Chapter11 TheNeoclassicalSchool AlfredMarshall MARSHALL SLIFEANDMETHODUTILITYANDDEMANDSUPPLYEQUILIBRIUMPRICEANDQUANTITYDISTRIBUTIONOFINCOMEINCREASINGANDDECREASINGCOSTINDUSTRIES 1 MARSHALL SLIFEANDMETHOD Marshallwasthegreatsynthesizer seekingtocombinethebestofclassicaleconomicswithmarginalistthinking henceproducing neoclassical economics Marshalldefinedhissubjectasfollows PoliticalEconomyorEconomicsisastudyofmankindintheordinarybusinessoflife itexaminesthatpartofindividualandsocialactionwhichismostcloselyconnectedwiththeattainmentandwiththeuseofthematerialrequisitesofwellbeing MarginalUtilityRationalConsumerChoiceLawofDemandConsumer sSurplusElasticityofDemand 2 UTILITYANDDEMAND AccordingtoMarshall demandisbasedonthelawofdiminishingmarginalutility Therearetwoimportantqualificationsatthispoint First hewasconcernedwithamomentintime whichistooshortanintervaltoconsideranychangesincharacterandtastesofaparticularperson Secondqualificationofthelawofdiminishingmarginalutilityconcernsconsumergoodsthatareindivisible MarginalUtility TheutilityapproachoftheMarshalliansystemdealtwithpleasuresandpains desiresandaspirations andincentivestoaction Howcanwemeasuretheutilityofsuchintangibles Marshallboldlysaid withmoney Theprecisemoneymeasurementofpreferencesormotivesinbusinesslifemakeseconomicsthemostexactofthesocialsciences Twopeoplewithequalincomeswillnotnecessarilyderiveequalbenefitfromitsuse Take1poundordollarfromeachofthem andtheintensitiesofthesatisfactiongivenupmaynotbeequalatall RationalConsumerChoice Marshalldemandanalysisalsoemployedtheideaofrationalconsumerchoice Inamoneyeconomy eachlineofexpenditurewillbepushedtothepointatwhichthemarginalutilityofadollar sworthofgoodswillbethesameasinanyotherdirectionofspending Onecanconstantlywatchtoseewhetherthereisanythingheisspendingsomuchthathewouldgainbytakingalittleawayfromthatlineofexpenditureandputtingitonsomeotherline Marshallsuccessfullytiedthisequimarginalruledirectlytothecontemporarylawofdemand LawofDemand Marshall slawofdemandfollowsdirectlyfromhisnotionsofdiminishingmarginalutilityandrationalconsumerchoice Supposethataconsumer sexpendituresareinequilibriumsuchthatthelastdollarspentoneachofseveralproductsyieldsidenticalmarginalutility thatis supposethatMUx Px MUy Py MUn Pn then ifthepriceofproductXfallswhilethepricesoftheothergoodsremainconstanttherationalconsumerwouldbuymoreofproductX WHY thepriceofX MUx Px MU P fortheothergoods torestoreabalanceofexpenditurestheconsumerwillsubstitutmoreofXforlessofY Z MUx andMU P fortheothergoods thenowlowerMUx thenowlowerPx MUy Py MUz Pz Thus equilibriumwillberestored Theamountdemandedincreaseswithafallinprice anddiminisheswithariseinprice Consumer sSurplus Marshallassertedthatthetotalutilityofagoodisthesumofthesuccessivemarginalutilitiesofeachaddedunit Table11 1Marshall sIdeaofConsumer sSurplus Howtocalculatetheconsumer ssurplus ElasticityofDemand Theonlyuniversallawpertainingtoaperson sdesireformoreofacommodity Marshallsaid isthat otherthingsbeingequal itdiminisheswitheveryincreaseinhissupplyofthatcommodity Ed thepercentagechangeinquantity thepercentagechangeinpriceEd 1 demandiselastic Ed 1 demandisinelastic Ed 1 demandisunitelastic Thedeterminantsoftheelasticityofdemand Elasticityofmarketdemandtendstobegreatwhenagoodhasahighpricerelativetothesizeofthebuyers incomes Marshallsaidthataloweringofthepriceresultsinmanymorebuyersbeingabletoaffordtheproduct Ontheotherhand whenthepriceofaproductislowrelativetopeople sincomes asimilarpercentagechangeinpricewillnotresultinmuchofanincreaseinpurchases Marshallalsonotedthatthedemandforaparticularproductwilltendtobemoreelasticthemoreitcanserveasasubstituteforothergoods ImmediatePresentShortRunLongRun 3 SUPPLY ImmediatePresent Marketpricesrefertothepresent withnotimeallowedforadaptationofthequantitysuppliedtochangesindemand Ifagoodisperishable andifweassumethattheselleristryingtomaximizeprofitsorminimizelosses themarketsupplycurveisperfectlyinelastic averticalstraightline Ifthegoodisnotperishable thesellershavereservationpricesbelowwhichtheywillnotsell Themarketsupplycurve therefore slopesupwardandtotherightuntilitencompassesthetotalquantityonthemarket Thenitbecomesvertical ShortRun ToanalyzetheperiodthatMarshallreferredtoastheshortrun hedividedcostsintotwotypes whichhecalledsupplementarycosts fixedcosts andprimecosts variablecosts Infact theshortrunisdefinedasthatperiodduringwhichthevariableinputscanbeincreasedordecreased butthefixedplantcostscannotbechanged Variablecosts Marshall sprimecosts includethoseforlaborandrawmaterialsthatchangeovertheshortrunaccordingtochanginglevelsofoutput Intheshortrun allvariablecostsmustbecovered butsomeofthefixedcostsneednotbe Intheshortrun thefirm ssupplycurveisbasedonvariablecosts Theshort runsupplycurveslopesupwardandtotheright thehighertheproductprice thelargeristhequantitysupplied Moderneconomicsviewstheshort runsupplycurveasamarginalcostcurve LongRun Inthelongrun allcostsarevariable andtheymustallbecoveredifthefirmistocontinueinbusiness Ifthepricerisessu