedwith the above empirical research,suchas R. A. Lesterand W. Eiteman,timeto become skeptical of the adequacyof marginalismto explainthe actualpricingbehavior

FredericS. Lee
1114
of firms.Thus by the end of the war a broadgroundswellof criticismof

marginalismhadbuiltup waitingto burstinto print [Dunlop1981; Lester
1981; andEiteman1982a].A
The Controversy Opens
The Lester-Machlup Exchange
In 1946, Lesterpublishedhis well knowncritiqueof the marginalproductivitytheoryof wages. He had originallyexpressedhis dissatisfaction
with the theorypriorto 1941, but the warpreventedhis views fromhaving any impacton economists.He becamemorecriticalof the theoryduring his work with the War Labor Board. In 1944, he began a study of
North-Southwage differentialsand later studiedthe data on the employment effects of the legal minimumwage. The studies,he felt, failed to
provideempiricalsupportfor marginalismand the marginalproductivity
theoryof wages.It was againstthisbackgroundthatLesterwrotehis 1946
article[Lester1941, 1981].
In the article,Lesterpresenteda batteryof empiricalevidencethat appearedinconsistentwith marginalism;however,the article'simportance
lies in the mannerin whichLestercharacterizedthe inadequaciesof marginalism.He felt that his empiricalresearchraised "gravedoubts as to
the validity of conventionalmarginaltheory and the assumptionson
whichit rests"in the followingways: (1) marketdemandwas more importantin determininga firm'svolume of employmentthan wage rates;
(2) the firm'scost structurewas not that suggestedby "conventional
andits capital-laborratiowas not tied to its wageratestrucmarginalism"
ture; and (3) "the practical problems involved in applying marginal
analysisto the multi-processoperationsof a modernplant seem insuperable,and businessexecutivesrightlyconsidermarginalismimpractical
as an operatingprinciplein such manufacturingestablishments"[Lester
1946, pp. 81-82]. In delineatingthese shortcomings,Lesterused two arguments.His firstand less developedargumentwas thatmarginalismwas
inherentlyincapableof explainingbusinessbehavior.That is, Lesterargued that businesspeopledid not thinkor behavemarginally,in partbecause the firm's cost structurewas not compatiblewith marginalism.
Therefore,if economistswere to explain,say, the wage-employmentrelationshipsfor the individualfirm, a new theory would be needed.9His
second argumentwas that marginalisttools were not sufficientlydeveloped for businesspeopleto use in theirwork (a Masonianargument)and
that specific economic conditionspreventedbusinesspeoplefrom using

TheMarginalistControversy
1115
the marginalist tools (a Berkelian argument). Consequently, it was rational for them to use rule-of-thumb procedures devoid of marginalist
attributes [Lester 1946].
A reply by Machlup quickly followed Lester's article.10In a carefully
designed article, Machlup argued that Lester's first argument was invalid
because he incorrectly understood marginalism. Developing more fully
the argument he presented before the war, Machlup maintained that marginalism was designed only to explain changes in employment, prices, and
output resulting from a change in the firm's environment and, therefore,
could not be criticized for failing to be used in the determination of a particular price, output, or wage rate. He strengthened the argument by stating that firms need only equate what they believe to be their marginal
costs and revenue when trying to maximize profits and that firms' subjectively estimated cost and demand curves included the future effects of
actions taken in the present (hence short-period profit maximization was
consistent with long-period survival). In short, Machlup attacked Lester's
first argument on the grounds that marginalism
[was not] designed to serve to explain and predict the behavior of real
firms;instead, it is designed to explain and predict changes in observed
prices (quoted, paid, received) as effects of particularchanges in conditons (wage rates, interest rates, import duties, excise taxes, technology,
etcetera). In this causal connection the firm is only a theoreticallink, a
mental constructhelping to explain how one gets from the cause to the
effect. This is altogetherdifferentfrom explainingthe behaviorof a firm
[Machlup1967, p. 9].
Thus Lester had simply mistaken the nature of marginalism and his argument was irrelevant [Machlup 1946].
Machlup also addressed Lester's second argument that marginalism
could not be used in practice or because of the existence of specific economic conditions. Using an analogy of an automobile driver, he argued
that firms need not consciously realize that they used marginalist tools
when reacting to changes in their environment or to establish definite numerical estimates of marginal costs, marginal revenue, and price elasticity
of demand when reacting to these changes. Hence the rule-of-thumb procedures used by businesspeople were, contrary to appearances, grounded
in marginalism. To substantiate this, Machlup showed that the "anti-marginalism" evidence Lester presented could be interpreted as completely
supporting marginalism.
Then, surprisingly, Machlup extended his critique of the "anti-marginalism" evidence to the full cost pricing evidence presented by Hall and

