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Understanding How Price Responds to Costs and Production

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  • Mark Bils
  • Yongsung Chang

Abstract

The importance of sticky prices in business cycle fluctuations has been debated for many years. But we argue, based on a large empirical literature from the 1950's and 60's, that it is necessary to distinguish the response of price to an increase in factor prices from its response to an increase in marginal cost generated by an expansion in production. Consistent with that earlier literature, we find for 450 U.S. manufacturing industries that prices do respond more to increases in costs driven by changes in factor prices than to increases in marginal cost precipitated by expansions in output. We explore two models that can potentially explain these findings. Both break the link between price and marginal cost, thereby generating what one might naively interpret as average-cost pricing. The first is driven by firms pricing to limit entry. The second is driven by firms pricing to limit non-price competition within their market.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7311.

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Date of creation: Aug 1999
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Publication status: published as Carnegie-Rochester Conference Series on Public Policy, Vol. 52, no. 1 (June 2000): 33-77
Handle: RePEc:nbr:nberwo:7311

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  1. Shea, John, 1993. "Do Supply Curves Slope Up?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 108(1), pages 1-32, February.
  2. Anil K. Kashyap, 1990. "Sticky prices: new evidence from retail catalogs," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 112, Board of Governors of the Federal Reserve System (U.S.).
  3. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 105(2), pages 249-83, April.
  4. Bils, Mark, 1987. "The Cyclical Behavior of Marginal Cost and Price," American Economic Review, American Economic Association, American Economic Association, vol. 77(5), pages 838-55, December.
  5. Robert E. Hall, 1986. "The Relation Between Price and Marginal Cost in U.S. Industry," NBER Working Papers 1785, National Bureau of Economic Research, Inc.
  6. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  7. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 321.
  8. Julio J. Rotemberg & Michael Woodford, 1991. "Markups and the Business Cycle," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 63-140 National Bureau of Economic Research, Inc.
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