Short-Answer Q&A Supplement to Capitalism: A Treatise on Economics

Short-Answer Q&A Supplement to Capitalism: A Treatise on Economics by

George Reisman

A Publication of

This page intentionally left blank.

Short-Answer Q&A Supplement to Capitalism: A Treatise on Economics by

George Reisman

The Jefferson School of Philosophy, Economics, and Psychology,Laguna Hills, California

Copyright © 2003 by George Reisman.

All rights reserved. No part of this publication may be reproduced in any manner without written permission of theauthor.

Copies of this publication may be purchased from the publisher. All inquiries should be addressed to The JeffersonSchool of Philosophy, Economics, and Psychology, PO Box 2934, Laguna Hills, CA 92654. Fax: 949-831-1783.

Contentss(hyperlinked) PageQuestions on Introduction 1 Answers for Introduction 3 Questions on Chapter 1 5 Answers for Chapter 1 10 Questions on Chapter 2 11 Answers for Chapter 2 18 Questions on Chapter 3 19 Answers for Chapter 3 24 Questions on Chapter 4 25 Answers for Chapter 4 29 Questions on Chapter 5 31 Answers for Chapter 5 40 Questions on Chapter 6 41 Answers for Chapter 6 47 Questions on Chapter 7 49 Answers for Chapter 7 61 Questions on Chapter 8 63 Answers for Chapter 8 72 Questions on Chapter 9 73 Answers for Chapter 9 85 Questions on Chapter 10 87 Answers for Chapter 10 108 Questions on Chapter 11 109 Answers for Chapter 11 123 Questions on Chapter 12 125 Answers for Chapter 12 135 Questions on Chapter 13 137 Answers for Chapter 13 147 Questions on Chapter 14 149 Answers for Chapter 14 161 Questions on Chapter 15 163 Answers for Chapter 15 170 Questions on Chapter 16 171 Answers for Chapter 16 184 Questions on Chapter 17 187 Answers for Chapter 17 191 Questions on Chapter 18 193 Answers for Chapter18 200 Questions on Chapter 19 201 Answers for Chapter 19 221

George Reisman

Contentss(


INTRODUCTION

1. The schools of economic thought thathave been the main supporters of capitalism are

a. Marxism and Keynesianismb. the British classical school and the Austrianschoolc. both (a) and (b)d. neither (a) nor (b)

2. The Manchester, Currency, and Chicagoschools have been among the principal allies of theclassical and Austrian schools.

3. The most important members of the classi-cal school were Adam Smith, David Ricardo, and JohnStuart Mill.

4. The most important members of the Aus-trian school were Carl Menger, Eugen vonBöhm_Bawerk, Ludwig von Mises, and F.A. Hayek.

5. Among the leading critic(s) of capitalismor various major aspects of it have been

a. Karl Marx b. John Maynard Keynesc. Joan Robinsond. Edward Chamberline. all of the above

6. Malthus and Sismondi were importantmembers of the classical school.

7. J. B. Say, James Mill, J. R. McCulloch,and Nassau W. Senior were important members of theclassical school.

8. The schools of economic thought that pre-ceded the classical school included the Scholastics, theMercantilists, and the Physiocrats.

9. The Mercantilists were intellectuallycloser to the classical school than were the Physio-crats.

10. Contemporary Keynesianism mostclosely resembles

a. mercantilismb. physiocracyc. classical economicsd. the Austrian school

11. The most important members of the Aus-trian school are

a. Alfred Marshallb. Milton Friedmanc. Leon Walrasd. all of the abovee. none of the above

12. The leading difference between classicaleconomics and Austrian economics pertains to the the-ory of value and price and centers on the theory of di-minishing marginal utility.

13. Classical economics was abandoneda. in part because it came to be viewed as imply-ing the leading ideas of Marxism and the case forsocialismb. in part because it’s espousal of the wages-funddoctrine offered fundamental opposition to essen-tial aspects of the case for socialismc. both (a) and (b)d. neither (a) nor (b)

14. The abandonment of classical economicsin the nineteenth century contributed to the success ofanticapitalist ideas in the twentieth century

a. insofar as the abandonment of the classicaleconomists’ ideas on the role of saving preparedthe ground for the acceptance of Keynesianism inthe 1930s b. insofar as the abandonment of the classicaleconomists’ ideas on the role of cost of produc-tion as a determinant of prices paved the way forthe acceptance of the doctrines of pure-and-per-fect competition and oligopoly and monopolisticcompetition in the 1930sc. both (a) and (b)d. neither (a) nor (b)

15. According to the instructor, classical eco-nomics makes possible a far more fundamental andthoroughgoing critique of the Marxian exploitation the-ory than that provided by Böhm-Bawerk and the Aus-trian school, despite the prevailing mistaken belief thatit implies the exploitation theory.

16. The schools of economic thought whichhave been opposed to capitalism or essential featuresof it include the German historical school and theAmerican institutionalist school, both of which deniedthe very possibility of a science of economic laws.

17. The leading members of the German His-torical school were Wilhelm Roscher (1817–94), Gus-tav Schmoller (1838–1917), Lujo Brentano(1844–1931), and Werner Sombart (1863–1941).

18. Sombart began his career as a Marxistand later became a leading supporter of Nazism.

19. The leading members of the American in-stitutionalist school were Thorstein Veblen (1857–1929), John R. Commons (1862–1945), and WesleyMitchell (1874–1948).

20. Alfred Marshall’s doctrine of the repre-sentative firm led to the conclusion that large-sizedfirms usually cannot gain by cutting their prices be-cause it viewed all competitors as perfectly equal.

21. The partial equilibrium approach of Al-fred Marshall focuses on the individual firm and indus-try divorced from the rest of the economic system.

Copyright © 2003 by George Reisman. All rights reserved. May not be reproduced in any form without the permission of

the author, in wrting.

Dr. Reisman Short-Answer Questions, Introduction 1

22. The general equilibrium approach of clas-sical and Austrian economics studies economic phe-nomena from the point of view of their effects on allmembers of the economic system, not just on those di-rectly involved.

23. The partial equilibrium approach led tothe breakup of economics into “microeconomics” and“macroeconomics,” the one studying the individualconsumer and firm apart from connection with the restof the economic system, and the other studying theeconomic system as a whole, apart from its connectionto the actions of individuals.

24. According to the instructor, the theoreti-cal substance of most textbooks on “microeconomics”is that the great bulk of business activity is tainted withan element of monopoly and that the only exception isthe domain of pure and perfect competition, which isvirtually nonexistent. At the same time, little or noth-ing of the sound price theory developed by the classi-cal and Austrian economists is presented in thesetextbooks.

25. According to the instructor, the theoreti-cal substance of most textbooks on “microeconomics”is “that with a few, limited exceptions, such as wheatfarming, the whole of a capitalist economic system istainted by an element of monopoly. The solution forthis alleged state of affairs is supposed to be a radicalantitrust policy, which would fragment all large busi-nesses, or else the nationalization of such businessesand/or government control over their prices—and fur-ther policies that would force firms in the same indus-try to produce identical, indistinguishable products.”

26. According to the instructor, the theoreti-cal substance of most textbooks on “macroeconomics”is the elaboration of the doctrines of Keynes that capi-talism causes depressions and mass unemploymentthrough overproduction and excess saving and thatwhat is needed to counteract or prevent these evils isinflation of the money supply and deficit-financed gov-ernment spending.

27. According to the instructor, a shortcom-ing of mathematical economics is that

a. “It leads to an undue concentration of attentionon states of final equilibrium, which are all that itsdifferential equations are capable of describing. Itthus takes attention away from the real-world op-eration of the profit motive and of the market pro-cesses by means of which the economic systemcontinually tends to move toward a state of fulland final equilibrium without ever actually achiev-ing such a state. The economic system never actu-ally achieves such a state because of continuouschanges in the fundamental economic data.”

b. “The use of calculus and differential equationsto describe economic phenomena represents a Pro-crustean bed, into which the discrete, discontinu-ous phenomena of actual economic life arementally forced, in order to fit the mold of mathe-matically continuous functions to which the meth-ods of calculus can be applied.”c. “One major consequence [of mathematical eco-nomics] is the aid given to the perpetuation of afalse theory of the determination of the prices ofthe factors of production: namely, the theory thatthe prices of the factors of production are directlyderivable from the value of the consumers’ goodsthey help to produce.”d. all of the abovee. none of the above

28. Von Mises a. is almost alone in the development of a system-atic defense of capitalism in all of its leading as-pectsb. is the leading critic of socialism and Marxismc. both (a) and (b)d. neither (a) nor (b)

29. Von Misesa. developed answers to virtually all of the accu-sations made against capitalism—from its allegedexploitation of labor and responsibility for unem-ployment and depressions to its alleged responsi-bility for monopoly, wars, and racismb. developed a social philosophy of capitalismwhich demonstrates the benevolent operation ofall of capitalism’s leading institutions, especiallyprivate ownership of the means of production, eco-nomic competition, and economic inequalityc. expounded a procapitalist interpretation ofmodern economic history, and provided a devasta-ting critique of socialism and government inter-vention in all of its formsd. all of the above

30. Von Mises demonstrated that a socialisteconomic system lacks the ability to engage in rationaleconomic planning because of its lack of a price sys-tem and thus the ability to perform economic calcula-tion.

31. In the instructor’s view, “what von Misesundertook, and which summarizes the essence of hisgreatness, was to build a systematic intellectual de-fense of capitalism and thus of material civilization.”

32. Von Mises’s major criticism of socialismis that it is impossible to practice a perfect system inan imperfect world.

2 Short-Answer Questions, Introduction Dr. Reisman

Answers to Questions 1-32 on the Introduction 3

CorrectQ. # Answer

1 b2 T3 T4 T5 e6 F7 T8 T9 F

10 a11 e12 T13 c14 c15 T16 T17 T18 T19 T20 T21 T22 T23 T24 T25 T26 T27 d28 c29 d30 T31 T32 F


CHAPTER 1. ECONOMICS AND CAPITALISM

PART A. THE NATURE AND IMPORTANCE OF ECONOMICS

1. According to the instructor, economics isa. the science of wealthb. the science that studies the production and ex-change of wealthc. the science that studies the use of scarce meansto achieve competing endsd. the science that studies the production ofwealth under a system of division of labor

2. In a division-of-labor society, the individ-ual lives by producing or helping to produce just oneor at most a very small number of items, almost all ofwhich are consumed by others; at the same time practi-cally all that he consumes is produced by the labor ofothers.

3. The importance of economics derivesfrom the importance of wealth insofar as the subjectcan be no more important than is wealth.

4. The importance of wealth is not sufficientto establish the importance of economics. For exam-ple, while wealth would be extremely important toRobinson Crusoe, he would not be able to obtain anyadvantage other than abstract knowledge pertaining tothe world he was cut off from, if he could salvagesome books on economics.

5. What necessitates the science of econom-ics is the fact that the production of wealth is not onlyimportant but in the conditions of the modern worldalso depends on the division of labor, which, in turn,does not exist or function automatically but dependson human choices, in particular, choices in the realmof politics and government policy.

6. Which of the following statements is themost completely true:

a. Approximately only one-fourth of the popula-tion of the present-day world lives in division-of-labor societies; the great majority of people livingin populous countries such as China, India, andIndonesia continue to produce mainly for theirown and their families’ personal consumption.b. The division-of-labor society, in the sense ofthe average individual devoting the great bulk ofhis working time to production for the market, andthus to satisfying the needs of others, while in turnbeing supplied almost entirely from the market,and thus by means of the labor of others, is pres-ently confined mainly to the United States, Can-ada, Great Britain, the countries of WesternEurope, Japan, South Korea, Taiwan, Australia,and New Zealand. c. Prior to the rise of the modern Western world,the greatest degree of division of labor wasachieved under the early Roman Empire.

d. The first country to develop into a division-of-labor society was Great Britain, in the eighteenthcentury.e. all of the abovef. none of the above

7. Which of the following statements is themost completely true:

a. The division of labor raises the productivity oflabor by bringing about a corresponding multipli-cation of the volume of knowledge that enters intothe production of goods and services.b. In a division-of-labor society, the total of theknowledge entering into the production of goodsand services is the sum of the bodies of knowl-edge of each of the differenct specialized occupa-tions and suboccupations. In contrast, in anon-division-of-labor society, there is essentiallyjust one occupation and one body of knowledge—that of self-sufficient farmer.c. Non-division-of-labor societies represent awasteful duplication of the mental contents of thehuman brain, in that everyone lives in the sameway and knows essentially just the same thingsabout production as everyone else.d. In a division-of-labor society, a large propor-tion of the most intelligent and ambitious mem-bers tend to concentrate on areas devoted to theacquistion and application of new knowledge, no-tably, science, invention, and business, with the ef-fect that the body of knowledge used in theproduction of goods and services is not only multi-plied to the extent that labor is divided into sepa-rate occupaiton, each with its own, distinct bodyof knowledge, but also tends to grow from genera-tion to generation.e. all of the above

8. The division of labor has radically in-creased the productivity of labor and made possiblethe survival of a vastly larger population, including avastly larger population in countries with relatively lit-tle division of labor, which obtain vital supplies, suchas food and medicines, from the countries constitutingthe division-of-labor society.

9. What people, including governments, do,depends on what they think and believe. Public opin-ion and government policy guided by an ignorance ofeconomics is capable of resulting in actions that se-verely damage, and can even destroy, the division oflabor, which has definite requirements for its mainte-nance and growth. Without knowledge of economics,the citizens of the division-of-labor society are in theposition of a crowd wandering through a modern fac-tory and randomly pushing buttons and pulling levers.



Dr. Reisman Short-Answer Questions, Chapter 1 5

10. Because they lived mainly as hunters, theaverage American Indian required so much land, to as-sure an adequate supply of game, that the populationof Indians living north of the Rio Grand river couldnot get beyond approximately one million people.

11. If the present population of the UnitedStates were to attempt to live as self-sufficient farm-ers, the average individual in the lower forty-eightstates could have no more than about seven acres ofland, including all the deserts and mountains. The situ-ation would be even worse in Western Europe andJapan, where population densities are much greater.There is simply not enough land to support today’snumbers if they were to attempt to abandon the divi-sion of labor and live as self-sufficient farmers.

12. The rapid growth in population figuresaround the world over the last two hundred years, aftercenturies of stagnation, is the result of the higher pro-ductivity of labor resulting from the division of labor.

13. The destruction of the modern division oflabor would cause radical depopulation all across theworld; the survivors would live in the kind of povertyexisting in the Dark Ages.

14. The major applications of economics, ac-cording to the instructor, include the very survival of adivision-of-labor society and all that depends on it.

15. The major applications of economics, ac-cording to the instructor, include the solution of suchmajor present or recent economic problems as

a. mass unemploymentb. inflationc. economic stagnationd. shortagese. economic conflict among groups within coun-tries or between countriesf. all of the above

16. An implication of economics for ethics isa. the proposition that one man’s gain resultingfrom an increase in production is not anotherman’s loss; indeed, is frequently the source ofother men’s gain

b. rather than the individual having to sacrificehis self-interest in order to live in society, the exis-tence of a division-of-labor society is essential tothe achievement of the material self-interest of theindividualc. the material self-interest of the individual isserved by the existence and the freedom of otherpeople who cooperate with him in the division oflabord. all of the above

17. Knowledge of economics a. is a powerful antidote to unfounded feelings ofbeing the victim or perpetrator of “exploitation”b. is a powerful antidote to to all feelings of“alienation” based on the belief that the economicworld is immoral, purposeless, or chaoticc. cannot help but support the conviction that thefundamental nature of the world is benevolent andthus that there is no rational basis for feelings offundamental estrangement from the worldd. all of the above

18. Knowledge of economics is indispens-able to

a. understanding the broad sweep of history, nota-bly the fall of ancient civilization and the rise ofmodern civilizationb. the pursuit of rational economic policyc. understanding one’s place in the world and thekind of world one lives ind. the defense of individual rightse. all of the above

19. Knowledge of economics is important for a. businessmenb. historiansc. journalistsd. the intelligent citizene. all of the above

20. Knowledge of economics is important tobusinessmen because

a. it can teach them how to earn profitsb. it explains why everyone benefits from theirbeing free to earn profits

PART B. CAPITALISM

21. Capitalism a. is a social system based on private ownershipof the means of productionb. is characterized by the pursuit of material self-interest under freedomc. rests on a foundation of the cultural influenceof reasond. all of the above

22. Capitalism is characterized by a. saving and capital accumulationb. exchange and money

c. financial self-interest and the profit motived. all of the above

23. Capitalism is characterized by a. the freedoms of economic competition and eco-nomic inequalityb. the price systemc. economic progressd. a harmony of the material self-interests of allthe individuals who participate in ite. all of the above

6 Short-Answer Questions, Chapter 1 Dr. Reisman

24. Almost every essential feature of capital-ism underlies the division of labor and several of themare profoundly influenced by it in their own operation.

25. Economics, as the science which studiesthe production of wealth under a system of division oflabor, is actually the science which studies the produc-tion of wealth under capitalism.

26. The foundations of capitalism and eco-nomic activity, without which they could not developor only minimally develop, include

a. philosophical convictions pertaining to the real-ity and primacy of the material world of sensoryexperienceb. the philosophical conviction that the world op-erates according to definite and knowable princi-ples of cause and effectc. the prevalence of conceptual awareness of thefutured. the individual’s identification of himself as aself-responsible causal agent with the power to im-prove his lifee. all of the above

27. The foundations of capitalism and eco-nomic activity, without which they could not developor only minimally develop, include

a. peace and tranquilityb. respect for individual rightsc. limited government and economic and politicalfreedomd. all of the above

28. Recognition of property rights presup-poses

a. recognition of the principle of causalityb. “secularism,” in the sense of the validity ofconcern with the physical world and material well-beingc. both (a) and (b)d. neither (a) nor (b)

29. Great entrepreneurship as a social phe-nomenon presupposes the conviction of the potentialfor human greatness.

30. The continued existence of a capitalist so-ciety depends on the ability of economic science to in-fluence people’s thinking so that they will favorcapitalism and sound economic policy.

31. Freedom means freedom from the initia-tion of physical force.

32. Physical force meansa. physically doing something to or with the per-son or property of another against his willb. is exercised through advertisingc. is present in irresistable logical argumentd. all of the above

33. Various individuals commit acts such asrobbery, rape, and murder.

a. In so doing, they are guilty of the initition ofphysical force.b. In forcibly apprehending such individuals andcarting them off to jail, the police are guilty of theinitiation of acts of physical force.c. both (a) and (b)d. neither (a) nor (b)

34. Fraud represents the initiation of physicalforce in that it entails the taking of property against itsowner’s actual will.

35. The existence of government secures theindividual’s freedom in relation to other private indi-viduals by virtue of apprehending and punishing thosewho initiate the use of physical force. To the extentthat the government is successful in this, the individualis made free of the initiation of physical force by otherprivate individuals.

36. In order for the individual to have free-dom in relation to the government, it is necessary thatthe government be limited to protection against the ini-tiation of physical force.

37. Freedom should be defined not merely asthe absence of the initiation of physical force, but, inaddition, in order to highlight its most crucial aspect,the absence of the initiation of physical force specific-ally by, or with the sanction of, the government.

38. Laws, rulings, decrees that punish byfines or jail terms behavior that does not entail the useof physical force (including fraud) themselves consti-tute the initiation of physical force and hence representa violation of the individual’s freedom.

39. Freedom is the foundation of economicsecurity in that it is the basis of everyone being as se-cure as the exercise of his own reason and the reasonof his suppliers can make him.

40. Where there is freedom, there is peace,because there is no use of force: insofar as force is notinitiated, the use of force in defense or retaliation neednot take place.

41. Under freedom, the individual canchoose to do whatever he judges to be most in his owninterest, without fear of being stopped by the physicalforce of anyone else, so long as he himself does not ini-tiate the use of physical force.

42. Under freedom, the individuala. can take the highest paying job he can find andbuy from the most competitive suppliers he canfindb. can keep all the income he earns and save asmuch of it as he likes, investing his savings in themost profitable ways he canc. cannot use physical force except in immediateself-defensed. all of the above

43. Peace as the accompaniment of freedom


a. means peace at any priceb. means giving in to the threats of aggressors, inorder to avoid conflictc. is in sharpest contrast to the “peace of slavesand cowards”d. all of the above

44. The existence of the social security sys-tem is a leading consequence of the belief that in orderto achieve economic security, one must violate eco-nomic freedom and establish a welfare state.

45. Social securitya. deprives the individual, to the extent of his con-tributions to the system, of the power to decidehow his savings are investedb. diverts the individual’s savings into the financ-ing of current government expenditures ratherthan capital investmentc. makes the individual dependent on the choicesof future legislators and future taxpayers as thesource of his actual supportd. all of the above

46. Freedom of the press is fully implied inthe property rights of a press owner to use his press,paper, and ink to print the words he wants to print andthen to distribute his product to all willing buyers ortakers.

47. Freedom of speech is fully implied in theproperty rights of the owner of a piece of land, or of ameeting hall, to invite speakers of his choice onto hisproperty and an audience of his choice to listen to thespeakers.

48. An individual’s freedom of press is vio-lated when

a. a newspaper or publisher refuses to publish hisviewsb. when a newspaper or publisher is willing topublish his views but is prevented from doing soby the government

49. An individual’s freedom of speech is vio-lated when

a. a radio or television station refuses to invitehim to speakb. when a radio or television station is willing toinvite an him to speak but is prevented from doingso by the government

50. Economic freedom and political free-dom—property rights and human rights—are indivisi-ble; they are, in fact, merely different aspects of thesame thing.

51. On the basis of the anarchic concept offreedom, it is claimed that freedom is violated anytime there is anything that, for whatever reason, a per-son cannot do, from flying to the moon, to being ableto afford a house or a college education that is beyondhis reach, to committing murder.

52. Such acts as murdering one’s mother-in-law or speeding through red lights and thereby threat-ening the lives of others, are so far from representingfreedom that their prohibition is what actually consti-tutes freedom.

53. The anarchic concept of freedom is pres-ent in the assertion of Communists and socialists thattheir freedom of speech is violated because they arethreatened with arrest for attempting to disrupt thespeech of an invited speaker by shouting him down orby speaking at the same time.

54. A prohibition on arbitrarily shouting‘fire’ in a crowded theater should not be construed asany kind of limitation on the freedom of speech, letalone a justified limitation. On the contrary, in the caseof a live theatrical performance, the freedom of speechis violated precisely when someone does arbitrarilyshout ‘fire.’"

55. “The anarchic concept of freedom is im-plicitly accepted by conservatives and fascists, as wellas by anarchists and hippies.

56. The freedom of the press is violated andcensorship exists not when a newspaper refuses to pub-lish a story or a column that, for any reason, it regardsas unworthy of publication, but when it is prepared topublish a piece and is stopped from doing so by thegovernment. A private newspaper cannot commit cen-sorship. Only the government can commit censorship.

57. The freedom of travel is not violatedwhen an individual wants to travel somewhere butlacks the ability to pay the cost of doing so. On thecontrary, it is violated when he has the ability to paythe cost, and wants to pay it, but the government stopshim—say, with a wall around his city (as existed until1989 in East Berlin), a passport restriction, or a pricecontrol on oil and oil products that creates a shortageof gasoline and aviation fuel and thus stops him fromdriving and the airlines from flying.

58. State laws that impose residency require-ments for the receipt of welfare violate the freedom oftravel, because they stop people from traveling in theknowledge that they will have no source of fundswhen they reach their destination.

59. Striking down residency requirements forthe receipt of welfare requirements represents violat-ing the freedom of taxpayers.

60. The anarchic concept of freedom leads tothe belief that freedom of speech is incompatible withthe communication of thought. The rational concept offreedom, on the other hand, establishes freedom ofspeech precisely as the safeguard of the communica-tion of thought.

61. What makes the anarchic concept of free-dom so destructive is the fact that in divorcing free-dom from the context of rationality, it not only seeksto establish a freedom to initiate physical force, as in


the case of the anarchic concept of the freedom oftravel, but also, on the basis of the consequences ofsuch a perverted concept of freedom, provides seem-ing justification for the violation of freedom as a mat-ter of rational principle.

62. In recent decades, the government’s ener-gies and efforts have more and more been divertedfrom the protection of the individual’s freedom to theviolation of it.

63. The growth of government corruption isa byproduct of the decline of freedom, in that this lastmeans that the government has gained the power bothto impose arbitrary harm and to give arbitrary benefit,the first of which citizens pay to avoid and the secondof which they pay to receive.

64. To the degree that they exist, freedomand the pursuit of material self-interest, operating in arational cultural environment, are the foundation of

a. private ownership of the means of productionb. saving and capital accumulationc. the development of the division of labord. the development of exchange and moneye. financial self-interest and the profit motivef. economic inequalityg. economic competitionh. the price systemi. economic progressj. the harmony of rational self-interestsk. all of the above

65. The economic freedom of the UnitedStates led to

a. a vast westward migrationb. a vast increase in private ownership of themeans of production as settlers appropriated landand natural resources from nature

c. the development of new and improved meansof transportationd. the development of new and improved prod-ucts and methods of productione. the founding and growth of new towns and cit-iesf. all of the above

66. The unpopularity of capitalism and eco-nomic activity are evident in the various attacks thatare frequently made on the profit motive, economiccompetition, economic inequality, money, saving, andvirtually every other feature of their existence, and inthe numerous laws and regulations that have been im-posed to restrain them.

67. Economics is controversial in part be-cause

a. of the inherent difficulties present in any sci-ence of reconciling scientific theory with unscien-tific personal observationsb. the prevailing prescientific worldview in therealm of economicsc. the fact that economics casts the pursuit of self-interest in a positive light and thereby appears inconflict with the received morality of altruismd. economics comes into conflict with the pursuitof self-interest by means of forcee. economics presupposes a willingness to followchains of deductive reasoning and to regard the re-sults of logical reasoning from true premises asbindingf. all of the above

68. The belief that science must be “valuefree” is contradicted by the fact that science itself pre-supposes such values as rationality, honesty, integrity,and the freedom of inquiry, without which sciencecould not be pursued.


10 Answers to Questions 1-68 on Chapter 1

Correct CorrectQuestion # Answer Question # Answer

1 d 35 T2 T 36 T3 T 37 T4 T 38 T5 T 39 T6 e 40 T7 e 41 T8 T 42 d9 T 43 c10 T 44 T11 T 45 d12 T 46 T13 T 47 T14 T 48 b15 f 49 b16 d 50 T17 d 51 T18 e 52 T19 e 53 T20 b 54 T21 d 55 T22 d 56 T23 e 57 T24 T 58 F25 T 59 T26 e 60 T27 d 61 T28 c 62 T29 T 63 T30 T 64 k31 T 65 f32 a 66 T33 a 67 f34 T 68 T

CHAPTER 2. WEALTH AND THE ECONOMIC PROBLEM

1. Wealth is material goods made by man.

2. The concepts of wealth and money are in-terchangeable.

3. The production of more wealth in the eco-nomic system necessarily means a larger total mone-tary value of that wealth, e.g., a larger GDP.

4. A larger total monetary value of wealthfundamentally depends on

a. more wealthb. the existence of a larger quantity of money

5. A connection exists between the quantityof money and the amount of wealth when the mone-tary unit is a physical commodity, such as gold or sil-ver, and the supply of the monetary commodityincreases.

6. Monetary aggregates such as GDP or GNPare

a. measures of the amount of wealth producedb. indicators of the quantity of money in existence

7. Economic goods are goods on whose be-half man must expend labor or effort. In contrast freegoods, such as air and sunlight, come to man automati-cally, without expenditure of labor or effort on his part.

8. Stocks, bonds, and bank deposits arewealth.

9. Licenses, such as liquor-store licences andtaxicab medallions,

a. are wealthb. restrain the supply of wealth by denying peo-ple the right to produce or offer it

10. Patents and copyrights can contribute tothe production of wealth but are not themselves wealth.

11. Patents and copyrightsa. serve to encourage the production of wealth b. the effect of their expiration after a reasonabletime is then to encourage it furtherc. both (a) and (b)

12. In a society that allows slavery, such asthe South before the Civil War,

a. slaves are wealth b. the production of wealth is reduced becausethe market value of slaves serves to displace theaccumulation of material capital goods of a com-parable value

13. Stocks, bonds, bank deposits, licenses,patents, copyrights, etc. are

a. wealthb. property possessing market value

14. Petroleum and uranium have always beeneconomic goods and thus wealth.

15. Petroleum and uranium, before becomingeconomic goods, first

a. had to be recognized as possessing propertiesthat enable them to serve human needs or wantsb. had to be made subject to man’s physicalpower to direct them to the satisfaction of hisneeds or wants without the expenditure of an in-ordinate amount of effortc. both (a) and (b)

16. Because iron is wealth, it follows thatiron on Mars or under the floor of the oceans is wealth.

17. Iron on Mars or under the floor of theoceans

a. can never be wealthb. could someday become wealth if means weredevised whereby man was in a position to gainphysical command over it such that he could di-rect it to the satisfaction of his needs or wantswithout having to perform inordinate labor or ef-fort

18. Deposits of iron, copper, or any of theother metals were not wealth to the men of the StoneAge.

19. The wealth consituted by the mineral de-posits of North America has steadily diminished asmore and more minerals have been extracted from theground.

20. The extent to which the land and mineraldeposits of North America represents wealth greatly in-creased over the 19th and 20th centuries.

21. Desert land on which crops could suc-cessfully be grown if the land was irrigated is gener-ally not an economic good or wealth.

22. Imaginary goods are things believed, incontradiction of the evidence, to be capable of satisy-ing a human need or want.

23. Goods a. of the first order are goods standing closest tothe satisfaction of human needs or wants, e.g.,breadb. of the second order are goods necessary to pro-duce goods of the first order, e.g., flourc. of the third order are goods necessary to pro-duce goods of the second order, e.g., wheatd. all of the above

24. Shale oil is presently not wealth. It wouldbecome wealth if its cost of extraction and processingwere reduced to a level comparable to that of liquid pe-troleum.

25. The source of the goods-character ofthings is ultimately within us. Goods derive their char-acter as goods by virtue of their ability to benefithuman beings.



Dr. Reisman Short-Answer Questions Chapter 2 11

26. The fact that more people are employedtoday in the various service industries than in manufac-turing, mining, and agriculture shows that our eco-nomic system no longer revolves around theproduction of wealth.

27. Economics is concerned with servicesonly insofar as they are necessary to the production,enjoyment, or acquisition of wealth, or depend on theuse of wealth. Economics is not at all concerned withthe rendition of services apart from their connectionwith wealth.

28. Its fundamental concern with the produc-tion of wealth under a system of division of labor iswhat leads economics to be vitally concerned with thestudy of exchange, including the explanation of the ra-tios at which services might be exchanged for services.

29. Economics is the science which studiesthe allocation of scarce means among competing ends.It is not a science of wealth.

30. Among the leading classical economistswere Menger, Böhm-Bawerk, and Mises.

31. Among the leading Austrian economistswere Smith, Ricardo, and Mill.

32. The ultimate source of the importance ofthe division of labor and capitalism, and of the scienceof economics, is their contribution to the production ofwealth.

33. It is incumbent upon economics, as a sci-ence of wealth, to provide philosophical validation forthe production of wealth being a central, continuingconcern of human existence, because its own import-ance is derived from the importance of the subject mat-ter it studies.

34. Man’s possession of the faculty of reasonimplies a limitless need and desire for wealth on hispart, because

a. it creates the potential for a limitless range ofknowledge and awareness, which in turn createsthe potential for a limitless range of action and ex-perienceb. wealth in the form of tools, implements, ma-chines, and instrumentalities of all kinds is the ma-terial means of actionc. wealth in the form of works of art and sculp-ture, fine homes and furniture, landscapedgrounds, and other objects of contemplation is thematerial source of valuable experiencesd. all of the above taken together

35. Man’s need for wealth merely in order toserve his needs for nutrition and health can range froma few primitive hunting implements to perhaps thegreater part of a modern economic system, includingsuch industries as iron and steel, electric power, petro-leum refining, motor vehicle and aircraft manufactur-ing, and shipbuilding.

36. Reason gives man the ability to usewealth progressively to enhance the exercise of the ca-pacities he shares in common with lesser species.

37. The withdrawal of the forms of wealthspecifically adapted to it would

a. reduce music to the untrained singing of thehuman voice before small, immediately presentaudiencesb. reduce science to the level of perhaps drawinga circle in the sand with one’s fingerc. reduce art probably to the level of making asketch on the wall of a cave with a piece of char-coal from a camp fired. all of the abovee. none of the above

38. Man’s nature as a rational being intro-duces additional, “higher” dimensions into the satisfac-tion of his “lower” needs such as nutrition.

39. Man’s desire for novelty and varietystands in the service of his life by inducing him to ex-plore things he would otherwise not have explored andwhich turn out to have major practical application, aswas the case, for example, with the automobile and thepersonal computer.

40. Even when no practical applications everresult directly from the things that are desired, such asthe paintings or sculptures that a millionaire desires toadd to his collection, their being desired still producesimportant practical results.

41. The proposition of Adam Smith that “thedesire of food is limited in every man by the narrow ca-pacity of the human stomach; but the desire of the con-veniences and ornaments of building, dress, equipageand household furniture seems to have no limit or cer-tain boundary” continues to be true when understoodin contemporary terms.

42. While the desire for additional wealthcan be presumed always to be present, philosophicalconvictions of a definite type must be present to in-duce people to desire it strongly enough to go out andactually produce it.

43. The fact that the need and desire forwealth are limitless does not mean that when peopledevote themselves to satisfying that need and desire,as in the nations of modern capitalism, they go throughlife with a sense of endless frustration, seeking morethan they can ever hope to obtain.

44. Far from creating endless frustration, thepursuit of ever more wealth should be expected to con-tribute powerfully to human happiness.

45. Progress is the natural result of the use ofreason as a constant.

46. Economic progress contributes to humanhappiness by enabling people to live in the present inthe light of the prospect of a better future.

12 Short-Answer Questions Chapter 2 Dr. Reisman

47. According to the doctrines of cultural rel-ativism and conspicuous consumption, the concept ofeconomic progress can have no objective meaning.

48. How man succeeds in relation to thephysical world provides an objective standard bywhich to judge the value of cultures.

49. The basis for claiming that the automo-bile is objectively an advance over the horse andbuggy is ultimately the same as the basis for claimingthat the possession of legs is objectively better thannot possessing legs.

50. The basis for claiming that radio is objec-tively an advance over the telegraph and tom tom, thattelevision is objectively an advance over radio, andthat color television is objectively an advance overblack and white, is ultimately the same as the basis forclaiming that

a. the possession of ears is objectively better thannot possessing earsb. the possession of eyes and ears together is ob-jectively better than possessing ears alonec. the ability to see in color is objectively betterthan being color blindd. all of the above

51. On the basis of the standard of the valueof being able to see, hear, move, do, and think, theearning of wealth deserves to bring prestige.

52. The attempt to substitute the gaining ofprestige for the incentive of gaining wealth

a. is tantamount to asking people to toil through-out the year in order to gain a medal on May Dayand then, hopefully, to thereafter be called a goodboyb. ends up bringing the opposite of prestige tothose who would accept the substitutionc. both (a) and (b)

53. The fact that in our culture many peoplewant to own such goods as horses, canoes, bows andarrows, and so on, and in some cases prefer units ofthese goods to units of more advanced goods servingthe same needs

a. is consistent with the objective superiority ofthe goods of modern capitalism b. further exemplifies the principle that man’sneed for wealth is limitlessc. both (a) and (b)

54. In the name of being able to see, hear,move, or do anything that our senses, limbs, and mindsenable us to do—in short, in the name of being able tolive as human beings—the division of labor and capi-talism and the values that underlie them—namely, rea-son, science, technology, individual rights, limitedgovernment and economic freedom, and private owner-ship of the means of production—deserve to be upheld.

55. The same principle that establishes theobjectivity of the economic advances of modern capi-

talism directly establishes the objectivity of the superi-ority of modern capitalist civilization as such, in com-parison to any other form of civilization.“

56. By the standard of the ability to acquireand apply knowledge,

a. societies that have developed the art of writingare objectively superior to those that have notb. societies that, in addition to having developedthe art of writing, have also identified importantprinciples of mathematics and science, are objec-tively superior to those that have developedmerely the art of writingc. societies that, in addition to having identifiedimportant principles of science and mathematics,have also identified the laws of logic and the prin-ciple of causality, are objectively superior to thosethat have not made these further identificationsd. societies that, in addition to having identifiedthe laws of logic and the principle of causality,have achieved an extensive division of labor andsecured the freedoms of speech and press, are ob-jectively superior to those that have not achievedthese further accomplishmentse. all of the above

57. Capitalist civilization—modern Westerncivilization—is

a. not the civilization of the white manb. a body of knowledge and valuesc. open to men of all racesd. the civilization of all men who wish to prosperand are prepared to adopt reason as their funda-mental means of doing soe. all of the above

58. Those who view modern Western civili-zation, whether with pride or with hatred, as the civili-zation of the white man only are implicitly racists, inthat they view civilization and culture as being raciallydetermined.

59. Racism is present in the belief that civili-zation and culture are determined by racial member-ship. On this basis,

a. earlier generations of racists held that the exis-tence of inferior civilizations and cultures wasproof of the racial inferiority of the members ofsuch civilizations and culturesb. present-day racists hold that the equal value ofall races of human beings implies the equal valueof all civilizations and culturesc. both (a) and (b)d. neither (a) nor (b)

60. The law of diminishing marginal utilitymeans that the larger is the supply of a good that an in-dividual consumes or possesses, the smaller is the uti-ity, importance, or subjective value that he attaches toany given unit of the good.

61. The law of diminishing marginal utilitymeans that the larger is the quantity of a given factor


of production applied to a fixed quantity of anotherfactor of production, for example, more labor appliedto the same quantity of land, the smaller is the increasein output compared to the increase in input.

62. The law of diminishing marginal utilityrests on the fact that

a. people choose to satisfy their more importantwants ahead of their less important wantsb. successive units of a supply encounter needsor wants that have already been satisfied to someextent by previous units of the supply and aretherefore now less urgentc. both (a) and (b)

63. “The concept ‘most important of ourwants that a good is capable of satisfying’ must be un-derstood as a variable range, whose extent depends onthe quantity of the good we possess.

64. The marginal wants that a good servesshould be thought of as being the least important of themost important wants that its supply suffices to serve.

65. The utility of the marginal unit of a sup-ply determines the utility of any of the units of thatsupply at that moment.

66. The law of diminishing marginal utilitycontradicts the proposition that man’s need for wealthis limitless.

67. Despite the views of Galbraith, the law ofdiminishing marginal utility is consistent with the factthat man’s need for wealth is limitless, because

a. so long as additional wealth has any utility atall, more wealth is better than less wealthb. the process by which wealth is increased is ac-companied by the discovery of new avenues ofconsumption, which serves to increase the mar-ginal utility of wealth in comparison with what itwould otherwise be—e.g., while literal horses inthe range 101-300 might have little or no marginalutility, the same is certainly not true for horse-power in the range 101-300 or 101-3000, e.g., inthe form of automobile engines, elevators and allkinds of other machines and motorsc. as wealth increases, the size of the marginalunit under consideration frequently increases aswell—e.g., a mansion instead of an ordinaryhome, a private jet instead of just an automobiled. all of the above

68. The law of diminishing marginal utilityresolves the classical economists’ paradox of value—i.e., the seeming paradox constituted by the fact thatgoods of apparently the lowest utility, such as dia-monds, are normally more valuable in exchange thangoods of apparently the highest utility, such as water.

69. Diamonds are more valuable than waterin the sense that a diamond is more valuable than, say,100,000 gallons of water added on to a supply of water

at one’s disposal that is already sufficient to providefor all of one’s need or desire for water.

70. Determination of price by cost is an in-stance of the operation of the law of diminishing mar-ginal utility in that the value of the means ofproduction, which constitutes the cost, is itself deter-mined by the value of the marginal product of themeans of production.

71. The law of diminishing marginal utilityhelps to explain the pattern of demand that prevails inthe economic system at any given set of prices ofgoods.

72. The pattern of consumer spending that re-sults from the operation of the law of diminishing mar-ginal utility is characterized by

a. equal proportionality between price and mar-ginal utility in all lines of expenditure.b. a condition in which a change in the pattern ofspending would be accompanied by the loss ofmore utility in the line where spending was re-duced than the gain of utility in the line(s) wherespending was increased

73. The principle of diminishing marginalutility helps to explain the phenomenon of partial, rela-tive overproduction and underproduction described bySay’s Law.

74. In essence, our desire for wealth outstripsour ability to produce it by virtue of the limitless rangeof the mental in comparison with the physical and thusby virtue of the fact that the range of our imaginationsis always incomparably greater than the power of ourarms.

75. Because basic advances in the ability toproduce are accompanied by the opening up of newmodes of consumption, our desire for wealth continuesto outstrip our ability to produce it by an undiminishedmargin, no matter how much we may augment ourability to produce.

76. What economists mean by “scarcity” isa. the lack of urgently needed suppliesb. an excess of the desire for wealth over the abil-ity to produce it

77. Scarcitya. in a capitalist society means an excess of thedesire for wealth over the ability to produce itb. in a precapitalist society means a lack of ur-gently needed supplysc. both (a) and (b)d. neither (a) nor (b)

78. Scarcity as experienced under capitalismis the cause of the progressive elimination of scarcityin the sense experienced in a precapitalist society.

79. Time preference a. means the preference, other things being equal,for goods in the present rather than in the future or


in the nearer future rather than in the more remotefutureb. is analogous in the valuation of temporallymore remote future goods to the perception of spa-tially more remote physical objectsc. both (a) and (b)d. neither (a) nor (b)

80. The principle of time preference is im-plied in the very nature of valuing something, in that ifone values something, then other things being equal,one must consume it today or never consume it.

81. The nature of human life implies timepreference

a. in that whatever value we attach to being alivein the future is attributable to our being alive inthe present, which, given the uninteruptibility ofhuman life, is the indispensable precondition toour continuing to be alive in the futureb. the value of our being alive in the present mustalways exceed the value we attach to being alivein the future because it is equal to the sum of thevalue we attach to being alive in the future plusthe value we attach to being alive between nowand that time in the futurec. both (a) and (b)

82. The existence of time preference pre-vents the existence of profit and interest from alwaysresulting in saving and the accumulation of additionalcapital.

83. Time preference manifests itself in the ex-tent to which individuals make provision for the futurerelative to their current consumption.

84. Time preference implies that if it is De-cember, an individual in Minneapolis should be ex-pected to value a bathing suit that will be available tohim

a. in the coming January more highly than onethat will be available to him in the coming Julyb. in the coming July more highly than one thatwill be available to him in the July of the follow-ing year

85. It is inconsistent with the principle oftime preference to value the first unit of a future sup-ply above the second unit of a present supply.

86. The ascending price structure of agricul-tural commodity futures

a. is inconsistent with the principle of time prefer-enceb. reflects the increasing scarcity of supplies ofagricultural commodities between harvests, whichis itself due to time preference in bringing aboutthe consumption of such supplies

87. Other things being equal, the savings ofan individual with a higher degree of time preferencewill be less than those of an individual with a lower de-gree of time preference.

88. The scarcity of capital goods exists a. in both a horizontal and a vertical dimensionb. in the sense that more capital goods are neededto produce the larger supplies of consumers’goods that people desirec. in the sense that more capital goods can beused per unit of consumers’ goods produced andresult in the ability to produce improvedconsumers’ goods or equally good consumers’goods with greater efficiencyd. all of the above

89. Examples of different degrees of capitalintensiveness in the production of products are

a. the substitution of machinery for manual laborb. the construction of railroads and highways thatfollow straighter, more level routes but at agreater initial costc. the maintenance of a higher rather than a lowerratio of inventories to sales, as, for example, inorder to provide a wider variety of selectiond. the production of twelve-year old whiskey in-stead of eight-year old whiskeye. all of the above

90. Industries typically differ from one an-other in their degree of capital intensiveness.

91. Time preference influencesa. the methods of production usedb. the kinds of products producedc. the relative size of various industriesd. all of the above

92. Time preference operates to keep capitalin its “vertical dimension” permanently scarce.

93. Before the scarcity of capital in its verti-cal dimension could be overcome capital would haveto be accumulated sufficient

a. to enable the 80 percent of the world that is notpresently industrialized to come up to the degreeof capital intensiveness of the 20 percent of theworld that is industrializedb. within the industrialized countries to enableevery factory, farm, mine, and store to increase itsdegree of capital intensiveness to the point pres-ently enjoyed only by the most capital-intensiveestablishmentsc. within the industrialized countries to enable allestablishments to raise the standard of capital in-tensiveness still further, to the point where no fur-ther reduction in costs of production orimprovement in the quality of products could beachieved by any greater availability of capital inits vertical dimensiond. all of the above

94. It is always necessary to leave undone anincalculable range of potential improvements whoseexecution would require a more abundant accumula-tion of capital in its vertical dimension than exists.


95. Other things being equal, time preferenceis

a. the lowerb. the higher

the higher is the degree of cultural rationality and ofeconomic freedom and respect for property rights.

96. Wealth is the result of human labor.

97. Labor is the means by which man’s mindtransmits his designs and purposes to matter.

The following is a four-part question.

98. Labor is man’s application of his bodilyand mental faculties for the purpose of altering matterin form or location and thereby making the matter thusaltered serve a further purpose.

99. Matter thus altered by man’s labor is aproduct.

100. Production is the process of thus alter-ing matter.

101. A producer is one who effects such alter-ations.

102. In a division-of-labor society, the con-cept of labor is not limited to manual labor. It em-braces much more, such as the labor entailed infounding, organizing, and directing business firms andin providing them with capital. Such labor achieves itseffects by operating through the manual labor of oth-ers, which it renders more efficient.

103. Man does not create the matter that natu-ral resources represent, but he does create their wealth-character by means of identifying their usefulproperties and by making it possible to gain such phys-ical command over them that he can direct them to thesatisfaction of his needs or wants without the expendi-ture of an inordinate amount of labor.

104. Labor is the source of equipment andmaterials, including additional agricultural commodi-ties and mineral supplies extracted from the ground.

105. The application of more labor is theonly fundamental requirement for increasing the sup-ply of wealth.

106. The scarcity of wealth implies a morefundamental scarcity of labor, inasmuch as labor is theonly fundamentally limiting factor of production.

107. The scarcity of labor is manifest in thefact that virtually everyone would like to enjoy an in-come many times greater than the income he is pres-ently capable of earning and at his present rate of paywould have to work more hours than there are in theweek in order to earn it.

108. In order for the average member of soci-ety to have, say, five times the real income (i.e., buy-

ing power) that he now has, it would be necessary forhim to

a. produce five times as much as he now producesb. in the present state of technology and methodsof production, with its present limitations on theoutput per hour of labor, expend five times thelabor, in order to produce five times the outputc. earn five times the money income that he nowearnsd. all of the abovee. (a) and (b), but not (c)

109. The reason that more production ratherthan more money income is the key to more buyingpower is

a. the increase in the quantity of money thatwould be necessary to raise money incomeswould operate equally to raise prices, leaving buy-ing power unchangedb. the increase in production and supply, on theother hand, prevents prices from rising (or fromrising as much) when the increase in the quantityof money raises money incomes, and would oper-ate to reduce prices in the face of the same moneyincomes, thereby still increasing buying powerc. both (a) and (b)d. neither (a) nor (b)

110. The supply of labor that people can pro-vide falls radically short of the supply whose productsthey would like to have.

111. The scarcity of personal services adds tothe scarcity of labor.

112. The scarcity of labor is implied in thefact that each of us is easily capable of forming desireswhose fulfillment requires the labor of multitudes, andyet by the laws of arithmetic, the average member ofany society can never obtain more than the labor, orproducts of the labor, of just one person.

113. The fundamental scarcity of labor impl-ies that there is no inherent reason for the existence ofmass unemployment—that mass unemployment is aman-made phenomenon created in opposition to theunderlying economic situation.

114. The scarcity of labor is ineradicable,i.e., is not eliminated either by a larger supply of laboror by a higher productivity of labor, because

a. additional workers bring with them desires forwealth far in excess of their ability to add to itsproductionb. a higher productivity of labor is accompaniedby new and additional kinds of consumers’ goods,for which new and additional needs and desiresappearc. both (a) and (b)

115. The fundamental and essential nature ofeconomic life is this: the need and desire for additionalwealth are there and the nature-given means of produc-


ing it are there; all that is lacking is the ability ofhuman labor to transform the nature-given means ofproduction into additional wealth. This implies

a. the scarcity of human labor b. the need to raise the productivity of humanlaborc. the need for a division-of-labor, capitalist soci-ety as the essential framework and foundation of aprogressively rising productivity of labord. all of the above

116. Always, what stands between man andhis need for greater wealth is his limited ability to pro-duce wealth—his limited ability and also willingnessto perform labor.

117. The economic problem is how continu-ously to raise the productivity of labor, to make possi-ble an ever increasing production and enjoyment ofgoods per capita.

118. An important subsidiary problem that isfrequently referred to as the economic problem is howto allocate an existing limited ability to produce in ac-cordance with the choices of individuals to satisfytheir more important wants ahead of their less import-ant wants.

119. The solution for the economic problemis capitalism.



Correct Correct Correct Question # Answer Question # Answer Question # Answer

1 T 41 T 81 c2 F 42 T 82 T3 F 43 T 83 T4 b 44 T 84 b5 T 45 T 85 F6 b 46 T 86 b7 T 47 T 87 T8 F 48 T 88 d9 b 49 T 89 e10 T 50 d 90 T11 c 51 T 91 d12 b 52 c 92 T13 b 53 c 93 d14 F 54 T 94 T15 c 55 T 95 a16 F 56 e 96 T17 b 57 e 97 T18 T 58 T 98 T19 F 59 c 99 T20 T 60 T 100 T21 T 61 F 101 T22 T 62 c 102 T23 d 63 T 103 T24 T 64 T 104 T25 T 65 T 105 T26 F 66 F 106 T27 T 67 d 107 T28 T 68 T 108 e29 F 69 T 109 c30 F 70 T 110 T31 F 71 T 111 T32 T 72 b 112 T33 T 73 T 113 T34 d 74 T 114 c35 T 75 T 115 d36 T 76 b 116 T37 d 77 c 117 T38 T 78 T 118 T39 T 79 c 119 T40 T 80 T

CHAPTER 3. NATURAL RESOURCES AND THE ENVIRONMENT 19

PART A. NATURAL RESOURCES

1. The production of products consumes irre-placeable natural resources.

2. Since the beginning of the Industrial Revo-lution, man has actually enlarged the supply of use-able, accessible natural resources right along with theincrease in the supply of products.

3. Man creates the goods and wealth charac-ter of natural resources in identifying the useful proper-ties of what nature has provided and in gaining thepower to direct it to the satisfaction of his needs orwants without having to expend an inordinate amountof labor to do so.

4. From the upper limits of the atmosphere,to its center, 4,000 miles down, the earth is a solid ballof natural resources, in that it consists of nothing butsolidly packed chemical elements.

5. The supply of useable, accessible naturalresources can be progressively increased as man gainsgreater knowledge of and physical power over nature.

6. The energy shortage a. proved the existence of a growing scarcity ofnatural resources in natureb. the destructive effects of price controls and re-strictions on supply

7. The law of diminishing returns states thatunder a given state of technological knowledge, theuse of successively larger quantities of any factor ofproduction or combination of factors of production inconjunction with a fixed quantity of any other neces-sary factor or factors of production eventually resultsin less than proportionate increases in output.

8. An important phenomenon analogous tothe law of diminishing returns is the resort to progres-sively less productive land and mineral deposits assources of additional supply.

9. The existence of continuous economicprogress and the law of diminishing returns

a. are mutually contradictoryb. can be logically reconciled by virtue of techno-logical progress and improvements in equipmentprogressively raising the points from which re-turns diminish

10. The law of diminishing returns a. confirms b. contradicts

the fact that the fundamentally limiting factor in pro-duction is always human labor.

11. Allowing fertile land to lie idle is a. economically wasteful because an opportunityto produce is lost

b. economically sound if the use of the landwould serve to make labor unavailable for the pro-duction of other, more important products or for usein conjunction with more productive land.

12. Government irrigation and flood controlprojects have often been motivated by the convictionthat allowing fertile land to lie idle is economicallywasteful because an opportunity to produce is lost.

13. The fact that, as a rule, only one-third ofthe oil physically present in a petroleum deposit isever extracted, is evidence of economic waste.

14. The law of diminishing returns impliesthat economic progress is necessary to maintain thestandard of living, not just to raise it.

15. Atomic waste disposal and the strip min-ing of coal should be prohibited because they destroythe future usefulness of the land sites involved, andevrey piece of land is of great value.

16. In order to avoid waste, we need to a. recycle materials, such as gold and silver,whose value is great enough to cover the cost ofdoing so by an amount sufficient to provide a com-petitive rate of profitb. recycle all materials capable of being recycled,such as tin cans and paper products, irrespectiveof the market value of the materialsc. both (a) and (b)

17. Recycling raw materials when fresh sup-plies are available at a low cost is wasteful of humanlabor.

18. American retailers are inherently waste-ful in giving shoppers fresh paper bags with every pur-chase. In the name of economy, they should adopt thepractice common in many parts of Europe of requiringshoppers to bring their own bags.

19. Driving at fifty-five miles an hour con-sumes less gasoline for the same distance travelledthan does driving at sixty-five miles an hour. Thus, itis only economic common sense to drive at fifty-fivemiles an hour.

20. “Conservation by the market” occurswhen the price of a material is high enough to slow itsrate of consumption to a point commensurate with theavailability of a long-term supply of the item.

21. In the early years of the twentieth cen-tury, logging companies often cut down forests with-out bothering to replant. This proves the destructivenature of the profit motive.



PART B. THE ECOLOGICAL ASSAULT ON ECONOMIC PROGRESS

22. In the last two centuries, loyalty to thevalues of science, technology, and capitalism has en-abled man in the industrialized countries of the West-ern world to put an end to famines and plagues, and toeliminate the once dread diseases of cholera, diphthe-ria, smallpox, and typhoid fever, among others.

23. Industrial civilization has radically in-creased human life expectancy: from about thirty yearsin the mid-eighteenth century to about seventy-fiveyears today. Since the beginning of the twentieth cen-tury, in the United States, it has increased life expec-tancy from about forty-six years to seventy-five years.

24. Industrial civilization hasa. greatly increased both life expectancy and pop-ulation figures over the last two hundred yearsb. greatly improved the quality of drinking waterc. improved outdoor air quality in large townsand cities in comparison with the past, by substi-tuting automobile traffic for horse trafficd. improved indoor air quality by eliminating theneed for indoor fires and providing such things ascentral heating, air conditioning, and modern ven-tilation systemse. all of the above

25. The use of man-made power, such as

power enable man to accomplish vastly more with hisgiven, relatively modest muscular capacity and to doso with far less strain and fatigue. In these ways, it ishas greatly added to human life expectancy, to popula-tion figures, and to the quality of human life.

26. The concepts of economic efficiency and“energy efficiency” frequently work out to be oppo-sites, in that economic efficiency centers on the savingof labor, which typically requires the expenditure ofgreater amounts of man-made power per unit of labor.Adhering to “energy efficiency” in contrast would pre-vent the use of that power and thus the greater effi-ciency of labor.

27. A buffalo hide and buffalo meat avail-able merely for the price of a bullet and the labor thatfollowed, often made economic sense, in that theywere very cheap. Buffalo hides and buffalo meat avail-able only at the much higher price necessary to coverthe costs of raising buffalo on ranches apparently didnot make economic sense in the light of the valuescales of the consumers of meat and hides. The resultwas that buffalo became headed for extinction.

28. The preservation of large numbers of buf-falo in the open range, as they had existed before thecoming of the settlers, would have prevented the useof that land for the raising of cattle, the operation offarms, and the establishment of towns and cities.

29. The environmental movement recognizesthe vital importance of man-made power to the produc-tivity of labor and the standard of living, and thereforesupports the construction of new power plants to theextent they are necessary to achieve these ends.

30. The environmental movement recognizesand applauds the numerous achievements of scienceand technology in promoting human life and wellbeing.

31. The environmental movement generallyholds that

a. the value of nature derives from the value ofhuman life and well-being, and thus that nature isvaluable only insofar as it serves human life andwell-beingb. the value of nature is intrinsic, i.e., is valuablein and of itself, totally apart from any connectionto human life and well-being

32. According to the doctrine of intrinsicvalue, hillsides, jungles, swamps, and rock formations,as well as each and every species of plant or animallife, possess intrinsic value and comprise parts ofman’s environment.

33. According to the environmental move-ment, harm to man’s environment means damage to ordestruction of features of man’s environment

a. of value to manb. possessing intrinsic value

34. Which of the following represents the de-struction of alleged intrinsic values

a. clearing junglesb. draining swampsc. cutting away hillsidesd. damming riverse. walking on the grassf. leaving footprints in the sandg. all of the above

35. The doctrine of intrinsic value implies aview of human beings as

a. inherently destructive insofar as their life andenjoyment require changes in the existing state ofnature and thus the destruction of the alleged in-trinsic values constituted by existing states of na-tureb. the more destructive, the more they are in a po-sition to act on a greater scale by employing moreadvanced science, technology, and capital equimp-entc. both (a) and (b)d. neither (a) nor (b)

36. The exact same set of facts, such as theclearing of a piece of land and its conversion into a


housing tract can be described both as an improvementin the environment and as destruction of the environ-ment, depending on whether the standard of valueadopted is that of human life and well-being or that ofintrinsic value.

37. From the perspective of the doctrine of in-trinsic value, the lives of spotted owls, snail darters,and gnat catchers are as valuable as the lives and well-being of human beings, and so is the existence of hill-sides, deserts, and jungles, because all allegedlypossess intrinsic value.

38. If human life and well-being are the stan-dard of value, then production and economic activitynecessarily tend to improve the environment. This isbecause, from a physical-chemical point of view, whatthey constitute is change in the locations and combina-tions of the same total quantities of the various chemi-cal elements, all of which taken together constituteman’s environment, in a way that improves the rela-tionship of the chemical elements to human life andwell-being.

39. According to the author,a. the environmental movement holds individualsresponsible for the actions of a collective, as forexample, in the causation of global warmingb. in cases in which causal responsibility for aharmful outcome cannot be assigned to any givenindividual but only to a the actions of a collective,the harmful outcome should be regarded as equiv-alent to one caused by an act of naturec. both (a) and (b)d. neither (a) nor (b)

40. If the environmental movement had ex-isted in the early 19th century, the settlement of theMidwest would have been greatly accelerated.

41. According to the author, provided theyare not allowed to use force, the voluntary, self-inter-ested actions of individuals always tends to accom-plish incomparably more good than harm. Such harmas occurs, which is not intended and for which no indi-vidual is actually responsible, should be regarded as anact of nature, which individuals should then be leftfree to deal with.

42. The doctrine of “externalities”a. refers to the fact that the actions individualssometimes impose costs or bestow benefits on oth-ersb. is frequently used to argue that individualsshould pay for all costs their actions impose onothers and be paid for all benefits their actions be-stow on othersc. both (a) and (b)d. neither (a) nor (b)

43. The externalities doctrine implies suchthings as that

a. successful competitors should be made to com-pensate their unsuccessful rivals

b. passersby who enjoy the appearance of an at-tractive home, should be made to pay part of thecosts of creating and maintaining the appearanceof that homec. men who enjoy the appearance of attractive,well-groomed women, should be made to contrib-ute to the costs the women incur on account oftheir wardrobes and cosmetics, and, if applicable,plastic surgeryd. all of the abovee. none of the above

44. According to the author, the appropriateprinciple in cases of externalities is

a. not that individuals are to be able to demandpayment for all the benefits they give to others,but only those for which the others have voluntar-ily contracted to receive and pay forb. not that individuals are to be held accountablefor all the costs they impose on others, but onlythose resulting from their actions that cause de-monstrable physical harm to the persons or prop-erty of specific other individualsc. both (a) and (b)d. neither (a) nor (b)

45. In the view of the author, the failure ofsocialism has contributed to the environmentalmovement’s distrust of science, technology, and thepower of human reason insofar as the intellectual main-stream believes that the failure of socialism is the fail-ure of human reason.

46. Socialism held that if people were left topursue their own material self-interests, the resultswould be such undesirable phenomena as the exploita-tion of labor, depressions, and monopoly, and that gov-ernment control of the economic system was necessaryto prevent these evils. Environmentalism is essentiallysimilar, because it holds that if people are left to pur-sue their own material self-interests, the results will besuch undesirable phenomena as global warming, de-struction of the ozone layer, and acid rain, and thatgovernment control of the economic system is neces-sary to prevent these evils.

47. The ecology movement is an attempt toresurrect the essential doctrines of socialism concern-ing the consequences of the uncontrolled, self-inter-ested actions of individuals.

48. According to the author, the devastatingfailure of socialism, coupled with the belief that its ad-vocacy rests on a foundation of reason, has led the leftto turn from the advocacy of “social engineering” tohostility to engineering of any kind.

49. According to the author, the basic politi-cal-economic conditions required for man to deal suc-cessfully with changes in economic conditions,including global warming (if in fact it were to come)and the inevitable climate changes, such as the next


ice age, that sooner or later will be produced by natureitself, are those of

a. free-market capitalismb. intelligent government planningc. both (a) and (b)

50. The concepts of economic progress andeconomic growth are essentially identical.

51. The concept of progressa. implies movement toward a desired goal, inthe case of economic progress, toward greaterprosperity, health, and longevityb. applies across successive generationsc. does not imply any fixed limitd. all of the above

52. The concept of growtha. fundamentally pertains to an individual livingorganism, such as one person, one tree, one tumorb. implies inherent limitsc. is valuationally neutral in that it applies both topositives and negativesd. all of the above

The following is a fourteen-part question.

53. According to the author, environmental-ism is the product of a growing loss of confidence inreason and is the leading manifestation of a rising tideof irrationalism that is engulfing our culture.

54. According to the author, contemporaryeducation promotes irrationalism and the influence ofthe ecology movement in

a. failing to provide essential foundations ofknowledge starting in the earliest gradesb. leading students to regard what they learn as aseries of arbitrary assertionsc. laying the foundation for irrational skepticismon the part of studentsd. conducting a systematic attack on reason andits role in human lifee. all of the above

55. According to the author, an essentialcause of the inability of contemporary education tosucceed in the task of educating is its denigration ofthe memorization of facts and principles, which runsdirectly counter to the essential nature of education asa process of the student’s internalizing knowledge.

56. According to the author, a major founda-tion of the ecologists’ irrationalism is the convictionthat whatever we may think we know today about any-thing, can turn out to be wrong tomorrow, because ofthe discovery of something new which totally invali-dates all of our presumed knowledge about it. It is onthis premise that the ecologists believe and project thatevery technological advance is a potential thalidomide.

57. According to the author, contemporaryeducation promotes irrationalism and thus the influ-ence of the ecology movement in propounding

a. the doctrine of collectivism, in its variousforms of Marxism, racism, nationalism, and femi-nismb. the doctrines of cultural relativism, determin-ism, logical positivism, existentialism, linguisticanalysis, behaviorism, Freudianism, and Key-nesianism c. both (a) and (b)

58. According to the author, all the varietiesof collectivism

a. deny the free will and rationality of the individ-ual and attribute his ideas, character, and vital in-terests to his membership in a collective: namely,his membership in an economic class, racialgroup, nationality, or sex, as the case may be, de-pending on the specific variety of collectivismb. in viewing ideas as determined by group mem-bership, deny the very possibility of knowledgec. create conflict between members of differentgroups: for example, between businessmen andwage earners, blacks and whites, English speakersand French speakers, men and womend. all of the above

59. According to the author,a. determinism, the doctrine that man’s actionsare controlled by forces beyond his power ofchoice, denies the very possibility of rationalthought being capable of guiding human life andachieving human happinessb. existentialism, the philosophy that man istrapped in a “human condition” of inescapablemisery, teaches the same conclusion as determin-ismc. both (a) and (b)

60. According to the author, cultural relativ-ism

a. denies the objective value of modern civiliza-tion and thus undercuts students’ valuation notonly of it, but also of the technology and sciencenecessary to build such a civilization, and the valu-ation of human reason itself, which is the ultimatefoundation of modern civilizationb. undercuts people’s willingness to work hard toachieve personal values in the context of moderncivilizationc. blinds people to the objective value of suchmarvelous technological advances as automobilesand electric light, and thus further prepares theground for the sacrifice of modern civilization tosuch nebulous and, by comparison, utterly trivialvalues as “unpolluted air”d. all of the above

61. According to the author,


a. logical positivism denies the possibility ofknowing anything with certainty about the realworldb. linguistic analysis regards the search for truthas a trivial word gamec. behaviorism denies the existence of conscious-nessd. Freudianism regards the conscious mind (the“Ego”) as surrounded by the warring forces of theunconscious mind in the form of the “Id” and the“Superego,” and thus as being incapable of exer-cising substantial influence on the individual’s be-haviore. all of the above

62. According to the author, Keynesianisma. regards wars, earthquakes, and pyramid build-ing as sources of prosperityb. looks to peacetime government budget deficitsand inflation of the money supply as a good substi-tute for the allegedly beneficial phenomena de-scribed in (a)c. results in the erosion of the buying power ofmoney and the undermining of credit, saving andcapital accumulation, and the general standard oflivingd. all of the above

63. According to the author, along with de-stroying confidence in science and technology, the ris-ing tide of irrationalism and growing loss ofconfidence in reason means loss of the philosophicalbasis of the valuation of man, inasumuch as reason is

man’s fundamental distinguishing attribute and aculture’s view of reason determines its view of man.

64. According to the author,a. confidence in the reliability of reason, and thusthe philosophical status of man, have declined sofar that now virtually no basis is any longer recog-nized for a radical differentiation between manand animalsb. with man’s distinctive attribute thus held to beunworthy of special valuation, man himself neces-sarily appears unworthy of special valuationc. as the environmentalists see matters, they areadvocates of a universal brotherhood of all spe-cies and all elements of the “environment”—intheir eyes, there are, in effect, blacks, caucasians,orientals, giraffes, snail darters, flies, spottedowls, and mountainsides, all with equal rights inthe “environmental family”d. all of the above

65. According to the author, the animalrights movement is a product of irrationalism and thecultural devaluation of man.

66. According to the author, in the view ofenvironmentalists and the advocates of animal rights,the assertion of man’s rights above those of any otherspecies or inanimate object is a form of racism andNazism—of “speciesism”—in which man seeks totreat other parts of the brotherhood of nature as concen-tration camp inmates.



Correct Correct Correct Question # Answer Question # Answer Question # Answer

1 F 23 T 45 T2 T 24 e 46 T3 T 25 T 47 T4 T 26 T 48 T5 T 27 T 49 a6 b 28 T 50 F7 T 29 F 51 d8 T 30 F 52 d9 b 31 b 53 T10 a 32 T 54 e11 b 33 b 55 T12 T 34 g 56 T13 F 35 c 57 c14 T 36 T 58 d15 F 37 T 59 c16 a 38 T 60 d17 T 39 c 61 e18 F 40 F 62 d19 F 41 T 63 T20 T 42 c 64 d21 F 43 d 65 T22 T 44 c 66 T

CHAPTER 4. THE GAINS FROM THE DIVISION OF LABOR 25

1. The division of labor is a system of pro-duction in which the labor required to support humanlife and well-being is broken down into separate, dis-tinct occupations.

2. In a division-of-labor society, the individ-ual lives by producing, or helping to produce, just onething or at most a very few things, which are con-sumed overwhelmingly by others, and is supplied bythe labor of others for the far greater part of his needs.

3. The multiplication of knowledge a. exists to the extent that labor is divided intoseparate occupations and suboccupations, becauseeach of these has its own specialized body ofknowledgeb. makes possible the production of products thatwould otherwise be impossible because of the in-ability of any given individual or small group ofindividuals to hold the necessary knowledgec. both (a) and (b)

4. Compared with division-of-labor societies,non-division-of-labor societies, such as those com-prised of large numbers of essentially self-sufficientfarm families, entail a wasteful duplication of the men-tal contents of the human brain.

5. The division of labor makes it possible forgeniuses to specialize in science, invention, and the or-ganization and direction of the productive activity ofothers, thereby further and progressively increasingthe knowledge used in production.

6. An important advantage of the division oflabor is that individuals at all levels of ability can con-centrate on the kind of work for which they are bestsuited on the basis of differences in their intellectualand bodily endowments.

7. The geographical gains from the divisionof labor refer to the fact that under a system of divi-sion of labor, each area tends to concentrate to an im-portant extent on the exploitation of any advantages itmay possess in terms of natural resources and climateconditions, with the result that each territory that par-ticipates in the division of labor is able to gain the ben-efit of the special advantages of every other suchterritory.

8. In producing more iron than is required byits inhabitants, Minnesota

a. wastes a scarce, precious natural resource forthe benefit of outsidersb. obtains the ability to obtain a wide variety ofnatural resources, agricultural commodities, andmanufactured products that it itself either cannotproduce at all or cannot produce very efficiently

9. Participation in the division of labor is es-sential to the ability of any geographical area to ex-ploit its natural resources effectively, in that, for

example, the ability to produce iron and steel from theiron ore of Minnesota depends on the availability ofcoal from West Virginia or Wyoming, and the abilityto mine coal depends on the use of steel drills and steelstructural supports in coal mines.

10. The division of labor increases the effi-ciency and effectiveness of the processes of learningthat are entailed in production by

a. making possible, through constant repetition ofthe same tasks, a subconscious automatizing ofknowledge and a corresponding increase in the ef-ficiency with which it is appliedb. increasing the ratio of the time spent in apply-ing knowledge to the time that must be spent in ac-quiring it, thereby making the acquisition ofknowledge more worthwhilec. making education and communications—allthe activities concerned with storing and transmit-ting knowledge—into specializations, which, likeall other specializations, tend to be carried on bythose best suited for themd. all of the above

11. The division of labor increases the degreeto which knowledge of production is assimilated andtherefore the efficiency with which it is used, the yieldto the time spent in acquiring it, and the efficiencywith which it is disseminated.

12. The division of labor increases the effi-ciency of the processes of motion that are entailed inproduction by

a. concentrating work of the same type in thesame placeb. breaking work down into the simplest possiblesteps, consisting of the smallest possible numberof separate motionsc. eliminating the time that would otherwise belost in walking back and forth from one place toanother to do different kinds of work, in con-stantly picking up and putting down differenttypes of tools, and in constantly having to finishup and perhaps clean up what one has been doingand warm up to what one is about to dod. all of the above

13. The division of labor underlies the use ofmachinery in production by means of

a. providing, through its multiplication of knowl-edge, a sufficient fund of knowledge in a societyto make the production of machinery possibleb. providing, through its geographical aspect, theextensive and widely scattered range of materialsnecessary for the production and use of most ma-chinesc. making science and invention into specializa-tions carried on by geniuses, which greatly facili-tates the invention of machinery



d. reducing jobs wherever possible to a smallnumber of distinct motions repeated over and overagain, as a result of which it enormously simpli-fies the problems of designing a machine or spe-cial tool to help do the work e. concentrating a large volume of work of thesame type in the same hands, the division of labormakes the use of machinery and specialized toolseconomically worthwhilef. all of the above

14. Knowledge of the gains derived from thedivision of labor fails to explain why 18th Century En-gland was the first country to experience the IndustrialRevolution.

15. A division-of-labor society represents theorganization of the same total sum of human brainpower in a way that enables it to store and use vastlymore knowledge than would otherwise be possible.

16. The effect of a division-of-labor societyis not only to increase the total of the knowledge thatthe same amount of human brain power can store anduse, but also to bring that knowledge up to a progres-sively rising standard set by the most intelligent mem-bers of the society.

17. While man always possesses the facultyof reason, a division-of-labor society is necessary if heis to use his rationality efficiently in production.

18. The division of labor increases the effi-ciency with which man is able to apply his mind, hisbody, and his nature-given environment to production.

19. The division of labor is an essential pre-condition for the achievement of a high and steadilyrising productivity of labor.

20. The division of labor is the essentialframework for the ongoing solution of the economicproblem.

21. Whoever, in the words of von Mises, pre-fers wealth to poverty, and life and health to sicknessand death, is logically obliged to value the existence ofa division-of-labor society and all that it depends on.

22. The widely held notion that life in soci-ety requires the sacrifice of the individual’s self-inter-est is

a. confirmed b. refuted

in regard to a division-of-labor society.

23. In a division-of-labor society, theindividual’s material self-interest is served to the ex-tent that others are secure in their persons and propertyfrom the initiation of force, because they are therebyenabled to produce more goods which are sold on themarket and available for the individual to buy.

24. In the light of knowledge of the gainsfrom the division of labor, the ethical principle of re-spect for the persons and property of others has a basis

in the requirements of the individual serving his ownmaterial self-interest.

25. The division of labor has raised the pro-ductivity of labor so high that today the average mem-ber of a division-of-labor society has

a. both substantial real wealth at his disposal andsubstantial leisure in which to enjoy itb. open to him in no small measure precisely thekind of life that the ancient Greeks thought couldbe enjoyed only by a slave-owning aristocracyc. both (a) and (b)

26. The claim that a division-of-labor societyis incompatible with the well-rounded development ofthe individual, in accordance with the ideals of the Re-naissance, is contradicted by the fact that it is preciselyin a division-of-labor society that the average worker,for the first time in all of human history, has the oppor-tunity of actually becoming something of a Renais-sance man.

27. A dull job performed for money is lessdull than one performed merely for the sake of a givenphysical result, to the extent that the earning of moneymakes possible a wide range of choice in what thework will accomplish for the individual.

28. Even the otherwise most monotonous,repetitious types of factory work might be given an im-portant measure of challenge and excitement if it werepossible to perform the work as piecework.

29. The proportion of interesting and chal-lenging jobs in the economic system has steadily de-clined with the progress of the division of labor.

30. While it is true that alienation—a senseof lack of belonging and lack of control in one’s life—is a growing problem in present-day society, thewealth and leisure and the resulting education andlevel of knowledge that a division-of-labor societymakes possible are powerful forces working againstsuch feelings.

31. Alienation is a growing problem in pres-ent-day society

a. because ofb. in spite of

the existence of the division of labor.

32. In the physical sense,a. production is man’s alteration of matter inform or location, in accordance with conscious de-sign, in order to make the matter thus alteredserve a further purposeb. a producer is one who effects such alterationsc. a product is matter that has been altered in oneor more of the above waysd. a product can also be an alteration of matterthat we perceive as essentially unchangede. all of the above

33. Labor is


a. the means by which man’s mind transmits hisdesigns and purposes to matterb. man’s application of his bodily and mental fac-ulties for the purpose of altering matter andthereby making it serve a further endc. both (a) and (b)

34. All production entails the presence of pre-existing matter, which is to be altered, and whose ulti-mate source is always nature.

35. “Land” a. is the name which economists have tradition-ally given to nature’s contribution to productionb. as the term is used by economists, includesland as we normally think of it, namely, pieces ofground, plus all the natural resources within it andall the trees and plants and animals that are natu-rally present upon it—i.e., present without man’sinterventionc. embraces bodies of water and their contents,air, and, eventually no doubt, even outer space, in-sofar as these things are employed in productiond. all of the above

36. Land and labor together are sometimes re-ferred to as the original factors of production.

37. The description of land as an original fac-tor of production can be misleading insofar as man isresponsible for whatever wealth-character it possesses.

38. Products produced are continuously usedup, worn out, or simply deteriorate through the actionof nature, as when they rust or rot.

39. “Consumption,” in its physical sensemeans the using up, wearing out, or deterioration bothof products and nature-given goods (such as mineraldeposits).

40. A consumer in the physical sense is onewho uses goods up, wears them out, or in whose pos-session they deteriorate.

41. Every product produceda. is subsequently consumedb. reflects a prior consumption in the process ofits own productionc. both (a) and (b)

42. Recognition that consumption is entailedin the very process of production itself, led the classi-cal economists to distinguish between two, and some-times three, very different kinds of physicalconsumption, which they called, respectively, produc-tive, unproductive, and reproductive consumption.

43. Productive consumption means consump-tion for the purpose of production.

44. Examples of productive consumption area. the consumption of flour and ovens for the pur-pose of baking bread b. the consumption of steel and stamping equip-ment for the purpose of producing automobiles

c. the consumption of cloth and sewing machinesfor the purpose of making clothingd. all of the above

45. Unproductive consumption is consump-tion not for the purpose of production. For example,the eating of bread, the driving of an automobile forpleasure, the wearing of clothes.

46. Reproductive consumption means that va-riety of productive consumption in which the productproduced can play the same role in further productionas the goods consumed in its own production, or canbe employed in the production of such products.

47. Examples of reproductive consumptionare

a. the consumption of seed in the production ofwheatb. the wearing out of trucks in making deliveriesto truck factoriesc. the wearing out of oxcarts in the constructionof a railroadd. the using up of steel in the manufacture of ironmining equipment and the subsequent wearing outof the iron mining equipmente. all of the above

48. The wearing out of oxcarts in the con-struction of a railroad is reproductive consumption inthat oxcarts and railroads play the same role in produc-tion, insofar as both are means of transport.

49. In the context of a division-of-labor, mon-etary economy, in which anything that is used in theproduction of a product to be sold can make possibleits own replacement by way of exchange—that is, byusing the sales proceeds its products bring in, to pur-chase its replacement—the concepts productive con-sumption and reproductive consumption becomesynonymous.

50. Capital goods in the physical sense aregoods productively or reproductively physically con-sumed. For example, the flour and ovens, steel andstamping equipment, cloth and sewing machines, andthe seed, trucks, oxcarts, and steel and iron miningequipment, mentioned above.

51. The aggregate of the capital goods in thepossession of an individual can be described as his cap-ital. And capital can be defined as wealth reproduc-tively employed—that is, as wealth employed in theproduction of wealth.

52. In the context of a division-of-labor econ-omy,

a. the concepts capital goods and capital come tobe inseparably connected with the question ofwhether or not the goods are purchased, or thesums of money are expended, for the purpose ofbringing in subsequent sales revenuesb. capital is wealth employed in the earning ofmoney


c. both (a) and (b)

53. The supply of capital goods is of vital sig-nificance to production because it is a major determi-nant of the productivity of labor—i.e., the output perunit of labor. A larger supply of capital goods per ca-pita operates to raise the productivity of labor, and asmaller supply to reduce it.

54. More capital goods make it possible toproduce not only more of various products, but prod-ucts whose production would otherwise be completelyimpossible. For example, while a plow enables afarmer to grow more food than he could grow withoutit, a furnace of some sort is necessary in order toproduce any steel at all.

55. A growing or improving supply of capitalgoods is indispensable to the adoption of more ad-vanced technologies and to the continuing rise in theproductivity of labor.

56. Because capital goods undergo produc-tive consumption, it follows that in order to

a. maintain the supply of capital goods, a propor-tion of production must be devoted to their pro-duction at least sufficient to offset their productiveconsumption, which proportion can be termed themaintenance proportionb. have capital accumulation, the proportion ofproduction devoted to the production of capitalgoods must be greater than the maintenance pro-portionc. both (a) and (b)

57. The existence of division of labor oper-ates to raise the productivity of labor in large measureby virtue of increasing the supply of capital goods percapita.

58. The increase in the supply of capitalgoods is the effect of division of labor in all the waysthat it serves to increase production and insofar as theproducts are capital goods.

59. Capital accumulation depends on a. the proportion of total production in which cap-ital goods are produced b. the general efficiency with which labor and ex-isting capital goods are used in productionc. both (a) and (b)

60. Greater efficiency in the utilization oflabor and existing capital goods serves to increase thesupply of capital goods because it

a. results in a larger total product, including alarger supply of capital goods for any given pro-portion of productive effort devoted to the produc-tion of capital goodsb. serves to reduce the proportion of productionrequired for the replacement of capital goods andto make possible capital accumulation with a rela-

tive concentration on the production of capitalgoods that was previously sufficient only to main-tain the supply of capital goods, c. serves increase the rate of capital accumulationto whatever extent an economic system was al-ready devoting to the production of capital goodsa larger proportion of its efforts than was requiredfor the mere replacement of capital goodsd. all of the above

The following is a six-part question.

A self-sufficient farmer must consume 1 bushel ofseed in order to grow 2 bushels of crop, from which heobtains replacement seed.

61. Calculate the farmer’s maintenance pro-portion.

62. Calculate the supply of capital goods(seed) that the farmer will produce if he devotes 50percent of his productive effort to the production ofseed.

63. Calculate the supply of capital goods(seed) that the farmer will produce if he devotes 60percent of his productive effort to the production ofseed.

64. Calculate the farmer’s maintenance pro-portion if he increases his efficiency and can now pro-duce 3 bushels of crop instead of 2, with the samelabor and seed.

65. Calculate the supply of capital goods(seed) that the farmer will now produce if he devotes50 percent of his productive effort to the production ofseed.

66. Production with capital goods always rep-resents an indirect, more time-consuming process ofproduction as compared to production without capitalgoods because labor must first be applied to the pro-duction of the capital goods and only then to the pro-duction of consumers’ goods.

67. The greater lapse of time between the per-formance of labor and the achievement of its ultimateresult, when capital goods must first be produced, iswell compensated for by the larger size of the productand by the fact that in many cases products of thesame kind could simply not be obtained otherwise.

68. The division of labor is intimately boundup with the question of the time factor involved in pro-duction insofar as one group of workers begins its pro-duction with capital goods produced by previousgroups of workers. Such temporal succession in thestages of division of labor can be described as the divi-sion of labor in its vertical aspect.


Answers to Questions 1-68 on Chapter 4 29

Correct Correct Question # Answer Question # Answer

1 T 35 d2 T 36 T3 c 37 T4 T 38 T5 T 39 T6 T 40 T7 T 41 c8 b 42 T9 T 43 T10 d 44 d11 T 45 T12 d 46 T13 f 47 e14 F 48 T15 T 49 T16 T 50 T17 T 51 T18 T 52 c19 T 53 T20 T 54 T21 T 55 T22 b 56 c23 T 57 T24 T 58 T25 c 59 c26 T 60 d27 T 61 50%28 T 62 1 bu.29 F 63 1.2 bu30 T 64 33.33%31 b 65 1.5 bu.32 e 66 T33 c 67 T34 T 68 T


CHAPTER 5. Part A, 31

DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM

1. In a division-of-labor society, each personbenefits from the fact that other people possess knowl-edge which he does not, and an intelligence separatefrom and often greater than his own.

2. The knowledge and intelligence of othersenter into the productive process and thus enable theindividual to obtain goods and services for the produc-tion of which his own knowledge and intelligencewould be insufficient.

3. The benefits the individual derives fromothers in the division of labor requires that others beable to acquire and apply their knowledge on theirown initiative, without having to await his orders, ap-proval, or permission, which, in the nature of the case,he would be unable to give in any rational way, sincehe necessarily lacks the knowledge that would be re-quired to do so.

The following is a nine-part question.

4. Private ownership of the means of produc-tion is the most fundamental of the institutions of capi-talism. It underlies a division-of-labor society in adirect way and in a variety of indirect ways.

5. The direct dependence of the division oflabor on private ownership of the means of productionis based on the nature of the gains provided by the divi-sion of labor, in particular, the gains derived under thehead of “the multiplication of knowledge” and “thebenefit from the existence of geniuses.”

6. The gains from the multiplication ofknowledge that the division of labor provides resultsfrom the fact that different individuals know differentthings about production, and yet the totality of all theirseparate knowledge enters into the productive processand benefits all who consume the products that result.

7. The gains from the existence of geniusesthat the division of labor provides results from the factthat different individuals have different degrees of in-telligence and that the intelligence of all enters into theproductive process and serves to benefit everyone whoconsumes the products.

8. Both the multiplication of knowledge andthe gains from the existence of geniuses that the divi-sion of labor provides derive from the fact that individ-uals possess separate, independent minds and thinkand hold knowledge separately and independentlyfrom one another.

9. The fact that individuals think and holdknowledge separately and independently from one an-other requires that they be able to act and produce sep-arately and independently from one another. If they

could not, then those with knowledge would be inthrall to those who lacked knowledge and those withgreater intelligence would be in thrall to those of lesserintelligence.

10. Since action and production require theuse of material means of action and production if theyare to achieve any significant or substantial results, theneed for separate, independent action and productionimplies a need for separate, independent holdings ofwealth and capital, i.e., a need for private property andprivate ownership of the means of production.

11. By the nature of the leading benefits itprovides, namely, the multiplication of knowledge andthe gains from the existence of geniuses, a division-of-labor society depends on the institution of private prop-erty and private ownership of the means of production.

12. Private property and private ownership ofthe means of production are fundamental and essentialto a division-of-labor society because the separate, in-dependent thinking and acting of individuals is funda-mental and essential to it, and because they are thematerial requirement of such separate, independentthinking and acting.

13. The existence of numerous medium andlarge-sized business enterprises, in which large num-bers of individual wage earners successfully produceunder the direction of businessmen and capitalists

a. refutes the claim that separate, independentproduction is necessary to the existence of the di-vision of labor, since in these important cases itdoes not existb. is consistent with the claim that separate, inde-pendent production is necessary to the existenceof the division of labor, because the formation andextent of all business enterprises is itself the prod-uct of the separate, independent thinking and act-ing of all the individual participants—e.g., theindividual stockholders decide the extent to whichit is advantageous to pool their capitals and em-ploy other people; the individual wage earners de-cide the extent to which working for such anenterprise is to their advantage compared withworking on their own, as businessmen, and withworking for any other such enterprisec. both (a) and (b)

14. In placing ownership of the means of pro-duction under government control, and thereby pre-cluding separate, independent production and thebenefits of separate, independent minds driving theproductive process, socialism and collectivism destroythe foundation on which rest the most important gainsfrom the division of labor and are thus fundamentallyincompatibile with a division-of-labor society.




George Reisman


15. As expressed in the phrase “central plan-ning,” which is an essential characteristic of its opera-tion, socialism and collectivism require that

a. the whole of society function as one, indivisi-ble unit in the conduct of the economic systemb. every citizen or, as a minimum, the SupremeDictator and the other members of the CentralPlanning Board know every significant fact per-taining to production anywhere in the economicsystemc. both (a) and (b)

16. In order for a socialist system to be oper-ated democratically,

a. it would be necessary that the voters decidesuch questions as whether a new steel mill shouldbe built in Gary, Indiana, or somewhere else; whatkind of steel mill it should be; how large it shouldbe; and so onb. in the face of hundreds or thousands of suchquestions arising every day, the voters would haveto devote their lives to nothing else, and still theywould be almost entirely ignorant about the mat-ters raised in each casec. both (a) and (b)

17. Any democratic decision making undersocialism would necessarily quickly give way to deci-sion making by a narrow group of governmentoffials—the Central Planning Board.

18. Central planning even by a board of ex-perts is actually impossible, because of its requirementthat a single mind be able to know and work withevery significant fact pertaining to production any-where in the economic system.

19. Socialism in fact does not represent anyform of coordinated central planning, but always lim-ited, partial planning, which is all that any humanmind is capable of accomplishing.

20. The necessarily limited, partial plans ofsocialism again and again turn out to be mutually con-tradictory, because of the lack of ability to overseethem all and thus to coordinatate and harmonize them.Thus, for example, separate plans are made by differ-ent authorities that presuppose the use of one and thesame supplies of means of production, with the resultthat the success of one plan necessitates the failure ofothers.

