History of Alfred Marshall

Abstract

   Marshall began his seminal work, the Principles of Economics, in 1881, and he spent much of the next decade at work on the treatise. His plan for the work gradually extended to a two-volume compilation on the whole of economic thought; the first volume was published in 1890 to worldwide acclaim that established him as one of the leading economists of his time. The second volume, which was to address foreign trade, money, trade fluctuations, taxation, and collectivism, was never published at all. He served as President of the first day of the 1889 Co-operative Congress. Over the next two decades he worked to complete his second volume of the Principles, but his unyielding attention to detail and ambition for completeness prevented him from mastering the work's breadth. The work was never finished and many other, lesser works he had begun work on - a memorandum on trade policy for the Chancellor of the Exchequer in the 1890s, for instance - were left incomplete for the same reasons. His health problems had gradually grown worse since the 1880s, and in 1908 he retired from the university. He hoped to continue work on his Principles but his health continued to deteriorate and the project had continued to grow with each further investigation. The outbreak of the First World War in 1914 prompted him to revise his examinations of the international economy and in 1919 he published Industry and Trade at the age of 77. This work was a more empirical treatise than the largely theoretical Principles, and for that reason it failed to attract as much acclaim from theoretical economists. In 1923, he published Money, Credit, and Commerce, a broad amalgam of previous economic ideas, published and unpublished, stretching back a half-century. From 1890 to 1924 he was the respected father of the economic profession and to most economists for the half-century after his death, the venerable grandfather. He had shied away from controversy during his life in a way that previous leaders of the profession had not, although his even-handedness drew great respect and even reverence from fellow economists, and his home at Balliol Croft in Cambridge had no shortage of distinguished guests. His students at Cambridge became leading figures in economics, including John Maynard Keynes and Arthur Cecil Pigou. His most important legacy was creating a respected, academic, scientifically-founded profession for economists in the future that set the tone of the field for the remainder of the 20th century. Having died aged 81 at his home in Cambridge, Marshall is buried in the Ascension Parish Burial Ground. The library of the Department of Economics at Cambridge University (The Marshall Library of Economics) as well as the University of Bristol Economics department are named for him.

Biography

    Marshall grew up in the London suburb of Clapham and was educated at the Merchant Taylor's School, Northwood and St John's College, Cambridge, where he demonstrated an aptitude in mathematics, achieving the rank of Second Wrangler in the 1865 Cambridge Mathematical Tripos. Although he wanted early on, at the behest of his father, to become a clergyman, his success at Cambridge University led him to take an academic career. He became a professor in 1868 specializing in political economy. He desired to improve the mathematical rigor of economics and transform it into a more scientific profession. In the 1870s he wrote a small number of tracts on international trade and the problems of protectionism. In 1879, many of these works were compiled together into a work entitled The Pure Theory of Foreign Trade: The Pure Theory of Domestic Values. In the same year (1879) he published The Economics of Industry with his wife Mary Paley Marshall.

While Marshall took economics to a more mathematically rigorous level, he did not want mathematics to overshadow economics and thus make economics irrelevant to the layman. Accordingly, Marshall tailored the text of his books to laymen and put the mathematical content in the footnotes and appendices for the professionals. In a letter to A. L. Bowley, he laid out the following system:

(1) Use mathematics as shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life (5) Burn the mathematics. (6) If you can’t succeed in 4, burn 3. This I do often."

Marshall had been Mary Paley's professor of political economy at Cambridge and the two were married in 1877, forcing Marshall to leave his position as a Fellow (college) of St John's College, Cambridge in order to comply with celibacy rules at the university. He became the first principal at University College, Bristol, which was the institution that later became the University of Bristol, again lecturing on political economy and economics. He perfected his Economics of Industry whilst at Bristol, and published it more widely in England as an economic curriculum; its simple form stood upon sophisticated theoretical foundations. Marshall achieved a measure of fame from this work, and upon the death of William Jevons in 1881, Marshall became the leading British economist of the scientific school of his time.

Marshall returned to Cambridge, via a brief period at Balliol College, Oxford during 1883–4, to take the seat as Professor of Political Economy in 1884 on the death of Henry Fawcett. At Cambridge he endeavored to create a new tripos for economics, which he would only achieve in 1903. Until that time, economics was taught under the Historical and Moral Sciences Triposes which failed to provide Marshall the kind of energetic and specialized students he desired.

Life and writings

    Alfred Marshall (1842–1924) was not among the protagonists of the 1871–4 ‘marginalist revolution’: his first major writings belong to the end of the 1870s, and his main contribution, his Principles of economics, appeared in 1890, nearly two decades after the works of Jevons, Menger and Walras. Marshall himself was averse to considering the new road taken by economic analysis as a ‘revolution’ or a clear-cut break with the past: in his opinion, this was instead a step forward, although certainly an important one, relative to the classical economists’ (in particular Ricardo’s and the Ricardians’) approach. Indeed, his personal contribution, in his own opinion, consisted in the synthesis between the great tradition inherited from the past and the new yeast of the subjective approach. Yet, we must recognise that Marshall contributed more than anyone else, possibly at least in part against his own intentions, to ‘shunt the car of economic science’ in the direction of that approach (which Hicks, Stigler and Samuelson preferred to call ‘neoclassical’, rather than ‘marginalist’ or ‘subjectivist’, in order to stress that the turn-around implied an important element of continuity with the past) which still today dominates the teaching and thinking of economists all over the world.

Marshall was born in London, on 26 July 1842, to a modest bourgeois family.1 His father, authoritarian if not tyrannical within the family, was a modest clerk of the Bank of England. Alfred studied in a school in the periphery of London, the Merchant Taylor’s School; he distinguished himself and was awarded a scholarship to Oxford, aimed at financing classical studies as a basis for an ecclesiastical career. However, he felt more inclined to mathematics and, thanks to a loan from an uncle who had migrated to Australia and had become rich, decided to defy his father’s pressures and choose Cambridge’s mathematical curriculum, as a student of St John’s College. In 1865 he brilliantly passed his examinations, second wrangler (that is, ranking second among the mathematics graduates, only surpassed by Rayleigh, future lord and Nobel prize winner for chemistry in 1904).

