Chapter 12 - Pages 158 - 160

After a good twenty-five years of sustained growth (from WW II to 1969) certain things in economics are going to happen. As assumptions abounded about the end of the business cycle, a new Nobel Prize was created for economics. This also came about as recognition of the third century mark of the world’s first central bank. It was thought that because economists mastered the workings of this fundamental central bank, this led to faster and more dependable growth.

Though there were differences in the economic field, economists were admired and things were at an all time high. Of course, as they say, all good things must come to end. Public opinion dramatically declined and there began to be “furious arguments” within the economic community. By the mid 1970’s “theorists were embroiled in something of a civil war.”

The differences quickly turned to theoretical orientation and what was to be modeled and how. The author tells us what was mostly missed was that these arguments were about new mathematical tools addressing familiar economic problems and none of the new tools were more valuable as the theory of general equilibrium.

Pages 157-158

Closing the last section, all of the young economists that published Essays on the Theory of Optimal Economic Growth abandoned the idea and redirected their efforts in other fields; all except Shell.

Solow gave a benediction on growth theory in 1969 by comparing the theories to reconnaissance exercises. They’re meant to see what it’s like out there before you build a huge model and gather a mountain of data. But theory had no more to offer and the Italian economic journalist Arrigo Levi said, “There are no new discoveries. All the great discoveries have been made.”

For a quarter century after WWII, the U.S., Japan, and Europe all enjoyed sustained business expansion. The business cycle seemed to be tamed or even eliminated after 150 years of wide peak-and-trough behavior. Swedish authorities decided to add economics to the list of Nobel Prizes in hopes that it might bring forth more economic insight and grow the field.

The Residual and Its Critics p.153-157

There were a few interesting topics mentioned in this section. The first would be the movement of new economists to MIT and the arrival of Karl Shell who desired to include technology into the growth problem instead of avoiding the issue. The next point of note would be the "maximum principle" which originated in Moscow and was a way to connect calculus/algebra to topology. Next there was a move from MIT and the economic thought there to Chicago. If I'm not mistaken, Chicago is still the Mecca of economic thought. From Chicago a few of the new growth economists attended a conference in Stanford which brought up an interesting question: "could economic growth be speeded up through policy?" Also mentioned were "turnpikes" which were avenues through which economics could move to higher levels of development by forced investment. However in the summer of 1965 all these new thoughts were squashed and ended up being published with little fanfare as "Essays on the Theory of Optimal Economic Growth" edited by Shell in 1967.

Chapter 11, Pages 148-153

In the field of economics, where consensus can be elusive, plenty questioned whether the "riddle of growth" had really been solved by Solow's model. Keynesians in Cambridge, Schumpeterians at Harvard, and a pair at U.C. Berkeley all made attempts to go beyond the model, but it was the RAND corporation and frequent visitor Kenneth Arrow that went the furthest. Arrow provided two significant insights into the production of knowledge. First, knowledge isn't appropriable. Second, Arrow suggested that knowledge is indivisible, it is a good that is "either altogether present or it (is) not"

Arrow built his model based on knowledge accumulated through experience. By using the idea of rational expectations, he assumed that everyone already knew all there was to know, as soon as others came to know it. These external increasing returns prevented a firm from building a monopoly from its own learning. Due to certain inconsistencies in the model it never became widely used, but several of Arrow’s ideas grew to be very significant.

Pg 147-148

Finally, we are understanding how growth overcomes diminishing returns, by technology growth. All the other important figures in economics understood that technology was important but it is said that Solow put their thoughts into modern calculus. This model became the blueprints for the Cold War, out grow the Soviet Union with technical advances. Growth had now been fit into the Keynesian model and Solow became disinterested and turned his attention elsewhere, helping the government with Cold War issues. Soon he began working on what would become know as the Phillips Curve, which is the theory that inflation and unemployment are linked. "Fine-tuning" the economy soon became a primary focus of polices which lead to the Kennedy tax cuts in 1964.