21. Economic planning under capitalism ex-ists

a. to the extent that the government becomes in-volved in economic decision making and thus in-troduces planningb. insofar as businessmen, investors, wage earn-ers, and consumers think about courses of actionthey expect to be profitable or otherwise benefi-cial to them and decide to follow the pattern of be-havior that their thinking indicates

22. Capitalism is characterized by economicplanning on the part of all of the individual partici-pants in the economic system—businessmen, invest-ors, wage earners, and consumers.

23. Economic planning is present under capi-talism when

a. a consumer plans to buy a home or automobileor new clothes or change his dietb. a wage earner plans to change his job or learna new skill or do his work in a different geographi-cal areac. a businessman plans to introduce a new prod-uct, or retire an existing product, build up his in-ventory or run it down, hire workers, or dischargeworkers, open or close a branch, change his meth-ods of production or keep them the samed. all of the above

24. Economic planning under capitalisma. exists and is all pervasiveb. routinely takes place on the part of all partici-pants in the economic systemc. is based on a consideration of prices in theform of costs or revenue or incomed. all of the above

25. The prices on which economic planningunder capitalism is based make possible economic cal-culations, which provide a standard of action for theplanner under capitalism, which is, other things beingequal, buy what costs the least and do what earns themost.

26. The standard of action described in theprevious question is objective in the light of one’s de-sire to obtain more wealth, since buying any giventhing for less releases funds that make additional pur-chases possible, and earning more provides additionalfunds for additional purchases.

27. Prices serve to coordinate and harmonizethe plans of each individual under capitalism with theplans of all other individuals in the economic system.

28. When a student changes his career planfrom actor to accountant on the basis of the differencein income he can expect to earn, the change signifiesmaking his career plan coordinate better with the plansof his fellow citizens, whose plans—as manifested inwhat they are willing to spend their money for—callmuch more for the kind of services he is likely to beable to provide as an accountant than for the kind ofservices he is likely to be able to provide as an actor.

29. When a prospective home buyer changeshis plan concerning which neighborhood to live in onthe basis of the difference in home prices, he is adjust-ing his housing plan to the housing plans of others, in-asmuch as it is the plans of others willing and able topay more to live in certain neighborhoods, and less tolive in certain others, that determine the relative hous-ing prices confronting our home buyer.


30. When a business changes its plan con-cerning product lines, methods and locations of pro-duction, or any other aspect of its activities in responseto profit-and-loss calculations, it is changing its plan inresponse to changes in the plans of others. This is be-cause it is the plans of its prospective customers, of allcompeting sellers of its goods, and of all other buyersof the means of production it uses or otherwise de-pends on, that enter into the formation of the prices de-termining the revenues and costs of any business firmand thus what it finds profitable or unprofitable to pro-duce.

31. Use of the expression “economic plan-ning” as a synonym for government planning ignoresthe massive planning of all of one’s fellow citizensand is thus an insult to them.

32. The price system is what makes possiblethe division of the intellectual labor required in the pro-cess of economic planning, in that it coordinates andharmonizes all the various separate, partial plans of themultitudes of different individual planners under capi-talism.

33. Capitalism isa. an anarchy of productionb. a thoroughly planned economic system, onewhich is planned on the basis of the thinking andvalues of all of the participants in the economicsystem

34. The price system rests on the profit mo-tive and the freedom of competition.

35. Operating in conjunction with one an-other, the profit motive and the freedom of competi-tion are the elements that

a. drive and regulate the price systemb. determine the formation of all individual pricesc. bring about the integration of all individualprices into a system of prices that coordinates andharmonizes the activities of all participants in theeconomic systemd. all of the above

36. The text promises to show that the profitmotive

a. provides powerful incentives for the steady ex-pansion and improvement of productionb. operates to keep the relative size of all the vari-ous industries and occupations in proper balancec. makes production accord with the will of theultimate buyers—the consumersd. ensures that the production of each individualgood takes place in a way that is maximally con-ducive to production in the rest of the economicsysteme. balances the demand and supply of each prod-uct and ensures the most rational and efficient dis-tribution of each product over space and timeamong all the markets that compete for itf. all of the above

37. The text promises to show that the profitmotive

a. ensures the delivery of each product into thehands of those individuals who, within the limitsof their wealth and income, need or desire it themostb. ensures the most rational and efficient alloca-tion of capital and of every type of labor and mate-rial among its possible alternative usesc. makes the economic system respond tochanges in economic conditions in the most ratio-nal and efficient manner possibled. creates economic order and harmony out of theactivities of all the different individuals who com-prise the economic systeme. is what enables capitalism to be an economicsystem that is rationally and cohesively plannedby each and every individual who participates in itf. all of the above

38. The profit motive is what prevents anysort of “anarchy of production.”

39. In seeking to serve his financial self-inter-est,

a. every seller under capitalism must be awarethat there are other sellers or potential sellers whomight sell to his customers and thus that he mustaccordingly limit the prices he asksb. every buyer under capitalism must be awarethat there are other buyers or potential buyers whomight buy from his suppliers and thus that hemust set the prices he offers accordinglyc. in the above ways, competition and the free-dom of competition are the built-in regulatorwhich provide the essential context in which theprofit motive operatesd. all of the above

40. While the price system vitally dependson the profit motive and the freedom of competition,they in turn depend on the institution of private owner-ship of the means of production.

41. Private ownership of the means of pro-duction

a. is what makes the profit motive operative inthe formation of prices, the prices both of meansof production and of productsb. underlies the very existence of the incentivesof profit and loss, in that it is private property,above all in the form of private ownership of themeans of production, that is the substance of whatis gained or lost by producersc. both (a) and (b)

42. Private ownership of the means of pro-duction underlies the existence of the incentives ofprofit and loss, because without the ability to accumu-late holdings of private property, there would be noth-ing for producers to


a. gain except the ability to enlarge their immedi-ate consumptionb. lose, because losses can be losses only of pre-existing propertyc. both (a) and (b)

43. With private ownership of the means ofproduction there is not only the incentive of profit andloss to use the means of production profitably but alsothe fact that an individual’s control over the means ofproduction is increased or decreased to the extent thathe uses them profitably or unprofitably.

44. An individual’s control over the means ofproduction is increased or decreased to the extent thathe uses them profitably or unprofitably because

a. those owners who use the means of productionprofitably are in a position to save and reinvest, inproportion to the extent of their profits andthereby to enlarge their control over the means ofproductionb. those owners of the means of production whosuffer losses correspondingly lose control over themeans of production, inasmuch as their lossesmean that their sales proceeds are less than theirinitial outlays and thus that they lack the funds toreplace the means of production with which theybeganc. both (a) and (b)

45. Private ownership of the means of pro-duction is what

a. gives the profit motive its substance andstrengthb. enables the profit motive both to be operativein the formation of the prices of means of produc-tion and products and to direct the use of themeans of productionc. enables success or failure in earning profits todetermine the extent of one’s control over meansof production in the futured. gives the profit motive virtually all of its eco-nomic influencee. all of the above

46. Private ownership of the means of pro-duction underlies economic competition, in that eco-nomic competition presupposes separate, independentproducers, who, in order to be separate and indepen-dent, must hold the wealth they use in production sepa-rately and independently from one another, i.e., asprivate property.

47. Competition among producers presup-poses private ownership of the means of production.

48. The freedom of competition, like virtu-ally all other freedoms, is an aspect of property rights:it is the freedom of owners of means of production toemploy their means of production in any branch of in-dustry they choose.

49. In addition to its dependence on theprofit motive and freedom of competition, the price

system, also depends on the institutions of exchangeand money.

50. The very phenomenon of exchange pre-supposes the separate ownership of the things ex-changed. Exchange is a mutual transfer of propertybetween two parties, with the property of each beinggiven as the condition of receiving the property of theother.

51. Prices are sums of money exchanged forunits of goods or services.

52. A collectivist monopoly on production,which is the essence of socialism, is incompatible withthe means of production being exchanged or, there-fore, having prices.

53. Under socialism, capital goods cannot bebought or sold because all capital goods are owned bythe same party: the state.

54. A leading purpose of socialism is sup-posed to be the removal of labor from the status of acommodity that is bought and sold in the market; and,indeed, labor cannot be bought and sold under social-ism except on the terms arbitrarily dictated by a univer-sal monopoly employer: the state, which would implywages at the level of minimum subsistence.

55. Private ownership of the means of pro-duction is essential for the existence of markets forcapital goods and of competitive markets for labor. Itis thus essential for the existence of market prices ofthe means of production.

The following is a five-part question.

56. The price system depends on the institu-tion of saving and capital accumulation, in that theprices of the means of production are not paid by theconsumers, who purchase only the ultimate final prod-ucts, but by businessmen.

57. All the materials and supplies, all thetools, equipment, and labor services used in produc-tion are purchased and paid for by businessmen, al-most entirely out of accumulated capital, not by theultimate consumers out of consumption spending.

58. True answers to the two preceding ques-tions imply that the prices of the means of productiondepend on saving and capital accumulation.

59. In order for people to save and accumu-late capital, to improve the productive property at theirdisposal in any way, or even just to maintain it, theymust have the expectation of benefiting from such ac-tion. They can rationally have that expectation only ifthat wealth—those means of production—are securelytheir private property.

60. Saving and capital accumulation vitallydepend on the institution of private ownership of themeans of production and its security. Where property


is insecure, there is little or no saving and capital accu-mulation.

61. The price system depends on the institu-tion of private ownership of the means of productionthrough its dependence on

a. the profit motiveb. competitionc. exchange and moneyd. saving and capital accumulatione. all of the above

62. The institution of private ownership ofthe means of production underlies

a. the profit motiveb. competitionc. exchange and moneyd. saving and capital accumulatione. the price systemf. all of the above

63. Saving and capital accumulation are nec-essary to the existence of a division-of-labor-societybecause

a. they are necessary to the production of allgoods whose production requires more time thanelapses between two mealsb. in raising the productivity of labor in the pro-duction of food and other vital necessities, theymake possible the release of labor for the produc-tion of other goods and thus the development ofthe division of laborc. they make possible a “division of payments”d. all of the above

64. The “division of payments” a. refers to the fact that instead of paymentsbeing made only at the end of a process of produc-tion, by the ultimate consumers, they are made atpoints along the way, within relatively short peri-ods of time after the producers at any given stageof production have completed their specific workb. is illustrated by the fact that autoworkers arepaid within one or two weeks after the start oftheir labor, and the producers of the steel andother capital goods that go into automobiles areusually paid within a month or two of their ship-ment of those capital goods, even though the con-sumers of automobiles may not complete paymentfor their cars for as long as five yearsc. both (a) and (b)

65. It is not uncommon for cases to exist inwhich labor must be performed decades or generationsbefore the ultimate final products appear—for exam-ple, the case of workers building a factory to produceconstruction equipment used in the construction of fur-ther factories.

66. The division of payments and thus savingand capital accumulation are vital to the existence ofthe division of labor in its vertical aspect (the aspect of

temporal succession in the process of production),since without them producers whose work is temporar-ily far removed from the payment by the ultimate con-sumers would simply be unable to produce suchproducts because the waiting time for payment wouldbe too long.

67. In a division-of-labor society exchangemust exist on a massive scale and be a central featureof economic life because

a. each product originates in a huge concentra-tion in the hands of a relatively small number ofproducers and must be brought into the hands of avast number of consumersb. exchange is the mechanism by means of whichthe movement of goods from producer to con-sumer is accomplished c. both (a) and (b)

68. A division-of-labor society depends spe-cifically on monetary exchange

a. in order to overcome the barriers to exchangethat would otherwise exist on account of the com-mon absence of a “double coincidence of wants”b. because of the necessity of monetary calcula-tions to serve as a guide to productionc. both (a) and (b)

69. The absence of money would mean thatin order to live, people would either have to them-selves be farmers or produce the kinds of goods or ser-vices frequently sought by farmers, such as theservices of blacksmiths.

70. In the light of its essential role in makingpossible the existence of a division-of-labor society, itmakes sense to claim that “money is the root of allevil.”

71. A major source of the gains from the divi-sion of labor is that the production of everything tendsto be carried on by those who are able to do it best.Economic competition is the process of establishingwho is able to produce things best.

72. Economic competition is the process ofdetermining the organization of a division-of-labor so-ciety with respect to the choice of

a. persons for occupations—for example, whowill be company president and who will be janitorb. which products will serve which markets andto what extentc. which technological methods of producing anygiven product will be employed and to what extentd. all of the above

73. Economic competition isa. essentially an antisocial phenomenon, repre-senting conflict, and more akin to combat than tosocial cooperationb. the mechanism for organizing and improvingthe efficiency of the process of social cooperation,which the division of labor represents


74. The freedom of competition, i.e., the free-dom to gain the customers of others by means of offer-ing better and/or less expensive goods or services,including goods or serivices that others may have cho-sen temporarily not to offer, serves to safeguard a divi-sion-of-labor society from possible extortion by themembers of individual vital industries.

75. Prohibiting the use of strikebreakers, ei-ther by law or by private intimidation, is a violation ofthe freedom of competition.

76. Economic inequality is a virtually inevita-ble result of economic freedom in that individuals arenot all equally intelligent, talented, or otherwise capa-ble, and not all equally lucky, and thus, while all try-ing to succeed, will almost certainly succeed tounequal degrees.

77. The imposition of economic equality rep-resents the destruction of the individual’s ability to re-gard himself as a causal agent because it divides theotherwise significant effects he is able to cause by a de-nominator equal to the number of equal sharers andthus correspondingly reduces the effect remaining tohim. For example, a man capable, by doubling his ef-forts, of doubling the income he earns, is able to expe-rience only one one-thousandth of that doublng if hemust share it with 999 others, and is able to experienceonly one one-millionth of it if he must share it with999,999 others.

78. The imposition of economic equality rep-resents the destruction of the individual’s perceptionof the cost of his actions, because that cost is dividedover a large group, possibly millions or even billionsof people, and correspondingly reduces the cost to theindividual concerned.

79. Assume that a quadruple-bypass opera-tion costs $100,000 but will be paid for by Medicareand thus by the taxes of perhaps 100 million Americantaxpayers. Calculate the cost of the operation to the in-dividual taxpayer, including the recipient of the opera-tion.


Mr. A can assemble 20 units of a product in anhour and must be paid $10 per hour. Mr. B, whois much less capable than Mr. A, can manage to as-semble only 10 units of the same product in ahour, but need by paid only $4 per hour.

80. Calculate the unit labor cost that resultsfrom employing Mr. A.

81. Calculate the unit labor cost that resultsfrom employing Mr. B.

82. Use the letter A or B, indicate which ofthese two individuals it would be more economical toemploy in terms of unit labor cost.

Now assume that the government’s minimum wage,which previously had been $3.75 per hour is raised to$5.25 per hour.

83. Calculate the unit labor cost of employ-ing Mr. B at $5.25 per hour.

84. Again using the letter A or B, indicatewhich of these two individuals it would now be moreeconomical to employ in the terms of unit labor costand be in compliance with the minimum wage law.

85. The minimum wage law in the above ex-ample operates in the material self-interest of Mr. B,because it enables him to earn more money than be-fore.

86. Economic inequality enables less capableindividuals to compete with, and even outcompete,more capable individuals by means of accepting in-comes that are lower in greater proportion than is theirrelative productivity.

87. The forcible elimination or reduction ofeconomic inequality serves to deprive less capable in-dividuals of the ability to successfully compete.

88. Relatively high incomes have no signifi-cant association with relatively high rates of saving outof income.

CHAPTER 5, PART B.

ELEMENTS OF PRICE THEORY: DEMAND, SUPPLY, AND COST OF PRODUCTION

89. In classical economics the concepts de-mand and supply refer to schedules of price and quan-tity and, when diagrammed, to curves showingquantitites demanded or supplied at varying prices ar-ranged in descending or ascending order.

90. In contemporary economics, the conceptsdemand and supply refer respectively to an amount of

expenditure of money and a quantity of a good or ser-vice put up for sale and sold.

91. The law of demand states that, otherthings being equal, the quantity of a good demanded isgreater at a lower price and smaller at a higher price.

92. At the level of the economic system as awhole, the law of demand follows directly from thefact that the need and desire for wealth has no limit


and that a fall in the prices of goods and services is allthat is necessary to enable any given expenditure ofmoney to purchase a larger quantity of goods and ser-vices.

93. The law of demand exists because of theoperation of

a. the law of diminishing marginal utilityb. the substitution effectc. the income effectd. all of the above

94. According to the substitution effect, achange in the price of a given good, while the prices ofits substitutes remain unchanged, has the effect of shift-ing expenditures to it, if the change in price is in thedownward direction, and away from it if the change inprice is in the upward direction, because of the implicitchange in the good’s competitive position vis-a-vis itssubstitutes.

95. According to the income effect, to the ex-tent that people were already prepared to buy a givenquantity of a good at a definite price, the effect of alower price is to enable them to buy that same quantityfor a smaller expenditure of money, which is equiva-lent to the generation of additional income and thusgives rise to an increase in the quantity of the good de-manded equivalent to the increase that would resultfrom an equivalent increase in income.

96. The marginal utility of every unit of agood that is purchased must exceed its price, if peopleare to buy it. A fall in price serves to put the pricebelow the marginal utility of additional units and thusto increase the quantity of the good demanded.

97. Other things being equal, a change inprice causes a

a. change in demandb. change in quantity demanded along one andthe same demand curve

98. A rise in price reducesa. demand and thus reduces priceb. quantity demanded

99. Changes in the demand for a good arecaused by changes in the price of the good.

100. Changes in the demand for a good arecaused by changes in

a. the prices of other goodsb. tastes and preferencesc. the quantity of moneyd. money incomese. the size and composition of the populationf. the state of technologyg. all of the above

101. Complementary goods are goods thatmust be employed together in order to produce the de-sired product or outcome. Cigarettes and matches, beer

and pretzels, automobiles and gasoline, the services ofcarpenters and electicians, are all examples.

102. A rise in the price of a complementarygood operates to decrease the demand for the othercomplementary goods.

103. A rise in the wage rates of bricklayers isin the interest of electricians and carpenters, becauseall wage earners have the same interests.

104. The elasticity of demand refers to the de-gree of increase or decrease in quantity demanded inresponse to a change in price.

The following is multi-part question.

A fall in price results in an increase in quantity de-manded, and a rise in price results in a decrease inquantity demanded.

105. In order for the demand to be elastic, thechange in quantity demanded must outweigh thechange in price, as shown by the total expenditure tobuy the item (or, equivalently, the total revenue re-ceived from the sale of the item) increasing when theprice decreases and decreasing when the price in-creases.

106. In order for the demand to be inelastic, thechange in price must outweigh the change in quantitydemanded, as shown by the total expenditure to buythe item (or, equivalently, the total revenue receivedfrom the sale of the item) decreasing when the pricedecreases and increasing when the price increases.

107. The type of demand that is on the bor-derline, between elasticity and inelasticity is the unitelastic demand, whose essential characteristic is theconstancy of total expenditure/total revenue, which re-sults from the changes in quantity demanded being inprecise inverse proportion to changes in price.


108. With a unit elastic demand, when pricedoubles, quantity demanded halves. When pricehalves, quantity demanded doubles.

109. Calculate the effect on quantity de-manded when price increases by ten percent.

110. Calculate the effect on quantity de-manded when price declines by twenty-five percent.

111. Calculate the effect on quantity de-manded when price declines by ninety percent.

112. A mathematical definition of elasticityis the percentage change in quantity demanded dividedby the percentage change in price.

113. Cases of close substitutes and luxurygoods represent examples of demands that are likely tobe elastic.


114. A fall in the price of a good that is agood substitute for other goods is likely to increase theamount of money spent to buy it, because buyers willshift funds to its purchase from the purchase of substi-tutes whose price has not fallen.

115. A fall in the price of a luxury good thatis widely desired will result in an increase in theamount of money spent to buy that good, to the extentthat the lower price makes it affordable by greaternumbers of individuals and thus opens up a mass mar-ket.

116. Cases of poor substitutes and necessitiesrepresent examples of demands that are likely to be in-elastic.

117. Economy-wide, aggregate demand isthe leading example of a unit elastic demand, becausetotal expenditure for goods and services is determinedby the quantity of money in the economic system andthus can be taken as given in the face of supply andprice changes.

118. In the case of the demand for an individ-ual good, total expenditure cannot be taken as givenbecause changes in the supply and price of any givengood affect its compeititive position vis-a-vis othergoods and thus the amount of money spent to buy it.Hence, the concept of unit elasticity has little or no ac-tual application at the level of the individual good.

119. The concept of elasticity of demandhelps to explain how labor-saving machinery some-times results in the employment of fewer workers inan industry and other times in the employment of moreworkers in an industry.

120. Labor saving improvements in agricul-ture should be expected to result in

a. moreb. less

employment in agriculture.

121. Labor saving improvements in au-tomobilies and personal computers s for the most parthave resulted in

a. moreb. less

employment in those industries.

122. Labor saving improvements in indus-tries with an inelastic demand result in

a. unemployment both in such industries and inthe economic system as a wholeb. make labor available to produce more of thegoods and services people are now enabled to buywith the money they save as the result of the fallin prices in the industries with inelastic demands

123. Labor-saving improvements in agricul-ture have been a major source of the rising demand forgoods and services throughout the rest of the economicsystem.

124. Suppose that successive price reduc-tions reduce total revenue. The supplier faces a de-mand curve that is, in this region:

a. price elasticb. unitary elasticc. infinitely price elasticd. of indeterminate elasticitye. price inelastic

125. If demand is price elastic within the rele-vant price range, then total revenue:

a. will rise with a fall in priceb. will fall with a fall in pricec. will remain constant with a fall in priced. may either rise or fall with a fall in pricee. will rise if price is greater than $1, but fall ifprice is less than $1

126. If demand is relatively price inelastic: a. a 1 percent increase in price evokes a less than1 percent decrease in quantity demandedb. a 1 percent increase in price evokes a largerthan 1 percent decrease in quantity demanded c. a 1 percent decrease in price evokes a largerthan 1 percent increase in quantity demanded d. a 1 percent decrease or increase in price in-duces no change in total revenuee. none of the above

127. In cases in which a seller need notworry about competition, say, because he has a patentor copyright, or trade secret, the concept of elasticityof demand can help to explain the effect on his profitsof charging a higher or lower price.

128. Elasticity remains constant over the en-tire length of the same demand curve.

129. Supply curves typically slope upwardand to the right.

130. In a modern division-of-labor economy,a major reason for the upward slope of supply curvesis the increasing marginal utility of the diminishingsupplies that remain to sellers as they increase theirsales volume.

131. The law of diminishing returns is usu-ally not relevant to upward sloping supply curves inthe short run.

132. The basic case with respect to supply isthat of a given stock available for sale, which is repre-sented by a vertical line reflecting a given quantity thatsellers are prepared to sell at the best price they can ob-tain. In this case, upward sloping supply curves arenevertheless present in partial markets, where they re-flect the competition of the buyers in other partial mar-kets for the limited supplies.

133. At any given time, the overall supply ofwheat, crude oil, gasoline, skilled or unskilled labor,and many other things is simply a given fact and canbe depicted by a vertical supply curve. Nevertheless,


any given partial market for such an item can be morefully supplied by drawing supplies away from othersuch partial markets. To do so, however, it is neces-sary to “ride up” the demand curves in those markets,and this is what creates the upward slope of the supplycurve in the given partial market.

134. In cases such as manufacturing and re-tailing, in which the quantity supplied is not a givenfact but actually depends, within broad limits, on thequantity demanded, the seeming determination ofprice by supply and demand curves actually representsdetermination of price on the basis of cost of produc-tion. But the prices that constitute the costs are directlyor indirectly determined by supply and demand.

135. Supply and demand curves are intellec-tual constructs based on logical deduction from truepremises under the assumption of all other thingsbeing equal. In the real world, however, the “otherthings” do not remain equal, and supply and demandcurves are therefore constantly changing and thus donot present themselves in a way that would enable usto observe the various individual points that make upsuch a curve. What we actually observe are continu-ally changing intersection points of continually chang-ing demand and supply curves, not points on any givendemand or supply curve.

136. It is incorrect to try to derive supply anddemand curves by observing changes in price andquantities demanded and supplied over time.

137. Cases in which both prices and quanti-ties demanded rise over time

a. contradict the law of demandb. reflect increases in demand and are consistentwith quantities demanded having risen still moreif prices had not risen or had risen less

The precise formula for calculating elasticity of de-mand is:

ED =

(Q2 − Q1)(Q1 +Q2)

2

all divided by

(P2 −P1)(P1 + P2)

2

Use this formula to answer the following twoquestions:

138. If at a price of $10, quantity bought willbe 5400 per day, and at $15, quantity bought will be4600 per day, then the price elasticity of demand is ap-proximately:

a. 0.2b. 0.4c. 0.6d. 2.5e. 6.0

139. If at a price of $8, the quantity of movietickets bought will be 3300 per day, and at $12, theticket quantity bought will be 2700 per day, then theprice elasticity of demand for movie tickets is approxi-mately:

a. 0.4 b. 0.5 c. 0.7 d. 2.0 e. 2.5



Correct Correct Correct CorrectQuestion # Answer Question # Answer Question # Answer Question # Answer

1 T 36 f 71 T 106 T2 T 37 f 72 d 107 T3 T 38 T 73 b 108 T4 T 39 d 74 T 109 10/115 T 40 T 75 T 110 4/36 T 41 c 76 T 111 107 T 42 c 77 T 112 T8 T 43 T 78 T 113 T9 T 44 c 79 .1 cent 114 T

10 T 45 e 80 50 cents 115 T11 T 46 T 81 40 cents 116 T12 T 47 T 82 b 117 T13 b 48 T 83 52.5 cents 118 T14 T 49 T 84 a 119 T15 c 50 T 85 F 120 b16 c 51 T 86 T 121 a17 T 52 T 87 T 122 b18 T 53 T 88 F 123 T19 T 54 T 89 F 124 e20 T 55 T 90 F 125 a21 b 56 T 91 T 126 a22 T 57 T 92 T 127 T23 d 58 T 93 d 128 F24 d 59 T 94 T 129 T25 T 60 T 95 T 130 F26 T 61 e 96 T 131 T27 T 62 f 97 b 132 T28 T 63 d 98 b 133 T29 T 64 c 99 F 134 T30 T 65 T 100 g 135 T31 T 66 T 101 T 136 T32 T 67 c 102 T 137 b33 b 68 c 103 F 138 b34 T 69 T 104 T 139 b35 d 70 F 105 T

CHAPTER 6. DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM II:THE PRICE SYSTEM AND ECONOMIC COORDINATION

PART A. UNIFORMITY PRINCIPLES

1. The uniformity-of-profit principle statesthat there is a tendency toward an equalization ofprofit margins throughout the economic system.

2. The uniformity-of-profit principle statesthat there is a tendency toward the equalization of therate of profit (rate of return) on capital investedthroughout the economic system.

3. The achievement, throughout the eco-nomic system, of a uniform rate of profit on capital in-vested is consistent with the existence of permanentlyunequal profit margins counterbalanced by perma-nently unequal capital turnover ratios.

4. Assume that supermarkets have profit mar-gins of 2 percent, automobile companies 10 percent,and electric utilities 20 percent. If the ratio of sales rev-enues to capital invested (i.e., capital turnover ratio) is5:1 for supermarkets, 1:1 for auto companies, and 1:2for electic utilities, calculate the respective rates ofprofit on capital invested for

a. supermarketsb. automobile companiesc. electric utilities

5. The existence of unequal rates of profit inthe various branches of production

a. creates incentives for the investment of addi-tional capital in the industries earning above-aver-age rates of profit and for the withdrawal ofcapital from industries earning below-averagerates of profitb. the effect of the investment of additional capi-tal in the industries earning above-average rates ofprofit is to increase the supply of products theyproduce and thus to reduce the selling prices,profit margins and rates of profit of those indus-triesc. the effect of the withdrawal of capital from theindustries earning below-average rates of profit isto reduce the supply of products they produce andthus to raise the selling prices, profit margins, andrates of profit of those industriesd. all of the above

6. An above-average rate of profit providesnot only the incentive for the investment of additionalcapital in the industries concerned but also the meansfor increased capital investment insofar as the above-average profits are themselves saved and reinvested.

7. Losses provide not only the incentive forthe withdrawal of capital from the industries con-cerned but also themselves directly reduce the capitalinvested in the industries that suffer them.

8. Low positive rates of profit that are insuffi-cient to cover dividends being paid also directly resultin the reduction of the capital invested in an industry.

9. The uniformity-of-profit principle servesto make mistakes of relative overinvestment and over-production and relative underinvestment and underpro-duction self-correcting.

10. The uniformity-of-profit principle coun-teracts the mistakes of relative overinvestment andoverproduction and relative underinvestment and un-derproduction, and thus promotes coordination in therelative size of the various branches of production be-cause

a. mistakes of the first kind result in low profitsor losses, which serve to halt and reverse the rela-tive overinvestment and overproductionb. mistakes of the second kind result in high prof-its, which provide the incentive and means forstepped up investment and productionc. both (a) and (b)

11. The uniformity-of-profit principle delim-its the size of the mistakes of relative overinvestmentand overproduction and relative underinvestment andunderproduction, by making the counteracting forcesof correction through respectively falling and risingrates of profit more powerful as the size of the mis-takes increases, with the result that “the bigger the mis-take, the harder it is to make it.”

12. The uniformity-of-profit principle servesto largely prevent the mistakes of relative overinvest-ment and overproduction and relative underinvestmentand underproduction from being made in the first place

a. because the desire of investors to make profitsand avoid losses and to make higher profits inpreference to lower profits makes them strive toavoid investments representing overinvestmentand overproduction and to seize the profit opportu-nities created by others’ insufficient investmentb. at any given time, most of the capital of theeconomic system tends to be in the hands of in-vestors with prior investment success, in that largecapitals will tend to be in the hands of those whohave succeeded in making high profits, whichthey have largely saved and reinvested, and theearning of which signifies investing in lines whereinvestment was greatly needed, while those whoinvested where investment was not needed haveincurred losses and thus now command corre-spondingly less capitalc. both (a) and (b)

13. The uniformity-of-profit principle givesconsumers the power to change the pattern of produc-tion, i.e., to cause industries to expand or contract,




merely by changing their pattern of buying and absten-tion from buying.

14. Products continue to be produced becausea. businessmen go on producing themb. consumers value the products and are preparedto pay profitable prices for them

15. Insofar as goods are produced in a freemarket to which various people object—such as alleg-edly nonnutritious breakfast cereals, automobiles with-out seatbelts or airbags, trashy or pornographicliterature, alcoholic beverages, cigarettes, and so on—the logical targets of the complaints are the consumers,even though the actual targets are almost always themanufacturers.

16. The uniformity-of-profit principle oper-ates to bring about a progressive increase in produc-tion because in order to earn an above-average rate ofprofit in the face of its operation, it is necessary to in-troduce repeated improvements in products and meth-ods of production.

17. Improvements in products and methodsof production are the source of high profits only untilcompetitors can copy them to the point of makingthem the general standard of the industry, at whichpoint the continued earning of high profits requires theintroduction of further improvements.

18. No matter what its record of past successin innovation, a company is doomed if competitors notonly catch up to it but now more and more pull aheadof it.

19. In the face of innovative competitors,adopting improvements is necessary not only to earnpremium profits but also to staying in business at all,in that while premium profits go to the innovators, noprofit whatever goes to those who lag too far behindthe innovators.

20. The uniformity-of-profit principle impliesa. increasing production and falling pricesb. where virtually costless, irredeemable paper isthe monetary unit, an increase in the quantity andfall in the value of such money more rapid thanthe increase in the production and supply of goodsand thus rising prices expressed in terms of suchmoneyc. both (a) and (b)

21. The empirical fact that the great majorityof prices have risen over the last seventy years is a con-tradiction of the proposition that the uniformity-of-profit principle operates to reduce prices.

The following is a two-part question, based on the as-sumption that a new light bulb sells for $1 and costs90¢ to produce and that a ten-times longer-lasting lightbulb could be produced at the same unit cost.

22. Give an estimate of how much more con-sumers would be willing to pay for the ten times-longer lasting bulb.

23. Give an estmiate of how much more thelight-bulb manufacturer would have to charge to makemore profit on one ten-times longer-lasting bulb thanon ten of the present bulbs, allowing five cents of lostrecovery of depreciation on each of the present bulbs.

24. Claims that businesses engage in“planned obsolescence”

a. imply that, contrary to the uniformity-of-profitprinciple, the profit motive operates to makeprices higher rather than lowerb. ignore the fact that to compensate for any lostunit volume due to greater durability of their prod-ucts, business firms need to raise their prices byfar less than the premium consumers are tyicallywilling to pay for the greater durabilityc. both (a) and (b)

25. Cutting costs of productiona. by means of the use of labor-saving ma-chinery, or the use of less expensive materials orcomponents that are less expensive because lesslabor is employed in their production, has the ef-fect of making labor available for the productioneither of more of the product whose costs of pro-duction are cut or more of other products in theeconomic systemb. by means of the use of less expensive laborwhich is less skilled, or of materials that are lessexpensive because of their comparative abun-dance and/or lack of valuable alternative uses, isequivalent to increasing the supply of more valu-able labor and materials and their products at theexpense of reducing the supply of less valuablelabor and materials and their productsc. both (a) and (b)

26. Cost cuts a. are sought by businessmen in order to improvetheir profitsb. serve to expand production in the economicsystemc. both (a) and (b)

27. Premium rates of profit can be earned bybetter anticipating changes in consumer demand thanothers, because doing so enables one to be early on thescene in cases in which increases in consumer demandserve to create a premium profit.

28. Economic progress results in such large-scale changes in the pattern of consumer demand as ac-companied cost-cutting improvements in agriculture,which served to make food and fiber less expensiveand thus to enable people to afford more of numerousother things.

29. Successfully anticipating changes in con-sumer demand operates to increase the gains from eco-nomic progress because it represents the movement of


capital and labor into the production of the things con-sumers wish to obtain as the fruits of the progress. Forexample, improvements in the efficiency of producingfoodstuffs would have been of far less value if the capi-tal and labor saved had been applied to the productionsimply of more foodstuffs rather than make possiblethe expansion of production outside of agriculture.

30. A minimum price control is a price con-trol that imposes

a. an artifically low priceb. an artifically high pricec. an artifically high price below which one isprohibited from selling

31. A maximum price control is a price con-trol that

a. imposes an artifically high priceb. an artifically low pricec. an artifically low price above which one is pro-hibited from selling

32. A synonym for maximum prices is ceil-ing prices.

33. A synonym for mimimum prices is floorprices.

34. Farm subsidies, minimum wage laws,and labor-union wage scales imposed by governmentpolicy are all examples of minimum prices.

35. Rent controls and the price controls im-posed on oil and other products in the 1970s are exam-ples of maximum price controls.

36. If the government abolished its farm sub-sidy program and refunded its cost to the taxpayers,who pay for it, the effects would be

a. a plunge in the sales revenues and profits of ag-ricultureb. a rise in the sales revenues and profits of theadditional things purchased by the tax payersc. a shift of capital and labor out of agricultureand into the things in additional demand by thetaxpayersd. a restoration of the rate of profit in the smaller-sized agriculture that would remaine. the elimination of premium profits on thethings bought by the taxpayers with their tax sav-ings as the production of those things expandedf. all of the above

37. The permanent effect of the abolition offarm subsidies and the equivalent reduction of taxeswould be the elimination of farm production that themarket does not want sufficiently to be willing to payprofitable prices for it and the expansion of the produc-tion of other goods that the market does want suffi-ciently to be willing to pay profitable prices for them.

38. If long-standing rent controls were re-pealed,

a. the immediate effect would be a sharp rise inrents and the profitability of rental housing

b. the longer-run effect would be an increase inthe supply of rental housing and a reduction inrents toward the costs of providing such housingplus only as much profit as required to provide thegoing, competitive rate of profitc. the still longer-run effect would be a progres-sive fall in the real cost of rental housing and im-provement in its quality as landlords once againcame under the necessity of earning premium prof-its through making such improvements and com-petition progressively passed them on to tenantsd. all of the above

39. The effect to be expected from repealinga maximum price control is a temporary surge in pricefollowed by an increase in supply and decline in price,to the point where the industry no longer earns an ex-ceptional rate of profit but is merely larger.

40. Experience following repeal of price con-trols on oil and oil products in the United States in1980 contradicts the expectation expressed in the pre-ceding question.

41. Since equity capital provides a buffer ofsecurity for the capital of lenders and thus reduces therisks of the lenders compared with those of the borrow-ers, the rate of profit on equity capital is generallylikely to exceed the rate of interest paid on borrowedcapital.

42. People are able to borrow money to theextent that they already have money because thewealth they have serves as a protective buffer for credi-tors. The greater their wealth, the greater the borrow-ings on which they can provide such a protectivebuffer.

43. The geographical uniformity-of-priceprinciple states that there is a tendency toward the es-tablishment of a uniform price for the same goodthroughout the world, plus or minus transportationcharges.

44. The basis of the geographical uniformity-of-price principle is that the existence of an unequalprice for the same good in two markets

a. creates the opportunity for profit by buying inthe cheaper market and selling in the dearer mar-ketb. the effect of such buying is to raise the price inthe initially cheaper market while the effect ofsuch selling is to lower the price in the initiallydearer marketc. the above process goes on until the price dis-crepancy is no greater than transportation costd. all of the above

45. When the price of the same good in twomarkets differs by less than transportation cost, it doesnot pay to buy in the cheaper market in order to sell inthe dearer market.


46. The ability of a government to create andmaintain an inequality of price greater than transporta-tion cost, as, for example, that created by a tariff, con-firms the geographical uniformity-of-price principlerather than contradicts it, because the discrepancy canbe maintained only if measures are taken of sufficientstrength to offset the operation of the principle, such assevere penalties against smuggling combined with agreat liklihood of being caught if one becomes a smug-gler. If not for such penalties and the liklihood of suf-fering them, the tariff could not be effective.

47. The operation of the geographical unifor-mity-of-price principle serves to spread the effect oflocal failures of supply over a wider area, thereby re-ducing the severity of the local reduction in supply andcorrespondingly limiting the resulting rise in price.

48. In a free market, the effect of the Arab oilembargo of 1973 would have been

a. a surge in the price of oil and oil products inthe Northeastern United States, which was the re-gion where the reduction in supplies mainly tookplaceb. the movement of replacement supplies to theNortheast from elsewhere in the United States assoon as the price of oil and oil products in theNortheast exceeded the price in the rest of thecountry by more than costs of transportionc. the movement of replacement supplies to theUnited States as a whole from non-Arab foreignsuppliers as soon as the price of oil and oil prod-ucts in the United States came to exceed the pricein those areas by more than the costs of transpor-tiond. the resumption, despite the embargo, of the in-direct import of Arab oil via third-parties, such asEuropean refiners using Arab oile. all of the above

49. In 1973 price controls on oil and oil prod-ucts in the United States served to make illegal the ac-tion people would otherwise have been able to take tomitigate the effects of the Arab embargo.

50. In a free market, the effect of a foreignembargo against a country on the part of suppliers notcontrolling substantially all foreign supplies will be toreduce the supply of the embargoed good in that coun-try

a. by the amount no longer supplied by those con-ducting the embargob. by nothing at all if those conducting the em-bargo go on selling the same overall amount butmerely to different buyers c. by an amount commensurate only with what-ever reduction the embargoing suppliers are ableto achieve in the global supply of the goodd. (b) and (c) but not (a)e. all of the above

51. The belief that if a country has lower tar-iffs than its trading partners it is at a disadvantage, isequivalent to the belief that if the winds and the oceancurrents run toward it and cause its inbound transporta-tion costs to be less than its outbound transportationcosts, it is at a disadvantage.

52. The temporal uniformity-of-price princi-ple

a. is that in a free market, the expected price of astorable good in the future tends to exceed itsprice in the present by no more than the costs ofstorage for the period in question together with anallowance for the competitive rate of profit for theperiod in questionb. exists because buying now for future salewhen the present price is less than the expected fu-ture price by more than the factors indicated in an-swer (a) serves to raise the present price and thecorresponding availability of more supply for thefuture serves to reduce the expected future price,thereby narrowing the difference in pricec. by coordinating anticipated future demand andsupply with present demand and supply, operatesto balance the consumption of commodities overtime and to minimize the effects of scarcitiesd. all of the above

53. In serving to raise current or spot pricesin anticipation of higher prices in the future, commod-ity speculators bring about a curtailment of presentconsumption and an enlargement of supplies availablefor the future when they are more needed.

54. By encouraging an undiminished rate ofconsumption, a price control can turn a scarcity of astorable good into a famine.

55. Speculators as a class cannot profit fromprice increases caused by their own activity because ifnothing else but their buying were present to raiseprice, they would eventually have to sell back at lowerprices than they bought.

56. The uniformity-of-wages principlea. is that there is a tendency toward a uniformityof wage rates for workers of the same degree ofskill and abilityb. exists because of the preference of workers forhigher wages rather than lower wagesc. exists because the movement of workers fromthe lower-paying fields into the higher payingfields reduces the supply of labor and raises itswages in the initially lower-paying fields and in-creases the supply of labor and reduces its wagerates in the initially higher-paying fieldsd. all of the above

57. The operation of the principle that thereis a tendency toward a uniformity of wage rates is un-realistic because it requires that forty-year olds be will-ing to change careers for ten or twenty percent paydifferences.


58. The uniformity-of-wages principle givesthe consumers the power to determine the relative sizeof the various occupations simply by changing theirpattern of buying and abstention from buying.

59. Positives or negatives, such as safety ordanger, pleasantness or unpleasantness, and low orhigh costs of training, associated with the differenttypes of jobs serve to create permanent inequalities inwage rates at any given level of skill and ability, withthe wages where the positives prevail being corre-spondingly higher and the wages where the negativesprevail being correspondingly lower.

60. Permanent inequalities of wage ratesexist between unskilled, skilled, and professional-levelworkers, because of the inability of those in the lowercategories to cross over into the higher categories andthereby change the relative supplies of the differenttypes of labor.

61. The inability of the less capable to crossover into the ranks of the more capable helps to ex-plain the extraordinarily high incomes of star perform-ers.

62. The effect of a rise in the demand for theproducts and services of skilled labor relative to thoseof unskilled labor reduces the disparity in the wages ofthe two groups.

63. Where changes in the pattern of theconsumers’ buying and abstention from buying are un-able to effect a change in the relative size of the vari-ous occupations, because of the inability of the wageearners to move from occupations in lesser demandinto those in greater demand, the effect is to changethe relative wage rates of the occupations.

64. Relative consumer demand in the face offixed supplies is what explains

a. the incomes of star performers relative to thoseof everyone elseb. inequalities in the wages of unskilled, skilled,and professional-level workersc. both (a) and (b)

65. The profit motive is consistent with pay-ing blacks and women less than whites and men fordoing the same work, because more profit is earned bypaying lower wages.

66. The fact that, other things being equal,more profit is earned by paying lower wages than

higher wages leads to an increase in the demand forthe workers earning the lower wages and a decrease inthe demand for workers earning the higher wages,which serves to raise the wages of the former andlower the wages of the latter, until they are equal orthe difference is imperceptible.

67. The profit motive is consistent withcharging blacks higher rents for the same housing andhigher prices for the same goods, because, other thingsbeing equal, higher rents and higher prices meanhigher profits.

68. Cost of production influences the pricesof products

a. indirectly by causing production to be in-creased and prices to fall where price exceeds costby more than enough to provide the going, com-petitive rate of profit, and by causing productionto decrease and prices to rise where price does notexceed cost by enough to provide the going, com-petitive rate of profitb. directly, in that large low-cost producers withcapacity to spare are in a position to set pricesclose to the costs of their less efficient rivals, whoare thereby normally prevented from earning highprofits and expanding, while they themselves canearn substantial profits on the basis of their lowercosts of productionc. both (a) and (b)

69. Cost of production at any given stage ofproduction

a. always reduces to a sum of prices times respec-tive physical quantities of the various means ofproductionb. consists in part of prices determined by furthercosts of production and of wage rates and otherprices determined by demand and supplyc. is more and more resolvable into wage ratesand other prices determined by demand and sup-ply as one goes further back in the chain of supplyd. all of the above

70. Cost of productiona. provides the ultimate explanation of pricesb. cannot be an ultimate explanation of prices,but leads back to supply and demand as the ulti-mate explanation of prices

PART B. ALLOCATION PRINCIPLES

71. This is a multipart question. Match thefollowing items with a “C” if their prices are normallydetermined directly on the basis of cost of productionand with a “D” if their prices are directly determindedby demand and supply.

a. agricultural commodities between harvestsb. skilled and unskilled labor

c. goods at retaild. second-hand goodse. manufactured or processed goodsf. paintings by old mastersg. scrap iron


72. The quantity of money determines the ab-solute height of goods and services in limited supplyand consumer preferences determine their relativeheight.

73. In a free market, the prices ofconsumers’ goods in limited supply are set highenough to limit quantity demanded to the supply avail-able and thereby prevent shortages of such consumers’goods.

74. The setting of prices in the manner de-scribed in the previous question

a. serves the interests of the sellers and the richbut harms the interests of the buyers and the poorb. serves the self-interests of buyers as well assellers, and of poor buyers as well as rich onesc. makes the distribution of goods and services inlimited supply take place in accordance with acombination of relative wealth and income and rel-ative need and desired. all of the abovee. (b) and (c)

75. In a free market, the prices of factors ofproduction in limited supply

a. are high enough to limit the quantity of suchfactors demanded to the supply of them availableb. carry through as costs of production to theproducts of such factors and serve to keep thequantities of them demanded within the limit ofthe supply of the factors of production availablec. are in the self-interest of buyers, including em-ployers, no less than sellersd. serve to bring about a distribution of the bene-fit of the factors in accordance with a combinationof the relative wealth and income and relativeneed and desire of the ultimate consumerse. serve to accomplish the added dimension ofdistribution of factors of production among thecompeting uses of them in the production of vari-ous products, e.g., the distribution of crude oil asbetween the production of gasoline and the pro-duction of heating oilf. all of the above

76. In a free market, the distribution of thefactors of production among their various uses takesplace in accordance with a process of bidding amongthe different needs, desires, and purposes of one andthe same set of consumers.

77. In a free market, the factors of productionare allocated to their most important uses, in accor-

dance with the bidding of the consumers for their prod-ucts.

78. The concept “most important uses” of afactor of production is

a. a given factb. a variable range determined by the supply ofthe factor available

79. A free market operates to maximizegains and minimize losses in connection with in-creases or decreases in the supply of a factor of produc-tion by means of

a. withdrawing a factor of production in dimin-ished supply or in additional demand from theleast important of its previous uses, i.e., its pre-viously marginal usesb. allocating the newly available supply of a fac-tor of production that result either from a decreasein demand for it or from an increase in its overallsupply to the most important of its previously sub-marginal usesc. both (a) and (b)

80. By prohibiting the rise in oil prices, pricecontrols during the Arab oil embargo led to submar-ginal uses of oil being able to go on obtaining suppliesat the expense of far more important uses of oil.

81. Free market prices, which are highenough to end shortages, prevent hoarding.

82. Cost of production signifies a combina-tion of the quantities and value of the factors of pro-duction that are made unavailable for alternative uses.The lower the cost of producing any given item, thelarger the quantities and the more valuable the factorsof production left available for use elsewhere in theeconomic system.

83. Cost calculations operate to lead eachproduct to be produced by methods that least impairproduction in the rest of the economic system.

84. In a free market, a reduction in the sup-ply of a factor of production causes a rise in its priceand efforts on the part of those faced with the higherprice to find substitutes and to respond by reducingtheir consumption of the more expensive item(s) inways that are least costly to themselves.

85. Price controls during the Arab oil em-bargo prevented the economic system from adopting arationally planned response to the reduction in oil sup-plies.



Correct Correct CorrectQuestion # Answer Question # Answer Question # Answer

1 F 31 c 61 T2 T 32 T 62 F3 T 33 T 63 T4 a) 10%, b) 10%, 34 T 64 c

c) 10%5 d 35 T 65 F6 T 36 f 66 T7 T 37 T 67 F8 T 38 d 68 c9 T 39 T 69 d10 c 40 F 70 b11 T 41 T 71 a) D, b) D, 12 c 42 T c) C, d) D13 T 43 T e) C, f) D14 b 44 d g)D15 T 45 T 72 T16 T 46 T 73 T17 T 47 T 74 e18 T 48 e 75 f19 T 49 T 76 T20 c 50 d 77 T21 F 51 T 78 b22 up to $10 52 d 79 c23 $2.50 53 T 80 T24 c 54 T 81 T25 c 55 T 82 T26 c 56 d 83 T27 T 57 F 84 T28 T 58 T 85 T29 T 59 F30 c 60 T


CHAPTER 7. DEPENDENCE OF THE DIVISION OF LABOR ON CAPITALISM III: 49 PRICE CONTROLS AND ECONOMIC CHAOS

PART A. PRICE CONTROLS AND SHORTAGES

1. The definition of inflation as being risingprices implies that

a. inflation comes into being only as and whenprices rise and would not exist if prices did not riseb. businessmen are responsible for inflation,since prices would not rise if they did not raisethemc. price controls are capable of eliminating infla-tiond. all of the above

2. In place of rising prices inflation has alsobeen defined as an

a. undue increase in the quantity of moneyb. increase in the quantity of money at a rate inexcess of the rate of increase in the supply of goldand silverc. increase in the quantity of money caused spe-cifically by the governmentd. all of the above

3. Defining inflation as an increase in thequantity of money at a rate in excess of the rate of in-crease in the supply of gold and silver is tantamount todefining it as an increase in the quantity of moneycaused specifically by the government, inasmuch as, inthe absence of government interference, the quantityof money could not for very long increase at a fasterrate than the increase in the supply of precious metals.

4. Rising prices are a. inflationb. a leading symptom of inflation, not the phe-nomenon itself, which can exist, and, indeed, ac-celerate, even though this particular symptom isprevented from appearingc. both (a) and (b)

5. The general consumer price level, i.e., theweighted average of the actual prices at which goodsand services are sold, is, literally, nothing more thanthe total spending to buy them divided by the totalquantity of them sold. It is thus an arithmetical quo-tient, with demand (spending) as the numerator andsupply (quantity of goods sold) as the denominator.

6. Rising aggregate demand or falling aggre-gate supply are the only two possible direct causes of ahigher price level. Any other, indirect cause must oper-ate through one or both of these two direct causes.

7. In explaining the chronically rising pricesof the last 70 years,

a. falling supply must be ruled out, because inpractically every year supply in the economic sys-tem has increased rather than decreased

b. the contribution of supply to the general con-sumer price level has not only not been to makeprices higher, but to make them lower than theyotherwise would have been c. the explanation of rising prices is a rise in ag-gregate demand great enough to overcome theprice reducing effects of growing supplyd. all of the above

8. The rise in aggregate demand is whata. bids up the prices of all goods and services inlimited supplyb. enables price increases initiated by sellers,whether businessmen or labor unions, to takeplace as a repeated phenomenonc. both (a) and (b)

9. In the absence of the rise in aggregate de-mand, price increases initiated by sellers would reducethe amount of goods and services that could be sold.This loss of sales volume, and the mounting unemploy-ment that goes with it, would soon put an end to suchprice increases.

10. An increasing quantity of money raisesaggregate demand and thus prices by virtue of beingspent and respent so long as it continues in existenceand thereby raises the level of aggregate spending.

11. The author holds that the quantity theoryof money—viz., the increase in the quantity ofmoney—is

a. the only valid explanation of the phenomenonof generally rising pricesb. one among several equally valid explanationsof generally rising prices

12. Once the truth of the quantity theory ofmoney is recognized, the government’s responsibilityfor rising prices follows immediately, because underthe conditions of the last seventy years, the govern-ment has had virtually total control over the quantityof money and has deliberately brought about its rapidincrease.

13. Since 1933, the quantity of money in theUnited States has increased from approximately $19billion to more than $2.5 trillion, an increase well inexcess of a hundredfold.

14. The imposition of price controls to com-bat inflation is analogous to an attempt to deal with ex-panding pressure in a boiler by means of manipulatingthe needle in the boiler’s pressure gauge, or to reducea patient’s fever by means of manipulating his ther-mometer reading.



15. Price controlsa. stop inflationb. combine with inflation to produce a differentand worse set of consequences than inflationalone would produce, namely, shortages and theconsequences of shortages

16. A shortage is an excess of the quantity ofa good buyers are seeking to buy over the quantity sell-ers are willing and able to sell. An example of a short-age is the case of eager buyers of gasoline who areunable to find gasoline.

17. The concept of a shortage a. is the same as b. differs from

that of scarcity.

18. In a free market scarcities do not result inshortages but in prices sufficiently high to reduce thequantity demanded to within the limit of the supplyavailable.

19. Gold and diamonds are widely desiredand are extremely scarce. As a result,

a. their prices are extremely high—high enoughto limit the quantity of them demanded to the sup-ply of them that is availableb. they are in a state of shortage, with suppliesbeing unavailable to buyers willing and able topay the market pricec. both (a) and (b)

20. Scarcities can result in shortages onlywhen they are accompanied by price controls, becausein the absence of price controls the effect of scarcity issimply to drive the price to whatever point is requiredto limit the quantity demanded to the supply available.

21. Price controls can create shortages evenwhen supplies of goods are at record-high levels, bybringing about an increase in the quantity of the gooddemanded to a point that exceeds the record-high-levelof the supply available. For example, a record-high-level of wheat production could be accompanied by asevere shortage of wheat if the government imposed aprice control low enough to make it profitable to usegreatly increased amounts of wheat as animal feed.

22. The oil shortage of the 1970s in theUnited States existed despite the fact that the supply ofoil in the United States was still large enough to makepossible per capita oil consumption far greater thanthat of practically any other country and far greaterthan that of the United States itself not many years ear-lier.

23. The combination of inflation plus pricecontrols easily results in large and growing shortagesof practically everything, because the increase in thequantity of money, and thus the increase in the willing-ness and ability to spend money, that inflation repre-sents, serves to increase the demand for virtuallyeverything. As soon it succeeds in increasing the quan-

tities demanded beyond the supplies available, short-ages come into existence.

24. Inflationa. in the absence of price controls results inhigher pricesb. in combination with price controls results inshortagesc. is wiped out of existence by price controlsd. all of the abovee. (a) and (b) but not (c)

25. Shortages cause scarcities by allowingsupplies to be diverted to less important uses at the ex-pense of more important uses, with the effect of under-cutting production. For example, diverting part of thesupply of oil required to keep oil wells in operation tosuch uses as providing the gasoline for shopping tripsthat would be avoided at a higher price of gasoline.Such outcomes occur because the price controls pro-hibit the more important uses from outbidding the lessimportant uses for the supply of the item.

26. In a free market, so far from there beingshortages, the typical case is that a seller is in a posi-tion to supply more than his present number of custom-ers, even when the overall supply of the item is strictlylimited for the time being.

27. The situation described in the precedingquestion results from the price being high enough tohold the quantity demanded to a point somewhatbelow that of the full supply available, thus leaving thesellers with a stock capable of serving additional cus-tomers.

28. When accompanied by inflation, whichdrives up costs, price controls cause industries to be-come progressively less profitable and more and moreunprofitable and thus to produce less and ultimately goout of existence altogether.

29. Rent controls first destroy the housing ofthe poor, because such housing starts out with operat-ing costs closer to rental revenues than is the case withhigher quality housing.

30. Price controls a. in a local market operate to deprive that mar-ket of supply by making it impossible for it tocompete for supplies with other local marketsb. in the natural gas crisis of 1977 served to pro-hibit areas such as New York and New Jerseyfrom obtaining additional supplies by virtue ofpreventing them from matching gas prices inTexas and Louisianac. caused the agricultural export crisis of 1972–73 by prohibiting Americans from bidding up theprice of agricultural commodities and thus re-straining the quantities demanded by foreign buy-ersd. all of the above


31. Price controls foment international hostil-ity and thus serve to promote wars, because

a. they create conditions in which the citizens ofa country (or region) are prohibited from compet-ing for supplies with foreign buyers and thus canbe deprived of urgently needed supplies by the for-eign buyersb. because of (a) can lead to prohibitions on ex-ports, i.e., embargoesc. countries that have price controls and whichare the target of embargoes, such as the US duringthe Arab oil embargo, suffer economic devasta-tion as the result of embargoes, since price con-trols deprive them of the ability to take thenecessary actions to respond to the embargoesd. all of the above

32. Price controls that are expected to remainin force for several more years reduce the supplies ofgoods held in storage.

33. Private hoarding is responsible for the ex-istence of shortages whether price controls exist or not.

34. In cases in which suppliers withhold sup-plies, in anticipation of the relaxation or repeal of aprice control in the near future, the resulting intensifi-cation of the shortage is due to the fact that the exist-ing price control prohibits those seeking to buy in thepresent from freely competing with prospective futurebuyers.

35. In contrast to the case of most goods,price controls on natural resources in the ground arelikely to result in a withholding of supplies.

36. A control on the wage rate of any particu-lar type of labor operates to reduce the supply of thattype of labor to the extent that workers who performthat type of labor have the ability to perform othertypes of labor whose wage rates are rising.

37. A price control on any particular productof a factor of production, such as milk, operates to re-duce the supply of that product even if the price of thefactor of production, in this case raw milk, is also con-trolled. This is because the uncontrolled prices of othermilk products, such as butter, cheese, and ice creammake them relatively more profitable uses for rawmilk and cause milk supplies to be diverted to them atthe expense of milk for drinking.

38. If rent controls are placed on apartments,it should be a source of shock and outrage when land-lords start converting their apartment buildings to co-ops and condominiums.

39. Government bodies that enact rent con-trols have every right to expect that their action willnot cause a decrease in the supply of rental housing.

40. Price controls are tantamount to a prohibi-tion of supply insofar as they amount to saying thatbusinessmen are allowed to produce something, in-deed, that their production of it is earnestly desired,

only that they will not be allowed to profit from pro-ducing it.

41. The likely effect of the combination ofprice controls and inflation on electric utilities andother regulated industries is that

a. these industries will simply continue to prosperand growb. will be unable to keep up with rising demandand potentially could go into decline

42. The general level of knowledge concern-ing the cause of shortages is in accord with the teach-ings of economic science.

43. The statement presented in the previousquestion is confirmed by the New York City law de-claring that rent controls could not be lifted until thevacancy rate in the City had first climbed to a certainsubstantial level.

44. Inflation raises nominal profits while re-ducing real profits.

45. Inflation reduces real profits because it in-creases the replacement prices of assets. In order topay those higher replacement prices, it would be neces-sary to use most of the higher nominal profits thatinflation creates. However, those profits are un-availabe to the extent that they have been taxed away.

46. Inflationa. proves the need for price controls, becausewhile the average wage earner suffers from risingprices, wealthy businessmen earn record profitsb. leads economically ignorant people, who aremisled by false appearances, to urge price controls

47. According to the author, the claim of thecity government of New York that in refusing to keepup their rent-controlled buildings landlords were‘milking’ their properties was an attempt of the guiltyto prosecute the innocent.

48. The expression “destructionist mentality”refers to a mindset that is hostile to business profitsand which is based on a combination of economic ig-norance, envy, and resentment.

49. If the landlords, electric utilities, and theoil companies were richer, the effect on tenants andconsumers of electricity and oil products would be thatthey would be

a. poorerb. have a more abundant and lower-priced supplyof rental housing, electric power and oil productsavailable to them

50. The fact that the greater wealth of produc-ers means a greater supply of products is a point that iswidely understood and accepted.

51. In an inflationary environment, the up-ward repricing of inventories already on the shelves isin the long-run interests of the consumers as well asthe producers in that it is necessary to provide the


funds to make possible the purchase of replacement in-ventories at their higher cost.

52. In the press and media campaign againstthe profits of the oil companies in the early 1970s, theclaim was repeatedly made that the rise in the profitsof the oil companies was the cause of the rise in theprice of oil. Sixty and seventy percent increases in oilcompany profits were repeatedly reported in connec-tion with inceases in the price of oil and oil productsof similar relative magnitude.

53. Essential facts omitted in the above-men-tioned campaign against the profits of the oil compa-nies were

a. the higher profits of the oil companies werenot earned on domestically produced oil or oilproducts but were the result of inventory profitsearned abroad, higher profits on other operations,such as chemical production, and profits earnedon foreign exchange holdingsb. higher profits could not have been earned ondomestically produced oil or oil products becauseof the combination of government controls ontheir selling prices and a dramatic increase in theircosts of production due to the rise in the worldprice of crude oil and thus in the cost of importedcrude oilc. the higher profits of the oil companies couldnot have contributed significantly to the rise in theprice oil and oil products in the United Stateseven if, contrary to fact, they had been earned ondomestically produced petroleum or petroleumproducts, inasmuch as oil industry profits the yearbefore were typically only on the order of 5 or 10percent of sales revenues, and thus a 60 or 70 per-cent increase in profits could at most explain an in-crease in prices of between 3 and 7 percent, not60 or 70 percentd. even with the 60 or 70 percent increase—fromwhatever sources—the profits of the oil compa-nies were only restored to the same level in rela-tion to sales revenues at which they had existed in1968e. the actual rate of return on capital of the oilcompanies, rather than the percentage increase intheir profit margins, was little more than the rateof increase in the consumer price index and some-times less than the rate of increase in the con-sumer price index, with the result that their realrate of profit ranged from modest to negative f. all of the above

54. In the 1970s, the oil companies werewidely blamed for having caused the oil shortage.Given the fact that a shortage results only from a pricebeing held too low, it follows that in order to be re-sponsible for causing the oil shortage, the oil compa-nies would have had to charge too low a price fortheir oil.

55. The accusation that the oil companieswere responsible for the oil shortage by charging toolow a price for oil is logically consistent with the al-most daily repeated accusation that their behavior is“monopolistic” or “oligiopolistic” and strives to keepthe price of oil artificially high.

56. In order to be responsible for a high priceof oil as distinct from a shortage of oil, the Americanoil companies would have had to be responsible for ar-tificially holding down the supply of oil.

57. The American oil companies have beenresponsible for holding down the supply of oil andthus for causing its price to be higher than necessary.This has been demonstrated repeatedly, in their effortsto prevent the environmental movement from expand-ing oil production on the North Slope of Alaska, fromestablishing new offshore wells on the continentalshelf, and from finding and developing new oilfieldsin the areas they (the oil companies) have succeeded insetting aside as wildlife preserves and wilderness areas.

58. In a free market, the oil companies’ profitmotive is tied to achieving as great a supply and aslow a price as possible because

a. the interests of the firms that are predomi-nantly petroleum refiners, and whose capital is in-vested primarily in refineries, pipelines, tankers,delivery trucks, and the like, rather than in depos-its of crude oil in the ground, lie with the greatestpossible supply and lowest possible price of crudeoil, which price is their costb. the interests of the producers of crude oil liewith the greatest possible efficiency of refining op-erations and the lowest possible price of refinedpetroleum products, because the lower the pricesof refined products, the greater the quantity ofthem demanded and therefore the greater the quan-tity demanded of crude oil, which means that theprice of crude oil can benefit by part of any costsavings in refiningc. the mutual tension between the interests of re-finers and producers of crude oil makes it neces-sary for each group to try to improve its ownproduction, because if the existing producers ofcrude oil lag behind, they can expect competitionfrom the refiners, who can develop their own sup-plies of crude oil or expand their existing crude oiloperations; if the existing refiners lag behind, theycan expect competition from the producers ofcrude oil, who, for their part, can undertake refin-ing operations or expand their existing refining op-erations d. both groups can expect competition from totaloutsiders if they fail to exploit any significant op-portunity for improvemente. within each group, whichever individual firmsucceeds in improving production ahead of its ri-vals will almost certainly gain at their expensef. all of the above


59. In contrast to the oil companies, the U.S.government, acting largely under the influence of theecology movement, restricted the supply of oil in thefollowing ways:

a. it prevented exploration for and developmentof oil reserves in vast areas of territory arbitrarilyset aside as “wildlife preserves” or “wildernessareas”b. it prevented the development of offshore wellson the continental shelfc. it prevented the construction of oil and gaspipelines, of new refineries, oil storage facilities,and facilities for handling supertankersd. it imposed price controls on oile. it acted further to restrict oil company profits,and thus oil industry investment, by punitively in-creasing their rate of taxation through first reduc-ing and then totally abolishing the customarydepletion allowance on crude oilf. it deterred investment in the oil industrythrough threats of antitrust actions forcing thebreakup of existing companies, and even throughthreats of nationalizationg. all of the above

60. Over the years, the U.S. government hasbeen responsible for increasing the demand for oil, andthus for raising its price, by means of

a. its policy of inflation of the money supply,which serves to increase the demand for and raisethe price of virtually everythingb. controlling the price of natural gas, thereby un-dermining the growth of that industry and causingthe demand for fuel that normally would havebeen supplied by natural gas to overflow into anexpanded demand for petroleum, which is its clos-est substitute for most purposesc. preventing the construction of atomic powerplants and restricting the mining of coal, whichserve to force the demand for fuel to rely moreheavily than necessary on oil suppliesd. all of the above

61. In restricting the supply of oil and ex-panding the demand for it, the policies of the U.S. gov-ernment have been responsible for the success of theOPEC cartel, because in their absence, in order toachieve the prevailing price of oil, OPEC would havehad to reduce its own production of oil by an amountequal to the reduction in supply and increase in de-mand that the U.S. government has achieved for it, anamount so substantial that the rise in price probablywould not have been worthwhile to OPEC.

62. In a free market, the achievement of ahigher price by a cartel which does not control all theavailable sources of supply, which is and was thesitutation of OPEC, serves to enrich its competitorsmore than itself, since they too receive the higher pricebut without having had to restrict their own produc-tion.

63. To the extent that the competitors of acartel are in a position to expand their production in re-sponse to the higher price it achieves, it must progres-sively further curtail its own production in order tomaintain that higher price.

64. Price controls and restrictions on produc-tion imposed on the American oil industry by the U.S.government served to insulate the OPEC cartel fromcompetition by preventing major competitors fromprofiting from the rise in prices it achieved and expand-ing their production.

65. In the absence of the U.S. government’sdestructionist policies, the Arab cartel would probablynever even have been formed in the first place, be-cause the conditions required for its success wouldhave been lacking.

66. To argue that the oil companies were re-sponsible for the oil shortage of the 1970s is an absurd-ity compounded by a triple injustice in that it

a. implies that the oil companies charged too lowa price for their oilb. evades the fact that it was the government’sprice controls that kept the price too low and socreated the shortagec. ignores the fact that by the nature of the profitmotive the oil companies have always worked toexpand the supply of oil and reduce its priced. evades the fact that the government and theecology movement did practically everything theycould to restrict the supply and expand the de-mand for oile. all of the above

67. Price control means a. the setting of prices, whether by private busi-nessmen, in the interest of private profit, or bygovernment officials, in the public interest; eitherway prices are controlled, just as there is censor-ship whether by the decisions of private publish-ers about what to publish or not to publish or bygovernment officials about what should be pub-lished or not be published b. the setting of prices by the government

68. The claim that in setting their prices pri-vate firms are engaged in a process of price control,with the result that the only choice left is between self-ish, private price controls and benevolent, governmentprice controls ignores the fundamental and radical dis-tinction between private action and government action,which is that private action is voluntary and proceedsby mutual consent to mutual advantage, while govern-ment action is based on the threat of physical force andproceeds against the will and the interests of one ormore of the parties involved.

69. When prices are set by private firms, theyare set with regard to the mutual self-interest of thebuyer and seller, including the need to take into ac-count the threat of competition or potential competi-


tion. Thus, a seller must ask prices that are not onlyhigh enough to enable him to stay in business andmake the best possible profit he can, but, simulta-neously, that are low enough to enable his customersto afford his goods and too low for other sellers or po-tential sellers to try to take away his market.

70. When the government sets prices, itsprices are backed by the threat of physical force, andare necessarily against the mutual self-interests of buy-ers and sellers. The government invariably sacrificeseither the seller to the buyer (by forcibly imposinglower prices), or the buyer to the seller (by forcibly im-posing higher prices). The government’s price, im-posed by force, is the controlled price.

PART B. FURTHER EFFECTS OF PRICE CONTROLS AND SHORTAGES

71. The shortages that result from price con-trols represent a situation in which

a. the excess of quantity demanded over supplyavailable means that there are waiting lines andwaiting lists of customers hoping to be suppliedb. if a dissatisfied customer were to leave anygiven supplier, he would have to go to the end ofthe waiting line or waiting list of some other sup-plier and might not be suppliedc. if a customer does leave a given supplier, thatsupplier suffers no economic loss because the cus-tomer is immediately replaceable by the next cus-tomer on the waiting line or waiting listd. buyers are deprived of economic power overthe sellers e. sellers are placed in a more powerful positionwith respect to ignoring the wishes of the buyersthan if they (the sellers) were protected legal mo-nopolistsf. producers can reduce their costs by reducingthe quality of their products and at the same timenot lose any business and thus have a powerfulmotive to do sog. all of the above

72. Price controls and shortages launch a spi-ral of mutually reinforcing hatred between buyers andsellers

a. in which buyers experience themselves as eco-nomically impotent and the sellers as all powerfultyrants, with their (the buyers) only recoursebeing resort to the power of the stateb. in which sellers experience buyers as pettychislers seeking to live at their (the sellers) ex-pensec. which is confirmed by the relations betweentenants and landlords living under rent controls inplaces like New York City and by relations be-tween motorists and service stations in the oilshortaged. all of the above

73. Shortages lead sellers to regard custom-ers not only as valueless, but as a positive nuisance—as a source of trouble and expense, not a source oflivelihood. This occurs because, in fact, under a sys-tem of shortages and waiting lines, that is just whatcustomers become. Under such a system, when a sellerrenders a customer some service or goes to some ex-

pense on his behalf, he is no longer doing it for thesake of gaining or keeping the customer’s business andthereby earning his own livelihood, because havingthe customer’s business no longer depends on perform-ing the service or incurring the expense. The seller canhave the customer anyway, or, if not that customer,then any one of ten or a hundred or a thousand othercustomers. If the seller is to continue to provide the ser-vice or incur the expense for the sake of the customer,he can only do so out of a sense of altruistic duty, notout of the sense that in serving the customer he serveshimself.

74. Repeal of rent controls would restore har-mony between landlords and tenants because

a. free markets rents would rise to the point of re-ducing the quantity of rental housing demandedsomewhat below the supply available, with the re-sult of establishing a significant vacancy rateb. in the face of vacancies available at rents com-parable to those they were presently paying, ten-ants would feel free to leave if they weredissatisfied with their present landlordsc. the absence of waiting lists would mean thatlandlords who lost tenants would experience an ac-tual economic loss and be motiviated to please ten-ants so as to avoid such lossd. all of the above

75. Price controls and shortages bring aboutthe disappearance of lower-priced models and a de-cline in the quality of higher-priced models as a dis-guised way of raising prices.

The following is a three-part question.

76. Under a severe shortage, quality and ser-vice are cut to the point that buyers are offered modelsthat would never appear in a free market in any pricerange. What happens is that sellers are led to cut cor-ners in order to make relatively small savings to them-selves and which have a great impact on the buyers.For example, situations can exist in which it is advanta-geous to a seller to save a few cents in manufacturingcosts that later imposes many dollars in repair costs onthe buyer. The harm inflicted on the buyers does notcause the sellers any economic loss, because at the con-trolled price there is a surplus of buyers eager to buyeven a very inferior product.


77. In the same way that price controls andshortages make it impossible for a consumer to selecthis model on the basis of cost, they also make it im-possible for a businessman to select his methods ofproduction on the basis of cost. For one or more of thefactors of production he requires may simply be unob-tainable, because a price control has created a shortageof it. Under price controls, businessmen must selectthose methods of production for which the means hap-pen to be available, and not necessarily those whichhave the lowest costs.

78. The inability to find the right factors ofproduction as the result of shortages, frequently resultsin a decline in the quality of products as well, andshould be viewed as a further and major cause of de-clining quality.

79. The deterioration of quality and servicethat results from shortages is itself a powerful sourceof higher costs both to businessmen and consumers. If,for example, a machine is produced or serviced in aninferior way, then even if its price remains the same, itwill cause higher costs of maintenance and repair andmay have to be replaced sooner.

80. Shortages of supplies and the mere threatof shortages themselves directly raise the costs of pro-duction. The effect of a shortage of a factor of produc-tion is to delay production. This causes the capitalinvested in all the other, complementary factors of pro-duction that depend on it, to have to be invested for alonger period of time than would otherwise be neces-sary. For example, a shortage of building-nails causescapital to be invested in half-finished houses and inpiles of lumber for an unnecessary period of time.Since interest must be paid on capital for the full timeit is invested, the effect of all such delays is to raisethe interest cost of production.

81. The mere anticipation of shortages of sup-plies leads businessmen to hoard supplies of all types.This requires that production be carried on with alarger capital investment—in the additional stocks ofsupplies and in facilities for storing them, which, inturn, means extra interest costs and extra costs on ac-count of the storage facilities.

82. Price controls and shortages also raisecosts because of the loss they cause of the valuabletime of executives in searching for sources of supplyand in performing all the paperwork required to com-ply with the government’s price controls and any asso-ciated regulations, such as rationing.

83. Shortages and the threat of shortages alsodirectly raise costs to consumers because

a. they must buy goods that do not last as long orneed more frequent repairs as the result of the de-cline in quality that shortages createb. consumers too suffer effects analogous to wastedinvestment—for example, consumers who could notobtain gasoline could not use their cars or enjoy

their country homes until such time as they couldobtain gasoline, and to that extent, the money theyhad spent for these complementary consumers’goods represented a kind of wasted investmentc. consumers too suffer effects analogous to theneed for more investment—namely, they too areled to hoard supplies and thus to tie up largersums of money in stocks of goods and, quite possi-bly, incur additional costs on account of acquiringextra storage facilities—for example, extra homefreezers, if there should be the threat of a foodshortaged. of the wasted man-hours spent in waiting linesduring every shortage, which, while not a moneycost, are nonetheless a real hardship and burdenand can well be at the expense of actual workingtimee. all of the above

84. Under price controls and shortages, nor-mal cost reductions, based on improvements in effi-ciency, cease to pay, even if they are still within afirm’s power to make, because their effect is merely topostpone the day that the firm is permitted to obtain re-lief by raising its prices on the basis of demonstratinghigher costs. The only cost reductions that pay underprice controls are the ones that can be made effort-lessly, namely, cost reductions at the expense of qual-ity—the kind of cost reductions that would not pay ina free market.

85. The willingness of the government toallow higher controlled prices on the basis of demon-strated higher costs of production leads to

a. multiple controlled prices of the same good incases in which different parts of the supply areproduced at different costs of productionb. a system of transfer payments from sellers ob-taining supplies at a lower controlled price to sell-ers obtaining supplies at a higher controlled pricein conditions in which both sets of sellers are re-quired to make their sales at the same controlledselling pricec. both (a) and (b)

86. Price controls and shortagesa. mean that consumers who get to stores whensupplies of goods arrive can snap them up to thepoint of leaving nothing for latecomersb. prevent consumers with greater wealth or in-come from benefitting from it by being able to out-bid consumers with lesser wealth or incomec. prevent consumers of equal wealth or incomebut with greater need or desire for particulargoods or services from outbidding consumerswith lesser need or desire for those goods or ser-vicesd. introduce chaos into the distribution ofconsumers’ goods to individualse. make government rationing appear necessaryf. all of the above


87. Price controls and shortages create chaosin the geographical distribution of goods among localmarkets by creating a situation in which

a. supplies can be taken away from any givenarea and the area is prohibited by price contolsfrom calling them back by offering higher pricesand greater profitabilityb. supplies can be brought into an area and not re-duce price or profitability but merely the severityof the local shortage until the local shortage is en-tirely overcome, at which point the price mustdrop to find buyers of additional unitsc. the movement of supplies between geographicalareas is made arbitarary and random within the lim-its of what is required to totally overcome a localshortage, because only then will considerations ofprice and profitability again become operatived. all of the above

88. The severity of shortages in particular lo-calities can depend on the time of year in which theprice controls are imposed—for example, price con-trols imposed on gasoline in summer time will favor re-sort areas in the following winter, while price controlsimposed in winter time will strangle resort areas in thefollowing summer.

89. Minor events, like the washout of abridge, or small bureaucratic adjustments in the con-trols can cause sudden, major swings in supply be-tween different geographical markets.

90. Price controls and shortages introducechaos into the distribution of factors of productionamong their various uses and make it possible forsome products of a price-controlled factor of produc-tion to be faced with extremely severe shortages, whileother products are faced with only minor shortages.

91. The position of the various products inthe preceding question can suddenly be reversed byminor changes in the uncontrolled prices of comple-mentary factors of production, by small bureaucraticchanges in the price controls, or by anything that re-sults in the slightest changes in the relative profitabil-ity of the various products of the factor of production.

92. The season of the year in which pricecontrols are imposed is relevant to the extent to whichdifferent products of a factor of production are facedwith shortages. For example, price controls imposedon oil and oil products in the winter time, when gasolineprices are low relative to heating oil prices, will result inan especially severe shortage of gasoline the followingsummer, because of the freezing of that price relation-ship. For the same reason, if the controls were imposed inthe summer time, the heating oil shortage would be espe-cially severe in the following winter.

93. Price controls and shortages create tre-mendous instability in supply. The supply of every-thing subjected to controls becomes subject to sudden,massive, and unpredictable shortages.

94. Hoardinga. comes into existence in response to the exis-tence of shortages and the fear of shortages; it isthe attempt to secure supplies when they are avail-able in preparation for their being unavailableb. represents a new and additional demand thatunder price controls operates to increase the sever-ity of the shortagesc. both (a) and (b)

95. Under price controls, the most vital andurgent employments of a factor of production are pre-vented from outbidding not only its most marginal em-ployments, but, from the standpoint of a free economy,employments that could not even qualify as submar-ginal, namely the accumulation of hoards as a safe-guard against shortages.

96. The abolition of price control puts an endto hoarding by allowing the price of a good to rise suffi-ciently high to limit the quantity demanded, including thehoarding demand, to the supply available. At that point,the good is available to whoever is willing to pay the mar-ket price and the need to hoard is eliminated.

97. It follows from the preceding questionthat following the repeal of price controls and pricesrising to levels high enough to cope with the desire tohoard, prices will actually decline somewhat, in re-sponse to the disappearance of the hoarding demand.

98. The effect of a shortage of any particularcommodity is to cause the unsatisfied demand for thatcommodity to spill over and add to the demand forother commodities.

99. “Selective” or partial price controls, thatis, price controls imposed merely on certain goodsonly, are contrary to any rational purpose the govern-ment might have in imposing them. This is becausetheir effect is to inhibit the profitability and thus theproduction of the goods the government deems import-ant while leaving uncontrolled the profitability of thegoods the government considers unimportant. At thesame time, the profitability and thus the production ofthe goods the government considers unimportant ispositively stimulated by the spillover of demand intothe markets for the uncontrolled goods that resultsfrom the shortages of the controlled goods.

100. The effect of selective or partial pricecontrols is to

a. raise the prices of uncontrolled goods becauseof the spillover of demand from the controlledgoods b. raise the general price level insofar as theyapply to the production of goods on which the pro-duction of other goods depends, such as oil orelectric power, and reduce their production andthus cause a reduction in the aggregate amount ofproduction and supplyc. both (a) and (b)


101. Price controls a. save people moneyb. cause them to spend less money for the goodsthey want, but cannot obtain because of the result-ing shortages, and more money for other goodsthat they want less

102. Rent control on part of the supply ofrental housing has the effect of raising rents on the partof the supply that remains free of rent controls. This isbecause insofar as it leads to part of the supply goingto tenants who could not have obtained it in the ab-sence of rent control, it equivalently reduces the sup-ply of housing available on the market andcorrespondingly raises its price.

103. Rent controls and housing shortagesacross broad regions have the potential for bringingabout the compulsory assignment of boarders tohomes and a system of internal passports so that it re-quires the government’s permission to move to variousplaces within one’s own country. In such conditions,which existed in Soviet Russia, such measures appearas necessary to prevent large numbers of people fromotherwise being homeless and to restrain the severityof housing shortages in areas of the country that arerelatively desirable in which to live and into whichlarge numbers of people might otherwise move.

104. Rent controls in the United States havenot resulted in the kind of conditions described in thepreceding question because the controls have appliedonly to local jurisdications surrounded by other juris-dictions in which there were no controls and in whichhousing could be found.

105. Rent control serves to increase the effec-tive cost of constructing new rental housing insofar asthe prospect of its later on being extended to the newhousing makes it necessary to recover one’s invest-ment more rapidly and thus to crowd the depreciationof the housing into the years one can expect it to re-main free of controls.

106. By keeping property values down, andthus the revenues that can be collected from propertytaxes, rent controls contribute to the imposition or in-crease in local sales and income taxes.

107. The effect of the immediate abolition ofrent control would largely be that the present “benefici-aries” of rent control would simply have to changeplaces with an equally large but generally unrecog-nized class of victims of rent control—those who pres-ently cannot find an apartment they can afford to rentin the rent-controlled area but must live with inlaws,roommates, or outside the area. The repeal of rent con-trol would place the apartments of its “beneficiaries”on the market, thereby enlarging the market supplyand reducing market rents to the point of apartmentsbecoming affordable by people who cannot presentlyafford them.

108. The “beneficiaries” of rent controlwould suffer far less hardship following its repeealthan the unseen victims of rent control have sufferedunder it, because repeal would be followed by a sharpincrease in the supply of rental housing and thereafterby a progressive increase and improvement in the sup-ply of rental housing making rental housing more andmore affordable.

109. There are no beneficiaries of rent con-trol in the long run because its seeming benefits in theshort run are made possible by the consumption of thecapital invested in rental housing, with the ultimate re-sult being the destruction of rental housing. And in theinterval, the “beneficiaries” live in deteriorating condi-tions, valueless to their landlords yet afraid to moveout of fear of being unable to duplicate the rental “bar-gain” they have.

110. The effect of repealing rent controls inan otherwise unregulated housing market would not beto make people sleep in the streets because

a. open-market rents would fall, as the result ofan expanded supply available for the market, notrise to the level of open-market rents reflectingthe restricted supply that is available for the mar-ket as the result of rent controlb. those unable to afford their own apartmentseven with the lower open-market rents that wouldexist without rent control would be able to shareapartments with others and in that way be able tofind housing at a rent they could affordc. both (a) and (b)

111. Government housing regulations thatimpose minimum standards too costly for poor peopleto afford have the potential to result in people havingto sleep in the streets, in the same way, say, that gov-ernment standards prohibiting automobiles more thanten years old, would serve to deprive poor people ofthe ability to drive cars, since such old cars are oftenall that they can afford.

112. Just as rent controls applied to part ofthe stock of rental housing serve to raise rents on thepart that is not subject to rent controls, so price con-trols applied to domestically produced oil served toraise the price of oil produced outside the country, no-tably in OPEC countries. Like partial rent controls, theprice controls on oil enabled part of the supply of oilto be consumed in submarginal uses and thus reducedthe supply available for the open market and therebyraised the price of oil on the open market.

113. The repeal of U.S. price controls on oilreduced the price received by the OPEC cartel even be-fore the production of oil was increased, simply bycausing existing supplies to be withdrawn from sub-marginal uses and be made available on the market,where the effect of greater supply was to reduce price.

114. The windfall profits tax on the oil indus-try, enacted in conjunction with the repeal of price con-


trols, contributed to subsequent widespread bankrupt-cies in the oil industry because it correspondingly de-prived oil producers of the ability to finance expansionout of profits and made them borrow money instead.

Then when oil prices plunged, as the result of ex-panded production, instead of merely losing back prof-its, producers lost borrowed money and went bankrupt.

PART C. UNIVERSAL PRICE CONTROLS AND THEIR CONSEQUENCES

115. Price controls tend to spread until allprices and wages in the economic system are con-trolled—i.e., partial price controls lead to universalprice controls.

116. Price controls spread becausea. price controls on products require controls onthe prices that constitute the costs of production, ifthe production of the product is not to be made un-profitable and cease, and then on the furtherprices that constitute the further costs of produc-tion of materials, machinery, and the like, goingall the way back in the chain of productionb. price controls on labor (wage controls) mustbe extended to more and more occupations to pre-vent workers from leaving the already controlledoccupations and taking jobs in better paying un-controlled occupationsc. price controls must be extended not only to theprices of the factors of production, which pricesconstitute the costs of production, but also, incases in which factors of production have morethan one product, to the prices of the other prod-ucts of the factors of production—for example,price controls on milk for drinking and on rawmilk lead to price controls on butter, cheese, andthe other milk products lest they become moreprofitable uses for raw milk than milk for drinkingd. all of the above

117. The shortages of individual goods thatexist under universal price controls tend to be far moresevere than the shortages that exist under partial or se-lective price controls because of the spillover of de-mand from all other goods in a state of shortage.

118. The nature of shortages under universalprice controls could be seen in Soviet Russia, wherethe shortages were so severe that when people saw aline forming, they would automatically get on it, evenwithout knowing what goods were available, becauseit was better to obtain practially any good than holdotherwise unspendable money.

119. Universal price controls existeda. in Nazi Germanyb. in the United States in World War IIc. briefly under President Nixon, when he im-posed a ninety-day freeze on all prices and wagesin August 1971 d. their equivalent exists under socialism, as forexample in the former Soviet Union and its satel-lites e. all of the above

120. Excess demand under price controlsbuilds up even though people’s incomes are controlledand even though the sum of the controlled prices timesthe quantities of goods available for sale does not ex-ceed those incomes. It occurs as the result of govern-ment spending financed by the creation of new andadditional money succeeding in obtaining supplies andthus causing a part of people’s incomes to back up onthem, so to speak, as unspendable funds. Then, in thenext year, the people may be paid the same incomes,but their available funds now equal the sum of those in-comes plus the unspendable funds from the year be-fore. If the government again makes purchases out ofnewly created money, then additional unspendablefunds accumulate.

121. Shortages under universal price controlsa. are both far more widespread and far more se-vere than under partial price controlsb. destroy production in all the ways that partialprice controls doc. destroy production in ways beyond partialprice controlsd. result in shortages of capital and labor, inwhich the production of any product can be ran-domly expanded at the expense of the productionof any other producte. result in disproportions in the supplies of thevarious capital goods, which serve to underminethe ability to produce and lead to a process of con-tinuing capital decumulationf. result in people losing the incentive to earnmore money, and to quitting their jobs, a processwhich is capable of causing a cumulative, self-re-inforcing decline in productiong. all of the above

122. Universal price controls and the short-ages they create result in chaos in the allocation of cap-ital and labor among the various branches ofproduction in the economic system, because price con-trols prohibit a rise in prices and profits when capitaland labor are withdrawn from an industry and the exis-tence of shortages prevents a fall in prices and profitswhen additional capital and labor are brought into anindustry. Thus any industry can be expanded at the ex-pense of any other industry, with nothing to counteractor limit the process.

123. Because of the spillover of demandcaused by shortages, and the fact that under universalprice controls the spillover into each industry is thesum of the spillovers from all other industries, theshortage facing any given industry may not be capable


of being overcome, irrespective of any increase in theindustry’s output, and thus nothing whatever may bepresent to limit the relative overexpansion of an indus-try.

124. As the result of the shortages created byuniversal price controls, capital and labor can be with-drawn from any industry and placed in any other indus-try, and there is no effect on the rate of profitanywhere.

125. Under universal price controls and short-ages, even though the consumers want more of onegood and less of another, say, more shoes and fewershirts, the producers can go ahead and do the exact op-posite and yet suffer no financial penalties.

