Tuesday, October 15, 2013

Lee on Post Keynesian Price Theory in The Oxford Handbook of Post-Keynesian Economics

Frederic S. Lee has a useful and up-to-date chapter on Post Keynesian price theory in The Oxford Handbook of Post-Keynesian Economics. Volume 1: Theory and Origins (Oxford, 2013). I summarise the main points below.

The crucial conclusions from empirical investigation of real world capitalist price systems are as follows:
(1) administered prices make up somewhere between about 50–70% of prices in modern market economies (for direct evidence for these percentages in, for example, the Eurozone, see Fabiani et al. 2006: 18, Table 4).

(2) in these widespread administered, fixprice markets, prices are not primarily a mechanism for economic coordination in the neoclassical sense, but a method by which a business obtains and stabilises its income and profits, in order to support the survival of the business (Lee 2013: 467–468). Administered prices are not market clearing prices, nor are they set in order to equate marginal costs to marginal revenue. Administered prices are set before the sale or exchange takes place and sometimes even before production (Lee 2013: 470). They are not the product of competitive bidding in a Walrasian auction-like market or a haggling process familiar from bazaars (Lee 2013: 474).

Rather, intense price competition is often shunned by businesses because competition via flexible prices and price wars will drive many enterprises toward bankruptcy. Hence administered prices provide a way by which private businesses control and avoid the uncertainty attached to intense and destructive price competition (Lee 2013: 476).

(3) administered price businesses are not concerned with maximisation of profits in the neoclassical sense. Rather, they wish to create a steady flow of income and stable profit to maintain and grow their business, increase market share, engage in new investment and/or produce new products, and so pursuit of profit can be conceived of as an “intermediate objective” (Lee 2013: 468). When possible, profits are generally increased by increasing the profit markup and reducing costs, rather than adjusting prices in response to demand changes.

(4) an administered price is calculated from average total costs (ATC) at a given capacity utilisation or output plus profit markup. Average total costs (ATC) are broken down into product average direct costs (ADC) and average overhead costs (AOHC) (Lee 2013: 469). In an industry where competition exists, the outcome is normally that a “price leader” – the largest and most successful producer or producers – set a profit markup and price for the product that strongly influences other businesses (Lee 2013: 473).

(5) depending on the market, administered prices are reviewed and possibly changed from 3 month periods to a year (Lee 2013: 474), and even then changes in price will generally be driven by costs of factor inputs.

(6) the most recent empirical evidence suggests that many modern administered price businesses often do not reduce their prices when factor input prices decrease, if they can avoid it. Instead, the business will increase its profit markup and maintain prices – a factor that tends to re-enforce the downward rigidity of prices in modern market economies (Lee 2013: 475; Álvarez et al. 2006).
Álvarez, L. J., Dhyne, E., Hoeberichts, M., Kwapil, C., Le Bihan, H., Lünnemann, P., Martins, F., Sabbatini, R., Stahl, H., Vermeulen, P. and J. Vilmunen. 2006. “Sticky Prices in the Euro Area: A Summary of New Micro-Evidence,” Journal of the European Economic Association 4.2–3: 575–584.

Fabiani, S., M. Druant, I. Hernando, C. Kwapil, B. Landau, C. Loupias, F. Martins, T. Mathä, R. Sabbatini, H. Stahl and A. Stokman. 2006. “What Firms’ Surveys tell us about Price-Setting Behavior in the Euro Area,” International Journal of Central Banking 2.3: 3–47.

Lee, Frederic S. 2013. “Post-Keynesian Price Theory: From Pricing to Market Governance to the Economy as a Whole,” in G. C. Harcourt and Peter Kriesler (eds.), The Oxford Handbook of Post-Keynesian Economics. Volume 1: Theory and Origins. Oxford University Press, Oxford and New York. 467–484.

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