Thus Marshall’s career began, first with a fellowship at St John’s, then (in 1868) as lecturer of moral sciences in the same college. Around the middle of the 1870s, perhaps in connection with his preparations for a trip to America in 1875, his interests shifted from mathematics and moral sciences towards political economy. Participating in a scheme to promote the admission of women to university, Alfred taught political economy to Newnham Hall’s female students.2 There he met Mary Paley, whom he married in 1877.

After a review in 1872 of Jevons’s 1871 book, Marshall’s first important contribution to economic theory was a collection of essays, published in 1879 for private circulation by Henry Sidgwick, on The pure theory of foreign trade. The pure theory of domestic values.3 In the same year he published, together with his wife, a declaredly didactic text, The economics of industry (Marshall 1879a), which had good sales and also constituted a most important original contribution in outlining a representation of economic life which we may define as evolutionary.

Following his marriage, Marshall was compelled to resign from St John’s College, which required celibacy of its fellows. Marshall was able to go back to Cambridge only when elected professor of political economy, as a successor to Fawcett, in 1884.4 In the meantime the Marshalls spent some difficult years in Bristol. Here Alfred, who appeared exhausted in body and in spirit, struggled under the workload – which included administrative tasks in addition to teaching – connected to his role as professor and simultaneously as principal of the University College. In 1881 he resigned, and the Marshalls spent a year largely travelling, with a long stay in Palermo where it seems the writing of the Principles began. Back in England, in 1882 Marshall became professor of political economy at Bristol, but in the following year he moved to Oxford, as the successor to Arnold Toynbee, lecturer at Balliol College. The prestigious Cambridge appointment, which came unexpectedly, marked a turning point in his life. Marshall held the political economy chair for twenty-four years, up to 1908, but remained in Cambridge until his death in 1924, and retained a strong interest in the vicissitudes of the economics curriculum created by his impulse in 1903.

 From Cambridge, Marshall exercised significant influence over the teaching of economics in the    rest of England. In 1890, with his active intervention, the British Economic Association was founded and the Economic Journal was launched. His Principles of economics (eight editions, from 1890 to 1920)5 soon became the reference text for generations of economics students: years later, Keynes said that the formation of a good economist only requires the Principles, accompanied by the careful reading of the economic pages of a good newspaper. Among the students, the small guide published by Marshall in 1892, Elements of the economics of industry, was widespread; it replaced the widely read (and in many respects much more interesting) Economics of industry (1879a),6 which had been written in collaboration with his wife. Marshall’s influence was exercised, perhaps mainly, through his pupils: without ever taking on the presidency of the British Economic Association or the direction of the Economic Journal, Marshall influenced the selection for these positions, and likewise influenced the nomination of the economics professors in the major English universities, among which Cambridge had come to dominate; there Alfred imposed Arthur Cecil Pigou as his successor. Marshall’s mark was so strong as to be perceptible decades later in post-Second World War Cambridge as well as in today’s textbooks. Side by side with the oral tradition of his lectures and the vast correspondence with interlocutors worldwide,7 an important component of the Marshallian theoretical legacy is represented by his Official papers, mostly testimonials to parliamentary commissions,8 and a group of articles collected after his death in a volume of Memorials.9 Considered as less important are the two volumes originally intended as the completion of the great design begun with the Principles, which Marshall published only in the final years of his life: Industry and trade, dated 1919, and Money, credit and commerce dated 1923. Marshall died, aged eighty, in 1924.

 Principles of Economics

   When in 1890 the first edition of the Principles of Economics appeared, after many years’ work, the ground had already been prepared to ensure the book had a major impact on the economic culture of the time. Marshall was then settled in the Cambridge chair, which thanks mainly to his prestige had become the main economics chair of the country, and his pupils occupied important positions in the English academic world (as we have noted, the same year saw the birth of the Royal Economic Society and the Economic Journal). Moreover, the influence of the classical tradition was still strong, while the marginalist heterodoxy attracted indeed the most brilliant minds but still less consensus than Cliffe Leslie’s English historical school.14 In such a situation, Marshall offered a set of elements designed to attract the convergent interest of the different streams of economic culture existing at the time: insistent reference to the classical tradition, from the Smithian theory of the division of labour to the ‘Ricardian’ theory of rent; acceptance of the basic elements of the marginalist revolution, with attribution of a central role to demand, hence to economic agents’ preferences, within a theory of value in which prices were determined by the mechanism of equilibrium between supply and demand insertion of this analytical structure in the context of broad discussions (which cannot be reduced to simple digressions) on the meaning of the concepts used in the analysis and on the historical evolution of society;and references to Darwinian evolutionism, which conferred an element of scientific modernity on the work and provided a flexible, open response – also in methodological terms – to historical evolution in comparison to the reference to physics (more precisely, to static mechanics) prevailing in the theories of equilibrium of authors of stricter marginalist faith.

The Principles were presented as the first of two volumes; the second volume, however, was never completed, and since the sixth edition (1910) the label ‘first volume’ disappeared. The second volume was originally planned to deal with foreign trade, monetary and financial issues, trade cycle, taxation, collectivism and a synthesis of tendencies of the economy towards social progress; only part of this ground corresponds to that covered in the two last works by Marshall, Industry and Trade (1919) and Money, credit and commerce (1923).16 From the first (1890) to the eighth (1920) edition, the Principles remained at the centre of Marshall’s theoretical work, undergoing substantive revisions; this is especially true for the fifth edition (1907), the last before his resignation from the Cambridge chair. The voluminous variorum editio (1961), promoted by the Royal Economic Society and edited by Marshall’s nephew, Charles Guillebaud, allows us to reconstruct this path.

