Transcript Marginalist Revolution

Marginalist Revolution … 1871
• Marx (1868) BIG Picture … Trajectory of capitalism
• Capitalism self-destructs
• 1871: Jevons, Walras, Menger
• Utility, not cost-of-production
• Allocation/Optimization
• Precursors: von Thünen, Cournot, GOSSEN
• Precursors to precursors:
• Aristotle: utility  value
• Bernoulli (1738): diminishing MU of income
– Reiterated by Bentham
• Galiani (1751): Value ≈ Utility x Scarcity (solves diamond:water
“paradox”)
• Condillac (1776): Industry & commerce  utility (not just agriculture)
• Say (1803): Entrepreneur’s concern with consumer wants  utility
• Senior (1834): diminishing (marginal) utility in consumption as well as
diminishing returns in production
• Lloyd (1834): Cardinal utility  MU
Marginalist Hall of Fame: Calculus Rules
Camera
Shy
Johann Heinrich von Thünen
1780-1850
Antoine Augustin Cournot
1801-1877
Hermann Heinrich Gossen
1810-1858
William Stanley Jevons, 1835-1882 Léon Walras, 1834-1910
Marginalist Hall of Fame: Neoclassical Economics
Vilfredo Pareto
1848-1923
Francis Ysidro Edgeworth
1845-1926
Philip H. Wicksteed
1844-1927
Knut Wicksell
1851-1926
John Bates Clark
1847-1938
The Marginalist Revolution: A Short Tour
• Johann Heinrich von Thünen, The Isolated State with respect
to agriculture and the national economy, 1826.
• Explicit optimization: agricultural production/intensity as function of
distance  Spatial economics
• Land rent declines with distance from “city”
• If all workers paid MPL of last worker  exploitation by employer
• “Just” wage ≈ SQRT(a.p.) … between MPL and APL
• August Cournot, Researches into the mathematical principle of
the theory of wealth, 1838.
• Profit maximization in competition, monopoly, and duopoly: MR = MC
• Precursor of non-cooperative game theory:
Duopolist acts in anticipation of opponent’s action
 reaction curves equilibrium between monopoly and competition
• Hermann Heinrich Gossen, Development of the laws
of human interaction, 1854.
– Obscure amateur … Acknowledged by Jevons
• Gossen’s 1st Law:
» Diminishing marginal utility  allocation of
resources, including time
• Gossen’s 2nd Law:
» Equilibrium where “the last atom of money creates
the same pleasure in each pleasurable use.”
» MUx/Px = MUy/Py
The Marginalist Revolution: The Heavy Hitters
• William Stanley Jevons, The Theory of Political Economy,
1871.
• “to maximize pleasure is the problem of economics”
• Constrained optimization in the face of diminishing marginal utility
(the final degree of utility)  relative prices
– MU decreases with quantity (Gossen’s First Law)
– Equilibrium: MUx/px = MUy/py = MUz/pz (Gossen’s Second Law)
• Léon Walras, Elements of Pure Economics,1874,1877
• General Equilibrium: Cantillon/Quesnay interdependencies
• Tâtonnement: “Groping” for equilibrium
» “Auctioneer” announces and revises prices until markets
clear
» Quantities demanded and supplied equate relative marginal
utilities to relative prices: MUx/MUy = px/py (Gossen’s Second
Law)
• Free competition  maximum welfare, given factor endowments
» Thems that gots gits
The Marginalist Revolution: Contributors
• Vilfredo Pareto, Manuel d’économie politique, 1906, 1909
• Walras explained
• Pareto’s Law of Income Distribution (people, not classes, get shares)
» Log (Fraction w/income >= x) = - a Log x
• Ordinal, not cardinal, utility for individual  can’t compare across individuals
• Pareto efficiency: if someone gains and no one loses, do it.
