Categories:
Macroeconomics
Money and Inflation
Some pundits argue that America’s recent inflation is caused by corporate price gouging. I find that claim to be rather implausible. Why would corporations suddenly choose to engage in price gouging in 2022? Why not 2017? Or 2012? So I decided to check the national income accounts. Here are the percentage changes from the 4th quarter of 2021 to the 4th quarter of 2022 (all nominal variables):
National income: +6.8%
Labor compensation: +7.1%
Capital (and proprietor) income: +0.9%
Corporate income: + 1.2%
What am I missing? Why would this data lead people to believe that profit margins are the major factor driving inflation?
READER COMMENTS
Brett
Apr 10 2023 at 1:16am
EPI was claiming it, using charts with data going back to the beginning of the pandemic in March 2020. I can’t remember who it was, but someone on Twitter pointed out that if you actually started instead from early 2021 (when inflation really started rising above 2%), then most of the increase was being driven by labor costs.
Azeem Hussein
Apr 10 2023 at 3:46am
Are you ignorant of Greed?
MarkW
Apr 10 2023 at 7:10am
I’m not sure if your comment is sarcastic or not, but the problem with the ‘greed’ explanation, is that you can’t explain a spike in inflation with plain old greed — you’d need a sudden increase in greed. What’s you explanation for why greed levels increased just when we see inflation taking off?
vince
Apr 10 2023 at 12:23pm
By greed, are you referring to labor, which took an oversized chunk of profits?
Michael Rulle
Apr 12 2023 at 7:40am
My two favorite answers about certain economic problems are “greed” and “tax cuts”.
Brandon Berg
Apr 10 2023 at 4:00am
As noted above, the claim comes from an EPI report that (of course) cherry-picked endpoints to support a false narrative.
Corporate profits before tax, CCAdj, and IVA more than doubled between Q2 2020 and Q2 2021. This was after several years of nominal stagnation and a large fall in the first half of 2020. As you note, they were flat for the next six quarters, though, and the left haven’t updated their talking points to reflect this.
The increase is much less substantial if you look at profits with IVA and CCAdj, so much of the increase in profits is directly attributable to inflation.
Brandon Berg
Apr 10 2023 at 5:59am
I made a mistake here. They increased around 60%. I don’t know why I said they more than doubled.
Andrew_FL
Apr 10 2023 at 9:27am
Exactly. If there’s a massive change in prices of certain physical goods, inventory valuations are going to massively increase, not causing inflation but caused by inflation.
Knut P. Heen
Apr 12 2023 at 5:18am
The valuation of inventory in accounting statements is often based on historic cost rather than market value. However, earnings will be affected because income is after inflation while costs are historic (before inflation). If you buy something last year for $100 and sell it today for $110, your earnings are $10 even if inflation is 15 percent and your inflation-adjusted earnings are a $5 loss.
seer of things
Apr 13 2023 at 2:41am
This seems wrong. The $10 buys the fraction $10 / ($10*1.15) of goods and services basket after inflation, so it buys 86.9% of what $10 used to buy. It buys an inflation adjusted $8.69 worth of the goods and services basket. The inflation adjusted profit is $8.69.
Presumably the inflation was unanticipated. If it were widely anticipated then it would have been possible to invest at a rate of more than 15%. Since it was unanticipated, there wasn’t such an investment opportunity so failure to invest in it doesn’t mean there was a foregone opportunity and associated opportunity cost.
Kenneth Duda
Apr 10 2023 at 4:38am
I’ve wrestled with the same nonsense in the context of real estate, where people sometimes argue that high rents are caused by landlord greed. I saw a great graph mocking this argument that showed the level of market rents over time, which of course goes up and down. The graph’s author then added arrows pointing to rent increases labeled “Landlords get greedier”, and arrows pointing to rent decreases labeled “Landlords become more altruistic.”
I love the idea that market rents are determined by landlords’ feelings of greed and altruism.
