|Publications||On the Stability|
It is my intention here to explore the inflationary potential of producer-set prices in a socialist centrally-planned economic system. One of the main variables of this analysis will be the degree of monopoly power that is present. While the connection between monopoly and inflation is firmly established in the minds of most laymen, a substantial group of economists deny any significant causal relationship. They argue that only an increase in the degree of monopoly power could cause prices to increase, and even then the price-increase would be a onetime occurrence, not a sustained inflation. In this paper I dispute this position......
I will argue my case in the context of an extremely simple hypothetical economic framework. ….
The labor force in the entire economy is of constant size L, and there is no unemployment. The wage rate wt is uniform and is set centrally each production period. There is a one-period lag between wage-rate determination and the disbursement of wages based on those rates. Household money incomes in period t are given by
(1) Yt = Lw t-1
…. workers desire a certain customary or target real wage l. … Each period, the planners set a new wage that is a geometric average between … l at current prices and the previous wage. The money wage in period t is given by
(2) wt = (pt l)a w t-1a-1
All income received by households is immediately spent on consumer goods. There is no personal saving or dissaving. The industry demand curve for consumer goods in period t, then, is given by
(3) Qt = Yt /pt
The Behavior of Firms
…. We make two assumptions: First, at any given planned price, each firm evaluates the … demand for its output to be the industry demand at that price minus the total planned output of all the other firms. Secondly, the price and quantity planned by each firm must be profit maximizing ….each firm will set a price that equates the … demand for its output with its planned production target. …..because every firm perceives the same total of production targets and the same industry demand curve. every firm will set the same price.
Suppose that total industry-wide planned production of consumer goods in year t turns out to be Qt. and that the planned output for each firm is qt = Qt/n. … The industry demand curve, (3), implies that the … demand for the output of each firm is given by
(4) qt = Yt / pt – (n-1) Qt /n
or, solving for p,
The individual-firm total revenue function R(q) is given by
so that marginal revenue is given by
On the cost side, the firms have identical fixed-proportions production functions. The consumer good is measured in units such that the coefficient of direct labor input per unit of the consumer good is one. Firms may require other inputs (intermediate goods and capital) in fixed proportions to the labor they use, and the price charged by the state for these other inputs is proportional to the wage rate over time. Consequently, the marginal cost of producing the consumer good in period t is constant and is given by
(8) C’(qt ) = (1 + v) w t-1
If qt is to be the profit maximizing level of output, we must have C’(qt) = R’(qt ) so that by (7) and (8)
and substituting Qt/n for qt yields
Substituting the right-hand side of (1) for Yt and solving for Qt yields
Substituting (3) into (10) and solving for pt yields
This then is an equilibrium solution. By setting quantity and price as in (12) and (13) each firm would be maximizing sure profits given the behavior of the other firms. …
Since, by (13), pt is a constant times w t , we have also that
Thus, the rate of inflation for both wages and consumer goods is
In attempting to interpret (16) it is helpful to consider the relationship between l , the target real wage, and the average productivity of labor, which we denote by g. Since the total cost, expressed in labor time, of producing a unit of the consumer good is 1 + v, it follows that
(17) g = 1/(1 + v)
Substituting (17) into (16) yields
and we see that the degree of market power as measured by n, and the ratio of the target real wage to the productivity of labor, l/ g, emerge as the key factors in determining the rate of inflation.
The Role of Money
It is not my intention to dispute this view. …. I would suggest that monetary authorities would be prone (or directed) to “finance” an inflation by creating in every period a money supply sufficient to meet transactions demand at current prices. The rate of inflation indicated in the previous sections would then prevail.
A Concluding Remark