Finn Kydland, along with edward prescott, received the 2004 Nobel Prize in economic science “for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles.” Because Kyland and Prescott worked so closely, this biography deals with their work on time consistency and Prescott’s biography deals with their work on business cycles. Although the issue of time consistency might sound arcane, it is crucial for economic policy. In their classic 1977 article, Kydland and Prescott pointed out that even governments that care deeply about their citizens often have “time-consistency” problems. A government may decide, for example, in the interest of all its citizens not to subsidize people’s losses if they are flooded. The reason is that if people expect to be bailed out when flooded, they will locate in areas where it is inefficient for them to locate, because they are not bearing the whole cost of that location decision. So the government announces that it will not bail out people if their homes are damaged by floods. Then a flood comes, and the government decides that the optimal strategy is to bail people out: there is no danger of the bailout causing them to locate there because they already have. Here is the problem: people figure out that the government has this time-consistency problem—making a decision later that contradicts the earlier announced policy—and so do locate in the flood-prone area in the first place. Of course, people do not talk about the government in these terms, but they will try to estimate how likely it is that the government will cave in to political pressure and change its policy. If there is even some substantial likelihood, people’s decisions to live in the flood-prone area will be distorted by it. In short, unless they can make a binding commitment regarding future policies, even governments that care about their people will have a credibility problem. Kydland and Prescott modeled this problem mathematically and showed that it applies to many policy issues. For example, “time inconsistency” could explain why governments had trouble ending inflation. Although low or zero inflation is an optimal long-run policy, a government that announces a monetary policy to achieve it will be tempted to increase the growth rate of the money supply so as to reduce unemployment. But each year, government will find itself in that position and may never take the necessary painful short-run measures to end inflation. Kydland’s and Prescott’s answer to the problem of persistent high inflation was to make central banks follow rules that would prevent them from inflating. But many economists and most government officials want the central bank to have some flexibility to deal with unanticipated events. The solution: structure the incentives so that central banks will care about keeping inflation low, but will still have the power to deal with unanticipated events. Economist Kenneth Rogoff,1 building on Kydland’s and Prescott’s framework, showed that this optimal balance between credibility and flexibility could be achieved if monetary policy were delegated to an independent central bank and if the central bank were managed by someone more averse to inflation than the citizens in general. Interestingly, Alan Greenspan, an inflation “hawk,” became chairman of the Federal Reserve Bank just two years after Rogoff’s research. Also, reforms of central banks in New Zealand, Sweden, and the United Kingdom were based on academic economists’ research that drew on the Kydland-Prescott framework—and the result was a substantial decline in inflation in those three countries. Another example of the time-consistency problem is patents. Patents involve a trade-off between the short-term welfare loss from monopoly exploitation of a patent and the long-term welfare gain from the patent-induced incentive to innovate (see intellectual property). A government that does not credibly commit to enforcing patents will often violate the intellectual property rights of patentees. Many governments around the world are doing this with patents on drugs. Potential innovators, anticipating this, will innovate less. So a government that wants optimal innovation needs to figure out some way to lock itself in to protecting patents in the future. One final example is tax policy. The incentive to accumulate capital will depend on the anticipated tax rate on capital in the future. A government may commit to a low tax rate in order to encourage capital formation. But once people have invested in capital, governments will be tempted to raise the tax rate on capital because the capital is already “formed.” Again, though, many people will anticipate this and, unless the government is tied in to its commitments, will invest less in capital than otherwise. One can see the U.S. Constitution, along with an independent judiciary that enforces it, as a way of handling this credibility problem. Kydland is a citizen of Norway. He earned his B.S. from the Norwegian School of Economics and Business in 1968 and his Ph.D. from Carnegie Mellon University in 1973. He is currently a professor at the University of California at Santa Barbara and at Carnegie Mellon University. Selected Works   1977 (with Edward Prescott). “Rules Rather than Discretion: The Inconsistency of Optimal Plans.” Journal of Political Economy 85: 473–490. 1982 (with Edward Prescott). “Time to Build and Aggregate Fluctuations.” Econometrica 50: 1345–1371. 2002 (with Carlos E. J. M. Zarazaga). “Argentina’s Lost Decade.” Review of Economic Dynamics 5, no. 1: 152–165.   Footnotes 1. Kenneth Rogoff, “The Optimal Degree of Precommitment to an Intermediate Monetary Target,” Journal of International Economics 18 (1985): 1169–1190.   (0 COMMENTS)

