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A note on price adjustment with menu cost for multi-product firms

Fernando Alvarez and Francesco Lippi
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Fernando Alvarez: University of Chicago

No 1018, EIEF Working Papers Series from Einaudi Institute for Economics and Finance (EIEF)

Abstract: We study the stylized problem of a multi-product firm that can revise prices only after paying a fixed “menu” cost. The key assumption, introduced by Lach and Tsiddon (1996, 2007) and Midrigan (2007, 2009), is that once the menu cost is paid the firm can adjust the price of all its products. The firm’s problem is to minimize the deviations of the profits incurred relative to the flexible price case, i.e. the case with no menu cost. We completely characterize the solution of a simple symmetric problem 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 by the firm. We also provide analytical expressions for the frequency of adjustment, the hazard rate of price adjustments, and the distribution of price changes in terms of the structural parameters.

Date: 2010, Revised 2010-12
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