Knowledge that Transforms

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.

I NTERNATIONAL trade in commodities such as steel, synthetic rubbers, plastics, electronics, chemicals, and man-made fibers takes place primarily among the advanced, industrial countries of Western Europe, the United States, and Japan. The Heckscher-Ohlin model, which dominated the work of interna.tional economists from the twenties to the sixties, has proven inadequate to explain the trading patterns of these commodities. There appear to be two major reasons for this seemingly poor explanatory power: (1) the relative similarity of the factor endowments of the industrialized countries, and (2) the assumption of uniform global technology for each industry, an assumption which is untenable for a number of industries the products of which are traded internationally.' Two accepted theories which appear to be capable of explaining part of the trade which takes place among the advanced countries are the Doctrine of Comparative Costs and the scale economies theory. Both of these theories argue that trade takes place because of differences in unit production costs. One of the causes of different unit production costs is differences in the wages and productivity of workers. Unit production costs may also differ because total output of certain products in certain countries is such that the industries of these countries are larger than the industries of these countries are larger than the same industries in other countries. Since internal and external economies of sca.le are significant in a number of industries such as the steel industry, one would expect those countries with the larger industries to be able to produce commodities at lower unit production costs, ceteris paribus, than those countries whose industries are small, if the industry in question is subject to significant internal and/or external economies of scale.2 A third reason for differences in unit production costs is differences in the production, techniques used by industries producing a given array of products in different countries. Production techniques may differ because entrepreneurs in different countries may adopt innovations in an industry at different times. This is the essential argument put forward by the recently developed Posner Technological Gap Theory. The Posner Technological Gap Theory is among the most promising theoretical arguments put forward for the trading patterns of products traded principally among the advanced countries.3 Posner adopted all of the

EMPIRICAL studies of aggregate price equations have shed little light on the choice among alternative theories of price-setting behavior. Specification of the price equation generally makes appeal to both profit maximizing and average cost pricing assumptions.1 Yet little effort has been spent in testing the comparative explanatory power of these alternatives.2 The choice among theories has important implications. The expected pattern of pricewage interactions, questions of bias and identification of the price equation, and use of the price equation for forecasting should all be analyzed with respect to particular hypotheses concerning pricing behavior.3 The need is for more explicit formulation of models and testing of hypotheses. A test of the relative explanatory power of a perfectly competitive model and a general version of average cost pricing is reported in this paper. Two supply and demand models of the final output of the manufacturing sector are specified. These show important differences in the relationship between the price level and its determinants. An empirical test for the United States manufacturing sector is provided.

Eric J. Toder, The Supply of Public School Teachers to An Urban Metropolitan Area: A Possible Source of Discrimination in Education, The Review of Economics and Statistics, Vol. 54, No. 4 (Nov., 1972), pp. 439-443

RECENT years have seen considerable progress toward an integration of the theory of consumer's choice with empirical demand analysis. Theory has been extended so as to bring dynamic adjustment and the effects of past expenditure decisions (primarily through the introduction of certain state variables) into its purview,1 while on the empirical side there now exist a number of studies whose demand functions respect to a letter the restrictions imposed by classical theory.2 Unlike the demand theorist, content to assume the existence of continuous partial derivatives through the second order and to specify the signs of first derivatives, the applied analyst must go considerably further and specify the actual analytical form of the utility function. Herein, however, lies one of the major obstacles to the continued progress in applied demand analysis, for the list of functions which are rich enough to incorporate the restrictions imposed by theory, but yet sufficiently simple to be estimated with the data and techniques at hand is not lengthy. Included in this list are: (1). The additive quadratic utility function used by Houthakker and Taylor (1970) and also by Phlips (1971); (2). The linear-expenditure system based on the Geary-Samuelson utility function employed by Stone and his associates (1954, 1965) and most recently by Phlips (1972); and (3). The Rotterdam system of demand functions developed by Barten and Theil.3 The present work was motivated initially by a desire to devise a better method of estimating the additive quadratic model (AQM) than that used by Houthakker and Taylor. In particular, H and T observed a tendency for the estimated marginal utility of income to decrease sharply at the very end of the sample period, and averred that this probably reflected a defect in the method of estimation (p. 230). However, once we began exploring this, it became clear that the defect was in the quadratic utility function itself. Accordingly, we then undertook a critical look at the appropriateness of the AQM as a tool for empirical research, and in so doing decided to do the same with the linear expenditure system (LES).