## Monday, April 25, 2011

### Slope Of "Demand Curve" Varying With Numeraire

1.0 Introduction
As I have previously blogged, Ian Steedman has a number of articles explaining price theory. These articles typically explain the implications, for example, for the slopes of certain functions, but often do not contain graphical illustrations. Here then is an opportunity for me to develop blog posts. For instance, this post works through the example in Section 4 of Arrigo Opocher and Ian Steedman's article, "Input price-input quantity relations and the numéraire" (Cambridge Journal of Economics, V. 33, N. 5 (2009): 937-948).

2.0 Technology
Consider a simple economy in which three commodities - iron, steel, and corn - are produced. Corn is the only commodity people consume, and corn is not used as an input in the production of any commodity. The problem considered here is how much of each input into the production of corn will be demanded by the firms in the corn-production industry.

Iron is produced by unassisted labor. The production function for iron is:
q1 = f1(l1, x1,1, x2,1, x3,1) = l1
where:
• qi; i = 1, 2, 3; is the quantity of the ith commodity produced in the period under consideration.
• fi( ); i = 1, 2, 3; is the production function for the ith commodity.
• lj; j = 1, 2, 3; is the number of person-years hired in the period under consideration to produce the jth commodity.
• xi,j; i = 1, 2, 3; j = 1, 2, 3; is the quantity of the ith commodity used in the production of the jth commodity in the period under consideration.

Steel is produced by labor from iron. Steel production is modeled by a Cobb-Douglas production function:
q2 = f2(l2, x1,2, x2,2, x3,2) = (l2)D (x1,2)E/(DD EE)
where D and E are positive parameters and D + E = 1.

Corn is produced by labor from inputs of iron and steel. The production function for corn is:
q3 = f3(l3, x1,3, x2,3, x3,3) = (l3)d (x1,3)e (x2,3)f/(dd eeff)
where d, e, and f are positive parameters and d + e + f = 1.

All production functions exhibit Constant Returns to Scale (CRS). All capital goods are totally used up in production, and all production processes require the same amount of time.

3.0 Cost Functions and Coefficients of Production
Consider competitive firms producing a commodity who want to adopt a cost-minimizing technique. For definitiveness, consider a firm producing steel. Let w be the wage (paid at the beginning of the period) and pj; j = 1, 2, 3; be the spot price of the jth commodity. The unit cost function, c2( ), for producing steel is the value of the objective function in the solution to the following mathematical programming problem:
Given w, p1, p2, p3
Choose l2, x1,2, x2,2, x3,2
To Minimize wl2 + p1x1,2 + p2x2,2 + p3x3,2
Such that:
f2(l2, x1,2, x2,2, x3,2) = 1
l2 ≥ 0; xi,2 ≥ 0, i = 1, 2, 3.

Solving this programming problem, one finds the unit cost function for producing steel is:
c2(w, p1, p2, p3) = (w)D (p1)E
In working out the cost function, I also figured out how much labor and iron a steel-producing firm would hire to produce one ton of steel. Opocher and Steedman pose the problem with given cost functions, not production functions. They derive the coefficients of production by invoking Shephard’s Lemma.

A similar cost-minimizing problem arises for corn-making firms.
The unit cost function, c3( ), for producing corn is:
c3(w, p1, p2, p3) = (w)d(p1)e(p2)f

The derivatives of the cost functions are summarized by the coefficients of production, a0 and A, where:
• a0 is a three-element row vector such that a0,j; j = 1, 2, 3; is the person-years of labor hired per unit output of the jth industry.
• A is a 3x3 matrix such that ai,j; i = 1, 2, 3; j = 1, 2, 3; is the quantity of the ith commodity purchased as an input per unit output in the jth industry.
Table 1 displays coefficients of production.

