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Who Are You Calling Irrational? Marginal Costs, Variable Costs, and the Pricing Practices of Firms

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Author Info

  • Russell Pittman

    (Director of Economic Research, Economic Analysis Group, Antitrust Division, U.S. Department of Justice, and visiting professor, New Economic School, Moscow)

Abstract

Economists sometimes decry the persistence with which firms set prices above marginal cost and thus, according to the economists, fail to maximize profits. But it is the economists who have it wrong – first, because variable accounting costs are not always a good proxy for marginal economic costs, but more importantly because in an industry with U-shaped cost curves, a firm at a long-run sustainable equilibrium faces increasing marginal costs – i.e., a rising shadow price on some constrained input – i.e., in general, acost of capital. A corollary is that in such an industry the equilibrium mark-up over variable cost varies directly with capital intensity.

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File URL: http://www.justice.gov/atr/public/eag/248394.pdf
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Bibliographic Info

Paper provided by Department of Justice, Antitrust Division in its series EAG Discussions Papers with number 200903.

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Length: 11 pages
Date of creation: Jul 2009
Date of revision:
Handle: RePEc:doj:eagpap:200903

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Postal: Department of Justice Antitrust Division 450 Fifth Street NW Washington, DC 20530
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Web page: http://www.justice.gov/atr/
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Related research

Keywords: market power; price; mark-up; marginal cost; variable cost;

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  1. Philippe Aghion & Nicholas Bloom & Richard Blundell & Rachel Griffith & Peter Howitt, 2002. "Competition and innovation: an inverted U relationship," IFS Working Papers W02/04, Institute for Fiscal Studies.
  2. Madhav V. Rajan & Stefan Reichelstein, 2009. "Depreciation Rules and the Relation between Marginal and Historical Cost," Journal of Accounting Research, Wiley Blackwell, vol. 47(3), pages 823-865, 06.
  3. Boone, J. & Ours, J.C. van & Wiel, H.P. van der, 2007. "How (Not) to Measure Competition," Discussion Paper 2007-32, Tilburg University, Center for Economic Research.
  4. Patrick McCloughan & Seán Lyons & William Batt, 2007. "The Effectiveness of Competition Policy and the Price-Cost Margin: Evidence from Panel Data," Papers WP209, Economic and Social Research Institute (ESRI).
  5. Nickell, Stephen J, 1996. "Competition and Corporate Performance," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 724-46, August.
  6. Nabil Al-Najjar & Sandeep Baliga & David Besanko, 2008. "Market forces meet behavioral biases: cost misallocation and irrational pricing," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 214-237.
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