Chapter 10: Alfred Marshall and Neoclassical Economics

Chapter 10: Alfred Marshall and Neoclassical Economics

Questions for Review, Discussion and Research (pp.

302-03)

1, 3, 4, 5, 6, 10

His first University degree and teaching position was in mathematics

Was influenced by two Continental mathematical economists: Cournot Von Thunen

Before he set out to translate Ricardian and Millian economics into mathematical forms

He combined his mathematical training with his background in history, his understanding in economic theory and his strong humanitarian interests

Scope of Marshallian Economics

“Study of mankind in the ordinary business of life”

He sought to correct the approaches of Jevons and Menger who seemed to regard “The theory of consumption as the scientific basis of Economics”

Jevons believed that wants and desires were inner impulses. They spring from within and are independent of our activities

Marshall appreciated the interconnections between consumer wants and producer activities

Marshallian Method

Understood history and the work of economic historians

Believed that the chief defect of classical economics was to recognize that society is constantly evolving via technological change, innovation, etc.

He wrote his publications for the educated lay reader and avoided precise definition in the main body of his books

Understanding the Complexities of Modern Economies

Believed that complex and subtle relationships existed between all parts of the economy

Overhead pp. 279-280

Causes do not instantan- eously produce final effects but take time to work themselves out

Four Time Periods

Not chronological time but based on time required to adjust quantities (ie. supply, demand etc.)

1. Market – Very short run Supply is fixed and

cannot respond2. Short-run – at least one

factor input is fixed (usually real capital) and the others are variable

1. Long-run – All factor inputs are variable

2. Secular – Aggregate variables such as population or technology are variable

Marshallian Supply and Demand Curves

Interrelationships and mutual causation are at the core of the early neoclassical theory of values along with intertemporal considerations

Overhead pp. 282 Marginal analysis had been

misunderstood by early neoclassical economists

Marginal values (whether cost, utility or productivity) were credited with determining the value of the whole

Overhead pp. 283

Marshall claimed that Ricardo recognized the role of demand but concentrated his analysis on the more difficult analysis of production

His own contribution of introducing time was merely an extension and development of Ricardian economic thought

Consumer Demand for Final Products

The influence of demand on price determination was studied by avoiding difficulties with his ceteris paribus assumptions

His most important contribution was a clear formulation of the concept of own price elasticity of demand

Consumer Demand for Final Products

Marshall followed Jevons by adopting his additive utility function which ignores substitution and complimentary relationships

In Marshall’s analysis, an explanation of the demand curve is the main task of demand theory

Marshall also accepted two assumptions credited to Gossen

Consumer Demand for Final Products Cont’d

1. Gossen’s first law Diminishing marginal

utility2. Gossen’s Second Law

The equilibrium conditions for an individual consumer is

MUA = MUB = … = MUN = MUM PA PB PN

Where MUM is the marginal utility of money defined as the marginal utility received from the last dollar of product

Consumer Demand for Final Products Cont’d

If savings are included as a product, then MUM is the utility received from the last dollar of income and the marginal utility of product A is MUA = PA * MUM

Problems with this analysis are summarized on pages 285 and 286

Concept of Consumer Surplus

Concept of the marginal utility of money being constant for small changes in price opened the door for welfare economics using the idea of consumer surplus

Fisher’s development of a non-additive utility function and other criticisms moved Marshall to emphasize the assumptions of a constant marginal utility of money is valid and a close approximation for equilibrium around price C

Taxes and Welfare

Read pp. 288-290 on your own

Marshall and the Early Neoclassical Theory of Distribution

Acknowledged the theoretical soundness based on marginal productiveness

The demand for factor inputs was views as a derived demand and he measured MPL by computing the net product of labour at the margin

Overhead pp. 292

Marshall accepted the Wicksteed-Flux conclusion that the total product was exhausted in the long run equilibrium of firms operating in competitive input and output markets

Concept of Quasi-Rent For Factors of Production

Provides insight into the operation of input markets in the process of adjustment to long-run equilibrium and resolving earlier debates

1. Classical Economists Payment for labour and

capital (but not land) were price determining so the price at final goods depends upon the costs of production (wages, interest) at the margin

Prices are determined in the long-run by supply side effects

Concept of Quasi-Rent For Factors of Production Cont’d

2. First Generation of Neoclassics

All payment for factor inputs (wages, interest, rent) are price determined

Marshall’s framework of time periods and the elasticity of supply of factor inputs helped to resolve the dispute

Issue of land rent entering into the determination of price depended on the existence of unsettled land and a moving agricultural frontier

Overhead pp. 293 Marshal also examined the

short-run returns of labour, management and capital in terms of quasi-rents

Overhead pp. 295

Stable Equilibrium in Marshall and Walras

Marshall’s explanation of equilibrium processes in competitive markets focuses on quantity adjustments, by suppliers and consumerOverhead pp. 296, 297

Read the discussion of unstable equilibrium on your own

Marshall’s Contributions to Macroeconomics

Established Cambridge School of Monetary Economics with its focus on the influence of monetary forces an the general price level

Marshall accepted J.S. Mills view that economic fluctuations were caused by business confidence and that depressions were not rooted in any fundamental contradictions within the economic system

Summary

Marshall viewed his theories as a continuation of Smith, Ricardo, and J.S. Mill

These classical writers al presumed that economic theory was universally true and assumed that human nature and behaviour was antecedent to culture

The Marshallian scope and methodology was a product of the controversies of the late 1800’s

Overhead pp. 301