Marginalist Hall of Fame: Austrian School
Carl Menger, 1841-1921
Eugen von Böhm-Bawerk, 1851-1914
Friedrich von Wieser, 1851-1926
The Marginalist Revolution: The Austrian School
• Friedrich von Wieser, On the Origin and Principle Laws of
Economic Value, 1884
• Marginal utility: Jevon’s “final degree of utility”  Grenznutzen  MU
Austrian cost theory/Pricing factor services
• Cost = Utility of 1st order goods foregone…opportunity cost concept
• Utility + Technology Values of goods in equilibrium
– Essentially demand and supply, but awkwardly avoided
– Joint determination of outputs and shadow prices, obscured
by causal analysis
– Anticipation of linear programming
Aside on Linear Programming
• Leonid Kantorovich, Soviet “Economist”, Nobel Prize, 1975
• Tjalling Koopmans, Yale Economist, Nobel Prize, 1975
• George Danzig, Stanford Mathematician, No Prize
A linear programming problem: Optimize subject to constraints
Max 4 x1 + 5 x2 + 9 x3 + 11 x4
s.t. 1 x1 + 1 x2 + 1 x3 + 1 x4 = 15 Laborer-Days
7 x1 + 5 x2 + 3 x3 + 2 x4 = 120 Machine Hours
3 x1 + 5 x2 +10x3 + 15 x4 = 100 Lbs of Raw Material
Note: fixed coefficient technology…factor substitution not possible
Solution: Optimal program
• how much x1, x2, x3 and x4 to produce
• shadow prices of resources
 activities used in the solution operate at zero net profit
 activities not in solution would operate at a loss.
The Marginalist Revolution: The Austrian School
• Friedrich von Wieser, On the Origin and Principle Laws of
Economic Value, 1884
• Marginal utility: Jevon’s “final degree of utility”  Grenznutzen  MU
Austrian cost theory/Pricing factor services
• Cost = Forgone utility…imputed opportunity cost
• Utility + Technology Values of goods in equilibrium
Essentially demand and supply, but awkwardly avoided
Joint determination of outputs and shadow prices, obscured by causal analysis
Anticipation of linear programming
• B-B “loss principle”: price of commodity lost if factor withdrawn
• Austrian methodology:
• Step-by-step human action, not equilibrium of supply and demand
• Market as information processor  price signals  learning
– von Mises – Lange debate: could economic planning work?
» Lange won on logic:
» efficient market capitalism provides socialist planner with initial
set of prices;
» he just has to tweak them and tell managers to optimize
» von-Mises won in fact … central planning didn’t work
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
Alfred Marshall, 1842-1924
• Student and teacher at Cambridge
• Majored in math
• Married Mary Paley, an economist
• Teacher of teachers: Pigou, Keynes
• …cool heads but warm hearts
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.
Did Marshall crib from Austrians?
B-B and Wieser were at school
when I thought these things out.
Marshall
• Insecure in his writings: held back publication
• Principles of Economics, 1890 (1st edition), 1920 (8th edition)
• Neoclassical economics: marginalist – mathematical framework
• Written for intelligent layman: graphs in footnotes; math in appendices
• Account for the concrete: biological, not mechanical/mathematical, analogies
Marshall’s Principles of Economics: Themes and Contents
• Economics…a study of mankind in the ordinary business of life
...pecuniary focus
• Partial equilibrium analysis … representative agents and firms
• Recognition of Walras’ general equilibrium framework…in Appendix
• Focus on specific markets…constant MU of money…a “preliminary” analysis
» Supply (costs) interact with demand (utilities)
» Ceteris paribus  conservative tilt: “Nature does not leap”
Marshall
• Partial analysis is less elegant than general equilibrium
…but better for application
• Supply and demand curves (the Marshallian cross)
value
• Value determined by both blades of the scissors
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Consumer and producer surplus
Reciprocal demand curves in trade (recall Mill)
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Elasticity of demand
• Price decline  increase in real income for elastic demand
• Anticipates income and substitution effect analysis
quantity
Marshall’s Principles of Economics: Themes and Contents
• Temporary, short-run and long-run supply – fixed and variable costs
• Elasticity of supply increases with time as factors adjust
» Value in short-run depends on demand
» Value in long-run depends on supply
» Quasi-rents: return of fixed capital (machines)
» In short-period:
» a rent determined by demand, as in classical econ.
