Transcript Power Point Slides Thirteen: Worldly Philosophers Ch. 7

 The Father of Neoclassical Economics (along with Leon Walras)
 The Originator of the Principles of Microeconomics
 Wrote “The Principles of Economics” (1890)
 The Stereotypical Economists (“It depends”)
 Marshall is a very careful thinker. His thoughts on marginal analysis
pre-date Stanley Jevons and Carl Menger, yet his publication of this
idea was twenty years after the other two rushed onto the economics
landscape.

Perhaps influenced, to some extent, by Mill’s hasty conclusion to value
theory.
 Marshall rarely attempted a statement or took a position without
expressing countless qualifications, exceptions, and footnotes. He
showed himself to be an astute mathematician—he studied math at
St. John’s College, Cambridge—but limited his quantitative
expressions so that he might appeal to the layman.
 http://www.econlib.org/library/Enc/bios/Marshall.html
ALFRED MARSHALL (1842-1924)
 from the Concise Encylopedia of Economics
 Alfred Marshall was the dominant figure in British
economics (itself dominant in world economics)
from about 1890 until his death in 1924. His specialty
was MICROECONOMICS—the study of individual
markets and industries, as opposed to the study of
the whole economy.
 In his most important book, Principles of Economics,
Marshall emphasized that the price and output of a
good are determined by both SUPPLY and demand:
the two curves are like scissor blades that intersect
at equilibrium. Modern economists trying to
understand why the price of a good changes still
start by looking for factors that may have shifted
demand or supply, an approach they owe to
Marshall.

http://www.econlib.org/library/Enc/bios/Marshall.html

for more on Marshall see…. http://www.economyprofessor.com/theorists/alfredmarshall.php
JOHN MAYNARD KEYNES ON MARSHALL
 “Marshall… arrived very early at the point of view that the bare
bones of economic theory are not worth much in themselves and
do not carry one far in the direction of useful, practical
conclusions. The whole point lies in applying them to the
interpretation of current economic life. This requires a profound
knowledge of the actual facts of industry and trade.”
 Keynes, John Maynard (1924). “Alfred Marshall, 1842-1924.” The Economic Journal. v34,
n135 (September), p. 342
MARSHALL ON ECONOMICS
(FROM 1885)
 (David) Ricardo and his chief followers did not make clear
to others, it was not even quite clear to themselves, that
what they were building up was not universal truth, but
machinery of universal application in the discovery of a
certain class of truths.
 While attributing high and transcendent universality to
the central scheme of economic reasoning, I do not assign
any universality to economic dogmas. It is not a body of
concrete truth, but an engine for the discovery of concrete
truth."
Alfred Marshall: Life in One Paragraph
• Alfred Marshall was born in Bermondsey, a London suburb, on 26
July 1842. He died at Balliol Croft, his Cambridge home of many
years, on 13 July 1924 at the age of 81. Professor of Political
Economy at the University of Cambridge from 1885 to 1908, he was
the founder of the Cambridge School of Economics which rose to
great eminence in the 1920s and 1930s: A.C. Pigou and J.M. Keynes,
the most important figures in this development, were among his
pupils. Marshall’s magnum opus, the Principles of
Economics (Marshall, 1890a) was published in 1890 and went
through eight editions in his lifetime. It was the most influential
treatise of its era and was for many years the Bible of British
economics, introducing many still-familiar concepts.
• Whitaker, J.K., “Marshall, Alfred,” The New Palgrave: A Dictionary
of Economics, Vol. 3 (K to P), John Eatwell et al., eds. (Macmillan
Press, 1987), pp. 350–363.
• http://http-server.carleton.ca/~karmstro/bios/Marshall.htm
More
Biography
http://econ.unt.edu/~dmoli
na/may2nd/history/Marsha
ll.ppt
 Son of a bank cashier. Father pushed him to the
point that had it not being for trips to an aunt in the
Summers he would have ended up as another J.S.
Mill.
 He did not make friends and his two favorite
hobbies (math and chess) were prohibited by his
father
 Refused Oxford scholarship (ministry)
More
Biography
(continuation)
http://econ.unt.edu/~dmolina/
may2nd/history/Marshall.ppt
 Went to Cambridge to study mathematics
 Had to leave Cambridge in 1877 since he decided to
marry (just like Malthus)
 Bristol took him (have a page dedicated to him in
their Web-page)
 Published “Economics of Industry” with his wife
Mary Paley
More
Biography
(continuation)
http://econ.unt.edu/~d
molina/may2nd/history
/Marshall.ppt
 In 1884 returned to Cambridge
 In 50 years of writting he produced 82 publications
including:




