Optimal Pricing Under Stochastic Inflation: State:Dependent (s,S) Policies
A model of firm-level optimal pricing under stochastic inflation and fixed costs of adjusting prices is solved and characterized. In this model, inflation alternates stochastically between some positive rate g and zero inflation. We find that a single (s,S) band is not optimal for the firm, as was claimed in the earlier literature. Rather, the firm will set a different (s,S) band for each state of the world, with the zero-inflation band wholly contained in the positive-inflation band. A numerical example is then presented, showing that a higher variance of aggregate price changes increases price dispersion in the positive-inflation state and decreases price dispersion in the zero-inflation state.
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- Andrew S. Caplin & Daniel F. Spulber, 1987.
"Menu Costs and the Neutrality of Money,"
The Quarterly Journal of Economics,
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- 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.
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- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, 01-2013.
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