 IronIndustry SteelIndustry CornIndustry Labor a0,1 = 1 a0,2 = D (p1/w)E a0,3 = dwd - 1 (p1)e(p2)f Iron a1,1 = 0 a1,2 = E (w/p1)D a1,3 = ewd (p1)e - 1(p2)f Steel a2,1 = 0 a2,2 = 0 a2,3 = fwd (p1)e(p2)f - 1 Corn a3,1 = 0 a3,2 = 0 a3,3 = 0 Output 1 ton iron 1 ton steel 1 bushel corn

4.0 Long Period Price Equations
The above shows the coefficients of production that perfectly competitive firms choose, given prices. Each column in Table 1 has been derived independently of the others. Firms will continue to produce corn, the consumption good, period after period only if some firms also choose to produce iron and steel. Cost-minimizing firms will not make these choices for any configuration of prices. The long-period condition that firm choices be self-sustaining yields the following system of three equations:
a0,1 w (1 + r) = p1
[p1 a1,2(w, p1) + w a0,2(w, p1)](1 + r) = p2
[p1 a1,3(w, p1, p2) + p2 a2,3(w, p1, p2) + w a0,3(w, p1, p2)](1 + r) = p3
where r is the rate of profits. Since production takes time, the rate of profits is generally positive. These equations, when solved, define long-period equilibrium prices for produced commodities as functions of the wage and the rate of profits:
p1 = w(1 + r)
p2 = w(1 + r)1 + E
p3 = w(1 + r)1 + e + f + (1 + E)f

5.0 The Numeraire
The above system of price equations has two degrees of freedom. One degree of freedom is removed when the numeraire is specified. Let the numeraire consist of σ1 units of iron, σ2 units of steel, and λ person-years:
σ1p1 + σ2p2 + λw = 1
Prices of the commodities comprising the numeraire are then:
w = 1/[σ1(1 + r) + σ2(1 + r)1 + E + λ]
p1 = (1 + r)/[σ1(1 + r) + σ2(1 + r)1 + E + λ]
p2 = (1 + r)1 + E/[σ1(1 + r) + σ2(1 + r)1 + E + λ]
Figure 1 shows the relationship between the wage and the rate of profits. This relationship is known as the wage-rate of profits frontier. In this example, coefficients of production vary continuously along the frontier.
 Figure 1: Wage-Rate Of Profits Frontier

6.0 Quantity Demanded for Inputs
The above derivations allow one to draw various graphs for specific parameter values. I set the parameters for the production functions as follows: D = 3/4; E = 1/4; d = 2/3; e = 1/6; and f = 1/6. And I considered two numeraires. For the first numeriare, σ1 = 1/3; σ2 = 1/3; and λ = 1/3. For the second numeriare, σ1 = 1/3; σ2 = 1/2; and λ = 1/6.

For each numeraire, the wage and other prices in a long-period position are defined as functions of the rate of profits. And the cost-minimizing coefficients of production are functions of these prices, that is, ultimately of the rate of profits. Figure 2 shows a locus constructed out of these functions. Curves at the top of the figure plot the price of iron against the quantity of iron demanded by the (non-vertically integrated) corn-producing industry. In drawing this figure, the quantity of corn produced is constrained to be unity. The curves are analogous to conditional demand curves in neoclassical economic theory. And one can see that, for certain regions, whether the slope of such a curve is positive or negative depends on the numeraire. But is not a main point of neoclassical economics to argue that demand curves are downward-sloping (for arbitrary numeraires)?
 Figure 2: A Locus for Firms in Long Period Equilibrium

7.0 Conclusion
So much for explaining the price of a capital good by well-behaved supply and demand curves in the market for that commodity.

## Thursday, April 21, 2011

### Book Series

Any number of publishers have published series of books over the last couple of decades of interest to heterodox economists. Some are, I think, targeted for reference libraries - who else can afford them1? Some collect papers for specific themes or schools of thought. And various publishers specialize in such.

But here I want to focus on the Modern Cambridge Economics Series. These books seem to be targeted for the more introductory student. They consist of, as far as I can tell:
• A. Asimakopulos (1991) Keynes's General Theory and Accumulation2
• Amiya Kumar Bagchi (1982) The Political Economy of Underdevelopment
• John Cornwall and Wendy Cornwall (2007) Capitalist Development in the Twentieth Century
• Phyllis Deane(1978) The Evolution of Economic Ideas2
• Michael Ellman (1989) Socialist Planning
• Eprime Eshag (1984) Fiscal and Monetary Policies and Problems in Developing Countries
• Frederick S. Lee (2006) Post Keynesian Price Theory
• Joan Robinson (1979) Aspects of Development and Underdevelopment
• Colin Rogers (1989) Money, Interest and Capital: A Study in the Foundations of Monetary Theory2
Phyllis Deane and Joan Robinson were the original editors. Phyllis Deane, Geoffrey Harcourt, and Jan Kregel were the editors after a later relaunch.

