Pricing, Price Stability, and Post Keynesian Price Theory ... · PDF fileEXTENDING POST...

INTRODUCTIONCH2. DENIAL AND ACCEPTANCE OF MEANS’S THESIS

CH3. EXTENDING POST KEYNESIAN PRICE THEORYCH4. HOW US INDUSTRY PRICES RESPOND

CH5. CONCLUSION

Pricing, Price Stability, and Post Keynesian PriceTheory

A Dissertation in Economics and SSC

GYUN CHEOL GU / University of Missouri-Kansas City

April 23, 2012

GYUN CHEOL GU / University of Missouri-Kansas City Pricing, Price Stability, and Post Keynesian Price Theory

CH5. CONCLUSION

Research QuestionsResearch Scope and Focus

Research Questions

I How did neoclassical economists deny and/or incorporateprices’ unresponsiveness to output fluctuations to theirtheoretical framework?

I How do we update and revise previous Post Keynesian pricetheory by utilizing newly accumulated studies on real-worldaccounting practices?

I What is a convincing PK explanation for the recent change inthe US price cyclicality from counter-cyclical to a-cyclicalmovement?

CH5. CONCLUSION

Research Questions

CH5. CONCLUSION

Research Questions

CH5. CONCLUSION

Research Scope and Focus

I Investigating neoclassical reactions to Gardinar Means’sadministered price thesis in the IO field as a critical review ofthe mainstream price theory during 1970s-2000s.

I Updating previous PK price theories such as Lee (1998) andLavoie (2001) by focusing on new empirical evidence oncosting and pricing practices after the early 1990’s.

I Conducting an econometric study on the mechanism for thechange in the PPI’s cyclicality - the movement of PPI overthe fluctuation of shipment - of the US manufacturingindustries during 1958-2005.

CH5. CONCLUSION

IntroductionDenial: Measurement ErrorsBastardization of the Administered-Price ThesisEmpirical Bastardization of the Administered Price ThesisConclusion

Administered Price Thesis

In an engineering economy prices are fixed byadministrative action for periods of time. Price isdetermined before a transaction occurs...In anengineering economy supply and demand never equateexcept by coincidence. (Means 1933: Ch. VI)

I As a real-world example, Means showed that the GreatDepression in the early 1930s caused the prices of agriculturalproducts to fall substantially (63%) whereas those ofagricultural implements only decreased moderately (6%).

I That observation triggered follow-up empirical studies on thisissue from the neoclassical point of view.

CH5. CONCLUSION

Administered Price Thesis

In an engineering economy prices are fixed byadministrative action for periods of time. Price isdetermined before a transaction occurs...In anengineering economy supply and demand never equateexcept by coincidence. (Means 1933: Ch. VI)

I As a real-world example, Means showed that the GreatDepression in the early 1930s caused the prices of agriculturalproducts to fall substantially (63%) whereas those ofagricultural implements only decreased moderately (6%).

I That observation triggered follow-up empirical studies on thisissue from the neoclassical point of view.

CH5. CONCLUSION

First Round of Denial: 1940s to 1970s

I In the earlier period of 1960s and 1970s, Stigler (1962),Stigler and Kindahl (1970), and Weston et al. (1974) tried torefute the administered-price thesis by showing measurementerrors in price data.

I The dual objectives of Stigler and Kindahl (1970) were toidentify biases in Means’s data, and to show that theadministered price was a fiction created in the samplingprocedures of the BLS price data.

I This first measurement error controversy was concluded byCarton (1986), who admitted that the degree of price rigidityin many industries was significant even using Stigler-Kindahldata.

CH5. CONCLUSION

Second Round of Denial: 1980s to 2000s

I Garber & Klepper (1986): no empirical consensus on therelationship between price and quantity ⇒ measurement errors

I Lichtenberg & Griliches (1989): price-index’s failure to adjustfor quality change

I Nordhaus (1996): “the construction of accurate price indexesthat capture the impact of new technologies on livingstandards is beyond the practical capability of officialstatistical agencies.”