The importance of Marshall’s revisions to his Principles testifies to the difficulties he met in his work of synthesis between different approaches and in his attempt to build a theory of value which was to include simultaneously the objective (cost of production) and the subjective (utility) element, and which was to be at the same time rigorous, realistic and open to historical evolution. Before discussing the difficulties Marshall met, it may be useful to run over the main aspects of his approach: the method (complexity of the realworld and short causal chains); the notions of equilibrium and competition; and the concepts of the firm and the industry. We will then consider the problem of increasing returns and the two solutions suggested by Marshall, the representative firmand external–internal economies. Marshall’s methodological standpoint was simple in its objective: to recognise the extreme complexity of the real world. Theory cannot but be abstract, but must keep its feet on the ground. Hence his tenet, which underlay his ‘partial equilibrium method’, that ‘short causal chains’ should be privileged. At each step, theory proceeds by isolating a logical nexus of cause and effect held to be the main one, and thus leave aside other effects held to be secondary, though not non-existent. This is legitimate, indeed necessary, for construction of each individual analytical piece. However, when we put together many logical links and generate long causal chains – as happens for instance in general economic equilibrium theory – the secondary effects left aside may in reality have repercussions which amplify step by step, and this may cause the conclusions drawn from the theoretical analysis to be misleading. Hence Marshall relegated to a mathematical note, in appendix to his Principles, his illustration of general economic equilibrium (an exposition which, compact as it is, is one of the most rigorous of the time). Instead, in the text Marshall preferred to focus on the ‘short causal chains’, in particular on the method of partial equilibriums.

The latter consisted in considering demand and supply of each good – that is, the conditions which concur in determining equilibrium in the corresponding market – as independent of what simultaneously happens on other markets for the other goods. The same awareness of the complexities of the realworld – an awareness which is demonstrated in the wealth of footnotes and qualifications he makes, that on occasion dominate the logical thread of the exposition – may also be perceived in the attention Marshall lent to the construction of the system of concepts by which to represent reality. In the first books of the Principles, step by step the concepts introduced are discussed by illustrating for each the shades of meaning and the ‘penumbra’ – to use Georgescu-Roegen’s evocative term – which rendered their contours imprecise. This is true in particular for the key notions of equilibrium and competition to which, in the intertwining of text and notes, affirmations and qualifications, it is very difficult to attribute a univocal meaning.

We can point to two terms of reference, between which Marshall’s position oscillated, in the impossible attempt to absorb both: on the one side, the notions which subsequently took the textbooks by storm, and which constitute what we might call the Marshallian vulgata; on the other, the esoteric notions, disseminated among the circle of pupils and direct followers, connected to an evolutionary view which drew more on Lamarck rather than on Darwin’s original theories. In the first case – the Marshallian vulgata – the notion of equilibrium corresponds to the static notion of equality between demand and supply, and the notion of perfect competition to the presence of a large number of firms in each industry, so large as to render the size of each firm irrelevant to the dimensions of the industry as a whole, and the choices of each individual firm irrelevant for the industry as a whole (hence for the equilibrium price level).

In the second case – the evolutionary view – the notion of equilibrium takes on dynamic features, in the attempt to take account of the irreversibility which characterises the actual movements of the firm and the industry along demand and supply curves; the notion of competition is softened by attributing to each firm some room for manoeuvre which among other things includes the possibility of violating the so-called law of the one price. Theoretical analysis – construction of well-structured models – is inevitably led to refer to clear-cut concepts of the first kind; in the case of the evolutionary view, as we shall see below, we remain instead in the field of metaphors, which are evocative but certainly not rigorous. In other words, in the oscillation from the first to the second pole of the Marshallian construct, what is gained on the side of realism is lost on the side of analytical rigour. The very notions of industry and firm constituted a bridge between the complexity of the real world and the requirement of simplicity of abstract theory. Marshall thereby distanced himself from the extreme methodological individualism of the first marginalist theoreticians, and privileged instead a classical feature, by which each commodity (‘good’, in the subjectivist terminology, which thus lays stress on their utility to the consumer) corresponds to a category which includes objects not identical between themselves but sufficiently similar to warrant unitary treatment, and in parallel each industry includes the firms (complex productive units) which operate in one of such commodity categories.

Economics becomes a profession Among Marshall’s contributions to the development of economics we should also recall his role in the transformation of the economist into a profession, with specific autonomy in the areas of research and teaching. When Marshall began his professional career, within university studies it was possible to distinguish two general curricula: human sciences and natural sciences. Within the first curriculum, philosophy (with a dominant role for moral philosophy), history and morals coexisted. Political economy had a smaller role; the economic lectures that Marshall gave to the female students of Newnham College were on many accounts lessons in civic education.

As already stated, Marshall made a decisive contribution in this direction. First of all, there was the foundation in 1890 of the British Economic Association (subsequently the Royal Economic Society) and of its publication, the Economic Journal. Second, we should recall the long struggle for the institution of a specialised curriculum of studies at the University of Cambridge, independent of the generic one in moral sciences. Economics (no longer ‘political economy’) was conceived as a science whose development was entrusted to specialists, on the model of natural sciences, and no longer as a branch of knowledge entrusted in part to those who could ponder on their own practical experiences (from Cantillon the banker to Ricardo the stockbroker) and in part to persons endowed of good general culture and with a political interest for an understanding of economic and social events (from the physicians Petty and Mandeville to a professional revolutionary such as Marx).

Monetary Theory: from the old to the new Cambridge school

   In his main work, the Principles, Marshall did not deal with money: as stated above, the subject was set aside for a subsequent volume of the great treatise initially planned; when Marshall, already eighty years old, succeeded in publishing Money, credit and commerce (1923), his analytical vigour had disappeared. His contributions to the field of monetary theory are rather to be found in his participation (mainly in the form of testimonials) in some commissions of enquiry into the subject, and in the oral tradition stemming from his teaching.

Two aspects of Marshall’s theory of money deserve mention here. First, Marshall transformed Irving Fisher’s quantity equation (cf. above, 12.5), MV = PQ, into the so-called Cambridge equation, kY = M.37 Second, there was the role of ‘monetary disturbances’ in explaining the cyclical oscillations of the economy around the long period equilibrium determined by the ‘real’ factors considered within the neoclassical theory of value.

