Marshall's Theory To The Marginal Cost Curve example essay topic

Alfred Marshall Alfred Marshall is considered to be one of the most influential economic teachers in the neoclassical school of thought. He researched and expanded upon previous economic philosophies that came from the classical school of thought. Marshall's thoughts and contributions are still used today to examine current economic issues. One of the major ideas that stemmed off of Marshall's thoughts was the theory of marginal utility. Marshall states: "The marginal utility of a thing to anyone diminishes with every increase in the amount of it he already has" (p. 297). In this quote Marshall focuses on the law of diminishing marginal returns.

There were two important factors in analyzing this law. Firstly, he was concerned with the moment in time. In time, when a person consumes a good or service, after a while their tastes will inevitably change. An example of this is in a television show like, Seinfeld.

The more one watches this shows and appreciates its greatness, the more he / she will like the show more. Along with time, Marshall added that the law of diminishing marginal utility depends on indivisible consumer goods. This means that a proportionate increase in pleasure will not be gained when one gets a particular portion of a good or service. Marshall states: "A small quantity of a commodity may be insufficient to meet a certain special want: and then there will be a more than proportionate increase of pleasure when the consumer gets enough of it to enable him to attain the desired end" (p. 298). An example of this, is putting on the fourth wheel to a skateboard. A person will be receiving more satisfaction out of the entire skateboard when all four wheels are secure.

For Marshall, the question remained on how a person could measure the utility of a good or service, when it is based on intangible feelings like pleasure, pain, desire, and aspirations. Marshall decided that the most plausible way to measure these intangibles was based on money, or labor. Measuring the satisfaction and desire of a good can be based on how much a person is willing to pay, or how much a person is willing to work for the good. Marshall believed that money measures utility at margin. He states: "If then we wish to compare even physical gratification's, we must do it not directly; but indirectly by the incentives which they afford to action" (p. 298). Money measures utility by the economic decisions that people are willing to make for the good.

Since one cannot measure the utility of a good by comparing the taste between two different people, or for that matter within one person, the amount of money that people are willing to spend from their pockets is the only way in which you can measure marginal utility. Along with Marshall's thoughts on utility, he further supports his demand analysis with the rational consumer choice theory. He believed that in a money economy, each line of expenditure would be pushed to the point that the marginal utility of one dollar's worth of goods will be the same as in any other direction of spending. Marshall states that each person can attain this result, "by constantly watching to see whether there is anything on which he is spending so much that he would gain by taking a little away from that line of expenditure and putting it on some other line" (p. 299). My decision of whether to purchase a skateboard or snowboard is a fine example of this.

Like any other consumer, I would weigh out the marginal utilities of each of the products, in making my final decision on which one to buy. From Marshall's statement above, one can figure out that the price an individual pays for a good never surpasses, and rarely equals, the price the consumer would be willing to pay rather than live without the good. Another major aspect that Marshall studied is the elasticity of demand. He studied this theory by examining charts, graphs, and diagrams. Once Marshall got a close look at the mathematics, he could then put his thoughts onto paper so that people could learn from his analysis. Marshall focused on the causes that made the demand curve slope downward.

In his studies, he found that the reason the demand curve sloped downward was because the lower the price of a good, the more the consumer will buy. This relates to three basic principles of the elasticity of demand. Firstly, demand is elastic when the percentage in quantity is more than the percentage change in price. Secondly, the demand is inelastic when the percentage change in quantity is less than the percentage change in price. Lastly, the demand is unit elastic when the percentage changes are equal. Along with simply discussing the theory of elasticity of demand, Marshall also studied what we call today, the determinants.

He concluded that the elasticity of demand of the market is higher when the prices of products are higher than the buyer's income. He also added that, lowering the price of a product gives more people the opportunity to consume. Furthermore, when the price of an expensive product declines, the demand will increase, whereas, when the price of a less-expensive product declines, the demand for product will not change considerably. Marshall added that the elasticity of demand for a product would tend to be more elastic if it can serve as a substitute to other goods.

Along with elasticity of demand, Marshall also addressed the factor of supply. Marshall stated that supply is determined by the cost of production. Marshall did not look at supply as one single amount, but rather, just like demand, he looked at it as a curve. This curve would determine itself in three different time periods: the immediate present, the short run, and the long run. The immediate present does not allow time for adaptation of the quantity supplied to the changes in demand.

This means that if the demand for a product increases or decreases, in the immediate present it is not plausible for the manufacturers to expand or downsize in the product. The fact of the matter is that it takes time for companies to increase or cut down in manufacturing because inventory and production is so complex. Marshall analyzed the short run by dividing the costs into two types: supplementary costs and prime costs. Today we are more familiar with supplementary costs as fixed costs, and prime costs as variable costs.

Fixed costs are always constant in the short run, while variable costs change in the short run. Furthermore, in the short run the firms supply curve is based on only variable costs. In the short run the supply curve sloped upward to the right. This means that as the price of the product rises, the quantity supplied is larger. Today, economists relate Marshall's theory to the marginal cost curve. In the last time period, the long run, Marshall studied the fact that all costs are variable.

