The purpose of this post is to examine and provide a critique of Austrian price theory, and in particular the Austrian denial of relative price rigidity in the real world.In the Austrian economist Ludwig Lachmann’s book Capital, Expectations, and the Market Process (Kansas City, 1977) there is a section where Lachmann reviews John Hicks’s book Capital and Growth (Oxford, 1965).The significance of Hick’s discussion is described by Lachmann:“Two other matters of great significance are dealt with in the first part of the book. As others have done before him, Professor Hicks finds it necessary to stress, in his chapter on Marshall’s method, that our world differs from that which Marshall took for granted in that we live in a world of prices ‘administered’ by manufacturers, ‘but in those days
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In the Austrian economist Ludwig Lachmann’s book Capital, Expectations, and the Market Process (Kansas City, 1977) there is a section where Lachmann reviews John Hicks’s book Capital and Growth (Oxford, 1965).
The significance of Hick’s discussion is described by Lachmann:
“Two other matters of great significance are dealt with in the first part of the book. As others have done before him, Professor Hicks finds it necessary to stress, in his chapter on Marshall’s method, that our world differs from that which Marshall took for granted in that we live in a world of prices ‘administered’ by manufacturers, ‘but in those days even manufactured goods usually passed along a chain of wholesalers and retailers, each of whom was likely to have some independent price-making opportunity.’ (55) Again, like others before him, our author attributes the cause of this change to the virtual disappearance of the wholesale merchant and his price-setting function after 1900. Formerly ‘the initiative would come from the wholesaler or shopkeeper, who would offer higher prices in order to get the goods which, even at the higher price, he could re-sell at a profit. Similarly, when demand fell, it would be the wholesaler who would offer a lower price. The manufacturer would have to accept that price if he could get no better.’ (56) Hence, while Marshall’s was a world of flexible prices, even though not of ‘perfect competition,’ ours is a ‘fixprice world’ with prices set on a ‘cost plus’ basis and wage rates as ultimate price determinants.Lachmann was well aware of the significance of fixprices, and discussed them in The Market as an Economic Process (Oxford, 1986), pp. 122–136.
The analytical significance of this historical change lies, on the one hand, in the fact that the ‘Temporary Equilibrium Method’ which Hicks himself, following Lindahl, used in Value and Capital in 1939, has lost much of its validity. ‘The fundamental weakness of the Temporary Equilibrium method is the assumption, which it is obliged to make, that the market is in equilibrium—actual demand equals desired demand, actual supply equals desired supply—even in the very short period.’ (76) Hence we have to look for another method of dynamic analysis. To find it we must move nearer to Keynes and his successors who are here given credit for having understood, earlier than others, that a fixprice world requires a fixprice method of analysis.” (Lachmann 1977: 238–239).
Now, while Lachmann seems to have thought that the reduction in the role of wholesalers as compared with the 19th century was a major factor here, Post Keynesians would also point to other factors such as the role that relatively stable prices have in reducing business uncertainty and stabilising profits. But we can put these points aside for the time being.
Crucially, Lachmann said this:
“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).Lachmann even concluded that his own fellow Austrians had badly neglected the task of studying real-world price formation (Lachmann 1986: 130–131).
There is even an interesting anecdote about Lachmann from Bruce Caldwell:
“I first met Ludwig M. Lachmann on February 4, 1982 at the first spring semester meeting of the Colloquium in Austrian Economics at New York University. ….While that story does in fact seem to tacitly accept that there is an equilibrium structure of prices and wages that would clear all markets (something that can be doubted), the point of the story is well taken: the belief in the market’s tendency to any such state in rapid price adjustments is mostly “a metaphysical assumption.”
During that first meeting I had an exchange with Mario Rizzo about the concept of market-clearing. I argued that though the speed of adjustment problem was an empirical issue, it was not something that could be tested as a general proposition. I drew the implication that one’s view of the rapidity of clearing was a matter of faith, nothing more than a metaphysical assumption, though obviously a crucial one. Lachmann nodded his head vigorously as I was finishing up, which pleased me immensely.” (Caldwell 1991: 140).
Lachmann was correct, and the ignorance of Austrians and advocates of Austrian economics on the issue of real-world prices continues to this day.
By the early 20th century, economists like Gardiner C. Means studied price setting by modern corporations in the United States in the 1920s and 1930s, and he concluded, after extensive empirical research, that prices of goods produced in many industrial corporations are set by a mark-up on cost of production (Downward 1999: 50), and simply are not flexible in the way required by Neoclassical theory. In other words, there is relative price rigidity that presents a severe problem for Neoclassical and Austrian theory.
