the classics david ricardo (1772 - 1832) the classics · the classics david ricardo (1772 - 1832)...

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


◮ 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



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)



◮ 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’



◮ 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


The Classics Robert Malthus (1766-1834)

The Classics

Thomas 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



◮ 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



◮ 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)


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


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)


The Neoclassics Hermann Heinrich Gossen (1810-1858)

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.



(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!



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.



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).



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).



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



◮ 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.


The Neoclassics Augustin Cournot (1806-1873)

The Neoclassics

Antoine Augustin Cournot (1806-1877)



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.



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



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



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!)



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.



0 x1

x2

R1(x2)

R2(x1)

x11x12x13

x21

x22

x23

Cournot’s reaction functions and a ‘stable’ equilibrium



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.


The Neoclassics Leon Walras (1834-1910)

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



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)



◮ 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


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