Marshal l , Marginalism, & Alternative Voices

Marshall, Marginalism,& Alternative Voices

Economic Analysis – Key Contributors, 19th century 1900 1800 Adam Smith (1723 – 1790) David Ricardo (1772 – 1823) John Stuart Mill (1806 – 1873) Mill Karl Marx (1818 – 1883) August Cournot (1807 – 1877) Johann von Thünen (1793 – 1850) Hermann Gossen (1810 – 1858) Cournot Stanley Jevons (1835 – 1882) Leon Walras (1834 – 1910) Carl Menger (1840 – 1921) Alfred Marshall (1842 – 1924) Jevons Walras Marshall

The marginalists revolutionized economics. Marginalism applied the concept of physics to economics. Marginalists focused on events that occurred on the margin. A whole group of thinkers had the same „marginalist” insights at roughly the same time. Marginal thinking affected incentives in buying and working.

Identifying Elements Applications of calculus, physics, engineering to economic analysis. Labor theory of value is disproved. Marginal principle provides a unifying framework. Less emphasis on growth. Focus on optimization. Equilibrium method. Mathematical methods and focus on economic science.

Related Issues Was it a revolution? What took so long? Change in method. Resistance by orthodoxy. Three stages in the development of the marginalist principle.

The Method of the Marginalists Marginal principle. Microeconomic emphasis. Abstract, deductive method. Assumption of perfect competition. Less emphasis on supply, more on demand in price setting. Subjective valuation. Equilibrium approach. Equal footing for all factors of production. Rational agents. Minimal government involvement.

Precursors to marginalism: Cournot Economists understand by the term Market, not any particular market place in which things are bought and sold, but the whole of any region in which buyers and sellers are in such free intercourse with one another that the prices of the same goods tend to equality easily and quickly. August Cournot 1803 - 1877

AugustinCournot(1801-77) 1838, Researches into the Mathematical Principles of the Theory of Wealth First systematic development of the application of the marginal principle to the firm Math. Econ of the “pure” type Approach was consistent with French Rationalism: a theory that reason is in itself a source of knowledge superior to and independent of sense perceptions

Cournot Supply and Demand Hypothesis: each person seeks the greatest value from his/her property or labor. Theory of monopoly, builds on this until he reaches the competitive case. Theory of the firm

Hermann Heinrich Gossen(1810-58) Theory of Consumption Frustrated by the neglect of others to his work. 1854, Development of the Laws of Human Relationships and of the Rules to be Derived Therefrom for Human Action. Gossen’s Two Laws. Contributions largely unrecognized until 1878 when Jevons pointed out his work to Walras.

Precursors to marginalism: Gossen’s 1st & 2nd “laws” Hermann Gossen, 1810-1858 The Development of the Laws of Exchange among Men and of the Consequent Rules of Human Action (1854) First Law "... the magnitude of a given pleasure decreases continuously if we continue to satisfy this pleasure without interruption until satiety is ultimately reached." Second Law "The magnitude of each single pleasure at the moment when its enjoyment is broken off shall be the same for all pleasures."

The “Revolution” Almost simultaneous publication in the 1870s of books by: William Stanley Jevons (1871), The Theory of Political Economy (England) Carl Menger (1871), Principles of Economics (Vienna, Austria) Leon Walras (1874-77), Elements of Pure Economics (Switzerland)

Revolution (2) Contributions of the three Why were the able to promote the new theory now? What was their influence?

William Stanley Jevons (1835-82) Background 1971, Principles of Political Economy Not aware of the work of Cournot, Thunen, or Gossen Extensive use of utility theory On the labor theory of value Empirics 1865, The Coal Question 1884, Investigations in Currency and Finance Includes a discussion of business cycles

The marginalist “revolution”: Jevons We may state as a general law that the degree of utility varies with the quantity of commodity, and ultimately decreases as that quantity increases. Stanley Jevons 1832 – 1882 "Brief Account of a General Mathematical Theory of Political Economy", 1866 The Theory of Political Economy , 1871.

Themarginaliststheorizedabouthawpeoplevalued and demandedgoodsand services. William Stanley Jevons made utility a central focus of the marginalist framework. Economic actors (such a consumers and workers) balanced utility and price. Merginalists measured utility by syudying people’s behavior. Jevons challenged the labor theory of value.

