Matias Vernengo on Marx’s Labour Theory of Value

Matias Vernengo explains the problems with Marx’s labour theory of value (LTV) as he sees them and why (in his view) Sraffa’s solution is the only viable interpretation of the idea of some labour-based value in prices:

“… [sc. Ricardo in his early writings presumed] that the economy produced corn (grain) with corn and labor, and the surplus was a physical amount of corn, so the rate of profit could be measured as ratio of corn (the surplus) to corn (the means of production advanced for production). He, then used, the labor theory of value as an approximation to the solution in his Principles, knowing that prices were not exactly proportional to the amounts of labor directly and indirectly used in production.

That was, also, essentially the role of the LTV in Marx’s volume I of his masterpiece Capital. That is, the LTV allows Marx to determine the rate of profit independently of prices. Note that Marx was also aware that relative prices determined by the amounts of labor directly and indirectly incorporated are incorrect once you have produced means of production. However, Marx thought that embodied labor redistributed by the process of competition meant that in the aggregate total surplus value corresponded to total profits, even if prices of production deviated from embodied labor. As a result, on the basis of the LTV it was still possible to obtain the correct rate of profit. As it turns out, there is no reason for positive and negative deviations of prices of production from the labor values to cancel out. You cannot argue with the algebra.

Marx had no way of knowing this. Only with Bortkiewicz, Dimitriev and Tugan-Baranovsky’s work, early in the 20th century, this was clearly understood. If in general commodities do not exchange at labor values, then there is no reason why that should be correct for two composite commodities that make the total physical surplus and the physical advanced means of production.

Sraffa's solution, based on the standard commodity (to be discussed in another post), shares with Ricardo's corn model the idea that one can measure the rate of profit as a share of a particular commodity (Sraffa’s being a composite commodity, that is, composed of several goods). It also shares with Ricardo the fact that only basics (commodities that enter the production of all goods including their own production), which for simplicity can be related to subsistence goods, affect the rate of profit, while non-basics, or luxury goods, are not relevant. Further, as noted by Sraffa too, his solution resembles Smith’s since the standard commodity can be seen as akin to the former's idea of labor commanded, that is relative prices are proportional to the amount of labor that they can command (buy). In that sense, Sraffa's prices are firmly based on a certain notion of the labor theory of value.”
Matias Vernengo, “Sraffa and Marxism or the Labor Theory of Value, what is it good for?,” Naked Keynesianism, August 14, 2012.

The central problem as it emerged in Classical economics and taken over by Marx was, according to Vernengo: how is the rate of profit determined independently of prices? (where the long-run, normal uniform rate of profit determines long-run prices). But it seems to me that the LTV was much more to Marx in volume 1 of Capital than just a way to “determine the rate of profit independently of prices.”

Marx really does try to explain individual commodity prices in terms of their abstract socially necessary labour time (SNLT) in volume 1, as in his absurd example of how rising unit SNLT in a reduced cotton crop after a spoiled crop is supposed to explain the rising price of cotton and even the price rise of cotton produced in previous production periods (Marx 1982: 317–318). When Marx says that exchange of commodities is an equality of value and that the cause of this equality is equal SNLT (Marx 1982: 127–129), how on earth can he say such a thing if he thinks that SNLT doesn’t actually determine individual commodity prices?

Right in Chapter 1 of Capital (vol. 1), Marx explains exchange value in these terms:

“We have assumed that the coat is worth twice as much as the linen. But this is merely a quantitative difference, and does not concern us at the moment. We shall therefore simply bear in mind that if the value of a coat is twice that of 10 yards of linen, 20 yards of linen will have the same value as a coat. As values, the coat and the linen have the same substance, they are the objective expressions of homogeneous labour.” (Marx 1982: 124).

If this was not meant to be an explanation of any real world exchange values at all, then Marx was one of the most incompetent economic writers ever, as Gray (1946: 320) notes.

But let us move on with the main points raised by Vernengo. First, Marx’s solution of saying that “in the aggregate total surplus value corresponded to total profits, even if prices of production deviated from embodied labor” was only published in volume 3 of Capital, so this seems to gloss over the contradiction between volume 1 and 3, which was noted by many people after volume 3 was published in 1894 such as V. K. Dimitriev, Werner Sombart, Achille Loria, Conrad Schmidt, Mikhail Ivanovich Tugan-Baranovsky, Ladislaus von Bortkiewicz, Peter Berngardovich Struve, and Eugen von Böhm-Bawerk. Even worse, some of these critics were actually Marxists themselves.

But even if we put these concerns above aside, we come to the issue of whether Sraffa provided a viable way to embed the idea of a certain labour value in a coherent theory of prices and capitalism, where the rate of profit is determined independently of prices.

The trouble here is that Sraffa’s own economic model has serious problems, as identified in Post Keynesian critiques of Sraffianism such as Halevi and Kriesler (1991), Lee (1994: 325–327), Minsky (1990) and Robinson (1979).

Sraffa’s model excludes real world money (Davidson 2003–2004: 247; Hodgson 1981: 83–84), and even if one might pick some commodity to function only as a numèraire/unit of account in it, everyone knows that this isn’t real world money, just as it isn’t in neo-Walrasian general equilibrium models, as argued by Rogers (1989: 46–47). Once real world money and uncertainty are introduced into Sraffa’s long-run model, one cannot legitimately defend the idea that prices and the profit rate are determined by technological factors and the real wage (Hodgson 1981: 93). A monetary production economy with uncertainty means the determination of wages, prices and profits becomes highly complex and, for want of a better word, messy.

Even worse is the notion of Sraffian long-run prices, where there is a uniform rate of profit (Lavoie 2014: 176). Many other Post Keynesians would reject the idea that there is any actual tendency to an economy-wide uniform rate of profit (Lavoie 2014: 176), and not just because there are permanent, severe barriers to entry and free competition in many sectors of a real world capitalist economy (and not just based on monopoly but on fundamental factors such as capacity utilisation). In essence, (1) one cannot reduce actual mark-up pricing to a simple practice of a mark-up on labour costs (Lee 1994: 325) and (2) the rate of profit mark-up in each industry and business will be determined by many factors such as custom, convention, different desires and needs for various profit rates, different levels of competition, and what mark-up the market will bear, etc., and these factors will themselves vary in different times and places (Lee 1994: 325–326). Consequently the Marxist and Sraffian notion of a real world tendency in capitalism to long-run prices of production with a uniform rate of profit is untenable (Lee 1994: 326–327).

