Abstract
Price theory in a monetary economy is outlined in this chapter. Prices are considered to equalize demand and supply in a barter economy. However, the function of price changes entirely in a monetary economy. As is evident from daily life, the value of money (the inverse of the price index) is determined by rational belief concerning its future value in itself. If individuals confirm the future devaluation of money, this immediately raises the current price level. In turn, if they are confident about the value of money, the price level becomes stable. However, goods markets are adjusted not by price but by quantity. Thus, when monetary theory is recognized to have intrinsic dynamic properties, quantity adjustment such as the multiplier process emerges consistently with neoclassical microeconomic theory. In addition, the theory outlined in this chapter contains the quantity theory of money as an extraneous rational belief under conditions of market equilibrium.
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