A Short History of Economic Thought - makro.uni-jena.de · The Neoclassics Vilfredo Pareto...

The Neoclassics Vilfredo Pareto (1848-1923)

The Neoclassics

Vilfredo Pareto (1848-1923)

Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 72 / 148


Considered – together with Edgeworth and Marshall – as the most

influential founder of modern microeconomics

◮ Born Jul/15/1848 in Paris during the exile period of his father

◮ Studied mathematics and physics in Turin, later engineering, 1869

Ph.D. in engineering

◮ First job as an engineer in a railway construction firm

(locomotives)

◮ Unsuccessful attempts to be elected as a member of the Italian

parliament (opponent of protectionism and militarism)



◮ 1890: first meetings with Maffeo Pantaleoni (1857-1924),

Professor of Political Economy in Turin

◮ 1891: first meeting with Walras. Pantaleoni recommended Pareto

as Walras’ successor in Lausanne. 1893: extraordinary professor,

1894 ordinary professor in Lausanne

◮ Lectures contained in Cours d’Economie Politique; did not love

teaching (eventually 6 students)

◮ 1911: emeritation after several attempts to retire earlier

◮ Late years: ‘Villa Angora’ in Celigny (Switzerland). Side story:

numerous cats as conversation partners

◮ Died Aug/19/1923 in Celigny, Switzerland



Major works:

◮ Manuale di economia politica (1906)

(mainly foundations of his economics)

◮ Trattato di sociologia generale (1916)

(mainly sociological reflections)

Elements of Pareto’s economic œuvre

◮ Homo oeconomicus, utility, ophelemity, rational choice

◮ logical acts: identity of objective and subjective targets. Under

same conditions: same behavior of an agent according to rationalprinciples which reflect the scientific state of the art.

◮ non-logical acts: anything else, practical everyday behavior,perhaps irrational, traditionally motivated etc.



◮ Homo oeconomicus (cont.)

◮ ophelemity: subjective, internal welfare received from acting in a

certain manner. Example: cigarette smoking as a subjectivepleasure

◮ utility: objective, possibly external welfare (concerning others)derived from individual acts. Can include a negative ‘disutility’:

example of cigarette smoking as disturbing others or destroying

individual health

◮ homo oeconomicus: agent maximizing his ophelemity under

objective restrictions

◮ indifference curves: adopted from Edgeworth. Utility (and

ophelemity): not measurable, only ordinal statements (‘better’ or‘worse’); no cardinal scale. Indifference curves and budget

constraint suffice to determine rational choice



◮ General equilibrium

◮ Like Walras: GE as a state in which no agent has an incentive toleave the state

◮ GE described as a (relative) price system under which each agentacts according to his interests.

◮ Similarity with the mechanistic equilibrium concept

◮ No intrinsic objective ‘value’ of goods (like the ‘classics’ withobjective production costs or the ‘neoclassics’ with subjective

tastes).



◮ Efficiency

◮ Adopted from Edgeworth: concept of ‘contract curve’

◮ Consideration of the ‘ophelemity’; no interpersonal comparison of

these indexes.

◮ Perfect competition: ‘nobody’s situation can be improved without a

disadvantage to someone else. (Type I). No maximum welfare(since compensation requires utility comparison)

◮ Other frameworks (like monopoly): historic reasons for income

distribution (Type II); various ways to improve welfare



OA

OBx1B

x2A

x1A

x2B

I

II

Figure 2: Pareto’s Exchange Box (‘Edgeworth Box’)



◮ Efficiency (cont.)

◮ Start at an initial allocation xI = (x1A, x2A, x1B, x2B)

◮ the individual indifference curves intersecting at I form a ‘lens’ (c.f.the shaded region) that contains all allocations which are (at least)

preferred by both individuals (as compared with the initial allocation)

◮ a sequence of preferable allocations end where two indifferencecurves are tangential to each other (a ‘Pareto allocation’)

◮ the connection of all tangential points defines the so-called contractcurve

◮ Later extended to production economies. Presentation technique

was employed in many setups, e.g. international trade theory



◮ Pareto’s distribution ‘law’

◮ Relative number of members N in a set who possess a certaincumulative property y (cumulated from above)

(Example: share of persons in a group who receive an income of yor more)

N = by−α or, in logs: log N = b − α log y (3)

◮ According to Pareto: can be found in many socio-economicprocesses

◮ Popular (but often wrong or misleading) ‘20% to 80% rule’:

(Examples: “20% of a country’s population possess 80% of the

entire national wealth” or ‘20% of an effort yield 80% of the result;

the remaining 80% yield only the missing 20%’)



0

1

2

3

4

−1

−2

−3

−4

3 4 5 6log y

log N

Figure 3: A Pareto line


The Neoclassics Francis Ysidro Edgeworth (1845-1926)

The Neoclassics

Francis Ysidro Edgeworth (1845-1926)



Vital Dates, Education and Academic Career

◮ Born Feb/8/1845 in Edgeworthstown, Ireland, as the son of

Francis Beaufort Edgeworth, and Rosa Florentina Eroles, a

Catalonian refugee

◮ no school attendance but privately educated by home tutors

◮ 1862: start of his studies at Trinity College, Dublin; excellent

degree in classics

◮ 1867: move to Oxford; graduation in 1867 in the humanities

◮ Started a career as a barrister but studied (autodidactically)

mathematics and taught Greek and philosophy

◮ 1880: regular post as a lecturer on logic at King’s College, London



◮ Edgeworth became interested in economics after having been

introduced to Jevons who himself arranged contacts with Marshall

in Cambridge

◮ During his post at King’s College, Edgeworth became interested in

statistics and could publish numerous articles in the field. In 1888,

he received a full professorship at King’s College; in 1891 he was

appointed Drummond Professor of Political Economy at All Souls

College in Oxford.

