Aristotle Value Theory

Aristotle Value The idea of value received little attention, and that little was from the point of view of ethics or justice. Plato says that according to law a man "should not attempt to raise the price, but simply ask the value," implying that value is an absolute quality inherent in the thing. This, however, is but a rudimentary discussion of the subject. Aristotle goes further. His notion of value is clearly subjective, and is based upon the usefulness of the commodity concerned.2 All things which are exchanged must be comparable through some standard of measure, and this standard he finds in man's wants: "In the truest and most real sense, this standard lies in wants, which is the basis of all association among men." An exchange is just, when each gets exactly as much as he gives the other; yet this equality does not mean equal costs, but equal wants. If men want the cobbler's product more than the husbandman's, more grain must be given for shoes. Money is the medium which makes wants commensurable.

Value and Just Price

Value and Just Price, Medieval Economic History Passing over ideas concerning wealth and industry, which were substantially those mentioned above, one reaches the heart of their economic thought in the doctrine of justum pretium. This doctrine rested upon their notion of value. This concerned exchange value, for exchanges had become more important than in Aristotle's day. But the institutions of an independent domestic economy, and the ideas of production for use, were sufficiently prevalent and competition was sufficiently absent to make freely determined market values seem "unnatural." Labor was the chief factor in production; the gild master worked at his trade; there was little capital. So the worth of a thing tended to be judged by the amount of labor required to produce it. Briefly stated, the doctrine of "just price" was that every commodity has some one true value which is absolute, and is to be determined and be made objective on the basis of the common estimation of the cost of production, which usually covers labor. The words, "is to be determined," are used deliberately; ior the doctrines of the scholastics are only to be understood when considered as ethical, as laying down what should be, rather than scientific conclusions as to what is. To sell a thing for "more than it is worth," was regarded as immoral. As formulated by Albertus Magnus (1193-1280) and Thomas Aquinas (1227 or 1225-1274), the theory was that value should equal the expenditure of labor and other costs. Thus, according to Aquinas, a man might lawfully charge more than he had paid "either because he has improved the article in some respect, or because the price of the article has been changed on account of difference of place or time, or on account of the danger to which he exposes himself in transferring the article from place to place, or in causing it to be transferred." 'This generalization, however, was qualified to the extent that only those costs which were incurred in producing things which satisfied normal or natural wants were determining. Furthermore, the labor element was weighted according to the social rank of the laborer. This involved the important idea of "status" and fixed rules as to the standard of life for each status, in order that the cost of production as it was conceived could be determined.

The value thus fixed was not necessarily expressed in market price, and was independent of the estimate of buyer or seller. It was a question of justice, and it was the duty of the law to step in and fix the price according to the above principles. In short, "just price" was akin to our concept of "fair value," and, as opposed to objectively determined market value, it involved a process of "valuation" or "price fixing" It was quite in harmony with this conception that Charlemagne, at an earlier time, ordained "that no man, whether ecclesiastic or layman, shall, either in time of abundance, or in time of scarcity, sell provisions higher than the price recently fixed per bushel." With the rise of towns and money economy, this notion of value began to be modified, though it dominated the whole period and beyond. Aquinas gave some consideration to utility and to the amount offered for sale, or supply. Buridan (1300-1358) went farther and, following Aristotle, stated that the measure of value is to be found in the satisfaction of wants: the greater the need, the higher the value. And Biel (died 1495), while standing for a necessary equality in value of goods exchanged, bases it upon their utility for human ends. But when all has been said, the conclusion is that it is broadly true that a conception of value as absolute and based on cost prevailed during the Middle Ages.

