Università degli Studi di Torino
DOTTORATO IN
ECONOMIA DELLA COMPLESSITA’ E DELLA CREATIVITA’
LECTURES ON
THE HISTORY OF ECONOMIC THOUGHT
ECONOMIC THEORY IN THE XXth CENTURY
ROBERTO MARCHIONATTI
(University of Torino)
1
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
THE CURRENT STATUS OF H.E.T. AMONG
MAINSTREAM ECONOMISTS
• MAINSTREAM = THE IDEAS THAT ARE HELD BY THOSE
GROUPS WHO ARE DOMINANT IN THE LEADING ACADEMIC
INSTITUTIONS AND JOURNALS AT ANY GIVEN TIME
• “NO HISTORY OF IDEAS, PLEASE, WE’RE ECONOMISTS”
•THE RESULT OF THE CONCEPTION OF ECONOMICS
PREVAILING AFTER 1945
• A PECULIAR KIND OF HISTORIOGRAPHY:
–G. STIGLER: THE EFFICIENT MARKET OF IDEAS
–P. SAMUELSON: A “WHIG” HISTORY OF SCIENCE
• H.E.T. AS A “RATIONAL RECONSTRUCTION”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
SCHUMPETER’S SOPHISTICATED PERSPECTIVE ON THE ROLE OF H.E.T.
WHY DO WE STUDY THE HISTORY OF ECONOMICS ?
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
SCHUMPETER’S SOPHISTICATED PERSPECTIVE ON THE ROLE OF H.E.T.
WHY DO WE STUDY THE HISTORY OF ECONOMICS ?
•
“WE STAND TO PROFIT FROM VISITS TO THE LUMBER ROOM …:
PEDAGOGICAL ADVANTAGES, NEW IDEAS, AND INSIGHTS INTO THE WAYS
OF THE HUMAN MIND”
•
FIRST, “THE PROBLEMS AND METHODS THAT ARE IN USE AT ANY GIVEN
TIME EMBODY THE ACHIEVEMENTS … THAT HAS BEEN DONE IN THE PAST
… THE SIGNIFICANCE AND VALIDITY … CANNOT BE FULLY GRASPED
WITHOUT A KNOWLEDGE OF THE PREVIOUS PROBLEMS AND METHODS TO
WHICH THEY ARE THE (TENTATIVE) RESPONSE”
“SCIENTIFIC ANALYSIS IS NOT SIMPLY A LOGICALLY CONSISTENT
PROCESS THAT STARTS WITH SOME PRIMITIVE NOTIONS AND THEN ADDS
TO THE STOCK IN A STRAIGHT-LINE FASHION”. RATHER IT IS
“AN INCESSANT STRUGGLE WITH CREATIONS OF OUR OWN AND
PREDECESSORS’ MINDS AND IT ‘PROGRESSES’, IF AT ALL, IN A CRISSCROSS FASHION … AS THE IMPACT OF NEW IDEAS …, AND AS THE …
TEMPERAMENTS OF NEW MEN, DICTATE”
•
•
•
•
SECONDLY, “OUR MINDS ARE APT TO DERIVE NEW INSPIRATION FROM THE
STUDY OF THE HISTORY”
THIRD, THE STUDY OF THE HISTORY “TEACHES US MUCH ABOUT THE
WAYS OF THE HUMAN MIND”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
A NEW CONCEPTION OF ECONOMICS and A NEW
CONCEPTION OF THE HISTORY OF ECONOMICS
•
THE MAINSTREAM PERSPECTIVE HAS BEEN RECENTLY CHALLENGED BY A
CONCEPTION OF ECONOMICS AS A SCIENCE OF SOCIAL COMPLEXITY IN
WHICH HISTORY MATTERS
•
IN THIS PERSPECTIVE, THE “HISTORICAL RECONSTRUCTION” OF THE
ECONOMIC THEORIES RE-ASSUMES AN IMPORTANT ROLE
•
•
•
•
•
MY APPROACH. KEY POINTS:
THE SPECIFICITY OF THE THEORIES TO THE HISTORICAL PERIOD
THE CULTURAL MATRIX AND CONVENTION OF DISCOURSE OF THE
COMMUNITY OF SCHOLARS UNDER FOCUS
THE IMPORTANCE OF THE BIOGRAPHICAL DATA
ECONOMICS PROFESSION AS A DYNAMIC ENTITY WHICH GENERATES AN
EVOLVING SYSTEM OF INTERACTING IDEAS
THIS APPROACH PERMITS:
–
–
TO ACCOUNT FOR THE NON-RECTILINEAR EVOLUTION OF THE THEORIES
TO EMPHASIZE CHANGE AND INNOVATION IN THIS EVOLUTION
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
THE SUBJECT OF THESE LECTURES: THE
EVOLUTION OF THE ECONOMIC THEORY IN THE
TWENTIETH CENTURY
PHASES OF THE ECONOMIC THEORY IN THE TWENTIETH
CENTURY:
• 1890-1914: THE CLASSIC AGE OF MARGINALISM
• 1919-1939: THE “YEARS OF HIGH THEORY”
• THE POST-WAR II PERIOD
• 1940s - 1970s
• 1980s – 1990s
MEN, SCHOOLS &INSTITUTIONS, CENTRES AND PERIPHERIES
(IDEAS HAVE ORIGIN AND GROW BETTER IN SOME
ENVIRONMENTS THAN IN OTHERS)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY
INTRODUCTION
THE EVOLUTION OF THE ECONOMIC THEORY IN THE
TWENTIETH CENTURY PRESENTED IN THE QJE
“WHAT DO ECONOMISTS KNOW NOW THAT MARSHALL AT HIS TIME
DID NOT?”
(BAUMOL,2000, STIGLITZ,2000, BOWLES&GINTIS, 2000)
Two types of answers. They focus:
• On the relation between theory and empirical research (Baumol)
• On the anticipations and intuitions of post-Walrasian economics
(Bowles,Gintis, Stiglitz)
Questions:
• What is the relation between the orthodox and the eterodox side of M?
• Why did M. adopt a loose attitude towards empirical work?
• Why did twentieth-century economics take the Walrasian path ?
• Is M. to be considered a precursor of contemporary post-Walrasian
economics ?
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE PERIOD 1890-1914: GENERAL CHARACTERISTICS
•
RAPID ECONOMIC GROWTH
•
INCREASE OF THE STANDARD OF LIVING
•
NEW WAVE OF INDUSTRIALIZATION
•
THE LEADERS: GREAT BRITAIN, THEN GERMANY AND UNITED
STATES
•
HIGH INTEGRATION OF THE WORLD ECONOMY AND THE GOLD
STANDARD
•
A GOLDEN AGE (J.M. Keynes)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: MEN AND SCHOOLS
CENTRES OF ECONOMIC THEORY
• Cambridge & Oxford in UK
• Lausanne
• Vienna (and Berlin)
MEN, SCHOOLS, INSTITUTIONS
Marshall, Edgeworth & the
Cambridge School
The Royal Economic Society, 1890
The Economic Journal, 1891
The Cambridge Ec.Tripos, 1903
Walras, Pareto and the Lausanne
School
Bohm-Bawerk, Wieser & the
Austrian School, Marxism,
Historical School,
Neoricardism (Bortkievicz)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: MEN AND SCHOOLS
PERIPHERIES
•
•
IN EUROPE
Sweeden
Italy: Roma and Torino
•
•
•
•
IN UNITED STATES
Johns Hopkins
Columbia, New York
Yale
Harvard
•
Chicago
MEN, SCHOOLS, INSTITUTIONS
Wicksell, Cassel
Pantaleoni & Barone; Einaudi, Jannaccone &
Cabiati
Il Giornale degli Economisti
S. Newcomb, R.T. Ely
J.B. Clark, W.C. Mitchell
I. Fisher
F.W. Taussig
The Quarterly Journal of
Economics
J.L. Laughlin
The Journal of Political Economy
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: THE LEGACY AND
SYSTEMATISATION OF MARGINALIST REVOLUTION
THEORY
A.
CONSUMER & DEMAND
•
THE NATURE OF UTILITY
–
–
•
Psychological Approach
Non-Psychological Approach
MEN AND SCHOOLS
Marshall & Edgeworth (Cambridge)
Pareto, Fisher (Lausanne)
MEASUREAMENT OF UTILITY
–
–
•
Cardinal
Ordinal
Marshall & Edgeworth (Cambridge)
Johnson (Ca.), Pareto&Slutsky (Lo.)
UTILITY & DEMAND
–
Utility Function
–
–
Indifference Curves
Non-Utilitarian Approach
Marshall&Edgeworth&Johnson (Ca.)
Pareto, Fisher (Lo.)
Edgeworth (Ca.), Pareto (Lo.)
Barone, Cassel, Moore
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD …
THEORY
B. MARKET EQUILIBRIUM
– General Equilibrium
– Partial Equilibrium
– Market Structure
– Competition
– Monopoly
– Oligopoly
•
C. DISTRIBUTION
•
D.CAPITAL
MEN AND SCHOOL
Walras&Pareto&Barone (Losanna)
Marshall (Cambridge)
Marshall (Ca.), Austrian school
Marshall (Ca.), Pareto (Lo.)
Marshall&Edgeworth (Ca.)
Wicksteed(UK), Marshall&Edgeworth &Berry&Flux(Ca.)
Walras&Pareto&Barone (Lo.), Wicksell (Stockolm)
Marshall (Ca.), Wieser&Bohm&Schumpeter (Vi.),
Wicksell, Cassel (Sv),
Fisher,Clark(US)
•
E.MONEY
Marshall&Pigou(Ca.), Wicksell, Fisher
•
F.TRADE CYCLE
Marshall et al.(Ca.), Spiethoff et al.(Berlin),
12
Mitchell (Columbia)
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: THE
EMERGENCE OF A MATHEMATICAL SCHOOL
• A CHANGING ATTITUDE IN ECONOMICS: THE ADOPTION OF
THE MATHEMATICAL METHOD OF REASONING, 1871-1915
“The logic of the calculus may be expressed in terms of a small
number of concepts such as variables, functions, limits,
continuity, derivatives and differentials, maxima and minima.
familiarity with these concepts – and with such notions as
systems of equations, determinateness, stability, all of which
admit of simple explanations – changes one’s whole attitude to
the problems that arise from theoretical schemata of
quantitative relations between things: problems acquire a new
definiteness; the points at which they lose it stand out clearly;
new methods of proof and disproof emerge” (SCHUMPETER)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
A PERIODIZATION OF THE CLASSICAL ERA
OF MATHEMATICAL ECONOMICS
• THE EMERGENCE OF MATHEMATICAL
REVOLUTION IN ECONOMICS, 1871-1881 (JEVONS,
MARSHALL, WALRAS)
• SPREAD AND CONSOLIDATON OF THE
MATHEMATICAL METHOD IN ECONOMICS, 1880s1890s (LAUNHARDT, AUSPITZ AND LIEBEN,
PANTALEONI, THE MARSHALLIANS,
WALRAS&PARETO, FISHER, BARONE,
BORTKIEVICZ, MOORE)
• THE ESTABLISHMENT OF THE MATHEMATICAL
APPROACH IN ECONOMICS, 1901-1915 (PARETO
AND THE PARETIANS)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
INTRODUCTION
AN APPRAISAL OF THE CLASSICAL ERA OF MATHEMATICAL
ECONOMICS
•
AT THE BEGINNING SOME ISOLATED PIONEERS
•
IN 1915 MATHEMATICAL ECONOMICS IS AN ACCEPTED, BUT SMALL,
SCHOOL IN ECONOMICS
•
THE EARLIER SCEPTICISM ABOUT APPLYING MATHEMATICS TO
ECONOMICS WAS LARGELY REDUCED
•
SCIENTISTS AND THE USE OF MATHEMATICS IN ECONOMICS: FROM
SCEPTICISM TO (MODERATE) FAVOUR
•
BUT THE GREAT EXPECTATIONS WERE STRONGLY REDUCED: THE
FIELD OF M.E. IS STATIC EQUILIBRIUM; ITS DEFECT: EXTREME
ABSTRACTNESS AND UNREALITY OF ASSUMPTIONS
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
“Marshall’s great work is the classical achievement of the period, that
is, the work that embodies, more perfectly than any other, the classical
situation that merged around 1900”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
LIFE
Educated at St John’s College, Cambridge
•
1868 - lecturer in political economy in Cambridge
•
1877 - Professor of Political Economy at the Bristol University
•
1883 - Professor of Political Economy at the Oxford University
•
1885-1908 – Professor of P.E. at the University of Cambridge
•
1890 – founding member of the Royal Economic Association
•
1891 – founding member of the Economic Journal (first editor F.Y. Edgeworth)
WORKS
• 1879 - The Pure Theory of Foreign Trade; The Pure Theory of Domestic Values
• 1879 - The Economics of Industry
• 1890 - Principles of Economics, first edition (1920, seventh edition)
• 1919 - Industry and Trade
• 1923 - Money, Credit, and Commerce
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
CAMBRIDGE’S CIVILISATION IN THE VICTORIAN AGE
AND MARSHALL’S CONCEPTION OF ECONOMICS
•
•
•
•
•
The Victorian demand: an authoritative social doctrine
The two dominant figures in Cambridge: H. Sidgwick and A. Marshall
“We are not at liberty to exercise ourselves on subtleties which lead nowhere”
Economics for Marshall= applied ethics
The mission: to get economics in a position where it could serve as an engine
for moral progress and instrument of social stability
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE INAUGURAL LECTURE, 1885:
“THE PRESENT POSITION OF ECONOMICS”
•
•
•
•
•
•
•
REFUTATION OF THE HISTORICAL SCHOOL'S CRITICISMS: "FACTS BY
THEMSELVES ARE SILENT“
ON CLASSICAL POLITICAL ECONOMY: CONTINUITY WITH THE CLASSICAL
ECONOMISTS AS FOUNDERS OF ECONOMICS ON A SCIENTIFIC BASIS, BUT:
“THEY REGARDED MAN AS … A CONSTANT QUANTITY … [THEY DID NOT
ALLOW FOR] HUMAN PASSIONS, INSTINCTS AND HABITS ... THEY
THEREFORE ATTRIBUTED TO THE FORCES OF SUPPLY AND DEMAND A
MUCH MORE MECHANICAL AND REGULAR ACTION THAN THEY ACTUALLY
HAVE”
“MAN HIMSELF IS IN A GREAT MEASURE A CREATURE OF CIRCUMSTANCES
AND CHANGE WITH THEM"
ECONOMICS IS INDEBTED TO THE SCIENTIFIC MOVEMENT FOR THIS
CHANGE, PARTICULARLY TO BIOLOGY
THE FUNCTION OF ECONOMIC THEORY: SUPPLYING A MACHINERY “TO AID
US IN REASONING ABOUT THOSE MOTIVES OF HUMAN ACTION WHICH ARE
MEASURABLE”
THE ECONOMISTS WORKS “IN THE LIGHT OF FACTS”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
“THE PRESENT TREATISE IS AN ATTEMPT TO PRESENT A MODERN
VERSION OF OLD DOCTRINES WITH THE AID OF THE NEW WORK,
AND WITH REFERENCE TO THE NEW PROBLEMS, OF OUR OWN
AGE”
THE STRUCTURE OF THE BOOK
–
–
–
–
Book I Preliminary survey
Book II, Some fundamental notions
Book III, On Wants and their Satisfaction
Book IV, The Agents of Production. Land, Labour, Capital and
Organization
– Book V, General Relation of Demand, Supply and Value
– Book VI, The Distribution of National Income
– Appendices
20
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
ON THE NATURE AND METHOD OF ECONOMICS: THE PRINCIPLES
•
•
•
The subject of Economics: “a study of men as they live and move and
think in the ordinary business of life”
Economics as a science:
"The methods required for this work are not peculiar to economics;
they are the common property of all sciences. All the devices for the
discovery of the relations between cause and effect, described in
treatises on scientific method, have to be used .. by the economist:
there is no any one method of investigation which can properly be
called the method of economics"
However, economics differs from the ‘harder’ sciences:
“Every cause has a tendency to produce some definite result if
nothing occurs to hinder it .. The law of gravitation states how any two
things attract one another; .. they will move towards one another if
nothing interferes to prevent them. The law of gravitation is therefore a
statement of tendencies. It is a very exact statement … Now there are
no economic tendencies which act as steadily and can be measured
as exactly as gravitation can: and consequently there are no laws of
economics which can be compared for precision with the law of
21
gravitation”
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
ON THE NATURE AND METHOD OF ECONOMICS: THE PRINCIPLES
•
ECONOMICS IS A SCIENCE OF SOCIAL COMPLEXITY
“Progress or evolution, industrial and social, is not mere increase and
decrease. It is organic growth, chastened and confined and
occasionally reversed by decay of innumerable factors, each of which
influences and is influenced by those around it; and every such
mutual influence varies with the stages which the respective factors
have already reached in their growth”
•
THIS COMPLEXITY HAS SEVERAL FACETS
“The forces of which economics has to take into account are more
numerous, less definite, less well known, and more diverse in
character than those of mechanics; while the material on which they
act is more uncertain and less homogeneous”
•
LAWS OF ECONOMICS AND LAWS OF BIOLOGY
“Economics, like biology, deals with a matter, of which the inner
nature and constitution, ... are constantly changing”
22
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
ON THE NATURE AND METHOD OF ECONOMICS: THE
PRINCIPLES
•
HOW DOES THE ECONOMIST HAVE TO DEAL WITH COMPLEXITY ?
