ON THE INFREQUENT ADJUSTMENT OF PRICE BY FIRMS

Many firms change price no more than twice a year. This phenomenon is readily explained by very small price adjustment costs, and the fact that the firm's rate of profit is often insensitive to deviations in the interval between price changes from its optimal level. As a result, firms which change price only once or twice a year may earn almost as much profit as firms that adjust price optimally. This refutes the standard objection that price adjustment costs are too small to matter. The argument does not require extreme assumptions about the flatness of the firm's profit function.     

VARIABLE PRICE ADJUSTMENT COSTS

The fixed (menu) cost approach has been criticized since administrative costs of price changes are small. This paper studies costs which depend on (i) the size or (ii) the frequency of adjustment. The optimal pricing policy is similar to that in the menu cost model which is, therefore, a simple benchmark case. While recent empirical evidence implies rejection of the fixed cost model, it is consistent with the general specification used here. The analysis strongly suggests that nominal inflexibilities at the individual level are not due to administrative costs but result from unfavourable market response to price changes.     

Political use of income: Some experimental evidence from Capitol Hill

The political-cost hypothesis predicts that managers in firms that are good political targets will use the leeway permitted by Generally Accepted Accounting Principles (GAAP) to lower income and, thereby, reduce their political exposure. Though the political-cost hypothesis has been widely tested, past tests have assumed that politicians use accounting income when selecting targets for costly legislation and/or regulation. This article uses experimental methods to test the validity of this assumption. The article employs a factorial survey design in which vignettes describing various factors related to a legislative bill introducing new regulatory costs on an industry were sent to aides of each U.S. member of Congress. The results suggest that legislators are less likely to impose new costs on industries with low income, which is consistent with the political-cost hypothesis.     

PRICE COMPETITION UNDER COST UNCERTAINTY: A LABORATORY ANALYSIS

We study the relation between the number of firms and price-cost margins under price competition with uncertainty about competitors' costs. We report an experiment in which two, three, and four identical firms repeatedly interact in this environment. In line with the theoretical prediction, market prices decrease with the number of firms, but on average stay above marginal costs. Pricing is more aggressive than in equilibrium. Absolute and relative surplus increases with the number of firms. Total surplus is close to the equilibrium level, because enhanced consumer surplus through lower prices is counteracted by occasional displacements of the most cost-efficient firm. (JEL C90 , C72 , D43 , D83 , L13 )     

EXCESS DEMAND AND MARKET ADJUSTMENT

This paper develops a model of wage and price adjustment that is based on the optimizing behavior of firms. The output of the model is a relationship between price changes and excess demands that looks like a generalized Walrasian adjustment but which is based on firm microfoundations. The model is then applied to stability analysis and the "Phillips curve," using restrictions derived from the underlying optimization to generate results.     

AN OPTIMAL MIDDLEMAN FIRM PRICE ADJUSTMENT POLICY: THE "SHORT-RUN INVENTORY-BASED PRICING POLICY"

This paper examines the optimum pricing policies of middleman firms who carry an inventory of goods bought for resale. Each period the firm in the theoretical model is required to post a price before it observes its realized demand. In disequilibrium situations, the firm's profit-maximizing pricing policy is shown to be a "short-run inventory-based pricing policy" which requires the firm to post a price below the long-run equilibrium price upon observing its actual beginning inventory level above its optimum level, and to post a price above the long-run equilibrium price upon observing its actual inventory level below its optimum level. The final section suggests that the use of such policies by middleman firms will lead to market price adjustments which are both consistent with the "law of supply and demand" and which are based on explicit maximizing behavor.     

AN EFFICIENCY EXPLANATION FOR WHY FIRMS SECOND SOURCE

Firms facing research costs and demand uncertainty may engage in second-sourcing, in which potential suppliers agree to pool production facilities. I show how sellers and buyers both can benefit from the practice. Second-sourcing allows firms to meet a wider range of possible rates of demand and often to supply a given rate of demand at a lower total cost than under non-cooperation. Buyers benefit through a reduced probability of stock-outs and frequently a lower purchase price. Semiconductor industry data are found to be consistent with the paper's predictions.     