1116
FredericS. Lee
Hitch.In his critique,he arguedthateven thoughbusinesspeoplemaynot

have understoodthe conceptof priceelasticityof demand,they implicitly
used it whenbasingtheirpriceson averagetotal costs, and thatthe use of
averagetotal costs when comparingactualand potentiallevels of output
was simply an indirect way of using marginalrevenue and marginal
costs."'Thus Machlupconcludedthat "marginaltheoryof businessconduct of the firm has not been shaken, discredited,or disprovedby the
empiricaltests discussedin this paper"[Machlup1946, p. 553].
With the publicationof Machlup'sarticle, the controversybetween
marginalismand the full cost pricingdoctrinethat had been simmering
since 1941 boiled over. By being concernedwith Hall and Hitch'sstudy
and, more importantly,by arguingthat their data was consistentwith
marginalism,Machlupprovideda broadforumin whicheconomistscould
debatethe adequacyof marginalismwith respectto the full cost pricing
doctrine.In particular,economists,upon rejectingMachlup'sfirst argument and hence the notion that the doctrineis reallydifferentfrom marginalism,drewupon his critiqueof full cost pricingto developtheir own
Masonianor Berkeliananalysesof the situation.Hence, the controversy
becamemuch narrowerin focus and addressedonly the problemof the
realism,applicability,and compatibilityof the marginalisttools and concepts in explainingbusiness behavior. Thus the subsequentdiscussion
becamemoreof a gropingtowarda unified,coherentexplanationshowing
that full cost pricingwas consistentwith neoclassicalpricetheoryin generalandmarginalismin particular.
Eiteman'sCritiqueof Marginalism
Concurrentwith the controversyover the full cost pricingdoctrine,a

differentcritiqueof marginalismwas brewing.At the same time Lester
was formulatinghis critiqueof marginalismas it appliedto pricing: "I
was teaching'principles'at Duke [circa19401presentingthe conventional
approachwhenit suddenlyoccurredto me thatas treasurerof a construction companyI had set pricesand talkedwith otherswho set pricesand
yet I had neverheardany pricesettereven mentionmarginalcosts. I said
'thisMC=MR stuffis non-sense'' [Eiteman,1981a]. He beganto piece
togethera critiqueof marginalismaimedat its productionand cost foundations.
Eitemanfirstcriticizedmarginalismin 1945 when, employinga Berkelian argument,he argued that it was not feasible for a multi-process
firmto determinethe marginalproductfor each variableinput with respect to each process. That is, when a firm employedtwo or more dis-

1117
jointed but interlockedproductionprocesses to produce its output, a

positive incrementof a variableinput to any productionprocess would
not increase"final"output, while an incrementaldecreaseof a variable
input to any productionprocess would result in a multiple decline in
"final"output.Moreoverthe negativemarginalproductof a variableinput wouldhave differentvaluesif the inputwereused in differentproduction processes.Consequently,the firm would face a hopelesslycomplicated task of determiningthe marginalproductof a variableinput since
its value could simultaneouslybe zero and less than zero. (This situation
cannotbe circumventedif the variableinputunit is expandedto include
the proportionsof the other variableinputs needed to achieve a single
synchronizedexpansionof output since the relativeproportionsof the
variableinputs can vary at differentflow rates of output.) Therefore,
Eitemanconcluded,businesspeopledo not try to determinethe marginal
productsof theirvariableinputs,and hence to achievemarginalisticeconomic efficiency;rather,they are more interestedin effectivelysynchronizing the productionprocesswhen faced with variationsin output.As
a result,businesspeopledo not employmarginalcost curveswhen setting
prices and thereforeeschew marginalistprice setting proceduresaltogether[Eiteman1945-46].
Eiteman'scritiqueof marginalismwas very close to Lester'ssecond
argumentagainstmarginalism.Thereforeit is not surprisingthat he employedLester'sfirstargument-that marginalismdependedon a specific
structureof costs-when expandinghis critique of marginalismin an
articlein 1947. Startingwith the premisethat marginalism"impliesthat
entrepreneurs
actuallyadjusttheirscalesof operationso as to equatemarginal costs and marginalrevenue"[Eiteman1947], Eitemanarguedthat
businesspeoplemust face averagetotal cost curvesthat permitthe play
of marginalcosts requiredfor marginalcalculations.More specifically,
the businesspeoplemustface a U-shapedaveragetotal cost curvewhose
minimumpoint is substantiallybelow full capacity.However, Eiteman
pointedout that such a cost curveis not generallyfoundin multi-process
firmsbecauseengineersdesignmultiprocessplantsto be most efficientat
full capacity.Consequentlythe plantshave the followingproperties:(1)
up to full capacity,the applicationof any particularvariableinput (such
as labor) resultsin increasingaverageproduct;(2) at full capacity,each
of the variableinputsare employedin the most efficientmannerwith respectto the fixedcapitaland to each other;and (3) beyondfull capacity,
not only are many of the individualvariableinputs encounteringfalling
averageproduct,but when taken as a whole, they are encounteringfalling total productand negativemarginalproduct.Eitemanconcludedthat