"The work to be done is so various that much of it must be left to be
dealt with by trained common sense”
“Economic science is but the working of common sense aided by
appliances of organised analysis and general reasoning, which
facilitate the task of collecting, arranging, and drawing inferences from
particular facts”
•
IMPLICATION FOR THE LANGUAGE OF ECONOMICS: EVERYDAY
LANGUAGE MAKES IT POSSIBLE TO MAINTAIN THE SHADES OF
MEANING THAT IN COMMON USE EVERY WORD HAS, WHICH CAN BE
INTERPRETED “BY THE CONTEXT”:
“The economist … must make the terms in common use serve his
purpose in the expression of precise thought, by the aid of qualifying
adjectives or other indications in the context. If he arbitrarily assigns a
rigid exact use to a word which has several more or less vague uses in
23
the market place, he confuses business men, and he is in some
danger of committing himself to untenable positions”
•
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
ON THE NATURE AND METHOD OF ECONOMICS: THE PRINCIPLES
WHAT IS THE ROLE OF ABSTRACT REASONING IN ECONOMICS?
• “There is a fairly close analogy between the earlier stages of
economic reasoning and the devices of physical statics. But is
there an equally serviceable analogy between the later stages
of economic reasoning and the methods of physical dynamics
? I think not. I think that in the later stages of economics better
analogies are to be got from biology than from physics; and
consequently, that economic reasoning should start on
methods analogous to those of physical statics, and should
gradually become more biological in tone”
• “The most helpful applications of mathematics to economics
are those which are short and simple, which employ few
symbols; and which aim at throwing a bright light on some
small part of the great economic movement rather than at
representing its endless complexities”
24
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
ON THE NATURE AND METHOD OF ECONOMICS: THE PRINCIPLES
WHAT IS THE ROLE OF ABSTRACT REASONING IN ECONOMICS?
•
•
“It is obvious that there is no room in economics for long trains of
deductive reasoning … It may indeed appear at first sight that the
contrary is suggested by the frequent use of mathematical formulae in
economic studies. But on investigation it will be found that this
suggestion is illusory … [The mathematician] takes no technical
responsibility for the material”
“While a mathematical illustration of the mode of action of a definite
set of causes may be complete in itself, and strictly accurate within its
clearly definite limits, it is otherwise with any attempt to grasp the
whole of a complex problem of real life, or even any considerable part
of it, in a series of equations. For many important considerations,
especially those connected with the manifold influences of the
element of time, do not lend themselves easily to mathematical
expression”
25
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM
• A COMBINED ANALYSIS OF OF BOOKS IV AND V
• BOOK IV
– COMPETITION AS A PROCESS: IT RESTS ON THE
‘OPENNESS OF MARKETS’ NOT ON ATOMISTIC PRICETAKING BEHAVIOUR
– THE ANALYSIS OF COMPETITION GOES ALONG WITH THE
THEORY OF THE FIRM’S GROWTH
• BOOK V: "GENERAL RELATIONS OF DEMAND,
SUPPLY AND VALUE"
26
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM
BOOK V
• IT IS THE ‘THEORETICAL’ BOOK OF THE VOLUME: “The word
‘Theory’ applies to the title of that book alone. It deals with
abstractions”
• MECHANICAL EQUILIBRIUM:
“a simpler balancing of forces which corresponds rather to the
mechanical equilibrium of a stone hanging by an elastic string,
or of a number of balls resting against one another in a basin”
27
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM
BOOK V
•
•
•
•
THE THEORY OF VALUE IS STUDIED WITH REGARDS TO THE NORMAL COST
OF PRODUCTION OF A COMMODITY UNDER THE CETERIS PARIBUS
HYPOTHESIS
FIRST STEP: EQUILIBRIUM OF NORMAL DEMAND AND SUPPLY OF A
COMMODITY THAT OBEYS THE LAW OF DIMINISHING RETURNS
SECOND STEP: EQUILIBRIUM WITH REFERENCE TO SHORT AND LONG
PERIODS
THIRD STEP: LONG TERM EQUILIBRIUM & THE REPRESENTATIVE FIRM:
IT “MUST BE ONE WHICH HAS A FAIRLY LONG LIFE, AND FAIR SUCCESS,
WHICH IS MANAGED WITH NORMAL ABILITY, AND WHICH HAS NORMAL
ACCESS TO THE ECONOMIES, EXTERNAL AND INTERNAL, WHICH BELONG
TO THAT AGGREGATE VOLUME OF PRODUCTION”
EQUILIBRIUM "AS RESEMBLING A BALANCING OF FORCES OF LIFE AND
DECAY"
28
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM
DIFFICULTIES
•
•
•
The difficulty of assuming the ceteris paribus condition “reach their
highest point in connection with industries which conform to the law
of Increasing Returns”
Long-term supply curves in relation to such industries are irrealistic:
“[They] are fascinatingly clear and vivid, but they are made too clear
and vivid to be at all near to reality”
“Abstract reasoning as to the effects of the economies in production,
which an individual firm gets from an increase of its output are apt to
be misleading, not only in detail, but even in their general effect. This
is nearly the same as saying that in such case the conditions
governing supply should be represented in their totality. They are …
especially troublesome in attempts to express the equilibrium
conditions of trade by mathematical formulae”
29
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM. FROM MECHANICAL
EQUILIBRIUM (BOOK V) TO BIOLOGICAL EQUILIBIRUM (BOOK IV)
•
Starting point: the Smithian division of labour concept
– the chief advantage of d.l.: machinery supplants purely manual skill
– the chief effect of improvement of machinery: “to cheapen and make more
accurate the work which would anyhow have been subdivided”
– d.l. generates increasing returns
– d.l. tends “to increase the scale of manufactures and to make them more
complex .. therefore to increase the opportunities for d. l. of all kinds”
•
The economies of production permitted by the division of labour:
– internal economies: “those dependent on the resources of the individual
houses of business engaged in it, on their organisation and the efficiency
of their management”
– external economies: “those dependent on the general development of the
industry”
30
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM. EXTERNAL AND
INTERNAL ECONOMIES
EXTERNAL ECONOMIES (discussed in connection with “the
concentration of specialised industries in particular localities”)
•
internal to the industry
•
inter-industrial
Typology:
•
dissemination of skill and know-how in the district-areas
•
diffusion of inventions and improvements in machinery and in the
general organisation of business
•
growth of subsidiary trades in the neighbourhood
•
increasing availability of entrepreneurial ability
•
a local market for special skill
Moreover, Marshall stresses that:
•
The e.e. are by their own nature essentially inter-industrial
•
They are partial irreversible
31
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE THEORY OF COMPETITIVE EQUILIBRIUM. EXTERNAL AND
INTERNAL ECONOMIES
INTERNAL ECONOMIES
• “economy of skill”
• “economy of machinery”
• the capability to exploit economies of buying and selling
32
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
MARSHALL VERSUS COURNOT
• Cournot: Exploiting increasing returns a firm becomes a monopoly
• Marshall: I. R. and competition can co-exist
MARSHALL’S REASONING
• as much as factors such as skill, inventiveness and
entrepreneurial energy, needed to exploit potential internal
economies, exist, a firm can growth rapidly
• Yet, the tendency to monopolisation is not inevitable because
the rise of diminishing returns in the life cycle of the firm
opposes it
• Monopolisation of the market on behalf of a firm can at the
most be partial and temporary limited
33
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE ECONOMICS OF MARSHALL: THE PRINCIPLES
THE TYPICAL ‘CYCLE OF LIFE’ OF A FIRM
An able man, assisted perhaps by some strokes of good fortune, gets a firm footing in the trade, he works
hard and lives sparely, his own capital grows fast, and the credit that enables him to borrow more capital
grow still faster; he collects around him subordinates of more than ordinary zeal and ability; ...
Corresponding to this steadily increasing economy of skill, the growth of his business brings with it similar
economies of specialised machines and plants of all kinds; every improved process is quickly adopted and
made the basis of further improvements; success brings credit and credit brings success; credit and success
help to retain old customers and to bring new ones; the increase of his trade gives him great advantages in
buying; … and thus diminish his difficulty in finding a vent for them. The increase in the scale of his
business increases rapidly the advantages, which he has over his competitors, and lowers the price at which
he can afford to sell. This process may go on as long as his energy, his inventive and organising power retain
their full strength and freshness; and … he and one or two others like him would divide between them the
whole of that branch of industry in which he is engaged … But here we may read a lesson from the young
trees of the forest as they struggle upwards through the benumbing shade of their older rivals. Many
succumb on the way, and a few only survive; those few become stronger with every year, they get a larger
share of light and air with every increase of their height, and at last in their turn they tower above their
neighbours, and seem as though they would grow on for ever ... But they do not. One tree will last longer in
full vigour and attain a greater size than another; but sooner or later age tells on them all. Though the taller
ones have a better access to light and air than their rivals, they gradually lose vitality; and one after another
they give place to others, which … have on their side the vigour of youth.
And as with the growth of trees,
so was it with the growth of businesses … In every trade there is a constant rise and fall of large businesses,
34
at any moment some firms being in the ascending phase and others in the descending
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
ALFRED MARSHALL(1842-1924)
THE CONCEPT OF ‘BIOLOGICAL EQUILIBRIUM’
•
•
•
•
“A business firm grows and attains great strength, and afterwards
perhaps stagnates and decays; and at the turning point there is a
balancing of equilibrium of the forces of life and decay”
this ‘business firm’ is typical, or representative, from a ‘biological
point of view’: it represents the typical growth path of a firm
With the representative firm, M. brings together the equilibrium of the
industry and the disequilibrium of the individual firms of the industry,
in which some firms are rising and others are declining
“a fine distinction between ‘theory’ and ‘real life’ in Marshall’s
economics is impossible to draw because Marshall himself did not
draw it, and never tired of warning others against drawing it”
(Chamberlin)
THE LESSON
• the abstract reasoning, the chain of theoretical deductions, has to be
limited: absolute rigour means neglecting time and irreversibilities and
so come to the wrong conclusions
35
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE MARSHALLIANS
•
•
•
•
Within the English-speaking world, Marshallian economics was the dominant
form of Neoclassicism from the 1890s to the 1920s.
It relied on practical, intuitive arguments rather than mathematical formalism taking into account items such as institutional and industrial structure and real
world phenomena, such as uncertainty, money and business cycles. Its main
focus was on representative conditions, rather than idealized conditions.
It was a leading force in the professionalization of economics and its
establishment as an independent entity in academia. The Marshallian formula
was exported to the United States in the hands of Frank Taussig at Harvard and
to Italy by Maffeo Pantaleoni.
Cambridge Marshallians
H.H. Cunynghame (1848-1935)
John Neville Keynes (1852-1949)
A.W. Flux (1867-1942)
Sir John H. Clapham (1873-1946)
Arthur Cecil Pigou (1877-1959)
Ralph G.Hawtrey (1879-1971)
Frederick Lavington (1881-1927)
John Maynard Keynes (1883-1946)
Walter Layton (1884-1966)
Dennis H. Robertson (1890-1963)
36
Gerald F. Shove (1887-1947)
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE MARSHALLIANS
Cambridge Marshallians
J.N. Keynes
Pigou
Hawtrey
J.M. Keynes
Robertson
37
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
WALRAS’S LEGACY
Léon Walras (1934-1910)
• Professor of political economy at Lausanne (1870-93)
• Works:
– Eléments d’économie politique pure (1874-77, 1889, 1900)
– Etudes d’économie sociale, 1896
– Etudes d’économie politique appliquée, 1898
38
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
WALRAS’S LEGACY
• The idea of the general economic equilibrium: “Walras’s claim
to immortality”
• The origin of W.’s formulation of G.E.T.: Louis Poinsot,
Eléments of statistique, 1803
• W.’s analysis of G.E.E.: a step-by-step process:
- The case of two-person, two-commodity barter of given stock of
consumer goods
- The case of multi-person, multi-commodity exchange of given
stocks of consumer goods
- The case of the production of new consumer goods and the market
for factor services
- The case of saving, investment, and the use of money and credit
39
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
WALRAS’S LEGACY
W.’s procedure: the static picture:
- To write down the demand and supply equations on the
assumption of perfect competition
- the demand functions of individuals are deduced by their utility
functions)
- In the cost-supply equations price are equated to average costs
-
To prove the existence of a general equilibrium solution for the
set of simultaneous equations by counting the number of
equations and unknowns
- If they were equal a general equilibrium solution was possible
W.’s procedure: the “realistic” picture: the tatonnement: the
automatic adjustment of price in response to excess of demand
or supply
40
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
Life
1870: Degree in Engineering at the Polytechnic Institute of Torino
1870-1888: Engineer and manager in industrial firms
1889: Retirement from business
1893-1907: Professor of Political Economy at the University of Lausanne
succeeding Léon Walras
Works
1892-3: “Considerazioni sui principi fondamentali dell’economia politica”,
Giornale degli Economisti
1896-7: Cours d’Economie Politique
1900: “Sunto di alcuni capitoli di un nuovo trattato di economia pura”,
GdE
1906: Manuale di Economia Politica
1909: Manuel d’Economie Politique
1916: Trattato di Sociologia Generale
41
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
42
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: PARETO VS. WALRAS, OR
EXPERIMENTAL METHOD VS. RATIONAL METHOD
Walras on method:
“The pure theory of economics … is a physico-mathematical
science like mechanics … Economists should not be afraid to
use the methods and language of mathematics.
The mathematical method is not an experimental method; it is a
rational method … The physico-mathematical sciences, like the
mathematical sciences, … do go beyond experience as soon as
they have drawn their type concepts from it. From real-type
concepts, these sciences abstract ideal-type concepts which
they define, and then on the basis of these definitions they
construct a priori the whole framework of their theorems and
proofs. After that they go back to experience not to confirm but
to apply their conclusions”
43
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: PARETO VS. WALRAS, OR
EXPERIMENTAL METHOD VS. RATIONAL METHOD
Pareto on method vs. Walras:
“Professor Walras’s great contribution to economic discussion
was his discovery of a general system of equations to express
the economic equilibrium. I cannot, for my part, sufficiently
admire this portion of his work, but I must add that I entirely
disagree with him … I am a believer in the efficiency of
experimental methods to the exclusion of all others. For me
there exist no valuable demonstrations except those that are
based on facts”
(Pareto 1897)
44
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: PARETO’s LOGICALEXPERIMENTAL METHOD
• “Political Economy is a natural science founded
exclusively of facts”
• Political Economy’s aim: to find out the regularities
of phenomena (i.e. their laws) on the guidance of
experience and observation
• The laws are simple hypotheses, abstractions
deduced by facts: they are good as far as they agree
with the facts (verifiable facts)
45
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: PARETO’s LOGICALEXPERIMENTAL METHOD
Logical-experimental method. Phases
1.
2.
3.
4.
Formulation of hypotheses on the basis of an
inductive process of observation of facts (from
“concrete cases” to “general propositions”)
Deduction of theories from the principles
Comparison of theoretical deductions with
concrete facts in order to confirm or not the theory
Statistics and history are the tools of verification of
a theory
46
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: MECHANICS, ECONOMICS AND
MATHEMATICS
• The use of mechanical analogy
– Fisher (1891): “a systematic representation, in terms of mechanical
interaction, of the economic equilibrium”
– Pareto (1896-7): mechanical analogy clarifies concepts in
economics; analogies are worthless “as demonstration of a
theory”, they “explain some statements which must be verified by
experience”
•
Mathematics (according to Pareto)
– It is necessary in order to examine the general conditions of
economic equilibrium
– It does not make demonstration more rigorous, but it permits us to
treat problems far more complicated than those generally solved
by ordinary logic
– To be used with caution
47
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
METHODOLOGICAL ISSUES: THE SUCCESSIVE
APPROXIMATION APPROACH
Logical-experimental method. Levels of abstraction:
• Pure economics, or first approximation: the facts
considered are the most fundamental (tastes and
obstacles of homo oeconomicus)
• Applied economics, or second approximation: the
facts considered go beyond the homo oeconomicus.
