Oct 30

Joan Robinson

Joan Violet Robinson, 1903-1983, was a British economist and Professor at Cambridge University, and belonged to the Post-Keynesian doctrine. She was recognized as a contributor to Keynes‘ famous “The General Theory of Employment, Interest and Money”, 1936.

One of her first and most notorious contributions to economics was in the field of imperfect competition, which can be seen in her book “The Economics of Imperfect Competition”. Along with Chamberlin’s work, Robinson’s book is considered to be the foundations of market structure analysis.

Robinson is well known for her heterodox economic thoughts; especially for her receptivity for certain Marxist approaches. Her top work “The Accumulation of Capital”, 1956, extended Keynesianism by going ahead of the issues in the short-run and analysing the long-run issues of development, economic growth and capital accumulation.

Oct 25

Lope Gallego

Fiscal policy

Fiscal policies are demand-side economic policies through which the government acts over its income and expenditure in order to influence the levels of income, output and unemployment of the economy. The government may do this via income taxes and unemployment benefits, or by discretionary measures, such as taxes on spending and increasing public spending. By increasing demand, firms are incentivized to produce more and therefore to hire more workers.

Keynesianism believed fiscal policies as the best tool to control the economy of a country, especially to reduce cyclical unemployment. Monetarism and following economic doctrines as New Classical Macroeconomics and New Keynesian Economics consider them to be ineffective in the long run, as demand cannot be increased continually.

Oct 25

Lope Gallego

Monetary policy

Monetary policies are demand-side economic policies through which the central bank of a country acts on the amount of money and interest rates in order to influence on the income levels, output and unemployment in the economy, being the interest rate the link binding money and income. The main tools used by monetary policies are open market operations, loans to commercial banks, and the use of reserve requirements. Ceteris paribus, an increase (decrease) in the money supply or a decrease (increase) in interest rates will have a positive (negative) ripple effect on private spending (consumption and investment). This will finally increase (decrease) production and employment. However, this will increase prices, which may lead to rapidly increasing inflation.

Monetarism is the main economic doctrine that defended this kind of policy. However, Keynesianism, New Classical Macroeconomics and New Keynesian Economics, criticize it and do not believe in their effectiveness as it has been demonstrated that increasing money supply will result in inflation and counteracting the positive effects of this policy. As Milton Friedman said, “inflation is always and everywhere a monetary phenomenon”.

Oct 25

Lope Gallego

Supply-side policies

The purpose of supply-side economic policies is to increase the amount of supply and therefore the productive potential that the economy is able to produce. This kind of policies shift rightward the long-run aggregate supply curve and outward the production possibility frontier. They can be divided in policies that act over the production function, and those that act over the cost of labour.

On the one hand, the former are targeted at increasing production levels and examples of this kind of policies include incentives to technological improvement and capital stock increase. On the other hand, the latter are targeted directly on decreasing the cost of labour and this way more workers can be hired. Examples of these policies include reduction of social security contributions, increase of subsidies for firms, reduction of indirect taxes etc.

Supply-side policies have been praised by many economists including Nobel laureate Robert Mundell. There have been many studies regarding their effectiveness, and although it is true that they take effect in the long run, they are the only ones that can lead to perdurable economic growth. Furthermore, critics coming from monetarists and Keynesians have questioned the effectiveness of other policies, such as fiscal and monetary, respectively, pointing out how they are only useful in the short run, but are useless or even harmful for the economy in the long run. In fact, the last two great economic doctrines, New Classical Macroeconomics and New Keynesian Economics, have proven the ineffectiveness of fiscal and monetary policies, leaving supply-side policies as the only ones that are useful.

Oct 25

Lope Gallego

Economic policies

Reducing unemployment and stimulating the economy has been one of the biggest, if not the only, concerns of governments since the dawn of economic science. Economic policies have been very much theorized, and by many doctrines. As a result, a rich and plentiful literature has been developed on this topic. We will discuss the main economic policies:

1. Policies in order to reduce labour supply:

By reducing labour supply the government is reducing the number of people that are legally suitable to work, what is known as the labour force, and by doing so it indirectly reduces unemployment. This kind of policy is mostly effective when targeted over a group that has a higher unemployment rate than the average. If a country suffers from high unemployment amongst the young population, by increasing the minimum age of employment, governments will decrease unemployment levels. It will also be useful even if the targeted group has a low level of unemployment, as there will be new vacancies that unemployed can fill. Other examples of this policy include retirement age reduction and the increase of military service duration. However, as it can be easily seen, these policies are what Frenchmen would call “trompe-l’oeil”, that is, they reduce or eliminate the symptom (unemployment), but without treating the disease (the economy malfunction).