If only more people understood markets.
vince
Apr 10 2023 at 12:30pm
Real estate is a good example. It seems like plain old supply and demand. Who hadn’t heard of the supply chain problems? Lower supply, higher prices–and then pour gas on the fire with with more money.
Brandon Berg
Apr 10 2023 at 5:25am
This is the specific EPI press release that gets referenced the most. Note that, much like the “billionaires’ pandemic windfall” report that set the baseline on March 18, 2020, near the bottom of the Q1 stock market crash, they start counting in Q2 2020, right after a 15% fall in corporate profits.
Emma
Apr 10 2023 at 6:34am
“Why would corporations suddenly choose to engage in price gouging in 2022? Why not 2017? Or 2012?”
I see a lot of this thinking since the pandemic as a rebuttal to “greedflation”. But, I can’t help but wonder: aren’t there fluctuating opportunities in markets? Because this reasoning seems to deny the possibility.
Couldn’t the pandemic (and all that happened while and since) be an economic opportunity, then answering your question about the timing of price gouging?
“Why would corporations suddenly choose to engage in price gouging in 2022? Why not 2017? Or 2012? Because the opportunity to do so presented itself in 2022.”
Am I getting something wrong here?
PS: I’m not saying it’s the case (about price gouging), I’m only curious about the reasoning “against” it.
Jon Murphy
Apr 10 2023 at 7:26am
Of course there are, but that’s not price gouging.
Emma
Apr 10 2023 at 10:30am
Do you mean that never are there market opportunities to increase one’s profit?
Emma
Apr 10 2023 at 10:33am
I’m not sure if my last attempt to comment worked, so I may ask twice :
Do you mean that never are there market opportunities to increase one’s (or many’s) profit?
Jon Murphy
Apr 10 2023 at 10:40am
Of course there are. But opportunities to increase one’s profits are not price gouging.
Besides the fact that one can often increase profits by lowering their price, if prices are rising then that means one of three things are happening:
One: Demand is rising
Two: Supply is falling
Three: Some combination of 1 & 2
In all three cases, there is no price gouging happening. It’s just normal price behavior.
Emma
Apr 10 2023 at 3:48pm
Thank you for the answers!
Let’s please forget about “price gouging” per se, and think about the core question:
Is there any economic opportunity possible where a business could raise their profit solely by raising the price of their good?
Genuine question, by the way. If it wasn’t clear.
And thanks (again) for the interest!
Jon Murphy
Apr 10 2023 at 3:58pm
Absolutely. For example, if a firm is constantly running out of a good, then raising their prices will likely raise their profits.
To go a bit more technical:
Raising the price of a good has two effects:
First: it will reduce the quantity demanded of the good
Second: it will increase the revenue per unit sold
If the percentage increase in revenue is higher than the percentage decrease in quantity, then one can increase one’s revenue (and potentially profit) by increases price. If the opposite is true, one can increase revenue (and potentially profit) by lowering price.
So, the short answer: yes, one can raise profit by increasing prices. It just depends on where one is on the demand curve.
Emma
Apr 11 2023 at 6:54am
That’s what I thought. And depending on elasticity, demand could fall (or not).
So, back to the initial reasoning : Why would corporations suddenly choose to [raise margins] in 2022? Why not 2017? Or 2012?
Could we say then that there was an opportunity to be seized in 2022 that wasn’t there in 2017 or 2012?
Jon Murphy
Apr 11 2023 at 7:25am
Not quite. Elasticity refers to the shape of the demand curve, not movement of the curve.
Well, it’s not a choice per se. They didn’t wake up one morning in 21 ans say “I want negative profit margins” (as was the case for oil & gas). They reacted to changing market conditions
Jon Murphy
Apr 11 2023 at 7:57am
Let me try to be a bit more clear:
Profit is a residual. It is what is left over of revenue after one pays costs. We don’t get to choose our profit or margins. We can influence them to some degree, but we can’t choose them.
