Download Post Keynesian Pricing Theory: Alternative Foundations and

Post Keynesian Pricing Theory:
Alternative Foundations and Prospects for Future
Research.1
Dr Paul Downward
Reader in Economics
Staffordshire University
Leek Road
Stoke on Trent
ST4 2DF
Tel:
+44 1782 294101 (direct line)
+44 1782 294074 (message)
Email: [email protected]
JEL classification code: B51, B52, D11, D21, D43, D57, D83, L11
PsycINFO classification code: 3660, 3920
Abstract
Using references to Post Keynesian pricing theory, this paper shows how decision
making under uncertainty, habits and institutions and consumer theory can be
integrated to provide a coherent alternative perspective on microeconomics.
Possibilities of clear research synergies between behavioural, psychological and Post
Keynesian economists are noted.
1
I am grateful for comments on this article from Peter Earl.
1
1.
Introduction
This short paper has two aims. The first is to provide readers of this Journal with an
overview of the ideas that underpin Post Keynesian pricing theory. This apparently
arbitrary objective in fact provides an opportunity to illustrate how subjects from
previous papers in this symposium, decision making under uncertainty, habits and
institutions, and consumer theory can be integrated. The second aim is to illustrate
further potential links with economic psychology and pricing, being suggestive of
future research agendas.
In the next section the three main origins of Post Keynesian pricing theory are
outlined. Section 3 addresses the issue of the coherence of these contributions. Section
4 suggests themes that, in the author’s opinion, offer potential for research synergies
with readers of this journal.
2.
Alternative Foundations of Post Keynesian Pricing Theory2
As Fontana and Gerrard indicate in their paper in this symposium, Post Keynesian
Economics has a long and diverse origin. The same is true of pricing wherein there is
a rejection of the core mainstream economic principle that market prices are an index
that measures, and aggregates, subjective individual valuations on alternative uses of
scarce resources. Of course, these principles were first developed out of the ideas put
forward in the ‘marginal revolution’ of Jevons, Menger and Walras.
These ideas were a reaction to a different perspective of prices put forward by the
‘Classical economists’. Despite at times exhibiting stark and fundamental differences
in key areas of their analysis and ideology, the classical economists, Smith, Ricardo
and Marx, united in distinguishing market prices from natural prices. Market prices
governed day to day transactions. However, these were regulated by natural prices,
which reflected long-run values deriving from the use of labour in production. Natural
prices ensured the reproducibility and/or growth of the economy. This distinction
facilitated an examination of the economy in terms of social relations, classes and
institutions.
2
For a detailed discussion of the historical evolution of Post Keynesian pricing, Lee (1998) is an
excellent source.
2
2.1 Neo-Ricardian Economics
Recognising analytical problems with the labour theory of value (summarised and
extended in Steedman, 1977), one branch of Post Keynesian pricing analysis draws
upon the classical approach without the labour theory of value by revisiting the work
of Sraffa (1960). The aim is to challenge neoclassical economics. Typically, referred
to as Neo-Ricardians, theorists analyse the determination of prices in input-output
systems of equations. Demand thus has no central role to play in determining prices.
In contrast the value of (input) commodities in production are marked up according to
profit rates to yield (output) prices of production. Marked-up prices and income
distribution are thus closely linked in this setting. Other key themes addressed by
Neo-Ricardians are capital theory and attempts to forge links with Keynes’ theory of
effective demand (see for example Harcourt, 1972; Roncaglia, 1978; Eatwell and
Millgate, 1983; Steedman, 1992)3. It should be noted that the historical focus has
been upon the ‘production of commodities by commodities’ – that is, manufacturing.
More recently, Eichner (1991)4 offered a ‘long-period’ analysis of prices in an inputoutput system of production that has its roots in Sraffa (1960) but which is linked to a
‘short-period’ analysis of pricing that is discussed below. This model determines the
system-wide set of equilibrium prices that allows the economy to experience steadystate expansion. Finally, drawing upon Eichner’s approach, Lee (1998) provides an
analysis of long-run prices that does not rely upon a duality between production and
prices. In this regard, Lee attempts to introduce history into the analysis that is
otherwise based in equilibrium terms.
