Over the past few years, inflation has once again become a keenly felt phenomenon across the globe. Inflation measures the rate at which prices of goods and services rise in an economy. When inflation occurs, the prices of various basic amenities – including food – will influence on society. The direct opposite of inflation is deflation, which occurs when there is a general fall in the price levels of goods and services, potentially caused by the shift in demand and supply.
Similarly, pricing is the process of setting up a value for products and services. Businesses establish a price that their customers must pay before they can acquire their products or services. Indeed, when the price of commodities and energy rises, there is a significant impact on the economy. For this reason, pricing and inflation are subjects of constant analysis in most economies. This guide will provide a deep insight into what inflation is, the significance of pricing to large companies, and more. Let’s dive in the 7 Top Facts and Guide to Pricing & Inflation !
What is inflation
Inflation is defined as the rate at which prices of goods and services, within an economy, increase over a specific period. The concept of inflation is often a broad measure, which could be used when there is a general rise in the cost of living – or prices of commodities – in a country. This could include a continuous rise in prices, as estimated by the Consumer Price Index (CPI). Similarly, we can say pricing increases when the value of money, required to purchase a product, drops.
Generally, inflation is often viewed as a state where too much money is used to chase fewer goods. In this case, the currency loses its purchasing power and this will keep diminishing over time. Take, for example, assuming $200 would purchase 5 pairs of quality jeans 10 years ago. When there is inflation, the same $200 would only be able to purchase 2 pairs of jeans in the current period. When there is inflation, pricing is affected. Businesses will tend to increase the price they set on their products once they perceive an increase in demand – or a rise in the amount people are willing to pay for it – which is often a result of inflation.
It is important to bear certain keywords in mind while defining inflation. The first is general or aggregate. This implies that the increase in the prices that resulted in inflation must account for the entirety of the goods in the economy as different from an isolated increase in the prices of a group of commodities or a single product. What this means is that any changes that occur in the individual prices of commodities cannot be regarded as inflation.
Yet, it must be stressed that the increase in the price of a single commodity might have a domino effect, raising the prices of other commodities in the process. Once again, this would not be considered as inflation until the price change is such that the aggregate level of price is induced to rise. The second keyword is continuity. This implies that the rise in the general price level must be continuous before inflation can be said to have occurred. There must be a sign of a continuous rise over various periods. This situation must be different from any kind of one-off increase in the price level.
Top 3 Causes of Inflation
Inflation stems from an increase in the amount of money in the economy. However, this can occur through various mechanisms in the economy. The amount of money supply in the economy can be increased, resulting in inflation. The mechanisms that drive inflation are discussed as follows:
This kind of inflation is a result of a rise in the amount of money that is supplied and the overall demand for goods and services in the economy is increased faster than the production capacity of the economy. This causes demand to rise, leading to an increase in price. As more money is pumped into the economy, it becomes easier for individuals to get money. Positive sentiments for various products can ensure higher spending. As a result, high demand pulls prices higher. This creates a big gap between demand and supply and this leads to higher prices.
Cost-push inflation occurs when the rise in prices is a result of an increase in the cost of production. When the excess supply of money into the economy is accompanied by a negative economic shock to the supply of important commodities, the costs for various kinds of intermediate goods increase.
The finished products and services become higher, they contribute to the increase in consumer prices. Take, for example, the expansion of the money supply can create a speculative boost in the prices of oil. As a result, the cost of energy can also increase, contributing to increased customer prices.
This kind of inflation is based on the idea that individuals in the economy expect the present rate of inflation to continue in the near future. The rise in the price of goods and services can ensure that workers and others can expect the inflation rate to keep rising at a similar rate. As a result, they will demand more wages to sustain their living standard. As their wages rise, the price of goods and services also increases. This continues and one factor initiates the other and vice versa.
How does Pricing work?
Pricing is carried out through different methods. However, oftentimes they are all guided by variants of three general approaches.
Some markets provide a mix of pricing techniques. Sometimes, wholesalers of a market are granted the right to set the price of commodities, based on the cost of products. Besides this, there are also markets where lots of sellers and buyers are very active. In this case, prices of products are set competitively among the sellers.
Elsewhere, sellers may demand more for a used product than the initial retail price just because there is a high demand for it. This represents a form of variable pricing method due to demand.
3 Basic Types of Pricing
(In the frame of inflation)
Pricing ensures that businesses can set value for the products and services they provide. This can be divided into three types, as discussed below:
This type of pricing places little focus on the price other sellers are willing to sell their products. Rather, this method considers the cost of operation before setting prices. In this case, the figure a seller uses may or may not be adopted by a competing seller.
