State-dependent pricing: Theory and evidence

The first chapter, "Magazine Prices Revisited," explores price adjustments in the magazine industry. In a frequently cited study, Cecchetti (1986) constructs and estimates a reduced-form ( S, s) model for firms selecting magazine cover prices. The estimates are inconsistent, however, due to the presence of lagged dependent variables. I illustrate the inconsistency in Cecchetti's results through Monte Carlo exercises and then suggest a method for producing consistent estimates based upon Heckman and Singer (1984). The corrected results indicate that cumulative inflation is the key determinant of a price change, providing support for models of state-dependent pricing.; The second chapter, "Estimation of Adjustment Costs in a Model of State-Dependent Pricing," provides a framework for direct analysis of the underlying price adjustment costs in an industry. A dynamic programming problem is specified for monopolistically competitive firms that face an idiosyncratic cost of price adjustment. A numerical solution is calculated using value function iteration. Among the parameters estimated are the mean and variance of the adjustment cost process. The estimated distribution of adjustment costs is non-degenerate, and the average adjustment cost paid by firms is large in comparison to other results in the literature.; The third chapter, "General Equilibrium of a Monetary Model with State-Dependent Pricing," is motivated by the macroeconomic consequences of sticky prices. I estimate the distribution of the micro-level adjustment costs that is consistent with macroeconomic evidence on the effects of monetary shocks obtained via VAR analysis. This model is similar in structure to that in the previous chapter except that movements in the price index are now endogenously determined by the actions of the firms and demand is a function of the real money supply. The numerical solution of an equilibrium requires the specification and estimation of a price forecast rule. The structural parameters of the model, focusing again on the parameters of the adjustment cost process, are estimated through an indirect inference procedure using aggregate data from the U.S. economy. According to the estimated results, large and variable adjustment costs are required for the model to match up against U.S. data.