Adam Smith Theory Of Value

Adam Smith Theory Of Value, Value Theory Definition Certain questions regarding value, or price, that should be kept separate were sometimes confused by early economists. (1) What determines the price of a good? In the language of modern economics, what determines relative prices? (2) What determines the general level of prices? (3) What is the best measure of welfare? The first and third questions are part of modern microeconomics; the second, although it defies the usually simple micro-macro dichotomy, is generally included under the broad umbrella of macroeconomics. Smith did not provide an unambiguous answer to any of these different questions. His treatment of them is, in places, confusing in this regard because he intermingled his discussion of what determines relative prices with his attempt to discover a measure of changes in welfare over time. It is not surprising that historians of economic ideas have argued over Smith's true opinion. One group of writers holds that Smith had three theories of relative prices (labor cost, labor command, and cost of production) and a theory explaining the general level of prices. Another group maintains that he settled on a cost of production theory of relative prices, a theory measuring changes in welfare over time, and a theory of the general level of prices. The latter group denies that Smith had a labor theory of relative prices. We believe that Smith experimented with all these theories: a theory of relative prices consisting of labor cost and labor command for a primitive society and cost of production for an advanced economy; the formulation of an index measuring changes in welfare over time; and a theory explaining the general level of prices. We first consider his theory of relative prices. Relative Prices Although Adam Smith explained relative prices as determined by supply or costs of production alone, he did not completely ignore the role of demand. He believed that market, or short-run, prices are determined by both supply and demand. Natural, or long-run equilibrium, prices generally depend upon costs of production, although Smith sometimes stated that natural price depends upon both demand and supply. These inconsistencies provide ample opportunity for historians of economic theory to debate Smith's real meaning. Smith's analysis of the formation of relative prices in the economy of his time distinguishes two time periods, the short run and the long run, and two broad sectors of the economy,

agriculture and manufacturing. During the short-run, or market, period, Smith found downward-sloping demand curves and upward-sloping supply curves in both manufacturing and agriculture; therefore, market prices depend upon demand and supply. Smith's analysis of the more complicated "natural price," which occurs in the long run, contains some contradictions. For the agricultural sector, natural price depends upon supply and demand because the long-run supply curve is upward-sloping, indicating increasing costs. But for the manufacturing sector, the long-run supply curve is at times assumed to be perfectly elastic (horizontal), representing constant costs, and in other parts of the analysis is downwardsloping, indicating decreasing costs. In manufacturing, when the long-run supply curve is perfectly elastic, price depends entirely on cost of production; but when it is downwardsloping, natural price depends upon both demand and supply. There are a number of possible interpretations of Smith's statements with regard to the forces determining natural prices for manufactured goods. One may assume that he was merely inconsistentpossibly because of the long period of time it took him to write Wealth of Nations or that he thought these issues were of minor importance. Another approach is to select one of his statements on manufacturing costs as representative of "the real Adam Smith." It makes little difference which approach is employed, because Smith consistently noted the role of demand in the formation of natural prices and in the allocation of resources among the various sectors of the economy. Nevertheless, regardless of the shape of the long-run supply curve in manufacturing, the major emphasis in the determination of natural prices is on cost of production, an emphasis that is characteristic of Smith and subsequent classical economists. The scholastics became interested in the question of relative prices because they were concerned with the ethical aspects of exchange, and the mercantilists considered it because they thought wealth was created in the process of exchange. Even though Smith on occasion discussed prices in ethical terms, he had a more important reason for being interested in the factors determining relative prices. Once an economy practices specialization and division of labor, exchange becomes necessary. If exchange takes place in a market such as the one existing at the time Smith wrote, certain obvious problems arise. The Meaning of Value Smith believed that the word value has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called "value in use"; the other, "value in exchange." The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it. According to Smith, value in exchange is the power of a commodity to purchase other goods its price. This is an objective measure expressed in the market. His concept of value in use is ambiguous; it resulted in a good part of his difficulties in explaining relative prices. On the one hand, it has ethical connotations and is therefore a return to scholasticism. Smith's own puritanical standards are particularly noticeable in his statement that diamonds have hardly any value in use. On the other hand, value in use is the want-satisfying power of a commodity, the utility received by holding or consuming a good. Several kinds of utility are received when a commodity is consumed: its total utility, its average utility, and its marginal utility. Smith's focus was on total utilitythe relationship between marginal utility and value was not understood by economists until one hundred years after Smith wroteand this obscured his understanding of how demand plays its role in price determination. It is clear that the total utility of water is greater than that of diamonds; this is what Smith was referring to when he pointed to the high use value of water as compared to the use value of diamonds. However, because a commodity's marginal utility often decreases as more of it is consumed, it

