Are Price and Quantity Conjugate Variables? I am taking a thermodynamics class. In this class one of the things that is discussed is how the partial derivatives of the internal energy with respect to extensive parameters (entropy, volume, mol number, etc) give rise to intensive parameters (temperature, pressure, electrochemical potential, etc). For example for pressure and volume:
$$ P = \left(\frac{\partial U}{\partial V}\right)_{S,N} $$
The similarity between pressure volume diagrams and price quantity graphs (see below) got me thinking, is there a similar conjugate relationship between price and quantity? Maybe something like this:
$$ P = \left(\frac{\partial U}{\partial Q}\right)_{D^*} $$
Where $P$ is the price, $Q$ is the quantity, $D^*$ is either demand, supply or the conjugate of either and $U$ is some sort of economic (as opposed to thermodynamic) potential. This $U$ could be found with an intrgral but does it have a name? Can we use Legendre transforms to generate more potentials?

Lauwrence Lau (1969) has pointed out that "Samuelson has pointed out the basic duality that exists between the direct and indirect utility functions: They are connected by Legendre’s duaI transformation."
Lau (1973, chapter 1.3, section 1.4) makes intensive use of the Legendre transformation for deriving dual relationships between production and profit functions. This chapter is available here.
Most duality theory between direct and indirect utility functions, and between production, cost and profit functions rely on these relationships (See also Blackorby, Primont and Russell, 1978).
Blackorby, Charles, Daniel Primont, R. Robert Russell, 1978, Duality, Separability, and Functional Structure: Theory and Economic Applications, North-Holland.
Lau, L., 1973, Applications of Profit Functions, in Production Economics: A Dual Approach to Theory and Applications, edited by Melvyn Fuss and Daniel L. McFadden, North-Holland.
Lau, L., 1969, Duality and the structure of utility functions, Journal of Economic Theory, 1, 374-396.

Let p denote pressure and V denote volume then U = p x V where the units of pressure times the units of volume must equal the units for work, heat, and energy.
Tables 2-4 of the NIST Guide to the SI Units show that pressure times volume are equivalent to work, power, and heat expressed as base SI units:
https://www.nist.gov/pml/special-publication-811/nist-guide-si-chapter-4-two-classes-si-units-and-si-prefixes
In physics internal energy U of a system may increase, remain constant, or decrease as the outcome of a natural process however the total of all forms of energy in the system and surroundings must remain constant. This defines a set of natural law relations between the system and surroundings during a process.
Let P denote price and Q denote quantity then Ue = P x Q where the units of price times the units of quantity (edit: revenue) must then be the units for "economic potential".
I would argue that even if price and quantity can be treated like conjugate variables in a model there is still the challenge of establishing a revenue model as an analog to thermodynamic internal energy models within the economic measurement context.


What's the effect of the used car market on car price? While justifying his decision to sell a one-use textbook to his students, a BYU econ professor states:

  A word about the Kearl text. I do not receive any royalties and have
  no economic interest in the text – when you buy the text, not a single
  penny goes to me. It’s designed to be a “disposable,” one-use text in
  order to keep the price down. (The used book market actually drives up
  the price of texts – to see why, think of what would happen to car
  prices if used car sales were not permitted.)

How does the used car markets drive up the price of the good? With an used market, the buyer is willing to pay more, knowing that he can resell later. However, without an used market, everyone is forced to buy new cars, raising demand, and thus raising the price of new cars. How to think about these countervailing effects?
Are the used books and used cars market actually analogous like the professor suggests? The professor and his publisher have a monopoly on the new textbook, but no one controls the new car market. Therefore, if people keep reselling text, the publisher will use their monopoly and raise the price of new books to compensate. In contrast, car manufacturers can't do so due to competitive pressure.

OP,

imagine that there are two kinds of people, rich and poor, and no market for used books. Rich people are willing to pay more for new textbooks. Poor people cannot afford to buy new textbooks. In the absence of a market for used books, poor people will not buy textbooks.

Imagine now that there is market for used books. Poor people are now able and willing to pay second hand textbooks. And rich people now have someone to sell the books too once they are done using these books.

A market for second hand textbooks raises the price of textbooks because some people are not able and willing to buy new textbooks but are willing to buy second hand textbooks. In the absence of such a market, they'll spend their income on other goods that they deem more important.

Think of it otherwise this way. In the absence of a market for used textbooks the full value of a textbook is not exploited because some people who would wish to trade with one another cannot trade with one another.

Hope that this helps.

From what I can understand, in the context of the used books market, lets assume that there is set, finite amount of demand for the books. When there is a used books market, the demand first goes to the used books market and finishes up the supply in that market. The remaining demand then goes to the new books market (the professor/publisher). To compensate for the loss in demand, the publisher would therefore have to raise prices of the new books.

Now for the cars market, when there is no used cars market, everyone is indeed forced to buy new cars which raises demand and consequently price. However, you are assuming that cars are a necessity and that the demand transfers 100% from used cars to new cars.

Some people maybe only purchasing cars from used cars market because they see the value in the lower price. When there is no longer a used car market, if the price of the new car remains the same, then people would deem that price to be too expensive since they are unable to resell it later on and ultimately choose not to buy at all or opt for alternatives. This actually reduces demand. To capture the market of such consumers, the car companies would ultimately reduce prices to get the market share. This is from the Bertrand competition model point of view.

In actual fact, Bertrand competition are not seen and huge companies work with each other more often then they engage in price wars. Now consider the Cournot competition model where inverse demand for the good is given as P = a - bQ (i.e. law of demand - when the price goes up, demand must go down ceteris paribus.) Since there is no used cars market, then demand for new cars market has gone up, the car companies produce more output (Q has gone up), ceteris paribus, P will come down. Just to reiterate, if there is a used cars market, then total output (Q) would be lower, therefore P will be higher.

Note that both the Bertrand and Cournot model dictates that prices will go down without a used cars market, just that the Cournot model reflects the actual situation clearer.

This is just my understanding and I hope it helps! Let me know if I am wrong in anyway! cheers :)


Why didn't the money printing by the US Federal Reserve since 2008 lead to inflation? http://www.telegraph.co.uk/finance/comment/liamhalligan/8484530/Americas-reckless-money-printing-could-put-the-world-back-into-crisis.html

  America's reckless money-printing could put the world back into crisis
  Last week, Ben Bernanke suggested that the US base interest rate will
  stay close to zero for an "extended period". It's been there since
  December 2008.

Today, the opposite has happened. Deflationary forces are strong in the U.S. Europe is even worse given the negative yield. Why has deflation prevailed despite money printing by central bankers?

Because you can't push on a piece of string.

As in the Great Depression of the 1930s, we've collectively got massive personal debt, depressing demand, moving us towards deflation, which pushes up debt, and so it goes.

We've also known since the 1930s that monetary expansion in and of itself cannot stimulate demand under these conditions: it can only create space for demand to expand into.

Add in the international fashion for fiscal contraction, a demand-suppressant, and that's how we get QE without broad-money expansion and without inflation.

We do have potential inflation. And at some point that potential will be realised. But not while there's this huge overhang of personal debt. It might get worn down over a long period of deflation, through defaults. Some other inflationary shock might inflate some of the debt away. And enlightened policy-makers might engage in a large exercise in personal-debt cancellation.

"Why has deflation prevailed despite money printing by central bankers?"

1) CPI
According to some pools in US, the number 1 concern for most Americans is the rising cost of living. Unfortunately, for political reasons, the official price index (CPI) doesn't capture properly most of such costs. There's an excellent video explaining that: https://www.youtube.com/watch?v=pwI3Nya5L9g

So, if you go shopping in the supermarket, you will be seeing a rise in price. But, if you are a person that only deals with assets such as stocks and real estates, then you will be seeing a fall in prices.

2) Reserve Currency
For historical reasons (gold standard) and also for political pressure, the US Dollar is still being used as a reserve currency. So, every time there is a worldwide crises, several investors flee their investments to US Dollar considering it as a safe haven. Which kick the can a little bit further down the road.

Unfortunately, since the beginning of FED in 1913, the US Dollar has devalued >95% and there is no reason to believe that this tendency will change in the foreseeable future. When the rest of the world realize that, probably it's gonna be the day of reckoning.


What would happen if corporations can only make a maximum profit of 10% per product I have learned in accounting that companies can add any amount of profit on their products as they want. That can be 10 - over 500 %.

I also think that international corporations like Coca Cola, Nestlé definitely make more than 200 % profit for each of their products (does anybody know how much).

I don't know much about what is done with that profit, as every cost the company has is already included in the price. That is not the question here.

My question is: What would happen if by law EVERY company on this planet can only make a maximum profit of 10 % for each product. When answering please ignore potential legal loopholes or anything similar.

Prices would definitely decrease but what about wages for workers. They would stay the same, because the profit doesn't affect them. Only the wage for managers and CEOs would decrease. But what about international economics. Would it remain stable.

And the most important question: Can a law like that (if valid in every country) actually work on long-term? This is a similar question as "Can communism/socialism work?" but It is also a little bit different.

I also think that international corporations like Coca Cola, Nestlé definitely make more than 200 % profit for each of their products (does anybody know how much).

How are you defining profit?

Coca Cola, first quarter 2018
Net income:  \$1.37 billion
Revenue:  \$7.6 billion
Profit:  18%
Percentage markup:  22%

Nestle was higher in the second half of 2017, around 49.9% profit or 98% markup.

