Plummeting prices of LCD screens, via this month’s Wired.
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With everyone so focused on Inflation, I (naturally) want to discuss Deflation. Or rather, the lack of it in Technology prices. Instead, lets  look at the Recency Effect and the life cycles of new tech products.

Technology poses a special challenge to the hordes of inflation watchers — Larry Kudlow calls them inflationistas. During the 2000s, this crowd completely missed the biggest inflationary spike since the 1970s until Oil was well over $100 and foodstuffs had skyrocketed. This was after decades of ignoring ballooning medical and college costs.

Having missed the last run up in prices, this same crowd now sees hyper-inflation everywhere.

There seems to be an inability to understand how CPI is officially constructed, and why it typically understates inflation. Complicating matters is the challenge of  recognizing the impact of Technology, and how it create the appearance of deflation.

The key is understanding Technology’s normal adaptation cycle, what this means for cyclical pricing declines, and why falling prices do not automatically equate with Deflation.

The Fed gets this wrong. Wall Street misunderstands this. Most economists seem not to recognize qualitative difference between the 1st Big Screen TV that rolls of the assembly line and the 10 millionth. (Those who want to delve into the finer wonkish points about this can see the Technology adoption lifecycle by Joe M. Bohlen and George M. Beal, (1957), later refined in Everett M. Rogers’ Diffusion of Innovations).

Consider this simple factoid: New technologies and products come down in price over time, regardless of the state of the economy, Fed monetary policies, Federal stimulus, or even income inequality in the broader society.

If tech prices are independent of the Fed and Congress and money supply and the value of a dollar, then its hard to say (as so many do) that this is deflationary per se. It is a simple fact of adoption cycles, and not the usual drivers of inflation.

Whether we are discussing washing machines, radios, auto airbags, cellphones, or even PCs — all manufactured goods go through a well established adoption process. In the classic definition (see chart below), the first group of people to use any new technology are called “innovators,” followed by “early adopters,” then the “early majority” and “late majority,” and lastly, the “laggards.”

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Technology Adoption Lifecycle

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The key to understanding this is recognizing the differences in perceived social status value of these products.

The impact of this adoption process and the manufacturing economies of scale are significant determinant of technology product prices. But understand the following: What the Innovators buy is a very different product qualitatively — in terms of social status and perceived value – than what the laggards purchase.

Here is a grossly over-simplified version of how this works: When innovators buy a product, they essentially pay for all of the R&D costs, and other development expenses. You paid 365 labor units for a VCR in 1972 because they were a limited production, custom product that was practically hand made. When a PC cost 465 labor units, chip fabs were nowhere near as plentiful as today — and the biggest cost in early PCs were the exorbitant chipsets contained in them.

Let’s take a closer look at the perceived social status value of these products: When you are the only person in town in 2000 who has a 50 inch flat screen TV — and it cost $10,000 — there are non-monetary, status benefits of ownership. Compare that in 2010, when EVERYONE has a big screen, thanks to the cheap Korean flatties sold for less than $600 at Best Buy.

The claim that the price drop is deflationary assumes these two products are nearly identical, and further ignores irrational human behavior regarding these early innovator purchases. These products are not identical, at least in terms of the value conferred social value of status-seeking consumers.

The early adopters pay less than the innovators, as factories get built to mass produce chips or tape transport mechanisms or cell phone keypads. But they also buy a product with lower social status. What was a nearly custom made product becomes a merely limited-production, high-end one. Where the innovators paid for the R&D, the early adopters paid for the fabs and factories to be built.

Recall the days before cell phones were ubiquitous: The early majority doesn’t get the use of the product for the first few years, but they get a big price benefit of manufacturing economies of scale.  But they also did not get the status symbol of those giant beige Motorola brick phones with their 8 inch black antenna. Mass production of components bring prices down; successful products attract competition to the space, and soon more manufacturers are cranking out more units. Through competition, prices begin dropping faster and faster. The late majority gets even cheaper prices. Consider the laggards and the VCR today — they cost about $29 each.