Pg 145-147

He talks more about Solow model. Explained is how the model changed thinking, by saying the equilibrium was general. It gave the model more flexibility. The system could now adjust and eventually approach a steady state of proportional expansion. Solow's model shows that savings rates don't effect growth rates. Only population and technological growth could effect growth. We get the definition of the Residual "the portion of growth that the model did not explain"

"The 'Solow growth model' is not intended to explain or derive the empirical residual, but rather to demonstrate how it will affect the economy in the long run when imposed on an aggregate model of the macro economy exogenous. This model was really a tool for demonstrating the impact of “technology” growth as against “industrial” growth rather than an attempt to understand where either type of growth was coming from. The Solow residual is primarily an observation to explain, rather than the outcome of a theoretical analysis. It is a question rather than an answer, and the following equations should not obscure that fact."-Wikipedia.com

The Residual and Its Critics p. 141-145

This section of the book introduces the first non-hasty model of Keynesian economics. This model was created by Robert Solow. An interesting point in the background of Mr. Solow was the push into mathematics. I'm not sure if after WWII was the first real push of mathematics into economic models or not, but the author mentions the importance of mathematics in Solow's model. A key improvement to Mr. Solow's model that hadn't been seen before was the shift from fixed capital/output to a variable function that allowed substitution. The model he came up with is Y=A(t)F(K,L) which means that output is a function of labor and capital multiplied by the rate of growth of knowledge. It was assumed that knowledge was to "grow steadily, naturally, with the passage of time." p.145

Chp 11 "The Residual and Its Critics" Pg 140-141

When World War Two ended suddenly in 1945 many economist feared another depression to the magnitude of the 30's. However, this didn't happen and the fastest growth ever seen happened during the 50's.(you can see the big spike in per captia growth in the 50's) This was fueled by the liquid assets built up during the war, but Keynesian policies got the credit. "Polite disagreement" then happened with the different schools of thought. Focus was shifted into making policies that worked.

During JKF administration and the cold war, economists became more valued in the White House and the country, at this point the boom in the 1950's needed to be explained. Economists turned to a Keynesian model now know as the Residual.

Chapter 10 - Pages 127 - 132

In 1943 Jacob Marschak led the Cowles Commission in Chicago and assembled a team that specialized in statistics, economics, philosophy, mathematics and strategy. The list of members and their diversity is impressive, but too long to list here. (They can all be found on page 127.) The commission was in Chicago from 1942 to 1954.

To say that the commission used mathematics and produced some very important and far-reaching developments is an understatement. The commission became famous for their macroeconometric model building, but there were four significant developments in total. The first was this idea of the mathematical model and the recruitment to Keynesian macroeconomics. Model is the key word as they replaced “hypothesis” that had been long used.

The second was in econometrics and the idea of marrying statistics to economics. The third was mathematical economics, specifically the new technique of linear programming. The author states that linear programming was as “significant as the discovery of double-entry bookkeeping in the Middle Ages.” Linear programming had a wide range of applications and moved so quickly in these applications that Samuelson, Robert Solow and Robert Dorfman wrote Linear Programming and Economic Analysis.

The fourth development was in game theory, the thought that one could mathematically anticipate the strategic moves of another, based on choices that have already been made. Or as the books simplifies the concept as strategic thinking.

This section begins by introducing the National Bureau of Economic Research. Its purpose was to research economic factors and advise policy makers accordingly. Over the years the NBER has had many talented scholars and economists; one of those was young Milton Friedman.

Milton Friedman was a dynamic individual. After receiving his M.A. from the University of Chicago, he worked at various jobs, including the NBER. Eventually he finished his Ph. D. from Columbia University and settled down as a professor at his alma mater, the University of Chicago, where he worked until his retirement.

Friedman made a profound impact at the University of Chicago. He challenged Keynesian dogmas and laid the foundations of positive economics by writing “An Essay on Methodology of Positive Economics,” explaining the economic science of “what is.” He also wrote “A Monetary History of the United States,” which presented a new explanation and view of the Great Depression.

Friedman also had a significant impact on the Cowles Foundation. He was a critic of their approach and methodology, and for good reason. Friedman’s friend, George Stigler, had been assigned to calculate the least costly “adequate diet.” Choosing over 510 food combinations, he found an acceptable answer. His answer was later tested by George Dantzig’s new simplex method of linear programming and was found to be a mere 24 cents off, reconfirming Friedman’s opinion that “the old ways were good enough.”

The chapter ends with explaining that before World War 2 there was a plethora of economic schools leading the field. By the end, there were two polar opposites: MIT with Paul Samuelson, primarily teaching Keynesian ideas, and Chicago, with Milton Friedman teaching the marvel and magic of markets.

Chapter 9 - Pages 115 - 119

We take a deeper look into Paul Samuelson and his influence on economics. Though Chamberlin drew Samuelson to Harvard it was Wassily Lenotief and Edwin Bidwell Wilson who where the big influences on Samuelson, the latter being of more importance. Wilson was a protégé of the thermodynamicist Willard Gibbs. After taking a class from Wilson, Samuelson began applying mathematical methods used in thermodynamics to economics.

