The Real Reasons That Prices Go Up

Between April 2021 and April 2023, airfare prices dipped and then shot upward:

In a recent blog, the NY Fed told us why.

Price Increase Decisions

Whereas “inflation” has become a standard answer to why prices are up, there is so much more. Presenting the preliminary results of research from the Atlanta, Cleveland, and NY Fed, the NY Fed’s Liberty Street Economics ranked reasons that firms hike prices. They conducted their research in two stages. Starting with 30 business decision-makers, researchers asked them to explain their higher prices, Then, hoping to identify what was “very important” and “important” among a broader group when they raised prices, they disseminated a quantitative survey to 700 businesses.

Below you can see that demand, followed by profit margins and labor costs, topped the list:

Our Bottom Line: Elasticity

To the leisure activity examples in our first graphic, we can add the groceries that also became more expensive during the two years preceding April 2023. While for eggs and margarine, prices rose slightly more than 50 percent, with bread, chicken, and milk, we are in the 20 percent range:

Again asking why, we can return to demand at the top of our list. And, as economists, that takes us to elasticity.

Involving a buyer’s response to a change in price, elastic behavior reflects price sensitivity. It means that a consumer’s proportional change in potential purchases exceeds the percent change in price. Correspondingly, inelastic behavior reflects a relatively small reaction to a price rise or fall. Typically, the kinds of goods and services that evoke an elastic response are luxuries, items that represent a big chunk of our income, and those that have substitutes. By contrast it’s the necessities, the items that are very inexpensive, and those without substitutes the that are categorized as inelastic.

Knowing that demand affected price increase decisions, we can hypothesize that sellers muc have been aware of their customers’ inelasticity.

My sources and more: Always my handy go-to, for current issues, Liberty Street is the NY Fed’s blog. With more specific price increases, CNBC was the ideal complement.