But, then, with a highly variable rate of profit (determined through prices and mark-ups) being a permanent condition of real world capitalism, it would seem that the profit rate is not independent of prices, and prices are not necessarily proportional to the amount of labor, given the failure of the system to converge to any long-run prices of production and the existence of permanent, different target profit rates in different industries that are never competed away. And we need only look at some real world mark-ups to see how absurd it is to think that prices or profits must be proportional to the amount of labour cost or time. If you are charging an astronomical mark-up of 2,000–4,000% (and get away with it in the long-run!), then many prices have only a tenuous relation to labour cost. Then when we add to this Philip Pilkington’s insightful observation that there is “a strongly subjective element in price formation that is manipulable on the supply-side (advertising and marketing etc.),” we can see that businesses can increase and maintain their mark-ups by affecting human psychology and subjective and intersubjective values.

All in all, if Sraffa’s model fails, then it cannot save Marxism, no matter how watered down a labour theory of value Sraffianism has.

BIBLIOGRAPHY
Davidson, Paul. 2003–2004. “Setting the Record Straight on ‘A History of Post Keynesian Economics,’” Journal of Post Keynesian Economics 26.2 245–272.

Halevi, Joseph and Kriesler, Peter. 1991. “Kalecki, Classical Economics and the Surplus Approach,” Review of Political Economy 3.1: 79–92.

Hodgson, G. 1981. “Money and the Sraffa System,” Australian Economic Papers 20: 83–95.

Lavoie, Marc. 2014. Post-Keynesian Economics: New Foundations. Edward Elgar, Cheltenham.

Lee, F. S. 1994. “From Post-Keynesian to Historical Price Theory, Part I: Facts, Theory and Empirically Grounded Pricing Model,” Review of Political Economy 6.3: 303–336.

Marx, Karl. 1982. Capital. Volume One. A Critique of Political Economy (trans. Ben Fowkes). Penguin Books, Harmondsworth, England.

Minsky, H. P. 1990. “Sraffa and Keynes: Effective Demand in the Long Run,” in Krishna Bharadwaj and Bertram Schefold (eds.), Essays on Piero Sraffa: Critical Perspectives on the Revival of Classical Theory. Unwin Hyman, London. 362–371.

Robinson, J. 1979. “Garegnani on Effective Demand,” Cambridge Journal of Economics 3: 179–180.

Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.

Progress in Marxism on the Labour Theory of Value?

Well, yes, but only if Marxists throw the mystical labour theory of value aside and abandon it.

I point readers to this article by Ernesto Screpanti:

Ernesto Screpanti, “The Demise of Marx’s Labour Theory of Value and the ‘New Interpretation’: A Recap Note,” n. 708, March 2015.
http://www.deps.unisi.it/sites/st02/files/allegatiparagrafo/14-03-2015/708.pdf

David Fields on the Naked Keynesian blog also refers to it here.

Screpanti wishes to show the following:

“Marx’s theory of labour value is flawed. This note summarizes the main reasons why this is so. At the same time, it claims that the theory of exploitation does not depend on a labour embodied valuation and can be expounded by resorting to the theory of production prices. Almost all Marxists have now accepted this truth. Most of them have been convinced by a ‘new interpretation’ which has been able to translate the price of net output into an amount of ‘living labour’ and the rate of exploitation into a ratio between unpaid and paid labour. What produced such a surprising result is the use of labour productivity as a numeraire.” (Screpanti 2015: 1).

He then expounds a corn model economy in which he analyses the relationship between labour and output (Screpanti 2015: 2–4). Screpanti also notes that many Marxists have abandoned Marx’s theory of value for Piero Sraffa’s theory of production prices, yet the so-called “new interpreters” also distance themselves from Sraffa too, even though Screpanti apparently thinks they can be reconciled (Screpanti 2015: 7, 9).

Let Marxists argue over the merits of this paper, because ultimately I wonder why they even bother to continue calling themselves Marxist at all. If you repudiate major defining aspects of your Marxist economic theory (such as the labour theory of value or historical materialism), then why even cling to the name “Marxist”? Could it have something to do with the fact that what you belong to is actually a cult and you have profound difficulties escaping from your cult?

For I have no doubt that the central aspect of classical Marxism – the labour theory of value – is a mystical and metaphysical dogma that requires faith to believe in.

For Marx, money prices/exchange values are determined by the socially necessary labour-time occurring in production:

“The production of commodities must be fully developed before the scientific conviction emerges, from experience itself, that all the different kinds of private labour (which are carried on independently of each other; and yet, as spontaneously developed branches of the social division of labour, are in a situation of all-round dependence on each other) are continually being reduced to the quantitative proportions in which society requires them. The reason for this reduction is that in the midst of the accidental and ever-fluctuating exchange relations between the products, the labour-time socially necessary to produce them asserts itself as a regulative law of nature. In the same way, the law of gravity asserts itself when a person’s house collapses on top of him. The determination of the magnitude of value by labour-time is therefore a secret hidden under the apparent movements in the relative values of commodities.” (Marx 1982: 168).

So money prices are determined and driven by a “magnitude of value by labour-time” and this is a type of anchor around which money prices might fluctuate, even though they are supposed to be driven back to the socially necessary labour-time anchor when they deviate from it.

Yet Marxists have devoted decades and dozens of books to attempting to solve their notorious transformation problem, and they have never solved it, because it is a complete pseudo-problem.

Missing in modern Marxism is hard empirical study of how most prices are actually determined in capitalist economies and the willingness to formulate theories based on the empirical evidence, not on a prior quasi-religious belief in the labour theory of value.

