Chicago school of economic thought, Key Econimist of chicago School of thought

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Chicago School of Economic Thought“A deep commitment to rigorous scholarship and open academic debate, an uncompromising belief in the usefulness and insight of neoclassical price theory, and a normative position that favors and promotes economic liberalism and free markets”.

PAF KARACHI INSTITUTE OF ECONOMICS AND TECHNOLOGY NURSERY BRANCH KARACHI

7th May, 2013

Submitted to:

Mr. Qazi Salman Course: Micro Economics

Class ID: 57074Semester: Spring 2013

Research & Complied by:

NOMAN KHAN Std. ID: 57154 Micro Economics MBA (Evening Programme)

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Chicago School of Economic Thought

PAF KARACHI INSTITUTE OF ECONOMICS AND TECHNOLOGY NURSERY BRANCH KARACHI

Submitted to:

Mr. Qazi Salman Course: Micro Economics Class ID: 57074 Semester: Spring 2013

Research & Complied by

NOMAN KHAN Std. ID: 57154

MICROECONOMICS MBA (Evening Programme)

Chicago School of Economic Thought Page (iv)

(INTENTIONALLY LEFT BLANK)

Chicago School of Economic Thought Page (v)

This Project assignment is thankfully dedicated to my beloved wife and children for providing me

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& specially Karachi Electric Supply Company (KESC).

for their excessive interruptions was not there, this report could have been more precise, and

Completed one week earlier... Thank You!!

Noman Khan Stud. ID: 57154

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Please do not hesitate to contact if you have any query – all suggestions hare welcomed Noman Khan 0333‐3274654

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ACKNOWLEDGEMENT

I, first of all, would like to express my gratitude to the Almighty Allah who

gave my resources, expertise and many more to initiate and complete the

project assignment happily on time, also would like to bless all those people

who provided support, specially my family, who offered me peace of mind to

concentrate and focus on the subject assignment.

I also would like to thanks my Institute (PAF KIET) and the instructor Mr.

Qazi Salman who thought me Economics which is new for me and i was

studying this dismal science subject very first time, and it’s proved to be an

understandable without any extra efforts. Instructor kind support took this

long & difficult journey converted into a destination.

It would not better, to cover up the unconditional support of my Office

for provision of best quality resources, and tools after office hour to complete

it effectively and efficiently, and support of related websites, books, and

articles, related to the concerned school of thought.

Noman Khan

Chicago School of Economic Thought Page (vii)

