General Equilibrium Analysis and Public Policy

Abstract

It is the intention in this paper to conduct an inquiry into the relations between general equilibrium analysis and public policy by the indirect method of examining the place of such analysis in the solution of a definite economic problem. The problem selected is the possibility of raising wages without raising prices. Traditional partial equilibrium theory made the solution of this problem a fairly simple one, but modern general equilibrium considerations, dynamic qualifications on these, and institutional changes in the organization of business and labour have opened up such areas of indeterminateness in the formation of prices that we may no longer trust the answers given by the simpler generalizations.In the development of ideas during this paper, the term “degree of monopoly” will be employed rather frequently. The term will be used in Professor Lerner's sense of the ratio between the excess of price over marginal cost and price itself. In terms of Figure 1, this is the ratio RP/MP. This definition has limitations but it is retained as the simplest to which analysis may be referred and sufficient for the particular purposes for which it is required here.The idea that the rise of wages in relation to prices may have consequences for the levels of employment and national income is, of course, based upon the Keynesian hypothesis that larger wage incomes in relation to national income as a whole tend to mean a lower level of savings, and the corollary that a lower level of net new investment will be needed to maintain a given level of employment and income where the wage share is higher. There is also some opinion that changes in the degree of monopoly during the business cycle are such as to aggravate the operation of the disequilibrating forces. For example, Dr. M. Kalecki in an article published in Econometrica in April, 1938, suggests that the Keynesian analysis respecting the relation between wages and prices requires emendation and expansion because it appears from his statistical and theoretical analysis that the degree of monopoly increases with recessions of the business cycle and decreases with its upward phase. If this be so, Dr. Kalecki points out that the cyclical redistribution of income carries with it the necessity of attaching a larger quantity of new investment to any given level of national income as the level of national income recedes, though this reasoning is qualified for effects of falling wages on the foreign balance.