The Path to Equilibrium

John Burr Williams

The Quarterly Journal of Economics, Vol. 81, No. 2. (May, 1967), pp. 241-255.

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 T H E PATH TO EQUILIBRIUM *

The question a t issue, 241. -The premises, 242. -The path to equilibrium,
245. - The profit motive, 248. - Bank loans, mortgage bonds, and equity
capital, 250. -Dividends, 251. - Reconciliation with standard theory, 252.

Every beginner is taught that selling price is equal to marginal

cost when free competition prevai1s.l Is this rule always correct, or
is it often misleading?
Furthermore, the beginner is taught that competition breaks
down whenever marginal cost is constant. If a gap appears between
price and cost, the student is told that sellers will try to exploit this
gap. They will produce more goods, and cut the price in order to sell
the extra output, because this marginal increment will return them a
profit above their out-of-pocket cost. A price cut by one firm will
always be met with a cut by another, and in the end the price will
fall to marginal cost. At this low price, total cost cannot be covered,
and a host of firms will go b a n k r ~ p t .Is~ all this correct?
The usual escape from this argument is to abandon the premise
of free competition, and resort to the doctrines of imperfect or mo-
nopolistic c~mpetition.~ But is there no other way out? *
*The author wishes to express his appreciation to Professors Gerald L.
Nordquist and John W. Kennelly for their comments on an early version of
this article. I am also much indebted to Professor Richard H. Day, with
whom I have had many talks about the whole problem during the last four
years.
1. Cf. Viner: "All these situations are consistent with short-run equi-
librium, which, so far as individual producers are concerned, requires only that
marginal cost equal price." [Italics mine.] Jacob Viner, "Cost Curves and
Supply Curves," in Zeitschrift fiir Natzonalokonomie, 1931, reprinted in Read-
ings i n Price Theory, ed. Stigler and Boulding, for the American Economic
Association (Chicago: Richard D. Irwin, Inc., 1952), p. 205.
2. Cf. Samuelson: "From now on our rule under perfect competition
must take the form:
Price = marginal cost, and marginal cost must be rising. I t shows us
how and why competition tends to break down!" Paul A. Samuelson, Eco-
nomics, A n Introductory Analysis (New York: McGraw Hill, 1961),.p: 537.
3. Cf. Sraffa: "Reduction in cost . . . arising from the possibility of
distributing overhead charges over a larger number of product units, must be
put aside as incompatible with competitive conditions!' Piero Sraffa, "The
Laws of Returns under Competitive Conditions," Economic Journal, XXXVI
(Dec. 19261, reprinted in Readings i n Price Theory, pp. 185-86.
Cournot said much the same thing nearly a hundred years earlier, when
he wrote: "Whenever i t is a question of working agricultural lands, of mines,
or of quarries, i.e., of what is essentially real estate, the function #(D) [repre-
senting marginal cost] increases with D [representing quantity produced] ; and,
as we shall soon see, it is in consequence of this fact alone that farms, mines,
 Q U A R T E R L Y J O U R N A L OF ECONOMICS

I should like to suggest a new answer, an answer that makes use

of three heretofore neglected factors, but a n answer that can never-
theless be reconciled with most of standard t h e ~ r y . ~

