Tuesday, 8 October 2019

The representative firm

Marshall's idea of  'representative firm' was created to reconcile his dynamic view of individual firms with the static view of industries. But this idea was somewhat nebulous and did not last very long in the economics literature. Marshall first wrote about the representative firm in his Principles of Economics published in 1890 but the idea was driven out of the literature by 1928, when it was replaced by A. C. Pigou's idea of the `equilibrium firm'.

Sunday, 29 September 2019

Becker versus Coase on consumer behaviour

From the Free to Choose Network comes this video of Gary Becker and Ronald Coase talking consumer behaviour. Half an hour very well spent.
Is the economic theory of utility a useful way of understanding consumer behaviour? Ronald Coase and Gary Becker, Nobel Economists at the University of Chicago, explain and discuss the theory of rational maximizing utility. They describe how consumers rank preferences and then attempt to choose the highest preference according to their resources, and they discuss whether firms and households operate with similar principals. They consider whether it is necessary to even have utility theory, and whether economists have been misled on this subject.

Roger Bootle: Europe is a complete disaster – Britain must leave

Economist & author Roger Bootle talks to Merryn Somerset Webb about Europe’s economic disaster, & should Britain pull out.

Thursday, 5 September 2019

Is the Phillips Curve Still a Useful Guide for Policymakers?

Morgan Foy writes in the September 2019 issue of the NBER Digest on the question, Is the Phillips Curve Still a Useful Guide for Policymakers?

The Phillips curve, named for the New Zealand economist A.W. Phillips, who reported in the late 1950s that wages rose more rapidly when the unemployment rate was low, posits a trade-off between inflation and unemployment. When unemployment is low, and the labor market is tight, there is greater upward pressure on wages and, through labor costs, on prices.

The conceptual foundations of this relationship have been a subject of active debate, but for many decades, the relationship seemed well-supported by U.S. data. In the last two decades, however, the U.S. inflation rate has not been particularly high, even during periods of low unemployment. The recent data have led many to wonder whether the Phillips curve has weakened or disappeared. In Prospects for Inflation in a High Pressure Economy: Is the Phillips Curve Dead or Is It Just Hibernating? (NBER Working Paper No. 25792) Peter Hooper, Frederic S. Mishkin, and Amir Sufi examine why the Phillips curve relationship has not been evident in recent aggregate data for the United States.

The researchers study both inflation in consumer prices and inflation in wages. They test for a "price" Phillips curve using data on annual costs of goods and services, and for a "wage" Phillips curve using hourly earnings data. They allow for different relationships between inflation and unemployment in tight and in slack labor markets. Using a simple model that assumes a linear relationship between inflation and unemployment, and data from 1961 to 2018, they estimate that a one percentage point drop in the unemployment rate increased inflation by a mere 0.14 percentage points. However, when they allow for different effects of unemployment changes in tight and slack labor markets, they find that the estimated effect of a 1 percentage point unemployment decline on the inflation rate is about -0.32 percentage points when the unemployment rate is 1 percentage point below the natural rate, and -0.12 when it is 1 percentage point above it.

When examining data only from 1988 to 2018, the researchers see less evidence for a robust price Phillips curve. The linear and nonlinear slopes are both close to zero, consistent with the common view that the Phillips curve is flattening. However, the wage Phillips curve is much more resilient and is still quite evident in this time period.

The study points out that in the last three decades, the Great Recession notwithstanding, there has been less variability in the national economy than in prior decades, which makes it harder to detect the impact of unemployment on inflation. In addition, the Federal Reserve has tried to avoid labor market overheating as a way to stabilize inflation, thereby "anchoring" inflation expectations at a 2 percent inflation level and reducing the effect of unemployment fluctuations on price movements.

The researchers observe that state- and city-level data provide more variability in unemployment rates and are less influenced by federal monetary policy than the national figures. Therefore, they explore the relationship between unemployment and inflation at this level. They find a strong negative relationship between the unemployment rate's deviation from the state average and the rate of wage inflation. They also find evidence of a nonlinear price Phillips curve in city-level data.

