Approches_Eco_Anal_Cours_2013

profits, and rents depend therefore on the demand and the prices of the consumer goods, they are determined by utility. The distribution of income becomes a part of the theory of prices. We owe to Menger the first expression of the neoclassical distribution theory which can be presented briefly as follows: If each factor receives the value of its productive contribution (in modern terms, we say: factors’ payments equal their respective marginal productivity), the value of the total production will be perfectly exhausted in the remuneration of the factors. And there will be no surplus that somebody can appropriate without having produced it. That is the theorem of product exhaustion: At the equilibrium, when all factors of production are paid at their respective productivity, there is no over-profit.

1. 3. Cournot as the forerunner of the neoclassicism

Antoine-Augustin Cournot (Recherches sur les principes mathématiques de la théorie des richesses, 1838) treated monopoly as the pure case and defined a demand function:

D=F(p);

a total revenue function:

R=pF(p);

and a marginal revenue function:

M=F(p)+pF’(p) where F’(p)<0 (that is the first derivative);

objectively given to the monopolist.

The monopolist maximises his gain when he produces an output such that the marginal cost equals marginal revenue of his production (F(p) is the production function and the first derivative of it F’(p)<0 because when the monopolist rises the level of his production, the price of his produce will decline at a given demand curve). Cournot considered the competitive economy as a marginal and a particular state of the market functioning. Then he developed a theory of duopoly (called the imperfect competition). His theory of duopoly is based on the competitive assumption that buyers make prices and that sellers merely adjust their output to given prices. Each duopolist estimates the demand function for the product and then sets the quantity sold on the assumption that his rival’s output remains fixed. Although each duopolist adjusts his output simultaneously to the

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output of the other, each assuming at every point that the rival’s output is constant; a determinate solution nevertheless emerges but under ad hoc assumptions called Cournot’s naïve conjectures (see Ülgen, 2002).

The demonstration is given by means of reaction curves which show the optimum output of each duopolist as a function of the output of its rival (assuming that either can supply the entire output). The reaction function of the duopolist i is:

qi=f(qj).

Following a reaction-chain scheme in notional terms (the decisions of the duopolist do not apply before the equilibrium reached)5, Cournot states that the equilibrium point is obtained and that this point is stable.

Cournot also planted the idea that perfect competition is the limiting case of the entire spectrum of market structures, defined in terms of the number of sellers. He showed that the duopolists would end up with a common price for mineral water (that is the industry studied by Cournot as example) that would be lower than the price that would obtain under simple monopoly but higher than the one generated by the free competition with many sellers; similarly, monopoly produces the lowest output and competition with many sellers produced the highest output, the duopoly case falling in between the two. He put that as the numbers of sellers increase, the output of the industry converges in the limit on the output of a perfectly competitive industry. Here we find explicitly the origin of the popular notion of perfect competition as the standard for judging the outcome of noncompetitive market structures as duopoly and monopoly.

2. Marshallian economics

Marshall’s main contribution to economics is the Principles of Economics

(1890).

2. 1. Utility and measurability

The founders of marginal utility theory never seriously raised the question of the measurability of utility. Jevons suggested a way of measuring the utility via the approximate constancy of the marginal utility of money, a procedure that Marshall

5 For the sake of simplicity, we do not produce here the formal demonstration of this scheme. The reader can see Ülgen, 2002 for a more complete and developed presentation of this problem.

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later adopted and refined. Marshall, with the hypothesis of a constant marginal utility of money, related the marginal-utility schedule of one good to the consumer’s demand schedule, and in so doing formulated the theory of the consumer surplus or rent.

This theory offered a way of measuring the returns, in terms of utility, that the consumer draws from exchange activity. This consists in comparing the marginal demand price that the agent is prepared to pay for a given quantity of good with its market price. D(q) is the demand curve, p is the current market price, q the quantity demanded. At price p0 the consumer buys q0 by spending a sum of money equal to the area Op0Cq0:

p

D0

p2

p1

C

p0

D(q)

q

0

However, he would be prepared to pay p2 to obtain q2, p1 to obtain q1, and so on. This means that his actual outlay is lower than what he would be prepared to pay to obtain the desired utility. Geometrically, this difference, which measures the consumer’s surplus is shown by the area of the triangle D0p0C in this figure.

2. 2. Competition and equilibrium

Cournot developed a notion of partial equilibrium by studying a market isolated from the rest of the economy and distinguished between two kinds of equilibrium: single-producer markets (monopoly) equilibrium and many-producer markets (competitive) equilibrium.

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The competitive equilibrium was seen as a limiting situation, as the state of the market that would be realised if none of the economic agents had monopolistic power. But this way was rejected by the Walrasian system which assumes that agents formulate their plans by taking prices as given. Marshall’s conception of competition is different from that of Walras, and rather nearer to that of Cournot.