It will be noted that orthodox theory overlooks certain details

that may provide the solution to the problem. Orthodox theory fails
to invoke the well-known distinction between current assets and
fixed assets, it fails to consider the turnover of working capital, and
it fails to show how present output is determined by past profits and
losses. These details, however, lead us t o an understanding of what
I call the Current Assets Mechanism. As we shall see, this mechanism
supports full-cost rather than marginal-cost pricing.
Essential to my argument is the familiar contrast between vari-
able cost and fixed cost. Variable cost varies with quantity produced,
but fixed cost depends on time elapsed. Variable cost is sometimes
called out-of-pocket cost, direct cost, or prime cost, while fixed cost
is also called supplementary cost, indirect cost, or overhead. The sum
of fixed and variable cost is total cost. Total cost per unit, or
average total cost, is full cost. The out-of-pocket cost of the final
unit is marginal cost, incremental cost, or differential cost.
If a company invests in more land, buildings, and machinery
in order to increase its output, its overhead will rise and become fixed
a t a new level. Outlays for bond interest, sinking funds, real estate
taxes, fire insurance, maintenance against weathering, and even the
and quarries yield a net revenue to their owners . . . . On the contrary, invest-
ments made under the condition that as [quantity] D increases, [cost] cp'D
decreases, can only yield a net income or a rent in the case of a monopoly
properly so-called, or of a competition sufficiently limited to allow the effects
of a monopoly collectively maintained to be perceptible!' Cf. Augustin Cour-
not, Researches into the Mathematical Principles o f the Theory of Wealth,
1838, trans. Nathaniel T. Bacon. (New York: Macmillan, 19291, p. 60.
Cournot's argument can be paraphrased as follows: "I myself cannot
explain a gross profit or rent under free competition when marginal cost is
falling (or constant). Whatever I cannot explain does not exist."
See also Hicks: "Under free competition marginal costs must rise as the
firm expands, in order to ensure that its expansion stops somewhere . . . If
there is a tendency to diminishing cost, however, and if the firm sells a t a price
equal to its marginal cost, it must sell a t a loss. It seems to be agreed that this
situation has to be met by sacrificing the assumption of perfect competition!'
J.R. Hicks, Value and Capital (London: Oxford University Press, 1939), p. gj.
4. For a comprehensive survey of the extensive literature on this whole
question, see Gerald L. Nordquist, "The Breakup of the Maximization Prin-
ciple," in Quarterly Review of Economics and Business Vol. 5 (Autumn 1W5),
pp. 33-46.
5. I n a recent article Richard H. Day presents a mathematical version of
my theory, and compares my results with those of neoclassical theory. Cf.
Day, "A Microeconomic Model of Business Growth, Decay and Cycles,"
Unternehmensforschung, forthcoming.
 T H E PATH TO EQUILIBRIUM 243
wages of watchmen, clerks, and supervisors will reach a new total.
If output now recedes for a while, these fixed expenses will stay up,
and refuse to fall. Overhead, in other words, will remain constant
in the short run. Since a firm can continue to produce for many years
even if it fails to earn its depreciation, I exclude this charge from my
definition of overhead. Nor does my model require any "normal re-
turn" on owners' capital in the short run.
Every firm uses a revolving fund of current assets to finance
its output. I n many industries these current assets exceed fixed
assets in value. This fund of current assets starts as cash. After-
wards it is spent for labor, materials, and overhead. Then it changes
into work in process, and finally into finished goods. When these
goods are sold, they become accounts receivable, and the receivables
when collected turn back into cash. Each turnover of the revolving
fund may yield either a gain or loss in working capital.
For the time being, I assume that marginal cost is constant, or
nearly so. Thus, in a shoe factory, the cash outlay for leather and
piecework wages is the same for every pair of shoes made, whether
the plant is running a t 70 per cent, 80 per cent or 90 per cent of
capacity. This gives a flat marginal cost curve.6 Although the law of
diminishing returns may be counted on to make every cost curve rise
a t its extreme right, this law often acts in a very gentle way a t first.
I also assume that every firm enjoys excess plant capacity when
the marginal cost curve is flat. Standard theory, whenever it says
that a firm has room to go ahead and exploit the gap between price
and cost, is likewise making this same assumption.
Most firms do in fact enjoy excess capacity. They do not run
full blast every day of the year. Sometimes, nevertheless, in order
to make room for new customers in the next boom, they add still more
capacity now. At other times they adopt improvements that speed
up their machines and save on labor. If so, the side effect is to in-
crease their excess capacity even though this outcome was not the
real motive for the new investment. The money to finance this over-
building of plant comes from earnings and borrowings made while the
industry is still growing and making good profits, and before i t
reaches stationary equilibrium.
I n some lines of business, to be sure, the term "capacity" has
no clear meaning. How can one define the capacity of a retail store?
If it is crowded in the rush hour, customers can always shop a t an-
6. Cf. Wilford J. Eiteman, "Factors Determining the Location of the
Least Cost Point," American Economic. Review, X X X V I I (Dec. 19471, 910-18.
See also his Price Determznation: Bustness Practice versus Economic Theory
(Ann Arbor: University of Michigan, 1949), preface.
244 QUARTERLY JOURNAL OF ECONOMICS

