Topics History Equilibrium 083

Franco Donzelli
Topics in the History of Equilibrium Analysis
Lesson 3
Marshall vs. Walras on
Equilibrium and Disequilibrium
Ph.D. Program in Economics
University of York
February-March 2008
Introduction 1
The problem:
Do Walrass and Marshalls approaches to price theory only differ in

the respective scope of the analysis (general vs. partial analysis)?
Or do they differ in presuppositions, aims, analysis, and results?
The received view as expressed by:
introductory and intermediate textbooks (e.g., Frank, Schotter,

Varian): graphical vs. algebraic development of price theory
advanced textbooks (e.g., Mas-Colell, Whinston, Green):

general analysis as a natural extension of partial analysis
Franco Donzelli
Lesson 3 - Marshall vs. Wa
Introduction 2
The working hypothesis:
Walrass and Marshalls approaches to price theory differ in essential

respects.
The main differences have to do with:
the basic assumptions about the functioning of the trading process
the nature of competition: perfect competition vs. bilateral

bargaining
the nature of the disequilibrium process: in either logical or real

time
the interpretation of the equilibrium construct: either an

instantaneous state or the limit point of a sequence in real time
the nature of prices: numeraire normalization vs. money prices
The manifest difference in the scope of the analysis, i.e., general vs.
partial analysis, is the necessary by-product of more fundamental
epistemological and theoretical differences
Franco Donzelli
Introduction 3
The structure of the presentation:
1.
A common ground for the analysis: the pure-exchange, twocommodity economy
2.
Walrass approach:
1.
2.
3.
4.
Marshalls approach:
3.
1.
2.
3.
4.
4.
basic assumptions about the trading process

the model of a pure-exchange, two-commodity economy
interpretation and textual evidence
limitations and extensions
basic assumptions about the trading process
the model of an Edgeworth Box economy
the temporary equilibrium model
limitations and extensions
Comparison between the two approaches and conclusions
Franco Donzelli
The pure-exchange, two-commodity economy 1
Walrass Elments dconomie politique pure:

I ed.: 1874-1877; II ed.: 1889; III ed.: 1896; IV ed. 1900; V ed.: 1926
Most important changes in II and IV editions
English ed.: 1954
Price theory: 31 Lessons out of 42

Pure-exchange, two-commodity economy: Lessons 5 to 10
A small part of overall price theory, but fundamental (as recognized by
Walras himself)
Marshalls Principles of Economics

8 editions, from 1890 to 1920
Most important changes in V edition (1907)
Price theory: Book V (out of 6, since II ed.)

Pure-exchange, two-commodity economy: Book V, Ch. 2 and App. F
A very small part of overall market equilibrium theory, but relevant
(Marshalls stance ambiguous on this)
Franco Donzelli
L = 2 commodities, indexed by l = 1, 2
I consumers-traders, indexed by i = 1, , I (I 2)
i = 1,, I,
a consumption set Xi = {xi (x1i, x2i)} = 2+ ;
a cardinal utility function ui: Xi , assumed additively

separable in its arguments, that is:
ui(x1i, x2i) = v1i (x1i) + v2i(x2i)

endowments i (1i, 2i) 2+ \ {0}
Let:
x = (x1,, xI) X = xi Xi 2I+ be an allocation
= i 2++ be the aggregate endowments
Ape2xI = {x X| xi = } be the set of feasible allocations
Assume:
ui() twice continuously differentiable, with

ui(xi) = (v1i(x1i), v2i(x2i)) >> 0 and (v1i(x1i), v2i(x2i)) << 0, xi Xi
Franco Donzelli
Let:
pe2xI = {(Xi, ui(), i)Ii=1} be a pure-exchange, two-commodity

economy
EB = pe2x2 = {(2+, ui(), i)2i=1} be an Edgeworth Box economy

Given pe2xI, x Ape2xI, let
MRSi21(xi) |dx2i/dx1i|ui(xi+dxi)=u(xi) = (u(xi)/u(x1i) / (u(xi)/u(x2i)
be consumer is marginal rate of substitution of commodity 2 for
commodity 1 when his consumption is xi
Let
zi(xi) (z1i, z2i)(xi) xi - i (x1i - 1i, x2i - 2i) 2
be consumer is excess demand, when his consumption is xi
If zli(xi) > 0, then zli(xi) is called consumer is net demand proper for
commodity I and consumer i is said to be a net buyer
If zli(xi) < 0, then |zli(xi)| is called consumer is net supply for
commodity I and consumer i is said to be a net seller
Franco Donzelli
Let us suppose that consumer i can trade commodity 2 for

commodity 1
If the marginal rate at which he can trade is

- dx2/dx1 = |dx2/dx1| = MRSi21(xi) ,
then his utility is unaffected by the trade, since in that case:
du(xi) = ui(xi)dxi = (u(xi)/u(x1i)dx1i + (u(xi)/u(x2i)dx2i = 0
On the contrary, if the marginal rate of exchange is