» not a cost-of-production
» In long-period:
» a measure of capital’s contribution to production
» related to interest rate
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Internal economies of scale  difficulties for competitive market paradigm
External economies (of industry scale): costs to all firms decline as industry expands
Adherent to Say’s Law
“Classical” foil for Keynes in General Theory
Pigou response:
Pigou effect = “Real Wealth” Effect
P down  (M/P) up
 Automatic adjustment to full employment (?!?)
Arthur Cecil Pigou
1877 - 1959
Elaborated on externalities
• 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
Classical – Neoclassical Economics: An Aside
Neoclassical Economics
Classical Economics
Smith – Ricardo/Malthus – Mill
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Labor theory of value
Malthusian population
Say’s law
Quantity theory of money
• Marshallian economics
• Gossen/Jevons/Edgeworth
• Microeconomics
Physiocrats – Marx
• Balanced growth/imbalance
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
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
Rags – Riches – Rags (not quite)
Irving Fisher
1867 – 1947
•Top Yale graduate (math) and Professor
•Married rich  Europe tour – networking/New Haven house
•Illness  Health fetish (corn flakes!)
•Inventor (card index system) – merged into Remington Rand  $$$$
Merged into Sperry (UNIVAC) merged into Unisys
•Stock market speculation  Crash  $
•Crusader: stable money, League of Nations, calendar reform, spelling
reform, Esperanto, environmental protection, prohibition
Prohibition at its Worst  trick wets into reading it
•Leading US economist/Public advocate/Government advisor
•First President of Econometric Society, 1930
• Contributions to price theory
• Consumption indifference curves/“utils” + Production possibilities frontier
• Market equilibrium: MRT = dy/dx = px / py = MUx / MUy = MRS
• Contributions to monetary economics
• Ideal index numbers: geometric mean of Paasche and Laspeyres
• Fisher effect: Nominal interest rate = Real rate + expected inflation (e)
• Quantity Theory of Money: MV + M’V’ = PT
» Velocity and Transactions independent of Money
» If M up, P up, ceteris paribus
» expectations lag  sticky nominal interest rate (stickier than Price)
gm up  π up  Real rate down  Investment spend up  EXPANSION
• Intertemporal optimization, given interest rate (see diagram)
Fisher’s Debt Deflation Theory of Depression
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Easy money  over-indebtedness/speculation/boom – bubble
Bubble bursts  Debt liquidation  distressed sale of assets
Contraction of bank balance sheets  M down
M down  P down
P down  Profits down  Business net worth down
• Liquidation does not liquidate but rather aggravates debt
“The more debtors pay the more they owe.”
• Output down / Employment down / Income down
• Depression
• Hoarding / reduced velocity of money / P down
• Vicious spiral of deflation
•Lecturer/Professional student – first job as economist at age 48
•Career at University of Lund
•Social radical serving conservative (neoclassical) science
•Champion of birth control (neo-Malthus), women’s rights, free love
•Military nihilist (Sweden can’t defend self  disband army…Russify)
•Jailed for sacrilege
Knut Wicksell
1851 – 1926
• Established marginal productivity theory of distribution
• Competition Linear homogeneous (Cobb-Douglas) production function
• Proposed Pareto optimal log-rolling before Pareto
Fiscal packages where everyone gains
• Level the playing field:
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inheritance tax!
public education!!
Market socialism!!!
