Marginalist Revolution

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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

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 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 added by the utility of one additional unit of a good or service) of a pound of diamonds exceeds the marginal value of a pound of water.

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 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 .

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Bibliography

• HEINRICH, David J. The Marginalist Revolution (lecture 2 of 34). In: Ludwig von Mises Institute website

• TUBARO, Paola. Doctoral dissertation. The Origins of Mathematical Economics: Calculus and Price Theory. Joint Doctoral Program, Université Paris X – Nanterre (France) and J.W. Goethe-Universität Frankfurt am Main (Germany).