- dx2/dx1 = |dx2/dx1| < MRSi21(xi) ,
then consumer is utility increases (resp., decreases) if he is a net
buyer (resp., a net seller) of commodity 1
If instead the marginal rate of exchange is
- dx2/dx1 = |dx2/dx1| > MRSi21(xi) ,
then consumer is utility decreases (resp., increases) if he is a net
buyer (resp., a net seller) of commodity 1
Franco Donzelli
Hence the marginal rate of substitution of commodity 2 for

commodity 1, MRSi21(xi), can also be interpreted as the maximum
(resp., minimum) quantity of commodity 2 that a utility maximizing
buyer (resp., seller) of commodity 1 is willing to pay (resp., to
receive) at the margin in exchange for one unit of commodity 1,
when his consumption is xi.
MRSi21(xi) represents consumer is reservation price of commodity

1 in terms of commodity 2, when his consumption is x i.
Both Walras and Marshall do not exactly employ the above

conceptual apparatus
They do not make any strong monotonicity assumption, ui(xi) =

(v1i(x1i), v2i(x2i)) >> 0; Walras explicitly allows for consumers to
become satiated at finite consumption bundles. But to assume nonsatiation is an unobtrusive simplifying assumption.
They both ignore both the notion of marginal rate of substitution and
that of reservation price.
Franco Donzelli
Yet, they do know and systematically employ the notion of

marginal utility of commodity l for consumer i, which, under the
stated assumptions on the properties of the utility functions, is:
(ui(xi)/(xli)) = vli(xli), for l = 1, 2.
Moreover, though not explicitly discussing the notion of marginal

rate of substitution as such, they do implicitly make use of it in
their analyses, since they compute the ratio of any two marginal
utility functions and examine its role in the agents choices.
Hence the above conceptual apparatus, though slightly more

general than that originally employed by Walras or Marshall, can
legitimately be said to lie at the foundation of both economists'
demand-and-supply analyses.
Any further development of either Walrass or Marshalls

approach, however, requires further assumptions, which are
specific to either economist.
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10
Walrass three basic assumptions about the trading process 1
The three assumptions are separately stated, even if they are

obviously interrelated, and often confused (occasionally by Walras
himself) or jointly formulated in the literature.
The wording of the assumptions is carefully chosen in order to

make their statement consistent with Walrass original discussion,
ambiguities not excepted.
The three assumptions underlie not only the model of a pureexchange, two-commodity economy, but all of Walrass models (in
their final form).
The undefined terms in the assumptions will be first defined with

specific reference to the model of a pure-exchange, twocommodity economy, and then discussed with reference to the
whole Walrasian approach.
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11
Walrass three basic assumptions about the trading process 2
Assumption 1. (Law of one price" or "Jevons' law of

indifference")
At each instant of the trading process, a price is quoted in the
market for each commodity. Moreover, if any transaction
concerning a given commodity takes place at any instant of the
trading process, then it takes place at the price quoted at that
instant.
Assumption 2. ("Perfect competition")

All traders behave competitively, that is, they take prices as given
parameters in making their optimizing choices.
Assumption 3. ("No trade out of equilibrium")

No transaction concerning any commodity is allowed to take place
out of equilibrium.
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12
Walrass model of a pure-exchange, two-commodity economy 1
Let pe2xI = {(Xi, ui(), i)Ii=1} be the pure-exchange, two-commodity

economy under consideration.
Let p = (p1, p2) 2++ be the price system, where prices are
expressed in terms of units of account and are positive in view of
the strong monotonicity of preferences.
In view of assumption 1, the price system ought to be referred to

a particular instant of the trading process; but dating the variables
is unnecessary at this stage: for the exogenous variables
(consumption sets, preferences, endowments) are constant, while
the endogenous (prices and traders choices) are all
simultaneous.
Under assumptions 1 and 2, consumers optimizing choices are

homogeneous of zero degree in prices.
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13
Hence prices can be normalized without any effect on consumers

behavior.
Let p12 p1/p2) p21-1 be the relative price of commodity 1 in terms

of commodity 2, where the latter is taken as the numeraire of the
economy (which implies p2 1).
Solving the constrained maximization problem for consumer i

yields:
u i x 1i,x 2i
x 1i
u i x 1i,x 2i
x 2i
p 12
p 12 x 1i x 2i p 12 1i 2i ,
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14
From that system one gets consumer is Walrasian direct demand

and excess demand functions, for i = 1, , I:
xi(p12,i) and zi(p12, i) = xi(p12,i) - i
Under assumptions 1 and 2, aggregating demand and excess

demand functions over consumers is immediate, since they all
receive the same price signals (by assumption 1), which they take
as given parameters (by assumption 2). Hence let
z(p12, ) = i zi(p12, i) = i xi(p12,i) - i
be the aggregate demand function, where =(1,, I).

The market-clearing conditions can be written as:
z 1 p W12 , 0
z 2 p W12 , 0 ,
where p12W is a Walrasian equilibrium price of commodity 1 in terms

of commodity 2.
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15

From budget equations, by rearranging terms and summing over
consumers, we get the so-called Walras Law:
I
p z p , i
i 1 12 1i 12
z 2i p 12 , i p 12 z 1 p 12 , z 2 p 12 , 0, p 12 0 .
Due to Walras Law, equation (2) is necessarily satisfied when

equation (2) holds. Hence we can focus on equation (2).
Equation (2) has at least one solution, not necessarily unique

under the stated assumptions.
Each solution yields a Walrasian equilibrium price of commodity 1

in terms of commodity 2, p12W , to which a Walrasian equilibrium
allocation x(p12W ) = (x1(p12W ),, xi(p12W ),, xI(p12W )) is associated.
Franco Donzelli
16
Walrass model: textual evidence and interpretation 1
Right at the beginning of Lesson 5 of the Elments, one finds a

long illustrative passage, where the functioning of the market for
3 per cent French Rentes is described in detail:
Let us take, for example, trading in 3 per cent French Rentes on
the Paris Stock Exchange and confine our attention to these
operations alone. The three per cent, as they are called, are
quoted at 60 francs. [...]
We shall apply the term effective offer to any offer made, in this
way, of a definite amount of a commodity at a definite price. [...]
We shall apply the term effective demand to any such demand for
a definite amount of a commodity at a definite price.
We have now to make three suppositions according as the
demand is equal to, greater than, or less than the offer.
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17

