Early Marginalists - History of Economic Thought - Lecture Slides, Slides of Economics

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Early Marginalists docsity.com Early Marginalists • Antoine Augustin Cournot (1801 – 1877) • Arsene-Jules-Emile Dupuit (1804 – 1866) • Herman Heindrich Gossen (1810 – 1858) • Johann Heinrich von Thunen (1783 – 1850) docsity.com Antoine Augustin Cournot (1801-1877) • Researches into the Mathematical Principles of Wealth (1838) • HET page docsity.com Theory of the Firm • Cournot pioneered the modern price theory for industries consisting of profit-maximizing firms. – This is basically the theory taught today in introductory microeconomics courses docsity.com Mathematical Methods • He introduced differential calculus and the associated mathematics of maximization into economic analysis. • These eventually became the indispensable tools of economic analysis. docsity.com Profit Maximization by a Monopoly Quantity 0 Costs and Revenue Demand Marginal revenue Price Monopoly quantity Marginal cost Competitive quantity docsity.com Monopoly and Costs • Cournot showed that an increase in production cost (more precisely, the cost of producing an additional unit, the marginal cost) would raise the price charged by the monopolist •  and that the price increase could be smaller than or greater than the increase in cost. docsity.com Profit Maximization by a Monopoly and Cost Increase Quantity 0 Costs and Revenue Demand Marginal revenue Price Monopoly quantity Marginal cost Competitive quantity docsity.com The Duopoly Problem • Two firms sell the same product. • If they together produce a high output, the price of the product will be low; if they together produce a low output, the price will be high. • Each firm independently decides what amount to produce. – That is, no firm knows the other firm’s output decision before making its own. • So, what reasoning would each firm use to decide what output to produce? • And, how will the duopoly outcome differ from the monopoly outcome? docsity.com Profit Maximizing Duopolists Quantity 0 Costs and Revenue Demand Marginal revenue Price Monopoly quantity Marginal cost Competitive quantity X Y There are two firms: A and B. This picture shows Firm A. If Firm B produces nothing, Firm A produces the monopoly output. If Firm B produces X, Firm A will respond by producing less. If Firm B produces Y, Firm A will produce even less. The bigger is Firm B’s output, the smaller is Firm A’s production. docsity.com Profit Maximizing Duopolists Quantity 0 Costs and Revenue Demand1 Marginal revenue Price Monopoly quantity Marginal cost There are two firms: A and B. This picture shows Firm A. If Firm B produces nothing, Firm A’s demand is Demand1. It produces the monopoly output. If Firm B begins to produce, Firm A will respond by producing less. If Firm B produces even more, Firm A will produce even less. The bigger is Firm B’s output, the smaller is Firm A’s production. docsity.com Duopoly and Monopoly • Cournot showed that the output will be higher and the price will be lower in duopoly than in monopoly. docsity.com Cartel Formation • The total profit of the two firms in a duopoly will be lower than profit of the one firm in a monopoly. – Why? • Nevertheless, the duopolists will not be able to coordinate their decisions to simulate the monopoly outcome. – Even if they agree to restrict their joint output to the monopoly output, they will have huge incentives to secretly renege on the agreement. – This was an early example of the Prisoners’ Dilemma. docsity.com Pure Competition • Cournot derived the familiar profit- maximization condition: Price = Marginal Cost. docsity.com ARSENE-JULES-EMILE DUPUIT (1804 – 1866) docsity.com Willingness-to-pay and utility • Dupuit argued that utility (or, happiness) can be measured by willingness to pay. – Marginal utility of money implicitly assumed to be constant. docsity.com Willingness-to-pay and demand • Dupuit derived the downward-sloping demand curve from willingness to pay • The height of Dupuit’s demand curve equals marginal utility – So, his demand curve is the marginal utility curve – Leon Walras criticized Dupuit later for not clarifying the difference between the demand curve and the marginal utility curve – Dupuit implicitly assumed the existence of a product with constant marginal utility docsity.com Deadweight Loss • Dupuit defined the deadweight loss of an outcome as the extent to which total utility in the outcome is less than the maximum