is quite possible that another unit of water would give less marginal utility than another unit of diamonds. The price we are willing to pay for a commoditythe value we place on acquiring another unitdepends not on its total utility but on its marginal utility. Because Smith did not recognize this (nor did other economists until the 1870s), he could neither find a satisfactory solution to the diamond-water paradox nor see the relationship between use value and exchange value. Smith on Relative Prices Because Smith was somewhat confused about the factors determining relative prices, he developed three separate theories relating to them. (1) a labor cost theory of value, (2) a labor command theory of value, and (3) a cost of production theory of value. He postulated two distinct states of the economy: the early and rude state, or primitive society, which is defined as an economy in which capital has not been accumulated and land is not appropriated; and an advanced economy, in which capital and land are no longer free goods (they have a price greater than zero). Labor cost theory in a primitive society. In the early and rude state of society which precedes both the accumulation of stock [i.e., capital] and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. According to Smith's labor cost theory, the exchange value, or price, of a good in an economy in which land and capital are nonexistent, or in which these goods are free, is determined by the quantity of labor required to produce it. This brings us to the first difficulty with a labor cost theory of value. How are we to measure the quantity of labor required to produce a commodity? Suppose that two laborers are working without capital, that land is free, and that in one hour laborer Jones produces one unit of final product and laborer Brown produces two units. Assume that all other things are equalor, to use the shorthand expression of theory, ceteris paribusso that the only cause of the differences in productivity is the difference in the skills of the workers. Does a unit of output require one hour of labor or two? Smith recognized that the quantity of labor required to produce a good cannot simply be measured by clock hours, because in addition to time, the ingenuity or skill involved and the hardship or disagree-ableness of the task must be taken into account. Labor theory in an advanced economy. Smith's model for an advanced society differs from his primitive economy model in two important respectscapital has been accumulated and land appropriated. They are no longer free goods, and the final price of a good also must include returns to the capitalist as profits and to the landlord as rent. Final prices yield an income made up of the factor payments of wages, profits, and rents. Cost of production theory of relative prices. Smith wrestled with developing a labor theory of value for an economy that included more than labor costs in the final prices of goods, but finally abandoned the idea that any labor theory of value was applicable to an economy as advanced as that of his times. Once capital has been accumulated and land appropriated, and once profits and rents as well as labor must be paid, the only appropriate explanation of prices, he seems to have found, was a cost-of-production theory. In a cost theory the value of a commodity depends on the payments to all the factors of production: land and capital in addition to labor. In Smith's system, the term profits includes both profits as they are understood today and interest. The total cost of producing a beaver is then equal to wages, profits, and rent, TCb = Wb + Pb + Kb; likewise for a deer, TCd = Wd + Pp + R-dThe relative price for beaver and deer would then be given by the ratio of TCb/TCd- Where Smith assumed that average costs do not increase with increases in output, this calculation gives the same relative prices whether total costs or average costs are used. Where Smith assumed that average costs change with output, prices depend upon both demand and supply.

However, in his analysis of the determination of long-run natural prices, Smith emphasized supply and cost of production, even when the supply curve was not assumed to be perfectly elastic. Where competition prevails, he maintained, the self-interest of the businessman, laborer, and landlord will result in natural prices that equal cost of production.

