Working Paper: NBER ID: w14933
Authors: Julio J. Rotemberg
Abstract: A model is considered where firms internalize the regret costs that consumers experience when they see an unexpected price change. Regret costs are assumed to be increasing in the size of price changes and this can explain why the size of price increases is less sensitive to inflation than in models with fixed costs of changing prices. The latter predict unrealistically large responses of price changes to inflation for firms that do not frequently reduce their prices. Adjustment costs that depend on the size of price changes also raise the variability on the size of price increases. Lastly, it is argued that the common practice of announcing price increases in advance is much easier to rationalize with regret concerns by consumers than with more standard approaches to price rigidity.
Keywords: Dynamic Pricing; Consumer Regret; Price Changes
JEL Codes: D11; E31; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| size of price changes (E30) | level of regret (D81) |
| inflation increases (E31) | larger price changes required (E30) |
| larger price changes required (E30) | greater consumer regret (D11) |
| greater consumer regret (D11) | firms' reluctance to raise prices (D21) |
| frequency of price adjustments (E30) | level of regret (D81) |
| preannouncing price increases (D49) | regret costs (J17) |
| preannouncing price increases (D49) | consumer behavior (D19) |