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Market Share and Price Rigidity

Survey evidence shows that the main reason why .rms keep prices stable is that they are concerned about losing customers or market share. We construct a model in which .rms care about the size of their customer base. Firms and customers form long-term relationships because consumers incur costs to switch sellers. In this environment, .rms view customers as long-lived assets. We use a general equilibrium framework where industries and .rms are buffeted by idiosyncratic marginal cost shocks. We obtain three main results. First, cost pass-through into prices is incomplete. Second, the degree of pass-through is an increasing function of the persistence of cost shocks. Third, there is a non-monotonic relationship between the size of switching costs and the rate of pass-through. In addition, we characterize the heterogenous response across industries to marginal cost shocks. The implications of our model are consistent with empirical evidence.

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Paper provided by HEC Montréal, Institut d'économie appliquée in its series Cahiers de recherche with number 08-01.

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Length: 52 pages
Date of creation: May 2007
Date of revision:
Handle: RePEc:iea:carech:0801
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