Competitiveness, market power and price stickiness: A paradox and a resolution
Are prices less sticky when markets are more competitive? Our intuition would naturally lead us to give an affirmative answer to that question. But we first show that DSGE models with staggered price or wage contracts have actually the opposite and paradoxical property, namely that price stickiness is an increasing function of competitiveness. To eliminate this paradox, we next study a model where monopolistic competitors choose prices optimally subject to a cost of changing prices as in Rotemberg (1982a,b). For a given cost function, we find the more intuitive result that more competitiveness leads to more flexible prices.
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