First supposition. The quantity demanded at 60 francs is equal to
the quantity offered at this same price. [...] The rate of 60 francs is
maintained. The market is in a stationary state or equilibrium.
Second supposition. The brokers with orders to buy can no longer
find brokers with orders to sell. [...] Brokers [...] make bids at 60
francs 05 centimes. They raise the market price.
Third supposition. Brokers with orders to sell can no longer find
brokers with orders to buy. [...] Brokers [...] make offers at 59
francs 95 centimes. They lower the price.
(Walras, 1954, pp. 84-85)
As this passage reveals, Walrass starting point is represented by

a very realistic picture of the trading process, a picture which
stands at a very great distance from the image of that same
process emerging from the basic assumptions and the formal
model.
Franco Donzelli
18
Which is the true Walras?
The first striking difference between the model and the securities
example lies in the moneyless character of the former as
contrasted with the monetary character of the latter.
This is particularly relevant when we consider the monetary

character of Marshalls temporary equilibrium model, where
corn is traded for money on the daily market of a small town
(corn, instead of securities, is the commodity traded for money
in Walrass original example in his 1874 first theoretical
contribution, the mmoire entitled Principe dune thorie de
lchange).
On this point, however, Walras is very clear. For, a few lines after
the securities example, he adds:
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19
Securities, however, are a very special kind of commodity.

Furthermore, the use of money in trading has peculiarities of its
own, the study of which must be postponed until later, and not
interwoven at the outset with the general phenomenon of value in
exchange. Let us, therefore, retrace our steps and state our
observations in scientific terms. We may take any two
commodities, say oats and wheat, or, more abstractly, (A) and
(B). (Walras, 1954, pp. 86-87)
Coming now to the three basic assumptions about the trading

process, we see that all three of them are apparently
disconfirmed in the securities example:
traders make prices, so that assumption 2 is violated;
different price bids can apparently coexist in time, so that also

assumption 1 fails;
trades can actually occur at out-of-equilibrium prices, so that

assumption 3 is violated as well.
Franco Donzelli
20
Also in this case Walras tries to sharply distinguish the informal

presentation of an issue by means of an example from the scientific
discussion of the same issue by means of a formal model.
As far as assumptions 1 and 2 are concerned, his line of defense is

not wholly convincing, but in the end they are vindicated.
What is really problematic is Walrass attitude towards assumption 3:
it is very likely that Walras did not initially realize the need for
such assumption as far as the pure-exchange model is
concerned;
it is certain that he did not make any similar assumption

concerning the production model in any one of the first three
editions of the Elments, that is, up to at least 1896.
But to allow out-of-equilibrium trades to actually occur in the

economy, as Walras does at least as far as the production model up
to 1896 is concerned, is inconsistent with the requirements of
equilibrium determination in Walrass approach.
Franco Donzelli
21
In the pure-exchange model the occurrence of disequilibrium

transactions would make the equilibrium indeterminate
by altering the data of the economy (individual endowments)
by altering such data in an unpredictable way, for while

Walrass theory can predict the optimally chosen plans of action
at both equilibrium and disequilibrium, it can only predict the
individual actions when the economy is at equilibrium.
Bertrands critique (1883) and Walrass reaction (1885)
In the second edition (1889), Walras changes the securities
example, by adding
the words "Exchange takes place" in the case of market

equilibrium;
the expressions "Theoretically, trading should come to a halt"

and "Trading stops" in the case of excess demand and excess
supply, respectively.
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22
Walrass model: limitations and extensions 1
Walras strenuously resists the generalized adoption of the no-tradeout-of-equilibrium assumption because, together with the other two,
it turns
the adjustment process towards equilibrium into a virtual,

unobservable process occurring in a logical time entirely
disconnected from the real time over which the economy
evolves;
the equilibrium concept into an instantaneous equilibrium

concept, instantaneously arrived at in one instant of real time.
All this appears to Walras overly unrealistic and potentially

undermining the empirical content of the theory
Yet there is a trade-off between unrealism and generality, which

eventually convinces Walras to endorse all the three basic
assumptions about the trading process
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23
Walrass model: limitations and extensions 2
Concerning generality:
by assuming perfect competition and the law of one price, Walras