DESIGNED TO FAIL: THE MEDICARE AUCTION FOR DURABLE MEDICAL EQUIPMENT

We examine the theoretical properties of the auction for Medicare Durable Medical Equipment. Two unique features of the Medicare auction are (1) winners are paid the median winning bid and (2) bids are nonbinding. We show that median pricing results in allocation inefficiencies as some high‐cost firms potentially displace low‐cost firms as winners. Further, the auction may leave demand unfulfilled as some winners refuse to supply because the price is set below their cost. We also introduce a model of nonbinding bids that establishes the rationality of a lowball bid strategy employed by many bidders in the actual Medicare auctions and recently replicated in Caltech experiments. We contrast the median‐price auction with the standard clearing‐price auction where each firm bids true costs as a dominant strategy, resulting in competitive equilibrium prices and full efficiency. (JEL D44, I11, H57)     

MONETARY NEUTRALITY UNDER EVOLUTIONARY DOMINANCE OF BOUNDED RATIONALITY

We provide evolutionary game‐theoretic microfoundations to a dynamic complete nominal adjustment in response to a monetary shock by introducing a novel analytical notion that we call boundedly rational inattentiveness. We investigate the behavior of the general price level in a context where a firm can either pay a cost (featuring a random component) to update its information set and establish the optimal price (Nash strategy) or freely use non‐updated information and establish a lagged optimal price (bounded rationality strategy). We devise evolutionary microdynamics (with and without mutation) that, by interacting with the dynamics of the aggregate variables, determines the coevolution of the frequency distribution of information‐updating strategies in the population of firms and the extent of the nominal adjustment of the general price level to a monetary shock. As it turns out, evolutionary learning dynamics take the information‐updating process to a long‐run equilibrium configuration in which, albeit either most or even all firms play the bounded rationality strategy, the general price level is the symmetric Nash equilibrium price and the monetary shocks have persistent, although not permanent, impacts on real output. (JEL E31, C73, D83)     

OUTPUT EFFECTS OF INFLATION WITH FIXED PRICE– AND QUANTITY–ADJUSTMENT COSTS

This article examines how the aggregate production varies with inflation when there are fixed price– and quantity–adjustment costs. It shows that such variation is determined by the elasticity of the firms’ marginal real revenue with respect to demand. The aggregate production decreases with inflation if this elasticity always exceeds minus unity, whereas the aggregate production increases with inflation if the elasticity is always less than minus unity. The aggregate production is independent of inflation in the special case that the elasticity always equals minus unity. The latter occurs if demand is derived from a log‐quadratic utility function. (JEL E31)     

SAFETY FIRST, BANKRUPTCY, AND THE PRICING AND INVESTMENT DECISIONS OF THE FIRM

The paper analyzes the impact of imposing a constraint on the probability of bankruptcy for the pricing and investment choices of firms. Two models are presented in which a firm faces stochastic demand; in one costs are known with certainty, and in the other costs of production are probabilistic. In both cases the constraint induces a reduction in optimal price if demand is elastic. For less elastic demand, price increases may be indicated. With constant costs, the constraint lowers optimal investment. The results are applicable to the analysis of rating agencies' behavior, or to the design of bond covenants, especially for public utilities.     

The field of graduate recruitment: leading financial and consultancy firms and elite class formation

The symbolic value of being recruited by a high status multinational company likely represents an important marker of distinction. For the first time, a unique Destinations of Leavers in Higher Education (DLHE) data‐set is used here to model entry to elite multinational company in finance, accountancy and consultancy sectors among graduates of different social origins, universities, degree subjects and with different degree classifications. From a sample of 11,755 graduates working across these three sectors, we examine what predicts entry to 31 leading firms and then examine pay hierarchies among the 3,260 graduates working for these companies using random‐effects models. At first glance, significantly, we find that elite recruits come from a much broader range of universities than might be imagined. However, a closer look at the highest paid graduates within these firms reveals more familiar patterns of social and institutional stratification. We argue that these patterns likely reflect the nature of work undertaken by graduates in these elite firms, with institutional and social origins of graduates differing according to the particular track taken in what are likely to be highly differentiated graduate recruitment schemes.     

PRICE ADJUSTMENT POLICIES AND FIRM SIZE

A number of U.S. State Departments of Transportation have adopted a price adjustment policy designed to limit cost fluctuations of oil‐based inputs in government procurement. Similar policies are common in defense contracting, and have been used to offset financial losses of health insurance companies in Medicare and the Affordable Care Act. We show that while all bidders submit lower bids after the policy is introduced, the extent of bid reduction diminishes with firm size. Small new firms are able to compete more frequently, promoting auction competition and efficiency. (JEL H4, H57, D44)     

HOW TO HAGGLE and TO STAY FIRM: BARTER AS HIDDEN PRICE DISCRIMINATION

Barter transactions, conducted openly by established corporations, play an increasingly significant role in the U.S. economy. The model developed here helps explain why firms use barter and yields predictions concerning the circumstances under which barter is likely to occur. It is shown that when two firms barter goods used as inputs, price discrimination occurs. This price discrimination is hidden from the firms' other customers because the real values of the transacted goods to the barterers are different from the accounting prices used in the transaction. Since price discrimination that is observed by potential customers might have an adverse effect on the selling firm's future bargaining power, barter will have value as a means of hiding price discrimination.     

