The Effects of Reforming the Chinese Dual-Track Price System



effect on the CPI through the induced change in the market price. Let ep denote
price elasticity of demand and
em the income elasticity of demand. Our next
proposition gives the efforts of reform of DTP on the CPI.

Proposition 2 If X is normal and its supply is non-decreasing in price p, tran-
sitional policy inflates the CPI, i.e., ddp > 0 > ddp.

We therefore have a paradoxical situation: when the government raises the
controlled price, the CPI is pushed up but the market equilibrium price is reduced.
The effects of a higher level of
p, with x constant, are illustrated in Figure 3, in
which the supply of
X is also fixed (we assume that p < p throughout). As in Figure
2, the household is at equilibrium point E initially. When
p is raised the plan-track
segment of the budget line, the downward-sloping line from point B
(0, 1), rotates
clockwise about point B. Assuming momentarily that
p is unchanged, the budget
line becomes BCD, the sharpness of the kink having been reduced. The household
consumes at point F on CD, which, given that
X is normal, is to the left of E. As
there is now an excess supply of
X, its market price p falls; i.e., the right-hand
portion of the budget line rotates anti-clockwise around point C. Given that the
quantity of
X supplied is unchanged, the rotation occurs until the quantity of X
demanded is at its original level. The new solution is at point G. Recall that the
average price of
X in the original situation was minus the slope of BE. Thus, it

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