9 editions of Principle of Economics
5 editions of Industry and Trade
2 editions of The Economics of Industry
Money, Credit and Commerce appearing in 1923
(year before his death) only appeared in one edition
 Father of modern orthodox microeconomic theory
(neoclassicism) along with Walras
More
Biography
(continuation)
http://econ.unt.edu/~
dmolina/may2nd/hist
ory/Marshall.ppt
Structural basis of
undergraduate
economic theory
(Walras more adequate
for graduate classes)
Translated Ricardo and
J.S. Mill economics into
mathematics
More
Biography
(continuation)
http://econ.unt.edu/~
dmolina/may2nd/hist
ory/Marshall.ppt
 Father of modern orthodox
microeconomic theory
(neoclassicism) along with Walras
In defining Economics he
stated:
 Political Economy or
Economics is a study
mankind in the ordinary
business of life; it examines
the part of the individual and
social action which is most
closely connected with the
attainment and with the use
of the material requisites of
well being (text 274)
APPROACHES TO ECONOMICS FROM
JOHN NEVILLE KEYNES
1.Positive economics
2.Normative economics
3.The art of economics
(i.e. blending of 1 and 2)
THE SCOPE OF ALFRED MARSHALL
Marshall used the term “economics” rather than “political
economics” because he wished to emphasize the positive aspects
of economic thought. However, Marshall’s work is best classified
as consistent with the “art of economics” not “positive
economics”
With respeect to the unification of the social sciences vs. the
narrow definition of economics.... Marshall emphasized the gains
to be achieved from a narrow focus, although he was sympathetic
to those who wished a broader perspective.
The chief task of economists: Eliminate poverty, which Marshall
said the classicals failed to address adequately.
Remember… given the Malthusian population doctrine, the
classical position on poverty is that it cannot be eliminated.
MARSHALL ON METHOD
HTTP://ECON.UNT.EDU/~DMOLINA/MAY2ND/HISTORY/MARSHALL.PPT
I know I had a growing feeling in the later
years of my work at the subject that a good
mathematical theorem dealing with
economic hypotheses was very unlikely to be
good economics: and I went more on the
rules…
MARSHALL ON METHOD
HTTP://ECON.UNT.EDU/~DMOLINA/MAY2ND/HISTORY/MARSHALL.PPT
1.
2.
3.
4.
5.
6.
Use mathematics as a shorthand language, rather than an engine of inquiry
Keep to them until you are done
Translate to English
Then illustrate by examples that are important in real life
Burn the mathematics
If you can’t succeed in (4), burn (3), This last I did often
Marshall believed mathematics could state your ideas
efficiently, but at a loss of realism. For Marshall, the
economist should always strive to bring the abstract
mathematical analysis back to the world in which we live.
Marshall’s contributions
summarized
Supply and Demand
Price Elasticity of Demand
Consumer Surplus
Impact of taxation on society
The Short-Run and Long-Run
Optimization
Marshall also taught John Maynard Keynes. If you have taken macroeconomics you
have been exposed to the work of Keynes.
History of Supply and Demand
The Question to be Addressed:
What Determines the Price of the
Good?
What Determines the Price of a
Good?
An Answer from David Ricardo and Karl Marx…
The Labor Theory of Value - The price of a good is determined by the cost of
production, and the cost of production is dictated by the quantity and quality of
labor utilized.
What of the other factors of production?
◦ Capital: Capital is simply stored up labor.
◦ Land: Ricardo argued that the price of corn determined the price of land,
rather than the price of land determining the price of corn. In other words,
the price of land is price determined, not price determining.
◦ What about demand? In the long-run, assuming competition, price will equal
the cost of production. This comes directly from the work of Adam Smith
More on the Labor Theory of Value
Karl Marx wished to show that even if capitalism worked exactly
as Ricardo believed, capitalism was still a very poor economic
system.
Consequently, Marx utilized the labor theory of value to explain
prices.
Given this explanation, Marx offered the following argument: If
the value of labor determines value, and value mostly is given
to the owners of capital, is it not the case that labor is
exploited?
Utility Theory
Karl Marx published Das Kapital in 1867. In the early
1870s, three different writers – Stanley Jevons, Leon
Walras, Carl Menger – offered a different answer to “what
determines prices?”
Utility - the satisfaction one receives from a good.
“The fact is, that labor once spent has no influence on the
future value of any article: it is gone and lost forever. In
commerce, bygones are for ever bygones.” W.S. Jevons,
1871
Marshallian Cross
http://econ.unt.edu/~dmolina/may2nd/history/Marshall.ppt
Marshall defined 4 time periods:
◦ Market period - Very short period in which supply is fixed
(perfectly inelastic). No reflex action of price on quantity
supplied
◦ Short run - A period in which the firm can change
production and supply but cannot change plant size.
Higher prices cause larger quantities to be supplied
(upward sloping supply curve).
Marshallian Cross
http://econ.unt.edu/~dmolina/may2nd/history/Marshall.ppt
◦Two components of total costs of the firm:
◦ prime costs - costs that vary with output (also
called special or direct costs). We call these costs
“variable costs”.
◦ supplementary costs - costs that do not vary with
output (fixed costs)
Marshallian Cross
http://econ.unt.edu/~dmolina/may2nd/history/Marshall.ppt
◦ Long run - Plant can vary and all costs become variable.
 Supply curve becomes size more elastic because of firms
adjustment in plant size and can take 3 forms:
◦ Increasing costs - slopes up and to the right
◦ Constant costs - perfectly elastic (horizontal)
◦ Decreasing costs - slopes down and to the right
(unusual situations)
◦Secular period - (Very long run) Permits
technology and population to vary
Marshallian Cross
http://econ.unt.edu/~dmolina/may2nd/history/Marshall.ppt
Controversy over whether cost of production
(classical)or utility (marginal utility school of
Jevons, Menger and Walras) determines
price.
◦Marshall believed that influence of time
and awareness of the independence of
economic variables would resolve the
question.
Marshallian Cross
http://econ.unt.edu/~dmolina/may2nd/history/Marshall.ppt
Supply curve depends on the time period under
analysis.
◦ The shorter the period, the more important the role of
demand in determining price.
◦ The longer the period, the more important the role of
supply. In LR in constant costs exist so that supply is
perfectly elastic, price will depend solely on cost of
production
CETERIS PARIBUS
 Defined ceteris paribus and the
purpose of this assumption
 Define partial equilibrium
analysis: “the one at a time
method”
PRICE ELASTICITY
HTTP://ECON.UNT.EDU/~DMOLINA/MAY2ND/HISTORY/M
ARSHALL.PPT
 Marshall on Demand
 Most important contribution to demand
theory was his clear formulation of the
concept of price elasticity of demand.