As far as the first aspect is concerned, at first sight it might seem a simple change in symbols: ‘Cambridge’s k’ corresponds in fact to the inverse of the velocity of circulation of money V in Fisher’s equation. However, behind this formal change a different notion of the demand for money shone through. This is connected not so much to financing requirements for exchange as to economic agents’ choices on the share of their income (or, in a different formulation, later to be developed by Keynes, on the share of their wealth) that they desire to keep in the form of money. In this way precautionary demand for money (and later, with Keynes, speculative demand) was made to appear explicitly side by side with demand for money for transaction purposes. In other words, the formal change in the equation of exchanges allowed Marshall to stress a new perspective from which to tackle the issue of the role of money: a potentially revolutionary perspective, as was to be seen when his pupil Keynes accomplished decisive steps forward. With respect to the role of money in the determination of the real variables of the economy, Marshall advanced further interesting ideas, admitting the influence of liquidity conditions on income and employment as well, together with its influence on money prices. However, in this case as well the decisive step forward was accomplished later, by Keynes. Marshall limited the ‘non-neutrality’ of money to the short period, as after him his pupils or followers, from Hawtrey to Robertson, and more or less the whole of the neoclassical tradition, up to Hayek and beyond were also to do.

Marshallism in the United States: from John Bates Clark to Jacob Viner

    The rise to dominance of the neoclassical vulgata in the teaching of economics and in economic culture in the first half of the twentieth century was due not only to developments in England and in particular in Cambridge with Pigou, but especially to the increasing role of American universities (favoured when Italian and then middle-European culture was upset by the rise of fascism and nazism) and the influence of a few protagonists there, who systematised economic theory in the simplified versions of partial or aggregate equilibrium.

Let us focus attention on two key figures: John Bates Clark (1847– 1938) and Jacob Viner (1892–1970).43 J. B. Clark was, with Richard Ely (1854–1943) and Henry Carter Adams (1851–1921), one of the three promoters of the American Economic Association in 1885, and was from 1895 to 1923 professor at Columbia University in New York. After studying at Amherst, in the 1870s he had spent two years at Heidelberg, feeling the influence of Knies’s German historical school; but already his first book (The philosophy of wealth, a collection of articles published in 1886) contained ‘a totally original and quite sophisticated statement of the principle of marginal utility (“effective utility” in Clark’s vocabulary)’.44 His main work, The distribution of wealth, published in 1899 after long years of elaboration, offered an organic illustration of the neoclassical theory of value and distribution based on the aggregate notion of capital, and had a wide impact.

Let us briefly examine this theory. Clark considered an economic system with only two factors of production, labour and capital (land, and any other productive input different from labour, were reduced to capital). Within such a system, the quantity of product obtained depends on the quantity utilised of the two factors of production and on their combination; rate of interest and wage rate correspond, in equilibrium, to the marginal productivity of the two factors, capital and labour, and constitute their prices or ‘natural values’Clark was a strong supporter of aggregate analysis, for the possibility it offers to achieve concrete and analytically robust results.46 Therefore, he rejected as irrelevant the attempts to develop a disaggregate theory of capital such as that of the mature Wicksell, derived from B¨ohm-Bawerk, based on the periods of production of the different capital goods (cf. above, §§ 11.4 and 11.5). Moreover, Clark proposed a ‘universal measure of value’ based on a combination of utility and labour. On the conceptual plane, his main contribution consisted in the distinction between statics and dynamics; at the analytical level, in the demonstration, though based on a simple graphical apparatus – in the framework of the aggregate neoclassical theory recalled above – of the erroneousness of considering the share of income going to capital or to land as a surplus, because of the symmetry between the determination of the wage rate and that of the interest rate, which correspond to the marginal product of the two factors of production, labour and capital.

In the generation following Clark’s, Jacob Viner taught at the University of Chicago, with very short breaks, from 1916 to 1946, and subsequently moved on to Princeton up to 1960. His main fields of research were the theory of international trade and the history of economic thought. His most influential contribution, however, was an article on ‘Cost curves and supply curves’ published in 1931. Therein Viner offered systematic treatment in four graphs of the determination of short run and long run equilibriums of the firm and the industry based on pairs of U-shaped curves representing average and marginal costs as functions of quantity produced. The long period supply curve for the firm, in particular, was obtained from the envelopment of short run supply curves. This systematic treatment was taken on substantially unchanged in economics textbooks of the subsequent half-century and beyond. In particular it was accepted – together with Clark’s aggregate neoclassical version of the theory of value and distribution – as the central core of the famous textbook Economics (1948a) by Paul Samuelson (b. 1912, Nobel prize in 1970), not only the best selling textbook of the last fifty years (more than three million copies sold in subsequent editions and in numerous translations), but also a model for various other authors

Welfare economics

    Among Marshall’s pupils, two emerged above the others: John Maynard Keynes, to whom the next chapter is devoted, and Arthur Cecil Pigou (1877–1959). Six years older than Keynes and by temper better suited to the university environment, although he was then very young Pigou was chosen by Marshall in 190859 as his successor to the economics chair in Cambridge, a position he held up to his retirement in 1943. Here there is only space to mention three of his contributions: his ‘orthodox’ version of the Marshallian theory of the firmand the industry; his most innovative contribution: the development of the research stream of welfare economics; and his analyses of employment and macroeconomic equilibriums, characterised by his torn relationship with Keynesian theory.

As we have already suggested in, Pigou chose to adopt, within the varied corpus of Marshall’s analysis, the approach that at least seemed better suited to rigorous analytic treatment, that of partial analysis of short and long period equilibriums based on U-shaped cost curves, dropping Marshall’s suggestions for an evolutionary analysis (‘the trees and the forest’). This also provoked some rigorously private reservations on the part of his mentor (cf. Bharadwaj 1989, pp. 159–75) and a growing isolation even with respect to his more strictly Marshallian colleagues, like Robertson and Shove. Despite his active participation in the debate started in 1922 by the publication of an article by Clapham in the Economic Journal, and especially despite his systematic application of Marshallian tools in different fields of analysis, we cannot consider this the field of his main analytical contribution. Though he preceded Viner in utilising a graph with U-shaped cost curves, more important for the systematic construct of the Marshallian vulgata was in fact Viner’s 1931 article mentioned in above.

