In the March 1972 issue of this Rezview, Duncan Bailev and Charles Schotta published a study of the returns to investment in the graduate education of Ph.D. academicians in the United States. They use as a proxy for the academic income of Ph.D. faculty, the salarydata reported by the American Association of Universitv Professors (.4A4UP). The alternative income used is an estinmate of the income of bachelor's degree holders taken from an extensive survey of salaries in occupations open to bachelor's degree holders in the state of California. They conmpute both a private and a social rate of return. Their private rate of return includes as costs an estimate of the foregone income of graduate students. Their social rate of return in addition to incomne foregone by students, includes an estimate of the per unit contribution of the state of California to graduate education at the Berkeley, and Los Angeles campuses of the University of California. A second social rate of return is computed by including an estimnate of the costs of graduate school dropouts. Each of these rates of return is estimated for two through six Xyear periods of time spent in graduate school and for eleven different academic income patterns.' Bailev and Schotta explicitly omit from their calculations all incomes earned by academicians in addition to their academic -ear contract salaries. Since they are interested only in test-of-the-marketplace conclusions, they do not consider externalities or the public good aspects of research. T heir conclusions may be surmmarized as:

When households have different consumption patterns, whose cost of living should actual price represent? This issue was first raised by J. L. Nicholson and S. J. Prais in 1950's. Both made essentially same point: official price indexes give each household's consumption pattern an implicit weight proportional to its total (see Nicholson, p. 540). Prais calls such plutocratic, and both Nicholson and Prais suggest alternative democratic price index which gives all households equal weight. A cost-of-living index is that measures impact of price changes on welfare of a group or population of households. To define such requires explicit or implicit concept of the welfare of a group, and hence requires interpersonal comparison and distributional judgments. Since group indexes such as Consumer Price Index play important role in our perception of inflation and formation of macro-economic policy and are used to escalate wages and Social Security benefits, they have significant effects on government decisions and economic welfare. Despite their intellectual interest and practical importance, however, until recently they have been virtually ignored by number theorists. The theory of cost-of-living (CLI) provides a generally accepted framework for measuring impact of price changes on welfare of a particular household. This paper extends CLI concept to groups and discusses which questions require group indexes and which do not. I begin by introducing some notation and terminology in context of household CLIs. A household's CLI is ratio of expenditures required to attain a particular base indifference curve in two price situations. Suppose there are n goods and S households, and denote preference ordering of rth household by R r. The base indifference curve can be identified by a goods collection, Xro, which lies on it. The function, Er(P, xr, Rr), shows minimum expenditure required to attain base indifference curve at prices P. The CLI of rth household, Ir(Pa,pb,XroRr) is ratio of minimum expenditure required to attain base indifference curve at prices pa (comparison prices) to that required at prices pb (reference prices). Except in very special cases, value of CLI depends on base indifference curve at which it is evaluated; as successively higher base indifference curves are specified, one would expect prices of luxuries to become more important relative to prices of necessities.' Hence, it is convenient to regard CLI as a function of base indifference curve rather than as a single number corresponding to a particular base. Thus, instead of offering guidance in choosing appropriate base indifference curve, theory suggests that there is no need to choose. To construct exact CLI, investigator needs to know household's preferences. Lacking this knowledge, he rnust fall back on indexes which require less information and which are upper bounds on exact index. The Laspeyres index, Jr(papbXrb) is ratio of cost of purchasing reference period consumption basket at comparison prices to its cost

In the process of cultivation of taste, tastes are changed by the experience of consumption. To model this we might assume that cultivation of taste for a particular good involves a change in only one parameter of the utility function, and that the other parameters, that is, the underlying utility function, remains unchanged. For example, assume that there are just two goods, x and z, of which x is subject to cultivation of taste, and z is not. Then

Drastic changes in central bank operations and monetary institutions in recent years have made previously standard approaches to explaining the determination of the price level obsolete. Recent expansions of central bank balance sheets and of the levels of richcountry sovereign debt, as well as the evolving political economy of the European Monetary Union, have made it clear that fiscal policy and monetary policy are intertwined. Our thinking and teaching about inflation, monetary policy, and fiscal policy should be based on models that recognize fiscal-monetary policy interactions.

