CHAPTER 1

INTRODUCTION

Change in price level can independently change the costs of construction of

public utility plants. Yet the larger changes in construction costs go along with and

are part of changes in the price level. So far, as this is the case problem of public

utility valuation for the purpose of rate regulation becomes a part of the general

problem of price level fluctuations and of the difficulties caused by them.

The general public might make a sort of tacit bargain- as some writers and

publicists would have it do- by which it would avoid a proportionate increase in

utility rates when prices in general, including construction costs, fall greatly and

when rates must be paid in dollars of higher value which it is harder to earn. But

such a bargain might turn out, in the end, to be a very bad one. Is it fair to

succeeding generations of consumers for this generation to make such a bargain?

Would succeeding generations be morally obligated to adhere to it? Permanently to

stabilize the general price level would go far to relieve us from this as from many

other troublesome problems. Instability of the price level may be thought of as an

evil that affects nearly all of our economic relations and arrangements. We can

best avoid its undesirable consequences by removing their cause. The bondholders

of a company are lenders to it who have, therefore, a claim on its earnings prior to

the claim of stockholders. Sometimes, too, there are preferred stockholders. But

the common stockholders are entitled to any returns from the business which are

left over after the fixed obligations have been met

1
 Although it is true that stockholders are guarantors of the bondholders and may

lose heavily if and when rates fall, nevertheless it is not unreasonable to presume

that they took the risk of loss along with the chance of exceptional gain. Why

should either beholders or the stockholders of a railroad (or other public-service

industry) be even indirectly and partially, through a policy of rate regulation,

guaranteed a fixed money income regardless of what happens to the general price

level, when investors in competitive industries have to take their chances? Then

how about the financial stability argument?

True, public utility companies are considerably financed by bonds and preferred

stock. True, a long period of falling prices with proportionately falling rates, would

especially injure common stockholders and might bring bankruptcies, but

manufacturing companies, hotels, office buildings, etc. are also largely financed by

bonds. And many home owners and farm owners are heavily burdened by

mortgages. These, too, suffer from falling prices. If public utility rates are kept up

in such a period, the relative decrease of money or credit is likely to bring it about

that other prices fall in an even greater degree. Thus, in protecting the public

utility stockholders, we make the situation even worse for countless farmers and

other debtors than it would be otherwise be. If to be financed so largely by bonds

or preferred stock is to protect these companies against rate falls when all other

are getting lower prices, these companies are likely, so soon as prices show signs

of dropping, to substitute preferred stock and bonds for even more of their

common stock. The remedy needed here is price level stabilization, a general

remedy for a general economic sickness, not protection of the utilities against rate

2
reduction when all other price are falling and when the lower rate would yield a

good rate of return on what it would then cost to construct the necessary plant.

And so, not conceding that any one class of industries is entitled to

consideration which other industries do not receive, we come back, at the end of

our inquiry into public utility rates and valuation, to the conclusion reached

towards the end of the chapter on business depression, that permanent

stabilization of the price level is among the most important of all economic

reforms. For we cannot face the problem of rate regulation in a period of rising or

one of falling prices, without taking cognizance of the relations between

stockholders and bondholders nor without realizing that these relations obtain

throughout corporate industry, and indeed, since stockholders and bondholders are

to each other but borrowers and lenders, throughout economic life in general.

Thus a period of falling prices which advantages bondholders of a public utility,

advantages bondholders and other lenders in all industries, at the expense of

stockholders and other borrowers. The losses to public utility stockholders if prices

are not stabilized and if public utility rates are based on current construction costs,

may fitly be compared with the losses to farmer and other debtors during the long

period of falling prices from 1865, following the Civil War inflation, to 1896.

We may reasonably hope for intelligent legislation in a democracy there is

needed- as, surely, all of us realize in the abstract- both wide-spread popular

understanding of the nature and mode of operation of the price system and a keen

3
sense of fair play. When shall we have these twin indispensable requisites of a wise

and just polity?

CHAPTER 2

II. PROBLEMS OF PRICE CHANGE

Essentially the problem of price change arises from the fact that all individual

prices do not rise or fall at the same rate of speed. Today, we assume, the cost of

living stands at 100. Tomorrow the cost of living rises at 200; each commodity

included in the cost living doubles in price. Am I better off than before? Am I worse

off? Am I just I was? If the prices I can charge for the rise of my work and wealth

also double, I am just I was. The cost of living rises from 100 to 200, but my

income also rises from 100 to 200. It would not affect me, therefore, if all prices

rose or fell at the same rate of speed. But prices do not behave as regularly as this.

When the cost of living rises by 100 percent, my income may rise by only 25, 50,

or 75 percent. In that event, rising prices reduce my purchasing power. When the

4
cost of living falls by 50 percent, my income may fall by only 10, 20, or 30 percent.

In that event, falling prices increase my purchasing power. When the price level is

moving upward, some individual prices go faster than others, some slower, others

remain constant. When the price level is moving downward, some individual prices
1
fall unequally.

What is the result? A, who gets his income in one way, becomes richer. B, who

gets his income in another way, becomes poorer. Moreover, whole classes of

individuals are affected. Farmers, manufacturers, workers, merchants, investors,

professional men, government employees- each group may be thrust up or down

by the process of rapid price change. We have been interested in the influences

that make the price of wheat high or low and the price of automobile tires low or

high in relation to each other and to the prices of other goods. Unless the price of

(for example) automobile tires is high enough, relatively to other prices, so that the

persons engaged in the work of producing them can get substantially the current

wages, as indicated by wage levels in other work of corresponding skill, many of

them may, in the long run, choose other occupations. And in like manner, unless

those persons whose property is devoted to the business realize approximately as

much as they could realize were their property used in a different business, some

of them will, when the opportunity to choose recurs, withdraw their property from

the industry. If, on the other hand, the price of tires is high enough to give the

persons who are engaged in or whose property is devoted to producing them, very

much more than is currently received by persons in other lines, then the inflow of

1 Willard E. Atkins. Our Economic World. (Harper and Brothers Publishers, 1934) p. 329

5
labor, land and capital from other businesses to this business will almost inevitably

prevent such a high price for tires from being permanent.2

But although we have thus explained the relation of various prices to each

other, we have not yet considered the causes that may make the average of all

prices high or low, the causes that may lead to a general rise or a general fall of

prices. And, clearly, automobile tires might rise in price along with all other goods,

even though the technological conditions of production did not change, since then

there would be no new inducement for the producers of other goods to become

producers of automobile tires. It is equally true in the case of the general level

prices as in the case of the price of any one article, that determining factors are

those which express themselves in or through demand and supply. But for

purposes of the present analysis it is desirable to think rather in terms of a

composite demand for goods-in-general by the persons having money or money

substitutes to spend for goods offered for sale, than to think of demand for and

supply of any particular kind or kinds of goods.3

In so thinking of a composite demand and a composite supply we need not

overlook the fact that demand for goods-in-general is made up of the separate

demands for many different kinds of goods. And likewise as to supply. And the

conditions-an increase of money or other spending power- which make an increase

of demand for goods-in-general do so only by bringing about an increase of

2 Ibid.

3 Harry Gunnison Brown. Economic Science and the Common Welfare. (Lucas Brothers,
Incorporation, 1929) p. 84

6
demand for specific goods. It is, nevertheless, entirely reasonable to distinguish

between an increase of demand for a specific kind of goods, due (say) to change of

taste and involving a decrease of demand for something else, and, on the other

hand, an increase of demand such that, at the former range of prices, more goods-

in-general would be wanted than could be had and such that general rise of prices

would be inevitable. And in like manner it is fair to distinguish between the supply

of any one kind of goods and the supply of goods-in-general.4

The theory of general prices that is most widely accepted by competent

economists is the so-called quantitative theory of the relation of money and prices.

A completely scientific statement of this theory involves considerable explanation

and qualification and may require a number of chapters. For present purposes,

however, we may state the theory as asserting that the general level of prices

depends upon the quantity of money, rising as the quantity of money increases

and falling as the quantity of money decreases. Under such circumstances, since

the people have more money to spend and since prices have not risen, they will

endeavor to purchase more goods. This will be true even if they are of a saving

disposition, unless they save money by burying it or otherwise taking it out of

circulation. If the people save, as is ordinarily the case in the modern civilized

world, by investing, they spend what they save as well as what they do not save.

The only difference is that with money which is spoken of as saved they buy

investment goods-machines, factories, ships etc. more money, then, means an

attempt to buy more goods. But while the amount of money has, in our assumed

4 Op. cit. p. 330

7
case, doubled, the current output of goods has not increased. Though people have

the means to buy twice as much as before, there are no more goods than before to

buy.5

Unless, therefore prices rise and rise greatly, demand for goods must exceed

supply of goods. Buyers will bid against each other to secure goods. Even if such

bidding is not active it is potential, for many of them- perhaps nearly all of them-

would pay higher prices rather than go without the goods of their desire. Sellers

can therefore raise their prices safely without having goods left in their hands.

Even if some sellers should not raise their prices, these sellers could not possibly

provide for all of the clamoring buyers, and the sellers who had raised their prices

would be able to sell with sufficient ease and with larger returns on their business.

In short, the increased money must raise prices and, other things being equal,
6
must raise them in proportion as the money has increased.

A popular understanding of the relation between money and prices would go far

to prevent the irrational complaining about so-called profiteers in periods of high

and rising prices. There are cases enough, of course, of business chicanery and

extortion. And the modern world is not without its experiences of monopoly. But it

is unreasonable to visit blame on producers and dealers for a general increase of

prices as it is to visit the blame on the tides for following the moon and sun. The

untrained mind is prone to explain occurrences in terms of the activities of

5 Ibid. p. 331

6 Ibid.

8
individuals rather than in terms of more or less impersonal forces. And just as,

before the laws of gravitation and centrifugal force were widely understood, the

motions of the planets were explained on the hypothesis that they were pushed by

angels; so by persons who do not comprehend the underlying influence of money

and money substitutes on prices, a rise in the price level is explained as due to

attempts at extortion by individual business men.7

During the process of transition to the higher prices made necessary by an

increase of money, there will be an active bidding for goods. For if prices do not

rise quite as rapidly as spending increases- and they probably will not, at first-

demand for goods tends still to exceed supply until prices rise further, meanwhile

goods sell quickly and easily. On the other hand, a period of transition to lower

prices is likely to involve inactive buying and comparatively dull business. For, if

prices do not fall as rapidly as spending decreases, demand for goods at the prices

asked tends to fall short of supply, thus forcing prices down further. But meanwhile

goods will sell slowly and with difficulty at the prices asked. Even at this stage of

our inquiry then, and so without going into all the intricacies of the alternation of

prosperity and depression, we can see that the currency, by its expansion or

contraction, may cause not only price changes but, so far as the price changes lag,
8
changes in the extent of business activity.

