Neoclassical is a theory or such school of economics. Neo means “new,” neoclassicism is implies a new form of classicism. Meanwhile the neoclassical economists were “marginalists” in the crucial scene that they emphasized decision making and price determination at the margin. There are three differences between earlier marginalists and neoclassical economists. Neoclassical thought stressed both demand and supply in determining the market prices of goods, services and resources. Neoclassical economics also uses mathematical equations to study various aspects of the economy. This approach was created in the 19th century, based on the books that are written by William Stanley Jevons, Carl Menger and Leon Walras and became popular in the early 20th century. Next, several of the neoclassical economists took a far greater interest in the role of money in the economy. Lastly, neoclassical economists developed classical economics’ free-market ideas into a full-scale model showing how an economy functions.
The term of neoclassical economics was officially create in 1990. Neoclassical economic believe that a consumer’s concern is to maximize personal satisfaction and that everyone make decisions based on fully informed evaluations of utility. This theory are based from the idea of the rational behavior theory which states that people act rationally when making the decisions. Then, neoclassical economic set that a good or services often has value that goes above and beyond its input costs. Finally, this economic thought states that competition leads to an efficient allocation of resources within an economy. This resource allocation establishes market equilibrium between supply and demand.
Marshall’s Life and Method
He was born on July 26, 1842, in Cambridge, England, to William Marshall, an employee in the Bank of England, and Rebecca Oliver. His father was a very strict person. He went to the Merchant Taylors’ School before moving on to St. John’s College, Cambridge, rebelling against his father who expected Alfred to go to Oxford with a classics scholarship.
He was a bright student having a deep interest in mathematics and science. However he experienced a mental crisis while at college and switched to philosophy. His interest in metaphysics led him to ethics which then prompted him to study economics. His early initiation in economics arose from the fact that the economy was important for the improvement of the working class. His ethical stand guiding him in his work on the economics.
In 1868, he became a lecturer in the moral science at St. John’s College, Cambridge. A few years later, he attended research on trade protection in the United States and at that time he want to make the political economy a serious subject in Cambridge. In 1885 he became a professor of political economics at Cambridge. Within the next few years, he became one of the country’s most prominent economists and retired from Cambridge in 1908.
He has begun working on ‘Principles of Economics’ in 1881 and spent ten years writing it. The book was finally published in 1890 and became the standard textbook for the generation of economic students. In successive editions of that work, he introduced so many qualifications, exceptions and hesitations into his system that he weakened the clear and define principles on which many love to lean.
Marshall is a productive writer that includes other works including ‘The Economics of Industry’ (1879), ‘Industrial Economics’ (1892) and ‘Industry and Trade’ (1919), ‘Money, Credit & Commerce’ (1923). He also created the British Economic Association in 1890, later known as the Royal Economic Association after 1902. He had great influence on the government’s policy on price, gold and silver, currency, and international trade.
An influential economist, he plays an important role in shaping the mainstream economic thinking over a long and productive career. He is considered among the founders of a neoclassical economic school. He is credited with the development of a supply demand graph and to popularize the use of diagrams in economic teaching. He also played an important role in “marginalized revolution”.
Economic laws are the statements of economic tendencies and are hypothetical. Since economic laws deal with man’s actions which are numerous and uncertain, they are to be compared with the laws of tides rather than with the simple and exact law of gravitation.
The implications of Marshall’s approach and definitions are interesting. Economics laws are not natural laws that are necessarily beneficent. It is not imperative, though it may be desirable, that they be allowed to work themselves out by themselves, but the society can influence that outcome if it so desires. Marshall’s thinking left room for cautious reform, that is, for modest departures from laissez-faire.
Marshall had a little to say about the business cycles, partly because of his microeconomics approach. He and others who developed theories of the behaviors of individuals and conduct of small representative firms found that it easy to ignore fluctuations. It was left to later aggregate economics to grapple with such problems.
