Most recessions begin from a position where the economy is operating at close to its natural rate. Therefore, when we visualize recessions we tend to think of economies where output is depressed to a level well below its natural rate.In principle, recessions could begin at any point in the business cycle. A recession could begin when the economy was already operating at well below potential, with the 1937-38 recession being the most famous example. A recession could also begin from a position where the economy is operating well above potential, as in the case of the 1946 recession (and to a lesser extent 1969). In some recent blog posts, George Selgin provides a really insightful analysis of the post-WWII recession (here, here and here), which in many respects didn’t look much like a recession at all. For instance, unemployment remained low even as measured RGDP fell sharply (as wartime industries were unwound.)This period is difficult to evaluate due to the distortions caused by the imposition of wartime price controls and their removal after the war, which artificially boosted measured RGDP during the war and artificially depressed growth after the war. It is difficult to accurately measure the value of war output that doesn’t sell at market prices. In my view, a situation where the economy returns from a position of above potential back to the trend line is so different from an ordinary recession that another term would be appropriate—say “correction”.  But I don’t get to make the rules, and I accept that the profession as a whole refers to this situation as a “recession”. During this sort of period, you might expect output figures to look much worse than employment figures.  That’s because when the economy is overheated, firms are not able to hire as many workers as they would like.  There is a shortage of workers.  Why don’t firms simply raise wages to eliminate the shortage?  Because they are monopsonists in the labor market. When the economy slows, firms will continue hiring workers for a period of time.  You will see very weak RGDP growth numbers combined with very strong gains in employment.  Sound familiar?  As long as the economy merely returns to the previous trend line, unemployment need not rise to very high levels.  It might look like a recession, but it won’t feel like one. This has implications for monetary policy.  Those of us that favor level targeting argue that the economy will be more stable if the Fed promises to return its target variable (prices or better yet NGDP) back to the previous trend line after a shock pushes it away from equilibrium.  The Fed accepted this argument, but only for making up demand shortfalls, not offsetting demand overshoots.  In 2020, they committed to make up the undershoot in inflation with higher than normal inflation in the future.  But in late 2021 they refused to commit to offsetting an overshoot in aggregate demand with lower than target inflation in future years.  That was the Fed’s key mistake.  (BTW, supply-side inflation over or undershoots need not be offset under the Fed’s dual mandate.) Why did they make this mistake?  I’m not sure, but perhaps they confused economic corrections with garden-variety recessions.  They might have assumed that if the economy had overheated, bringing aggregate demand back to the previous trend line would push us into recession.  In a technical sense that might be true (depending on how sharp the adjustment), but it would be a recession utterly unlike anything we’ve experienced since 1946.  A sort of painless recession. To be sure, the Fed could very easily overshoot and create an ordinary (painful) recession, with output well below trend and high unemployment.  Ironically, the Fed’s refusal to do symmetric level targeting makes that unfortunate outcome much more likely.  With level targeting, monetary policy mistakes have less severe consequences, as market anticipation of future make-up policy corrections prevents demand from moving as far off course as otherwise.  In other words, the Fed is making it hard on itself with its “let bygones be bygones” approach to stabilizing demand.   (0 COMMENTS)

Economist Elizabeth (Betsy) Bailey died on August 19. She was one of the key members of the Civil Aeronautics Board who helped deregulate airlines under President Carter. Carter nominated her to one of the Republican slots. Why do I call her Betsy? Because I saw her speak once–I can’t remember where–sometime in the mid to late 1970s, and she encouraged the audience to call her Betsy. Here are some nice quotes from the Washington Post obit: Dr. Bailey was a forceful supporter of deregulation and set out, as she put it, to “free the airline industry from the tentacles of restrictive government.” “I think we should rely more on market forces to determine the price and variety of air services,” Dr. Bailey told the New York Times upon her appointment to the panel. “What is so exciting about joining the board at this time is that I can point out what regulatory reform is all about — getting the regulatory agency out of making every little decision about how much a ticket costs, and leaving some things to the market.” And: “There are a lot of people who have never had enough money