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Business as Usual: A Consumer Search Theory of Sticky Prices and Asymmetric Price Adjustment

  • Luís Cabral

    (IESE Business School and NYU)

  • Arthur Fishman

    ()

    (Bar-Ilan University)

Empirical evidence suggests that prices are sticky with respect to cost changes. Moreover, prices respond more rapidly to cost increases than to cost decreases. We develop a search theoretic model which is consistent with this evidence and allows for additional testable predictions. Our results are based on the assumption that buyers do not observe the sellers׳ costs, but know that cost changes are positively correlated across sellers. In equilibrium, a change in price is likely to induce consumer search, which explains sticky prices. Moreover, the signal conveyed by a price decrease is different from the signal conveyed by a price increase, which explains asymmetry in price adjustment.

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File URL: http://www.biu.ac.il/soc/ec/wp/2011-01.pdf
File Function: Working paper
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Paper provided by Bar-Ilan University, Department of Economics in its series Working Papers with number 2011-01.

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Date of creation: Jan 2011
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Handle: RePEc:biu:wpaper:2011-01
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