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 Antoine Augustin Cournot Camera Shy Hermann Heinrich Gossen William Stanley Jevons, Léon Walras,

Marginalist Hall of Fame: Neoclassical Economics John Bates Clark Francis Ysidro Edgeworth Vilfredo Pareto Knut Wicksell Philip H. Wicksteed

The Marginalist Revolution: A Short Tour Johann Heinrich von Thünen, The Isolated State with respect to agriculture and the national economy, 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, 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, –Obscure amateur … Acknowledged by Jevons (Recall: Jevons also recovered Cantillon) Gossen’s 1 st Law: »Diminishing marginal utility  allocation of resources, including time Gossen’s 2 nd Law: »Equilibrium where “the last atom of money creates the same pleasure in each pleasurable use.” »MU x /P x = MU y /P y

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: MU x /p x = MU y /p y = MU z /p z (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: MU x /MU y = p x /p y  Gossen’s 2 nd 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 Distribution Under competition, Wage = Marginal Value Product labor = P x MPP labor –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 * MPP Labor ) * L + (r * MPP Kapital ) * K = P –Knut Wicksell …did it all first

Marginalist Hall of Fame: Austrian School Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser,

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 (1 st edition), 1920 (8 th 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, From Keynes’ eulogy: [An economist] must be a mathematician, historian, statesman, philosopher – in some degree. He must understand symbols and speak in words. Keynes on Jevons – Marshall priority: [Jevon’s final utility] lives merely in the tenuous world of bright ideas … 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 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 Theory Pigou response: Pigou effect = “Real Balance Effect P down  (M/P) up  Automatic adjustment to full employment (?!?)

Classical – Neoclassical Economics: An Aside Classical Economics Ricardo Smith – Ricardo/Malthus – Mill Labor theory of value Malthusian population Say’s law Quantity theory of money Physiocrats – Marx Balanced growth/imbalance consequences of capitalist accumulation Concern: consequences of capitalist 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 allocation Concern: allocation of scarce resources First Principles: Decision at margin Prices determined by interaction of supply (costs) and demand (utilities) Distribution accords with marginal productivities