Preferences for Fair Prices, Cursed Inferences, and the Nonneutrality of Money

50 Pages Posted: 31 Jan 2015 Last revised: 26 Feb 2015

See all articles by Erik Eyster

Erik Eyster

London School of Economics & Political Science (LSE) - Department of Economics

Kristof Madarasz

London School of Economics & Political Science (LSE)

Pascal Michaillat

Brown University - Department of Economics

Date Written: February 2, 2015

Abstract

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

Eyster, Erik and Madarasz, Kristof and Michaillat, Pascal, Preferences for Fair Prices, Cursed Inferences, and the Nonneutrality of Money (February 2, 2015). Available at SSRN: https://ssrn.com/abstract=2557785 or http://dx.doi.org/10.2139/ssrn.2557785

Erik Eyster

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Kristof Madarasz

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Pascal Michaillat (Contact Author)

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

HOME PAGE: http://www.pascalmichaillat.org

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