Transcript The End of Laissez-Faire: Macroeconomic Instability and

The End of Laissez-Faire:
Macroeconomic Instability and
Microeconomic Inefficiency
Peter J. Boettke
Econ 881/Spring 2005
14 February
Historical Context
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Turn of the Century America
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Poverty Amidst Plenty
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Progressive Era Legislation
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Antitrust policy
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Interpretation of Imperialism and War Socialism
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Capitalism as cause, socialism as solution
Great Depression
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Aggregate demand failure (underconsumption)
New Deal Legislation
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Exploitation
WWI
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consumer protection from impure products
Working Conditions
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cut-throat competition
Pure Food and Drug Act
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inequality
Putting people to work and giving them hope
WWII
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“Greatest Generation”
Importance of the Soviet Union
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Socialism as a Viable Alternative
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Socialism tamed by Democracy = Interventionism
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No monopolistic exploitation and now crisis such as the
Great Depression
Nothing in the idea of socialist planning is inconsistent with
democratic freedom; in fact, in the 1930s it was often
argued that socialism was the fulfillment of democracy in
economic life.
Socialist Reality

Orwell --- Animal Farm --- “all animals are equal, just some
animals are more equal than others”
Why No Socialism in the US?
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Check your premise

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60% of GDP during WWII was government it is
hard to argue that your country is not socialist.
Nationalization vs. Regulation
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Regulatory apparatus was established to control
capitalist excess
Union power to eliminate exploitation
See Samuelson, Economics, p. 152-154; 185ff, esp., 186.
The Economics of Over Production and
Under Consumption
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Overproduction --- Samuelson, Economics, p. 4.
Command and Control for Public Administration --ibid, p. 5.
The Fallacy of Composition --- ibid., p. 9.
The System as a whole --- ibid, p. 9.
“What is true of one of kind of world may be false of another. Similarly, for the modern world of
unemployment, the conclusions of the classical or Euclidean economics may not be at all
applicable. … The important hard kernel of truth in the older economics of full employment can
then be separated from the chaff of misleading applications. Moreover, as we shall see later, if
modern economics does its task well so that widespread unemployment is substantially banished
from democratic societies, then its (i.e., national income accounting) importance will wither away
and the traditional economics (whose concern is wise allocation of fully employed resources) will
really come into its own – almost for the first time.” Samuelson, Economics, p. 10.
Income Expenditure Keynesianism
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National Income Accounting
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Circular Flow and Avoiding Double Counting
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Aggregate Demand Failure and Depression
Economics
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Final Goods Prices (e.g., bread, flour, wheat)
Full employment level of income
Savings and Investment
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Leakage in the system due to liquidity traps, etc.
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Coordination failure between savers and investors
The Determination of Price By Supply
and Demand
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The Logic of Market Clearing
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The Structure of Perfect Competition

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Numerous buys and sellers and no control over price
Monopoly
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Non-economic considerations for blocking the price system
Complete control over price except as set by government
regulation
Imperfect and Monopolistic Competition
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Some control over price
See Samuelson, Economics, p. 492.
Income Expenditure
C, I, G
45o
C + I + G1
C + I + Go
G
Y
Yu
YF
G * 1/1-b = Y
Multiplier effect
Microeconomic Inefficiency
MC
AC
P
P> MC
PC
Profit max --- MR =
MC
D = MR
Cannot Min AC
P
Q
QC
P=MC
MC
Profit Max – MR=MC
D
Min AC
Q
MR
Welfare Economics: Market Efficiency and
Market Failure
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Character of General Competitive Equilibrium
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First Fundamental Welfare Theorem
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Exchange Efficiency
Production Efficiency
Product Mix Efficiency
An Economy in competitive equilibrium is Pareto Efficient
Second Fundamental Welfare Theorem
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Any Pareto-efficient resource allocation that society desires
can be obtained through the market mechanism
When Does This Hold?
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Under conditions of macroeconomic balance
and perfect competition.
Absent those conditions due to macroinstability, imperfect market structure, or the
existence of significant externalities,
imperfect information, and/or missing markets
(e.g., public goods) and the efficiency
properties cannot be achieved.
Social Welfare Functions and the Critique
of Welfare Economics
A
2
SW
1
B
Government
as corrective
device to
move from 1
to 2. E.g.,
StructureConductPerformance
Critique of this Idea

Inefficiencies are an Illusion
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Marginal Costs are not appropriately calculated
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No stable Social Welfare Function
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Arrow’s theorem and the problems of democratic decision
making
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Costs of transition from one state to another are not fully
considered
Hayek and the Limits of Agreement
Correctives are Worse than the Problem
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Public Choice concerns with the manner in which
government policy will be pursued