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Relative prices

January 5th, 2007

Obviously, I’m not the only one who gets annoyed by pieces pointing to purchases of consumer goods as evidence that rising inequality isn’t really a problem. But, as an economist, it particularly annoys me when this claim is put forward by people who claim to understand markets. I’ve been going on about this for yearsand years.

The most important thing that happens in markets is that relative prices change. If prices change, but income and preferences don’t, what we expect is that people will consume more of the goods and services for which prices have fallen and less of those for which prices have risen. So, when Jeff Taylor tells us that

With price points dropping below the $1000 mark, high-end TVs are moving down-market fast with Wal-Mart leading the way.

we can all cheer this renewed verification of the Law of Demand. But, of course, this tells us precisely nothing about what’s happening to inequality.

More importantly, since we know that prices are increasing (and, for most US workers, increasing faster than wages over the last few years), it’s obvious that if TVs are getting cheaper, other things must be getter dearer in real terms. With this hint, it’s not hard to find examples – college tuition and health care are obvious candidates.

So, if you want to show that increasing inequality isn’t really a problem, looking at sales figures for consumer durables won’t cut it. You need to look at the proportion of the population without health insurance or the accessibility of college education to the working class.

Of course, the big decline in US national savings means that consumption has grown more strongly than income for most goods and services. This raises a lot of complex issues.

It’s possible to make a case that the income stats overstate the growth in inequality. But it’s unlikely that someone who doesn’t understand the basics of relative prices is going to do a good job of making this case.

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  1. gordon
    January 6th, 2007 at 09:48 | #1

    For the macro-minded, Brad Setser reprints a column by one Pearlstein on how it all works. Interesting read.

  2. conrad
    January 6th, 2007 at 15:20 | #2

    You could look on the bright side about it, since it is surely politically easier to change the level of health and educatational inequality than inequality based on consumer items. Thus if consumer goods inequality solves itself thanks to cheap Chinese production, you only need worry about all the other things — and giving someone free health-care is much more acceptable than giving them a free plasma TV. The main problem is that the majority of the population (or perhaps at least the political parties) evidentally don’t want to.

  3. January 7th, 2007 at 01:06 | #3

    Why do you say we know prices are increasing? If you mean inflation, then that should also be seen in wage inflation, so it’s a moot point with regard to welfare or inequality.

    The general point that technology leads to lower prices which leads to welfare gains is an important one to keep in mind. I don’t see how it necessarily impacts on inequality, but it certainly impacts on absolute poverty.

    And what do you mean about the prices increasing for health/education etc? Do you mean that the cost of producing the same level of service is increasing… because I don’t think that’s true.

  4. Martin
    January 7th, 2007 at 12:14 | #4

    Once upon a time it took a peasant a full day to till the soil to grow and collect enough food and drink for himself and his family. Now someone can subsist on less only a couple of hours’ work. Over the long-run, prices are falling, not rising.

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