But administered pricing has been recognised and studied by economists since the 1930s, and the literature is vast. Below is a sample of the important early literature on fixprices and administered pricing:
(1) Gardiner C. Means
Berle, Adolf A. and Gardner C. Means. 1932. The Modern Corporation and Private Property. Macmillan, New York.Gardiner C. Means studied price setting by modern corporations in the United States, and was one of earliest and most important economists who examined administered pricing. He concluded, after extensive empirical research, that prices of goods produced in many corporations are set by a mark-up on cost of production (Downward 1999: 50).
Means, G. C. 1992 . “The Corporate Revolution,” in Frederic S. Lee and Warren J. Samuels (eds.), The Heterodox Economics of Gardiner C. Means: A Collection. M.E. Sharpe, Armonk, N.Y.
Means, G. C. 1935. Industrial Prices and their Relative Inflexibility. US Senate Document no. 13, 74th Congress, 1st Session, Government Printing Office, Washington DC.
Means, G. C. 1936. “Notes on Inflexible Prices,” American Economic Review 26 (Supplement): 23–35.
Means, G. C. 1939–1940. “Big Business, Administered Prices, and the Problem of Full Employment,” Journal of Marketing 4: 370–381.
Means, G. C. 1962. Pricing Power and the Public Interest. Harper and Brothers. New York.
Means, G. C. 1972. “The Administered Price Thesis Reconfirmed,” American Economic Review 62: 292–306.
He was clear that the neoclassical price theory with its ideas of flexible prices adjusted by agents in auction or auction-like transactions is not a description of reality for most markets:
“Basically, the administered-price thesis holds that a large body of industrial prices do not behave in the fashion that classical theory would lead one to expect. It was first developed in 1934–35 to apply to the cyclical behavior of industrial prices. It specifically held that in business recessions administered prices showed a tendency not to fall as much as market prices while the recession fall in demand worked itself out primarily through a fall in sales, production, and employment.” (Means 1972: 292).(2) Hall and Hitch
“Fourth, the actual behavior of administration-dominated prices … tends to differ so sharply from the behaviour to be expected from classical theory as to challenge the basic conclusions of that theory. However well the theory may apply to market-dominated prices, it would not seem to apply to the bulk of the administration-dominated prices in the sample or to that part of the industrial world which they typify.
Until economic theory can explain and take into account the implications of this nonclassical behavior of administered prices, it provides a poor basis for public policy. The challenge which administered prices make to classical economics is as fundamental as that made by the quantum to classical physics.” (Means 1972: 304).
Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.Hall and Hitch were part of the Oxford Economists Research Group and postulated a “full cost” theory of pricing, plus mark-up for profit (Downward 1999: 46). Mark-ups are constrained to some extent by competing businesses.
(3) Michał Kalecki
Kalecki, M. 1939. Essays in the Theory of Economic Fluctuations. Allen and Unwin, London.Michał Kalecki (1939) treats fixprices as set by means of production costs and profit. He also noted the important role of excess capacity in industries. Hall and Hitch’s work influenced Kalecki’s views on prices (Downward 1999: 51).
Kalecki, M. 1939–1940. “The Supply Curve of an Industry under Imperfect Competitions,” Review of Economic Studies 7: 91–112.
Kalecki, M. 1954. Theory of Economic Dynamics. Allen and Unwin, London.
Kalecki, M. 1971. Selected Essays on the Dynamics of the Capitalist Economy. Cambridge University Press, Cambridge.
In Kalecki (1954 and 1971), he developed his theory of prices. He divided prices in market economies into two types, as follows:
(1) cost determined prices; andMost finished goods are cost determined, while many raw materials and primary commodities are demand determined (that is, flexprice markets).
(2) demand determined prices.
Most manufactured goods have prices that are cost determined. Prices are set under conditions of uncertainty and, crucially, profits are not, strictly speaking, maximised in the neoclassical sense (Downward 1999: 52).
