A model is considered where firms internalize the regret costs that consumers experience when they see an unexpected price change. Regret costs are assumed to be increasing in the size of price changes and this can explain why the size of price increases is less sensitive to inflation than in models with fixed costs of changing prices. The latter predict unrealistically large responses of price changes to inflation for firms that do not frequently reduce their prices. Adjustment costs that depend on the size of price changes also raise the variability on the size of price increases. Lastly, it is argued that the common practice of announcing price increases in advance is much easier to rationalize with regret concerns by consumers than with more standard approaches to price rigidity.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
14933.
Length: Date of creation: Apr 2009 Date of revision: Handle: RePEc:nbr:nberwo:14933
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Find related papers by JEL classification: D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
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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.:
Fabiani, Silvia & Druant, Martine & Hernando, Ignacio & Kwapil, Claudia & Landau, Bettina & Loupias, Claire & Martins, Fernando & Matha, Thomas & Sabbatini, Roberto & Stahl, Harald & Stokman, Ad, 2006.
"What Firms' Surveys Tell Us about Price-Setting Behavior in the Euro Area,"
MPRA Paper
808, University Library of Munich, Germany.
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