Pricing in the Trade Cycle: A Quasi-Competitive Model

The problem of pricing in the trade cycle has recently been characterised as “a phenomenon in search of a theory” (Nordhaus, 1976). The fact that price-cost margins in practice show only a very weak responsiveness to demand fluctuations ² is certainly difficult to reconcile with an assumption of perfect competition in product markets. Models of imperfect competition, on the other hand, appear prima facie to offer a plausible theory. The most familiar approach is to appeal to a flat marginal cost curve (which derives considerable support from empirical studies, for example Johnston, 1960), and to assume that the shifts in the demand curve are isoelastic, as would be plausible if the increase in demand derived from solely an increase in the number of buyers. While price-cost margins remain constant under these assumptions, a problem with the approach lies in its reliance on this particular form of demand shift – if we consider the rise in demand as emanating, at least in part, from an increase in the income of existing consumers, then the demand curve is likely to become less elastic at the upswing, so that price-cost margins would increase (Robinson, 1933, chapter 4).