Ricardos Value Theory Economic Value Theory

Ricardos Value Theory, Economic Value Theory Definition Ricardo's theory of value was developed in response to the Corn Law controversy. A number of writers, chiefly Malthus, argued that raising tariffs on the importation of grain would be beneficial to England. Ricardo, however, was in favor of free international trade and against tariffs, which he maintained would be harmful to English economic development. He reasoned that high tariffs would reduce the rate of profits, which in turn would mean a slower rate of capital accumulation. Because the rate of economic growth depended upon the rate of capital accumulation, tariffs would lower the growth rate. Ricardo found Adam Smith's economic theory unsatisfactory in several ways in dealing with this problem. The cost of production theory of value was being used by protectionists to argue that higher tariffs would not result in lower profits. Ricardo and the protectionists agreed that higher tariffs would result in higher money wages, but a long and bitter debate arose concerning their effect on profits and rent. Both sides agreed that increased tariffs would push down the margin as less fertile lands were utilized and land under cultivation was farmed more intensively. The resulting increase in the costs of producing grain would require an increase in money wages in order for workers to maintain a subsistence standard of livin'g, because the cost of grain was a major part of the workers' food budgets. The protectionists argued, using Smith's cost of production theory of value, that higher money wages would not necessarily reduce profits. Some protectionists also argued that removing or lowering the tariffs ori grain would produce falling food prices and money wages, followed eventually by a general fall in all prices, which would lead to depression. Ricardo, therefore, wanted to refute the prevailing cost of production theory of value in order to establish the benefits to England of removing the tariffs on grain. He also saw that the most important economic consequence of the Corn Laws was their impact on the distribution of income and that the prevailing economic theory had no satisfactory income distribution theory. Thus, he was led to develop an alternative theory of value. Most theories of value attempt to explain the forces determining relative prices at a given point in time. However, according to Ricardo, the primary problem for a value theory is to explain the economic forces that cause changes in relative prices over time. Ricardo attacked the question of value in this way because of his interest in the income distribution consequences of the Corn Laws. So he is not concerned with determining why two deer can be exchanged for one beaver at a point in time, but with what forces cause changes in this ratio over time. If, for example, the price of beaver increases so that 3D = IB, there is a problem of interpretation. Which is it correct to say: that the price of beaver increased, or that the price of deer decreased? Both conclusions are correct, but neither tells us as much as an invariable measure of value would. With an invariable measure of value, we could ascertain whether the price of beaver increased because beaver had become more costly to produce or because deer had become less costly to produce. If there were some commodity whose value was invariant over time, then the true causes of changes in relative prices over time could be discovered. Ricardo recognized that no such commodity existed; but finding this problem challenging, he expended some effort in trying to formulate a measure of absolute value that would be invariant over time. He considered the problem in the first edition of the Principles and discussed it thoroughly in his last paper, "Absolute Value and Exchangeable Value." (Curiously enough, this paper was lost and not rediscovered until 1943. It had passed from James Mill to

John Stuart Mill and then to Mill's heirs. It can be found in Volume IV of Ricardo's Works.) But Ricardo was never able to formulate a satisfactory measure of absolute value. We turn, therefore, to Ricardo's primary concern with respect to value: what causes changes in relative prices over time?

Mill Theory Of Value Stuart Mill Value Theory

Mill Theory Of Value, John Stuart Mill Value Theory The theory of value, or relative prices, presented by Mill is a fundamental rejection of Ricardo's labor theory of value, although Mill characteristically stressed not his deviations from Ricardian dogma but the continuity between his theory and the past. He presented a cost of production theory of value in which money costs fundamentally represent the real costs or disutilities of labor and abstinence. In this regard, Mill and Senior have comparable theories of. value. However, Mill gave up the Ricardian search for absolute value based on some invariant measure of value, believing that the purpose of value theory is to explain relative prices. In his discussion of rent, he recognized that the opportunity cost of land is not always zero and that rent is a social cost of production in cases in which there are alternative uses of land. Although Mill did not distinguish between short run and long run in the manner of Marshall, he did seem to have a vague idea of this distinction and regarded his primary task as explaining how relative prices are determined in the long run. Though he did not explicitly formulate supplyand-demand schedules, his value theory clearly reflects a recognition that the quantities demanded and supplied are a function of price. For this reason, we may present his theory of long-run prices in the familiar Marshallian form without doing an injustice to either Marshall or Mill. For a good to have exchange value, or a price, it must be useful and difficult to obtain; but use value determines exchange value, or price, only in unusual circumstances. Mill discussed the price of a musical snuff-box using two hypothetical cases he borrowed from a contemporary writer: one set in London, where, he assumed, the boxes are produced under conditions of constant costs; the other on a boat on Lake Superior, where only one such box exists. Mill's purpose in this example was to demonstrate that prices will almost always depend on cost of production rather than on utility. Where supply is absolutely limited, the supply curve is perfectly inelastic (vertical), and price depends upon supply and demand. This first class of commodities Mill regarded as relatively unimportant, because few commodities are perfectly inelastic in supply; it includes wines, works of art, rare books, coins, the site value of land, and potentially all land as population density increases. He also used this case to analyze monopoly situations in which the monopolist can artificially limit the supply. A second group of commodities, manufactured goods, has a perfectly elastic (horizontal) supply curve, and Mill concluded that the cost of production of these goods determines their price. Mill assumed that all manufacturing industries are constant-cost situations (see Figure 6.1b); that is, their marginal costs do not change as their output increases. For Mill's third group of commodities, those produced by agriculture, he assumed that marginal costs do increase as output expands (increasing costs); the price of these commodities depends upon cost of production in the most unfavorable circumstances. Thus, he applied the principle of diminishing marginal returns to agricultural production but not to manufactured goods. Although Mill was very careful to make clear that utility (demand) and difficulty of attainment (supply) must both exist before any commodity has a price, the terminology of his conclusions obscures the fundamental applicability of the laws of supply and demand to all three groups of goods. He saw clearly how equilibrium prices are brought about in markets through the forces of demand and supply and that the proper mathematical analogy is that of an equation. Demand and supply, the quantity demanded and the quantity supplied, will be made equal. If unequal at any moment, competition equalizes them, and the manner in which this is done is by an

