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Mar 29

Neoclassical school of economics

This school of thought, which appeared around 1870 in what is known as the marginal revolution, can be considered a development of the classical school of economics’ main ideas. Supporting the concept of marginalism, and being more scientific in its work than its predecessors, the neoclassical school left aside classical economics’ matters such as wealth distribution and value theory, to study thoroughly the mechanisms that allow the allocation of scarce resources in different markets. This is, understanding how agents, such as consumers and producers, will try to maximize its objective function, utility and production, considering some given constraints, such as budget and input constraints. Indeed, it was the neoclassical school that initiated the study of optimisation problems including utility maximisation and, its dual problem, cost minimisation.

Although the boundaries of this school are quite diffuse, a number of common characteristics can be found in its adherents’ work. They will work supporting methodological individualism, and extensively using mathematics in order to support their conclusions. There will usually appear analysis studying the relations between both supply and demand, instead of studying them separately. They will use throughout their studies the Latin phrase ceteris paribus, as well as the term homo economicus. Finally, it was in the work of neoclassical economists that a distinction between positive economics and normative economics started to shape.

As the neoclassical school includes many renowned doctrines and schools, a mention to some of these schools is in order. The Austrian school included one of the most important marginalist economist, Carl Menger, as well as other renowned neoclassical economists such as Eugen von Böhm-Bawerk, Ludwig H. E. von Mises and Friedrich A. von Hayek. The Lausanne school included economists such as Léon Walras and Vilfredo Pareto. Finally, the Cambridge school included Alfred Marshall, considered the “father of modern economics”, as well as Arthur C. Pigou and Francis Ysidro Edgeworth.

Mar 27

Lope Gallego

Edgeworth box

In 1881, Francis Y. Edgeworth came up with a way of representing, using the same axis, indifference curves and the corresponding contract curve in his book “Mathematical Psychics: an Essay on the Application of Mathematics to the Moral Sciences”. However, the representation given, using as an example the work being done by Friday and wages being paid by Robinson Crusoe, was not the one we commonly know nowadays.

It was Vilfredo Pareto, in his book “Manual of Political Economy”, 1906, who developed Edgeworth’s ideas into a more understandable and simpler diagram, which today we call the Edgeworth box.

This diagram is widely used in welfare economics, game theory or general equilibrium theory, to name a few. It is easy to draw and can be easily explained. In the adjacent image, we can see two examples of an Edgeworth box, and how it is drawn.

The first example is mainly used for welfare economics and distribution matters. As we see, this “box” is formed using two sets of typical indifference maps, which in this case represent the indifference curves of agents A (green) and B (red), who must choose quantities of goods x and y. When the indifference map of agent B is rotated, and put on top of the map of agent A, the box is formed. When indifference curves are tangent to each other, which is the case in this example, a contract curve (blue) can be drawn using these tangency points.

Our second example is mainly used to explain Ricardian trade theory graphically. In this case, we draw the production-possibility frontier for countries 1 (green) and 2 (red). When we rotate the diagram of country 2, we end up with an Edgeworth box, which here will help understand how great the gains of international trade are and therefore helps illustrate how trade is not a sum zero game.

Video – Edgeworth box:

Mar 27

Lope Gallego

Malthusian population theory

Thomas Robert Malthus stated this theory, which indicated that the population would increase geometrically, while food production would only increase in arithmetical proportion, thus creating the conditions for a shortage in the long term that would require an adjustment lowering the birth rate.

Nowadays, we call Malthusianism a doctrine, strongly influenced by the theory explained above, which recommends that the world’s population should stop increasing since resources and the available capacity of the biosphere are insufficient to meet future needs. This doctrine promotes birth control, primarily through measures of delayed marriage and of contraceptive character.

Mar 27

Lope Gallego

Anne-Robert-Jacques Turgot

Turgot Turgot was a French abbot (1727-1781), Baron de l’Aulne, who after leaving the clergy became an economist and stateman, and author of the book “Reflections on the Formation and Distribution of Wealth” published in 1776. One of the great Physiocrats, and student of François Quesnay, was the first to clearly formulate the law of diminishing returns. Turgot was an early supporter of trade and economic liberalization, this being the main reason of his great influence on Adam Smith.