The Evils of a Fluctuating Price Level

7 Allyn A. Young, et. al. Outlines of Economics. (The Macmillan Company, 1926) p. 352

8 Ibid. p 353

9
 There are very great evils in fluctuating currency whether it is paper or gold. A

fluctuating currency makes values uncertain. When prices rise, borrowers gain;

lenders and persons with fixed money incomes lose. When prices fall, borrowers

lose; lenders and persons with fixed incomes gain, the general level of prices, like

the price of any specific kind of goods, depends on demand and supply. The

demand for goods-in-general, at any given price level, tends to be larger in

proportion as the amount of money is larger. So, the larger is the amount of

money, the higher must the price level be, in order that demand for goods shall

not exceed supply. The prices of goods in any community tend to be related to the

prices of goods in other communities, if the money of both is based on the same

material, gold, since such a common money material will flow from where prices
9
are high to where they are lower.

Tariffs interfere with this flow. And a country which, by a protective tariff,

restricts the purchases of its citizens from other countries will in turn export less to

other countries. Where there is free and unlimited coinage of gold the level of

prices and the value of money is related to the value of gold as bullion. Cheaper

money tends to push out or keep out circulation a somewhat less amount of dearer

money when the dearer money is worth, to begin with, the same as the material of

which it is made. When the dearer money is all pushed out, further increase of the

cheaper money raises prices rapidly since it then means a net addition to money

supply. A fluctuating level of prices upsets the relations of borrowers and lenders,

9 Lionel D. Edie. Economics: Principles and Problems. (Crowell Company Publishers, 1926)
p. 70

10
enabling the former to gain at the expense of the latter when prices rise, and

enabling the latter to gain at the expense of the former when prices fall. To prevent

fluctuations in general price level would therefore be to prevent a great deal of

injustice and would be to accomplish a most important economic reform. 10

Prices may be thought individually: the price of a bale of cotton, of a ton of

scrap iron, of an eight-cylinder five-passenger automobile, of a dozen fresh eggs,

of a ten-room one-family house. Individual prices like these often vary more or less

at random in response to special causes like overpopulation of a single commodity,

short crops in respect to some particular product, changing fashions in automobiles

or homes, cutthroat competition in one industry, the mergence of monopoly power

in another. But prices may also be thought of as averages: the average price of

foodstuffs, farm produce, manufactured commodities, household appliances, etc.

Furthermore, when we measure the purchasing power of money we seek to take an

average of many prices. The average of all prices taken together constitutes the

price level. Upward and downward movements of the price level cause far-reaching

adjustments in the riches and well-being of all men.11

By the "value of money" we mean the purchasing power of money as reported

or expressed by the money prices of other things. Money has, in reality, a large

number of different values, expressed by the different quantities of different things

it will purchase. If the price of wheat is one dollar per bushel, then one value- the

10 Ibid.

11 Ibid. p. 71

11
wheat value- of money is a bushel per dollar. Similarly, the purchasing power of

money in sirloin steaks may be two pounds per dollar. The notion of the general

value of money is simply a useful abstraction, based on a board view of all its

different specific values. When we fix our attention upon changes in the various

purchasing powers of money, however, we are able to distinguish between

changes that are widespread and general, and changes that affect only one or two

commodities.12

For example, a new invention may decrease the price of a particular

commodity, without affecting the prices of other things except by shifting demand

from other things to the commodity in question- an affect which would usually be

slight so far as the price of any one of these other things is concerned, for the

demand would very likely be shifted from many different lines of consumption. Or,

if the demand for the commodity in question is inelastic, a lessening of its price

may increase the demand for other things. But there are, on the other hand, price

fluctuations which are widespread and which show general trend in one direction

or the other, and these we may call, with substantial accuracy, changes in the

value of money.13

A. LEVEL OF PRODUCTION

12 Ibid.

13 Ibid. p. 72

12
 A larger supply of any good involves either more labor by those already

engaged in producing it or a larger number of such producers. Neither can

ordinarily be had without higher price as an inducement.14

1. OVERPOPULATION

The population problem, as we may call it, deals with the effects on mans

livelihood which follow from increase, decrease, or no change in human numbers.

It was long the fashion in economic thought to say that most of the difficulties of

human life were due to the fact that the world was overpopulated. In recent

years, however, the fear of overpopulation has waned. In place of it has arisen

the belief that the maladjustments of our economic order are largely due to

overproduction. Nevertheless, the question of how much population is too little,

15
enough, or too much still continues to perplex the minds of thoughtful men.

The population problem deals with the effects on mans livelihood of increase,

decrease, or no change in human numbers. From the point of view of eugenics,

population is a question of improving the quality of the human race. From that of

religion, population is the question of the duty of a man. From the standpoint of

national prestige, population is a question of the obligations of the citizen.

Overpopulation and underpopulation, however, are concepts which relate to

the optimum theory. The ordinary wage earner thinks of population in relation to

14 Fred Rogers Faichild, et. al. Elementary Economics. (The Macmillan Company of
Canada, 1937) p. 56

15 Ibid. p. 58

13
his job. The working force of any country comprises all those who are fit, able, and

willing to work. Its size is determined not only by population totals but by the force

of custom, the force of law, methods of work, wage rates, and the mobility of

labor.16

Even if it were possible to get the most desirable proportion of the population in

each kind of work and in each class or stratum of labor, this would not alone solve

the population problem; population as whole must be reasonably limited. Invention

may for a while go on so rapidly that a larger population can be better fed than a

smaller one was before. Inventions and discoveries of some sorts make it desirable

to devote more time to less land, for example, the discovery that spraying trees
17
leads to their yielding of more, larger and better fruit.

Inventions and discoveries of such a kind may mean that a larger population

can secure as much per capita as, with the same degree of skill and knowledge, a

smaller population could secure. But not all inventions and discoveries work to this

effect. Some, for example the invention of much of agricultural machinery, enable

fewer people effectively to utilize larger areas. The consequence of such inventions

is that a large population is relatively superfluous, that the additional men add

relatively little to the total product of industry, that the point of diminishing returns

is passed when with the same population and less advance in the mechanic arts it

would not be reached. This conclusion is not inconsistent with the fact that

16 Ibid.

17 Brown, Op. cit. p. 125

14
inventions in question may enable the existing population to be supported in

greater average comfort than before.18

2. INFLATION AND DEFLATION

In common language, inflation and deflation are used loosely, the former to

denote rising prices, and the latter, falling prices. More strictly, the terms should be

confined to changes in price levels, which are due to an increase or decrease of

money in circulation (currency dollars plus bank deposit dollars). By inflation we

understand a rising price level due to an increase of money in circulation. By

deflation we understand a falling price level due to a decrease of money in

circulation. Inflation and deflation as defined here are frequently the result of

government policy.19

Inflation may be used as an instrument of war finance or as a device for

bringing about a revival of prosperity. During a war the government engages in

tremendous outlays. Billions of dollars are expanded yearly for munitions, rifles,

battleships, supplies, uniforms, soldiers' pay, etc. It is easier to get these dollars by

printing money and by borrowing it than by levying taxes. Printing money directly

increases the quantity of it in circulation. Government borrowings operate to

increase the volume of bank credit by a round-about method which we need not

consider here. In short, the quantity of money in circulation increases, the

government spends with a lavish hand, and prices rise. The story is much the same

18 Ibid. p. 126

19 Atkins, Op. cit. p. 335

15
when the government seeks to revive prosperity by inflation. It may issue

quantities of fiat money with which it pays many of its ordinary bills. It may also

borrow heavily, and use the proceeds of the loans for construction projects.20

In order for prices to rise as a result of inflation, each of these two conditions

must be fulfilled: (1) Money in circulation increases, the sum total of currency plus

bank deposit dollars grows larger. (2) The additions to the money supply actually

circulates, they are spent on raw materials, semi-finished products, finished goods,

in manufacture, transportation, and agriculture. In order for prices to fall as a result

of deflation, each of the following conditions must be fulfilled: (1) Total money in

circulation decreases. (2) Money in circulation is spent less rapidly than before. 21

Deflation, in contrast, many be used as a method of stopping short a business

boom that has run beyond safe limits. In this case, the government seeks to

reduce the volume of money. One way of accomplishing this is to withhold from

further circulation some of the currency and bank deposits received in payment of

taxes or as the proceeds of loans. Another way is to have the central bank contract

the volume of bank credit. The central bank tries to get commercial banks to call in

many of their old loans, and to be sparing of new loans. If the banks do this,

business enterprises are denied purchasing power, must spend less, and have to

sell merchandise in a hurry in order to get cash. Falling prices result.22

20 Loc. cit.

21 Ibid. p. 336

22 Young, Op. cit. p. 309

16
 By deflation we mean an arbitrary or planned decrease in the volume of money

or bank credit, accompanied by falling prices. The most important object in view in

deflating the currency is the restoration of a stable monetary standard, with the

advantages such a standard gives in the transaction of domestic and foreign trade.

The methods which must be employed to secure deflation must be, it should be

clear, the opposites of those which bring about inflation. Deflation may also be

accomplished, in effect, by the complete or partial repudiation of the obligations of

the government or the banks. Partial repudiation occurs when the government or

the banks redeem their obligations, but at a discount or in a monetary unit reduced
23
in size. The morality of repudiation has been mush discussed.