So, if we want to discuss the connection between price and profit (which, statistically, there is no correlation, for the reasons we discussed above), we have to point to some market mechanism that changes rather than some choice a firm made. For inflation, which is a general change in the price level, we must look for general factors. After all, if every firm “decided” to raise prices all at once, then the profit maximizing decision is to defect and not raise prices.
Let me end with a metaphor:
To say that there are opportunities for higher prices misunderstands the cause and effect. It’s like saying a wave creates an opportunity for the boat to rise. Assuming the captain doesn’t wish to sink, he doesn’t have much choice in the matter.
Emma
Apr 11 2023 at 9:41am
Pardon me if I’m being dense, but a business absolutely can raise the price of its product, without there being a change in the economic conditions.
I understand that would be tough in perfect competition but I guess you’ll agree this ideal state of economic affairs is pretty rare.
So then, could a little market power and an exogeneous crisis/opportunity let a business raise its prices in a way that directly raises their profit, at least in the sort or medium term?
And thanks for the details!
Jon Murphy
Apr 11 2023 at 11:37am
I don’t think you’re being dense. I think I am being unclear. You are right, but under very specific conditions.
Let me start here:
(1)Let’s assume that a firm is always profit-maximizing. That is, they always want to be at the point where they are maximizing their profits.
(2) We can drop the distinction of whether a firm is in a perfectly competitive market or not. That doesn’t matter really.
Given the first assumption, a firm will always produce at the level where their revenue from selling one more unit (marginal revenue) exactly equals the cost of making that one more unit (marginal cost). That is the profit maximizing level. If marginal revenue is greater than marginal cost, then one can increase profit by selling one more unit. In order to sell one more unit, the firm has to lower price. If marginal cost is higher than marginal revenue, then the firm is losing money and they have to sell less. They can raise their price there to sell fewer units and they will maximize their profits.
If I am reading you right, I see you as making a statement like the last two: a firm is losing money by selling that extra unit and they raise their prices to sell fewer units and maximizing their profit. That would be a case like you describe: the firm raises their prices and increases profit without a change in market conditions. That would be because the firm incorrectly estimated the market.
However, if the firm is already maximizing their profits, then they cannot raise prices to increase prices. The loss from the fewer goods sold is greater than the gain from the higher revenue. Something would have to happen for prices to rise.
I tried to keep this as non-technical as possible. I hope I was able to achieve that.
Emma
Apr 11 2023 at 2:41pm
This is very clear and interesting. Thank you again!
If may : so if I understand correctly, a firm could raise prices and profits if they had a wrong picture of their market and undervalued their goods… like if the customer surplus is higher than they thought which would mean that the customer would(could?) still consume the good at a higher price.
Does that make sense? heh.
Jon Murphy
Apr 11 2023 at 3:10pm
Yeah I think you could phrase it that way. It would probably be better to say the demand curve is higher than they thought it was rather than consumer surplus (since consumer surplus is the difference between the demand curve and the price, the firm who prices too low could potentially reduce consumer surplus).
Emma
Apr 12 2023 at 5:57am
Great!
If I can pick your brain once more : do you think this kind of wrong lecture of the market is happening a lot in the real world?
And I keep thinking about Martin Shkreli and the price of Insulin. What would you make of that? Is it an example of what we were talking about?
These are the last questions. I promise! Heheh
Thanks again!
Jon Murphy
Apr 12 2023 at 8:07am
You’re welcome to pick my brain anytime. In fact, if you click my name, it’ll take you to my website. My email is at the bottom of the page.
I’m not sure I know what you mean by “wrong lecture.” Could you elaborate on the question?
