In the late 1970s and early 1980s, small business owners were playing catchup to the surge in inflation that occurred. They appear to have been reacting to inflation as it occurred by raising selling prices. They apparently learned their lesson and started paying more attention to inflation in their management decisions to set prices. After Federal Reserve Chairman Volcker’s term, owners incorporated their assessments of the path of inflation into their pricing decisions. Chart 1 shows the relationship between plans to raise prices in a quarter to the percent of firms in the next quarter reporting that they actually raised prices as planned[1]. The percent planning to raise prices by 5% or more clearly accelerates the percentage that actually raises prices a quarter later.
Small Business Economic Trends survey
What prompts owners to decide to raise prices? One likely factor is their personal experience with inflation and inflation they see on the input side of their businesses as well as competitor behavior. The relationship between plans to raise selling prices and actual inflation in the prior few months is (statistically) strong.
Compared to the 1980s, owners are raising prices well ahead of the current inflation experience (Chart 2)[2]. In the late 1970s-early 1980s, owners raising prices matched well the degree of inflation they experienced in prior quarters (double digit!). However, in this inflation episode, owners appear to be raising prices significantly more in response to the inflation they experience, as predicted levels of price raising are lower than what would be expected based on historical inflation data.
Past Inflation & Plans to Raise Prices
Other factors such as changes in labor costs, profits and sales could influence the decision to raise prices. Data on compensation increases were not collected until 1984. Regressing planned price increases on past inflation, lagged profit trends, and compensation changes produced positive, but insignificant coefficients on profit trends and compensation. Past inflation was the only significant and dominant predictor. Rising prices presents an opportunity to raise selling prices, but it also brings rising operating costs, an encouragement to raise prices and protect profits.
Small firms are on the front line of the economy, being the ultimate distributors of our output (GDP) to consumers. Lacking the market power enjoyed by large firms with few competitors, they raise prices only when costs force them to do so. Competition keeps prices under control. Regulations, taxes, and wages are cost factors that small firms must respond to, and raising prices is their defense mechanism. Their plans to raise prices reflect changes in cost factors common to them all.
[1] “Quarterly” surveys are conducted in the first month of each quarter. Thus, for example, the percent of owners planning to raise prices in January will produce a report of selling price changes in April, 3-4 months later when respondents are asked if they actually raised prices in the preceding 3 months. Raised = -6.03 + .77* %Plan lag +2.26* %Plan>5%lag, R2=77%
[2] A regression of the percent planning to raise prices on average inflation in the prior 2 quarters: %Planning=17.89 + 2.18* Past Inflation, R2= 51%, data are percentages.
