CAPIZ STATE UNIVERSITYMain Campus, Roxas City Graduate ProgramEDUC. 306 ECONOMICS OF EDUCATION

ARNIEL N. SOMILDR. LUCILA VIPINOSAEd. D. Student/Reporter Professor

ECONOMICS OF EDUCATION

Economics education or economic education is a field within economics that focuses on two main themes: 1) the current state of, and efforts to improve, the economics curriculum, materials and pedagogical techniques used to teach economics at all educational levels; and 2) research into the effectiveness of alternative instructional techniques in economics, the level of economic literacy of various groups, and factors that influence the level of economic literacy. Economics education is distinct from economics of education, which focuses on the economics of the institution of education.

Numerous organizations devote resources toward economics education. In the United States, organizations whose primary purpose is the advancement of economics education include the Council for Economic Education and its network of councils and centers, the Foundation for Teaching Economics and Junior Achievement. The U.S. National Center for Research in Economic Education is a resource for research and assessment in economics education. Among broader U.S. organizations that devote significant resources toward economics education is the Federal Reserve System. The Federal Reserve Bank of St. Louis has a website, EconLowdown http://www.stlouisfed.org/education_resources/ that includes free resources for teaching economics and personal finance in K-16 classes. These resources include online courses, videos, podcasts, lesson plans and more. In the United Kingdom there is The Economics Network, a government-funded national project to support economics education in Higher education contexts, and the non-profit Economics & Business Education Association (EBEA) for secondary education.

A. Keynesian Economics

Keynesian economics (/kenzin/ kayn-zee-n; or Keynesianism) is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.

The theories forming the basis of Keynesian economics were first presented by the British economist John Maynard Keynes in his book, The General Theory of Employment, Interest and Money, published in 1936, during the Great Depression. Keynes contrasted his approach to the aggregate supply-focused 'classical' economics that preceded his book. The interpretations of Keynes that followed are contentious and several schools of economic thought claim his legacy.

Keynesian economists often argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, in particular, monetary policy actions by the central bank and fiscal policy actions by the government, in order to stabilize output over the business cycle. Keynesian economics advocates a mixed economy predominantly private sector, but with a role for government intervention during recessions.

Keynesian economics served as the standard economic model in the developed nations during the later part of the Great Depression, World War II, and the post-war economic expansion (19451973), though it lost some influence following the oil shock and resulting stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused a resurgence in Keynesian thought.

Prior to the publication of Keynes's General Theory, mainstream economic thought held that a state of general equilibrium existed in the economy: because the needs of consumers are always greater than the capacity of the producers to satisfy those needs, everything that is produced will eventually be consumed once the appropriate price is found for it. This perception is reflected in Say's Law and in the writing of David Ricardo, which state that individuals produce so that they can either consume what they have manufactured or sell their output so that they can buy someone else's output. This argument rests upon the assumption that if a surplus of goods or services exists, they would naturally drop in price to the point where they would be consumed.

Keynes's theory overturned the mainstream thought of the time and brought about a greater awareness of structural inadequacies: problems such as unemployment, for example, are not viewed as a result of moral deficiencies like laziness, but rather result from imbalances in demand and whether the economy was expanding or contracting. Keynes argued that because there was no guarantee that the goods that individuals produce would be met with demand; unemployment was a natural consequence especially in the instance of an economy undergoing contraction.

He saw the economy as unable to maintain itself at full employment and believed that it was necessary for the government to step in and put under-utilized savings to work through government spending. Thus, according to Keynesian theory, some individually rational microeconomic-level actions such as not investing savings in the goods and services produced by the economy, if taken collectively by a large proportion of individuals and firms, can lead to outcomes wherein the economy operates below its potential output and growth rate.

Prior to Keynes, a situation in which aggregate demand for goods and services did not meet supply was referred to by classical economists as a general glut, although there was disagreement among them as to whether a general glut was possible. Keynes argued that when a glut occurred, it was the over-reaction of producers and the laying off of workers that led to a fall in demand and perpetuated the problem. Keynesians therefore advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. According to the theory, government spending can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation.

Theory

Keynes argued that the solution to the Great Depression was to stimulate the economy ("inducement to invest") through some combination of two approaches:

1) A reduction in interest rates (monetary policy), and 2) Government investment in infrastructure (fiscal policy).

