Neoclassical Economics: The School Born From the Marginalist Revolution

Value, according to the classical economists

Before the marginalist revolution, the value of a good was explained by looking at how it was made. According to the academic site The History of Economic Thought, classical economists tied natural prices, the equilibrium prices of the long run, mainly to relative production costs, and in particular to relative labor costs. The reasoning started from the supply side: what it costs to make a good decides what it is worth.

Jevons and Menger reverse the chain

In 1871 William Stanley Jevons published the Theory of Political Economy and turned that reasoning around. According to the HET site, in his construction production cost sets how much gets supplied, supply sets the final degree of utility, and that degree of utility, not the cost, sets value.

That same year, Carl Menger reached a similar conclusion by a different route. For Menger, value is not a property that belongs to goods; it is the importance people place on meeting their own needs — a good is worth something because it serves someone.

A practical example: faced with a rising price, a classical economist asks first how much it cost to produce that extra unit of the good. A marginalist economist asks the opposite question: how much is one more unit, for the person buying it, worth on top of what they already have. The same question gets different answers depending on the good and on who wants it, and that very variability is what Jevons and Menger set out to explain in 1871.

Walras and general equilibrium theory

Léon Walras reached the same turning point three years after his two colleagues, in 1874, with the Éléments d’économie politique pure. He calls what is now known as marginal utility “rareté,” and defines it as personal and subjective. What sets him apart from Jevons and Menger is the framework: the HET site calls him the father of general equilibrium theory, because he alone set the new theory of value inside a complete formal system, one where the prices of every market are determined together. The same source reports Joseph Schumpeter’s judgment that Walras was “the greatest of all economists” — Schumpeter’s own opinion, not a verdict shared by every historian of economic thought.

Marshall’s synthesis

In 1890 Alfred Marshall proposed a synthesis of the two readings. His construction, according to the HET site, runs like this: utility sets how much must be supplied, the quantity to be supplied sets the necessary production cost, and that production cost sets value. It is the same chain as Jevons’s, read backward, and the source calls it a “textbook synthesis,” one that carried neoclassical theory to an audience far wider than specialists. The supply-and-demand diagram that comes out of it is the same one microeconomics textbooks use to introduce the subject.

Where neoclassical economics ends

Neoclassical economics, in the form Jevons, Menger, Walras and Marshall gave it between 1871 and 1890, is a theory of value and prices. It should not be confused with “New Classical economics” (sometimes framed as neo classical economics), a separate and more recent school: according to Econlib, the New Classical economists argue with Keynesians in the twentieth century, and hold that even the labor market adjusts quickly on its own, clearing shortages and surpluses, to the point that business cycles can be efficient.

On that ground, the state’s role during expansions and recessions, the same source describes a different position: many Keynesians, though not all, favor an activist stabilization policy to reduce the swings of the business cycle. That is a later debate, and one about managing aggregate demand rather than about the theory of value. The Recap on Keynesianism picks up that chapter.