Foundations of Marginal Analysis
– “First Generation Marginalists”
Chapter 8
What is Marginal Analysis?
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A basic technique used in economics that
analyzes small, incremental changes in key
variables
A marginal change is a proportionally very
small addition or subtraction to the total
quantity of some variable.
In microeconomic theory, "marginal" concepts
are employed primarily to explain various
forms of "optimizing" behavior
Utility for consumers, profit for producers
Marginal Analysis
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For the decision maker trying to determine
how many units of a good to consume or
provide to the market, net total benefits
(benefits minus costs) will always be
maximized at that level of consumption (or
provision to the market) where the
marginal benefit derived from adding
the last unit equals the marginal
addition to total costs of producing or
acquiring that last additional unit
Marginal Analysis
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Looked at another way, an additional
unit should be consumed or produced
as long as the marginal benefit >
marginal cost
Maximization occurs when MB = MC
Jevons Quote
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“In commerce, bygones are for ever
bygones; and we are always starting
clear at each moment, judging the
values of things with a view to future
utility.”
What does this mean?
Applications of Marginal
Analysis
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Supply
Demand
The first generation marginalists were
almost exclusively concerned with
demand and marginal utility
Components of the "marginalists'"
critique of the Classical's value theory
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Classical’s focus was on supply
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Labor Theory of Value
Price depended upon the cost of
production
And, these costs occurred in the past
Marginalists said that price depended
upon the marginal utility accruing to
consumers – focus on the future
Components of the "marginalists'"
critique of the Classical's value theory
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The question then arises – is the value
(price) of final goods and services determined
by the value of the factors of production, or
does the price of final goods and services
determine the value of the factors of
production?
Are pearls valuable because people dive for
them or do people dive for them because
they are valuable (have utility)?
Components of the "marginalists'"
critique of the Classical's value theory
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The second criticism has to do with
marginal utility vs total or average utility
(see Table 8.1, pg. 227)
Diamond-Water Paradox
Diminishing marginal utility –water
usage is high, so MU is low and price is
low. Diamond usage is low, so MU is
high and price is high
Utility
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What is utility?
Not precisely defined, but it can be
measured
It diminishes with additional units of a
good or service
What is the utility maximization
condition?
What does this assume?
Utility
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A consumer can compare the utility of
different goods and services
But what about interpersonal
comparisons of utility?
What about the marginal utility of
income?
Factor Prices
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Factor prices are determined by the
price of the final good
They are NOT price determining, but
they are price determined
First generation marginalists
and Classicals
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Remember Mill’s three scenarios on page 177
When supply is perfectly inelastic, price
depends upon demand and supply
When supply is perfectly elastic, price
depends upon supply only – in this case the
Classicals’ focus on cost of production as
determining price is correct
In the “normal case” price depends upon
both supply and demand
First generation marginalists
and Classicals
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IN GENERAL
Classicals said value (price of final good or
service) depends upon supply – costs of
production – labor theory of value
First generation marginalists said that value
depends upon demand – marginal utility
In fact, both analyses are deficient in that
they are incomplete, and later economists
cleared this up