2. Policies to stimulate labour demand:

There are different policies depending if they affect demand of labour by using demand-side policies or supply-side policies.

-Demand-side policies stimulate the economy by increasing the demand for goods and services, thus incentivising firms to produce more, which will result in firms hiring more workers. Expansive fiscal and monetary policies are the tools that governments can use. This kind of policies is considered by their different advocates (Keynesian economists would implement fiscal policies whilst monetarists would implement monetary policies) to be most effective at reducing cyclical unemployment during economic depression.

-Supply-side policies focus on firms and their production of goods and services, in order to increase the supply (output) of the economy. These policies aim at the costs of labour and the production function. If the cost decreases there will be more money available to increase the workforce. This kind of policies is nowadays regarded by the latest economic doctrines as the only real possibility to ensure a perdurable economic growth. However, they are less attractive than demand policies since they need time to be implemented and to generate actual effects on unemployment and growth.

3. Structural reforms:

These policies aim at reducing real wages. With lower wages, the firms will be able to hire more workers. Examples of this policy are: minimum wage reduction, unemployment benefit reduction and removing differences between insiders and outsiders.

4. Income policies:

A pact between the firm and its workers allow for reduction of real wages, this way firms can hire more labour force, which reduces unemployment levels.

5. Labour distribution policies:

Employees will work fewer hours, they will earn less, and so a greater amount of employees will be able to be hired. Marginal productivity is also increased by these policies. However, these policies are not really popular.

It is important to notice that not all policies are effective in the same time frame nor their effects remain over the same period. While supply-side policies and structural reforms have an effect in the long term, the rest have an effect in a shorter time, being this the reason why they were thoroughly studied by Keynesians and monetarists. However, contemporary economic doctrines, such as New Classical Macroeconomics and New Keynesian Economics have proven their inefficiency, thus turning back to supply-side policies as the only plausible solution.

Oct 23

Lope Gallego

Michael Spence

Andrew Michael Spence

Andrew Michael Spence, born in 1943, is an American economist and has been Professor at Harvard University and Stanford University, amongst others. He is currently a lecturer at New York University. His researches and contributions have been mainly in the field of economics of information, and together with economists George A. Akerlof and Joseph E. Stiglitz, Spence was awarded the Nobel Prize in Economic Sciences in 2001 for his work regarding asymmetric information.

Spence paid special attention to the study of those situations in which if certain market participants have more information than the rest, they will take care of disseminating this information to everybody. For instance, it shows how companies use their dividend policy to signal their profitability to market analysts.

In his book “Job Market Signaling”, 1973, he develops Akerlof’s previous studies and applies them to the labour market: when hiring a new employee, and as the firm does not know the labour value that this potential employee will add, they will offer an average salary level that will not match what the best candidates deserve. It is therefore important to inform others about the features that are not readily observable, what Spence called signalling. Academic degrees are a way of signalling inside the labour market as they are used to show above average labour value.

Oct 21

Lope Gallego

Period analysis

Period analysis show the inter-temporal dimension of production theory. It was developed by Alfred Marshall in his “Principles of Economics”, 1890, and has remained practically unaltered since. It tries to explain how equilibrium is achieved and explains the adjustment processes to reach it, going from the short-run equilibrium to the long-run equilibrium. His method is able to classify forces with references to the length of time needed for the production process; and then confine in ceteris paribus those forces that are of less importance with regards to the specific time we are considering. Four periods can be distinguished: very short-run, short-run, long-run and very long-run.

The very short-run period is normally not studied as it is considered irrelevant. It is a period characterized by having all its production factors or inputs, fixed; thus implying there can be no change in their quantities. Costs are therefore considered to be fixed and logically there is inexistence of technological progress in this period.

The short-run period is a period in which some factors remain fixed while others may vary in their quantity. Capital elements, such as equipment, are considered fixed factors while labour is considered to be a variable factor. During this period, cost analysis has a large dependence on marginal cost and average total costs. But, since not all factors can be increased, this will result in diminishing returns, which will imply that marginal costs will increase. A firm should stop production until marginal costs reach average total costs in order to maximize profits. In this period technological progress is still non-existing.

