Archive for October, 2013

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Oct 23

Lope Gallego

Harold Hotelling

Harold Hotelling, 1895-1973, was an American statistician and an important economic theorist. He was Associate Professor at Stanford University and Professor at Columbia University and the University of North Carolina at Chapel Hill. Amongst his pupils we can highlight Kenneth Arrow and Milton Friedman. His greatest contribution was to the monopolistic competition field.

Harold Hotelling developed in his article “Stability in Competition”, 1929, what is known nowadays as the Hotelling model or linear city model, which greatly contributed to the field of product differentiation. In this model he introduced the notions of locational equilibrium in a duopoly in which two firms have to choose their location taking into consideration consumers’ distribution and transportation costs. The Hotelling model has been source of inspiration for a great amount of fruitful literature which does not only constrain to industrial organization theory but also to other sciences, such as politics, as some of its conclusion can be directly applied to them.

Oct 19

Lope Gallego

Thomas Bayes

Thomas-Bayes Thomas Bayes, 1702-1761, was an English mathematician and reverend at the Presbyterian church. Nevertheless, his mathematical theorems on subjective probability have been very valuable and have had a great repercussion in science, economics and law.
He developed the Bayes’ theorem which is based on finding out the probability of a certain event “A” occurring, subject to the occurrence of a certain event “B”. In his post-mortem published “Essay Towards Solving a Problem in the Doctrine of Chances”, 1763, he reviews his theorems and presents the solution to an “inverse probability”. His mathematical theorems are greatly used in game theory and static and dynamic game analysis when complete information is available.

Oct 16

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Ernst Engel

Ernst Engel, 1821-1896, was a Prussian statistician, founder of the International Statistical Institute and from 1860 to 1882 he was director of the Prussian statistical bureau in Berlin. However, he is best known for the formulation of his Engel’s law, deriving on what is known as the Engel curve.

Engel developed his famous curve in his book “Die Productions- und Consumtionsverhältnisse des Königreichs Sachsens” 1857, from observing and collecting data of the consumption patterns of Belgian working-class families, and he related their level of income with their expenditure in food and other goods. He observed that households with higher incomes tended to allocate a lower share of their income to food than poorer households. The Engel curve captures this inverse relation. His law is a reflection of this phenomenon and states this same relation. As Engel himself expressed, the implication of this law is very interesting in the macroeconomic sense as it implies that the higher the economic development of a country, the lower the share of agriculture will be in aggregate production.

Oct 13

Lope Gallego

Macroeconomics

Macroeconomics is the study of the economy as a whole, by means of aggregate variables, this is, the part of economic theory that studies the behaviour of economic agents in large aggregates of demand and supply, monetary aggregates, gross domestic product, etc. Macroeconomics therefore relate to the concepts of the national economy that are measured through national accounting, input-output models, etc. During the 30s, J.M. Keynes, promoted the study of this matters with his concepts of aggregate demand, full employment and so on.

In contrast to microeconomics, macroeconomics seeks the “large picture”, showing the operations of the economy as a whole, rather than its internal diversity. In fact, it regards the economy as producing a single and unique good. Its purpose is to obtain the least complex vision of the economy’s functioning, but in such a way that it also, allows the analysis of the level of economic activity.

We can use Engel’s Law to show the close relations between micro and macro concepts and how one can have profound implications in the other. Ernst Engel analysed Belgian working class families’ consumption patterns and related their levels of income with their expenditure on food and other goods. He discovered that the higher the income of the family, the lower the share of food in comparison to other expenses. This analysis would become the central statement of his law. As Engel already realized, this had huge consequences in the economic development. Agriculture production, which relies heavily on food consumption, as this is its main product, will see a decline regarding its share of the aggregate total production, as the share for food decreases in aggregate terms as the economy grows. From this concept, we can extract that growth of all sectors at the same rate is impossible, and we also find the close relation between micro and macro concepts.

There are a many topics covered in the field of macroeconomics: aggregate demand and supply, business cycles, unemployment, government role, inflation, etc.

Oct 9

Lope Gallego

Microeconomics

Microeconomics is a branch of economic theory that is centred in modelling the interactions amongst market agents, specially between consumers, which are trying to maximise their utility, and firms, which try to maximise their profits. It analyses the underlying logic of the individual behaviour of economic agents such as the employer, the consumer, etc., and the notions that derive from them, such as, profit, utility, market structures, etc. In its purest form it answers the philosophical question regarding the resources allocation process.

The line that separates microeconomics from macroeconomics has become increasingly narrow throughout time. Nevertheless, it has always existed, and most probably will always exist, as some barriers are insurmountable. The goal of macroeconomics is to understand and predict the behaviour of economic variables in its aggregate terms. Therefore we make the distinction of microeconomics as relating to individual, micro, terms (consumers, firms, etc.), while macroeconomics relate to aggregate, macro, variables (consumption, unemployment, investment, etc.). A way to view both terms is from a disaggregated vs. aggregated perspective.

The methods and tools used in microeconomics are mainly the construction of models that simplify the reality so that the interdependence between variables can be analysed and represented. Many techniques may be used for the construction of these models; however, the great majority of them fall into the categories of optimisation analysis and equilibrium analysis. Furthermore, models of optimising behaviour represent nearly all of the models of individual behaviour in microeconomics.

Oct 2

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Frank P. Ramsey

Frank Plumpton Ramsey, 1903-1930, was an English mathematician who applied his knowledge and interest to the disciplines of philosophy and economics, resulting in remarkable contributions. Regarding his works on Economics, he produced three master pieces which were, however, disregarded for many years.

His first economic paper “Truth and Probability”, 1926, covers subjective probability and utility. Ramsey argues Keynes’ point of view on the importance of subjective probabilities. Keynes believed in the relation between knowledge and probability, being knowledge common and available for all individuals and thus implying that everybody would have the same probability distribution. Ramsey argued that each individual would have its own knowledge resulting in different probability distributions. For him there was a difference between the notions of probability in physics and logic.

In his second paper “A Contribution to the Theory of Taxation”, 1927, Ramsey centred in optimal taxation so that revenue and utility are maximised and produced the concept of Ramsey pricing used to calculate the price a monopolistic firm should set in order to maximise social welfare subject to profit constraint.

Finally, in his third paper “A Mathematical Theory of Savings”, 1928, Ramsey tries to determine the optimal amount of savings for an economy in order to maximise its future utility. This would result in the infinite horizon growth model. His mathematical background is strongly noticed due to the use of calculus of variations and he laid the bases for the development of optimal accumulation theory or theory of optimal path of accumulation. His model was later adapted by Tjalling C. Koopmans and David Cass to maximise household’s utility function.