As the COVID-19 pandemic comes to an end in America, economic activity has been increasing rapidly. But with many potential workers choosing to stay out of the labor force, there have been concerns about the effect a possible labor shortage will have on inflation.
But how are labor shortages related to inflation anyway?
What is Inflation?
We must first consider what inflation is. It’s when the price of your regular groceries suddenly increases (goods inflation). Or the price of your haircut, always $20, now becomes $25 (services inflation).
Inflation destabilizes society and causes discontent, and as such is enormously important. This is why policymakers watch it closely and express concern when it seems likely.
The Importance of Supply and Demand – With Examples
Labor Shortages and Inflation
Now we can start to see how labor shortages affect inflation. Behind every service and product is a worker. And if you have fewer workers to produce and distribute your groceries, there’s definitely going to be less groceries produced and distributed.
The grocery store will notice that their products are selling out and inventories are running low and will take this as a signal from the market to raise prices.
And voila, we have inflation!
In the case of services like your regular barbershop haircut, the barber will notice the long lines and the overabundance of customers that he cannot serve in his 8 hour day. Surely, he thinks to himself, he can raise the prices a bit and still retain enough customers to keep himself busy, so he does. Soon his barber friends notice and do the same.
And now we have inflation in the services sector.
Why was the barber able to do this? Because there was so much demand for his services, which was due to fewer barbers working overall. If other barbers were open, customers would go to them and this would keep the opportunistic barber in check. But when labor is short, customers have nowhere else to go.
Why was the barber able to do this? Because there was so much demand for his services, which was due to fewer barbers working overall.
Now there’s nothing wrong with the barber or grocer raising their prices, this is more of a feature of the market, not a defect, the only alternative to this type of behavior is a shortage, which is much worse for society.
This is why policymakers rightly focus on the root cause of the inflation, the inadequate labor force, rather than on trying to control prices.
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