The tale below is a chapter from a manuscript I
put together back in '84 and '85. I have never
gotten an answer to the issue presented. I tried
to elicit a response from the expert economists
who frequent the sci.econ newsgroup but all they
provided was some circumlocutious nonsense without
ever arriving at a simple definitive answer.
Could that be because economists just won't admit
it when they're wrong?
XIII
SUPPLY AND DEMAND, AGAIN
Now that we know about supply and demand in the automobile industry we will see what we can learn about the whole of the economy. Economists measure the quantity of things produced in an economy as the Gross National Product. The quantities of things produced are usually measured in terms of pounds, acres, inches or some other physical dimension. Pounds, acres, and inches are difficult to add together in a meaningful way.
Economists avoid this problem by adding the quantity of things by their measure in dollar value. They then go through a circumlocutious analysis to explain that this is not really the Gross National Product measured in dollar value but is the physical measure of things produced expressed as the dollar value.
They do this by showing how when one is dealing in physical quantities like pounds, acres and inches these same quantities can be converted to dollar values by multiplying the physical quantity by its price per physical unit and arrive at its total dollar value. They then state that the quantity they are using for Gross National Product is the physical quantity converted to dollar value. But, for all their effort, they can not come up with a description of the physical measure of Gross National Product that is used for this conversion. They just dismiss this necessary condition as trivial and proceed to claim that inflation can have an effect on the output of the economy by labeling supply and demand curves similar to those developed for individual goods as the supply and demand curves for the economy as a whole.
In their analysis of the economy as a whole economists also face the problem of a changing value of the dollar. Economists take care of this problem by adjusting the measure of the Gross National Product to account for changes in the value of the dollar. They use the Gross National Product Implicit Deflator to do this. They compute their value of Q by using the GNP Deflator much the same way I computed my version of Q using the Consumer Price Index. For their purposes the Deflator is probably a better choice.
The Deflator is a price index much like the Consumer Price Index. It accounts for some of the things not included in the CPI. These are such things as the cost of factories, tools, iron ore, trees, battleships and the printing of government tax forms. Useful things all. Well, maybe not the last item. In any case, this is the index economists prefer. They call their measure of Q the Real Gross National Product or RGNP. Since I use the CPI, I will call my measure CGNP.
Just as the measure of Q can be adjusted for inflation so can prices. To be consistent economists use the Gross National Implicit Deflator for this purpose too. This is what makes them experts. They sometimes stay consistent.
As a monetarist I believe the quantity of money only affects the value of money and not the quantity of goods produced or available in the market place. [NOTE: This is what in times past was the meaning of monetarism. The meaning has changed somewhat subsequently so I must note here that this is all I mean by calling myself a monetarist.] If this is true both the supply and demand curves for the whole economy must look like the plot below.
|
| SUPPLY
| ----------------------------------------------
P | DEMAND
|
|
|________________________________________________
Q (GDP)
The quantity of things produced are the number of market
baskets containing only those items in the Consumer Price Index.
From Figure 6.3 we see that in August 1983 we bought things at
the rate of $1.121 trillion worth of CGNP's per year. We did not
actually buy this many CGNP's. We also bought other things that
are included in the RGNP market basket. Well maybe WE did not.
But somebody did. However, WE did buy many other things. We
bought used cars, used houses, stocks, bonds, etc.
These things are not counted in the Gross National Product. They are counted in the Consumer Price Index. Well, not stocks and bonds, but most of the other things we buy are. Now I cannot really say it is better to count CGNP's instead of RGNP's. Both are useful. Let us just say that I think it is more fun to count CGNP's.
Before I forget, I had better say something about those exceptions to the normal demand curve mentioned in Chapter XII. These exceptions are those few things that supposedly have rising demand curves. Economists call these things inferior goods. The reason economists call these goods inferior is that these are the things we buy when we cannot afford normal or superior things. That is, when costs push up the price of things we want, our demand for these inferior goods pulls up these prices. When we can afford normal goods we do not buy as much of these inferior goods and their prices fall.
