Abstract

AbstractThis paper proposes a theory of pricing premised upon the assumptions that customers dislike unfair prices—those marked up steeply over cost—and that firms take these concerns into account when setting prices. Because they do not observe firms’ costs, customers must extract costs from prices. The theory assumes that customers infer less than rationally: When a price rises due to a cost increase, customers partially misattribute the higher price to a higher markup—which they find unfair. Firms anticipate this response and trim their price increases, which drives the passthrough of costs into prices below one: Prices are somewhat rigid. Embedded in a New Keynesian model as a replacement for the usual pricing frictions, our theory produces monetary nonneutrality: When monetary policy loosens and inflation rises, customers misperceive markups as higher and feel unfairly treated; firms mitigate this perceived unfairness by reducing their markups; in general equilibrium, employment rises. The theory also features a hybrid short-run Phillips curve, realistic impulse responses of output and employment to monetary and technology shocks, and an upward-sloping long-run Phillips curve.

Highlights

  • ITEDD Prices are neither exactly fixed nor fully responsive to cost shocks (Carlsson and Skans E 2012; De Loecker et al 2016; Caselli et al 2017; Ganapati et al 2020)

  • D arises through the same channel as in the monopoly model: expansionary monetary E policy raises prices and nominal marginal costs; customers partially misattribute N higher prices to higher markups, which they perceive as unfair; as a result, the U price elasticities of the demands for goods rise; firms respond by reducing markups, L stimulating the economy

  • We look for a perfect Bayesian equilibrium (PBE) that is fully separating: the monopoly chooses different prices for different marginal costs, which allows a rational customer who knows the monopoly’s equilibrium strategy and observes the price to deduce marginal cost

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Summary

Introduction

D Prices are neither exactly fixed nor fully responsive to cost shocks (Carlsson and Skans E 2012; De Loecker et al 2016; Caselli et al 2017; Ganapati et al 2020). When price increases by x%, customers correctly infer that marginal cost has increased by x%, and that the markup has not changed. D arises through the same channel as in the monopoly model: expansionary monetary E policy raises prices and nominal marginal costs; customers partially misattribute N higher prices to higher markups, which they perceive as unfair; as a result, the U price elasticities of the demands for goods rise; firms respond by reducing markups, L stimulating the economy. The model yields reasonable impulse responses to I monetary shocks and to technology shocks when the parameters governing fairness G concerns and subproportional inference are calibrated to match the microevidence Ion cost passthroughs. Because people partially misattribute higher prices to higher markups, inflation leads them to perceive transactions as less fair, generating disutility. Deflation leads people to misperceive markups as lower and deem transactions more fair, generating utility

Related Literature
Microevidence Supporting the Assumptions
Customers’ Fairness Concerns
Monopoly Model
Assumptions
Fairness Concerns and Observable Costs
Fairness Concerns and Subproportional Inference of Costs
New Keynesian Model
Demand for Goods and Pricing
Common parameters
Effects of Monetary Policy in the Short Run
Conclusion
Princeton University
University of Chicago
Full Text
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