Knowledge that Transforms

Truncated Normal, Econometrica 42 (Nov. 1974), 999-1011. Dagenais, Marcel, Application of a Threshold Regression Model to Household Purchases of Automobiles, this REVIEW 57 (Aug. 1975), 275-285. Goldfeld, Stephen, and Richard Quandt, Estimation in a Disequilibrium Model and the Value of Information, Journal of Econometrics 3 (1975), 325-348. Hausman, Jerry, and David Wise, Evaluation of Results from Truncated Samples: The New Jersey Income Maintenance Experiment, Annals of Economic and Measurement 5 (1976), 421-445. , Social Experimentation, Truncated Distributions, and Efficient Estimation, Econometrica 45 (May 1977), 919-938. Heckman, James, Shadow Prices, Market Wages, and Labor Supply, Econometrica 42 (July 1974), 679694. , Common Structure of Statistical Models of Truncation, Sample Selection, and Limited Dependent Variables and a Simple Estimator for Such Models, Annals of Economic and Measurement 5 (1976), 475-492. Keeley, Michael, Philip Robins, Robert Spiegelman, and Richard West, Labor Supply Effects and Costs of Alternative Negative Income Tax Programs, Journal of Human Resources 13 (Winter 1978), 3-36. Nelson, Forrest, Censored Regression Models with Unobserved, Stochastic Censoring Thresholds, Journal of Econometrics 6 (1977), 309-327. Rosen, Harvey, Taxes in a Labor Supply Model with Joint Wage-Hours Determination, Econometrica 44 (May 1976), 485-507. Rosett, Richard, and Forrest Nelson, Estimation of the Two-Limit Probit Regression Model, Econometrica 43 (Jan. 1975), 141-146. Shishko, Robert, and Bernard Rostker, Economics of Multiple Job Holding, American Economic Review 66 (June 1976), 298-308. Tobin, James, Estimation of Relationships for Limited Dependent Variables, Econometrica 26 (Jan. 1958), 24-36.

S INCE the development of formal macroeconomic models for open economies, most of the relevant literature has been characterized by a dichotomy in the specification of the economy's supply of real output: either a simple Keynesian case of perfectly elastic supply, or an inelastic output supply specified.' Only recently attempts have been made to study the intermediate, and plausible, case in which changes in demand for a country's output lead both to a price and output response. The key element in such attempts the explicit incorporation of factor markets and of a Phillips-curve type of analysis into the macroeconomic model of the open economy.2 The importance of explicitly studying output supply in the open economy primarily lies in that many well-known results on the effectiveness of different policies, as well as the economy's dynamic adjustment to internal and external shocks, critically depend on the specification adopted. For example, Salop (1974) has shown that the incorporation of a classical labor supply function, one that specifies a positive relationship between labor supply and real wages, into an otherwise standard macro model of the open economy leads to the prediction that a successful devaluation causes a fall in output and employment. As noted by Salop, this result contradicts the conclusion of more conventional models (see, for example, Meade (1951) and Tsiang (1961)) that devaluation increases output and employment. Similarly, Casas (1975) has recently studied the case of an economy operating under floating exchange rates and perfect capital mobility. He finds that to the extent that wages are fully indexed to the price level, changes in the domestic money supply will not affect the level of output, but fiscal expansion will raise real output. Such a result is a complete reversal of the well-known theorem (see Mundell (1968) and Fleming (1962)) that only monetary changes affect employment under flexible exchange rates and perfect capital mobility (Casas (1975, p. 697); parentheses are mine).3 These considerations suggest that the aggregate output-supply function has a key role in the macroeconomics of the open economy. Yet no empirical estimates of this function, comparable to estimated import and export functions, for example, are available.4 The main purpose of this study to derive and estimate simple specifications of output supply in the open economy. In particular, I investigate below the responsiveness of output supply to actual and unanticipated changes in domestic and import prices for the seven main industrialized countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States), based on annual data from 1955 to 1975. Rather than attempting to obtain the best possible results for each country, the main emphasis of this study has been on getting comparable results for the countries considered.5 The plan of this paper as follows. Section II Received for publication September 29, 1978. Revision accepted for publication December 17, 1979. * Tel-Aviv University and Boston University. I would like to thank R. Barro, M. Blejer, K. Clements, A. Stockman, seminar participants at the University of Rochester, and two anonymous referees of this REVIEW for helpful comments on an earlier draft. Any errors are mine. ' For studies embodying the simple Keynesian case of perfectly elastic output supply; see, for example, Meade (1951), Tsiang (1961), Mundell (1968), and Fleming (1962). On the other hand, basic versions of the monetary approach to the balance of payments have usually assumed the inelasticoutput-supply specification; see, for example, Frenkel and Johnson (1976, ch. 6 and part II). 2 See, for example, Branson (1975, 1976), Dornbusch and Krugman (1976), Kenen (1978), Kingston and Turnovsky (1978), Laidler (1976), Leiderman (1978), and Salop (1974). 3 For analysis along these lines using a model that includes non-traded goods see Makin (1978). 4 For surveys of econometric work in international trade see Leamer and Stern (1970), and Magee (1975). Output-supply elasticities, in the context of open-economy models, have recently been estimated by Clements (1978) for the United States, and by Leiderman (1979) for Italy. On the estimation of output reduced-forms for several of the countries included in our sample, see Brunner and Meltzer (1978), and Stockman (1978). 5 Lucas (1973) and Taylor (1979) have empirically examined output determination by applying a given model across different countries. These studies, however, have abstracted from explicit open-economy considerations.

