Price Inflexibility in Markets with Repeat Purchasing

Abstract

This paper develops an enduring idea: price rigidity occurs because repeat-purchasing customers in retail markets learn their regular firm's price at each purchase but are informed of other firms' prices less frequently. Although potentially having important implications for macroeconomics, previous attempts to formalize this argument in an intertemporal setting have failed to treat firms and customers as forward looking, maximizing agents. In contrast, this paper models the optimal response of firms and customers, both of whom have rational expectations, to a transitory demand shock. A specific set of assumptions sufficient to unambiguously generate relative price rigidity is revealed.