A MODEL OF OPTIMAL PLANT SIZE WITH AN APPLICATION TO THE DEMAND FOR COGNITIVE ACHIEVEMENT AND FOR SCHOOL SIZE

A model of optimal plant size is developed which predicts that 1) plants experience increasing returns to in-plants inputs, 2) the relative price of plant output is greater in rural areas than in urban areas, and 3) plants are larger in urban areas than in rural areas. The model's predictions appear to be consistent with behavior in a number of consumer services (e. g., grocery, movie, and library services). These predictions are more rigorously tested and are strongly supported when demand functions for cognitive achievement and for school size are estimated. These regressions also lend support to the quality-quantity model of fertility.     

Firm outsourcing decisions: evidence from U.S. foreign trade zones

This article examines the operations of firms located in U.S. foreign trade subzones to study the responsiveness of outsourcing to international cost changes. I find that firms reduce their reliance on foreign inputs when dollar depreciation increases the relative price of imported inputs. The effect is pervasive across industries and is economically significant. In addition, firms that rely more heavily on imported intermediate inputs reduce their overall shipments when dollar depreciation elevates their imported, input costs. However, the magnitude of the shipments effect is economically small, suggesting that firms respond to exchange rate movements by adjusting their operations on other dimensions.     

INNOVATION: ITS PUBLIC AND PRIVATE ASPECTS AND SOME OF THEIR EMPIRICAL IMPLICATIONS FOR MERGERS

Innovators may have incentives to incur the expense of the search for new knowledge even if others can use the results without contributing to the costs of the search for them. Why? Assume firms choose their actions independently. Assume new knowledge is a free public good: a firm can make the product at lower cost even if it spends nothing on research, if another does the research. The most plausible noncooperative equilibrium in this situation is stochastic: firms will decide what to do on the basis of a random device. The theory determines the probability that the firm spends nothing, or something, on research. In consequence, no firm can be certain that a rival will do the research; no firm can be certain of becoming a free rider. In consequence, there will be no relation on average between returns on research-outlays and size of outlays; but the yield on research always will be positive. Innovation can lead to differences among firms, but these differences should not persist, as firms can gain by eliminating them. In a non-cooperative equilibrium, where firms have different cost conditions, the allocation of output among them is inefficient. Such inefficiency can be eliminated if information about methods of production is sold, say by way of licensing. But royalty receipts are a very small fraction of total revenues, even in research and development intensive industries such as chemicals and scientific instruments. Merger is another avenue of cooperation. The theory which assumes research results are private predicts a positive relation between merger activity and technical change. Empirical evidence for the 1879–1930 inverval supports this prediction.     

A SIMPLE MACROECONOMIC MODEL WITH MONOPOLISTIC FIRMS

This paper presents a simple macroeconomic model in which firms' outputs are imperfect substitutes, and explores the macroeconomic implications of monopolistic competition. The model is classical in some respects, but Keynesian in others. Multiple or unstable equilibria are not unlikely. Permanent price controls will, in principle, be desirable, since they allow a permanent and efficient increase in aggregate output. Small costs of price adjustment may induce large deviations of output from the natural rate. Fiscal policy will generally affect aggregate output, but the sign and magnitude of the government expenditure multiplier cannot be determined a priori.     

LABOR CONTRACTS AND FLEXIBILITY: EVIDENCE FROM A LABOR MARKET REFORM IN SPAIN

This paper evaluates the effects of a labor market reform in Spain that removed restrictions on fixed‐term or temporary contracts. Our empirical results are based on longitudinal firm‐level data that cover observations before and after the reform. We posit and estimate a dynamic labor demand model with indefinite and fixed‐term labor contracts, and a general structure of labor adjustment costs. Experiments using the estimated model show important positive effects of the reform on total employment (i.e., a 3.5% increase) and job turnover. There is a strong substitution of permanent by temporary workers (i.e., a 10% decline in permanent employment). The effects on labor productivity and the value of firms are very small. In contrast, a counterfactual reform that halved all firing costs would produce the same employment increase as the actual reform, but much larger improvements in productivity and in the value of firms. (JEL J23, J32, J41)     

THE NEAR OPTIMALITY OF MARK-UP PRICING

Mark-up pricing policies result in a loss of profits compared to marginal pricing behavior. These losses, however, are often very small, even for large changes in the money supply. But by adopting a simple pricing rule the firm does not have to forecast the future, and avoids the informational and computational costs required to determine the profit maximizing price each period. Thus, even if these costs are small, mark-up pricing policies may be optimal, or approximately so, at least for some firms. In a macro model this is likely to imply large monetary non-neutralities.