Economies of Specialization and Downward Sloping Supply Curves: An Inframarginal Analysis

Abstract

This paper explores the implications of a small elasticity of substitution between consumption goods and the framework with consumer-producer, economies of specialization, and transaction costs for the analysis of demand and supply. In this framework, a consumer-producer's decision cannot be solved by the marginal analysis. An inframarginal analysis, which implies total benefit-cost analysis across several comer solutions in addition to the marginal analysis of each comer solution, is necessary for deriving demand and supply functions. The tradeoff between economies of specialization and transaction costs is specified to explore the relationship between transaction efficiency, the elasticity of substitution, and the equilibrium level of division of labor and related productivity and extent of the market network. It is shown that supply curves are downward sloping if the elasticity of substitution between consumption goods is smaller than one. As improvements in transaction efficiency drive division of labor to evolve, demand and supply functions discontinuously jump, generating structural changes in economic organization.