The annual Summer School in Economics at HU was directed until last year by Kenneth Arrow, along with Eyal Winter. Arrow decided this year to step down as a director and Eric Maskin is replacing him. The 2008 Summer School was devoted to Arrow’s economics. The list of speakers was quite impressive, with six lecturers who are Nobel Laureates. (Our local Institute for Advanced Study runs five schools every year, in Physics, Economics, Life Sciences, Jewish Studies, and Mathematics.)
Economic puzzles told by Arrow
Let me tell you about three economics puzzles mentioned by Arrow in an earlier summer school. I doublechecked some details with Arrow himself; still, if my description contains errors I will be happy to be corrected. (Arrow spent a considerable amount of time talking with the workshop students. Another remarkable thing about him: he takes lecture notes! Is it a good idea to take detailed lecture notes at lectures? Let’s return to this question sometime.)
Puzzle 1: Why is there unemployment?
Why is this even a puzzle? Because the economics teaching that “the market will clear” means that all people who can work will. A person who can work and is not working represents inefficiency, which is not supposed to exist in a competitive economy. Part of the issue is referred to as “friction” and accounts for economics processes being slow rather than instantaneous. But it appears to be true that there is more to unemployment than that. What can explain the 30% unemployment that was witnessed in the US in the 1930s?
Is this puzzle a scientific problem? You bet it is! And it is a fairly clear-cut scientific problem. I suppose there are several answers to this puzzle in the literature but we are far from a definite understanding of the issue.
Puzzle 2: What is the reason for high volatility of prices in markets, say in stock markets?
The price of a stock, according to economics theory, represents the long-term value of the company. What accounts for the fact that the overall value of the entire stock market may fluctuate by more than 1% on a typical day? What accounts for fluctuations (more often drops) of 3-5% in one day? (Such fluctuations are not rare.) A famous question is to explain the one-day drop of 20% in October 1987. Continue reading