Frequent price changes under menu costs

This paper investigates the effect of uncertainty on a single firm's pricing behaviour in a dynamic menu cost model that results in (S,s)-rules where the price is fixed inside a band. It will be demonstrated that even though the band of inaction widens in response to increased uncertainty, the price may be changed more frequent in the short run, and in the long run it definitely will. Hence, observing frequent price changes is not necessarily inconsistent with a firm operating under menu costs. This paper relies on an article by Dixit (1991), (Review of Economic studies, 58, 141-151), but it offers a different solution technique. In particular, the solution of the model will be derived explicitly, unlike Dixit where approximations are resorted to. (C) 1999 Elsevier Science B.V. All rights reserved.