Normal price floors are set by costs of production, and ceilings – at least to some extent – by the average price level in the particular industry concerned.
(4) P. W. S. Andrews
Andrews, P. W. S. 1949 “A Reconsideration of the Theory of the Individual Business,” Oxford Economic Papers n.s. 1.1: 54–89.Andrews noted the existence of excess capacity in many firms and how administered pricing is often normal even in markets where competition exists, or that is, “irrespective of the degree of competition which the firm has to meet” (Andrews 1949: 58–59). When firms wish to increase market share, it will often be by means of superior quality and reputation, rather than price cuts (Downward 1999: 50).
Andrews, P. W. S. 1949a. Manufacturing Business. Macmillan, London.
Andrews, P.W.S. 1964. On Competition in Economic Theory. Macmillan, London.
Finally, I note how John Kenneth Galbraith in his own important work on administered prices also drew on this earlier literature, particularly Berle and Means and Kalecki (Dunn 2011: 144, n. 46).
Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Northamption, Ma.
Dunn, Stephen P. 2011. The Economics of John Kenneth Galbraith: Introduction, Persuasion, and Rehabilitation. Cambridge University Press, Cambridge and New York.
Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.
Thanks a lot for this. This is something I'd just started looking into, myself, so the timing couldn't be better.ReplyDelete
How would you say Weintraub's work on price theory fits in with these?
Obviously Sidney Weintraub's work on administered prices fits into the later mainstream Post Keynesian literature. I suppose he must have drawn on this earlier literature to some extent.Delete
His major contribution was tax based incomes policy.
There is a good discussion of this in John Edward King, Companion to Post Keynesian Economics (2002), p. 333.
Also, there is a new edition of King's companion now, so you can look up "tax based incomes policy" here too:Delete
J.E. King (ed.), The Elgar Companion to Post Keynesian Economics (2nd edn.). Edward Elgar, Cheltenham. 2012.
I treat this is a good starting point and reference work for PK economics.
"Michał Kalecki (1939) treats fixprices as set by means of production costs and profit."ReplyDelete
Assuming this to be true then how do businesses determine how much to produce if they are not also guided by changes in their profit margin that would result from varying their price and output level?
Also how does this model explain business innovation ? If firms set prices administratively rather than to maximize profit then why spend money on R&D when this will just add to costs without increasing profits ?
"Assuming this to be true then how do businesses determine how much to produce "Delete
Past signals on the quantity of their output sold, and expectations (whether right or wrong) of future demand.
Changes in the quantity signals (that is, stock/inventory changes, changes in the sales volume or sales orders), generally, lead to direct changes in quantity of output produced and employment. The price of the goods will generally remain unchanged, unless there are changes in the wage bill or costs of other factor inputs.
"If firms set prices administratively rather than to maximize profit then why spend money on R&D when this will just add to costs without increasing profits ? "
Because innovation can give them the edge over competitors by increasing quality, functionality or providing new goods or improved goods, and decreasing the costs of production.
"Assuming this to be true then how do businesses determine how much to produce"Delete
You don't need to assume. Go work in one and you'll see that it is true.
What I find tedious is this idea that every business is massively capital intensive and enormous.
The majority are not. They are small and medium sized. Most are now service based - and what determines production schedule is the order pipeline.
Sales to order is not instantaneous. It takes time to convert prospects. But those prospects provide information to the production system during the sales process - based on statistical conversion ratios.
With current customers you can estimate their demand and you adjust on a regular basis by comparing output with actual sales.
There is a ton of information from the lead system and very little of it is to do with price. The same service or product can have wildly different prices with different customers. It's all a matter of what makes the customer sign on the dotted line.
"Also how does this model explain business innovation"
Lots of reasons. I've worked on quite a few jobs where the owner just wanted something building and was prepared to pay for it.
