1. The Marginal “Revolution”: Jevons Menger Walras
History of Economic Thought
Boise State University
Fall 2015
Prof. D. Allen Dalton

2. William Stanley Jevons (1835-1882)
born Liverpool, merchant
undergrad work at University College, London in chemistry and metallurgy
1854, leaves school to become assayer at Sydney (Australia) mint
private research meteorology, railroads, economics, national statistics
1859, returns to London to finish university education
1863, tutor at Owens College, Manchester
1866, professor of political economy at Owens
1876, professor University College, London
1880, retires due to ill health

3. Jevons’ Minor Works
“Notice of a General Mathematical Theory of Political Economy” (1862)
sketch of ideas to be later fleshed out in Theory of Political Economy, paradoxically without any mathematics
(pamphlet) A Serious Fall in the Value of Gold Ascertained and its Social Effects set forth (1863)
pioneering methodological and empirical contribution to index numbers, showing gold discoveries were source of commodity price rises
The Coal Question (1865)
alarmist argument that coal was being exhausted and would limit British economic growth
bestseller, widely debated, brought him instant fame
Investigations in Currency and Finance (1884)
exogenous business cycle theory (“sunspot cycle”)

4. Jevons’ Contributions
The Theory of Political Economy (1871)
Value and Exchange; Capital and Interest
Value and Exchange
starting point: “to maximize pleasure is the problem of economics”
utility is function of quantity of goods consumed, u = u(x); disutility a function of “discommodities”
(x) = du/dx = u’(x) is defined as degree of utility
the “degree of utility” of the last increment consumed is termed the final degree of utility (marginal utility)
degree of utility diminishes as quantity increases
for good with alternate uses, optimal allocation occurs when same final degree of utility occurs in all uses (weak form of Gossen’s Second Law)

5. Jevons’ Contributions
Utility maximization is basis of theory of exchange
relative price () defined as ratio in which small quantities of goods exchanged against one another;  = px/py = dy/dx
for homogenous goods in well-functioning markets, one price will prevail - Jevons’ Law of Indifference (Law of One Price)
implies that total quantities exchanged by given trader stand in same ratio as any small quantities; y/x=dy/dx = .
Thus, “the ratio of exchange of any two commodities will be the reciprocal of the ratio of the final degrees of utility of the quantities of commodity available for consumption after the exchange is completed”

6. Jevons’ Contributions
Let  be given, as well as quantities of x and y (a and b, respectively).
If b expressed in terms of a, total resources are R = a + b/.
Blue curve represents MU of x; Black curve represents utility of marginal unit of x exchanged for Y (and exchange occurs at ratio )
Optimality requires (x) =  (y), or (x)/(y) = , and  = px/py, so...
(x)
 (y)
R = a + b/
(x)/(y) =  = px/py

7. Jevons’ Contributions
but this is true for every individual, so the price ratio between commodities equals the ratio of marginal utility between those commodities for all individuals
(x)1/(y)1 =  = px/py = (x)2/(y)2
Capital and Interest
capital regarded as stock of goods waiting to be consumed (directly or indirectly-machines)
essential function of capital is to allow an interval between labor input and final consumption
“capital is concerned with time”
to measure the interval Jevons introduces concept of “average interval of investment”
anticipates Bohm-Bawerk’s “average period of production”

8. Jevons’ Contributions
MPK
Capital and Interest
output increasing function of interval of investment [Q = F(t), where F’(t) > 0]and the interest rate is equal to the increment in output obtainable from the last increment in time, divided by output [ i = F’(t)/F(t)]
given the length of production time, the market rate of interest will equal the rate of growth of output from waiting
marginal productivity principle and Jevonian Triangles
Labor income i
Capital income K K
Slope equals i
Value of output
Time

9. Jevons’ Contributions
The Principles of Science - a Treatise on Logic and Scientific Method (1874)
laws of science begin from creative act of inventing hypothesis from which logical implications are deduced and tested against observation
certainty of science can never be attained; probability plays a crucial role
reads like early Popper

10. Carl Menger (1840-1921) born Galicia (Poland)
studied law at Vienna and Prague, obtained doctorate at Cracow
financial journalist, civil servant
1873, professor extraordinary in Faculty of Law at Vienna
1876, tutor to Crown Prince Rudolph
1879, chair of political economy at Vienna
1903, retires
controversy over reasons for retirement

11. Menger’s Contributions
Principles of Economics (1871) - Grundsatze
first volume in planned four volume work, others never written
Investigations on the Method of the Social Sciences (1883)
response to Schmoller’s unkind review of the Grundsatze which argued theory had no place in political economy
founder of the Austrian School
emphasis on causal-genetic explanations
centrality of subjective utility, uncertainty, adjustments in disequilibrium, and time