As we have seen, inflation is accompanied by a heavy burden of disguised

taxation, unequally distributed. Some few people gain, many others lose, during a

period of rapidly rising prices. Even if the depreciated currency could quickly be

brought back to par by adequate provisions for redeeming it, a new series of

burdens and injustices would be created. Heavy taxation would be necessary, and

it is wholly unlikely that the bulk of its weight would fall upon those who have

profited rather than lost in the period of inflation. The falling prices and changing

incomes that accompany deflation would undoubtedly tend, in some slight

measure, to redress the balance; that is, to benefit those whom inflation had

injured. But the compensation would be partial and inadequate. The wrong done by

inflation cannot be undone by deflation.24

23 Ibid. p. 310

24 Atkins, Op. cit. p. 338

17
 Price change can give rise to a multitude of vexing problems. Rising prices may

wipe out the purchasing power of lifetime savings, stimulate manufacturing and

construction, raise the cost of living faster than labor earnings, create new

millionaires, and impoverish holders of fixed income. Falling prices may force

farmers, merchants, manufacturers, and landlords into bankruptcy; slowdown the

pace of commodity output; cause widespread unemployment, and enrich holders

of fixed incomes. Our economic order may be thought of as a complex and vast

machine run by human beings for the purpose of human welfare. If prices move

up, the machine works in another manner. If prices move down, the machine works

in another manner. Nothing changes, so to speak, but the purchasing power of

money, yet that change is enough to promote or diminish human welfare. After all,

whether prices rise or fall, the sun still shines, water runs as before, the soil

remains fertile, and machines continue subject to the same laws of mechanics.

Whether prices rise or fall, men retain their knowledge of how to produce,

distribute, and exchange commodities.25

In a certain sense, therefore, our economic order is the slave of price change.

This is the basis of the case for price control. Man, it is said, should be the master

of prices. Man, it is argued, should regulate prices, instead of letting prices

regulate him. Those who believe in price control usually argue in favor of steady

prices. They say: "The government should not engage unthinkingly either in

inflation or deflation on a large scale. Each of these policies disturbs the even tenor

of production; one stimulates it too sharply and the other depresses it too deeply.

25 Ibid.

18
Deliberate inflation and deflation are both unjust. The one gives riches from to

those who are lucky enough to be in business, and takes away riches to those who

are unlucky enough to have fixed incomes. The other takes away riches from those

who work and produce, and gives riches to those who have lent money in the past.

Steady prices maintain the even tenor of production and distribute justice

impartially among individuals. Human welfare, our world being organized as it is,

depends as much on the behavior of prices as on man's knowledge of how to use

natural and physical forces. Since we seek to control natural and physical forces,

and aim to prevent them from harming human well-being, we should also seek to
26
control price behavior for the same purpose."

Other people deny the wisdom and practicability of maintaining prices at some

constant level. They argue that prices, under competition, represent "the natural

relations of supply and demand." What is "natural," they hold, should not be

disturbed. When production is kept in balance with consumption. Such people

argue, prices will take care of themselves. Suppose, however, that prices have

already begun to rise or fall. What should be done to check the tendency? In

circumstances like these, the believer in price control recommends either inflation

or deflation in minute doses, for, according to him, "A little inflation (or deflation)

at the right time is a good thing."27

26 Ibid. p. 339

27 Ibid.

19
 A little inflation or deflation: that is essential point. Too much inflation, by

forcing a world rise in prices, may bring about a rush of speculation and

production, leading finally to a crisis. Too much deflation, by forcing a headlong fall

in prices, may cause a breakdown in production and employment. Accordingly, the

government is advised to inflate or deflate by only the amount necessary to keep

prices at some level from which they have begun to depart. Some satisfactory

year, say, 1926, should be chosen to represent a price index of 100. Thereafter

every effort should be made to hold the index of later years at round 100, with only

the slightest and most gradual variations. To control prices in such a manner would

require a managed currency.28

B. NUMBER OF JOB EMPLOYMENTS

According to conventional economic analysis, increasing the minimum wage

reduces employment in two ways. First, higher wages increase the cost to

employers of producing goods and services. The employers pass some of those

increased costs on to consumers in the form of higher prices, and those higher

prices, in turn, lead the consumers to purchase fewer of the goods and services.

The employers consequently produce fewer goods and services, so they hire fewer

workers. That is known as a scale effect, and it reduces employment among both

low-wage workers and higher-wage workers. Second, a minimum-wage increase

raises the cost of low- wage workers relative to other inputs that employers use to

produce goods and services, such as machines, technology, and more productive

28 Ibid. p. 340

20
higher-wage workers. Some employers respond by reducing their use of low-wage

workers and shifting toward those other inputs. That is known as a substitution

effect, and it reduces employment among low-wage workers but increases it

among higher-wage workers.29

However, conventional economic analysis might not apply in certain

circumstances. For example, when a firm is hiring more workers and needs to

boost pay for existing workers doing the same work to match what it needs to pay

to recruit the new workershiring a new worker costs the company not only that

new workers wages but also the additional wages paid to retain other workers.

Under those circumstances, which arise more often when finding a new job is time-

consuming and costly for workers, increasing the minimum wage means that

businesses have to pay the existing workers more, whether or not a new employee

was hired; as a result, it lowers the additional cost of hiring a new employee,

leading to increased employment. There is a wide range of views among

economists about the merits of the conventional analysis and of this alternative. 30

After a minimum-wage increase, some employers try to preserve differentials in

pay that existed beforefor example, so that supervisors continue to be paid more

than the people they superviseby raising the wages of people who previously

earned a little more than the new minimum. Also, some wages determined by

collective bargaining agreements are tied to the federal minimum wage and could

therefore increase. As a result, an increase in the minimum wage causes some

29 Fairchild, Op. cit. 76

30 Ibid.

21
workers who would otherwise have earned slightly more than the new minimum

wage to become jobless, for the same reasons that lowerwage workers do; at the

same time, some firms hire more of those workers as substitutes for the workers

whose wages were required to be increased.31

The change in employment of low-wage workers caused by a minimum-wage

increase differs substantially from firm to firm. Employment falls more at firms

whose customers are very sensitive to price increases, because demand for their

products or services declines more as

prices rise, so those firms cut production more than other firms do. Employment

also falls more at firms that can readily substitute other inputs for low-wage

workers and at firms where low-wage workers constitute a large fraction of input

costs. However, when low-wage workers have fewer employment alternatives

overall, employment can fall less at firms that offset some of the increased costs

with higher productivity from employees working harder to keep their better-

paying jobs and with the lower cost of filling vacant positions that results from

higher wages attracting more applicants and reducing turnover. Some firms,

particularly those that do not employ many low-wage workers but that compete

with firms that do, might see demand rise for their goods and services as their

competitors costs rise; such firms would tend to hire more low-wage workers as a

result.32

31 Ibid. p 77

32 Ibid.

22
 The change in employment of low-wage workers also differs over time. At first,

when the minimum wage rises, some firms employ fewer low-wage workers, while

other firms do not; the reduced employment is concentrated in businesses and

industries where higher prices result in larger reductions in demand. Over a longer

time frame, however, more firms replace low-wage workers with

inputs that are relatively less expensive, such as more productive higher-wage

workers. Thus, the percentage reduction in employment of low-wage workers is

generally greater in the long term than in the short term, in CBOs assessment.

(However, the total reduction in employment might be smaller in the long term;

that total depends not only on the percentage reduction in employment of low-

wage workers but also on the number of such workers, which could decline over

time if wage growth for low-wage workers exceeded any increase in the minimum

wage, all else being equal.)33

Employers might respond to an increase in the minimum wage in ways other

than boosting prices or substituting other inputs for low-wage workers. For

example, they might partly offset a minimum-wage increase by reducing other

costs, including workers fringe benefits (such as health insurance or pensions) and

job perks (such as free meals). As a result, a higher minimum wage might increase

total compensation (which includes benefits and perks) less than it increased cash

wages alone. That, in

turn, would give employers a smaller incentive to reduce their employment of low-

wage workers. However, such benefit reductions would probably be modest, in part

33 Ibid.

23
because low-wage workers generally receive few benefits related to pensions or

health insurance. In addition, tax rules specify that employers who reduce low-

wage workers nonwage benefits can face unfavorable tax treatment

for higher-wage workers nonwage benefits. Employers can also partly offset higher

wages for low-wage workers by reducing either formal training or informal

mentoring and coaching. The evidence on how much employers reduce benefits,

training, or other costs is mixed.34

An increase in the minimum wage also affects the employment of low-wage

workers in the short term through changes in the economy wide demand for goods

and services. A higher minimum wage shifts income from higher-wage consumers

and business owners to low-wage workers. Because those low-wage workers tend

to spend a larger fraction of their earnings, some firms see increased demand for

their goods and services, boosting the employment of low-wage workers and

higher-wage workers alike. That effect is larger when the economy is weaker, and it

is larger in regions of the country where the economy is weaker. Low-wage workers

are not the only ones whose employment can be affected by a minimum-wage

increase; the employment of higher-wage workers can be affected as well, in

several ways. Firms that cut back on production tend to reduce the number of both

higher-wage workers and low-wage workers. But once a minimum-wage increase

makes higher-wage workers relatively less expensive, firms sometimes hire more

of them to replace a larger number of less productive low-wage workers. Another

factor affecting higher-wage workers is the increase in the economywide demand

34 Ibid. p. 78

24
for goods and services. All in all, a higher minimum wage tends to increase the

employment of higher-wage workers slightly.35

C. DEMAND AND SUPPLY

Specialization necessitates exchange and exchange implies a rate or rates of

exchange. Hence, a consideration of specialization and the division of labor leads

to a consideration of the problem of value or price. We have to inquire, them, what

forces determine the value of any kind of goods in terms of other goods or what

forces determine the value or price of any one kind of goods in terms of the

medium of exchange, money. What forces bring it about that, for example, wheat

is worth (say) $1 per bushel and bituminous coal $10 per ton? The forces which

determine prices express themselves through the competition of buyers and

sellers and this competition is the outgrowth of the various alternatives of these

buyers and sellers. Thus, consider the determination of a price per ton of $10 on

coal. If the various forces expressing themselves through the market fix the price

of $10, this must be the price at which the demand and the supply are equal. For it

can be shown that a price either lower or higher than such an equalizing price

represents a condition of unstable equilibrium and cannot continue. Suppose that,

while $10 is the equalizing price, the market price is $8. This lower price would

mean that more coal would be purchased than a price $10. Some persons who, at

$10, would have economized in their purchases of coal would, at $8, more fully

35 Ibid.

25
satisfied their desire for heat. The lower price would mean a larger demand than a

higher price.36

On the other hand, at the relatively low price of $8, some producers would find

continuance of production unprofitable and would cease to mine coal. The richer

mines could doubtless still be operated profitably, but the mines which, at $10 a

ton, barely paid the expenses of operation, the so-called marginal mines, would

not be used, continued operation of these poorer mines might be possible, so far

as the operators were concerned, if the mine employees would consent to a

substantial reduction in their wages. Such a reduction, even though made, would

probably leave in the work of coal mining some employees who were relatively ill

adapted or poorly prepared for other work. But any considerable reduction in the

wages of coal miners generally while wages in other lines remained as before,

would reduce the output of coal. A price of $8 would, then, mean a demand for

coal appreciably in excess of supply. Buyers would, at that price, desire more coal

than they could get. All could not be satisfied. The tendency would be to sell the

coal to those persons willing to pay the most; and the price would rise to such a

point that demand no longer exceeded supply.37

As the price of coal, under the assumed conditions, could not fall much below

$10 without setting into motion a train of forces which would raise it so it could

not rise much above %10 without setting into motion forces which would lower it.

