Real Prices fall where Consumers Spend their own Money which is why Health Care Prices have Soared

Posted by PITHOCRATES - December 23rd, 2012

Week in Review

A lot of us no doubt hear our elders talk about how cheap things used to be.  “When I was a kid you could buy a bottle of pop for a nickel.”  “When I started driving you could fill up the gas tank for a couple of dollars.”  “I remember when 99 cents would buy you two eggs, 4 sausage, a slice of ham, 4 rashers of bacon, hash browns, toast and a cup of coffee.”  And, yes, everything they said was true.  Things cost a lot less back then.  But our paychecks were a lot smaller back then, too.

When President Nixon decoupled the dollar from gold we started printing money.  And when we did we devalued the dollar.  Causing a sustained and permanent inflation.  This inflation caused prices to go up.  And our paychecks grew, too, to allow us to afford those higher prices.  So prices are relative.  They become more expensive when they rise greater than our paychecks.  They become less costly when our paychecks rise greater than prices.  There is a better way to look at how prices change over time.  Something that factors in the affect of inflation.  By looking at the number of hours worked required for a purchase (see The Cost of Health Care: 1958 vs. 2012 by Chris Conover posted 12/22/2012 on Forbes).

Mark Perry has posted some interesting comparison of how prices have plummeted between 1958 and 2012 when measured in terms of the hours of work required to purchase items. He concludes that today’s consumer working at the average wage of $19.19 would only have to work 26.6 hours (a little more than three days) to earn enough income ($511) to purchase a toaster, TV and iPod.  The equivalent products (in terms of their basic function, not their quality) would have required 4.64 weeks of work in 1958. In short, the “time cost” of these items has massively declined by 86% in less than 5 decades.

Similarly, Perry calculates that measured in the amount of time working at the average hourly wage to earn enough income to purchase a washer-dryer combination, the “time cost” of those two appliances together has fallen by 83%, from 181.8 hours in 1959 to only 31 hours today.

What if we applied this kind of analysis to health care? The results are quite interesting. In 1958, per capita health expenditures were $134. This may seem astonishingly small, but it actually includes everything, inclusive of care paid for by government or private health insurers. A worker earning the average wage in 1958 ($1.98) would have had to work 118 hours—nearly 15 days–to cover this expense. By 2012, per capita health spending had climbed to $8,953. At the average wage, a typical worker would have to work 467 hours—about 58 days.

In short, while time prices for other goods and services had shrunk to less than one quarter of their 1958 levels, time prices for health care had more than quadrupled…!

This simple comparison reminds us of three basic truths. In general, private markets tend to produce steadily lower prices in real terms (e.g., in worker time costs) and steadily rising quality. This is exactly what we observe for goods such as toasters, TVs, iPods, washers and dryers. In contrast, while the quality of health care unequivocably has risen since 1958, real spending on health care has climbed dramatically. This isn’t an apples-to-apples comparison insofar as the bundle of goods and services that constitute health care is also much larger today than in 1958. In contrast, even though the quality may be better, a washing machine in 2012 is still a washing machine.[2] If we were willing to rely more on markets in medicine, we might be able to harness the superior ability of Americans to find good value for the money to produce results more similar to other goods.

So why are health care prices soaring in real prices when everything else is falling?  In a word, waste.  Where consumers spend their own money real prices have fallen.  Where consumers receive benefits other people pay for real prices have soared.  Where there are market forces (i.e., competition) prices fall and quality goes up.  Because manufacturers have to get consumers who are looking for the best value for the money to buy from them.  Where there are no market forces because someone else is paying for your benefits (single payer, third-party, insurance, government, etc.) people don’t look for the best value for the money.  They just look to get the most someone else will pay for.  So there is no incentive to reduce costs or find cheaper ways to deliver higher quality.  Like in the private sector.

Obamacare won’t improve this.  In fact, adding vast layers of bureaucracy will only add waste.  And increase prices further.  With all that money feeding into the new Obamacare bureaucracy there will be less available for health care services.  Resulting in longer wait times, service rationing and service denials.  Health care may be free one day to patients.  But the cost of that free health care will soar even higher for the taxpayers who will have to pay for all of that bureaucratic waste.

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Inflation, Prices and Wages (Real and Nominal)

Posted by PITHOCRATES - April 23rd, 2012

Economics 101

Inflation is Good for those who Owe Money but Bad for Bankers 

There is a direct correlation between the amount of money in circulation and prices.  The more money the higher the prices.  The less money in circulation the lower the prices.  During the Great Depression the Federal Reserve contracted the money supply and prices fell.  And it caused havoc in the economy.  Low prices a problem?  Yes.  For some.  It was good for anyone buying anything for their money was worth more and could buy more.  But it wasn’t good for people who owed money.  Or banks.

