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The Theory of the Consumer Price Level1

Published online by Cambridge University Press:  07 November 2014

Sidney Weintraub
Sidney Weintraub*
Affiliation:
University of Pennsylvania
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Extract

The theory of prices developed by Keynes in the General Theory is always likely to appeal strongly to the student approaching the subject from the side of value theory for in his analysis customary supply-demand categories are reaffirmed. Yet, despite its insights, his analysis here is incomplete: although there is a fairly detailed account of the supply curve the chapter is vague on the exact composition of the corresponding demand function. This paper reviews the problem, constructs an appropriate demand-supply apparatus, and uses it to analyse the determination of the price level of consumer goods, as measured by index numbers. It appears, however, that the same technique can be extended to explain the price level of investment goods if certain of the functional connections are modified.

The essential distinction between the analysis of the firm (or industry) and the analysis of the economy is that in the former supply and demand can be regarded as independent, whereas in the latter interdependence must be stressed from the very beginning. Causally, however, it is usually argued that the initial impetus comes from the supply side. Factors are viewed as being paid for by reason of entrepreneurial decisions to hire them for productive uses, and resource owners as thereafter expending these earnings, in whole or in part, on the forthcoming consumer good output. Viewing this as the essential proposition descriptive of the economic process, let us develop its implications for the theory of the price level.

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 18 , Issue 2 , May 1952 , pp. 163 - 172
Copyright
Copyright © Canadian Political Science Association 1952

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Footnotes

1

I should like to thank Professor Raymond T. Bowman, University of Pennsylvania, and Dr. Arthur I. Bloomfield, Federal Reserve Bank of New York, for some helpful remarks on an earlier draft of this article.

References

2 See Keynes, J. M., The General Theory of Employment, Interest and Money (New York, 1936), chap. 21Google Scholar, “The Theory of Prices.”

3 This is surprising. Keynes declares: “It is on the side of demand that we have to introduce quite new ideas when we are dealing with demand as a whole and no longer with the demand for a single product taken in isolation, with demand as a whole assumed to be unchanged.” General Theory, 294–5.Google Scholar Alvin Hansen, in his admirable restatement of Keynesian thinking in Monetary Theory and Fiscal Policy (New York, 1949)Google Scholar, draws the appropriate functional relationship between prices and output (pp. 135–9), but lacking a demand curve linking purchases and price level, the price level is indeterminate until, by aid of separate income determination diagrams, the output position is fixed. At another place (chap. 7) in his volume Professor Hansen utilizes microscopic analysis to describe price phenomena in various sectors of the economy.

4 For a concise, cogent statement see Pigou, A. C., Lapses from Full Employment (London, 1945), 10–11.Google Scholar

5 It is assumed, however, that saving as an alternative to consumer outlay is possible.

6 This need not constitute the precise sum of entrepreneurial factor outlays at this output. In the “long period” we could be more confident of it; in the short period the situation is obscured by fixed commitments which may inflate the firm's immediate factor disbursements, while various withholdings will deflate them. For equilibrium analysis, however, these qualifications can be ignored.

7 Supply price, in our simplified scheme, is analogous to Keynes's aggregate supply price, except that his function relates employment to expected sales proceeds instead of output to expected price. The latter usage is, of course, closer to the traditional Marshallian concept. See General Theory, 24.

8 As we are dealing with finite output and income changes, g would more properly signify an “average marginal propensity.”

9 Factor receipts would actually be less because some components of marginal cost, and thus of supply price, reflect sums withheld, as user costs, rather than moneys disbursed as factor income.

10 The intersection yields not only the output and price level, but also the income level, for income in the one consumer commodity model is price times output (plus the investment outlay). Hence for this restricted model we have an alternate theory of income determination.

11 Cf. Keynes' view of why consumer good expansion is ultimately blocked. He declares that an expansion in output can sustain itself “only if the community's marginal propensity to consume is equal to unity, so that there is no gap between the increment of income and the increment of consumption.” General Theory, 261.

12 The ultimate interdependence of supply and demand phenomena, which can be neglected when output and factor payments are small but not when they are large, may explain Marshall's reluctance to draw the demand curve in any way other than concave upward when off to the right.

13 Inasmuch as our demand price varies with output, for the purposes in hand Wicksteed's dictum that supply is an implicit form of demand phenomena may well be reversed: demand depends upon “supply”—the output volume and income earned in producing it. See The Common Sense of Political Economy, ed. Robbins, L. (London, 1934), II, 506.Google Scholar

14 See the illuminating passages in Kevnes, J. M., A Treatise on Money (New York, 1930), I, 79–88.Google Scholar

15 For each commodity the relevant supply price entering the price index consists of the marginal cost of producing the amount of the particular commodity, where marginal cost is taken to be the same for each firm producing identical commodities.

16 The problem is that of pricing a given stock of goods, given the income size and division. See Cassel, Gustav, The Theortl of Social Economy, Barron, S. L., trans. (New York, 1932), 138–40.Google Scholar

17 The cobweb theorem of particular market analysis can be introduced here, complicated however by movements from curve to curve rather than along the course of unique singletrack schedules.

18 Duopoly and oligopoly interdependence are neglected as not particularly vital at this stage. Given the precise manner of price formation in these markets they can be fitted into the scheme in the way indicated for monopoly.