History of Economic Thought FINAL

Creative destruction (Schumpeter)

"Creative destruction" means a process in which old players or ways of doing things are eliminated very quickly while new players and new ways of doing things are established. "This creative destruction, he believed, caused continuous progress and improved standards of living for everyone." "Creative destruction" is a powerful economic concept since it can explain many of the dynamics of industrial change: the transition from a competitive to a monopolistic market and back again. In a broader sense, creative construction represents his prediction that Capitalismʼs success will finally make entrepreneurship unsuitable, and eventually socialism will replace capitalism.

Socially necessary labor (Marx)

"The labor-time socially necessary is that required to produce an article under the normal condition of production, and with the average degree of skill and intensity prevalent at the time." Additionally all labor is reduced to differing durations of low intensity, simple, unskilled labor

John Stuart Mill (Bio)

- Family • Dad is a political economist/philosopher, tries to raise him as the smartest human being possible • He learned to read and translate Latin by the age of 4, dad also tried to teach Calculus • Tutored siblings on his knowledge, best way to know something is to be able to teach it to others • Believed everyone comes into the world with a blank slate, and you accumulate knowledge - Life • Has a nervous breakdown at age 20 • Meets Harriet Taylor and marries her, has influence on his ideas for his work "On Liberty" (suffrage) - History of 19th century England Liberalism - Context of Utilitarianism • Father was a big proponent of Bentham

Walras

- General equilibrium (interdependence of markets) - How can complicated general equilibrium equations be satisfied simultaneously? "tatonnement" process, concept of auctioneer - Circular flow, introduce production into system - One of the first to develop marginal analysis Interaction as n agents change consumption choices - m goods and n agents U (x1, x2,....xm) - MUxj/Pxj - Trade units of goods until they reach an equilibrium where MU/P is equal across all agents and all goods - Also MUxj/MUxk = Pj/Pk

Manipulation of workers (Marx)

- Lengthening working day - Increasing intensity of work / responsibilities / technology - Pay cuts

Circular flows (Schumpeter)

-------------------- Labor/Capital ----> Households -------------------------- Firms <-----------------------Wages------------ ------------Goods/Services------> Firms ------------------------------ Households <-----------------------Cash----------- Long run steady state equilibrium

Three categories of unemployment (Keynes)

1) Frictional unemployment 2) Voluntary unemployment 3) Involuntary unemployment (omitted mostly by classical economists but emphasized by him)

Keynes equilibrium

AD = AS "I define the marginal efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price."

Commodities and money (Marx)

All commodities take labor to produce. "Abstract from use-value, there remains value in goods. Exchange value is the only form in which the value of commodities can manifest itself or be expressed." Magnitude of value = duration of socially necessary labor Use value does not guarantee value (air, meadows, etc.) No use value = no value, even if labor involved Value isn't realized until it is exchanged

Theory of supply & production over time (Marshall)

Application of Time and Ceteris Paribus analysis (case of fish market) • Immediate (vertical): Responding to shock price adjusts • Short Run (upward sloping): Adjustment of demand • Long Run (horizontal): Long run shocks Definition of time as a functional concept rather than a chronological concept

Monopoly (Schumpeter)

Argued that some monopoly is preferred to perfect competition. Competition from innovations is more important than "perfect competition". His view on monopoly is shared by a lot of current economists. This is why we allow companies keep their secret, patent, etc.

Marx (Bio/Context)

Born Post-Napoleonic War, Pre-Unification of Germany o Political Instability o Economic Pamphlets unhelpful to government trying to rebuild Marx got censored Beginning of industrialization (England, Belgium, Netherlands, then northern Germany) o Have to have coordination in factory setting o Capital Owners - Exploitation Involves imposition of hierarchy Discipline/Coercion 1848: Year of Revolutions o Germany, Austria-Hungary, France o Marx was a part of this 1849: Government exiles Marx

C-M-C

Capital-generating Make a commodity, sell it, and buy more commodities or inputs to keep producing

Goods market (Keynes)

Concept of effectual demand (aggregate demand): AD = consumption + investment + government spending MPC+MPS=1 MPC = ∂c / ∂Y MPS = ∂S / ∂Y 1/MPS is the multiplier, it measures how much output can be increased given one more unit of saving ( or investment) IS - LM model (suggested by Hicks) Notice that we are dealing with closed economy in most our fundamental economic model. Fiscal policy: trying to balance budget in bad times is stupid and dangerous.

