Download Alfred Marshall and Neoclassical Economics

Alfred Marshall and
Neoclassical Economics
Chapter 10
Alfred Marshall
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British, initially wanted to be a clergyman
Wanted to make economics more
mathematical, more rigorous, more
“scientific”
Principles of Economics, published in 1890
Brings the ideas of supply and demand,
marginal utility and costs of product into a
coherent whole
Father of neoclassical economics
Framework of Analysis
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What are the questions that Marshall is
asking?
How can economics be used to improve
the lot of the poor?
He was trying to develop an “engine of
inquiry” – a way of analyzing the world
to arrive at “the truth”
He was a microeconomist
Framework of Analysis
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What are the assumptions that Marshall
is making?
Diminishing returns
Perfect competition
Framework of Analysis
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What is the economic/political/cultural/
social environment of Marshall (18421924)?
Heyday of capitalism, free markets,
Industrial Revolution
Victorian age
Lots of wars
Framework of Analysis
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What is the economic/political/cultural/
social environment of Marshall (18421924)? (continued)
Continued attacks on Classical
economics
Laissez-faire under attack because of
dreadful living conditions for people in
factories
Framework of Analysis
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What is the role of the market?
Entire analysis based on competitive
markets – micro level
Framework of Analysis
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What is the role of government?
He was interested in analyzing
government action affected economic
welfare
Marshall's definition of
economics
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He equated political economy with
economics.
It is the “Study of mankind in the
ordinary business of life”
Includes analysis of individual and
social (in part government) action
Marshall and Time
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Marshall had four time periods
Market period – supply inelastic
Short run – upward sloping supply curve –
can change level of output but not plant
capacity; prime costs and supplementary
costs
Long run – can vary output and plant
capacity
Secular period = very long run – technology
and population can change
Marshall and Time
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(continued)
In modern microeconomics, there are
two time periods, short run and long
run – the definitions are about the
same as Marshall’s
prime costs = variable costs and
supplementary costs = fixed costs
Price Elasticity
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The price elasticity of demand measures the
percentage change in quantity demanded
divided by the percentage change in price. It
is a measure of the slope or steepness of the
demand curve.
It is important in measuring
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the incidence of a tax
how total revenue of a seller changes when price
changes
Price Elasticity
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(continued)
the price elasticity of demand is
affected by:
the availability of substitute goods
the proportion of income spent on the
good
the time elapsed since a price change
Marshall’s Demand Curve
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The amount of a good demanded varies
inversely with the price of the good due
to the substitution effect and the
income effect
Substitution Effect
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The substitution affect always yields a
downward sloping demand curve
because, for example, as the price of a
product falls, consumers will substitute
more of this (relatively) in lieu of other
products
Income Effect
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The impact of the income effect depends upon the type of good
in question.
Normal good - lower price will increase the real income of the
consumer and he/she will purchase more of the produce
Inferior good - lower price will increase the real income of the
consumer and he/she will purchase other more desirable
products and less of the inferior good. In this case if the
income effect is greater than the substitution effect, then the
demand curve will be upward sloping! Then we have problems
with unstable equilibrium. These types of goods are called
Giffen Goods
To deal with this possible problem Marshall assumed that the
income effect was small
Welfare Economics
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It is not the study of government
“welfare programs”
Welfare Economics
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(continued)
Welfare analysis is a systematic method
of evaluating the economic implications
of alternative allocations
It answers the following questions:
Is a given resource allocation efficient?
Who gains and who loses from different
resource allocations?
Welfare Economics
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(continued)
Microeconomic approach to analyzing
efficiency and equity effects of
particular actions
May be used to develop criteria for
government intervention in markets
Consumer Surplus
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Gain to consumers that occurs because they
are willing to pay higher than market price for
initial units of a good
Consumer surplus exists because of the
concept of diminishing marginal utility and a
downward sloping demand curve. The first
unit of a good is “worth” more to a consumer
than subsequent good (or services).
Consumer Surplus and Taxes
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Marshall compared the loss in consumer
surplus to the gain from tax revenue
The gain or loss from the tax depends
upon the elasticity of the supply curve
Marshall’s Contribution to Cost
Analysis - Supply
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Short run v. long run
Fixed cost v. variable cost - A firm will continue to
operate in the short run as long as it is covering its
variable cost
Internal economics of scale – forces internal to the
firm – affects costs
If there are internal economics of scale (advantages
to being big) then there will be decreasing costs;
internal diseconomies of scale (disadvantages to
being big) result in increasing costs
External economics of scale – can explain falling
prices in an industry over the long run – think of
personal computers and other electronic goods
Marshall’s Quasi-rent
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Are payments to factors of production (e.g., wages,
profits) price determined or price determining?
Classicals believed them to be price determining –
that is, the price of the final product depended upon
the price of the factors of production (inputs) used to
produce the final product. (supply oriented) An
exception was rent, which was price determined
since it was fixed in supply.
Marginalists said that payment to factors of
production were price determined – that is, the price
of the final product determined the factor payments
(demand oriented)
Marshall said “it depends.”
Upon what does “it depend”?
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Land rent is price determined from the perspective of
the entire economy but price determining from the
perspective of the individual farmer.
To the individual farmer, rent is a cost of production
Under some circumstances, however, rent can be
price determining from the perspective of the
economy as a whole. For a country that has
unsettled land, the supply curve of land is upward
sloping, therefore higher prices of land will cause
more of it to be developed.
In the short run wages are price determined
(inelastic supply) but in the long run they are price
determining (more elastic supply)
Is price a dependent or
independent variable?
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Conventional mathematical analysis places the independent
variable (X) on the horizontal axis and the dependent variable
(Y) on the vertical axis.
Marshall’s analysis had price as the dependent variable and
quantity as the independent variable P = f(Q)
Walras and modern economic theory places price as the
independent variable and quantity as the dependent variable.
Q = f(P). Therefore, adjustments to get to equilibrium occur via
changes in price.
Interestingly enough, modern supply and demand models that
you see in principles of microeconomics are drawn with price as
the dependent variable (like Marshall) even though it is the
independent variable in modern analysis.