TABLE OF CONTENT

Dedication ………………………………………………………………………………………………………………….. v

Acknowledgement ………………………………………………………………………………………………………………….. vi

Table of Content ………………………………………………………………………………………………………………….. vii

A. Economics school of thought: ………………………………………………………………………………………..…. 1

B. Chicago school of thought: ……………………………………………………………………………….………….. 1

C. History of Chicago SoT: …………………………………………………………….…………………………….. 2

D. Main Ideas: …………………………………………………………………………………………… 5

E. Key Economist : …………………………………………………………………………………………… 5

E.1. Frank Knight: …………………………………………………………………………………………… 5

E.2. Ronald Coase: …………………………………………………………………………………………… 5

E.3. George Stigler: …………………………………………………………………………………………… 6

E.4. Milton Friedman: …………………………………………………………………………………………… 6

E.5. Robert Fogel: …………………………………………………………………………………………… 7

E.6. Gary Becker: …………………………………………………………………………………………… 7

E.7. Richard Posner: …………………………………………………………………………………………… 7

E.8. Robert E. Lucas: …………………………………………………………………………………………… 8

E.9. Eugene Fama: …………………………………………………………………………………………… 8

E.10. Friedrich Hayek: …………………………………………………………………………………………… 8

F. Key theories / laws: …………………………………………………………………………………………… 9

G. Impact of the school in society: ………………………………………………………………………….……………….. 9

H. Quotable quotations: …………………………………………………………………………………………… 10

I. Conclusion: …………………………………………………………………………………………… 11

J. References: …………………………………………………………………………………………… 12

Chicago School of Economic Thought Page 1 of 11

CHICAGO ECONOMICS SCHOOL OF THOUGHT

A. ECONOMICS SCHOOLS OF THOUGHTS:

A.1 Schools of thought (SoT) define as “the viewpoint or belief or system of beliefs acknowledged as convincing by some group or school". In economics, a school of thought can be thought of as a belief or system of beliefs held by some cluster of economists. Each SoT differs by the set of economic phenomena they wish to explain, the economic practices used, and the assumptions used in order to explain those economic phenomena.

A.2 Here the word "school" does not mean to be a terrestrial place but it is a thought or belief of economists. However most often the economists belong to certain schools of thought that have been linked to the specific universities / schools, such as the Austrians School of Economics, University of Chicago etc.

A.3 There are variety of approaches (school of thoughts) exist in the economics theory, various economics classify the various SoT in variety of phases: Economic thought may be divided into three following phases but the methodical economic theory has been developed mainly from the establishment of the last phase i.e, “modern” era.

Pre modern period “start form Chinese civilization, and Greco Roman

Early‐modern period of mercantilist & physiocrate thoughts

Modern period start from 1776 from great economist Adam Smith till to the classical economies era 1930,

B. CHICAGO SCHOOL OF THOUGHT:

B.1 The Chicago school of economics having a thought of neoclassical school inside the hypothetical community of economists, they usually have a strong focus around the faculty of the University of Chicago, some of whom have constructed and popularized its principles.

B.2 In the macroeconomics background, it is linked to the freshwater school of macroeconomics, in contrast to the saltwater school based in coastal universities. Chicago macroeconomic theory forbidden the Keynesianism until the mid‐1970s in favor of monetarism, when it turned to new classical macroeconomics heavily based on the concept of rational expectations. The freshwater‐saltwater distinction is largely antiquated today, as the two traditions have heavily incorporated ideas from each other. More specifically, without having to give up the Keynesian focus traditional sticky and imperfect competition in New Keynesian economics, elected to incorporate the insights of rational expectations, was developed as a response to new classical economics.

B.3 Chicago economists have also left their intellectual influence in other fields, notably in pioneering public choice theory and law and economics, which have led to revolutionary changes


in the study of political science and law. Other economists affiliated with Chicago have made their impact in fields as diverse as social economics and economic. Thus, there is not a clear delineation of the Chicago SoT, a terminology that is frequently used in the public and electronic and print media especially in educational groups. Nevertheless, the Chicago SoT is characterized mostly by Kaufman in 2010 in this way:

C. HISTORY OF CHICAGO SCHOOL OF THOUGHT

C.1 Major conceptual protector of traditional economics and capitalism, it has been one of the most influential bodies of economic thought in recent times. This monetarist school is connected with the economics department at the University of Chicago, especially during 1970s and particularly with professor (1948‐79) Milton Friedman (1912‐2006) who won Nobel Prize in economics in 1976 for his theory of normal rate of joblessness. His colleagues went on to win seven more Nobels, including George Stigler (1911‐91) in 1982 for deregulation theory, Merton Miller (1923‐) in 1990 for financial economics, Ronald Coase (1910‐) for Coase's theorem in 1991, Gary Becker (1930‐) for application of microeconomics to non‐market behavior in 1992, and Robert Lucas (1937‐) for the theory.

C.2 Its basic beliefs of this SoT are: (1) Free (open) markets are best allocate resources in an economy than any government,

(2) Market Failure is caused by the Monopolies that are created by government, attempt to

regulate an economy,

(3) Governments should avoid trying to manage aggregate demand and, instead,

(4) There should be a minimal government intervention (monopolies); economic freedom and free trade, tax cutting and tax reforms will serve and relief the market / economy in the best way.

(5) Should focus on maintaining a steady and low rate of growth of money supply.

(6) Inflation adjustment and inflation targeting in another main idea of this SoT.