1118
FredericS. Lee
the businesspeoplefaced a declining average total and marginalcost

curvesup to full capacity,wherethey stop (see appendix). As a result,
not only is the firm driven, independentlyof marginalcalculations,to
produceat full capacitybut not beyond, it also does not use marginal
calculations to determine price [Eiteman 1947].12
Marginalism and the Rationalization of Full Cost Pricing
One line of discussionsaw the conflictbetweenfull cost pricingand

marginalismas primarilya theoreticalproblem.That is, while it did not
disputethe empiricaldata concerningfull cost pricingprocedures,it did
disagreewith its anti-marginalisttheoreticalinterpretation.However,to
show that the pricing proceduresand marginalismwere compatible,it
had to show that the full cost pricewas theoreticallyidenticalto the marginalistprice. Provingthis requiredthat the cost and mark-upconstituents of the full cost pricingprocedurebe compatiblewiththeirmarginalist
counterparts.
Drawing on the Berkelianconclusionthat full cost prices could be
analyzedin a marginalistcontext, it was arguedthat if averagedirect
costs of productionwere constantwith respectto differentflow rates of
output,they would coincidewith marginalcosts. As for the mark-up,it
was arguedthat if it werebased on short-or long-perioddemandconsiderationsand were sufficientlyflexible,it could stand as a proxy for the
priceelasticityof demand[Machlup1946; Cartwright1951; Clark1952;
and Hawkins1950]. Therefore,if the two conditionswere fulfilled,then
the businesspersonwouldin fact be equatingmarginalcost and marginal
revenuewhenusingfull cost pricingprocedureto set (profitmaximizing)
price. Moreover the argumentcan account for the existence of stable
pricesassociatedwiththe pricingprocedures.13
This simplebut eleganttheoreticalargument,initiallysuggestedby E.
A. G. Robinson in his review of Hall and Hitch's articlein 1939, was
adoptedby economistsand widelypropagatedvia textbooksand articles.
The argument'sacceptancewas a resultof its eleganceand of the numerous referencesto empiricalcost studiesshowingconstantmarginalcosts,
and to demandconsiderationsembodiedin the mark-up.Thus by 1952,
there existed a widespreadbelief that full cost pricingwas marginalism
in a differentlanguage.All that was needed to crystallizethis belief into
an economiccanon and put an end to this aspect of the controversywas
a well-knownarticle by an authorityin the field of pricingsupporting
that argument [Apel 1948; Tarshis 1947; Bain 1948; and Scitovsky
1951].

1119
In June 1952, RichardB. Heflebowerpresenteda paper at the Conference on BusinessConcentrationand Price Policy that did indeed put
an end to thisaspectof the marginalistcontroversy.Inspiredby the earlier
work of the committeeon price determination(publishedin Cost Behaviorand PricePolicy), the NBER-UniversitiesCommitteein 1950 decidedto sponsora conferenceon businessconcentrationand pricepolicy
sincethesetopics wereof currentinterestto economists.As a resultHeflebower, a Berkeley-educatedeconomistwell known in the area of industrialpricingthroughhis work at the officeof PriceAdministrationand at
The BrookingsInstitution,was invitedto give a paper showingthe extent
to which one needed to reconcilemarginaltheorywith businesspractice
-an assignmentthat implicitlymeantshowingthatthe full cost doctrine
was marginalismin a different language. In fact, Hefleboweraccomplishedhis assignmentrathereasily since there alreadyexisted the theoreticalargumentshowingthat full cost pricingcan be viewedcompletely
in marginalistterms and since "the abstracttheorists [were] so nearly
unanimousand severe in condemningit" [Clarkto Saville 1948], thus
preventinga more open dialogueon the doctrine[Adelman1982; Machlup 1981; Markham1954; Grether1981; and Ruggles 1981].
To accomplishhis task, Heflebowerhad to show that the procedures
businesspeopleused to set and to changepriceswerenot inconsistentwith
marginalism.Presupposingthat full cost pricingcould be describedin
marginalistterms,Heflebowerproceededto show that the empiricalevidence supportedsuch an interpretation.First, he laid out the empirical
evidenceshowingthe constancyof marginalcosts and concludedthat the
firm'spricelevel and pricechangesdependedon the price elasticityof its
demandcurve and how it changesas demandchanges.Secondly,he argued that the mark-upincorporatedelementsof demandand indirectly
respondedto changesin demand.On the one hand, he showedthat various formulationsof full cost pricingincorporateddemandassumptions
when statingthat the height of the mark-upwas dependentupon goodwill, long-perioddemandconsiderations,and the reactionsof competitors. On the other hand, he showedthat transactionprices differedfrom
full cost (list) pricesand variedpositivelywith changesin demand,thus
implyingthat businesspeopledo take demandinto accountwhen setting
prices. Takingtogetherthe above considerations,Heflebowerconcluded
that the mark-upwas sufficientlydemand-influencedso as to make it
amenableto marginalanalysis [Heflebower1955].
By showingthat each constituentpart of the full cost price was consistent with marginalism,Heflebowerimplied that full cost pricingwas
consistent with marginalism.This in turn implied that businesspeople

