When Is Inflation Not Inflation: A Note
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Abstract
Discoveries of valuable minerals in undeveloped parts of the world frequently lead to a very sharp rise in prices of daily necessities . Examples are the diamond and gold mine rushes and, perhaps, the situation in Saudi Arabia and a number of other Arab states. Discussing the matter with a number of economists, I find that they take the view that these situations are inflationary because prices have gone up. This is, I believe, erroneous. The prices of daily necessities are going up very sharply but other prices, concealed within the internal accounting system of producing units, have fallen even more. Let us suppose that diamonds are discovered in some rural area. People pour in from all over the world for the purpose of mining diamonds, and prices of housing, food, and the like, shoot up. Whereas before, the very occasional visitors found it possible to get the use of some farmer 's spare room for little or nothing, now the right to sleep on the ground in half of a pup tent may cost $10 per night. The currency in which this payment is made, however, is still stable currency elsewhere. Is there then an inflation? In Figure 1 the quantity of something let us say housing is shown on the horizontal axis, and the supply curve and demand curve before the discovery of diamonds are shown, respectively, by line S and line D. This leads to quantity Q0 being consumed at price P0. With the discovery of diamonds, the demand shifted up to line D ' . At the same time, however, there was a fairly rapid influx of capital in the form of such things as tents, with the result that the supply curve fell to S'. Nevertheless, the intersection of the new demand curve and the new supply curve leads to quantity Q1 being purchased at price P1. P1 is very much higher than P0. Is this an inflation? Note that ie marginal cost of each unit is now lower ian it was previously. What has happened is that iere has been a very large shift in demand, wii ie result that much more is being demanded. The thousandi unit of housing would have had, effectively, an infinite price under ie old regime, and now it has a Elnite new price. Neverieless, the fact remains iat prices are much higher than iey were before.