I Georganta (2003): systematic inaccuracies in themeasurement of price date

CH5. CONCLUSION

I What they meant are that the traditional neoclassicalexplanation for price movement along with demand change isstill viable.

I All the economists attempt to deny the administered pricethesis by arguing that the thesis is the unfortunate outcome ofmeasurement errors which are found in major economicvariables as well as price data - the same argument as Stigler’sconviction that the notion of the administered price ispredicated on illusions.

CH5. CONCLUSION

I What they meant are that the traditional neoclassicalexplanation for price movement along with demand change isstill viable.

I All the economists attempt to deny the administered pricethesis by arguing that the thesis is the unfortunate outcome ofmeasurement errors which are found in major economicvariables as well as price data - the same argument as Stigler’sconviction that the notion of the administered price ispredicated on illusions.

CH5. CONCLUSION

As the Result of Pricing Smoothing

I Barro (1972), Wu(1979), Carlton (1979), Blinder (1982), etc:transaction costs, search costs, or inventories ⇒ pricingsmoothing policy (vs. conventional optimal policy)

The essence of a price smoothing strategy is the more orless complete divorce between current market events andcurrent prices. (Encaoua and Geroski 1986: 51)

I These theories turn out to support what contemporary PostKeynesian price theory means - normal cost based pricedetermination

CH5. CONCLUSION

As the Result of Pricing Smoothing

I Barro (1972), Wu(1979), Carlton (1979), Blinder (1982), etc:transaction costs, search costs, or inventories ⇒ pricingsmoothing policy (vs. conventional optimal policy)

The essence of a price smoothing strategy is the more orless complete divorce between current market events andcurrent prices. (Encaoua and Geroski 1986: 51)

I These theories turn out to support what contemporary PostKeynesian price theory means - normal cost based pricedetermination

CH5. CONCLUSION

As the Result of Collusion

I Oligopolistic collusion literature interpreted the empiricalstudy by Means (1935) as suggesting that collusion isassociated with a greater tendency toward price rigidity. Thebest known theory is the kinked demand curve theory offeredby Sweezy (1939) and Hall and Hitch (1939).

I Hall and Hitch provided a non-neoclassical explanation for theexistence of stable prices. They introduced a kinked demandcurve for an oligopolist enterprise in which kink occurred atthe predetermined full cost price instead of the marginal cost.

CH5. CONCLUSION

I Oligopolistic collusion literature interpreted the empiricalstudy by Means (1935) as suggesting that collusion isassociated with a greater tendency toward price rigidity. Thebest known theory is the kinked demand curve theory offeredby Sweezy (1939) and Hall and Hitch (1939).

I Hall and Hitch provided a non-neoclassical explanation for theexistence of stable prices. They introduced a kinked demandcurve for an oligopolist enterprise in which kink occurred atthe predetermined full cost price instead of the marginal cost.

CH5. CONCLUSION

I Athey et al. (2004), Carlton (1989), and Connor (2005):Neoclassical IO economists have kept the informal view thatprice rigidity is associated with collusive firms, because arigid-price collusive scheme prevents the risk of a price war.

I Even though Scherer (1970) and Tirole (1988) criticized thekinked demand theory of price rigidity as having importantshortcomings, there had been no neoclassical alternativesbased on collusion until 2000s - sixty years after thedevelopment of the kinked demand curve.

CH5. CONCLUSION

I Athey et al. (2004), Carlton (1989), and Connor (2005):Neoclassical IO economists have kept the informal view thatprice rigidity is associated with collusive firms, because arigid-price collusive scheme prevents the risk of a price war.

I Even though Scherer (1970) and Tirole (1988) criticized thekinked demand theory of price rigidity as having importantshortcomings, there had been no neoclassical alternativesbased on collusion until 2000s - sixty years after thedevelopment of the kinked demand curve.

CH5. CONCLUSION

As the Result of Product Characteristics

I Conlisk et al. (1984) developed a model for the pricingpattern of a durable-good monopolist over time and showedthat price remained high for a certain length of time.

