Achieving the goals of the Employment act of 1946--thirtieth anniversary review

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Achieving the goals of the Employment act of 1946--thirtieth anniversary review
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Table of Contents
    Front Cover
        Page i
        Page ii
    Letter of transmittal
        Page iii
        Page iv
    Table of Contents
        Page v
        Page vi
    I. Introduction and summary of conclusions
        Page 1
        Page 2
        Page 3
        Page 4
        Page 5
    II. Theory of markup pricing
        Page 6
        Page 7
        Page 8
        Page 9
        Page 10
        Page 11
        Page 12
    III. Market power and measures of economic concentration
        Page 13
        Page 14
        Page 15
        Page 16
    IV. Price markups during postwar recessions
        Page 17
        Page 18
        Page 19
        Page 20
        Page 21
        Page 22
        Page 23
        Page 24
        Page 25
    V. Policy implications
        Page 26
        Page 27
        Page 28
        Page 29
    Comments by Prof. Howard N. Ross
        Page 30
        Page 31
        Page 32
        Page 33
    Reply to Prof. Howard N. Ross' comments by Professors Wachtel and Adelsheim
        Page 34
        Page 35
        Page 36
    Back Cover
        Page 37
        Page 38
Full Text
. c


94th Congress JOINT COMMITTEE PRINT
Session


ACHIEVING THE GOALS OF THE

EMPLOYMENT ACT OF 1946-
THIRTIETH ANNIVERSARY REVIEW


Volume 3-Inflation and Market Structure


PAPER No. 1
THE INFLATONARY IMPACT OF UNEMPLOYMENT:
PRICE MARKUPS DURING POST WAR
RECESSIONS, 1947-70



A STUDY

PREPARED OR THIE USE 09'HE

JOINT ECONOMIC COMMITTEE

CONGRESS OF THE UNITED STATES









NOVEMBER 3, 1976 .
IN



Printed for the use of the Joint Economic Commi tt


U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1976


73-425


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Washington, D.C. 20402 Price 55 cents
There is a minimum charge of $1.00 for each mail order.


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JOINT ECONOMIC COMMITTEE

(Created pursuant to sec. 5(a) of Public Law 304, 79th Cong.)
HUBERT H. HUMPHREY, Minnesota, Chairman
RICHARD BOLLING, Missouri, Vice Chairman


SENATE
JOHN SPARKMAN, Alabama
WILLIAM PROXMIRE, Wisconsin
ABRAHAM RIBICOY', Connecticut
LLOYD M. BENTSEN, JR., Tex&
EDWARD M. KENNEDY, Massachusetts
JACOB K. JAVITS, New York
CHARLES H. PERCY, Illinois
ROBERT TAFT, J., Ohio
WILLIAM V. ROTH, JR., Delaware


HOUSE OF REPRESENTATIVES
HENRY S. REUSS, Wisonsin
WILLIAM S. MOORHEAD, Pennsylvania
LEE H. HAMIITON, Tndiai'
GILLIS W. LON G, Louisiana
OTIS PIKE, New York
CLARENCE J. BROWN, Ohio
GARRY BROWN, Michigan
MARGARET M. HECKLER, Massachusetts
JOHN H. ROUSSELOT, Californa


JOHN R. STARK, Ezecutiv Director
-PiCm .RD F. KAUFMAN, Gemrj Couml

EcONOMI8s


WILLIAM R. BUECHNER
G. THOMAS SATOR
WILLIAM A. Cox
LucY A. FALCONZ


REAULES I1. BRADFORD


ROBERT D. HAHRm
SARAH JACKSON
JOHN R. KAWK
L. DOUGLAS Lz


MINORITY


GEOROE D. KRUMBHAlR, r
MARK R. POLICINSKI
(n)


PHILIP MCMAPTIN
RALPH L. SCULOSTEIN
COURTENAY M. SLE
GEORGE R. TYLER


M. CATHERINE MILLER











LETTER OF TRANSMITTAL

OCTOBER _27, 1976.
To the Members of the Joint Economic Committee:.
Transmitted herewith for the use of the Members of the Joint Eco-
nomic Committee and other Members of Congress isa study entitled
"The Inflationary Impact of Unemployment: Price Markups During
Postwar Recessions, 1947-70," by Professors Michael M. Wachtel and
Peter D. Adelsheim of the American University Department of Eco-
nomics, assisted by-David Moore. A comment on the paper by Profes-
sor of Economics Howard N. Ross of the Bernard M. Baruch College
of the City-University of New York is appended, as well as a reply
to the comment by Messrs. Wachtel and Adelsheim. The study is the
first in a volume dealing with the relationship of market structure to
inflation as part.of the Joint Economic Committee's 30th anniversary
study .series
. In the courseof the 30th anniverar yseriet; wide range of economic
issues is being examined in an attempt to develop improved means to
achieve the goals of the Employment Act of 1946. Other studies focus
on the problems of economic growth, planning, monetary and fiscal
policy, and international issues, among others.
This study offers an explanation for the persistence of rapid inflation
during periods of recession. Few problems in the past several years
have proved more perplexing or more difficult to overcome. Messrs.
Wachtel and Adelsheim recommend systematic government monitor-
ing of prices in industries in which recent pricing behavior displays
certain objective criteria indicating a lack of vigorous competition.
I would like to thank Messrs. Wachtel and Adelsheim, their as-
sistant Mr. Moore, and Professor Ross for their extensive work in
preparing this paper.
The views expressed in this document do not necessarily represent
those of the Joint Economic Committee, individual Members of the
Committee, or its staff.
HUBERT H. HUMPHREY,
airman, Joint Economic committee.

OCTOBER 22, 1976.
Hon. HUBERT H. HUMPHREY,
airman, Joint Economic Committee, U.S. Congress,
Washington, D.0.
DEAR MR. CHAIRMAN: Transmitted herewith is a study entitled
"The Inflationary Impact of Unemployment: Price Markups During
Postwar Recessions, 1947-70," by Professors Michael M. Wachtel and
Peter D. Adelsheim of the American University Department of Eco-
nomics. They were assisted by David Moore. A comment on the paper
(III)








by Professor of Economics Howard N. Ross of the Bernard M.
Baruch College of the City University of New York is appended, as
well as a reply by the authors.
Messrs. Wachtel and Adelsheim expound a markup theory of pricing
by firms and develop new evidence to show that recessions can spur
rather than dampen price increases, thereby explaining the coexistence
of rising unemployment and rising inflation rates in recent years.
Examining the cyclical behavior ofprice markups over the business
cycle, the authors conclude that many firms-particularly in concen-
trated industries-suceed in raising the margins between prices and
direct costs in an effort to maintain profits, even though their sales
and output levels are declining. They conclude furthermore, in view
of the inverse relationship between margis and output in these in-
dustries, that Keynesian-type policies of macroeconomic restraint
cannot be fully effective in combating inflation. Consequently, they
aroue, such policies must be supplemented by direct efforts to curb
prce pressures in those sectors which do not behave competitively.
Thispaper presents, number of new perspectives at a time when
public policy toward controlling inflation and unemployment is being
critically reexamined in an atmosphere of growing dissatisfaction with
the performance of the economy.
JOHN R. Sm UC,

























CON TENTS


Letters of transmittal- ------
THE INFLATIONARY IMPACT OF UNEMPLOYMENT:
PRICE MARKUPS DURING POSTWAR RECESSIONS,
1947-70
I. Introduction and summary of conclusions
II. Theory of markup pricing------6
III. Market power and measures of economic concentration-------13
IV. Price markups during postwar recessions---------------------------17
V. Policy implications------26
Comments by Prof. Howard N. Ross-30
Reply to Prof. Howard N. Ross' comments by Professors Wachtel and
Adelsheim..---------------------------------------------------34
(V)



















Digitized by the Internet Archive
in 2013














http://archive.org/details/actietha00u nit











THE INFLATIONARY IMPACT OF UNEMPLOYMENT:
PRICE MARKUPS DURING POSTWAR RECESSIONS,
1947-70*

By Howard M. Wachtel and Peter D. Adelsheim** With the
Assistance of David Moore


I. INTRODUCTION AND SUMMARY OF CONCLUSIONS
Public policy is more comfortable in dealing with unemployment
than it is in treating the problem of inflation. This would be of mini-
mal consequence if inflation were not too severe or if inflation and
unemployment occurred at different times but not concurrently. The
problems of inflation and unemployment reach crisis proportions when
inflation becomes very severe and when it occurs simultaneously with
unemployment. This is the present state of affairs in the American
economy and one which is likely to be a recurrent problem unless we
take serious steps to confront the root causes of the problem: growing
economic concentration and power.
This study addresses the specific question of why the simultaneous
occurrence of inflation and unemployment is not an anomaly but is a
logical and systematic outcome of the intersection of the business
cycle with the prinMmg practices of concentrated industries. Economists
have had difficulty in the past several years in the face of economic
developments which transcend the boundaries of their traditional
models. Keynesian economic theory and policy appears relatively
impotent in the face of economic events not only in the United States
but in virtually every other mature market economy in the world
today.
Inflation explanations have been dominated by three main themes
in recent years: inflationary expectations, excess demand, and random
events leading to increased fuel and food prices. This study represents
a departure from these other explanations in that the analysis of
inflation is located in the pricing decision of firms-in particular, the
formation of price markups during recessions.'
*Manuscript copyrighted, 1976, by Howard M. Wachtel and Peter D. Adelsheim; reprinted
with permission.
*Howard M. Wachtel is associate professor in the Department of Economics. The Ameri-
can University. Peter D. Adelsheim is an instructor in the Department of Economics,nThe
American University. David Moore is a graduate student in the Department of Economics,
The American University. William Noellert served as a research assistant on this study.
1 A similar theme was echoed at a recent seminar on industrial concentration sponsored
by the Library of Congress and the Joint Economic Committee. Frederic Sherer, Director
of the Bureau of Economics of the U.S. Federal Trade Commission, said at that seminar:
"Something is obviously wrong in the interaction between microeconomic behavior,
especially industrial price setting, and macroeconomic events." And at that same seminar
Lee E. Preston asked: "What is the connection between microeconomic organization...
and the composition and functioning of macroeconomic systems?" (Library of Congress,
Congressional Research Service, "Seminar In Industrial Concentration" (Sept. 20, 1975)).
(1)







In this study we examine the cyclical behavior of price markups.
Of most importance for this study is how a model of price markups
with target profits operates in the recessionary phase of the business
cycle. Here we encounter a most interestng model which goes a long
way toward explaining why the simultaneous occurrence of inflation
and unemployment is a logical outcome of this type of economic
behavior rather than a paradox as it is in traditional Keynesian
theory. Consider a firm operating in a concentrated market environ-
ment attaining its desired target profit rate. Then introduce a reces-
sion (caused for any reason). If the firm loses revenue through a sales
reduction during the recession, it will try to recoup the lost revenue
from those diminished sales by increasing the price markup for its
remaining sales so that it can get closer to the target profit rate it
started with. The motivation to do this is pressure from stockholders
on the company executives which takes the form of imposing some
profit expectations on management as dictated by its previous profit
posture and the profit position of others in the firm's orbit of
comparison.
The consequence of this for economic policy is that traditional
Keynesian macro prescriptions which call for the creation of unem-
ployment and recession to mitigate inflation are in reality a major
contributing cause to the inflation that occurs during recessions, as
suggested in the theoretical discussion below of markup pricing and
target profit behavior.
In the next section of this study we examine the theory of markup
pricing and target profit behavior as it illuminates the phenomenon of
stagflation-the simultaneous occurrence of inflation and unemploy-
ment. With conditions of economic concentration, the theoretical and
empirical clue to unlocking the mystery of stagflation is found in a
comprehension of the way markup prices and target profit behavior
evolve during recessions. Following this, in the next section we discuss
the problems encountered with the data needed to conduct an empirical
inquiry flowing from the theoretical foundation we have prepared in
the first section. With those data qualifications in mind, we then
proceed in the final section to conduct an empirical inquiry into
the movement of price markups during the postwar recessions.
Finally, in the fourth section we combine our theoretical and empirical
findings into some operational policy proposals concerning stagflation.
The following are some of the principal conclusions that emerge
from the study:
1. In conventional economics, widely accepted among academic
economists and policymakers, the firm is viewed as a passive recipient
of prices which are established in a reasonably competitive market over
which the firm has little control. However, when markets become con-
centrated, av they now are, firms are able to take an active role in set-
ting the prices charged for their products. And if their sales fall below a
level which would enable them to attain their target rate of profits,
then they will raise their prices in order to recoup the revenue lost
through the declining sales which occur in a recession. In this way the
business cycle intersects with pricing practices in the firm. During
it recession, when sales fall, firns operating in concentrated markets
with substantial economic power will increase their prices to offset
revenue losses from declining sales, thereby charging a higher markup
per unit of sales in order to attain their desired target rate of profits.