I don't know which, but if you are getting 200+%, I think that you are leaving out a lot of costs.  If you enforced that standard, companies would go out of business, because you aren't leaving enough for operating expenses.

If all companies, even the risky ones, could only have 10% profit, their product prices would tend to swing greatly.  Because when their costs are high relative to their revenues (e.g. in a recession), their prices would go up.  When costs are relatively low, their prices would be restrained.  So they would be cutting prices in good markets and increasing them in bad markets.

Companies would also have trouble financing through equity, which is rewarded by profits.  They would have to borrow, as that would show up as costs.  But it's hard to borrow unless a company is already profitable.  So no venture capital startups.

Companies would also tend to become bigger.  Because it is easier for a company that does many things to make sure that some are not so profitable.  And of course they wouldn't have to worry about startups stealing their business.

Companies would take few risks.  Because the maximum return is 10%, they have no incentive to pick the riskier choices.  They might just as well pick the safe choice, as it has the same return.  Progress would slow.

To engage in things like pharmaceutical development or oil discovery, companies would basically write off the upfront costs (to minimize profit).  Then if they actually succeeded, they'd have to engage in a flurry of additional costs so as to get full value for their products.  So the companies engaging in such behavior would expand revenues quickly.  And only companies that are already profitable could undertake the most profitable activities.

This encourages companies to out and out waste money.  Higher costs means a higher base, so the 10% is bigger.

If you ignore loop holes, it is easy to do and would lead to a very stable economy, because companies would stop making "bubble prices", that implode as soon as other companies join the field. Also if would help the customer because you would know that a more expensive product includes more in it's price, be it extra function or quality.

But of course loop holes are the big problem. Just look at the CEOs at companies, they always claim to need 100 million bonus for taking "responsibility", which in itself is nonsense because when actually something goes wrong and they could actually take the responsibility then just run away with another big extra bonus for leaving. And all that can be calculated into the production costs, as well as other random nonsense.

If you want to stop companies to screw people over the best way would be a "public base economy".

In short:
On one side are classical companies like we have today but there are also state controlled coulter companies. For example you have private car companies but you have also a state car company, that produces cars, by law on the same level as the private companies but only with so much profit as the state (and in a democracy the people) thinks is reasonable.
So private companies get limited over the normal marked. You could also control other aspects that way, as long as the consumer cares about the issue.


Definition of capitalism Does the discipline of economics have an accepted rigorous definition of capitalism?
 I.e. not something like "some economists would quote Hayek and say that so and so constitutes capitalism" but an if and only if definition that most economists would agree on.

The dictionary definitions of capitalism (currently the most upvoted answer) have been critiqued as inadequate, in the sense that they are too broad, by Geoffrey Hodgson in his treatise, Conceptualising Capitalism (University of Chicago Press, 2015).

  Definitions proliferate. Most dictionaries stress private
  ownership and markets; many add the profit motive. The entry in The
   New Encyclopaedia Britannica (1998, 2:831) is typical: “Capitalism, also
  called free market economy, or free enterprise economy: economic system
  . . . in which most of the means of production are privately owned
  and production is guided and income distributed largely through the operation
  of markets.”

  But, if we consider systems based largely on private ownership, the
  profit motive, and markets, we can find many examples before the medieval
  era. [...] trade has existed for tens of
  thousands of years, markets may have appeared as long as five millennia
  ago in China, and they were evident in several locations in the eastern
  Mediterranean and the Middle East around 600 BC. Private ownership,
  the pecuniary calculus, and the profit motive have similarly played
  a prominent role in leading economic regions for thousands of years.
  Hence, prominent dictionary definitions of capitalism make it a system
  that has lasted for multiple millennia. If we adopt such definitions, then
  we need to find another word to describe the institutional structures that
  were consolidated in the eighteenth century and gave rise to spectacular
  economic growth and ongoing technological innovation.

And he does have his own definition (which I will not try to argue that is mainstream); its premise is that:

  Capitalism [...] requires special forms of state that cannot confiscate property arbitrarily at will, that are effectively restrained by laws, that have internal
  checks and balances, and that are faced with countervailing (democratic
  or other) powers that help protect a relatively autonomous legal system.
  Such states are necessary to legitimate and protect property rights and
  to enforce contracts. They required peculiar circumstances and a long
  time to evolve. Foreshadowed in the Italian city- states, they did not appear
  on a national scale until the seventeenth century, in Britain and the
  Netherlands. [...]

  I argue that, while markets are central to capitalism, capitalism is not
  simply a market system: unavoidably it contains different subsystems of
  governance, production, distribution, and exchange. Furthermore, capitalism
  cannot in principle have markets for everything or bring everything
  within the orbit of commodity exchange.
  In particular, under capitalism there can never be a complete set of
  markets for future labor power. For there to be full futures markets for
  labor, all workers must enter into contracts for their expected working
  life. This would be tantamount to voluntary bondage, limiting the freedom
  of workers to quit their employment. Paradoxically, pushing markets
  to their limits would mean the return of slavery for the workforce.

He goes on to semi-formalize a list of tenets that constitute capitalism first according to [his interpretation of] Marx and then similarly for Schumpeter

  M[arx]-capitalism

  A legal system supporting widespread individual rights and liberties to own,
  buy, and sell private property
  Widespread commodity exchange and markets involving money
  Widespread private ownership of the means of production by firms producing
  goods or services for sale in the pursuit of profit
  Much of production organized separately and apart from the home and
  family
  Widespread wage labor and employment contracts

  Most dictionary and encyclopedia definitions emphasize conditions
  (1), (2), and (3), albeit often without emphasis on the legal system. More
  than Marx, the notion of M-capitalism emphasizes the legal system and
  individual rights. Regarding condition (4), the separation of much production
  from the family and the domestic sphere was emphasized by Weber
  (1968) and is implicit in Marx’s writings. Weber rightly argued that
  this separation was important to subject production to systems of rational
  accounting and pecuniary motivation. Marx emphasized condition
  (5) because it flows from the nature of capitalism as generalized commodity
  production and encapsulates the driving antagonism between
  the employing class and the working class. [...]

  A problem [...] is that the addition of
  condition (5), widespread wage labor, to the preceding four does not effectively
  demarcate modern industrial capitalism from the four preceding
  centuries when wage labor was widespread in rural England.
  M-capitalism, as specified above, gives us a better-than-average definition,
  but not one that is sufficiently sharp in terms of historical specificity.

  Further problems of historical demarcation arise with the first four
  conditions. As noted in section 4.4 above, the idea that secure property
  rights were first established in England in the seventeenth century is a
  myth. Furthermore, money, markets, and private ownership have existed
  for millennia. The fourth condition is helpful but hardly sufficient as an
  explanation of massive expansion of capitalism around 1800. The five
  conditions are inadequate to demarcate historically the explosion of capitalist
  productivity even if they are necessary for that system.

As for S[chumpeter]-capitalism, he argues that it contains all of the above, except for #5, but that additionally it has

  A developed financial system with banking institutions, the widespread use
  of credit with property as collateral, and the selling of debt

  The addition of condition (6) takes seriously the monetary definition
  of capital and institutions promoting collateralization and the salability
  of debt. Capitalism is thus marked by “the predominance of ‘capital’”
  (Sombart 1930, 196). This definition points to the development of institutions
  of clearer historical specificity. According to this definition, the
  emergence of capitalism in England is marked by developments in financial
  institutions in the eighteenth century.

  Note that condition (1) in the definitions of M-capitalism and
  S-capitalism rules out (at least widespread) slavery. Consequently, both
  M-capitalism and S-capitalism involve missing futures markets for labor.
  With S-capitalism, there may be self-employment or worker cooperatives
  but not extensive slave labor. M-capitalism rules out an economy
  with predominant self- employment or worker cooperatives.

As you can probably guess, by synthesis, he argues that the definition of capitalism should include the superset of 1-6 from both M- and S-capitalism (which already have a lot in common).

  But there is a cost to the exclusion of condition (5) from this definition. [...] the advantage of retaining
  the employment contract in the definition of capitalism is that it demarcates
  the system from economies involving self-employed producers or
  worker cooperatives. Furthermore, the introduction of wage labor gave
  important incentives for labor-saving innovations and led to increases in
  productivity. Consequently, the definition of capitalism that is favored
  here— and described simply as capitalism, without any prefix— involves
  all six of the above conditions. [...]

  Conditions
  (5) and (6) serve as fuzzy historical bookends, together demarcating
  capitalism from preceding systems and possible successors. [...]

  Explicit reference to social class is also absent from the definition offered
  above. In his review of different definitions of capitalism, Michael
  Merrill (1995) argued that capitalism is much more than simply a market
  economy. He was right about that. But he wanted to define capitalism as
  “a market economy ruled by, or in the interests of, capitalists” (322). A
  problem [...] is that the basis of class itself has to
  be defined, and Marx and Engels were obliged to use legal terms such as
  ownership to do so. Being a capitalist or a worker is not a congenital attribute:
  it is the occupation of a social role that is determined in part by
  legal relations. Class-related legal terms appear in all points above, except
  condition (4).