The science of economics has some constraints and tensions that set it apart from other sciences. One reflection of these constraints and tensions is that, more than in most other scientific disciplines, it is easy to find economists of high reputation who disagree strongly with one another on issues of wide public interest. This may sug gest that economics, unlike most other scientific disciplines, does not really make progress. Its theories and results seem to come and go, always in hot dispute, rather than improving over time so as to build an increasing body of knowledge. There is some truth to this view; there are examples where disputes of earlier decades have been not so much resolved as replaced by new disputes. But though econom ics progresses unevenly, and not even monotonically, there are some examples of real scientific progress in economics. This essay describes one—the evolution since around 1950 of our understanding of how monetary policy is determined and what its effects are. The story described here is not a simple success story. It describes an ascent to higher ground, but the ground is still shaky. Part of the purpose of the essay is to remind readers of how views strongly held in earlier decades have since been shown to be mistaken. This should encourage continuing skepticism of consensus views and motivate critics to sharpen their efforts at looking at new data, or at old data in new ways, and generating improved theories in the light of what they see. We will be tracking two interrelated strands of intellectual effort: the methodol ogy of modeling and inference for economic time series, and the theory of policy influences on business cycle fluctuations. The starting point in the 1950s of the the ory of macroeconomic policy was Keynes's analysis of the Great Depression of the 1930s, which included an attack on the Quantity Theory of money. In the 1930s, interest rates on safe assets had been at approximately zero over long spans of time, and Keynes explained why, under these circumstances, expansion of the money sup ply was likely to have little effect. The leading American Keynesian, Alvin Hansen, included in his (1952) book A Guide to Keynes a chapter on money, in which he explained Keynes's argument for the likely ineffectiveness of monetary expansion in a period of depressed output. Hansen concluded the chapter with, Thus it is that modern countries place primary emphasis on fiscal policy, in whose service mone tary policy is relegated to the subsidiary role of a useful but necessary handmaiden. The methodology of modeling in the 1950s built on Jan Tinbergen's (1939) seminal book, which presented probably the first multiple-equation, statistically estimated economic time series model. His efforts drew heavy criticism. Keynes

The front matter of the December 2010 issue contains the Table of Contents

Many classes of assets are illiquid or nonmarketable in that they cannot always be traded immediately. Thus, a portfolio position in these becomes at least temporarily irreversible. We study the asset-pricing implications of this type of illiquidity in an exchange economy with heterogeneous agents. In this market, one asset is always liquid. The other asset can be traded initially, but then not again until after a “blackout” period. Illiquidity has a dramatic effect. Agents abandon diversification and choose polarized portfolios instead. The value of liquidity can represent a large portion of the equilibrium price of an asset.

Consumer's surplus is a widely used tool in applied welfare economics. Both economic theorists and cost benefit analysis often use consumer's surplus despite its somewhat dubious reputation. The basic idea is to evaluate the value to a consumer or his willingness to for a change in price of a good from say pricep? to pricep'. Because price changes affect consumer welfare, an evaluation of this effect is often a key input to public policy decisions. Yet consumer's surplus is probably the most controversial of widely used economic concepts. Both Paul Samuelson and Ian Little conclude that the economics profession would be better off without it. It is my feeling of the situation that substantial agreement exists on the correct quantities to be measured: the amount the consumer would pay or would need to be paid to be just as well off after the price change as he was before the price change. The quantities correspond to John Hicks' compensating variation measures. An alternative measure which takes ex post price change utility as the basis of comparison is Hicks' equivalent variation.' The controversy arises in the measurement of these quantities. The usual measurement procedure is to use the area to the left of the Marshallian (market) demand curve between two price levels. Jules Dupuit originated this measure of welfare change, and Alfred Marshall and Hicks derived appropriate conditions for its use. The primary condition for the area to the left of the demand curve to correspond to the compensating variation is to have constant marginal utility of income. Marshall gave this condition, and if it holds, the same quantity will be derived as the area to the left of the compensated (Hicksian) demand curve. This area to the left of the compensated demand curve is exactly what the compensating variation and equivalent variation measure. Thus the constant marginal utility of income is a sufficient condition for Marshallian consumer's surplus to be equal to Hicks' consumer's surplus. In this case Arnold Harberger's plea to use the welfare triangle as one-half times the product of the price change times the quantity change to measure deadweight loss corresponds to the correct theoretical amount of welfare change. In a recent paper, Robert Willig derives bounds for the percentage difference between the correct measure of either the compensating or equivalent variation and the Marshallian measure derived form the market demand curve. His bounds, which depend on the income elasticity of demand for the single good in the region of price change being considered as well as the proportion of the consumer's income spent on the good, demonstrate that the Marshallian consumer's surplus is often a good approximation to Hicks' consumer's surplus. The fact that the proportion of the consumer's income spent matters as well as the income elasticity was first pointed out by Harold Hotelling. Willig contends that the approximation error will be less than the errors involved in estimating the demand curve. Thus he hopes to remove the need for apology that applied economists often need to give to theorists who remark on the inappropriateness of using Marshallian consumer's surplus to measure welfare change. However, in this paper I show that for the case primarily considered by Willig of a single price change, which is also the situation in which consumer's surplus is often used in applied work, no approximation is necessary. *Professor of economics, Massachusetts Institute of Technology, and research associate, National Bureau of Economic Research. I would like to thank Peter Diamond, Erwin Diewert, Daniel McFadden, Robert Merton, Robert Solow, Hal Varian, Joel Yellin, and the referees for help and comments. Research support from the National Science Foundation is acknowledged. 'The reason that we still have two, rather than one, of Samuelson's six measures of consumer's surplus arises from an index number problem of the correct basis for the welfare comparison. I will give both measures but plan to concentrate on the compensating variation.