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

CameraShy

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”• If all workers paid MPL of last worker exploitation by employer• “Just” wage ≈ SQRT(a.p.) … between MPL and APL

• 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

• 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,1874,1877• 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 Second 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 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

• 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• 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