Price rigidity, inflation and market concentration: Some Canadian evidence from the 1970s

Abstract

In the literature on industrial pricing there is a long-standing dispute over the theoretical rationale for, and the empirical validity of, price rigidity. Briefly, the arguments is that the speed of price adjustment is a function of market structure: in competitive markets prices are flexible (they adjust rapidly to supply and demand shocks), but in oligopoly they can be relatively rigid (they adjust only slowly, if it all, to these same shocks). 1 1The term ‘price rigidity’ is used to cover all price reactions to demand and supply shocks that differ from those associated with the ‘price flexibility’ of perfect competition. For example, during general deflations (inflations) where demand falls (rises), flexible prices will be falling (rising); but rigid prices may, remain the same or fall (rise) less than flexible prices. But, because the theoretical basis fot the rigidity hypothesis is decidedly ad hoc, it is often summarily dismissed. 2 2See the review by Ross (1987). Empirically, however, a number of studies for various countries and time period have found relationship between concentration (a proxy for oligopolistic market structure) and price change and/or some other measure of the speed of price adjustment, compatible with price rigidity. 3 3For a sampling of studies using US data see: Means (1935, 1972), Wesis (1966), Ross and Krausz (1986), Carlton (1986). For studies using Canadian data see: Sellekaerts and Lesage (1973) and Jones and Laudadio (1977). For Great Britian see, Aaronovitch and Sawyer (1981); and for a number of OECD countries, see Encaoua and Geroski (1986). Although these result are not totally unambiguous, 4 4For criticisms (particularly of Means), and contrary results see: Stigler and Kindahl (1970, 1973) Kottke (1978), Qualls (1978), Garber and Klepper (1980). A number of the items in footnote 3 criticize the ctitics listed in this footnote. the Canadian evidence, at least prior to the 1970s, strongly supports the rigidity hypothesis (Sellekaerts and Lesage, 1973; Jones and Laudadio, 1977; McRae and Tapon, 1979). The object of this paper is to report the results of testing the general hypothesis that, under the inflationary conditions that prevailed in Cananda in the 1970s, oligopolistic price adjustment to supply and demand shocks was less rapid than more competitive markets. The methodology is to examine the concentration–price change relationship using regression techniques for a cross-section sample of 54, 3 and 4 digit SIC manufacturing industries every year from 1971 to 1982. The major conclusion is that, while initially the concentration–price change evidence supports the rigidity hypothesis, as inflation continued unabated and as inflationary expectations were incorporated into the in-pricing policy. oligopolistic firms adjusted with the same rapidity as competitive firms. The remainder of the paper details the reasons underlying these conclusions and is organized as follows: Section I, a theoretical rationale for the rigidity hypothesis is presented; Section II, the regressional model is outlined; Section III, the empirical results are reported; and Section IV, conclusions and policy inferences are drawn.