Chapter Six

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, Wicksteed, 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 ¼ 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 D 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

CHAPTER six
6.3-6.4
THE
MARGINALIST
SCHOOL
OUTLINE
 First - Generation Marginalists:
 Jevons,
 Walras, and
 The Austrian School
 Second - Generation Marginalists:
 Edgeworth,
 Clark

First - Generation Marginalists: Jevons, Walras,
and The Austrian School
 The final three decades of the nineteenth century
witnessed the birth of neoclassical microeconomic

theory.
 During this period the forging of a new set of analytical

tools helped transform classical economics into
neoclassical economics.
 The most important of these tools was marginal analysis.

First - Generation Marginalists: Jevons, Walras, and The
Austrian School
 The first notable application of marginal analysis was to
the theory of demand.
 In the early 1870s, three academicians independently

applied marginal analysis to demand theory and
developed the concept of marginal utility.
 Two of these, Leon Walras and Carl Menger, also
applied marginal analysis to the theory of the firm.

 Walras even went beyond the application of marginal analysis
and formulated general equilibrium analysis, which will be
treated in HET-II.
First - Generation Marginalists: Jevons, Walras, and The
Austrian School
 This group were in agreement that economics was
largely concerned with resource allocation, or

microeconomics, but they had different views about the
appropriate methods to be used:
 Jevons advocated more empirical work;
 Menger, abstract deductive logic; and
 Walras, mathematics.

William Stanley Jevons (1835–1882)
 He was born in Liverpool.
 He spent five years in Australia as an assayer at the

mint, where he earned enough to return to England to
continue his studies.
 He invented a logic machine, exhibited before the Royal
Society in 1870, that could yield a conclusion

mechanically from any given set of premises.
 At the age of forty-seven he drowned while swimming.

Jevons on Value Theory
 On the first page of The Theory of Political Economy,
first published in 1871, Jevons stated:

“Repeated reflection and inquiry have led me to the somewhat
novel opinion, that value depends entirely upon utility.
Prevailing opinions make labour rather than utility the origin of
value; and there are even those who distinctly assert that labour
is the cause of value. I show, on the contrary, that we have only
to trace out carefully the natural laws of the variation of
utility, as depending upon the quantities in our
possession, in order to arrive at a satisfactory theory of
exchange, of which the ordinary laws of supply and demand are a
necessary consequence.

Jevons on Value Theory
This theory is in harmony with facts; and, whenever there is any

apparent reason for the belief that labour is the cause of value, we
obtain an explanation of the reason. Labour is found often to
determine value, but only in an indirect manner, by varying the
degree of utility of the commodity through an increase or
limitation of supply.”
 Jevons is saying that pearls have value because buyers

get utility from them and that people dive for pearls
because pearls have such value. The specific level of
utility associated with the pearls depends on the number
of pearls people presently possess.
JVT……Theory of diminishing marginal utility
 To explain he’s value theory, we must therefore begin
with his theory of the law of diminishing marginal

utility.
 Jevons said that utility cannot be measured directly, at
least with the tools at hand.
 This subjective pleasure or satisfaction can be estimated

only by observing human behavior and noting human
preferences.

 He also rejected any attempt to compare the intensity of

pleasures and pains among different people.
 But a single individual can compare utilities of successive

units of a single good, said Jevons, and can compare the
marginal utilities of several goods.
 With respect to the former, Jevons used graphical analysis

to illustrate his “law of variation of the final degree of
utility of a commodity.” A contemporary version of his
representation is shown as Figure 6-2

 The top graph in Figure 6-2 measures total utility on the
vertical axis and the quantity of a particular commodity,

say, good X, on the horizontal axis.
 Total utility, TU, rises as more of good X is consumed.
 Notice, however, that as more of X is consumed, total
utility increases at a Diminishing rate.
 Each successive unit of X adds less to total utility than

did the previous unit.

 In the lower graph in the figure, the vertical axis
measures the change in total utility, or marginal utility,

MU.
 Marginal utility, equivalent to Jevons’s “final degree of

utility … varies with the quantity of [the] commodity, and
ultimately decreases as that quantity increases. No commodity
can be named which we continue to desire with the same force,
whatever be the quantity already in use or possession.”

 If the person having the marginal utility curve in Figure 6-

2 decides to purchase X units of the commodity, said
Jevons, then the total utility would be TU1 and the final
degree of utility (marginal utility) would be MU1 .
 Marginal utility in the lower graph is found by plotting the

slope of TU (upper graph) at each of its points.
“ We shall seldom need to consider the degree of utility except

as regards the last increment which has been consumed, or,
which comes to the same thing,
the next increment which is about to be consumed. I shall

therefore commonly use the expression final degree of
utility, as meaning the degree of utility of the last addition, or
the next possible addition of a very small, or infinitely small,
quantity to the existing stock.”
 Jevons’s law of diminishing marginal utility solved the

paradox of water and diamonds that puzzled some of
the classical economists.

