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Information-Constrained State-Dependent Pricing

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  • Michael Woodford

Abstract

I present a generalization of the standard (full-information) model of state- dependent pricing in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market conditions. The imperfect information is endogenized using a variant of the theory of "rational inattention" proposed by Sims (1998, 2003, 2006). This results in a one-parameter family of models, indexed by the cost of information, which nests both the standard state-dependent pricing model and the Calvo model of price adjustment as limiting cases (corresponding to a zero information cost and an unboundedly large information cost respectively). For intermediate levels of the information cost, the model is equivalent to a "generalized Ss model" with a continuous \adjustment hazard" of the kind proposed by Caballero and Engel (1993a, 1993b), but provides an economic motivation for the hazard function and very specific predictions about its form. For high enough levels of the information cost, the Calvo model of price-setting is found to be a reasonable approximation to the exact equilibrium dynamics, except in the case of (infrequent) large shocks. When the model is calibrated to match the frequency and size distribution of price changes observed in microeconomic data sets, prices are found to be much less flexible than in a full-information state-dependent pricing model, and only about 20 percent more flexible than under a Calvo model with the same average frequency of price adjustment.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14620.

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Date of creation: Dec 2008
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Publication status: published as Information-constrained state-dependent pricing Michael Woodford Year of Publication: 2009 Authors: Woodford, Michael Published in: Journal of monetary economics.- Amsterdam : Elsevier, ISSN 0304-3932, ZDB-ID 1911557. - Vol. 56.2009, 1/d15/m10, p. 100-124
Handle: RePEc:nbr:nberwo:14620

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  1. Defending rational expectations
    by Mainly Macro in Mainly Macro on 2013-11-07 23:59:00
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Cited by:
  1. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  2. Bartosz Mackowiak & Frank Smets, 2008. "On implications of micro price data for macro models," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 53.
  3. Julio Blanco & Isaac Baley, 2013. "Learning to Price," 2013 Meeting Papers 663, Society for Economic Dynamics.
  4. James Costain & Antón Nákov, 2009. "Dynamics of the price distribution in a general model of state-dependent pricing," Banco de Espa�a Working Papers 0831, Banco de Espa�a.
  5. Julio J. Rotemberg, 2010. "Altruistic Dynamic Pricing with Customer Regret," Scandinavian Journal of Economics, Wiley Blackwell, vol. 112(4), pages 646-672, December.
  6. George-Marios Angeletos & Jennifer La'O, 2009. "Incomplete Information, Higher-Order Beliefs and Price Inertia," NBER Working Papers 15003, National Bureau of Economic Research, Inc.
  7. Altig, David & Christiano, Lawrence & Eichenbaum, Martin & Lindé, Jesper, 2004. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," Working Paper Series 176, Sveriges Riksbank (Central Bank of Sweden).
  8. Jean Boivin & Robert Clark & Nicolas Vincent, 2010. "Virtual Borders: Online Nominal Rigidities and International Market Segmentation," NBER Working Papers 15642, National Bureau of Economic Research, Inc.

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