Tuesday, February 15, 2011

Coming to a store near you: Increases in Prices

In his 1946 classic book on economics, the late Henry Hazlitt, who is one of my favorite journalists and economists, wrote that once inflation settles in the firms in the higher orders of production will eventually have to push costs onto consumers.

That time has come.

The New York Times recently published an article on this exact idea. It explains that consumer prices are expected to rise 15, 20, and 30 percent in some areas by the end of this year and many big name companies like Kraft, Hanes, and Polo Ralph Lauren are being open about it.

The pressure to raise prices is just that great.

It works like this:

Retailers, while trying to maintain profits, will keep prices the same or raise them slightly. But the time will come when the costs increases can no longer profitably be absorbed by retailers, so the cost will be pushed on to consumers instead.

Who gets hurt in all of this? The NYT gets it right:
People at the bottom of the income scale struggle more as these prices rise, of course, because a larger share of their spending is on such essentials.
To raise prices or not to raise prices:

These companies are constantly walking a tightrope on how far do I go,” said Jack Russo, a consumer goods analyst at Edward Jones. “Do I offset with price or other cost cuts, or do I just take it and have it eat into my profit margins?”

Well, I think cutting into profit margins is the last thing that should be done. Profits are a necessary function for a free-economy. They help market participants/firms to gauge whether or not they are providing good service to customers or using their resources in the best way that benefits other market participants. Profits aren't units that people wantonly hoard and accumulate to keep for themselves; they are gauges for success. Inflation makes that function even harder.

Inflation tends to have another effect that the NYT rightly points out.

It means lower quality:

Restaurants, which resisted raising prices to keep customers coming through the doors last year, are also fretting. They may take other steps too, like lowering thermostats, shrinking packaging or reducing portion sizes to minimize the sticker shock.

Here’s a thought:
This year, “you’re going to have to raise prices to stay in business,” said Len M. Steiner, owner of the Steiner Consulting Group, which works with restaurant companies on ingredient purchasing.

And the reason is that companies operate on profit margins. Even when under inflationary pressures, business can’t cut even. They can't help the consumer by keeping prices low and cutting into their own profits. If they do, they will have less money for capital investment, wage increases, the expansion of goods and services and employment.

Read chapters 21 and 22 of Henry Hazlitt's Economics in One Lesson to Understand in depth. It's free.

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