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Chp 24 : The Chicago School (Gary S. Becker (Fertility (children are…
Chp 24 : The Chicago School
Major Tenets
Optimizing behavior
support the neoclassical principle that people attempt to maximize their well-being.People make rational choices by seeking more information
Decision is made once the marginal benefit from extra information equal to its marginal cost
Consumers,workers and firms respond to monetary incentives and disentives
Observed prices and wages in general tend to be good approximation of their long-run competitive one
Prices and wages reflect opportunity costs to society at the margin
Mathematical orientation
Relieves heavily on mathematical theorizing,using both the Marshallian partial equilibrium method and Walrasian general equilibrium approach
Rejection of keynesianism
Changes in the money stock cause direct changes in nominal GDP
The economy is self-adjusting and regulating, with minor fluctuations being self - limiting
Fiscal policy is ineffective
Limited governement involvement
Government is inefficient as an agent for achieving objectives that can be satisfied through private exchange
Government regulations generally benefits those who seek the regulation or those who learn to marshal it private advantage
Milton Friedman
Consumption Function
He contended that Keynesian consumption function is too simplistic
Household consumption is determined by permanent income rather than current income
Permanent income = average income that people expect to receive over a period of years.
Consumption does not respond to every change in income caused by changes in investment or goverment spending
The implication is that the marginal propensity to consume out of changes in current income is smaller than the Keynesian theory
Monetary Theory : The Demand for Money
People demand cash balances bcs they provide utility to the holder
Unlike keynes,Friedman made no distinction between types of money,precautionary and speculative balances
Friedman views the DD for money as DD for cash balance
3 determinants of DD for money and independent of factors that influence the money supply
Total wealth
Cost of holding money
However,money DD is less sensitive to changes in interest rate bcs yield spread between return on transaction and non transaction forms of wealth is relatively stable
This is the opportunity cost of foregone capital gains on real assets,that is return sacrified on assets that appreciate in value
Higher expected rate of inflation enhance the prospects for capital gains and thus increase the cost of holding money
The higher the price level, the less the nominal cost of holding money bcs each dollar held will buy less
as a result, people wil desire to increase their cash balance to keep them constant in real term,that tehy will want to hold more cash to buy the higher-priced goods
The Modern Quantity Theory of Money
According to Fridman, the amount of money demande is relatively stable in short -run
Central bank controls SS of money. If money SS increase,there is excess cash balances held by people
They will attempt to reduce the excess cash balances as the opportunity cost is high by increasing their DD for goods.
In circumstances wherein the economy is operating at its natural level of employment and output, only prices will rise over the long-run
As price rises, the DD for money increases bcs people desire to hold more money to buy higher-priced goods
Eventually, equlibrium between quantity of money supplied and demanded is restored, but a higher price level
Friedman says that DD for money function is highly stable and stated that inflation is always and everywhere a monetary phenomenan,produce in first instance by rapid growth
The Long-run Vertical Phillips Curve
In long run, the PC is perfectly vertcal at the natural rate of unemployment
Monetary authority can reduce unemployment below its natural rate in long run only by continuosly increasing the rate of inflation
In his model,Friedman concludes
When the actual rate of inflation exceeds the expected rate,unemployment will fall
Point on short run Phillips curve show the various rate of unemployment associated with rates of actual inflation that differ from expected rate
Monetary Rule
Performance of Fed
Limitation of economic knowledge
Confidence
Neutralization
Robert E.Lucas Jr
Rational Expectation
Different from Friedman expectation-people determine their expectation about future inflation on basic part and present inflation and change their expectation only as new events unfold
He says that economic agents reflect their past errors, use and process all available information, and succeed in eliminating regularities in errors in prdicting future price level
This is bcs people understand the expansionary fiscal and monetary policies produce inflation, they immediately adjust their inflation expectation upward when government undertakes these policies
Resource and financial markets immediately adjust such that workers receive higher nominal wages, sellers of raw material and other capital goods receive higher prices, and lender receive higher nominal interest rate
Thse reactions to expected inflation under expansionary fiscal and monetary policies ineffective
Aggregate Supply Analysis
Lucas distinguished between short and long run AS
In new classical model, an unanticipated change in AD does affect the level of real output,but only temporarily
In contrast, an anticipated change in AD has no effect on real output and employment
Gary S. Becker
Believes that neoclassical theory can be used to explain all human behaviour
His approach to human behaviour is based on rational choice, market equilibirum and stable preferences
Discrimantion on market forces that will impose cost upon discrimantors, reducing discrimiantion
Investment in Human Capital
Human capital is going to be an important part of thinking abt development, income distribution, labor turnover and many other problems
Time Allocation
Time used is cost, and will be optimized
Higher incomes will lead people to move to goods-incentive commodities
Time saving convencies can increase time
Marriage
allows for divison of labor that enables partners to maximizes their consumption of commodities which provide economic well being
reproducing and raising children are central commodities that marriage facilititates-people form families out of self interest
Fertility
children are durable capital,which add to a family income or welfare
marriage partners optimize their number of children they have based on cost benefit analysis
rural families have traditionally had more children bcs it is cheaper to raise children in rural areas
welfare programs reduce the cost of having children,so increase fertility
Gary becker rotten theory suggest that family members, even if they selfish, will act to help one another if their financial incentives are properly linked
Becker creates a hypothetical situation in which children will receive gifts of money income from a wealthy parent in order to make them happy
The theorem suggest that parent should delay gifts of money to their children until they are older, or possibly until after they die