1Edward Elgar has a series on Schools of Thought in Economics, another series called The Elgar Companion to ..., and The International Library of Critical Writings in Economics. Palgrave Macmillan had themed extracts from the New Palgrave (with some original entries) and is currently publishing their Great Thinkers in Economics series. (This last series is more introductory and affordable by some students.) Routledge has their multi-volume Critical Assessments of Leading Economists collections and, for the Austrian school, the Foundations of the Market Economy Series. Back in the 1970s, Penguin had the Penguin Modern Economic Readings collections. (Links are to information about random books in a series.)

2 I have read and enjoyed these.

## Sunday, April 17, 2011

### Cyril Hédoin On The Failure Of Macroeconomics

Some time ago, I noted James Galbraith's article, "Who Are These Economists, Anyway?" Galbraith suggests that it might be worthwhile to on the work of those economists who were researching "the nature and causes of financial collapse" before the present crisis and had presciently warned of potential problem areas. These empirically successful economists happen to be non-orthodox economists.

The other day, I stumbled upon a somewhat old response to Galbraith,
"Vers un changement de paradigme en économie" (English version), from Cyril Hédoin. As I understand it, he thinks neoclassical economics is collapsing and - what with behavioral economics, evolutionary game theory, complexity economics, etc. - mainstream economics is pluralist. Given these changes, he thinks economists have no need to look among traditionally heterodox economists for good ideas. Hédoin cites articles I like by David Colander, Richard Holt, & Barkley Rosser and by John B. Davis.

Galbraith replies in the comments. He unequivocally rejects the idea that his recommended alternative is on the periphery of economics. He says he cites the economists he does because he thinks their work is good.

Mainstream economists certainly have a problem in explaining - especially to outsiders - why one should not cite certain past presidents of the American Economic Society, various Harvard-trained economists or professors in the Harvard economics department, articles published in certain economics journals associated with the University of Cambridge, some "Nobel Prize" winners, and so on. (For any Austrian-school economists who may be reading this - certain economists trained at New York University don't count either.)

## Monday, April 11, 2011

### Nozick's Anarchy, State, and Utopia

1.0 Overview
Propertarianism, misleadingly called "libertarianism" by its fans, is a political philosophy. Do any supposedly rigorous arguments exist for this philosophy? Some cite Robert Nozick's 1974 tome, Anarchy, State, and Utopia as a demonstration that this question can be answered in the affirmative.

The book has three main parts. In the first part, Nozick argues that a state can emerge from an anarchistic state of nature without violating anybody's rights. The state, according to Nozick, evolves from a private protection agency; its clients become citizens. In the second part, Nozick argues that a state that tries be to more than a minimal state will violate somebody's rights, especially their right to property. For the distribution of property to be just, according to Nozick, three conditions must be met:
• The original acquisition of property must not have violated anybody's rights.
• The transfer of holdings must be likewise just.
• Whatever injustices may nevertheless have arisen in original acquisition or transfer must be rectified justly.
In the last part, Nozick provides a recipe for cookbooks of the future. He describe an association of voluntary communities, where people are free to join whichever commune they like. Only some of these communities may initially be propertarian.

This obvious decomposition of the book explains the three-word title. Despite Nozick's pretense to be presenting an analytic argument, I did not find nearly as much structure at a lower level. The first part seems to beg how people in an original anarchy would behave. Nozick postulates bourgeois contract-making; I think feudalism would more likely result. He continually brings up objections and needed refinements, pursues the argument to an arbitrary level, and then declares the resolution of these details beyond his scope since he is not writing a work of psychology or epistemology or whatever. So I find it difficult to summarize much more of the book.