Joint production (Mill)

Cow/beef/hide illustration (Qb:Qh) The issue is how to allocate the costs to each of the two products that the one input generates. In the case where goods are produced jointly in fixed proportions, the equilibrium price of each product must be such as to clear its market, subject to the condition that the sum of the two prices equals their (average) joint costs.

Growth, change, entrepreneurship (Schumpeter)

Economic growth is driven by change: (1) creation of a new good or new quality of good (2) creation of a new method of production (3) the opening of a new market (4) the capture of a new source of supply (5) a new organization of industry In early times he viewed individual entrepreneurs as the key players; later he viewed that big companies play bigger roles in entrepreneurship as they can invest heavily in research and development. There is difference between inventions and entrepreneur innovations.

Derived demand (Marshall)

Face different demand curves in different markets, but supply curve is from one input For intermediate goods (ex: bread), the demand in their markets is derived from the original input (ex: flour) Market for knives -> demand for knives -> demand for handles and blades • Demand side factors determine prices Ultimate final price of knife reflects production costs • Quantity of knives determine quantity of handles Understand the picture in his Chapter, p. 372

Lower order goods (Menger)

Finished products

Menger (Summary)

Goods do not have intrinsic value Derived demand from goods satisfying wants (subjective) Mutually beneficial trade (middlemen important)

Involuntary unemployment (Keynes)

He claimed that according to Say's Law, involuntary unemployment cannot exist due to inadequate aggregate demand. It is nominal/money wage rigidity that causes involuntary unemployment under equilibrium Itʼs bad idea that we should allow wage to fall itself as time goes by, since the expectation of wage reduction will cause output contract, and finally economy might enter into recession. Government should interfere whenever it finds wage is above market clearing level and there is involuntary unemployment.

Reciprocal demand (Mill)

He combines cost and demand together to decide the international exchange ratio and terms of trade. Develop goods that we are hoping to supply, then we want to trade these goods for goods we demand International Demand - Demand comes from willingness to pay - Export value, import value

Diminishing marginal utility (Jevons)

He formulated this law. He recognized that the laws of supply and demand (which JS Mill had already advocated should be analyzed separately) can be deduced from the principle of marginal utility he had articulated. BUT he failed to make the concepts of supply and demand fully operational. (Marshall did this)

Hayek's normative political economic theory

In the latter half of his career he made a number of contributions to social and political philosophy, which he based on his views on the limits of human knowledge, and the idea of spontaneous order in social institutions. He argues in favor of a society organized around a market order, in which the apparatus of state is employed almost, though not entirely, exclusively to enforce the legal order (comprised of abstract rules, and not particular commands) necessary for a market of free individuals to function. These ideas were informed by a moral philosophy derived from epistemological concerns regarding the inherent limits of human knowledge.

Wages fund doctrine (Mill)

Initially agrees, then recants this idea. He argues for long run stationary state because of diminishing returns and falling incentive to invest. He thinks the stationary state may not be bad. Once it is achieved, problems of equity in distribution could be evaluated and social reforms could proceed apace.

Higher order goods (Menger)

Inputs

Bohm-Bawerk

Interest is a surplus, a remainder when value of consumed capital is deducted from productive capital. Interest reflects the opportunity cost of money across time. From this idea comes discounted present value, amortization, and other time-related interest concepts. Note also how this ties in Smith's and Ricardo's ideas of paying the workers now out of future produce (but the DPV is less than the future value). Not only was this a really devastating critique of Marx; this was a big addition to economic theory and has come to be the central idea identified with Austrian economics.