  Marxists have abused class-centered definitions of capitalism. They
  see class struggle, where the destiny of one class is to seize control of the system from another. But, notwithstanding the power of capitalists over
  workers, capitalists do not control capitalism: it is more the other way
  round. Such large and complex systems cannot be fully controlled, as if
  from a single chamber of power.

And while he disses that idea that capitalists control capitalism itself as a caricature, he nevertheless argues that it is an integrated economic and political system (and in this he is not that original, as he acknowledges):

  The central role of the state within capitalism means that we must
  address politics as well as economics. [...] Douglass C. North, John J. Wallis,
  and Barry R. Weingast (2009, 269) argued: “The seeming independence
  of the economic and political systems on the surface is apparent, not
  real. In fact, these systems are deeply intertwined.” I also concur with
  Bruce R. Scott (2009, 4) in his claim that capitalism is both “a political
  phenomenon” and “an economic one” and that “specifically it requires
  the visible hands of political actors exercising power through political
  institutions.” Capitalism always involves legal and political institutions:
  pure “anarchocapitalism” is an unrealizable fantasy.

And since the Austrians (Hayek actually) got mentioned in the question, Hodgson has this to say about their approach to defining capitalism:

  The Austrian economists had
  little to say about the sphere of production—conditions (4) and (5)—
  including the employment contract. Although they mentioned money
  many times, they paid insufficient attention to the use of property as collateral
  or to the selling of debt—condition (6). Their theory of money
  downplays the vital constitutive role of the state. At best, they stressed
  three of the six conditions only. The first three conditions are insufficient to identify the institutions of the capitalist system that were responsible
  for the explosive production of wealth in the last three hundred
  years.

While this may not be any sort of consensus statement, it is at least a comparative analysis of various definitions (from fairly prominent sources).

Capitalism is

considering money capital, i.e., considering money itself productive
"control over economic life in the name of the unrestricted and unlimited acquisitive interests of those who own capital." (Heinrich Pesch, S.J., Ethics and the National Economy p. 159; cf. these quotes from it)
"state-sponsored usury" (E. Michael Jones, Barren Metal: A History of Capitalism as the Conflict Between Labor and Usury)
"means of production […] being concentrated in the hands of a few owners" (John Médaille)
a "dictatorship" of "those who, since they hold the money and completely control it, control credit also and rule the lending of money" and "regulate the flow, so to speak, of the life-blood whereby the entire economic system lives" (Pius XI, Quadragesimo Anno §106)


Why do people trade derivatives? If I have information that an asset will increase or decrease in value, I can profit on that information by buying or shorting the asset. Why, then, would anyone trade derivatives when they can just profit by directly trading the asset? How does this work from a theoretical perspective (game theoretic, etc)? This is a very simple question, I'm not sure if this is the right place for it, but thought I would try asking.

There are number of reasons to use derivatives. How practical the following are? It, in turn, depends on the costs compared to the importance (utility) of the case. The costs can be substantial.

Hedging purposes, which comes in many forms. E.g. when you buy stocks in foreign currency, you may want to take only the equity risk, not currency risk. Or you buy a fund or etf that comes with country or industry risk that you want to get rid off. Or you believe equity in the long run but don't like the volatility, so you (try to) hedge volatility away.
Limit controlling. E.g., if you are working in asset management industry and take care of funds of customers, the portfolio should have set limits: the derivatives may give you an easy way to comply with limits ("you are happy with the instruments you have chosen to your portfolio and want to keep them but without derivatives, say the minimum amount of equity risk would not be attained").
Leveraging a (sub-)portfolio. "Sometimes you cannot apply loans. But want to have more exposure than is otherwise possible."
Bearing a particular type of risk, e.g., you may believe that volatility is going to increase from the current level. This particular example can work as a hedge to your portfolio at the same time, since usually the increase of volatility means that portfolio performs badly. Moreover, this is an example of risk that is hard to get in to your portfolio without derivatives.
Quick change of allocation for tactical reasons. Say, evolving crisis either forces you to move quickly, e.g., because of limits as in case 2, or because of the capacity to bear risk (economic reason). And this case includes also the panic moves.
Sometimes, there are other motives behind applying derivatives that somehow build upon the first four cases. E.g. you have a complex company structuring case in your hand and you may have to transfer particular types of risk from one party to the other. To the other this is hedging and to the other risk taking: the derivative use could be classified to be "enablers" of transactions.
In the spirit of previous case, derivatives can be used in product design. E.g. some hedge funds promise to apply certain derivatives strategies. These products (hedge funds) may be targeted to professional investors and retail customer. Another example include index loans, typically marketed to retail customers, and may include exotic derivatives like binary options where the underlying is determined e.g. by the month end values of the last 12 months for a basket of securities. The motivation for options reduces to the first one listed above (hedging): the index loan may include a promise ("a guarantee") that, say 95% of nominal will be preserved in every possible scenario to be faced. So hedging appears to be provided to customers.
"Personal characteristics" like willingness to gamble may apply as reason. These may reduce to the third item.

Derivatives provide the investor a way of transferring risk. Plain and simple. They are incredibly complex if you want to get into them, but there's your answer.


How do I change the base year of real GDP using the GDP deflator and nominal GDP? I'll use the US as an example. I have three data series

nominal GDP $(Y)$
real GDP in 2005 USD $(\bar{Y})$
the GDP deflator $(d)$, with 2005 as the base year, so $d_{2005} = 100$

I want to change the base year to 2000. Are these calculations accurate? I use the notation $\$_{t}$ for USD in year $t$ prices to help myself keep the units straight.

My goal is $\bar{Y}_{t} \ \$_{2000}$.
\begin{align}
\frac{d_{2000}}{d_{t}} \cdot Y_{t} \ \$_t
&= \frac{Y_{2000} \ \$_{2000}}{\bar{Y}_{2000} \ \$_{2005}} \cdot \frac{\bar{Y}_{t} \ \$_{2005}}{Y_{t} \ \$_{t}} \cdot Y_{t} \ \$_t \\
&= \frac{Y_{2000} \ \$_{2000}}{\bar{Y}_{2000}} \cdot \bar{Y}_{t} \\
&= \bar{Y}_{t} \ \$_{2000} \cdot \frac{Y_{2000}}{\bar{Y}_{2000}}
\end{align}

I think those are all the correct unit cancellations, but now I'm stuck with the unitless quantity $\frac{Y_{2000}}{\bar{Y}_{2000}}$, so I don't know how to complete the conversion.

Am I doing this right?

It's just real GDP in year t, times (deflator in year 2000 / deflator in year t).

Deflator in 2000 should be 100 as it your base year.


Long Run Equilibrium of Oligopolies The long run equilibrium of a perfectly competitive market is well established. My question is - are the concepts of a long run equilibrium in a perfect competition extendable (analogous or otherwise) to an oligopoly, specifically considering the the Cournot model and the Bertrand model.

Suppose I want to find the equilibrium number of firms $ N $ in a Cournot model, for example - will the approach be similar to that of a perfect competition?

The 'long run' assumption is not about whether the firms already on the market are price takers (perfect competition) or oligopolists but whether entry to the market is free. If entry to the market is free then in the long run profits tends toward zero, as a profitable market makes it tempting for more firms to enter.

If you have special asymmetric conditions where some entrants have different cost functions than the new ones the zero profit condition may not hold even in the perfect competition case.

I reiterate the point made above: In oligopolies, we use a concept of game theory called Nash Equilibrium. If a game (in this case and oligopoly) is in Nash Eq., this means no firm has unilateral incentives to deviate. That means in a sense if nothing else changes, the equilibrium is sustainable in the long run. No different parameters, no different answers.

I would like to elaborate further on your question regarding Cournot and Bertrand. There is something called a Bertrand Paradox in Industrial Organization, which assuming products are homogeneous (that is, if when choosing between purchasing products between different firms the consumer only cares about prices, and no other characteristic of this good) than modeling firm competition choosing quantity (Cournot) and modeling them competing choosing price (Bertrand) will yield completely different equilibria. This had a lot of attention a while back in Economics, but people don't take it too seriously anymore because it requires some very strong assumptions (like if one company charges a penny less than the other, it captures a 100% of the market, so demand is perfectly elastic and consumers have perfect knowledge of prices and no transaction costs) it isn't taken too seriously anymore. Instead, many of the present day applications of the Bertrand model are applied to heterogeneous (other aspects of the good beyond price are taken into account by the consumer, like quality, or simply distinct tastes and preferences) but somewhat substitutable goods (thus there is a cross price elasticity component). Those also have a Nash Eq., and brings forth some really interesting results.


EMH: Difference between market price and fundamental value? I am confused by the relation between stocks market prices and fundamental (or intrinsic) values stated by Efficient Market Hypothesis. How these deviates regarding to efficient market theory or are these the same according to EMH?

Why I am asking this is because among the literature, there can be found two kind of statements.

This is the very general statement that can be found from here and there:

  Investopedia: This principle is called the Efficient Market Hypothesis (EMH), which asserts that the market is able to correctly price securities in a timely manner based on the latest information available. Based on this principle, there are no undervalued stocks to be had, since every stock is always trading at a price equal to its intrinsic value
  **.

