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Optimal Pricing Under Stochastic Inflation: State:Dependent (s,S) Policies


  • Christian R. Ahlin

    () (Department of Economics, Vanderbilt University)


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.

Suggested Citation

  • Christian R. Ahlin, 2001. "Optimal Pricing Under Stochastic Inflation: State:Dependent (s,S) Policies," Vanderbilt University Department of Economics Working Papers 0127, Vanderbilt University Department of Economics.
  • Handle: RePEc:van:wpaper:0127

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    References listed on IDEAS

    1. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, June.
    2. Andrew S. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, Oxford University Press, vol. 102(4), pages 703-725.
    3. 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.
    4. Eytan Sheshinski & Yoram Weiss, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 44(2), pages 287-303.
    5. Eytan Sheshinski & Yoram Weiss, 1983. "Optimum Pricing Policy under Stochastic Inflation," Review of Economic Studies, Oxford University Press, vol. 50(3), pages 513-529.
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    More about this item


    Inflation; inflation variability; menu costs; price dispersion; state-dependent pricing;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy


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