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

Marginalist Hall of Fame: Calculus Rules

Johann Heinrich von Thünen  1780-1850

Antoine Augustin Cournot1801-1877

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Hermann Heinrich Gossen1810-1858

William Stanley Jevons, 1835-1882 Léon Walras, 1834-1910

Marginalist Hall of Fame: Neoclassical Economics

John Bates Clark1847-1938

Francis Ysidro Edgeworth1845-1926

Vilfredo Pareto1848-1923

Knut Wicksell1851-1926

Philip H. Wicksteed1844-1927

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

• 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

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,1874,1877General 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

The Marginalist Revolution: Contributors• Vilfredo Pareto, Manuel d’économie politique, 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 efficiencyPareto efficiency: if someone gains and no one loses, do it.

• Francis Ysirdo Edgeworth, Mathematical Psychics, 1881• Indifference curves Edgeworth Box Contract Curves

• Marginal Productivity Theory of DistributionUnder 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

Marginalist Hall of Fame: Austrian School

Carl Menger, 1841-1921

Eugen von Böhm-Bawerk, 1851-1914 Friedrich von Wieser, 1851-1926

The Marginalist Revolution: The Austrian School• Carl Menger,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.” Jürg Niehans

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 avoidedJoint 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

• 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 economicsNeoclassical 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

From Keynes’ eulogy:[An economist] must be a mathematician, historian, statesman, philosopher – in somedegree. He must understand symbols and speak in words.

Keynes on Jevons – Marshall priority: [Jevon’s final utility] livesmerely in the tenuous world of brightideas … 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.

Marshall’s Principles of Economics: Themes and Contents• Economics … a study of mankind in the 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 curvesSupply 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)

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

Adherent to Say’s Law“Classical” foil for Keynes in General TheoryPigou response:

Pigou effect = “Real Balance EffectP down (M/P) up

Automatic adjustment to full employment (?!?)

Classical – Neoclassical Economics: An AsideClassical Economics

Smith – RicardoRicardo/Malthus – Mill • Labor theory of value• Malthusian population• Say’s law• Quantity theory of money

Physiocrats – Marx• Balanced growth/imbalance

Concern: consequences of consequences of capitalist accumulationcapitalist 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• MicroeconomicsMicroeconomics

Concern: allocationallocation of scarce resources

First Principles:• Decision at margin• Prices determined by

interaction of supply (costs) and demand (utilities)

• Distribution accords with marginal productivities