There is something that has been puzzling me for some time regarding inflation, and I am hoping that someone can throw light on the matter. One of the causes of the current high inflation in the United States is said to be the tightness in the labor market. As I understand it, this means something like the following: employers are having difficulty filling jobs because there are too few people looking for work. In an attempt to attract employees, employers raise the wages that they offer. This reduces their profits and so they respond by raising prices. The result is inflation, which is to say a rise in prices.
My question is this: why don’t they raise their prices
before they are compelled to offer higher wages? If they can sell their goods after raising
their prices in response to their rising labor costs, then presumably they can
sell their goods after raising their prices even if their labor costs are not
going up, in which case they would make more money. If they are unable to sell
their goods at the higher prices after their labor costs go up, then they would
be forced to bring their prices back down to sell their goods, with the result
that they would make lower profits but at least they would make something since
the alternative would be that they had unsold goods in their warehouses.
This is such a simple question that there must be a simple
answer to it but I confess I am unable to figure out what that is.
Adam Smith fils,
ReplyDeleteLabor shortages presumably affect similar industries similarly. So, if restaurant A has a labor shortage and raises wages in order to attract employees, and in turn raises its prices, so will restaurant B raise wages in order to attract employees, and likewise raise prices to offset the higher costs of labor. This will run true for all comparable industries and services, i.e., all auto repair shops; all auto manufacturers; all ….
However, if a participant in a particular industry simply raises prices without the need to pay higher wages, then its competitors who do not raise prices will have a competitive advantage against those businesses that raise prices, but without doing so because it has raised wages. The latter will lose business, and thereby lose profits on business it does not have, losing those profits to its competitors that did not raise prices and captured their competitor’s business.
I know that is the standard explanation, but it does not make sense. Why does not restaurant B, despite having to pay higher wages to get employees, hold it is prices firm and get a competitive advantage against restaurant A? it can get back at least some of what it pays in higher wages by serving more customers. This in turn puts pressure on restaurant A to bring its prices back down. The standard explanation just does not make any sense.
ReplyDeleteBecause profit margins in these industries are so narrow that a restaurant which raises wages without raising prices will start operating at a loss and go out of business.
ReplyDeleteAll of these explanations assume perfect information and instantaneous calculation of the sort that does not exist. Why is not it just as reasonable to suppose that some restaurants edged their prices up a few cents, without losing customers, thereby encouraging their competitors to do the same thing so that there is a slow steady rise in prices and profits for some time before customers start shifting their trade? Besides, very few sectors of the economy operate on profit margins this small.
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteThat is my point, Jerry. I was going to write a long post about the way the new order grows in the womb of the old – capitalism has advanced to a point at which it has created within itself the possibility for socialism.
ReplyDeleteThe premise just isn't true. The inflation isn't due to (or is only very slightly due to increased wage demand). So no need to solve the puzzle.
ReplyDeleteApart from Covid, the war and attendant sanctions, I think monopoly conditions play the biggest role. Hence your question (why don’t they raise their prices before they are compelled to offer higher wages?) is the explanation. That is what is going on.
In restaurants at least people do shop around.
ReplyDeleteThere's a neighborhood near where my partner lives in Santiago with streets filled with cafés and restaurants. We often eat out and if we see that one restaurant is more expensive than another, we go to the cheaper one.
It's obviously not always the case that one can shop around so easily, but actually with internet shopping around becomes increasingly easy, since now not only do many restaurants have their menus and prices online, but also supermarkets, pharmacies, clothing stores, etc.
With all due respect, Prof. Wolff, you are mistaken. The net profit margin in the construction industry, for example, is 5%; in the hotel industry, it is 8%; in the retail industry it is 5%. Business owners are inclined to raise their prices commensurate with the increase in wages which they are offering, not in small increments, as you are proposing. This is not irrational – they wish to keep their profit margins, as small as they are, steady. Incremental changes will reduce their profits, and thereby reduce the incentive to stay in business, which requires long hours and hard work.
ReplyDeleteWell, maybe I just do not understand the world as it is. I have never run a business, of course.
ReplyDelete
ReplyDeleteRestaurants are more consumers then producers. Food at home and food out have had similar increases (10.1% to 11.3%) - the war in Ukraine, bird flu, and energy prices hit both sectors hard.
