Working Paper No. 67
By Simon Hall, Mark Walsh and Anthony Yates
This paper reports the results of a survey conducted by the Bank of England in the autumn of 1995 to investigate the price-setting behaviour of 654 UK companies. The survey sheds light not only on the extent of price rigidity in general, but also on the form this rigidity takes, and the characteristics of companies and markets that influence it. The survey found that, although market conditions are of primary importance in price determination, many companies set prices on the basis of cost plus a mark up. There was also evidence of considerable price rigidity. In the year preceding the survey, the average company reviewed its prices once a month. Time-dependent pricing rules appeared to be much more widespread than state-dependent pricing rules, suggesting that the short-run real effects of monetary policy could increase at lower rates of inflation. Retailers reviewed and changed their prices more frequently than manufacturers. As in Carlton (1986), companies operating in more competitive markets reviewed prices more often than companies with few direct competitors; but in contrast to his findings long-term relationships with customers appeared to reduce price flexibility. Despite the frequency of reviews, actual prices were only changed twice on average, indicating that there may be substantial costs of changing prices. Companies stated that the physical menu costs of changing prices were a less important source of price rigidity than the need to preserve customer relationships (due to explicit or implicit contractual arrangements) or to maintain market share. In addition, cost-based rather than market-led pricing was widespread and the overwhelming majority of companies indicated that they would be more likely to increase overtime and capacity than change their price in response to a boom in demand. The survey also found substantial asymmetries in the factors which drive prices up and those that push prices down. Overall, the survey results indicate that UK markets do not behave as if prices are costlessly and instantaneously determined. It appears that uncertainty about the extent or permanence of changes in market conditions combined with costs of adjusting prices means that many companies’ short-run response to a change in demand is to adjust output rather than price. Taking account of such behaviour could be important in explaining the short-run real effects of monetary policy.
How do UK companies set prices?