A mix of theory and applied research
48
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
CONCEPTUAL ISSUES: FROM THE CARDINAL UTILITY
TO THE ORDINAL UTILITY
• The neoclassical theory of value considers the
perfect hedonist homo oeconomicus – each force of
a system works for the maximum utility of everyone
• Is such an abstraction permissible ?
• Pareto 1892-3: the hedonistic hypothesis as a first
approximation
• But: is utility a measurable quantity ?
• Pareto 1900: The rejection of hedonism: economists
are not interested in the reasons why a good is
useful, only in the fact that it is useful
49
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
CONCEPTUAL ISSUES: FROM THE CARDINAL UTILITY TO THE
ORDINAL UTILITY
“Until now [1900], in order to establish economic doctrines we went
back to choice. Choices have been explained as man’s aim to achieve
maximum pleasure. Between two things, man choses the one that
provides more pleasure. The point of equilibrium is obtained by
expressing the conditions mathematically which enable the individual
to enjoy the maximum pleasure compatible with the obstacles he
meets … The use of this point of view forces us to consider pleasure
as a quantity. And this is what the economists who have established
pure economic theories have done, and what we ourselves have done
in the Cours: but we must admit that this is not a throughly rigorous
method”
“In order to examine general economic equilibrium, this measurement
is not necessary. It is sufficient to ascertain if one pleasure is larger or
smaller than another, This is the only fact we need to build a theory”
50
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
CONCEPTUAL ISSUES: FROM THE CARDINAL UTILITY TO THE
ORDINAL UTILITY
“In reality and in most general ways, pure economics equations
simply express the fact of a choice, and can be obtained
independently of the notion of pleasure and pain. This is the
most general point of view and also the most rigorous … For
us, it is sufficient to note the fact of individual choice, without
investigating the psychological or metaphysical implications of
such a choice … We do not inquire into the causes of men’s
actions: the observation of the fact itself is sufficient … Pure
economics equations and their consequences exist unchanged
whether we start from the consideration of pleasure as a
quantity, or we limit our investigation … exclusively to the fact
of choice”
51
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
CONCEPTUAL ISSUES: FROM THE CARDINAL UTILITY TO THE ORDINAL
UTILITY
Pareto, Edgeworth, Poincaré and the late Walras
•
•
•
•
To develop his theory of choice Pareto makes use of Edgeworth’s
indifference curves
Edgeworth assumes a measurable utility function from which
indifference curves are derived, Pareto starts from the indifference
curves themselves, “provided directly by experience”
In Pareto’s mathematical formulation, a different index is associated
with each indifference curve, with an increasing algebraic value for
combination of goods chosen in preference to the initial one
Pareto’s position is similar to the one affirmed by Poincaré in his letter
to Walras, September 30, 1901. In it Poincaré
– asserts the satisfaction is not a measurable quantity though it can be
examined mathematically
– introduces the notion of preference
– preference is defined by means of an ordinal function
•
Walras (1909) accepts Poincaré’s criticism
52
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
VILFREDO PARETO (1848-1924) AND THE ECONOMICS
IN LAUSANNE
PARETO’S GENERAL ECONOMIC EQUILIBRIUM
The basic structure of the Paretian model of general
equilibrium in the Manuale is similar to the static Walras model,
although, unlike that system, everything is now cast in the
“tastes and obstacles” structure rather than in the “demand
and supply functions”:
“The emphasis is entirely on the existence of some set of
compatible optimizing choices … The problem is no longer
conceived as that of proving that a certain set of equations has
a solution. It has been reformulated as one of proving that a
number of maximizations of individual goals under
interdependent restraints can be simultaneously carried out”
(Koopmans)
53
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
GREAT CONTROVERSIES.THE CONTROVERSY EDGEWORTHWALRAS ON MATHEMATICS IN ECONOMICS, 1889-1891
1889:
• Edgeworth’s review of Walras’s second edition of the Eléments
• Edgeworth’s “On the Application of Mathematics to Political
Economy”, Presidential Address to section F of the British
Association for the Advancement of Science
• Two criticisms:
– Walras’s theory of the entrepreneur
– Walras’s theory of tâtonnement
•
Edgeworth agrees with Walras “in his plea for the use of mathematical
reasoning in economics”, but adds that the French economist
prejudices “the case by his advocacy”, because of his excessive use
of symbols
• There is an ‘excessive elaboration’ of mathematical reasoning in the
Eléments, “in such a manner as to justify the particular prejudice
against it” : this is the factor that unifies Edgeworth’s criticism
1890: Walras’s and Bortkievicz’s reaction, Revue d’économie politique
1891: Edgeworth’s “The Mathematical theory of supply and demand and
the cost of production”, Revue d’économie politique
54
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
GREAT CONTROVERSIES.THE CONTROVERSY EDGEWORTHWALRAS ON MATHEMATICS IN ECONOMICS, 1889-1891
The Protagonists
Walras
Edgeworth
Bortkievicz
55
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
The issues under discussion
A.
The concept of the entrepreneur who makes neither a profit
nor a loss
– a characteristic of the Walrasian equilibrium in production
– in the state of perfect equilibrium, when there is equality in
the quantities supplied and demanded and equality of
price and average cost, profit does not exist since total
profit is the difference between price and average cost
multiplied by the number of units of output sold
– Hence, in equilibrium the Walrasian entrepreneur makes
neither a profit nor a loss
B. The process towards equilibrium - the so-called tâtonnement.
This is the process through which Walras represents the
determination of the equilibrium prices in a competitive
market system
56
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
EDGEWORTH’S CRITICISM: THE NOTION OF IDEAL
ENTREPRENEUR VERSUS THE PRINCIPLE OF INDUSTRIAL
COMPETITION
• The ‘ideal entrepreneur’ who makes neither a profit nor a loss
is an “extreme abstraction”
• Walras confines his attention to final utility.
• He does not use, among the factors which determine the
equilibrium, the concept of the cost of production considered
as importing sacrifice and effort
• Walras’s representation is useful only to illustrate “the
operation of a simple market” of free competition
• Walras’s representation cannot be accepted “when we
advance from the simplest type of market to the complexities
introduced by division of labour”
Edgeworth’s criticism is a criticism of Walras’s mode of
conceiving competition
57
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
WALRAS’S AND BORTKIEVICZ’S REPLY
•
Walras left cost of production out of his theory of
exchange in which the quantities of the several
products were designated as parameters.
• Walras introduced the cost of production into his
theory of production where these quantities became
variables to be determined by a two-fold condition:
that cost of production must equal price and that the
quantities demanded of productive services must
equal the quantities offered.
• Hence Walras did not make abstraction of the cost of
production considered as importing sacrifice and
effort.
58
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
EDGEWORTH’s REPLY
•
•
•
•
•
•
The concepts of commercial and industrial competition
Commercial competition = “the system of markets .. is that which
would arise if all the articles of exchange were periodically rained
down like manna upon several proprietors”: economic equilibrium
does not include the cost of production explicitly
Industrial competition = the equilibrium is conceived as the result of
the combined effect of utility and cost of production in order to deal
with the industrial competition. It takes account of efforts and
sacrifices
In industrial competition two equations – that of the final utility for
different kinds of expenditure and that of the ‘net advantages’ in
different occupations – may be considered the conditions of normal
economic equilibrium
Consequently industrial competition, which characterizes the modern
economic world, may be represented only by considering the disutility
of labour in an ‘more explicit’ way than Walras’s.
Moreover: the complexity of the mathematical problem of dealing with
industrial competition
59
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
EDGEWORTH’s 1925 RI-EXAMINATION OF THE
CONTROVERSY
“Economic theory ... does require the recognition of
the ... industrial competition. ... Walras’s peculiar
doctrine ... cut him [the entrepreneur] from this
[industrial competition] essential principle ... It is
difficult to see how the equality .. of profits in
different occupations can be reconciled with this
favourite tenet of the Lausanne School. Of course it
may be tolerated as an extreme abstraction, a
simplification permissible to a path-breaker. But it
seems to deserve pardon rather than praise”
60
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
WALRAS’S TÂTONNEMENT VERSUS EDGEWORTH’S RECONTRACTING
WALRAS’S TÂTONNEMENT
• Walras poses the problem of the relation between the theoretical
solution of the exchange and the market solution - “which is solved in
practice in the market by the mechanism of free competition”
• “the upward and downward movement of market prices in conjunction
with the effective flow of entrepreneurs from enterprises showing a
loss to enterprises showing a profit is purely and simply a method of
tâtonnement towards a solution of the equations involved in these
problems”
• Walras conceives the general market as an auction market and
introduces an auctioneer who continues to change prices until supply
and demand imbalances with respect to all commodities disappear
• Walras considers the tâtonnement as the way the mechanism of free
competition solves his system of equations
• Walras’s tâtonnement is an ideal simulation of the mechanism working
in the actual markets if free competition were to prevail
61
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
EDGEWORTH’S CRITICISM
• “Walras’s lessons indicate a way, but not the way of descent to equilibrium”
• Walras’s account of tâtonnement lacks sufficient generality (its validity is
restricted to competitive markets)
“[Walras] describes a way rather than the way by which economic equilibrium is
reached. For we have no dynamical theory determining the path of the economic
system from any point assigned at random to a position of equilibrium. We only
know the statical properties of the position ... Walras’s laboured description of
prices set up or cried in the market is calculated to divert attention from a sort of
higgling which may be regarded as more fundamental than his conception, the
process of recontract ... The proposition that there is only one price in a perfect
market may be regarded as deducible from the more axiomatic principle of
recontract”
• The problem is to present “a conception appropriate for a certain kind of facts”
• Edgeworth re-contracting hypothesis is not only an alternative mechanism but
one more general than Walras’s tâtonnement
62
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
E.’ RE-CONTRACTING HYPOTHESIS IN MATHEMATICAL PSYCHICS
•
•
•
•
•
•
•
•
•
•
•
Man as a pleasure machine
The calculus of pleasure is divided into Economical and Utilitarian Calculus
Economical Calculus investigates the equilibrium of a system of hedonic forces
each tending to maximum individual utility
Contract = a type of action according to which a self-interested agent acts with
‘the consent of others affected by his action’
E. inquires the degree to which a contract is indeterminate
E. begins with a case of barter
E. inquires into when the two individuals will reach equilibrium
The contract does not supply conditions sufficient enough to determine the
equilibrium solution
Then E. introduces additional competitors into the field until the limit case of
the perfect market is reached: here the contract is determined
Competition needs to be supplemented by arbitration
Arbitration between self-interested contractors is based upon the greatest
possible sum-total utility
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF CERTAINTY, 1890-1914
THE CONTROVERSY EDGEWORTH-WALRAS ON MATHEMATICS
IN ECONOMICS, 1889-1891
The controversy. Its meaning
• two different conceptions of the core of the
theory of exchange: Walras’s competitive
markets and Edgeworth’s fields of
competition
• the controversy may be traced back to the
issue of the role of abstract reasoning and
the use of mathematics in economics, and
ultimately to the two authors’s difference
about what economics is
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE PERIOD BETWEEN THE TWO WORLD WARS
• World War I: the end of the “yesterday’s world” and its main
institutions: gold standard and free markets
• Chief problems of European Governments:
– Public Debt
– Inflation
– Unemployment
• Phases of economic growth
– 1920s: crisis in Europe and rapid growth in the US
– 1929: the Wall Street great crash
– 1930-1937: world depression
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: MEN AND SCHOOLS
CENTRES OF ECONOMIC THEORY
Europe
Cambridge, UK
LSE, UK
Vienna, Austria
Kiel Institute, Germany
MEN, SCHOOLS, INSTITUTIONS
Pigou, Hawtrey, Keynes, Robertson, Kahn,
J. Robinson,
Economic Journal
Robbins, Hayek, Hicks
Economica (1921), Rev. of Ec. Studies (1933)
Mises, Hayek and the Neo-Austrians,
Morgenstern, Zeitschrift fur Nationalokonomie (1921)
Wiener Kries, Menger, Wald, vonNeumann
Lowe, Marschak, Leontief, Neisser,
Weltwirtschaftliches Archiv (1913)
North Europe Countries:
Stockolm
Oslo
Rotterdam
Torino, Italy, an important periphery
Cassel, Myrdal, Ohlin, Lindhal (The
Stockolm School)
Frisch
Tinbergen
Econometrica (1933)
Einaudi, Cabiati and Jannaccone
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: MEN AND SCHOOLS
CENTRES OF ECONOMIC THEORY
USA
Harvard
MEN, SCHOOLS, INSTITUTIONS
Young, Schumpeter, Leontief,
Hansen, Chamberlin, Samuelson,
Quarterly Journal of Economics
Rev. Economics & Statistics (1919)
Chicago
The Walrasians (Lange, Schultz),
Cowles Commission (1939)
The Knight- Viner ‘Chicago School’
Journal of Political Economy
Columbia
Mitchell and the Institutionalism,
NBER
New School for Social Research, NY Lederer, the ex-Kiel Institute
Yale
Fisher
Princeton
von Neumann, Morgenstern
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD:
DESTRUCTION AND RECONSTRUCTION
THEORY
A.
MICROECONOMIC THEORY
Systematisation of Paretian
consumer theory
General equilibrium
- neo-walrasian model
- input-output analysis
- dynamic stability
Imperfect competition
Monopolistic competition
Industrial Organisation
Uncertainty and knowledge
Game theory
MEN AND SCHOOL
HicKs&Allen, LSE; Samuelson, MIT
Schlesinger&Wald&von Neumann, Vienna
Leontief, Kiel
Samuelson, MIT
P. Sraffa, J. Robinson, Cambridge
Chamberlin, Harvard
Mason, Harvard
Hayek, LSE
von Neumann and Morgenstern
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD:
DESTRUCTION AND RECONSTRUCTION
THEORY
MEN AND SCHOOL
B. MACROECONOMICS
Cycle Theories
- Multiplier-accelerator model
Harrod, Oxford; Samuelson, MIT
- impulse-propagation business cycle Frisch, Oslo; Slutsky, URSS
- quantitative studies on business cycle Mitchell, Columbia, NBER
- structural theories of growth
Lowe and the Kiel Institute
- monetary overinvestment theories Hayek (Vienna,LSE), Hawtrey, Ca.
