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This paper is an exploratory study that aims to conceptualize the inflation dynamic from the perspective of price setting by firms with market power. We start by reconsidering principles of price setting by firms with market power, drawing on long-standing literatures of imperfect competition, administered prices and institutional economics as well as quarterly earnings calls, where firms present quarterly financial results to investors. This follows other recent examples that have established firms’ earnings call transcripts as a valuable source to study the current inflation (Dayen and Mabud, 2022, Mabud, 2022a, b, Owens, 2022a, b).3 We argue that firms with market power typically refrain from lowering prices and raise prices only if they expect other firms to do the same. Besides a formal cartel and norms of price leadership, there can be implicit agreements that coordinate price hikes. Sector-wide cost increases can generate such an implicit agreement: since all firms want to protect their profit margins and know that the other firms pursue the same goal they can increase prices, relying on other firms following suit. If firms deviate from this price hike strategy, the threat of share sell-offs by financial investors can enforce compliance with such implicit agreements. Bottlenecks can create temporary monopoly power which can even render it safe to hike prices not only to protect but to increase profits.
This implies that market power is not constant but can change dynamically in a changing supply environment. Publicly reported supply chain bottlenecks and cost shocks can also serve to create legitimacy for price hikes and create acceptance on the part of consumers to pay higher prices, thus rendering demand less elastic. Meanwhile cash transfers have enabled some groups of consumers to accommodate higher prices that they could not otherwise have paid. Absent such a temporary monopoly or implicit agreement, firms must lower costs to increase profit margins – which is what happened in the decades before the pandemic.
We conceptualize this inflation as what Lerner (1958) called a ‘seller-induced inflation’ driven by the pricing decisions of firms. Lerner observed: ‘There is... no essential asymmetry between the wage element and the profit element in the price asked for the product.’ A sellers’ inflation can just as well be set off by firms trying to protect or increase their profits as by rising wages. Whether profits or wages are the main driver of inflation depends on power relations in the economy.
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