But the status associated with being the very first to own this is why the Innovators pay more for these products. And its also why the 100 millionth 50 inch television screen to roll off the assembly line has no status associated with it — where has the first few 1000 had massive status attached to it.

Technology adoption cycles reflect this in their price changes. Technology price decreases across their production life cycle are not only about industrial economies of scale — they are also about the decreasing status of an object as it becomes an everyday household product.

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Previously:
Hackonomics (February 2008)

Category: Inflation, Markets, Really, really bad calls, Technology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “Why Technology Price Drops Are Not Proof of Deflation”

  1. Petey Wheatstraw says:

    If I remember correctly, the first digital watches, produced in the ’70s, sold for a couple of hundred bucks (a relative king’s ransom at the time). Within a few years, you could buy a bucket full of them for next to nothing.

    The pocket calculator also follows the same pricing path (from Wikipedia):

    “The first American-made pocket-sized calculator, the Bowmar 901B (popularly referred to as The Bowmar Brain), measuring 5.2×3.0×1.5 in (131×77×37 mm), came out in the fall of 1971, with four functions and an eight-digit red LED display, for $240, while in August 1972 the four-function Sinclair Executive became the first slimline pocket calculator measuring 5.4×2.2×0.35 in (138×56×9 mm) and weighing 2.5 oz (70g). It retailed for around $150 (GB£79). By the end of the decade, similar calculators were priced less than $10 (GB£5).”

  2. b_thunder says:

    So, Barry, what can we do to get you into the next Fed press conference, so that you could explain this to the Chairman?

    Or even better, how can we get the NY Fed President “eat the iPad” Bill Dudley to debate you on the topic of inflation/deflation at your next conference?

  3. statspotting says:

    I would respectfully disagree with the premise of the article.

    You have picked up a very convenient example, i.e. technology. However, remember that the inferred value logic holds not just for technology products.

    “Technology price decreases across their production life cycle are not only about industrial economies of scale — they are also about the decreasing status of an object as it becomes an everyday household product.”

    But the reason why this is still indicative of deflation is because, the above logic holds true for so many things that we use on a daily basis. So it IS a valid proxy for deflation.

    ~~~

    BR: The same status value applies to Laundry machines (1930/40s) A private (not shared) landline telephone (1940/50s). Dishwashers (1960s), etc.

  4. RW says:

    Yep, as my pappy used to say, “never be the first kid on the block to buy anything; it’ll cost too much and won’t be repairable when it breaks which will be fairly soon.”

  5. Bob is still unemployed   says:

    > New technologies and products come down in price over time

    Except Microsoft’s Windows.

    It has remained at about the same price for years and years. The hardware on which Microsoft Windows runs has plummeted in price and drastically increased in performance and features. Yet Microsoft’s Windows seems to sit around the same price level.

    ~~~

    BR: I originally was going to mention that some software did not seem to come in price — but then I realized that you could use Star Office or Google Docs for free.

    Not sure how to account for that

  6. rktbrkr says:

    I heard Windows is free in Israel and China!

  7. DustySmith says:

    Here’s an excellent NYT graphic of how inflation is calculated:
    http://www.nytimes.com/interactive/2008/05/03/business/20080403_SPENDING_GRAPHIC.html

  8. rktbrkr says:

    How long will Apple be able to maintain a price premium on their products? This time it will it be different?

    As Ben would say “cool is transitory”

  9. Bill Wilson says:

    Great article. I never thought of it that way before.

    The latest and greatest TV will still cost you $4000.00. Human progress in itself is not deflationary.

  10. Mike in Nola says:

    Re: Software

    Windows and Office are really following the same pattern that much hardware does in a way that was not the topic of the main post, i.e. that new or improved products haave a somewhat constant price although the capabilities are greater. Retail prices for Windows and Office are still high because MSFT learned you can only keep charging as much if you come out with a new product: Windows 7 is a huge improvement over XP which was a huge improvement over Win98, etc. Apple does the same thing. It could not keep charging the same for the iPhone or iPod over years, so it provides a new, improved version at roughly the same price. Same for PC’s. The pc you buy today may not be cheaper than the one you got five years ago, but it’s vastly more powerful.