(unlike Jevons and Marshall) can immediately attack the problem of
equilibrium determination in a pure-exchange economy with any finite
number of traders, rather than just two;
by giving up the descriptively realistic hypothesis that one of the two

commodities be money, and by deciding to normalize prices by means
of a numeraire, he makes the transition from a two-commodity to a
multi-commodity economy easier: for, when all commodities are
symmetrical, and every one can indifferently play the role of the
numeraire, the dimensionality of the price system (two vs. many
prices) becomes irrelevant; moreover, the cardinality assumption is
irrelevant and can be dispensed with;
by making the no-trade-out-of-equilibrium assumption, on top of

assuming perfect competition and the law of one price, he arrives at
defining a concept of instantaneous equilibrium which can be easily
applied, without significant change, to economies that are more
general than the pure-exchange economy, such as economies with
production, capital formation, and even money.
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24
Marshalls basic assumptions about the trading process 1
Marshall does not assume traders to behave competitively (in

Walrass sense), that is, as price-takers and quantity-adaptors.
Hence, in Marshall one does not find individual and aggregate

demand functions of the Walrasian type, since the latter depend on
the perfect competition assumption and the law of one price.
Marshalls fundamental ideas about the trading process are that:
the trading process should be viewed as a sequence of bilateral

bargains, each involving two consumers at a time
the conditions governing each individual bargain depend on the
MRSs of the two traders participating in it, viewed as reservation
prices (of either a buyer or a seller, as the case may be).
Precisely, let us focus on consumer i.
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25
Let MRS21i(1i,2i) = (u(1i,2i)/u(x1i) / (u(1i,2i)/u(x2i) be the

initial value of consumer is marginal rate of substitution of commodity
2 for commodity 1
Supposing j s.t. j i and MRS21j(1j,2j) MRS21i(1i,2i), let

kij() = min {MRS21i(1i,2i), MRS21j(1j,2j)}
and
Kij() = max {MRS21i(1i,2i), MRS21j(1j,2j)}
A bilateral bargain involving a marginal trade (dx1i,dx2i) = - (dx1j,dx2j)

between traders i and j is weakly advantageous to both iff
| (dx2i/dx1i)| = |(dx2j/dx1j| [kij(),Kij()]
Marshall assumes that any weakly advantageous bargain will

be exploited.
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26
Hence, if the traders initial endowments are not all alike, the initial
allocation will change. But, the direction of change cannot be
predicted.
Similarly, even if one can predict that the trading process will come
to an end, neither the final allocation nor the final rate of exchange
can be predicted, failing further assumptions.
According to Marshall, this sort of indeterminacy is characteristic of

any trading process involving two commodities proper, that is, to any
system of barter.
To discuss the problem of indeterminacy, as well as other aspects of

barter, Marshall focuses attention on an Edgeworth Box economy
EB = pe2x2 = {(2+, ui(), i)2i=1} .
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27
Marshalls model of an Edgeworth Box economy 1
Marshall shows that the barter process between two consumers

trading apples for nuts may follow a number of alternative paths,
each of which eventually terminates
because any terms that the one is willing to propose would be
disadvantageous to the other. Up to this point exchange has
increased the satisfaction on both sides, but it can do so no further.
Equilibrium has been attained; but really it is not the equilibrium, it is
an accidental equilibrium (Marshall, 1961a, p. 791; Marshall's
italics).
So, any final allocation or rate of exchange is an equilibrium

allocation or rate of exchange. But, in general, any such equilibrium
is accidental or arbitrary
There is however a path, characterized by a constant rate of

exchange between the two commodities over the exchange process,
which stands apart from all the other possible paths, occupying a
position that, according to Marshall, is theoretically unique, though
practically irrelevant.
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28
There is, however, one equilibrium rate of exchange which has

some sort of right to be called the true equilibrium rate, because if
once hit upon would be adhered to throughout. [...] This is then the
true position of equilibrium; but there is no reason to suppose that it
will be reached in practice (Marshall, 1961a, p. 791)
Let us formalize Marshalls discussion. Let i =1,2. Assuming

MRS211(11,21) MRS212(12,22), let
k12() = min {MRS211(11,21), MRS212(12,22)} <
< max {MRS211(11,21), MRS212(12,22)} = K12 ()
The Pareto set of EB is the set
P EB x P A 2pe 2 MRS 121 x P1 MRS 221 x P2 ,

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29
while the contract curve of EB is the set
C EB x C P EB u 1 x C1 u 1 1 , u 2 x C2 u 2 2 .
CEB . Any xC CEB is an equilibrium allocation and any

MRS21i(xjC) = p1C, for i =1, 2 is an equilibrium rate of exchange, but
in general such equilibria would be arbitrary.
Only a rate of exchange p1* = MRS211(x1*) = MRS212(x2*)

satisfying the additional condition
p 1
x 21
21
x 11 11
x 22
22
x 12 12
being constant over the trading process, would qualify as a true

equilibrium rate.
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30
Finally, since
MRSi21(xi) |dx2i/dx1i|ui(xi+dxi)=u(xi) = (u(xi)/u(x1i) / (u(xi)/u(x2i),
for i = 1,2, in Marshalls true equilibrium the following condition also
holds:
u i x i u i x i
/
x 1i
x 2i
dx 2i
dx 1i
x 2i
2i
x 1i 1i
which is nothing but Jevons equilibrium condition, as expressed in