I Tirole (1988) argued that a durable-good monopolist wouldbe generally better off with sticky prices because the producerneeded to signal that price would not drop continuouslyduring a recession to consumers with the ability to arbitrageinter-temporally.

I What they are trying to do is substitute the durable andnondurable dichotomy for the administered and market pricedivision by Means. Still, they fail to explain the price rigidityof consumer goods, which are non-durable.

CH5. CONCLUSION

As the Result of Production Process

I More lagged process of production can increase pricestickiness.

I The accumulation of small lags leads to longer lags in someindustries.

I What they are trying to do is substitute the less lagged andmore lagged process dichotomy for the administered andmarket price division by Means.

CH5. CONCLUSION

If it takes time to produce goods, output prices mayreact with input prices with a lag. This proposition restson theoretically weak grounds, as prices should be basedon opportunity costs rather than purchase prices forinputs. It nevertheless may have some empirical validity(Blanchard 1987: 83)

CH5. CONCLUSION

As the Result of Customer Behavior

I By distinguishing between auction and customer markets,Okun (1981) recognized the indirect cost involved in changingprices, which stems from potential harm to customerrelationship and company reputation.

I A price rise in the customer markets which is clearly seen asunfair may lead the customers to search for alternatives; but ifthe customer acknowledges that the increase in price is theresult of rising costs, eventually he or she will accept theincrease as fair, which of course takes some time. Prices,therefore, are characterized by some degree of rigidity.

CH5. CONCLUSION

I By distinguishing between auction and customer markets,Okun (1981) recognized the indirect cost involved in changingprices, which stems from potential harm to customerrelationship and company reputation.

I A price rise in the customer markets which is clearly seen asunfair may lead the customers to search for alternatives; but ifthe customer acknowledges that the increase in price is theresult of rising costs, eventually he or she will accept theincrease as fair, which of course takes some time. Prices,therefore, are characterized by some degree of rigidity.

CH5. CONCLUSION

I What Okun (1981) did here is to replace Means’sadministered market with the notion of the customer markets,shifting the focus back to the consumer choice, that is,neoclassical demand curve analysis.

I Not surprisingly, Okun’s analysis gained much moreacceptance in the academic circles.(Goode 1994: 182)

CH5. CONCLUSION

I What Okun (1981) did here is to replace Means’sadministered market with the notion of the customer markets,shifting the focus back to the consumer choice, that is,neoclassical demand curve analysis.

I Not surprisingly, Okun’s analysis gained much moreacceptance in the academic circles.(Goode 1994: 182)

CH5. CONCLUSION

Empirical Bastardization of the Administered Price Thesis

I Means’s original thesis has been transformed through amultiplicity of rationalization processes in one or anotherbastardized form, and then it has come under severe criticismbased on these vulgarized concepts as if they were Means’sown hypotheses.

CH5. CONCLUSION

Conclusion

I Although even Stigler and Kindahl, who sharply attackedMeans’s works, admitted, “We reckon him among the mostinfluential of economists in the history of this country”,Means’s original administered price thesis gained littleacceptance in the economics profession; furthermore his thesishas been continuously denied.

I Means’s administered price thesis challenged the vestedinterests of mainstream economists who advocate marketsuperiority based on coordinating price mechanism (Ware1992; Lee 1998, 1999).

CH5. CONCLUSION

Conclusion

I Although even Stigler and Kindahl, who sharply attackedMeans’s works, admitted, “We reckon him among the mostinfluential of economists in the history of this country”,Means’s original administered price thesis gained littleacceptance in the economics profession; furthermore his thesishas been continuously denied.

I Means’s administered price thesis challenged the vestedinterests of mainstream economists who advocate marketsuperiority based on coordinating price mechanism (Ware1992; Lee 1998, 1999).