1120
FredericS. Lee
adopt pricing procedures and policies that appear non-marginalist, but in

fact produce the marginalist results. Hence the ultimate conclusion that
could be drawn from Heflebower's analysis was that the only difference
between marginalism and full cost pricing is the language used to describe them. In fact these were precisely the conclusions of the conference
participants:
I had the impression,at the end of readinghis paper, that if the full-cost
principlewas still standingit was only because it was supportedby two
old gentlemen, one of whom was certainly Demand and the other of
whom looked uncommonlylike MarginalAnalysis.It is clear from Heflebower'smasterlysurvey that many of the argumentsused by supporters
of the full-cost principle are in no way inconsistentwith orthodox economic theory [Coase 1955].
The moral of the Heflebowerpaper, it seems to me, was that business
executives go through a somewhat round-aboutprocedure to do what
they would do more directly if they had a lot of informationthey don't
have [Adelman19811.
As a result, the marginalist controversy ceased to exist since there were
seemingly no conflicting issues between full cost pricine and marginalism.
Thus with the ending of the conference on June 19, 1952, this aspect of
the marginalist controversy came to an end: "In effect, Heflebower gave
the game away, and from then on no issues were seen to exist. Full cost
pricing was seen as the practical businessman's approach to implementing
'true marginal analysis' " [Ruggles 1981].
The Generalization of Neoclassical Price Theory and the
Absorption of Full Cost Pricing
A second line of discussion saw the conflict between full cost pricing
and marginalism as a problem with the realism and applicability of the
marginalist tools to explaining business behavior. That is, drawing on the
Masonian and Berkelian arguments, economists produced a synthesis
that explained the use of non-marginalist pricing procedures according to
irreducible complexity, ignorance, and uncertainty that characterized the
business world and that suggested that marginalism could be served if its
theoretical core were generalized. Many economists contributed to the
development of this synthesis, but it was Robert A. Gordon's 1948 article
that fully articulated it and presented it to economists for adoption. Gordon's view of the conflict between full cost pricing and marginalism "was
influenced to a significant extent by the numerous interviews with busi-

TheMarginalist
Controversy
1121
ness executivesthathe conductedin connectionwithhis workon Business

Leadershipin the Large Corporation"[Gordon1983]. So in 1947, at the
annualmeetingof the PacificCoast Committeeon Price Policy, Gordon
presenteda paper on "Issuesin the CurrentMarginalAnalysis Controversy"in which he statedthe core ideas of his 1948 article.Reactingto
the criticismof the conferees,who includedJ. Bain, W. Fellner, E. T.
Grether,L. G. Reynolds, and possibly T. Scitovsky,Gordon wrote his
well-known article "Short-PeriodPrice Determinationin Theory and
Practice"[SocialScienceResearchCouncil 1947].
In the article,Gordoncriticizednot neoclassicalpricetheoryitself, but
some of its unrealisticassumptionsthatrendermanyof its analyticaltools
less useful than they should be for the economistinvestigatingbusiness
behavior.Attackingthe assumptionof profitmaximization,and the strict
formulationof the cost and revenuefunctions,he presenteda twofold
argumentfor why firmsadoptfull cost pricepoliciesand full cost pricing
procedures:(1) becausebusinesspeopleare largelyignorantand uncertain about their economic environment,they are unable to obtain the
informationneeded for marginalistdecision making;consequentlythey
employfull cost pricepoliciesand pricingproceduresthatmakethe most
of their limited information(and entrepreneurialability); (2) because
businesspeopleview their firm as a going concern, short period profit
maximizationis not adoptedas a policy since it would lead to the firm's
demisein the long period. Thus, insteadof strivingto maximizeprofits,
businessmenstrive for satisfactoryprofits;instead of tryingto calculate
accuratemarginalcosts, giventhe presenceof commoncosts, theyopt for
averagetotal costs as determinedby their cost accountants;and instead
of tryingto calculatemarginalrevenue(or the priceelasticityof demand)
associatedwitheveryshiftin the unknowableshortperioddemandcurve,
the businessmanwas more apt to maintaina fixedfull cost price and let
outputadjustto the new conditions.14
Sincefirmscannotbehavein the mannerassumedby marginalism,Gordon concludedthat the conventionalanalyticaltools of the empirical
economistswere of little help to him in his investigations.However,all is
not lost, Gordonsuggested,if the analyticalcore of marginalismis generalized,that is, made more useful: "Whilethis paper is, in a limited
it is not intendedto be antitheoretical.It is a plea
sense, 'antimarginalist,'
for new and more useful analyticaltools than those which empirical
workersnow have at their disposal.... The theoryof the firm needs to
reshapeits tools to fit morecloselythanheretoforethe factsof commodity
andlabormarkets"[Gordon1948, pp. 287-88].
The argumentscontainedin Gordon'sarticlewerewidelydisseminated

