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Ineconomicsandpolitical science,fiscal policy is the use of
government revenue collection(taxation) and expenditure (spending)
to influence the economy.[1]The two main instruments offiscal
policy are government taxation and changes in the level and
composition of taxation andgovernment spending can affect the
following variables in the economy:
Aggregate demandand the level of economic activity; The pattern
of resource allocation; The distribution of income.
Fiscal policy refers to the use of the government budget to
influence economic activity.
Stances of fiscal policy
The three main stances of fiscal policy are:
Neutral fiscal policy is usually undertaken when an economy is
in equilibrium.
Government spendingis fully funded bytaxrevenueand overall the
budget outcome hasa neutral effect on the level ofeconomic
activity.
Expansionary fiscal policy involves government spending
exceeding tax revenue, and isusually undertaken during
recessions.
Contractionary fiscal policy occurs when government spending is
lower than tax revenue,and is usually undertaken to pay down
government debt.
However, these definitions can be misleading because, even with
no changes in spending or taxlaws at all, cyclic fluctuations of
the economy cause cyclic fluctuations of tax revenues and of
some types of government spending, altering the deficit
situation; these are not considered to bepolicy changes. Therefore,
for purposes of the above definitions, "government spending"
and"tax revenue" are normally replaced by "cyclically adjusted
government spending" and"cyclically adjusted tax revenue". Thus,
for example, a government budget that is balanced overthe course of
the business cycle is considered to represent a neutral fiscal
policy stance.
Methods of funding
Governmentsspend moneyon a wide variety of things, from the
military and police to serviceslike education and healthcare, as
well astransfer paymentssuch as welfare benefits. Thisexpenditure
can befundedin a number of different ways:
Taxation Seigniorage, the benefit from printingmoney
Borrowingmoney from the population or from abroad Consumptionof
fiscal reserves Saleof fixed assets (e.g.,land)
Borrowing
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A fiscal deficit is often funded by issuingbonds, liketreasury
billsorconsolsandgilt-edgedsecurities. These pay interest, either
for a fixed period or indefinitely. If the interest and
capitalrequirements are too large, a nation maydefaulton its debts,
usually to foreign creditors. Publicdebt or borrowing refers to the
government borrowing from the public.
Consuming prior surpluses
A fiscal surplus is often saved for future use, and may be
invested in either local currency or anyfinancial instrument that
may be traded later once resources are needed; notice, additional
debt isnot needed. For this to happen, the marginal propensity to
save needs to be strictly positive.
Economic effects of fiscal policy
Governments use fiscal policy to influence the level of
aggregate demand in the economy, in aneffort to achieve economic
objectives of price stability, full employment, and economic
growth.Keynesian economicssuggests that increasing government
spending and decreasing tax rates are
the best ways to stimulateaggregate demand, and decreasing
spending & increasing taxes afterthe economic boom begins.
Keynesians argue this method be used in times of recession or
loweconomic activity as an essential tool for building the
framework for strong economic growthand working towards full
employment. In theory, the resulting deficits would be paid for by
anexpanded economy during the boom that would follow; this was the
reasoning behind theNewDeal.
Governments can use abudget surplusto do two things: to slow the
pace of strong economicgrowth, and to stabilize prices when
inflation is too high. Keynesian theory posits that
removingspending from the economy will reduce levels of aggregate
demand and contract the economy,thus stabilizing prices.
Economistsdebate the effectiveness of fiscal stimulus. The
argument mostly centers oncrowding out: whether government
borrowing leads to higherinterest ratesthat may offset
thestimulative impact of spending. When the government runs a
budget deficit, funds will need tocome from public borrowing (the
issue of government bonds), overseas borrowing, ormonetizingthe
debt. When governments fund a deficit with the issuing of
government bonds,interest rates can increase across the market,
because government borrowing creates higherdemand for credit in the
financial markets. This causes a lower aggregate demand for goods
andservices, contrary to the objective of a fiscal stimulus.
Neoclassical economists generallyemphasize crowding out while
Keynesians argue that fiscal policy can still be
effectiveespecially in aliquidity trapwhere, they argue, crowding
out is minimal.
Someclassicalandneoclassical economistsargue that crowding out
completely negates anyfiscal stimulus; this is known as theTreasury
View[citation needed], which Keynesian economicsrejects. The
Treasury View refers to the theoretical positions of classical
economists in theBritish Treasury, who opposed Keynes' call in the
1930s for fiscal stimulus. The same generalargument has been
repeated by some neoclassical economists up to the present.
