1
THE CHICAGO SCHOOL
Whom Did the Chicago School Benefit or Seek to Benefit?
Advocates of the Chicago view helped persuade the general public and elected
officials that the competitive market system, when the government stays out of it as
much as possible, leads to the most economic freedom, which in turn leads to the
most economic well-being for everyone. So long as this claim is true, the Chicago
view is good for society as a whole.
The more widespread acceptance of Chicago views has helped many business
interests. Some people have pushed for and helped spread these ideas. The new
classical economists have helped show why there should be less paperwork and rules
from the government. They have also said, to the delight of many businesses, that
monopolies don't matter or don't last long, that corporate mergers are a necessary part
of the "market for corporate control," and that advertising helps create a competitive
market by telling consumers about the different options they have. One could also say
that the Chicago economists helped high-income groups by making the case that the
tax system should be used to raise money and not to redistribute income.
But the ideas of the Chicago school "cut both ways." For example, they stop the
government from doing things like giving loans to companies that are going bankrupt
or putting limits on how much foreign goods can be brought in. In the same way, they
don't like barriers that aren't real, like unnecessary licence that make it hard for new
people to get into certain jobs and raise pay for those jobs.
SEEK TO BENEFITS
On the other hand, groups and people who depend on the government for subsidies,
jobs, rules, or special laws stand to lose if Chicago school policies are accepted
politically. For example, farm groups that want price supports and subsidies from the
government have been against the Chicago view. Unions and professional groups that
represent government workers have also spoken out against Chicago-style economics
in a strong way. Also against these ideas are government officials whose jobs and
incomes depend on how the government regulates economic activity. Even though
2
many of the more recent economists from the Chicago school are not interested in
politics, the school as a whole did a lot to help conservatives in the United States. As
Melvin W. Reder, a member of the Chicago school himself, said:
1. The Chicago School's tremendous success in the third quarter of this century was
largely a result of its ability to play a leading role in both scientific research and the
promotion of political conservatism.
2. Due to Friedman and Stigler's and their lucky mix of scientific ability and
explanatory competence, as well as probably even more so due to the bankruptcy of
After World War II, there was an intellectual conservatism.
3. The political right had very little intellectual backing as a result of the Great
Depression's ability to discredit laissez-faire capitalism and Hitler's ability to cast
doubt on any form of nationalistic-conservative theory.
4. Although there were other advocates of laissez-faire (such as the Mises group), [the
Chicago economists] had a significant advantage in the decades that followed 1945
when competing for the attention and support of the conservative public due to their
high professional standing, academic positions, and proficiency in non-technical
communication.
3
How Was the Chicago School Valid, Useful,
or Correct in Its Time?
1.Preserve the legacy of Classical, Marginalist and Neo-Classical Economics
Chicago school maintained and strengthened the marginalist tradition at a time when
it had diminished popularity. It helped preserve the long legacy of classical and Neoclassical economics, while the Keynesian revolution was dominating the intellectual
scene. Economists have once again turned to microeconomics analysis to expand their
insights into the issues of the day, including those that previously seemed to be the
exclusive domain of macroeconomic theorists. Example; the analysis of
unemployment now includes emphasis on the microeconomics theories of job search
and inter-temporal substitution between work and leisure.
2. Keeping Alive The Monetary Views Of Fisher
Fisher monetary view could have become permanently buried by the weight of
Keynesian ideas. The rapid inflation of the 1970s and early 1980s turned the nations
attention away from the main concern of Keynesianism (unemployment) -concern of
Fisher and Friedman (inflation) The simultaneous economics problem led many
Keynesians to call for incomes policies, although they acknowledged that such
policies would likely produce negative side-effects on efficiency. The new classicists
arguing - long-run trade-off between inflation and employment was illusory,
preserved the optimistic classical perspective that economic efficiency, price stability
and a natural rate of full employment are mutually attainable.
Which Tenets of the Chicago School Became
Lasting Contributions?
Major Tenets
1. Mathematical Orientation(Using both the marshallian partial equilibrium
method and the walrasian general equilibrium)
2. Rejection of Keynesian (The economy is self adjusting and regulating with
minor fluctuations being self-limiting)
3. Limited Government (Government regulations normally benefits those who seek
the regulations)
4
The New Classical Ideas Have Already Penetrated Deeply Into The Curriculum
Of U.S. Universities.
1.Discussions of a natural rate of unemployment, rational expectations, a long-run
vertical Philips curve and short run versus long-run aggregate supply.