The book gives the example of Samuelson using a chemistry principle, Le Chatelier, and applying this to a broad range of economic applications. Samuelson was applying calculus to obtain maximum and minimum values for consumer behavior, international trade, public finance and more. Samuelson was applying math along the spectrum of economics.

In 1936 Keynes wrote The General Theory and Samuelson stated he didn’t fully understand what it was about, or the significance of it. As the mathematical models appeared and as Samuelson began to realize the future of these concepts, he set out to demonstrate the underlying unity of the Modern approach and Keynesian theory. As he states, he wanted to create a “general theory of general theories.” Samuelson wrote his thesis Foundations of Analytical Economics, which became a book seven years later as Foundations of Economic Analysis. Samuelson, and this book, had a large effect on the post WW II generation of students and "economists now learned to express themselves mathematically."

Chapter 9 Pages 119-121

After graduating from Harvard, Paul Samuelson took a job at MIT. During his time there, he continued to make a significant impact in his field. He became an advisor to President Kennedy, received the Nobel Prize in Economics, and wrote eighteen different editions of his textbook, Economics: An Introductory Analysis. He also made a considerable contribution writing drafts for Vannevar Bush's Science, the Endless Frontier, which helped government to create the National Science Foundation and sponsor the National Institutes of Health.

Harvard, on the other hand, was struggling. Their resistance to include mathematics in economics was holding them back. Chairman Harold Burbank ordered the printing plate of Samuelson's book to be destroyed after only 1,500 copies were printed. Edward Chamberlin, one of the school's leading professors, was being attacked for not giving a mathematical explanation of his work, in addition to moving away from the idea of perfect competition. Joan Robinson, another Harvard professor, had different ideas which led to a life-long rivalry between the two.

Chapter 9 pg. 108-111

The chapter begins by introducing how the Modern Movement and the Keynesian Revolution affected modern economics, and a few major, influential economists of the era. During this movement economists began changing their outlook about which questions concerning the long-term were most important and most likely to be answered. This was an era filled with economic advancements and remarkable economic minds. Paul Samuelson is one of the greatest contributors to modern economics. He is famous for writing the textbook Economics: An Introductory Analysis that explained Keynesian theory and how to think about economics. Another is the man responsible for drawing Samuelson to Harvard, Edward Chamberlin. Chamberlin had a prominent understanding of the economic growth during the Roaring Twenties. Due to the "steady stream of new products and new methods" entering the market, the economy was experiencing the effects of what Chamberlin labeled monopolistic competition.(p.109) At the same time, Joan Robinson was studying similar effects in England, but she refered to this as imperfect competition. Allyn Young (mentioned in Mitch's post Ch. 7 p. 84-88) studied the "selling expenses" of monopolistic competition. These are the expenses aquired while convincing customers to purchase a product.

The book uses the example of pin makers to explain how monopolistically competitive markets develop. Initially, sellers will sell as many pins as they can make, at whatever price the customers will pay. Eventually, sellers will naturally learn how to produce in more cost efficient ways. For example, producers will buy wire in bulk at lower costs, invest in new machinery, hire salesmen, contract with retailers for shelf space, use advertising to increase sales, and even hire engineers to discover the most efficient manufacturing methods. By producing at minimal cost and taking advantage of new sales techniques, the first pin makers had the opportunity to take control of the market.

Mathematics Is a Language p.111-115

We take a step back from discussing Paul Samuelson to learn about Edward Chamberlin, "the man who drew Samuelson to Harvard" (p.109). Edward Chamberlin is important because he came up with the theory of Monopolistic Competition, which in a nut shell is "any seller who had a market mostly to himself could sell not at a market price...but rather at whatever combination of quantity and price he thought would afford him the greatest profit." (p.112-113) The example given in the book is on railroads, and how they had no real competitors on shipping and transportation. Also mentioned is price discrimination which is charging different prices to different people. Sadly Chamberlin published at the wrong time and his book, Theory of Monopolistic Competition, was ignored due to the onset of the Great Depression.

Other topics of interest from this chapter are 1. Joan Robinson, who also developed theories on Monopolistic Competition, but not to the same extent as Chamberlin. 2. Chamberlin's work on Oligopolies, which are a few firms that collude to drive prices/revenues up. 3. The theory of "Indivisibility" by Nicholas Kaldor. I still don't really understand what this is, but it seems like he is just saying that specialization results in market power which causes increased returns.

