Despite the latest inflation figures for New Zealand coming in slightly lower than expected by many economists, the rate remains stubbornly high. At 6.7% for the year to March 2023, the inflation rate is more than double the Reserve Bank’s target range of 1-3%.
But not everyone seems to be feeling the pain of increasing prices.
Major banks, retailers, and other corporates are reporting, or expected to report, record profits this year. It is tempting to ask, as others have overseas and in New Zealand, to what extent corporates’ mega profits and pricing are driving inflation.
The answer may surprise you. The reality is that corporate profit-making contributes very little to the inflation rate.
Market power and inflation
When a seller has the ability to choose the price, economists say that the firm has market power. But their ability to raise prices is not unlimited. Just consider the case of Arivale, a health-tech startup in the United States that ultimately failed because it set the initial price of its offering too high.
The extent of market power determines how high a business can set its price above its costs (its markup) in order to maximise its profitability. The optimal markup for a business depends on how sensitive its customers are to price changes.
Read more: Four reasons inflation will stay stubbornly high for some time
In markets where customers are very sensitive to price changes, businesses will set lower prices (a lower markup) than in markets where customers are less sensitive to price changes. The optimal markup (as a percentage of the price) won’t change unless there is a change in customers’ price sensitivity.
Higher inflation is unlikely to cause consumers to suddenly become less sensitive to price changes. If anything, they will become more price sensitive and optimal markups should fall. That is why a strong majority (79%) of economists recently polled by the University of Chicago disagreed or strongly disagreed that market power was a significant factor in higher. Original Source
