Dec 7

George Stigler

George Stigler George Joseph Stigler, 1911-1991, was an American economist and Professor at Brown University, Columbia and University of Chicago. Furthermore, and regarding the University of Chicago, he stands out as one of the most prominent members of the School of Chicago. Stigler was awarded the Nobel Prize in Economic Sciences in 1982 for his researches regarding industrial structures, functioning of markets and causes and effects of public regulations.

From Stigler’s contribution to the microeconomic theory and industrial organization we can highlight his work of enhancement and adaptation of microeconomics in such a way, that it allows its use and analysis in a great range of real phenomena. In this field we find Stigler’s cost analysis theory, which changed the way we understand economies of scale. Amongst his top works we can find “The Economics of Information”, 1961 and “The Theory of Economic Regulation”, 1971.

Stigler also produced a great amount of work as a historian of the economic thought. His merit does not related to the amount he covered, but the depth and originality of his analysis, and how clarifying they were. We can highlight his first economic history book “Production and Distribution Theories” 1941, that studies the formative period of neoclassical economics.

Dec 5

Lope Gallego

Unemployment

Unemployment refers to the situation of a jobless worker. The unemployment rate measures the number of unemployed workers as a percentage of the labour force. Massive unemployment levels are the result of situations of economic crisis followed by depressions, and are the result of a large economic readjustment studied in business cycles theory. During the Great Depression, 1929-1939, unemployment insurance benefits were introduced in the U.S. in order to reduce the consequences of high unemployment levels. This measure was introduced to prevent workers’ misery, and as a way of maintaining effective demand, as stated by the Keynesians’ fiscal policy proposals.

Unemployment can be divided into different types depending on its cause and depending if it is involuntary or voluntary:

Involuntary Unemployment

Classical unemployment is explained as the situation that exists in the labour market when the number of people able and willing to work at the prevailing wage levels exceeds the number of vacancies available. In simple words, demand and supply do not meet. This occurs when real wages are higher than those corresponding to equilibrium at full employment levels. This type of unemployment was explained by the Classical school (hence its name) as those cases in which certain imperfections prevent unemployed people from reducing their aspirations to lower their wages so that firms will believe it is interesting to create new jobs and hire people.

Frictional unemployment, also referred to as searching unemployment, happens when a person is temporarily unemployed between jobs. This is the unemployment in its theoretical lowest possible level. It occurs even in full employment conditions because a considerable number of people are moving from one job to another. The only way to reduce this kind of unemployment is for economic institutions to make information more available.

Structural unemployment occurs when people are unable to find jobs in which their skills can be useful because their skills are no longer demanded, and thus creating an excess of labour supply generally at well-defined locations. As structural unemployment is not caused as a result of a general decline in demand, it cannot be softened with reflationary type measures, but instead ad hoc economic policies are needed. These types of policy include retraining of workers and reallocation of industries. The main difference between structural and frictional unemployment relies on the time horizon, as the former is a long lasting phenomenon while the latter a short term one.

Seasonal unemployment is generally of short duration and it is generated on a regular basis as a result of the different seasonal activities through the year, especially regarding agriculture activities and tourism.

Disguised unemployment is not actually unemployment. It refers to a characteristic situation of countries that are both underdeveloped economically and highly bureaucratized, in which there is a high number of workers with low levels of productivity that would be employed if the country had a better organisation or better technology levels.

Voluntary Unemployment

Voluntary unemployment consists of workers that are jobless as they are reluctant to work due to economic, sociological or psychological reasons.

Dec 5

Lope Gallego

Laissez-faire

Laissez-faire, laissez-passer is a French expression that translates as “to let do, let pass”, that is letting things work on their own. In a sense it sums up the economic doctrine of physiocracy, expressing that there is a natural order of things, with its own laws, and it is best to let them run by themselves without laying restrictions.

Leaving the economy to run at its own pace, in a laissez-faire way, where the government’s only concern is to assure sufficient property rights, has been praised by some economic doctrines such as neoclassical economics, monetarism and new classical macroeconomics. Government should only be responsible of providing and ensuring protection for firms and people; the forces of demand and supply should be left to act when economic cycles require it.

Dec 1

Lope Gallego

Money illusion

Money illusion refers to the situation in which some nominal income increases, can generate the mistaken feeling that a person, or a particular group is increasing its real purchasing power, when in fact monetary erosion due to inflation may be decreasing their purchasing power in real terms. Money illusion is a psychological matter as a result of people being biased and thinking in nominal monetary values rather than real, as it may report the illusion of higher purchasing power.

