prices - E202 - Prices STYLIZED FACTS: Prices and Inflation...

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E202 - Prices 1 STYLIZED FACTS: Prices and Inflation • Deflation in 19 th century; inflation in 20 th century • High inflation during wars • Inflation fluctuates procyclically with a lag
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E202 - Prices 2 PRICE ADJUSTMENT QUESTIONS 1. What is the market environment for our discussion of price adjustment? 2. What are the basic components in firms price setting decision? 3. What variables influence firms markups? 4. How is unit cost calculated? 5. What determines non-labor input prices P RM ( ) ? 6. What determines the wage rate (W)? 7. What about productivity? PRICE ADJUSTMENT Prices adjust to changes in costs and competitive conditions in the goods market, but are assumed to do so slowly — prices are sticky. The price level can be viewed as a “markup” over production costs: P = μ UC μ — markup (profit margin) UC — unit cost (cost of producing one unit of output) Or: δ P = δ μ + δ UC
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E202 - Prices 3 DETERMINANTS OF THE MARKUP The markup is positively affected by: • Capacity utilization (Q/ Q ) When capacity utilization is high, shortages may develop allowing firms to raise prices. • Import prices in $ ( P* / E ) If import price rise, firms that compete with imports may be able to raise their prices. To summarize: + + μ = f Q Q , P * E [ ] UNIT COST Unit cost is the cost of the inputs required to produce one unit of output. E XAMPLE : U NIT COST FOR LABOR (UC L ) Let: Q = total output (units per period) L = labor input (hours per period) W = wage rate ($ per hour) Then: UC L = W x L Q = W Q/L Q/L measures output per hour (the productivity of labor). Hence: UC L = W labor productivity
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E202 - Prices 4 DETERMINANTS OF UNIT COST Unit cost is the cost of the inputs required to produce one unit of output. It will depend on: • Input price (for labor, W, the wage rate) (for raw materials, P RM ) Higher input price means higher unit cost. • Input productivity
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prices - E202 - Prices STYLIZED FACTS: Prices and Inflation...

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