• Francis Ysirdo Edgeworth, Mathematical Psychics, 1881
• Indifference curves  Edgeworth Box  Contract Curves
• Marginal Productivity Theory of Distribution
Under competition, Wage = Marginal Value Productlabor = P x MPPlabor
– John Bates Clark … championed principle: to each according to his
contribution (given his endowments)  Capitalism Rocks
– Phillip Wicksteed … established product exhaustion  no exploitation
• Wage Bill + Profit Bill = Value of Output
• wL + rK = (P * MPPLabor ) * L + (r * MPPKapital ) * K = P
– Knut Wicksell …did it all first
Marginalist Hall of Fame: Austrian School
Carl Menger, 1841-1921
Eugen von Böhm-Bawerk, 1851-1914
Friedrich von Wieser, 1851-1926
The Marginalist Revolution: The Austrian School
• Carl Menger, Principles of Economics (Grundsätze), 1871
• Civil servant, professor, tutor of Crown Prince, appointed to Herrenhaus
• Value established by loss principle: satisfaction of last unit
– Given supply, where does price settle? No S – D adjustments
• Realistic decisions about lumpy alternatives, not marginal
adjustments
• “Causal analysis” … calculus not needed/welcome in Vienna
• Eugen von Böhm-Bawerk, Capital and Interest, 1884
• Civil servant, Professor, Finance Ministry, Minister, Professor
• Roundaboutness of production  increased productivity
 interest rate without reference to time preference
• Causal vs. mathematical analysis: debates with Wicksell and Fisher
– Interest jointly determined with output, wages and capital intensity, the
simultaneous equations that Böhm-Bawerk rejected but implicitly used
» “His denunciation of mathematics became a curse that
condemned his followers to provincialism.” Jürg Niehans
The Marginalist Revolution: The Austrian School
• Friedrich von Wieser, On the Origin and Principle Laws of
Economic Value, 1884
• Cost = Forgone utility
• Values of goods in equilibrium: Utility + Technology
Essentially demand and supply, but awkwardly avoided
Joint determination of outputs and shadow prices, obscured by causal analysis
• Marginal utility: Jevon’s “final degree of utility”  Grenznutzen  MU
• Austrian methodology:
• Step-by-step human action, not equilibrium of supply and demand
• Market as information processor  price signals
– von Mises victory over Lange: economic planning could never work
From Keynes’ eulogy:
[An economist] must be a mathematician,
historian, statesman, philosopher – in some
degree. He must understand symbols and
speak in words.
Keynes on Jevons – Marshall
priority: [Jevon’s final utility] lives
merely in the tenuous world of bright
ideas … Jevons saw the kettle boil
Alfred Marshall, 1842-1924
and cried out with the delighted
• Student and teacher at Cambridge voice of a child; Marshall too had
seen the kettle boil and sat down
• Majored in math
silently to build an engine.
• Married Mary Paley, an economist
• Teacher of teachers: Pigou, Keynes
• …cool heads but warm hearts
• Insecure in his writings: held back publication
• Principles of Economics, 1890 (1st edition), 1920 (8th edition)
• Neoclassical economics: marginalist – mathematical framework
• Written for intelligent layman: graphs in footnotes; math in appendices
• Account for the concrete: biological, not mechanical/mathematical, analogies
Marshall’s Principles of Economics: Themes and Contents
• Economics … a study of mankind in the ordinary business of life.
• Partial equilibrium analysis … representative agents and firms
• Recognition of Walras’ general equilibrium framework
• But focus on specific markets
» Supply (costs) interact with demand (utilities)
» Ceteris paribus  conservative tilt: “Nature does not leap” (Marshall)
• Supply and demand curves (the Marshallian cross)
• Value determined by both blades of the scissors
• Consumer and producer surplus
• Reciprocal demand curves in trade
• Elasticity of demand
value
• Price decline  increase in real income
• Anticipates income and substitution effect analysis
• Short-run and long-run supply – fixed and variable costs
• Elasticity of supply increases with time
» Value in short-run depends on demand
» Value in long-run depends on supply
quantity
• Internal economies  difficulties for competitive market paradigm
• External economies (of industry scale)
Adherent to Say’s Law
“Classical” foil for Keynes in General Theory
Pigou response:
Pigou effect = “Real Balance Effect
P down  (M/P) up
 Automatic adjustment to full employment (?!?)
Arthur Cecil Pigou
1877 - 1959
• Economics of Welfare, 1920 … Reform, not Revolution
• Economies and diseconomies of production
• Divergence between private and social costs and benefits
•  Role for government
» Make railroads liable for damage sparks do to forests
» Subsidize smokeless smokestacks
» Fine polluters
Classical – Neoclassical Economics: An Aside
Neoclassical Economics
Classical Economics
Smith – Ricardo/Malthus – Mill
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Labor theory of value
Malthusian population
Say’s law
Quantity theory of money
• Marshallian economics
• Gossen/Jevons/Edgeworth
• Microeconomics
Physiocrats – Marx
• Balanced growth/imbalance
Concern: consequences of
capitalist accumulation
First Principles:
• Price independent of demand
» Labor theory of value
• Natural (long-run) prices
equalize rates of profit
• Real wage = “subsistence”
» Wage fund – Iron Law
Concern: allocation of scarce
resources
First Principles:
• Decision at margin
• Prices determined by
interaction of supply (costs)
and demand (utilities)
• Distribution accords with
marginal productivities