THE NEW

PALGRAVE

THE WORLD OF ECONOMICS

THE NEW

PALGRAVE

THE WORLD OF I

EDITED BY

JOHN EATWELL · MURRAYMILGATE · PETER NEWMAN

M

©The Macmillan Press Limited, 1987, 1991

Softcover reprint of the hardcover 1st edition 1991 978-0-333-55176-9

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

No paragraph of this publication may be reproduced, copied, or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licencing Agency, 33-34 Alfred Place, London WCIE 7DP.

Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

First published in The New Palgrave: A Dictionary of Economics Edited by John Eatwell, Murray Milgate and Peter Newman in four volumes, 1987

Published in the United Kingdom by THE MACMILLAN PRESS LIMITED, 1991 London and Basingstoke Associated companies in Auckland, Delhi, Dublin, Gaborone, Hamburg, Harare, Hong Kong, Johannesburg, Kuala Lumpur, Lagos, Manzini, Maseru, Melbourne, Mexico City, Nairobi, New York, Singapore, Tokyo.

The New Palgrave is a trademark of The Macmillan Press Limited

British Library Cataloguing in Publication Data

The New Palgrave: the world of economics. I. Economics I. Eatwell, John II. Milgate, Murray III. Newman, Peter 330

ISBN 978-0-333-55177-6 ISBN 978-1-349-21315-3 (eBook) DOI 10.1007/978-1-349-21315-3

Contents

Acknowledgments viii Preface ix

Agricultural Growth and E. Boserup 1 Population Change

Bribery Susan Rose-Ackerman 15 Bubbles Charles P. Kindleberger 20 Burden of the Debt Robert Eisner 23 Bureaucracy Mancur Olson 27 Capital Gains and Losses E. Malinvaud 35 Chicago School M.W. Reder 40 Coase Theorem Robert D. Cooter 51 Cobweb Theorem B. Peter Pashigian 58 Codetermination and Profit-sharing D.M. Nuti 62 Common Law P.S. Atiyah 74 Common Property Rights Steven N.S. Cheung 83 Communications Roger G. Noll 87 Comparative Advantage Ronald Findlay 99 Competition and Selection Sidney G. Winter 108 Conflict and Settlement Jack Hirshleifer 117 Congestion A. A. Walters 126 Constitutional Economics James M. Buchanan 134 Continuity in Economic History Donald N. McCloskey 143 Counterfactuals Donald N. McCloskey 149 Crowding Out Olivier Jean Blanchard 155 Declining Industries Lester C. Thurow 160 Distributive Justice Edmund S. Phelps 164 Dividend Policy James A. Brickley 168

and John J. McConnell

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Contents

Economic Integration Bela Balassa 176 Economic Interpretation of Ernest Gellner 187

History Economic Theory and the Kenneth J. Arrow 198

Hypothesis of Rationality Efficient Market Hypothesis Burton G. Malkiel 211 En ti tlemen ts Hillel Steiner 219 Equilibrium: an Expectational Edmund S. Phelps 224

Concept Equilibrium: Development of the Murray Milgate 228

Concept Exchange Robert B. Wilson 237 Family Gary S. Becker 248 Financial Intermediaries James Tobin 261 Fine Tuning Francis M. Bator 279 Free Lunch Robert Hessen 285 Full Employment G.D.N. Worswick 286 Gender Francine D. Blau 291 Gifts C.A. Gregory 305 Gold Standard Marcello de Cecco 315 Hunting and Gathering Economies Vernon L. Smith 330 Hyperinflation Phillip Cagan 339 Import Substitution and John Eatwell 345

Export-led Growth Interests Albert 0. Hirschman 349 Interpersonal Utility Comparisons John C. Harsanyi 361 Keynesianism John Eatwell 367 Law and Economics David Friedman 371 Leisure Gordon C. Winsto·n 381 Liberalism Ralf Dahrendorf 385 Limits to Growth Wilfred Beckerman 390 Macroeconomics: Relations with Peter Howitt 394

