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Price Stickiness in Customer Markets with Reference Prices

CIRPEE Working Paper 12-30

32 Pages Posted: 22 Aug 2012  

Nicolas Vincent

HEC Montreal - Institute of Applied Economics

Date Written: August 2012

Abstract

Price rigidity is often modeled by assuming that firms face a fixed cost of price change. However, in surveys, firms report that the main reason they wish to keep prices stable is for fear of antagonizing customers. Moreover, marketing studies show that most consumers engage in very little product comparison on a typical shopping trip. In this paper, we explore the implications of these observations for price rigidity. In our model, comparing prices and characteristics of alternative brands is time-consuming. While some consumers behave as bargain hunters with zero opportunity cost form shopping, most are loyal to firms as long as posted prices are not raised. A price increase is interpreted as a signal that a better alternative may be available and triggers consumer search. Firms do not face menu costs and are free to change nominal prices, but understand that their pricing decisions will affect their customer base and hence future profits. We show that this micro-founded mechanism is akin to a nominal rigidity and naturally generates price stickiness. It is also compatible with the observation of frequent sales at the retail level and can rationalize the decreasing or flat hazard functions observed empirically.

Keywords: Price stickiness, customer relations, nominal rigidities, consumer inattention

JEL Classification: E30, L16

Suggested Citation

Vincent, Nicolas, Price Stickiness in Customer Markets with Reference Prices (August 2012). CIRPEE Working Paper 12-30. Available at SSRN: https://ssrn.com/abstract=2134059 or http://dx.doi.org/10.2139/ssrn.2134059

Nicolas Vincent (Contact Author)

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

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