Utility and Demand
According to Marshall, price and output of goods are determined by supply and demand. Demand is based on the law of diminishing marginal utility which the marginal utility of a commodity to anyone diminishes with every increase in the amount of it he already has. Marshall was introduced two qualification on this point. First, he concern with time, which is too short an interval to consider any changes in character and tastes of a particular person. This mean that with the passage of time one’s tastes can change. Second, Marshall concerns consumer goods that are indivisible.
A rational consumer aims at maximizing satisfaction from his consumption. The amount of satisfaction is closely related to the quantity of that commodity consumed by the consumer. Thus demand is based on the law of diminishing marginal utility. Marshall stated the law thus, “the additional benefit which a person derives from a given increase of the stock of a thing, diminishes with every increase in the stock that he already has”.
Demand refers to the quantity of a commodity demanded at a certain price, other things remained the same. The individual demand curve can be directly derived from the law of diminishing marginal utility. Assuming the marginal utility of money to be constant as the satisfaction from the additional units of a commodity diminishes, the price offered to additional units will fall. Hence the demand curve slopes downwards.
These individual curves can be added together to get market demand curve. The market demand curve represents the total demand of all the consumers for a commodity at various prices on the basis diminishing utility, Marshall has developed the law of substitution.
So far consumer behavior has been analysis with reference to only one commodity. In practical life, the consumer has to choose between more than one commodities. A rational consumer will spend his money in such a way that his total satisfaction is maximum. He will go on substituting one commodity for another till he gets maximum satisfaction.
Marshall illustrated the law of demand by using a table and a demand curve. He drew his demand curve by assuming that the period of time is sufficiently short to justify a ceteris paribus assumption.
According to Marshall, consumers’s surplus is the excess of price which he would be willing to pay rather than go without the thing, over that which he actually does pay, is the economic measure of this surplus satisfaction. It may be called consumer’s surplus.
The consumers are generally prepared to pay higher price for a commodity rather than go without it. But they actually pay less for it. As a result the consumer enjoys a surplus satisfaction and it is known as consumer’s surplus. The concept of consumer’s surplus has become the basis of welfare economics.
Elasticity of demand
The elasticity of demand in the market is great or small according as the amount demanded increases much or little for a given fall in price and diminish much or little for a given rise in price.
He distinguished between five degrees of elasticity which is absolutely elastic, highly elastic, elastic, less elastic and inelastic. He laid down that the demand for luxuries was highly elastic, for comforts elastic and for necessaries inelastic.
Elasticity of demand can be measure by the percentage change in the amount demanded or percentage change in price. Generally, elasticity of demand refers to price elasticity. Demand is elastic when the percentage change in quantity over the percentage change in price, demand is inelastic when the percentage change in quantity is less than the percentage change in price and demand is unit elastic when the percentages changes are equal.
Marshall said supply is governed by cost of production. Marshall conceived of supply not as a point or single amount but rather as a curve. Supply is a whole series of quantities that would be forthcoming at a whole series of prices. For purpose of exposition, Marshall divided time into three periods that is
1. The immediate present
2. The short run
3. The long run.
The immediate present
Market prices refer to the present, with no time allowed for adaption of the quantity supplied to changes in demand. The market supply curve slopes upward and to the right until it encompasses to the total quantity on the market. Then it becomes vertical because of no matter how the market price, no greater quantity can be supplied during the market period.
Marshall divided costs into prime and supplementary costs. Prime cost are known as variable cost and include wages and raw materials. Supplementary cost are known as fixed costs and include depreciation, interest on loans, rent and salaries of executives. In the short run, a firm has to cover its prime costs. Variable input can be increased or decrease but the fixed plant cost cannot be changed. The SR supply curve slopes upward and to the right ; the higher the product price, the larger the quantity supplied.
Long Run (LR)
In the long run, a firm must cover both prime and supplementary costs if the firm is to continue the business. If the price rises such that total revenue exceeds the total cost of production, capital will enter the industry, market supply will increase and the entire supply curve will shift rightward. If the price falls below the average cost of the production, capital will withdraw, probably by the exit of a firm. Consequently, the market supply will decline (the supply curve will shift leftward).