Nor will basing modern Marxism on Sraffian economics save Marxism, because Sraffian economics has serious problems, as outlined here and here.

Human labour has historically been required and is still required to engage in production and creation of output (though we will probably reach a time in the next 100 years when only minimal human labour is required to run an advanced capitalist economy). In this utilitarian sense, of course labour has value. Obviously it is a necessary factor of production, but then so are non-labour factor inputs too.

But the trouble is: this doesn’t take you very far. It is almost a trivial truth.

For example, without the sun and the energy it provides, there wouldn’t be any production either. Maybe we could even invent an economic cult based on a “sun theory of value”: we could argue that all commodities are just embodiments of the “physically-necessary sun energy” required to produce them. Therefore all prices must really just be reducible to and determined by “physically-necessary sun energy.” We could waste our lives desperately trying to solve our “transformation problem”: how is the quantity of “physically-necessary sun energy” transformed into money prices of goods on the market? We could also argue that we are all – workers and capitalists – ruthlessly exploiting the poor, oppressed and innocent sun!, and so on and so forth. The trouble is, it would all be a lot of nonsense.

Let us now return to the real world. Why is the labour theory of value wrong? Most prices in modern economies are mark-up prices. Fundamentally, there is no reason to think that some mystical “socially necessary labour-time” determines prices in modern capitalism. First, it is not labour time per se but average unit cost of labour along with the average unit cost of all other non-labour factors at a given quantity of output that is used to calculate most prices. Then businesses add a profit mark-up to this, nearly always.

There is no universal tendency towards cost of production prices and zero profits throughout a competitive capitalist economy. Even if there was, there is no reason to think that “cost of production” prices would embody socially necessary labour-time involved in producing them. Most mark-up prices do not gravitate towards cost of production (whether based on total average unit costs or marginal cost), and mark-up pricing and highly imperfect competition in any real world market economy therefore badly undermine the Marxist, Classical and Sraffian view that there exists a tendency towards zero or a uniform rate of profit throughout a competitive capitalist economy.

The labour theory of value is mystical nonsense and the whole Marxist project is just another example of how people on the Left have wasted their lives and careers on an utterly embarrassing cult, when they could have been doing constructive things with their time.

It is good news that economic Marxism has become a fringe movement. It is bad news, however, that the Left is still ridden with lots of other outrageous nonsense too, and large numbers of other modern left-wing people have also wasted their lives on cultural Marxism, Poststructuralism, and Postmodernism.

Further Reading
“Mysticism and the Labour Theory of Value,” May 7, 2014.

“Lavoie on ‘Should Sraffian Economics be dropped out of the Post-Keynesian School?,’” June 19, 2014.

“Sraffians versus Kaleckians versus Fundamentalist Post Keynesians,” June 17, 2014.

“Did Kalecki Accept the Labour Theory of Value?,” April 18, 2014.

“Automation and Robots in the News,” February 23, 2015.

“Adam Smith on the Labour Theory of Value,” April 20, 2014.

BIBLIOGRAPHY
Marx, Karl. 1982. Capital. Volume One. A Critique of Political Economy (trans. Ben Fowkes). Penguin Books, Harmondsworth, England.

Screpanti, Ernesto. 2015. “The Demise of Marx’s Labour Theory of Value and the ‘New Interpretation’: A Recap Note,” n. 708.
http://www.deps.unisi.it/sites/st02/files/allegatiparagrafo/14-03-2015/708.pdf

Callahan on Price Rigidity

Gene Callahan has an interesting post here that he regards as a “brief sketch of the Keynesian ‘vision’”:

Gene Callahan, “A Brief Sketch of the Keynesian ‘Vision,’” La Bocca della Verità, February 3, 2014.

His point (5) on price rigidity is a crucial one:

“5) Producers are likely to adjust to this situation [sc., aggregate demand failure] through cutting back on production rather than by making price adjustments, so that the economy spirals down into a recession.”

His comment on this is as follows:

“5) Here is the final spot for a genuine argument against Keynes, and once again it turns out to be an empirical matter: do price adjustments take place rapidly enough in a largely unfettered market that quantity adjustments will play a relatively minor role? If so, a recession will never really build any momentum.”

Callahan seems to be thinking of old neoclassical synthesis Keynesians and New Keynesians here. But it is important to distinguish between the New Keynesian view of price rigidity and that of Post Keynesianism.

Many New Keynesians believe that, if only wages and prices were perfectly flexible, then economies would adjust rapidly to full employment equilibrium. Post Keynesians, following Keynes himself, reject the view that perfectly flexible wages, prices and perfect competition would lead to full employment equilibrium. Even if there were perfectly flexible wages and prices, there could still be failures of aggregate demand (Davidson 1992; Hill: 1996: 377). But let me put that issue entirely to the side, and assume a standard New Keynesian analysis.

One must ask why should a “genuine argument against Keynes” (or, rather, New Keynesians) have to be made with respect to a “largely unfettered market”? Surely the relevant concept is “real world markets.”

Here a mountain of empirical evidence has been available for many years, and it shows that administered prices/mark-up prices/full cost prices are the majority of prices in modern market economies.

Such prices are set by businesses through their cost accounting conventions in an ex ante manner before transactions take place, on the basis of (1) total average unit costs plus (2) a profit mark-up, at a given, estimated, projected or target quantity of output or level of sales (from which of course the ex post or actual quantity of output produced or sold in a given time period might differ).

Empirical evidence shows us that mark-up prices are generally inflexible with respect to demand, but tend to change – though it is by no means a necessary or universal process – when total average unit costs change or when the business wants to change its profit mark-up.

The early empirical work and theory development on administered prices/mark-up prices was done by Gardiner C. Means (1935, 1936, 1939–1940, 1962, 1992 [1933], and 1972, which are discussed here and here), Hall and Hitch (1939) (discussed here and here), P. W. S. Andrews (1949, 1949a, 1964), Kalecki (1954, 1971), A. D. H. Kaplan (Kaplan et el. 1958), and others.

