Price Rigidity and Strategic Uncertainty An Agent-based Approach

Robert Somogyi and Janos Vincze
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Janos Vincze: Institute of Economics - Hungarian Academy of Sciences, Corvinus University of Budapest

No 1135, CERS-IE WORKING PAPERS from Institute of Economics, Centre for Economic and Regional Studies

Abstract: The phenomenon of infrequent price changes has troubled economists for decades. Intuitively one feels that for most price-setters there exists a range of inaction, i.e. a substantial measure of the states of the world, within which they do not wish to modify prevailing prices. However, basic economics tells us that when marginal costs change it is rational to change prices, too. Economists wishing to maintain rationality of price-setters resorted to fixed price adjustment costs as an explanation for price rigidity. In this paper we propose an alternative explanation, without recourse to any sort of physical adjustment cost, by putting strategic interaction into the center-stage of our analysis. Price-making is treated as a repeated oligopoly game. The traditional analysis of these games cannot pinpoint any equilibrium as a reasonable "solution" of the strategic situation. Thus there is genuine strategic uncertainty, a situation where decision-makers are uncertain of the strategies of other decision-makers. Hesitation may lead to inaction. To model this situation we follow the style of agent-based models, by modelling firms that change their pricing strategies following an evolutionary algorithm. Our results are promising. In addition to reproducing the known negative relationship between price rigidity and the level of general inflation, our model exhibits several features observed in real data. Moreover, most prices fall into the theoretical "range" without explicitly building this property into strategies.

Keywords: Agent-based modeling; Evolutionary algorithm; Price rigidity; Social learning; Strategic Uncertainty (search for similar items in EconPapers)
JEL-codes: B52 C63 L13 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2011-09
New Economics Papers: this item is included in nep-cmp, nep-com and nep-ind
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Citations: View citations in EconPapers (1)

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