Chapter 8: 102-108

In the book Pasteur’s Quadrant, scientist Donald Stokes discusses the different motivations behind deciding to do scientific research. Stokes believes that the most rewarding research is that done “seeking to expand the frontiers of knowledge in connection with a pressing problem.” Stokes believed John Maynard Keynes’s research fit under this category. But as brilliant as Keynes was, he had a hard time communicating how his ideas worked. He cared more about getting results than making sure people understood his “science.” To bridge the gap between himself and other economists, he hired an “interpreter.” John Hicks worked brilliantly and was able to simplify Keynes’s ideas using mathematics in a paper titled “Mr. Keynes and the Classics.” Once Keynes’s ideas were simplified, they spread rapidly and spawned two new classifications of economists: Modernists and Keynesians. The author described Keynesians as doctors; they wanted to find a cure for the economic troubles of our country. Modernists believed economic understanding was “an end in itself” and that is wasn’t very applicable to the real world.

The section ends by talking about John Hicks's most memorable work, Value and Capital. In the book he is very firm on the idea of perfect competition. He believes that without assuming perfect competition, the general equilibrium theory wouldn't work the way that it is supposed to.

Chapter 8 Pages 90-94

One of the first economists that made progress using mathematics was young Francis Plumpton Ramney. In his short life of only twenty-six years, he published three papers of relative importance. In 1928 he published "A Mathematical Theory of Saving," where he used calculus to devise a savings theory. Using a model of labor and capital he calculated the necessary ratio of output and consumption to the rate of interest in order to maximize a country's "satisfaction."

During the Great Depression some people turned to more quantitative solutions for unanswered questions. One of these men, Alfred Cowles, was looking to fund someone with answers. He soon discovered the newly forming international society, which eventually became the Econometric Society. Alfred then formed the Cowles Commission which organized a seminar each year with the elite economists around the world. They discussed economic, physics, mathematics, and electricity.

Chapter 8, Pages 94-98

The history of electricity may have been particularly compelling to the economists of the Modern movement. Around the same period, Benjamin Franklin and Adam Smith were each pioneers in their individual field, and much of their work became the basis upon which those who followed built. The study of electricity began with experimentation. Theories were created explaining individual aspects of electricity and its behavior. Next, models were used to illustrate ideas and provide further insight. Finally, straightforward equations were used to summarize ideas. Mathematics became the primary tool for James Clerk Maxwell and the other great minds involved in the investigation of electricity.
The advancement of economics as a field followed a similar course. At the time of the Modern movement, economists were moving away from models, and mathematics was on the verge of becoming the field's lingua franca.

Chapter 8: 88-90

By the 1930’s, growth in the field of economics seemed to have halted. Economists were stuck on the same subjects, unable to move forward. The economists of this time were very “literary” and didn’t deal much with mathematics. Then the “Modern Program” and John Maynard Keynes began to change economics. The Modern Program was a “shared determination to supplant the ambiguities of verbal reasoning with more rigorous methods.” With Einstein and other prominent scientists flocking to America, economists began to see the possibilities of science and the tools it gave them. Economists then began using “mathematical methods and formal logic” over their old ways. Keynes, while trying to save industrial capitalism and unlock the mysteries behind the Great Depression, unwittingly created a revolution. He discovered macroeconomics, something people at first thought strange because it was so different than microeconomics. With the discovery of macro there came a new “conviction;” the fields of microeconomics and macroeconomics couldn’t be accepted unless they became unified. This led to the building of macro phenomenon on the foundation of micro’s behavior of individuals.

Chapter 7 Pages 84-88

Marshall's theory of external increasing returns was a matter of serious debate during his time. Opinions on the subject varied because most economists couldn't completely understand it. A.C. Pigou, Marshall's successor, claimed that externalities were so important that the government should either subsidize or tax businesses based on falling or rising costs. Others, like John Clapham, protested that it it was an "empty economic box" without any evidence or data. Frank Knight's logic was that "one man's spillover is another man's internal economy," asserting that it was prevalent in manufacturing.

Allyn Young was the one that made the most progress in the theory. He narrowed it down to the division of labor, but in a way that had never been thought of before. His idea was that the division of labor also dealt with knowledge, innovation, and differentiating products. That meant manufacturers could find new applications, thereby leading to specialization. He was soon elected president of the British Association's economies and statics and gave a speech titled "Increasing Returns and Economic Progress." This was probably his greatest contribution before he passed away shortly before the great depression.

