In an event hosted by the Federal Bank in Kerala, RBI Governor Raghuram Rajan was asked an unexpected question. Just when he had proclaimed that the central bank had won the war on inflation, a student asked him “In real life, I have a query on Dosa prices — when inflation rates go up, Dosa prices go up, but when inflation rates are lower, the Dosa prices are not lowered. What is happening to our beloved Dosa, sir?” she asked. His response revolved on technology. There has been no significant improvements in the technology involved in making dosas and thus, the prices have remained constant.
The same question was then posed in our GCPP forum. Here’s my response:
First and most importantly, inflation is the rate of change of prices and thus, when Rajan says inflation has come down, it means that the rate of change in prices have slowed (prices are increasing less rapidly). It does not mean that prices have decreased and thus, the Dosa prices will not come down. So, the input costs and labour costs are still increasing, but at a slower rate, and thus, dosa prices stay the same.
Also, remember that prices do not react to inflation. Rather, the inflation number is an index of how prices of different commodities are moving.
Second, there is always a considerable lag in the macroeconomy for changes to take place. Even if all the input costs are decreasing, it takes time for it to travel through the economy. The more complex the product, the greater the lag for the transmission. The only things that you see where prices fluctuate often is farm produce (fruits and vegetables). This is so because there are very few people in the chain between the producer and the consumer. Thus, prices go up and down quite quickly reacting to demand and supply.
However, wages for labour are usually very sticky (read the concept of sticky prices by Keynes). No worker would agree to get a reduction in nominal wages even if the economy is in a deflationary (negative inflation). Newer contracts may be signed for lesser wages, but that takes time. Other aspects, such as rent, interest rate, etc will also not change immediately. Thus, our Dosa chap cannot reduce the price of his Dosa following a lowering of inflation.
Finally, prices of common commodities do come down after a sustained period of low inflation. When people expect inflation to stay low for a long period, they might be willing to renegotiate contracts. So, inflation expectations are also extremely important for this.
Raghuram Rajan is also correct in saying that technology plays a huge role. We can see in the field of electronic products that prices are continuously dropping or you are getting better models for the same price, which amounts to the same thing. That is due to the usage of better technology in producing these products.
There are a few restaurants in Bangalore who have optimized the technology, streamlined the production process for quicker turnaround and turned it into an assembly line production. They seem to offer dosas at the cheapest prices (Rs.20 in Jayanagar 4th block).
Anupam Manur is a Policy Analyst at the Takshashila Institution and teaches Economic Reasoning for GCPP students. He tweets @anupammanur