Logit Price Dynamics
51 Pages Posted: 16 Jul 2014
Date Written: June 5, 2014
We model retail price stickiness as the result of errors due to costly decision-making. Under our assumed cost function for the precision of choice, the timing of price adjustments and the prices firms set are both logit random variables. Errors in the prices firms set help explain micro "puzzles" relating to the sizes of price changes, the behavior of adjustment hazards, and the variability of prices and costs. Errors in adjustment timing increase the real effects of monetary shocks, by reducing the "selection effect". Allowing for both types of errors also helps explain how trend inflation affects price adjustment.
Keywords: nominal rigidity, logit equilibrium, state-dependent pricing, near rationality, information-constrained pricing
JEL Classification: E31, D81, C73
Suggested Citation: Suggested Citation