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In the classical view, the expansionary fiscal policy also
decreases net exports, which has amitigating effect on national
output and income. When government borrowing increases
interestrates it attracts foreign capital from foreign investors.
This is because, all other things beingequal, the bonds issued from
a country executing expansionary fiscal policy now offer a
higherrate of return. In other words, companies wanting to finance
projects must compete with their
government for capital so they offer higher rates of return. To
purchase bonds originating from acertain country, foreign investors
must obtain that country's currency. Therefore, when foreigncapital
flows into the country undergoing fiscal expansion, demand for that
country's currencyincreases. The increased demand causes that
country's currency to appreciate. Once the currencyappreciates,
goods originating from that country now cost more to foreigners
than they didbefore and foreign goods now cost less than they did
before. Consequently, exports decrease andimports increase.[2]
Other possible problems with fiscal stimulus include the time
lag between the implementation ofthe policy and detectable effects
in the economy, and inflationary effects driven by increaseddemand.
In theory, fiscal stimulus does not cause inflation when it uses
resources that would
have otherwise been idle. For instance, if a fiscal stimulus
employs a worker who otherwisewould have been unemployed, there is
no inflationary effect; however, if the stimulus employs aworker
who otherwise would have had a job, the stimulus is increasing
labor demand while laborsupply remains fixed, leading to wage
inflation and therefore price inflation.
Fiscal straitjacket
The concept of a fiscal straitjacket is a general economic
principle that suggests strict constraintson government spending
and public sector borrowing, to limit or regulate the budget
deficit overa time period. The term probably originated from the
definition ofstraitjacket(anything thatseverely confines,
constricts, or hinders).[3]Various states in theUnited Stateshave
various
forms of self-imposed fiscal straitjackets.
Neoclassical economics is a term variously used for approaches
toeconomicsfocusing on the
determination of prices, outputs, and incomedistributionsin
markets throughsupply and demand,
often mediated through a hypothesized maximization ofutilityby
income-constrained individuals and of
profitsby cost-constrained firms employing available information
and factors of production, in
accordance withrational choice theory.[1]Neoclassical economics
dominates microeconomics, and
together withKeynesian economicsforms theneoclassical
synthesiswhich dominatesmainstream
economicstoday.[2]Although neoclassical economics has gained
widespread acceptance by
contemporary economists, there have been many critiques of
neoclassical economics, often
incorporated into newer versions of neoclassical theory as
awareness of economic criteria changes.
The term was originally introduced byThorstein Veblenin 1900, in
his article 'Preconceptions ofEconomic Science', to
distinguishmarginalistsin the tradition ofAlfred Marshallfrom those
intheAustrian School.[3][4]
"No attempt will here be made even to pass a verdict on the
relative claims of the recognized twoor three main "schools" of
theory, beyond the somewhat obvious finding that, for the purpose
in
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hand, the so-called Austrian school is scarcely distinguishable
from the neo-classical, unless it bein the different distribution
of emphasis. The divergence between the modernized classicalviews,
on the one hand, and the historical and Marxist schools, on the
other hand, is wider, somuch so, indeed, as to bar out a
consideration of the postulates of the latter under the same headof
inquiry with the former." - Veblen[5]
It was later used byJohn Hicks,George Stigler, and others[6]to
include the work ofCarl Menger,William Stanley Jevons,John Bates
Clarkand many others.[3]Today it is usually used to refer
tomainstream economics, although it has also been used as
anumbrella termencompassing anumber of otherschools of
thought,[7]notably excludinginstitutional economics,
varioushistorical schools of economics, andMarxian economics, in
addition to various otherheterodoxapproaches to economics.
Neoclassical economics is characterized by several assumptions
common to manyschools ofeconomic thought. There is not a complete
agreement on what is meant by neoclassicaleconomics, and the result
is a wide range of neoclassical approaches to various problem
areas
and domainsranging from neoclassical theories of labor to
neoclassical theories ofdemographic changes. As expressed byE. Roy
Weintraub, neoclassical economics rests on threeassumptions,
although certain branches of neoclassical theory may have different
approaches:[8]
1. People haverational preferencesamong outcomes that can be
identified and associatedwith a value.
