The Impact of Inflation and Uncertainty on the Optimum Markup Set by Firms *

This paper argues that non-colluding price setting firms in an uncertain economic environment will set a ‘low’ markup relative to the profit maximising markup if; (a) they are uncertain of the profit maximising markup; and (b) the cost to firms of mistakenly setting a ‘high’ markup is greater than if they mistakenly set a ‘low’ markup. Furthermore, firms will set a lower markup the higher is the level of uncertainty. It follows, therefore, that if uncertainty increases with inflation then firms will choose a lower markup the higher is inflation.