Pigou’s main contribution is commonly considered to be his recourse to notions of external economies and diseconomies, illustrated by Marshall in the Principles, for the development of a new field of theoretical research: welfare economics. Let us recall that we have external economies (or diseconomies) whenever an economic activity – be it production or consumption – generates indirect effects on third parties, from which they reap a benefit (or a loss), without having participated in the decision of the economic agent directly concerned. For instance, we have a case of external economies when the roses I decide to cultivate at my expense in my garden gladden not only myself but also my neighbours; we have a case of external diseconomies whenever the car I drive pollutes the air and contributes to a traffic jam. When the (assumedly selfish) economic agent decides how much to produce and consume, he or she considers the effects of the action which directly concern him or her, but not the effects on others; this implies that too little is consumed and produced of what generates external economies, and too much of what generates external diseconomies. Hence the desirability of public intervention in the economic field, aimed at stimulating with subsidies the first kind and hindering with taxes the second kind of activity.Welfare economics is precisely the field of analysis which studies the nature and measure of such interventions, aimed at driving the economy towards optimal situations for the community as a whole.

Pigou’s main contribution to this line of research is Wealth and welfare (1912), which in the widely revised second edition took on the title of The economics of welfare (1920). In these writings Pigou systematically used the analytical tool of ‘consumer’s surplus’, proposed by Marshall in the Principles in the context of partial equilibrium analysis. Such a notion designates the gain of total utility obtained by the buyer from exchange thanks to the fact that, while for the last (infinitesimal) dose purchased the price paid corresponds to the additional utility obtained (marginal utility), the utility of the preceding doses was greater than the price paid. The difference between these two magnitudes (assuming that utility is measured in terms of money, under the assumption of constant marginal utility of money), added up for all units purchased, gives the consumer’s surplus. Obviously the choice between different situations is easily derived by comparing the consumer’s surplus realised within the economy in different cases: this is in fact the road taken by welfare economics.

Finally, Pigou was known as the representative of that orthodoxy that Keynes attacked in his General theory. In this work, the critiques to the ‘classical theory’ were indeed aimed at Pigou and his Theory of unemployment (1933). In the debates which followed publication of Keynes’s General theory, too, Pigou’s name was connected to the defence of the idea of re-equilibrating power of competitive markets confronted with unemployment. The idea is that, even when the traditional re-equilibrating mechanism based on the reduction of the real wage rate is abandoned, since it does not work when the reduction in the money wage rate induced by unemployment induces a parallel reduction in the price level, we may resort to the so-called ‘Pigou effect’ or ‘real wealth effect’. This mechanism is set in motion by the effect that the price decline, induced by unemployment through the reduction of money wages, has on the real value of money balances (or balances anyhow denominated in money terms) held by families. The increased value of such balances, hence of the real value of the families’ wealth, induces an increase in consumption, hence in aggregate demand, which leads to reabsorption of unemployment.

Imperfect Competition

   As we have already hinted, the notion of competition within Marshall’s theory was more nuanced – hence less restrictive – than in other marginalist theoreticians, in particular Jevons and Walras. In the theories of these latter, as in the textbook vulgata, perfect competition was that situation in which the economic agent is too small, relative to the dimensions of the market of a clearly defined and homogeneous product, to be able to influence with his behaviour the determination of the price: at the limit, it is necessary to assume that the dimension of each firm, or of each consumer, be infinitesimal compared to the dimension of the market, hence that the number of firms, or of consumers, be infinite. In technical terms, the price is considered an externally given parameter for the theory explaining the behaviour of the individual firm or consumer, while the unknown to be determined is the quantity respectively supplied or demanded. In Marshall’s theory, conversely, many arguments presupposed some degree of freedom for firms in price setting. This margin of freedom of action, which disappeared in Pigou’s and Viner’s vulgata, was present in the evolutionary metaphors with which Marshall illustrated the behaviour of the representative firm, in the attempt to strike a compromise between theoretical rigour and realism.

In the Cambridge school we will find subsequently an analogous notion of competition, for instance in Keynes’s theory (notwithstanding Kahn’s efforts to bring it into the more ‘rigorous’ forms of the vulgata). The main manifestation of a representation of the working of the economic system which left firms some margins of freedom – the price should not necessarily be the same for all firms within an industry – was represented by the theory of imperfect competition, for which the traditional reference is Joan Robinson’s book published in 1933. Behind this book, however, we must recall the long series of contributions which constituted its background.

We might say that the story begins with a famous controversy on the theory of the firm started in 1922 by an article by Clapham, ‘On empty economic boxes’, in the Economic Journal. The ‘empty boxes’ to which Clapham pointed in the title of his article were the categories of increasing, constant and decreasing returns to scale: categories which appeared to be inapplicable to the case of real industries. Among the responses of the orthodox Marshallians (with Pigou in the front line), who occasionally provided novel contributions, and the critical voices who added to Clapham’s criticisms, a contribution by Sraffa published in 1926 came to dominate the scene. The first half of this article summarised the critiques of the Marshallian theory of the long run equilibrium of the firm and the industry under competitive conditions, which had been illustrated in a long essay published in Italian the previous year; the second part proposed a way out of the difficulties by recalling the noncompetitive elements commonly present in reality (and already variously illustrated by Marshall in the Principles), which allow us to consider each firm as endowed with a distinct market of its own within the industry. The imperfect nature of real-world competition allows us to assume that each firm is confronted with a demand curve which is not horizontal, but rather decreasing, so that within certain limits the firm can increase the price of its product without losing all of its clientele (or can decrease it without having to absorb all the demand previously directed to the other firms in the same industry). In a situation of this kind, equilibrium of the firm is possible even in conditions of constant, or slowly decreasing, costs when the quantity produced increases.

