The Price Equation: A Cross-Sectional Approach
The imposition of price controls in the U.S. economy during the period 1971-73, together with the persistent inflationary bias in the decade of the 1970's, has brought forth a renewed research interest in the process of price determination.' The longstanding debate regarding whether firms tend to use full-cost or target return pricing rules on the one hand, or marginalist principles on the other has been intermingled with questions regarding the efficacy of price controls. In addition, the administered-price inflation hypothesis has been subjected to renewed empirical testing. Each of these areas of inquiry is of current policy relevance to the general problem of inflation. Although this paper will touch on each of the above areas, its principal objectives are narrow: 1. to specify a cross-sectional price equation which is consistent with both target return and marginalist principles; 2. to estimate the parameters of the price equation using data on year to year rates of change during the period 1958-72, for a large sample of four-digit SIC manufacturing industries; 3. to test hypotheses: a) regarding the relative effects of cost changes, demand changes, degree of concentration and price expectations on industry prices; and b) regarding the effects of the Phase I and II price controls of 1971-72. Many studies have examined the issues discussed in this paper. A discussion of selected studies which have treated some or all of the issues listed above will illustrate their current status. Most researchers agree that cost changes show up more strongly in price equations than do demand changes, although that result could be because the latter seem to be more difficult to measure. Researchers also agree that there are differences in the price adjustment process among concentrated and nonconcentrated industries, but the exact nature of these differences is controversial. The issue of rule of thumb versus marginalist pricing practices has also not been settled in the empirical literature since most price equations are consistent with either practice. In their study of the price equation, Eckstein and Fromm test the relative significance of target return and competitive elements in the determination of price changes. The equations which they estimate cover all manufacturing, durable manufacturing, and nondurable manufacturing based on two-digit SIC sectors. They utilize a time-series approach with data mainly for the period 1954:1 to 1965:4. Cost and demand elements are included in the equations. The authors make the general conclusion that: While the different forms of the equations yield varying results on the relative importance of the competitive mechanism vis-a-vis oligopolistic pricing, there is pretty strong evidence that equations combining both mechanisms are superior to equations using either approach in isolation (p. 1171). In a cross-section study of 395 four-digit SIC manufacturing industries, Frank Ripley and Lydia Segal estimate a price change equation for the period 1959-69. Changes in unit labor cost, changes in the materials cost, changes in real output, and changes in productivity are independent variables, with industries classified by broad concentration category. They find that over the elevenyear period covered by their study concen*Department of economics, University of South Carolina. i Rather than cite each item in the extensive literature, the following articles and their bibliographies provide broad coverage: William Nordhaus, Otto Eckstein and Gary Fromm, and Eckstein and David Wyss on price equations; Robert Lanzillotti, M. Hamilton and Blaine Roberts on Phase 11 controls; J. Fred Weston on alternative models of pricing behavior; and Steven Lustgarten and Ralph Beals on tests of the administered pricing inflation hypothesis. A more general survey on inflation has recently been provided by David Laidler and Michael Parkin.
- Export
- BibTeX
- Sources
- openalex