Socialist  Controversy



Marginal Cost Pricing

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by John Lai, October 1988


Abba P. Lerner is a strong advocate of decentralized socialism. He proclaims that “the benefits of both the capitalist economy and the collectivist economy can be reaped in the controlled economy.“*l(decetralized socialist economy). The controlled economic system is the best system in Lerner‘s mind because the dogmas of both “pure“ forms, capitalism and collectivism are absent and the best devices of the both “pure“ forms are utilized.*2 The fundamental point of the controlled economy is that it denies both collectivism and private enterprise as principles for the organization of society, but recognizes both of them as perfectly legitimate means. Its fundamental principle of organization is that in any particular instance the means that serves society best should be the one that prevails.*3


The non-collectivist nature of decentralized socialism does not mean the economy is not regulated in socialist interest. But in forms, it is similar to capitalist society. A decentralized socialist economy has “regulations of pub­lic utilities, pure food laws, income taxes, and social security, and in hundreds of ways the various government, local and national, limit and control and themselves undertake economic activities in the general interest.“*4

The ideal of a socialist society has no dogmas about collectivism but it is a controlled economy in which the public interest in the criterion for judging whe­ther any industry should be collectivized or whether it should be left in the hands of private enterprise.



1.    Lerner, A. P., The economics of Control, (New York, MacMillan Co.) page 2

 2.    Ibid., page 2

  3.    Ibid., page 5

4.    Ibid., page 3

5.    Ibid., page 5

Marginal Cost Pricing in the 1930‘s



American Economic Review, Vol. 67, No.1, February 1977.


I came to the London School of economics (LSE) as a socialist, with Marxist inclinations and with some rather grandiose notions of turning bourgeois economics to socialist use. I could not yet have been cured of my first vision of the Russian Revolution as the emancipation of man from subservience to money, the root of all evil,... I fell in with a group of revolutionary socialists at the school, finding great enlightenment in the idea of the Class Struggle, until I decided that ...a closer approximation to the real world was obtainable by considering more than two interest groups. ....


My own shift of interest .... from Communism to Trotzkyism, occurred in 1931. (I say shift of interest rather than conversion, because ... I was never able to accept either the labor theory of value or dialectical materialism. In 1931 a communist fellow student, .... had come back from a tour of the Ukraine ... and reported the impending mass starvation imposed on the peasants by the forced grain collections. For this he was denounced as a Trotzkyist and he then indeed became one, and I became a Trotzkyist "fellow traveller."


Before I began my studies at LSE, ... I remember being quite impressed with the idea of consumer‘s surplus, ... I had also read Henry George, and found him quite impressive, ... and had been completely taken in by Veblen ... I was thus greatly puzzled by the amusement displayed by John R. Hicks, who was my tutor in the first year, when I told him what I had read in economics.

At the end of my first year ... it seemed to me that the only thing I had learned was the idea of "marginal."...This brings me to the topic of my paper. I became a rabid marginalist, fanatically enthusiastic about the principle that economic efficiency, which is, of course, socially desirable, required every product price to be equal to the marginal cost ....


I remember reaching the conclusion that retail stores should charge the marginal cost of making each sale, ... My fellow socialists were outraged at such devices, which would penalize the poor, and I was forced prematurely to the conviction that what was wrong with the poor was not the prices they have to pay but that they had too little money— that the solution of poverty lay not with the manipulation of prices but with the distribution of money income.

My enthusiasm for marginalism did not at first have any special connection with socialism or with socialist pricing. It first was directed to the social inefficiency of monopoly in raising price above marginal cost and thus interfering with my newly discovered Invisible Hand and its promise of economic efficiency....


It seems obvious that socialist societies must be just as concerned with economic efficiency as capitalist societies, .... But I do not think I thought of marginal cost pricing as particularly relevant to socialism until I found myself in debate with socialists who objected to the view that socialist societies should make use of this principle.

I had an exchange of articles with Maurice Dobb who seemed to believe, at the time, that pricing of any kind was inconsistent with the rational planning of the economy in physical terms which would be possible when capitalism had been replaced by socialism, so that neither marginal cost nor average cost had any place in socialism. Durbin and Dickinson and a number of others argued in favor of socialist societies charging the average cost. I remember especially having long discussions on this with Dickinson ...


It was at this stage that Oscar Lange came to London and wrote an article on market socialism for the Review of Economic Studies of which I was the managing editor. He laid down the same principle of charging the marginal cost for everything, and I was of course delighted to have this article in the Review, as were all the other editors. But Lange got caught in the puzzle of what to do if the sum of the marginal costs did not add up to the total cost, which would be bound to happen unless the marginal costs, on the average, happened to be just equal to the average cost.