The Theory of Political Economy (1871, Ch. 4, pp. 142-143).
As can be seen, the extreme form of Jevons law of indifference is

interpreted by Marshall as an equilibrium condition, precisely, as a
condition for achieving a true equilibrium. But but there is no
reason to suppose that it will be reached in practice.
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31
For Marshall, the indeterminacy of equilibrium in the apple and

nuts model depends on its being a model of barter:
The uncertainty of the rate at which the equilibrium is reached
depends indirectly on the fact that one commodity is being bartered
for another instead of being sold for money. For, since money is a
general purchasing medium, there are likely to be many dealers
who can conveniently take in, or give out, large supplies of it; and
this tends to steady the market. (Marshall, 1961a, p. 793)
As far as the indeterminacy problem is concerned, the fundamental

property of money is that its marginal utility is practically constant
This allows one to distinguish between the theory of barter (two

commodities) and the theory of buying and selling (money and
commodity)
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32

The real distinction then between the theory of buying and selling
and that of barter is that in the former it generally is, and in the latter
it generally is not, right to assume that the stock of one of the things
which is in the market and ready to be exchanged for the other is
very large and in many hands; and that therefore its marginal utility
is practically constant. (Marshall, 1961a, p. 793)
According to Marshall, if one commodity (nuts) shared the

essential properties of money (constant marginal utility), then the
indeterminacy problem would not arise in the Edgeworth Box model
either.
Let EBm = pe2x2,m be an Edgeworth Box economy where the first

commodity (apples) still is a commodity proper, but the second one
(nuts) is a money-like commodity, with constant marginal utility
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33
Let consumer is utility function be quasi-linear in commodity 2, that is:
u i x 1i , x 2i v 1i x 1i x 2i ,
i 1, 2 ,
where (ui(x1i, x2i)/(x1i)) = v1i(x1i), assumed positive and decreasing for

x1i [0, 1], depends only on the quantity consumed of commodity 1,
while (ui(x1i, x2i)/(x2i)), the marginal utility of the money-like commodity,
is constant (normalized to 1).
Hence
MRS21i(xi) = (ui(x1i, x2i)/(x1i)) / (ui(x1i, x2i)/(x2i)) = v1i(x1i)
depends only on the quantity consumed of commodity 1.
Let
d1i(x1i,1i) = max {0, x1i - 1i}
be consumer is net demand proper for commodity 1 for x1i [0, 1]
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34

s1i(x1i,1i) = |min {0, x1i - 1i}|
be consumer is net supply of commodity 1 for x1i [0, 1]
If x1i > 1i, then d1i(x1i,1i) > 0 and consumer i is a net buyer of
commodity 1; hence MRS21i(xi) = v1i(x1i) can be interpreted as a
buyers reservation price, or demand price.
If x1i < 1i, then s1i(x1i,1i) > 0 and consumer i is a net seller of
commodity 1; hence MRS21i(xi) = v1i(x1i) can be interpreted as a sellers
reservation price, or supply price.
Consumer is Marshallian inverse supply correspondence of

commodity 1, p1is: [0,1i] +, is defined as follows:
p1is(s1i) = [0,v1i(x1i)] for s1i = 0
p1is(s1i) = v1i(1i s1i) for s1i (0,1i) (a continuous increasing function)
p1is(s1i) = [v1i(0),) for s1i = 1i
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35
Consumer is Marshallian inverse demand correspondence for

commodity 1, p1id: [0,1 - 1i] +, is defined as follows:
p1id(d1i) = (, v1i(1i)] for d1i = 0
p1id(d1i) = v1i(1i + d1i) for d1i (0, 1 - 1i) (a continuous decreasing
function)
p1id(d1i) = (v1i(1), 0] for d1i = 1 - 1i
By taking the inverses of the above two functions, and suitably

extending them to cover the whole price domain, one gets the
Marshallian direct supply and demand functions.
Consumer is Marshallian direct supply function of commodity 1 is the

continuous function s1i: + [0,1i] defined as follows:
s1i(p1is) = 0 for p1is [0, v1i(1i))
s1i(p1is) = 1i (v1i)-1(p1is) for p1is [v1i(1i), v1i(0))
s1i(p1is) = 1i for p1is [v1i(0), )
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Consumer is Marshallian direct demand function for commodity 1 is

the continuous function d1i: + [0, 1 - 1i] defined as follows:
d1i(p1id) = 0 for p1id (, v1i(1i)]
d1i(p1is) = (v1i)-1(p1id) - 1i for p1id (v1i(1i), v1i(1)]
d1i(p1id) = 1 - 1i for p1id (v1i(1),0]
Let p1mind = mini {v1i(1)} and p1maxd = maxi {v1i(1i)};

let p1mins = mini {v1i(1i)} and p1maxs = maxi {v1i(0)}.
If the consumers tastes are not identical, then p1maxd > p1mins
Let d1(p1d) = i d1i(p1id), for p1d = p1id, for i = 1, 2 and p1d [0, );
let s1(p1s) = i s1i(p1is), for p1s = p1is, for i = 1, 2 and p1s [0, ).
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The functions d1() and s1(), arrived at by aggregating the individual

demand and supply functions over consumers, are called the Marshallian
aggregate demand and supply functions for commodity 1, respectively.
d1() is nonincreasing in p1d, and strictly decreasing for

p1d [p1mind, p1maxd], except possibly when d1i = 1 1i, i = 1,2
s1() is nondecreasing in p1s, and strictly increasing for
p1s [p1mins, p1maxs], except possibly when s1i = 1i, i = 1,2