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C.3 The hierarchy of various Economics SoT in chronological order from 1500 to 2010 can also be

shown in the following family tree of economics:



C.4 Most of the economics belief and have a consensus on the classification of various SoT that there are two major school of thoughts exist in society of economics one is Classical SoT and other is neo‐classical SoT, classical SoT initiate right from the Adam Smith era 1776 whereas Neo‐classical era start form 1930, whereas Chicago SoT is actually belong to the neoclassical school of thought. From 1950 till late 70s, Keynes' view and its theory were considered as the main factor in the economy, after that era, in late 1970, Friedrich Hayek's view that the state / government should have a minimum role in the economy and market, this thought got popularity in the world of business. This inspiration of F. A. Hayek's concepts and of the Chicago SoT was the real cause of end of Keynesian thoughts and Chicago SoT appears as a right wing of mainstream of economics. The classification of wings is given below:


D. MAIN IDEAS OF CHICAGO SoT:

D.1 As we have described earlier that the Chicago SoT strictly tracks the neoclassical price theory and libertarianism and they disbelieved the concept of Keynesianism, Chicago SoT more belief on the monetarism concept of Friedman's, and Robert Lucas’s rational expectations theory. It also disregards government laissez‐faire regulation of business, and dominant many ideas and approaches. The main ideas of this SoT are given below:

Free (open) markets are best allocate resources in an economy, There should be a minimal government intervention (monopolies); economic freedom and free trade, tax cutting and tax reforms will serve and relief the market / economy in the best way.

Inflation adjustment and inflation targeting in another main idea of this SoT. Monetarist of this SoT belief that supplies and demand of money must be kept in equilibrium in free market.

The ideology of Globalization and International trade / finance was come out in this era, in which Chicago SoT played an important contribution.

Privatization & marketization Variables like output and wages in macro‐economic should be considered collectively for the entire economy because both are interdependent to each other.

E. KEY ECONOMIST OF CHICAGO SoT:

E.1 Frank Knight: Frank Knight (1885–1972) was an early member of this SoT and one of the faculty members of University of Chicago department. Knight have a great contribution in macroeconomics and his has a most significant work was over “Risk, Uncertainty and Profit” in 1921 from which the term “Knightian uncertainty” was invented. Knight's perception was revolutionary, and noticeably different from later Chicago school thinkers. He believed on free market and less intervention of government that while the free market could be inefficient, government programs were even less efficient.

E.2 Ronald Coase: The Noble Prize‐winner, Ronald Coase (b. 1910) is the most projecting economic analyst of law and for this contribution he won this prize in 1991. His first article in 1937 “The Nature of the Firm”, argued that the existence of firms like companies, partnerships, etc. are the causes of the existence of transaction costs. Rational individuals trade through mutually agreed contracts on free markets until the costs of transactions mean that using corporations to produce things is more cost‐effective. Ronald has second major article is “The Problem of Social Cost” published in 1960, that argued if we lived without transaction costs, people in the world would bargain with one another to create the same allocation of resources, regardless of the way a court might rule in property disputes.


The base of this phenomenon was legal court case about nuisance named Sturges v Bridgman, filed in 1879 in London, in which a noisy sweet‐maker was functioning next to the quiet clinical activity place of a doctor; the doctor filed the case to court in search of an injunction against the noise produced by the sweet‐maker. Ronald Coase said that regardless of whether the judge ruled that the sweet maker had to stop using his machinery, or that the doctor had to put up with it, they could strike a mutually beneficial bargain that reaches the same outcome of resource distribution. Coase beliefs that the only one solution exist for prevention of this dispute that is transaction costs. The concept is that government legislation and regulation are not as essential or effective for helping people as lawyers and government planners believe. Coase and others like him wanted a change of approach, to put the burden of proof for positive effects on a government that was intervening in the market, by analyzing the costs of action.

