Price Formation in an Open Economy: Theory and Evidence for the United Kingdom, 1951-1991

Abstract

Price formation is an increasingly important part of modern macroeconomics. However, the empirical literature on price‐setting is diverse and confused. This paper uses cointegration techniques to test theories of price‐setting on UK aggregate data for 1951–91. We find: (i) domestic prices are determined by both domestic costs and world prices and (ii) at the macroeconomic level, prices are related to marginal cost rather than average or normal cost.

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