The New Inflation: The Collapse of Free Markets

by W. David Slawson

Overview

In this lively but profound study, W. David Slawson contends that balancing the government budget will not stop current inflation short of a disastrous depression.

Originally published in 1982.

The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.

Product Details

ISBN-13:	9780691613888
Publisher:	Princeton University Press
Publication date:	07/14/2014
Series:	Princeton Legacy Library , #599
Pages:	438
Product dimensions:	6.10(w) x 9.10(h) x 1.20(d)

Read an Excerpt

The New Inflation

The Collapse of Free Markets

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By W. David Slawson

PRINCETON UNIVERSITY PRESS

Copyright © 1981 Princeton University Press
All rights reserved.
ISBN: 978-0-691-04229-9

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CHAPTER 1

The Inflationary Forms of Competition

Competition holds prices down, when it does, by threatening sellers with lowered sales if they increase their prices. It does not hold prices down, therefore, when sellers have means of increasing their prices without lowering their sales or increasing their sales without lowering their prices. In a modern economy like ours, sellers increasingly do have such means, which I will call "nonprice forms of competition." The name will serve to distinguish these forms of competition from price competition, in which a seller engages to the extent he relies upon his prices to maintain or increase his sales. Price competition, of course, does hold prices down, or at least tends to.

Not only do nonprice forms of competition not hold prices down; if they are costly, as they generally are, they tend to drive prices up at least to the extent of covering their costs. This must be so: if a form of competition did not increase receipts from sales more than enough to cover its costs, it would not be profitable and sellers would not engage in it; and although it is logically possible for increased sales to reduce unit costs enough to more than compensate for the added costs of obtaining the increased sales, under normal conditions in an economy like ours this rarely happens. Most producers in the United States are already producing at volumes well above those that are required to maximize their efficiencies, and there is no persuasive evidence that it is nonprice forms of competition that make it possible for them to do so. Most competition is mutually canceling anyway, in its effects on sales. Generally, the sales that any seller gains he gains at other sellers' expense, since all sellers' sales together are limited by what people want to or can afford to buy.

Traditional economic theory agrees that nonprice forms of competition do not hold prices down but rather drive them up, although the agreement is not always avowed. What I call nonprice forms of competition are in traditional theory regarded as practices that obtain "monopoly power" or that are evidence of "monopoly power" which sellers already have, and "monopoly power" is the traditional term for the power to increase profits by increasing prices. Moreover, in the traditional view, a power to increase profits is invariably exercised. Simple observation also confirms that nonprice forms of competition lead to higher prices. The most common nonprice form of competition is advertising. A glance at almost any supermarket shelf is enough to demonstrate that the heavily advertised brands of foods and beverages sell at substantially higher prices than the less-advertised or unadvertised brands. Surveys confirm that this is the case, at least in general. Advertising whose primary purpose is to convey information about the sellers' (truly) lower prices may reduce prices, either by reducing sellers' profits or by permanently increasing the sales of some sellers enough to reduce their unit costs, but this situation is rare, and in any event it is a form of price rather than nonprice competition.

Although nonprice forms of competition do tend to raise prices by raising costs, this tendency is not an immediate cause of indeterminate inflation. It can serve to initiate the inflation, as we will see, but the tendency is not to continue to increase prices indefinitely, in real terms. A producer may spend, say, 10 percent of his gross receipts on advertising his products. His costs and prices are presumably both increased thereby. But if there is inflation, his advertising costs, his other costs, his profits, and therefore also his prices will presumably all rise apace. The advertising costs will not cause, or even permit, his prices to go up any faster than they otherwise would. The significance of nonprice forms of competition for inflation is rather that they serve to free sellers from the market forces that would otherwise determine their prices for them. They contribute to the creation of the "gaps."

The profitability of nonprice forms of competition such as advertising is ordinarily impossible to predict with precision. A seller can usually be sure that advertising, for example, will increase his sales somewhat, but he cannot ordinarily be sure how much, so he also cannot be sure whether or to what extent the increased sales will more than offset the expense of the advertising. Precise predictions of such matters are impossible for several reasons. Advertising is available in a wide variety of kinds and amounts, each of which will have different effects on different people. The effects of advertising are on people, and people's reactions inherently cannot be predicted precisely. Advertising ordinarily must be planned well in advance of its presentation to the public, which in turn is ordinarily well before its effects on sales will be felt, and the advertiser has no control over events (including his competitors' advertising) that may intervene between his commitment to the plans and his hoped-for sales. All these uncertainties are equally true of other nonprice forms of competition. And when, as is usually the case, a seller has available a wide variety of different forms of nonprice competition, the uncertainties of choosing are compounded. Moreover, the uncertainties of predicting what combinations of forms of competition — what "selling strategy" — a seller will choose generally exceed even the seller's own uncertainties as to which combinations will be the most profitable for him. For it will often be the case that so far as he can tell, several different combinations would be equally profitable. In that case, he will have to make his choices among them on some basis other than their expected profitability, and an outsider, such as an economist seeking to ascertain how to predict the propensities for inflation in the situation, will have no way of knowing which combination the seller will actually choose without getting inside the seller's mind, so to speak.

