The Dynamic Behavior of Prices and Investment: Financial Constraints and Customer Markets
Abstract: Chapter II (with Nils Gottfries and Charlotte Bucht) explores the interaction between prices and investment. We construct a dynamic model of a financially constrained firm making pricing and investment decisions. The firm operates in a market where customers respond slowly to price changes and there are implementation lags in investment (time to build). Our model implies that the markup over marginal cost is counter-cyclical, the product price responds slowly to demand shocks, and quickly to cost shocks, and the price is strongly related to investment.Chapter III presents microeconometric evidence that investment in fixed capital is an important determinant of price adjustment. A price equation including investment, wage and demand factors is estimated using a unique data set for Swedish manufacturing plants. The main result is that investment in capital stock has a significantly positive and quantitatively large effect on the price. Wage costs and competitors prices have a positive impact on the price, but the price responses of changes in demand are small and negative, suggesting that markups are countercyclical.Chapter IV examines the relationship between prices and investment using international aggregate data. A price equation is estimated for the manufacturing sector in thirteen OECD countries. The main result is that investment in real capital is an important determinant of prices in almost all countries. Both labor costs and competitors' prices affect the price, and the relative effect of foreign competitors' price changes is higher for small open economies. Furthermore, the effect of investment on prices appears to be stronger in periods when firms are likely to be financially constrained.Chapter V (with Joakim Jansson) uses between-firm variation in the user cost of capital to provide user cost elasticities for investment in machinery and equipment for Swedish firms. A theoretical model is constructed to investigate the effect of a firm-specific user cost of capital on the firms' investment decision. We find estimates of the user cost of capital elasticity in the range of -0.3 to -0.5, which is in line with previous Swedish studies using more aggregate measures of user cost of capital.
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