adjustment of the value. If the demand increases, the value rises; if the demand diminishes, the value falls: again, if the supply falls off, the value rises; and falls if the supply is increased. Final equilibrium is reached when quantity demanded equals quantity supplied. Even though Mill did not use mathematical equations, schedules, or supply-and-demand curves, his analysis of price determination is a notable advance over Ricardo's, particularly because Mill's conceptual apparatus was obviously set up in accord with supply-and-demand functions. The only group of commodities he failed to cover are those with decreasing costs and downward-sloping long-run supply curves. Mill also made some original contributions to value theory in discussing noncompeting groups (he recognized that in labor markets mobility was far from perfect), pricing where a firm produces two or more products in fixed proportions (wool and mutton), rent as pricedetermining when land has alternative uses, and economies of scale. His satisfaction with the development of value theory was manifested by his view that "Happily, there is nothing in the laws of value which remains (1848) for the present or any future writer to clear up; the theory of the subject is complete." A number of economists writing after Mill have been amused by this statement, and it was probably the reason why Marshall suggested that his own contributions to microeconomic theory would soon be obsolete. Yet it can be argued that our general understanding of the workings of supply and demand in allocating resources under competitive markets has not fundamentally changed since Mill. Of course, many developments have occurred that permit more technical analysis and greater insights; but Mill, with cruder technical apparatus and a complete lack of mathematical notation, was able to carry out a significant analysis of markets with few analytical errors. The great gap in Mill's micro-economic theory, a gap not filled until the 1930s, was his inability to analyze less than perfectly competitive markets. Some would say that this gap still remains to be filled

Marshallian Economics Marshallian Economic

The Movement Away From Marshallian Economics, Marshallian Economic Marshall's engine of analysis, combining supply and demand curves with common sense, could answer certain questions, but others exceeded its scope. Supply-and-demand analysis was partial equilibrium analysis applied to problems of relative prices. But many of the questions economists were trying to answer, such as what determines the distribution of income or what effect certain laws and taxes would have either introduced problems beyond the applicability of partial equilibrium analysis or violated its assumptions. Nonetheless, economists continued to apply partial equilibrium arguments to such issues, assuming that the aggregate market must constitute some as yet unknown combination of all the partial equilibrium markets. Most economists were content with this state of affairs for quite a while. After all, Marshallian economics did provide a workable, if not formally tight, theory that was able to answer many real-world questions. It was the middle ground. Marshallian economists were engineers rather than scientists, and engineers are interested not in pondering underlying forces bjit in building something that works. Marshallian economists were interested in the art of economics, not in positive or normative economics. As Joan Robinson put it, Marshall had the ability to recognize hard problems and hide them in plain sight. Marshallian economics attempted to walk a fine line between a formalist approach and a

