Alfred Marshall (1842 – 1924) and Francis Ysidro
Edgeworth (1845 – 1926)
The two leading late 19th century British economists
1
Marshall and Cambridge, first professor of
economics
Always seen as something special: his analysis is easier to
follow than, say Walras’, as his approach is ”plain English”.
Seen as someone that was the beginning of the Cambridge
tradition: Marshall, Pigou, Robertson, Keynes, Sraffa,
Austin Robinson, Joan Robinson, Kaldor, Robert Neild,
Frank Hahn, Angus Deaton and many, many more.
Marshall was a well-trained mathematician. “Burn the
mathematics when the analysis is done, then “plain
English”.
No doubt that his foremost pupil, John Maynard Keynes,
thought that Marshall was a giant. In 1933, Keynes wrote
an essay on Marshall and his economics – referred to by
Sandmo. This essay together with similar articles on other
economists are impressively well researched and
composed. Moving social profiles.
Marshall was a bit strange: very conscious of offering polite
words to his colleagues and competitors but often with a
tone of jealousy. It took him 20 years to write his main
work, Principles of Economics (1890)
2
What did Marshall accomplish?
Marshall is the inventor of several important concepts: The
Partial Equlibrium Method, elasticity, the interrelation
between market equilibrium and social welfare , ceteris
paribus and more. He uses supply and demand in the
same way as we do.
Principles was a textbook – perhaps the first modern one –
and it is large (871p); economic theory is in Book 5.
3
The Marshallian cross 1
From p. 346 in a footnote! – what is so great about that?
4
The Marshallian cross 2
Now what is so great about this?
Demand based on decreasing marginal utility – as in Jevons
and Walras – but much clearer.
Supply curve rising due to increasing marginal costs. Very far
from the classical conception of a flat supply curve (Labour
theory of value, determining the price alone)
“We might reasonable dispute whether it is the upper or
under blade of a pair of scissors that cut a piece of paper,
as whether value is governed by utility or cost of
production” (p. 348) – General equlibrium as in Walras?
Probably, but illustrated partially, only one market at display.
Much easier to understand and makes adjustments clearer.
In the short run, supply may be vertical, price increases
with demand, but in the longer run supply becomes flatter.
As Sandmo explains, this was an important piece of
analysis that Keynes took over.
5
Partial or general equlibrium?
Walras had a model of all markets; it determines all quantities
and all relative prices. Is Marshall doing the same?
He invented ceteris paribus to do one market at a time. He
also have many remarks on the interrelationships of all
markets. Also clear, that Walras’ model could not take into
account all the particularities of each individual market.
Marshall’s method is very practical – very useful to go from
market to market. Ref. i.e. Tobin who talked about
monetary theory in his path-breaking 1969-article it was
called “A General Equlibrium Approach to Monetary
Theory”, but it was partial as only monetary markets were
considered. So, it is used a lot. In addition, no one
analyzing a small market would try to put it into a
complete setting. However, did Marshall really understand
interdependencies? Perhaps he did not is Sandmo’s
conclusion and that is not so innocent.
He understands substitution effects but maybe not income
effects.
6
Utility, demand and welfare 1
Marshall understands that a decreasing MU will lead to a
decreasing demand curve. Higher price, lower demand.
However, a lower price will also increase the purchasing
power of the person’s nominal income. The MU of the
income increases and we not only have a substitution
effect (higher price, lower demand) but also an income
effect (a higher real income can buy more of all goods).
Now, Marshall assumes this away as he is only referring to
a “small” market.
7
Utility, demand and welfare 2
Now add all demand curves to get the market demand for a
particular good:
8
Utility, demand and welfare 3
The consumers’ surplus measures the gain to consumers from
a fall in price down to equlibrium. They would have been
willing to pay more but they do not have to. Similarly,
producers enjoy a producers’ surplus. Had the price been
lower, their surplus would have been lower et vice versa.
The sum of these two surpluses, Marshall calls the social
surplus and it proves to be an extremely interesting
concept.
9
Utility, demand and welfare 4
“There is indeed on interpretation of the doctrine {social
surplus at its maximum in equlibrium} according to which
every position of equlibrium of demand and supply may
fairly be regarded as a position of maximum satisfaction.
For it is true that so long as the demand price is in excess
of the supply price, exchanges, exchanges can be effected
at prices which will give a surplus of satisfaction to buyer
or to seller or to both.” (p 470). All this of great interest to
many, many kinds of applications.
Market equlibrium is a social optimum, but Marshall is aware
that one may – or should – intervene in markets to obtain
distributional effects.
10
Elasticities
Were invented by Marshall to present a way of giving meaning
to reactions or steepness. Of enormous practical use in
multiple situations! As you know well!
