Friedman, Milton - Price Theory (1977)

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    Nobel Laureate in Economics, 1976

    MILTON FRIEDMANUniversity of Chicago




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    Milton Friedman is Paul Snowden Russell Distinguished Service Professor ofEconomics, University of Chicago; a member of the research staff, NationalBureau of Economics Research; a past President of the American EconomicAssociation; and a fellow of the Econometric Society, the American StatisticalAssociation, and the Institute of Mathematical Statistics. He is the 'author ofman y journal articles and books. Among his best known works are Essays inPositive Economics, Studies in the Quantity Theory of Money, A Theory ofthe Consumption Function, A Program tor Monetary Stability, Capitalismand Freedom, Dollars and Deficits: Inflation, Monetary Policy and theBalance of Payments, The Optimum Quantity of Money and Other Essays,A Monetary History of the United States (with Anna J. Schwartz), MonetaryStatistics of the United Slates (with Anna J. Schwartz), Money and EconomicDevelopment, and There's No Such Thing as a Free Lunch.

    Copyright 1962, 1976 by Aldine Publishing Company

    All rights reserved. No part of this publication may bereproduced or transmitted in any form or by any means,electronic or mechanical, including photocopy, recording,or any information storage and retrieval system,without permission in writing from the publisher.

    First published 1976 byAldine Publishing Company529 South Wabash AvenueChicago, Illinois 60605

    ISBN 0-202-06074-8

    Library of Congress Catalog Number 76--1397

    Printed in the United States of America

    l,;,Second printing, 1977

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    Table of Contents


    Preface to Price Theory: A Provisional Text

    ChapterIntroduction 1Theory of Demand 12The "Welfare" Effects of Taxes 65The Utility Analysis of Uncertainty 76The Relationships Between Supply Curves and Cost Curves 85The Law of Variable Proportions and a Firm's Cost Curves 130Derived Demand 153The Theory of Distribution with Fixed Proportions 166The Theory of Marginal Productivity and the Demand forFactors of Production . 176Marginal Productivity Analysis: Some General Issues 194The Supply of Factors of Production 201Wage Determination and Unemployment. 213Wages in Different Occupations . 238Relation Between the Functional and Personal Distributionof Income . 251The Size Distribution of Income . 262Profits 279The Theory of Capital and the Rate of Interest 283




    A. Reading AssignmentsB. Problems




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  • Preface

    Shortly after the initial edition of this book was published, I shifted fornearly a decade from teaching price theory to teaching monetary theory.Three years ago, I resumed teaching price theory. Next year (the aca-demic year 1975-76), I plan to teach it for the last time. Hence, if I wereever to revise substantially the provisional version that was published in1962, now seemed the time to do so.I cannot pretend that the present version is the finished treatise that I

    had in mind (or in youthful dreams) in the earlier years of teaching thecourse. But it is a much expanded and, I hope, improved version. I havefilled in four of the six gaps that I enumerated in the preface to the initialversion. The two I have not filled in are industrial organization, for reasonsgiven at the end of chapter 6, and the theory of general equilibrium, be-cause there are such good extant expositions of the classical Walrasiangeneral equilibrium approach and I am not competent to present a suc-cinct yet faithful exposition of the more recent general equilibrium de-velopments, particularly in the field of growth models. In addition, Irather suspect that these developments are as yet in a preliminary and un-satisfactory state.In addition to filling in the designated gaps, I have added a discussion

    of personal probability to complete the utility analysis of choices involv-ing uncertainty and have inserted a largely expository lecture on the Phil-lips curve, which I gave in September 1974 in London. This topic mayseem to belong in monetary theory rather than in price theory. However, Ibelieve that it belongs in both, for reasons that I trust the text makes clear.

