Self-Fulfilling Prophecy part 2

In my last article I looked at the idea that companies see a fall in demand for their products as inevitable and ultimately take action that ends up fulfilling their outlook.  If you have been paying attention while shopping you will notice that prices of goods have been increasing significantly.  I have observed that many imported goods have increased by 25% or more despite the fact that the dollar has revalued.  In addition many local produced goods have seen significant price increases.

In the time of recession the demand for the company’s product starts to fall and companies who want to maintain or increase their profits compensate by increasing their products’ prices.  In economics there is a theory of the elasticity of demand.  The basic concept is that there is an inverse relationship between the price of a product and the demand for the product.  In simple terms as the price of the product increases then the demand for the product decreases.  There are some products that exhibit what is known as inelastic demand which means that changes in price have very little effect on demand.  However in reality there are very few such items, water and electricity would be examples.  So as the companies increase their prices, the demand for their products decrease resulting in further increases and further reductions in demand.  Once again the company has helped to fulfill the prophecy.

Once again I am not suggesting that companies should never increase their prices, it is their attitudes that need to change.  For the last thirty years companies have been spoiled because devaluation and high interest rate have resulted in profits increasing every year.  However this does not reflect the real business cycle which has its ups and downs.  Our unique circumstances have changed our view of the real business cycle. Now that we are experiencing low interest rate and a low rate of inflation, there is nothing to compensate for the fall in demand.  What needs to be changed is our expectations and to understand the reality of the economic situation.  It is time to put away our backward thinking and to adopt a new approach to meet the future challenges that await us.