CHAPTER 5: MARGINALISTS, MARSHALL AND LATE NEOCLASSICAL

5.1. MARGINALISTS:
 initiated in the 1870s
 Major contributors: William Stanley Jevons (1835–82), Carl Menger (1840–
1921), and Leon Walras (1834–1910).
 Refuted classical value and distribution theory, but supported their policy
views
 Focused its attention on the point of change where decisions are made (margin),
incremental unit
 people act rationally in balancing pleasures and pains, in measuring marginal

utilities of different goods, and in balancing present against future needs.

 individual person and firm take center stage (Microeconomic emphasis)

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MARGINALISTS . . .

 use the abstract, deductive method, rejected the historical method in favor
of the analytical method
 Assumes the pure competition

 demand became the primary force in price determination

 Emphasis on subjective utility

 believed that economic forces generally tend towards equilibrium—a

balancing of opposing forces
 continued the classical school’s defense of minimal government involvement
in the economy as the most desirable policy
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 FORERUNNERS OF THE MARGINALIST SCHOOL

a) Antoine Augustin Cournot

 first economist to apply mathematics to economic analysis

 his analysis focused on the rates of change of total cost and revenue functions (MC

&MR)
 firm can maximize its profits by setting a price at which MR=MC. This also applies

to monopolistic firm with positive MCs.

 first economist to analyze the conduct and performance of sellers in an

oligopolistic market structure with two firms competing (duopoly)

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 FORERUNNERS . . .
b) Jules Dupuit
 Was an engineer, developed diminishing marginal utility concept (using water): as the

price of a good falls, people buy more of it to satisfy less pressing, lower marginal utility
wants (MU and demand r/p)
 Consumer Surplus - the sum of differences between each unit’s MU and its price

 Monopoly Price discrimination - can occur only where it is possible to segregate buyers

into identifiable groups and where resale of the product by customers is impossible or
prohibitively expensive.
 It converts consumer surplus to higher revenues

 can also increase total output and enhance total utility

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 FORERUNNERS . . .
C) Johann Heinrich Von Thünen
 founder of location theory and agricultural economics

 With increasing distance from the Town, the land will progressively be given up to

products cheap to transport in relation to value

 established a crude marginal productivity theory of wages and capital.

 employer should add units of labor until the MRPL = Wage

d) Herman Heindrich Gossen

 Two laws: the law of diminishing returns,

 the rational person should allocate his/her money income so that the last unit of

money spent on each product bought yields the same amount of extra utility i.e
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MUx/Px = MUy/Py - secure maximum satisfaction
The First Generation Marginalists
 arisen almost simultaneously in different places at the time

 Were W. Stanley Jevons in England, Carl Menger in Austria, and Léon Walras at

Lausanne, Switzerland
a) William Stanley Jevons
 Theory of diminishing marginal utility - utility cannot be measured directly, at least with

the tools at hand but only by observing human behavior and noting human preferences
 rejected comparing the intensity of pleasures and pains among different people

 But a single individual can compare utilities of successive units of a single good, and

can compare the MUs of several goods

 used graphical analysis to illustrate his law of variation of the final degree of utility of a
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commodity
William Stanley Jevons …
 general theory of rational choice - equi-marginal rule - maximize utility allocation of

money income in such a way that the MU of the last dollar spent on all commodities is
equal: MUx/Px = MUy/Py … =MUn/Pn
 Cost of production determines supply; Supply determines final degree of utility; Final

degree of utility determines value.

 favored free public museums, concerts, libraries, and education.

 He believed that child labor should be restricted by law and that health and safety

conditions in factories should be regulated.

 Labor: Its value must be determined by the value of the produce. When exchange value

changes the value of labor used to produce the good changes

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The First Generation Marginalists . . .
b) Carl Menger
 published his path breaking treatise, Principles of Economics

 his theories of value and imputation were among his contributions.

 Menger’s Value Theory: based on the concept of utility, like that of Jevons with no use

of mathematics
 The basis for exchange value for Menger is the difference in relative subjective

valuations of the same goods by different individuals

 The Theory of Imputation: present value of the means of production is equal to the

prospective value (based on marginal utility) of the consumer goods they will produce

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The First Generation Marginalists . . .
c) Friedrich Von Wieser
 introduced the term marginal utility to the economic lexicon, although Dupuit, Jevons,

and Menger had developed the concept before him

 famous for opportunity-cost principle, or the alternative-cost concept

 suggests that the value of a commodity is the value of the commodities forgone, but

what determined the value of those alternative goods is unclear.

d) Eugen von Böhm-Bawerk
 analysis of the element of time

 time as a significant element in the normal course of economic affairs, influencing all

values, prices, and incomes.