Mar 22

Lope Gallego

Cambridge school

Name given to British economist Alfred Marshall and his followers, who were also part of the neoclassical school of economics, such as Arthur C. Pigou and Francis Y. Edgeworth, which fully assimilated the concepts and methods of marginalism.

They are also considered to be part of the Cambridge school, although in other terms not relating to neoclassical economics, the group of economists which in one way or another collaborated with J. M. Keynes in the thirties and forties, partly in connection with the problems of war. These include Post-Keynesian economists Joan Robinson and Nicholas Kaldor, extending the group to the Neo-Keynesians John R. Hicks, Paul A. Samuelson and James Tobin.

Mar 22

Lope Gallego

Arthur Cecil Pigou

Arthur Cecil Pigou Pigou was a British economist (1877-1959), disciple of Alfred Marshall, whom he succeeded as a professor at Cambridge. Pigou is remembered above all as a precursor of welfare economics, for his books “Wealth and Welfare”, 1912, and “The Economics of Welfare”, 1920, in which he used measures of national income and its distribution in order to understand how wealth and welfare are related. He is also remembered for making a distinction between different degrees of price discrimination.

Being part of the Cambridge school, Pigou used common tools derived from neoclassical economics, such as marginalism, amongst others.

Mar 22

Lope Gallego

Bullionism

Bullionism is the name given to the essential features of economic thought in the first mercantilist era, during the XVI century. According to this economic doctrine, the State acted directly, through laws and regulations on precious metals in order to make them enter the country and prevent them from leaving. The volume of gold and silver stock was considered at the time as an expression of the wealth of a country.

Mar 22

Lope Gallego

Tableau Économique

Tableau economique First circulatory diagram explaining how a national economy works. It was a contribution to economics by French physician and economist François Quesnay. Contrary to the prevailing mercantilist thought at the time, which saw in the possession of gold, silver and other precious metals the wealth of a country, Quesnay argued that real wealth came from production.

However, his Tableau was drawn considering agriculture as the only source of wealth, which gave his findings limited use, since industrial activity was gaining importance.

Mar 22

Lope Gallego

François Quesnay

François Quesnay Quesnay was a French physician (1694-1774), who also studied economic issues, and was the true founder of the economic doctrine known as Physiocracy. His early works were written in the Encyclopédie of Diderot and d’Alembert (1756,1757). However, his most important contribution to economics was his famous Tableau Économique, 1758, the first circulatory diagram, allowing a further understanding of how an economy works. He did it by comparing the income flow of a given country to the blood in the human body.

The tableau allowed further developments in the matter, such as Léon Walras’ general equilibrium and Wassily W. Leontief’s input-output model.

Mar 22

Lope Gallego

Alfred Marshall

Alfred Marshall was an English economist (1842-1924), and the true founder of the neoclassical school of economics, which combined the study of wealth distribution of the classical school with the marginalism of the Austrian School and the Lausanne School. Professor at Cambridge, he was the author of “Principles of Economics”, 1890, which became the most widely read manual in microeconomics in his time. This book, which is his major work, established a radical change on how economics were taught. Instead of just writing long pages, Marshall draw diagrams throughout the chapters, allowing a better understanding of economic theories and models, such as J. S. Mill’s reciprocal demand, or an analysis on the differences between fixed and variable cost, and the importance of time periods when analyzing these matters. In fact, Marshall is the precursor of today’s cost analysis.

Of unquestionable educational clarity and filled with profound social principles, Marshall contributed to economic science with concepts such as elasticity and the further development of other subjects, surpluses for instance. Although he did not invent the term nor did he initiate this theory, he did made a clearer separation and definition of different kind of surpluses, such as consumer’s and producer’s surplus.

Also in his “Principles of Economics”, he stated the differences between internal and external economies of scale, as well as a diagram which depicted the fluctuations in supply and demand that took place before arriving to a steady state, a general equilibrium. This equilibrium was reached by means of changing amounts, not prices, as Léon Walras stated.

He is also considered as founder of the Cambridge School, where he taught economics until his retirement. Other renowned economists belonging to this school are Arthur C. Pigou and J. M. Keynes.