But much more empirical evidence has been done over the past 50 years too (much of it listed here or in Appendix 1 below, including literature from the related “marginalist” controversy), and especially by central bank surveys on price setting over the past 10 years that were inspired by Blinder’s influential direct surveys on US business price setting (Blinder 1998).

The standard Post Keynesian works on mark-up pricing are Lee (1998) and Downward (1999).

The most recent empirical evidence on mark-up pricing in many nations can be seen below, with longer analysis given in separate posts I link to at the end of each “literature” section:

(1) The United States

Literature:
Kaplan, A. D. H., Dirlam, J. B. and Lanzillotti, R. F. 1958. Pricing in Big Business: A Case Approach. The Brookings Institution, Washington DC.

Lanzillotti, R. F. 1964. Pricing Production and the Marketing Policies of Small Manufacturers. Washington State University Press, Pullman, Washington.

Gordon, L. A., Cooper, R., Falk, H., and D. Miller. 1981. The Pricing Decision. National Association of Accountants, New York.

Govindarajan, V. and R. Anthony. 1986. “How Firms use Cost Data in Price Decisions,” Management Accounting 65: 30–34.

Shim, Eunsup, and Ephraim Sudit. 1995. “How Manufacturers Price Products,” Management Accounting 76.8: 37–39.

Blinder, A. S. et al. (eds.). 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage Foundation, New York.

Downward, Paul and Frederic Lee. 2001. “Post Keynesian Pricing Theory ‘Reconfirmed’? A Critical Review of Asking about Prices,” Journal of Post Keynesian Economics 23.3: 465–483.

“Two Marketing Studies on US Administered Prices,” November 16, 2013.

Govindarajan and Anthony (1986) and Shim and Sudit (1995) are two marketing surveys that found that from the 1980s to the 1990s mark-up pricing accounted for roughly 70% to 85% of US industrial prices.

In a much broader and more representative survey for the US economy as a whole, Blinder et al. (1998: 200–201) found that 56.8% of the firms they surveyed said that the idea that prices and price changes depend mainly on costs of production ranked as “very important” (38.8%) or moderately important (18%).

(2) Canada

Literature:
Amirault, D., Kwan, C. and G. Wilkinson. 2004. “A Survey of the Price-Setting Behaviour of Canadian Companies,” Bank of Canada Review 2004/2005: 29–40.
http://www.bankofcanada.ca/2006/09/publications/research/working-paper-2006-35/

“Mark-up Pricing in Canada,” January 7, 2014.

Amirault, Kwan, and Wilkinson (2004) examine price setting in Canada, and report the results of a survey of 170 private, unregulated, non-primary sector firms in the sectors of construction (10%), manufacturing (26%), trade (14%), and services (49%), in a sample which should give representative results for about 70% of Canada’s output in 2002 (Amirault, Kwan, and Wilkinson 2004: 3–4).

An impressive 67.1% of firms surveyed attributed price inflexibility to “cost-based pricing” – that is, to mark-up pricing (Amirault, Kwan, and Wilkinson 2004: 21).

(3) Eurozone

Literature:
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.

Fabiani, Silvia, Suzanne Loupias, Claire, Monteiro Martins, Fernando Manuel and Roberto Sabbatini. 2007. Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York.

“Administered Prices in the Eurozone: Some Empirical Data,” October 16, 2013.

The wide-ranging survey of Fabiani et al. (2006) and (2007) on prices in the Eurozone from many central bank studies finds that the average for mark-up pricing throughout the Eurozone is 54%, a majority of firm prices.

In goods markets in Germany, the largest economy in Europe, a strikingly high 73% of firms have administered prices (Fabiani et al. 2006: 18, Table 4).

(4) the UK

Literature:
Greenslade, Jennifer V. and Miles Parker. 2012. “New Insights into Price-Setting Behaviour in the UK: Introduction and Survey Results,” Economic Journal 122.558: F1–F15.

Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’ Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.

“Administered Pricing in the United Kingdom,” October 19, 2013.

“Downward’s Pricing Theory in Post-Keynesian Economics: Chapter 8,” January 23, 2014.

Greenslade and Parker (2012), the most recent study, finds that cost-based pricing with variable mark-ups accounted for 58% of firms surveyed.

Downward (1999, Chapter 8) presents a survey of 283 UK manufacturing enterprises (Downward 1999: 150–151). When asked whether the firm set its prices for its products by means of a mark-up on average costs, 63.7% of firms said either “very often” (29.9%) or “often” (33.8%). A further 17.3% said “sometimes.” Only 7% said “rarely,” and only 8.1% said “not at all” (Downward 1999: 160).

(5) Norway

Literature:
Langbraaten, Nina, Nordbø, Einar W. and Fredrik Wulfsberg. 2008. “Price-setting Behaviour of Norwegian Firms – Results of a Survey,” Norges Bank Economic Bulletin 79.2: 13–34.
http://www.norges-bank.no/en/about/published/publications/economic-bulletin/economic-bulletin-22008/price-setting-behaviour-of-norwegian-firms--results-of-a-survey/

“Mark-up Pricing in Norway,” November 23, 2013.

Langbraaten et al. (2008) cite a well-sampled survey of 725 firms throughout many sectors of the Norwegian economy that found that 69% of Norwegian businesses use mark-up pricing.

(6) Ireland

Literature:
Keeney, Mary, Lawless, Martina, and Alan Murphy. 2010. “How Do Firms Set Prices? Survey Evidence from Ireland,” Central Bank of Ireland, Research Technical Papers, no 7/RT/10.
http://ideas.repec.org/p/cbi/wpaper/7-rt-10.html

“Mark-up Pricing in Ireland,” November 22, 2013.

Keeney et al. (2010) report the results of a survey of 1000 Irish firms and finds that the largest type of pricing is mark-up pricing at 44% of firms. Other evidence from their paper, presented in my post here, suggests that the real percentage is higher than this, since when firms were asked how likely it was that they would adjust prices downwards in response to a negative demand shock, 66.5% of firms said that negative demand shocks were of little or no relevance to pricing decisions.

(7) Iceland

Literature:
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
www.sedlabanki.is/lisalib/getfile.aspx?itemid=8891‎

“Mark-up Prices in Iceland,” November 25, 2013.