2.The Chicago theories of human capital, household production, job search and
discrimination all are discussed within textbooks on contemporary labor economics.
3.The case for flexible foreign exchange rates is standard fare in international
economics textbooks.
4. The Coase theorem of externalizes, although still controversial, is treated in
textbooks on public finance and environmental economics.
The Coase theorem of externalities is A theory that bargaining between individuals
or groups over property rights will lead to an optional and efficient outcome
5
GARY S.BECKER
IDEAS / THEORIES
DISCRIMINATION
Gary Baker is a sociologist and professor who has studied discrimination and its
effects on various marginalized groups. One of his key theories is that discrimination
operates at both individual and institutional levels, and that it creates and perpetuates
inequality through a variety of mechanisms.
At the individual level, discrimination can take the form of prejudice, bias, and
stereotype-based behaviors, which result in unequal treatment of individuals based on
their race, gender, sexual orientation, or other identity characteristics.
At the institutional level, discrimination operates through policies, practices, and
norms that reinforce and normalize existing inequalities, such as discriminatory hiring
practices, unequal pay scales, and a lack of representation in leadership positions.
Baker argues that addressing discrimination requires a multi-faceted approach that
addresses both individual attitudes and institutional structures. This may involve
education and awareness-raising initiatives, as well as the implementation of antidiscrimination laws and policies that address the root causes of inequality and create
more equitable outcomes.
Overall, Gary Baker's theory highlights the interconnections of discrimination and its
impact on individuals and society, and underscores the importance of addressing both
individual biases and systemic inequalities in order to create a more just and equitable
world.
The demand for preferred personnel will be higher than it would be without the
preference for discrimination if the broader economy has positive discrimination
coefficients. As a result, preferred workers will be paid more on the market than
equally productive unpreferred ones. This fact has a significant implication:
Companies who discriminate will pay greater wages than employers who do not.
Businesses that practise discrimination will be required to pay a salary premium or
6
"price" for their preferences. Employing the equally productive unpreferred workers
at the lower wage gives companies that lack this taste for discrimination—or whose
preference is low compared to the wage differential—a cost advantage over their
discriminating rivals. Theoretically, in a competitive market economy, only the
lowest-cost producers can remain over time; discriminators will have average costs
that are higher than the market-determined price, which means they will experience
losses.
Therefore, Becker's thesis is in line with the more comprehensive New Classical
perspective: Long-term costs imposed by the competitive market system on
discriminators will lead to a decline in all forms of discrimination, including those
based on gender, ethnicity, and religion. The government's responsibility in
accelerating this process should be to defy interest group efforts to obstruct the
freedom of occupation choice.
INVESTMENT IN HUMAN CAPITAL
Gary Baker's theory of investment in human capital argues that individuals,
governments, and organizations should invest in the development of human capital as
a means of promoting economic growth and prosperity. Human capital refers to the
knowledge, skills, abilities, and other attributes that individuals bring to the workforce
and contribute to their productivity and earning potential.
According to Baker, investment in human capital can take many forms, including
education and training, health and wellness initiatives, and support for career
development. He asserts that these investments can have a significant impact on an
individual's earning potential and quality of life, as well as the overall health of the
economy.
Baker argues that investment in human capital is particularly important in today's
rapidly changing global economy, where technological advancements and
globalization are rapidly transforming the nature of work and the skills that are
required for success. He believes that investment in human capital is a key factor in
ensuring that individuals and organizations are able to adapt and thrive in this rapidly
changing environment.
7
In addition to promoting individual success, Baker argues that investment in human
capital can also contribute to the overall well-being of society, by creating a more
educated and skilled workforce, reducing income inequality, and promoting economic
growth. He argues that investment in human capital should be a top priority for
governments and organizations, as it is essential for creating a more prosperous and
sustainable future.
Overall, Gary Baker's theory on investment in human capital emphasizes the
importance of investing in individuals and the development of their skills and abilities
as a means of promoting economic growth and prosperity, both at the individual and
societal levels.
THEORY OF THE ALLOCATION OF TIME
Gary Baker's theory of the allocation of time suggests that individuals and organizations
allocate their time and resources in ways that reflect their priorities and values. According to
Baker, the allocation of time is a key factor in determining an individual's or organization's
level of success and well-being, as it impacts their ability to achieve their goals and fulfill
their responsibilities.