Maximising profit is another textbook myth. Lot's of stuff gets built to further a dream or a vision. It all depends what game you're playing and what gets you out of bed on a morning.
Why would a firm wish to improve quality or reduce costs if not to maximize profits ?Delete
Further: Are costs not often derived from prices not the other way around. The costs of a scarce raw material (or of skilled labor) cannot be derived from any attribute it possesses but only from the price people are prepared to pay for goods embodying it.
Rob Rawlings@May 8, 2013 at 8:46 AMDelete
Didn't you read what I wrote? I am not saying businesses never try and increase profits.
I am saying, firstly, that many businesses do not do this in the neoclassical/marginalist sense of adjusting flexible prices in response to demand.
Secondly, that to increase market share (and hence profits), a business can try produce goods of superior quality and reputation to its competitors, engage in advertising, sales promotion and so on, rather than price cuts (that might induce a price war, which, by and large, businesses often avoid).
Thirdly, businesses face other considerations, alongside profit maximisation: survival, growth, reputation, goodwill with clients.
Fourthly, profit stability is also important. Stable profits are a benefit of price administration (Gu, G. C. and F. S. Lee. 2012. “Prices and Pricing,” in J. E. King, The Elgar Companion to Post Keynesian Economics (2nd edn.). p. 461). Stable profits in turn allow stable margins for internal financing of investment.
See also Joan Robinson's work on this, referenced in Frederic S. Lee, 1998. Post Keynesian Price Theory. pp. 184-185.
" The costs of a scarce raw material (or of skilled labor) cannot be derived from any attribute it possessesDelete
What? Scarcity does not influence price, even in flexprice raw materials markets?
but only from the price people are prepared to pay for goods embodying it."
Is there any room here for basic wage rates below nobody can live in this statement? Union power?
"What? Scarcity does not influence price, even in flexprice raw materials markets?"Delete
A good that is scarce will still have a zero price if no one values it.
"Is there any room here for basic wage rates below nobody can live in this statement? Union power?"
The wage rate will be determined by both supply and demand. Unions can undoubtedly affect the supply, but consumer preference will still ultimately determine the demand.
"Didn't you read what I wrote?...."Delete
I agree that all the things you list here are relevant to the behavior of firms in a modern economy and will contribute to the observed existence of sticky prices.
I think however to conclude from this that "cost + markup" is the determining factor in how prices are set is incorrect.
It is simply impossible to build a coherent model where "cost + markup" drives prices. Rather one needs a marginalist foundation to show how prices are determined. From this it is possible to show how prices will adjust so that "cost + markup" becomes true. And from there it will be possible to show why firms may adopt strategies based upon "cost + markup" in order to be sucessful.
But to deny the marginalists basis for pricing as Post-Keynsians seem to do is to adopt a model that is both circular and incoherent.
So after all these comments, the essence of what you're saying is:Delete
"yes, many firms set prices by means of cost of production plus profit markup.
But I don't think that conflicts with neoclassical price theory at all, even though it sees prices as being flexible in response to demand changes and adjusted towards their market clearing levels."
Let people read this and marvel.
I would rather think that people reading this would instead marvel at a model centered upon "price = cost+markup" that can explain neither how cost nor how mark-ups are derived !Delete
In case you are unclear:Delete
(1) economic utility in the sense of the pleasure, happiness, or satisfaction people derive from consumption goods is subjective; but "utility" in this sense is not the same thing as price.
(2) businesses ultimately would not produce things that nobody demands, or that is to say that people wish to buy with money and consume.
These 2 propositions are true, are consistent with Post Keynesian price theory, and proposition (2) also implies that demand drives production and investment.
Prices for certain raw materials and commodities are flexprice and driven by supply and demand.
But a vast range of other goods, both capital goods and consumer goods are not. They fixprice. The price is set by businesses and remains mostly unchanged when demand changes.
And as for the idea that fixprice theory does not explain how mark-ups are derived, the bibliography above gives you a vast literature showing actually how businesses in the real world set mark-ups: it depends on the industry concerned, what the competition charges, etc.
