RJsEconomics101: 1969 Nobel in Economics explained
In the first edition of #RJsEconomics101, let's talk about when the first time Nobel was awarded in Economics, the 1969 Nobel laureates, Ragnar Frisch and Jan Tinbergen. Economics used to be pretty theoretical for most of humanity’s history. It had rules like a farmer should pay 1/3rd of the entire crop he sows as tax to the ruler, without considering any data and using statistics to study the effect. As you can imagine, such a system was not optimized, fair, and productive at all. No one understood what the tuning knobs and their power are. Even before the prizes were awarded, economists have long tried to link statistics to theoretical economics and called the new field econometrics. Two people who contributed much to the emerging field and can be called founding fathers were Frisch and Tinbergen. They were awarded for developing and applying dynamic models for the analysis of economic processes.
Frisch was one of the first economists to represent complex and real-world situations in the form of equations, use mathematical measures to solve them, and confluence to solve many issues conjointly. He also contributed to “equilibrium and disequilibrium” analysis. There are multiple kinds of markets, for example, the labor market, the goods market, etc. Equilibrium means that supply is precisely the same as demand in the market. So, if we consider, labor market, the number of people working in industries is precisely the number of people industry demands. There is no unemployment as well as no shortage of workers. It’s one of the most comfortable scenarios but assumes ideal conditions like the workers are alike in every aspect and ignores physical factors like proximity, skill, social-roles, etc. A market in equilibrium is called market-equilibrium. If all markets are in equilibrium, we call it general equilibrium. Any shift from equilibrium is called disequilibrium.
Frisch also related macro-economics of a nation to dynamic business models. He also showed how random shocks to the economy result in the creation of impulse, which leads to oscillation in business cycles. Most dynamic systems are in an oscillating cycle from the initial point. Any impulse that hits them will cause a change in their time period and amplitude. But the tendency to recover or get boosted or damped by the impulse depends on the internal characteristics of the system as well. That’s why you see certain sectors coming up well after lockdowns, and some just got damped and probably died as well. Being a good fan of linear and non-linear programming, most of his works were where the total number of equations was equal to the number of independent variables of the system, hence solvable. :)
Last but not the least, Frisch was a crucial consultant for the development planning of under-developed countries, one example is India. He also worked in circulation planning, which talks about reviving production and circulation in an economy suffering depression due to reduced demand. He mainly explained that the free-market interest rate and the ones set up by the monetary organizations (which he termed as inherent inflation or deflation biased) cause disequilibrium in the society. He also advocated that depression in the economy is not caused by a real lack of demand but forced due to these organizations. He also advocated the formation of the National Exchange Organization, which will collect all the information from the market and monetary institutions, correctly predict supply-demand values, and hence plan for boosting or damping certain factors or even setting the prices of goods.
Quite a socialist approach, I would say, and be much more prevalent in the post-WWII period.
The other laureate was Jan Tinbergen. Based on data from 1923–1933, he created an economic model of the Dutch Economy, consisting of 24 equations, describing key macroeconomic relationships as consumption and investment spending. He also proposed a model based on the cobweb theorem, which explains why prices might be subject to periodic fluctuations in certain market types. The reason is an inherent cyclical supply and demand in the market where the amount produced must be chosen before the prices are observed. Using the above model, he proposed why price and quantities in agricultural markets often move in opposite directions if output reacts to prices with a time lag.
Take a real-world example as shown in the figure; due to bad weather conditions, the onion crops failed this year and resulted in the production of quantity Q1. By the supply-demand curve, you can see that the price will be on a higher side, let it be P1. The farmers for the next season assumed that the high price will continue and sowed more onion crops. This year the weather didn’t fail either and resulted in high quantity Q2 (Q2>Q1). The price this time will be on the lower side, P2 (P2<P1). Farmers again followed the same logic and sow a quantity Q3 (Q3<Q2), and now the spiral of high-low sowing each season will continue. This spiral can either gradually converge as we get more data and farmers become more experienced or can either diverge due to various internal and external influences. As the output responds to prices with a time lag, such a spiral is inevitable, and the best we can do is make it converge.
In Tinbergen’s approach to the formation of macro-economic policy, the central proposal is that to simultaneously achieve a set of independent policy objectives (eg full employment and a stable price level), we need to have at least the same number of independent policy instruments (eg government expenditure and the money supply). To say it simply, the unknown variables should not be more than the number of equations. Like Frisch, he also worked with numerous underdeveloped nations on economic planning and suggested theories on income inequalities and income distribution over time. He was often criticized for developing mathematical objectives and not caring about other social things, which can be reflected in his 24-equation model for the Dutch or 48-equation model for the US economy.
The article is based on my understanding of the limited knowledge I got from different internet sources and publications. Opinions may differ. I would like to know about them in the comments.
Hope to see you next time soon.