Neoclassical Economics Flashcards
Classical Propositions discarded by Neoclassicals - Iron law of wages
this was that wages must stay at subsistence
was held by Malthus (population theory)
Held by Ricardo
Held by Marx because employers could exploit workers and take advantage of industrial reserve army of the unemployed
After 1870 there was a rise in real wages in UK, USA, Germany - became unambiguous - ie Malthus was wrong
Reformers lost their main stumbling block and anti-reformers lost their main excuse
Classical Propositions discarded by Neoclassicals - Wage fund theory
there was an annual sum available to pay as wages, so if worker had more, others have less
- used to show trade unions were ineffective/harmful
But theory was an agricultural hangover from days when harvest was the annual wage fund
1869: John Stuart Mill recanted
Classical Propositions discarded by Neoclassicals - Labour theory of value
replaced by subjective theory of value
value of good = utility to the consumer
Climate of Reform
UK electorate doubled in 1867reform act and redoubled in 1884 - working class voters demanded change
Trade union rights extended in 1870s so:
- picketing now legal
- trade unions no longer liable for losses caused by strikes
1870 - education act established a school in every parish (1891 - education became completely free)
working week restricted to 56 hours
redistributive taxation advanced by death duties in 1893
Alfred Marshall’s aims for economics
- wanted economics to guide social reform especially abolition of poverty
- principles of economics (book) starts with account of the ‘cycle of deprivation’
“I would promote redistribution from rich to poor by every means in my power that were legitimate”
- BUT wanted a more ‘scientific, professional’ economics before economists re-engaged with topical questions
- Economics provided not a set of conclusions but an ‘engine of analysis’
Marshall avoiding economic policy
1903: conservatives proposes an end to free trade
Marshall’s response was to worry that the subject was getting topical when he wanted to lecture on it
Instead Marshall strengthened and professionalised economics by extending the marginal principle to the firm and income distribution
The Marshallian synthesis
was the first to draw supply & demand cross
was a synthesis between…
Classical: price depends on cost of supply (especially labour costs)
Neoclassical: price depends on demand which depends on utility
Marshall compared supply & demand curves to the two blades of a pair of scissors, neither of which would cu without the other
this is in line with Marshalls mission to synthesis classical and neoclassical economics
Neoclassical theory of the firm
- Firm will maximise profits
- does this by producing at point where:
marginal costs equals marginal revenue (ie producing one more unit will add same amount to costs and revenues)
- there exists an equilibrium output where this is the case (perfect competition):
marginal revenue = price hence the firm is a price-taker (so small that its output can’t affect the market price)
and producing an identical good to its rivals so that its demand curve is horizontal: price up = no sales
but faces rising marginal costs (necessary for there to be an equilibrium output)
Neoclassical theory of distribution
- Firm will max profits
- it does this by hiring a factor of production until its marginal product equals its price
in the case of labour, marginal product = wage
Assaults on Marshall’s Theory of the firm - firms don’t maximise profits
instead they
- Maximise size
- bigger firm has more power to control its environments
- can prevent entry of new firms
- can develop R&D
- more power over its suppliers
- more power over government legislation
(Neoclassicals say firms only do this to maximise profits anyway)
- they maximise salaries, bonuses etc (principal-agent problem)
- maximise size of firm = maximise manager’s marginal product = maximise managers pay - Study by Hall and Hitch, 1939 concluded:
“an overwhelming majority of the entrepreneurs thought that a price based on full average cost was the ‘right’ price, the one which ‘ought’ to be charged”
ie Don’t try to maximise profits but work out their unit costs and add ro markup for profit
Machlups rebuttal of Hall and Hitch
- They say firms add markup to costs but don’t say they decide the size of the markup
- what id they vary it so as to maximise profits? - H&H’s businesses also said they might charge more when demand was high and less when it was low
- don’t trust questionnaires
- businesses might be rationalising their behaviour: high profit margins sound like exploitation of consumer, low ones sound like unfair competition
- average costs and ‘fair’ profit margin - firm is ‘living up to accepted standard of law and decency’
Assaults on Marshall’s Theory of the firm - In the long run, firms don’t face rising marginal cost
- in long run - long enough to vary inputs of all factors of production ie you can double inout of both capital and labour
- won’t you get twice as much output?
- if so, your unit (capital&labour) costs won’t be rising
Assaults on Marshall’s Theory of the firm - even in short run, firms din’t face rising marginal cost
- because short run is period not long enough to vary the inputs of all factors
e. g it might take a year to install new capital - then short run is less than a year - and during that time you can only vary output by varying no. of workers
- if you take on too many, there’s no capital for them to work
- ie marginal product of labour falls or marginal labour costs of each unit of output rises
Assaults on Marshall’s Theory of the firm: Piero Sraffra
said that firms don’t face rising costs
- precisely to avoid shortage of capital, firms build spare capacity
- Ste Keen, ‘Debunking Economics’: “factories are built with significant excess capacity, and are also designed to work at high efficiency right from low to full capacity”
ie if demand is high, and you take on more workers, the capacity’s there for them to work
- so no mismatch of over-plentiful workers and scare capital
so no dealing marginal product of labour
so no rising marginal cost
How does competition survive?
- could be that it doesn’t (built in tendency to monopoly)
- Marshall: firms growth limited by their finite life-span
- Monopolistic competition (E. Chamberlain, 1933)
- even if an industry has many small firms, they don’t produce an identical product
- even if they did, transport costs might give a single firm a local monopoly
- thus a typical small firm faces a downward sloping demand curve, not a horizontal one
- it won’t lose all its customers if it raises its price
- but it will have to cut its price to get another buyer
therefore marginal revenue is less than price because addition to revenue when you sell one more good = price of that good minus revenue loss because you’ve had to cut the price on the others
e.g sell 10 cars at £10,000 each, revenue = £100k
cut price to £9500 to sell 11, revenue = £104.5k
marginal revenue = £4500