 Sraffawas soon to abandon this line of research. However, the notion of competition on which it relied corresponded, as we stated above, to Marshall’s original orientations and to a well established attitude in the oral tradition of the Cambridge school. Thus a view of the way the economy worked which stressed the role of market imperfections resurfaced, for example, in Kahn’s 1929 fellowship dissertation (The economics of the short period), which remained unpublished at the time and was published only recently, first in Italian in 1983, then in English. The same direction was perhaps taken by Gerald Shove (1888– 1947) who, however, published only two articles, one in 1928 and a contribution to the 1930 Economic Journal symposium on the Marshallian theory of the representative firm. Robinson’s 1933 book thus represented the point of arrival of a line of research to which various representatives of the Cambridge school had contributed. By utilising an analytical tool commonly attributed to Kahn, the notion of marginal revenue, Joan Robinson provided a vulgate of the theory of imperfect competition, in which static equilibrium is determined, for the short and the long run, the firm and the industry. Joan Robinson’s book remained within the traditional Marshallian framework, relying on the notions of the firm and the industry. The work by Chamberlin62 on monopolistic competition, published in the same year and commonly placed side by side with that of Joan Robinson, constituted instead a different contribution on important accounts. In stressing the margins of freedom enjoyed by each firm because of the widespread presence of market imperfections, Chamberlin remarked that in this way the very notion of industry loses meaning, since its boundaries had been established artificially on the basis of the assumption of homogeneity of the product of firms included in the same industry. In the place of groups of firms (the industry) producing an identical commodity, we now have a continuum of qualitative variations among products of different firms. In this sense, Chamberlin’s contribution (as was to be better shown by a subsequent contribution by Robert Triffin, 1940) represented a shift in the direction of the modern axiomatic theory of general economic equilibrium, in which each economic agent represents a case by itself.

Marshall’s Heritage in Contemporary economic thought

    Marshall had an exceptional impact on the development of economic thought, stronger than is commonly recognized. The reason for this under-valuation is that his contribution embraced two distinct if not opposite streams of economic culture. On the one side, the Marshallian vulgata still played in the second half of the twentieth century, and often still plays today, a central role in basic economic instruction in secondary schools and undergraduate university textbooks, with an impact which is felt not only in the theory of prices (equilibrium of the firm and the industry) but also in collateral disciplines, from industrial economics to public finance. With its apparent greater generality and rigour, the general economic equilibrium approach, despite frequent references, often remained in the background, due to its sterility for concrete applications.

On the other side, the Marshallian approach to economic development as an evolutionary process, its nuanced notion of competition and the attribution to monetary disturbances of a key role in determining the cyclical swings of the economy, constituted a strong call for important streams of contemporary thought, intermediate between heterodoxy and orthodoxy.

Apart from references to Schumpeter, indeed, it was to Marshallian evolutionism that theories of the firm like those by Nelson and Winter (1982) referred; these theories considered the firm as an organism whose genes consist in a set of routines. Technological progress takes place, according to such theories, through substitution of old routines with new ones, more adequate to the tasks of the firmand the environment in which it operates. The spreading of such routines then takes place through a mechanism of spreading and selection, in which latecomers are doomed to succumb. (Once again, the reference here was more to Lamarck’s genetic theories than to Darwin’s: exactly as had already happened for Marshall, through the intermediary of Spencer’s sociology.) This approach had an important role in bringing attention to dynamic processes and technological change63 with a wealth of empirical research. However, at the theoretical level it remained trapped in the same blind alley in which Marshall had found himself. Indeed, the promises of a vague conceptual apparatus, which precisely because of its imprecision seems ready to take into account different aspects of the process of economic development, cannot be kept when one seeks to formalise in rigorous models a theoretical approach which tried to circumvent the need for a frontal critique of the neoclassical notion of equilibrium and the tradition of which this notion is a constituent element.

As for the Marshallian notion of competition, the idea of economies of scale external to the individual firm but internal to the industry (or rather to a local industrial system) found an important outlet in the recent flourishing of studies on local economies, in particular on the notion of the industrial district, already hinted at in Marshall’s work. In this case too, however, apart from throwing light on the concrete importance of a particular form of territorial aggregation of small and medium firms and on the factors which favour them, the theory of the industrial district did not manage (nor did it aim) to develop an analytical apparatus endowed with sufficient generality to allow a theory of prices and distribution to be built on top.

Finally, in so far as monetary theory is concerned, Marshall’s influence was flanked by similar influences from other theoretical streams, such as the Austrian one of Wicksell and Hayek, who also sought an explanation for cyclical phenomena and unemployment in monetary ‘disturbances’. Thus reinforced, the impact of the Marshallian monetary tradition on economic culture was very strong, but the main result was to favour sterilisation of Keynes’s theory within the so-called neoclassical synthesis which, as we shall see below, tried to render compatible the long period equilibrium of traditional marginalist theory on the one side with the cyclical swings and unemployment on the other, relegating the latter to the short period.

On the whole, therefore, the undoubted conceptual richness of Marshall’s thought had a far-reaching, lasting impact on economic thought, with important ramifications which persist in contemporary economic thought. However, the problem which Marshall himself had encountered remains unsolved: that of translating such an intrinsically dynamic conceptual apparatus into theoretical models which, linked to the marginalist tradition, remain based on the irremediably static key concept of equilibrium between demand and supply.

The Theory of Demand 

Utility and Demand  

    Marshall based demand on utility, lauding Jevons’s work on the theory of marginal utility. His translation from utility to demand was informal, but nevertheless shows that Marshall thoroughly understood the issue. Unlike Jevons, Marshall did not believe that marginal utility was the most important determinant of value. Marshall placed more emphasis on costs of production, following Ricardo in this.  

Demand Schedules and Curves:

   Marshall carefully laid out the concept of a demand schedule, used it to draw a demand curve, then derived the law of demand: “Thus the one universal rule to which the demand
curve conforms is that it is inclined negatively throughout the whole of its length.”  

Price Elasticity of Demand:  

    Marshall recognized that the slope of a demand curve was an inappropriate measure of the sensitivity of price to changes in quantity (as he put it, price being the dependent variable in Marshallian economics). A change in the units of measurement changes the slope of a demand curve, without changing the true relationship between price and quantity demanded. Since the demand curve is always negatively sloped, the elasticity measure is negative. However, by convention the negative sign is dropped.

The Theory of Production  

    Marshall conceived of four different periods of production. The market period is a period so short that the quantity of output brought to market cannot be altered except by sale or destruction. In the market period, the supply curve is perfectly inelastic. In the short run, some but not all factors of production can be varied. In the long run, all factors of production are variable. In the secular period, even technology and population are variable.  

Laws of Return in the Short Run

    Law of diminishing returns, Marshall worked this out for agriculture, following the classical tradition. He understood that the addition of any variable factor to a fixed factor of production leads to diminishing marginal returns, however.  

