The Showdown- Chapter 19 Pages 256-259

Before his 1986 paper was even published, Romer changed his mind regarding methods and switched from a model of perfect competition to one of monopolistic competition. With this model of monopolistic competition, Romer explained that through gaining knowledge one seeks to "differentiate his product," to gain the special something that will set him apart. Lucas lectured that most of what we know is learned from others free of cost, while Romer argued that we only think we get it for free. Good will and the expectation of future gains (contribution to accounts in the favor bank) were the currency used in the exchange of knowledge.

Recombinations pg 249-250

Warsh talks about Lucas's "Mechanics" Lectures which is simliar to Keynesian economics, but was slightly rejected by the freshwater economics of the time. However, it did shake up the field in early 1986. The Invisible Hand idea is once again brought up but has yet to be explained.

Chapter 19: 253-256

The Chicago faculty was thrilled for the publication of Romer’s paper, especially three professors known as The Trio. The Trio was three young economists (Andrei Shleifer, Kevin Murphy and Robert Vishny) who wrote many papers together that showed how increasing returns can help clarify controversial matters. Working off Romer’s research done on increasing returns, The Trio wrote Industrialization and the Big Push, which demonstrated how spillovers can create enough economic growth to be relied upon by governments. Vladimir Lenin based his economic policy upon the “big push” idea. His belief was that huge investments in industrial production would free Russia from its tradition of agricultural production. Economists, like Paul Rosenstein-Rodin, believed a big push would work in nearly any underdeveloped country but that only the government could be expected to “have deep enough pockets to bear large fixed costs and enough power to force others to comply.” In the early 1900’s, this was an idea largely ignored, but by 1987, when The Trio published their paper, it was gaining popularity. Now, thanks to the use of mathematics, young economists started flocking to the theory of increasing returns.

Ch. 18 Pg. 247-249

By the end of the lecture, the majority of the Keynesian audience is furious about Lucas's alterations to Solow's model. Lucas's theory is completely opposed to the approach that nearly everyone in the audience is familiar with which has put them on the defensive. Very few liked what Lucas had to say, and even they were uncertain of his theory. Three years later, Lucas's lengthy paper is finally printed in "On the Mechanics of Economic Development" and is considered today to be the reason why much of economics has steadily transformed. His paper alter the focus of economics from business cycles to growth. It still is still not clear today what exactly gives richer nations the edge over poorer nations. All that is certain is that there is lock-in, but with modern mathematics Lucas has inspired a new generation of economists to continue searching for the answer.

Ch. 18 Pg. 242-245

Now, Lucas is going to explain how the influence of spillovers acts as a "function of the average level of skill". To begin, we know from everyday experiences that working in groups effects an individuals productivity. The accrual of human capital is based around "social activities" that do not result in the fabrication of a physical product. Lucas shows this in Solow's model by substituting "exogenous technology" or A(t), with H^y or the effect that we have on each others productivity (human capital spillovers). For example, assuming that human capital spillovers equals 0.4 means that the country's production is 40% greater than it would be without spillovers, such as: unions, company membership, universities, or any sort of team involvement. Lucas creates a second model using computers and potatoes to demonstrate how international trade is affected by the increasing returns suggested by human capital externalities. The second model uses the basic principle of comparative advantage, but does not provide a method to catch-up on Solow's model. Instead, the model proves the develop countries get the advantage of human capital spillovers, while the undeveloped countries lose their greatest human capital assets to richer countries. This model proves that countries that start with little human and physical capital will always be undeveloped. Lucas concludes that with no way to accurately measure the effects of human capital spillover, these economic influences will continue to be a mystery.

