The Economy: A Complex Formula For Prices

• Share

By specifying weeks ago a goal of getting the inflation rate down to 2% to 3% by the end of next year, President Nixon in effect fixed the Price Commission's post-freeze guideline in advance. For the record, commission members last week announced the target for price increases during the next year at an average of 2½%, or midway between the President's figures. Far more important, they drafted an ingenious plan that ties most Phase II price levels to a company's current health as measured by its productivity and profits. If the U.S. economy expands vigorously in 1972—the year that Nixon has predicted could be "great" for business—and corporate executives zealously observe the spirit of the guideline, some prices could actually go down.

The commission ruled that price hikes in most industries must be limited to increased costs minus any gains in productivity, the amount that a single worker can produce in one hour. Thus in order to raise prices a businessman must be prepared to prove that 1) he faces increased outlays for labor or materials and 2) these rises will not be offset by productivity improvements. Productivity is difficult to measure in many industries, particularly services (TIME, Nov. 15), and the commission has not yet announced how it should be calculated by businessmen seeking price rises. Economists agree, however, that productivity generally rises in a post-recessionary period like the present one, and thus should put a brake on price boosts.

Lessened Leeway. The costs-less-productivity formula is basically the one used by Kennedy and Johnson economists in the mid-'60s to gauge informally which price increases seemed justified. It was eventually criticized by labor leaders for providing too much leeway for businessmen to realize high profits. To overcome that objection in the current plan, the Price Commission added another stipulation: no firm will be able to increase its basic profit per unit of production by raising prices. Businessmen are encouraged to raise total profits by increasing sales, and they are also allowed to increase their per-unit profits as long as they do not raise prices —by realizing new efficiencies, for example. But if a company's earnings as a percentage of sales begin edging up, no price boosts will be allowed.

One intent of these rules is to encourage businesses with relatively stable costs, rising productivity and expanding profit margins into cutting prices and increasing sales. The commission, however, can order price cuts only in unusual circumstances, chiefly when it finds that a company has raised prices unjustifiably. The first reaction of many businessmen to the complex formula was to order their accounting departments to calculate recent profit margins—frequently as the first step toward asking for price increases.