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MARKET POWER, PRICE ADJUSTMENT, AND INFLATION*

Authors

  • Allen Head,

    1. Queen's University, Canada; University of Victoria, Canada; Queen's University, Canada
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  • Alok Kumar,

    1. Queen's University, Canada; University of Victoria, Canada; Queen's University, Canada
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  • Beverly Lapham

    1. Queen's University, Canada; University of Victoria, Canada; Queen's University, Canada
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    • 1

      We thank Dale Mortensen, Michael Rauh, Shouyong Shi, Harald Uhlig, Randall Wright, three anonymous referees, and seminar participants at the Universities of Basel, British Columbia, Humboldt, Indiana, Paris Jourdan, Pennsylvania, Pompeu Fabra, Victoria, Toronto, and Western Ontario; the Bank of Canada, the Canadian Macroeconomics Study Group, the Cleveland Fed Summer Workshop in Monetary Economics, the Society for Economic Dynamics, and the Society for the Advancement of Economic Theory for helpful comments. The Social Sciences and Humanities Research Council of Canada provided financial support for this research. Please address correspondence to: Allen Head, Department of Economics, Queen's University, Kingston, ON, Canada K7L 3N6. Phone: 613 533 6308, Fax: 613 533 6668. E-mail: heada@econ.queensu.ca.


  • *

    Manuscript received September 2007; revised July 2008.

Abstract

We study a monetary search economy in which endogenous fluctuations in market power driven by changes in consumers' search intensity determine the extent of price adjustment to movements in productivity and the money growth rate. A calibrated version of the economy exhibits countercyclical fluctuations in markups and is consistent with the observed incomplete response of nominal prices to cost movements associated with productivity fluctuations and to changes in the money growth rate. Furthermore, a higher average rate of inflation results in a lower average markup and increases the sensitivity of prices to fluctuations in either productivity or money growth.

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