  Polish economist Oskar Lange is best known for his contributions to the economics of socialism. His views on the feasibility of socialism changed back and forth throughout his life. While teaching at the University of Kraków in 1934, he outlined, with coauthor Marek Breit, a version of socialism in which the government owned all plants and each industry, called a public trust, was organized as a monopoly. Workers would have a large say in running each industry. Lange left Europe in 1935 to teach at the University of Michigan. In 1936 and 1937 he entered the debate with friedrich hayek about the feasibility of socialism. He presented “market socialism,” in which the government would own major industries and a central planning board (CPB) would set prices for those industries. The CPB would alter prices to reach equilibrium, raising them to get rid of shortages and lowering them to get rid of surpluses. Hayek pointed out that having government set prices to mimic competition, as Lange suggested, seemed inferior to having real competition. Whether in response to Hayek’s criticism or for other reasons, Lange modified his proposal, advocating that the government set prices only in industries with few firms. In 1943 Lange moved to the University of Chicago. That same year he advocated that the Polish government socialize key industries, but that farms, shops, and many other small and medium-sized industries remain in private hands. A large private sector, he wrote, was necessary to preserve “the kind of flexibility, pliability and adaptiveness that private initiative alone can achieve.” In 1945, Poland’s newly formed communist government appointed Lange ambassador to the United States, and in 1946 he became Poland’s delegate to the United Nations. When Stalinist orthodoxy was imposed in Poland in 1949, Lange was recalled to Poland and given a minor academic job. In 1953, with Poland still under Stalinist oppression, Lange reversed himself and wrote an article praising Stalin’s totalitarian economic control. In 1955, after the political oppression had lifted somewhat, Lange was made a professor at the University of Warsaw and chairman of the Polish State Economic Council. Selected Works   1936. “On the Economic Theory of Socialism, Part I.” Review of Economic Studies 4, no. 1: 53–71. 1937. “On the Economic Theory of Socialism, Part II.” Review of Economic Studies 4, no. 2: 123–142. 1942. “The Foundations of Welfare Economics.” Econometrica 10, nos. 3–4: 215–228. 1943. Working Principles of the Soviet Economy. New York: Russian Economic Institute.   (0 COMMENTS)

  From the time he was a young man growing up in Saint Petersburg, Wassily Leontief devoted his studies to input-output analysis. When he left Russia at the age of nineteen to begin the Ph.D. program at the University of Berlin, he had already shown how leon walras’s abstract equilibrium theory could be quantified. But it was not until many years later, in 1941, while a professor at Harvard, that Leontief calculated an input-output table for the American economy. It was this work, and later refinements of it, that earned Leontief the Nobel Prize in 1973. Input-output analysis shows the extensive process by which inputs in one industry produce outputs for consumption or for input into another industry. The matrix devised by Leontief is often used to show the effect of a change in production of a final good on the demand for inputs. Take, for example, a 10 percent increase in the production of shoes. With the input-output table, one can estimate how much additional leather, labor, machinery, and other inputs will be required to increase shoe production. Most economists are cautious in using the table because it assumes, to use the shoe example, that shoe production requires the inputs in the proportion they were used during the time period used to estimate the table. There’s the rub. Although the table is useful as a rough approximation of the inputs required, economists know from mountains of evidence that proportions are not fixed. Specifically, when the cost of one input rises, producers reduce their use of this input and substitute other inputs whose prices have not risen. If wage rates rise, for example, producers can substitute capital for labor and, by accepting more wasted materials, can even substitute raw materials for labor. That the input-output table is inflexible means that, if used literally to make predictions, it will necessarily give wrong answers. At the time of Leontief’s first work with input-output analysis, all the required matrix algebra was done using hand-held calculators and sheer tenacity. Since then, computers have greatly simplified the process, and input-output analysis, now called “interindustry analysis,” is widely used. Leontief’s tables are commonly used by the World Bank, the United Nations, and the U.S. Department of Commerce. Early on, input-output analysis was used to estimate the economy-wide impact