Pop quiz

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Electrolux_Green_2Does the average CC reader understand more about Economics than Nicolás Maduro? Let’s see.

Suppose you sell vacuum cleaners in Caracas. You bought the vacuum cleaner from the wholesaler at BsF1,200. You paid for it in cash, and you owe the wholesaler nothing. The vacuum cleaner is yours to resell.

You are selling it for BsF 1,500.That is the price at which you have decided to sell it, it’s been marked that way.

The wholesaler informs you that, due to inflation, the wholesale price has shot up to BsF2,200.

Question: are you making a profit?

1 COMMENT

        • It depends on whether you are using a quantum time machine to sell it at exactly the same time you are buying it. If not, you are selling at a loss.

        • Yeap but the vacuum cleaner doesn’t sell itself, you have to pay overhead, a gazillion taxes, labor costs. You could be selling at 1500 at a lost. Besides, you have to restock after the vacuum cleaners run out and buy at 2.200. Then, to buy the same amount of vacuum cleaners to make the same profit, you will have to reinvest part of your earnings for the ones you sold at 1.500.

  1. I think if bought for Bs 1,200 and sold for Bs. 1,500 you make a profit regardless of other sellers. Inflation just makes the margin obtained less valuable.

    • No, you do NOT make a profilt. You get kicked out of business right away because you don’t have the money to pay BsF 2,200 for another vacuum cleaner.

      • My answer might be wrong but you are missing the point… This is not about re-stocking or the viability of the business but about the profitability of a single transaction.

  2. On the sale, yes, you are making a profit if you intend to stop right there. No intention of continuing selling vacuum cleaners. But if you intend to continue in the vacuum cleaner selling business, you are in trouble.

      • Since prices go up in general and not for a particular good, what you get from BsF 1,500 is much less when the wholesale price of vacuum cleaners got to be worth BsF 2,200 than when you made the sale at BsF 1,500. Hence, your money gets you now about 45% less in goods and services. You not only did not make a profit, you lost a lot of money.

        • Exactly. It is the same whether you want to go into the Hoover business or you just saw it as an investment, one opportunity of using that money.

          • Well, ok, If you assume that *everything* (all other local goods, foreign currency, etc) went up 83.3% (1200->2200) in the period from the moment you bought the vacuum cleaner to the moment you sold it, then, yes, you effectively lost money – not as much as if you would’ve kept the Bs in the bank, but it was a bad transaction. You would’ve been better off purchasing foreign currency. Fact is, if everything went up 25% (1200->1500) or more in the period , then you effectively lost value.

  3. Given the mutiplicity of impacting parameters in the scenario set forth, one may be numbered among those who would go “back to basics” as a first step. Fortunately, such basics are clearly setout in a widely cited paragragh from an early Tome, namely, “When you are a Bear of Very Little Brain, and you Think of Things, you find sometimes that a Thing which seemed very Thingish inside you is quite different when it gets out into the open and has other people looking at it.”

  4. At the end of the deal you end up with 1500BsF in your hand. If the change on price from the wholesaler is indeed due to inflation, then these 1500BsF are actually equivalent to 818BsF of the time you bought the cleaner. So, inflation adjusted, you are loosing 382BsF (from before the inflation, not sure how to get it in current BsF). You are still better of than if you had not gotten into business and just kept the money bellow the pillow, but you are certainly not making a gain.

  5. What about the 1000 Bsf you have to give the Guardia Nacional as a bribe so you can haul the vacuum cleaner out of there without much hassle?

  6. Beside, of the “profit” of Bs. 300 you will have to deduct 10 % to be paid to employees as profit sharing (utilidades) and 30% on the remaining as income tax to Seniat. So it is even less remaining to replenish you inventory.

  7. You make a profit if you never buy vacuum cleaners anymore and leave the market without hoovers. Then you begin selling cats, so they take care of the balls of dust accumulated in the floor… that venture did not go so well. People begin queuing for buying the little amount of vacuums left in the country… a lot of scarcity. The government blames the seller, the people go mad when they realize they are cover in dust, they strike, the national guard represses the protest. Then they go even madder and eventually after years and years of dust, the return of the broom and a lot of respiratory diseases, people overthrow the government which forced the poor seller to sell his hoover at BsF. 1,500 on the first place.