- Keynesian theories
Kalecki, Kaldor, LSE
Money and Employment
- Keynesian ‘revolution’
Keynes, Cambridge
- Wicksellian macrodynamics
Myrdal&Lindhal&Ohlin, Stockolm;
Robertson,Ca
- Neo-classical synthesis
Harrod, Ox.; Meade, Ca.; Lange, Ch.; Hicks, LSE
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD:
DESTRUCTION AND RECONSTRUCTION
THEORY
C. EMPIRICAL RESEARCH
- empirical studies
- econometrics
D. METHODOLOGY
- Mill restated
- Logical positivism
- Axiomatisation program
- Marshallian tradition
- Institutionalism
MEN AND SCHOOL
Mitchell, Kutznets and NBER
Frisch, Tinbergen and the Cowles Commission
Mises, Vienna; Robbins, LSE
Vienna Circle
Menger Circle, Vienna
Keynes, Cambridge
Mitchell, Columbia
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
The protagonists
Edgeworth
Sraffa
Pigou
Young
Knight
Robertson
Robbins
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
PHASES OF THE CONTROVERSY
• The starting point: he “bewildering vagueness” of the term
competition in Marshall (H. L. Moore, 1906)
• A discussion in three stages:
1. external economies: a device to resolve the dilemma
increasing-returns competition ? (Edgeworth, Pigou,
Young)
2. The criticism of Marshall in the Twenties in USA and
UK. The pre-Sraffian phase:
- Knight 1921-1925
- The controversy on the ‘empty economic boxes’, 1922-‘24
3. The criticism of Marshall. Sraffa 1925-26
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
FIRST STAGE
EXTERNAL ECONOMIES AS A SOLUTION OF COURNOT’S DILEMMA
• Edgeworth,1905: two key-points and an ingenious solution
– The marginal cost is a function of a particular firm’s output and of the
aggregate industrial output: rising marginal cost curves for the individual
firms would shift downwards with a rise in industrial output, leading to a
falling long-term supply curve of the industry;
– the output of each producer is small in comparison with the collective
output of all his competitors: the individual firm must be so small that the
entrepreneur does not take into account the influence of his output on
industrial output. He therefore acts as if his costs were rising (as a function
of his output) when actually they may be falling
• Pigou (1912, 1920) adopted E’s treatment of external economies
• Marshall (1914): Pigou overrated the possibilities of the statical
method
• Allyn Young (1913): lack of practical relevance of Pigou’s theory
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
KNIGTH’S CONTRIBUTION (1921-1925)
The complete formulation of the concept of perfect competition
and the separation between statics and dynamics
WORKS
- Risk, Uncertainty and profit (1921)
-‘Cost of production and price over long and short period’,JPE 1921
- Fallacies in the interpretation of social cost’, JPE 1924
CRITICISM OF MARSHALL
– Marshall’s theory: old-fashioned, eclectic
– Marshall adopted a cautious, almost anti-theoretical attitude
towards fundamentals
– K. argues for a sharp separation between the static and the
dynamic problems
– The Marshallian concept of external economies and I.R. fall within
the dynamic area
– The assumptions of perfect competition: complete ‘rationality’;
‘perfect mobility in all economic adjustments’, no costs involved in
movements or changes; ‘perfect, continuous, costless
intercommunication between all individual members of the
74
society’, free and independent individuals
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
KNIGTH’S CONTRIBUTION (1921-1925)
The formulation of the concept of perfect competition and the separation
between statics and dynamics
• The criticism of the idea of external economies
– Under conditions of perfect competition the long-term supply curve
must have an increasing shape. In fact
– decreasing cost as a long-run tendency is incompatible with longrun competitive conditions
– the Pigouvian idea of external economies is dismissed:
“I have never succeeded in picturing them in my mind, or finding any
convincing reason to believe they exist”
“the category of decreasing cost under stable competition remains an
empty economic box”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
The controversy on the ‘empty economic boxes’, E. J.
1922-‘24
•
•
•
J.C. Clapham, ‘Of empty economic boxes’ (1922)
‘[In]The Economic of Welfare … there is not even one illustration of
what industries are in which boxes, though argument begins - ”when
conditions of diminishing returns prevail” or “when conditions of
increasing returns prevail”, as if everyone knew when that was.’
Pigou (1922) :
‘These boxes .. are not merely boxes; they are also elements in the
intellectual machinery by which the main part of modern economic
thought functions... These elements … cannot be singled out from the
rest and condemned as useless; they are an organic and inseparable
part of that machinery’
Dennis H. Robertson (1924):
‘So determined is the Professor to banish these old friends that,
disturbed by the apparent theoretical incompatibility of pure
competition with the prevalence of decreasing cost at all, he seems to
hold that each firm is … working under conditions of i. c. while the
industry as a whole is working under conditions of decreasing costs. I
would prefer to offend the mathematical theory of competition than to76
follow him through this logical hole in his own logical net’
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Sraffa’s contribution, 1925-’26
1925: “Sulle relazioni tra costo e quantità prodotta”, Annali di economia
1926: ”The law of returns under competitive conditions”, Economic
Journal
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Sraffa’s contribution, 1925-’26
First Step. The difficulties in classifying the various industries
• They depend on the heterogeneousness of the laws of increasing and decreasing returns
• Such heterogeneousness depends on the fact that those laws a) originate from different
parts of classic theoretical apparatus and b) are connected one, the law of decreasing
returns, to changes in factor proportions, the other, the law of increasing returns, to
changes in the scale of production
• The co-ordination of the two laws in a single law of variable costs in order to explain the
value of competition – which emphasises the functional connection between cost and
quantity produced - was a neo-classical operation. But in order to reach this result:
‘It was found necessary to introduce certain modifications into the form of the two laws.
Very little was necessary as regards the law of diminishing returns, which merely required
to be generalised from the particular case of land to every case in which there existed a
factor of production of which only a constant quantity was available. The law of increasing
returns, however, has to be subjected to a much more radical transformation: the part
played in it by the division of labour – now limited to the case of independent subsidiary
factories coming into existence as the production of an industry increases – was greatly
restricted; while consideration of that greater internal division of labour, which is rendered
possible by an increase in the dimensions of an individual firm, was entirely abandoned, as
it was seen to be incompatible with competitive conditions. On the other hand, the
importance of ‘external economies’ was more and more emphasised – that is, of the
advantage derived by individual producers from the growth, not of their own individual
undertakings, but of the industry in its aggregate.’
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Sraffa’s contribution, 1925-’26
Second step. The analytical difficulties of Marshallian theory
‘The really serious difficulties make their appearance when it is
considered to what extent the supply curves based on the laws of returns
satisfy the conditions necessary to enable them to be employed in the
study of equilibrium value of single commodities produced under
competitive conditions’
• the punctum dolens: the decreasing supply curve. He assumes Knight’s
criticism of Pigouvian external economies
• To explain increasing returns by external economies, external to the
individual firm but internal to the industry is a way of escaping from
this difficulty and constructing an industry decreasing supply curve
‘perfectly correct, at least from the formal point of view’, but:
‘Those economies which are external from the point of view of the
individual firm, but internal as regards the industry in its aggregate,
constitute precisely the class which is most seldom to be met with … In
any case, in so far as external economies of the kind in question exist,
they are not likely to be called forth by small increases in production.’ 79
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Sraffa’s contribution, 1925-’26
In general:
• “the supply schedule with variable costs cannot claim to be a
general conception applicable to normal industries; it can
prove a useful instrument only in regard to such exceptional
industries as can reasonably satisfy its conditions”
• “There are strong reasons .. for saying that, in a static
system of perfect competition, in the determination of the
particular equilibria of commodities, not proportional cost
curves cannot be traced, if not in exceptional cases, without
introducing hypotheses which are contrary to the nature of
the system”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Sraffa’s contribution, 1925-’26
Viable research directions
• As a first approximation, the Ricardian constant cost hypothesis,
according to which the cost of production of commodities produced
competitively ‘must be regarded as constant in respect of small
variations in the quantity produced’
• ‘Of course in reality the connection between cost and quantity produced
is obvious’ but ‘simply cannot be considered by means of the system of
particular equilibria for single commodities in a regime of competition
devised by Marshall’.
The routes available were a) the simultaneous equilibrium of all
industries (Pareto’s point of view), b) the abandon of assumption of
perfect competition. According to Sraffa the Paretian conception was
not fruitful because of its complexity (a judgement shared with many
Italian economists, Pantaleoni for example), therefore Cournot’s route
seemed to be the only viable research direction: it is a further
approximation, which permits consideration of the increasing returns
case
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Robbins’ attack of the representative firm, 1928
•
•
•
•
•
The Representative Firm is essentially a long-period conception without
statistical significance neither practical usefulness
The representative firm is not a necessary tool: ‘There is no more need for us to
assume a representative firm or representative producer, than there is for us to
assume a representative piece of land, a representative machine, a representative
worker. All that is necessary for equilibrium to prevail is that each factor shall get
at least as much in one line of production as it could get in any other’
The representative firm is unessential to the hypothesis of static equilibrium,
which Marshall rejected because of ‘his curious predilection for biological
analogies’ or ‘for fear of becoming unintelligible to business men and economic
historians’
The representative firm is a very poor tool in order to examine the problems of
change and development. In a note, he refers to the contemporary research
program of Allyn Young
He questions the existence of external economies referring to the criticisms of
Young and Knight to the external economies
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
The Marshallian defence: Pigou, Robertson and Shove, 1927-1930
•
•
•
Pigou’s definite statement of the theory of competitive supply, 1927-’28
Robertson defence, 1930
“We seem to agree that the [Marshall’s] theory cannot be interpreted in a way
which makes it logically self-consistent and, at the same time, reconciles it with
the facts it sets out to explain. Mr. Robertson’s remedy is to discard mathematics,
and he suggests that my remedy is to discard the facts; perhaps I ought to have
explained that, in the circumstances, I think it is Marshall’s theory that should be
discarded’”
Shove’s contribution, 1930
The firm’s costs are not a function of only two variables (firm’s and industry’s
output), but three (… and time). The Marshallian life cycle of the firm explains
the coexistence of a large number of firms. He proposes an analysis of
dynamic equilibrium
[Newman & Wolfe 1961, the distribution of firm size as the result of a process
of chance, employing the technique of non-homogeneous Markov chains]
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE COST CONTROVERSY IN THE 1920s
Young , 1928, and Schumpeter, 1928: the return to
the classics’ dynamics
• the partial equilibrium apparatus which economists have built up for
dealing with the range of questions raised by the phenomena of
increasing returns permits examination only of some aspects of it
• ‘No analysis of the forces making for economic equilibrium … will serve
to illuminate this field, for movements away from equilibrium, departures
from previous trends’
• Smith’s theorem ‘the division of labour depends upon the extent of the
market’
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
The protagonists
Mises
Hayek
Menger
Schlick
Wald
Neurath
Carnap
v.Neumann
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
(Based on: G. Becchio and R. Marchionatti, “Economic Theory, Philosophy and Mathematics. A
reconstruction of the viennese debate in the Wiener Kreis and in the MathematischeKolloquium, 1922-38”)
Between the Wars a great debate on the economic theory took
place in Vienna:
• in Hans Mayer’s and Ludwig von Mises’s seminars where
the Austrian school tradition was being continued
• in two other circles:
– the Wiener Kreis, created at the beginning of the 1920s
by the physicist and philosopher of science Moritz
Schlick, where neo-positivism was founded
– the Mathematische Kolloquium run by the
mathematician Karl Menger
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
WIENER KREIS AND MATHEMATISCHE KOLLOQUIUM.
A HISTORICAL OUTLINE
1922. The Kreis comes into existence. It is a philosophical
circle gathered weekly around Moritz Schlick.
Members of the circle: the mathematicians Hans Hahn and
Kurt Reidemeister, the social scientist Otto Neurath, the
philosopher Rudolph Carnap, the mathematician and
philosopher Friedrich Waismann
1929. Wissenschaftliche Weltauffassung: Der Wiener Kreis (A
scientific world-view. The Vienna Circle)
From 1934 on. Emigration. The project of The International
Encyclopaedia of Unified Science
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
WIENER KREIS AND MATHEMATISCHE KOLLOQUIUM.
A HISTORICAL OUTLINE
1928. The mathematician Karl Menger -- the son of the economist Carl
Menger - founds the Mathematische Kolloquium
“Studies on the recent development of geometry and logics as well as
studies concerning the new applications of exact sciences to problems of
sociological character were carried out … for example on the existence
and uniqueness of solutions for the production equations in
mathematical economics”
• Some economists and mathematicians dealt with economics: Karl
Menger, Karl Schlesinger, Abraham Wald and John von Neumann
• The axiomatization of the Walrasian general economic equilibrium
• Mid 1930s the great Viennese culture began to fade: “it resembled a bed
of delicate flowers to which its owner refused soil and light while a
fiendish neighbour was waiting for a chance to ruin the entire garden”
• 1938: Nazi occupation
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
The logical positivism of the Wiener Kries
•
•
The true task of philosophy is to analyze statements with the aim of making
such propositions clear and unambiguous
Use of logical analysis for the clarification of problems:
“we have characterized the scientific world-conception essentially by two
features. first it is empiricist and positivist: there is knowledge only from
experience, which rest on what is immediately given. this sets the limits for the
context of legitimate science. second, the scientific world-conception is marked by
the application of a certain method, namely logical analysis. the aim of scientific
effort is to reach the goal, unified science, by applying logical analysis to the
empirical material” (H. Hahn, O.Neurath and R.Carnap, Der Wiener Kries)
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
The logical positivism of the Wiener Kries
•
Only meaningful statements have scientific status
• Meaningfulness is defined as being attributable
statement:
to two types of
– analytical statements - that can be evaluated using the rules of logic
– synthetic statements, i.e. factual statements, verifiable by empirical
evidence
“the consistent empiricist does not deny the transcendent world, but
shows that both its denial and affirmation are meaningless … the
empiricist does not say to the metaphysician ‘what you say is false’, but
‘what you say asserts nothing at all!’. he does not contradict him, but
says ‘i don’t understand you’” (M. Schlick)
• Verifiability implies testability: a proposition is meaningful only to the
extent that it may be subjected to empirical test
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
ECONOMICS IN THE WIENER KRIES
•
•
•
Manifesto
Economics is placed among the five branches of science that “must conduct an
epistemological examination of its foundations, a logical analysis of its
concepts”. A program of “purification” of metaphysical residuals, an antimetaphysical attitude
Encyclopaedia
Economics is defined a social science. According to Neurath it is a part of the
sociology founded on relatively constant quantitative relations expressed in the
universal language of empiricism, i.e. physicalism
Wiener Kries and Econometric Society
The aim of unifying theoretical rigour and empirical analysis found its
achievement in the program of the Econometric Society, whose founders were
strongly influenced by the logical empiricism
Robert Gibrat (1936) at the Paris Conference in 1935:
– the use of mathematical language has become unavoidable in the making of
economic theory because the ordinary language is inadequate
– He proposes to employ econometrics. Econometrics “has to be defined as a way of
treating economic problems, not an a priori demarcation of its field”.
– He associates Kries’s program with the recently born econometric movement.
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
Ragnar Frisch, founder of Econometrica
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
The Econometric Society, 1930 and Econometrica 1933
•
•
•
Econometrics = the unification of statistics, economic theory and
mathematics
Econometrica, the official journal of the Econometric Society
First editorial: The object of the journal presented by R. Frisch:
– “[The main object] shall be to promote studies that aim at a
unification of the theoretical-quantitative and the empiricalquantitative approach to economic problems and that are
penetrated by constructive and rigorous thinking similar to that
which has come to dominate in the natural sciences”
– “Thus mutual penetration of quantitative economic theory and
statistical observation is the essence of econometrics. And therein
lies the need for mathematics, both in formulation of the principles
of economic theory, and in technique of handling the statistical
data. Mathematics is certainly not a magic procedure which in
itself can solve the riddles of modern economic life, as is believed
by some enthusiasts. But, when combined with a thorough
understanding of the economic significance of the phenomena, it
is an extremely helpful tool”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
ECONOMICS AS A MATHEMATICAL SCIENCE IN THE MATHEMATISCHE
KOLLOQUIUM
•
•
•
•
•
In in Walrasian and Paretian schools the key problem was the correspondence
between the theoretical model and the empirical reality, whereas the mathematical
side of the model was considered in a large extent completed and the analytical
problems essentially solved.
