Knowledge that Transforms

A. Ross Shepherd correctly reasons that the monopoly firm examined in my original analysis must expand with fixed input prices and that the average cost curve must, therefore, exclude rent to fixed factors. In relaxing this assumption to allow for rising input price (and the payment of full rent), Shepherd introduces the possibility that the output (or revenue) maximizing firm may produce the Pareto optimal output. We should conclude therefore that in the case of single markets under increasing cost the output maximizing monopoly will attain Pareto optimal output if the average cost curve coincides with the competitive supply schedule but will exceed Pareto optimal output if the average cost curve lies below the competitive supply schedule. In the ordinary case we would predict a lower average cost curve because the firm probably can avoid the payment of full rent and may practice various forms of discrimination in factor markets. It would seem that the possibility of rent avoidance is especially significant in the case of regulated industries where effective calculations of opportunity costs are frustrated by legal and regulatory barriers which prevent consideration of alternative uses and by rate base calculations in terms of historical money costs. In the case of publicly-owned utilities this situation may be aggravated by tax exemptions and other concessions. Supported by such institutions the firm may be expected to develop a cost schedule which fails to reflect the full opportunity costs of the resources employed and, if restrained only by the fair return criterion, will be able to expand output beyond Pareto optimal. Shepherd's comment is especially instructive because it brings attention to the fact that the level of the average cost curve is affected by industrial structure. However, since most of these effects will be intramarginal, the marginal cost curve may not be altered significantly and analysis on the traditional assumption of profit-maximization may yield correct price and output predictions. On the other hand, output and price may be affected significantly by the level of the average cost curve in the case of restrained firms. In such cases it becomes necessary to be more explicit about intramarginal factor payments than my original treatment. * Professor of economics, University of Florida.

I accept Robert Eisner's thesis that . . . the tax surcharge should never, on basic theoretical grounds, have been considered an effective anti-inflationary device and that, given a sufficiently excessive rate of government spending, there is little that any meaningful monetary policy can do to stop (p. 898). I also share his concern that the failures of current policies will turn our fates back to know-nothings. I am critical not so much of what Eisner says, as of what he omits. Is the Johnson administration's desertion of the Guideposts in the presence of the inflationary enemy in 1966 of no -value in explaining our quickened inflation since then? If the administration had escalated that particular effort, had rallied public opinion, had acquired ultimate legal sanctions against noncompliance, would not the inflation have been lessened? George Perry's findings that the guideposts had a significant effect on the pace of wage changes (1967, p. 903) appear to have survived all attacks to date.1 Perry found that during 1965 and 1966 the guideposts were reducing wage increases by about 2 percent below what would otherwise be obtained. If this level of effectiveness had been maintained, wage payments would have been reduced by about $10 billion in 1968.2 This is as large as the impact upon demand which was expected from the $10 billion surtax, an impact which Eisner argues did not materialize because the surtax did not change personal and corporate estimates of permanent income (p. 898). Moreover, wage restraint holds down the cost level; in contrast a policy which allows excessive income gains, and then tries to tax them away involves us with barn doors and stolen horses. The Keynesian economists would be less discomforted by know-nothings, in my opinion, if they themselves had been closer students of Keynes. No better place for a fresh start for arriving at correct analysis can be found than in the good book General Theory. It is all there: the Phillips curve,3 the guidepost prescription,4 and Keynes' Theory of the Price Level of which so few Keynesians appear to be even aware.