2.0 Popular Bits
I think Nozick originated many sayings now popular among propertarians. Maybe some he reformulated or re-emphasized.

Nozick's calls his version of Descartes' demon "The Experience Machine". His story is a science fiction story with technology, tanks to float in, and computers. It raises the question, "What else can matter to us, other than how our lives feel from the inside?"

Nozick comes fairly close to saying that there is no such thing as society:
"But there is no social entity with a good that undergoes some sacrifice for its own good. There are only individual people, different individual people, with their own individual lives."

Nozick formulates a non-aggression principle, now called the No-Initiation-of-Force principle in propertarian polemics:
"An underlying notion sufficiently powerful to support moral side constraints against the powerful intuitive force of the end-state maximizing view will suffice to derive a libertarian constraint on aggression against another."

Nozick creates a well-known example with Wilt Chamberlain. Wilt Chamberlain's contract with a basketball team gives him a share of the gate. People "cheerfully attend his team's game". Nozick's imagines that when they buy their tickets, part of the price is that each person "drops" 25 cents "of their admission price into a special box with Chamberlain's name on it." What can be wrong with all of these voluntary transactions making Chamberlin rich? In the course of this exposition, he comes up with a clever turn of phrase:
"The socialist society would have to forbid capitalist acts between consenting adults." (my emphasis)

3.0 Some Absurdities
Nozick's book is a work of political philosophy containing much economic reasoning. But Nozick makes many mistakes in economics, and ignores what seems to me some major problems in political philosophy.

For example, I think a major question in political philosophy is how people with different ideas of good and evil can live together. Nozick acknowledges he doesn't address this question:
"I have proceeded in this essay (as much as possible) without questioning or focusing upon the assumption common to much utopian and anarchist theorizing, that there is some set of principles obvious enough to be accepted by all men of good will, precise enough to give unambiguous guidance on particular situations, clear enough so that all will realize its dictates, and complete enough to cover all problems that actually will arise. To have rested the case for the state on the denial of such an assumption would have left the hope that the future progress of humanity (and moral philosophy) might yield such agreement, and so might undercut the rationale for the state.

... the day seem[s] distant when all men of good will shall agree to libertarian principles... People who prefer peace to the enforcement of their view of right will unite together in one state."

In contrast to my opinion, Nozick thinks Marxian exploitation is a normative idea1:
"One traditional socialist view is that workers are entitled to the product and full fruits of their labor; they have earned it; a distribution is unjust if it does not give the workers what they are entitled to."

Nozick doesn't understand marginal productivity. He incorrectly thinks that it is a theory of distribution:
"Almost every suggested principle of distributive justice is patterned: to each according to his moral merit, or needs, or marginal product, or how hard he tries, or..."
I could cite many more instances in which Nozick makes this mistake.

Nozick erroneously ignores the possibilities of multiple equilibria and of path dependence:
"Let us suppose that we know from economic theory that under the standard assumptions defining a competitive market economy, income and wealth will be distributed in an efficient way, and that the particular efficient distribution which results in any period of time is determined by the initial distribution of assets, that is, by the initial distribution of income and wealth, and of natural talents and abilities. With each initial distribution, a definite efficient outcome is arrived at."
Also, Nozick begs the question of the definition of property rights, of how a society determines what can be a commodity and what cannot. I could cite even more examples of Nozick getting economics wrong.

Nozick has a definite view on the always burning question of whether or not slavery is compatible with propertarianism. He thinks it is:
"Perhaps no persons completely sell themselves into slavery... Since this very extensive domination of some persons by others arises by a series of legimate steps, via voluntary exchanges, from an initial situation that is not unjust, it itself is not unjust."
And again:
"The comparable question about an individual is whether a free system will allow him to sell himself into slavery. I believe that it would."

4.0 Conclusion
I do not find Nozick's book convincing2. You might want to read it to understand some context for certain debates in political philosophy. Nozick treats Rawls in the second part of his book. Before having read Nozick, I already knew about some of the popular bits from having read Alan Haworth. Nozick tends to be cited by many soi-disant libertarians - I suspect by more than have actually read him.

