Sunday, April 27, 2014

Mark-up Pricing in Luxembourg

Lünnemann and Mathä (2006) report the results of a survey on price setting behaviour of firms in Luxembourg (see also Lünnemann and Mathä 2007).

The survey was conducted by the Banque centrale du Luxembourg in the second half of 2004 and involved responses from 367 firms in the construction, industry, services, trade and retail trade sectors, and the replies were adjusted to be representative of the Luxembourg economy as a whole (Lünnemann and Mathä 2006: 7–8).

An interesting finding was that 76% of firms generate the largest share of their turnover with long-term customers (Lünnemann and Mathä 2006: 12).

An unusual finding was that purely state-dependent price reviews were more frequent than purely time-dependent rules (Lünnemann and Mathä 2006: 17), but despite this it was found too that the median firm in the survey changed its price twice a year and 28% of firms just once a year (Lünnemann and Mathä 2006: 21).

Firms were given 15 proposed theories to explain price stickiness, and were asked to rank the importance of these theories from “unimportant” (1) to “very important” (4).

The following results were obtained:
(1) Implicit contracts;

(2) Constant marginal cost;

(3) Explicit contracts;

(4) Procyclical elasticity of demand;

(5) Thick markets demand;

(6) Fixed costs / liquidity constraints;

(7) Price means Quality;

(8) Thick markets supply;

(9) Coordination failure;

(10) Threshold pricing;

(11) Temporary shock;

(12) Countercyclical finance;

(13) Menu costs;

(14) Non-price factors;

(15) Costly information.
(Lünnemann and Mathä 2006: 27).
The failure to include cost-based pricing is a bad failing of the survey, but the finding that increases in labour costs and other factor costs are the most important cause of price movements upwards tends to confirm that mark-up pricing must be a significant form of price setting (Lünnemann and Mathä 2006: 30). In contrast, a surge in demand was seen at the least important factor explaining price increases (Lünnemann and Mathä 2006: 30).

The effect of demand on price can be seen in this finding:
“... following a substantial increase in demand for their main product, almost every second firm does not change their price at all. The share of firms not adjusting their prices following an increase in demand is particularly sizeable in the trade sector (almost 60%).” (Lünnemann and Mathä 2006: 33).
For price decreases, the most important factors were price reductions by competitors and falling wage costs (Lünnemann and Mathä 2006: 31).

Though this survey is flawed by its failure to ask firms directly whether they use cost-based pricing, nevertheless the evidence on the importance of costs in relation to price and the weak role of demand are suggestive, and the importance of constant marginal cost to many firms are all important findings.

Lünnemann, P. and T. Y. Mathä. 2006. “New Survey Evidence on the Pricing Behaviour of Luxembourg Firms,” ECB Working Paper Series No 617

Lünnemann, P. and T. Y. Mathä. 2007. “A Survey of Price Setting Practices of Luxembourg Firms,” in S. Fabiani, C. Suzanne Loupias, F. M. Monteiro Martins and Roberto Sabbatini (eds.), Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York. 124–139.

1 comment:

  1. Interesting, although somewhat dated. I wonder if you know/realise that Luxembourg is one of the few countries in Europe to still have wage indexation (you can find references to that in the report). Meaning, legislation to enforce wage adjustments in line with inflation. The Luxembourg business sector is constantly grumbling about this since (supposedly) it is killing the country's competitiveness. Preaching the evils of the "Index" is a common addition to the usual neo-liberal catechism over here. Still, no government has dared abolish the Index, although they are constantly manipulating it to tone down its effects. A 'temporary' measure that has been prolonged so many times as to have become a permanent feature is to provide that salary adjustments only take place once a year at most. Belgium is the only other country in the EU to have automatic wage indexation, I think. Luxembourg has been in Economic Union with Belgium since 1922, sharing a currency with them, too, before the Euro.