NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Monopolistic Competition and Deviations from PPP

Joshua Aizenman

NBER Working Paper No. 1552
Issued in 1985
NBER Program(s):   ITI   IFM

The purpose of this paper is to explain deviations from PPP in an economy charaterived by a mononolistic competitive market structure in which pricing decisions incur costs. That lead producers to pre-set the price path for several periods. The paper derives an optimal pricing rule, including the optimal pre-setting horizon. It does so for a rational expectation equilibrium, characterized by staggered, unsynchronized price setting, for which the degree of staggering is endogenously determined. The discussion focuses on the critical role of the degree of domestic-foreign goods substitutability in explaining observable deviations from PPP.

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