 The principle of diminishing marginal utility reveals that

whereas the total utility of water is greater than the total
utility of diamonds, the “final degree of utility” or
marginal utility of diamonds is far greater than the
marginal utility of water.
 We would rather have all the water in the world and no

diamonds than the other way around; but we would rather
have an additional diamond than an additional unit of
water, given our abundant stock of the latter.

Rational choice: the equimarginal rule
 Jevons employed his notion of final utility (marginal
utility) to formalize a general theory of rational choice.

“Let s be the whole stock of some commodity, and let it be
capable of two distinct uses [“barley may be used either to make
beer, spirits, bread, or to feed cattle.”] Then we may represent the
two quantities appropriated to these uses by x1 and y1 ,it being a
condition that x1 + y1 =s. The person may be conceived as
successively expending small quantities of the commodity;

now it is the inevitable tendency of human nature to choose that

course which appears to offer the greatest advantage at the
moment. Hence, when the person remains satisfied with the
distribution he has made, it follows that … an increment of
commodity would yield exactly as much utility in one use as in
another…. We must in other words, have the final degrees of
utility [marginal utilities] in the two uses equal.”
 In the example a consumer wishing to maximize utility will
allocate money income in such a way that the marginal utility of
the last dollar spent on all commodities is equal. {compare it
with Gossen’s second law?} Samuel S. WLDU, HET 2016

Rational choice: the equimarginal rule.
 As more of X is obtained, its marginal utility declines; as
fewer units of goods such as Y and Z are consumed,

their marginal utilities rise.
 Eventually the ratios of marginal utilities to the

respective prices of the goods equalize and the
consumer’s total utility is maximized.

Theory of exchange
 Now assume there are two parties (trading body) one
providing commodity x and another commodity y.
 How is it that exchange will benefit each, and at what

point will exchange cease?
 Once again the equimarginal rule comes into play. Because
party A has only X, the ratio of the marginal utility of x to
its price will be low, whereas the ratio of the marginal
utility of Y to its price will be high.

Theory of exchange
 The equimarginal rule correctly suggests that party A will

benefit by obtaining Y and giving up X. A similar situation
exists for party B.
 The lost utility from sacrificing Y will be less than the gain
in utility from the X gained.
 At which point will trade cease? The answer, said Jevons,

is the point at which there are no further possibilities of
utility gains from exchange.

Jevons on labor
 Recall that Jevons held utility to be the determinant of
exchange value.
 At one place in his Principles, he formulated his idea this

way:
Cost of production determines supply.
Supply determines final degree of utility.
Final degree of utility determines value.

Jevons on labor
 Why, therefore, does not cost of production determine
value?
 Jevons, in refuting the labor theory of value, argued that
labor cannot be the regulator of value because labor itself
has unequal value; it differs infinitely in quality and
efficiency.
“I hold labour to be essentially variable, so that its value must be

determined by the value of the produce, not the value of the
produce by that of the labour.”
Jevons on labor
 Labor itself is a subjective, psychological cost, a “painful
exertion.”
 The problem of economics is “to satisfy our wants with

the least possible sum of labour.”
 To accomplish this, the worker must compare the pain
of work and the pleasure of earnings.
 Jevons presented his theory of the optimal amount of

work graphically as shown in Figure 6.3.

Jevons on labor
 The line OX represents the potential amount of product

that the worker can earn in a working day, given some
hourly wage rate.
 The height of points above the line OX measures pleasure

(utility); the points below it measure pain (disutility).
 At the beginning of the working day, labor is usually more

irksome than later in the day when the worker adjusts to it.

Jevons on labor
 Thus, there is neither pleasure nor pain at points b and c

on the curve labeled MDU (marginal disutility of work),
and there is actual pleasure from working—independently
of the earnings—between those two points. Beyond c,
however, the pain (marginal disutility) of additional work
increases.
 The marginal utility of the product, or more appropriately the
marginal utility of the earnings, is shown by MUC (marginal
utility of earnings).


 You should confirm that m is this person’s optimal
amount of work by scrutinizing points other than m

along OX.
 It should be pointed out that Jevons did add some

realism to his discussion by pointing out that
“it is not always possible to graduate the [length of the

workday] to the worker’s liking.”