When a recession exists, the tendency is for firms to raise their price
markups if they are able to do so with relative immunity from any
market revolt. This occurs primarily, but not exclusively, in markets
which are highly concentrated.
In this way the simultaneous occurrence of unemployment and
inflation becomes a logical and systematic outcome of the pricing
practice of firms with economic power in the market rather than a
paradox. If this analysis is valid then unemployment feeds inflationary
pressures instead of mitigating them.
How long will the recession be inflationary under conditions described
here? This depends on the concentration of economic power. The
more markets are concentrated and the more intense is the perverse
price behavior, the longer will be the period in which the response to
the firm in the market is weak thereby permitting the firm to raise
markups without suffering the consequences of substantially reduced
sales in the market. Consequently, as the concentration of economic
power increases in the economy, we need longer and deeper recessions
before the conventional policy of creating unemployment to reduce
inflation becomes anti-inflationary.
2. To evaluate the validity of our hypothesis that price markups rise
during recessionary periods, particularly in concentrated industries,
we collected data on price markups for three-digit manufacturing
industries. We studied the behavior of price markups during the
five postwar recessions from 1947 through 1970 and classified our indus-
tries into three concentration groups: High, medium, and low con-
centration. In general, the more concentrated the industry the greater
the likelihood that price markups would increase during recessions,
though this was not a total explanation for movements in price
markups during recessions.
For example, between 53 and 57 percent of the industries in the
high-concentration sector raised their markups during the postwar
recessions (excluding the 1969-70 recession) while typically less than
50 percent of all industries in the low- and medium-concentration sec-
tors raised their markups during the postwar recessions. On average,
the increase in price markups in the high concentration sector was
from 5 to 14 percent (again excluding the 1969-70 recession) while
typically declines or only small increases in markups were recorded
in the medium- and low-concentration sectors.
Though economic concentration takes us a good distance in ex-
plaining the perverse phenomena of rising markups during recession,
it is not the complete answer to this puzzle because each recession is
unique. For example, the concentration explanation is weakest during
the 1969-70 recession for several reasons: first, the 1969-70 recession
came on the heels of 9 years of expansion-a unique event in the
American experience; second, foreign competition impacted with par-
ticular ferocity in the high-concentration sector during that period;
and third, the conglomerate movement rendered our classification of
industries by degree of concentration less reliable because a conglom-
erate is not identified in the data on economic concentration.
Since our data do not account for conglomerates, we discovered a
most important phenomenon in the recessions of the 1960's cownmpared
with those of the 1950's. In the recessions of the 1960's the sectors of
low- and medium-concentration manifested behavior more like the


73-425-76------2








high concentration sector in that many more industries increased
their markups during the recessions of the 1960's than had done so in
the 1950's. And we find that on average the decline in markups is
much less in the 1960's in the low- and medium-concentration sectors,
and in one instance they even rise.
The reason appears to be that, with the conglomerate movement,
industries which are classified as being of low- or medium-concentra-
tion are owned by a parent company which operates in the sector of
high concentration. Consequently, those industries which are parts of
conglomerates take their price markup behavior from the sector of
high concentration even though they remain classified as being in
the sector of low or medium concentration. Thus, economic power
overall has become more prevalent in the economy, and this is revealed
in price markup behavior in the low- and medium-concentration sectors
even though the data on economic concentration show minimal
change in the quantitative measures we have to use to study economic
concentration. As a totality, though, this implies that the economy is
becoming more inflation prone as the sectors of low and medium
concentration join the high concentration sector in perverse flexibility
in their price markups during recessionary periods. In short, as market
power becomes more severe in the economy, the tendency for recession
to feed inflation becomes greater, making it even more difficult to use
traditional Keynesian policy prescriptions to alleviate inflation.
3. The statistical results of our study of price markups during
the postwar recessions have important policy implications for inflation
and unemployment. Standard economic policy used to combat
inflation requires the creation of unemployment to ease demand
pressures and thereby reduce the rate of increase of prices. However,
this policy prescription is based upon the existence of a high degree
of competition in product markets. If such competition is lacking
then a different result occurs when unemployment is created to reduce
inflation. As we have seen in this study, in sectors of economic con-
centration price markups are increased when unemployment exists
in order to recoup the revenue lost from reduced sales.' And increas-
ingly more sectors of the American economy are manifesting this
type of perverse economic behavior. So instead of reducing inflation,
unemployment can increase the rate of inflation under conditions of
economic concentration. The traditional Keynesian antidote of un-
employment to cure inflation may in fact be the toxin which spreads
and multiplies the disease!
Once this problem is faced, then an array of possible policy options
are opened, all of which focus on the way in which price markups
evolve during recessionary periods. If we are in a situation of inflation
2 John Blair in his "Economic Concentration" (New York: Harcourt Brace Jovanovich,
1972) reports that the share of total value added in the economy accounted forby the
200 largest conipanie increased between 1947 and 1954. then remained fairly stable be-
tween 1954 and 1958, and has risen slowly but steadily since 1958. Over the period
1947-66. the share of total value added In the economy accounted for by the 200 largest
companies rose from 30 percent to 42 percent (p. 69).
3To see if increases in unit labor costs(contributed to rising price markups during
recessions, we analyzed fluctuations in unit labor costs for our three concentration groups.
The results Indicate that movements in unit labor costs are randomly distributed with
respect to degree of concentration and therefore do not contribute to an explanation of
rising markups In more concentrated sectors during recessions.







and recession, as we are today, using more recession to cure the
inflation may be self-destructive, not to mention the numerous
other pernicious effects of unemployment on the population. However,
once a recession begins, for whatever reason, it is important to monitor
price markup developments, since failing to do so might easily trigger
a period of inflation making it all the more difficult to turn the recession
around. To do this we need selective price markup monitoring. The
industries and firms initially selected for price markup monitoring
are based on the objective criteria that they increased their price
markups during the most recent recessions. Rather than trying to
influence prices on a universal basis, we should make anti-inflation
policies selective and rooted in some objective criteria. If we try to
control all prices, we control none, since the job is so vast as to paralyze
any administrative effort mounted to monitor and influence prices.
However, we could very easily monitor price markups selectively
without undue administrative burdens. But this monitoring must
be based on some objective economic criteria. The one proposed here,
and implied by the theoretical and empirical work of this study,
would have those price markups monitored in industries and firms
which manifested perverse flexibility in recent recessions. Then once
the recession begins, we can head off a potentially serious inflation
which makes the recession more difficult to correct by selectively.
monitoring price-markups in particular industries..
At this stage of development, our abilityto select industries and
firms for price markup monitoring is severely-constricted by- the
availability of data. In order -to effect- such a policy, ,we need more
accurate currentdata on price markups, as well as-much moredetailed
data which will enable us to transcend the coarse three-digit classifi-.
cation with which we worked in this: study. Additionally, we will
need more rapid data Collection so price markups can be -identified
and monitored quarterly.
Before these steps in data collection can have an impact, however,
we need to accept market power as a way of economic life and under-
stand that this market power can affect macroeconomic policy in
ways not-foreshadowed by competitive economic theory. The so-called
anomaly of stagflation must now be put on center stage so the spot-
light of research and policy formation can illuminate it to see its
systemic contours more clearly than heretofore.












II. THEORY OF MARKUP PRICING


The firm in traditional competitive theory is seen as taking the
price it receives for its product as given; it is simply a passive recipient
of price information generated by the market. Since it deals in a very
competitive environment, according to this theory, it is fanciful and
indeed self-destructive for the firm to try to influence the price it
charges for its product in any meaningful sense. Whether such a
firm ever existed is a matter for serious conjecture; however, there is
no doubt that such a firm exists in the minds of economists and has
dominated the thinking of economists ever since Alfred Marshall in the
late 19th century fathered, what is now called, neoclassical
economics.
Once we depart from an assumption of competition the contours
of the economic landscape become transformed. The firm operating
in concentrated markets is not a mere passive recipient of market
prices, but is an aggressive actor in the process of price formation.
Instead of viewing the market in which it sells its products as com-
petitive, the firm attempts to reduce the degree of competition in
the market so it may better control the price it charges for its product.
In fat, even if there ever were a perfectly competitive system, it
could not be self-sustaining since the motivation of the dominant
actors in such a system is to appropriate control over pricing decisions
by beginning to control the markets for their products.
The firm controls the market for its product and, therefore, the
price it can charge in two interrelated ways. First, it seeks to reduce
the degree of competition it faces by eliminating other firms from the
market for its product. Hence, price competition has as one of its
outcomes the production of its opposite: Namely, the elimination of
price competition and the creation of concentration. The competitive
economy posited in the textbooks, viewed from this perspective, is an
unstable one-it is not self-reproductive. Once an advantage is at-
tained by one firm, say throuch a temporary technological break-
through, it then uses that temporary advantage to create for itself
a .permanent advantage by pricing other firms out of the market,
using its additional surplus to gain yet further technological advan-
tages, buying out its comp)etitors via "mergers," and so on. Whatever
the mechanism used, the result is the same: The dynamic of a com-
1)etitive system is toward concentration and noncompetition..And
the economic history of this century in the United States is dominated
l)y the phenomenon of concentration of market power. During this
century competition has given way to concentration in more and more
sectors of the economy until today we can legitimately classify the
American economy by a variety of labels which tend toward one
i)ric(.ipal (harac teris tic: economic concentration.
Ihl1 price decision in the firm is based on its motivation to acquire
profit In traditional economic theory, firms maximize profits within
the cotrainit imposed by the demand for its product, the technology
(6)








it available to produce its product, and the price it must pay to
aa te factors of production to produce its product. All this infor-
mation is summarized in the price the market sets for a product,
thereby seriously constraining the profits the firm can make. As a
cnsequence all the firm can do is set its level of production in such
a way as to maximize its profits in light of the price it obtains for
its output and the other constraints we have mentioned above,
all of which lie outside of the firm's control. Parenthetically, the
dynamic toward concentration and away from this form of competition
i precisely to push against these constraints forcing them further
outward so a modicum of control over the firm's activity is internalized
within the firm and not left to the "impersonal" decision of others in
the market.
The firm in concentrated industries has a different profit motivation
and faces different forms of constraints. Rather than trying to
maximize profits by adapting its level of output to a variety of param-
eters, the firm in economically concentrated industries attempts
to attain a target rate of profit by adjusting both its price and (to a
lesser extent) its level of output.' The target rate of profit is a result
of a number of forces. First, the firm in concentrated industries
patterns its profit posture after firms of a similar structure in terms
of size, market power, type of product, and so forth. Executives of
coporations in such concentrated industries are evaluated in terms
of how effectively they keep up with the pattern set within the orbit
of firms to which their firm can legitimately be compared. Within
this context, the executives of such firms will no doubt attempt to
outstrip its patterned position by expanding profits beyond those
normally indicated by its position within a particular orbit. But like
the star circulating in its orbit, such movements are glacial in their time
dimension and for the short term can be precluded from our considera-
tion without doing undue violence to the propositions advanced here.
A second important consideration in the profit behavior we are
describ ig are the profits attained by a firm in the recent past. Cor-
porate executives will be evaluated by their stockholders in terms of
how effectively they attain a rate of profit to which they have become
accustomed as defined by profits in the most recent period of time.
f you like, some form of profit "epochs" are informally defined.
placing severe expectations on corporate executives in terms of what
profits should be in their company.2
With this type of profit behavior in mind, the next question is
how a target profit perspective is translated into pricing behavior
by the firm. The link in the argument is found in the notion of price
.pu&Whenever economists examine price behavior of firms in
tne situations, inevitably the words "price markup" appear.
I For a slightly different version of target profit behavior, see: John M. Blair, "Infation in the United
"The Roots of Inflation" (New York: Burt Franklin & Co., 1975), pp. 3-67.
2 Putting these two consideraions together and using more technical language, target profit rates depend
u some weighted average of previous years' profit rates for the firm (with some weighted distributed
function) and the position of the firm in its profit orbit, as described by the pa :tte4 profit behaviUr
ofaparticuar firm in relation to other firms in iLts orbit.