to go to Europe,” she added. “The idea of offering lower fares and special services is really appealing. I only wish I’d been at the board [sooner].” And: “I know lots of people who went to work for the government and found they were bored. I never had that experience,” she told Forbes in 1983, reflecting on her time on the Civil Aeronautics Board. “In fact, I never had as much fun professionally as I did in deregulating the airlines. Every time I step onto a [discount] flight I get to reap some of the benefits of my work in Washington.” And sadly: Elizabeth E. Bailey once reported for a meeting at Bell Laboratories, where she was chief of economic research in the 1970s, when a male executive directed her to take notes in the back of the room. He had assumed she was a stenographer. HT2 Tyler Cowen. Here are the two articles on airline deregulation in David R. Henderson, ed., The Concise Encyclopedia of Economics: 1st edition: Alfred E. Kahn, “Airline Deregulation.” 2nd edition: Fred L. Smith, Jr. and Braden Cox, “Airline Deregulation.” (0 COMMENTS)

Attempting to mask the ugliness of the Biden Administration’s ‘forgiveness’ of student loans, the President’s Democratic friends are comparing it favorably to the Payroll Protection Program (PPP), a program put in place during the pandemic that extended loans to businesses and then forgave these loans if the companies kept their employees. Here’s Sen. Bernie Sanders (I–VT) making the comparison: “If we could afford to cancel hundreds of billions in PPP loans to business owners in their time of need, please do not tell me we can’t afford to cancel all student debt for 45 million Americans.” This argument is lame. In this case, the massive $800 billion PPP that the government could “afford” to make is simply the inefficient and unfair disbursement of funds that the government is able to do because it has access to other people’s money – that is, to taxpayers’ money. What happened with the PPP provides no excuse to double down or pass an even worse program such as the ‘forgiveness’ student loans. It’s also a bad comparison. The student-loan forgiveness move was done unilaterally and likely on very shaky legal grounds while the PPP was passed with bipartisan support by Congress – and passed when the economy was being forcibly locked down. Further, student-loan forgiveness helps only those kids who went to college using funds borrowed willingly. These debts are now to be paid off by many people who didn’t go to college because they couldn’t afford to and those who have already paid in full their collegiate debts. In theory, the PPP applied to all “small” businesses not just to, say, green energy or other favored industry companies. (FYI, according to the Small Business Administration, 99.7 percent of businesses are “small,” thanks to its ridiculously large definition of the word “small.”) And loans from the PPP were designed to be forgiven from the get-go as an incentive for companies to keep their employees. There were no such expectations or requirements on students borrowing money to go to college. Now, many people are foolishly glorifying PPP as if it was a wonderful program. As I have written here (and in many other places ever since the PPP was announced), it wasn’t close to being wonderful. By most accounts, the PPP was a $800 billion failure. It was regressive in its own way, in part because the companies most likely to apply for PPP loans were those who were big enough to know how to navigate the bureaucratic nightmare that is the Small Business Administration’s application process. Also, many of the companies that got loans under the PPP which were subsequently forgiven where never at risk of getting rid of their employees, since these workers easily transitioned to working from home. Most of the loans went to economic sectors that were among those least economically affected by the pandemic. Also, many PPP loans went to big companies (shocker!). Finally, the whole point of the PPP was for companies to keep their workers, but as is always the case with bailouts, it mostly benefited shareholders, not workers. Peter Suderman writes: “A recent study of the program’s effects from the National Bureau of Economic Research (NBER) finds that the majority of the funds spent by the program went to business owners and shareholders rather than to workers themselves. Ultimately, “only 23 to 34 percent of the program’s funds went directly to workers who would have otherwise lost their jobs.” The jobs kept in place by the PPP were preserved at very high cost—somewhere between $170,000 and $257,000 a year, far more than the typical earnings of affected workers, which are closer to $58,000 per year. While the PPP was able to save some jobs, albeit at a very high cost, the overall result of the program was precisely the opposite of what was intended. The purpose of the program was to preserve the jobs of wage workers, not to funnel money to business owners. As David Autor, a Massachusetts Institute of Technology economist and the lead researcher behind the paper, told The New York Times recently, “it turns out [the money] didn’t primarily go to workers who would have lost jobs. It went to business owners and their shareholders and their creditors.” The program, he added, was “highly regressive.” “ So there you have it; PPP and student loan forgiveness are comparable after all. They are both terrible policies. The student loan forgiveness one is simply much worse.   Veronique de Rugy is a Senior research fellow at the Mercatus Center and syndicated columnist at Creators. (0 COMMENTS)