Hence, supposing p1maxd = v1i(1i) and p1mins = v1j(1j), i, j = 1, 2 and i j,
and assuming v1i(1i) < v1j(0), there must exist a unique price
p1M = p1dM = p1sM (p1mins,p1maxd) s.t.
or
Franco Donzelli
d 1 p M1 s 1 p M1
d 1 p M1 s 1 p M1 0
38

where p1M is the Marshallian equilibrium price of commodity 1 in terms
of commodity 2, while the common value d1(p1M) = s1(p1M) = q1(p1M) is
the Marshallian equilibrium total traded quantity of commodity 1, or,
for short, the equilibrium quantity of commodity 1.
Equation (7) resembles the Walrasian equilibrium equation (2), any

solution of which is a Walrasian equilibrium price of commodity 1 in
terms of commodity 2, p12W .
Yet, in spite of its appearance, and unlike equation (2), equation (7) is
not a market-clearing equation; similarly, p1M, unlike p12W , is not a
market a market-clearing price.
In fact, in general, the two consumers will not carry out their trades at
the constant rate p1M; and yet, even if different trades take place at
different rates, at the end of the process the total quantity traded of
commodity 1 will still be equal to the common value q1(p1M).
Franco Donzelli
39
An illustration:
Assumption 1. (Utility functions quadratic in commodity 1 and quasi-linear

in commodity 2)
ui(x1i, x2i) = v1i(x1i) + v2i(x2i) = ai(x1i - 1i) - bi(x1i - 1i)2 + x2i, i = 1,2.
Hence: MRS21i(xi) = v1i(x1i) = ai - bi(x1i - 1i) , i = 1,2.
Assumption 2.
K12() = MRS211(1) = a1 > a2 = MRS212(2) = k12()
Assumption 3.
11 < 12 ; v11(1) < v12(0)
Equilibrium:
p11d(d11) = p11s(s12) and d11 = s12 . Hence:
p1M = (a1b2 + a2b1) / (b1 + b2) ;
q1M = (a1 - a2) / (b1 + b2)
Franco Donzelli
40

p11d,
p11s
p12d,
p12s
p11s
p12
p1d,
p1s
p1maxs
v11(11)
s1(p1s)
p1maxd
p1M
v12(12)
p1mins
d1(p1d)
p1mind
p11d
11
1 -11
Franco Donzelli
p12d
d11, s11
1 - 12
12
d12, s12
q1M
41
1 d , s
1
1
When the two consumers have already cumulatively traded a

quantity q1 of commodity 1, such that q1 [0, q1(p1M)), there still
exists a positive difference between the demand and the supply price
of commodity 1 corresponding to q1, that is p1d(q1) - p1s(q1) > 0.
Hence there still is room for a weakly advantageous marginal trade

between the two consumers, at any rate of exchange
p1 [p1d(q1),p1s(q1)]
The rate of exchange p1M ought to be interpreted as the final rate to

which the sequence of the rates at which the consumers have traded
during the trading process necessarily converges, along a path which
may exhibit no regularity other than the stated convergence.
The total quantity of commodity 1 traded by the traders, q1(p1M)),

ought instead to be interpreted as the quantity of commodity 1 to
which the monotonically increasing sequence of the quantities
cumulatively traded by the consumers during the exchange process
necessarily converges.
Franco Donzelli
42
The total quantity of the money-like commodity 2 cumulatively

traded by the consumers at the end of the trading process remains
undetermined, its final value being however necessarily confined to
the interval
q 1 p M
q 1 p M
1 s
1 d
p 1i s 1i ds 1i ,
p 1j d 1j dd 1j
0
0
where i, j = 1,2, i j; i, j are s.t. v1i(1i) = p1mins and v1j(1j) = p1maxd.
Hence in Marshalls model there exists no counterpart of equation

(2) in Walrass model, where it provides the market-clearing
condition for commodity 2.
Further, in Marshalls model there is nothing comparable to Walras

Law, even if, due to the bilateral character of any exchange, the
total value of sales must always equal that of purchases for each
consumer, hence for the whole economy.
Franco Donzelli
43
Marshalls temporary equilibrium model 1
Marshall's "temporary equilibrium" model actually consists in a limited

extension of his Edgeworth Box model with a money-like commodity to a
pure-exchange, two-commodity economy with an arbitrary finite number
of traders, that is, an economy
pe2xI,m = {(2+, ui(), i)Ii=1} with I >2,
where commodity 1 is a consumers' good, commodity 2 is money, and the
marginal utility of commodity 2 is assumed to be constant.
An ambiguity of the model:
formally: an entire economy general equilibrium analysis

substantially: a single market partial equilibrium analysis
Effects on the possibility of formalizing Marshalls empirical justifications

for assuming the marginal utility of money to be constant:
money should be in large supply and general use (possible)
the expenditure on the good for which money is traded should
represent a small part of [each traders] resources (meaningless)
Franco Donzelli
44
Assumption 1 (new):
No strategic or game-theoretic considerations are allowed: each
bilateral bargain is regarded as a self-contained transaction by the
two traders involved in it, so that each trader, in deciding whether to
get engaged in a bargain, takes into account only the immediate
effects of that bargain on his utility. (Edgeworth and Berry)
Assumption 2:
An individual bargain can only take place if it is weakly
advantageous for the two consumers involved in it.
Assumption 3:
Each consumer will not stop trading as long as he can increase his
utility by so doing.
Under these assumptions, the generalization of the model of an

