Price Setting With Menu Cost for Multiproduct Firms

Authors

  • Fernando Alvarez,

    1. Dept. of Economics, University of Chicago, Rosenwald Hall, 1101 East 58th Street, Chicago, IL 60637, U.S.A.; f-alvarez1@uchicago.edu
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  • Francesco Lippi

    1. EIEF and University of Sassari, via Sallustiana, 62, 00187 Rome, Italy; flippi@uniss.it
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    • We thank a co-editor and three anonymous referees. We benefited from discussions with Andy Abel, Ricardo Caballero, Carlos Carvalho, John Leahy, Bob Lucas, Virgiliu Midrigan, Luigi Paciello, Ricardo Reis, Raphael Schoenle, Kevin Sheedy, Rob Shimer, Paolo Surico, Nancy Stokey, Harald Uhlig, and Ivan Werning, as well as seminar participants at EIEF, the University of Chicago, NYU, Tinbergen Institute, ASSA 2012, Hong Kong University, the Federal Reserve Banks of Chicago, Minneapolis, New York, and Philadelphia, the Bank of Italy, the European Central Bank, the London Business School, the Bank of Norway, and the 2012 NBER Monetary Economics Meeting in New York for their comments. Alvarez thanks the ECB for the Wim Duisenberg fellowship. Lippi thanks the Italian Ministry of Education for sponsoring this project as part of PRIN 2010–11. Part of the research for this paper was sponsored by the ERC Advanced Grant 324008. Katka Borovickova and Philip Barrett provided excellent assistance.


Abstract

We model the decisions of a multiproduct firm that faces a fixed “menu” cost: once it is paid, the firm can adjust the price of all its products. We characterize analytically the steady state firm's decisions in terms of the structural parameters: the variability of the flexible prices, the curvature of the profit function, the size of the menu cost, and the number of products sold. We provide expressions for the steady state frequency of adjustment, the hazard rate of price adjustments, and the size distribution of price changes, all in terms of the structural parameters. We study analytically the impulse response of aggregate prices and output to a monetary shock. The size of the output response and its duration both increase with the number of products; they more than double as the number of products goes from 1 to 10, quickly converging to the response of Taylor's staggered price model.

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