As a student of public choice, I’m never surprised when politicians act in ways that promote their number one goal – re-election.  No one should be.  Political leaders are human beings, maybe with an extra tablespoon of narcissism, but nonetheless mere mortals who put on their pants and sweat, and worry, and try to live like regular people.  Like most of us, they want to keep their jobs and get ahead.  I would also inject a little Austrian subjectivity into the notion of “self-interest”.  Sometimes politicians pursue pleasure through hobbies or want to live “normal” lives, because they are just like us.  Sometimes that leads to Dick Cheney accidentally shooting someone while hunting, but again, politicians are human and they make mistakes. Setting aside the stunning sexist double standard being applied to the current prime minister of Finland Sanna Marin, forgive me if I don’t think it’s news, or relevant, or important, or even noteworthy that she’s got moves.  Look, I don’t believe politicians are any more noble or courageous or quasi divine than the rest of us.  What’s more, if I were running a Western European democracy I’d imagine my stress level would be considerably higher than it is now.  She’s got the right to burn off some steam, live life, and relax every once in a while.  And unlike Dick Cheney’s hobby, no one went to the hospital. I was a caregiver for a while.  That’s another one of those jobs which everyone assumes make you superhuman and completely selfless.  If you don’t take a little time and flip the relax switch, it’ll eat you alive, and you’ll make bad choices.  I say to the Finns, leave her alone.  Russia’s your neighbor and you want your elected leader sharp.   G. Patrick Lynch is a Senior Fellow at Liberty Fund. (0 COMMENTS)

My friend Ryan and his wife Abbie recently took a break from their two small kids and stayed in the Monterey area, going to a nice restaurant Friday evening and staying in a luxury hotel that night. He told me that they could have stayed in the Navy Lodge for about $100 but wanted to do it with style at the Clement Hotel on Cannery Row for $400. I told him that he and Abbie were demonstrating what we UCLA graduate students called the “oranges principle.” Here’s the explanation of that principle in Universal Economics. Good and bad grapes: larger proportions of relatively good quality California oranges and grapes are shipped to New York than the proportions that remain in California. Are New Yorkers richer or more discriminating? Possibly—but the quality ratio is higher also in the poor districts of New York and the whole East Coast. The question can be posed for other goods: Why are disproportionately more expensive foreign cars and other “luxuries” exported than are purchased in the home country? Why do young parents go to expensive plays rather than movies on a higher percentage of their evenings out than do young childless couples? Why are “seconds” (slightly defective products) more heavily consumed at the site of manufacture? Why do more of the better, rather than the mediocre, students attend more distant colleges? Why should a tourist be more careful buying leather goods in Italy than when buying Italian exports in other countries? Why is most meat shipped to Alaska “deboned”? The answers to these questions are based on an implication of the first law Edition: current; Page: [128] Table 9.1 Better Quality Is Shipped Away Prices of Grapes in New York = Transport Costs + Prices of Grapes in California Choice $1.50 = $.50 + $1.00 Standard $1.00 = .50 + .50 Relative Prices in New York Relative Prices in California 1.5 Standard for 1 Choice 2 Standard for 1 Choice of demand. In table 9.1, suppose California grapes a) cost 50¢ a pound to ship to New York, regardless of quality, and b) in California the choice grapes sell for $1 a pound and the standard grapes for 50¢ a pound. Since the cost is the same per unit of shipping either quality to New York, the price in New York is 50¢ higher than in California for both types. But in New York, a consumer of choice grapes sacrifices only 1.5 pounds of standard, whereas in California, one pound of choice costs two pounds of standard. New Yorkers have a lower cost of choice grapes relative to standard grapes, and, therefore, in accordance with the first law of demand, they will demand a larger fraction of choice grapes than do Californians. In California, where standard grapes are cheaper than in New York relative to choice grapes, a larger fraction of standard grapes will be consumed. We don’t need to resort to conjectures about differences in “consumer tastes and preferences” to understand this phenomenon. A general effect of an added cost to related products: an addition of a constant value to a high and to a low value will reduce the resulting ratio of the new values. The prices of high- and low-quality meat