How Sticky are Prices?
As FairTaxers, we all hear the refrain from our anti-capitalist opponents. Typically this is from those folks who are more of the knee-jerk opponents, not the people making reasonable arguments. But even unreasonable people need to be refuted from time to time.
“I just don’t think these greedy businesses are going to lower their prices! After all, these corporations will charge as much as they can, and why would they lower prices when the embedded taxes are removed?”
To those sorts of people, who are typically the kind who think price gouging exists and must be stamped out by the government, the response needs to be simple and something everyone can relate to. How about this?
“And just what has happened to your gas prices in the last few weeks? After the hurricanes, when prices shot up, why didn’t they stay there? After all, the gas stations knew that people could afford to pay the prices, but they lowered them anyway!”
In the last 3-4 weeks, I’ve seen gas prices here in Marietta drop about $0.50/gallon. From their highs after they stabilized a couple of days after Hurricane Rita hit, they’re about 70 to 80 cents lower. What’s brought this on? Lower wholesale prices and competition.
To people who don’t believe in capitalism and competition, it’s not enough to just say to them that it will happen because the market demands that they drop their prices. These are the types of people who think that the gas stations actually set the price of gasoline, as opposed to the market setting the price and the gas stations conforming to market conditions. When you can show a concrete example of the market driving prices down, however, the message just might sink in.
The burden of price reduction must be placed on the consumer. When the gas prices did drop, they did not all drop at all stations at the same time. Let’s say that a Shell station receives a two-day supply of gas on a given morning at $3.09 per gallon. That afternoon wholesale prices drop 15 cents per gallon. Then the BP station across the street gets a tanker delivery for two-day supply. The BP business owner could price his gas at $2.94 – but decides to sell gas at $2.99 because that price still beats the Shell station.
Now where are you going to fill up? Sure the BP station is making more money per gallon than normal – you might even call it price gouging. However, the lines will form at the BP station. Two days latter, the wholesale price has dropped another 5 cents per gallon. The Shell station prices its new gas at $2.89. The BP station still has the $2.94 gas (selling at $2.99) and drops his price 5 cents to minimize the price difference.
At the end of the second day, Shell is at $2.89 and BP is at $2.94. Where are you going to fill up?
If a business does fight for sticky prices, DON’T SHOP THERE – find a retailer that does offer lower prices. The BP station was smart to try to sell the gas for 5 cents more than he could – that is his job. A business’s job is to sell for as much as it can. Demanding lower prices is the job of the consumer.
So, anyone who believes business will try to keep prices sticky is correct. Again, that’s their job. We would be wrong to deny that fact. But, if these same people think that they have no influence on prices, they are wrong. If the price is too high, keep your money in your pocket or find a fair retailer – That is our job as a consumer.
When the FairTax legislation is enacted, and your favorite retailer does not lower prices, delay the purchase and hold your money for another week. The business will either come around and lower prices or go bankrupt. I think they will choose to offer lower prices.
We all live with an interesting duplicity. During the day, we fight for the highest price we can – our wage. Then at night we fight for the lowest price at the supermarket. This duplicity is called a free market. It works when we all do our part.
[On a side note, the high gas prices was not caused or set by the oil companies. Fear of a shortage hit the market and everyone filled their tank and gas stations ran dry. Gas station managers had to call for emergency deliveries and paid a premium price. The resulting price increase reinforced consumer fear and those who did not yet fill up did. Those of us who did fill up, topped off our tanks again. More shortages resulted in higher prices, and so the story continued. The moral here is that we did the high gas prices to ourselves.]
Bill,
All true and valid points. And it went way over the head of the people who just think businessmen are greedy and will charge “whatever they want”.
And I was afraid I was talking too far down and would insult them. In any case, at least I met them half way. The will need to get over there unfounded presumptions and deal with logic and numbers.
On second thought, maybe I will start a business that they have to use where I can just take all their money. I’ll call it Ineffective Required Services.
I suppose I’m going to be accused of harping on a single issue – if this is actually posted at all – but this time a Biggie none other than Thomas Sowell (Markets and Minorities) is on my side. (More accurately, I am on his side and invoke his writings in support of my position.) Sowell noted that rental housing – specifically, low-end apartments and trailer parks – are undesirable to the middle class, and therefore subject to supply quotas (zoning) which artificially inflate rents and thereby redistribute income from (lower income) renters to (higher income) homeowners. Because supply is often limited to levels below demand, rents are sticky and fail to decline as a result of provider cost reductions, unless a major decline in demand also occurs. Largescale property tax reductions such as California’s Proposition 13 did not result in rent reductions even though property taxes were cut (in this case) an average 57 percent.
