Pricing Options

The pricing device chosen by a firm would largely be determined by the type of profit margin and allowable cost control being exercised by the Price Commission, and by the new demand curve that the firm faced. The ultimate choices are displayed below:

Column 1 (the starting point) and column 2 (the effect on profits of the demand shift by itself) are pesented only for the purposes of developing the analysis. Column 3 would be prohibited by the profit margin constraint, whether rigid or easy. This column represents the profit maximizing device used under "normal" or non-price stabilization circumstances. Column 5 is always available, but the profit yielded by it would never be greater than that in Column 7, which is also always available.

The choice of Column 4, which can be made only with all cost increases being allowable, will depend on the efficiency of the schedule of cost additions facing the firm. For the purpose of portrayal, the arbitrary assumption is that any firm could add costs with an average return (efficiency) of 37.5% and that no firm could add sufficient costs and produce an average return above 75%. (The actual limits, Table II, are 33% and 76%, respectively.)

Under rigid margin control and easy cost control, a firm is likely to choose the column 4 device since column 6 (which permits a firm to exceed its margin providing it has taken no price increases) is not available. The purposes of price stabilization are served better by the choice of column 6, however, since a lower price is obtained.

The choice between column 6 and column 7 would depend on the magnitude of the price increase versus that of the volume increase or, in other words, on the slope of the new demand curve.

The choice of column 7 is always available and is mandated with the imposition of both rigid margin and rigid allowable cost constraints.

The calculations for the determination of a firm's choice of pricing devices are shown in Table II. Firms A, B, and C face different demand shifts and, therefore, different costs and profits, as computed for Table I. The required efficiency from added costs would be the amount of profits sacrificed, column 4 versus column 6 or 7, divided by the amount of costs that must be added to hold the firm at its BPPM (10%). Firm A may well choose the column 6 device since the profits (3.6) it would sacrifice amount to 82% (.82) of the costs (4.4) it could add in column four. However, if the profit margin constraint were rigid, thus obviating column 6, the firm might well choose column 4, since the profits it then sacrifices (1.0) by not choosing column 7 would amount to only 23% (.23) of the added costs (4.4). If both profit margin and allowable cost constraints were rigid, the firm would have no choice but the column 7 device, assuming it desired to maximize its profits.

* Pricing device (column) refers to Table I.

Factors Affecting Choices

The "Price (Column) Choice under Control Devices" assumes that a firm will not add costs when the efficiency demanded is more than 75%, but will always add costs when the efficiency demanded is less than 37.5%. Between 37.5% and 75%, the firm may well look to other factors such as:

1) Will the price stabilization program be of short duration (if so, choose added "costs").

2) Is there a fear of increased competition in the industry (if so, choose to lower prices as with columns 6 or 7).

3) Uncertainties (always present) with respect to the actual nature of the demand curve and with the prospective payout on added costs will tend to minimize the changes that a firm is willing to make.

Table II: Choice Between Adding "Costs" and Maximizing
Profits Under Control Devices

Results of Analysis

There are at least three different pricing options that a firm may choose under Price Commission profit margin and allowable cost constraints:

1) Raise "costs" and maintain the base period profit margin (BPPM);

2) Forego a price increase, expand volume, and exceed the BPPM;

3) Maximize profits, expand volume, while maintaining the BPPM.

The choice of pricing option by the firm will be heavily governed by the type of margin and allowable cost constraints (particularly the latter) imposed by the Price Commission.

This study concludes that (1) a rigid profit margin test in the absence of a rigid allowable cost test is the most inflationary type of control, (2) holding neither test rigid is the second most inflationary, (3) an easy margin test is third, and (4) both tests rigid is the least inflationary.

WAGE

STABILIZATION

POLICIES

Phase II Wage Stabilization
Policies and Concepts

By: Thomas R. Goin

Assisted by: Jon Hayman

Phases III-IV Wage Stabilization Policies

By: Richard Mullins

Throughout the Economic Stabilization Program, wage controls were administered separately from price controls. The first paper in this group describes the concepts governing wage stabilization during the life of the Program, specifically discussing the operations of the Phase II wage stabilization effort. The following paper, dealing with Phase III and IV wage stabilization, presents a view of the contrasting philosophy and style of wage stabilization policies that followed Phase II.

Mr. Goin was associated with the Economic Stabilization Program in Phases I and II, primarily as a Policy Analyst at the Pay Board. A 1971 honors graduate of Brown University with a B.A. in political science, Mr. Goin is currently a student at the School of Law, University of California at Davis.

Mr. Hayman worked as Program Analyst at the Pay Board during Phase II. A 1972 graduate in economics from the University of California at Berkley, Mr. Hayman is currently a second-year student at Santa Clara University School of Law.

Mr. Mullins served as a Pay Stabilization Analyst in the Office of Wage Stabilization, Cost of Living Council. Prior to working at the Council, he was associated with the Brookings Institution. He holds a B.A. in economics from Oberlin College and has done graduate work at the University of Maryland.