Alfred Marshall 1842-1924

Biography Son of a bank cashier. Father pushed him to the point that had it not being for trips to an aunt in the Summers he would have ended up as another J.S. Mill. He did not make friends and his two favorite hobbies (math and chess) were prohibited by his father

Biography (continuation) Refused Oxford scholarship (ministry) Went to Cambridge to study mathematics Had to leave Cambridge in 1877 since he decided to marry (just like Malthus) Bristol took him (have a page dedicated to him in their Web-page) Published “Economics of Industry” with his wife Mary Paley

Biography (continuation) In 1884 returned to Cambridge In 50 years of writting he produced 82 publications including: 9 editions of Principle of Economics 5 editions of Industry and Trade 2 editions of The Economics of Industry Money, Credit and Commerce appearing in 1923 (year before his death) only appeared in one edition

Alfred Marshall (cont.) Father of modern orthodox microeconomic theory (neoclassicism) along with Walras Structural basis of undergraduate economic theory (Walras more adequate for graduate classes) Translated Ricardo and J.S. Mill economics into mathematics

Alfred Marshall (cont.) Father of modern orthodox microeconomic theory (neoclassicism) along with Walras In defining Economics he stated: Political Economy or Economics is a study mankind in the ordinary business of life; it examines the part of the individual and social action which is most closely connected with the attainment and with the use of the material requisites of well being (text 274)

Alfred Marshall (cont.) Forged the principles of supply and demand analysis Religious and humanitarian convictions Concern for the poor and desire to improve the well-being of society through economics (focused on applied theory)

Alfred Marshall (cont.) Initiated not just modern economics but THE PROFESSION: Students: J.M. Keynes and Joan Robinson TEXT BOOK LEGACY At the end of his life he began to deal in what today we call Macroeconomics

Alfred Marshall (cont.) Economics is not a body of concrete truths, but an “engine for the discover of concrete truth.” Published findings in Principles of Economics (1890) after 20 years of work, with mathematics and graphs in footnotes and appendices so as to be understandable to businessmen and society as a whole

Alfred Marshall (cont.) Refused to take rigid positions on theoretical and methodological issues. Practiced the art (rather than the science) of economics (related the insights of the positive science to the goals determined in the normative branch).

Alfred Marshall (cont.) Marshall on Method The Scope and Method of Political Economy (1891) Consumer wants proceed from activities (allies him more closely with classical emphasis on supply than with neoclassical emphasis on demand—Jevons, Menger) Suggested economists start with preliminary demand, proceed to activities and supply, then return to demand. Observe complex interconnections between wants and activities

Alfred Marshall (cont.) Marshall on Method The Scope and Method of Political Economy (1891) Consumer wants proceed from activities (allies him more closely with classical emphasis on supply than with neoclassical emphasis on demand—Jevons, Menger) Suggested economists start with preliminary demand, proceed to activities and supply, then return to demand. Observe complex interconnections between wants and activities

Alfred Marshall (cont.) Marshall on Method Chief task of economics - elimination of poverty. Believed in the possibility of increasing the well-being of the working classes (as opposed to classicals)

Alfred Marshall (cont.) Marshall on Method Attempted to Merge Theoretical, Mathematical, and Historical Approach However he saw mathematics to have limitations:

Alfred Marshall (cont.) Marshall on Method …I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more on the rules

Alfred Marshall (cont.) Marshall on Method (1) Use mathematics as a shorthand language, rather than an engine of inquiry (2) Keep to them until you are done (3) Translate to English (4) Then illustrate by examples that are important in real life (5) Burn the mathematics

Alfred Marshall (cont.) Marshall on Method (6) If you can’t succeed in (4), burn (3), This last I did often (TEXT 278). Of course, trying to merge three methodologies had the result of being disliked by all:

Alfred Marshall (cont.) Critics: German & English historically oriented economists found his economics too abstract and rigid. Veblen and institutionalists attacked his method. Advocates of abstract mathematical methodology criticized his historical method and resented his remarks about the limitations of theory and mathematics

Alfred Marshall (cont.) Marshall defined 4 time periods: Market period - Very short period in which supply is fixed (perfectly inelastic). No reflex action of price on quantity supplied Short run - A period in which the firm can change production and supply but cannot change plant size. Higher prices cause larger quantities to be supplied (upward sloping supply curve).