2. Individualsmaximize utilityand firmsmaximize profits.3.
People act independently on the basis offull and relevant
information.
From these three assumptions, neoclassical economists have built
a structure to understand theallocation of scarce resources among
alternative endsin fact understanding such allocation is
often considered the definition of economics to neoclassical
theorists. Here's howWilliamStanley Jevonspresented "the problem of
Economics".
"Given, a certain population, with various needs and powers of
production, in possession ofcertain lands and other sources of
material: required, the mode of employing their labour whichwill
maximize the utility of their produce."[9]
From the basic assumptions of neoclassical economics comes a
wide range of theories aboutvarious areas of economic activity. For
example, profit maximization lies behind the neoclassicaltheory of
the firm, while the derivation ofdemandcurves leads to an
understanding ofconsumergoods, and thesupplycurve allows an
analysis of thefactors of production. Utility maximizationis the
source for the neoclassical theory of consumption, the derivation
of demand curves forconsumer goods, and the derivation of labor
supply curves andreservation demand.[10]Marketsupply and demand are
aggregated across firms and individuals. Their interactions
determineequilibrium output and price. The market supply and demand
for each factor of production isderived analogously to those for
marketfinal outputto determine equilibrium income and theincome
distribution. Factor demand incorporates
themarginal-productivityrelationship of thatfactor in the output
market.[6][11][12][13]
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Neoclassical economics emphasizes equilibria, where equilibria
are the solutions ofagentmaximization problems. Regularities in
economies are explained bymethodologicalindividualism, the position
that economic phenomena can be explained by aggregating over
thebehavior of agents. The emphasis is onmicroeconomics.
Institutions, which might be consideredas prior to and conditioning
individual behavior, are de-emphasized.Economic subjectivism
accompanies these emphases. See alsogeneral equilibrium.
Origins
This section does notciteanyreferences or sources. Please help
improve this sectionbyadding citations to reliable sources.
Unsourced material may be challenged andremoved.(August 2011)
Classical economics, developed in the 18th and 19th centuries,
included avalue theoryanddistributiontheory. The value of a product
was thought to depend on the costs involved inproducing that
product. The explanation of costs in Classical economics was
simultaneously anexplanation of distribution. A landlord received
rent, workers received wages, and a capitalisttenant farmer
received profits on their investment. This classic approach
included the work ofAdam SmithandDavid Ricardo.
However, some economists gradually began emphasizing the
perceived value of a good to theconsumer. They proposed a theory
that the value of a product was to be explained withdifferences in
utility (usefulness) to the consumer. (In England, economists
tended toconceptualize utility in keeping with
theUtilitarianismofJeremy Benthamand later ofJohnStuart Mill.)
The third step from political economy to economics was the
introduction ofmarginalismand theproposition that economic actors
made decisions based onmargins. For example, a persondecides to buy
a second sandwich based on how full they are after the first one, a
firm hires anew employee based on the expected increase in profits
the employee will bring. This differsfrom the aggregate decision
making of classical political economy in that it explains how
vitalgoods such as water can be cheap, while luxuries can be
expensive.
The marginal revolution
The change in economic theory from neoclassical economics has
been called the 'marginalrevolution', although it has been argued
that the process was slower than the term suggests .[14]It
is frequently dated fromWilliam Stanley Jevons's Theory of
Political Economy (1871),CarlMenger's Principles of Economics
(1871), andLon Walras's Elements of Pure Economics(18741877).
Historians of economics and economists have debated:
Whetherutilityor marginalism was more essential to this
revolution (whether the noun orthe adjective in the phrase
"marginal utility" is more important)
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ikipedia.org/wiki/Microeconomicshttp://en.wikipedia.org/wiki/Methodological_individualismhttp://en.wikipedia.org/wiki/Methodological_individualismhttp://en.wikipedia.org/wiki/Agent_%28economics%29
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Whether there was a revolutionary change of thought or merely a
gradual developmentand change of emphasis from their
predecessors
Whether grouping these economists together disguises differences
more important thantheir similarities.[15]
In particular, Jevons saw his economics as an application and
development ofJeremy Bentham'sutilitarianism and never had a fully
developedgeneral equilibrium theory. Menger did notembrace this
hedonic conception, explained diminishing marginal utility in terms
of subjectiveprioritization of possible uses, and emphasized
disequilibrium and the discrete; further Mengerhad an objection to
the use of mathematics in economics, while the other two modeled
theirtheories after 19th century mechanics.[16]Walras' conception
of utility, like that of Menger, wasthat ofusefulness in
general,[17]rather than the hedonic conception of Bentham or of
Mill; andWalras was more interested in the interaction of markets
than in explaining the individualpsyche.[15]
Alfred Marshall's textbook, Principles of Economics (1890), was
the dominant textbook inEngland a generation later. Marshall's
influence extended elsewhere; Italians would complimentMaffeo
Pantaleoniby calling him the "Marshall of Italy". Marshall
thoughtclassical economicsattempted to explain prices by thecost of
production. He asserted that earlier marginalists wenttoo far in
correcting this imbalance by overemphasizing utility and demand.