- How does Post-Keynsian theory believe that wage levels for skilled workers are set ?
- What is the quick answer to the question "what determines the level of mark-up that firms charge" ?
(1) if minimum wage laws apply, then that will be a floor. If unions are some degree of power in the industry, then they will have influence on wages.Delete
Nobody denies that supply and demand, negotiation, etc. can and does enter into the picture.
(2) already answered that. A business can look at what its profit markup was in the past, what its competitors charge; a new business could also take a guess, based on their perception of quality of product or what their customers will accept, and what competitors charge.
It is summed by Lee 1998, 226, with a vast citation of the empirical evidence:
"custom, convention, tradition, reasonableness, and short- and long-term competition are predominate among the determinants of the mark up for profit."
the price of a good = cost + markup
one of those costs is skilled labor which "Nobody denies that supply and demand" is a factor in its cost.
But this demand will depend upon the demand for, and the price of , the good in question.
So wages supposedly both contribute to determining the price of a good and are at the same time determined by it.
This is not viable and shows what is wrong with the cost+markup model.
"Why would a firm wish to improve quality or reduce costs if not to maximize profits ?"Delete
Competition is mostly about maintaining market share in the majority of cases. You need to have enough business - whatever enough is.
People buy from people and all the variance of human behaviour feeds into that.
It just isn't a mechanical process and it changes depending upon the feeling in the air - which is based upon people talking to each other and getting a sense of the the general mood.
That's what "animal spirits" are all about.
The ultimate judge regarding how much of what is produced and sold and at what price is the customer. Obviously, sellers must take production cost into account to determine what a profitable price might be. But that profitable price cannot be forced upon a voluntary customer.ReplyDelete
Thanks for the excellent Austrian example about how prices are established.
Thanks for your comment.Delete
Yes, businesses cannot sell things that nobody wants.
Let us assume that you can give an intelligent and straightforward opinion on basic Austrian concepts.
(1) Are you saying that prices adjusted in a flexible manner towards their market clearing levels is NOT a fundamental element in Austrian price theory and in Misesian economic calculation?
(2) That is, do you agree with these basic Austrian concepts or not?:
(a) “prices that are generated by the market process and serve as the data for economic calculation. These are realized prices; or, in other words, they are the actual outcome of the historical market process at each moment in time and are determined by the value scales of the marginal pairs in each market. They are, therefore, also market-clearing prices the establishment of which coincides with a momentary situation, what Mises calls the ‘plain state of rest’ (PSR), in which no market participant, given his existing marginal-utility rankings of goods and money and knowledge of prevailing prices, can enhance his welfare by participating in further exchange.” (Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: 113–146. at p. 121).
(b) “Mises conceives the market process as coordinative, ‘the essence of coordination of all elements of supply and demand.’ This means that the structure of realized (disequilibrium) prices, which continually emerges in the course of the market process and whose elements are employed for monetary calculation, performs the indispensable function of clearing all markets and, in the process, coordinating the productive employments and combinations of all resources with one another and with the anticipated preferences of consumers.” (Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: p. 124).
Capable of giving a clear and straight answer?
I'm going to read the entire article first. Your question[s] always appear to be out-of-context attempts at "gotcha".Delete
So you're saying that you do not even know whether prices adjusted in a flexible manner towards their market clearing levels is a fundamental element in Austrian price theory and in Misesian economic calculation?Delete
In other words, you are ignorant of basic Austrian concepts?
No. I just told you:Delete
I'm going to read the entire article first. Your question[s] always appear to be out-of-context attempts at "gotcha".
I want to make sure I understand the precise context of each word and punctuation mark.
"No. I just told you:.. etc."Delete
Great! Then ignore the second question with the quotations, and just give a direct, clear answer to question (1):
Are you saying that prices adjusted in a flexible manner towards their market clearing levels is NOT a fundamental element in Austrian price theory and in Misesian economic calculation?
