Shrinking Goods and Sticky Prices: Theory and Evidence

Bar-Ilan University, Department of Economics, Research Paper Series

Emory Law and Economics Research Paper

54 Pages Posted: 16 Mar 2011

See all articles by Avichai Snir

Avichai Snir

Bar Ilan University - Department of Economics

Daniel Levy

Bar-Ilan University - Department of Economics; Emory University - Department of Economics; Rimini Center for Economic Analysis

Date Written: March 13, 2011

Abstract

If producers have more information than consumers about goods’ attributes, then they may use non-price (rather than price) adjustment mechanisms and, consequently, the market may reach a new equilibrium even if prices remain sticky. We study a situation where producers adjust the quantity (per package) rather than the price in response to changes in market conditions. Although consumers should be indifferent between equivalent changes in goods’ prices and quantities, empirical evidence suggests that consumers often respond differently to price changes and equivalent quantity changes. We offer a possible explanation for this puzzle by constructing and empirically testing a model in which consumers incur cognitive costs when processing goods’ price and quantity information. The model is based on evidence from cognitive psychology and explains consumers’ decision whether or not to process goods’ price and quantity information. Our findings explain why producers sometimes adjust goods’ prices and sometimes goods’ quantities. In addition, they predict variability in price adjustment costs over time and across economic conditions.

Keywords: Sticky Prices, Rigid Prices, Cognitive Costs of Attention, Information Processing Cost, Rational Inattention, Price Adjustment, Quantity Adjustment, Downsizing

JEL Classification: D03, D11, D21, D40, E31, L11, L16, M21, M31

Suggested Citation

Snir, Avichai and Levy, Daniel, Shrinking Goods and Sticky Prices: Theory and Evidence (March 13, 2011). Bar-Ilan University, Department of Economics, Research Paper Series; Emory Law and Economics Research Paper . Available at SSRN: https://ssrn.com/abstract=1784464 or http://dx.doi.org/10.2139/ssrn.1784464

Avichai Snir

Bar Ilan University - Department of Economics ( email )

Ramat-Gan, 52900
Israel
+972 3 736 0835 (Phone)
+972 3 535 3180 (Fax)

Daniel Levy (Contact Author)

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 5290002
Israel
+972 3 531-8345 (Phone)
+972 3 738-4034 (Fax)

HOME PAGE: http://econ.biu.ac.il/en/levy

Emory University - Department of Economics ( email )

1602 Fishburne Drive, Suite 306
Rich Building
Atlanta, GA 30322-0001
United States

HOME PAGE: http://economics.emory.edu/home/people/faculty/Levydaniel.html

Rimini Center for Economic Analysis ( email )

Wilfrid Laurier University
75 University Ave W.
Waterloo, Ontario N2L3C5
Canada

HOME PAGE: http://rcea.org/

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