Misspecified profit functions and full-cost pricing

Choné, Philippe and Laurent Linnemer

No 18240, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the behavior of a firm that consistently maximizes a misspecified profit function as the misspecification error remains undetected in equilibrium. Our framework encompasses a price-taking firm and a cost-taking firm, which respectively take the unit price and the unit cost as given. At the stable equilibrium for the cost-taking firm, the price increases with the level of fixed costs, a phenomenon known as full-cost pricing. We show that the equilibrium price may be lower than the rational price and can be reached by a tatonnement process. We also describe a stochastic version of that process in a dynamic setting with random costs and Bayesian learning. Finally, we endogenize the cost curve. When technology duplication is possible, the cost-taking firm and the rational firm end up producing the same level of output.

JEL-codes: L12 L21 L23 L25 M41 (search for similar items in EconPapers)
Date: 2023-06
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Journal Article: Misspecified profit functions and full‐cost pricing (2025)
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