Other Topics Addressed by Jevons
 Business cycles attracted Jevons’s attention. He theorized

that the sunspot cycle influences the weather, which
affects the size of crops.
 Large crops occur when sunspots are at a minimum, and
the resulting low prices of agricultural products stimulate
the economy.
 The effects may manifest themselves internationally; a

large crop and cheap food in India will leave wage earners
surplus income that can be spent for clothing, thereby
promoting prosperity for the cotton mills of Manchester.
Carl Menger (1840–1921)
 He was born in Galicia and the son of a lawyer, studied
at the universities of Vienna and Prague and received his

doctorate at the University of Cracow.
 When he was in University of Vienna, Menger published

his path breaking treatise, Principles of Economics.
 Numerous later economists, collectively known as the
Austrian school, championed and expanded his

principles.

Carl Menger (1840–1921)
 Friedrich von Wieser and Eugen von Böhm-Bawerk
were the first leading Austrian school economists .
 Later members of this group include such notable

economists as
 Ludwig von Mises,
 Joseph Schumpeter, and
 Friedrich von Hayek.
 Two of Menger’s more significant contributions were his
theories of value and imputation. Samuel S. WLDU, HET 2016

Menger’s Value Theory
 Like Jevons, Menger based his value theory on the
concept of utility.
 Contrary to Jevons, however, he deliberately made no use
of mathematics in formulating his theory.
 His exposition of diminishing marginal utility and the

balancing of marginal utilities included an example
reproduced here as Table 6-1.
 The table shows the hypothetical values of marginal utility
for various numbers of units of 10 commodities, or classes
of commodities (I through X).
Table 6.1

 The successive figures down each column represent

successive additions to total satisfaction resulting from
increased consumption of the designated commodity.
 Suppose that this person wished to spend $10 and that all
units of all commodities cost $1 per unit. How would the
$10 be allocated?
 Using the equimarginal rule to confirm that the answer is 4
units of I, 3 units of II, 2 units of III, and 1 unit of IV.
 At this combination, the entire $10 will be expended, and the

marginal utility/price ratios for each item will be 7/$1.
 An implicit assumption of Menger’s table is that
 each unit of each commodity represents the same

expenditure of money or effort or sacrifice.
 the economizing individual is able to rank satisfactions not

only ordinally but cardinally as well.
 Ordinal ranking allows one to say that the 1st dollar spent
on food in any one day gives more satisfaction than either
the 2nd dollar spent on food or the 1st dollar spent on
anything else represented in the table.
 This is a relative statement indicating that one item is more

or less highly ranked in terms of value than others.
 With cardinal values, one must say that the 1st dollar spent
on food gives exactly twice as much utility as either the 6th
dollar spent on food or the 2nd dollar spent on tobacco.
 Menger drew an interesting conclusion from his table
 Suppose an individual could afford only 7 units of food.
 What would be the usefulness of the 7 units of food to

this person?
 Jevons would add the marginal utilities of each unit from

the 1st through 7th to obtain an answer of 49 (10 +9 +8 +
7+6+5 +4).
 Menger’s answer, however, would be 28 (4* 7), the

marginal utility of the last unit times the number of units.
Why?
 Menger answered that all units are alike; thus each has
the same utility as the marginal unit.

 Menger thereby equated exchange value with total
utility, unlike Jevons, who equated exchange value with

marginal utility.
 Jevons would have said that in column I of Table 6-1, 10
units of a good have greater total utility than 5 units, but
the 10th unit has a smaller marginal utility than the 5th
unit.
 Similarly, a large wheat crop offers more total utility than

a small wheat crop, even if the larger one sells for less
money. Samuel S. WLDU, HET 2016

 The measure of value, said Menger, is entirely

subjective. Therefore, a commodity can have great value
to one individual, little value to another, and no value at
all to a third, depending on the differences in the
preferences of the three individuals and the amounts of
income available to each.
 Thus, not only the nature of value but the measure of

value is subjective. Value has nothing to do with cost of
production:
 “The value an economizing individual attributes to a good is

equal to the importance of the particular satisfaction that
depends on his command of the good. There is no necessary
and direct connection between the value of a good and
whether, or in what quantities, labor and other goods of higher
order were applied to its production. A non-economic good (a
quantity of timber in a virgin forest, for example) does not
attain value for men if large quantities of labor or other
economic goods were applied to its production. Whether a
diamond was found accidentally or was obtained from a
diamond pit with the employment of a thousand days of labor
is completely irrelevant for its value. In general, no one in
practical life asks for the history of the origin of a good in
estimating its value, Samuel S. WLDU, HET 2016
but considers solely the services that the good will render him
and which he would have to forgo if he did not have it at his
command. Goods on which much labor has been expended
often have no value, while others, on which little or no labor
was expended, have a very high value. Goods on which much
labor was expended and others on which little or no labor was
expended are often of equal value to economizing men. The
quantities of labor or of other means of production applied to
its production cannot, therefore, be the determining factor in
the value of the good.“
 The basis of exchange value, said Menger, is the difference
in relative subjective valuations of the same goods by different
individuals.
 He denied Smith’s dictum that exchange value is due to