and not from the explicit examination of substitutability between private and public provision of goods and services. If private and government investment expenditures are perfect substitutes (the limiting case) then increases in government investment goods purchases financed by additional debt creation reduces potential output because private net-of-deficit savings decline by more than the increase in government investment at the initial level of output. Since government debt is viewed as an addition to wealth there is a decline in the relative desire to accumulate capital goods, whether private or public. Thus, the observation that there may be a potential decrease in steady state output is not due to perfect (or any other degree of) substitutability between private and public expenditures but rather is due to a less than perfect symmetry to the wealth effects associated with tax and deficit financing. The introduction of less-thanperfect' expenditure substitutability mitigates against this revenue composition effect, as a one dollar increase in government investment goods would initially cause a less than one dollar decrease in private investment demand. In like fashion, von Furstenberg's assertion that the marginal propensity to save must be unity if fiscal actions are not to affect steady state output (p. 77) is correct only within the context of his particular private savings function. If future tax liabilities are perfectly discounted then the marginal propensity to save will be unity out of the obtained by the private sector from changes in the form of financing government expenditures. Thus, alluding to an observed savings rate of 8% in the United States does not constitute any substantive evidence about possible impacts on potential output of changes in government expenditures, as that average savings rate cannot be applied to marginal changes in disposable income when future tax liabilities are fully, or even partially, discounted.

E CONOMISTS have long recognized the desirable qualities of a competitive market. The milk industry, although it might appear to be a prototype competitive market, is far from competitive. This is due in part to locational factors and in part to a vast network of federal and state governmental regulations and controls. Over 95% of raw milk sales to processing plants are regulated, and in 1972 about a quarter of all wholesale and retail sales of fluid milk products, the concern of this paper, were regulated (USDA, 1972). As a result of increased interest in regulation in general, economists have become increasingly concerned with milk regulation. I Furthermore, some states have recently dropped wholesale and retail price regulation. The implications of these various government controls are important to both consumers and public policy makers. Some studies have found that state retail price regulation leads to higher prices.2 Economic theory also predicts that insulation from price competition may have significant effects on the number of participants and the efficiency of production in an industry. The previous studies have failed to consider the structural implications of wholesale and retail price regulation. This paper notes the announced and implied objectives of state retail fluid milk price regulation. Application of the Chamberlinian monopolistic competition model will aid in heuristically contrasting unregulated and regulated equilibria. Empirically, a simultaneous equations model will be used to study the effects of regulation upon both the performance and structure of the fluid milk industry. Further, an estimate of the social cost of regulation will be deduced from the empirical results. Finally, the implications for public policy will be presented.

7 The F-statistic for the first test is F(4,107) = 0.50 while for the second test it is F(4,11 1) = 0.81. Both of these values are well below the critical-F at conventional levels of significance. 8 Further experimentation showed that one additional parameter could be eliminated by, for example, disposing of the last join point (setting d2 = 0.). However, since the purpose here was simply to show that fewer than 12 parameters are required, the equation has been left in the present form.