What? Product Prices Are Cheaper Than Ever Before?

I wonder how many people in countries like the United States, Switzerland, South Korea, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy! Prices are not falling, you are thinking! They are rising way too fast is probably what you believe!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, most goods and services are becoming relatively less expensive. Of course, the paradox is that although nominal prices (the actual price tags) are, in fact, increasing, nominal income (the average, actual wage or salary) has been growing even faster over the decades. This is a topic that in economics is called “real income” or a macroeconomic measurement that compares a nation’s nominal income growth relative to the nominal growth in prices that the same income buys. In the United States, and virtually every country around the world, nominal income has grown at a faster percentage than nominal prices causing real income to increase, meaning that most Americans enjoys greater access to more and better goods and services than ever before.

Let’s take some specific facts:

In the United States real median household income grew from $42,934 to $53,657 from 1967 through 2014 for a total percentage gain of 25% (source: U.S. Census Bureau). Both of the aforementioned median household incomes are stated in current dollars, which makes the comparison valid meaning that inflation is stripped out of the comparison. Median household real income is an attempt to quantify the progress that the “middle American” family or typical family has made over time. So, in summary, the median household in America can buy 25% more with their income today than they could in 1967. In other words, relative prices are lower than they have ever been before. Due to productivity (think PPC curve shifts right due to technology, education, and trade) we are producing more products and services than ever before and anytime there is more of something the price will fall relative to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (25%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated and highly skilled driving up real income average growth rates much faster than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark actual product price increases to nominal income increases in order to really understand whether things are becoming relatively more expensive or inexpensive. The vast majority of products and services are relatively cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own much larger homes, drive more and better cars, have cable and computers, and have access to better healthcare and prescription drugs. The reason we are led to believe differently (ie, prices are out of control!) is because we are victims of our own human nature, which tends to focus on the problem areas (higher actual or nominal prices) and not the true picture (lower relative prices when compared to income). Many citizens observe things adversely “at the margin” and quickly notice those products and service prices that are rising faster than average like gasoline prices, education, and healthcare! Hey, even gasoline prices are not at an all-time relative price high as incomes have increased faster over time.

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether a country’s middle class has access to more or less products and services. “Real income” really is just a measurement of the quantity of the products and services that the median family personally has, although it says nothing of the quality of those goods but quality has improved as well. The median and average American continually has more actual products and services in the aggregate as U.S. income gains have averaged 6.0% per year, over the last 40 years, outpacing higher price increases averaging 3.0% per year leading to a real, overall gain in products and services or income of 3.0% per year. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

Now let me introduce one word of caution; over the last 15 years in the United States, there has been an increase in real average incomes of 2.7% per year, but little of those real income gains have accrued to our nation's middle class, working class, or poor, but rather to the more highly educated and skilled. The purchasing power (real incomes) of the middle class has actually fallen from $56,080 in 1999 to $53,657 today, which is a 4% decline!. The primary reasons for this fall off in real incomes for the middle class family is attributed by most economists to increased global competition and increased technology integration into companies, which tends to keep wages down (more supply of global labor substitutes and technology keeping middle class workers keeping middle class wages in check). The educated and highly skilled, however, have seen their real incomes increase consistently over that same period. 

So fellow APers, my first new car, a 1979 Buick Regal that I bought out of college costing $6,700  with my $14,500 annual salary working for Price Waterhouse was a lot "more expensive" than the first new car of comparable status that you may buy immediately after college for $20,000! Get it?

Review Questions:

1. Before reading this blog, did you have an impression created by the media that the average American was somehow worse off economically than the previous generation?

2. Why are goods and services today relatively less expensive than they were for the previous generation? Provide an answer using the terms "nominal income", "inflation", and "real income". 

3. In Fairfax County, do you think nominal (actual) incomes have risen much faster than product prices when compared to the US overall average? Support your answer! Hint: you can get the correct answer if you trust your visual observation as you drive through the County! You don't need to do research via Google!

4. What has happened to the purchasing power or real income of the middle class in America since 1999? What is the cause? Do you have any recommendations or policy actions that you would take if you were President to increase middle class American's real income?

5. Explain the answer to my "car riddle" in the very last paragraph of the blog?

Socialism vs. Capitalism: A Classroom Experiment

This current week in my economics' classes we will be discussing different types of “economic systems” or the ways that economies tend to organize themselves. We describe the three types of economic systems in terms of a continuum with a purely free market economy (pure capitalism) at the one extreme and a command economy (communism) at the other extreme, with anything in between the two extremes being called a mixed system.

Often in the media, we use a word called “socialism”, which is economically close to “communism” in terms of households all earning closer to the same incomes even though workers provide varying skills and value to society. Usually, the word "socialism", when used in the United States regarding our current situation, is characterized by the wealthy paying increasingly higher taxes, relative to the poor, which are, in turn, spent by the government for common goods (national defense, health care, roads, airports, etc.) or directly transferred to the poor (more welfare, higher unemployment benefits, etc.)

Relatively more economists than non-economists would be in support of a more capitalistic system than a socialistic system as the study of economics (how do we satisfy our unlimited wants with scarce resources) is mostly about having the proper incentives.

Let’s consider a hypothetical experiment in socialism (communism) using an AP classroom full of high achieving economic students:

Effective immediately, all grades in AP Macro will be averaged together and everyone will receive the same grade. My guess is that after the first test the grades might average to a B. The students who studied hard would become upset and the students who studied little would be happy. But, as the second test rolls around, the students who studied little would probably study even less and the ones who studied hard would decide not to study as hard as they did on the first test. My guess is that the second test would average to a D or C-! After the second test, no one would be happy, especially with me, as they would see their college transcripts deteriorating rapidly. When the 3rd test rolled around the average would probably fall to an F. Attempts by certain classmates to rally the class to a higher average would probably not be effective, even though their grade or standard of living would be at risk. I would predict that the scores would never increase and bickering, blame, and name calling would result in hard feelings as no one would study any longer for the benefit of anyone else. All of you may end up failing, and I would quickly be fired and have my tires slashed!

Socialism is ultimately economically inferior to capitalism because under capitalism (free market economy) when the reward is great, the effort to succeed is great; but when the government levels the playing field and takes more of the reward system for the achiever away; few will try or want to succeed as much as before and things tend to worsen with less productivity.

And that, economic students, is why virtually all economies tend to move in the direction of capitalism or free markets, as opposed to moving more towards communism or socialism.

Discussion Questions:

1. Is the classroom grading experiment discussed above a valid analogy, in your opinion, as to why most economists say that a capitalistic society will increase standards of living much faster than a more socialistic system (more leveling as the government transfers wealth from the rich to the poor)?

2. What positives can be achieved through a socialistic system, either economically or otherwise? Are their aspects of socialism in the US currently that you strongly support?

3. In the United States, many Republicans say that President Obama is intentionally leading the nation towards socialism. What do you think? Is this view simply an unsupported bias asserted by mostly Republicans since they currently don’t control the White House and want to gain reelection, or, is this view accurate and factual?