The another one what can be found from academic literature and books, states:

  Fama (1965) In  other words,  in  an  efficient  market  at  any  point
  in   time   the   actual   price   of   a   security   will   be
  a good estimate of its intrinsic value.

and line with previous, other source states :

  Market efficiency
  does not require that the market price be equal
  to true value
   at every point in time. All it requires is that errors in the
  market price be unbiased,
  i.e.,
  that
  prices
  can
  be
  greater
  than
  or
  less
  than true value, as long as these deviations are random

I also saw algebraig illustration where it was shown that the market price estimates the fundamental value of security better any individual trader can estimate it. (with certain assumptions)

So the question is, why here and these is stated, that in efficient market, the market price of stock is trading at a price equal to fundamental (or intrinsic) value? Which is right?

And if the market price is at the best good estimate of intrinsic value, how can it be stated that in efficient market there are not under- or overvalued stocks, if the market price is only best estimate of instrinsic value?

I am not very familiar with algebraig definitions, but some kind of clarification behind this issue would be appreciated.

Thank you for clarification.

The fundamental value of an asset over an infinite horizon is the sum of dividends discounted over time.

You are stumbling into the literature on rational and irrational bubbles. In general, the difference between the fundamental value of an asset and its market price constitutes, to some degree, bubble behavior.

Edit — I can probably expand this for clarity.  Each of those definitions tries to get at the same thing — there is no room for systematic bias in the prices of assets traded on the market. Markets, more or less, are powerful because they aggregate massive amounts of information. They incorporate ever trader’s wants, fears, expectations, etc. and distill it all into a single thing — a price. And markets do this very quickly. We can see this, for example, when markets adjust to incorporate information shocks that occur around FOMC statements. Because of this, it should be true that prices do not deviate systematically from fundamentals. The argument boils down to one of arbitrage opportunities, I suppose.

However, many economists (many people, really) openly discuss bubbles. A bubble, rather loosely stated, exists if prices deviate systematically from fundamentals. The common theme of each definition above is that we should see systematic deviations on prices away from fundamentals. They just vary a bit in how emphatically they say this. Nevertheless, we all talk about bubbles.

Also — how do we know if prices have deviated from fundamentals? Well, there is a nice literature built around this idea, but I am not convinced this is possible to do with empirical data. However, economists have used the laboratory to show that this happens in markets. In fact, generating bubbles in an asset market is probably among the most reproducible laboratory phenomena I can think of.

There are many valuation models. These models take fundamental or technical data as input and specify value as the output. Each model specifies how to calculate value. Different models give different values. Which value is true value?
The efficient market hypothesis is a tautology which says the market value is the intrinsic value and the intrinsic value is the market value at any point in time. Don't get confused by the words used to describe EMH. It is a tautology. It means the market price is always right and your valuation model, if it deviates from market price at the time of trade, is wrong, according to those who advocate EMH.
I challenge anyone who is tempted to vote down this answer to provide an objective model for "intrinsic value" of a stock or equity trading on the secondary market. If one uses discounted cash flow models then future earnings and revenue are forecast projections, subject to uncertainty and therefore not objective, and one has a choice of discount factor, subject to judgment of the person making the DCF analysis, so there is no objective model for intrinsic value.
This 53 page paper describes how discounted cash flows are used to make estimates of instrinsic value in a context of uncertainty:
http://people.stern.nyu.edu/adamodar/pdfiles/DSV2/Ch2.pdf
where there is no one objective way to predict future cash flows, to specify risk, or to apply a uniform discount factor during the discounted cash flow analysis. Everyone who is honest with self and others must recognize that there is no intrinsic value.
This is a quote from the link above, at the end of Chapter 2, the book title is The Dark Side of Valuations

What do intrinsic valuation models tell us?

All  of  the  approaches  described  in  this  chapter  try  to  estimate  the  intrinsic  value of an asset or a business. However, it is important that we understand exactly what we are doing in the process. We are estimating what an asset or business is worth, given its cash flows and the risk in those cash flows. To the extent that the value is dependent upon the assumptions we make about cash flows, growth and risk, it represents what we think the intrinsic value is at any point in time.

So,  what  if  the  intrinsic  value  that  we  derive  is  very  different  from  the  market price?  There  are  several  possible  explanations.  One  is  that  we  have  made  erroneous  or unrealistic assumptions about a company’s future growth potential or riskiness. A second and related explanation is that we have made incorrect assessments of risk premiums for the entire market. A third is that the market is, in fact, making a mistake in its assessment of value.

Even  in  the  last  scenario,  where  our  assessment  of  value  is  right  and  the  market price is wrong, there is no guarantee that we can make money of our valuations. For that to  occur,  markets  have  to  correct  their  mistakes  and  that  may  not  happen  in  the  near future. In fact, we can buy stocks that we believe are under valued and find them become more  under  valued  over  time.  That  is  why  a  long  time  horizon  is  almost  a  pre-requisite for using intrinsic valuation models. Giving the market more time (say 3 to 5 years) to fix its mistakes provides better odds than hoping that it will happen in the next quarter or the next six months.


Regarding the units of the shift produced by subsidies on supply curve I am giving my first steps on microeconomics and I can't fully understand why by applying a per unit subsidy, the supply curve is shifted by a fixed amount. In wikipedia's words:

  Marginal subsidies on production will shift the supply curve to the right until the vertical distance between the two supply curves is equal to the per unit subsidy

But let's say that my supply curve is given by
$$ Q_s = -200 +3 \cdot P $$
If a per unit subsidy is applied, the new supply curve is now given by:
$$ Q_s = -200 +3 \cdot (P+50) $$
But if the unit of the subsidy is $[\frac{\$}{units}] $ the units of the equation don't match:
$$ Q_s [units] = -200[units] +3[\frac{units}{\$}] \cdot (P[\$]+50[\frac{\$}{units}]) $$
So shouldn't a per unit subsidy change the slope of the supply curve rather than shifting it?

The confusion stems from the fact that the price is also a $\frac{\$}{units}$


Scarcity in Relation to Free Goods This is a basic economics question about scarcity in relation to free goods. The hypothetical question is that if iTunes decided to have free streaming for all their songs, would there still be scarcity for songs and would the incentives change?

I'm fairly new to these definitions and principles as it is economics 101. My understanding leads me to believe that songs remain scarce, as not all consumers have access to computer and as such to iTunes, and the incentives do change, as more people seeking free tunes will buy computers for the additional factor of the unlimited, free streaming.

Am I correct?

No, all would be the same. Except that its will monetize the android and iOS networks to make money that way.

Like youtube's model, this is how iTunes might operate


Why doesn't Dollar exchange rate go down? I am from India and my question is related to conditions based in India which may be applicable to other countries as well.
Dollar value is gradually rising in India. I was trying to understand why. During this COVID season I was expecting the Dollar value to go down base on my below reasons and it didn't happen.
I read about a little bit about it and trying to make connection between the below points to understand why.
India's usual major expense for Dollar in large scale

Crude oil purchase and Defense purchase expense.

India's Rupee(currency) gain

Huge remittance from US and middle east countries
India's forex reserve increase because of increase in foreign remittance
Crude oil prices were down before a few months due to COVID
India's IT service sector performance was excellent and got many US deals worth billions.

What perplexing me are

How can the foreign reserve go high without reducing Dollar exchange rates? The country holding more Dollars and still the exchange rate is high.
When the main expense of Crude oil purchase was down(also demand was down) why didn't it affect the exchange rate?

Dollar is a safe heaven currency, when there is crisis or economic uncertainty like the one we are in now (i.e., Covid) most people start to hoard US dollars.
USD is the world reserve currency and it provides unmatched privilege to USA, any attempt to by pass it in international trade is fatal, you get boomed to ashes like Iraq or Libya.


Does price affect quantity or vice versa? On nearly all graphs found within economics textbooks, quantity is label on the x-axis and price on the y-axis, implying that the quantity supplied affects the price. Is this really so? Intuition would tell you (or me at least!) that the quantity someone wishes to buy is dictated by the price, which in turn is decided by whoever is selling the item.

This is a common problem among students first learning economics. The way these graphs are displayed are not meant to tell you anything about causality, let along the direction of causality. The reason that price is on the y-axis is partly because of tradition and partly because that's what makes the most sense from the perspective of developing economic theory.

One of the central questions of economics is the determination of prices. What causes prices to be what they are? So, it maybe seems natural to write relationships that give a price as the dependent variable. However, the layout is not meant to convey any information about causality.

When strawberries are in season they are cheaper.

The only thing that has changed is the supply.


Has an increase in housing supply in popular cities including Amsterdam led to an increase in house prices? Common economic thinking dictates that an increase in price should lead to an increase in supply, and that an increase in supply should then lead to a decrease in price.  According to Maarten van Poelgeest, former alderman of Amsterdam, the opposite is happening in Amsterdam and other popular cities.  He is quoted in an article in De Groene Amsterdammer as saying:

  ‘Hoe meer er gebouwd wordt, hoe aantrekkelijker de stad wordt. Er komen meer voorzieningen, er komt meer reuring. Nieuw aanbod maakt de vraag dus juist weer groter – en de huizenprijzen hoger.’

Which means:

  ’The more there is built, the more attractive the city becomes. There will be more facilities, there is more bustle. New supply therefore makes the demand even larger – and house prices higher.’

The reasoning by Maarten van Poelgeest appears plausible, but is there any evidence that this is actually happening?  Is there evidence that an increase in housing supply leads to an increase in house prices, due to housing in the area becoming more attractive?