1122
FredericS. Lee
(see [Fellner1948; Scitovsky1951; Bain 1952; and Reynolds 1948]),

but they did not immediatelyresultin argumentsthat reconciledfull cost
pricing with marginalism;rather Gordon's article began bearing fruit
nearlya decadeafterbeing published.In the interveningyears two argumentsslowlytook form,each centeringon the assumptionof profitmaximizationbut froma differentperspective.One argumentreplacedthe assumptionwith some other maximizationassumptionwhile maintaining
the strictformulationof the cost and revenuefunctions.That is, starting
with Hicks [1935] and Higgins [1939], there began emergingthe viewpoint that underimperfectlycompetitiveconditions,firmscan adopt objectives other than profit maximization-such as utility maximization
[Higgins1939; Papandreou1952], salesmaximization[Lynch1940], and
maximizationof the firm's present value [Committeeon Price Determination 1943]. In the 1950s, economistsrecognizedthat these nonprofitmaximizingobjectivesnot only were consistentwith the neoclassical notions of rationalityand efficiency,but they were also entirelyconsistent with marginalism[Papandreou1952]. Therefore when economistsarmedwithmodelsof the firmbasedon these nonprofitmaximizing
objectives,such as Baumol [1959], turnedtheir attentionto the full cost
pricingdoctrine,they found that the doctrinewas compatibleand consistentwith the new extendedmarginalism.So by generalizingmarginalism, economistswereable to makeneoclassicalpricetheoryappearmore
realisticand,in doingso, reconcileit withthe full cost pricingdoctrine.
A secondargumentthat arose replacedthe profitmaximizingassumption with a satisfactoryprofitobjectiveand assumedthat uncertaintyand
incompleteinformationexist with respect to both the firm's cost and
revenuefunctions.That is, startingin the 1940s, a line of thoughtbegan
developingthat saw the firmas a complexbureaucraticorganizationsituated in a complex environmentthat it has incompleteand uncertaininformation about. Thereforethe firm pursues satisfactoryprofits, and,
moreimportantly,institutes"rule-of-thumb"
procedures-such as inventoryproceduresto generatedemandinformationandcost accountingproceduresto generateaccuratecost information-designed to improveits
chancesof survivalin the long period. In this case, the full cost pricing
procedurescame to be viewed as one of many rules-of-thumbthe firm
employsas a guideto makingprice decisions.Becausethis line of reasoning (called the behavioraltheoryof the firm) acceptedthe generalframework of neoclassicalprice theory while simultaneouslyrepudiatingmarginalism,its absorptionof the full cost pricingproceduresmeantthat the
doctrineitself ceasedto be viewedas inconsistentwith neoclassicalprice
theory [Cyertand March1963; Cyertand Pottinger1979].

1123
With the emergenceof the managerialand behavioraltheoriesof the

firm,the full cost pricingdoctrineceasedto be anomalous.In the former
case, the extensionof marginalismremoved,in one sense, the conflictbetween it and the doctrine;in the latter case, the doctrinewas shown to
be consistentwiththe frameworkof neoclassicalpricetheoryalthoughnot
with marginalism(extendedor not). Withthe generalizationof neoclassical price theory and the articulationof these new theoriesof the firm,
this phase of the marginalistcontroversycame to an end.
Marginal Backlash:
The Dismissal of Eiteman's Critique
The response to Eiteman'scritiquewas extensive. Economistswho