Ch. 18 Pg. 240-242

Lucas continues to discuss the idea that some markets have a "suboptimal" outcome because a lock-in pattern is occurring. Lucas focuses on the phenomenon of the global distribution of income that has a contradictory reaction compared to the forecasts of Solow's standard model. The data suggests that rich nations/individuals continue to grow and become richer while the poor continue to struggle. The flaw with Solow's model is that the model is dependent on technology to justify the changes in growth making the model suitable to explain growth in developed nations, but is not accurate in the study of poorer nations. Lucas plans to adjust for the flaws in Solow's model by accounting for human capital, like skill level and the spillovers of that capital. The research of human capital has proven to be quite enlightening of over the last couple of decades. Knowing the skills a person possesses can explain that person's expected salary, how they make decisions about work and leisure time, and also their household duties.

Chapter 18 - Pages 238 - 240

Robert Lucas continues his discussion on income and growth differentials among nations, specifically talking about the popular model that was used in the discussion, the Solow Model. (Also known as the exogenous growth model, neo-classical growth model or Solow-Swan growth model).

Lucas admires and gives praise for the form of the model, yet he describes it as an unfit model. Lucas focuses on the “convergence debate.” A expectation that while countries grow at different rates, the poor should grow at a faster rate until they will eventually reach about the same levels of income. This theory was written in the 1952 paper “Economic Backwardness in Historical Perspective” by Alexander Gershenkron. Lucas points out that this has not happened and the Solow model seems to only apply to developed nations.

Lucas goes on to give an easy-to-understand explanation on why this convergence hasn’t happened; because the poor migrate to rich areas of development for better jobs, more income, etc. And rarely, do the rich migrate to poorer areas or nations.

Chapter 18 pages 228 to 235

A meeting in Dallas in December of 1984 was attended by many economists, among whom are W. Arthur Lewis, Kenneth Arrow, Robert Solow, Paul David and Peter Temin. The men are chiefly interested in the authority of economics as a science.

William Parker from Yale opens the meeting denouncing the mathematical turn that economics has taken. Kenneth Arrow talks about how economic history is like the history of the world as interpreted by geology. Virtually all the study of geology is done in labs yet it's a flourishing subject. Robert Solow says that the hard sciences are good at dealing with complex systems and topics such as hydrogen atoms or the optic nerve. Topics in economics are far more complex.

Paul David and economic historian gives a good example of the way the typewriter keyboard has developed. He says that the QWERTY arrangement isn't the best system for placing letters on a keyboard, and that there were a few arrangements that were even proven to be better. It was found that Typists preferred the QWERTY arrangement because it was the most prevalent and that they wanted their skills to be portable. This created an effect that caused all the other designs to disappear. This was viewed as a market failure because it did not result in the single best outcome. QWERTY had increasing returns as it gained traction in the marketplace.

The meeting in Dallas was interesting to say the least, however they were missing some important pieces to the discussion namely Paul Krugman, Elhanan Helpman, Paul Romer and the rest of "the kids." it's apparent that the older generation just talking among themselves and that they will have little more effect on the future of economics.

Pg 225-226

This wasn't a very important part of the book. Warsh mostly just talks about how Romer strays away from the new "freshwater" economics and perfect competition. He then goes on to talk about Lionel McKenzie who taught the people who became leaders in the economic field of academia and taught Romer around the time of this transition.

Chapter 17 Pages 226 to 227

Romer wrote a paper entitled "Increasing Returns and Long-Run Growth" and submitted it to the Journal of Political Economy. The paper was published in the October 1986 issue of the journal after some trouble. Turns out those people that were responsible for giving approval to publish the article were divided on whether or not it should be published. In the end José Scheinkman, who was the editor of the journal sided with publishing the article.

There is however, irony in the paper's publication. Romer no longer believed his result. He no longer considered externalities to offer a promising approach to capturing the economics of knowledge. He slipped something into the published version of his paper that let readers know that his thinking had changed. He wrote how knowledge isn't an technological externality, it is a good.