126. The chaos in the relative production ofcapital goods that results from universal price controlsand shortages undermines the subsequent ability to pro-duce, including the subsequent ability to produce capi-tal goods. If, for example, the steel industry is undulyexpanded at the expense of the coal industry, say, theeconomic system’s subsequent ability to produce willbe impaired: not only the extra steel mills, but part ofthe existing steel mills may be inoperable for lack offuel.

127. Like a human body, whose total perfor-mance cannot exceed the power of its brain, heart,lungs, or any other vital organ, the overall perfor-mance of an economic system cannot exceed thepower of any one of a large number of vital industries.If some are unduly expanded at the expense of others,the effect is to reduce the functioning of the whole.

128. The ability of the economic system toproduce is undercut by disproportions

a. among major industries, like steel and coalb. within the output of individual industries—forexample, the production of too many trucks tohaul farm products and of not enough tractors toharvest themc. in the production of just a few key productshere and there—like ball bearings, lubricants formachinery, spare parts, even ordinary screws, andso on, a shortage of any one of which or of anyone special type of which, such as ball bearings ofa particular size, must cause a widespread paraly-sis and the grossest inefficiencies in productiond. all of the above

129. The problem of disproportions in thesupply of capital goods is further compounded by thedeclines that result from producers just not having tocare any longer about the quality of their products orabout economies in producing them.

130. In Soviet Russia, hydroelectric stationswere built without generators and without the exis-tence of industries to supply; wheat could not be har-vested because the necessary tractors had not beenbuilt, or, if they had been built, they lacked spare parts,or were in the wrong place, or quickly became inopera-

ble; factories could not operate because they lackedmaterials; new buildings and new machines wereworthless, because of shoddy construction due to lackof care or lack of the necessary materials.


131. Since capital goods are continuouslyused up in production and must be replaced out of pro-duction, a severe reduction in the ability to producecapital goods, because of malportions among them andbecause of the various other inefficiencies that arecaused by universal price controls, results in a smallersupply of capital goods being produced than is con-sumed in production.

132. As the result of a smaller supply of capi-tal goods being produced than is consumed in produc-tion, the stock of capital goods falls.

133. Once the stock of capital goods falls,production must decline further, because it will be car-ried on with fewer capital goods.

134. If the smaller supply of capital goods isused as inefficiently as was the larger supply, becauseof continuing chaos in production, it will not be possi-ble to replace the smaller supply of capital goods ei-ther. Thus, once again production will decline.

135. The process of less production causingfewer capital goods causing less production, can go onuntil the economic system is carried back all the wayto the level of barbarism.

136. Universal price controls result in a se-vere labor shortage because

a. every industry is eager to employ more labor,inasmuch as whatever extra products it can pro-duce with more labor will be snapped up bygoods-hungry buyers b. the inefficiencies in production under univer-sal price controls imply a need for more labor perunit of output and thus intensify the labor shortagec. shortages of consumers’ goods and the accu-mulation of surplus unspendable funds leads work-ers to quit their jobs since there is no point inworking to earn money they cannot spend and thefunds they have are sufficient to enable them toget by for an extended period; this worsens theshortage both of labor and consumers’ goodsd. all of the above

137. Like the process of capital decumula-tion, the labor shortage under universal price controlsis a factor making for a self-reinforcing, cumulative de-cline in production, because workers quitting their jobsreduces the supply of consumers’ goods and thus fur-ther intensifies the shortage of consumers’ goods,which, in turn, further reduces the incentives to workand earn money and thus leads to still more workersquitting.


138. The combination of inflation and pricecontrols and the shortages they created promoted a de-lusion of prosperity in the United States in World WarII, by making it extremely easy to earn money, whichincluded finding employment; people ignored the factthat much of the money they earned was currently un-spendable, that major categories of civilian goodswere not being produced, and that the goods that wereavailable were of reduced quality; they looked forwardto spending the money after the war.

139. The government’s typical response tothe chaos resulting from price controls and shortages isto seize the power to determine what goods are pro-duced, in what proportions, by what methods, and towhom they are distributed.

140. The U.S. government’s response to thechaos that resulted in connection with price controlson oil and the resulting oil shortage was the creation ofa new government agency—the Federal Energy Ad-ministration (now the Department of Energy), whichhad the power to tell the various oil companies howmuch of each of the various petroleum products theywere to produce and to which industries, firms, and re-gions they were to distribute those products.

141. The meaning of ownership is the powerto determine the use and disposal of property. If thegovernment determines what a firm is to produce, inwhat quantity, by what methods, and to whom it is tosell its output and at what prices, then it is the govern-ment that determines the use and disposal of the firm’sproperty. The government, therefore, becomes the realowner of the firm—the de facto owner.

142. The government’s assumption of the fur-ther powers required to deal with the economic chaoscaused by universal price controls and shortages repre-sents the de facto socialization of the economic sys-tem, because it gives to the government all theessential powers of ownership.

143. Socialism on what von Mises calls “theGerman or Nazi pattern,” in contrast to “Socialism onthe Russian or Bolshevik pattern,” in which the gov-ernment openly nationalizes all of the means of pro-duction, is the de facto socialism that results fromuniversal price controls and the government’s responseto the shortages and chaos that result.

144. Nazi Germany was a capitalist countryonly in outward guise and appearance. In it, privateownership of the means of production existed in nameonly. All substantive economic decisions were madeby the government; the Nazi government held and ex-ercised all the actual powers of ownership—the setting

of prices and wages, the determination of what was tobe produced, in what quantities and locations, and bywhat methods, and to whom the products were to bedistributed.

145. While Nazi Germany was a socialistcountry, Sweden is not a socialist country, nor wasGreat Britain or Israel when they were governed by so-cialist parties. The great bulk of the means of produc-tion in the economy of these latter countries was and isprivately owned and they did not have price controlsand shortages nor, therefore, the government’s defacto seizure of ownership.

146. Private ownership of the means of pro-duction in countries such as Sweden has, to be sure, la-bored under all sorts of restrictions, prohibitions, andcompulsions, but still it has been private ownership—production has been carried out characteristically atthe initiative of private owners for the sake of privateprofit.

147. Economies such as Sweden, and that ofthe United States too, are more appropriately de-scribed as “hampered market economies” or “ham-pered capitalist economies” rather than as “mixedeconomies,” inasmuch as socialism, understood alongthe lines of universal price controls and the destructionof the price system, cannot actually be combined witha functioning price system, which last represents capi-talism.

148. The expression “mixed economy”should only be used if it is understood that what ismeant is an economy based on private ownership ofthe means of production but more or less severely ham-pered by an extensive list of socialistically motivatedacts of government intervention—i.e., a hampered cap-italist economy.

149. The existence of isolated socialized in-dustries, such as the postal service and passenger rail-road service, does not warrant characterizing a countryas socialist. So long as such industries operate in thecontext of a market and market prices based on a foun-dation of private ownership of the means of productionand the profit motive, they represent, in effect, merelya blemish on an otherwise capitalist body.

150. Examples of genuinely socialist econo-mies are those of the Communist countries, most ofwhich no longer exist, Nazi Germany, and those of nor-mally capitalist or market economies for the durationof their imposition of all-round price controls, as inWorld War II.




1 d 39 F 77 T 115 T2 d 40 T 78 T 116 d3 T 41 b 79 T 117 T4 b 42 F 80 T 118 T5 T 43 F 81 T 119 e6 T 44 T 82 T 120 T7 d 45 T 83 e 121 g8 c 46 b 84 T 122 T9 T 47 T 85 c 123 T

10 T 48 T 86 f 124 T11 a 49 b 87 d 125 T12 T 50 F 88 T 126 T13 T 51 T 89 T 127 T14 T 52 T 90 T 128 d15 b 53 f 91 T 129 T16 T 54 T 92 T 130 T17 b 55 F 93 T 131 T18 T 56 T 94 c 132 T19 a 57 F 95 T 133 T20 T 58 f 96 T 134 T21 T 59 g 97 T 135 T22 T 60 d 98 T 136 d23 T 61 T 99 T 137 T24 e 62 T 100 c 138 T25 T 63 T 101 b 139 T26 T 64 T 102 T 140 T27 T 65 T 103 T 141 T28 T 66 e 104 T 142 T29 T 67 b 105 T 143 T30 d 68 T 106 T 144 T31 d 69 T 107 T 145 T32 T 70 T 108 T 146 T33 F 71 g 109 T 147 T34 T 72 d 110 c 148 T35 T 73 T 111 T 149 T36 T 74 d 112 T 150 T37 T 75 T 113 T38 F 76 T 114 T


Chapter 8, Part A

1. The defining characteristic of socialism isgovernment ownership of the means of production. Itis irrelevant to the nature of socialism whether

a. socialism has been established openly, throughthe explicit nationalization of all industry, orthrough the enactment of price and wage controlsand the governmnent’s seizure of the power to de-termine what is produced, in what proportions, bywhat methods, and to whom it is to be distributed,which gives the government de facto ownershipof the means of production under the outwardguise and appearance of private ownership of themeans of productionb. socialism has been brought about through vio-lent revolution or a democratic electionc. its professed goal is universal brotherly love orthe supremacy of a particular race or classd. all of the above

2. The findings of economics concerning so-cialism apply to all variants of socialism, including

a. the socialism of the Communistsb. the socialism of the Nazisc. the socialism of the Social Democratsd. any economic system actually based on gov-ernment ownership of the means of productione. all of the above

3. The findings of economics concerning so-cialism do not apply to countries such as Great Britain,Israel, and Sweden, which, though governed for exten-sive periods by political parties espousing the philoso-phy of socialism, did not implement socialism as theiractual economic system.

4. A vital principle to grasp about socialismis that its economic consequences are essentially thesame as those which result from universal price con-trols.

5. The essential economic identity betweensocialism and universal price controls consists in thefact that both of them destroy the same thing, namely,private ownership of the means of production and itsoffshoots the profit motive and the price system.

6. Price controls destroy private ownershipof the means of production in the very fact of destroy-ing the right to bid and ask prices. In a division-of-labor economy, in which buying and selling areindispensable to production and all other economic ac-tivity, the right to bid and ask prices is a fundamental,indispensable right of ownership. Without it, all otherrights of ownership are meaningless.

7. The right to own a factory or store is mean-ingless if the owner is prohibited from charging or pay-ing the prices required to keep his factory or store inexistence. Essentially, price controls are fully as de-structive of the rights of ownership as socialism itself.And, of course, when price controls are compounded

by shortages, the government’s response to the conse-quences is to seize total control over the means of pro-duction and establish de facto socialism.

8. What makes price controls produce thechaos they do is precisely the fact that they interferewith the property rights of businessmen. Specifically,they prohibit businessmen from using their capitals inthe ways that would be most profitable to themselves.If they did not interfere with the right of businessmento use their capitals in the most profitable way, thenthey could produce none of their chaotic effects.

9. Among the elements of chaos that havebeen shown to result from price controls are

a. shortages and the destruction of vital industriesb. the impotence of consumers accompanied byhatred between buyer and sellerc. an impetus to higher costsd. chaos in the personal distribution of goods toconsumerse. chaos in the geographical distribution of goodsamong various local marketsf. chaos in the distribution of a factor of produc-tion among its various productsg. chaos in the distribution of capital and laboramong the various industriesh. all of the above

10. Each of the elements of chaos describedin the preceding question results from just one thing:interference with the businessman’s property rightsand profit motive.

11. Businessmen do not voluntarily sell theirgoods too cheaply and thus cause shortages. In orderfor them to do so, their property rights must be vio-lated and they must be forced to do so.

12. Businessmen would not abandon the pro-duction of any goods if they were able to obtain profit-able prices for them. What causes the abandonment ofthe production of vital goods is that the government vi-olates the property rights of businessmen and preventsthem from charging profitable prices for those goods.

13. Businessmen would never drive awaycustomers offering them profitable business. Whatmakes businessmen drive away customers is that pricecontrols compel them to charge prices that create short-ages and thereby make customers economically value-less and a source of expense rather than profit.

14. Businessmen would not run up the costsof production if those costs came out of profits, as theywould have to in the absence of price controls andshortages. But in the face of shortages, there is no re-sistance to a rise in costs.

15. Businessmen do not voluntarily sell outtheir entire stocks of goods to whomever happens to ar-rive first, leaving those who come later to go away




empty-handed, when they know that the latter wouldbe willing and able to pay more than some of the earlycomers. They behave this way only when their prop-erty rights are violated and they are prohibited fromraising prices to the point required to reserve suppliesfor late comers.

16. Businessmen would not voluntarily ig-nore the incomes and preferences of consumers in dis-tributing their goods. They do so only when theirproperty rights are violated and they are prohibitedfrom setting prices that accord with the incomes andpreferences of the consumers.

17. Businessmen would not for long saturatesome geographical markets at low prices, while starv-ing others offering them high prices. But if their prop-erty rights are violated and prices are prohibited fromrising even though markets are starved, and cannot falleven when supplies increase because the effect ismerely to reduce the severity of a shortage, then suchchaos can exist.

18. Businessmen would not use a factor ofproduction to produce some products to excess at lowprices, while producing not enough of other productsoffering them high prices. But again, if their propertyrights are violated and prices are prohibited from ris-ing even though not enough of some products arebeing produced, and prices cannot fall when otherproducts are produced to comparative excess becausethe effect is merely to reduce the severity of their short-age, then, indeed, such chaos can exist.

19. Businessmen would not knowingly andvoluntarily overinvest in some industries at low profitsor loses, while underinvesting in other industries offer-ing high profits. But if their property rights are vio-lated and prices and profits are prohibited from risingbecause of price controls, while shortages preventprices and profits from falling, then the pattern of in-vestment becomes random and can totally contradictthe actual wishes of the consumers.

20. What causes all of the above types of eco-nomic chaos is the violation of the property rights ofbusinessmen and thus preventing them from doingwhat is profitable to themselves.

21. The wider principle that emerges fromthe above questions is that the entire price system andall of its laws and harmonies depend on one essentialfact: the observance of private property rights and thusthe freedom of businessmen to act for their own profit.

22. Private property rights and the profit mo-tive are the foundation and the motive power that un-derlie and drive the entire price system.

23. Private property rights and the profit mo-tive underlie and actuate

a. the uniformity-of-profit principleb. the various principles of price and wage unifor-mity

c. the cost-of-production principled. the principle that prices are set high enough tolimit demand to the supplye. the principle that factors of production arechannelled to their most important employmentsf. all of the above

24. All of the economic laws pertaining toprices and all of their benevolent consequences are theresult of just one thing: private property rights and theprofit motive.

25. Socialism destroys all private propertyrights in means of production. And in so doing, it de-stroys the operation of the profit motive and the entireprice system.

26. Socialism produces the same chaotic ef-fects as price controls, because it destroys the samething as price controls, namely, the one and onlysource of economic order and harmony in the world:private property rights and the profit motive.

27. The essential fact to grasp about social-ism, which explains why it is essentially identical toprice controls, is that it is simply an act of destruction.Like price controls, it destroys private ownership andthe profit motive, and that is essentially all it does. Ithas nothing to put in their place.

28. Socialism is not actually an alternativeeconomic system to private ownership of the means ofproduction. It is merely a negation of the system basedon private ownership—a massive act of sheer destruc-tion.

29. In destroying the price system, socialismdestroys

a. economic calculation as the basis of economicplanning by individuals and business firmsb. the means of coordinating the separate eco-nomic plans of all the different partiesc. the intellectual division of labor in the plan-ning processd. all of the above

30. Socialisma. presents itself as a system in which economicactivity will be “centrally planned,” thereby avoid-ing the “anarchy of production” that allegedly ex-ists under capitalismb. as the result of its destruction of the price sys-tem and thus the intellectual division of labor inthe planning process, places itself in the positionin which economic planning must be centralized,because the separate plans of independent plan-ners no longer have a monetary basis and cannotbe coordinatedc. both (a) and (b)

31. Central planning requires that in the plan-ning of each aspect of production, the direct and indi-rect effects on the entire rest of the economic systembe taken into account, since in using factors of produc-


tion that might be used for the production of otherthings, the production of each thing correspondinglylimits the production of other things, and judgmentsmust be made as to which overall arrangement is best.

32. In trying to plan the production of a sim-ple item, such as shoes, a socialist state must take ac-count of the fact that shoes can be produced

a. in varying quantitiesb. in various styles or combinations of stylesc. by various methods or combinations of meth-ods, such as by machine or by hand, including thechoice between using various proportions of ma-chine or hand production in different parts of theoverall processd. from different materials or combinations ofmaterials, such as leather, rubber, and canvas, andin different geographical locations, again, in bothinstances, in varying proportionse. and that each of the above choices has a differ-ent effect on production in the rest of the eco-nomic systemf. all of the above

33. Under capitalism, decisions concerningthe various matters described in the preceding questionare made on the basis of economic calculations. Thus

a. shoe production as a whole tends be carried tothe point where further production would makethe shoe industry relatively unprofitable in com-parison with other industriesb. the styles are those which the consumers arewilling to make profitablec. the methods of production, the materials used,the geographic locations are all the lowest cost ex-cept insofar as they provide special advantages forwhich the consumers are willing to bear the extracostd. all of the above

34. The economic calculations which are thebasis for the decisions about production under capital-ism in the preceding question

a. take into account the effect of those decisionson production throughout the rest of the economicsystem, because that effect is reflected in theprices of the various factors of productionb. in favoring, other things being equal, produc-tion at the least possible cost, serve to make pro-duction in the individual instance consistent withmaximum production in the rest of the economicsystemc. both (a) and (b)

35. In contrast to capitalism and its use ofeconomic calculation, socialism and its absence of aprice system require that the planner or planners mustgrasp the physical connections, direct and indirect, be-tween the production of each thing and the productionof every other thing.

36. Because each of the different choices re-specting the production of any one thing makes a dif-ferent combination of factors of productionunavailable for alternative employments (for example,shoes produced by hand reduce the number of handi-craft workers available for other purposes, those pro-duced by machine reduce the number of machinemakers and the amount of fuel available for other pur-poses, shoes produced in Minsk leave less labor avail-able for other purposes in Minsk than if they wereproduced in Pinsk, and so on), it follows that in orderto intelligently make the kind of choices that areneeded, the planners of socialism would have to beable to know the direct and indirect impact of each ofthose choices on the rest of the economic system.

37. In drafting its plans for shoe production,or any other good, a socialist government is obliged toconsider

a. the extent of shoe production in relation to theproduction of all other goods using the same fac-tors of productionb. such questions as whether shoe productionmight be expanded with factors of productiondrawn from the production of some other good,and whether the production of that other goodmight be maintained by drawing factors of produc-tion from a third good, and so onc. all of the industries using any of the factors ofproduction used in the shoe industry, what de-pends on the output of those industries, and whatalternative factors of production are available tothose industriesd. all of the industries using the alternative fac-tors of production just referred to, what dependson their products, and what further alternative fac-tors of production may be available to them, andso one. and at each step, the possibility of expandingthe overall supply of the factor of production inquestion, and, if so, by what means, where, and atthe expense of whatf. all of the above

38. In order to deal with the innumerable eco-nomic relationships among all the different aspects ofproduction, the economic planning of socialism wouldrequire

a. a superhuman intellect to be able to grasp thephysical connections among all the various indus-tries and to be able to trace the consequences of al-terations in any one industry on all the othersb. the ability to hold in mind at one time a preciseinventory of the quantities and qualities of all thedifferent factors of production in the entire eco-nomic system, together with their exact geographi-cal locations and a full knowledge of the varioustechnological possibilities open to them, i.e., all ofthe millions of separate farms, factories, mines,warehouses, and so forth, down to the last repairshop, together with a knowledge of the quantity


and quality of all the machines, tools, materials,and partly-finished goods that they contained, andexactly what they were potentially capable of ac-complishing and whenc. the ability to project forward in time all of thedifferent new combinations of factors of produc-tion that might be produced out of the existing fac-tors, together with where and precisely when theywould come into existence and the technologicalpossibilities that would then be open to themd. the ability to make the projection just de-scribed for an extended period of time—say, ageneration or more—in order to avoid the possi-bly wasteful production of machines and build-ings lasting that longe. the ability to pick out of all the virtually infi-nite number of different possible permutationsand combinations of what might be produced andwhen, that one that on some undefined and unde-finable basis it considered “best,” and then order itand all the steps incorporated in it to be under-taken as its economic planf. all of the above

39. Under capitalism the economic system isplanned in the light of the magnitude of knowledge in-dicated in the preceding question, but the knowledge isheld in small portions by large numbers of individualsand is manifested in prices, which then serve to coordi-nate the plans and actions of all the various individuals.

40. Under capitalism,a. different individuals in combination—that is,when their knowledge is added together—doknow the precise quantities, qualities, locations,and technological possibilities open to all the vari-ous factors of production in the economic systemb. everybody’s production is based on the sum ofall of this knowledge, because the knowledge is re-flected in the prices of all the various factors ofproduction and productsc. for example, the price of wheat at any giventime reflects the knowledge of each owner ofwheat concerning the amount, quality, and loca-tion of the wheat he owns; it also reflects theknowledge of each user of wheat about the techno-logical possibilities open to wheatd. the knowledge just described enters into thesupply and demand and hence the price of wheate. it is the same with every other good: its pricereflects the sum of existing knowledge about theamount of it available, the technological possibili-ties open to it in production, and every other rele-vant considerationf. the future supply, locations, and productionpossibilities of factors of production are taken intoaccount in the anticipation of their future pricesg. all of the above

41. Unanticipated events, negative or posi-tive, require the replanning of the entire economic sys-

tem, because in each of these cases, it is necessary todetermine which specific products will be produced inlesser or greater quantity, where, by what methods,and to what extent.

42. Thus, for example, if a a socialist econ-omy were confronted with the wreck of a tank traincarrying a shipment of oil and thus an unexpectedly re-duced supply of oil, it would have to replan the eco-nomic system in order to decide where to take out theloss. It would have to look at all of the different usesfor oil, all the possible remote consequences of itswithdrawal from this or that area of production, and itwould have to look at all of the alternative employ-ments of factors of production that might be used to re-place the lost oil, and all the permutations andcombinations entailed in that, and then decide. By thesame token, if, as a result of good fortune, a socialisteconomy had an unexpected increase in the supply ofoil, it would have to replan the entire economic systemto find the right uses for the extra supply of oil.

43. A capitalist economya. routinely goes about such replanning, on thebasis of the price systemb. responds easily and smoothly to unforeseenchanges in economic conditions, because suchchanges simply bring about a change in the struc-ture of prices and thus generate the most efficientresponse on the part of all concernedc. both (a) and (b)

44. In a capitalist economy,a. a reduction in the supply of oil, to continuewith that example, acts to raise the price of oilb. the rise in price diminishes the consumption ofoil in its marginal employments and simulta-neously encourages its production—and, ofcourse, at the least possible expense to other pro-ductive activitiesc. users of petroleum replan their use of oil andoil products in the light of the availability of alter-native fuels and their price; they replan their con-sumption and production activities, cutting backand possibley abandoning somed. in all uses of oil and oil products in produc-tion, the plans of customers are taken into accountby virtue of estimates of their willingness to payor not pay prices that cover the higher cost of con-tinuing the operatione. routine replanning goes on throughout the restof the economic system in response to changes inspending patterns resulting from changes in expen-ditures for oil and oil productsf. all of the above

45. The insuperable difficulty of socialistplanning is that, because of the destruction of the pricesystem under socialism, and thus of the possibility ofdivision of labor in the planning process, it is neces-sary to plan the production of the entire economic sys-tem as an indivisible whole, with one planner having


to plan the entire economic system. But the planningof the economic system as an indivisible whole is sim-ply impossible.

46. Because of the impossibility of planningthe economic system as an indivisible whole, by oneplanner, it should not be surprising that in reality, theactual planning of socialist countries is undertaken byseparate government ministries, each responsible fordifferent industries or regions, with even the individualfactories undertaking part of the planning process.

47. The—necessarily—decentralized plan-ning of socialism causes chaos, because without aprice system—without the foundation and mainspringof the price system, i.e., private ownership of themeans of production and the profit motive—the indi-vidual planners must operate without coordination andat cross purposes, since nothing is present to harmon-ize and integrate their separate plans. In such condi-tions, the very success of any given plan serves tocause the failure of other plans, by virtue of deprivingthem of factors of production required for their beingcarried out.

48. The repeated, chronic failure of individ-ual, partial plans under socialism results in part fromthe fact that every industry’s suppliers are in the posi-tion of being disinterested monopolists, because theydo not have profit-and-loss incentives and need notfear competition.

49. The Soviet quota system assigned physi-cal production goals to each factory, farm, and mine inthe Soviet Union, which they were required to meet.Penalties were imposed for failure to meet the goalsand incentives were provided to exceed them.

50. The Soviet quota system produced condi-tions identical to those that exist under a system of uni-versal price controls and universal shortages, for itmeant that there was a ready and waiting employmentfor more factors of production in every branch of pro-duction, with the result that any branch was capable ofexpanding at the expense of any other, more importantbranch.

51. The physical quotas assigned usuallylacked precision. Thus the quota for screw productionmight be set in terms of overall pounds of screws or asimple overall number of screws. In the one case, theresult was the production of a relatively small numberof very heavy screws; in the other, a very large num-ber of very small screws. Such results contributed tothe economic chaos of the Soviet Union.

52. What gave rise to the Soviet quota sys-tem and its stress on meeting and exceeding quotaswas the fact that a socialist government

a. cannot rationally planb. wants to expand production, but is unable totrace the connections among the different indus-tries

c. is unable to determine—and is not even awarethat it is necessary to determine—the effects ofproducing more of any one item on the ability toproduce other itemsd. sees the particular product it wants to producein each case, but, because it lacks a price system,has no concept of the cost of producing that prod-uct or, therefore, of what other products it mustforgo in the processe. can do no more than simply gives orders to pro-duce as much as possible of everythingf. all of the above

53. Socialism’s inability to determine costsand consequent lack of concern with costs produces ex-actly the same kind of labor shortage as exists underuniversal price controls.

54. A labor shortage exists under socialismbecause

a. a socialist government desires to produce moreof everything and its inefficiency in how it pro-duces anything in particular compounds the prob-lem by increasing the amount of labor required foreverythingb. shortages of consumers’ goods lead workers towork less, since there is no point in doing workthat does not result in one’s being able to obtainconsumers’ goodsc. both (a) and (b)

55. The extent of the labor shortage under so-cialism is such that factory managers in the SovietUnion routinely hoarded labor, that is, kept it on thepayroll in idleness, merely to have it available as andwhen the need for it might arise.

56. Shortages of consumers’ goods are a nec-essary feature of socialism even without inflation.They exist as a result of the following factors:

a. the chaos in the production and geographicaldistribution of the various goods: at any time,goods can cease being produced, or cease beingsent to particular localities; this can occur becauseparticular plans are fulfilled that snatch away thenecessary factors of production or perhaps thevery consumers’ goods themselves from otherplansb. when the preceding occurs, the managers ofthe local stores and warehouses of the socialist so-ciety have no incentive and no authority to raisepricesc. nor do the managers have the incentive or au-thority to try to anticipate such events and buildup stockpiles, which would be “speculation”d. the managers also have no incentive or author-ity to bring in supplies from other areas (or sendsupplies to other areas), for that would be anotherform of activity possible only under capitalism,namely, arbitragee. all of the moral and political pressures of a so-cialist society work against prices being raised


f. all of the above

57. The moral and political pressures of a so-cialist society work against prices being raised because

a. a basic moral postulate of socialism is thatgoods should be free to whoever needs them, or, ifnot free, then at least as inexpensive as possibleb. in the political realm the pressures are exactlythe same as those which make rent control so pop-ular in New York City, namely, whoever succeedsin buying at the low price sees his benefit and ap-plauds the government officials responsible; onthe other hand, those who are victimized by theshortage the too-low price creates rarely see anyconnection between the too-low price and their in-ability to obtain the goods they want; they viewthe low price as being in their interest, too, andhope to be able to buy at that pricec. both (a) and (b)

58. The shortages of consumers’ goods undersocialism are worsened by

a. the desire to hoard that necessarily accompan-ies themb. the socialist’s government’s issuance of addi-tional money to the consumers, which, expandsaggregate demand in the face of a given, frozenlevel of pricesc. the general decline in production that takesplaced. all of the above

59. The most fundamental fact about social-ism is that government ownership of the means of pro-duction constitutes an attempt to make intelligence andinitiative in production a monopoly of the state.

60. Production depends on the possession ofmeans of production. If the means of production aremonopolized by the state, because it arbitrarily claimsto own them all, then no one is free to produce on hisown initiative and to regard his own intelligence andjudgment as the ultimate authority for his action. In asocialist economy, no one can produce without the per-mission, indeed, without the orders, of the state.

61. Socialism’s attempted monopoly of intel-ligence and initiative in production is the cause of itsanarchy of production, because this monopoly prohib-its all of the independent planning of millions of free,self-interested individuals that is required to run aneconomic system in a rational and ordered way.

62. Corollary consequences of socialism’smonopoly character are

a. the necessary technological backwardness ofsocialismb. the utter powerlessness of the plain citizenunder socialismc. both (a) and (b)

63. Under capitalism, whoever sees a profit-able opportunity for action

a. is free to act on his own initiative

b. is powerfully motivated to act by the prospectof the profit he can makec. is restrained from rash action by the risk of los-ing his own moneyd. can turn to any one of hundreds or even thou-sands of independent sources of financing by of-fering to share his profits with potential backerse. all of the above

64. Under capitalism, the actions of the indi-vidual innovator constitute a challenge to the estab-lished ways of doing things. For if what he is doing isin fact an improvement over present products or meth-ods of production, then those producing the presentproducts or practicing the present methods must copyhis or be driven out of business.

65. Because of its freedom of initiative, its in-centives to use that initiative, and its freedom of com-petition, the products and methods of production ofcapitalism tend to be literally the very best that anyonein the entire society can think of, and to improve fur-ther as soon as anyone can think of any still better idea.

66. In contrast to capitalism, under socialism a. the exercise of individual initiative in produc-tion is illegal, because of the state’s monopoly onthe means of production and the illegality of act-ing outside it’s economic “plan”; thus, if an indi-vidual does manage to think of some improvementunder socialism, he must submit it to the governmentb. the necessity of submitting all new ideas to thegovernment for its approval and implementationmeans that there is only one or, at most, a handfulof chances for the approval and implementation ofan ideac. whatever officials the individaul turns to in thegovernment have no economic incentives to adopthis idea, whatever its possible merit, and will beinclined to reject it, in order to spare themselvesthe difficulties and uncertainties that are alwaysentailed in implementing an innovation—such asthe need to find new suppliers of raw materials,obtain new workers, or discharge or relocate pres-ent workers; the officials will not want to run therisk of the innovation being judged a failure andthus arousing the displeasure of those in a positionto do them harm; in addition, if the innovationwere somehow to succeed, by whatever arbitrarystandard success is judged under socialism, the ef-fect on the officials would likely be merely the dif-ficulties of establishing the new arrangements andthen having their assigned production quotas in-creasedd. all of the above

67. Under socialism, very few new ideas arethought of, fewer still are implemented, and virtuallynone at all are of benefit to the plain citizen.

68. Under socialism, the fact that the plaincitizen is no longer the customer, “who is always


right,” but the serf, who must take his rations and likeit results from

a. the utter inability of the plain citizen to deter-mine what is produced by the way he spends hismoney, because of the lack of profit and loss in-centives and freedom of competition under social-ism, the presence of which are necessary ifchanges in consumer spending are to have an ef-fect on productionb. the fundamental moral-political postulate of asocialist society, which is that the individual doesnot exist as an end in himself, but as a means tothe ends of “Society”c. both (a) and (b)

69. Holding the individual to be the means tothe ends of “Society” means that he is placed in a ser-vile relationship to the rulers of the socialist state, be-cause “Society” is not an independent entity with awill and voice of its own and thus the alleged ends ofSociety are necessarily ends divined, interpreted, anddetermined by the rulers of the socialist state, whichmeans that under socialism the individual is actuallynothing more than a means to the ends of the rulers.

70. A socialist government has no compel-ling reason to supply the plain citizen with anythingmore than is necessary to prevent an uprising.

71. In contrast to the politicians, democraticor totalitarian, the people who really do work to im-prove the economic conditions of the general public,who—literally—stay up nights thinking of ways to pro-vide them with such things as grocery stores, more andbetter shoes and means of transportation, and everythingelse they may possibly want, are capitalists, who are con-tinually motivated by the prospect of making or losing afortune and who can act on their own initiative.

72. The only kind of technological develop-ments that a socialist government is interested in arethose which are of value to its rulers, above all, im-provements in weapons production and in the kinds ofthings that add to the rulers’ prestige, such as‘sputniks’—or pyramids.

73. Because civilian technology is open-ended and thus very broad-based, being made to ex-plore avenues that initially are of value only assubjects of novelty and curiosity, such as the automo-bile, radio, and personal computer in their early days,repression of the free development of civilian technol-ogy in response to consumer demand and profit andand loss incentives serves in the long run to cut theground from under the development of military tech-nolgy. The tank, for example, could not have been de-veloped in the absence of the prior development of theautomobile, which there would have been no basis fordeveloping under socialism.

74. The ability of the civilian economy tobenefit from military technology depends on the exis-tence of a capitalist economic system, which provides

the profit-and-loss incentives and the freedoms of ini-tiative and competition necessary to make applicationsof military technology to civilian purposes.

75. Without the aid of capitalist countries, so-cialism must revert to feudalism as the result of its in-ability to coordinate the different branches ofproduction and thus its chronic shortages of supply ofvital items, which creates the need for economic self-sufficiency. A series of crop failures and resulting fam-ines, for example, in addition to killing off much of thepopulation would lead most of the survivors to flee thecities for the countryside, where they would have a bet-ter chance of obtaining food.

76. The economic inefficiencies of the SovietUnion shed light on its inability to accumulate capitaldespite a reputedly very high degree of concentrationon the production of capital goods, because the result-ing output is so low per unit of capital goods expendedthat it is difficult or impossible to produce a supply ofcapital goods great enough to equal the supply used upin production.

77. Capital accumulation under socialism ispossible only at the cost of human life, on the scale im-posed by Stalin. For only if the concentration on theproduction of capital goods is so great that inadequateresources are left over for the production ofconsumers’ goods is it possible for socialism to pro-duce more capital goods than it consumes.

78. Market socialism is an imaginary theoret-ical construction in which capitalism’s price system isappended to the body of socialism.

79. Under market socialism profits will alleg-edly serve as a “parameter,” that is, as a guide to whatto do—though, of course, no one will actually profitfrom doing what he is supposed to do.

80. The way socialism is to achieve a pricesystem is by dividing the socialist economy up intoseparate sections or firms. Each will be assigned a bal-ance at the government’s central bank. The govern-ment will set prices for all goods and services. At leaston paper, these firms will then buy from and sell toeach other; they will also sell to consumers and paywages. They will pay interest on capital to thegovernment’s central bank and even to other enter-prises, and they will record profits and losses.

81. Market socialsim is similar to socialismon the German or Nazi pattern, in that seemingly sepa-rate, independent enterprises will exist.

82. The difficulties of market socialism canbe grasped most simply by starting with the existenceof capitalism and then imagining two alternativethings to occur: (1) the government imposes price andwage controls, (2) the government obtains the powerto expropriate any firm’s or individual’s capital andturn it over to any other firm or individual at its discre-tion.


83. Advocates of market socialism assumethat the government can set prices and then vary themin just the same way that this is done under capitalism,a belief which is totally contradicted by actual experi-ence of price controls.

84. Rent controls and price controls on oilare set in exactly the same way that landlords and oilcompanies would set their rents and prices, which iswhy these parties were always very well satisfied withthe controls.

85. Government price-control officials donot and cannot control prices in the way a free marketwould have set them. For the driving force of the freemarket’s prices is the self-interests of the different indi-viduals concerned, acting in an environment of free-dom of competition. Government control of pricesnullifies this driving force.

86. Market socialism in its logically consis-tent form wants to entrust the supreme management of

the socialist economic system to firms and individualswho will have absolutely no security of property or in-centives of ownership, and then to give them discre-tion as to its investment. Their powers of discretion ininvestment would be genuine powers of ownership,but they would last no longer than the state desired.They would be in the position of people facing the con-stant threat of expropriation.

87. Market socialism in its logically consis-tent form might achieve an economic system at thelevel of, say, Turkey under the arbitrary, despotic ruleof the sultans, when no one could be secure in the pos-session of any property, when no one dared to improvehis house or fields, let alone build a factory, for fear ofhaving them seized by the government.

88. The world-wide abandonment of social-ism means that the debate over market socialism isnow closed and the correctness of von Mises’s posi-tion definitively established.

Chapter 8, Part B

89. Where the government owns all the print-ing presses and meeting halls and is the sole employer,freedom of press and speech is impossible.

90. It is not accidental, but logically neces-sary that wherever socialism has actually been en-acted, as in the Communist-bloc countries and NaziGermany, violent and bloody means have been used toachieve it and/or maintain it. And where socialist par-ties have come to power but abstained from wholesaleviolence and bloodshed, as in Great Britain, Israel, andSweden, they have not enacted socialism, but retaineda so-called mixed economy, which they did not radi-cally or fundamentally alter.

91. Even if democratically elected, a socialistgovernment must begin with an enormous act of force,namely, the theft of all privately owned means of pro-duction.

92. It takes the Communists to establish so-cialism, for the same reason that those who seriouslywant to steal must go armed and be prepared to killthose whom they plan to rob, should the latter offer re-sistance, which they almost certainly will in a case inwhich their property is to be taken en masse withoutcompensation.

93. The social democrats are unwilling to takethe bloody steps necessary to establish socialism and soleave the existing economic system essentially unchanged.

94. The leaders of a socialist society findthemselves in a dilemma in that socialism assumes re-sponsibility for people’s lives and promises them a lifeof bliss but delivers a life of hell. In the face of inevita-ble public outrage logically directed at the rulers, themaintenance of power requires hysterical propaganda,periodic purges, and a reign of terror. In the absence of

these measures, socialism would be characterized byan endless series of coups and civil wars.

95. The requirements merely for effectivelyimposing a system of price controls are an army ofspies and informers, draconian penalties for their viola-tion, and administrative tribunals to convict and punishthe transgressors.

96. Black market activity under Russian-style socialism implies the theft of state property andunder both Russian and German-style socialism, thecrime of sabotage, because it disrupts the execution ofthe national economic plan. Hence, it is not surprisingthat such “economic crimes” under socialism result inthe execution of those found guilty.

97. Under socialism it is dangerous to be aproduction manager, because one may find onselfbeing blamed for inevitable plan failures. To avoidthis, production managers under socialism need strongpolitical connections and subordinate officials avail-able for sacrifice.

98. Forced labor is implied in the very ideaof socialist planning. If the state is to plan the produc-tion of all commodities, it must also plan the skills thatthe workers will possess who are to produce thosecommodities, and where those workers are to live andwork. It is incompatible with socialist planning for pri-vate individuals to have the freedom to acquire theskills they want and to live where they want. Such free-dom would alone make socialist planning impossible.

99. What brings about forced labor under so-cialism even though it cannot plan is the existence of alabor shortage that results from socialism’s attempt toencourage the maximum possible production of eachitem. In such conditions, vital and urgent employments


of labor can be deprived of labor. To prevent this, thesocialist state exercises the power to order labor intothe employments it considers vital and urgent.

100. Forced labor existed in the SovietUnion in that

a. millions were forced to toil in concentrationcamps—the infamous Gulag system, which in theStalin years may have held as many as 20 to 30million slave laborers, a large proportion of whomdied in captivityb. all people living on collective farms—as muchas 40 percent or more of the Soviet population—were prohibited from moving away from thosefarms without the permission of the collectivefarm managementsc. at harvest time, all available urban workerscould be forced into the countryside to help bringin the harvestd. every graduate of a university or technicalschool in the Soviet Union was compulsorily as-signed to a job for a period of two to three yearsfollowing graduatione. every remaining worker in the Soviet Unionwas compelled to have a labor book that detailedall of his previous employment, including com-ments by the government officials who were hisformer employers, reasons for changing jobs, andso on. This arrangement discouraged the worker’sleaving any given job against the governmentemployer’s wishes, and was, in fact, a forcible de-terrent to changing jobs inasmuch as one couldnot obtain employment without presenting itf. it was illegal in the Soviet Union to be unem-ployedg. all of the above

101. During World War II, workers in GreatBritain, Australia, and Canada could not quit orchange their jobs without government permission, andthey could be ordered to work wherever the govern-ment required them. Similar legislation was proposedto the Congress of the United States by President Roo-sevelt in his State of the Union Message of January1944 but was not enacted.

102. By its nature socialism is a system ofaristocratic privilege, in which the citizens are viewedas means to the ends of the rulers, an outcome whichfollows inexorably from viewing the individual as themeans to the ends of society.

103. In the Soviet Union, a system of aristo-cratic privilege was manifested in such facts as

a. government assignment of different grades ofhousing based on rank in the government or Com-munist Partyb. government determination of who could andwho could not buy an automobile

c. the government’s maintainance of specialstores that were closed to the general public andwhich exclusively served high government andparty officials and their favorites in the arts andsciences; these stores carried many kinds of West-ern imports, from clothing to tape recorders, andthe limited supplies of whatever worthwhilegoods as were produced in the Soviet Union itself;while such things as meat were unavailablethroughout most of the Soviet Union for monthson end, the privileged customers of these storeswere supplied with caviard. all of the above

104. The existence of a system of aristocraticprivilege is incompatible with the slogan from each ac-cording to his abilities to each according to his needs.

105. A socialist society has no incentives ofany kind.

106. A socialist society has incentives thatare geared to the achievement of the values of the rul-ers, not to the achievement of the values of the plaincitizens. Its system of incentives is comparable to thatof an army, in which there are incentives for privatesto attempt to be promoted to corporal, and so on, butin which the purpose is to make the army a more effec-tive instrument in achieving the goals of the command-ing general, not the goals of the privates.

107. In contrast to socialism, the incentivesystem of capitalism compels the “captains of indus-try” to serve the needs of everyone.

108. As a result of a socialist state’s twinpowers over the individual’s work and consumption,everyone’s life comes to depend unconditionally onthe good graces of every government official withpower or influence. In such circumstances, not onlyare people stopped by terror from criticizing anythingthe government or any government official does, but acompetition breaks out in the positive praise and adula-tion of the government and its officials.

109. The socialist society that so many intel-lectuals have yearned for is a society in which the onlyway that intellectuals can advance is by means of dis-playing the most abject servility to Neanderthals.

110. While private slave owners in the daysof slavery were at least motivated to treat their slaveswith the same consideration they gave their livestock,forced labor under socialism goes even beyond slaveryand results in mass murder, because under socialism,the slaves are “public property”—the property of thestate—and those who have charge of the slaves, there-fore, have no personal economic interest in their livesor well-being. The slaves of socialism are slaves, butthey are no one’s property and therefore no one’s loss.




1 d 36 T 71 T 106 T2 e 37 f 72 T 107 T3 T 38 f 73 T 108 T4 T 39 T 74 T 109 T5 T 40 g 75 T 110 T6 T 41 T 76 T7 T 42 T 77 T8 T 43 c 78 T9 h 44 f 79 T

10 T 45 T 80 T11 T 46 T 81 T12 T 47 T 82 T13 T 48 T 83 T14 T 49 T 84 F15 T 50 T 85 T16 T 51 T 86 T17 T 52 f 87 T18 T 53 T 88 T19 T 54 c 89 T20 T 55 T 90 T21 T 56 f 91 T22 T 57 c 92 T23 f 58 c 93 T24 T 59 T 94 T25 T 60 T 95 T26 T 61 T 96 T27 T 62 c 97 T28 T 63 e 98 T29 d 64 T 99 T30 c 65 T 100 g31 T 66 d 101 T32 f 67 T 102 T33 d 68 c 103 d34 c 69 T 104 F35 T 70 T 105 F

CHAPTER 9INFLUENCE OF THE DIVISION OF LABOR ON THE INSTITUTIONS OF CAPITALISM

PART A: PRIVATE ONWERSHIP OF THE MEANS OF PRODUCTION

1. The belief that only the owners gain fromprivately owned means of production is manifested in

a. the belief that if you advocate capitalism, youmust be a capitalistb. the media’s surprise when a blue-collar districtvotes for a pro-free-enterprise candidatec. the belief back in the days of the cold war thatin order to save a country from communism, itwas necessary to create more capitalistsd. all of the above

2. In a non-division-of-labor society,a. privately owned means of production, such asa farmer’s field and his tools and animals, areused to produce for the consumption of their own-ers and the owners’ familiesb. the beneficiaries of the privately owned meansof production are the owners and the owners’ fam-iliesc. in order to benefit from means of production,one must be an owner of the means of productiond. all of the above

3. In a division-of-labor, capitalist marketeconomy, such as our own,

a. privately owned means of production are usedoverwhelmingly to produce for the market andonly to an insignificant extent to produce for theconsumption of their ownersb. in order to benefit from privately ownedmeans of production, it is not necessary to be anowner of the means of production but merely tobe in a position to buy the productsc. the privately owned means of production phys-cially serve nonowners as well as owners, and, in-deed, the nonowners to a far greater extent thanthe ownersd. all of the above

4. The factories and machinery of GeneralMotors and the oil wells, pipelines, and refineries ofExxon produce products which are consumed for themost part by

a. businessmen and capitalists, out of profit andinterest incomeb. by ordinary people, out of wages and salaries

5. In a division-of-labor, capitalist marketeconomy, such as our own, privately owned means ofproduction are the source of the demand for the laborof the nonowners of the means of production.

6. The more numerous and more wealthy thecapitalists are, the greater is the demand for the laborof wage earners and thus the higher is the level of

wages and the greater the ability of wage earners toconsume the products of the means of production.

7. The benefit to the nonowners from otherpeople’s private property in the form of means of pro-duction—of capital—is that it is the source of

a. the supply of what the nonowners buy b. the demand for what the nonowners sellc. both (a) and (b)

8. The benefits of privately owned means ofproduction to nonowners are generally recognized, as,for example, in the case of tenants in New York City,who recognize the value to themselves of having land-lords who are rich and own many excellent buildingsrather than poor and own only a small number of oldand run-down buildings.

9. The accumulation of capital and thus thedemand for the labor of the nonowners of means ofproduction and the supply of goods produced andavailable for the nonowners to buy is the greater, themore secure is the institution of private ownership ofthe means of production and thus the greater the pro-spective benefits from saving and accumulating capital.

10. The institution of private ownership ofthe means of production operates to the benefit of thenonowners of the means of production by providingthem with the benefit of profit-and-loss incentives andthe freedoms of individual initiative and competitionin the production of the goods and services they (thenonowners) buy.

11. The benefit of privately owned means ofproduction to nonowners is the greater and the morerapidly increasing, the more the property rights of theowners are respected.

12. The benefit of privately owned means ofproduction to nonowners is the greater and the morerapidly increasing, the more the property rights of theowners are respected. This is the case because of

a. the encouragement given to saving and capitalaccumulation by respect for property rightsb. the encouragement given to improvements inproducts and methods of production by the pros-pect of keeping more of the profits earned therebyand the concomitant absence of taxes and subsi-dies that perpetuate the use of inefficient methodsof production and the production of products nolonger desired by the consumersc. the major positive effects on capital accumula-tion of the freedom to use methods of productionthat achieve the highest possible output per unit ofexisting capital goods


the author, in wrting. [September 13, 2003.]


d. all of the above

13. The institution of private ownership ofthe means of production is to the material self-interest

a. of the ownersb. of everyone, both owners and nonowners

14. The benefit that owners of the means ofproduction derive from them that nonowners do not is

a. the receipt of profit and interestb. the ability to consume a portion of the profitsor interest and the potential of consuming the ac-cumulated capital

15. Profits and interest that are saved and in-vested

a. represent a special benefit that the owners ofthe means of production receive and that the non-owners do notb. operate in the same way as the original capital,to which they are added, and serve to benefit thenonowners by means of raising the demand fortheir labor and increasing the supply of the goodsand services they buy

16. The potential enjoyed by the owners ofcapital of consuming their capital is

a. typically taken advantage ofb. usually not taken advantage of by large capital-ists but is of great psychological comfort simplyas a potential

17. The consumption of the businessmen andcapitalists includes such things as the support of operacompanies, universities, and hospitals, and to this ex-tent is of benefit to a substantially wider circle of peo-ple than just their own families.

18. Advocates of the redistribution of wealthtypically regard the wealth of capitalists as a vast sup-ply of consumers’ goods, most of which the rich capi-talists do not need but which poor starving wageearners and others desperately need.

19. Enacting a policy of redistribution ofwealth is in fact a policy of “eating the seed corn,” inthat the overwhelming bulk of the wealth of the capi-talists is not in supplies of personal consumers’ goodsbut in means of production, including funds for thepayment of wages; it could be used to serve the con-sumption of the poor only at the expense of reducingthe ability to produce and the ability to employ labor,which would result in greater poverty than had ex-isted before.

20. What is available from the significant-sized capitalists for redistribution without directly andimmediately encroaching on their capitals is merelywhat they consume.

21. The attempt to limit the consumption ofcapitalists destroys their motivation to accumulate cap-ital or maintain capital they have already accumulated,because capital that can never be consumed or used toaugment one’s consumption is of no value. Thus the re-

sult of a redistributionist policy confined to seizingwhat the capitalists consumed would serve to reduceproduction by more than the amount seized.

22. A policy of strict protection of propertyrights, as opposed to any form of policy of redistribu-tion of wealth, makes possible continued increases inthe goods and services going to nonowners of meansof production, repeatedly doubling and redoublingtheir real incomes.

23. Government ownership of business enter-prises

a. should be welcomed by people because thenthe business firms become theirsb. should be opposed by everyone because itserves to deprive consumers of the benefit ofprofit-and-loss incentives and the freedoms of in-dividual initiative and competition in the produc-tion of the goods and services they buy

24. The superiority of public ownership overprivate ownership is confirmed by the level of serviceand efficiency displayed by the US Postal Service andAmtrak in comparision with private suppliers of com-munications and transportation services.

25. Public ownership of means of productionprovides the same special benefits of ownership asdoes private ownership of the means of production inthat the dividend payments it makes enable its ownersto consume, while the value of its shares and the poten-tial of selling them provides a nest egg for its owners.

26. Public ownership of means of productiona. provides dividends for its owners to consumeb. is the cause of higher taxes, to cover the defi-cits entailed in its inherently inefficient operation

27. A major factor bearing on the superiorityof privately owned enterprises over government-owned enterprises is the fact that the former are charac-terized by what von Mises calls profit management,while the latter are characterized by what he calls bu-reaucratic management.

28. The institution of inheritance is of benefitto heirs; nonheirs derive benefits from it only insofaras inheritances are taxed and the proceeds spent for thepublic benefit.

29. The institution of inheritancea. promotes the accumulation of capital to the ex-tent that funds are accumulated and maintainedfor the purpose of being transmitted to heirsb. by virtue of (a) serves to increase the demandfor the labor of nonheirs and the supply of prod-ucts available for nonheirs to buyc. the existence of the institution of inheritance isin the material self-interest of everyone d. all of the above

30. Only capitalists are advocates of policiesfavoring capital accumulation, because only capitalistshave something to gain from capital accumulation, in-


asmuch as more capital increases neither the demandfor labor nor the supply of consumers’ goods.

31. The true advocates of the interests of themasses are politicians urging policies of capital con-sumption.

32. Inheritance taxes serve to reduce capitalaccumulation and thus hold down both the demand forlabor and the supply of consumers’ goods, on both ofwhich the well-being of nonheirs depends.

33. Taxes that fall heavily on saving and cap-ital accumulation include

a. the inheritance taxb. the progressive income taxc. the corporate income taxd. the capital gains taxe. social security taxesf. all of the above

34. Government budget deficits and inflationundermine capital accumulation.

35. From the point of view of any given indi-vidual, the most beneficial tax cut is a cut in the taxesthat he himself pays. It follows from this that if one isa wage earner, a tax cut that reduced one’s own taxesby, say, $1,000 per year and the taxes of tens of mil-lions of other wage earners by that amount, would bemore beneficial than a tax cut of the same overall ag-gregate amount going to business and rich capitalists.

36. The economic interests of wage earnersand capitalists are mutually opposed.

37. Private ownership of land and natural re-sources encounters special hostility because of the be-lief that landowners are in a position to pocket all ofthe gains of economic progress simply by waiting forpopulation growth and accompanying diminishing re-turns to raise land rents.

38. In fact, private ownership of land oper-ates to provide the incentive basis for continuous andrapid increases in the productivity of land, whichserves to increase the supply of agricultrual productsand of minerals and thus to reduce their prices andthereby land rents and the economic significance ofland rent.

39. In 1750, the source of most wealth inGreat Britain was ownership of land. By 1850, it wascommerce and industry.

40. The economic significance of land rent inthe 19th century was reduced by great improvementsin the productivity of land due to the greater operationof the incentives provided by private ownership,which was made possible by

a. the establishment of private ownership of landin the territory of the United States from theeastern seaboard to well west of the Mississippiriver

b. the enclosure movement in Great Britain,which brought about the privatization of largeareas of land previously owned and controlledcommunallyc. the establishment of private property rights inland on the European continent, where, prior tothe French Revolution, most land was in thehands of the feudal nobility, as a monopoly privi-lege under which they alone had a legal right toown itd. all of the above

41. Today, the economic significance of min-ing rents derived from the ownership of oil depositshas been increased by policies opposed to private prop-erty rights in land.

42. A policy of privatization of lands pres-ently owned by the Federeal government in the west-ern states and in Alaska, and of the continetal shelf,and of full respect for the property rights of its ownerswould result in a substantial increase in the supplyboth of oil and its substitutes, such as coal, atomicpower, and natural gas. This would reduce the price ofoil and the mining rents derived from the ownership ofoil fields.

43. Insofar as it prevents improvements in ag-riculture and mining, the environmental movement op-erates to increase the economic significance of landrent.

44. Again and again, especially in Europeand Asia, the ownership of land can be traced back toviolent appropriation from previous owners. Neverthe-less, once land ceases to pass by violent appropriationand a free market in land is established, in which landthereafter passes by purchase and sale, the stain of vio-lent appropriation is progressively washed away. Foreach set of owners is obliged to devote his land to thedemands of the market, a market in which everyone’spurchasing power is more and more based on havingsuccessfully served the market in the past.

45. In cases in which large landed estatesexist that are less economic than would be the sameland divided into numerous small parcels

a. land reform consisting of the forcible breakupof the estates is necessaryb. a free market would bring about the breakupvoluntarily by making the sum of the value of thesmall parcels greater than the value of the presentestates, in the same way as it does when farmlandis subdivided for housing plots, commerce, and in-dustry; the alleged need to resort to forcible landreform implies the opposite of this condition

46. Just as it is not necessary for the consum-ers of products to own the means of producing thoseproducts, but merely to be free to buy them, so it is notnecessary for a country to have sovereignty over the in-dustries and natural resources that supply its citizens,


but merely for its citizens to be free to buy from thosesources of supply, wherever they might be located.

47. The citizens of Germany need iron andsteel products. But the iron mines are in France, notGermany. Therefore, the self-interest of Germans re-quires the conquest of France.

48. A country that pursued a policy of protec-tion of property rights, including the equal protectionof the property rights of foreign investors, coupledwith policies of free trade in imports and exports, andfree immigration, would give the maximum possiblebenefit of its industries, land, and natural resources tothe world as a whole. Conquest of such a country by asocialist, fascist, or any other such power would beagainst the material self-intersts of all other countriesand probably even against the material self-interest ofthe conqueror, since the policies it would impose

would serve to reduce what is available from the coun-try for its benefit too.

49. The development of a backwardcountry’s natural resources by foreign capital

a. represents economic exploitation of the poorfor the sake of profitb. enables the world to gain from the resources inquestionc. increases the local demand for labor and thuslocal wage rates, and, by providing foreign ex-change earned by the sale of the resources aroundthe world, makes possible the import of goods in-capable of being produced locallyd. all of the abovee. (b) and (c) but not (a)

Part B: ECONOMIC INEQUALITY

50. The prevailing belief concerning eco-nomic inequality is that

a. one man’s gain is another man’s lossb. the rich get richer and the poor get poorerc. one man’s gain is not another man’s lossd. one man’s gain is another man’s gaine. all of the abovef. (a) and (b)

51. The proposition that one man’s gain is an-other man’s loss

a. rests on the assumption that the amount ofwealth in the world is a fixed, static sumb. does not apply in division-of-labor society,since it makes possible a continuous increase inthe total of the wealth producedc. both (a) and (b)

52. In a division-of-labor society, differencesin wealth and income among individuals are the resultof

a. being unfairly favored or ignored by the distri-bution fairyb. differences among individuals in their capacityfor looting wealth from nature and/or from one an-otherc. differences in their positive productive contri-bution, as judged by the market

53. In a division-of-labor society, the expres-sion “distribution of wealth” realistically refers to

a. an actual, physical distribution of wealth bythe distribution fairyb. the arithmetical expression of the wealth pro-duced by various individuals or groups as a per-centage of the total of the wealth produced in thesociety

The following is a five-part question. A desert island isoccupied by Crusoe and Friday. Initially, they eachgather five coconuts per day. But then Crusoe finds away to gather ten coconuts per day, while Friday con-tinues to gather only five per day. Taking total outputas representing “national income,”

54. Calculate the respective shares of na-tional income initially going to Crusoe and Friday.

55. Calculate the respective shares of na-tional income going to Crusoe and Friday afterCrusoe’s increase in production.

56. If unequal shares of national incomegoing to groups comprising equal percentages of thepopulation is unjust, then it is unjust in the presentcase for Crusoe to increase his production.

57. Crusoe’s increase in production will bethe source of Friday increasing his production once hecopies Crusoe’s improved method of gathering coco-nuts.

58. By the time Friday copies Crusoe’s im-proved method, Crusoe may have gone on to a still fur-ther improvement, in which case economic inequalitywould both exist alongside general economic improve-ment and be a foundation of such improvement.

59. In a division-of-labor society, one man’sgain is other men’s gain on the foundation of

a. the process of productive emulation, which ispresent in competitionb. the nature of free exchange, in which both par-ties must benefitc. the sharing of the growing gains from the divi-sion of labor in the form of increasing quanititiesand improving quality of goodsd. all of the above


60. The notion of a distribution of wealthleads to the conclusion that it is unjust for one personto produce more than another.


61. Great fortunes are accumulated bya. earning a low rate of profit and consuming it allb. earning a low rate of profit and saving it allc. earning a high rate of profit and consuming italld. earning a high rate of profit over many yearsand in each year saving and reinvesting the fargreater part of it

62. The earning of a high rate of profit overmany years typically requires the introduction of a se-ries of important innovations, since competition elimi-nates the premium profit earned on any giveninnovation as soon as it can.

63. To the extent that profit is saved and rein-vested, i.e., added to capital, it increases the demandfor labor and the supply of products.

64. Both in their origin and in their use, greatfortunes are a source of gains to everyone who partici-pates in the economic system.

65. Henry Ford’s accumulation of $1 billionafter having started with about $25,000 was the reflec-tion of a series of important innovations he made inthe production of automobiles, such as the moving as-sembly line and interchangeable mass-produced parts.These were the basis of his continuing high rate ofprofit. The saving and reinvestment of those profitswas the basis of the physical expansion of the FordMotor Company from a single barn-like structurewhen it started, to the vast plants, and all the equip-ment they contained, at the time of Ford’s death. In ef-fect, Ford’s profits were the reflection of theimprovements he provided for the automobile-buyingpublic and his fortune was the means of physically pro-ducing and delivering them to that public on an ex-panded scale.

66. What is true of the origin and dispositionof Ford’s fortune is true, mutatis mutandis (i.e., withthe necessary changes), of great business fortunes ingeneral.

67. Relative rates of growth or decline in ac-cumulated wealth are the result of a combination of rel-ative rates of profit and relative degrees of saving outof profits.

68. If 10 percent of the population in a divi-sion-of-labor society owns 90 percent of the wealth ofthe society, what that signifies is that

a. some people have contributed more to produc-tion than others—in the more important cases, in-troducing a series of major improvements intoproduction, and then saving and investing veryheavily out of the higher incomes they earned

b. the 90 percent of the wealth that is owned bythe 10 percent then serves the 90 percent of thepopulation that did not contribute as much to pro-ductionc. because of the freedom of the 10 percent to cre-ate and earn the wealth and income they do, thereis incalculably more wealthd. because of the freedom of the 10 percent tocreate and earn the wealth and income they do,there is more saving and the means of productionthat exist at any given time are more efficientlyused, both of which facts are causes of the continu-ous further increase in the supply of means of pro-duction—of capital goods—that are used toproduce overwhelmingly for the benefit of the 90percent of the population that allegedly owns only10 percent of the wealth of the economic systeme. all of the above

69. If 10 percent of the population in a divi-sion-of-labor society, capitalist society owns 90 per-cent of the wealth of the society, what that actuallysignifies is that

a. 90 percent of the wealth of the society is notonly owned but was also created and earned bythe 10 percent who own it (or by their parents orgrandparents)b. 10 percent of the society makes possible thefar greater part of the real incomes of the 90 per-centc. both (a) and (b)

70. According to the Marxian doctrine oneconomic inequality

a. the inequality between capitalist and worker isessentially no different than the inequality that pre-vailed in earlier periods of history between masterand slave or between lord and serfb. all of history is the record of one continuousclass struggle that has been carried on in differentforms and under different guises—in the AncientWorld, between master and slave; in the MiddleAges, between lord and serf; in modern times, be-tween capitalist and workerc. the worker under capitalism is a slave—a“wage slave”d. the capitalist is an “exploiter,” even more ruth-less than the feudal lord or ancient slave ownere. all of the above

71. The essential differences between eco-nomic inequality under capitalism and economic in-equality under feudalism are

a. economic inequality under feudalism is the re-sult of theft by the nobility from the serfs, with theresult that the enrichment of the nobility is at theexpense of the impoverishment of the serfsb. economic inequality under capitalism is the re-sult of differences in positive productive contribu-tion, in which the greater productive contributionof the businessmen and capitalists serves to in-


crease the wealth available to all and from whichall gainc. both (a) and (b)

The following is a five-part question. John KennethGalbraith wrote: “The worker in a Calcutta jute millwho loses his job—like his American counterpart dur-ing the Great Depression—has no high prospect ofever finding another. He has no savings. Nor does hehave unemployment insurance. The alternative to hispresent employment, accordingly, is slow but definitestarvation. So though nominally a free worker, he iscompelled. The fate of a defecting southern slave be-fore the Civil War or a serf before Alexander II wasnot appreciably more painful. The choice between hun-ger and flogging may well be a matter of taste.” (TheNew Industrial State, 2d ed. rev., p. 141.)

72. Galbraith claims that what we think of asconstituting free labor is so in name only, while in sub-stance it is the same as slavery. Thus, as in the novel1984, for Galbraith, “freedom is slavery.”

73. An essential difference, ignored by Gal-braith, in the relationship between a slave owner andthe suffering of his slave, on the one hand, and an em-ployer and the suffering of his poor, hungry worker,on the other, is that the slave owner and his whip arethe cause of the slave’s suffering, while the employerand the wages he pays are the cause of the alleviationand prevention of the worker’s suffering hunger

74. A further essential difference, ignored byGalbraith, is that what keeps a worker at his job underslavery is physical force: chains, whips, and guns;while in the case of the worker in the Calcutta jutemill, physical force would probably need to be appliedto keep the worker from his job, because it is the posi-tive source of what keeps him alive and what he des-perately wants to have, not what he desperately wantsto run away from.

75. Yet another vital aspect of freedom ig-nored by Galbraith is that it is essential if the worker isto be able choose the best of whatever employment op-portunities may be open to him, and that even if noother such opportunities are currently open to him, it isalmost certain that some will be at some point. Thefree worker can then choose the best among them; theslave cannot.

76. Lack of employment opportunities is it-self the result of the violation of freedom, i.e., the free-dom to offer and accept the lower wage rates whichwould serve to increase the quantity of labor de-manded to the point of sufficient jobs being availableto provide opportunities for alternative employment.

77. According to feudalism, landed estateswere not the property of any given individual, but ofhis bloodline, and thus of his unborn children and

grandchildren, and their descendants, as much as him-self. On this basis, the sale of land by the nobility or itspossible loss as collateral on loans was forbidden.

78. The feudal nobility were not landownersin the proper sense of the term, because

a. they lacked essential rights of owners, in thatthey could not sell the lands that were allegedlytheirs, nor fire workers who became unnecessary,nor seek to attract workers from the estates ofother noblemenb. they possessed powers that are no part of own-ership, such as those of “low” and “high” justice(i.e., the respective powers to flog and hang)c. their position was actually that of governmentofficials, analogous in effect to that of hereditarycommanders of military basesd. all of the above


79. Socialism views the individual not as anend in himself, but as a means to the ends of “society.”

80. The ends of “society” can easily belearned by asking it in person, or, if you know itsphone number or address, by means of a telephone callor correspondence.

81. The ends of “society” can never be di-rectly known, since “society” is not a real, living en-tity, but only an idea or abstraction, and thus any endsthat it may allegedly have must first be interpreted ordivined by a special class of people, namely, the rulersof the socialist state.

82. Socialism’s view of the individual as ameans to the ends of “society” reduces to the view ofthe individual as a means to the ends of the rulers ofthe socialist state.

83. Socialism, rather than capitalism, by thenature of its view of the purpose of the individual, rep-resents a revival of the conditions of feudal-type in-equality.

84. The existence, in the days of the Commu-nist bloc, of special stores, housing, schools, and hospi-tals reserved exclusively for members of theCommunist Party and government elite followed fromthe nature of socialism’s view of the purpose of the in-dividual.

85. The law of diminishing marginal utility isused to justify attempts to equalize wealth and income,e.g., by means of progressive income taxes, on thegrounds that the marginal utility of a unit of wealth isless to a richer, higher income individual than it is to apoorer, lower income individual and thus that an in-crease in overall marginal utility to society can beachieved by transferring units of wealth from the richto the poor.

86. The use of the law of diminishing mar-ginal utility to justify the seizure of others’ wealth orincome ignores the fact that


a. “society” is not a living, valuing being and isthus incapable of experiencing marginal utility ofany kindb. all judgments of value and marginal utilitymust always be those of specific individualsc. to any given individual the marginal utility ofhis nth unit of wealth or income can be and usu-ally is greater to him than the marginal utility tohim of the first unit of wealth enjoyed by strang-ers—e.g., that he values a desert in his own stom-ach above the value he attaches to essentialnutrition in the stomach of a strangerd. from the perspective of the individual, the lossof his desert for the purpose of feeding an anony-mous stranger most likely represents a loss of util-ity, which is demonstrated by the fact that whenthey are free to choose, most people continue toeat desert (or at least substantially beyond the min-imum essential for bare survival) rather than sacri-fice it for the benefit of otherse. all of the above

87. If an individual benefits from something,he implicitly benefits from what created and now main-tains that something. Thus an individual who benefitsfrom his ownership of an automobile, say, implicitlyindirectly benefits from the automobile factory thatproduced the automobile and all of the other comple-mentary means of production directly or indirectly re-quired to produce his automobile. He also benefitsfrom the gas he buys to keep his car running and theoil changes needed to maintain its performance.

88. The selfish thing for the owner of a car todo is to refuse to buy gas for his car, because the gasbenefits the car, not him.

89. The selfish thing for a parent who loveshis child to do is to refuse to buy food for his child,since the food benefits the child, not him.

90. The selfish thing for a person who valuesa friend to do is never to help that friend, because onlythe friend would benefit, not him.

91. Human beings can be selfishly concernedwith the well-being of the rest of mankind

a. in the same way that when they watch moviesor read novels, they are concerned with innocentvictims escaping harm and generally value happyendingsb. up to a point that is probably no greater thantheir concern with literature and artc. both (a) and (b)

92. The solution to the problem of massive,overwhelming poverty on a global scale is

a. private charityb. governmental foreign aid c. knowledge of the science of economics and theestablishment of capitalism, to make it possiblefor average people everywhere to support them-selves in abundance

93. The doctrine of external benefits goes be-yond the egalitarian version of diminishing marginalutility in that, according to its logic, if a painting isstolen from the private collection of a millionaire whodoes not appreciate it very highly, and is stolen notmerely by someone who appreciates it more, but bysomeone who exhibits it to multitudes of others, manyof whom also appreciate it more, then what is presentis not only the alleged gain in marginal utility that ex-ists by virtue of the painting falling into the hands ofthe more-appreciative thief, but also the further al-leged gain of the more-appreciative multitude’s enjoy-ment, which is an alleged “external benefit” of thetheft.

94. As an attempt to wring benefits for othersfrom sacrificial victims, by means of force, the exter-nal-benefits doctrine destroys the basis of the exis-tence of benefits to others being a value to anindividual, for he is being asked to value the satisfac-tions of his tormentors. It is thus a self-nullifcation.

The following is a four-part question. “Abilities aremuch more equally distributed than are incomes . . . .While human traits seldom differ by more than a fac-tor of 3, high incomes today are more than 100 timesgreater than the lowest.” (Paul Samuelson and WilliamNordhaus, Economics, 13th ed. (New York: McGraw-Hill Book Company, 1989), p. 649.)

95. The meaning of the above quotation isthat economic inequality has little or nothing to dowith ability, inasmuch as the “distribution” of incomedoes not follow the pattern of distribution of ability, asindicated, for example, by IQ tests. In the case of IQs,approximately 99 percent of the population has an IQbetween 50 and 150, i.e., the inequality is rarelygreater than a factor of 3.

96. According to the logic of the above quo-tation, what would be necessary for intelligence to bethe explanation of inequalities of income would be ifthe earnings of those with IQs of 150 were only threetimes as high as those with IQs of 50, rather than onehundred or more times as high—in other words, if theearnings of geniuses were only three times those ofmorons, rather than a hundred or more times those ofmorons.

97. The “distribution” of income and wealthis more skewed than the normal curve, because con-trary to the above quotation, the effect of intelligence,when present in appropriate combination with othernecessary factors, is exponential, not linear. That is,each additional few points of intelligence, or, better,productive ability (however that might be preciselygauged) should be expected to yield exponentially in-creasing results. Those of average ability, representedby IQs of 100, should be expected to earn substantiallymore than twice as much as morons, represented byIQs of 50. Productive geniuses who revolutionize the


work of hundreds of thousands of individuals and theconsumption of hundreds of millions, should be ex-pected to earn and accumulate many thousands oftimes the wealth and income of the average person,which, in fact, is what they do. In connection with pro-ductive geniuses, moreover, it should be recognizedhow crucial is that extra measure of intelligence andability which separates them from individuals who aremerely very bright, and which gives the geniuses theability to conceive of the new and original, not merelyrepeat what others have done, which is all that eventhe merely very bright can do.

98. The “distribution” of income and wealthis more skewed than the normal curve, in part becausethe success of men of exceptional ability so radicallyincreases the wealth and income of all individuals oflesser ability. This makes the negative deviations fromthe mean value of wealth and income much smallerthan the positive deviations. Thus, while productive ge-niuses may earn a thousand or more times what the av-erage individual earns, productive morons, to coin aphrase, earn many times more than one one-thou-sandth of what a person of average ability earns.

99. The equality-of-opportunity doctrinea. views opportunities as fundamentally externalto the individual—in effect, as various dishes carriedby waiters on trays, which, under capitalism, are ar-bitrarily served to some and withheld from othersb. wants the government to seize control not, itsays, of the distribution of wealth and income, butmerely of the distribution of these dishes, as itwere—that is, of the opportunities to earn wealthand income—and so give everyone an equalchance c. provides a basis for the confiscation of inheri-tances, public education through the postgraduatelevel, and laws preventing private discriminationon the basis not only of such factors as race, reli-gion or national origin, but also age, medical con-dition, and physical handicap, which laws areadvocated as necessary to the provision of equalopportunitiesd. is a fallback position for advocates of eco-nomic equalitye. all of the above

100. Besides inequality of financial inheri-tance, other factors that affect the opportunities a childhas, including his opportunity to earn wealth and in-come, are

a. the intelligence of his parents, their educationand vocabulary, their system of values, and theirlove for him and treatment of him, not to mentiontheir level of income and the kind of material lifethey lead and thereby expose him to while he isgrowing upb. his genetic inheritance, especially as it relatesto his intelligence, looks, and healthc. both (a) and (b)

101. To achieve equality of opportunity, itwould be necessary not only to abolish or otherwiseequalize financial inheritances, but also to bring childrenup in the same environment, i.e., in government orphan-ages, and give them equal genetic inheritances, i.e., adopta program of eugenics and genetic engineering.

102. The doctrine of equality of opportunityis as much against the nature of reality as is the doc-trine of the out-and-out equality of wealth and income.

103. The last time the appointment of a newPresident of General Motors was considered, my namedid not appear on the short list of candidates, or evenon the long list. Thus I did not have any equality of op-portunity in connection with the choice of a new Presi-dent by GM’s board of directors. The same is true inrelation to the appointment of virtually all companypresidents over the course of my lifetime. As far as mychances of being made a company president are con-cerned, I have never been able to play on a level field.In fact, it would be more accurate to say that I’ve beentotally off any kind of field, in a deep ditch. In all suchcases only individuals who had already achieved high-level executive positions were considered for the jobof president. Those who, like myself, had not been ahigh-level executive, were simply not given an oppor-tunity to be considered.

104. Opportunitiesa. are occasions on which successful action ispossibleb. exist every time there is the possibility of im-proving oneself in any way, such as in terms ofknowledge and skillc. are never a matter merely of external circum-stances that are served up on a plate, as it were,but always depend on what the individual himselfbrings to the external circumstances in the way ofskills and abilities, which in turn are the cumula-tive product of what the individual has done withhis life up to that point, reflecting his initialchoices to use his genetic inheritance to deal withexternal circumstances in ways that developed cer-tain skills and abilities, and then further choices touse those skills and abilities to deal with furtherexternal circumstances in ways that developedstill further skills and abilities, and so on up to thepresent momentd. are created by individuals on the basis of previ-ous choices that have developed various skills andabilitiese. all of the above

105. A child who chooses to use his mind tolearn arithmetic thereby creates an indispensable pre-condition for the potential opportunity to learn alge-bra. Unless and until he learns arithmetic, there can beno possibility of any opportunity for him to learn alge-bra.

106. The individual who exploits the opportu-nity to become a worker in a factory thereby creates a


possible basis for his later on becoming a foremanthere. If he becomes a foreman, he creates a possiblebasis for later promotion to a higher managerial posi-tion, and so on.

107. Opportunity presents itself as the rungsof a ladder. Each rung is open only to those who haveclimbed within reach by ascending previous rungs.

108. It is ludicrous to think that what a per-son does is the outcome merely of his environmentand genes. In between the environment and the genesis a lifetime of choices, each of which has a vital bear-ing on the individual’s ability to deal with his environ-ment and to make further choices.

109. It is not necessary that people make thechoices that develop their skills and abilities at any pre-cise moment. There is considerable leeway. And it isnever completely too late to start. For example, some-one can learn to read even in old age and then beginrapidly to build on that foundation.

110. In a free society, everyone, whatever hisstarting point in life, is able to raise himself very far, ifthat is what he chooses to do. He can miss many,many opportunities, and still there will be more. Hecan begin improving his ability to exploit them at anytime, and start moving up from that moment.

111. The freedom of opportunity means theability to exploit the opportunities afforded by reality,without being stopped by the initiation of physicalforce.

112. Given man’s limitless need and desirefor wealth and the fact that production is limited onlyby the availability of labor, it follows that employmentopportunities are potentially far in excess of the abilityof people to work and that choices must be made be-tween which employment opportunities are to be ex-ploited and which are not to be exploited.

113. What explains the side-by-side exis-tence of virtually limitless employment opportunitiesand mass unemployment is violations of the freedom

of people to exploit employment opportunities, as inthe case of employers being prohibited from paying,and wage earners from receiving, wage rates below co-ercively imposed labor-union scales or legal minimumwages, which lower wage rates would expand thequantity of labor demanded and open up jobs for allwho wanted a job.

114. If two individuals in a free society wereborn equal in every respect, except that one had richerparents than the other, and if they both actively andconstantly chose to develop their skills and abilitiesfrom birth on, the one with the richer parents wouldprobably always be ahead of the one with the poorerparents.

a. this is an embarrassment to a free societyb. it is perfectly just that things be this way, be-cause what else is wealth for if not to provide ben-efits compared with not having it?; moreover, thegreater wealth of the one can benefit the other notonly in the ways explained in connection with thediscussion of the general benefits from the institu-tion of inheritance, but also in the more specificway of the two possibly becoming unequal part-ners in an arrangement that enables the poorerpartner to increase his wealth far more rapidlythan he otherwise could, thanks to the use of thericher one’s capital

115. On the basis of the fact that the individ-ual creates his own opportunities, it is possible for achild born to poor parents, and suffering numerousother disadvantages, ultimately to far outstrip in his ac-complishments practically everyone else, includingchildren born to extremely wealthy parents and enjoy-ing all manner of other initial advantages.

116. One of the consequences of the equality-of-opportunity doctrine is that it causes some parentsdeliberately to do less for their children than they oth-erwise would, on the grounds that other parents are un-able to do as much.

Part C: ECONOMIC COMPETITION

117. Competition in the animal kingdom isa. competition in the grabbing off of limited sup-plies of nature-given necessities, such as nuts andberries growing on trees or zebras and gazellesroaming the forest or plainb. won by those animals with the keenest senses,the greatest speed, and the strongest teeth andclaws; they get the food; the older, weaker ani-mals die of starvation and diseasec. the law of the jungle, the survival of the fittestd. all of the above

118. Animals must take their environment asthey find it; they lack the power to adapt it to them-selves. Thus, for example, lions in the jungle are inca-

pable of enlarging the supply of the animals they re-quire as food.

119. In sharpest contrast to the animals,man’s possession of reason enables him to identify theconditions on which his well-being depends and totake effective action in improving those conditions,from actually growing food for the animals he wantsto eat, to reshaping the chemical elements of the earthinto an ever expanding array of products, from air con-ditioners to zippers, and doing all of it ever more effi-ciently.

120. Economic competition, in contrast tocompetition in the animal kingdom, is competition inthe positive creation of new and additional wealth.


121. IBM and Apple, General Motors andToyota, are in competition

a. for limited supplies of computers and automo-biles growing on the computer and automobiletreesb. in the positive creation of new and better com-puters and automobiles

122. Economic competition has in commonwith athletic competition an upward ratcheting of stan-dards accompanied by continual efforts to match andexceed the rising standards.

123. The effect of competition among foodgrowers and pharmaceutical manufacturers on the hun-gry and the sick is to

a. grab away their food and medicinesb. provide them with food and medicine, andmore and better as time goes on

124. Because it is competition in the positivecreation of new and additional wealth, in the nature ofthe case there are no long-run losers as the result ofeconomic competition.

125. Everyone is related to the process ofeconomic competition in his capacity both as a con-sumer and as a producer.

a. as a consumer, he simply benefits from all ofthe competition that takes place in the productionof whatever he buysb. as a producer, he may sometimes lose his jobor ownership position as the result of the competi-tion that takes place in the good he produces, inwhich case, his benefit from this specific competi-tion may be delayed until such time as he has rees-tablished his position as an income earner andnow benefits in his capacity as a consumer evenfrom the improvement that initially displaced himc. both (a) and (b)

126. Under economic competition, individu-als can sometimes lose their jobs, or even ownershippositions, as the result of the adoption of labor-savingimprovements or of the products their firms producebeing made obsolete. In such cases, there are short-runloss periods of different length for unskilled workers,skilled workers, and those who lose invested fortunes.

127. The short-run loss periods fora. unskilled workers can be as short as a few daysor weeksb. skilled workers can be as long as severalyears—however long it takes to acquire a compa-rable level of skill and ability in a different line ofwork and thereby earn a level of income compara-ble to what one earned initiallyc. the losers of invested fortunes, can be as longas the rest of their livesd. all of the above

128. Blacksmiths and horsebreeders whowere displaced by the automobile

a. died of starvation

b. ended up with the benefits of the automobileand of more efficient transportation in the produc-tion of virtually all of the products they bought,thanks to trucks displacing horse-drawn wagons

129. Once individuals who lose a given com-petition succeed in acquiring a level of skill and abilityin a different line of work comparable to what theypossessed in their initial line of work, and thereby rees-tablish their position as income earners, they end upbenefitting even from the very improvements in pro-duction that initially caused them a loss.

130. Under continuing competition and re-sulting economic progress, a young man who loses aninvested fortune (presumably inherited) as the result ofcompetition, and who is thus reduced to the status ofan average wage earner, could nevertheless ultimatelystill come out ahead in terms of his material standardof living, assuming that there is enough economicprogress to make the standard of living of the averagewage earner two generations later surpass that of mil-lionaires when the fortune was lost.

131. A sixty-five year-old man who loses aninvested fortune will probably never reestablish his po-sition as an income earner. And if he loses his fortunein his youth, the fact that in his old age his standard ofliving as an average wage earner may finally surpasswhat it was when he was a millionaire is not sufficientcompensation, since he will not be alive long enoughto make up for his loss. Thus, the losers of invested for-tunes who cannot quickly reacquire their fortunes canlegitimately claim that economic competition reducestheir standard of living.

132. The losers of invested fortunes who can-not quickly reacquire their fortunes, and skilled work-ers who lose their jobs and cannot acquire skills andearning capacity in other lines of work comparable towhat they had before, can legitimately claim that

a. economic competition harms themb. that it now gives them less than it used to givethem, while still giving them virtually everythingthey have, inasmuch as it underlies virtually thewhole of what is produced and the efficiency withwhich it is produced

133. Those who denounce competition as the“law of the jungle” implicitly support the real law ofthe jungle, insofar as they imply a case for the use ofphysical force to maintain their standard of livingthrough suppressing the economic competition of oth-ers, an act which constitutes the human equivalent ofliving by means of teeth and claws.

134. Economic competition, rather thanbeing in conflict with economic security, is in fact anessential foundation of economic security, in that it un-derlies the existence and availability of the materialgoods on which economic security depends.

135. The hardships of those who lose theirjobs as the result of economic competition would be al-


leviated if there were more freedom of competitionrather than less, for what anyone who loses his job re-quires is the fullest possible freedom to compete in therest of the economic system, so that he will be able toexploit the best of the opportunities available to him.

136. Seniority systems artificially increasethe length of the short-run loss periods.

137. Restrictions on economic competitioncreate a seeming need for further such restrictions, inthat, by closing off opportunities for employment, theymake the consequences of losing a given competitionmore severe.

138. The law of comparative advantageshows that there is room for everyone in the economiccompetition of a division-of-labor society, even if he isproductively less capable than other people in every re-spect.

139. If country A is only half as efficient ascountry B in the production of every good, then

a. country A simply cannot compete with country Bb. country A can compete with country B, pro-vided its wages rates are half of those of B

140. Country B is more efficient than coun-try A in the production of every good without excep-tion. Its productive superiority ranges from twice asefficient to ten times more efficient, with an averagesuperiority of five times the efficiency. (Twice as effi-cient means B requires only half the labor of A. Tentimes as efficent meant that it requires only one-tenththe labor.) Thus

a. country A simply cannot compete with country Bb. country A will outcompete country B in theproduction of all goods in which its productive in-feriority is less than a factor of five, provided itswages rates are one-fifth of those that prevail incountry B

141. Free international trade does not causeunemployment if a country’s relative wage rates arefree to adjust to correspond to its relative productivitylevel.

142. Select the best of the choices below.a. Free international trade promotes world peace.b. Government-supported labor-union interfer-ence stands in the way of free international tradeby preventing the necessary adjustment of relativewage rates to the relative productivity of labor,thereby making substantial unemployment theprice of free trade.c. Free international trade depends on free labormarkets domestically.d. all of the above

143. A productive genius as great as Edisoncan benefit from being able to employ the humblestcleaning lady, despite the fact that he could almost cer-tainly clean his office in the barest fraction of the timeit takes her to clean it. His gain is the release of his

time for tasks in which his comparative advantage isgreater, indeed, infinite.

144. Even though it might take Edison one-tenth the time to clean his office as it takes the humblecleaning lady of the previous question, she can easilyoutcompete Edison for the job of cleaning lady if thehourly wage that would have to be paid to Edison is athousand or more times higher than the hourly wagethat has to be paid to her.

145. The fact that Edision is there to do thejob of Edison is very much to the material self-interestof the humble cleaning lady, because it will enable herto obtain goods which, left to herself, she would proba-bly never have been able even to imagine, such as elec-tric light and the phonograph.

146. The pyramid-of-ability principle showshow the competitive success of the more able serves toraise the productivity and standard of living of the lessable in a division-of-labor society.

147. The scarcity of labor in relation topeople’s need and desire for products and servicesguarantees that in a free market there is room for all inthe economic competition of a division-of-labor soci-ety, with comparative advantage and relative wagerates determining who will go where.


148. When a more qualified individual suc-ceeds in outcompeting a less qualified individual, hisgain is also the gain of the consumers of the producthe produces or helps to produce.

149. If I could be president of a major corpo-ration, my income and standard of living would dra-matically improve. However, I have no hope ofobtaining such a position through free competition.Thus free competition stands in the way of my stan-dard of living.

150. If, despite my lack of qualification, I be-came the president of a major corporation and misdi-rected the labor of hundreds of thousands of workersand the use of tens of billions of dollars of capital, themagnitude of the losses I caused to others would farexceed the increase in my own income and wealth.

151. If, throughout the economic system, oth-ers equally unqualified as myself came to occupy sim-ilar positions of major responsibility which theyproceeded to abuse, I would lose back in my capacityas a consumer far more than I gained in greater incomeand wealth. I would not be able to trust the airlines Iflew, or the medications I consumed, or the surgeonwho might be called upon to operate on me. It is to myself-interest, and the self-interest of everyone, thatmore qualified individuals be free to outcompete lessqualified individuals—from more qualified executivesoutcompeting less qualified executives down to more


qualified workmen, such as mechanics, plumbers, andelectricians, outcompeting less qualified workmen.

152. When understood as a principle operat-ing throughout the economic system, the competitivesuccess of the more qualified individuals over the lessqualified individuals is the source of gains

a. only to the more qualified individuals, whowin the competitionsb. to the less qualified individuals, who lose thecompetitions, as well as to the more qualified indi-viduals who win the competitions

153. In a division-of-labor society with a freemarket, the less qualified individuals who lose thecompetitions must

a. die of starvationb. find other jobs, in which their comparativelack of ability is least and is more than offset bytheir acceptance of lower wage rates, which as-sures that these are competitions that they win

154. Select the best of the choices below.a. The law of comparative advantage shows thegains to the more able of cooperating with the lessable in a division-of-labor society. b. The pyramid-of-ability principle shows thegains to the less able of cooperating with the moreable in a division-of-labor society. c. Both principles are aspects of the wider principleof the harmony of rightly understood material self-interests of all men in a division-of-labor society. d. all of the above

155. Competition isa. in conflict with social cooperationb. the process of organizing and improving the ef-ficiency of the division of labor, which is the sumand substance of social cooperation

156. Competition is the process of organiz-ing the division of labor with respect to

a. persons for jobs, e.g., who will be companypresident, who will be janitor, and who will fillany other positionb. products for markets, i.e., which products andwhich models will supply which markets to whatextentc. which methods of production will be used andto what extentd. all of the above

157. Population growth in a non-division-of-labor society can represent a competitive conflict ofinterests as the larger numbers more and more encoun-ter the effects of diminishing returns.