CH5. CONCLUSION

Conclusion

I Even so, their failure finally led some mainstream economistssuch as Blinder et al. (1998) and a great deal of follow-upstudies including Fabiani et al.(2007) to ask administratorsabout how they set prices and why their prices are stable,which is exactly what Post-Keynesian and Institutionaleconomists usually do to build and test theoretical frameworks.

CH5. CONCLUSION

IntroductionRecent Development of Pricing Procedures in PracticeExtended Classification of Pricing ProceduresPricing Analysis for Price Stability and CyclicalityConclusion

Introduction

I Since Lee(1998) and Lavoie(2001), there have beenaccumulating new empirical evidence, which suggests the needto update and extend their studies.

I We need two different taxonomies: one being based oncosting process and the other mark-up process, since theyoccupy different dimensions, respectively.

I There can be theoretically nine combinations of costing andmarking-up processes, which help in the understanding of theevolutionary path of pricing procedure.

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Development of New Costing Technique since 1980s

I Activity-based costing (ABC) has attracted high levels ofinterest from both academics and practitioners since itsemergence in the late 1980s.

I The ABC procedure promises greater costing accuracy,improved decision making, enhanced strategic planning, andinsight concerning activity management.

I Traditional costing procedure is easy and cheap to implement,but the information obtained could be too raw to be accurate,whereas the ABC procedure solves the problem but it isexpensive and time-consuming to implement.

CH5. CONCLUSION

Development of Pricing Strategies since 1980s

I The cost-based method still remains prevalent in most sectorsand business type across the world.

I Nevertheless, there is a tendency that the adoption of themarket-based method has been increasing and dominating insome business types and sectors since 1980s.

I Renaming: Traditional Cost-plus Pricing (TCP) vs RefinedCost-plus Pricing (RCP)

CH5. CONCLUSION

An Extended PK Pricing Taxonomies

TAXONOMY PRICING PROCEDURE PRICING STRATEGY IN THE FIELD(1) Costing-oriented Traditional Cost Pricing Direct Cost Pricing full-cost pricingTaxonomy Refined Cost Pricing Total Cost Pricing full-cost pricing

ABC Cost Pricing full-cost pricing(2) Markup-oriented Traditional Cost-plus Pricing Fair-rate of Return Pricing cost plus pricingTaxonomy fair return pricing

Target-rate of Return Pricing target return pricingbreak-even pricing

Refined Cost-plus Pricing Product-based skimming pricingMarkup Pricing premium pricing

economy pricingpenetration pricingexperience/learning curve pricingprice bundling or system pricingcomplementary product pricing

Competitor-motivated leader pricingMarkup Pricing parity pricing

low price supplieropportunistic pricing

Class-induced perceived-value pricingMarkup Pricing second-market discounting

price signalingimage pricingreference pricing

CH5. CONCLUSION

Pricing Analysis for Price Stability and Cyclicality

I Intrinsic Price Stability: Prices are stable at least during anpricing period, since they are determined along with the firm’sroutine budgeting process and then are administered to themarket during that period. Price stability is inherent to theprice-setting mechanism.

I Extrinsic Price Stability: It refers to the number of theconsecutive pricing periods during which prices remainunchanged. This is a price stability induced by low volatility ofthe cost base, incomplete pass-through policy as well as thechange in the profit markup itself. Extrinsic price stabilityreinforces and extends intrinsic price stability.

I The notion of price cyclicality is directly related to theextrinsic price stability as the cost base and pass-throughpolicy are cyclical variables.

CH5. CONCLUSION

Conclusion

I Post Keynesians rely on a pricing theory with strong links tothe real world. In order to maintain the link, continuousprocess of learning on and expanding our understanding of thereality is required, which is the heart of grounded theorizing.

I While cost-plus pricing comes in several variants, firms setprices based on some measure of full costs, rather than as areaction to demand fluctuations.

I The two-taxonomy system helps in gaining a betterunderstanding of the recent pricing practices.