Baker argues that the allocation of time is shaped by a variety of factors, including personal
values and priorities, societal expectations, and organizational culture. He suggests that
individuals and organizations can optimize their allocation of time by aligning their priorities
and values, and by making conscious and deliberate decisions about how they allocate their
time and resources.
In addition to the impact of individual and organizational priorities and values, Baker also
recognizes that external factors, such as economic conditions, technological advancements,
and social and political changes, can influence the allocation of time. He argues that
individuals and organizations must be flexible and adaptable in their allocation of time in
order to respond to these changing circumstances and achieve their goals.
Baker believes that the optimal allocation of time is a key factor in promoting individual and
organizational success, and that individuals and organizations that allocate their time and
resources in ways that align with their goals and values are likely to experience greater levels
of satisfaction and well-being.
8
Overall, Gary Baker's theory of the allocation of time emphasizes the importance of aligning
personal values and priorities with the allocation of time and resources, and recognizes the
influence of external factors on this process. It highlights the need for individuals and
organizations to make conscious and deliberate decisions about how they allocate their time
and resources in order to achieve their goals and fulfill their responsibilities
ON THE FAMILY
1.THEORY OF MARRIAGE
Marriage allows for a division for labour that enables partners to maximize their joint
production and consumption of commodities Normally, "positive sorting" between
"high quality" man and female develops during marriage. The complementary nature
of production is the factor. The beneficial characteristics of one partner boost their
marginal contribution to generate full income.
2. FERTILITY
Families produce children, which add to the family's full income, or economic welfare.
But families do not produce as many children as would be biologically possible
because they are costly. As wage opportunities increase for women, the price of each
child increases (the opportunity cost rises). Parents opt to have fewer, but "higherquality" (healthier, better-educated) children.
3. ALTRUISM
A person is altruistic when her or his utility increases because someone else's utility
rises. Altruism adds to the potential gains from marriage, because consumption of a
commodity enables utility to rise by more than the rise in utility to the consumer. One
family member's joy adds to other family members' joy.
Becker's theorem states that altruism in the family will tend to overcome selfishness.
Translated: Even the most troublesome children won't want to do anything that could
reduce their potential inheritance. Each beneficiary, no matter how selfish, maximizes
the family income of his benefactor.
9
Selfish kids recognize that harming the family comes at the expense of harming
themselves. But the restraining effect of altruism on self-interest diminishes with the
number of benefactors. The idea here is that an action that reduces the family's full
income will result in the altruistic head of the family having less full income to
transfer.
4.DIVORCE
Divorce are more likely early in the marriage than later because accumulation of
information occurs during the first few year of marriage. The increase in the market
productivity of women reduces the gains from specialization and increases the
QUESTION
Use Becker’s theories to explain each of the following:
(a) Discrimination will be costly to a firm operating in a competitive environment.
(b) Young people on average receive more schooling and on-the-job training
than older people.
(c) The number of meals consumed at restaurants in the United States has
increased more rapidly than the number consumed at home.
(d) Altruism adds to the potential gains from marriage.
ANSWER:
(a) According to Becker's theories, discrimination will be costly to a firm operating in
a competitive environment because it will lead to the firm losing out on the best
workers, who may be discouraged from applying due to the discrimination, and thus
reducing its efficiency and productivity. In addition, the firm may incur legal costs
and reputation damage if the discrimination is brought to light. (Becker, 2019)
(b) Becker's theories suggest that young people on average receive more schooling
and on-the-job training than older people because of the higher returns to these
investments for young people, who have longer periods of time to benefit from them.
This is due to the higher productivity gains from education and training, which are
10
likely to be larger when young people are involved, as well as the lower costs
associated with offering such investments to young people. (Becker, 2019)
(c) According to Becker's theories, the number of meals consumed at restaurants in
the United States has increased more rapidly than the number consumed at home
because of the convenience of eating out, which is especially attractive for working
individuals who may not have the time or energy to prepare meals at home.
Additionally, there is a higher level of leisure-time activities associated
d) Becker's theory of the family and household explains that altruism adds to the
potential gains from marriage by explaining that individuals benefit from exchanging
goods and services within the household as well as from mutual support and
companionship. This theory suggests that altruistic behavior, such as caring for a
spouse, can increase the potential gains from marriage by reducing the costs of
household production and increasing the overall well-being of both partners
MILTON FRIEDMAN
1. Milton Friedman was one of the most influential economists of the 20th century
and a key figure in the development of the Chicago School of economics.
2. His primary contribution to the field of economics was his monetarist philosophy,
which argued that the money supply was the primary determinant of economic
activity.