By reducing the interest rate at which the central bank lends money to commercial banks, the government sends a signal to commercial banks that they should do the same for their customers.

Investment by government in infrastructure injects income into the economy by creating business opportunity, employment and demand and reversing the effects of the aforementioned imbalance. Governments source the funding for this expenditure by borrowing funds from the economy through the issue of government bonds, and because government spending exceeds the amount of tax income that the government receives, this creates a fiscal deficit.

A central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. This conclusion conflicts with economic approaches that assume a strong general tendency towards equilibrium. In the 'neoclassical synthesis', which combines Keynesian macro concepts with a micro foundation, the conditions of general equilibrium allow for price adjustment to eventually achieve this goal. More broadly, Keynes saw his theory as a general theory, in which utilization of resources could be high or low, whereas previous economics focused on the particular case of full utilization.

Concept

1. Wages and spending

During the Great Depression, the classical theory attributed mass unemployment to high and rigid real wages.

To Keynes, the determination of wages was more complicated. First, he argued that it is not real but nominal wages that are set in negotiations between employers and workers, as opposed to a barter relationship. Second, nominal wage cuts would be difficult to put into effect because of laws and wage contracts. Even classical economists admitted that these exist; unlike Keynes, they advocated abolishing minimum wages, unions, and long-term contracts, increasing labour market flexibility. However, to Keynes, people will resist nominal wage reductions, even without unions, until they see other wages falling and a general fall of prices.

Keynes rejected the idea that cutting wages would cure recessions. He examined the explanations for this idea and found them all faulty. He also considered the most likely consequences of cutting wages in recessions, under various different circumstances. He concluded that such wage cutting would be more likely to make recessions worse rather than better.

Further, if wages and prices were falling, people would start to expect them to fall. This could make the economy spiral downward as those who had money would simply wait as falling prices made it more valuable rather than spending. As Irving Fisher argued in 1933, in his Debt-Deflation Theory of Great Depressions, deflation (falling prices) can make a depression deeper as falling prices and wages made pre-existing nominal debts more valuable in real terms.

2. Excessive Saving

Classics on Saving and Investment.

To Keynes, excessive saving, i.e. saving beyond planned investment, was a serious problem, encouraging recession or even depression. Excessive saving results if investment falls, perhaps due to falling consumer demand, over-investment in earlier years, or pessimistic business expectations, and if saving does not immediately fall in step, the economy would decline.

Keynes had a complex argument against this laissez-faire response. First, saving does not fall much as interest rates fall, since the income and substitution effects of falling rates go in conflicting directions. Second, since planned fixed investment in plant and equipment is based mostly on long-term expectations of future profitability, that spending does not rise much as interest rates fall.

3. Keynes on Saving and Investment.

Third, Keynes argued that saving and investment are not the main determinants of interest rates, especially in the short run. Instead, the supply of and the demand for the stock of money determine interest rates in the short run. Neither changes quickly in response to excessive saving to allow fast interest-rate adjustment.

Finally, Keynes suggested that, because of fear of capital losses on assets besides money, there may be a "liquidity trap" setting a floor under which interest rates cannot fall. While in this trap, interest rates are so low that any increase in money supply will cause bond-holders (fearing rises in interest rates and hence capital losses on their bonds) to sell their bonds to attain money (liquidity).

This pile-up of unsold goods and materials encourages businesses to decrease both production and employment. This in turn lowers people's incomes and saving. For Keynes, the fall in income did most of the job by ending excessive saving and allowing the loanable funds market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a recession does so.

Whereas the classical economists assumed that the level of output and income was constant and given at any one time (except for short-lived deviations), Keynes saw this as the key variable that adjusted to equate saving and investment.

Finally, a recession undermines the business incentive to engage in fixed investment. With falling incomes and demand for products, the desired demand for factories and equipment (not to mention housing) will fall. This accelerator effect would shift the I line to the left again, a change not shown in the diagram above. This recreates the problem of excessive saving and encourages the recession to continue.

In sum, to Keynes there is interaction between excess supplies in different markets, as unemployment in labour markets encourages excessive saving and vice versa. Rather than prices adjusting to attain equilibrium, the main story is one of quantity adjustment allowing recessions and possible attainment of underemployment equilibrium.