158. In contrast, population growth in a divi-sion-of-labor society

a. makes possible an extension of the division oflaborb. increases the liklihood of technological prog-ress by virtue of increasing the numbers of people

engaged in the discovery and application of newscientific and technological knowledgec. can easily more than offset the effects of dimin-ishing returns through accelerating the pace oftechnological progressd. all of the above

159. The large populations of great cities iswhat makes possible the great variety of shops and cul-tural attractions to be found in them, in that, in them,even needs and desires that appear in only modest fre-quency amount to sufficiently great absolute numbersto make it worthwhile for people to specialize in meet-ing those relatively infrequent needs and desires.

160. If, on a given day, only one person in ahundred thousand is interested in buying a 19th cen-tury mystery novel, that nevertheless represents the po-tential of a hundred customers per day in a city of tenmillion inhabitants.

161. Freedom of immigration into a division-of-labor, capitalist society would

a. reduce the wage rates of unskilled labor rela-tively to the wages of skilled laborb. probably enable the middle class to afford toemploy servantsc. serve to accelerate the rate of economic progressas immigrants with talent, and the talented childrenof immigrants, came into an environment in whichthey were free to develop and apply their talentsd. all of the above

162. The existence of a fixed quantity ofmoney, and a corresponding fixed volume of spendingin the economic system, would represent a situation inwhich

a. there was a genuine conflict of interests as a re-sult of the fact that the competition of larger num-bers of workers would drive down wage ratesb. the competition of larger numbers of workerswould drive down prices as well as wage rates,and to a greater degree than wage rates insofar asit served to increase the productivity of labor, i.e.,the output per worker

163. The existence of a fixed quantity ofmoney, and a corresponding fixed volume of spendingin the economic system, would represent a situation inwhich an increase in output on the part of one grouprelative to that of other groups would serve to increasethe money income of that one group while equiva-lently reducing the money income of all other groups.This would

a. represent a conflict of interests among thegroupsb. not represent a conflict of interests among thegroups, because the resulting fall in prices wouldoffset the fall in money incomes, and the fall inprices would be greater than the fall in the moneyincome of any group to the extent that it increasedits productivity.



Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 d 29 d 57 T 85 T 113 T 141 T2 d 30 F 58 T 86 e 114 b 142 d3 d 31 F 59 d 87 T 115 T 143 T4 b 32 T 60 T 88 F 116 T 144 T5 T 33 f 61 d 89 F 117 d 145 T6 T 34 T 62 T 90 F 118 T 146 T7 c 35 F 63 T 91 c 119 T 147 T8 F 36 F 64 T 92 c 120 T 148 T9 T 37 T 65 T 93 T 121 b 149 F10 T 38 T 66 T 94 T 122 T 150 T11 T 39 T 67 T 95 T 123 b 151 T12 d 40 d 68 e 96 T 124 T 152 b13 b 41 T 69 c 97 T 125 c 153 b14 b 42 T 70 e 98 T 126 T 154 d15 b 43 T 71 c 99 e 127 d 155 b16 b 44 T 72 T 100 c 128 b 156 d17 T 45 b 73 T 101 T 129 T 157 T18 T 46 T 74 T 102 T 130 T 158 d19 T 47 F 75 T 103 T 131 F 159 T20 T 48 T 76 T 104 e 132 b 160 T21 T 49 e 77 T 105 T 133 T 161 d22 T 50 f 78 d 106 T 134 T 162 b23 b 51 c 79 T 107 T 135 T 163 b24 F 52 c 80 F 108 T 136 T25 F 53 b 81 T 109 T 137 T26 b 54 50:50 82 T 110 T 138 T27 T 55 2:1 83 T 111 T 139 b28 F 56 T 84 T 112 T 140 b


Chapter 10

The Meaning of Freedom and of Freedom of Competition

1. According to the rational concept of free-dom,

a. freedom means the absence of the initiation ofphysical force—in particular, on the part of thegovernmentb. viewed in a positive light, freedom is the free-dom to do whatever one is otherwise capable ofdoing, unconstrained by the initiation of physicalforcec. the inability to perform logical contradictions,to violate the laws of mathematics or of nature, orto resort to physical force against others withoutfear of apprehension and punishment are not viola-tions of freedomd. all of the above

2. According to the anarchic concept of free-dom,

a. freedom is the ability to do whatever one maywish to dob. is violated by obstacles that stand in the wayof the realization of one’s desiresc. both (a) and (b)

3. According to the anarchic concept of free-dom, “freedom of competition”

a. is violated by the existence of high capital re-quirements that most people cannot meetb. is violated by the need for technologicalknowledge and managerial skills that most peopledo not possessc. would be promoted if goods could be producedin simple barn-like structures rather than in costlymodern factoriesd. would be promoted if the level of technologi-cal knowledge and managerial skill required werewithin the range of all, or at least of the majorityof peoplee. all of the above

4. High capital requirementsa. constitute a violation of the freedom of compe-titionb. exist as the result of the freedom of competi-tionc. are the result of the fact that other producers inthe industry, who are probably using largeamounts of capital in their operations, are charg-ing low prices; their low prices necessitate that tobe profitable, one must have low costs of produc-tion, which, in turn, are achieved by the employ-ment of large sums of capitald. all of the abovee. none of the abovef. (b) and (c) but not (a)

5. According to the political concept of mo-nopoly,

a. monopoly is a market, or part of a market, re-served to the exclusive possession of one or moresellers by means of the initiation of physical forceby the government, or with the sanction of thegovernmentb. monopoly exists insofar as the freedom of com-petition is violated, with the freedom of competi-tion being understood as the absence of theinitiation of physical force as the preventive ofcompetitionc. where there is no initiation of physical force toviolate the freedom of competition, there is nomonpolyd. the freedom of competition is violated only in-sofar as individuals are excluded from markets orparts of markets by means of the initiation of phys-ical forcee. monopoly is something imposed upon the mar-ket from without—by the governmentf. all of the above

6. According to thea. political concept of monopoly,b. the economic concept of monopoly,

monopoly is something which emerges from the nor-mal operation of the economic system, and which thegovernment must control.

7. The political concept of monopoly is thecorollary of the rational concept of freedom in generaland the rational concept of the freedom of competitionin particular.

8. According to the political concept of mo-nopoly, monopoly is, as it was originally understood tobe, an exclusive grant of government privilege, such aswas extended by English monarchs in earlier centuriesto the British East India Company and to variousguilds of producers or merchants.

9. According to the original meaning of mo-nopoly, the British East India Company was a monop-oly because

a. it was the only company conducting trade be-tween England and Indiab. it was the only company legally allowed toconduct trade between England and India

10. According to the political concept of mo-nopoly, leading present-day examples of monopoly are

a. exclusive government franchisesb. licensing lawsc. tariffsd. minimum-wage and prounion legislation




e. government-owned and government-subsi-dized enterprisesf. the antitrust lawsg. all of the above

11. Examples of exclusive government fran-chises have included, and for the most part still in-clude, electric, gas, and water service, cable television,local telephone service, and, in many localities, localbus service.

12. Exclusive government franchises consti-tute monopolies according to the political concept ofmonopoly, because they reserve markets to the exclu-sive possession of the holders of the franchises, and doso by means of the government’s initiation of force.

13. What is essential to the monopoly consti-tuted by exclusive government franchises is the factthat

a. there is only one sellerb. the market is reserved to the exclusive posses-sion of that seller by means of the initiation ofphysical force

14. For many years, Alcoa was the only sup-plier of aluminum ingot in the United States. Neverthe-less, according to the political concept of monopoly,this fact did not make Alcoa a monopoly

15. What made it possible for Alcoa to be thesole supplier of aluminum ingot was

a. its ability and willingness to produce and sellits aluminum at prices that were profitable to it,but yet too low for any potential competitor to beprofitableb. the initiation of physical force on its behalf bythe government.

16. If the freedom of competition resulted inonly one electric or gas company supplying a givenarea, that would not make that company a monopolyaccording to the political concept of monopoly.

17. Under the freedom of competition, inorder for a company to be the sole supplier of gas orelectricity, it would have to offer its customers lowerrates and than any other supplier offered and would al-most certainly have to offer its customers contractualguarantees concerning its rates, so that they would nothave to fear temporary arbitrary increases in the periodin which competitors did not yet have the time re-quired to enter the field.

18. Exclusive private franchises, such as Mc-Donalds, are not monopolies according to the politicalconcept, because granting them represents merely thechoice of private property owners to decide who is andwho is not to receive the use of their property, whereasthe government, as the agent of the people—of eachand every person equally—and properly having noproperty of its own whose use it can give or withhold,in denying anyone the right to undertake an economicactivity simply initiates the use of force.

19. Licensing laws create monopolies by vir-tue of initiating force to reserve markets to the exclu-sive possession of the license holders.

20. Examples of monopolies created by li-censing laws are the occupations of

a. accountantb. barber c. beauticiand. constructrion contractore. dentistf. lawyerg. liquor store ownerh. opticiani. pharmacistj. physiciank. psychologistl. teacherm. taxicab drivern. all of the above

21. Only the holders of the licenses are le-gally allowed to pursue the field in question. All othersare excluded by means of the initiation of physicalforce.

22. The fields controlled by licensing lawsare monopolies even though they contain numeroussellers, because they reserve markets to the exclusivepossession of the license holders by means of the initia-tion of physical force and thereby keep out of thosefields suppliers who otherwise would be in them—sup-pliers with whom the public would be glad to deal vol-untarily, without any form of force or fraud beingpresent.

23. The effect of licensing-law monopoly isto

a. reduce the quantity of services received by thebuyersb. raise the prices of the services buyers are al-lowed to receivec. raise the incomes of the license holdersd. reduce the incomes of those who are excludedfrom the licensed fields and forced to crowd intoother, less-well-paying fieldse. all of the above

24. Licensing laws are defended on thegrounds that they are necessary to public health orsafety and to guarantee some minimum level of compe-tence and service.

25. It may be the case that licensing some-times does serve to raise the minimum level of compe-tence and expertise in a field and thus to guarantee tothe buyers a higher level of service than they wouldhave received in its absence. But even if this is true, itis not by any means an advantage to the buyers. Itmerely means, in many cases, that buyers are forced tobuy a higher level of service than they want or needand, if they cannot afford the higher level of service,


are forced to do without the service they could havehad.

26. The effect of a licensing law that raisesthe minimum level of service that can be provided iscomparable, in essence, to a law that would requirethat the minimum quality of automobiles on the roadbe no less than, say, that of a five-year-old Chevroletof average quality. While such a law would undoubt-edly raise the average quality level of the cars that re-mained on the road, it would also operate to preventmany people from driving—namely, those who couldnot afford anything beyond the quality of the cars theypresently drove and whose cars were below the qualityof the average five-year-old Chevrolet.

27. The effect of liberalizing or abolishingmedical licensing would be to

a. increase the ability of the poor to afford medi-cal care by increasing the supply of medical careavailale on the low end of the scaleb. reduce the demand for and thus the rates ofmedical practioners further up on the scale of ser-vice to the extent that their patients turned to prac-titioners previously denied entry into the marketc. increase the ability of everyone to afford theservices of the more highly qualified medical prac-titionersd. all of the above

28. In the absence of medical licensing, a. it would not be the case that barbers and butch-ers would be able to compete as doctors, any morethan they can compete in the automobile or steelindustryb. competition would establish educational, per-formance, and other requirementsc. it would still be fraud to claim a degree, or anyother form of private certification, that one did nothaved. new competition in medicine would comefrom people who today must be content to be reg-istered nurses, pharmacists, paramedics, biolo-gists, and so forth, but who could becomequalified to practice important aspects of medi-cine presently monopolized by the licensed physi-cians, and do so with a high degree of competencee. all of the above

29. A free market would meet the legitimateobjectives of licensing laws by such means as privatecertification, insistence on an established reputation oron endorsements from those with established reputa-tions and whose judgment one trusted.

30. The advantage that the absence of govern-ment licensing would offer to individuals that is notpossible under such licensing is that

a. the supply of the service would be greater andthe price correspondingly lowerb. not only would there almost certainly be morethan one private certification agency in any given

occupation, but the individual would always havethe right to step outside the system and decide en-tirely for himselfc. no one would be compelled to accept the judg-ment of government officials or of any othergroup of people concerning the products or ser-vices he might buyd. there would permanently be more chances fornew ideas being tried, and thus improvementswould come far more rapidly than is possibletodaye. it would not be necessary that before trying anew cure for a disease, or a new method of con-structing a building, a person would have to waitupon the pleasure of any group of government of-ficials to approve it or depend exclusively on theirstate of knowledgef. all of the above

31. The existence of freedom carries with itthe possibility that people will make wrong and evenfoolish choices. But there is no alternative. That possi-bility exists with or without freedom. The great advan-tage of freedom is that each individual has the right tomake his own choices and need not be bound by the ig-norance or stupidity of others.

32. It is no doubt true that under the freedomof competition, some individuals would act irresponsi-bly and at the first opportunity turn to quacks. The ex-istence of such people, however, is no reason fordenying freedom to everyone else, who would use it togreat advantage. Moreover, under freedom, stupidityof choice serves as its own punishment.

33. If the misuse of freedom by the ignorantand the foolish is what is feared, then a better case canbe made for the licensing of politicians and govern-ment officials than of doctors or the members of anyother profession or trade. This is because here, whenpeople turn to charlatans, the consequences are suf-fered by all. But, of course, there can be no such thingas the licensing of politicians and government offi-cials, for who would license them, but other politiciansand government officials? And what could be moredangerous than to allow politicians and government of-ficials to have such power?

34. The premise of a free country is that thecitizens are intelligent enough to run their own affairsand, in the time left over from their own affairs, the af-fairs of their government as well. Citizens who are notqualified to pass judgment on the qualifications oftheir doctor or building contractor (or on the qualifica-tions of the experts whose advice they accept) are evenless qualified to pass judgment on matters of foreignpolicy or domestic policy.

35. In the light of the uniformity-of-profitprinciple, it follows that if licensing requirements andother government regulations in connection with theestablishment and operation of hospitals were abol-ished, the cost of hospital stays would be driven down


to the point of covering only the necessary costs of pro-viding the hospital stays plus only as much profit as re-quired to earn a competitive rate of profit, and that thenecessary costs would be progressively reduced whilethe quality of the stays progressively improved.

36. Under the influence of the anarchic con-cept of freedom, many people’s idea of the right tomedical care is that of an alleged right which is to beimplemented without regard to the willingness of oth-ers to cooperate. The government is to take moneyfrom the taxpayers, at the point of a gun, to implementthis alleged right to medical care and it is to hold a gunto the heads of physicians and hospitals to make themsupply medical care on the terms and by the methods itimposes.

37. In contrast to the anarchic concept, themeaning of the right to medical care implied by the ra-tional concept of freedom is that of the right to all themedical care one can afford to buy and chooses to buyfrom any willing provider.

38. The present high cost of medical care isthe result of

a. the violation of the right to medical care under-stood in the light of the rational concept of free-dom, b. collectivization of the costs of medical carec. compelling some individuals to pay for themedical care of othersd. implementation of the anarchic concept of theright to medical caree. all of the above

39. Protective tariffs constitute monopoly leg-islation according the political concept of monopoly,because they attempt to reserve the market, or a shareof the market, to the exclusive possession of domesticproducers, by means of the initiation of force.

40. Protective tariffs and licensing laws high-light the fact that monopoly, according to the politicalconcept,

a. is not limited to the case of sole producers pro-tected by the initiation of physical forceb. applies equally to cases of very large numbersof producers whose market is protected by the ini-tiation of physical forcec. can serve to protect tens of thousands of small,inefficient producers against competitiond. exists wherever markets or parts of the marketare reserved to the exclusive possession of someto the exclusion of others by means of the initia-tion of forcee. correspondingly denies the freedom of compe-tition to those who are forcibly excludedf. all of the above

41. Monopoly legislation can protect the lessefficient many against the competition of the more effi-cient few, or even just one, as, for example, in the caseof protecting large numbers of individual taxicab own-

ers from the potential competition of a small numberof large fleets of taxicabs, or protecting large numbersof small shops from the competition of small numbersof large department stores and chain stores.

42. Monopoly exists, and the freedom ofcompetition is violated, not because there happens tobe just one seller in a market when all have the legalright to enter, but when there are millions in the mar-ket and all but one are allowed to enter, with that oneotherwise able and willing to enter. For example, a mo-nopoly would exist in the automobile market even if itwere comprised of thousands of small automobile com-panies and everyone in the world were allowed toenter it with the single exception of the original HenryFord. Such exclusion of Ford would constitute a mo-nopoly, in violation of the freedom of competition.

43. Minimum-wage and prounion legislationoperate to

a. prevent less-efficient workers from competingwith more efficient workers in terms of labor costper unit by preventing them from compensatingfor their lower productivity by means of acceptingcorrespondingly or more-than-correspondinglylower incomesb. attract the competition of relatively moreskilled workers to the fieldc. exclude the less able and the disadvantagedfrom the marketd. monopolize markets in favor of more-skilledworkerse. all of the above

44. In creating a deficiency in quantity oflabor demanded in relation to the supply of labor avail-able and thus an artificial surplus of workers and thenecessity of choosing among them, minimum-wageand prounion legislation create an opportunity for theplay of such factors as personal favoritism, cronyism,and racial and other forms of group prejudice. This isbecause, with the ability to compete by means oflower wage rates eliminated, wherever there are no dis-cernible differences in skill among the applicants forjobs, it is such factors that tend to determine the deci-sion of who will be employed.

45. Minimum-wage and prounion legislationhave had particularly harmful effects on blacks, espe-cially teenagers, and have often resulted in lifelong un-employment and welfare dependency.

46. Governmental actions that serve to in-crease housing costs are

a. zoning laws that impose minimum size lots ora maximum height of buildingsb. building codes that mandate expensive provis-ions that are not essentialc. the compulsory withdrawal of land from devel-opmentd. compelling home builders to deal with laborunions and thus to suffer the artificially high wagerates and inefficiencies imposed by the unions


e. rising property taxesf. rent controls, insofar as they serve to reducethe supply of housing available for the market g. urban renewalh. all of the above

47. The governmental actions described inthe preceding question, when combined with high gov-ernment-imposed minimum housing standards forhealth and safety, serve to cause homelessness.

48. Government-imposed minimum housingstandards on a local basis have the unintended effectof worsening the housing conditions of the poor else-where by virtue of pushing more of them into the areasthat remain free of such housing standards.

49. Government-owned and government-sub-sidized enterprises represent monopolies, according tothe political concept of monopoly, in that their marketsare reserved to them by means of the initiation of forceagainst the taxpayers who must finance their opera-tions.

50. Competitors of government-subsidizedenterprises cannot gain their markets even if they aremore efficient and offer better products, for the subsi-dized enterprises are enabled to sell their products at aloss, and even to give them away free of charge.

51. Public education represents monopoliza-tion of a major part of the education market against thecompetition of private education.

52. What public education accomplishes isthat education is supplied without the benefit of the in-centive of profit and loss in an environment of free-dom of competition.

53. If education had to operate prvately, andthus in the same basic economic context as the automo-bile industry or grocery business,

a. a powerful incentive would exist to improvequality and reduce costs, because this would bethe way to increase profitsb. any school or chain of schools that introducedany perceptible improvement in education wouldhave a substantial increase in its profits, because itwould be giving students and their parents morefor their money and thus they would want to dealwith it, not its less efficient competitorsc. if any school or chain of schools succeeded incutting its costs and could operate profitably at alower level of tuition, it would also enjoy a largeexpansion in business, as a larger part of the mar-ket came to prefer to deal with it, because its tu-ition charges were now lower than its competitors’d. in response to the competitive pressure of theloss of business to the schools which improvedtheir quality and efficiency, all the other schoolswould be compelled to improve their quality andefficiency, or else be driven out of businesse. as the schools in the group just describedcaught up, it would no longer be possible for the

schools that had introduced the improvements tocontinue to make exceptional profits; to go onmaking exceptional profits, they would now haveto introduce further improvements, with the sameultimate resultsf. the uniformity-of-profit principle and its ef-fects would apply to educationg. the basis would exist for continuous im-provements in quality and efficiency, for the bene-fit of the buying publich. all of the above

54. Under public education, a. there is no incentive of profit and lossb. there is little or nothing to be gained by intro-ducing improvementsc. there is little or nothing to be lost in failing tomatch any improved performance of othersd. a loss of students, whether it results from animprovement in the performance of other schoolsor from a decline in the performance of one’s ownschool, does not mean a loss out of the schoolsuperintendent’s pocket or out of the pocket ofanyone who sits on the local school boarde. all of the above

55. The position of private education today,and that of education as a whole, is analogous to whatthe position of the automobile industry would be if theproduction of all the low- and medium-priced modelswere in the hands of the government, which subsidizedtheir production to the point of giving these modelsaway for nothing—indeed, of compelling every adultto accept one for nothing—while the privately ownedportion of the automobile industry were confined tothe production of very expensive models, and essen-tially prohibited from cutting its costs.

56. The system of public educationa. in making it impossible for private schools tobe commercially successful, prevents all thoseimprovements in quality and efficiency from com-ing into being that would take place in educationunder the competitive quest to make profits andavoid losses, and which would eventually bring amuch higher quality education within the reach ofall than is now available even to the wealthiestb. precludes any significant competitive barrierto deterioration in the education the publicschools themselves offerc. has the potential to decline in quality all theway to the point where it becomes clear to mostpeople that what it offers is no longer worth evena zero priced. all of the above

57. According to the political concept of mo-nopoly, the antitrust laws

a. prevent capable newcomers from entering anindustry—for example, they would almost cer-tainly operate to prevent General Motors from en-tering the steel industry in any significant way


b. prevent the capable firms within an industryfrom acquiring the markets of the less capableones by absorbing them in mergers, by buyingthem out, or by driving them outc. reserve markets to the exclusive possession ofall but those who in a state of freedom of competi-tion would occupy themd. monopolize markets precisely against the mostcapable and efficient firms, which, in their ab-sence, would be able to be in those markets, andwhich instead, because of their existence, aretoday forcibly excluded from theme. constitute promonopoly legislationf. all of the above

58. Socialism represents the most extremeform of monopoly in that the government of a socialistsociety forcibly appropriates all the means of produc-tion and thereafter forcibly reserves the entire marketof its country to its own exclusive possession.

59. The effect of monopoly is often to enablehigh cost producers to survive, rather than securing ex-ceptionally high profits for anyone.

60. The monopolies made possible by tariffprotection, government subsidies, and the antitrustlaws often do not result in any exceptional profitabilityon the part of the monopolists.

61. Patents on new inventions, copyrights onbooks, drawings, musical compositions, and the like,and trademarks and brandnames

a. reserve markets, or parts of markets, to the ex-clusive possession of the owners of the patents,copyrights, trademarks or brandnames, and theydo so by means of the use of physical force inas-much as it is against the law to infringe on theserightsb. do not rest on the initiation of physical force,because in all of these cases, the governmentstands ready to use physical force merely in de-fense of a preexisting property right established ei-ther by an act of personal creation or by the fact ofdistinct identityc. do not constitute monopoliesd. all of the above

62. The existence of patents and copyrights,and trademarks and brandnames,

a. like all other protection of property rights,serves to increase the supply of goods and ser-vices—by making it possible for those who arethe cause of the increase to benefit from the im-provements they make

b. serves to reduce prices and to increaseeveryone’s buying power as time goes on.c. both (a) and (b)

63. The long-run effect of the abolition of pa-tents and copyrights would be to make prices higherthan they otherwise would be, because of a substantialreduction in new inventions, since no one would investyears of effort and perhaps millions of dollars of capi-tal in the development of a new invention only to findthat as soon as he brought it to market, a competitorwho purchased a working model would have the bene-fit of all that effort and capital just for the price of theworking model, and that he, the innovator, would prob-ably be unable to profit from his efforts because of therapid fall in the price of the product that would followin such a situation.

64. The abolition of patents and copyrightswould serve to establish the monopoly of the dull andincompetent by forcibly depriving the intelligent andcompetent of the benefit of their intelligence and com-petence, and thereby forcibly excluding them from themarket.

65. The abolition of trademarks andbrandnames would result in producers losing the incen-tive to increase or even maintain the quality of theirgoods, inasmuch as their goods would be rendered in-distinguishable from those of everyone else, and con-sumers would thus have no way of singling them outfor purchase.

66. According to the political concept of mo-nopoly,

a. all monopoly is based on government interven-tion, which restricts the freedom of entry and com-petitionb. the significance of monopoly is that it forciblybars from the market sellers who would otherwisebe capable of being in the market and thus re-stricts the range of choice buyers have in suppliersand compels them to deal with less efficient sup-pliers and to accept higher costs and poorer qual-ity than a free market would require them to acceptc. both (a) and (b)

67. It follows from the political concept ofmonopoly, that the program of the announced enemiesof monopoly should not be, as it has been for manyyears, the breakup of big business or the government’sgrowing control over big business. Rather, it should bethe progressive elimination of government interven-tion into the economic system.

The Economic Concept of Monopoly

68. The economic concept of monopolya. is in sharpest contrast to the political conceptof monopoly

b. holds that monopoly emerges from the normaloperation of the economic system—not on thebasis of the initiation of physical force, but on thebasis of mere economic circumstances, and that it


nonetheless produces evils of such magnitude thatthe government must suppress or control it bymeans of forcec. claims that monopoly exists whenever there isonly one supplier of a given good in a given terri-toryd. views the essential feature of monopoly as the“oneness” of the seller, irrespective of how he hasachieved his positione. all of the above

69. The economic concept of monopoly canbe construed in such a way that it embraces hardly any-thing or almost everything.

70. The existence of monopoly a. was viewed as minimal before the 1930sb. has been viewed as almost all pervasive sincethe 1930sc. both (a) and (b)

71. The concepts of “oligopoly” and “monop-olistic competition” have served to greatly enlarge theperception of the prevalence of “monopoly.”

72. “Oligopoly” is supposedly characterizedby the existence of a relatively small number of sellersin a given market.

73. Depending on the circumstances, an oli-gopolist is held to behave either exactly as a “monopo-list” would behave in terms of the price he charges andthe output he produces, or to occupy some middleground between a monopolist and a “pure competitor.”

74. The concept of “monopolistic competi-tion”

a. is supposed to describe cases in which thereare a large number of sellers of only slightly dis-similar productsb. implies that an element of monopoly is presentto whatever extent one product is different fromanotherc. claims that the unique elements of a productconstitute its “monopolistic” aspectd. all of the above

75. The concept of “monopolistic competi-tion” views companies such as Pepsi Cola and CocaCola as

a. competitorsb. monopolistsc. both (a) and (b)

76. Full-bodied competition—viz., “pure–and–perfect competition”—is now held to exist onlyas a rare exception.

77. The essential requirements for the exis-tence of pure–and–perfect competition are the exis-tence of a vast number of sellers all selling perfectlyidentical, homogeneous products.

78. The acceptance of the contemporary the-ory of the comparative extent of monopoly and compe-

tition has led to a rewriting of economic history to ac-count for the fact that competition was traditionallyconsidered to be the norm.

79. Despite the fact that after the Civil Warfewer producers remained in many branches of indus-try, there was nevertheless an increase in the numberof producers in actual competition with one another.

80. The alleged consequences of monopolyrange from the most dire and extreme, in the form ofthe specter of a single giant firm coming to own the en-tire economic system, to what must be regarded as ab-solutely trivial, in the form of thepure-and-perfect-competition doctrine’s criticism ofbig business as being monopolistic merely for refusingto sustain unnecessary losses.

81. The doctrine of the tendency toward theformation of a single giant firm controlling the entireeconomic system

a. played a major role in the doctrine of the al-leged inevitability of socialism, inasmuch as thegiant firm was regarded as representing the cre-ation of the structural framework of a socialist so-ciety and differing from socialism only in themotivation and character of its board of directorsb. played a major role in support for antitrust leg-islation, in part in the belief that it was necessaryto prevent the coming of socialismc. contradicts the essential nature of the gains de-rived from the division of labord. all of the above

82. The only place that centralized controlover all the means of production has been establishedwas under socialism, by means of force, and was per-petuated only by means of force and in opposition tothe actual material self-interests even of the membersof the various socialist regimes.

83. The experience of socialism confirms thefact that monopoly is a political phenomenon, not aneconomic phenomenon.

84. The phenomenon of bad mergers and thesubsequent need for spinoffs and breakups confirmsthe fact that there is no tendency toward the formationof a single giant firm under capitalism.

85. The formation of conglomerates, contain-ing separate divisions each with its own management,would not be a feasible means of overcoming the con-flict between a megacombine and the essential gainsfrom the division of labor, because a businessman withconfidence in his own ability to succeed in an industryhe knows and understands, and in which his income isdetermined exclusively by his own success or failure,would not be willing to exchange such a position forone in which he receives a much smaller share of theprofits of a conglomerate, which are the outcome ofthe success or failure of many others, whom he is un-likely to consider as capable as himself.


The following is a two-part question.

Imagine an industry composed of 10 firms, each pres-ently doing 10 percent of the industry’s business, andowned by individuals each of whom expects thatunder his management his firm will grow to the pointof doing 50 percent of the industry’s business.

86. Calculate the percentage of the mergedcompany’s stock that would have to be given to theowners of the ten fimrs to compensate them for theloss of what they believe they would have by remain-ing independent.

87. It is not possible to merge such firms, be-cause it is impossibled to make the merger appearworthwhile in comparison with the anticipated gainsfrom remaining independent.

88. Successful mergers, by increasing thecapital of the particpants, serve to provide the basis forthe formation of new firms, if not in the industrywhere a given merger occurs, then in other industries.

89. The continuous formation of large num-bers of new firms, some of which grow to considerablesize serves to keep the proportion of the total capital ofthe economic system in the hands of the merged firmsfrom growing.

90. A major potential source of the formationof new firms in virtually every industry is key execu-tives of the existing firms who believe that they coulddo better on their own. If not for the personal incometax, such executives would be able to accumulate farmore personal wealth in their present positions. In theabsence of restrictions on stock trading based on “in-side” knowledge, their accumulations of personalwealth would be greater still. In such conditions, itwould be possible to start even new domestic automo-bile and steel companies requiring an initial invest-ment of a billion dollars or more.

91. The tax laws have encouraged unecono-mic mergers as a means of reducing corporate and per-sonal tax liability.

92. The effect of insider trading based on ad-vance knowledge of a development that is favorable toa company is

a. to enable stockholders who have decided tocontinue to hold the stock to gain that much soonerb. to induce some stockholders who were plan-ning to sell the stock, upon seeing the rise causedby the insiders’ buying, to hold it instead and thusto enjoy gains they would otherwise not have hadc. to enable stockholders who have made up theirminds to sell their shares to sell them at a betterprice, thanks to the demand for them coming fromthe insidersd. all of the above

93. If the insiders sell in advance on the basisof their inside knowledge of negative developments(which they themselves have done nothing to cause),they are not responsible for the loss that is suffered bythose who continue to hold the stock, because that losswould come in any case, when the bad news finally be-came public knowledge.

94. In the absence of insider selling, the de-cline in price would come more precipitously and dra-matically, rather than being preceded by declinescaused by the insiders’ selling.

95. Insiders’ selling and the lower stock priceit causes can provide a clue to other stockholders tobegin selling and to potential buyers to abstain frombuying. Those who decide to buy in any case, are en-abled to buy at a lower price.

96. If the gains of the insiders, who knowwhat they are doing, must be transferred to those whodo not, the latter will not be able to keep those gainsfor very long. For they will have no basis on which toargue for the retention of their unearned, accidentalgains from society as a whole. If knowledge is not anadequate basis for earning a profit that others do notearn, the mere accident of owning the right stock at theright time can hardly be such a basis.

97. Mergers are economically sounda. when they achieve economies of scaleb. in cases in which companies carry complemen-tary product lines, which can easily be sold by thesame sales forcec. when they achieve important economies in con-nection with advertising expenditures and/or theraising of capitald. when they enable more competent individualsto gain control over the management of additionalcapital, as when a better-run firm gains control ofthe assets of a poorer-run firme. all of the above


98. Imagine that in a small-scale plant, manu-facturing cost is $10 per unit of product, while in alarge-scale plant, thanks to economies of scale, manu-facturing cost can be brought down to only $1 per unit,provided the facility operates at a sufficient percentageof its capacity. Assume that initially, however, trans-portation costs are 50¢ per mile per unit. Calculatehow many miles closer to the market a small-scaleplant needs to be to have an advantage in total, deliv-ered cost over the large-scale plant.

99. Assume now that major improvements inthe transportation system reduce transportation costs inthe preceding example from 50¢ per mile per unit to1¢ per mile per unit. Calculate how many miles closerto the market a small-scale plant now needs to be to


have an advantage in total, delivered cost over thelarge-scale plant.

100. In the post–Civil War era, major im-provements in transportation, notably the large-scalebuilding of railroads and the development of steam-powered iron and then steel ships, brought about majorreductions in transportation costs, which gave a com-petitive advantage to large-scale manufacturing oversmall-scale manufacturing and thereby created theneed for widespread mergers.

101. In the period following the Civil War,corporate law did not immediately provide a mecha-nism whereby one corporation could be combinedwith another one. The trusts were a device for accomp-lishing that purpose.

102. Under a trust arrangement, the stock-holders of separate corporations turned their sharesover to trustees, who then had the power to vote theshares and run the corporations. By assembling the

shares of two or more corporations in the hands of thesame trust, it was possible to operate the corporationsas a single unit and thus achieve a merger.

103. Between 1870 and 1914, the era of trust-building and the development of big business,

a. the resulting monopoly power resulted in wide-spread declines in production and increases inpricesb. production in the industries controlled by thetrusts rapidly increased and prices fell

104. The 1911 Supreme Court decision thatbroke up Standard Oil sharply criticized that companyfor raising the price of petroleum and reducing its qual-ity.

105. The Supreme Court broke up StandardOil

a. because of the harm that company had causedb. despite the good it had achieved

The Predatory Pricing Doctrine

106. The predatory-pricing doctrine claimsthat a large firm, because it is big and rich, and possi-bly operates in many different markets at the sametime,

a. can afford losses which a small firm cannot, be-cause the latter is small and poorb. finds it to its interest temporarily to slash itsprice and sell at a loss, in order to force the smallfirm out of businessc. will be able, after it has driven its small com-petitors out of business, to raise its price to ahigher level than ever befored. will be able to keep new competitors out bytheir fear of being ruined by a repetition of preda-tory-price cuttinge. can succeed in unconscionably gouging thehelpless public, which, in simple innocence, hastaken the large firm’s lure of a temporarily lowerpricef. all of the above

107. The influence of the predatory-pricingdoctrine serves to make people regard all the achieve-ments of big business in reducing prices and improv-ing quality as having no reality, but as being merely aprelude to a subsequent price gouge.

108. The attempt to practice predatory pric-ing will result in increasing the price received by theintended target rather than decreasing it if the lower,predatory price attracts a new and additional quantitydemanded which, because of a lack of productive ca-pacity on the predatory firm’s part, must be met withsupplies that are now made unavailable for satisfyingthe firm’s regular quantity demanded. In this case, theitem actually becomes scarcer for the firm’s regularcustomers, and they will now have to turn to the

smaller firm, where their competition will actuallydrive up the price.

109. In order for a firm practicing predatorypricing to be able to succeed in imposing a lower priceon the intended target,

a. it must possess sufficient additional productivecapacity to meet any resulting expansion in quan-tity demanded at the lower, predatory priceb. and then, if it should actually succeed in clos-ing down the small competitor and thereuponraise its price, which is its presumed plan, it mustcontinue to maintain this additional capacity, eventhough it no longer uses it in production, as ameans of imposing low prices on potential new en-trantsc. the amount of additional capacity necessary toimpose the predatory price will be increased to theextent that the prospect of a small competitor’sentry followed by a plunge in price leads peopleto postpone their purchases until such time as thesmall comopetitor’s entry occurs d. it must go to considerable expensee. all of the above

110. If it were the case that as soon as thesmall competitor is driven out, the large firm cansharply increase its price, while so long as the smallcompetitor remains in business the price is held belowthe level of his costs, the interests both of theindustry’s suppliers and of the producers of goodscomplementary to is products would lie with subsidiz-ing the continued existence of the small competitor, asthe means of maintaining the demand for their prod-ucts.

111. If it is the case that the large, predatorfirm, which has succeeded in becoming the sole sup-


plier and presently obtains a high price, will slash itsprice as soon as it is confronted with a small, compet-ing firm, people are placed in a position in which theycan use that very knowledge to

a. sell short the commodity the predator sells andprofit from the fall in price that will resultb. sell short the stock of the predator company,which will fall when its price and profitability fallc. profit precisely by forming small competingfirms against whom the predator will slash priced. all of the above

112. To the extent that the predatory big andrich firm is larger in the same market, it must take theprice cut and the resulting loss on a correspondinglylarger volume than the small and poor firm. This is be-cause it cannot cut the price only to the customers ofthe small firm, because that leaves the small firm freeto cut price by a much smaller amount to an equalnumber of customers of the large firm. If the smallfirm is not to be able to sell to anyone except at thelow price imposed by the large firm, the large firmmust make that low price available to all of its owncustomers as well as to the customers of the small firm.

The following is a seventeen-part question.

The price of a product is $1. There are only two pro-ducers: “Big John” and “Little Joe.” “Big John” cur-rently produces and sells 9 units of the product, while“Little Joe” currently produces and sells only 1 unit ofthe product. The unit cost of both producers is 90¢.

113. Calculate the sales revenues of “BigJohn.”

114. Calculate the total costs of “Big John.”

115. Calculate Big John’s total profit.

116. Calculate the sales revenues of “LittleJoe.”

117. Calculate the total costs of “Little Joe.”

118. Calculate Little Joe’s total profit.

Now imagine that in order to make Little Joe suffer aloss and thus drive him out of business, Big Johnslashes his price from $1 to 80¢.

119. Calculate Little Joe’s loss.

120. Calculate Big John’s loss.

121. Find the number of times by which BigJohn’s loss is greater than Little Joe’s loss.

Now assume that Big John’s cost per unit is less thanLittle Joe’s, i.e., while Little Joe’s cost per unit contin-ues to be 90¢, Big John’s cost per unit is only 80¢.

122. Again calculate Big John’s total profitwhen the selling price is $1.

123. Calculate Big John’s total profit whenthe selling price is 80¢.

124. Calculate the amount by which BigJohn’s profit is reduced by his practice of predatoryprice cutting.

125. Find the number of times by which thereduction in profits experienced by Big John is greaterthan the reduction in profits experienced by Little Joe.

126. The fact that the large firm may havelower unit costs than the small firm does not changethe principle that its profit reduction is a multiple ofthe smaller firm’s profit reduction to the extent that itsvolume in the same market is greater.

Now assume that Little Joe’s cost per unit is only 80¢,while that of Big John remains at 90¢.

127. Calculate the reduction in Big John’sprofit needed to make make Little Joe’s profits gofrom +20¢ to -10¢.

128. Calculate the size of the loss Big Johnnow needs to suffer in order to impose a 10¢ on LittleJoe.

129. The implication of the preceding ques-tions is that the small firm can be in a better position towithstand its relatively smaller losses than is the largefirm to withstand its multiple losses.

130. Practicing predatory pricing would ne-cessitate setting one’s price below the target’s operat-ing costs, not his total costs, and then keeping themthere for the life of his plant and equipment. Only thiswould serve to keep his plant and equipment out of op-eration.

131. Neither sustaining losses or major profitreductions for years in order to drive out one’s smallcompetitors, nor buying out the small competitors atpremium prices, can actually pay, because

a. both methods imply that later on, once LittleJoe’s capacity is out of the way by one method orthe other, it is absolutely necessary for Big Johnto charge a premium price merely in order to re-coup the reduction in profits he has sustained orthe premium price for Little Joe’s assets that hehas paidb. but any premium price he charges in the fu-ture, after Little Joe’s capacity is out of the way,will only serve to attract new competitors, towhom the premium price will offer the prospectof a premium rate of profitc. because of its highly self-destructive nature,and for all of the other reasons explained, thesecompetitors cannot be kept out by the fear of stillmore predatory pricingd. all of the above

132. The permanent, long-run price that BigJohn can obtain is limited by the costs of production—


the full costs—of potential new entrants, together withan allowance for the competitive rate of profit on theircapital. These costs set an objective limit above whichthe price cannot be maintained in the absence of legalprotection from competition—namely, that providedby monopoly according to the political concept. As aresult, the large firm cannot in fact later on charge thepremium price that is necessary to recoup the profits itmust forgo or the additional expense it must incur.

133. If the large firm must accept a price thatis limited by outsiders’ costs, the extent of its gains ifit should succeed in capturing the business of a smallerrival would be merely his share of the market, at sell-ing prices not significantly higher than the sellingprices that prevailed before he began his effort to drivethem out.

134. It follows from the answer to the preced-ing question that more than one company in an indus-try is the normal case.

135. What must be present to make it worth-while for a large, low-cost firm that already does thebulk of an industry’s business to cut its price belowwhat is required to enable its smaller rivals to stay inbusiness, is the prospect of a major expansion of profit-able volume at the lower price, since merely gainingtheir existing volume is not sufficient.

136. If the condition explained in answer tothe preceding question is present, becoming the soleproducer would not pay if the large firm’s cost advan-tages are of a kind that can be patented and thus sharedwith other producers in exchange for royalty pay-ments. For then, the firm could make additional profitson 100 percent of an expanded market without havingto accumulate by itself all the capital required to sup-ply the market.

137. If the only substantive gain from pricecutting is the volume of business presently carried onby one’s competitors, then it follows that it is more ef-ficient small firms that have much more to gain by fol-lowing an aggressive pricing policy than moreefficient large firms. For example, a large firm, with90 percent of the market, has only the 10 percent shareof its rivals to gain. But a small firm, with 10 percentof the market, has the 90 percent share of its rivals togain.

138. The claims of “dumping” made againstJapan in the years in which its industry was still asmall fraction of that of the United States are tanta-mount to a claim that Little Joe practices predatorypricing against Big John.

139. Japan’s success in exporting was the re-sult of

a. selling below its costsb. subsidies from the Japanese governmentc. intelligent guidance from its Ministry of Inter-national Trade and Industryd. all of the above

e. none of the above

140. Success in exporting depends ona. selling below costsb. achieving costs below those of one’s foreigncompetitors and selling close to or below theircosts while selling well above one’s own costs

141. Subsidies to business by the Japanesegovernment are drawn from

a. the vast and causeless resources of the Japan-ese governmentb. taxes on successful Japanese business firms

142. The direction of investment by a govern-ment ministry is necessary to

a. make business firms do what is profitable tothemselvesb. compel business firms to do what they judge tobe less profitable or unprofitable to themselves

143. The chain-store variant of the predatorypricing doctrine

a. refers to cases in which the larger firm is largerby virtue of its presence in more than one mar-ket—for example, chain stores that compete withlocal merchants, or conglomerates that competewith smaller firms in a variety of different indus-triesb. differs from the predatory pricing doctrine as ithas been considered up to now insofar as if thelarger firm were to slash its price for the purposeof making its smaller rival run at a loss, it wouldnot have to suffer a reduction in its own revenuesand profits in proportion to its overall greater size,but only in proportion to its greater size in the par-ticular market concernedc. both (a) and (b)

144. Shark, Incorporated has a capital of $1billion, which is invested in 1,000 branches scatteredaround the country. One of its branches is currently at-tempting to drive the tiny firm of Minnow & Motherinto bankruptcy for the purpose of then being able togouge the local consumers by sharply increasingprices and reaping an additional $100,000 per year inprofit foreverafter. To achieve its objective, Shark canrationally afford to temporarily lose

a. its entire $1 billion of capitalb. no more than $1 million of its capital if the pre-vailing rate of return is ten percent per annum

145. The overwhelming bulk of the largercapital of a chain of stores, or other multi-market firm,is irrelevant to the size of the losses it might rationallybe willing to sustain on a temporary basis in order tobecome the sole seller in a local market and thereafterforever reap a premium profit in that market.

146. The size of the firms that would be in aposition to match even the largest chains in the abilityto sustain temporary losses in a rational—or at least asemi-rational—expectation of being able ultimately toearn an above average rate of profit by doing so


a. need exceed only the discounted present valueof the assumed additional profitsb. must be at least as large as that of the chains

147. The effect of losing any part of the capi-tal one had calculated that it was reasonable to lose inan effort to secure a monopoly position in a local mar-ket is to deprive one of the ability to meet the competi-tion of a newcomer who has made the samecalculation but has not yet lost any of his capital.

148. The fact that any firm that attempted topractice a policy of predatory pricing in local marketswould be exposed to the competition of other firmsthat had not yet lost any funds, and that if those otherfirms pursued this policy, they would in turn find them-selves in the same position in relation to still other out-siders means that there is no way of actually securingthe kind of premium profits imagined by the predatory-pricing doctrine and that all that can result from the at-tempt is the pouring of money down a bottomless well.

149. Whoever would attempt to practice apolicy of predatory pricing in local markets would findhimself in the position of having made a larger-than-necessary capital investment, which he would laterneed to recover through higher-than-necessary pricesand more than a competitive rate of profit, but wouldbe unable to recover in the actual conditions of themarket. The capital he expended in the effort toachieve the illusory extra profits would place him inthe same position as someone who had constructed hisstore or bought the land for it at an unnecessarily highprice.

150. Selling under long-term contract cana. provide the small competitor of a large, would-be practitioner of predatory pricing automatic pro-tection against such practice and can do so evenwhile allowing customers to decide not to actuallybuy the quantities they have contracted forb. make the predator finance the small firm’scosts in order to gain its businessc. both (a) and (b)

151. While long-term contract pricing mayoften not be feasible at the level of retailers’ custom-ers, market factors such as greter convenience and ser-vice operate to protect small retailers from beingdislodged even by permanently lower prices charged

by larger firms. At the same time, the existence of thesmaller suppliers and their ability to do a larger vol-ume of business contributes to preventing the largerfirms from raising their prices.

152. The predatory-pricing doctrine impliesthat real prices in retailing and elsewhere over the last130 years or so, i.e., since the days of the generalstore, whale oil, and the local blacksmith shop, have

a. risenb. fallen

153. A large firm bent on cutting off vitalsupplies to a small competitor (which is the doctrine ofpredation with respect to suppliers) would have to beable to

a. succeed in cutting off all of the possiblesources of supply of the small competitor for thegood or service in question, since he requires theavailability of only any one of those possiblesources in order to be suppliedb. make dealing with it rather than the small com-petitor more profitable to every actual and poten-tial supplier to whom the small competitor mightturn, and to offer more to them not only than thesmall competitor is currently capable of doing, butalso is potentially capable of doing in the futurec. both (a) and (b)

154. The prospect of the large firm charginghigh prices in the event it succeeds in cutting off vitalsupplies to its small competitors should make suppli-ers

a. its alliesb. allies of the small competitors

155. It would not make matters easier for thelarge firm if there were only one or a few suppliers orpotential suppliers who would need to be securedagainst the small firm, because then the consequencewould be that any one of the suppliers or potential sup-pliers with sufficient capacity to meet the requirementsof the small firm would be in a position to demand alion’s share of whatever additional profits might beearned by virtue of the absence of the small competitorand the consequent alleged ability to charge substan-tially higher prices.

The Marginal-Revenue Doctrine

156. Marginal revenue is the change in totalrevenue that accompanies an increase or decrease inquantity produced and sold.


157. You are given the following informa-tion. At a price of $15 per unit, 100 units are de-

manded. At a price of $9 per unit, 200 units are de-manded. Calculate marginal revenue per unit.

If, in the preceding question, cost per unit is $8 and re-mains at $8 dollars as output changes, calculate totalprofits when output is

158. 100 units.


159. 200 units.

160. Calculate the profit in producing 100units at a cost of $8 per unit and a selling price of $9per unit.

161. On the basis of the concept of marginalrevenue, it is argued that the firm in the precedingquestions is motivated to restrict its production to 100units even though a second 100 units considered by it-self, i.e., apart from the effect on the price of the first100 units, would be profitable.

162. On the basis of the doctrine of marginalrevenue, it is claimed that to the degree that a firm islarge relative to the size of the market it serves, it ismotivated to restrict its production to a quantity ofproduct that is less than what would be produced if theeffect on the price of the quantity already being soldwere ignored.

163. According to the supporters of the mar-ginal-revenue doctrine, given the elasticity of demandfor the product of the industry, the smaller is a givenfirm relative to the industry as a whole,

a. the less will be the reduction in price that re-sults from any given percentage increase in its out-putb. the more motivated it will be to expand its pro-duction and cut the price of the productc. both (a) and (b)

164. A large firm can be denounced both formonopolistically restricting supply if it does not pro-duce the extra output that supposedly should be pro-duced, and for being a monopolist if it does producethat extra output.

165. If the increment of output that suppos-edly should be produced is profitable in its own right,i.e., is profitable when considered apart from the effectof its production on the price of the quantity that is al-ready being produced, a large firm that must experi-ence the price reduction on its present quantity, doesnot have the alternative of deciding between a largerindustry-wide quantity at a lower price and a smallerindustry-wide quantity at a higher price, but only be-tween whether it will produce the larger quantity at thelower price or a smaller quantity at the lower pricewhile some other firm produces the additional quantity.

166. Where competition is physically possi-ble and is peaceful—that is, in which the same or asimilar good is capable of being produced by otherswithout violation of anyone’s intellectual propertyrights—and is legally free, the decision of any seller orgroup of sellers to produce less, or not to produce atall, cannot lastingly establish a selling price that isabove the cost of production, plus allowance for thegoing rate of profit, of potential competitors.

167. The cost of production of potential newentrants constitutes an objective given that limits one’sprice. One’s only choice is to sell either a smaller vol-

ume at that cost-limited price or a larger volume at thatcost-limited price or a still larger volume at a lowerprice. But one cannot get a higher price.

168. According to the textbook, a. if one allows for the time that may be requiredfor new firms to enter a field, one can say that irre-spective of the elasticity or inelasticity of the de-mand for the product of an industry as a whole,the elasticity of the demand for the product of anyindividual firm, however large, is virtually infiniteif it charges a price above outsiders’ costs plus al-lowance for the going rate of profitb. under the freedom of competition the elasticityof demand for the product of any individual com-pany or group of companies at a price aboveoutsiders’ costs plus allowance for the going rateof profit, is determined by the sum of the elastic-ity of demand for the product of the industry as awhole plus the elasticity of supply of competitorsand potential competitorsc. while the demand curve facing the industry asa whole may be almost perfectly inelastic, or, in-deed, actually be perfectly inelastic, as in the caseof table salt, the demand curve facing any individ-ual firm in the industry tends to be perfectly elas-tic at a price above outsiders’ costs plus allowancefor the going rate of profitd. all of the above

169. The absence of legal freedom of entry iswhat makes it possible for firms without trade secretsor patent or copyright protection to set price on thebasis of consideration of the industry’s elasticity of de-mand, above the point of outsiders’ costs plus an al-lowance for the going rate of profit.

170. Legal freedom of entry is an essentialfoundation of competitive price determination.

171. The prices normally charged for goodssuch as necessities and spare parts, which are gener-ally faced with highly ineleastic demand curves, arebased on

a. the elasticity of demandb. cost of production

172. If sellers could base the price of table salt onthe elasticity of demand for table salt, it would be

a. higherb. radically higherc. lowerd. radically lower

than it is today.

173. Contractual agreements a. can make cost of production rather than theelasticity of demand the determinant of pricesb. that tie price to cost of production can containa major element of variability that make the priceconform to changes in market conditions; for ex-ample, a contractually determined price of compo-


nents or supplies might contain a provision forvariability with the price of the principle raw ma-terials used in their productionc. can serve to make buyers the major beneficiar-ies of any supply reductions and price increasesthat sellers might otherwise be motivated to bringaboutd. all of the above

174. Using our previous example in which acompany could sell 100 units at a price of $15 per unitand 200 units at a price of $9 per unit, but with themodification that it is contractually obligated to sell100 units at a price of $9, identify the beneficiary ofthe higher price if the company now decides to pro-duce only 100 units and thereby establishes a price of$15.

a. the companyb. the company’s customers who have the con-tractual right to buy 100 units at $9 and who areenabled by the product’s scarcity to sell it at $15

175. Even if there were just one producer oftable salt, it would probably not be possible for himeven temporarily to take advantage of the inelasticityof demand for table salt by reducing his productionand raising his price if a sufficient portion of his out-put were sold under contract and with buyers havingthe option to increase their purchases at the contractu-ally set price.

176. Even though when the excise tax on cig-arettes is increased, the price immediately rises and isaccompanied by relatively little decline in the quantityof cigarettes demanded, it generally does not pay an in-dividual tobacco company or combination of all thepresent tobacco companies taken together to attempt toraise price by the equivalent of an excise tax increase,which is why they don’t do it.

177. Böhm-Bawerk a. agrees with Ricardo that in many instancescost of production is the direct determinant ofprice rather than the good’s own utility or mar-ginal utilityb. holds that marginal utility in other lines of pro-duction is the ultimate determinant of cost of pro-ductionc. both (a) and (b)

178. In cases in which cost of productionrather than considerations of the elasticity of demanddetermines prices, there is no implication that cost ofproduction can make anything more valuable than cor-responds to its marginal utility, but only that it canmake something less valuable than corresponds to itsdirect marginal utility.

179. The notion that cost of production hasno significant explanatory role in economics comesfrom Jevons, not from Böhm-Bawerk and Wieser.

180. After devoting chapter after chapter todeveloping a theoretical analysis that is entirely depen-

dent on the concept of marginal revenue, Samuelsonand Nordhaus are surprised to find that

a. it is largely irrelevant to the real world and thatthey have no theory to explain the actual facts ofpricingb. case after case shows that markup pricing isthe norm in imperfectly competitive marketsc. both (a) and (b)

181. If a firm can assume that a. its own costs of production are no higher thanits competitors’ or potential competitors’, then insetting its prices in conformity with its costs—thatis, above its costs only by enough to earn thegoing rate of profit—it ensures that it is not likelyto be undersold to any great extent or to attractnewcomers to its fieldb. its own costs are significantly below those ofits competitors, then it will want to set its pricenot too far above its competitors’ costs, as a maxi-mum, so that it can earn high profits while theyare not in a position to accumulate much capitaland expand at its expense, and also in order not toprovide an incentive for others to enter the indus-tryc. its costs are above those of its competitors,then except to the extent its product may be of pre-mium quality over theirs, it must simply match theprices they setd. all of the above

182. Absence of knowledge of the connec-tion between prices and costs, and the belief that theprice of each and every product must be determined bythe specific demand for and supply of the product—byits own independent marginal utility—is what has ledcontemporary economics

a. to the expectation that without the presence ofa vast number of individually insignificant firms,sellers will be in a position to exploit theproduct’s elasticity of demandb. to regard big business per se in a way thatshould be reserved for one or a few firms operat-ing under monopolistic legal protection againstcompetition, but not when operating under thefreedom of competition c. in the last analysis, to find that its theory sim-ply does not fit the facts and that it has no applica-ble theoryd. all of the above

183. The adoption of lower-cost methods ofproduction, even when protected by patents, soonserves to reduce prices somewhere—if not in the indus-try where introduced, then in another industry or indus-tries insofar as the funds released from the productionof the given item bring about an expansion of the pro-duction of other items.

184. Cost of production serves to limit theprice that it is profitable to charge for a good producedunder patent or copyright protection insofar as


a. what the patent or copyright protects is a moreefficient method of producing a good that is al-ready being produced, in which case the price ofthe good is limited by the cost of producing it bythe older, less efficient methodsb. what the patent or copyright protects is an im-provement in the methods of satisfying a need thatpreviously had been satisfied by other goods lesseffectively, in which case the price of the newgood is still limited by the prices and costs of pro-duction of the older goods that satisfy the needless effectivelyc. both (a) and (b)

185. Because of their newness and the diffi-culties of estimating their elasticity of demand, theprices of patented or copyrighted products, such asbooks, movies, and CDs, are typically set in a more orless standard way, on the basis of cost of production,though with the addition of a substantially greater-than-usual profit margin accompanied by the attemptto achieve the maximum possible volume along withthe higher-than-normal profit margin.

186. It is generally a sound business policyto reinvest the proceeds of an extremely high profitmargin and rate of profit in order to earn a largeramount of profit on the strength of a lower profit mar-gin and rate of profit applied to a greater volume ofsales and quantity of capital invested in the productionof the good (or more advanced versions of the good),because this policy

a. helps to guard against others being tempted toenter into competition through the development ofcomparable new products or methods of produc-tion of their own, which even patent or copyrightprotection cannot preventb. can achieve reductions in unit costs and im-provements in product quality stemming from the

adoption of more capital-intensive methods of pro-ductionc. serves further to increase the capital require-ment of any potential competitor and thus furtherto reduce the likelihood of the actual appearanceof such a competitord. is the way to transform a temporary bonanzainto greater and more lasting successe. all of the above

187. The ability to practice price discrimina-tion would make it possible to price life-saving pat-ented drugs in a way that did not deprive the marginalbuyers of their life’s savings.

188. The combination of collectivized pay-ment of medical expenses, widespread opposition toprice discrimination, and FDA delays in the approvalof new drugs serve to make drug prices higher thanthey would otherwise be.

189. Pricing under long-term contract has thepotential to make possible unregulated private owner-ship of the various utilities, such as electricity, water,and gas, telephone and sewage services, the provisionof bridges and tunnels, and fire-fighting services.

190. The injustices associated with the exer-cise of eminent domain would be greatly reduced if

a. its exercise were limited merely to cases inwhich a handful of capricious individuals couldotherwise frustrate the construction of necessaryprojects such as the construction of roads and pipe-linesb. the owners of the property sought were offeredsubstantially above-market prices rather than sub-stantially below-market pricesc. both (a) and (b)

Cartels

191. Cartels are associations of independentproducers of a good who agree to limit their produc-tion of it in order to obtain a higher price on the result-ing smaller supply.

192. Every cartel faces a problem of decid-ing which producers must curtail production howmuch.

193. Profitable cartels typically face the prob-lem of

a. deciding which producers must curtail produc-tion how muchb. controlling the reinvestment of the profits oftheir members, because if the firms are profitableand want to reinvest their profits in expanding production in the industry, the cartel’s price will fall in efforts to find buyers for the additional output

c. the profitable price attracting outside entrantsto the field, which not only makes the cartel’sprice fall, but also deprives the cartel’s membersof volume they could have hadd. all of the above

194. Apart from the handful of cases such asdiamonds, in which there are very few physicalsources of supply, the special problems faced by profit-able cartels imply that cartels can succeed under capi-talism only when they serve merely to reduce theextent of losses, i.e., raise a price from a point of moresevere losses to a point of less severe losses or modestprofits. In this case, the problems of controlling the re-investment of profits and the attraction of outside en-trants do not come up.


195. The prices that the few successful car-tels in mining can charge in a free economy may belimited by

a. the cost and price of various substitutes,which, however imperfectly, can be used in placeof the item for various purposesb. the possibility that additional deposits of theitem exist, which would be capable of commercialexploitation at a sufficiently high level of pricesc. both (a) and (b)

196. In a free economy, even successful car-tels, such as the diamond and mercury cartels, areunder continuous pressure to improve their methods ofproduction and lower their costs and the real pricesthey charge, so long as the producers of substitutes canimprove their methods of production, so long as newsubstitutes can be developed, and so long as the realcosts of exploiting submarginal deposits can be re-duced.

197. What is true of the price charged by asuccessful cartel is that at any given time it is higherthan would be the case if the same known physicalquantity of the good were found in widely scattered de-posits.

198. The effect of the higher price chargedby a successful cartel is to slow down the rate at whichthe limited known supplies are consumed and thus toserve, as von Mises described it, as a means of conser-vation.

199. Cartels as an economic problem, as inthe case of the Imperial German cartels, the OPEC oilcartel, and present-day American agriculture undergovernment price supports and supply restrictions, arethe result of government intervention, and where theyare formed or maintained on this basis, they representpart of the genuine and very serious problem of mo-nopoly.

The Pure-and Perfect-Competition Doctrine

200. The doctrine of pure and perfect compe-tition condems business as monopolistic for refusingto sustain unnecessary losses.

201. The doctrine of pure and perfect compe-tition is the standard by which contemporary economictheory and the Antitrust Division of the Department ofJustice decide whether an industry is “competitive” or“monopolistic,” and what should be done about it ifthey find that it is not “competitive.”

202. While normally, one thinks of competi-tion as denoting a rivalry among producers, in whicheach producer strives to match or exceed the perfor-mance of other producers, the doctrine of pure and per-fect competition claims that rivalry is incompatiblewith competition.

203. While competition as normally under-stood rests on a base of individualism, the pure-and-perfect-competition doctrine rests on

a. “the tribal premise,” i.e., the collectivist viewthat the individual human being is a cell in agreater organism, known variously as Mankind,the State, the Nation, or the Tribeb. a tribal concept of property, according towhich no property is to be regarded as truly pri-vate but rather as being held in trusteeship for itsalleged true owner, “society” or the “consumers,”who allegedly have a right to the property ofevery producer and suffer him to continue asowner only so long as society receives what it orits professorial spokesmen consider to be the max-imum possible benefitc. the rationing theory of prices, according towhich a price is viewed not as the payment re-ceived by a seller in the free exchange of his pri-vate property, but as a means of rationing his

products among those members of society or thesovereign consumers who happen to desire them,with prices being justified on the grounds thatthey are a means of rationing superior to the issu-ance of coupons and priorities by the governmentd. a collectivist concept of cost, according towhich cost is not an outlay of money made by abuyer to obtain goods or services through free ex-change, but the value of the most important alter-native goods or services society must forgo byvirtue of obtaining any particular good or servicee. all of the above

204. According to the tribal concept of prop-erty,

a. society has a right to 100 percent of everyseller’s inventory and to the benefit of 100 percentuse of his plant and equipmentb. the exercise of this alleged right is to be lim-ited only by the consideration of society’s allegedalternative needsc. a producer should retain some portion of his in-ventory only if it will serve a greater need of soci-ety in the future than in the presentd. a producer should produce at less than 100 per-cent of capacity only to the extent that society’slabor, materials and fuel, which he would require,are held to be more urgently needed in anotherline of productione. all of the above

205. According to the doctrine of pure andperfect competition and its underlying collectivism,

a. supply means the goods that are here—in thepossession of sellers—and the potential goods thatthe sellers would produce with their existing plant


and equipment, if they considered no limitation totheir production but marginal costb. demand means the set of quantities of thegoods that buyers will take at varying pricesc. every price is supposed to be determined atwhatever point is required to give the buyers thefull supply and to limit their demand to the size ofthe supplyd. all of the above

206. According to the doctrine of pure andperfect competition and the rationing theory of prices,

a. every seller’s goods and the use of his plantand equipment belong to society and should befree of charge to society’s members unless anduntil a price is required to ration themb. up to the point of price being necessary toserve as a rationing device, the goods of sellersshould be free goods, like air and sunlightc. prior to the point of price being necessary toserve as a rationing device, any value that thegoods of sellers have is the result of an “artificial,monopolistic restriction of supply”—of a deliber-ate, vicious withholding of goods from “society”by their private custodiansd. all of the above

207. Marginal cost is a. always the extra cost that must be incurredfrom a given, present starting pointb. different with different starting pointsc. usually held to be the cost of the labor, materi-als, and fuel required to produce an additional unitof a product, the cost of the plant and equipmentbeing regarded as “sunk costs”d. regarded as representing the value of the mostimportant alternative goods or services that soci-ety forgoes in obtaining an additional unit of agiven goode. all of the above

208. The pure-and-perfect-competition doc-trine regards

a. an excess of price over marginal cost as repre-senting a situation in which society can gain moreof something it values more highly at the expenseof less of something it values less highlyb. an excess of marginal cost over price as repre-senting a situation in which society loses some-thing it values more highly and gains something itvalues less highlyc. the equality of price with marginal cost as theachievement of a social optimum, in which soci-ety obtains the maximum benefit from the alloca-tion and use of its scarce resourcesd. all of the above

209. According to Samuelson and Nordhaus,only when prices of goods are equal to marginal costsis the economy squeezing from its scarce resourcesand limited technical knowledge the maximum of out-puts.

210. The “imperfect competitor”—viz., the“monopolist,” the “oligopolist,” or the “monopolisticcompetitor”—is condemned because

a. he does not produce goods up to the pointwhere their alleged social cost—as measured bymarginal cost—is equal to what the last unit of thegood is allegedly worth to “society”—as mea-sured by market priceb. he contrives to keep his output a little scarce,and keep price above marginal cost because whatmaximizes his profit is to set not price but mar-ginal revenue equal to marginal costc. society does not get quite as much of the imperfectcompetitor’s good as it allegedly wants in terms ofwhat that good allegedly costs society to produced. he refuses to accept unnecessary lossese. all of the above

211. The alleged sin of the “imperfect com-petitor” is manifested in

a. the example of the primitive fishing villagewhose fleet has a catch so abundant that the mar-ginal utility of fish would be zero or negative andwhose owners decide to throw some fish back intothe sea, in order to obtain a positive price on thereduced supply that remainsb. the earning of a royalty or profit by virtue ofthe use of an idea, which by its nature is capableof being employed without limit and which canachieve value only by its use being deliberatelylimitedc. the earning of depreciation on existing plant andequipment whose services do not qualify as scarced. all of the above

212. The earning of depreciation charges isheld to be improper short of capacity operation of theplant and equipment in question because it signifiesthe receipt of a price for plant-and-equipment servicesthat are not yet scarce.

213. The doctrine of pure and perfect compe-tition regards depreciation as properly recoverableonly in circumstances similar to those in which Ri-cardo held land rent to come into existence, namely, ascarcity of the services of the grade of capacity or landin question.

214. Competition in contemporary econom-ics is viewed as the means by which prices are drivendown either to equality with marginal cost or to thepoint where they exceed marginal cost only by what-ever premium is necessary to ration the benefit ofplant and equipment operating at full capacity.

215. Pure and perfect competition is the setof conditions required to make profit-seeking business-men set their prices equal to marginal cost.

216. According to the doctrine’s supporters,the requirements of pure and perfect competition are

a. uniform products offered by all the sellers inthe same industry


b. perfect knowledgec. quantitative insignificance of each sellerd. no fear of retaliation by competitors in re-sponse to one’s actionse. constant changes in price, and perfect ease ofinvestment and disinvestmentf. all of the above

217. An example that would meet the require-ments listed in the previous question would be

a. the competition that exists between Ford andGeneral Motorsb. the competition that exists between Dell andHewlett Packardc. the competition that would exist between fourhundred and one movie theaters, all in the sameneighborhood and all showing the same picture,which all potential viewers had already seen manytimes yet desired to see still again while being in-different to any possible differences between thetheaters except for the smallest difference in price,and if the theaters were tent-like affairs ratherthan durable structures

218. In the conditions described in the lastchoice in the preceding question,

a. any theater owner who cut his price by as little asone mill would supposedly be able to regard doingso as the means of filling all of his empty seatsb. the gain in business of any one theater as theresult of cutting its price would come mainly fromother theaters, but the loss of business to any oneof the other theaters would be too small to pro-voke a response, since, for example, 400 emptyseats in a given theater might be filled by drawinga mere single customer from each of 400other theatersc. all the theater owners would be driven to con-tinually cut their prices in the belief that doing soserved only to expand their volume to the level ofcapacity operationd. the profit motive would quickly drive price toequality with marginal coste. all of the above

219. The pure-and-perfect-competitiondoctrine’s

a. stress on the need for a large number of indi-vidually insignificant sellers as an essential condi-tion of driving price to equality with marginal costrests on the need for the individual businessmanto be able to assume that his cutting price willhave no perceptible effect on the business of anyof the other sellers and thus will not be the causeof their cutting priceb. incompatibility with the existence of a smallnumber of significanct-sized sellers derives fromthe fact that in such a case cutting price wouldhave a major, perceptible effect on the business ofothers, who would therefore be driven to cut pricein response, and the knowledge that this is what

would happen would prevent the price cut frombeing made in the first place, with the result thatprice would not be driven to marginal costc. both (a) and (b)

220. The pure-and-perfect-competitiondoctrine’s stress on the need for product uniformityrests on the greater responsiveness of customers toprice changes in such conditions. If in contrast to 401theaters showing the identical movie, they showed dif-ferent movies, customers would be less likely to shifttheir business among the various theaters in responseto infinitesimal price differences, and so a theaterowner would have less incentive to trim his price.

221. Having to set prices equal to marginalcosts in conditions in which operations were belowfull capacity, would imply prices of zero or not veryfar above zero for

a. airlines and railroads whose planes or trainshad empty seatsb. movie theaters, baseball stadiums, and operahouses that had empty seatsc. toll bridges and tunnels not confronted withheavy trafficd. all of the above

222. According to Samuelson and Nordhaus,in conditions in which setting price equal to marginalcost means incurring chronic losses, the solution is to

a. abandon the setting of prices equal to marginalcostb. have the government subsidize the producer

223. According to the logic of the the pure-and-perfect-competition doctrine and its underlyingdoctrine that prices are justified only as a rationing de-vice, the only time that

a. movie theaters, baseball stadiums, and operahouses, whose marginal costs of admitting an addi-tional customer are virtually zero, should be ableto charge a positive price is when they are at ca-pacity operationb. airlines and railroads, whose marginal cost ofcarrying an additional passenger is little morethan the additional fuel that may be required,should be able to charge a price above such mar-ginal cost is when they have no empty seatsc. steel mills, automobile factories, and almost allother manufacturing firms should be able tocharge a price above their marginal costs of labor,materials, and fuel, is when the grade of manufac-turing capacity in question has become scarced. all of the above

224. The effect of imposing marginal costpricing would be

a. the widespread incurrence of massive losseswhen operations were at less than full capacityb. a great reduction in the volume of capacity inexistence, to the point that the capacity that re-mained would be in a state of scarcity often


enough so that the premium earnings in such peri-ods would be sufficient to offset the losses in theperiods of less-than-capacity operationc. a corresponding reduction in the ability of theeconomic system quickly to meet increases in de-mand without having to build new and additionalcapacityd. all of the above

225. The standard of ‘efficiency’ used to jus-tify the doctrine of marginal-cost pricing is one accord-ing to which the economy of Soviet Russia was moreefficient than that of the United States, because eventhough there was less of everything in Soviet Russiathan in the United States, what there was, was usedmore fully.

226. The ideal of the pure-and-perfect-com-petition doctrine“ implies a state of affairs in whichproducers are unable to take business away from otherproducers, because

a. if a producer is operating at full capacity, hecannot meet the demand of a single additionalbuyer, let alone compete for that demandb. a producer cannot compete for additional busi-ness if he is operating merely at the full capacityof a given grade of plant and equipment and hisidle capacity is of a kind whose operating cost isgreater than the currently prevailing pricec. if a producer is not producing at full capacityeven of a given grade of plant and equipment andis charging a price equal to his “marginal cost,” hestill cannot compete for the business of any addi-tional buyers because he is forbidden to “differen-tiate” his product or to advertise itd. all of the above

227. Ironically, what the pure-and-perfect-competition doctrine seeks is the abolition of competi-tion among producers and its replacement with acompetition among consumers for scarce supplies.

228. The pure-and-perfect-competition doc-trine is to the left of Marxism in that Marxism de-nounced capitalism merely for the existence of profits,while it denounces capitalism because businessmen re-fuse to suffer unnecessary losses, which they wouldhave to suffer if they treated their plant and equipmentas costless natural resources that acquired value onlywhen they happened to be scarce.

229. Choose the most completely true an-swer.

a. empirical studies based on the assumption thatmarginal cost is equal to total average cost plus anallowance for earning a competitive rate of profitlead to the finding that monopoly profits are insig-nificant in the economic system as a whole, ac-counting perhaps for about .5% of GDPb. empirical estimates of the burden of monopolyprofits do not distinguish between above-average-prof-its that are the result of positive productive contribu-

tion and those which are the result of restrictionsof production based on the initiation of forcec. what reconciles the enormous concentration onthe problem of monopoly in contemporary eco-nomic theory with its insignificance in practice isthat contemporary economic theory regards the fail-ure to sustain unnecessary losses as a problem of mo-nopoly and spends much of its time focusing on thisd. all of the above

230. The supporters of the pure-and-perfect-competition doctrine accuse capitalism of lackingprice competition, because their notion of price compe-tition is that of the process of driving prices down tothe level of “marginal cost” or to the point where they“ration” the benefit of “scarce” capacity, which pro-cess is typically absent.

231. Price competition is given by every firmthat charges prices too low for other firms to be profit-able and is an omnipresent feature of capitalism.

232. Price competition exists even in themidst of inflation in that even under inflation, everyfirm is still interested in improving the productivity ofthe labor it employs and to the extent it succeeds indoing so, it is able to hold its price increases below thewage increases it must pay, with the result that otherfirms in the same line of business are compelled to in-crease the productivity of the labor they employ orelse suffer reduced profits or losses and eventually goout of business.

233. The competitor who cuts his price isfully aware of the impact on other competitors and thatthey will try to match his price. He acts in the knowl-edge that some of them will not be able to afford thecut, while he is, and that he will eventually pick uptheir business, as well as a major portion of any addi-tional business that may come to the industry as awhole as the result of charging a lower price. He isable to afford the cut when and if his productive effi-ciency is greater than theirs, which lowers his costs toa level they cannot match.

234. The ability to lower the costs of produc-tion

a. enables an efficient producer to be profitable atprices too low for less efficient producers to beprofitableb. enables an efficient producer who lowers hisprices, to gain most of the new customers in hisfield because his lower costs become the source ofadditional profits, the reinvestment of which en-ables him to expand his capacity and thus to sup-ply the increase in quantity demanded at a lowerpricec. is the foundation of the ability to take businessaway from others in the field d. permits a producer to forestall the potentialcompetition of outsiders who might be tempted toenter his field, drawn by the hope of making prof-


its at high prices, but who cannot match his costefficiency and, consequently, his lower pricese. is the base of price competitionf. all of the above

235. Price competition, under capitalism, isthe result of a contest of efficiency, competence, ability.

236. Price competitiona. is not the self-sacrificial chiseling of prices tomarginal cost or their day-by-day, minute-by-min-ute adjustment to the requirements of “rationingscarce capacity” b. is the setting of prices—perhaps only once ayear—by the most efficient, lowest-cost produc-ers, motivated by their own self-interestc. varies in extent in direct proportion to the sizeand the economic potency of these producersd. is more powerful when it comes from a Gen-eral Motors or Toyota than when it comes from amicroscopic-sized wheat farmere. all of the above

237. Price competition frequently forcessome of the sellers in an industry to sell at a price thatis equal to or not far above their marginal costs, yet, atthe same time, is substantially above the marginal costsof the more efficient, more competitively capable firms.This is part of the process by which the more efficientfirms gain the business of the less efficient firms, whichwill be unable to replace their assets and thus unable tocontinue in business on the present scale.

238. More efficient firms typically sell atprices below the marginal costs of a substantial portionof the capacity of the less efficient firms. Such pricesare what keeps that less efficient capacity from servingthe market, and thus competitively reserves the marketto the more efficient firms.

239. It can be to the rational self-interest of alarge firm to cut its price in response to a fall in de-mand, even though the industry demand curve ishighly inelastic and other firms will quickly match itscut. This will be the case when the drop in demandidles capacity with a relatively low marginal cost ofoperation, while other firms continue to supply themarket with capacity that has a relatively high mar-ginal cost of operation. In this case it is to the self-in-terest of the firm with the lower-cost capacity to cutthe price in order to make way in the market for its ca-pacity. Cutting the price below other firms’ higher mar-ginal costs is the means of eliminating the higher-costcapacity of those firms from the market.

240. Alfred Marshall’s doctrine of the “repre-sentative firm”

a. conceives of an industry as consisting of amere multiplication of so many interchangeable,identical “representative firms”b. proceeds on the assumption that all the firmsin an industry have exactly equal efficiency andequal costs

c. rules out any basis for price cutting, since noone can have any rational basis for expecting tosucceed by doing so, because the moment anyonecuts his price, the other producers, who are as-sumed to be equally efficient, cut theirs in re-sponsed. serves to blind contemporary economists to theexistence of price competition outside of the con-ditions of “pure and perfect competition” e. all of the above

241. An implication of Marshall’s doctrine isthat the only possible gain for a producer in cutting hisprice is the same gain that would exist if there wereonly one producer. On this basis, contemporary eco-nomics concludes that what it calls “oligopoly” is es-sentially the same in its effects as “monopoly,”because it appears to it that it will pay an “oligopolist”to cut his price only when it would pay a “monopolist.”

242. Contrary to Marshall’s doctrine, compe-tition, centering precisely on an inequality in the pro-ductive efficiency of firms, is the means by whichcontinuous progress and improvement are broughtabout, in terms both of falling real prices of productsand ever better products.

243. Cost of production operates toa. set many prices, such as those of spare partsand other goods with highly inelastic demands, farbelow what they would be if they were deter-mined on the basis of the direct marginal utility ofthe good concernedb. establish prices at a point that is above whatthey would be if producers did in fact have to re-gard their plant and equipment and intellectualproperty as not deserving to command an allow-ance in the price of the product because their ren-ditions of service were not scarcec. both (a) and (b)

244. Setting prices above what they wouldbe if producers had to regard their plant and equipmentand intellectual property as not deserving to commandan allowance in the price of the product short of thepoint of their being scarce, serves in the long run tokeep prices below what they would be if based on theproduct’s own, direct marginal utility and to progres-sively lower real prices, because

a. it makes possible the existence of the capacityrequired to quickly increase the production ofgoods whose own, direct marginal utility may bevery high and thereby to hold their prices to thelower level corresponding to cost of productionb. being able to profit from intellectual property,including trade secrets and all manner of techno-logical and other knowledge not yet widely dis-seminated, whose services are never physicallyscarce, is what underlies the incentive and abilityto go on introducing further productive innova-tions, which steadily reduce prices in real termsc. both (a) and (b)


The following eight questions are drawn from thetext by Samuelson and Nordhaus.

245. A perfect competitor’s output in theshort run is the quantity that:

a. sets MC equal to MR = Pb. sets AVC = P c. minimizes ATCd. sets ATC = P e. none of the above are correct

246. In the situation of imperfect competi-tion, the relation between market price P and marginalrevenue MR for each supplying firm is that:

a. P is less than MR at all or most output levelsb. P is greater than MR at all or most output levelsc. P is the same as MR at all output levelsd. P is either less than MR at particular outputlevels or the same as MRe. none of the above, since P is not related to MR

247. A monopoly finds that, at its presentlevel of output and sales, marginal revenue equals $5and marginal cost is $4.10. Which of the followingwill maximize profits?

a. Leave price and output unchangedb. Increase price and leave output unchangedc. Increase price and decrease outputd. Decrease price and increase outpute. Decrease price and leave output unchanged

Use the following Table to answer the next two questions:

P Q Revenue Profit

$5 7

$4 12

$3 17

$2 22

$1 27

248. Consider the demand curve implied inthe above Table. If the imperfectly competitive firm isable to produce at any output level, then the price andquantity which maximize total revenue are:

a. P=5; q=7 b. P=4; q=12c. P=3; q=17d. P=2; q=22e. P=1; q=27

249. Suppose an imperfect competitor facesthe demand curve defined in the above Table, and itsMC is constant at $2.00. If the firm is able to produceat any output level, then it maximizes profits at:

a. P=5; q=7 b. P=4; q=12 c. P=3; q=17d. P=2; q=22e. none of the above if fixed costs are less than$1.00

250. If the firm described in the previousquestion has no fixed costs, its profits are:

a. $48b. $54c. $24d. $4e. -$12

251. If a firm finds out that its marginal reve-nue is greater than its marginal cost, it should:

a. increase production and salesb. decrease production and salesc. encourage the entry of other firms into the mar-ketd. keep raising its selling price till marginal reve-nue equals marginal coste. change nothing because profits are maximized

252. Falling marginal revenue facing an indi-vidual firm is incompatible with:

a. growth of the firmb. perfect competitionc. oligopolyd. barriers to entrye. none of the above


Answers to Questions 1-244 on Chapter 10 and 245-252 on Samuelson 108

Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 d 31 T 61 d 91 T 121 9 151 T 181 d 211 d 241 T2 c 32 T 62 c 92 d 122 $1.80 152 a 182 d 212 T 242 T3 e 33 T 63 T 93 T 123 zero 153 c 183 T 213 T 243 c4 f 34 T 64 T 94 T 124 $1.80 154 b 184 c 214 T 244 c5 f 35 T 65 T 95 T 125 9 155 T 185 T 215 T 245 a6 b 36 T 66 c 96 T 126 T 156 T 186 e 216 f 246 b7 T 37 T 67 T 97 e 127 $2.70 157 $3 187 T 217 c 247 d8 T 38 e 68 e 98 >18 128 $1.80 158 $700 188 T 218 e 248 c9 b 39 T 69 T 99 >900 129 T 159 $200 189 T 219 c 249 b

10 g 40 f 70 c 100 T 130 T 160 $100 190 c 220 T 250 c11 T 41 T 71 T 101 T 131 d 161 T 191 T 221 d 251 a12 T 42 T 72 T 102 T 132 T 162 T 192 T 222 b 252 b13 b 43 e 73 T 103 b 133 T 163 c 193 d 223 d14 T 44 T 74 d 104 F 134 T 164 T 194 T 224 d15 a 45 T 75 c 105 b 135 T 165 T 195 c 225 T16 T 46 h 76 T 106 f 136 T 166 T 196 T 226 d17 T 47 T 77 T 107 T 137 T 167 T 197 T 227 T18 T 48 T 78 T 108 T 138 T 168 d 198 T 228 T19 T 49 T 79 T 109 e 139 e 169 T 199 T 229 d20 n 50 T 80 T 110 T 140 b 170 T 200 T 230 T21 T 51 T 81 d 111 d 141 b 171 b 201 T 231 T22 T 52 T 82 T 112 T 142 b 172 b 202 T 232 T23 e 53 h 83 T 113 $9 143 c 173 d 203 e 233 T24 T 54 e 84 T 114 $8.10 144 b 174 b 204 e 234 f25 T 55 T 85 T 115 90 cents 145 T 175 T 205 d 235 T26 T 56 d 86 500% 116 $1 146 a 176 T 206 d 236 e27 d 57 f 87 T 117 90 cents 147 T 177 c 207 e 237 T28 e 58 T 88 T 118 10 cents 148 T 178 T 208 d 238 T29 T 59 T 89 T 119 10 cents 149 T 179 T 209 T 239 T30 f 60 T 90 T 120 90 cents 150 c 180 c 210 e 240 e

CHAPTER 11THE DIVISION OF LABOR AND THE CONCEPT

OF PRODUCTIVE ACTIVITY

PART A: THE ROLE OF MONEYMAKING IN PRODUCTIVE ACTIVITY

1. The prevailing concept of productive activ-ity is that it is synonymous with manual labor.

2. The IRS regards profits, interest, divi-dends, and capital gains as “earned income,” andwages and sararies as “unearned income.”

3. Labor union leaders, and many or mostmembers of labor unions, and probably most of thegeneral population, believe that the true producers ofthe products are the working men and women who toilon assembly lines or stand on their feet all day, whilethe bosses take a major slice off the top, in the form ofprofits and similar incomes.

4. A leading reason for the advocacy of so-cialism has traditionally been the belief that its estab-lishment would give all income back to its trueproducers, i.e., the manual workers.

5. The belief that productive activity andmanual labor are synonymous is held by

a. labor unionsb. the IRSc. socialists, especially Marxistsd. all of the above

6. If productive activity is viewed as limitedto manual labor, then the following major partici-pant(s) and/or activity(ies) of a capitalist society arenecessarily viewed as unproductive and/or parasitic

a. businessmen and capitalistsb. retailingc. wholesalingd. advertisinge. the banking and financial system including thestock market and commodity marketsf. all of the above

7. The belief that productive activity andmanual labor are synonymous is reasonable in the con-text of

a. a division-of-labor societyb. a non-division-of-labor societyc. both (a) and (b)d. neither (a) nor (b)

8. The doctrine that productive activity andmanual labor are synonymous is a heritage from theconditions of the non–division-of-labor societies of old.

9. In the context of a division-of-labor soci-ety, money-making is an essential aspect of productiveactivity, because in such a society, the earning ofmoney is necessary if an individual’s activity is to en-

able him to be in a position to obtain the goods and ser-vices of others and thus to secure the benefits of life ina such a society.

10. Manual labor and the physical making ofgoods are not sufficient to enable an individual to ob-tain the goods and services of others. There is the fur-ther requirement that the activity earn money, withwhich to buy others’ goods and services.

11. In the context of a division-of-labor soci-ety, manual labor that does not earn money does notserve to sustain the individual who performs it and isnot productive.

12. The activities of a paid housekeeper andan unpaid housewife who perform identical physicallabor are

a. perfectly equivalentb. differ in the essential respect that the activitiesof the paid housekeeper make it possible for her toobtain the goods and services of other people andthus to sustain herself, while those of the unpaidhousewife do not

13. If GNP/GDP were a true measure of pro-ductive activity, it would make an imputed allowancefor the activities of unpaid housewives, whose labordoes not differ in any significant way from those ofpaid housekeepers. Failure to allow for the labor ofhousewives leads to the understatement of GNP/GDPby trillions of dollars every year.


14. In the context of a division-of-labor soci-ety, the starting point of virtually all physically produc-tive activities is an outlay of money to purchasematerials, tools, equipment, and other means of pro-duction.

15. In the course of production, means of pro-duction are physically consumed—i.e., used up orworn out—and sooner or later need to be replaced.

16. Insofar as physically productive activitiesare carried on for the purpose of earning money, themoney earned makes possible replacement purchasesof the means of production physically consumed in theprocess of production, and to this extent the means ofproduction are not simply used up and gone but arecontinually replaced, by virtue of the activity in whichthey are used up.



17. Insofar as physically productive activitiesare not carried on for the purpose of earning money,the means of production physically used up in the pro-cess of production cannot be replaced by virtue of thatprocess of production, but are simply used up andgone.

18. In the context of a division-of-labor soci-ety, activity that physically results in the production ofa product represents consumption if it is not carried onfor the purpose of earning money, since means of pro-duction are physically used up in the product’s produc-tion and cannot be replaced by virtue of its production.The process is a “consumptive production.”

19. The concept of productive activity ulti-mately rests on the promotion of human life and well-being and must always be consistent with that ultimatepurpose. Thus, to qualify as productive, the moneybrought in, in a process of productive activity must beobtained through voluntary trade, not physical force.

20. A successful bank robbery brings inmoney and is therefore a productive activity.

21. Productive expenditure isa. buying for the purpose of sellingb. self-sustaining and a source of fundsc. a means by which one grows richerd. made implicitly for the purpose of earning aprofite. synonymous with reproductive expenditure, inthat it is money which is both laid out and broughtback by virtue of productive expendituref. all of the above

22. Consumption expenditure isa. buying not for the purpose of selling, but forany other purposeb. a using up of fundsc. a means by which one grows poorerd. synonymous with unproductive expendituree. all of the above

23. Two people, both beginning with identi-cally the same sum of money (we might imagine twobrothers sharing equally in an inheritance), the one pro-ductively expending his funds, the other un-productively expending his funds, will almostnecessarily arrive at opposite stations in life. The onewill be richer; the other will be impoverished.

24. In the preceding example, the party whowill be impoverished is the one making productive ex-penditures; the party enriched is the one making con-sumption expenditures.

25. Capital goods area. goods purchased for the purpose of makingsubsequent salesb. the source of the funds required for their re-placement, and of more besides, to the extent thatthe sales revenue they help to bring in shows aprofit

c. like productive expenditures, self-sustainingand a source of fundsd. the same as producers’ goodse. all of the above

26. In order to qualify as capital goods, it isnecessary that the goods purchased themselves be sub-sequently sold.

27. In order to qualify as capital goods, it issufficient that the goods purchased contribute to theproduction of goods or services that are subsequentlysold, as is the case with materials or machinery pur-chased by a manufacturer rather than by a dealer.