36 Brown, Op. cit. p. 110

37 Ibid.

26
Thus, suppose a price of $12 a ton. Such a price would curtail buying. It would

stimulate economizing in the use of coal, where, were the price lower, the coal

would be consumed more carelessly or more freely. The price of $12 a ton would

also be a price at which, could they receive that price, operators would be willing

to utilize relatively poor mines, even, perhaps, if this meant paying somewhat

higher wages to secure more labor. But this would mean an excess of supply as

compared with demand. At $12 a ton more coal could be produced than could be

sold. Since, all who would be willing to produce coal at $12 per ton could nor

remain in the business (or the work, in the case of the laborers) of coal mining and

sell their coal at that price, those would sell and would remain in the business who

were willing to take the lowest price; and those workers would get employment in
38
the industry who were willing to work for the lowest wages.

Competition would bring the price down to such a point that supply no longer

exceeded demand and would tend to bring wages down to such a point that supply

of workers no longer exceeded demand, the surplus workers preferring, at the

wages paid, to seek employment in other industries.39

The analysis is of course similar in the case of wheat. But while a lowered price

of coal diminishes supply through making the operation of the poorest mines

unprofitable and causing their abandonment, a lowered price of wheat may

diminish supply as well by causing the diversion of some wheat land to other lines

38 Ibid. p. 111

39 Ibid.

27
of production. While a coal mine cannot be used as source of copper or iron ore, a

wheat farm can often be used to produce hay, corn or oats. Hence, a price of 90

cents a bushel for wheat might at the same time cause the non-living cultivation of

some land previously used wheat production, the diversion of some land to the

production of corn, rye, hay, potatoes, etc. the use for producing rye or oats of

equipment previously used to produce wheat, and the devoting to other kinds of

production of labor which, at a price $1 per bushel, would have found production of

wheat worth while. Thus, the relation between the amounts of goods produced in

various lines depends partly upon the desires and means of purchase of consumers

and partly upon the obstacles to production met by producers. If consumers desire

much of a given kind of goods they must be ready to pay a price high enough to

draw into the production of such goods a large amount of labor, capital and land. It

will not exactly do to say merely that price paid by consumers must cover the cost

of production. For cost of production is variable and itself depends upon the
40
amount produced.

The cost of production of wheat is the amount that must be paid to bring into or

keep in the production of wheat the labor, land and capital requisite to produce it.

The amount necessary to keep labor in wheat production depends on what labor

can get in other kinds of production. The amount necessary to keep capital and

land in wheat production depends upon what the owners of the capital and land

can get, as interest and rent respectively, if the capital and land are otherwise

used. But some laborers will stay in wheat production for a less wage per bushel

40 Ibid.

28
produced than others, either because they like the work better than any other

work, or because they are relatively efficient in it, or because they are relatively

inefficient in other work. Likewise, some land will be kept in wheat production at a

lower price of wheat per bushel than is necessary to keep other land in it, because

the land id well adapted to the production of wheat or because it is ill adapted to
41
other lines.

Cost of production is therefore, not a definite expression unless it is used in

connection with a definite part of the product or in connection with an assumed

definite total output. If the total output is assumed as definite, then we may speak

of the marginal cost of production of wheat as being the amount or price necessary

to keep in wheat production that labor, that capital and that land which, at any less

wages, interest and rent for wheat production and, therefore, at any lower price for

wheat, would be turned to some other line or lines of production. If no less wheat is

required by purchasers, then the price of wheat must cover this marginal cost. In

other words it must be high enough to give to the labor, capital and land which is

marginal between this and other production as much as these factors could get in

such other production, and so keep them in this.42

Can a demand for increased wages raise the level of prices? Any large increase

of money and deposits would tend to have the same kind of effect on wages as on

other prices. It is a fact in common observation that, when prices are rapidly rising,

41 Young, Op. cit. p. 235

42 Ibid.

29
wages also rise. This rise of wages cannot be explained merely by reference to the

increased cost of living and to a resulting need for higher wages. It is true that

increased prices often cause discontent among wage earners and make them ask

more insistently for wage increases. But in the absence of increased demand for

labor, higher usages would mean fewer men employed; and the competition

resulting from wide-spread unemployment tends to reduce wages. On the other

hand, it is equally illogical to argue that demands for increased wages can explain

general rise of prices. Yet such a theory is often advanced by newspaper writers,

by members of the employing class, and by sympathizers of that class, in periods

of rapidly rising prices. It is observed, in such periods, that wages are rising. Basing

their notion of what constitutes a fair rate of wages upon what wages have been in

money, some employers are apt to feel resentful at the continued demands for

higher wages and are so predisposed to attribute to the action of laborers and

labor unions the concomitant rise of prices.43

Furthermore, in an era when manufacturers and other producers are under

criticism because of price increases and are being referred to, often, as

profiteers, it may seem convenient to be able to find some other persons upon

whom to put the blame, indeed, some producers doubtless sincerely feel that they

are raising their own prices just because of the fact that they have to pay higher

wages. And it is true that if, there being less demand for labor in other lines, these

producers could easily get more labor and turn out a larger supply of goods, the

prices of these goods would be lower. But to say that a demand for higher wages

43 Ibid. p. 236

30
by wage earners increases the price level generally is a very different thing. For,

except as the laborers increase the money and credit in circulation or decrease the

volume of goods to be exchanged, they can hardly be expected to increase

average prices. If wage earners succeed in getting higher wages generally, and if

neither money in circulation nor circulating credit increases, then their employers,

or capitalists, landowners must get less. Probably, however, higher general wages

would decrease employment, make supply of labor in excess of demand, and force

a reduction of wages to the old level.44

But let us suppose a successful attempt of the wage earners in some one line,

to raise their wages, suppose the coal mine workers succeed in raising their wages,

by threats of a strike, above the normal relationship of these wages to wages in

other lines. Then, unless the coal mine operators would remain in business with

smaller return to themselves- possibly at a considerable loss- or unless they could

reduce sufficiently their rental or interest expenses- conceivably, in some cases, to

less than nothing- coal would have to rise in price in order that the public should

be able to get it. The reasoning of many persons would be to the effect that, as

coal is used in most industries, the cost of producing goods must be greater and

that, therefore, the prices of these goods must be higher. Such reasoning fails to

take account of the relation between prices and the media of exchange. If coal is

made higher in price and if, in consequence, the public in general spends more for

44 Ibid. p. 237

31
coal than before, there will be correspondingly less money spent for other goods.

Then other goods must fall in price if they are to be readily sold.45

No more being spent than before in any given period for all goods more being

spent for coal, less is spent for other goods. If, the minuend remaining the same,

the subtrahend becomes greater, the remainder must be less. To be sure, the coal

miners will spend their increased wages- after these are received. But had the coal

not gone up in price, consumers would have been able to spend this extra money

at once on the other things, and the producers and sellers of these other things

would have spent it after receiving it, presumably as quickly as the mine operators

and workers. Hence, its diversion to pay for coal must tend to reduce other prices.

If producers of other goods cannot stay in business and pay the former rate of

wages, while receiving these lower prices, demand for labor in these other lines

may decline and wages in them may fall.46

But suppose that, in consequence of the higher price of coal, the public

generally buys much less, so that the total amount of money spent for coal is not

increased. Then there is as much money to spend for other things before. In this

case, however, the fact that less coal is produced means that some of the coal

miners are superfluous as such. Unless the adjustment to the diminished demand

is made by a reduction of the hours of work of each miner, it must involve the

necessity, for some, of seeking other employment, this would tend to increase the

45 Ibid.

46 Ibid. p. 238

32
supply of labor in other lines, to lower wages in these lines, to increase the supply

of the products of these other industries and to lower their prices.47

It is curious the amount of theory- and fallacious theory at that-which fills the

minds of men who pride themselves on being practical. It seems obvious to

many such men, from their theorizing, that prices rise because of the demands of

organized labor; yet only a little observation and reflection should demonstrate

that wage earners are just as anxious to increase their wages at other times when,

nevertheless, they are unable to do so. In 1919 demands for wage increases were

insistent and were frequently granted; prices, also , rose. When, in 1920 and in

1921, wage increases ceased and decreases began, this was certainly not because

wage earners desired it so. The reduced wages came because the demand for

labor at the previously prevailing wages, was declining, as was the demand for

goods at the previously prevailing prices. Even had any group of wage earners

then succeeded in raising its wages, it could not have stemmed the tide of general

price decline. We can, therefore, more reasonably think of wage and price changes

as being, in the main, joint effects of a common cause, than as being, either, the

cause of the other.48

If wage increases can ever be a cause of price increases, this must probably be

when bank reserves are in excess and when credit expansion is, therefore, easily

possible. Under such conditions it is quite conceivable that demands for higher

47 Ibid.

48 Ibid. p. 238

33
wages might lead to larger loans from banks to employers and that the increased

money and credit so circulating would operate to raise prices. But it is also

conceivable that increased wage bills of their customers would in some cases

cause bankers to fear that these customers would lose money, and that the banks

would, therefore, loan more hesitatingly and in smaller amounts than before. Also,

in case bank reserves are in excess, it is at least possible, if not probable, that

loans would be expanded and prices rise in equal degree whether or not wages in

any line were advanced first. In the long run the demands of wage earners are

quite likely not to influence in any considerable degree the ratio of bank reserves

to loans or to deposits. And, certainly, such demands can hardly increase credit
49
and raise prices when bank reserves are not in excess of requirements.