historically institutional approach. It is not surprising that in doing so it created critics on both sides. In the United States, a group called the institutionalists wanted simply to eliminate the theory, arguing that history and institutions should be emphasized and the inadequate theory dropped. Other critics, whom we will call formalists, went in the opposite direction: they believed that economics should be a science, not an engineering field, and that if economics were to conclude that the market worked well, we needed a theory to show how and why it did so. These formalists agreed with the institutionalists that Marshallian economic theory was inadequate, but their answer was not to eliminate the theory: they wanted to provide a better, more rigorous general equilibrium foundation that could adequately answer more complicated questions. The Formalist Revolution in Microeconomics In the late 1930s the formalist research program won and the Marshallian approach started to wane. By the 1950s the formalists had reformulated microeconomics into a mathematical structure dependent on Walras, not Marshall. Applications became less important than logical consistency. The formalist revolution reached its apex in 1959 with the publication of the Arrow-Debreu model. With the completion of that general equilibrium work, economists turned once again to applied work. But they did not return to Marshall's engine of analysis approach, which downplayed the use of mathematics and stressed judgment. Instead, they integrated policy prescriptions into the mathematical models. As that happened, the neoclassical era evolved into the modern modeling era. In the modeling approach, mathematics is used to develop simple models that ideally capture the essence of the problem. Then econometric techniques are used to test those models. This development and empirical testing of models has become the modern economic method. The Battle over Formalist Approaches The mathematical approach is rooted in the thought of several nineteenth- and early twentieth-century figures discussed in our earlier chapters on neoclassical economics. The first of these great pioneers in stating hypotheses in mathematical form was A. Cournot, who published his Researches into the Mathematical Principles of the Theory of Wealth in 1838. Cournot expected that his attempts to bring mathematics into economics would be rejected by most economists, but he adhered to his method nonetheless because he found the literary expression of theory that could be expressed with greater precision by mathematics to be wasteful and irritating, Leon Walras and Vilfredo Pareto, who succeeded Walras as professor of economics at Lausanne, were other early devotees of mathematical economics. Whereas Marshall had focused on partial equilibrium, Walras, using algebraic techniques, focused on general equilibrium. His general equilibrium theory has substantially displaced Marshallian partial equilibrium theory as the basic framework for economic research. Jevons, in his influential Theory of Political Economy (1871), also advocated a more extensive use of mathematics in economics. Jevons was followed by another pioneer in mathematical economics, F. Y. Edgeworth (18451926), who pointed out in 1881 that the basic structure of microeconomic theory was simply the repeated application of the principle of maximization. This finding raised the question, Why re-examine the same principles over and over again? By abstracting from the specific institutional context and reducing a problem to its mathematical core, one could quickly capture the essence of the problem and apply that essence to all such micro-economic questions. Following this reasoning, Edgeworth declared that both an understanding of the economy and a basis for the formulation of proper policies were to be found in the consistent use of mathematics. He accused the Marshallian economists of being seduced by the "zigzag windings of the flowery path of literature." As this extension was occurring, there was a simultaneous attempted extension of

