Money illusion

Two years ago I wrote a theoretical framework on the self-defeating nature of a successful "buy local" community that voluntarily makes the majority of what it consumes, but has no trade barriers to enforce it.

A reader recently commented:

This part: "individuals may have more and more cash on hand, but it will buy less and less stuff." is not necessarily accurate without an analysis of the price elasticity of supply for the local goods. Without that information, you can't know for sure whether more money will in fact buy less goods, or more. 

 Also, your scenario conflicts with itself. The only way the money supply would increase in a certain local area ("...more and more cash on hand....") is for "outsiders" to be spending money on the "local" goods or services. However, if this were the case, the increase in money would correspond to an increase in real income in the "local" area, thus, by definition, cancelling your inflation scenario.

The reader proposes that we don't know exactly what would happen to purchasing power. The community would have higher prices, but the community members would also have more money.

We can see exactly what would happen to prices. One merely needs to shed the veil of money and look at the bare resources moving around to see what would go on. Resources would leave the community, no new resources would come in. Instead, green pieces of paper would come in. Inflation is an increase in green pieces of paper in proportion to the goods and resource they stand for, and that's exactly what is happening this scenario.

As for price increases, you have to perform work inefficiently and the residents/customers have artificial limits on where they can purchase goods from. That is a standard recipe for increases in prices.

"However, if this were the case, the increase in money would correspond to an increase in real income in the "local" area, thus, by definition, cancelling your inflation scenario.

The reader has confused real and nominal incomes. I agree nominal incomes will go up if they could keep finding customers outside the community, which will be increasingly harder as prices increase. However, since that money can only be spent within the community, and the community is inefficient, then customers will see their purchasing power drop. Keep your eye on the resources, not the money.

How could everyone's purchasing power go up when there's less to buy?


The increase in nominal income is an illusion, and without trade barriers, the community members will experience more and more temptation to break the pact and purchase cheap goods from the next town over. Only trade barriers between communities, which are unconstitutional in America, could keep the farce alive.