Farmers had borrowed a lot of money to mechanize their farms in the Twenties.  So they owed the banks a lot of money.  When prices fell so did their earnings as the crops they grew sold for less at market.  Good for the consumer.  But bad for the farmer.  For with that big ‘pay cut’ they took they could not repay their loans.  They defaulted.  And when a lot of them defaulted they left banks with a lot of bad loans on the books and little cash in their vaults.  Causing bank runs and bank failures.

This is why farmers are in favor of inflation.  Increasing the amount of money in circulation.  Instead of deflation.  Decreasing the amount of money in circulation.  For when you increase the money supply prices rise.  Meaning more money for them at market.  Making it easier for them to repay their loans.  For although the money supply increased loan balances remained unchanged.  Higher earnings.  Same old debt.  Therefore easier to pay off.  Even though the value of the dollar fell.  So inflation is good for the farmer.  But bad for the banker.  Because the dollars they get back when the farmer repays his loan now buy less than they did before the inflation.

To Fully Appreciate the Impact of Inflation we must talk about Real Prices and Real Wages

Think of a grocer.  He buys from a food distributor to stock his grocery store shelves.  His distributor buys from farmers and food processing companies.  These purchases and sales happen BEFORE a consumer buys anything from a grocery store.  Now BEFORE the consumer goes shopping let’s say the Federal Reserve doubles the amount of money in circulation.  So the consumer goes shopping with a dollar worth HALF of what it was worth when the grocer stocked his shelves.  So if the grocer doesn’t raise his prices to account for this inflation he’ll be able to replace only HALF of what he sells with the proceeds from those sales.  Because his distributors will have doubled their prices to reflect the halving of the value of the dollar.

Of course doubling prices throughout the food supply chain will ultimately lower sales.  Which no one in this chain wants.  Which creates somewhat of a problem.  Especially when consumers don’t like paying higher prices.  Food processing companies will raise their prices.  But they can do something else to make it look like they’re not raising their prices that much.  They can reduce their packaging.  So boxes of cereal and bags of chips get smaller while prices increase only a little.  This lessens the perception of inflation on both consumer and seller.  At least, for those who can do this.  We sell gasoline by the gallon.  Which means they have to pass on the full impact of inflation in the price at the pump.  Which makes it look like gasoline prices are rising faster than most other prices.  Which is why consumers hate oil companies more than food companies.

The price we pay in the grocery store and at the pump are nominal prices.  Prices noted in dollars.  Nominal prices rise to factor in inflation.  But they don’t tell us the real impact of inflation.  That is, how it reduces our purchasing power.  For prices aren’t the only thing that rise.  Our wages do, too.  And if our nominal wages rise at the same rate as nominal prices do we won’t really notice a difference in our purchasing power.  If our nominal wages rise faster than nominal prices then we gain purchasing power.  If nominal prices rise faster than our nominal wages we lose purchasing power.  So to fully appreciate the impact of inflation we must talk about real prices and real wages.  Not the dollar amount on the price tag.  But the affect on our purchasing power.  In times of increasing purchasing power a single earner may be able to meet all the financial needs of a family.  In times of declining purchasing power it may take a second income to meet the financial needs of the family.  This is what we mean when we talk about real prices and real wages. 

Government causes the Erosion of Purchasing Power Always and Everywhere

You may get a large raise at work giving you a high nominal wage.  But if nominal prices are rising (as in a higher price at the gas pump) real wages are falling.  Because you can’t buy as much as you once did.  Meaning you’ve lost purchasing power.  So even though you got a nominal raise you may have taken a real pay cut.  Pretty much everyone today earns more than their father did.  Yet today we struggle to have as much as our fathers did.  Even with a second income in the family.  This is the impact of inflation.  Which causes real prices to rise.  Real wages to fall.  And our standard of living to fall.

As real prices rise and real wages fall we have to make choices.  We can’t have the same things we once did.  If we lose too much purchasing power our spouse may have to provide a second income, spending less time with his or her children.  Or people may work more overtime.  Or take a second job.  Or simply cut back on things.  And enjoy life less.  Cut out movie night.  Or going out to dinner.  Not renew their season tickets.  Or give less to charity.  This is the true cost of inflation. 

This all goes back to the amount of money in circulation.  As Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon.”  Meaning that only government can create inflation.  Because government controls monetary policy.  And the amount of money in circulation.  Which means government causes the erosion of purchasing power always and everywhere.  Even the price at the pump.  As oil is a global commodity priced nominally in U.S. dollars.  So whenever the Americans inflate their money supply the oil producers raise their prices to offset the devalued U.S. dollar.  So government causes much of the pain at the pump.  Whose monetary policies decrease real wages.  And increase real prices.   

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