Alfred Marshall (cont.) Two components of total costs of the firm: prime costs - costs that vary with output (also called special or direct costs) supplementary costs - costs that do not vary with output (fixed costs)

Alfred Marshall (cont.) Long run - Plant size can vary and all costs become variable. Supply curve becomes more elastic because of firms adjustment in plant size and can take 3 forms: Increasing costs - slopes up and to the right Constant costs - perfectly elastic (horizontal) Decreasing costs - slopes down and to the right (unusual situations)

Alfred Marshall (cont.) Secular period - (Very long run) Permits technology and population to vary

Alfred Marshall (cont.) Controversy over whether cost of production (classical)or utility (marginal utility school of Jevons, Menger and Walras ) determines price. Marshall believed that influence of time and awareness of the independence of economic variables would resolve the question. Demand curve for final goods slopes downward and to the right and individuals will buy larger quantities at lower prices.

Alfred Marshall (cont.) Supply curve depends on the time period under analysis. The shorter the period, the more important the role of demand in determining price. The longer the period, the more important the role of supply. In LR in constant costs exist so that supply is perfectly elastic, price will depend solely on cost of production

Alfred Marshall (cont.) Marshall on Demand Most important contribution to demand theory was his clear formulation of the concept of price elasticity of demand. Price and quantity demanded are inversely related to each other; demand curves slope down and to the right. Degree of relationship is shown by the coefficient of price elasticity:

Alfred Marshall (cont.) Elasticity of Demand eD = percent change in quantity demanded = - q / p percent change in price q p Coefficient is negative b/c of inverse relationship; by convention the coefficient is shown as positive by adding the negative sign to the right side of the equation. If price decreases by 1 percent and quantity demanded increases by 1 percent, total revenue is unchanged, and the coefficient value is 1. The commodity is said to be price elastic..

Alfred Marshall (cont.) If price decreases by a given percentage and the quantity demanded increases by a smaller percentage, total revenue decreases and the coefficient < 1. The commodity is price inelastic Marshall also applied the elasticity concept to the supply side. Marshall was 1st to express the concept of elasticity with mathematical precision and is considered its discoverer.

Alfred Marshall (cont.) Marshall ignored substitution and complementary relationships (utility received from consuming good A depends solely on the quantity of A consumed, not on the quantities of other goods consumed). This gives an additive utility function: U = f1qA + f2qB = f3qC + . . . + fnqn More generalized utility function (F.Y. Edgeworth & Irving Fisher) now general used: U = f (qA, qB, qC, . . . , qN )

Alfred Marshall (cont.) Consumers’ surplus - the difference between the total expenditures consumers would be willing to pay and what they actually pay. MU Consumer Surpluss Demand Quantity

Alfred Marshall (cont.) Marshall on Supply Most important contribution to theory of supply was his concept of the time period, particularly the short run and the long run. Spoiling the market - selling at low prices today and preventing the rise of market prices tomorrow, or selling at prices that incur resentment of other firms in the industry. True cost curve for SR is not marginal cost curve but a supply curve to the left of the marginal cost curve (here, Marshall dropped the assumption of perfect competition).

Alfred Marshall (cont.) Marshall on Supply LR forces that determine the shape and position of firm’s cost and supply curves: Internal forces - as the size of firm increases, internal economies of scale lead to decreasing costs and internal diseconomies result in increasing costs.

Alfred Marshall (cont.) Marshall on Supply LR forces that determine the shape and position of firm’s cost and supply curves: External forces - external economies (not clear whether to firm or industry) result in downward shift of firm and industry cost and supply curves as industry develops. Major causes of external economies are the reductions in costs that take place for all firms in an industry when all firms locate together and share ideas and attract subsidiary industries and skilled labor to the area.

Alfred Marshall (cont.) Stable and Unstable Equilibrium Stable equilibrium is achieved when any displacement from equilibrium will produce forces returning the market to equilibrium Unstable equilibrium is possible when supply curve in downward sloping. If price or quantity attain equilibrium values, they will remain there, by if system is disturbed it will not return to these equilibrium values.

Alfred Marshall (cont.) His dabbling into Macroeconomics Economic Fluctuations, Money and Prices Marshall studied influence of monetary forces on general level of prices. Money, Credit and Commerce (1923)

Alfred Marshall (cont.) His dabbling into Macroeconomics Suggested 2 public policies to combat depression and unemployment: Control markets so that credit is not over-expanded in periods of rising business confidence b/c over-expansion may lead to recession. If depression occurs, governments can help restore business confidence by guaranteeing firms against risk