of converting from war production to civilian production after World War II. It has also been used to understand the flow of trade between countries. Indeed, a 1954 article by Leontief shows, using input-output analysis, that U.S. exports were relatively labor intensive compared with U.S. imports. This was the opposite of what economists expected at the time, given the high level of U.S. wages and the relatively high amount of capital per worker in the United States. Leontief’s finding was termed the Leontief paradox. Since then, the paradox has been resolved. Economists have shown that in a country that produces more than two goods, the abundance of capital relative to labor does not imply that the capital intensity of its exports should exceed that of its imports. Throughout his life Leontief campaigned against “theoretical assumptions and nonobserved facts” (the title of a speech he delivered while president of the American Economic Association, 1970–1971). According to Leontief too many economists were reluctant to “get their hands dirty” by working with raw empirical facts. To that end Wassily Leontief did much to make quantitative data more accessible, and more indispensable, to the study of economics. Selected Works   1941. The Structure of American Economy, 1919–1929. Cambridge: Harvard University Press. 1966. Essays in Economics: Theories and Theorizing. New York: Oxford University Press.   (0 COMMENTS)

  Robert Lucas was awarded the 1995 Nobel Prize in economics “for having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy.” More than any other person in the period from 1970 to 2000, Robert Lucas revolutionized macroeconomic theory. His work led directly to the pathbreaking work of finn kydland and edward prescott, which won them the 2004 Nobel Prize. Before the early 1970s, wrote Lucas, “two very different styles of macroeconomic theory, both claiming the title of Keynesian economics, co-existed.” One was an attempt to make macroeconomics fit with standard microeconomics. The problem with this was that such models could not be used to make predictions. The other style was macroeconometric models (see forecasting and econometric models) that could be fit to data and used to make predictions but that did not have a clear relationship to economic theory. Many economists were working to unify the two, but economists themselves saw the results as unsatisfactory. Lucas thought he could do better. His major innovation in his seminal 1972 article was to get rid of the assumption (implicit and often explicit in virtually every previous macro model) that government policymakers could persistently fool people. Economists milton friedman and Edmund Phelps had pointed out that there should be no long-run trade-off between unemployment and inflation; or, in economists’ jargon, that the long-run phillips curve should be vertical.1 They reasoned that the short-run trade-off existed because when the government increased the growth rate of the money supply, which increased prices, workers were fooled into accepting wages that appeared higher in real terms than they really were; they accepted jobs sooner than they otherwise would have, thus reducing unemployment. Lucas took the next step by formalizing this thinking and extending it. He pointed out that in standard microeconomics, economists assume that people are rational. He extended that assumption to macroeconomics, assuming that people would come to know the model of the economy that policymakers use; thus the term “rational expectations.” This meant that if, say, the government increased the growth rate of the money supply to reduce unemployment, it would work only if the government increased money growth more than people expected, and the sure long-term effect would be higher inflation but not lower unemployment. In other words, the government would have to act unpredictably. In a 1976 article he introduced what is now known as the “Lucas critique” of macroeconometric models, showing that the various empirical equations estimated in such models were from periods where people had particular expectations about government policy. Once those expectations changed, as his theory of rational expectations said they would, then the empirical equations would change, making the models useless for predicting the results of different fiscal and monetary policies. So, for example, if an econometric model showed that for some time period a three-percentage-point drop in inflation was accompanied by a two-percentage-point increase in unemployment, one could not use this correlation to predict the effect of a future three-percentage-point drop in inflation, because people’s expectations would not be the same as they were in the time period for which this relation was estimated. One important implication of Lucas’s work, which was confirmed by Thomas Sargent,2 is that a government that is credible—that is, a government that makes itself understood and believed—can quickly end a major inflation without a big increase in unemployment. The reason: government credibility will cause people to quickly adjust their expectations. The key to that credibility, wrote Sargent, is fiscal policy. If governments commit to balanced budgets, then one of their main motives for inflation is gone (see hyperinflation). Not all macroeconomists have agreed