While there are several good commentators on inflation at EconLog, a recent lunch outing with a good friend prompted me to think more deeply about how inflation has affected some of my favorite local restaurants. It may be better for customers and the company itself to raise prices in an inflationary environment.
During the meal my friend noticed that the nominal prices of the meals had increased. As economists, we were not discouraged by this fact, for two reasons: A) the food we ate was great as usual, and B) we understood that the price increase was in large part due to the inflation we have been experiencing lately endure. few years.
From June 2020 to June 2024, the annual CPI inflation rate amounted to more than 5%. The producer price index, an index of the prices that producers pay for inputs, increased compared to 2020 and 2022. While the latter has fallen slightly, pent-up consumer demand for restaurant meals kept prices from falling as people returned to their normal lives, hungry for the activities they enjoyed before the pandemic. It would be unreasonable to assume that prices at one of our favorite busy local eateries would remain constant during this time.
In fact, I was pleased to see that this restaurant had increased its prices. The reason for this is that companies facing rising input prices and high demand face a difficult choice, especially if they cannot afford a hit to their margins to survive financially. They have two primary options. First, they can increase the prices their customers pay. Wages – the price for labor – tend to rise in an inflationary environment, allowing customers to absorb the increase.
Second, they can reduce quality. This invokes the well-known term ‘shrinkflation’. Instead of giving you four slices of meat on the sandwich, they can give you two. They can add more water to their tomato sauce or stop serving lemons with your drink. See the Costco hot dog for an example. Some methods of reducing quality may be less obvious, such as closing earlier or cutting back (being stingier with) napkins handed out to customers.
I can remember several examples of the latter option in restaurants I used to love. Although the prices were exactly the same as many years before, the quality of their product had deteriorated dramatically. Disappointed, I stopped patronizing those restaurants. The culprit, at least in part, was the inability or refusal to raise prices to cover the higher costs and use option 2 instead.
Although I had to pay a few more dollars to get it, my recent trip for fried chicken and fries was as good as ever. I was grateful that they chose option 1, and I hope this will help the restaurant survive for years to come.
Those who would say that higher nominal prices that maintain quality are all well and good for someone like me, but not for those most in need, should consider that reduced quality for the same nominal price is a more expensive meal. Don Boudreaux made this point well in a message in Café Hayek in August 2021, where he previously predicted impending inflation “transient” versus “persistent” debate started.
Second, companies that keep their prices rigid over the long term can find themselves in financial trouble and reduce quality to the point where the customer base shrinks in a vicious circle until the company has to close. Inflation makes local businesses harder to manage. It can be particularly difficult for owners without formal business training.
Finally, companies don’t cause this a general increase in the price level – inflation – drives government policy, mainly by printing new money to finance government spending. Politicians are quick to blame others for rising inflation, because admitting that inflation stems from policies they have consciously supported and implemented is political suicide and should be avoided for a self-serving politician. Companies that don’t raise prices—or can’t—protect them to some extent from the political fallout.
The current political and digital social environment may prevent companies from raising prices in response to higher input costs or increased demand. McDonald’s and other chains recently came under fire at prices that have become higher than customers expect from fast food restaurants. They and others are trying to offer new menu choices that deliver value and keep prices lower. Innovative ways of doing this are commendable and laudable in inflationary and otherwise difficult economic conditions. However, beware of the Money illusion; Lower quality for the same price leaves you with a more expensive product. The culprit is inflation, not entrepreneurs.
Giorgio Castiglia is a program manager for the Project on Competition at the Mercatus Center and a PhD student in economics at George Mason University.