Before you read on: what sets the price of a good, the cost of making it or how much buyers want it?
Alfred Marshall argued that cost and utility work together, like the two blades of a pair of scissors. Classical economists stressed cost, and the marginalists stressed utility.
- Emerged
- From the 1870s, out of the marginal revolution; Thorstein Veblen gave it its name at the turn of the 20th century
- Key figures
- William Stanley Jevons, Carl Menger, Léon Walras and Alfred Marshall; later Arthur Pigou and Paul Samuelson
- Key works
- Jevons, The Theory of Political Economy (1871); Menger, Principles of Economics (1871); Walras, Elements of Pure Economics (1874 to 1877); Marshall, Principles of Economics (1890)
- Where it dominated
- British economics from about 1890, led by Marshall at Cambridge; today, mainstream economics and what university students are taught
- Main challengers
- Keynes in the 1930s; Marxian, Austrian, post-Keynesian and institutional economics; behavioural economists, who question the rational agent
What it was reacting to
Classical economists, David Ricardo above all, held that the value of a good comes from the labour or cost of making it.
In the 1870s three economists broke with that view, each working on his own: Jevons in Manchester, Menger in Vienna and Walras in Lausanne. They argued that value depends on utility, the satisfaction a good gives, judged at the margin: what one more unit is worth to the buyer.
Alfred Marshall then joined the two views. He treated cost as shaping supply and utility as shaping demand, and used time to show when each matters more.
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.
The key ideas
Can you name the four key ideas of neoclassical economics?
The extra satisfaction from one more unit of a good. Each extra unit gives less satisfaction than the one before, so the value of a good depends on what its last unit is worth to the buyer.
Can you think of an example?
To a hungry diner, the first slice of pizza is worth a lot. A fourth slice is worth very little.
Neoclassical models assume that people have consistent preferences, that households maximise utility and firms maximise profit, and that each acts on full and relevant information.
Can you think of an example?
Jevons held that a shopper does best by spreading spending so that the last pound spent on each good brings the same extra satisfaction. A firm picks the output that earns it the most profit.
Price and quantity are set where supply meets demand, which Marshall compared to the two blades of a pair of scissors. He also split adjustment into the market period, the short period and the long period.
Can you think of an example?
Frost wrecks a coffee harvest. At first the price jumps, because no more coffee can be grown at once. Over the long period, farmers plant more and the price eases.
Walras modelled every market in an economy at once, as a set of equations with as many equations as unknowns. Solving them gives the prices and quantities at which all markets clear together.
Can you think of an example?
A jump in the oil price changes demand for cars, then car workers' wages, then what those workers buy. General equilibrium tracks these knock-on effects together.