Preferences for Fair Prices, Cursed Inferences, and the Nonneutrality of Money
50 Pages Posted: 31 Jan 2015 Last revised: 26 Feb 2015
Date Written: February 2, 2015
This paper explains the nonneutrality of money from two assumptions: (1) consumers dislike paying prices that exceed some fair markup on firms’ marginal costs; and (2) consumers underinfer marginal costs from available information. After an increase in money supply, consumers underappreciate the increase in nominal marginal costs and hence partially misattribute higher prices to higher markups; they perceive transactions as less fair, which increases the price elasticity of their demand for goods; firms respond by reducing markups; in equilibrium, output increases. By raising perceived markups, increased money supply inflicts a psychological cost on consumers that can offset the benefit of increased output.
Keywords: nonneutrality of money, fairness, cursedness, markups
JEL Classification: E03, E10, E40
Suggested Citation: Suggested Citation