Philip Andrews’s research led him to conclude that many businesses’ average direct cost curves were horizontal, and that even the notion of downward-sloping enterprise demand curves were problematic in manufacturing markets (Lee 1998: 101–102).
Moreover, many industrial markets were oligopolistic, used administered pricing, and engaged in competition not necessarily involving price adjustment (Lee 1998: 102).
Andrews held that both average direct costs and indirect costs will decline as a business increases its flow rate of output (Lee 1998: 105).
The setting of prices, though based on cost of production plus profit markup, was called by Andrews “normal cost price” (Lee 1998: 109). This involves the following concepts:
(1) a normal flow rate of output, determined by past experience and future expectations about sales;But the profit margin is also constrained by the behaviour of competitors, and by “goodwill” relationships with suppliers and consumers (Lee 1998: 107–108). Some markets have a “price leader” that sets the market price because it is the business with the largest scale of production (Lee 1998: 112). Alternatively, trade associations allow businesses to share information about average normal costs and determine a common profit markup (Lee 1998: 112). The result of either of these is a stable administered price in many markets.
(2) normal average direct costs and normal average indirect costs to calculate normal average total costs;
(3) the addition to normal average direct costs of a “costing margin” to cover normal average indirect costs and a profit margin (Lee 1998: 109).
A particularly interesting finding of Andrews relates to the prices of factor inputs: he found that reductions by suppliers in the prices of factor inputs do not necessarily induce more purchases of a factor by a producer if its sales are stagnant or falling (Lee 1998: 108).
As previous researchers had found, changes in normal cost pricing tend generally to be caused by changes in factor input costs.
Andrews, Philip Walter Sawford. 1949. Manufacturing Business. Macmillan, London.
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.