Marshall thoughtthat "We might as reasonably dispute whether it is
the upper or the under blade of a pair ofscissors that cuts a piece
of paper, as whether value is governed by utility or cost of
production".
Marshall explained price by the intersection of supply and
demand curves. The introduction ofdifferent market "periods" was an
important innovation of Marshalls:
Market period. The goods produced for sale on the market are
taken as given data, e.g. ina fish market. Prices quickly adjust to
clear markets. Short period. Industrial capacity is taken as given.
The level of output, the level of
employment, the inputs of raw materials, and prices fluctuate to
equatemarginal costandmarginal revenue, where profits are
maximized.Economic rentsexist in short periodequilibrium for fixed
factors, and the rate of profit is not equated across sectors.
Long period. The stock ofcapitalgoods, such as factories and
machines, is not taken asgiven. Profit-maximizing equilibria
determine both industrial capacity and the level atwhich it is
operated.
Very long period. Technology, population trends, habits and
customs are not taken asgiven, but allowed to vary in very long
period models.
Marshall took supply and demand as stable functions and extended
supply and demandexplanations of prices to all runs. He argued
supply was easier to vary in longer runs, and thusbecame a more
important determinant of price in the very long run.
Further developments
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An important change in neoclassical economics occurred around
1933.Joan RobinsonandEdward H. Chamberlin, with the near
simultaneous publication of their respective books, TheEconomics of
Imperfect Competition (1933) and The Theory of Monopolistic
Competition(1933), introduced models ofimperfect competition.
Theories ofmarket formsandindustrialorganizationgrew out of this
work. They also emphasized certain tools, such as themarginal
revenuecurve.Joan Robinson's work on imperfect competition, at
least, was a response to certain problems ofMarshallianpartial
equilibriumtheory highlighted byPiero Sraffa. Anglo-American
economistsalso responded to these problems by turning
towardsgeneral equilibriumtheory, developed onthe European
continent by Walras andVilfredo Pareto.J. R. Hicks'sValue and
Capital(1939)was influential in introducing his English-speaking
colleagues to these traditions. He, in turn,was influenced by
theAustrian SchooleconomistFriedrich Hayek's move to theLondon
Schoolof Economics, where Hicks then studied.
These developments were accompanied by the introduction of new
tools, such as indifference
curvesand the theory of ordinalutility. The level of
mathematical sophistication of neoclassicaleconomics increased.Paul
Samuelson'sFoundations of Economic Analysis(1947) contributed
tothis increase in mathematical modelling.
The interwar period in American economics has been argued to
have been pluralistic, withneoclassical economics
andinstitutionalismcompeting for allegiance.Frank Knight, an
earlyChicago schooleconomist attempted to combine both schools. But
this increase in mathematicswas accompanied by greater dominance of
neoclassical economics in Anglo-Americanuniversities after World
War II.
Hicks' book,Value and Capitalhad two main parts. The second,
which was arguably not
immediately influential, presented a model of temporary
equilibrium. Hicks was influenceddirectly by Hayek's notion of
intertemporal coordination and paralleled by earlier work
byLindhal. This was part of an abandonment of disaggregated long
run models. This trend probablyreached its culmination with
theArrow-Debreu modelofintertemporal equilibrium. The Arrow-Debreu
model has canonical presentations in Grard Debreu's Theory of Value
(1959) and inArrow and Hahn's "General Competitive Analysis"
(1971).
