Marginal customers
Piero Sraffa’s 1926 article “The Laws of Returns Under Competitive Conditions” is, like everything Sraffa published (well, with the obvious exception of his 11-volume The Works and Correspondence of David Ricardo) extraordinarily short and dense. His intention in the piece is to disturb what he terms the “almost unanimous agreement at which economists have arrived regarding the theory of competitive value, which is inspired by the fundamental symmetry existing between the forces of demand and those of supply”.1 At the heart of his position is the fact that the supply curve is a fragile basis upon which to found a pillar of an argument as important to neoclassical economics as equilibrium. To quote at length:
“In the tranquil view which the modern theory of value presents us there is one dark spot which disturbs the harmony of the whole. This is represented by the supply curve, based upon the laws of increasing and diminishing returns. That its foundations are less solid than those of the other portions of the structure is generally recognized. That they are actually so weak as to be unable to support the weight imposed upon them is a doubt which slumbers beneath the consciousness of many, but which most succeed in silently suppressing. From time to time someone is unable any longer to resist the pressure of his doubts and expresses them openly; then, in order to prevent the scandal spreading, he is promptly silenced, frequently with some concessions and partial admission of his objections, which, naturally, the theory had implicitly taken into account. And so, with the lapse of time, the qualifications, the restrictions and the exceptions have piled up, and have eaten up, if not all, certainly the greater part of the theory.”
Essentially, Sraffa is stating that the clarity which is expressed in the standard economic equilibrium model in which demand and supply are coterminously paired is incorrect, and the simplicity of the model which gives it its theoretical import is in fact a kludged-together claptrap of exceptions, clarifications, and work arounds which have “eaten up” the theory and thereby severely limit its use and application. He continues with a brief critique of Alfred Marshalls’ own particular spin on the s/d symmetry by pointing out that production is essential in the determination of price because any given firm operating within a particular sector produces on the basis of input prices and is thereby embedded within the broader “production space” of its suppliers. If we then take costs of inputs from previous production processes which the firm commands in its own production process, it becomes clear that these form an (ahem) “center of gravity” for the particular price of their finished product (whether it is itself an intermediate input, consumer good, or something more complex like a building, let’s say). Thus the limit to production in general is to be “found in the internal conditions of production in their firm” as they take into account the prices set by previous firms owing to their own internal conditions of production – not in the consumer market at all. The external quality of “received prices” in a great vertically integrated chain is salient at this point, which is precisely the point in which supply is determined. Sraffa rightly considers it absurd to consider that a producing firm, which, as should be obvious, produces as an existential imperative, would draw down its production based on imputed knowledge of the demand schedule (which is why overproduction is such a messy and central fixture of crises in capitalist economies, obviously).
From this point Sraffa concerns himself with the “demand side”, that is, on price determination within consumer markets. As you may guess by the title, we are in competitive conditions, but not “perfect competition” – that is, the market environment within a segment corresponding to the sale of a particular commodity will be dominated by a “regulating capital” which sets the price of that commodity in what somewhat resembles a “monopoly” setting. However, as we saw above, this price is a figure compounded from the price of production experienced by that firm, developed in accordance with not only the conditions of production in that sector but also in all inputting sectors, and thus connected to the entire economy. For Sraffa (and this is his most damning flaw) the only thing relevant here is the technological level of production (in terms of dictating prices and their changes). Obviously, class struggle is also key here, given the wage bill forms a chunk of the price of production along with considerations of fixed capital, and thus an increase in wage will diminish the share of profits without a corresponding increase in price, etc. (though not by that much, if Ricardo’s “93% rule” is true).2
Anyway. Competition in the consumer market sees demand enter the picture again. However, this demand is unknown and can only be discovered incrementally by stress testing would-be consumers – or, put another way, firms engaged in the consumer market have to actively plumb the market for demand elasticity: “the less elastic the demand for his product”, Sraffa writes, “the greater is his hold on his market”. Thus, only a particular firm knows the demand for their particular product, and even then not with any sort of certainty. Individual demand curves cannot meaningfully be averaged into a general demand curve given this segmentation and the large amount of imputation required to get some fake-ass number on market share for one individual firm.3 A firm’s only capacity for finding their elasticity (that is, the number of would-be customers) is by looking for marginal customers. Sraffa identifies “two classes of marginal customers”.
