(S, s) price rules and the frequency of price adjustment

Abstract

(S, s) price rules build on the assumption that monopolistically competitive firms face a real fixed cost when adjusting nominal price. The models of (S, s) pricing strategies state that the firm is only willing to reset price once the optimal or "desired" price has deviated a certain distance from the fixed nominal price. A rise in the rate of inflation drives the optimal price further away from the fixed price and thus encourages the firm to increase the frequency of price adjustment. However, higher inflation also causes the outer bounds of the price rule to widen, reducing the frequency of price setting. The issue is which effect will prevail and what will be the final effect of inflation on the frequency of price adjustment? A review of the empirical literature on (S, s) price rules concludes that pricing behaviour in certain industries exhibited large, infrequent jumps in prices and that a rise in the rate of inflation increased the frequency of price adjustment. Data on New Zealand magazine prices were used to evaluate the effect of the current rate of inflation, the cumulative rate of inflation since the last price change and the cumulative time since the last price change on the frequency of price adjustment. The empirical investigation, which replicates Cecchetti's (1986) test of US magazine prices, found no conclusive evidence that a rise in inflation caused an increase in the frequency of price adjustment. Nevertheless, magazines allowed their real prices to erode significantly before eventually resetting nominal price.