CH5. CONCLUSION

Conclusion

CH5. CONCLUSION

Conclusion

CH5. CONCLUSION

IntroductionEffects of Changes in Pass-through Policy on Price CyclicalityEffects of Neoliberal Labor Market Reform on Price CyclicalityMechanism for Labor Productivity Stabilization in the U.S. IndustriesConclusion

Introduction

I The counter-cyclicality of prices has become a stylized factsince there is a great deal of aggregate and disaggregateempirical evidence.

I Haan & Sumner (2011) and Mumtaz et al.(2011) find thatthe correlation between price index and output gap hasbecome much less negative - nearly zero - during the last twodecades for the United States, while no substantial change isobserved for the other G7 economies.

I I also found that for about 51% of 4-digit US manufacturingindustries PPI’s were countercyclical along the fluctuation ofshipment before 1983, while their prices have turned a-cyclicalsince 1984. (Table 4&5, and Figure 3)

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Introduction

I Neoclassical economists continue to explain price movementover the cycle predicated on cyclical profit mark-up orelasticity of demand with the MC constant or increasing.

I The PK economists argue that constant average direct costsand fixed overhead costs cause average total costs to fall asthe output increases, while the profit mark-up does not varysignificantly with output. It implies counter-cyclical pricemovement.

I By conducting econometric analyses, this chapter identifieseconomic and structural factors behind the sign-shift, which ismotivated and supported by the PK price model in theprevious chapter.

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Introduction

CH5. CONCLUSION

Effects of Changes in Pass-through Policy

I The PK Pricing Model

I P ≡ (WL+PMM)RQ

I R = CZ a1M Z a2

L Pa3M W a4Qa5

I p = (a1−sM)zM +(a2−sL)zL+(sM +a3)pM +(sL+a4)w +a5q

II Econometric Specification for the NBER manufacturing paneldata.

I pit = c + θt + β1i zMit + β2i zLit + β3i pMit + β4i wit + β5i qit + εit

CH5. CONCLUSION

I The PK Pricing Model

I P ≡ (WL+PMM)RQ

I R = CZ a1M Z a2

L Pa3M W a4Qa5

I p = (a1−sM)zM +(a2−sL)zL+(sM +a3)pM +(sL+a4)w +a5q

II Econometric Specification for the NBER manufacturing paneldata.

I pit = c + θt + β1i zMit + β2i zLit + β3i pMit + β4i wit + β5i qit + εit

CH5. CONCLUSION

I The results of fixed effect estimation for Equation (4.7) areshown in Table 7 and 8.

I All signs of the estimated coefficients of the variable sets arein line with the new empirical evidence. In other words, morefirms started to consider pricing as a strategic variable due tothe diversification of pricing strategies, which changes theirpass-through policy in such a way that more shocks to inputprices and productivity are absorbed in the profit markup. Themore absorption causes cyclical changes in the cost base tohave less impact on price cyclicality.

CH5. CONCLUSION

I The results of fixed effect estimation for Equation (4.7) areshown in Table 7 and 8.

I All signs of the estimated coefficients of the variable sets arein line with the new empirical evidence. In other words, morefirms started to consider pricing as a strategic variable due tothe diversification of pricing strategies, which changes theirpass-through policy in such a way that more shocks to inputprices and productivity are absorbed in the profit markup. Themore absorption causes cyclical changes in the cost base tohave less impact on price cyclicality.

CH5. CONCLUSION

I In addition, it is a consistent result with previous studies thatdemand pressure as such never plays any significant role in thepricing process. β5 is interpreted as the percentage change inprofit markup responding to 1% increase in output or demand.Even if all the values of β5 are statistically significant, theresponsiveness of markups to quantity changes is quite weakcompared to markup changes associated with input price andproductivity pass-through policy.

CH5. CONCLUSION

Effects of Neoliberal Labor Market Reform

I P ≡ ATC (1 + r) ≡PMZM

ΘM+ΘL

I Table 9 and 10 show that the fall-off in theproductivity-output correlation reflects a decline in thecorrelations between productivity and labor inputs.