agreedwith the critiquefelt that it destroyedthe foundationsupon which
marginalismstands [Eiteman1949, p. vi; Eiteman 1982b]; the economistswho disagreedwiththe critiquethoughtthatit was nonsense[Haines
1983]. However,when the responseswere publishedthe followingyear
in the September1948 issue of the AmricanEconomicReview, only the
negativeones were printed.'5Thus the substanceof Eiteman'scritique
was virtuallyignoredby the economicsprofession.'6Undauntedby the
criticism,Eitemantried to substantiatehis thesis that marginalismwas
predicatedon the shape of the averagetotal cost curveby promulgating
a survey.The surveyshowedthat businesspeoplebelievedthatthey faced
averagetotal cost curves that sloped downwardup to full capacity or
turnedupwardonly nearfull capacity.Eitemanconcludedthat"short-run
marginalprice theoryshouldbe revisedin the light of reality"[Eiteman
and Guthrie1952]. Again Eitemanreceivednumerousletters,especially
from the businesspeople,supportinghis results,none of which appeared
in printwhile the commentsof economistswho disagreedwiththe article
did [Eiteman1982b].'7In fact, one commentwent so far as to state that
the cost controversywas a shamif the "AC and MC [are]practicallycoincidentalfor most of the relevantpart of theirranges"[Bronfenbrenner
1953]-a statementthatwas in fact incorrect[Bronfenbrenner
1983]. In
the final analysis,Eiteman'scritiqueof marginalismwas completelyrejectedand with it the notionthat the costs thatthe firmuses in its pricing
proceduresareinconsistentwithmarginalism.
Conclusion
The outcomeof the marginalistcontroversywas, quite obviously,that

economistsviewedthe full cost pricingdoctrineas beingcompatiblewith

1124
FredericS. Lee
neoclassicalprice theory and more specificallywith marginalism.This

victory was clearly evident in the economics textbooks where, for example,a weakmarginalistrationalizationof full cost pricingwas replaced
by a very strongone in whichthe mark-upwas interpretedaccordingto
priceelasticityof demand[Lee 1984b].
However,the triumphof neoclassicalprice theory was a bit tainted.
Its triumphdid not resultentirelyfrom its supposedlytheoreticalsuperiority; it also rested upon the doctrinalnatureof the neoclassicalprice
theoryparadigmitself. On the one hand,most of the neoclassicaleconomistsinterestedin the controversywere simplyunableto see that the full
cost pricing doctrinecould be theoreticallydifferentfrom neoclassical
price theory or marginalism.18
Thereforewhen criticalargumentswere
directedtowardits "hardcore"(to use a Lakatosianphrase), the neoclassical economistswould find them misdirectedand their proponents
ratherstupid.This was not only the basisof Machlup'sresponseto Lester
and the reasonwhy MachlupinitiallyrejectedLester'sarticle,but it was
also the basis of the virulentcriticismdirectedtowardEitemanand his attack on marginalism.Moreover,in responseto the criticism,the neoclassical economistssuitablyadjustedthe auxiliaryhypothesesof theirresearch
programin order to accommodatethe criticism.This kind of response
was obviouslythe basis for the emergenceof extendedmarginalism,the
marginalistrationalizationof full cost pricing,and the behavioraltheory
of the firm-all of whichwereable to absorbthe full cost pricingdoctrine.
On the other hand, because any criticismof the "hardcore"threatens
their theoreticalbeliefs, we find neoclassicaleconomistsengagingin explicit (or apparentlyexplicit) acts to bringaboutthe demiseof the doctrine. One example was Heflebower'sassignmentto reconcilefull cost
pricingwith marginalism.Another examplewas that the supportersof
the full cost pricingdoctrinewere apparentlydenied access to print (as
in the case of the cost controversy)or conferenceswhere the doctrine
was debated(no proponentof the doctrineappearsto have been invited
to the Conferenceon BusinessConcentrationandPricePolicy).
The moralof this articleis that the demiseof the full cost pricingdoctrinewaslargelybasedon the doctrinalneedto deflectany criticismof the
"hardcore"of neoclassicalpricetheory.This doctrinalneedwas also, one
could venture,present in the "marginalization"
of other concepts and
theoriesdevelopedoutside of neoclassicalmicro or macro theory, such
as Michel Kalecki'sshort period theory of unemployment.However, if
one is not concernedwith doctrinalpurityor even the need to maintain
neoclassicaltheory,then the demiseof full cost pricingdoctrineneed not