The mathematical dimension becomes central in the Mathematische Kolloquium
1935. Karl Schlesinger first took on the issue of the existence of economically
meaningful (positive) solutions in the Walrasian model. The model considered by
Schlesinger was the so-called Walras-Cassel system, based on Gustav Cassel’s
simplified reformulation of the Walrasian general economic equilibrium
(1918).Schlesinger reformulated Cassel’s system in terms of inequalities, but
without going on in its mathematical solution
1935-36. Abraham Wald demonstrates the existence of an equilibrium for the
Walras-Cassel system
John Von Neumann publishes his 1932 paper on general economic equilibrium
dynamics read to the Princeton Mathematical Society in the Ergebnisse. It was
published in the 1935-36 volume edited by Menger and Wald
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
Towards the mathematization of economics: Karl Menger
on mathematical economics
Menger (1936) shared Hilbert’s formalism. He builds a meta-mathematical model
applicable to economics. The meaning of meta-mathematical model is the
following:
•
“Following a suggestion of Hilbert, modern logicians refer to the study of the
logical relations between the statements of a theory as the corresponding metatheory”
•
“from the point of view of methodology”, Menger’s writing represents “the
first instance in economics of a clear separation between the question of
logical interrelations among various propositions and the question of
empirical validity”. This was the key point needed in order to transform
economics into a science
•
This “clear separation” between the question of logic and the question of
empirical validity, is at the basis of Wald’s work and of the programme of
new mathematization of Walrasian general economic equilibrium theory
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ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
Wald’s and von Neumann’s mathematical economics: the formalist perspective
Abraham Wald’s contribution: between tradition and innovation
•
•
•
•
•
•
•
“mathematical economics” is “a new method”
“mathematics has already became an indispensable tool for many subtle
investigations of various areas of economic phenomena”
Unfortunately “sins have been committed in mathematical economics”:
unawareness of the assumptions and their implications, of their realism and
their condition of validity: “They have their origin in inappropriate, even
erroneous, applications of mathematics”
For a “fruitful application of mathematics in economics” it was essential that all
the assumptions “be enumerated completely and precisely”
“if these directions are strictly adhered to”, then “the only objection which can
be raised against a theory is that it includes assumptions which are foreign to the
real world and that, as a result, the theory lacks applicability”
The analytical questions: existence and uniqueness of equilibrium: “the
equality of the number of equations and unknowns does not prove that a solution
exists, much less the uniqueness of a solution”
Wald shows the existence of solutions under a set of hypotheses
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
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ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
Wald’s and von Neumann’s mathematical economics: the formalist
perspective
Beyond tradition: John von Neumann’s 1937 contribution
The intellectual origins of the model:
a)
the Viennese discussion on the Walras-Cassel model
b) the Berlin debate in Bortkievicz’s circle. Von Neumann adopted a
representation of the economy as a circular process of production of
classical (neo-ricardian) type (Remak)
Von Neumann’s method of analysis
•
It did not use differential techniques but used topological techniques for the
first time in economics
•
The demonstrative technique transformed the problem of determining an
equilibrium into a minimax problem: “The solution of the system of
equations is possible only by means of a generalization of Brouwer’s FixedPoint Theorem”
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
Wald’s and von Neumann’s mathematical economics: the formalist
perspective
Beyond tradition: John von Neumann’s 1937 contribution
The axiomatic approach in economics
• It is applied in a totally coherent way, in the sense that the concern for the
economic interpretation of the model disappears:
“In order to be able to discuss [the properties of the economic system] quite
freely we shall idealize other elements of the situation …”
• This theoretical attitude derived:
– firstly, from the fact that von Neumann dealt with the economic question
“as a mathematician” . In this way he obtained a mathematical solution of
a “highly generalised problem in theoretical economics”, that it
characterized by elegance, logical completeness, concision and rigor, but
adopts “extremely artificial assumptions” or “idealisations”
– secondly, von Neumann’s attitude derives from the fact that he dealt with
theoretical economic problems like a formalist mathematician -- i.e. he
conceived the model as a formal structure whose legitimacy and cogency
depend on its internal consistency
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
ECONOMICS, MATHEMATICS AND PHILOSOPHY IN VIENNA
ON THE RELATIONSHIP BETWEEN WIENER KRIES AND
MATHEMATISCHE KOLLOQUIUM
Continuity and discontinuity between the Wiener Kries and the
Mathematische Kolloquium
•
•
the Kolloquium was influenced by the Kreis reaction against metaphysics
However, a fundamental epistemological break took place between the two
circles:
–
–
–
•
Kries’s members adopted Russell’s logicism and the inductive-experimental
approach to reality taken by physics
Kolloquium’s members adhered to Hilbert’s mathematical formalism and
adopted a deductive, highly formalized, and axiomatic method
Moreover, the mathematicians of the Kolloquium refuted Kreis’s physicalism and
tended to reduce the importance of the verificationist paradigm
The disagreement between the Wiener Kries and the Mathematische
Kolloquium may be trace back to the old classical disagreement between
Léon Walras and Vilfredo Pareto on the nature and method of political
economy
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE METHODOLOGICAL DEBATE IN THE 1930S
L.ROBBINS, ESSAY ON THE NATURE AND SIGNIFICANCE OF ECONOMIC
SCIENCE (1935)
•
•
•
•
A restatement of the Mill-Cairnes position, influenced by Mises
It generalizes the apparatus of economics in order to deal with non-material
welfare, as well as material:
‘Economics is the science which studies human behaviour as a relationship
between ends and scarce means which have alternative uses”
“The generalizations of economics”: neither historical experience nor
controlled experiment provides us with grounds for asserting the general
propositions of economics. They are deductions from a series of postulates, or
universally acknowledged facts of experience.
Economics “can never be completely assimilated to the procedure of the physical
science”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
LIFE
Educated at Eton and King’s College, Cambridge
1906 –8 - Civil Servant, UK India Office
1908 -42 – Teacher in economics, University of Cambridge
1911 – Editor of the Economic Journal
1915-1918 – UK Treasury
1918 - member of the British delegation to the Versailles Peace Conference
Second World War II – UK Treasury
1944 – Head of the British delegation to the international conference in Bretton Woods
WORKS
1913 - Indian Currency
1919 – The Economic Consequences of the Peace
1921 – The Treatise on Probability
1923 – Tract on Monetary Reform
1930 – The Treatise on Money
1931 - Essays in Persuasion
1936 - The General Theory of Employment, Interest and Money
1940 - How to Pay for the War
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JOHN M. KEYNES (1883-1946)
Keynes on Marshall, 1924
“The study of economics does not seems require any specialised gifts of an usually high
order. It is not, intellectually regarded, a very easy subject compared with the higher
branches of philosophy and pure science ? Yet good, or even competent, economists are the
rarest of birds. An easy subject, at which very few excel ! The paradox finds its explanation,
perhaps, in that the master-economist must possess a rare combination of gifts. He must
reach a high standard in several different directions and must combine talents not often
found together. He must be mathematician, historian, statesman, philosopher – in some
degree. He must understand symbols and speak in words. He must contemplate the
particular in terms of the general, and touch abstract and concrete in the same flight of
thought. He must study the present in the light of the past for the purposes of the future.
No part of man’s nature or his institutions must lie entirely outside his regards. He must be
purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an
artist, yet sometimes as near the earth as a politician. Much … of this ideal many-sidedness
Marshall possessed. But chiefly his mixed training and divided nature furnished him with
the most essential and fundamental of the economist’s necessary gifts – he was
conspicuously historian and mathematician, a dealer in particular and the general, the
temporal and the eternal, at the same time”
Marshall understood that the economic interpretation of the “complex and incompletely
known facts of experience” requires to go beyond the “bare bones of economic theory”.
Marshall was able to amalgamate “logic and intuition and wide knowledge of facts, most
of which are not precise”. This “is required for economic interpretation in its highest form”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
ON THE NATURE AND METHOD OF ECONOMICS
• “Economics is essentially a moral science (i.e. human science) and not a
natural science”
• “Economics is a science of thinking in terms of models joined to the art
of choosing models which are relevant to the contemporary world. It is
compelled to be this, because, unlike the typical natural science, the
material to which it is applied is, in too many respects, not homogeneous
through time”
• “Economics … employs introspection and judgements of value”
• “[Economics] deals with motives, expectations, psychological
uncertainties. One has to be constantly on guard against treating the
material as constant and homogeneous”
• Due to the nature of economic material, “a generalisation to cover
everything is impossible and impracticable"
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JOHN M. KEYNES (1883-1946)
ON THE NATURE AND METHOD OF ECONOMICS
•
•
“Generalising in economics is thinking by sample, not by generalisation”
As a consequence economics’s way of exposition is quasi-formal:
“When we write economic theory we write in a quasi-formal style; and there can
be no doubt, in spite of these disadvantages, that this is our best available means
of conveying our thoughts to one another. But when an economist writes in a
quasi-formal style, he is composing neither a document verbally complete and
exact .. nor a logically complete proof. Whilst it is his duty to make his premises
and his use of terms as clear as he can, he never states all his premises and his
definitions are not perfectly clear-cut. He never mentions all the qualifications
necessary to his conclusions. He has no means of stating, once and for all, the
precise level of abstraction on which he is moving, and he does not move on the
same level all the time. It is, I think, of the essential nature of economic
exposition that it gives, not a complete statement, which, even if it were possible,
would be prolix and complicated, to the point of obscurity, but a sample
statement, so to speak, out of all the things which could be said, intended to
suggest to the reader the whole bundle of associated ideas”
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JOHN M. KEYNES (1883-1946)
ON THE NATURE AND METHOD OF ECONOMICS
•
•
•
•
If “we cannot hope to make completely accurate generalisations”, the right
language for the construction of the model is ordinary language:
in ordinary discourse, … we are not blindly manipulating but know all the time
what we are doing and what the words mean …”
Ordinary language seems to be more efficient in handling the complexity of
the economy. The essential consequence of this argument is that economic
thinking cannot be reduced simply to “blind manipulation”:
“The object of our analysis is, not to provide a machine, or method of blind
manipulation, which will furnish an infallible answer, but to provide ourselves
with an organised and orderly method of thinking out particular problems;
and, after we have reached a provisional conclusion by isolating the
complicating factors one by one, we then have to go back on ourselves and
allow, as well as we can, for the probable interactions of the factors among
themselves. This is the nature of economic thinking”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
ON THE NATURE AND METHOD OF ECONOMICS
• The construction of the relevant model is the key problem
• The adequacy of the model depends on the ability to select the relevant
factors, “the factors whose changes mainly determine our quaesitum”
• The decision which part of concrete reality to incorporate into a model
is termed by Keynes ‘judgement of value’. This also makes economics
an art because the construction of the relevant model needs the art of
‘introspection’ in order to study psychic processes, and judgements of
value
• The model is the result of a continuous correction of judgement. The
selection of the relevant factors which constitute the model begins with
the analysis of facts and facts are what economists must continuously
refer to
• “The specialist in the manufacture of models will not be successful
unless he is constantly correcting his judgement by intimate and messy
acquaintance with the facts to which his model has to be applied”
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JOHN M. KEYNES (1883-1946)
ON THE NATURE AND METHOD OF ECONOMICS
Conclusions
• K. emphasises the characteristics of economic material, which makes
economics a moral science and a science of thinking in terms of models
• This forces the economist to use introspection and judgement of value
constantly corrected by “intimate and messy acquaintance with the
facts”
• The economist is often force to write in a quasi-formal style
• This methodological strategy of research has its core in the logical
question: is it correct to apply a certain method to a certain specific
problem ? This is the opposite of the method of blind manipulation
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JOHN M. KEYNES (1883-1946)
The economics of Keynes:The General Theory
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
“This book is chiefly addressed to my fellow economists. I
hope that it will be intelligible to others. But its main purpose
is to deal with difficult questions of theory, and only in the
second place with the application of this theory to practice …
An attempt by an economist to bring to an issue the deep
divergences of opinion between fellow economists which
have for the time being almost destroyed the practical
influence of economic theory … A more general theory,
which includes the classical theory with which we are
familiar, as a special case … The composition of this book
has been for the author a long struggle to escape from
habitual models of thought and expression … The difficulty
lies, not in the new ideas, but in escaping from the old ones,
which ramify … into every corner of our minds”
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JOHN M. KEYNES (1883-1946)
The economics of Keynes:The General Theory
The“habitual models of thought and expression”. The classical
economic analysis
The classical economic analysis:
• is concerned “with long-period equilibrium”
• assumes that “the amount of the factors employed was given
and the other relevant facts were known more or less for
certain”
• assumes that “at any given time facts and expectations were
… given in a definite and calculable form … The calculus of
probability … was supposed to be capable of reducing
uncertainty to the same calculable status as that of certainty
itself”
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JOHN M. KEYNES (1883-1946)
The economics of Keynes:The General Theory
The contents
• Book I.Introduction
• Book III.The Propensity to Consume
• Book IV.The Inducement to Invest
• Book V. Money-Wages and Prices
• Book VI. Short Notes Suggested by the General
Theory
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book I. Introduction
“I have called this book the General Theory of
Employment, Interest and Money, placing the emphasis
on the prefix general. The object of this title is to contrast
the character of my arguments with those of the classical
theory of the subject … which dominates the economic
thought, both practical and theoretical, of the governing
and academic classes of this generation… The postulates of
the classical theory are applicable to a special case only and
not to the general case, the situation which it assumes being
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a limiting point of the possible positions of equilibrium”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book I.Introduction
The criticism of the classical postulates
•
•
•
The postulates of the classical economics determine the amount of employment
at the point of full employment. They are compatible with frictional and
voluntary employment. But:
– “Ordinary experience tells us … that a situation where labour stipulates for a
money wage … is the normal case”
– “The contention that the unemployment which characterises a depression is
due to a refusal by labour to accept a reduction of money-wages is not clearly
supported by the facts”
If the wage bargain does not determine the real wage, then “there is no longer
any reason to expect a tendency towards equality between the real wage and the
marginal disutility of labour”
Keynes introduces a third category of unemployment, namely involuntary
unemployment
“If the classical theory is only applicable to the case of full employment, it is
fallacious to apply it to the problems of involuntary unemployment - if there be
114
such a thing (and who will deny it ?)”
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book I.Introduction
The criticism of Say’s Law
“From the time of Say and Ricardo the classical economists have taught
that supply creates its own demand … As a corollary of the same
doctrine, it has been supposed that any individual act of abstaining from
consumption necessarily leads to … causing the labour and commodities
… to be invested in the production of capital wealth … Those who think
in this way are deceived, nevertheless, by an optical illusion, which makes
two essentially different activities appear to be the same. They are
fallaciously supposing that there is a nexus which unites decision to
abstain from present consumption with decision to provide for future
consumption; whereas the motives which determine the latter are not
linked in any simple way with the motives which determine the former”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book I.Introduction
The principle of effective demand
•
•
•
The aggregate supply function
Z =  (N) where Z = the aggregate supply price of the output from employing N men
The aggregate demand function
D = f (N) where D = the proceeds which entrepreneurs expect to receive from the
employment of N men
“If for a given value of N the expected proceeds are greater that the aggregate supply price,
i.e. if D is greater than Z, there will be an incentive to entrepreneur to increase employment
beyond N … up to the value of N for which Z has become equal to D ... Thus the volume of
employment is given by the point of intersection between the aggregate demand function
and the aggregate supply function; for it is at this point that the entrepreneurs’ expectation
of profit will be maximised. The value of D at the point of the aggregate demand function,
where it is intersected by the aggregate supply function, will be called the effective demand”
Note that, according to the classical doctrine, the “Supply creates its own Demand”, that
is  (N) and f (N) are equal for all values of N, i.e. for all levels of output and
employment. Instead, effective demand “is an infinite range of values all equally
admissible”
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book I. Introduction
The essence of the General Theory
•
•
The amount of labour N which the entrepreneurs decide to employ depends on
the sum (D) of two quantities, namely the amount which the community is
expected to spend on consumption, and the amount which is expected to
devote to new investment. D is the effective demand
Hence the volume of employment in equilibrium depends on 1) the aggregate
supply function, 2) the propensity to consume, and 3) the volume of
investment. This is the essence of the General Theory of Employment.
“The volume of employment is not determined by the marginal disutility of
labour … The propensity to consume and the rate of new investment determine
between them the volume of employment, and the volume of employment is
uniquely related to a given level of real wages – not the other way round. If the
propensity to consume and the rate of new investment result in a deficient
effective demand, the actual level of employment will fall short of the supply of
labour potentially available at the existing real wage ”
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Charter 11. The marginal efficiency of capital
•
•
•
“I define the marginal efficiency of capital as being equal to that rate of discount
which would make the present value of the series of annuities given by the
returns expected from the capital-asset during its life just equal to its supply
price”
The marginal efficiency of capital is defined in terms of prospective yield, i.e.
income expectation. It depends on the prospective yield of capital, and not
merely on its current yield”
“The schedule of the marginal efficiency of capital is of fundamental importance
because it is mainly through this factor (much more than through the rate of
interest) that the expectation of the future influences the present. The mistake of
regarding the marginal efficiency of capital primarily in terms of the current
yield of capital equipment, which would be correct only in the static state where
there is no changing future to influence the present, has had the result of
breaking the theoretical link between to-day and to-morrow … The fact that the
assumptions of the static state often underlie present-day economic theory,
imports into it a large element of unreality”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 12. The state of long-term expectations, 1
The state of long-term expectation depends on:
• The most probable forecast we can make
• The confidence with which we make this forecast – on “how highly we
rate the likelihood of our best forecast turning out quite wrong”
• “The state of confidence, as they term it, is a matter to which practical
men always pay the closet and most anxious attention … The state of
confidence is relevant because it is one of the major factors determining
[the schedule of the marginal efficiency of capital]”
• “There is … not much to be said about the state of confidence a priori.
Our conclusions must mainly depend upon the actual observation of
markets and business psychology”
• The state of confidence depends on knowledge
• “The outstanding fact is the extreme precariousness of the basis of
knowledge on which our estimates of perspective yields have to be made”
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The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 12. The state of long-term expectations, 3
• How to get around the informative and cognitive shortage, so permit
investment activity?
