Price Dynamics with Customer Markets

53 Pages Posted: 9 Jan 2017

See all articles by Luigi Paciello

Luigi Paciello

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: January 2017

Abstract

The customer base of a firm is an important and persistent determinant of its performance. Using rich U.S. data on consumer shopping behavior and good prices, we document that customer turnover is sensitive to price variation. Motivated by this finding, we study an economy where the customer base of a firm is persistent because of search frictions preventing customers from freely relocating across suppliers of consumption goods, and firms set prices under customer retention concerns. The key feature of our model is that the elasticity of the customer base to price -the extensive margin elasticity of demand- depends on the customers' endogenous opportunity cost of search, and interacts with heterogeneity in firm productivity. More productive firms enjoy less customer attrition and lower elasticity of demand. An increase in customers' search intensity leads to higher demand elasticity and lower prices. This provides a new channel affecting the relationship between consumer search and price markups in response to aggregate shocks. In particular, an increase in the utility of consumption relatively to the cost of search results in higher demand elasticity and lower prices, amplifying the effects of demand shocks on output. We highlight that the price response to demand shocks is heterogeneous across firms affecting dispersion in prices and consumption across consumers.

Suggested Citation

Paciello, Luigi and Trachter, Nicholas, Price Dynamics with Customer Markets (January 2017). CEPR Discussion Paper No. DP11753, Available at SSRN: https://ssrn.com/abstract=2896043

Luigi Paciello (Contact Author)

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

Via Due Macelli, 73
Rome, 00187
Italy

Nicholas Trachter

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

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

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