Chapter 10 Alfred Marshall and Neoclassical Economics Questions

Chapter 10: Alfred Marshall and Neoclassical Economics Questions for Review, Discussion and Research (pp. 302 -03) 1, 3, 4, 5, 6, 10

n n His first University degree and teaching position was in mathematics Was influenced by two Continental mathematical economists: n n Cournot Von Thunen

n n 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 n n “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”

n n 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 n n n 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 n Believed that complex and subtle relationships existed between all parts of the economy Overhead pp. 279 -280 n Causes do not instantaneously produce final effects but take time to work themselves out

Four Time Periods n Not chronological time but based on time required to adjust quantities (ie. supply, demand etc. ) 1. 2. Market – Very short run § Supply is fixed and cannot respond Short-run – at least one factor input is fixed (usually real capital) and the others are variable

1. 2. Long-run – All factor inputs are variable Secular – Aggregate variables such as population or technology are variable

Marshallian Supply and Demand Curves n n n 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

n n 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 n n 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

n n 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 n Diminishing marginal utility 2. Gossen’s Second Law n The equilibrium conditions for an individual consumer is MUA = MUB = … = MUN = MUM PA PB PN

n 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 n n 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 n n 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 nonadditive 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 n Read pp. 288 -290 on your own

Marshall and the Early Neoclassical Theory of Distribution n n Acknowledged theoretical soundness based on marginal productiveness The demand for factor inputs was views as a derived demand he measured MPL by computing the net product of labour at the margin Overhead pp. 292

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

Concept of Quasi-Rent For Factors of Production Cont’d 2. First Generation of Neoclassics n All payment for factor inputs (wages, interest, rent) are price determined n Marshall’s framework of time periods and the elasticity of supply of factor inputs helped to resolve the dispute

n n Issue of land rent entering into the determination of price depended on the existence of unsettled land a moving agricultural frontier Overhead pp. 293 Marshal also examined the shortrun returns of labour, management and capital in terms of quasi-rents Overhead pp. 295

Stable Equilibrium in Marshall and Walras n n Marshall’s explanation of equilibrium processes in competitive markets focuses on quantity adjustments, by suppliers and consumer Overhead pp. 296, 297 Read the discussion of unstable equilibrium on your own

Marshall’s Contributions to Macroeconomics n n 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 n n 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

n The Marshallian scope and methodology was a product of the controversies of the late 1800’s Overhead pp. 301