might be $10 and $5. Now, add $10 to each, which become $20 and $15. Though both absolute prices are increased equally, the high-quality meat becomes cheaper relative to the low-quality; or, in reverse, the low-quality becomes more expensive relative to the high-quality. Formerly, a purchase of high-quality meat was equivalent to giving up twice as much low-quality meat. But, with $10 added to both prices, the new price of the high-quality is lower relative to the low-quality—being only 1.33 rather than two times as expensive. So the amount of high-quality meat demanded increases relative to the demanded amount of low-quality meat, when the price of each is increased by the same absolute amounts. The percentage reduction in demanded amount of low-quality meat is greater than for the higher-quality. Of the total demanded amount of meat, a larger proportion is now the higher-quality meat. Edition: current; Page: [129] Here’s how to apply it to Ryan and Abbie. There’s a cost of having someone take care of kids: this could be a monetary cost or a “favor” cost: someone did them a favor and they owe that person a favor and even if they don’t ever repay the favor, they, as good people, take account of the cost their friends bear and feel some of it themselves. And because they love their kids, there’s also a cost because their kids will miss them and that counts in their computation of costs. So let’s say the cost of having someone take care of the kids overnight is $200. If they had no kids the relative price of Clement to Navy Lodge would be $400 to $100, or 4 to 1. Since they have kids and there’s a cost the relative price of Clement to Navy Lodge is $600 to $300, or 2 to 1. QED. I was telling Ryan of another application of the principle. Back in the 1980s, my mentor and editor at Fortune, Dan Seligman, was writing a heavily researched article for Fortune on the gambling industry. Dan loved gambling. He noticed an empirical regularity and called me about it: people who had a higher cost of getting to Vegas (I think Dan went distance here, which is not a bad proxy for transportation cost) lost more per day than people who had a lower cost of getting to Vegas. Even though, as far as I know, he had never read Alchian and Allen, he correctly reasoned the same way they did. His question to me was: is there a name for that principle? There absolutely is, I told him. It’s called the “oranges principle.” Needless to say, he wasn’t totally satisfied by my answer. (0 COMMENTS)

The Economist has published an article on books to read to understand how economists think. The selection starts with Milton Friedman’s Capitalism and Freedom,* which is always good. It includes Freakonomics, the old The Worldly Philosophers by Robert Heilbroner (you can do worse for a broad introduction to economic thinkers), Capitalism, Alone by Branko Milanovic and Africa: Why Economists Get It Wrong by Morten Jerven, which I haven’t read; thus I can’t comment upon. What strikes me as funny is the broader tone. So the author writers about Milton Friedman: Ignore the fact that Friedman was ultra-libertarian. It does not matter. Very often his arguments were plain wrong. That does not matter either. This book is perhaps the best way to learn to think about trade-offs, because that was how Friedman always thought about the world. For instance, consider minimum wages. Friedman accepts that the people who receive them take home more money. But then the trade-offs come steaming in. What, he asks, about the people who are now priced out of the labour market? Or take regulation of medicines. Unnecessary, he says. Yes, you may save some lives by insisting that pharmaceutical companies jump through hoops before taking a drug to market, as fewer dangerous drugs are sold. But those reviews will also cost lives, he says, by delaying the delivery of safe drugs to patients. (In 2006 we published this article on Friedman and his legacy.) I wish this sounded more like: get rid of your ideological prejudices for a moment, read Friedman with a clear mind, and you’ll see he was an impressive thinker. But it does not quite sound like that. It sounds like an apology: I recommend a book by Friedman, but I must make it clear that his arguments (which ones?) were “plain wrong”. Now, mind that this is The Economist, not Jacobin. The sad truth is that we classical liberals tend not to realize how far apart we now are from the mainstream of Western elites. You may tell me that this was always the case. Well, up to a point. Twenty years ago it was true of anti-war libertarians, a tiny group who were ostracized by right and left. But broadly speaking, a certain understanding of the market economy and the dangers of over-regulating it was shared by a good number of people who perfectly fit within the political establishment. Fear of inflation and appreciation of restrained monetary policy was mainstream. For a while, nationalizations were unpopular with the left, socialist parties presented proposals to make welfare more efficient, and it was commonplace, for Davos men and the business elite to say that globalization was a good thing. Now you need to apologize to the readers of The Economist before reminding them that, hey, there are trade-offs!!! (0 COMMENTS)