Many of these developments were against the backdrop of
improvements in botheconometrics,that is the ability to measure
prices and changes in goods and services, as well as their
aggregatequantities, and in the creation ofmacroeconomics, or the
study of whole economies. The attemptto combine neo-classical
microeconomics andKeynesianmacroeconomics would lead to
theneoclassical synthesis[18]which has been the dominant paradigm
of economic reasoning inEnglish-speaking countries since the 1950s.
Hicks and Samuelson were for example instrumentalin mainstreaming
Keynesian economics.
Macroeconomics influenced the neoclassical synthesis from the
other direction, underminingfoundations of classical economic
theory such asSay's Law, and assumptions aboutpoliticaleconomysuch
as the necessity for a hard-money standard. These developments are
reflected in
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i/Chicago_school_%28economics%29http://en.wikipedia.org/wiki/Frank_Knighthttp://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Foundations_of_Economic_Analysishttp://en.wikipedia.org/wiki/Paul_Samuelsonhttp://en.wikipedia.org/wiki/Utilityhttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/Indifference_curvehttp://en.wikipedia.org/wiki/London_School_of_Economicshttp://en.wikipedia.org/wiki/London_School_of_Economicshttp://en.wikipedia.org/wiki/Friedrich_Hayekhttp://en.wikipedia.org/wiki/Austrian_Schoolhttp://en.wikipedia.org/wiki/Value_and_Capitalhttp://en.wikipedia.org/wiki/J._R._Hickshttp://en.wikipedia.org/wiki/Vilfredo_Paretohttp://en.wikipedia.org/wiki/General_equilibriumhttp://en.wikipedia.org/wiki/Piero_Sraffahttp://en.wikipedia.org/wiki/Supply_and_demandhttp://en.wikipedia.org/wiki/Marginal_revenuehttp://en.wikipedia.org/wiki/Marginal_revenuehttp://en.wikipedia.org/wiki/Industrial_organizationhttp://en.wikipedia.org/wiki/Industrial_organizationhttp://en.wikipedia.org/wiki/Market_formhttp://en.wikipedia.org/wiki/Imperfect_competitionhttp://en.wikipedia.org/wiki/Edward_H._Chamberlinhttp://en.wikipedia.org/wiki/Joan_Robinson
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neoclassical theory by the search for the occurrence in markets
of the equilibrium conditions ofPareto optimalityand
self-sustainability.
Criticisms
Main article:Criticisms of neoclassical economics
Neoclassical economics is sometimes criticized for having
anormativebias. In this view, it doesnot focus on explaining actual
economies, but instead on describing a "utopia" in
whichParetooptimalityapplies.
The assumption that individuals act rationally may be viewed as
ignoring important aspects ofhuman behavior. Many see the "economic
man" as being quite different from real people. Manyeconomists,
even contemporaries, have criticized this model of economic
man.Thorstein Veblenput it most sardonically. Neoclassical
economics assumes a person to be,
"a lightning calculator of pleasures and pains, who oscillates
like a homogeneous globule ofdesire of happiness under the impulse
of stimuli that shift about the area, but leave himintact."[19]
Large corporations might perhaps come closer to the neoclassical
ideal of profit maximization,but this is not necessarily viewed as
desirable if this comes at the expense of neglect of widersocial
issues. The response to this is that neoclassical economics is
descriptive and notnormative. It addresses such problems with
concepts of private versus social utility.
Problems exist with making the neoclassicalgeneral
equilibriumtheory compatible with aneconomy that develops over time
and includes capital goods. This was explored in a major
debate in the 1960sthe "Cambridge capital controversy"about the
validity of neoclassicaleconomics, with an emphasis on theeconomic
growth,capital, aggregate theory, and themarginal productivity
theoryof distribution. There were also internal attempts by
neoclassicaleconomists to extend the Arrow-Debreu model to
disequilibrium investigations of stability anduniqueness. However a
result known as theSonnenschein-Mantel-Debreu theoremsuggests
thatthe assumptions that must be made to ensure that the
equilibrium is stable and unique are quiterestrictive.
Neoclassical economics is also often seen as relying too heavily
on complex mathematicalmodels, such as those used ingeneral
equilibriumtheory, without enough regard to whetherthese actually
describe the real economy. Many see an attempt to model a system as
complex as
a modern economy by a mathematical model as unrealistic and
doomed to failure. A famousanswer to this criticism isMilton
Friedman's claim that theories should be judged by their abilityto
predict events rather than by the realism of their
assumptions.[20]Mathematical models alsoinclude those ingame
theory,linear programming, andeconometrics. Critics of
neoclassicaleconomics are divided into those who think that highly
mathematical method is inherently wrongand those who think that
mathematical method is potentially good even if contemporary
methodshave problems.
