Thursday, April 8, 2010

Did Rothbard "Borrow" the Income and Substitution Effects?

This article refutes the claim made by Bryan Caplan that Murray Rothbard’s value scale framework cannot explain the income and substitution effects of a price change. Caplan’s implicit assumption that it is impossible to derive the two effects without the use of the concept of indifference is also incorrect. This is shown by using an example where the value scale approach is used in a scenario often presented in most mainstream microeconomics textbooks: an individual with a given stock of money is set to exchange the entire stock for two goods. The article also points out that professor Rothbard did indicate that a price change has an effect on individual orderings of ends and means, which implies the substitution effect. On the other hand, the fact that a price increase reduces the purchasing power of a given stock of money directly implies the income effect. This article presents these two ideas in a simple framework in order to make them more transparent.

The article can be seen online here. If you would like to see the PDF of the original manuscript, please click here.

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