The Times Australia
The Times World News

.
The Times Real Estate

.

It might be tempting to blame inflation on profits, but the reality is still about high demand and short supply

  • Written by Michael P. Cameron, Professor of Economics, University of Waikato
It might be tempting to blame inflation on profits, but the reality is still about high demand and short supply

Despite the latest inflation figures for New Zealand coming in slightly lower than expected[1] by many economists, the rate remains stubbornly high. At 6.7%[2] for the year to March 2023, the inflation rate is more than double the Reserve Bank’s target range of 1-3%.

But not everyone seems to be feeling the pain of increasing prices.

Major banks[3], retailers[4], and other[5] corporates[6] are reporting, or expected to report, record profits this year. It is tempting to ask, as others[7] have[8] overseas[9] and in New Zealand[10], to what extent corporates’ mega profits and pricing are driving inflation.

The answer may surprise you. The reality is that corporate profit-making contributes very little to the inflation rate.

Market power and inflation

When a seller has the ability to choose the price, economists say that the firm has market power. But their ability to raise prices is not unlimited. Just consider the case of Arivale[11], a health-tech startup in the United States that ultimately failed because it set the initial price of its offering too high.

The extent of market power determines how high a business can set its price above its costs (its markup) in order to maximise its profitability. The optimal markup for a business depends on how sensitive its customers are to price changes.

Read more: Four reasons inflation will stay stubbornly high for some time[12]

In markets where customers are very sensitive to price changes, businesses will set lower prices (a lower markup) than in markets where customers are less sensitive to price changes. The optimal markup (as a percentage of the price) won’t change unless there is a change in customers’ price sensitivity.

Higher inflation is unlikely to cause consumers to suddenly become less sensitive to price changes. If anything, they will become more price sensitive and optimal markups should fall. That is why a strong majority (79%) of economists recently polled by the University of Chicago[13] disagreed or strongly disagreed that market power was a significant factor in higher US inflation.

If not profit, then what?

So, if businesses aren’t profiting by increasing their markups, what explains the increased profits in a period of high inflation?

There are two other reasons why prices may rise, one of which may contribute to higher profits.

First, businesses may face an increase in demand for the goods or services they provide. With historically low interest rates (until recently), coupled with the wage and other subsidies as we emerged from the pandemic, a lot of money was chasing the same number of goods and services. That sort of increased demand pushes up prices and makes businesses more profitable.

Read more: Modern monetary theory: the rise of economists who say huge government debt is not a problem[14]

Second, businesses face higher costs[15] because of inflation, including wage inflation. When costs are higher, businesses pass on some of those higher costs onto their customers in the form of higher prices. For most businesses, higher prices arising from higher costs will not lead to higher profits.

Taking those two factors together (higher demand leading to increasing prices and profits; and higher costs leading to increasing prices), it is likely that increased profits are not a cause of inflation, but are themselves a consequence of the other underlying causes of higher inflation.

Recent work[16] by economists at the Treasury showed that the surge in New Zealand inflation was one-third driven by demand-side factors, one-third by supply-side factors, and the remaining one-third was ambiguous (it could be demand-side or supply-side). All of the recent increases in food prices was able to be attributed to demand-side or supply-side factors. That again suggests that there has been little scope for businesses’ profit-seeking to contribute to inflation.

Periods of high inflation are unwelcome. We may be tempted to blame corporate profits as they represent an easily identifiable target. However, it is unlikely that profits are contributing much, if anything, to the inflation we are currently facing.

References

  1. ^ lower than expected (www.nzherald.co.nz)
  2. ^ 6.7% (stats.govt.nz)
  3. ^ Major banks (www.rnz.co.nz)
  4. ^ retailers (www.rnz.co.nz)
  5. ^ other (www.stuff.co.nz)
  6. ^ corporates (www.stuff.co.nz)
  7. ^ others (www.theguardian.com)
  8. ^ have (www.themonthly.com.au)
  9. ^ overseas (www.abc.net.au)
  10. ^ in New Zealand (www.stuff.co.nz)
  11. ^ the case of Arivale (www.geekwire.com)
  12. ^ Four reasons inflation will stay stubbornly high for some time (theconversation.com)
  13. ^ polled by the University of Chicago (www.igmchicago.org)
  14. ^ Modern monetary theory: the rise of economists who say huge government debt is not a problem (theconversation.com)
  15. ^ higher costs (www.stuff.co.nz)
  16. ^ Recent work (www.treasury.govt.nz)

Read more https://theconversation.com/it-might-be-tempting-to-blame-inflation-on-profits-but-the-reality-is-still-about-high-demand-and-short-supply-204181

The Times Features

Discover the Charm of a Girl's White Dress

Key Highlights Timeless elegance: White dresses feel pure and have classic charm. They are perfect for many types of events. Versatile styles: You can pick from lace, embroid...

Top Medical Grade Red Light Therapy Devices in Australia

Key Highlights Lumitter™ has advanced red light therapy devices that combine new ideas with wellness. Red light therapy helps lower pain and swelling and boosts skin health. ...

Why Regional Small Businesses in Bendigo Deserve Better Access to Finance in 2025

In the heart of regional Victoria, Bendigo has long stood as a beacon of innovation, resilience and community spirit. As we step further into 2025, the importance of nurturing sm...

Is It Time for a Deep Cleaning? Signs You Shouldn’t Ignore

Most people know they should visit the dentist for a regular check-up and cleaning every six months. But sometimes, a standard cleaning isn’t enough. When plaque and tartar build...

The Hidden Meaning Behind Popular Engagement Ring Cuts

When it comes to engagement rings, the cut of the diamond is not just about aesthetics. Each shape carries its own symbolism and significance, making it an important decision for...

Annual Health Exams in the Office: How They Can Reduce Sick Days and Healthcare Costs

Regular health check-ups, especially annual health exams in the office, can significantly impact the overall well-being of your workforce. A proactive approach to employee health...

Times Magazine

The Essential Guide to Transforming Office Spaces for Maximum Efficiency

Why Office Fitouts MatterA well-designed office can make all the difference in productivity, employee satisfaction, and client impressions. Businesses of all sizes are investing in updated office spaces to create environments that foster collaborat...

The A/B Testing Revolution: How AI Optimized Landing Pages Without Human Input

A/B testing was always integral to the web-based marketing world. Was there a button that converted better? Marketing could pit one against the other and see which option worked better. This was always through human observation, and over time, as d...

Using Countdown Timers in Email: Do They Really Increase Conversions?

In a world that's always on, where marketers are attempting to entice a subscriber and get them to convert on the same screen with one email, the power of urgency is sometimes the essential element needed. One of the most popular ways to create urg...

Types of Software Consultants

In today's technology-driven world, businesses often seek the expertise of software consultants to navigate complex software needs. There are several types of software consultants, including solution architects, project managers, and user experienc...

CWU Assistive Tech Hub is Changing Lives: Win a Free Rollator Walker This Easter!

🌟 Mobility. Independence. Community. All in One. This Easter, the CWU Assistive Tech Hub is pleased to support the Banyule community by giving away a rollator walker. The giveaway will take place during the Macleod Village Easter Egg Hunt & Ma...

"Eternal Nurture" by Cara Barilla: A Timeless Collection of Wisdom and Healing

Renowned Sydney-born author and educator Cara Barilla has released her latest book, Eternal Nurture, a profound collection of inspirational quotes designed to support mindfulness, emotional healing, and personal growth. With a deep commitment to ...

LayBy Shopping