Download Supply of Capital

Alfred Marshall (1842 – 1924)
Background:
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studied mathematics at Cambridge and later taught economics there
1867 began studying economics to understand inequality
1879 publication of his first major work Economics of Industry, coauthored with his wife
1890 publication of Principles of Economics
- immensely popular with many editions
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published numerous other books
- enormously influential due to
a) the success of his books
b) his impact on his students, including Joan Robinson and J.M. Keynes
c) centre of the Cambridge school
- credited only 5 economists as predecessors
- Smith, Ricardo, J.S. Mill, Cournot, and von Thunen
- von Thunen he “loved above all my masters”
- very generous to classical predecessors but unkind to Menger, the Austrians, and Walras
- provided the synthesis that most perfectly embodied the classical situation of @1890
Method
- mathematical, historical, and practical
- worked out material mathematically but insisted that if it could not be presented clearly
in words, the formulation was useless.
- illustrated arguments with real examples
- believed that neo-classical (post 1890) economics was merely a more analytically and
more refined version of classical economics
”It’s all in Adam Smith”
- used Cournot, von Thunen, and Bentham to systematize Ricardo and Mill
- critics branded him ‘eclectic’ for his synthesis of classical and marginal utility analysis
- Partial Equilibrium Analysis (Cournot first but Marshall was the master)
- examined the relationship between economic phenomena by concentrating on a few
variables, withholding the others constant
-> the ceteris paribus condition
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Alfred Marshall (1842 – 1924)
- “Principle of Negligibility of Small Effects”
- examined sufficiently small sectors of the economy (e.g., an industry, a particular
commodity) such that changes in price and quantity of this commodity would not alter
the rest of the economy and the parameters for the isolated sector.
- an important aspect of his partial approach was his recognition of different time
periods:
1. Market Price: supply absolutely fixed
2. Short-run Normal Price: capital fixed and labour variable
3. Long-run Normal Price: capital and labour variant
4. Normal Price: allowed the data of the system (e.g., population, technology,
etc.) to change.
- Walras, in particular, criticized the partial approach for its failure to recognize
general interdependence of variables
- however, relaxation of the ceteris paribus conditions brings the analysis closer and
closer to a general analysis. Isolated examination, moreover, is a useful first
approximation
- Marshall was always very aware of interdependence and much of his work pointed
to general equilibrium
Utility
- Marshall independently discovered diminishing marginal utility (“the Law of Satiable
Wants”) by 1871 before publication Jevons and Menger but didn’t publish until later
=> MU = f(Q)
- recognized that he could not measure desire or satisfaction directly but that one could
“fall back on the measurement which economics supplies of the motive or moving force
to action”, i.e., the objective phenomena of demand in the market measuring
satisfaction in money (or income)
=> still assumed cardinal utility
- unlike Jevons, he constructed a demand curve form marginal utility
- since MU = f(Q) and P measured MU => P =f(Q)
(reverse of our present competitive relation Q = f(P) but Marshall is so influential that
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Alfred Marshall (1842 – 1924)
our graphs still have P on the vertical and Q on the horizontal since Marshall had Q as
the independent variable and P as the dependent variable)
- Marshall recognized that measurement by money (income) assumed that the marginal
utility of money was constant (most unlikely if all other commodities obeyed
diminishing marginal utility)
Marshallian Demand Curve
- Marshall used his concept of diminishing marginal utility to create a demand curve, not
relative prices through the equimarginal principle (and fixed supply) as did his
immediate predecessors.
- Demand is the relationship between the price and the quantity of a good ceteris paribus.
- examined movements along the curve due to changes in Q or P and shifts in the curve due
to changes in the ceteris paribus conditions.