Footnotes
1Nozick does foreshadow John Roemer's game-theoretic definition of exploitation:
"An individual benefits from the wider system of extensive cooperation between the better and the worse endowed to the extent of his incremental gain from this wider cooperation; namely, the amount by which his share under a scheme of general cooperation is greater than it would be under one of limited intra-group (but not cross-group) cooperation."
Nozick formulates "a condition of stable associations" much like this in the third part of his book.

2This is probably not surprising, given my preconceptions.

## Thursday, April 07, 2011

### Robert Lucas On The Impossibility Of Involuntary Employment

As I understand it, so-called Dynamic Stochastic General Equilibrium (DSGE) models are central to contemporary mainstream macroeconomics. Some may want to criticize DSGE on the grounds that they failed to predict the recent global financial crisis. I think a stronger criticism would be that they led their users to believe in the impossibility of current circumstances arising.

I think of DSGE models as having evolved out of trends in macroeconomics started by Robert Lucas. Here is Lucas being sarcastic:
"The first sentence in Malinvaud, The Theory of Unemployment Reconsidered, is 'The term involuntary unemployment makes it obvious from the start that the labor market is one in which supply exceeds demand.' Thus we acquire factual information about labor markets from the terminology earlier theorists have used to describe them!" -- Robert E. Lucas, Jr. Models of Business Cycles. Basil Blackwell (1987).
And here is more:
"A theory that does deal successfully with unemployment needs to address two quite distinct problems. One is the fact that job separations tend to take the form of unilateral decisions - a worker quits, or is laid off or fired - in which negotiations over wage rates play no explicit role. The second is that workers who lose jobs, for whatever reason, typically pass through a period of unemployment instead of taking temporary work on the 'spot' labor market jobs that are readily available in any economy. Of these, the second seems to me much the more important: it does not 'explain' why someone is unemployed to explain why he does not have a job with company X. After all, most employed people do not have jobs with company X either. To explain why people allocate time to a particular activity - like unemployment - we need to know why they prefer it to all other available activities: to say that I am allergic to strawberries does not 'explain' why I drink coffee. Neither of these puzzles is easy to understand within a Walrasian framework, and it would be good to understand both of them better, but I suggest we begin by focusing on the second of the two." -- Robert E. Lucas, Jr. Models of Business Cycles. Basil Blackwell (1987).

## Sunday, April 03, 2011

### Joe Stiglitz As Cambridge Economist?

Joseph Stiglitz has an article, "Of the 1%, By the 1%, For the 1%", in next month's Vanity Fair. In analyzing America's increasingly ridiculous unequal society, he writes:
"Economists long ago tried to justify the vast inequalities that seemed so troubling in the mid-19th century—inequalities that are but a pale shadow of what we are seeing in America today. The justification they came up with was called 'marginal-productivity theory.' In a nutshell, this theory associated higher incomes with higher productivity and a greater contribution to society. It is a theory that has always been cherished by the rich. Evidence for its validity, however, remains thin. The corporate executives who helped bring on the recession of the past three years—whose contribution to our society, and to their own companies, has been massively negative—went on to receive large bonuses. In some cases, companies were so embarrassed about calling such rewards 'performance bonuses' that they felt compelled to change the name to 'retention bonuses' (even if the only thing being retained was bad performance). Those who have contributed great positive innovations to our society, from the pioneers of genetic understanding to the pioneers of the Information Age, have received a pittance compared with those responsible for the financial innovations that brought our global economy to the brink of ruin."
Stiglitz had negative reviews in 1974 and 1975 of books by Harcourt and Pasinetti. Nevertheless, the idea that marginalism was formulated to justify those with high income echoes certain ideas from Sraffa and others. Likewise, finding marginal productivity theory to be "all bosh" is a long-standing Cambridge idea.

I can think of three ways to attack a theory
• To claim, as above, that the premises and conclusions of the theory are empirically false.
• To argue that, even given all the premises of the theory, the conclusions do not follow.
• To argue that the premises of the theory are mutally inconsistent.
I guess it is a matter of taste which approach you think is strongest. I have a preference for the second.