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Rockets and Feathers in the Laboratory

  • Ralph-C Bayer
  • Changxia Ke

Consumers often complain that retail prices respond faster to increases in wholesale prices than to decreases. Despite many empirical studies confirming this "Rockets-and-Feathers" phenomenon for different industries, the mechan¬ism driving it is not well understood. In this paper, we show that, in contrast to the theoretical prediction, asymmetric price adjustment to cost shocks, as well as price dispersion, arises in experimental Diamond (1971) markets. The analysis of individual behavior suggests that the observed price dispersion can be explained by bounded rationality, as our data are well explained by Quantal Response Equilibrium (McKelvey and Palfrey 1995). Asymmetric price adjustment is caused by the buyers with adaptive expectation updating differently quickly after positive and negative shocks.

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File URL: http://www.tax.mpg.de/RePEc/mpi/wpaper/Tax-MPG-RPS-2011-10.pdf
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Paper provided by Max Planck Institute for Tax Law and Public Finance in its series Working Papers with number rockets_and_feathers_in_the_laboratory.

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Length: 39 pages
Date of creation: Sep 2011
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Handle: RePEc:mpi:wpaper:rockets_and_feathers_in_the_laboratory
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