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 Eugen von Böhm-Bawerk . . .
 Theory of Interest – clearly shows his incorporation of time in economic analysis

 Interest arises for three reasons: Present orientation (wish to enjoy life today rather

than sacrifice for the future); Expectation of rising wealth (prepared to borrow now);
and Roundabout production (more roundabout the process of production, the
more productive and efficient it becomes)
 total utility of a good is its marginal utility times the number of units

e) Léon Walras
 developed and advocated general equilibrium analysis;

 emphasized the application of mathematics to economic analysis and

 is credited for calling economists attention to Cournot’s earlier work.

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 ii) The Second Generation Marginalists
a) Francis y. Edgeworth
 accepted Bentham’s notion that every person is a “pleasure machine
 Consumers seek to maximize the utility from their limited income,
 workers seek to maximize the net gain from their labor, and
 entrepreneurs seek to maximize their profits
 Upheld differential calculus as the most fruitful tool for analyzing this economic
behavior
 originated the idea of an indifference curve
 indeterminacy that we now generally associate with the pricing behavior of
oligopolists
 elucidated the difference between average and marginal product
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 Second Generation Marginalists . . .

b) Francis y. Knut Wicksell (1851–1926)

 was deeply influenced by the Malthusian theory of population and wrote on:

 population and family planning, feminism, alcoholism, and the monarchy

 was much more the pure theorist

 wrote on a number of topics, including public finance, price theory, marginal

productivity theory, public choice theory

 economic instability - the basis of differences between the “natural” (return on

new capital) and “market” (what banks charge) rates of interest

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 The Second Generation Marginalists …
b) John Bates Clark
 invented the term marginal productivity, and presented marginal productivity (MP)

theory of distribution
 distribution of the income of society is controlled by a natural law

 assigns to everyone what he has specifically produced

 his theory was based on the law of diminishing returns, which he applied to all

factors of production
 MP of a factor alone cannot determine its rate of reward unless the quantity of a

factor supplied is assumed to be fixed

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 5.2. NEOCLASSICAL ECONOMICS
 Who were neoclassicals?

 Neo – means new; thus, ‘new form of classicism’

 were “marginalists” (emphasized decision making and price determination at the

margin) but with some differences with earlier marginalists:
a) stressed both demand and supply in determining the market prices of goods,
services, and resources,
b) greater interest in the role of money in the economy than did the earlier
marginalists
c) extended marginal analysis to market structures other than pure competition,
pure monopoly, and duopoly

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 Neoclassical Economics . . .
1. Alfred Marshall (1842-1924)

 appeared at a time when the classical school was under heavy fire
 His aim was to reconstruct economic science in the light of the new developments
and in the context of the changed conditions.
 To do this, he was guided by various principles:

a) Principle of continuity: He believes that no definition or specification can ever be

precise, rigid, or absolute. Just as in real life, so in theory also' there cannot be any
sharp line of division between two things.

b) principle of "the marginal increment: He argued that our observations of nature

relate not so much to aggregate quantities as to increments of quantities.

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 Alfred Marshall . . .
 Criticized the use of the classical method (for narrowing down the scope of

economic science)

 Defined ‘Economics’ as a study of mankind in the ordinary business of life

 Considered man as ‘the living force’ as opposed to classical who consider man as

‘selfish.’

 Central force behind all activities relating to production and consumption

 Treated of wants, and other aspects of consumption in greater detail.

 According to him, consumption is the beginning and the end of all economic

activities.

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 Alfred Marshall . . .
 introduced the idea of ‘elasticity’ in economics

o As to Marshall elasticity of demand refers to proportionate changes in the

demand of a commodity according to the changes in its price.

 to Marshall land and labor are the two chief factors of production;

o defined capital as all stored up provision for the production of material goods i.e.

secondary or derived agent of production

 Marshall stressed the doctrine of demand and supply to be a key to the solution of

most of the problems of the science

 Marshall has stressed that in the long-run the supply of the factors of production

will be determined by their cost of production.

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 Alfred Marshall . . .
 thought that the value of money, like that of other commodities was a function of

the dual forces of supply and demand

 proposed paper currency for the circulation

2. Irving Fisher (1867–1947)

 Was one of the leading US economist educated at Yale
 developer of the quantity theory, which, in his model, included both currency and
bank credit
 any change in the money supply, M, likely affected only the price level, P, in the
equation P = MV/T. With the economy stable at full employment, the velocity of
the use of money, V, would likely not change, nor would the level of
transactions, T (or output, O, in a different formulation of the theory).
 Other contributions: theory of interest, the theory and practice of index numbers;
price theory; capital theory
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Late Neoclassical
3. Wicksell and Fisher on interest rates
4. Schumpeter, Fisher and Kalecki on business cycles

Reading Assignment

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