That whole situation is different. It is more akin to the price gouging you were discussing originally. What makes that situation different is that the medical field in the US is highly subsidized. People do not pay the full cost of health care. Usually helath insurance companies, the government, or some 3rd-party payer covers most of it. In turn, that makes the consumer less sensitive to changes in price. Depending on the rules of the 3rd-party payer, the manufacturer (Martin Shkreli, in this case) may be able to greatly increase the price of insulin. Whether or not he can increase his profit is another question (I don’t know what the financials looked like after that move). But he would have more ability to raise prices than other kinds of companies given the sturucture of the US health care industry.
Emma
Apr 12 2023 at 9:49am
Yeah! Thanks. I may do again in the future!
By “wrong lecture” I meant times where the firm may get wrong information on the market and so, sets its price below what they could charge without losing customers. Clearer?
I’m francophone so maybe “wrong lecture” was a frenchism. hehe.
As for the case of insulin, since it’s a life saving drug, am I mistaken to think that Shkreli could have raised prices substantially even without subsidies?
Jon Murphy
Apr 12 2023 at 11:11am
Yes, thank you! So, to answer your question: yes, there are constantly wrong prices set by firms. Either they over-price or they under-price. All they can do is guess and adjust over and over. It’s a process.
Assuming no subsidies, he probably could have raised prices, but I don’t know by how much. It would depend on what other actions people could do. For example, would a better diet and exercise help control insulin levels? If prices were lower, would people consume more insulin? If yes, then Shkreli probably could not have raised prices a lot and increased his profit.
That said: I don’t know much about how insulin works. I don’t know how effective diet and exercise would be in lieu of regular shots. I am making a claim about economic theory here.
And I should say: I do not wish to be mistaken as saying that what Shkreli did was right or good. That’s a question for another time.
Emma
Apr 13 2023 at 5:41am
Great. I wasn’t mistaken… hehe.
And thank you again for this exchange. It was enlightening.
Dylan
Apr 10 2023 at 11:03am
Here’s a thing I’ve heard in discussions with some small business owners in the neighborhood over the last year or so, mostly restaurants. The price of their inputs started to rise dramatically, and they felt they had no choice but to raise prices. However, they raised prices even more than their inputs rose. Talking with people, there seemed to be a few thoughts about this. 1) It’s really hard to raise restaurant prices, and it isn’t something you want to do frequently, so 2) many restaurants hadn’t raised prices for a number of years, and gross margins had shrunk, 3) the inflationary period of the last year gave “cover” to big price hikes, so the thought was raise prices by a bunch now, because we might not get the chance again later.
And now we have it so that the price of a sandwich at a fast food kind of place has gone from about $11-13, to $18-$20.
I don’t think of that as “gouging” in any sense, the business owners are just trying to survive, and the last few years have been pretty tough on their industry in all sorts of ways. But, I can see how it would look like gouging to some.
Walter Boggs
Apr 10 2023 at 1:01pm
Price gouging seems like one of those concepts whose usefulness disappears with any attempt to define the term. Like “living wage” or “sustainability”.
MarkW
Apr 10 2023 at 7:17am
Of course ‘greed’ is always a dumb, useless economic explanation, but it will probably always remain a useful political explanation. When trying to deflect responsibility for bad things happening, some politicians will invariably have a go at blaming it on mean, evil, rich, greedy people. This will always resonate with a large fraction of the electorate. Gavin Newsome, for example, is not stupid. He obviously knows that blaming ‘greed’ is economic nonsense and cannot account for California’s high gasoline prices. But it remains a viable political strategy for appealing to his voters, so that’s what he does.
Jon Murphy
Apr 10 2023 at 7:27am
Maybe he does and maybe he doesn’t, but I wouldn’t be surprised if he doesn’t. I can’t tell you how often I have been lectured by politicians and others that “everybody knows” greed causes high prices.
MarkW
Apr 10 2023 at 7:47am
I can’t tell you how often I have been lectured by politicians and others that “everybody knows” greed causes high prices.
