Competition and Price Adjustment in the Euro Area

TLDR: In this paper, the authors explored the role of a number of factors in explaining the heterogeneity in the degree of price stickiness across industries, on the basis of the information provided by surveys on pricing behavior conducted in nine euro area countries.

Abstract: This paper explores the role of a number of factors in explaining the heterogeneity in the degree of price stickiness across industries, on the basis of the information provided by surveys on pricing behavior conducted in nine euro area countries. The main focus is placed on the influence of competition on the degree of price flexibility. Our results suggest that the price setting strategies of the most competitive firms give them a greater capacity to react to shocks and make, in practice, for greater flexibility in their prices. The direct influence of market competition on price flexibility is corroborated by a cross-country cross-industry econometric analysis based on the information provided by surveys. This analysis also shows that the cost structure and demand conditions help to explain the degree of price flexibility. Finally, it suggests that countries in which product market regulation is more relevant are characterized by less price flexibility.

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COMPETITION AND PRICE
ADJUSTMENT IN THE EURO AREA
Documentos de Trabajo
N.º 0629
Luis J. Álvarez and Ignacio Hernando
2006

COMPETITION AND PRICE ADJUSTMENT IN THE EURO AREA

COMPETITION AND PRICE ADJUSTMENT IN THE
EURO AREA (*)
Luis J. Álvarez and Ignacio Hernando (**)
BANCO DE ESPAÑA
(*) This paper will be published in an Oxford University Press book entitled
Pricing Decisions in the Euro Area: How
Firms Set Prices and Why, edited by Silvia Fabiani, Claire Loupias, Fernando Martins, and Roberto Sabbatini
.
We are
grateful to all members of the Eurosystem Inflation Persistence Network (IPN) and, particularly, Luc Aucremanne, Jose
f
Baumgartner, Martine Druant, Silvia Fabiani, Angela Gattulli, Marco Hoeberichts, Claudia Kwapil, Bettina Landau, Claire
Loupias, Patrick Lünnemann, Fernando Martins, Thomas Mathä, Pedro Neves, Roland Ricart, Roberto Sabbatini,
Johann Scharler, Harald Stahl and Ad Stokman for helpful discussions and for providing industry data from their national
surveys. We also acknowledge comments from Juan Peñalosa. The views expressed in this paper are those of the
authors and do not necessarily reflect the views of the Banco de España.
(**) E-mail: Luis J. Álvarez (ljalv@bde.es). Ignacio Hernando (hernando@bde.es).
Documentos de Trabajo. N.º 0629
2006

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© BANCO DE ESPAÑA, Madrid, 2006
ISSN: 0213-2710 (print)
ISSN: 1579-8666 (on line)
Depósito legal: M. 45470-2006
Imprenta del Banco de España

Abstract
This paper explores the role of a number of factors in explaining the heterogeneity in the
degree of price stickiness across industries, on the basis of the information provided by
surveys on pricing behavior conducted in nine euro area countries. The main focus is
placed on the influence of competition on the degree of price flexibility. Our results
suggest that the price setting strategies of the most competitive firms give them a
greater capacity to react to shocks and make, in practice, for greater flexibility in their
prices. The direct influence of market competition on price flexibility is corroborated by a
cross-country cross-industry econometric analysis based on the information provided
by surveys. This analysis also shows that the cost structure and demand conditions
help to explain the degree of price flexibility. Finally, it suggests that countries in which
product market regulation is more relevant are characterized by less price flexibility.
Keywords: price setting, competition, survey data.
JEL Codes: D40, E31.

Frequently asked questions

Q1. What are the distinguishing features of this study?

The distinguishing features of their study are the consideration of the whole euro area, the use of survey data and the inclusion of services sectors, which are generally neglected in this type of analysis. 

Q2. What is the rationale for this choice?

The rationale for this choice is that it can be expected that the more competitive is the environment faced by a firm, the more its pricing strategy is likely to be affected by the behavior of its competitors. 

Q3. What is the likely reason for the low price flexibility?

According to the results from country specific studies (see, for instance, Álvarez and Hernando (2005), this result is most likely driven by the high stickiness of pricing policies of transport firms. 

Q4. How many times per year do firms review prices?

the share of companies reviewing prices at most three times per year is 68% (45%) for firms reporting that competitors’ prices are unimportant (very important) on their pricing decisions. 

Q5. How many times per year do firms review their prices?

For the euro area as a whole, the fraction of firms reporting that competitors’ prices are unimportant (very important) and reviewing prices at least twelve times per year is 23% (34%).