Working Paper: NBER ID: w23778
Authors: Erik Eyster; Kristof Madarasz; Pascal Michaillat
Abstract: This paper proposes a theory of price rigidity consistent with survey evidence that firms stabilize prices out of fairness to their consumers. The theory relies on two psychological assumptions. First, customers care about the fairness of prices: fixing the price of a good, consumers enjoy it more at a low markup than at a high markup. Second, customers underinfer marginal costs from prices: when prices rise due to an increase in marginal costs, customers underappreciate the increase in marginal costs and partially misattribute higher prices to higher markups. Firms anticipate customers’ reaction and trim their price increases. Hence, the passthrough of marginal costs into prices falls short of one—prices are somewhat rigid. Embedded in a simple macroeconomic model, our pricing theory produces nonneutral monetary policy, a short-run Phillips curve that involves both past and future inflation rates, a hump-shaped impulse response of output to monetary policy, and a nonvertical long-run Phillips curve.
Keywords: Pricing; Fairness; Price Rigidity; Monetary Policy
JEL Codes: D21; D42; E03; E52; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Customer Fairness Concerns (M38) | Price Rigidity (E31) |
| Underinference of Marginal Costs (D40) | Perceived Markup (D49) |
| Price Increases (P22) | Demand Elasticity (D12) |
| Perceived Markup (D49) | Demand Elasticity (D12) |
| Price Rigidity (E31) | Monetary Policy Nonneutrality (E49) |