Tuesday, August 03, 2010

Learning about inflation from a box of eggs

Milan Kumar Biswas, General Manager of Keggfarms Pvt. Ltd. knows something about inflation. In a note addressed to his customers, stuffed in a box of eggs, he announced an increase in the unit price of his eggs.

P = (1+markup) MC. To justify the change in P, of course not due to his own greed (the "markup"), Mr. Kumar blames various "exogenous" factors for the price increase, all bunched in what economists call "marginal cost". He tells us about the components of his marginal cost:
1. Input costs for feed: read food grains and other food items.
3. Packaging and transportation costs: read a mixture of wages, services and fuel prices.
This points to something more than just food inflation. Mr Kumar, just like our RBI Governor, seems to suggest that price pressures are indeed quite generalised.

On 1), we knew about food inflation from the the WPI and the CPI. What is novel is the information on the pass-through to processed food items from unprocessed ones. It is a clear example of the cascading effects of input costs into prices downstream from the production chain.

On 2), unfortunately we have no direct and timely statistical evidence about wages in India. Hence, we, alongside our Central Bank, are left grasping for evidence from anecdotal and piecemeal information. If true, it would be indeed bad news. A input cost increase passed onto wages, i.e. the famous "second round effects". This puts us into something like that classic story of mishandled inflation, the oil shock of the 1970s.

On 3), we unfortunately have no clue what are the developments in services prices. Hopefully CSO will soon release a new CPI so we can start seeing some of this.

Last, but not the least, can we also trust Mr. Kumar that he will not raise his markup in a period of ongoing recovery of demand? Economists have long disagreed on this question. See the seminal papers by Rotemberg and Woodford, and, more recently, Ramey and Nekarda.

1 comment:

1. Dr. Shah, as part owner of a small manufacturing facility, I can vouch for wage increases. These have been sharpest for daily wage earners averaging between 25-40% mostly in response to food price inflation. For salaried employees, wages have risen between 15-25% over the last year for the same reason. We are indeed firmly in the grip of "second round effects".

However, despite the recent increase in fuel prices, transportation costs haven't increased proportionately. There is considerable overcapacity in the transportation sector which leads me to suspect that we aren't out of the woods on demand growth yet.

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