Active Fiscal Policy

1. Typical intervention strategies under different conditions

Classical economists have traditionally advocated balanced government budgets. Keynesians, on the other hand, believe that it is entirely legitimate and appropriate for governments to incur expenditure in excess of taxation revenues during periods of economic stagnation such as the Great Depression, which dominated economic life at the time he was developing and publicising his theories.

Contrary to some critical characterizations of it, Keynesianism does not consist solely of deficit spending. Keynesianism recommends counter-cyclical policies. An example of a counter-cyclical policy is raising taxes to cool the economy and to prevent inflation when there is abundant demand-side growth, and engaging in deficit spending on labour-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. Classical economics, on the other hand, argues that one should cut taxes when there are budget surpluses, and cut spending or, less likely, increase taxes during economic downturns.

Keynes's ideas influenced Franklin D. Roosevelt's view that insufficient buying-power caused the Depression. During his presidency, Roosevelt adopted some aspects of Keynesian economics, especially after 1937, when, in the depths of the Depression, the United States suffered from recession yet again following fiscal contraction. But to many the true success of Keynesian policy can be seen at the onset of World War II, which provided a kick to the world economy, removed uncertainty, and forced the rebuilding of destroyed capital. Keynesian ideas became almost official in social-democratic Europe after the war and in the U.S. in the 1960s.

Keynes developed a theory which suggested that active government policy could be effective in managing the economy. Rather than seeing unbalanced government budgets as wrong, Keynes advocated what has been called countercyclical fiscal policies, that is, policies that acted against the tide of the business cycle: deficit spending when a nation's economy suffers from recession or when recovery is long-delayed and unemployment is persistently high and the suppression of inflation in boom times by either increasing taxes or cutting back on government outlays. He argued that governments should solve problems in the short run rather than waiting for market forces to do it in the long run, because, "in the long run, we are all dead."

The Keynesian response is that such fiscal policy is appropriate only when unemployment is persistently high, above the non-accelerating inflation rate of unemployment (NAIRU). In that case, crowding out is minimal. Further, private investment can be "crowded in": Fiscal stimulus raises the market for business output, raising cash flow and profitability, spurring business optimism. To Keynes, this accelerator effect meant that government and business could be complements rather than substitutes in this situation.

Second, as the stimulus occurs, gross domestic product rises, raising the amount of saving, helping to finance the increase in fixed investment. Finally, government outlays need not always be wasteful: government investment in public goods that will not be provided by profit-seekers will encourage the private sector's growth. That is, government spending on such things as basic research, public health, education, and infrastructure could help the long-term growth of potential output.

2. "Multiplier effect" and Interest Rates

Two aspects of Keynes's model has implications for policy:

First, there is the "Keynesian multiplier", first developed by Richard F. Kahn in 1931. Exogenous increases in spending, such as an increase in government outlays, increases total spending by a multiple of that increase. A government could stimulate a great deal of new production with a modest outlay if:

The people who receive this money then spend most on consumption goods and save the rest. This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase in consumer spending.

This process continues. At each step, the increase in spending is smaller than in the previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium. This story is modified and moderated if we move beyond a "closed economy" and bring in the role of taxation: The rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect.

Second, Keynes re-analyzed the effect of the interest rate on investment. In the classical model, the supply of funds (saving) determines the amount of fixed business investment. That is, under the classical model, since all savings are placed in banks, and all business investors in need of borrowed funds go to banks, the amount of savings determines the amount that is available to invest. Under Keynes's model, the amount of investment is determined independently by long-term profit expectations and, to a lesser extent, the interest rate. The latter opens the possibility of regulating the economy through money supply changes, via monetary policy. Under conditions such as the Great Depression, Keynes argued that this approach would be relatively ineffective compared to fiscal policy. But, during more "normal" times, monetary expansion can stimulate the economy.

B. Post-Keynesian

Post-Keynesian economics is a school of economic thought with its origins in The General Theory of John Maynard Keynes, although its subsequent development was influenced to a large degree by Micha Kalecki, Joan Robinson, Nicholas Kaldor, Paul Davidson and Piero Sraffa. Keynes's biographer Lord Skidelsky writes that the post-Keynesian school has remained closest to the spirit of Keynes's own work.