attainable total utility • The deadweight loss of a tax was graphically described docsity.com Tax Policy • Dupuit showed that, to reach a tax target, it is better to have low taxes on many goods rather than high taxes on a few goods. – This is because the deadweight loss of a tax increases very rapidly as the size of the tax increases. • Dupuit explained the logic underlying what today is called the “Laffer Curve” docsity.com Price Discrimination Boosts Welfare • For a natural monopoly, price discrimination can reduce deadweight losses – Dupuit was an engineer, working for the government and building public works, such as the water supply, roads, and bridges – Naturally, he wondered what price should be charged for the public services and how the benefit to the public could be measured docsity.com Equimarginal Principle • Gossen introduced the equimarginal principle—also called Gossen’s Second Law— of the theory of consumer behavior. • This is a rule that a consumer can follow to decide how much of each good to consume. • The consumer would then do so in a way that maximizes his or her utility without going over-budget. docsity.com Equimarginal Principle • The equimarginal principle says that the consumer must spend his or her money in such a way that the utility of the last dollar spent on a good is the same. • 𝑀𝑈𝑥 𝑃𝑥 = 𝑀𝑈𝑦 𝑃𝑦 = 𝑀𝑈𝑧 𝑃𝑧 = ⋯ docsity.com Applying the Equimarginal Principle • Gossen applied the equimarginal principle to a problem in which an individual figures out how to allocate a limited amount of time among various activities so as to maximize utility. • This exercise served as a precursor for Gary Becker’s extension of economic analysis to sociological issues in the 1960s. docsity.com Johann Heinrich von Thünen (1783-1850) • The Isolated State (1826, 1863) docsity.com Theory of Resource Allocation • Thünen pioneered the marginalist theory of the allocation of resources to production. • Assume that the prices of goods and of the resources used in production are given. • Then, how much of a good will be produced? • What amounts of the various productive resources will be used in the production of the produced good? • These are the questions that Thünen tried to answer. docsity.com One good case • Assume a central marketplace surrounded by agricultural land, all of equal fertility • There is one agricultural good, wheat • Landowners hire workers to produce wheat – L workers make Q(L) units of wheat • The cost of transporting wheat to the market is t dollars per mile – The market price of wheat is P dollars per ton – Therefore, wheat grown d miles away from the market will earn P – (t × d) dollars per ton docsity.com One good case • Thünen defined the marginal product of labor MPL as the increase in output Q when labor L increases by one worker • He also assumed diminishing returns – That is, MPL decreases as L increases • He then showed that profit-maximizing landowners will choose L to make [P – (t × d)] × MPL = w • This is the key idea of the marginal productivity theory of distribution docsity.com Profit Maximization • How is a firm to decide how much of a resource to use? • Profit maximization implies that the firm should follow this rule: – Marginal Product of a resource = Factor Price of the resource (measured in units of the produced good). docsity.com One good case • When the farm’s distance to the market d is greater, P – (t × d) is smaller • As [P – (t × d)] × MPL = w, MPL must be higher when d is greater • Diminishing MPL then implies that L must be smaller when d is greater • Notice that Thünen has used the idea of profit maximization to derive a testable hypothesis: farms that are farther away from the market will have fewer workers docsity.com One good case • Graphically, the greater the distance between the farm and the central market/city, the lower the rent • Note that this theory of differential rent does not assume that land varies by quality, as Ricardo did Distance, d Rent docsity.com One good case • Thünen also showed that if transportation cost t decreases, fields that are farther off would be brought into cultivation: another testable hypothesis Distance, d Rent docsity.com Multiple goods case • What if there are three goods: wheat, corn, and rice? • The three crops will be cultivated in concentric circles around the central market/city— another testable hypothesis. • This was the birth of location economics or geographical economics Distance, d Rent Wheat Corn Rice Wheat Corn Rice docsity.com