other time of day. The store never reaches full capacity until a queue
of customers can be seen all day long waiting outside to gain admit-
tance. This hardly ever happens.
I n cases like the textile industry, where capacity can be more
clearly defined, the marginal cost curve ends when full capacity is
reached. The curve does not make a sharp corner and become
vertical. It simply stops. A vertical line would imply incorrectly
that marginal cost took on more than one value a t full capacity.
Whenever a shortage rather than an excess of capacity prevails,
price is determined solely by the resulting scarcity of output, and
marginal cost has nothing to do with the outcome. I n Figure Ia
below, the dotted upright line represents the limit of capacity, not
the cost of production.
When the rate of operations rises in an industry, all of the firms
tend to go ahead together, because the customers want prompt
service, and usually favor the seller who is least busy for the moment.
In my model, as we will see, no firm need foretell what price it
will get for its product when current output is ready for market a t
last. No one need know the shape of the demand curve, nor the
elasticity of demand. While everyone produces on hope, he sells for
whatever price he can get when the time comes. Likewise no one
tries to guess what his competitors will do. Furthermore, no pro-
ducer need know what his unit cost of production is; he can wait for
time to reveal this fact, just as the farmer does. My model does not
ask businessmen to make the difficult guesses that many of the old
theories require.
As another assumption, I say that all firms in the industry are
alike. Since mine is a short-run model, I also say that the number
of firms holds constant? Later I will drop these two restrictions.
As a final assumption, I say that free competition prevails. Per-
haps in real life free competition is rather hard to find. Oligopoly
and other forms of imperfect competition may be more common.
But that does not matter. It is not the question a t issue. What I
seek to prove is simply this: Given free competition, with every
producer a price-taker: price a t equilibrium equals full cost, not just
marginal cost, when the latter is constant or nearly so.
7. Viner, op. cit., tacitly makes this same assumption. Chamberlin,
however, using a long-run model in his description of monopolistic competi-
tion, makes the opposite assumption. See Edward Chamberlin, The Theory
of Monopolistic Competition (Cambridge: Harvard University Press, 1936),
pp. 83-84, where he says, "The extra profit, however, will attract new competi-
tors into the field!'
8. Cf. P J D . Wiles, Price, Cost and Output (Oxford: Basil Blackwell,
19561, Chap. 4.
 THE PATH TO EQUILIBRIUM 245

I start with an industry that is out of equilibrium because sell-

ing price exceeds full cost, let alone mere marginal cost. The double
diagram below, for the industry as a whole, traces the path to equi-
librium that this industry will follow year by year.
By "year" I mean the length of time needed for a batch of goods
to be made and sold, regardless of the exact number of weeks or
months this may take each time. If a second batch is started before
the first is sold, this second batch will need its own quantum of cash
to finance it. When the successive batches overlap closely enough,
production becomes a "continuous process" rather than a "batch
process," but this change does not upset the logic of my argument.
Usually the length of the process is fixed by technological factors.
246 QUARTERLY JOURNAL OF ECONOMICS