    Yes, some prices are a bit cheaper, but I’m talking generally here.

    Google Docs and Star Office are really not relevant to the discussion unless they catch on in a much bigger way than they have. They are a tradeoff of ease of use, support, etc for cost. Most big companies don’t trust Google’s business model of throwing stuff against a wall, seeing what sticks, then cancelling the rest. You can’t run a big business on that, which is why slow, backward-compatiblitiy-obsessed MSFT still dominates there. The threat of competition does help keep a fire under MSFT and keep prices down, but that’s just competition in the same way that Apple has to keep an eye on Android features and prices.

  11. Bob is still unemployed   says:

    @BR – “…Not sure how to account for that”

    I think that discussion might be more suitable for a column of its own. :)

    But some quick opinions…

    Microsoft, through its Windows desktop monopoly, has pretty much stifled the operating system competition in the PC industry for years. Only now is enough competition emerging that real innovation is beginning to appear once again. That elimination of competition has allowed Microsoft to keep the price of Microsoft Windows fairly steady over the years. There is the current festering question of whether Microsoft still has any ability to innovate, but that is also another topic…..

    I look at many of the Open Source projects and free software projects (such as the two you cite) as more along the lines of disruptive technologies (nod to Clayton Christensen), not as much “disruption” in technology as in price. Look at the pricing models for Microsoft Office nowadays, special pricing for home use, student use, etc.

    But as I said, this is a bit off-topic here…..

  12. Bill in SF says:

    Good printers can be gotten for well under $100 (or buy a PC – get one free), but the ink cartridges will still bleed you dry. Sort of like the razor vs razor blade trick. Does this explain those economists with beards?

  13. machinehead says:

    Seems to be something wrong with the Wired chart. The lowest value on its vertical axis is $500. But it ought be zero.

    For instance, I’m viewing this post on a 23-inch LCD screen which includes a TV tuner, and cost $250. Why is it off the chart?

    Sloppy work, Wired. Try again.

  14. DMR says:

    I agree with your premise on variable quality, but disagree with the premise that the Fed does not take this into account.

    Here is the definition right from the BLS website: “The hedonic quality adjustment method removes any price differential attributed to a change in quality by adding or subtracting the estimated value of that change from the price of the old item.”

    That’s exactly what they do when estimating CPI.

  15. KJ Foehr says:

    Imo, the decreasing cost of hardware products, especially “high tech” hardware is due to internal economies of scale and the rapid obsolescence of technologies, not deflation.

    However, this does not apply to software because is not really “technology” but rather publishing of pure intellectual property, like a book. It does not contain hardware that is subject to economies of scale and obsolescence. The media it is printed on, such as DVDs, may fall in price due to those factors, but the information itself will always be worth whatever the market will bear and, therefore, would be subject to true deflation.

    .
    “If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless”
    — Thomas Jefferson

  16. gms777 says:

    If Virgin Galactic is charging $200,000 for suborbital flights starting in 2012, then perhaps the price of an orbital flight will be $20,000 in 2025.

    If Virgin today said that would be the cost in 2025 and you could make a reservation for a $5,000 down payment (refundable), I wonder how many people would do that….

  17. JimmyDean says:

    Good point BR. Will be a while before masses can afford a Tesla so they can get out from under gas inflation. Harder for them to spend a few grand to stockpile in case food inflation gets really nasty too.

  18. redcharlie says:

    Inflation means different things to different people.

    If you are a working stiff like myself, inflation means an increase in what I have to pay to live. The big items there are housing, medical care/insurance, education, and to a lesser extent, food and transportation (inc. the cost of the car as well as the fuel). Everything else really doesn’t rate. We have several computers, we pay monthly charges for broadband and an iphone, but all our annual technology expenses are a rounding error compared what it cost when I had surgery last year, and that’s with good insurance. Food and gas bounce around a bit, but unless you are desperate and have given up on the first three (owning a home, having health insurance, and getting a degree) you don’t notice all that much.

