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Wednesday, March 2, 2011

What if we print more money and give each one of us $10,000?

If we print more money, prices will rise such that we’re no better off than we were before. To see why, we’ll suppose this isn’t true, and that prices will not increase much when we drastically increase the money supply. Consider the case of the United States. Let’s suppose the United States decides to increase the money supply by mailing every man, woman, and child an envelope full of money. What would people do with that money? Some of that money will be saved, some might go toward paying off debt like mortgages and credit cards, but most of it will be spent.

I’m not going to be the only one who runs out to buy an Xbox. This presents a problem for Walmart. Do they keep their prices the same and not have enough Xboxes to sell to everyone who wants one, or do they raise their prices? The obvious decision would be to raise their prices. If Walmart (along with everyone else) decides to raise their prices right away, we would have massive inflation, and our money is now devalued. Since we’re trying to argue this won’t happen, we’ll suppose that Walmart and the other retailers don’t increase the price of Xboxes. For the price of Xboxes to hold steady, the supply of Xboxes will have to meet this added demand. If there are shortages, certainly the price will rise, as consumers who are denied an Xbox will offer to pay a price well in excess of what Walmart was formerly charging.

For the retail price of the Xbox not to rise, we will need the producer of the Xbox, Microsoft, to increase production to satisfy this increased demand. Certainly this will not be technically possible in some industries, as there are capacity constraints (machinery, factory space) that limit how much production can be increased in a short period of time. We also need Microsoft not to charge retailers more per system, as this would cause Walmart to increase the price they charged to consumers, as we’re trying to create a scenario where the price of the Xbox won’t rise. By this logic we also need the per-unit costs of producing the Xbox not to rise. This is going to be difficult as the companies that Microsoft buys parts from are going to have the same pressures and incentives to raise prices that Walmart and Microsoft do. If Microsoft is going to produce more Xboxes, they’re going to need more man hours of labor and obtaining these hours cannot add too much (if anything) to their per-unit costs, or else they will be forced to raise the price they charge retailers.

Wages are essentially prices; an hourly wage is the price a person charges for an hour of labor. It will be impossible for hourly wages to stay at their current levels. Some of the added labor may come through employees working overtime. This clearly has added costs, and workers are not likely to be as productive (per hour) if they’re working 12 hours a day than if they’re working 8. Many companies will need to hire extra labor. This demand for extra labor will cause wages to rise, as companies bid up wage rates in order to induce workers to work for their company. They’ll also have to induce their current workers not to retire. If you were given an envelope full of cash, do you think you’d put in more hours at work, or less? Labor market pressures require wages to increase, so product costs must increase as well. And those are the reasons why we cannot just out rightly print more money. by

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