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The Role of Consumer's Risk Aversion on Price Rigidity

Sergio A. Lago Alves () and Mirta N S Bugarin
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Mirta N S Bugarin: University of Brasilia

No 128, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: This paper aims at contributing to the research agenda on the sources of price stickiness, showing that the adoption of nominal price rigidity may be an optimal firms' reaction to the consumers' behavior, even if firms have no adjustment costs. With regular broadly accepted assumptions on economic agents behavior, we show that firms' competition can lead to the adoption of sticky prices as an (sub-game perfect) equilibrium strategy. We introduce the concept of a consumption centers model economy in which there are several complete markets. Moreover, we weaken some traditional assumptions used in standard monetary policy models, by assuming that households have imperfect information about the inefficient time-varying cost shocks faced by the firms, e.g. the ones regarding to inefficient equilibrium output levels under flexible prices. Moreover, the timing of events are assumed in such a way that, at every period, consumers have access to the actual prices prevailing in the market only after choosing a particular consumption center. Since such choices under uncertainty may decrease the expected utilities of risk averse consumers, competitive firms adopt some degree of price stickiness in order to minimize the price uncertainty and "attract more customers"

Keywords: Inflation dynamics; price rigidity; risk aversion; choice under uncertainty; Calvo type model; monetary policy; DSGE models. (search for similar items in EconPapers)
JEL-codes: E31 E52 D81 (search for similar items in EconPapers)
Date: 2006-07-04
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