Price adjustment and market structure

Abstract

The present thesis is concerned with the relationship between price adjustments in response to changes in economic conditions and industrial market structure. Its point of departure consists of abandoning the time-honoured assumption that firms in industrial markets act as if they were price takers. Instead, attention is focused on the determinants of price adjustment in a more realistic industrial setting. Following the introductory analysis, a synthesis is proposed between the long-standing "administered prices" hypothesis, and the recent theories associated with the "new view" of Keynes. It is suggested that both approaches have common theoretical underpinnings which are themselves closely related to this thesis. The main body of analysis consists of a theoretical and an empirical investigation. In the theoretical section, two distinct aspects of the price adjustment decision are examined. The first concerns the comparative statics of adjustment and involves an analysis of the factors which determine the magnitude of price adjustments following changes in cost and demand. Moreover, the influence of market structure on the adjustment process is examined through its impact on the costs of search which are associated with the pricing decision. The second, and no less important aspect of the theoretical investigation concerns the dynamics of price adjustment. The object of this analysis is to assess the impact of market structure on the rate of price adjustment over time. The two hypotheses developed in the theoretical section are put to extensive empirical testing. The quantitative analysis involves mainly time-series and cross-section regressions, but other statistical techniques such as rank correlation and covariance tests are also employed. The first of these hypotheses is that price adjustments in response to short-run changes in demand could be attenuated relative to those occasioned by changes in marginal costs. The rationale for this asymmetry is based on the unequal impact of search costs. The empirical findings, whilst by no means conclusive, do not contradict this view. The second hypothesis suggests that a high degree of industrial concentration will be associated with high rates of price adjustment. This is because concentration facilitates the process of dynamic co-ordination amongst firms by reducing the costs of search. The empirical results come out strongly in favour of this hypothesis. The consequential implications regarding "administered prices" and the management of inflation are explored in the concluding chapter of this thesis