mathematics not only into positive economics but also into questions of economic policy. Vilfredo Pareto, whose name is familiar to many students of economics from its use in the phrase Pareto optimal criteria, extended Walras's general equilibrium analysis in the early 1900s to questions of economic policy. Thus, in the push for formalization little distinction was made between positive economics and the art of economics, John Neville Keynes's distinction between the two was lost, and the same formal methodology was used for both. Irving Fisher (1867-1947), writing in the last decade of the nineteenth century, was an early American pioneer of formalism who supported and extended Simon Newcomb's (1835-1909) advocacy of increased use of mathematics in economics. The mathematical approach was not well received in the United States, however, until nearly the middle of the twentieth century. All these pioneers were, therefore, unheeded prophets of the future. Inattention to their efforts can be attributed partly to the strength of Marshall's analysis, a judicious blend of theory, history, and institutional knowledge. Unable to compete with the Marshallian approach, early mathematical work in economics was practically ignored by mainstream economists until the 1930s. In the early 1930s this situation began to change. Expositions of the many geometric tools that now provide the basis for undergraduate microeconomics began to fill the journals. The marginal revenue curve, the short-run marginal cost curve, and models of imperfect competition and income-substitution effects were "discovered" and explored during this period. Though rooted in Marshall, these new tools formalized his analysis, and as they did so they moved farther and farther from the actual institutions they represented. The Marshallian approach to interrelating theory and institutions had been like a teeter-totter: it had worked as long as the two sides balanced. But once the theory side gained a bit, the balance was broken and economics fell hard to the theoretical side, leaving history and institutions suspended in air. History and institutions were abandoned because the new mathematical tools required stating precisely what was being assumed and what was changing, and stating it in such a way that the techniques could handle the entire analysis. History and particular institutions no longer fit in. One could no longer argue, as in the earlier Marshallian economics, that "a reasonable businessman" would act in a certain way, appealing to the reader's sensibility to know what "reasonable" meant. Instead, "reasonableness" was transformed into a precise concept "rational"that was defined as making choices in conformance with certain established axioms. Similarly, the competitive economy was defined as one in which all individuals are "price takers." Developing one's models mathematically required noncontextual argumentation, abstracted from any actual setting, in which assumptions are spelled out. Though the use of geometry as a tool in Marshallian analysis was a relatively small step, it was the beginning of the end for Marshallian economics. When geometry disclosed numerous logical problems with Marshallian economics, the new Marshallians responded with further formalization. Thus, by 1935 economics was ripe for change. Paul Satnuelson summed up the situation: "To a person of analytic ability, perceptive enough to realize that mathematical equipment was a powerful sword in economics, the world of economics was his or her oyster in 1935. The terrain was strewn with beautiful theorems waiting to be picked up and arranged in unified order." Because many economists had by this time acquired the requisite analytic equipment, the late 1930s and early 1940s witnessed a revolution in micro-economic theory, which formalism won. Cournot, Walras, Pareto, and Edge-worth gained more respect, and Marshallian economics was relegated primarily to a role in undergraduate education. The first step in the mathematization of microeconomic theory was to extend the marginal analysis of the household, firm, and markets and to make it more internally consistent. As economists shifted to higher-level mathematical techniques, they were able to go beyond partial equilibrium to general equilibrium, because the mathematics provided a method by which to keep track more precisely of items they had formerly kept somewhat loosely in the back of their heads. The second step was to reformulate the questions in a manner consistent

with the tools and techniques available for dealing with them. The third step was to add new techniques to clarify unanswered questions. This process is continuing today. These steps did not follow a single path. One path had strong European roots; it included generalizing and formalizing general equilibrium theory. An early pioneer on this path was Gustav Cassel (1866-1945), who simplified the presentation of Walras's general equilibrium theory in his Theory of Social Economy (1918; English versions 1924, 1932), making it more accessible. In the 1930s two mathematicians, Abraham Wald (1902-1950) and John von Neumann (19031957), turned their attention to the study of equilibrium conditions in both static and dynamic models. They quickly raised the technical sophistication of economic analysis, exposing the inadequacy of much of previous economists' policy and theoretical analysis. Their work was noted by economists such as Kenneth Arrow (1921- ) and Gerard Debreu (1921- ), who extended it and applied it to Walras's theory to produce a more precise formulation of his general equilibrium theory. Following Wald's lead, Arrow and Debreu then rediscovered the earlier writings of Edgeworth. So impressed were they by these writers that they declared Edgeworth, not Marshall, to be the rightful forefather of modern microeconomics. The work of these theorists, in turn, has continued a highly formalistic tradition of general equilibrium theorists. Some of the questions that general equilibrium analysis has addressed are Adam Smith's questions: Will the unfettered use of markets lead to the common good, and if so, in what sense? Will the invisible hand of the market promote the social good? What types of markets are necessary for that to be the case? Because they involve the entire system, these are essentially general equilibrium questions, not questions of partial equilibrium. They could not, therefore, be answered within the Marshallian framework, although they could be discussed in relatively loose terms, as indeed they were before formal general equilibrium analysis developed. General equilibrium theorists have found the answer to the question "Does the invisible hand work?" to be yes, as long as certain conditions hold true. Their proof, for which Arrow and Debreu received Nobel prizes, was a milestone in economics because it answered the conjecture Adam Smith had made to begin the classical tradition in economics. Much subsequent work has been done in general equilibrium theory to articulate the invisible-hand theorem more elegantly and to modify its assumptions, but by first proving it, Arrow and Debreu earned a place in the history of economic thought.

