Working Paper

Price Dynamics with Customer Markets

Abstract: We study a tractable model of firm price setting with customer markets and empirically evaluate its predictions. Our framework captures the dynamics of customers in response to a change in the price, describes the behavior of optimal prices in the presence of customer acquisition and retention concerns, and delivers a general equilibrium model of price and customer dynamics. We exploit novel micro data on purchases from a panel of households from a large U.S. retailer to quantify the model and compare it to the counterfactual benchmark of the standard monopolistic competition setting. We show that a model with customer markets has markedly different implications in terms of the equilibrium price distribution, which better fit the available empirical evidence on retail prices. Moreover, the dynamic of the response of demand to shocks that affects price dispersion is also distinctive. Our results suggest that inertia in customer reallocation across firms increases the persistence in the response of demand to these shocks.

JEL Classification: E12; E30; L16;

Bibliographic Information

Provider: Federal Reserve Bank of Richmond

Part of Series: Working Paper

Publication Date: 2014-12-04

Number: 14-17

Pages: 53 pages