The other branches of Post Keynesian pricing theory have different origins. They are
rooted in the marginalist controversy, prompted by the Oxford Economists Research
Group in the 1930s and the institutionalist economics of the US of the same era. At
3
Much Neo-Ricardian effort was devoted to the theoretical attack on the (aggregate) marginal
productivity theory of distribution in the Cambridge capital controversies. Key results depended on the
fact that prices of production, and hence the value of capital, changed with changes in income
distribution. No well-behaved demand curve for (the value of) aggregate capital can be assumed to
exist.
4
The reference to Eichner (1991) is to a posthumously published volume that draws together a long-
standing research programme.
3
the core of the marginalist controversy lie tensions of methodology that persist in Post
Keynesian economics today. This concerns the respective merits of formal theory and
a historical/behavioural approach to theory.
2.2 Industrial Organisation Theories
In the former case key exemplars are Kalecki (1940), Eichner (1991) and Cowling
and Waterson (1976). Sharing an emphasis with both neoclassical economics and
Neo-Ricardian analysis upon equilibrium, these contributions essentially draw upon
and refine the Structure-Conduct-Performance industrial organisation paradigm. This
paradigm applies optimising behaviour to more realistic industrial scenarios than
perfect competition, wherein large firms, supplying differentiated products can earn
persistent ‘abnormal’ profits. A key historical result, addressed in the marginalist
controversy, was that mark ups on marginal costs reflected the reciprocal of the price
elasticity of demand as a measure of monopoly power.
Kalecki (1940) thus presents a profit maximising, model of imperfect competition in
which marginal revenues and costs are equated. Cowling and Waterson (1976)
extended this analysis to argue that mark ups would also depend upon the industrial
concentration in an industry and the degree of ‘Cournot’ competition. Likewise,
Eichner, (1991) offered a determinate model of pricing that he intended to provide a
microfoundation for macroeconomics. He developed a microeconomic model of the
core oligopolistic sector of the US, wherein price-leader ‘megacorps’ seek to
maximise their growth subject to institutional constraints, such as the degree of entry
to the market and government scrutiny.
2.3 Historical/Behavioural Theories
The final branch of Post Keynesian pricing theory, tends to reject the formalism and
equilibrium approach of the above strands of thought and embrace the original
analyses of the Oxford Economists research Group and US institutional economists.
In the former case, the seminal contributions were Hall and Hitch (1939) and
Andrews (1949, 1964). Based on interviews with businessmen, Hall and Hitch argued
that the, then emerging, general approach to pricing that emphasised marginalist rules
was misplaced. Uncertainty facing businessmen meant that firms did not make use of
4
either marginal revenue or costs to set prices, nor made (even implicit) calculations of
the price-elasticity of demand in setting mark ups and prices. In contrast firms marked
up their prices on full average costs to the extent that the ‘group of competing
producers’ (p. 19) would allow. The mark up was set to cover both overheads and a
conventional allowance for profit per unit. In order to allocate overheads and hence
determine their margin for profit and the level of prices, businessmen in practice used
a hypothesised or normal level of output to govern their pricing decisions, rather than
a consideration of actual levels of output, which may change or deviate from this
hypothesised level as demand changes.
On the whole, therefore, nominal prices would stabilise at a conventional level
corresponding to the normal level of output for firms, reflecting normal competitive
conditions. A kinked demand curve was presented by Hall and Hitch to capture these
conjectures. Andrews’ (1949, 1964) in many respects echoed their work but described
the pricing procedures as normal-cost pricing. Andrews was, moreover, keen to
emphasise that competition was fierce and that ‘known rivalry’ embracing both actual
and potential competitors helped to structure prices. In this respect full-cost pricing
should not be thought of as bureaucratic behaviour. In contrast price stability reflected
uncertain expectations about potential competition.
In the US, the institutional economist Gardiner Means’ (1935, 1936, 1962, 1972)
central concern was with articulating how prices are set in large ‘modern’
corporations. In this respect he was less concerned with the nature of external market
constraints on prices than, say, Andrews or Hall and Hitch. His thesis was that one
can distinguish price-setting as reflecting two extremes. In large modern corporations
prices are ‘administered’ rather than set in the ‘auction’ conditions implied in
neoclassical price theory. Administered prices are prices that are fixed by
administrative fiat before transactions occur and are held constant for periods of time
and for sequential sets of transactions. Nevertheless, as Means (1962) illustrates,
pricing is carried out in terms that are analogous to full/normal-cost pricing. The
implication thus is that once again, prices are set with reference to mark-up
procedures and prices will change more closely with cost changes than demand
changes.