All this contributes to the creation of a "gap" in the market determination of a seller's prices, because every combination of nonprice and price forms of competition implies a particular set of prices, and the objectively ascertainable market conditions do not alone determine which combination the seller will choose from the number available to him. For example, a soft-drink manufacturer choosing a selling strategy for his products might have these three strategies (among hundreds of others) available to him: simply selling the drinks for a very low price, without any advertising or other promotion, in the expectation that people will buy them to try them out because they are so low-priced, and then continue buying them because they like them; an initial and very expensive advertising blitz, coupled with very low introductory prices, to persuade large numbers of people to try his drinks, followed by higher prices that would more than recoup the high initial expenses of advertising and the high initial losses from the very low introductory prices; or a long-range advertising campaign of moderate dimensions, designed both to persuade people to buy the drinks initially and to keep them buying, coupled with prices high enough to cover the costs of the advertising and to return a good profit. The price consequences of these strategies differ. To the extent that they differ, there is a gap in the market determination of the prices.

If, on the other hand, the only way open for a seller to sell his soft drinks is through price competition, his prices will generally be predictable, and they will be largely determined by the objective conditions of the market. If he succeeds in surviving against the competition of his competitors, his prices will eventually be the same as theirs for their comparable products. This price, which is by definition the "market price," will tend to be just high enough to keep the least profitable seller from giving up and withdrawing from the market. The availability of nonprice forms of competition tends, however, to create gaps in the market determination of sellers' prices, within which sellers are free, both individually and as a group, to increase their prices.

It might seem that even if sellers engaged in nonprice forms of competition they would have to engage in price competition too, if only because at least one seller in every market would be likely to do so and thereby compel the others to follow, and that the price competition would keep prices down despite being mixed with other forms. But nothing compels a seller to respond to another seller's competition in the same form, except in the rare case in which there is only one form available to him. Ordinarily, a lower price by one seller can be offset or more than offset by another seller's greater advertising, for example. The exception exists in the markets for those commodities in which the only form of competition available is price competition, because all the sellers' goods possess identical qualities.

It might also seem that at least the "competition" to lower costs would tend to lower prices, and this is seemingly a nonprice form of competition. But cost reduction is not really a form of competition. To the extent a business can achieve what it wants at lower costs, it is rewarded with higher profits whether or not it is in competition. It is probably true that a seller whose receipts are only slightly above his costs has a very strong incentive to lower his costs, and competition, of course, may thus squeeze a sellers' profit margins, but neither the competition that has this effect nor the competition by which the seller responds needs to be price competition. Any form of competition is capable of squeezing a seller's profit margin.

Finally, it might seem that although nonprice forms of competition would raise prices, they could not be a source of inflation because they could not keep prices rising. Once every seller had increased his prices to the full extent permitted by his gaps, it would seem, the price-increasing and so the inflation would stop. I cannot fully explain why this limit is never in fact reached until I explain competitive inflation, but, very briefly and incompletely, the explanation is this. Once gaps come to exist for enough sellers in enough markets, for the reasons to be dealt with in the present chapter and Chapters 2 through 4, and once enough of the sellers for whom the gaps exist make use of them to raise their prices, not only will prices rise but costs will rise too. If goods are sold that are not consumer goods, those prices constitute a part of some other seller's costs. The prices of steel constitute a part of the costs of manufacturing automobiles, for example. And as costs rise, so do the price levels at which the gaps exist. A soft-drink manufacturer who is permitted by the conditions of his industry to vary his prices 20 percent up or down by varying his advertising expenditures, for example, will ordinarily find that if inflation (caused by other sellers' price increases within their gaps) raises his costs, it will have raised the costs of his competitors in the soft-drink industry by about the same amounts, and that his gap — and their gaps — will all now exist at higher price levels than they did before. So he is now given more space, so to speak, within which to raise his prices still more. If he does raise his prices still more, his doing so will of course contribute to still more inflation; other sellers doing the same will presumably raise his costs and other sellers' costs still more; and the gaps will all rise again, and so on without limit. No seller's gap-limit, ordinarily, will ever be reached, at least not for long.