E.3 George Stigler: George Stigler (1911–1991) was a follower of Frank Knight and worked on his thesis under the nose of Knight and developed “Economic Theory of Regulation”, also known as capture, and won the Nobel Prize in 1982. His theory says those interest groups and other political participants will use the regulatory and coercive powers of government to shape laws and regulations in a way that is beneficial to them. This theory is an important component of the Public Choice field of economics. Stigler also conducted an extensive research and study on the history of economic thought and published an article in 1962 of "Information in the Labor Market" that developed the theory of search unemployment.

E.4 Milton Friedman:

Milton Friedman (1912–2006) is one of the most influential economists of the late twentieth century in this SoT. He was also a student of Frank Knight along with above mentioned George; Friedman won the Nobel Prize in 1976 for his contribution in Economics. His article “A Monetary History of the United States” publicized in 1963 in which he emphasized that the Great Depression had been caused by the Federal Reserve's policies through the 1920s, and worsened in the 1930s. Friedman argued that laissez‐faire government policy is more desirable than government intervention in the economy. There is a famous slogan we usually use in daily life i,e. "money matters" associated with Friedman, but he had also leveled punitive criticism of his ideological opponents. Referring to Thorstein Veblen's assertion that economics unrealistically models people as "lightning calculator(s) of pleasure and pain", Friedman wrote.


E.5 Robert Fogel: Robert Fogel (b.1926), a co‐winner of the Nobel Prize in 1993 in the field of Economics, he has a lot of involvement by setting a new standards of Economics in which he is best known for his introduction of “New economic history”, “historical analysis”, “invention of cliometrics”, and “a notation system for quantitative data”. Fogel also set out to rebut systematically the idea that railroads contributed to economic growth in the 19th century by his two abstracts namely “Railroads and American Economic Growth: Essays in Econometric History”, and “Time on the Cross: The Economics of American Negro Slavery” in 1964 & 1974 respectively. He argued that slavery was morally wrong, but argues that it was not necessarily less efficient than wage‐labor, he proved analytically that before the American civil war, slaves in the Southern states of America had a higher standard of living than the industrial proletariat of the Northern states.

E.6 Gary Becker: Gary Becker (b. 1930) is best known for his work for applying economic methods of thinking to other fields of society such as sexual relationships, criminality, slavery and drugs, assuming that people act rationally. This value addition in Society of Economics and very well focused‐work on labor economic put him a Nobel Prize‐winner in 1992. There are some quotations that are named with Gary Becker, as stated bellow:

E.7 Richard Posner: Richard Posner (b. 1939) is basically a legal advisor and lawyer rather than an economist and is known primarily for his work in law and economics. Posner's main works is not only about corporations, contract, tort, labor law, but also detail discussion on criminal law, discrimination and family law. He attempts to apply rational choice models to areas of law, that reflect in “Economic Analysis of Law”. Posner goes so far as to say that: "{The central} meaning of justice, perhaps the most common is – efficiency… (Because) in a world of scarce resources waste should be regarded as immoral."


E.8 Robert E. Lucas: Robert Lucas (b. 1937), was another assert of Chicago SoT who got the Nobel Prize earlier in 1995. he was ranked consistently in top 10 great economist in research papers in the field of Economics. His contribution in Macroeconomics and its several tools / topics included asset pricing, economic growth, and monetary Economics. Lucas given the concept of integration of Micro & Macroeconomics, he belief that macroeconomics must not be considered as an isolated mode of thought from microeconomics, and that analysis in both should be built on the same foundations.

E.9 Eugene Fama:

Eugene Fama (b. 1939) is an American economist who is well identified as “the father of the hypothesis”, his theoretical and empirical work on “Random walk theory” as well as “Portfolio theory” give him a distinguish place in the world of economics. He has expended his entire teaching career at the University of Chicago. Fama is also famous for his Ph.D. thesis in 1965 "The Behavior of Stock Market Prices", he concluded that stock prices are unpredictable and uncertain and follow an unplanned walk pattern of movement. He solidified this idea in his 1970 article, "Efficient Capital Markets: A Review of Theory and Empirical Work", this concept of Price behavior of stock Market & efficient market latter caused the establishment of modern economic theory.

