Monday, May 2, 2011
Posted by D. Daniel Sokol
Avichai Snir (Bar-Ilan University and Humboldt-Universität zu Berlin) and Daniel Levy (Department of Economics, Bar Ilan University and RCEA) explain Shrinking Goods and Sticky Prices: Theory and Evidence.
ABSTRACT: If producers have more information than consumers about goods’ attributes, then they may use non-price (rather than price) adjustment mechanisms and, consequently, the market may reach a new equilibrium even if prices remain sticky. We study a situation where producers adjust the quantity (per package) rather than the price in response to changes in market conditions. Although consumers should be indifferent between equivalent changes in goods' prices and quantities, empirical evidence suggests that consumers often respond differently to price changes and equivalent quantity changes. We offer a possible explanation for this puzzle by constructing and empirically testing a model in which consumers incur cognitive costs when processing goods’ price and quantity information. The model is based on evidence from cognitive psychology and explains consumers’ decision whether or not to process goods’ price and quantity i! nformation. Our findings explain why producers sometimes adjust goods’ prices and sometimes goods’ quantities. In addition, they predict variability in price adjustment costs over time and across economic conditions.