Knowledge that Transforms

This paper develops an equilibrium model of the determination of exchange rates and prices of goods. Changes in relative prices of goods, due to supply or demand shifts, induce changes in exchange rates and deviations from purchasing power parity. These changes may create a correlation between the exchange rate and the terms of trade, but this correlation cannot be exploited by the government to affect the terms of trade by foreign exchange market operations.

This paper presents an answer, not found in the literature, to Rothschild's criticism that search models are unsatisfactory until they provide an explanation of price dispersion. The search models of Stiler and McCall are closed by explaining the firm's optimal decision-making problem. Then the existence of an equilibrium distribution of prices is established for both models. The analysis shows that price dispersion is supported and explained by a dispersion of production costs. The Stigler model shows that the variance of the price distribution increases while the McCall model shows that the variance eventually decreases with the intensity of search.

Using the Heckscher-Ohlin-Vanek model of trade, it is shown that a country is revealed to be relatively well endowed in capital compared with labor if and only if one of the following three conditions holds, where K"x, K"m, L"x, L"m, K"c, L"c are capital and labor embodied in exports, imports, and consumption: (a) K"x - K"m extgreater 0, L"x - L"m extless 0; (b) K"x - K"m extgreater 0, L"x - L"m extgreater 0, (K"x - K"m)/(L"x - L"m) extgreater K"c/L"c; (c) K"x - K"m extless 0, L"x - L"m extless 0, (K"x - K"m)/(L"x - L"m) extless K"c/L"c. Leontief's data for the United States in 1947 satisfy b, and the United States is actually revealed by trade to be capital abundant. The comparison by Leontief of K"x/L"x with K"m/L"m is shown to be theoretically inappropriate.

[Using Kendrick's recently published data on human and nonhuman wealth in the United States, log-linear money demand functions of the "partial adjustment" variety are estimated by introducing in each nonhuman, total, or human wealth as the scale or the "constraint" variable. It is found that the long-run elasticity of money demand with respect to nonhuman wealth is somewhat larger than that with respect to total wealth, and the elasticity with respect to human wealth is the lowest. Such a structure in the elasticities is observed consistently, although differences between the elasticities are not large and perhaps not statistically significant.]

Fluctuating input prices are shown to cause greater variability in the profits of monopolies than of competitive firms. Hence monopolies have greater incentives to hold input stocks and participate in futures markets than do competitive firms.

Economies of scale and domestic divergences offer an important scope for gains from industrial integration among developing countries. Underutilized industrial capacity, together with distorting policies and imperfections in factor markets, provides a rationale for countries to swap opportunities for industrial expansion. Through integration, Ghana and the Ivory Coast stand to achieve welfare gains of 33 and 22 percent of gross output in world prices. About two-fifths of these gains have their source in Viner's trade-creation effects, one-fifth in Corden's cost-reduction effects, and two-fifths in the newly suggested production effects.

The theory of commercial policy has recently addressed three phenomena: (i) tariff (quota) seeking or lobbying by potential beneficiaries for the imposition of a tariff (quota), (ii) tariff (quota) evasion, and (iii) rent seeking or lobbying for getting an allocation of the import quota to earn the rents generated. Revenue seeking or lobbying to secure a share in the disposition of the tariff revenues is analyzed here. it is shown that revenue seeking may, even for a small country, result in a reduction in importable output. Furthermore, revenue seeking may be welfare improving. Rent seeking may be welfare improving as well.