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Adapting Prices or Quantities in the Presence of Adjustment Costs?

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Author Info

  • Torben M. Andersen
  • Eric Toulemonde

    () (Department of Economics, University of Aarhus, Denmark)

Abstract

A dominant explanation of price rigidity is the so-called "menu cost model" according to which small costs of changing prices may imply that firms keep nominal prices unchanged to nominal shocks which therefore have real effects. Crucial to this explanation is the assumption that price adjustment is costly while quantity adjustment is not. This paper analyses the role of costs of adjusting both prices and quantities, and it is found that the "small cost" argument used to support menu cost models does not hold. The predictions of menu cost models only hold if price adjustment costs are larger than quantity adjustment costs. Empirical evidence clearly indicates that the costs of adjusting quantities are non-trivial. Quantity adjustment costs also open for the possibility of non-market clearing.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 1999-6.

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Length: 18
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Handle: RePEc:aah:aarhec:1999-6

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Menu-costs; nominal rigidities; price adjustment and quantity adjustment;

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Cited by:
  1. Leif Danziger, 2007. "Adjustment Costs, Inventories and Output," Kiel Working Papers 1340, Kiel Institute for the World Economy.
  2. Leif Danziger, 2007. "Output Effects Of Inflation With Fixed Price- And Quantity-Adjustment Costs," Economic Inquiry, Western Economic Association International, vol. 45(1), pages 115-120, 01.
  3. Georg Müller & Mark Bergen & Shantanu Dutta & Daniel Levy, 2007. "Non-price rigidity and cost of adjustment," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(7), pages 817-832.
  4. Montornès, J. & Sauner-Leroy, J-B., 2010. "Wage-setting Behavior in France: Additional Evidence from an Ad-hoc Survey," Working papers 282, Banque de France.

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