Edgeworth Box economy with a money-like commodity, EBm =
pe2x2,m, to the "temporary equilibrium" model of a pure-exchange
economy with I consumers, pe2xI,m, with I > 2, is immediate.
Franco Donzelli
45
We shall rewrite equations (6) and (7) as:

I I,M
d I1 p I,M
s
1
1 p 1
I I,M
d I1 p I,M
s
1
1 p 1 0 ,
it being understood that, in deriving equations (8) and (9), the

Marshallian aggregate demand and supply functions for commodity 1
are, respectively:
d1I(p1d) = i d1i(p1id), for p1d = p1id, for i = 1, , I, and p1d [0, ),
and
s1I(p1s) = i s1i(p1is), for p1s = p1is, for i = 1, , I, and p 1s [0, ).
In equations (8) and (9) p1M is the Marshallian temporary equilibrium

money price of commodity 1, while the common value d 1(p1M) = s1(p1M)
= q1(p1M) is the Marshallian temporary equilibrium quantity of
commodity 1.
Franco Donzelli
46
Marshalls interpretation of equations (8) and (9) is essentially the

same as that of equations (6) and (7). Yet Marshalls claims are not
entirely justified.
Marshalls temporary equilibrium model is developed by means of

an example, referring to a corn market in a country town, where
corn is traded for money. The illustration is based on the facts
summarized by the following table (Marshall, 1961a, pp. 332-333):
At the price Holders will be Buyers will be
Franco Donzelli
willing to sell
willing to buy
37s.
1000 quarters
600 quarters
36s.
700
"
700
"
35s.
600
"
900
"
47

Many of the buyers may perhaps underrate the willingness of the
sellers to sell, with the effect that for some time the price rules at the
highest level at which any buyers can be found; and thus 500
quarters may be sold before the price sinks below 37s. But
afterwards the price must begin to fall and the result will still
probably be that 200 more quarters will be sold, and the market will
close on a price of about 36s. For when 700 quarters have been
sold, no seller will be anxious to dispose of any more except at a
higher price than 36s., and no buyer will be anxious to purchase any
more except at a lower price than 36s.
In the same way if the sellers had underrated the willingness of the
buyers to pay a high price, some of them might begin to sell at the
lowest price they would take, rather than have their corn left on their
hands, and in this case much corn might be sold at a price of 35s.;
but the market would probably close on a price of 36s. and a total
sale of 700 quarters. (Marshall, 1961, p. 334)
Here we have a distinctly non-Walrasian equilibration process, since

out-of-equilibrium trades are explicitly allowed for.
Franco Donzelli
48
And yet the process is said to converge to a well-determined price of

corn in terms of money (36s.) and a well-determined total traded quantity
of corn (700 quarters), where such price and quantity incidentally
coincide with the Walrasian equilibrium ones.
According to Marshall, also in this case the determinateness of

equilibrium crucially depends on the "constant marginal utility of money"
assumption.
But is Marshall justified in supposing that the "constant marginal utility of

money" assumption is sufficient for granting equilibrium determinateness
in a pure-exchange economy with many traders, pe2xI,m with I>2, as it
was in an Edgeworth Box economy with a money-like commodity, EBm?
The answer is: not quite.
In the model of an Edgeworth Box economy with a money-like

commodity, the sharp result which has been obtained concerning p1M, the
Marshallian equilibrium price of commodity 1 in terms of commodity 2,
crucially depends on the existence of only two traders in the economy.
Franco Donzelli
49
With only two traders, the marginal rate of exchange at which the last marginal
trade occurs necessarily coincides with both the marginal demand price of the only
marginal buyer, p1d(q1(p1M)), and the marginal supply price of the only marginal
seller, p1s(q1(p1M)).
Hence, assuming uniqueness of the equilibrium price, it also necessarily coincides

with p1M, which can therefore be legitimately interpreted as the final rate to which
the sequence of the rates at which the traders have traded during the exchange
process necessarily converges.
But in Marshall's "temporary equilibrium" model there are more than two traders in
the economy: hence, in general, not only there may exist more than one marginal
buyer or seller, but also there may be some buyers or sellers that are not marginal.
Due to this, in Marshall's "temporary equilibrium" model the total quantity of

commodity 1 traded in the market still converges to the Marshallian "temporary
equilibrium" quantity, q1(p1M), but the sequence of the money prices of commodity 1
at which the traders buy and sell that commodity during the trading process no
longer necessarily converges to the Marshallian "temporary equilibrium" price, p1I,M:
the outcome depends on the order of the matchings.
50
Franco Donzelli
Marshalls pure-exchange models: limitations and extensions 1
Marshalls Edgeworth Box model is propedeutical to his temporary

equilibrium model, which is in turn propedeutical to Marshalls
normal equilibrium models.
But, even if propedeutical, Marshalls pure-exchange models still

play a fundamental role in the overall structure of Marshalls
thought.
In his pure-exchange, two-commodity models Marshall wants to

show how an equilibrium comes to be established as the final
outcome of a realistic process of exchange in "real" time, where
trades can actually take place at out-of-equilibrium rates of
exchange or prices.
This program inevitably raises the issue of equilibrium determinacy.
Marshall's solution consists in imposing some related restrictions on

