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Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical Some Criteria for Economic Models models I. The Demand in view of the Energy Shift side II. The supply side III. Matching demand and supply Gaël Giraud 1 1 CNRS, Paris School of Economics Centre d’Economie de la Sorbonne, UMR CNRS 8174 Labex REFI Houches Feb. 2014.

Some Criteria for 0. Background on neo-classical models Economic Models Gaël Giraud ◦ Households maximize an exogenously given utility function 0. Background on neo-classical models max u i ( x i 0 , L i 0 ; x i 1 , L i I. The Demand 1 ; ... ) side II. The supply side III. Matching demand and supply p t · x i t ≤ w t L i subject to the budget constraint ∀ t ≥ 0 . t , x i L i w t = wages at time t t = consumption at t ; t = labor at t .

Some Criteria for 0. Background on neo-classical models Economic Models Gaël Giraud ◦ Households maximize an exogenously given utility function 0. Background on neo-classical models max u i ( x i 0 , L i 0 ; x i 1 , L i I. The Demand 1 ; ... ) side II. The supply side III. Matching demand and supply p t · x i t ≤ w t L i subject to the budget constraint ∀ t ≥ 0 . t , x i L i w t = wages at time t t = consumption at t ; t = labor at t . ◦ Example: 1 t ) − 1 � 1 , ... ) = E π �� �� u i ( x i 0 , x i ln ( x i � L i . t ∆ t 2 t ∆ ∈ ( 0 , 1 ) = discount factor.

Some Criteria for 0. Background on neo-classical models Economic Models Gaël Giraud ◦ Households maximize an exogenously given utility function 0. Background on neo-classical models max u i ( x i 0 , L i 0 ; x i 1 , L i I. The Demand 1 ; ... ) side II. The supply side III. Matching demand and supply p t · x i t ≤ w t L i subject to the budget constraint ∀ t ≥ 0 . t , x i L i w t = wages at time t t = consumption at t ; t = labor at t . ◦ Example: 1 t ) − 1 � 1 , ... ) = E π �� �� u i ( x i 0 , x i ln ( x i � L i . t ∆ t 2 t ∆ ∈ ( 0 , 1 ) = discount factor. ◦ Remark on the Inada conditions: lim x → 0 + Du i t ( x ) = + ∞ .

Some Criteria for Economic Models Gaël Giraud ◦ The firm j maximizes its discounted profit: 0. Background on neo-classical 1 models � β t p t · ( y j t − x j max t ) I. The Demand side t ≥ 0 II. The supply side subject to y j t ≤ f j ( x j t ) . III. Matching demand and supply f j ( · ) = production function. x j t = input at time t y j t = output at time t .

Some Criteria for Economic Models Gaël Giraud ◦ The firm j maximizes its discounted profit: 0. Background on neo-classical 1 models � β t p t · ( y j t − x j max t ) I. The Demand side t ≥ 0 II. The supply side subject to y j t ≤ f j ( x j t ) . III. Matching demand and supply f j ( · ) = production function. x j t = input at time t y j t = output at time t . ◦ Example: Cobb-Douglas production function. f j ( K j t , L j t , E j t ) := A ( K j t ) α ( L j t ) β ( E j t ) γ K j L j E j t = capital, t = labor, t = energy. α + β + γ ≤ 1 . A > 0= Total Productivity Factor.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand Cobb-Douglas, CES, etc. side II. The supply side ◦ Smooth functions III. Matching demand and supply

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand Cobb-Douglas, CES, etc. side II. The supply side ◦ Smooth functions III. Matching demand and supply ◦ Substitutability across production factors.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand Cobb-Douglas, CES, etc. side II. The supply side ◦ Smooth functions III. Matching demand and supply ◦ Substitutability across production factors. ◦ No path-dependence of the production.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand Cobb-Douglas, CES, etc. side II. The supply side ◦ Smooth functions III. Matching demand and supply ◦ Substitutability across production factors. ◦ No path-dependence of the production. ◦ Decreasing returns to scale.