Ólafsson et al. (2011) cite a survey of 580 Icelandic firms and finds that mark-up pricing is the largest type of pricing at 45%. Evidence suggests that more mark-up prices are concealed in the other categories in the survey, so that the real percentage is higher than this.

(8) Sweden

Literature:
Apel, Mikael, Friberg, Richard and Kerstin Hallsten. 2005. “Microfoundations of Macroeconomic Price Adjustment: Survey Evidence from Swedish Firms,” Journal of Money, Credit and Banking 37.2: 313–338.

“Mark-up Pricing in Sweden,” January 9, 2014.

Apel et al. (2005) provide data on price setting behaviour in Sweden, from a survey of about 600 private sector firms (Apel et al. 2005: 314) weighted to create a more representative sample of the Swedish economy (Apel et al. 2005: 316), but their study fails to directly ask firms how they set price.

Interestingly, when asked why they leave prices unchanged in response to small changes in demand, many firms said “it is better to leave the price unchanged as long as the costs do not change” (Apel et al. 2005: 323), which gives some support to the view that mark-up pricing is important.

(9) Japan

Literature:
Hsu, Robert. 1999. “Pricing Practices in Japan,” Global Business and Economics Review 1.2: 164–171.

Nakagawa, S., R. Hattori and I. Takagawa, 2000. “Price-Setting Behaviour of Japanese Companies,” Bank of Japan Research Paper
http://www.boj.or.jp/en/research/brp/ron_2000/ron0009b.htm/

“Mark-up Pricing in Japan,” November 29, 2013.

Nakagawa and Takagawa (2000) cite a survey of 630 Japanese companies. As interpreted by Fabiani et al. (2007: 190), the data suggest that least 54% of Japanese firms use mark-up pricing.

(10) New Zealand

Literature:
Parker, Miles. “Price-Setting Behaviour in New Zealand”
https://cama.crawford.anu.edu.au/amw2013/doc/Parker,Miles.pdf

“Mark-up Pricing in New Zealand,” November 30, 2013.

Parker cites a survey of around 5,300 New Zealand firms that finds that mark-up prices account for about 54% of business prices.

(11) Australia

Literature:
Park, Anna, Rayner, Vanessa and Patrick D’Arcy. 2010. “Price-Setting Behaviour – Insights from Australian Firms,” Reserve Bank of Australia Bulletin (June Quarter): 7–14.
http://www.rba.gov.au/publications/bulletin/2010/jun/bu-0610-2a.html

“Mark-up Pricing in Australia,” November 30, 2013.

Park, Rayner, and D’Arcy (2010) cite a survey of around 700 Australian firms that finds that mark-up prices account for at least 49% of firm prices. Once we add likely mark-up prices concealed in the other categories in the survey, the percentage will be higher than this.

BIBLIOGRAPHY
Amirault, D., Kwan, C. and G. Wilkinson. 2004. “A Survey of the Price-Setting Behaviour of Canadian Companies,” Bank of Canada Review 2004/2005: 29–40.
http://www.bankofcanada.ca/2006/09/publications/research/working-paper-2006-35/

Andrews, P. W. S. 1949. “A Reconsideration of the Theory of the Individual Business,” Oxford Economic Papers n.s. 1.1: 54–89.

Andrews, P. W. S. 1949a. Manufacturing Business. Macmillan, London.

Andrews, P.W.S. 1964. On Competition in Economic Theory. Macmillan, London.

Apel, Mikael, Friberg, Richard and Kerstin Hallsten. 2005. “Microfoundations of Macroeconomic Price Adjustment: Survey Evidence from Swedish Firms,” Journal of Money, Credit and Banking 37.2: 313–338.

Berle, Adolf A. and Gardner C. Means. 1932. The Modern Corporation and Private Property. Macmillan, New York.

Blinder, A. S. et al. (eds.). 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage Foundation, New York.

Davidson, P. 1992. “Would Keynes be a New Keynesian?,” Eastern Economic Journal 18.4: 449–463.

Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Downward, Paul and Frederic Lee. 2001. “Post Keynesian Pricing Theory ‘Reconfirmed’? A Critical Review of Asking about Prices,” Journal of Post Keynesian Economics 23.3: 465–483.

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.

Fabiani, Silvia, Suzanne Loupias, Claire, Monteiro Martins, Fernando Manuel and Roberto Sabbatini. 2007. Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York.

Govindarajan, V. and R. Anthony. 1986. “How Firms use Cost Data in Price Decisions,” Management Accounting 65: 30–34.

Greenslade, Jennifer V. and Miles Parker. 2012. “New Insights into Price-Setting Behaviour in the UK: Introduction and Survey Results,” Economic Journal 122.558: F1–F15.

Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.

Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’ Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.

Hill, Greg. 1996. “Capitalism, Coordination, and Keynes: Rejoinder to Horwitz,” Critical Review 10: 373–387.

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.

Kaplan, A. D. H., Dirlam, J. B. and Lanzillotti, R. F. 1958. Pricing in Big Business: A Case Approach. The Brookings Institution, Washington DC.

Keeney, Mary, Lawless, Martina, and Alan Murphy. 2010. “How Do Firms Set Prices? Survey Evidence from Ireland,” Central Bank of Ireland, Research Technical Papers, no 7/RT/10.
http://ideas.repec.org/p/cbi/wpaper/7-rt-10.html

Langbraaten, Nina, Nordbø, Einar W. and Fredrik Wulfsberg. 2008. “Price-setting Behaviour of Norwegian Firms – Results of a Survey,” Norges Bank Economic Bulletin 79.2: 13–34.
http://www.norges-bank.no/en/about/published/publications/economic-bulletin/economic-bulletin-22008/price-setting-behaviour-of-norwegian-firms--results-of-a-survey/

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

Means, G. C. 1992 [1933]. “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.

