Tag: Bill Allen

The mirage of cost-push inflation

It does appear  too many that rising costs push up prices, but this impression is an illusion caused by the way inventories delay the effect of money supply increases on retail prices.

When increased money growth causes total spending to rise more quickly, sales of particular businesses will increase. But sales fluctuate from day to day and week to week, so managers of these businesses cannot immediately know that this sales increase will last.

As sales continue to rise, restaurants will use up their inventories. Larger orders will then be placed with suppliers, and inventories of these suppliers will begin to shrink.

The retail price has not yet changed because inventories have absorbed the initial impact of the increased spending.

But as more orders to replace depleted inventories work their way down the chain of distribution, orders for  too wholesalers also will rise faster.

The available inventories are inadequate to meet the rising amounts demanded at existing prices.

As a result, wholesale prices will rise as packers bid more intensely for scarce factory supplies. These higher prices then cause factories and other base suppliers to raise their prices; and higher wholesale prices cause retailers  to charge more.

As higher prices work their way up the distribution chain to the consumer, they create an illusion that higher costs are pushing up prices.

But both costs and prices are being pulled up by the increased spending caused by a more rapidly growing money stock. Because the effects of more money and more spending are delayed by inventories, hasty conclusions about the cause of inflation can be deceptive.

HT: Bill Allen

Sure, there’s a temptation to fix prices, but it isn’t as strong as the urge to put one over on your competitors

Figure 2

The desire to collude and thereby to raise prices must be distinguished from the ability to do so.

Not only is it difficult for rival companies to agree on the production cuts each must make in order to force up price, but it is difficult to prevent each company from undercutting the others in order to increase its sales. It is unlikely that, without–and sometimes even with–government support, firms will long curb their rivalry–even in industries with high levels of concentration…

It is not easy to organize a cartel, melding highly autonomous organizations into a monopolistic facsimile. There are markets to divide, prices to set, and production quotas to assign.

Successful operation is even harder than initial organization. Members must remain persuaded that they enjoy net benefits from collusion compared to acting as independent agents.

The more profitable the collusive efforts, the greater the incentive for outsiders to seek admission or to organize their own club or individually to compete.

The more numerous the participants and the more lucrative the tightening of the screws on consumers, the greater the temptation for individual members to cheat–and the greater the fear of each that some other member will cheat.

Long-term survival of the cartel has two fundamental requirements: first, cheating by a member on the stipulated prices, outputs and markets must be detectable; second, detected cheating must be adequately punishable without leading to a break-up of the cartel.

Bill Allen

The economist did not invent scarcity

If we do not have all of every­thing we want, there is a problem of rationing. This is the major corollary of scarcity. An individ­ual cannot escape the requirement for "economizing." How shall he disburse his limited income?

The very impersonal­ity of the pricing mechanism, which the advocate of freedom should consider an asset, does not appeal to the compassionate person determined to do good.

Thus we find widely advocated processes of rationing, founded not on each person bidding in the open mar­ket on the basis of his own scale of priorities, but on direct disposal of goods and services by some pub­lic authority on the basis of what the authority somehow decides are the relative "needs" of the mem­bers of the community…

The Smythean scheme [rationing by prices] achieves a number of desirable results.

First, the rationing is done with a minimum cost in time and in­convenience. Paying a price in terms of money, i.e., generalized purchasing power, is neater (al­though not necessarily smaller in the estimation of everyone) than paying in terms of a specific re­source, in this case, the energy re­quired in arising early and grop­ing to the parking lot by moon­light. That, as Smythe has often said, is why money was invented.

Second, a dispensing bureauc­racy—suffering the temptations of frail men, guided by arbitrary and often nebulous criteria, and subject to no rewards for efficiency or penalties for inefficiency—is avoided.

Third, there is upheld the basic principle that those who get (in this case, the parking spaces) shall pay. Fourth, there is upheld the equally basic principle that gifts and rewards are best given in generalized purchasing power.

Bill Allen

The Moving Forces Behind Market Prices

Some economic fallacies don’t die easily. Take the belief that the only determinant of a market price is the cost of producing the particular good. When a price rises or falls, it is commonly assumed that the item’s cost of production must have gone up or down. And there is a tendency to condemn price increases which are not apparently due to higher production costs.

But market prices are not mere reflectors of production costs….

What does determine [prices]… is competition among consumers for the available supply. An increased demand would cause the price to be bid up. A smaller available quantity would further intensify consumer’s bidding. Conversely, a diminished demand or an increased supply would weaken consumers’ competition and cause the price to fall.

There are thus two factors which determine a market price: consumers’ demand and the available supply. Either or both can change without any change in the cost of production…

The lesson is clear. Prices move up or down in order to ration the existing supply among those who demand it. And market-clearing prices can be very different for the same good at different times or in different locations–even though production costs are identical. So long-distance calls are cheaper at night; matinees are cheaper than evening performances; early-bird restaurant specials are less expensive; and U-Haul trucks from Detroit to Houston were much higher priced than the same trucks from Houston to Detroit.

Production costs do influence market prices, but only to the extent that these costs affect the available supply. It is that supply and consumers’ demand which are the real moving forces behind market prices.

Bill Allen

Wages are set by the market process, not by employers

The more valuable the worker, the higher the bid for his services.

The high wage offer reflects rational concern of employers for their well-being, not a delicate sense of altruism or fairness. If you are technologically efficient in performing services which the community values highly, and if relatively few other workers are so productive, you will prosper.

It is competition among the hateful employers that raises wages, for they must bid against each other for labour to supply demanded products and thereby earn rewards. And it is competition among the lovable fellow workers that holds wages down by providing alternatives to employers…

The wage one employer is obliged to pay for labour is affected mightily by how much other employers are offering and it is a happy situation for me when rival employers bid against each other for my services. So competing workers offering labour lower my wage and competing employers bidding for labour raise my wage.

Bill Allen, The Midnight Economist

Alchian and Allen’s list of economic fallacies

  • Price controls prevent higher costs to consumers;
  • reducing unemployment requires creating more jobs;
  • larger incomes for some people require  smaller incomes for others;
  • free, or low, tuition reduces costs to students;
  • unemployment is wasteful;
  • stockbrokers and investment advisors predict better than throwing a dart at a list of stocks;
  • international trade deficits are bad and surpluses are good;
  • inflation is caused by government deficits;
  • government budget deficits reduce saving and raise interest  rates;
  • new taxes are borne by the consumer of the taxed items;
  • employers pay for "employer provided" insurance;
  • tax-exempt bonds avoid taxes;
  • minimum wages help the unskilled and minorities;
  • housing developers drive up the price of land;
  • foreign imports reduce domestic jobs;
  • "equal pay for equal work" aids women, minorities and the young;
  • very low unemployment causes inflation; and
  • the Federal Reserve Board controls the rate of interest.

Source: Universal Economics

Should we simply outlaw the scourge of sweatshops and walk away in prim satisfaction?

What is to happen to the erstwhile workers–commonly uneducated, poorly trained, illegally in a land foreign to them, with little experience and marketplace sophistication–who have had their livelihoods abolished? They had been surviving–even if meanly by civilized standards–in market competition by selling their limited services of low value at meager wages.

Taking away those miserable jobs, pricing them out of what had been their best option, does not magically provide them with better alternative employment. Reducing their already poor power to compete, leaving them more handicapped than before, is a strange way to help them.

Bill Allen