For example; if we can afford meat and potatoes we do not buy as much beans and flour. There are not many inferior goods in the GNP. Since most of the things we buy are normal goods, then it is obvious that the demand curve for RGNP's must be like the normal demand curve for individual products. After all, the demand for RGNP's is only the average of all the things that make up an RGNP.
If this is true, the demand curve for the economy as a whole should decline with increasing price just like the demand curves of all the normal goods that make up the Gross National Product. Like the relevant portion of the supply curves for individual goods and services, the supply curve should do the opposite and increase with increasing prices as shown below.
| D S
| D S
| D S
| D S
| D S
| D S
| D S
| S D
P | S D
| S D
| S D
| S D
|
|________________________________________________
Q (GDP)
How can I say that the demand curve for the economy as a whole
is independent of price?
The demand curve for RGNP's may be a normal demand curve, but CGNP's are different. CGNP's contain just as many inferior goods as superior goods. Because of this, the demand for the average of all things that make up a CGNP is independent of price. What are the inferior goods in the CGNP's?
Some of them are the cheaper foods we buy when we cannot afford expensive foods. Others are the used cars, used houses, used furniture, etc. that we buy when we cannot afford new items. However, most of the inferior goods in our CGNP's we do not buy at all. We simply keep them. These are the cars we keep a little longer because we can not afford a new one, the house that is not just right but will make do, the clothes we wear that are out of style but we can wear one more year anyway.
There is one more good of particular interest that behaves in a funny way. Sometimes it is a superior good and we want it more than any other thing. Other times it is a neutral good and we just keep enough for our convenience. Other times it is an inferior good and we try to exchange it for almost anything else we can get. Occasionally, when this good is being particularly inferior we even borrow some to get more superior goods. This good is, of course, money.
When money is a superior good we tend to save money and not buy the goods offered for sale. This tends to reduce or stabilize prices. When it is not just a superior good, but is superior to most other things available for purchase, we even prefer to keep our money and let our cars or farms or houses be repossessed. When it becomes the most superior good, we prefer to keep money in preference to almost anything except our minimum daily needs. Then we have a depression like we did in the 1930's. No matter how low prices go, we just save the little money we may have and expect prices to go ever lower.
When money is an inferior good we tend to buy things on credit and save only the minimum amount of cash that is necessary to buy every day requirements like today's lunch or tomorrow's dinner. When it is a most inferior good we even buy wheelbarrows to take the stuff to anybody who will exchange it for even a slice of bread. This extreme does not happen very often. Remember Germany of the 1920's? Some people claim that we are doing the same thing now as Germany did then by letting the Federal Reserve System create too much money. Of course there are others who think inflation is a good thing and say the Federal Reserve System is not creating enough money.
I think neutral money is better. I also say the demand curve for RGNP's is just like the demand curve for CGNP's. More than that, even if money is not maintained as a neutral good by monetary policy, I am certain the demand curve for the economy as a whole is neutral as I have depicted above. The reason I am certain is because this is one of our tautological friends.
When we tried to determine a measure for the quantity of goods produced in the whole economy we found that we could not meaningfully add together the pounds, inches and acres of things actually produced. To overcome this problem it was necessary to add together the various products by their measure in dollar value. Adding all of these dollar values of production together gives us the Gross National Product as a measure for the economy as a whole. The number of pounds or inches or acres of cars that are demanded tend to increase as the price of a pound or inch or acre of car is reduced. However, no matter how many dollars worth of cars or anything else gets produced, the price of a dollars worth is always a dollar. That is why we call it a dollars worth.
If the price is changed to $.99 or $1.01 then it no longer is a dollars worth. Since the Gross National Product is measured as dollars worth or real dollars worth or CPI dollars worth of things then the price of a dollars worth of GNP or RGNP or CGNP is always a dollar or a real dollar or a CPI dollar. How then can the quantity supplied or quantity demanded in the economy as a whole be depicted as anything but a dollars worth for a dollar?
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