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In general, allegedly overly unrealistic assumptions are one of
the most common criticismstowards neoclassical economics. It is
fair to say that many (but not all) of these criticisms canonly be
directed towards a subset of the neoclassical models (for example,
there are manyneoclassical models where unregulated markets fail to
achieve Pareto-optimality and there hasrecently been an increased
interest in modeling non-rational decision making).
Alfred Marshall (26 July 184213 July 1924) was one of the most
influential economists ofhis time. His book,Principles of
Economics(1890), was the dominant economic textbook inEngland for
many years. It brings the ideas ofsupply and demand, marginal
utility, and costs ofproduction into a coherent whole. He is known
as one of the founders ofeconomics. Marshallwas born in Clapham,
England, July 26, 1842. His father was a bank cashier and a
devoutEvangelical. Marshall grew up in the London suburb
ofClaphamand was educated at theMerchant Taylors' SchoolandSt
John's College, Cambridge, where he demonstrated an aptitudein
mathematics, achieving the rank ofSecond Wranglerin the
1865Cambridge MathematicalTripos.[1][2]Marshall experienced a
mental crisis that led him to abandon physics and switch
tophilosophy. He began with metaphysics, specifically "the
philosophical foundation of
knowledge, especially in relation to theology.".
[3]
Metaphysics led Marshall to ethics,
specificallyaSidgwickianversion of utilitarianism; ethics, in turn,
led him to economics, because economicsplayed an essential role in
providing the preconditions for the improvement of the working
class.Even as he turned to economics, his ethical views continued
to be a dominant force in histhinking.
Marshall took a broad approach to social science in which
economics plays an important butlimited role. He recognized that in
the real world, economic life is tightly bound up with
ethical,social and political currentscurrents he felt economists
should not ignore. Marshall envisioneddramatic social change
involving the elimination of poverty and a sharp reduction of
inequality.He saw the duty of economics was to improve material
conditions, but such improvement wouldoccur, Marshall believed,
only in connection with social and political forces. His interest
inliberalism, socialism, trade unions, women's education, poverty
and progress reflect the influenceof his early social philosophy to
his later activities and writings.
Marshall was elected in 1865 to a fellowship at St John's
College at Cambridge, and becamelecturer in the moral sciences in
1868. In 1885 he became professor of political economy atCambridge,
where he remained until his retirement in 1908. Over the years he
interacted withmany British thinkers includingHenry Sidgwick,W.K.
Clifford,Benjamin Jowett,WilliamStanley Jevons,Francis Ysidro
Edgeworth,John Neville KeynesandJohn Maynard Keynes.Marshall
founded the "Cambridge School" which paid special attention to
increasing returns, thetheory of the firm, and welfare economics;
after his retirement leadership passed to Arthur CecilPigouandJohn
Maynard Keynes.
Economics
He desired to improve the mathematical rigor of economics and
transform it into a morescientific profession. In the 1870s he
wrote a small number of tracts on international trade andthe
problems of protectionism. In 1879, many of these works were
compiled into a work entitled
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The Theory of Foreign Trade: The Pure Theory of Domestic Values
. In the same year (1879) hepublished The Economics of Industry
with his wifeMary Paley.
Although Marshall took economics to a more mathematically
rigorous level, he did not wantmathematicsto overshadow economics
and thus make economics irrelevant to the layman.
Accordingly, Marshall tailored the text of his books to laymen
and put the mathematical contentin the footnotes and appendices for
the professionals. In a letter toA. L. Bowley, he laid out
thefollowing system:
(1) Use mathematics as shorthand language, rather than as an
engine of inquiry. (2) Keep to themtill you have done. (3)
Translate into English. (4) Then illustrate by examples that are
importantin real life (5) Burn the mathematics. (6) If you cant
succeed in 4, burn 3. This I do often. "[4]
Marshall had been Mary Paley's professor of political economy at
Cambridge and the two weremarried in 1877, forcing Marshall to
leave his position as aFellow (college)ofSt John's
College,Cambridgein order to comply with celibacy rules at the
university. He became the first principal
atUniversity College, Bristol, which was the institution that
later became theUniversity ofBristol, again lecturing on political
economy and economics. He perfected his Economics ofIndustry while
at Bristol, and published it more widely in England as an economic
curriculum;its simple form stood upon sophisticated theoretical
foundations. Marshall achieved a measure offame from this work, and
upon the death ofWilliam Jevonsin 1882, Marshall became theleading
British economist of the scientific school of his time.