E.10 Friedrich August Hayek: Friedrich August Von Hayek, the Liberal economist usually known as F. A. Hayek was a major political thinker of the 20th century was the instructor of another area of study (committee of social thought) at Chicago University during 1950s and he had a little knowledgeable interaction with the economics department and he was not considered a Chicago School member but the Austrian School. Nevertheless he and Milton Friedman worked together to devoted the libertarian and democratic ideology. F. A. Hayek collectively got the Nobel Prize for his pioneering work with Gunnar Myrdal in “the theory of money and economic fluctuations” and “the interdependence theory of economic, social and institutional phenomena".

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F. KEY THEORIES / LAWS:

There are various theories developed under the umbrella of Chicago SoT. Some of them are described below:

S/N THEORY CONTRIBUTOR

1. Theory of natural rate of unemployment Milton Friedman (1912‐2006) in 1976

2. Deregulation theory George Stigler (1911‐91) in 1982

3. The economic theory of regulation George Stigler (1911–1991)

4. Quantity theory of money Milton Friedman (1912–2006)

5. Modern economic theory Eugene Fama (b. 1939)

6. Rational choice theory Gary Becker (b. 1930)

7. Modern public choice theory Knut Wicksell (1851 – 1926) in 1896

8. Game theory John von Neumann (1903 – 1957

9. Friedman's k‐percent rule Milton Friedman (1912–2006)

10. Efficient‐market hypothesis (EMH) Jules Regnault (1834 ‐1894),

Louis Bachelier, (1870 –1946)

11. Random walk theory Eugene Fama (b. 1939)

G. CONTRIBUTIONS / IMPACT OF THE SCHOOL IN THE SOCIETY:

The Chicago SoT strictly tracks the neoclassical price theory and libertarianism and they disbelieved the concept of Keynesianism, Chicago SoT more belief on the monetarism concept of Friedman's, and Robert Lucas’s rational expectations theory. It also disregards government laissez‐faire regulation of business, and dominant many ideas and approaches.

Milton Friedman, The most influential economist of Chicago SoT, who has more than 30 books on Monetary beliefs with his name, pressed specific initiative and emphasis on de‐regulation that is the key to economic success, that contained by three U. S. presidents Nixon, Reagan, Ford, and also encompassed by British prime minister Margaret Thatcher.


The economists Chicago SoT, Ronald Coase, G. Stigler, and J. M. Buchanan were the inventor of Political science and institutional theory, while in neoclassical economics; economic history was set by Robert Fogel.

Detailed economic interpretation on various sociological matters such as marriage, addiction, and family issues were given by Gary Becker. His most well‐known effort was “Path‐breaking analysis” of "human capital", who impact a lot to serve the society, in which he emphases on the government to expenditure on three important area, he said, "deals with expenditures on people for education, training, health & safety, that in a broad sense raise productivity."

Chicago SoT contribution was to demonstrate the market power, externalities, and the people choices, in “public policy” as well as in economic sciences. Chicago school also had a strong top management commitment and a lot of self‐confidence that we had the right concept for the well‐being of the society and the rest of the profession was wrong.

Economists of Chicago SoT had also left their intellectual impact not only in Economics but in other area of study, particularly on “Pioneering public choice theory” and law, which has given the direction to the ground‐breaking changes in the Law study and political science. Other economists affiliated with Chicago have made their impact in fields as diverse as social economics and economic history.

H. QUOTABLE QUOTATIONS:

H.1 Frank Knight:

H.2 Ronald Coase:


H.3 Milton Friedman:

H.4 Gary Becker:

H.5 Robert Lucas:

H.6 Eugene Fama:

H.7 Friedrich Hayek:


I. CONCLUSION:

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Chicago school of economic thought, Key Econimist of chicago School of thought