The term post-Keynesian was first used to refer to a distinct school of economic thought by Eichner and Kregel (1975) and by the establishment of the Journal of Post Keynesian Economics in 1978. Prior to 1975, and occasionally in more recent work, post-Keynesian could simply mean economics carried out after 1936, the date of Keynes's The General Theory.

Post-Keynesian economics can be seen as an attempt to rebuild economic theory in the light of Keynes's ideas and insights. However even in the early years post-Keynesians such as Joan Robinson sought to distance themselves from Keynes himself and much current post-Keynesian thought cannot be found in Keynes. Some Post Keynesians took an even more progressive view than Keynes with greater emphases on worker friendly policies and re-distribution. Robinson, Paul Davidson and Hyman Minsky were notable for emphasizing the effects on the economy of the practical differences between different types of investments in contrast to Keynes' more abstract treatment.

The theoretical foundation of post-Keynesian economics is the principle of effective demand, that demand matters in the long as well as the short run, so that a competitive market economy has no natural or automatic tendency towards full employment. Contrary to the views of New Keynesian economists working in the neo-classical tradition, post-Keynesians do not accept that the theoretical basis of the market failure to provide full employment is rigid or sticky prices or wages. Post-Keynesians typically reject the IS/LM model of John Hicks, which was very influential in neo-Keynesian economics.

The contribution of post-Keynesian economics has extended beyond the theory of aggregate employment to theories of income distribution, growth, trade and development in which money demand plays a key role, whereas in neoclassical economics these are determined by the real forces of technology, preferences and endowment. In the field of monetary theory, post-Keynesian economists were among the first to emphasize that the money supply responds to the demand for bank credit, so that the central bank cannot control the quantity of money, but only manage the interest rate by managing the quantity of monetary reserves.

C. Neoclassical Economics

Neoclassical economics is a set of approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand. This determination is often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits by firms facing production costs and employing available information and factors of production, in accordance with rational choice theory.

Neoclassical economics dominates microeconomics, and together with Keynesian economics forms the neoclassical synthesis which dominates mainstream economics today. Although neoclassical economics has gained widespread acceptance by contemporary economists, there have been many critiques of neoclassical economics, often incorporated into newer versions of neoclassical theory.

The term was originally introduced by Thorstein Veblen in his 1900 article 'Preconceptions of Economic Science', in which he related marginalists in the tradition of Alfred Marshall et al. to those in the Austrian School.

"No attempt will here be made even to pass a verdict on the relative claims of the recognized two or three main "schools" of theory, beyond the somewhat obvious finding that, for the purpose in hand, the so-called Austrian school is scarcely distinguishable from the neo-classical, unless it be in the different distribution of emphasis. The divergence between the modernized classical views, on the one hand, and the historical and Marxist schools, on the other hand, is wider, so much so, indeed, as to bar out a consideration of the postulates of the latter under the same head of inquiry with the former." Veblen

Neoclassical economics is characterized by several assumptions common to many schools of economic thought. There is not a complete agreement on what is meant by neoclassical economics, and the result is a wide range of neoclassical approaches to various problem areas and domains - ranging from neoclassical theories of labor to neoclassical theories of demographic changes.

Three central Assumptions

It was expressed by E. Roy Weintraub that neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches:

1. People have rational preferences between outcomes that can be identified and associated with values.2. Individuals maximize utility and firms maximize profits.3. People act independently on the basis of full and relevant information.From these three assumptions, neoclassical economists have built a structure to understand the allocation of scarce resources among alternative ends - in fact understanding such allocation is often considered the definition of economics to neoclassical theorists. Here's how William Stanley Jevons presented "the problem of Economics".

"Given, a certain population, with various needs and powers of production, in possession of certain lands and other sources of material: required, the mode of employing their labour which will maximize the utility of their produce."

Market supply and demand are aggregated across firms and individuals. Their interactions determine equilibrium output and price. The market supply and demand for each factor of production is derived analogously to those for market final output to determine equilibrium income and the income distribution. Factor demand incorporates the marginal-productivity relationship of that factor in the output market.

