Working Paper: NBER ID: w19094
Authors: Kenneth Burdett; Guido Menzio
Abstract: We study the effect of menu costs on the pricing behavior of sellers and on the cross-sectional distribution of prices in the search-theoretic model of imperfect competition of Burdett and Judd (1983). We find that, when menu costs are small, the equilibrium is such that sellers follow a (Q,S,s) pricing rule. According to a (Q,S,s) 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 changes its nominal price so that the real value of the new price is randomly drawn from a distribution with support [S,Q], where Q is the buyer's reservation price and S is some price between s and Q. Only when the menu cost is relatively large, the equilibrium is such that sellers follow a standard (S,s) pricing rule. We argue that whether sellers follow a (Q,S,s) or an (S,s) rule matters for the estimation of menu costs and seller-specific shocks.
Keywords: No keywords provided
JEL Codes: D11; D21; D43; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| small menu costs (D24) | QSS pricing rule (D49) |
| QSS pricing rule (D49) | inflation erodes real value of nominal prices (E31) |
| inflation erodes real value of nominal prices (E31) | threshold ('s') is reached (Y60) |
| threshold ('s') is reached (Y60) | sellers incur a menu cost to change nominal price (D40) |
| large menu costs (L11) | SS pricing rule (L11) |
| QSS pricing rule (D49) | understanding seller-specific shocks (D89) |