Sellers Generally Prefer Nonprice Forms of Competition

Economic investigations indicate that many — perhaps most — sellers prefer nonprice to price competition, even if price competition would be more profitable in the short term. Price competition runs a greater risk of getting out of control, with the result of drastically reducing the profits of all concerned. Price competition fails to erect what economists call "barriers to entry" against new sellers entering a market, thus increasing the competition when they do. If a seller can build up strong buyer loyalty to his products by advertising or by distinctive attributes, for example, a new seller will generally have to make large expenditures in advertising or otherwise before he can expect to persuade many buyers to buy his products instead; whereas if buyers have been in the habit of buying the goods primarily on the basis of price, a new seller can enter the market without any additional initial expense, simply by offering his products at the same or a slightly lower price. Nonprice forms of competition can also be more difficult for competitors to counteract than price reductions. A clever advertising campaign can increase sales for months or years, while competitors are trying to devise ones as clever for themselves. Price reductions, on the other hand, can be matched or exceeded almost overnight. In the course of my interviews with businessmen I never met one whose firm sold consumer products who did not express a preference for nonprice forms of competition. One told me proudly that his firm had never engaged in price competition during his entire tenure as vice president in charge of sales, some twenty years.

Additional evidence of manufacturers' preference for nonprice competition is provided by the long history of "resale price maintenance"— the practice by which a manufacturer dictates to those to whom he sells the minimum prices at which they can resell the products. The practice goes back at least to 1911, when its legality under the federal antitrust laws was first decided (in the affirmative) by the United States Supreme Court. Its legality under both federal and state laws has had a checkered history, and it is currently illegal everywhere except to the extent that a manufacturer is able to enforce it simply by refusing to sell to those who fail to resell at or above the resale prices he sets. But the economic effects of the practice have managed largely to survive its (perhaps only temporary) legal demise. It remains legal for manufacturers merely to suggest the prices at which their goods should be resold, and in most cases suggestions are enough. Suggested resale prices are frequently printed on the goods or on the packages in which the goods come wrapped. Resale price maintenance of course eliminates price competition among retailers of the same manufacturer's goods.

Investigations have revealed that manufacturers of consumer goods like resale price maintenance because it protects the public image of a product against retail price cutting, which can make the product appear cheap; because it can guarantee retailers sufficiently high profits from a product to be able to offer services in connection with the product before or after sale (demonstrations of the product before sale and free warranty service after sale, for example); because it can guarantee retailers sufficiently high profits per sale to encourage them to carry the product even when sales volume is low; because it can force retailers to engage in nonprice forms of competition when the manufacturer believes that such forms are more effective for the product concerned; because it encourages a retailer to sell the manufacturer's products in preference to other manufacturers' products of the same kind; and because it prevents retail price competition, which can spread back to the manufacturers' level.

Retailers also generally prefer nonprice forms of competition, although it is generally more difficult for them than for manufacturers to act on their preferences. Retailers have in the past joined with manufacturers in lobbying legislatures to make mandatory resale price maintenance legal, and the current systems of suggested resale prices work only because retailers generally join them voluntarily. It is not uncommon for retailers to show their distaste for price competition by declining to engage in it even if a manufacturer tries to force them. They will price the products higher than the manufacturer wants, or fail to reduce their prices to the public when the manufacturer reduces its prices to them. Retailers' preferences rest on substantially the same considerations as do those of manufacturers. The forms of nonprice competition generally available to retailers differ from those available to manufacturers, of course. A retailer's decision to emphasize nonprice forms of competition usually takes the form of offering a wide selection of goods of a kind, displaying them in an attractive setting, providing knowledgeable sales personnel, and locating outlets in convenient places. The existence of retail stores that offer one or more of these services while charging higher prices than do discount stores demonstrates that nonprice forms of competition can succeed at retail.

(Continues...)

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Excerpted from The New Inflation by W. David Slawson. Copyright © 1981 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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Table of Contents

• FrontMatter, pg. i
• Contents, pg. vii
• ACKNOWLEDGMENTS, pg. ix
• INTRODUCTION, pg. 1
• 1. The Inflationary Forms of Competition, pg. 25
• 2. Inflationary Markets, pg. 46
• 3. Pricing Institutions, pg. 65
• 4. Sellers' Uncertainties, pg. 108
• 5. Competitive Inflation, pg. 126
• 6. Demand-Pull / Cost-Push / Wage-Push, pg. 155
• 7. The Sources of Economic Determinism, pg. 179
• 8. The Costs of Economic Determinism, pg. 223
• 9. The New Economics, pg. 267
• 10. The Shape of the Program, pg. 303
• 11. Some Specific Directions for the Program, pg. 350
• INDEX, pg. 415