Adam Smith once said, “There is a great deal of ruin in a nation.”  People with the good fortune of living in a highly successful country often have little sense of how much worse things can get.  Perhaps you’ve met Americans who think Mexico is a “poor country”.  That would certainly be news to residents of Haiti! This problem came to mind recently when I saw a news feed from the South China Morning Post (SCMP): The third article is exactly the sort of propaganda you’d expect from a Mainland Chinese news source.  The first two are the sort of news stories you’d expect from an independent minded Hong Kong newspaper. In recent years, the Chinese government has cracked down on dissent in Hong Kong, and the city has lost much of its independence.  Hong Kong is a much more repressive place than even 5 years ago. At the same time, when I read the SCMP I am reminded of Adam Smith’s famous maxim.  Despite a rather draconian crackdown by the Chinese government, Hong Kong seems to remain much freer than the mainland.  Recent trends at the SCMP are disappointing, but the mainland papers are far worse—just pure propaganda.  It will be interesting to see if the SCMP continues to deteriorate over the next few years, or levels off somewhere intermediate between the China Daily and a US or European media outlet. (Even if you hate the mainstream media because of bias, they are willing to criticize their own government.) The following statements are all true: 1. Today, Mainland China is vastly freer than when Mao ruled China. 2. Today, Hong Kong is vastly freer than Mainland China. 3. The Hong Kong of 2018 was vastly freer than the Hong Kong of today. 4.  The Hong Kong of 2018 wasn’t even a democracy. Don’t think that things can’t get any worse.  In 1918, I imagine lots of people thinking that the “Great War” was as bad as war could get. A common mistake is to fixate on one fact about a country, which a person might read in the media, and draw sweeping conclusions from that fact. “Did you hear about the Covid policy in Australia?  It’s become a police state.” That Covid policy you read about was probably bad, but I doubt that, by itself, it would have caused an otherwise free country to become a police state.  There’s a great deal of ruin in a nation. A second mistake is to pay more attention to abuses elsewhere than at home.  I would never deny that the Russian government’s imprisonment of Brittney Griner on drug charges is an outrageous violation of her human rights.  Nor would I deny that her punishment is more severe than she would have received in the US.  Even so, it’s a bit odd to see so much attention paid to this one case at a time when nearly 400,000 Americans are in prison for drug charges, often for doing things that would be completely legal in at least a dozen American states.  That strikes me as pretty grotesque, but our news media doesn’t seem to agree, as they focus all their attention on Griner. This is why we should never give up.  A libertarian utopia may be out of reach, but even preventing things from getting worse would be an achievement worth celebrating, with vast consequences for human welfare.   (1 COMMENTS)

Why are people choosing Medicare Advantage plans? The main reasons are that the insurance plan is required to cover everything in Medicare Part A and B, but it is also allowed to provide additional services–at no additional cost to the patient. Some common add-ons include certain vision, hearing, and dental services, and sometimes services like transportation to the doctor and subsidies for joining a health club. In addition, Medicare Advantage plans can be customized, so that they provide more coverage (say, lower co-pays) for the services you know you are more likely to use. In some areas, you can even make a fairly seamless transition from health insurance provided through your employer, by a certain company, to health insurance provided by Medicare, through the same insurance company. This is from “Medicare: Becoming a Channel for Private-Sector Insurance,” Conversable Economist, August 30, 2022. The whole thing is well worth reading. It makes me wonder whether, when I retired at age 66, I should have taken Medicare Advantage. I didn’t. I had great insurance as a federal employee and the feds pay the same towards my and my wife’s insurance that they would have paid if I had remained employed. Still, I’m paying $7,000 a year for my health insurance. And of course that doesn’t include co-pays and deductibles. I also found this part particularly interesting: For example, various versions of “Medicare for All” legislation have been proposed. In some versions, this would be a universal national health insurance plan run by the government. Whatever the merits or demerits of such a proposal, actual real-world Medicare is shifting to a choice of plans run by insurance companies, and only funded by the government. The elderly have a choice between having their health insurance administered by the US government or by a private insurance firm–and they are choosing the private firm. Since 48% of Medicare beneficiaries are in Medicare Advantage, up from just 19% in 2007, that means that one of the biggest lobbies against