Pure economic theory
Pareto’s contributions to pure theory during this initial stage were significant, although modest in comparison to his subsequent achievements, and primarily fell within the areas of consumer theory and the pure theory of distribution.
In regard to the former, his contribution was largely positive in the sense that it culminated in an enhancement of demand analysis. In regard to the latter, his contribution was largely negative in the sense that it culminated in a rejection of the strict marginal theory of productivity and distribution. Importantly, he also extended Walras’s analysis based on free competition to cover the case of monopoly.By way of context, it should be noted that at this stage in his academic career, Pareto adopted the then prevailing practice of using cardinal valuations. His introduction of terms like ophelimity and homo wconomicus when framing pure theory, as outlined above, was not motivated by a desire to introduce ordinal preference rankings in pure theory and his early contributions to consumer theory, as reflected in his “Considerazioni” (1892-93 [2007]), are best seen in that light. He addressed the issue of demand based on two main assumptions: first, that an individual’s final degree of utility (in 1892-93 Pareto used Jevons’s phrase) from the acquisition of a good is a function of the quantity of that good only; and second, that Daniel Bernoulli’s general theorem, concerning the diminishing final degree of utility, is valid. Pareto was of the view that people only have a clear perception of variations in utility from the prevailing existing social state and he appreciated that total utility may not exist when economic values are path dependent. These assumptions were important to him as they were a deliberate simplification from which he could consider the consequences for the demand relationship when the final degree of utility diminishes in a manner that was independent of the consumption of other goods.
He was also motivated to consider this relationship in light of his newly acquired understanding of Walrasian interdependence, as he employed comparative static analysis to derive a downward sloping demand curve without resort to Marshall’s practice of keeping marginal utility constant for the economic good that serves the function of money. In the process of this demonstration, Pareto introduced Hessian determinants to economic analysis. This work on consumer theory also has an important legacy, as Pareto’s solution to the downward sloping demand curve became the basis from which Slutsky developed his analysis of consumer demand to isolate the income and substitution effects (Chipman 1976; Dooley 1983; Weber 1999).Pareto also undertook extensive investigations of the potential functional forms that can show variations in the final degree of utility that are consistent with theory and observation, including the specification of a logarithmic utility function with the main characteristics of the Cobb-Douglas utility function (Weber 1998). Pareto subsequently summarized his early contributions to consumer theory in the Cours, although in a less extensively developed manner as that book was intended as a textbook for students at the University of Lausanne and he adopted Marshall’s practice of limiting mathematical formalization to the footnotes.
Pareto’s contribution to the pure theory of production and distribution has its genesis in his landmark paper “Il Massimo di utilita dato della libera concorenza” (Pareto 1894b [2008]), where variable coefficients of production were introduced to the mathematical formalization of Walras’s theory for the purposes of applying that theory to an investigation of the welfare consequences of varying the combination of productive services used in the production of consumer goods. Pareto does not explicitly discuss the distributional implications of minimizing his unit cost equations for distribution theory, but marginal properties are implied by the cost minimizing conditions he identified.
In the Cours, however, Pareto largely rejects the marginal theory of production and distribution. Henry Schultz (1929, 1932) and John Hicks (1932a, 1932b) subsequently entered into an insightful, albeit heated, debate on the extent to which Pareto abandoned marginal productivity theory. Pareto’s stated concern with the marginal theory of distribution was related to the need to account for the use of both fixed and variable coefficients of production, which served to constrain the capacity for substituting productive services. In addition, he recognized that interdependence between coefficients of production can also influence production and distribution. However, he was not motivated by a desire to interrogate the mathematical properties of production equations and functions. Rather, it was a reflection of a more basic view that the general parameters of distribution are largely established by historical conditions, which gives some context to his empirical study of the distribution of income over very long periods of time. Consequently, to the extent that his approach to production accommodates the marginal theory of production, it appears to be regarded by Pareto as limited to the static space around local equilibrium. It should be noted that Pareto’s contribution to this issue also persuaded others of the limits of marginal production theory and influenced Enrico Barone and Philip Wicksteed in their decisions to abandon that theory (Schultz 1929; Dorfman 1964).
Finally, the Cours is important for recognizing that Walras’s general equilibrium system need not be limited to the state of free competition. Pareto formally introduced the theory of monopoly to general equilibrium, in which the equilibrium profit is not zero, as in the case of free competition. This laid a foundation for subsequent discussion in the Manual concerning strategic behaviour aimed at altering prices.