Speaking on the topic of stock-outs on store shelves and elsewhere: this is often caused by the contractual arrangements between the retailer, its suppliers, and the brand. There are also issues in which the retailer may be trying to substitute for an out-of-stock brand but was unable to make the replacement in a reasonable time period.
Customers are not rational and will complain when retailers allow prices to rise to the equilibrium level. The complaints that customers have are different for out of stock and for high prices. A store manager may decide that they would prefer the OOS complaints to the insane price complaints. Some marketplaces like Amazon will actually deactivate your offers if you let the price rise to the equilibrium level to delay a stock-out, because their automated systems consider a price X% above the historic price to be a bad customer experience.
Additionally, customers are touchier the higher the price goes. It may be preferable to sell nothing and to cede ground to competitors than it is to suffer customer complaints and reputational damage related to price-driven quality complaints. For example, a customer will consider a $9 product a five star product because of the value perception. The same product at $24, priced so to prevent a stock-out, suddenly becomes a three star product in the eyes of the now pickier consumer. A three star product is not profitable to sell online: the drop-off in profitability is insane at every half-star rating below 4.5. It is better to never sell again something with a bad customer reputation. So, it can be better to stock-out until it can be replaced.
Also under officially declared emergency conditions, many states have price gouging laws. Retailers do get letters from stage AGs shaking them down for settlements, so these legal actions do not necessarily surface to the level at which the public sees them. For online retailers this means getting potentially shaken down by prosecutors from dozens of states. The C****D-1* emergency declarations are mostly done with, but you never know when minds will change on that front. So, with those, you have suppliers raising prices on retailers, but retailers having to either eat the loss or wait for the general price level to increase to restock. You cannot get a mean letter from an AG for an empty shelf, but you can if you raise your price 25% prematurely.
So, brands and retailers alike are sensitive to price perceptions which get in the way of efficiency. You watch what other people are doing and raise your prices in tandem with the others, using inflation sizing and other methods to smooth out the changes. Doing the economically efficient thing makes people and governments real mad about it, which has real consequences for managers. It is easier to be economically efficient further up the supply chain because people at the retail level have mob mentality and business people are more rational about such things.
If you view supply/demand systems as feedback control systems, where changes in demand induce changes in supply, the criticality of response times becomes obvious. If slight increases in demand result in rapid increases in supply as companies like Walmart send sales information directly to producers who then know they will see a reorder of x in the near future and plan for the production and it all happens smoothly.
If the demand varies on a business cycle time scale of a decade or so but the supply size takes 2 decades to respond demand (cycle times < supply response times), because of permission problems with building more capacity (visualize permission for a major housing development or refinery or chemical plant or mine), the system goes unstable as prices go way beyond any relationship with real costs. A good example of this phenomena was solar grade silicon that went to 10 time the production cost when Germany went subsidized solar years ago and Western suppliers couldn't get permission for new facilities (big chemical plants), but China allowed construction of a new solar grade silicon facility that was build in 15 months with a huge fraction of the world capacity. Now china owns solar grade silicon and solar technology markets.
Delay time are critical and drop out of using partial differential equations to describe any dynamic system including economics.
As a non economist I've learned the quantity theory of money.
M x V = P x T
It is kind of tautological - P x T is sum the transaction volumes, V is how many transactions you get from a unit of money (on average) - so M x V is how many transactions you get times their volumes - the same thing as P x T
So when I saw the Feds M0 charts and I was puzzled why there is no inflation, it is impossible that T has grown so much. Then I learned that the way inflation is measured does not take into account all T, only a subset of it - so the tautology still holds - only that V becomes very low, because all the dollars go into financial assets and these transactions are not counted.
If we allowed all transactions to enter the equations - then we would get a high inflation (of the financial assets) - but it does not enter the 'real economy' because the dollars just slush from one financial asset to another and are never 'spent' on anything 'real'.
