Pricing function

The price setting function (English: price setting relation ) is a model that represents the relationship between the price level and the nominal wage with the profit mark-up of the company in economics . This price level results from the companies' pricing behavior and corresponds to the nominal wage multiplied by the factor 1 plus the profit markup.

general definition

The price setting function is based on the assumption that the overall economic price level is above the wage rate due to market power on the part of companies. Market power is expressed in the profit premium and is dependent on perfect competition.

Derivation of the function

The prices of goods in an economy depend on the costs that are required to produce them. For the sake of simplicity, the assumption is made that companies only consider the production factor labor for the production of goods. The production function is then:

${\displaystyle \ Y=AN}$

with = production = labor productivity = employment
${\displaystyle Y}$
${\displaystyle A}$
${\displaystyle N}$

For the sake of simplicity, it should also be assumed that labor productivity remains constant. This results in:

${\displaystyle \ Y=N}$

It can be seen from this that an employee produces exactly one production unit. As a result, the cost of an additional unit of production corresponds precisely to the cost of an additional employee. This corresponds to:

${\displaystyle \ Y=W}$

With

${\displaystyle W}$ = Nominal wage

If there were perfect competition in the goods markets, then the profit premium would be zero due to the competitive situation and the price would correspond to the wage (P = W).

As a rule, however, competition is imperfect and companies take into account their market power in setting prices and charge a price that is above marginal costs. The pricing function results from this pricing behavior of the companies:

${\displaystyle \ P=(1+\mu )W}$

With

${\displaystyle P}$= Price level = nominal wage µ = profit premium
${\displaystyle W}$

Entrepreneurial profit markup and natural unemployment rate, with the pricing function

If the pricing function is divided by the nominal wage, the result is:

${\displaystyle {\frac {P}{W}}=1+\mu }$

The reciprocal value of this function gives the real wage, which is implied by the price-setting behavior.

The more imperfect the competition, the greater the profit premium µ.

If companies increase the profit markup more than wages, the ratio of wages to prices decreases, which corresponds to a decrease in real wages.

The price setting function is shown graphically in the figure as a horizontal straight line.

Effects

In the present model, companies can pass on higher wages entirely to prices and thereby prevent real wages from increasing.

criticism

The production function derived above neglects the factors capital and technical progress , which are still taken into account in the original model by Jerger and Landmann.

Application example

Let us take the increase in electricity prices as an example.

Four energy groups ( E.ON AG , Vattenfall Europe AG , RWE AG and EnBW ) have a strong market position in Germany on the gas and electricity market thanks to the regional division of the Federal Republic of Germany. Because of this imperfect competitive market, the four corporations can enforce larger profit premiums through their market power. The greater the profit premium, with the nominal wage of all employees in the Federal Republic remaining the same, the lower the real wage (W / P). Since electricity accounts for a relatively large part of the cost of living and nominal wages remain the same, real wages fall.

Individual evidence

1. ↑ Cf. Blanchard, O. / Illing.G .: Makroökonomie, 2004, ISBN 3-8273-7051-5 , p. 206.
2. ↑ Cf. Blanchard, O. / Illing.G .: Macroeconomics, 2004, ISBN 3-8273-7051-5 , p. 192.
3. ↑ Cf. Blanchard, O. / Illing.G .: Macroeconomics, 2004, ISBN 3-8273-7051-5 , p. 193ff.
4. ↑ Eckhard Hein: The NAIRU - a post-Keynesian interpretation. In: INTERVENTION, Volume 1 (2004), Issue 1. PDF ( Memento of the original from November 20, 2008 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice. 
5. ↑ Jerger / Landmann: Level of wages, demand for goods and employment (PDF; 66 kB)

literature

• Oliver Blanchard, Gerhard Illing: Macroeconomics , 3rd edition, Munich 2004, ISBN 3-8273-7051-5 .