When all prices go up, consumers no longer know how much it is reasonable to pay.
“In an inflationary environment, everyone knows prices go up,” said Z. John Zhang, a professor of marketing at the Wharton School at the University of Pennsylvania who has studied pricing strategy. “Obviously, this is a great opportunity for every company to realign their prices as much as they can. You won’t get an opportunity like this again for a long time.
Understanding inflation and its impact on you
The real disagreement is whether higher profits are natural and good.
Basic economic theory teaches that charging what the market can bear will induce firms to produce more, limit prices, and ensure that more people have access to the missing good. Say you make empanadas and enough people want to buy them that you can charge $5 each, even though they only cost $3 to produce. It might allow you to invest in another oven so you can make more empanadas – perhaps so much that you can drop the price to $4 and sell enough that your net income continues to grow.
Here’s the problem: what if there’s a waiting list for new ovens due to a strike at the oven factory, and you already have three shifts? You can’t make more empanadas, but their popularity has grown to the point where you’d charge $6. People could buy calzones instead, but eventually the oven shortage makes all kinds of baked goods hard to come by. In this situation, you make a nice margin without doing a lot of work, and your consumers lose out.
It happened in the real world. Consider the supply of fertilizer, which dwindled when Russia’s invasion of Ukraine led to sanctions on the chemicals needed to make it. Fertilizer companies have recorded their best profits in years, even as they struggle to increase supply. The same is true for oil. The drillers didn’t want to increase production because the last time they did, they ended up in a glut. Increasing production is expensive and investors are demanding profitability, so supply has lagged while drivers are paying dearly.
Even if high prices are unable to increase supply and scarcity persists, an Economics 101 class could still teach that price is the best way to allocate scarce resources – or at least, that is better than price controls or government rationing. Therefore, less wealthy people may simply not have access to empanadas. Michael Faulkender, professor of finance at the University of Maryland, says that’s how capitalism works.
“With price adjustment, people who have substitutes or who can perhaps consume less of them will choose to consume less of them, and you have the allocation of the goods for which there is a shortage that goes to the use the highest,” said Dr. Faulkender said. “Every good in our society is based on price. People who earn more money can consume more.
Sort chickens and eggs
The question of whether profit margins accelerate inflation is more difficult to understand.
Economists calculated how much other variables might have contributed to inflation. The Federal Reserve Bank of San Francisco found that fiscal stimulus programs were 3 percentage points, for example, while the St. Louis Fed estimated that manufacturing inflation would have been 20 percentage points lower without supply chain bottlenecks. Dr Bivens of the Economic Policy Institute performed a simple calculation of the share of price increases attributable to labor costs, other inputs and profits over time, and found that the contribution earnings had increased significantly since the start of 2020 compared to the previous four decades.