1 - Introduction

Summary

A microeconomics parable

Imagine that you have just received the latest textbook in advanced microeconomics theory. Flipping through you come to chapter 3, “The Theory of Markets.” The first section is “Demand theory.” Treating pancakes as output, the section derives a market demand function for pancakes.

In this model pancakes are special. First, they are indestructible. Second, they serve as tickets that will determine the holders' station in an afterlife. If there is only one pancake outstanding, then the holder of that pancake will assume the highest possible station. All others in the individual's age cohort will disappear into nothingness upon death. If there are two pancakes available to the cohort, then the holders of each will assume the second highest possible station in afterlife (and so on). If the amount of pancakes equals the cohort population, then everyone in the cohort has a pancake and they confer no special status. Individuals assign pancake values according to their assessment of the station pancakes will enable them to attain.

Although this theory of demand seems somewhat peculiar, you continue to the next section expecting to find a theory of supply. Instead, the title is “The problem of a determinate price level.” Here you discover that pancake consumers have a problem. How can they establish their current demand without knowing the current supply and whether this supply will be augmented in the future? The upshot is that today's equilibrium price of pancakes depends on current and all future supplies. So the problem of a determinate price level is fundamentally an issue of whether consumers are able to look into the future and ascertain pancake supplies.