    I have included in this edition, as I did in the initial version, my classreading list and a collection of the problems that I have. assigned to theclass to work on at home. I have been gratified at the professional attentionattracted by the problems in the initial version. However, I have not kepttrack of the articles and notes that they have stimulated, so I cannot pro-vide comprehensive references. I have retained in this edition all the prob-lems from the initial edition and have simply added the problems that I


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    have assigned since then. My heaviest debt for problems remains to AaronDirector and George]. Stigler, but I have continued to borrow from othercolleagues as well.

    In preparing this edition, I have benefited from criticisms and sugges-tions of a number of readers, including teachers who have used the hookin their courses. Marshall Colberg was particularly helpful. To him andthe others who sent me comments, my sincere thanks. I am deeply in-debted also to my secretary, Gloria Valentine, who, in preparing the man-uscript for this edition, continued her unbroken record of displaying adegree of efficiency exceeded only by her good cheer.I cannot end this preface without recording the great personal satisfac-

    tion that I have derived from teaching price theory to successive genera-tions of able and enthusiastic graduate students. The formal structure ofprice theory has an aesthetic quality that has always reminded me of thefamous last lines of Keats's "Ode on a Grecian Urn":

    "Beauty is truth, truth beauty,"-that is allYe know on earth, and all ye need to know.

    Milton FriedmanEly, VermontAugust 3, 1975

  • Preface to Price Theory:A Provisional Text

    It is now more than a decade since the contents of this book were firstmimeographed and used in classes in price theory at the University ofChicago. Throughout that period, I have been extremely reluctant tohave these notes offered for general sale. The reluctance has derived frommy dissatisfaction with their scrappy nature, from my intention to usethem as a basis for a fuller and more satisfactory treatment of price theory,and from my optimistic belief that I would be able to turn to the prepara-tion of the fuller treatment momentarily. As an empirical economist, how-ever, I cannot neglect the evidence that has accumulated in that decade.Clearly, I must reject the hypothesis that a fuller treatment is imminent.Moreover, it has not been feasible to keep the mimeographed notes fromgetting fairly wide circulation. Hence, despite my continued dissatisfac-tion with them, it has seemed best to make them generally available.These notes had their origin in the entrepreneurship of David 1. Fand

    when he was a student at the University of Chicago. He induced WarrenJ. Gustus to collaborate in preparing summaries of lectures in a two-quarter course in price theory that I have given at the University of Chi-cago since 1946. I went over the summaries, revised them in detail, wrotealternative versions for some, substituted previously written but unpub-lished material for others, and inserted, both then and at intervals since,published material that seemed particularly relevant. These notes wouldnever have been brought out but for Fand's and Gustus's work, and I ammuch indebted to them.

    In the present version, the reprinted material includes an article on"The 'Welfare' Effects of an Income Tax and an Excise Tax," a revisedversion of an article that first appeared in the] ournal of Political Econ-omy) reprinted here from my Essays in Positive Economics; a few pages onstatistical cost curves from a comment of mine in Business Concentration'and Price Policy; part of an article of mine that appeared in DavidMcCord Wright (ed.), .The Impact of the Union; and an article on"Choice, Chance, and the. Personal Distribution of Income," reprinted


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    from the Journal of Political Economy. I am indebted to the University ofChicago Press, Princeton University Press, and David McCord Wright forpermission to reprint.In teaching the course on price theory since these notes have been avail-

    able, I have found that the chief gaps in them, which it is necessary tosupplement by class presentation, are in respect to (1) the theory of thedivision of income between current consumption and the accumulation ofwealth; (2) industrial organization, with special reference to problems inthe economics of the individual firm; (3) fact and theory about the sizedistribution of income; (4) the theory of profits; (5) capital theory-. thefinal section of the notes on this topic have turned out to be too succinctand condensed, particularly with respect to the arithmetic of the relationbetween income streams and capital values and the stock-flow analysis em-bedded in that section; and (6) the theory of general equilibrium.I have added to this version of the notes two appendixes that may help

    to fill these gaps as well as supplement the notes. Appendix A gives thereading list that I have used in my course. Appendix B gives a collectionof some of the problems that I have assigned to the class to work on duringour so-called reading period. The problems are in two