(1) What is “Relative Price Rigidity”?
First of all, what do we mean by “relative price rigidity”?
It means this:
In the real world, there is a high degree of relative price rigidity, but relative to the models of Austrian or the most unrealistic versions of Neoclassical theory, where all or the vast majority of prices are assumed to be highly flexible, rapidly responsive to demand changes, and are flexible enough to cause a rapid and effective tendency towards market clearing in product markets.Note well: this does not mean there is no flex-price sector (where prices are highly flexible) or no auction or auction-like markets.
This does not mean there are no goods whose production is inelastic and hence supply and demand have a greater role in determining prices.
Some goods like fresh produce, petrol, and seafood clearly have much more flexible prices than other goods, especially when goods are perishable.
In the retail sector, there is a higher degree of flexible prices, given retail sales. However, in the service sector and manufacturing sector, many prices are highly inflexible with respect to demand changes. Since both the service and manufacturing sectors together dominate most market economies, the use of widespread cost-based mark-up prices in these sectors are the fundamental cause of relative price inflexibility.
(2) Austrian Theory and Price Flexibility
Austrian economic theories absolutely require a high degree of price flexibility and nominal wage flexibility to be accurate models of the real world.
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, Austrian economic theory encounters insuperable difficulties, for the following reasons:
(1) there is no strong, economy-wide tendency to Misesian “economic coordination” by which full use of resources is achieved as product markets and labour markets have a tendency towards clearing, so that unused resources offered for sale are eliminated.For these reasons, Austrian theories would be clearly inaccurate and highly flawed models of real-world economies, if we can show that relative price rigidity is a significant factor of reality.
(2) there can be no strong, effective, economy-wide tendency towards Mises’ shifting, dynamic “final states of rest” general equilibria in a modern economy (the “final state of rest” is Mises’ general equilibrium state).
(3) the idea of rapid and smooth recovery from recessions/depressions will not work, if there are widespread price and money wage rigidities, and firms adjust their output to demand changes, since adjustment will occur mainly via production output and employment changes, not via price and money wage adjustment.
(4) 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 for the firm 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, it turns out, many goods actually are in modern capitalist economies, except in primary sectors producing raw materials and agricultural products (Nell 1996: 108), and so on.
(5) 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 consumers, as modern capitalist firms do.
Supply shocks in primary commodities and other crucial factor inputs could be dealt with through 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).
(3) Responses to the Reality of Price Rigidity by Austrians
The standard response by libertarians and Austrians to evidence for price rigidity usually takes the following forms:
(1) libertarians deny that there is any evidence of relative price inflexibility;So, first of all, what is the empirical evidence of significant relative price rigidity?
(2) libertarians pretend that there is only minor relative price rigidity;
(3) libertarians will throw up all sorts of strawman misrepresentations of your arguments.
(4) The Evidence for Relative Price Rigidity
We can lay out the evidence as follows:
(1) the evidence of stickiness in aggregate price movements in Consumer Price Indices (CPIs) and Producer Price Indices (PPIs), and the fact that price levels generally even rise in recessions;First of all, it is well known that stickiness in aggregate price movements are observed in every modern Western capitalist economy.
(2) the quantitative data and quantitative studies of how frequently prices change;
(3) survey data and empirical investigation of firms and how and why they set prices, and how frequently.
Crucially, during most recessions since 1945 general price inflation continues even in the face of general negative demand shocks and we hardly ever see price deflation in a recession. That is, the general price level in recessions generally still rises, and generally recessions are just disinflationary (disinflation is a type of inflation, just inflation at a lower rate than in the previous year). In the United States since 1945, for example, virtually every recession has been inflationary: the only exceptions are 1949–1950, 1954–1955, and 2009.
For example, in the second quarter of 2020 American GDP collapsed by 32.9% in the face of the coronavirus pandemic and lockdowns. This kind of massive negative demand shock would require massive price deflation under Austrian theory, but instead the US economy has continued to experience price inflation, albeit at lower rates.
How can it be that when the economy suffers moderate to strong negative demand shocks in a recession, the general price level keeps rising if prices are highly flexible? The answer is that prices are not highly flexible in the way imagined by Austrian theory.
Now let’s move to the other quantitative data.