Marshall returned to Cambridge, via a brief period atBalliol
College, Oxfordduring 18834, totake the seat asProfessor of
Political Economyin 1884 on the death ofHenry Fawcett. AtCambridge
he endeavored to create a newtriposfor economics, a goal which he
would onlyachieve in 1903. Until that time, economics was taught
under the Historical and Moral Sciences
Triposes which failed to provide Marshall the kind of energetic
and specialized students hedesired.
Principles of Economics (1890)
Main article:Principles of Economics (Marshall)
Marshall began his economic work, the Principles of Economics,
in 1881, and spent much of thenext decade at work on the treatise.
His plan for the work gradually extended to a two-volumecompilation
on the whole of economic thought. The first volume was published in
1890 toworldwide acclaim that established him as one of the leading
economists of his time. The second
volume, which was to address foreign trade, money, trade
fluctuations, taxation, andcollectivism, was never published.
Principles of Economics established his worldwide reputation. It
appeared in 8 editions, startingat 750 pages and growing to 870
pages. It decisively shaped the teaching of economics
inEnglish-speaking countries. Its main technical contribution was a
masterful analysis of the issuesof elasticity, consumer surplus,
increasing and diminishing returns, short and long terms, and
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marginal utility; many of the ideas were original with Marshall,
others were improved version ofideas byW. S. Jevonsand others.
In a broader sense Marshall hoped to reconcile the classical and
modern theories of value. JohnStuart Millhad examined the
relationship between the value of commodities and their
production
costs, on the theory that value depends on effort expended in
manufacture. Jevons and theMarginal Utilitytheorists had elaborated
a theory of value based on the idea of maximizingutility, holding
that value depends on demand. Marshall's work used both these
approaches, buthe focused more on costs. He noted that, in the
short run, supply cannot be changed and marketvalue depends mainly
on demand. In an intermediate time period, production can be
expanded byexisting facilities, such as buildings and machinery;
but since these do not require renewal withinthis intermediate
period their costs (called fixed, overhead, or supplementary costs)
have littleinfluence on the sale price of the product. Marshall
pointed out that it is the prime or variablecosts, which constantly
recur, that influence the sale price most in this period. In a
still longerperiod, machines and buildings wear out and have to be
replaced, so that the sale price of theproduct must be high enough
to cover such replacement costs. This classification of costs
into
fixed and variable and the emphasis given to the element of time
probably represent one ofMarshall's chief contributions to economic
theory. He was committed to partial equilibriummodels over general
equilibrium on the grounds that the inherently dynamical nature
ofeconomics made the former more practically useful.
Alfred Marshall's supply and demand graph.
Much of the success of Marshall's teaching and Principles book
derived from his effective use ofdiagrams, which were soon emulated
by other teachers worldwide.[5]
Alfred Marshall was the first to develop the standard supply and
demand graph demonstrating anumber of fundamentals regarding supply
and demand including the supply and demand curves,market
equilibrium, the relationship between quantity and price in regards
to supply and demand,
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law of marginal utility, law diminishing returns, and the ideas
of consumer and producersurpluses. This model is now used by
economists in various forms using different variables todemonstrate
several other economic principles. Marshall's model allowed a
visual representationof complex economic fundamentals where before
all the ideas and theories were only capable ofbeing explained
through words. These models are now critical throughout the study
of
economics because it allows a clear and concise representation
of the fundamentals or theoriesbeing explained.
Later career
He served asPresidentof the first day of the 1889Co-operative
Congress.[6]
Over the next two decades he worked to complete the second
volume of his Principles, but hisunyielding attention to detail and
ambition for completeness prevented him from mastering thework's
breadth. The work was never finished and many other, lesser works
he had begun workon - a memorandum on trade policy for
theChancellor of the Exchequerin the 1890s, for
instance - were left incomplete for the same reasons.
His health problems had gradually grown worse since the 1880s,
and in 1908 he retired from theuniversity. He hoped to continue
work on his Principles but his health continued to deteriorateand
the project had continued to grow with each further investigation.
