Knowledge that Transforms

This paper presents a sorting model of education in which individuals are tested in school. By assuming that higher-ability individuals are more likely to succeed on a given test, one can construct a sorting model of education that does not hinge on the more able having lower nonpecuniary costs of schooling. Nash equilibria always exist in this model (even with a continuum of types of individuals); however, some are "unreasonable." To eliminate these unreasonable Nash equilibria, more restrictive definitions of equilibrium are proposed. I also show that when schooling affects productivity--and therefore a worker's probability of passing the test--a sorting equilibrium may be characterized by too little investment in education.

This paper examines the effects of government attempts to stabilize the prices of commodities by use of buffer stocks. Agricultural goods subject to supply uncertainty as well as depletable resources are considered. In each case, it is shown that the resulting rational expectations competitive equilibrium contains a speculative attack--a situation where the entire government stock is suddenly purchased by previously inactive speculators. The analysis is applied to the historical attempt to peg the gold price, which caused the attack of 1968. The insights gained and the methodology developed also apply to the various international agreements to impose bans on commodity prices which have been proposed by the United Nations Conference on Trade and Development.

In this model, the effects of advertising are infinitely durable, fixed (and sunk) costs give rise to economies of scale, post-entry behavior is noncooperative, and pre-entry expectations are rational. Despite the obvious resemblance to work on the use of investment in production capacity to deter entry, here the incumbent monopolist never finds it optimal to advertise more if entry is possible than if it is not. This result and other features of this model indicate the dangers of analyzing advertising with analogies to other sorts of investments. The results make clear the need for more theoretical work on advertising and entry deterrence.

Understanding inventory movements is central to an understanding of business cycles. This paper presents an empirical study of the behavior of inventories in the automobile industry. It finds that inventory behavior is well explained by the assumption of intertemporal optimization with rational expectations. The underlying cost structure appears to have substantial costs of changing production as well as substantial costs of being away from target inventory, the latter being a function of current sales. Given this cost structure, whether inventory behavior is stabilizing or destabilizing depends on the characteristics of the demand process. In the automobile industry, inventory behavior is destabilizing: the variance of production is larger than the variance of sales.

Numerous authors, including Shiller, LeRoy and Porter, and Singleton, have reported empirical evidence that stock prices and long interest rates are more volatile than can be justified by standard asset-pricing models. This paper shows that in small samples the "volatility" or "variance-bounds" tests tend to be biased, often severely, toward rejection of the null hypothesis of market efficiency. Thus the apparent violation of market efficiency may be reflecting the sampling properties of the volatility measures, rather than a failure of the market efficiency hypothesis itself. The paper also reports some unbiased estimates of the bounds on holding period yields and long interest rates. Much of the evidence of excess volatility disappears when the tests are corrected for small sample bias.

The paper incorporates the formation of human capital into the two-factor, two-good model of international trade. Workers can choose between being unskilled and earning the corresponding wage or obtaining an education that enables them to earn a higher wage. The wages of skilled and unskilled labor and the direct and indirect costs of education are all determined endogenously, along with the terms of trade and the pattern of comparative advantage. The implications of the model are consistent with the extensive empirical research on the role of human capital in explaining patterns of comparative advantage.

The lecture focuses on the reasons that new ideas are accepted or rejected by a science. A distinction is drawn between prescientific and scientific stages of a discipline. The diverse fates of new ideas are illustrated by a variety of episodes in the history of economics, including the economics of information and the theory of economic regulation.

This paper uses an infinite-horizon model based on individual maximizing behavior to study whether explosive price-level paths unrelated to monetary growth--speculative hyperinflations--can be equilibrium paths under rational expectations. In a pure fiat money regime, speculative hyperinflations can be excluded only through severe restrictions on individual preferences; but when the government fractionally backs the currency by guaranteeing a minimal real redemption value for money, speculative hyperinflations are impossible, even if agents are not completely certain that they can redeem their money in any given period. The analysis also confirms that implosive price-level paths and divergent paths for capital asset prices are not equilibria under either monetary regime.

Strong restrictions on the structure of preferences are a central feature in the received theory of intertemporal allocation. In fact, most of the modern literature concerned with capital-theoretic problems represents preferences by a functional in which an additive utility function is discounted by a constant rate of time preference. This specification is attractive because it is analytically tractable in dynamic models, and it clearly delineates how tastes and opportunities interact to determine an economy's (household's) paths of consumption and capital formation. However, its rigid structure (constancy of time preference) severely limits the conclusions and explanatory power of the corresponding models. This paper considers a class of utility functionals (in continuous time) which have the appealing feature that the rate of time preference depends systematically on an index of aggregate future consumption. The more flexible structure embodied in these functionals leads to important generalizations and modifications of standard conclusions. We highlight this added richness by examining five basic problems in dynamic economic analysis.