Price Dynamics with Customer Markets

53 Pages Posted: 4 Oct 2014

See all articles by Luigi Paciello

Luigi Paciello

Einaudi Institute for Economics and Finance (EIEF)

Andrea Pozzi

Einaudi Institute for Economics and Finance (EIEF)

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Multiple version iconThere are 4 versions of this paper

Date Written: October 1, 2014

Abstract

We study a tractable model of firm price setting with customer markets and empirically evaluate its predictions. Our framework captures the dynamics of customers in response to a change in the price, describes the behavior of optimal prices in the presence of customer acquisition and retention concerns, and delivers a general equilibrium model of price and customer dynamics. We exploit novel micro data on purchases from a panel of households from a large U.S. retailer to quantify the model and compare it to the counterfactual benchmark of the standard monopolistic competition setting. We show that a model with customer markets has markedly different implications in terms of the equilibrium price distribution, which better fit the available empirical evidence on retail prices. Moreover, the dynamic of the response of demand to shocks that affects price dispersion is also distinctive. Our results suggest that inertia in customer reallocation across firms increases the persistence in the response of demand to these shocks.

Keywords: customer markets, price setting, product market frictions

JEL Classification: E30, E12, L16

Suggested Citation

Paciello, Luigi and Pozzi, Andrea and Trachter, Nicholas, Price Dynamics with Customer Markets (October 1, 2014). FRB Richmond Working Paper No. 14-17. Available at SSRN: https://ssrn.com/abstract=2505022 or http://dx.doi.org/10.2139/ssrn.2505022

Luigi Paciello

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Andrea Pozzi

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Nicholas Trachter (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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