Thursday, August 15, 2013

Lee’s Post Keynesian Price Theory: Chapter 2

The second chapter of Frederic S. Lee’s Post Keynesian Price Theory (Cambridge, 1998) continues to study the career and work of Gardiner C. Means, an American Institutional economist and researcher.

Means came to see “administrative coordination” as a fundamental concept for the internal operations of corporations (Lee 1998: 48).

Means identified three ways to conceptually categorise market economies as follows:
(1) the atomistic market economy or the competitive economy imagined by Marshall and in neoclassical theory, in which owner-worker enterprises pursing profit maximisation predominate and where these businesses produce one type of good for sale, and such sales were made by haggling and bargaining;

(2) the factory system, with significant market concentration and scale of production. In such a system, businesses can control wages and prices;

(3) the corporate economy, in which market concentration greatly increases with corporate businesses, with separate ownership and management, and “administrative coordination” of decisions and pricing within firms (Lee 1998: 50).
Means of course realised that markets in any real world economy are a mix of these three models, but (3) was especially important.

The business behaviour of large corporations where ownership and management are split came to be governed by the firm’s management and its increasing size and scale of production. Barriers to entry had become strong in many markets and firms were no longer as motivated by the idea of long-period maximisation of profits; instead, they were more concerned with not inducing new entries into their markets (Lee 1998: 54–55).

The most important type of “administrative coordination” was achieved by price administration: prices are set for a given period of transactions on the market and often held there (Lee 1998: 55).

An equally important practice was the “flow principle of production”: market activity and demand will cause the rate of production at a given administered price (Lee 1998: 55).

In determining the profit markup, the corporation calculated a target rate of return and then took account of market competition and the prices of competitors (Lee 1998: 56).

In addition, many corporations came to shun price wars or significant price competition since this would damage the corporation’s financial health (Lee 1998: 57). Instead, they preferred to focus on advertising and sales campaigns to attract more buyers (Lee 1998: 57).

Means also saw the ultimate source of the general procyclical nature of prices as lying in the flexprice markets, which, for example, would decline in a recession and cause factor input costs for administered price businesses to fall as well.

But in administered price markets demand falls would generally cause direct reductions of employment and output, and not price reductions (Lee 1998: 60–61). Thus Means saw that demand is the primary driver of business cycles (Lee 1998: 61).

Means also had a theory of inflation in the administered pricing sector, and identified three forms of inflation:
(1) demand side inflation (or monetary inflation) at full employment, which stemmed from the flexprice sector.

(2) reflation during an upswing in a business cycle whereby market flexprices rise and induce possible changes in administered prices, and

(3) administered inflation caused by corporate decisions to raise administered prices, caused by factors such as rising wages, or to increase the profit markup (Lee 1998: 61–63).
Means understood one of the most important trends in modern capitalism: the upwards rise in prices and general inflation that occurs because of the relative downwards rigidity in administered prices.



  1. I have a question.

    In administrative pricing models prices are determined by costs + markup.

    However as well as the costs of inputs (labor, raw materials, factory rent etc) there is also a costs attached to the length of time it takes to get the goods to market. How is this factored into fixprice models ?

    (To give a simple example of what I mean: Suppose a whiskey producer can with the same inputs produce either a one-year batch or a 10-year batch and the only difference is the maturing time. People will pay more for the 10-year batch. How will this additional waiting-time be factored into the price under fixprice?)

    1. Nobody says costs + markup explains absolutely everything. 10 year whiskey has a higher markup, given that it is valued more, will incur further costs in 10 years of maturing it (as to how much the cost is, I don't know), and the whiskey business's competitors also will charge a higher price for it.

    2. So any difference in price would be down to additional storage costs plus a higher mark-up ? There would be no additional costs due to the fact that the initial capital was tied up for longer ?

    3. costs plus markup is an accounting statement, not a theory. the theory is that firms forecast costs based on an expected level of output and construct a "conventional" profit margin based on the product and specific industry conditions. clearly the maturing time in 10 year whiskey means much higher costs and much higher than average profit margins.