Working Paper: NBER ID: w1787
Authors: Joshua Aizenman
Abstract: The purpose of this paper is to explain price and output dynamics in an open economy characterized by a monopolistic competitive market structure in which pricing decisions incur costs. That lead producers to pre-set the price path for several periods. The paper derives an optimal pricing rule, including the optimal pre-setting horizon. It does so for a rational expectation equilibrium, characterized by staggered, unsynchronized price setting, for which the degree of staggering is endogenously determined. The discussion focuses on the critical role of the degree of domestic-foreign goods substitutability in explaining price and output effects of monetary and real shocks.
Keywords: monopolistic competition; relative prices; output adjustment; open economy
JEL Codes: F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| degree of substitutability of domestic and foreign goods (F49) | pricing strategy adopted by producers (L11) |
| higher degree of substitutability (L15) | reduced monopoly power of producers (D42) |
| reduced monopoly power of producers (D42) | shorter presetting horizon for prices (G13) |
| shorter presetting horizon for prices (G13) | more flexible pricing equilibrium (D41) |
| lower degree of substitutability (L15) | longer pricing cycle (D49) |
| lower degree of substitutability (L15) | greater price shocks (P22) |
| lower degree of substitutability (L15) | smaller output shocks (F41) |
| unexpected monetary shocks (E39) | persistent aggregate output and relative price shocks (E30) |
| degree of substitutability (L15) | nature of shocks (E32) |
| interplay between price and output adjustment (L11) | trade-off identified (F16) |