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Suppose there’s an island that for whatever reason has a finite amount of US Dollars; 1000 residents live on the island and use this fixed amount of currency to exchange goods and services.

Suddenly, a millionaire with a briefcase containing his fortune survives a shipwreck and arrives on the island, so there are now 1001 residents.

It’s my understanding that economic theory predicts that the price of goods and services will rise in response to this economic stimulus.

I’m curious, however, by what mechanisms does this actually happen?

If bartering is assumed then producers can get a measurement of what the millionaire is willing to pay, infer demand curves, and optimize pricing. And in consequence, prices go up on the island.

But suppose that bartering is not the custom on this island. If unaware of the millionaire’s wealth of his willingness to pay, how will prices naturally accommodate the new resident?

My best guess: pricing experiments. Residents randomly adjust prices, re-evaluate demand curves and optimize from time to time.

But other than this mechanism, I can’t envision a means by which prices on island naturally chase this new money if residents are not explicitly made aware of it.

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  • $\begingroup$ They'll become aware of the money when he start spending it and it enters circulation. $\endgroup$ Commented Sep 10, 2023 at 2:14
  • $\begingroup$ So essentially, he doesn't need to barter/haggle but by just purchasing goods/services at the listed prices, the money will enter circulation and the island economy will naturally adjust accordingly? $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:23

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The prices will only start adjusting once the new millionaire starts spending some money. If he is washed ashore without his credit card or cash then even if he has millions somewhere else it will have absolutely no impact on economy. Money that are not circulating in the economy do not affect prices.

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  • $\begingroup$ This example introduced that his suitcase contained his money, so assume that the millionaire is able to participate in this island economy. $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:24
  • $\begingroup$ ThisIsNoZaku proposed that the millionaire doesn't need to buy goods/services above listed prices (remember, no haggling). But buy simply participating in the economy, prices will accommodate the new money in circulation. $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:27
  • $\begingroup$ While this is a toy example, it has real world corollary: Gentrification in neighborhoods causing prices for goods and services to increase. For example, the price of tacos & margaritas in Pilsen (Mexican neighborhood in Chicago) has increased dramatically in last 10 years. So producers are able to deduce willingness to pay by means other than adherence to listed prices (ex: pricing experiments.) $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:30
  • $\begingroup$ Or alternatively, producers have mental schemas about willingness to pay given demographic data about consumers, which they rely on when setting prices. $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:32
  • $\begingroup$ Or another alternative, perhaps there is no economy where zero bartering happens. It's somewhat rare to negotiate prices for consumer in the United States (ex: the price of a Big Mac are not subject to negotiation) but negotiation is very common in home sales. So even if negotiation only happens in realistic, the effects could be felt by downstream goods/services. $\endgroup$
    – jbuddy_13
    Commented Sep 10, 2023 at 16:35

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