Asking About Prices: A New Approach to Understanding Price Stickiness, by Alan Blinder, review by Steve Keen
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The chief author of this book is Alan Blinder, once a Vice-President of the American Economic Association, a Vice-Governor of the Federal Reserve, and currently President of the Eastern Economic Association. He is, in other words, no maverick, but firmly within the mainstream of economic thought. And yet the research he reports in this book challenges many of the accepted tenets of both micro and macro economics.

The publication should therefore be taken seriously by the economics profession, and raked over carefully to find out whether what Blinder reveals is really the case, or simply a product of poor research.

It speaks volumes for the way that economics handles contrary evidence to accepted beliefs that this has not happened. Blinder's book has instead simply been ignored. The book languishes around the 750,000 mark in Amazon's "best sellers" list, and this review will be the first ever given of it. Meanwhile Mas-Colell's Microeconomic Theory, published three years before Blinder's book, which states the accepted neoclassical microeconomic canon in excruciating mathematical detail, ranks in the mid 100,000s, and has over 80 reviews--most of them from economics PhD students and highly laudatory.

Perhaps some of them should read this book and see whether they can reconcile Mas-Colell's elaborate theory with the reality Blinder found. Neoclassical theory presumes that firms face rising marginal costs, and firms profit maximize by equating marginal cost and marginal revenue. Blinder instead found that 89 per cent of firms in his survey reported constant or falling marginal cost.

If marginal cost falls for the majority of firms, then neoclassical pricing theory can't work--as Blinder acknowledges by saying that "The overwhelmingly bad news here (for economic theory) is that, apparently, only 11 percent of GDP is produced under conditions of rising marginal cost." (102)

Fixed costs are also much higher, and much more significant for firms' operations, than implied by economic theory. Quoting Blinder again:

"Firms report having very high fixed costs-roughly 40 percent of total costs on average. And many more companies state that they have falling, rather than rising, marginal cost curves. While there are reasons to wonder whether respondents interpreted these questions about costs correctly, their answers paint an image of the cost structure of the typical firm that is very different from the one immortalized in textbooks." (105)

Blinder's results were garnered by an unusual approach for economists: he interviewed firms to find out what their costs, operations, demand profiles, etc. were. This approach has been disparaged in economics ever since Friemdan's "assumptions don't matter" methodology paper in the 1950s--whose real target was very similar work by researchers like Gardiner Means, which found very similar results to Blinder today.

Blinder mounts an effective defence of the survey method, and also applies more resources to the issue than any previous researcher. He and his team of economics PhD students conducted face to face interviews with Presidents, CEOs and senior managers of 200 firms. The firms surveyed represented 7.1% of the USA's GDP, so what was found was statistically robust: what these firms reported was representative of US industry as a whole. As Blinder put it, "we interviewed an astounding 10 to 15 per cent of the target population-a large fraction by any standard." (68)

The research was used to explain the macroeconomic phenomenon that interests Blinder of "sticky prices". Economic theory implies that price adjustments should dominate market responses, but prices are notoriously inflexible, at least in the downward direction. Blinder's macroeconomics presumes this, but he wanted to know the microeconomics of why. His survey was designed to test 18 different theories as to why this might be so, and the results did let him distinguish between them. But the key surprise for Blinder and his team was the extent to which economic reality did not look at all like the models that economists assume are true.

This is the issue that most interests me, and I'll close with an extended quote from Blinder on this topic. I would love to see some of those who believe Mas-Colell is so wonderful explain why the real world looks so unlike economic theory:

"First, about 85 percent of all the goods and services in the U.S. nonfarm business sector are sold to "regular customers" with whom sellers have an ongoing relationship ... And about 70 percent of sales are business to business rather than from businesses to consumers...

Second, and related, contractual rigidities ... are extremely common ... about one-quarter of output is sold under contracts that fix nominal prices for a nontrivial period of time. And it appears that discounts from contract prices are rare. Roughly another 60 percent of output is covered by Okun-style implicit contracts which slow down price adjustments.

Third, firms typically report fixed costs that are quite high relative to variable costs. And they rarely report the upward-sloping marginal cost curves that are ubiquitous in economic theory. Indeed, downward-sloping marginal cost curves are more common...

If these answers are to be believed ... then [a good deal of microeconomic theory] is called into question... For example, price cannot approximate marginal cost in a competitive market if fixed costs are very high." (p. 302)