[no subject]

[Paul Davidson <PB108928%UTKVM1.BITNET@xxxxxxxxxxxxxxxxx>]

FROM:  Paul Davidson
*** Resending note of 03/03/94 14:24
Date:         Thu, 03 Mar 94 14:23:17 LCL
From:         PB108928@UTKVM1
To:           pb108928@utkvm1


March 2, 1994
From: Paul Davidson in response to Peter Skott's request

In a personal email note Peter Skott has asked me to respond to
Skott's 17 February posting to pkt on his interpretation of the
Davidson - Devine dispute and Skott's suggestion for a consensus.
In essence Skott states that firms -- whether in perfect or
imperfect competition -- pick a point on their conjectured demand
curve to determine how much to produced and how much to hire
(assumption 1) -- while for simplicity profit maximization is
assumed; and (assumption 2) these short-run sales expectations of
entrepreneurs are fulfilled. (I interpret Skott as suggesting that
assumption 2 implies that the conjectured demand curve and the
realized demand curve coincide.)

     Skott claims that Davidson states that assumptions 1 and 2
holds in Keynes "and more importantly that any sensible theory of
short run equilibrium should incorporate both assumptions. The two
assumptions together provide the supply side of Marshall's
scissor".

     Skott then goes on to characterize Devine's position as
denying either assumption 1 or assumption 2 -- but Skott hopes that
Devine is denying only 2 because assumption 1 "is pretty solid".
I do not know if Devine really is denying only 2; I suspect that
sometimes Devine is denying only 2, other times denying both 1 and
2, and at other times accepting both 1 and 2-- as long as we limit
the discussion to imperfect competition.

     I think Skott has over simplified my approach to what Keynes
said ( e.g., Skott does not nail down the entrepreneurs' state of
expectations) - but it is at least a respectable starting point for
an useful dialogue so I will accept it as a first approximation to
my view of Keynes.

     I have suggested (in my previous discussion on pkt) that there
needs to be some assumption regarding what motivates entrepreneurs
to explain how they reach their output and employment hiring
decision. As Davidson and Smolensky showed one can construct an
aggregate supply function (conditions) on other than profit
maximizing assumption, e.g., one can derive an aggregate supply
function  if one prefers sales maximization-minimum profit
constraint entrepreneurial motivation; or target return pricing
entrepreneurial behavior, etc. (Of course, these alternative
hypothesis of entrepreneurial behavior were not popular during
Keynes's time -- so his analysis did assuming profit motivated
entrepreneurs -- which was the standard assumption at that time.)

     Moreover, Keynes ASSOCIATED the point of effective demand with
an equilibrium position -- hence must have assumed -- at least -
- short term expectations of entrepreneurs would be ASSOCIATED with
the point of effective demand.

      Now I must be careful not to ruffle feathers -- so I am using
Skott's characterization of the difference between Devine and
Davidson. (Please Jim do not accuse me of making this
distinction!!<G>) Skott implies that Devine throws away the
association of the point of effective demand with short-term
equilibrium. Then the question is "how do firms react" when the
market demand realized is not the same as the demand conjectured?
Skott puts the following words into Jim's mouth: "firms choose to
react primarily through quantity adjustments".

     But the question first should be: Can the point of effective
demand differ from a Marshallian short-run FLOW-SUPPLY PRICE
equilibrium? Second, if actual demand differs from expected demand
how do entrepreneurs react to disappointed expectations? (For
example, what is the elasticity of expectations assumed? Is the
unwanted inventory durable or non-durable? What is the carrying
cost of unplanned inventory? How many periods (i.e., how much
calendar time do entrepreneurs think) will have to pass before the
existing redundancy of entrepreneurial inventory can be worked
off?)

Skott has Jim conflating the first and second questions of the
previous paragraph. I hope Jim is smart enough not to have made
that problem for himself -- for if he had then there is no logical
system that contain the imagination of such an analyst. (Hint: In
microeconomics what does it mean to say that actual demand is not
a point on the Marshallian demand curve, or is not described by the
demand equations of a Walrasian system? What then do we mean by
demand as a schedule indicating buyers behavior when confronted
with different (relative)prices AND INCOMES? Please do not respond
by saying that such Marshallian and/or Walrasian tools are useless,
or we have no common dialect at all.)

     If firms have made an error in their expectations of the
market demand function, then how do they react? To say that they
are "quantity constrained" is to make the classical error of
assuming that if, in the aggregate, firms react by reducing output
and employment, the resulting fall in  income does NOT alter the
(original) realized (or actual) market demand curve. In other
words, a reduction in employment as a result of an initial
shortfall in demand relative to supply does not induce any further
reduction in aggregate demand. (Dear me, whatever happened to the
Keynesian multiplier?)

     But if demand does fall as employment declines, then won't
this require a further reduction in employment that leads to
additional declines in the quantity demanded until the point of
effective demand is reached?

     Moreover, if production is storable will not the excessive
(unplanned inventory) require entrepreneurs to reduce employment
by more than is necessary to supply the (presumed) fixed "quantity
demand" constraint.  Now to respond to the question of inventory
overhang, one must go to Keynes's "user cost" analysis of Chapter
6 and introduce that into the system. [The result is a more complex
system -- but Sidney Weintraub has the key in his 1949 book on
PRICE THEORY and I have attempted to use this user cost analysis
on several occasions in the 1960s and later (e.g., AER 1963). I
would hope we need not cloud the argument with  the user cost
analysis -- as Keynes tried to do by relegating it to an appendix.
When we get to the nitty-gritty of Devine's "empirical" facts,
however, then we will have to delve into whether the excess
production is durable or not and what the cost of maintaining and
carrying inventory is relative to selling the product at a SPOT
price that may even be below the unit costs of production.  All of
this was developed by Keynes in Chapter 17, by Kaldor in his
1939 article on "Speculation and Economic Activity" by Davidson in
Chapter 4 of MONEY AND THE REAL WORLD and by Davidson in my
forthcoming book POST KEYNESIAN MACROECONOMIC THEORY. In any case,
the belief that the market price always equals a constant mark-up
on unit costs can not be maintained if one throws out the notion
that one is explaining a short-period equilibrium.]

     In sum, if Skott's characterization of Devine's position is
that he is at a minimum rejecting the usefulness of the notion of
short-period equilibrium  while maintaining that market prices area
constant mark-up over unit costs, then the resulting  analysis is
"the most frightful muddles possible".  As Keynes once
characterized Hayek, such an approach  would be "an extraordinary
example of how, starting from a mistake ... [one] can end up in
Bedlam". (Remember please I am saying this about Skott's
representation of what Skott believes Jim's position is. I do not
necessarily agree with Skott's characterization of Devine's
position. I have not tried to characterized Devine's position.]