Price Setting Behaviour of Pakistani Firms: Evidence from Four Industrial Cities of Punjab (Article)

Macroeconomic research has mostly been focused on investigating micro foundations of the theory and transmission channels of policy ever since rational expectations have found place in the literature. It was in the 1990s that macroeconomists started working on models incorporating the assumption of nominal rigidity in the optimal behaviour of individuals and firms. These models have gained empirical support from both aggregate as well as firm-level data. The evidence for developing countries on the issue is limited and Pakistan is no exception. This study aims at investigating the price setting behaviour of Pakistani firms. Besides this, the potential effects of changes in financial cost on the overall pricing and production decisions have also been investigated.

Pakistani firms perceive themselves to be operating in a competitive environment though most of their clientele is regular. The majority of the firms use current information while reviewing prices. Around 70 percent of the firms use either a state-dependent pricing rule or a combination of both time and state-dependent rules. Pakistani firms revise and change their prices usually in the months of June and July. The main determinants of change in the price level are the cost of raw material, energy and inflation. The competitors’ price generally figures in price decrease. Among the causes of price stickiness, implicit contract with the customers is at the top; the fixed term contract comes next. Most of the firms change their wage structure annually. About half of the firms index their workers’ wages to inflation and for the purpose refer to the earlier inflation rate. On the whole labour productivity and changes in inflation rate are observed as the main determinants of wage change.

1. INTRODUCTION

Ever since rational expectations nave found place in the literature much of the research in the area of macroeconomics has been focused on investigating micro foundations of macroeconomic theory and transmission channels of policy. Macroeconomists started working on macro models in the 1990s incorporating the assumption of nominal rigidity with explicit modelling of optimal behaviour of individuals and firms, [see for instance, Rotemberg and Woodford (1997); McCallum and Nelson (1999); Woodford (2003)]. These models incorporate various forms of price and wage rigidities making monetary policy effective, though only in the short run. More recently these models have gained empirical support1 from both aggregate as well as firm-level data. In this regard micro-level evidence is more convincing since aggregated data may depend on the assumptions used and methodology employed, whereas micro level research offers direct evidence. For instance, micro level data directly investigates the price-setting behaviour of firms.

Some studies in the literature on the price setting behaviour of the firms investigate the issue by collecting data from a particular sector of the economy or a group of firms [e.g. Kashyap (1995); Dutta, et al. (1999); Copaciu (2004)]. Another strand of literature, with the pioneer work of Blinder (1991), uses a survey-based approach to investigate various aspects of price stickiness. These studies have an added advantage as they allow additional insights and permit a clear ranking of the causes and patterns of price stickiness. Hall, et al. (1997) extended Blinder’s work for UK firms. Similarly Apel, et al. (2005) investigated the price setting behaviour of Swedish firms and Fabiani, et al. (2004) did the same for Italian firms. A number of survey-based studies conducted within the Eurosystem’s Inflation Persistence Network used this approach.

A limited number of studies are also available that focus on developing countries. Studies in Pakistan have little micro level focus which this study as the first attempt to deal with the firms’ price setting behaviour aims to do. Besides this, the potential effects of changes in financial cost on the overall pricing and production decisions have also been investigated. Moreover this study is different from others in that data has been collected through enumerators and field investigators instead of mailing questionnaires to respondents.

The study mainly focuses on four issues. First, the type of pricing rule; whether it is state-dependent or time-dependent? Second, what type of information (past, current or future forecast) is used for price calculations and, what is the frequency and size of the average price change. Third, it deals with different theories of price stickiness by investigating the determinants. The wage setting behaviour, which has certain implications for the effectiveness of monetary policy, is the fourth area the study deals with.

The study proceeds as follows: Section 2 highlights the methodological issues. Section 3 outlines the main characteristics of the market. Section 4 deals with the price setting behaviour while Section 5 highlights determinants of price change and causes of price stickiness. The wage setting behaviour is investigated in Section 6 and Section 7 concludes the study.