14 - Pricing Through Time and Adjustment Clauses

Abstract

This chapter discusses pricing through time and adjustment clauses. The time pattern of price adjustments has attracted much attention in the practice of public and private enterprises. Of particular interest is the question whether it is preferable to have few large price adjustments or many small price adjustments. Sheshinski and Weiss in 1977 addressed the problem for a one-product monopoly that perfectly anticipates a constant rate of inflation. Demand andprofit or welfare depend on the real price of the good, that is on the nominal price divided by the general price level. The latter continuously increases with inflation. The chapter presents the assumption where price-adjustment costs are same no matter how small the price change. The optimal policy is (S, s); there is a series of intervals during which the nominal price is held constant. If, because of inflationary erosion the real price falls to a lower threshold s, the nominal price is increased so that it corresponds to a real price S. Subsequently, the nominal price will once again be eroded and the policy will continue. The endogenous limits s and S depend, inter alia, on the rate of inflation and the price-adjustment costs.