3. He also believed in free markets and advocated for deregulation and a free-floating
exchange rate system.
4. Friedman's views on monetary policy were based on his belief that the government
should not be involved in the money supply and that the money supply should be
determined by the market, not by government intervention.
5. He was also a strong advocate for tax cuts, believing that lower taxes would lead to
increased economic growth.
11
6. His theory of the "natural rate of unemployment" argued that there was a point
where, even with full employment, wages and prices would not rise further since the
economy was at full capacity.
7. He argued that an economy could operate at full employment without inflation,
provided there was enough aggregate demand and that the money supply was not
increased too quickly.
8.Friedman also argued that inflation was caused by increases in the money supply,
and not by the demand.
Some key ideas associated with the Chicago School include:
Neoliberalism: The Chicago School is associated with neoliberalism, which is a
political and economic ideology that prioritizes individual freedom and marketoriented policies.
Methodological individualism: The Chicago School argues that economics should
focus on the behavior and decision-making of individual actors rather than aggregates
like firms or industries.
Free market economics: The Chicago School supports the idea that markets are the
best means of allocating resources and producing outcomes that serve the interests of
society as a whole.
Price mechanism: The Chicago School believes that prices, determined by the
interactions of supply and demand, serve as the main mechanism for coordinating
economic activity and allocating resources.
Efficiency: The Chicago School emphasizes that market outcomes are efficient and
that intervention in markets should be limited to promote efficiency and prevent
market failure.
MILTON’S IDEA/THEORY
1. Consumption Function
2. Monetary Theory
3. Economic Liberalism
12
13
CONSUMPTION FUNCTION
In 1957, Friedman published a Theory of The Consumption Function book, he
suggested that The Keynesian Consumption Function is too simplistic. Household's
consumption determined by permanent income rather than current income, where
permanent income is defined as the average income (people expect to receive over a
period of years)
Changes in income that considered to be temporary will neither greatly increase nor
decrease people's present consumption .It responds only to changes in income that
people view to be permanent and long-lasting
Implication: Marginal propensity to consume out of changes in current income is
smaller than the Keynesian theory would suggest.
MONETARY THEORY
THE DEMAND FOR MONEY
(i) Total Wealth
Including human capital, measured by permanent income,
Permanent income Increases, the amount of money people desire to hold as cash
balances also increases
(il) Cost of Holding Money
increase costs, decrease money being held.
Costs vary with interest rate, the expected rate of inflation,and the price level.
(in) Preferences
Basic attitudes, holding and using cash
Remain relatively constant "over significant stretches of space and time"
14
MODERN QUANTITY THEORY OF MONEY
Friedman says that in the short run, the demand for money is pretty stable. The Fed
System controls how much money is in circulation. If the number of dollars in
circulation goes up, people will have more cash than they need. They will spend cash
and write checks to try to get rid of these extra transaction assets.
(literally about bekalan wang)
But the community as a whole can't get rid of its extra cash because when one person
spends money, it ends up in the billfold or chequebook of someone else. So, people
trying to get rid of their cash balances will increase the demand for goods and services,
which will increase production, prices, or a mix of both.
-The demand of money increases because the community desire to
hold additional money to buy the higher priced goods.
-Inflation stated by Friedman, is always and everywhere a monetary
phenomenon produced in the first instance by an unduly rapid
growth in the quantity of money.
So, Friedman says that the modern quantity theory of money is proven. It doesn't
assume that velocity is constant, like the older quantity theory did. Instead, it says that
the demand for money is "highly stable—more stable than functions like the
consumption function that are offered as alternative key relations."
15
THE CAUSE OF THE GREAT DEPRESSION
1. Most economists at the time, including Keynes, thought that the Great Contraction
in the United States happened even though the monetary authorities tried hard to grow
the economy.They did their best, but it wasn't enough.
2. Recent studies have shown that the facts are exactly the opposite: the U.S.
government's monetary policy was very deflationary.
3.During the contraction, the amount of money in the United States dropped by onethird.
4.And it went down not because no one wanted to borrow it .It went down because the
Federal Reserve System forced or allowed a sharp drop in the monetary base.
5.This happened because it didn't do what the Federal Reserve Act said it should do to
keep the banking system liquid.
6.The Great Depression is a sad example of how powerful monetary policy is, not
how powerless it is, as Keynes and many of his contemporaries thought.
