ECN 3111

1. ECN 3111 History of Economic Thought THE MARGINALIST SCHOOL

2. Introduction • Marginalist school began in 1871, • The year that Javons and Menger published their influential book of “Marginal Utility Theory”. • Before this several other writers use marginal analysis in economics e.g. the English economist David Ricardo employed this approach in his theory of rent.

3. Introduction • The marginalist school is so-called because of two features: 1. The principle of diminishing marginal utility. • Recognized as the fundamental law governing consumption on the demand side. 2. Equimarginal principle. • Making decisions on the margin by comparing the incremental cost with the incremental benefit – used in the derivation of the optimal consumption equilibrium.

4. Introduction • The difference from the classical school; • The classical focus on long-term economic development or increase in the quality quantity of resources to satisfy ever expanding human wants. • Marginalist school focus on utilization of goods or resources in a static frramework.

5. Background History • The marginalist school said to begin in 1871. • The year when Javons and Menger published their influential books on marginal utility theory. • The marginal analysis in economics has been used by several forerunners predating Javons and Menger.

6. Background History • David Ricardo employed the marginal approach in his theory of rent. • There have been subsequent contribution in developing the theory by the efforts of various individuals in several countries working independently. • Antoine Cournot and Jules Dupuit in France • Johann von Thünen in Germany.

7. Background History • The widespread poverty and escalating economic problems caused people to seek solutions beyond the narrow confines of the classical economic thinking. • To attack on the social problem in Europe, the trend of the nineteenth century was to develop three approaches: • Promote socialism • To bolster trade unionism • Demand government action to ameliorate conditions by regulating the economy, eliminating abuse and redistribution of income.

8. Background History • The marginalist opposed all the three. • To them although values and distribution theories of the classical school were inaccurate, their policy views are correct. • The marginalist defended market distribution, deplored government intervention, denounced socialism and discouraged labor unionism.

9. Major Tenets of the Marginalist School 1. Focus on the margin – attention on the point of change when decisions are made – on the margin. Extended the work of Ricardo in the theory of rent. 2. Rational economic behavior. – they assume people act rationally in weighing out pleasure and pain, measuring marginal utility of different goods and weighing out current and future needs. Random abnormalities will cancel each other out. (the work rooted from Benthem” human’s dominant drive is to seek utility and avoid disutility)

10. Major Tenets of the Marginalist School 3. Macroeconomic theory. Individual person and firms are the focus of attention. Marginlist considered individual decision making, market conditions for single type of goods, the output of specific firms, etc. 4. The use of abstract, deductive methods. Rejected historical method in favor of analytical, abstract approach, pioneered by Ricardo and other classicalists. –the use of mathematic , demonstrated the power of this method, leading eventually to the widespread use and dominance of mathematical model in the economic analysis.

11. Major Tenets of the Marginalist School 5. The pure competition emphasis. –based their assumption on pure competition – the world of small individualistic, independent entrepreneurs; numerous buyers; many sellers; homogenous products; uniform prices; and no advertising. Not any individual is significant enough to influence the market and actions are adapted to market mechanisms.

12. Major Tenets of the Marginalist School 6. Demand oriented price theory. Unlike the classicalist, (who emphasized cost of production - supply) as the significant determinant of exchange value the marginalist took demand as the primary force in price determination. 7. Emphasis on subjective utility. According to the marginalist demand depends on marginal utility.

13. Major Tenets of the Marginalist School 8. Equilibrium approach. They believe economic forces generally tend toward equilibrium. 9. Merger of land and capital goods. They lumped land and capital resources together and in their analysis on interest, rent and profits were treated as return to property resources. 10. Minimal government involvement as the most desirable policy

14. Antoine Augustin Cournot • (1801-1887) a French mathematician • He published treatise in mathematics, philosophy, and economics. • First economist to apply mathematics to economic analysis • First to develop concise mathematical models of pure monopoly, duopoly, and pure competition. • The earliest to complete a model for the derived demand for resources.

15. Antoine Augustin Cournot • Focused his work on rates of change of total cost and revenue functions – what economist now refer as marginal cost and marginal revenue. • He began his analysis with pure monopoly and analyze the market circumstance wherein competitors exist,-unlike those who analysis market starting with pure competition first.