11
External effects. Marshall analyzing a special case only
Can the long run supply curve be downward bending so that
price will decrease with an increased demand? Yes, with
increasing returns to scale. Costs may go down when
production becomes more efficient. Demand for computers
have been rising for 30 years and they have become far
better – because of much technological progress.
Inventions etc. have cut costs. However, also the opposite,
ref. Marshall’s example with fishing.
Not quite what we would call external effects, but clearly
important. He had a “plan” for taxing firms with increasing
returns to scale and transferring to money to those with
increasing! Taxing Intel and give the money to fishermen
.
12
Factor Markets and Income Distribution 1
The Iron Law of Labour does not work anymore!
Marshall’s demand for labour:
In addition, this is influenced by training (human capital and
education). A high wage makes it possible for parents to
give their children a good start in life (Marshall’s father
persuaded his employer (Bank of England) to pay for
Alfred in a fine school!). Moral principles and Christian
ideas are somehow behind what men do!
“Cambridge is for men with cool heads and warm hearts”
Read Sandmo.
13
Factor Markets and Income Distribution
2
Upwards sloping as MU increases as w increases.
Much the same for capital, one will be investing (supplying
capital) until rate of profit equals interest rate.
14
Monetary Theory 1
Not in Sandmo. Marshall published a Money, Credit and
Banking when he was 80! It was a Quantity Theory of
Money approach, but
He is close to see M as a demand for money function and not
the supply of money, later slowly leading up to Keynes’
liquidity preference. Also Interest rate is (as we have seen)
something that can differ from the rate of profit. Wicksell
made much of that! What about the real rate of interest?
15
Monetary Theory 2
Purchasing Power parity, exchange rates adjust according to
inflation differentials and – again – the change of the
money supply.
In favor of index-linked clauses in long term contracts.
Sandmo is not very enthusiastic about his monetary theory –
can’t see way!
16
Francis Ysidro Edgeworth (1845 – 1926)
Mathematical economist concerned with the interactions
between equlibrium and welfare.
.
What is utility? How to measure it and compare between
individuals?
We saw that economists from Cournot, Mill etc. discussed
utility and that Marshall intuitively argued that marginal utility
was negative and (therefore) the demand curve downward
sloping. He was also arguing that society would reach a
“maximum satisfaction” with regard to one market when it
was in equlibrium:
What is utility?
However, what is this ”maximum satisfaction?
A key to understanding this is Utilitarianism
(from Bentham). It can be measured, one can compare
between individuals and it can be aggregated!
Edgeworth worked with Exact Utilitarianism:
“We cannot count the golden sands of life; we cannot number
the “innumerable smile” of seas of love; but we seem to be
capable of observing that there is here a greater, there a less,
multitude of pleasure-units, mass of happiness; and that is
enough.”
Based on psychology, Edgeworth argued that marginal utility
of income must be decreasing.
Social welfare
My understanding of this is that Edgeworth in fact did believe
that one could compare utility between individuals! This is
believe contradicts the quote on the previous slide! Take from
a rich person an give to a poor will increase total utility; this is
what we call cardinal utility. It obviously has political
implications.
Social welfare is the sum of individual utility functions. As we
will se, Pareto had the opposite opinion while Pigou assumed
the same as Edgeworth (even though he did not care too
much). This is a very fundamental issue with enormous
consequences for politics!
Utility functions
Anyway, how do we measure the utility of one specific
individual?
As we saw, Marshall considered good after good (the partial
equlibrium approach):
Edgeworth realized that goods may be substitutes (butter and
cooking oil); consumption of one good dependent on the
consumption of another:
More consumption of x, less utility of y. Nevertheless,
obviously, it could be the other way round (university class
teaching and e-learning). What we now call complementary
goods.
Indifference curves
Coming so far, Edgeworth is the first to draw the indifference
curve (here a series of curves – each indicating a level of
individual utility
Why must these curves be
concave? Starting from a point
on one specific curve in the
North West corner, one is willing
to surrender much y to get
extra x et vice versa.
The shape of indifference curves
Why must these curves be concave? Starting from a point on
one specific curve in the North West corner, one is willing to
surrender much y to get extra x et vice versa.
Now, an exercise in transactions in a perfect equilibrium with :
There are two consumers A and B and two goods
X (first axis) and y (second axis). At the
beginning, they are in E1; A owns little x and
much y and the other way round with B. A’s
indifference curves are observed from A and B’s
from B. By making transactions both A and B can
improve their positions and obviously their utility;
both are moving to higher indifference curves. The
invisible hand working!
Sketching the perfect equilibrium
As Sandmo sketches by increasing infinitely the number of A’s
and B’s we end up with an equlibrium that is perfect
competition. This is what we call positive or descriptive
analysis.
Or on YouTube:
http://www.youtube.com/watch?v=fAbwlxb9ffE