Chapter 6.1-2

CHAPTER six
6.1-6.2
THE
MARGINALIST
SCHOOL
OUTLINE
 Overview of the Marginalist School, The Maximization

Principle
 Forerunners of Marginalism:
 Antoine Augustin Cournot and Herman Heinrich Gossen
 First - Generation Marginalists:
 Jevons, Walras, and The Austrian School
 Second - Generation Marginalists:
 Edgeworth, Clark,
Samuel S. WLDU HET,2016
OMS… The HB of the Marginalist School
 Serious economic and social problems remained

unsolved even a hundred years after the beginning of
the industrial revolution.
 Poverty was widespread, although productivity was
increasing dramatically.
 The extremely uneven distribution of wealth and income

created much dissatisfaction even though the general
standard of living was rising.
 Business fluctuations affected many people adversely….So

and so forth.
 These and others caused people to seek solutions beyond
the narrow confines of classical economic thinking.
 In nineteenth century Europe people develop three

approaches of attack on pressing social problems, These
approaches were:
 to promote socialism;
 to bolster trade unionism; or
 to demand government action to ameliorate conditions by

regulating the economy.
 The marginalists opposed all three “solutions.” They
theorized with seemingly Olympian impartiality and

concluded that,
 although the value and distribution theories of the classical
economists were inaccurate, their policy views were
correct.
 they defended market allocation and distribution,
deplored government intervention,

 denounced socialism, and sought to discourage labor

unionism as either ineffective or pernicious.
 To the leading early marginalists, classical value and

distribution theories erred in seemingly concluding that
 land rent is an unearned income and that
 exchange value is based on the labor time involved in the

production process.
 then the science of economics was overdue for a

thorough revision.
OMS… Major Tenets of the Marginalist School
FOCUS ON THE MARGIN.
 This school focused its attention on the point of change
where decisions are made; in other words, on the margin.
RATIONAL ECONOMIC BEHAVIOR.
 The marginalists assumed that people act rationally in
balancing pleasures and pains, in measuring marginal
utilities of different goods, and in balancing present
against future needs.
 The dominant drive of human action is to seek utility and

avoid disutility
Microeconomic emphasis.
 The individual person and firm take center stage in
the marginalist drama.
 Instead of considering the aggregate economy, or

macroeconomics, the marginalists considered
individual decision making,
 market conditions for a single type of good, the

output of specific firms, and so forth.
Samuel S. WLDU, HET 2016

The use of the abstract, deductive method.
 The marginalists rejected the historical method (see
Chapter 5) in favor of the analytical, abstract approach
pioneered by Ricardo and other classicists.
The pure competition emphasis.
 They normally based their analysis on the assumption of
pure competition.
 No one person or firm has enough economic power to

influence market prices perceptibly.
 Demand-oriented price theory.
 For the early marginalists, demand became the primary

force in price determination, thus This school swung to the
opposite extreme of what classical economists believed.
 Emphasis on subjective utility.
 According to marginalists, demand depends on marginal
utility, which is a subjective, psychological phenomenon.
 Costs of production include the sacrifices and irksomeness

of working, managing a business, and saving money to
form a capital fund. Samuel S. WLDU, HET 2016
Equilibrium approach.
 The marginalists believed that economic forces generally
tend toward equilibrium—a balancing of opposing forces.
 Whenever disturbances cause dislocations, new

movements toward equilibrium occur.
Merger of land with capital goods.
 The marginalists lumped land and capital resources
together in their analysis and spoke of interest, rent, and
profits as being the return to property resources.

Minimal government involvement.
 The marginalists continued the classical school’s defense of
minimal government involvement in the economy as the
most desirable policy.
 In most cases, no interference with natural economic laws

was in order if maximum social benefits were to be
realized.