As the name implies, this method of pricing is based on a look into the prices of the seller’s competition before fixing a price. The knowledge of the price of a competitive seller can provide a framework on which prices can be set. Sellers may decide to undercut the competition, match them, or charge more than them while offering products or services of better quality.
This method of pricing is based primarily on the level of demand for certain commodities. Growth in demand ensures that the selling price is increased by the seller, particularly when supply is limited. In other words, the movement of demand determines the price that is set.
How to increase profits without harming volume
There are lots of businesses out there that choose to raise their sales volume just to generate greater proceeds. To many, this might sound like a strong strategy. What if the business is a small one and there is no way to manage a bigger inventory that comes with increasing sales volume?
To be a profitable enterprise, there is often no need to raise the volume of sales. The basic understanding of profit margin is why several companies, despite strong sales, have low percentages. It is also why profits can be raised without necessarily boosting the number of sales.
Profit margin represents the overall difference between the amount of money an organization gains and the total amount lost as the cost of operation. The net margin (the difference divided by net sales) is a percentage that reflects how well an enterprise is doing. The higher the percentage, the higher the profits. What then is the reason why companies make low profits?
A possible reason for low profits is a high operating cost. Regardless of the number of customers a company has or the number of sales it generates, the high cost of production or storage can reduce the profits. As mentioned earlier, increasing sales do not necessarily translate to greater profit. By keeping an eye on what is stocked and what is being bought and moved, it is possible to avoid incurring costs for any overstocked products. Minimizing the cost of operation and inventory can increase profit margin.
Pricing is an essential way of boosting profits without harming sales. Even though this may seem counterintuitive, adjusting the value of products to match the cost of operation is often effective. There is no need to reduce prices or give discounts to boost sales. This will only reduce the amount of money that covers the cost of operation. Giving discounts is only a strategy used by large organizations that can afford profitability that is focused on volume. It is always best to focus on providing products of higher quality to justify the higher price.
Increase Your Prices and Avoid Giving Discounts
This may seem counterintuitive, but the strategy of giving discounts is best used by large businesses that can afford to have volume-focused profitability. Don’t reduce your prices just to drive sales, as this will leave you with less money to cover your costs. Focus on providing a quality product that can justify a slightly higher price compared to your competitors or make it more convenient for your customers to buy the same item from you despite being more expensive.
The Effects of Inflation on The Government and Ordinary Man
Different economic agents feel the impact of inflation differently. There are two general economic groups in society: the flexible income group and the fixed income group. Usually, when inflation occurs, the first group gains while the second group loses. This is due to the fact that the prices movement of various products and services are different. In other words, the rate of increase in the price of individual commodities varies. Some commodities will have faster rates of increase than others. Many might even remain the same.
Furthermore, the increase in the price of commodities will not correspond with the increase in the earnings of the fixed income group. For instance, a trader will adjust the price of their products to ensure that the value of their income – and not the amount – remains the same. However, a civil servant (whose income is fixed) will experience a decrease in the value of their income. The former will keep getting richer at the expense of the latter. This is the exact reason why the middle classes and the poor suffer more from the impact of inflation than the elite in society.
Generally, this results in a transfer of wealth and income. The loss or gain that is experienced by the income group of the society due to inflation depends on who expects and prepares for the inflation and who does not. Appropriate preparations will ensure that an adequate adjustment is made to present buying and earnings to tackle the loss of income and wealth caused by inflation. It is important to assess the impact of inflation on society by discussing its effect on different groups:
- Salaried people: Those that depend on salaries lose since their income often does not respond accordingly to the increase in prices.
- Creditors and Debtors: When there is inflation, creditors lose while debtors emerge as the winner. This is because during inflation, the value of money borrowed drops. Therefore, the value of money borrowed is higher than the value of money returned. For instance, $50 borrowed will have a lower value than the same $50 returned during inflation. With this in mind, it is safe to affirm that inflation favors debtors at the expense of the creditors.
- Fixed income group: These people only get a fixed amount as their earnings, including pension, social security, and more. These people also lose when there is inflation since the constant amount of money they receive will keep losing its value with increasing prices.
- Investors and Equity Holders: This group of people gains since the rising prices during inflation ensure that they can expand their business activities while they make a profit. This also encourages an increase in dividends on equities.