28. Consumers’ goods are goodsa. purchased not for the purpose of making subse-quent salesb. require an outside source of funds if their pur-chase is to be repeatedc. like consumption expenditures, represent ausing up of fundsd. all of the above

29. A roast beef purchaseda. by a housewife is a consumers’ goodb. by a restaurant is a capital goodc. both (a) and (b)

30. The distinction between capital goodsand consumers’ goods is

a. exclusively one of the purpose for which thegoods are purchased—for business purposes (i.e.,the making of subsequent sales at a profit) or notfor business purposesb. a matter of their physical characteristicsc. both (a) and (b)

31. Machines, materials, tools, implements,and structures are

a. often consumers goodsb. capital goods

32. Washing machines, sewing machines, au-tomobiles, corn flakes, roast beefs, lathes, drill presses,earthmoving equipment are

a. consumers’ goodsb. capital goodsc. sometimes consumers’ goods, sometimes capi-tal goods, depending on the purpose for whichthey are purchased

33. The heavy construction equipment of theArmy Corps. of Engineers is

a. consumers’ goodsb. capital goods

34. If the Army Corps. of Engineers owned afactory for the purpose of producing its constructionequipment, that factory would be

a. a consumers’ goodb. a capital good

35. Government is essentially a consumerand its expenditure, consumption expenditure.


36. The governmenta. does not buy for the sake of sellingb. uses up the funds it expends, in that the fundsare not recovered in sales revenuesc. must turn to the taxpayers or the printing pressin order to be able to continue spending d. all of the above

37. The leading exception to the propositionthat government is a consumer is the IRS, whichbrings in revenues far in excess of its expenditures.

38. The expenditures of a gang of safecrack-ers for such things as nitroglycerin and a get-away carare productive expenditures in that they serve to bringin far more money than is laid out.

39. Producers’ labor isa. labor employed for the purpose of its employermaking subsequent salesb. the source of funds making possible a repeatedpayment of its wagesc. similar in nature to capital goods and produc-tive expenditured. all of the above

40. Producers’ labor is a. essentially just the labor of salesmen, sincethey alone make salesb. the labor of all the employees of businessfirms, who are employed for the purpose of thefirm making subsequent sales, to which their labordirectly or indirectly contributes or which it facili-tates in some way

41. Consumers’ labor isa. labor employed not for the purpose of the em-ployer making subsequent salesb. not a source of funds making possible its con-tinued receipt of wagesc. similar in nature to consumers’ goods and con-sumption expenditured. all of the above

42. The distinction between producers’ laborand consumers’ labor is from the perspective of

a. the employerb. the wage earner

43. An individual grows richer by the [intelli-gent] purchase of capital goods and employment ofproducers’ labor, and poorer by the purchase ofconsumers’ goods and consumers’ labor.

44. Examples of consumers’ labor area. maids employed by housewivesb. butlers, cooks, and chauffers employed byvery wealthy individualsc. government employees—e.g., the clerks andsecretaries in all the bureaus, the teachers in thepublic schools, policemen, firemen, the membersof the armed forcesd. all of the above

45. Producers’ loans are

a. loans taken out for the purpose of making sub-sequent salesb. are normally a source of funds for the paymentof interest and principal on the loans and of aprofit to the borrower besidesc. both (a) and (b)

46. Consumers’ loans area. loans taken out not for the purpose of makingsubsequent salesb. loans on which the principal and interest mustbe paid out of a source of funds not provided bythe loans themselves, such as the income from theborrower’s jobc. both (a) and (b)

47. Loans taken out by the government repre-sent consumer loans, since the government does notearn revenue or income by virtue of its borrowing andmust pay interest and principal out of a source of fundsnot provided by the loans themselves, i.e., out tax reve-nues.

48. An essential difference between govern-ment borrowing and private consumer borrowing isthat in the case of private consumer borrowing, it isthe borrowers who must pay the principal and interest,while in the case of government borrowing, it is a dif-ferent party who must repay, namely, the taxpayers—agroup which includes the lenders.

49. Capital isa. in general, wealth reproductively employedb. in the context of a division-of-labor society,the wealth employed by business enterprisesc. both (a) and (b)

50. Consumers’ wealth is wealth that existsbut is in the process of being consumed without provid-ing the funds required for its maintenance and replace-ment, such as owner occupied housing, homeappliances, furniture, and personal automobiles.

51. The prior expenditure reflected in the pos-session of goods—whether productive expenditure inthe possession of capital goods, or consumption expen-diture in the possession of consumers’ goods—is theirbook value.

52. Book value can be said to reflect a put-ting of money into goods.

53. Investment is the putting of money intogoods for the purpose of making subsequent sales.

54. Just as the concept of property possessingmarket value is wider than the concept of wealth, theconcept of capital value is wider than the concept ofcapital, and includes, in addition to the value of actualcapital goods, the value of intangibles such as stocksand bonds, patents and copyrights, goodwill, and ofloans made to consumers for homes, automobiles, va-cations, and the like.


55. While capital value reflects prior produc-tive expenditure, not all productive expenditure resultsin capital value, because not all productive expendi-ture is invested; some of it, such as expenditures for ad-vertising and administrative overhead, is typicallyexpensed rather than being added to any asset account.

56. Expenditures for consumers’ goods thatare necessary to keep one alive and able to work

a. qualify as productive expendituresb. do not qualify as productive expenditures be-cause earning money is not their purpose butmerely their consequence, i.e., their byproduct

57. If expenditures for consumers’ goods thatare necessary to keep one alive and able to work weretreated as productive expenditures,

a. they would have to be deducted as costs fromone’s earnings, and one’s net income would thenhave to be stated merely as the remainder ratherthan as one’s actual total earningsb. the net income of wage earners would have tobe regarded not as their wages but as the profitthey made on those wagesc. since the purpose of the concept of net incomeis to show the financial gain from an activity, thegain would be held to begin only after all provi-sion had been made for keeping oneself alived. there is no greater gain from working and earn-ing money than being able to stay alive, whichmeans that the money that must be expended to ac-complish this should not be excluded from net in-come, thus should not be counted as a cost andtherefore should not be counted as a productiveexpenditure in the first placee. all of the above

58. Consumption expenditures imposed bythe earning of an income, such as the employment of ahousekeeper or babysitter by a working mother, hav-ing to eat one’s lunches out, having to incur transporta-tion expense getting to and from work, having to incurthe costs of winter clothing and fuel for heating one’shome if one works in a cold area, should be counted asproductive expenditures and costs of earning one’s in-come

a. in order to reduce one’s taxable income b. because such expenditures really are made forthe purpose of earning money rather than as a mat-ter of one’s personal convenience in the context ofearning money

59. Consumption expenditures of a kind thatsave money, such as the purchase of a home in compar-ison with renting, or the purchase of a washing ma-chine in comparison with using a laundromat

a. should be treated as productive expendituresbecause they are income producing in that they re-duce one’s expenses, and the absence of an ex-pense is the equivalent of money earnedb. should not be treated as productive expendi-tures because they represent merely smaller con-

sumption expenditures, and smaller consumptionexpenditures are still consumption expenditures:i.e., the purchase of the house or the washing ma-chine does not provide the funds to make possibleits replacement purchase, which is still dependenton an outside source of funds


60. Government expenditures that increasethe capacity of the citizens to pay taxes, such as, per-haps, expenditures for highways and river and harborimprovements, are

a. productive expendituresb. consumption expenditures that have beneficial,productive effects for others

61. The government collects the additionaltax revenues because the taxpayers

a. voluntarily choose to pay them, in exchangefor the goods and services the government has pro-vided b. want to avoid being sent to prison

62. Workers employed in a charity’s fundraising activities should

a. be regarded as producers’ labor since theirwork serves to bring in moneyb. not be regarded as producers’ labor since themoney brought in is charitable donations, not pay-ments made in exchange for the receipt of goodsor services

63. Other than for tax purposes, treating ex-penditures for personal, vocational education as pro-ductive expenditures, and thus the net incomes of theworkers who incurred them as profits rather thanwages, would entail radical conceptual change in orderto deal with a relatively small set of concretes. At thesame time, it would have no bearing on the amount orrate of profit that is of actual concern. To avoid such afruitless procedure, it is far simpler for all practicalpurposes to regard such productive expenditures ofwage earners as consumption expenditures.

64. Improvements in an individual’s personalcapacities, including his ability to earn an income,should not be regarded as capital or any kind of wealthbecause, unlike capital and wealth, they cannot be sep-arated from the individual’s person and sold off as asource of funds that would enable him to live for atime without working.


65. The artificial capital constituted by themarket value of slaves in a society that sanctions slav-ery operates to prevent the formation of genuine capi-tal, in that it creates the appearance of wealth andcapital where it does not exist in reality and leads tothe failure to accumulate genuine capital in the belief


that sufficient such capital already exists and thereforeneed not first be accumulated.

66. The owner of a factory in the pre-Civil-War North counted as his capital the value of his fac-tory and its equimpent and inventories. He did notcount his workers in his calculation of his capital. Theowner of a plantation in the pre-Civil War Southcounted in the calculation of his capital the marketvalue of his slaves and, in effect, considered himself,wealthy mainly because of the mere fact that he hadworkers. The prevalence of this delusion is largelywhat caused the South to be so much poorer in actualphysical assets than the North.


67. Adam Smith distinguished between pro-ductive and unproductive labor on the basis of whetherthe labor was employed

a. to produce a tangible physical product that en-dured after the labor was performed or a servicethat disappeared in the instant in which it was cre-atedb. for the purpose of bringing in subsequent salesrevenues or not bringing in subsequent sales reve-nuesc. both (a) and (b)

68. Of the two criteria Adam Smith used indistinguishing between productive and unproductivelabor,

a. the question of whether or not a tangible physi-cal product is created is actually irrelevantb. the valid and valuable distinction is whether ornot the employment of the labor is for the purposeof making subsequent salesc. both (a) and (b)

69. The latter distinction in the previous twoquestions is what explains

a. whether or not an employer grows rich or poorby the employment of any given type of laborb. why in Smith’s words, “The sovereign, for ex-ample, with all the officers both of justice and warwho serve under him, the whole army and navy,are unproductive labourers. . . . Their service, howhonourable, how useful, or how necessary soever,produces nothing for which an equal quantity ofservice can afterwards be procured. The protec-tion, security, and defence of the commonwealth,the effect of their labour this year, will not pur-chase its protection, security, and defence for theyear to come.”c. both (a) and (b)

70. The owner of a restuarant or theater cangrow rich by the employment of workers whose ser-vices vanish in the instant in which they are created.He does so because the wages he pays them serve tobring in sales revenues that enable him not only to re-

peat the payment of their wages but also to earn aprofit.

71. In contrast to the restaurant or theaterowner of the previous question, a government-ownedshipyard, say, that employs large numbers of construc-tion workers consumes its funds, despite the produc-tion of massive, enduring tangible products, becausethe funds expended do not serve to bring in sales reve-nues to the government.

72. The doctrine of imputed incomea. claims that the absence of a cost constitutes anincome—for example, that the saving of expensein owning a home compared with having to rentcomparable accommodations constitutes equiva-lent extra income to the homeowner b. ends up treating the sum that the homeownersaves on rent, plus the whole cost of owning andoperating his home, as a pament of rent, despitethe fact that no rent is paid—a payment of rent tohimselfc. regards the homeowner’s consumption expen-ditures incurred in connection with owning andmaintaining his home as business productive ex-penditures to be deducted from the fictional grossrent that he allegedly receives from himselfd. treats the difference between the fictionalrental revenue and the fictional business produc-tive expenditures and costs as the homeowner’snet rental income and adds it to GNP/GDPe. all of the above

73. The concept of imputed income could beapplied to the saving of expense provided by

a. the ownership automobiles, furniture, and evenclothing, as well as housing, with a correspondingfurther enlargement of GNP/GDPb. being married and not having to pay for the ser-vices that are provided by one’s spouse withoutchargec. not having all manner of possible illnesses ordisabilitiesd. all of the above

74. The concept of imputed income can turnbeggars into millionaires, by crediting them with mas-sive incomes based on the lack of all kinds of major ex-penses, such as the saving of expense from not havingcancer or heart disease, or needing a psychiatrist, eventhough they may not be able to afford to buy a cup ofcoffee.

75. The concept of imputed income has thepotential to raise taxes, to the extent that it would beused not only to artifically bloat people’s incomes butalso to make those bloated incomes subject to taxation.

76. The doctrine of opportunity cost holdsthat the absence of an income constitutes a cost—forexample, that the wages and interest that the self-em-ployed owner of a shop foregoes because he works in


his shop and has his capital invested in it, should becounted as costs of his business.

77. The doctrine of opportunity cost a. can lead to the conclusion that a business certi-fied to be profitable by its accountant is neverthe-less unprofitable b. can lead to the conclusion that the owner ofthat business who has managed both to consumeout of the profit reported by its accountant andadd to his net worth, to the extent he has con-sumed less than the reported accounting profit,has nevertheless lost moneyc. both (a) and (b)


78. An example of the opportunity-cost doc-trine is that a small business and its accountant report aprofit of $75,000 in a given year. Nevertheless, some-one who accepts the opportunity-cost doctrine claimsthat the business has actually lost $25,000, because itsowner could have earned $50,000 a year in wages orsalary doing the same or less work as an employeesomewhere else and could have earned $50,000 in in-terest on his capital if he had invested it elsewhere.When these additional costs, which, taken together,amount to $100,000, are subtracted from the reportedprofit of $75,000, the result, according to the opportu-nity-cost doctrine, is a loss of $25,000.

79. In the preceeding example, despite theopportunity-cost doctrine’s claim of a loss of $25,000,the business owner has managed to consume $40,000and add $35,000 to his net worth. If the business hadactually lost $25,000 while its owner drew $40,000from it for his own consumption, the firm’s net worthwould have declined by $65,000, not increased by$35,000.

80. The opportunity-cost doctrine reconcilesits implication of a $65,000 decline in the firm’s networth with the fact that the firm’s net worth has in-

creased by $35,000—a discrepancy of $100,000—byclaiming that the business owner, who did not earn anywages or interest, and whose failure to do so was al-leged to constitute the additional costs of $100,000, byintroducing the contradictory claim that the businessowner did after all earn the wages and interest hedidn’t earn. He not only has non-existent costs in theamount of $100,000 but also non-existent income inthe amount of $100,000. He allegedly earns the wagesand interest he didn’t earn, as well as incurring themas additional costs deducted from his profit. Thus, in-stead of the $75,000 profit he and his accountant be-lieve he has, he has $100,000 of fictional wages andinterest income alongside a fictional loss of $25,000.

81. It follows from the opportunity-cost doc-trine that precisely to the degree that one is confrontedwith profitable ways to invest one’s capital, and pre-cisely to the degree that one’s services are in great de-mand, one’s profit income must be less, because one’sopportunity costs of choosing any given alternativewill be correspondingly greater.

82. It follows from the opportunity-cost doc-trine that someone who makes a small accountingprofit and who has little or no alternative opportunitiesfor the employment of his labor or profitable use of hismeager capital earns a higher profit than someone whomakes a huge accounting profit but also has alternativeopportunities for earning money that yield almost asmuch income or more.

83. It follows from the opportunity-cost doc-trine that if one invests a million dollars in stock A,which doubles in value, but might have invested thatmillion in stock B, which triples in value, one has losta million dollars and perhaps should contemplatejumping from a tall building. It also follows, that ifone loses a million dollars but might have lost two mil-lion dollars, one has gained a million dollars, and per-haps should at least throw a party.

PART B: THE PRODUCTIVE ROLE OFBUSINESSMEN AND CAPITALISTS

84. The productive role of businessmen andcapitalists is to raise the productivity of manual labor,and thus its real remuneration, by means of

a. creating division of laborb. coordinating the division of laborc. improving the efficiency of the division oflabord. all of the above

85. Businessmen and capitalists create divi-sion of labor by means of

a. founding and organizing business enterprisesb. providing capital

c. making productive expendituresd. all of the above

86. Business firms are the central units of thedivision of labor, in that the division of labor existsboth between the various individual business enter-prises, all of which engage in specialized areas of ac-tivity, and within each individual business enterprisethat comprises the labor of more than one person.

87. The provision of capital is essential to theexistence of the division of labor in its vertical aspect,in that it makes possible the existence of a necessarydivision of payments in the productive process. In its


absence, the only source of payments to producerswould be the ultimate consumers, with the result thatmany groups of producers would be compelled to waitintolerable lengths of time between the completion oftheir contribution to production and their receipt ofpayment.

88. The provision of capital contributes tothe division of labor in its horizontal aspect—that is,the extent to which it can be carried at any given stageof production. This is because greater division of laborat any given stage of production requires the existenceof larger-scale production, which in turn requires theexistence of greater amounts of capital.

89. The saving and productive expenditure ofbusinessmen and capitalists is what makes possible theexistence of a class of wage earners separate and dis-tinct from the sellers of products, and thus of the exis-tence of the division of labor insofar as it depends onthe existence of wage earners.

90. Businessmen and capitalists coordinatethe division of labor

a. among the various firms and industries by thevery fact of seeking to make profits and avoidlosses, which serves, via the uniformity-of-profitprinciple, to keep the various branches of the divi-sion of labor in proper relative sizeb. within each individual firm insofar as they per-form the functions of management, managementbeing largely the coordination of the activities ofseparate individuals working within an establish-mentc. both (a) and (b)

91. Businessmen and capitalists improve theefficiency of the division of labor by means of

a. their competitive quest for higher profits,which leads to the continuous introduction of newand improved products and more efficient meth-ods of producing existing products, the benefits ofwhich are continuously passed forward to the con-sumersb. their saving and productive expenditure, whichresults in a growing supply of capital goods bymeans of assuring a sufficiently high relative pro-duction of capital goodsc. their efficiency in the use of existing capitalgoods, which also serves to increase the supply ofcapital goodsd. progressively increasing the supply of capitalgoods, which is essential to a rising productivityof labor and rising real wagese. all of the above

92. The essential productive role of the stockand bond markets, the banking system, and financialmarkets and financial institutions in general is to

a. promote the investment of savingsb. the efficiency of the investment of savingsc. the overall degree of saving

d. all of the above

93. In the absence of financial markets and fi-nancial institutions,

a. the only way that anyone could invest his sav-ings would be either under his own direct manage-ment, in his own business, or under themanagement of a trusted friend or relativeb. a substantial portion of savings would not beinvested but held in the form of cashc. the efficiency with which funds were investedwould be sharply curtailed by the narrowness ofthe alternatives available for investmentd. all of the above

94. The effect of the additional saving and in-vestment and greater efficiency of investment broughtabout by the existence of financial markets and finan-cial institutions is

a. to raise the demand for and productivity oflabor and the general standard of livingb. similar to the productive role of businessmenand capitalists themselves insofar as they providecapital and are responsible for a growing supplyof capital goodsc. both (a) and (b)

95. Since the stock market deals overwhelm-ingly in already outstanding shares, rather than in newissues of stock, it does not play a significant role inchanneling funds to business firms.

96. The existence of the stock market and theready ability it gives people to sell the stocks theyhave bought, greatly promotes the purchase of thestocks in the first place, since people to know that theycan easily disinvest.

97. A stockmarket investor’s sale of alreadyoutstanding shares that he owns can be a meanswhereby he obtains the funds for direct investment inhis own business.

98. A company’s stock price determines theextent to which ownership of the company must beturned over to outsiders as the condition of raising ad-ditional capital.

99. The stock market makes it possible forfirms that demonstrate their success to obtain capital ata much faster rate than they could if they had to relyexclusively on the reinvestment of their profits. This isbecause a firm’s demonstration of the ability to earn ahigh rate of profit on its existing capital operates toraise the price of its outstanding shares and thus tomake it possible and worthwhile for the firm to obtainsubstantial additional capital from the sale of addi-tional stock.

100. The existence of the stock market servesto penalize poor management and to offer a protectionagainst the abuse of stockholders by corporate manage-ments.


101. The effect of poor management, or ofthe abuse of stockholders, is

a. a low price of the firm’s stock relative to thevalue of the firm’s assetsb. an invitation to an outside takeover of the firm,the firing of its present management, and, veryoften, the sale of some or all of its assets to otherfirms which are capable of putting them to betterusec. both (a) and (b)

102. Government restrictions on hostile take-overs improve the stockmarket’s ability to penalizebad managements.

103. The productive contribution of retailingand wholesaling rests on the fact that in a division-of-labor society,

a. the producer and consumer are different per-sonsb. the supply of every product originates in agreat concentration, in the hands of a relativelysmall number of producers and in order for anybenefit to be derived from these supplies, theymust be moved into the hands of the vast body ofconsumersc. retailing and wholesaling, along with exchangeand money, are the means whereby goods arebrought from their producers to their consumersd. all of the above

104. The failure to appreciate the value of re-tailing and wholesaling rests on the failure to keep inmind the existence of the division of labor and then toapproach the subject of production and consumptionas though all that were required to consume was physi-cally to produce.

105. In a view of the economic world domi-nated by the image of conditions in a pre-division-of-labor society, it appears that retailing and wholesalingare useless appendages to what really counts: i.e., themere physical production of goods.

106. What is accomplished by retailing andwholesaling is

a. nothing but the addition of “markups” by use-less “middlemen” to the prices charged by manu-facturers and farmers, which prices are all that theconsumers justly ought to be made to payb. an enormous increase in the benefit derivedfrom physical production in bringing goods fromtheir producers, where the far greater part of thesupply would be useless if it had to remain withthe producers, to their consumers, who value thesupplies far more highlyc. Retailing and wholesaling are responsible for amajor reduction in the amount of time and moneythat would otherwise need to be spent in obtaininggoods, and for an equally major increase in the va-riety and quality of goods available.d. all of the above

e. (b) and (c) but not (a)

107. Retailing and wholesaling make possib-ile the saving of expense to

a. consumers of not having to send their own pur-chasing agents, trucks, and so forth out to the doz-ens or hundreds of manufacturers or farmerswhose products the retail store carriesb. producers of not having to send out their ownsalesmen and establish their own distribution out-lets wherever they sought to sell their goodsc. both (a) and (b)

108. The existence of wholesalers makes pos-sible

a. a radical reduction in the number of transac-tions that would otherwise have to exist betweenretailers and manufacturers, and a correspondingreduction in costsb. economies of large-scale purchases and low-cost storage, which are largely passed on to retail-ers and consumersc. both (a) and (b)

109. It is inherently unjust for the retail priceof a good, such as potatoes or eggs, to rise at the sametime that the price paid to the farmers or manufactur-ers who physically make the good falls.


110. In the case of inexpensive bulky goods,like potatoes, or goods which require special handlingand packaging, like eggs, the price of the good to theproducer may well account for less than half of thetotal cost of bringing the good to the consumer, be-cause other costs, such as transportation and packag-ing, play such a large role.

111. In such cases, even though from astrictly physical point of view the product is hardlychanged when it reaches the consumer from what itwas when it left the producer, the price to the producerrepresents no greater proportion of the total cost than,say, the price of steel represents in the cost of an auto-mobile.

112. In such cases, a fall in the price of thegood to the producer may very well be accompaniedby a rise in other components of its total cost that aremore than offsetting and thus raise its total cost and ne-cessitate a rise in the retail price of the good.

113. The existence of the division of labor iswhat makes advertising necessary, in that the producerand consumer are separate persons and the consumerthus has no automatic knowledge of what is available,where, or on what terms.

114. The productive role of advertising is tosupply the knowledge desribed as lacking in the previ-ous question.


115. Even when people already know whatgoods are available and where and on what terms, ad-vertising still has the effect of increasing the amountof benefit that is derived from the same amount ofphysical production. Advertising accomplishes this byincreasing the awareness people have of the availabil-ity of various goods and by thus inducing them to trygoods they would not otherwise have tried, or tried assoon, which they then discover that they prefer togoods they were previously consuming and would oth-erwise simply have gone on consuming.

116. There is an important gain from adver-tising even in conditions in which its use leads to a risein the price of the type of product being advertised, inthat it leads consumers to try different things and oftento find that they are better satisfied as a result.

117. There is an inherent limit to any rise inprice that advertising might ever cause, in that thosewho chose to advertise less and thus to incur less coston account of advertising would be in a position to ad-vertise their lower costs and prices.

118. There is such a thing as diminishing re-turns to advertising. Once a certain degree of aware-ness of a product is established, additional advertisingserves to increase awareness less and less and even tobecome annoying. Any producer spending excessivelyfor advertising will find himself at the mercy of otherproducers, who advertise adequately, but less than hedoes and who can advertise their lower prices based onlower advertising costs.

119. Normally advertising serves to reduceprices, by encouraging new competition and the intro-duction of new and improved products.

120. In the absence of extensive advertisingof new products, people’s main guide to what to con-sume would be personal experience, which necessarilywould favor the established firms, since they are theonly existing firms with which people have had experi-ence. Extensive advertising, however, allows new en-

trants into an industry to gain entree into people’sawareness alongside of the established firms.

121. Advertising reduces prices and pro-motes the introduction of new and improved productsby shortening the period of time required for a productto gain a mass market

a. and thus achieve the economies of large-scaleproductionb. and over which it would otherwise be neces-sary to earn compound profits on outlays for suchthings as research and development, thereby in-creaing the extent to which such outlays would ne-cessitate a higher price of the productc. both (a) and (b)

122. It usually does not pay to advertise prod-ucts which people will buy only once and then adviseothers against buying.

123. The expenditure for advertising is com-parable to a seller’s posting a bond with the public, in-sofar as it is usually necessary, if the advertising is tobe effective, that those who are induced to try a prod-uct buy it again and recommend it to others. A largeadvertising budget can be taken as signifying theseller’s conviction that this will be the case with hisproduct.

124. The rule for success in advertising is toadvertise products of the kind that when tried will beliked and recommended by the buyers. Apart perhapsfrom people who are highly suggestible, the advertis-ers have little or no power over what it is that whentried will be liked and recommended.

125. People consume what advertisers tellthem to. This is confirmed by the fact that advertisinghas the power to make people prefer candles to electriclight, and the horse to the automobile. The competitivesuccess of electric light and the automobile is the re-sult of the fact that the advertisers chose to advertise infavor of them rather than against them.

PART C: BUSINESSMEN AND CAPITALISTS: CLASSICAL ECONOMICS VERSUS THE MARXIANEXPLOITATION THEORY

126. The leading source of the denial of theproductive role of businessmen and capitalists and ofthe hostility to profits and interest is the Marxian ex-ploitation theory.

127. The essential claim of the Marxian ex-ploitation theory is that all income naturally and right-fully belongs to the wage earners, but that undercapitalism the wage earners receive only bare, mini-mum subsistence, while everything over and abovethis is expropriated by the capitalist exploiters in theform of profits, interest, and land rent, or, in the termi-nology of Marx, “surplus-value.”

128. The classical economists held ideas, no-tably, “the labor theory of value” and “the iron law ofwages,” which are almost universally assumed to leadinexorably to the Marxian exploitation theory.

129. The labor theory of value claims thatthe prices of goods are in proportion to the quantitiesof labor directly or indirectly required to producethem, that, for example, if the total quantity of labor re-quired at all stages of production to produce an auto-mobile is five times the quantity of labor required toproduce a motorcycle, the price of the automobile willtend to be five times as high as that of the motorcycle.


130. The classical economists held the labortheory of value only with major qualifications.

131. The iron law of wages held by the classi-cal economists claims that the combination of popula-tion growth and the operation of the law ofdiminishing returns drives real wage rates toward anequilibrium of minimum subsistence.

132. In the view of the author, what Marxmeant by the labor theory of value and the iron law ofwages are two very different sets of ideas than whatthe classical economists meant, and are in fact grossdistortions of what the classical economists meant.

133. In the view of the author, the main con-tribution of classical economics to the Marxian exploi-tation theory was

a. the labor theory of valueb. the iron law of wagesc. its errors and confusions pertaining to the con-ceptual framework of the exploitation theory,which assumes that all income due to the perfor-mance of labor is wages and that profits are a de-duction from what is originally, naturally, andrightfully wages

134. In the view of the author, the validity ofthe conceptual framework of the exploitation theory isaccepted by the opponents of Marx as much as byMarx.

135. In the view of the author, despite what-ever support certain aspects of classical economicsmay have given to the Marxian exploitaion theory,

a. essential elements of classical economics pro-vide the basis for demolishing both the conceptualframework of the exploitation theory and thewhole of the specific substance of the exploitationtheoryb. classical economics makes it possible to under-stand such propositions as why profits, not wages,are the original and primary form of income andthat precisely because of the work of businessmenand capitalists, wages can rise out of all connec-tion with minimum subsistence—literally withoutlimitc. both (a) and (b)

136. The classical economists’ doctrine ofthe wages-fund held that at any given time there is adeterminate total expenditure of funds for the paymentof wages in the economic system, and that the wagesof the employees of business firms are paid by busi-nessmen and capitalists, out of capital, which is the re-sult of saving; not by consumers in the purchase ofconsumers’ goods.


137. In the view of the author, the abandon-ment of classical economics doctrine of the wagesfund in the late 19th century, and with it, its perspec-

tive on saving and capital, made possible the accep-tance of Keynesianism and the policy of inflation, defi-cits, and ever expanding government spending in the20th century.

138. In the view of the author, with roughlythe same time lag, the abandonment of classicaleconomics’ doctrine that cost of production, ratherthan supply and demand, is the direct (though not theultimate) determinant of the prices of most manufac-tured or processed goods led to the promulgation ofthe doctrines of “pure and perfect competition,” “oli-gopoly,” “monopolistic competition,” and “adminis-tered prices,” with their implicit call for a policy ofradical antitrust or outright nationalizations to “curbthe abuses of big business.”

139. In the view of the author, the ideas ofAdam Smith on the subject of productive activity areamong the best and the worst in the literature of eco-nomics.

140. Adam Smith a. essentially recognized the necessity of money-making in order for an activity to be productiveand its connection to the distinction between pro-duction and consumptionb. essentially identified government as a con-sumerc. maintained that the only productive parties inthe economic system are wage earnersd. regarded businessmen, capitalists, and land-owners as having no productive function, and asexisting as parasites upon the labor of the wageearnerse. all of the above

141. Adam Smith a. equated labor with wage earningb. declared that “the produce of labour consti-tutes the natural recompence or wages of labour”and believed that if an income is due to the perfor-mance of labor, it must be wagesc. denied that profits could be an income attribut-able to the labor of those who make profits be-cause of the fact that profits tend to vary with thesize of the capital investedd. believed that the profits earned on capital bearno relation to the quantity, the hardship, or the in-genuity of the businessman’s labore. declared that “As soon as land becomes privateproperty, the landlord demands a share of almostall the produce which the labourer can either raiseor collect from it. His rent makes the first deduc-tion from the produce of the labour which is em-ployed upon the land.”f. declared that “. . . profit makes a second deduc-tion from the produce of the labour which is em-ployed upon land” and that “The produce ofalmost all other labour is liable to the like deduc-tion of profit.”g. all of the above


142. Adam Smith can properly be called thefather of the Marxian exploitation theory because heprovided the conceptual framework of that theory.

143. The conceptual framework of the exploi-tation theory, that Adam Smith provided, is the pri-macy-of-wages doctrine.

144. The “primacy-of-wages doctrine,” ad-vanced by Adam Smith and taken over by Karl Marx,claims that wages are the original and primary form ofincome from which profits and all other nonwage in-comes emerge as a deduction with the coming of capi-talism and businessmen and capitalists.

145. The conceptual framework of the exploi-tation theory and its supporting beliefs easily lead tothe assertion of the wage earner’s right to the wholeproduce or to the full value of that produce.

146. Adam Smith understood the essentialrole of private ownership of land in progressively in-creasing the output from the land and in raising livingstandards while holding down the economic signifi-cance of land rent.

147. Adam Smith understood the vital role ofbusinessmen and capitalists and private ownership ofthe means of production in increasing the standard ofliving of wage earners.

148. Smith understood that the division oflabor and the rise in living standards that it brings de-pends on the accumulation of capital.

149. Smith implied that the division of labor,and the consequent rise in the productivity of labor,has no connection with the activities of businessmenand capitalists, nor with the institution of private prop-erty in land, and might have developed just as well intheir absence.

150. Adam Smith is usually regarded as theleading advocate of capitalism in the history of eco-nomic thought.

151. Smith’s view of an alleged “early andrude state of society,” in which all income is wagesand no income is profit, and the alleged effects of thecoming of capitalism and capitalists is repeated byMarx in his C–M–C and M–C—M′ sequences that hesays respectively desribe “simple circulation” and“capitalistic circulation.”

The following is an eight-part question.

152. In the view of the author, a. “Profit” is the excess of receipts from the saleof products over the money costs of producingthem.b. A “capitalist” is one who buys in order subse-quently to sell for a profit, i.e., a capitalist is onewho makes productive expenditures.

c. “Wages” are money paid in exchange for theperformance of labor—not for the products oflabor, but for the performance of labor itself.d. all of the above

153. On the basis of above definitions, it fol-lows that if there are merely workers producing andselling their products, the money which they receive inthe sale of their products is not wages.

154. In buying commodities, one does notpay wages, and in selling commodities, one does notreceive wages. What one pays and receives in the pur-chase and sale of commodities is not wages but prod-uct sales revenues.

155. The proposition that in buying commod-ities one does not pay wages was propounded by thegreat classical economist John Stuart Mill, who heldthat “Demand for commodities is not demand for lab-our.”

156. In the precapitalist economy imaginedby Smith and Marx, all income recipients in the pro-cess of production are workers. But, in the view of theauthor, the incomes of those workers are

a. not wagesb. they are, in fact, profitc. both (a) and (b)

157. In the view of the author, all incomeearned in producing products for sale in the precapital-ist economy is profit or “surplus-value” and no incomeearned in producing products for sale in such an econ-omy is wages. For not only do the workers of a pre-capitalist economy earn product sales revenues ratherthan wages, but also those workers have zero moneycosts of production to deduct from those sales reve-nues.

158. The workers of a precapitalist economyhave zero money costs precisely because they have notacted as capitalists. They have not bought anything inorder to make possible their sales revenues, and thusthey have no prior outlays of money to deduct as costsfrom their sales revenues. Having made no productiveexpenditures, they have no money costs.

159. Because the workers of Smith’s “earlyand rude state of society” and Marx’s “simple circula-tion” had product sales revenues and zero money coststo deduct from those sales revenues, it follows thatprofits, rather than wages, are the original and primaryform of income.


As we have seen, Adam Smith and Karl Marx postu-lated a simple state of affairs in which manual laborersproduced and sold products, kept the whole sales pro-ceeds, and did not act as capitalists, i.e., did not buyfor the sake of subsequently selling. They believedthat in such circumstances all income was wages, and


no income was profits. They held that profits cameinto existence only with the development of “capitalis-tic circulation” (buying for the sake of selling) andwere a deduction from what was originally all wages.To test these propositions, you are given the followinginformation: Receipts from the sale of products are1000, all of which is consumed and which constitutesa fresh 1000 of receipts from the sale of products inthe next period.

160. State the amount of productive expendi-ture present.

161. State the amount of wages paid in theproduction of products.

162. State the amount of money outlays to bededucted from sales revenues as costs.

163. State the amount of profits earned onthe sales revenues.

164. State the amount of nominal capital inexistence.

165. State the rate of return on capital.

166. Businessmen and capitalists are not re-sponsible

a. for the phenomenon of profit, which existsprior to their appearance and equals the entiresales revenues received by the workers of Smith’s“early and rude state of society” and Marx’s “sim-ple circulation”b. but rather for the phenomena of productive ex-penditure, wages, and costs, and for the reductionin the proportion of income that is profit and risein the proportion of income that is wagesc. both (a) and (b)

167. While important passages in AdamSmith’s The Wealth of Nations support the primacy-of-wages doctrine, the doctrine of John Stuart Mill that“demand for commodities is not demand for labor” op-poses it.

168. Ricardo’s doctrine that profits fall aswages rise and rise as wages fall supports the primacy-of-profit doctrine and the harmony of interests of wageearners and capitalists, rather than class warfare, whenit is realized that it is capitalists, not consumers, whopay the wages expended in the production of productsfor sale. For then, it follows that if, as in the precapital-ist economy, there are no capitalists, then there are nowages paid in production, and if there are no wagespaid in production, the full income earned in Ricardo’sframework must be profits.

169. The fact that profits are an income dueto the performance of labor can be observed all aroundus in the present day world, but is systematically oblit-erated by contemporary economic theory.

170.

a. Everyday, accountants report the incomes ofsmall proprietors, whose labor bulks overwhelm-ingly large in the success or failure of their opera-tions, as profits.b. Despite the fact that that these profit incomesare obviously attributable to the performance oflabor by these small businessmen, the doctrine of“opportunity cost” serves to obliterate this fact byrenaming the profit as wages, interest, and losses,and leaving as profit only the extent to which theprofit exceeds all the opportunity costs.c. both (a) and (b)

The following is an eleven-part question.

171. In the complex conditions of modern so-ciety and of “capitalistic circulation,” profit continuesto be a labor income, indeed, the income of the mostimportant workers, whose labor is now mainly one ofthinking, planning, and decision making, rather thanmanual labor.

172. The variation of profits with the size ofthe capital invested is perfectly consistent with theirbeing attributable to the labor of businessmen and capi-talists because

a. such labor tends to be predominantly of an in-tellectual nature—a work of thinking, planning,and decision makingb. capital is the means by which businessmen andcapitalists implement their plans—it is theirmeans of buying the labor of helpers and of equip-ping those helpers and providing them with thematerials of workc. the possession of capital serves to multiply theefficacy of the businessmen’s and capitalists’labor, for the more of it they possess, the greateris the scale on which they can implement theirideasd. all of the above

173. Equal labor does not necessarily pro-duce equal products. It produces unequal productswhen unequal means are employed. It is always laborwhich produces, however, because it is labor whichsupplies the guiding and directing intelligence in pro-duction.

174. Guiding and directing intelligence, notmuscular exertion, is the essential characteristic ofhuman labor, and the basis for attributing all produc-tion to labor.

175. All labor is the “labour of direction.” Itis because the man directs the tool, that he, and not thetool, produces the product. The tool, whether an ordi-nary shovel, a steam shovel, dynamite, or an atomic ex-plosive, does not produce, but is the means by whichthe man who employs it produces.

176. Guiding and directing intelligence inproduction is supplied by businessmen and capitalists


on a higher level than by wage earners—a circum-stance which further reinforces the primary productivestatus of profits and profit earners over wages andwage earners.

177. In the view of the author, the fact thatprofits are an income attributable to the labor of busi-nessmen and capitalists, and the further fact that theirlabor represents the provision of guiding and directingintelligence at the highest level in the productive pro-cess, requires a radical reinterpretation of the doctrineof labor’s right to the whole produce.

178. In the view of the author, properly un-derstood, labor’s right to the whole produce is satisfiedwhen first the full product and then the full value ofthat product comes into the possession of businessmenand capitalists, for they, not the wage earners, are thefundamental producers of products.

179. In the view of the author, the employeesof the firm are accurately described by the common ex-pression “help.” They are the helpers of the business-men and capitalists in the production of their—thebusinessmen’s and capitalists’—products.

180. In the view of the author, the realizationof labor’s right to the whole produce is exactly whatoccurs in the everyday operations of a capitalist econ-omy, inasmuch as it is businessmen and capitalistswho are the owners first of the products and then ofthe sales proceeds received in exchange for the prod-ucts.

181. By the standard of attributing results tothose who conceive and execute their achievement atthe highest level, one must attribute to businessmenand capitalists the entire gross product of their firmsand the entire sales receipts for which that product isexchanged.

182. The underlying standard of attributionused in the preceding questions is the same as that nor-mally employed in fields outside of economic activity.For example, one attributes the discovery of Americato Columbus, the victory at Austerlitz to Napoleon, theforeign policy of the United States to its President.These attributions are made despite the fact that Co-lumbus could not have made his discovery without theaid of his crew, nor Napoleon have won his victorywithout the help of his soldiers, nor the foreign policyof the United States be carried out without the aid ofthe employees of the State Department. The help thesepeople provide is perceived as the means by whichthose who supply the guiding and directing intelli-gence at the highest level accomplish their objectives.The intelligence, purpose, direction, and integrationflow down from the top, and the imputation of the re-sult flows up from the bottom.

183. By the standard of attribution to theguiding, directing intelligence at the highest level, theproducts of the old Ford Motor Company and Stan-dard Oil Company are to be attributed to Ford and

Rockefeller, and today those of Microsoft are to be at-tributed to Gates.


184. If the payment of incomes to capitalistswhose role in production might be judged to be pas-sive, such as, perhaps, most minor stockholders andmany recipients of interest, land rent, and resource roy-alties, represented an exploitation of labor, it would bean exploitation of the labor

a. not of wage earnersb. but of businessmen and the active capitalists,from whose profit incomes they are a deduction c. would mean that individuals like Ford andRockefeller were exploited by such people as wid-ows and orphans, who largely make up the cate-gory of passive capitalistsd. all of the above

185. In fact there is no genuine exploitationin the case described in the preceding question, be-cause the payment of such incomes is a source of gainto those who pay them. They are paid in order to ac-quire assets whose use is a source of profit over andabove the payments which must be made.

186. Furthermore, the recipients of such in-comes need not be at all passive; they may very wellearn their incomes by the performance of a consider-able amount of intellectual labor. Anyone who has at-tempted to manage a portfolio of stocks and bonds orinvestments in real estate should know that there is nolimit to the amount of time and effort that such man-agement can absorb, in the form of searching out andevaluating investment possibilities, and that the jobwill be better done the more such time and effort onecan give it.

187. In the absence of government interven-tion in the form of the existence of national debts, loanguarantees, and insurance on bank deposits, the magni-tude of truly passive income in the economic systemwould be quite modest. This is because most forms ofinvestment require the exercise of some significant de-gree of skill and judgment. Those not able or willingto exercise such skill and judgment would either rap-idly lose their funds or would have to be content withvery low rates of return in compensation for safety ofprincipal and, in many cases, would have to bear theexpense of the deduction of management fees by trust-ees or other parties.

188. In a laissez faire economy, without per-sonal or corporate income taxes (a real exploitation oflabor) and without legal restrictions on such businessactivities as insider trading and the award of stock op-tions, the businessmen and active capitalists are in aposition to own an ever increasing share of the capitalsthey employ. With their high incomes they can pro-gressively buy out the ownership shares of the passivecapitalists. In this way, under capitalism, those work-


ers—the businessmen and active capitalists—who dohave a valid claim to the ownership of the industries infact come to own them.

189. Böhm-Bawerk, who is regarded as theleading critic of the exploitation theory, bases his cri-tique on

a. the primacy-of-profit doctrineb. the primacy-of-wages doctrine

190. According to Böhm-Bawerk, profits/in-terest are a justified deduction from what is originallyall wages.

191. The labor theory of value as held by theclassical economists

a. admitted the existence of numerous cases inwhich prices were determined simply by demandand supply, by the utility and scarcity of goods,and to which neither the labor theory of value noreven determination by cost of production appliedb. especially Ricardo, recognized the importantrole in the determination of relative prices of thetime which must elapse between the payment ofwages and the sale of the ultimate consumers’goods, over which time the rate of profit had tocompound; goods produced by equal quantities oflabor but over unequal such periods of time wouldhave permanently unequal pricesc. especially Ricardo, implicitly recognized therole of the rate of profitd. recognized the role of differences in wagerates between skilled and unskilled labor and be-tween different countries e. all of the above

192. The labor theory of value held by Marxclaimed to apply to all goods and services without ex-ception and that relative quantity of labor alone wasthe explanation of relative value.

193. The labor theory of value held by theclassical economists can be harmonized with recogni-tion of the productive role of businessmen and capital-ists by virtue of

a. the fact that the activities of businessmen andcapitalists progressively reduce the quantities oflabor required to produce goods, and thus reducetheir prices

b. recognizing that wage rates are among theprices not determined by quantity of labor but bysupply and demand, with the result that the activi-ties of businessmen and capitalists progressivelyreduce prices while leaving wage rates un-changed, thereby progressively raising real wageratesc. both (a) and (b)

194. The “iron law of wages” claims that thenatural, equilibrium level of wages is minimum subsis-tence.

195. According to the classical economists,such wages

a. were the result of the combination of popula-tion growth and the operation of the law of dimin-ishing returns, including the need to resort toprogressively inferior lands as population grewb. existed as a tendency, not as an absolute factand could be escaped by means of capital accumu-lation and economic progressc. both (a) and (b)

196. According to the version of the iron lawof wages propounded by Marx, wages

a. were arbitrarily set at minimum subsistence bythe fiat of the capitalists, not by virtue of the ef-fects of population growth and diminishing returnsb. could not rise above minimum subsistence onthe basis of economic progress, but would be im-mediately reduced by the capitalists in response toany cheapening in the price of the wage earner’snecessitiesc. would be reduced even below the level of mini-mum subsistence as the result of capital accumula-tion in the form of a rise in fixed capital relative to“variable” capital (the doctrine of progressive im-poverishment of the masses) d. all of the above

197. The “iron law of wages” could seem rea-sonable in the early 19th century, when Ricardo wrote,because all of human history prior to that time seemedto confirm it, in the same way that it seemed to con-firm the proposition that land rents tended to constitutea growing proportion of the total, combined income ofa nation’s inhabitants.


Answers to Questions 1-198 on Chapter 11 123Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 T 34 a 67 c 100 T 133 c 166 c2 F 35 T 68 c 101 c 134 T 167 T3 T 36 d 69 c 102 F 135 c 168 T4 T 37 F 70 T 103 d 136 T 169 T5 d 38 F 71 T 104 T 137 T 170 c6 f 39 d 72 e 105 T 138 T 171 T7 b 40 b 73 d 106 e 139 T 172 d8 T 41 d 74 T 107 c 140 e 173 T9 T 42 a 75 T 108 c 141 g 174 T

10 T 43 T 76 T 109 F 142 T 175 T11 T 44 d 77 c 110 T 143 T 176 T12 b 45 c 78 T 111 T 144 T 177 T13 F 46 c 79 T 112 T 145 T 178 T14 T 47 T 80 T 113 T 146 F 179 T15 T 48 T 81 T 114 T 147 F 180 T16 T 49 c 82 T 115 T 148 F 181 T17 T 50 T 83 T 116 T 149 T 182 T18 T 51 T 84 d 117 T 150 T 183 T19 T 52 T 85 d 118 T 151 T 184 d20 F 53 T 86 T 119 T 152 d 185 T21 f 54 T 87 T 120 T 153 T 186 T22 e 55 T 88 T 121 c 154 T 187 T23 T 56 b 89 T 122 T 155 T 188 T24 F 57 e 90 c 123 T 156 c 189 b25 e 58 a 91 e 124 T 157 T 190 T26 F 59 b 92 d 125 F 158 T 191 e27 T 60 b 93 d 126 T 159 T 192 T28 d 61 b 94 c 127 T 160 zero 193 c29 c 62 b 95 F 128 T 161 zero 194 T30 a 63 T 96 T 129 T 162 zero 195 c31 a 64 T 97 T 130 T 163 1000 196 d32 c 65 T 98 T 131 T 164 zero 197 T33 a 66 T 99 T 132 T 165 infinity


MONEY AND SPENDING (Chapter 12)

The Quantity Theory of Money

1. The quantity theory of money claims thatthe main determinant of the amount of money that isspent is the amount of money that

a. existsb. is owedc. was spent in the year befored. all of the above

2. The quantity theory of money holds that Mx V = D, where M is the quantity of money in exis-tence, V is the average number of times a unit ofmoney is spent, and D is the amount of money spent.

3. In the quantity theory-of-money equation,D is usually to be understood as the aggregate demand(amount of spending) specifically for consumers’goods, i.e., as Dc.

4. In the quantity-theory-of-money equation,V is usually to be understood as the average number oftimes a unit of the money supply is spent specificallyin buying consumers’ goods, i.e., as “consumption ve-locity” or “income velocity.”

5. a. GDP is essentially the sum of consumptionspending (private and government) plus gross in-vestmentb. Since approximately 85 to 90 percent of GDPconsists of consumer spending, the quantity-the-ory-of-money equation can be understood as pro-viding an approximate expression of nominal, i.e.,current-dollar GDPc. both (a) and (b)d. neither (a) nor (b)

6. In 2001, nominal GDP was reported as ap-proximately $10.2 trillion. If the money supply istaken as $2.5 trillion, calculate velocity.

7. a. The money supply is essentially the sum of cur-rency in circulation outside the banking systemplus checking depositsb. Until 1994, the money supply was accuratelyreported in the statistic known as M1. Currently,the money supply can best be measured by takingthe sum of M1 plus accumulated sweep accountsplus retail money market mutual fund accountsc. both (a) and (b)d. neither (a) nor (b)

8. a. Different magnitudes of aggregate spending re-quire different measures of velocityb. The aggregate demand for consumers’ goodsand GDP are related to the money supply via “con-sumption velocity” or “income velocity.”

c. Aggregate spending of all kinds, including forstocks, bonds, and real estate is related to themoney supply via the concept of “transactions ve-locity.”d. all of the above

9. An increase in the quantity of money oper-ates to raise the volume of spending in the economicsystem to a higher annual level simply by being spentand respent so long as it is in existence.

10. Where P is the general consumer pricelevel, Dc is the aggregate demand (spending) forconsumers’ goods, and Sc is the aggregate supply ofconsumers’ goods produced and sold, the general con-sumer price level equals Dc/Sc.

11. Calculate the effect on the general con-sumer price level if the quantity of money and the ag-gregate demand for consumers’ goods increase by 4%over the course of a year while aggregate productionand supply increase by 2%.

12. If the situation described in the precedingquestion were to be repeated year after year, how longwould it take for the general consumer price level todouble?

13. How long would it take the general con-sumer price level to double if the annual increase inthe quantity of money and volume of spending were10% while the annual increase in production and sup-ply were 2%?

14. Increases in prices occur insofar as the in-crease in the quantity of money and volume of spend-ing outstrips the increase in production and supply.

15. a. A commodity money is one in which the mone-tary unit is a quantity of a physical commodityb. Historically, gold and silver are the leading ex-amples of commodity moniesc. All money begins as a commodity moneyd. Paper money originates as a secure, transfer-able claim to commodity money payable on de-mand by the issuere. all of the above

16. Paper money which is not redeemable incommodity money is known as “fiat money.”

17. The concept of paper money excludescheckbook money.

18. a. A major difference between commoditymoney and fiat money concerns their potentialrates of increase. b. Specifically, the rate of increase of a gold orsilver commodity money is almost certain to berelatively small because of the comparative rarityof these elements in nature and because increases




in their production and supply depend on costlymining operationsc. On the other hand, the rate of increase in a fiatmoney is potentially limitless, since there is nosignificant rarity of the necessary elements in na-ture and the process of increase is virtually costlessd. all of the abovee. none of the above

19. Assume that over a generation the quan-tity of money and volume of spending increase ten-fold, while production and supply double. How greatis the percentage rise in the general consumer pricelevel?

20. a. The formula for the general consumer pricelevel shows demand as a numerator and supply asa denominatorb. In the light of this formula, it is simply incon-ceivable that prices could rise without demand ris-ing or supply falling, or bothc. both (a) and (b)d. neither (a) nor (b)

21. It is no more likely for prices to riseunder a system of fiat paper money than under a sys-tem of commodity (i.e. gold or gold and silver) money.

22. Gold and silver moneys were often ac-companied by long periods of falling prices, as in thegeneration preceding the discovery of the Californiagold fields and the generation from 1873–1896.

Origin and Evolution of Money and the ContemporaryMonetary System

23. The essential condition that must be pres-ent in order for a barter exchange to take place is theexistence of a double coincidence of wants, i.e., a stateof affairs in which each of two parties possesses agood that the other desires and values the good in thepossession of the other above the good he possessesand that the other desires.

24. In the absence of a double coincidence ofwants, some of our more intelligent ancestors began toresort to indirect exchanges.

25. a. An indirect exchange is one in which an indi-vidual exchanges his good or service for a goodwhich he himself does not desire to consume or touse in production but rather as a means of makinga further exchangeb. An indirect exchange is resorted to in cases inwhich a double coincidence of wants is lackingand it occurs to someone to exchange the good hehas for something that he himself may not wantbut which the other party wants, i.e., the partywho has the good our man wantsc. Goods that are sought for the purpose of beingreexchanged are called media of exchange

d. all of the abovee. none of the above

26. a. Before a good can be used as a medium of ex-change, it must have a recognized value as an ordi-nary commodityb. Goods that are more widely and more fre-quently desired as ordinary commodities have agreater likelihood of becoming media of exchangethan goods that are less widely and less frequentlydesired as ordinary commoditiesc. In the course of history, numerous goods haveserved as media of exchanged. all of the above

27. a. A generally accepted medium of exchange con-stitutes moneyb. The process of a medium of exchange develop-ing into money is cumulative and self-reinforcingc. The use of a good as a medium of exchangerepresents an additional source of demand for itand operates to raise its value, thereby reducingthe extent to which it is used for its ordinary, com-modity purposesd. all of the above

28. In some parts of Europe in the mid 1940scigarettes developed into a kind of quasi-money. In theprocess non-smokers became eager to accept ciga-rettes in exchange for their goods and smokers reducedtheir smoking because of the resulting higher value ofcigarettes.

29. Historically, gold and silver in particularcame to be money as civilization developed. This wasbecause

a. In an environment of fixed settlements, the pre-cious metals are the most suitable physical com-modities for most people to saveb. The growing use of gold and silver as a storeof value set the stage for their use as media of ex-changec. The growing use of gold and silver as media ofexchange added relative stability to their valueand thus favored their use as a medium in whichto write contracts and state debtsd. The making of contracts payable in gold or sil-ver reinforced the use of gold and silver as mediaof exchange by creating a class of people needingto obtain them to meet their contractual obligationse. all of the above

30. Paper currency and checkbook money a. came into existence as secure claims, payableon demand, in gold or silver coin and could nothave come into existence without being a claim toa preexisting, commodity moneyb. In establishing a uniform, gold-backed papercurrency, that people could regard as “as good asgold,” the National Bank Act of 1863 played a


critical role in fostering the use of paper money inthe United States in place of gold coinc. By the outbreak of World War I, two genera-tions of experience with the day-to-day use ofpaper money and virtual disappearance of goldcoin from circulation had created the potential forpaper money to be acceptable even without re-deemability into goldd. all of the above

31. The great bulk of the American people’sgold came into the governments hands

a. in World War I, as the result of a wartimeamendment to the Federal Reserve Act of 1913b. in 1933, when the New Deal ordered all pri-vately held monetary gold to be turned into theFederal government

32. The Federal Reserve’s possession of thegold previously held by the private banking systemmade possible a substantial increase in the supply ofdollars by virtue of a pyramiding of the gold reserves.

33. After 1933 people continued to acceptpaper dollars, even though they were no longer re-deemable in gold, because the paper dollars had ac-quired a history of acceptability, in which everyone’sexperience taught that paper dollars were and wouldcontinue to be generally acceptable and led virtuallyeveryone to be willing to go on accepting them.

34. Even though after 1933 the law requiredthe Federal Reserve to hold substantial gold reservesagainst the dollars it created, for many years this re-quirement did not impose an effective limit on theFed’s ability to increase the supply of dollars becauseof its possession of substantial excess gold reserves.

35. Excess gold reserves are gold reservesheld in excess of the gold reserves legally required tobe held.

36. From 1935 to the end of World War II,the Fed possessed large and growing excess gold re-serves

a. as the result of the rise in the official price ofgold from $20.67 per ounce to $35 per ounceb. as the result of the influx of large amounts ofgold from the rest of the world, especially West-ern Europec. both (a) and (b)

37. The excess gold reserves of the Fed weregradually eliminated in the twenty years followingWorld War II in the attempt to hold the world price ofgold at $35 per ounce.

38. In 1965, as the exhaustion of the Fed’sexcess gold reserves threatened, Congress abolishedthe Fed’s gold reserve requirements.

39. Abandonment of external convertibilityof the dollar at the rate of $35 per ounce was not inevi-table, despite the fact that its maintenance in the faceof rising prices for almost everything other than gold

served to make gold cheaper and cheaper relative to al-most everything else and had to create an ever risingindustrial demand for gold.

40. The potential for a spontaneous remoneti-zation of gold

a. is created under conditions of substantial infla-tion, in which there is a growing use of gold as aninflation hedgeb. Would be greatly increased if it were legal forbusinessmen to discriminate between preciousmetal coins and paper currency of the same facevaluec. both (a) and (b)d. neither (a) nor (b)

41. “Fiduciary media”a. are transferable claims to standard money, re-deemable by the issuer on demand, and acceptedin commerce as the equivalent of standard money,but for which no standard money actually existsb. are backed by debtc. create the potential for a deflation of themoney supply because of bankruptcies of businessfirms that are indebted to banks and consequentbank failuresd. represent the far greater part of the present-daymoney supplye. the process of their being wiped out played amajor role in the great depression of the 1930sf. all of the above

42. Standard moneya. unlike, fiduciary media, is not a claim to any-thing further but has ultimate, final debt-payingpowerb. under a gold standard is gold coin or bullionc. at the present time consists of irredeemablepaper dollarsd. all of the above

43. The “monetary base”a. is the sum of currency in circulation outsidethe banks plus the checking deposits of the Fed-eral Reserve systemb. represents the supply of standard moneyc. both (a) and (b)

44. Fiduciary media come into existencea. when a bank lends out currency that has beendeposited with it in a checking accountb. when a bank creates and lends out a new andadditional checking deposit on the basis of the cur-rency or other reserves that it has obtainedthrough its receipt of a checking depositc. both (a) and (b)d. neither (a) nor (b)

45. The checking deposits of a bank can beviewed

a. as fully covered up to the limit of the bank’sstandard money reserves and then as totally uncov-


ered to the extent that the deposits exceed thebank’s standard money reservesb. as uniformly partially covered by a fractionalreserve to the extent that the bank has standardmoney reservesc. both (a) and (b)

46. The opposite system of fiduciary mediais the 100 percent reserve system.

47. Under the 100 percent reserve principle,checking deposits and banknotes are 100 percentbacked by standard money.

48. The 100 percent reserve principle appliesonly to checking deposits and banknotes, i.e., only toactually spendable money, not to savings deposits ortime deposits, which cannot be spent until they arewithdrawn.

49. Under fractional reserve banking, papercurrency and banknotes are backed only fractionallyby standard money and for the rest by debt.

50. Fractional-reserve demand deposits pos-sess a deflationary potential that,

a. once unleashed, tends to be self-reinforcingand cumulative, ultimately capable of wiping outall fiduciary mediab. was unleashed during the 1929 depressionc. to be avoided, requires the government’s abil-ity to create large sums of new and additional stan-dard money to whatever extent may be necessaryto assure the redeemability of all or most outstand-ing fiduciary mediad. all of the above

51. A 100 percent reserve monetary systemwould make the money supply absolutely independentof the failure of any debtors and thus make sudden,drastic reductions in the money supply virtually im-possible.

52. In a banking system that was free of gov-ernment interference, the creation of fiduciary mediawould be greatly limited by

a. the loss of reserves by banks creating fiduciarymedia to banks that were not creating fiduciarymedia or not creating them as rapidlyb. the loss of reserves by the whole banking sys-tem as the result of the public’s need to increaseits holding of currency as the overall supply ofmoney increasedc. both (a) and (b)

53. Over the course of many years, govern-ment policy has promoted fractional reserve bankingby means of

a. increasing the supply of standard money, withthe effect both of reducing or preventing clearinglosses by expanding banks and of meeting thepublic’s growing demand for currency holdings,in both ways reducing or preventing the loss of re-

serves as the banks expanded the supply of fidu-ciary mediab. central bank rediscounting of commercial bankassets, thereby encouraging the commercial banksto hold assets other than standard money as asource of reserves when necessaryc. imposing deposit insurance and bank examina-tions, thereby increasing the public confidence’sin the banking system and permitting the banks tooperate with a lower level of reserves than wouldotherwise have been necessaryd. permitting temporary suspensions of paymentsby the banks to their depositors, thereby enablingthe banks to hold a lower level of reserves thanwould have been necessary to avoid suspensionsof paymentse. all of the above

54. Short of prohibiting fiduciary media, thegovernment could greatly reduce their issuance simplyby means of doing nothing that encourages their issu-ance.

55. President Andrew Jackson’s specie circu-lar represented a refusal by the government to acceptfiduciary media in the payment of taxes.

56. The Federal Reserve’s “open-market op-eration”

a. is its buying and selling of securities, typicallyof the US government, in the open market, withthe effect of increasing or decreasing the standardmoney reserves of the banking system and thepublic’s holdings of currencyb. operates substantially more on the side of buy-ing than on the side of sellingc. is the principal mechanism by means of whichit puts new and additional standard money into theeconomic system, since it buys securities withmoney that it itself createsd. is the mechanism by means of which govern-ment budget deficits are financed by the creationof new and additional standard money.e. all of the above

57. The demand for money for holding re-flects the need and desire of people to hold money.

58. A rise in the demand for money for hold-ing is the cause of a rise in the velocity of circulationof money and its fall is the cause of a fall in the veloc-ity of circulation of money.

59. The demand for money for holding de-clines and as

a. the security of property improvesb. financial markets and financial institutions de-velopc. improvements in transportation and the devel-opment of clearing houses occurd. all of the above

60. As the security of property declines


a. the demand for precious-metal money for hold-ing risesb. the demand for fiat paper money for holdingdeclinesc. both (a) and (b)

61. The fact that the demand for money forholding declines and thus velocity rises as the result ofeconomic improvements such as greater security ofproperty and the development of financial markets andfinancial institutions means that these developmentshave an inflationary effect in that in raising velocitythey raise the demand for consumers’ goods and thusthe prices of consumers’ goods.

62. When the demand for money for holdingdeclines as the result of economic improvements suchas greater security of property and the development offinancial markets and financial institutions, the result-ing rise in velocity is largely in the form of total trans-actions velocity rather than income or consumptionvelocity, because the same improvements entail the de-velopment of greater division of labor and thus morebuying and selling at stages other than the sale ofconsumers’ goods. At the same time, these im-provements serve to increase the production and sup-ply of consumers’ goods.

63. In the context of an economic systemwith developed financial institutions and financial mar-kets,

a. funds that are saved are put back into thespending stream almost immediately, while fundsthat are held for consumption may not be spentuntil the consumption purchases they are held foractually take placeb. the effect of saving is to increase the availabil-ity of credit, which represents an important substi-tute for the holding of cashc. saving operates to raise the income velocity ofmoney, by virtue of (a) and (b)d. all of the above

64. In the conditions in which the velocity ofcirculation of a gold money rises, there is unlikely tobe any fall in the purchasing power of gold as a result.

65. The more rapidly the quantity of moneyincreases, the less will be the demand for money forholding and thus the greater will be the velocity of cir-culation of money, including income velocity.

66. The reason that the more rapidly thequantity of money increases, the more the demand formoney for holding declines is that

a. the more rapidly do prices rise and the more itappears advantageous to reduce cash holdings inorder to buy sooner rather than laterb. the easier it becomes to profitably liquidate in-ventories and other noncash assets, with the resultthat the holding of such assets appears to be a bet-ter source of cash in the future than the holding of

actual cash, and thus takes the place of the hold-ing of cashc. the higher, after a time, do interest rates tend tobe, with the result that it becomes worthwhile tolend out progressively smaller and shorter-termsums that otherwise would have been retained incash holdingsd. to the extent that the increase is in the form ofcredit expansion (i.e., the creation of new and ad-ditional money for the purpose of being lent out),the easier and more profitable it becomes to substi-tute the prospect of obtaining credit for the hold-ing of cashe. all of the above

67. Increases in the quantity of money thattake place in the form of credit expansion, i.e., areused to finance the granting of new and additionalloans,

a. initially serve to reduce the rate of interestb. when absorbed into the spending stream serveto raise sales revenues, profit margins, and therate of profit, and thereby to increase the demandfor loanable funds and to reduce the supply ofloanable funds, with the result that the rate of in-terest now tends to rise to reflect the higher rate ofprofitc. both (a) and (b)

68. Once the increase in the quantity ofmoney created by credit expansion becomes absorbedinto the spending stream, the only way to prevent inter-est rates from rising is by accelerating the increase inthe quantity of money, which then makes the rate ofprofit rise still higher and further increases the demandfor loanable funds and reduces the supply of loanablefunds, requiring a still further acceleration in the rateof increase in the money supply if the rate of interest isnot to rise. Thus to avoid rapid destruction of the mon-etary system, there is no practical alternative but toallow the rate of interest to follow the rate of profit onup as the quantity of money increases.

69. Interest is the price of money. Thus, thelarger the money supply, the lower must be the rate ofinterest.

70. Interest isa. the price of moneyb. the difference between the sum of money bor-rowed and the larger sum that must be repaid

71. The changes in the velocity of circulationof money in the period 1929–1945 are inconsistentwith a positive relationship between velocity andchanges in the quantity of money.

72. The changes in the velocity of circulationof money in the period 1946–1981 are inconsistentwith a positive relationship between velocity andchanges in the quantity of money.

73. The changes in the velocity of circula-tion of money in the period 1981 to the present are in-


consistent with a positive relationship between veloc-ity and changes in the quantity of money.

74. The present monetary system has the po-tential both for major inflation and for major deflation.

The Balance of Trade and Payments

75. The “balance of trade” is a. the difference between the sum of all of acountry’s exports and the sum of all of its importsb. typically described as favorable to the extentthat its exports exceed its imports and unfavorableto the extent that its imports exceed its exportsc. both (a) and (b)

76. The “balance of payments” isa. a broader concept than the balance of trade,being the difference between the sum of all of acountry’s receipts from abroad and all of its out-lays to abroadb. typically described as favorable to the extentthat its outlays to abroad exceed its receipts fromabroad and unfavorable to the extent that its re-ceipts from abroad exceed its outlays to abroadc. both (a) and (b)

77. The doctrines of the balance of trade andthe balance of payments imply international economicconflict, since they imply that each country shouldseek a “favorable” balance that in the nature of thecase must be regarded as “unfavorable” to other coun-tries and thus that an implicit goal of every country isthe infliction of harm on other countries.

78. The doctrines of the balance of trade andthe balance of payments were first propounded by

a. the Classical economistsb. the Mercantilistsc. the Physiocrats

79. So long as the only significant interna-tional economic dealings were in the form of importsand exports, the concepts of the balance of trade andthe balance of payments could be taken as interchange-able.

80. When the doctrines of the balance oftrade and balance of payments originated

a. gold and silver were moneyb. most European countries had no significantgold or silver mines within their bordersc. an excess of exports over imports was soughtas the means of accumulating “treasure” within acountry, which could later be used for financingforeign military venturesd. an excess of exports over imports was themeans for achieving an increase in the quantity ofmoney in such countries e. an excess of exports over imports came to beconsidered favorable for all the reasons that peo-ple believe an increase in the quantity of money isfavorable

f. all of the above

81. In the eyes of the supporters of the bal-ance of trade/payments doctrines, the individual itemsin the balances are all essentially separate and indepen-dent of one another, with the result that the overall bal-ance is regarded as essentially fortuitous, capable ofbeing “harmed” by anything that would enlarge this orthat import or other category of outlay or reduce thisor that export or other category of receipt, and “im-proved” by anything that would enlarge this or that ex-port or other category of receipt or reduce this or thatimport or other category of outlay.

82. In the eyes of the supporters of the bal-ance of trade/payments doctrines, each export or re-ceipt from abroad constitutes an equivalent addition tothe money supply of a country, while each import orother outlay to abroad constitutes an equivalent sub-traction from the money supply of a country.

83. In the eyes of the supporters of the bal-ance of trade/payments doctrines, in the absence ofgovernment intervention to prevent it, imports andother outlays to abroad have the potential of com-pletely draining a country of its money supply.

84. Concern with an unfavorable balance oftrade or payments under a gold standard may havesome plausibility, but under the conditions of a fiatpaper money, in which any part of the money supplythat might be lost to abroad can easily be replaced bymeans of printing more money, it makes no sensewhatever.

85. To some extent the position of the dollaras an international money entails some actual loss ofdollars to abroad each year, but such loss,

a. far from being a proper source of worry, sim-ply represents a modest lessening of the degree ofdomestic inflation of the money supplyb. is analogous to the loss of gold experiencedevery year by a gold-producing country, such asSouth Africa, with the difference that the papermoney that is exported costs next to nothing toproducec. both (a) and (b)

86. The far greater part of what is recordedas an unfavorable balance of payments represents

a. an actual outflow of moneyb. an increase in short-term foreign lending to thecitizens of the country, or to its government, theproceeds of which are not counted on the receiptsside because they are short term

87. Insofar as it represents short-term foreignlending to a country’s citizens or its government, theactual significance of an “unfavorable balance of pay-ments” is favorable, because it represents capital in-vestment in the country and/or a mitigation of theconsequences of its government’s borrowing.


88. The various items in the balance of pay-ments accounts are not independent, but rather are mu-tually interconnected. For example, the so-calledunfavorable balance of trade (the excess of importsover exports) that the United States has experienced inrecent years is precisely the result of the excess of re-ceipts by the United States over outlays in the vitalarea of lending and investing. This excess is what pro-vides the money to pay for the excess of imports overexports.

89. It is in the very nature of foreign invest-ment that it be accompanied by a so-called unfavor-able balance of trade in the country receiving theinvestment, because the way that one country physi-cally invests in another is by sending in the equipmentand materials to build up the recipient country’s meansof production, and by sending in consumers’ goods tosupply the workers involved. For example, Western in-vestment in building up Saudi Arabia’s oil industry en-tailed the arrival of many shiploads of Western goodsin Saudi Arabia, bringing in the necessary equipment,construction materials, and consumers’ goods forWestern workmen.

90. The purchase of imports does not repre-sent any significant carrying out of money from theUnited States or any reduction in total, overall spend-ing for goods and services in the United States. On thecontrary, the imports represent new and additionalwealth brought into the United States, where they areadded to the supply of domestically produced goodsand made available for purchase by the same total ex-penditure of money that would otherwise take place.

91. The rise in the foreign exchange value ofa country’s money that foreign investment in the coun-try causes not only does not cause unemployment inthat country, but actually tends to be accompanied byless unemployment in that country, because the for-eign investment serves to increase the demand forlabor in that country.

92. The prohibition or forced reduction ofauto and steel imports would reduce unemployment inthose industries but, in the absence of wage rate reduc-tions, increase unemployment in the rest of the eco-nomic system, since reduced imports of autos and steelwould be accompanied by reduced exports of othergoods and/or increased imports of other goods.

93. The results of the reduction or elimina-tion of foreign investment and the excess of importsover exports that is the accompaniment of net foreigninvestment would include a rise in prices resultingfrom the loss of the supply of goods representing theexcess of imports over exports, and a reduction in em-ployment and/or wage rates resulting from the fall inthe demand for labor that rested on foreign investment.

94. What is called a favorable balance oftrade can in fact be fully as much unfavorable as an al-legedly unfavorable one is favorable, as, for example,

if it results from such a thing as the granting of foreignaid the proceeds of which are used to finance exports.Such a case is comparable to the doorman of a restau-rant giving money to passersby on the condition thatthey will spend it in eating at that restaurant.

95. Under an international gold standard, a. the world’s money supply, other things beingequal, would tend to be distributed among the vari-ous individual countries in proportion to the rela-tive size of their respective economies, whichimplies that there would be relatively increasingmoney supplies in countries with above averagerates of economic progress and relatively decreas-ing money supplies in countries with below aver-age rates of economic progressb. consistent with the operation of the principlejust named, a country with extensive gold mineswould most likely experience an “unfavorable”balance of payments, while a country withoutthem would most likely experience a “favorable”balance of payments; otherwise, the money sup-plies of the different countries would not corre-spond to the relative size of their respectiveeconomiesc. given the relative size of the various countries’economies in the world, and given the world’squantity of money, the balance of trade and pay-ments of all countries always tends toward balanced. labor union activities, by virtue of retarding orpreventing the rise in the productivity of labor andin causing unemployment, operate to reduce thesize of a country’s economy in comparison towhat it would otherwise have been and thus to re-duce its share of the world’s money supply incomparison with what it would otherwise havebeene. to the extent that labor union activities reducethe quantity of money that can accompany full em-ployment in a country’s economy, they reduce theheight of money wage rates that can accompanyfull employment in that countryf. all of the above

96. Under a system of various fiat moneys inthe economies of the different countries,

a. the world’s money supply is distributed amongthe different countries in essentially the same wayas it is under an international gold standardb. the distribution of the world’s money supplycan be found in the combination of the number ofunits of the various currencies and their respectivecurrency exchange rates, so that, for example, ifthe United States has a money supply of $2 tril-lion while Japan has a money supply of ¥140 tril-lion, and the exchange rate is 140 yen to thedollar, the US money supply is twice that of Japanc. if the economy of one country grows relativelyto that of another, either the number of units in itsmoney supply will tend to grow in the same pro-portion relative to the number of units in the


money supply of the other country, or its ex-change rate will rise in proportion to the relativeincrease in the size of its economy, or some com-bination of these two will occurd. all of the above

97. Under an international gold standard, thecreation of fiduciary media in any one country oper-ates to cause a drain of gold from that country, because

a. its creation of fiduciary media is tantamount toan enlargement of the world’s money supplyb. the country cannot, other things being equal,retain a quantity of money greater than corre-sponds to the relative size of its economy in theworld economy, so that if, for example, the in-crease in its supply of fiduciary media is equiva-lent to a 1 percent increase in the world’s supplyof money, while its economy is ten percent of theworld’s economy, the country can retain only onetenth of the amount by which it has increased theworld’s money supplyc. other countries will most likely wish to receivetheir portion of the additional world supply ofmoney in gold, rather than the paper of the ex-panding countryd. all of the above

98. Under a system of various fiat moneys inthe economies of the different countries, the creationof additional money, whether fiduciary media or stan-dard money, in any one country will cause it either tolose foreign currency reserves or, lacking sufficientsuch reserves, suffer a devaluation of its currency rela-tive to foreign currencies.

99. What explains an “unfavorable” balanceof payments in the sense of an actual outflow ofmoney from a country is that the citizens of the coun-try have an insufficient demand for that money to keepit in the country. In essence, they wish to hold a quan-tity of money corresponding to the relative size oftheir country’s economy in the world, plus or minus anamount that corresponds to the special circumstancesof their country and their psychology. They do notwish to hold the larger quantity of money that pres-ently exists in their country, most probably as the re-sult of credit expansion or other domestic inflation ofthe money supply. And as a result, they seek to spendit abroad and not replace it.

100. In the circumstances described in thepreceding question, it is futile to try to keep the excessquantity of money in the country by such measures asblocking this or that category of imports or encourag-ing this or that category of exports, for so long as themoney is present in the country and the citizens do notwish to hold it, it will serve to raise domestic prices rel-ative to foreign prices. This in turn encourages importsand discourages exports, with the result that as soon asone category of import is prohibited, people turn toone or more others, and as soon as an additional line ofexports is forced into existence, some other line or

lines of exports becomes uncompetitive or imports arestepped up.

101. In contrast to the circumstances apply-ing to the last two questions, when the citizens of acountry do have a demand for its existing quantity ofmoney, no amount of outlays to abroad will for verylong deprive them of any part of that quantity ofmoney. As illustration, imagine, for example, that anew foreign aid bill is passed and that, as part of it, anarmy of tax collectors is dispatched into the streets toseize money from every passerby and from every shop-keeper and businessman. The money, we can imagine,is then loaded into armored cars, rushed to nearby air-ports, and then flown to various foreign capitals

a. This foreign aid will not for very long be at theexpense of the cash holdings of the American peo-ple. The American people cannot afford such a re-duction in their cash holdings. They will becompelled to replace those cash holdingsb. To replace their cash holdings, they will haveto sell more and buy less, and borrow more andlend less. The effect of this will very soon be acombination of lower domestic prices and higherdomestic interest ratesc. The effect of this in turn is decreased Ameri-can imports and increased American exports, anddecreased American lending to abroad and in-creased American borrowing from abroad. Thisgoes on until American cash holdings are restoredto approximately their former leveld. all of the above

102. In the light of the answer to the preced-ing question, the observation of Adam Smith that “theattention of government never was so unnecessarilyemployed, as when directed to watch over the preser-vation or increase of the quantity of money in anycountry” seems simplistic.

103. What needs to be understood in connec-tion with the balance of trade and payments viewed assource of changes in the quantity of money in a coun-try is that the change in the stock of money in people’spockets, like the change in the stock of food in their re-frigerators, is fully within their control and that theirdecisions about changes in the stock determine the re-lationship between their receipts and outlays, not thatthe relationship between their receipts and outlays de-termines the change in the stock.

104. A man owns a refrigerator into whichfrom time to time he puts food and from which fromtime to time he takes food.

a. The change in the stock of food in the refrigera-tor is caused by the difference between the extentto which food is put into and taken out of the re-frigerator. If no food is put into the refrigeratorwhile the man continually withdraws food from it,he will be in danger of running out of food. Stepswill have to be taken to reduce his withdrawals of


food from the refrigerator and increase his depos-its of food into the refrigeratorb. The man’s decision about whether to increaseor decrease the stock of food in the refrigerator isthe cause of the difference between the food thathe puts into the refrigerator compared with thefood that he takes out of the refrigerator. For ex-ample, if he plans to throw a party, he will be sureto stock the refrigerator and not to take from ititems that he wants to save for his guests. Simi-larly, if he plans to go on vacation, he will tend touse up what he has in the refrigerator and not re-place it. Changes in the stock of food in the refrig-erator are entirely within the man’s power and nota cause for concern.

105. In a free market, all other things beingequal, the balance of payments of a country tends to-ward zero

a. because the effect of a positive balance of pay-ments is to increase the quantity of money in acountry that experiences it, while the effect of anegative balance of payments is to decrease thequantity of money in a country that experiences itb. the effect of an increase in the quantity ofmoney in a country is raise the prices of goodsproduced in that country, while the effect of a de-crease in the quantity of money in a country is re-duce the prices of goods produced in that countryc. the effect of higher prices of goods producedin a country is to discourage exports from it andencourage imports into it, which, in turn, serves toreduce its balance of payments, while the effect oflower prices of goods produced in a country is toencourage exports from it and discourage importsinto it, which, in turn, serves to increase its bal-ance of payments; thus positive balances diminishand negative balances increased. all of the above taken together

106. In a free market, the balance of pay-ments of a country tends toward zero

a. in the absence of further changes in theworld’s quantity of moneyb. in the absence of further changes in the rela-tive size of the economies of the different coun-triesc. in the absence of further changes in the spe-cific needs for cash holdings in the various coun-tries, such as the degree of security of propertyand the development of financial institutions andfinancial markets in the various countriesd. all of the above taken together

107. It follows from the principle that the bal-ance of payments of a country tends toward zero

a. that a unilateral tariff reduction by a countryand any resulting surge in its imports would soonbe followed by a diminution of the increase in itsimports and an increase in its exports, until its bal-ance of payments was in balance—provided that

wage rates and thus costs and prices in that coun-try were free to fallb. that in a country in which wage rates and thuscosts and prices were free to fall, the adoption ofinternational free trade, even unilaterally, wouldnot entail any lasting unemployment but a shift inemployment from the relatively less efficient pro-duction of goods for domestic consumption to therelatively more efficient production of goods forexport, with the attendant consequence of a higherstandard of living at home and abroadc. that an essential requirement of being able toadapt to international free trade and its possibleconsequence of a temporary outflow of money isthe absence of legislation aimed at artificially rais-ing wage rates or forcibly maintaining any givenlevel of wage ratesd. all of the above

108. In the light of the proposition that thebalance of payments tends toward zero, it follows thatif a country pursued a policy of international freetrade, while all other countries absolutely and success-fully prohibited the importation of its goods, that ulti-mately that country would cease importing, becausethe decrease in its money supply and equivalent in-crease in the money supply of the rest of the worldwould so reduce the level of wages, costs, and pricesin it compared to the level of wages, costs, and prices,in the rest of the world, as to remove the incentive ofits citizens to buy anything abroad.

Invariable Money

109. Depending on circumstances, changesin prices reflect

a. changes taking place on the side of goods,such as changes in the supply of various goodsand changes in the need or desire for variousgoodsb. changes taking place on the side of money, no-tably an increase or decrease in the supply ofmoney or an increase or decrease in the demandfor money for holding, such as occurs wheneverthere is inflation or deflationc. both (a) and (b)

110. The variability of the value of moneycoming from the side of money applies even to a puregold or silver standard—i.e., to a 100-percent-reservegold or silver standard—if for no other reason, then be-cause the supply of gold and silver tends steadily to in-crease as the result of their continued mining andsubstantially smaller annual loss or disappearance.This serves either to make prices higher from year toyear or at least to make them fall by less than theywould have in the absence of such change on the sideof money.

111. In order for a money to serve as an in-variable standard of value, it would have to be such


that changes in prices would reflect exclusivelychanges operating on the side of goods, not money.

112. The kind of money that would render allchanges in the prices of goods having to come fromchanges on the side of goods and not from changes onthe side of money,

a. would be one in which the total annual expen-diture to buy newly produced goods—and equiva-lently, total business sales revenues in sellingsame—was a fixed, constant amount, such as onetrillion dollars or twenty trillion dollars, i.e., anydefinite, fixed dollar amountb. A fixed total expenditure for newly producedgoods and equivalently fixed total business salesrevenues in selling same, would be the result of afixed quantity of money times a fixed velocity ofcirculation of money in relation to newly pro-duced goodsc. Under such an invariable money, all changesin the general consumer price level would reflectincreases or decreases in the supply of consumers’goods—they would, indeed, be inversely propor-tionate to such supply changesd. Under such an invariable money, all changesin the relative prices of individual consumers’goods, such as the price of apples relative to theprice of oranges, or the price of both relative tothe price of automobiles or steel, would reflect acombination of changes in their relative suppliesand in the relative need or desire for them at themargin. (In the case of goods like automobiles andsteel, whose prices are typically determined in thefirst instance on the basis of their cost of produc-tion, the relevant supplies and demands are of/formeans of production.)e. Under such an invariable money, a definiteelasticity of aggregate demand is implied equal tounity, because a constant expenditure implies thatquantity demanded changes in inverse proportionto price—e.g., doubles when the price levelhalves, halves when the price level doublesf. all of the above

113. The concept of invariable money impliesa. that every measure of velocity must remain un-changed

b. only velocity in relation to the demand fornewly produced goods must remain unchanged

114. Ricardo believed that in order for goldto serve as an invariable standard of value an ounce ofgold would always have to be the product of the samequantity of labor of the same degree of skill and ability.

115. Hazlitt expresses no opinion, explicit orimplicit, concerning an invariable money.

116. The concept of an invariable money as atool of analysis represents the adoption of a procedureanalogous to that of mechanics when it conceives ofsuch a thing as the velocity of a moving body as thejoint outcome of the operation of separate, distinctforces.

117. The assumption of an invariable moneyis made, implicitly, by everyone who thinks about eco-nomic phenomena on the assumption of all otherthings being equal, for among those other things is al-most always the total volume of spending in the eco-nomic system.

118. The concept of invariable money andrecognition of the fact that money is not in fact invari-able sheds light on the respective roles of a system offiat paper money and the businessman’s profit motivein the causation of the rising prices we have seen al-most all around us.

119. Among the uses that will be made of theconcept of invariable money in the chapters ahead are

a. the isolation of the distinct determinants of theaverage rate of profit in the economic systemb. recognition of important cases in which moneyincome and real income can move in opposite di-rectionsc. analysis of the nature of inflation and deflationd. analysis of the effect of increases in produc-tion and accompanying falling prices on the rateof profit and on the difficulty of repaying debte. analysis of the role of saving in capital accumu-lation and of the effect of saving on the averagerate of profitf. analysis of the causes of capital accumulationg. all of the above



Quest- Correct Quest- Correct Quest- Correct tion# Answer tion# Answer tion# Answer

1 a 41 F 81 T2 T 42 d 82 T3 T 43 c 83 T4 T 44 c 84 T5 c 45 c 85 c6 4.1 46 T 86 b7 c 47 T 87 T8 d 48 T 88 T9 T 49 T 89 T10 T 50 d 90 T11 2% 51 T 91 T12 35 years 52 c 92 T13 9 years 53 e 93 T14 T 54 T 94 T15 e 55 T 95 f16 T 56 e 96 d17 F 57 T 97 d18 d 58 F 98 T19 400% 59 d 99 T20 c 60 c 100 T21 F 61 F 101 d22 T 62 T 102 F23 T 63 d 103 T24 T 64 T 104 b25 d 65 T 105 d26 d 66 e 106 d27 d 67 c 107 d28 T 68 T 108 T29 e 69 F 109 c30 d 70 b 110 T31 a 71 F 111 T32 T 72 F 112 f33 T 73 F 113 b34 T 74 T 114 T35 T 75 c 115 F36 c 76 a 116 T37 T 77 T 117 T38 T 78 b 118 T39 F 79 T 119 g40 c 80 f


PRODUCTIONISM(Chapter 2, Sections 1 – 3, 6 and 8; and Chapter 13, Part A)

1. Productionism holds that the fundamentalproblem of economic life is how steadily to increasethe ability to produce in the face of a limitless needand desire for wealth.

2. Consumptionism holds that man’s needand desire to consume are essentially fixed and given,and that the ability to produce threatens constantly tooutrun them, with the result that the fundamental prob-lem of economic life is not the production of wealth,but the production of consumption.

3. Productionism is closely connected witha. the quantity theory of moneyb. Say’s Law of Marketsc. the proposition that a general or absolute over-production is impossibled. all of the above

4. Productionism is closely connected withthe proposition that

a. the productive process generates an aggregatereal demand that is equal to aggregate supply andgrows precisely as aggregate supply growsb. the productive process generates an aggregatemonetary demand that in the absence of govern-ment interference is sufficient to buy the aggre-gate supply at a profitc. what is saved is spentd. saving is the source of most spending in theeconomic system and underlies both a growing ag-gregate real demand for goods and services and agrowing aggregate monetary demand for theme. all of the above

5. Productionism is closely connected with aseries of further propositions, among them

a. that man’s nature as a rational being underliesa limitless need and desire for wealthb. that the division of labor is essential for a highand rising productivity of laborc. the law of comparative advantaged. that real wages and thus the average worker’sstandard of living are determined by the productiv-ity of labore. all of the above

6. a. The leading philosophic basis for consumption-ism, that has become increasingly more influentialin recent decades, is the belief that man is funda-mentally no different than the lower animals andthus does not have fundamental needs that extendbeyond theirs.b. When confronted with the fact that man’s de-sires obviously do extend beyond the range of ananimal’s, consumptionists can be expected toreply that this is the result of “social and culturalconditioning” and the work of advertisers and that

the desires are “unnatural,” “artificial,” and “cre-ated.”c. both (a) and (b)d. neither (a) nor (b)

7. Every increase in the demand for the prod-uct of a particular industry that is based on the need ordesire for its product intensifying and thus pushingahead of the needs and desires for the products ofother industries and coming to the forefront, must beaccompanied by an equivalent decrease in the demandfor the products of other industries.

8. The need and desire for goods count in de-mand only insofar as they operate to determine towhich of various possible competing alternatives de-mand is directed.

9. To those concerned only with a particularindustry, it correctly appears that because any given in-dustry, at one time or another, could experience an in-crease in demand by virtue of the need or desire for itsproduct gaining in priority relative to the need and de-sire for the products of other industries, that all indus-tries might gain in this way at the same time.

