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A Menu Cost Model with Price Experimentation

Author

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  • Chen Yeh

    (University of Chicago)

  • David Argente

    (University of Chicago)

Abstract

We document a new set of salient facts on pricing moments over the life-cycle of products. First, entering products change prices twice as often as the average product. Second, the average size of these adjustments is 50 percent larger than the average price change. We argue that a menu cost model with price experimentation can rationalize these findings. The firm is uncertain about its demand elasticity under this setting, but can experiment with its price to endogenously affect its posterior beliefs. Firms face the trade-off between increasing the speed of learning through price experimentation and maximizing their static profits. This mechanism can endogenously generate large price changes, without the use of fat-tailed shocks, and can replicate the life-cycle patterns we document. We show that the cumulative output effect of an unanticipated monetary shock is 40 percent larger than in Golosov and Lucas (2007). On impact, selection is weakened as the experimentation motive alters the distribution of desired price changes and decreases the fraction of firms near the margin of adjustment. Furthermore, the notion of a product’s life-cycle generates an additional form of cross- sectional heterogeneity in the frequency of price adjustment. This causes the monetary shock to be further propagated.

Suggested Citation

  • Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1515
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    File URL: https://economicdynamics.org/meetpapers/2016/paper_1515.pdf
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    References listed on IDEAS

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    1. Fernando Alvarez & Francesco Lippi, 2014. "Price Setting With Menu Cost for Multiproduct Firms," Econometrica, Econometric Society, vol. 82(1), pages 89-135, January.
    2. Mark Gertler & John Leahy, 2008. "A Phillips Curve with an Ss Foundation," Journal of Political Economy, University of Chicago Press, vol. 116(3), pages 533-572, June.
    3. Adam Reiff & Peter Karadi, 2011. "Large Shocks in Menu Cost Models," 2011 Meeting Papers 884, Society for Economic Dynamics.
    4. Oleksiy Kryvtsov & Nicolas Vincent, 2014. "On the Importance of Sales for Aggregate Price Flexibility," Staff Working Papers 14-45, Bank of Canada.
    5. Caballero, Ricardo J. & Engel, Eduardo M.R.A., 2007. "Price stickiness in Ss models: New interpretations of old results," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 100-121, September.
    6. Ricardo J. Caballero & Eduardo M.R.A. Engel, 2007. "Price Stickiness in Ss Models: New Interpretations of Old Results," Levine's Bibliography 321307000000000856, UCLA Department of Economics.
    7. Isaac Baley & J. Andrés Blanco, 2016. "Menu costs, uncertainty cycles, and the propagation of nominal shocks," Economics Working Papers 1532, Department of Economics and Business, Universitat Pompeu Fabra.
    8. Mirman, Leonard J & Samuelson, Larry & Urbano, Amparo, 1993. "Monopoly Experimentation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(3), pages 549-563, August.
    9. Tim Willems, 2017. "Actively Learning by Pricing: A Model of an Experimenting Seller," Economic Journal, Royal Economic Society, vol. 127(604), pages 2216-2239, September.
    10. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    11. Judith A. Chevalier & Anil K. Kashyap & Peter E. Rossi, 2003. "Why Don't Prices Rise During Periods of Peak Demand? Evidence from Scanner Data," American Economic Review, American Economic Association, vol. 93(1), pages 15-37, March.
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    Cited by:

    1. Daniel Levy & Sourav Ray & Li Wang & Mark Bergen, 2019. "Pricing Better," Working Papers 008-19 JEL Codes: M31, E3, International School of Economics at TSU, Tbilisi, Republic of Georgia.

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