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It is easy, even for the best economists, to get stuck thinking about only one side of a market, or on only one margin of adjustment, when discussing policy. For example, opponents of the minimum wage seem to unilaterally focus on the possibility that raising wages will cause less employment. This is undoubtedly the case. But it is also possible that raising wages would encourage employers to adjust on other margins in response to these higher costs. Perhaps non-wage benefits will fall. Perhaps the offices will be colder in the winter. Who knows? Each employer responds differently to changes in costs.

Similarly, when folks discuss the problems with inflation (a general and sustained rise in all prices) and deflation (a general and sustained fall in all prices) they seem to think that people on only one side of the market matter. For example, one common defense of inflation is that if consumers expect prices to rise in the future, that will stimulate them to increase consumption today. Then, if one holds the erroneous view that consumption is what drives prosperity, you might conclude the expected inflation is a good thing because it acts like a regular economic stimulator.

Aside from the macroeconomics being wrong here the microeconomics is wrong. What this idea forgets is that there is an entire half of the market whose behavior is likely to change if higher prices are to be expected. Remember the producers! If prices are expected to be higher next year than this year, it is entirely plausible to think that producers will want to build inventories and withhold selling some goods and services until the future when prices (and profits) would be higher. This would cause a decrease in supply today, putting even more upward pressure on prices and downward pressure on employment and economic activity. In the extreme, if producers were 100% confident that prices would rise considerably, it might even be profitable to fire all workers today, only to hire them in the future when profits will be higher. Not only would consumption fall, it would plummet to zero. So which is true? I don’t know, but the simple Keynesian idea that spending increases will necessarily come from inflation are again a big giant blinking red light that reads, “Warning: Priceless Economics Ahead.” Priceless here in the sense that they are ignoring how prices impact the other side of the market.

The same idea holds for deflation. The fear of many macroeconomists and those who read the modern popularizers of Keynesian ideas, is that if prices begin to fall, and consumers expect them to fall, that people will hold back consumption of goods and wait until prices are even lower in the future. This will leave (supposedly helpless) firms with no ability to sell goods, and the lack of consumption and sales will put the economy into a depressionary spiral. Leave aside the obvious problem with this fact from the consumers’ standpoint that expected declines in the prices of certain goods in the economy seems not to have limited the purchases of those goods. For example, my two year old laptop was twice as expensive and half-as-fast as a new model that could be had today. Same for my iPod, or even models of cars, bicycles, ice-skates, hockey sticks, and the like. But ignore that behavior. Once again, these deflation fears ignore the fact that when prices are expected to fall, producers have an even stronger incentive to unload their inventories today, and to sell as much as they can while prices are still higher than they expect them to be. Again, which effect is bigger, I have no idea. But it doesn’t follow from the fact that prices today are lower than in the past that the economy is set to go into a free-fall. That general improvements in economic productivity have not plunged economies into depressions seems to suggest that what is understanding what is happening on the producer side of the market is as important as how consumers react to changing prices.

I find it regularly puzzling that in certain applications producers are completely overlooked, while in others they receive the only attention (e.g. in trade discussions) while consumer desires and behaviors get completely ignored. Bonus points to any student who can advance a consistent theory that explains these attention deficits.

2 Responses to “Two Sides to Every Coin”

  1. Greg says:

    I found myself discussing a similar topic yesterday. A friend went on the usual anti-Walmart rant about supporting goods made in China, eliminating the “local store owner”, etc. I said something along the lines of “okay, so you’re clearly concerned about the makers of goods, but what about the buyers? Do you agree the Walmart makes you a little better off, by bidding the price down of something that you normally buy? And do you agree that this isn’t just happening with you, but with millions of people? And do you think that perhaps that may come close to cancelling out the consequences faced by our local shop owners?”

    It’s interesting how one side can be completely overlooked. It seems to me the most noise is put on the most obvious side of the coin. If prices rise, that means things are going to cost more, which is unfortunate for me (obvious right? Everyone can sort of reason with that). If jobs are shipped overseas or put into big boxes, then some people will be displaced, which seems unfortunate for them (obvious right?). Taking the thought a bit deeper and looking at the other side of the coin requires people to think a little bit, maybe that’s the issue.

    I definitely have not provided a consistent theory, so I would not like any bonus points, but you do bring up something that frustrates me often.

  2. Douglas J Bennett says:

    You can replace costs and benefits below with producers and consumers, or any other group you wish. I simply chose those labels for the “coin.”

    Argument 1: Costs are irrelevant if the benefits, even indirectly, can somehow be argued to accrue to “the children” (or some other “disadvantaged” group)- even if the costs themselves also accrue to “the children.”

    Argument 2: Benefits are irrelevant if the costs, even indirectly, can somehow be argued to accrue to “the children” (or some other “disadvantaged” group)- even if the benefits themselves also accrue to “the children.”

    Will the politician use the first argument and support the program instead of railing against it with the second one? Will the program increase the politician’s power or influence? They are the same question.

    A pithier response: Consider who’s flipping the coin.

    In the context of media and public discourse I suspect it’s a combination of the above and the breakdown of the seen and unseen.

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