10. a. The preceding question describes a case of add-ing up as additional demands what are in fact a se-ries of mutually exclusive alternatives, each ofwhose individual existence is predicated on anequivalent decline in demand in the rest of the eco-nomic system. b. The preceding question is an example of whatlogicians call “the fallacy of composition,” that is,invalidly generalizing from what occurs in part ofa system to the system as a whole.c. both (a) and (b)

11. Businessmen who think of the effect ofthings exclusively on their own company or industryand not, at the same time, on the rest of the economicsystem, are easily led to the conclusion that

a. what is required to increase demand in the eco-nomic system is the creation of additional needsand desiresb. what explains low profits in the economic sys-tem is too much productionc. are often led to accept a consumptionist viewof things on the basis of misinterpreting their expe-rienced. all of the above

12. In contrast to the businessmen describedin the previous question, those who look at the effectof things not only on an individual company or indus-try but also on the rest of the economic system realizethat




George Reisman


a. when the emergence of a greater need or desirefor a particular product serves to increase the de-mand for that product, it simultaneously mostlikely reduces the demand for some other productor products to the same extent because people’soverall means of purchase do not suddenly be-come greater and there is no reason to supposethat the one thing they will give up is the satisfac-tion and security they derive from holding theamount of money they presently holdb. that the role of needs and desires in connectionwith demand is that the needs and desires that arejudged relatively more urgent are satisfied andthose that are judged relatively less urgent are notsatisfied; that needs and desires overall far exceedpeople’s ability to satisfy them and that moreneeds and desires do not increase overall demandbut merely change its direction, from some thingsto other thingsc. given the total amount of money spent to buyproducts and the total amount of money spent toproduce them, the total amount and average rateof profit in the economic system does not dependon the physical volume of production in the eco-nomic system and is not reduced by a larger vol-ume of production d. when the production and sale of a greater sup-ply of any particular product serves to reduce therate of profit that is earned on the product, the ac-tual reason is that the product has gotten into a sit-uation of relative oversupply, i.e., it is beingproduced too heavily relative to other products,which, in the nature of the case, are being pro-duced in insufficient quantity relative to the prod-uct in question and are thereby rendered moreprofitable to the same extent that this particularproduct is rendered less profitablee. all of the above

13. Businessmen who think of the effect ofthings exclusively on their own company or industryand not, at the same time, on the rest of the economicsystem, are often led to accept a consumptionist viewof things on the basis of misinterpreting their experi-ence.

14. In contemporary terms the proposition ofAdam Smith that “the desire of food is limited in everyman by the narrow capacity of the human stomach; butthe desire of the conveniences and ornaments of build-ing, dress, equipage and household furniture seems tohave no limit or certain boundary” can be stated as“The man who has no automobile would like to beable to afford one. The man who has an automobilewould like to be able to afford a newer, better one. Theman who has several new automobiles of the highestquality would like to be able to afford a yacht or aplane. If he is rich enough to afford both a yacht and aplane, then he would like to be able to afford a yachton which the plane can land, and so on.”

15. The sense in which one can legitimatelysay that a lack of desire for wealth constitutes an eco-nomic problem is that

a. it renders demand inadequate to purchase thesupplyb. it deprives people of the motive to work andproduce

16. Among the philosophical convictionsthat must be present to induce people to desire addi-tional wealth strongly enough to go out and actuallyproduce it are

a. those underlying limited government, eco-nomic freedom, and the security of propertyb. the conviction that the material world is fullyreal and operates according to causal laws thatman’s mind can grasp and applyc. that the individual is a self-responsible causalagent capable of improving his life in the futureby means of his actions in the presentd. all of the above

17. The fundamental basis in human naturefor the desire for goods outstripping the willingnessand ability to produce goods is

a. the success of the advertising industry in incul-cating the conviction that more is better than lessand that big is better than smallb. the cultural heritage of the society in which welive, with its emphasis on material achievement ir-respective of the cost to the environmentc. the limitless range of the mental in comparisonwith the physical and thus the fact that the rangeof our imaginations is always incomparablygreater than the power of our armsd. all of the above

18. The desire for goods continues to outstripthe willingness and ability to produce goods no matterwhat the advances in the ability to produce because

a. the advertising industry never sleepsb. the cultural heritage of the society in which welive always demands more from usc. no matter how much we may augment thepower of our arms by means of tools and ma-chinery, at the same time, as part of the same pro-cess, we augment the power of our imaginations,in that the new knowledge required to provide thetools and machines also opens up new vistas interms of what can be producedd. all of the above

19. The fundamental basis in human naturefor man’s need for goods having no limit is

a. man’s possession of reason gives him the po-tential for a limitless range of knowledge andawareness, hence of action and experienceb. goods are the material means of acting and ex-periencing c. both (a) and (b)d. neither (a) nor (b)


20. There is an inherent, ineradicable scar-city of human labor because

a. there is a limitless need and desire for goodsand servicesb. human labor is always the limiting factor inthe production of goods and servicesc. both (a) and (b)

21. The scarcity of labor in relation to thegoods and services we would like to have is indicatedby the fact that practically everyone would like to earnfive or more times the income he now earns

a. and that to earn this income at his present rateof pay for a forty-hour week, he would have towork more hours than there are in the weekb. and that to produce the goods and services thatwould constitute a five-or-more-times higher levelof real income in the present state of technologyand productivity of labor, five or more times thelabor would have to be employed than is now em-ployedc. both (a) and (b)

22. We could work ourselves into the hospi-tal from exhaustion long before we could produce allthe goods and services we would like to have.

23. Each of us is easily capable of formingdesires whose fulfillment requires the labor of multi-tudes, and yet by the laws of arithmetic, the averagemember of any society can never obtain more than thelabor, or products of the labor, of just one person.

24. The fundamental and essential nature ofeconomic life is this: the need and desire for additionalwealth are there and the nature-given means of produc-ing it are there; all that is lacking is the ability ofhuman labor to transform the nature-given means ofproduction into additional wealth.

25. The adoption of labor-saving machineryis held to be a cause of unemployment on the basis ofthe belief that

a. there is a fixed, limited need and desire to con-sumeb. the higher productivity of labor that improvedmachinery makes possible causes the ability toproduce at the point of full employment to exceedthe allegedly fixed, limited need and desire to con-sumec. the supply of goods and services correspond-ing to the allegedly fixed, limited need and desireto consume can be produced with a correspond-ingly smaller quantity of labor as improvements inmachinery take placed. all of the above

26. According to Hazlitt, the effect of ma-chinery is

a. to cause unemploymentb. to cause additional employmentc. to increase production and raise the standard ofliving

27. The belief, at the core of consumption-ism, that man’s need and desire for wealth is fixed, im-plies that

a. there is only a fixed stock of work to be donein the worldb. that improvements in machinery reduce thework available to be done by peoplec. that to the extent that the members of somegroups obtain additional employment, equiva-lently less employment remains for the membersof other groupsd. that it is necessary and valuable to make worke. all of the above

28. According to Hazlitt, the effect of“spread-the-work” schemes is

a. a reduction in efficiency insofar as they takethe form of arbitrary job classifications requiringthe employment of unnecessary workers to accom-plish a given result, and a reduction of employ-ment elsewhere in the economic system by virtueof people having to pay higher prices to cover thehigher costs resulting from the inefficiencies andthereby being deprived of the funds to buy theproducts of other industriesb. a subsidization of previously unemployedworkers by workers already employed, insofar asthe schemes take the form of a reduction in hoursworked per worker, are not accompanied by at-tempts to offset the reduced hours with higherhourly wage rates, and provided that there are asufficient number of unemployed in every indus-try to take up the slack provided by the reductionin hoursc. greater unemployment in the economic systemas a whole insofar as the schemes are accompa-nied by increases in hourly wage rates in order tooffset the effects of the reduction in hoursd. all of the abovee. none of the above

29. Consumptionism and its notion that whatis scarce is not goods but the need and desire forgoods, supports the belief that by increasing the needand desire for goods

a. war and destruction are a source of prosperity,via the greatly enhanced need for weapons produc-tion during the war and the need for replacementof damaged or destroyed property that takes placeduring and after the warb. a policy of additional peace-time governmentspending, even if it were for pyramid building, isa source of prosperity by virtue of adding to theneed and desire for goods and services andthereby to employmentc. advertising is a source of prosperity, preciselyby virtue of its alleged inherent fraud of leadingpeople to desire things that they do not reallyneed, because in so doing it adds to the demandfor goods and labor


d. a higher birthrate is a source of prosperity, bycreating new and additional consumers, each onewith his respective new and additional desires—provided the new and additional consumers do notattempt to work and produce and thereby add tothe supply of labor and ability to produce as muchas they add to the supply of needs and desirese. a policy of imperialism is a source of prosper-ity by virtue of adding to the outlet for goods theneeds and desires of large numbers of desperatelypoor potential consumersf. all of the above

30. In his discussion of “the blessings of de-struction” Hazlitt

a. refers to the belief that many people have thatwar and destruction are sources of prosperityb. describes the confusion between need and de-mandc. describes the confusion between more moneyand more purchasing powerd. illustrates the mistaken habit of looking only atpart of the economic picture rather than the wholee. all of the above

31. Consumptionism’s notion of a limitedneed and desire for goods lead to the belief that

a. the presence of great wealth in a country is a li-ability, in that it represents the using up of the al-legedly limited stock of needs and desires forwealth, thereby leaving the country relativelypoor in terms of its remaining stock of unmetneeds and desires for wealth and thus in its abilityto support employment and productionb. the absence of wealth in a country is an asset,in that it represents a correspondingly limitedusing up of the allegedly limited stock of needsand desires for wealth, thereby leaving the coun-try relatively rich in terms of its remaining stockof unmet needs and desires for wealth and thus inits ability to support employment and productionc. both (a) and (b)d. neither (a) nor (b)

32. The actual effect of government spendingon employment and prosperity is

a. to increase demand and employment in certainlinesb. to equivalently reduce demand and employ-ment in other linesc. to deprive the individual taxpayer of the powerto decide how his income shall be spentd. all of the above

33. Hazlitt believes that war and governmentspending undertaken for the purpose of stimulating em-ployment

a. reduce the average standard of livingb. cause unemploymentc. both (a) and (b)

34. According to consumptionism, a largerpopulation contributes to prosperity by virtue of

a. increasing a country’s ability to produceb. increasing a country’s need and desire to con-sumec. increasing a country’s need and desire to con-sume and not increasing its ability to produced. all of the above

35. The actual effect of an increase in popula-tion on aggregate demand is

a. to divert aggregate demand from lines servingthe needs of adults to lines serving the needs ofchildren, in the period when the larger populationis in its childhoodb. to increase overall aggregate demand in the pe-riod when the larger population is in its childhoodonly insofar as parents are led to work and pro-duce more in order to be able to provide for theirchildren without suffering an equivalent reductionin what they provide for themselvesc. to increase overall aggregate demand when thelarger population reaches adulthood insofar as theadditional people go to work and enlarge the totalof what is producedd. all of the above

36. The consumptionist belief in the exis-tence of a fixed need and desire for goods leads to thebelief that

a. the opening up of export markets, especially topoor countries, is helpful to employment by en-abling the country’s labor force to serve the needsand desires of additional peopleb. the increase in imports reduces the extent towhich the needs and desires of the country’s popu-lation are served by its own labor force and corre-spondingly reduces employment opportunities forthat labor forcec. the ideal arrangement in foreign trade from thepoint of view of promoting employment in thecountry is to export as much as possible and im-port as little as possibled. all of the above

37. The notion of a fixed need and desire forgoods leads to the belief that the gain from foreigntrade is in importing, not exporting.

38. Advertising is inherently fraudulent, ac-cording to consumptionism, because it attempts to leadpeople to desire goods and services that, according toconsumptionism’s very limited theory of needs, theyhave no rational basis for desiring.

39. The actual relationship between advertis-ing and aggregate demand is

a. advertising diverts demand from some lines toothers by making people aware of the alternativesb. advertising increases aggregate demand inso-far as it leads people to work and produce more in


efforts to earn the additional income to buy the ad-vertised goodsc. both (a) and (b)

40. The belief that falling prices are deflationa. implies that increases in production cause de-pression and thus unemploymentb. represents support for consumptionismc. both (a) and (b)

41. The role of technological progress in rela-tion to capital accumulation is

a. to provide new and additional uses for an ex-panding supply of capital goods that results fromsavingb. to keep up the rate of profit and interest in theface of an expanding supply of capital goods thatresults from savingc. both (a) and (b)d. that of a major source of capital accumulation

42. According to consumptionism, technolog-ical progress

a. raises the rate of profit and interest by provid-ing new and additional investment opportunities

b. increases the supply of consumers’ goods,thereby causing falling prices and deflationc. both (a) and (b)

43. Consumptionism claims thata. the gain from foreign trade is in the exports,not the importsb. the gain from an increase in population is inthe additional people’s need and desire to con-sume, not in their contribution to productionc. nonproducing consumers are a source of bene-fit to producers by providing an excess of con-sumption over production equal to the producers’alleged deficiency of consumptiond. all of the above

44. Acceptance of the consumptionist prem-ise leads serious people to regard capitalism as flawedby fundamental paradoxes and thus to be prone to seekan alternative.

45. In the light of his views on the economiceffects of war and pyramid building, Keynes must beclassified as a productionist.

SAY’S LAW(Chapter 13, PART B)

46. Monetary demand isa. the goods and services the monetary demandactually buysb. the amount of expenditure of money

47. Real demand is the amount of money re-ally spent in the purchase of goods and services.

48. Real demand isa. the monetary demand adjusted for the wageand price levelb. the quantity of goods and services that themonetary demand, whatever it is, is capable of ac-tually buyingc. both (a) and (b)

49. An example of a monetary demand isa. one trillion dollarsb. one billion dollarsc. ten trillion dollarsd. one hundred dollarse. all of the above

50. The cause of a steadily rising aggregate monetary demand is

a. an increase in the quantity of moneyb. an increase in the production of ordinarygoods and services, such as shoes and televisionsets

51. A smaller monetary demand can consti-tute a larger real demand if prices are more than pro-portionately lower.

52. Increases in production and supply createreal demand by virtue of

a. raising the level of money incomes andthereby increasing purchasing powerb. driving down prices and increasing the buyingpower of any given level of income and expendi-ture

53. Over a period of years, the quantity ofmoney and volume of spending in the economic sys-tem double. Over the same period of years, aggregateproduction and supply remain constant.

a. state the change in aggregate monetary demandb. calculate the change in the general consumerprice level using the formula P = Dc/Scc. calculate the change in aggregate real demand

54. Over a period of years, the quantity ofmoney and volume of spending in the economic sys-tem double. Over the same period of years, aggregateproduction and supply also double.

a. state the change in aggregate monetary demandb. calculate the change in the general consumerprice level using the formula P = Dc/Scc. calculate the change in aggregate real demand

55. Over a period of years, the quantity ofmoney and volume of spending in the economic sys-tem remain constant. Over the same period of years,aggregate production and supply double.

a. state the change in aggregate monetary demandb. calculate the change in the general consumerprice level using the formula P = Dc/Sc


c. calculate the change in aggregate real demand

56. Increases in production and supply are es-sential to create more real demand, because

a. increases in monetary demand taken by them-selves serve merely to raise prices in the same pro-portion, with the result that the larger monetarydemand buys no more, i.e., constitutes no morereal demand, than did the smaller monetary de-mand before itb. only to the extent that there is an increase inproduction and supply will an increase in mone-tary demand be able to represent an increase inreal demand, because only to that extent willprices not rise by as much as the increase in mone-tary demandc. both (a) and (b)

57. In the absence of more monetary de-mand, increases in production and supply create morereal demand by means of driving down prices and cor-respondingly enlarging the purchasing power of thesame amount of monetary demand.

58. Increases in production and supply areboth necessary and sufficient to create more real de-mand.

59. Say’s Law most closely relates toa. supplyb. demandc. real demandd. aggregate real demande. aggregate real demand as determined by aggre-gate supply

60. In a barter economy, the producers of po-tatoes, a good faced with an inelastic demand, doubletheir production and supply, with the result that the ex-change value of potatoes falls by more than half, say,to one-third.

a. As a result, the supply of goods offered in ex-change for potatoes is now only two-thirds aslarge as before and thus there is a one-third fall inthe real demand for potatoes caused by the dou-bling of their supply.b. Aggregate real demand in the economic sys-tem as a whole, however, does not fall as the re-sult of the fall in the real demand for potatoes,because the goods that the producers of thingsother than potatoes no longer exchange with thepotato growers, they exchange with each other—e.g., the reduced demand for potatoes in terms ofshirts is offset by an enlarged demand for shoes,eggs, bars of iron, etc., in terms of shirts, and simi-larly for all the other goods in terms of which thedemand for potatoes has fallen; i.e., the fall in theother-goods demand for potatoes is offset by anequivalent rise in the other-goods demand forother goods.c. The doubled supply of potatoes constitutes adoubled potato demand for other goods.

d. All elements of the matter considered, the dou-bled supply of potatoes is accompanied by a pre-cisely equivalent increase in economy-wide,aggregate real demand.

61. The losses of the potato growers in thepreceding question are more than offset by the gains ofproducers in the rest of the economy because

a. the reduction in the real demand for potatoes isaccompanied by an equivalent rise in the real de-mand for goods other than potatoesb. the real demand for goods other than potatoesis also increased to the extent of the increase inthe supply of potatoesc. both (a) and (b)

62. In the case of an inelastic industry de-mand for an individual good, such as potatoes, an in-crease in supply serves to reduce the volume of goodsreceived by the producers in the industry concerned.Consequently, there is a reduction in the real demandfor the products of this industry as the result of the in-crease in their supply and therefore Say’s Law doesnot hold up in this case.

63. In the case of an inelastic industry de-mand for an individual good, such as potatoes, an in-crease in supply serves to reduce the volume of goodsreceived by the producers in the industry concerned.

a. Consequently, there is a reduction in the realdemand for the products of this industry as the re-sult of the increase in their supply.b. There is nonetheless an increase in aggregatereal demand that is precisely equivalent to the in-crease in aggregate supply in the economy as awhole.c. both (a) and (b)

64. In a monetary economy, once again thesupply of a good confronted with an inelastic demand,such as potatoes, doubles. The result is that this timethe money price of the good falls by more than half,again, for the sake of simplicity, say, to one-third. Theresult is

a. the potato growers take in two thirds themoney they previously took inb. producers in the rest of the economy take inequivalently more money, as the buyers of pota-toes now spend one-third of the money they usedto spend in buying potatoes in buying goods otherthan potatoesc. the same total aggregate monetary demand isnow a larger real demand to the extent that the in-crease in the supply of potatoes constitutes an in-crease in total aggregate supplyd. all of the above

65. Even though an industry as a whole maylose when its supply increases, the individual produc-ers within the industry who are responsible for the in-crease in its supply can nevertheless gain at theexpense of a still greater loss on the part of the produc-


ers in the industry who have not increased their produc-tion.

66. If gradual, the adoption of improvementsin the ability to produce can be accompanied by gainsto all who adopt them, while the accompanying lossesto the industry as a whole are suffered exclusively bythe producers who fail to adopt the improvements.

67. The potato growers, who initially lose asthe result of the doubling of the supply of potatoes,will

a. never be able to make up their lossb. later on be able to gain from the improvementin the ability to produce potatoesc. gain from the improvement in the ability toproduce potatoes once enough potato growersleave potato growing and move into other lines ofproductiond. all of the above

68. Examples concerning the potato industryare provided

a. to convey information about the potato industryb. as an illustration of the conditions faced byany industry with an inelastic demand for its prod-uctsc. both (a) and (b)

The following six questions belong together,with later questions presupposing the contextestablished by the earlier questions.

69. We start with a situation in which an in-dustry confronted with an inelastic demand—again,for the sake of illustration, the potato industry—has in-creased its production, with the result that its sales rev-enue and the total income of its members have beenreduced. In response to their lower incomes, some ofthe potato growers will give up potato growing and re-locate in other industries, in which incomes have actu-ally been elevated as part of the same process whichhas depressed the incomes of the potato growers. As aresult of their movement into other lines

a. the production of potatoes will decline and theprice of potatoes will riseb. the incomes of the remaining potato growerswill increasec. the income of producers in industries outsideof potato growing will decline somewhat as the re-sult of the influx of former potato growersd. all of the above

70. The process of adjustment described inthe preceding question will go on until the incomes ofthe remaining potato growers are once again on a parwith those outside of potato growing.

71. Meanwhile, though having risen from itslow of one-third, the price of potatoes settles at a levelfar below its original level of one. In fact, if the dou-

bling of the supply of potatoes was brought about byvirtue of the average potato grower being able to pro-duce twice as many potatoes with the same labor as be-fore, the price of potatoes will tend to settle at a priceof one-half of its initial price, since at that price the re-maining growers’ incomes will come all the way backup to where they were before the increase in the sup-ply of potatoes.

72. In the new equilibrium, assuming therehas been no increase in the quantity of money and vol-ume of spending, the potato growers, ex-potato grow-ers, and those who never were potato growers all endup with their initial money incomes, buy potatoes athalf the initial price, and, to the extent that they buyless than twice the quantity of potatoes as originally,spend less money in buying potatoes, and with themoney left over from the purchase of potatoes are ableto afford more of other goods. An expanded produc-tion of these other goods is made possible precisely onthe foundation of labor released from potato growing.

73. The overall, long-run result of the in-crease in the ability to produce potatoes is that thosewho remain in potato growing come out ahead, theex-potato growers come out ahead, and those whowere non-potato growers from the beginning comeout ahead.

74. The initial doubling in the supply of pota-toes, when judged from the perspective of the finalequilibrium, represents a

a. a relative overproduction of potatoesb. a relative underproduction of goods other thanpotatoesc. both (a) and (b)

75. If the production of everything—frommatches and salt to swimming pools and yachts—sud-denly doubled overnight

a. a general overproduction would existb. as much under production would exist as over-productionc. both (a) and (b)

76. “‘Overproduction’ is never partial andrelative, but always general and absolute.”

77. The economic system benefits even froman increase in the ability to produce goods with whichpeople may already be fully sated, such as table salt.The source of the benefit in such a case is the ability toreduce the amount of labor applied to the productionof the good with which people are sated and thus tohave additional labor available to expand the produc-tion of other goods, with which, for the most part, peo-ple are very far from being sated.

78. The concentration of an increase in theability to produce in the particular industry in which itoriginates often represents a less efficient use of theimprovement than is possible if that particular industryexpands less than the full amount by which the im-


provement would allow it to expand, and allows otherindustries to expand instead.

79. In the preceding question what decideswhich is the more efficient use is the marginal utilityof additional supplies of the products of the industrywhere the improvement in efficiency takes place com-pared with the marginal utility of additional suppliesof other products that could be produced in largerquantity if the necessary additional labor were madeavailable from this industry. The relative marginal util-ities determines the relative prices and profitability ofthe different products as their supply is increased.

80. What appears as an overproduction in anindividual industry would often cease to appear as anoverproduction if other industries could increase theirproduction sufficiently.

81. The belief that a fall in general businessprofitability is the result of too much production re-flects the fallacy of composition.

82. The general profitability of business a. depends on the difference between aggregatesales revenues and aggregate costsb. is independent of the level of physical produc-tion of ordinary goods, that is, of goods other thanthe monetary commodities gold and silver on aprecious metal standardc. both (a) and (b)

83. The profitability of an individual industryis not independent of its level of physical productionand will

a. decline as its production increasesb. decline as its production increases insofar asthe increase in its production causes a decline inthe marginal utility of its products relative to themarginal utility of products elsewhere in the eco-nomic system that can be produced with the samemeans of production

84. The profitability of an individual industrywill not decline in the face of an increase in its produc-tion if at the same time the production of other indus-tries increases to the point of equivalently reducing themarginal utility of their larger supplies.

85. The profitability of business in the aggre-gate depends on

a. the level of physical production in the eco-nomic systemb. the difference between the dollar amount ofsales revenues and the dollar amount of costs irre-spective of the level of physical production

86. The difference between the dollaramount of sales revenues and the dollar amount ofcosts is roughly equal to the difference between the de-mand for consumers goods and the demand for labor,i.e., to net consumption.

87. The sharp decline in profits and thegreater difficulty of repaying debts that are the hall-marks of depressions are the result of

a. falling prices caused by increased productionb. a monetary contraction resulting in a decline inaggregate sales revenues

UNEMPLOYMENT(Chapter 13, Part C)

88. The repeated existence of long periods ofmass unemployment proves that

a. there is no inherent, ineradicable scarcity ofhuman laborb. money wage rates can often be unduly high rel-ative to the demand for labor for protracted peri-ods

89. In a free labor market the existence of un-employment operates to drive down money wage ratesby virtue of the competition of the unemployed forjobs and the desire of employers to take advantage ofbeing able hire equally good but unemployed workersat lower wage rates.

90. In a free labor market the existence of un-employment is self-liquidating insofar as the reductionin money wage rates it brings about operates to in-crease the quantity of labor demanded.

91. In a free labor market the existence of un-employment automatically tends to reduce moneywage rates to the level required to achieve full employ-ment.

92. The fall in wage rates brought about in afree labor market in the process of eliminating unem-ployment is a fall not only in money wage rates butalso an equivalent fall in real wage rates, i.e., in thebuying power of the worker’s wages.

93. The fall in money wage rates broughtabout in a free labor market in the process of eliminat-ing unemployment is not accompanied by a fall in realwage rates insofar as prices also fall and insofar as theburden of supporting the unemployed is reduced.

94. If, in the process of eliminating unem-ployment, output per worker remains the same, it fol-lows that the increase in employment would beaccompanied by a proportional increase in the produc-tion and supply of consumers’ goods and thus, assum-ing constant monetary demands both for consumers’goods and for labor, a fall in the prices of consumers’goods proportional to the fall in wage rates.

95. Real wages actually rise in connectionwith the fall in money wages that is necessary toachieve full employment


a. if the increase in production and fall in pricesis approximately the same as the increase in em-ployment and fall in wage ratesb. by virtue of the elimination of the burden ofsupporting the unemployedc. both (a) and (b)

96. The fall in wage rates and prices that isnecessary to eliminate unemployment in a free labormarket results in a reduction in the average rate ofprofit in the economic system.

97. In a context in which the aggregate de-mands for consumers’ goods and labor remain thesame, albeit at a lower level following a financial con-traction, the fall in wage rates and prices that is neces-sary to eliminate unemployment does not result in afall in the aggregate amount or average rate of profit inthe economic system. This is because the difference be-tween a given amount of demand for consumers’goods and a given amount of demand for labor impliesa more or less unchanged difference between aggre-gate sales revenues and aggregate costs, hence a moreor less unchanged amount of aggregate profit.

98. In a context in which the aggregate de-mands for consumers’ goods and labor remain thesame, increases in the production and supply ofconsumers’ goods

a. reduce prices in inverse proportionb. reduce unit costs in inverse proportionc. reduce profits per unit in inverse proportiond. leave total, aggregate profits unchanged be-cause the reduction in profit per unit is offset bythe increase in the number of unitse. all of the above

99. Since mass unemployment would beeliminated by a fall in wage rates, which would in-crease the quantity of labor demanded, it follows thatanything that stands in the way of a fall in wage ratesoperates to perpetuate mass unemployment.

100. Among the obstacles that have stood inthe way of a fall in wage rates and the achievement offull employment are

a. minimum wage legislationb. prounion legislationc. welfare legislationd. employer altruisme. executive branch pressure not to reduce wageratesf. all of the above

101. The fall in wage rates was held back inthe early 1930’s by the intervention of President Hoo-ver, who at a series of White House conferences ob-tained the agreement of the leading businessmen of thecountry not to reduce wage rates. Hoover believed thata fall in wage rates was equivalent to a fall in totalwage payments and would thus result in a reduction inconsumer spending and a deepening of the depression.

102. The failure of wage rates to fall suffi-ciently in the early ’30s led to a deepening of the de-pression by causing major postponements ofinvestment spending, awaiting the necessary fall inwage rates. The reductions in investment spending inturn further reduced sales revenues, profits, and theability of business firms to repay debts, thereby precip-itating more bank failures and further declines in thequantity of money and volume of spending in the eco-nomic system.

103. When wage rates fall to the full employ-ment point, payroll spending actually tends to increaserather than remain the same, because funds that hadbeen held back from investment spending, awaitingthe necessary fall in wage rates, now come out into thespending stream.

104. The sharply higher unemployment ratescurrently prevailing in France and Germany in compar-ison with the United States have nothing to do withgreater government interference in wage rates in thosecountries but rather are the result of preparations forthe adoption of the Euro currency unit.

105. Governmental encouragement of fidu-ciary media precipitates mass unemployment by bring-ing about increases in the level of spending in theeconomic system that are not sustainable. When spend-ing drops, the quantities of goods and labor demandedat the prevailing level of prices and wages correspond-ingly falls, resulting in the emergence of correspond-ing unemployment.

106. Continuous economic progress would a. hold back investment because investmentsmade in the future would be more efficient than in-vestments made in the presentb. would not hold back investment becausetoday’s investments would be as much more effi-cient compared with the investments of the past asthe future’s investments would be compared withtoday’s

107. The prospect of falling prices due to eco-nomic progress should be expected

a. to result in a postponement of consumerspending because of the prospect of being able tobuy more cheaply in the futureb. to result in a rise in consumer spending be-cause of the prospect of being materially better offin the futurec. to have no significant overall effect on con-sumer spending

108. Full employment was not achievedunder the New Deal in the 1930s, despite a policy oflarge-scale money creation and rapid increases in totalspending because the far more powerful labor-unionmovement created under the New Deal was able to in-crease wage rates at a substantial rate even in the midstof mass unemployment, with the result that the largerpayrolls achieved by inflation could not employ corre-


spondingly more labor or, indeed, enough additionallabor to make any major headway in eliminating unem-ployment.

109. In principle, a policy of inflating themoney supply and thus artificially increasing the vol-ume of spending is unlikely by itself to achieve fullemployment. This is because if monopoly labor unionsand other government intervention prevent unemploy-ment from being eliminated by a fall in wage rates, thesame forces will likely operate to cause a rise in wagerates in the face of a rising demand for labor and thusto make the rising demand for labor incapable of elimi-nating the unemployment.

110. What made possible the achievement offull employment in World War II was

a. the creation of a huge supply of additionalneeds in the form of the need for tremendousquantities of tanks, aircraft, and numerous otherweaponsb. massive wartime inflation of the money supplyand consequent rapid increase in the volume ofspending in the economic systemc. massive wartime inflation of the money supplyand consequent rapid increase in the volume ofspending in the economic system, coupled withwage and price controls

111. The combination of wartime inflationand price and wage controls made it possible for the in-crease in spending to represent a more or less corre-sponding increase in the quantities of goods and labordemanded.

112. The additional employment achieved bya policy of inflation and government budget deficitsrepresents a decline in the standard of living of mostpeople insofar as the reemployed workers are em-ployed in connection with government projects. This isbecause such workers are remunerated with the outputof other people while their own output is of little or novalue to those others, being called into being in factfor no other essential purpose than to secure them em-ployment and income.

113. The full employment achieved in WorldWar II represented a situation in which roughly half ofthe net output of the economic system was consumedin the war effort, e.g., in flying bullets, exploding

bombs and artillery shells, and in the rifles, cannons,tanks, planes, and ships required to fire or launchthem. The effect was that while everyone worked andworked long and hard, the average member of the eco-nomic system obtained the material benefit of roughlyonly half of his labor.

114. Many people believed that World WarII represented a period of prosperity because they mea-sured their prosperity in terms of the amount of moneythey earned, which sharply increased as the result ofthe wartime inflation, and also felt themselves well offbecause of the unprecedented ease with which theycould earn money. The ease with which money couldbe earned was an effect of the combination of the war-time inflation and price and wage controls, which, to-gether, resulted in substantial shortages of goods andlabor, making it very easy to find buyers for practi-cally anything one had to sell.

115. Only the end of World War II and the re-turn to peace made possible full employment withprosperity.

116. Full employment could be achieved andmaintained

a. through a monetary system free of contractionsin aggregate spendingb. the establishment of a labor market free of gov-ernment interferencec. both (a) and (b)

117. Von Mises denies that the fall in moneywage rates needed to eliminate unemployment is ac-companied by a fall in real wage rates.

118. Depressions are caused by excess inven-tory accumulation, proving once again that too muchwealth can be a cause of poverty.

119. Excess inventories and depressions areboth the result of the same cause, namely, inflation inthe form of credit expansion.

120. Inventories can be viewed as deficientrather than excessive in a depression insofar as a largervolume of inventories would represent more capitaland thereby act as a protection against the widespreadbankruptcies that are an essential characteristic of de-pression.



Quest- Correct Quest- Correct Quest- Correct tion# Answer tion# Answer tion# Answer

PART A 41 d 81 T1 T 42 c 82 c2 T 43 d 83 b3 d 44 T 84 T4 e 45 F 85 b5 e PART B 86 T6 c 46 b 87 b7 T 47 F PART C8 T 48 c 88 b9 F 49 e 89 T10 c 50 a 90 T11 d 51 t 91 T12 e 52 b 92 F13 T 53 2x, 2x, none 93 T14 T 54 2x, none, 2x 94 T15 b 55 none, 1/2, 2x 95 c16 d 56 c 96 F17 c 57 T 97 T18 c 58 T 98 e19 c 59 e 99 T20 c 60 d 100 f21 c 61 c 101 T22 T 62 F 102 T23 T 63 c 103 T24 T 64 d 104 F25 d 65 T 105 T26 c 66 T 106 b27 e 67 c 107 c28 d 68 b or c 108 T29 f 69 d 109 T30 e 70 T 110 c31 c 71 T 111 T32 d 72 T 112 T33 a 73 T 113 T34 c 74 c 114 T35 d 75 b 115 T36 d 76 F 116 c37 F 77 T 117 F38 T 78 T 118 F39 c 79 T 119 T40 c 80 T 120 T


Chapter 14, Part A

1. According to the exploitation theory, capi-talism is a system of virtual slavery, serving the nar-row interests of a comparative handful of“exploiters”—the businessmen and capitalists—who,driven by insatiable greed and power-lust, exist as par-asites upon the labor of the masses.

2. The essential claim of the Marxian exploi-tation theory is that all income naturally and rightfullybelongs to the wage earners, but that under capitalismthe wage earners receive only bare, minimum subsis-tence, while everything over and above this is expro-priated by the capitalist exploiters in the form ofprofits, interest, and land rent, or, in the terminologyof Marx, “surplus-value.”

3. Marx’s “absolutist” version of the labortheory of value differs in many ways from the labortheory of value of the classical economists.

4. Marx’s “absolutist” version of the labortheory of value ignores the role of

a. demand and supplyb. time c. the rate of profitd. differences in the value of labore. all of the above

in determining the relative value of commodities

5. Marx’s “absolutist” version of the labortheory of value

a. claims that the quantity of labor directly or in-directly expended to produce a product is the oneand only circumstance governing its valueb. implies that newly fermenting grape juice and10-year old wine made from such grape juicemust have the same value, if they are products ofthe same quantity of laborc. implies that the only thing which can explainwhy one product is more valuable than another isthat it is the product of a larger quantity of labord. implies that the products of a fully automatedfactory would not differ in value from the capitalgoods consumed to produce them e. implies that the only thing which explains whya product is more valuable than the capital goodsthat have been consumed in its production, andwhose value passes over into it without increaseor decrease, is the application of fresh labor in pro-ducing the productf. all of the above

6. Marx’s version of the labor theory ofvalue implies that all value is added exclusively by theapplication of fresh labor.

7. The Marxian version of the “iron law ofwages” claims that wages are determined by the quan-tity of labor required to produce the commodities con-stituting the wage earner’s minimum subsistence.

8. Profit or “surplus value,” according toMarx, is caused by virtue of the wage earner adding tothe value of the capital goods he uses up in productiona value corresponding to the number of hours of hislabor, while he is paid a wage that corresponds only tothe smaller number of hours required to produce his ne-cessities.

9. According to Marxa. “surplus value” embraces profits, interest, andland rent (i.e., all incomes other than wages andsalaries)b. necessary labor time is the time required toproduce the wage earner’s necessities (minimumsubsistence)c. surplus labor time is the amount of time bywhich the working day exceeds the necessarylabor timed. surplus value corresponds to surplus labor timee. all of the above

10. According to Marx, capital has two com-ponents: “variable capital” and “constant capital.”

11. According to Marx, constant capitala. is the capital invested in materials, machinery,and structuresb. passes over into the product with no alterationin its valuec. is not value creatingd. all of the above

12. According to Marx, “variable capital” isa. the part of capital that pays wagesb. value creating in that the wages it pays corre-spond only to the number of hours of labor re-quired to produce the wage earner’s necessities,while the number of hours of labor obtained forthose wages is the larger number of hours repre-sented by the full working dayc. the source of profit or “surplus value”d. all of the above

13. According to Marx, the “rate of exploita-tion” equals the ratio of

a. profits to wagesb. “surplus value” to “variable capital”c. “surplus labor time” to “necessary labor time”d. all of the above

The following is a seven-part question.

You are given the following assumptions: The work-ing day is 12 hours. “Necessary labor time” is 6 hours.The labor time embodied in the materials and ma-chinery and other fixed capital used up is 48 hours. Toeach hour of labor embodied in a product, there corre-sponds $1 of product value.




14. Calculate “surplus labor time.”

15. Calculate “the rate of exploitation.”

16. Calculate the daily wage in dollars.

17. Calculate the monetary value of the prod-uct.

18. Calculate the monetary cost of producingthe product.

19. Calculate the monetary profit in produc-ing the product.

20. The monetary profit isa. the same asb. greater thanc. less than

the monetary value of the “surplus labor time.”

21. According to the Marxian exploitationtheory, profit rests on the same foundation as the gainsof a slave owner, namely, the worker’s ability to workfor more hours than is required to produce his subsis-tence or products of equivalent exchange value.

22. According to Marx,a. the wage earner under capitalism is free onlynominally; in substance he is a slaveb. the capitalist is essentially the same as a slaveowner or feudal aristocratc. all of human history is the record of one contin-uous class struggled. all of the above

23. According to Marx, all improvements inproduction either pass the wage earners by, to the ex-tent they occur in goods that remain beyond the wageearners’ reach, or are the occasion for a cut in wagerates to correspond to the lower price of their necessi-ties.

24. Marxism implies that under laissez-fairecapitalism, business publications would feature a set offinancial statistics that they presently do not carry,namely, the prices of the things constituting the wageearner’s minimum necessities, such as mud cabin rent-als and the price of loin-cloths and the very cheapestbread, to which the capitalists would peg wages,quickly reducing them every time the prices of suchnecessities fell.

25. Marx’s doctrine of the progressive im-poverishment of the masses holds that under capital-ism, wages decline from subsistence tosub-subsistence—that “capitalism cannot maintain itsslaves even in their slavery.”

26. The basis of the doctrine of the progres-sive impoverishment of the masses is supposedly

a. the fact that the capitalists are more calculat-ingly greedy than previous exploitersb. the tendency toward a declining rate of profitas capital is accumulated, predominantly in theform of constant capital

c. both (a) and (b)The following is a three-part question. Assume thatinitially the total capital invested in the economic sys-tem is 100 monetary units, of which 25 is “variablecapital” and 75 is “constant capital,” and that the “rateof exploition” is 100 percent. In addition, assume thatwhile everything else remains the same, the total capi-tal invested in the economic system doubles over a pe-riod of years and that the entire increase in the amountof capital invested is in the form of constant capital.

27. Calculate the initial average rate of profitin the economic system.

28. Calculate the average rate of profit in theeconomic system after the doubling of capital invested.

29. According to Marx, in order to forestallsuch a declining rate of profit, the capitalists will raisethe rate of exploitation by such means as

a. reducing hourly wage rates, thereby necessitat-ing a longer working day and thus the working ofadditional surplus labor time and the correspond-ing creation of additional surplus valueb. reducing hourly wage rates to the point of ren-dering the labor of the adult male worker insuffi-cient to support his family and necessitating thatthe labor of his wife and children be added to hislabor, with a corresponding creation of still moresurplus labor timec. speeding up the general pace and intensity ofwork, in order to reduce the number of hours oflabor required to produce the wage earner’s mini-mum necessities and thereby again increase sur-plus labor time and surplus valued. cheapening the wage earner’s diet, say, by sub-stituting for relatively expensive wheat bread suchcheaper items of food as potatoes or ricee. all of the above

30. The influence of the exploitation theoryis present in people’s beliefs about the functioning of

a. the present, highly interventionist, welfare-state economic systemb. laissez-faire capitalism, under which therewould be no minimum-wage, maximum-hours,pro-union, or child-labor legislationc. the economic system in the 19th Century andthe early part of the 20th Century, when therewere no such laws as described in (b)d. all of the abovee. (b) and (c) but not (a)

31. The Marxian exploitation theory is thebasis on which people understand both the very badeconomic conditions of the past and the source of theirimprovement, namely, the lack of government eco-nomic intervention under laissez-faire and its subse-quent progressive introduction.

32. People believe for the most part that


a. the wage increases caused by unions and mini-mum-wage laws come out of profits and corre-spondingly benefit the average worker, i.e., ineffect represent forcing employers to proceed asthough the necessary labor time were greater, withthe result merely that surplus labor time and sur-plus value are less b. maximum-hours and child-labor legislation areat the expense merely of profits and represent acorresponding benefit for the average wageearner, i.e., in effect represent a reduction merelyin surplus labor time and surplus valuec. both (a) and (b)

33. From the perspective of Marxism, theconfiscatory taxation of profits, interest, dividends,

capital gains, and land rents represents “the expropria-tion of the expropriators.”

34. The Marxian exploitation theory under-lies the present-day “liberals’” beliefs

a. concerning the effects of minimum-wage, pro-union, maximum-hours, and child-labor legislationb. their belief in the justice of the confiscatorytaxation of the capitalists’ incomes and the use ofthe proceeds to support social welfare spending,which arrangement they regard as constituting ameasure of restitution to the victims of “exploita-tion”c. both (a) and (b)

Chapter 14, Part B, The Productivity Theory of Wages

35. The exploitation theory appears plausiblebecause

a. wage earners need to work in order surviveand are willing, if necessary, to work for mini-mum subsistence rather than die of starvationb. employers, like all other buyers, prefer to payless rather than morec. when (a) and (b) are taken together, it appearsthat in the absence of government intervention,wage rates would plunge to the minimum-subsis-tence level before encountering any resistance totheir falld. all of the above

36. The need of wage earners to work andtheir willingness to work for minimum subsistence ifnecessary is irrelevant to the wages they must actuallyaccept because human labor is fundamentally scarceand its price, like that of any scarce good, is deter-mined by the competition of buyers, in this case em-ployers, for the limited supply.

37. The desire of employers, like all otherbuyers, to pay less rather than more, i.e., lower wagesrather than higher wages, is also irrelevant to thewages the workers must actually accept, because therational self-interest of employers and all other buyersis not to attempt to pay the lowest price or wage theycan imagine or would desire, such as minimum subsis-tence, but merely the lowest price or wage that is si-multaneously too high for any other employer or buyerwho would otherwise obtain the labor or good in ques-tion.

38. As wage rates fall below the free-marketequilibrium level, a growing labor shortage develops,which makes it to the self-interest of employers desir-ing to employ more workers and keep the workersthey have, to bid wage rates back up to the free-marketequilibrium level.

39. A higher price or wage is never to theself-interest of a buyer/employer, as shown by the factthat it never pays a bidder at an auction to raise his bid.

40. A higher price or wage is to the self-inter-est of a buyer/employer when it serves to make theitem too expensive for some other potential buyer/em-ployer who otherwise would obtain it instead.

41. Money wage rates are determined by theutility and scarcity of labor on the one side and thequantity of money and volume of spending in the eco-nomic system on the other.

42. The fall in wage rates required to elimi-nate unemployment

a. opens up the possibility of wages having to goto subsistence as the condition of achieving fullemploymentb. is accompanied by more production and sup-ply and also lower unit costs, either or both ofwhich imply lower prices as the accompanimentof the lower wage rates and at the same time elimi-nates the burden of having to support the unem-ployed and thus actually tends to raise realtake-home wage rates

The next 15 questions belong together and re-quire the use of the wage and price-level for-mulas. The first twelve of these questionsrepresent four groups of three questions each.

The following is a three-part question. Assumethat the quantity of money and thus the aggregatemonetary demands for consumers’ goods andlabor both double, while the supply of labor, theproductivity of labor, and the supply ofconsumers’ goods all remain the same.


43. What is the change in the general con-sumer price level?

44. What is the change in average moneywage rates?

45. What is the change in average real wagerates?

The following is a three-part question. Assumethat the quantity of money, the aggregate mone-tary demands for consumers’ goods and labor,and the supply of labor all remain the same, whilethe productivity of labor and thus the supply ofconsumers’ goods double.




The following is a three-part question. Assumethat the quantity of money, the aggregate mone-tary demands for consumers goods and labor, andthe productivity of labor and supply ofconsumers’ goods all double, while the supply oflabor remains the same.




52. What factor in the four preceding three-part problems determines the change, if any, in aver-age real wage rates?

53. What factors in the same problems deter-mine the change, if any, in average money wage rates?

54. What factors in those sets of problems de-termine the change, if any, in the general consumerprice level?

This is a four-part question. Again using the for-mulas for the price and wage level, assume afixed quantity of money and fixed aggregate de-mands for labor and consumers’ goods. Assumealso that all wage earners are married and that ini-tially only husbands work. Then assume that allmarried women also go to work and have thesame productivity as their husbands on average.

55. Calculate the effect on average moneywage rates.

56. Calculate the effect on the general con-sumer price level.

57. Calculate the effect on the money incomeof the average working family.

58. Calculate the effect on the real income ofthe average working family.

This is a three-part question. Again using theformulas for the price and wage level, assume afixed quantity of money and fixed aggregate de-mands for labor and consumers’ goods. Assumealso that over the course of a generation the sizeof the working population doubles as the result ofimmigration and, over the same period, thanks insome significant part to the productive contribu-tions of the immigrants, the productivity of laboralso doubles.

59. Calculate the effect on average moneywage rates.

60. Calculate the effect on the general con-sumer price level.

61. Calculate the effect on the average realwage rates.

62. In the light of the formulas for the priceand wage level and the critical role of the productivityof labor, it follows that phenomena which begin by re-ducing money wage rates, such as immigration or alarger labor force due to population growth or the par-ticipation of more married women, as well as the elimi-nation of unemployment

a. may well cause prices to fall by more thanwage ratesb. need not reduce real wage rates but can actu-ally raise real wage ratesc. will in fact end by raising real wage rates inso-far as they serve to raise the productivity of laborand/or reduce the burden of supporting the unem-ployedd. all of the above

63. The cause of a rise in average moneywage rates is either an increase in the demand for laboror a decrease in the supply of labor, both of which tendto rase prices as much as wages, which implies that arise in money wage rates cannot be the cause of a risein real wage rates.

64. If a rise in money wage rates is to repre-sent a rise in real wage rates,

a. it is essential that prices not rise as much aswage rates, since only that makes it possible forwage earners to succeed in actually buying morewith their higher monetary earnings


b. what stops prices from rising as much as wagerates when the quantity of money increases andraises the demand for consumers’ goods as muchas it raises the demand for labor is a rise in the pro-ductivity of laborc. a rise in the productivity of labor increases thesupply of consumers’ goods relative to the supplyof labor and thus makes it possible for the essen-tially equal-proportional increases in the demandfor consumers’ goods and labor to be accompa-nied by an increase in the consumer price levelthat is less than the increase in the wage leveld. all of the above

65. A rise in the productivity of labor is re-sponsible for a fall in prices even in cases in whichprices stay the same or increase in comparison withwhat they were in the past. In such cases, it is responsi-ble for prices falling in comparison with what they oth-erwise would have been, had the increase in theproductivity of labor not taken place.

66. Improvements in the productivity oflabor raise average real wages

a. by raising money wagesb. by reducing prices not by raising money wages

67. As real wages have risen, so too havemoney wages, because

a. the two phenomena are inseparably connectedb. earning more money is the sum and substanceof being materially better offc. the rise in the productivity of labor, whichraises real wages, has been accompanied by an in-crease in the quantity of money, which raisesmoney wages

68. An intrinsic but limited connection be-tween higher average real wages and higher averagemoney wages exists under a system of commoditymoney, such as a gold standard, insofar as im-provements in the average productivity of labor are ac-companied by improvements in the productivity oflabor specifically in the production of the commoditythat serves as money. This is because to this extent, thequantity of money and thus the monetary demand forlabor can be expected to increase along with the gen-eral rise in the productivity of labor.

69. Any given individual is likely to perceivea close connection between improvements in his own,personal productivity of labor and the money wagerate he earns. This proves that

a. a higher productivity of labor translates intohigher monetary earnings rather than lower pricesb. a higher relative productivity of labor on thepart of a given individual translates into highermonetary earnings for him and correspondinglylower monetary earnings for those whose relativeproductivity of labor is reduced at the very sametime that his is elevated

70. If everyone in a group of competitors in-creased the productivity of his labor to the same extent

a. the improvement in the productivity of labor ofany individual member of the group would not re-sult in a rise in his money wage rate, for he wouldhave no greater means of succeeding in the com-petition with the other members of the group nowthan he had beforeb. the average money wage rate of the membersof this particular group might actually fall as theresult of the improvement in their productivity oflabor causing a relative oversupply of the productor service that they produced—a situation thatoften occurred following the adoption of piece-work and the incentives it gave to become moreproductivec. both (a) and (b)d. neither (a) nor (b)

71. If all the members of a society improvedthe productivity of their labor equally and there wereno change on the side of money and spending,

a. average money income would stay the sameand there would be no improvement in the aver-age standard of livingb. average money income would stay the same,prices would fall, and the average standard of liv-ing would improve correspondingly

72. If the adoption of piecework in a givenbranch of production, and the rise in the productivityof labor it causes in that branch, results in a fall in theaverage money income of the producers in that branch,this proves that

a. piecework can be inimical to the general stan-dard of livingb. a situation essentially the same as that of thepotato growers back in Chapter 13 is present,which means that the average standard of livingdoes rise, because the gains of the rest of the eco-nomic system through a combination of lowerprices and higher incomes outweigh the loss ofthe pieceworkers in this branch and, in addition,even the pieceworkers in this branch will ulti-mately gain, once enough of them have relocatedinto other lines of work, where their skills aremore needed

73. In cases in which a rise in the productiv-ity of labor in a given branch of the economic systemreduces the average earnings of the members of thatbranch, it follows that none of the producers in thatbranch can monetarily gain from the improvement.

This is a four-part question. Assume that in agiven case, the adoption of the piecework systemresults in a doubling of the productivity of laborand is followed by a reduction in the piece rate toone-third of its initial amount.


74. Calculate the change in the money in-come of the average piece rate worker in this case.

75. Calculate the change in the money in-come of any piece rate worker who has succeeded inquadrupling his particular productivity of labor

76. Calculate the change in the money in-come of any worker under the piece-rate system who,following its adoption, has failed to increase his partic-ular productivity

77. The piece rate system, even in cases inwhich its adoption initially serves to reduce the aver-age level of money income in the branch of productionin which it is adopted, can nevertheless be of financialbenefit to exceptional individual workers in thatbranch—i.e., those whose productivity increases morethan in proportion to the fall in the piece rate.

This is a seven-part question. Assume that halfof the working population succeeds in doublingits productivity of labor, while the productivity oflabor of the other half remains the same. Ignorethe likely resulting short-run problems of relative,partial overproduction and relative, partial under-production. As with many previous questions, as-sume that the quantity of money and thus theaggregate demands for consumers’ goods andlabor remain the same. Assume further that rela-tive incomes will be in proportion to relative pro-ductivity, so that the fifty percent of thepopulation that becomes twice as productive willearn twice the income as the fifty percent of thepopulation whose productivity remains the same.

78. State the now larger aggregate output rel-ative to the initial aggregate output.

79. Calculate the effect of the larger supplyon the general consumer price level.

80. Calculate the change in the money in-come of the members of the group whose productivityof labor doubles and who now earn two-thirds of thetotal income of the society instead of one-half.

81. Calculate the change in the money in-come of the members of the group whose productivityof labor remains unchanged and who now earn one-third of the total income of the society instead of one-half.

82. Calculate the change in the real incomeof the members of the group whose productivity oflabor doubles.

83. Calculate the change in the real incomeof the members of the group whose productivity oflabor remains unchanged.

84. Name the element to which the change inthe real income of both groups corresponds.

85. If in the course of economic competition,the success of the members of one group in raisingtheir productivity serves to reduce the money incomesof the members of another group, it follows that themembers of the first group have economically harmedthe members of the second group. (Answer in the lightof your answers to the preceding series of questions.)

This is a 12-part question. Assume that initiallyan egalitarian society exists in which everyonehas the same productivity of labor and earns thesame money income. Now, perhaps because of ex-posure to rays from outer space, five percent ofthe population becomes energized into becomingthe most intelligent, ambitious and hardest-work-ing five percent, whereupon it succeeds in increas-ing its own productivity of labor a full twelvefold.The process of increasing the productivity of itsown labor entails such things as the members ofthis five percent founding and organizing busi-ness firms and introducing new, improved meth-ods of production and new, improved products.As a result, in the course of improving the produc-tivity of its own labor, the activities of the fivepercent serve to double the productivity of laborof the remaining ninety-five percent of the popula-tion, which is induced to work with the newer,better methods of production and to produce thenewer, better products. As before, assume that therelative incomes of the two groups will be in pro-portion to their relative production. As usual, as-sume that the quantity of money and thus theaggregate demands for consumers’ goods andlabor remain the same.

86. State the now larger aggregate output rel-ative to the initial aggregate output. (You must add12x.05 plus 2x.95.)

87. State the resulting general consumerprice level as a decimal of the original consumer pricelevel.

88. Calculate the percentage of the total mon-etary income of the economic system, which now ac-crues to the 5 percent of the population that hasincreased its productivity of labor twelvefold. (Youneed to know the output of this group relative to totaloutput.)

89. Calculate the change in the money in-come of the 5 percent of the population whose produc-tivity of labor increases twelvefold. (To do this statethe new percentage of income going to this group as a


decimal and then divide it by .05, which was the initialincome of this group.)

90. Calculate the percentage of the total mon-etary income of the economic system, which now ac-crues to the 95 percent of the population that hasincreased its productivity of labor twofold. (Again,you need to know the output of this group relative tototal output.)

91. Calculate the change in the money in-come of the 95 percent of the population. (To do thisstate the new percentage of income going to this groupas a decimal and then divide it by .95, which was theinitial income of this group.)

92. Calculate the change in the real incomeof the 95 percent of the population. (To do this youneed to divide the change in the group’s money in-come by the change in the general consumer pricelevel. Your answer should be 2.)

93. Calculate the change in the real incomeof the 5 percent of the population whose productivityof labor increases twelvefold. (Follow the same proce-dure as in the preceding question. Your answer shouldbe 12.)

94. How much more does the average mem-ber of the 5 percent group earn than the average mem-ber of the 95 percent group? (You need to divide eachgroup’s percentage of total earnings by its percentageof population and then divide the per capita earningsof the 5 percent group by those of the 95 percentgroup.)

95. How much more does the average mem-ber of the 95 percent group earn in real terms by virtueof the activities of the members of the 5 percent group?

96. How much more will the average mem-ber of the 95 percent group earn in real terms if the im-provements introduced by members of the 5 percentgroup serve to double the productivity of labor of themembers of the 95 percent group every generation?

97. The preceding all goes to show how in acapitalist society

a. the rich get richer and the poor get poorerb. the material self-interests of rich and poor areharmonious, with the “poor” becoming progres-sively richer, thanks precisely to the activities ofthe richc. injustice exists because the rich are always sev-eral steps ahead of the poor, no matter how muchricher the poor are becoming

98. The productive contribution of business-men and capitalists is manifested precisely in the deter-mination of the exchange value of products largely bythe quantity of labor required to produce them, be-cause the activity of the businessmen and capitalistsserves continually to reduce those quantities and thusto make the prices of goods continually to fall relative

to wage rates and thereby continually to raise realwage rates.

99. Show mathematically how, starting withthe formulas for the price and wage level, real wagerates are expressible as the product of the productivityof labor times the “distribution factor.” Be sure to indi-cate the mathematical meaning both of the productiv-ity of labor and the “distribution factor.”

100. Real wages depend on the productivityof labor; the productivity of labor, in turn, depends onthe supply of capital goods per worker.

101. The determinants of the supply of capi-tal goods are

a. the extent to which the economic system de-votes labor and existing capital goods to the pro-duction of capital goods relative to the extent towhich it devotes labor and existing capital goodsto the production of consumers’ goodsb. the productivity of labor and existing capitalgoodsc. the demand for capital goods relative to the de-mand for consumers’ goodsd. all of the above

The following is a 6-part question.

102. Capital goods are continuously used upand worn out in the course of production and thusmust continuously be produced if their supply is to bemaintained.

103. The proportion of the economicsystem’s existing output that must be devoted to theproduction of capital goods if their supply is to bemaintained is called the maintenance proportion.

104. In order for capital accumulation to takeplace, it is necessary for the actual proportion of theeconomic system’s existing output that is devoted tothe production of capital goods to exceed the mainte-nance proportion.

105. The demand for capital goods relativeto the demand for consumers’ goods determines theproduction of capital goods relative to the productionof consumers’ goods and thus whether or not the pro-portion of the economic system’s output that is de-voted to the production of capital goods will equal,exceed, or fall short of the maintenance proportion.

106. The demand for capital goods relativeto the demand for consumers’ goods depends on theextent to which individuals and business firms devotetheir revenues and incomes to saving and productiveexpenditure rather than to consumption expenditure.

107. The greater is the degree of saving andproductive expenditure relative to consumption expen-diture

a. the higher will be the demand for capital goodsrelative to the demand for consumers goods


b. the greater will be the production of capitalgoods relative to the production of consumers’goodsc. once beyond the maintenance proportion, themore will the production of new capital goodstend to exceed the productive consumption of ex-isting capital goods and thus the more rapidly willthe supply of capital goods tend to increased. the higher and more rapidly rising will the pro-ductivity of labor and thus real wages tend to bee. all of the above

108. The productivity of capital goods is theratio of output to the supply of capital goods used upin producing the output.

109. The higher is the productivity of capitalgoods,

a. the lower is the maintenance proportionb. the easier it is to accumulate capitalc. the more rapidly will capital accumulation takeplace for any given relative production of capitalgoods in excess of the maintenance proportiond. all of the above

110. Technological progressa. serves to maintain the productivity of capitalgoods in the face of increasing supplies of capitalgoodsb. offsets the operation of the law of diminishingreturns in the face of increasing supplies of capitalgoodsc. is an essential requirement of continued capitalaccumulationd. all of the above

111. The higher is the productivity of capitalgoods, the higher is the proportion of output that needsto be devoted to the production of capital goods inorder to maintain the supply of capital goods.

112. The economic degree of capitalism isthe ratio of productive expenditure for capital goodsand labor to business sales revenues.

113. The “distribution factor” is the ratio ofthe demand for labor by business to the demand forconsumers’ goods from business.

114. The higher is the distribution factor, thehigher tends to be the proportion of national incomethat is constituted by wages.

115. The higher is the economic degree ofcapitalism

a. the higher is the demand for capital goods rela-tive to the demand for consumers’ goodsb. the higher is the distribution factorc. the higher and more rapidly rising are realwagesd. all of the above

116. Saving underlies capital accumulationinsofar as it determines the demand for and production

of capital goods relative to the demand for and produc-tion of consumers’ goods.

117. Technological progressa. is essential for continued substantial capital ac-cumulationb. depends on an increasing supply of capitalgoods as the means of implementing more ad-vanced technologiesc. both (a) and (b)

118. Insofar as businessmen and capitalistsare motivated to save and productively expend and toimprove the methods of production, the effect of theiractivities is

a. to increase the demand for and production ofcapital goods relative to the demand for and pro-duction of consumers’ goods and thus to bringabout capital accumulation and a rising productiv-ity of laborb. to change the distribution factor in favor ofwage earners by means of raising the demand forlabor by business relative to the demand forconsumers’ goodsc. to maintain or increase the productivity of capi-tal goods and thereby further contribute to capitalaccumulation and the rise in the productivity oflabord. to raise real wagese. all of the above

119. Capital accumulation is fostered bya. savingb. technological progress c. international free traded. economic freedom in general e. all of the above

120. The concept that subsumes both techno-logical progress and economic freedom as causes ofcapital accumulation is

a. savingb. a rise in the productivity of capital goodsc. both (a) and (b)

121. The ultimate foundations of capital ac-cumulation and a rising productivity of labor and realwages are

a. individual freedom to pursue one’s materialself-interestb. a substantially rational cultural environmentc. both (a) and (b)

122. Saving and productive expenditure andthus the demand for and production of capital goodsare reduced by

a. the corporate income taxb. the progressive personal income taxc. the inheritance taxd. the social security systeme. all of the above


123. Government budget deficits reduce orretard

a. the demand for private securitiesb. productive expenditurec. the demand for and production of capitalgoods relative to the demand for and productionof consumers’ goodsd. capital accumulatione. the productivity of laborf. real wagesg. all of the above

124. Government budget deficits financed byinflation of the money supply promote capital accumu-lation.

125. Capital accumulation under capitalismwas inaugurated by a rise in the economic degree ofcapitalism, combined with a rise in the efficiency withwhich existing capital goods were employed, both ofwhich operated to raise real wage rates from the verybeginning.

126. The effect of the higher economic de-gree of capitalism was a rise in the demand for laboralongside the rise in the demand for capital goods.

127. The Industrial Revolutiona. represented a great increase in the efficiency ofproduction and in the use of existing capital goodsb. brought about a sharp decrease in the mainte-nance proportionc. was accompanied by capital accumulation thattook place out of an increase in production ratherthan as the result of any absolute fall in per capitaconsumptiond. all of the above

128. If and when it occurs, a rise in the de-mand for capital goods at the expense of the demandfor labor is

a. permanently against the interests of the wageearners because it operates to reduce wage ratesb. ultimately accompanied by a fall in the pricesof consumers’ goods that is greater than the fall inwage rates and is so by an ever wider margin

129. It is almost impossible that the inaugura-tion or intensification of capital accumulation and eco-nomic progress in a capitalist country could ever resultin a reduction in average real wages that would not bemade good very quickly. This is because

a. the basic effect of a higher economic degree ofcapitalism is to raise the demand for labor, as wellas the demand for capital goods, relative to con-sumption and total sales revenues in the economicsystemb. at the same time, the higher economic degreeof capitalism is itself part of an even wider pro-cess which has as another major effect a rise inthe productivity of capital goods and correspond-ing fall in the maintenance proportion

c. any rise in demand for capital goods at the ex-pense of the demand for labor that might takeplace, despite the fundamental background of arise in the demand for both, would not take placesuddenly and dramatically, all at once, but onlygradually, over a period of years, with the resultthat each succeeding year over which the processoccurred would benefit from the operation offorces already in place that were working to bringabout a rise in real wagesd. all of the above

130. In the case of the Industrial Revolutionin England, the process of capital intensification andthe corresponding rise in the ratio of the value of accu-mulated capital to wage payments, appears to havetaken place and been largely completed in the centuryand a half or more prior to 1775—the year usuallytaken as marking the beginning of the Industrial Revo-lution. This was manifested in the fall in the rate of in-terest on long-term government bonds in England to 3percent as early as 1757.

131. Capital accumulation under capitalismmust initially reduce real wages because getting theprocess started requires a sudden sharp drop in the de-mand for labor by business in order to make possiblethe necessary rise in the relative demand for and pro-duction of capital goods.

132. The bad economic conditions of the av-erage worker in Great Britain in the early years of theIndustrial Revolution were the result of

a. twenty-five years of almost uninterrupted warwith France between 1790 and 1815b. taxes and loans that deprived business firms ofthe ability both to pay wages and to buy capitalgoods and thereby worked against real wages viaboth the “distribution factor” and the productivityof laborc. both (a) and (b)

133. In a socialist country, such as SovietRussia, with its gross inefficiencies and impossiblyhigh maintenance proportion, any capital accumula-tion that may occur based on domestic sources islikely to be at the expense of the extreme deprivationof the citizens.

134. The low real wages, long hours of work,and poor working conditions that characterized muchof the nineteenth century were the result of

a. a low productivity of laborb. the greed of the capitalists and a correspond-ingly unjust distribution of wealth and income

135. As the productivity of labor rose overthe course of the nineteenth century,

a. the supply of goods increased relative to thesupply of laborb. prices fell relative to wage ratesc. wage rates rose relative to pricesd. real wage rates rose


e. all of the above

136. As real hourly wage rates rose in thenineteenth century, the hours of work could fall be-cause

a. more and more workers could afford to acceptjobs requiring shorter hours and paying less thanjobs requiring longer hoursb. it became competitively advantageous for em-ployers to offer shorter hours, as more and moreworkers were placed in a position of being able toafford to take jobs with shorter hours at wageslower by enough to make their offer profitablec. in accordance with the growing ability of work-ers to afford to accept jobs with shorter hours andtheir growing desire for same, the market startedto create a wage premium for jobs with longerhours and a wage discount for jobs with shorterhoursd. all of the above

137. As real hourly wage rates rose in thenineteenth century, child labor could disappear be-cause more and more parents could afford to keeptheir children home longer and longer and at the sametime increasingly desired to do so.

138. As real hourly wage rates rose in thenineteenth century, working conditions improved be-cause

a. the same process of technological progress thatwas essential to the rise in the productivity oflabor made possible improvements in workingconditions technologically possibleb. to the extent that improvements in workingconditions contributed to greater efficiency andcould be implemented at a smaller and smallerreal cost, it increasingly paid employers to adoptthemc. the rise in real wages enabled workers to af-ford to accept lesser increases in real wages incases in which improvements in working condi-tions did not increase efficiency or did not do sosufficiently to pay for themselvesd. all of the above

139. A rise in the productivity of labor isa. one possible cause of a sustained, significantincrease in real wage rates, a redistribution ofwealth and income being anotherb. one possible cause of a sustained, significantincrease in real wage rates, an increase in the de-mand for labor being anotherc. the only possible cause of a sustained, signifi-cant increase in real wage ratesd. all of the above

140. A rise in money wage rates constitutes arise in real wage rates when it takes place by means of

a. an increase in the quantity of money and vol-ume of spending in the economic system

b. a decrease in the supply of labor available toworkc. an increase in the demand for labor at the ex-pense of the demand for capital goodsd. an increase in the demand for labor by meansof taxation the proceeds of which is used to paywagese. all of the abovef. none of the above

141. It is possible to raise real wage rates bymeans of raising the demand for labor and thus moneywage rates

a. when the rise in demand for labor is made pos-sible by a fall in the personal consumption of busi-nessmen and capitalists b. when the rise in demand for labor is made pos-sible by a fall in taxation and government spend-ingc. both (a) and (b)d. neither (a) nor (b)

142. A reduction in government spendingand taxation

a. can make a significant one-time contributionto raising real wage rates by means of raising thedemand for laborb. makes an ultimately much more important,continuing contribution to the rise in real wagerates by means of bringing about an increase inthe relative demand for and production of capitalgoods and by operating to raise the productivity ofcapital goods via increasing the incentives to intro-duce improvementsc. both (a) and (b)

143. A policy of redistribution of wealth andincome

a. assumes that the wealth of businessmen andcapitalists exists in the form of a vast supply ofconsumers’ goods and can be taken with little orno effect on the amount of wealth produced b. ignores the fact that the great bulk of thewealth of businessmen and capitalists exists in theform of capital goods and underlies the demandfor labor, and that it’s seizure must cause substan-tial capital decumulation and a decline in the pro-ductivity of labor and real wagesc. both (a) and (b)

144. The general public and the labor unionsa. correctlyb. mistakenly

believe that raising money wage rates is the means ofraising real wage rates.

145. The efforts of individuals, who must op-erate under the freedom of competition, to raise theirreal wages by means of earning more money are per-fectly reasonable, fully consistent with the productiv-ity theory of wages, and serve to raise the averagelevel of real wage rates. However, the attempt to raise


the average money wage rate of wage earners as agroup, by means of violating the freedom of competi-tion, serves to cause unemployment and lower realwages.

146. Depending on the extent of their influ-ence, the effect of labor unions is

a. to raise the wage rates of some groups of work-ers artificially while more than equivalently reduc-ing the real wage rates of other groups of workersb. to cause unemploymentc. both (a) and (b)

147. Labor unions area. a genuinely prolabor institution insofar as theyachieve increases in money wage rates, becausethat is the most effective means of raising the gen-eral level of real wage ratesb. an antilabor institution insofar as in preventingor delaying the introduction of labor-saving im-provements and in other ways holding down theproductivity of labor, they actively combat therise in real wage ratesc. both (a) and (b)

148. When labor unions recognize a connec-tion between the productivity of labor and wages, theconnection they seek to establish is between a higherproductivity of labor and

a. higher money wage ratesb. lower prices

149. According to the belief that a higher pro-ductivity of labor should translate into correspondinglyhigher money wage rates

a. the wages of workers producing such goods ascomputer memory and computer hard drives,where there has been an enormous rise in the pro-ductivity of labor over the last fifteen or twentyyears, should have increased correspondinglyb. the wages of workers like waiters or busboysin restaurants, where there has been virtually norise in the productivity of labor for many genera-tions, should have remained essentially un-changed over this timec. both (a) and (b)

150. According to the productivity theory ofwages, among the consequences of minimum wagelegislation are:

a. unemployment, especially among the least edu-cated, least skilled members of societyb. a life-long depressing effect on the earnings ofsociety’s most disadvantaged members, who inbeing prevented from being employed in entrylevel jobs at sub-minimum wages, are preventedfrom gaining the experience and developing theskills that might have enabled them to becomequalified for better paying jobs later onc. both (a) and (b)

151. According to the productivity theory ofwages, maximum- hours legislation

a. forces people to do less work than they arewilling and able to dob. reduces the real wages of people to the extentthat it reduces the work they performc. both (a) and (b)

The following is a four-part question. Assum-ing that the monetary demands for consumers’goods and labor are both unchanged,

152. Calculate the effect on average hourlywage rates of a twenty-five percent reduction in thework week from forty hours to thirty hours.

153. Calculate the effect on the productionand supply of consumers’ goods of the above reduc-tion in the work week on the further assumption thatthe productivity of labor remains constant per hourworked.

154. Calculate the effect on the prices ofconsumers’ goods of the reduction in the supply ofconsumers’ goods calculated in answer to the previousquestion.

155. Calculate the effect on average realweekly wage rates on the basis of the change in the re-lationship between average weekly money wage ratesand the general consumer price level.

156. Maximum-hours legislation does not re-duce real wages when hourly wage rates are increasedto offset the reduction in hours, because in this caseweekly wage rates are unchanged.

The following is a four-part question. Assum-ing that the monetary demands for consumers’goods and labor are both unchanged, and that in apoor, backward society, the labor of children ini-tially accounts for ten percent of the supply oflabor and produces ten percent of the output ofconsumers’ goods, calculate the effect of the abo-lition of all child labor on

157. The money income of the average work-ing family.

158. The supply of consumers’ goods pro-duced.

159. The general consumer price level.

160. The real wages of the average workingfamily.

161. According to the productivity theory ofwages, the effect of child labor legislation is

a. simply to eliminate child laborb. in the absence of offsetting increases in theproductivity of labor, to reduce the real earningsof poor families at the same time that it eliminateschild labor


162. According to the productivity theory ofwages, the effect of forced improvements in workingconditions is

a. a rise in costs of production and pricesb. unemployment or a fall in take-home moneywage rates sufficient to offset the rise in costscaused by the forced improvementsc. a fall in real take home wagesd. all of the above

163. According to the productivity theory ofwages, the effect on real wages of freedom of competi-tion in the employment of women and members of mi-nority groups is positive despite a possible reduction inthe money wage rates of those already employed

a. to the extent that it succeeds in raising the aver-age productivity of labor and thus reduces pricesrelative to wage ratesb. to the extent that it enables the average work-ing family to have the benefit of a larger numberof hours of laborc. both (a) and (b)

164. The effect of the competition of womenand members of minority groups entering the labormarket

a. under economic freedom is not unemploymentbut a reduction in money wage rates and an in-crease in the supply of goods produced and a cor-responding fall in the prices of goods

b. in the face of prounion and minimum wage leg-islation and racial and sexual quotas, the creationof unemployment among white male workersc. both (a) and (b)

165. The concept of the aggregate demandfor labor employed by the productivity theory ofwages is fundamentally different than the classicaleconomists’ concept of the wage fund.

166. John Stuart Mill abandoned the idea ofa fixed wage fund on the grounds that a rise in wagerates compelled by labor unions could result in a risein the wage fund at the expense of the personal con-sumption expenditure of businessmen and capitalists.

167. The productivity theory of wages andthe marginal productivity theory of wages differ withrespect to

a. the attempt to derive the value of labor ser-vices on the basis of the value of product lost byvirtue of the withdrawal of a unit of laborb. the significance they accord to changes inprices as a factor determining real wagesc. both (a) and (b)

168. Attempting to derive the value of com-plementary factors of production from the value oftheir product, e.g., derive the value of a steering wheel,carburetor, and brake from the value of the automobilein which they are parts, easily results in the attributionof far more value to such factors of production than ispossessed by the product.



Correct Correct Correct CorrectQ. # Answer Q. # Answer Q. # Answer Q. # Answer

1 T 43 2x 85 F 127 d2 T 44 2x 86 2.5 128 b3 T 45 none 87 0.4 129 d4 e 46 halves 88 24% 130 T5 f 47 none 89 4.8 131 F6 T 48 2x 90 76% 132 c7 T 49 none 91 .76/.95 133 T8 T 50 2x 92 2 134 a9 e 51 2x 93 12 135 e10 T 52 prod. of labor 94 6 136 d11 d 53 DL, SL 95 2x 137 T12 d 54 DC, SC 96 2x more/gen. 138 d13 d 55 halve 97 b 139 c14 6 hours 56 halve 98 T 140 F15 100% 57 none 99 see text 141 c16 $6 58 2x 100 T 142 c17 $60 59 half 101 d 143 c18 $54 60 one-fourth 102 T 144 b19 $6 61 2x 103 T 145 T20 a 62 d 104 T 146 c21 T 63 T 105 T 147 b22 d 64 d 106 T 148 a23 T 65 T 107 e 149 c24 T 66 b 108 T 150 c25 T 67 c 109 d 151 c26 c 68 T 110 d 152 four thirds27 25% 69 b 111 F 153 three fourths28 12.50% 70 c 112 T 154 four thirds29 e 71 b 113 T 155 three fourths30 e 72 b 114 T 156 F31 T 73 F 115 d 157 no change32 c 74 two thirds 116 T 158 nine tenths33 T 75 four thirds 117 c 159 ten ninths34 c 76 one third 118 e 160 nine tenths35 d 77 T 119 e 161 b36 T 78 three halves 120 b 162 d37 T 79 two thirds 121 c 163 c38 T 80 four thirds 122 e 164 c39 F 81 two thirds 123 g 165 F40 T 82 2 124 F 166 T41 T 83 1 125 T 167 c42 b 84 prod. of labor 126 T 168 T


Chapter 15 (Includes Review of Chapter 14, Part B, Section 3)

1. The volume of spending in the economicsystem is a measure of the quantity of money that ex-ists, not of the volume of wealth that is produced.

2. The use of price indexes to adjust the vol-ume of spending for changes in the price level makespossible a precise measure of what is produced.

3. The concept of gross product properly in-cludes the production of capital goods such as flourand wheat and steel and iron ore.

4. Productive consumption is consumptionfor the purpose of production.

5. The net product of the economic system isa. the gain from productionb. equal to the final productc. the difference between the gross product andproductive consumptiond. all of the abovee. none of the above

6. According to most of today’s textbooks,what a producer produces is

a. simply his actual product, such as bread in thecase of a bakery and steel in the case of a steel millb. the difference between his actual product andthe previously produced means of production heuses up in producing it—for example, the differ-ence between bread and flour or the difference be-tween automobiles and steel sheet

7. According to most of today’s textbooks,wheat farmers and flour millers respectively produceonly wheat and flour, not bread.

8. What contemporary economics describesas the gross product of the economic system is actuallya highly netted product.

9. According to the prevailing concept ofgross product, to claim that both bread and flour orboth automobiles and steel are produced is to claimthat more is produced than is in fact produced and thusto commit the error of double counting.

10. According to contemporary economics,the production of the final products already counts theproduction of all the products leading up to their pro-duction, which is why it represents double counting tocount them again, separately.

11. In reporting both so many million auto-mobiles and so many million tons of steel as being pro-duced in the United States in a given year, TheStatistical Abstract of the United States must bejudged guilty of the alleged error of double counting.

12. The view that one’s product is not one’sactual physical product but an abstraction, i.e., the con-ceptual difference between one’s product and the pre-viously produced means of production one uses up to

produce it implies that the total product of the eco-nomic system

a. is essentially just the production of consumers’goods, i.e., of “final products”b. that the total production of the economic sys-tem is measured by the sum of values added to thepreviously produced means of productionc. that the total production of the economic sys-tem is measured by the value of the final productd. all of the above

13. What leads to the conclusion that a finalproduct, such as bread, counts all the intermediateproducts whose production is necessary to its produc-tion is

a. viewing the final product as though it con-sisted of a bundle of abstractions, i.e., the concep-tual product differences that each producerallegedly produces at the various stages leadingup to the final productb. taking apart and putting together this collec-tion of abstractions to represent different entitiesand in the process often altogether forgetting theexistence of one or more of the conceptual prod-uct differencesc. adopting a Platonic-Heraclitean view of the na-ture of entitiesd. all of the abovee. none of the above

14. The belief that the value of the final prod-uct counts the value of the intermediate products in ad-dition to its own value rests on

a. expressing the value of the final product in var-ious mutually exclusive alternative formulationsb. ignoring one or more terms in all but one ofthe alternative formulationsc. adding up the remaining elements of the mutu-ally exclusive alternative formulations d. all of the abovee. none of the above

15. The belief that the value of the final prod-uct counts the value of the intermediate products in ad-dition to its own value rests represents a twofoldviolation of the laws of arithmetic.

16. The belief that the value of the final prod-uct counts the value of the intermediate products in ad-dition to its own value entails a double counting of thevalue of the final product.

17. Productive expenditure isa. expenditure for the purpose of producinggoods and servicesb. expenditure for the purpose of making subse-quent sales

18. Consumption expenditure is expenditurenot for the purpose of making subsequent sales.




19. An individual grows richer through pro-ductive expenditure and poorer through consumptionexpenditure.

20. In buying a consumers’ good, one buys a. the consumers’ good one buysb. the factors of production that were used up toproduce the consumers’ good one buysc. the factors of production that the sellers of theconsumers’ good will buy with the pieces ofmoney received in exchange for the consumers’good one buysd. the products into which the good one buys willbe madee. all of the abovef. none of the above

21. In buying a consumers’ good, one paysfor the seller’s research and development outlays andfor his political and charitable contributions.

22. It is often believed that in buying aconsumers’ good one also buys

a. the factors of production that were used up toproduce the consumers’ good one buysb. the factors of production that the sellers of theconsumers’ good will buy with the pieces ofmoney received in exchange for the consumers’good one buysc. the products into which the good one buys willbe maded. all of the above

23. In buying a consumers’ good, one buyssimply and only the consumers’ good.

24. A quantity of wheat is produced that sellsfor $100 and is used to produce a quantity of flour thatin turn sells for $150. The flour is then used to producea quantity of bread that sells for $225. State the totalvalue of what is produced.

25. A quantity of wheat is produced that sellsfor $100 and is used to produce a quantity of flour thatin turn sells for $150. The flour is then used to producea quantity of bread that sells for $225.

a. the total value of what is produced is $475b. the total value of what is produced is $225

26. The belief that in buying a consumers’good one buys everything necessary to its productionsupports the belief that saving is hoarding.

27. The proposition that “the demand for Ais the demand for A”

a. means, for example, that the purchase of an au-tomobile is the purchase simply and only of thatautomobile and not the purchase of the automo-bile and the steel used to make itb. is a restatement of John Stuart Mill’s proposi-tion that “demand for commodities is not demandfor labor,” in a positive and more extended form

c. serves to prevent confusing real entities andreal purchases with “shadow entities and shadowpurchases”d. all of the abovee. none of the above

28. The belief that wheat and flour are inbread because the bread was made from flour that wasmade from wheat implies that ice is in steam if thesteam came from water that came from ice.

29. The difference between a real purchaseof bread, flour, and wheat and a “shadow-entity” typepurchase is that in the first case one leaves the storewith three distinct items, while in the second oneleaves only with bread.

30. The notion that in buying the final prod-uct one buys the labor and capital goods necessary toits production is consistent with the fact that business-men need capital in order to buy the means of produc-tion

31. The notion that in buying the final prod-uct one buys the labor and capital goods necessary toits production does not imply that in eating a loaf ofbread one eats flour, wheat, and tractor parts.

32. The fact that one buys the output is proofthat one has not bought the inputs.

33. If someone in fact bought flour and paidthe wages of bakers and then were charged for the re-sulting bread, he would be in the position of a manforced to buy his own property.

34. “The demand for consumers’ goods isnot only not a demand for factors of production, but isin competition with the demand for factors of produc-tion.”

35. If the sellers of consumers’ goods usedthe whole of their sales proceeds to consume, their de-mand for factors of production would

a. rise to infinity, according to the Keynesianmultiplier analysisb. fall to zeroc. both (a) and (b)d. neither (a) nor (b)

36. If wealthy businessmen decide to with-draw funds from their firms in order consume in theform of buying yachts, say, the effect will be

a. an increase in the demand for capital goodsand labor by the yacht-building industryb. a decrease in the demand for capital goods andlabor by the industries producing capital goodsc. a decrease in the overall demand for capitalgoods and labor in the economic system to the ex-tent that the purchase of yachts takes the place ofthe purchase of capital goods and labord. all of the abovee. none of the above


37. A rise in the demand for consumers’goods at the expense of the demand for factors of pro-duction increases the proportion of the demand for fac-tors of production that is made by the consumers’goods industries while reducing the overall size of thedemand for factors of production in the economy as awhole.

38. The only income of any significance thatcould be increased by virtue of the repeated rounds ofconsumption expenditure depicted in the multiplierprocess would be profit income, not wage income.

39. Saving isa. the nonspending of fundsb. hoardingc. the nonconsumption of fundsd. all of the abovee. none of the above

40. People of limited education and with nobusiness experience are especially prone to confusesaving with hoarding because they have no first-handfamiliarity with productive expenditure and thus con-clude that if funds are not consumed, they are simplynot spent.

41. The fallacy that saving is hoardinga. appears in the financial press when fears areexpressed that a rise in saving portends a reces-sion or depressionb. is accompanied by the belief that investmentspending comes virtually out of nowhere and isexpansionaryc. is present in contemporary economics textswhen they describe saving as a “leakage” from thespending streamd. all of the abovee. none of the above

42. Most present-day economics textbooksdescribe the macroeconomic effects of taxes and gov-ernment spending as the same as saving and invest-ment, i.e., the one as representing hoarding and theother as representing new and additional spending, vir-tually out of nowhere.

43. The belief that saving is hoardinga. can apply to a given individual in certain cir-cumstancesb. represents the fallacy of composition when itis applied to the economic system as a wholec. both (a) and (b)d. neither (a) nor (b)

44. When large-scale hoarding, i.e., an in-crease in the demand for money for holding, actuallyoccurs it

a. causes a decline in sales revenues, profits, andbusiness net worthb. causes unemployment and dissaving by the un-employedc. is the cause of an overall reduction in savings


45. When it occurs on a significant scale,“hoarding”

a. has nothing fundamentally to do with any at-tempt to save or to save moreb. does not originate with consumersc. represents the attempt of business firms and in-vestors to convert previously accumulated savingsfrom their usual form of investments in physicalassets or claims to physical assets, into cash, in aneffort to become more liquidd. all of the abovee. none of the above

46. “Hoarding” a. comes about after inflation and credit expan-sion have created the potential for a sudden rise inthe demand for money for holding by first causingan undue decline in the demand for money forholding and the consequent creation of a state ofilliquidityb. operates to increase the degree of liquidity inthe economic system—i.e., the ratio of the quan-tity of money to such magnitudes as current liabili-ties—and finally to put an end to the desire furtherto increase cash holdingsc. can be prevented from having harmful conse-quences by means of avoiding inflation and creditexpansiond. all of the abovee. none of the above

47. What is saved is not only spent, but is thesource of most spending in the economic system inas-much as saving is the foundation of all of the produc-tive expenditure that is made out of business salesrevenues.

48. Saving is the foundation ofa. the demand for goods at wholesaleb. the demand for all capital goods, i.e., the de-mand for all buildings, machinery, materials, com-ponents, and supplies by business firmsc. the demand for labor by business firmsd. the demand for expensive consumers’ goodse. all of the abovef. none of the above

49. The proposition that saving is the sourceof most spending in the economic system is implied

a. by the fact that profit margins are typically onthe order of ten percent or lessb. costs and thus productive expenditure relativeto sales are typically on the order of ninety per-cent or morec. a substantial portion of costs and the produc-tive expenditure that gives rise to them are for cap-ital goods, behind which there are furthersubstantial costs and productive expenditured. all of the above



50. A rise in the rate of saving raises the de-mand for houses and expensive consumers’ goods ingeneral.

51. All the wages of the employees of busi-ness firms are paid out of saving and productive expen-diture by the business firms; essentially only the wagesof domestic servants and government employees arepaid out of consumption expenditure.

52. Via the payment of wages and salaries,saving and productive expenditure are the source of al-most all consumption expenditure.

53. a. Financially the individual business firm is vi-tally dependent on the consumers, because it mustcompete with other business enterprises for thefunds that the consumers can choose to spend onthe one or the other business firmsb. From the perspective of the economic systemas a whole, however, it is the consumers who arevitally dependent on business, because “moneycomes to goods”—i.e., all the funds in theconsumers’ posesssion are sooner or later inevita-bly drawn from them to business in buying thegoods and services necessary to their survival,well-being, and enjoyment, with the result thatthey must obtain fresh money from businessc. both (a) and (b)d. neither (a) nor (b)

54. Through its productive expenditure andthrough the consumption expenditure of its ownersand creditors, business is the source of its own demandand profitability, with the result that there is no needfor government created outside consumption.

55. In making possible capital accumulationand rising production, saving

a. is the source of an increasing aggregate de-mand in real termsb. is the source of an increasing aggregate de-mand in monetary termsc. in the long run, is the source of rising consump-tion in both real and monetary terms, as the post–World War II history of Japan and other Asianeconomies vividly illustratesd. all of the abovee. none of the above

56. Given the same quantity of money in theeconomic system, to the extent that savings are used topay wages, and the wage earners consume their wages,the effect is to leave aggregate consumption un-changed, with consumption by wage earners taking theplace of consumption by the savers.

57. The fact that national income equals con-sumption plus net investment and that consumptionoften exceeds net investment by more than ten to one

implies that most of national income is paid by con-sumption expenditure.

58. The equality between national income(i.e., the sum of profits plus wages), on the one side,and net national product (i.e., the sum of consumptionexpenditure plus net investment), on the other, is infact an identity in which the only difference betweenthe two sides is a change in the order of addition of theexact same revenue-expenditure subcomponents.