Though this form of price behavior is quite common, economists,
with few exceptions, have not built a markup price theory into either
their micro or macro models.3
Markup pricing suggests that firms form their prices by first
computing their labor and raw material costs, then adding a "markup"
over raw material and labor costs in order to attain their profits.
Theoretically, firms are constrained as to their price markup pri-
marily by the extent to which increases in the price markup will
result in a loss of sales owing to the excessively high price charged
for the product. This is the familiar concept of demand elasticity
used in the theory of price formation. If the firm faces a highly elastic
demand for its product-that is, an increase in price will evoke a
virulent negative response by consumers resulting in a more than
proportionate loss in sales-then the ability of firms to increase their
price markup is severely mitigated. In competitive economic theory,
it is assumed that all firms face just such an elastic demand curve for
their product. But any firm facing such a severe constraint, which
cuts to the core of its profitmaking ability, will undertake steps to
offset or elimi*nate this obstacle as much as possible by gaining control
over their market, thereby influencing the demand curve for its
product. The most common ways in which the firm gains control
over its market is through acquisition of other firms, differentiating
its product in order to obtain customer attachment, advertising and
other forms of the sales effort, and the like. In short, it undertakes
actions to concentrate market power within the firm rather than
permitting this power to be dispersed in the anonymous market where
consumers have the upper hand. Thus, we return to the proposition
that competition is unstable and the dynamic is toward reductionsin
competition and the augmentation of economic concentration.
As the economy becomes more concentrated, induced by the normal
motivation on the part of corporate executives to mitigate their
constraints, firms can set their price markups in order to attain their
target profits. Here the two theoretical arguments intersect-the
one about target profit rates and the other about markup pricing.
Firms will establish a price in order to attain a target profit rate for
any given level of sales. In a curious way, the argument about what is
taken as given by the firm is reversed from traditional theory: with
economic concentration firms can adjust their price more readily
than they can control their sales in the short term once you introduce
an economy with business cycles.4
S An important exception to this statement is the Polish economist, Michael Kalecki. who developed an
inte rated micro and macro model using a markup price system as his micro fondaion in the early 1980's,
predating the work of Keynes. The ideas developed in this study are in the Kalecki tradition. dlecki's
work appears in his "Theory of Economic Dynamics" (New York: Monthly Review, 1965) and "Selected
Essays on the Dynamics of the Capitalist Economy" (Cambridge: Cambridge University Press, 1971).
A most useful treatise on the work of Kalecki has been written by George R. Feiwel, "The Intellectual
Capital of Michael Kalecki" (Knoxville: University of Tennessee Press, 1975).
Additionally, the work done by R. L. Hall and Charles 3.Hitch, "Price Theoryand BusnessBehavior,"
Oxford Economic Papers (May 1939), pp. 12-45 initiated a debate surrounding kup pricing practices
of concentrated firms which is summarized in Frederic M. Sherer, "Industrial Maaketu8tructure and Eco-
nomic Concentration" (Chicago: Rand McNally & Co., 1970), pp. 173-179.
Anyone addressing the issues encompassed by this paper must acknowledge their Intellectual debt to
Gardiner C. Means who, perhaps more than any livingeconomist. has persistenlyreinded usof theimpact
of concentration on price formation and economic instability. For example, see his essay, "Simultaneous
Inflation and Unemployment," in The Roots of Inflatio (New York: Burt Franklin & Co., 1975), pp.
1-31.
4 1I traditional micro theory, full employment of resources is an assumption. Once this assumption is
dropped the1 price adaptation, rather thaii output changes, becomes the dominant active variable used
to adjlut to varying macro conditions.







This study addresses the question of the cydicd behavior of price
.Of most importance for this study i- how this model of
price arkups with target profits operates in the recsionay phase
of the business cycle. Here we encounter a most interestin model
which goes a long way toward explaining why the simultaneous
occurrence of inflation and unemployment is a logical outcome of the
behavior posited here rather than a paradox as it is in traditional
Keyiesian theory. Consider a firm operating in a concentrated market
environment attaining its desired target profit rate. Then introduce
a recession (caused for any reason). If the firm loses revenue through
a sales reduction during the recession, it will try to recoup the lost
revenue from those diminished sales by increasing the price markup
for its remaining sales so that it can get closer to the target profit
rate it started with. The motivation to do this is pressure from stock-
holders on the company executives which takes the form of imposing
some profit expectations on management as dictated by its previous
profit posture and the profit position of others in the firm's orbit of
comparison.
An arithmetic illustration is helpful in illuminating this theoretical
point. For example, say a firm operating in a concentrated industry
has direct costs (raw material and labor) of $200 per unit of output
and sets its profit markup 20 percent above direct costs, therefore
selling the product for $240 per unit and making a profit of $40 per
unit. Let us say the firm has a target level of profits of $40,000
(derived from its target rate of profits); to realize this profit level it
will have to sell 1,000 units at $240 per unit. Now we have unemploy-
ment and a recession which causes the volume of sales to fall from
that expected to 950 units. But if the firm still has a target profit
level of $40,000, which it wants to attain, it will have to raise its
price to slightly over $242 per unit from the previous level of $240
per unit. It does this by raising its percentage markup over costs to
21 percent compared to the previous 20 percent. Having increased
their profit per unit, the firm now achieves its target profit level, but
the resultant manifestation in the economy is the simultaneous occur-
rence of inflation and unemployment."
In traditional theory this option is precluded from consideration
because each firm faces an elastic demand for its product owing in
large measure to the degree of competition in the market. But once
that competition is mitigated, then the firm's demand curve becomes
much less elastic and the option is available of raising the price markup
during a recession. And as the economy becomes more concentrated,
this is precisely what happens. So, as a consequence, reductions m
sales during recessions lead to increased price markups and inflation.
And if public policy assumes a traditional posture of using the creation
of unemployment to reduce inflation, it could very well be self-defeat-
ing and merely fuel inflation for a time. Put blumtly, unemployment is
nflationary whenever economic concentration leads to the adjustment
of the price markup to attain a target rate of profit. How long will a
recession be inflationary? This depends on the degree of econonc
concentration. The more markets are concentrated, the longer the
5This hypothetical example posits a veryinelastic demand response. Such a restrictive
case is presented for illustrative purposes, but even with a less Inelastic demand response
the conclusion holds.





10


period of recession in which the firm's demand response remains
inelastic. Only when unemployment reaches a point where the firm
encounters an elastic response to its price markup, policy will tra-
ditional macropolicy toward inflation be operational in the way it is
designed to be. Hence, as the economy becomes more concentrated
we need longer and deeper recessions, even a depression, before such
policy becomes anti-inflationary. Up to that point at which the
firm begins to face an elastic response to price increases for its product,
a recession will feed inflation. This suggests that price markup behavior
will be different at different phases of the recession. In the early stages
of the downturn, price markups should rise as firms try to recoup their
lost revenues. But as the recession grows longer and deeper, price
markups should increase by less or perhaps become stable (and even
fall if the recession continues longer).6
The history of the postwar period is one of increased economic
concentration which should lead to the necessity of deeper and
longer recessions in order to offset inflation through traditional
Keynesian tools. Traditional Keynesian theory and policy has milsed
this point because economists conventionally treat the behavior of
prices in the microeconomy as being formed in competitive markets.7
Indeed, Keynes himself accepted this. As a consequence, even today,
macropolicy is formed in the context of a competitive inicroeconomy
with the resultant inability to come to grips with the intersection of
the micro- and macro-economy, as revealed through price markup
and target profit behavior.
Though our chief concern in this study is the behavior of price
markups during recessions, a word is in order concerning markups
during the expansionary phase of the cycle. If the market is increas-
ingly acting as a weaker constraint on the pricing power of firms in
concentrated industries, why don't markups increase substantially
during expansions too? The answer is that they do increase, through
not without limit. The limits to the expansion of markups derive
from the possibility that other firms in the oligopolistic industry nafy
not initially follow the firm's expansion in its price markup causing
ultimately severe damage to the target profit posture of the firm
which tried to break from the pack in the first instance. Such be-
havior would indeed be self-destructive for a manager. In brief, the
accepted theories of oligopoly behavior, whether they be of the
game theory sort or the kinked demand curve variety, are sufficient
to explain why price markups and target profit levels do not expand
without limit during the expansion phase of the cycle. This raises a
collateral theoretical point. It is possible to describe profit epochs
in which the target profit posture is established for a given orbit of
4A query is in order here concerning the form of the demand curvc posited. Before examining that issue,
however, a caveat is warranted. Since we are dealing with fluctuations in the level of demand, we are en-
countering dynamic eniifI8 in the demand curve for the firm's product rather than static movements along a
fixed diand curve,
If we start with a variant of the static kinked demand curve model, then Aifts in that demand curve will
yidld a composite response in the market which is initially inelastic then becomes elastic at low levels of
output. The profits attained in this manner may or may not he optimal. The presumption is that such a
profit maimizing position is unknown whenever fluctuations in levels of demand exist. The search for
optimal poflts is conducted by varying the price markup, gauging consumer response to each alteration
in the markup.
Noteworthy exceptions to this generalization are found In the work of Gardiner Means
wli'we initial work in the 1930's stimulated a debate which is still raging today. See
Gardiner C. Means, "Industrial Prices and Their Relative Inflexibility," S. Doe. No. 13,
74th Congress (January 1936).








