In general, everything everywhere is getting cheaper all the time. This claim is counter-intuitive because in our experience, with a few notable exceptions, we see prices going up all the time. Economists have a word for that: inflation. It’s a broad increase in the prices of goods and services, which decreases the purchasing power of money. While inflation is a reality, it is not the whole story.
It is useful to distinguish between the “real” and the “nominal.” The sticker price is the number of dollars you pay at the store. That’s the nominal price. Inflation is an increase in the nominal price level. Price level refers to the nominal prices of a very large collection of goods and services. Inflation is a universal phenomenon, although it varies greatly in time and place.
It is also true that on average, the real prices of most goods and services are falling all the time. Evidence for that is not hard to find.
Just notice that more people are able to consume more goods and services today than they have consumed ever before. This can only be so because the real prices must have come down. This is what the “law of demand,” the most fundamental of all economics laws, is: the lower the price is, the greater is the quantity consumed. Conversely, if it is true that the quantity consumed is higher than before, then it must be true that the price is commensurately lower than before. That conclusion is logically inescapable.
We are talking averages here. Prices have fallen but on average. It is logically impossible for all real prices to fall. At least one real price has to go up.
All real prices could fall but only in Lake Wobegone, that fabulous town in Minnesota “where all the women are strong, all the men are good-looking, and all the children are above average.” When it comes to real prices, all prices cannot fall. Why? Because real prices are relative, not absolute. Relative prices rise and fall with time and place.
So now let’s make this a bit more concrete with a personal account. When I first started working at HP, a major technology corporation in the Silicon Valley, my starting salary in 1985 was a princely $40k. Then my two-bedroom luxury apartment in Sunnyvale, CA, rented for $800 a month; now a similar two-bedroom apartment rents for $3,500 a month. But now starting salaries are around $160k. The nominal rental prices have increased but so have salaries. Rentals have not gone up much if at all relative to incomes. Real rental rates have not gone up as much as nominal rental rates.
Prices, real and nominal, rise and fall for different goods and services. My first TV was a 22” Toshiba, bought from a store on El Camino Real. I was delighted. It cost me $400. It was heavy and the picture was (I guess 720p but I could be wrong.) Now I can order a 65” 4K UHD LED smart TV from Costco or Amazon, and have it delivered to my home in a day or so for $400. I get a lot more TV for the same nominal price. The real prices of TVs have fallen around 95%.
Back in the 1980s, an economy class round trip ticket to India would set me back around $1000. After all these decades, I can still get an economy class round trip ticket to India for almost the same nominal price. Granted, economy class then had great service compared to today’s. However, the real price of air travel has fallen dramatically. Adjusted for inflation, I can get a business class ticket today for what I paid for economy class then. Air travel has become cheaper.
Talking of air travel, the prices of a Mumbai-Nagpur flight on Indian Airlines (a monopoly for domestic air travel) used to be around Rs 600 in the 1980s. Now it is around Rs 6000. Nominal prices have gone up 10x. But real prices of flights in India have fallen. I don’t have the numbers handy but I would not be surprised if the volume of domestic air travel in India has gone up at least 20x compared to forty years ago. That logically implies that the real price of domestic air travel must have fallen.
Now back to my claim that everything everywhere is cheaper today than it has been ever before. Another way of saying that is that real prices have fallen. Real prices of nearly everything nearly everywhere have fallen. We can go into the exceptions in a bit. But first, let’s ask why this is so.
Prices and costs are causally connected. The explanation is simple, elegant and parsimonious. I would love to go into the basic tool of my trade: the supply-demand diagram with an upward-sloping supply schedule and a downward-sloping demand schedule, and their intersection jointly determining the equilibrium price and the quantities bought and sold. But I shall resist that temptation. This is not an Econ 101 lecture.
The simple lesson is that if costs decrease, prices fall. Therefore since the prices have fallen, it must be that costs have decreased. What, then, is the reason for lower costs?
There are many factors that decrease production costs. Here’s a short version. Costs decrease due to increase in scale. The cost per unit of producing 1000 units is lower than producing 10 units. Therefore it is better to have a large market — meaning more people who are willing and able to buy your stuff.
Next, there’s what we call “learning by doing.” The cost of producing the first Boeing 747 airliners was much higher than the cost of the 1,574th, the last built over the program’s 54-year production run, which lasted from 1968 until late 2022. That is why in the initial stages of production, a corporation usually makes losses on its sales, expecting to recoup those losses from the profits it makes from later sales when they have learned how to cut their production costs.
This was not the case for Airbus with their super jumbo double-decker A380: the market demand shifted to twin-engine more efficient wide-bodied planes. To break even Airbus would have had to produce around 420 A380 but had to shut down after only 251, having a production run of 18 years between 2003 and 2021. Airbus lost heaps of money.
Alright then, costs come down. That’s so because we learn how to do stuff, and that lowers the costs, and that lowers prices, and at lower prices more stuff is sold, and so scale economies kick in, further reducing costs. And things get better all the time.
Knowing how to do things is “technology.” We develop technology and that brings down the cost. Costs can come down arbitrarily close to zero. But can it ever be zero? The answer is no.
Why not? Second law of thermodynamics. Let’s go there next.
Read next post: Energy Matters.
All this talk about the ’80s makes me nostalgic. Here’s a song from that era.
Be well, do good work, and keep in touch.
Atanu Dey : Life is a Random Draw 
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