On the other hand, businesses with actual pricing power have used that power arbitrarily to test the margins. Overall I believe wages have been flatish while productivity is up.
I would assume that private equity and venture capital would make socialism less likely.
BTW, I see that our governor has indicated that California won't do business any longer with Walgreens as a result of that company caving to Republican AGs in other states over abortion meds. Good decision to emulate.
In relation to the professor's abandoned plan (post on January 28) to ramble on about the latest AI bots, a new piece by Chomsky in NYT: It starts with a great bit of Borges, then after a few paragraphs comes the marvelous sentence (which sounds like a characterization of major aspects of (my 'field' of) contemporary art): "It sacrificed creativity for a kind of amorality." And the last third or so struck me as particularly interesting: https://www.nytimes.com/2023/03/08/opinion/noam-chomsky-chatgpt-ai.html?action=click&module=Well&pgtype=Homepage§ion=Guest%20Essays&fbclid=IwAR2Az9tu1mdixRAepzsZDx-Sx6R50a-g-sw2FziHfKa5K_er6za57ixgtBA
ReplyDeletethanks for the link John Rapko,
ReplyDeleteit is of course a harsh judgment to compare ChatGPT with Adolf Eichmann. But I suspect that even this will not be enough to bring the hype around AI down to the level of what AI can really do. There are already too many dollars in these projects.
However, if you leave aside for a moment the function of reconstructing human grammar, and consider that the function of pattern recognition in huge amounts of data can play a very helpful role in medical diagnostics, then there is some justification for the investments in this area of research. Such systems could also play a similar role in the sustainable use of nature, for example in the fight against climate change.
This is very serious.
ReplyDeletehttps://www.cnn.com/videos/business/2023/03/08/donie-osullivan-calls-mom-using-deepfake-audio-pkg-ac360-vpx-zw-orig.cnn-business
Achim,
ReplyDeletePerhaps this will amuse and/or frighten you: the example of the neural network that famously had reached a level of accuracy comparable to human dermatologists at diagnosing malignant skin lesions. However, a closer examination of the model’s saliency methods revealed that the single most influential thing this model was looking for in a picture of someone’s skin was the presence of a ruler. Because medical images of cancerous lesions include a ruler for scale, the model learned to identify the presence of a ruler as a marker of malignancy, because that’s much easier than telling the difference between different kinds of lesions.
Here's a recent article that addresses some of your question. (In short: companies are starting to raise prices based on dubious excuses -- "excuseflatoin" -- increasing their profits while testing the limits of consumer tolerance.)
ReplyDeletehttps://www.msn.com/en-us/money/other/how-excuseflation-is-keeping-prices-and-corporate-profits-high/ar-AA18poxq
Ed Barreras,
ReplyDeleteSorry, that anecdotal story as an explanation for inflation is bogus. That is one bakery in one city. Extrapolating from this one instance to an explanation of inflation across the entire economy is hardly defensible reasoning. In the absence of an actual increase in costs – whether labor or materials – using world events as an excuse to increase prices just makes the Jarosch bakery an easy target for his competitors, who will not raise prices in the absence of legitimate increases in labor and/or materials.
More AI innovations to be concerned about. Human avatars spreading disinformation.
ReplyDeletehttps://www.cnn.com/videos/business/2023/02/11/nft-bored-ape-moonpay-lawsuits-reeve-pkg-ebof-vpx.cnn
I'd assume the bakery's competitors used the spike in commodities to also raise their prices and, like Jarosch, are loath to reduce them and legitimately fear price wars (most of the folks here likely remember the 1950s and 60s gas wars).
ReplyDeleteWe learned in 2008 that wages tend to be sticky and it seems prices behave the same way for many businesses - look at the oil industry and shipping profits. In 2021 chicks were basically rationed and feed grains went bonkers. Feed prices are still way up. And again, local businesses like bakeries and restaurants are at the end of the chain. Lots of competition and little power. Hardly a mystery they would use the recent disruptions to increase profit margins.
aaall
ReplyDeleteLots of speculation and no data.
