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Market Power, Price Adjustment, and Inflation

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  • Allen Head

    ()
    (Queen's University)

  • Alok Kumar

    ()
    (University of Victoria)

  • Beverly Lapham

    ()
    (Queen's University)

Abstract

We study the responses of real and nominal prices to random flutuations in costs and money growth using a monetary search economy in which there are no costs or temporal restrictions on sellers' ability to change prices. The economy exhibits a form of price stickiness in that the price level may react incompletely to either type of shock as a result of endogenous changes in the average mark-up driven by movements in consumers' search intensity. The average mark-up falls as inflation rises, a finding consistent with emprical observations. As a result of this reduction in market power, prices become more responsive to shocks as inflation rises. Our results are consistent with empirical findings that the degree of price adjustment in response to both cost and money growth shocks is increasing in the average rate of inflation, that the variance of inflation increases with its average level, and that positive and negative shocks to money growth have asymmetric effects.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1089.pdf
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1089.

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Length: 47 pages
Date of creation: Jan 2006
Date of revision:
Handle: RePEc:qed:wpaper:1089

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Keywords: Search; Mark-up; Inflation; Price Dispersion; Pass-through;

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References

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  1. Allen Head & Alok Kumar, 2005. "Price Dispersion, Inflation, And Welfare," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 533-572, 05.
  2. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  3. Eden, Benjamin, 1994. "The Adjustment of Prices to Monetary Shocks When Trade Is Uncertain and Sequential," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 493-509, June.
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  7. Saul Lach, 2002. "Existence And Persistence Of Price Dispersion: An Empirical Analysis," The Review of Economics and Statistics, MIT Press, vol. 84(3), pages 433-444, August.
  8. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
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  12. Aleksander Berentsen & Gabriele Camera & C hristopher W aller, 2005. "The Distribution Of Money Balances And The Nonneutrality Of Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(2), pages 465-487, 05.
  13. David Bowman, 2003. "Market power and inflation," International Finance Discussion Papers 783, Board of Governors of the Federal Reserve System (U.S.).
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  18. Miguel Molico, 2006. "The Distribution Of Money And Prices In Search Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 701-722, 08.
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  25. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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Citations

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Cited by:
  1. Ciżkowicz, Piotr & Rzońca, Andrzej, 2013. "Does inflation harm corporate investment? Empirical evidence from OECD countries," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 7(16), pages 1-38.
  2. Craig, Ben & Rocheteau, Guillaume, 2008. "State-dependent pricing, inflation, and welfare in search economies," European Economic Review, Elsevier, vol. 52(3), pages 441-468, April.
  3. Liang Wang, 2011. "Inflation and Welfare with Search and Price Dispersion," Working Papers 201113, University of Hawaii at Manoa, Department of Economics.
  4. Allen Head & Lucy Qian Liu & Guido Menzio & Randall Wright, 2012. "Sticky Prices: A New Monetarist Approach," Journal of the European Economic Association, European Economic Association, vol. 10(5), pages 939-973, October.
  5. Williamson, Stephen D. & Wright, Randall, 2010. "New Monetarist Economics: Models," MPRA Paper 21030, University Library of Munich, Germany.
  6. Becker, Sascha S. & Nautz, Dieter, 2012. "Inflation, price dispersion and market integration through the lens of a monetary search model," European Economic Review, Elsevier, vol. 56(3), pages 624-634.
  7. Sascha S. Becker, 2011. "What Drives the Relationship Between Inflation and Price Dispersion? Market Power vs. Price Rigidity," SFB 649 Discussion Papers SFB649DP2011-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  8. Ratul, Lahkar, 2011. "The dynamic instability of dispersed price equilibria," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1796-1827, September.

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