(5) Quantitative data on How Frequently Prices Change
Secondly, we have quantitative data and quantitative studies of how frequently prices change from various nations. Such research has been done for over 40 years and the results are very clear.
Moreover, central banks from various nations have recently made available their huge data sets on prices and price changes so that samples of quantitative data on price changes are very large. For example, a French study had a data set of more than 750,000 products tracked for price changes from 1994 to 2003 (this is Baudry et al. 2004 as described below), over a period of nearly 10 years.
Here is a sample of the quantitative data on price rigidity:
(1) Means, G. C. 1936. “Notes on Inflexible Prices,” American Economic Review 26 (Supplement): 23–35.In many nations, prices change on average once a year (e.g., Carlton 1986: 637; Klenow and Malin 2011: 242, 232; Kehoe and Midrigan 2015). Of especial interest is the recent finding that in the Euro area that average duration of price changes is 13 months (Dhyne et al. 2006: 176).
(2) Carlton, Dennis W. 1986. “The Rigidity of Prices,” The American Economic Review 76.4: 637–658.
This paper presents an analysis of price rigidity in America, and finds that for “many transactions, prices remain rigid for periods exceeding one year” (Carlton 1986: 637) and it “is not unusual in some industries for prices to individual buyers to remain unchanged for several years” (Carlton 1986: 638).
(3) Cecchetti, Stephen G. 1986. “The Frequency of Price Adjustment: A Study of the Newsstand Prices of Magazines,” Journal of Econometrics 31: 255–274.
This is a study of price rigidity in the prices of magazines.
(4) Kashyap, Anil K. 1995. “Sticky Prices: New Evidence from Retail Catalogs,” Quarterly Journal of Economics 110: 245–274.
(5) Bils, Mark and Peter J. Klenow. 2004. “Some Evidence on the Importance of Sticky Prices,” Journal of Political Economy 112.5: 947–985.
This paper shows a higher degree of price flexibility but only by including mere temporary price cuts (as in retail sales). Their method is disputed by Nakamura and Steinsson (2008) who point out temporary sales not affecting long-run prices of a good are abnormal and make prices appear more flexible than they really are.
(6) Baudry, Laurent, Le Bihan, Hervé, Sevestre, Patrick, and Sylvie Tarrieu. 2004. “Price Rigidity. Evidence from the French CPI Micro-Data,” ECB, Working paper series No. 384 https://ideas.repec.org/p/ecb/ecbwps/2004384.html
This paper uses a large dataset of prices from the non-farm business sector of the French economy. More than 750,000 products were tracked for price changes (that is, the time duration between two price changes of a product) from July 1994 to February 2003 (Baudry et al. 2004: 5). This study finds significant rigidity of consumer prices. The weighted average duration of prices was 8 months, but the authors calculate that extension of the data to include the whole French CPI would yield a weighted average duration of price change higher than 8 months (Baudry et al. 2004: 5–6). The study found that service prices are especially sticky: they typically last for a year (Baudry et al. 2004: 6).
(7) Dhyne, Emmanuel, Álvarez, Luis J., Le Bihan, Hervé, Veronese, Giovanni et al. 2006. “Price Changes in the Euro Area and the United States: Some Facts from Individual Consumer Price Data,” The Journal of Economic Perspectives 20.2: 171–192.
This paper analyses large quantitative price data sets from numerous European nations, including Austria, Belgium, Finland, France, Germany, Italy, Luxembourg, the Netherlands, Portugal, and Spain. The major finding is that in the Euro area that average duration of price changes is 13 months (Dhyne et al. 2006: 176). The sectors that have the most price rigidity are services, non-energy industrial goods, and even processed food (Dhyne et al. 2006: 189). In particular, the services sector (the largest sector in most nations today) shows very strong downwards price rigidity: on average, only 2 price changes out of 10 are downwards in the services sector (Dhyne et al. 2006: 181). On average throughout various sectors, just 4 price changes out of 10 are decreases in prices (Dhyne et al. 2006: 180), which shows that there is a bias towards price rises in modern capitalist economies.
(8) Sabbatini, Roberto, Álvarez, Luis J., Dhyne, Emmanuel et al. 2007. “What Quantitative Micro Data Reveal about Price Setting Behavior,” 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.
(9) Nakamura, Emi and Jón Steinsson. 2008. “Five Facts about Prices: A Reevaluation of Menu Cost Models,” The Quarterly Journal of Economics 123.4: 1415–1464.