EQUILIBRIUM PRICE AND QUANTITY
The classical economist determined market price is “cost of production” which means is objective labor-time cost, and the sacrifice of abstinence. Marshall illustrated the idea of equilibrium competitive market price and quantity with both of table (numerical) and a graph (graphical).
Marshall’s determination of equilibrium as below:
Competitive Market Price and Quantity
(SHILLINGS) AMOUNT HOLDERS ARE WILLING TO SELL (UNITS) AMOUNT BUYERS ARE WILLING TO BUY (UNITS)
37 1000 600
36 700 700
35 600 900
Table above shown that the amount each farmer or other seller offers for sale at any price is governed by his or own immediate need for money and estimate of future prices. Assuming equality of bargaining power between sellers and buyers, the “higgling and bargaining” of the market will result in a price close to 36 shillings. The price can called the true equilibrium price, because if it were fixed at the beginning and throughout, it would exactly equate the quantities demanded and supplied (700).
Marshall said “higgling and bargaining” of seller and buyers are result in an equilibrium price that equates quantity supplied and quantity demanded. Figure below shows buyers collectively receive consumer surplus and sellers collectively receive producer surplus. Price shillings was 37, a surplus of 400 units (100-600) of wheat would occur, and this would push the price downward. On the other hand, if the price were 35 shillings, suppliers would be willing to sell 300 fewer units (600-900) of wheat than demanders desire. This shortage obviously would drive the price upward.
Figure above shows Marshall’s equilibrium price and quantity. Marshall placed quantity on the horizontal axis because he viewed to be the independent variable. Marshall presented the idea of a producer surplus. Some sellers would be willing to sell their product at less than the market price rather than hold onto their goods.
DISTRIBUTION OF INCOME
Distribution of income in a competitive economy determined by the pricing of factors of production. Marshall said that businesspeople must constantly compare the relative efficiency of every agent of production they employ. They should consider the possibilities of substituting one agent of another. As an example:
HANDPOWER ? HORSEPOWER ? STEAMPOWER
Its mean horsepower replaced handpower, and steampower replaced horsepower.
The most striking advantage of economic freedom is manifest when a businessperson experiments at his own risk to find the combination of factor inputs that will yield the lowest costs in producing the output. Entrepreneurs must estimate how much an extra unit of any one factor of production will add to the value of their total product. Based on this analysis, Marshall said the diminishing returns that result from the “disproportionate use of any agent of productions.”
Marshall said wages are not determined by the marginal productivity of labor alone. Wages means return to any factor of production, depend on both demand and supply. If the supply of labor increase, other things remaining constant, the marginal productivity of labor will fall. While, Marshall also discussed the determinants of the wage elasticity of labor demand. Marshall’s four law of derived demand as follow:
1. Other things being equal, the greater the substitutability of other factors for labor, the greater will be the elasticity of demand for labor.
2. Other things being equal, the greater the price elasticity of product demand, the greater will be the elasticity of labor demand.
3. Other things being equal, the larger the proportion of total production costs accounted for by labor, the greater will be elasticity of labor demand.
4. Other things being equal, the greater the elasticity of the supply of other inputs, the greater the elasticity of demand for labor.
Another distributive share that Marshall considered is interest. “Interest” is a rise in the rate of interest diminishes the use of machinery because the business person avoids the use of all machines whose net annual surplus is less that the rate of interest. Lower interest rates will increase capital investment. Diminishing marginal productivity are associated with an increase in the quantity of the factor. Demand for consumer goods are based on diminishing marginal utility from successive quantities consumed. The quantity of saving supplied depends on the rate of interest, and the rate of interest are depends on the supply of saving.
Marshall recognized that other motives for saving might also be important. Some saving might occur old age, he might save less at a high rate of interest than at a low rate. High rate would yield the same total sum of money with a lower amount of saving. So the conclusion is, a fall in the interest rate will generally induce people to consume more in the present and a rise will induce them to consume less.