A demand of wage earners for higher wages probably would not appreciably,

the output of goods for any long period, since wage earners cannot afford to

remain long idle. It would not usually, if ever, increase bank loans and the volume

of bank deposit accounts. It could not, therefore, be a significant force in raising

prices. All this does not mean that there is no such thing as a "demand for money."

Using the word money in its broadest sense, including all "rights to receive money"

that are used in making payments, it is clear that every sale of a commodity may

be viewed as a purchase of money, and every purchase of a commodity as a sale

50
of money.

49 Ibid.

50 Ibid. p. 239

34
 Going a step farther, and remembering that one wants money only because of

the things money will buy, we may say that every sale of one commodity is

purchase of the power of acquiring other things. A buyer cares not how much

money he parts with in exchange for a definite quantity of goods, except in so far

as the money has alternative uses of greater or less importance. The quantity of

money-the number of dollars in the aggregate supply of the instruments in which

payments are made- has no significance apart from the values of the dollar. These

two things- quantity and value- are in the case of money bound together in a

peculiar way. There are, in a very real sense, not only interdependent but

interchangeable. A small amount of money of high purchasing power per unit.51

1. JOINT SUPPLY AND JOINT DEMAND

Two cases of value, sometimes called special cases though really, perhaps,

more usual than the more simple case, remain to be cleared up. One is the case of

joint demand; the other is the case of joint supply.52

Demand for the services of railroads may be mentioned as a case of joint

demand. Demand for rail transportation involves, indirectly, demand for rails, ties,

ballast, engines, cars, services of engineers, etc. All of these together are

necessary for transportation. Demand and supply fix a set of rates for

transportation and these rates go out indirectly as payments for the various

services by which the service of transportation is made possible. If any one thing

51 Ibid.

52 Brown, Op. cit. p. 71

35
needful form transportation is scarce, ties, the price of that thing may go very high

indeed without raising the price of transportation in anything like the same degree,

and therefore without greatly diminishing the demand for transportation. The

different articles and services included in joint demand may change greatly in price

relatively to each other, according to their relative costs of production, without

changing the price or the demand for the desired combined service.53

Joint supply is the familiar case of by-products. Two or more things are in part

produced by the same process. In this case, as in most cases of joint supply or joint

cost, not all of the cost is joint. The cost of shearing is not joint but is necessary

only to get the wool. The cost of slaughtering is necessary to get the mutton. The

expenses of marketing are also, for the most part, special. But a considerable part

of the total expense is joint. In the case of joint supply, a part of the expense of

production, the part which is joint, will be covered in varying proportions in the

price of the several goods so produced, according to the relative demand for such

goods. The producers must, in the long run, receive, from all the goods jointly

produced, the average return on the labor and capital applied to production of such

goods. But any one of the by-products may, if demand for it is small, sell for little

more than enough to cover the special expense of producing and marketing it. 54

D. CRISIS AND DEPRESSION

53 Ibid.

54 Ibid. p. 72

36
 The crisis is the beginning of a period of liquidation. This is a period when old

debts are paid off faster than a new ones are made. So far as concerns bank credit,

it is a period when the banks are making new loans and renewals more

circumspectly and hesitantly than ordinarily. Our present problem is to discover the

factors which explain the development of this policy. There are several lines of

development which may, possibly, tend to produce a crisis. The most obvious and

probably the most fundamental is the diminishing ratio of bank reserves to bank

deposits, as a result of which bankers come to feel that further credit expansion is

dangerous and that loans should be made carefully. This feeling is accentuated by

such other conditions in the business world as may appear, to bankers, likely to
55
precipitate trouble for which they would wish to be prepared.

A second possible influence is the uneven variation and adjustment of expenses

and prices. The period of prosperity is a period of rising prices, rising wages, rising

discount rates on short-term loans, rising interest charges on long loans and rising

rentals. At first, the discount and interest rate and rentals do not greatly rise. The

so-called supplementary expenses of business concerns, such as interest on

funded debt and rentals for real estate hired, are expenses fixed, in many cases,

by previous contract, for many years in advance. In the early stages of revival,

many contracts previously are made are still operative. Interest owed each year on

funds secured by the sale of ten-year or twenty-year bonds is what it was when the

bonds were first issued. Rent on property leased remains what it was when the

lease was arranged for. But if loans have to be refunded at the height of prosperity,

55 Ibid. p. 120

37
higher interest is likely to be charged. And if rental contracts have to be renewed

when business confidence is greatest and demand for space most insistent, the

sums paid in rent will be larger. Thus it may be that the inactive elements in

business ventures during the early period of prosperity, receive a larger part as

prosperity approaches its peak.56

If this is so, then the business-enterpriser class finds its large profits of early

prosperity being cut into, as prosperity near its end, by the growing incomes of

these inactive elements. Conclusive statistical evidence that the active elements in

business, as a whole, are making less near the termination of prosperity than

during the months or years immediately preceding, is probably not now available.

Indeed, this may not be the fact. Perhaps in some cases prices rise, almost until

the crisis itself, fats enough to keep ahead of rising interest and rentals. But a high

interest or a high rent which could be easily met if prices continued to rise, may

prove to be a heavy burden if, because of restricted bank credit consequent on

diminished proportionate reserves, prices in general cease to rise or begin to fall.

At any rate, interest and rentals do rise; they are apt to be highest late in

prosperity; and it is probable that some business concerns, at least, have their

profits narrowed in consequence. This tends, of course, to make the banks less

willing to grant them large credits. Yet if bank reserves are ample and business

confidence is high, decreased loans to some concerns may go along with increased

loans to others and business activity may continue without abatement. The

56 Ibid. p. 121

38
condition of bank loans and deposits and of bank reserves is, therefore, the most
57
fundamental factor in the problem.

The period of prosperity may be marked by some unevenness of demand or

some maladjustment of production. A spirit of over-confidence, even of

speculation, may cause retail dealers to order from wholesalers more rapidly than

they are selling to consumers, and may cause manufacturers to order raw

materials in excess of their immediate needs for turning out finished products. If, in

any line, there appears to be a deficiency of goods, and producers ship less

amounts than are ordered, some dealers may deliberately order more than they

want in the hope that, after the order is trimmed down by producer, they will still

get what they need. This, of course, tends to raise the prices of the goods so

ordered. At any rate, it appears to be a fact that, as prosperity develops, raw

materials rise in price more than finished products, producers goods more than

consumers goods, and wholesale prices more than retail. So long as

supplementary expenses, such as rentals and interest on long-term loans, do not

rise, manufacturers and middlemen may derive an increased return from their

more active business, despite the more rapidly rising prices of raw materials and

wholesale goods than of finished products and retail goods. But when

supplementary expenses also rise, the rise of raw materials and wholesale prices
58
becomes a matter of concern.

57 Ibid.

58 Ibid. p. 122

39
 The returns in some lines of business may, in consequence, be seriously

reduced. In other lines, the returns may seem to be unusually large but if such

returns depend upon a continuance of maladjusted and, perhaps, speculative

demand they can only temporary. So far as demand for raw materials and

wholesale goods is thus speculative, any considerable sign of approaching crisis

will cause this demand rapidly to fall off. And so far as the effect of it, through

increasing the expenses of manufacturers and dealers, is to lower their net returns,

it tends towards hesitation, on the part of producers, wholesalers, etc. in selling

59
them goods on time (book credit or charge accounts).

Here again, however it should be noted that hesitation on the part of banks in

loaning to some customers, whose profit margins are being narrowed, may go

along with increasing loans to others whose profit margins remain wide or are

growing wider. Even while prosperity is increasing, some concerns do poorly and

find credit difficult to obtain; yet this does not bring crisis or depression. May not

the nearing of the limit to which, under reserve requirements, credit can be

extended, be the principal influence tending to bring crisis depression? If

restriction of credit occurs on any large scale, it must sharply diminish effective

demand for raw materials and finished products. If, furthermore, repayment of

loans is called for from persons or business concerns that have borrowed to

produce raw materials or manufactured good or to buy goods at wholesale or

retail, these persons or concerns may be forced to sell out at comparatively low

59 Ibid.

40
prices. Restriction of credit tends, thus, both to decrease the demand for goods
60
and, in some degree, to increase the supply.

Taking the credit structure as a whole or, more narrowly, taking the banks as a

whole, there is no such thing as self-liquidating credit. Those who have borrowed

to buy goods and who, being unable to renew their loans, have to sell, can sell only

to persons whose buying power, at anything like prevailing prices, depends on

bank credit. The buyer is, usually, a borrower, in large part, of the means to buy.

But even if he is not, his buying power depends on bank credit; for the goods he

himself has sold, in order to get the means to buy other goods, are bought with

funds borrowed from banks. Even the retailer who sells in small quantities and for

cash to wage earners, is dependent for his sales upon the wages which his

customers receive; and these wages, in all probability, are paid with money

borrowed from banks.61

Let us, then, give consideration particularly to the banks and to their condition

towards the end of prosperity. Their loans are large. Hence, deposits subject to

check are likely to be large relative to the bank reserves. The amount of money in

circulation bears a larger proportion to the amount of money in bank reserves than

during the preceding stages of the cycle. As a result of the comparatively deficient

bank reserves the banks are charging higher interest and discount rates than

before. And they may even be putting an arbitrary limit on their lending. The

60 Ibid. p. 123

61 Ibid.

41
higher interest, by itself, doubtless has some tendency to restrict borrowing. And

as it operates to reduce the salable value of many securities and so to reduce the

value of their collateral, it may lessen the borrowing even of some to whom the

high interest rates would be no deterrent. The growing restriction of credit

exercises not only a direct but also an indirect effect on the demand for goods and

services. Men who are ready to order large quantities of goods when they fear that

prices are going to rise still further, rapidly lose their enthusiasm for such large

purchases when limitation of credit makes prices cease to rise, and are anxious to

cut their orders to the lowest point when they become convinced that prices will

fail. They, therefore, borrow less from the banks to buy with, even though their

credit is good, their collateral ample, and the discount rate which seems high to

others a matter of minor importance to them. Or, if they do not borrow less, they

spend their money and checking accounts more hesitantly, which is to say less

rapidly.62

As bank credit decreases, book credits or charge accounts probably also

decrease. The business establishment to which credit is refused by its bank, or

whose credit is sharply limited, is less able, itself, to extend credit to customers.