Unlike with gas prices – to use Bill Rook’s example – where consumers can easily change providers to take advantage of price differences, renters face high costs in switching to a different housing provider (landlord). If both landlord A and landlord B stand pat on pricing (as opposed to reducing prices), renters get screwed and there is little they can do about it. I also note that large landlords typically maximize profit at an occupancy level somewhat below 100 percent: there is more money to be gained with $500 rent and 15% vacancy than with full occupancy at $400 – so it would be counterproductive to cut your rents to $400.
If both landlord A and landlord B stand pat on pricing (as opposed to reducing prices), renters get screwed and there is little they can do about it.
That’s a big if. When I lived in San Jose, it was right in the middle of the technology sector meltdown (2001-2002). When myself and my roommate got a 2 bdr, < 1000 sq ft apartment, it was renting for $1875/month. That was January. In November, we decided to part ways, and he moved into downtown San Jose while I rented a room in a house to save money. At that time, with the change in the market, our landlord was willing to drop the price to $1500/month to keep us there. That’s a 20% drop, based just on the laws of supply and demand.
And as to your point of keeping rents at $500 @ 15% vacancy, why don’t landlords just raise rent to $600? Probably because they might then be at 35% vacancy and unprofitable. After the FairTax, if they’re currently at $500 @ 15% vacancy (their preferred equilibrium point), all it takes is one landlord dropping prices for their $500 rent to suddenly equal 20% or 25% vacancy, and they’ll be forced to reduce rents.
Now, you (and Sowell) are right, in that rents are more sticky than gas prices. But that doesn’t mean that they won’t go down. At the very least, you can take solace in the fact that if you are working at minimum wage, you’ll see about a 10% effective raise (due to ending withholding of payroll taxes and your small federal tax burden), plus the prebate. Depending how close you are to the poverty line, that could be somewhere around a 30% effective raise. I don’t think rents will raise that much.
Based on the above cited 30% raise for minimum wage workers, and the opposing viewpoint that all prices will be sticky–the 23% tax would cause an increase in real costs. However, with the 30% raise and 23% increased cost of living, the minimum wage worker will be 7% better off. I think this really makes the legislation a windfall for minimum wage earners.
Viewing the entire legislation from a single issue, or sub-issue like sticky rent prices, is dangerous. In the long-run, rents prices will come down. It is just that simple. Also, in the long-run, consumers will be reducing their cost of gasoline from current prices. If prices don’t fall, consumers will find ways to use less of the product. Accordingly, in the long-run, the total cost of total product purchased will roll back from the recent cost spike.
But how long is the long-run? That can be an issue even more complicated than the entire FairTax legislation. For gasoline expenses, you can cancel your auto trip this weekend and save a few green backs—but not your commute to work. In three years when you sell your old trusty Betsy and get a new or new used car, you may elect to get a small hybrid auto. Your gas mileage is three times better than thirsty old Betsy. The majority of gasoline consumption cuts were achieved with the replacement of the car. The long-run in this case would be three years. You could elect to sell the car next week after 2 years of ownership to decrease the long-run to 2 years.
For an apartment, the typical lease is 12 months. So is the long-run is 12 months for the apartment? No, it is not. Not if you don’t move. If you just signed a 12 month lease, then your long-run is a minimum of 12 months, without breaking the lease. The long-run will be however long between the times that you move.
Will all the price-drops occur within one long-run cycle? Maybe—maybe not. In auto sales, there are so many new cars added to the market every year and most cars make it to the junk yard within 10 years. So, the price competition in auto sales will be governed more by the monthly sales cycle than the long-run cycle and price adjustments will occur on a monthly basis. Remember, the long-run cycle is related to your use of the product, not the market.
For real-estate, a lot of new houses and apartments are added every year—but not really that many more when compared to the existing market. Remember, houses and apartments have a life span ranging from 20 to 80 or so years. For this reason, I think that long-run cycle of the users will have a more important impact on price drops than just the real-estate sales cycle. This means that rent drops are more likely to occur on an annual basis than the shorter sales cycles of other products.
Overall real-estate prices and rent prices will decrease over time under the FairTax. It may take years for meaningful decreased to occur—but they will. Now, this is overall prices, not individual prices. In high-growth places like my own Sarasota, Florida, prices may never drop. In other places like central Ohio, prices will drop more than the average. –I think I’ll move.
I am one of the people who believe that capitalism and competition is enough to make the prices of gas and other comodities to drop their prices.
A lot of businessman are afraid to loose even one of their regular customers because of price difference so see competition is good for the consumers.