This paper proposes a theory of pricing consistent with two well-documented patterns : customers care about fairness , and firms take these concerns into account when they set prices. The theory assumes that customers find a price unfair when it carries a high markup over cost, and that customers dislike unfair prices . Since markups are not observable , customers must extract them from prices. The theory assumes that customers infer less than rationally: when a price rises after an increase in marginal cost , customers partially misattribute the higher price to a higher markup---which they find unfair. Firms anticipate this response and trim their price increases, which reduces the passthrough of marginal costs into prices below one: prices are somewhat rigid. Embedded in a New Keynesian model---as a replacement of Calvo pricing---our theory produces monetary nonneutrality. When monetary policy loosens and inflation rises, customers misperceive markups as higher and feel unfairly treated; firms mitigate the perceived unfairness of prices by reducing their markups , which in general equilibrium leads to higher output .
This paper proposes a theory of pricing based on two facts : customers care about the fairness of prices , and firms take these concerns into account when setting prices. The theory assumes that customers dislike unfair prices , namely those marked up steeply over cost. Since costs are unobservable , customers must extract them from prices. The theory assumes that customers infer less than rationally: when a price rises after a cost increase , customers partially misattribute the higher price to a higher markup---which they find unfair. Firms anticipate this response and trim their price increases, which drives the passthrough of costs into prices below one: prices are somewhat rigid. Embedded in a New Keynesian model as a replacement for the usual pricing frictions, our theory produces monetary-policy nonneutrality: when monetary policy loosens and inflation rises, customers misperceive markups as higher and feel unfairly treated; firms mitigate this perceived unfairness by reducing their markups ; in general equilibrium , employment rises. The New Keynesian model also features a hybrid short-run Phillips curve, realistic impulse responses of output and employment to monetary and technology shocks, and an upward-sloping long-run Phillips curve .
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consistent with two well-documented patterns
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fairness
the fairness of prices
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they set
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find a price unfair when it carries a high markup over cost, and that customers
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. Since markups are not observable
, namely those marked up steeply over cost. Since costs are unobservable
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an increase in marginal cost
a cost increase
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reduces
drives
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marginal
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model---as a replacement of Calvo pricing---our theory produces monetary nonneutrality. When
model as a replacement for the usual pricing frictions, our theory produces monetary-policy nonneutrality: when
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the perceived unfairness of prices
this perceived unfairness
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, which
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leads to higher output
, employment rises. The New Keynesian model also features a hybrid short-run Phillips curve, realistic impulse responses of output and employment to monetary and technology shocks, and an upward-sloping long-run Phillips curve