    If you are in D.C. or on Wall Street or just someone who pays wages, inflation means just that. Wages. Labor is the biggest cost for most businesses. That’s why such types look back on the ’70′s “wage price spiral” in horror. Not because the cost of living was increasing, but just because they had to pay their share of said increase thru higher wages. But after 40 years of union busting, supply-side Reaganomics, free trade and outsourcing, wages are flat or decreasing, and any prices increases come straight out of the hide of the working class (meaning 95% of the US population).

    The cost of technology is largely irrelevant to either of the above viewpoints. If you think owning a TV means someone isn’t poor, all that shows is that you’re a coprolite whose thinking hasn’t changed since Barry Goldwater was running for president (and owning a TV actually meant something).

    The various standards of measuring it (i.e. core or headline inflation, CPI, etc.) don’t really measure either of the two above viewpoints, leaving everyone dissatisfied. But no one can agree on how to fix it as they are really talking about two different things, so everyone talks past each other.

    Core inflation is laughable to me for various reasons. But none of those reasons concern the pricing or value of technology. Instead, I’m irked that rent is used to measure housing costs, instead of , you know, actually measuring the cost of a frickin’ house. But if you have kids and want a decent place to live with low crime and good schools, renting isn’t the best option. That’s why the housing debacle was regarded as an “asset bubble” rather than housing inflation, which is how it affected me, and anybody else who needed to buy a house, most of whom weren’t speculators.

    The measurement of medical costs are perverse. Believe it or not, increases in the cost of medical care get counted as… wait for it… wage INCREASES!!! I sh8t you not. It’s just because, you know, most people under 65 get their insurance thru their job, so like, any increase in insurance premiums are usually shared by the employer. So, like, everytime your medical insurance goes up, you give a big shout for joy because you’re getting paid more, right? And hedonics means that since chemo is 5 times as effective as it was in the 70′s, getting that 2nd mortgage to pay for it means it’s a wash, at least inflation wise, right?

    But no, technology prices? You gotta be kidding me. I worry about paying my mortgage, paying my medical bills, and putting my kids thru school. Whether an ipad costs $10K or $0 doesn’t change that.

  19. SilverOz says:

    However, these items have very little impact on the CPI. The weight of non-subscription service (ie non-cable) audio and video in the CPI is .57 and the weight of all other information technology is but .804. In other words, all this tech accounts for about 1.31% of CPI.

  20. michaelb says:

    While I’m not convinced inflation is understated there is one aspect of hedonic adjustments that bothers me. New product categories, such as PCs or cell phones, are introduced as improvements in the standard of living with no prior equivalent so do not impact CPI. Subsequently, however, the technology cost curve drives the price down and this reduction does impact CPI. In other words, the CPI benefits from the deflation but not the initial inflation. IMHO it can’t be one without the other.

  21. Julia Chestnut says:

    Product life cycle theory suggests that as a technology ages it comes down in price. This is a result of the adoption curve that you show and also because new technologies replace the old ones: constant innovation makes last year’s huge advance look old at an increasingly accelerated pace. As you note, this is not inflation or deflation: it is the normal life cycle of a technological product. Indeed, the general impact should be negligible, because as one product is disseminating at a lowering price, another is coming out at a premium. If our purchases are aggregated up, theoretically (depending on the depth of penetration of the technology) it should pretty much even out.

    But I really don’t see a lot of innovation going on in a lot of areas any more. If you think about it: when was the last time that you saw really interesting and shocking innovation in an area outside consumer electronics and telecom? We’re all just saving up for that fourth wall at this point – but the real economy seems to be stagnant in a lot of ways.

  22. [...] How technology affects prices paid.  (Big Picture) [...]