The U-Turn p. 223-225

This section of the book continues with some of the problems Romer faced in completing his model. The first one mentioned is how Romer was to describe a variety of goods. We saw this in class the other day when we tried to simplify the Robinson Crusoe function; it's not easy getting down to the bare minimum. The problem Romer was finding was that his model basically came up with a monopolistic competition model (not what he wanted.) The solution was to change the model to a production function instead of a consumption function. Another problem with the model was "you couldn't just turn the mathematical crank" (p. 224) meaning that the math might not be 100% correct all the time. However, the model was good and it led to a better model that showed how specialization was the key to rising output.

P. 216- 219

In Romers pure spillover world of his Thesis, if Kodak produced a new type of file, Fuji knew about it the next day. So this puts emphasis on differentiating your product and keeping your discoveries secret for a time. This will help you be a price maker and act like monopolists for a time to help you gain a higher profit. This is the same logic that Edward Chamberlin had on monopolistic competition about 60 years before. But what Romer was doing differently is he was writing math in such a way to describe this world that he saw.

P. 212-214

When Paul Romer published his dissertation (with the one underlying topics being that productivity would improve if government policy subsidized the construction of new plants with new technology), everyone just knew that there was a new kind of economics to be explore at this point. But the Impact of Paul Romer on the world of Economics was not done, it was just beginning and continued after he was hired as an assistant professor at the University of Rochester.

The U-Turn Chpt. 17: 215-216

Romer observed companies investing heavy sums into R&D. At the same time, he was able to witness a controversy about the university's reluctance to hire a Fuji executive to the school of business because Kodak feared he would gain too much insight into their secrets. In Romer's previous model, this didn't make sense; if it was perfect competition, then Kodak would invent something and Fuji would find out the next day. But now there was an incentive to keep that information a secret, otherwise why would these companies invest so much money into inventing them. So Romer creates a new model. However, he has to make the assumption that Fuji may receive some benefit from Kodak's discovery, but not much (which is a shortcut). But now the math keeps coming back to haunt him and he has to go out and deal with it.

The U-Turn Ch.17 pg 214-215

Romer began teaching at the University of Rochester in 1982. His first year at the University was very demanding. In addition to teaching, he was expected to finish his thesis and prepare a portion of it for publication. He also started a family. Amidst all of this, however, he found time to think. Eventually he concluded that his work with perfect competition was going nowhere and he decided to change directions. In a drastic paradigm shift, he began exploring monopolistic competition.

Chapter 16 Pages 210-212

Late 1981 Romer's thesis was completed. 143 pages, most of which included very difficult math. He gives an examples of exogenous growth versus endogenous growth. During a warming trend in the Middle Ages he noted that the northern limit of farmland was had moved 100 miles to the north. this was an exogenous change, no human could have influenced this result. Endogenous change happened during those same years as people purposely planted better strains of grain to increase crop output. This change was brought about within the system.

Romer asserted that the math that he had devised might be used throughout economics. In the theory of the firm, in asset pricing, in macroeconomic fluctuations, and so on.

It took another eighteen months to completely finalize his dissertation and it was three years after that that it was published in a journal. For those that worked on the frontier of economics it was clear that the world had changed. Suddenly somehow everyone just knew there was a great deal of new economics to be explored.

In Hyde Park p. 208-210

There is a ridiculous amount of information in these two pages. The main point I think is that Romer finally came up with his model. The section talks about the mathematics used to get the model working (Pontryagin-style) then moves on to some of the problems associated with creating the model. A few of the problems faced were graphical representation (few personal computers and essentially no software), demonstrating stability in the model, etc. After finishing the model, "It came as a shock to read an editorial arguing that the space race had been good for economic growth, and realize that the abstractions in which he (Romer) was investing so heavily might one day have practical value." p.210

Chapter 16 - Pages 204 -206

It had been twenty-five years since the Cowles Commission had left Chicago and in 1980 the economics department was divided and tensions were high.

