Saturday, April 19, 2014

Mark-up Pricing in Italy

Fabiani, Gattulli and Sabbatini (2004) report the results of a survey on price setting behaviour by Italian firms (see also Fabiani, Gattulli and Sabbatini 2007).

The survey was conducted in January 2003 and involved 333 industrial and service firms (Fabiani et al. 2004: 8), although about 66% were industrial firms. Furthermore, the survey was biased towards firms selling producer goods or wholesale goods (Fabiani et al. 2004: 13).

It was found that about 60% of firms review prices once a year, and around 50% only actually change prices once a year too (Fabiani et al. 2004: 21).

Firms were asked how their unit variable costs change when there is an increase in the level of production, and the following results were obtained:
Increasing costs | 48.5%

Unchanged/flat costs | 21.3%

Decreasing costs | 27.2%

N.A. 2.5%.
(Fabiani et al. 2004: 14).
So 48.5% of firms reported flat or decreasing unit variable costs: roughly half of firms surveyed.

The firms were asked how they set the price of their main product, and the following answers were obtained:
Mark-up on unit variable costs | 63.1%

Regulated price | 13.3%

Other | 7.3%

No Answer | 16.3%.
(Fabiani et al. 2004: 16).
Mark-up pricing emerges as the overwhelmingly important type of price setting behaviour. It is also interesting here to see that regulated prices only account for only 13.3% of prices, which is far lower than the percentage for mark-up pricing.

As I have argued here, it is a mistake to think from survey data like this that firms are only using unit variable costs to calculate their mark-up price. On the contrary, when firms are pressed on this issue and we look at all the other empirical evidence, it emerges that most mark-up pricing firms are using total average unit costs (including fixed/overhead costs).

Firms were also asked to assess the importance of various theories explaining price rigidity and the theories were ranked as follows from most important to least important:
(1) Co-ordination failure

(2) Temporary shocks

(3) Explicit contracts

(4) Pricing thresholds

(5) Menu costs

(6) Bureaucratic reasons.
(Fabiani et al. 2004: 25).
These results are in line with other national surveys, but the failure to include cost-based as a theory was a major oversight.

Firms were also asked if a rise/fall in demand was an important factor in causing price changes, but some 51.1% of firms said demand changes were either unimportant (13%) or of minor importance (38.1%) in driving price changes (Fabiani et al. 2004: 26). Only 34% of firms said demand was an important factor.

Most firms reported that cost shocks were the most important factor driving price changes (Fabiani et al. 2004: 27).

Finally, price changes tend to be asymmetric: cost shocks are more likely to raise prices than reduce them (that is, firms often do not decrease prices if costs fall), and demand changes, to the extent they influence prices, tend to cause price decreases rather than price increases (that is, firms generally do not adjust prices upwards when demand increases but might reduce them if demand falls) (Fabiani et al. 2004: 34).

Fabiani, Silvia, Gattulli, Angela, and Roberto Sabbatini. 2004. “The Pricing Behaviour of Italian Firms: New Survey Evidence on Price Stickiness,” ECB Working Paper Series No. 333

Fabiani, Silvia, Gattulli, Angela, and Roberto Sabbatini. 2007. “The Pricing Behaviour of Italian Firms: New Survey Evidence on Price Stickiness,” in S. Fabiani, C. Suzanne Loupias, F. M. Monteiro Martins and Roberto Sabbatini (eds.), Pricing Decisions in the Euro Area: How Firms set Prices and Why. Oxford University Press, New York. 110–123.


  1. How many ENDLESS studies of mark-up pricing will you cite, LK before you realize that you are being too narrow minded and technical and entirely missing the point!

    Yes, firms mark-up prices. Yes there are fix price markets. Yes, those fix price markets aren't auction markets where buyers bid on objects and DIRECTLY influence price setting

    Nevertheless, "central planners" at corporations do not mark-up prices for the sake of marking up prices. They mark-up prices for the sake of selling their products to a customer base, which unlike the auction market, has the choice of hitting the asking price (buying) or not. (not buying and shopping elsewhere) Customers control the profits of corporations, and thus INDIRECTLY, control their pricing process. A company and mark-up all it wants but if customers don't come, all that mark-up is simply hot air.