And as business becomes less active and prices begin to fall, suspicion of the

solvency of customers may lead to further limitation on their credit buying. Then

the demand of these customers for goods is almost necessarily decreased. All

along the line, then, there is in evidence a tendency towards diminishing demand.

There is diminishing demand for manufacture goods, diminishing demand for raw

62 Ibid. p. 124

42
materials, diminishing demand for labor, diminishing demand of consumers for

goods at retail. From the stage of prosperity, business has passed, through the so-

called crisis, into the stage of depression.63

But why should a decrease of credit and a decreased spending for goods,

necessarily involve business depression? It must, clearly, involve either a reduction

of prices or a decrease of business or both. And we cannot reasonably expect that

the entire effect of the decreased expenditure of money and credit will be

expressed, immediately in lower prices. Producers and dealers will not see why

they should accept greatly prices for their output or for the goods which they have

bought to sell. They will lower their prices only with reluctance. Artisans and

laborers will not easily be convinced that there is any adequate reason why they
64
should take lower wages.

Persons who have land and buildings to rent or to sell will not readily

understand why they should accept lower rents or price than those which they

have come to look upon as reasonable. Speculative holders of vacant land will, in

many or most cases, continue to ask the prices they have been asking. But with

less money and credit being spent, unless prices-in-general fall in proportion, the

volume of business must decline. Continued lack of demand for goods and labor,

with unsalableness of goods and diminished employments for laborers, will force a

readjusting reduction in prices and wages. The will to maintain prosperity prices

63 Ibid.

64 Ibid. p. 125

43
wages is broken by the compulsion of circumstances. And there is doubtless some

level of prices, wages, etc. low enough so that, even with greatly diminished

spending, business would be active. But the process of readjustment- through

lowered prices, lowered discount rates, growing confidence, and increased

borrowing-may be one requiring several months or (sometimes) years, during

which business is relatively inactive and depression is said to continue.65

Business depression is the occasion of tremendous waste, since it means the

inactivity of many men and the non-use of much capital. It is marked by

widespread unemployment, diminished comforts, and sometimes serious

deprivation among wage earners. Bread lines, parades of the unemployed, and

similar phenomena are common consequences in the industrialized countries,

where the alternation of prosperity is most extreme. Workingmen feel themselves

injured by forces which they do not understand and which they cannot control. And

they are too easily induced to impute responsibility to others, the leaders of

government and the leaders of industry, who seem wiser than they but who are no

more able to apply a remedy.66

65 Young, Op. cit. 24

66 Ibid.

44
CHAPTER 3

III. RATES OF PRICE CHANGE

We have seen that some discrimination in rates is economically defensible end

even desirable. Business which cannot be secured except at low rates and which

can be handled without increase of plant facilities may properly be taken at lower

than average rates if these low rates cover the special or additional costs which

can be handled without increase of plant facilities may properly be taken at lower

than average rates if these low rates cover the special or additional costs which

the business imposes. But although some business may advantageously be taken

at these low rates, the business as a whole should be able to pay a reasonable

return on the fair value of the property. Here we have an objective test of whether

land, labor, and capital should be or should have been devoted to this particular

service. Unless the public is great enough so that rates can be paid yielding as

much on the land, labor, and capital used as this land, labor and capital would

yield if it had been devoted to other lines, there is a fair presumption that the land,

labor and capital might better have been used in such other lines.67

It would seem, then, that the most satisfactory impersonal test of the worth-

whileness of a given public service is the ability of the public served to pay rates

high enough so that the labor in this industry is as well paid as it would be

elsewhere, so that the land used yields as large a return to its owners as it would if

67Brown, Op. cit. p. 167

45
otherwise used and so that the capital constructed yields as large a recent on its

cost as if the savings which made possible its construction had been turned,

instead, into other lines or other places. Unless the public can afford such rates,

the construction of the plans should not be undertaken and the capital and labor

should be used for other purposes or in other territories. But not to permit rates

which yield returns comparable to the returns in competitive industries, when the

public does need and can pay for the service, is to risk preventing the investment

of land and capital in the needed service.68

On the other hand, exorbitant rates charged to the public are also

objectionable. Such rates not only enrich the owners of public service industries at

the expense of the industrial and the consuming public. They also injure the public

still further by preventing a worth-while development of the service. If telephone

rates are too high there is an injury not only to those who pay the high rates but

also to those who are prevented by these high rates from having convenience of

telephone service. What those lose who are overcharged for the service, nobody

gains. If electric power rates are exorbitant the loss is not only in the higher rates

paid by those nevertheless purchase the power (and, ultimately, by consumers of

the product made with the aid of this power) but also in the less economical

methods of industry or in the uneconomical diversion of manufacturing industry to

other localities.

69
To measure rates of change in price levels, some sort of "price index" is used.

68 Ibid.

46
A. PRICE INDEX

1. WHOLESALE PRICES

Wholesale prices move faster (both up and down) than retail prices, retail

prices faster than the cost of living. Offhand, it might seem that retail prices ought

to change at the same rate as wholesale prices. However, the cost of the

wholesale commodity is in most cases only part of the total cost of the retail

commodity. Thus, if silk rises from $1.50 or $3.00 a yard (100percent) silk dresses

may rise from $20 to $30 (50 percent). Retail prices and the cost of living as

calculated in the usual indexes, are not the same thing. Rent, which accounts for

about 15 to 25 percent of the cost of living for most city families, is not included in

the many indexes of retail prices. And rent (for various reasons) changes less

rapidly than the retail prices of food and clothing.70

2. RETAIL PRICES

The retail prices paid by the consumer do not generally respond to all the

variations in wholesale prices brought about by changes in supply and demand.

There are sometimes tacit or explicit local price agreements between local

merchants, which apply even to competitively produced goods. Some retailer

consistently sell a few kinds of goods at less than cost to attract custom for the

goods on which they may make a profit. Merchants who make a specialty of a high

69 Ibid. p. 168

70 Atkins, Op. cit. p. 329

47
class of goods, and thus cater to a wealthy clientele, are prone to exact higher

prices for ordinary goods than do merchants who deal with a poorer class of

customers. Custom has more effect on retail than on wholesale prices. The prices
71
of the various articles sold by haberdashers illustrate the influence of custom.

Retail prices are also influenced by the denominations of the coins in general

use, and are generally expressed in round numbers. In the long run, demand and

supply govern retail prices, but they do not set a definite price point so accurately
72
as they do in the case of most wholesale prices.

3. COST OF LIVING

We shall see that much the same kinds of competitive forces which fix any one

price in relation to other prices, fix the general level of prices of goods in terms of

money. We shall consider supply of goods, including the services of labor and of

waiting offered for money, and the demand for goods by those having money to

spend. Where there is only fiat money, the supply of goods in general, offered for

money, at any level of average prices of those goods, would be just the same as at

any other level of prices. This is very nearly true no matter what the money what

the system. If wheat prices are higher than corn prices, or vice versa, productive

effort may be diverted from one line into another. If the general level of prices

71 Ibid.

72 Ibid. p. 330

48
should double, there is no reason to believe that the amount of goods produced for

sale would on that account greatly increase.73

Supposing a community to be in reasonable prosperity and business activity at

the lower prices, an increase of these prices would not make possible a very

greatly increased production. It would not enable men to work longer hours nor

would it make machinery more efficient. Neither would it stimulate the sales of

goods by making such sales more profitable, since a general rise of prices simply

means that money has a less value. If everything should sell for twice as much

money as before, the sellers would gain nothing, for the things they desire to buy

would also cost twice as much. Looking at the matter from any reasonable point of

view, it must be admitted that the supply of goods in general, at a higher level of

prices, would be no greater than at a lower level. Likewise, at a lower level of

prices, the supply of goods would be no less than at a higher one. A lower level of

prices would not mean less activity or a smaller sale of goods. It would pay as well

to sell goods at a low level of prices as at a high level, since at the lower level the

money received would have correspondingly greater purchasing power.74

The lower level of prices would only decrease the supply of other goods and the

higher level increase it, in one contingency, and then only to a very limited degree.

When the currency system is based on a precious metal, gold, a lower level of

prices means a higher value of gold as money. It might therefore divert some labor

73Brown, Op. cit. p. 195

74 Ibid.

49
from the production of other goods to the production of gold for coinage. A higher

level of prices might tend, in the same degree, to divert labor from gold production

towards the production of other goods. To this extent only, a higher level of prices

would tend to increase the supply of goods in general other than money, and a

lower level of prices to decrease it.75

On the other hand, a higher level of prices of goods would tend to decrease the

demand for goods by persons having money to spend. For with higher prices, and

no greater amount of money to spend buyers of goods would be unable to

purchase as much as at lower prices. Lower prices of goods would mean that the

money of purchasers would go farther. Prices would tend to increase in nearly the

same proportion. Suppose prices did not rise. The purchasers of goods would buy

all they were in the habit of buying and still have as much money left to spend as

they formerly spent all together. This they would endeavor to spend at once. For in

modern countries money is not hoarded away, but only enough is kept on hand for

emergency requirements, and the rest is spent. Those who save are spending just

as effectually as any others. The difference is in what they buy. Those who save

buy factories, warehouses, railroads, farms, etc. Even though their savings are put

into a savings bank, they are none the less spent for investments goods. It follows

that a sudden doubling of the amount of money, if prices did not increase, would

mean a demand for goods far exceeding the supply, the amount of land is

75 Ibid.

50
practically constant. Doubling the amount of money would not enable people to
76
work longer hours and so increase the products of labor.

The supply of goods to be sold simply could not be doubled except with an

increase of population or invention. The increased money would therefore mean

that at the old prices the demand for goods in general would exceed the supply.