16. Work of Augustin Cournot • Known for his work on monopoly and duopoly. • The durability of Cournot contribution – the monopoly and duopoly still prescribed in modern text book.

17. Work of Augustin Cournot • In his monopoly model about the proprietor of a mineral spring. • He assumed that the cost of producing mineral water was zero. • Hence, marginal cost is also zero. • Maximum profit was determined at the point where marginal revenue was also equal to zero. • This was the first time proven mathematically that profit was maximized when MC=MR

18. Work of Augustin Cournot • Cournot duopoly model represents the first attempt to model an analyze the conduct and performance of sellers in an oligopolistic market. • Here he assumed two proprietors and two springs of which the qualities are identical. • He showed using mathematic and geometry the reaction curves of the two market participants and it finally stable equilibrium is reached. • This was subsequently generalized in the 1950s into the so-called Cournot-Nash equilibrium.

19. Work of Augustin Cournot • Cournot considered as the forerunner of the marginalist school. • The first to demonstrate the equimarginal principle equating marginal cost with marginal revenue to derive maximum profit. • His fame lies in the first to apply mathematics to economics.

20. Jules Dupuit • Arsène-Jules-Emile Dupuit (1804-1866) • The second important French forerunner to marginalism. • Was born in Italy but returned to Paris in 1814. • Attended school at Versailles, Louis-le-Grand, and Saint Louis. • Earned a degree in Engineering from a prestigious École des Ponts et Chaussèes.

21. Jules Dupuit • He studied designs of roadways, water navigation and municipal water system and widely acclaimed engineering profession. • 1843 he was awarded the prestigious French Legion of Honor for his work. • 1850 he was chief engineer in Paris • 1855 he became inspector-general of the French Corps of Civil Engineers.

22. Jules Dupuit’s Contributions • Dupuit developed an ardent side-interest in theoretical and applied economics. • Between 1884 and 1853 he published journal articles concerning diminishing marginal utility consumers surplus and price discrimination. • ”On the measurement of Utility of Public Works” – 1844 • “On Tolls and Transport Charges” - 1849. • “On Utility and Its Measure” - 1853. • Central to these concepts was ‘decisions making at the “margin” ‘.

23. Jules Dupuit’s Contributions • Famous for his concept of surplus utility or consumer surplus in modern terminology. • Used marginal utility curve or consumption curve in deriving his consumer surplus concept. • Proposed the multiple-tier pricing system to increase the returns on the sellers – called the price discrimination in modern terminology.

24. Jules Dupuit’s Contributions • In his analysis the marginal utility curve served as the demand curve – as known today. • His insight on consumer surplus and how part of this surplus could be transferred to the seller via price discrimination • Quite a remarkable contributions considering the standard demand curve as we know today was yet to be invented then. • Consumer surplus and price discrimination are now a standard material in courses in welfare economics.

25. Johann Heinrich Von Thünen • (1783-1850) – born in Oldenburg Germany. • Studied at university of Göttingen. • He purchased an estate and farmed • He wrote “The Isolated State.” • In volume 1 (1826) of his publication he found the location theory and agricultural economics. • In volume 2 (1850) expanded his analysis and in the process he established a crude marginal utility theory.

26. Johann Heinrich Von Thünen - contribution • Famous for his location theory • In the theory he developed the concentric rings – known as von Thünen rings, around a central city, showing how transportation cost influenced the type of activities that could be probably undertaken. • Dairying activities will be close to the city centre because of the perishability of the product

27. Johann Von Thünen - Theory of Agricultural Location “Isolated State”,- a series of concentric rings, each devote to a particular type of agricultural use, develop around the central city. Growth of Cereals The farther the ring from the city, the less intensive is the production, the less perishable is the produce, and the greater is the ability of the commodity to bear costs of transportation. I II III IV Market Gardening and Horticulture Forestry Rotation of Crops Planted Land /Pasture Planted Land / Fallow Land Stock Farming Hunting

28. Johann Heinrich Von Thünen - contribution • The location theory led him to develop marginal productivity of employment. • E.g. he postulated that the number of agricultural workers employed must not exceed that number where wage of labor was equal to the marginal product of last worker employed. • All labor will be paid wage equal to the marginal product of the last worker employed. – production economics.

29. Johann Heinrich Von Thünen - contribution • His name often cited with spatial economics and work done by economic geographers. • Link with the current work of Paul Krugman 1990.