OMS… Whom Did the Marginalists Benefit
or Seek to Benefit?
 The marginalists sought to advance the interest of all of
humankind through promoting a better understanding

of how a market system efficiently allocates resources
and promotes economic liberty.
 The marginalists succeeded in this goal. By showing
that, under competitive circumstances, the pay received

by workers would be equal to their contribution to the
value of the output, the marginalists helped counter the
Marxian call for revolution by the proletariat.
OMS… Whom Did the MB or SB?
 But marginalism—the economics of liberalism or

political conservatism also benefited those whose
interests were simply in maintaining the status quo; that
is, those who resisted change.
 This type of theory benefited employers (eventhough
most of them did not really understand it) by opposing

unions and by attributing unemployment to wages that
were artificially high, inflexible on the downward side,
or both.
OMS… Whom Did the MB or SB?
 Marginalism also defended landowners against attacks
based on Ricardian rent theory.
 This school also could be said to have benefited the

wealthy, who generally opposed government
intervention that might redistribute income.

OMS… How Was the Marginalist School Valid,
Useful, or Correct in Its Time?
 The marginalist school developed new and powerful
tools of analysis, especially geometric diagrams and

mathematical techniques.
 Conditions of demand were given their rightful
importance as one set of determinants for prices of both
final goods and factors of production.
 The school emphasized the forces that shape individual

decisions; this was valid in a world where such decisions
were significant in determining the course of economic
activities. Samuel S. WLDU, HET 2016
 The marginalists explicitly stated fundamental

assumptions underlying economic analysis, as opposed
to leaving them lurking in the background as did many
of the classical economists.
 The methodological controversies that the marginalists
aroused resulted in a separation of objective and

verifiable principles that are based on stated
assumptions from those principles that depend on value
judgments and philosophical outlook.
 The method of partial equilibrium analysis championed
by many members of this school was useful for

abstracting from the complexity of the real world.
 The microeconomic approach of marginalism

complements the macroeconomic approach, which may
overlook many problems by viewing the economy as a
whole.

OMS… Which Tenets of the Marginalist School
Became Lasting Contributions?
 There are many critics from institutional economists on
its failure
 to explain Economic growth
 its theory proved to be inadequate for slowly developing
countries
 Of employment theory.
 Dispute all the criticisms, many of the marginalist

theories remained relatively unscathed.
 The school eventually was absorbed by the broader
neoclassical school, which, together with variations of
Keynesian macroeconomics. Samuel S. WLDU, HET 2016
 These economists and their forerunners developed such
lasting contributions as
 mathematical economics,
 the basic monopoly model,
 a theory of duopoly,
 the theory of diminishing marginal utility,
 the theory of rational consumer choice,
 the law of demand,

 the law of diminishing marginal returns as it applies to
manufacturing enterprises,
 the concept of returns to scale,
 work-leisure choice analysis,
 the marginal productivity theory of factor returns,
 and so forth.
 In the past two decades, this “choice-theoretic” approach
introduced by the marginalists has experienced

resurgence within economics.
ANTOINE AUGUSTIN COURNOT
 He was the first economist to develop concise

mathematical models of pure monopoly, duopoly, and
pure competition.
 He also developed the earliest complete model of what

we now refer to as the derived demand for resources.
 Cournot is considered to be a forerunner to the
marginalist school because much of his analysis focused

on the rates of change of total cost and revenue
functions.
Cournot’s Theory of Monopoly
 He is credited with being the first economist to derive the
now-familiar proposition that

 a firm can maximize its profits by setting a price at which
marginal revenue equals marginal cost.
“Suppose that a man finds himself proprietor of a mineral spring

which has just been found to possess salutary properties possessed
by no other. He could doubtless fix the price of a liter of this water
at 100 francs; but he would soon see by the scant demand
[quantity demanded], that this is not the way to make the most of
his property. Samuel S. WLDU, HET 2016
He will therefore successively reduce the price of the liter to the

