The Classics David Ricardo (1772 - 1832)
The Classics
David Ricardo (1772 - 1823)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 25 / 148
The Classics David Ricardo (1772 - 1832)
◮ Born in London, son of a Jewish family from Amsterdam (originally
from Portugal)
◮ Son of an exchange broker; Ricardo himself won a fortune by
speculating on the victory of Britain and the Continental Coalition
against Napoleon the day before the battle of Waterloo
◮ 1797: Discussion about a suspension of the duty to redempt cash
in exchange for gold in the banking system. Ricardo acts as a
prominent participant in the ‘Bullion Controversy’
◮ Participates also in the taxing debate over corn imports
◮ 1819: Member of Parliament
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 26 / 148
The Classics David Ricardo (1772 - 1832)
2 most relevant items of interest
◮ Free Trade (Comparative Cost Advantages)
Product\Land Portugal England
per unit o f wine 80 120
per unit o f clothes 90 100
Consequence: Exclusive production:
◮ England: 2 units of clothes (2 x 100 = 200 working hours, savings:
20 hours
◮ Portugal: 2 units of wine (2 x 80= 160 working hours, savings: 10
hours
Basic result (and even literal passages in Ricardo’s Principles)
occasionally attributed to his friend James Mill (1773-1836)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 27 / 148
The Classics David Ricardo (1772 - 1832)
◮ Value Theory
◮ Amount of used labor in the production of different goods as a
common base for evaluating surpluses, profit rates etc.:‘labor value theory’
◮ So-called ‘Corn model’
◮ ‘Fundamental law of income distribution’
◮ Example: Necessary for the production of, say, 1000 kg corn:
500 kg corn for the (natural goods) payment of agricultural workers)
250 kg corn for the use as seed
250 kg corn: ‘surplus’
Profit rate: 1/4
◮ Distinction between ‘usage value’ and ‘exchange value’
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 28 / 148
The Classics David Ricardo (1772 - 1832)
◮ Rent Theory
◮ A first farmer chooses the bestland; no rent has to be paid
◮ A second farmer has to take aless fertile land with a lower yield;
the first farmer has to pay the
rent of 10 units to the landlord
◮ A third farmer has to accept an
even less fertile lot; the first 2farmers pay the difference
between their yields and the third
farmer’s yield as their rents to thelandlord
Ricardo’s Rent Example
Cultivated
AreaProduce Rent
Lot #1 100 0
– – – – – – – – – –
Cultivated
AreaProduce Rent
Lot #1 100 10
Lot #2 90 0
– – – – – – – – – –
Cultivated
AreaProduce Rent
Lot #1 100 30
Lot #2 90 20
Lot #3 70 0
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 29 / 148
The Classics Robert Malthus (1766-1834)
The Classics
Thomas Robert Malthus (1766-1834)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 33 / 148
The Classics Robert Malthus (1766-1834)
◮ Born as the son of Daniel Malthus, a friend of J.-J. Rousseau and
David Hume
◮ 1805: ‘Professor for general history, politics, trade and finance’,
East India College. Later denoted as ‘Professor for History and
Political Economy’, i.e. first professional chair in economics.
◮ Mainly known as the founder of a new ‘population economics’.
Previously dominating attitude: attempts to justify a high
population growth rate: the higher the population, the higher the
political power of the sovereign and the overall tax revenue
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 34 / 148
The Classics Robert Malthus (1766-1834)
◮ Major work: Essay on the Principles of Population (1798)
◮ Population dynamics: exponential growth due to more or less
constant growth rate: 1, 2, 4, 8, 16 etc.
◮ Nutrition dynamics: maximally linear growth (decreasing growth
rates): 1, 2, 3, 4, 5 etc.
◮ Consequence: Critical point at which population growth cannot be
supported by the available food production
t
Nutrition
t
Population
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 35 / 148
The Classics Robert Malthus (1766-1834)
◮ Political and social consequences:
◮ Claim: reduction of population growth rates, birth control etc.
