B.  Examples of Neoclassical Theory
C.  Sample Problems
D.  Criticisms of Neoclassical Theory
E.  Summary

Step 2:  Find a solution equation in which a single unknown variable (such as Price) is defined only in terms of the slopes and intercepts defining all the other variables.

Let capital letters represent the size or magnitudes of those things which vary in size,
such as variables for Price and Quantities demanded & supplied.

Let lowercase letters represent the slopes and intercepts (or parameters and constants) of linear demand and supply curves. 

(Letters a and c are intercepts along the horizontal axis; letters b and e are the slopes of demand and supply curves respectively.)  Then

Equation 1 is  D = a – b P is a linear demand curve.

Equation 2 is  S = c + e P is a linear supply curve.

D is quantity demanded; S is quantity supplied; and P is price.


 

Recognize that forces underlying demand and supply produce an equilibrium price and an equilibrium quantity if Equations 1 and 2 are set equal to one another.

Setting the right sides of equations 1 and 2 equal to each other says that:    a – bP = c + eP.
Collecting the intercepts on the left-side and adding bP to both sides says that:   a – c = bP + eP
Factoring P from the right-side leads to a – c = P(b + e)
Dividing both sides by (b + e) results in:

a – c = P                          This is how you find equilibrium price!
 b + e

Note that a variable P has been defined soley in terms of slopes and intercepts, all known values.  Therefore we can write that

 a – c_ = P*                 This is called an equilibrium solution.
 b + e

 

Said differently, equilibrium price is “the difference in the intercepts divided by the sum of the slopes”.

You always get the right answer when you know the intercepts “a” and “c,” and the slopes “b” and “e.”  Your Excel spreadsheet can easily find equilibrium price within a marketplace, given appropriate meta-assumptions and data, and you can earn an “A” letter grade.

Neoclassical economics produces precisely calculated results.

Neoclassical econ makes (1) profs scientific, and (2) students happy!

 

Principle:  The value of labor’s marginal product (VMP) determines the extent to which businessmen hire workers.

Definition:  VMP, the value of hiring one more worker, equals the price of the final product multiplied the number of products that worker adds to the total.

Example:  Weed Your Garden Using Gerry’s Weed-wackers

Gerry pays her weed-wackers $40 per day.  The market for her services has many buyers and sellers.  Gerry charges you $20 to weed your garden.  The table shows how many gardens can be weeded by hiring workers:

     1.  Find the marginal product of the third worker.
Solution:  Since 2 workers weed 7 gardens and 3 workers week 14 gardens, the 3^rd worker’s marginal product was
14-7 = 7 additional gardens.

2.  Find the VMP of the third worker.
Solution: A weeded garden adds $20 to Gerry’s revenues.
So the third worker’s VMP is 7 gardens X $20 = $140. 

3.     Complete the table of marginal products added by each worker.

     Solution:

4.  What is the VMP of each worker:

Solution: Multiply the marginal product of each worker by the price of weeded garden.

 5.  How many workers will Gerry hire so as to maximize profits?

Solution:  Hire workers until their VMP no longer exceeds their wage rate.

Do not hire the 6^th worker because that worker adds more to costs than his or her value of marginal product adds to the firm’s revenues.

6.  What are Gerry’s total revenues, total costs, and profits associated with hiring each worker?

Solution:

6.  Did hiring until the declining VMP (value added to the firm’s revenues) equaled the wage rate produce the same maximum profit found by subtracting total costs from total revenues?

Solution: Yes.  Gerry hired five workers, knowing that the demand for labor, known as “value of marginal product” when set equal to wage rate maximizes profit.

Subtracting total costs from total revenues also produced maximum profit when five workers were hired.

Neoclassical economics produces precisely calculated results.

Neoclassical econ makes (1) profs scientific, and (2) students happy!