point which will have him the greatest possible profit, i.e. if F(p)
denotes the law of demand [quantity demanded], he will end,
after various trials, by adopting the value of p [price] which
renders the product pF(p) [total revenue] a maximum.”
 Assuming that the total cost, and therefore the marginal

cost, of obtaining the mineral water is zero, total profits
will be maximized at that quantity of output where total
revenue (price quantity) is the greatest.
 Notice in graph (a) that the proprietor of the mineral
water faces a downward sloping demand curve, D.
 The marginal revenue curve, MR, lies below the demand

curve because lower prices apply to all liters of the
mineral water, not just the extra one sold.
 That is, each additional unit sold will add its own price
to total revenue, but if that extra unit had not been

offered for sale, the price received on the other liters
would have been higher.
 The loss of this potential revenue must be subtracted
from the gain in revenue received through the sale of the

extra liter.
 Thus, we see that marginal revenue is less than the price

at all but the first unit of output and that the marginal
revenue curve falls more rapidly than the demand curve.

 Note once again that the points on the marginal revenue
curve in graph (a) represent the rates of change of total

revenue shown by the TR curve in graph (b); marginal
revenue is the derivative of the product P Q.
 At 60 francs, buyers will purchase 200 liters, and, as
shown in graph (b), total revenue will rise to 12,000

francs. This is the monopolist’s maximum total revenue.
Because total costs are assumed to be zero, 12,000 francs
is also the maximum profit.
 Observe that marginal revenue in graph (a) is zero at the
profit-maximizing price and output of 60 francs and 200

liters.
 Because marginal costs are also zero, marginal revenue,

MR, equals marginal cost, MC; that is, the profit-
maximizing condition is fulfilled.
 We see in graph (b) that any price above or below 60

francs will reduce total revenue and, in this zero-cost
case, total profit.
 Cournot extended his theory to circumstances in which
marginal costs are positive.
 The monopolist facing positive costs, he said, will also

maximize profits—total revenue minus total cost—at
that level of output where MR = MC.
 This rule also applies in situations where numerous
competitors exist.

Cournot’s Theory of Duopoly
“To make the abstract idea of monopoly comprehensible, we

imagined one spring and one proprietor. Let us now imagine
two proprietors and two springs of which the qualities are
identical, and which, on account of their similar positions,
supply the same market in competition. In this case the price is
necessarily the same for each proprietor. If p is this price, D =
F(p) the total sales, D1 the sales from the spring (1) and D2 the
sales from the spring (2), then D1+ D2= D.”

If so, to begin with, we neglect the cost of production, the

respective incomes of the proprietors will be pD1 and pD2 ; and
each of them independently will seek to make this income as large
as possible.”
 In formulating his theory of duopoly, Cournot assumed

that buyers name the prices and that the two sellers
merely adjust their output to those prices.

 Each duopolist estimates the total demand for the
product and sets his own volume of output and sales on

the assumption that the rival’s output remains fixed.
 A stable equilibrium is achieved through a step-by-step

adaptation of output by each producer, with the
duopolists ultimately selling equal quantities of the good
at a price that is above the competitive price and below
the monopoly one.

 The horizontal axis represents the sales (D1) by

proprietor 1, and the vertical axis the sales (D2) by
proprietor 2. Curves m1n1 and m2n2 represent the
maximum profit curves of proprietors 1 and 2,
respectively.
 Curve m2n2 shows the specific levels of proprietor 2’s

output that will maximize 2’s profit, given the various
levels of output offered by proprietor 1.

 For example, point a on curve m2n2 is instructive. It tells us that

if proprietor 1 sells x units of mineral water, then proprietor 2
will discover that she can maximize her profits by selling y1 unit
of the product.
 Curve m1n1 shows the maximum profit levels of output

for proprietor 1 for the various levels of output offered
by proprietor 2.
 For example, point b on this curve indicates that if proprietor 2
offers y1 units of output for sale, then proprietor 1 will choose to
offer output level x to maximize his profits.

