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Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty

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  • Rosen Valchev

    (Duke University)

  • Nicolas Vincent

    (HEC Montréal)

  • Cosmin Ilut

    (Duke University)

Abstract

Price rigidity is central to many predictions of modern macroeconomic models, yet, standard models are at odds with certain robust empirical facts from micro price datasets. We propose a new, parsimonious theory of price rigidity, built around the idea of demand uncertainty, that is consistent with a number of salient micro facts. In the model, the monopolistic firm faces Knightian uncertainty about its competitive environment, which has two key implications. First, the firm is uncertain about the shape of its demand function, and learns about it from past observations of quantities sold. This leads to kinks in the expected profit function at previously observed prices, which act as endogenous costs of changing prices and generate price stickiness and a discrete price distribution. Second, the firm is uncertain about how aggregate prices relate to the prices of its direct competitors, and the resulting robust pricing decision makes our rigidity nominal in nature.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Rosen Valchev & Nicolas Vincent & Cosmin Ilut, 2014. "Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty," 2014 Meeting Papers 716, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:716
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    3. Cosmin L. Ilut & Martin Schneider, 2022. "Modeling Uncertainty as Ambiguity: a Review," NBER Working Papers 29915, National Bureau of Economic Research, Inc.
    4. Cosmin Ilut & Rosen Valchev & Nicolas Vincent, 2020. "Paralyzed by Fear: Rigid and Discrete Pricing Under Demand Uncertainty," Econometrica, Econometric Society, vol. 88(5), pages 1899-1938, September.
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    6. James Costain & Anton Nakov, 2019. "Logit Price Dynamics," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(1), pages 43-78, February.
    7. Axelle Ferriere & Anastasios G. Karantounias, 2019. "Fiscal Austerity in Ambiguous Times," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(1), pages 89-131, January.
    8. Ogawa, Shogo, 2022. "Survey of non-Walrasian disequilibrium economic theory," MPRA Paper 115011, University Library of Munich, Germany.
    9. Hahn, Volker & Marenčák, Michal, 2020. "Price points and price dynamics," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 127-144.
    10. Radoslaw Paluszynski & Pei Cheng Yu, . "Commitment versus Flexibility and Sticky Prices: Evidence from Life Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    11. Ambrocio, Gene, 2020. "Inflationary household uncertainty shocks," Research Discussion Papers 5/2020, Bank of Finland.
    12. Stephane Dupraz, 2017. "A Kinked-Demand Theory of Price Rigidity," 2017 Meeting Papers 387, Society for Economic Dynamics.
    13. Ilut, Cosmin & Saijo, Hikaru, 2021. "Learning, confidence, and business cycles," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 354-376.
    14. Artem Kuriksha, 2021. "An Economy of Neural Networks: Learning from Heterogeneous Experiences," Papers 2110.11582, arXiv.org.
    15. Timothy J. Richards, 2022. "Agribusiness and policy failures," Applied Economic Perspectives and Policy, John Wiley & Sons, vol. 44(1), pages 350-363, March.
    16. Yulei Luo & Jun Nie & Xiaowen Wang & Eric R. Young, 2021. "Production and Inventory Dynamics under Ambiguity Aversion," Research Working Paper RWP 21-05, Federal Reserve Bank of Kansas City.
    17. Rosen Valchev & Cosmin Ilut, 2017. "Economic Agents as Imperfect Problem Solvers," 2017 Meeting Papers 1285, Society for Economic Dynamics.
    18. Claudio Michelacci & Luigi Paciello, 2020. "Aggregate Risk or Aggregate Uncertainty? Evidence from UK Households," EIEF Working Papers Series 2006, Einaudi Institute for Economics and Finance (EIEF), revised Apr 2020.
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    More about this item

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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