Knowledge that Transforms

THIS study is concerned with the optimal, or warranted, growth of the monetary system. It constructs a rudimentary model of financial developrlent and deduces optimal trends in the money supply from a demand equation for money balances that is sensitive to both real and financial phenomena of growth. This model, we suggest, is relevant in both retrospect and prospect to the American economy. Against the trends that emerge from the model we array data on this country's financial and monetary experience since i8oo. The fit may be good enough to justify further experimentation with the demand equation for money as one basis for defining secular standards of monetary policy and for revising the structure and interrelationships of our financial institutions, monetary and nonmonetary alike.

THE literature on industry pricing practices and policies discloses that a distinguishing feature of oligopolistic structures is the emergence of a who characteristically initiates price adjustments upward and downward for the industry. In recognizing the prevalence and significance of this practice and its implications for theoretical analysis and public policy, economists have endeavored to identify the particular types of price leadership which prevail in industrial markets and to determine the extent to which each type might circumvent the forces of competition.' The theoretical treatment of the subject has been limited to a few special cases, and in most instances emphasis has been placed on conditions which make price leadership of some sort inevitable and at the same time identify the price leader. 2 For various reasons the dynamic aspects of the market conditions under which prices set by the leader might or might not be followed by others have not been worked into the theory of price leadership. The seriousness of this omission is evident from the confusions arising when attempts are made to integrate traditional price leadership models with the theory of the market equilibrium process. Moreover, the models appear to be based largely on highly institutionalized structures wherein interfirm price relationships are essentially settled, under which circumstances price leadership emerges as a type of collusion with the ringleader clearly identifiable. Consequently, current models reveal little about the process of price formation and the development of price leadership patterns in unsettled or immature structures. When applied to price behavior in these in-between markets, the weaknesses of the contemporary models begin to appear. Yet, these are the areas with which public policy is intimately concerned. Thus, if the economic implications of price leadership as an effective weapon against price competition in oligopolistic markets be accepted, the specific conditions attending the development and stability of price leadership patterns need to be re-examined. This article will be addressed primarily to this task. We will proceed (i) by identifying a new type of price leadership which takes cognizance of various dynamic factors in price formation, and (2) by appraising the economic significance of this and the traditional price leadership models in the light of empirical evidence of interfirm behavior in an oligopolistic industry (the hardsurface floor covering industry).

IN the fall of I954 the Board of Governors of the Federal Reserve System at the request of the Subcommittee on Economic of the Joint Committee on the Economic Report appointed consultant committees to study certain aspects of economic statistics. The committee reports were submitted during the summer of I955 and were published shortly thereafter both by the Federal Reserve Board and the U. S. Government Printing Office Two of the reports contain extensive discussions of survey statistics which call for some comment.' I am sure that the substantial work carried out by the eminent committees appointed by the Federal Reserve Board will prove useful. Only the future can tell what specific effects the reports and the publicity given to them will have. I may mention a few probable beneficial effects of the reports on consumer statistics. The first aspect relates to consumer economics. Regarding the past neglect of consumers by economists, it may suffice to recall that not so long ago of the three sectors of the economy only two, business and government, were assumed to be autonomous in generating income and shaping economic trends. During the last ten years, however, the importance and autonomy of consumers have been much more widely recognized. The impact of rising incomes and the influence of purchases of consumer durables on business-cycle trends, the work of Arthur Burns and the National Bureau, the Surveys of Finances conducted cooperatively by the Federal Reserve Board and the Survey Research Center, as well as the progress of market research brought about this recognition. The Smithies report will add to it. Secondly, regarding the use of sample interview surveys for economic research, the unequivocal statement about the indispensability (page i) of survey statistics, and the cogent arguments marshalled in explanation of the statement, will no doubt accelerate the current trend. Turning to a third aspect, the intermarriage of socio-psychological studies with more narrowly conceived economic studies, we find that the reports do not consider explicitly the basic problems of cross-disciplinary or behavioral research. Nevertheless, the emphasis placed on the study of attitudes, expectations, and intentions in the one, and on savings habits and purposes in the other report will, I believe, facilitate the task of students of businessmen's and consumers' behavior. Finally, I expect positive results from the committees' insistence on more methodological research. As a mere guess, I may say that in my opinion government agencies and foundations, even if they hesitate to adopt some of the more extensive and expensive recommendations, will be responsive to methodological projects suggested by the committees. In commenting on the reports I shall be concerned exclusively with scientific conclusions. Regarding the extensive observations about operational techniques and organizational matters, I might say simply that I agree with most conclusions. I feel especially indebted to the members of the committees for recommending that more complete data be collected, more frequent periodic surveys conducted, the analysis of results extended, and further checks on the accuracy of results sought. I shall here consider fundamental problems of theory and research design, regarding which there exist some differences of opinion, rather * This paper was delivered at a joint meeting of the American Economic Association and the American Statistical Association in New York, 29 December, I955. The author is Program Director of the Survey Research Center, University of Michigan, which conducts the Surveys of Finances for the Federal Reserve Board. 1 The two reports to be discussed here are entitled Consumer Survey (Chairman, Arthur Smithies) and Statistics on Saving (Chairman, Raymond Goldsmith). The reports will be referred to by the names of the committee chairmen. The page references in this paper refer to the Federal Reserve Board publications.