1125
be accepted,and moreimportantlycan be viewedas a partialtheoretical

basison whichto developa non-neoclassicaltheoryof price.
APPENDIX
Eiteman'sargumentin his 1947 articleis ratherdifficultto see. Therefore let us simplifyit by assumingthat there is a single variableinputx,
two productionprocesses,and a singleoutput.The input-outputrelationship can be denotedas q = f(x1, x2, x12) and it has the followingproperties:
(i) if q/x < maximum,then A q/ A x > A (q/x) / A x > 0 eventhough
A (q/x1)/ ax1 <0 or A (q/x2)/
Ax2 <0, and A2q/ Ax2 < 0.
(ii) if q is pushedbeyondfull capacity,thenA q/ A x < 0 andA (q/x1) /
A xl < 0, A (q/x2) / A x2 < 0, and A (q/x12)/Ax12 < 0.
Consequentlyproductioncould not take place when the averageproduct
is fallingwhilethe total productis increasing.Translatingthe production
propertiesinto costs,we have:
(i) if q is less than or equalto full capacity,then marginalcosts < averagetotalcosts;and
(ii) if q is greaterthanfullcapacity,thenmarginalcostsarenegative.
Now it is appropriateto ask whetherit makeseconomicsense to say that
the marginalcost curve is verticalat full capacity.Eitemanarguedthat
the statementmade no economicsense since a counterfactualstatement
concerningmarginalcosts wouldresultin a negativevalue. Thereforehe
concludedthat the marginalcost curvesimplystoppedat full capacity.
Notes
1. This does not mean, however,that the doctrineceased to be of empirical

interestto U.S. economists.Since 1956 there have been more than fifteen
empirical investigationsinto the price setting behavior of firms and an
untold numberof econometricinvestigationsof full cost pricingby U.S.
economists.
2. Other full cost pricing proceduresinclude mark-uppricing and target
return pricing procedures. It should be noted that although Hall and
Hitch [1939] were the first to presentthe full cost pricing doctrine, the
doctrine itself is centered on the pricing proceduresthemselves and the
implicationsderived from them (see [Lee 1983, 1984a] for a more detaileddiscussionof the doctrine).

1126
FredericS. Lee
3. Although Meansintroducedthe concept of administeredprices in a manner that would suggest that it was theoreticallyincompatiblewith marginalism,most economistsdid not view the concept in that manner.This
was primarilya result,ironically,of Means'spresentationof it, in that on
the one hand, he presented administeredprices as an addition to the
theory of prices under competitive conditions and used the perfectly
competitivetheory of prices as an heuristic device for interpretatingan
economc system made up of administeredprices, and on the other hand,
he did not explicitlycontrastit with marginalismas found in EdwardH.
Chamberlin'smonopolisticcompetitionor in Joan Robinson'simperfect
competition (for a similar view of administeredprices, see [Nourse and
Drury 1938, pp. 250-75]). In addition, Means stated many times that
there was a connectionbetween administeredprices and marketconcentration. Therefore economists viewed administeredprices as simply an
empiricalphenomenato be investigatedand not as a concept represen'ting
an empiricialphenomenathat contradictedmarginalism.Hence administered prices, while contributingto the backgroundof the marginalist
controversy,did not have any direct theoreticalimpact on it as seen in
the eyes of the participatingeconomists [Means 1935, 1939, and 193940; Gruchy 1947; Cox 1981].
4. In the following quote, J. F. Due capturesthis theoreticalquandaryas
seen by the economistsinvolved:
My early interest in what came to be called full cost pricing began
when I had work in marketingat both the undergraduateand graduate
level at Berkeleyfrom E. T. Grether.... Gretherwas particularlyinterestedin questionsof retailpricingand price maintenanceand markup systems and the like, and it was obvious that mark-upsystems did
not involve a marginalcost approachto pricing. I wrote my dissertation on the theory of incidence of sales taxation and, of course, encounteredthe featurethat the most casual empiricalobservationssuggested that when excises or sales taxes were increased,typicallymanufacturersor retailersraisedprices, more or less by the same amounts.
Later more serious empiricalwork validated this. The question was:
how did this behaviorconform with marginalcost pricing?Clearly it
did not (emphasisadded) [Due 1983].
5. Machlup also advanced a subsidiaryargumentin which he questioned
the accuracyof empiricalinvestigationsof the pricingbehaviorof firms
based on questionnairesand interviews. This argument as well as his
principle argument were developed more fully in his 1946 reply to
Lester.
6. It should be noted that Mason, unlike Machlup, assumedthat the marginalisttools were applicableto any marketstructure,includingoligopoly.
7. For example, see [Reynolds 1942]. As indicatedin the following quote,
Reynoldswas not then convincedby the arguments:
I suppose the main thing which led me to take a rather strong antimarginalistposition was experience in field interviewswith business
executivesabout wage and price decisions.At Harvardin the late 'thirties I worked mainly on pricing.... During World War 1I I was
deeply involved with wages as a staff member of the National War