• In his answer K. considers two phases of capitalism:
• Under old-fashioned capitalism. “In former times, when enterprises
were mainly owned by those who undertook them or by their friends and
associates, investment depended on a sufficient supply of individuals of
sanguine temperament and constructive impulses who embarked on
business as a way of life, non really relying on a precise calculation of
prospective profit”
• Under mature capitalism. With the development of organised
investment markets “certain classes of investment are governed by the
average expectation of those who deal on the Stock Exchange at an
immediate profit … rather than by the genuine expectations of the
professional entrepreneur”
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The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 12. The state of long-term expectations, 4
•
•
•
•
“How then are these highly significant daily, even hourly, revaluations of existing
investments carried out in practice ?”
“In practice we have tacitly agreed, as a rule, to fall back on what is… a convention. The
essence of this convention … lies in assuming that the existing state of affaire will continue
indefinitely, except in so far we have specific reasons to expect a change”
This convention gives stability in affairs, but it is arbitrary and consequently precarious
Factors which accentuate this precariousness:
– Owners’ ignorance of the business in question
– Excessive influence on the market of the day-to-day fluctuations in the profits of
existing investments
– Dependance on sudden fluctuation of opinion, in abnormal times in particular: the
market will be subject to waves of optimistic and pessimistic sentiment
– Behaviour of professionals: ‘To beat the gun’. “Most of these persons are … largely
concerned, not with making superior long-term forecasts of the probable yield of an
investment over its whole life, but with foreseeing changes in the conventional basis of
valuation a short time ahead of the general public”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 12. The state of long-term expectations, 5
Keynes’s conception of business activity
• Business activity is a mix of enterprise, stock market evaluations and
speculation
• Enterprise is based, as far as possible, on reasonable calculation,
supplemented by spontaneous optimism and “animal spirits”
“Animal spirits .. A spontaneous urge to action rather than inaction”
• Investor activity is fundamentally guided by conventional judgement
• Thus, comprehensively, business behaviour is a mix of reasonable
calculation, conventional judgement and animal spirits
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 13. The general theory of the rate of interest
What determines the rate of interest ?
•
•
•
•
“The psychological time-preferences of an individual require two distinct sets of decisions
to carry them out completely”
“The first is concerned with … the propensity to consume, which, … determines for each
individual how much of his income he will consume and how much he will reserve in some
form of command over future consumption”
“But this decision having being made, there is a further decision which awaits him, namely,
in what form he will hold the command over future consumption which he has reserved …
Does he want to hold it in the form of immediate, liquid command ? Or is he prepared to
part with immediate command for a specified or indefinite period ? … In other words, what
is the degree of his liquidity-preference ?”
“The mistake in the accepted theories of the rate of interest lies in their attempting too
derive the rate of interest from the first of these two constituents of psychological timepreference to the neglect of the second”
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JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 13. The general theory of the rate of interest
What is the rate of interest ?
“The rate of interest cannot be a return to saving or waiting as such. For if a
man hoards his savings in cash, he earns no interest, though he saves just as
much as before … The rate of interest is the reward for parting this liquidity for a
specified period … Thus the rate of interest at any time, being the reward for
parting with liquidity, is a measure of the unwillingness of those who possess
money to part with their liquidity control over it . The rate of interest is not the
price which brings into equilibrium the demand for resources to invest with the
readiness to abstain from present consumption. It is the price which equilibrates
the desire to hold wealth in the form of cash with the available quantity of cash…
Liquidity-preference is a potentiality … which fixes the quantity of money which
the public will hold when the rate of interest is given … L = L(r)”
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PART I. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
Chapter 13. The general theory of the rate of interest
“Why such a thing as liquidity-preference exists”
• “Given that the rate of interest is never negative, why should anyone
prefer to hold his wealth in a form which yields little or no interest to
holding it in a form which yields interest ?"
• The “necessary condition is the existence of uncertainty as to the future
of the rate of interest” (“risk of a loss being incurred in purchasing a
long-term debt and subsequently turning it into cash, as compared with
holding cash”)
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
“The General Theory of Employment”, QJE 1937
“we have … only the vaguest idea of any but the most direct consequences of
our acts … Our knowledge of the future is fluctuating, vague and
uncertain … [This] renders [the accumulation of Wealth] a peculiarly
unsuitable subject for the methods of the classical economic theory”
“I accuse the classical economic theory of being itself one of these pretty,
polite techniques which tries to deal with the present by abstracting from
the fact that we know very little about the future … This is particularly
the case in his treatment of money”
“Our desire to hold money as a store of wealth is a barometer of our distrust
of our own calculations and conventions concerning the future”
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
CHAPTER 18. THE GENERAL THEORY OF EMPLOYMENT RESTATED
Given elements:
•
The existing skill and quantity of available labour, the existing
quality and quantity of available equipment, the existing technique,
the degree of competition, the tastes and habits of the consumer, the
social structure
Independent variables:
•
The propensity to consume, the schedule of the marginal efficiency
of capital, the rate of interest
Dependent variables:
•
THE VOLUME OF EMPLOYMENT and THE NATIONAL
INCOME
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
CHAPTER 18. THE GENERAL THEORY OF EMPLOYMENT RESTATED, 2
“The division of the determinants of the economic system into the two
groups of given factors and independent variables is … quite arbitrary …
The division must be made entirely on the basis of experience, so as to
correspond on the one hand to the factors in which the changes seem to
be slow or so little relevant as to have only a small and comparatively
negligible short-term influence on our quaesitum; and on the other hand,
to those factors in which the changes are found in practice to exercise a
dominant influence on our quaesitum"
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
CHAPTER 18. THE GENERAL THEORY OF EMPLOYMENT RESTATED, 3
• The rate of new investment is pushed to the point where the marginal
efficiency of capital approximates the rate of interest
• “That is to say, the physical conditions of supply in the capital-goods
industries, the state of confidence concerning the perspective yield, the
psychological attitude to liquidity and the quantity of money .. Determine
… the rate of new investment"
• “An increase in the rate of investment will have to carry with it an
increase in the rate of consumption … The ratio … between an
increment of investment and the corresponding increment of aggregate
income … id given by the investment multiplier … We infer the
increment of the employment …”
• “repercussions …”
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
JOHN M. KEYNES (1883-1946)
The economics of Keynes: The General Theory
Book IV. The inducement to invest
CHAPTER 18. THE GENERAL THEORY OF EMPLOYMENT RE-STATED, 4
“Thus the position of equilibrium will be influenced by these
repercussions; and there are other repercussions also …
Hence the extreme complexity of the actual course of events.
Nevertheless these seem to be the factors which it is useful
and convenient to isolate. If we examine any actual problem
along the lines of the above schematism, we shall find it
more manageable; and our practical intuition … will be
offered a less intractable material upon which to work”
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
(in collaboration with Giovanna Garrone)
The protagonists
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Jan Tinbergen (1903-1994)
1936-38: League of Nations Secretariat
Statistical Testing of Business-Cycle Theories (1939)
Vol.1: A Method and its Application to Investment Activity
The method of econometric study as a synthesis of statistical business
cycle research and quantitative economic theory
• multiple correlation analysis applied to business cycle theory
translated into a a parametrised mathematical-economic model
(dynamic form)
• application to 3 case studies
- innovative testing procedures
- aimed at providing forecasts and guide policies
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Keynes’s harsh critique:
•
•
•
triggers a lively debate (1939-1943)
compounds methodological questions, technical remarks and a few
misunderstandings
assessment still controversial
- 1940s-1970s: “a priori antieconometrician”
- since 1970s: increasing recognition of relevance
Stages of the debate:
•
•
•
August-September 1938: exchange of letters (with T., Tyler, Harrod,
Kahn, Loveday)
September 1939: Keynes’s review
March 1940: Tinbergen’s reply
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Keynes’s Criticism
“Professor Tinbergen’s Method”, EJ, 1939
“This brand of statistical alchemy is [not] ripe to become a branch of science”
1.
2.
The question of methodology:
“The logic of applying the method of multiple correlation to unanalysed economic
material, which we know to be non-homogeneous through time”
“…I would urge that the next instalment should be primarily devoted to the logical
problem, explaining fully and carefully the conditions which the economic material must
satisfy if the application of method to it is to be fruitful”
Specific issues: the conditions of validity
2.1. Completeness of significant factors:
otherwise “the method is not able to discover the relative quantitative importance [of
the included ones]”
2.2. Measurability of all significant factors
“It withdraws from the operation of the method all those economic problems where
political, social and psychological factors, including such things as government policy,
the progress of invention and the state of expectation, may be significant.”
2.3. Independence of factors, simultaneity, and ‘spurious correlations’
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Keynes’s Criticism
“Professor Tinbergen’s Method”, EJ, 1939
2.4. Choice of the functional form
Keynes criticizes the assumption of linear relations, and points out that the
uniqueness of the result depends on the choice of the forrn.
2.5. Time-lags and trends
 Problems of data manipulation: “with a free hand to chose coefficients
and time lags, one can always [cook] a formula to fit moderately well a
limited range of past facts. But what does it prove?”
3.
The question of structural instability and inductive generalisation
“How far are these curves and equations meant to be no more than a piece
of historical curve-fitting and description, and how har do they make
inductive claims with reference to the future as well as to the past?”
“[For inductive geenralisation] the most important condition is that the
environment in all relevant respects, other than the fluctuations in those
factors of which e take particular account, should be uniform and
homogeneous over a period of time”
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Tinbergen’s Reply, EJ, 1940
“The proof of the pudding is in the eating”
1. “It is difficult to meet Keynes’ remarks on methodology in general”
2. Technical questions
2.1. A correct specification is subject to statistical testing.
2.2. Expectations are product of human mind:
are based on past experience;
are hidden in some systematic variables;
may be influenced by external events: part of unexplained residuals.
2.3. Independence of the explanatory variables: for statistical purposes
they only need to be uncorrelated
2.4. Stability of the coefficients: assumed as a first approximation
2.5. Lags and trends: “they are sometimes assumed by common sense
guessing”
3. Inductive generalisation and structural change
Inductive generalisation is possible in the absence of structural changes,
but “even if structural changes take place, it will, in many cases, be
136
possible to localise their influence”
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
An Appendix to the Debate: Review of Tinbergen’s Vol. II (Business
Cycles in The USA, 1919-32)
by Erwin Rothbarth
(German economist working closely with Keynes in Cambridge)
•
Previous review of Tinbergen (1937), on Dutch economy: the case for
econometrics is “unassailable”, but caution as to how far it can go
•
“Brilliant pioneering effort”, in spite of failure to explain trade cycle in the USA:
–
–
–
–
•
•
•
findings do not allow to decide between alternative interpretations
results not conclusive: poor statistics and behaviours not constant in time
potential importance of immeasurable factors
neglect of collinearity and degrees of freedom
Exhortation to use smaller models
Greater weight to be placed on the investigation of the economic material prior
to manipulation
Non-homogeneity
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
The Econometricians and Keynes, 1939-1943. From Reconciliation to Rejection.
Exchange with Szeliski, 1939.
•
Szeliski and Roos’s study on the determinants of the demand for automobiles, reviewed by
Willford I. King:
–
–
•
suitability of data and neglect of the movement of the supply curve, problem of identification
general distrust in inductive methods; limited role for mathematics
Roos and Szeliski’s reply:
–
–
Econometrics as a step towards defining concepts “in terms of the series of operations by which
they are measured”, as in physical sciences.
But too much attention devoted to purely formal mathematical exercises: “… little has been done
regarding examination of underlying premises of economic theory, the basic material for the
deductions.” Keynes among the exceptions.
“Actual demand schedules can only be found by analysis of statistics. The issue here is
how they shall be analysed, and above all how the method of analysis can be related to the
theoretical background…”
•
Keynes (replying to Szeliski, who asked whether his criticism applied to their work):
“…you have chosen just the sort of problem where multiple correlation methods may be
useful. You are dealing with details of a specific problem where the main causes are pretty
well known a priori, and where the statistics are definite and precise. The method is always
full of danger, but …[here it] is properly in place.”
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
The Econometricians and Keynes, 1939-1943. From Reconciliation to Rejection
Attempts at reconciliation: Marshack-Lange, 1940
• Article submitted to EJ in February 1940 and rejected
(Tinbergen’ reply had already been accepted)
• Overall conciliatory tone: “profound agreement” with Keynes’
theories “capable of empirical and statistical verification” (but
weakly argued)
• Technical remarks, some to the point:
– Cycles determined by linear relationships
– Treatment of qualitative variables
• …others less convincing:
– Defence of trends
– Discussion of the correct shape of investment equation to estimate
• Issue of homogeneity tests
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
The Econometricians and Keynes, 1939-1943. From Reconciliation to Rejection
Koopmans, 1941. Attempt at a rigorous defence while taking in Keynes’s points.
•
“Elements of the logical situation”: Availability of time series data; “General working
hypothesis” (causal connections dominate on mere chance fluctuations); additional
information.
Statistician seeks set of coefficients and lags compatible with all 3 sets of premises:
•
–
–
–
Mathematical function representing the influence on dependent variable by determining vars.
Other influences either sum up to random component, or to a function of time, or affect only a
few observations
Assumptions on value of coefficients and lags.
But economic premises are crucial:
“Knowing how easily a statistically undetectable omission of one relevant
determining variable , or an incorrect specification of an a priori known lag, may
…distort the values and even the signs of the other coefficients, the investigator
will devote a full share of his suspicion to the less technical part of the procedure:
the choice of the premises”
•
Alternative premises to dubitable ones must be expressed so as to be liable to
statistical testing.
The validity of method is reaffirmed. When basis of premises is solid and sufficient (not
Tinbergen’s case), results can be used for policy purposes and for prediction - a “more
hazardous undertaking”.
Keynes replies with appreciation but stresses the unaddressed point of the stability of the
environment.
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PART II. ECONOMICS IN THE AGE OF UNCERTAINTY, 1919-1939
THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
The Econometricians and Keynes, 1939-1943. From Reconciliation to Rejection
Haavelmo (1943-44): The Probabilistic Approach Takes Over
•
•
•
•
•
•
Change of paradigm necessary for “an objective and intelligent
discussion of such questions as those of Lord Keynes”, a supposed
believer in the supremacy of “the noble art of theoretical deductions
based on ‘general economic considerations’”
Model as formal logical construction: non-logical jump between model
and reality always needed.
Actual data arbitrarily chosen as counterparts of theoretical variables
(Both redefined as stochastic objects)
Theories as hypothesis on joint probability law allowing probability
statements about facts (room for type I and II errors)
Ineliminable problem of different theories indistinguishable from point
of view of observations:
“Theories with different economic meaning might lead to exactly the
same probability law… just as different pairs of supply and demand
curves might have the same intersection point”
Provides basis for Cowles Commission methodology
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THE KEYNES-TINBERGEN CONTROVERSY ON ECONOMETRIC
METHOD
Concluding Remarks
•
•
Keynes not a critic of econometric work per se…
Core question of methodology / Conditions for induction
“The successful application of this method to so enormously complex
a problem as the business cycle does strike me as singularly
unpromising project in the present state of our knowledge”
•
Why was Keynes’s criticism so harsh?
– Mistrust for a new anti-Marshallian conception on the nature, method and
style of economics
– Concern for the appropriation of his work by the emerging approach:
“I am frightfully afraid of the tendency of which I see signs in you
[Harrod], to appear to accept my constructive part and to find some
accommodation between this and deeply cherished views which
would in fact be only possible if my constructive part had been
partially misunderstood”
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
INTRODUCTION
The period. General characteristics
• Phases of economic growth:
- 1950-1973: rapid growth
- 1970s: stagflation and international monetary disorder
- 1980s-today: growth interrupted by short recessionary period
• Leader: USA
• Globalization is identified with a number of trends developed since
World War II. These include:
– greater international movement of commodities, money, information, and
people
– development of technology, organizations, legal systems, and
infrastructures
– Culturally, the major trend is the great international cultural exchange
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INTRODUCTION
THE ECONOMIC THEORY OF THE PERIOD: MEN AND SCHOOLS
CENTRES OF ECONOMIC THEORY
USA
Harvard, MIT
Chicago
Yale& Cowles Foundation
Princeton
New York Universitties and institutions
Carnegie-Mellon
Pennsylvania
Californian universities
(Stanford, Berkeley, LosAngeles)
Hansen, Leontiev, Haberler, Samuelson, Solow, Modigliani,
Kuznets, Duesenberry, Arrow, Galbraith
Friedman, Stigler, Becker, Coase, Lucas, Hayek
Tobin, Marschak, Koopmans, Debreu
Morgenstern, Machlup, Koopmans, Baumol
Machlup, Baumol, …
Modigliani, Lucas, Simon
Klein
Bain, Stiglitz, Williamson, Leijonhufvud, Clower, Debreu,
Arrow
Santa Fe Institute
Arthur
PERIPHERIES OF ECONOMIC THEORY
The other American Universities
Europe (the most important universities)
Cambridge
Sraffa, J.Robinson, Meade, Hahn, Kaldor
Oxford
Harrod, Hicks
LSE
Robbins, Hayek
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
INTRODUCTION
THE ECONOMIC THEORY 1947-early 1980s
THEORY
A. Microeconomics
Method
General equilibrium
Theory of games
B. Macroeconomics
Neoclassical Synthesis
Chicago School, I
Monetarism
Chicago School, II
New Classical School
MEN AND SCHOOL
Samuelson
Debreu, Arrow, Hahn
Nash
Hansen, Modigliani, Samuelson,
Solow, Tobin, Patinkin
Friedman
Lucas
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INTRODUCTION
THE ECONOMIC THEORY 1947-early 1980s
THEORY
C. Empirical Research
Econometrics
MEN AND SCHOOL
Cowles Commission
D. Methodology
Operationalism
Samuelson
Instrumentalism
Friedman
Popperian approaches
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
INTRODUCTION
THE ECONOMIC THEORY mid1980s- today
THEORY
Economics of Information
Bounded Rationality
Transaction costs
Behavioral Approach
Evolutionary game theory
Economics of complexity
Empirical research
- Computer Simulation
- Experimental economics
Methodology
- Rethorical Approach
- Critical realism
Stiglitz, Akerlof
Simon
Williamson
Akerlof, Kahnemann, Twerski
M.Smith
Arthur
McCloskey
Lawson
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
INTRODUCTION
The rise in the number of economics journals.
