0DUNHWV dqG 3ULFHV
3ULFLQJ %HKDYLRXU rI )LUPV Lq *RRGV 0DUNHW
'RPHVWLF 3ULFHV
It is assumed that firms set prices sluggishly and they especially respond to changes in the
level of capacity utilisation in the following form.
log(3 ) = padj(UCl / UC* ) + ∑ πi log(3-i ) with Σπi = 1.
(18a)
Notice, this rule together with the labour demand equation implies that prices set by firms in
the current period depend on three elements, namely current unit labour costs U∕Ct prices
set in the past and two measures of cyclical conditions, namely the rate of capacity
utilisation and the change in employment. These last two terms represent cyclical
fluctuations of the markup.
log(PW ) = (1 + PDdj)-1 ∑ πi log(PW-i ) + pDdM (UCW + -Q-∆ log( 1W )) + SDGM log(u∕CW )
1+ sdGM 1- qO 1+ sdGM
(18b)
The consumption price deflator 3CW is defined in the following way
__ (↑ _ √'H ʌ C
pci = 3(1 i ) P0,s
(1 +WYDW)
(19)
where WydW is the VAT-rate and the variable 6m measures the share of imports in total
domestic demand. Identical assumptions are made for the investment deflator and the
deflator of government purchases (including government investment). This formulation
implies that aggregate consumption is close to a Cobb-Douglas aggregate of domestic and
foreign goods. We find the price elasticity estimates for imports and exports consistent
with this assumption.
([SRUW 3ULFHV
Depending on market structure and the type of products traded, export prices (in domestic
currency) charged by firms may deviate from prices charged in domestic markets at least
temporarily. This phenomenon has been extensively studied in recent years, both
theoretically as well as empirically (see for example Dornbusch (1987), Dixit etc). To
capture a wide spectrum of theoretical possibilities we specify the following pricing rule for
exports
p;r = 3 (1-p’^:p;6P<«
(20)
where 3;W is the export price deflator and :3;6W is a competitor’s price index expressed in
domestic currencies. The parameter SWP determines to what extent there is pricing to
11
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