Marshall distinguished between market behaviour and normal behaviour. The market behaviour concerns the quantity of goods actually bought and sold at a given moment and at a given price. The normal behaviour reflects what the single agent decides to buy or to sell “normally” per unit of time, over a certain time-span. The normal decisions depend on the normal level of prices the agents expect to prevail during the period considered. The agent will base his own daily decisions (if the day is the unit of time considered in the analysis) on the marketprice trend knowing from experience that the market price is usually different from the normal price. However, his final aim is to realize, within the time-span considered, his own normal decisions. The gap between market price and normal price will induce the agent to anticipate or delay the buying or selling of a certain good, but will not change his own ideas of what normal behaviour is, the latter constituting the fixed reference point. It is on the basis of the expected prices on the market at a particular time in the future that the single entrepreneur decides on the size and type of plant to adopt.

There is a marked difference between Walras and Marshall in regard to their definitions of competition. Marshall believed that a perfectly competitive market is one in which a large number of agents operate; each has objectives which conflict with those of the others, and will try to pursue them without entering into coalitions and without using special bargaining powers. Marshall’s perfect competition does not presuppose that each agent takes the price of goods as given or that the firms are identical.

Marshall distinguished between demand price, Pd, which is the maximum price at which the demand reaches a pre-determined level, and supply price, Ps, which is the minimum price that induces the sellers to supply a quantity equal to that predetermined. Given a certain level of demand, the market is in disequilibrium if the demand price differs from the supply price. A disequilibrium situation implies the following modifications: If Pd>Ps, the sellers will react by

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increasing the volume of supply either by an increase in the production level or by a reduction in the level of inventories; and vice versa when Pd<Ps. In this way, the existence of a disequilibrium produces first a variation in the quantities and only later and as a consequence, a variation of prices. Marshall’s sellers prefer to increase their own profits by acting on quantities rather than on prices as in the

Walras’s model of competitive market’s price mechanism. Marshall’s reasoning is founded on the assumption that the price changes may be difficult in perfect competition situation. In movements towards equilibrium Marshall admitted variations in supply, not only of the products but also of the other factors, if these are reproducible.

2. 3. Periods, costs and external economies

Marshall’s theory of price determination revolves around the distinction between a market period (supplies are absolutely fixed in amount), a short period (quantities supplied can be augmented but productive capacity is fixed), and a long period (productive capacity is variable but the resources potentially available to the industry are fixed in amount). Then there is also a very long period in which techniques of production as well as productive capacity can be modified. In longrun equilibrium, all adjustments are possible and, therefore, complete. However, in the short run, the dynamic problems that characterise temporary adjustments are the main matter. Adjustments depend, in the short run, on whether the change in price is expected to be temporary or permanent; expectations of the future do affect the adjustment process. The reactions of producers in a given time period are asymmetrical with respect to a rise and a fall in price. Because of the durability of existing equipment, the short run may be much longer when the adjustment is a contraction than when it is an expansion.

In the marginal schema, costs are assumed to be increasing and revenues decreasing as the output produced is increasing. That is the well-known figure of downward-sloping long-run revenue curves and upward-sloping long-run cost curves which give us upward-sloping long-run supply curves on the bi-dimensional quantity-price space. Then, the supply of each entrepreneur can be represented by the following upward-sloping supply curve in bold:

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the market. For example, the changes in knowledge, which are the results of the activities of Research and Development of economic agents are not captured entirely by the originators even with a patent and copyright system. In the economics of information, that is called as the externalities of the production of knowledge: the information is not entirely a normal private good in the sense that its property right is difficult to establish in order to protect its producer. Some industries become decreasing-cost industries and get out of the diminishing returns market constraints.

3. The marginal productivity

3. 1. A theory of distribution

Marginal productivity approach means that in equilibrium each factor of production is rewarded in accordance with its marginal product as measured by its effect on the total product. For example, the wage rate cannot in equilibrium exceed the marginal value of the product that the last unit of labour used in the production contributes to create. When the wage rate is under the marginal value product of labour, additional labour adds more to revenue than to costs then it is profitable for the firm to use more labour (to demand more labour on the market) until the equalisation of the wage to the productivity of the labour. This reasoning implies a distribution theory of the income between wages, profits and rents.

In this order J.B. Clark (The Distribution of Wealth, 1899) said that each production factor receive a share of the national income proportional to the contribution it gives to production. This provided a normative principle of distributive justice. In the perfect competition context (that is a stationary state with perfect foresight and perfect factors’ mobility between alternative uses and markets), if a factor is relatively scarce, it will command a high price and vice versa.

This theory assumes that each factor is homogeneous, all units of the factor are equally efficient; the marginal productivity of labour falls as more labour is added to a given amount of capital because capital per unit of labour is falling. Then the greater marginal productivity of fewer workers is solely the result of the fact that they have more capital to work with. So the problem arises when the

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change of the marginal productivity is a simple arithmetical result of the ratios between labour, used capital amount and the total product. There is no relationship between this result and the idea of a just wage (or just profit).

