Before you read on: Alfred Marshall compared supply and demand to an everyday object. Which one?
Marshall said that arguing over whether utility or cost of production governs value is like arguing over which blade of a pair of scissors does the cutting. Both blades work together, and so do demand and supply.
- Lived
- Born 26 July 1842 in London; died 13 July 1924 in Cambridge
- Nationality
- British
- Work
- Professor of political economy at Cambridge, 1885 to 1908; earlier, first principal of University College, Bristol; member of the Royal Commission on Labour, 1891 to 1894
- Key works
- The Economics of Industry (1879, with Mary Paley Marshall), Principles of Economics (1890), Industry and Trade (1919), Money, Credit and Commerce (1923)
- School
- Neoclassical economics, of which he was a chief founder in England; the Cambridge school grew from his teaching
What Marshall was reacting to
Marshall turned to economics in 1867 after reading John Stuart Mill's Principles. At the time, economists were split over what sets the value of a good. The classical economists, such as Ricardo and Mill, looked to the cost of producing it. From the 1870s William Stanley Jevons and the Austrian school looked instead to marginal utility, the extra satisfaction buyers get from one more unit.
Marshall set out to join the two. He argued that demand counts for more over short periods, and cost of production over long ones.
We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production.
Marshall's key ideas
Can you name Marshall's four key ideas?
Price and the quantity sold are set by supply and demand together, where the two curves cross. Marshall argued that the cost side and the utility side each matter, as both blades of a pair of scissors do the cutting.
Can you think of an example?
A frost ruins half the coffee crop. Supply falls, buyers compete for what is left, and the price rises until the amount people want to buy matches the smaller amount on offer.
How strongly buyers respond to a change in price. Marshall sorted demand into elastic (buyers respond a lot), inelastic (they respond a little) and unitary (spending stays the same).
Can you think of an example?
A 10% rise in the price of one brand of cola may cut its sales sharply, because buyers switch. A 10% rise in the price of salt barely changes how much people buy.
The gap between the most a buyer would pay for something and the price they actually pay. Marshall also described producer surplus, and used the two to measure who gains and loses from a tax.
Can you think of an example?
You would pay up to £5 for a sandwich and it costs £3. Your consumer surplus is £2.
Marshall split analysis by time. In the market period supply is the stock on hand; in the short period firms can add workers but not plant; in the long period they can build new plant. He studied one market at a time, holding other things equal (ceteris paribus), an approach now called partial equilibrium.
Can you think of an example?
When demand for hotel rooms jumps, hotels can only raise prices at first. Given time, new hotels are built and prices settle back towards cost.