SEMINAR 21 November 2011: Marcus Asplund, Royal Institute of Technology, CEPR

Abstract

Do firms set profit maximizing prices? An affirmative answer implies

that firms both aims at, and are able to, set prices to maximize profits.

Despite the question’s importance it is difficult to devise an empirical

test since it requires not only knowledge about firms’ costs and demand

conditions but also the nature of the strategic interaction in markets.

This paper sidesteps the problem of strategic interaction by providing

a detailed case study of a monopolist’s pricing decisions. The idea is

to examine pricing behaviour of a monopolist facing a dynamic demand

where current sales influence future demand. Empirically, I estimate an

Euler equation implied by profit maximization on data from the Swedish

Tobacco Monopoly’s sales of moist snuff (an addictive tobacco product)

over the period 1917-1959. It is found that the monopolist’s prices are

well below those that would maximize the expected net present value of

profits. I discuss the extent to which the evidence from STM is consistent

with implications from the maximization of some alternative objective

functions.