Francis YsidroEdgeworth(1845-1926) Editor of the Economic Journal Wrote many articles and a monograph entitled Mathematical Psychics (1881) Sought to apply mathematics to the social sciences Expanded Jevons notions on the utility function Introduced indifference curves and the Edgeworth box

Philip H. Wicksteed(1844-1927) Developed a theory of marginal productivity and distribution. He alone asked whether and under what conditions the total product would be exhausted by the marginal products

Wicksteed (2) Argued that exhaustion of the marginal product requires a linear homogeneous production function. Also argued that this requires constant returns to scale. 1894, Essay on the coordination of the Laws of Distribution Not a fan of Marshall’s supply-demand apparatus.

The marginalists theorized about the productivity of inputs. John bates clarkconrfonted the challenge of marx’s labor theory of value. In marginalist thinking, all workers did not contribute equelly to productivity. The value of what was produced was distributed according to people’s contribyutions.

Marginal analysis Marginal utility: “Every successive application will commonly excite the feelings less intensely than the previous application. The utility of the last supply of an object, ... decreases ... as some function of the whole quantity received.” Marginal effort as the explanation for supply of labour: “labor will be exerted both in intensity and duration until a further increment will be more painful than the increment of produce thereby obtained is pleasurable.”

Marginal analysis “Marginal exchange”: “one person will now give to the other so much of his commodity, and at such a ratio of exchange, that if he gave an infinitely small quantity, either more or less, but at the same rate, he would not gain in utility by it. The increments of utility lost and gained at the limits of the quantities exchanged must be equal, otherwise further exchange would take place.” [Jevons OREF] Individuals start with given quantities of commodities Exchange continues until marginal utility of all commodities held is equal Price ratios reflect relative marginal utilities

Marginal analysis “Marginal exchange”: “one person will now give to the other so much of his commodity, and at such a ratio of exchange, that if he gave an infinitely small quantity, either more or less, but at the same rate, he would not gain in utility by it. The increments of utility lost and gained at the limits of the quantities exchanged must be equal, otherwise further exchange would take place.” Individuals start with given quantities of commodities Exchange continues until marginal utility of all commodities held is equal Price ratios reflect relative marginal utilities

Marginal Analysis Marginal productivity Income distribution reflects contribution to production (vs. Marx: surplus & exploitation): Payment to factor equals quantity of factor times marginal contribution to output Marginal analysis completely supplants classical approach 2 streams to analysis: General equilibrium analysis Partial equilibrium Some things held constant (“ceteris paribus”); Analysis of isolated markets (Marshall); Neoclassical “macroeconomics” (Hicks)

Alfred Marshall (1842-1924) Alfred Marshall combined various aspects of marginalist thinking.

Marshall’s Inaugural Lecture, Cambridge, February 1885 “It is vain to speak of the higher authority of a unified social science. No doubt if that existed Economics would gladly find shelter under its wing. But it does not exist; it shows no signs of coming into existence. There is no use in waiting idly for it; we must do what we can with our present resources. “There is wanted wider and more scientific knowledge of facts: an organon stronger and more complete, more able to analyze and help in the solution of the economic problems of the age. To develop and apply the organon rightly is our most urgent need: and this requires all the faculties of a trained scientific mind. Eloquence and erudition have been lavishly spent in the service of Economics. They are good in their way; but what is most wanted now is the power of keeping the head cool and clear in tracing and analyzing the combined action of many combined causes. Alfred Marshall 1842 - 1924 “… that part of economic doctrine, which alone can claim universality, has no dogmas. It is not a body of concrete truth, but an engine for the discovery of concrete truth, similar to, say, the theory of mechanics. “… why are so many lives draggled on through dirt and squalor and misery? Why are there so many haggard faces and stunted minds? Chiefly because there is not wealth enough; and what there is, is not well distributed, and well used … “Never was there an age so full of great social problems as ours; surely they are not unworthy of the best efforts of the best minds among us. … “It will be my most cherished ambition, my highest endeavor, to do what with my poor ability and my limited strength I may, to increase the numbers of those, whom Cambridge, the great mother of strong men, sends out into the world with cool heads but warm hearts …”

Marshall’s early life and educational pursuits His father was a taskmaster. He began by studying ethics, moved on to mathematics, than to physics, and finally ended up on economics.

Marshall’s early life and educationalpursuits. A. Mashall shrank from publishing his ideas. Marshall developed ideas but it took him longer to perfect and publish them. Marshall was quirjy regarding his intellectual pursuits. He wasprogressive in his treatment of women, even thouth he opposed admitting them to Cambridge.

