Knowledge that Transforms

We consider an economy with pure factors of production, private ownership of endowments and constant returns to scale in production. Typically in such an economy, the weak axiom of revealed preference for market demand does not hold. The main reason for this is that the income distribution in such a private ownership economy depends too sensitively on the price system.

This study examines a disequilibrium model of a small, open economy with explicit links between periods due to inventory accumulation, as well as the more conventional channels through current account imbalances and the government budget constraint. The key features of the model are that agents have perfect foresight with neutral public debt and that inventories adjust to smooth production intertemporarily. The paper explores the extent to which fiscal policy can be used selectively for coping with an export slump without running into a balance of payments constraint. Copyright 1989 by The Review of Economic Studies Limited.

The predictability of rates of return on gold and silver are examined. Econometric tests do not reject the martingale hypothesis for either asset. This failure to reject is shown to be misleading. Correlation dimension estimates indicate a structure not captured by ARCH. The correlation dimension is between 6 and 7 while the Kolmogorov entropy is about 0·2 for both assets. The evidence is consistent with a nonlinear deterministic data generating process underlying the rates of return. The evidence is certainly not sufficient to rule out the possibility of some degree of randomness being present.

In the Edgeworth non-tatonnement process, trade occurs if there exists some coalition of agents able to make a Pareto-improving trade among themselves at current prices. It is known that the coalition size required is bounded by the number of commodities and that, provided all agents always have strictly positive endowments, bilateral trade suffices. These results are generalized, but it is shown that, when some agents do not hold all commodities, the information requirements for coalition formation can be very severe. Coalition size is not the only problem; very detailed information on preferences may be needed. Copyright 1989 by The Review of Economic Studies Limited.

In the theory of competitive markets, agents act as if they do not affect prices. By analogy with the language of econometrics, agents may be said to take prices as "exogenously given," which suggests that prices are econometrically exogenous in individual behavioral equations. This involves semantic confusion between different meanings of the word "exogenous." Simultaneity problems cannot be dispelled by working with disaggregated data. In particular, nothing is gained by disaggregating the dependent variable in a regression equation if the "micro" and the "macro" equations use the same regressors. However, there may be substantial gains from disaggregation of the regressors. Copyright 1989 by The Review of Economic Studies Limited.

The paper studies an idealized gold standard in a two-country setting. Without flexible national domestic credit expansion (dce) policies which offset the effect of money demand shocks on international gold reserves, the gold standard collapses with certainty in finite time through a speculative selling attack against one of the currencies. Various policies for postponing a collapse are considered.When a responsive dce policy eliminates the danger of a run on a country's reserves, the exogenous shocks disturbing the system which previously were reflected in reserve flows, now show up in the behaviour of the public debt. Unless the primary (non-interest) government deficit is permitted to respond to these shocks, the public debt is likely to rise (or fall) to unsustainable levels. For the idealized gold standard analysed in the paper, viability can be achieved only through the active and flexible use of monetary and fiscal policy.

For thirty years it has been accepted that consumption is smooth because permanent income is smoother than measured income. This paper considers the evidence for the contrary position, that permanent income is in fact less smooth than measured income, so that the smoothness of consumption cannot be straightforwardly explained by permanent income theory. The paper argues that in postwar U.S. quarterly data, consumption is smooth because it responds with a lag to changes in income.

In many markets consumers have “switching costs”, for example learning costs or transaction costs, of changing between functionally equivalent brands of a product, or of using any brand for the first time. We analyse a four-period complete-information model of a market with switching costs in which new entry occurs after the second period. The new entry results, in equilibrium, in a price war. That is, the new entrants' prices are higher in the post-entry period than in the entry period, and the incumbent's price falls in either the pre-entry period or the entry period and subsequently rises. We can interpret the incumbent's lowering its price in the pre-entry period as limit-pricing behaviour. We distinguish between two types of price war that can occur, and show how the type or mixture of types that arises depends on the size of switching costs.

This paper presents and estimates a dynamic model of married women's labour force participation and fertility in which the effect of work experience on wages is explicitly taken into account. Because current participation alters future potential earnings, the investment return to work will be an important factor in the current work decision in any forward-looking behavioural model. The model is estimated using the National Longitudinal Surveys mature women's cohort. We use the estimates of our model to predict changes in the lifecycle patterns of employment due to changes in schooling, fertility, husband's income, and the magnitude of the experience effect on wages. We find that although work experience increases the disutility of further work, the effect is overwhelmed by the positive effect of experience on wages, leading to persistence in the employment patterns of these women. In addition we find that an increase in young children and in husband's income substantially reduces participation while increased schooling has a powerful positive impact on participation.

Competitive rational expectations models have the unsatisfactory property, dubbed the “schizophrenia” problem by Hellwig, that each trader takes the equilibrium price as given despite the fact that he influences that price. An examination of information aggregation in a non-competitive rational expectations model using a Nash equilibrium in demand functions shows that the schizophrenia problem is avoided by having each trader take into account the effect his demand has on the equilibrium price. Given a distribution of private information across traders, prices reveal less information than in the competition equilibrium, and prices no longer become fully informative in the limit as noise trading vanishes or as traders become risk neutral. With small traders, the model may become one of monopolistic competition, not perfect competition. In contrast to the competitive model, a reasonable model of endogenous acquisition of costly private information is obtained, even when traders are risk-neutral.