firms operating in concentrated industries. However, the dynamic
of the system is to move those profit targets upward via increasing
concentration, a higher degree of maturity and stability within the
orbit of firms, influencing government policy, and so forth. So, not
only are firms better able to control their markets over time, enabling
them to adapt their price markups to the business cycle, but they can
also raise their target profit levels, adding yet another dimension of
inflationary bias to the economy.
The problems surrounding the relationship between economic
concentration and prices over the cycle has been addressed by other
research. However, this study is quite unique in its focus on the forma-
tion of price markups over the cycle, based as it is on a model of target
profit behavior in the concentrated firm. Although there may be no
direct link between these earlier studies and the present one, never-
theless it-is useful to review that literature if for no other reason than
to identify some shortcomings in the earlier work which this study
avoids.
In modern times the controversy was kicked off by the work of
Gardiner C. Means during the depression of the 1930's. His work
evoked a virulent response and the debate has raged to this day with
the most recent chapter written by Ralph E. Beals and Means
himself.8 In his early work Means argued that firms operating in
concentrated industries manifested decidedly less price flexibility
in all stages of the cycle than firms in less concentrated industries.
In his empirical work he found that there was some tendency for
firms in concentrated industries to raise their prices less in an expan-
sion period and reduce their prices by less in recession in comparison
with firms in less concentrated industries. This led to the beginning
of the so-called administered price thesis. He extended his work in the
1950's to postulate an administered inflation thesis in which firms in
concentrated industries have sufficient power to create inflation by
raising their prices beyond the rate justified by cost increases and sup-
ported by more competitive markets. In his most recent salvo on the
subject, Means argues that administered inflation is one that "may
be initiated by management in an effort to widen profit margins and
could then be properly called profit-push inflation." 9
The critique of Means has as long a history as the work of Means
itself. This critical interpretation of the Means work is admirably
summarized by Beals, and we need only indicate the direction of
criticism, inviting the reader to consult the Beals paper for detailed
elaboration of the critique. The critique focuses on three points:
First, Means' use of BLS wholesale prices is challenged in that those
prices do not reflect rebates and other forms of special allowances.
Second, Means eliminated certain industries from his study so that
in his early work he reduced his initial 282 industries to 37 which
S See Ralph E. Beals, "Concentrated Industries, Administered Prices and Inflation: A Survey of Recent
Empirical Research" (Washington: Council on Wage and Price Stability, 1975); Gardiner C. Means, "The
Administered Price Thesis Reconsidered," American Economic Review, 62, 3 (June 1972), pp. 292-306;
and Gardiner C. Means," Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy,"
Challenge, 18, 4 (September/October 1975), pp. 6-20. The "encyclopedia" for this entire area of inquiry is
John Blair's" Economic Concentration" (New York: Harcourt Brace Jovanovich, 1972).
9 Means, "Simultaneous Inflation and Unemployment: A Challenge to Theory and Policy," Challenge,
18, 4 (SeptemberlOctober 1975), p. 11.


73-425-76------3






12


complied with his criteria.10 Third, Means' work takes no account of
changes in costs as possible justifications for the form of price behavior
he examined. Beyond these criticisms lies a further point: Namely,
what is a "significant" relationship between economic concentration
and )nce behavior? One's choice of adjectives to explain a regression
coefficient which is statistically significant, yet small, leads to just
such subjectivity.
The empirical work of this study goes some distance in avoiding
the criticism thrust at Means. First, we are using price markups,
derived from census data, so the problem of price rebates and other
forms of deviation of actual prices from those reported to the BLS
is mitigated. Second, by using price markups, we automatically take
account of cost changes since our markups reflect price augmentations
over direct labor and raw materials costs. Third, we do not eliminate
any industries from our study, except where the census has not re-
ported the data necessary for the computation of price markups.
10 Means criteia of selection retained industries where: (1) The product of the industry is relatively homog-
enous; (2) the product is produced for a national or international market; (3) more than one-third of the
value added is derived from the manufacturing process; and (4) "Reasonably reliable data" on prices exists.












IL. MARKET POWER AND MEASURES OF ECONOMIC
CONCENTRATION
In the theoretical section on markup pricing, much stress was
placed on the concept of economic concentration. But how faithfully
can we translate the theoretical concept of economic concentration
into an empirical measure? Traditionally, the concept of "market
power" has been translated into an empirical measure, "economic
concentration," as revealed, for example, in the share of sales (value
of shipments) accounted for by the four largest fiims in an industry.
Though this is the most inclusive quantitative measure we have of
economic power in the market, it may fall short of being a precise
indicator of "market power" in the conventional use of that term.
It is possible that market power may increase during a particular
period of time without any change at all in the measure of economic
concentration. Consequently, measures of economic concentration
may understate degrees of market power. This statement may at
first glance seem contradictory, but it is not. Paradoxical perhaps, but
not contradictory.
Why might this be so? The concept of market pouer connotes an
ability to exercise influence with buyers of your product, suppliers
of your inputs, and the political forces around you. At best, economic
concentrafion is some indicator of power to influence buyers of your
product through advertising, pricing policy, control of what is supplied
to the market, and so forth. Taking just this one aspect of market
power, however, our measure of economic concentration may not be
adequate. First, measures of economic concentration which are
available reflect only the.proportion of sales accounted for by the
four or eight largest companies in a particular industry. Because the
measure of economic concentration is computed in this way, it ignores
the aspect of conglomeratization in which one company begins to
dominate several industries.' For example, Hostess Bakery is assigned
to the industry covering its main line of output even though it is
now owned by ITT (International Telephone and Telegraph)-
certainly one of the corporate giants which can exercise enormous
economic power.However, for purposes of the statistics on economic
concentration, this aspect of conglomerate ownership is neglected.
In fact, Hostess Bakery would appear as operating in a relatively
competitive industry even though it is owned by one of the most
powerful international corporations.
Consequently, the measure of economic concentration takes no
account of the fact that the same firm may account for a considerable
portion of sales in different industries. For example, say the concentra-
tion ratio in three different industries has remained the same for the
'Blair in his "Economic Concentration" (p. 41) defines conglomerate concentration as
"the possession of a share of a given industry's resources or activity by companies that
are primarily engaged in other industries but are not suppliers or users of the given
industry's products."
(13)






14


past 20 years. Now consider two scenarios: First, have each industry
self-contained in the sense that there is no ownership spillover from
one industry to another. Put differently, no one company operates
in more than one industry. However, during the 20 years of our ex-
ample, there is now some conglomeratization so that one company is
the leader in each of three industries even though its subsidiaries
account for no more output in their particular industries than they
accounted for at the outset. Statistically, there would be no change
in the concentration ratio for each industry; however, there might very
well be an increase in concentrated market power in these industries
by virtue of the fact that one company is now the leader in terms of
sales in all three industries. From the data on economic concentration,
we have no way of detecting this development. This complicated point
is simply meant to illustrate the fact that concentration ratios may
remain constant while market power has been enhanced because of
the development of conglomerates which operate via subsidiaries in
many different industries.
The phenomenon of conglomerates can lead to more market power
without being revealed in the conventional data on economic concen-
tration. This occurs for several reasons: First, the subsidiaries of a
conglomerate operating in what is classified as a competitive industry
have more market power without a greater market share as revealed
in the data, owing to preferential access to capital through the parent
conglomerate, greater access to advertising resources and other forms
of the sales effort, the potential for cross-subsidization, preferential
access to sophisticated management capabilities, and access to political
influence exercised through- the parent conglomerate. Second, the
parent conglomerate may have achieved its objective of increasing the
price-earnings ratio of its stock without going to the extreme of reduc-
ing competition in the industries in which its subsidiaries operate.
Third, market shares may remain fixed in an industry, but the entrance
of the conglomerate can transform it from a type of competitive pricing
behavior to one of price leadership exercised through the powerful
conglomerate. As Blair in his book "Economic Concentration" states
the argument (p. 47):
The danger to competition is that what had previously been an actively
competitive industry might be transformed into one dominated by a single com-
lmany and characterized by price leadership and a general absence of price rivalry.
This would come about even though the share of the industry in the hands of the
conglomerate is no greater than the share held by the firm it replaced.
A second point about the inadequacy of concentration ratios as
a measure of economic power relates to the ability of members of
an oligopoly to learn over time and develop a settled relationship
whichenlhances their aggregate power as an oligopoly at the expense
of consumers in the market. Initially, an oligopoly can be very un-
-ettled in ternis of its internal relations. Each member attempts to
outsmart the others an(l obtain a larger share of the market in the
holes of becoming the most powerful. So, for example, price wars
,re a frequent result of this initial unsettled behavior, what can be
(clled the stage of 'ilnft oligopoly. Some of us are old(1 enough to
recall )rice wars among gasoline stations where each of the stations
on the four corners of an intersection would reduce their prices almost
dily to attract you as a customer and undercut the other members of







the fuel oligopolies. What a far cry from today where now the fuel
oligopoly has developed a more settled internal relationship which
enables it to maximize their aggregate economic power at the expense
of the consumer.
As an oligopoly matnres, it creates a more settled and routine re-
lationship for itself in which market shares are more or less stabilized
and the "cutthroat competition" comes closer to the jugular of the
consumer than the producer. In short, there is something distinctly
different about a mature oligopoly as opposed to an infant oligopoly.
A mature oligopoly acts to maximize the aggregate economic power
of all members of the oligopoly at the expense of the consumer while
the infant oligopoly can produce price competition in the short-run
as fierce or more fierce as any in the competitive sector. It is important
to note, however, the qualifying phrase, short-run; because it indeed
is short-run behavior which has no long-run stability to it. The reverse
is the case; the long-run dynamic of an oligopoly is to move toward a
mature stage where pricing power is used to maximize aggregate
profits and the days of price wars are relegated to the ash heap of
history.2 Consequently market shares can remain fixed and concen-
tration ratios more or less stable, while market power is augmented
substantially as an oligopoly moves from an infant to a mature stage.
No doubt this has happened in the postwar period. Starting from
the stage of infant oligopolies after the Second World War, more and
more oligopolies have moved to the mature stage in which internal
price relationships are settled even though market shares and concen-
tration ratios have not changed as much. For example, this has hap-
pened in retail gasoline sales, some food processing industries, some
textile industries, and others. Put differently, market power can in-
crease substantially, owing to the evolution of an oligopoly, while the
measure of economic concentration changes by much less, if at all.
A third aspect of the way in which the measure of economic con-
centration understates the degree of market power pertains to whether
the market for a product is national or regional/local in scope. The
data on concentration ratios pertain to the Nation as a whole. How-
ever, the national measure of concentration may reveal a good deal
of competition while in any particular local market there may be a
great deal of economic concentration. Blair gives an example for the
bread and other bakery products industry: In 1954, the four-firm
concentration ratio for the Nation in that industry was 20 percent-
that is, the four largest firms in the bread and other bakery products
industry accounted for only 20 percent of the sales in that industry
for the Nation as a whole. Conventionally, therefore, that industry
would be classified as competitive. However, in that same year,
retabulating the data, he found that in "only three States did the 4
largest companies in the State produce less than 30 percent of the
product, while in 23 their proportion was over 50 percent." 3 In
sum, locally a product might be sold in a concentrated market but
if controlled by many different "local monopolies" this phenomenon
will not be revealed in the national data where no one firm exercises
its power nationwide.
2 Many of the neoclassical oligopoly models would confirm tbese behavioral observations,
from Cournot's 1838 version of oligopoly behavior to Sweey' 1:;9 model.
3 Blair, "Economic Concentration," p. 10. See also his table on p. 11.






16

For all these reasons, the conventional measure of economic con-
centration understates the degree of market power that may exist
in any particular industry. However, in one significant way the data
on economic concentration overstate the degree of domestic market
power exercised-namely in its exclusion of foreign competition. For
example, the auto industry is classified as a highly concentrated one.
However, foreign competition at times has impacted severely on that
industry thereby rendering its actual price power in the market less
than the simple data on economic concentration would suggest. Using
the data on economic concentration which exclude foreign competition
would, therefore, mislead us into thinking certain industries have
more market power than is actually the case. On the other hand, to
the extent that imports are products of foreign subsidiaries of U.S.
multinational corporations, the concentration ratio will understate
the degree of market power exercised by domestic corporations.
These qualifications and biases in the data should be borne in
mind as we now proceed to confront our theory of cyclical markup
pricing with an empirical investigation of the behavior of price
markups over the business cycle in the postwar period.









