A Pricing Model
Production & Sales Increasing
The instructions below the model will guide you through setting up a simulation that demonstrates what happens when both production and sales of both products increase over time.
Production & Sales Increasing — Description

What happens when production & sales for both shoes and wheat steadily increase?

The scenario used for this series of simulations consists of rising production and sales – at different rates – for both shoes and wheat over the period of the simulation. As before, you will change the money supply growth rates in order to compare direct exchange prices with money prices.


Variables

Set for this scenario

You should set these values before the first simulation, and leave them during succeeding simulations in this scenario.

annual fractional shoe increases
0.08 [Unitless] Set and leave for these simulations
annual fractional wheat increases
0.04 [Unitless] Set and leave for these simulations

Adjust this variable as instructed

annual fractional money increase rate
[Default] 0.0/Year

 

GIF89a 
Fixed Money Supply - Simulation 1
We will run this first simulation, with the assumption of rising sales and production, to compare direct exchange prices with money prices in the quantity of money remains fixed for the entire period.

Variables to Adjust

annual fractional money increase rate
0.0/Year

Simulations

Sales
Sales of shoes and wheat rise steadily as determined by their respective production rates, throughout the simulation. Note: Read shoe sales on the left scale and wheat sales on the right scale.
Inventories
Because the producers of both products sell less than their total production inventories rise steadily.
Direct Exchange Prices
Because shoe sales rise faster than wheat sales, the marginal utility of shoes, relative to wheat, falls steadily, and so does the bushel/pair price of shoes. Conversely the marginal utility wheat, relative to shoes, rises steadily, and so does the pair/bushel price of wheat.
Money Supply
The quantity of money remains the same ($10,000) for the whole 60 months.
Dollar Prices
The increasing production and sales of both products make both of their dollar prices fall, at rates that inversely reflect their sales increases.
Price Conversion
Converts back to direct exchange prices.

Comments:

Here we get a glimpse of what happens with the general trend in an "economy" in which production and sales rise.

Note that I have to put the different products on different scales. This "economy" has a generally upward trend, but we can apply no single measure to those trends to get one "gross production" figure.

Relative prices, in direct exchange and in indirect dollar terms, change over time, but both price indicators point to the same conclusion: rising production of both products with shoe production rising more rapidly.

Increasing Money Supply - Simulation 2
Now, we will see how direct exchange prices differ from money prices on the quantity of money expands continuously for the simulation period.

Variables to Adjust

annual fractional money increase rate
0.07/Year

Simulations

Sales
Same as simulation 1.
Inventories
Same as simulation 1.
Direct Exchange Prices
Same as simulation 1.
Money Supply
The quantity of money (dollars) remains the constant ($10,000) for the first 10 months; it then increases steadily (at 7% per annum) for 40 months; and it levels off again for the last 10 months.
Dollar Prices
This simulation dramatically demonstrates the influence of an expanding money supply on dollar prices. During the first 10 months dollar prices decline as one would expect with increasing supplies. During months 11 through 50, however, we see a very different picture. The price of shoes continue to decline—but, much slower, and wheat prices actually reverse and rise in the face of increased supply. In the last 10 month, after money growth stops, price declines return to their former rates.
Price Conversion
In spite of the dollar price gyrations, when converted to direct exchange prices, those prices match the ones calculated directly.

Comments:

During the period of monetary expansion, direct exchange prices and dollar prices give conflicting signals.

Look back at the first simulation and contrast the dollar prices for each. Without inflation, prices drop steadily. With inflation, strange signals get transmitted to the market. The declines in shoe prices slow. The prices of wheat actually reverse during the inflationary period.

Think about the important role that price signals play in market decisions.

Now, let's see the effects of deflation.

Decreasing Money Supply - Simulation 3
Again, we will reverse the assumption about changes in the money supply while leaving the production and sales parameters the same.

Variables to Adjust

annual fractional money increase rate
-0.07/Year

Simulations

Sales
Same.
Inventories
Same as simulation 1.
Direct Exchange Prices
Same as simulation 1.
Money Supply
The quantity of money (dollars) remains the constant ($10,000) for the first 10 months; it then decreases steadily (at -7% per annum) for 40 months; and it levels off again for the last 10 months.
Dollar Prices
Like the inflation scenario, this simulation dramatically demonstrates the influence of changes in the money supply on dollar prices. During the first 10 months dollar prices decline as one would expect with increasing supplies. During months 11 through 50, however, the decline of the dollar prices of both shoes and wheat accelerates, in the face of increasing supply. In the last 10 month, after money decline stops, price declines return to their former rates.
Price Conversion
Same as simulation 1.

Comments:

Again changes in the quantity of money distorts the market prices. But, in this case the message seems a little different.

If steadily declining prices indicate satisfaction of market demand, what do more rapidly falling prices indicate? Might producers become more inclined to withdraw production from the market?

Increasing Production & Sales - SUMMARY

Production & Sales Assumptions

  • Shoe Production & Sales: increase by 8% per annum
  • Wheat Production & Sales: increase by 4% per annum

Fixed Money Supply

With no changes in the money supply in increased production and sales for both shoes and wheat, we find that the money prices of both shoes and wheat fall consistently throughout this period. As one would expect, the increasing supplies of both of these products cause their incremental values, and therefore their money prices, to decline.

Inflation

Even though the production of both of these products continues to grow throughout the simulation, the increased quantity of money causes some strange effects in the money prices. The decline of shoe prices slows while the decline of wheat prices actually reverses and rises during the period of inflation.

Deflation

The contraction of the money supply is a different effect on the prices of these two products. In both cases the price declines accelerate during the period of the deflation.

Summary Comments

By adding the somewhat more realistic assumptions that the production and sales of both products rise, but at different rates, we get an even clearer picture of the distorting influences of changes in the money supply. In both cases, the information provided by market prices gives a false impression as to the relative supplies of both products.

I reiterate the reminder I gave with a fixed production and sales simulations that the market sees only prices as a guide to relative supply and demand.

Let's see what happens when we invert the production trend...