Saturday 22 April 2023

Is "Greedflation" happening? I'm sceptical

What is causing current inflation?

There are a number of articles saying that rather than a wage-price spiral, it is being caused by companies increasing their profit margins. In fact, even some people at the ECB are taking this view. 

When you do Econ101, one of the first things you learn how companies maximise their profits. It is also probably the first time you think economics is very far away from reality. Do companies really find their marginal revenue and equate to their marginal cost? Not a chance.

What actually happens is people think about their "mark-up". The price they sell it at vs the amount it costs. So if I sold coffee for £1 and it costs me 10p to make then my mark-up is 90p. But what price should I charge? Well, crucially this depends on demand. If you charged £100 for your coffee your mark up would be £99.90 - but no one would buy it. If you charged 11p for your coffee you would selling 100 cups of coffee would make you £1 in profit.

What I am saying here is that demand matters. If you mess about with your price a bit you will probably hit a nice sweet spot where you get the most profits (you are doing MR=MC without knowing it!).

So this is why I find it hard to buy that profits are driving inflation. Just because companies raise their price doesn't mean they will be able to sell the same amount as it should lower demand. Even if you are more likely to buy a product if you think inflation is a reasonable excuse, at some point demand is going to fall. This is especially true if wages are not rising as you literally can't afford it. You can only be spun a yawn by companies so many times before you run out of money.

You might not buy the wage-price spiral story (for what it's worth, I don't think this is what's happening now), but the reason why inflation persists in theory is that when prices increase, workers demand wage rises at least in line with inflation, which then increases demand and pushes prices up further an so on and so forth. There isn't a mechanism like this in "greedflation", there is not really a way for it to spiral.

But what about necessity goods like food, you have to buy food!? Well, yes. But it would mean we should be seeing prices fall in other areas as people spend more on food. Also, if companies are just crying wolf over inflation why are some not undercutting each other? 

Supermarkets are notoriously cutthroat when it comes to competition on price, so your story needs to explain why suddenly firms have discovered their market power and also are tacitly colluding with each other to maintain high prices. 

I don't really have an issue with profits being the cause of inflation - I just don't know how this is meant to work. At the moment, it is a slogan looking for a theory.

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