Use Your Economics!

Shortages are caused by sticky prices, not supply-chain problems

Tyler Cowen writes,

The demand is hitting the market, and the supply can’t catch up. And it’s not just one problem that has an easy, direct fix, but rather a series of interlocking paths of economic chaos and delay.

Nowadays, parents say to young children "Use your words!" The idea is to steer children away from grunting, whining, or hitting to express their desires or frustrations.

Similarly, it bothers me when someone whines that "supply can't catch up" with demand. Use your economics! Supply and demand depend on price. There is a price at which supply equals demand. If there are "shortages," that is because prices have not gone up enough.

Start with what Megan McArdle calls

the labor shortage, which may be the strangest phenomenon of all.

. . .This trend seems most pronounced in the hospitality industry, where restaurant and hotel jobs are going begging. But you can see it all over, from workers who say they’re ready to quit rather than get vaccinated or return to the office, to the International Alliance of Theatrical Stage Employees (IATSE), one of Hollywood’s most powerful unions, which just overwhelmingly voted to authorize what would be the first strike in the union’s history.

The businesses affected by this need to pay workers more. Higher pay might increase supply (it might not, if workers only want so much income, and then they would rather have leisure). It certainly will reduce demand for workers. It will lead some businesses to shut down. Others will reduce output. Some firms will substitute capital for labor.

Or take the automobile shortage, which is supposedly blamed on a chip shortage. The market solution to this is for the prices of chips to rise. Some industries will reduce their usage of chips. When this happens, maybe auto manufacturers will buy a whole lot of high-priced chips, or maybe they will be the ones who reduce their usage of chips, so that fewer cars are built. In either case, the price of cars should go way up, but dealer lots should not be empty.

In fact, dealer lots are empty. I am told that dealers do not bid up prices of cars to get more cars from manufacturers. Instead, manufacturers allocate cars to dealers by formula. That is an interesting institutional fact that might help account for sticky prices.

There should be no lack of availability of Christmas toys, regardless of what is happening at the ports. Instead, the cost of unloading goods should be going up. The prices of trucks to haul goods away after they have been unloaded should be going up. And the prices of goods to consumers should be going up.

If you use your economics, then no matter how complex the supply-chain problems might appear, they can be solved using the price system. The price system may or may not be able to call forth more supply, but it certainly can ration demand, and it can do so more efficiently than is being done at present. Everywhere the supply chain is “broken,” higher prices can ensure that scarce goods are allocated to the highest-priority uses.

Wherever you see buyers unable to find goods, you should ask why the rationing takes place by availability rather than by price. If the market were operating smoothly, the shelves would be fully stocked, but prices would be higher.

My hypothesis for why we observe price stickiness is that businesses fear consumer backlash. When the price is high, the consumer blames the business. If instead the product is not in the store, the consumer blames “the supply chain.” In fact, it should be the other way around—the business should be blamed for not raising prices to prevent a shortage, and the higher prices should in turn be blamed on higher costs in the supply chain.

The “blame-dodging” hypothesis does not explain the labor shortage. Workers are not worried about being blamed for wanting higher wages. But businesses try to avoid raising wages. Perhaps they think that the supply of workers is going to increase soon, and they don’t want to raise wages now and then have to try to cut them later. Perhaps they think that they cannot raise prices to cover higher wage costs, so that reducing output is a better alternative.

Whatever factors are holding back wages and prices right now, I do not think they will persist. The pressure in the market is for higher wages and prices, and that is what I expect to see in the months ahead.