Medicare for All, if run by government, will be participants in Medicare Advantage. I had heard that Medicare Advantage costs the government more than it pays for people in Medicare Parts A (hospital) and B (doctors.) That’s true. But here’s what Tim Taylor writes about that: I do not have a fully convincing answer here. It’s true that the government pays a little more for Medicare Part C [that’s the name for Medicare Advantage], on average, than for Parts A and B, but it’s only about $300 per person per year, so that’s unlikely to be the main driver. My guess is that big insurance companies are better at managing health care costs, and perhaps no worse at managing paperwork and administrative costs. After all, the insurance companies are paid a flat amount per patient, rather than being reimbursed on a fee-for-service basis like traditional Medicare A and B. One can, of course, raise concerns about just how private insurance might seek to control health care costs. But again, the key point is that the elderly are increasingly showing by their actions that they prefer the Medicare Advantage plans, funded by the federal government, but run by private insurance companies. $300 per person is way less than I had thought. It’s close to rounding error. (0 COMMENTS)

President Biden announced plans to forgive between $10,000 and $20,000 in student loan debt for individuals earning up to $125,000 a year and married couples earning up to $250,000. There are many criticisms one could make of this proposal. Here I consider just one – the precedent it creates and the expectations this creates for the future. Whenever the government engages in a bailout, it creates the expectation of future bailouts. Someone debating taking out a student loan today may be more inclined to do so than before, because they might now expect at least some portion of the debts they promise to pay back will actually get passed on to the taxpayer. According to a recent story in the Washington Post, this isn’t simply idle speculation on my part – we’re already seeing it happen: Some students looking to take advantage of the promised forgiveness have already signed up for more loans, according to Betsy Mayotte, president of the Institute of Student Loan Advisors. “There are people who are applying for loans for this semester or more loans than they had originally applied for because they assume they’re going to be forgiven,” said Mayotte, who works closely with student and parent borrowers. This fall, millions of high school seniors will begin applying to college for the 2023-2024 academic year. One wonders if they might overextend themselves with the expectation that they, too, will someday not have to repay part or all of their loans. Is there a way to solve this new moral hazard problem? Perhaps, but it wouldn’t be pretty. A history of the English banking system provides an example of what I mean. As documented in Fragile By Design: The Political Origins of Banking Crises and Scarce Credit, by Charles Calomiris and Steven Haber, throughout the nineteenth century, the Bank of England made a habit of bailing out financial institutions when they became illiquid or insolvent. Predictably, this created a significant moral hazard problem, and the British banking system had suffered from severe banking crises in 1825, 1836, 1847, and 1857. Eventually, the Bank of England realized they couldn’t keep this up. They announced a new policy, declaring they would be much more strict as a lender of last resort when a bank was illiquid, and they would not save institutions which had become insolvent. But political talk is cheap – it often needs to be demonstrated to be believed. Unfortunately, this meant for the new policy to effectively reduce moral hazard, it needed to actually be demonstrated, which in turn required the occurrence of another banking crisis. When Overend & Gurney collapsed in 1866, this new commitment was put to the test. The Bank of England stood firm and allowed Overend & Gurney, one of England’s largest financial entities, to fail on account of its insolvency. This made their stated commitment credible – and the performance and stability of England’s banking system was significantly improved for the next several decades. We may well be entering a situation where even if the administration insists this is a one time program, the expectation of future bailouts or loan forgiveness will take root. And it may end up being the case that the way to dislodge this expectation is a full blown debt crisis being allowed to occur. Lacking that, we may end up stuck with an ongoing series of bailouts, followed by further expectations of more bailouts, leading to more debt accumulation, and so on. A pessimistic outlook? Possibly. But am I wrong?   Kevin Corcoran is a Marine Corps veteran and a consultant in healthcare economics and analytics and holds a Bachelor of Science in Economics from George Mason University. (0 COMMENTS)