He added that these costs must be covered if the firm is to stay in business. Thus, if the price of a good increases, total revenue will exceed total cost and produce a positive profit for the firms, and new firms will enter the market. Marshall also investigated what determines market price in the economy. He believed that market price was determined by both supply and demand. In Marshall's graphical representation he placed quantity on the horizontal axis because he viewed it to be the independent variable, and he placed price on the vertical axis. Today while many economists view that quantity as the dependent variable, they still place pride on Marshall's hypothesis.

Through his graphs Marshall addressed the ideas of the producer surplus and the consumer, two ideas that were not looked at by other economists. He focused on the relationship that time has on the consumer and the market price of the product. He states: "Marshall said, the shorter the time period, the greater the influence of demand on value. The reason is that the influence of cost of production takes longer to work itself out than does the influences of changes in demand" (p. 307). Therefore, in the long run, the cost of production is the most important determinant of price and value.

Along with looking at the determinants of market price, Marshall also studied the impacts of wages and labor in the economy. He stressed that wages are not determined solely by marginal productivity. He believed that wages depended on both supply and demand. This being said, if the supply of labor increases, all factors remaining constant, the marginal productivity of labor would decline. At the other end of the spectrum, if the supply of labor decreases, all factors remaining constant, the marginal productivity of labor would increase. Therefore, the conclusion is "wages measure and are equal to marginal productivity with a given supply of labor" (p. 309).

It is important to understand that it is false to believe that marginal productivity does not solely determine wages, since changing the number of workers will inevitably produce much more marginal productivity. Along with identifying the demand for labor as a "derived demand", Marshall also discussed the factors of the wage elasticity of labor demand. Today, his theories are known as the four laws of elasticity of labor demand. Firstly, the greater the substitutability of other factors for labor, the greater the elasticity of demand for labor will be. Secondly, the greater the price elasticity of product demand, the greater the elasticity of labor demand will be.

Thirdly, the larger the proportion of total production costs accounted for by labor, the greater the elasticity of labor demanded will be. Lastly, the greater the elasticity of the supply of other inputs, the greater the elasticity of demand will be. These four rules that Marshall identified are used today to study derived demand in the economy. Marshall also studied the effects of interest on the economy. He believed that when interest rates increase, the use of machinery diminishes. The cause of this is that people in business avoid the use of all machines whose net annual surplus is less than the rate of interest.

Marshall found that the higher the price, the less capital would be demanded, whereas, if the price was lower, more capital would be demanded. The quantity of saving supplied depends on interest rates, and interest rates depend on the supply of saving. The interest rate is acting as the price of the good, which is the quantity of saving supplied, and the supply of saving is acting as the quantity. Consequently, the interest rate determines the quantity of the savings. Marshall also addressed the comparisons of manufactured goods and land. In doing this he incorporated the Ricardian rent theory.

He speculated that in the short run, both land and capital have fixed supplies. Marshall said, "There is not much difference between land and buildings; both are subject to diminishing returns as their owner tries to gain additional output from them. For society as a whole, however, the supply of land is permanent and fixed" (p. 311). This being said, the return on capital investment is similar to rent earned from land. Marshall called this theory of short-term rent, "quasi- rent". Marshall was determined to analyze his concept of a "representative firm" because he believed that they were the sole proprietorships of the nineteenth century.

He proposed three major purposes in his analysis of markets. Firstly, in relation to the normal cost of producing a good or commodity, a firm would be neither the most efficient nor the least efficient in the industry. Secondly, the representative firm showed that an industry could be in the long period even when some firms are growing and others are downsizing. In a sense these firms are neutralizing each other. Thirdly, even though a firm may not be experiencing increasing internal efficiency, it can still experience falling costs in production. Along with proposing the idea of a representative firm, he also believed that in the market there were both internal and external economies.

Marshall said, "Internal economies are the efficiencies or cost savings introduced by the growth in size of the individual firm" (p. 314). As the firm grows stronger and larger, it has the ability to welcome more specialization and mass production. External economies are a little different. They are economies that come outside of the firm, and they depend mostly on the general development of the industry. This means that if a company expands, suppliers around them have the ability to build more plants so that the expansion can come quicker and easier. As a result to the closeness, the supplies become much cheaper because they do not have to travel as much to get to the company, and also, the supplies are mass produced in firms that are growing.

In addition to the internal and external economies, Marshall also believed in the theory of increasing returns to scale in industry. He believed that the only time that we do not have increasing returns in industry is when we rely too much on agricultural industries. His analysis of constant, increasing, and decreasing cost industries led Marshall to his thoughts on welfare effects of taxes and subsides. His knowledge of the different industries allowed him to come to three different novel policy conclusions. First, a tax or subsidy will reduce net consumer satisfaction in a constant cost industry. Second, a tax can add to the overall satisfaction in an increasing cost industry.

Third, a subsidy can add to the overall satisfaction in a decreasing cost industry. These conclusions led to the implication that the previous arguments of competitive pricing and laissez-fair may not necessarily result in the most positive outcome. Alfred Marshall was considered one of the most influential economists of his time. Most of his findings and proposals that concerned the economy were correct. Today, we still use his theories of supply and demand, elasticity of demand, the long and short run, and interest rates in examining the current economy of the twentieth century.

Just as he expanded upon previous theories from other economists before his generation, today economists are applying Marshall's knowledge, and are expanding and figuring out there own philosophies in our current economy.