An optimising model of price adjustment with missing information

Abstract

An optimising model of price adjustment with missing information is developed where firms choose the speed of price adjustment to minimise the expected loss in disequilibrium.The loss is due to lost profits and the expected cost of failing to coordinate price changes with competitors.Assuming that a higher speed of price adjustment decreases the former and increases the latter, it is shown that higher steady state inflation reduces the markup.This follows as the loss in profits increases with inflation and firms respond by increasing the speed of adjustment.However, the fear of coordination failure restricts the increase in the speed of adjustment and the markup falls.

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