Shrinking Goods and Sticky Prices: Theory and Evidence

Snir, Avichai and Levy, Daniel (2011): Shrinking Goods and Sticky Prices: Theory and Evidence.

Abstract

If producers have more information than consumers about goods’ attributes, then they may use non-price (rather than price) adjustment mechanisms and, consequently, the market may reach a new equilibrium even if prices remain sticky. We study a situation where producers adjust the quantity (per package) rather than the price in response to changes in market conditions. Although consumers should be indifferent between equivalent changes in goods' prices and quantities, empirical evidence suggests that consumers often respond differently to price changes and equivalent quantity changes. We offer a possible explanation for this puzzle by constructing and empirically testing a model in which consumers incur cognitive costs when processing goods’ price and quantity information. The model is based on evidence from cognitive psychology and explains consumers’ decision whether or not to process goods’ price and quantity information. Our findings explain why producers sometimes adjust goods’ prices and sometimes goods’ quantities. In addition, they predict variability in price adjustment costs over time and across economic conditions.

• Item Type: MPRA Paper
• Language: English
• Keywords: Sticky Prices; Rigid Prices; Cognitive Costs of Attention; Information Processing Cost; Rational Inattention; Price Adjustment; Quantity Adjustment; Downsizing
• Subjects: D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior: Theory; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure ; Size Distribution of Firms; D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D40 - General; L - Industrial Organization > L0 - General > L00 - General; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L16 - Industrial Organization and Macroeconomics: Industrial Structure and Structural Change ; Industrial Price Indices; D - Microeconomics > D0 - General > D03 - Behavioral Microeconomics: Underlying Principles; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M31 - Marketing; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L15 - Information and Product Quality ; Standardization and Compatibility; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M2 - Business Economics > M21 - Business Economics

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