Some new entries
The Journal of Economic Theory (1969)
Journal of Economic Literature (1969)
Bell Journal of Economics (1970)
The Journal of Economic Issues (1967)
The Journal of Post-Keynesian Economics (1978)
Journal of Economic Behaviour and Organisation (1980)
Journal of Evolutionary Economics (1990)
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
THE PROTAGONISTS
Samuelson
Tobin
Modigliani, Samuelson and Solow
Arrow
Klein
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POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
THE PROTAGONISTS
Stigler
Friedman
Coase
Lucas
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
PAUL A. SAMUELSON (1915-)
“Samuelson’s contribution has been that, more than any other contemporary
economist, he has contributed to raising the general analytical and
methodological level in economic science” (From the reasons for
awarding Samuelson the Nobel Prize)
Life
1941 PhD Harvard University
1944 Professor of Economics, MIT
1970 Nobel Prize in Economics
Works
1939 “A Synthesis of the Principle of Acceleration and the Multiplier”, JPE
1947 Foundations of Economic Analysis
1948 “Consumption theory in terms of revealed preferences”, Economica
1948 Economics. An Introductory Analysis
1949 “International trade and the equalisation of factor prices”, EJ
1958 Linear Programming and Economic Analysis (with R. Dorfman and R. Solw)
1960 "Analytical Aspects of Anti-Inflation Policy", with R.M. Solow, AER
1969 "Lifetime Portfolio Selection by Dynamic Stochastic Programming", REStat.
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
PAUL A. SAMUELSON (1915-)
Education
Samuelson’s teachers at Harvard:
• E.B. Wilson: “revered teacher of mathematical economics and statistics”
and “the last of the universal mathematicians”
• Hansen, Schumpeter, Haberler and Leontief
The atmosphere in Harvard in that period:
“My transfer from Chicago to Harvard put me right in the forefront of the
three great waves of modern economics: the Keynesian revolution …, the
monopolistic or imperfect competition revolution, and … the fruitful
clarification of the analysis of economic reality resulting from the
mathematical and econometric handling of the subject”
“Harvard made us. Yes, but we made Harvard”
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POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Samuelson’s Foundations of Economic Analysis (1947), 1
•
•
•
Aim: to provide a unified treatment of the most disparate fields of economic
theory in accordance with general criteria
– the methods to apply are a particular application of “the more general
practice of scientific deduction”, identified with the study of the behavior
of a system through a system of equation
– Physics is the ideal point of reference for the construction of economic
theory
– Analogies with the biological sciences are rejected
Any problem of economic theory may be reduced to the specification of a
system of equations
– The structure of the mathematical model marks the borderline between
rigorous theory and hazy knowledge
– Economic thery is a family of models dealing at differing levels of
abstraction with different fields
Walrasian general equilibrium is an example of the maximum analytical
generality
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Samuelson’s Foundations of Economic Analysis (1947), 2
• Purpose of the Foundations is to identify within the various fields of
the theory “formally identical meaningful theorems … each derived by
an essentially analogous method”
• A meaningful theorem is “simply an hypothesis about empirical data
which could conceivably be refuted, if only under ideal conditions”
• This sounds like a statement of Percy Bridgam’s operationalism
applied to economics. Bridgam (1927) insisted that concepts which are
to be permitted into the domain of scientific discourse must be
definable by a specifiable set of operations: “we mean by any concept
nothing more than a set of operations”
• Samuelson’s work as contained in his Foundations was a development
informed by a positivistic philosophy of science (in the Vienna Circle
sense)
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
SAMUELSON’S ECONOMICS.
ECONOMIC THEORY AND MATHEMATICS (1952)
•
•
•
•
•
•
Mathematics is language
Economics = a very imperfect science, based on induction and deduction
The importance of deduction
On Marshall’s objections. What Marshall must have had in mind when
speaking of the dangers involved in long chain of logical reasoning: “Obviously
… Marshall was describing a property of that biological biped or computing
machine called homo sapiens”
“The convenience of mathematical symbolism for handling certain deductive
inferences is, I think, indisputable … Logic is no protection agaist false
hypotheses; or against misinterpretation of reality; or against the formulation of
irrelevant hypotheses. I think it is one of the advantages of the mathematical
medium … that we are forced to lay our cards on the table so that all can see our
premises”
Samuelson's method of economic theory, as illustrated in his Foundations
(1947), follows two rules : with every economic problem (1) reduce the number
of variables and keep only a minumum set of simple economic relations; (2) if
possible, rewrite it as a constrained optimization problem
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
The Macroeconomics of the Neo-classical Synthesis
Macroeconomics reconceived in terms of equilibrium
Hicks (1937), “Mr. Keynes and the Classics. A
suggested interpretation”: he reduces the two
theories to three equations:
- One for the demand of money
- One for investment
- The third taking investment as equal to saving
Reformulated in this manner the two theories hardly
conflict any more
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HARVARD-CHICAGO ECONOMICS, 50s - 70s
The Macroeconomics of the Neo-classical Synthesis
Hicks (1937),2
•
•
•
•
Classical model: (1) M = kY, (2) I = I (i), (3) I = S(i, Y)
K.’ special theory: (1) M=L(i), (2) I = I (i), (3) I = S (Y)
K.’general theory: (1) M = L(i,Y), (2) I = I (i), (3) = I =S(i,Y)
Hicks turns the “generalized General Theory” into a graphic
presentation in a diagram on which he draws the IS-LL
diagram, the ancestor of the IS-LM model.
• “The most important thing in Mr.Keynes’s book” is “the shape
of the curve LL”, “nearly horizontal on the left, and nearly
vertical on the right”. Thus, if the IS curve lies to the left of the
LL curve, then “we cannot … increase employment by
increasing the quantity of money”. “So the GT is the
Economics of depression”
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
The Macroeconomics of the Neo-classical Synthesis
Macroeconomics reconceived in terms of equilibrium
The search for a simplified version of Keynes’s theory
• 1944, F. Modigliani, “Liquidity preference and the theory of
interest and money”:
• The hypothesis of wage stickiness essential to explain
underemployment equilibrium
• 1947, L. Klein, The Keynesian Revolution and Samuelson,
Foundations: two mathematical repesentations of the GT, along
the same line as Hicks and other
• 1960, Samuelson & Solow, “Analytical aspects of Anti-Inflation
Policy”: The Phillips curve entered the arsenal of Keynesian
Macroeconomics
Theoretical refinements:
• 1963, Modigliani, “The life-cycle hypothesis of saving”
• 1958, J. Tobin, “Liquidity Preference as Behavior towards Risk”
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POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Chicago economics: Milton Friedman
Friedman on method
Essay on the Methodology of Positive Economics (1953)
He proposed a sort of methodological instrumentalism, or the idea that
theories are instruments for generating predictions
• “positive economics deals with ‘what is’, not with ‘what ought to be’”
• “Its task is to provide a system of generalizations that can be used to make
correct predictions about the consequences of any change in circumstances.
Its performance is to be judged by the precision, scope, and conformity with
experience of the predictions it yields. In short, positive economics is, or can
be, an ‘objective science, in precisely the same sense as any of the physical
sciences”
• “The ultimate goal of a positive science is the development of theory or
hypothesis that yields valid and meaningful (i.e., not truistic) predictions about
phenomena not yet observed. Such a theory is, in general, a complex
intermixture of two elements. In part, it is a language designed to promote
systematic and organized methods of reasoning. In part, it is a body of
substantive hypotheses designed to abstract essential features of complex
reality”
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HARVARD-CHICAGO ECONOMICS, 50s - 70s
Chicago economics: Milton Friedman
Essay on the Methodology of Positive Economics (1953), 2
•
•
•
Viewed as a body of substantive hypotheses “theory is to be judged
by its predictive power”:
“The only relevant test of the validity of a hypothesis is comparison of
its predictions with experience. The hypothesis is rejected if its
predictions are contradicted …; it is accepted if its predictions are not
contradicted; great confidence is attached to it if it has survived many
opportunities for contradiction. Factual evidence can never prove a
hypothesis; it can only fail to disprove it, which is what we generally
mean when we say, somewhat inexactly, that the hypothesis has been
confirmed by experience”
“the choice among alternative hypotheses equally consistent with the
available evidence” must be arbitrary to some extent because
“relevant considerations are suggested by the criteria ‘simplicity’ and
‘fruitfulness’”
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Chicago economics: Milton Friedman
Essay on the Methodology of Positive Economics (1953, 3
•
•
“In so far as a theory can be said to have "assumptions" at all, and in so far as their
"realism" can be judged independently of the validity of predictions, the relation between
the significance of a theory and the "realism" of its "assumptions" is almost the opposite
of that suggested by the view under criticism. Truly important and significant hypotheses
will be found to have "assumptions" that are wildly inaccurate descriptive representations
of reality, and, in general, the more significant the theory, the more unrealistic the
assumptions (in this sense)”.
With reference to the last proposition, he says:
“The reason is simple. A hypothesis is important if it "explains" much by little, that is, if it
abstracts the common and crucial elements from the mass of complex and detailed
circumstances surrounding the phenomena to be explained and permits valid predictions
on the basis of them alone. To be important, therefore, a hypothesis must be descriptively
false in its assumptions; it takes account of, and accounts for, none of the many other
attendant circumstances, since its very success shows them to be irrelevant for the
phenomena to be explained. To put this point less paradoxically, the relevant question to
ask about the "assumptions" of a theory is not whether they are descriptively "realistic,"
for they never are, but whether they are sufficiently good approximations for the purpose in
hand. And this question can be answered only by seeing whether the theory works, which
means whether it yields sufficiently accurate predictions. The two supposedly independent
tests thus reduce to one test”
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POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Chicago economics: Milton Friedman
Essay on the Methodology of Positive Economics
(1953), 4
According to Friedman, a good theory is one that predicts
successfully on the basis of a few important elements.
Friedman thus argued that the relevant issue was not the
realism of the assumptions but whether the assumptions were
good enough approximations for the purpose in hand. This
statement implies that theories are not ways of description of
the reality, but that are instruments to formulate predictions
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Chicago economics: Milton Friedman
Essay on the Methodology of Positive Economics (1953)
Samuelson vs Friedman on the irrelevance of the realism of assumptions
“When a writer on positive economics says that hypotheses or theories should be
judged on their consequences – or their ability to describe well and organize well
empirical observations – he is saying something valuable … But what I and
other readers believe is his new twist – which from now on I shall call the F-Twist
… - is the following: a theory is vindicable if (some of) its consequences are
empirically valid to a useful degree of approximation; the empirical unrealism of
the theory itself, or of its assumptions, is quite irrelevant to its validity and worth.
At points, the F-Twist seems to go even farther and claim: It is a positive merit of
a theory that (some of) its content and assumptions be unrealistic since only if it
is not tailored closely to one small bit of reality can it give a useful fit to a wide
spread of empirical situations. Unless we explain complex reality by something
simpler than itself we have accomplished little …
The basic F-Twist … is fundamentally wrong in thinking that unrealism in the
sense of factual inaccuracy even to a tolerable degree of approximation is
anything but a demerit for a theory or hypothesis”
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
Chicago economics, Milton Friedman
Friedman’s monetarism
1956, “The quantity theory of money: a restatement”
1963, “The relative stability of monetary velocity and the investment
multiplier in the USA, 1897-1958”
1968, “The role of monetary policy”
The main points:
• The demand for money is a relatively stable function (the velocity of
circulation of money is stable)
• The income multiplier is low and unstable
• Keynesian policies (public spending) are ineffective
• Monetary policies are unpredictable
• Classical liberalism re-stated
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POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
A Modigliani-Friedman model ?
According to Modigliani (1977):
• Neoclassical synthesis and Friedman’s criticism
could be joined into the Keynesian
Macroeconomics
• Convergence at the analytical level, divergence at
the political level
• Theoretical differences could be reduced to a
controversy about the empirically relevant values
of the parameters
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS I:
HARVARD-CHICAGO ECONOMICS, 50s - 70s
The new Chicago economics, from Friedman to Lucas
Lucas’s New Classical Macroeconomics
• Walrasian microfoundations for macroeconomics
• A reconstruction of macroeconomics on the basis of the
extension of the rationality postulate to include
information and expectations
• 1972, Lucas
Two sources:
Stigler 1961
Muth 1961
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
The Protagonists
Stiglitz
Arthur
Akerlof
David
Simon
Kahneman
V.Smith
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
POST-WALRASIAN ECONOMICS
Two key contributions
• H. Simon and the concept of bounded rationality
• Santa Fe Institute and the conception of economics as a
science of complexity
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED
RATIONALITY
• 1942, Ph.D. in Political Science from the University of Chicago
• From 1949 until his death: Professor of Computer Science and
Psychology at Carnegie Mellon University
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
Hayek’s notions of information and knowledge, 1
•
•
•
•
•
•
“Fragmentation of knowledge” or “dispersed knowledge”. Individuals
possess only a bit of information, that is, information is dispersed among a
number of agents (we “have only a small fraction of the knowledge possessed
by all”
Individuals do not possess perfect information, therefore they only seek
“relevant information” to achieve their plans
Information is a flux and not a state, which changes over time. In general
terms, knowledge is a continuous process of discovery (search)
Cognitive processes are implicitly evoked to explain how knowledge and
information are subjectively used, and how and why a certain element of
information is perceived as “relevant”, where others are not
Cognitive processes determine relevance criteria
Yet these concepts (knowledge and information) are not theoretically
distinguished in Hayek’s work, and are prevalently treated as synonyms
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
Hayek’s notions of information and knowledge, 2
• Inarticulate (tacit) knowledge:
a) Individuals act “not by conscious choice” or “deliberate control”:
“we can make use of so much experience, not because we possess that
experience, but because, without our knowing it, it has become
incorporated in the schemata of thought which guide us”
b) These latter are abstract “rules of conduct”, which prevailed by
means of cultural selection, “because they made a group of men
successful”, although they “were not adopted because it was known
that they would bring about desired effects”
c) Abstract rules of conduct “are observed in action without being
known to the acting person in articulated (‘verbalized’ or explicit)
form.”, and manifest themselves “in a regularity of action”; therefore
they help coordination among individuals. Finally, they have an
essential role in characterizing institutions, market and society as
“spontaneous orders”
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
Hayek’s notions of information and knowledge, 3
•
•
•
•
“Fragmentation of knowledge” and “inarticulate knowledge” refer
to two different notions of information:
On the one hand, explicit information is “dispersed” among
individuals. On the other hand, each individual possesses a certain
amount of unconscious information
Dispersed, explicit, information implies a quantitative notion: a
fragment of information is measurable
On the contrary, inarticulate knowledge and information imply a
more complex cognitive process (an unconscious mechanism which
permits their tacit use). In short, inarticulate knowledge and
information are not measurable
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
Hayek and Simon
• There are many differences between Hayek and
Simon’s approaches. Yet they share at least three
points:
• Individuals are characterized by bounded
rationality (informational, computational,
cognitive limits)
• Cognitive limitations induce search processes;
• Individuals adopt strategies for reducing the
complexity of the world
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
SIMON’S CONTRIBUTION, 1
• Theories of bounded rationality, Simon maintains,
dealt with the limits of “information processing
capacities”. More precisely, the definition of
information processing stresses two constraints on
individuals:
• a) the limits of information, which is gathered and
processed;
• b) the limits of computational capacities, which
emerge when agents face complex situations
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
SIMON’S CONTRIBUTION, 2
•
Actors, upon receiving an external input or stimulus, react by either
replicating past behaviours (routines), if they do not encounter unforeseen
situations, or by following new courses of action, in order to solve new and
unexpected situations. In the latter case, problem-solving procedures are
activated, and agents treat complex problems sequentially
•
In particular, they reach a node (a choice point) using information collected
in the previous steps, and this latter, in turn, allows them to gather new
information. Since uncertainty prevails in the real world, neither all the
alternatives nor the consequences that would follow from them are
evaluated, and heuristics are adopted for simplifying search processes
•
Therefore, decision-makers look for a “satisficing”, rather than an optimal,
alternative, and the criteria, which perform this role in decision-making
processes, are called “aspiration levels”
•
Finally, problem-solving (sequential) procedures are attained by breaking
down the problem into smaller components. In fact, problems are often too
complex for the agents’ computational capacities, and this requires their
decomposition into sub-problems that are less computationally complex
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
THREE DIFFERENCES BETWEEN SIMON AND HAYEK
•
•
•
Simon emphasizes the analogy between human thinking and computer
intelligent behaviour. Human thought and problem-solving process are
considered in terms of an information processing system (IPS), that is, a
system consisting of a set of memories, a processor, effectors, and receptors.
