Regulatory change and the pricing behaviour of firms

Abstract

The empirical literature examining the effect of economic reform in New Zealand since 1984 does not yet include a quantitative analysis of the implications for pricing behaviour. This thesis addresses this issue by specifying an empirical model of firm pricing behaviour which explicitly incorporates a role for regulatory reform. The model specified has three characteristics. Costs of price adjustment create a zone of price inaction, within which it is no longer optimal for the firm to adjust its price. Secondly the model contains source asymmetries; the response of price to cost and demand shocks can differ. The third feature is the possibility of directional asymmetries; the response of price to positive may differ to that for negative shocks. This model is estimated using firm-level data from the New Zealand Institute of Economic Research's (NZIER) Quarterly Survey of Business Opinion (QSBO). Price is estimated as a function of directional cost, demand and business outlook shocks, and inflation, using an Ordered probit procedure. To identify the effect of regulation throughout the period 1963:3 to 1996:1 the model is estimated for five regulatory regimes, which differ in the extent of government control prevailing. The effect of specific industry reform during the last regulatory regime (1984:3 to 1996:1) is also incorporated by including interactive dummy variables which coincide with important reform in each industry. From the estimated model three key results can be identified. Firstly, there is evidence that the zone of inaction narrows with the removal of regulation. Secondly, the effect of industry reform on the sensitivity of price to a cost increase varies across industries. Finally, the sensitivity of price to positive shocks relative to negative shocks has fallen during the last regulatory regime. The pricing behaviour observed in Some industries however differs from these general conclusions. This suggests that industry specific features need to be incorporated to better account for changes in pricing at the industry level.