IV. PRICE MARKUPS DURING POSTWAR RECESSIONS
To examine the behavior of markups over the business cycle, we
collected data for three-digit manufacturing industries I for the postwar
period. We isolated five recessions in order to determine whether
markups increased during these recessions, thereby exhibiting what
we are calling perverse flexibility. We label this form of behavior
perverse flexibility-namely, an increase in price markup during the
recession--since this type of pricing development is precisely opposite
of what would be predicted by traditional Keynesian macroeconomics,
based, as it is, on traditional neoclassical economic theory. In tradi-
tional theory, markups should not increase beyond the rise in costs
during a recession since presumably sales are falling (or not rising as
rapidly). and to adapt to this market condition firms should not increase
their price markups.
The five recessions measured from peak to trough, for which we
have data, are: 1948-49, 1953-54, 1957-58, 1960-61, and 1969-70.2
We have not examined the most recent recession for two reasons:
first, the recession may not be over as of the time this is being written;
and second, the data are not yet available.3
We divided our industries into three groups based on the degree
of market concentration in 1967, as indicated by the value of ship-
ments accounted for by the four largest enterprises in an industry.
Our high concentration sector includes all industries with a concen-
tration ratio of 50 percent or more; our low concentration sector
includes all industries with a concentration ratio of less than 25
percent; and the medium concentration sector includes all industires
with a concentration ratio between 25 percent and 50 percent.4 This
measure of concentration is based on data provided by the Bureau of
the Census and is typically called a four-firm concentration ratio.
The data for price markups are also obtained from Census publica-
tions. They are computed first by totaling the sum of labor and raw
material costs-what is called direct costs. The price markup is then
computed by dividing the value of shipments by these direct costs.5
So, mn effect, what the markup represents is a markup over direct
costs. This method of computing markups is the standard one which
has been used in studies of price behavior, sometimes called full-cost
pricing behavior.6
I"Three-digit industries" is a Census Bureau classification used to delineate industries in the American
economy. There are over 100 three-digit classifications: each represents a particular type of output. The
Census Bureau divides industries further into a "four-digit" industry classification. For example, the
Census Bureau has a three-digit classification for "household appliances" and breaks this category into
several "four-digit" categories for particular types of appliances.
2 These dates for the postwar recessions are those used by the National Bureau of Economic Research.
They identify a turning point by the month it occurs, while we have only annual data. Consequently,
where a turning point occurs in the first half of the year, we used data for the preceding year. This affects
the 2 recessions in the 1950's where we use data for 1952-54 and 1956-58. In the manuscript, we have used
the conventional dating of these recessions as 1953-54 and 1957-58. Adequate data do not exist for 1948, so
we took 1947 as our peak.
3 The data before 1960 are sparser than for the recessions of the 1960's.
4 We examined the classification of industries by degree of concentration using both 1958 and 1967 con-
centration ratios. Sinec there was general stability in industry classification, we used the 1967 data to classify
industries.
5Specifically, the formula used is: M.U.= [ (1 )-] where M.U. is markup, V.S. is value of ship-
ment, L is production-worker wages, and M Is cost of materials.
6 Kalecki uses this method in his work cited earlier. It is also used by A. L. Hall and C. J. Hitch, "Price
Theory and Business Behavior," Oxford Economic Papers (May 1939), in which they coin the term, "full
cost pricing."
(17)








18

If the hypothesis derived from our theory of target profit behavior
is valid, we should expect to find rising markups in the more heavily
concentrated sectors of the economy during the postwar recessions
and less of a tendency in this direction in the less concentrated sectors.
Though our primary hypothesis focuses on the impact of concentra-
tion on price markup behavior, nevertheless as in any complex pricing
process, this .is not the only explanation for fluctuations in price
markups, owing to the peculiarities of each recession, the varying
impact of these recessions on different industries, and so forth. As
the analysis unfolds, we will be examining some important exceptions
to the general concentration hypothesis we have been advancing.7
Table 1 presents the results of our fist test of the perverse markup
pricing .hypothesis. In that table we have indicated the percentage of
industries in our three concentration groups which show either rising,
declining, or stable markups during the five postwar recessions from
1948 to 1970. An industry was classified as having either a rising or a
declining markup from the peak to trough of a recession if it had,
respectively, more or less than a 1-percentage point change in its
markup. Put differently, an industry with a stable markup was one
which had a less than 1-percentage point change; an industry with a
rising markup wasone with a more than 1-percentage point increase;
and an industry with a declining markup was one with a more than
1-percentage point decrease from peak to trough of each recession.

TABLE 1.-PERCENTAGE OF 3-DIGIT INDUSTRIES SHOWING RISING, STABLE, OR DECLINING MARKUPS DURING
POSTWAR RECESSIONS, BY DEGREE OF CONCENTRATION

Recession I
1969-70 1960-61 1957-58 .1953-54 1948-49

High concentration :2
Number of industries. -------------- 31 28 13 14 15
Markups:
Percent decline--------------- -41.9 25. 0 46. 2 35. 7 40. 0
Percent show no change .......-16. 1 17.9 0 7. 1 6. 7
Percent rise------------------- 41.9 57.1 53. 8 57. 1 53. 3
Medium concentrations
Number of industries---------------66 61 20 17 16
Markups:
Percent decline---------------27.3 27.9 45. 0 29. 4 62. 5
Percent show no change ....... 30.0 36.1 15.0 11.8 12.5
Percent rise------------------- 42. 4 36. 1 40. 0 58.8 25. 0
Low concentration :s
Number of industries---------------43 38 20 17 14
Markups:
Percent decline--------------- -23.2 18. 4 50. 0 35. 3 64. 3
Percent show no change .......-25. 5 36. 8 20. 0 23. 5 0
Percent rise------------------- 51.2 44. 7 30. 0 41.2 35.7

I Markups measured from peak to trough.
S High concentration: 4-firm concentration ratio 50 percent or more. Medium concentration: 4-firm concentration ratio
between 25 and 50 percent. Low concentration: 4-firm concentration ratio less than 25 percent.

Several interpretative points are worth noting about the data in
this table:
1. In each recession, exclusive of 1969-70, a majority. of the indus-
tries in the high concentration sector exhibited perverse economic

7 Another perspective on the fluct uat ions of price markups over the cycle is provided by Howard N. Ross,
"Concentration and Margins: The implications for IPrice Behavior," in The Hoots of Inflation" (N.Y.:
Burt Franklin & Co., 1975), pp. 275 286.
A sampler of other empirical work relating economic concentration to price markups is contained in:
Daniel lSits," Principles of Economics," second Adition (N.Y.: Htarper & Row Publishers, 1973), ch. 18.
In a paper by Norman r. Collins and Lee E. Preston," Price-Cost Margins and Industry Structure,"" Re-
view of Economics and ;,atistics" 51 (I19). pp. 271-280, the relation between price markups and concen-
tration is found to be sigificant after contruling for the capital intensity of production among 417 4-digit
industries.






19

behavior. For example, in the 1953-54 and 1960-61 recessions, 57
percent of all the industries in the high concentration sector raised
their markups, and nearly 54 percent raised their markups in the
1957-58 recession.8 By way of contrast, less than 50 percent of the
industries in both the medium and low concentration sectors raised
their markups during the postwar recessions with but two exceptions-
1953-54 in the medium concentration sector and 1969-70 in the
low concentration sector.
2. Although typically the low and medium concentration sectors
exhibit less of a tendency toward perverse economic behavior, the
trend in these sectors over the postwar period has been to manifest
increasing amounts of perverse economic behavior. For example,
in the medium concentration sector, nearly 63 percent and 45 percent
of the industries had a declining markup during the 1948-49 and
1957-58 recessions, respectively.9 However, during the recessions of
the 1960's less than 28 percent of the industries in the medium con-
centration sector showed a decline in their markups. Though there was
some increase in the percentage of industries which increased their
markups in the 1960's, the largest shift in the data was from the
area of declining markups to stable markups. In the pre-1960 period
only 12 to 15 percent of the industries had stable markups; in the 1960
recessions over 30 percent of the industries had stable markups.
Consequently, overall the medium concentration sector exhibited
a greater degree of perverse economic behavior in the 1960's compared
to the 1950's, though still not as much as in the high concentration
sector.
A similar trend appears in the sector of low concentration. In the
recessions before 1960, anywhere from 35 to 64 percent of the industries
in the low concentration sector showed a declining markup, while
from 30 to 41 percent showed a rising markup. But in the recessions
of 1960-61 and 1969-70, only slightly more than 18 percent and
23 percent, respectively, exhibited a declining markup and more than
44 percent and 51 percent, respectively, showed a rising markup.
Therefore, like the sector of medium concentration, taken as a totality
the sector of low concentration is also exhibiting a greater degree of
perverse economic behavior in that its markups are increasingly
behaving like the sector of high concentration in the recessions
of the 1960's.
3. These two sets of observations reveal how our economy is in-
creasingly susceptible to the type of stagflation we are experiencing
in the current recession. Not only is there a sector in our economy
which typically exhibits preverse economic behavior-the sector of
high economic concentration-but the sectors of medium and high
concentration are increasingly becoming like the sector of high
concentration in their pricing behavior during recessions. The con-
sequence of this for economic policy is that traditional Keynesian
macro prescriptions which call for the creation of unemployment and
recession to mitigate inflation are in reality a major contributing
cause to the inflation that occurs during recessions, as suggested in
our previous theoretical discussion of markup pricing and target
profit behavior.
0 The 1969-70 recession departs from this pattern, and we discuss this later.
9 1953-54 seems to be an exception to the pre-1960 period for this sector.






20

So far the evidence we have accumulated relates solely to the
direction of change during the postwar recessions. It is instructive
to examine, as well, the precise amount of increase or decrease in the
size of markups over the postwar business cycles. These data are
presented in table 2, where we show the percentage change in the size
of markups for the three concentration groups. In this case we are
presenting the percentage change in the size of markups for both the
expansion and recession phase of each postwar cycle.
TABLE 2.-PERCENTAGE CHANGE IN SIZE OF PRICE MARKUP DURING RECESSIONS AND EXPANSIONS IN POSTWAR
BUSINESS CYCLES, BY DEGREE OF CONCENTRATION

High con- Medium con- Low con-
centration centration centration
1948-52 cycle: t
1948-49 recession..............-------------------------------- 10. 78 -8.52 -8. 16
1949-52 expansion. . ..---------------------------------------4.76 8.67 -4.54
1953-56 cycle: 2
1953-54 recession. . ..---------------------------------------14. 15 -.08 -.32
1954-56 expansion. . ..---------------------------------------6.97 14.42 3.60
1957-60 cycle: 3
1957-58 recession..............-------------------------------- 13. 47 -4.91 -7.55
1958-60 expansion.. . ..------------------------------------- -10.92 7.42 5.04
1960-649 ce:
1960-61 recession. . ..----------------------------------------5.29 -1.86 1.34
1961-69 expansion. . ..-------------------------------------- 15.28 18.36 13.65
1969-70 cycle:'&
1969-70 recession.. . ..-------------------------------------- -1.05 .82 2. 54
Excluding the auto industry 6. ..-------------------------------- 1.75-...........................
I Base=1947.
2 Base= 1952.
3 Base= 1956.
4 Base=1960.
Base= 1969.
$ The auto industry was removed from this calculation of the change in markups in the high concentration sector.

