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Neoclassical :. Monetary Economics. Monetary Economics. There is no separate school of monetary economics. Money in economics became more important with the growth of banking, credit and economic fluctuations.
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Neoclassical : Monetary Economics
Monetary Economics • There is no separate school of monetary economics. • Money in economics became more important with the growth of banking, credit and economic fluctuations. • The monetary policies of central banks and governments became increasingly important.
WHO PAY ATTENTION TO MONETARY ANALYSIS? • Marshall devoted some attention to monetary analysis. • He stated the equation of exchange called the Cambridge Equation. M = kPT • M = the stock of money • k = fraction of income people collectively wish to hold in the form of cash balance. • P = the general price level. • T = is either the volume of trade or real income
Marshall’s k is the reciprocal of the velocity of circulation, V, MV = PT • Fisher later developed this later version of the equation. • Wicksell, Fisher and Hawtrey are within the Marshallian neoclassical tradition.
The trio’s contribution to economics: • They explored monetary analysis which had been neglected but was growing in importance. • They helped integrate monetary analysis into general economic theory. (Although they may have exaggerated the role of money). • There was a split within the neoclassical:
Split in Neoclassical NEOCLASSICAL MONETARIST NON-MONETARIST Individual person’s or firm’s real sacrifice Income, C, S and I Emphasized monetary factors along with Real factors. AGGREGATE ANALYSIS TOTAL DEMAND TOTAL MS TOTAL SAVING TOTAL INVESTMENT
JOHN GUSTAV KNUT WICKSELL(1851-1926) • Born in Stockholm, Sweden. • His work was greatly influenced by Bawerk’s book on capital theory.
JOHN GUSTAV KNUT WICKSELL(1851-1926) – Major Contributions • He was one of the earliest economists to suggest that the typical firm will experience (1) increasing returns, then (2) constant returns and finally (3) decreasing returns as it expand its size. • He anticipated the theory of monopolistic competition, and later was worked out by Chamberlin and Robinson in 1930’s.
His famous contribution to monetary economics: • An analysis of the role of interest rates in achieving an equilibrium price level or in generating cumulative inflationary or deflationary movements. • Recognizing the potential contribution of the government and central bank in retarding or promoting price stability. • Saving-Investment approach to macroeconomics equilibrium – this established Wicksell as the so-called father of the Stockholm school of economics.
WICKSELL • His work became sources of Keynesian economics. • His overall objective was to synthesize monetary theory, business cycle theory, public finance and price theory into one system. • Although he was not totally successful, he advanced the state of economic thinking in this area.
Price Level Changes Why do prices collectively rise or fall? • To answer this he turned to an analysis of interest rates. • Here he distinguished between the normal or natural rate of interest and the bank rate. • Normal or natural rate of interest depends on supply and demand for real capital that is not yet invested. • Interaction of supply and demand determines the natural interest rate.
Price level will change in either 2 cases: Case 1: Bank rate < natural rate • If bank lend money at r lower than natural rate, S will be discouraged, and demand for C goods and services will . As cost of borrowing , I will in, thus income. The price of C goods begins to rise and continue to rise as long as bank rate < natural rate.
Case 2: Bank rate < natural rate • If the bank rate > natural rate prices will fall. This is because S will and I will . Decline in I will reduce national income, which in turn will cause the prices of consumer goods to decline. The general price level will decline and deflation will occur.
Implication for Public Policy • His analysis in interest rate led him to emphasize the role of government and the central bank in promoting economic stability. • In his Interest and Prices, published in 1898, he became the first economist to advocate stabilizing wholesale prices by controlling discount and interest rates. • He advocated that banks established a normal or natural rate of interest (a rate that neither raises nor lower commodity prices).
Forced Saving • He analyzed the theory of forced saving. • This was not a new idea, Bentham presented this idea, Mill also discussed about this and Walras stated the theory in 1879.
Imperfect Competition • He recognized the inadequacy of the purely competitive model in retail markets. • Chamberlin and Robinson systematically developed it after 32 years. • In complete monopoly case, he followed Cournot and others by indicating that volume of sales is artificially restricted to the point that yields maximum profits.