Figure I b above, like Figure Ia, applies to a whole industry, and

not just a single firm, unlike many figures of this sort.
Both of these figures show the same facts. I n these figures q
means quantity produced, p means price obtained, R means revenue
received (whence pq = R ) , C means cash overhead (where C is
constant), m means marginal cost (constant also a t first), and M
means prime cost, or the integral of marginal cost (whence M = mq
if m is constant). Furthermore, T means total cost of the entire out-
put of the whole industry (whence T = M + C). Likewise G means
gross profit on the entire output (whence G = R - M = R - T
+ C ) . I n equilibrium, as we shall see, gross profit barely suffices to
cover overhead (whence G, = C ) . The price p shown in Figure I b
is represented on Figure I a by the tangent of angle T, because
tan T = R / q = pq/q = p.
Figure I b shows a demand curve such that a t one point the
quantity sold is zero because the price is too high t o attract any
buyers, while a t another point the price received is likewise zero
because the quantity offered is too large to be sold out completely.
The product then becomes a free good. I n between lies a point where
total revenue reaches a maximum, as shown on Figure Ia.
I start with output ql in Figure Ia. This quantity is sold a t
whatever price it will fetch, and brings in revenue R1, which exceeds
total cost T I . The firms then use their entire revenue R1 to finance a
larger output q2 next year, a t a new total cost T 2 = R1. (With-
drawals for dividends and receipts from bank loans will both be
discussed later.) I n each year fixed cost remains the same, as shown
by the horizontal line CC', and total cost increases only by the
amount m A q .
I n the second year output q2 is likewise sold a t a profit, because
R2 is greater than T2. All of this profit is used to finance a further
increase in output in the third year. Revenue and output thus climb
upwards along a series of steps. Since no one knows beforehand what
the shape of the demand curve and revenue curve will prove to be,
no one can foretell how many times the process can be repeated a t
a profit.
The revenue R8 from the third year is then used to finance out-
put q4 in the fourth year. I n this last year, however, no profit above
total cost results, because R4 = T 4 .After paying both prime cost and
overhead the firms retain only enough money to finance the same out-
put in the fifth year as in the fourth. They only get a new dollar
for an old. A further increase in output becomes impossible. Al-
though a gap between selling price p and marginal cost m remains,
 THE PATH TO EQUILIBRIUM 247

as shown in Figure Ib, the firms cannot exploit it. The industry is
now in equilibrium, with price equal to p, and quantity equal to qe
in Figure Ib.
The path to equilibrium thus follows the staircase of steps
shown in Figure Ia. Each step arises from one turnover of the
revolving fund of current assets.
A look a t the diagram shows that the line CT need not be
straight in Figure Ia, and the marginal cost curve need not be flat in
Figure Ib. The diagram would still yield equilibrium if the line CT
bent up or down, and the marginal cost curve rose or fell. With a
rising curve, however, the marginal increment could by mistake be
sold a t a loss.
The position of equilibrium is given by three equations in three
unknowns, m, p, and q, with C constant, thus:
(1) P = f (4) , the demand curve
(2) m = 9(q) , the marginal cost curve
(3) pq = C +*Ymdq , the income account.
I n Figure I a the curve OR for total revenue happens to have
just the right shape to make the last step in the staircase reach the
exact point of equilibrium. Usually, however, this will not happen.
If the industry reaches a region where the demand becomes inelastic,
so that the curve of total revenue turns down, then the diagram will
often show a cyclical pattern of prices and quantities.
I n this particular diagram equilibrium takes place where de-
mand is inelastic and revenue is falling. Hence marginal revenue is
negative a t the point of equilibrium q,. On Figure I b the curve for
marginal revenue, after cutting the marginal cost curve a t m, qs,
proceeds to fall so fast that it lies below the horizontal axis by the
time output reaches q,.
When a country is growing and demand is rising, the curve OR
for total revenue becomes higher and wider every year. As a result,
the typical industry never quite reaches stationary equilibrium.
Instead, it makes a small profit year after year, with its rate of
profit tied to its rate of growth.
9. I have borrowed the phrase "path to equilibrium" from Peter New-
man. See his article "The Erosion of Marshall's Theory of Value" in this
J o u m l , LXXIV (Nov. 1960), 592 and 597,
1. The staircase of steps shown in this figure is a graphic representation
of a difference equation directly involving total cost and total revenue that is
equivalent to a quadratic difference equation in output q. For a detailed
mathematical analysis see Day, op. cit.
248 QUARTERLY JOURNAL OF ECONOMICS

