Menu Costs, Strategic Interactions, and Retail Price Movements

This paper examines a state-dependent pricing model in the presence of fixed adjustment costs of prices – menu costs. A model with menu costs has potential to explain an important characteristic of retail price movements: prices discretely jump. This paper shows that the assumption about market structure is crucial in identifying menu costs. Especially, prices in a tight oligopolistic market could be more rigid than those in more competitive market such as monopolistically competitive one. If so, the estimates of menu costs under the assumption of monopolistic competitions in the past studies are potentially biased upwards due to the rigidity from strategic interactions among brands. In addition, the estimate could be biased downwards without controlling for the benefits from unobserved promotional activities. ∗Queen’s University, Department of Economics, Kingsotn, ON, Canada and Department of Economics, The University of British Columbia, Vancouver, BC, Canada. e-mail:kanok@econ.queensu.ca. I appreciate the research guidance by Margaret Slade. I am also grateful to Susumu Imai, Takashi Kano, Thomas Lemieux, Daniel Levy, Kevin Milligan, Art Shneyerov. The earlier version of the paper was presented at the University of British Columbia, the University of Warwick, Concordia University, Hitotsubashi University, the 2004 Canadian Economic Association Meetings at Ryerson University, and the poster session in the 2006 Numerically Intensive Economic Policy Analysis at Queen’s University. I truly appreciate useful and helpful comments from seminar participants. Especially, I appreciate helpful discussions by Avi Goldfarb and Victor Aguirregabiria. Finally, I also appreciate the James M. Kilts Center, Graduate School of Business, University of Chicago for the use of the data in this paper. I am responsible for all errors in this paper.

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