Sticky Prices as Coordination Failure: An Experimental Investigation 

Abstract

Coordination failures are thought to be an important factor generating nominal rigidities. We theoretically solve a monopolistically competitive pricing game and show that a range of multiple equilibria emerges when there are price adjustment costs (menu costs). In a laboratory price setting game, we find that without menu costs subjects almost always adjust prices, regardless of the size of the production cost shock. In treatments with menu costs, subjects' behavior is consistent with the pure rigidity and pure flexibility equilibria for small and large cost shocks, respectively. In the zone of production cost shocks where both pure rigidity and pure flexibility are possible equilibria, subjects are unable to coordinate on either. In the range of multiple equilibria, the share of subjects adjusting prices is proportional to the size of the shocks, so there is more coordination on the price flexibility equilibrium when cost shocks are larger.

Keywords: experimental macroeconomics, laboratory experiment, sticky prices, coordination failure, expectations

JEL Classification: C92, D84, E31, E71