Economics Questions

Re: Say's law: How does real income grow?

Think Blue — Tue, 05 Apr 2011 04:10:43 GMT

joemac:

Can you help me understand the difference between the two?

The Fisher equation is MV = Y and the cambridge k us M = kY

Equation of Exchange (per Fisher, et al.) is:

MV = PQ

But sometimes economists substitute quantity Q for real output Y:

MV = PY

Therefore PY is nominal output, while Y by itself is real output.

For the Cambridge Equation, velocity V is defined as:

V = 1 / k

Therefore plug the above back into the Equation of Exchange:

M * (1/k) = PY

joemac:

Let's say k = 1/12, that means that on average moneyholdings are 8% of nominal income. Why does that mean that the veolcity of each dollar is 12? Weird.

Yes.

Re: Say's law: How does real income grow?

joemac — Tue, 05 Apr 2011 03:39:06 GMT

Can you help me understand the difference between the two?

The Fisher equation is MV = Y and the cambridge k us M = kY

Let's say k = 1/12, that means that on average moneyholdings are 8% of nominal income. Why does that mean that the veolcity of each dollar is 12? Weird.

Thanks.

Re: Say's law: How does real income grow?

Think Blue — Fri, 01 Apr 2011 04:28:07 GMT

joemac:

I simply convert any of the incomes into the price of one of the three goods to compare their incomes in terms of the goods.

NGDP is $21,000. No cash balances are ever held. So the demand for money is zero.

What is the money supply? Can this info be put int terms of the equation of exchange MV = PQ, or into the cambridge k, M = kY?

The problem is that transition from barter to money can't be done without an intermediate step. Money is a commodity just like any other good.

In the former British colonies in America, some of them use tobacco as a form of money. Tobacco had its direct use for consumption, and its indirect use as a medium of exchange for exchanging other goods.

For the barter model, introduce Producer D as a tobacco farmer, who supplies tobacco to Producer A, B, and C, and then establish appropriate exchange ratios for good D with respect to goods A, B, and C.

Have each producer consume some of the tobacco himself, but have some leftover for trade.

Remove direct barter exchange among Producers A, B, and C, and replace it with indirect exchange. For example, let's say Producer A wishes to trade with Producer B. Instead of a direct exchange of good A for good B, this will happen:

Producer A trades with Producer D, exchanging good A for good D.
Producer A trades with Producer B, exchanging good D for good B.
Producer B trades with Producer A, exchanging good D for good A

Money supply is that total amount of good D in existence. For your purposes, the Equation of Exchange (MV = PQ) is more appropriate, since the Cambridge equation (M (1/k) = PY) is simply a derivation of the Equation of Exchange.

Re: Say's law: How does real income grow?

joemac — Fri, 01 Apr 2011 02:23:54 GMT

My little model here on my paper (took 6 hours to figure out) shows that when productivity increases for the butcher, his marginal cost of production goes down and so the price relative to other goods of meat goes down. In response to the movement down their demand curves, the baker and the tailor request far more than before of meat. As a result the butcher has more bread and clothes than before and the other two have more meat. Here are my numbers...

Relative prices: Meat $100 - Bread $183 - Clothes $225

Incomes Spending
Butcher $8500 $8500

Baker $7500 $7500

Tailor $5000 $5000

I simply convert any of the incomes into the price of one of the three goods to compare their incomes in terms of the goods.

NGDP is $21,000. No cash balances are ever held. So the demand for money is zero.

What is the money supply? Can this info be put int terms of the equation of exchange MV = PQ, or into the cambridge k, M = kY?

I will try to go from here and figure out how this transforms when productivity for the butcher goes up. Will take some time

Re: Say's law: How does real income grow?

John James — Thu, 31 Mar 2011 10:53:34 GMT

joemac:
Now, all I have to do is figure out how all this works with money! Will be back with more really annoying questions!

If you can get it with real goods in a barter system, money is even easier...because remember money is just a commodity too...it just happens to be a commodity that gets value from its utility as a facilitator of trade...a "medium of exchange".

So when you say the "price" of something goes down in terms of dollars due to increased productivity, what you're really saying is that the value of that good relative to the value of the currency has gone down...therefore, the purchasing power of the money has increased. This means that everyone who holds that money is able to buy more stuff with the same amount of money...they are, for our purposes here, wealthier.

It's great to see that you're so interested in learning this and putting such effort into it as well as making progress. The best read for you at this point might be Peter Schiff's How an Economy Grows and Why it Crashes. It goes into this as well as many other basic economic concepts in a very easy-to-follow way. It's an update and expansion of his father's book of a similar title. You'll have to check out a library or bookstore to get Peter's updated book, but his father's version is available in pdf here, and our own Nielsio posted a nice reading of it here.

Re: Say's law: How does real income grow?

Think Blue — Thu, 31 Mar 2011 07:31:25 GMT

Andris Birkmanis:

Think Blue:
Because of diminishing marginal utility, the supply curve (from the tailor) should be upward sloping, while the demand curve (from the baker) should be downward sloping.

The graph represents relationship between utility of two goods, why do you want to treat one of them preferentially?

The preference is arbitrary. The demand and the supply curves could had been easily priced in terms of clothes, instead of bread (as per the above example), and the roles would had been reversed.

Re: Say's law: How does real income grow?

Micah71381 — Thu, 31 Mar 2011 06:22:45 GMT

Andris Birkmanis:

Because of diminishing marginal utility, the supply curve (from the tailor) should be upward sloping, while the demand curve (from the baker) should be downward sloping.

The graph represents relationship between utility of two goods, why do you want to treat one of them preferentially?

