In a large saucepan, saute onion in butter until tender. Stir in flour, salt and pepper until blended. Gradually add milk. Bring to a boil; cook and stir for 2 minutes or until sauce is thickened.
Place half of potatoes in a greased 3-qt. baking dish. Pour half of sauce over potatoes. Repeat layers. Bake, uncovered, at 350 degrees F for 60-70 minutes or until potatoes are tender and top is lightly browned. Serve immediately.