The researchers point out that the relationship between inflation and the unemployment rate is a key input to the design of monetary policy. They note that the unemployment rate in the U.S. economy is currently near record lows, and they caution that they cannot predict whether inflation will rise in the coming years. However, they conclude that "Evidence that the price Phillips curve has been dormant for the past several decades does not necessarily mean that it is dead... it could be hibernating, and there is a risk of the Phillips curve waking up, with inflationary pressures rising in the face of an overheating labor market."

Tuesday, 3 September 2019

Normative versus positive analysis in the history of the theory of production

This paper looks at the history of the theory of production. Before the seventieth century, with the advent of mercantilism, the predominant mode of enquiry was a descriptive/ normative one. The frameworks applied were ethical and/or religious. The questions asked were about what production or occupations would find favour with God or what production was ethically justified. The important point is that these normative frameworks did not give rise to a theory of production. Such a theory only began to emerge with the emergence of a positive approach to economic reasoning more generally.

Friday, 30 August 2019

Should we assess our economy through trendy 'wellbeing' metrics?

GDP, or Gross Domestic Product, a strange statistic in modern political debate. Economists point out that it fails to capture the value of an increasingly digital economy but it remains the measure most politicians and journalists pay attention to. According to GDP, if a mother decides to go out to work as a childminder and pay a childminder to look after her own child, rather than look after the child herself, that is increased GDP, despite the fact the same number of children are being looked after the same number of people. So, should we be looking to alternative measures, perhaps ones which measure a country’s social and economic performance more holistically? Recently New Zealand’s Prime Minister Jacinda Ardern has backed a ‘different approach for government decision-making altogether.’ “We are not just relying on Gross Domestic Product, but also how we are improving the wellbeing of our people,” said her Finance Minister. Joining the IEA’s Digital Manager Darren Grimes to discuss the best ways to measure a country’s economic performance is the IEA’s Senior Academic Fellow, Professor Philip Booth.

Thursday, 1 August 2019

Who pays for the minimum wage?

This question is asked in a new article, Who Pays for the Minimum Wage?, in the latest issue (Vol. 109, No. 8, August 2019) of the American Economic Review.

The paper is by Peter Harasztosi and Attila Lindner and looks at the margins along which firms responded to a large and persistent minimum wage increase in Hungary. It finds that the employment elasticities are small, but negative.

The abstract reads,
This paper provides a comprehensive assessment of the margins along which firms responded to a large and persistent minimum wage increase in Hungary. We show that employment elasticities are negative but small even four years after the reform; that around 75 percent of the minimum wage increase was paid by consumers and 25 percent by firm owners; that firms responded to the minimum wage by substituting labor with capital; and that disemployment effects were greater in industries where passing the wage costs to consumers is more difficult. We estimate a model with monopolistic competition to explain these findings.

Bad economic justifications for minimum wage hikes

Ryan Bourne has authored a recent paper at the Cato Institute on Bad Economic Justifications for Minimum Wage Hikes.

The bad reasons he gives are,
  • A solution to a market failure?
  • To keep pace with productivity trends?
  • Costs of living
  • Poverty
His conclusion reads,
The metrics that $15 minimum wage advocates use to make the case for substantial minimum wage hikes are not, on their own, economically sensible benchmarks by which to set minimum wage rates.

Economy-wide productivity growth can be a poor guide to productivity trends for minimum wage workers and different localities, and it tells us little about whether firms have the power to set below-market wage levels.

Housing and childcare costs are unrelated to firms’ ability to pay or the value of the work minimum wage employees undertake. And comparing the income of someone working full-time at the federal minimum wage to existing poverty thresholds ignores the role of anti-poverty programs and the fact that many minimum wage earners are not poor.

Campaigners’ arguments often imply that minimum wages should be linked to productivity measures, living costs, or poverty thresholds. The evidence presented above suggests that translating these arguments into policy could produce damaging labor market outcomes.

Bernie Sanders and bad justifications for minimum wage hikes

This audio is from the Cato Daily Podcast.
The tiff between workers for the Bernie Sanders campaign and the campaign leadership illustrates some of the tradeoffs inherent in mandating wage floors. Ryan Bourne is author of a new paper on minimum wage hikes and bad justifications for them.