with Lucas, but all have found themselves needing to confront his critique in some way. Although many economists in the 1970s, for example, thought that Lucas had pounded the final nail in the Keynesian coffin, Keynesians responded with models that assume rational expectations (see new keynesian economics). In his Nobel lecture, one of the most readable Nobel economics lectures of the last twenty years, Lucas summed up his and others’ contributions in the 1970s: The main finding that emerged from the research of the 1970s is that anticipated changes in money growth have very different effects from unanticipated changes. Anticipated monetary expansions have inflation tax effects and induce an inflation premium on nominal interest rates, but they are not associated with the kind of stimulus to employment and production that Hume described. Unanticipated monetary expansions, on the other hand, can stimulate production as, symmetrically, unanticipated contractions can induce depression.3 Lucas has also been one of the leaders in the field of economic growth. In “On the Mechanics of Economic Development” (1988), he helped break down the barrier that had existed between economic development economics (applied to poor countries) and economic growth (the study of growth in already rich countries). He argued that the same basic economic framework should apply to each and that it was crucial to understand how poor countries could grow. Lucas wrote: Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. (Lucas 1988, p. 5; italics in original) Lucas also did important work on the optimal tax structure. His work led him to change a fundamental belief. In the early 1960s, he had believed that “the single most desirable change in the U.S. tax structure would be the taxation of capital gains as ordinary income.” By 1990 he believed that “neither capital gains nor any of the income from capital should be taxed at all.” He estimated that eliminating capital income taxation would increase the U.S. capital stock by about 35 percent. This belief in low or zero taxation of capital gains is often attributed to believers in so-called supply-side economics. Lucas wrote, “The supply side economists, if that is the right term for those whose research we have been discussing, have delivered the largest genuinely free lunch that I have seen in 25 years of this business, and I believe we would be a better society if we followed their advice.”4 Politically, Lucas is libertarian. Asked by an interviewer in 1982 whether there is social injustice, Lucas replied, “Well, sure. Governments involve social injustice.”5 Asked by another interviewer in 1993 to name the important issues on the economic frontier, Lucas answered, “In economic policy, the frontier never changes. The issue is always mercantilism and government intervention vs. laissez-faire and free markets.”6 An interesting side note: when Lucas and his wife, Rita, got a divorce in 1988, she negotiated for 50 percent of any Nobel Prize money that he might receive, with an October 31, 1995, expiration date on this clause. He won the prize on October 10, 1995. Economists joked that Lucas’s model applied to his wife: she had rational—or at least correct—expectations. Lucas earned his B.A. in history in 1959 and his Ph.D. in economics in 1964, both at the University of Chicago. From 1963 to 1974, he was an economics professor at Carnegie Institute of Technology and Carnegie Mellon University. From 1974 to the present, he has been a professor of economics at the University of Chicago. Selected Works   1972. “Expectations and the Neutrality of Money.” Journal of Economic Theory 4: 103–124. 1976. “Econometric Policy Evaluation: A Critique.” Carnegie-Rochester Conference Series on Public Policy 1: 19–46. 1981. Studies in Business-Cycle Theory. Cambridge: MIT Press. 1987. Models of Business Cycles. Oxford: Basil Blackwell. 1988. “On the Mechanics of Economic Development.” Journal of Monetary Economics 22: 3–42. 1990. “Supply Side Economics: An Analytical Review.” Oxford Economic Papers 42: 293–316. 1990. “Why Doesn’t Capital Flow from Rich to Poor Countries?” American Economic Review 80: 92–96.   Footnotes 1. Milton Friedman, “The Role of Monetary Policy,” American Economic Review 58 (1968): 1–17; Edmund S. Phelps, “Money Wage Dynamics and Labor Market Equilibrium,” Journal of Political Economy 76 (1968): 687–711.   2. Thomas Sargent, “The Ends of Four Big Inflations,” chap. 3 in Sargent, Rational Expectations and Inflation (New York: Harper and Row, 1986).   3. See http://nobelprize.org/economics/laureates/1995/lucas-lecture.pdf, p. 262.   4. Lucas, “Supply-Side Economics,” p. 314.   5. Arjo Klamer, Conversations with Economists (Totowa, N.J.: Rowman and Allanheld, 1983), p. 52.   6. Interview with Robert E. Lucas Jr., The Region, Federal Reserve Bank of Minneapolis (June 1993), online at: www.minneapolisfed.org/pubs/region/93-06/int936.cfm.   (0 COMMENTS)