It is a major premise of standard theory that every firm seeks

to earn a profit, and the more the better. Figure I a makes it easy to
see how this process works.
Figure I a shows that the gross profit of the industry as a whole
+
is R1 - T1 C when output is ql, and the same for q2, etc. Like-
wise Figure I b shows that the change in the industry's gross profit
A G in response to a change in its output A q is given by the equation
AG=qAp+ (p+Ap-m)Aq.
Because the demand curve for the industry as a whole slopes down-
ward to the right, A p is negative when A q is positive. As a result,
the first term in the foregoing equation is negative and the second
positive (unless p - m is smaller than A p in absolute value, which
almost never happens).
Although the output of an industry containing n firms is q, that
of a single firm when all are alike is only q/n. If the total increase
in output A q were to be made by a single firm while the others stood
still, then the gain in gross profit for this individual firm would be

I n this equation, when n is large, the negative first term is small,

while the positive second term remains large (except in rare cases).
I n other words, an increase in output A q by a single firm normally
leads to a good increase in profit AGi enjoyed by this same firm.
From this rule is derived the well-known theorem that a single firm
with many competitors can go ahead and increase its own output a
lot without fear of hurting its selling price much, because the price
effect -4 A p of such an increase is very small.
n
As long as marginal cost holds constant or nearly so, each firm
by itself feelsthat to increase sales means to increase profits. T o
aim a t one target is to aim a t the other, too. Consequently no con-
tradiction arises between Baumol's finding12 on the one hand, that
most firms try to maximize their revenue (unless they face steeply
rising marginal cost), and the old rule, on the other hand, that all
firms try to maximize their profit.
Furthermore, if any one firm refuses to seek more sales and
profits whenever possible, but decides instead to stand still while
its rivals go ahead, then it is sure to see its own earnings shrink
2. Cf. William J. Baumol, Business Behavior, Value and Growth (New
York: Macmillan, 1959), Chap. 6.
 THE PATH TO EQUILIBRIUM 249

badly. Whenever an industry as a whole enlarges its output in the

face of a stationary demand curve, selling price falls for everyone.
A laggard firm, meanwhile, enjoys no increase in volume to offset its
shrinkage in gross profit per unit. The result is to make all firms
feel a strong incentive to maintain or increase their "share of the
market'' whenever they can contrive to do so.
Before equilibrium is reached, profits are good, retained earn-
ings pile up, and more money can safely be borrowed year after year.
Output can then be raised in larger steps each time. If firms refuse
to increase their debt whenever they make a profit, i t shows that
competition is less than perfect.
Perfect competition, however, drives the industry as a whole
far past the point where total profit would be maximized, and every
member firm suffers as a result. The most profitable output is shown
on Figure I a to be q3, where the spread between R and T is a
maximum. This same output is indicated on Figure I b by the cross-
ing of the marginal revenue and marginal cost curves for the industry
as a whole. On both figures the maximizing quantity q3 is much less
than the equilibrium quantity q,.
Even beyond the equilibrium quantity q,, and all through the
interval q, to q, on Figure Ib, the profit incentive would still drive
the individual firm to enlarge its output if i t could. I n other words,
even if the industry is already overproducing in the sense that price
fails to cover full cost, nevertheless each firm by itself feels that its
own salvation lies in boosting its output still further. It always
wants to spread its fixed cost over a larger volume. This drive for
extra sales, a t any price above marginal cost, is always emphasized
by standard theory. Yet here is where the old theory leads us
astray.
What is wrong with standard theory is its failure to see that,
regardless of the profit motive, output in the region q, to q, is
financially impossible. The spirit is willing but the purse is weak.
Even if all firms held excess cash in the beginning, they would run
out of money in the end if their receipts fell short of their outgo year
after year. Then, willy nilly, they would be forced to curtail their
outlays on labor and materials. The result is to put a floor under
price a t a level where price equals full cost, not just marginal cost.
M y theory as a whole thus has two parts instead of one: while
i t still invokes the old pursuit of gross profit, it now includes the new
limit set by cash flow.
Cost accountants seldom compute marginal cost, or "incremen-
tal cost," as distinct from full cost. There is good reason for this
250 QUARTERLY JOURNAL OF ECONOMICS

