Evolution of Neoclassical Economics into the 20th' Century

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Evolution of Neoclassical Economics into the
20th. Century

• Bernardo Aguilar-Gonzalez

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Pareto Efficient Allocation

• Pareto Efficient Allocation Each individual is
  on the highest possible indifference curve, given
  the indifference curve of the other individual.

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Edgeworth Box
Individual B
a
Total amount of
YB
b
Individual A
Total amount of
XA
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Pareto Inefficient Allocation

• a and b are Pareto inefficient allocations.
• Why? Because there exists changes in allocations,
  starting from a or b, that would make at least
  one individual better off without making the
  other individual worse off.

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Edgeworth Box
Edgeworth Box
Individual B
Total amount of
Total amount of
g is a pareto efficient point
g
Individual A
Individual A
Total amount of
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Pareto Efficient Allocation

• At point/allocation g
• Individual A is on the higher possible
  indifference curve given Bs indifference curve
  and
• Individual B is on the highest possible
  indifference curve given As indifference curve.
• Therefore, g is a pareto efficient allocation
• Note The two indifference curves are tangential
  to each other

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Pareto Efficient Allocations
Individual B
Total amount of
Total amount of
e
e and d are also Pareto efficient allocations
g
d
Individual A
Individual A
Total amount of
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Contract Curve
Individual B
Total amount of
Total amount of
e
Joining up these Pareto efficient points yields
the contract curve
g
d
Individual A
Individual A
Total amount of
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Contract Curve

• The curve connecting all Pareto efficient
  allocations is known as the contract curve.
• At each point on the contract curve, the MRSs
  for A and B are equal, i.e.
• MRSAxy MRSBxy

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Market Place Exchange Economy Equilibrium
Individual B
UA
Total amount of
Total amount of
UB
Individual A
Individual A
Total amount of
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Exchange Edgeworth Box Summary
XB
Individual B
Total amount of
Total amount of
YB
YA
Individual A
Total amount of
XA
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Production Economy

• Two firms produce two products (X and Y)
• The firms use two factors of production, capital
  (K) and labour (L)
• Assume fixed endowments of K and L.

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(Production) Edgeworth Box
Firm Producing Good Y
Y0
Total amount of
X1
At the tangency points MRTSXLKMRTSYLK
Y1
X0
Firm Producing Good X
Total amount of
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(Production) Edgeworth Box
Firm Producing Good Y
Y0
Total amount of
X1
You can join up all these (Pareto) efficient
points to form the contract curve.
Y1
Y
X0
Firm Producing Good X
Total amount of
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Production Possibility Curve
Each point on the production possibility curve is
(Pareto) efficient
y
x
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Production Possibility Curve
Where on the PPC? How much X and how much Y
should be produced?
y
x
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General Equilibrium
The slope of the PPF Px/Py
y
Px/Py
x
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General Equilibrium
At this point we can draw in the amount of x and
y produced
y
Px/Py
x
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General Equilibrium
This is the amount of x produced
y
Px/Py
x
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General Equilibrium
This is the amount of y produced
y
Px/Py
x
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General Equilibrium
Recall the Edgeworth box
y
Px/Py
x
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General Equilibrium

y
Individual B
Px/Py
Individual A
x
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General Equilibrium
y
Individual B
Px/Py
Individual A
Individual A
x
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General Equilibrium
Recall that MRSxy Px/Py
y
Individual B
Px/Py
Individual A
Individual A
x
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General Equilibrium
y
MRS MRPT Px/Py
Px/Py
UA
Px/Py
UB
x
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General Equilibrium
Three Conditions for General Equilibrium
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Welfare Economics

• 1st Fundamental Theorem of Welfare Economics
• If all markets are perfectly competitive, the
  allocation of resources will be Pareto efficient.
• But what type of human being is needed?

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Homo economicus
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Butwhat do we do when there is a recession or a
world war?
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Twentieth Century Contributors
Liberal
Pure Econ.
Conservative
Keynes
Galbraith
Samuelson
Von Hayek
Friedman
Leontieff Schumpeter
Nash
Myrdal
Simon
Lucas
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John Maynard Keynes (1883-1946)

• Most influential economist of the XX Century.
• The economy is intrinsically unstable because of
  the instability of aggregate demand. Aggregate
  demand is composed by consumption, investment and
  government expenses (creates macroeconomic
  analysis).
• Expands the analysis to include all sectors that
  participate in demand processes.
• Reacts to the economic reality of his time (great
  depression). So, unemployment comes from
  deficiencies on aggregate demand, consumption or
  investment dont allow the desired growth. So the
  state can stabilize the economy through monetary
  or fiscal policy. Favors fiscal policy.
• GNP CIG(X-I)T

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Frederick Von Hayek (1899-1992)

• Member of the Austrian School of Economics,
  taught at the London School of Economics and the
  University of Chicago.
• Hayek showed how fluctuations in economy-wide
  output and employment are related to the
  economy's capital structure.
• The central macroeconomic problem in a modern
  capital-using economy is how can the allocation
  of resources between capital and consumer goods
  be aligned with consumers' preferences between
  present and future consumption?
• the economy's structure of production depends on
  the characteristics of capital goods--durability,
  complementarity, substitutability, specificity,
  and so on
• Every artificial boom induced by credit expansion
  is self-reversing. Recovery consists of restoring
  the time structure of production so that it
  accords with consumers' intertemporal
  preferences.
• Road to Serfdom (1944) planning and control from
  the left will lead to the same totalitarian
  outcome as the right (fascist times)The
  Constitution of Liberty .