1127
LaborBoard;and after comingto Yale in 1945 I startedmy large study

of the New Haven labor market. This immersion in empirical data
made me very conscious of the wide gap betweenmarginaltheory and
actualbehavior[Reynolds1983].
8. If one can generalizefrom a single letter, then graduatestudentsin economics were perplexedand confused over the "practicalityof employing
the theoretical'tools' of the economistsin real markets"as early as 1943.
Lloyd Saville to J. M. Clark,9 July 1948, ClarkPapers.
9. He strengthenedthe argumentfurther in later articles by arguing that
price followingfirmsdo not think in termsof marginalrevenueand price
elasticity of demand, and that the concepts of short period had little if
any theoreticalmeaning [Lester1947-48, 1949].
10. The reasonfor the quick responseby Machlupwas that when Lestersubmitted his article to American Economic Review (AER), the regular
editor, Paul Homan, was away and Macblup was the acting editor.
Machlup initially rejectedthe manuscript,but Homan, upon returning,
asked Lesterto give him a chance to obtain other opinions, and it was on
the strengthof these opinions that the article was accepted for publication. Upon hearing this, Machlupwrote his rebuttal,which appearedin
the September1946 issue of AmericanEconomic Review [Lester1981].
11. Machlupalso arguedthat the study carriedout by the Oxfordeconomists
restedprimarilyon a questionnaireand poorly conductedinterviewsand,
moreover, that the only fruitful empirical inquiry into pricing requires
close personalcontact with those makingthe pricing decisions. The first
part of the Machlup argumentis simply wrong (see [Lee 1983, pp. 12230]); the second part implies that all the empirical data supportingthe
full cost pricing doctrineis faulty and thereforecan not supportthe antimarginalisminterpretationgivento it.
12. Eitemantemneredhis commentson price settingby statingthat the firm's
demandcurve was not extremelyinelastic.However this made him quite
vulnerableto the criticism that a downwardsloping average total cost
curve was not necessarily inconsistentwith marginalism.He corrected
this mistake in a later article by specifying that the firm'sdemandcurve
was horizontal,or high and nearlyhorizontalrEiteman1948].
13. The argumentcan be summarizedin the following manner: let MC =
marginal costs, which is constant over the relevant range of output;
now in equilibriumMC = MR (marginal revenue) or the price P =
where e, is the price elasticity of demand. Letting
MC[1/ (I-I/ed)]
= 1 + k, we have P = MC(1 + k) where is the percentage
l/(l-l/ed)
markup and is equal to 1/ (ed - 1). Assuminga constantk with respect
to shifts in demand (that is, assuminga constant ed), P will not change
because MC is constant.This argumentwas used in both a short and long
periodcontext.
14. In the following quote, Scitovskysuccintly capturesthe above argument
as it was seen by othereconomistsinvolved:
As to full cost pricing, my reaction at the time was to regardit as a
confirmationof my suspicion that the practical obstacles to empirically calculating marginal cost (especially in a multi-productfirm)
were insurmountable,and that averagedirectcosts were a kind of best

1128
15.
16.
17.
18.
FredericS. Lee
approximationto the calculation of marginal cost. The addition to
averagedirect costs of a percentagemarginto cover overheadsand an
allowance for profit seemed like a good rule of thumb for estimating
the profit-maximizingmark-up.In other words, I tended to ignore or
slue over the oligopoly case and to regardpricingby addinga mark-up
to estimatedaverage direct costs as profit-maximizingbehaviorunder
real-life circumstances,given the businessman'sinability to estimate
the two quantities dear to the economist's heart: marginal cost and
priceelasticityof demand[Scitovsky1982].
Why this was the case cannot be determinedsince the AER papers for
the Homan yearsdo not exist.
Acceptanceof Eiteman'scriticismwas also temperedbecausehe appeared
to offer nothing in its place. As a resulthe wrote Price Determinationin
which prices were set by full cost pricing proceduresand price changes
were based on the rate of turnoverof workingcapital. However because
his explanation eschewed marginalism,it was also rejected [Eiteman
1982a].
Again the reason for this cannot be determinedsince the AER papers
for the Haley yearsdo not exist.
An example of such closed-mindednesscan be seen in the following
quote:
I think that it's ratherobvious that someone trainedat Chicago in the
early 1950s would only be baffledby an attack on marginalcost pricing, which is merely an elaborationof the assumptionthat firmsmaximize profits.Full cost pricingis not possibleif one assumesprofitmaximization and/or competitive markets.... As for my 'colleagues' at
Chicago,whetherprofessorsor students,I assumethat it neveroccurred
to them that microeconomicscould be based on anything other than
marginalism.This is, after all, nothing more than what the founders
of the neoclassicalschool of economics-Jevons, Menger,and Walras
-took to be the foundationsof economic theory [Kaplan1983].
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The Marginalist Controversy and the Demise of Full Cost Pricing

Author(s): Frederic S. Lee

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The MarginalistControversyand the

In the decade followingWorldWar II, U.S. economistsengagedin a

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be answeredis why the marginalistcontroversyended. Yet to answerit

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