    The "marginalist" supply and demand story is the forest, while mark-up pricing is the trees. You are missing the forest for the trees.

    And you are becoming boring. I used to read your blog a lot, because even as I disagreed with you, (A LOT!) I found your points of view fascinating. Now, whenever I another study in an endless slew on mark-up pricing my eyes glaze over and I leave the blog.

    1. That businesses need sufficient demand for their product for the company to be profitable and viable and for them to use mark-up prices does not vindicate the marginalist theory of pricing.

    2. Edward,

      I think you err in contending unconditionally that corporations axiomatically "mark up prices for the sake of selling their products to a customer base".

      A corporation is run by individuals; it is not a machine. There might be a number of motivations for increasing the mark-up that do not have "selling their products to a customer base" as their central focus.

      For example, the inflation in food prices in the last decade has helped the biggest agribusiness firms to consistently increase their overall capitalization, but it has done so at the expense of the profits and capitalization of food retailers and smaller firms in agribusiness. Since these price increases have not correlated tightly at all with the global food supply, this indicates a consistent increase of the mark-up on the part of dominant firms. This phenomenon suggests that the customer base is not the primary focus; instead, the focus is on redistribution, or rather in augmenting the earnings and capitalization of the largest agribusiness firms by incapacitating their smaller competitors.

      That is not to say there aren't a great many firms whose mark-ups carry the intentions you mentioned; but it invalidates the notion that the ONLY possible reason corporations mark-up their prices is to "maximize" sales to the customer base.

      For quantitative evidence and research on the case of agribusiness and food prices, Joseph Baines's 2013 article in 'New Political Economy' is enlightening:

  2. Yes,
    You see it does.

    Because I'm looking at ultimate causes and final goals, customer demand and satisfaction, while you are focused on confusing proximate causes and technical details with ultimate ones.

    1. I sort of agree with Edward, but I think there is an important, if technical, point. Marginalist models assume that all states are accessible, so if conditions persist the equilibrium can be reached. This is a necessary assumption to use smooth curves. It is a simplification. It could be wrong. LK argues that in many cases it is wrong. Thus the dynamics won't work the way marginilists say.
      I am not convinced he is right, but I am convinced he could be. It's an empirical question. Citing Mises is beside the point.

    2. Edward,

      The marginalist theory of pricing says much more than just "businesses need sufficient demand for their product for the company to be profitable".

      It is a whole theory of why firms produce and how much they produce, how prices are set, what even constitute rational firm behaviour, and how prices are supposed to clear markets.

      It is fundamentally flawed and there is no way around that.

      If you want tor reduce marginalist pricing theory to some trivial statement about the need for demand, then this proves only how little you know about marginalist pricing theory.

    3. Ken B,

      I think even Austrians and neoclassicals recognise that smooth demand curves are an analytical tool, and that more realistic graphs would use discrete points.

      And of course neither Austrians nor neoclassicals really believe that the world reaches a general equilibrium state.

      What Austrians and the more dogmatic neoclassicals think is that, even though the world is in disequilibrium, there is nevertheless a strong real-world tendency **towards** supply and demand equilibrium in product markets by flexible prices (and labour markets by flexible wages), so that market economies achieve a strong degree of economic coordination this way.

      This is plainly untrue, nor are decisions on how much to produce explained by marginalist theory either (in terms of equating price to marginal cost).

      Nor is it even remotely rational for most firms to equate price to marginal cost, ignore fixed costs or ignore sunk costs.

      Taken together, these observations are devastating to marginalist theory.

  3. Off topic, I think it is a worthwhile idea to post your recent argument from murphy's he is risen on your blog. Not everyone has the stomach or patience for that vitriolic clown show called free advice.

    1. Oh, there is whole set of posts critical of Christianity over at my other blog. I took that comment mostly from those posts.

  4. Replies

      For a selection of the posts criticising Christianity and on the origin of Christianity: