Aldo Rustichini (CORE, UniversitÊ Catholique de Louvain, B-1348, Louvain la Neuve, BELGIUM) Anne P. Villamil (Department of Economics, University of Illinois, Champaign, IL 61820, USA)
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This paper provides a theory of intertemporal pricing in a small market with differential information about the realizations of a stochastic process which determines demand. We study the sequential equilibria in stationary strategies of the stochastic game between a seller and buyer. The seller has zero cost of producing one unit of a non-durable good in all market periods. The buyer's value for the good is a random variable governed by a simple Markov process. At the beginning of each period the unit's value is determined by nature and is privately revealed to the buyer. The seller posts a single price offer each period, which the buyer either accepts or rejects. Only two types of price paths emerge in equilibrium: either prices are constant, or they have persistent cycles between a low and a high value. In both cases, however, prices are "sticky" in the sense that changes in price are less frequent than changes in the economy's fundamentals.
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Article provided by Springer in its journal Economic Theory.