Microeconomics Malthus's Theory of Population D.R. Weir 401 Market Failure John 0. Ledyard 407 Marketing Boards Peter Bauer 413 Market Places Polly Hill 419 Markets with Adverse Selection Charles Wilson 424 Marxist Economics Andrew Glyn 428 Mercantilism William R. Allen 440 Monetarism Phillip Cagan 449 Monetary Policy David E. Lindsey and 460

Henry C. W allich Monopoly Edwin G. West 475 National Income Wilfred Beckerman 483

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Contents

National System Henry W. Spiegel 489 Natural Selection and Evolution Sidney G. Winter 493 'Neoclassical' Tony Aspromourgos 502 Neoclassical Synthesis Olivier Jean Blanchard 504 Neutral Taxation Arnold C. Harberger 511 Open Field System Donald N. McCloskey 516 Opportunity Cost James M. Buchanan 520 Optimum Currency Areas Masahiro Kawai 526 Perfectly and Imperfectly John Roberts 534

Competitive Markets Performing Arts William J. Baumol 544 Periphery Immanuel Wallerstein 549 'Political Economy' and Peter Groenewegen 556

'Economics' Poverty A. B. Atkinson 563 Predatory Pricing Paul Milgrom 574 Prisoner's Dilemma Anatol Rapoport 578 Property Rights Armen A. Alchian 584 Rent Armen A. Alchian 591 Rent Control Kurt Klappholz 598 Rent Seeking Gordon Tullock 604 Rhetoric Donald N. McCloskey 610 Ricardian Equivalence Theorem Andrew B. Abel 613 Rising Supply Price Peter Newman 623 Scholastic Economic Thought Henry W. Spiegel 627 Scottish Enlightenment John Robertson 634 Self-interest D.H. Monro 640 Shadow Pricing Ravi Kanbur 646 Social Cost J. De V. Graaff 649 Specie-flow Mechanism William R. Allen 655 Sports James Quirk 659 Terms of Trade Ronald Findlay 665 Tiebout Hypothesis Bruce W. Hamilton 672 Time Preference Murray N. Rothbard 678 Trade Unions Henry Phelps Brown 684 Utopias Gregory Claeys 694 Value Judgements John C. Harsanyi 702 Value of Life Thomas C. Schelling 706 Welfare Economics Allan M. Feldman 713 Zero-sum Games Michael Bacharach 727

Contributors 732 Subject Classification 745 Index 747

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Acknowledgments

The following contributors (articles shown in parentheses) acknowledge support from public bodies or permission to reprint copyright material:

Andrew B. Abel (Ricardian Equivalence Theorem), financial support from the Amoco Foundation Term Professorship in Finance, the National Science Foundation and the Sloan Foundation. Kenneth J. Arrow (Economic Theory and the Hypothesis of Rationality), support from the Office of Naval Research; originally published as 'Rationality of Self and Others in an Economic System' in Rational Choice: The Contrast between Economics and Psychology, (eds R.M. Hogarth and M.W. Reder) © University of Chicago Press. John C. Harsanyi (Value Judgements), financial support from the National Science Foundation (SES82-18938) administered by the Center for Research in Management, University of California, Berkeley. R. Wilson (Exchange), support from Stanford University, Stanford; research support from the National Science Foundation (SES83-08723) and the Office of Naval Research (N00014-79C0685).

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Preface

Most of us remember learning how to ride a bicycle, the struggle it was to stay on, to steer straight, to turn without falling to one side. Then, after minutes or hours or even days of practice we suddenly got the hang of it, and learned that almost miraculous sense of balance which makes riding on two wheels so easy, and which never goes away.

A similar experience in learning their subject is often reported by economists, even by some of the most famous. For weeks or months or even years they listen to the lectures, read the textbooks, even pass the examinations with flying colours; yet they still do not really understand what economic analysis is all about. Then quite suddenly the clouds disperse, the sun shines brightly and they realise just how economics, with its own particular vision of the way in which society allocates resources and organizes production and distribution, can and does illuminate the world around them.