This paper shows that without mere temporary price cuts (as in retail sales where prices revert to the normal, higher level after a sale) average US prices change infrequently: only about every 7–11 months.
(10) Klenow, Peter J. and Benjamin A. Malin. 2011. “Microeconomic Evidence on Price-Setting,” in Benjamin M. Friedman and Michael Woodford (eds.), Handbook of Monetary Economics Volume 3A. North Holland, Amsterdam and London. 231–284.
This chapter provides a table on p. 239 (Table 4) that summarises quantitative data from 19 nations on price rigidity. The data mostly comes from service and industrial sectors (and sometimes in addition also other sectors). For most nations, prices change “on average” at least once a year (Klenow and Malin 2011: 242). If merely short-lived prices (such as mere temporary price discounts) are excluded, prices change closer to once a year (Klenow and Malin 2011: 232).
(11) Nakamura, Emi and Jón Steinsson. 2013. “Price Rigidity: Microeconomic Evidence and Macroeconomic Implications,” Annual Review of Economics 5: 133–163.
(12) Kehoe, Patrick and Virgiliu Midrigan. 2015. “Prices are Sticky after All,” Journal of Monetary Economics 75: 35–53.
This paper responds to Bils and Klenow (2004) who looked at US consumer prices. Kehoe and Midrigan show that Neoclassical apologists cannot appeal to temporary sales or temporary price discounts in US consumer goods to justify the idea of high price flexibility, because after such temporary price changes the nominal price usually just reverts back to pre-existing nominal price, and one also needs to take account of producer prices. Kehoe and Midrigan find that, without temporary sales, prices change about once a year.
In view of this evidence, a libertarian cannot refute the evidence for relative price rigidity by simply looking at random prices and finding price changes. As we can see, quantitative studies have already been done of large data sets of prices by Neoclassical economists and the overwhelming finding is a world of relative price rigidity, that is, relative to the price models of Neoclassical economics.
(6) Survey Data and Empirical Investigation of Firms
Surveys of and face-to-face interviews of price administrators, managers and CEOs of firms also reveal a great deal about price setting and price rigidity.
Here are some of the most important studies:
(1) Hall, R. L. and C. J. Hitch. 1939. “Price Theory and Business Behaviour,” Oxford Economic Papers 2: 12–45.This evidence of surveys and face-to-face interviews of business people has been going on since the 1930s, and it consistently finds that cost-based mark-up prices (sometimes called “full cost prices,” “normal cost prices,” or “cost-plus prices,” or “administered prices”) are a plurality, or even a majority, of prices in modern Western nations and even in Third World nations (where evidence exists).
This early important paper by R. L. Hall and Charles J. Hitch from research in the 1930s concluded that UK 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 we would now call cost-based mark-up pricing. They also concluded 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).
(2) 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. 1949. Manufacturing Business. Macmillan, London.
Andrews, P.W.S. 1964. On Competition in Economic Theory. Macmillan, London.
Andrews noted the existence of excess capacity in many firms and how cost-based mark-up prices were normal even in markets where competition exists, or that is, “irrespective of the degree of competition which the firm has to meet” (Andrews 1949: 58–59). When firms wish to increase market share, it will often be by means of superior quality and reputation, rather than price cuts (Downward 1999: 50).
(3) Bhaskar, V., Machin, Stephen and Gavin C. Reid. 1993. “Price and Quantity Adjustment over the Business Cycle: Evidence from Survey Data,” Oxford Economic Papers n.s. 45.2: 257–268.
This paper reports data from a questionnaire posed to managers of 73 small UK firms in 1985. It shows quantity adjustments “are overwhelmingly more important than price adjustments over the business cycle” (Bhaskar 1993: 257) and “[m]ost firms do not increase prices in booms or reduce them in recessions, and when they do, managers suggest that these are relatively unimportant” (Bhaskar 1993: 266).
(4) Blinder, A. S. et al. (eds.). 1998. Asking about Prices: A New Approach to Understanding Price Stickiness. Russell Sage Foundation, New York.
This book reports a well-sampled survey of 200 US businesses. It was found that a typical good in the US is repriced roughly once a year, and prices are most sticky in the service sector, but the least sticky in wholesale and retail trade (Blinder et al. 1998: 105). Over 50% of firms said that they would not increase their prices when demand increased (Downward and Lee 2001: 476). Blinder et al. (1998: 200–201) also 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%).
(5) Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.
