Flexible reservation prices and price inflexibility

This paper studies conditions under which prices are sticky in a non-competitive market even though there is no menu cost associated with price changes. We posit that a typical seller encounters a series of repeat-buyers some of whom may revise their reservation prices (in an unknown fashion) if the seller changes the price offer. In this sense the reservation prices are pliable, or flexible. The seller fails to learn some of the changes in reservation prices from the market data instantaneously. As a result, a rational seller may find it profitable to adjust the price partially in order to collect more endogenous information about the unknown demand parameters. An incomplete price adjustment will thus turn out to be the optimal pricing strategy of a seller even if there is no explicit price adjustment cost, such as menu costs. Price rigidity, in the absence of explicit price adjustment costs (such as menu costs), can assume central importance in providing a theoretical salience to fix-price models and, thereby, explain persistence of unemployment. (C) 2007 Elsevier B.V. All rights reserved.