Purchasers would bid against each other. Prices would rise. Equilibrium would only

be reached, supply and demand be equal, at a general level of prices nearly twice

that which had preceded.77

In a country which has a gold standard monetary system prices are largely

dependent upon the amount of gold mined and hence upon the number and

richness of gold mines. If prices rose equally, this would mean a doubling in the

money wages of labor for the same results produced and similarly, a doubling in

the money interest receive for waiting. Aside from disturbing effects during the

period of transition the rate of interest would be the same with the high prices as

with the low. The money value of the sum waited for would be doubled and the

money value of the interest would be doubled. The ratio between them would be

the same as before. In other words, since prices have doubled, borrowers, for

example, would require twice as many dollars as before and would also, of course,

pay twice as many dollars in interest.78

76 Ibid. p. 196

77 Ibid.

78 Ibid. p. 197

51
 In the light of the principles above set forth, regarding supply and demand, we

can explain why the excessive amounts of inconvertible paper money sometimes

issued by government, issued particularly in time of war, have resulted in very

exceptional rises in the price level. This increased amount of money means, at any

level of prices, a greater demand for goods. Therefore, that the demand for goods

may not exceed the supply, the level of prices must rise. There is another factor of

importance at such time, public confidence in the money issued. If there is a

general belief that the money will become absolutely valueless or greatly decrease

in value, then many who have goods to sell will refuse to sell them for this money,

but will demand gold or silver or other goods in exchange. This decrease in the

supply of goods, offered for money, will mean that only a higher level prices than

otherwise would result can equalize supply and demand.79

4. RAW MATERIALS, SEMI-MANUFACTURERS, FINISHED PRODUCTS.

Raw materials move a little faster in price than semi-manufacturers, and semi-

manufacturers much faster than finished products. As we go outward from the raw

material to the finished product, the original commodity price becomes a smaller

and smaller percentage of the total cost. Labor costs, transportation, charged,

mortgage interest payment, fuel, power and light bills, real estate taxes and

rentals are all added. Many of these later charges are relatively unvarying. A

mortgage or interest payment may be determined by contract for many years in

advance. Wage rates may be determined for a long time to come by a collective

79 Ibid.

52
bargain between the employers and trade unions. Real estate taxes may be

changed only at infrequent intervals. Into the prices charged by public utilities,

there may enter a certain amount of monopoly power.80

CHAPTER 4

IV. PERSONAL INCOMES

Personal income refers to an individual's total earnings from wages, investment

enterprises, and other ventures. It is the sum of all the incomes actually received

by all the individuals or household during a given period. Personal income is that

income which is actually received by the individuals or households in a country

during the year from all sources. Personal incomes may be of two types, fixed and

varying. If an income remains fixed while prices continue to rise, the sum of money

represented by that income loses steadily in purchasing power. If an income

remains fixed while prices continue to fall, then the sum of money represented by
81
that income gains steadily in purchasing power.

In almost any establishments, any increase in product will be attended by some

specific increase in expenses: more raw material and more labor will be used,

possibly more power; although the increased expenses for labor and power may

not be proportionate to the increase in production. Such expenses are called

80 Atkins, Op. cit. p. 330

81Ibid. p. 331

53
variable expenses, and are to be contrasted with fixed expenses, which remain

approximately the same, no matter what the amount produced is. The interest on

the funds invested in the factory building and its equipment of machinery is a fixed

expense; the expense of management and general office expenses will not usually

be increased proportionately by an increase in the annual product of an

establishment. It is often assumed that whether only a part of the expenses varies

with the amount produced, the establishment is ipso facto one in which large-scale

production is especially economical. Whether this assumption holds true or not

82
often depends on the scale of production we have in mind.

Factories and other plants are built with a certain maximum capacity, and until

that maximum capacity is utilized, production may be increased without a

proportionate increase in expenditure. But when the maximum is reached, more

equipment, and often more building, will be needed before there can be a further

increase in product. There is often a certain most efficient size of plant; an increase

in business beyond the capacity of the most efficient size of plant necessities

either a curtailing of the business or a duplication of a plant. When business

conditions are such as to warrant temporarily pushing the output of a plant beyond

its normal capacity, the result is, as every manufacturer knows, that this increased

output is produced uneconomically, that is, at relatively increased expenses of

production per unit of output. Many seemingly constant expenditures (like interest

on cost of the plant) are variable in the long run. Such expenditures increase, but

only at considerable intervals of time, as additional investments in fixed capital are

82 Ibid.

54
made. From the long time point of view, the expenses of production per unit of

output in such an establishment might be approximately constant; although of

course some of the real economies of large-scale production might be present and

might result in really smaller expenses, per unit, for a large than for a small

output.83

Relation of fixed and variable expences to prices. The fact that, within limits,

the expenses of a business undertaking do not increase proportionately as the

output increases has an important bearing upon competitive price-making. The

proprietors of a business establishments of a business establishment will feel

justified in increasing their output, provided the additional output will sell for

enough to afford some profit above the actual amount by which it increases their

expenses. If the full capacity of their plant is not already utilized, they will count as

profit any additional income they can secure above the necessary increase in

variable expenses. If they are producing some staple commodity for the general

market, so that they cannot discriminate in the prices at which they sell to different

buyers, they will find it difficult to cut prices on part of their output. But if they are

producing a variety of goods, if they are making highly specialized products to

order, or if they are selling in two or more widely separated markets, they may

often be able to increase their output by accepting prices too low to contribute

anything to the payment of their fixed expenses. This is often the explanation of

the dumping of part of a manufacturers product on a foreign market at a lower

price than he charges at home. Railways are able to take advantage of the fact

83 Ibid. p. 332

55
that only part of their expenses vary with their traffic, for they do not have to

charge a uniform rate per ton per mile, but can classify their rates according to the

origin, destination, and nature of the traffic. The rates charged by electric plants

are often less for current use at certain hours of the day when the capacity of the

plant is only partly utilized.84

If a business establishment is hard pressed by competition. Or if for any other

cause, such as a dull season, its sales are small. Its proprietors may decide to cut

prices on their whole output to a point that will cover variable expenses and

possibly contribute toward meeting fixed expenses. Some fixed charges, like

depreciation, interest, rent, insurance, taxes, will continue even if the output is

little or nothing. It will very likely be sound business policy to make the best of a

bad situation by getting what little income can be had over and above the variable

expenses of production. Much money may have been irrevocably invested in the

business, and although possibly under no conditions can it be made to yield the

return that had been expected, matters will not be bettered by letting the plant lie

idle.85

It may be that the prices which the proprietors of the business thus reluctantly

decide to accept are high enough to pay all the expenses of production, fixed and

variable, in some competing plants, better organized or more favorably located. Or

it may be that some or all of the competing plants also find it necessary to accept

84 Brown, Op. cit. p. 144

85 Ibid.

56
prices that do not cover their fixed expenses. Sometimes the fact that it is more

profitable to produce at prices which cover merely the variable expenses than not

to produce at all leads someone establishment to cut prices. Other establishments

have to reduce prices in order to protect themselves, and a period of cut-throat

86
competition may ensue.

A. FIXED INCOMES

Many types of income remain virtually fixed, regardless of rather violent

changes in the prices level for the time being. I may own long-term bonds paying

$60 interest a year for each $1000 of principal. As a landlord, I may have ten-year

contracts with my tenants. I may have a government job (salaries here change

slowly) or be living on the proceeds of an annuity policy (so many dollars a year for

life). As the receiver of a fixed income, I gain during periods of falling, and lose

during periods of rising, prices. This assumes, however, that I am just likely to

receive my fixed income when prices are falling as when they rise. But to assume

this in the face of a violent fall in prices is often invalid, because rapidly falling

prices may bring on depression, and thus make it harder for business men and the
87
government to pay fixed charges.

Investors in fixed-income securities are typically looking for a constant and

secure return on their investment. For example, a retired person might like to

receive a regular dependable payment to live on like gratuity, but not consume

86 Ibid. p. 145

87 Atkins, Op. cit. p. 331

57
principal. This person can buy a bond with their money, and use the coupon

payment (the interest) as that regular dependable payment. When the bond

matures or is refinanced, the person will have their money returned to them. The

major investors in fixed-income securities are institutional investors, such as

pension plans, mutual funds, insurance companies and others. In order for a

company to grow its business, it often must raise money - for example, to finance

an acquisition; to buy equipment or land; or to invest in new product development.

The terms on which investors will finance the company will depend on the risk

profile of the company. The company can give up equity by issuing stock, or can

promise to pay regular interest and repay the principal on the loan (bonds or bank

loans). Fixed-income securities also trade differently than equities. Whereas

equities, such as common stock, trade on exchanges or other established trading

venues, many fixed-income securities trade over-the-counter on a principal basis. 88

B. VARYING INCOMES.

Most incomes are varying rather than fixed. Wages and salaries vary. They rise

and fall together with the price level. Profits also are a varying income. As prices

rise, profits multiply; as prices fall, profits disappear. Whether a varying income will

gain or lose in purchasing power depends on how rapidly it grows or shrinks as

prices rise and fall. The wage earner, so it is sometimes said, gains in purchasing

power when prices fall, and loses when prices rise. True, wage rates (pay per hour,

week, or month) "lag behind" the cost of living, wage rates both fall and rise more

88 Ibid.

58
slowly than the cost of living. But the wage rate tells us only how much the worker

would earn if he had an hour, a week, or a month of work. Rising prices, by

stimulating business through "windfall" profits, make for brisk employment; but

falling prices, by depressing business through "windfall" losses, make for slack

employment. Accordingly, the earnings of the worker (per week, month, or year)

increase rapidly during an upward price movement, perhaps as rapidly as the cost

of living, if not even faster. During a downward price movement, in contrast, the

earnings of the worker decrease rapidly, perhaps fully as much as, if not more
89
than, the cost of living.

The term variable-income security refers to investments that provide their

owners with a rate of return that is dynamic and determined by market forces.

Variable-income securities provide investors with both greater risks as well as

rewards. The business enterprise uniformly profits from rising prices. Naturally, the

costs of production rise when the price level trend is upward. But the costs of

production do not rise as rapidly as the prices at which commodities are sold.

