Reply To: Colbertism and Inflation


Let’s stipulate an international gold standard.

Scenario 1: If the purchasing power of gold is higher in foreign countries than domestically, then people domestically will sell gold to and buy goods from foreigners. As the supply of goods shrinks in foreign countries, their prices will rise there. As the supply of goods rises domestically, their prices will fall there. As the supply of money increases in foreign countries, it purchasing power will fall there. As the supply of money declines domestically, its purchasing power will rise there. The prices of particular goods will rise in the foreign countries or fall in the domestic country according to the particular conditions of demand and supply. This arbitraging will stop when there is no more profit from moving goods and money from where their prices are low to where their prices are high.

If the domestic country bans imports, then prices of goods will stay high domestically and low in foreign countries. Likewise the purchasing power of money will stay low domestically and high in foreign countries.

You are starting Scenario 2 in the middle of the chain of cause and effect. You say prices increase domestically, but to do the analysis we need to know what has caused prices to rise. If we start with the condition that they are above prices in foreign countries, then we just have Scenario 1.

On your quick question: You must distinguish between demand, which we depict as the entire demand curve, and quantity demanded, which is a point on the demand curve. The position of the demand curve depends on people’s preferences. And the revenue maximizing price is at its mid-point. If an entrepreneur can lower his cost of production,this does not raise people’s preferences for his output and so he will not lower his price since doing so would reduce his revenues.