Alfred Marshall (1842-1924)

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Alfred Marshall (1842-1924)

• from the Concise Encylopedia of Economics
• Alfred Marshall was the dominant figure in
  British economics (itself dominant in world
  economics) from about 1890 until his death in
  1924. His specialty was MICROECONOMICSthe study
  of individual markets and industries, as opposed
  to the study of the whole economy.
• In his most important book, Principles of
  Economics, Marshall emphasized that the price and
  output of a good are determined by both SUPPLY
  and demand the two curves are like scissor
  blades that intersect at equilibrium. Modern
  economists trying to understand why the price of
  a good changes still start by looking for factors
  that may have shifted demand or supply, an
  approach they owe to Marshall.
• http//www.econlib.org/library/Enc/bios/Marshall.h
  tml
• for more on Marshall see. http//www.economyprofe
  ssor.com/theorists/alfredmarshall.php

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Marshalls contributions

• Supply and Demand
• Price Elasticity of Demand
• Consumer Surplus
• Impact of taxation on society
• The Short-Run and Long-Run
• Optimization
• Marshall also taught John Maynard Keynes. If you
  have taken macroeconomics you have been exposed
  to the work of Keynes.

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The Marshallian Method

• Step One Math can be used, but only as a
  shorthand language.
• Step Two Any math should be translated into
  words.
• Step Three A theory should be illustrated by
  examples that are important in real life.
• Step Four With words and real world
  illustrations in hand, you can now burn the
  mathematics.
• Step Five If you cannot find any real world
  examples, burn the theory.
• Marshalls Lesson Analysis must relate to the
  world we observe.

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Deduction vs. induction

• Deduction a method of reasoning in which on
  deduces a theory based on a set of almost
  self-evident principles.
• Induction a method of reasoning in which one
  develops general principles by looking for
  patterns in the data.
• Abduction a method of analysis that uses a
  combination of inductive and deductive methods.

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More on deduction and induction

• The basic microeconomic theory of the firm
  which we are about to review is an example of
  deduction.
• Estimating a firms demand function is an example
  of induction.
• Interpreting a demand function is an example of
  abduction since one needs to understand both
  data analysis and economic theory to make sense
  of the empirical results.

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Maximizing the Value of the Firm

• Profit Total Revenue Total Cost
• The value of the firm is impacted by
• Total Revenue.... which is a function of
  marketing strategies, pricing and distribution
  policies, nature of competition....
• Total Cost .... which is a function of the price
  and availability of inputs, alternative
  production methods...
• The model of the firm is a deductive exercise
  designed to describe both factors that determine
  profit.
• We begin with some basic definitions

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Total, Average, and Marginal RelationsDefinitions

• Marginal change in a dependent variable caused
  by a one unit change in an independent variable.
• A Marginal Change is represented as
• ?Y / ?X
• Alternative definitions
• Rate of change
• Slope

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Graphing Total, Marginal, and Average Relations

• Slope a measure of the steepness of a line.
• OR The rate of change
• The marginal relation
• Tangent a line that touches but does not
  intersect a given curve.
• This is used to find the slope of a nonlinear
  curve.
• Inflection Point a point of maximum slope.

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Examples of Marginal Relationships

• Marginal Revenue change in total revenue
  associated with a one-unit change in output.
• Marginal Cost Change in total cost associated
  with a one-unit change in output.
• Marginal Profit Change in profit associated
  with a one-unit change in output.

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Examples of Average Relationships

• Average Revenue Total Revenue/Output
• What is another name for average revenue?
• Average Cost Total Cost/Output
• Average Fixed Cost TFC / Q
• Average Variable Cost TVC/Q
• Average Profit Total Profit/ Output

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Review of Basic Microeconomics

• Law of Demand As the price of a good rises,
  quantity demand will fall, ceteris paribus.
• In equation form P a bQ
• Total Revenue Price Quantity
• In equation form TR PQ
• OR TR aQ bQ2

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Review of Basic Microeconomics

• Revenue Maximization Activity level that
  generates the highest revenue.
• If P 100 2Q, how much should I produce to
  maximize total revenue?
• Marginal Revenue 100 4Q
• Total Revenue is maximized when marginal revenue
  is zero. WHY???
• When Marginal Revenue is positive, Total Revenue
  is rising.
• When Marginal Revenue is negative, Total Revenue
  is falling.
• When Marginal Revenue is zero, Total Revenue is
  neither rising or falling, therefore it is
  maximized.
• Therefore, total revenue is maximized at 25 units.

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Review of Basic Microeconomics

• What is the objective of the firm?
• PROFIT MAXIMIZATION
• Profit Total Revenue Total Cost
• To understand profit, you need to understand both
  revenue and cost. Understanding total revenue
  begins with the Law of Demand. Understanding
  total cost begins with the Law of Diminishing
  Returns.

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Review of Basic Microeconomics

• The Law of Diminishing Returns As a variable
  input increases, holding all else constant, the
  rate of increase in output will eventually
  diminish.
• OR..... As a firm increases its employment of
  labor, holding capital and all other factors
  constant, the productivity of each worker hired
  will eventually diminish.
• WHY? Each additional worker has less and less
  capital to work with.
• The Law of Diminishing Returns is the foundation
  from which we build the relationship between
  output and total cost, marginal cost, and average
  cost.

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Review of Basic Microeconomics

• Average Cost Minimization
• Why not Total Cost Minimization?
• If Marginal Cost is less than Average Cost,
  Average Cost will be declining.
• If Marginal Cost is greater than Average Cost,
  Average Cost will be increasing.
• When MC AC, Average Cost is Minimized.
• THE MATH OF AC MINIMIZATION

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Review of Basic Microeconomics

• Profit Total Revenue Total Cost
• Marginal Profit MR MC
• Profit is maximized when marginal profit equals
  zero. WHY?
• When marginal profit is positive (MRgtMC), profit
  is rising.
• When marginal profit is negative (MRltMC), profit
  is falling.
• When marginal profit is zero (MRMC), profit is
  not rising or falling, it is maximized.

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The Law of Demand
Law of Diminishing Returns

• Total Cost and Output
• Marginal Cost and Average Cost
• AVERAGE COST
• MINIMIZING LEVEL OF
• OUTPUT

• Price and Output
• via Own-Price Elasticity
• Total Revenue and Output
• Marginal Revenue and Output
• REVENU E MAXIMIZING LEVEL
• OF OUTPUT

Profit Total Revenue Total Cost Marginal
Profit Marginal Revenue Marginal Cost PROFIT
MAXIMIZING LEVEL OF OUTPUT