5
Some of the later work of Kalecki (1954, 1971) also presents a theory of pricing in
which ‘exact’ profit maximising behaviour is rejected because of the uncertainties
faced by firms. The emphasis is on firms marking up average direct costs with mark
ups being constrained by the degree of monopoly of the firm and the price of similar
products. The degree of monopoly however is not measured by the reciprocal of the
price elasticity of demand but reflects institutional features of the market such as sales
promotion activities, trade-union power, the degree of industrial concentration and the
level of overheads relative to direct costs. Although Kalecki treats overheads
differently than Hall and Hitch and Andrews, one can argue that the similarities are
stark. For debate, particularly over the behaviour of costs, see Kriesler, (1987),
Downward and Reynolds (1996), Lavoie, (1996) and Lee, (1996). It remains that
Kalecki’s analysis also emphasises that firms follow mark-up procedures to determine
prices and that as a result prices vary directly with costs but only indirectly with
demand.
3. A Coherent perspective?
Though drawing upon a wide set of ideas there are two ways in which the coherence
of Post Keynesian pricing can be understood and out of which research agendas with
behavioural and psychological economics established.
The first of the approaches is the traditional perspective that finds congruence in
structural aspects of pricing in inter-industry, particular industry and firm-level
contexts. The emphasised link between the theories is that prices are set according to
mark-up procedures and that prices will vary with costs but not directly with demand.
Of course, this proposition contrasts greatly with the general equilibrium, perfectly
competitive core of neoclassical economics.
Attempts have been made to directly synthesise the Neo-Ricardian and industrial
organisation approaches to pricing. As noted earlier, Eichner (1991) considers his
megacorp approach to pricing to be a ‘short-period’ analysis that determines ‘actual
prices’, which are then linked to the long-run analysis of prices consistent with
steady-state growth in the Neo-Ricardian framework as discussed above. Reynolds
(1987) also argues that the ‘short-period’ aspect of Eichner’s work is closely linked to
the Structure-Conduct-Performance approach while, in general, Sawyer (1990) argues
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that Post Keynesian economics, as defined by these contributions, strongly overlaps
with the industrial organisation literature. This possibility of synthesis is shared in
Arestis (1992) and Lavoie (1992) in their textbook analyses of Post Keynesian
economics.
The second approach is more radical, selective and draws upon methodological
criteria. As indicated above textbook perspectives of Post Keynesian economics argue
that the fundamental difference between neoclassical and Post Keynesian accounts of
pricing lie in the emphasis upon mark-up procedures and asymmetrical effects of
costs and demand upon prices. Yet, there is a problem. The ergodic/non-ergodic,
closed-system/open system ontological distinctions referred to by Fontana and
Gerrard as distinguishing between mainstream and Post Keynesian analysis can
clearly apply to the above pricing theories. To put it bluntly, the Neo-Ricardian and
industrial organisation perspectives both emphasise equilibrium solutions. The latter
also explicitly draw upon an optimising explanation of behaviour. These are
properties of ergodic or closed systems, which are at odds with uncertainty and
historically contingent decision making. The rationale for mark-up procedures is thus
different, emphasising a logical counterpart to marginalist rules. To this end, though
particularly drawing upon a Critical Realist methodological perspective, Downward
(1999, 2000) argues that only the historical/behavioural contributions constitute a
constructive alternative to mainstream analysis.
4. Potential Links with Behavioural and Psychological Economics
On the basis of the above perspectives of coherence, potential links between Post
Keynesian and Behavioural and Psychological economics can be identified. Let us
take the Neo-Ricardian approach first. Despite the historical emphasis on the interindustry linkages associated with the physical production of output, it is clear that
there is a need to understand how complex products are supplied and the effects that
this has on price – i.e., value – in modern service and consumer-oriented industries.
The ‘value-chain’ perspective popularised as generic by the Business Strategist
Michael Porter, for example, is potentially consistent with the Neo-Ricardian
perspective.
7
One could use the input-output structure of Neo-Ricardian economics to analyse the
physical linkages between activities in firms or implied by supply-chains between
firms. An extension of this analysis would be to recognise that often technical factors
such as the quality of inputs can act as an important constraint here. Another
possibility is to recognise the conception of products as ‘brands’ with sets of distinct
qualitative characteristics that are combined to produce economic value as implied in
conceptions of brand equity in marketing and accounting. The aggregation of these
characteristics into an expression of value is clearly possible in Neo-Ricardian terms.