The old literary school was breaking up as the mathematical approach was becoming more popular. This had a lot to do with Milton Friedman’s success in his battle with Kenyes. Among many things, he wrote the book Capitalism and Freedom and did a ten-part television series titled Free to Choose. (You can watch each one-hour part here on YouTube. (Extra credit for the first person to watch all ten videos and give a written summary to Professor Tufte on Monday morning. j/k) Chicago also hired its first “cutting-edge mathematical economist” in 1971, William Brock, but he left for University of Wisconsin as these tensions escalated in the economic department.

However, there was also a rise of labor economists. This list of economists can be found on page 205 and they were theorist and econometricians who looked in particular markets rather than the whole economy.

Chapter 16 Pages 203-204

Romer arrived at Hyde Park Campus in June of 1980. Normally students take the economics department's core exams only after completing Chicago's two-year sequence of courses. Romer took the exams as soon as he arrived. He passed immediately.

The sixth president of the university, Lawrence Kimpton, described the university as a place "where one is always in principle allowed to pose the hardest question possible of a student, a teacher, a colleague and feel entitled to expect gratitude rather than resentment for one's effort"

Romer enrolled in several courses as he prepared to write his thesis. He connected with a couple other economists José Scheinkman, and Robert Lucas. Scheinkman agreed to supervise Romer's dissertation and Lucas joined the committee soon after.

pg 198-201

Warsh gives a brief history on Romer's mentor Russell Davidson. Warsh then describes when Romer is taught by Davidson about the Von Neumann model or the Minimax theory, which was an early predecessor to the Solow and Keynesian models. The Von Neumann model held technology consist, to which Romer's responds was "But that's stupid!"(pg 199).

Romer then decided that he was going to build a better model that took into account the change of knowledge. Which he found to be a bigger problem then he anticipated and helped him to become a true economist.

Paul Romer, Pages 196-198

Paul Romer was born and raised in Colorado, where his father ran businesses, practiced law, and later served as governor. Romer entered the University of Chicago in the summer of 1973. His original intentions were to study cosmology, and he later toyed with the idea of becoming a corporate lawyer. It was a course in price theory that pushed Romer into the field of economics. After graduating from Chicago, Romer was admitted to MIT where, as result of a burglar in his apartment, he met his wife. He moved with his new wife to Canada for a year, and then returned to the University of Chicago to write his dissertation.

Chapter 15 pgs 195-196

Paul Romer in the early 1980’s was preparing to return to graduate school. The thesis he had decided up was quite interesting. He would build a new model of economic growth that was built upon falling costs, technological change as internal, and growth as something speeding up rather than slowing down.

This section didn’t really have much more than a brief description that he decided to do this. But as I read a little more into Paul Romer(the information can be found on the link to his name at the first) I found it quite interesting how he looked at economic growth compared to the general outlook of what seemed to be the dominant theme of his time.

Pg 191-194

Warsh begins talking about the idea of supply side economics that was popular in the late 1970's and early 1980's but never seemed to get it right as to what was really happening in the jungle of the time.

Two view points of supply-side economics were brought into consideration, one from Mundell and the other from Laffer. The two, however, never considered each others arguments and little was done to determine who was right or wrong. Mundell wrote a book called Man and Economics while Laffer developed what is now know as the Laffer curve. Both of them soon disappeared out of mainstream economics and supply-side ideas where phased out into more modern economic theories of growth instead of supply.




I just thought this was an intersting quote from the preface of Mundell's book(Man and Economics): "Economics is the science of choice. It began with Aristotle but got mixed up with ethics in the Middle Ages. Adam Smith separated it from ethics, and Walras mathematized it. Alfred Marshall tried to narrow it, and Keynes made it fashionable. Robbins widened it, and Samuelson dynamized it, but modern science made it statistical and tried to confine it again"