Come on, an intelligent fellow like you -- what, with all your years of reading Austrian economics and clear understanding of economic calculation!!
Surely you can tell us "yes" or "no"!
Or are you terrified that an honest, clear answer would reveal that you are ignorant of basic Austrian concepts?
You still do not or will not understand economic calculation and therefore you cannot or will not understand what follows from economic calculation. Further, you do not understand the difference between a voluntary exchange and an exchange subject to various types of intervention especially the impact of Keynesian interventions upon economic calculation. Finally, your silly attempt to extract the concept of changing prices into a straight jacket that excludes the plain meaning of "prices of what and how much of what" is dishonest. Since you still think your silly "fixprice" example refutes Mises and the Austrians, I want to present a thorough explanation of my position that will minimize your inevitable attempt to distort it.Delete
Interesting... So are you saying that prices adjusted in a flexible manner towards their market clearing levels is NOT a fundamental element in Austrian price theory and in Misesian economic calculation?Delete
Can you give a direct answer to that question? It would easy for a knowledgeable person familiar with basic Austrian concepts!
No Bob.you shown to be an illiterarate on Austrian economics,you don´t even know basic Austrian economics!Lord Keynes have been kind enough to educate you on the topic.It explains your latest smearings and personal attacks on the real J.M Keynes on other places.I would say you by that totally discredited yourself.Delete
Anonymous, Roddis is laughable and there is no reason for anyone to take him seriously.Delete
Notice how he's incapable of answering a simple question about the Austrian "economic calculation" that he says no Keynesian else understands.
Yes Lord Keynes!I am stunned by the stupidity of this Bob Robbis,he seem to be a simpleton in extreme,and it tells something since it´s a internet Austrian!I don´t even understand what sort calculation this Bob refer to.it´s a very confused soul.These Austrian trolls use to bring the Mises et al.calculation debate way back in the 30s but i can´t understand how he could implement that to the discussion on the topic you bring up in this well written blog article.It don´t make sence!Delete
During my blue-collar days, I was interested in understanding the political economy of my industry...the US automobile Big Three, in the aftermath of the Chrysler loan guarantees. I ran across the efforts of Estes Kefauver, both in a book discussing (in part)auto "administered" pricing, and in the form of congressional hearings on the topic. GM had a level of market dominance and economies of scale that permitted it to unilaterally set automobile prices. Ford followed suit, and Chrysler was always a relatively marginal player, dragged along in the wake of GM. And how were those prices set? They calculated the monthly car payment that their customers could carry, and worked backwards to arrive at prices that reflected the target monthly note. Oligopolistic pricing and fantastic profits, at least until its hegemonic position was undermined by the entry of the Europeans and Japanese.ReplyDelete
Has anyone in the economics profession written about this phenomenon?
I am sure there is scholarly work on it somewhere, but I would have to do a literature search.Delete
Also, private health care costs make US car manufacturing more expensive -- US competitors have national, universal health care systems, so that means car manufacturers in Europe or Japan are not hit with providing health benefits to workers, or at least not to the same extent.
By the way LK,our deeply beloved and admired friend, the profound thinker Bob Roddis,reach new intellectual hight´s in his attempt to in all ways discredite Keynsian theory by using all sort of ad-homs and personal attacs.I guess it´s as fare an internet Austrian could reach.Delete
"Niall Ferguson’s apology is an epic fail"
Yes, Roddis is devoid of any serious argument, isn't he.Delete
If ad hominem arguments were valid, then we could dismiss all of Austrian economics simply by pointing out that Mises praised Italian fascism in a disgraceful manner:
Or that the lunatic Rothbard believed in torture:
I am looking for a picture of Gardiner Means and have looked and looked and could not find a decent one. Could anybody help please?
That would be greatly appreciated.
I am not aware of any photo of Means online.Delete