59. Net investment a. equals productive expenditure minus businesscosts—the same costs as are deducted from salesrevenues in calculating aggregate profitsb. like the visible portion of an iceberg, is theheading under which most spending in the eco-nomic system is concealedc. equals net investment in plant and equipmentplus net investment in inventoriesd. equals productive expenditure on account ofplant and equipment minus depreciation cost, plusproductive expenditure on account of inventoryand work in progress minus cost of goods sole,plus productive expenditure not debited to anyasset account minus the costs represented by suchproductive expendituree. all of the abovef. none of the above

60. Gross national revenue (GNR)a. equals total business sales revenues plus wagepaymentsb. equals the sum of consumption expenditureplus productive expenditurec. both (a) and (b)d. neither (a) nor (b)

61. Gross national revenue (GNR)a. reduces to national income if costs are sub-tracted from sales revenuesb. reduces to net national product if costs are sub-tracted from productive expenditurec. both (a) and (b)d. neither (a) nor (b)

62. Gross national revenue (GNR) reduces toGNP if all costs but depreciation are deducted fromproductive expenditure, which is equivalent to addingdepreciation to net national product.

The following pertains to the next eleven questions.Assume that the demand for consumers’ goods is 1000units of money, the demand for capital goods is also1000 units of money, the demand for labor by businessfirms is 800 units of money, the demand for labor byconsumers is 100 units of money, and total businesscosts deducted from sales revenues are 1700.

63. Find aggregate profits.

64. Find aggregate wages.

65. Find national income.


66. Find total consumption.

67. Find net investment.

68. Find net national product.

69. Find total sales revenue and income pay-ments in the economic system.

70. Find the portion of total sales revenueand income payments constituted by consumption ex-penditure.

71. Find the portion of total sales revenueand income payments constituted by productive expen-diture.

72. What portion of wages is paid by con-sumption expenditure?

73. What portion of wages is paid by produc-tive expenditure?

The following pertains to the next 4 questions. One-hundred of additional net investment takes place, gen-erated by 100 of additional demand for capital goods,and the Keynesian “marginal propensity to consume”is .75.

74. Find the “investment multiplier.”

75. Find the alleged increase in national in-come.

76. How much of the additional national in-come is wages?

77. How much of the additional national in-come is profits?

The following pertains to the next 4 questions. Onceagain, one-hundred of additional net investment takesplace, generated this time by 50 of additional demandfor capital goods and 50 of additional demand forlabor by business. This time, the Keynesian “marginalpropensity to consume” is .90.

78. Find the “investment multiplier.”

79. Find the alleged increase in national in-come.

80. How much of the additional national in-come is wages?

81. How much of the additional national in-come is profits?

82. a. The only incomes raised by the successiverounds of consumption expenditure envisioned bythe multiplier doctrine would be profits, notwages. b. Any rise in wages, in the demand for goods atwholesale, in the demand for capital goods of anykind depends on saving, which the Keynesians re-gard as a “leakage” and as allegedly diminishingthe amount of subsequent incomes.c. both (a) and (b)

d. neither (a) nor (b)

83. a. Real wages depend on the productivity oflabor.b. The productivity of labor depends on the sup-ply of capital goods per worker, increasing as it in-creases, decreasing as it decreases.c. both (a) and (b)d. neither (a) nor (b)

84. The determinants of changes in the sup-ply of capital goods are

a. the production of capital goods relative to theproduction of consumers’ goodsb. the demand for capital goods relative to the de-mand for consumers’ goodsc. the degree of saving in the economic systemd. the productivity of capital goodse. all of the abovef. none of the above

85. All capital goods are sooner or later usedup or worn out in the course of production and must bereplaced through the fresh production of capital goods.The proportion of the economic system’s output thatneeds to be in the form of capital goods in order to re-place the capital goods used up or worn out is calledthe _____ proportion.

86. The higher is the degree of saving,a. the greater is the demand for capital goods rela-tive to the demand for consumers’ goodsb. the greater is the production of capital goodsrelative to the production of consumers’ goodsc. the more rapid is capital accumulation, oncethe relative production of capital goods exceedsthe maintenance proportiond. all of the abovee. none of the above

87. The assumption that the output of the eco-nomic system increases in proportion to the increase inthe supply of capital goods appears to contradict

a. the law of diminishing marginal utilityb. the law of diminishing returnsc. both (a) and (b)d. neither (a) nor (b)

88. Technological progress is necessarya. to keep up the rate of profit by providing addi-tional investment opportunities for the growingsupply of capital goods made possible by addi-tional savingb. to make possible continued capital accumula-tion in the face of the existence of the law of di-minishing returnsc. both (a) and (b)d. neither (a) nor (b)

89. Technological progress is necessary tokeep up the productivity of capital goods as the supplyof capital goods increases.


90. The relationship between technologicalprogress and capital accumulation is

a. one of cause to effectb. reciprocal in that the implementation of moreadvanced technologies typically requires a largersupply of capital goodsc. both (a) and (b)d. neither (a) nor (b)

91. Capital accumulation is fostered bya. economic freedom, including free internationaltrade and freedom of immigration for self-support-ing immigrantsb. anything that contributes to the ability to pro-duce in generalc. a higher degree of saving and provision for thefutured. respect for property rightse. all of the above

92. Economic freedom promotes capital accu-mulation by virtue of

a. promoting saving and thereby the demand forand production of capital goods relative to the de-mand for and production of consumers’ goodsb. raising the productivity of capital goodsc. reducing the maintenance proportiond. all of the abovee. none of the above

93. Under the conditions of an invariablemoney, an increase in saving and the relative demandfor capital goods is necessary in order to achieve a. capital accumulation

b. an acceleration in the rate of capital accu-mulation

94. The rapid economic progress of Japanover the last forty years or more is the result of

a. high saving rates, which have resulted in therelative production of capital goods far surpassingthe maintenance proportion, and of a high produc-tivity of capital goods based on industriousnessand innovativenessb. the application of advances in statistical tech-niques making possible greatly improved qualitycontrol in Japanese manufacturing compared withAmerican manufacturingc. the Samurai heritage of the Japanese

95. The relative stagnation of the Americaneconomy over the last generation is the result of

a. a lower demand for capital goods relative toconsumers’ goods than in the past, caused by gov-ernment economic policies hostile to savingb. a lower productivity of capital goods than inthe past, resulting from government interferencethat increases cost per unit and equivalently re-duces output per unit of costc. both (a) and (b)d. neither (a) nor (b)

96. The stagnation and retrogression of so-cialist economies, such as that of the former SovietRussia, was the result of

a. too low a concentration on the production ofcapital goods and the building up of heavy indus-tryb. the profound inefficiencies of socialism result-ing from its lack of a price system and of profit-and-loss incentivesc. both (a) and (b)d. neither (a) nor (b)

97. Recognizing the separate existence of thedemand for capital goods, and the separate, distinctproduction of capital goods, is not necessary in orderto understand that an additional supply of capitalgoods serves to increase the supply of capital goods aswell as the supply of consumers’ goods.

98. The failure to recognize the separate exis-tence of the demand for capital goods and the corre-sponding separate production of capital goods leads to

a. an inadequate appreciation of the role of sav-ing in capital accumulation, which is as force toaccelerationb. a corresponding overemphasis on the role ofsaving in capital accumulation, which is mistak-enly seen as one to onec. an inability to recognize the role of technologi-cal progress as a cause of capital accumulation inserving to maintain the productivity of an increas-ing supply of capital goodsd. an inability to grasp the principle that capitalaccumulation is fostered by anything that in-creases the ability to produce in general, such as,above all, economic freedome. all of the abovef. none of the above

The following is a 5-part question.

99. The demand for consumers’ goods is 500monetary units and the demand for capital goods is500 monetary units. Taking the demand for capitalgoods as total costs on account of capital goods, findnational income.

100. The demand for consumers’ goods nowfalls to 400 monetary units and the demand for capitalgoods rises to 600 monetary units. Again taking the de-mand for capital goods as total costs on account of cap-ital goods, find national income.

101. The answers to the preceding two ques-tions imply that in the context of an economic systemwith an invariable money, the relationship between na-tional income and economic progress and prosperity isinverse, because capital accumulation will be greaterwhen the demand for capital goods rises relative to thedemand for consumers’ goods, even though as a resultnational income falls.


102. The answers to those same two ques-tions referred to in the previous question imply that inthe context of an economic system with an invariablemoney, national income is basically the counterpartjust of consumption expenditure.

103. In the context of the economic systemwith a 600 demand for capital goods and a 400 de-mand for consumers’ goods, real incomes would soonfar surpass, and further and further surpass, real in-comes in the economic system with a 500 demand forcapital goods and a 500 demand for consumers’ goods.In that former ecoomic system, the mechanism bywhich economic progress raises real incomes is

a. the average member of the society earns moreand more money with every passing yearb. prices fall year after year while the money in-come of the average member of the society re-mains the same

The following pertains to the next 4 questions. The“balanced-budget multiplier” of the Keynesians claimsthat equal increases in taxes and government spendingcause a rise in national income that is equal to the risein taxes or government spending because the tax multi-plier is one less in absolute value than the governmentspending multiplier while being opposite in sign. Tak-ing the “marginal propensity to consume” as .75,

104. Find the government spending multi-plier, using the same basic formula as for the invest-ment multiplier.

105. Find the tax multiplier.

106. Find the effect on national income of arise in government spending and taxes of $100 billion.

107. The significance of the rise in nationalincome in the preceding question is

a. that higher taxes are actually costless in the ag-gregate because national income rises by enoughto pay for themb. that it illustrates the inverse relationship be-tween national income, on the one side, and capi-tal accumulation, economic progress, andprosperity, on the otherc. both (a) and (b)d. neither (a) nor (b)

108. The doctrine of the “Conservatives’ Di-lemma”

a. is based on the doctrine of the balanced-budgetmultiplierb. claims that fiscal conservatives must choosebetween their basic values of balanced budgetsand small government, because achieving a givenrise in national income requires only a relativelymodest increase in government spending if the ad-ditional government spending is financed by abudget deficit but requires a much greater in-crease in government spending if the additionalgovernment spending is to be financed by equiva-lent additional taxes. (This is because in the firstcase the government-spending multiplier alleg-edly applies, while in the second case only themuch smaller balanced-budget multiplier applies.)c. is overthrown by recognition of the inverse re-lationship between national income and economicprogress and prosperity, which recognition restson the realization that the increase in national in-come entails reducing the demand for capitalgoods relative to the demand for consumers’ goodsd. all of the abovee. none of the above



Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 T 26 T 51 T 76 zero 101 T2 F 27 d 52 T 77 400 102 T3 T 28 T 53 c 78 10 103 b4 T 29 T 54 T 79 1000 104 45 d 30 F 55 d 80 50 105 -36 b 31 F 56 T 81 950 106 $100 billion7 F 32 T 57 F 82 c 107 b8 T 33 T 58 T 83 c 108 d9 T 34 T 59 e 84 e10 T 35 c 60 c 85 maintenance11 T 36 d 61 c 86 d12 d 37 T 62 T 87 b13 d 38 T 63 300 88 b14 d 39 c 64 900 89 T15 T 40 T 65 1200 90 c16 T 41 d 66 1100 91 e17 b 42 T 67 100 92 d18 T 43 c 68 1200 93 b19 T 44 d 69 2900 94 a20 a 45 d 70 1100 95 c21 F 46 d 71 1800 96 b22 d 47 T 72 100 97 F23 T 48 e 73 800 98 e24 $475 49 d 74 4 99 50025 a 50 T 75 400 100 400

Chapter 16, Part A

1. The treatment of interest in Reisman’sChapter 16 is

a. to ignore it as a cost by taking profits as grossof itb. to include consumption out of it as part of theconsumption of businessmen and capitalistsc. both (a) and (b)d. neither (a) nor (b)

2. The amount of profit in the economic sys-tem can be provisionally understood as the differencebetween the demand for the products of business andthe demand for factors of production by business.

3. The determinants of the average rate ofprofit in the economic system as a whole are no differ-ent than the determinants of the rate of profit of an in-dividual company.

4. The significance of an individual companyearning a given high rate of profit, such as 50 percent,and the average rate of profit in the economic systembeing that high, is essentially the same.

5. The interest rate on government bonds is agood indicator of the average rate of profit in the eco-nomic system.

6. According to Capitalism, the interest rateon government bonds is probably

a. substantially less than the average rate of profitin the economic systemb. substantially more than the average rate ofprofit in the economic systemc. about the same as the average rate of profit inthe economic system

7. Net consumption isa. business sales revenues minus productive ex-penditureb. consumption expenditure for the goods and ser-vices of business minus the wages paid by busi-nessc. total consumption expenditure counted in netnational product minus total wagesd. all of the above

8. Net investment is productive expenditurecosts.

9. Given that profits in the economic systemequal aggregate sales revenues minus aggregate costs,the algebraic difference between profits and net invest-ment is business sales revenues paid by consumersminus productive expenditure in payment of wages,i.e., net consumption.

10. Productive expenditure isa. a source of business sales revenuesb. the source of business costsc. ultimately the source of business costs equal tothe productive expenditure


11. An invariable moneya. means a fixed quantity of money in the eco-nomic system, supporting a fixed aggregate de-mand for the products of business enterprises, i.e.,fixed aggregate business sales revenuesb. implies that increases in aggregate productionand supply result in inversely proportionate reduc-tions in the general level of pricesc. both (a) and (b)

12. In an economy with an invariable money,if productive expenditure were the only source of busi-ness sales revenues,

a. the equalization of productive expenditure andcosts would imply the absence of profitb. an aggregate profit could exist only to the ex-tent that net investment existedc. the average rate of profit would tend steadilyto fall unless net investment could go on in-creasign at a compound rate, which is impossibled. all of the above

13. a. If net consumption is defined in terms of thedifference between business sales revenues andproductive expenditure, it reduces to the portionof business sales revenues that is paid by consum-ers minus the portion of productive expenditurethat goes for the payment of wages.b. If net consumption is defined in terms of thedifference between the demand for the products ofbusiness and the demand for factors of productionby business, it reduces to the difference betweenthe demand for consumers’ goods from businessminus the demand for labor by business.c. both (a) and (b)

14. The principal source of net consumptionis the consumption expenditure of businessmen andcapitalists, made possible by dividend, draw, and inter-est payments.

15. a. Dividend and draw payments, to the extentthat they are consumed, are the source of businesssales revenues that have no counterpart whateverin productive expenditure and thus in the genera-tion of business costs. As a result, they are thesource of sales revenues exceeding productive ex-penditure and costs. b. Interest payments by business, to the extentthat they are consumed, are the source of businesssales revenues in excess of the productive expendi-ture and costs that need to be considered in ex-plaining the determination of aggregate profits.c. both (a) and (b)d. neither (a) nor (b)




16. In Reisman’s Chapter 16, a. the productive expenditure of any given year isfrequently assumed to result in equivalent aggre-gate costs in the following year.b. What determines the allocation of any givenyear’s total productive expenditure between theproduction of the capital goods and the productionof the consumers’ goods of the following year,and thus the respective aggregate costs of the capi-tal goods and consumers’ goods of the followingyear, is the demand for capital goods relative tothe demand for consumers’ goods in the followingyear.c. both (a) and (b)d. neither (a) nor (b)

17. The sources the demand for the productsof business are

a. the demand for capital goods by businessb. the demand for labor by business, whichmakes possible the demand for consumers’ goodsby wage earnersc. the demand for consumers’ goods by the own-ers and creditors of businessd. all of the above

18. The basic sources of the money that con-sumers spend are

a. wage payments by business, and dividend,draw, and interest payments by businessb. government transfer paymentsc. extensions of new credit

19. What allows business to sell each yearfor more money in toto than it expends in buying thefactors of production is the consumption expenditureof the owners and creditors of business, which is a de-mand for the products of business but not a demandfor factors of production by business.

20. The role of net consumption as a determi-nant of aggregate profit is brought out most clearlywhen productive expenditure is assumed to generatebusiness costs

a. equal to itselfb. less than itselfc. greater than itself

21. Net consumption is a source of aggregateprofit by virtue of making sales revenues greater thanproductive expenditure and greater than aggregatecosts equal to productive expenditure.

22. Aggregate profit equals a. national income minus wagesb. net national product minus wagesc. consumption minus wages, plus net investmentd. net consumption plus net investmente. all of the above

The following four questions require a copy ofReisman’s Figure 16–2.

23. In every year of Figure 16–2, businessboth spends all of its cash and yet ends up with exactlythe same amount of cash with which to begin opera-tions in the following year.

24. What is the aggregate amount of profit inevery year in Figure 16–2?

25. What is the average rate of profit in everyyear in Figure 16–2?

26. What is the source of the aggregate profitin Figure 16-2?

27. Other possible sources of net consump-tion besides the consumption expenditure of business-men and capitalists are

a. corporate stock repurchasesb. extensions of consumer credit by businessc. both (a) and (b)d. neither (a) nor (b)

28. In addition to its other formulations, netconsumption also equals total consumption expendi-ture that constitutes sales revenue or wages, minustotal wages paid in the economic system.

29. It is unreasonable to assume that all thewages paid by business have a counterpart in the de-mand for consumers’ goods from business, if wageearners save.

30. In an economy with an invariable money,a rise in the amount and rate of net consumption raisesthe amount and rate of profit by virtue of leaving ag-gregate sales revenues unchanged while reducing ag-gregate costs.

31. In an economy with an invariable money,if all businessmen were to consume 100 percent oftheir sales proceeds and thus cease to act as capitalists,the rate of profit would rise to infinity by virtue ofmoney costs and capital expressed in money both fall-ing to zero.

32. The answer to the preceding question re-futes Adam Smith’s and Karl Marx’s contention thatin a society without capitalists all income would bewages and no income would be profits. (Note: Creditfor this question will be given only if the answer to thepreceding question is also correct.)

33. Businessmen and capitalists cannot arbi-trarily increase the rate of net consumption and therate of profit, because greater consumption by any indi-vidual businessman or capitalist

a. is incapable of raising the rate of profitb. reduces his own capital by more than it raisesthe rate of profit, with the result that his amount ofprofit falls

34. Insofar as the average rate of profit in theeconomic system is determined by the rate of net con-


sumption, capital tends to gravitate into the hands ofthose businessmen and capitalists whose rate of con-sumption relative to their accumulated capitals isbelow average and out of the hands of those whoserate is above average.

35. The two principles operating to deter-mine the growth and decline of individual fortunes rel-ative to the total wealth of the economic system arerelative rates of consumption in relation to capital andrelative degrees of efficiency in production.

36. The two principles referred to in the pre-ceding question work by determining both relativerates of profit and the extent to which profits are savedand reinvested.

37. In a free economy, those businessmenand capitalists who are relatively more efficient andwho save and invest relatively more heavily continu-ally increase the proportion of the total capital of theeconomic system that they own at the expense of thosebusinessmen and capitalists who are relatively less effi-cient and who save and invest relatively less heavily.

38. The possession of accumulated capital isa major factor making possible net consumption andexplains why net consumption exists even in the faceof general business losses.

39. If aggregate profit were wiped out forany reason, businessmen and capitalists would con-tinue to consume out of their accumulated capitals.Their consumption expenditure would constitute salesrevenues in the economic system and would serve tomake aggregate sales revenues greater than productiveexpenditure. An aggregate profit would be restored assoon as costs fell to or below the level of productiveexpenditure. At that point, profit would exist becauseif sales revenues exceed productive expenditure, theymust equivalently exceed costs equal to productive ex-penditure (and further exceed costs that are less thanproductive expenditure).

40. The process described in the precedingquestion would be hastened by writedowns of businessassets.The following pertains to the next 6 questions. As-sume that an individual who possesses a capital of $10million consumes at an annual rate of 2 percent of thesum of his capital and annual income together.

41. Calculate this individual’s consumptionif his income this year is zero.

42. Calculate his consumption if his incomethis year is $200,000.

43. Calculate both the amount of his con-sumption and the percentage of his income that hesaves if his income is $300,000.

44. Calculate both the amount of his con-sumption and the percentage of his income that hesaves if his income is $400,000.

45. Calculate both the amount of his con-sumption and the percentage of his income that hesaves if his income is $1 million.

46. Calculate both the amount of his con-sumption and the percentage of his income that hesaves if his income is $1 million and his capital is $50million.

47. Seeing the consumption of businessmenand capitalists as determined mainly by their accumu-lated capital helps to explain

a. the relationship between relatively high in-comes in the economic system and high rates ofsaving, insofar as such incomes are usually earnedas high rates of profitb. the lack of relationship between rising averagereal incomes and the rate of savingc. both (a) and (b)d. neither (a) nor (b)

48. Time preference means that, other thingsbeing equal, people prefer

a. to accomplish given results in less timeb. goods of the same kind and number in the pres-ent rather than in the future, or in the nearer futurerather than in the more remote futurec. both (a) and (b)d. neither (a) nor (b)

49. Time preference is implied bya. the very nature of human valuationb. the fact that the uninterruptibility of humanlife makes life in the present necessarily appearmore valuable than life in the future, and life inthe nearer future more valuable than life in themore remote futurec. both (a) and (b)d. neither (a) nor (b)

50. A high or low time preference in a soci-ety operates to make the rate of profit high or low

a. directlyb. indirectly, by making the rate of net consump-tion high or low

51. The absolute temporal extent of the pres-ent and future—i.e., whether the present is taken as thecoming year, month, week, or day, and the future aseverything beyond it, has an important bearing on therole of the rate of net consumption in determining theannual rate of profit.

52. Other things being equal, because of theeffect on time preference, the average rate of profitand interest will be the higher, the freer and more ratio-nal is a society.

53. In the light of the influence of economicfreedom and rationality on time preference and thus onthe rate of net consumption, the effect of the activityof revolutionary bandits and plundering governmentofficials who rail against the existence of profit and in-


terest is actually to raise the average rate of profit andinterest.

54. The distinction between productive ex-penditure and costs is one of timing, in that today’sproductive expenditures will largely be costs in the fu-ture, while today’s costs are largely the result of pro-ductive expenditures made in the past.

55. Much of productive expenditure is addedto asset accounts; much of cost represents subtractionsfrom asset accounts.

56. The asset account which is reduced whencost of goods sold is incurred is:

a. cashb. inventory and work in progressc. net plant and equipmentd. none of the above

57. The asset account which is reduced whendepreciation cost is incurred is:


58. The asset account which is increasedwhen depreciation cost is incurred is:


59. The asset account which is increasedwhen depreciation cost is incurred is the accumulateddepreciation reserve.

60. The accumulated depreciation reserve isa deduction from the gross plant and equipment ac-count, and when deducted yields the net plant andequipment account.

61. The asset account which is increasedwhen productive expenditure for plant and equipmenttakes place is

a. the gross plant and equipment accountb. the net plant and equipment accountc. both (a) and (b)

62. The asset account which is increasedwhen productive expenditure for inventory or work inprogress takes place is

a. cashb. net plant and equipmentc. gross plant and equipmentd. none of the above

63. Aggregate profit and net investment areclosely related on the basis of their mathematical defi-nitions, the one being sales revenues minus costs andthe other being productive expenditure minus thosesame costs, with productive expenditure generating ag-gregate sales revenues equal to itself.

64. Aggregate profit and net investment dif-fer from one another on the basis of their mathematicaldefinitions only by the amount of

a. s - Bb. sc - wbc. net consumptiond. all of the abovee. none of the above

65. Starting with the fact that aggregateprofit equals aggregate sales revenues minus aggregatecosts, it follows that it also equals the sum of net con-sumption plus net investment. This can be shown

a. by inserting B both as a positive and a negativeterm between s and db. on the basis of the fact that B - d equals Ic. on the basis of the fact that s - B equals NCd. all of the above taken together

66. Where K stands for total invested capital,a. the net consumption rate equals NC/Kb. the net investment rate equals I/Kc. the average rate of profit in the economic sys-tem equals the sum of the net consumption andnet investment ratesd. all of the abovee. none of the above

67. “Secondary productive expenditure”a. is productive expenditure made out of thewages paid by businessb. enlarges total productive expenditure whileleaving aggregate sales revenues unchangedc. reduces the amount of net consumption, whichcould, conceivably, be made negative if theamount of secondary productive expenditure weregreat enoughd. comes to an end once the accumulated savingsof the wage earners become great enoughe. all of the above

68. The existence of negative net consump-tion is unlikely, given the fact that much or all of thesavings of wage earners normally has a counterpart inthe granting of loans to consumers, such as home mort-gages and automobile loans.

69. Productive expenditure equal to or evengreater than aggregate sales revenues is compatiblewith the existence of an aggregate profit in the eco-nomic system provided

a. aggregate costs are less than sales revenuesb. positive net investment exists in excess of theamount of any negative net consumptionc. both (a) and (b)d. neither (a) nor (b)

70. The same amount of productive expendi-ture for plant and equipment can be accompanied bynew and additional net investment

a. if the average life of plant and equipment in-creases, because this will decrease annual depreci-


ation charges until as many batches of the longer-lived plant and equipment are in existence as cor-responds to their longer lifeb. to the extent that the average period of time re-quired for the construction and or installation ofthe new plant and equipment increases, becausethis will postpone the date when the productive ex-penditure begins to show up as depreciation costc. both (a) and (b)

The following pertains to the next 8 questions. Pro-ductive expenditure for new plant and equipment in ahypothetical economic system is 100 units of moneyevery year, year in and year out. The average life ofplant and equipment in that economic system is ini-tially ten years. However, starting in Year X, which issometime long after Year 10, the average life of newplant and equipment rises to twenty years.

71. Find the amount of annual depreciationcost on the plant and equipment purchased in any oneyear prior to Year X.

72. Find the total amount of annual deprecia-tion cost in the economic system after Year 10 andprior to Year X.

73. Find the amount of annual net investmentafter Year 10 and prior to Year X.

74. Find the amount of annual depreciationcost on the plant and equipment purchased in any oneyear starting in Year X.

75. Find the amount of net investment inYear X.

76. Find the amount of net investment inYear X + 1.

77. Find the amount of net investment inYear X + 9 (i.e., the tenth year).

78. Find the total amount of annual deprecia-tion cost in the economic system in every year startingwith Year X + 19 (i.e., the twentieth year).

79. Net investment results from a change inthe disposition of a given amount of aggregate produc-tive expenditure in the following ways:

a. a shift of productive expenditure for inventoryand work in progress from inventory and work inprogress requiring a shorter period of time be-tween outlays for factors of production and re-ceipts from the sale of the product to inventoryand work in progress requiring a longer period oftime between outlays for factors of productionand receipts from the sale of the product—for ex-ample, a shift from the production of eight-year-old scotch to the production of twelve-year-oldscotchb. a shift of productive expenditure from ex-pensed expenditures to expenditure for inventoryand work in progress

c. as a rule, a shift of productive expenditure forinventory and work in progress to productive ex-penditure for plant and equipmentd. a shift of productive expenditure for plant andequipment of a shorter average life or shorter pe-riod of construction time to plant and equipmentof a longer average life or longer period of con-struction timee. all of the above

80. By means of the various changes in thedisposition of productive expenditure described in theprevious question, the existence of net investment canbe indefinitely prolonged under the existence of an in-variable money.

81. The shifting of productive expendituresfrom points less remote from the making of sales topoints more remote from the making of sales

a. operates to reduce aggregate costs in the eco-nomic system and thereby create net investmentb. operates to increase the amount and rate ofprofit in the economic systemc. both (a) and (b)

82. The expression the marginal productivityof capital, as used in Capitalism,

a. denotes a net physical product attributable tothe employment of additional capital goodsb. means the savings of cost or additions to salesrevenue that additional capital would achieve forindividual business firms, relative to the addi-tional capital in questionc. both (a) and (b)d. neither (a) nor (b)

83. If the marginal productivity of capital, inthe sense in which the expression is used in Capital-ism, exceeds the rate of profit, incentives are createdthat serve to increase the amount of net investment andthe amount and rate of profit in the economic systemby virtue of causing productive expenditure to shift topoints more remote from the making of sales.

84. In an economic system with an invariablemoney, and in the absence of continuing technologicalprogress, the marginal productivity of capital, in thesense in which the expression is used in Capitalism,and the rate of profit tend to

a. equalizeb. permanently differ

85. Under the conditions of an invariablemoney, the ability of net investment to add to the rateof profit is an inherently self-limiting phenomenon.

86. Under the conditions of an invariablemoney, the ability of net investment to add to the rateof profit is an inherently self-limiting phenomenon.This is because the higher is the rate of net investmentand consequently the economy-wide average rate ofprofit, the more difficult it is for still more net invest-ment to be perceived as worthwhile, in view of the fact


that a condition of investing is that the marginal pro-ductivity of capital must now surpass a higher rate ofprofit for the investment to take place.

87. Under the conditions of an invariablemoney, it becomes progressively more difficult tokeep net investment in being in the face of any givenrate of profit.

88. Under the conditions of an invariablemoney, it becomes progressively more difficult tokeep net investment in being in the face of any givenrate of profit. This is because all additional net invest-ment implies an increase in the degree of remotenessof portions of productive expenditure from the salesrevenues they serve to bring in, with these more re-mote portions having to pass the hurdle of the prevail-ing rate of profit being compounded for the additionalperiods of time involved.

89. Under the conditions of an invariablemoney, the rate of profit comes to equal the rate of netconsumption alone.

90. Under the conditions of an invariablemoney, the effect of net investment is to bring about asubsequent rise in net consumption and reduction ofproductive expenditure.

91. Under the conditions of an invariablemoney, the rate of profit comes to equal the rate of netconsumption alone

a. because the growing accumulation of capitalthat net investment results in serves to increasethe amount (though not the rate) of net consump-tion and thus to reduce the amount of productiveexpenditureb. costs tend to rise toward productive expendi-turec. both (a) and (b)d. neither (a) nor (b)

92. Under an invariable money, savings andcapital would be accumulated up to a certain ratio toincome, and then, in the absence of a fall in time pref-erence, further accumulation would cease.

93. The increase in the quantity of moneyand volume of spending operates to perpetuate the ex-istence of net investment.

94. The increase in the quantity of moneyand volume of spending operates to perpetuate the ex-istence of net investment

a. because it brings about a systematic rise in pro-ductive expenditure while costs do not riseb. because it brings about a systematic rise in pro-ductive expenditure while the resulting rise in ag-gregate costs lags behind the rise in productiveexpenditure

95. The rate of increase in the quantity ofmoney and volume of spending tends to add an approx-imately equivalent percentage to the nominal rate ofprofit.

96. The rate of increase in the quantity ofmoney and volume of spending tends to add an approx-imately equivalent percentage to the nominal rate ofprofit

a. because costs are the reflection of productiveexpenditures made largely in the past, which pro-ductive expenditures and costs are not retroac-tively increased by any increase in the quantity ofmoney and volume of spending made subsequentto those productive expendituresb. the increase in the quantity of money and vol-ume of spending systematically enlarges sales rev-enues relative to the productive expendituresmade in the past to bring in those sales revenueswith the degree of enlargement corresponding tothe rate of increase in the quantity of money andvolume of spendingc. both (a) and (b)

The following pertains to the next 9 questions. As-sume initially the existence of an invariable moneyand a 5 percent annual rate of profit, which will beearned in all of the following cases. Additionally, as-sume that in all of the following cases the outlay ofmoney by a businessman, i.e., his productive expendi-ture, is $100, and that it is all expended at the sametime.

97. Calculate the businessman’s sales pro-ceeds in the case of a product that requires exactly oneyear between the making of his productive expenditureand the sale of his product.

98. Calculate the businessman’s sales pro-ceeds in the case of a product that requires exactly onemonth between the making of his productive expendi-ture and the sale of his product.

99. Calculate the businessman’s sales pro-ceeds in the case of a product that requires two yearsbetween the making of his productive expenditure andthe sale of his product.

The following pertains both to the preceding threequestions and to the next 6 questions. Now, whilecontinuing to assume the undiminished existence ofthe forces that bring about the five percent annual rateof profit under an invariable money (i.e., a five percentannual rate of net consumption), drop the assumptionof an invariable money and assume that starting in theinstant of the businessman’s outlay, the quantity ofmoney and volume of spending in the economic sys-tem increase at an annual rate of two percent.

100. Recalculate the businessman’s sales rev-enues in the first of the three preceding questions.

101. Recalculate the businessman’s rate ofprofit in the first of the three preceding questions.

102. Recalculate the businessman’s sales rev-enues in the second of the three preceding questions.


103. Recalculate the businessman’s annualizedrate of profit in the second of the three preceding questions.

104. Recalculate the businessman’s sales rev-enues in the third of the three preceding questions.

105. Recalculate the businessman’s annualizedrate of profit in the third of the three preceding questions.

The following pertains to the next 9 questions. As-sume initially the existence of an invariable moneyand a 4 percent annual rate of profit, which will beearned in all of the following cases. Additionally, assumethat in all of the following cases the outlay of money by abusinessman, i.e., his productive expenditure, is $100,and that it is all expended at the same time.

106. Calculate the businessman’s sales pro-ceeds in the case of a product that requires exactly oneyear between the making of his productive expenditureand the sale of his product.

107. Calculate the businessman’s sales pro-ceeds in the case of a product that requires exactly onemonth between the making of his productive expendi-ture and the sale of his product.

108. Calculate the businessman’s sales pro-ceeds in the case of a product that requires two yearsbetween the making of his productive expenditure andthe sale of his product.

The following pertains both to the preceding threequestions and to the next 6 questions. Now, whilecontinuing to assume the undiminished existence ofthe forces that bring about the four percent annual rateof profit under an invariable money (i.e., a four per-cent annual rate of net consumption), drop the assump-tion of an invariable money and assume that starting inthe instant of the businessman’s outlay, the quantity ofmoney and volume of spending in the economic sys-tem increase at an annual rate of three percent.

109. Recalculate the businessman’s sales rev-enues in the first of the three preceding questions.

110. Recalculate the businessman’s rate ofprofit in the first of the three preceding questions.

111. Recalculate the businessman’s sales rev-enues in the second of the three preceding questions.

112. Recalculate the businessman’s annualizedrate of profit in the second of the three preceding questions.

113. Recalculate the businessman’s sales rev-enues in the third of the three preceding questions.

114. Recalculate the businessman’s annualizedrate of profit in the third of the three preceding questions.

115. The net investment rate, i.e., the ratewhich net investment bears to the total of invested cap-ital, tends to equal the rate of increase in the quantityof money and volume of spending.

116. The net investment rate, i.e., the ratewhich net investment bears to the total of invested cap-ital, tends to equal the rate of increase in the quantityof money and volume of spending. This is because theincrease in the quantity of money and volume ofspending systematically enlarges the productive expen-diture of the present relative to the productive expendi-tures made in the past which now constitute costs, anddoes so to an extent corresponding to the rate of in-crease in the quantity of money and volume of spend-ing.

117. The rate of increase in production andsupply adds an approximately equal percentage to thereal rate of profit.

The following pertains to the next 5 questions. As-sume the existence of an invariable money and that theannual rate of profit generated by the rate of net consump-tion is 5 percent. Now assume that production and supplybegin to increase at a two percent annual rate.

118. Calculate the real rate of profit before pro-duction and supply begin to increase. (You should as-sume that the price level is stable in these conditions.)

119. Calculate the annual rate of fall inprices, once production and supply begin to increase.

120. Taking into account the fall in prices,calculate the year-end buying power of any given sumof money on which the five percent rate of profit isearned.

121. State the real rate of profit implied bythe difference between the year-end buying power ofany sum on which the 5 percent rate of profit is earnedand the buying power of the initial sum invested at thestart of the year.

122. Calculate the difference in the annualreal rate of profit that results from the two percent an-nual rate of increase in production and supply.

123. The fact that the rate of increase in pro-duction and supply adds an approximately equal per-centage to the real rate of profit can be inferred from

a. the fact that the rate of increase in the quantityof money and volume of spending adds an approx-imately equal number of percentage points to thenominal rate of profit, but if the rate of increase inproduction and supply equals the rate of increasein money and spending, prices will be unchangedand thus the addition to the nominal rate of profitwill turn out to be an equivalent addition to thereal rate of profit as wellb. the fact that if there is no increase in the quan-tity of money and volume of spending, the in-crease in production and supply reduces prices ininverse proportion and thus correspondingly in-creases the buying power of the capital invested,along with that of the profit earned on the capital


invested, thereby adding an approximately equiva-lent percentage to the real rate of profitc. both (a) and (b)

124. The degree of capital intensiveness ofan economic system is expressed by the ratio of thenominal value of its capital invested to

a. total sales revenues in the economic systemb. total consumption in the economic systemc. total wages paid in the economic systemd. all of the abovee. none of the above

125. The higher the degree of capital inten-siveness in an economic system, the greater is the like-lihood of its being able to implement technologicaladvances.

126. In which context does net investmentrepresent the achievement of a higher degree of capitalintensiveness in the economic system

a. that of an economic system with an invariablemoneyb. that of an economic system with an increasingquantity of money and volume of spending

127. In an economic system with a modestlyincreasing quantity of money and volume of spending,accumulated capital relative to other macroeconomicaggregates

a. increasesb. decreasesc. remains about the same

128. Which of the following represent“springs to profitability” (i.e., factors which operate tobring profit back into existence in the economic sys-tem if it should be temporarily wiped out)?

a. net consumptionb. net investment as the cause of growing capitalintensiveness and thus of more rapid economicprogress, which implies a greater ability to pro-duce or import precious metals, with a resultingpositive effect on the rate of profitc. net investment and an equivalent rise in theamount of profit, coming about precisely in re-sponse to a prevailing very low or negative rate ofprofitd. all of the above

129. In the case of any individual industry, alower rate of profit acts as an incentive to the with-drawal of capital. This must also be true of the eco-nomic system as a whole.

130. In the economic system as a whole, alower rate of profit actually encourages greater capitalintensiveness

a. by reducing the extent of the cost savings orrevenue increases that the investment of addi-tional sums of capital need to achieve in order tobe considered worthwhile

b. by favoring the adoption of lower-cost, more-capital-intensive methods of productionc. by favoring the production of more-capital-in-tensive productsd. by favoring the expansion of more-capital-in-tensive industries.e. all of the abovef. none of the above

131. Whatever else their undesirable effectsmay be, wage-rate rigidities do not operate to blockthe spring to greater general profitability through themovement toward greater capital intensiveness.

132. The increase in the quantity of moneythat is the by-product of economic progress operates toreduce the degree of capital intensiveness of the eco-nomic system, according to Capitalism.

133. The productivity theory [of profit and in-terest] holds that profit and interest are

a. determined by the marginal net productivity ofcapitalb. that additional saving operates to reduce themarginal net productivity of capital and thus therate of profit and interestc. that technological progress operates to raisethe marginal net productivity of capital and thusthe rate of profit and interestd. all of the above

The following pertains to the next 8 questions. Youare given the following information: The averagemember of a very primitive tribe of fishermen gathers3 fish per day that are washed up in tide pools. Nowone of the tribesmen, who is prepared to get by on eat-ing only 2 fish per day, devotes 1/3 of his daily laborfor each of 150 days to working on a crude boat andnet. At the end of that time, he has the boat and net,and for each of the next 100 days (the useful life of theboat and net), this tribesman is able to catch an aver-age of 30 fish per day.

134. Calculate, in terms of fish, the “mar-ginal gross product” of the boat and net.

135. Calculate, in terms of fish, the “mar-ginal net product” of the boat and net.

136. Calculate, in terms of fish, the averagecapital outstanding in the boat and net from the time itis brand new to the end of its useful life.

137. Basing your calculation on just one turnof the capital, calculate the rate of profit on the boatand net according to the productivity theory.

138. How many times in the course of a yearcould the capital invested in the boat and net be turnedover on the assumption that the boat and net last forjust 100 days?


139. Based on your answer to the two previ-ous questions, calculate the annualized rate of profiton the capital invested in the boat and net.

140. According to the productivity theory,the very high rate of profit present in this series ofquestions would be reduced by

a. further savingb. the accumulation of additional capital c. the operation of the law of diminishing returnsd. all of the above

141. According to the productivity theory,the very high rate of profit present in this series ofquestions would be reduced by technological progress.

142. According to the instructor, diminishingreturns and technological progress determine

a. the rate of profit/interestb. the rate of capital accumulation in real termsc. both (a) and (b)d. neither (a) nor (b)

143. Among the difficulties encountered bythe productivity theory of profit/interest are

a. a reliance on the doctrine of opportunity costb. the problem of having to subtract mathemati-cally incommensurate quantities, such as loavesof bread forgone versus extra fish producedc. a confusion of more physical output with moremoney revenued. the fact that the rate of profit is highest beforethere is any capital or productivity of capitale. all of the abovef. none of the above

The following pertains to the next 24 questions.Building on the assumptions underlying questions 134–141, assume a nation of one million primitive fisher-men, each of whom initially produces three fish perday which sell at a price of $1 per fish. Assume thatthe million fishermen are organized into one millionfishing enterprises, each of which pays wages to itsone fisherman employee of $2 per day. The enterprisesmake no productive expenditures other than the pay-ment of wages.

144. Calculate total sales revenues in thiseconomic system.

145. Calculate total costs in this economicsystem.

146. Calculate total profits in this economicsystem.

Now assume that one fishing enterprise alone be-gins using a boat and net which raise its daily out-put from 3 fish per day to 30 fish per day.

147. Based on this additional assumption,state the total daily production and supply of fish inthe economic system.

148. On the further assumption that the eco-nomic system of this nation of fishermen operatesunder an invariable money, calculate the average priceof fish corresponding to the total daily production andsupply of fish expressed in answer to the previousquestion.

149. Calculate the sales revenues of the fish-ing enterprise that raises its daily fish catch to 30 fish.

150. Calculate the profits of the fishing enter-prise that raises its daily fish catch to 30 fish.

151. Calculate the total profit of the 999,999fishing enterprises that continue to catch only 3 fishper day.

152. Calculate the change, if any, in the prof-its of the 999,999 fishing enterprises whose productionremains at 3 fish per day following the success of theone fishing enterprise that increases its catch to 30 fishper day.

Now, continuing with the assumption of an invari-able money, assume that all one million fishing en-terprises succeed in increasing their fish catch to 30fish per day.

153. State the total daily production and sup-ply of fish in the economic system under this new as-sumption.

154. Calculate the average price of fish corre-sponding to the total daily production and supply offish expressed in answer to the last question.

155. Calculate the sales revenues of the aver-age fishing enterprise under this new assumption.

156. Calculate profit of the average fishingenterprise under this new assumption.

157. Calculate total sales revenues in the eco-nomic system under this new assumption.

158. Calculate total profit in the economicsystem under this new assumption.

159. A proper conclusion to be drawn fromthe preceding questions is that the productivity theoryof profit/interest is correct in holding that the net pro-ductivity of capital goods explains the rate of profitand interest in the economic system.

160. A proper conclusion to be drawn fromthe preceding questions is that the adoption of moreproductive methods of production serves to raise theaverage rate of profit and interest in the economic sys-tem.


Now assume that during the time that the one mil-lion fishing enterprises are in process of construct-ing their boats and nets (150 days in all), they eachdevote one-third of the daily labor of their workersto that purpose.

161. Calculate the daily output of fish foreach of these enterprises.

162. Calculate the aggregate, economy-widedaily output of fish.

163. Calculate the average price at which thefish are sold under the continuing assumption of an in-variable money.

164. State the sales revenues of the economicsystem during this period.

165. Calculate the aggregate cost of goodssold during this period.

166. Calculate the aggregate profit of the eco-nomic system during this period.

167. It is a mistake to conclude from the an-swers to these questions that the effect of divertinglabor and the corresponding payment of wages to theconstruction of a fixed asset is to correspondingly re-duce cost of goods sold and thus to equivalently raiseprofits in the economic system.

168. The productivity of capital goods, suchas a boat and net, can explain

a. a virtually corresponding addition to the profitsof an individual enterprise if it is alone in adopt-ing the more productive method represented bythe use of a boat and netb. the existence of an addition to the aggregateprofits of the economic system, because the adop-tion of more productive methods of production byany one enterprise has no implications for the prof-itability of other enterprisesc. both (a) and (b)d. neither (a) nor (b)

169. If, in an economic system with an invari-able money, all firms employ more productive meth-ods of production based on the use of more capital,

a. prices fall in inverse proportion to the increasein production and supplyb. aggregate sales revenues remain unchangedc. no addition to aggregate profits or the averagerate of profit in the economic system is implied solong as aggregate productive expenditure remainsthe same and aggregate cost remains equal to ag-gregate productive expenditured. all of the above

170. An indirect connection can exist be-tween the adoption of more productive methods of pro-duction and a positive contribution to the rate ofprofit/interest via

a. the effect of the adoption of more productivemethods of production on the rate of increase in

the quantity of commodity money in an economicsystem that uses commodity moneyb. the effect of the adoption of more productivemethods of production on net investment in the pe-riod in which additional capital required for theadoption of the more productive methods is beingaccumulatedc. both (a) and (b)d. neither (a) nor (b)

171. The general marginal net productivityof physical capital goods, conceived of in terms of ab-stract units of wealth, such as the productive consump-tion of each unit K of capital goods resulting in anoutput equivalent to 2K or, alternatively, 4K, of capitalgoods, is far higher than the average rate of profit/inter-est because

a. wage cost as well as the cost of the capitalgoods must be subtracted from sales revenues, butthis is not allowed for in calculations of physicalproductivityb. increases in the production of commodities(other than the commodities that themselves serveas money) do not increase aggregate sales reve-nues but reduce prices in the face of the same ag-gregate sales revenuesc. both (a) and (b)d. neither (a) nor (b)

172. Select the best choice. a. According to the time preference theory in itstraditional form, the totality of the means of pro-ducing a future good, such as ten apples to beready in one year, are purchased at a discount, forexample, for nine present apples—i.e., for nine ap-ples available right now. In one year, when theproduct ten apples appears, those apples will beten present apples, and thus a profit of one applewill have been earned.b. According to the time preference theory in itstraditional form, profit/interest exists because fac-tors of production represent future goods (i.e., theproducts into which they will be transformed),and are thus purchased at a discounted value incomparison to the present goods they will later be-come. When they finally are transformed intotheir products and have thus become presentgoods, the products represent a larger quantity ofpresent goods than did the discounted value of themeans of producing them. The difference is profitor interest.c. both (a) and (b)d. neither (a) nor (b)


The following applies to the next 3 questions. Ac-cording to the time preference theory in its traditionalform, calculate the various rates of profit/interest thatresult if one begins with 9 present apples and succeedsin ending up with a product that then represents

173. 10 present apples.



The following 13 questions require a copy ofReisman’s Figure 16–2.In each year of Reisman’s Figure 16–2, a product of1C of consumers’ goods is produced, which sells for500 units of money and has a cost of production of400 units of money. The amount of profit earned onthose consumers’ goods is 100 units of money and therate of profit/interest expressed as a percentage of thecost value of the consumers’ goods is 25 percent.From the perspective of the production box of eachyear of Figure 16–2, the consumers’ goods to be avail-able at the beginning of the following year are futuregoods.

176. Express the cost of producing the 1C ofconsumers’ goods to be available at the start of the fol-lowing year in terms of the quantity of presentconsumers’ goods that is of equivalent monetaryvalue, i.e., state what portion of the consumers’ goodsavailable in Year 1 is equivalent in monetary value tothe means of producing the consumers’ goods to beavailable at the start of Year 2.

177. Express the rate of profit in terms of thedifference between the present goods value of themeans of producing 1C of consumers’ goods and theresulting actual 1C of consumers’ goods.

Now assume that the economic system suddenly be-comes more productive. Thus, imagine that in Year2, say, the same means of production that were pre-viously able to produce just 1C of consumers’ goodsnow become able to produce 2C of consumers’goods, which will become available at the start ofYear 3.

178. State the quantity of present goods thatrepresents the cost value of the means of producing theconsumers’ goods that will become available at thestart of Year 3.

179. Calculate the difference between thepresent consumers’ goods one ends up with at the startof Year 3 and the present goods value, back in Year 2,of the means of producing them.

180. Calculate, in terms of a percentage ofcost, the rate of profit/interest implied by your answerto the previous question.

181. Using Figure 16–2’s framework of aninvariable money, compare the monetary receipts fromthe sale of consumers’ goods in Year 3 with the moneycost of producing those consumers’ goods and statethe difference.

182. The monetary differnce arrived at in an-swer to the preceding question continues to prevaileven though the physical product that is produced andsold rises from 1C to 2C.

Now assume that the economic system had sud-denly become less productive instead of more pro-ductive. Thus, imagine that in Year 2, the samemeans of production that were previously able toproduce 1C of consumers’ goods now become ableto produce only .5C of consumers’ goods, whichwill become available at the start of Year 3.

183. Calculate for this case the difference be-tween the present consumers’ goods one ends up withat the start of Year 3 and the present goods value, backin Year 2, of the means of producing them.

184. Also calculate for this case, in terms ofa percentage of cost, the rate of profit/interest impliedby your answer to the previous question.

185. Using Figure 16–2’s framework of aninvariable money, compare the monetary receipts fromthe sale of consumers’ goods in Year 3 with the moneycost of producing those consumers’ goods and statethe difference.

186. The monetary differnce arrived at in an-swer to the preceding question continues to prevaileven though the physical product that is produced andsold falls from 1C to .5C.

187. On the basis of the preceding examples,it is clear that the basic formula of the time-preferencetheory demonstrates exactly what it is supposed todemonstrate. Starting with 9 present apples and endingwith 10, 20, or 5 present apples a year later tells us therate of return that is actually earned in production.

188. The time-preference theory assumesthat the prices of present goods

a. fall when production increasesb. rise when production decreasesc. remain the same, irrespective of changes inproductiond. none of the above

The following applies to the next 3 questions. Therate of profit/interest calculated as a percentage of costis initially twenty-five percent. Now production in theeconomic system doubles while the expenditure ofmoney to produce the product remains the same.

189. State the rate of profit/interest impliedby the time-preference theory.


190. State the rate of profit/interest impliedby the doctrine of purchasing-power price premiums ifthe increase in production takes place under an invari-able money and thus causes a halving of prices.

191. The supporters of the time-preferencetheory and of the doctrine of purchasing-power pricepremiums in the rate of profit/interest hold the contra-diction of regarding increases in production as thecause both of an increase and a decrease in the rate ofprofit.

192. The time-preference theory shares withthe productivity theory the error of assuming that agreater or smaller physical product implies correspond-ingly greater or smaller money sales revenues.

193. According to the doctrine of purchasing-power price premiums a fall in prices reduces the rateof profit/interest by an equivalent percentage.

194. Böhm-Bawerk’s exposition of the time-preference theory in its traditional form shares with hiscritique of the exploitation theory the error of regard-ing the wage earners as the real producers of the prod-ucts, rather than, as is in fact the case, the businessmenand capitalists.

195. Like Böhm-Bawerk’s exposition, Rothbard’s exposition of the time-preference theoryalso regards the wage earners as the real producers ofthe products.

196. According to the time-preference theoryin its traditional form, the value of consumers’ goodsrepresents a fixed starting point from which the valueof the factors of production is derived by the applica-tion of a rate of discount to the value of theconsumers’ goods.

The following pertains to the next 8 questions. Therate of profit/interest is 10 percent. Two consumers’goods, one a quantity of wheat which takes 6 months togrow and the other a quantity of scotch which takeseight years to produce, are each worth $100. Bothproducts can be produced with the same kind of labor,with the result that labor can be transferred from theproduction of the one to the production of the other.We assume that labor is the only factor of productionthat needs to be purchased in the two cases.

197. Find the value of the labor required togrow the wheat according to the time preference the-ory in its traditional form.

198. Find the value of the labor required toproduce the scotch according to the time preferencetheory in its traditional form.

Now assume that the rate of profit/interest falls to 5percent.

199. Find the new value of the labor requiredto grow the wheat according to the time preference the-ory in its traditional form.

200. Find the new value of the labor requiredto produce the scotch according to the time preferencetheory in its traditional form.

201. This example shows that in order for thevalue of consumers’ goods to be a fixed starting pointfrom which the value of the factors of production is de-rived, wage rates of the same kind of labor would haveto become permanently unequal in the production ofproducts requiring different periods of time in theirproduction.

202. In reality, when the rate of profit/inter-est fell from 10 percent to five percent,

a. wage rates in the production both of the wheatand the scotch would rise, but the wage rates inthe production of the scotch would tend to rise bymoreb. labor would be attracted to the production ofthe scotch from the production of wheat, tendingto equalize wage rates in the production of thetwo goodsc. the price of scotch would fall, because of theincrease in its production and supply, while theprice of wheat would rise, because of the decreasein its production and supplyd. all of the abovee. none of the above

203. The correct answer to the precedingquestion shows the market value of consumers’ goodscan properly be taken as a fixed starting point for thedetermination of the value of the factors of productionby the application of a rate of discount to the value ofconsumers’ goods.

204. It is an error to take the value ofconsumers’ goods as a fixed starting point and to as-sume that changes in the rate of profit/interest affectonly the value of the factors of production used to pro-duce them.

205. Select the best choice. a. the prices of factors of production are funda-mentally determined by supply and demand noless than the prices of consumers’ goodsb. the rate of discount (viz., profit/interest)emerges as the result of differences between thedemand/supply situation in the market for prod-ucts and the demand/supply situation in the mar-ket for factors of productionc. the demand for products tends regularly andpermanently to exceed the demand for factors ofproduction by the amount of net consumptiond. the supply of products can be less or more thancorresponds to the supply of factors of production


to the extent that there is positive or negative netinvestmente. all of the above

206. Böhm-Bawerk’s recognition that who-ever has savings of any kind thereby demonstrates thathe values the last unit of wealth that he devotes to thefuture above an additional unit of wealth that he mightdevote to enjoyment in the present

a. implies that to this extent an individual has apreference for future goods over present goodsb. undermines the time preference theory in itstraditional form, which holds that profits/interestderive from the higher valuation of present goodsover future goodsc. does not eliminate the role of time preferencein determining the rate of profit/interest if the roleof time preference is perceived as determining theextent to which individuals divide their wealthand income between consumption and provisionfor the future, and thus as the major determinantof the rate of net consumptiond. all of the above

207. Ricardo’s proposition that “profits riseas wages fall and fall as wages rise”

a. was advanced in the context of an invariblemoneyb. can be understood as representing profits ris-ing as productive expenditure and costs fall, if

wages are regarded as representing all of produc-tive expenditurec. implicitly presupposes the existence of net con-sumption as the basis of sales revenues beinggreater than “wages” or productive expenditured. is consistent with real wages and real profitsboth rising together and with real wages risingeven when “profits rise and wages fall”e. all of the above

208. John Stuart Mill’s proposition that “de-mand for commodities is not demand for labor”

a. must be accepted, at least implicitly, in orderto see that the demand for consumers’ goods regu-larly and consistently exceeds the demand forlabor and thus to recognize net consumption as asource of aggregate profit/interestb. was accepted by Ricardo and thus helps tomake his doctrine that “profits rise as wages falland fall as wages rise” compatible with the netconsumption theoryc. both (a) and (b)d. neither (a) nor (b)

209. If John Stuart Mill’s proposition that“demand for commodities is not demand for labor”were not true, and the demand for commodities were ademand for labor, the demand for consumers’ goodscould not exceed the demand for labor and thus netconsumption could not exist.


Answers to Questions 1-209 on Chapter 16 *See next page concerning 97-114. 184

Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 c 31 T 61 c 91 c 121 7.10% 151 $999,970 181 1002 T 32 T 62 d 92 T 122 2.10% 152 -$27 182 T3 F 33 b 63 T 93 T 123 c 153 30000000 183 -.3C4 F 34 T 64 d 94 b 124 d 154 $0.10 184 -37.5%5 F 35 T 65 d 95 T 125 T 155 $3 185 1006 a 36 T 66 d 96 c 126 a 156 $1 186 T7 d 37 T 67 e 97* $105.00 127 c 157 $3,000,000 187 F8 T 38 T 68 T 98 $100.4074 128 d 158 $1,000,000 188 c9 T 39 T 69 c 99 $110.25 129 F 159 F 189 150%

10 d 40 T 70 c 100 $107.10 130 e 160 F 190 -25%11 c 41 $200,000 71 10 101 7.10% 131 F 161 2 191 T12 d 42 $204,000 72 100 102 $100.5732 132 F 162 2,000,000 192 T13 c 43 $206000 also $94000/$300000 = 31.33% 73 0 103 7.10% 133 d 163 $1.50 193 T14 T 44 $208000 also $192000/$400000 = 48% 74 5 104 $114.70 134 2700 164 $3,000,000 194 T15 c 45 $220000 also $780000/$1000000 = 78% 75 5 105 7.10% 135 2550 165 $1,333,333 195 T16 c 46 $1020000 also -$20000/$1000000 = -2% 76 10 106 $104.00 136 75 166 $666,667 196 T17 d 47 c 77 50 107 $100.33 137 3400% 167 F 197 $9518 a 48 b 78 100 108 $108.16 138 3.65 168 a 198 $4719 T 49 c 79 e 109 $107.12 139 12410% 169 d 199 $97.5020 a 50 b 80 T 110 7.12% 140 d 170 c 200 $6821 T 51 F 81 c 111 $100.5732 141 F 171 c 201 T22 e 52 F 82 b 112 7.12% 142 b 172 c 202 d23 T 53 T 83 T 113 $114.75 143 e 173 11.11% 203 F24 200 54 T 84 a 114 7.12% 144 $3,000,000 174 122.22% 204 T25 11.11% 55 T 85 T 115 T 145 $2,000,000 175 -44.44% 205 e26 NC of 200 56 b 86 T 116 T 146 $1,000,000 176 .8C 206 d27 c 57 c 87 T 117 T 147 3,000,027 177 0.25 207 e28 T 58 d 88 T 118 5.00% 148 $0.999991 178 .8C 208 c29 F 59 T 89 T 119 1.96% 149 $30 179 1.2C 209 T30 T 60 T 90 T 120 1.0710 150 $28 180 150%

The following relates to questions 97-114. 185

Rate of Net Sales Rate of Increase Sales Rate of Annualized

Consumption/ Revenues in Money and Revenues Profit Profit Rate of Profit

Rate of Profit $100*(1+B) Spending C*(1+D) E - $100 F/100

Annual 5.00% $105.00 2.00% $107.10 $7.10 7.10% 7.10%

Monthly 0.4074% $100.4074 0.1652% $100.5732 $0.57 0.5732% 7.10%

Biannual 10.25% $110.25 4.04% $114.70 $14.70 14.70% 7.10%

Annual 4.00% $104.00 3.00% $107.12 $7.12 7.12% 7.12%

Monthly 0.33% $100.33 0.25% $100.57 $0.57 0.57% 7.12%

Biannual 8.16% $108.16 6.09% $114.75 $14.75 14.75% 7.12%

Question Answer

1 c

2 T

3 F

4 F

5 F

6 a

7 d

8 T


Chapter 17

1. Capital accumulation can take place onlywith an accompanying fall in the rate of profit.

2. When production increases and prices fall,the result is

a. a fall in profit margins and the rate of profitb. an increase in the difficulty of repaying debtsc. deflationd. all of the abovee. none of the above

3. Capital accumulation can take place withboth no accompanying fall in the rate of profit and nogreater difficulty of repaying debts.

4. In the conditions of an invariable money, afall in the rate of profit is associated with an accelera-tion of the rate of capital accumulation and fall inprices, rather than with capital accumulation and fall-ing prices per se.

5. In the conditions of an invariable money,capital accumulation can take place

a. on the basis of a sufficiently high but stablevolume of demand for capital goods and of pro-ductive expenditure overallb. only on the basis of a rising demand for capitalgoods and of productive expenditure overall

6. The habit of focusing almost exclusivelyon the production of consumers’ goods, as though allthat were produced were consumers’ goods,

a. prevents one from recognizing that once alarger supply of capital goods comes into exis-tence and increases the ability to produce, that cir-cumstance causes an increase in the productionand supply of capital goods as well as an increasein the production and supply of consumers’ goodsb. leads to the belief that the only source of capi-tal accumulation is more savingc. both (a) and (b)d. neither (a) nor (b)

7. The conclusion that the effect of capital ac-cumulation is a lower rate of profit

a. is a valid generalization from the effects ofgreater investment in an individual industryb. rests on the fallacy of compositionc. both (a) and (b)

8. Falling prices caused by increased produc-tion and supply are not preceded or accompanied byfalling unit costs.

9. Given the monetary demands for the prod-ucts of business and for factors of production by busi-ness, falling prices caused by increased production andsupply are preceded by falling unit costs to the sameextent.

10. Given the monetary demands for theproducts of business and for factors of production by

business, falling prices caused by increased productionand supply are preceded by falling unit costs to thesame extent, because the increase in the supply ofproducts is preceded by a corresponding increase inthe supply and/or productivity of the factors of produc-tion.

11. A fall in the rate of profit that resultsfrom a fall in the rate of net consumption differs froma fall in the rate of profit that results from a financialcontraction and deflation because

a. a fall in the rate of net consumption entails arise in saving and productive expenditure, net in-vestment, and the formation of new capital givingrise to a higher degree of capital intensiveness,and makes possible a correspondingly greateravailability of credit, which characterizes it as thevery opposite of a period of deflation or financialcontractionb. in a deflation or financial contraction, produc-tive expenditure falls, net investment becomesnegative, capital values decline, and credit be-comes largely unobtainablec. both (a) and (b)

12. The process of falling prices resultingfrom increased production and supply is likely to be ac-companied by an increased difficulty of repaying debt.

13. Under a gold standard, the process of fall-ing prices resulting from increased production and sup-ply is actually almost certain to be accompanied by agrowing ability to repay debt rather than by an in-creased difficulty of repaying debt.

14. Under a gold standard, the process of fall-ing prices resulting from increased production and sup-ply is actually almost certain to be accompanied by agrowing ability to repay debt rather than by an in-creased difficulty of repaying debt because the in-crease in production and supply will almost certainlybe accompanied by an increase in the production andsupply of gold and thus correspondingly rising spend-ing and sales revenues in terms of gold.

15. Under a system of commodity money,the fall in the rate of profit that is the accompanimentof launching or accelerating the process of capital ac-cumulation by means of a fall in the rate of net con-sumption, is in part reversed by the consequences ofthat capital accumulation, which include an increase inthe production and supply of the commodity serving asmoney, along with an increase in the production andsupply of commodities in general.

16. Just as technological progress is not re-quired as an “outlet” for capital goods accumulatedmerely by means of saving, but is itself a source ofcapital goods, so in its relation to the increase in thesupply of commodity money it is not an outlet for netinvestment, but is itself a source of net investment.




17. Technological progressa. provides new and additional uses for an ex-panding supply of capital goods resulting fromsavingb. is a major source of new and additional capitalgoods

18. Ricardo’s essential insight concerningthe nature of capital accumulation was that it is the re-sult of anything that increases production in general.

19. A fall in the rate of profit caused by a fallin the rate of net consumption is unlikely to be accom-panied by a rise in the demand for money for holding,as is the case when the rate of profit falls because of afinancial contraction/deflation, because

a. it does not render the rate of profit negativeb. it results in additional saving and capital accu-mulation and thus in the availability of additionalcredit, which last operates to reduce the demandfor money for holdingc. both (a) and (b)

20. With the passage of time, the cumulativeproportion of the capital goods and labor in existencein any given base year that directly or indirectly servesin the production of consumers’ goods continuallygrows, while the proportion continuing to serve indi-rectly in the production of capital goods and thus ofconsumers’ goods in the still further future continuallydeclines.

21. Irrespective of how high is the relativeproduction of capital goods and how low is the relativeproduction of consumers’s goods, virtually the totalsupply of the means of production existing in anygiven year are ultimately devoted to the production ofconsumers’ goods.

22. The average period of production orlength of the structure of production can be expressedin terms of how many years must elapse before somegiven percentage of the capital goods and labor in exis-tence in a base year will have ended up directly or indi-rectly serving in the production of consumers’ goods.

23. A continuous lengthening of the periodof production is necessary for the existence of capitalaccumulation.

24. The role played in capital accumulationby the average period of production explains why tech-nological progress by itself is limited in its ability tobring about capital accumulation.

25. An economic system with a longer aver-age period of production is in no better position to im-plement technological advances than an economicsystem with a shorter average period of production.

26. In an economic system with either an in-variable money or a quantity of money and volume ofspending that increases at any given rate, the taxationof profits

a. raises

b. lowersc. leaves unchanged

the pretax rate of profit.

27. Under a system of commodity money,the taxation of profits

a. raisesb. lowersc. leaves unchanged

the rate of net investment and the rate of profit insofaras it depends on the rate of net investment.

28. In an economic system with either an in-variable money or a quantity of money and volume ofspending that increases at any given rate, budget defi-cits financed by borrowing from the public operate to

a. raiseb. lowerc. leave unchanged

the rate of profit.

29. Under a system of commodity money,budget deficits financed by borrowing from the publicoperate to

a. raiseb. lowerc. leave unchanged

the rate of net investment and the rate of profit insofaras it depends on the rate of net investment.

30. The goal of increasing saving and capitalformation through balancing the government’s budgetis facilitated more by cutting government spendingthan by increasing taxes, insofar as the additional taxeswould come at the expense of saving.

31. When the rate of profit is 5%, it pays aninvestor to wait an additional year for payback if thelater payback will be more than 5% greater than theearlier payback, and to wait an additional two yearsfor payback if the later payback will be more than10.25% greater than the earlier payback, and so on.How much greater must the paybacks be if the rate ofprofit is 10%?

32. To the extent that government interven-tion has served to raise the rate of profit in the eco-nomic system, it has contributed to an emphasis onshort-term results.

33. To the extent that chronic budget deficitsin the United States have made the rate of profit higherin the United States than in Japan, they have

a. encouraged Japanese investment in the UnitedStatesb. contributed to the negative US balance of tradewith Japanc. mitigated the reduction in capital available andrise in the rate of profit that would otherwise havetaken place in the US as the result of its budgetdeficitsd. all of the above



10PT = The following is four-part question:

34. Economic freedom and respect for prop-erty rights promote capital accumulation and eco-nomic progress by

a. increasing the productivity of capital goodsand thus reducing the maintenance proportionb. increasing the relative production of capitalgoodsc. both (a) and (b)

35. The relative size of a country’s economyin the world as a whole depends in the long run on itsrate of capital accumulation and economic progress.

36. The relative size of a country’s economyin the world as a whole depends in the long run on theextent of its economic freedom and respect for prop-erty rights.

37. In the face of more rapid increases in pro-duction in the rest of the world than in the UnitedStates, greater economic freedom and respect for prop-erty rights in the United States is necessary in order tostem the decline in the relative size of the Americaneconomy.

38. In the absence of increases in the quan-tity of money, net saving in terms of money wouldshow a tendency to disappear.

39. In the absence of increases in the quan-tity of money, net saving in terms of money wouldtend to disappear because

a. costs tend to rise toward any given level of pro-ductive expenditureb. to the extent that net saving continued and in-creased the total of accumulated savings and capi-tal, the amount of net consumption would tend torise and thus cause productive expenditure to fallc. both (a) and (b)

40. The actual economic significance of sav-ing lies at the gross level, rather than at the net level,because this is the level at which the respective de-mands for capital goods and labor relative to the de-mand for consumers’ goods are present and play theirvital role even though net saving in terms of moneymay be zero.

41. Continued net saving in terms of moneya. reduces the rate of profitb. is the product of forces that add to the rate ofprofit, viz., the increase in the quantity of moneyand volume of spending

42. In the long run, hoarding is the cause of ahigher rate of profit rather than a lower rate of profitbecause the funds hoarded are as much a foundation ofnet consumption as the funds invested; at the sametime, the ratio of net consumption to funds invested is

increased, to the extent that people hold their savingsin the form of cash hoards rather than investments.

43. The scarcity of capital in its vertical di-mension refers to

a. the extent to which capital is available for em-ployment at stages of production more remotefrom the production of consumers’ goods, e.g., inthe production of the steel that is used to produceautomobiles, in the construction of the steel millsthat are used to produce that steel, and so onb. the relation between the supply of capital andthe need for more overall capital directly or indi-rectly employed per unit of consumers’ goods pro-ducedc. the need for a higher degree of capital inten-sivenessd. all of the above

44. In its horizontal dimension, the scarcityof capital is as great as is the scarcity of consumers’goods.

45. Outlets for additional investment of capi-tal in its vertical dimension exist in accumulating capi-tal sufficient

a. to enable the vast majority of the world that ispresently not industrialized to come up to the de-gree of capital intensiveness of the portion of theworld that is industrializedb. within the industrialized countries to enableevery factory, farm, mine, and store to increase itsdegree of capital intensiveness to the point pres-ently enjoyed only by the most capital-intensiveestablishmentsc. to enable all productive establishments to raisethe standard of capital intensiveness to the pointwhere no further reduction in costs of productionor improvement in the quality of products couldbe achieved by any greater availability of capitalin its vertical dimensiond. all of the above

46. The potential for a rise in the value ofland constitutes an outlet for virtually unlimited sav-ings and capital accumulation in its vertical dimensionat a positive rate of return on capital.

47. The doctrine of underconsumptionisma. holds that an increase in saving and decreasein consumption requires that in order for the addi-tional savings to be invested, business must buyfor more at the very time that it sells for lessb. omits the demand for capital goods when itconcludes that an increase in saving and decreasein consumption means a reduction in businesssales revenuesc. both (a) and (b)

48. The demand for capital goods and laborcan

a. not lastinglyb. radically and permanently


exceed the demand for consumers’ goods.

49. The demand for capital goods and laborcan radically and permanently exceed the demand forconsumers’ goods because under such conditions

a. most of the demand for capital goods and laborcomes to be made in the production of capitalgoods, not consumers’ goodsb. the demand for consumers’ goods needs to ex-ceed only the limited part of the demand for capi-tal goods and labor made directly in theproduction of consumers goods, while the demand

for capital goods in the production of consumers’goods constitutes a further demand for goods, be-hind which stands a further demand for capitalgoods and labor, and so on, indefinitelyc. matters are described by an infinite series thefurther terms of which are larger the smaller is theinitial term and the larger is the proportion inwhich later terms stand to earlier termsd. all of the above


Chapter 17, Questions 1-48. 191

Ques- Correct Ques- Correct tion # Answer tion # Answer

1 F 26 a2 e 27 b3 T 28 a4 T 29 b5 a 30 T6 c 31 >10% & >21%7 b 32 T8 F 33 d9 T 34 c10 T 35 T11 c 36 T12 F 37 T13 T 38 T14 T 39 c15 T 40 T16 T 41 b17 b 42 T18 T 43 d19 c 44 T20 T 45 d21 T 46 T22 T 47 c23 F 48 b24 T 49 d25 F


Chapter 18

1. An economist’s acceptance of the proposi-tion that unemployment can be eliminated by a fall inwage rages and prices implies opposition on his part tolabor legislation and all other government interventionthat stands in the way of wage rates falling in the faceof unemployment.

2. In view of the influence of the Marxian ex-ploitation theory, opposition to government interven-tion on the side of raising and maintaining wage rates

a. opened an economist up to the condemnationof being ready to leave wage earners defenselessagainst exploitation by businessmen and capitalistsb. required that an economist be able to refute theMarxian exploitation theory if he wished to over-come such condemnation, which was a task be-yond the ability of most economistsc. required that an economist who was capable ofrefuting the Marxian exploitation theory take astand in opposition to the overwhelming intellec-tual current of the timed. all of the above

3. The essential claim of Keynesianism isthat a free market in labor and fall in wage rates is in-capable of eliminating unemployment and that massunemployment is an inescapable feature of a capitalisteconomic system in modern conditions.

4. A leading implication of Keynesianism isthat there is no need for economists to oppose govern-ment interference raising or maintaining wage rates,since the abolition of such interference would notserve to eliminate unemployment in any case, and thusthat there is no reason for economists to have to be in astate of conflict with the prevailing opinion of virtuallyall other intellectuals.

5. According to Keynesianism, the solutionfor mass unemployment is “fiscal policy,” by which,in essence, is meant that the government must adopt apolicy of budget deficits.

6. According to Keynesianism, the more thegovernment spends for any purpose—even for theleast valuable programs imaginable, such as pyramidbuilding—the more prosperous must the economic sys-tem become.

7. Keynesianism was a source of intellectualrelief for many economists, because his ideas filledwhat perhaps the majority of economists experiencedas a vital need—it gave them a way out of conflictwith the rest of the intellectual world and with a goodportion of their own convictions. For if Keynes wereright, economists need not oppose labor legislation. In-deed, they could join in the calls for expanded govern-ment intervention.

8. Such ideas as that pyramid building andbudget deficits are economically beneficial marks Key-

nesianism as an enemy both of common sense and thelove of liberty (viz., the freedom from excessive gov-ernment, which excess is fostered by the policy of bud-get deficits).

9. Keynesianism a. holds that even though the quantity of moneyin the economic system remains the same, a fall inwage rates and prices is accompanied by propor-tionately less spending, since it alleges that thereis no increase in the quantity of goods and labordemanded at the lower prices and wagesb. is incompatible with the quantity theory ofmoneyc. is a species of consumptionismd. all of the above

10. The success of Keynesianism in overcom-ing opposition was the result in large part of the unnec-essary abandonment two generations earlier of themain body of classical economic thought in the mis-taken belief that it supported Marxism, in particularthe abandonment of classical economics’ views on thewages fund doctrine and the role of saving in spend-ing.

11. Neo-Keynesianism a. arose in response to some relatively mild criti-cism of Keynes levied by A. C. Pigou, a colleagueat Cambridge University b. admits that a fall in wage rates would be capa-ble of eliminating unemployment, but claims thatthe fall would have to be enormously out of pro-portion to any additional employment achieved,with the implication that in the process of achiev-ing full employment virtually every debtor wouldbe bankrupted, because the grossly disproportion-ate drop in wage rates and prices implies corre-spondingly large reductions in aggregate spendingand revenues and thus in the ability to repaydebts. c. claims that a necessary condition of pricesbeing able to fall would be the adoption of a radi-cal antitrust policy, or a program of widespreadnationalization of industry, as the means of estab-lishing “price competition,” because big business,left to its own devices, is “oligopolistic” and prac-tices “administered pricing”—i.e., won’t reducepricesd. fully agrees with Keynesianism with respect tothe conclusion that a free economy cannot havefull employmente. all of the above

12. The neo-Keynesians are led to concludethat reductions in wage rates and prices can have onlya relatively modest impact on the increase in employ-ment and output because the only mechanism they canimagine by which a fall in wage rates and prices can




increase the quantity of goods and labor demanded isby virtue of its effect in increasing the buying powerof the stock of money and on that basis increasing thedemand for consumers’ goods and thereby creating ad-ditional employment.

13. Pigou’s doctrine is even weaker than theKeynesians themselves recognize, because if themoney supply of the economic system rests on a frac-tional reserve, and if it were the case that there must besome significant drop in total spending accompanyingthe fall in wage rates and prices, then there would besubstantial business failures, which would result insubstantial bank failures and in a reduction in the quan-tity of money. In such a case, the “Pigou effect” wouldbe reduced to depending on the ability of a fall inwage rates and prices to raise the purchasing powernot of a fixed stock of money (which would not befixed, but falling) but of a much more limited fixedmonetary base.

14. Samuelson and Nordhaus depart bothfrom Keynesianism and traditional neo-Keynesianismin their explanation of unemployment as being causedby wage-rate rigidities rather than by the alleged per-fect inelasticity or at least extremely high inelasticityof the aggregate demand curve.

15. When they say, “The classical approachholds that prices and wages are flexible, so the econ-omy moves to its long-run equilibrium very quickly,”Samuelson and Nordhaus

a. misrepresent the views of the classical econo-mists, who never maintained that wages andprices are flexible in the face of minimum-wageand prounion legislation and similar governmentinterferenceb. ignore the existence of such government inter-ferencec. both (a) and (b)

16. When they say that the classical econo-mists preached “that persistent unemployment was im-possible,” Samuelson and Nordhaus ignore the factthat the classical economists’ proposition was intendedto apply only to a labor market free of government in-terference, not to one in which such interference pre-vents a fall in wage rates.

17. Choose the answer which is most com-pletely true.

a. According to Samuelson and Nordhaus,Keynes emphasized that because wages and pricesare inflexible, there is no economic mechanism torestore full employment and ensure that the econ-omy produces its potential.b. Keynes’s actual position was that there is noway for a free economy, which has flexible wagesand prices, to achieve full employment.c. Samuelson and Nordhaus’s claim represents anunadmitted capitulation to the claims of classicaleconomists, in that it concedes that what stands inthe way of full employment is a failure of wage

rates to fall and thereby increase the quantity oflabor demanded.d. all of the above

18. As presented by Samuelson andNordhaus, what remains of the Keynesian position ismerely an obstinate refusal to challenge the govern-ment intervention that is responsible for mass unem-ployment, and an insistence that the problem ofunemployment be dealt with by means of still moregovernment intervention.

19. The Keynesian doctrine of the unemploy-ment equilibrium is the claim that

a. a fall in wage rates and prices is incapable ofincreasing the quantity of labor demanded, be-cause it is accompanied by a corresponding fall inthe aggregate monetary demands for consumers’goods and laborb. a free economy cannot escape from mass un-employmentc. both (a) and (b)

20. The Keynesian aggregate demand curveis identical to the consumptionist aggregate curve pre-sented in Chapter 13 except for the horizontal axis rep-resenting employment as well as output, and the use ofthe letter Y to denote output.

21. The claim of many union leaders thatwage rate reductions result in proportionate reductionsin consumer spending

a. is often thought to be the basis of the Keynes-ian aggregate demand curveb. is fallacious because while the wage-rate re-ductions reduce the spending of the individualwage earner, they increase the number of workersemployed and thereby enable the same overalllevel of spending to be maintained by the individu-ally smaller spending of a larger number of work-ers, which unchanged level of overall spending issufficient to buy the output of the larger numberof workers by virtue of lower pricesc. both (a) and (b)

22. The fall in wage rates to their equilib-rium, i.e., full-employment, level is in fact almost cer-tain to be accompanied by a rise in total payrollspending and in productive expenditure as a whole, be-cause it brings out the investment expenditures whichhad been postponed, awaiting the fall in wage rates.Thus, in actuality, it is accompanied by a rise in the ag-gregate monetary demands for labor and for goods,both consumers’ goods and capital goods.

23. The actual basis of the vertical Keynes-ian aggregate demand curve is

a. the claim of many union leaders that wage ratereductions result in proportionate reductions inconsumer spendingb. the IS curve

24. The IS curve


a. is the relationship alleged by the Keynesiansbetween the “marginal efficiency of capital” (viz.,the rate of profit and interest), on the one side, andthe volume of output and employment, on theother, for equilibria of investment and savingb. purports to show that as output and employ-ment expand, as measured along the horizontalaxis, the rate of return on capital falls, as mea-sured along the vertical axisc. both (a) and (b)

25. The IS curve underlies the Keynesian ag-gregate demand curve in that the Keynesians claimthat at the point of full employment on the IS curve,namely Yf and its corresponding output, the rate of re-turn would either be negative or, if not negative, atleast unacceptably low (below 2 percent is the usual es-timate of what is unacceptably low). This alleged insuf-ficiency of the rate of return that would exist if fullemployment were achieved is supposed to be the rea-son that full employment cannot exist, or if it did exist,could not be maintained.

26. The Keynesian argument for an unem-ployment equilibrium is based on the claim that theachievement of full employment would entail a rate ofprofit and interest too low for investment to be worth-while. And thus, if somehow full employment wereachieved, say the Keynesians, savings would behoarded rather than invested, with the effect being adrop in spending for output and labor and a reductionin output and employment below the full-employmentlevel, which would go on until sufficient movementhad taken place up and to the left along the IS curve toraise the rate of return on capital back up to the allegedminimum acceptable rate of return.

27. While 2 percent is the figure most oftencited as the minimum acceptable rate of return, noth-ing depends on that specific assumpiton. If the mini-mum acceptable rate of return were instead assumed tobe zero, the Keynesian argument could simply be re-cast as claiming that full employment required a rateof return below zero.

28. The IS curve is derived froma. the production functionb. the saving functionc. the equality of investment with savingd. the marginal efficiency of capital schedulee. all of the above

29. The production function describes the re-lationship between the quantity of labor employed, onthe vertical axis, and the quantity of output (real na-tional income) produced, on the horizontal axis.

30. The “saving function”a. is the Keynesian doctrine that a definite, deter-minate mathematical relationship exists betweenthe level of income, on the one side, and the vol-ume of saving out of income, on the other

b. when diagrammed shows saving on the verti-cal axis and national income on the horizontal axisc. is the corollary of the more widely known Key-nesian doctrine of the “consumption function,” ac-cording to which consumption spending ismathematically determined by the level of incomed. is derived by subtracting the consumption func-tion from national incomee. is presented as the algebraic formulaS = –a + (1–c)Y,f. all of the above

31. The equilibria of investment and savingis diagrammitically depicted by a 45 degree line thatshows investment equal to saving at every point, withthe vertical axis representing saving and identical tothe vertical axis of the saving-function diagram, andthe horizontal axis representing net investment.

32. The reason for showing the equality ofsaving and investment is to

a. ask what would happen if all that were savedat every level of real income were actually in-vestedb. set the stage for showing why investment can-not in fact be equal to saving when saving is sub-stantialc. both (a) and (b)

33. The marginal efficiency of capital sched-ule

a. is drawn showing the rate of return on capitalon the vertical axis and the volume of net invest-ment on the horizontal axisb. claims that as the volume of net investment in-creases, the rate of return on capital decreasesc. both (a) and (b)

34. The IS curve is derived on the basis ofthe proposition that

a. a given volume of employment results in a cor-responding volume of output (real national in-come) on the production functionb. that volume of output (real national income)implies a definite amount of saving, based on thesaving functionc. that volume of saving requires an equivalentvolume of net investment if hoarding is not to re-sultd. that volume of net investment implies a defi-nite rate of return on capital according to the mar-ginal efficiency of capital schedulee. the pairing of the rate of return on capital im-plied by the marginal efficiency of capital sched-ule with the volume of output (real nationalincome) that gave rise to it represents a point onthe IS curvef. all of the above

35. Keynesianism alleges thata. the “marginal efficiency of capital” is deter-mined by the volume of investment in physical


terms, and thus that as wage rates and prices fall,the effect is to reduce the monetary value of themaximum physical amount of investment that isconsistent with the minimum acceptable rate of re-turnb. since total spending is essentially just a multi-ple of investment spending, the effect of a reduc-tion in wage rates and prices and a proportionalreduction in investment spending is a proportionalreduction in total spendingc. both (a) and (b)

36. According to Keynesianism, there cannotlastingly be a level of employment, output, and real in-come greater than what produces the limited volumeof saving that can be accommodated by the limited vol-ume of profitable investment opportunities.

37. According to Keynesianism, full employ-ment is not possible because if it existed, people wouldattempt to save more than can profitably be invested(i.e., invested at the minimum acceptable rate of returnor better).

38. According to Keynesianism, the achieve-ment of a rate of return on capital high enough to beminimally acceptable requires the existence of unem-ployment in order to reduce

a. the level of output/real incomeb. the volume of saving, which is allegedly deter-mined by the size of output/real incomec. the need for investment to offset the savingd. the downward pressure on the rate of return al-legedly caused by more investmente. all of the above

39. According to Keynesianism, if therewere no additional savings requiring offsetting invest-ment as employment increased, full employment couldactually be achieved, because in that case the rate of re-turn on capital would not have to fall as employmentincreased. Thus, if only people were sufficiently profli-gate, they could be prosperous, according to Key-nesianism.

40. The grounds for the MEC doctrine area. an alleged rise in the purchase price of capitalassets as net investment increasesb. a fall in the selling prices of products as the re-sult of increasing net investment and the addi-tional productive capacity that it brings about,which fall in prices allegedly causes a fall in profitmargins and the rate of profitc. the operation of the law of diminishing returnsas net investment increases, accompanied by a fur-ther fall in the prospective yields to capital assetsd. all of the above

41. “Fiscal policy” is essentially a policy ofgovernment budget deficits designed to deal with thealleged excess of saving over profitable investmentoutlets at the point of full employment.

42. Fiscal policy, in the form of chronic gov-ernment budget deficits, is supposed to be the solutionfor the unemployment equilibrium, according to Key-nesianism, by virtue of providing an additional outletfor saving, alongside the allegedly insufficient outletprovided by profitable investment. With a deficit, em-ployment, output/real income, and saving can alleg-edly be greater with no additional downward pressureon the marginal efficiency of capital, because the ex-cess saving is siphoned off into financing the deficit.

43. An analogy to the Keynesian doctrine ofthe unemployment equilibrium would be the assump-tion of an environmental pollution function in place ofthe saving function and the further assumption of amaximum tolerable amount of pollution. In that case,as employment and output/real income increased, sotoo would the magnitude of pollution. If full employ-ment generated more pollution than the alleged maxi-mum tolerable amount, then a basis would exist for theallegation of an unemployment equilibrium on environ-mental grounds.

44. An analogy to the Keynesian doctrine ofthe unemployment equilibrium would be the assump-tion of an alcholic beverage/narcotic function in placeof the saving function and the further assumption of amaximum tolerable limit to the consumption of al-chohol/narcotics consistent with people being able towork effectively. In that case, as employment and out-put/real income increased, so too would the consump-tion of alchohol/narcotics. If at the point of fullemployment and its corresponding level of output/realincome, the consumption of alchohol/narcotics was sogreat that people could not work, an unemploymentequilibrium could be held to exist for that reason.

45. The Keynesian claim that as net invest-ment increases, the purchase price of capital assetsrises, thereby reducing the rate of return on capital,drops the context that the question at issue is the effectof a fall in wage rates and prices. When wage rates andprice fall, the purchase price of capital assets will fall,not rise. The additional net investment is analogous toan additional quantity demanded at lower prices. Justas the additional quantity demanded at lower prices isnot a rise in demand and does not raise prices, so toothe additional net investment that occurs in response tolower wage rates and prices does not raise the pur-chase price of capital assets, but is in response to thefall in their prices.

46. The Keynesian claim that as net invest-ment increases and thus causes an increase in produc-tive capacity, which in turn leads to a fall in sellingprices, drops the context that what initiates the processis a fall in wage rates, which means a fall in costs ofproduction preceding the fall in selling prices. The ef-fect of the fall in costs is to prevent the fall in sellingprices from reducing profit margins and the rate ofprofit.


47. The Keynesian claim that as net invest-ment increases, the operation of the law of diminishingreturns serves to reduce the yield to successive incre-ments of net investment, drops the context of the in-crease in employment. When wage rates fall andemployment increases, the effect is to increase labormore than capital and thus, if anything, to increasemarginal physical returns to capital, not decreasethem. If ever capital were too abundant, the employ-ment of more labor would be the cure.

48. The Keynesian claim that a fall in wagerates and prices cannot lift the economic system out ofa depression and achieve full employment because atfull employment the rate of return on capital would betoo low, is a claim that the rate of return in the recov-ery from a depression would be lower than it is in thedepression.

49. A major reversal of economic reality onthe part of the Keynesian analysis is its belief that in adepression saving and net investment are at their maxi-mum possible limits, and the problem is that full em-ployment requires that they be carried still further. Theactual fact is, however, that far from being at theirmaximum limits, saving and net investment are ex-tremely low or even negative in a depression.

50. In a depression, net investment is sharplyreduced and even becomes negative as the result of theplunge in productive expenditure, including plant andequipment spending and spending on account of inven-tory, while depreciation and cost of goods sold con-tinue to reflect earlier, higher levels of productiveexpenditure.

51. In a depression, saving is sharply reducedand even becomes negative as the result of

a. the plunge in business profits and the paymentof dividends out of earned surplus, which servesto reduce accumulated business savingsb. the existence of mass unemployment and un-employed workers having to consume their sav-ingsc. both (a) and (b)

52. Profit is sales receipts minus costs. Netinvestment is productive expenditure, which is thesource of the overwhelming bulk of business’s sales re-ceipts, minus those same costs. It follows that in thecontext of a business cycle, in which productive expen-diture and sales reveunes move together virtually dol-lar for dollar, net investment and profits move togethervirtually dollar for dollar.

