Gains from Price Rigidity

This paper shows that there are substantial gains from price rigidity in an imperfectly competitive economy. Firms can increase their profits by agreeing some markets as markets of long-term contracts, of which prices are determined in advance to other spot market prices. Although they determine prices non-cooperatively in both markets, the mutual commitment making some markets’ prices predetermined induces a price-price spiral between firms, which results in substantial gains for both firms. These gains outweigh the cost of inflexibility arising from price rigidity even though demand fluctuation is large and marginal cost is increasing.