Rationally Inattentive Seller: Sales and Discrete Pricing

Abstract

This paper presents a model of a rationally inattentive seller responding to shocks to unit input cost. The model generates price series imultaneously exhibiting all three of the following features that can be found in the data. 1) Prices change frequently. 2) Responses of prices to aggregate variables are delayed. 3) Prices move back and forth between a few rigid values. Discrete pricing arises even if the unit input cost varies in a continuous range. Results of the model also agree with the evidence that reductions in price, e.g. sales, are usually short-lasting and that the highest price in a sample tends to be the most quoted price. Discrete and asymmetric pricing is a seller's optimal response to his limited information capacity. Moreover, the model provides rationale for faster responses to aggregate shocks in industries with more volatile idiosyncratic shocks as well as for a steeper Philip's curve in less stable aggregate conditions.