Neoclassical economics emphasizes equilibria, where equilibria are the solutions of agent maximization problems. Regularities in economies are explained by methodological individualism, the position that economic phenomena can be explained by aggregating over the behavior of agents. The emphasis is on microeconomics. Institutions, which might be considered as prior to and conditioning individual behavior, are de-emphasized. Economic subjectivism accompanies these emphases.

The third step from political economy to economics was the introduction of marginalism and the proposition that economic actors made decisions based on margins. For example, a person decides to buy a second sandwich based on how full he or she is after the first one, a firm hires a new employee based on the expected increase in profits the employee will bring. This differs from the aggregate decision making of classical political economy in that it explains how vital goods such as water can be cheap, while luxuries can be expensive.

The Marginal Revolution

The change in economic theory from classical to neoclassical economics has been called the 'marginal revolution', although it has been argued that the process was slower than the term suggests. It is frequently dated from William Stanley Jevons's Theory of Political Economy (1871), Carl Menger's Principles of Economics (1871), and Lon Walras's Elements of Pure Economics (18741877). Historians of economics and economists have debated:

Whether utility or marginalism was more essential to this revolution (whether the noun or the adjective in the phrase "marginal utility" is more important)

Whether there was a revolutionary change of thought or merely a gradual development and change of emphasis from their predecessors.

Whether grouping these economists together disguises differences more important than their similarities.

Alfred Marshall's textbook, Principles of Economics (1890), was the dominant textbook in England a generation later. Marshall's influence extended elsewhere; Italians would compliment Maffeo Pantaleoni by calling him the "Marshall of Italy". Marshall thought classical economics attempted to explain prices by the cost of production. He asserted that earlier marginalists went too far in correcting this imbalance by overemphasizing utility and demand. Marshall thought that "We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production".Marshall explained price by the intersection of supply and demand curves. The introduction of different market "periods" was an important innovation of Marshalls:

Market period. The goods produced for sale on the market are taken as given data, e.g. in a fish market. Prices quickly adjust to clear markets.

Short period. Industrial capacity is taken as given. The level of output, the level of employment, the inputs of raw materials, and prices fluctuate to equate marginal cost and marginal revenue, where profits are maximized. Economic rents exist in short period equilibrium for fixed factors, and the rate of profit is not equated across sectors.

Long period. The stock of capital goods, such as factories and machines, is not taken as given. Profit-maximizing equilibria determine both industrial capacity and the level at which it is operated.

Very long period. Technology, population trends, habits and customs are not taken as given, but allowed to vary in very long period models.

Marshall took supply and demand as stable functions and extended supply and demand explanations of prices to all runs. He argued supply was easier to vary in longer runs, and thus became a more important determinant of price in the very long run.

Neoclassical economics is sometimes criticized for having a normative bias. In this view, it does not focus on explaining actual economies, but instead on describing a "utopia" in which Pareto optimality applies.

The assumption that individuals act rationally may be viewed as ignoring important aspects of human behavior. Many see the "economic man" as being quite different from real people. Many economists, even contemporaries, have criticized this model of economic man. Thorstein Veblen put it most sardonically. Neoclassical economics assumes a person to be,

"A lightning calculator of pleasures and pains, who oscillates like a homogeneous globule of desire of happiness under the impulse of stimuli that shift about the area, but leave him intact."

Neoclassical economics is also often seen as relying too heavily on complex mathematical models, such as those used in general equilibrium theory, without enough regard to whether these actually describe the real economy. Many see an attempt to model a system as complex as a modern economy by a mathematical model as unrealistic and doomed to failure. A famous answer to this criticism is Milton Friedman's claim that theories should be judged by their ability to predict events rather than by the realism of their assumptions. Mathematical models also include those in game theory, linear programming, and econometrics. Critics of neoclassical economics are divided into those who think that highly mathematical method is inherently wrong and those who think that mathematical method is potentially good even if contemporary methods have problems.

In general, allegedly overly unrealistic assumptions are one of the most common criticisms towards neoclassical economics. It is fair to say that many (but not all) of these criticisms can only be directed towards a subset of the neoclassical models (for example, there are many neoclassical models where unregulated markets fail to achieve Pareto-optimality and there has recently been an increased interest in modeling non-rational decision making).

9