Asymmetric Pricing

Asymmetric pricing is the empirically observed tendency for prices to rise more readily in response to cost increases than they fall in response to cost decreases, presenting a critical challenge to conventional linear economic models. This chapter establishes asymmetric pricing as a canonical example of nonlinear dynamics in economics, driven by factors such as menu costs, market power, and search frictions. This complex, path-dependent behavior requires a deliberate shift from linear to nonlinear econometric frameworks. Hence, this chapter systematically reviews the core theories underpinning price asymmetries and introduces the suite of advanced techniques including threshold autoregressive (TAR) models, Markov-switching models, and local projection methods, essential for their robust empirical validation in both micro- and macroeconomic contexts. This synthesis provides researchers and policymakers with conceptual and analytical tools to move beyond symmetric assumptions and better model the true inertia and complexity of price dynamics in modern economies. In the end of the chapter with the given project work, readers must demonstrate their comprehensive understanding by implementing a complete empirical project that bridges theoretical models with real-world data analysis. This capstone project will guide you through constructing and estimating both threshold VAR and Markov-switching models to analyze asymmetric price dynamics, requiring you to identify regime-dependent inflation behavior, test for asymmetric responses to cost shocks, and generate policy-relevant forecasts under different economic scenarios. By working through data collection, model specification, hypothesis testing, and counterfactual analysis, you will develop the practical skills needed to move beyond linear assumptions and confront the complex, state-dependent nature of price dynamics in modern economies, ultimately producing a complete research paper suitable for academic or policy applications.