(Q,S,s) Pricing Rules
We study the effect of menu costs on the pricing behavior of sellers and on the cross-sectional distribution of prices in the search-theoretic model of imperfect competition of Burdett and Judd (1983). We find that, when menu costs are small, the equilibrium is such that sellers follow a (Q,S,s) pricing rule. According to a (Q,S,s) rule, a seller lets inflation erode the real value of its nominal price until it reaches some point s. Then, the seller pays the menu cost and changes its nominal price so that the real value of the new price is randomly drawn from a distribution with support [S,Q], where Q is the buyer's reservation price and S is some price between s and Q. Only when the menu cost is relatively large, the equilibrium is such that sellers follow a standard (S,s) pricing rule. We argue that whether sellers follow a (Q,S,s) or an (S,s) rule matters for the estimation of menu costs and seller-specific shocks.
We are grateful to Roland Benabou, Ben Eden, Allen Head, Greg Kaplan, Moritz Meyer-ter-Vehn, Pierre-Olivier Weill and, especially, Randy Wright for useful discussions on early versions of the paper. We are also grateful to seminar participants at Princeton University, UCLA, UCL, the Econometric Society Meeting (Evanston 2012) and the Search and Matching Workshop (Philadelphia 2012). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Kenneth Burdett & Guido Menzio, 2018. "The (Q,S,s) Pricing Rule," The Review of Economic Studies, vol 85(2), pages 892-928. citation courtesy of