My Two Cents - "Substitution vs. Subtraction"

10/12/2007

Media outlets have recently trumpeted the supposedly tame inflation numbers, most recently PPI that stood at 1.1% for the month of September. While this in itself is an astronomical increase for a single month, they conveniently blame much of the increase on rising oil prices. Somehow this should make us feel better because the price of oil certainly doesn’t affect us in the least. This ridiculous logic works on the markets though, and after all, that is all that matters.

One of the mechanisms used to come up with these often laughable price indexes is the substitution effect. I have often been amazed at the misuse of the substitution effect. In essence, what happens is that the statisticians who calculate the ‘inflation’ indexes substitute cheaper comparable goods for more expensive ones. For example, if the price of steak goes up (which it has), ground beef might be substituted for steak. Since ground beef is cheaper, the statistics will reveal that the cost of living (all else being equal) has decreased. While in theory, this may be true since the person eating ground beef has still eaten and is nourished; their standard of living has been reduced by just a little bit. Their pay buys less than it used to. Of course, the next obvious conclusion is that when the cost of ground beef goes up too much, SPAM could be substituted for ground beef. Then dog food perhaps. I think you get the idea.

However, there is another more important effect that has been rearing its ugly head. I will call it the subtraction effect for lack of a more descriptive term. Last night I had the opportunity to visit a popular eating franchise with my family. One of those places where you go and there are a hundred different TV’s, all with some insipid game on mute. The tables have striped laminate tops, are way too small and patrons unfortunate enough to have to sit in the aisle spend their time dodging waiters, other patrons and flying silverware. For this honor, you pay about nine dollars for a hamburger and fries. But not just any hamburger and certainly not just any fries. I hadn’t eaten at this particular establishment in a few years and was shocked at how the portions had decreased despite a healthy increase in the price of the meals. Of the two of us that ordered cheeseburgers, one of us had all of 18 tiny French fries on his plate and the ‘beef’ patty in the burger was almost totally obscured by the fluffy roll. The platters reminded me of kid’s meals from yesteryear. I was half expecting to receive a coloring book and a pack of crayons with my dinner.

And so I pondered the double whammy of inflation. Not only do you pay more for something, but you get less of it as well. I am sure that numerous examples of this phenomenon are pounding their way into your consciousness as you read this. Understandably, these occurrences do not find their way into the traditional measures of price increase. However, quantity and quality also need to be considered in addition to price. While a few fries may not seem like much, the aggregate result of the subtraction effect is a diminished standard of living.

The bill for last night’s venture for 4 adults and one kids meal was well over fifty dollars. Closer to sixty when you figure in a modest tip. Sixty dollars for anemic portions, an appetizer and watered down iced tea.

Unfortunately, the subtraction effect is but one of the many consequences of the irresponsible runaway monetary policy we have been pursuing. While comparing a burger and fries to the subprime housing market may seem a bit like comparing the World Series to Mad Magazine, the linkage becomes a bit clearer when you consider the value of your labor shrinking before your very eyes thanks to bailouts and relentless credit expansion.

I guess the take home message should be ‘keep printing Ben’. Maybe the next time I venture out, I’ll pay $12 for a smaller burger and even fewer fries. But I will rest easy knowing that the DOW is at another record high. Not likely.

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.