How Do U.K. Companies Set Prices?

Abstract

This paper reports the main results of a survey carried out by the Bank in the autumn of 1995 of the price-setting behaviour of 654 U.K. companies. It elaborates on an article in the May 1996 Bank of England Quarterly Bulletin. In the year preceding the survey, the average company reviewed its prices once a month. The extent and source of price rigidity varied across different types of company and market. Retailers reviewed and changed their prices more frequently than manufacturers. Companies operating in more competitive markets reviewed prices more often than companies with few direct competitors; but 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 need to preserve customer relationships (due to explicit or implicit contractual arrangements) or to maintain market share were important sources of price rigidity. In addition, 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. There were substantial asymmetries in the factors which drive prices up and those that push prices down. 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. Overall, the survey results indicate that U.K. 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.