Prices and quantities

Sobre teoría neoclásica

"As I discussed before, in particular with respect to capital, this approach (supply and demand or marginalist), which contrasts with the surplus approach, has serious problems. Even if we dismiss, for simplicity sake, the subjective part (about preferences) and concentrate just on supply conditions, the difficulties are insurmountable. Producers only supply more at higher prices, which means that they must encounter increasing costs (diminishing returns). It cannot be the case that they are only willing to supply more at higher prices (higher remuneration) even if costs are not higher, since if one producer obtained higher remuneration free entry of new producers (attracted by the higher remuneration) would imply that more would be produced. So the supply curve depends on diminshing returns.

And diminishing returns are a highly improbable proposition, as Sraffa argued back in the 1920s. Not many producers, if any, would tell you that they don’t produce more because their costs would go up (and that would reduce demand as prices get higher). Most simply would reply that, although they could produce more at the same price, they don’t have enough demand. But the diminishing returns fetish dominates the profession (I won’t say much about imperfect competition, but Franklin Serrano noted here that this would be related to barriers to entry).

In the surplus approach, that concerns itself with the way in which societies reproduce themselves (usually in an amplified scale and with accumulation), prices and quantities are treated separately. Since costs of production, for a given technology, seem to be independent from the quantity produced (i.e. the cost would be the same if you produced slightly more or less), then the quantity can be taken as given for the discussion of the determination of prices. It is well know that, in that case, prices depend on the technology, which must allow for reproduction (including of the labor force) and by the way in which the surplus (what is left over, above and beyond the needs of reproduction) between classes.

Be that as it may, I’m more interested in the macroeconomic implications of the mainstream views about prices and quantities. Since the late 1960s, these views have coalesced around the notion that, whereas there is a short run tradeoff between prices and quantities (the so-called Phillips Curve, PC), in the long run the tradeoff vanishes. Put simply, if you push demand too much (through fiscal and monetary policy), output would increase and unemployment fall (as per Okun’s Law: higher output implies lower unemployment) inflation would accelerate. In the long run, however, the economy is self-adjusted and output cannot be above the optimal level, so the only effect of the expansionary policies would be inflation (Friedman dixit).

By the way, the same (the mainstream loves symmetry) is true for deflation. Yes it may cause some problems, but the system returns to full employment, even in the face of contractionary policies (the Greek should not worry about contraction, because markets would produce full employment if they are allowed to work; hence, the need of labor market flexibility). In the long run contractionary policies only would affect prices. In sum, supply and demand would lead to the optimal price and quantity, so if you get off my market (cranky old neoclassical guy would say), and stop expanding demand, there would be no inflation.

The evidence for a natural rate or for a PC is incredibly weak. In order to argue that there is a natural rate, the mainstream has basically suggested that it moves around all the time. So in the 1980s the natural rate was higher (in the US), when the actual unemployment was higher, than in the 1990s (particularly towards the end of the decade), when the actual rate was also lower. The ad hoc nature of the solution is evident. They tell you that the natural (which they measure as an average of the actual) is the attractor of the actual rate, and not the reverse."