Abba Lerner was the milton friedman of the left. Like Friedman, Lerner was a brilliant expositor of economics who was able to make complex concepts crystal clear. Lerner was also an unusual kind of socialist: he hated government power over people’s lives. Like Friedman, he praised private enterprise on the ground that “alternatives to government employment are a safeguard of the freedom of the individual.” Also like Friedman, Lerner loved Free Markets. He opposed Minimum Wage laws and other price controls because they interfered with the price system, which he called “one of the most valuable instruments of modern society.”1 Both his clear writing and his hatred of authority are illustrated in the following defense of consumer sovereignty: One of the deepest scars of my early youth was etched when my teacher told me, “You do not want that,” after I had told her that I did. I would not have been so upset if she had said that I could not have it, whatever it was, or that it was very wicked of me to want it. What rankled was the denial of my personality—a kind of rape of my integrity. I confess I still find a similar rising of my hackles when I hear people’s preferences dismissed as not genuine, because influenced by advertising, and somebody else telling them what they “really want.”2 Lerner, like Friedman, had a sharp analytical mind that made him follow an argument to its logical conclusion. During World War II, for example, when john maynard keynes gave a talk at the Federal Reserve Board in Washington, Lerner, who was in the audience, found Keynes’s view of how the economy worked completely convincing and challenged Keynes for not carrying his own argument to its logical conclusion. Keynes denounced Lerner on the spot, but Keynes’s colleague Evsey Domar, seated beside Lerner, whispered, “He ought to read The General Theory.” A month later, wrote Lerner, Keynes withdrew his denunciation. Lerner was born in Romania and immigrated with his parents to Britain while still a child. He tried out several avocations: as tailor, Hebrew teacher, typesetter, and owner of a printing business that went bankrupt during the Great Depression. He turned to economics, enrolling in a night course at the London School of Economics in 1929, in order to discover why his business had failed. Lerner earned top honors and several scholarships for his logically reasoned essays, many of which were published while he was still an undergraduate. His appointment as assistant lecturer at the LSE in 1936 was the first of many teaching positions, the rest of which he held in the United States after 1937. paul samuelson, in a tribute to Lerner on his sixtieth birthday, wrote that Lerner’s experience “tempts one to advise students in Economics A to quit college, fail in business, marry and raise a family, and resist being overpaid.”3 One of Lerner’s first papers, published in 1934, is a clear diagrammatic exposition of international trade. Earlier, he had written, but not published, a proof of the conditions under which free trade in goods causes the prices of factors to be equal even when factors are immobile. Samuelson showed the same thing in an article much later. “After I had enunciated the same result in 1948,” Samuelson later wrote, “Lord Robbins mentioned to me that he thought he had a seminar paper in his files by Lerner of a similar type…. He exhumed this gem, which appeared 17 years later in the 1950 Economica.”4 Probably Lerner’s best-known article is “The Concept of Monopoly and the Measurement of Monopoly Power.” In it he laid out clearly why setting the price of a good equal to its marginal cost is important for efficiency. The amount by which the price exceeds marginal cost is a measure of monopoly power in an industry. In 1964 Samuelson wrote: “Today this may seem simple, but I can testify that no one at Chicago or Harvard could tell me in 1935 exactly why P = MC was a good thing.”5     Lerner’s main contribution to macroeconomic policy is his concept of functional finance. Lerner thought that if governments wanted to increase aggregate demand so as to maintain employment, and if the federal budget was balanced, the government should run a deficit by increasing government spending or decreasing taxes. If, on the other hand, the government wanted to decrease aggregate demand, it should, if the budget was balanced, run a surplus by decreasing government spending or raising taxes. These thoughts are often attributed to Keynes, and they do follow from Keynes’s reasoning. But Keynes never stated them. It took Lerner’s clear thinking to get from Keynes’s model of the economy to these policy conclusions. Lerner’s thoughts are attributed to Keynes because textbook writers, wanting to make Keynes’s thinking clear, were immediately drawn to Lerner’s thinking. As economist David Colander has written, Keynes could be considered just as much a Lernerian as a Keynesian. Lerner was active in economic analysis until the day he died. In 1980, for example, he laid out a plan for breaking OPEC. In an article titled “OPEC—a Plan—If You Can’t Beat Them, Join Them,” Lerner advocated that the United States and other governments of oil-consuming countries impose a 100 percent excise tax on the difference between OPEC’s price and the pre-OPEC price adjusted for inflation. In 1980 OPEC charged twenty-six dollars for a barrel of oil. The pre-OPEC price adjusted for inflation was six dollars. Therefore, at that price, the tax would have been 100 percent of 26 − 6, or twenty dollars. Lerner’s plan, if followed, would have caused the price to consumers to rise two dollars every time OPEC raised its price one dollar. More important, it would have caused the price to fall by two dollars every time OPEC lowered