THE LONG RUN VERTICAL PHILIPS CURVE
Each short-run Phillips curve shows the combinations of inflation and
unemployment that are possible when the actual rate of inflation diverges from
the expected rate. When inflation is greater than expected, such as P2 rather
than P1, unemployment temporarily falls below its natural rate (from Un to
U1, as shown at b). But once P2 becomes the new expected rate, the short
run Phillips curve shifts from SRPC1 to SRPC2 and the rate of unemployment
returns to its natural level (point c). In the long run, said Friedman, there is
no trade-off between inflation and unemployment. The long-run Phillips
curve is vertical, indicating that any one of several rates of inflation is
compatible with the natural rate of unemployment.
16
THE MONETARY RULE
The Fed should stop making decisions about monetary policy on its own and stick to
the monetary rule, which says that the money supply should grow every year at a
steady rate roughly equal to the long-run rate of growth of capacity. There are four
reasons why there needs to be such a rule.
1. How the Fed has done in the past. Friedman says, "Throughout the Fed's history, it
has said that it was using its power to help keep the economy stable. But what we
know doesn't back up this claim. On the other hand, the Fed has caused a lot of
instability.
2. Limitations of economic knowledge.What we don't know about economics. There
are time lags between changes in the amount of money in circulation and changes in
output and prices, and these time lags vary and are hard to predict. Trying to fine-tune
the economy is just as likely to make things worse as it is to fix them.
3Confidence. With a monetary rule, businesses, consumers, and workers would be
able to sign contracts knowing that the Fed wouldn't change things on them later.
4.Neutralization."A monetary rule would protect monetary policy from both the
random power of a group of men who aren't accountable to the voters and the shortterm pressures of partisan politics.
17
ECONOMIC LIBERALISM
-He was reffering, to the economic liberalisme that we associate with the classical
economists who emphasized economic freedom.
-Over the years he advocated a series of reform that would place less reliance on
goverment and more reliance on the market.
-Friedman also say political freedom not only economic freedom.
-Friedman's reform have been enacted liked proposals include an international system
of flexible, market-determined foreign exchange rates.
-Friedman's admires and critics alike agree that he helped establish that money
'matters' in the economy.
-The also would agree that Friedman himself made a difference.
QUESTION
What are the major determinants of the demand for money, according to
Friedman? Is this demand stable or unstable in the short run? How does an
increase in the supply of money that exceeds the long-run growth of output
cause a rise in the general price level?
ANSWER
According to Milton Friedman, the demand for money is primarily determined by
three factors: transactions demand, precautionary demand, and speculative demand.
Transactions demand refers to the demand for money to make payments for goods
and services. This demand depends on the level of economic activity, which in turn
depends on income and the price level.
Precautionary demand refers to the demand for money to guard against unexpected
changes in income or prices. This demand increases with income and the level of
uncertainty.
18
Speculative demand refers to the demand for money as a store of value, which can
be invested in financial assets. This demand depends on interest rates and the
expected rate of return on alternative investments.
Friedman believed that the demand for money is relatively stable in the short run but
can become unstable in the long run. In the short run, changes in the supply of money
affect mainly the price level, while in the long run, changes in the supply of money
also affect output and employment.
According to Friedman, if the supply of money increases at a rate that exceeds the
long-run growth of output, the general price level will rise. This is because the
increase in the supply of money leads to an excess supply of money, which puts
upward pressure on prices. The rise in the price level reduces the real value of money
and thus reduces the demand for money, which reduces the excess supply and
eventually stabilizes the price level.
Question
Explain this quote by Friedman: “A rising rate of inflation may reduce
unemployment, a high rate will not.”
Answer
This quote by Milton Friedman highlights his belief in the trade-off between inflation
and unemployment in the short run, as expressed by the Phillips curve. According to
this idea, there is a short-run negative relationship between inflation and
unemployment, meaning that an increase in inflation can reduce unemployment and
vice versa. However, Friedman argued that this trade-off is only temporary and cannot
be sustained in the long run. He believed that a rising rate of inflation, no matter how
low, would reduce unemployment in the short run by boosting expectations of higher
nominal wages and encouraging more spending. But a high rate of inflation, which
would result from continued increases in the money supply, would not reduce
unemployment in the long run because it would erode the real value of money, reduce
economic efficiency, and lead to higher nominal wages without corresponding
increases in productivity. In essence, Friedman was saying that a modest and gradual
increase in inflation can have a positive effect on unemployment in the short run, but
once inflation reaches a high level, it will not continue to have this effect and will
instead lead to negative economic consequences.