I'm looking for an answer based on empirical evidence from trends in the past up to the present, in order to present the claim/hypothesis by Maarten van Poelgeest up to the best available measurements.

NB: I am emphatically not asking just for a correlation.  A correlation between increase in supply and increase in price can easily be explained by the reverse of the causation I'm asking for here.  I'm aware that causation is harder to provide evidence for but it should not be impossible.

Let's just say that economists don't really agree with this thesis, and most city-level empirical evidence points in the opposite direction. E.g.

  We ultimately conclude, from both theory and empirical evidence, that adding new homes moderates price increases and therefore makes housing more affordable to low- and moderate-income families.

  [...]

  A few studies use panel data and find that the imposition of more stringent land-use controls
  leads to lower supply and higher prices. Jackson (2016) uses longitudinal data from California’s
  cities to assess the effect a city’s adoption of additional land-use regulations has on the number of
  new construction permits issued, and finds that each additional land-use regulation adopted
  reduced multifamily and single-family permits by an average of more than 6% and 3%, respectively,
  and that regulations reducing allowable density had even larger effects. Zabel and Dalton
  (2011) use longitudinal data from localities in Massachusetts and find that increases in minimum lot
  sizes are followed by significant increases in prices. Looking at longitudinal data on municipalities
  in the Boston (Massachusetts) metropolitan area, Glaeser and Ward (2009) find that the adoption of
  stricter local regulations leads to higher house prices, but the coefficient falls in magnitude and
  loses significance once they control for population demographics. They point out that this is
  expected, if homes in other jurisdictions are seen as perfect substitutes. Thus, whereas supply
  restrictions may increase prices in a market as a whole, they may not increase them disproportionately
  in the particular locality where they are imposed due to spillover effects across jurisdictions.

  Several other researchers use instrumental variables to try to more clearly assess the causal
  effects regulatory restrictions have on housing supply and prices. Ihlanfeldt (2007) uses such an
  approach to study regulation in localities in Florida and finds that predicted regulations significantly
  increase the price of single-family homes. Saks (2008) uses instrumental variables and shows
  that increases in labor demand lead to less residential construction and larger increases in housing
  prices in metropolitan areas with more restrictive housing supply. Hilber and Vermeulen (2016)
  show that changes in demand lead to increases in local house prices rather than increases in
  supply in municipalities in England with greater regulatory restrictions, measured by the refusal
  rate of proposed residential projects and the number of project approvals delayed more than
  13 weeks.

  In sum, the preponderance of the evidence shows that restricting supply increases housing
  prices and that adding supply would help to make housing more affordable. [...] although it is surely true that land is constrained, especially in certain
  markets (Saiz, 2010), land can be used more intensively to allow for more housing. The limits on the
  land with which housing is bundled make housing different from many goods, but the difference is
  one of degree: the supply of housing can and does increase even in constrained markets, and
  prices should generally fall in response (see the review by Dipasquale, 1999; Mayer & Somerville,
  2000).

  [...] most housing filters down, or loses
  value as it ages, representing new supply in submarkets at lower price points. [...] Indeed, recent research shows that filtering
  was the primary source for additions to the affordable rental stock between 2003 and 2013,
  whereas new construction was the largest contributor for the higher priced rentals, and tenure
  conversion was the largest source for moderately priced rentals (Joint Center for Housing, 2015, fig.
  14). Further, Weicher, Eggers, and Moumen (2016) report that 23.4% of the rental units that were
  affordable to very low-income renters in the United States in 2013 had filtered down from higher
  rent categories in 1985. Another 21.8% were conversions from formerly owner-occupied homes or
  seasonal rentals.9 Most of the higher priced rental units that filtered down to become affordable in
  2013 were moderate-rent units in 1985, but 15% of those that filtered down were high-rent units in
  1985. Note that filtering occurs over a shorter time frame too; among affordable units in 2013,
  19% had been higher rent units as recently as 2005.

  Recent research analyzing the incomes of successive occupants of homes also suggests substantial
  downward filtering, particularly of the rental stock due to tenure conversion; as the owner-occupied
  stock ages, a portion converts to rental (Rosenthal, 2014). Rosenthal also finds, however,
  that filtering rates are considerably lower in areas with high house price inflation, although
  downward filtering still occurs.

  In short, new construction is crucial for keeping housing affordable, even in markets where
  much of the new construction is itself high-end housing that most people can’t afford. A lack of
  supply to meet demand at the high end affects prices across submarkets and makes housing less
  affordable to residents in lower-cost submarkets.

Finally getting to the discussion of the precise thesis you ask about:

  Some skeptics argue that even if additional supply could help make housing more affordable in the
  short run, it won’t in the long run because the additional supply will induce more demand, especially
  among buyers or renters wealthier than the existing residents in the neighborhood (Redmond, 2015).
  The claim is analogous to the argument that building more highways will not reduce congestion
  because the lower cost of travel will simply cause more people to drive or to take that particular route
  (Gorham, 2009). In this case, the argument is that by making the jurisdiction more affordable, adding
  housing supply will attract new demand—both from current residents who would otherwise leave,
  and from people living elsewhere who will now choose to move to the jurisdiction. Further, the argument goes, lower rents and prices may also induce latent demand—people who are living with
  roommates or family members may choose to form their own households (Ellen & O’Flaherty, 2007) or
  people may choose to invest in pied-à-terres in a city. That additional demand will drive prices back up
  until supply can again respond, causing housing to be more affordable, at best, only cyclically,
  according to the argument, and increasing the density of the jurisdiction, with the attendant costs
  of congestion.

  Although building additional highways does appear to induce more demand (Duranton &
  Turner, 2011), in the case of housing, additional demand is unlikely to completely offset the new
  supply. Such an offset requires demand curves to be perfectly elastic—or, in other words, it
  assumes that neighborhoods and jurisdictions are perfect substitutes and that there are no
  constraints on the ability and willingness of households to move. That is unrealistic. Moving
  homes is not like driving a few extra miles (Lewyn, 2016), and costs associated with moving may be
  high. Any additional demand induced by new housing is limited by personal and economic
  constraints on the ability and willingness of households to move, restrictions on immigration, and
  uncertainty and other factors that might inhibit renters and buyers from renting or buying in the
  market in which housing supply increases. Indeed, mobility rates have fallen sharply over the past
  several decades, and although the reasons for the decline are being debated, the decline reveals
  significant constraints on the ability and willingness to move.

  Thus, in the long run, whereas some additional households may be drawn from outside (or from
  within the city) to buy or rent homes as supply increases, it is highly unlikely that prices will end up
  at the same level that they would have reached absent any new supply. Finally, as noted above, the
  empirical evidence shows that allowing more supply leads to lower housing prices; if adding
  supply induced sufficient additional demand to offset the increased supply, the studies would
  not find an association between supply and prices.

It can happen indeed in some very limited circumstances, and with localized [e.g. neighborhood] effect, which is probably on what this faulty generalization is based on:

  Many renters in neighborhoods where market-rate housing is proposed express concern that the
  construction of new housing will actually make their affordability problems worse by raising rents or
  house prices, fueling gentrification, and potentially displacing existing residents (Atta-Mensah, 2017;
  Savitch-Lew, 2017). Hankinson (2017) theorizes that renters’ opposition to local additions to supply is
  driven by such worries; he argues that it is plausible that the construction of an attractive new building
  will increase prices locally (by improving the physical landscape, bringing new amenities to the
  neighborhood, and signaling that the neighborhood is improving), even as it reduces them citywide.

  Testing this proposition empirically is quite challenging, given that developers will naturally be
  attracted to areas where prices and rents are rising. There is evidence that improvements to
  blighted housing can, in some circumstances, increase surrounding property values, even when
  the new or improved housing is subsidized, low-income housing (Diamond & McQuade, 2016;
  Schwartz, Ellen, Voicu, & Schill, 2006). The new housing studied, however, typically replaced
  vacant, abandoned buildings and littered vacant lots, in essence removing a disamenity. [...]

  There is little empirical evidence about the net effect new market-rate housing has on the prices or
  rents of nearby homes, and what exists may not be causal. One recent study examines the effect of
  market-rate single-family homes newly constructed on infill sites, and finds that newly constructed
  single-family homes can have positive impacts on the sales price of other single-family homes nearby,
  but the effect varies with context (Zahirovich-Herbert & Gibler, 2014). A study of multifamily high-rise
  infill developments in Singapore found positive price effects on nearby houses (Ooi & Le, 2013), as did
  a study of single multistory apartment buildings constructed in Helsinki (Kurvinen & Vihola, 2016).
  These studies all consider property values and not rents, and none is able to prove a causal relationship
  given that market-rate developments aim to target neighborhoods where they expect property
  values to improve. Unfortunately, we found no study examining impacts on rents, although one study
  by the California Legislative Analyst Office concluded that additional market-rate construction is linked
  to lower displacement rates (Taylor, 2016). Examining low-income neighborhoods in the Bay Area
  between 2000 and 2013, these researchers found that the production of market-rate housing was
  associated with a lower probability that low-income residents in the neighborhood would experience
  displacement. Although a singular study, the findings suggest that for neighborhoods in high-demand
  cities, blocking market-rate construction may place greater pressures on the existing stock.