Marshall’s early life and educationalpursuits. In his later career, marhall built the modern economics profession. He taught generations of economists at bristol and Cambridge. He developed the British economics profession.

Marhall’s principles of economics and his accomplishments Marshall focused on human behavior rather than on the wealth of nations, relationship between classes, or analytical problems. Mahall regarded economics as a social scince. He believed that work shaped people’s lives. He wrote about the impact of poverty upon economics and upon people’s lives.

Marhall’s principles of economics and his accomplishments Marhallbroughtmathematicalclarity to economicterms.

Marshall on method I never read mathematics now; in fact I have forgotten how to integrate a good many things… But 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 and more on the rules – (1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them until you have done. (3) Translate into English. (4) Then illustrate by examples that are important to real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). Alfred Marshall 1842 - 1924

Marshall’sanalysis was based on a systematizedtheory of supply and demand. Marginal thinking led to the formulation of the demand curve. Marginal costs of production led to formulation of the supply curve. Marshall’s writings ended the dispute over value. Marshall thought that both supply and demand contributed to the determination of value. Marhall developed economic diagrams still in use today.

Marhall built the vocabulary of modern economics. He developed the idea of measuring price alasticiti. He broke costs into fixed and marginal costs. He wrot about substitution among different objects of consumption and labor. He spoke about the long and short run and about how the passage of time affected conomic analysis. He discussed economies of scale and external economies.

Marhall offered a gentle defense of competition and selffihness. He strongly defended competition but also saw an important role for goverment and educational institutions. He wanted to use economics as a tool.

Marshall was neoclassical economist with a concern for social justice. Marshall offered a direct critique of Marx. He did not think Marx’s scientific thoughts worked in practice. He did not agree that the state would either away.

Marhall felt it was important to deal with human beings as they actually behave, rather than as we would prefer them to behave. Marhall launched an economic counrerattack in support of social justice. He regarded both apathy and exaggeration as evils. He made on honest effort to devise sensible ways to improve society.

Alternative voices in the history of economic thought German Romanticism Adam Muller (1779 – 1829) Early German Historical School Wilhelm Roscher (1817 – 1894) Friedrich List (1789 – 1846) Karl Knies (1821 – 1898) Later German Historical School Early American Economists Austrian School Methodenstreit Gustov Schmoller (1838 – 1917) Werner Sombart (1863 – 1941) Carl Menger (1840 – 1921) Friedrich von Wieser, (1851 -- 1926), Eugen von Böhm-Bawerk (1851 -- 1914) Richard Ely (1854 – 1943) John Bates Clark (1847 – 1938) Early American Institutionalism Ludwig von Mises (1881 – 1973) Joseph Schumpeter (1883 – 1950) Richard Ely (1854 – 1943) John Bates Clark (1847 – 1938) Old Institutionalism New Institutionalism Friedrich von Hayek (1889 – 1992) Oscar Morgenstern (1902 – 1976) John Kenneth Galbraith (1908 – 2006) Ronald Coase Oliver Williamson

Carl Menger (1840-1921) Background Had a substantial following, and came to be considered the leader of the Austrian School. Opposed by the German Historical School. Substantial legal training led him to make careful definitions. Unlike Jevons and others, related utility maximization to “needs” not “pleasure”.

Menger (2) Theory of Imputation (Zurechnung) Value is not inherent in goods, but is imputed to them. Value = exchange value. Monetary Theory 1883, Problems of Economics and Sociology Defense of Menger’s approach to economics

Friedrich von Wieser (1851-1926)Eugen von Bohm-Bawerk (1851-1914) Later Austrians—von Hayek, von Mises, Schumpeter—were students of these two. Bohm-Bawerk always aware of the “cutting edge” of thinking, while von Wieser was completely attached from his time. Both argued strongly against socialism.