Furthermore, we can easily see that “There is no such thing as a specific marginal product of labour considered in isolation; the factors of production are essentially complements and marginal product of factor is a consequence of the marginal product of the other factors”(Blaug,1997,p.409)

3. 2. Entrepreneur and profit: risk, uncertainty, and innovation

The marginal productivity approach says that in long-run competitive equilibrium the reward of each factor equals its marginal value product. Then what is called profits in this schema is the return to a distinct factor of production: organisation, management or entrepreneurship (comprising the services of coordination of the productive process, decision making, risk taking, and so on). Profit is defined as normal profit and residual profits over this normal profit are zero. Residual profit, called pure profit, is a return in excess of real costs, since it is not required to maintain any productive agent in existence. However, it is difficult to say that entrepreneurship is a function that satisfies the conditions required to define a factor of production, beyond the interest capital, the wages of management and the insurance premium against the calculable risk of losses.

In his Risk, Uncertainty and Profit (1921) F. Knight introduced, following Thünen (The Isolated State,1850) a distinction between risk (when the objective probability of the chances on a foresighted event can be calculated when the agents make their economic decisions) and uncertainty (there is no room for probability calculus on the future events). Production takes place in anticipation of consumption, and since the demand for factors of production is derived from the expected demand of consumers for output, the entrepreneur is forced to speculate on the price of his final product. But it is impossible to put the price of the final product without knowing what payments are being made to the factors of production. The entrepreneur deals with this question by guessing the price of which output will sell, thereby translating the known marginal physical products of the factors of production into their anticipated marginal value products. Although the factors are hired on a contractual basis and therefore must be paid their anticipated marginal value product, the entrepreneur as a residual, non contractual

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income claimant may make a windfall gain if actual receipts are greater than forecasted receipts. But, as we can see here, we cannot describe the windfall gain as a necessary price that must be paid for the performance of a specific service.

The entrepreneurs’ profit, in this sense, does not have the characteristics of a productive factor and marginal productivity theory would not apply to it.

In 1912 (The Theory of Economic Development), J.A. Schumpeter developed an argument by constructing a model of an economy without technical change. That is a repetitive perfectly routine economic process without uncertainty about the future (where there would be no profits). Then only technical innovations and dynamic change can produce a positive rate of interest. Schumpeter distinguished between invention and innovation. The invention is the discovery of a new technical knowledge and the innovation is its application to industry. The innovation, in its broader sense, is the introduction of new technical methods, new products, new sources of supply and new forms of organisation. Schumpeter identified the innovator with the entrepreneur. This later is the source of all dynamic changes in the economy. The Schumpeterian entrepreneur is not a single physical person and not a well-defined group of people. The entrepreneur may be the capitalist, a corporate manager, or a visionary. He/she tries to change the established economic structure in order to create novelty. He/she is a novelty lover. The profit appears to be a consequence of this innovative behaviour. But this schema is not in keeping with the long-run equilibrium productivity theory.

4. The development of the neoclassical theory

4. 1. The Austrian School: the subjectivism

Böhm-Bawerk was the most prestigious personality of the Austrian School up to the beginning of the 1920s. In 1896, he published Zum Abschluss des Marxischen System (Karl Marx and the Close of his System). His main work, the Positive Theory of Kapitales (1889), set out to extend the Mengerian theory of subjective value to the theory of capital and interest. Böhm-Bawerk’s specific contribution lies in the idea that the fundamental characteristic of every productive activity using capital, intended as a set of reproducible means of production, is that of linking the events in time-sequences. In this case, they are relations of complementary rather than of substitutability that characterize the set of possible

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technological transformations. Time is considered as an irreversible succession of moments, so that the productive structure in a given instant depends not only on past investments but also on the time-sequences in which they have been made.

Capital enters the production process the duration of the time lapsing from the introduction, at different moments, of the original productive factors, labour and land, to the attainment of the final output. In this Austrian conceptualization, capital is almost always circulating capital (there is no place for fixed capital). BöhmBawerk argued that it was possible to explain interest in these terms: as production takes time, as individuals systematically prefer present to future goods, the production process that use capital must generate a product which allows the payment of interest to those who, in preceding periods, have invested in the indirect productive process.

But after the First World War, the Austrian scenario changed with F. von Hayek, O. Morgenstern, P. Rosenstein-Rodan. With Hayek an Austrian theory of the business cycle is developed. The upward phrase of the cycle was attributed to mistaken inter-temporal allocations caused by a too low rate of interest. The mistake lies in the fact that the firms begin productive processes which imply the existence of a certain desire by consumers to postpone consumption, while in reality this is incompatible with the true pattern of their time preferences. The consequent abandonment of the process already started then triggers the downward phase of the cycle.

We remark four cardinal ideas of the Austrian School:

1)The methodological individualism which claims that the solely valid propositions of the social sciences are those that can be reduced to propositions about individual wills and actions, that all the motivations of agents and institutions are derived from individual behaviour, and, finally, that there is no immanent tendency towards goals independent of individual desires.

2)The subjectivism which claims that individual actions can only be understood with reference to the knowledge, beliefs, and expectations of the individuals themselves.

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