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Milton Friedman (1912-)

• University of Chicago
• Widely regarded as the leader of the Chicago
  School of monetary economics, which stresses the
  importance of the quantity of money as an
  instrument of government policy and as a
  determinant of business cycles and inflation.
• The solution to stimulate the economy lies in
  managing monetary policy to stimulate the
  functioning of the private sector.
• also written extensively on public policy, always
  with a primary emphasis on the preservation and
  extension of individual freedom. His most
  important books in this field are (with Rose D.
  Friedman) Capitalism and Freedom

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Paul Samuelson (1915- )

• MIT Professor
• Foundations of Economic Analysis (1947)
• In order to understand price determination in
  modern economics, mathematical analysis is
  indispensable.
• From this impulse, econometrics is clearly born
  The art of expressing economic theories in a
  mathematical form, making them subject to
  quantitative empirical tests.
• A true generalist

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John Nash Jr. (1928- )

• Professor at Princeton
• His work is recognized for the use of game theory
  to resolve equilibrium in prices in strategic
  market situations where there are a few
  noon-cooperating firms.
• Firms dont act without regard to what other
  firms do.

Example A zero sum game the players are
directly competitive-
what A wins, B loses and vice
versa. In formal terms   A -B  B's
strategies b1
b2  
  In this case a2,b2 is a Nash equilibrium
a,b
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John K.Galbraith Gunnar Myrdal
(1908- ) (1898-1987 )

• Swedish School of Economics
• theory of cumulative causation, of poverty
  breeding poverty. The same idea became a leading
  feature of Myrdal's writings on development
  economics, in which he argued that, rather than
  rich and poor countries converging with economic
  development, they might well diverge, the poor
  countries becoming poorer as the rich countries
  enjoyed economies of scale and the poor ones were
  forced to rely on primary products.

• Prof. Emmeritus Harvard
• A renegade in American economics.
• Institutionalism
• advocated for price controls.
• American post-war success arose not out of
  "getting the prices right", but rather of
  "getting the prices wrong-(consumer sovereignty
  is a myth) and allowing industrial concentration
  to develop. It is a formula for growth because it
  enables technical innovation which might
  otherwise not been done. However, it can only be
  regarded as successful provided there is a
  "countervailing power" against potential abuse in
  the form of trade unions, supplier and consumer
  organizations and government regulation.

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Joseph Schumpeter Vassily Leontieff
(1883-1950) (1906-1999)

• Harvard Professor
• Capitalism, Socialism and Democracy(1942)
  predicted the downfall of capitalism in the hands
  of intellectuals
• theory of the development of capitalism,
  integrating it into a business cycle theory and a
  theory socio-economic evolution. Pre-analytic
  vision

• Harvard Professor
• Input-Output Analysis
• 1953 finding that Americans were exporting
  labor-intensive rather than capital- intensive
  goods - the "Leontief Paradox" -

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Robert Lucas (1937- )
Julian Simon(1932-1998)

• New Classical School
• Rational Expectations derive in the popularity of
  supply-side economics.
• Real Business Cycle
• Time series-Macroeconomics.

• Doomslayer
• Believed in technological cornucopia
• Immigration should be open and unrestricted.

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Claimed Success of Neoclassical Approach in NAFTA

• Foreign Trade is one of the main motors of
  economic growth. Mexico quadrupled its exports
  and increased its imports by more than 300
  between 1989 and 1999
• Commercial aperture brings with it investment.
  Currently more than 60 of Mexicos FDI comes
  from the US and Canada. This investment leads to
  new jobs, technology transfer, indirect export
  opportunities through chains of suppliers, and
  training for workers and executives.

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Questions

• Is the discussion between government and private
  initiative sufficient?
• What are common problems with the Keynsian or the
  Hayek Approach?
• Do you think economics is a value free science
  after seeing this video?

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Summary of problems of the Neoclassical Approach

• A. Emphasizes theoretical modeling over reality,
  ignoring information that does not fit theory.
  This methodological purity results in
• B.  The environment is a factor of production
  only relevant in its relative scarcity in the
  market. The role of the environment as a supplier
  of energy and materials and as a waste deposit is
  generally ignored.
• C.  Even when they can receive some valuation,
  environmental services are not considered
  essential because of infinite substitutability
  assumption.
• D.  The belief in infinite substitutability takes
  to a rejection of the limits to growth.
  Continuous growth is not only possible but the
  only solution to poverty and environmental
  degradation. Population and economic growth go
  hand to hand and their interaction is the only
  possible way to maintain the standards of living.
• E.  Human welfare is conceptualized using a
  mechanistic view of the human being (economic
  molecules). This human being seeks to achieve
  personal interest through free markets. This
  collection of individual welfares adds up to
  general welfare.
• F.  Thus there is no need to consider factors
  that are beyond the economy.