Nakagawa, S., R. Hattori and I. Takagawa, 2000. “Price-Setting Behaviour of Japanese Companies,” Bank of Japan Research Paper
http://www.boj.or.jp/en/research/brp/ron_2000/ron0009b.htm/

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
www.sedlabanki.is/lisalib/getfile.aspx?itemid=8891‎

Park, Anna, Rayner, Vanessa and Patrick D’Arcy. 2010. “Price-Setting Behaviour – Insights from Australian Firms,” Reserve Bank of Australia Bulletin (June Quarter): 7–14.
http://www.rba.gov.au/publications/bulletin/2010/jun/bu-0610-2a.html

Parker, Miles. “Price-Setting Behaviour in New Zealand”
https://cama.crawford.anu.edu.au/amw2013/doc/Parker,Miles.pdf

Pittman, Russell. 2009. “Who Are You Calling Irrational? Marginal Costs, Variable Costs, and the Pricing Practices of Firms,” Economic Analysis Group Discussion Paper 09-3
http://www.justice.gov/atr/public/eag/248394.htm

Shim, Eunsup, and Ephraim Sudit. 1995. “How Manufacturers Price Products,” Management Accounting 76.8: 37–39.

Appendix 1
Below are the main surveys and articles in the “full cost” and marginalist pricing debate of the 1940s to 1970s

Against Marginalism
Kaplan, A. D. H., Dirlam, J. B. and Lanzillotti, R. F. 1958. Pricing in Big Business: A Case Approach. The Brookings Institution, Washington DC.

Lanzillotti, Robert F. 1958. “Pricing Objectives in Large Companies,” American Economic Review 48.5: 921–940.

Kahn, Alfred E. 1959. “Pricing Objectives in Large Companies: Comment,” American Economic Review 49.4: 670–678.

Lanzillotti, Robert F. 1959. “Pricing Objectives in Large Companies: Reply,” American Economic Review 49.4: 679-687.

Barback, R. H. 1964. Pricing of Manufactures. Macmillan and Co Ltd., London.

Wentz, Theodore E. 1966. “Realism in Pricing Analyses,” Journal of Marketing 30.2: 19–26.

Skinner, R. C. 1970. “The Determination of Selling Prices,” Journal of Industrial Economics 18.3: 201–217.

Sizer, John. 1971. “Note on ‘the Determination of Selling Prices,’” The Journal of Industrial Economics 20.1: 85–89.

Hague, D. C. 1971. Pricing in Business. George Allen and Unwin, London.

Burck, G. 1972. “The Myths and Realities of Corporate Pricing,” Fortune 85.4: 85–89, 125–126.

Atkin, B. and Skinner, R. 1975. How British Industry Prices. Industrial Market Research Limited, London.

Shipley, David D. 1981. “Pricing Objectives in British Manufacturing Industry,” The Journal of Industrial Economics 29.4: 429–443.

Gordon, L. A., Cooper, R., Falk, H., and D. Miller. 1981. The Pricing Decision. National Association of Accountants, New York.

Hankinson, A. 1985. A Study of Pricing Behaviour of Dorset-Hampshire Small Engineering Firms. Dorset Institute of Higher Education, Poole, Dorset.

Bruegelman, T., Haessly, G., Wolfangel, C. P. and Schiff, M. 1985. “How Variable Costing is used in Pricing Decisions,” Management Accounting 66: 58–61, 65.

Samiee, S. 1987. “Pricing in Marketing Strategies of US- and Foreign-based Firms,” Journal of Business Research 15: 17–30.

Defending Marginalism
Gordon, R. A. 1948. “Short Period Price Determination in Theory and Practice,” American Economic Review 38: 265–288.

Hague, D. C. 1949–1950. “Economic Theory and Business Behaviour,” Review of Economic Studies 16: 144–157.

Edwards, R. S. 1952. “The Pricing of Manufactured Products,” Economica 19: 298–307.

Simon, H. A. 1952. “A Behavioural Model of Rational Choice,” Quarterly Journal of Economics 69: 99–118.

Simon, H. A. 1959. “Theories of Decision Making in Economies,” American Economic Review 49: 253–283.

Shackle, G. L. S. 1955. “Businessmen on Business Decisions,” Scottish Journal of Political Economy 2: 32–46.

Earley, James S. 1956. “Marginal Policies of ‘Excellently Managed’ Companies,” American Economic Review 46.1: 44–70.

Cook, A. C., Dufty, N. F. and Jones, E. H. 1956. “Full Cost Pricing in the Multiproduct Firm,” The Economic Record 32: 142–147.

Pearce, I. F. 1956. “A Study in Price Policy,” Economica n.s. 23.90: 114–127.

Pearce, I. F. and Amey, L. R. 1956–1957. “Price Policy with a Branded Product,” The Review of Economic Studies 24: 49–60.

Fog, B. 1960. Industrial Pricing Policies: An Analysis of Pricing Policies of Danish Manufacturers. North Holland Publishing, Amsterdam.

Knox, R. L. 1966. “Competitive Oligopolistic Pricing,” Journal of Marketing 30: 47–51.

Neutral Studies
Alt, R. M. 1949. “The Internal Organisation of the Firm and Price Formation: An Illustrative Case,” Quarterly Journal of Economics 63: 92–110.

Woodruff, W. 1953. “Early Entrepreneurial Behaviour in Relation to Costs and Prices,” Oxford Economic Papers 5: 41–64.

Blackwell, R. 1953–1954. “The Pricing of Books,” Journal of Industrial Economics 2: 174–183.

Cook, A. and Jones, F. 1954. “Full Cost Pricing in Western Australia,” The Economic Record 30: 272–274.

Balkin, N. 1956. “Prices in the Clothing Industry,” Journal of Industrial Economics 5.1: 1–15.

Lazer, W. 1956–1957. “Price Determination in the Western Canadian Garment Industry,” Journal of Industrial Economics 5: 124–136.

Pool, A. G. and Llewellyn, G. 1957. The British Hosiery Industry: A Study in Competition. Leicester University Press, Leicester.

Lydall, H. F. 1958. “Aspects of Competition in Manufacturing Industry,” Institute of Economics and Statistics Bulletin 20: 319–337.