  8. they didn’t teach inventory pricing under inflation in accounting 101 when i was in college–just LiFO, FIFO, W AC.
    Regardless of the paper profit, you’re running a negative cash flow business, you have to dip again into your savings (less than the original purchase) to continue selling, and the business is not viable if current conditions hold.
    The situation gets worse if you get hit with fixed cost increases (electricity, rent, salary, prestaciones, interest rates on working capital loans) at the same time…
    People/companies with sufficient equity might stay in business and bet on the situation reversing, but they have to reduce their unit sales

  9. “Back in the early 1970’s, with both high inflation and slow growth, Nixon’s economic challenge may have been even more intractable than Mr. Bush’s. So, with his re-election in jeopardy, Nixon and his Treasury secretary, John B. Connally, bludgeoned both the Congress and Federal Reserve into a truly radical experiment. Congress passed wage and price controls and the Federal Reserve simultaneously increased the money supply.

    The gamble was that a big jolt of money would rev up the economy while the price controls would suppress inflation. It worked, allowing Nixon to win in 1972. But success came at a huge cost. Once the price controls were removed through 1973 and 1974, all the suppressed inflation came roaring out, hitting the double digits and plaguing the second half of the 1970’s. Worse, the resulting collapse of the dollar led to the 1973 OPEC ”oil price shock.” Altogether, it was one of history’s most expensive election campaigns.”

    http://www.nytimes.com/2004/02/07/opinion/the-nixon-recovery.html

  10. The crux of the matter is whether the value of money has declined since your purchase more than the 300 that you’re nominally getting as a profit:

    Let’s say T0 is when you purchased the vaccum cleaner, and T1 is when you sold it.

    The purchasing power (what money buys you) of 1200 at T1 = 1200
    If there was NO INFLATION, your profit would be 1500-1200 = 300
    With inflation, money lost its value by a factor of
    1200 / 2200 = 0.54, i.e. your money in T1 buys only over half of what it used to in T0.
    So if you sell for 1500 in T1, you are only able to buy things whose value in T0 was:
    1500 X 0.54 = 810.
    You spent 1200 (in T0) and only got 810 in return (in T0 terms).
    This is a net loss of 290.

    • And there is the opportunity cost. What if instead you would have given the 1200 to a nephew of Diosdado Cabello who needs more capital for CADIVI investment?
      He would have been able to multiply your cash in revolutionary ways.

  11. You are making a nominal profit, just in numbers, but it’s not real, not in value. It’s all about the buying power. Here’s the same question but in something that most will understand better. If you bought $100 at Bsf 40 to the dollar, and you sell them today, are you making a profit?

  12. Incredibly, some people are really “meando fuera del perol” on this subject. To help understanding why you would be losing money in the example, regardless of the higher amount in BsF you’re getting from the sale, consider this: In 1977, a state-of-the-art Apple computer cost 475 US$ whereas today, an iMac goes for at least 1300 US$… now ask yourself: does that mean Apple computers are today more than twice as expensive as they were in the 70s?

  13. I was a little bit staggered to realize I don’t know the correct answer to this question. I don’t even know if the accounting answer and the economic answer are the same in this case, or if there are competing accounting standards that could give different answers.

    My gut, though, is with LGL above. “Profit” is sort of a slippery concept, but cash flow is easy. What’s clear is that your *cash*flow* is negative. And negative cash flow businesses don’t stick around for long, do they?

  14. Trick question! There are two types of profits (relevant to this question): Accounting and Economic profits. Accounting profits are BsF 300 whereas economic profits are BsF -700. The latter takes into account opportunity costs whereas the former does not.

  15. You have made a profit. If you can’t restock, go to a Bank and get a loan. Like my friend Saman would say: That’s what Banks are for.

  16. You do not make a profit…looters are lined up outside of your store and eventually steal everything. Hoping you will re-stock your inventory, large crowds wait outside for another “bargain” opportunity.