Discontinuous change (Schumpeter)

Inventions and discoveries take place irregularly but continuously. Their transformation into entrepreneurial innovations, however, occurs in distinct waves. The reason is that existing environment is resistant to change, it takes time to accumulate breakthrough. (1) Resistance of status quo, from economic, political, cultural reasons, only a certain accumulation of innovation power can break such resistance. (2) Institution. (certain innovations have to be approved by laws) (3) Uncertain future of innovation, so it takes certain test and time before fully adopted.

Information and knowledge (Hayek)

Knowledge and information are held diffusely, and are private, "not given to any one person". Such knowledge is more than scientific knowledge. For example a better knowledge of facilities of communication or transport will be very useful, yet they are not given proper recognition in economic research. Actually, the use of such knowledge makes the economy run much more efficiently. He argues that a lot of essential knowledge cannot be entered into statistics and cannot conveyed to any central authority. In other words, a central planning system is doomed to failure because it cannot use all useful knowledge in the society efficiently. Endorses a decentralized system that uses market competition and prices as an institution to efficiently use diverse knowledge and discover new knowledge.

Labor power (Marx)

Labour-power or capacity for labour is to be understood as the aggregate of those mental and physical capabilities existing in a human being, which he exercises whenever he produces a use-value of any description. Ability to work, not merely a quantity of human tissue Labor is the action of exercising this potential

Financial market & fiscal monetary policy (Keynes)

Liquidity preference: Demand for real cash balance increases with income and decreases with interest rate. (We are talking about Md curve here) He thinks the first is based on transaction and precautionary motives. The second is based on speculation of future return. He argues that monetary policy is ineffective in saving economy out of recession because of liquidity trap. (90s Japan is really a good example for his argument.) So comes expansionary fiscal policy. Even it means deficit.

Subjective utility (Menger)

Menger did not believe that goods provide "utils", or units of utility. Rather, he wrote, goods were valuable because they served various uses whose importance differed. For example, the first pails of water are used to satisfy the most important uses, and successive pails are used for less and less important purposes. Used this to refute LTOV If the value of goods is determined by the importance of the wants they satisfy, then the value of labor and other inputs of production (he called them "goods of a higher order") derived from their ability to produce these goods.

Entrepreneur (Schumpeter)

New combinations of materials • Disrupts Circular Flow Innovation Equilibrating force Disruptive Innovation

Meaning of competition (Hayek)

Perfect competition is a theoretical neoclassical economics construct, not an accurate depiction of reality: i) perfect knowledge of every relevant utility function of both buyers and sellers and of all relevant prices ii) an infinitely large number of buyers and sellers iii) complete and open entry and exit of all firms iv) constant expectations v) homogeneous products "The market is a process whereby scattered and often contradictory bits of information are assimilated and transmitted to individual market participants, in his phrase, the competitive market process is a discovery procedure."

Bentham

Pleasure principle: seek out pleasure and avoid pain (maximize pleasure utility) Wants to maximize social welfare Berndulli: Diminishing marginal utility of income • The wealthier you are, the lower your marginal utility of income • Can increase total welfare by redistributing income from the wealthy to the poor • Marginal utility of poor person is larger than marginal utility of rich person • Making assumptions on commonality of utility Social Welfare Function, and his idea of utility we still use today Makes assumption that utility is homogeneous, same for everyone

Why do value and price diverge? (Marx)

Price is affected by supply and demand Value is affected by long run socially necessary labor

M-C-M

Simple circulation, Marx believes it creates no value Start out with money, buy a commodity, and re-sell for more money

John Stuart Mill (Overview)

Supply and demand as separate relationships, not as a ratio or single relationship. Marshall is often credited with this, but ___ thought of it first. From this, ___ can be viewed as a bridge guy between classical economists and marginal era economists. Theory of joint production Theory of reciprocal demand General equilibrium

Say's law

Supply creates its own demand. Classical model compared with Keynesian model, long run supply curve--- difference between these models is focused on Say's Law

