Marginalist Revolution … 1871

1. 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

2. Camera Shy Marginalist Hall of Fame: Calculus Rules 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

3. Marginalist Hall of Fame: Neoclassical Economics Vilfredo Pareto 1848-1923 John Bates Clark 1847-1938 Francis Ysidro Edgeworth 1845-1926 Philip H. Wicksteed 1844-1927 Knut Wicksell 1851-1926

4. 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” • Marginal products and distribution: • von Thünen treats labor & capital symmetrically • If all workers paid MPL of last worker  exploitation by employer • “Just” wage ≈ SQRT(ap) … falls between MPL and APL • a = subsistence wage • p = per capita output • 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

5. Hermann Heinrich Gossen, Development of the laws of human interaction, 1854. • Obscure amateur … Acknowledged by Jevons (Recall: Jevons also recovered Cantillon) • 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

6. 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 2nd Law • Free competition  maximum welfare, given factor endowments • Thems that gots gits

7. The Marginalist Revolution: Contributors • Vilfredo Pareto, Manuel d’économiepolitique, 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 YsirdoEdgeworth, 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

8. Marginalist Hall of Fame: Austrian School Carl Menger, 1841-1921 Eugen von Böhm-Bawerk, 1851-1914 Friedrich von Wieser, 1851-1926

9. 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.” JürgNiehans

10. 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

11. 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 and cried out with the delighted voice of a child; Marshall too had seen the kettle boil and sat down silently to build an engine. • Student and teacher at Cambridge • Majored in math • 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 Alfred Marshall, 1842-1924

12. Marshall’s Principles of Economics: Themes and Contents • Economics … a study of mankind inthe 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 (recall Mill) • 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 quantity • Value in long-run depends on supply • Internal economies  difficulties for competitive market paradigm • External economies (of industry scale)

13. 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

14. Classical Economics Smith – Ricardo/Malthus – Mill Labor theory of value Malthusian population Say’s law Quantity theory of money 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 Neoclassical Economics Marshallian economics Gossen/Jevons/Edgeworth Microeconomics 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 Classical – Neoclassical Economics: An Aside