Chapter 14: 188-191

In 1980, at the University of Warwick, an economic workshop on international trade was being held. In attendance were top economists as well as up and coming youngsters, one of which was Paul Krugman. Krugman, while presenting a paper on reciprocal dumping, was invited by Elhanan Helpman to help write a textbook on trade. The two eventually became research partners and wrote a book together titled Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition, and the International Economy, which provided “a systematic exposition on the theory of monopolistic competition.” The idea of monopolistic competition was hugely popular and spread rapidly. This new idea of trade gave us a two tiered view of commerce. The first tier has commodities driven by perfect competition and comparative advantage while the upper tier was categorized by governments assaulting other government's markets as well as market size dictating what each government specialized in. This idea caused countries to become more industrial and to be more open to trade. The author ended with the idea that if commodities on the bottom level came about by the distribution of natural resources, then the upper tier was simply who got to the idea first.

Trade Theory - Pages 180-183

In the mid-seventies, MIT graduate Paul Krugman began to question the accepted theory of trade. For centuries, it was believed that specialization existed in a natural pattern, based on the natural resources found within a given nation. Perfect competition and constant returns to scale were the forces that governed the interaction between nations. However, this standard view of international trade seemed strained with the advancements of the Japanese. Japan’s protected home market seemed to provide the nation with a practice field where the advantages of scale could be achieved. Once achieved, lower prices in foreign markets put the nation in position to dominate. The example of the Japanese suggests the possibility of manipulation by nations, who through coordinated effort may achieve advancements to put themselves ahead.

Chp 14 New Departures Pg 179-180

Warsh starts off talking about how the 70's and 30's where both a "watershed" in economics. Many problems caused the economic downturn, but little was know about how to fix them.

He then goes on to say how the 30's and the 70's were exact opposites with regards to the economy. However, students and professionals were at a loss at how to fix it. The 70's had so many problems which were well reflected by Led Zepplin's song "Dazed and Confused," (which was later turned into a movie).

The focus is then turned back to the original problem; why growth happens in certain areas and not others. Japan's car growth manufacturing of the 70's is bought up and little is done to explain it.

"What was the secret of success?"(pg 180)

Chapter 13 Pages 175-176

This section starts out listing the winners of the Nobel Prize in economics. For a complete list of winners check out this link. A lot of economists mentioned in this book are on the list. Looking at the the economists and their theories it's apparent that the moderns had won in Stockholm.

The rest of the section has to do with how growth theory had been brushed aside. The author finds this odd because so much of the problems in the economy had to do with growth. Examples include, productivity slowdown, high inflation, the rise of Asian "tigers" the return to prominence in Europe, and so on. Economists however, had their minds on business cycles and policy effectiveness, "besides, the main issues in growth theory were considered to have been largely settles."

Of course the model made by Solow consisted of bold outlines with little interior detail. (like a map) This leaves lots of areas that needed to be mapped, and young economist could be sure to venture into these unknown areas soon enough.

Chapter 13 Pages 173-175

The new techniques that were brought about by the previously mentioned economists provoked great battles. However, these new methods eventually won out over the old. The gains in understanding were to great to ignore. This didn't mean that everyone agreed on everything. In fact it ended up dividing people into two different camps, the New Classicals and New Keynesians.

New Classicals emphasized the convenience of the assumption of perfect competition, and the different kinds of government failure. New Keynesians embraced the new methods and stressed the same types of problems that had been addressed by their predecessors. Their methods preferred some sort of regulation to solve problems in the economy.

At some point people started to distinguish between Freshwater macroeconomics and Saltwater macroeconomics. Freshwater macro dominated inland universities situated near rivers and lakes; Saltwater macro ruled among coastal universities. Freshwater challenged the prevailing theories while Saltwater stuck more to those methods.

Regardless of what theories economists chose to believe, it was hard to argue with the fact that economic theory was learning to say much more about the real world

Chapter 13 Pages 171-173

This section introduces three economists that began to study the economics of information. The first, George Akerlop, became interested in growth theory while studying at MIT. He studied the relationship between “fixed and variable capital-labor ratios” called a “putty-clay” model but soon moved on to study the market and price volatility in car sales.