seeming disregard of standard economic theory. Except in cases of

dumping, businessmen do not need to know their marginal cost. Since
they usually sell a t a price well above this cost in any event, all they
really need to know is full cost.
Even if an industry should become seriously overbuilt, and start
to run a t a loss, it need not wait for demand to catch up with capacity
before losses would end. On the contrary, equilibrium a t a no-profit
and no-loss level would return in a short time. This rule would still
hold good even if the overcapacity was brought about by a severe
shrinkage in demand. A few years of temporary losses would soon
reduce current assets to the right size for a smaller volume of out-
put that would then command a better price, and equilibrium would
thereby return. Excess capacity combined with fierce competition
does not cause unending losses; it only causes zero profits, accord-
ing to the model we are using. (This outcome rests on the premise
that all firms are alike. If they differ, however, with some being
high-cost producers and others low-cost, the result will be modified
somewhat in a way to be described later.)

Once an industry has reached equilibrium, any infusion of

extra money, whether from bank loans, mortgage bonds, or equity
capital, will only upset its present balance. I n pursuit of profit, each
firm by itself will use the new money to increase its own output.
Prices will fall, and losses will follow. In due course the new money
will all leak away into the hands of the public. With less money to
spend, the firms will now be forced to curtail their output. As a
result, prices will rise enough to cover full cost, including interest
on any recently issued debt. Then the firms can once more earn and
pay their cash overhead and prime cost, and the industry will be
back in equilibrium.
The borrowing power of an industry is strictly limited. Bank
loans can only be secured up to the point where the current ratio is
2 to 1 or better, if sound banking practice is followed. Mortgage
bonds can only be written up to 50 per cent or so of fixed assets. And
common stock can only be sold if a company has a record of good
3. The traditional view is well expressed by J. M. Clark in his Studies in
the Economics of Overhead Costs (Chicago: University of Chicago Press,
1923), p. 435, where he says, "Competition tends to force prices down to the
level of differential cost, if existing productive capacity will supply the demand
a t that price. And as industry is in a chronic state of idle capacity, to insist
that producers shall compete unchecked appears to amount to inviting
competition, and private industry with it, to commit suicide!'
 T H E PATH T O EQUILIBRIUM 251
earnings, which can no longer be shown once an industry reaches
equilibrium with profits zero. Even if an industry were to receive a
huge tax refund or other windfall, the new money would do the
stockholders no good in the end, because the extra funds would all
be frittered away in useless price cutting.
I n the case of firms privately held, to be sure, their owners might
resort to self-financing. They might raise money by mortgaging
their homes, for instance. Enticed by the gap between marginal cost
and selling price, and impelled by their competitors to exploit this
gap, they might put every dollar they could raise into their own
business, and finish with all their eggs in one basket. But the extra
money they thus sank in the industry would only upset its equi-
librium. Prices would fall, and the new money would all be lost.

If the various firms, before reaching equilibrium, use part of

their earnings to pay dividends in one year, less cash will remain to
buy labor and raw material next year. Then the size of each step
in Figure I a will be smaller, while the number of steps will be larger.
Income taxes will have a like effect, and so will the repayment of
debt or the accumulation of idle cash. Yet in the end, if demand
holds steady, equilibrium will be reached a t the same point as before.
Outlays on plant, like disbursements of dividends, delay the
attainment of equilibrium. They also shift the position thereof, be-
cause they alter the marginal cost curve and change the amount of
overhead. But the Current Assets Mechanism still controls the
process.
Dividends are a matter of managerial discretion. The economist
can advise, but the directors will decide for themselves. They often
feel that the added profit from reinvesting all of last year's earnings
is hardly worthwhile when the industry is close to equilibrium.
Moreover, they also know that the main purpose of running a
corporation is to pay cash dividends. Yet they cannot be forced to
pay, because dissatisfied stockholders are helpless, and cannot with-
draw their capital a t will. Consequently dividend payments fol-
low no fixed rule.
Nevertheless, any dividend rate once adopted soon becomes an
obligation to stockholders. The reputation of the company likewise
becomes involved. I n this way the dividend gets frozen into over-
head. This raises the level of the line CC' in Figure Ia, and increases
the area G, in Figure Ib, where G, = C.
252 QUARTERLY JOURNAL OF ECONOMICS

