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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. 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, MIT Press, vol. 114(2), pages 655-690, May.
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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. Julio J. Rotemberg, 2010. "Altruistic Dynamic Pricing with Customer Regret," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 112(4), pages 646-672, December.
  2. Anton Nakov & James Costain, 2009. "Dynamics of the Price Distribution in a General Model of State-Dependent Pricing," 2009 Meeting Papers, Society for Economic Dynamics 611, Society for Economic Dynamics.
  3. 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.
  4. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices, Review of Economic Dynamics 09-191, Review of Economic Dynamics.
  5. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," NBER Working Papers 11034, National Bureau of Economic Research, Inc.
  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. Julio Blanco & Isaac Baley, 2013. "Learning to Price," 2013 Meeting Papers, Society for Economic Dynamics 663, Society for Economic Dynamics.
  8. Maćkowiak, Bartosz & Smets, Frank, 2008. "On implications of micro price data for macro models," Working Paper Series, European Central Bank 0960, European Central Bank.

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