its price by one dollar. Lerner’s thinking, which was absolutely watertight, was that this plan would double consumers’ elasticity of demand, causing them to demand less oil at higher prices and thus reduce the strength of the cartel. The plan was never adopted. Lerner never developed a following. One reason, wrote Tibor Scitovsky of Stanford, was “Lerner’s unrelenting logic,” which “overruled whatever loyalties he started with” and “made him seem like a cold fish to just about everybody.”6 Another reason was that Lerner rarely stayed in one university long; he taught at Columbia, the University of Virginia, Kansas City, Amherst, the New School for Social Research, Roosevelt, Johns Hopkins, Michigan State, and the University of California at Berkeley. Another reason was that although he made major contributions in so many areas, he did not have a specialty. Also, Lerner made his insights so clear and so apparently obvious that people who adopted his ideas forgot where they learned them. Probably because he lacked a following, Lerner never received the Nobel Prize, although many economists think he should have. Selected Works   1934. “The Concept of Monopoly and the Measurement of Monopoly Power.” Review of Economic Studies 1: 157–175. 1934. “The Diagrammatical Representation of Demand Conditions in International Trade.” Economica, n.s., 1 (August): 319–334. 1936. “The Symmetry Between Import and Export Taxes.” Economica, n.s., 3 (August): 306–313. 1943. “Functional Finance and the Federal Debt.” Social Research 10: 38–51. 1944. The Economics of Control: Principles of Welfare Economics. New York: Macmillan. 1972. “The Economics and Politics of Consumer Sovereignty.” American Economic Review 62 (May): 258–266. 1980. “OPEC—a Plan—If You Can’t Beat Them, Join Them.” Atlantic Economic Journal 8, no. 3: 1–3.   Footnotes 1. Tibor Scitovsky, “Lerner’s Contributions to Economics,” Journal of Economic Literature 22, no. 4 (1984): 1549.   2. From “The Economics and Politics of Consumer Sovereignty,” p. 258.   3. Paul A. Samuelson, “A. P. Lerner at Sixty,” Review of Economic Studies 31, no. 3 (1964): 169.   4. Ibid., p. 172.   5. Ibid., p. 173.   6. Scitovsky 1984, p. 1549.   (0 COMMENTS)

Born in England, John Locke was a persistent champion of natural rights—the idea that each person owns himself and should have certain liberties that cannot be expropriated by the state or anyone else. When someone labors for a productive end, the results become that person’s property, reasoned Locke. Locke also believed that governments should not regulate interest rates. In a pamphlet titled Considerations of the Consequences of the Lowering of Interest, Locke opposed a bill before Parliament to lower the maximum legal interest rate from 6 percent to 4 percent. Because interest is a price, and because all prices are determined by the laws of nature, he reasoned, ceilings on interest rates would be counterproductive. People would evade the ceiling, and the costs of evasion would drive interest rates even higher than they would have been without the ceiling. Locke’s reasoning on the subject, sophisticated for his era, has withstood the test of time: economists make the same objection to controls on interest rates today (see interest rates, price controls). Locke also sketched out a quantity theory of money, which held that the value of money is inversely related to the quantity of money in circulation. Locke erroneously believed that a country was in danger of falling into depression if its gold inflows from trade fell relative to those of its trade partners (see Mercantilism). What he did not realize, and what no one realized until David Hume pointed it out, was that gold flows cannot get out of line with trade flows. If “too little” gold came into Britain relative to gold inflows to other countries, for example (Locke assumed that the supply of gold would grow relative to the volume of trade), then British goods would become cheap relative to other countries’ goods, causing more gold to flow to England from other countries. Selected Works   1690. Two Treatises of Government. 1691. Some Considerations of the Consequences of the Lowering of Interest and Raising the Value of Money. 1696. Several Papers Relating to Money, Interest and Trade, et cetera.   (0 COMMENTS)

  Malthus was interested in everything about populations. He accumulated figures on births, deaths, age of marriage and childbearing, and economic factors contributing to longevity. His main contribution was to highlight the relationship between food supply and population. Humans do not overpopulate to the point of starvation, he contended, only because people change their behavior in the face of economic incentives. Noting that while food production tends to increase arithmetically, population tends to increase naturally at a (faster) geometric rate, Malthus argued that it is no surprise that people thus choose to reduce (or “check”) population growth. People can increase food production, Malthus thought, only by slow, difficult methods such as reclaiming unused land or intensive farming; but they can check population growth more effectively by marrying late, using contraceptives, emigrating, or, in more extreme circumstances, resorting to reduced health care, tolerating vicious social diseases or impoverished living conditions, warfare, or