◮ High labor supply leads to a tendential fall in wages towards wagemiminum
◮ Intense discussion in the public and in academics
◮ Marx: Malthus is a person without any intellectual format
◮ Darwin: Example for typical forms of the behavior of species in the
natural world
◮ Further research topics:
◮ Value theory (statements in contrast to Ricardo)
◮ ‘Effective demand’ as a demand backed up by purchasing power(as a precursor to Keynes)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 36 / 148
The Neoclassics
Classics Neoclassics
Social Needs Individual Optimization
— —
Long-term Price Determination Short-term Price Determination
— —
Macroeconomic Perspective Microeconomic Perspective
— —
Supply-side Determination of
Prices
Demand-side Determination of
Prices— —
Concentration on Production Concentration on Consumption
A Few Elementary Differences between
Classical and Neoclassical Authors
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 46 / 148
The Neoclassics
The Neoclassics
The Most Relevant Neoclassical Writers:
◮ Johann Heinrich Gossen (1810-1858)
◮ Antoine Augustin Cournot (1806-1877)
◮ Leon Walras (1834-1910)
◮ Carl Menger (1840-1921)
◮ Vilfredo Pareto (1848-1923)
◮ Francis Edgeworth (1845-1926)
◮ Alfred Marshall (1842-1924)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 47 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
The Neoclassics
Hermann Heinrich Gossen (1810-1858)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 48 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
Vita
◮ Born as the son of a tax collector in the occupied (by Napolean
troops) Duren near Cologne
◮ Education as a lawyer at the University of Bonn
◮ No distinctive education in economics
◮ Employed as a civil servant in Cologne until his early retirement at
the age of 37
Bibliography
“Entwicklung der Gesetze des menschlichen Verkehrs, und der daraus
fließenden Regeln fur menschliches Handeln” (1854)
Virtually no organization of the book in the form of chapters, sections
etc.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 49 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
(originally: no publisher found. In 1854, published by Friedrich Vieweg
in Braunschweig on Gossen’s own account. No financial success, only
a few copies sold. Gossen’s consequence: buying of the remaining
copies and burning them in his garden)
The “Entwicklung . . . ” was later recognized by Stanley Jevons in 1879
in a letter to Walras as the first source containing a subjective utility
theory
Gossen viewed himself as a person who can be compared to
Copernicus and Newton in astronomy!
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 50 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
Gossen’s utility theory (in more recent terms)
Standard (cardinal) utility function: U(x1, x2, . . . , xn),
associated prices: pi, i = 1, . . . , n,
individual income: Y.
2 Gossen “Laws”
1st Law The utility obtained from consuming a good i in the
quantity xi increases with an increasing quantity xi, but the
utility increase decreases with this increased quantity. In
more recent formal terms: U(x1, x2, . . . , xn) > 0,
Uxi(·) > 0, and Uxixi
(·) < 0.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 51 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
2nd Law Consider any two goods i and j entering the utility function.
In the optimum, a given income Y is spent such that the
marginal utilities of all goods, expressed in terms of the
associated prices are equal in all allocations, i.e.
Uxi
pi=
Ux j
p j= λ ∀ i, j = 1, . . . , n, i , j (1)
with λ as the marginal utility of income, or, in more common terms
Uxi
Ux j
=
pi
p j∀ i, j = 1, . . . , n, i , j, (2)
A long time later, Hicks (1939 established the term marginal rate of
substitution for the l.h.s. of (2).
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 52 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
Gossen’s own presentation:
‘Consumption’ (‘Genuss’) takes place in time. Denote by x1 the
consumption of a particular ‘good’ at a point in time t.
x1(t1): total quantity of the good consumed from the beginning of the
observation until the recent point t1 in time.
x1(t1), =⇒ U1(
x(t1))
=⇒ U1(t1).
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 53 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
0
1
2
3
4
5
0 1 2 3 4 5t1
U1
t ∈ [T1,T2]
0
1
2
3
4
5
0 1 2 3 4 5t1
U1
t ∈ [T2,T3]
Figure 1: Saturation during ‘consumption’ within two consecutive time
intervals
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 54 / 148
The Neoclassics Hermann Heinrich Gossen (1810-1858)
◮ The marginal utility decreases until a saturation level is reached,
i.e., utility reaches an absolute value within a certain time interval
[T1,T2].
◮ When the consumption process is repeated during a later time
interval [T2,T3], the consumption is associated with a lower utility
level and an earlier saturation point in time (within this new
interval).
◮ The utility gained from consuming one good is independent of the
consumption of other goods
◮ The relevant restriction (beyond a possible income restriction) is
time. If t1 and t2 are the time ‘amounts’ spent for the consumption
of two goods, then t1 + t2 ≤ T with T as the total length of the
relevant time interval.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 55 / 148
The Neoclassics Augustin Cournot (1806-1873)
The Neoclassics
Antoine Augustin Cournot (1806-1877)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 56 / 148
The Neoclassics Augustin Cournot (1806-1873)
Vital Dates, Education and Career
◮ Born August/28/1801 in Gray, Haut-Saone, France. Educated
mainly in the family of his grandfather, a notary.
◮ 1821 admission to the Ecole Superieur, in Paris. After the
shut-down of the school, C. transfered to the Sorbonne; license
degree in mathematics in 1823. Dedicated friend of Johann P. G.
Dirichlet, a renowned mathematician already at that time.
◮ 1823-33: private secretary of a French marshal and a tutor to his
son. On a private basis: doctoral theses in mechanics and in
astronomy. In passing: degree in law. Best selling translations of
books on mechanics and astronomy.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 57 / 148
The Neoclassics Augustin Cournot (1806-1873)
Vital Dates, Education and Career (cont.)
◮ Acquaintance with the mathematician Simeon Denis Poisson who
arranged a professorship in analysis and mechanics at the
University of Lyon in 1834. Rector of the Academy of Grenoble in
1834, later inspector general of education, commander of the
Legion of Honor and rector of the University of Dijon. Retirement
in 1862.