PROFITS, RENT AND QUASI-RENT
According to Marshall, normal profits include interest, the earnings of management and the supply price of business organization. The earnings of management are a payment for a specialized form of labor and remain is portion of normal profits, supply price of business organization are reward to entrepreneurship. For the rent, Marshall define that rent is a payment of natural gift of nature which is it is involved with the fertility of land, the price of the produce and the position of the margin. It excess of the value of the total returns which capital and labor applied to land to do obtain.
Marshall also said that land and manufactured capital goods are similar because the supplies of both are fixed. So, Marshall called the return to old capital investments is something akin to rent is “quasi-rent” which means the quasi-rent is the earnings on previous capital investments in the short run.
INCREASING AND DECREASING COST INDUSTRIES
A key analytic device for Marshall was his concept of the “representative firm”. He has at least three major purposes in his analysis. The first is, speaking of the normal cost of producing a commodity and he referred to the expenses of a representative producer who is neither the most efficient in the industry. Secondly, this analytic device showed that an industry can be in a long-period equilibrium. Lastly, even though the representative firm may not be increasing its internal efficiency, it can experience falling costs of production as the industry expands.
INTERNAL VS EXTERNAL ECONOMIES
Marshall said that internal economies is efficiencies or cost savings introduced by the growth in size of the individual firm. As the firm grows larger, it can enjoy more specialization and mass production, using more and better machines to lower the cost of production. While, external economies Marshall illustrated that it come from outside the firm; they depend on the general development of the industry.
INCREASING AND DECREASING RETURNS TO SCALE
Marshall thought that we generally have increasing returns to scale in industry; as labor and capital expand, organization and efficiency improve. We have laws of increasing and decreasing returns to scale are balanced, the law of constant returns: expanded output obtained through a proportionate expansion of both labor and the sacrifice waiting. Marshall drew an optimistic conclusion from his analysis where there are may be disadvantages resulting from a rapid growth of population, and the final outcome likely to be favorable. Overall, if the industry confirms with the law of increasing returns to scale, increased demand will ultimately cause the price to fall and more will be produced that if it were an industry of constant returns.
WELFARE EFFECTS OF TAXES AND SUBSIDIES
Alfred use his concept of consumer’s surplus in order to analyze the welfare effects of taxes and subsidies. From the figure, it is related to the simple situation which is a constant cost industry. Based on analysis’s Marshall, per unit tax on a constant cost industry reduces net consumer utility. A tax of IH shifts the supply curve upward from S to S’ and increases the product price from A to B. Government gains tax revenue of the amount represented by ABEF, but consumers lose consumer surplus of the greater amount ABEI, which is area ACI minus BCE.
Then, Marshall extended this analysis to increasing and decreasing cost industries. His analysis showed that a tax would rise tax revenue and it would reduce consumer surplus. By put a limit on the output of firms in the increasing cost industry, unit costs of tax would fall. The revenue received should be used to subsidize the industries experiencing decreasing costs. As the output of decreasing cost industries rises, their unit cost of subsidy will fall and the gain in consumer surplus will exceed the subsidy. Marshall thus concluded that there may give advantages to the society from taxing certain decreasing cost industries and using the collected revenues to subsidize increasing cost industries
Alfred Marshall, (26 July 1842 – 13 July 1924) was one of the most influential economists of his time. His book, Principles of Economics (1890), was the dominant economic textbook in England for many years. It brings the ideas of supply and demand, marginal utility, and costs of production into a coherent whole. Income distributions come from profit, interest, wages, quasi rent and rent. He is known as one of the founders of neoclassical economics. Although Marshall took economics to a more mathematically high level, he did not want mathematics to overshadow economics and thus make economics irrelevant to the citizen. Marshall concentrated on reconciling the classical labour theory of value, which had concentrated on the supply side of the market, with the new marginalist theory that concentrated on the consumer demand side. Marshall’s graphical representation is the famous supply and demand graph, the “Marshallian cross”. He insisted it is the intersection of both supply and demand that produce an equilibrium of price in a competitive market. Over the long run, argued Marshall, the costs of production and the price of goods and services tend towards the lowest point consistent with continued production.