The data in table 2 lend additional weight to the conclusions we
derived from the evidence presented earlier:
1. In each recession of the postwar period (excluding the 1969-70
recession), markups increased in size in the high concentration sector.
In the 1948-49 recession they increased by almost 11. percent in the
high concentration sector, reaching a peak in terms of increase in
size during the 1953-54 recession when they increased by over 14
percent in the high concentration sector. By way of conrast, typically
markups decreased during recessions in the low and medium con-
centration sectors, though this tendency weakens a bit in the 1960's.
2. While markups were increasing during recessions in the sector of
ligh concentration, typically they decreased or increased by less
(luring the expansion phase of the cycle in these sectors. However, in
the sectors of low and medium concentration, markups typically de-
creased (uring recessions and increased during periods of expansion,
in some instances more than the increases recorded in the sector of high
concentration. As a consequence, once again we see how the sectorof
high coocentration exhibits its perverse reactions to the business cycle:
In periods of recession markups increase; while in periods of expansion,
markups increase by less than in recessions (and in one instance they
decrease). Ilowever, in the sectors of low and medium concentration,
iarkup) bIehavior is more normal, in that markups typically decrease
(1 ril g recessionls and increase during eXi)aismnS.





21
3. As we discovered earlier, although the sectors of low and medium

concentration exhibit more normal reactions to the business cycle, in
the 1960's their behavior becomes more perverse as it takes on more
of the form of price markup behavior of the sector of high concen-
tration. For example, in the recessions of the 1969's, markups increased
in the sector of low concentration and either decreased by less or in-
creased in the sector of medium concentration. Even though the
sector of high concentration had markup increases of less in the re-
cessions of the late 1960's than in the 1950's, overall the economy was
more inflation-biased during recession because the sectors of low and
medium concentration were no longer offsetting the perverse behavior
of markups in the sector of high concentration, but instead were
reinforcing that perverse behavior.
Our data on price markups over the cycle implicitly take account
of changes in unit costs. However, since movements in unit costs-
especially unit labor costs-are so frequently cited as causes of inflation,
there is some merit in making those movements in unit costs more
explicit. In table 3 we present data on movements in unit labor costs
for the two recessions of the 1960's.1o Of particular interest for our pur-
poses are the differential movements in unit labor costs among different
sectors of industrial concentration, since the existence of such differen-
tial movements would occasion a qualification to our concentration
hypothesis. In general, the data on unit labor costs reveal no difference
in movements during recessions by concentration groups. In both the
1960-61 and 1969-70 recessions, unit labor costs changed by roughly
the same amount in all three concentration groups. Consequently, the
greater propensity for price markups to rise in more concentrated sec-
tors is not explained by industries in those sectors experiencing sharp
rises in unit labor costs. Since fluctuations in unit labor costs are
distributed randomly across concentration groups, explanations for
changing price markups during recessions must be located within the
pricing decision itself.
TABLE 3.-PERCENTAGE CHANGE IN UNIT LABOR COSTS DURING RECESSIONS, BY DEGREE OF CONCENTRATION
High Medium Low
concentration concentration concentration
Recession:
1960-41 .-------------------------------------------------------0.63 -0.45 -0.53
1969-70S. ..---------------------------------------------6.00 6.32 5.92
1Base= 1960.
2 Base= 1969.
A distinctly different behavior pattern appears in the price markup
data for the high concentration sector between the cycles of the 1950's
and the cycles of the 1960's. We have had occasion to note these dif-
ferences in both tables 1 and 2, and this phenomenon requires some
further elaboration. With reference to table 2, markups declined (by
about 1 percent) in the 1969-70 recession in the sector of high con-
centration for the first time during the postwar period. That recession
had one specific peculiarity which we have investigated in some detail:
Namely, during the 1969-70 recession, foreign competition provided
an extraordinarily intense competitive check in the auto industry on
10 Data of sufficient detail for previous years were unavailable






22


what had traditionally been a mature oligopoly with routinized pricing
behavior." Imports as a percent of total auto sales in the United States
reached a peak of 23 percent in 1970, reflecting a steady rise from about
9 percent in 1966. This foreign competition, in effect, reduced the
auto pricing policy for domestically produced cars to something
closer to a competitive form. In fact, price markups in the auto
indIustry declined by 5.8 percent in the 1969-70 recession, while in the
1960-61 recession they had increased by almost 6 percent. When we
eliminate the auto industry from our calculations of markup changes in
the 1969-70 recession, we find that overall markups increased by
almost 2 percent instead of the decline of 1 percent caused by the un-
usual (eveloprrents in the auto industry during that cycle and the
heavy weight that autos exert in the high concentration sector.12
It is also worth noting that the impact of foreign competition in the
auto industry was specifically addressed by national economic policy
in the early 1970's by increasing tariffs on autos and by our dollar
devaluations and flexible exchange rate policy. No doubt these
policies have had the effect of substantially eliminating the "com-
petitive".pressures induced by foreign competition so that the auto
in(lustry is behaving more like its former self of the 1950's and early
1960's. The policies adopted by the auto industry during the most
recent periods of declining auto sales suggests they are following a
policy of increasing their markups during periods of declining sales
up to the point at which they reach an elastic demand response for
their product, as our model of markup pricing in the sector of high
concentration would predict.
Even though the sector of high concentration without the auto
industry produces movements in markups in the 1969-70 recession
which are consistent with earlier movements, during recessions,
the extent to which markups have been increasing is dimished in
that recession as compared to earlier ones. This development has
several )ossible explanations.
First, there may be something unusual about the 1969-70 recession
since it follows directly on the heels of the longest period of expansion
in the postwar period which extended from 1961-69. Perhaps managers
of the companies in the sector of high concentration did not adjust
hell markup policy quickly as previously if they perceived the
recessionl as short-lived and instead based their markup policy more
on the experience of the expansion in the 1960's. If they did not view
the recession as "real" or "permanent" they would be less likely to
adjut their markups instantaneously than if they perceived the re-
cessioi as being serious enough to penetrate their own corporate
really. This raises the question of the extent to which the length of the
expansion conditions increases in price markups during recessions in
the sector of high concentration. At this juncture, we have insufficient
knowledge of price markup behavior over the cycle to advance any
Ii The impact of import- on domestic cornpotition has been noted in a study by Otto Ecksteln and Roger
Brinner "Tho Inflation Process in the United States," (Washintgon: U.S. Government Printing Oflic,
1972) where they argue that (p.2): "While the introduction of import quotas on several major product lines
2hs diminished competition, the overall increase of imports strengthened competition generally." And,
they conclude that "foreign competition remains the major factor in limiting market powr" (p.44).
12 The cigarette industry in the 1969-70 cycle also had an atypical movement to it owing to the cigarette
cancer scare and the attention devoted to this problem by national policy. Markups in that industry declined
by 16 percent in the 1969-70 recession when before they hadincreased by 3.6 percent in 1960-61, 13.8 percent
in 1957-58, 29.2 percent in 1953.5 and 18 percent in 1948-49.






23

defiitve answer to this question, only to note that there quite likely
Ssomes gnificance in the fact that the 1969-70 recession followed an
expary period of some 8 years in contrast to all .the other
recessions of the postwar period which followed expansions of no more
than 4 years duration.
Second, the period of the 1960's ushered in a substantial growth
in the formation and expansion of conglomerate forms of inustral
organization."3 In terms of the evidence we have been presenting, this
development has two impacts: first, as indicated earlier, the method
of data collection does not reveal this growth in industrial power
in the statistics on economic concentration. For example, ITT-a
multinational conglomerate-acquired Hostess Bakery as part of
their conglomerate empire. However, Hostess Bakery continue to
appear in the food processing industry, and in terms of our classiica-
tion is not considered to be an industry of high concentration even
though it is part of ITT, an obviously powerful economic giant which
belongs in the sector of high concentration. In short, the ubsidiaries
of conglomerates are assigned to an industry according to the product
line of each individual company within the conglomerate, which
frequently means assigning them to a sector of low or medium cn-
centration. Where should one classify ITT; in which "in,:u.tr"
does it belong? Asking the question reveals the statistical dilemma.
As a consequence of the development of conglomerates and the way
in which subsidiary companies of the conglomerates are given sta-
tistical treatment by the census, the data on price markups in the
1960's have to be given a most careful interpretation.14
The expansion of these conglomerates can explain why iditries
classified as low and medium concentration begin to take on ore
of the markup pricing posture of the sector of high concent101ion
in the 1960's. For example, take Hostess Bakery: it is part of ITT
and being a part of this conglomerate has access to the pricing ability,
managerial talent, capital markets and advertising resources I a
very concentrated company. However, in terms of the data it appears
as being in a sector of low or medium concentration. Therefore, its
actual price markup behavior will take on the form of a concentrated
industry, while it remains classified as low or medium concentration.
The data in the 1960's which reveal more perverse behavior in the
sector of low and medium concentration can be explained in part
by the development of conglomerates. Many subsidiaries of conglom-
erates appear as sectors of low and medium concentration, but they
formulate prices in terms of a sector of high concentration thilough
their conglomerate parent.
A second part of this argument is the leverage that conglomerates
can exercise in the market by using different price policies in differ ent
sectors according to an overall market strategy to maximize their
economic power. They might, for example, price like an oligopoly
in a sector of low or medium concentration where they have newly
acquired economic power and use their superior marketing and
distributional systems to sidestep competition, while pricing more like
13 One of the problems one encounters in studying economic concentration is the paucity
and inadequacy of data on conglomerates. Blair, in his book "Economic Concentration,'
concludes that conglomeration increased in the 1960's, piecing together whatever bits of
information are available. (See chs. 3 and 4.)
14 Our earlier dislusion of the inadequacy of the data on economic concentration is
relevant here. This is contained in the section "Market Power and Measures of Economic
Concentration."






24


a quasi-competitive industry in a sector of higher concentration in
order to undercut oligopolistic competitors in an industry of relatively
high concentration. The conglomerate, in short, need not necessarily
behave like an oligopolist in its pricing activity only in the sector of
high concentration. It can realize its market power by pricing like an
oligopolist in sectors that are statistically classified as low or medium
concentration. Put differently, a company like Hostess Bakery ac-
quires it pricing policy through a parent company whose economic
power in the market is vast even though Hostess Bakery might
itself be housed in an industry of lesser concentration. And for ITT,
they exercise their concentrated economic power through sectors of
the economy traditionally classified as being of low or medium con-
centration. The result is manifested in the increased inflationary bias
of the economy in general as indicated by the increasingly perverse
pricing behavior of the sectors of low and medium concentration in
the 1960's.
Evidence presented in table 4 indicates that there has been a greater
movement toward increasing concentration in the low and medium
concentration sectors lending support to our interpretation of the
results on price markup behavior in the 1960 recessions. In table 4,
we present data showing the percentage of industries within each of
our three sectors that manifested a declining, stable, or rising degree
of concentration. These data are presented for four-digit manufacturing
industries which give us more detail than we previously had. About
62 percent of all the industries within the sector of low concentration
increased their concentration ratio by more than 1 percent from 1947
to 1970, in contrast with 40 percent and 35 percent in the medium and
high concentration sectors, respectively. In brief, the trend toward
concentration in the postwar period has been greater in the low
concentration sector, even though its level of concentration is still less
than that in the high and medium concentration sectors. This is
consistent with the proposition that many industries in the sectors of
high and medium concentration reached a stage of oligopolistic ma-
turity during the postwar period, resulting in stable market shares.
And faced with that stability, companies in those sectors went fishing
in the low concentration sector, acquired firms, and created con-
glomerates where now the process of evolving mature oligopolies out
of infant ones is just beginning. This can account for the type of price
markup behavior we witness in the most recent recessions in the
sectors of low and medium concentration.
TABLE 4.-PERCENTAGE OF FOUR-DIGIT INDUSTRIES SHOWING RISING, STABLE, OR DECLINING DEGREES OF
CONCENTRATION, BY SECTOR, 1947-70
Percent of industries with: t
More than
I percent More than
Increase In 1 percent
degree of Stable decrease in
concentration concentration concentration
Low concentration (29) 2...............................- 62.1 10.3 27.6
Medium concentration (34)2-............................- 40.0 5.7 54.3
High concentration (45)2-................................ 35.6 4.4 60.0
An industry is classified as having increased in concentration if its concentration ratio Increasedbym nore thanI percent
from 1947-1970. The converse is true for the industries classified as having declining concentration ratios. Industries are
classified as stable if their concentration ratios changed by less than 1 percent.
2 Numbers in parentheses indicate total number of industries included.






