UCL ECON1006. HISTORY OF ECONOMIC THOUGHT. Hugh Goodacre.

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UCL ECON1006. HISTORY OF ECONOMIC THOUGHT. Hugh
Goodacre. 5. MARGINALIST ECONOMICS
5.1 Classical Political Economy review and
assessment. 5.2 Demand in Classical Political
Economy. 5.3 Utility and the margin. 5.4 From
value to price.
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5.1 Classical Political Economy review and
assessment. Classical political economy Shift
from exchange / trade / mercantilism to
production / efficiency Focus on economic
growth growth linked to distribution
Smith Static Harmonious Natural
Ricardo Dynamic Conflictual Problematic
Post-Ricardo (e.g. John Stuart Mill) Product
ion Laws, whether natural or problematic.
BUT Distribution can be altered, unlike laws
of production. Reforms, Factory Acts,
etc. Prefigures positive / normative
distinction.
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Constant returns Each additional unit of land
cultivated (say, in millions of acres) adds same
amount to output, say 100m quarters ? trivial
result
Number of acres (m) 1 2 3 4 5
Amount of added output (qtrs, m)
100
100
100
100
100
Added output(qtrs, m) 100 80 60 40 20 10
Output per acre
Constant returns
1 2 3 4 5
Acres (m)
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Diminishing Returns.
Land No. 1 2 3
Amount of added output 100 90 80
Corn per acre
100 90 80
Acres
?No. 1? ?No. 2? ?No. 3? Lands under cultivation
Constant returns only prevail when land of top
quality (e.g. Land No. 1 in diagram) is in
sufficient supply (e.g. abundant land, small
population). Pressure of population ? best land
all cultivated ? lands of lower fertility are
successively brought into cultivation (Lands No.
2 and 3 in diagram) ? Diminishing Returns lower
output per acre.
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Plotting the production function constant
returns. Same data as in marginal diagram, but
with total output (Q0) on vertical axis
Number of acres (m) 1 2 3 4 5
Amount of added output (qtrs, m) 100 100 100 100 100
Total output 100 200 300 400 500
Production Function
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Production function with diminishing returns.
Number of acres (m) 1 2 3 4 5
Amount of added output (qtrs, m) 100 90 80 70 60
Total output 100 190 270 340 400
Production Function
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QO / QI
RENT
PROFIT
WAGES
N1 N2
N3 NSS N
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• Preview Advances, e.g. from the Wage Fund
• Suits agriculture annual advance, as in
  Physiocrats.
• BUT Industry, etc. not predetermined
  periodically in this way?
• Continuous, dynamic, other determinants, e.g.
  technology.
• What determines proportions between capital and
  labour inputs?
• Ricardos machinery example just arbitrary /
  exogenous / unexplained.
• No explicit account of relation of proportion of
  inputs to factor returns, etc.
• Example of how CPE focused on social distribution
  gt functional relations between factors.
• These SUPPLY side problems addressed in
  neo-classical economics but first major
  departure from CPE was on DEMAND side.

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• 5.2 Demand in Classical Political Economy.
• Todays micro no problem
• S D intersection determines price.
• But CPE problem Demand
• No solution to problem of relation of exchange
  value to use value raised by Smith, not solved.
• After Smith, Demand largely considered in macro
  terms / aggregate demand gt micro / price
  determination.
• Drastically downgraded in Says Law, etc.
• Malthus-Ricardo debate.

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Smith on demand Raised a problem
water-diamond paradox value in use, value in
exchange. i.e. Saw problem, but left it
unanswered. Similarly Ricardo commodity must
have value in use as prerequisite for exchange
value, but no formal relation established between
them. Demand just a simple question of whether
Effectual or ineffectual. Poor man desires
coach and six ineffectual. Fluctuations in
demand exogenous trivial Only example is
black cloth for public mournings.
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• Smith thus illustrates
• CPE emphasis supply side / cost of production.
• Emphasis in price determination is on natural
  price gravitation towards this.
• Interlinked with distribution / natural order of
  society / components of value.
• Post-Smith, this downgrading of demand taken
  further
• At macro level, demand spirited away in Says Law

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• Demand in CPE at macro level.
• Malthus
• Problem of tendency to under-consumption
• Spending habits of landlords necessary to sustain
  aggregate demand through unproductive
  consumption.
• Economy does not have sufficiently strong
  self-correcting forces to ensure this on its own.
  