I've run 2 businesses where price stability/instability is a poker game with one's competition. Does one call or raise each competitor's price increase? How does a call or raise affect my profit margin? What are my cost increases versus my competitors' increases? We were always calculating, yet a lot of our price decisions were based on speculating, not calculating with ample data.
ReplyDeleteA close friend ran a tax practice where she kept her client fees very low compared with other tax professionals, hoping to skim off clients from their practices. This worked for a while, but then the number of additional clients became marginal, her costs continued to increase, and soon she was far behind the price curve, yet believed she couldn't raise her fees very much for fear of losing clients.
Doesn't much matter whether your product is tax returns or widgets. Same issues. Same anxieties. Same calculations--and very, very often miscalculations. Whether to raise prices before wage increases consists mostly of guessing. It ain't close to being an exact science.
So, if you are confused, so are the people in the game.
Prof. Wolff, it seems a felony indictment in NY is imminent.
ReplyDeleteA long, long time ago, as the monetary values will show, I worked for a small academic book publisher. The book was just about ready to go. And I was sitting in the meeting where one of the items of discussion between the author of the book and the publisher was the price of the book. Let's make it $11, said the publisher. No, said the author, you can't ask students to pay more than $10 for a textbook. OK, said the publisher, let's make it $9. No, said the author, let's make it $9.95
ReplyDeleteI imagine economic rationality was in there somewhere. But where?
Anonymous,
ReplyDeleteThe pricing decision was a combination of both economic reality, and psychological reality. $9.95 is still more than $9.00, thereby providing greater profit to the author; it is less than $10.00, so as not to deter students from purchasing it; and it is considerably less than $11.00, so as not to appear to be price gouging. All objectives, both economic and psychological, are satisfied. Hence, it was a rational decision.
Except, Adam Smith fils, the author's tone of voice intimated that he was stating a sort of moral reluctance to ask students to pay $10 for his textbook. Hence, his upping the price from $9 to $9.95 struck me as a moral failing. It still does.
ReplyDelete.95 extra per book will often suffice to allay moral concerns.
ReplyDelete1. Capitalism is not now nor ever has been entirely rational so imputing broad rationality is quite simply an error in methodology.
ReplyDelete2. With some respect to Adam Smith fils, I have worked in 'business' for 30+ years and although bottom line 'net' profit margins 'may' be in the single figures in certain industries/sectors, gross margins are typically in the 35% - 65% range and individual business operators also siphon off incremental profit and economies of scale from the items compromising the difference between gross and net margin. Stated simply: net margin is often deliberately understated.
3. In the current highly consolidated, monopolistic environment, inflation can be chiefly attributed to greed and opportunism.
Well, one person's rationality is another person's greed and selfish opportunism.
ReplyDeleteI assume the prof. was assuming the resistance was psychological (ditto the $0.95) as the difference between $9, $10, and $11 was materially trivial even in the 1950s & 60s relative to the cost of college.
ReplyDeleteIn the wake of SVB, this describes our tech-bro overlords:
“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
https://slate.com/technology/2023/03/silicon-valley-bank-rescue-venture-capital-calacanis-sacks-ackman-tantrum.html
ASf, a take on your old man from Corey Robin:
https://www.nybooks.com/articles/2022/12/08/empathy-the-economy-being-me-being-you-adam-smith/
aaall,
ReplyDeleteThank you for that superb article. It does my old man proud. “The left is still preoccupied with the decades-old debate over which is more important: recognition of our identities or material redistribution. Adam Smith ended that argument before it began.” Indeed. Too bad my old man did not live long enough to read about his vindication.
(Sorry for the latish comment - I was "on vacation" from retirement.
ReplyDeleteRob, I know you don't think much of Paul Krugman, but he has written about the non-existence of a "wage-price spiral" - instead it's a price-price and wage-wage spiral. That is, a business will raise wages if it expects that its competitors are or will be raising wages. And it will raise prices if it expects its competitors ditto. There is also the sitcky issue - wages certainly, and prices often, are set once a year rather than minute-by-minute, expect in industries with commodity-futures markets. Thus things are set with significant influence from expectations of year-ahead conditions.
Oops, "...expect in" should be "except in".
ReplyDelete