Haynes, W. W. 1962. Pricing Decisions in Small Business. University of Kentucky Press, Lexington, KY.

Haynes, W. W. 1964. “Pricing Practices in Small Firms,” The Southern Economic Journal 30: 315–324.

Lanzillotti, R. F. 1964. Pricing Production and the Marketing Policies of Small Manufacturers. Washington State University Press, Pullman, Washington.

Rosendale, R. B. 1973. “The Short Run Pricing Policies of Some British Engineering Exporters,” National Institute Economic Review 65: 44–51.

Nowotny, Ewald and Herbert Walther. 1978. “The Kinked Demand Curve—Some Empirical Observations,” Kyklos 31: 53–67.

Forgionne, G. A. 1984. “Economic Tools used by Management in Large American Operated Corporations,” Business Economics 19: 5–17.

Jobber, D. and Hooley, G. 1987. “Price Behaviour in the UK Manufacturing Service Industries,” Managerial and Decision Economics 8.2: 167–171.

Smiley, Robert. 1988. “Empirical Evidence on Strategic Entry Deterrence,” International Journal of Industrial Organization 6.2: 167—180.

Blinder, Alan S. 1991. “Why are Prices Sticky? Preliminary Results from an Interview Study,” American Economic Review 81.2: 89–96.

Additional Studies
Alchian, A. A. 1950. “Uncertainty, Evolution and Economic Theory,” Journal of Political Economy 58: 211–221.

Robinson, A. 1950. “The Pricing of Manufactured Products,” Economic Journal 60: 771–780.

Machlup, F. 1946. “Marginal Analysis and Empirical Research,” American Economic Review 36: 519–554.

Heflebower, R. F. 1955. “Full Costs, Cost Changes, and Prices,” in National Bureau of Economic Research, Business Concentration and Price Policy. Princeton University Press, Princeton. 361–392.

Coase, R. 1955. “Full Cost, Cost Changes, and Prices: Comment,” in National Bureau of Economic Research, Business Concentration and Public Policy. Princeton University Press, Princeton. 392–394.

Wiles, P. 1950. “Empirical Research and the Marginal Analysis,” Economic Journal 60: 515–530.

Robinson, J. V. 1953. “Imperfect Competition Revisited,” Economic Journal 63: 579–593.

John Kenneth Galbraith on Price Controls

This fascinating passage from John Kenneth Galbraith’s A Theory of Price Control (1952) gives us a crucial insight into Galbraith’s prices controls when he worked as deputy head of the Office of Price Administration (OPA) from 1941 to 1943 during World War II:

“The next major respect in which the imperfect market assists the price-fixer arises from the tendency for prices to be inflexible and also, in some measure, institutionalized, in such markets. Where the seller has control over his prices—and ex hypothesi he has some measure of control in every imperfect market—he may for any one of a number of reasons seek to minimize the frequency of price changes. In some instances, market control, the entente between sellers itself, can be maintained only if prices are stable; the understanding may not be sufficiently complete or durable to survive too many ups-and-downs. In other cases, customers, or the Department of Justice, may have become accustomed to stable prices and may be aroused by change. Changes in prices also may be costly either in money or administrative convenience. Accordingly, profit maximization in an imperfect market may require that prices be kept constant over substantial periods; the price changes that would be required by any attempt to keep profits at a maximum at every point of time would reduce returns over a period of time.

The phenomenon of inflexible prices had been well-observed before the war, but so far as I am aware (and for good enough reasons) no one had observed that this inflexibility would facilitate wartime control. The contribution was considerable. Not only had buyers and sellers in markets characterized by rigid prices become accustomed to the level of the price, but they had also become familiar with the differentials, discounts, special deals, and all the other appurtenances of the price structure. It is much easier to continue and enforce such a settled and familiar structure than to check the upward surge of a more nearly competitive market. And in competitive markets, because differentials and discounts, like the level of prices itself, may change in day-to-day bargaining, no price schedule is as likely to conform neatly to a past structure. So, precisely at the time when sellers or market operators in such markets lose the prospect of higher prices or speculative gains, they must alter their business to conform to rules laid down in some not very engaging government prose.

For such sellers, compared with those who have been selling at infrequently changing prices, the discomforts of price control are great. The Office of Price Administration controlled the prices of all steel mill products with far less man power and trouble than was required for a far smaller dollar volume of steel scrap. Handlers of farm products complained with especial bitterness of OPA regulations, perhaps partly because it is their nature to complain, but partly because, as participants in competitive markets, their difficulties were greater. I am tempted to frame a theorem that is all too evident in this discussion: it is relatively easy to fix prices that are already fixed.

Infrequent changes in prices may best serve the long-run earnings position of a firm or industry. There is also a strong element of convention in price-making, which works on the side of infrequent change, and which does not directly serve the goal of maximum return. Traditionally (or in textbooks, at least), custom or convention has been considered an exceptional or off-type factor in price-making. The experience of modern wartime price control, I believe, would indicate its more general importance. It, too, helped the price-fixer.

The stronghold of conventional or customary pricing is in distributors’ margins, particularly in retail selling. For a large proportion of all retailers and a rather smaller proportion of all retail trade, the price charged for the service is a strictly conventional markup or ‘mark-on.’ Sometimes this is the markup suggested by the supplier; sometimes it is conventional with the store or trade for that particular class of merchandise. In either case, price control was invoked in markets in which participants had ceased to look upon price-setting as one of the exploitive or profit-making decisions on which the revenues of the business depended.” (Galbraith 1952: 15–17).

The significance of this passage is clearly that price control was relatively easy in many US markets precisely because these were markets that already had private sector price administration: that is, relatively inflexible mark-up prices that are relatively easy to calculate and infrequently changed, and, when changed, are done so because of changes in total average unit costs or the level of the profit mark-up.

In these markets, prices are not conveying information about supply and demand or performing some Hayekian informational and allocative role (Dunn 2011: 131).

When US bureaucrats like Galbraith found so much of the US economy under private price administration, as he says above, their controls were much easier to calculate and implement.

Conventional economic arguments against price control do not work in these sectors, because these sectors simply do not have the price taking behaviour required in neoclassical theory in the first place.

