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Price Dynamics with Customer Markets

  • Luigi Paciello

    (EIEF and CEPR)

  • Andrea Pozzi

    (EIEF and CEPR)

  • Nicholas Trachter

    (Federal Reserve Bank of Richmond)

We study a model of firm price setting with customer markets and empirically evaluate its predictions. Our framework captures the dynamics of customers in response to a change in the price set by firms, describes the behavior of optimal prices in the presence of customer retention concerns, and delivers a general equilibrium model of price and customer dynamics. We exploit micro data on purchases from a large U.S. retailer by a panel of households to quantify the model and compare it to the counterfactual benchmark of the monopolistic competition setting. We show that our model with customer markets has markedly different implications in terms of the equilibrium price distribution, and better fits the available empirical evidence on retail prices. Moreover, the dynamic of the response of demand to policy relevant shocks is also distinctive. Our results suggest that inertia in customer reallocation across firms increases the persistence in the response of firms' demand to these shocks.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1328.

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Length: 53 pages
Date of creation: 2013
Date of revision: Oct 2014
Handle: RePEc:eie:wpaper:1328
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