7.2.4 Implications of empirical studies
Many empirical studies of short-run cost functions have been conducted, both
at the level of the individual firm and at industry level, since the 1930s. The
landmark studies, which are frequently quoted at length in textbooks, are
those by Dean5 in 1941 (hosiery) and Johnston in 19606 (road passenger transport).
Both these researchers also estimated cost functions in other industries,
as have other researchers, and there are now extensive studies of the furniture,
food processing, steel, electricity, coal, cement and other manufacturing
industries. It is not necessary to consider any of these in detail here, since
they come to largely the same conclusions. Walters7 has summarized many of
the earlier findings, concluding that they generally do not support the hypothesis
of the U-shaped average cost curve. More recent studies also tend to
indicate that total cost functions are frequently linear, with constant marginal
costs, at least in the normal range of output of firms. For example, in a study of
a firm producing plastic containers,8 it was found that for all ten products
manufactured by the plant the linear cost function provided the best fit.
Economists have come to some different conclusions based on these findings,
in order to reconcile them with the U-shaped average cost curve of
economic theory:
1 The data used have related only to a limited range of output, the normal
output range of the firms studied. As already explained in the previous
chapter, it may well be that the law of diminishing returns only starts to
take effect as firms approach full capacity, perhaps at around 95 per cent of
maximum output. Firms do not normally operate at this level, and indeed
managers try to avoid such operation because of the rising unit costs.
2 The studies have actually been long-run rather than short-run, because
capital inputs have varied, allowing the ratio of labour to capital to remain
constant.
Therefore, it is not necessary to re-evaluate the premises of economic theory in
view of the empirical findings. Furthermore, there is one other finding in
practice that tends to confirm that, ultimately, marginal cost curves must be
rising at higher levels of output. This is the fact that an increase in demand for
a product results in an increase in both the quantity supplied and the price of
the product in the short run. It will be seen in the next chapter that an upwardsloping
supply curve is dependent on an upward-sloping marginal cost curve.