July 30, 2003

Price Must Equal Costs, But What Costs?

James DeLong writes on how the idea of marginal costs have been taken from their theoretical context and distorted as weapons in policy debates. Here's a key paragraph:

The axiom "prices must equal marginal cost" does not tell you whether the relevant time dimension is a decade, a year, or an hour, which makes it into a meaningless statement. So to set up an identity between marginal cost and price, without a tight specification of the assumptions about time, or to assume that short-term marginal cost is the ticket, produces nonsense.

"Marginalized" [via PrestoPundit]