Neoclassical

William Stanley Jevons

1. William Stanley Jevons argues that economic value is determined by marginal utility, meaning the value of a good depends on the satisfaction gained from the last (additional) unit rather than total usefulness.

2. As consumption increases, the final degree of utility (marginal utility) declines, so each extra unit of a good gives less additional satisfaction than the previous one.

3. Because of diminishing marginal utility, people are willing to pay less for additional units, so market value is determined by marginal rather than total utility, resolving puzzles like water being cheap and diamonds expensive.

4. Consumers allocate their spending according to the equimarginal principle, meaning they distribute income so that the last unit of money spent on each good gives the same marginal satisfaction.

5. Labour is treated as disutility, so workers continue working only until the marginal utility of income earned equals the marginal disutility (fatigue) of extra effort.

6. Jevons treats utility as cardinal (measurable), meaning it can be quantified and compared across units, not just ranked.

7. Overall, value and exchange ratios depend on marginal utility at the margin, not total utility, forming the basis of modern consumer theory and mathematical economics.

Carl Menger

1. Carl Menger argues that value is subjective, meaning goods have no intrinsic value; they only matter because people believe they can satisfy human needs.

2. Value is determined at the margin, specifically by the importance of the least urgent need satisfied by the last available unit of a good, so as quantity increases, marginal value falls.

3. This explains exchange value: abundant goods satisfy less urgent needs at the margin (low value), while scarce goods satisfy more important needs (high value), resolving the water–diamond paradox.

4. Individuals allocate goods across different uses according to a ranked hierarchy of needs, ensuring that the marginal unit of each good goes to uses of roughly equal importance.

5. Menger distinguishes first-order goods (consumer goods that directly satisfy needs) from higher-order goods (inputs like labour, land, and machinery used in production).

6. The value of higher-order goods is imputed backward from the value of the consumer goods they help produce, meaning production factors derive their value from final consumer demand.

7. This creates a causal chain: human needs → value of consumer goods → imputed value of production factors → factor prices in the market.

8. Unlike Jevons and Walras, Menger develops marginalism using a verbal, logical-causal method rather than mathematics, focusing on real-world causal relationships rather than formal models.

9. Overall, his system unifies consumption and production by grounding all economic value in subjective human needs and marginal utility at the final point of consumption.

Léon Walras

Walras argues that the economy is a system of interconnected markets in which the price of every good depends on all other prices, incomes, and production conditions, so no market can be analysed in isolation.

Because consumers maximise utility and firms maximise profits simultaneously across all markets, the entire economy can be represented as a system of equations.

Under perfect competition, where all agents are price takers, there exists a set of prices at which supply equals demand in every market at the same time—general equilibrium. Through the process of tâtonnement, an auctioneer adjusts prices upward when demand exceeds supply and downward when supply exceeds demand, with no trade occurring until equilibrium prices are reached. The result is a system-wide equilibrium in which decentralized decisions are coordinated through prices, making the economy an ordered and interconnected whole.

Alfred Marshall

1. Marshall argues that price is determined jointly by demand and supply, where demand reflects consumers’ marginal utility and supply reflects firms’ production costs, so neither side alone can explain market prices.

2. Like the two blades of a pair of scissors, both demand and supply are necessary to determine price and quantity. However, their relative importance depends on time:

short run: some factors of production are fixed, so supply cannot adjust much and changes in demand mainly affect prices,

long run: firms can expand, enter, or leave markets, causing production costs and supply conditions to become the main determinant of the normal price.

To analyse how markets respond to changes, Marshall introduced elasticity, which measures the responsiveness of demand or supply to price changes, and consumer surplus, which measures the benefit consumers receive from paying less than they are willing to pay. Unlike Walras, who studied all markets simultaneously, Marshall used partial equilibrium analysis, examining one market at a time while holding other conditions constant, creating a practical framework for understanding how prices are determined in real-world markets.

The neoclassical macroeconomic model

1. The neoclassical macroeconomic model is a static general-equilibrium system with four interlinked markets: labour, goods, bonds, and money, where all markets clear through flexible prices and wages.

2. The labour market determines the real wage and full-employment level of employment; any unemployment is voluntary because the wage adjusts to clear the market.

3. Given employment and fixed capital/technology, the production function fixes output at its full-employment level, meaning output is a function of E and K.

4. The goods and bond markets jointly determine the real interest rate, which adjusts so that saving equals investment (and ensures total demand matches full-employment output).

5. The money market determines the price level, where a fixed money supply meets transactions demand for money, making prices proportional to money supply and inversely related to output.

6. Once the price level is set, all nominal variables (including money wages) are determined residually from real variables (output, employment, interest rate, capital) multiplied by prices.

7. This structure reflects the classical dichotomy: real variables (output, employment, real interest rate) are determined independently of money, while money only determines nominal magnitudes.

8. As a result, money is neutral, meaning changes in the money supply affect only the price level and not real output, employment, or the real interest rate.

9. Fiscal policy cannot raise output because the economy is already at full employment; instead it raises the real interest rate and crowds out private investment one-for-one.

10. Overall, the model implies a self-adjusting full-employment economy, where markets automatically clear and policy interventions only change prices or the composition of spending, not real output.