Sure, but that doesn’t mean they are so dumb as to believe their own rhetoric, only that they’re good enough politicians not to drop the mask. In the end, I guess it doesn’t really matter if Newsome drinks his own Kool-Aid or not, with one exception — if he’s really just misinformed or uninformed then there’s some chance that a clear explanation of why blaming ‘high prices on greed’ is dumb will cause the scales to fall from his eyes and change his outlook and political rhetoric. But I think we both know that there’s roughly zero chance of that. The economics really don’t matter. The only way he’d give up the ‘corporate greed’ talk is if somehow the political calculus changed so that it was no longer advantageous. This might happen, for example, if he decided to run against Biden for the Democratic nomination as a centrist (not likely, but weirder things have happened).
Jon Murphy
Apr 10 2023 at 8:22am
Agreed. We cannot get into his head to know what he really knows.
One hopes (though, as you note, the chances are effectively zero). Even politics aside, so many people are completely wedded to their “everybody knows” stories that they will refuse to change their minds pretty much no matter what.
MarkW
Apr 10 2023 at 8:12am
My proposed bon mot of the day — “Blaming inflation on greed is like blaming a plane crash on gravity”.
Jon Murphy
Apr 10 2023 at 8:23am
I love that bon mot. It’s something that seems true at first blush but then becomes absurd once one thinks about it.
Monte
Apr 10 2023 at 11:31am
Notwithstanding EPI’s claims, President Biden has developed a legendary capacity for self-deception. He suffers from a multitude of cognitive distortions and has become almost childlike in his blame-shifting. So it should come as no surprise that he blames our current level of inflation on…wait for it…Trump.
But looking at the real vs imagined, we have what the Winston Group calls the Presidential Inflation Rate (PIR):
For the last 8 presidential administrations, Biden’s overall PIR score was 15% compared to Trump’s 4.1%, second only to Carter’s score at 18.1%.
Introducing the ‘Presidential Inflation Rate’: Biden trails only Carter
Dale Doback
Apr 10 2023 at 1:57pm
Jay Powell was appointed by…wait for it…
Monte
Apr 10 2023 at 2:59pm
How does that negate anything I said about Biden?
Scott Sumner
Apr 10 2023 at 1:57pm
“from their inauguration month to the month of the most recent CPI report”
I wouldn’t pay too much attention to the timing of leaving office. Trump replaced Janet Yellen with Jay Powell. Biden reappointed Powell. They share the blame for this mess.
If you wish to blame fiscal policy (I don’t), both engaged in massive fiscal stimulus.
Monte
Apr 10 2023 at 3:01pm
I don’t disagree.
Monte
Apr 10 2023 at 3:05pm
Although I do partially blame fiscal policy. And I would assign more blame for that to Biden and the dems.
vince
Apr 10 2023 at 4:36pm
Agreed. Trump did it when Covid first hit and created panic. Biden did it after vaccines rolled out. Nonetheless, PPP seemed like a ridiculous program from the beginning.
Scott Sumner
Apr 11 2023 at 1:37pm
After he was defeated, didn’t Trump complain the 2021 stimulus was too small?
In addition, Trump’s reckless fiscal stimulus pre-dates Covid by years. Look at the trajectory of the deficit during 2017-19.
Monte
Apr 11 2023 at 3:17pm
According to Politifact:
vince
Apr 11 2023 at 4:56pm
Hmm, a post didn’t make it. Anyway, I’m not trying to justify Trump’s federal spending. Most of the deficit through 2019 is from tax cuts. Did you not like those?
It’s relevant that Trump made policy in a noninflationary environment, but Biden is making policy during high inflation. What would the rate be if he got Build Back Better?
Scott Sumner
Apr 12 2023 at 11:53am
“Did you not like those? ”
If accompanied by spending cuts. Otherwise, it merely leads to higher future taxes. We’ll see those higher taxes in the near future.
vince
Apr 12 2023 at 4:15pm
“If accompanied by spending cuts. Otherwise, it merely leads to higher future taxes.”
My hope has always been that higher deficits will force tighter budgets rather than higher future taxes. There’s no good reason for it to not do that, but it hasn’t worked out that way.