This term was popularized by J.M. Keynes although it was originally coined by Irving Fisher in his “The Money Illusion”, 1928, while dealing with the differences between nominal and real monetary aggregates.

In relation with the Philips-curve, money illusion helps sustain this theory as it will mean workers will perceive their wages in nominal values. When workers think so, they don’t demand an increase in wages to compensate inflation, and therefore firms’ real hiring cost becomes cheaper. Therefore the higher the inflation rate, the more workers a firm can hire, hence, fulfilling the Philips-curve relation.

However, economist such as Milton Friedman and Edmund Phelps believed money illusion was only possible in the short-run as this illusion could not be maintained constantly, due to adaptive expectations. This is why the expectations-augmented Phillips curve was developed.

Nov 30

Lope Gallego

X-inefficiency

X-inefficiency is known as the result of inputs not producing their maximum output as a consequence of an “X” factor. This translates into both cost minimisation and production maximisation failure and, hence, implies a loss of efficiency. This term was first introduced by Harvey Leibenstein in his “Allocative efficiency vs “X-efficiency”, 1966, since concepts such as organisation inefficiency or motivational inefficiency were not yet available. Therefore X-inefficiency makes reference to all non-allocative inefficiencies.

There are four main identified reasons that try to answer for X-inefficiencies:

Relaxing maximisation behaviour: as the psychological Yerkes-Dodson Law postulates, individuals who are exposed to low pressure will not put much effort in their actions. As pressure builds up, maximising behaviours are reached until a point where too much pressure will again result in inefficiency. Other non-maximising decision making processes include habits, conventions, moral imperatives, etc.
Incomplete contracts: employment contracts define workers economic compensation but other concerns such as the effort, the work load or specific tasks may remain undefined, which creates an incompleteness in contracts.
Inertia: forces that are external to the company may exert pressure to make the firm become more competitive. Only with this external force efforts will increase.
Discretion: it is assumed that workers will not show their “full potential” or maximize their efforts, and at the same time, that employers will not pay the maximum wages they could offer.

However empirical tests and models about X-inefficiency relevance have mixed results so no final transcendence can be assured. However, is interesting to realise the debate it has created, specially regarding incomplete contracts and managerial inefficiency, both also studied in the field of business management.

Nov 29

Lope Gallego

Stigler’s cost analysis theory

As a contribution to industrial organization, George Stigler developed his “own” theory on cost analysis in his article “Production and Distribution in the Short Run”, 1939, which moved slightly away from neoclassical cost analysis.

This theory arises as many economist started to criticize the traditional U-shaped representation of a firm’s average costs. George Stigler used empirical data to question the traditional theory. His cost theory can be divided into the analysis of both the short-term and long-term average costs:

Average Costs in the short-term

According to classical economics, each plant ensured only a specific level of output could be produced in the short-run because of production inflexibility. However, Stigler introduced the notion that firms could adapt to changes in demand and be flexible even in the short-run. His main argument in favour of this idea is that whenever a firms built a plant they would have what is known as a reserve capacity.

The existence of this reserve capacity is justified by economic and technical reasons. From the former we include possible changes in the good’s demand due to cyclical reasons, favourable changes in consumers’ tastes or as a preventive method to avoid a production stop in case there is a breakdown or a repair. The latter can arise as there are some basic installations that are indivisible or as managers and workers are hired in excess to allow future expansions.

-before X₁ : marginal costs < decreasing average costs (increasing returns to scale)

-X₁ to X₂: marginal costs = average costs (constant returns to scale, maximum efficiency)

-after X₂: marginal costs > average costs (both increase, therefore decreasing returns to scale)

It must be noted that this theory allows for maximum efficiency to exist for a while, which completely differs from the neoclassical view, which viewed maximum efficiency as a point of inflection, rather than a straight line.

Average Cost in the long-term

Taking into account production costs and managerial costs, Stigler argued that in the long-run average costs will decrease until a point where they cannot longer do so and from which they will become constant.

Production costs will decrease due to economies of scale until the optimum size is reached and then remain constant. Further average production cost reduction could come along with technological or skills increase. As for managerial cost, he considers, they will start to increase after a certain size is reached. However, managerial diseconomies of scale would be compensated by technical economies of scale, with a zero sum net effect and therefore would remain constant as a result.

Nov 27

Lope Gallego

Edward Chamberlin

Edward Hastings Chamberlin, 1899-1967, was an American economist and Professor at Harvard University. He performed a major innovation in modern microeconomic theory, specially regarding the study of the structure of markets, developing monopolistic competition.