   Principle of substitution, A firm maximizes its profit by minimizing the cost of production of any given output. To minimize costs, the firm should substitute cheaper for more expensive inputs. The optimal input combination represents an application of Gossen’s second law to production theory. Combine inputs so that factor demands are derived from the marginal revenue products of factors. The quantity of a factor demanded is determined by equating MRP to the factor price. Marshall’s marginal productivity theory was mainly a theory of factor demand; it served as a theory of income distribution only in the short run.

Laws of Return in the Long Run  

   Marshall identified three possible patterns that might result as an industry expands in the long run: constant returns, increasing returns, and diminishing returns. His theory of returns to scale was tied closely to the concepts of external and internal economies. External economies result from “the general progress of the industrial environment” and enable all firms in an expanding industry to experience decreasing costs. Better transportation and marketing systems and improvements in resource-producing industries might produce external economies. Internal economies are gained by a particular firm as it enlarges its size to achieve greater advantages of large-scale production and organization. Increasing returns to scale that are internal in origin can lead to the monopolization of markets, as large firms develop lower cost structures than smaller firms, driving smaller competitors out of business. External economies are not, however, anti-competitive. Marshall believed that limits to internal economies existed, that managerial and organizational problems would eventually lead to internal diseconomies that would increase costs. Therefore, he believed that long-run increasing returns were likely to be caused by external economies.
Costs of Production and Supply  

    Marshall examined both the real and money costs of production. Real costs derive from the disutility of labor and abstinence. Money costs derive from the necessity of paying a price that will “call forth an adequate supply of the efforts and waiting that are required” to produce goods and services. Included in the money cost of production is a normal rate of profit that is earned by entrepreneurs to repay them for the effort and waiting of the labor of enterprise.
Prime cost — variable cost.  

Supplementary cost — fixed cost.

Diminishing Returns and Short-Run Cost Behavior:  

     Marshall understood that profit maximization requires producing where MR = MC. In the presence of diminishing marginal productivity, this implies producing on the upward-sloping portion of the marginal cost curve. Industry supply curves are summations of individual firms’
supply (MC) curves, hence are positively sloped in the short run.

Long-Run Cost and Supply Curves:  

     In the short run all factors of production are in relatively fixed supply. The incomes earned by these factors are determined by the interaction of demand and supply. Demand for factors derives from marginal revenue product. Hence, if supply is perfectly inelastic, marginal productivity determines factor payments.  The price received for a factor in the short run may not equal the cost of reproducing the factor. If the price is above the cost of production, the factor earns a quasi-rent. This is the excess above what is required to induce factor suppliers to produce additional units of the factor. Quasi- rents tend to be eliminated in the long run by competition.
Marshall carried out his long-run analysis in terms of a representative firm. Such a firm “has had a fairly long life, and fair success, which is managed with normal ability and which has normal access to the economies, external and internal, which belong to that aggregate volume of production.” Marshall examines the long-run industry supply curve by referring to the costs of the representative firm. Marshall believed that competition and internal diseconomies would prevent individual firms from becoming unduly large over time. In his view, an expansion in industry output over time was accomplished by adding more firms to the industry, rather than by initial firms growing larger.  

Theory of Price Determination:

    Although Marshall was not the first to draw demand and supply curves and use them to determine equilibrium price and quantity, he nevertheless is regarded as the pioneer in their use. Marshall claimed to be developing the Ricardian tradition, and in a sense he was. Unlike Jevons, Marshall placed appropriate emphasis on cost of production as a determinant of supply and hence of price. However, he went far beyond Ricardo in his treatment of demand, basing it on utility as had Jevons. Ricardo understood that market prices are determined by demand and supply, but he failed to analyze demand in a thorough manner.

Marshall argued that the role of demand in price determination was greater in the short run than in the long run. In the market period, demand determines price (and thus marginal utility determines price), because the quantity supplied is inelastic. In the short run, the supply curve is positively sloped, so marginal utility and marginal cost each have a role to play. In the long run, price equals marginal cost. If returns to scale are constant, marginal utility plays no role in price determination. Of course, it continues to play a role if returns are increasing or diminishing.

Prices That Deviate from Cost of Production  

Marshall examined two other cases (besides the market period) in which demand determines price. The first is the case of joint production. When two products are jointly produced, it is impossible to determine the marginal cost of either product in isolation. For
example, the production of beef and cattle hides is joint production. The price of a particular joint product is governed, even in the long  run, by the relative intensity of market demand rather than by cost of production. Whenever a change in the demand for one joint product induces a change in their joint supply, their prices vary inversely with one another.
Marshall’s third case of demand-determined price is the case of monopoly. A profit-maximizing monopolist equates marginal revenue with marginal cost, as Cournot understood. Marshall discussed the issue in terms of demand price and supply price, but reached the same conclusion. Marshall argued that monopolists attempt to maximize monopoly net revenue. They do this by subtracting the supply price from the demand price; the difference is monopoly net revenue. The object is to select the volume of output that, given the demand for the product, maximizes aggregate net revenue. Graphically, the triangle defined by the price axis and the marginal revenue and marginal cost curves (which Marshall concentrated on) equals the rectangle defined by the difference between price and average cost multiplied times quantity (which Cournot concentrated on).  

Consumer Surplus:  

Jules Dupuit discovered the concept of consumer surplus before Marshall was born. However, Marshall gave the concept its name and applied it to more problems than Dupuit did. Marshall defined consumer surplus as the monetary value of the utility a consumer gains when the price at which a good can be purchased is lower than the price an individual would pay rather than go without it. When the price of a product changes, the change in the consumer surplus is measured in terms of a sum of money that will offset the gain or loss  resulting from the price change. Marshall used the concept to analyze the welfare effects of taxes and subsidies.
Two problems reduce the usefulness of consumers’ surplus. First, applying the concept to a market demand curve requires interpersonal utility comparisons, an impossibility. Second, changes in market price also change real income. Unless the marginal utility of income is constant, the effect on an individual’s utility of a price change is uncertain. Marshall combatted the second problem by applying the concept only to products whose purchase was a minor part of an individual’s budget, thereby limiting the income effect.  