• Interest and Prices,1898,1924:
• Cumulative process in full-employment economy using bank money …
Say’s Law holds  real GDP steady
Wicksell: Pioneer of Aggregate Demand and Supply
• A general rise in prices is only conceivable (if) the general
demand has for some reason become, or is expected to
become, greater than the supply…Any theory of money worthy
of the name must be able to show how and why monetary or
pecuniary demand for goods exceeds or falls short of the
supply of goods in given conditions.
• MV = “efficiency of money” (Karl Helfferich’s term)
– In a pure credit system, MV is perfectly elastic, subject to the bank rate
» The effective supply of money accommodates the demand
for money…unless the bank rate set by the central bank
imposes monetary discipline.
Wicksell’s Monetary Economics
• Interest and Prices,1898,1924:
Cumulative process in full-employment economy using bank money
 real GDP steady
i = market rate of interest set by banks…credit and Ms adjust to Md at market rate i
r = “normal” rate of interest—keeps P steady = “natural rate” = return on capital
r = f(fundamentals, expectations)
I/Y = Investment/Real GDP = F(i – r) demand for credit (remember, Y is fixed)
$Y = $C + $I = PY
Steady-state equilibrium ($I = 0): $Y = $C = $Yt-1
Disequilibrium (r rises; i steady):
$Y = $C + $I = $Yt-1+ $I
 $I = Δ$Y = ΔPY = $S
 Investment is financed out of forced saving owing to inflation (real C down)
$I = PI = ΔPY  ΔP/P = I/Y = F(i – r)
• In summary, if i<r, firms demand credit to finance investment
…banks create money to meet demand for credit
» Prices and wages rise (wages not as much as prices)
Profit expectations rise  r remains > i  Demand for Credit Up
Monetary equilibrium requires i = r
Equilibrium reached when
• Credit system is linked to convertible metal … demand for credit pushes i up
Or … Central Bank management of i … goodbye laissez-faire
Wicksell’s interest rate rule for monetary equilibrium:
Precursor of inflation targeting
So long as prices remain unaltered the (central) bank’s
rate of interest is to remain unaltered. If prices rise, the
rate of interest is to be raised; and if prices fall, the rate of
interest is to be lowered; and the rate interest is
henceforth to be maintained at its new level until a further
movement of prices calls for a further change in one
direction or another.
Wicksell, Interest and Prices, p. 189
quoted in Michael Woodford, Interest and Prices:
Foundations of a Theory of Monetary Policy, p. 38
Monetary Theory
• David Hume – specie flow, prices, and trade balance
Of Money (1742)
– Long-run neutrality: M  P
But there’s an economic expansion story before the long-run is reached…
…since the discovery of the mines in America, industry has increased in all the
nations of Europe, except in the possessors of those mines…In every kingdom into
which money begins to flow, every thing takes on a new face: labor and industry
gain life; the merchant becomes more enterprising…and even the farmer follows his
plow with greater alacrity…Though the price of commodities be a necessary
consequence of the increase of gold and silver, yet it follows not
immediately…
At first no alteration [in prices] is perceived; by degrees the price rises, first of one
commodity, then of another…When any quantity of money is imported into a nation,
it is …confined to the coffers of a few persons who immediately employ it to
advantage…They are thereby enabled to employ more workmen than
formerly…who can now eat and drink better. [The workman] carries his money to
market where he finds everything at the same price as formerly but returns with a
greater quantity…The farmer and gardener, finding that all their commodities are
taken off, apply themselves with alacrity to raising more…
We may conclude, that it is of no consequence whether money be in greater or less
quantity… Good policy consists only in keeping it, if possible, still increasing.
Monetary Theory
• David Hume – specie flow, prices, and trade balance
• David Ricardo – The High Price of Corn
:
{Thornton, Senior}
• Alfred Marshall – Cambridge oral tradition: M = k PY
People find it convenient
to hold some fraction of their
income in the form of money
…varies with distribution of
income.
Professor Irving Fisher has been the first, in several instances, to publish in book form
ideas analogous to those which had been worked out by Marshall at much earlier dates.
