Asymmetric Price Adjustment in the Small: An Implication of Rational Inattention

T.C. Koopmans Research Institute Working Paper; Bar-Ilan University Economics Working Paper; Emory University Economics Working Paper

53 Pages Posted: 13 Jul 2004

See all articles by Daniel Levy

Daniel Levy

Bar-Ilan University - Department of Economics; Emory University - Department of Economics; Rimini Center for Economic Analysis

Haipeng (Allan) Chen

University of Kentucky - Gatton College of Business and Economics

Sourav Ray

McMaster University - DeGroote School of Business

Mark E. Bergen

University of Minnesota - Carlson School of Management

Date Written: May 11, 2005

Abstract

Analyzing scanner price data that cover 27 product categories over an eight-year period from a large Mid-western supermarket chain, we uncover a surprising regularity in the data - small price increases occur more frequently than small price decreases. We find that this asymmetry holds for price changes of up to about 10 cents, on average. The asymmetry disappears for larger price changes. We document this finding for the entire data set, as well as for individual product categories. Further, we find that the asymmetry holds even after excluding from the data the observations pertaining to inflationary periods, and after allowing for various lengths of lagged price adjustment. The findings are insensitive also to the measure of price level used to measure inflation (the PPI or the CPI). To explain these findings, we extend the implications of the literature on rational inattention to individual price dynamics. Specifically, we argue that p rocessing and reacting to price change information is a costly activity. An important implication of rational inattention is that consumers may rationally choose to ignore - and thus not to respond to - small price changes, creating a "range of inattention" along the demand curve. This range of consumer inattention, we argue, gives the retailers incentive for asymmetric price adjustment "in the small." These incentives, however, disappear for large price changes, because large price changes are processed by consumers and therefore trigger their response. Thus, no asymmetry is observed "in the large." An additional implication of rational inattention is that the extent of the asymmetry found "in the small" might vary over the business cycle: it might diminish during recessions and strengthen during expansions. We find that the data are indeed consistent with these predictions. An added contribution of the paper is that our theory may offer a possible explanation for the presence of small price changes, which has been a long-standing puzzle in the literature.

Keywords: Asymmetric Price Adjustment, rational inattention, cost and benefit of information acquiring and processing, price rigidity

JEL Classification: E31, D11, D21, D80, L11, M31

Suggested Citation

Levy, Daniel and Chen, Haipeng (Allan) and Ray, Sourav and Bergen, Mark E., Asymmetric Price Adjustment in the Small: An Implication of Rational Inattention (May 11, 2005). T.C. Koopmans Research Institute Working Paper; Bar-Ilan University Economics Working Paper; Emory University Economics Working Paper. Available at SSRN: https://ssrn.com/abstract=563867 or http://dx.doi.org/10.2139/ssrn.563867

Daniel Levy (Contact Author)

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 5290002
Israel
+972 3 531-8345 (Phone)
+972 3 738-4034 (Fax)

HOME PAGE: http://econ.biu.ac.il/en/levy

Emory University - Department of Economics ( email )

1602 Fishburne Drive, Suite 306
Rich Building
Atlanta, GA 30322-0001
United States

HOME PAGE: http://economics.emory.edu/home/people/faculty/Levydaniel.html

Rimini Center for Economic Analysis ( email )

Wilfrid Laurier University
75 University Ave W.
Waterloo, Ontario N2L3C5
Canada

HOME PAGE: http://rcea.org/

Haipeng (Allan) Chen

University of Kentucky - Gatton College of Business and Economics ( email )

550 South Limestone
Lexington, KY 40506
United States

Sourav Ray

McMaster University - DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
905-525-9140 x 22370 (Phone)
905-521-8995 (Fax)

Mark E. Bergen

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-624-1821 (Phone)

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