- Wage Earners: Depending on how their wages respond to increasing prices, wage earners can either gain or lose. For those with a strong union, their wages may become connected to their cost of living index. Through this, adequate protection can be provided against the adverse impacts of inflation. Oftentimes, there is a lead time between the rise in price and the increase in employee wages.
- Agriculturalists: These include peasant proprietors, landlords, and landless agricultural workers. Since they are only paid fixed amounts as rent, this group of people loses since the value of the money they receive falls when there is inflation. Similarly, peasant proprietors who own and cultivate their farmlands gain during this period. This is because the prices of products increase more than the cost of production. Land revenues and input prices do not experience the same rise as farm products. However, when it comes to the landless agricultural owners, they lose since their wages are not increased.
- Businessmen: These include traders, real estate holders, and producers. They all gain during a time when prices of goods increase. On the other hand, the rise in the prices of their goods is greater than the cost of production. In this case, the rise in prices will cause the value of the producer’s inventories to rise in equal proportion. This is the same for traders in the short term. Similarly, real estate holders also make a profit when there is inflation due to the fact that landed properties often increase faster than the price level. However, it is difficult to make business decisions when prices are unstable. There could be a rise in wages in the long run. This will minimize the proceeds, producing a negative impact on future investments.
- Government: The effect of inflation on the government can either be positive or negative. As a debtor, the government gains at the expense of its principal creditors since the interest rates on government bonds are fixed, without being increased to offset the expected rise in the price level. In turn, the government issues less service tax. When there is inflation, the actual value of taxes is minimized. Inflation ensures that the government can finance its activities via inflationary finance. As the income of people rises, it is collected by the government in the form of taxes on income and commodities. For this reason, as prices rise, the revenue of the government.
What is the cost of inflation in the economy?
The effects of inflation in an economy cannot be stressed enough. The uncertainty can result in reduced investment levels and lower economic growth, in general. During high inflation, society is destabilized, and this can lead to loss of confidence in the economic system. Some of the effects caused by inflation are better discussed below:
Volatility and uncertainty
High inflation results in uncertainty in what people spend their money on. Besides this, firms become unwilling to invest during high inflation as there is uncertainty about the future prices and costs, as well as profits. Over a long period, this confusion can result in a reduced economic growth rate. This represents one of the major issues of high inflation rates.
Reduction in the level of international competitiveness
Countries with higher rates of inflation than their trading partners will experience a lower level of competitiveness in their exports. This leads to a reduction in exports. This is a serious problem for countries with a fixed exchange rate. This reduced competitiveness will also result in a reduced rate of economic growth.
During periods of inflation, some people gain while others lose. Typically, lenders of money are worse off while borrowers are better off. Inflation reduces the value of money saved, particularly when the interest rate is low. The effects of inflation are more felt by older people who rely mainly on a fixed income. As more money is required to purchase a lower quantity of commodities, individuals whose income cannot match the inflation rate lose.
Yet, for those who rely on the interest rate on savings, they emerge as winners when the rate of interest is higher than the inflation rate. When there is extremely high inflation (hyperinflation), the increasing price levels weaken the basic economic confidence, which has an adverse impact on economic activity. During this period, there is a total loss of confidence in money and people try to spend their money as they receive it.
Countries with hyperinflation often exhibit a “barter economy”, which results in consumers exchanging goods for services since money becomes useless. Indeed, the issue of hyperinflation in Germany in 1923 is well documented. There are several stories of people carrying money with the use of a wheelbarrow. It was said that anytime they stopped outside a shop, the money is left untouched while the wheelbarrow is stolen. In fact, children used bundles of banknotes to build blocks, reflecting how worthless the currency was in Germany during that period.
Periods of hyperinflation ensure that the cost that is associated with dealing with increasing prices can become extreme. In some cases when prices rise 100% daily, some people prefer to be paid twice a day as they spend the money once they receive it. Unsurprisingly, hyperinflation is followed by fast redistribution of income since the rising prices move faster than interest rates. Furthermore, when inflation is expected, the impact is less severe than when inflation is unexpected. A firm’s cost is more impacted by unanticipated inflation.
Who benefits the most from high inflation?
Most times during inflation, consumers enjoy negligible or no benefits. On the other hand, experienced & prepared investors gain since the assets they hold on to increase in value due to inflation. For instance, those who invest in oil might experience a rise in their stock prices once the price for oil rises.
In some cases, companies can enjoy the benefits of inflation since they can increase the amount they charge for their products as the demand surges. For an economy that is performing well, as housing demand increases, the charges for selling homes increase as well. For this reason, it is safe to affirm that businesses have greater pricing power during inflation.