Josh S
Apr 10 2023 at 2:42pm
Along the same lines as the price-gouging narrative, I recently read this post: https://jabberwocking.com/war-profiteering-how-about-pandemic-profiteering/
The data apparently comes from the BEA too, but unfortunately doesn’t link to the specific source. I’m curious what the difference is that accounts for such extreme opposing assessments of where the money is going to.
FWIW, I don’t have a specific agenda and I am interested in better understanding the data and how to interpret it.
Richard W Fulmer
Apr 10 2023 at 9:03pm
When the pandemic hit, the government sent workers home and production took a hit. At the same time, the government sent out checks to individuals and businesses. Fewer goods and more money drove up the prices of the goods that were available or that could still be produced. As a result, companies that could supply goods saw large increases in their profits. At the same time, though, many companies went out of business. Increased average profits during and after the pandemic, therefore, reflected:
Higher prices due to the reduction of available goods
Higher prices due to increased money supply
The “survivor bias” (failed companies weren’t around to be surveyed)
Josh S
Apr 15 2023 at 6:49pm
Thanks, that explanation helps a lot to put the numbers in perspective.
Luty
Apr 10 2023 at 5:31pm
What makes you think that data is driving the views of most people?
The people I’ve known who were socialists were preaching socialism in 1970 and 1990 and 2010 and today. Inequality goes up, they preach socialism. Inequality goes down, socialism. Socialist governments in the world turn in amazing economic performances – this proves we should be socialist! Socialist governments screw up – this proves that we need more socialism!
Capitalists, the same. Single-taxers, progressives, theocrats, liberals, trade unionists, anarchists, Falangists – most people decide the policies or values they think society should have on emotional grounds, adding only as much analysis as their brain requires for them to rationalize their positions as being “obviously logical” – very very little, for most of us – and then they stick with those values and damn the data.
Jose Pablo
Apr 11 2023 at 10:16am
Why would corporations suddenly choose to engage in price gouging in 2022? Why not 2017? Or 2012?
Corporations set prices as high as they can at any given time; to the point that, if they set them higher, they will start losing clients to competitors or substitutes.
They “gouge” prices every single time they sit around and discuss pricing … unless reducing prices lead to higher profits. After all, they are not in the business of setting prices higher, they are profit maximization entities … big surprise!
And it works wonderfully by the way! … particularly when compared with the North Korean / Cuban (or even Turkish or Russian) systems.
If you are in charge of “controlling” corporation’s profits look at competition and barriers of entry. I very much doubt this two things significantly change due to inflation.
Scott H.
Apr 14 2023 at 12:11pm
This data shows more than just the fact that profits didn’t drive inflation. It shows the difficulty of the profits inflation claim to begin with. Given that labor’s share of the economy is 5.66 times greater than profits’ share (as of Q4 2022), it would take an enormous amount of lopsided profit increases in order to materially affect the overall inflation rate.
Ben Leet
Apr 14 2023 at 5:35pm
I have an essay on corporate profits of nonfinancial corporations at my blog, Economics Without Greed, Part Two, http://benL88.blogspot.com. Between 2020 and 2022 nonfinancial profits increased by 72% which was an additional $1 trillion. Arguably it is price gouging. In the long essay I quote from Josh Bivens at the Economic Policy Institute, and from Mike Konczal from the Roosevelt Institute. From my essay, here’s a quote: “Also one can look at the Federal Reserve’s Flow of Funds report, page 10, line 10, multiple years from 2015 to the present, March 2023, “Profits before tax, Domestic nonfinancial”. Simply looking at page 10 at just 2 years 2020 through 2022, on the March 2023 report shows a huge 72% profit gain from $1.455 trillion in 2020 to a total profit of $2.507 trillion in Q2 of 2022. That’s a 72% increase in 2 years, and an increase of profits of $1.052 trillion, which comes to an additional $8,092 per household of added expenses.”
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