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The Role of Consumer's Risk Aversion on Price Rigidity

Author

Listed:
  • Alves, Sergio A Lago

    (Central Bank of Brazil)

  • Bugarin, Mirta N S

    (University of Brasilia)

Abstract

This paper aims at contributing to the research agenda on the sources of price stickiness, showing that the adoption of nominal price rigidity may be an optimal firms' reaction to the consumers' behavior, even if firms have no adjustment costs. With regular broadly accepted assumptions on economic agents behavior, we show that firms' competition can lead to the adoption of sticky prices as an (sub-game perfect) equilibrium strategy. We introduce the concept of a consumption centers model economy in which there are several complete markets. Moreover, we weaken some traditional assumptions used in standard monetary policy models, by assuming that households have imperfect information about the inefficient time-varying cost shocks faced by the firms, e.g. the ones regarding to inefficient equilibrium output levels under flexible prices. Moreover, the timing of events are assumed in such a way that, at every period, consumers have access to the actual prices prevailing in the market only after choosing a particular consumption center. Since such choices under uncertainty may decrease the expected utilities of risk averse consumers, competitive firms adopt some degree of price stickiness in order to minimize the price uncertainty and "attract more customers"

Suggested Citation

  • Alves, Sergio A Lago & Bugarin, Mirta N S, 2006. "The Role of Consumer's Risk Aversion on Price Rigidity," Computing in Economics and Finance 2006 128, Society for Computational Economics.
  • Handle: RePEc:sce:scecfa:128
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    References listed on IDEAS

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    1. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters,in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
    2. Almeida, Heitor & Bonomo, Marco, 2002. "Optimal state-dependent rules, credibility, and inflation inertia," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1317-1336, October.
    3. Jeffery D. Amato & Thomas Laubach, 1999. "Monetary policy in an estimated optimization-based model with sticky prices and wages," Research Working Paper 99-09, Federal Reserve Bank of Kansas City.
    4. Sergio A. L. Alves & Waldyr D. Areosa, 2005. "Targets and Inflation Dynamics," Working Papers Series 100, Central Bank of Brazil, Research Department.
    5. Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 683-708.
    6. Marco Bonomo & René Garcia, 2001. "The macroeconomic effects of infrequent information with adjustment costs," Canadian Journal of Economics, Canadian Economics Association, vol. 34(1), pages 18-35, February.
    7. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
    8. Chakrabarti, Rajesh & Scholnick, Barry, 2005. "Nominal rigidities without literal menu costs: evidence from E-commerce," Economics Letters, Elsevier, vol. 86(2), pages 187-191, February.
    9. Simon Hall & Mark Walsh & Anthony Yates, 1997. "How do UK companies set prices?," Bank of England working papers 67, Bank of England.
    10. Mark J. Zbaracki & Mark Ritson & Daniel Levy & Shantanu Dutta & Mark Bergen, 2004. "Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 514-533, May.
    11. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters,in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Solange Gouvea, 2007. "Price Rigidity in Brazil: Evidence from CPI Micro Data," Working Papers Series 143, Central Bank of Brazil, Research Department.
    2. Marcelo Y. Takami & Benjamin M. Tabak, 2007. "Evaluation of Default Risk for The Brazilian Banking Sector," Working Papers Series 135, Central Bank of Brazil, Research Department.
    3. Correa, Arnildo da Silva & Minella, André, 2010. "Nonlinear Mechanisms of the Exchange Rate Pass-Through: A Phillips Curve Model with Threshold for Brazil," Revista Brasileira de Economia - RBE, FGV/EPGE - Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil), vol. 64(3), September.
    4. Gilneu F. A. Vivan & Benjamin M. Tabak, 2007. "A New Proposal for Collection and Generation of Information on Financial Institutions' Risk: the case of derivatives," Working Papers Series 133, Central Bank of Brazil, Research Department.
    5. repec:wsi:ijtafx:v:11:y:2008:i:02:n:s0219024908004774 is not listed on IDEAS
    6. repec:ijc:ijcjou:y:2017:q:2:a:7 is not listed on IDEAS
    7. Barbara Alemanni & José Renato Haas Ornelas, 2006. "Herding Behavior by Equity Foreign Investors on Emerging Markets," Working Papers Series 125, Central Bank of Brazil, Research Department.
    8. Ricardo Schechtman, 2017. "Joint Validation of Credit Rating PDs under Default Correlation," International Journal of Central Banking, International Journal of Central Banking, vol. 13(2), pages 235-282, June.
    9. repec:wsi:ijtafx:v:09:y:2006:i:08:n:s0219024906003974 is not listed on IDEAS
    10. Sergio R. S. Souza & Benjamin M. Tabak & Daniel O. Cajueiro, 2008. "Long-Range Dependence In Exchange Rates: The Case Of The European Monetary System," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(02), pages 199-223.
    11. Benjamin M. Tabak, 2006. "The Dynamic Relationship Between Stock Prices And Exchange Rates: Evidence For Brazil," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 9(08), pages 1377-1396.

    More about this item

    Keywords

    Inflation dynamics; price rigidity; risk aversion; choice under uncertainty; Calvo type model; monetary policy; DSGE models.;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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