The Role of Prevailing Prices and Wages in the Efficient Organization of Markets

Abstract

Among the ways a product or labor market might operate is the following: All firms quote the same price or wage. Customers or job-seekers search among sellers until they find one willing to sell them or employ them. They do not need to consider the possibility that another seller or employer might offer a better deal, since all offers are identical, under prevailing prices or wages, the small participants in the market -- customers and workers -- have very limited responsibilities for processing information. By contrast, where markets are equilibrated by conscious search for the best price or wage, the small participants face complex problems of gathering and interpreting information. Adherence to prevailing prices and wages may explain part of the macroeconomic puzzle of price and wage stickiness and the sensitivity of real variables to nominal disturbances.