The End of Laissez-Faire: Macroeconomic Instability and Microeconomic Inefficiency

1. The End of Laissez-Faire: Macroeconomic Instability and Microeconomic Inefficiency Peter J. Boettke Econ 881/Spring 2005 14 February

2. Historical Context • Turn of the Century America • Poverty Amidst Plenty • inequality • Progressive Era Legislation • Antitrust policy • cut-throat competition • Pure Food and Drug Act • consumer protection from impure products • Working Conditions • Exploitation • WWI • Interpretation of Imperialism and War Socialism • Capitalism as cause, socialism as solution • Great Depression • Aggregate demand failure (underconsumption) • New Deal Legislation • Putting people to work and giving them hope • WWII • “Greatest Generation”

3. Importance of the Soviet Union • Socialism as a Viable Alternative • No monopolistic exploitation and now crisis such as the Great Depression • Socialism tamed by Democracy = Interventionism • 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”

4. Why No Socialism in the US? • Check your premise • 60% of GDP during WWII was government it is hard to argue that your country is not socialist. • Nationalization vs. Regulation • Regulatory apparatus was established to control capitalist excess • Union power to eliminate exploitation See Samuelson, Economics, p. 152-154; 185ff, esp., 186.

5. The Economics of Over Production and Under Consumption • 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.

6. Income Expenditure Keynesianism • National Income Accounting • Circular Flow and Avoiding Double Counting • Final Goods Prices (e.g., bread, flour, wheat) • Aggregate Demand Failure and Depression Economics • Full employment level of income • Savings and Investment • Leakage in the system due to liquidity traps, etc. • Coordination failure between savers and investors

7. The Determination of Price By Supply and Demand • The Logic of Market Clearing • Non-economic considerations for blocking the price system • The Structure of Perfect Competition • Numerous buys and sellers and no control over price • Monopoly • Complete control over price except as set by government regulation • Imperfect and Monopolistic Competition • Some control over price See Samuelson, Economics, p. 492.

8. Income Expenditure C, I, G 45o C + I + G1 C + I + Go G Y Yu YF Multiplier effect G * 1/1-b = Y

9. Microeconomic Inefficiency MC AC P P> MC Profit max --- MR = MC Cannot Min AC PC D = MR P Q QC P=MC Profit Max – MR=MC Min AC MC D Q MR

10. Welfare Economics: Market Efficiency and Market Failure • Character of General Competitive Equilibrium • Exchange Efficiency • Production Efficiency • Product Mix Efficiency • First Fundamental Welfare Theorem • An Economy in competitive equilibrium is Pareto Efficient • Second Fundamental Welfare Theorem • Any Pareto-efficient resource allocation that society desires can be obtained through the market mechanism

11. When Does This Hold? • Under conditions of macroeconomic balance and perfect competition. • Absent those conditions due to macro-instability, 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.

12. Social Welfare Functions and the Critique of Welfare Economics A 2 SW Government as corrective device to move from 1 to 2. E.g., Structure-Conduct-Performance  1 B

13. Critique of this Idea • Inefficiencies are an Illusion • Marginal Costs are not appropriately calculated • Costs of transition from one state to another are not fully considered • No stable Social Welfare Function • Arrow’s theorem and the problems of democratic decision making • Hayek and the Limits of Agreement • Correctives are Worse than the Problem • Public Choice concerns with the manner in which government policy will be pursued