Pricing Productive Factors:  

The prices in factor markets are at the same time costs of production to entrepreneurs and incomes to the factors. Marshall tied value theory to distribution theory by working out a theory of factor pricing linked to final product markets.  Demand for factors is derived demand. It is based on the marginal revenue product of factors. The market demand curve for a factor is less elastic than an individual firm’s demand curve, because an increased supply of final output reduces the price at which the output sells, thereby reducing the marginal revenue product of factors. Mathematically, in a competitive market a firm’s demand for factor inputs is MPPP, where P is taken as given by the firm. The market factor demand curve is MPPMR, where MR is declining as output increases. IvIRP declines because IVIPP falls as output rises anyway. When MR also falls, MRP falls more sharply yet.  Marshall treated supply of productive factors much as he treated supply of final output. In the short run, the supply of factors is highly inelastic. As a result, the factors may earn quasi-rents. However, there exists a “reflux influence of remuneration” that operates to increase the quantity of a factor supplied over time if positive quasi-rents are earned in the short run. Labor moves into those specialties which pay better. Capital flows into the types of production that are most remunerative.

Marshall’s theory of factor supply and his focus on individual markets led him to reevaluate Ricardo’s theory of rent. Ricardo had argued that rent is price-determined rather than price-determining. Price is determined by the cost of production of food on marginal land that pays no rent. The excess earnings on better-quality land (rent) are determined by the price. Marshall showed that for individual entrepreneurs, who could use land for a variety of purposes, rent is a cost of production. Land has alternative uses and will be used in an income-maximizing manner. Rent is thus a competitive price that must be paid to acquire a factor of production.
Marshall distinguished between interest and profit. Interest is earned on capital. The interest rate is determined by the demand for and supply of loan able funds. Profit is the remuneration for enterprise, the organization and management of production. Firms earn only normal profits in the long run, since excess profits attract competitors who drive down market price and reduce profitability.

Major Books of Alfred Marshall

- A Plea for the Creation of a Curriculum in Economics and Associated Branches of Political Science, 1902

- Economic Teaching at the Universities in Relation to Public Wellbeing, 1902

- The Economics of Industry, with Mary Paley Marshall, 1879

- Elements of the Economics of Industry, 1892

- Industry and Trade, 1919

- Introduction to the Tripos in Economics and Associated Branches of Political Science, 1906

- Money, Credit and Commerce, 1923

- National Taxation After the War, 1917, in Dawson, editor, After-War Problems

- The New Cambridge Curriculum in Economics, 1903

- Preface, 1885, in W. Bagehot, Postulates of Political Economy

- Preface, 1887, in L. Price, Industrial Peace

- Presidential Address before the Co-operative Congress, 1889

- The Present Position of Economics, 1885

- The Pure Theory of Foreign Trade, 1879

- The Pure Theory of Domestic Values, 1879

- Principles of Economics: an introductory text, 1890 - (Books 1 to 6; French 1906 transl.: Vol.  

  1, Vol. 2)

- Some Aspects of Competition, 1891, Report of British Association for Advancement of

  Science

- Where to House the London Poor, 1884, Contemporary Review

Major Articles of Alfred Marshall

- 1872, Mr Jevons's Theory of Political Economy, Academy

- 1874, A Note on Jevons, Academy

- 1874, The Future of the Working Classes, Eagle

- 1876, On Mr. Mill's Theory of Value, Fortnightly Review

- 1881, Review of F.Y. Edgeworth's Mathematical Psychics, Academy

- 1885, On the Graphical Method in Statistics, Jubilee Volume of Royal Statistical Society

- 1887, Remedies for Fluctuations of General Prices, Contemporary Review

- 1892, The Poor Law in Relation to State-Aided Pensions, EJ

- 1893, On Rent, EJ

- 1897, The Old Generation of Economists and the New, QJE

- 1898, Distribution and Exchange, EJ

- 1898, Mechanical and Biological Analogies in Economics, EJ

- 1907, The Social Possibilities of Economic Chivalry, EJ

Summary

The broad view of the economy suggested by the foregoing is of a complex evolutionary process of combined economic, social and individual change in which each individual's abilities, character, preferences and knowledge develop jointly, along with social institutions, markets and the technologies of production and communication. The pursuit of self interest, broadly conceived, is ubiquitous in directing this evolutionary process, but is subject to inertia, ignorance and limited foresight, not to mention individual mutability.

    Unfortunately, Alfred Marshall was able to bring little formal analysis to bear on this general 'biological' vision of the economy and could only evoke it descriptively. It might be true that 'the Mecca of the economist lies in economic biology rather than in economic dynamics' (1920, p. xiv). Nevertheless, the only available tools were those of classical mechanics, tools which Marshall's early mathematical training had equipped him to employ skillfully. In fact, chief reliance had to be put on that branch of classical mechanics dealing with statics. Dynamics, beyond a few qualitative applications, required more precise information than was likely to be available. Perforce then, much of Marshall's formal analysis, like that of W.S. Jevons or Leon Walras, was based on simple assumptions of individual optimization and market equilibrium, which took preferences, technology and market institutions for granted. Such provisional or tentative 'statical' treatments could often be valuable. Indeed Marshall viewed them as indispensable for the correct analysis of many questions. But he was always anxious to stress that the analysis was preliminary, and perhaps of only transitory validity. This awareness made him impatient of over­elaboration, so that, for example, he showed no interest at all in pushing the statical approach to its logical conclusion in the general equilibrium analysis of the stationary state. For him, equilibrium analysis was an indispensable but rough and ready instrument which needed to be employed with due caution and a continuing awareness of its limitations in the face of a complex ever-evolving reality. It was a tool and did not itself constitute concrete knowledge.

  Alfred Marshall had no great profundity as a philosopher of science and had little patience with metaphysics. His discussions of methodology largely reflect the philosophical presuppositions of his day. His method was in the general deductive tradition of David Ricardo, John Stuart Mill and CAIRNES. But he sought to emphasize the relativity of particular theories, as contrasted with the universality of the general theoretical 'organon' or toolbox. And he was anxious to choose his assumptions with close regard to the facts of the case: anxious, too, to keep prominently in mind potential disturbing causes and to make due allowance for them. Marshall's method was described by John Maynard Keynes as 'deductive political economy guided by observation' (1891, p. 217n.) and Keynes's chapter 'On the Deductive Method in Political Economy' (1891, pp. 204-35) is perhaps as good a rationalization of Marshall's method as one can find.