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Estimation of adjustment costs in a model of state-dependent pricing

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Jonathan L. Willis

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Abstract

This paper provides a framework for direct analysis of the underlying price adjustment costs in an industry. A dynamic programming problem is specified for monopolistically competitive firms that face idiosyncratic costs of price adjustment. A numerical solution is calculated using value function iteration. I estimate the structural parameters of the model using data on magazine cover prices. Among the parameters estimated are the mean, variance, and persistence of the adjustment cost process. The estimated distribution of adjustment costs is nondegenerate, and the average adjustment cost paid by firms is large in comparison to other results in the literature.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 00-07.

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Date of creation: 2000
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Handle: RePEc:fip:fedkrw:rwp00-07

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Keywords: Prices;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Cecchetti, Stephen G., 1986. "The frequency of price adjustment : A study of the newsstand prices of magazines," Journal of Econometrics, Elsevier, vol. 31(3), pages 255-274, April. [Downloadable!] (restricted)
  2. Rust, John, 1987. "Optimal Replacement of GMC Bus Engines: An Empirical Model of Harold Zurcher," Econometrica, Econometric Society, vol. 55(5), pages 999-1033, September. [Downloadable!] (restricted)
  3. Simon Gilchrist & Charles P. Himmelberg, 1995. "Evidence on the Role of Cash Flow for Investment," Working Papers 95-01, New York University, Leonard N. Stern School of Business, Department of Economics.
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  4. Heckman, James & Singer, Burton, 1984. "A Method for Minimizing the Impact of Distributional Assumptions in Econometric Models for Duration Data," Econometrica, Econometric Society, vol. 52(2), pages 271-320, March. [Downloadable!] (restricted)
  5. Caplin, Andrew & Leahy, John, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 683-708, August. [Downloadable!] (restricted)
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  6. Aguirregabiria, Victor, 1999. "The Dynamics of Markups and Inventories in Retailing Firms," Review of Economic Studies, Blackwell Publishing, vol. 66(2), pages 275-308, April. [Downloadable!] (restricted)
  7. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181. [Downloadable!] (restricted)
  8. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May. [Downloadable!] (restricted)
  9. Kashyap, Anil K, 1995. "Sticky Prices: New Evidence from Retail Catalogs," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 245-74, February. [Downloadable!] (restricted)
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  10. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May. [Downloadable!] (restricted)
  11. Ball, Laurence & Romer, David, 1990. "Real Rigidities and the Non-neutrality of Money," Review of Economic Studies, Blackwell Publishing, vol. 57(2), pages 183-203, April. [Downloadable!] (restricted)
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  12. Levy, Daniel, et al, 1997. "The Magnitude of Menu Costs: Direct Evidence from Large U.S. Supermarket Chains," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 791-825, August.
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  13. Russell Cooper & John Haltiwanger & Laura Power, 1999. "Machine Replacement and the Business Cycle: Lumps and Bumps," American Economic Review, American Economic Association, vol. 89(4), pages 921-946, September. [Downloadable!] (restricted)
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  14. Barro, Robert J, 1972. "A Theory of Monopolistic Price Adjustment," Review of Economic Studies, Blackwell Publishing, vol. 39(1), pages 17-26, January. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mark Zbarack & Mark Bergen & Shantanu Dutta & Daniel Levy & Mark Ritson, 2005. "Beyond the Cost of Price Adjustment: Investments in Pricing Capita," Emory Economics 0518, Department of Economics, Emory University (Atlanta). [Downloadable!]
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  2. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Young, Andrew & Levy, Daniel, 2006. "Explicit Evidence on an Implicit Contract," MPRA Paper 926, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  4. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Peter J. Klenow & Jonathan L. Willis, 2006. "Sticky information and sticky prices," Research Working Paper RWP 06-13, Federal Reserve Bank of Kansas City. [Downloadable!]
    Other versions:
  6. Levy, Daniel & Young, Andrew, 2004. "The Real Thing: Nominal Price Rigidity of the Nickel Coke, 1886–1959," MPRA Paper 1046, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  7. Russell Cooper & Joao Ejarque, 2000. "Exhuming Q: Market Power vs. Capital Market Imperfections," Econometric Society World Congress 2000 Contributed Papers 0528, Econometric Society. [Downloadable!]
    Other versions:
  8. Gautier, E., 2008. "Les ajustements microéconomiques des prix : une synthèse des modèles théoriques et résultats empiriques," Documents de Travail 211, Banque de France. [Downloadable!]
  9. Alexander L. Wolman, 2007. "The frequency and costs of individual price adjustment," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(6), pages 531-552. [Downloadable!]
    Other versions:
  10. Mark Bils & Peter J. Klenow & Oleksiy Kryvtsov, 2003. "Sticky prices and monetary policy shocks," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-9. [Downloadable!]
  11. Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: market power capital market imperfections," Working Papers 611, Federal Reserve Bank of Minneapolis. [Downloadable!]
  12. Peter Tinsley & Sharon Kozicki, 2003. "Alternative Sources of the Lag Dynamics of Inflation," Computing in Economics and Finance 2003 92, Society for Computational Economics. [Downloadable!]
    Other versions:
  13. Mark Zbaracki & Mark Ritson & Daniel Levy & Shantanu Dutta & Mark Bergen, 2004. "Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets," Macroeconomics 0402020, EconWPA. [Downloadable!]
    Other versions:
  14. Lapo Filistrucchi, 2005. "The Impact of Internet on the Market for Daily Newspapers in Italy," Economics Working Papers ECO2005/12, European University Institute. [Downloadable!]
  15. Jonathan L. Willis, 2003. "Implications of structural changes in the U.S. economy for pricing behavior and inflation dynamics," Economic Review, Federal Reserve Bank of Kansas City, issue Q I, pages 5-27. [Downloadable!]
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