With his clever and original work “The Theory of Monopolistic Competition”,1933, Chamberlin became the father of modern industrial organization analysis providing this field with the theoretical core that it was lacking. He changed the focus of microeconomics from the industry to the firms, including important variables as selling costs and product differentiation, in contrast to neoclassical economists, who studied markets only from a pricing power perspective.

Chamberlin gave special importance to what he coined as product differentiation, as a key aspect through which firms are able to control the prices of their products without being monopolists. Along with Joan Robinson’s work, Chamberlin’s book is considered to be the foundations of market structure analysis.

Nov 25

Lope Gallego

Structure, conduct, performance paradigm

Structure, Conduct and Performance paradigm (SCP) is used as an analytical framework, to make relations amongst market structure, market conduct and market performance. It was developed in 1959 by Joe S. Bain Jr., who described it in his book “Industrial Organization”. The SCP paradigm is considered a pillar of industrial organization theory, and it has been since its conception a starting point when analysing markets and industries, not only in Economics, but also in the fields of business management and controlling. For instance, the mainline of Michael E. Porter’s works on competition are based on premises derived from this paradigm.

Following its reasoning, an industry performance (which could be considered as the potential benefits to consumers and society as a whole) are determined by the conduct of the firms within the boundaries of this industry, which in turn depend on the structure of the market.

Elements of the Paradigm

– Structure: those set of variables that are relatively stable over time and affect the behaviour of sellers and/or buyers. The way in which markets fail to follow perfect competition conditions, depends basically in the degree of: supply concentration, demand concentration, product differentiation and market entrance barriers. Also, the structure of the market will always be determined by the nature of the product and the technology available.

– Conduct: the way in which buyers and sellers behave, both amongst themselves, and amongst each other. Firms choose their own strategic behaviour, investment in research, in development, advertising levels, collusions, etc.

– Performance: It is measured by comparing the results of firms along the industry in efficiency terms, and different ratios are used to assess different profitability levels. The variables considered at this level are such as pricem quantity, product quality, resource allocation, production efficiency, etc.

The dynamic behaviour of buyers and sellers have an effect on the markets, making it harder to predict and establish fixed market structures. Difficulties arise when trying to explain the paradigm and this is due to data shortage, and the multiple definitions and extension of markets. Actually, the main problem when using this methodology to analyse a market or an industry is the difficulty of defining the limits or boundaries of a given industry.

As implications of all this, regarding economic policies, Harvard school recognizes market power as being dangerous, and establishes a relation between, the concentration ratio, and the harmful effects on social welfare.

Nov 25

Lope Gallego

Friedrich von Wieser

Friedrich von Wieser Friedrich Freiherr von Wieser, 1851-1926, is one of the founding trio of the Austrian school along with Carl Menger and Böhm-Bawerk. He taught in the largest Austrian universities, mainly in Vienna. Amongst his students, there were well-known would-be economists such as Friedrich A. von Hayek and Joseph A. Schumpeter, who were strongly influenced by the thoughts of their professor.

Wieser’s main works include “On the Origin and the Main Laws of the Value of Factors”, 1884, where he develops the concept of marginal productivity valuation of factors and his cost theory; “Natural Value”, 1889, where Wieser further develops his previous work, but giving it normative distributional content; and “Social Economics”, 1914, which is considered the definitive textbook of the Austrian school.

Nov 21

Lope Gallego

Knut Wicksell

Johan Gustav Knut Wicksell, 1851-1926, was a Swedish economist and Professor at Lund University. He is considered one of the most important founders of the school of Stockholm.

In his most influential contribution, “Interest and Prices”, 1898, Wicksell made the differentiation between the natural rate of interest and the money rate of interest. The former was the interest rate that was neutral to prices in the real market, that is, at which equilibrium between supply and demand was found in the real market, and the latter was the interest rate in the capital market. This notion would be used by Milton Friedman when formulating the natural rate of unemployment.Wicksell carried out a remarkable synthesis of other economist works. In his “Value, Capital and Rent”, 1893, he used marginal utility, the marginal productivity theory of William S. Jevons, Carl Menger and Alfred Marshall and he combined it with Böhm-Bawerk’s analysis of capital. He then fused the result in a Walrasian comparative static general equilibrium framework, by which he became the father of the marginal productivity theory of distribution.

In many aspects, Wisksell is considered to be a precursor of J. M. Keynes, especially regarding his emphasis towards the role of the levels of saving and investment in the cumulative process of expansion and contraction of the economy.