1. “those who are at the margin only from its own individual standpoint and fix a limit for the excess of its prices over the prices generally ruling, and
2. those who are at the margin from the standpoint of the general market and fix a limit for the general increase in price of the product”.
Bohm-Bawerk (who is now burning in hell for his stupidity) makes much of these marginal customers, claiming that they are the lemma of price-setting for entire industries (using a rather insipid example with horsetraders)4 as does Hotelling in his duopoly models.5 But what is interesting here, I think, is that the loss of marginal customers for any firm is in effect their only information on market conditions, and only available after “supply” has already occurred. Instead of the smooth link between supply and demand, there is instead, on one hand, the imbecilic imperative to produce at all costs, and on the other, a ceaseless war between firms to capture the marginal customers cast off by other firms within an incredibly tight market.
What I really want to look at here is the differences between a typical commodity market, as Sraffa is writing about here, and the housing market. The housing market is also segmented according to “consumer” incomes as well as geographically.6 We may say rental prices function as the prices consumers encounter for commodities in other markets (close enough anyway). Landlords with vacancies exhibit similar “market dousing” behavior as they try to raise rent prices to their limit (to maximize their profits, of course) while keeping their market share maximized. However, what is curious about the rental market is that the problems of marketing, demand inducement, etc. are not as salient because, of course, “shelter goods” are basically required purchases. Becoming a “marginal customer” within the rental housing market is not making a choice to consume another good or go without, it means you either find a cheaper place or, barring that, become homeless. Turning back to the landlord, given they are “selling” a unique commodity which they only need to sell once, they are actually much freer to pursue aggressive price increases with the knowledge that they only need to engender a single sale (a signed lease, if you prefer) and this sale may be revised favorably with respect to profit once the initial sale has been completed (rent increases mid-lease). What this means, ultimately, is that runaway increases in rental markets (geographically and otherwise segmented) are functionally independent altogether of supply just as supply does not enter into the price considerations of producing firms. Put another way, when price is concerned, supply is assumed – and again, in the rental market, since supply is a prerequisite for even getting to the “demand stage” (you can’t ask a rent for an apartment that doesn’t exist, duh), the problem is even harsher. Compounding this is the fact that the landlord may not necessarily have had anything to do with the construction of the building they are renting access to; the building-commodity leaves the construction sector and passes into the control of another firm or owner in the real estate sector prior to being leased. From there it may change hands many time over its life as well, further occluding any information about initial selling price, etc.
Finally, we can ask: what of large landlords who command gigantic portfolios of residential rental properties? Ultimately, little changes with an increase in scale from the above example of a single landlord with a single property for rent who encounters the entire local universe of would-be renters. Again, their building-commodities are produced outside their remit. In fact, here it becomes more apparent that the prices for buildings a would-be landlord encounters hew closer to the conditions Sraffa describes. At the point of building sale, one process of demand-answering closes and the firms involved in construction make good on their process of production. From there, they enter into a redistributive market as they set rents in accordance with information gleaned from “marginal customers”, potentially seek to undercut other firms by offering temporarily cheaper rents, and so on. Again, supply is a distant memory and an assumed fact by the time the rental price is a consideration.
Basically, if you want all that summed up: supply has no bearing on rental price because supply is unknown by the landlord as they set their rental price.
Sraffa, Piero. “The Laws of Returns under Competitive Conditions.” The Economic Journal 36, no. 144 (1926): 535–50. https://doi.org/10.2307/2959866.
Stigler, George J. “Ricardo and the 93% Labor Theory of Value.” The American Economic Review 48, no. 3 (1958): 357–67.
This isn’t psychology!
Egger, John B. “Clarifying and Teaching Bohm-Bawerk’s ‘Marginal Pairs.’” The Journal of Economic Education 29, no. 1 (1998): 32–40. https://doi.org/10.2307/1182965.
See Chen, Xiaofeng, and Qiankun Song. “Two-Player Location-Price Game in a Spoke Market with Linear Transportation Cost.” Discrete Dynamics in Nature and Society 2021 (December 26, 2021). https://doi.org/10.1155/2021/9971103 if you want to be bored by dumb shit.
Teresa, Benjamin F., and Kathryn L. Howell. “Eviction and Segmented Housing Markets in Richmond, Virginia.” Housing Policy Debate 31, no. 3–5 (September 3, 2021): 627–46. https://doi.org/10.1080/10511482.2020.1839937.