Information-Constrained State-Dependent Pricing
I present a generalization of the standard (full-information) model of state- dependent pricing in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market conditions. The imperfect information is endogenized using a variant of the theory of "rational inattention" proposed by Sims (1998, 2003, 2006). This results in a one-parameter family of models, indexed by the cost of information, which nests both the standard state-dependent pricing model and the Calvo model of price adjustment as limiting cases (corresponding to a zero information cost and an unboundedly large information cost respectively). For intermediate levels of the information cost, the model is equivalent to a "generalized Ss model" with a continuous \adjustment hazard" of the kind proposed by Caballero and Engel (1993a, 1993b), but provides an economic motivation for the hazard function and very specific predictions about its form. For high enough levels of the information cost, the Calvo model of price-setting is found to be a reasonable approximation to the exact equilibrium dynamics, except in the case of (infrequent) large shocks. When the model is calibrated to match the frequency and size distribution of price changes observed in microeconomic data sets, prices are found to be much less flexible than in a full-information state-dependent pricing model, and only about 20 percent more flexible than under a Calvo model with the same average frequency of price adjustment.
I would like to thank Marco Bonomo, Ariel Burstein, Ricardo Caballero, Eduardo Engel, Ricardo Fernholz, Michael Golosov, Bob King, John Leahy, Bart Mackowiak, Filip Matejka, Giuseppe Moscarini, Emi Nakamura, Chris Sims, Tony Smith, Jon Steinsson and Alex Wolman for helpful discussions; Maxim Pinkovskiy and Luminita Stevens for outstanding research assistance; the NSF for research support through a grant to the NBER; and the Arthur Okun and Kumho Visiting Professorship, Yale University, for providing the time to begin work on this project. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Information-constrained state-dependent pricing Michael Woodford Year of Publication: 2009 Authors: Woodford, Michael Published in: Journal of monetary economics.- Amsterdam : Elsevier, ISSN 0304-3932, ZDB-ID 1911557. - Vol. 56.2009, 1/d15/m10, p. 100-124 citation courtesy of