53. The marginal-efficiency-of-capital doc-trine constitutes a reversal of the actual relationship be-tween net investment and the rate of profit in thecontext of a business cycle, because more net invest-ment accomanying the return to full employmentwould result in a virtual dollar-for-dollar increase inthe amount of profit in the economic system and thusin a rise in the rate of profit, not a fall.


Assume that the Keynesian investment multiplier is 4and that profits are a constant 10 percent of sales reve-nues (actually they are usually a rising percentage ofrising sales revenues).

54. Calculate the increase in national incomeresulting from an increase in net investment of 10.

55. Calculate the increase in profit income.

56. Calculate the ratio of the additional profitincome to the additional net investment.

57. Calculate what the rate of profit wouldhave to have been before the increase in net invest-ment in order for it not to be higher now.

58. The marginal-efficiency-of-capital doc-trine and the multiplier doctrine are mutually contra-dictory in that the former claims that as net investmentincreases the rate of return on capital falls, while thelatter claims that as net investment increases, nationalincome increases by a multiplied amount, which impl-ies that profits increase at a substantial rate relative tothe additional net investment and thus that the rate ofprofit rises.

59. In bringing about a restoration of produc-tive expenditure, particularly for plant and equipment,which had been postponed, awaiting their fall, a fall inwage rates brings about the restoration of net invest-ment and profitability along with full employment.

60. If wage rate reductions were accompa-nied by reduced total wage payments, and the savingof funds were used to buy plant and equipment, aggre-gate business profits would increase, because while ag-gregate sales revenues in the economic systemremained the same, aggregate business costs wouldfall because expenditures for plant and equipment typi-cally show up as costs more slowly than do wage pay-ments.

61. The paradox-of-thrift doctrine is theclaim that the attempt to save a larger proportion of na-tional income results in a smaller amount of nationalincome.


Assume that 10 is the maximum amount of net invest-ment that can occur at the minimum acceptable rate ofreturn or better.

62. If saving is equal to 25 percent of na-tional income, calculate the maximum amount of na-tional income that is consistent with saving notexceeding the allegedly limited profitable investmentopportunites.

63. If saving is equal to 10 percent of na-tional income, calculate the maximum amount of na-tional income that is consistent with saving not


exceeding the allegedly limited profitable investmentopportunites.

64. If saving is equal to 1 percent of nationalincome, calculate the maximum amount of national in-come that is consistent with saving not exceeding theallegedly limited profitable investment opportunites.

65. The paradox-of-thrift doctrine rests en-tirely on the central notion of the Keynesian analysisthat there is room in the economic system for only astrictly limited amount of profitable investment. If thatwere so, then the higher the percentage of incomesaved, the smaller must be the income that results inthe maximum amount of saving that the economic sys-tem can allegedly tolerate by offsetting it with profit-able net investment.

66. Saving out of money income continuesas a permanent phenomenon only because of the con-tinuing increase in the quantity of money and thus thecontinuing increase in the level of money incomes. Insuch conditions more saving is necessary to maintainany given desired ratio of accumulated savings to cur-rent income. If the increase in the quantity of moneyand the consequent rise in money incomes came to anend, it would no longer be necessary to go on savingout of income once accumulated savings reached thedesired ratio to current income. Thus there is no suchthing as saving being a mathematical function of in-come.

67. The continuing saving and net invest-ment that goes on in the world as the result of an in-creasing quantity of money, so far from reducing therate of return on capital, takes place largely out of arate of return that is elevated by that same increase inthe quantity of money and volume of spending.

68. “Liquidity preference,” or cash prefer-ence, as Hazlitt calls it, is

a. people’s preference for holding moneyb. is the basis, according to the Keynesians, forthe minimum acceptable rate of return on capitalbeing 2 percent; 2 percent is the alleged minimumrate of return required to overcome liquidity pref-erencec. allegedly has no limit when the rate of returnfalls to its minimum acceptable leveld. all of the above

69. The arguments the Keynesians advancefor expecting 2 percent to be the minimum rate of re-turn at which people are willing to lend or invest are

a. the costs of bringing borrowers and lenders to-getherb. the potential for capital losses if interest ratesshould rise from a level at or below 2 percentc. both (a) and (b)

70. In a free economy, without inflation andcredit expansion, the rate of profit and interest wouldalmost certainly be above 2 percent as the result of the

combined operation of net consumption and the in-crease in the quantity of gold.

71. If the rate of return on capital somehowdid get so low that people attemted to hoard, that veryfact would operate to raise the rate of return, becausethe rate of net consumption applies to cash holdings aswell as to investments in capital assets other than cash,with the result that the larger are cash holdings relativeto capital assets other than cash, the higher is theamount of net consumption and thus the amount ofprofit in the economic system relative to the value ofcapital assets other than cash.

The following is a four-part question, in which the rateof net consumption is assumed to be constant at 2 per-cent.

72. Assume that initially there is 100 of cashin the economic system and 900 of assets other thancash in the form of capital. Calculate the rate of profiton the capital assets other than cash.

73. Now assume that there is major increasein cash preference, such that while the quantity of cashremains 100, the monetary value of capital assets otherthan cash is cut from 900 to 400.

74. Assume that there is another, evengreater increase in cash preference, such that while thequantity of cash continues to be 100, the monetaryvalue of capital assets other than cash is cut from 400to 100. Calculate the rate of profit on the capital assetsother than cash.

75. Calculate the rate of return on capital as-sets other than cash if cash preference were so powerulthat while there continued to be 100 of cash, the mone-tary value of capital assets other than cash fell to 10.

76. If cash preference were so great that peo-ple did not productively expend and invest at all, what-ever consumption that took place would be profit andthe average rate of profit would be that amount ofprofit divided by zero of invested capital, with the re-sult that the rate of return on capital would be infinite.

77. The fact that there are costs of bringinglenders and borrowers together, and of otherwise in-vesting, and that the absolute amount of return mustexeed these costs in order for lending and investing tobe worthwhile, merely implies that the size of the loanor investment, and the period of time for which it ismade, must be of some minimum, not that all lendingand borrowing cease to be worthwhile as the rate of re-turn falls below some arbitrary level such as two per-cent.

78. When the pooling of small sums is al-lowed for, as is accomplished every day by such insti-tutions as savings banks, the sums which it pays tolend and invest even at a rates of return below 2 per-cent, can be quite small and need be available only forvery short periods of time.


79. If the rate of return on capital is ex-tremely low and people hesitate to lend or invest forfear that it will rise, then either they are right in expect-ing the rate of return to rise, or they are wrong. If theyare right, then the rate of return rises, and the allegedproblem of too low a rate of return simply disappears.If they are wrong, and the rate of return does not rise,then there is no actual reason to fear the rise and theycan lend and invest at the low rate of return. Eitherway, the argument about uncertainty concerning the fu-ture of the rate of interest as a permanent basis of large-scale hoarding does not hold up.

80. If we consider the phenomenon of a risein the rate of return on capital as such, rather thanmerely a rise in the rate of interest on loans, and keepin mind that what brings it about in the circumstancesof recovery from a depression—namely, a recovery ofproductive expenditure and sales revenues—then it be-comes clear that people have good reason to go aheadand invest immediately if they expect the rate of returnto rise. This is because if they invest as stockholders orother categories of equity owners, they will actuallygain from the rise in the rate of return. And if they donot expect the rate of return to rise, then they have nogood reason to abstain from investing out of any fearof securities prices falling.

81. If the rate of return on capital did fall toan extremely low level, the effect would be

a. a reduction in the volume of lending and bor-rowing of relatively small sums for relativelyshort periods of timeb. a reduction in the velocity of circulation ofmoneyc. a counteracting tendency toward a rise in theaverage rate of return because of the applicationof net consumption to cash holdings that werenow larger relative to capital assets in forms otherthan cashd. all of the above

82. According to Keynes, the problem of un-employment, rests on the fact that people insist on sav-ing. If they did not save, if they only consumed, the“multiplier” would allegedly be infinite, and full em-ployment would exist.

83. In conditions in which there would be nosaving whatever, no net saving out of income and nogross saving out of sales revenues, no saving even inthe form of cash holdings, because everyone wouldrace to consume immediately,

a. liquidity preference would be zerob. productive expenditure, costs, and capitalwould be zeroc. profits would equal sales revenuesd. the rate of profit and interest would be infinitee. the employment of wage earners in the produc-tion of products for sale would be zerof. all of the above

84. In Keynes’s view, in the conditions de-scribed in the preceding question,

a. the rate of interest, as the price paid for partingwith liquidity preference, would be zerob. employment would be fullc. both (a) and (b)

85. The economic consequences of Key-nesianism, manifested in the adoption of the impliedeconomic policies have been

a. chronic federal government budget deficitsb. the abandonment of the gold standard and con-tinuous inflation of the supply of paper moneyc. growth in the size of government, in the beliefthat increases in government spending do not re-quire additional taxes and are a source of prosper-ity d. the large-scale undermining of saving and capi-tal accumulation as the result of deficits, inflation,and the confiscatory taxation of high incomese. the “rust belt”f. all of the above

86. Although Keynesianism is, and must be,radically opposed to the quantity theory of money, forthe reasons explained at the beginning of Chapter 18,it nevertheless recognizes the need to couple its policyof budget deficits with an expansion in the quantity ofmoney. This is because even though Keynesianismavows that what increases spending is the mere exis-tence of budget deficits, the fact is that in the absenceof substantial increases in the quantity of money, a pol-icy of sustained large-scale budget deficits would inev-itably result in the government’s bankruptcy.


Chapter 18, Questions 1-86 200

Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion # Answer tion # Answer tion # Answer tion # Answer

1 T 26 T 51 c 76 T2 d 27 T 52 T 77 T3 T 28 e 53 T 78 T4 T 29 T 54 40 79 T5 T 30 f 55 4 80 T6 T 31 T 56 0.40 81 d7 T 32 c 57 > or = 40% 82 T8 T 33 c 58 T 83 f9 d 34 f 59 T 84 c10 T 35 c 60 T 85 f11 e 36 T 61 T 86 T12 T 37 T 62 4013 T 38 e 63 10014 T 39 T 64 100015 c 40 d 65 T16 T 41 T 66 T17 d 42 T 67 T18 T 43 T 68 d19 c 44 T 69 c20 T 45 T 70 T21 c 46 T 71 T22 T 47 T 72 2.22%23 b 48 T 73 2.50%24 c 49 T 74 4.00%25 T 50 T 75 20.20%

Chapter 19, Part A

1. Inflation isa. rising pricesb. an undue increase in the quantity of moneyc. an increase in the quantity of money morerapid than the increase in the supply of gold d. all of the abovee. (b) and (c) but not (a)

2. “Demand-pull inflation” a. refers to an increase in the quantity of moneyand volume of spending as pulling prices up in theface of limited supplies of goods or servicesb. is alleged to be the only way in which in-creases in the quantity of money and volume ofspending can succeed in raising pricesc. both (a) and (b)

3. “Cost-push inflation” a. alleges that prices rise from the side of supplyrather than from the side of demandb. is presented as a mutually exclusive alternativeto the quantity theory of money, whose operationis allegedly confined to “demand-pull inflation”c. both (a) and (b)

4. The doctrine of “cost-push inflation” em-braces rising prices allegedly caused by

a. rising wage rates, in which case it is known as“wage-push inflation” b. the greed of businessmen for higher profits,which is described as “profit-push” or “sellers’ in-flation” c. sudden substantial reductions in the supply ofcritical materials, such as oil, in which case it isdescribed as “crisis-push inflation”d. all of the above

5. The doctrine of the “wage-price spiral”rests on the doctrine of cost-push inflation.

6. Like “cost-push inflation,” so-called de-mand-pull inflation is also supposed to take a varietyof forms. In addition to being caused by an increase inthe quantity of money, it is supposed to be capable ofbeing caused by

a. inexplicable increases in the velocity of circula-tion of moneyb. the unexplained existence of “inflation psy-chology”c. the growing use of credit cards, installmentcredit, or other forms of creditd. the increasing greed of consumers for moregoodse. all of the above

7. Since numerous possibile causes can be ad-duced to explain rising prices in this or that case, thedefinition of inflation as rising prices results in peoplehaving no ready idea of what causes inflation at anygiven time.

8. The definition of inflation as rising pricesimplies that

a. if businessmen did not raise their prices, infla-tion would not existb. the greed of businessmen is responsible for in-flationc. the imposition of price controls would stop in-flation by prohibiting the rise in pricesd. all of the above

9. The definition of inflation as rising pricesdistinguishes between prices rising from the side of de-mand (i.e., from the side of money and spending) andprices rising from the side of production and supply.

10. The definition of inflation as rising pricescan lead to the government’s inflation of the moneysupply in misguided efforts to hold interest rates downor to pay subsidies to producers in order to enablethem to sell at below-market prices.

11. The formula for the general consumer

price level is P = DC

SC.

12. The formula for the general consumerprice level limits the direct, immediate explanation ofrising prices to either a rise in aggregate demand orfall in aggregate supply and implies that if an allegedcause of rising prices cannot be shown to cause one orthe other of these two direct causes, then it is simplynot a cause of rising prices.

13. As far as it goes, the effect of supply onprices in the United States and practically all othercountries over the last seventy years has been

a. a continuing rise brought about by a progres-sive fall in supplyb. a continuing fall brought about by a progres-sive rise in supply

14. Where falling supply has contributed torising prices, its role has been relatively minor, in themost extreme cases accounting for perhaps as much asa doubling of prices over a period years over whichprices rose many times more altogether.

15. In order for falling supply to account fora sustained 2 percent compound annual rise in prices,

a. supply would have to halve approximatelyevery 35 yearsb. supply would have to fall to approximatelyone-eighth of its initial level in little more than acenturyc. the rapid disappearance of material civilizationwould be impliedd. all of the above

16. Falling supply is itself often the by-prod-uct of rapid increases in the quantity of money and ag-gregate demand.




17. An inflationary rise in prices includes notonly a rise in the strict weighted average of all pricesbut also the fact that all prices, or at least the fargreater part of them, are able to rise at the same time.

18. In cases in which a fall in supply takesplace in the production of a necessity or a vital mate-rial, i.e., in any case in which the demand for a productis inelastic, the outcome will be

a. a rise in the price of the item more than propor-tionate to the reduction in its supplyb. a rise in the amount of money spent to buy thatitem and a corresponding fall in the amount ofmoney spent to buy other itemsc. a tendency toward a fall in prices whereverspending has had to decline in order to make pos-sible the concentration of funds on the purchase ofthe good in reduced supply.d. all of the above

19. Because it would be accompanied by afall in many prices, falling supply cannot explain therange of price increases that exists under inflation,which extends to all goods and services, or at least tothe far greater part of them, at the same time.

20. In contrast to falling supply, the combina-tion of an increase in the quantity of money and risingaggregate demand is capable of raising all prices at thesame time and so satisfies the requirement of explain-ing the necessary range of price increases that existsunder inflation.

21. An inflationary rise in prices includes notonly a rise in the strict weighted average of all prices,and in at least the broad range of prices, but also a sys-tematic tendency for stockholders to gain at the ex-pense of bondholders and for debtors in general togain at the expense of creditors.

22. Rising prices caused by falling supply donot enable stockholders and other debtors to gain atthe expense of bondholders and other creditors, be-cause falling supply does nothing to increase the mone-tary income or wealth of the average stockholder orcreditor, who is in the position of having as manyfewer physical units of goods and wealth as the priceper unit of goods and wealth has risen.

23. Rising prices caused by falling supply areincompatible with the debtor/creditor effects associ-ated with inflation.

24. Rising prices caused by falling supply,such as would result from massive enemy bombing offactories in a war, would result in stockholders actu-ally being worse off than bondholders as the result ofrising prices, because they would lose their capitals toa greater extent than the bondholders, as well as hav-ing to pay the same higher prices as the bondholders.

25. Unlike rising prices caused by falling sup-ply, rising prices caused by rising aggregate demand

a. are accompanied by rising monetary incomesand wealth on the part of stockholders and debt-ors, which enables these groups to gain as pricesrise, to the extent that their monetary incomes andwealth rise more rapidly than pricesb. are fully compatible with the debtor/creditor ef-fects associated with inflationc. both (a) and (b)

26. The belief that falling supply is a causeof inflation implies

a. the belief that rising supply is a cause of defla-tion and thus of depressionb. the overproduction doctrinec. both (a) and (b)

27. Falling aggregate supply must be elimi-nated as the cause of an inflationary rise in prices, leav-ing only rising aggregate demand because

a. with few exceptions supply has increased overthe period in which prices have been rising, mak-ing its actual contribution a reduction in pricescompared with what they otherwise would havebeenb. where supply did fall, its fall could not beginto explain the extent of the rise in pricesc. reductions in supply are frequently the resultof rapid increases in aggregate demandd. reductions in supply as a sustained cause evenof moderately rising prices would imply the disap-pearance of material civilization at a rate rivalingor surpassing that of the collapse of the RomanEmpiree. all of the above

28. Falling aggregate supply must be elimi-nated as the cause of an inflationary rise in prices, leav-ing only rising aggregate demand because it

a. cannot explain the range of price increases as-sociated with inflationb. cannot explain the effects on the relations be-tween stockholders and bondholders, and debtorsand creditors in general, associated with inflationc. implies the overproduction doctrined. all of the above

29. People are led to believe that the risingprices of the last two generations could not have beencaused by rising aggregate demand, but only by risingcosts of production or the greed for higher profits, be-cause they mistakenly believe that more demand raisesprices only at the point of full employment, which wehave not had during this time, and short of that pointserves merely to increase employment.

30. The cost-push doctrine is mathematicallyequivalent to blaming rising prices on falling supply,since it claims that no increase in demand is necessary,which leaves only falling supply as the explanation ofrising prices.



Starting from a position of full employment and givenunchanged aggregate demands for consumers’ goodsand labor, an unchanged productivity of labor, and anunchanged size of the labor force, calculate the unem-ployment rate that would result from

31. A cumulative rise in wage rates of 10 per-cent.

32. A cumulative rise in wage rates of 25 per-cent.

33. A cumulative rise in wage rates of 33 1/3percent.

34. The effect of wage increases imposed bylabor unions is to create mounting unemployment ifthere is no increase in the quantity of money and thusin aggregate demand.

35. Starting from a position of full employ-ment, and recalling that in the depths of the Great De-pression the unemployment rate did not exceed 25percent, calculate to what extent labor unions couldsucceed in raising wage rates before bringing about anunemployment rate comparable to that of the great de-pression, if there were no increase in the quantity ofmoney and thus in aggregate demand.

36. Given the fact that a mounting unemploy-ment rate would finally lead to an end to further unionwage demands as more and more of the unions’ mem-bership came to be added to the unemployment roles,and even assuming that the unemployment rate thatwould be necessary for this would be as high as that ofthe Great Depression, the maximum, cumulative effectof labor unions driving up wage rates would be an in-crease in priceson the order of one-third.

37. In the early 1980s, an unemployment ratebriefly in excess of 11 percent was sufficient to elimi-nate most of “wage push.”

38. Starting from a position of full employ-ment and given unchanged aggregate demands forconsumers’ goods and labor and an unchanged size ofthe labor force, but now assuming a doubling of theproductivity of labor over the same period of time thatthe labor unions succeed in driving up wage rates suffi-ciently to cause a Great-Depression level of unemploy-ment, calculate the change in the general consumerprice level.

39. If, over the same period of time that theunions were driving up wage rates, the productivity oflabor were to rise, prices could actually fall substan-tially, despite the rise in wage rates.

40. Over time, labor unions are not a signifi-cant cause of rising prices, but of unemployment.

41. “In order for “wage-push” to have a sus-tained significant effect on the general consumer pricelevel, and avoid burning out in mounting unemploy-

ment, it must be sustained by an increasing quantity ofmoney and rising aggregate demand.”

42. The increase in the quantity of moneyand rising aggregate demand

a. allows “wage push” to continue because it re-moves the brake of mounting unemploymentb. calls wage push into being when it otherwisewould not exist, by virtue of reducing or removingthe threat of its causing additional unemploymentc. positively encourages wage push by virtue ofraising nominal profits, which constitutes a verita-ble red flag to the unions and their demands forwage increasesd. causes prices of goods available only in lim-ited quantity to rise, which, together with risingprices caused by the unions’ previous wage de-mands, leads the unions to demand wage in-creases to keep pace with price increasese. all of the above

43. Given that wage push could not be verysignificant in the absence of increases in the quantityof money and volume of spending, it follows that theintellectual zone of explanation of rising prices pre-viously regarded as belonging to the wage-push doc-trine should henceforth be regarded as having beenannexed by the quantity theory of money.

44. The “profit-push” doctrine claims thatthe greed of businessmen for profits is what drives upprices.

45. In the absence of increases in demandeven a protected legal monopolist, while almost cer-tainly charging high prices, would not charge continu-ally rising prices.

46. Even if a protected legal monopolistwere faced with a rising demand for his particularproduct, no rise in the general consumer price levelwould be present in the absence of a rise in aggregatedemand, because in that case the rise in demand forthe monopolist’s product would presuppose or causean equivalent fall in the demand for other products andthus operate to reduce the prices of other products.

47. Apart from the case of protected legalmonopolists, the normal operation of the profit motiveis steadily to reduce prices, not increase them, becausea major way to earn premium profits is to reduce thecosts of production, which cost reductions competitionpasses on to consumers.

48. What explains the association betweenrising prices and higher nominal profits is an increas-ing quantity of money and rising aggregate demand,which raises both prices and sales revenues, which lat-ter serves to increase profit margins and thus the rateof profit.

49. The “crisis-push” doctrine refers to theprice-raising effects of sudden substantial reductionsin the supply of critical materials, such as oil.


50. In the absence of increases in the quan-tity of money and aggregate demand, supply criseswhile causing dramatic increases in the prices of somegoods, would result in numerous price reductions, in-cluding reductions in prices that constitute costs of pro-duction, because the concentration of spending on thegoods whose supply had been reduced would comefrom spending on numerous other goods, whose priceswould thus be driven down.

51. The effect of a decrease in the supply ofoil is to

a. increaseb. decrease

the demand for automobiles, iron and steel, and the ser-vices of auto workers and steel workers

52. A decrease in the supply of oil is what ex-plains the rising prices of all other materials and in theprices based on the prices of those other materials.

53. Any given supply crisis is unable to ex-plain more than a one-time delimited rise in the gen-eral consumer price level corresponding to the extentto which it serves to reduce aggregate supply.

54. In the absence of increases in the quan-tity of money and aggregate demand, the resolution ofany given supply crisis should usually be expected tobe followed by a reduction in the general consumerprice level, probably all the way to the point of wherethe price level was before the crisis.

55. In judging the effects of supply crises,the public and the media confuse

a. the dramatic rise in the price of the goodwhose supply is in crisis and in the prices of itsproducts, with a general rise in prices, failing to re-alize that the steep rise in the price of the goodwhose supply is in crisis implies a reduction inmany other pricesb. an essentially one-time, delimited rise in priceswith a continuing rise in pricesc. both (a) and (b)

56. The public’s views about the effects ofsupply crises on prices are misled by the fact that newsof the crisis appears on page one of the newspapers,while news of its resolution is more likely to appear onpage fifty-one.

57. In order to explain a rising price level onthe basis of supply crises, one would have to find notonly replacement crises for the ones that have beensolved, but additional crises as well. And in the nextyear, one would have to find replacements for thislarger number of crises, along with still more addi-tional crises; and this would have to go on from yearto year at a compound rate.

58. According to the wage-price spiral doc-trine, prices rise because wages rise, and wages rise be-cause prices rise. Wages and prices, it is believed,

simply chase each other upward in a spiral, and that iswhy prices go on rising.

59. In the absence of increases in the quan-tity of money and aggregate demand, any wage-pricespiral would quickly burn itself out in mounting unem-ployment. This proposition is illustrated by the phe-nomenon of “givebacks” in the early 1980s, when itwas common for labor unions to give up their contrac-tual right to such things as cost of living increases.

60. The “velocity” doctrinea. admits the essential role of rising aggregate de-mand in raising pricesb. denies the essential role of increases in thequantity of money in raising aggregate demandc. implies that spending rises because of de-creases, often unexplained, in the demand formoney for holdingd. all of the above

61. Increases in velocity caused by factorssuch as growing security of property and the develop-ment of financial markets and financial institutions areaccompanied by an increase in the number of stages inproduction and a corresponding need for more stagesof spending in the ultimate production of consumers’goods, and also by increases in the production and sup-ply of consumers’ goods. Therefore, it is unlikely thatthey would be a cause of rising prices of consumers’goods.

62. Increases in the quantity of money oper-ate to raise velocity by means of reducing the demandfor money for holding.

63. Increases in the quantity of money re-duce the demand for money for holding by means of

a. causing rising prices, which can lead to peopleprefering to buy sooner rather than hold cash tobuy laterb. creating the belief that cash can readily be ob-tained by borrowing it, thus reducing the need tohold it, which belief is the result of inflation in theform of credit expansionc. causing rising demand for products and thus agreater ability to liquidate inventories easily andprofitably, thereby encouraging the holding ofmore inventory and less cashd. raising short-term interest rates and making itworthwhile to lend out sums that otherwise wouldhave been held in cashe. all of the above

64. All that is required to reduce velocity isto cut back on the rate of increase in the quantity ofmoney, the effect of which will be to raise the demandfor money for holding by going in reverse along thelines indicated in the choices in the previous question.

65. Velocity is lower in countries with lessrapidly increasing quantities of money and higher incountries with more rapidly increasing quantities of


money—for example, it is much higher in Brazil thanin the United States.

66. Velocity is higher in the United Statestoday than it was when the country was on the goldstandard and its money supply increased less rapidly.

67. Since the early ’80s, velocity has de-clined, along with slowing of the increase in the quan-tity of money.

68. The intellectual zone of explanation pre-viously claimed by the velocity doctrine should hence-forth be regarded as annexed by the quantity theory ofmoney. For it is the growth in the quantity of moneythat explains the inflationary rise in the velocity of cir-culation of money.

69. Properly understood, the term “inflationpsychology” refers to the various ways in which a rap-idly expanding quantity of money reduces the desireof people to hold money.

70. Inflation psychology isa. caused by prolonged experience of the fact ofinflationb. an uncaused primary that explains inflation

71. Inflation psychology operates from theside of supply as well as from the side of demand. Itdoes so by influencing the expectations of sellers.

72. Inflation psychology operates from theside of supply when

a. businessmen come to anticipate that in theyears ahead inflation will raise the replacementcosts of their plant and equipment, and that theymust begin to raise prices today, in order to be ina position to accumulate sufficient replacementfundsb. workers demand wage increases in order tocover the rise in prices they expect to occur overthe life of their employment contractsc. landlords demand rent increases to cover therise in prices and costs they expect to occur overthe life of their rental contractsd. lenders demand interest rates high enough tocover the increase in prices they expect to occurover the life of their loan contractse. all of the above

73. In operating in the ways described in theprevious question and thus leading to a rise in prices inadvance of the actual increase in spending, inflationpsychology makes inflation into a cause of unemploy-ment.

74. What is required to eliminate inflationpsychology is

a. speeches by public officials ridiculing it andurging people to abandon itb. the government’s stopping its policy of infla-tion

75. Once its policy of inflation has created in-flation psychology, stopping inflation may not im-

mediately appear to work, because, in the belief thatthe government will soon resume its policy of infla-tion, people may have placed themselves in even moreoverextended positions, in which they are operatingwith even lower money balances, have further in-creased their borrowings, and are asking still higherwages and prices. In such conditions, the eliminationof inflation psychology is likely to be accompanied bya major recession.

76. Inflation psychology would not be a prob-lem under a gold standard because it would have littleor no factual basis. To the extent such a psychologybegan to develop, it would quickly run up against thefact that the money supply did not keep up with it, be-cause it simply could not. At that point, the conse-quence would be that inflation psychology woulddisappear.

77. The “credit-card doctrine” holds thatcredit cards make possible a rise in spending withoutany expansion in the quantity of money and thus serveto raise prices.

78. The use of credit cards, such as the Amer-ican Express card, in which the whole balance due ispayable at once, requires the existence of two cash bal-ances instead of one to finance the same purchase: thechecking-account balance of the credit-card customerto pay his credit-card bill, and a cash balance by thecredit-card company to pay the merchant. Thus, it is ar-guable that the use of this credit card serves actually toreduce the velocity of money rather than increase it,despite the fact that people no longer need to hold asmuch currency as they otherwise would.

79. Insofar as the possession of credit cardsmay actually contribute to a rise in velocity, by repre-senting guaranteed lines of credit and thereby sparingpeople the need to hold cash balances as large as be-fore, the rise in velocity is to be attributed to the abilityof the banking system to increase the quantity ofmoney, because this is what makes possible the grant-ing of lines of credit not based on savings. Where sav-ings are the foundation of the lines of credit, theprocess originates in a decline in spending elsewherein the economic system and thus will not serve to in-crease overall spending in the economic system.

80. According to the consumer-installment-credit doctrine, prices rise because the granting of con-sumer-installment credit enables consumers to makean additional demand for goods.

81. To the extent that consumer-installmentcredit or any other form of credit is granted out of sav-ings, it does not serve to increase aggregate demand,but merely to divert the ability to spend from the saverot the borrower.

82. The granting of credit is inflationarywhen the funds lent are newly created, not when theyare the result of saving.

83. Debts incurred through the borrowing


of savings are not inflationary, while debts incurred through the borrow-ing of newly created money are inflationary.

84. The “consumer-greed” doctrine is theclaim that inflation is the result of the consumers’“greed,” including their desire for a higher standard ofliving.

85. The consumer-greed doctrine mistakenlyassumes that

a. “greed” implies a reduction in the demand formoney for holdingb. the effect “greed”—i.e., of the desire for ahigher standard of living—is to raise prices ratherthan lower them by virtue of people’s efforts toproduce more, as the means of earning higher in-comesc. both (a) and (b)

86. What is required to make “consumergreed” translate into a lower demand for money forholding rather than a higher demand for money forholding is the government’s policy of inflation, whichpenalizes the ownership of cash holdings through ris-ing prices.

87. As far as the explanations of rising pricesother than the quantity theory of money contain anykernel of validity at all, it is only as an extension of thequantity theory of money.

88. The undue increase in the quantity ofmoney that underlies the rise in prices must be laid atthe door of the government, because

a. the moneys chosen by the market were, andwould be again, in the absence of government in-tervention, gold and silver, which are moneys thatdo not increase at a rate sufficient to cause a sus-tained, significant rise in pricesb. in the last seventy years, the government of theUnited States, like that of virtually every othercountry, has had unlimited power to expand thequantity of fiat paper money and has made ampleuse of that powerc. both (a) and (b)

89. All of the knowledge concerning thecause of rising prices can be summarized in a defini-tion of inflation as an increase in the quantity ofmoney more rapid than the increase in the supply ofgold and silver, which is to say, an increase in thequantity of money caused by the government.

90. In contrast to the definition of inflation asrising prices, the definition of inflation in the preced-ing question provides

a. essential comprehensive knowledge concern-ing the cause of rising pricesb. the ability to understand the causation of thefull range of symptoms associated with inflationc. the ability to distinguish between rising pricescaused by more demand and rising prices causedby less supplyd. knowledge concerning how to stop inflatione. the ability to raise further questions about thecauses and effects of inflation properly understoodf. all of the above

Chapter 19, Part B

91. A government budget deficita. means an excess of government spending overits tax revenuesb. requires that the government borrow equiva-lent fundsc. both (a) and (b)

92. Government borrowing can be froma. the citizens (other than the fractional-reservebanking system)b. the central bank (in the US, the Federal Re-serve System)c. from the private, fractional-reserve bankingsystemd. all of the above

93. Government borrowing from the centralbank entails the creation of new and additional stan-dard money, which the central bank creates and thenlends to the government.

94. Government borrowing from the private,fractional-reserve banking system typically entails thecreation of new and additional checking deposits,which is what the banks lend.

95. Government borrowing from the centralbank or from the fractional-reserve banking system en-tails the creation of new and additional money, whilegovernment borrowing from the citizens does not.

96. Government budget deficits financed bythe creation of new and additional money

a. enable the government to increase its spendingwithout the citizens having to decrease theirspendingb. result in an elevation of the level of total spend-ing as the new and additional money passes fromhand to handc. is inflationaryd. all of the above

97. Government budget deficitsa. when financed by the savings of the citizens,are accompanied by a reduction in spending onthe part of the citizens or on the part of those towhom the citizens would otherwise have lent themoney b. in and of themselves are not inflationaryc. both (a) and (b)


98. Government budget deficits are a. inflationary insofar as they are financed by thecreation of new and additional moneyb. not inflationary insofar as they are financed bythe lending of previously accumulated savingsc. both (a) and (b)

99. If the monetary unit were gold, whosesupply the government and the banking system cannotincrease, budget deficits could not be financed by thecreation of new and additional money.

100. Inflation can take place while the gov-ernment operates with a budget surplus, if the centralbank or the fractional-reserve banking system buys uppreviously issued government securities and therebycreates new and additional money.

101. Only the budget deficit of the federalgovernment can be inflationary, not those of state orlocal governments, because only the federal govern-ment has the power to create new and additionalmoney and to place the fractional-reserve banking sys-tem in a position to create such money. Lacking thatpower, the states and localities are essentially forced toborrow only from the citizens.

102. No matter how large its debt becomes,the ability of the federal government to create new andadditional money prevents it from going bankrupt inthe technical sense of not having the money availableto meet its debt, so long as its debt is payable in thekind of money that it can create.

103. Because creating money to pay its debtreduces the purchasing power of money and thus can-not serve to repay debt defined in terms of a given pur-chasing power, the federal government has probablylong been bankrupt in the sense of an inability to repayits debt in terms of the same purchasing power inwhich the debt was contracted.

104. So long as the federal government hasthe power to create money, no lack of money compelsit to reduce its spending or its indebtedness.

105. Compelling the government to limit itsspending and indebtedness requires depriving it of theability to create new and additional money.

106. If the monetary unit were defined as afixed weight of gold, of a definite finess, as it was inthe United States from 1788 to 1933, the government,not being able to create gold, could not enlarge thebasic money supply and thus could not finance its defi-cits by means of inflation.

107. In the absence of the ability to inflatethe money supply, government budget deficits

a. would not be inflationaryb. would ultimately lead to government bank-ruptcy if pursued as a policyc. both (a) and (b)

108. The specter of government bankruptcyunder a gold standard, and the accompanying uncer-tain political and economic climate, would lead to

a. an increased demand for gold for holdingb. an increased demand for gold for exportc. a threat to the solvency of the banking system,insofar as its assets included government securitiesd. a threat to the quantity of money, insofar asgold was exported and insofar as government se-curities provided backing for fractional-reservechecking deposits or bank notese. all of the above

109. Answers to the previous question implythat under a gold standard, government budget deficitswould ultimately be deflationary rather than inflation-ary.

110. Government budget deficits have the po-tential to be deflationary even in the short-run, to theextent that their financing deprived business firms ofworking capital—a highly unlikely result in today’sconditions, but very possible under a gold standard.

111. The motives and rationale for budgetdeficits and inflation can be described under the fol-lowing headings:

a. the welfare stateb. inflation and war financec. inflation and the “easy money” doctrined. inflation as the alleged cure for unemploymente. all of the above

112. Deficits, and the inflation to financethem, are the cornerstone of the welfare state. They areindispensable in order to lend the appearance of realityto the belief that the government is the source of freebenefits, which belief is the fundamental delusion un-derlying the welfare state.

113. The ability to inflate is valued in part be-cause it makes it possible for the government to fi-nance wars which it would not be politically possibleto finance through taxation.

114. Inflation in the form of a policy of “easymoney” is supported by the belief that credit expan-sion is a means of creating capital and lowering inter-est rates.

115. Probably the most important single rootof the policy of inflation in the present day is the beliefthat inflation is necessary in order to prevent or com-bat mass unemployment.

116. An underlying influence of the socialistideology is present in the use of inflation to finance thewelfare state, in that

a. the expansion in government functions andpowers entailed in the growth of the welfare stateis a major step toward the establishment of social-ismb. both the welfare state and socialism itself areadvocated in the name of the alleged helplessness


of the average individual and the alleged omnisci-ence and omnipotence of the Statec. inflation creates the appearance of the kind ofrelationship between the individual and the Statedescribed in (b): on the one side stands the individ-ual with his unmet needs, and on the other side,the State, ready to help with funds not derivedfrom individuals, but miraculously created outsidethe economic system, out of thin aird. all of the above

117. The socialist ideology and support forthe “easy money” doctrine overlap insofar as

a. both share a belief in the existence of free ben-efits, in this case the alleged benefit of capital cost-lessly created out of thin air by the manufacture ofnew and additional moneyb. credit expansion and its accompanying reduc-tion in the rate of interest is perceived to be themeans of achieving the “euthenasia of the ren-tier”—Keynes’s effort to achieve the goals ofMarxism without the necessity of a revolutionc. both (a) and (b)

118. The belief that inflation is necessary toprevent or combat unemployment is largely an indirectresult of the influence of the socialist ideology. This isbecause the labor legislation and other government in-terference that creates the problem of mass unemploy-ment in the first place is the result of the influence ofthe Marxian exploitation theory, which holds that inthe absence of government interference on behalf ofhigher wages, wage rates will go to the level of mini-mum subsistence.

119. A policy of government budget deficitsis incompatible with the principle of representativegovernment, since it obligates future generations topay taxes for the payment of principal and interest on adebt neither they nor their representatives have anyrole in incurring and which their representatives can-not be present to oppose.

120. The government’s ability to inflate themoney supply has contributed to the growth in the sizeof the government relative to the economic system bymaking new and additional government programs ap-pear costless, because the government is no longerunder the compulsion of financing them by raisingtaxes. This enables supporters of the programs merelyto describe their prospective benefits, while opponentsare depicted as maliciously opposing the benefits.

121. The government’s ability to inflate themoney supply destroys peoples’ understanding of thefact that the government is supported by them andleads them to believe instead that they are supportedby the government.

122. The government’s ability to inflate themoney supply underlies the belief that Washington,D. C., a city that is economically insignificant in termsof what it produces or contributes to production, is nev-

ertheless capable of bailing out the economies of suchmajor cities as Detroit, Newark, and New York, in-deed, the economies of entire states and multistate re-gions.

123. When the gold standard is overthrownand the government gains the power to spend funds itdoes not have to obtain from the people,

a. the government can no longer easily be viewedas deriving its powers and rights from the peopleb. the government is enabled to throw off its sta-tus as the servant of the people, deriving its justpowers from the consent of the governed, and toappear instead in the guise of the Provider and Fa-ther of the people, with the people deriving theirexistence, powers, and rights from the governmentc. a veritable revolution occurs in the relationshipbetween the government and the peopled. all of the above

124. Inflation operates to redistribute wealthand income from creditors to debtors, as the result of

a. the rising prices it causesb. its increasing the incomes and monetarywealth of the debtors, while the incomes and mon-etary wealth of the creditors are contractually fixedc. (a) and (b) in combination

125. To the extent that their corporations aredebtors, stockholders receive the benefits of debtorsduring inflation.

126. A government’s power to inflate is po-tentially capable of achieving a redistribution ofwealth and income among its citizens on a scale rival-ing that of the French and Russian revolutions.

127. Inflation does not raise all prices at thesame time and to the same extent, but rather raisessome prices sooner than other prices.

128. In addition to its effects on the redistri-bution of wealth and income between debtors and cred-itors, inflation also redistributes real income in favorof those who receive the new and additional money rel-atively early, and who are thus in a position to buy atprices that have not yet rise for the most part, andthose who receive it only later on and who have had tobuy at rising prices before their selling prices and in-comes rose.

129. Those who introduce the new and addi-tional money gain at the expense of others, inasmuchas they are enabled to consume without having had toproduce, and thereby drain away part of the productionof others without providing goods and services in ex-change.

130. The poor and the elderly have tradition-ally been among the worst victims of inflation, be-cause they frequently must live on fixed incomeswhile inflation proceeds to drive up the prices of practi-cally everything they must buy.



131. Inflation makes the traditionally safesttypes of investments, such as high grade bonds, life in-surance policies, and savings accounts, the least safe interms of its potential damage to the purchasing powerof such investments.

132. Under a fiat, paper money system, thesafety of all such contractually fixed investmentscomes to depend on

a. the rate at which prices riseb. the rate at which the quantity of money andvolume of spending increasesc. knowledge of the quantity theory of money onthe part of the government officials in charge ofthe increase in the money supply d. the courage and integrity of government offi-cials who may know and understand the quantitytheory of money, to be quided by their knowledgein the face of political pressures urging more rapidincreases in the quantity of moneye. all of the above

133. In making the traditionally safest typesof investments the least safe, inflation undermines cap-ital formation by placing the large number of peoplewho require such investments, in the position either ofhaving to turn to alternative vehicles, such as goldhoarding, which do not provide funds for business in-vestment, or ceasing to save altogether, or doing soonly on a smaller scale.

The following is an eleven-part question.

An imaginary tiny business firm buys a supply of mer-chandise for $100 and exactly one year later sells itsmerchandise for $110. The tax rate on profits is 50 per-cent and does not change. After some years the quan-tity of money and volume of spending in the economicsystem come to increase at a 10 percent compound an-nual rate, as do both the selling price and the replace-ment cost of the firm’s merchandise.

134. State the firm’s profit before the onsetof inflation.

135. State the amount of tax the firm mustpay before the onset of inflation.

136. State the amount of the firm’s profit thatit needs to use for the replacement of its merchandise,before the onset of inflation.

137. State the amount of after-tax profit re-maining to the firm, before the onset of inflation, afterit has made full allowance for replacement.

138. State the firm’s sales revenues in thefirst year in which the inflation begins.

139. State the firm’s profit in the first year ofthe inflation.

140. State the amount of tax the firm mustpay in the first year of the inflation.

141. State the amount of the firm’s profit thatit needs to use for the replacement of its merchandise,in the first year of the inflation.

142. State the amount of after-tax profit re-maining to the firm, in the first year of the inflation,after it has made full allowance for replacement.

143. Recalculate the firm’s pretax profit toserve as a measure of its gain from operations onlyafter full allowance for replacement of its merchandisehas been made.

144. Calculate the percentage of the firm’s re-stated profit in your answer to the preceding questionthat is constituted by the amount of taxes you pre-viously calculated that the firm owed in the first yearof the inflation.

The following is a fifteen-part question.

An imaginary business firm buys a machine that willlast for 10 years for $1 million. It depreciates the ma-chine on a straight-line basis over 10 years. In a periodin which there is no inflation, the firm’s annual salesrevenues in connection with this machine are also $1million, while its annual operating costs in connectionwith the machine are $850,000. Sometime during thecourse of the machine’s depreciable life, inflation suc-ceeds in doubling the quantity of money and volumeof spending in the economic system and also in dou-bling the annual sales revenues and operating costs ofthis firm in connection with the use of this machine. Italso succeeds in doubling the replacement price of thefirm’s machine to $2 million. Throughout, the rate oftax on profits remains unchanged at 50 percent.

145. Calculate the firm’s annual gross profit(i.e., its profit pre-deduction of depreciation cost) inthe year(s) before the start of the inflation.

146. Calculate the firm’s annual depreciationcharge in the year(s) before the start of the inflation.

147. Calculate the firm’s annual net profit be-fore tax in the year(s) before the start of the inflation.

148. Calculate the amount of tax the firmmust pay on its profit in the year(s) before the start ofthe inflation.

149. Calculate the amount of the firm’s profitthat it needs to set aside for the replacement of its ma-chine, in the year(s) before the start of the inflation.

150. Calculate the amount of after-tax profitremaining to the firm, in the year(s) before the start ofthe inflation, after it has made full allowance for re-placement.


151. Calculate the firm’s annual gross profit(i.e., its profit pre-deduction of depreciation cost)when sales revenues and operating costs have doubled.

152. Calculate the firm’s annual depreciationcharge when sales revenues and operating costs havedoubled.

153. Calculate the firm’s annual net profit be-fore tax when sales revenues and operating costs havedoubled.

154. Calculate the amount of tax the firmmust pay on its profit when sales revenues and operat-ing costs have doubled.

155. Calculate the amount of the firm’s an-nual profit that it would need to set aside for the re-placement of its machine at a price of $2 million, ifsomehow it had a full 10 years over which to accumu-late an additional million dollars in repalcement funds.

156. Calculate the amount of after-tax profitremaining to the firm after making such additional al-lowance for replacement.

157. Recalculate the firm’s pretax profit toserve as a measure of its gain from operations onlyafter this necessary additional allowance for replace-ment of its machine has been made.

158. Calculate the percentage of the firm’s re-stated profit in your answer to the preceding questionthat is constituted by the amount of taxes you pre-viously calculated that the firm owed when its salesrevenues and operating costs had doubled.

159. Inflation operates to increase the effec-tive rate of taxation on business profits with un-changed rates of taxation. It does so by increasing theamount of profit that is subject to the unchanged taxrate at the same time that most of that additional profitis required for the repacement of assets whose pricesinflation raises, and which thus does not represent anysort of genuine economic gain. The rise in the effec-tive rate of tax is seen when recalculates pre-tax profitto allow for the additional funds required for replace-ment at higher prices and takes the tax the firm is re-quired to pay as a percentage of that much smallerrecalculated profit.

160. The preceding sets of questions showthat the high nominal profits that accompany inflationare also accompanied by sharply reduced after-tax realprofits.

161. The preceding sets of questions showthat the public and the media know very well whatthey are talking about when they complain of highprofits as the cause of inflation or as a source of bene-fit from inflation.

162. To offset the effects of inflation on prof-its, tax rates on profits need to be

a. raised to capture the unconscionable gainsbeing reaped by large corporations

b. reduced in order to prevent the rise in the effec-tive rate of taxation of real profits resulting fromthe enlargement of nominal profits and rise in re-placement prices

163. In impoverishing people through risingprices and at the same time bloating nominal profitswhile reducing real profits, inflation both foments anti-capitalistic hostility and undermines economic activity.

The following is a thirteen-part question.

In a period of no inflation and no annual rise in prices,an individual has a capital of $1 million, which helends out at a 4 percent annual interest rate. At thesame time, there is a flat-rate proportional income taxof 25 percent, which remains unchanged all through-out. Subsequently, inflation ensues and succeeds inraising prices at an annual rate of 6 percent and in rais-ing interest rates to 10 percent.

164. Calculate this individual’s annual in-come from this $1 million of capital when there is noinflation.

165. Calculate the amount of thisindividual’s income tax on the interest income fromthis $1 million of capital.

166. Calculate this individual’s after-tax in-come derived from his ownership of this $1 million ofcapital.

167. State the amount of this individual’safter-tax income derived from his ownership of this $1million of capital that needs to be set aside and addedto his capital in order to maintain the buying power ofhis capital at an unchanged amount, i.e., equal to thatof $1 million the year before.

168. Calculate the rate of interest this individ-ual earns on his million dollars of capital after deduct-ing his payment of taxes on the interest income.

169. Calculate the rate of interest this individ-ual earns on his million dollars of capital after deduct-ing both his payment of taxes on the interest incomeand any necessary set aside of income to maintain thebuying power of his capital.

170. Calculate an individual’s annual incomederived from $1 million of capital when inflation hasraised interest rates to 10 percent.

171. Calculate his income tax on the incomeyou stated in your answer to the preceding question.

172. Calculate his after-tax income.

173. Calculate the amount of thisindividual’s after-tax income derived from his owner-ship of this $1 million of capital that now needs to beset aside and added to his capital in order to maintainthe buying power of his capital at an unchangedamount, i.e., equal to that of $1 million the year before.


174. Calculate the amount of thisindividual’s after-tax income derived from his owner-ship of this $1 million of capital that remains after set-ting aside the sum shown in answer to the previousquestion as necessary to maintain the buying power ofhis capital, i.e., his “real” income or gain on his capital.

175. Calculate the rate of interest this individ-ual earns on his million dollars of capital after deduct-ing both his payment of taxes on the interest incomeand any necessary set aside of income to maintain thebuying power of his capital.

176. The preceding questions show thatwhile sharply increasing nominal rates of interest andnominal interest incomes, inflation serves to sharply re-duce real rates of interest and real interest incomes.

177. In the absence of inflation, assets suchas houses, land, and buildings would not show any gen-eral or systematic tendency to rise. As a result, anyoneselling existing such assets would generally not be sub-ject to the payment of a capital gains tax. In this envi-ronment, we can imagine a vast collection of assets allof which have a given price, that we will call 100.Anyone selling an asset at the price of 100 can buyother such assets also at a price of 100. Now we imag-ine inflation to ensue, with the result that over a periodof years, assets that were previously 100 now sell for200. If the capital gains tax is 25 percent, calculate thequantity of other assets that a seller of a given asset for200 will be able to buy after paying the capital gainstax.

178. Inflation operates to raise the effectiverate of taxation on capital gains by virtue of systemati-cally raising the prices of previously purchased assets,thereby creating taxable capital gains on those assetsas and when they are sold, with the taxes being thegreater, the greater is the inflation and the consequentrise in the prices. At the same time, after having paidthe capital gains tax, the funds remaining to the sellersare the less adequate to buy comparable assets themore that prices have risen and the capital gains taxhas deprived them of the funds needed to keep up.

179. Inflation can play a major role in thedecay of the highways and other so-called infrastruc-ture of a country. This is because as it pours new andadditional revenues into their hands, governments fre-quently proceed as though the revenues were availablefor the expansion of government activities, and neglectthe need to devote an adequate portion of them to re-placement and maintenance at progressively risingprices. The result is decaying water and sewage sys-tems, subway and rail lines, and bridges and tunnels,as well as decaying roads and highways.

180. The prosperity delusion of inflation a. refers to the rise in nominal incomes and assetvalues that it creates and which leads people to be-lieve that they are more prosperous and can thusafford to consume more, when in fact, after allow-

ing for higher replacement prices and the higherprices that must be paid to acquire other assets,they are not more prosperous and cannot afford toconsume moreb. serves to undermine saving and capital accu-mulationc. both (a) and (b)

181. Even after people stop regarding them-selves as enriched by inflation, inflation continues topromote overconsumption insofar as it leads people tobelieve that they still have positive investment incomewhen in reality their position is one of losses.

182. In a period of inflation, with pricessteadily rising, everyone has an exaggerated idea ofthe purchasing power of money, based on his past ex-perience of prices, which, necessarily, is now out-moded. For example, his notion of the purchasingpower of money rests in part on his estimate of theprice of a new car or washing machine. But that esti-mate is based on his last experience of the prices ofsuch goods, which may have occurred several monthsor even several years in the past, at which time theprices were undoubtedly lower than they are today.Thus, people consume in the mistaken belief that theirincomes will enable them to afford to buy more than isactually possible at the now higher level of prices.

183. Inflation in the form of credit expansionoperates

a. to reduce the rate of interest relative to the rateof profit b. to raise both the rate of profit and the rate of in-terest absolutelyc. to encourage the incurrence of debtd. all of the above

184. Von Mises has shown that credit expan-sion, and the artificial reduction in the rate of interestthat it causes, creates the appearance of a more abun-dant supply of capital than in fact exists. On the basisof this appearance, businessmen are led to undertakeprojects for whose execution the actual supply of capi-tal is inadequate. Such use of capital, for purposes in-appropriate to the actual supply of capital, constitutesmalinvestment.

185. Malinvestment is a. the wasteful investment of capitalb. brought about by credit expansion and the lowrate of interest it causes relatively to the rate ofprofit and to the rise in pricesc. exists in cases in which the profitability of aninvestment rests on no other foundation thancredit expansion itselfd. exemplified by cases of wasteful inventory ac-cumulation and wasteful investment in owner oc-cupied housing e. all of the above

186. Inflation in the form of credit expansionmakes investments that actually lose in real terms ap-


pear to be profitable nonetheless, and to be profitablein fact to some investors.


In normal conditions, it does not pay to hold invento-ries for the sake of holding inventories. In fact, storagecosts would make such behavior downright loss mak-ing. But now assume the existence of inflation strongenough to raise prices in general 15 percent per year,and the price of a specific commodity, say, copper,also 15 percent per year. Assume annual storage costsequal to 3 percent of the initial value of the copper. As-sume also that credit expansion serves to keep the rateof interest at 10 percent.

187. Calculate the real rate of return on in-vesting in an inventory of copper, holding it for a year,and selling it at a 15 percent higher price.

188. Calculate the percentage of the value ofcopper next year, after allowing for storage costs, thatwould nevertheless constitute the profit of a borrowerif he can finance his investment in copper entirely withborrowed money.

189. Calculate the loss in real terms sufferedby the lender.

190. The lender’s loss finances the gain ofthe borrower and the loss on the investment as a whole.

191. The borrower’s profit is made possibleby the combination of the rise in prices and the relativelowness of the rate of interest, both of which arecaused by inflation in the form of credit expansion.

The following is an eight-part question.

In the absence of inflation, with no secular trend of ris-ing new-home prices, the prices of houses would tendto gradually decline as they got older. In such circum-stances, buying a home would not often be thought ofas an investment. Nevertheless to the extent that infla-tion proceeds more rapidly than houses depreciate, itmakes the price of houses increase as they grow older.In this context imagine that the price of a home that isnow 25 years old is twice as high as it was when thehome was brand new. Over the same interval of time,however, the general consumer price level, includingthe price of new homes, has tripled. Assume that thehome was originally purchased for $100,000, of which$80,000 was borrowed, and that through various refi-nancings, $80,000 continues to be owed on the house.

192. Calculate the real rate of return (takenas a total, not annualized) on the $100,000 investmentmade to purchase the new home, which is sold 25years later at twice the price, when prices have tripled.

193. Calculate the homeowner’s equity in thehouse at the time of its sale.

194. Calculate the homeowner’s monetaryprofit on his investment.

195. Calculate the homeowner’s real profit interms of the prices prevailing in the year in which hepurchased his home.

196. Calculate the mortgage lenders’ loss interms of the buying power of $80,000 at the time ofsale when prices are 3 times higher than they werewhen the $80,000 was originally lent.

197. State the amount of loss in buyingpower on the overall original $100,000 investment inthe house in terms of the prices that prevailed in theyear in which the house was originally purchased.

198. Calculate the difference in real terms be-tween the mortgage lenders’ loss and the sum of thehomeowner’s gain plus the overall loss on the invest-ment.

199. The mortgage lenders’ loss finances theloss on the investment as a whole plus the gain of thehomeowner.

200. In making home ownership a profitableinvestment for homeowners, inflation in the form ofcredit expansion encourages the diversion of savingsand capital into home ownership at the expense ofother investments.

201. Malinvestment impairs capital forma-tion in reducing the efficiency with which existing cap-ital is used, in that this holds down the production ofnew capital goods as well as new consumers’ goods.

202. The existence of malinvestment con-firms the proposition that inflation does not raise allprices at the same time and to the same extent, in thatthe credit expansion that causes it tends to raise theprices of such things as storable commodities andhouses relative to most other prices, by virtue of creat-ing an artificial additional demand for them based onthe desire to take advantage of the special profit thatsuch inflation creates in those lines.

203. When credit expansion and the malin-vestment that it fosters come to an end, the prices ofthe goods and services artifially elevated relative toother prices then fall disproportionately relative toother prices.

204. The withdrawal-of-wealth effect is theuncompensated withdrawal of wealth from producersby the spenders of newly created money. It is essen-tially similar to the gains of counterfeiters, who takewealth out of the economic system while putting nonein, and the corresponding loss of others.

205. The withdrawal-of-wealth effecta. represents a diversion of capital to consump-tion insofar as the spenders of the new and addi-tional money are consumers


b. represents probable malinvestment insofar asthe spenders of the new and additional money arebusiness firms, inasmuch as the firms which de-pend on the creation of new and additional moneyhave proved unable to compete for capital on theregular loan market and require the subsidy thatcredit expansion representsc. contributes to the undermining of capital for-mation d. all of the above

206. Inflation operates to reduce the real rateof return on capital at the same time that it impairs cap-ital formation via

a. the reversal-of-safety effect, which threatenssavers with losses in terms of buying powerb. the tax effect, which diminishes the real after-tax rate of return through the rise in effective taxrates on profit and interestc. the malinvestment effect, which represents theinvestment of capital in ways that are less effi-cient and actually loss-making in real termsd. the withdrawal-of-wealth effect, which repre-sents the withdrawal of wealth that constitutespart or all of firms’ real rate of return on capitale. all of the above

207. The fact that inflation reduces the realrate of return on capital as such implies that the gainsof debtors resulting from inflation are less than thelosses of creditors, a proposition which is explicitlydemonstrated in the examples drawn from malinvest-ment in inventories and housing.

208. In its undermining of capital accumula-tion, inflation operates to

a. reduce the demand for capital goods relative tothe demand for consumers’ goods and the degreeof capital intensiveness in the economic systemb. reduce the efficiency with which existing capi-tal goods are employedc. reduce the demand for labor relative to the de-mand for consumers’ goodsd. reduce the productivity of labore. all of the above

209. As a result of its undermining of capitalaccumulation and thus both the productivity of laborand the so-called distribution factor, inflation serves toreduce real wages.


Assume that as a result of inflation’s undermining ofthe foundations of real wages, the point has beenreached where the prices of consumers’ goods are ris-ing more rapidly than wage rates, and the labor unions

are imposing wage increases equal to the rate of priceincreases.

210. More specifically, assume that while thedemand for consumers’ goods is rising at a rate of 10percent per year, the demand for labor is rising at arate of only 8 percent per year and that if nothing elsewere present, this would cause prices to rise by 10 per-cent while wage rates rose by only 8 percent. Assumethat to prevent this outcome, the unions demand wageincreases of 10 percent, to keep pace with the price in-creases. Calculate the proportion of the presently em-ployed wage earners who must become unemployedeach year as the result of the continuation of suchunion demands.

Now assume in addition that while the supply of laboris unchanged, the supply of consumers goods is fallingat a rate of 2 percent per year.

211. Calculate the annual rise in prices whenthe 2 percent annual fall in the supply of consumers’goods is combined with a 10 percent annual increasein the demand for consumers’ goods.

212. State the rise in wage rates now neededto keep pace with the rise in prices.

213. Recalculate the proportion of the pres-ently employed wage earners who must become unem-ployed each year as the result of union demands forwage increases on a par with price increases.The efforts of labor unions to resist the fall in realwages caused by

214. The efforts of labor unions to resist thefall in real wages entails an attempt to raise wage ratesrelative to the demand for labor and thus results in un-employment.

215. Since common stock prices depend onthe degree of saving, which inflation undermines, inthe long-run inflation prevents stock prices from keep-ing pace with the prices of consumers’ goods.

216. The negative effects of inflation on sav-ing and the availability of real capital gives rise to thephenomenon of an inflationary depression—i.e., a rap-idly increasing quantity of money and rapidly risingprices accompanied by widespread insolvencies andbankruptcies, as the money available for the purchaseof capital goods and labor becomes inadequate by be-coming unable to grow rapidly enough relative to therise in the demand for consumers’ goods and in prices.


217. On the basis of the various ways inwhich it reduces the demand for money for holding, in-flation, expecially in the form of credit expansion,


brings about an increase in the volume of spendingand in sales revenues and incomes in the economic sys-tem that is more than proportional to the increase inthe quantity of money and thereby reduces the degreeof liquidity in the economic system, i.e., the ratio ofcash holdings to current liabilities.

218. In reducing interest rates relative to therate of profit, inflation in the form of credit expansionencourages the incurrence of debt.

219. Inflation in the form of credit expansioncauses malinvestments, i.e., investments whose profit-ability is based on the existence of credit expansion.

220. When inflation in the form of credit ex-pansion stops or significantly slows,

a. the demand for money for holding risesb. the growth in sales revenues in the economicsystem slows, stops, or is reversedc. profit margins and the general rate of profit inthe economic system are reduced, as is cash flowd. the unprofitability of malinvestments is re-vealed e. many debts become unpayable because of thecombination of now inadequate sales reveunuesand cash flow and the unduly large debts incurredin the process of credit expansionf. some substantial business firms suddenly failg. banks that have made substantial loans to busi-ness firms that have failed also failh. the failure of banks and their inability to re-deem their checking deposts (and or bank notes)on demand reduces the quantity of money and fur-ther reduces the volume of spending in the eco-nomic system with the potential result of furtherbusiness failures and then further bank failures, insuccessive waves, until the quantity of fiduciarymedia in the economic system is greatly reducedor even completely wiped outi. all of the above

221. Inflation, especially in the form ofcredit expansion, sets the stage for a financial contrac-tion and deflation.

222. To the extent that credit expansionserves to raise wage rates and/or materials prices, it

a. reduces the adequacy of existing capital funds,with the result that firms requiring credit turn outto need more credit than they had planned on,while those firms normally supplying credit turnout to be able to supply less than had beencounted on, and may even need credit themselvesin order to meet the requirements of their own in-ternal operations at these higher wage rates andpricesb. can result in a “credit crunch” and the precipi-tation of business failures and then bank failuresc. both (a) and (b)

223. The failure of inflation to accelerate suf-ficiently can also cause the demand for money for

holding to increase, and thus velocity to decrease, inso-far as the demand for money for holding has becomeunduly low based on the expectation of a more rapidacceleration of inflation than turns out to be the case.


224. A gold clause is a feature of contractsthat calls for payment either in physical gold of a defi-nite weight and fineness or in whatever amount ofpaper money may be required to purchase such quan-tity of gold at the prevailing market price of gold.

225. If a bond is payable in the amount of$1,000 gold dollars, in which a gold dollar is definedas one-twentieth of an ounce of gold of a definite fine-ness, calculate the amount of paper dollars required toredeem that bond if the price of gold rises to $35.

226. If a bond is payable in the amount of$1,000 gold dollars, in which a gold dollar is definedas one-twentieth of an ounce of gold of a definite fine-ness, calculate the amount of paper dollars required toredeem that bond if the price of gold rises to $350.


Assume the existence of a money supply that contains250 million physical ounces of gold, with each ounceof gold defined as $20. Assume also that along withthe gold, the money supply consists of a further $20billion of paper money, payable in gold on demand,and up to now treated as the equivalent of $20 billiongold dollars.

227. Calculate the number of dollars repre-sented by the gold component of the money supply.

228. Calculate the total money supply, con-sisting of the sum of the gold dollars represented bygold and the equivalent of gold dollars represented bythe paper money.

Now assume that the supply of paper money is ex-panded from $20 billion to $22 billion and that, as re-sult, the market price of gold rises from $20 per ounceto $25 per ounce.

229. Calculate the total money supply interms of paper dollars, using $25 per ounce to deter-mine the number of paper dollars represented by thegold supply.

230. While the price of an ounce of gold isnow $25, calculate the price of a paper dollar in termsof a gold dollar still defined as one-twentieth of anounce of gold.

231. Calculate the size of the total moneysupply expressed as gold dollars defined as one-twenti-eth of an ounce of gold.


232. Under a fractional-reserve gold stan-dard, such as described above, inflation of the supplyof paper money that is redeemable on demand in goldcan lead to

a. a reduction in the quantity of money insofar asit is considered as the equivalent of goldb. a reduction in the ability to repay debts con-taining gold clausesc. both (a) and (b)

233. In the context of a fractional-reservegold standard with numerous gold-clause contracts inexistence, inflation of the paper money can constitutedeflation from the perspective of gold money.

234. At the time of the Great Depression in1929, most long-term debt in the United States, bothgovernment and private, contained gold clauses. Basedon this fact and on your answers to the preceding ques-tions, it follows that the policy of the Hoover Adminis-tration of running what for the time were major budgetdeficits, and the policy of the Federal Reserve of at-tempting to increase the supply of dollars in order toreduce interest rates and to finance the deficits, mayhave served to intensify the deflation and depressionof the early 1930s by threatening the future convertibil-ity of the dollar at $20 to the ounce of gold.

235. With international trade carried on on agold basis, the policy of inflation and consequent de-valuation against gold may have served to reduce theworld supply of money calculated in gold and thushave been responsible for much of the decline in thevolume of international trade in the early 1930s.

236. In recent years, the effect of an increasein the supply of Mexican pesos that caused a more-than-proportionate devaluation of the peso against thedollar

a. reduced the ability of Mexican firms to paytheir dollar debtsb. represented a deflationary inflationc. both (a) and (b)

237. In setting the stage for it to happen, in-flation and credit expansion must be blamed for themass unemployment that results from financial con-traction, deflation, and depression.

238. In the face of the existence of strong mo-nopoly labor unions, inflation is ineffectual as a rem-edy for existing unemployment because the unionswill take advantage of the inflation to drive up wagerates, with the result that the larger volume of spend-ing is likely to result in little or no increase in the quan-tity of labor demanded and thus little or no reductionin unemployment.

239. Those who are reemployed on the vari-ous make-work projects that almost always accom-pany any attempt to eliminate unemployment bymeans of inflation, are employed at a loss to the rest ofthe population, in that additional goods must be pro-vided for them, including the means of production that

they use, and while goods go to them from the rest ofsociety, they do not produce any comparable outputthat can make compensation possible.


240. Inflation, having caused mass unem-ployment by creating all the necessary conditions for afinancial contraction, can

a. never bring about a restoration of employment b. bring about a restoration of employment pro-vided either that there are no substantial monop-oly labor unions present or, if there are, they areweakened to the point that they will not use the oc-casion of a rising aggregate demand to force upwage rates significantly

241. In the case in which inflation can bringabout a restoration of employment, the essential prob-lem remains that the policy of inflation continues, andwith it, all of its destructive consequences.

242. If inflation is ever to be eliminated, thegovernment must lose the power to inflate even in con-ditions in which doing so can reduce unemployment.Unemployment must be eliminated through a fall inwage rates and prices.


243. The resumption and continuation of in-flation is bound to be accompanied by substantial un-employment sooner or later, by virtue of

a. the tendency of real wage rates to fall as the re-sult of inflation and because of efforts to preventthis fall by forcing wage rates to rise fully as rap-idly as prices, without benefit of the necessary in-crease in the demand for laborb. the fact that as inflation becomes more ex-treme, the potential for sudden mass unemploy-ment is created by efforts merely to moderate theinflation, and even by the failure sufficiently to ac-celerate itc. both (a) and (b)

244. Assume the existence of a country inwhich the quantity of money and volume of spendingare increasing at a rate of 50 percent per year and areaccompanied by comparable increases in wage ratesand prices. (Many Latin American countries have pro-vided real world examples of such conditions.) Nowassume that the country’s government, having becomealarmed at the pace of the inflation, decides to cut therate of increase in the quantity of money to 25 percent,and the volume of spending follows suit. Calculate theproportion of the labor force that is presently em-ployed that will suddenly become unemployed if,while the aggregate demand for labor now increasesby only 25 percent, wage rates continue, simply by aprocess of inertia as it were, to rise by 50 percent.


245. If aggregate demand has been growingat a 50 percent annual rate and wages and prices beginto rise at a 75 percent annual rate, in anticipation of ag-gregate demand growing at 75 percent, and then aggre-gate demand fails to grow more than 50 percent,calculate the proportion of the labor force that is pres-ently employed that will suddenly become unem-ployed.

246. A similar outcome to that described inthe previous two questions results in conditions inwhich the demand for money for holding has fallen inanticipation of a degree of inflation that does not mate-rialize, which then leads to a rise in the demand formoney for holding.

247. The potentially most devastating conse-quence of inflation is that, once begun, the processtends to accelerate, with no necessary stopping pointshort of the destruction of the monetary unit by virtueof its losing its acceptability.

248. The loss of acceptability of the mone-tary unit occurs when people realize that between thetime they accept it and even the earliest possible timethey can spend it and thus pass it on to someone else,they will have suffered a substantial loss in buyingpower, at which point they refuse any longer to acceptit and revert to barter if necessary.

249. According to von Mises, the threestages that inflation goes through before reaching itsultimate limit are

a. the belief that although prices are rising, theywill come down, and so it is better to postponepurchasesb. the belief that prices will never come down butonly go on rising, and so it is better to buy now in-stead of waitingc. the belief that the loss in the buying power ofmoney will be so rapid that it is better to buy any-thing than to continue to hold the moneyd. all of the above

250. Inflation has a tendency to accelerate be-cause

a. a major underlying premise which leads to thepolicy of inflation in the first place—namely, thepremise of the welfare state that the governmenthas the power to provide free benefits for peoplewho need them, a premise given the appearanceof reality when the benefits are financed by meansof inflation, logically calls for more and moresuch free benefits, financed by more and more in-flationb. the stimulative effects of any given rate of in-flation tend to wear off and to require a morerapid rate of inflation to maintain themc. inflation itself creates problems whose solutionis perceived as requiring still more inflationd. all of the above

251. On the basis of the fact that a morerapid rate of increase in the quantity of money leads toa fall in the demand for money for holding and thus toa rise in the velocity of circulation of money, it fol-lows that

a. any one-time rise in the rate of increase in thequantity of money will be followed by a morerapid rate of increase in spending and thus in busi-ness sales revenues so long as velocity as well asthe money supply is risingb. any one-time rise in the rate of increase in thequantity of money will later on be followed by ano more rapid rate of increase in spending and insales revenues once the demand for money forholding and consequent rise in velocity stabilizeat their respective lower and higher levelsc. the rate of increase in spending and in salesrevenues corresponding to any given rate of in-crease in the quantity of money must fall at somepointd. to maintain the rate of increase in spendingand in sales revenues corresponding to any givenrate of increase in the money supply in the periodwhen it is joined by the effects of a rising velocityof circulation, a more rapid rate of increase in themoney supply becomes necessary e. all of the above

252. Because the rate of increase in spendingand in sales revenues adds a corresponding componentto the average rate of profit in the economic system, itfollows that

a. the fall in the rate of increase in spending andsales revenues resulting from velocity stabilizing,operates to reduce the average rate of profit in theeconomic systemb. the maintenance of the average rate of profit atthe level achieved by the combination of anygiven rate of increase in the money supply cou-pled with a rising velocity of circulation requiresan acceleration in the rate of increase in themoney supply c. both (a) and (b)

253. In raising sales revenues and profits, in-flation operates to benefit stockholders at the expenseof bondholders, whose interest returns are contractu-ally fixed. Yet in the face of continuing inflation, inter-est rates tend to rise, to offset this imbalance. In orderfor the stockholders to continue to gain at the expenseof bondholders, an acceleration of inflation is required.

254. In the absence of an acceleration of in-flation, the gains experienced by debtors at the ex-pense of creditors as the result of inflation wear off.

255. The factors making for an accelerationof inflation in connection with profits are

a. the acceleration needed to maintain the oveallrate of profit on capitalb. the acceleration needed to enable stockholdersto go on benefitting at the expense of bondholders


c. both (a) and (b)

256. Examples of inflation coming to be de-manded as the means of solving problems largely cre-ated by inflation are

a. inflation-financed government rescues andbailouts of businesses, which have been driven tofailure by the effects of credit expansion or thetaxation of replacment funds resulting from theoverstatement of profits brought about by infla-tion b. inflation-financed government aid to the el-derly, who have been impoverished by the declinein the buying power of their incomes and assetscaused by the government’s previous inflationc. inflation-financed government aid to the mort-gage market brought to near extinction by thethreat posed by inflation to all long-term contracts d. inflation to offset the reduction in the buyingpower of the government’s own revenuese. inflation to paper over credit crunches andprofit squeezes brought on by inflationf. all of the above

257. The use of inflation to solve problemscreated by prior inflation turns recessions into infla-tionary fueling periods.

258. Price indexinga. addresses the problem of lags between the risein the prices one must pay and the prices or in-come that one receivesb. at most enables an individual to catch up withthe rise in prices, but does not compensate him forthe loss of purchasing power in the interval beforecatching up, nor compensate him for the effects ofagain falling behind, as the prices he must pay risebefore the prices he receives

259. In response to inflation and the threat ofinflation, price indexes have come into use in theUnited States in

a. employment contractsb. social security paymentsc. the determination of the boundaries of incometax bracketsd. the payment of interest on a small amount ofgovernment bondse. all of the above

260. Additional areas that are likely candi-dates for the use of price indexes in the future are

a. the calculation of depreciation allowances forincome-tax purposesb. the calculation of interest income for income-tax purposesc. a larger proportion of government-bond inter-est paymentsd. all of the above

261. The use of price indexes operates tomake inflation accelerate insofar as it serves to makeprices rise still higher, as in price increases causing

wage increases which then cause further price in-creases.

262. The use of price indexes operates tomake inflation accelerate insofar as

a. it brings about a more rapid increase in thequantity of money and volume of spending in gov-ernment efforts to overcome or forestall the re-duced quantities of goods and labor otherwisedemanded at the higher prices, and the unemploy-ment this would cause.b. the reductions in government revenue and in-creases in government expenditures that it causeslead the government to rely more heavily on thecreation of new and additional money as a sourceof funds. c. both (a) and (b)

263. Apart from wage indexing, there is notendency for inflation to accelerate in thegovernment’s efforts to avoid unemployment.


264. Assume that labor unions demand an in-crease in wage rates 2 percent above the prevailing in-crease, if any, in the general consumer price level, butthat there is no rise in the productivity of labor or inthe distribution factor. The outcome will be

a. the unemployment of about 2 percent of theworkers presently employed plus a further rise inprices of 2 percentb. a further rise in prices of 2 percent but possi-bly no additional unemployment, if at the sametime the government increases the quantity ofmoney and thus the volume of spending by a fur-ther 2 percentc. both (a) and (b), considered as alternatives

265. Calculate the rise in prices in a futureyear when the unions not only continue to demand anincrease in wages of 2 percent above the expected risein prices but the expected rise in prices now alsocomes to incorporate the additional 2 percent annualrise brought about by the unions’ policy itself, sup-ported by the government’s policy of accomodating itthrough increases in the money supply.

266. Calculate the rise in prices in a furtherfuture year when the unions not only continue to de-mand an increase in wages of 2 percent above the ex-pected rise in prices but the expected rise in prices isnow still further elevated by a second 2 percent.

267. Witnessing the repeated failure of wagedemands 2 percent above the expected rise in prices toachieve any actual benefit, because prices turn out torise 2 percent faster, a likely effect is an accelerationof union demands, perhaps to 4 percent above the nowprevailing rise in the consumer price level, as a meansof offsetting the effect of the recurring extra 2 percentrise in prices.


268. Union wage demands in combinationwith a government policy of accommodating themthrough increases in the quantity of money and vol-ume of spending

a. operate as a kind of upward “ratcheting” inconnection with the acceleration of inflationb. have the potential to reach double and tripledigit levelsc. both (a) and (b)

269. The losses that inflation inflicts on bond-holders and other creditors

a. result in increases in the rate of interest, as ameans of preventing such lossesb. the establishment of a rate of interest highenough both to offset the rise in prices and toyield a positive real rate of return, would not onlyeliminate the gains of stockholders and other debt-ors, but impose losses on them equal to the losseson investments as a whole that are caused by infla-tionc. to avoid or eliminate losses and regain the ad-vantage of inflation, stockholders and other credi-tors must demand more rapid inflationd. all of the above taken together

270. After repeated rounds of interest ratesrising to levels sufficient to protect creditors from pre-vailing levels of rising prices, only soon to be followedby prices that rise still more rapidly so that once againcreditors suffer losses, creditors will ultimately con-clude that no rate of interest is high enough to protectthem from inflation. At that point the loan market ei-

ther withers and dies or must be maintained by infu-sions of new and additional money on a scale suffi-cient to meet whatever credit needs will be met.

271. The United States began to approachthe kind of conditions described in the preceding ques-tion in the late 1970s, when the long-term fixed ratemortgage market virtually disappeared.

272. When the limits of the upward ratchet-ing of interest rates is reached, the potential is createdfor a quantum leap in the rate of inflation in an effortto supply vast needs for credit by means of the cre-ation of new and additional money.

273. The potential of inflation to destroy theexisting monetary unit, by accelerating to the point ofpeople refusing to accept it,

a. would be accelerated by the availability of analternative monetary unit that retained its purchas-ing power better and whose competition wouldrapidly undermine the demand for the inflatingmonetary unitb. can result in the destruction of the division oflabor and the material civilization that depends onthe division of labor, if the destruction of the exist-ing monetary unit is turned into the destruction ofmoney as such by a combination of the continuedacceleration of inflation and the prohibition of thedevelopment of an alternative monetary unitc. both (a) and (b)

274. The leading historical example of the de-struction of money is the late Roman Empire, whosecivilization and culture could not survive without it.

Chapter 19, Part C

275. The widespread ownership of gold andsilver coins coupled with the freedom to use them asmedia of exchange at their bullion value and to writeenforceable contracts payable in them

a. would provide powerful competition for a rap-idly inflating paper money and result either in thepublic spontaneously abandoning the papermoney or in the government halting its inflationand making the paper money once again redeem-able in gold on demand b. would serve as a guarantee against the destruc-tion of money as the result of hyperinflationc. both (a) and (b)

276. Assuming that its rapid or at least sub-stantial inflation is virtually inevitable, fiat money canbe maintained in existence only by the forcible sup-pression of the competition of gold.

277. Inflation at the rate experienced in theUnited States in the 1970s turns the real rate of returnon capital negative, for the reasons explained in con-nection with its undermining of capital accumulation.In such conditions, ownership of gold becomes a bet-ter alternative than normal investments, by virtue of

the fact that the rise in its price along with prices ingeneral maintains its purchasing power, while its mini-mal cost of storage is less than the losses in buyingpower experienced on normal investments. In suchconditions, the rising demand for gold makes its pricerise faster than the general rise in prices.

278. If not prevented by government interfer-ence, growing ownership of gold as an inflation hedgewould lay the foundation for its spontaneous reemer-gences as money

a. inasmuch as the sizable number of people seek-ing to add to their ownership of gold would bewilling takers of gold in exchange for goods andservicesb. the existence of the people described in (a)would further increase the number of people will-ing to take gold in exchange, because even peoplenot seeking to hold gold as an inflation hedgewould know that they could reexchange it withthe extensive group of those who were seeking todo soc. the addition of the further group described in(b) to the number of people willing to take gold in


exchanges would lead to still more people becom-ing willing to take it on the basis of the now stillgreater ability to rexechange itd. the culmination of a self-reenforcing processof growing numbers of people willing to takegold, would be its universal acceptability, i.e., itsreestablishment as moneye. all of the above

279. The spontaneous remonetization of theprecious metals would be greatly fostered if

a. it were not illegal for merchants to practice dis-crimination between paper money and preciousmetal coins of the same face value. (The constant,day-to-day experience of people being able to usea twenty-dollar gold piece as the equivalent of320 or more paper dollars—its recent bullionvalue—and four silver quarters or ten silver dimesas the equivalent of more than $3, reflecting therecent bullion value of silver, would teach peoplethat the problem of inflation resided in the papermoney and make them want their pensions andcontracts payable in gold or silver.)b. if contracts payable in precious metal were le-gally enforcable and not treated as usuriousmerely because the depreciation of paper moneymight entail the repayment of vastly more paperdollars than were equivalent to the gold when thecontract was madec. if the increase in the paper dollar value of goldcontracts, resulting from nothing other than the de-preciation of the paper, were not subject to taxa-tiond. all of the above

280. Among the positive measures the gov-ernment might take that would foster the remonetiza-tion of the precious metals are

a. the phasing in, over a period of a few years per-haps, of the collection of certain taxes, such as theproceeds of the tariff and perhaps certain excisetaxes, in gold or in transferable claims to gold pay-able on demand and 100 percent backed by gold b. the sale of government assets, such as the landit owns in the Western states and in Alaska, forgold or transferable claims to gold payable on de-mand and 100 percent backed by gold c. enactment of a creditors’ protection bill requir-ing that some modest portion of existing con-tracts, such as 5 or 10 percent of the sumsinvolved, be payable in gold, at the option of thecreditor, at the price of gold prevailing at the timeof the bill’s enactment (in the case of new con-tracts, the price of gold could be that prevailingwhen the contracts are made)d. all of the above

281. The government’s establishing a goldrevenue for itself would

a. immediately sharply increase the demand forgold and its value

b. immediately make payment in gold acceptableto whoever had to pay such taxesc. be a clear indication to everyone of the courseof things to comed. provide the government with a secure sourceof revenue that would be sufficient to maintain itsessential, non-welfare-state, peacetime functionson the scale on which they existed earlier in Amer-ican historye. promote the highly desirable objective of themonetary demand for gold increasing as far as pos-sible in advance of major financial obligationscoming to be expressed in gold, which would benecessary in order for borrowers of gold not tofind that it is vastly more difficult to acquire it atthe time of repayment than at the time they bor-rowed itf. all of the above

282. The kind of creditors’ protection legisla-tion described above would serve to provide a signifi-cant measure of protection for creditors against thepossibility of being wiped out by the depreciation ofpaper money, because the almost certain rise in theprice of gold far in excess of the rise in the general runof prices in such circumstances would make theamount of gold that was originally equal to just 5 per-cent of the value of a contract equal to a substantiallyhigher percentage in terms of buying power.


Assume that a contract is made calling for the paymentof $1 million in 20 years. Assume that the price ofgold at the time of the making of the contract is $500per ounce.

283. Calculate the quantity of gold in whichthe contract would be payable if the contract guaran-tees the option of the creditor to collect 5 percent ofthe face value of the contract in gold at the present,$500 price of gold.

284. Assume that by the time the $1 millionbecomes payable, prices in general have increased bya factor of 10 and that the price of gold has increasedby a factor of 50. Calculate the percentage of the buy-ing power of $1 million at the time the contract wasmade, that the payee would be able to collect at thetime of the contract’s fulfillment.


285. Almost any gold standard that was ad-hered to would eliminate the problem of inflation.

286. A 100-percent-reserve gold standardwould make both inflation and deflation/depression im-possible.

287. The falling prices that would exist underthe gold standard, as the result of the increase in the


production and supply of goods surpassing the in-crease in the supply of gold and consequently the vol-ume of spending in terms of gold,

a. would not be deflationary with respect to therate of profit, which not only would not fall as theresult of the falling prices, but would be positivelyincreased to the extent that the increase in the sup-ply of gold was the source of a continuing rise inproductive expenditure and sales revenues andthus of a corresponding addition to the averagerate of profit in the economic systemb. would not be deflationary with respect to theability of business firms to repay their debts, be-cause the average business would be in the posi-tion of having a larger supply of goods to sell atprices that fell less than in proportion to the in-crease in its supply, because of the increase in thequantity of money and volume of spending thattakes place c. would not be deflationary with respect to theability of wage earners to repay their debts be-cause the increase in the quantity of money andvolume of spending that takes place would almostcertainly surpass the increase in the supply oflabor, with the result that money wage rateswould not tend to fall but to modestly rise (realwages would rise both to this extent and to what-ever extent prices fell)d. all of the above

288. The 100-percent-reserve gold standard,so far from being deflationary would actually serve asthe strongest possible guarantee against deflation be-cause

a. the slow rate of increase in the quantity ofmoney that it made possible would not give rise totemporary, unsustainable decreases in the demandfor money for holding that in turn would serve to

temporarily raise the velocity of money, only tobe followed by a rise in the demand for money forholding and accompanying fall in the velocity ofmoneyb. it would make impossible any significant de-cline in the quantity of money and volume ofspending, irrespective of the failure of any debtorsc. both (a) and (b)

289. A 100-percent-reserve gold standard, in-deed, any real gold standard that was adhered to, would

a. eliminate the possibility of peacetime govern-ment budget deficits on the part of any even semi-responsible government, by making bankruptcythe price of such a policyb. sharply limit growth in the size of government,since all new spending would have to be financedby tax increases in the very same yearc. reduce the frequency and duration of wars,which would be an occasion for major tax in-creasesd. eliminate the risk of arbitrary redistribution ofwealth and income through inflatione. reduce the taxation of profit and interest in-come by not artifically creating such income,which is then subjected to taxation, but insteadmaking it possible for a significant portion ofprofit and interest income in real terms to take theform of falling prices and thereby escape taxationf. greatly encourage saving and capital accumula-tiong. eliminate the risk of currency depreciation onthe part of countries that had ith. create the potential for a single currency acrossthe whole world, with enormous benefit to interna-tional trade and investmenti. all of the above



Ques-Correct Ques- Correct Ques-Correct Ques-Correct Ques- Correct Ques-Correct Ques- Correct Ques- Correct Ques- Correct Ques- Correct tion #Answer tion # Answertion #Answer tion #Answe tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer tion # Answer

1 e 31 9.09% 61 T 91 c 121 T 151 $300,000 181 T 211 12% 241 T 271 T2 c 32 20% 62 T 92 d 122 T 152 $100,000 182 T 212 12% 242 T 272 T3 c 33 25% 63 e 93 T 123 d 153 $200,000 183 d 213 4% 243 c 273 c4 d 34 T 64 T 94 T 124 c 154 $100,000 184 T 214 T 244 16.70% 274 T5 T 35 33% 65 T 95 T 125 T 155 $100,000 185 e 215 T 245 14.28% 275 c6 e 36 T 66 T 96 d 126 T 156 zero 186 T 216 T 246 T 276 T7 T 37 T 67 T 97 c 127 T 157 $100,000 187 -3% 217 T 247 T 277 T8 d 38 -33% 68 T 98 c 128 T 158 100% 188 2% 218 T 248 T 278 e9 F 39 T 69 T 99 T 129 T 159 T 189 5% 219 T 249 d 279 d

10 T 40 T 70 a 100 T 130 T 160 T 190 T 220 I 250 d 280 d11 T 41 T 71 T 101 T 131 T 161 F 191 T 221 T 251 e 281 f12 T 42 e 72 e 102 T 132 e 162 b 192 -33% 222 c 252 c 282 T13 b 43 T 73 T 103 T 133 T 163 T 193 $120,000 223 T 253 T 283 100 oz.14 T 44 T 74 b 104 T 134 $10 164 $40,000 194 $100,000 224 T 254 T 284 25%15 d 45 T 75 T 105 T 135 $5 165 $10,000 195 $20,000 225 $1,750 255 c 285 T16 T 46 T 76 T 106 T 136 none 166 $30,000 196 $53,333 226 $17,500 256 f 286 T17 T 47 T 77 T 107 c 137 $5 167 none 197 $33,333 227 $5 billion 257 T 287 d18 d 48 T 78 T 108 e 138 $121 168 3% 198 zero 228 $25 bill. 258 b 288 c19 T 49 T 79 T 109 T 139 $21 169 3% 199 T 229 $28.25 bill 259 e 289 I20 T 50 T 80 T 110 T 140 $10.50 170 $100,000 200 T 230 $0.80 260 d21 T 51 b 81 T 111 e 141 $10 171 $25,000 201 T 231 $22.6 bill. 261 F22 T 52 F 82 T 112 T 142 $0.50 172 $75,000 202 T 232 c 262 c23 T 53 T 83 T 113 T 143 $11 173 $60,000 203 T 233 T 263 F24 T 54 T 84 T 114 T 144 95.50% 174 $15,000 204 T 234 T 264 c25 c 55 c 85 c 115 T 145 $150,000 175 1.50% 205 d 235 T 265 4%26 c 56 T 86 T 116 d 146 $100,000 176 T 206 e 236 c 266 6%27 e 57 T 87 T 117 c 147 $50,000 177 0.875 207 T 237 T 267 T28 d 58 T 88 c 118 T 148 $25,000 178 T 208 e 238 T 268 c29 T 59 T 89 T 119 T 149 none 179 T 209 T 239 T 269 d30 T 60 d 90 f 120 T 150 $25,000 180 c 210 2% 240 b 270 T


Short-Answer Q&A Supplement to Capitalism: A Treatise on Economics

Documents