Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics
The role of inventories in making prices "sticky" is studied by analyzing a dynamic linear-quadratic model of a monopoly firm facing stochastic demand, but able to store its finished goods in inventory. It is shown that, in contrast to the usual presumption, firms that exhibit the smallest output responses to demand fluctuations may also exhibit the smallest price fluctuations. Specifically, firms which have very flexible inventory storage facilities or are subjected to very transitory demand shocks will rely on inventories as buffers, and will change neither production nor price very much. On the other hand, firms which have very inflexible storage facilities or whose demand shocks are quite permanent will display large swings in both price and output. The standard assumption about inventory carrying costs that has been used in the literature (that they are linear) is shown to imply that production is impervious to fluctuations in demand. It is also established that prices may respond more strongly to positive demand shocks than to negative ones if it is impossible to hold negative inventories (i.e., to have unfilled orders). The model offers an explanation for "stickiness" in relative prices. However, under certain circumstances, it may help explain the persistence of inflation
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Volume (Year): 72 (1982)
Issue (Month): 3 (June)
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- Phlips, Louis, 1980. "Intertemporal Price Discrimination and Sticky Prices," The Quarterly Journal of Economics, MIT Press, vol. 94(3), pages 525-42, May.
- Zabel, Edward, 1972. "Multiperiod monopoly under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 524-536, December.
- Maccini, Louis J, 1976. "An Aggregate Dynamic Model of Short-Run Price and Output Behavior," The Quarterly Journal of Economics, MIT Press, vol. 90(2), pages 177-96, May.
- Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
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