Then I learned that there are some 'wealth effects' from the fact that when someon's 'paper wealth' grown up (that is the financial assets he owns are up) - then he would feel wealthy and spend more (from his other assets) in the 'real economy'. But in comparison with the growth of financial assets this cannot be a very big effect. In a pure for it would require selling a part of the financial asset to have the money to spend. People don't spend all of the gains, and also for the wealthy people they don't really need to buy anything real anymore.
But that partition of all transactions into 'financial' and 'real' parts sounds very tricky for me. If I buy a gold bar (or a copper bar) - then I guess this would be a 'real' transaction, but when I buy a gold index - then this is a financial transaction.
Maybe at some point people start buying more 'copper bars' instead of gold indexes?
You write that “the central bank is not able to make much difference [to inflation]. The growth in paper wealth has to subside if inflation is going to be contained.” But, actually, a central bank is very well positioned to retard the growth in paper wealth, by reducing the rate at which it is creating new money, even to zero; even to below zero--by selling the bonds (or other assets) it holds and *retiring (destroying) the money* it receives in exchange. Money is paper wealth.
But the main point is that inflation is reduced not by reducing *paper wealth* in general, but by reducing (the rate of increase of) the quantity of *money*. And controlling the money supply is precisely what the central bank is in the business of doing. (This “monetarist” view of inflation has nothing to do with GDP-factory thinking.)
Inflation can be viewed not as price increases but currency value decreasing and loss of an assumed relationship between money and the value of money. When this happens, the ability to plan trade-offs between present valve and future values becomes impossible.
When there is a solid reserve value measure you can use that for analysis over time, but what happens when the reserve currency of the world becomes corrupted by unstable inflation?
For economists. I have the impression that when non-economists talk about shortages, they mean situations when (to use your own expression) people used to a stable pattern of prices for a good are suddenly no longer able to buy it at those prices. Sure, in the absence of non-market restrictions the price quickly adjusts to balance supply and demand at a lower level, so that technically, from an economist's point of view, there is no shortage as such, but practically it means that lots of erstwhile buyers are priced out of the market, and they are unlikely to be consoled by economic reasoning if the market in question deals in necessities such as basic food items.
The inflation phase change/boiling water metaphor reminded me of the Rudiger Dornbusch quote, "In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could." And upon googling one of my first page result is from an Econlog post from 2011 on European debt.
Could you discuss in more detail the nature of wealth and, specifically, the distinction between "paper wealth" and non-paper "wealth"?
For instance, you mention "wealth" trickling down from Silicon Valley and "paper wealth" from governmental money creation. What are the practical differences between these kinds of wealth? For example, if I buy $100k of Google stock and tomorrow it's worth $1.1M, what happens? Am I really $1M richer? I'd assume I am only if I cash it out at that moment. At that point, does my $1M spend any differently than the $1M the government creates out of thin air?
"Concerning the first misconception, when prices are free to move, there are no shortages. You can create a shortage of gasoline by fixing the price at a penny a gallon. There will be more demand than supply at that price. But if you let the price go higher, demand will decrease and supply will increase. At the right price, they will be in balance. When I read stories of empty shelves in stores, that tells me that prices for those goods have further to rise."
You are making two mistakes in your paragraph on shortages, one minor, one major.
Minor: The QUANTITY demanded/supplied changes, not demand or supply themselves. E.g. people want the stuff to the same degree they did before, but buy less.
Major: Prices do not, and can not, adjust instantly to the equilibrium price. Neither do demanders or suppliers change their behaviors instantly to changes in price. In that time period between getting quantity and price to align, shortages exist. Shortages exist, Dr. Kling. They are corrected by markets eventually, this is true, but they can exist, just like surpluses, while the market process does its thing. How long they can persist is a matter of how long it takes prices and quantities to adjust, as well as how many further shocks the system keeps getting that changes the equilibrium. Really long term shortages are usually the result of government price fixing, just as long term surpluses are, but the market cannot adjust instantly and so does leave time for misalignments of supply and demand to exist.