In other words, inflation can provide businesses with pricing power and increase their profit margins. If profit margins are rising, it means the prices that companies charge for their products are increasing at a faster rate than the increase in production costs. Similarly, businesses can decide to keep away their supplies from the market, ensuring that prices of products can increase to a favorable level.
Yes, businesses can be negatively impacted by inflation if the surge in price results in an increase in the cost of production. Organizations are exposed to risk if they are unable to recover the higher cost of production in the form of a higher price to the consumers. In this case, when the higher cost of production has no effect on foreign competition, local companies might end up losing their customers to foreign companies unless they are ready to eat the increased costs of production.
Which areas are more subject to inflation?
Inflation produces a significant impact on several sectors of the economy. However, none can feel the impact than consumable goods, real estate, technology, and transport.
The consumer goods sector includes a great selection of retail products that consumers purchase, from basic needs like food to luxury items like jewelry. Higher demands drive up the prices of these commodities during inflation. Generally, food items will not see a wild variation in their demand, optional items such as electronics might experience a great fluctuation in their demand due to inflation.
It is worth noting that as inflation rates affect the prices of commodities, there is a significant impact on the spending power of the consumer on goods. For this reason, the Consumer Price Index (CPI) and Producer Price Index (PPI) are considered as the best indicators for economic growth. With a high inflation rate, the purchasing power of the consumer fades away. This implies that consumers are less likely to have excess income to spend after basic needs, including food and housing, are met. Besides, non accurate price tags placed on consumer goods will also discourage spending.
As signs of inflation begin to appear, several real estate investors are wary of its implication for their business and assets. As the inflation rate increases, consumer prices rise. However, how does this affect real estate? Inflation has several effects on real estate. These include expensive construction, rising asset prices, increased mortgage rates, devaluation of long-term debt, among others.
Mortgage rates rise due to inflation. In other words, an increase in the inflation rate will raise interest rates. During this period, central banks usually increase short-term rates to ensure that downward pressure is applied to environments affected by inflation. More people tend to borrow money once interest rates are low, which implies that there is more money to spend, moving inflation up in the process. As the interest rates are increased by central banks to tackle inflation, individuals tend to save more since the rates of returns – due to higher interest rates – become appealing.
Asset prices can also rise because of inflation. The surge in the price of commodities will affect real estate. Usually, inflation ensures that the prices of housing and other real estate assets increase. Since the rate of the mortgage goes up, this serves as a major headwind to demand for real estate since debt becomes more costly. This results in downward pressure on asset prices as demand reduces.
Furthermore, another impact of inflation is felt in real estate as the costs of construction begin to rise. Since the price of commodities goes up, the cost of materials that are used during construction rises too. As inflation creeps in, rent becomes more expensive. Due to the effect of the higher prices of commodities, the real estate sector can be said to perform relatively well during inflation. This is because, during this period, rents rise while the value of properties increases as inflation rates rise. Besides these, the debt on assets gets devalued as inflation causes the value of the debt to decrease.
For this reason, investors must be aware of environments that are susceptible to high inflation since borrowing becomes associated with increased cost, having a negative effect on cash flows, as well as real estate demand if there is a need to liquidate. This also ensures that the development of real estate becomes more costly.
That said, investors need to be wary of high-inflation environments, primarily because the cost of borrowing will increase, putting downward pressure on your cash flows and demand for real estate if you want to liquidate. It also makes new real estate development more costly. There are more advantages than downsides and with this, real estate can gain in an inflationary environment if they make smart acquisitions.
The impact of inflation can also be felt in the technology sector. Several tech companies struggle to grow due to higher prices of commodities as the inflation rate increases across the globe. Yet, there are certain technology companies that will perform better in an inflationary environment than others. It is important for investors to understand how exactly inflation works before winners can be separated from losers.
Another way tech companies feel the downward pressure of inflation is higher rates of interest, as well as reduction of future earnings. Several governments resort to raising the interest rates their central banks charge to tackle inflation. The surge in interest rates attracts the attention of more consumers and they become willing to invest money in higher-yield bonds and savings accounts. This temporarily makes it possible for the economic growth of a country to cool off while slowing down the rate of inflation. However, the increase in interest rates can have an adverse impact on growing technologies in a number of ways.
First, the cost of borrowing money to expand businesses becomes higher, which is a harbinger of reduced growth for tech companies. After all, they are constantly burning cash with widening losses. Besides this, a surge in interest rates will reduce the estimates of a company’s proceeds in the long term, as well as the growth of free cash flow. This reduction will hurt tech companies that depend on the growth of their future free cash flow, rather than their profits in the short term.
