Knowledge that Transforms

to GNP as the CEA had anticipated that it would. As a general conclusion to this brief paper, the following points can be made. The CEA was wrong in stating in its 1963 Report that the tax cut would lessen the sensitivity of income tax revenue to GNP. As a matter of fact, the tax cut of 1964 increased that sensitivity. As a consequence of this increase, the built-in flexibility of the tax declined less than anticipated and would soon recover the before-1964 value. This increase in elasticity would have increased the need for frequent tax reductions if expenditure had continued to increase at the rate that would have been realistic to assume in 1964. The elasticity of the rate structure increased in importance and became almost as important as that of the base. REFERENCES

D. M. Schydlowsky, M. Syrquin, The Estimation of CES Production Functions and Neutral Efficiency Levels Using Effective Rates of Protection as Price Deflators, The Review of Economics and Statistics, Vol. 54, No. 1 (Feb., 1972), pp. 79-83

The three primary conclusions of my previous study can be summarized briefly. First, there appears to be a permanent excess demand for physicians' services. The observed prices and quantities are not points on the demand function and the market does not follow a Marshallian or Walrasian process of adjustment to remove the excess demand. Second, physicians' fees rise when patients' ability to pay improves through higher income or more complete insurance coverage. More than a third of the potential gain from improved insurance coverage has been dissipated by induced price increases. Third, the supply equation indicates that physicians reduce the quantity of services provided when fees rise. This in turn implies that government action to control physicians' fees may increase the quantity of services provided. Professors Brown and Lapan raise some questions about the research and about the first and third of these conclusions. However, a careful analysis of their note shows that the original conclusions can remain unchanged. Their own discussion, on the other hand, contains a number of serious errors.

imports, where quoted import price indexes are used to avoid serious measurement errors and information on changes in the variables over years is utilizecl. It has been found that the elasticity is numerically larger for finished goods than for crude materials and intermediate goods. Effects of time lags are different between commodity types; in the case of finished goods, adjustment to price changes seem to be completed within a year, but for materials or intermediate goods, adjustment seems to take longer. There is an evidence, which is not very strong, that shows that the progressive trade liberalization that has taken place in Japan has worked to increase the numerical value of the elasticity of substitution.

W E shall not know for many months if AVIV~the introduction of direct controls over wages and prices in late 1971 was followed by a significant slowdown in the trend of price and wage increases. Even if inflation will moderate somewhat, as is likely, economists will still be debating for years whether this can be attributed to the controls or whether it is simply the delayed result of considerable slack in the economy. But whatever the outcome of this future academic debate, some form of direct control is likely to be with us for some time. The establishment of direct controls on August 15, 1971 was popular among the public at large and subsequent opinion polls indicate that this program, despite its uncertain performance to date, has not become a political liability. The controls are only likely to be abandoned if they seriously hurt some important pressure group without visible offsetting benefits elsewhere, but this has not happened so far. Although some discontent among West Coast longshoremen gave most of the labor representatives on the Pay Board a pretext for walking out, most union members, and even the departed leaders themselves, are apparently quite willing to live with continued controls. The Price Commission has so far managed to avoid widespread criticism, except on the issue of food prices over which the Commission has only limited jurisdiction. Aside from public reaction, another reason for thinking that controls will not disappear soon is that inflationary pressures are likely to become more intense as the economy comes closer to capacity operation. If there is a case for controls when unemployment is around 6 per cent, it will be even stronger if unemployment drops to a more sustainable level. Unlike the control programs imposed in wartime, the present program has no natural termination point. The view that the present controls will be effective mainly by bringing about a reversal in inflationary psychology is not likely to be substantiated unless inflation can be curtailed much more drastically than official pronouncements suggest. A reduction in the inflation rate from 4 per cent to 3 per cent, while welcome, will scarcely allay widespread apprehension about large budget deficits and rapid monetary expansion. In fact, the belief that sheer psychology, as opposed to expectations based on experience, plays an important role in the inflationary process does not appear to be supported by any evidence. Unless real output can be made to grow at a much higher rate than has so far been achieved, the rapid growth in the money supply combined with the usual lags virtually guarantees the preservation of inflationary pressures well into 1973, if not longer.1 A recent Brookings study (Schultze et al. 1972, especially chapter 13) suggests that the Federal budget will not be a restraining influence either. If this prognosis for controls is correct, the question is what they will actually achieve. Even if attained, the modest reduction in the inflation rate officially set as a goal provides only weak justification for this drastic departure from our generally successful economic traditions. There is some indication that the Pay Board and Price Commission will serve less as a means of curtailing inflation than as watchdogs over big business and big labor. The three-tier classification of business firms by the Price Commission is one indication in this direction, and it has been further reinforced by the recent exemption of most small enterprices from price and wage controls. The Pay Board and the Construction Industry Stabilization Committee already spend most, if not all, of their time on organized labor. There is indeed a case for better supervision of the labor unions. In the last few years we

From 1954 up to 1964, when Congress approved a new Revenue Act, legal structure of individual income tax of United States remained virtually unchanged. That structure was substantially changed by Revenue Act of 1964. Under previous legislation rate structure had begun at 20 per cent and had ended at 91 per cent; new rate structure started at 14 per cent and ended at 70 per cent. The first bracket, to which 20 per cent rate had applied and which had included tax income of 0 to 2000 dollars, was replaced by four smaller brackets of 500 dollars each (or 1000 dollars for married persons) to which rates of 14, 15, 16 and 17 per cent, respectively, became applicable (Pechman, 1965). The most important but by no means sole objective of new Act was reduction of fiscal drag of Federal budget. Personal income tax liabilities were reduced by 6.7 billion dollars at 1964 levels of income. Further reductions in 1965 cut individual income tax revenues by an estimated total of about 11 billion dollars (Pechman, 1965, p. 247; Council of Economic Advisers, 1965, p. 65). This reduction in revenues was necessitated by characteristics of individual income tax revenue of growing at a somewhat faster rate than income. This high elasticity, together with relative importance of this tax, has made it a powerful automatic stabilizer in United States. However, as it came to be recognized in early part of 1960's, under certain circumstances, automatic stabilization can become an ambiguous blessing. In words of Council of Economic Advisers (CEA), the protection [that] it gives against cumulative downward movements of output and employment is welcome. But its symmetrical 'protection' against upward movements becomes an obstacle on path to full employment . (Council of Economic Advisers, 1963, p. 68). The 1963 CEA's Report continued by stating that:

control the money supply. However, we feel any such problems are outweighed by the possibility of the FRB providing, some compensation for what almost all economists agree, is the uneven impact of tight money on the housing market. In fact, increasing the money supply by buying FHLB bonds may make monetary policy even more effective by increasing the FRB's ability to more stringently ration funds to other sectors while not forcing a collapse of the housing market. Table 4 shows a quarterly comparison of actual interest costs for FHLB financing since 1965 versus costs under the hypothetical condition that FHLB bonds had been sold to the FRB as suggested above. The cost differential between the two alternative arrangements adds up to 150 million dollars during the period 1969 and the first half of 1970. This is a savings foregone by abiding with the present financing arrangement.

groups in our sample. It is quite likely that the higher an individual's permanent income prospect the higher the cost of incarceration and consequently the less likely will be the willingness to risk the act of purchase (or consumption). To the extent that permanent income prospects at present and total expenditures are positively correlated, then we might expect the tendency to increase the consumption of marijuana with to;tal expenditures to be compensated by the higher cost of incarceration and the consequent lower willingness to pay this price in the face of such high opportunity costs.