Obamacare will raise prices (not that there’s anything wrong with that)
Matt Yglesias makes an uncharacteristic error in mocking a restaurateur who claims that Obamacare will increase prices:
This is self-refuting nonsense. The only situation in which it would make sense for Ruffer to raise prices is if price increases will on net lead to higher revenue. And if price increases will lead to higher revenue (which they might) then it makes sense for Ruffer to raise prices no matter what happens with Obamacare. In fact, Ruffer himself articulates the truth later which is that Obamacare is going to reduce his profits by about one-eighth and he (and any investors in his business) will eat the loss.
The restaurant industry has relatively free entry and lots of firms (meaning it’s what economists call “competitive” or “monopolistically competitive.”) Here are some facts about those industries:
1. Higher variable costs raise prices in both the short and long run.
2. Higher fixed costs raise prices in the long run. (Which is just another way of saying that all prices are variable in the long run.)
So he’s wrong in the long run, and probably even a little bit wrong in the short run, as workers are usually considered variable factor. However the short run impact will probably be pretty small–it will mostly come out of profits. In the long run competitive and monopolistically competitive industries earn zero economic profit, and hence all cost increases are passed on to consumers.
It’s possible that costs would not rise at all, as the extra cost of health care might be offset by lower wages. But it’s unlikely that workers value health-care benefits and wages equally, otherwise there would be no uninsured workers.
This doesn’t mean Obamacare is a bad idea, it’s appropriate that costs be passed on to consumers, and there are other arguments in favor. I happen to oppose Obamacare, but not the principle that everyone should be forced to either self-insure, or buy some sort of coverage.
PS. Matt’s argument does apply to monopolies, when the cost increase is a fixed cost. My favorite example is big contracts for athletes. Many sports fans blame high ticket prices on the big contracts, but the causation goes the other way. Owners set prices at a level that maximizes revenue. Then owners and athletes fight over the pie. As TV money made the pie much bigger, athletes were able to grab much bigger salaries. But if they didn’t get the money, it would go to owners. BTW, I’m not saying teams are a pure monopoly, but rather that the entry into the industry is controlled. The issue of free entry affects pricing far more than whether something is a monopoly or has numerous competitors.
PPS. Speaking of restaurant jobs, I highly recommend Bryan Caplan’s post on the minimum wage.
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12. March 2013 at 18:58
Ah yes, Matt “gee it’s hard to open a business!” Yglesias. I’m guessing he hasn’t gotten to the “running a business” part yet. No doubt further epiphanies will follow 🙂
Once Matt actually runs a business, he’ll learn that businesses maximize profit, not revenue.
The way higher costs work in practice is this: if you’re really, really profitable, you shrug and order another diamond-encrusted Bluetooth headset. If you’re reasonably profitable and costs are mostly unit-variable, you raise prices and accept less gross revenue because that maximizes profit. If your business is only marginally profitable, you say “That’s it folks!” and close up shop.
Also, your customers have some knowledge of your costs and your competitors will share them. The latter point means you can raise prices without losing business to them, the former means you may be able to get them to accept higher prices as a result of the new costs.
Just a tremendously naive post by Matt.
12. March 2013 at 19:22
I thought restaurant workers were going to 25 hour workweeks, with job sharing among different restaurants. Hence, the cost is borne by workers who have to juggle multiple jobs.
12. March 2013 at 19:58
Still, I find the approach of a Great Britain or Japan to health care must offer something. They get about the same results, but by expending a much lower fraction of GDP.
Maybe it is time in the USA for a simple payor, no lawsuits, and good luck but it is a lot cheaper.
12. March 2013 at 20:00
As for the endless snitfittery (Bryan Caplan et al) about the minimum wage (that effects less than 2 percent of the workforce) why is there no equivalent noise about maximum wages for lawyers, who create their own business and create barriers to entry?
12. March 2013 at 20:53
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12. March 2013 at 23:35
“Obamacare is going to reduce his profits by about one-eighth and he (and any investors in his business) will eat the loss.”
New businesses start when investors see a potential for profits that are worth the risk. These fixed costs that cut into profits filter into the economy as businesses not started, jobs not created, products and choices that are not available. These oportunitiy costs are inumerable and imeasurable and never seen.
13. March 2013 at 00:04
Scott, Do you read Karl Smith?
He doesn’t blog often now, but his takes are very similar to yours, and he always get there in a different way.
His points about bubbles should be especially interesting to you I think. Because he believes in bubbles, and has a explanation for them that is consistent with EMH.
But his take on Obamacare raising costs, and the relationship of it to macroeconomic policy is very insightfull:
http://www.forbes.com/sites/modeledbehavior/2013/03/12/restaurants-will-pass-on-costs-by-going-out-of-business-or-why-macroeconomics-matters-in-real-life/
13. March 2013 at 00:45
Great teaching post – the practical relevance of intro-econ. Duly filed away.