Price and quantity demanded are inversely related to each other; demand curves slope down
and to the right.

Degree of relationship is shown by the coefficient of price elasticity:
PRICE ELASTICITY
HTTP://ECON.UNT.EDU/~DMOLINA/MAY2ND/HISTORY/MARSHALL.PPT
 Elasticity of Demand
 eD = percent change in quantity demanded = - q / p
percent change in price
q
p

Coefficient is negative b/c of inverse relationship; by convention the coefficient is shown as
positive by adding the negative sign to the right side of the equation.

If price decreases by 1 percent and quantity demanded increases by 1 percent, total revenue is
unchanged, and the coefficient value is 1. The commodity is said to be price elastic..
PRICE ELASTICITY
HTTP://ECON.UNT.EDU/~DMOLINA/MAY2ND/HISTORY/MARSHALL.PPT
 If price decreases by a given percentage and the
quantity demanded increases by a smaller
percentage, total revenue decreases and the
coefficient < 1. The commodity is price inelastic
 Marshall also applied the elasticity concept to
the supply side.
 Marshall was 1st to express the concept of
elasticity with mathematical precision and is considered
its discoverer.
SUBSTITUTION AND INCOME EFFECTS
 Substitution effects produced a negatively sloped demand curve
 Income effects produce a positive or negatively sloped demand
curve depending on whether it is an inferior or normal good.
 Marshall did not have the tools to explain theoretically the impact
of substitution and income effects so he assumed income effects
were not important (i.e. the marginal utility of money is constant)
 These concepts are used by theorists to discuss the “Giffen good”
http://gregmankiw.blogspot.com/2007/07/real-world-giffengood.html
CONSUMER SURPLUS
 Price and marginal utility are related. People
will pay more for the first units consumed
than the will for later consumption. However,
you only pay one price, so there is a
consumer surplus, or the difference between
what you pay and what you are willing to pay.