This article will criticize the Neoclassical School for hypocrisy and provide an improved definition of the long run and short run in economics.
In the Neoclassical School of economics there exist two foundational ideas which have an important characteristic in common. The two ideas are the natural rate of unemployment and potential output, which is also referred to as the natural rate of output or natural GDP. The thing that these two ideas hold in common is that they are tautologies built on the logic of the long run in economics rather than an empirical model.
This is Neoclassical as Milton Friedman of the Chicago School was a major developer of the idea of the natural rate of unemployment and the Chicago School is considered Neoclassical.
The general principle, which we might call Natural Economic Theory, is that economic parameters will converge to certain values in the long run. These long run values are essentially unchangeable by any means.
This is very consistent with Classical Economics. In fact, Milton may have gotten his idea of natural values directly from the Classical School, where a very old idea called a natural price is essentially the expected price in a free market. This was contrasted with the market price demonstrating a de facto assumption that the observed market is not a free market.
Notably, the natural price idea is at once both related to and different from the ideas I would consider Natural Economic Theory. It is related in that the natural price is the price expected in a free market, and the idea behind Natural Economic Theory is that the economy will become a free market in general equilibrium in the long run. However, the natural price is the expected free market price right now, in the short run. The new natural price, the natural price under my extension of Friedman’s ideas, is the long run free market price.
Both the natural price and new natural price are intrinsic value arguments in subtly different ways. The intrinsic value of a good is equal to the present value of the new natural price of the good. One important hypothesis of mine is that in the long run, the price of any good is 0. This hypothesis would be interesting to test as it would at once both confirm the logic of intrinsic value while also setting that value equal to 0.
The point is that Natural Economic Theory, which is a little-discussed but important idea in Neoclassical Economics, is tautological. It says “the unemployment rate in the long run will be the unemployment rate in the long run.” There are various assumptions and meanings behind this statement such as the idea of a free market in the long run, the idea of convergence, the idea that these parameters are unchanging, and so on, but the basic working of Natural Economic Theory is tautologically based logical reasoning.
It is stated here that the natural rate of unemployment has never been used in a standard supply and demand model. It has been supposedly used in defeating the Phillips Curve, but the Phillips Curve itself is a logical construct rather than an empirical one. It has been shown empirically that a single-cycle Phillips Curve doesn’t work. Proponents tried to patch up the theory by claiming that a secondary Phillips Curve cycle can begin mid-cycle of another curve. The problem is that with enough Phillips Curves running into each other at varying times and angles, any curve can be reproduced! So the Phillips Curve is not empirically acceptable or falsifiable. It is a logical construct.
Consider the stark hypocrisy of a practitioner of Natural Economic Theory criticizing the Austrian School for use of logical means with little empirical work. I would also point out that Austrians do empirical work, opposite what their critics and even some of their proponents say. Austrians conduct historical analysis which is a kind of empirical work.
I would also like to improve on the definition of the long and short runs in economics. Currently, the long run is “the conceptual time period in which there are no fixed factors of production.” The short run is where, “some factors are variable and others are fixed, constraining entry or exit from an industry.”
I think we should use the following 5-step time scale:
- The very short run describes the period of time where all factors of production are fixed.
- The short run describes the time period where some specified factor of production is fixed in quantity demanded, quantity supplied, or price.
- The medium run is the period of time between the long and short runs. In other words, factors adjust, but the economy is not in general equilibrium.
- The long run occurs as time approaches infinite. It is a limit in Calculus, not an actual date or time. Many notable things happen in an economy as time approaches infinite, but these notable things do not define the long run. This has sometimes been called the very long run (example 1, example 2).
Notably, none of these contain specific timelines. They also collectively map out all of time without any gaps. I would argue that they are also much more theoretically useful and precise.
A critic would argue that these are not practical definitions. The long run ends as time approaches infinite and the very short run begins at the current time, but these two are the closest to a real-world time frame as we can get without specifying the production function and economy in question.
This is on purpose. Factors of production behave heterogeneously. While an average may be calculable across an economy it will be at once both difficult to calculate and also extremely practically limited. It might be a nice tool for the Fed or Congress, but for the businessman it will be at best useless and at worst misleading. The business economist should remember these practical timelines and develop them around the specific production function in question.
This also allows us to calculate firm agility. A firm which achieves the medium run or long run most rapidly is also a most agile and adaptive firm, suffering minimal loss through the creative destruction process and able to capitalize on innovation more effectively.