Kinetic Principle of Price Decision
Price means that a pair of shoes is sold at 200 dollars and a suit at 500 dollars as well as the exchange ratio between the cloth and the shoes is 5 to 2. The monetary values and the exchange rate of these particular commodities can not be determined unless the prices of the whole commodities are given. Given the overall price level, the currency value of a particular commodity or the exchange rate between a commodity and the other commodities can also be determined. What an economic principle works to determine the transaction rate between a particular commodity and the other commodities, including each prices of all commodities? It is the kinetic principle of price decision.
This principle is not present in the current economics. It is better to clarify the conclusion first because the principle is unknown to even economists. The conclusion help you to understand the logic development ahead. In short, money and income determine price, income and price determine money while price and money determine income. What does it mean? Price, money and income influence each other and are determined by each other. They interact with each other by forming a ternary relationship like a movement system of binary stars in the universe, as below.
First, price is affected by money. Price rises as money increases. In fact, values or prices of all commodities are converted into monetary units. However, price does not rise exactly as much as the increase of money. Sometimes price rises at a higher rate than the increase rate of money. Hyperinflation is a typical example of this phenomenon which is used to happen when the economy is overheated. At other times, price rises smaller than the increase of money, which is especially noticeable when the economy is sluggish. The fluctuation in price is revealed different in the economy according to the economic situation as above. So to speak, price is directly affected by the change of income.
Price also affects money. When price rises and inflation rate rises, especially when hyperinflation occurs, the inflation raises demand for money because the price rise increases transaction amount in the economy. If there is no increase in money, the trade of the economy is shrinking, all the economic activities slows and the economy is falling into a slump. And then an economic crisis may occur. That is why hyperinflation is terrible. If the inflationary pressure calls for the increase of money, hyperinflation will take place. This issue will be covered in detail in the ‘Monetary Financial Principles’ and the ‘Economic Pathology’.
The increase in money raises not only price but also it stimulates production. The increase in production, that is, the increase in income, stimulates the inflation rate through the increase of demand. As a result, the price rise stimulates production at least in the short term. The increase of production which results the increase of transaction volume requires the increase of money. If the volume of money does not increase as much as the volume of transaction increases, the economy would be sluggish due to constraints of production and trading activities.
Even though the mainstream economics ignores the effect of increasing income caused by increasing money, some economists argued that ‘money increases income’ before the publication of [The Wealth of Nations] written by Adam Smith, especially before the establishment of classical economics. David Hume(1711~1776) and Sir James Stuart(1712~1780) are the representatives. For an instance, Hume argued that ‘although money raises price, it does not happen immediately. the industry will be stimulated in the meantime as there is a time gap between the increase of money and the rise of price.’ However, the meaning of this argument has been lost and the mainstream economics has taken the increase of money as a price hike. This issue will be discussed in detail in the ‘Monetary Financial Principle’.
Change of income also calls for a natural increase or decrease of the amount of money. When the income increases, the economy is activated and the amount of money is increased by raising of the multiplier of credit creation, accelerating the circulation speed of money and activating the money functions of some goods such as stocks and real estates. In the opposite case, when the economy enters the recession cycle, the money functions of the goods which played the role of quasi-money are inactivated, the circulation speed of money is slowed down and the multiplier of credit creation is decreased.
Change in income has not only a direct impact on price but also it changes the exchange rate between all goods. Take a look around. Home appliances such as television sets and refrigerators which were luxury goods in the 1960s become necessities nowadays. They have become so common and the exchange rates for the other goods has also decreased. In the 19 century an automobile was rolled out of a rich house, but most of household have one or two automobiles now. And mobile phones were used by the privileged in the 1980s, but now they are popular. If income changes, the exchange rate changes as well as price changes.
Price starts moving when the economy rises and the inflation pressure becomes bigger and bigger when the economy overheats. On the other hand, price is under pressure to decline if the economy enters in the contraction period. This fact is already well known. By the way, price tends to fluctuate with time lag due to the relatively low sensitivity of the reaction, and the speed of price is relatively fast once the response is obtained. The inflation does not appear immediately even if the economy overheats but appears time lag. However its speed is accelerated once the price starts to rise. So the inflation does not stop even when the economy enters in recession. This is stagflation, which is accompanied by economic sluggishness and price instability.
It is also well known that there is a time lag in the process of which money affects price. It is investigated that the increase of money affects the inflation rate with a time lag of six months to two and half years. In other words, price keep rising as long as two and half years when money increases. This is why the price rise is scary. Most of the time it can not get out of hand if price has risen in earnest, but the mainstream economics has failed to provide the rationale to the phenomenon. The mainstream economics does not fully understand the interrelationship between price, money and income.
It is also essential for diagnosing and predicting the economy that recognizing the time lag between the interactions of price, money and income, even though the mainstream economics does not show interest in it. In general, price is relatively insensitive to money and income, but it is the fastest in them when it starts to speed up. The response of money is relatively sensitive to price but the speed is relatively slow and insensitive relatively to income but relatively fast. The response of income is the most sensitive but the slowest than price and money.
The differences of sensitivity and speed in these reactions make the economy be in dynamic balance without infinite diffusion or infinite convergence. Income rises first when the economy rises and money increases after it followed by inflation. If the inflation is faster than the others and exceeds the growth of money and income, income declines later. If price rises quickly, it makes spend less on the same income. When the economy declines due to a decrease in income money is reduced and price goes down gradually. If the fiscal spending is expanded or money is expanded to prevent the economic downturn, this general phenomenon does not happen but a stagflation or hyperinflation appears which is hard to heal.
The following is a brief summary of the above logical developments so far. Money affects income and price, income affects money and price, and price also affects others by stimulating income and money. This is the 'kinetic principle of triplet star' of price. That is, money, price and income are determined self-confidentially in the mutual relationship of the triplets. Here, the term "self-confidentially" means that they are mutually influenced and determined together.
This price determined self-confidentially as above is adjusted by the kinetic principle of price fluctuation. Price rises when demand increases more than supply and price declines when supply increases more than demand. However, price fluctuation due to the relation between supply and demand usually does not go beyond a certain range. By analogy, the lengths of day and night change day by day, but the average length is not exceeding 12 hours each. The price level determined by the kinetic principle of price decision is the most crucial. The kinetic principle of price chaos is the same as the kinetic principle of price fluctuation. It is usual that the kinetic principle of price chaos does not go beyond the range of price fluctuation determined by the kinetic principle of price fluctuation. However, the price change caused by the kinetic principle of price chaos affects the kinetic principle of price fluctuation and it causes another problem if it affects income. In reality, the principle of price chaos, the principle of price change, and the principle of price decision affect each other. Actually it happened shortly after the two oil crises that erupted in the early 1970s and the late 1970s.
The principle of price decision plays a very important role in the real economy even though it is not found in the mainstream economics. The price fluctuation in the stock market to be discussed next demonstrates just how important the principle plays in the economy. The increase of income determines how quickly the savings increase, the increase of savings determines the demand for stocks and the demand thus determined dominates prices of the stock market. The same is true of the real estate market. If we look at this issue in the stock market, we can easily understand the role of principle of price decision in economics.