IN order to overcome the harmful effects on regression and correlation estimates of using highly collinear time series observations, and in order to obtain more accurate estimates of income elasticities of demand, economic statisticians have turned increasingly to the device of extraneous estimators. This technique has been most commonly employed in demand studies but also could be used in other applications. In the case of demand functions the procedure has been to obtain the income coefficient from cross-section budget data for which the price variables are presumably constant. Thus an estimate of the partial regression of quantity on income, with price given, is obtained. This cross-section estimate of the income regression-coefficient is then multiplied by the time-series aggregate of income, and the product is in turn subtracted from the annual time series of quantity demanded, to form a new dependent variable. This new dependent variable, as a possibly unintended consequence, usually has a larger variance than the original dependent series, which often displays little variation beyond the simplest trend component. Having been thus corrected, the dependent series is then regressed against the time series of the price variables to obtain an estimate of the price elasticity of demand.' It should be fairly clear that when the purpose is to make short-run forecasts, the described techniques often may be unnecessary and in many instances could actually prove harmful.2 Specifically, someone making forecasts need not be especially worried about multicollinearity. If some of the explanatory variables are multicollinear, the prediction interval obtained from such a set of observations will be quite large. By eliminating a number of the collinear variables it will usually be possible to substantially reduce the prediction interval for given values of included independent variables. Of course, while the elimination of collinear explanatory variables will tend to reduce the prediction interval, the actual prediction, by hypothesis, will change very little. Hence the pragmatic forecaster might be indifferent to the extent of collinearity, while the more sophisticated forecaster will not be indifferent; both will make similar forecasts and the actual errors of the forecast will be approximately the same. The combined use of cross-section and timeseries data is therefore intended to overcome multicollinearity (which entails the arbitrary splitting up of the influence of the explanatory variables) in order to obtain structurally mnore accurate estimates of the various coefficients. The question, however, can legitimately be asked: Exactly what structure does the statistician seek to estimate? Insofar as demand studies are concerned, it is quite possible, as will shortly be argued at length, that the kind of behavior measured from cross-section * For helpful comments and discussions on an earlier draft of this paper, we are indebted to John S. Chipman, Gregory Chow, James S. Duesenberry, John Lintner, Guy H. Orcutt, Robert Solow, and Charles Zwick. The authors were aided in preparing this paper by research grants from the School of Industrial Management, Massachusetts Institute of Technology, and Division of Research, Harvard Business School (under a Rockefeller Foundation grant for a Study of Profits and the Functioning of the Economy). 'While the techniques used differ in some important respects, the rationale is fully explained in each of the following sources: Richard Stone, The Measurement of Consumers' Expenditure and Behavior in the United Kingdom 1920-1938 (Cambridge, England, I954); and particularly J. Durbin, Note on Regression When There is Extraneous Information About One of the Coefficients, Journal of the American Statistical Association, xLvm (December I953), 799-808; Herman Wold and Lars Jureen, Demand Analysis (New York, I953). This method has also been used by J. Tobin, Statistical Demand Function for Food in the U.S.A., Journal of the Royal Statistical Society, Series A, cxiII (Part II I950), II3-4I. A comprehensive review article, William C. Hood, Empirical Studies of Demand, Canadian Journal of Economics and Political Science, xxi (August I955), 309-27, provides a worthwhile reference on the subject. The distinction between longand short-run estimates is to be found in the useful paper by Richard J. Foote, Price Elasticity of Demand for Nondurable Goods with Emphasis on Food, Agricultural Marketing Service Bulletin 96, USDA (Washington, D.C., I956). 'Although none of the people who have used the combined techniques has had short-run forecasting as his immediate goal, it seems useful to indicate how such prediction fits into the scheme of possible objectives.