25


A final reason for the difference in price markups in the 1969-70
recession in the sector of high concentration relates to the overall
impact of foreign competition in the 1960's. Though we have only
isolated the auto industry from our calculations for the 1969-70
recession, the phenomenon of increased foreign competition in the
1960's as compared to the 1950's extended beyond that industry to
others in the high concentration sector, rendering the movement of
price markups in that recession atypical of the others in the postwar
period. Foreign competition, in general, impacted on the sector of
high concentration rendering its price markup behavior less perverse.
For example, among industries in the high concentration sector,
imports increased from 1960 to 1970 by the following percentages:
machinery and transport equipment-662 percent; rubber tires and
tubes-876 percent; iron and steelmill products-352 percent. Com-
parable increases in foreign sales were recorded in plastics and petrole-
um products. The impact of foreign competition is another of those
phenomena that occasion a qualification to the measure of economic
concentration. In this instance, our measure of economic concentra-
tion overstates the degree of market power since it does not take into
account competition from foreign sources. In the context of this
discussion, price markup behavior in the sector we call high con-
centration was mitigated by this foreign competition in the late
1960's, thereby reducing its markup behavior to more like that of the
competitive sector of the economy.












V. POLICY IMPLICATIONS


Macro economic theory and policy has been dominated by Key-
nesian economics in government circles since approximately 1960
and in academic circles around a decade earlier. The theoretical
foundations of Keynesian economics are based upon a high degree
of competition in product markets (what economists call perfect
competition) and a lesser degree of competition (imperfect competi-
tion) in labor markets. Since pre-Keynesiantheory of competitive
pricing in product markets was highly developed in neoclassical
economics and since unemployment was the key problem of his time,
Keynes devoted almost no attention in his own work to the problem
of inflation which, by definition, involves the pricing of goods and
services. Economists following Keynes have also neglected the study
of the actual way in which prices are formed in the American economy,
relying more on the traditional neoclassical theory of competitive
pricing for presumptions about the actual pricing behavior of firms.
As a consequence of the paucity of conceptual and empirical work
on pricing, we know little about the causesof inflation. The micro
(pricing) theory is separated from the macro (employment) theory,
and no integrative link has been seriously attempted in traditional
economics in the context of concentrated product markets. In
Keynesian terms, if a deficiency of aggregate demand causes unem-
ployment (what used to be called deflation), then an excess of aggre-
gate demand (relative to productive capacity) must be the source of
inflation. Such excess demand places pressure on existing productive
capacity which cannot expand in the short run, and the consequence
is increased prices rather than increased production. So inflation occurs
when there is too much aggregate demand and unemployment when
there is insufficient aggregate demand. But what of the a ast several
recesion,? Demand nnsu.mciencies are seen as the source o unemploy-
ment but we have also experienced inflation-which does not jibe
with the theory.1
The theoretical clue to unlocking this mystery requires jettisoning
the assumption of perfect competition in pricing behavior among firms
selling products and services. When we add this missing ingredient to
Keynesian theory, "an analysis of inflation emerges which is consistent
with the empirical evidence and provides us with a systematic explana-
tion of inflation that is rooted in the functioning of enterprises in the
American economy." We need a theory of noncompetitive pricing to
add to the macro model of the economy in order to un(lerstand why
inflation an(d unemployment are systemic outcomes of the pricing and
profit behavior within firms.
Though Western economists have been wont to study the American
economy by looking at noncompetitive pacing behavior within a
I The reader will no doubt have detected the pertinence of this study to the notion of a Philips cure
which posits some trade-ofl between inflation and unemployment. Rather than being #sb#tttite, as in the
Phillips curve analysis, our work suggests that Inflation and unemployment complcmet each other during
particular phases of a recession under conditions of economic concentration.
(26)






27


micro context, the Polish economist, Michael Kalecki, did this in his
macro work even before Keynes formulated his general theory.2
Kalecki specifically incorporates both price and employment in his
macro system. Additionally, he grafts onto his macro model of em-
ployment, a micro theory of pricing which explicitly recognizes the
noncompetitive character of that decision. The work in this mono-
graph is compatible with the way in which Kalecki constructs his
model.
Several policy implications and suggestions for a policy research
program flow from the theoretical and empirical work of this study.
The Keynesian policy approach to inflation is called into question
bv this study, and we must start afresh in designing an inflation
policy consonant with conditions of economic concentration. Rather
than reducing inflation by using the Keynesian tool of recession to
mitigate inflation, the very recession itself is a contributor to in-
flation. That explains why we have both inflation and unemploy-
ment occurring side by side, and we will continue to experience this
even more as the economy increases in economic concentration. The
Phillips curve, an offshoot to Keynesian analysis, which posits that
there is a tradeoff between unemployment and inflation-the more
we have of one, the less we have of the other-is seriously called into
question by this work. The Phillips curve has been challenged by the
conditions of the last several recessions, and this work merely provides
a theoretical and empirical insight into why unemployment and
inflation have occurred together. The reason Keynesian policy
prescriptions become ineffective is a theoretical weakness of that model
based as it is on a competitive theory of pricing within firms. Once we
admit to noncompetitive pricing behavior of firms operating in con-
centrated markets, we then have both a theoretical and empirical
basis for explaining events in an economy that does not depend on
random shocks and anomalies. In short, the Keynesian antidote of
unemployment to cure inflation may in fact be the to xin which spreads
and multiplies the disease!
Once this problem is faced, then an array of possible policy options
is opened, all of which focus on the way in which price markups evolve
during recessionary periods. If we are in a situation of inflation and
recession, as we are today, using more recession to cure the inflation
may be self-defeating not to mention the numerous other pernicious
effects of unemployment on the population. However, once a recession
begins, for whatever reason, it is important to monitor price markup
developments, since failing to do so might easily trigger a period of
inflation making it all the more difficult to turn the recession around.
To do this we need selective price markup monitoring. The industries
and firms initially selected for price markup monitoring are based
on the objective criteria that they increased their price markups
during the most recent recessions. Rather than make price con-
trols universal or haphazard, we should make them selective and
rooted in some objective criteria. If we try to control all prices, we
control none, since the job is so vast as to paralyze any administrative
effort mounted to control prices. However, we could monitor price
markups selectively without undue administrative burdens. But
this monitoring must be based on some objective economic criteria.
2 We have had occasion to reference Kalecki's work earlier in this study.






28

The one prOposed here, and implied by the theoretical and empirical
work of this study, would have those price markups monitored in
industries and firms which manifested perverse flexibility in recent
recessions. Then once the recession begins, we can head off apoten-
tially serious inflation which makes the recession more difficult to
correct by selectively monitoring price markups in particular in-
dustries.
TABLE 5.-PERCENTAGE INCREASE IN PRICE MARKUPS FOR SELECTED 3-DIGIT INDUSTRIES IN 1969-70 AND 1960-61
RECESSIONS

1969-70 1960-61

High concentration:
211-Cigars.. ..------------------------------------------------------12. 1 2.7
286-Gum and wood chemicals. . ..-----------------------------------------13.7 4.1
301-Tires and inner tubes......------------------------.--------------------13.7 18.5
312-Industrial leather belting.. .. .. ..---------------------------------------3.9 18.3
357-Office and computing machines.. . . ..-----------------------------------10.6 2.2
363-Household appliances. ..-----------------------------------------8.3 8.7
372-Aircraft and parts----------.-----------------------------------------8.2 1.6
386-Photographic equipment and supplies-----------.---------------------- 12.3 2.8
Medium concentration:
227-Floor covering mills.-----------------------------------------10. 1 2.5
252-Office furniture.............--------------------------------------------12. 2 4.6
274-Publishing.............-----------------------------------------------15.0 4.6
393-Musical instruments----------------------------------------- 10.2 14.8
394-Toys and sporting goods--------------.------------------------------- 11. 1 13.4
Low concentration:
201-Meat products. . ..-----------------------.-------------------------- 8.7 3.5
224-Fabric mills----- _.------------------------------------------2.3 9.2
231-Men's and boys' suits and coats-.----------------------------------- --5. 3 11.7
236-Children's outerwear.....................6. 7 3.9
236Chlden' otewea--------------------------------------- 7_3.9
237-Fur goods.-------------------------- -------------------------5.6 6.5
311-Leather tanning..---------------...--------------------------------7.7 2.4

Illustrative of this policy approach are the data presented in table 5.
We have taken our gross three-digit industry data on price markups
during the recessions of the 1960's and indicated the percent change
in markups for selected industries during those recessions. These
industries are selected from all three sectors of concentration: high,
medium, and low.' By no means is this an exhaustive list of industries
which conform to our criteria. We have limited this presentation to
an illustrative selection. Even though our data by three-digit classifica-
tion are somewhat coarse to perform an adequate administration
of selective price markup monitoring, nonetheless they are illustrative.
Those industries identified in table 5 increased their price markups
during each of the previous two recessions. They are obvious candi-
dates therefore, for selective price markup monitoring. Each recession
is different in that some industries will no doubt increase their markups
in the next recession which are not identified here. However, tne
industries identified in table 5 form the basis for a policy and an
administration of that policy. One can simplify the taskeven further
by eliminating those industries which are of little consequence in the
aggregate output of the economy. This would involve positing some
minimum share of total output before any administrative time is
spent monitoring price markups in that industry. In fact, one may

3 The fact that price markups rise in some industries in the low and medium concentra-
tion sectors does not negate the general theoretical proposition advanced in this study.
Some industries in those sectors show perverse flexibility, others do not. And in the sub-
aggregate, the behavior of the low and medium concentration sector is less perverse than
that in the high concentration sector as we discovered earlier in connection with our
discussion of tables 1 and 2.






29


choose to monitor price markups in an industry with a large weight
in total output if its price markup has been increasing by only 2
percent and ignore another industry whose price markup rose by
10percent but contributed only a small amount to total production.
At this stage of development, our ability to select industries and
firms for price markup monitoring is severely constricted by the
availability of data. In order to effect such a policy, we need more
accurate current data of price markups, as well as much more detailed
data which will enable us to transcend the coarse three-digit classifica-
tion with which we worked in this study. Additionally, we will need
more rapid data collection so price markups can be identified and
monitored quarterly.
Before these steps in data collection can have an impact, however,
we need to accept market power as a way of economic life and under-
stand that this market power can affect macro policy in ways not
foreshadowed by competitive price theory. The so-called anomaly
of stagflation must now be put on center stage so the spotlight of
research and policy formation can illuminate it to see its systemic
contours more clearly than heretofore.












