SORCE Insights: The Relationship between Costs and Prices

Introduction

Researchers at the Federal Reserve Bank of Cleveland regularly survey business contacts about recent and expected near-term changes in their firms' costs and prices as part of the Survey of Regional Conditions and Expectations (SORCE). Since 2021, periodic special questions added to the SORCE have extended the outlook horizon to 12 months and provided more detail about factors affecting firms' pricing decisions. Recent District Data Briefs have explored how firms have navigated tariff-related uncertainty and responded to rising costs. We continue in this vein by analyzing the specific relationship between firms' expected changes in costs and prices.

Firm Pricing Is about More than Costs

One way economists attempt to better understand inflation is to study how firms set prices. Researchers at the Cleveland, Atlanta, and New York Feds previously looked at firms' price-setting behavior (Dogra et al., 2023), and here we update some of those results among our SORCE respondents based on questions asked during January 2026.

Basic economic theory would generally suggest that a profit-maximizing firm that faces an increase in input costs would, in turn, raise its selling prices. However, Fourth District SORCE respondents indicate that some other factors are at least as important as costs when setting prices and that firms may not necessarily pass 100 percent of their cost increases through to selling prices.

Figure 1 shows the average level of importance placed on different factors when firms make decisions about setting prices-a value of 1 indicates low importance, and a value of 5 indicates high importance. Among these factors, the strength of demand was assigned the highest average level of importance (4.3 out of a possible 5). Competitors' prices (3.8) were also an important consideration. Lower on the list were factors reflecting input costs, namely, wages and labor costs (3.6) and nonlabor costs (3.5). Still, maintaining steady profit margins-which are inherently impacted by input costs-was assigned an average importance of 3.9.