If we depart from our usual assumption that all firms are alike,
and say that some firms are low-cost producers who pay large
dividends, while others are high-cost producers who pay small divi-
dends, then the effect of dividends in general is to make total cost
more nearly alike for all firms.

Equilibrium for the individual firm, as distinct from the industry

as a whole, is usually shown by means of Figure I1 below. I n this
diagram, as is customary, the horizontal line AR means average
revenue, or selling price for a single firm. Likewise MC means
marginal cost, and AC means average cost, or total cost per unit of
output by the firm.

I n Figure II the marginal cost curve displays the same shape

as in Figure I b but the distance q, is much longer. I n this new
diagram, output is being pushed to the region of diminishing re-
turns, and so marginal cost is now rising steeply instead of holding
constant.
I can reconcile Figure I1 with Figures I a and I b if I simply drop
the usual assumption4 that all firms are alike in every respect.
Instead I assume that some firms enjoy lower costs than others do
because they use better equipment than their rivals. This simple
shift in our premises means that the number of firms in the industry
will no longer hold constant. Instead, the number will slowly shrink,
with the survivors taking over the sales surrendered by the firms
they outlast.
I also assume that each firm holds title to the land and buildings
4. Cf. Joan Robinson, op. cit., p. 88. She a4sumes all firms alike.
 THE PATH TO EQUILIBRIUM 253
and the plant and equipment that it uses. Then no firm will pay
rent on these assets to any outside l a n d l ~ r d . Instead,
~ each firm
will receive in cash all the economic rent and quasi-rent that its own
assets earn. If some firms use better plants than others, these firms
will collect more rent. This rent arises from the lower prime cost
that the better plants achieve. I n this way the low-cost firms will
get hold of extra money wherewith to finance extra output. This
sets in motion a new competitive process that takes a great many
years to run to completion.
The market we are talking about is quite unlike an auction
market in one important respect. I n our market the outcome cannot
be determined in a few hours, or even a few days, by mere negotiation
over the telephone. Instead, the ultimate result takes a very long
time to work itself out.
I n the beginning the firms which are low-cost producers can
make a cash profit a t a price that barely covers full cost for their
less efficient rivals. Then the low-cost firms can increase their out-
put next time, while their rivals cannot. These low-cost firms, to be
sure, may see fit to pay part of their profits out in dividends, but the
rest they can reinvest in their business if they wish.
Only by accepting reduced prices, however, can the low-cost
firms find an outlet for their extra output. Lower prices will mean
losses for their high-cost rivals. These losses will eventually put the
high-cost firms into receivership. These unfortunate firms will then
default on their bond interest, and will scale down or write off their
debt. They may also use their plight to secure for themselves a cut
in real estate taxes and a reduction in executive salaries. Thus in
the end they will come out of receivership with reduced cash over-
head. Their moves will give them a lower full cost than before, and
will let them stay in business for a long time after all. If prices are
sticky because competition is less than perfect, the weak firms will be
able to hang on even longer. So long as they survive, they will keep
the strong firms from getting all the business they could handle.
Even if the low-cost firms are willing to devote all their profits
to increasing their output, foregoing all dividends meantime, never-
theless they will find that their rivals take a long, long time to suc-
cumb. For one thing, these high-cost firms, after scaling their debt
down, can postpone their replacements. They can make do with old
buildings and old machines for many, many years. It takes a long
time for fixed assets to become worn out beyond repair. I n the mean-
5. Chamberlin, op. cit., p. 22. uses the opposite assumption from mine,
and so he includes rents in costs. See also Joan Robinson, op. kt., p. 125.
254 QUARTERLY JOURNAL OF ECONOMICS