I Table 11 shows that the industries which have turned fromcountercyclical to a-cyclical price movement (CA) tend tohave had experienced more drastic transition tocountercyclical labor productivity in the post-1984 period thanthe AA industries.

CH5. CONCLUSION

ΘM+ΘL

CH5. CONCLUSION

ΘM+ΘL

CH5. CONCLUSION

I r fp,q = δ1 + δ2r fq,l + δ3r fl ,zL + ui

I A basic cross-section regression model is also estimated inorder to assess the influence of the negative correlationbetween labor productivity and labor input on the correlationsof price index and output during the two sub-periods,pre-1984 and post-1984 era.

I Table 12 and 13 indicate that the price cyclicality is relatednegatively to the cyclicality of labor productivity. Morecountercyclical labor productivity tends to drive price morestrongly in the opposite direction.

CH5. CONCLUSION

I r fp,q = δ1 + δ2r fq,l + δ3r fl ,zL + ui

I A basic cross-section regression model is also estimated inorder to assess the influence of the negative correlationbetween labor productivity and labor input on the correlationsof price index and output during the two sub-periods,pre-1984 and post-1984 era.

I Table 12 and 13 indicate that the price cyclicality is relatednegatively to the cyclicality of labor productivity. Morecountercyclical labor productivity tends to drive price morestrongly in the opposite direction.

CH5. CONCLUSION

Theoretical Models for Labor Productivity Stabilization

I I develop a simple aggregate production model to explain thepositive relationship between unemployment and laborproductivity.

I εzL,l = (εq,l − 1) + εq,vεv ,l

II A two-sector price-output-employment model can also be builtand utilized to explain the relationship.

I alm + lc = L/Qc

CH5. CONCLUSION

Theoretical Models for Labor Productivity Stabilization

I I develop a simple aggregate production model to explain thepositive relationship between unemployment and laborproductivity.

I εzL,l = (εq,l − 1) + εq,vεv ,l

II A two-sector price-output-employment model can also be builtand utilized to explain the relationship.

I alm + lc = L/Qc

CH5. CONCLUSION

Conclusion

I It shows that at the center of the mechanism for some U.S.industries’ recent transition from counter-cyclical to a-cyclicalprice movement in the early 1980s are two key factors. First,more firms started to consider pricing as a strategic variable,which changes their pass-through policy in such a way thatmore shocks to input prices and productivity are absorbed inmarkups.

CH5. CONCLUSION

Conclusion

I Second, a structural change in the labor productivity isassociated with the cost-base stability during the post-1984period. A decline in hiring and firing costs and cutbacks insocial security benefits have made labor discipline effectdominate labor hoarding effect, which implies that laborproductivity increases as unemployment rate increases, withthe result that the cyclicality of the cost base has beenweakened and thus prices have become less cyclical.

CH5. CONCLUSION

I The objective of the dissertation is to refine a Post Keynesianframework for price stability and cyclicality. The dissertationhas four major implications for heterodox microeconomics.

I First, it demonstrates that there is no such thing as adeterministic relationship between sales and prices predicatedon the neoclassical supply and demand framework (Chapters 2and 3).

I Second, it demonstrates that it is not elasticity of demand butthe cost base that works as the key driver of price cyclicality(Chapters 3 and 4).

CH5. CONCLUSION

I Third, it refines the heterodox theory of intrinsic price stabilityby updating Lee (1998)’s grounded price theory (Chapter 3).

I Last but not least, it extends the heterodox price stabilitytheory by differentiating between intrinsic and extrinsic pricestability, identifying their roles and implications andincorporating labor hoarding and discipline effects to thetheorization of the extrinsic price stability (Chapter 4).

I All these contributions will be of crucial importance for therefinement and development of heterodox microeconomics.

CH5. CONCLUSION

Pricing, Price Stability, and Post Keynesian Price Theory ... · PDF fileEXTENDING POST...

Documents

Transcript of Pricing, Price Stability, and Post Keynesian Price Theory ... · PDF fileEXTENDING POST...