  In short, although it is clear that the construction of new homes will moderate price and rent
  increases citywide, neither theory nor empirical evidence provides clear guidance about when
  localized spillover effects might occur and when they might actually cause an increase in the prices
  and rents of immediately surrounding homes.

There's a more recent study on the core issue of the question, not covered in the above review:

  Preliminary results using a spatial difference-in-differences approach suggest that any induced demand effects are overwhelmed by the effect of increased supply. In neighborhoods where new apartment complexes were completed between 2014-2016, rents in existing units near the new apartments declined relative to neighborhoods that did not see new construction until 2018. Changes in in-migration appear to drive this result. Although the total number of migrants from high-income neighborhoods to the new construction neighborhoods increases after the new units are completed, the number of high-income arrivals to previously existing units actually decreases, as the new units absorb a substantial portion of these households. On the whole, our results suggest that—on average and in the short-run—new construction lowers rents in gentrifying neighborhoods.

See also a blog discussing it (which also does a good job at debunking the roads analogy); in summary, the gist of the latter study is in this chart:

  This chart shows that rental prices for apartments close to the new building fell relative to the prices for apartments located further away. The dashed “before” line has a negative slope, suggesting that prices declined the further you got from the site of the new building.  The solid “after” line has a positive slope (prices increase the further you get from the new building).  Overall, prices are higher (the solid line is above the dashed line), but prices actually went down next to the new building, and increased far less than in the area further away from the new building.

  These data are a strong challenge to the induced demand theory.  If a new building made an area more attractive, one would expect the largest effect in the area very near the building. But, consistent with the traditional “more supply reduces rents” view, the addition of more units in an area seems to have depressed rents (or at least rent increases) compared to buildings in the surrounding area.

In other words, even the theory that prices might increase locally in the neighborhood of a new building doesn't hold up, on average, to a difference-in-differences test. Without a difference-in-differences approach one can of course draw the wrong conclusion since overall demand in a city may be increasing faster than the overall supply.

Even more recently, another paper on NYC (not yet published in a peer-reviewed venue, but was mentioned in a recent NYT article):

  I find that for every 10% increase in the housing stock within a 500-foot buffer,
  residential rents decrease by 1%. The rent reduction is caused by the completion of new
  high-rises rather than their approval. Across neighborhoods, the impact is smaller in more
  central areas, presumably due to more elastic demand. Within neighborhoods, the impact
  is smaller for lower-rent buildings. Finally, the negative impact appears to be driven by
  supply effects rather than dis-amenity effects, like changes in neighborhood physical features,
  blocked views, or shadows. New housing units alleviate the growing demand for existing
  housing units and moderate the rapid growth of residential rents.

  Residential property sales prices also decrease when new high-rises within 500 feet
  are completed. [...] Because 99% of new high-rises are condos and rental
  buildings, they do not significantly affect sales prices of co-ops and 1-5 family homes. The negative impact is bigger for closer substitutes, further confirming the negative impact is due to supply effects.

  To address the hypothesis about amenity effects, I find new high-rises and their
  high-income tenants attract new full-service restaurants, cafes, and coffee shops. These consumption amenities likely make neighborhoods more attractive and potentially increase rents
  and sales prices (Couture and Handbury, 2017). However, the amenity effect is dominated by the supply effect, given that rents and sales prices still fall on net.

As was mentioned in a OP's comment below, living in a big city vs a small town (and vs the prairie) is an amenity effect. However, there seems to be a limit to this effect after which more housing supply lowers the (rental) price.

The amenity effect has been studied for decades but alas often in isolation, most prevalently perhaps with the the Roback model, which basically adapted Rosen's more general spatial equilibrium model to "nontraded" goods like housing. ("Nontraded" because Roback only considered effects on rents.) Using this model, one essentially gets (rental) price-amenity gradients. Roback assumed that "the cost of changing residences is zero" (i.e. costless migration). Modelling "partially open" cities, i.e. with non-zero (and non-infinite) relocation costs across its boundaries is a relatively more recent endeavour. Likewise for considering the combined effect of housing supply and amenities on rents. As one such theoretical work notes

  as housing is supplied more elastically [...] the rent effect of amenities approaches zero.

Housing is something subject to socio-economic events and policy, which may produce a variety of outcome. So this is not a simple "supply and demands" issue.

First, somebody must afford the house, i.e. enough business and job activities to sustain house purchase. You can build tons of house in the middle of nowhere, but without a job nearby, nobody going to buy it.

Second, a land is scarce, you cannot keep building houses/apartment on already used up land.

Third, housing price can be speculated and fuel by lenient bank loan terms

Fourth, there is housing ownership tax and policies to curb speculation

Fifth, Speculation on demands

So you will see:

Hong Kong: expensive houses with builders monopoly, favourism and price fixing in place.
Germany: only scarce city center are expensive, suburban housing price is still stable. Bank are very careful screening the client, little room for speculation.


How huge is the multiplicator of social welfare in current societies? If you give somebody with a high consummate some extra money, most likely it will be spent. Having this spent for e.g. groceries this will make sales man, farmer, ... employed so they pay taxes are buy groceries for their own. How huge is the multiplicator on this for modern services oriented societies?

Keynesianism (what you're apparently basing this on) is incoherent and relies on arbitrary eigenvalues such as "autonomous consumption". In real life the multiplier is small and inconsequential.

However, the multiplier may appear close to one or slightly above simply because GDP increases the instant the government approves spending in public-subsidised enterprises, due to the way GDP is defined. For example, let's say the government spends $1 to subsidize Fannie Mae and this is counted as a consumption item (for whatever reason). GDP immediately increases by a dollar. Now Fannie Mae spends this on some irrelevant bureaucratic expense (buying mortgage derivatives, legal fees, financial services etc). GDP increases by a dollar again. So we just achieved a multiplier of two while having absolutely no effect on the real world.

As you can see, measured GDP is subject to all sorts of random problems that make any attempt to calculate the multiplier pointless.

Furthermore, strictly speaking, the "multiplier" is only technically supposed to apply to government consumption, and not transfers as you are asking about.


Would a fair distribution of wealth from the super rich increase the purchasing power/life quality of the average person? I will start by saying that I do not have any background in finance and that the following question might be very much naive, but it has been bugging me for a while now. The general narrative seems to be  that redistribution of wealth from the super rich (top 1%) would benefit the other 99% and increase their quality of life. In the answer to this question, it is calculated that in case of redistribution from the top 1%, everybody among the bottom 99% would receive around $111,000. However, this answer does not really go into detail on what would happen in terms of purchasing power if everyone in the bottom 99% would get said amount. Specifically, my question is the following (and is, to first degree, purely of abstract nature). Let us consider a closed economic system in which most of the population is similarly wealthy, but a very tiny fraction owns a large amount of money. For simplicity, let us assume that we have a city with 1,000,0000 inhabitants from which 999,999 inhabitants are similarly wealthy, while there is 1 inhabitant who owns 90% of the wealth. Let us assume the wealth this one person owns is purely in the form of cash and he basically just hoards his money, so that this money is virtually non-existent in our system. Now assume that his money gets equally distributed between the inhabitants. Would this really make any difference to the purchasing power of the inhabitants and thus to their life quality? Wouldn't prices just simply rise so that purchasing power would stay roughly constant? The question boils down to two main assumptions:

The number of super rich people is much smaller than the number of average people
The money of the super rich is hoarded and virtually non-existent in our closed economic system

If my reasoning is correct with those assumptions, how are these assumption distorted in the real world?

tl;dr: In the hypothetical you set in the body of your question redistribution cannot help poor. However, this is not because redistribution could not significantly raise the welfare of the poor but rather because in your question 'the rich' actually dont have any resources to share with the rest. In fact the way how you set up your hypothetical example what you call 'redistribution' is equivalent to monetary expansion.
However, in real life redistribution, even redistribution of money, is not equivalent to monetary expansion and can help to raise material welfare of people especially of the poor and to the extent quality of life depends on material welfare their quality of life as well.