Consumer Surplus
”The excess of the price which he [the consumer} would be willing to pay rather than
go without the thing, is the economic measure of the surplus satisfaction. It may be
called consumer’s surplus”
-> this concept lead to welfare analysis but Marshall’s exposition was weakened by
a) the assumption of constant marginal utility of money
b) the aggregation of the surplus of different consumer’s without resolving problems of
interpersonal differences in utility
Elasticity of Demand
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defined in modern form though only analyzed point elasticity and only in relation to
price and quantity
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he used the concept of demand to demonstrate that demand, and hence marginal
utility, determines price without supply only in the case where supply is fixed (as in
Jevons and Menger). Since Supply is vertical in this case, price is determined solely by
Demand (i.e., where Demand intersects Supply)
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if supply is not fixed, then the Jevons and Austrian argument that marginal utility
first determines price of consumer goods and then price determines the value of
producer goods and costs is inadmissible because the marginal utility of the consumer
gods depends upon their quantity and the quantity depends upon cost.
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Alfred Marshall (1842 – 1924)
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he also showed that if costs were constant (as in the Classical case of Smith, Ricardo,
etc.), then Supply was perfectly horizontal at a given Price and Supply alone
determined price
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Marshall argued that you needed a supply function determined by costs as well as a
demand function. This gave rise to his famous ‘scissors’ analogy that price and
quantity need demand and supply just as a scissors needs both blades to cut.
=> the development of a supply curve determined by costs
=> Marshall’s value and distribution theories combine marginal utility with subjective real
costs as the forces behind supply and demand respectively, which together determine
value and factor pricing
DISTRIBUTION: FACTOR PRICES
- factor prices determined by supply and demand
Derived Demand
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“The demand schedule for any factor of production of a commodity can be derived
from that of the commodity by subtracting from the demand price of each separate
amount of the commodity the sum of the supply prices for corresponding amount of
the other factors”
more simply “the direct demand for the finished product is in effect split up into the
derived demands for the things used in producing it.”
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these is really an imputation theory of demand since he examines the marginal utility
product not marginal revenue product
- Supply is determined by real costs (subjective)
“The exertions of all the different kinds of labour that are directly or indirectly
involved in making it; together with the abstinences or rather the waitings required for
saving the capital used in making it; all thee efforts and sacrifices together will be
called the real cost of production of the commodity”
Supply of Labour
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determined exactly along Jevonian lines (even mentions Jevons) except that labour
need not be painful
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the equality of the marginal disutility of labour and the marginal utility of wage
income determines the supply price of labour for each quantity of labour
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Alfred Marshall (1842 – 1924)
- supply of and demand for labour determine wages
Supply of Capital
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marginal product theory cannot explain the return to capital by itself because what
prevents the supply of capital from increasing until the return disappears?
=> need an explanation for capital supply that still leaves an interest
- Marshall proposed “waiting” due to the production period but he really seems to mean
‘abstinence’ as sacrifice, i.e., forgoing consumption for savings
- supply and demand for capital determine interest
Rent
- no cost of production or supply of production
- Marshall continued the classical tradition of interpreting rent as a residual due to
differential productivity
- does develop a concept of quasi-rent as a return to factors in the short-run
Profit
- return to the entrepreneur
- greater than zero unlike Walras because of
a) earnings of management
b) quasi-rents to unique ability
c) successful technological or commercial improvements
d) organizational improvements
- Marshall’s Normal Profit is not incompatible with Walrus’s zero profit since Marshall,
unlike Walras, does not assume perfect equilibrium (a stationary state with no growth)
or perfect competition .
Supply Curve
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“representative firm” is the bridge between the firm and industry
- “one which has a fairly long life, and fair success, which is managed with normal
ability, and which has normal access to the economies, external and internal, which
belong to that aggregate of production”
- representative with respect to average costs
- does not assume perfect competition because he is more interested in reality
Principle of Substitution
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Alfred Marshall (1842 – 1924)
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entrepreneur’s substitute cheaper for more expensive resources under pressure of
competition and profit maximization
- did not recognize consumer substitution
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develop the modern short-run and long-run analysis of the firm and industry
- developed the concept of internal and external economies of scale and decreasing average
costs.
-> lead to an analysis of monopoly, second only to Cournot
- recognized
a) that competition did not necessarily maximize satisfaction for all given the
differences in wealth
b) that monopolist’s cost structure might allow monopoly prices to be lower and output
greater than competitive firms
-> incompatibility of decreasing costs due to internal economies of scale and
competition.
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