That vision was created at the end of the 18th century. In 1776 Adam Smith, building on the work of Fran9ois Quesnay, set out in The Wealth of Nations his understanding of the workings of a competitive economy, in which production and distribution are organized through market exchange. In such economies, he claimed, the decisions of all individuals and firms respond to the same price signals and to the calculation of profit and loss reckoned at those prices. But in all other ways those agents make decisions entirely independently of one another. In the first great insight of modern economics, Smith argued that such an economy would not collapse into chaos but would instead constitute a system, with its own patterns of operation and its own 'laws' of behaviour; and it was the job of the economist to discover those laws, what they are and how they work.

Smith then showed how the economist should proceed on the path towards that discovery. From the infinite complexity of daily life one should extract the connected skeleton of the market system, which supports the whole structure. This analytical abstraction is then to be taken and used as the fundamental representation of the major forces shaping the economy. The science of economics

ix

Preface

is not merely descriptive, but instead consists both of abstract analysis and of description that is informed and structured by that analysis.

It was David Ricardo's Principles of Political Economy and Taxation ( 181 7) that firmly established deductive reasoning as the central method of economics. The workings of the economy were to be inferred logically from a few fundamental presumptions: that individuals and firms pursue specified objectives through markets which function in particular ways, most especially through freely competitive markets over which no individual agent has any control.

Thus, by 1817 the key components of the discipline of economics were in place. An economy was to be seen as a system which operates through market exchange and so through a price mechanism. Individuals in society, pursuing their own interests, interact in their economic relations both with nature and with each other. Both aspects of this vision are important, the interests of the individuals -not necessarily narrowly selfish or 'economic' - and the ways they interact in society. It is precisely their combination by deductive analysis which characterizes the way in which economists perceive the world.

All coherent bodies of economic thought share this vision of the way in which economies operate, even though they may differ - and differ quite profoundly- in many other respects. Non-economists in the media and elsewhere seldom understand this, and as a result that acceptance of scientific difference which is routinely extended to such controversial sciences as biology and cosmology is seldom extended also to economics. Almost every day, for example, many econometric forecasts are proved false by the actual realization of events; and the same is true of innumerable meteorological forecasts. Yet unlike economic forecasters weather forecasters are seldom sacked, and when they are it is usually for lack of media presence rather than lack of accuracy. The fact that most economists, like most physicists, have a well-defined vision of their world does not imply that they also have to agree about how it actually works, any more than physicists have to agree about the nature of the fundamental particles which constitute their universe.

Perhaps John Maynard Keynes put the point best, in a famous quotation: 'The Theory of Economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking, which helps its possessor to draw correct conclusions.'

TheN ew Palgrave: A Dictionary of Economics was published in four large volumes in late 1987, and has rapidly become a standard reference work in economics. Its name is explained by the fact that it is the modern successor to the Dictionary of Political Economy, edited by R. H. Inglis Palgrave and published by Macmillan in three volumes in 1894, 1896 and 1899. A second and slightly modified version, edited by Henry Higgs, appeared during the mid-1920s.

As editors of The New Palgrave we asked its contributors not to write surveys

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Preface

of current literature nor to adhere to a prescribed point of view. Instead, each was asked- while remaining accurate in discussing the work of others- to make clear his or her own views on the subject concerned. Moreover, the contributions were to be written from an historical perspective wherever possible, to describe not only present problems but also past growth and future prospects. For we believe that knowledge of the historical development of any theory enriches both its present understanding and the possibilities for better theories in the future. Even though not all the nearly 2000 topics covered in the Dictionary lent themselves to such historical treatment, the authors' responses to this request were generally positive.

All one hundred essays in this volume are taken from The New Palgrave, and appear essentially as they did there. They have been chosen to show how that 'technique of thinking' to which Keynes referred can be applied so as to illuminate a wide range of diverse topics. However, those readers quite new to economics will inevitably encounter certain terms and tools of the trade- such as elasticity, Pareto optimality, substitutes and complements- that are unfamiliar. Such readers should be undeterred. With the guidance of the index, help can often be found elsewhere in the collection; and in the last resort there are always the textbooks of the subject, for which The World of Economics is a complement, not a substitute.

John Eatwell Murray Milgate

Peter Newman

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