Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Why do firms raise prices more readily than reducing them?

20.01.2003


Chancellors and central bankers face a perennial headache: booms typically cause inflation, while recessions mainly reduce output without reducing prices or inflation. New ESRC-funded research by Professor V. Bhaskar of the University of Essex explains how this problem emerges through the phenomenon of ’asymmetric price adjustment’ – the fact that firms are far quicker to increase prices than to cut them.



This work has important implications for inflation targeting by the Bank of England and other central banks. The Nobel Laureate Robert Lucas has recently argued that the optimal inflation target may be negative, so that central banks may need to deflate the economy persistently. But Bhaskar’s research on pricing asymmetries shows that deflation would aggravate the negative effects on output and employment considerably.

Positive inflation has the effect of raising output, since it prevents the output and employment losses due to price asymmetries. On the other hand, the inflation target for the central bank should not be too high, since the output gains are relatively modest.


’Firms are quick to raise prices when their costs increase, but not so keen to reduce prices when their costs fall.’

Talk to a non-economist, and you would probably get 80 per cent agreeing with this statement. Ask an economist, and you would probably get a more sceptical response. That is, until recently, after a wide range of careful empirical studies have shown that non-economists are indeed correct in their suspicions.

The economist’s scepticism is warranted since asymmetric price adjustment is a puzzle. Although monopoly power on the part of firms or retailers is often advanced as an explanation, it is not a very good one. Monopoly producers will choose their best price, and this moves symmetrically, in line with costs.

This research provides an explanation for price asymmetry based on limited monopoly power. Bhaskar argues that in most markets, sellers have some monopoly power, but this is circumscribed by competition. Asymmetric price adjustment allows sellers to keep prices as high as possible, within the constraints imposed by competition.

Although asymmetric adjustment makes for higher prices, the research also identifies a countervailing force. Since firm’s prices will, on average, be too high when they do not adjust their price, firms will find it optimal to choose lower prices when they do adjust price. This mitigates some of the consequences of asymmetric adjustment.

Nevertheless, prices on average will be higher. Consequently, the level of output in the economy as a whole will be lower and unemployment will be higher. Bhaskar quantifies the effect and show that while there is an output loss, it is relatively modest: for the UK economy, it is the equivalent of £1.3 billion per year, or £20 for every man, woman and child.


For further information, contact Professor V. Bhaskar on 01206-872744 or email: vbhas@essex.ac.uk; homepage: http://privatewww.essex.ac.uk/~vbhas/ or Iain Stewart at ESRC,
on 01793-413032-413119 or email: iain.stewart@esrc.ac.uk.

The full study, ’Asymmetric Price Adjustment: Microfoundations and Macroeconomic Implications’, Discussion Paper 547, Department of Economics, University of Essex is available at: http://www.essex.ac.uk/economics/discussion-papers/papers-text/dp547.pdf

Iain Stewart | EurekAlert!
Further information:
http://www.esrc.ac.uk/
http://privatewww.essex.ac.uk/~vbhas/
http://www.essex.ac.uk/economics/discussion-papers/papers-text/dp547.pdf

More articles from Business and Finance:

nachricht Microtechnology industry is hiring – positive developments of past years continue
09.04.2018 | IVAM Fachverband für Mikrotechnik

nachricht RWI/ISL-Container Throughput Index with minor decline on a high overall level
20.03.2018 | RWI – Leibniz-Institut für Wirtschaftsforschung

All articles from Business and Finance >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: New opportunities in additive manufacturing presented

Fraunhofer IFAM Dresden demonstrates manufacturing of copper components

The Fraunhofer Institute for Manufacturing Technology and Advanced Materials IFAM in Dresden has succeeded in using Selective Electron Beam Melting (SEBM) to...

Im Focus: New Pitt research finds carbon nanotubes show a love/hate relationship with water

Carbon nanotubes (CNTs) are valuable for a wide variety of applications. Made of graphene sheets rolled into tubes 10,000 times smaller than a human hair, CNTs have an exceptional strength-to-mass ratio and excellent thermal and electrical properties. These features make them ideal for a range of applications, including supercapacitors, interconnects, adhesives, particle trapping and structural color.

New research reveals even more potential for CNTs: as a coating, they can both repel and hold water in place, a useful property for applications like printing,...

Im Focus: Magnets for the second dimension

If you've ever tried to put several really strong, small cube magnets right next to each other on a magnetic board, you'll know that you just can't do it. What happens is that the magnets always arrange themselves in a column sticking out vertically from the magnetic board. Moreover, it's almost impossible to join several rows of these magnets together to form a flat surface. That's because magnets are dipolar. Equal poles repel each other, with the north pole of one magnet always attaching itself to the south pole of another and vice versa. This explains why they form a column with all the magnets aligned the same way.

Now, scientists at ETH Zurich have managed to create magnetic building blocks in the shape of cubes that - for the first time ever - can be joined together to...

Im Focus: A new quantum data classification protocol brings us nearer to a future 'quantum internet'

The algorithm represents a first step in the automated learning of quantum information networks

Quantum-based communication and computation technologies promise unprecedented applications, such as unconditionally secure communications, ultra-precise...

Im Focus: Distorted Atoms

In two experiments performed at the free-electron laser FLASH in Hamburg a cooperation led by physicists from the Heidelberg Max Planck Institute for Nuclear physics (MPIK) demonstrated strongly-driven nonlinear interaction of ultrashort extreme-ultraviolet (XUV) laser pulses with atoms and ions. The powerful excitation of an electron pair in helium was found to compete with the ultrafast decay, which temporarily may even lead to population inversion. Resonant transitions in doubly charged neon ions were shifted in energy, and observed by XUV-XUV pump-probe transient absorption spectroscopy.

An international team led by physicists from the MPIK reports on new results for efficient two-electron excitations in helium driven by strong and ultrashort...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

VideoLinks
Industry & Economy
Event News

First International Conference on Agrophotovoltaics in August 2020

15.11.2019 | Event News

Laser Symposium on Electromobility in Aachen: trends for the mobility revolution

15.11.2019 | Event News

High entropy alloys for hot turbines and tireless metal-forming presses

05.11.2019 | Event News

 
Latest News

New laser opens up large, underused region of the electromagnetic spectrum

15.11.2019 | Power and Electrical Engineering

NASA sending solar power generator developed at Ben-Gurion U to space station

15.11.2019 | Power and Electrical Engineering

Typhoons and marine eutrophication are probably the missing source of organic nitrogen in ecosystems

15.11.2019 | Ecology, The Environment and Conservation

VideoLinks
Science & Research
Overview of more VideoLinks >>>