13. March 2013 at 01:50
Yes, this is what I was talking to myself when reading Matt’s article. I thought that there exists a lot of empirical studies showing that incidence of payroll taxes falls overwhelmingly on the shoulders of the workers. Facts that you mentioned – relatively free markets in restaurant business – makes this argument only that much more powerful.
13. March 2013 at 03:33
I would argue this is a characteristic error from Yglesias.
13. March 2013 at 03:46
Scott if I remember correctly-maybe I don’t-I thought you had said you agreed with the SJC decision last year not to strike down ObamaCare.
In saying you “oppose” ObamaCare do you mean you would have preferred that the previous status quo were maintained-just asking about your choice between these two options not what you’re best option choice would be-though that would be interesting as well.
13. March 2013 at 03:51
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13. March 2013 at 04:07
Arthur, Karl seems to confuse revenue and profit maximization in the same way that Matt does. But yes, I do enjoy reading Karl’s posts–he’s very good.
Mike, Yes, I opposed the court striking down Obamacare. What relevance does that have for this post?
13. March 2013 at 06:05
Well in this post you said you oppose ObamaCare-which might make one assume you would have supported the court striking it down.
13. March 2013 at 06:07
As you didn’t want the court to do that what do you mean by “oppose”-most would take “oppose” as you wanting the law struck down or abolished.
13. March 2013 at 06:28
The point about free entry being important reminds me of a great econ 101 example of that. A long time ago, a bunch of real estate agents colluded to fix a 7% commission and submit their listings to their exclusive multiple listing service, and sustained real economic profits because of that. At some point, a judge or the city council decided that they could not prevent others from accessing the listings (but they could force anyone who was an agent to charge 7% – probably through some licensing law or something). So what happened? A bunch of un-and-underemployed folks saw the excess profits they were making and became real estate agents. Before long, there were twice as many agents, still all charging 7%, but they generally made half as much money as before because the total number of transactions did not change. Maybe apocryphal, but a great way to remember that you need both price-setting and barriers to entry to make economic profits.
13. March 2013 at 06:35
Mike Sax wrote:
“Scott if I remember correctly-maybe I don’t-I thought you had said you agreed with the SJC decision last year not to strike down ObamaCare.
In saying you “oppose” ObamaCare do you mean you would have preferred that the previous status quo were maintained-just asking about your choice between these two options not what you’re best option choice would be-though that would be interesting as well.”
It’s possible to oppose a law without believing it is unconstitutional, no?
13. March 2013 at 06:57
“It’s possible to oppose a law without believing it is unconstitutional, no?”
It’s possible though not very common to say the least. Most who hate ObamaCare would have loved for the court to strike it down.
Also Scott I’m still curious: would you have preferred not to have passed ObamaCare-ie, to have stayed with the pre ObamaCare status quo?
13. March 2013 at 08:21
You posted on stock market doomsday predictions before. Now Steve Keen has joined in.
http://finance.yahoo.com/blogs/daily-ticker/stock-market-debt-fueled-bubble-steve-keen-121950839.html
I think what he says makes a lot of sense–excess margin debt is blowing up the bubble. Your opinion?
I’m with Keen on this one.
13. March 2013 at 09:19
In sports with single leagues, like the NFL, it’s really monopsony power as the NFL is the only buyer of labor. Of course it’s a bit different with Champions Leage, pro basketball, etc. where there are more leagues. In the NFL, owners set prices for tickets/tv revenue, then share some with the league and keep some for themselves. Owners and players negotiate over their slices.
13. March 2013 at 11:30
Doesn’t Obamacare shift the supply curve upwards? If the demand curve is sloping downwards, the cost of Obamacare will only partially be passed on to consumers. Isn’t it the same analysis as an increase in a tax?
13. March 2013 at 11:56
[…] Scott Sumner (though it’s on ObamaCare technically, but could be applied to minimum […]
13. March 2013 at 12:01
I will add that if demand doesn’t change, supply should decrease with restaurant closings or some such decrease in supply. Thus capital will leave the restaurant industry. Total profits will also decrease. But the smaller remaining capital will earn the same rate of return as before, just on smaller total profits.
13. March 2013 at 13:25
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13. March 2013 at 13:28
‘Now Steve Keen has joined in.’
To say both that we’re in a huge stock market bubble, AND that the market, adjusted for inflation, isn’t any higher than ten years ago.
Which is pretty typical for Keen.
14. March 2013 at 12:07
Mike , You said;
“Well in this post you said you oppose ObamaCare-which might make one assume you would have supported the court striking it down.”
I believe in democracy. So no, I don’t favor having unelected judges “strike down” laws enacted by our elected policymakers. (Unless clearly unconstitutional.) Do you favor democracy, or a system where unelected judges enact your personal policy preferences?
Nick, Good example.
John, I don’t think I or anyone else can predict the stock market, and I don’t believe in stock bubbles.
Randy, Both monopsony and monopoly. Don’t forget the players unions.
Travis, It is like tax analysis, but the long run supply of restaurants is essentially flat.