In both of these cases, the reasons for the weights by which components of activities
or brands are aggregated – i.e., the structure of interlinked demands – need
investigating.
Obvious lines of enquiry here are examining how firms signal their quality to
customers and how quality symbols affect the consumption and supply of products
and services. Such symbols will act as thresholds on behaviour and, as such, limit and
refine search. In general the behaviour and negotiations of industrial buyers and
suppliers as they balance the need to be competitive with the need to promote longerterm links needs investigation. In general, the message is that clearly psychological
and behavioural analysis as much as technical concern is important in fleshing out
how these forms of economic activity develop and evolve. To put it bluntly, there are
social and power relationships involved not simply technical coefficients of
production. Consistent with psychological economics, as Hodgson’s contribution to
this symposium recognises, rules and habits underpin behaviour in which agents
grapple to make ‘rational choices’ under conditions of uncertainty. Clearly in the
multiactivity and multiagency contexts noted above such behaviour will be
manifested and needs investigation. Of, course, one should recognise that the NeoRicardian concept of ‘value’ does have it roots in the classical intellectual tradition.
This emphasises the material conditions of production. Movements towards
psychological and more subjective notions do imply some compromise here.
Similar arguments apply in consideration of the industrial organisation theories of
pricing. While essentially drawing upon structural features of markets to explain
prices, such as concentration and the price elasticity of demand, it is clear that the
agency that shapes these structural features needs investigation. The concept of
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concentration thus could be unpicked in terms of the type of Neo-Ricardian analysis
discussed above. The sensitivity of consumers to price can also be investigated. The
sense in which this can take place also applies to the historical/behavioural
approaches to pricing. Some suggestions now follow.
Further links with behavioural and psychological economics could easily be made in
examining the focus upon rule-following behaviour. Mark-up pricing procedures
conform to this behaviour. One can argue that this is the case because information on
costs – because of cost accounting procedures – provides reliable information for
firms but stable margins are set and defended to produce predictability in the external
sphere of markets in which information is less complete. Change thus tends to be
incremental.
This is a feature emphasised, for example, in Hall and Hitch (1939) in which unstable
prices arise when falls in demand are sufficiently high and persistent for firms to
revise their expectations of normal output. Here, they seek to promote an increase in
output by cutting prices, which will also reduce average total costs. In the short run,
however, firms avoid this behaviour for fear of promoting a price war. ‘Habits’ in this
context become manifest as pricing procedures and rules.
Yet two further lines of research spring to mind in extending this analysis. The first
underlies the motives and constraints perceived to generate rule following and
procedural decision-making. As well as general concerns over the uncertainty
associated with decision making, it is important to note that both Hall and Hitch and a
number of subsequent case-study investigations into pricing emphasise defence of the
firm’s goodwill in setting ‘fair prices’ by following their procedures (see Downward,
1994). The aim is not to ‘antagonize’ customers. In mainstream economics, and Post
Keynesian economics such concepts have tended to be conflated with ‘competitive’
pressure. Yet it is clear that in cases of ‘known rivalry’, whether or not one refers to
supply-chain relationships or local markets, personal contact and attitudes will shape
behaviour. It should be noted that in many of the case-studies on pricing surveyed in
Downward (1994) prices were also set to meet concerns over the firm’s prestige and
to avoid personal worries such as financial embarrassment. As Lavoie argues in this
9
volume, in the case of consumers moral issues may dispense with the principle that
everything has a price. These are issues that need investigation.
Related to this, of course, is the notion of brand equity again and how firms seek to
manage competition in order to generate the ‘degree of monopoly’ emphasised in post
Keynesian accounts of pricing. Taking Kalecki’s (1954) theory as an example, this
emphasises that at the firm level average costs are marked up to a limit constrained by
union power, sales and promotion activities, the degree of concentration in the market,
the level of overheads to be covered and, crucially, the level of prices of competing
products. Hidden away in this rather structural account lies a rejection of the
traditional economic definition of markets as comprising homogeneous products and
the law of one price. Kalecki’s formulation allows for both differentiated products and
prices that remain related through competitive pressure. How firms use branding to
create psychological attachment to products and services, and hence a degree of price
independence, whether this be on the basis of perceived or actual differences in
product attributes is a further issue that needs investigation.
