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The author is professor and NBER research associate, Economics Department, University of Delaware, Newark, DE 19716, USA ; email: [email protected]. Web page: http://lerner.udel.edu/faculty-staff-directory/farley-grubb/
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Michener claims I incorrectly constructed the paper money's asset present value (APV). He says I constructed it as an average utility measure. He says I should have constructed it as a marginal utility measure. This is because a utility-held-constant demand curve represents the marginal, and not the average, utility at each point. He also claims I constructed APV as ‘an inverse function of the current money supply’ thus making the current paper money supply (M) and APV mechanically related. This in turn invalidates any estimated relationship between M and any variable with APV in it. He is disputing my APV analysis because he does not want anyone to think about colonial paper monies in asset terms. Michener wants everyone to think of colonial paper monies as fiat currencies.
Both of Michener's claims are fallacious. With regard to the first, he makes a fundamental error in microeconomic theory. With regard to the second, he fails to do minimal due diligence in investigating how I construct APV.
Michener's wormy apples
Nowhere do I say I constructed APV as an average utility measure. Michener made that up. I constructed APV as the expected payoff from a random draw from a known distribution of payoffs. An analog is the expected payoff to buying a lottery ticket. Suppose there are 100 lottery tickets for a $100 prize with only one ticket winning it all. What is the expected payoff of one randomly drawn ticket? Another analog is to ask what value you would place on say the fortieth apple purchased, namely where your demand curve for apples is located at the fortieth apple, if the fortieth apple is randomly drawn from a bin of apples with a known distribution spanning from excellently crisp to wormy?
If we translate these examples into utility-held-constant demand curves – what Michener implicitly does – then your demand curve is the average of the marginal utilities of the quality of goods available to be randomly drawn from, or across the set of lottery tickets available to be randomly drawn from. Michener mistakenly claims that your utility-held-constant demand curve is the marginal