The marginal Revolution

Ms Salma Shaheen

The marginal Revolution

• The marginal revolution took place in the latter half of nineteenth century. The marginalist school developed in many countries at the same time.

• The term marginal Revolution is applied to the writings of the above economist because they made fundamental changes in the apparatus of economic analysis.

• And they started looking at some of the important economic problems from altogether new angle different from the classical economist.

• Marginal economist has been used to analyze the single firm and its behavior, consumer behavior, the market for a single product, and the formation of individual prices.

• Marginalism dominates western economic thought for nearly a century until it was challenged by Keynesian attack in 1936.

• Keynesian economist however shifted the sphere of enquiry from microeconomics to macroeconomics, where the problem of the economy on the whole is analyzed.

• So the leading early marginalist felt the need for thoroughly revising the classical doctrines, especially the theory of value.

• They thought by rejecting the labour theory of value and by advocating the marginal theory of value, they could strike at the theoretical basis of socialism.

• Meaning of Marginal revolution and its implication for the theory of Value

• The classical theory emphasized on supply, production and cost. But the marginalist school emphasizes on consumption, demand and utility.

• Utility is key word of marginalist school.

• And they have used this concept to shift the emphasis from supply to demand and from cost to utility as the basis of value.

• The marginal analysis is regarded as an innovation in the method of approach of science.

• As has already be noted, the essential elements of modern techniques, namely the emphasis on demand and utility and the recognition of marginal utility were adopted in 19th century.

• The utility approach is subjective approach.

• Value is the central problem in exchange. We can consider the economic system as a number of interdependent markets. Then the central problem of economic enquiry becomes the explanation of exchange processor ,explanation of formation of price.

• The classical economist explains value in term of labour. It was an objective theory.

• The marginal utility theory school takes consumption as the starting point. The school claims that its theory of value independent of any social order.

• But as we have already noted , the classical theory was not strong enough to withstand the attacks of the growing working class movement.

• So the early marginalist abandoned the labour theory of value together.

• There is another point which we have to remember. Classical political economy was developed more or less entirely by English economist.

• Essential ideas of the Marginalist school.

• 1) The marginlaist school, concentrated on the ‘margin’ to explain economic phenomena. According to this school, all economic discussions are made at the point of margin. The marginal utility school extended the marginal principle to all economic doctrine

• We know that economist were in trouble for a long time about the paradox of value. For instance, water had great value in use but very low value in exchange. On the other hand, diamonds which had very low value in use had high exchange value.

• There explanation is presented by J.B.Say that air and water are so use full that their value is infinite and therefore we cannot buy them.

• On the other hand the marginal utility theory helps us to explain this theory.

• Though the total utility of water is great its marginal utility is very low. In the case of diamond as the supply is small, marginal utility tend to very high.

• As value depend on marginal utility, its command high value in exchange.

• 2) The approach of the marginalist school is microeconomics rather than the macroeconomics. The marginalist school does not deal with the aggregate economy. It deals with decision making of individual buyers and sellers, price of single commodity, the output of single firm and so on.

• In other words, it is concerned mainly with the problem of partial equilibrium analysis.

• 3) The marginal school has adopted the abstract and deductive method (deductive methods involve beginning with a

general concept or given rule and moving on to a more specific conclusion.)of classical economist.

• 4) The marginal utility analysis is based on the assumption of competition. There is larger buyer and sellers who can influence the decision making by their action.

• 5)while the classical economist consider the cost of production, that is supply, as the determinant of value, the marginalist school considered demand to be important element in the determination of value.

• 6) The analysis of marginal school is based on the subjective and psychological approach.

• The marginalist approach is based on the assumption of rational behavior on the part on individuals.

• The marginalist assumes that man act in a rational manner in balancing their pleasures and pain and in measuring the marginal utilities of different value.

• 8)the marginalist school believes that economic forces generally tend towards equilibrium.

• 9) Lastly the marginal school supported the laissez fair policy of classical economist.

Alfred Marshall (1842-1924)

• Alfred Marshall was the leader of the second generation of marginal utility school.

• One great difference between the economist of the earlier marginal utility school and the Marshall is that the early economist of marginalist school rejected the classical theory of value based on the cost of production.

• Marshall made an attempt to bring about a synthesis of the classical theory and the new theory based on marginal utility.

• On account of this, Marshall is sometimes also described as a leading neo- classical economist.

• Marshall was born in a middle class family in London in 1842.

• He was a son of cashier in the Bank of England.

• Marshall specialized in mathematics at Cambridge and latter on studies economics.

• He was professor of Economics at Cambridge from 1885 to 1908.

• Marshall’s masterpiece “the principles of economics”, appeared in 1890. His other important works included “economics of Industry”, in 1879, ‘Money, credit and commerce’ in 1924

• Nature and scope of economics

• According to Marshall, “political economy is a study of mankind in the ordinary business of life, it examines that pat of individual and social action which is most closely connected with the attainment and with the use of material requisites of well -being”.