• Policy conclusions Keep Corn Laws.
• i.e. Demand was considered by Malthus, but
• with respect to CPE concern with growth and
  distribution,
• not price determination
• i.e. macro gt micro.

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Demand in CPE at macro level, contd Ricardo
agreed with Malthus on spending habits of
landowners (and added that war could achieve same
result), but came to OPPOSITE policy
conclusion! Free trade in corn ? more efficient
allocation of resources (comparative advantage)
? cheaper corn. i.e. Ricardo added allocation of
resources / allocative theory i.e. as well as
distributional. More faith in self-correcting
capacity of market forces. Recall Keynes
Malthus to underworld / Ricardo became
orthodoxy / Spanish Inquisition.
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• 5.3 Utility and the margin.
• CPE, utility and demand.
• CPE (England) nature of demand / determinants of
  intensity of desire remained unexplored.
• A separate intellectual tradition considered this
  (France, Italy).
• Even utilitarianism of Bentham, despite its
  quantitative formulation (felicific calculus),
  not taken up as basis for demand theory by CPE.

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• Benthams utilitarianism.
• Context
• Formulated for legislative reform, though clearly
  had an economic dimension.
• Beneficence of natural order / invisible hand
  coming under question.
• Individual not best judge of own interest anyway?
  
• Poverty, rapid social change need for active
  reform.
• Utility (max happiness for max number, etc.) as
  theoretical / ideological basis for reform
• Education (UCL!) penalties.
• But problem quantification of utility /
  mathematical formalisation.

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• The margin.
• Ricardos rent and distribution theory
• Abstract, model-type theory.
• Can be presented in formalistic terms, as seen.
• But his own presentation
• Some basic building blocks of this approach
  remained implicit only.
• e.g. average and marginal quantities.
• Despite this, marginalist idea was there, in
  informal terms
• Rent determined by last / least profitable / zero
  rent area.

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Jevons the marginal principle applied to
utility. Diminishing returns to agricultural
land. ? Rent determined by last / least
profitable area of land cultivated while still
worth cultivating. ? general concept of
determination at margin. Jevons Apply to
demand, as diminishing marginal utility
Subjectively experienced decreasing utility of
successive units of a good consumed. ? Demand
determined by last unit / unit that provides
least utility while still worth the price /
final degree of utility. i.e. A theory of
exchange value alternative to that of CPE.
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Marginal utility theory of demand. Nature of
demand conceptualised in terms of utility at the
margin. Allowed application of quantitative
techniques / calculus. Solved water-diamond
paradox Exchange value determined by per unit
demand at the margin. Water worth something in
drought! Relative scarcity / modelable nexus
between value in use (utility) and value in
exchange.
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i.e. Satisfaction / demand related to price in
modelable form. In particular, calculus /
marginal utility / derivatives Solves Bentham's
quantification problem. i.e. Ordinal gt
cardinal. Consequence Decisive shift Exchange
value / price determination From CPE cost of
production. To Marginal utility / subjective.
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• 5.4 From value to price.
• Value seen as a problem
• Associated with concepts of surplus and
  distribution components of value (and thus
  price) linked to social order.
• But reform and radical movements question the
  social order!
• In particular
• Value according to labour embodied?
• i.e. Labour Theory of Value e.g. Petty /
  corn-silver, etc.
• Value according to labour commanded?
• i.e. what product of labour can buy / is
  equivalent to.
• These two things are not equal!
• Opens door to theory of exploitation /
  expropriation of surplus / Marx.

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Question the social order? Smith No natural
associated with natural liberty static /
harmonious perspective. Ricardo Yes
contradiction between interests of landowners and
industrialists. Radicals (Ricardian socialists,
Marx) Yes contradiction between interests of
workers and capitalists. Distribution and the
social order
Smith Harmonious Harmonious Existing order is natural
Ricardo Conflictual Landowners vs. industrialists Free competition / capital accumulation necessary to defend existing order
Radicals Conflictual Capitalists vs. workers Replace the existing order
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• i.e. Strong ideological need to switch away from
  value.
• Its association with surplus and distribution.
• Even Ricardo who defended the social order
  pointed out its adverse aspects.
• Marginal utility answered this need.
• Whole emphasis on distribution / social order
  abandoned.
• Focus entirely on subjective side / individual.
• Labour embodied, etc., becomes redundant.
• Stationery state converted
• from pessimistic conclusions things go wrong.
• to equilibrium desirable situation when market
  goes right.

