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Transcript of Chapter 9: The Transition to Neoclassical Economics Questions for Review, Discussion and Research 1,...
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Chapter 9: The Transition to Neoclassical Economics
Questions for Review, Discussion and Research1, 2, 3, 4, 7, 8, 9
-The full importance of the discoveries” of Jevons, Menger and Walras eluded the first generation
Overhead pp. 244
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Marginal Analysis Extended
Early neoclassical writers applied marginal analysis almost exclusively to the theory of demand
The supply of factor inputs was exogenous so resource allocation was to assign them to alternate activities
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Marginal Productivity Theory
Recall Ricardo’s earlier contribution to the concept of diminishing returns in agriculture
Q = f[T, L, K, R] (L, K in fixed proportions and technology constant)
Doses of labour and capital inputs applied to fixed quantities of land will result in diminishing marginal productivity
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Ricardian Theory of Income Distribution
It is a “residual” theory where…Rent – The residual after wages and profit are deducted from total (revenue) productProfit – The residual after determined by the Malthusian population doctrine, are deducted from wages and profit
Classical writers did not fully appreciate the significance of marginal analysis and it was left to the second generation of
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neoclassical economists to apply it to marginal productivity
Austria – Bohm-Bawerk, Weiser
Sweden – WicksellU.S.A. – J.B. ClarkBritain – Wicksteed,
Edgeworth
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Textbook Illustration of Optimal Purchase of a Variable Input Using Micro Theory
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Textbook Illustration of Optimal Purchase of a Variable Input Using Micro Theory
VMPL = P x MPPL
= Additional revenue derived from output generated from the hiring of additional labour
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Development at the Neoclassical Theory of Distribution
Wicksteed published a pamphlet in 1894 claiming that factor prices would equal their marginal productivity when input and output markets are competitive
Review by Flux showed that “product exhaustion would only exist when productions had mathematical properties identified by Euler, a Swiss mathematician
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Development at the Neoclassical Theory of Distribution Cont’d
When Production functions are homogeneous of degree one, constant returns to scale exist so
Q = f [T, L, K, R]
Q = δQ * L + δQ * K + δQ * R δL δK δR
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= MPPL * L + MPPK * K + MPPR * R
so P * Q = [P*MPPL*L] + [P*MPPK*K] +[P*MPPR*R]
P * Q = [VMPL*L] + [VMPK*K] + [VMPR*R]
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Development at the Neoclassical Theory of Distribution Cont’d
Total Revenue = Total Payments for Factor Inputs
This equality does not hold when production functions are
I. Decreasing returns to scale
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II. Increasing returns to scale
In all circumstances the optimal decision rule for purchasing inputs
MPPL = MPPK = MPPR
PL PK PR
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Wicksell’s Contribution to Production Exhaustion
Made an independent “discovery” of the marginal productivity concept
In 1902 he noted that firms often experience
I. Increasing returns to scaleII. Constant returns to
scaleIII. Decreasing returns to
scale
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Wicksell’s Contribution to Production Exhaustion Cont’d
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Wicksell’s Contribution to Production Exhaustion Cont’d
Competition in input and output markets will guarantee that the long-run equilibrium will occur when firms experience constant returns Read page 255 to 259 on your own
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New marginal productivity theory has many critics such as Taussig
He claimed that final output is a result of the joint effort of land, labour and capital and it is not possible to separate the marginal productivity of each factor input
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Wicksell’s Contribution to Production Exhaustion Cont’d
Marshall’s “solution” was to measure the net product of labour by deducting the cost of capital from the value marginal product of last units (dose?) of labour capital
A residual theory (?)
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Theory of Profits
Classical theory did not distinguish between interest and profit
Profits were often viewed as a payment forI. Use of finance capitalII. Management servicesIII. Business risk
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Clark, Marshall and Schumpeter viewed economic profits as a temporary income resulting from dynamic changes
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Frank Knight combined both approaches into one theory of profit based on
I. RiskII. Managerial abilityIII. Economic change
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Historical Theories of Interest
1. Monetary Theories - Prevailed in the
mercantilist era from 1500 to 1750
- Resurrected in 1930’s with Keynes liquidity preference
2. Non-monetary Theories - Classical concern with
the long-run and neo-classical productivity theory places focus on real sector
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3. Synthesis - Post war interest in
general equilibrium framework lead to integration of monetary and real forces based on Fisher’s writings
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Problem of Interest
Overhead pp. 264
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Bohm-Bawerk Interest Theory
Fundamental reasoning for the existence of interest is that present goods are worth more than an equal amount of future goods
The cause of interest is not found in the institutional structure of society but in technological and economic considerations independent of social forms
Overhead pp. 266 – special note
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Fisher’s Interest Theory
Agreed that the greater productivity of roundabout methods would not result in a positive rate of interest in the absence of the first two reasons
While adapting some of Bohm-Bawerks concepts he discarded the classification of separate factor inputs and his entire concept of the period of production
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All productive agents yielded flows of income over time and two forces determined interest rates in a market economy1. Subjective – reflect
preferences for present over future goods and services
2. Objective – available investment opportunities and the productivity to produce final goods
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Fisher’s Interest Theory Cont’d
A complete explanation of interest requires both
The supply of savings is a function of the rate of interest while the demand for investment funds is an inverse relationship with interest rates
Factors of production will receive the discounted values of their marginal products
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John Bates Clark
First American economist to gain an international reputation and represents America’s greatest contribution to the second generation of marginal analysis
Claims he had independently conceived the influence of marginal utility on exchange value around 1880
He invented the term marginal productivity and was the most articulate writer on the early neoclassical theory of distribution
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John Bates Clark Cont’d
Clark believed that land and capital were not separate factors of production but the same category of inputs
He recognize that his analysis merged Ricardo’s rent with interest and that his theory of distribution was a generalization of Ricardo’s theory of rent
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Quotation
Special attention was given to the nature of capital
Profits are also described in terms familiar to first year students