Tuesday, 8 December 2009

Alfred Marshall and hold-up

In their paper "Reflections on the Theory of the Firm", Journal of Institutional and Theoretical Economics, 143 (1987), 110- 136, Armen Alchian and Susan Woodward use the following example of hold-up,
We first acknowledge the forgotten precedence of Alfred Marshall, who in his principles [1890] identified "composite quasi-rent". First, a quasi-rent is the excess above the return necessary to maintain a resource's current service flow. It is a recovery of sunk costs. Composite quasi-rent is that portion of the quasi-rent which depends on continued association with some other specific resources, and consequently is vulnerable to expropriation. Marshall's compelling example of such vulnerability was a steel mill that locates near a public utility and makes investments which depend on being able to buy power at some given price. Once the steel mill's investment is complete and the sunk costs are sunk, the utility can raise the price of power and the steel mill will continue to operate because marginal cost, even with the higher cost of power, still exceeds marginal revenue, even though the sunk costs are not being recovered.
Now there is an obvious problem with the "marginal costs ... exceeds marginal revenue" bit at the end of the quote but my question is aimed at example of the steel mill and a public utility. Marshall's Principles first came out in 1890 and the eighth edition appeared in 1920. Given this timing what are the chances that Marshall would use the example of a steel mill and power producer? Was the technology even available at this time to make the example credible?

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