the traders' utility functions, which are assumed to be quasi-linear in
one of the two commodities, and the nature of the commodities
themselves, one of which is interpreted as a money-like commodity
or money tout court.
Franco Donzelli
51
Marshalls pure-exchange models: limitations and extensions 2
But, at the same time, Marshall inexorably restrains the scope of

his analysis.
His suggested solution of the equilibrium indeterminacy problem

only applies when no more than one commodity proper is explicitly
accounted for in the model, so that the only unknowns to be
determined boil down to the money price and the quantity traded of
that single commodity proper.
There is no way to extend to a multi-commodity world, made up of

many interrelated markets, the results achieved by Marshall within
his one-commodity world, consisting in the isolated market where
the only commodity proper explicitly contemplated by the model is
traded for money.
Marshall's analysis remains necessarily confined to the partial

equilibrium framework in which it is originally couched, even when
production is brought into the picture, as it happens with normal
equilibrium models.
Franco Donzelli
52
Conclusions 1
In this paper we have contrasted the received view on price theory,

according to which Walrass and Marshalls approaches, while
differing in scope, are basically similar in their aims, presuppositions,
and results.
By focusing on the pure-exchange, two-commodity economy, which

has been formally studied by both Walras and Marshall with the help
of similar tools, we have been able to precisely identify the
differences between the two approaches.
First, the very basic assumptions underlying the analysis of the

trading process and shaping the conception of a competitive
economy have been shown to widely differ between the two
economists.
Secondly, it has been shown that, starting from such different sets of
assumptions, the two authors arrive at entirely different models of
the pure-exchange, two-commodity economy.
Franco Donzelli
53
Conclusions 2
By reducing the trading process to a purely virtual process in "logical"

time, Walras arrives at a well-defined notion of "instantaneous"
equilibrium, which can be easily extended to more general contexts (such
as pure-exchange, multi-commodity economies and production
economies).
By making a few further assumptions on the characteristics of the traders

and the nature of the commodities involved, one of which must be money
or a money-like commodity, Marshall can indeed show that a determinate
(or almost determinate) equilibrium emerges from a process of exchange
in "real" time with observable out-of-equilibrium trades.
But his analysis cannot be significantly generalized beyond the partial

equilibrium framework in which it is necessarily couched from the
beginning.
There exists a trade-off between realism and scope of the analysis:

the more realistic the representation of the disequilibrium trading process,
the less comprehensive and general is equilibrium analysis.
Franco Donzelli
54

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Franco Donzelli

Topics in the History of Equilibrium Analysis

Do Walrass and Marshalls approaches to price theory only differ in

Or do they differ in presuppositions, aims, analysis, and results?

The received view as expressed by:

introductory and intermediate textbooks (e.g., Frank, Schotter,

advanced textbooks (e.g., Mas-Colell, Whinston, Green):

Lesson 3 - Marshall vs. Wa

The working hypothesis:

Walrass and Marshalls approaches to price theory differ in essential

The main differences have to do with:

the basic assumptions about the functioning of the trading process

the nature of competition: perfect competition vs. bilateral

the nature of the disequilibrium process: in either logical or real

the interpretation of the equilibrium construct: either an

the nature of prices: numeraire normalization vs. money prices

Lesson 3 - Marshall vs. Wa

The structure of the presentation:

A common ground for the analysis: the pure-exchange, twocommodity economy

basic assumptions about the trading process

Comparison between the two approaches and conclusions

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 1

Walrass Elments dconomie politique pure:

Price theory: 31 Lessons out of 42

Marshalls Principles of Economics

Price theory: Book V (out of 6, since II ed.)

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 2

a consumption set Xi = {xi (x1i, x2i)} = 2+ ;

a cardinal utility function ui: Xi , assumed additively

ui(x1i, x2i) = v1i (x1i) + v2i(x2i)

x = (x1,, xI) X = xi Xi 2I+ be an allocation

= i 2++ be the aggregate endowments

Ape2xI = {x X| xi = } be the set of feasible allocations

ui() twice continuously differentiable, with

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 3

pe2xI = {(Xi, ui(), i)Ii=1} be a pure-exchange, two-commodity

EB = pe2x2 = {(2+, ui(), i)2i=1} be an Edgeworth Box economy

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 4

Let us suppose that consumer i can trade commodity 2 for

If the marginal rate at which he can trade is

On the contrary, if the marginal rate of exchange is

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 5

Hence the marginal rate of substitution of commodity 2 for

MRSi21(xi) represents consumer is reservation price of commodity

Both Walras and Marshall do not exactly employ the above

They do not make any strong monotonicity assumption, ui(xi) =

Lesson 3 - Marshall vs. Wa

The pure-exchange, two-commodity economy 6

Yet, they do know and systematically employ the notion of

Moreover, though not explicitly discussing the notion of marginal

Hence the above conceptual apparatus, though slightly more

Any further development of either Walrass or Marshalls

Lesson 3 - Marshall vs. Wa

Walrass three basic assumptions about the trading process 1

The three assumptions are separately stated, even if they are

The wording of the assumptions is carefully chosen in order to

The undefined terms in the assumptions will be first defined with

Lesson 3 - Marshall vs. Wa

Walrass three basic assumptions about the trading process 2