One cannot overemphasise the importance of such analysis. From a theoretical
perspective there are opportunities for further demonstrating congruence between
Kalecki (1954) - who describes pricing in ‘degree of monopoly’ terms - and Andrews
(1949, 1964) - who tends to emphasise competition. In the past, as discussed above,
debate has focussed upon cost behaviour and mark-up formulae. Behavioural
relationships are probably as important and need investigation. The implications can
be profound. Earl (2003, p32), indicates how the same product – in this case referring
to the same vehicle – can command radically different prices under different brand
names. Such possibilities raise subsequent public policy issues for research. Waterson
(2003) has broached this issue by arguing that consumer search and switching
behaviour is essential to the process of competitive behaviour and hence the welfare
of consumers. The point is that consumer welfare can fall if search and switching
behaviour is curtailed. The desire and ability of consumers to search out and switch
purchases between alternatives, to an extent depends on the availability of
information. Suppliers can control and manipulate this as Lavoie indicates in his
discussion of Galbraith.
10
The second major research opportunity involves branching out from the analysis of
the actual pricing rule itself and linking this in with the wider structure of decision
making. Once again, there are historical precedents here. Katona (1951) was one of
the earliest analyses of general business behaviour drawing explicitly upon
psychological concepts. Cyert and March (1963) likewise analysed pricing behaviour
within the context of broader institutional decision making procedures and the
presence of bounded rationality. The marketing literature did likewise (see, for
example, Capon et al, 1975; Hulbert, 1980).
Downward (1999) draws upon these ideas in and attempt to build such a research
agenda. Based on questionnaire research, factor-analytical techniques are applied to
explore the broader organisational dimensions of decision making within an opensystem/cybernetic framework to attempt to link the Post Keynesian focus on the mark
up with behavioural economic concepts. Drawing upon Earl and Kay (1985) it is
argued that price formation emerges out of the complex interplay of rule-based
behaviour and adjustment in the light of competitive or environmental pressure, but
also reflects these processes individually. The research also indicates that the rulebased nature of pricing (and hence inertia in price adjustment) is not necessarily
concerned with the actual cost-plus formula of pricing but essentially the broader
decision-making structure of the firm. Critically developing this work would thus be a
fruitful line of enquiry.
Finally, perhaps the greatest scope for developing a joint research agenda actually
follows from the areas that both Post Keynesians and Economic Psychologists have
tended to ignore. These include new product pricing and retail pricing. New products
can, of course, arise from both minor changes in detail of products and larger nonincremental changes that reflect substantial technical innovations. The ‘mental
models’ and subsequent organisational processes that describe such revision in
product specification or innovative behaviour are not well researched. But, clearly a
research agenda here would help to forge links between accounts of behaviour that
tend to emphasise rules and those that focus on evolution. This could link prices to
strategies appropriate for the product life-cycle as discussed by Dean (1951) and the
evolution of firms more generally as analysed by, say, Nelson and Winter (1982).
11
In the case of retail pricing, it is true that Andrews discusses some issues, but not in a
systematic way. Significantly, concepts of hierarchical choice concerning product
ranges, as discussed by Lavoie in this volume, and goodwill, that is consumer loyalty,
are noted (Andrews, 1964; Andrews and Friday, 1960). As Earl (1983, 1993) argues,
under such circumstance competition is essentially about the patronage of outlets and
brands than prices of specific, individual products. This is a point emphasised in
earlier economic pyschology analyses such as Katona and Mueller (1954) where the
lack of extensive search and advanced planning predominated. Sustained mutual
research between Post Keynesians and Economic psychologists could thus offer much
in terms of highlighting the strategies adopted in different contexts in which outlets
and the ‘strategic’ importance of purchases varies. This could take place, for example,
in much the same way that work has begun, and could begin, as noted above, on
industrial pricing.
5. Conclusion
This short article, it is hoped, illustrates how the themes in Post Keynesian economics
discussed in other contributions to this symposium can be integrated as part of the
analysis of specific issues. In this case pricing is discussed. In particular this article
has illustrated that while Post Keynesians have eclectic intellectual traditions, the
analysis of this concrete issue reveals that Post Keynesians take the problems of
decision making under uncertainty, as discussed by Fontana and Gerrard very
seriously. In this regard it is fully expected that agents on both sides of the market will
rely on habits and rules as discussed by Hodgson and Lavoie. It is also hoped,
moreover, that the article reveals that symbioses of ideas permeate both the Post
Keynesian and Economic Psychology literatures and, in this respect there is much to
be gained from mutual future research.
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