Pricing When Customers Care About Fairness But Misinfer Markups

75 Pages Posted: 11 Sep 2017 Last revised: 27 Dec 2017

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: September 2017

Abstract

This paper proposes a theory of price rigidity consistent with survey evidence that firms stabilize prices out of fairness to their consumers. The theory relies on two psychological assumptions. First, customers care about the fairness of prices: fixing the price of a good, consumers enjoy it more at a low markup than at a high markup. Second, customers underinfer marginal costs from prices: when prices rise due to an increase in marginal costs, customers underappreciate the increase in marginal costs and partially misattribute higher prices to higher markups. Firms anticipate customers’ reaction and trim their price increases. Hence, the passthrough of marginal costs into prices falls short of one—prices are somewhat rigid. Embedded in a simple macroeconomic model, our pricing theory produces nonneutral monetary policy, a short-run Phillips curve that involves both past and future inflation rates, a hump-shaped impulse response of output to monetary policy, and a nonvertical long-run Phillips curve.

Suggested Citation

Eyster, Erik and Madarasz, Kristof and Michaillat, Pascal, Pricing When Customers Care About Fairness But Misinfer Markups (September 2017). NBER Working Paper No. w23778, Available at SSRN: https://ssrn.com/abstract=3035129

Erik Eyster (Contact Author)

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

Brown University - Department of Economics ( email )

64 Waterman Street
Providence, RI 02912
United States

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

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