 

Examine the following Wed., March 29, 2006  WSJ article
“Labor Law Ignites French Anxiety” pages A1 and A8:

    France’s most famous period of violent protests in 1968 saw students rioting against what they saw as a rigid and smothering state.  Today, it seems, they want the state back.  Serge July, director of France’s main left-of-center newspaper, Liberation, and a ’68 veteran, says his country is gripped by “anguish about the future.”  It is also suffering from, he says, a “crisis of identity.”
    According to a recent poll, France is the only country among 20 surveyed where those who didn’t have faith in the free market outnumber those who do.  Only 36% of those polled in France agreed with the proposition that the free market is the “best system on which to base the future of the world” – compared with 71% in the U.S., 66% in Britain and 65% in Germany.  In nominally communist China, 74% said they favored the free market, according to the University of Maryland’s Program on International Policy Attitudes.
    Police put the number of protestors yesterday across France at 1.05 million, more than twice as many as the previous biggest protest on march 16.    Trade unions, which organized the rallies, put the figure at three million.  A one-day strike to coincide with the protest disrupted hospitals, schools, rail services and air traffic, halted delivery of newspapers, dented production at France’s biggest oil refinery and shut down the Eiffel Tower.
…  students and anti-globalization activists took down a statue of Jean Jares, a former socialist leader, saying they wanted to mourn the rise of capitalism.”

So what’s the brew-ha-ha all about?

According to the new law, a student’s “first job contract, ” known by its French acronym CPE, will lower unemployment, which stands at 9.6% for the population as a whole, and around 23% for young people.  It allows employers to fire workers under the age of 26 without explanation during a two-year period of probation.  The CPE would replace a complicated system that makes it hard to dismiss workers without big payoffs or expensive legal battles.”
  

Analysis (and criticisms of neo-classical theory):

- Employment in one’s first job in France is not governed by economic theory.  In France, one is protected from being fired in one’s first job by expensive lawsuits and big payoffs.  (This is good for workers, but bad for businessmen.)  Protected marketplaces in labor markets are not supposed to exist in neoclassical theory.

- Students are not acting irrationally in protesting the new law.  Businessmen are not irrational in upholding the new law.  Such behavior is consistent with  neoclassical theory.

 - However, students are acting out as a group, rather than as individuals.  And businessmen are seeing their interests protected, as a group, rather than as individuals.  (This conflicts with neoclassical meta-assumptions.)

- Interestingly, the data suggest a degree of non-uniformity among countries regarding use free market economic principles.  Even China purports to support the free market more than the French, the U.S., the Germans, etc.  (This conflicts with neoclassical meta-assumptions.)  Data gathering introduces dirt into otherwise well-functioning economic models.

- Wages are rarely set by inspecting declining VMP curves, because such curves are often too difficult to measure.  What, for example, governs the wages of economics professors?  Probably, what they can earn at an alternative school.  Said differently, schools may adjust hiring salaries so that professors can be bid away from their existing job positions when necessary.

 - The models I’ve shown you are static models; they lack the quality and the insight that dynamic models might better reveal.  Click dynamic models (or see the next page) for a related example.

How to Ride a Bicycle (that doesn’t move)
by Using a Static Model

Rule #1:  Without moving the bicycle, sit upright, keeping your weight exactly over the precise center of the bicycle until you can do so without falling over. 

Rule #2:  Practice that often.  You could probably master that skill within a month.

 Question:  Does a static model really teach a child how to ride a bicycle?

What Insights a Dynamic Model of Bicycling Reveals

Suppose you now begin rolling forward on your bicycle.  Everything will work fine, unless you try to turn by moving the handlebars.

 By following Rule #1, when you turn the handlebars, you are now going to fall over.  That’s because centripetal forces were zero when the bicycle was stationary.  Centripetal and centrifugal forces are not zero when a wheel is in motion.

Using a dynamic model, you will find that riding a bicycle requires you to unlearn Rule #1 and Rule #2.

Rule #3 is to practice leaning into the turn.

 

Models are things of beauty, and they tell you about how things are supposed to work.

Neoclassical models describe static conditions.

1.  Supply and demand are neoclassical models.

2.  Labor is hired until its VMP no longer exceeds its wage rate.

3.  Not all behavior is rational.

4.  People may act in groups rather than independently.

5.  Societies may not believe in the importance of free market principles.

6.  Full and relevant information is not always widely available.

Neoclassical economics produces precisely calculated results.

Neoclassical econ makes (1) profs scientific, and (2) students happy!

Thank you for inviting me to speak about …

The Demand Curve for Labor:
Neoclassical Theory and Its Critics  

Tom Meyer