Akerlop discovered that consumers are drawn to new cars because used cars may have hidden defects known only to the salesmen. In his own words, “If he wants to sell it, it’s probably because it’s a lemon, and I don’t want to buy it.” He soon published “The Market for ‘Lemons,’” where he describes the problems with adverse selection in different markets.

Another economist, Michael Spence, further addressed adverse selection in an article called “Market Signaling” explaining how two parties could overcome the problem of asymmetrical information through education and advanced degrees. This had a significant effect on markets that have problems with accessing quality like finance and insurance.

Joseph Stiglitz expanded this research and came up with screening mechanisms whereby one party could obtain information from another in order to solve the problem of adverse selection. A good example of this is insurance companies sorting customers into risk classes by means of varying deductibles.

Chapter 13 pg 166-167

The use of tools such as spreadsheets and game theory by scientists began to change the entire view of economist beginning mainly in the early 1970's. One of the main things that came to the forefront was the way economists approached inflation and monopolistic competition.
Samuelson and Solow addressed this issue in their paper on the Phillips curve. They believed that a little unemployment would help drive down inflation while the reverse effect on the other side was a little inflation would also help drive down unemployment. There was a problem though. As unemployment rose inflation didn’t seem to go down. Many economists believe that the key factor is that people expected the inflation. They had realized what the government was trying to do by affecting unemployment and inflation and therefore they did not react as would have been expected.

Chapter 13: 167-168

The Cobweb Theorem has long been the textbook demonstration of how the passage of time causes fluctuations in market prices. Over time, however, economists realized that fluctuations in prices were also a result of consumer expectations. This caused the Cobweb Theorem to transform into Adaptive Expectations; the idea that people look at their past mistakes and adjust for them in the future. Keynesians use these assumptions because they are “convenient.” Others, however, believed people were actually forward thinking and capable of adapting to new information. These “Others” didn’t deal much with mathematics though, so they couldn’t use “sophisticated modeling techniques” to solve their problems. Then, a man named Robert Lucas came along and solved this dilemma. A graduate student under Milton Freidman, Lucas would translate what Freidman taught into the language of math that he learned from Paul Samuelson’s Foundations of Economic Analysis. By doing this, Lucas realized that the only way to accurately look at economic theory is with mathematical analysis.

Theory of General Equilibrium Pages 160-163

Today's concept of the theory of general equilibrium can be ascribed to two separate economists American Kenneth Arrow and Frenchman Gerard Debreu. Both men came to much the same conclusions and published separate studies in 1951 that showed how set theory and convex analysis could be used to determine when the equations describing an economy had solution. these theories led to a "mathematical wonderland above the clouds."

Of course the question was raised. Was all this new math really necessary? Mathematical economists were divided. Koopmans pointed out that the same objections had been brought up in other fields before such as the idea of negative numbers which was the topic of ridicule and doubt when they were discovered almost 2000 years ago. Of course we now know that negative numbers are very real and they have been with us for a very long time.

While the studies and math these men worked with have been with us for less than 100 years, perhaps they are the negative numbers of generations to come.

The State-Contingent Model, Pages 163-166

Building upon the concept of option contracts in commodity trade, Arrow created a model to give application to the new math. Arrow took the idea of an options market and generalized it to include all that is in the economy, and every possible situation. The physical definition of any given commodity thus became dependent on the “state of the world.” This insight gave uncertainty to the theory of equilibrium, by allowing for the possibility that anything could happen in what Arrow called “the complete market.” A few years later, Debreu published the text Theory of Value: An Axiomatic Analysis of Economic Equilibrium, which came to essentially the same conclusions. The Arrow-Debreu model, when coded and put into computers, became what was essentially an early spreadsheet. A significant tool for those who followed, this "spreadsheet" was one of infinite dimensions, with “all the possibilities for all the markets for all the commodities in the world.”