This is getting a bit off topic and if you are interested in a discussion about it I would be interested in discussing the merits of inflation/deflation in another thread. However, I think that for money to optimally serve it's purpose no inflation or deflation should occur. Both inflation and deflation, while not terrible for money, is suboptimal in my opinion.

Re: Say's law: How does real income grow?

Andris Birkmanis — Thu, 31 Mar 2011 06:20:21 GMT

Because of diminishing marginal utility, the supply curve (from the tailor) should be upward sloping, while the demand curve (from the baker) should be downward sloping.

The graph represents relationship between utility of two goods, why do you want to treat one of them preferentially?

Re: Say's law: How does real income grow?

Andris Birkmanis — Thu, 31 Mar 2011 06:17:01 GMT

Money (in theory) is just another good (like cloths, bread, meat, etc.) except new money isn't produced (ideally) and money isn't destroyed (ideally).

I do not think changing the amount of money is bad per se, provided the cost of producing money is high enough (e.g., mining gold).

Re: Say's law: How does real income grow?

Micah71381 — Thu, 31 Mar 2011 05:33:01 GMT

Money (in theory) is just another good (like cloths, bread, meat, etc.) except new money isn't produced (ideally) and money isn't destroyed (ideally). This means there is a fixed amount of money in the economy giving it a flat amount of supply and demand if I using the terminology correctly here.

Re: Say's law: How does real income grow?

joemac — Thu, 31 Mar 2011 04:58:11 GMT

I figured it out!

I drawed out three s & d graphs, one for each trade. When productivity of the butcher happened the following occured...

1. The value of meat relative clothes and bread goes down, as the supply curve of meat shifts down

2. The demand for meat goes up.

3. The total amount of bread and clothes that the butcher gets as income goes up, thus his real income goes up.

4. The total amount of meat that the tailor and baker get goes up, thus their real income goes up

Fantastic!

Now, all I have to do is figure out how all this works with money! Will be back with more really annoying questions!

Re: Say's law: How does real income grow?

Think Blue — Thu, 31 Mar 2011 04:58:01 GMT

joemac:

So, now I'm trying to create supply and demand graphs for each of the three trades to actual show this in real time so that I can get a clear visual in my head. But I'ms stuck because I can't figure out what and how many supply graphs for each trade: 1, 2, 3, or, 4. What should be on teh x and y axis, and how everything should look. I've thought through everything But I don't see it.

This depends on whose perspective you are drawing the graphs for.

From the perspective of the tailor, clothes in units should be on the horizontal axis (quantity of clothes supplied), and bread in units should be on the vertical axis (price of the clothes supplied in terms of bread).

Because of diminishing marginal utility, the supply curve (from the tailor) should be upward sloping, while the demand curve (from the baker) should be downward sloping.

From the perspective of the baker, the roles are reversed, so the quantity is bread and the price is clothes.

There should be a total of six graphs for all possible permutations of clothes, bread, and meat.

For a more detailed explanation, refer to this thread for the barter example (direct exchange):

http://mises.org/Community/forums/t/14325.aspx

I would also recommend you read the first few chapters of Man, Economy, and State by Murray Rothbard.

Re: Say's law: How does real income grow?

Smiling Dave — Thu, 31 Mar 2011 03:41:57 GMT

Lets say the tailor originally made two shirts every six months. The other guys have to buy new shirts every six months due to wear and tear. Then the tailor doubles his productivity and makes four shirts.

When the other guys wear out their old shirts, there is no reason for him to sell his shirts any cheaper. Why should he? Even though he has more shirts in his warehouse, he knows they are willing to pay the old price for the first two shirts.

He then sells them the two extra shirts that came from his increased productivity for cheaper, knowing they don't need extra shirts as badly.

What he gets for his extra shirts is his increased wealth, them having extra shirts is theirs.

Now to make sure we get what these supply and demand curves are about, let's quote Hazlitt:

All valuation begins in the minds of individuals. We are accus-
tomed to saying that market value is determined by supply and
demand, and this is as true of money as of other commodities. But
we should be careful not to interpret either supply or demand in
purely physical terms, but rather in psychological terms. Demand
rises when people want something more than they did before. It
falls when they want it less. Supply is more often thought of in a
purely physical sense, but as an economic term it also refers to
psychic factors. It may vary with price. At a higher price producers
may make more of a commodity, or be ready to offer more of the
existing stock for sale.

He's saying that

1. Supply= willingness to sell and Demand = Willingness to buy.

2. Make no mistake, supply is also a subjective thing. Of course it is influenced by physical considerations, but it's ultimately exactly as subjective as demand.

When AE talks about how value is subjective, they don't mean "But we are talking about the buyer. The seller is a robot, whose value scale can be determined with a mathematical formula and a chart." The sellers willingness to sell [=Supply] is also subjective.

Re: Say's law: How does real income grow?

joemac — Thu, 31 Mar 2011 03:30:16 GMT

I think so, I have a rough idea in my head of what's going on. But I'm going to continue trying to graphically portray this through a supply and demand graph of barter trade.

Thank you for all your help!

Re: Say's law: How does real income grow?

Micah71381 — Thu, 31 Mar 2011 03:04:41 GMT

When the tailor doubles his clothing production the cost won't half. The cost will decrease but always at a slower rate than the production increases.

So if the tailor now produces 3 times as many cloths, they may be worth half as much, not one third as much. Does this resolve your problem of how the tailor ends up wealthier? How much a good decreases in value as production increases depends on the good but it will always be somewhere between no change in cost and the production amount but never equal to those two.

So if you made 100 shirts in a day originally and they were worth $1 each and then you started making 200 shirts in a day their new value would be ($0.5, $1). Note the ( and not [ indicating that they will not be worth $1 or $0.5, only something in between those numbers.