Lange‘s solution was to make a compensating adjustment to the wage.... My contribution was to point out that this would be a departure from the efficiency principle. The surplus could be distributed in any way whatsoever that seemed good to the authorities, provided it was not related to the wage. Relating it positively to the wage would not only discriminate in favor of those who already had a higher wage, aggravating the inequality of income regrettably required for economic efficiency, but would also cause a departure from the efficient use of resources. Lange quickly saw my point and accepted the correction.


Strangely enough, on rereading my article, I find it repeating the very error in Lange‘s article which I was correcting. .... If the price of a product is, say. twice the marginal cost, all is still well if the price of the product is also twice the marginal cost in all the alternative uses of the factors. .... Distributing the surplus in proportion to the wage, as initially proposed by Lange would still leave price proportional to marginal private cost and equal to marginal social cost. I was thus doing exactiy what I was criticizing Lange for doing, even while successfully persuading him that he was wrong!


The trouble with Lange‘s original rule, as well as with the formulation in my "correction" of his rule, was that the rule cannot be applied universally in all the other uses of the factors. The use of labor time for leisure, for "do it yourself" or for private exchange of services with a friend or neighbor made the private marginal cost equal to the price or value of the product, so that universal proportionality of marginal cost to price could be attained only by the special proportionality of equality of price and marginal cost.

This more satisfactory formulation was not developed until later. (It is in my economics of Control, published in 1944, twelve years after I had started working on it.) Nevertheless, the agreement between Lange and myself on the necessity of having the wage equal to and not merely proportional to the marginal product, shows that although my formulation was faulty our understanding of the issues was correct.


It somehow seemed natural, both to Lange and to myself, in those days, to suppose that the revenues from the sale of all products at marginal cost would exceed the total cost, i.e. that in general the marginal cost would be above the average cost. There would then be a surplus available which I later (in my economics of Control) called a "social dividend" to be distributed equally among the whole population as the simplest and most efficient way of alleviating poverty or increasing equality. We did not anticipate the growth that has taken place in government spending on armaments and on much more complicated and much less efficient ways of helping the poor and various other groups disguised as deserving poor. ... More recently it has received much publicity as Milton Friedman‘s "negative income tax."


In my gropings toward the maximum social benefits to be derived from marginalism I had originally given practically no attention to administrative problems, and had almost automatically pictured socialist society as some sort of universal government enterprise which would instruct all the managers, who would be government employees, to follow the marginal cost pricing principle. I remember being surprised by Lange‘s acceptance of naturally small private enterprises, "farmers and barbers," as perfectly compatible with socialism. I had never thought of this but found it immediately acceptable. In general it seems to me that no disagreement between Lange and myseif on economic theory ever survived an hour‘s discussion, although I understand that many economists have written on differences between our approaches of which I am quite unaware.


Perhaps marginalism has continued to be my hangup, but I still feel that this principle is not fully exploited by many modern economists. The egalitarianism behind the suggested equal division of Lange‘s excess of average price over average marginal wage cost, my "social dividend" or Friedman‘s negative income tax, I see economically justified as a more efficient way of using income to provide satisfaction to individuals. It is based on my assumption that other people, like myseif, have their well-being increased by having more income, and that, like myself, they experience diminishing marginal utility of income as a result of some element of rationality in their use of their income. …. In the absence of knowledge of the absolute level of the satisfaction of others, the best way of distributing the surplus … is to divide it equally. This is how my learning some economics at LSE gave a rational meaning to my egalitarian impulses. …


But egalitarian impulses will out. Other rationalizations are sought, and this has led to a plethora of other, or apparently other, reasons for advocating the egalitarian distribution of surplus. Rawls finds it in fairness and/or justice. His "original state" allegory is certainly a most dramatic way of saying "let us not be biased," but in his "maximin" principle I see no basis (in spite of his denials) other than the assumption of diminishing marginal utility of income or an infinite risk aversion, or perhaps both.


Arrow and Amartya Sen find it in "equity." I have just had some intensive discussion on this subject with Sen. He rejects the utilitarianism on which I base my case for the equal distribution of surplus. Instead he turns to equity (or, more modestly, to his "weak equity principle") aimed not at maximizing utility but at equalizing it. …I see neither the possibility nor any desirability in equalizing the utility levels of different individuals, nor indeed of any or "some" movements in that direction.

Arrow’s equity principle seem to come to the same thing as Sen’s. I see in both a retreat from marginalism, … They are forced by their abhorrence of the subjective basis for assuming individual diminishing marginal utility of income, without comparing them, to rest their egalitarianism on the much less defensible comparison of the actual levels of individual total utility.



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