On the contrary Hayek refers to a neurobiological approach (The Sensory
Order)
Simon denies any form of tacit knowledge. Rationality can be represented in
symbolic form, and as a sequence of unambiguous operations
The “architecture of complexity” is different. According to Hayek,
“planning” impedes the emergence of evolutionary “spontaneous orders”.
On the contrary, Simon considers “planning” to be a coherent part of
evolutionary processes: unintentional outcomes derive from endless
interaction among plans of different actors (social institutions and
individuals)
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
ECOLOGICAL RATIONALITY:
A NEW VERSION OF BOUNDED RATIONALITY, 1
This perspective is summarized as follows:
“The concept of an adaptive toolbox, as we see it, has the following
characteristics: First, it refers to a collection of rules or heuristics rather than to
a general-purpose decision-making algorithm […]. Second, these heuristics are
fast, frugal, and computationally cheap rather than consistent, coherent, and
general. Third, these heuristics are adapted to particular environments, past or
present, physical or social. This “ecological rationality” - the match between the
structure of a heuristic and the structures of an environment – allows for the
possibility that heuristics can be fast, frugal and accurate all at the same time by
exploiting the structure of information in natural environments. Fourth, the
bundle of heuristics in the adaptive toolbox is orchestrated by some mechanism
reflecting the importance of conflicting motivation and goals.” (Gigerenzer and
Selten, 2002)
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
ECOLOGICAL RATIONALITY:
A NEW VERSION OF BOUNDED RATIONALITY, 2
•
•
•
•
This vision suggests that (limited) rationality is less characterized by precise
(sequential) choices, and is more unintentional and adaptive, where adaptive
rationality implies a decision-making activity largely connoted by unconscious
(adaptive) mechanisms.
In the former case, individuals are considered intentional problem solvers, whose
explicit rationality is limited; in the latter one, individuals are adaptive problem
solvers, connoted by scarce degrees of awareness, as regards their responses to the
environment.
Heuristics are fast and frugal, because they use little information and computation to
make a variety of kinds of decision, and “only search for some of the available
information”. In fact, “There is a point where to much information and too much
information processing can hurt” (Gigerenzer, Todd, 1999)
Fast and frugal heuristics exploit environmental structure to make adaptive
decisions, and lead to accurate and useful inferences. In short, simple heuristics use
“minimal time and information”, and this happens both in basic ecological situations
(as in the prey-predator case), in which fast decisions provide an advantage, and in
complex social circumstances
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
H. SIMON (1916-2001) AND THE CONCEPT OF BOUNDED RATIONALITY
ECOLOGICAL RATIONALITY:
A NEW VERSION OF BOUNDED RATIONALITY, 3
•
•
•
Ecological rationality is a theory (among others) which introduces a notion
of rationality weaker than Simon’s one, although Simon’s heritage is widely
recognized.
Computation has a limited role, since the most important bounds of
rationality are not computational or mental (internal) factors, but depend
on the environment (external) pressures, and on how environmental forces
have selected simple heuristics for making decisions.
In particular, “computationally simple strategies” are better than
“computationally complex” ones. On the contrary, in Simon’s view, given
the computational limits of processing information, the more such limits are
reduced, the more subjects are rational, and the more they carry out good
strategies for solving problems
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and
the Economics as a science of complexity
•
Ph.D., industrial engineering operations research, Un. of California at Berkeley
•
Professor of Economics, the Santa Fe Institute, New Mexico
Works
• The Economy as an Evolving Complex System II (1997)
• Increasing Returns and Path Dependence in the Economy (1994)
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
The present state of economics according to B. Arthur
“The history of science in the twentieth is one of a steady loss of certainty. Much of
what was real and machine like and objective and determinate at the start of the
century, by mid-century was a phantom, unpredictable, subjective and
indeterminate. What had defined the science at the start of the century –its power
to predict, its clear subject/object distinction – no longer defined it at the end.
What is then of economics? Is economics a science? I believe it is. It is a body of well
reasoned science. Yet until the last few years it has maintained its certainty. And
so we must ask: Is its object of study, the economy, inherently free of
uncertainties and indeterminacies? Or is economics in the process of losing its
innocence and thereby joining the other sciences?
I believe the latter. In fact, there are indications everywhere these days in economics
that the discipline is losing its rigid sense of determinism, that the long
dominance of positivist thinking is weakening and that economics is opening
itself to a less mechanistic, more organic approach”.
Brian Arthur 1998, The End of Certainty in Economics
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
Arthur’s Analytical Contributions
Premise
•
“economy relies on human beings and not on
orderly machine components. Human beings
with all their caprices, emotions, and foibles.”
•
“technology destroys neatness because it
keeps the economy changing”
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POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
Arthur’s Analytical Contributions
•
•
the case for indeterminacy when perfectly rational actor has to
form expectations on the behaviour of others whose
expectations, in turn, depend of what the former actor decides
So there results a self referential loop that prevents the
deductive method from working. He proposes to substitute
inductive reasoning and bounded rationality to the previous
decision-making models (AER 1994)
treatment of increasing returns and path dependence (19881989)
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as
a science of complexity
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PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
Santa Fe Institute
The SFI is a private institution which was founded in 1984 by
physicists, biologists, and economists (Kenneth Arrow)
Its primary concern is to focus the tools of traditional scientific
disciplines and emerging new computer resources on the
problems and opportunities that are involved in the
multidisciplinary studies of complex system
The SFI is the culmination and the fusion of two phenomena that have
began to ripe years before its foundation
i)
The growing dissatisfaction with the Harvard-Chicago approach
ii)
Cheapening of computational power and development of versatile
programming languages
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
• Complexity theory represents an effort to analyse the functioning of
highly organised but decentralised systems composed of very large
numbers of individual components.
• Complexity theory starts from the bold and controversial conjecture
that these diverse systems have important features in common that
transcend their apparent differences in scale, material components
and laws of motion.
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
THE PREDECESSORS OF THE COMPLEXITY THEORY:
Norbert Wiener(1894-1964) and the CYBERNETICS
1910 he began graduate studies in zoology at Harvard than he changed to
mathematics and philosophy at Cornell
1911 Cambridge (UK) to study under Russel who told him that in order to
study the philosophy of mathematics he needed to know more
mathematics so he attended courses by Hardy
1914 Göttingen to study differential equations under Hilbert
1915 receives an invitation from O. Veblen to undertake war work on
ballistics at the Aberdeen Proving Ground in Maryland
appointed as an instructor in mathematics at the MIT
1931-32 mainly in UK visiting Hardy in Cambridge which provided a base
from where he was able to visit colleagues on the Continent. Among
these were K. Menger, Frank and Godel
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
THE PREDECESSORS OF THE COMPLEXITY THEORY:
Norbert Wiener(1894-1964) and the CYBERNETICS
Wiener’s idea (1956) was that, in order to obtain a complete
mathematical treatment of a system, it was necessary to assimilate
its different parts to a single basis either human or mechanical. Since
the understanding of mechanical elements appeared far ahead of
psychological understanding, he chose to construct a mechanical
analogue of the relation between human and mechanical: the
feedback which, roughly, implies circular causation
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
THE PREDECESSORS OF THE COMPLEXITY THEORY: John von NEUMANN
From 1943 to 1955 von Neumann worked at Los Alamos National Laboratories as a
consultant to the armed forces
In a close relation with his applied work with simulation, in the late ’40 he started
developing a theory of automata that, due to his premature death, was left
incomplete. Being convinced of the existence of important similarities between
computer and natural organisms and of the usefulness of comparing such
related systems, he sought a theory that would cover them both. He called it
the “Theory of cellular automata”. It was concerned with the structure and
organisation of both natural and artificial systems and the role of language and
information, programming and control in such systems
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
•
•
What these systems share is a potential to configure their components
in an astronomically large number of ways (they are complex),
constant change in response to environmental stimulus and their own
development (they are adaptive), a strong tendency to achieve
recognisable stable patterns in their configuration (they are self
organising), and an avoidance of stable, self-reproducing states (they
are non-equilibrium systems).
The task complexity science sets itself is the exploration of the
properties of complex, adaptive, self-organising, non equilibrium
systems and the attempt to grow them:
“fundamental social structures and group behaviours as emerging
from the interaction of individuals operating in artificial environments
under rules that place only bounded demands on each agent’s
information and computational capacity. We view artificial societies as
laboratories where we attempt to grow certain social structures in the
computer […] the aim being to discover fundamental local or micro
mechanisms that are sufficient to generate the macroscopic social
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structures and collective behaviour” (Epstein and Axtell)
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
COMPLEX SYSTEMS: DEFINITION
•
•
•
•
•
•
dispersed interaction among heterogeneous acting locally on each
other in some space
no global controller that can exploit all opportunities or interactions in
the economy even though there might be some weak global
interactions
cross-cutting hierarchical organization with many tangled interactions
Continual adaptation by learning and evolving agents
Perpetual novelty as new markets, technologies, behaviours, and
institutions create new niches in the ecology of the system
Out of equilibrium dynamics with either zero or many equilibria
existing and the system unlikely to be near a global optimum
(Arthur, Durlauf and Lane 1997)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
A complexity theorician at work
“no one would fault a “theoremless” laboratory biologist for
claiming to understand population dynamics in beetles when he
reports a regularity observed over a large number of
experiments. But when agent based modellers show such
results […] there is a demand for equations and proofs. […] one
can do perfectly legitimate science with computer, sweeping the
parameter space of one’s model, and conducting extensive
sensitivity analysis, and claiming substantial understanding of
the relationship between model inputs and model outputs, just
as in any empirical science for which general laws are not yet in
hand” (Epstein, 1999)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
WHAT COMPLEXITY THEORY IS ?
IMPLICATIONS
•
The appropriate model for economics is evolutionary biology
•
Methods are highly empirical and inductive. The complex system scientist
tends to study the properties of particular simplified and abstract models of
complex systems
•
Experimental science: models are laboratories in which one can make different
hypotheses on the phenomenon under study and observe the output (i.e.
regularities emerging from micro rules)
•
These models involve the study of the interaction of large numbers of elements
represented in computer simulations with the aim of identifying properties of
adaptability and self organisation common to a wide range of complex systems
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
Implications for economics or the debate on the role of
mathematics re-opened
•
•
“previously, a premium was placed on a deductive formal proofs of theorems
that sought to derive general solutions broadly applicable […] Now we see a
greater emphasis on computer simulations and experimental methods to
determine possible outcomes and ranges of solutions. Emergent phenomena
from complex systems are not usually discovered by theorems, but more
frequently by the use of increasingly powerful computers to explore the limits
and possibility that can arise.” Barkley Rosser (2003)
“not only will our successors have to be far less concerned with general laws
than we have been, they will have to bring to the particular problems they will
study particular histories and methods capable of dealing with the complexity
of particular, such as computer simulation. Not for them […] the pleasure of
theorems and proofs. Instead, the uncertain embrace of history, sociology and
biology”. Frank Hahn (1991):
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
Implications for economics or the debate on the role of
mathematics re-opened
Mathematics is inappropriate because:
- is descriptive and not explanatory: an oscillatory time series can
-
-
be described by a function of the kind P(t) = A+B Sin(Ct). The
behaviour of P is accurately described in mathematical terms, but
what happens inside the system, which “rule of behaviour” generates,
on aggregate, the observed oscillation, remains unknown. To this
purpose, the function is devoid of explanatory power in spite of its
descriptive accuracy (Epstein 1999)
is not manageable: for complex systems in not obvious how to write
down (choose the functional form) and then solve the equations
(probably high dimensional difference or differential equation)
(Epstein 1999)
cannot deal with non-linearity complex systems are non-linear.
They exhibit qualitative differences in their behaviour in stimulus to
different intensity and scales (Foley 2003)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
The Santa Fe solution: Agent-based models
Agent-based models are computer simulations that describe agent,
rules and environment and let them interact locally with no
intervention of the researcher side
Agent-based models allow for:
• Explanation: what kind of micro rule generates a given macro
pattern
• Decentralisation: “natural” non-linearity
• Heterogeneity
• Bounded demand on cognitive computational skills of the involved
entities
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
INCREASING RETURNS as ANOMALIES
•
Smith virtuous cycle linking the division of labour as resulting and, at
the same time, fostering the widening of the market is an early
example of increasing returns (But pervasive increasing returns is
incompatible with the establishment of a neoclassical competitive
equilibrium)
•
Marshall and Young:
– i) with increasing returns one firm tends to dominate each industry
– ii) from a dynamic perspective, they destroy the local stability and the
uniqueness of the neoclassical equilibrium but firms cannot grow
indefinitely large, and countervailing forces come into play to regulate the
evolution even if competition cannot enforce the neoclassical marginal
equalities
197
Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
INCREASING RETURNS as PERVASIVE
Arthur (1988-89), the technology case, 1
• economy is inherently open-ended and path dependent like the
evolution of species
• if rival technologies independently of their relative efficiency are
cumulative, an initial advantage that could depend on entirely on
casual circumstances can neutralise the competitive selection.
• If a technological solution gains some advantages on its rivals there
arise strong incentives to subtract resources from investment in the
latter. This is a self-reinforcing mechanism: once the resources are
concentrated on the dominant technology its further improvements
encourage the abandonment of the rival technologies.
• Concentration occurs due to:
i) large fix set up costs that imply decreasing costs as the production
increases (Arthur 1989)
ii) learning effects thank to which products are improved or produced at a
lower cost as their prevalence increases (David 1985)
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Roberto Marchionatti , ECONOMIC THEORY IN THE XXth CENTURY.
PART III. ECONOMICS IN THE AGE OF GLOBALIZATION, 1947 TO NOW
POST-WAR ECONOMICS, II:
POST-WALRASIAN ECONOMICS, mid ’80s to now
(in collaboration with Stefano Fiori and Magda Fontana)
Arthur, the Santa Fe Institute and the Economics as a science of complexity
INCREASING RETURNS as PERVASIVE
Arthur (1988-89), the technology case, 2
iii) network externalities that generate advantages from cooperation among agents
that adopt similar actions (Katz-Shapiro 1985)
iv) adaptive expectations according to which the current prevalence of a solution
increases the likelihood of a future prevalence (Arthur 1988).
•
The crucial hint is that there is no reason to believe that the selected
technology will be somehow the optimal one and that the selection of a
technology cannot be predicted in advance. In fact, quite the opposite is
the case: the emergence of the suboptimal QWERTY typewriter board
(Arthur 1989, David 1985) to the ubiquity of the MS-Dos software, and the
victory of the inferior VHS video system over the BETAMAX standard
(Arthur 1988).
•
This kind of selection is called hyperselection. It occurs when the growth
rate of technologies are coupled in non-linear ways. The result is that
very different evolutionary outcomes can emerge from small variations in
initial conditions (the butterfly effect) and the dynamic is irreversible: once
a path is taken even small amendments are made very difficult.
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