Institutionalism in Economic Thought A complex organism cannot be understood if each segment is treated as if it were unrelated to the larger entity. Economic activity is not merely the sum of the activities of persons motivated individually and mechanically by the desire for maximum monetary gain. In economics there are also patterns of collective action that are greater than the sum of the parts. An institution is not merely an organization or establishment for the promotion of a particular objective, like a school, a prison, a union, or a federal reserve bank. It is also an organized pattern of group behavior, well-established and accepted as a fundamental part of the culture. It includes customs, social habits, laws, modes of thinking, and ways of living … Economic life, said the institutionalists, is regulated by economic institutions, not by economic laws. Thorestein Veblen 1857 - 1929 John Commons 1862 – 1945 Stanley Brue, The Evolution of Economic Thought Wesley Mitchell 1874 – 1948

Veblen and neoclassical analysis In all the received formulations of economic theory, whether at the hands of English economists or those of the Continent, the human material with which the inquiry is concerned is conceived in hedonistic terms; that is to say, in terms of a passive and substantially inert and immutably given human nature … The hedonistic conception of man is that of a lightning calculator of pleasures and pains who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift him about the area, but leave him intact. He has neither antecedent nor consequent. He is an isolated definitive human datum, in stable equilibrium except for the buffets of the impinging forces that displace him in one direction or another. Self-imposed in elemental space, he spins symmetrically about his own spiritual axis until the parallelogram of forces bears down upon him, whereupon he follows the line of the resultant. When the force of the impact is spent, he comes to rest, a self-contained globule of desire as before. Spiritually, the hedonistic man is not a prime mover. Thorestein Veblen 1857 - 1929 Why is Economics not an Evolutionary Science? (1898)

Veblen’s Style: Theory of the Leisure Class Generally, as industrial activity further displaces predatory activity in the community’s everyday life and in men’s habits of thought, accumulated property more and more replaces trophies of predatory exploit as the conventional exponent of prepotence and success. Conspicuous consumption of valuable goods is a means of reputability to the gentleman of leisure. Throughout the entire evolution of conspicuous expenditure, whether of goods or of services or human life, runs the obvious implication that in order to effectually mend the consumer’s good fame it must be an expenditure of superfluities. In order to be reputable, it must be wasteful.. Thorestein Veblen 1857 - 1929 The Theory of the Leisure Class (1899)

Veblen’s Critique of Modern Capitalism In more than one respect the industrial system of today is notably different from anything that has gone before. It is eminently a system, self-balanced and comprehensive; and it is a system of interlocking mechanical processes … it lends itself to systematic control under the direction of industrial experts, skilled technologists, who may be called “production engineers,” for want of a better term … technological specialists whose constant supervision is indispensable to the general staff of industry … The captains [of industry] have per force continued to employ the technologists, to make money for them, but they have done so only reluctantly, tardily, sparingly, and with a shrewd circumspection; only because and so far as they have been persuaded that the use of these technologists was indispensable to the making of money. By settled habit, the technicians, the engineers and industrial experts, are a harmless and docile sort, well fed on the whole, and somewhat placidly content with the “full dinner-pail” which the lieutenants of the Vested Interests habitually allow them. Thorestein Veblen 1857 - 1929 The Engineers and the Price System (1921)

Schumpeter’s contradictory views Capitalism, Socialism and Democracy (1942): Can capitalism survive? No. I do not think it can. But this opinion of mine, like that of every other economist who has pronounced upon the subject, is in itself completely uninteresting. What counts in any attempt at social prognosis is not the Yes or No that sums up the facts and arguments which lead up to it but those facts and arguments themselves. They contain all that is scientific in the final result. Everything else is not science but prophecy … The thesis I shall endeavor to establish is that the actual and prospective performance of the capitalist system is such at to negative the idea of its breaking down under the weight of economic failure, but that its very success undermines the social institutions which protect it, and “inevitably” creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent. Joseph Schumpeter 1883 – 1950

Schumpeter’s “Creative Destruction” “The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” Joseph Schumpeter Capitalism, Socialism and Democracy Schumpeter 1883 – 1950

Galbraith’s “New Industrial State” The Affluent Society (1958) The New Industrial State (1967) From The New Industrial State, chapter 31: “Viewing the whole economy in purely technical terms, no natural superiority can be assumed either for the market or for planning. In some places market responses still serve. Over a very large area such responses cannot be relied upon; the market must give way to more or less comprehensive planning of demand and supply. Here, if the industrial system does not plan, performance will be poor and perhaps appalling … The error is in basing action on generalization. There is no natural presumption in favor of the market; given the growth of the industrial system the presumption is, if anything, the reverse. And to rely on the market where planning is required is to invite a nasty mess.” John Kenneth Galbraith 1898 – 2006

Marshal l , Marginalism, & Alternative Voices