An Analysis of the Price-Inventory Nexus with Empirical Application to the Canadian Manufacturing Sector

Abstract

Most empirical work dealing with the behavior of prices focuses on the aggregate price level2. This is not surprising, given countries' concern with inflation and the fact that inflation is defined in terms of the movement in some aggregate price index, such as the consumer price index. In addition, this work has been most fruitful: policy-makers now, as well as economists, are talking in terms of trade-offs between prices and unemployment. Nevertheless, there is a cost involved in such analyses. By concentrating on the determinants of the aggregate price level, these studies take price behavior out of the context of the industry or firm where the decisions concerning prices are actually made. The result may well be that such studies fail to provide adequate explanations for the behavior of the components of the aggregate price level. Equally important, an analysis of industry price behavior may yield valuable insights into aggregate price behavior -insights not available from aggregate analyses. It is within this setting that the present paper attempts to proceedto investigate price movements at a disaggregated level and to interpret the findings in the context of the current empirical literature on price behavior. More specifically, the purpose of this paper is two-fold: (1) to investigate the determinants of short-run price movements at an industry level, and (2) to ensure that these price equations are suitable for integration into the context of a larger industry submodel, including other decision variables such as inventories, production, and unfilled orders. Happily, to anticipate the results, these turn out to be complementary objectives. This occurs primarily because we hypothesize (and verify empirically) that short-run price changes are determined, in part, by considerations involving inventories. In fact, the variable that satisfies both these objectives-equilibrium inventories minus actual inventories-is the only variable that bears a consistent empirical relationship to quarterly price movements over 1956-1962, the time period of