◮ 1891 to 1926: editor and joint editor (together with J.M. Keynes,

among others) of the Economic Journal

◮ Retirement from his chair in 1922. Edgeworth died on

Feb/13/1926



Major Works

◮ New and Old Methods of Ethics. Oxford: Parker 1877

◮ Mathematical Psychics: An Essay on the Application of

Mathematics to the Moral Sciences. London: Paul Kegan 1881

◮ Metreike, or the Method of Measuring Probability and Utility.

London: Temple 1887

◮ Papers Relating to Political Economy. 3 volumes,. London:

Macmillan 1925



Elements of Edgeworth’s Work

◮ Probability theory and statistics: index numbers and mathematical

theories of banking. Explanation of banks’ demand for reserves in

terms of stochastic deposit losses

◮ Monopoly prizing and price discrimination. Discussion of

Cournot’s duopoly model with an emphasis on expected reactions

of competitors

◮ Introduction of indifference curves as contour lines; however,

utility still measured as cardinal quantities

◮ Description of the convexity of indifference curves



Edgeworth’s Work (cont.)

◮ Concentration on the core of an economy as that part of the

contract curve lying entirely in the lens described by the

indifference curves through the initial endowment

◮ Possibility of recontracting allows for an infinite number of final

allocations (indeterminacy result for an exchange process)


The Neoclassics Alfred Marshall (1842-1924)

The Neoclassics

Alfred Marshall (1842-1924)



Vital dates

◮ Born: July/26/1842 as the son of a bank cashier

◮ Maried to Mary Paley, a former student and later renowned

economist

◮ Died: July/13/1924 in Cambridge

Education and Academic Career

◮ 1862: St. John’s College, Cambridge. 2nd rank in a mathematics

contest. Later, M. switched to social sciences with an emphasis

on philosophical questions and moral foundations. 1868: College

Lecturer in Moral Sciences at St. John’s with an obligation to teach

economics

◮ 1875: trip to the US with the purpose of learning more about

economic conditions in other countries



Education and Academic Career (cont.)

◮ After the marriage with Mary Paley, M. had to leave the college in

Cambridge. Move to the newly founded University of Bristol.

Professor of Political Economy in 1882.

◮ After a stay in Oxford, return to Cambridge in 1883. Professor of

Political Economy in 1885. Early retirement in 1908 (with the plan

to quickly end the preparation of the second volume of the

Principles)

Major Works

◮ Principles of Economics. London: Macmillan 1890

◮ Industry and Trade. London: Macmillan 1919

◮ Money, Credit, and Commerce. London: Macmillan 1923



Elements of Marshall’s Work

Concentration on Partial Equilibrium Analysis

◮ Methodological Aspects

◮ Market excess supply and demand as the most important means to

establish “prices”

◮ Introduction of the notions of consumer’s rent and producer’s rent

◮ Introduction of the notion of ‘Elasticity’:

change of a dependent variable y (in %)

change of an independent variable x (in %)=

dy

y

dx

x

=

dy

dx·

x

y



A

S’

D’

F

H

Consumer’sRent

Producer’sRent

x

y

Figure 4: Marshall’s Supply and Demand Cross



◮ Methodological Aspects (cont.)

◮ Temporal Aspects (example: fish market from daily fixed supply toan adjustment of the entire fleet)

◮ Short period: supply is fixed; equil. price determined by demand

◮ Intermediate period: reaction of supply when short-run equil. prices

exceed production costs for some time

◮ long period: adjustment of capital and labor in order to persistently

increase supply

◮ Representative Agent as an artificial construct

◮ Qualitative Aspects

◮ International Trade (example below)

◮ Theory of the Firm (basic elements of ‘Industrial Organization’); therole of increasing and diminishing returns to scale; distinction

between internal and external economies of scale



International Trade

here: determination of the international exchange ratio

Problem: Ricardo established comparative cost advantages of 2

countries but could determine only the interval of the exchange ratio:

a1A/a2A < p1/p2 < a1B/a2B

Marshall’s approach

◮ definition of export/import functions for two countries (England

and Germany).

◮ Cost advantages: Germany for linen (flat a1G/a2G curve); England

for wool (steep a1E/a2E curve) (“1” for ‘linen’ and “2” for ‘wool’)

◮ ‘Offer curves’ intersect at the equilibrium ratio p∗1/p∗

2



E’s wool exportG’s wool import

E’s linen importG’s linen export

England

Germany

0

Figure 5: Marshall’s Determination of the International Exchange Ratio


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