Machlup’s essay is a defense of marginal analysis against empirical critics who claimed that actual business behavior refuted it. His thesis is not that firms are perfectly rational calculating machines, but that the research offered against marginalism misunderstands what the theory asserts. Marginalism is, for him, the logic of economic adjustment under scarcity; it need not exclude traditional, mistaken, or non-pecuniary conduct, but it remains the proper framework for explaining systematic responses to changed conditions.
Economic theory, static as well as dynamic, is essentially a theory of adjustment to change.
The first half reconstructs the marginal analysis of the single firm. Machlup stresses its modesty: it does not explain every historical reason a firm makes a product, charges a price, or employs a workforce. Rather, it asks what kinds of changes induce changes in output, price, or employment. Its crucial variables are not objective accounting magnitudes but the entrepreneur’s own expectations. Cost, revenue, and profit are relevant only as they are perceived by those acting within the firm.
The business man does what he does on the basis of what he thinks, regardless of whether you agree with him or not.
This subjectivist move is central. Marginal cost and marginal revenue are expectations about future alternatives, often over a narrow practical range, not complete blackboard curves extending over every imaginable output. Nor must they be numerically explicit. Business routines may embody earlier judgments; experienced managers may “size up” situations without formal calculation. Thus the absence of arithmetical marginal estimates is not evidence against marginal reasoning.
Marginal analysis of the firm should not be understood to imply anything but subjective estimates, guesses and hunches.
Machlup extends the same clarification to input and employment. Marginal productivity, in the theory of the single firm, means marginal net revenue productivity: the value of added output, adjusted for price effects and associated changes in other costs. Monopoly and monopsony do not invalidate the principle; they alter marginal revenue or marginal factor cost. His analogy of a driver overtaking a truck captures the methodological point: an explanatory model may identify variables that agents consider tacitly rather than calculate explicitly.
the explanation of an action must often include steps of reasoning which the acting individual himself does not consciously perform
The second half turns to empirical research. Machlup’s critique is not anti-empirical; it is a critique of uncritical empiricism. Businessmen do not speak the vocabulary of elasticities, marginal revenue, or marginal productivity, but scientific explanation need not reproduce actors’ own terminology. Researchers must translate between business language and economic analysis rather than infer theoretical irrelevance from unfamiliar words.
The technical terms used in the explanation of an action need not have any part in the thinking of the acting individual.
His discussion of average-cost pricing is the essay’s most important reinterpretive move. Reports that firms price by “full cost” need not contradict marginal analysis. Average costs may average fluctuations over time, express a legally or ethically acceptable justification, support cartel discipline, or serve as a clue to competitors’ likely supply conditions and hence to demand elasticity. In the Hall and Hitch evidence, Machlup finds not refutation but confirmation: firms avoid higher or lower prices because of competitors, future reversals, and expected demand responses.
Business men’s answers to direct questions about the reasons for charging the prices they are charging are almost certainly worthless.
Machlup is especially critical of Lester’s wage-employment questionnaires. Asking firms to rate the “importance” of factors such as demand, wages, materials, profits, and technique confuses frequency, magnitude, and causal effect. Worse, the listed factors are themselves determinants of marginal productivity. Ambiguous notions of capacity and simplified questions about substitution between labor and capital cannot test the theory they purport to reject.
The article’s continuing relevance lies in its account of how theory and evidence should meet. Marginal analysis is not a literal psychology of business calculation, but a disciplined way of interpreting adjustments to perceived alternatives. Empirical research is indispensable, yet it must be designed with theoretical clarity, institutional knowledge, and attention to language and rationalization.
The correctness, applicability and relevance of economic theory constantly need testing through empirical research; such research may yield results of great significance.
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