even infanticide. Malthus was fascinated not with the inevitability of human demise, but with why humans do not die off in the face of such overwhelming odds. As an economist, he studied responses to incentives. Malthus is arguably the most misunderstood and misrepresented economist of all time. The adjective “Malthusian” is used today to describe a pessimistic prediction of the lock-step demise of a humanity doomed to starvation via overpopulation. When his hypothesis was first stated in his best-selling An Essay on the Principle of Population (1798), the uproar it caused among noneconomists overshadowed the instant respect it inspired among his fellow economists. So irrefutable and simple was his illustrative side-by-side comparison of an arithmetic and a geometric series—food increases more slowly than population—that it was often taken out of context and highlighted as his main observation. The observation is, indeed, so stark that it is still easy to lose sight of Malthus’s actual conclusion: that because humans have not all starved, economic choices must be at work, and it is the job of an economist to study those choices. Malthus addressed many other issues. His Principles of Political Economy (1820) was the first text to describe a demand schedule as separate from the quantity demanded at a given price. His exposition of demand curves clarified the debate on Say’s law and gluts (to which he objected in the long run on the grounds that markets self-adjust). His work centered on contrasting the long run, as exemplified by population growth, with the short run, reflected by cyclical events such as those affecting agriculture. Writing before the industrial revolution, Malthus did not fully appreciate the impact of technology (i.e., pesticides, refrigeration, mechanized farm equipment, and increased crop yields) on food production. Malthus died in 1834, before seeing economics characterized as the “dismal science.” That phrase, coined by Thomas Carlyle in 1849 to demean John Stuart Mill, is often erroneously thought to refer to Malthus’s contributions to the economics of population growth. About the Author Lauren F. Landsburg is a private computer consultant. She is the editor of the Library of Economics and Liberty. Previously, she taught economics at the University of Rochester and was a senior economist with President Ronald Reagan’s Council of Economic Advisers. Selected Works   1798. An Essay on the Principle of Population. 1st ed. 1798, online at the Library of Economics and Liberty, http://www.econlib.org/library/Malthus/malPop.html; 6th ed. 1826, online at the Library of Economics and Liberty, http://www.econlib.org/library/Malthus/malPlong.html. 1811. “Pamphlets on the Bullion Question.” Edinburgh Review 18 (August): 448–470. 1820. The Principles of Political Economy Considered with a View to Their Practical Applications. London: John Murray.   (0 COMMENTS)

Born in Austria, Fritz Machlup moved to the United States in 1933. He worked in two main areas: industrial organization, with particular emphasis on the production and distribution of knowledge, and international monetary economics. One of Machlup’s most famous articles in industrial organization is his 1946 defense of the economist’s standard assumption that firms maximize profits. Economist Richard Lester had argued that businessmen do not know enough about their demand and cost conditions to maximize profits. Machlup agreed but maintained that the purpose of assuming profit maximization is not to predict everything a firm does, but instead to predict how it will react to changes in demand or in costs. For this purpose, argued Machlup, the assumption is appropriate. Machlup expanded on this argument in two later books, The Economics of Sellers’ Competition and The Political Economy of Monopoly. Machlup’s 1949 book, The Basing-Point System, is said to have influenced President Harry S Truman’s decision to veto a bill that would have forced cement producers to charge the same price irrespective of their buyers’ locations. Machlup also wrote at length about the economics of the patent system. Machlup studied economics at the University of Vienna in the 1920s under Ludwig von Mises and Friedrich Hayek. He wrote his doctoral dissertation under Mises on the gold-exchange standard. From 1922 to 1932 he worked in his family’s cardboard-manufacturing business, and his interest in and insights into the economics of industry are often attributed to his experience there. Machlup taught at the University of Buffalo from 1935 to 1947, moved to Johns Hopkins in 1947, and moved to Princeton in 1960. After retiring in 1971 he joined the faculty of New York University, where he was active until his death. Machlup was president of the American Economic Association in 1966. Selected Works   1949. The Basing-Point System. Philadelphia: Blakiston. 1952. The Economics of Sellers’ Competition. Baltimore: Johns Hopkins University Press. 1952. The Political Economy of Monopoly. Baltimore: Johns Hopkins University Press. 1958. An Economic Review of the Patent System. Study of the Subcommittee on Patents, Trademarks, and Copyrights of the Committee on the Judiciary, U.S. Senate, study no. 15. 1962. The Production and Distribution of Knowledge in the United States. Princeton: Princeton University Press. 1976. International Payments, Debts, and Gold. 2d ed. New York: New York University Press.   (0 COMMENTS)