time these high-cost firms will take in money enough to cover cash
overhead as well as prime cost, and selling price will remain above
short-run marginal cost even for them.
Yet if technology stood still, in the end the low-cost firms could
indeed drive the others out of business, just as the old theory asserts.
As the weak firms failed one by one, the level of overhead CC' for
the industry as a whole would decline step by step in Figures I a and
Ib. Meanwhile the retirement of the weak firms would leave more
business for the strong firms. These strong firms would then find
themselves running a t a very high rate of output, a rate so high that
constant marginal cost would no longer prevail for them.
Figure I1 shows that the proper stopping point for each firm by
itself would lie where MC = AC = AR (provided the limit of capac-
ity was not reached first). Only the marginal firm, however, would
be working a t this point. All other firms, because their costs were
lower, would still be making a profit, and would be raising their out-
put each year. As a result selling prices would fall for the industry
as a whole, AR would drop for the marginal firm, losses would be
incurred by this firm, and in due course it would be forced out of
business by lack of working capital.
After enough high-cost firms had been driven out of business,
the survivors might finally reach a place on their own marginal cost
curves where output was a t full capacity. When this time came,
however, these firms might take steps, like building new plant, that
would change the shape of the curves themselves. Then the competi-
tion between the strong and the weak would start all over again
among the remaining firms.
If the process of wearing the weak firms out persisted for fifty
or a hundred years, with no change in technology and no increase
in population, the industry might indeed turn into an oligopoly, or
even a monopoly, just as the old theory asserts. But the old theory
implies that all this could come about in a fairly short time, with the
high-cost firms retiring from the fray just as soon as they found
themselves no match for their more efficient rivals. I n reply I claim
that no such sudden take-over by the strong firms is financially
possible. Meanwhile the managers of the weak firms will cling to
their jobs year after year even though their stockholders despair
of ever getting another dividend.
I n surveying the free enterprise system, how often do we see an
industry to which Figure I1 clearly applies? Do not Figures I a and
I b apply more often? Most industries enjoy excess capacity. De-
mand is rising, technology is changing, and profits are forthcoming.
 T H E P A T H T O EQUILIBRIUM 255
Hence plant can be enlarged and improved, and capacity remains
ample. As a result, most firms work under conditions of constant or
nearly constant marginal cost. Scarce indeed are the industries
where the low-cost producers have driven so many of their weaker
rivals to the wall that they themselves are left free to press hard
against their own capacity all the time. Only then can they reach
out to the far end of their cost curve, only then do they face steeply
rising marginal cost, and only then does Figure I1 apply.
Since long-run equilibrium is so elusive, do we really need to
specify its shape precisely? Is not the path to equilibrium our main
concern? To chart this path we must invoke the Current Assets
Mechanism. This mechanism makes selling price equal or exceed
full cost (except for the very weakest firms) even when shortrun
marginal cost is constant or nearly so, no matter how fiercely each
firm may compete.
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The Path to Equilibrium
John Burr Williams
The Quarterly Journal of Economics, Vol. 81, No. 2. (May, 1967), pp. 241-255.
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3
The Laws of Returns under Competitive Conditions
Piero Sraffa
The Economic Journal, Vol. 36, No. 144. (Dec., 1926), pp. 535-550.
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6
Factors Determining the Location of the Least Cost Point
Wilford J. Eiteman
The American Economic Review, Vol. 37, No. 5. (Dec., 1947), pp. 910-918.
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9
The Erosion of Marshall's Theory of Value
Peter Newman
The Quarterly Journal of Economics, Vol. 74, No. 4. (Nov., 1960), pp. 587-599.
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