Wednesday, March 2, 2011
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.
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A for Jane.
ReplyDeleteNow we're getting deeply into my personal area of expertise. There's no classes to teach this stuff at SUU, but I know the Lucas stuff backwards and forwards if it ever comes up ;)
The basic point is that if you make something now to sell at a later date, your expectations of prices in the future effect your decisions today. It gets more complex if the demander is doing this while the supplier is too. But, it's essential to work through how they form those expectations if you're going to model their decision-making correctly.
FYI: Lucas "hurried home to translate what Friedman had said into math" because his wife did most of the work for him. No knock on the Lucas of the last 40 years as a great theorist, but in the early days she did all the heavy lifting. He had far less math background than she did. This is a well-known story, and here's a quote from Lucas' Wikipedia page about it: "His ex-wife, Rita Lucas, upon their divorce in 1988, had a clause placed in their divorce settlement that she would receive half of any Nobel Prize won by Lucas in the next seven years. When Lucas did win the Nobel Prize in 1995 (falling just within the time limit), she was awarded half of the prize money."