“How often do the prices of your most important products change in a typical year?” (Blinder et al. 1998: 84).The results were:
(1) less than 1 | 10.2%It follows that 78% of US GDP consists of goods that are repriced quarterly or less. But of this fully 49.2% of firms reprice their goods only once a year or less.
(2) 1 | 39.2%
(3) 1.01 to 2 | 15.6%
(4) 2.01 to 4 | 12.9%
(5) 4.01 to 12 | 7.5%
(6) 12.01 to 52 | 4.3%
(7) 52.01 to 365 | 8.6%
(8) more than 365 | 1.6%.
(Blinder et al. 1998: 84).
Blinder et al. (1998: 84) conclude that the US does have an auction-like market sector where prices are highly flexible, but it is very small indeed.
Most of the 78% is almost certainly accounted for by the cost-based/mark-up pricing sector of the US economy, and numerous empirical studies show us that every other nation for which there is evidence has a large mark-up pricing sector too. Even when mark-up prices change, they change not, generally speaking, because of demand, but because total unit costs change (especially when business managers expect these to be permanent) or when variations in the profit mark-up are made.
Contrast the reality of mark-up price determination in most markets and the important degree of price rigidity with the grossly unrealistic Austrian price theory:
“At a price higher than the intersection [sc. of the supply and demand curves], then, supply is greater than demand, and market forces will then impel a lowering of price until the unsold surplus is eliminated, and supply and demand are equilibrated. These market forces which lower the excessive price and clear the market are powerful and twofold: the desire of every businessman to increase profits and to avoid losses, and the free price system, which reflects economic changes and responds to underlying supply and demand changes. The profit motive and the free price system are the forces that equilibrate supply and demand, and make price responsive to underlying market forces.” (Rothbard 2008: 20).Of course, there are markets like this, if demand curves are well behaved. But, as we have seen, they are but a small proportion of the markets in modern economies, and this type of analysis does not apply to most product markets.
“Clearly then, the profit-loss motive and the free price system produce a built-in ‘feedback’ or governor mechanism by which the market price of any good moves so as to clear the market, and to eliminate quickly any surpluses or shortages. For at the intersection point, which tends always to be the market price, supply and demand are finely and precisely attuned, and neither shortage nor surplus can exist … . Economists call the intersection price, the price which tends to be the daily market price, the ‘equilibrium price,’ for two reasons: (1) because this is the only price that equilibrates supply and demand, that equates the quantity available for sale with the quantity buyers wish to purchase; and (2) because, in an analogy with the physical sciences, the intersection price is the only price to which the market tends to move. And, if a price is displaced from equilibrium, it is quickly impelled by market forces to return to that point—just as an equilibrium point in physics is where something tends to stay and to return to if displaced.” (Rothbard 2008: 21–22).
An Austrian economist might complain that the comments above are meant to apply only to an ideal/hypothetical “free market” where this type of price setting is by definition true.
But, in that case, it is clear that Austrian price theory needs to be radically changed to reflect and describe most real world markets.
Blinder, A. S., Canetti, E. R. D., Lebow, D. E. and J. B. Rudd (eds.). 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage Foundation, New York.
Rothbard, Murray N. 2008. The Mystery of Banking (2nd edn.). Ludwig von Mises Institute, Auburn, Ala.