Fritz Machlup’s edited-volume essay examines whether decreasing production costs provide a justification for monetary expansion. Its organizing move is to dismantle an apparently unified argument into distinct economic mechanisms. “Decreasing costs” can mean changing factor proportions, spreading overhead, technical or organizational progress, economies within expanding firms, or economies arising from industrial growth. These cases require different assumptions about time, competition, and employment. Machlup argues that none independently establishes the benefits or sustainability of inflation, which he defines as an increase in the quantity of money in its widest sense, without building assumptions about prices into the definition.
The essay proceeds through five numbered discussions corresponding to this classification. First, Machlup separates the law of variable proportions from monetary analysis. Adding a variable factor to fixed quantities of other factors initially raises output more than proportionately, but eventually produces diminishing returns. These are relations between physical inputs and products; expressing them in money does not establish a connection with credit expansion. Under sufficient divisibility, factors would already be combined in their most efficient proportions.
It is most misleading to handle the law of proportions in terms of money cost. There is no possible interrelation between this law and an increasing supply of money or credit.
The second discussion distinguishes decreasing average costs from the incremental costs governing production decisions. The initial downward-sloping portion of the incremental-cost curve concerns output below the minimum commercially relevant scale. At practical operating levels, Machlup maintains, incremental costs rise. Although increased output can spread fixed overhead across more units and reduce average total costs, this accounting result does not itself make additional production profitable.
The fixed burden is absolutely the same at any volume of production and, since it does not influence the cost of producing one unit more, it does not influence the price or the output at a given price.
This distinction supplies his answer to the claim that inflation can activate idle capacity without raising prices. Competitive producers expand when expected additional receipts cover additional costs, not because expansion reduces the average burden of past commitments. A monopolist might offer more at unchanged prices, but such conduct requires a separate explanation. Machlup thus rejects the passage from observed spare capacity to an assumed costless response to increased monetary demand.
The third and longest discussion turns to “progress”: improvements in technique and organization, and increases in productive resources. With a constant money supply, a larger quantity of goods requires some prices to fall. Against proposals to stabilize the price level through monetary expansion, Machlup distinguishes productivity-driven price reductions from disruptive losses.
The first point—that a price fall which comes about by a decrease in cost is no disturbing factor in the system—should be clear.
His example holds total costs constant while output increases: a corresponding fall in unit price can leave total receipts and profits unchanged. Different demand elasticities complicate adjustment across industries, but he treats these as ordinary reallocations of demand, not consequences peculiar to a falling price level. His objection is therefore to treating price stability as a sufficient monetary objective without examining why prices change.
Machlup nevertheless recognizes that growth and innovation can put downward pressure on money wages. Labor-saving techniques, additional labor supply, and under certain conditions increased capital supply may produce unemployment when institutions prevent wage adjustment. He rejects inflation as a durable substitute for wage flexibility: credit expansion may encourage further substitution of capital for labor, while the forces sustaining wage rigidity may also drive wages ahead of monetary expansion. He separately allows that additional holdings of unspent cash can matter to a neutral-money policy. This qualification distinguishes changes in effective monetary circulation from attempts to manage real wages through inflation.
The essay then separates inflation intended to compensate for progress from inflation intended to induce it. Investments financed by new credit rather than genuine saving may generate an unsustainable expansion. Machlup acknowledges that employing idle workers differs from bidding workers away from existing occupations, but maintains that the central difficulties remain. He refers the fuller business-cycle argument elsewhere; here his narrower claim is that easy credit cannot simply be classified as a source of decreasing production costs.
The final sections consider internal and external economies. Expansion under monopolistic competition may permit plant-level savings, but this does not show that inflation directs resources toward socially beneficial uses. Under widespread unemployment, moreover, enlarging plants is a questionable remedy when existing capacity remains unused. Similar problems affect claims about industry-wide economies: their location and magnitude are uncertain, and monetary expansion offers no demonstrated means of selecting them.
Machlup’s most concrete concession concerns unemployment relief financed by taxes on industry. Reemployment can reduce relief expenditure and thereby lower other firms’ taxes, making the social gain exceed the hiring firm’s private gain. Where those taxes enter direct rather than overhead costs, this constitutes a genuine external economy. Yet the argument requires actual tax reductions and evidence that other rising costs do not offset them. Machlup further contends that an expansion dependent on continuing inflation faces either renewed crisis when inflation stops or eventual monetary breakdown.
The conceptions of the decreasing costs, however, form neither such arguments nor such conditions.
The essay’s enduring analytical contribution is its insistence that physical productivity, average-cost accounting, marginal incentives, and social economies are different objects of explanation. Its anti-inflationary conclusion rests on keeping those distinctions intact rather than accepting “decreasing costs” as a general warrant for monetary stimulus.
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