  17. At the risk of going back to my high school physics class, I think it depends on your frame of reference (of time). If you consider just the action of buying it at 1,200 and selling at 1,500, you made 300 profit. Even if there’s inflation, you still made profit (maybe only 200, or 150, but still positive). But after that, if you were to buy a new vacuum cleaner you either couldn’t or you’d have to go in debt, which means there was no profit if you extend your “window” of time. I’m guessing there’s some sort of distinction between short term profit (i.e. more in than out) and the long term sustainability of an economic activity.

  18. I think Maduro simply didn’t have the money to buy the piñata that El Gigante de América gave away last year, so he simply made the storeowners pay for it (READ: stole it), making a great deal of people happy with their Year’s-End ñapas, securing (perhaps) a number of votes, and wiping out a bunch of evil , capitalist, imperial-infected, Obama-loving empresarios. What’s there lo lose for him? The debasement of its voter base? The country-wide stock of appliances and their spare parts? The Economy, stupid?

    It’s very sad, but, while your reasoning is absolutely justified, it’s irrelevant in this situation, useless as applies to these so-called Government.

  19. This is an interesting exercise. The extreme inflation complicates the equation, since the “measure” of “value” is a moving target. One thing is very clear, though. If the government forces retailers to sell at prices based upon the cost of goods acquisition and does not allow the store owners to adjust prices based on replacement value of stock, the store will quickly go out of business, being unable to generate enough revenue to restock goods. Under the vague set of rules being promulgated by the regime, combined with inflation, the entire retail sector could collapse as vendors simply cease buying new goods to sell.

  20. The question is: why doesn’t anyone ask in front of the journalists where Maduro or Saman or some other of these idiots has any idea what “replacement value of stock” is.

    What’s the word in Spanish?

    “Maduro, trata de mostrarles a los habitantes del mundo entero, incluso a los capitalistas chinos, qué es el valor de reposición de un producto. Seguro que eso no lo aprendiste mientras te trataban de explicar los cubanos cómo la culpa era de los demás”

    • I suspect someone may by now have explained some of this to Maduro. As pollinob inuited, the point of maduro’s year end clearance sale is to eliminate the parallel economy that has been built around the parallel dollar rate.

      • Yeah, but my point is not Maduro. It’s about making nini’s and Chavistas hear it. But I guess at this stage even if we tried to use loudspeakers in a couple of places to rhetorically send the question “to Maduro” (in reality to the people) we would only get a thousand people hear about it…and they will just keep on thinking of their flat screens.

  21. It depends what inventory system you are using. If using FIFO then you would be making a profit. If you are using LIFO instead then you must account for the replacement cost of the inventory. In the case of Caracas, Venezuela, given a +50% inflation rate, it would be idiotic to use FIFO as your method of tracking inventory and costs.

    Ok, I guess that was more of an accounting than an economics answer. If inflation is widespread (affected the whole economy and not just a sector of it) you are essentially loosing money by selling the product at $1,500. If inflation was only constrained to that sector of the economy and you were not planning on selling any more vacuum cleaners, then you could say that you are still making a profit.

    • Even if she were to admit she was giving a 10% to the Chávez family (the Bolivarian tithe) and that the Swiss account of Adan Chávez she was sending money to was 27112912301 Credit Suisse and even if said Credit Suisse were to confirm that was right, millions of Chavistas would tell us: “pero tenemos patriaaaa no jodas”.
      And they and the opportunists from every side would just keep watching their films in those flat screens.

  22. Yes, you’re making a profit. If you intend to walk out of the vacuum cleaners market and get into a market where you can keep buyin’ at 1200 and selling at 1500.

    If you’re planning to stay in the vacuum cleaners business, you are, as it was pointed out before, making a negative profit (I can see SIBCI using that euphemism).

  23. Profit: a financial gain, esp. the difference between the amount earned and the amount spent in buying, operating, or producing something.

    Therefore, on a purely technical definition, YES you are making a profit. Nobody is asking whether you intend to stay or not stay in the vacuum cleaner business. And this assumes no inflation. As an alternative. had I bought gold in September of 1964 I would have paid $ 257 an ounce. Had I sold that gold in June of 1968 I would have received $ 263 and ounce for a $ 6 PROFIT. The fact that in February of 1980 gold was worth $ 1,908 and ounce is entirely irrelevant.

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