Production & Sales Decreasing — Description

What happens when production & sales for both shoes and wheat steadily decrease?

Although this scenario seems like a simple inverse of the preceding scenario, I think you will find some interesting differences in the effect that changes in the quantity of money have on money prices.

Variables

Set for this scenario

You should set these values before the first simulation, and leave them during succeeding simulations in this scenario.

annual fractional shoe increases: -0.08 [Unitless] Set and leave for these simulations
annual fractional wheat increases: -0.04 [Unitless] Set and leave for these simulations

Adjust this variable as instructed

annual fractional money increase rate: [Default] 0.0/Year

GIF89a

Fixed Money Supply - Simulation 1

After you have set the annual fractional decreases for shoes and wheat, you should be able to run the simulation with no further changes (you might want to make a quick check to assure the money increase rate is set to zero.)

Variables to Adjust

annual fractional money increase rate: 0.0/Year

Simulations

Sales: Sales of shoes and wheat decline steadily as determined by their respective production rates, throughout the simulation. Note: Read shoe sales on the left scale and wheat sales on the right scale.
Inventories: Because the producers of both products sell less than their total production inventories rise steadily.
Direct Exchange Prices: Because shoe sales decline faster than wheat sales, the marginal utility of shoes, relative to wheat, rises steadily, and so does the bushel/pair price of shoes. Conversely the marginal utility wheat, relative to shoes, declines steadily, and so does the pair/bushel price of wheat.
Money Supply: The quantity of money remains the same ($10,000) for the whole 60 months.
Dollar Prices: The increasing production and sales of both products make both of their dollar prices increase, at rates that inversely reflect their sales increases.
Price Conversion

Converts back to direct exchange prices.

Comments:

It seems that our little—two-product—economy has entered a depression. Sales decline steadily, and direct exchange prices and money prices consistently indicate that fact.

Now, this model does not accommodate additional actors, but consider the inclination of other producers entering this market when prices rise continually.

Let's see what happens when the system throws more money at the situation.

Increasing Money Supply - Simulation 2

Make the appropriate adjustment to the annual fractional money increase rate and rerun the simulation.

Variables to Adjust

annual fractional money increase rate: 0.07/Year

Simulations

Sales: Same as simulation 1.
Inventories: Same as simulation 1.
Direct Exchange Prices: Same as simulation 1.
Money Supply: The quantity of money (dollars) remains the constant ($10,000) for the first 10 months; it then increases steadily (at 7% per annum) for 40 months; and it levels off again for the last 10 months.
Dollar Prices: Like the inflation simulation with increasing production, this simulation dramatically demonstrates the influence of an expanding money supply on dollar prices, but instead of having the influence of reversing declining prices, inflation accentuates price increases. During the first 10 months dollar prices increase, as one would expect with increasing supplies. During months 11 through 50, however, the price increases of both products accelerate, because of the influence of the expanding supply of money. In the last 10 months, after money growth stops, price increases return to their former rates.
Price Conversion: Same as simulation 1.

Comments:

Some might argue that, if rising prices send a signal to outsiders to bring products into the market, won't faster rising prices create an even greater incentive? Does this amount to monetary stimulus?

Yes, the false signals might bring more production to this market. But, in the long-run, does that have a positive effect on this economy?

If producers respond to flawed signals, might they over-produce those products that demonstrate excessively rapid money price increases? Might this "stimulation" create a "boom" that precedes the next "bust?"

Let's look at deflation.

Decreasing Money Supply - Simulation 3

Make the appropriate adjustment to the annual fractional money increase rate and rerun the simulation.

Variables to Adjust

annual fractional money increase rate: -0.07/Year

Simulations

Sales: Same as simulation 1.
Inventories: Same as simulation 1.
Direct Exchange Prices: Same as simulation 1.
Money Supply: The quantity of money (dollars) remains the constant ($10,000) for the first 10 months; it then decreases steadily (at -7% per annum) for 40 months; and it levels off again for the last 10 months.
Dollar Prices: This simulation represents almost a mirror image of the simulation with sales growth for both products and inflation. During the first 10 months dollar prices rise as one would expect with declining supplies.

Then during months 11 through 50 the price of shoes continue to rise—but, much slower, and wheat prices actually reverse and fall in the face of reduced supply. In the last 10 months, after money growth stops, price increases return to their former rates.
Price Conversion: Same as simulation 1.

Comments:

This simulation gives us a glimpse of the dangerous sort of deflation: a contraction in the money supply causing downward pressure on prices.

If we isolate on shoe prices, we see, during the period of the deflation, prices that should rise actually decline. The market received signals of relative excess in spite of relative shortage in actual sales.

Note: The price declines caused by increased production (see the fixed money simulation) reflects the strength of the product in the market. Price declines caused by money deflation send false, and dangerous, signals to the market.

Fed Chairman Bernanke needs to understand the difference.

Declining Production & Sales - SUMMARY

Production & Sales Assumptions

Shoe Production & Sales: decrease by 8% per annum
Wheat Production & Sales: decrease by 4% per annum

Fixed Money Supply

Rising money prices for both products give a clear indication that the production and sales of both products also increase during this simulation.

Inflation

When production and sales decline, money prices should increase at a rate inversely related to the rate of sales decrease. An increasing money supply, however, will cause money prices to rise faster than in the case of a fixed money supply. The accelerated money price increases will indicates relative shortages greater than actually exist.

Deflation

When the money supply declines it has a negative influence on the natural money price increases. It will either retard or reverse the normal trend. In this case, the rise in shoe prices slows and the rise in wheat prices reverses and declines. These trends give false signal that indicates either relative shortages less than actually exist or relative abundance when actually relative shortages exist.

Summary Comments

We have now seen how, in the context of either decreasing production and sales, changes in the money supply can have a dramatic influence on the price signals received by the market.

As the ones who set the parameters for this model we know beforehand that sales and production are declining. The market has continually less of both products as time progresses. Market observers, however, generally must take their cues from the dollar prices. With a fixed quantity of money prices rise in relation to the relative supply of the goods, giving accurate signals to which the market can respond. When the money supply increases, prices indicate relative shortages greater than actually exist. When the money supply declines, the relative shortage of shoes appears less than actual, and the relative shortage of wheat appears to have reversed.

Finally, we view production up and down...