Monday, November 25, 2013

Mark-up Prices in Iceland

Ólafsson et al. (2011) reports the results of a survey of Icelandic firms that was conducted in June to July of 2008, and that involved 580 firms selected from all sectors – including manufacturing, the financial sector, construction, and services – and in proportion to the composition of these different sectors of the Icelandic economy (Ólafsson et al. 2011: 7).

The firms were asked directly about the price setting of their main product, or that product that accounts for 60–80% of the firm’s annual turnover (Ólafsson et al. 2011: 8).

Curiously, those companies and businesses whose prices were set by regulation or by a parent company were excluded (Ólafsson et al. 2011: 8).

That would suggest that the final data are not entirely representative since businesses whose price are set as a mark-up by a parent company are excluded.

One finding was that 73% of firms surveyed had long-term relationships with their customers and this factor is conducive to greater price stickiness (Ólafsson et al. 2011: 9).

The second finding is as follows:
Cost-based pricing with variable or constant mark-up is found to be the most common price setting method, as 45 per cent of firms claim to use this method of price setting. Almost 35 per cent of firms set their prices with reference to competitors’ prices, and a fifth of firms index their prices to the consumer price index …. Price indexation is especially common in the financial, construction, and other services sectors. In wholesale, retail, transport, and various services, 60 per cent of firms set prices using a constant or variable mark-up on costs.” (Ólafsson et al. 2011: 12).
Mark-up pricing is thus the most prevalent form of price setting in Iceland, higher than both other categories.

As in other studies, it seems possible that the category of prices “dependent on competitors’ prices” conceals more mark-up firms, since in some mark-up pricing markets a market leader sets the standard mark-up price and other businesses follow the price leader.

This is confirmed in my mind by the later finding that costs rather than demand are the major factor driving price changes.

Firms were asked what the principal determinant of price changes was. The results are as follows:
Price Increases
(1) Costs | 68.7%
(2) Exchange rate changes | 22.9%
(3) Competitors’ price | 1.5%
(4) Demand | 6.9%

Price Decreases
(1) Costs | 37.6%
(2) Exchange rate changes | 20%
(3) Competitors’ price | 20.8%
(4) Demand | 21.8%
(Ólafsson et al. 2011: 18).
Also of extraordinary interest but concealed in a footnote is this statement about how the survey avoided the use of the term “marginal cost”:
“We follow a common procedure within the literature and do not use the term ‘marginal cost’ in our questionnaire as it has generally been found that it is hard to question firms about their marginal costs. The concept is both complicated to explain in layman’s words and hard for firms to compute.” (Ólafsson et al. 2011: 12, n. 8).
How on earth can it be that in neoclassical economics prices are thought to be strongly related to “marginal cost,” and yet businesses not only have difficulty understanding the concept (even when explained in “layman’s words”), but also find it hard to calculate?

Of course, the answer is that marginal cost is irrelevant for many – possibly most firms – and that neoclassical price theory is badly flawed.

A further datum from the survey is that time dependent price setting – where firms only review prices periodically – is predominant in Iceland: about 40% of firms have purely time-dependent price reviews, and 47% mainly time dependent reviews with some state dependent ones (Ólafsson et al. 2011: 14).

In contrast to New Keynesian Phillips curve analysis where forward-looking price setters are an important element, about 68% of firms “evaluate their prices mainly on the basis of current information and past developments and are therefore backward-looking” (Ólafsson et al. 2011: 14).

In any case, it is clear that even in small, open economies like Iceland mark-up prices are still very important.

Ólafsson, Thorvardur Tjörvi, Pétursdóttir, Ásgerdur, and Karen Á. Vignisdóttir. 2011. “Price Setting in Turbulent Times: Survey Evidence from Icelandic Firms,” Working Paper Central Bank of Iceland‎

1 comment:

  1. Thanks a lot for this series of posts and articles on prices. It is always a pleasure to read them and to see that there exist economists who really care about firms and their actual behaviours.