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

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 agg