Absolute Price Levels Research Articles

The Real Balance Effect: An Exercise in Capital Theory

In his celebrated book, Money, Interest and Prices, Professor Patinkin took the position that an individual's demand for nominal balances was not homogeneous of the first degree in the absolute level of prices. His analysis, based on concepts of inferiority and superiority with respect to real cash balances, failed to distinguish between short-period transition and long-period equilibrium. For this failure, Patinkin was taken to task by Archibald and Lipsey, who, while accepting Patinkin's assumptions, showed that as between alternative positions of long-period equilibrium when the actual stock of real balances is equal to the desired stock, a doubling of the price level does, in fact, double the nominal quantity of cash balances demanded, thereby validating the classical position.My primary purpose is to show that it is unnecessary to assume, as do Patinkin and his critics, a unique relation between the desired stock of balances and the flow of commodities. This stock-flow equilibrium should not be assumed, but rather can be deduced, as is done in capital theory, from initial assumptions. Indeed, the accumulation of cash balances to attain a long-run equilibrium level is properly treated as an aspect of the theory of capital accumulation. Specifically, if we assume that real cash balances have positive carrying costs and that the rate of time preference is zero, we can show that an individual in long-run equilibrium will hold the satiety level of cash balances and that the equilibrium is unique and stable.

A DENIAL OF PATINKIN'S CONTRADICTION

SUMMARY The classical theory of value and price comprises a real sector which determines relative prices and a monetary restriction (the Cambridge equation) which determines the absolute price level. Patinkin considers this system inconsistent because the supply and demand for real goods automatically defines a demand and a supply for money (the “mirror-image”). Patinkin's position is (a) that the system contains, without justification, two monetary equations and (b) that these two are contradictory. It is argued here that neither the mirror-image nor the Cambridge relations constitute market equations in the sense in which such equations apply to commodities. Commodity stocks or flows are desired for themselves and motivate exchange. In the classical system money is not so desired and it does not motivate exchange. The Cambridge equation is a technical restriction having no relation to the demands and supplies of real goods. The mirror-image equation, on the other hand, though it reflects real demands and supplies, is not a behavior restriction at all. Consequently it cannot be part of any monetary theory. Therefore the Cambridge restriction may be superimposed on the real sector without contradiction.,

Excise-Tax Shifting and Incidence: A Money-Flows Approach

T HE money-flows analysis reported in this paper grew out of attempts to cope with one of most intractable obstacles in path of theory of excise-tax shifting and incidence, namely, problem of distinguishing between fiscal and monetary effects on market prices. The conventional expedient for coping with this obstacle is to try to avoid it by impounding monetary conditions in ceteris paribus while imposing an excise tax. Although this conventional expedient may be useful for certain analytical purposes, it is no real solution of problem. Price effects of impounded monetary conditions always return, like proverbial drowned cat, to plague excise-tax theorist. Even Harry Gunnison Brown, whose pioneering analysis of of a general output or sales tax is best of three significant articles examined in this paper, was not quite able in two attempts to distinguish between price effects of his tax and those of his assumed constant quantity of money in circulation.2 Direct assaults on this intractable monetary obstacle have recently been attempted by two writers. Earl R. Rolph located crux of this problem in question: If excise taxes raise prices to consumers, what shall be done about monetary theories which hold that an increase in aggregate demand is a necessary condition for a rise in general level of prices?3 His proposed solution was to convert quantity theory of money into a tool for excise-tax theory by means of his income effect. This paper will demonstrate that Rolph's assault on monetary obstacle failed because he falsely equated monetary deflation with backward shifting of excise taxes. Still more recently, Richard A. Musgrave diagnosed this problem as simply an aspect of distinction between absolute and relative prices. As shown above, he asserted, incidence depends on changes in relative price, and these are independent of change in absolute prices or price levels.4 Musgrave's proposed solution was to relegate changes in absolute prices and in price level to domain of the money supply and to reserve tax-induced changes in relative prices as hunting ground for an independent theory of incidence. ' I am greatly indebted to Mr. Roland N. McKean and Professors Howard S. Ellis, Bernard F. Haley, Milton Friedman, and James M. Buchanan for their helpful criticisms and suggestions at various stages in preparation of this paper.

Dichotomies of the Pricing Process in Economic Theory

In a recent paper it was argued that classical economics attempted dichotomize the economic processes of a monetary economy into a real sector, dependent upon and determining relative prices, and a money sector, dependent upon and determining absolute prices In the event that the operations of the latter sector are described by the quantity theory of money, such a dichotomization is involved in a logical contradiction. Specifically, the classical quantity theory attribute[s] a fundamental role to the effect of real cash balances on demand, for this effect is the vehicle by which . . . a change in the amount of money [is presumed] to influence the absolute price level ; on the other hand, the assumption that the demand function depends only on relative prices implies that [demand] is independent of real cash balances The assumption of Say's Identity does not remove this contradiction.' Abandoning the quantity theory of money does not resolve this difficulty. For the assumption that commodity demand functions depend only on relative prices is inconsistent with any monetary theory which attempts to make money prices determinate. This can be seen simply in the following way: Consider an economy in which excess demand depends only on relative prices, and assume it to be in equilibrium at a certain set of money prices. Assume now that all money prices are changed in the same proportion. This does not change relative prices. Hence, by assumption, the commodity markets are still in

The Classical Monetary Theory: The Outcome of the Discussion

I. INTRODUCTORY Recently a number of economists have shown a revived interest in the monetary theory of the classicists and of the members of the Lausanne School and their successors.2 It has been maintained that all of these authors held basically common views which have been called the classical system . Moreover, it has been argued that this system suffers from serious formal shortcomings, in particular that either it is inconsistent or it must leave the absolute price level indeterminate. We believe a summary of the results of the discussion is now appropriate, and that the conflicting views can be evaluated and to some extent reconciled. Moreover, the arguments can be stated rigorously without recourse to the mathematical apparatus which has been employed. A detailed restatement is therefore included in the belief that the discussion will become available to many who did not follow it before. For our purposes we may consider the attack on the earlier writers to have been opened by Lange [I3], although the discussion, as is indicated below, goes back much further. However, the immediate centre of contention is Patinkin's restatement and refinement of the Lange position. We shall therefore describe the Lange-Patinkin version of the classical system and the difficulties which they have shown to be inherent in it. A more satisfactory structure which Patinkin has called the modified classical system will then be outlined. Finally, it will be argued through reexamination of some of the classical writings that most of the group probably never held views like those ascribed to 1 The authors are indebted to Professors Viner and Brunner for their comments and suggestions.