◮ Died March/31/1877 in Paris
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 58 / 148
The Neoclassics Augustin Cournot (1806-1873)
Works
◮ Price determination and different market structures
◮ International trade; consistency of currency systems; arbitrage
possibilities
Price Determination
View point: from monopoly to pure competition
a. The monopoly case
Cournot’s discussion more or less identical with modern presentations
(note, however, the concentration on p as the supporting variable in the
calculation!)
Demand function p = g(x), g′ < 0. No underlying utility function
and optimization problem; determined empirically
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 59 / 148
The Neoclassics Augustin Cournot (1806-1873)
Cost function C = C(x), C′(x) > 0, C′′(x) R 0
Revenue R = p · x = g(x) · xProfits P = R − C = g(x) · x − C(x)
Profit MaximumdP
dx= g′(x) · x + g(x) − C′(x) = 0
=⇒dp
dx· x + p = p ·
(
dp
dx· x
p+ 1
)
= C′(x)
p ·(
1
ε+ 1
)
= C′(x)
(last eq.: ‘Amoroso-Robinson-Relation’ with ε as direct price elasticity
of demand)
(Cournot maximized over p→ problems in case of duopoly!)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 60 / 148
The Neoclassics Augustin Cournot (1806-1873)
b. The duopoly case (two firms)
Setup: x = x1 + x2 = F(p) or the inverse function p = g(x) = g(x1 + x2)
Assumption: Each firm considers the quantity supplied by a competitor
as constant (i.e. not influenced by the first firm’s decision).
‘Remaining’ demand function for the first firm:
x1 = F(p) − x2
Optimization problem of the first firm: (optimization over p is
problematic at this place)
maxx1
P1 = g(x1 + x2) · x1 − C1(x1)
Varying x2 yields the optimal ‘reaction curve’ of firm 1. Analogous
procedure for firm 2.
Consistent plans at the point of intersection of the two curves.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 61 / 148
The Neoclassics Augustin Cournot (1806-1873)
0 x1
x2
R1(x2)
R2(x1)
x11x12x13
x21
x22
x23
Cournot’s reaction functions and a ‘stable’ equilibrium
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 62 / 148
The Neoclassics Augustin Cournot (1806-1873)
c. Pure Competition
Large number n of identical firms (here also with identical costs):
→ xi =x
nDemand function: p(x) = p
(
∑ni=1 xi
)
Profit for each firm:
Pi(xi) = p(
∑ni=1 xi
)
· xi − Ci(xi) = p
xi +∑n
j=1i, j
xi
· xi − Ci(xi)
Optimum for each firm: p(x) + p′(x)xi = C′i(xi)
With xi =x
nand lim
n→∞x
n= 0 it follows that in the limit
p(x) = C′i(xi)
i.e. the familiar competitive optimality criterion holds.
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 63 / 148
The Neoclassics Leon Walras (1834-1910)
The Neoclassics
Leon Walras (1834-1910)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 64 / 148
The Neoclassics Leon Walras (1834-1910)
◮ Born Dec/16/1834 in Evreux, France, as the son of Auguste W.
who was strongly interested in economics, 2 volumes on Political
Economy
◮ First attempts as a belletristic author, later intense studies of
mathematics
◮ Unsuccessful attempt to find a professorship in economics in
France; dominated by the orthodox school that concentrated more
on policy advise
◮ 1870: Chair of Political Economy in Lausanne/Switzerland until his
emeritation
◮ 1902: honory member of the newly founded American Economic
Association
◮ 1909: celebration of his 40th jubilee (denoted as the founder of
General Equilibrium Analysis)
◮ Died Jan/5/1910 in Montreux, Switzerland
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 65 / 148
The Neoclassics Leon Walras (1834-1910)
2 major topics
◮ Existence of a General Equilibrium in an exchange economy◮ goods: i = 1, . . . , n
individual agents: j = 1, . . . ,m
pi: price of good i
zi j(p1, p2, . . . , pn): excess demand of agent j for good i∑m
j=1 pizi j = pizi(·): aggregated excess demand for good i
◮ Question: Is it possible to find (p1, p2, . . . , pn) such that∑n
i=1 pizi(p1, p2, . . . , pn) = 0 ?
◮ Answer: Yes, under certain continuity and convexity assumptions(Walra’s Law)
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 66 / 148
The Neoclassics Leon Walras (1834-1910)
◮ Stability of a General Equilibrium
◮ Problem: who is setting prices when an economy is characterized
by price takers in a competitive scenario? No monopoly, nooligopoly, no administered prices!
◮ Educational answer: tatonnement process
◮ ‘Auctioneer’ as an artificial institution ‘cries’ out arbitrary prices and
collects individual excess demands for each good.
◮ In case of excess demand: prices will be increased
◮ In case of excess supply: prices will be decreased
◮ Result: if dzi/dpi < 0 and certain continuity, convexity and
monotonicity assumptions hold, the price vector approaches itsequilibrium value: equilibrium is stable.
◮ Standard critique: it is mandatory to forbid trade during theadjustment process
Hans-Walter Lorenz (FSU Jena) A Short History of Economic Thought Winter 2017/18 67 / 148