Chp 15 :Neoclassical School- Alfred Marshall
Utility and Demand
MU diminishes as the amount increase
2 important qualifications
Demand is based on the law of diminishing MU
He pointed out that he was concerned with moment of time which is - too short a time an interval will not lead to changes in character and taste of person
Consumer goods that are indivisible. Small quantity of commodity may be insufficient to meet certain special want, there will be more than proportionate increase of pleasure when consumer gets enough to meet desirable end.
He suggested money could be used to measure utility of intangibles
Money measure utility at the margin-the point at which decision are made
Price of money has greater MU to poor person than rich person bcs poor person has less mony initially
Pure Neoclassical
Rational Consumer Choice
Decision to spend will be done by weighing the MU of 2 different types of expenditures
Marshall successfully tied this equimarginal rule directly to the contemporary law of demand
His demand analysis used idea of rational consumer choice
Law of Demand
The amount demanded increase with a fall in price, and diminishes with rise in price
Suppose MUx/Px =MUy/Py..=MUn/Pn . If price of X decline,ratio of MUx/Px > MU/P of all other goods
His law of demand follows directly his notion of DMU and rational consumer choice
As substitution occurs, MU of X will fall and MU of others will increase until equilibrium is restored
He focused on substitution effect and income effect ( when consumer experienced gain in purchasing power)
Consumer Surplus
Therefore the price a person pays for a good never exceeds or / to what he/she willing to pay
Marshall is credited for using the concept 'consumer surplus' and systematically exploring it.
TU of goods is the sum of successive MU of each added unit
Although there's problem, Marshall consumer surplus has proved to be valuable tool for analyzing several economics phenomena-deadweight or efficiency losses from taxes,monopoly and tariff
In other words, the consumer surplus is therefore the area below the demand curve and above the market price
NeoClassical
Elasticity of Demand
The lower the price, the more consumer will buy. So the demand curve slope downward to the right
Ed tells us whether the decrease of desire is slow or rapid as Q increase
Law of person desire for commodity- other things being equal , it diminishes with every increase in his supply of commodity
In absolute term, Ed > 1 demand is elastic, Ed < 1 demand is inelastic, Ed = 1 demand is unit elastic
Supply
Supply is governed by cost of production
divided into 3 periods
Intermediate present
Short run
Long run
Market price refer to present, no time allowed for adaptation of Quantity supplied to changes in demand
Market supply curve vertical straight line-perfectly inelastic. Bcs no matter how high price, quantity supplied cannot be increased
To analyze the period he divided cost into 2 types: supplementary cost and prime cost
SR is period where variable inputs can be changed, but fixed cost cannot be changed
SR supply curve slope upward and to the right,the higher the price,the larger Q supplied
All cost are variable and they must be covered if firm wants to continue production.
Equilibrium Price and Quantity
Marshall
Behind supply-financial and subjective cost
Behind demand-utility and dmu
Both demand and supply
Using tables to demand and supply and determination of equilibrium price and quantity
Distribution of Income
Business people constantly compare relative efficiency of every agent of production they employ
In competitive economy distribution of income is determine by pricing of factors of production
He based his analysis on the diminishing returns
NeoClassical
Wages
It is correct to say wage measure are equal to MP with a given supply of labor
Not determine by Marginal Productivity of labor alone
Marshall is correct in identifying demand for labor as a derived demand and also discussed the determinants of wage elasticity of labor demand
Interest
4 laws
The greater the price elasticity of product demand,the greater the Ed for labor
The larger the proportion of total production cost accounted by labor,the greater the Ed for labor
The greater the substitutability of other factor for labor, the greater the Ed for labor
Rise in interest diminishes the use of machinery, bcs businessman avoids use of all machine whose net annual surplus is less than rate of interest
Quantity of saving supplied depends on rate of interest, and rate of interest depends on supply of savings
Lower interest rate increase capital investment
Fall in interest rate will induce people to consume more in present
Interest rate will move towards equilibrium
Profit,Rent, Quasi-Rent
Normal profits include interest,earnings of management and supply price of business organizations
Remaining portion of normal profits, supply price of business organizations is reward to entrepreneurships
Earning of management are payment for specialized form of labor
Only variable cost influence prices in short run
Price in turn determined the earnings of fixed investment.
Internal vs External Economies
Internal economies
Efficiencies or cost savings introduced by the growth in size of individual firm. As firm gets large they enjoy specialization,mass production, using more and better machine and thus powering cost of production
External economies
Come from outside of the firm. They depend on the general development of the industry that would affect the firm
Increasing and Decreasing Return to Scale
If we heavily depend on agriculture we would have decreasing return to scale
Constant cost return-an increased demand in product does not affect price in long run
Increasing return to scale-as labor and capital expand, organizatiion and efficiency improve. Increased demand will ultimately cause price to fall and more be produced
Welfare, Taxes & Subsidies
A tax may add to net consumer utility in increasing cost industry
A subsidy may add to net consumer utility in a decreasing cost industry
Either tax or subsidy will reduce net consumer utility in a constant cost industry.
The greater the elasticity of the supply of other inputs, the greater the elasticity demand of labor