Rates of interest on borrowings take a long time to be adjusted. Many other costs

like mortgage debt, real estate taxes, and depreciation are fixed in amount. Finally,

rising prices are usually accompanied by rising sales. Due to the operation of

overhead costs, a slight increase in sales may lead to a considerable increase in

profits. Rising prices accordingly act as stimulus to more production. This makes

for prosperity. Periods of falling prices, in contrast, mean periods during which

business enterprise languishes. For any one producer the costs of production fall,

89 Ibid. p. 332

59
but not as rapidly as his sales prices. Because of the public's diminished

purchasing power, sales decline, which leads to a still greater decline in profits die

to overhead costs. Accordingly, production contracts, employment diminishes, and

depression results.90

CHAPTER V

V. CREDITORS AND DEBTORS

RISING PRICES ENRICH DEBTORS AND IMPOVERISH CREDITORS

FALLING PRICES ENRICH REPAID CREDITORS AND IMPOVERISH DEBTORS.

Suppose someone borrowed $1000 sometime between 1923 and 1925. As a

borrower of money he became a debtor. The lender of the money becomes a

creditor. Ten years later, say early in 1933, $1000 was repaid. In terms of

purchasing power dollars, however, there was repaid not $1000, but a sum much

nearer $1538. (Due to the fall of prices, the purchasing power of the dollar had

increased by more than 50 percent.) Since the debtor repaid in dollars of greater

purchasing power than those he borrowed, he was impoverished. Since the creditor

was repaid in dollars of greater purchasing power than those he lent, he was

enriched. Suppose, in contrast, that someone borrowed $1443 in 1913. About ten

years later, the principal amount of this sum was repaid. In terms of purchasing

power dollars, however, there was repaid not $1443 but only $1000. (Prices had

risen so much that the purchasing power of the 1923-1925 dollar was about 40

90 Edie, Op. cit. p. 112

60
percent less than that of the 1913 dollar.) Since the debtor repaid in dollars of less

purchasing power than those he borrowed, he was enriched. Since the creditor was

repaid in dollars of less purchasing power than those he lent, he was

impoverished.91

* A Wheat Farmer As An Example (A) The wheat farmer pays $1000 a year to a

mortgage company on account of a past loan. The farmer is the debtor, the

mortgage company the creditor. (b) The farmer raises 10,000 bushels of wheat a

year. Fluctuations due to the whether, insect pests, and plant diseases are left out

of account. (c) The price of wheat is assumed to vary directly with the purchasing

power of the dollar. If we grant (a), (b), and (c), it is easy to see how rising prices

enrich the debtor, falling prices the creditor. (A) Wheat sells at $I a bushel; the

index of purchasing power= 10092

* Corporation As An Example. When a corporation borrows money through the

sale of bonds, the bondholders, legally speaking, become creditors. They are

entitled to the return of their money at some definite maturity date, and to the

receipt of interest at a fixed rate during the interval. Since the corporation is

owned, legally speaking, by its common stockholders, we may say that the

stockholders become the debtors. Let us imagine a simplified corporation, in which

all the income over operating expenses is shared between the bondholders

(creditors) and the stockholders (debtors). The bondholders receive $10,000 a year

as their fixed return. The shareholders divide the profits, if any. Assume, further,

91 Atkins, Op. cit. p. 333

92 Ibid.

61
that the corporation's net income rises and falls in exact ratio with the purchasing
93
power of the dollar.

The Credit Expansion and Rising Prices. It should be sufficiently obvious,

however, that continued expansion of credit, after business has attained its

maximum in the prevailing state of the arts and with the prevailing type of

business organization, must raise the price level. But why should such continued

expansion of credit take place? The explanation appears to lie in the eagerness of

the business man, as such, to take advantage of what he regards as good

business. The period of good business so called may not be good for all of the

community. To persons having constant or fixed incomes, it is a period of relatively

high prices with no additional money inflow. But to the borrowing-hiring-buying

business man, it is period of opportunity. It is a period of opportunity because the

business mans expenses do not increase as largely as his gross returns and

because, therefore, his profits are rising. With rising profits he feels that he has a

motive for increasing his business. But to increase his business he needs larger

current funds as well, perhaps, as to use more completely what funds he already

has. He seeks, therefore, larger loans of his bank.94

While, however, many business men may thus try to expand their respective

businesses, general expansion is practically impossible when once the unemployed

have full-time employment. The manufacturer who expands his business by

employing more artisans and a smaller business. If, in such a period, this second
93 Ibid. p. 334

94 Ibid.

62
manufacturer-along with others-declines to allow his business to be curtailed, the

net result is that all pay more labor but total business done is no greater. (In turn,

the increased spending power of wages earners makes possible some rise of retail

prices.) Likewise as to rent paid for the use of premises occupied. So, also, as to

raw materials. But if so, then some other product to the making of which the labor,

capital and land might have been devoted will be diminished and its price raised.

So it comes about that a period of prosperity is usually a period of rising prices,

rising wages and rising rents as well as of more active business and fuller and

steadier employment.95

CHAPTER VI

VI. CONCLUSION

Changes in the price level cause far-reaching adjustments in the well-being of

all men. Prices are always changing; the purchasing power of money rises and

95 Ibid.

63
falls. Essentially, the problem of price change is that individual prices do not rise or

fall at the same rate of speed. Unequal rates of price change affect different

incomes unequally. Incomes are two types, fixed and varying. A fixed income gains

in purchasing power with a fall on prices, and loses with a rise. A varying income

usually loses in purchasing power with a fall in prices, and gains with a rise.

Changing prices act as a stimulus on business. Rising prices enrich debtors and

impoverish creditors. Falling prices impoverish debtors and enrich creditors. The

debtor borrows dollars of more or less purchasing power. Thereafter he repays in

dollars of more or less purchasing power. By inflation he understand rising prices

due to an increase of money in circulation. By deflation he understand falling

prices due to a decrease of money in circulation. In a certain sense, our economic

order is the slave of price change. This is the basis of the argument for price

control.

The change of the value of money especially for price change is to be

determined in the way that other values are determined. But the task is not so

simple as that. The analysis of marginal utility formed the basis of our explanation

of the shifting of demand from one commodity to another, but it does not help me

to explain the demand for money. Marginal utility depends upon the capacity of

things to satisfy human wants, and money does not directly satisfy as single

human want, except the abnormal wants of the miser. I want money only as I want

things that money will buy for me. And when I turn to "supply and demand" I find

at first little help. For, it will be remembered, when I was discussing the relations

between the prices of things and their supply and demand, I limited myself to the

64
consideration of one commodity at a time. That is, I assumed that the money price

of the one commodity I was considering was alone variable, and that of all prices of

all other things remained, for the time being, constant. Now the problem of the

value of money is the obverse of the problem of the money values of all other

things. If I were studying the wheat value of money to be held constant. But my

present problem is that of the wheat value of money and the sirloin-steak value of

money and all other values of money. I can't resort to the strategy of breaking the

sticks in our bundle one by one.

In this connection it ought to be clear that those who think public utility rates

must not be raised proportionately when the general price level has risen, because

of supposed unfairness to the public, are in an utterly illogical position. When

prices in general have doubled, a doubled rate for transportation or light or power

is really no increased burden at all on the public. To pay twice as many as dollars

for shipping goods, when twice as many dollars are received by the producers of

goods; to pay twice as much for gas, electric light and commuters railroad

services when wages and salaries are also twice as high as previously, is not really

to pay more in any but a nominal sense. It is to pay twice as many dollars when

each dollar is worth half as much. And at the same time security holders of the

public service industries, though they receive twice as many dollars as before, do

not receive any more in real purchasing power.

Suppose, on the other hand, that the price level should fall, during a fairly short

period, by one-half, and that concomitantly, cost of construction of railroads and

65
other public utility plants should fall by the same percent. Then if the railroads and

other utilities were allowed rates to make the usual percentage return and to make

it on their historical cost of construction, the public which patronized them would

have to pay rates appreciably higher than would suffice to yield the current rate on

newly-constructed plants. These rates, therefore, would not be lower than the

previous rates in the proportion in which prices generally were lower. Persons who

had invested in other industries would find their returns cut in half, although these

returns would be as high a percentage of the likewise-halved cost of plant

production. These lowered returns, however, would buy as much at the reduced

price level as the higher returns had previously bought, so that there would be, for

the investors in these industries, as a class, no real loss. But it is proposed that the

investors in public-service industries shall occupy a protected position. When all

other prices fall by one-half, the rates of railroads, shall be regulated so as to fall

by a much less amount and so as to leave for investors in railroads returns as high

as before and returns which, at the reduced price level, will purchase twice as

much as before.

Unfortunately, most contracts with bondholders and other lenders are made

with no allowance for possible changes in the price level. Therefore, rising prices,

with the usually accompanying larger returns from business, leave bondholders

with no increase in money incomes. The whole increase goes to the stockholders

who, therefore, normally secure an increase in their money incomes much more

than in proportion to the increase of prices.

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 On the other hand, falling prices with corresponding decreased returns from

business, leave bondholders receiving the agreed money incomes, even though

this means larger real incomes and even though there may be nothing at all left for

the stockholders. All this is really but an exemplification of the genera; fact that in

periods of rising prices borrowers gain at the expense of lenders and that in

periods of falling prices lenders gain at the expense of borrowers. But it has been

made the basis of an argument in favor of the historical-cost basis of valuation.

The contention made is that public utility companies are largely financed by bond

issues preferred stock, that these securities, especially the bonds, should be

protected against possible default in payment in periods of falling prices, that it is

undesirable for common stockholders to be subjected to heavy loss from falling or

exceptional gain from rising prices, and that bankruptcies in the public service

industries, which may result from making rates fall with average prices and with

construction costs, are demoralizing to efficiency.

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CHAPTER 7

VII. BIBLIOGRAPHY

Atkins, Willard E., Wubnig, Arthur.(1934). Our Economic World. Harper and Brothers

Publishers.

Brown, Harry Gunnison. (1929). Economic Science and the Common Welfare. Lucas

Brothers.

Edie, Lionel D., (1926). Economics: Principles and Problems. Crowell Company

Publishers.

Fairchild, Fred Rogers, et. al.(1937). Elementary Economics. The Macmillan

Company of Canada.

Young, Allyn A., et. al.(1926). Outlines of Economics. The Macmillan Company.

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