Asking About Prices: A New Approach to Understanding Price Stickiness

Chapter 5: Basic Results on the Twelve Theories

Chapter 5 Basic Results on the Twelve Theories When the One Great Scorer comes to write against your nameHe marks-not that you won or lost-but how you played the game. -GRANTLAND RICE The main objective of the survey was not to compile the unadorned facts that were examined in chapter 4, fascinating as they may be. Rather, the study was designed to gather the opinions of real-world decision makers on the validity of economists' theories of price stickiness. It is to these central results that we now turn. This chapter focuses on broad-brush findings that cut across the twelve theories . Which theories are most "popular" with actual price setters? Which theories are correlated with which? Are prices more sticky downward than upward? The following twelve chapters then delve more deeply into the details of each theory, one by one. Numbers, names, and very brief descriptions of each theory are given in table 5.1 for the convenience of the reader. Fuller descriptions were offered in chapter 2; further analysis can be found in chapters 6 through 17. On the Empirical Validity of the Theories The most obvious question to ask is how well each of these theories fares in the eyes of our two hundred decision makers. Respondents were asked how important each theory is as a cause of price stickiness in their own firm. Respondents answered in their own 108 Asking About Prices Table 5.1 The Twelve Theories Theory Number and Name B1 Nominal contracts B2 Implicit contracts B3 Judging quality by price B4 Pricing points B5 Procyclical elasticity B6 Cost-based pricing B7 Constant MC B8 Costly price adjustment B9 Hierarchy B10 Coordination failure B11 Inventories B12 Nonprice competition Brief Description Prices are fixed by contracts. Firms tacitly agree to stabilize prices, perhaps out of Hfairness" to customers. Firms fear customers will mistake price cuts for reductions in quality. Certain prices (like $9.99) have special psychological significance. Demand curves become less elastic as they shift in. Price rises are delayed until costs rise, and these delays cumulate through a multi-stage production process. MC is flat and markups are constant. Firms incur costs of changing prices. Hierarchical delays slow down decisions . Firms hold back on price changes, waiting for other firms to go first. Firms vary inventory stocks instead of prices. Firms vary nonprice elements such as delivery lags, service, or quality. words, and interviewers coded the responses on the four-point scale, which is reproduced here for convenience: 1 = totally unimportant 2 = of minor importance 3 = moderately important 4 = very important It is straightforward to compare the average ratings accorded to each of the twelve theories, and we shall do so shortly. But first the reader should be cautioned against identifying the above-mentioned scale with the standard four-point scale used to grade college stu- Basic Results on the Twelve Theories 109 dents. For example, if some theory achieved an average grade of 4.0, that would not connote anything as mundane as a "straight-A" average-something that the best students at every school routinely attain. Rather, it would mean that every single respondent had branded the theory "very important," that is, we had discovered God's truth! Plainly, this is not going to happen. A more plausible standard of excellence would be an average rating of, say, 3.0which is equivalent to half the firms rating the theory as "of minor importance" and half rating it as "very important." That would be vastly superior to a B average. On the low end, an average score of 1.0 would mean that every single respondent totally rejected the theory-which is closer to brain death than to a D. So it is perhaps more useful to think of the likely range of survey results not as going from 4.0 to 1.0, but rather from a top score of 3.0 for a wonderful theory to, say, 1.5 for a disastrous one. With this caveat in mind, we turn now to the results of the "beauty contest." Table 5.2 ranks the theories by mean scores (column 4) and also gives the standard deviation across firms (column 5).1 The other columns require some explanation. The "t-stat" in column 6 is the test statistic for the hypothesis that the theory'S mean score significantly exceeds that of the theory ranked just below it. As...