Chapter 7, Pages 73-77

Alfred Marshall's Principles of Economics became a widely used and highly influential work. Backing away from the mathematics, Marshall approached the subject primarily with the use of literature and diagrams. Marshall introduced the vocabulary of supply and demand, and illustrated their application with the diagram still used today. Though some at the time had ventured to explain everthing on which a price may depend, Principles used the idea of a partial equilibrium which focused on interactions within specific markets. Viewing a given market in this way was made possible by assuming that all other factors remain constant- the idea of ceteris paribus.

Chapter 7 Pages 72-73

Towards the end of the 18th century, England was thriving in a way it never had before. The Industrial Revolution had created large factories, monopolies and a rising middle class. Even the poor seemed to have more food, clothes and shelter. To many, this new era was unexplainable and considered to be a passing tide. In 1890, however, Alfred Marshall theorized that specialization and competition would lead to lower per-unit cost, and as a result, lower prices. This principle came to be known as external increasing returns, the foundation of economies of scale.

Chapter 6 pg 68-72

A “second great escalation” happened in the history of Economics. The idea of marginalism came into view. Using the example of the price of a diamond verse the price of water, they described how it was not necessarily the amount of a good that dictated the price but the “additional increment.” A great proprietor of this was Walras. He “resolved to do for economics what engineers already had done for various intricate physical systems—that is, construct a model of economic general equilibrium from among the relevant interdependent variables.”

Chapter 6 pg. 63-65

One could call Karl Marx a close student of Ricardo. He bought in to Ricardo’s ideas whole heartedly but rather than making Ricardo’s mistake of assuming away continued growth, he used it as his starting point. But this initial closeness of ideas would not last. While they began close in their ideas by the end of it all one of the only discernable common grounds is that Ricardo thought production would cease because of the scarcity of natural resources and Marx believed it would flourish because of the increase in knowledge. Marx’s ideas while based in much truth and some things that describe today, including public schools, central banking, etc, there was a great deal more of absurdities in language and ideas. Marx’s son-in-law, Paul Lafargue described it very well I think in his use of a painter analogy describing Marx. It can be found here.

Chapter 6 Pg. 61-63

While Ricardo and Malthus pushed their ideas upon the world and in great part were accepted for them, there were still those “dissenters” who put forth other ideas. J.R. McCulloch, a Scottish economist, supported some truth to Ricardian claims, while pointing out that many of the supposed “certainties” of their claims would not hold true. An example is that of agricultural skill staying the same. Whereas Ricardo would be right if the skill stayed the say, it did not. That given time the skill would improve, as shown by his pointing out that the “worst lands in his day, yielded more than the best lands of two hundred years before.”

While J.R McCulloch was correct in many of his ideas, as well as many others including Augustine Cournot and Jules Dupuit, and Charles Babbage, the world was not ready to see the banner they had raised concerning specialization. As Kenneth Arrow described, “the Economics of the Pin Factory had become “an underground river, springing to the surface only every few decades.””

Chapter 5 Pg. 58-61

At times it might be said that a man may become too smart for his own good. This idea could be applied to Ricardo and Malthus. While they had much insight into the study of economics they found a way to detour the entire study into a long and lengthy side trip described in the book as the flow and ebb and flow of knowledge. Using what could be called an “easy excuse,” or “easy write off” of exogenous causes as the reason behind things they did not want to or could not explain.

To describe this they used the example of map making of Africa. How many maps had great detail in the past but while they were detailed, after a time, they were not always correct, completely ignored key facts, and at times were completely false. That it took great time before the maps were able to be brought back to the details and knowledge they once had because certain things were blown out of proportion and others completely ignored.

Chapter 5 Pg 57-58

Resistance to change has always been a common theme throughout the ages. This theme held true in the development and introduction of new ideas in Economics. Outsiders to Ricardo and his followers felt that they, Ricardo and his followers, pushed off and paid little heed to the importance of verifying their results. They felt that annoying facts and inconvenient realities were simply ignored. This even became known as the Ricardian Vice. Despite the opposition Ricardo continued to grow in both wealth and influence and entered the political scene in 1819 as “the representative of the science.”

I may have read the paragraph out of context but as it talked about Ricardo’s chapter on machinery it seemed he believed that machinery was only a “quick-fix” and in the end would have no real affect, shown by his statement, “…(t)hat the opinion entertained by the laboring classes, that the employment of machinery is detrimental to their interests, is not founded upon prejudice or error, but is conformable to the correct principles of political economy….”