IRVING FISHER (1867 – 1947) A Yale mathematician-turned-economist.
Fisher’s Theory of Interest • In his The Rate of Interest, published in 1906, Fisher first set forth his theory on how interest rates are determined. • In 1930, his expanded and revised the theory.
He perceived 2 factors interacting to establish r: • The impatience rate – community willingness to obtain present consumption by giving up future consumption. It is a trade off which depends on how impatient it is. The less impatient, the more it is willing to save and invest thereby gaining future consumption. It is subjective valuation. • The investment opportunity rate – is determined by real factors such as quantity, quality of resources and the state of technology.
Departure From Pure Competition • Interest in imperfect competition arose because of the gap in economic theory between the pure models of competition and monopoly. • Pure competition applied fully to agriculture but even than the theory was becoming less suitable to modern conditions.
Departure From Pure Competition • The theory of monopolistic competition came in between the 2 extremes of pure competition and monopoly. • This new ideas were fully developed by Edward Chamberlain in USA, Joan Robinson in England
PIERO SRAFFA (1898-1983) • An Italian who migrated to England and taught at Cambridge University. • A leading member of the Post-Keynesian and was a critic of neoclassicism. • However, his earlier work was within the tradition of neoclassical and he produced important work in criticizing the theory of pure competition.
PIERO SRAFFA (1898-1983) • 1926, he published in Economic Journal an important article. • In his article he pointed out how as firm become increasingly efficient, its size increases, there will be fewer firm and less competition and this can lead to natural monopoly.
PIERO SRAFFA (1898-1983) • 1926, he published in Economic Journal an important article. • In his article he pointed out how as firm become increasingly efficient, its size increases, there will be fewer firm and less competition and this can lead to natural monopoly.
PIERO SRAFFA (1898-1983) • Sraffa presented a well-defined theory but both pure competition and natural monopoly are extreme cases. • His article created an outburst of thinking about the shortcomings of the current economic theory.
EDWARD HASTINGS CHAMBERLIN(1899-1967) • An American, born in La Conner, Washington. • An undergraduate at University of Iowa and earned his PhD at Harvard. • He published The Theory of Monopolistic Competition in 1933. • His book fused the separate theories of monopoly and competition, and it explained a range of market situations that are neither purely competitive nor total monopolistic. • Most market prices are actually determined by both monopolistic and competitive elements.
The Theory of Monopolistic Competition • Key concept of the theory of monopolistic competition is about product differentiation. • This implies that each firm’s demand curve slopes downward, and MR curve must lie below the demand or AR curve. • He was among the first of many theorists in the late 1920’s and 30’s who applied MR idea in Cournot’s monopoly model (implicit). • However, it was Joan Robinson is credited for emphasizing the importance of MR in theories of the firm.
JOAN ROBINSON (1903-1983) • Long time professor of economics at Cambridge University. • She was a student of Alfred Marshall. • Her book, The Economics of Imperfect Competition was published a few months after Chamberlin’s covers substantially the same ground.
JOAN ROBINSON (1903-1983) • She made significant contributions in Keynesian and Post-Keynesian economics, economic development, and international trade. • Her overall work was difficult to fit within any particular school of thought. • This fact must be kept in mind in discussing her early neoclassical contribution.
Monopsony • Monopsony is a situation with a single buyer in a market or a group of buyers acting as one. • She analyzed the outcomes of monopsony buying power in 2 types of market. • Product-market monopsony • Resource-market monoposony
Product-market monoposony • Robinson stated 2 generalization: • Under pure competition, the buyer will purchase successive units of goods at any time up to the point where the P = MU • Under monopsony, the buyer will regulate purchases in such a way that the MC to him (different from the MC of production) is equal to marginal utility(MC=MC).
Resource-market monoposony • In analyzing monopsony in the resource market, she used labor market as an illustration. • The contemporary graphical representation of labor market monopsony derived from Robinson’s presentation.
Resource-market monoposony • She concluded that: • Labor market monopsonist will employ fewer workers than would be hired by employers competing with one another for workers. Monoposonist reduces employment to avoid driving up the wage it must pay to all workers. • Under monopsonist worker is exploited.
