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Optimal Pricing Under Stochastic Inflation: State:Dependent (s,S) Policies

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  • Christian R. Ahlin

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    (Department of Economics, Vanderbilt University)

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    Abstract

    A model of firm-level optimal pricing under stochastic inflation and fixed costs of adjusting prices is solved and characterized. In this model, inflation alternates stochastically between some positive rate g and zero inflation. We find that a single (s,S) band is not optimal for the firm, as was claimed in the earlier literature. Rather, the firm will set a different (s,S) band for each state of the world, with the zero-inflation band wholly contained in the positive-inflation band. A numerical example is then presented, showing that a higher variance of aggregate price changes increases price dispersion in the positive-inflation state and decreases price dispersion in the zero-inflation state.

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    File URL: http://www.accessecon.com/pubs/VUECON/vu01-w27.pdf
    File Function: First version, 2001
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    Bibliographic Info

    Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0127.

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    Date of creation: Nov 2001
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    Handle: RePEc:van:wpaper:0127

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    Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

    Related research

    Keywords: Inflation; inflation variability; menu costs; price dispersion; state-dependent pricing;

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    References

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    1. Sheshinski, Eytan & Weiss, Yoram, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Wiley Blackwell, vol. 44(2), pages 287-303, June.
    2. Andrew C. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," NBER Working Papers 2311, National Bureau of Economic Research, Inc.
    3. Caplin, A. & Leahy, J., 1992. "Aggregation and Optimization with State-Dependent Pricing," Harvard Institute of Economic Research Working Papers 1595, Harvard - Institute of Economic Research.
    4. 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.
    5. Sheshinski, Eytan & Weiss, Yoram, 1983. "Optimum Pricing Policy under Stochastic Inflation," Review of Economic Studies, Wiley Blackwell, vol. 50(3), pages 513-29, July.
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