Price Stickiness in Customer Markets with Reference Prices

Abstract: Price rigidity is often modeled by assuming that firms face a fixed cost of price change. However, in surveys, firms report that the main reason they wish to keep prices stable is for fear of antagonizing customers. Moreover, marketing studies show that most consumers engage in very little product comparison on a typical shopping trip. In this paper, we explore the implications of these observations for price rigidity. In our model, comparing prices and characteristics of alternative brands is time-consuming. While some consumers behave as bargain hunters with zero opportunity cost form shopping, most are loyal to firms as long as posted prices are not raised. A price increase is interpreted as a signal that a better alternative may be available and triggers consumer search. Firms do not face menu costs and are free to change nominal prices, but understand that their pricing decisions will affect their customer base and hence future profits. We show that this micro-founded mechanism is akin to a nominal rigidity and naturally generates price stickiness. It is also compatible with the observation of frequent sales at the retail level and can rationalize the decreasing or flat hazard functions observed empirically.

Keywords: Price stickiness; customer relations; nominal rigidities; consumer inattention (search for similar items in EconPapers)
JEL-codes: E30 L16 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-com, nep-ind, nep-mac and nep-mkt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://www.cirpee.org/fileadmin/documents/Cahiers_2012/CIRPEE12-30.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:1230

Access Statistics for this paper

More papers in Cahiers de recherche from CIRPEE Contact information at EDIRC.
Bibliographic data for series maintained by Manuel Paradis ().