12. Menger’s Contributions
Principles of Economics (1871)
Chapter 1: “The General Theory of the Good”
characteristics of goods in general
need, property of satisfaction, knowledge, access
first-order (consumer) goods v. higher-order (producer) goods
value of higher orders derived from first-order goods
necessary complementarity in time-consuming production process

13. Menger’s Contributions
Principles of Economics (1871)
Chapter 3: “The Theory of Value”
extensive discussion of subjectivity of utility
analysis of economizing by single individual of lumpy alternatives of equal-expenditure bundles of alternative goods
value of any good in comparison with another is determined by its least dependent use
extended discussion of uncertainty, error and changes in knowledge upon economizing process

14. Menger’s Contributions
Principles of Economics (1871)
Chapter 4: “The Theory of Exchange”
purpose of exchange; mutual beneficence of exchange
exchange as result of inverted subjective evaluations
Chapter 5: “The Theory of Price”
analysis of price formation, progressing from monopoly to competition
Chapter 6: “Use Value and Exchange Value”
reemphasis of difference between subjective utility and objective exchange ratio

15. Menger’s Contributions
Principles of Economics (1871)
Chapter 7: “The Theory of the Commodity”
commodities are goods intended for sale
extensive discussion of marketability
Chapter 8: “The Theory of Money”
money arises on the market as a commodity
the commodity money arises as a consequence of its being the most marketable of all commodities

16. Léon Walras ( )
father, Auguste Walras, disappointing career as teacher and economic writer
father championed notion that price reflects relative scarcity
rejected by Ecole Polytechnique, enrolls in Ecole des Mines but neglects studies and does not graduate
1858 conversation with father leads to interest in economic matters
1860, wins fourth prize in essay contest at International Tax Congress in Lausanne
1870, appointed professor of political economy in law faculty at Lausanne
1892 retires; Pareto succeeds him

17. Walras’ Contributions
Elements of Pure Political Economy (1874, 1877)
first volume in planned three volume work, dealing with pure, applied, and social economics; latter two never written
Minor Works: Etudes d’économie sociale (1896) and Etudes d’économie politique appliqué (1898)
develop views of ideal society, role of government and private property
favored land nationalization; government to provide public goods and control natural monopolies from land rent; abolition of taxes; abolition of paper currency and institution of managed gold standard (stabilize prices via changing supply of overvalued silver coins); otherwise free competition.

18. Walras’ Contributions
Elements of Pure Political Economy (1874, 1877)
General Equilibrium Analysis
begins with analysis of exchange under partial equilibrium (two goods); arrives at Gossens’ Second Law, allowing him to explain why prices are determined by scarcity (solving his father’s problem)
generalization from two goods to n goods; explicit analysis of general equilibrium
view of money as numeraire good
derivation of demand from utility maximization
general equilibrium defined as zero excess demand in all market simultaneously

19. Walras’ Contributions
General Equilibrium Analysis
Tâtonnement process
iterative process to solve simultaneous equations; disallows false trading (exchange at nonequilibrium prices) by use of auctioneer who changes prices due to excess demand conditions
stability questions understood but not analyzed
Extension of model to production
assumed fixed coefficients of production
profits and losses are signal for expansion or contraction of input usage and output production
households endowed with factors that produce incomes
incomes replace endowments on demand for output side

20. Walras’ Contributions
General Equilibrium Analysis
Extends model to account for growth through investment and saving
investment defined as value of new capital goods; price of each capital good is capitalized value of rental income it provides (therefore inverse relation between investment and interest rate)
saving is income not consumed, determined by marginal equality of present consumption foregone and future income gained
Treats money as an asset held as inventory to accomplish function of exchange over a time period
demand for cash balance is diminishing function of interest rate

21. Influences/Differences
Menger had greatest initial influence in spreading “marginalist” ideas
Walras and Jevons mathematical versions eventually became more widespread and influential
Walras had greatest impact on mainstream modern economist’s toolkit
Differences
Menger’s emphasis on causality in time differs from simultaneous equations approach of Walras
Menger emphasizes uncertainty, error and processes rather than Jevons’ and Walras’ emphasis upon equilibrium

22. Additional Contributions
Friedrich von Wieser
cost is marginal utility foregone from application of unit of input to produce one good rather than another
imputation problem; expected prices of first-order goods determine the prices of higher order goods
John Bates Clark
extension of emphasis on marginal productivity theory of distribution as applied to all factors of production
argued marginal productivity pricing of factors was just

23. Additional Contributions
Philip Wicksteed
mathematical presentation of marginal productivity theory
used Euler’s Theorem to show that in equilibrium, when production function is homogeneous and linear, that shares to wages, rent, and interest exhaust the revenue of the firm
Francis Ysidro Edgeworth
extension of exchange analysis to note multiplicity of possible equilibria from original endowments; contract curve