Tuesday, June 25, 2013

John Kenneth Galbraith on Administered Prices

John Kenneth Galbraith’s The New Industrial State (1985) is a classic book, and rightly so. It is not just that Galbraith provided an insightful (old) Institutionalist perspective on economics (with a nice dose of heterodox Keynesianism), but he was also a wordsmith.

I summarise Galbraith’s analysis of prices here. One must remember that some of Galbraith’s observations were written with respect to the US economy of the 1970s.

Galbraith notes the many US markets are oligopolistic and prices set by businesses based on costs with relatively inflexible prices (Galbraith 1985: 188).

Galbraith argues that
“Once established, industrial prices tend to remain fixed for considerable periods of time. None supposes that prices of basic steel, aluminum, automobiles, machinery, chemicals, petroleum products, containers or like products of the planning system will be sensitive to the changes in cost or demand which cause constant price readjustments for commodities, such as lesser agricultural products, where producers are still subject to control by the market. This stability of prices, in face of changing costs and demand, is a further indication, it may be noted, that in the short run the mature corporation pursues goals other than profit maximization.

Stable prices reflect, in part, the need for security against price competition.” (Galbraith 1985: 202).
Today we tend to call these “administered prices,” and how they are not confined to market oligopolies. Of course, Galbraith himself also knew that major changes in costs (above all, wages and energy) do have an important role in driving changes in administered prices (Galbraith 1985: 203).

Crucially, Galbraith himself stressed the importance of this idea for his work:
“[The New Industrial State] is built on the notion not of monopoly prices but broadly speaking of administered prices. It is administration which provides the certainty which the modern, very large technocratic organization requires. I have gone on from administration of prices to the management of the other economic parameters including that of consumer demand.” (J. K. Galbraith, Letter to Gardiner C. Means, August 19, 1970, as quoted in Lee 1998: 68, n. 2).
Galbraith famously called the industrial and corporate structure of America a “planning system,” because of the widespread existence of anti-market planning by these institutions, of which “price control”/administered prices was a fundamental element.

The first benefit of administered prices to a firm is stability of profit, and a minimum profit level (Galbraith 1985: 200). Truly flexible prices or price wars are shunned by many businesses as a grave threat to stability of profit.

The second benefit of administered prices is that they are a private sector method of reducing uncertainty. A truly flexible price system as dictated by the dynamics of supply and demand curve, as in neoclassical theory, introduces a high level of uncertainty into business life. But businesses don’t like this much. And administered prices provide a degree of predictability in the future planning of business production, estimation of profit level, and even costs (since one firm’s administered prices are another’s costs of production) (Galbraith 1985: 202).

Thirdly, relatively stable profits also allow stable capital investment, often important for productivity growth. On this point, Galbraith notes that government price regulation of certain agricultural commodities (as, for example, price floors) in advanced nations, far from being some “unnatural” practice, mimics the behaviour of private fixprice corporations, by providing stable income to farmers and allowing increased capital investments with new technology and strong improvements in productivity and greater output (Galbraith 1985: 199, n. 1).

In place of attempts to stimulate demand by cutting prices (which, we might note, evidence suggests do not always work anyway), fixprice businesses have developed other methods for increasing demand: advertising (Galbraith 1985: 208). This is a complex process, and for many businesses involves market research, creating a base of loyal customers and brand recognition (Galbraith 1985: 214).

If sales slip, in place of price cutting, generally a different strategy is employed:
“When a firm is enjoying patronage by its existing customers and recruiting new ones, the existing sales strategy, broadly defined, will usually be considered satisfactory. The firm will not quarrel with success. If sales are stationary or slipping, a change in selling methods, advertising strategy, product design or even in the product itself is called for. Testing and experiment are possible. Sooner or later, a new formula that wins a suitable response is obtained.

This brings a countering action by the firms that are then failing to make gains. This process of action and response, which belongs to the field of knowledge known as game theory, leads to a rough equilibrium between the participating firms. Each may win for a time or lose for a time but the game is played within a narrow range of such gain or loss.” (Galbraith 1985: 215).
In short, in place of price competition is another form of inducement of demand: business “demand management” by advertising, promotion, and product redesign.

Further Reading
“Early Literature on Administered Pricing,” May 8, 2013.

“Gardiner Means on Administered Prices,” June 20, 2013.

“Lachmann on Hicks on Fixprices,” May 13, 2013.

“Lachmann and Post Keynesianism on Prices,” August 1, 2012.

“Mises versus Lachmann on Equilibrium Prices,” December 17, 2012.

“Caldwell on Lachmann on Equilibrium Prices,” November 6, 2012.

“Kaldor on Economics without Equilibrium,” March 9, 2013.

Galbraith, J. K. 1985. The New Industrial State (4th edn.). Houghton Mifflin, Boston.

Lee, Frederic S. 1998. Post Keynesian Price Theory. Cambridge University Press, Cambridge and New York.


  1. The unquestioning acceptance of flexible market prices as a beneficial thing is predicated on not thinking about firms making decisions through time and having to deal with the consequences of decisions made in the past.

    Can you bring out the implications this has for macroeconoic policy?

    Also, how is price setting effected by the macroeconomic background changing?

    I notice that J Finegold has just bought a copy of Lee's book from Amazon - so expect something from that quarter soon.

    1. Anonymous@June 26, 2013 at 1:26 AM

      I think the main consequence for macroeconomic policy is that Keynesian fiscal stimulus does indeed drive increased output and employment, since fixprice markets are an important element in all modern advanced economies. Extra demand will not just cause inflation.

      The corollary is that extra private spending too (from bank credit or money diverted from spending on second hand asset markets) also stimulates extra output and employment.

  2. Although this might work in a closed or completely dominant economy, in a global economy with free trade, productivity shocks from external firms makes this approach less useful, given that domestic firms might have to alter prices to retain business.

    1. Even many corporations producing in developing nations use cost of production plus profit markup pricing (administered pricing), so far from being irrelevant, it still is.

    2. Firms are forced to use markup pricing because they can't operate at a loss, therefore liquidity is elastic and price isn't. JK Galbraith cited the first insight from Veblen and the second from Keynes.

  3. I would agree with Tom. Fixed price markets are increasingly rare in a globalised economy.

    The problem, as we've seen in the west, is that flexible pricing, as Galbraith recognised, sends poor signals to invest for private firms.

    I would suggest this increases the need for public sector investment in the infrastructure or hardware of an economy.

    One of the benefits of a fixed price economy is an incentive for the firm to invest in a way that creates positive externalities as they believe they will be around for forever. In a dynamic pricing environment they are less inclined to do so. The result is less private sector investment. The public sector must step in.

    This spurs firm and job creation though here too things are more dynamic. Continual public investment smooths cycles and creates more private sector opportunities.