Lee’s Post Keynesian Price Theory: Chapter 5

Chapter 5 of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) looks at the work of the economist Philip Andrews, who served as secretary of the Oxford Economists’ Research Group (OERG), chief statistician of the Nuffield College Social Reconstruction Survey, a participant in the Courtauld Inquiry on business enterprises, and was developer of the theory of “competitive oligopoly.”

Philip Andrews’s research led him to conclude that many businesses’ average direct cost curves were horizontal, and that even the notion of downward-sloping enterprise demand curves were problematic in manufacturing markets (Lee 1998: 101–102).

Moreover, many industrial markets were oligopolistic, used administered pricing, and engaged in competition not necessarily involving price adjustment (Lee 1998: 102).

Andrews held that both average direct costs and indirect costs will decline as a business increases its flow rate of output (Lee 1998: 105).

The setting of prices, though based on cost of production plus profit markup, was called by Andrews “normal cost price” (Lee 1998: 109). This involves the following concepts:

(1) a normal flow rate of output, determined by past experience and future expectations about sales;

(2) normal average direct costs and normal average indirect costs to calculate normal average total costs;

(3) the addition to normal average direct costs of a “costing margin” to cover normal average indirect costs and a profit margin (Lee 1998: 109).

But the profit margin is also constrained by the behaviour of competitors, and by “goodwill” relationships with suppliers and consumers (Lee 1998: 107–108). Some markets have a “price leader” that sets the market price because it is the business with the largest scale of production (Lee 1998: 112). Alternatively, trade associations allow businesses to share information about average normal costs and determine a common profit markup (Lee 1998: 112). The result of either of these is a stable administered price in many markets.

A particularly interesting finding of Andrews relates to the prices of factor inputs: he found that reductions by suppliers in the prices of factor inputs do not necessarily induce more purchases of a factor by a producer if its sales are stagnant or falling (Lee 1998: 108).

As previous researchers had found, changes in normal cost pricing tend generally to be caused by changes in factor input costs.

BIBLIOGRAPHY
Andrews, Philip Walter Sawford. 1949. Manufacturing Business. Macmillan, London.

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

Lee’s Post Keynesian Price Theory: Chapter 4

The fourth chapter of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) turns to the work of the Oxford Economists’ Research Group (OERG), an empirical and research group that was instituted at Oxford University in 1936, and involved economists such as Hubert Henderson, James Meade, and George L. S. Shackle.

The research conducted by this group involved direct interviews with UK businessmen, and one of the many topics of interest was price setting.

One of the findings of the research was that often business people were ignorant of the standard marginalist neoclassical price theory (Lee 1998: 87):

“… the problem was that businessmen were seeing common phenomena in a different light than the members of the OERG. The most important example of this, according to Robert Hall …, was that businessmen saw prices as non-market-clearing and not even designed to clear the market, while the members of the OERG saw prices as a market-clearing (Lee 1998: 88; emphasis in original).

The members of the OERG quickly realised that they had uncovered novel and important facts about price setting in the private sector:

“In fact severe questioning by the Group failed to uncover any evidence that the businessmen paid any attention to marginal revenue or costs in the sense defined by economic theory, and that they had only the vaguest ideas about anything remotely resembling their price elasticities of demand. The Oxford economists were shocked, to say the least. But what caught their attention even more was the relative stability of prices over the trade cycle, and this became the phenomenon which really needed to be explained.” (Lee 1998: 89).

Yet another finding was that the interest rate had considerably less influence on investment than standard economic theory held, and that uncertainty was an overriding factor in the investment decision – an insight which was of particular interest to Shackle (Lee 1998: 88).

The economists R. L. Hall and Charles J. Hitch found themselves much concerned by the findings of the OERG on price setting, and after further research published their now classic paper “Price Theory and Business Behaviour” (Oxford Economic Papers 2 [1939]: 12–45) to explain the evidence they found. Hall and Hitch concluded that businessmen did not generally estimate the elasticity of the demand curves for their products or equate marginal revenue with marginal cost, but instead set prices by means of “full cost pricing” (Lee 1998: 90), which was their terminology for what are now called “administered prices.”

Hall and Hitch found that full cost pricing was determined by the following factors:

(1) direct material and labour costs per unit of output;

(2) indirect costs at an expected level of output, and

(3) a markup for profit. (Lee 1998: 90).

However, given either the competition in a particular industry or the presence of a “price leader,” the profit margin and hence the price of products would tend to be similar in many markets even with full cost pricing (Lee 1998: 90–91). Thus the profit markup and profit margin tended to be a stable and conventional one (Lee 1998: 92), so that full cost prices are not profit maximising prices and are set before the many transactions in a given period.

Furthermore, businesses found that frequent price changes were unpopular with customers, that often price reductions would not induce significant additional market sales, and that they feared price wars (Lee 1998: 91). The business expectation that (1) price reductions would be followed by competitors but that (2) price increases would not be followed therefore tended to cause a price stability in full cost pricing markets.

Lee concludes by noting that Hall and Hitch’s full cost pricing research was developed by Philip Andrews in his own theory of competitive oligopoly.

UPDATE
Philip Pilkington has some related discussion of neoclassical price theory here:

Philip Pilkington, “Teleology and Market Equilibrium: Manifesto for a General Theory of Prices,” Fixing the Economists, August 16, 2013.

Philip Pilkington, “Quantity Rationing as Business Strategy: Furthering the Case for a General Theory of Pricing,” Fixing the Economists, August 17, 2013.

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

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