J.M. Keynes, Alfred Marshall, 1842 – 1924, p. 336 fn.
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Ludwig von Mises –cash balance approach linked with marginal utility
Irving Fisher – Quantity Theory and Real Interest Rate
Knut Wicksell – Natural rate of interest/cumulative process
Gustav Cassel – Quantity Theory  Purchasing Power Parity
• “Money doctors”
• Gunnar Myrdal – Monetary Equilibrium: Ex ante – ex post
• John Maynard Keynes
– Tract on Monetary Reform (1924)
• Cambridge k
– Treatise on Money (1930)
– The General Theory of Employment, Interest and Money (1936)
• Liquidity preference and real balances
– The General Theory of Employment, QJE, 1937.
The Stockholm School
Gustav Cassel
1866 – 1945
Purchasing Power Parity
General equilibrium … extension of Walras
A writer less generous than Cassel would be hard to find.
Marx at least paid tribute to Quesnay and Ricardo. Cassel
paid tribute to nobody. Walras had written the first system of
simultaneous equations of general equilibrium. Pareto had
purged it of any measure of sensations. Cassel followed both
but mentioned neither…
Eli Heckscher
1879 – 1952
Economic
historian at
University of
Stockholm
“Classical” theory of interest: rate that equates saving & investment
Foil for Keynes in General Theory
Ohlin-Hecksher
Trade Theory
Teacher of Myrdal, Ohlin
(Factor Endowments)
The Stockholm School, 1927 – 1937
Extending Wicksell’s Cumulative Process
Eric Lindahl, 1891 – 1960 General equilibrium theory
Dag Hammarskjöld
1905 – 1961
UN Secretary General
Gunnar Myrdal
1898 – 1987
• Myrdal, Monetary Equilibrium, 1933
• Ex ante intentions drive macro-performance.
• Ex post results are basis for next period’s
intentions.
• S = I ex post, but not necessarily ex ante.
•Unlike Wicksell, Myrdal and Ohlin recognized market
imperfections  inflexible factor prices
Iex ante ≠ S
 Output changes while prices hold steady
 Anticipation of Keynes
Bertil Ohlin
1899 – 1979
•Autonomous changes in
consumption
•Extension of Wicksell model.
The Stockholm School
Beyond Macrodynamics
• Dag Hammarskjold – Secretary General of UN
• Gunnar Myrdal … extensions of cumulative process
• Cumulative causation – vicious circles
» An American Dilemma, 1944  Brown v. Board of Education
» Rich Lands and Poor, 1957
» Asian Drama, 1968
• Wife, Nobel Laureate Alva Myrdal
» Director of UNESCO
» Swedish Ambassador to India
• Bertil Ohlin
• Transfer problem (1929): income adjustment
» Keynesian analysis vs. pre – General Theory Keynes
• Head of opposition social – liberal People’s Party
Sweden’s Commission on Unemployment
• 1924: Return to gold standard at overvalued rate
• 1927: Recession … formation of Commission
• Ohlin (1934) Monetary Policy, Public Works, Subsidies
and Tariffs as Means for Reducing Unemployment
• Focus on Aggregate Demand, not wage reduction to get out of
depression
• Deficit finance of Public Works + Easy Money for Investment
+ Price Supports for Farmers
Spending Multiplier and Investment Accelerator
• Myrdal (1934) The Effects of Fiscal Policy
• Countercyclical policies … balance budget over cycle
» Build infrastructure in depression
… not US “leaf-raking”
» Easy money in recession … tight money in expansion
• 1936: Swedish depression ended
Vicious Spirals of Note
• Fisher – Minsky: Debt Deflation Spiral
• Foreclosure “Death Spiral”
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Wicksell: Loan rate < Real rate  hyperinflation
J.H. Williams: Depreciation – Inflation Spiral
Myrdal: Discrimination – Poverty Spiral
Debtor “Death Spiral”
• Budget “Death Spiral”
• Insurance “Death Spiral”