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Understanding How Price Responds to Costs and Production

Listed author(s):
  • Mark Bils
  • Yongsung Chang

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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File URL: http://www.nber.org/papers/w7311.pdf
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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
Publication status: published as Carnegie-Rochester Conference Series on Public Policy, Vol. 52, no. 1 (June 2000): 33-77
Handle: RePEc:nbr:nberwo:7311
Note: EFG
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