Many firms have operations in multiple geographic locations. Data from the U.S. Census Bureau show that such geographically dispersed firms account for 70 percent of sales and payroll. Similarly, firms operating across multiple states make up 68 percent of total employment.
From a public policy perspective, it would be useful to know how such “national” firms respond to changes in local conditions. The two local conditions that economists care about the most concern demand and cost. Regarding demand, we want to know how the price charged by national firms will change when the demand for a product goes up or down in a specific setting or locally. Similarly, with regard to cost, suppose the excise tax a firm pays changes in a particular locality. How will the national firm respond?
Textbook analyses of such questions are unhelpful because these analyses typically focus on single firms and not on national firms. In addition, these analyses tell us that firms set local prices optimally which means that they are chosen to maximize profits. Finally, when local demand or cost changes, the textbook analysis indicates that the price charged by the firm will also change.
This textbook story about supposedly changing prices has been soundly refuted by Stefano DellaVigna and Matthew Gentzkow. These economists showed that within a retail chain, retail prices tend to be uniform in the sense that there is very little change in price when one or more demand conditions change. This finding has the following startling implication: A local demand change or adverse shock has a very small impact on local prices relative to a national change or adverse shock of the same size. However, there is still a spillover impact in the sense that the retail chain will raise the price not only in the store or stores directly affected by the adverse shock but also in faraway stores that have experienced no adverse shock.
Why do local prices not change in response to changes in local demand? We do not have a good answer to this question and thus we have what can be called a “uniform pricing puzzle.” Is the story the same for cost changes? In other words, is it the case that when the cost experienced by a local firm changespotentially when the excise tax it pays changeswe will again see little change in the local price and hence another “uniform pricing puzzle?”
This question has recently been studied by Andrew Butters, Daniel Sacks, and Boyoung Seo. These economists examine how national grocery, mass merchandise, and drug chains respond to local cost shocks stemming from local excise tax changes. Their analysis demonstrates that unlike the case of demand, there is now no uniform pricing in local stores. Specifically, when an excise tax increases, i.e., when an adverse cost shock hits a local store, the relevant national chain changes only the local price and there is no spillover effect. Put differently, following an excise tax increase, there is no corresponding price increase in stores that are unaffected by the excise tax increase.
So, at least as far as cost changes are concerned, the empirical evidence tends to support the textbook model of pricing. Even so, the central puzzle confronting us is this: Why do stores that are part of a national chain behave one way for local demand changes but another way for local cost changes? In other words, why do we see asymmetric responses by stores when local demand and cost conditions change? While there are conjectures about why we see this asymmetry, there are no persuasive answers. This dichotomy needs to be researched carefully because it has important ramifications for tax policy. Specifically, it indicates that the statutory incidence of taxes may influence their economic incidence, and this is likely to shape how useful different tax policies are in altering consumer behavior.
Amit Batabyal is the Arthur J. Gosnell professor of economics and the interim head of the Department of Sustainability, both at Rochester Institute of Technology, but these views are his own.
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