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• Walras General equilibrium.
• Whole economy represented as a system of
  efficient markets.
• i.e. no macro-micro split.
• Begins with two commodities
• MUa / MUb Pa / Pb
• Assumptions
• Supply is fixed.
• Full employment of all productive resources.
• Technical coefficients of production fixed.
• Utility functions of consumers fixed.

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Walras General equilibrium, contd. Constructs
(x 1) equations, where x is number of unknowns
(quantities and prices). Each individual
maximises utility with respect to all goods
simultaneously. Choose one commodity as
numéraire ? equality of number of independent
equations with number of unknowns. ? simultaneous
solution of entire system of equations quantities
and prices all defined in terms of the numéraire.
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• Walras General equilibrium, contd.
• Further assumption
• Transactions take place outside time!
• Tatonnement very descriptive image, but
  paradoxically totally abstracted
• Instantaneous unlike CPE gravitation from
  market price to natural price.
• No transactions take place till tatonnement
  complete!
• (no false trading at false prices.)
• i.e. A postulate only automatically true if
  assumptions hold.
• Pure theory from maths to economics.

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Walras General equilibrium, contd. Contrast
with CPE CPE Growth, circular flow,
reproduction. Maximise supply. GE
Market-clearing. i.e. Asks different
question Utility-maximising allocation of given
supply. Achieved through system of
market-clearing prices.
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Walras General equilibrium, contd. Contrast
with CPE, contd CPE Stationary state is
bad. GE Stationary state theory now abandoned
for equilibrium. Equilibrium is good
market-clearing / optimisation.
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Mercantilism (1) Bullionism Gold / precious metals Get it from the Spanishprevent gold exports.
Mercantilism (2) Mun, etc. Trade surplus Gold exports OK if for re-exports / expanding trade
Mercantilism / Transitional Petty, etc. Number of people, particularly those in arts Encourage higher birth rate. Welcome immigration (forced, Petty)
Mercantilism / Transitional Petty, etc. Beginnings of emphasis on increasing productivity Improve technology (Bacon) Compact the population.(Petty)
Classical Political Economy Physio-crats Powers of nature Ensure high proportion of expenditure is productive rather than sterile
Classical Political Economy Adam Smith Organisation of production process / division of labour Encourage extension of market this allows further division of labour
Classical Political Economy Ricardo Accumulation of capital / industrialisation Ensure surplus product is not all appropriated by landlords as rent.
Neo-classical economics Traditional/ liberal Focus on a different question allocation of given / scarce resources by market (1) Laissez-faire!
Neo-classical economics New Focus on a different question allocation of given / scarce resources by market (2) Prevent market failure
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• Assessment of the marginal revolution
• Achieved decisive break with CPE.
• Gave economics its technical / mathematical
  character.
• Initially (Jevons, Walras first generation)
  left many issues hanging in the air
• Distribution side-stepped.
• Supply left vague no S schedule.
• Supply undetermined ? no explanation for
  existence of price in the first place.
• Macro theory weak aggregate of course same
  laws as individual labour theory just
  disutility.
• Lacked theory of profit.

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Assessment of the marginal revolution,
contd Second generation (i) Much elaboration
of the technical paraphernalia Indifference
curves, Edgeworth Box, etc., etc. (ii) Most
importantly (preview) Marginalism extended to
supply side Marginal productivity ? distribution
/ allocation of productive factors. i.e.
Functional distribution rather than CPE
distribution to social groups. ? Complete Demand
and Supply system in micro terms Marshallian
economics / neoclassical economics. Note This
was partial equilibrium / micro. ? Keyness
critique argued it was inadequate basis for
macro.
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5. MARGINALIST ECONOMICS Summary 5.1
Classical Political Economy review and
assessment. 5.2 Demand in Classical Political
Economy. Smith water-diamond paradox effectual
demand fluctuations in demand. Says Law.
Deficient demand Malthus, Ricardo. 5.3 Utility
and the margin. Bentham. The marginal principle
applied to utility. 5.4 From value to
price. Value as a problem. Walras general
equilibrium contrasts with Classical political
economy. Conclusions Assessment of the
marginalist revolution. Preview
(Neo)-Classical economics.