  Alfred Marshall was the dominant figure in British economics (itself dominant in world economics) from about 1890 until his death in 1924. His specialty was microeconomics—the study of individual markets and industries, as opposed to the study of the whole economy. In his most important book, Principles of Economics, Marshall emphasized that the price and output of a good are determined by both supply and demand: the two curves are like scissor blades that intersect at equilibrium. Modern economists trying to understand why the price of a good changes still start by looking for factors that may have shifted demand or supply, an approach they owe to Marshall. To Marshall also goes credit for the concept of price elasticity of demand, which quantifies buyers’ sensitivity to price (see demand). The concept of consumer surplus is another of Marshall’s contributions. He noted that the price is typically the same for each unit of a commodity that a consumer buys, but the value to the consumer of each additional unit declines. A consumer will buy units up to the point where the marginal value equals the price. Therefore, on all units previous to the last one, the consumer reaps a benefit by paying less than the value of the good to himself. The size of the benefit equals the difference between the consumer’s value of all these units and the amount paid for the units. This difference is called the consumer surplus, for the surplus value or utility enjoyed by consumers. Marshall also introduced the concept of producer surplus, the amount the producer is actually paid minus the amount that he would willingly accept. Marshall used these concepts to measure the changes in well-being from government policies such as taxation. Although economists have refined the measures since Marshall’s time, his basic approach to what is now called welfare economics still stands. Wanting to understand how markets adjust to changes in supply or demand over time, Marshall introduced the idea of three periods. First is the market period, the amount of time for which the stock of a commodity is fixed. Second, the short period is the time in which the supply can be increased by adding labor and other inputs but not by adding capital (Marshall’s term was “appliances”). Third, the long period is the amount of time taken for capital (“appliances”) to be increased. To make economics dynamic rather than static, Marshall used the tools of classical mechanics, including the concept of optimization. With these tools he, like neoclassical economists who have followed in his footsteps, took as givens technology, market institutions, and people’s preferences. But Marshall was not satisfied with his approach. He once wrote that “the Mecca of the economist lies in economic biology rather than in economic dynamics.” In other words, Marshall was arguing that the economy is an evolutionary process in which technology, market institutions, and people’s preferences evolve along with people’s behavior. Marshall rarely attempted a statement or took a position without expressing countless qualifications, exceptions, and footnotes. He showed himself to be an astute mathematician—he studied math at St. John’s College, Cambridge—but limited his quantitative expressions so that he might appeal to the layman. Marshall was born into a middle-class family in London and raised to enter the clergy. He defied his parents’ wishes and instead became an academic in mathematics and economics. Selected Works   1890. Principles of Economics. Vol. 1. London: Macmillan. 1920. Principles of Economics. 8th ed. London: Macmillan. Available online at: http://www.econlib.org/library/Marshall/marP.html   (0 COMMENTS)

In 1990, U.S. economists Harry Markowitz, William F. Sharpe, and Merton H. Miller shared the Nobel Prize “for their pioneering work in the theory of financial economics.” Their contributions, in fact, were what started financial economics as a separate field of study. In the early 1950s Markowitz developed portfolio theory, which looks at how investment returns can be optimized. Economists had long understood the common sense of diversifying a portfolio; the expression “don’t put all your eggs in one basket” is certainly not new. But Markowitz showed how to measure the risk of various securities and how to combine them in a portfolio to get the maximum return for a given risk. Say, for example, shares in Exxon and in General Motors have a high risk and a high return, but one share tends to go up when the other falls. This could happen because when OPEC raises the price of oil (and therefore of gasoline), the prices of oil producers’ shares rise and the prices of auto producers’ shares fall. Then a portfolio that includes both Exxon and GM shares could earn a high return and have a lower risk than either share alone. Portfolio managers now routinely use techniques that are based on Markowitz’s original insight. Markowitz earned his Ph.D. at the University of Chicago. He has taught at Baruch College of the City University of New York since 1982. Selected Works   1952. “Portfolio Selection.” Journal of Finance 7, no. 1: 77–91. 1959. Portfolio Selection: Efficient Diversification of Investments. Reprint. Hoboken, N.J.: Wiley, 1970.   (0 COMMENTS)