This book reports a survey conducted by P. Downward involving 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%). When asked whether the firm sets prices to create price stability on the market, 65.5% of firms said “very often” (17.3%) or “often” (48.2%) (Downward 1999: 160).
(6) Hall, S., Walsh, M. and A. Yates. 2000. “Are UK Companies’ Prices Sticky?,” Oxford Economic Papers 52.3: 425–446.
This paper reports the results of a survey of 654 UK companies in 1995. When asked what happens when there is strong demand and this cannot be met from inventories or stocks, only 12% of firms said they would increase the price of their goods (Hall, Walsh, and Yates 2000: 442).
(7) 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.
This paper examines price setting in a survey of 170 private, unregulated, non-primary sector Canadian firms. 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).
(8) Fabiani, Silvia, Gattulli, Angela, and Roberto Sabbatini. 2004. “The Pricing Behaviour of Italian Firms: New Survey Evidence on Price Stickiness,” ECB Working Paper Series No. 333 http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp333.pdf
This paper reports a survey in 2003 of 333 industrial and service firms in Italy (Fabiani et al. 2004: 8). It was found that about 60% of firms review prices once a year, and around 50% only actually change prices once a year too (Fabiani et al. 2004: 21).
(9) Kwapil, Claudia, Baumgartner, Josef and Johann Scharler. 2005. “Price-Setting Behavior of Austrian Firms,” ECB Working Paper Series no. 464 http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp464.pdf
This paper reports a 2004 survey of 873 Austrian firms mainly in the manufacturing sector. The firms were asked how often they changed prices on average in a given year:
No change: 22.1%;
Once a year: 54.2%;
2 to 3 times a year: 13.9% (Kwapil, Baumgartner and Scharler 2005: 18).
Moreover, 63% of firms said they would leave their prices unchanged in response to a large positive demand shock, and 52% would leave prices unchanged in response to a large negative demand shock (Kwapil, Baumgartner and Scharler 2005: 33). In the face of small demand shocks (either positive or negative), 82% of firms simply leave prices unchanged (Kwapil, Baumgartner and Scharler 2005: 33).
(10) Parker, Miles. 2017. “Price-Setting Behaviour in New Zealand,” New Zealand Economic Papers 51.3: 217–236.
An earlier version is online here:
Parker, Miles. 2014. “Price-Setting Behaviour in New Zealand”
This paper reports a survey of 5,300 firms selected as a representative sample of all sectors of the New Zealand economy (Parker 2017: 217). It was found that the average firm reviews prices twice a year but changes its prices only once a year (Parker 2017: 229). When asked whether temporary price reductions were important, 44% of firms said “not at all,” and 17% said “a little important” (Parker 2014: 17). Parker also finds that mark-up prices account for about 54% of business prices.
(11) 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.
This paper reports results from a survey of about 600 private-sector firms in Sweden. When asked to report how often prices were changed, the weighted results were that 40.3% of firms change prices once per year, and 27.1% adjust their prices less than once a year (Apel et al. 2005: 318).
(12) Aucremanne, Luc and Martine Druant. 2005. “Price-Setting Behaviour in Belgium. What can be learned from an ad hoc Survey?,” ECB Working Paper Series No. 448.
This paper report the results of a survey of 1,979 firms in the industrial, construction, trade and services sectors, in a sample that should represent about 60% of Belgian GDP. It was found that 55% of firms changed prices once a year, 18% less often, and 27% more than once a year (Aucremanne and Druant 2005: 31).
(13) Martins, Fernando. 2007. “How Portuguese Firms set their Prices,” 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. 152–164.
This chapter reports a 2004 survey by the Banco de Portugal of 1,370 Portuguese firms, mainly from manufacturing. The survey found that 75% of firms generally changed their prices but once a year (Martins 2005: 24).
(14) 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.
This reports a well-sampled survey of 725 firms throughout many sectors of the Norwegian economy: nearly 50% of firms said that they only changed their product price once a year, and about 23% of firms said that they changed the price twice a year (Langbraaten et al. 2008: 18).
(15) Levy, Daniel. 2007. “Price Rigidity and Flexibility: New Empirical Evidence,” Managerial and Decision Economics 28.7: 639–647.
This review article summarises 14 empirical studies of price rigidity in a special issue of Managerial and Decision Economics.
(16) 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.
This paper reports a survey of 1,000 Irish firms. 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.
(17) 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.
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 industrial 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).
(18) 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.