The outbreak of theFirstWorld Warin 1914 prompted him to revise his
examinations of the international economy and in1919 he
publishedIndustry and Trade at the age of 77. This work was a more
empirical treatisethan the largely theoretical Principles, and for
that reason it failed to attract as much acclaimfrom theoretical
economists. In 1923, he publishedMoney, Credit, and Commerce, a
broadamalgam of previous economic ideas, published and unpublished,
stretching back a half-century.
From 1890 to 1924 he was the respected father of the economic
profession and to mosteconomists for the half-century after his
death, the venerable grandfather. He had shied awayfrom controversy
during his life in a way that previous leaders of the profession
had not,although his even-handedness drew great respect and even
reverence from fellow economists,and his home atBalliol Croftin
Cambridge had no shortage of distinguished guests. His studentsat
Cambridge became leading figures in economics, includingJohn
Maynard KeynesandArthurCecil Pigou. His most important legacy was
creating a respected, academic, scientificallyfounded profession
for economists in the future that set the tone of the field for the
remainder ofthe 20th century.
Having died aged 81 at his home in Cambridge, Marshall is buried
in theAscension Parish
Burial Ground.[7]The library of the Department of Economics at
Cambridge University (TheMarshall Library of Economics), the
Economics society at Cambridge (The Marshall Society)[8]as well as
theUniversity of BristolEconomics department are named for him.
His home, Balliol Croft, was renamedMarshall Housein 1991 in his
honour when it was boughtbyLucy Cavendish College,
Cambridge.[9]
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Theoretical contributions
Marshall is considered to be one of the most influential
economists of his time, largely shapingmainstream economic
thoughtfor the next fifty years, and being one of the founders of
theschool ofneoclassical economics. Although his economics was
advertised as extensions and
refinements of the work ofAdam Smith,David Ricardo,Thomas Robert
MalthusandJohnStuart Mill, he extended economics away from
itsclassicalfocus on the market economy andinstead popularized it
as a study of human behavior. He downplayed the contributions of
certainother economists to his work, such asLon Walras,Vilfredo
ParetoandJules Dupuit, and onlygrudgingly acknowledged the
influence ofStanley Jevonshimself.
Marshall's influence on codifying economic thought is difficult
to deny. He popularized the useofsupply and demandfunctions as
tools of price determination (previously discoveredindependently
byCournot); modern economists owe the linkage between price shifts
and curveshifts to Marshall. Marshall was an important part of the
"marginalistrevolution;" the idea thatconsumers attempt to adjust
consumption untilmarginal utilityequals the price was another
of
his contributions. Theprice elasticity of demandwas presented by
Marshall as an extension ofthese ideas. Economic welfare, divided
intoproducer surplusandconsumer surplus, wascontributed by
Marshall, and indeed, the two are sometimes described eponymously
as'Marshallian surplus.' He used this idea of surplus to rigorously
analyze the effect of taxes andprice shifts on market welfare.
Marshall also identifiedquasi-rents.
Marshall's brief references to the social and cultural relations
in the "industrial districts" ofEngland were used as a starting
point for late twentieth-century work ineconomic
geographyandinstitutional economicsonclusteringandlearning
organizations.
Gary Becker(b. 1930), the 1992 Nobel prize winner in economics,
has mentioned that Milton
Friedman and Alfred Marshall were the two greatest influences on
his work.
Another contribution that Marshall made was differentiating
concepts of internal and externaleconomies of scale. That is that
when costs of input factors of production go down, it's a
positiveexternality for all the firms in the market place, outside
the control of any of the firms.[10]
The Marshallian industrial district
A concept based on a pattern of organization that was common in
late nineteenth centuryBritainin which firms concentrating on the
manufacture of certain products were geographicallyclustered.
Comments made by Marshall in Book 4, Chapter 10 of Principles of
Economics[11]have been used by economists and economic geographers
to discuss this phenomenon.
The two dominant characteristics of a Marshallian industrial
district[12]are high degrees ofvertical and horizontal
specialisation and a very heavy reliance on market mechanism
forexchange. Firms tend to be small and to focus on a single
function in the production chain. Firmslocated in industrial
districts are highly competitive in theneoclassicalsense, and in
many casesthere is little product differentiation. The major
advantages of Marshallian industrial districts
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