The long-run period is formed by the succession of several short-run periods and it is considered to be like an envelope of many of these. As inputs can be increased, economies of scale can be achieved, so the cost of producing an extra unit of output will decrease, and thus reduce the average costs. Inputs and outputs should be increased until the point where the optimum size of the firm is achieved and from whereon an increase in size will only mean diseconomies of scale. All inputs may be varied but the basic technology of production still cannot be changed.

Finally, it is in the very long-run period when new production processes and new products come as a result of the existence of technological changes within this period, which allow for new ways of producing and different input requirements.

Oct 20

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Christopher Pissarides

Christopher Pissarides
Christopher Antoniou Pissarides, born in 1943, is a Cypriot economist and a School Professor at the London School of Economics. His research has mainly been focussed in the field of macroeconomics, specially in job search frictions explaining unemployment. Pissarides, along with Peter A. Diamond and Dale T. Mortensen were the joint winners of the Nobel Prize in Economic Sciences in the year 2010, for their analysis of markets with search frictions.

Pissarides’ studies have been of great contribution to the search and matching theory. He has observed the relations and interactions between the labour market and the macro economy. He is one of the developers of the matching function, a concept that tries to explain the flows from unemployment to employment, at a given moment, using empirical work to support it.

Pissarides and Mortensen wrote their famous “Job Creation and Job Destruction in the Theory of Unemployment” first published in 1994 in the Review of Economic Studies. This paper was a summation of the authors’ researches and conclusions. The Mortensen-Pissarides modelthat was forged in this work has been key in modern macroeconomics. It has a matching function that describes how workers are matched to vacancies based on a Nash’s bargaining analysis.

Oct 19

Lope Gallego

Production in the very long run

Production in the very long run differs from long run production in that there may be changes in technology. There are three main types of technological advances:

New technology allows for completely new products
New technology allows us to produce equal quantities with less inputs, displacing our isoquants
New technology allows us to produce greater quantities with equal inputs, displacing our production function

These technological advances may displace our ratio of capital to labour one way or the other. Let’s see it graphically first:

-the first technological change shown in the adjacent figure is called Hicks-neutral, which translates into an unchanged ratio of capital’s marginal product to labour’s marginal product. John Hicks devised it in his book “The Theory of Wages”, 1932. Analytically: Y = AF(K,L)

-the second technological change is called Harrod-neutral or labour-augmenting increases efficiency of labour. Roy Harrodformulated it in his book “Towards a Dynamic Economics”, 1948. Analytically: Y = F(K,AL)

-the third and last technological change shown is called Solow-neutral or capital-augmenting , which increases the efficiency of capital. It was devised by Robert Solow in his article “Technical Change and the Aggregate Production Function”, 1957. Analytically: Y = F(AK,L)

Finally, we must also take into account the possibility of endogenous growth derived from endogenous technical changes. This can be easily plotted by using a Cobb-Douglas function, such as:

Oct 18

Lope Gallego

Production in the long run

When dealing with long run production, the main change from short run production is that we can vary the levels of fixed inputs we use (capital, K), as well as variable inputs (labour, L). Our levels of production will be determined by our returns to scale. It’s worth introducing here the concept homogenous functions. A function is considered homogenous if, when we have a multiplier, λ:

That is, we can reduce a production function to its common multiples multiplied by the original function. This is important to returns to scale because it will determine by how much variations in the levels of the input factors we use will affect the total level of production. Also, an homothetic production function is a function whose marginal rate of technical substitution is homogeneous of degree zero.

All this becomes very important to get the balance right between levels of capital, levels of labour, and total production. We can measure the elasticity of these returns to scale in the following way:

That is, the sum of the partial derivatives of production with regards to each factors multiplied by the proportion each input makes up of the whole. Graphically:

If µ is greater than one, we say that we have positive returns to scale (green). The more we produce, the less our costs will be per unit. If it is between one and zero, we have constant returns to scale (blue), and if it is negative, we will have negative returns to scale (red). When dealing with Cobb-Douglas functions, we can also determine which returns of scale are present, since α+β=µ.

All this will determine the average size of a business in the sector. Positive returns to scale, the most common scenario, will naturally attract a concentration of very large businesses, as is often the case in industrial, capital intensive sectors. Getting it right is crucial for another reason: in the long term, market equilibrium will determine that the total production of a certain good will be such to eliminate economic profits.