COMMENTS ON THE INFLATIONARY IMPACT OF UNEM-
PLOYMENT: PRICE MARIKUPS DURING POSTWAR RE-
CESSIONS, 1947-70
By HOWARD N. Ross, Professor of Economics, Bernard M. Baruch
College, The City University of New York
The influence of monopoly and competition on the performance of
the economy is a vital and still missing link in our perception of eco-
nomic problems and their remedies. Without the link, I think it is
impossible to say how the price level and changes in the price level
are determined, macroeconomic dictates notwithstanding. To pre-
sUIme, as some do, that the degree of competition in a market is irrele-
vant to the behavior of the market, especially in regard to price
movements, becc mes with the passage of time and events the ultimate
in pretense or innocence.
At this juncture in the history of the Employment Act, it is appro-
priate to reexamine the limitations of the stabilization policies created
to fulfill the objectives of high employment without inflation. A new
limitation has been painful .discovered in recent years: the inability
of traditional stabilization policies to control inflation during periods
of recession and to dampen price level changes during periods of
galloping inflation.
Promises of a renewed emphasis on employment and growth as
inflation slows must reasonably be hedged by the uncertainty of future
inflation, especially so because we lack a decisive interpretation of the
causes of the runaway inflation of recent years. It is timely to ask
wiat role monopoly has played in past inflations, and it is under-
standably expedient to concentrate on monopoly in the product mar-
kets as an initial exploration, setting aside the problem of monopoly
in the input markets.
I am sympathetic to the efforts of Professors Wachtel and Adelsheim
to e-tablish a basis for understanding the conundrum of inflationary
rece1ions which have recurred since the 1950's. However, I must
qfiaify my agreement with their analysis and methodology. The
authors considerably overstate their basic thesis (p. 4):
As we have seen in this study, in sectors of economic concentration price mark-
ups are increased when unemployment exists in order to recoup the revenue lost
from reduced sales. And increasingly more sectors of the American economy are
manifesting this type of perverse economic behavior. So instead of reducing
inflation, unemployment can increase the rate of inflation under conditions of
economic concentration. The traditional Keynesian antidote of unemployment to
cure inflation mn1,Y in fact be the toxin which spreads and multiplies the disease!
If incmployment causes inflation in a dynamic sense, more unem-
p~loyiucit causing g more inflation, rising unemployment causing rising
ilflltilon, then we are in the topsy turvy world of a positively sloped
Phillips (urve. The aut hors come too close to suggesting this (second
piir.rruph, p. 3), and all we need do to escape the ghastly fantasy is
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31


contemplate how rapidly real income will fall under simultaneously
increasing prices and unemployment. The seemig paradox of rising
and rigid oligopoly prices during recessions is due to the fact that the
postwar downswings are short-lived, typically a year in length, and
that the downswings are not long enough nor deep enough to exact a
fall in money wages and raw material prices. As demand falls during
recessions, oligopolists will use their market power to set prices which
limit profit losses-an option unavailable to more competitively
organized industries.
The mechanism of the full-cost price is ideally suited for such
purposes since it can be designed to protect gross margins above direct
costs (labor and raw material costs). However, the power of oligopo-
lists to limit profit losses by "perverse" pricing is surely contrained by
consumers who will seek substitutes or defer purchases (as in the case
of durable goods), by a watchful government and by the recognition
that the policy works well-and perhaps only-under a shortt run
decline in demand.
The authors should take note of the automobile industry, a classic
oligopoly industry, which reduced prices during the 1973-75 reces-
sion in the form of unabashed rebates to stimulate sales and reverse
the devastation to profits. The proposition that unemployment creates
inflation is legitimate only as a short run, temporary and undynamic
(static) depiction of events.
The notion that practitioners of markup pricing constrained by a
target rate of return raise their percentage markups on direct costs
during contractions and continue to raise markups during expansions
(p. 10) is a challenge to the more orthodox views of such a price policy.
Wachtel and Adelsheim are really talking about a variant of a full-cost
price, and though they cite the relevant literature, they reject the
inherent logic of a full-cost price.
The several versions of full-cost pricing to be found in the literature
stress common features: price is unresponsive to cyclical swings in
demand; on the other hand, price reflects all changes in direct costs,
and the gross margin, determined at some standard volume of output
either as a percentage markup or an absolute amount above direct
costs, tends to be rigid over the cycle.
The rigidity of gross margins (profits and overhead) and con-
sequently, the relative rigidity of a full-cost price over a cycle, is due
to the embodiment of cyclicality in the determination of the gross
margin at standard volume. If a recession is sharp or if the prices of
capital goods are increasing, the rise in overhead costs per unit of
output on reduced sales may cause an upward adjustment to margins
as realized profits deviate below expected profits. In this way, _ross
margins could expand during recessions among concentrated in-
dustries, but are they likely to expand in revivals as well? The logic
of a full-cost price says no. As output increases, the decrease in over-
head costs per unit will raise the profit component without any change
in the marnitude of the gross margin or markup. The pattern of antic-
ipated markups and prices is that during recessions they will fall less
or rise more than competitive industries, and during revivals they
will rise less than competitive industries. The theory is tied to the
operational short run and pointedly excludes longer-run considerations
such as growth and technological change within industries.






32

The expected behavior of markups during recessions is fairly well
confirmed in Table 2, particularly in the 1957-58 contraction which
is the most severe of those included; the data on the expansions span
greater intervals and are confounded by long run forces, but still
they tend to support the theory.
My argument with the authors is that they do not provide suf-
ficient and more precise motivation for oligopolists to raise markups
continuously throughout the cycle. Is the objective a target return
on investment? A target return is supposed to be achieved over a
cycle rather than during each phase of a cycle. Is the objective a
secularly higher profit rate? There is not much evidence for that, and
there are reasons to believe that oligopolists are far more interested
in reducing the dispersion of profit rates over a cycle than in increasing
the size of profit rates. A reduction in the dispersion of profit rates
reduces the risk of investment and can lead to a decrease in the cost
of capital, which in and of itself can enormously increase the wealth
of the firm.
Wachtel and Adelsheim think that only increased markups during
recessions are inflationary. If wages and raw materials costs are
rising, constant markups are also inflationary. This can best be seen
by reexamining the authors definition of markup.
V.S.
(1) M.U. L M-1

where M.U.=markup, V.S.=value of shipments, L-production
worker wages and M=cost of materials. The definition can be re-
written as
V.S.-(LM) G.M.
(2) M.U.- LM L+M
where G.M.=gross margins of overhead expenses and profits. These
variables should be on an average per unit of output basis to deter-
mine what effects fluctuations in output have on their values.
If L+M per unit is rising in an inflationary context, despite a
recession and a constant M. u., gross margins will rise as will price.
A policy geared toward monitoring markups as sugested by the
authors must include cases of this kind. However, I think the analyti-
cal foundation for a policy review of markups is misleading.
The crux of the matter between myself and the authors can be
clarified in Equation (2). They believe that producers decide on
M.U. as a determinant of prices and profits; I believe that producers
stake their decisions on G.M. and therefore M.U. is a passive out-
come of decisions on G.M. and market influences on L anAd M.
This is not a question of emphasis, but one of cause and effect.
If oligopolists are primarily interested in maintaining profit and
profit rates, control of the proximate variable gross margins will
achieve their objectives simply and efficiently. In light these
objectives, why would oligopolists want to control the ratio
G.M.iL+-M when in effect it adds no new information and compli-
cates the fulfillment of the profit goals?






33


My understanding of the literature is that markup formulae prevail
in the distributive trades, in pricing in local markets and perhaps
in loose knit oligopolies but not among the big time operators whose
price changes are newsworthy and of calculated importance. My own
work leads me to conclude that a public policy with aims to reduce
structural inflation-and there should be one-would bet concern-
trate on gross margins per unit of output to determine whether and to
what extent price increases are justified.
The authors' attacks on Keynesian economics are as gratuitous as
they are unwarranted. An enlightened public policy must supplement
the macroeconomic policies of Keynesian economics, not replace them.
There is no way to eliminate an excess demand inflation but by
attempts to restrict the growth in aggregate demand by fiscal and
monetary measures. If as a result, a recession occurs and the price
level continues to rise, the fault lies not with the policy but with the
structural response of the economy.
Macroeconomic policies are structurally blind, and that is inherent
to their nature and perhaps to their effectiveness. They represent
hard won progress in American economic thinking and responsibility.
They do require supplementary aids to contain undesirable increases
in the price level due to monopoly in all markets, including the
market for labor. A demand by the public for justification of price
and wage increases in important industries which have multiple
effects on the price level would be an auspicious beginning.












REPLY TO PROF. HOWARD N. ROSS' COMMENTS
By HOWARD M. WACHTEL and PETER D. ADELSHEIM
We welcome Professor Ross' comments on our study paper, the
more so because Professor Ross' own work in the area of concen-
tration and price behavior is a significant contribution to our under-
standing of contemporary economic phenomena.
Professor Ross is in agreement with us in his discussion of short-
term recessions, when he concludes that "oligopolies Mill use their
market power to set prices which limit profit losses" in such a way
that they "protect gross margins above direct costs . ." Our data
support this proposition. In certain sectors of the economy, gross
margins are protected via the mechanism of an increased price
markup, creating a segment of the Phillips Curve which is indeed
positively sloped, although Professor Ross seems to contradict
himself at an earlier part of his commentary when he expresses
skepticism about this possibility. A positively sloped Phillips Curve
in the short-term need not imply a rapid fall in real income, as Profes-
sor Ross suggests, simply because government policy, dissaving, and
trade union pressure can mitigate the potential fall in real income
under contemporary political-economic conditions.
We agree with Ross when he argues that the phenomenon we have
identified applies best to the short-term. In fact, we indicate this in
our paper when we argue that, should a recession continue for a sub-
stantial period of time and become deeper, we would then encounter
a more traditional Keynsian world of elastic consumer responses to
rising price markups. When this occurs, sales would fall off sufficiently
to cause a rollback in price markups. But this happens only in the
longer-term (in the sectors of high economic concentration that con-
cern us); and since the price behavior we have identified is becoming
more pervasive throughout the economy, recessions must be longer
and deeper before we reach this "Keynsian" world. The example of
the auto industry, which Ross cites as counter-evidence, is in fact
some of the strongest evidence in support of our analysis. In the auto
industry markups were substantially increased at the same time as
sales fell. Only when the rise in markups became self-defeating
that is, sales fell more rapidly in percentage terms than the percentage
increase in price markups-did the auto firms reduce their markups
through the sales gimmick of a rebate. But the rebate never pushed
the price back to its earlier level; it only reduced the price slightly after
the auto firms overshot the limits to which they could raise their
markups. In brief, we have a situation where the auto firms increase(
their markups in the face of declining sales but increased them too
much. Then they reduced their markups, but the end result was a
higher markup after the declining sales than before.
Professor Ross cites the speculation about the cyclical behavior
of price markups in the earlier literature on full-cost pricing. All we
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35


can say is that our data and analysis indicate clearly that price
markups are not stable over the cycle. Rather than "reject" the
models of full-cost pricing, we have simply subjected those models
to empirical inquiry and let the data speak for themselves. Behind
our empirical analysis is a theoretical model of target profit behavior.
This is the "sufficient" and "precise motivation" for oligopolists
which Ross asks us to provide.
Finally, Ross raises the issue that firms "stake their decisions on
[gross margins] rather than price markups." We do not see anything
incompatible between these two propositions, since price markups
are the means by which gross margins are attained and protected
during recessions. Our method commenced with a theory of profit
behavior, within which price markup practices were the means or
instruments by which target profits were attained. We then translated
this theoretical model into operational hypotheses and an empirical
test. And the data indicate support for our hypotheses and the
theoretical foundation upon which the empirical test was erected.
This is the most cogent argument for our version of the contemporary
economy. Instead of an "attack" on Keynsian economics, we see our
work as bringing Keynes up-to-date with the addition of a price
sector to his model which incorporates markup price behavior over
the cycle under conditions of economic concentration.










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