Speaking on the topic of stock-outs on store shelves and elsewhere: this is often caused by the contractual arrangements between the retailer, its suppliers, and the brand. There are also issues in which the retailer may be trying to substitute for an out-of-stock brand but was unable to make the replacement in a reasonable time period.
Customers are not rational and will complain when retailers allow prices to rise to the equilibrium level. The complaints that customers have are different for out of stock and for high prices. A store manager may decide that they would prefer the OOS complaints to the insane price complaints. Some marketplaces like Amazon will actually deactivate your offers if you let the price rise to the equilibrium level to delay a stock-out, because their automated systems consider a price X% above the historic price to be a bad customer experience.
Additionally, customers are touchier the higher the price goes. It may be preferable to sell nothing and to cede ground to competitors than it is to suffer customer complaints and reputational damage related to price-driven quality complaints. For example, a customer will consider a $9 product a five star product because of the value perception. The same product at $24, priced so to prevent a stock-out, suddenly becomes a three star product in the eyes of the now pickier consumer. A three star product is not profitable to sell online: the drop-off in profitability is insane at every half-star rating below 4.5. It is better to never sell again something with a bad customer reputation. So, it can be better to stock-out until it can be replaced.
Also under officially declared emergency conditions, many states have price gouging laws. Retailers do get letters from stage AGs shaking them down for settlements, so these legal actions do not necessarily surface to the level at which the public sees them. For online retailers this means getting potentially shaken down by prosecutors from dozens of states. The C****D-1* emergency declarations are mostly done with, but you never know when minds will change on that front. So, with those, you have suppliers raising prices on retailers, but retailers having to either eat the loss or wait for the general price level to increase to restock. You cannot get a mean letter from an AG for an empty shelf, but you can if you raise your price 25% prematurely.
So, brands and retailers alike are sensitive to price perceptions which get in the way of efficiency. You watch what other people are doing and raise your prices in tandem with the others, using inflation sizing and other methods to smooth out the changes. Doing the economically efficient thing makes people and governments real mad about it, which has real consequences for managers. It is easier to be economically efficient further up the supply chain because people at the retail level have mob mentality and business people are more rational about such things.
If you view supply/demand systems as feedback control systems, where changes in demand induce changes in supply, the criticality of response times becomes obvious. If slight increases in demand result in rapid increases in supply as companies like Walmart send sales information directly to producers who then know they will see a reorder of x in the near future and plan for the production and it all happens smoothly.
If the demand varies on a business cycle time scale of a decade or so but the supply size takes 2 decades to respond demand (cycle times < supply response times), because of permission problems with building more capacity (visualize permission for a major housing development or refinery or chemical plant or mine), the system goes unstable as prices go way beyond any relationship with real costs. A good example of this phenomena was solar grade silicon that went to 10 time the production cost when Germany went subsidized solar years ago and Western suppliers couldn't get permission for new facilities (big chemical plants), but China allowed construction of a new solar grade silicon facility that was build in 15 months with a huge fraction of the world capacity. Now china owns solar grade silicon and solar technology markets.
Delay time are critical and drop out of using partial differential equations to describe any dynamic system including economics.
Excellent post!
As a non economist I've learned the quantity theory of money.
M x V = P x T
It is kind of tautological - P x T is sum the transaction volumes, V is how many transactions you get from a unit of money (on average) - so M x V is how many transactions you get times their volumes - the same thing as P x T
So when I saw the Feds M0 charts and I was puzzled why there is no inflation, it is impossible that T has grown so much. Then I learned that the way inflation is measured does not take into account all T, only a subset of it - so the tautology still holds - only that V becomes very low, because all the dollars go into financial assets and these transactions are not counted.
If we allowed all transactions to enter the equations - then we would get a high inflation (of the financial assets) - but it does not enter the 'real economy' because the dollars just slush from one financial asset to another and are never 'spent' on anything 'real'.
Then I learned that there are some 'wealth effects' from the fact that when someon's 'paper wealth' grown up (that is the financial assets he owns are up) - then he would feel wealthy and spend more (from his other assets) in the 'real economy'. But in comparison with the growth of financial assets this cannot be a very big effect. In a pure for it would require selling a part of the financial asset to have the money to spend. People don't spend all of the gains, and also for the wealthy people they don't really need to buy anything real anymore.
