[THOMAS.BEHNKE]

Hey Dr. Herbener,

I’m trying to figure out who benefited from price inflation under Colbert-mercantilism (if anyone)…

SCENARIO 1: Suppose goods were a lot cheaper in other countries, so I imported a lot. This would increase the purchasing power of my money, causing prices to decrease. Do these price decreases benefit anyone in my country? Is anyone in my country hurt by these price decreases? I can’t seem to figure out how prices would decrease…I’m sure it wouldn’t be through a “helicopter effect.” (By the way, since every country specializes in something, I understand that this is somewhat implausible, because imports-exports will normally balance themselves out. However, I’m assuming that sometimes this is not the case, and I am wondering what would happen in such instances.)

SCENARIO 2: Now if prices increased in my country, I would naturally want to import more foreign goods (if they were cheaper than domestic ones). But if I imported a lot, foreign countries now have more gold in their hands, so the chances are that prices in foreign countries are now increasing . Prices are now probably higher abroad than they are at home, so import-exports will balance out.

How would the above scenario play out when a country bans imports? I’m assuming this would lead to an excess supply of gold, which would cause the purchasing power of money to decline. Prices would increase, but who would benefit from these increases? And I know that regardless of the purchasing power of money, prices would increase anyway…because instead of purchasing foreign goods for less money abroad, I’d be forced to buy from less efficient producers at home. I can see how in this case, the domestic producers would benefit, since they would be getting more sales (although in the long run, they probably wouldn’t benefit, because they’d be paying more money for other goods). But would anyone benefit strictly from the decline in purchasing power (because I’m assuming prices wouldn’t magically rise at the same time)? Would those that have the most gold benefit, since they’d have the opportunity to purchase goods before the price increases?

As always, thanks so much for your help!

[THOMAS.BEHNKE]

Now that I’m thinking of it, I have one more quick question:

Suppose I’m a shirt manufacturer. I take a shirt-making workshop to gain more experience. I can now make one shirt in 45 minutes instead of an hour. Thus, I can decrease the price of my shirts.

^^Is it almost 100% safe to say that demand will increase? Or can it stay put, causing me to make only an X amount of shirts in the future and use my surplus productive capacity on making something else, like socks (instead of more shirts)?

Thanks again!

[jmherbener]

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.

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