Knowledge that Transforms

JN THE LAST DECADE, the levels of unemployment in industrialized countries have risen dramatically. Rates now are typically two, and in some cases, three and four times those prevailing in the 1950s and 1960s. The fact that these new higher levels are widely tolerated suggests that our thinking about the meaning and significance of unemployment has changed enormously over the period. Such a change is certainly present in the thinking among professional economists. In the 1960s the standard view was that the unemployed represented unutilized resources; their existence in an economy where the vast majority of people had unsatisifed wants was seen as a major social paradox and the most important unsolved intellectual puzzle of the capitalist economic system. This fed the rationale for Keynesian countercyclical fiscal policy and government deficit spending: The government could reasonably print money in order to hire the unemployed because the resources absorbed in the process were essentially free Today, a good number of professional economists, certainly in the United States but to a lesser extent throughout the world, have come to view measured unemployment in industrial economies as an artifact in at least three senses. It is a statistical artifact of a measurement process that classifies as unemployed people who are not really available for work. It is an institutional artifact of a system of social insurance and public welfare that encourages an extension of the process of job search. And it is an artifact of the language that uses a term which in everyday parlance means forced idleness for activities that have important productive functions akin to the functions of inventories, information processing, and investment associated with the utilization of capital goods. These interpretations to be sure hardly constitute a consensus about the meaning of unemployment. But they are no more diverse than the range of views that underlay the older orthodoxy. And for policy makers and economic researchers, they carry a single message: There are many more serious problems toward which to direct attention. These new views about unemployment were developed out of a set of ideas originally associated with the Chicago School of economics, where the emphasis-at once positive and normative-was placed on the competitive market as the gover* A Review of Alexander Keyssar, Out of Work: The First Century of Unemployment in Massachusetts. Cambridge: Cambridge University Press, 1986 and Robert Salais, Nicolas Baverez, and B6nedicte Reynaud, L'invention du chomage: Histoire et transformations d'une categorie en France des annees 1890 aux annees 1980. Paris: Presses Universitaires de France, 1986.

We thank Lincoln Anderson, Orley Ashenfelter, Costas Azariadis, David Card, William A. Darity, Jr., Belton Fleisher, Richard Froyen, James J. Heckman, Solomon Polachek, Lawrence H. Summers, and two anonymous referees. Particular thanks go to Didi Dunphy for drafting the figures and to the University of North Carolina, College of Arts and Sciences, Endowment for Scholarly Publications for providingfinancial support. Sarah Mason did her usualfine job of typing, Karen Smith and Jonathan Veum provided valuable computing assistance, and Cynthia McCarty cheerfully checked citations for completeness and correctness. Preliminary versions of this paper have been presented at the 1982 Annual Meetings of the Econometric Society, the Fifth World Congress of the Econometric Society, 1985, and the 1986 Annual Meetings of the Eastern Economic Association.

During the last decade, while overlapping generations provided the framework for the study of many theoretical issues, no one seems to have noticed the use of this model in the book published by Maurice Allais in 1947, Economie et intert. The introduction of the model is commonly attributed to a well-known article published in 1958 by Paul Samuelson. This note intends to bring the unnoticed anteriority of Allais' use of the model to the attention of a wide readership. The case may be of interest not only to economic theory but also to the more general historicological study of the process by which science is being built. Indeed, my role in the story is surprising and may reveal something worth remembering. I had closely studied Economie et inWret in 1948, in particular the appendix in which the overlapping generations model is used. I later worked on capital theory and intensively reflected in 1958 on the relationship between Samuelson's findings and my own results. But I did not pay attention to the similarity between the models used independently by Allais and Samuelson. It is only recently, when looking for what might be the subject of my contribution to a festschrift in honor of Allais that I became conscious of this similarity (Malinvaud 1986). In the meantime, like others, I referred to Samuelson's article when introducing overlapping generations in my own writings. '

This paper is concerned with situations where firms not only recognize the dependence of quality on price (of productivity on wages, of default probability on the interest rate charged), but also attempt to use what control they have over price (wages, interest rates) to increase their profits. The recognition of this possibility has important implications for economic theory, which have recently been explored in a large number of papers in several disparate fields. The objective of this paper is to survey these papers and to draw out the central themes of this literature. This paper is divided into four parts, In Part I, we discuss the most important implications of the dependence of quality on price for competitive equilibrium theory--the repeal of the law of supply and demand (Part I.1), the repeal of the law of the single price (Part I.2), the existence of discriminatory equilibria (Part I.3), the comparative static consequences (Part I.4), and the inefficiency of market equilibria (Part I.5). Part II discusses alternative explanations for the dependence of quality on price in labor, capital, and product markets.