But that partition of all transactions into 'financial' and 'real' parts sounds very tricky for me. If I buy a gold bar (or a copper bar) - then I guess this would be a 'real' transaction, but when I buy a gold index - then this is a financial transaction.
Maybe at some point people start buying more 'copper bars' instead of gold indexes?
You write that “the central bank is not able to make much difference [to inflation]. The growth in paper wealth has to subside if inflation is going to be contained.” But, actually, a central bank is very well positioned to retard the growth in paper wealth, by reducing the rate at which it is creating new money, even to zero; even to below zero--by selling the bonds (or other assets) it holds and *retiring (destroying) the money* it receives in exchange. Money is paper wealth.
But the main point is that inflation is reduced not by reducing *paper wealth* in general, but by reducing (the rate of increase of) the quantity of *money*. And controlling the money supply is precisely what the central bank is in the business of doing. (This “monetarist” view of inflation has nothing to do with GDP-factory thinking.)
Inflation can be viewed not as price increases but currency value decreasing and loss of an assumed relationship between money and the value of money. When this happens, the ability to plan trade-offs between present valve and future values becomes impossible.
When there is a solid reserve value measure you can use that for analysis over time, but what happens when the reserve currency of the world becomes corrupted by unstable inflation?
> First, it is wrong to talk about a "shortage"
For economists. I have the impression that when non-economists talk about shortages, they mean situations when (to use your own expression) people used to a stable pattern of prices for a good are suddenly no longer able to buy it at those prices. Sure, in the absence of non-market restrictions the price quickly adjusts to balance supply and demand at a lower level, so that technically, from an economist's point of view, there is no shortage as such, but practically it means that lots of erstwhile buyers are priced out of the market, and they are unlikely to be consoled by economic reasoning if the market in question deals in necessities such as basic food items.
The inflation phase change/boiling water metaphor reminded me of the Rudiger Dornbusch quote, "In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could." And upon googling one of my first page result is from an Econlog post from 2011 on European debt.
Could you discuss in more detail the nature of wealth and, specifically, the distinction between "paper wealth" and non-paper "wealth"?
For instance, you mention "wealth" trickling down from Silicon Valley and "paper wealth" from governmental money creation. What are the practical differences between these kinds of wealth? For example, if I buy $100k of Google stock and tomorrow it's worth $1.1M, what happens? Am I really $1M richer? I'd assume I am only if I cash it out at that moment. At that point, does my $1M spend any differently than the $1M the government creates out of thin air?
"Concerning the first misconception, when prices are free to move, there are no shortages. You can create a shortage of gasoline by fixing the price at a penny a gallon. There will be more demand than supply at that price. But if you let the price go higher, demand will decrease and supply will increase. At the right price, they will be in balance. When I read stories of empty shelves in stores, that tells me that prices for those goods have further to rise."
You are making two mistakes in your paragraph on shortages, one minor, one major.
Minor: The QUANTITY demanded/supplied changes, not demand or supply themselves. E.g. people want the stuff to the same degree they did before, but buy less.
Major: Prices do not, and can not, adjust instantly to the equilibrium price. Neither do demanders or suppliers change their behaviors instantly to changes in price. In that time period between getting quantity and price to align, shortages exist. Shortages exist, Dr. Kling. They are corrected by markets eventually, this is true, but they can exist, just like surpluses, while the market process does its thing. How long they can persist is a matter of how long it takes prices and quantities to adjust, as well as how many further shocks the system keeps getting that changes the equilibrium. Really long term shortages are usually the result of government price fixing, just as long term surpluses are, but the market cannot adjust instantly and so does leave time for misalignments of supply and demand to exist.
I have heard you say elsewhere, something along the line of “central bank is just another bank.”
Can you expand on that? How do you account for money creation?
BTW, former Homestore employee here.