Inflation

When Is Inflation Not Inflation?

A Note by Gordon TuUock

Discoveries of valuable minerals in undeveloped parts ofthe world frequently lead

to a very sharp rise in prices of daily necessities. Examples are the diamond and gold

mine rushes and, periiaps, the situation in Saudi Arabia and a numberof other Arab

states. Discussing the matter with a number of economists, I find that they take the

view that these situations are inflationary because prices have gone up. This is, I

believe, erroneous. The prices of daily necessities are going up very sharply but

other prices, concealed within the internal accounting system of producing units,

have fallen even more.

Let us suppose that diamonds are discovered in some rural area. People pour in

from all over the world for the purpose of mining diamonds, and prices of housing,

food, and the like, shoot up. Whereas before, the very occasional visitors found it

possible to get the use of some farmer's spare room for little or nothing, now the right

to sleep on the ground in half of a pup tent may cost $ 10 per night. The currency in

which this payment is made, however, is stilt stable currency elsewhere. Is there

then an inflation?

In Figure 1 the quantity of something—let us say housing—is shown on the

horizontal axis, and the supply curve and demand curve before the discovery of

diamonds are shown, respectively, by line S and line D. This leads to quantity 2o

being consumed at price /*«. With the discovery of diamonds, the demand shifted up

tolineD'. At the same time, however, there was a fairly rapid influx of capital in the

form of such things as tents, with the result that the supply curve fell to S'.

Nevertheless, the intersection of the new demand curve and the new supply curve

leads to quantity Q, being purchased at price P,. P, is very much higher than P^. Is

this an inflation? Note that the marginal cost of each unit is now lower than it was

previously. What has happened is that there has been...