seems to me much too severe and based in part on a misinterpretation or misunderstanding of the Ricardian doctrines. Knight as a full adherent of the post-I870 revolution in value and distribution theory, or departure from the Ricardian-classical to the utility and marginalist analysis, is I think half blind to the insights, of enduring value, contained in the former and preserved in the Marshallian synthesis. But I cannot, for lack of space, go further into this subject. My final advice to the reader must be: don't rely on this review but read the book!

Tp HE sales-oriented American economy relies on credit for nine-tenths of its transactions at the business level. Not on bank credit, consumer credit, real estate credit, investment credit; some producers and distributors can do without them, important as they all are. But today's business cannot be carried on without mercantile credit, which is extended by manufacturers and wholesalers to their business customers. No supplier can abstain from offering and no buyer from taking it. There are but few exceptions to this rule. Mercantile credit, therefore, has become a matter of life and death for the modern economy. The volume of mercantile credit is hardly matched by any other kind of credit. Around $300 billion a year may have been used in the 'decade following World War II.V In view of the fact that mercantile credit is generally given on short terms, the total of $300 billion covers a huge number of single credit transactions at a rapid turnover rate another striking feature of this form of credit. Amounts outstanding at any one time (receivables), furthermore, fluctuate in close response to business conditions and become a barometer of the economic atmosphere. There is sufficient evidence of the dominant role of mercantile credit. But what is its meaning in terms of the economic process? 2

Papers by Fisher I and Lydall 2 are illustrative of recent efforts by economists to determine how demographic variation affects consumer behavior. It is obvious that such population characteristics as age, family size, and educational levels do change over time. If these demographic changes do affect consumer behavior, much quantitative economic research will have to be modified. Whether it will be necessary to incorporate demographic variables in a model of consumer behavior will depend on the purpose for which the model has been constructed. Estimation of unbiased behavioral parameters for economic variables will require that demographic variables be included in the model if their movements have been correlated with price and income changes employed in the estimation procedure. When the objective is one of forecasting, demographic variables will not have to be included in the model if their movements are correlated with price and income variables. Here one must distinguish between short-run and longerrun forecasts. In the short run, price and income movements will probably be independent of movements in demographic variables. Finally, it is clear that if the purpose is a better understanding of consumer behavior, demographic variables should be included in the model regardless of whether or not movements in these variables are correlated with changes in prlces and income. The research reported in this paper tested whether the hypothesis that price and income elasticities vary with demographic variation is consistent with an available set of data. Weekly observations on the meat, fish, and poultry purchases of I5I families were employed. These data were obtained from a sample of families in the city of Medford, Massachusetts, and were collected over the 32-week period October I2, I952-May 23, I953.3 Table i gives the distribution of the I 5I families by family characteristics.

ONE argument often used to justify public services is that the benefits of the activity cannot be limited to the direct recipients of the services those who would purchase the product if it were privately produced. These benefits, which are presumed to accrue to a large sector of the nation, are referred to as secondary or indirect benefits. There are many formulations of these secondary benefits. This paper will focus on the use of this concept and its measurement by the Bureau of Reclamation. In the case of the Bureau of Reclamation the development of this concept and its measurement is more than an argument for an extension of the public sector. The measurement is claimed to be part of the planning process, since it is supposed to enter into the determination of the scale of investment in water projects and the allocation of public funds among projects. There are several other formulations of the appropriate concept of secondary benefits in use in federal agencies, but these will receive only passing attention.' As background it should be mentioned that those who advocate the use of the secondary benefits concept in project justification are today on the defensive. The current position of several staff coordinating agencies in Washington is to minimize the importance of secondary benefits. In this paper we shall restrict our attention to one type of public investment dams and distribution systems for irrigation projects. The conclusions of this paper are that the procedures followed by the government agencies are confusing and incorrect, but that secondary benefits can be significant. The proper framework within which to discuss the secondary benefits is the theory of external economies.