One of the best parts of Alchian and Allen’s classic textbook, University Economics, is its discussion of the cost-price illusion. The analysis, though worded somewhat differently, is also in the newer textbook Universal Economics, which is based on the original. It’s free on line from Liberty Fund. Here’s the passage: SPEED OF DETECTING CHANGES IN DEMAND OR SUPPLY: THE ILLUSION THAT COST DETERMINES PRICE Buffer stocks, inventories, and reserve capacity help make it appear as if prices are sluggish or inflexible and are determined by costs, instead of by competition among consumer-demanders. Suppose that for some reason (possibly higher incomes) demand for meat increases. As sales and consumption increase, butchers’ inventories are unexpectedly depleted. Normally, as with any retailer, inventories are large enough to accommodate transiently increased sales without producers having to raise prices. Inventories larger than an average day’s sales help assure that supplies are immediately available to demanders at predictable prices. One day’s above-average sales is not regarded instantly as a persistent increase at that price; nor is it viewed as a long-term sales increase that requires a higher price to keep inventories from being further depleted. When the increase in sales reflects a higher average demand, no seller will be able to detect the increase in demand immediately. A high transient deviation may induce retailers to purchase more for replacement of normal inventories, but they would buy even more if they knew the long-term demand had increased. If the public’s aggregate demand really had increased (not just toward this one butcher and away from other butchers), the demand by all butchers to restore inventories would increase the demand facing the meat packer-suppliers. Packers will see their inventories declining as they supply more meat to retailers. To replenish their extraordinarily depleted inventories, packers will compete with each other for more cattle than before. But with an unchanged supply of cattle, some packers must get less than the increased amount they demand at the old price. They bid up the price of cattle. The packers are, in this scenario, the first to see a price (cattle cost) rise consequent to the increased consumer demand, and they will correctly interpret that as a rise in their costs. The existence of inventories in the chain of suppliers from producer to consumer can cause a delay during which the increased consumer demand is communicated Edition: current; Page: [149] from retailers to initial producers. That delays the price increase until the cattle-producer stage. WHO IS RESPONSIBLE FOR HIGHER PRICES? LOOK IN THE MIRROR Packers raise their prices to retailers, saying their prices are higher because their costs are higher. But we know that costs are higher because it was the increased consumer demand that prompted a higher price of cattle at the feedlot. Because of the increased consumer demand, a higher price is obtained and maintained in the consumer market. When consumers complain about the higher price of meat, butchers say it isn’t their fault. Their costs have gone up. And the packers can say the same. To see who really was responsible for the higher prices, the consumers can look in the mirror behind the butcher’s counter and see themselves. Not all prices adjust instantly to the new equilibrium price to clear the market, as they do in the organized stock and commodity markets. In fact, a lag occurs between the time some demand or supply situation has changed and the time people detect and distinguish that from a random, transient, reversible change in the current purchase rates or in supply conditions. As emphasized earlier, the amount demanded may refer to the underlying average amount demanded in an interval, with momentary random offsetting deviations taking place around that average value. Because of the transient variations around the average, a shift in that average may be hard to detect quickly. An increase in sales may be interpreted as only a randomly high sales rate, rather than as a new higher normal sales rate. And once a seller begins to suspect that demand has shifted, difficulties exist in knowing what are the best adjustments to make in supply response. If the demand is believed to have fallen, should a supplier shift to some other production activity or should the price be lowered and work continued at a lower rate? Should an employer attempt to reduce wages of employees immediately when sales fall? So-called delays and lags in adjusting price or output are the result of inability to foresee the future perfectly and to understand what really is happening. They are not results of some inherent inflexibility in, or inability to change, prices. It takes time to decide that an underlying change, rather than a random, transient deviation has occurred. And the time it takes to discover what is the most appropriate adjustment misleads outside observers into thinking that prices are “rigid.” Prices actually are instantly flexible—as instantly as it is discovered that a change is appropriate. Edition: current; Page: [150] Why is this particularly relevant today? Because many commentators argue that cost increases are the cause of price increases. That can be true. But more often, given the huge recent increases in the money supply, it’s demand increases that are driving price increases. But the way that often shows up is similar to the analysis in Alchian and Allen. (0 COMMENTS)