Marginalist Revolution

The Marginalist Revolution refers to the establishment of what has been called Neoclassical economic theory. The dating of this "revolution" is commonly ascribed to 1871-74, when the concept of "diminishing marginal utility" was introduced, independently and almost simultaneoulsy, by William Stanley Jevons , Carl Menger and Léon Walras , to analyse the character of demand -- thus the term "Marginalist". Actually the fundamental principles of marginalism had been discovered much earlier, in 1854, by the Prussian civil servant Hermann Heinrich Gossen (1810-1858), who first formulated, in a rare and unknown book, the "Gossen second law" or "the law of diminishing marginal utility", which was his most original contribution and presaged the Marginalist Revolution of 1871-74. Gossen's work was utterly disparaged by scions of the all-powerful German Historical School (Schmoller dismissed him as an "ingenious idiot"). Gossen died bitter and unknown. His work was only uncovered and graciously acknowledged by Jevons in 1878.

The Water-Diamond Paradox

On determining value, the Classicals -- Adam Smith, David Ricardo, John Stuart Mill, Karl Marx, etc. -- followed the pattern set by Richard Cantillon (1755). They argued that subjective desires and scarcity may be important factors in determining market (or temporary or short-run) prices, but they insisted that the natural (or equilibrium or long-run) prices were determined solely by relative costs of production (usually, relative labor costs). But the Classicals could not fully explain some aspects of value. The most important of them was described by Smith as the "water-diamond paradox".

The most famous application of marginalism is the solution to the so-called water-diamond paradox, which seemed to stump Adam Smith in his Wealth of Nations. The problem is this: Why do diamonds have a higher exchange value than water, when diamonds are a mere frippery while water is essential to life? Shouldn't people be willing to offer more in exchange for a unit of water than for a unit of diamonds?

The solution is that no individual is ever in the position of choosing between all of the diamonds in the world and all of the water in the world. A given choice is made on the margin. If offered a choice between a cup of water and a handful of diamonds, most people would pick the latter because the marginal utility (the additional utility perceived by the consumer by the addition of one extra unit of a good) of those particular diamonds is higher than the marginal utility of that particular cup of water. The marginal-utility theory of value resolves the paradox. Water in total is much more valuable than diamonds in total because the first few units of water are necessary for life itself. But, because water is plentiful and diamonds are scarce, the marginal value (the value, or the "worth", of the utility added by one additional unit of a commodity or service) of a pound of diamonds exceeds the marginal value of a pound of water.

Alfred Marshall in England, on his book Principles of Economics (1890), greatly extended the concept and recognized that prices are determined simultaneously by factors of cost and factors of demand. Marshall's theory also analyses the complexes phenomena occurring in a price system, with various goods interacting among themselves and affecting each other's prices.

History

The Marginalist Revolution set the foundations for the Neoclassical theory of value, which was bound to replace the "Classical" theory of value of Adam Smith, David Ricardo, John Stuart Mill and Karl Marx. However, the task of establishing the Neoclassical theory as the dominant approach to economics took quite some time, it can be roughly divided in three steps:

(1) 1871-74: the use of the concept of "diminishing marginal utility" as the basis of a theory of exchange -- accomplished independently by William Stanley Jevons, Carl Menger and Léon Walras.

(2) 1890-1894: the establishment of the marginal productivity theory of distribution by John Bates Clark, Phillip H. Wicksteed and Knut Wicksell.

(3) 1934-1947: the period of Paretian revival , whereby the introduction of ordinal utility and the solidification of the Neoclassical theory of value -- including its welfare implications -- helped resurrect Neoclassical theory from its moribund state; the critical figures here were John Hicks, Harold Hotelling, Oskar Lange, Maurice Allais and Paul Samuelson.

Therefore, the 1871-74 period was actually the "Marginalist Insurrection", the "Revolution" itself took a further half-century to work out fully. A timeline denoting the main contributions of the protagonists of the Marginalist Revolution follows:

Main Proto-Marginalists

• 1838 Antoine Augustin Cournot (French, b. 1801) Recherches sur les principes mathématiques de la théories des richesses;

• 1844 Jules J. Dupuit (French, b. 1804) De la mesure de l'utilité des travaux publics;

• 1850 Johann H. von Thunen (German, b.1783) Des isolierte Staat, Vol. II;

• 1854 H. Heinrich Gossen (Prussian, b.1810) Entwicklung der Gesetze des menschlichen Verkerhs .

The Revolutionaires

• 1871 William Stanley Jevons (English, b. 1835) Theory of Political Economy;

• 1871 Carl Menger (Austrian, b.1840) Grundsätze der Volkwirtschatslehre;

• 1874 Léon Walras (French, b.1834) Eléments d'économie politique pure.

The Consolidators

The initial discoveries on marginalism made by the "Revolutionaires" were soon followed by the contributions of a great number of followers, such as Eugen von Böhm-Bawerk (1886), Friedrich von Wieser (1889), Alfred Marshall (1890), John Bates Clark (1891), Irving Fisher (1892), Knut Wicksell (1893), Philip H. Wicksteed (1894), Vilfredo Pareto (1896) and Enrico Barone (1896) who greatly refined the initial marginalist concepts, and thus laid the foundations for the Neoclassical economy

Aftermath

Although sharing the same Neoclassical theory of value, the different emphasis, approaches and methods of the various pioneering Marginalists on production, money, capital, dynamics, etc. led to the segmentation of the Neoclassical school into various largely independent "schools of thought", rather than a consolidation into a "monolothic" Neoclassical edifice. the "Marginalist Revolution" had severer growing pains than the scope of this article can describe. Initiated in 1871-4, it only began to be noticed in the 1880s and by the late 1890s it was already running out of steam. In the early part of the twentieth century, the Marginalist Revolution was, in fact, retreating on many fronts. However, a mere two decades later, we begin to notice that Neoclassicism seemed more and more to have become a peripheral "fringe" movement in the economics profession as a whole. The reasoning for the Neoclassical retreat in the 1900s is largely because, to many contemporaries, it seemed to be descending into "quackery". Marginal utility is hardly a scientific concept: unobservable, unmeasurable and untestable, marginal utility is a notion with very dubious scientific standing.

The Paretian revival

The theoretical achievements of the 1930s by a few young technically-minded economists saved Neoclassical economics. The Hicks-Allen "ordinalist" revolution and Paul Samuelson's "revealed preference" approach helped remove much of the "quackery" from the utility theory. Welfare economics, firstly via A.C. Pigou and then through the hands of Harold Hotelling, Oskar Lange, Maurice Allais and the London School of Economics economists (John Hicks, Abba Lerner, etc.), demonstrated that there was still something quite useful in the hypothesis. Cassel's resurrection of the Walrasian general equilibrium system, the consolidation of the Neoclassical theory of production, the empirical efforts of Shultz and Douglas, and even Hayek's foray into macroeconomics were all done on the basis of demand functions. All these theoretical developments helped lend "scientific" foundations to Neoclassicism that were previously missing.

After the fervor of the 1930s -- the "Paretian revival" as we call it nowadays -- Neoclassical theory managed to displace virtually all other theories and approaches from economics. Thus, the "Marginalist Revolution" was not something that just happened in the 1870s, but, in fact, it took at least six decades to entrench itself.