Alternative PK microeconomic foundations

1. Alternative PK microeconomic foundations The firm: Costing and pricing

2. Realistic features • The modern firm operates in oligopolistic industrIes. • Oligopolies are dominated by megacorps, i.e., Galbraith's technostructure. • Unit costs are NOT U-shaped. • Cost-plus pricing is a pervasive phenomenon. • Prices set by firms in the short run are not market-clearing prices, i.e., prices are not such that they equate demand to supply.

3. Domain of validity • Sylos-Labini (1971) • Cost-determined industries vs • cost and demand determined • Means (1936), Hicks (1965): • Fixed administered prices vs • flexible prices • Kalecki (1954): • Finished and industrial products vs • agriculture and raw materials • Sraffians: • reproducible goods vs • non-reproducible goods

4. Power through growth • "The basic goal of those in charge of the firm is to cause sales revenue to grow as rapidly as possible.... But I do not agree with Marris that this pattern of behaviour is caused by the separation of ownership from control. Instead, I believe it to reflect the fact that (in so far as the two conflict) the urge for power is stronger than the urge for money. As a result, growth maximisation is a phenomenon which is to be observed in (all except the smallest) unincorporated firms and in closely owned companies as well as in large quoted companies with widely dispersed ownership" [Wood 1975 p.8].

5. Kalecki’s principle of increasing risk • «...The expansion of the firm depends on its accumulation of capital out of current profits. This will enable the firm to undertake new investments without encountering the obstacles of the limited capital markets or `increasing risk'. Not only can saving out of current profits be directly invested in the business, but this increase in the firm's capital will make it possible to contract new loans » [Kalecki 1971]. • "Finance raised externally -- whether in the form of loans or of equity capital -- is complementary to, not a substitute for, retained earnings'(Kaldor 1978).

6. The constraints on growth I = (F – iK)+ (F – iK) retained earnings + new loans Profit rate r = i + g/(1+) R  Finance Frontier G r  Expansion Frontier 1/(1+) i g Growth rate

7. Stylized facts of costing • Marginal costs are constant up to practical capacity (fixed technical coefficients) • Total unit costs are decreasing up to practical capacity • Full capacity is defined as the sum of practical capacity of all plants • It is possible to produce beyond total capacity, up to theoretical capacity • Firms usually operate at 70 to 90% of total capacity

8. Why is there ‘excess capacity’? • 1. Excess capacity is a deterrent to entry by new or outside firms (Sylos Labini). • 2. A reserve of capacity is necessary to take care of possible shifts in the pattern of demand (Steindl 1952). • 3. Fear of losing share of market when demand suddenly rises. • 4. Indivisibility of plants.

9. The shape of cost curves mc TUC AVC AVC = UC = mc q qpc qth

10. p TUC mc p .NUC NUC .UC UC q qs qpc qth 80% 100%

11. Variants of cost-plus pricing • 1. Simple mark-up pricing (Kalecki) p = (1+)(UC) , UC=W/pr • 2. Historic full cost pricing (Godley) p = (1+)(EHUC) • 3. Normal cost pricing (Andrews) p = (1+)(NUC) • 4. Target-return pricing (Lanzillotti, GM)  = rsv/ (us – rsv)

12. Historic full cost pricingp = (1+)(EHUC) • Historic full cost pricing takes into consideration the fact that goods sold this period are in part taken out of stocks of inventories, i.e., goods that were produced in the previous period at the unit cost UC(-1), the rest of what is being sold having been produced this period, at the current cost UC. • To set prices firms must make estimates of sales (se); they don’t know the proportion of sales that will arise out of inventories. Call this proportion: • σse = in(-1)/se • EHUDC, the expected historic direct costs will thus be: • EHUDC = σse.UC-1 + (1 - σse).UC

13. Historic full cost pricing (2) • To the direct costs, Godley adds the interest costs on inventories, to get EHUC: • EHUC = (1 - σse).UC + σse (1 + r).UC-1 • Ultimately, putting together equations (9.A.19) and (9.A.21), the price equation, assuming full-cost historic pricing, is given by: p = (1+)(EHUC) • p = (1 + ){(1 - σse).UC + σse (1 + r).UC-1} • With cost inflation, the formula becomes: • p = (1 + ){(1 + σse.rr).UC} • where rr is the real rate of interest

14. Normal cost pricing • With normal cost pricing, normal unit costs are computed. These are costs computed as if normal ratios were achieved. • The normal inventories to sales ratio is the target rate set by firms, σT = inT/s • It follows that normal direct costs are: • NDC = (1 - σT).UC + σT.(1 + r).UC-1 And hence: p = (1+)(NUC) • p = (1 + ){(1 - σT).UC + σT.(1 + r).UC-1} • With cost inflation, the formula becomes: • p = (1 + ){(1 + σT.rr).UC}

15. Target return pricing or the determinants of the costing margin  or normal profit rate rs • Check: • p = (1+)(NUC) •  = rsv/ (us – rsv) • Use: r = i + g/(1+) • Higher target rates are induced by: • Faster growth rates • Higher real interest rates • Tougher borrowing requirements (low )

16. Implications • Cost-plus pricing shows clearly that the purpose of pricing is income distribution • Income distribution is at the heart of inflation phenomena • Higher demand does not necessarily induce higher prices or higher inflation rates • Cost inflation may be induced by energy and material world price increases