Some Criteria for Economic Models Gaël Giraud ◦ Perfect foresight ? 0. Background on neo-classical Rational Expectations. models Performativity of economics ? I. The Demand side Alternatives : Temporary equilibrium (Grandmont, 80s’). II. The supply side III. Matching demand and supply

Some Criteria for Economic Models Gaël Giraud ◦ Perfect foresight ? 0. Background on neo-classical Rational Expectations. models Performativity of economics ? I. The Demand side Alternatives : Temporary equilibrium (Grandmont, 80s’). II. The supply side III. Matching ◦ Equilibrium is a fixed point. Impulse Response Function. demand and supply A static theory where Past= present= future. No uncertainty on prices. Caution: Risk � = Uncertainty.

Some Criteria for Economic Models Gaël Giraud ◦ Perfect foresight ? 0. Background on neo-classical Rational Expectations. models Performativity of economics ? I. The Demand side Alternatives : Temporary equilibrium (Grandmont, 80s’). II. The supply side III. Matching ◦ Equilibrium is a fixed point. Impulse Response Function. demand and supply A static theory where Past= present= future. No uncertainty on prices. Caution: Risk � = Uncertainty. ◦ The budget constraint is 0-homogeneous: p t · x i t ≤ w t L i ∀ t ≥ 0 . t e i t =initial endowment of household i at time t . ⇒ No money.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models ◦ Believe it, or not , this is the core of mainstream economic I. The Demand theory ! side II. The supply side III. Matching demand and supply

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models ◦ Believe it, or not , this is the core of mainstream economic I. The Demand theory ! side II. The supply side ◦ Roots: III. Matching demand and supply Jevons, Menger, Walras ( ≈ 1870) Marshall (1890)

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models ◦ Believe it, or not , this is the core of mainstream economic I. The Demand theory ! side II. The supply side ◦ Roots: III. Matching demand and supply Jevons, Menger, Walras ( ≈ 1870) Marshall (1890) ◦ Keynes (1936) : Deep revolution... ...rapidly forgotten: Hicks (1937, 1981)

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models ◦ Believe it, or not , this is the core of mainstream economic I. The Demand theory ! side II. The supply side ◦ Roots: III. Matching demand and supply Jevons, Menger, Walras ( ≈ 1870) Marshall (1890) ◦ Keynes (1936) : Deep revolution... ...rapidly forgotten: Hicks (1937, 1981) ◦ Real business cycles: Kydland & Prescott (1982) Rational Expectations: Lucas (1972).

Some Criteria for Economic Models Gaël Giraud 0. Background on ◦ “The most visible outcomes of this new approach are the neo-classical models dynamic stochastic general equilibrium (DSGE) models. They I. The Demand are models derived from micro foundations—that is, utility side maximization by consumers-workers; value maximization by II. The supply side III. Matching firms; rational expectations; and a full specification of demand and supply imperfections, from nominal rigidities to some of the imperfections discussed above—and typically estimated by Bayesian methods.” Blanchard 2009, p. 223.

Some Criteria for Economic Models Gaël Giraud 0. Background on ◦ “The most visible outcomes of this new approach are the neo-classical models dynamic stochastic general equilibrium (DSGE) models. They I. The Demand are models derived from micro foundations—that is, utility side maximization by consumers-workers; value maximization by II. The supply side III. Matching firms; rational expectations; and a full specification of demand and supply imperfections, from nominal rigidities to some of the imperfections discussed above—and typically estimated by Bayesian methods.” Blanchard 2009, p. 223. ◦ “The state of macro is good.” Blanchard 2009, p. 210.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand side ◦ “Identifying the flaws of existing policy is (relatively) easy. II. The supply side Defining a new macroeconomic policy framework is much III. Matching demand and supply harder... It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater. Most of the elements of the pre-crisis consensus, including the major conclusions from macroeconomic theory, still hold.” Blanchard, Dell’Ariccia et al. 2010, p. 207.

Some Criteria for Economic Models Gaël Giraud 0. Background on neo-classical models I. The Demand side ◦ “Identifying the flaws of existing policy is (relatively) easy. II. The supply side Defining a new macroeconomic policy framework is much III. Matching demand and supply harder... It is important to start by stating the obvious, namely, that the baby should not be thrown out with the bathwater. Most of the elements of the pre-crisis consensus, including the major conclusions from macroeconomic theory, still hold.” Blanchard, Dell’Ariccia et al. 2010, p. 207.