Comparison Of Neoclassical and Modern Microeconomics

A Comparison Of Neoclassical and Modern Microeconomics Let us conclude this chapter with a discussion of six attributes that distinguish neoclassical from modern economics. 1. Neoclassical economics focuses on allocation of resources at a given time. This attribute is embodied in Robbins's definitionthe allocation of scarce resources among alternative uses which became the standard definition of neoclassical economics. The focus on allocation at a given point in time ended long ago. Been there, done that. The focus of research in modern economics has turned to allocation over time, a much harder problem. During the 1990s, for example, growth was a key topic; and the new growth theory is decidedly mainstream and non-neoclassical. In fact, it is generally contrasted with neoclassical growth theory.

2. Neoclassical economics accepts some variation of utilitarianism as playing a central role in understanding the economy. The movement to demand and subjective choice theory, and away from supply considerations, was a hallmark of early neoclassical thought. While initially the focus was almost entirely on utilitarianism and demand, the focus quickly evolved to a view that demand was only one blade of the scissors. Few modern economists accept utilitarianismmost view it as merely historicaland utility theory is rarely used today. In his Nobel Prize speech, Amartya Sen recounted the problems of utilitarianism. While it is true that, in principles and intermediate books, students are still taught versions of utilitarianism, these are presented for pedagogical reasons only, not because utilitarianism is the reigning approach of modern economists. 3. Neoclassical economics focuses on marginal tradeoffs. It came into existence as calculus spread to economics, and its initial work was centered on the marginal tradeoffs that calculus focused on. While many undergraduate texts still present economics within a marginal framework, that is not the way it is presented in graduate schools or the way top economists think about issues. In fact, by the 1930s, in cutting-edge theory, calculus was already being dropped, having been mined for its insights, and the mathematics being used was moving to set theory and topology, as economists tried to expand the domain of economics to include a wider variety of topics. In modern graduate microeconomics, game theory has almost completely replaced calculus as the central modeling apparatus. 4. Neoclassical economics assumes far-sighted rationality. In order to structure an economic problem within a constrained-maximization framework, one has to specify rationality in a way that is consistent with constrained optimization. Specific rationality assumptions quickly became central to the neoclassical approach. The decrease in the focus on utilitarianism has been accompanied by a decrease in the farsighted rationality assumption. In modern economics, bounded rationality, norm-based rationality (perhaps established through evolutionary game theory), and empirically determined rationality are fully acceptable approaches to problems. 5. Neoclassical economics accepts methodological individualism. This assumption, like the two before it, is closely tied to the constrained-maximization approach. Someone must be doing the maximizing, and in neoclassical economics it was the individual. One starts with individual rationality, and the market translates that individual rationality into social rationality. While individualism still reigns, it is under attack by certain branches of modern economics. Complexity theorists challenge the entire individualistic approach, at least when that approach is used to understand the aggregate economy. Evolutionary game theorists are attempting to show how such norms develop and constrain behavior. New institutionalists consistently operate within a framework that is at odds with methodological individualism. 6. Neoclassical economics is structured around a general equilibrium conception of the economy. This last attribute is more debatable than the others. Schumpeter made the general equilibrium conception of the economy central to his definition of neoclassical economics.12 Admittedly it is important, but if it were absolutely central, it would eliminate Marshall from the neoclassical school. However, Schumpeter is right in the following way: in order to make neoclassical economics more than an applied policy approach to problems (something Schumpeter wanted to do), one needs a unique general equilibrium conception of the economy. Formal welfare economics is based on this general equilibrium conception. The existence of a unique general equilibrium is still the predominantly held view, but that is primarily because general equilibrium models are seldom used. In theory, work on multiple equilibria is ongoing, and equilibrium selection mechanisms are an important element of study. Neoclassical economics never seriously considered the problem of multiple equilibria. In modern economics, theoretical economists are quite willing to consider multiple equilibria, as can be seen in the work of economists such as Karl Shell and Michael Woodford. It is true that modern work in policy generally avoids any discussion of multiple equilibria, and that is one of

the contradictions in modern economics, but the topic of multiple equilibria is no longer out of bounds.