 This process of trial and error will continue until an
equilibrium is established at point e.
 Notice that at this intersection of the two reaction curves

each sell the same amount of the product (x = y) and
receive maximum profits, given the output of the other.
 This position, said Cournot,
“is stable, i.e. if either of the producers, misled as to his true

interest, leaves it temporarily, he will be brought back to it by a
series of reactions, constantly declining in amplitude.”.
Herman Heinrich Gossen (1810–1858),
 Gossen were not truly appreciated until after his death.
Yet his thinking was so advanced that he deserves

mention.
 Two laws stated by Gossen, in particular, foreshadowed

the contributions of Jevons and other marginalists.
 First law was the law of diminishing returns:
 the added utility of a good decreases as more of it is

consumed.

Herman Heinrich Gossen
 Among other things, this law explains how voluntary
exchange produces mutual gains in utility.
 Gossen’s second law relates to the balancing of marginal

utilities through rational consumption spending to
secure maximum satisfaction.
 The rational person, said Gossen, should allocate his or
her money income so that the last unit of money spent

on each product bought yields the same amount of extra
(marginal) utility.
Herman Heinrich Gossen
 The marginal utility per unit of money spent on a
product is marginal utility (MU) divided by the

product’s price (P). Therefore, symbolically, Gossen’s
condition for maximizing utility is:


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CHAPTER six

 Overview of the Marginalist School, The Maximization

 Antoine Augustin Cournot and Herman Heinrich Gossen

 First - Generation Marginalists:

 Jevons, Walras, and The Austrian School

 Second - Generation Marginalists:

 Serious economic and social problems remained

 The extremely uneven distribution of wealth and income

 Business fluctuations affected many people adversely….So

 These and others caused people to seek solutions beyond

the narrow confines of classical economic thinking.

 In nineteenth century Europe people develop three

 to demand government action to ameliorate conditions by

 The marginalists opposed all three “solutions.” They

theorized with seemingly Olympian impartiality and

Samuel S. WLDU HET,2016

 denounced socialism, and sought to discourage labor

 To the leading early marginalists, classical value and

 exchange value is based on the labor time involved in the

 then the science of economics was overdue for a

 The dominant drive of human action is to seek utility and

 Instead of considering the aggregate economy, or

 market conditions for a single type of good, the

Samuel S. WLDU, HET 2016

 No one person or firm has enough economic power to

 Demand-oriented price theory.

 For the early marginalists, demand became the primary

 Costs of production include the sacrifices and irksomeness

 Whenever disturbances cause dislocations, new

Samuel S. WLDU, HET 2016

 In most cases, no interference with natural economic laws

Samuel S. WLDU, HET 2016

 The marginalists sought to advance the interest of all of

humankind through promoting a better understanding

 The marginalists succeeded in this goal. By showing

that, under competitive circumstances, the pay received

 But marginalism—the economics of liberalism or

 This type of theory benefited employers (eventhough

most of them did not really understand it) by opposing

 Marginalism also defended landowners against attacks

based on Ricardian rent theory.

 This school also could be said to have benefited the

intervention that might redistribute income.

Samuel S. WLDU, HET 2016

 The marginalist school developed new and powerful

tools of analysis, especially geometric diagrams and

 The school emphasized the forces that shape individual

 The marginalists explicitly stated fundamental

 The methodological controversies that the marginalists

aroused resulted in a separation of objective and

 The method of partial equilibrium analysis championed

by many members of this school was useful for

 The microeconomic approach of marginalism

Samuel S. WLDU, HET 2016

 There are many critics from institutional economists on

 Dispute all the criticisms, many of the marginalist

 These economists and their forerunners developed such

 the basic monopoly model,

 the theory of diminishing marginal utility,

 the theory of rational consumer choice,

 the law of demand,

Samuel S. WLDU, HET 2016

 the law of diminishing marginal returns as it applies to

 the concept of returns to scale,