Full Answer:
The full answer will be structured in three parts. I will first try to answer your question in body of the text, then explain the problems with your assumptions and finally try to answer question in your title with small changes that will be still true to the spirit of the question and make it actually answerable in objective fashion (I do this because I think that most of the attention this question is driving comes from the question in its title).
PART I: Answer to the Question in the Body:
In order to answer your Q lets try to model it. In your example you talk about hypothetical economy when nobody works there are just people with some given wealth so we are in some endowment economy where people are endowed with some output $Y$ which constitutes their 'wealth', but rich people have only cash/money $M_r$. What even more you assume that the cash was not used in anyway so for all practical purposes it simply is not even part of the economy. Moreover, as per the question I will assume the money are equally distributed among everyone.
Well taking assumptions above seriously we can just analyze the effect of such money transfer the same way as just an expansion of money supply using simple equation of exchange (this is not normally appropriate model for evaluating redistribution but in your case redistribution is just monetary expansion in disguise and this model is a simple textbook example of a model that can be used to analyse effect of monetary expansion):
$$MV=PY$$
where, $V$ and $P$ which were not yet introduced  are velocity of money and price level respectively. In this case $Y$ is fixed as there is no production just everyone has some certain level of wealth. Hence when $M$ increases by adding the $M_r$ either $P$ increases or $V$ must drop (which would happen if the money people get from the rich end up 'buried' and not used), or some combination of thereof.
In either case whether prices or velocity changes people cant be made better off by the transfer of cash in your hypothetical scenario as in your scenario the rich $1\%$ really has nothing of value to give to the $99\%$. Their endowments $Y$ remain fixed. Again, I would normally never recommend using this model for analyzing redistribution but in your case you are not really talking about redistribution.
PART II: Problems With Your Question:
The main problem to your question is that if really taken to its logical conclusion it boils down to the following. Does creating more money make people any richer? Well answer to that is no. What makes people rich is the amounts of goods and services they have access to. In fact from an economic perspective the $1\%$ of population in your question must be miserable bunch because by your assumption they only have money while the other $99\%$ actually have some other 'wealth' which presumably in your question implies some goods and services to enjoy.
However, the above situation is clearly absurd and does not correspond to reality. Rich people do not sit upon piles of sterile cash that is not used in economy. If their money circulates in the economy either because the rich spend it, or put it in bank into their accounts or invest it into some assets they will already be part of the $M$ and redistribution, even redistribution of money, will not expand $M$.
Redistribution might decrease output due to the fact that it distorts incentives, however at the same time there are arguments that it might boost output as high levels of inequality can make harder for poor people to become entrepreneurs or realize their full potential in different ways. Empirical studies actually show that the relationship between economic growth and intensity of redistribution is mixed, suggesting that on net it has no impact on economic growth save for cases of extreme redistribution that would be well above what we typically see in developed nations nowadays (see Ostry, Berg, and Tsangarides 2014 and sources cited therein). When it comes to velocity redistribution can slightly increase it as some research shows that people with lower savings rate contribute to higher velocity (see Wang & Ding 2005), however the effects are nowhere near strong enough so any transfer will have no net effect on welfare of recipients.  As a matter of fact it is generally agreed by the profession that over long time periods it is an increase in $M$ which leads to inflation (see pretty much any conventional textbook for example Blanchard et al Macroeconomcis an European Perspective or Mankiw Principles of Economics).
As a consequence of the above, redistribution can be more or less viewed not just as a transfer of money but as a transfer of resources and in fact this is how redistribution is treated in wast majority of the literature in public economics (see models presented in any public economics textbook). Many redistribution models will not even explicitly include money at all and this is not due to lack of oversight but deliberate simplification (the same way as physicists often may assume that some part of space contains perfect vacuum even if it has some particles) reflecting the view that redistribution is not simply some money creation especially when financed by taxes (even though relative prices might change which can still affect welfare but this is accounted for in the models).
Part III: Answer to the Question in the Title:
The question in your title:

Would a fair distribution of wealth from the super rich increase the purchasing power/life quality of the average person?

is actually far more sensible but I will still make 3 changes that I think are true to the spirit of what you are actually interested in.
First I am going to change the word fair distribution to redistribution to get rid of the word 'fair'. Well what is fair or fair distribution? That's a question that human race pondered ever since civilization emerged from the fertile crescent and perhaps even in prehistory without any generally agreed upon answer and discussion of fairness belongs to moral philosophy not economics.
Second I will change wealth to wealth/income. The reason for this is that I feel that like many other non-economist you do not distinguish between wealth and income and treat them jointly. For example, who is in your opinion a richer person? A old retiree whose net assets are worth $\\\$1,000,000$ because his house happened to be in gentrified area and went up in value but with measly salary of $\\\$500$ working as shop greeter, or a superstar which might have no net assets (i.e. living in fancy hotel instead of owning house) but with monthly paycheck of $\\\$70,000$? The retired person has more wealth but I think many would actually consider person in that situation poor whereas the second person has no wealth but I think most reasonable people would consider such person rich.
Third I will replace average person with low income people. The reason for this is that in any right skewed income distribution (an income distributions are world are right skewed) an average person will actually be better off than more than half of the population and optimal redistribution systems are designed to help people at the bottom not people who are better off than most (even though unfortunately in practice governments often engage in such 'perverse' redistribution as well).
Hence I will try to answer the following question:
Would a redistribution of wealth/income from the super rich increase the purchasing power/life quality of the low income people?
the answer here when it comes to income is resounding yes, when it comes to wealth the answer is not clear or rather the answer would be maybe.
Redistribution via Income Taxes
The literature on optimal income tax shows that optimal top marginal tax rates for the richest can be somewhere in rage of $50-75\%$ in the US (see Saez 2001) an generally similar estimates are also found for other developed countries.
The simulations for these tax rates are already made with an explicit goal of maximizing actual welfare of the recipients and society overall  - not to maximize any monetary transfer per se - but to maximize their underlying utility. They are based on the following optimal non-linear tax function which comes from the seminal works of Mirrlees (1971) - who in fact got Nobel Prize in Economics for this contribution, Diamond (1998) and Saez (2001).
Furthermore, the optimal tax rate even takes into account all the labor supply response and other factors in fact the formula is given by:
$$ \frac{T'(z_n)}{1-T'(z_n)} = \left( 1 + \frac{1}{\epsilon_{lT}} \right)\frac{\int (1-b_m)f(z_m)dz_m}{1-F(z_n)} \frac{1-F(z_n)}{z_nf(z_n0)}$$,
with $b_n \equiv \frac{\Psi'(u_n)u_c}{\eta}+ nT'(z_n) \frac{\partial l_n}{\partial \rho} $.
I wont go over every single term in the formula as this would turn this answer into a book but broadly speaking the first part $\left( 1 + \frac{1}{\epsilon_{lT}^*} \right)$ is given by elasticity of labor supply to income taxes and you can think of it as an 'efficiency' parameter, the second part $\frac{\int (1-b_m)f(z_m)dzm}{1-F(z_n)}$ tells us what the marginal benefit of redistribution is and this marginal benefit factors in underlying actual welfare which is captured by $b_n$ which depends on both utility of consumers and the societal utility function,  and finally $\frac{1-F(z_n)}{z_nf(z_n0)}$ is the part that captures the relative magnitude of distortions created by this taxation. Again since we are talking about improvements in actual underlying utility what the aggregate price level is does not matter.
If redistribution would not be able to improve welfare in poor this formula would give you zero marginal tax rates. Since simulations based on real world parameters (Saez 2001) show that top marginal tax rates could be as high as almost $80\%$ clearly redistribution can improve the welfare of poor.
An important caveat is that this optimal taxing formula does not take into account general equilibrium effects and general equilibrium effects generally (no pun intended) result in lower taxes but no reasonable estimate of the magnitude of general equilibrium effects would push the top marginal tax rates to zero. Even if we would say that in general equilibrium these taxes would be half of what partial equilibrium analysis suggests they would still result in redistribution that would be able to significantly help the low income individuals.
Redistribution via Wealth Taxes
When it comes to wealth taxes the literature is much smaller as studying wealth taxes is exponentially more difficult than income taxes due to the fact that they are rare and we also don't have good data. As a consequence the discussion on wealth taxes to some extent takes a form of twitter fights between various economists (I am referring to Summers-Saez & Zucman infamous twitter battle) rather than in some proper research.  This being said some academic work was already done on this topic but it remains highly inconclusive. I will try to present both views fairly starting with the no wealth tax view and then presenting the pro wealth tax view.
Anti wealth tax view:
Some economists argue that optimal wealth tax is simply $0$. If this is so then obviously wealth tax cannot help improve welfare of the poor. There are several reasons why this would be so which are all summed nicely in this article from Larry Summers. Here is the digest:

Wealth taxation also raises practical concerns — for example, issues of valuation: Is a partnership in a law firm wealth? How will illiquid assets — like football teams or newspapers — be valued? And issues of liquidity: If someone owns 1 percent of Uber — still a private company — she will owe roughly $20 million in taxes each year, but it’s unclear where she can get this money. She can’t sell shares and, if involved with the operation of the company, is likely to be barred from borrowing against the value of her stock.

There are also family unit issues: If a couple files separately or gets divorced, do they get two $50 million exemptions? And issues of gaming: There will be incentives to use legal structures to relinquish direct ownership of assets while maintaining control of them. For example, owning assets in a trust or a nonprofit to benefit from wealth while avoiding tax liability. Granting that capital income should be taxed more heavily than it now is, and that unrealized capital gains going untaxed is a serious problem, there is also a question of just how a punitive tax is appropriate.

It is important not to be misled by the 2 percent annual rate: A 50-year old who has accumulated a substantial fortune can expect to pay more than half of it in taxes before she dies.

Imagine that a wealthy person invests in 10-year treasury bonds, with a 2.4 percent return. The wealth tax would extract 2 of the 2.4 percent return. Combined with income taxes levied at a 40 percent rate, the wealth tax could make the effective tax rate on capital income well over 100 percent. And then at the end of life would come the estate tax. While we are not aware of formal estimates of the loss in economic efficiency from wealth taxes, we suspect that if levied without concomitant reductions in income tax rates or estate tax rates, the ratio of burden on the economy to revenue raised would be far higher than with the base-broadening measures we advocate.

....

The Organization for Economic Cooperation and Development recently assessed wealth taxation and concluded that “from both an efficiency and equity perspective, there are limited arguments for having a net wealth tax.” Of the three countries with a wealth tax, two — Norway and Spain — raise an average of 0.305 percent of GDP. These taxes generate less than one-third of what the wealth tax estimates despite having a much broader base: While precise data are hard to come by, we suspect that less than 10 percent of this revenue — or 0.03 percent of GDP — comes from those in the top 0.1 percent of the wealth distribution.

