A version of this article first appeared on TKer.co
Sentiment surveys confirm that consumers are very aware of rising prices, and they are complaining about them. People hate inflation.
Interestingly, inflation hasn’t really stopped people from spending. Economic data confirm this.
This contradiction helps explain why, despite poor vibes, the economy continues to grow, profit margins continue to expand, and corporate earnings continue to rise.
A recent research note from Goldman Sachs highlights studies reflecting these trends.
First, they cite two studies (this and this) that provide evidence companies have been increasing price markups on the stuff they sell. This evidence is in line with data showing gross profit margins have been expanding.
“After-tax corporate profits as a share of value added have roughly doubled from about 5% in the late 1980s to over 10% recently,” Goldman economists wrote. “Over the same period, U.S. firms have substantially raised markups — the amount by which prices exceed the marginal cost of producing goods and services.”
At least some of this trend toward rising markups over the years can be explained by falling costs. Regardless, the point is that what customers are paying increasingly covers much more than the costs.
But why hasn’t there been more pushback from consumers?
As I’ve been arguing for a while, customers will pay up if they can afford it.
On that, the Goldman economists found studies showing consumers’ sensitivity to price has been on the decline (study), a trend that can be explained by rising incomes (study).
“Higher income raises the opportunity cost of time, leading consumers to search less for lower prices,” Goldman economists wrote.
Of course, this also means wealthier folks are less price sensitive than poorer folks.
“[Economist Kunal Sangani] estimates that increases in average income and in income inequality — which has meant that less price-sensitive households account for a larger share of total consumption — can account for a roughly 8pp rise in the aggregate retail markup from 1980 to 2018,” Goldman economists added.
This speaks to the K-shaped economic narrative, which argues that higher-income cohorts have increasingly driven spending while those on the lower end retrench.
For those familiar with the concept of price elasticity of demand, this discussion isn’t exactly mind-blowing. Nevertheless, it’s a timely one as everyone wrestles with why corporate profit margins remain high despite consumers’ distaste for higher prices.