Govindarajan and Anthony (1986) conducted a survey in which over 500 US industrial companies answered a questionnaire on how they set prices. They found that 85% of companies surveyed used full cost pricing (Govindarajan and Anthony 1986: 31). Shim and Sudit (1995: 37) conducted a survey in 1993 of US industrial companies, and found that 69.5% used full cost pricing.
Mark-up 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. Importantly, cost-based mark-up prices are not set with the primary purpose of clearing markets nor creating a tendency towards supply and demand equilibrium in product markets.
One typical Austrian response to all this data is pretend it doesn’t exist! A second response is to focus on some studies like Blinder et al.’s Asking about Prices (1998) and claim that because they have what looks like small sample sizes (Blinder’s research looked at about 200 US businesses, for example), somehow the research is invalid. But this is all desperate dishonest apologetics. Blinder’s sample was carefully selected to be generally representative of large swatches of the goods in US GDP, and one cannot simple dismiss it because it was a small sample. Worse still for Austrians, there are dozens of survey studies from over twenty-one nations on how businesses set prices and they all come to the same conclusion: that cost-based mark-up prices exist and are often a majority of prices. For example, Parker (2017: 217) examined an impressive 5,300 firms selected as a representative sample of all sectors of the New Zealand economy. One cannot simply dismiss this evidence.
In fact, to reject this vast body of evidence that extends back to the 1930s as being false or inaccurate would require Austrians to believe in some vast conspiracy theory, which is obviously absurd.
Finally, let us run through some other strawman responses by Austrian charlatans:
(1) Austrians will misrepresent the Post Keynesian argument and pretend their Post Keynesian opponent has said that “prices never change at all, or most prices never change.”None of these arguments deployed by libertarians and Austrians are anything but dishonest misrepresentations of the Post Keynesians argument offered to them.
This is an obvious and dishonest lie. This is not what Post Keynesians say. Of course, cost-based mark-up prices do change over time, either upwards or downwards. But what was said is that relative to Neoclassical and Austrian models, most prices have a high degree of inflexibility, and are not set with the primary purpose of clearing markets and creating a tendency towards supply and demand equilibrium in product markets. Showing that prices do in fact change over time does not refute the critique above in any manner.
(2) Austrians will say Post Keynesians have said there is no flex-price sector where prices are highly flexible.
Once again, this is an obvious lie. There is a flexprice sector in all nations, where prices are highly flexible, for example, in auction-like markets, but the extent and significance of this flexprice sector are grossly exaggerated.
(3) Austrians will say their Post Keynesian opponent has said there are no sales in retail stores done temporarily to clear certain stock.
This is a straw man. Retail sales obviously occur, but their existence does not refute the massive evidence of relative price rigidity, relative to the models of Neoclassical and Austrian theory. Furthermore, the extent of sales is much less significant in the service sector and the sector that produces intermediate goods and factor inputs.
In short, the accusation of Ludwig Lachmann that his fellow Austrians had failed to understand real-world prices was entirely correct, and remains correct to this day, and the quotation in question deserves to be repeated:
“Those who glibly speak of ‘market clearing prices’ tend to forget that over wide areas of modern markets it is not with this purpose in mind that prices are set. They seem unaware of the important insights into the process of price formation, an Austrian responsibility, of which they deprive themselves by clinging to a level of abstraction so high that on it most of what matters in the real world vanishes from sight.” (Lachmann 1986: 134).BIBLIOGRAPHY
Bils, Mark and Peter J. Klenow. 2004. “Some Evidence on the Importance of Sticky Prices,” Journal of Political Economy 112.5: 947–985.
Caldwell, Bruce J. 1991. “Ludwig M. Lachmann: A Reminiscence,” Critical Review 5.1: 139–144.
Downward, Paul. 1999. Pricing Theory in Post-Keynesian Economics: A Realist Approach. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.
Hicks, John Richard. 1965. Capital and Growth. Oxford University Press, Oxford.
Lachmann, Ludwig M. 1966. “Sir John Hicks on Capital and Growth,” South African Journal of Economics 34: 113–123.
Lachmann, Ludwig M. 1977. Capital, Expectations, and the Market Process: Essays on the Theory of the Market Economy (ed. Walter E. Grinder). Sheed Andrews and McMeel, Kansas City.
Lachmann, L. M. 1986. The Market as an Economic Process. Basil Blackwell. Oxford.
Nell, Edward J. 1996. Making Sense of a Changing Economy: Technology, Markets, and Morals. Routledge, London and New York.