  23. Inflation is ever and always best measured by the prices of things whose costs of production and demand for usage are stable over time. I speak, of course, of agricultural commodities. Supply and demand are relatively stable on a short-term (i.e., several years) basis. Demand grows with population, that is steadily growing worldwide about 1% a year, which production is well capable of meeting. Don’t believe for an instant all the headlines touting expanding demand and crimped supply explaining the two and three fold increase in agricultural commodities about now. There may be a bit of each in some instances, but the real story is the decline in value of the metric used to determine their value, i.e., the dollar.

    But it’s true that the Fed is stupid about product life cycles. They understand that all prices wish to come down over time, as costs are contained by efficiencies in production, but are so ridiculously afraid of deflation until they see any price decline as nefarious, which explains, more than anything, the idiocy behind their monetary shenanigans in the aughts that led to the housing boom and bust. They manufactured inflation, and because inflation is a monetary phenomenon, there can be inflation even when prices decline or remain stable, if they don’t decline as much as they otherwise would.

    Inflation ultimately breeds deflation, so expect this inflationary round to end as poorly as all the rest. If you’re interested, more on that can be found here http://thecurmudgeonsattic.wordpress.com/2011/02/04/how-inflation-sows-the-seeds-of-deflation/

  24. cognos says:

    This is 100% wrong – philosophical, economically, and by any measure of common sense.

    The POINT of inflation is to measure the DECLINE in purchasing power of $1 across ALL THINGS. In Argentina or Zimbabwe when then have inflation… they dont have 55in flat screens go down by 50% and housing go down by 50% while bread goes to 1 Zillion per loaf. The price of ALL THINGS is similarly affected.

    The POINT of economic growth is to measure the INCREASE in the standard of living. By ALL COMMON SENSE MEASURES… our standard of living is through the roof. Therefore I suspect that inflation is highly overstated.

    Barry completely missed this in the last cycle (screaming inflationista in 2008 right before we lost 5 years of “price inflation” in 5 months). Commodities tend to move in boom-bust cycles. Therefore they are poor long-term inflation indicators (just like 2008, just like now). Therefore economists invented something called “core”… and it empirically really works (how is this hard? core inflation gives a BETTER read, just like it did in 2008).

  25. cognos says:

    Furthermore, as we become wealthier commodities become less and less relevant to our spending and thus to “inflation”.

    We spend 4% of our budget on gasoline and energy. We spend 40% on housing.

    How is there possibly any inflation?

  26. socaljoe says:

    Deflation is a natural consequence of productivity improvements. Lower prices should be a good thing.

    Yet, our government is trying desperately to create inflation.

    Why is this so? Because we have a debt based monetary system. Every dollar that is borrowed into existence creates one dollar of debt plus the liability to service that debt. Where does the extra money to pay the interest on that debt come from… it needs to be borrowed into existence, creating further debt plus interest… and so on. The result… exponential growth of money supply resulting in inflation… or default.

    Of course, exponential growth in a world with finite resources can not go on forever.

  27. I think you missed out a sub group in the innovators category for which the category is probably named. That would be innovators. Those people that actually buy the product out of necessity and function and not as a status symbol. A good example would be the satellite telephone. A must have among many long distance truckers for safety reasons alone but not adopted by the rest of us yet.

    That old brick phone brings back memories. I once used one of those while making deliveries. It made me more efficient because I didn’t need to search for a payphone(what is that the kids will say) to call dispatch. Thus I could make more cash. Ah, the good old days of early cell phones. I even have the radiation burns to prove it :)

  28. willid3 says:

    first time i have ever seen Microsoft being called worried about being backward compatible. ever. of course i haven’t seen it happen either

  29. sellstop says:

    I think the more important metric would be the total amount of money going into flat panel TVs or whatever consumer good is in question. Only a few people spent money on those first $10,000 TVs, but millions have spent money on the $600 ones. And given all of the money that has been spent, what is the contribution to productivity of all of those flat panel screen? Not to mention the ipods, ipads, playstations, etc…. I am a laggard. I usually miss out on the whole fad. But I can’t help thinking that the money could have been used for something more constructive….
    gh