The Effects of General Inflation and Idiosyncratic Cost Shocks on Within-Commodity Price Dispersion: Evidence from Microdata

Posted: 15 Sep 1999

See all articles by Joe Beaulieu

Joe Beaulieu

Board of Governors of the Federal Reserve - Division of Research and Statistics - Industrial Output Section; National Bureau of Economic Research (NBER)

Joe Mattey

affiliation not provided to SSRN

Abstract

This study investigates the dispersion of price levels within highly dis-aggregated markets by examining plant- level product records from the U.S. Census of Manufactures. The paper estimates the effects of inflation on price dispersion through cross-sectional variation in the drift rate of average target prices within a market. In a menu cost model, where sellers try to keep posted prices close to desired prices, an increase in the price of an important input raises the desired output price in much the same way that an increase in general inflation raises target prices. We measure the drift rate of the desired price from the average growth rates of composite input price indices. We then compare the drift rates of the desired prices with the dispersions of prices within markets. With microdata, we also disentangle the effects of aggregate and idiosyncratic shocks to target prices. In menu cost models, a higher variance of total shocks leads to a widening of adjustment bands, and consequently an increase in dispersion. Higher aggregate variation, however, may also lead to clumping as in Caplin-Leahy (1991), leading to lower dispersion. Higher variation also reduces the signal-to-noise ratio in imperfect information models, and it reduces the information content in a single observation in search models such as Tommasi (1992). Lower information content also may increase price dispersion in these models. Overall, our results are significant; we explain about one-fifth of the variation in the amount of price dispersion across different commodities. In general, we find that the higher the drift rate of the desired price of a given commodity, the larger the amount of price dispersion. The standard deviation of idiosyncratic shocks also is positively correlated with the degree of price dispersion, while the standard deviation of aggregate shocks is negatively correlated with price dispersion.

JEL Classification: E43

Suggested Citation

Beaulieu, J. Joseph and Mattey, Joe, The Effects of General Inflation and Idiosyncratic Cost Shocks on Within-Commodity Price Dispersion: Evidence from Microdata. Available at SSRN: https://ssrn.com/abstract=5924

J. Joseph Beaulieu (Contact Author)

Board of Governors of the Federal Reserve - Division of Research and Statistics - Industrial Output Section

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Washington, DC 20551
United States
202-452-3819 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Joe Mattey

affiliation not provided to SSRN

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