Pro wealth tax view
However, Saez and Zucman the main proponents of wealth tax  would argue that the worries mentioned above are overstated (see here).
According to Saez and Zucman the main reason why the European wealth taxes failed is that Europe tolerates (and arguably even encourages) tax competition. In this article they argue that:

The specific form of wealth taxation applied in a number of European countries had three main weaknesses. First, European
countries were exposed to tax competition and tax evasion through offshore accounts, in a
context where until recently there was no cross-border information sharing. Second, European
wealth taxes had low exemption thresholds, creating liquidity problems for some moderately
wealthy taxpayers with few liquid assets and limited cash incomes. Third, European wealth
taxes, many of which had been designed in the early 20th century, had not been modernized,
perhaps reflecting ideological and political opposition to wealth taxation in recent decades.
These wealth taxes relied on self-assessments rather than systematic information reporting.
These three weaknesses led to reforms that gradually undermined the integrity of the wealth
tax: the exemption of some asset classes such as business assets, a preferential treatment of
others such as real estate, or a repeal of wealth taxation altogether.
A modern wealth tax can overcome these three weaknesses. First, offshore tax evasion can
be fought more effectively today than in the past, thanks to recent breakthrough in cross-border
information exchange, and wealth taxes could be applied to expatriates (for at least some years),
mitigating concerns about tax competition. The United States, moreoever, has a citizenshipbased tax system, making it much less vulnerable than other countries to mobility threats.
Second, a comprehensive wealth tax base with a high exemption threshold and no preferential
treatment for any asset classes can dramatically reduce avoidance possibilities. Third, leveraging
modern information technology, it is possible for tax authorities to collect data on the marketvalue of most forms of household wealth and use this information to pre-populate wealth tax
returns, reducing evasion possibilities to a minimum. We also discuss how missing market values
could be obtained by creating markets. In brief, the specific way in which wealth was taxed in a
number of European countries is not the only possible way and it is possible to do much better
today

This being said even the most extreme serious wealth tax proposals are somewhere in ballpark of $5\%$ - this is much less then the top marginal taxes that are optimal for income redistribution. It can still be argued to be somewhat well-being enhancing but clearly it is debatable of how significant would this effect be.
Nonetheless as correctly pointed by Brian in his +1 answer/comment the argument can be made that wealth tax will help to erode the political power of the rich which will ultimately help the poor. There are also counterarguments, in fact Summers argues that wealth tax might actually increase the political power of the rich but this debate is something that is outside the field of economics so feel free to read their papers and articles I linked here in full to make up your mind about this. I personally am agnostic about this power argument as there is not much research done on this issue. I suspect that even Summers and Saez and Zucman would agree that on both sides of this argument evidence is mixed.
Hence when it comes to wealth taxes it is hard to say if they can improve the lives of low income people significantly, but this is not because of a high inflationary effect redistribution via these taxes would have but rather due to the fact that optimal wealth taxes are either zero or low.
The only exception of the above is land or similar type of property which can still be counted as wealth and which is actually easy to be taxed even at high rates without generating some of the above issues (although the liquidity and difficulty of valuation argument would remain) . However, this being said most of the wealth around the world does not really consist of land so this is more or less side note.
PS: The above is just a tip of an iceberg. I did not discuss how factoring in the effect on incentives for education change the result, what is the role of capital, inheritance, consumption taxes in all of this, I also did not discussed in great lengths general equilibrium analysis, or fully factored in all dynamic effects, but all I have written still holds in spirit even if the issues mentioned here could change the actual numbers presented. If your intent is to actually learn about the field then in addition to sources already presented here and sources cited therein I wholeheartedly recommend reading the Mirrlees review which is probably the best literature review on optimal taxation there is and also the book by Inequality Atkinson who before his death was one of the top experts in the area of inequality and redistribution.

How does one become super rich in the first place?
To understand the consequences of such a policy, it might be useful to consider how one can become extremely wealthy in the first place through economic activity.
When Amazon was just a humble online bookstore it could only make money by providing a service that people deemed valuable. Jeff Bezos' net worth is an expression of how well he has been able to improve people's quality of life. The profits from booksales allowed the company to hire more staff and expand its operations. There was no guarantee that this expansion would satisfy any demands of the consumers, but the fact that Amazon is today highly valuable and Bezos is extremely rich are signs that the company has improved people's quality of life. Using their wallets, consumers "vote" on which companies provide the most important services that they would like to see expanded.
Confiscating the profits of owners of highly valuable firms prevents them from reacting to consumer demands by expanding their business. While it would no doubt be nice for the recepients to get free money, the range and quality of valuable products they can actually buy with it is reduced. Such a law would also encourage shareholders of Amazon to do everything in their power to dodge the tax, i.e. by sending it to offshore accounts or by tying their money up in assets that are not subject to the law.
Things get a bit more complicated when we consider, that one can also get rich by benefitting from special favours granted by the government. A government may extract taxes from the populace and pay Amazon for a service that consumers do not actually find valuable. Alternatively, laws can be passed that make it more difficult to start businesses that compete with Amazon.


In the short run, why do higher interest rate lower inflation? A common interpretation is "Higher interest rates put less borrowing power in the hands of consumers and businesses. And when they spend less, firms are not selling everything and prices naturally falls." In the perspective of AS-AD model, this is caused by a downward shift of the demand curve.

However, I suppose it will cause a supply curve shift as well. Today, most production is funded by short-term borrowing and relied on people paying them for the goods and then pay back the loans. So when the interest rate goes up, the production costs go up, and hence causing a negative supply shock as well.

But reality seems to confirm the fact that higher interest rate lower inflation. Why is that? Is that because the supply shock is not as significant as the demand shock? If so, why is that?

In the short run, why do higher interest rate lower inflation?

As you say:

  "Higher interest rates put less borrowing power in the hands of consumers and businesses. And when they spend less, firms are not selling everything and prices naturally falls."

There's also the effect on the velocity of money and the money supply that less borrowing brings to provide further downward pressure on prices.

I also think your concerns about supply falling in the short term are unfounded. Firms are slow to adjust their production/supply due to greater borrowing costs. Instead, they will attempt to keep up production and clear their inventories by lowering prices in the hopes that the next season will show them a success and bail them out. Any such effect from interest rates would be a much longer-run effect.

The primary source of monetary inflation is when banks create deposits.  Another way of putting this is that banks artificially create liquidity (money) when they mismatch short term low yield debt with long term high yielding assets (aka demand deposit reserves are lent out).

Maturity mismatching is the key source of inflation and is poorly regulated by the Fed.  In fact is it encouraged, which is strange as it is inherently unstable and inflationary.

So why do higher interest rates lower inflation?  Again, monetary inflation roughly equals the extent to which maturity mismatching takes place.  Yield is roughly proportional to maturity...so in a siltation with high interest rates if you have long term debt than short term debt (relatively speaking).  Put another way, it is tougher for a bank to engage in maturity mismatching when the price of short debt goes up.

This hinders a banks ability to create money and is why high interest rates reduce inflation.

Many attribute inflation to non-banking factors like private production and what not...but this is mostly not true.  Most inflation or deflation comes from the private banking sector.


Inelastic offer, tax paid by seller, who supports the charges I have a small problem, I have a situation where we have a perfectly inelastic offer and a normal demand, then there is a tax that is paid by the supplier who supports the totality of the charges ? Is it not the buyer ? Since the supplier can just lower his production ? I need some explanation om this thanks and sorry for my bad english.

If "supply is perfectly inelastic" it cannot be the case that the supplier can "just lower his production". The point of "perfectly inelastic supply", is exactly to represent the case, where the supplier will offer a specific quantity at whatever price, even zero.  The classic case here is a good that is it deteriorates quickly in terms of quality or even consumption safety (say fresh foods).

The equilibrium price is then determined by demand. If the state appears and wants to take a chunk out of the price by imposing a tax, the tax will fully burden the supplier.

Of course this is the static approach. In a dynamic setting, such a situation may for example create incentives for an unofficial market, where the supplier tries to hide sales from the state in order to reduce the tax burden.

With perfectly inelastic demand, the consumer will pay the entire tax.  The supplier will not be adversely impacted at all.  He'll sell the same amount but at a price boosted by the amount of the tax.


Sequential price setting SPNE Firms A and B are in an oligopoly. They both face the linear market demand curve $X=A-\alpha P$, where $X$ is total market demand, and $P$ is price. Assume constant marginal costs $C_{A}$ and $C_{B}$, where $C_{B}<C_{A}$.

What will be the SPNE outcome if firm A sets price first? Is the following correct?

So long as firm A sets $P>C_{B}$, then it will get 0 profits (as firm B will profitably undercut and take all market demand). Therefore, it is indifferent between any $P>C_{B}$. If, however, A sets $P \leq C_{B}$, then firm B will not be able to profitably undercut, and so market demand will be split between the two firms, at some $P \leq C_{B}$. But then firm A will be making negative profits, and so can profitably deivate to setting some P>$C_{B}$.

Is this analysis correct? Or can firm A set some $p\leq C_{B}$ in an SPNE?

Your logic is correct. You need one more step. Using the same logic you can show that, in any SPNE, firm $A$ must set a price greater than the price that maximizes $B$'s profits. Firm $B$ then chooses such price.