In his later price control theory, Galbraith argued that effective price control should be limited to the mainly oligopolistic mark-up pricing sector (Dunn 2011: 131), which is a large part of any modern capitalist economy and an important source of inflation, the worst form being wage–price spirals.


BIBLIOGRAPHY
Colander, David. 1984. “Galbraith and the Theory of Price Control,” Journal of Post Keynesian Economics 7.1: 30–42.

Dunn, Stephen P. 2011. The Economics of John Kenneth Galbraith: Introduction, Persuasion, and Rehabilitation. Cambridge University Press, Cambridge and New York.

Galbraith, John Kenneth. 1952. A Theory of Price Control. Harvard University Press, Cambridge, Mass.

Administered Prices Discredit the Austrian Economic Theories of Mises

Why? The reason is that Austrian economics – via the work of Mises – is fundamentally dependent on the idea of flexible prices and wages moving at least towards their market clearing values in a way that allegedly coordinates markets. Although Austrians do not think that economies ever actually reach an equilibrium state (such as Mises’s final state of rest) because of constant changes in the data, nevertheless the fundamental equilibrating mechanism in Misesian economics is the flexible price system:

“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 1993: 124).

But if the majority of real world prices are relatively inflexible, not properly set by supply and demand dynamics, nor set to converge to market-clearing levels, Misesian economic theory encounters insuperable difficulties, for the following reasons:

(1) there is no strong tendency to Misesian “economic coordination” by which full use of resources is achieved as product markets and labour markets are cleared, so that unused resources offered for sale are eliminated.

(2) the idea of rapid and smooth recovery from recessions/depressions will not work, if there are widespread price and wage rigidities, and firms adjust their output to demand changes.

(3) the whole Misesian argument against price controls collapses (at least in administered price markets) if a price control simply mimics an administered price already set by a private firm, allowing it a sufficient profit and allowing it continue to adjust its output to demand.

If a firm’s total average costs change, government price controls can always be reviewed and changed, when necessary.

There is no clear theoretical reason why such price controls could not work and be effective in those markets already subject to private capitalist administered prices, especially when production of the goods under price control is highly elastic (which, its turns out, many goods actually are in modern capitalist economies outside of primary sectors producing raw materials and agricultural products [Nell 1996: 108]).

(4) Mises’s argument against socialist economic calculation is also rendered highly questionable if many firms already shun his flexible price mechanism.

Even if all consumer prices and prices for factor inputs were set by costs of production plus profit mark-up by a planning board, profit and loss could still be calculated by means of administered prices. If the production system had state-owned firms with unused excess capacity and stocks and inventories, they would simply adjust output quantity to the quantity demanded by production decisions, as modern capitalist firms do.

Supply shocks in primary commodities and other crucial factor inputs could be dealt with government buffer stocks – just as in fact Western capitalist nations did in the Golden Age of Capitalism and, to some degree, even to this day (e. g., think of the US Strategic Petroleum Reserve). (Admittedly, another point is that, unless such a planned economy had persistent trade surpluses, it would probably need to retain its financial and real asset markets to attract foreign exchange to pay for trade deficits, which would require that (1) bonds or stocks and shares for some state-owned companies are still sold in a way that allows minority ownership by the private sector, (2) some private property in real assets such as real estate is allowed, and (3) the government can sell bonds to foreigners.)

Why do we have good reasons to think that such a planned economy would work, at least in an advanced industrial nation? Because so many of the elements of such a system are already used and practised in modern capitalist nations by the private sector.

So many “free markets” have long since been abolished by private businesses themselves, because they do not like the consequences of such free markets, such destructive price wars, cut throat competition, and a chaotic price system that makes profit and loss difficult to calculate or estimate.

All this is not an argument for actually adopting a planned economy, of course, but merely an exercise in showing theoretically why Mises’s socialist calculation critique is flawed and how a hypothetical system could function.

BIBLIOGRAPHY
Nell, Edward J. 1996. Making Sense of a Changing Economy: Technology, Markets, and Morals. Routledge, London and New York.

Salerno, Joseph T. 1993. “Mises and Hayek Dehomogenized,” Review of Austrian Economics 6.2: 113–146.

Some More Empirical Evidence on Full Cost Pricing

The following provide some useful research, surveys and literature reviews on full cost/mark-up pricing:

Andrews, P. W. S. 1949. Manufacturing Business. Macmillan, London.

Atkin, B. and R. Skinner. 1975. How British Industry Prices. Industrial Market Research, London.

Barback, Ronald Henry. 1964. The Pricing of Manufactures. Macmillan, London.

Dorward, Neil. 1987. The Pricing Decision: Economic Theory and Business Practice. Harper & Row, London.

Gabor, André. 1985. Pricing: Principles and Practices. Gower, Aldershot.

Hague, Douglas Chalmers. 1971. Pricing in Business. Allen and Unwin, London.

Hall, Simon, Walsh, Mark and Antony Yates. 1997. “How do UK Companies set Prices?,” Bank of England Working Paper No. 67, Bank of England.

Hankinson, A. 1985. “Pricing Decisions in Small Engineering Firms,” Management Accounting 63: 36–37.

Lere, J. C. 1980. “Observable Differences Among Prime, Variable and Absorption Costing Firms,” Journal of Business Research 8.3: 371–387.

Mills, R. W. and Sweeting, C. 1988. Pricing Decisions in Practice: How are they Made in UK Manufacturing and Services Companies?. The Chartered Institute of Management Accountants, London.

Scapens, R. W., Gameil, M. Y. and Cooper, D. J. 1983. “Accounting Information for Pricing Decisions,” in J. Arnold, R. W. Scapens, M. Y. Gameil, and D. J. Cooper (eds.), Management Accounting Research and Practice. CIMA, London. 283–306.

Skinner, R. C. 1970. “The Determination of Selling Prices,” The Journal of Industrial Economics 18.3: 201–217.

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.


BIBLIOGRAPHY
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
www.sedlabanki.is/lisalib/getfile.aspx?itemid=8891‎