Monopoly (Marshall)

Theory of the firm o Firm maximizes profit π = pQ - (MC)Q o Firm chooses Q to do this o MC curve is supply curve Post Office article, difference between demand and marginal revenue, producing where MR=MC leads to less production than P=MC US Mail should do long distance mail, local offices should do local mail Government granted monopoly • Inefficient • No incentive for them to make things better, innovation • Monopolies should lower price since they generate so much revenue

Supply & demand (Mill)

Thinks supply and demand should be separate equations and relationships • Supply Qs = f(P) • Demand Qd = g(P) • Subtle analysis of the interaction of supply and demand Value: Purchasing Power (not fixed) • Technology change leads to decrease in value and drives prices lower Move away from proportion • Competition -> Balance of supply and demand • Exchange of value for value • Step away from classical economists

Labor power as a commodity (Marx)

Under capitalism, according to Marx, labour-power becomes a commodity - it is sold and bought on the market. A worker tries to sell his or her labour-power to an employer, in exchange for a wage or salary. If successful (the only alternative being unemployment), this exchange involves submitting to the authority of the capitalist for a specific period of time. Wage is the price for labor power

Subjective value

Unlike Ricardo, who might say that pearls have value because people need to dive for them, JEVONS said that pearls have value because buyers get utility from them, and that people dive for pearls because pearls have such value. This subjective utility theory of value is a large departure from the previous labor theory of value, and represents the most significant paradigm shift in the set of ideas weʼve studied.

Determining value (Jevons)

Value is determined by final degree of utility (marginal utility of last unit consumed). Jevons is one of the first (the other two are Menger and Walras) to develop marginal analysis, and to distinguish the difference between "total utility" and "marginal utility". He was the first to distinguish clearly between total utility and marginal utility; he does so in his Theory of Political Economy (1871) by referring to the diamond/water paradox of Smith. Jevons also articulates that marginal utility can actually be negative, a very new concept.

Production of surplus (Marx)

Value of labor power is the necessary labor time required for a worker to produce an amount equal to his means of subsistence. Any amount of time worked beyond the necessary labor time is called surplus labor. The Working Day = A-------B----------C. The line AC represents the working day. AB is the necessary labor time and BC is surplus labor.

Demand and consumer surplus

We consume up to Px = MUx Concept of consumer surplus, producer surplus, deadweight loss (Marshall)

Schumpeter (Bio)

• Born in Austria • Mother remarried high ranking general • Went to school with all the children of the aristocracy • Studied law and economics in Vienna • Bunbober was his main economics professor • Studied a lot of history too, but not good at math • Wife and him had long happy marriage, had a son Remembered for change, innovation, and entrepreneurship • Importance of change, causes of change

Business cycle theory (Schumpeter)

• In his work of "The theory of economic development" • Circular flow diagram • A model of four main cycles. • Without entrepreneur and innovation, the economy will end up in a stationary state. • The entrepreneur disturbs this equilibrium and is the cause of economic development, which proceeds in cyclic fashion along several time scales. "creative destruction" works here.

Marshall's contributions (summary)

• Marginal analysis • Graphical analysis • Ceteris Paribus/partial equilibrium analysis- trade off between tractability of model and the reality of the model • Time • Other: - Law of diminishing utility - Elasticity, invented by him - __________ cross

Spontaneous order (Hayek)

• The free price system is not a conscious invention, but result of spontaneous order. "the result of human action but not of human design." • The price mechanism evolves like language.

Schumpeter on Walras

• Walrasʼ analysis of general equilibrium, stationary state • Schumpeter considers stationary state as a pattern "circular flow", he wants to departure from stationary state to analyze growth and development of economy. • Although he has the vision that "entrepreneur" will be the hero of his development theory, he never succeeded in forming a coherent theory, not even to say a mathematically formalized one. The theory isnʼt formalized until 1980s.

Jevons theory of exchange

p1/p2 = −dx2/dx1