In addition, bonds can be turned into safer investments through higher interest rates for big institutional investors. For this reason, as yields increase, so much money moves from the technology sector into the bond market.
Another sector of the economy that is affected by inflation is the financial sector. This sector plays a crucial role in the economic growth and stability of a country. As a result, great attention is focused on this sector since improved performance signals the strategic strength of a country. As the rate of inflation rises, this produces a headwind that slows down consumption while raising the cost of financial services, and in the process, minimizing the demand for financial services.
Different sectors adopt the use of dynamic pricing
Dynamic pricing is a popular strategy that is adopted to find an optimum price point at any given period. There could be factors on which price changes are based, including the perception of the amount consumers are willing to pay for an item, competitors’ prices, among other variables. This is a common practice in various sectors such as hospitality, entertainment, sports, retail, and transport. Depending on the demand for products and needs, each sector adopts a slightly varying approach to dynamic pricing.
The tourism industry embraces time-based pricing as the standard pricing method. During peak season or periods of special events, higher prices are often charged. During off-seasons, hotels may decide to charge based on the establishment costs while gains are made on any proceeds and investments in the high season. Alongside other major players in the hospitality industry, hotels use dynamic pricing to ensure that the cost of packages and rooms are adjusted depending on the level of demand and supply at that instance.
This industry employs the use of dynamic pricing to determine the highest price customers are willing to pay. (Responsive) Demand pricing is another name for dynamic pricing in the hospitality industry. This price variation strategy can be used to maximize review depending on the willingness of several market segments to pay. Price increases as demand rises and reduces when demand is low. The availability of different prices as a result of the demand at every point within a day ensures that hotels can generate more proceeds as customers are brought in at varying price points they can afford.
Depending on the time of the day, as well as the specific day of the week, there is variation in the price airlines charge. Airlines embrace dynamic pricing, based on different factors, including the number of seats the flight had, the number of cancellations on similar flights, and departure time. Besides this, public transportation also adopts the use of congestion pricing. In this case, prices are set based on how busy the day is or when drivers are more likely to travel. This is an advantage since it represents an effective way through which revenue can be boosted due to high demand. This also manages demand as drivers who are not eager to pay the premium can avoid these times.
Dynamic pricing is also embraced in retail. The growth of e-commerce, as well as the size of assortments, across the far reaches of the globe, cannot be understated. This has ensured that retailers can resort to software to monitor the prices of products as they make updates on pricing. Adjustments of price are done by retailers in accordance with the rates of conversion, traffic, time, sales goals, and competitors. The retail industry is quickly embracing dynamic pricing and is becoming a very popular strategy to help stores manage the aforementioned factors in a market characterized by fast pace.
Dynamic pricing software & tool ensures that retailers can easily figure out all that happens in their assortment and set up a plan to tackle any changes in the market. Indeed, while some retailers design their dynamic pricing software, others outsource to a software vendor & consultant. Retailers employ the use of dynamic pricing strategy, including fashion, sporting goods, beauty, auto parts, home care, among others.
Dynamic pricing is also used by several professional sports teams to raise revenue. In baseball, various MLB & NFL teams find this strategy very important. Some play about twice as many games as others in different sports, as well as in bigger sports venues. There are various factors that outdoor sports must consider for the right pricing strategy. These include weather, date of purchase, opponent, and date of the game. During chilly weather, game tickets often sell better when the price is lower. In contrast, fans will be eager to pay for tickets when their teams are winning, irrespective of how slightly higher the ticket price is.
How brands use dynamic pricing
Over the past few years, several brands have introduced several channels that encourage direct sales to consumers. This is intended to gather more consumer data while controlling brand perception. Several brands resort to dynamic pricing to ensure that they can manage their sales market as they follow the market.
Dynamic pricing will ensure that brands can easily exert certain control on their market perception while they create a good relationship with their consumers. Yet, an interesting upside of dynamic pricing is that market data on consumers can be easily gathered by brands.
Inflation is a serious economic issue that is felt by many countries across the globe. During this process, several businesses display their pricing power as demands for products and services. In other words, the prices of commodities rise significantly and in extreme situations, people tend to spend money as they receive it. Furthermore, inflation affects various individuals differently. While some emerge as winners, others lose during inflation. As prices increase, businesses set prices for their products to ensure that costs of operation are covered.
7 Top Facts and Guide to Pricing & Inflation
Baydhir Badjoko, CEO & Founder The Consultants bvba
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