• Marshall definition of economics is known as the materialistic welfare definition of economics.

• Marshall agreed with the view of Adam Smith that economics studies about the wealth. But it is only the part of the study.

• In his own words “thus it is on the one side a study of wealth and on the other hand and more important side a part of the study of man”.

• It may be interesting to note that Marshall treatise (discussion) was the first to establish the use of the term ‘Economics’ from 1890 in England and United State.

• In the nineteenth century , the term commonly in use was ‘Political economy’

• Economics Laws

• Marshall Regarded economics laws as statement of tendencies.

• He was the aware of the fact that they were not as exact as the law of Physics and Chemistry.

• Diagrammatic Approach• Though Marshall was an expert in Mathematics, he

had his own doubt the value of mathematics in economics.

• But he was in favour of using diagrams to illustrate theories.

• In fact he translated many of the theorems of Mill and Ricardo into diagrammatic language.

• Keynes described him as “founder of modern diagrammatic economics’

• Marginal utility of Demand• According to Marshall, demand is based on the law of

diminishing marginal utility.• The law tells that the marginal utility of a thing

diminishes with every increase in the amount of the person already has.

• We should remember that the law of diminishing utility is based on the following assumptions.

• 1) it refers to given amount in a time

• 2) there are no changes in the habits and taste

• 3) all units of a good are homogeneous

• Marshall stated the general law of Demand as follows.

• ‘the greater the amount to be sold, the small must be the price at which it is offered in order that it may find purchasers.

• Or in other words the amount demanded increases with a fall in price, and diminishes with a rise in price.’

• On the basis of diminishing utility, Marshall has developed the law of substitution, known as the law of equi marginal utility in consumption.

• The law tells that demand is based on the balancing of marginal utilities.

• A consumer will spend his money on different things in such a way that their marginal utilities are proportionate to their prices.

• Marshall believed that the marginal utility of a good could be measured in term of money.

• Consumer surplus

• Marshall has added the term consumer surplus to economic literature.

• Consumer surplus measured the difference between the potential price which a consumer is prepare to pay and the actual price he pays.

• The concept of consumer’s surplus has been derived from the law of diminishing marginal utility.

• Elasticity of Demand

• Marshall has introduced the concept of elasticity of demand to explain the rate of change of demand.

• The rate at which demand may change when price change is known as elasticity of demand.

• The law of demand tells us that when price fall, demand increases.

• But it does not tell to what extent the demand will change in price.

• The concept of elasticity of demand relates the fall in price to the percentage increase in quantity demand.

• The elasticity of demand at any price can be measured by the percentage change in the amount demanded divided by the percentage change in the price.

Elasticity of demand=Percentage change in Qd

Percentage change in price

• The concept of elasticity of demand is very useful in economics theory and practice.

• It is useful to studying the problem of value under monopoly.

• The monopolist generally fixes a higher price for commodities with inelastic demand rather than those with elastic demand.

• Again the monopolist can practice the price discrimination only with the elasticity of demand is different in different market.

• The problem has also helpful in studying the problem of taxation.

• Generally the govt. taxes those commodities with inelastic demand at a higher rate than those with elastic demand.

• Supply and cost of production

• According to Marshall, supply is governed by cost of production.

• And cost of production is measured in terms of money.

• But behind the monetary cost, there are the real cost.

• Thus Marshall has distinguished between the real cost of production and the expense of production.

• Supply increases when price increases. in other words supply curve upward slope.

• Marshallian theory of value and Time element

• For a long time, there was a controversy regarding what determined the value of a commodity.

• The classical economist said that the cost of production determined value.

• But the economist of early marginalist school promote demand, base on marginal utility.

• Marshallian theory of value combining both demand and supply side.

• According to Marshall, the forces behind both supply and demand determine the value.

• Behind demand is marginal utility. It is reflected in the demand price of buyer i.e. at the price at which given quantities are demanded.

• Behind supply is the real cost that is the marginal efforts and sacrifice.

• It is reflected in the supply price of sellers that is, the price at which the given quantities will be supplied.

• Marshallian theory of value, owing to its emphasis both on supply and demand as forces of governing value, is also known as “Dual theory of value’.

• The value is determined by the forces of supply and demand at the margin.

• It is the marginal utility and marginal cost of production that govern value.

• On the basis of time element, Marshall has classified value in to four kinds.

• 1) market value

• 2) Short period value

• 3) long period value

• 4) Secular value

• The market price of a commodity may be defined as the price ruling at a particular period.

• In the case of market price, the supply is fixed and price mainly determined by demand.

• For example take the example of perishable commodities.

• In the case of short period price, we may think supply as the amount which can be produced at the given price, with existing equipment and labour.

• In other words the short is defined as the period in which the variable inputs can be increased or decreased, but the fixed plant cannot be changed

• In case of long period, supply means, what can be produced by the plant which itself can be remuneratively produced and applied within given time.

• Marshall has conceived of gradual or secular change in normal price. Secular changes in normal value are caused by the changes in economic data:population, taste, capital, and so on.