Industry and Bus in Japan by Sato Kazuo;

Author:Sato, Kazuo;
Language: eng
Format: epub
Publisher: Taylor & Francis Group

4. Market Behavior (2) – Price Formation

Price Volatility

The essence of industrial organization lies in whether it is capable of determining product prices at a (socially) optimal level or not. When product differentiation is limited, product designs or postpurchase services are not very important to industrial organization. The decisive factor is whether product prices are high or low.

Intense price competition often occurs in the steel industry because product prices can be used as a strategic weapon in market competition. On the other hand, collusive pricing may also predominate because limited product differentiation facilitates agreements on product qualities and prices. In other words, the steel industry sometimes forms very low prices and at other times maintains high quasi-monopoly prices.

There are two factors in the steel industry which make price changes volatile. First of all, demand for steel fluctuates a great deal during business cycles. This is because demand for steel is influenced very much by total investment in the economy. It is something unavoidable in the steel industry. Second, the steel industry is a "fixed cost" industry in which fixed cost is a relatively large proportion of total cost. This requires the steel industry always to maintain a high rate of capacity utilization. Conventional argument puts very strong emphasis on this supply factor of the process industry; some economists go as far as to claim that the market mechanism does not function in such an industry because the industry cannot reduce its capacity use under the burden of fixed cost.

It is true that wages are quasi-fixed in Japan because employment cannot be adjusted by layoffs as in the United States. But fixed cost covering interest payments, depreciation charges, and wages and salaries is above 25% of total cost in the steel industry, a ratio comparable to that in the chemical and paper and pulp industries. The price mechanism is unable to function fully to adjust demand and supply only when the ratio of fixed cost to total cost exceeds 50%, as in transportation and electric power. In the steel industry, the relative importance of fixed cost contributes merely to a greater volatility in price changes than in other industries.

Therefore, it is necessary to note the phase of the business cycle in checking steel prices. In other words, one must view prices through two lenses – one when looking at a boom and the other when looking at a slump. One is likely to misjudge price data if they are viewed through only one lens. One may be told that steel prices are too low in a recession, but this may be only an optical illusion.

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