Optimal Pricing Under Stochastic Inflation:
State-Dependent (s,S) Policies
Working Paper No. 01-W27
Christian R. Ahlin
ABSTRACT [article]
A model of firm-level optimal pricing under stochastic inflation and fixed
costs of adjusting prices is solved and characterized. In this model, inflation
alternates stochastically between some positive rate g and zero inflation. We
find that a single (s,S) band is not optimal for the firm, as was claimed in
the earlier literature. Rather, the firm will set a different (s,S) band for
each state of the world, with the zero-inflation band wholly contained in the
positive-inflation band. A numerical example is then presented, showing that a
higher variance of aggregate price changes increases price dispersion in the
positive-inflation state and decreases price dispersion in the zero-inflation
state.