TY - JOUR

T1 - The (Q,S,s) pricing rule

AU - Burdett, Kenneth

AU - Menzio, Guido

N1 - Publisher Copyright:
© The Author 2017. Published by Oxford University Press on behalf of The Review of Economic Studies Limited.

PY - 2018/4/1

Y1 - 2018/4/1

N2 - We introduce menu costs in the search-theoretic model of imperfect competition of Burdett and Judd. When menu costs are not too large, the equilibrium is such that sellers follow a (Q,S,s) pricing rule. According to the rule, a seller lets inflation erode the real value of its nominal price until it reaches some point s. Then, the seller pays the menu cost and resets the real value of its nominal price to a point randomly drawn from a distribution with support [S,Q], where s<S<Q. A (Q,S,s) equilibrium differs with respect to a standard (S,s) equilibrium: (1) in a (Q,S,s) equilibrium, sellers sometimes keep their nominal price constant to avoid paying the menu cost, other times because they are indifferent to changes in the real value of their price. An exploratory calibration reveals that menu costs account less than half of the observed duration of nominal prices. (2) in a (Q,S,s) equilibrium, higher inflation leads to higher real prices, as sellers pass onto buyers the cost of more frequent price adjustments, and to lower welfare.

AB - We introduce menu costs in the search-theoretic model of imperfect competition of Burdett and Judd. When menu costs are not too large, the equilibrium is such that sellers follow a (Q,S,s) pricing rule. According to the rule, a seller lets inflation erode the real value of its nominal price until it reaches some point s. Then, the seller pays the menu cost and resets the real value of its nominal price to a point randomly drawn from a distribution with support [S,Q], where s<S<Q. A (Q,S,s) equilibrium differs with respect to a standard (S,s) equilibrium: (1) in a (Q,S,s) equilibrium, sellers sometimes keep their nominal price constant to avoid paying the menu cost, other times because they are indifferent to changes in the real value of their price. An exploratory calibration reveals that menu costs account less than half of the observed duration of nominal prices. (2) in a (Q,S,s) equilibrium, higher inflation leads to higher real prices, as sellers pass onto buyers the cost of more frequent price adjustments, and to lower welfare.

KW - Menu costs

KW - Search frictions

KW - Sticky prices

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U2 - 10.1093/restud/rdx048

DO - 10.1093/restud/rdx048

M3 - Article

AN - SCOPUS:85043230938

VL - 85

SP - 892

EP - 928

JO - Review of Economic Studies

JF - Review of Economic Studies

SN - 0034-6527

IS - 2

ER -