the propensity to truck, barter, and exchange one thing
for another, that trading is an end in itself because it is
pleasurable.
 Menger argued instead that trading is undertaken to
increase the satisfactions enjoyed by the parties to the
exchange. Trade increases the total utility of both
traders.
“The principle which leads men to exchange is the same principle
that guides them in their economic activity as a whole; it is the
endeavor to ensure the fullest possible satisfaction of their
needs.”

Menger’s Theory of Imputation
 Menger originated the idea of imputation in pricing
factors of production.
 The marginalists emphasized the importance of

consumer demand, especially in its subjective
psychological aspects, in determining price.
 The concepts of marginal and total utility refer to
consumer wants; therefore, they apply only to consumer

goods and services.

 What governs the prices of “higher order” goods used in
production, such as machinery, raw materials, land, and

so forth?
 Menger held that such goods also yield satisfactions to
consumers, though only indirectly, by helping to produce
things that do satisfy consumer wants directly.
 The principle of marginal utility is thereby extended to the

whole area of production and distribution.

 The rent received by landowners, for example, is

governed by the utility of the products grown on that land.
 The factors, or agents, of production are assigned use

values that govern their exchange values.
 The present value of the means of production is equal to

the prospective value (based on marginal utility) of the
consumer goods they will produce, with two deductions: a
margin subtracted “for the value of the services of capital”
(interest) and a reward for entrepreneurial activity (profit).

 The doctrine of imputation was an attack on the labor
and real-cost theories of value.

 The value of goods used in production must, without
exception, be determined by the prospective value of the
consumer goods they help produce.
 Menger denied that the price of common labor is

determined by the cost of minimum subsistence for the
laborer and his family.

 The prices of labor services, like the prices of all other
goods, are governed by their value. And their values are

governed “by the magnitude of importance of the
satisfactions that would have to remain unsatisfied if we
were unable to command the labor services.”

Francis Y. Edgeworth (1845–1926)
 He was born in Ireland, attended Trinity College in
Dublin, and studied at Oxford University.
 He later became the Tooke Professor of Political

Economy at Oxford, where he remained throughout his
career.
 He was one of the founders of the Royal Economic
Society, was editor of the Economic Journal for thirty-

five years, served a term as president of the Statistical
Society, and was a fellow of the British Academy.
Francis Y. Edgeworth (1845–1926)
 Of Edgeworth’s various contributions to the content of
economic thought, three in particular stand out.

 First, he originated the idea of an indifference curve,
 Second, he was one of the first economists to show the
indeterminacy that we now generally associate with the
pricing behavior of oligopolists.
 Finally, he elucidated the difference between average and

marginal product, thus aiding in the development of the
modern short-run production function and its numerous
applications. Samuel S. WLDU, HET 2016
Indifference Curves and Exchange
 Edgeworth introduced the notion of “curves of

indifference,” which he said show the various
combinations of two items that will yield an equal level
of utility to an individual.
 He used this graph [see figure 6.3] to analyze an isolated
exchange between two sole possessors of products, in

this case Robinson Crusoe and his right-hand man
Friday.





 Edgeworth correctly noted that this is not the case;
under such conditions all the parties to trade must

accept the prices of goods and labor determined in the
market.
 But in the bilateral monopoly situation—a circumstance
where there are single sellers on each side of a

transaction—the price is indeterminate.

Duopoly theory
 His idea of indeterminacy is also present in his theory of
duopoly.
What make this theory different from one made by

Cournot?
Recall
 Cournot had a restrictive assumptions
 The duopoly sell mineral water each charging the same price
and each garner ½ of the total sell.
 At equilibrium both produce a determinate equilibrium price.

Duopoly theory
 For Edgeworth
 Each seller of the mineral water have a limited capacity to

meet consumers demand.

Duopoly theory

Duopoly theory

Duopoly theory

Duopoly theory

Marginal vs average product
 Edgeworth explicitly distinguished between the average
and marginal products of a production function

characterized by variable proportions of inputs.
 To make his point he assumed that
 land was the fixed resource and that labor, together with
tools, was the variable resource.
 Recall your contemporary microeconomics text books!







Chapter Six

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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:

 Edgeworth, Wicksteed, Clark,

 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,